Aggregate Consequences of Innovation and Informality
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The fundamental question in development economics is what causes some countries to become more prosperous than others. The literature, starting with Hall and Jones (1999), has identified differences in total factor productivity (TFP) as being the driver of cross-country income differences. I investigate policies that may give rise to these differences in TFP. I pay particular attention to the influence of informal economies in developing countries and how macroeconomic policies can distort firm-level incentives to innovate and operate formally. To address these questions, I construct a series of macroeconomic models which have several common elements. First, I model firm-level decisions with regard to innovation. These firm-level decisions ultimately give rise to differences in productivity across countries. Second, I embrace the role of firm heterogeneity in productivity to examine the dynamics of firm choice. Finally, through the use of computational methods, I simulate these models to evaluate the macroeconomic effects of policy distortions on firm-level decision making. Subject to the common elements above, each chapter answers a specific policy question. Chapter II asks whether size-based tax distortions can generate firm-size distributions often observed in developing countries. I find that a model with innovation and firm-level heterogeneity can explain the prevalence of large firms in response to tax distortions, but additional frictions are necessary to explain the ubiquity of small firms in most developing countries. It also illustrates tax distortions may have little impact on aggregate output while dramatically reducing innovation. Chapter III documents that tax rates can negatively affect growth by inducing firms to participate in the informal sector rather than the formal sector. Finally, Chapter IV shows how tax revenues are affected by changes in tax rates given the provision of a productive public good.