International Business Cycles

A long standing puzzle in international macroeconomics is the failure of standard to reproduce positive cross-country investment comovement in a standard open economy model. CEP associate Keyu Jin and coauthor Nan Li address this stylized macroeconomic fact in a two country framework in which goods differ in their factor intensity of production.

They also find that in the data the cyclical behaviour of labour- and capital-intensive sectors diverge substantially, the price and share of employment of the former are respectively countercyclical and procyclical whereas the converse is true for the latter.

Embedding this feature in their model is the key element that allows them to match the positive investment correlation. For instance, a country hit by a country-specific labor productivity shock, which expands disproportionately its labor-intensive sector, will increase the world supply of labor intensive goods and hence drive up the world price of the relatively scarcer, capital-intensive goods. Facing a higher relative price for capital-intensive goods, the foreign country expands its production of this sector's goods by allocating more resources there. This compositional shift in the foreign country, a production structure more tilted towards capital-intensive goods, causes its aggregate demand for investment to rise. Thus, an additional channel driving investment flows emerges: investment resources tend to flow towards the country that has become more capital-intensive in production, a composition effect. This composition effect, underpinned by intra-temporal trade, competes with the standard resource shifting effect, underpinned by inter-temporal trade, which has capital flowing towards the more productive country. When the latter effect is the only driving force in the standard models, both inputs and outputs invariably diverge across countries. With multiple sectors, the composition effect can dominate the resource shifting effect, causing investment to rise globally in response to a positive productivity shock in Home.

They suggest that for a given country pair this effect will be stronger the larger the difference in their factor content of trade. To read more about Jean-Baptiste Michau's work on unemployment insurance and cultural transmission see:

• ""Factor Proportions and International Business Cycles"" [Full document in Adobe PDF] (Keyu Jin and Nan Li), CEP Discussion Paper no. 1090, November 2011.