Showing papers in "Journal of Economic Perspectives in 1994"

The Origins of Endogenous Growth

Abstract: This paper describes two strands of work that converged under the heading of 'endogenous growth.' One strand, which is primarily empirical, asks whether there is a general tendency for poor countries to catch up with rich countries. The other strand, which is primarily theoretical, asks what modifications are necessary to construct a theory of aggregate growth that takes the economics of discovery, innovation, and technological change seriously. The paper argues that the second strand of work will ultimately have a more significant impact on our understanding of growth and our approach to aggregate theory.

Systems Competition and Network Effects

Abstract: This paper discusses firm behavior, market performance, and the public and private institutions that arise in systems markets, i.e., markets where consumers use compatible components together to generate benefits. In such markets, which include communications networks and 'hardware/software' networks, popular products are inherently more valuable. These 'network effects' can drive corporate strategies and are critical in understanding innovation in many high-technology markets. The discussion here emphasizes the dynamics of consumer adoption decisions in the presence of network effects, competition between incompatible systems, and how suppliers choose which components are compatible and which are not.

Contingent Valuation: Is Some Number Better than No Number?

Abstract: Without market outcomes for comparison, internal consistency tests, particularly adding-up tests, are needed for credibility. When tested, contingent valuation has failed. Proponents find surveys tested poorly done. To the authors' knowledge, no survey has passed these tests. The 'embedding effect' is the similarity of willingness-to-pay responses that theory suggests (and sometimes requires) be different. This problem has long been recognized but not solved. The authors conclude that current methods are not suitable for damage assessment or benefit-cost analysis. They believe the problems come from an absence of preferences, not a flaw in survey methodology, making improvement unlikely.

Valuing the Environment through Contingent Valuation

Abstract: The ability to place a monetary value on the consequences of pollution discharges is a cornerstone of the economic approach to the environment. If this cannot be done, it undercuts the use of economic principles, whether to determine the optimal level of pollution or to implement this via Pigouvian taxes or Coase-style liability rules. Sometimes, the valuation involves a straightforward application of methods for valuing market commodities, as when sparks from a passing train set fire to a wheat field. Often, however, the valuation is more difficult. Outcomes such as reducing the risk of human illness or death, maintaining populations of native fish in an estuary, or protecting visibility at national parks are not themselves goods that are bought and sold in a market. Yet, placing a monetary value on them can be essential for sound policy. The lack of a market to generate prices for such outcomes is no accident. Markets are often missing in such cases because of the nonexcludable or nonrival nature of the damages: for those affected by it, pollution may be a public good (or bad). The public good nature of the damages from pollution has several consequences. It explains, for example, why the damages are sometimes large—only a few people may want to own a sea otter pelt, say, but many may want this animal protected in the wild. It also explains why market prices are inappropriate measures of value. In the presence of externalities , market transactions do not fully capture preferences. Collective choice is the more relevant paradigm. This is precisely what Ciriacy-Wantrup (1947) had in mind when he first proposed the contingent valuation method. Individuals should be interviewed

Endogenous Innovation in the Theory of Growth

Abstract: This paper makes the case that purposive, profit-seeking investments in knowledge play a critical role in the long-run growth process. First, the authors review the implications of neoclassical growth theory and the more recent theories of 'endogenous growth.' Then they discuss the empirical evidence that bears on the modeling of long-run growth. Finally, the authors describe in more detail a model of growth based on endogenous technological progress and discuss the lessons that such models can teach us.

Network externality : an uncommon tragedy

Abstract: Economists have defined 'network externality' and have examined putative inframarginal market failures associated with it. This paper distinguishes between network effects and network externalities, where the latter are market failures. The authors argue that while network effects are important, network externalities are theoretically fragile and empirically undocumented. Some network externalities are merely pecuniary. Network ownership or transactions among network participants can internalize some network effects. The type of market failure that has been associated with these externalities is a transition problem that has little to do with externality.

