Institutional Factors

YOU MUST USE EViews software 

This homework will take you to the actual test, with real data, of some of the Theories of Economic Development. Please use Eviews. Excel will NOT do.

1. In an effort to better understand investment and its connection to population and institutions in, one can run Equation (2).

ln (I)t = β0 + βln (i)t + β2 ln (FR)t + βln (PI)t + εt (2)

Where, I is investment, i is the domestic market interest rate, FR is fertility rate, and PI is political instability as captured by the index of economic freedom defined by the Heritage Foundation. Please remember that an AR(1) process might exist.

Estimate and evaluate the outcomes of equation (2) for all the two countries you included in the previous question. Once again, remember to test and control for all the typical violations of OLS.

Is investment sensitive to fertility rates? How has the opening of the economy or its lack thereof impacted the process of growth in these countries? Explain.

Given your results, does the Neo-Classical theory of investment, which proposes that investment is a function of interest rates, hold in these countries? Do institutional factors have a role in its determination?

2. An alternative channel for human capital to contribute to growth is through the impact that this can have in the accumulation of physical capital. Lucas (1990) has suggested that one reason for physical capital not to flow to developing countries could be that these countries are poorly endowed with factors complementary to physical capital. Consequently, the marginal product of capital in developing countries may not be that high in spite of the apparent scarcity. Other studies have shown that political instability or a skewed income distribution affects negatively economic growth. In order to examine how, if at all, these dynamics play in Guatemala the ratio of gross investment to capital stock can be regressed on factor stocks: human capital (h), physical capital (K), labor force (L), as well as the GINI coefficient (PGINI or proxy for the GINI coefficient) and the Index of Economic Freedom (IEF)so as to capture both the effects of political instability and income distribution. This reduced form is captured in Equation (3).

(ΔKt/K) = β+ α Kt + βLt + β((1/T) ∑0T ln (ht)) + βPGINI + βIEF + εt (3)

Estimate and analyzed the results of equation (3).

Do capital and human capital stock as well as political stability show the expected results? Explain.

How does income inequality play on gross investment? Is this consistent with the findings of Pritchett (1997) and Mankiw (1992)?

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