Recent Works

Abstract: A salient feature of emerging economies is that fiscal policy is conducted against the traditional stabilization recipe. Government spending is procyclical (falls in recessions) while tax rates, in particular labor taxes, move countercyclically (increase in recessions). We account for this result as the outcome of a model where the government conducts fiscal policy optimally and is able to commit to future policies. The setup is a small open economy with incomplete markets and a rich labor market structure including an informal sector. Our quantitative results are: (i) the cyclical properties of labor taxes differ according to the nature of the shocks (productivity or foreign interest rates) affecting the economy; and (ii) the presence of an informal sector widens the set of parameters under which distorting labor taxes are negatively correlated with output. The second result is implied by the role of informality in amplifying the fluctuations of the tax base over the business cycle.

Abstract: We document the evolution of labor markets of five Latin American countries during the COVID-19 pandemic, with emphasis on informal employment. We show, for most countries, a slump in aggregate employment, mirrored by a fall in labor participation, and a decline in the informality rate. The latter is unprecedented since informality used to cushion the decline in overall employment in previous recessions. Using a business cycle model with a rich labor market structure, we recover the shocks that rationalize the pandemic recession, showing that labor supply shocks and productivity shocks to the informal sector are essential to account for the employment and output loss and for the decline in the informality rate.


(with Ruy Lama and Gustavo Leyva, IMF Economic Review, 2022)

Abstract: We build a small open economy business cycle model with search and matching frictions to assess the impact of labor market policies on the dynamics of unemployment and other macroeconomic variables in emerging economies. The model features an endogenous selection mechanism by which inefficient jobs are destroyed in recessions, thus linking labor market dynamics and aggregate productivity. In a quantitative version of the model calibrated to the Mexican economy, we find that reducing labor taxes and increasing firing costs would have mitigated the fall in employment during the Great Recession of 2008-9. However, by preventing firms from dismissing low-productive workers, higher firing costs would have impaired this selection mechanism, thus generating a larger fall in TFP and delaying the recovery. Cutting labor taxes, in contrast, have minor effects on productivity by mainly affecting hiring decisions. An extension of the model shows that lowering labor taxes provides an additional productivity boost by expanding formal hirings and reducing the informality rate.

Abstract: This paper documents a transmission channel from credit conditions to capital accumulation via investment wedges at a disaggregated level. We use a simple multi-industry model of production and investment to identify these wedges (i.e., deviations from the optimality condition based on a stochastic Euler equation) from a panel of observations at the 4-digit industry level from Mexican manufacturing. We measure the dynamic distortions in capital accumulation and show that their behavior is important in accounting for changes in the aggregate capital stock over time. We then analyze the sources of these distortions, working with one important candidate: bank credit. Using a simple model of investment with financial frictions, we show that greater availability and cheaper access to credit reduce capital distortions and find empirical support for this mechanism in the data.

(with Gustavo Leyva, Journal of International Economics, 2020)

Technical Appendix        Replication codes (.zip)

Abstract: We ask how labor regulation and informality affect macroeconomic volatility and the propagation of shocks in emerging economies. For this, we propose a small open economy business cycle model with frictional labor markets, endogenous labor participation, and an informal sector. Our own calculations from the ENOE national household survey reveal that these three margins are important to account for the labor market dynamics in Mexico. The model is calibrated to the Mexican economy, in particular to business cycle moments for employment and informality. We show that interest rate shocks, which affect specifically job creation in the formal sector, are key to obtain a countercyclical informality rate. In our model, the presence of an informal sector might help to mitigate the impact of a stringent labor regulation on employment and consumption fluctuations. In that sense, it adds flexibility to the economy in its adjustment to shocks, but at the cost of a lower productivity and an excess TFP and output volatility. Reducing the burden of labor regulation to the formal sector might achieve the goal of reducing output volatility while improving at the same time the efficiency in the allocation of resources.

(with Enrique Alberola, Journal of Development Economics, 2020)

Replication codes (.zip)

Abstract: Informality is a structural trait in emerging economies affecting the behavior of labour markets, financial access and economy-wide productivity. This paper develops a simple general equilibrium closed economy model with nominal rigidities, labor and financial frictions to analyze the transmission of shocks and of monetary policy. In the model, the informal sector provides a flexible margin of adjustment to the labor market at the cost of a lower productivity. In addition, only formal sector fitchrms have access to financing, which is instrumental in their production process. In a quantitative version of the model calibrated to Mexican data, we find that informality: (i) dampens the impact of demand and financial shocks, as well as of technology shocks specific to the formal sector, on wages and inflation, but (ii) heightens the inflationary impact of aggregate technology shocks. The presence of an informal sector also increases the sacrifice ratio of monetary policy actions. From a Central Bank perspective, the results imply that informality mitigates inflation volatility for most type of shocks but makes monetary policy less effective.

