Showing papers in "Journal of Political Economy in 2000"

Does Entrepreneurship Pay? An Empirical Analysis of the Returns to Self-Employment

Abstract: Possible explanations for earnings differentials in self-employment and paid employment are investigated. The empirical results suggest that the nonpecuniary benefits of self-employment are substantial: Most entrepreneurs enter and persist in business despite the fact that they have both lower initial earnings and lower earnings growth than in paid employment, implying a median earnings differential of 35 percent for individuals in business for 10 years. The differential cannot be explained by the selection of low-ability employees into self-employment and is similar for three alternative measures of self-employment earnings and across industries. Furthermore, the estimated earnings differentials may understate the differences in compensation across sectors since fringe benefits are not included in the measure of employee compensation.

Testing for Asymmetric Information in Insurance Markets

Abstract: The first goal of this paper is to provide a simple and general test of the presence of asymmetric information in contractual relationships within a competitive context. We also argue that insurance data are particularly well suited to such empirical investigations. To illustrate this claim, we use data on contracts and accidents to investigate the extent of asymmetric information in the French market for automobile insurance. Using various parametric and nonparametric methods, we find no evidence for the presence of asymmetric information in this market.

Measurement Error and the Relationship between Investment and q

Abstract: Many recent empirical investment studies have found that the investment of financially constrained firms responds strongly to cash flow. Paralleling these findings is the disappointing performance of the q theory of investment: even though marginal q should summarize the effects of all factors relevant to the investment decision, cash flow still matters. We examine whether this failure is due to error in measuring marginal q. Using measurement error–consistent generalized method of moments estimators, we find that most of the stylized facts produced by investment‐q cash flow regressions are artifacts of measurement error. Cash flow does not matter, even for financially constrained firms, and despite its simple structure, q theory has good explanatory power once purged of measurement error.

Prices Rise Faster than They Fall

Abstract: Output prices tend to respond faster to input increases than to decreases. This tendency is found in more than two of every three markets examined. It is found as frequently in producer goods markets as in consumer goods markets. In both kinds of markets the asymmetric response to cost shocks is substantial and durable. On average, the immediate response to a positive cost shock is at least twice the response to a negative shock, and that difference is sustained for at least five to eight months. Unlike past studies, which documented similar asymmetries in selected markets (gasoline, agricultural products, etc.), this one uses large samples of diverse products: 77 consumer and 165 producer goods. Accordingly, the results suggest a gap in an essential part of economic theory. As a start on filling this gap, the study finds no asymmetry in the resonse of an individual decision maker (a supermarket chain) to its costs, but it finds above‐average asymmetry where a cost shock is filtered through a fragmented w...

Is Child Labor Inefficient

Abstract: We build a model of child labor and study its implications for welfare. We assume that there is a trade‐off between child labor and the accumulation of human capital. Even if parents are altruistic and child labor is socially inefficient, it may arise in equilibrium because parents fail to fully internalize its negative effects. This occurs when bequests are zero or when capital markets are imperfect. We also study the effects of a simple ban on child labor and derive conditions under which it may be Pareto improving in general equilibrium. We show that the implications of child labor for fertility are ambiguous.

Hierarchies and the Organization of Knowledge in Production

Abstract: This paper studies how communication allows for the specialized acquisition of knowledge. It shows that a knowledge‐based hierarchy is a natural way to organize the acquisition of knowledge when matching problems with those who know how to solve them is costly. In such an organization, production workers acquire knowledge about the most common or easiest problems confronted, and specialized problem solvers deal with the more exceptional or harder problems. The paper shows that the model is consistent with stylized facts in the theory of organizations and uses it to analyze the impact of changes in production and information technology on organizational design.

Reform without Losers: An Interpretation of China's Dual‐Track Approach to Transition

Abstract: This paper develops a simple model to analyze the dual‐track approach to market liberalization as a mechanism for implementing efficient Pareto‐improving economic reform, that is, reform achieving efficiency without creating losers. The approach, based on the continued enforcement of the existing plan while simultaneously liberalizing the market, can be understood as a method for making implicit lump‐sum transfers to compensate potential losers of the reform. The model highlights the critical roles of enforcement of the plan for achieving Pareto improvement and full liberalization of the market track for achieving efficiency. We examine how the dual‐track approach has worked in product and labor market liberalization in China.

Do the Rich Save More

Abstract: The question of whether higher–lifetime income households save a larger fraction of their income was the subject of much debate in the 1950s and 1960s, and while not resolved, it remains central to the evaluation of tax and macroeconomic policies. We resolve this long‐standing question using new empirical methods applied to the Panel Study of Income Dynamics, the Survey of Consumer Finances, and the Consumer Expenditure Survey. We find a strong positive relationship between saving rates and lifetime income and a weaker but still positive relationship between the marginal propensity to save and lifetime income. There is little support for theories that seek to explain these positive correlations by relying solely on time preference rates, nonhomothetic preferences, or variations in Social Security benefits. There is more support for models emphasizing uncertainty with respect to income and health expenses, bequest motives, and asset‐based means testing or behavioral factors causing minimal saving rates amo...

