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Economics Working Papers, 2005

Copies may be downloaded on pdf, or hard copies may be requested from Joshua Hall, Working Paper Coordinator.

05 - 01: Roy, Suryadipta.

"Are Illegal Drugs Inferior Goods."

Abstract: Using data from the National Survey on Drug Use and Health, evidence of income inferiority in illegal drug consumption is presented. This is done by estimation of binary choice probit models with endogenous regressors. The simultaneity issue between drug consumption and income has been addressed by using a two-step estimation procedure. The results indicate that accounting for simultaneity shows income inferiority with regard to drug consumption. An implication of this study is that income distributive policies might be effective in controlling drug consumption. It also points out the regressive nature of the government's substance abuse program.

05 - 02 Bandyopadhyay, Subhayu and Sudeshna C. Bandyopadhyay.

"Illegal Immigration: Optimal Enforcement and Capital Mobility."

Abstract: This paper analyzes the effectiveness of enforcement in controlling illegal immigration in two scenarios, capital mobility and capital immobility in the host nation (for illegal immigrants). The source nation is assumed throughout to have immobility of capital. We show that the net enforcement expenditure is higher (lower) in the presence of capital mobility if the host nation is an importer (exporter) of capital at the target immigration level. Furthermore, we show that if the host nation is an exporter of capital at the point of zero enforcement (unrestricted immigration), it must have lower enforcement expenditure (compared to capital immobility) for any illegal immigration target. If it is an importer of capital at zero enforcement, there is some ambiguity. National income must be higher (lower) under capital mobility (compared to immobility) if the host nation is an importer (exporter) of capital at the target immigration level. The analysis is extended to consider endogenous determination of optimal immigration level. Under capital mobility, for a capital exporting nation, the optimal enforcement and the national income levels are higher, while the optimal immigration level is lower.

05 - 03 Bandyopadhyay, Subhayu and Sudeshna C. Bandyopadhyay.

"Trade and Child Labor: A General Equilibrium Analysis."

Abstract: This paper augments the existing literature on trade and child labor by exploring the effects of terms of trade changes in the context of a three good general equilibrium model, where one of the goods is a non-traded good. We find that under quasi-linear preferences the effect of the terms of trade on child labor depends critically on the pattern of substitutability (or complementarity) in the excess demand functions between the export good and the non-traded good. We extend the analysis to the case of homothetic preferences and find that the basic result is somewhat modified in a context where the marginal utility of income is affected by the terms of trade. We also extend the analysis to the case where factors move freely between the three goods as in a Heckscher-Ohlin type framework. Finally, we show that a balanced budget policy of taxing the education of skilled families and subsidizing the education of unskilled families must reduce child labor without any impact on aggregate welfare.

05 - 04 Bandyopadhyay, Subhayu and Ryo Takashima.

"Trade Policy and Illegal Immigration."

Abstract: We use a version of the Meade model to consider the effects of interdependent import tariffs in the presence illegal immigration. First, we consider the small union case and derive the Nash tariff equilibrium for two potential members of a Preferential Trade Agreement (PTA). We analyze conditions under which a movement from the Nash equilibrium to complete intra-bloc tariff elimination (FTA) is likely to be welfare augmenting. The paper also considers how reduction of the external tariff may impact the Nash equilibrium tariffs of the potential bloc members. The analysis is extended to the large union case to consider the conditions under which terms of trade of bloc members improve with respect to the non-member nation(s).

05 - 05 Balvers, Ronald J. and Dayong Huang.

"Productivity-Based Asset Pricing: Theory and Evidence."

Abstract: This paper considers asset pricing from the production side. It differs from earlier approaches to production-based asset pricing in that the pricing kernel is derived by replacing the marginal rate of intertemporal substitution with an amended version of the marginal rate of intertemporal transformation in a complete markets economy. Relying on a general version of the traditional Real Business Cycle macro model we find that the variables determining the mean returns of all financial assets are the productivity shock as the sole factor together with the capital stock and lagged Solow residual (productivity level) as conditioning variables. Standard GMM estimation finds that our model improves on the complementary consumption-based and market-based approaches and is competitive with the Fama-French three-factor model. The model explains the size premium from differences in the unconditional sensitivity to productivity shocks-small firms are more sensitive to productivity shocks-and explains the value premium from differences in the conditional sensitivity to productivity shocks-growth stocks are more sensitive to productivity shocks in good states when the risk premium is low.

