GDP at market prices (Y), gross domestic investment (I), and gross domestic saving (NS) are conventional concepts of national income drawn from EPDNA data files of the World Bank, Economic Analysis and Projections Department. The dependency ratio is the ratio of dependent population (persons under 16 years old and over 64 years old) to working-age population (ages 15 to 64 years), drawn from the same source. For the ratio of military expenditure to GNP, military expenditures were taken from data files of the U.S. Arms Control and Disarmament Agency. The definitions for official borrowers, market borrowers, and combined borrowers—as well as lists of countries in each category—can be found on pages 173-74 of the International Monetary Fund’s World Economic Outlook (Washington, April 1986).
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)| false Summers, Lawrence H., “Tax Policy and International Competitiveness,”paper presented at the Conference on International Aspects of Fiscal Policies, Cambridge, Massachusetts, December 13-14, 1985 ( Cambridge, Massachusetts: National Bureau of Economic Research, December 1985).
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Mr. Dooley, Chief of the External Adjustment Division in the Research Department of the Fund, is a graduate of Duquesne University, the University of Delaware, and the Pennsylvania State University.
Mr. Frankel is Professor of Economics at the University of California, Berkeley, and is a graduate of Swarthmore College and the Massachusetts Institute of Technology. This paper was written while he was a consultant in the Research Department.
Mr. Mathieson is Chief of the Financial Studies Division in the Research Department. Educated at the University of Illinois and Stanford University, he was on the staff of Columbia University before coming to the Fund.
A similar problem arises if measurement errors for investment are incorporated in measures of national saving. In that case the covariance of ∈ and national saving would clearly not be zero. The instrumental variables approach is used in Section II to minimize these difficulties.
Sachs (1981) included a GNP gap variable in his regressions. Frankel (1985) tried two approaches: decade averages on a ten-year time sample of U.S. data, and cyclically adjusted annual saving and investment rates on shorter postwar time samples. A third time-series study is Obstfeld (1986).
Summers (1985) argued, for developing countries in particular, that the influence of the growth rate on the other two variables explains the saving-investment correlation. Obstfeld (1986) makes the argument carefully, in the context of OECD countries. But Summers (1985, p. 22) added the rates of population growth and GNP growth to his regressions and found no effect on the saving coefficient.
The ‘“policy-reaction” argument has been made by Fieleke (1982), Tobin (1983). Westphal (1983), Caprio and Howard (1984), and Summers (1985). Summers called it the “maintained external balance” hypothesis.
Many of these factors would probably bias the correlation upward. But some would go in the direction of a negative correlation. If a country discovers oil, investment should go up, but saving should go down. Similarly, an investment tax credit should raise investment but lower the budget surplus and, therefore, national saving.
Feldstein and Horioka’s four instrumental variables were the ratio of retirees over the age of 65 to the population aged 20-65, the ratio of younger dependents to the working-age population, the labor force participation rate of older men, and the benefit-earnings “replacement ratio” under social security.
Total government expenditure may not be a good enough instrument, as Summers (1985) found, because under the policy-reaction argument it is endogenous.
The ordinary least-squares regressions in Tables 4 and 5 differ for official borrowers and the combined set of market and official borrowers. One official borrower was excluded in Table 5 because of lack of data for some of the instrumental variables; since the samples are identical, the results for the market borrowers in Table 4 are not repeated in Table 5.
Tobin (1983) acknowledged that the solution is relevant only for time-series, not cross-section, studies, but he seems to believe that the problem itself is relevant and serious even in cross-section studies.
It followed from this argument that, if two regions joined together, the aggregate unit would be less open than either region taken individually. Mundell (1961) put the argument in terms of labor mobility, and McKinnon (1963) couched it in terms of openness to trade.
But note that, even if capital is sufficiently mobile to equalize internationally expected rates of return on two assets, the equalization will take place in terms of any common currency or other numeraire, not in terms of the countries’ respective goods. Thus, real interest parity, which is the condition relevant for saving and investment, need not hold unless investors anticipate no changes in real exchange rates. See Frankel (1985) for an elaboration of this point.
In terms of the literature, we are thus assuming “perfect capital mobility” but no currency substitution. Note, however, that the addition of nontraded securities to the model will alter the “standard” interpretation of capital mobility as defined by equation (10).