Equity, bonds and bank debt : Capital structure and financial market equilibrium under asymmetric information

Abstract: This paper proposes a model of financial markets and corporate finance, with asymmetric information and no taxes, where equity issues, bank debt, and bond financing coexist in equilibrium. The relationship banking aspect of financial intermediation is emphasized: firms turn to banks as a source of investment mainly because banks are good at helping them through times of financial distress. This financial flexibility is costly since banks face costs of capital themselves (which they attempt to minimize through securitization). To avoid this intermediation cost, firms may turn to bond or equity financing, but bonds imply an inefficient liquidation cost and equity an informational dilution cost. We show that in equilib‐rium the riskier firms prefer bank loans, the safer ones tap the bond markets, and the ones in between prefer to issue both equity and bonds. This segmentation is broadly consistent with stylized facts.

Sustaining Fiscal Policy through Immigration

Abstract: This paper explores the fiscal implications of immigration to the US, and argues that immigration policy should be viewed as a vital part of fiscal policy. In particular, a case is made that skill ...

Comparative Politics and Public Finance

Abstract: We propose a model with micropolitical foundations to contrast different political regimes. Compared to a parliamentary regime, the institutions of a presidential‐congressional regime produce fewer incentives for legislative cohesion but more separation of powers. These differences are reflected in the size and composition of government spending. A parliamentary regime has redistribution toward a majority, less underprovision of public goods, and more rents to politicians; a presidential‐congressional regime has redistribution toward powerful minorities, more underprovision of public goods, but less rents to politicians. The size of government is smaller under a presidential regime. This last prediction is consistent with cross‐country data.

Equilibrium Price Dispersion in Retail Markets for Prescription Drugs

Abstract: This study seeks to establish the empirical importance of price dispersion due to costly consumer search by examining retail prices for prescription drugs. Posted prices in two geographically distinct markets are shown to vary considerably across pharmacies within the same market, even after one controls for variation due to pharmacy differences. Pharmacy heterogeneity accounts for at most one‐third of the observed price dispersion. The empirical analysis hinges on the observation that consumers’ incentives to price‐shop depend on characteristics of the drug therapy. Cross‐sectional patterns in price distributions across drugs are consistent with the predictions of a search model: prices for repeatedly purchased prescriptions (for which the expected benefits of search are highest) exhibit significant reductions in both dispersion and price‐cost margins.

In Sickness and in Health: Risk Sharing within Households in Rural Ethiopia

Abstract: Much of the literature on consumption smoothing and on risk sharing has focused on the ability of the household as a unit to protect its consumption. Little is known about the ability of individual...

Gain, Loss, and Asset Pricing

Abstract: We develop an approach to asset pricing in incomplete markets that bridges the gap between the two fundamental approaches in finance: model‐based pricing and pricing by no arbitrage. We strengthen the absence of arbtrage assumption by precluding investment opportunities whose attractiveness to a benchmark investor exceeds a specified threshold. In our framework, the attractiveness of an investment opportunity is measured by the gain‐loss ratio. We show that a restriction on the maximum gain‐loss ratio is equivalent to a restriction on the ratio of the maximum to minimum values of the pricing kernel. By limiting the maximum gainloss ratio, we can restrict the admissible set of pricing kernels, which in turn allows us to restrict the set of prices that can be assigned to assets. We illustrate our methodology by computing price bounds for call options in a Black‐Scholes economy without intermediate trading. When we vary the maximum permitted gainloss ratio, these bounds can range from the exact prices implie...

Effects of Air Quality Regulation on in Polluting Industries

Abstract: This paper examines unintended effects of air quality regulation, using plant data for 1963–92. A key regulatory tool since 1978 is the annual designation of county air quality attainment status. Nonattainment status triggers specific equipment requirements, with the severity and enforcement of regulations rising with plant size. The differential in regulation favors attainment areas, reducing births for polluting industries in nonattainment areas by 26–45 percent. Industries and sectors with bigger plants are affected the most, shifting industrial structure toward less regulated single‐plant firms. Large preregulation plants do benefit from grand‐fathering provisions, but both grandfathering and shifts to small‐scale new plants contribute to environmental degradation.

