ESSAYS ON ECONOMIC POLICY AND FIRM DYNAMICS

Abstract

This dissertation examines the impact of economic policies on aggregate economy by analyzing their effects on firms' behavior. It employs theoretical and quantitative macroeconomic models to explore how these policies affect social welfare. In Chapter 1, I study the second-best optimal carbon taxes when negative externalities from carbon emissions coexist with another inefficiency, specifically, the misallocation of production inputs across heterogeneous firms. This research holds relevance because governments may possess policy tools to address climate change, yet lack other means to alleviate additional inefficiencies. The motivation for this research stems from two prominent empirical facts. First, there is enormous heterogeneity in emission intensity across firms, even within narrowly defined 4-digit industries. Second, there is dispersion in the marginal products of production inputs, such as capital and labor, for firms within the industry, which is interpreted as evidence of misallocation of production inputs. Using a theoretical model, I show that when firms with lower emission intensity exhibit higher marginal products of production inputs, a carbon tax yields a double dividend: 1) it reduces carbon emissions; 2) it enhances allocative efficiency by reallocating resources to more distorted firms. Using firm-level data, I show that firms with lower emission intensity indeed have higher marginal products of capital and labor. Based on the empirical evidence, I develop a quantitative firm dynamics model that incorporates carbon emissions, emission externalities, adjustment costs, and financial frictions. In a calibrated version of this model, the optimal carbon tax is three times higher than in a counterfactual economy in which there is no relation between emission intensity and marginal products. Furthermore, I find that a policy directly targeting adjustment costs and financial frictions, if it exists, can simultaneously reduce carbon emissions and boost output, ultimately surpassing a carbon tax in increasing overall welfare. In Chapter 2 (co-authored with Thomas Drechsel), we explore the optimal macroprudential policy when firms face earnings-based borrowing constraints. Conventional wisdom in the literature suggests that when agents face asset-based collateral constraints—where the amount of debt is limited by the value of their asset holdings—they tend to over-borrow compared to the socially efficient level of debt. In this case, optimal policy aims to reduce debt positions through taxes. The reason is that agents do not internalize the effects of their debt choices on asset prices. However, recent empirical evidence shows that firms primarily borrow against their earnings rather than their assets. We show that agents over-save (and under-borrow) relative to the social optimum, as they do not internalize changes in wages, which in turn affect firms' earnings. This is the opposite conclusion to the previous literature. A numerical model exercise demonstrates that incorrectly rolling out a tax policy derived under the assumption of asset-based constraints in an economy where firms actually borrow based on earnings leads to a consumption equivalent welfare loss of up to 2.55%. Thus, we argue that optimal macroprudential policy critically depends on the specific form of financial constraints. In Chapter 3, I investigate how the 2020 Small Business Reorganization Act, a corporate bankruptcy reform in the U.S. designed to reduce debt reorganization costs for small businesses, affects the aggregate economy. Under current U.S. law, businesses have two bankruptcy options: Chapter 7 liquidation and Chapter 11 reorganization. In Chapter 7, an insolvent company sells all of its assets, repays existing debts, and exits the market. In contrast, Chapter 11 is designed to rehabilitate efficient but financially distressed businesses. However, legal scholars have long argued that Chapter 11 is too costly for small businesses, causing productive but insolvent firms to choose liquidation, which could be potentially harmful to the economy. Using a general equilibrium model with bankruptcy decisions of firms, I evaluate the Small Business Reorganization Act. The main contribution to the literature is that I calibrate and estimate the model parameters using novel data encompassing the universe of bankrupt firms in the U.S., whereas existing literature primarily relies on data from bankrupt publicly listed large firms. I find that the bankruptcy reform has small but positive impact on aggregate welfare, while output and productivity decrease. A lower Chapter 11 cost helps distressed firms to reorganize, but also prompts firms that would not declare bankruptcy absent the reform to reorganize. Despite this unintended consequence, welfare of the economy improves.