Technological Diversification By Koren and Tenreyro Discussion CEPR-World Bank Conference on The Growth and Welfare Effects of Macroeconomic Volatility CREI March 2006

1.Theory combining love for variety and firm failures to get: (i) endogenous growth, (ii) endogenous increase in varieties, (iii) endogenous fall in volatility 2.Aggregating up firm dynamics (Presentation) 3.Open economy with endogenous specialization 4.Empirical tests at country, sector, firm levels

WOW! Ambitious, Relevant, Well-realized…

But you gotta do what you gotta do… Nitpick on Theory Nitpick on Empirics Nitpick on Contribution Some suggestions on the way

Theory - Foundations Growth = Number of varieties / firms Volatility falls because of (i)availability of “nearby” substitutable inputs (ii)LLN Substitutability crucial. Under inputs complementarity, volatility increases with number of varieties. Now, for Kremer (e.g.), sophistication = complementarities. Unless *labor* is substitutable across sectors. Can salvage the result if assume failure is just fall in productivity rather than shutdown, and labor can reallocate freely between firms. Varieties lower volatility because increase opportunities to reshuffle labor in order to limit output drops. But now labor has to be substitutable if other inputs are not. Cut your losses: you need substitutability.

Theory – First Floor: Sectors LLN: impact of shock to one variety diluted with many varieties, i.e. in sophisticated sectors. Flavor of Acemoglu-Zilibotti where fixed cost of new variety easier to cover for rich economies (which are rich because they have many varieties) Bit of a difference in that this here is a model of sophistication/varieties at the sectoral level. Electricity production, agriculture can source away from shock in rich economies. Not in primitive poor economies. Aggregate volatility only falls because volatility in each sector falls – not because number of sectors increases. LLN within sector, not between as A-Z

Theory – Second Floor: Countries Cross-country dimension introduced through model of trade and comparative advantage specialization. Assumption 1: cannot import output of foreign firms (otherwise could circumvent having to install varieties domestically, and grow without domestic sophistication). Can only import foreign goods to use for installing domestic firms. Plausible? Assumption 2: balanced trade each period, and no borrowing, which constrains investment and forces gradual growth in varieties. Weakness relative to Acemoglu-Zilibotti who have international capital flows. In addition, plausible?

Theory – Third Floor: Open Economy Assumption 3: international specialization motivated by directed technological change. Skill labor is more productive, generates more profits in sectors where it is in use, and attracts more investment. Increasing Returns and History Dependence. Countries born with some skill-labor intensive sectors will attract investment, specialize and grow rich. Opposite for the others. Implies “volatility traps” and “volatility divergence” Implies the same sector becomes less volatile in growing country – remains unchanged elsewhere (as in Agriculture, Electricity examples).

Empirics – What’s up? Model is one of sector-level volatility. In cross-section: is the same sector more volatile in poor country controlling for aggregate volatility (not what is in the paper) In panel: is divergence in GDP associated with divergences in sectoral volatility? Are there volatility traps? In both cases, difference in differences estimation: relative to a treatment (non growing) economy, are GDP differences related with volatility differences in a given sector? Also important to control for aggregate developments, e.g. institutions (finance?) liable to affect aggregates. Focus on international differentials at sector level, controlling for country differences.

Empirics – What’s in the paper (I read) Volatility correlates negatively with per capita GDP. Technology diffuses from rich to poor countries Sector volatility higher and sector productivity lower in poor countries (NOT controlling for aggregates – could be higher/lower across all sectors) Labor productivity higher, less volatile in sectors that, in the US, use capital inputs originating from a large number of other sectors.

Empirics – What’s in the paper (I read) Negative correlation between volatility and per capita GDP is a stylized fact – does not vindicate this model particularly (cross country or over time). R&D is highest in rich economies – that’s where technologies are developed, and then they diffuse to rest of the world – does not vindicate this model particularly Sector test fine – but controls are missing Complexity measure. Two concerns: –Why not use some international evidence on I/O tables? Text says that “actual level of complexity observed would respond endogenously to the level of development of the country”, which prevents using data outside of the US. But is that not precisely what is being tested? –Tables (in the paper) suggest complex manufacturing sector is “leather products”, “pottery”, “glass”. Is that plausible? Is it plausible that I/O relations are the same across all countries for these sectors (or others)?

Empirics – What’s in the paper (I read) Poor countries specialize in less complex, more volatile sectors. Captured via interaction term: Complexity(US) i x GDP j or Volatility i x GDP j Nice result. But even more convincing if show directly mapping between Skill => Complexity => Low Volatility (e.g. using country specific measure of complexity)

Empirics – What’s in the presentation (I hope) Firm level evidence: Large firms are less volatile – firm of size N is less volatile than N firms of size 1 (I think) Again, nice result. But large firms could differ from small ones in many other ways than their access to a wide range of inputs. Not quite ceteris paribus – e.g. access to finance, indivisibilities…

Conclusion Extremely ambitious and impressive “It’s good to be the Discussant!” Perhaps be more transparent on model assumptions, especially open economy. Clearer predictions on within and between sectors volatility. Contrast with Acemoglu-Zilibotti Tie empirics with model