Beyond Arbitrage: "Good-Deal" Asset Price Bounds in Incomplete Markets

Abstract: One often wants to value a risky payoff by reference to prices of other assets rather than by exploiting full‐fledged economic models. However, this approach breaks down if one cannot find a perfect replicating portfolio. We impose weak economic restriction to derive usefully tight bounds on asset prices in this situation. The bounds assume that investors would want to buy assets with high Sharpe ratios‐“good deals”‐as well as pure arbitrage opportunities. We show how to calculate the price bounds in one‐period, multiperiod, and continuous‐time contexts. We show that the multiperiod problem can be solved recursively as a sequence of one‐period problems. We calculate bounds in option pricing examples including infrequent trading and an option written on a nontraded event, and we use the bounds to explore the economic significance of option pricing predictions. We find that much variation in S&P 500, index option prices over time and across strike prices fits within the bounds.

The Making of an Oligopoly: Firm Survival and Technological Change in the Evolution of the U.S. Tire Industry

Abstract: The number of producers in the U.S. tire industry grew for 25 years and then declined sharply, and the industry evolved to be an oligopoly. The role of technological change in shaping the industry’s market structure is explored. A model of industry evolution featuring technological change is used to derive predictions that are tested using a novel data set on firm entry, exit, size, location, distribution networks, and technological choices prior to the shakeout of producers. Consistent with the model, earlier‐entering and larger firms survived longer, principally because of the influence of age and size on technological change.

A Ricardian Model with a Continuum of Goods under Nonhomothetic Preferences: Demand Complementarities, Income Distribution, and North‐South Trade

Abstract: This paper develops a Ricardian model of trade in which goods are indexed according to priority and higher‐indexed goods are consumed only by richer households. South (North) has a comparative advantage in lower‐ (higher‐) indexed goods and, hence, specializes in goods with lower (higher) income elasticities of demand. Product cycles and a southern terms‐of‐trade deterioration result from faster population growth and uniform productivity growth in South and a global productivity improvement. South’s domestic income redistribution policy can improve its terms of trade so much that every household in South may be better off, at the expense of North.

Redistributing Income under Proportional Representation

Abstract: Although majoritarian decision rules are the norm in legislatures, relatively few democracies use simple majority rule at the electoral stage, adopting instead some form of multiparty proportional representation. Moreover, aggregate data suggest that average income tax rates are higher, and distributions of posttax income flatter, in countries with proportional representation than in those with majority rule. While there are other differences between these countries, this paper explores how variations in the political system per se influence equilibrium redistributive tax rates and income distributions. A three‐party proportional representation model is developed in which taxes are determined through legislative bargaining among successful electoral parties, and the economic decision for individuals is occupational choice. Political‐economic equilibria for this model and for a two‐party, winner‐take‐all, majoritarian system are derived and compared.

The Dynamics of Political Compromise

Abstract: We characterize efficient self‐enforcing divisions of political or economic surplus between two parties that interact repeatedly The party in power can decide the allocation, and the parties' political strength changes according to a Markov process We find that the share of the party currently in power depends not only on its current strength but also on whether it had previously been even stronger since it last came to power We find that the constitutional supermajority requirements that attempt to constrain the use of power can counterproductively create less compromise

Sequential Voting Procedures in Symmetric Binary Elections

Abstract: We explore sequential voting in symmetric two-option environments. We show that the (informative) symmetric equilibria of the simultaneous voting game are also equilibria in any sequential voting structure. In unanimity games, (essentially) the whole set of equilibria is the same in all sequential structures. We also explore the relationship between simultaneous and sequential voting in other contexts. We illustrate several instances in which sequential voting does no better at aggregating information than simultaneous voting. The inability of the sequential structure to use additional information in voting models is distinct from that in the herd-cascade literature.

Redistribution in a Decentralized Economy: Growth and Inflation in China under Reform

Abstract: Despite expanding at an annual rate of nearly 9 percent, China's economy has exhibited a marked cyclical pattern: Periods of rapid growth, accompanied by accelerating inflation, are followed by contractions during which both growth and inflation fall. A widening gap also emerged between the output contribution of the state sector and its share of investment and employment. In this paper, we offer a consistent explanation for this behavior that reflects several key institutional features of China's economic reform: (i) economic decentralization, (ii) the government's commitment to the state sector, and (iii) the credit plan and credit control.

What Happens When You Tax the Rich? Evidence from Executive Compensation

Abstract: This paper examines the responsiveness of taxable income to changes in marginal tax rates using detailed compensation data on several thousand corporate executives from 1991 to 1995. The data confirm that the higher marginal rates of 1993 led to a significant decline in taxable income. Indeed, this small group of executives may account for as much as 20 percent of the aggregate change in wage and salary income for approximately the one million richest taxpayers over this time period; one person alone can account for more than 2 percent. The decline, however, is almost entirely a short‐run shift in the timing of compensation rather than a permanent reduction in taxable income. The short‐run elasticity of taxable income with respect to the net‐of‐tax share exceeds one in this sample, but the elasticity after one year is at most 0.4 and probably closer to zero. Breaking out the tax responsiveness of different types of compensation shows that the large short‐run responses come almost entirely from a large inc...