The Contingent Valuation Debate: Why Economists Should Care

Abstract: T he contingent valuation method involves the use of sample surveys (questionnaires) to elicit the willingness of respondents to pay for (generally) hypothetical projects or programs. The name of the method refers to the fact that the values revealed by respondents are contingent upon the constructed or simulated market presented in the survey. A spirited (and occasionally mean-spirited) battle over such methods is currently being waged, involving competing factions within the federal government, economists and lawyers representing business and environmental groups, and interested academics as well. At issue is a seemingly quite specific question: should environmental regulations currently under development at both the Department of the Interior and the Department of Commerce sanction the use of the contingent valuation method in estimating the damage done by spills of oil, chemicals, or other substances covered by federal law? More generally, the debate raises broad questions about what economists have to say about the values that individuals place on public or private goods. The two papers that follow this one make cases for and against the use of the contingent valuation method. My aim here is to provide an overview of the technique and the debate surrounding it. I also want to suggest why this debate should matter to economists, both professionally and in their roles as citizens and consumers.

Choosing How to Compete: Strategies and Tactics in Standardization

Abstract: In a network industry, each firm must decide whether or not it wants its product to be compatible with those of rivals. This horizontal compatibility strategy determines whether competition is a battle to establish a standard or the more conventional competition within a standard. The two forms of competition involve different tactics and may differ in the extent to which they dissipate industry profits. In some cases, all firms in an industry may prefer the same form of competition. In other cases, firms may prefer different forms of competition and either may prevail.

Perspectives on Growth Theory

Abstract: This essay relates recent developments in growth theory to problems and ideas that first engaged R. F. Harrod, E. Domar, and their neoclassical successors. The body of 'new growth theory' began by finding special ways to assume that there are constant returns to capital. It is shown that this is a very nonrobust assumption, thus not a good basis for growth theory. More promising is the attempt to create a genuinely endogenous theory of the process of innovation. This notion has always been present in the literature or just beneath the surface. Current ideas, for all their ingenuity, may be too mechanical.

Selling Spectrum Rights

Abstract: The design of the FCC spectrum-license auction is a case study in the application of economic theory. Auction theory helped address policy questions such as: Should an open auction or a sealed-bid auction be used? Should the licenses be auctioned sequentially or simultaneously? Should the government allow bids for combinations of licenses, or should it accept only single-license bids? How should the auction be structured to promote the interests of minority-owned and other designated firms? Should the government impose royalties or reserve prices? How much should the bidders be informed about their competition?

Economics in the Laboratory

Abstract: Vernon Smith (1927–) received his Ph.D. in economics at Harvard. Although his more than two hundred books and articles address issues in many areas of economics, he is best known for his work on experimental economics, for which he received the Nobel Prize in 2002. After many years at the University of Arizona, Smith is now a professor of economics at George Mason University. Why do economists conduct experiments? To answer that question, it is first necessary briefly to specify the ingredients of an experiment. Every laboratory experiment is defined by an environment , specifying the initial endowments, preferences and costs that motivate exchange. This environment is controlled using monetary rewards to induce the desired specific value/cost configuration (Smith, 1991, 6). An experiment also uses an institution defining the language (messages) of market communication (bids, offers, acceptances), the rules that govern the exchange of information, and the rules under which messages become binding contracts. This institution is defined by the experimental instructions which describe the messages and procedures of the market, which are most often computer controlled. Finally, there is the observed behavior of the participants in the experiments as a function of the environment and institution that constitute the controlled variables. Using this framework of environment, institution, and behavior, I can think of at least seven prominent reasons in the literature as to why economists conduct experiments. Undoubtedly, there are more (Davis and Holt, 1992, Chapter 1 and passim).

Intergenerational Transfers and the Accumulation of Wealth

Abstract: H t ouseholds acquire wealth from two sources: they save out of income they have earned, and they receive transfers from other people. The first method of wealth accumulation goes under the name of life-cycle saving, in which people save during their working lives and dissave after retirement; the second involves either an inter vivos transfer (that is, a transfer between living people) or a bequest (a transfer that occurs at the death of the donor). While inter vivos transfers and bequests will arise in dynastic models where preferences include a taste for the well-being of one's descendents, few empirical life-cycle models reflect these concerns. Indeed, a sharp debate has arisen over the ability of the simple life-cycle model to explain observed wealth accumulation. Understanding the relative sizes of these sources of wealth accumulation affects a variety of issues. For example, the effects of government debt, social insurance, public transfer programs, estate taxes, and incentives for charitable giving depend to some extent on the magnitude and nature of private saving and transfers of wealth. Analyses of the inequality of wealth may depend on whether most of wealth is earned or received as transfers. Appropriate policies for encouraging private saving may look rather different, depending on whether most saving is to be consumed later in life or passed along to the next generation. Finally, evidence on transfer patterns relates to more fundamental

