Debt, Investment, and Growth in Developing Countries with Segmented Labor Markets

Abstract

We introduce a new suite of macroeconomic models that extend and complement the Debt, Investment, and Growth (DIG) model widely used at the IMF since 2012. The new DIG-Labor models feature segmented labor markets, efficiency wages and open unemployment, and an informal non-agricultural sector. These features allow for a deeper examination of macroeconomic and fiscal policy programs and their impact on labor market outcomes, inequality, and poverty. The paper illustrates the model's properties by analyzing the growth, debt, and distributional consequences of big-push public investment programs with different mixes of investment in human capital and infrastructure. We show that investment in human capital is much more effective than investment in infrastructure in promoting long-run economic development when investments earn their average estimated returns. The decision about how much to invest in human capital versus infrastructure involves, however, an acute intertemporal trade-off. Because investment in education affects labor productivity with a long lag, it takes 15+ years before net national income, the private capital stock, real wages for the poor, and formal sector employment surpass their counterparts in a program that invests mainly in infrastructure. The ranking of alternative investment programs depends on the policymakers' social discount rate and on the weight of distributional objectives in the social welfare function.

Loss-of-Learning and the Post-Covid Recovery in Low-Income Countries

“…To quantify the impact of this complex shock we deploy a version of the macroeconomic model developed by the authors under the auspices of the IMF (Buffie et al (2020)). This model, which can be found in the Appendix, describes a representative multi-sector small open low-income economy in which smallholder agriculture plays an important role in both output and employment.…”

“…Since health and education are gross complements, the degree of complementarity depends positively on the rates of return to the two types of human capital. The size of returns to education and health in low-income countries is highly contested (see Buffie et al (2020) for an extensive discussion of the evidence). Here we assume an internal rate of return (IRR) of 12 percent for basic education and 10 percent for upper-level education.…”

“…The model is calibrated to an initial equilibrium following the procedure outlined in Buffie et al (2020). The key calibration parameters are shown in Table 1, but readers are referred to our earlier work for a detailed discussion on the basis for these values.…”

Economic Growth in the Western Balkans: A Panel Analysis

“…DIG-Labour models feature segmented labour markets, efficiency wages and open unemployment, and an informal non-agricultural sector. Thus investment in education affects labour productivity with a long lag, it takes 15+ years before net national income, the private capital stock, and real wages for the poor, and formal sector employment to surpass their counterparts in a program that invests mainly in infrastructure (Buffie et al 2020). Thus the 2025 EU Accession target for the Western Balkans represents a highly ambitious best-case scenario, which could serve as a powerful incentive for countries in the region to speed up their reform agendas (Grieveson, Grübler, and Holzner 2018).…”

Bulgaria

“…The results also suggest a greater impact of the public investment in education than that in transport, albeit with a significant time lag, probably reflecting education's direct contribution to the accumulation of human capital. Capital expenditures in general public services, which could strengthen provision of public services and improve public governance, are also positively 1 Recent related studies include Ari et al (2020) and Buffie et al (2020).…”