Disability Insurance Benefits and Labor Supply

Abstract: A critical input for assessing the optimal size of disability insurance programs is the elasticity of labor force participation with respect to the generosity of benefits. Unfortunately, this parameter has been difficult to estimate in the context of the U.S. disability insurance program since all workers face an identical benefits schedule. I surmount this problem by studying the experience of Canada, which operates two distinct disability insurance programs: for Quebec and for the rest of Canada. The latter program raised its benefits by 36 percent in January 1987, whereas benefits in Quebec were constant. I find a sizable labor supply response to the policy change; my central estimates imply an elasticity of labor force nonparticipation with respect to disability insurance benefits of 0.28–0.36.

Estimating Preferences under Risk: The Case of Racetrack Bettors

Abstract: In this paper we investigate the attitudes toward risk of bettors in British horse races. The model we use allows us to go beyond the expected utility framework and to explore various alternative proposals by estimating a multinomial model on a 34,443‐race data set. We find that rank‐dependent utility models do not fit the data noticeably better than expected utility models. On the other hand, cumulative prospect theory has higher explanatory power. Our preferred estimates suggest a pattern of local risk aversion similar to that proposed by Friedman and Savage.

Balladurette and Juppette: a discrete analysis of scrapping subsidies

Abstract: This paper studies the effects of subsidies on durable goods markets In particular, we focus on a recent policy in France in which the governments of Balladur and Juppe subsidized the replacement of old cars with new ones To study this policy, we construct a dynamic stochastic discrete choice model of car ownership at the household level The resulting decision rules and equilibrium conditions are used to estimate the underlying parameters of the model using aggregate data These policy functions are used to evaluate the short‐ and long‐run effects of the French policies We find that these policies do stimulate the automobile sector in the short run but, through the induced changes in the cross‐sectional distribution of car ages, create the basis for subsequent low activity Further, while these policies increase government revenues in the short run, revenues in the long run are lower relative to a baseline without intervention

Age and the Quality of Work: The Case of Modern American Painters

Abstract: Psychologists have found that the age at which successful practitioners typically do their best work varies across professions, but they have not considered whether these peak ages change over time, as economic models suggest they might. Using auction records, we estimate the relationship between artists’ ages and the value of their paintings for two successive cohorts of leading modern American painters: de Kooning, Pollock, Rothko, and others born during 1900–1920 and Frank Stella, Warhol, and others born during 1921–40. We find that a substantial decline occurred over time in the age at which these artists produced their most valuable—and most important—work and argue that this was caused by a shift in the nature of the demand for modern art during the 1950s.

Extensive Margins and the Demand for Money at Low Interest Rates

Abstract: We argue that the relevant monetary decision for the majority of U.S. households is not the fraction of assets to be held in interest‐bearing form, but whether to hold any such assets at all (we call this “the decision to adopt” the financial technology). We show that the key variable governing the adoption decision is the product of the interest rate times the total amount of assets. This implies that the interest elasticity of household money demand at low interest rates can be estimated from the variation in asset holdings in a cross section of households rather than historical interest rate variations. We do so with the 1989 Survey of Consumer Finances. We find that (a) the elasticity of money demand is very small when the interest rate is small, (b) the probability that a household holds any amount of interest‐bearing assets is positively related to the level of financial assets, and (c) the cost of adopting financial technologies is negatively related to participation in a pension program. At intere...

On the State of the Union

Abstract: An overlapping generations model of marriage and divorce is constructed to analyze family structure and intergenerational mobility. Agents differ by sex, marital status, and human capital. Single agents meet in a marriage market and decide whether to accept or reject proposals to wed. Married couples must decide whether to separate or not. Parents invest in their children depending on their wherewithal. A simulated version of the theoretical prototype can generate an equilibrium with a significant number of female‐headed families and a high degree of persistence in income across generations. To illustrate the model's mechanics, the effects of two antipoverty policies, namely child support and welfare, are investigated.

A Market Test for Discrimination in the English Professional Soccer Leagues

Abstract: This chapter proposes a market test for racial discrimination in salary setting in English league soccer over the period 1978–93 using a balanced panel of 39 clubs. If there is a competitive market for the services of players, the wage bill of the club will reflect their productivity and hence the performance of the club in the league. Discrimination can be said to exist if clubs fielding an above-average proportion of black players systematically outperform clubs with a below-average proportion of black players, after one controls for the wage bill. Statistically significant evidence of discrimination in this sense is found.