05 - 06 Balvers, Ronald J. and Dayong Huang.

"Evaluation of Linear Asset Pricing Models by Implied Portfolio Performance."

Abstract: We develop a measure, previously considered in a different context by Kandel and Stambaugh (1995), to evaluate linear asset pricing models. The "KS-ratio" criterion rates a model's usefulness based on the mean portfolio return that a mean-variance decision maker obtains for any given variance choice by using the model for optimal portfolio decisions. It is equivalent to a cross-sectional GLS R-square criterion and to a measure of minimum distance between the factor frontier and the asset frontier. We assess the value of the KS-ratio compared to the HJ-distance and ad hoc goodness-of-fit evaluation criteria for simulated returns and apply the criteria with actual data to nine prominent asset pricing models. The KS criterion outperforms the HJ criterion and complements the OLS R-square in selecting the "true" asset pricing model. The real-data application shows that, with or without correction for the number of factors, the Chen-Roll-Ross five-macro-factor model outperforms the Fama-French three-factor model and all theory-based models according to the KS and HJ measures but not according to the OLS R-square criterion. For each criterion random-factor models outperform the CAPM and the CCAPM.

05 - 07 Arabinda Basistha.

"Trend Cycle Correlation, Drift Break and the Estimation of Trend and Cycle in Canadian GDP."

Abstract:  This paper argues, using Monte Carlo experiments, that bivariate correlated unobserved components (UC) framework delivers more accurate estimation results for trend and cycle parameters than the univariate framework.  The paper estimates stochastic trend and cyclical fluctuations in Canada from a bivariate, correlated UC model with drift breaks. In contrast to the univariate results, bivariate estimation shows a fairly volatile stochastic trend after accounting for the drift break along with a negative trend-cycle shock correlation.  The estimated cyclical component is moderately large, persistent and consistent with ECRI denoted Canadian recessions.

05 - 08 Subhayu Bandyopadhyay and Howard J. Wall.

"Immigration and Outsourcing: A General Equilibrium Analysis."

Abstract: This paper analyzes the issues of immigration and outsourcing in a general-equilibrium model of international factor mobility. In our mode, legal immigration is controlled through a quota, while outsourcing is determined both by the firms (in response to market conditions) and through policy-imposed barriers. A loosening of the immigration quota reduces outsourcing, enriches capitalists, leads to losing for native workers, and raises national income.   If the nation targets an exogenously determined immigration level, the second-best outsourcing tax can be either positive or negative.   If in addition to the immigration target there is a wage target (arising out of income distribution concerns), an outsourcing subsidy is required.   The analysis is extended to consider illegal immigration and enforcement policy.   A higher legal immigration quota will lead to more illegal immigration if skilled and unskilled labor are complements in production.   If the two kinds of labor are complements (substitutes), national income increases (decreases) monotonically with the level of legal immigration.

05 - 09 Subhayu Bandyopadhyay and Howard J. Wall. 

"Oligopoly and Outsourcing."

Abstract: With outsourcing comes a perceived tension between the competitive pressures faced by domestic firms and the effect that outsourcing has on domestic workers.   To address this tension, we present a general-equilibrium model with an oligopolistic export sector and a competitive import-competeing sector.   When there is a minimum wage, an outsourcing tax might be desirable and the usual profit-shifting objectives of an export subsidy are mitigated, perhaps completely, because it might lead to higher unemployment.   Also, increased international competition has no effect on the level of outsourcing, but the direction of its effect on unemployment and national income depends on the relative factor intensities of the two sectors.   Under wage flexibility, an outsourcing tax cannot be justified and the profit-shifting motive is the same as in a model without outsourcing.   Further, if export subsidies are not possible due to WTO regulations, it is optimal to subsidize rather than to tax outsourcing.   Finally, the effect of increased foreign competition on welfare depends on the relative factor intensities of the two sectors.