(with Felipe Meza and Sangeeta Pratap, Review of Economic Dynamics, 2019)

Abstract: We study the effect of credit conditions on the allocation of inputs, and their implications for aggregate TFP growth. For this, we build a new dataset for Mexican manufacturing merging real and financial data at the 4-digit industrial sector level. Using a simple misallocation framework, we find that changes in inter-industry allocative efficiency account for 41 percent of changes in aggregate TFP. We then construct a model of firm behavior with working capital constraints and borrowing limits which generate sub-optimal use of inputs, and calibrate it to our data. We find that the model accounts for 38 percent of the observed variability in efficiency. An important conclusion is that heterogeneity in credit conditions across industries is key in accounting for efficiency gains. Despite overall credit stagnation, more access to credit and lower interest rates to distorted industries contributed substantially to the recovery from the 2009 recession, suggesting a plausible mechanism for credit-less recoveries.

(with Peter Paz, Review of Developmen Economics, 2015)

Abstract: In the last two decades, the Peruvian economy exhibited rapid growth. Moreover, the composition of the labor force improved in terms of education and experience, two variables which are typically associated to higher human capital. The average worker in 2012 had a higher level of education and was one and a half years older than in 1998, reflecting the impact of the demographic transition. However, the average real wage was roughly constant. We show that a decline in the wage premium for education, and to a minor extent for experience, is responsible for the lack of growth in the average real wage. Had these two premia remained constant throughout the period of analysis, average labor earnings would have increased by about 2.6 percent per year, of which 0.7 percentage points are accounted for the changes in the composition of the labor force in terms of age and education. We explore the role of the relative supply of workers with different levels of human capital as an explanation for the decline in the wage premium for education. Finally, we analyze the implications of these findings for some macroeconomic variables, as earnings and wage inequality, the labor share and total factor productivity.

Abstract: Financial crises in emerging economies are accompanied by a large fall in total factor productivity. We explore the role of financial frictions in exacerbating the misallocation of resources and explaining this drop in TFP. We build a two-sector model of a small open economy with a working capital constraint to the purchase of intermediate goods. The model is calibrated to Mexico before the 1995 crisis and subject to an unexpected shock to interest rates. The financial friction generates an endogenous fall in TFP and output and can explain more than half of the fall in TFP and 74 percent of the fall in GDP per worker.

(with Felipe Meza, Journal of International Economics, 2011)

Abstract: The last twenty years have witnessed periods of sustained appreciations of the real exchange rate in emerging economies. The case of Mexico between 1988 and 2002 is representative of several episodes in Latin America and Central and Eastern Europe in which countries opening to capital flows experienced large appreciations accompanied by a significant reallocation of workers towards the non-tradable sector. We account for these facts using a two sector dynamic general equilibrium model of a small open economy with frictions to labor reallocation and two driving forces: (i) differential productivity growth across sectors (the Balassa-Samuelson effect), and (ii) a decline in the cost of borrowing in foreign markets. These two mechanisms account together for 60% of the decline in the domestic relative price of tradables in Mexico and account for a large fraction of the observed reallocation of labor across sectors. The results are robust to the inclusion of terms of trade into the model. We do not find a significant role for migration remittances, foreign reserves accumulation, government spending, or import tariffs.

Abstract: We study the effects of a social security reform in a large overlapping generations model where markets are incomplete and households face uninsurable idiosyncratic income shocks. We depart from the previous literature by assuming that, because of lack of commitment in the credit market, the borrowing constraint in the unique asset is endogenously determined by individuals' incentives to default on previous debts. In our model, after the reform the incentives to default are lower and consequently households face more relaxed borrowing limits, leading to an increase in debt and a reduction in the size of precautionary savings. However, the quantitative impact of this mechanism on stationary aggregate savings is small. Computing the transitional dynamics for the basic model following the social security reform we obtain important welfare gains for workers at the bottom of the income distribution (equivalent to 1.3% of consumption each period) associated to the relaxation of the endogenous borrowing constraints, which are missed in an environment with fixed borrowing limits.

(with Francesc Obiols-Homs, Economic Theory, 2005)

Abstract: We study the evolution of the distribution of assets in a discrete time, deterministic growth model with log-utility, a minimum consumption requirement, Cobb-Douglas technology, and agents differing in initial assets. We prove that the coefficient of variation in assets across agents decreases monotonically in a transition to the steady state from below, if (i) the consumption requirement is zero, or (ii) the consumption requirement is not too big and the initial capital stock is large enough. We also show how a positive consumption requirement or a small elasticity of substitution between capital and labor can generate non-monotonic paths for inequality.