Generational Accounting: A Meaningful Way to Evaluate Fiscal Policy

Abstract: This paper illustrates the technique of generational accounting, a new way to evaluate fiscal policy that overcomes the inherent ambiguities of traditional deficit accounting. The authors illustrate why there is no 'correct' measure of the deficit and how generational accounting--estimating the fiscal burdens current policy places on different generations--provides a clearer picture of the intergenerational and macroeconomic effects of fiscal policy than any measure of the deficit. Their calculations suggest that, despite recent changes, U.S. fiscal policy is unsustainable in that it will ultimately require future generations to bear a much higher burden than those currently alive.

Endogenous Growth Theory: Intellectual Appeal and Empirical Shortcomings

Abstract: This paper examines whether the recent theoretical insights stemming from endogenous growth theory have provided a better guide to explaining actual growth experience than the neoclassical model. The paper considers the available empirical evidence on a number of related subjects, including the slowing of growth in the OECD countries over the last two decades; the acceleration of growth in several Asian countries since the early 1960s; studies of the determinants of growth in a cross-country context; and sources of the differences in international productivity levels. It concludes that the empirical confirmation, so far, of endogenous growth theory is limited.

Universal health insurance in the Clinton plan: coverage as a tax-financed public good.

Abstract: The financing arrangements embodied in the Clinton health reform plan involve some important differences in the way in which public goods are usually financed. The subsidies to small, low-wage firms mandated to provide benefits distort markets in both labor and products, and offer incentives for the creation of small firms. In addition, the financing scheme implicitly envisions a head tax on families at modest income levels but offers a possible rationale for it. Nevertheless, the main reason for many of the financing features appears to be an attempt to hold down the apparent budgetary cost of universal coverage.

Enterprise Reform in Chinese Industry

Abstract: The Chinese economy commands attention because of its immense size, and because China's unique combination of dynamic performance and unusual institutional arrangements challenges many popular notions about the reform of socialist systems. Industry, which by Chinese convention includes mining and utilities as well as manufacturing , exemplifies this arresting mix of scale, dynamism, and unexpected structural features. Industry is the largest sector of China's economy, accounting for 50 percent of total output and 80 percent of exports, and employing 102 million workers in 1992 (Survey, 1993). Its robust growth, amounting to well above 10 percent annually during the 1980s (Table 1), undergirds China's standing as the world's fastest-growing economy.1 Since China's initial reform efforts began as experimental changes aimed at improving performance rather than, as in eastern Europe, establishing a Western-style market system, it is not surprising that institutional change has been gradual and uneven, with many features of the pre-reform system surviving even today. Rather than attempting a "big bang," China's reform path is more akin to "growing out of the plan" (Naughton, 1994). Industry stands at the core of China's reform problem. Efforts to revitalize and restructure domestic industry are closely linked to the reform of pricing, banking, public finance, ownership, social welfare, and research and 1We refrain from detailed comment on the accuracy of Chinese economic statistics, except to note that officially compiled data on industrial inputs and outputs typically convey the order of magnitude of relevant levels and rates of change.

How Are the Mighty Fallen: Rejected Classic Articles by Leading Economists

Abstract: The authors asked the world's leading economists to describe instances in which journals rejected their articles. More than sixty essays, by a broadly diverse group that includes fifteen Nobel Prize winners, indicate that most have suffered publication rejection, often frequently. Indeed, journals have rejected many papers that later became classics. The authors discuss the prize-winners' experiences, other notable cases, and rejections by John Maynard Keynes when he edited the Economic Journal. Finally, they search in economists' almost universal experience of rejection for patterns and lessons about the publication process.