05 - 10 Ronald J. Balvers and Douglas W. Mitchell. 

"Linear Riccati Dynamics, Constant Feedback, and Controllability in Linear Quadratic Control Problems."

Abstract: Conditions are derived for linear-quadratic control (LQC) problems to exhibit linear evolution of the Riccati matrix and constancy of the control feedback matrix.   One of these conditions involves a matrix upon whose rank a necessary condition and a sufficient condition for controllability are based.   Linearity of Riccati evolution allows for rapid iterative calculation, and constancy of the control feedback matrix allows for time-invariant comparative static analysis of policy reactions.

05 - 11 Todd M. Nesbit. 

"Excise Taxation and Product Quality: The Gasoline Market."

Abstract:  Following Barzel (1976), product quality increases in response to unit taxation but remains unchanged by ad valorem taxation.  While many tax theorists agree this argument is theoretically sound, empirical support of Barzel’s theory is limited to the cigarette market. This paper tests and confirms his theory in the gasoline market, a market in which Barzel failed to find supporting evidence in his original article. Using a direct test proposed by Sobel and Garrett (1997) and improved data, I find the market shares of premium and mid-grade gasoline rise in response to per-unit taxation but are unaffected by ad valorem taxation.

05 - 12 Todd M. Nesbit. 

"The Revenue Impacts of Cross-border Sales and Tourism: Wine and Liquor Taxation."

Abstract: As tax rates have risen through time, voter dislike of increased taxation has strengthened, leaving some states in a budget crunch.  If policy-makers are to keep pace with the growing demand for public services, they must find ways to export tax burdens outside of the district.  Taking advantage of cross-border shopping and tourism are two such ways to export tax burdens.  This paper attempts to measure the revenue impacts of cross-border shopping and tourist purchases of wine and liquor in West Virginia.  I find that cross-border shopping and tourism exert significant impacts on tax revenues from wine and liquor sales.

05 - 13 Nathan J. Ashby. 

"The Effect Of Economic Freedom on Migration Flows Between U.S. States: is Economic Freedom a Determinant of Flow Differentials?"

Abstract: Utilizing data from the U.S. Census survey (2000) and the North American Economic Freedom Index (Karebegovic, McMahon, and Samida, 2004), this study evaluates the outcome of economic freedom on gross migration flows within the United States.  The estimation process is to use a gravity model.  Since longitudinal data is not available, regressions are run on a cross section of data drawn from the survey of 2000. In addition to ordinary least squares estimates, various models of spatial dependency are employed to improve estimation of coefficients and hypothesis results.  It is determined that greater economic freedom positively impacts migration between states.  Further, it is discovered that a general autoregressive spatial model (GSAR) performs the best out of the selected models and augments the impact of economic freedom on migration.

05 - 14 Nathan J. Ashby. 

"Property Rights, Trade, and the Quality of Life: A Cross-Sectional Analysis Using Alternative Measures."

Abstract: The effect that the components of the Economic Freedom of the World Index (Gwartney, Lawson, and Block, 2004) have on alternative measurements of well being is investigated.  The objective is to observe the effect of trade policies and property rights on the quality of life using the Human Development Index (UNDP, 1995) and the Index of Human Progress (Emes and Hahn, 2001).  Positive results are found with regard to the effect of property rights, free trade, and limited regulation on the quality of life.  The results for property rights are robust.

05 - 15 Subhayu Bandyopadhyay, Cletus C. Coughlin and Howard J. Wall. 

"Ethnic Networks and U.S. Exports."

Abstract: This paper provides new estimates of the effects of ethnic network on U.S. exports.  In line with recent research, our dataset is a panel of exports from U.S. states to 29 foreign countries.   Our analysis departs from the literature in two ways, both of which have noteworthy empirical consequences.  Our main departure is to remove the restriction that the network effect is the same for all ethnicities.  In addition, because our dataset contains a time dimension, we are able to control for unobserved heterogeneity with properly specified fixed effects.  We find that ethnic-network effects are much larger than has been estimated previously, although they are important only for a subset of countries.