Abstract: We build a partial equilibrium model of firm dynamics under exchange rate uncertainty. Firms face idiosyncratic productivity shocks and observe the current level of the real exchange rate each period. Given their current level of capital stock, firms make their export decisions and choose how much to invest. Investment is financed through one period loans from foreign lenders. The interest rate charged by each lender is set to satisfy an expected zero-profit condition. The model delivers a distribution of firms over productivity, capital stocks and debt portfolios, as well as an exit rule. We calibrate the model using data from a panel of Mexican firms, from 1989 to 2000, and analyze the effect of the 1994 crisis on these variables. As a result of the real exchange rate depreciation, the model predicts: (i) an increase in the debt burden, (ii) an increase in exports, and (iii) a large decline in investment. These real effects are consistent with the evidence for the Mexican crisis.

(with Diego Restuccia,  American Economic Review, 2004)

Abstract: Recent empirical evidence for the U.S. indicates a high degree of intergenerational persistence in economic status. Assessing the effectiveness of various public policies in reducing persistence and equalizing opportunities in society requires measures of the contribution of major sources of persistence. In this paper we provide a quantitative model of intergenerational human capital transmission and earnings inequality that focuses on three sources of persistence: innate ability, early education, and college education. We find that about half of the intergenerational persistence and one fourth of the cross-sectional inequality in permanent earnings are accounted for by parental investments in education. Our model implies that early education accounts for most of the persistence generated by parental investments while college education accounts for most of the inequality. We show that these results have important implications for education policy. Our model indicates that a 20% increase in public resources devoted to early education has a 10% increase on earnings mobility while a similar increase in college subsidies has virtually no effect on earnings mobility. Despite this result, the progressivity of the college subsidy affects earnings mobility largely because of the indirect incentive effects on investments in early education by poor parents.

(with Diego Restuccia,  Journal of Monetary Economics, 2001)

Abstract: We construct a panel for the price of aggregate investment over consumption and report the following observations. (1) Relative price differences across countries are large over the entire sample period, and this conclusion is not affected by excluding non-tradable consumption goods. (2) Relative price dispersion has decreased during the sample period. (3) Relative price changes are not persistent across periods, while average price levels are. Moreover, the persistence in relative price levels is higher for countries at low relative price levels. We show the relative price of investment is negatively correlated with investment rates in a cross section of countries. The standard one sector growth model is a natural framework to study quantitatively the effects of barriers to capital accumulation since there is a very simple mapping between barriers to investment and relative prices in this environment. We simulate a calibrated version of the model, in which barriers follow a stochastic process common to all countries and estimated using relative price data, and obtain statistics for investment rates that closely resemble what we observe in the data. In particular, the model accounts for 90% of the 1985 Gini index of relative investment rates and the decline in investment rate dispersion over time. The model has two limitations as a theory of development. First, it cannot account for the income disparity in the data unless we assume unmeasured capital with barriers affecting the broad measure of capital. Second, even under these extreme assumptions, the model cannot account for the evolution of income disparity over time.

Unpublished Papers

(with Marina Mendes Tavares,  August 2016)

Abstract: Cross country evidence suggests a negative relation between inequality and intergenerational mobility, sometimes dubbed as the “Great Gatsby's Curve". From a time series perspective, we analyze the relation between the increase in inequality and the observed trends in intergenerational mobility in the U.S. over the last three decades. As an empirical contribution, we document a significant increase in the intergenerational elasticity of earnings, both at the family level and at the individual level, between 1977 and 2012. However, we do not observe a significant trend in the intergenerational elasticity of family income, suggesting an important role for transfers in mitigating the impact of earnings inequality on intergenerational mobility. 

Abstract: We build a small open economy, real business cycle model with search and matching frictions to evaluate the impact of different labor market policies on the dynamics of unem- ployment and other macroeconomic variables in emerging economies. The model features an endogenous selection effect by which inefficient jobs are destroyed in recessions, thus providing a link between labor market dynamics and aggregate productivity. In a quanti- tative version of the model calibrated to the Mexican economy we find that both reducing labor taxes and increasing firing costs would have mitigated the fall in employment and the severity of the downturn in the Great Recession episode of 2008. However, increasing firing costs entails a stronger selection effect, preventing firms to dismiss redundant workers and impairing the selection mechanism by which inefficient matches are destroyed. Hence, higher firing costs would have generated a bigger fall in TFP, dragging investment and the speed of the recovery. Lowering labor taxes, in contrast, have minor effects on productivity by affecting mostly hiring decisions. We extend the model to include an informal sector, whose size is endogenous, and show that our results are robust to this feature. Moreover, lowering labor taxes provides an additional boost to productivity by expanding hirings in the formal sector and reducing informal employment.