Completing China's Move to the Market

Abstract: Beginning in late 1978, by luck as much as design, China arrived at a strategy for market-oriented economic reform that combined substantial reform with rapid growth in GDP and exports. The sequencing of reform began with the 'easy to reform' sectors, agriculture and foreign trade, and then took up the more difficult task of reforming the large state-owned enterprises. With respect to agriculture, small-scale industry, and foreign investment, China found ways of introducing meaningful property rights into the increasingly marketized system. A partially unreformed financial system and inadequate autonomy of large state enterprises accounts, however, for the current stop-go nature of Chinese development.

Economic Incentives and the Defense Procurement Process

Abstract: This paper describes some of the insights that the economic theory of incentives can contribute to defense procurement policy analysis. It describes the underlying incentive problems that shape the defense procurement problem, the nature of current institutions and how they affect actors' behavior, and possible directions for improving the procurement process suggested by viewing it as a solution to a complex set of incentive problems. Incentive problems between government and defense firms and incentive problems within government are both considered.

Should Generational Accounts Replace Public Budgets and Deficits

Abstract: The author assesses the concept of 'generational accounts' and the specific accounts constructed by Alan Auerbach, Jagadeesh Gokhale, and Laurence Kotlikoff (1991). Although these accounts support the assertion of present-orientation in fiscal policy, they rest on numerous assumptions based on judgments that are open to question. These involve the treatment of the public budget constraint, the benefits from public exhaustive expenditures, economic and population projections, the discount rate, and fiscal incidence. Alternative and equally reasonable assumptions could yield radically different conclusions. The author concludes that the Auerbach, Gokhale, and Kotlikoff accounts should not replace the annual public budget, as they argue.

The Allocation of Resources in the Presence of Indivisibilities

Abstract: T he major problem presented to economic theory by the presence of indivisibilities in production is the impossibility of detecting optimality at the level of the firm, or for the economy as a whole, using the criterion of profitability based on competitive prices. I will explore this issue in a rather leisurely way, beginning with a discussion of the role played by competitive prices in verifying optimality when production takes place under constant returns to scale; then illustrating the failure of prices to perform this task when indivisibilities are significant; and, finally, suggesting the replacement of the pricing test by a specific quantity test. It is my hope that continued study of these quantity tests will increase our understanding of the division of labor in a large firm.

Facts and Myths about Refereeing

Abstract: Referees' and editors' behavior is illustrated by data from a random sample of refereeing requests by seven economics journals. Referees tend to be higher-quality (better-cited, prime-age) than authors. Except for a few superstar authors, there is no matching of authors and referees by quality. Nearly 80 percent of those asked to referee do so, with a median completion time of less than two months. Except for a few very slow referees and another few who promise but fail to accomplish the task, the slow editorial process is not due to referees' behavior. Paying referees speeds the job, mainly by speeding up those who would barely not qualify for the fee.

The Politics of Market Socialism

Abstract: The debate over market socialism has ignored the importance of the assumptions about the objectives of politicians in determining resource allocation. Theory and evidence suggest that totalitarian socialism does not lead to efficient resource allocation because dictators do not maximize social welfare. But democratic governments have political objectives different from social welfare as well. The authors argue that because these governments command greater resources (have more control rights) under socialism, democratic socialism (even if it could exist) is a less efficient system than democratic capitalism. Thus the political case against market socialism is even stronger than the economic case.

China's Macroeconomic Performance and Management During Transition

Abstract: Since reforms started in 1978, China has combined rapid growth with moderate price stability This paper analyzes China's macroeconomic performance over the past fifteen years with special attention to factors responsible both for the pace of economic expansion and the periodic fluctuations Regarding the former, the author identifies four sources of stimuli: administrative decentralization, high levels of fixed capital investment, the elastic supply and quality of the labor force, and the increasing volume of savings supplemented in recent years by a large inflow of foreign direct investment Future growth with stability calls for controlling and implementing banking and fiscal reform

