Intersectoral Linkages Good Shocks Bad Outcomes 1 National

Intersectoral Linkages: Good Shocks, Bad Outcomes? 1 National Kristian 1, 2, 3 BEHRENS , Sergey 1, 4 KICHKO , and Philip 1 USHCHEV Research University Higher School of Economics; 2 Université du Québec à Montréal; 3 CEPR; 4 CESifo. Motivation Equilibrium Assessing the welfare effects of economic shocks is of paramount importance in many fields of economics. There is, e. g. , a large literature on the welfare gains from trade liberalization 1 and productivity improvements 2, 3. One important issue is to understand whether good sector-specific shocks—i. e. , shocks that directly affect only a single sector and are welfare-improving in a single sector economy—are magnified or dampened in a general equilibrium context. Although multi-sector general equilibrium models are a staple in many applied fields of economics, little is known in general on their welfare properties. The general theory of the second-best 4 tells us that a potentially welfare improving shock to one sector need not be welfare improving when there are multiple distortions. We do, however, not know much beyond that. How do, for example, productivity-improving shocks in one industry affect overall welfare when sectors are linked? Are there always welfare gains? And which properties of preferences magnify or dampen the magnitude of these shocks? Our key objective is to answer these questions and to better understand how intrasectoral shocks translate into aggregate welfare changes in multi-sector models with endogenous product variety. Main objective and key results The overall welfare effect First, we propose a fairly general multi-sector model that nests many of the approaches used in the applied literature. Using this model, we derive a statistic that tells us what share of the direct gains of the positive sector-specific shock materializes in general equilibrium—and establish precise conditions under which welfare-improving intra-sectoral shocks are magnified or dampened in the aggregate. In a two-sector economy, we show that when two goods are gross complements, the welfare effects are magnified ceteris paribus if the shock affects the sector that has a less elastic price index; whereas they are dampened if goods are gross substitutes. Cobb-Douglas preferences are a limiting case for which a welfare-improving shock in one sector is always welfare improving in general and of the same magnitude as the sectoral shock itself. Second, we show that a specific combination of assumptions that is widely used in the literature—CES preferences and monopolistic competition— guarantees that a positive sector-specific shock always translates into aggregate welfare gains when the cross-sectoral elasticity of substitution is lower than the elasticities of substitution within sectors. This result is, however, not robust as there exists a large class of homothetic preferences and different market structures under which it need not hold. The intuition is that a positive shock to one sector—followed by a reallocation of budget towards that sector—forces firms out of other sectors. If that exit effect is strong enough, welfare can decrease because the negative effects of higher prices (markups) and less variety in the sectors not exposed to the shock dominate the positive price and variety effects in the sector subject to the shock. This is, for example, likely to occur when the sector not exposed to the shock is oligopolistically competitive and sufficiently ‘granular’ (i. e. , there a small number of competing firms). Two-sector economy Model Contacts Prof. Kristian BEHRENS Email: behrens. kristian@uqam. ca Dr. Sergey KICHKO Email: skichko@hse. ru Dr. Philip USHCHEV Email: fuschev@hse. ru This project was funded by the Russian Academic Excellence Project ‘ 5 -100’. Behrens gratefully acknowledges financial support from the CRC Program of the Social Sciences and Humanities Research Council of Canada for the funding of the Canada Research Chair in Regional Impacts of Globalization. References 1. Arkolakis, C. , Costinot, A. , and A. Rodríguez-Clare. 2012. “New trade models, same old gains? ” American Economic Review, 102(1): 94– 130. 2. Matsuyama, K. 1995. “Complementarities and cumulative processes in models of monopolistic competition. ” Journal of Economic Literature 33(2): 701– 729. 3. Segerstrom, P. S. , and Y. Sugita. 2015. “The impact of trade liberalization on industrial productivity. ” Journal of the European Economic Association 13(6): 1167– 1179. 4. Lipsey, R. G. , and K. Lancaster. 1956. “The general theory of second best. ” Review of Economic Studies 24(1): 11– 32. 5. Blackorby, Ch. , D. Primont, and R. R. Russell. 1978. Duality, Separability, and Functional Structure: Theory and Economic Applications, Dynamic Economics Vol. 2. Elsevier Science Ltd. , North Holland. 6. Varian, H. R. 1983. “Non-parametric tests of consumer behaviour. ” Review of Economic Studies 50(1): 99– 110. 7. Gorman, W. M. 1961. “On a class of preference fields. ” Metroeconomica 13(2): 53– 56. 8. Jehle, G. A. , and P. J. Reny. (2011). Advanced Microeconomic Theory (3 rd Edition), Pearson Education: Harlow, UK.