Issues in the Design of Environmental Excise Taxes

Abstract: T ax law has long had environmental consequences, although the consequences have often been unintended. For example, tax provisions passed to assist the timber industry in the 1920s permitted expensing of the costs of reforestation and planting (rather than having to depreciate them over a period of time), along with capital gains treatment for harvested timber, provisions which may have encouraged a more rapid harvest of domestic timberland. Percentage depletion allowances to assist the oil industry-a deduction based on a percentage of the value of oil sold rather than the taxpayer's basis in the oil-which became part of the Internal Revenue Code in 1926, arguably have led to exploitation of oil and mineral deposits at a rate greater than the socially optimal rate. Similarly, the purpose of the federal motor fuels tax, when expanded in 1956, was to fund highway construction, although now it is common to regard it as (at least potentially) an environmental tax, aimed at addressing the externalities caused by automobile use. Of course, these tax provisions were not motivated by environmental concerns. The 1970s began to see efforts at environmental tax policy, although at the time the focus of the policies more often was energy conservation rather than reduction in pollution. Between 1978 and 1986, Congress provided tax credits for residential energy conservation expenditures. In 1978, Congress enacted the gas guzzler excise tax, an excise tax that varies with the Environmental Protection Agency's fuel economy rating of automobiles. It remains in force today. Congress also made available tax-exempt bond finance for pollution control equipment between 1978 and 1986.

Nonprofit organizations in the health sector.

Abstract: Nonprofit organizations have a substantial share of the U.S. health care markets. They care for approximately 70 percent of all inpatient cases in acute care hospitals, and for half of the market for inpatient specialty mental health treatment and substances abuse treatment. Nonprofits are predominant in home health care, where visiting nurse associations typically serve more than half the market. Nonprofits are less dominant in the nursing home market but still account for nearly one-fourth of all days of care. In 1990, 54 percent of the enrollment in health maintenance organizations was in the nonprofit sector (Interstudy, 1991), although for-profit HMOs have been increasing their market share rapidly, from 26 percent in 1985 to 46 percent in 1990. As a crude overall measure, one can use expenditure data as an indicator of the importance of nonprofit organizations in the health sector. Data for 1989 shows $191.4 billion in revenues for health sector nonprofits (Independent Sector, 1993, p. 147, SIC code 80); this was 31.8 percent of total U.S. health spending for that year (Levit et al., 1991). Given the size and scope of the nonprofit sector, it perhaps inevitably inspires conflicting sentiments. Government appears to both promote and mistrust nonprofit organizations in the health sector. On the supportive side, not-for-profit providers are exempted from most federal, state and local taxes, and they receive preferential treatment in the contract procurement process in many states; for example, for-profit firms are precluded from bidding on requests to provide residential services to the mentally disabled in Maryland. On the negative side, legislation was recently introduced in the Congress to link

Distinguished Lecture on Economics in Government Public Policy, Values, and Consciousness

Abstract: Economists should pay more attention to value formation in economic analysis. First, preferences are not stable in any operationally meaningful sense. Any estimated micro behavior that does not take account of the consequences of the behavior on underlying preferences is incapable of serving as a guide to future action. Second, the economist's model of human psychology is inaccurate and misleading. Third, most analyses of complex social behavior start from models incapable of producing empirical results adequate for useful structural analyses. The paper suggests avenues for making progress on each of these issues, beginning with a different approach to utility maximization.

The Usefulness of Core Theory in Economics

Abstract: economic problems. It has an undeserved reputation of being too abstract, owing mainly to the manner in which it is employed in the theory of general equilibrium. In fact, core theory is a highly flexible way of looking at practical economic problems, especially problems in industrial orga- nization. This paper seeks to show how simple numerical examples can illus- trate the idea of the core, and, in turn, how the core can illustrate basic principles of economics.

A guide to health care reform.

Abstract: There are four rationales for health care reform: increasing the efficiency of health delivery; reforming the market for health insurance; providing universal coverage; and reducing the federal deficit. These goals are reflected in most reform proposals. Achieving these goals involves several problems, however. Paying for universal coverage may lead to labor supply or demand reductions. In addition, reform involves large federal risks that must be dealt with through deficit financing, reduced benefits, or lower subsidies.

Economic FAQs About the Internet

Abstract: This is a set for frequently asked questions (and answers) about the economic, institutional, and technological structure of the Internet. The authors describe the current state of the Internet, discuss some of the pressing economic and regulatory problems, and speculate about future developments.