Showing papers in "The American Economic Review in 1994"

Economic Performance Through Time

Abstract: Economic history is about the performance of economies through time. The objective of research in the field is not only to shed new light on the economic past but also to contribute to economic theory by providing an analytical framework that will enable us to understand economic change. A theory of economic dynamics comparable in precision to general equilibrium theory would be the ideal tool of analysis. In the absence of such a theory we can describe the characteristics of past economies, examine the performance of economies at various times, and engage in comparative static analysis; but missing is an analytical understanding of the way economies evolve through time.

Inductive Reasoning and Bounded Rationality

Abstract: The type of rationality we assume in economics--perfect, logical, deductive rationality--is extremely useful in generating solutions to theoretical problems. But it demands much of human behavior--much more in fact than it can usually deliver. If we were to imagine the vast collection of decision problems economic agents might conceivably deal with as a sea or an ocean, with the easier problems on top and more complicated ones at increasing depth, then deductive rationality would describe human behavior accurately only within a few feet of the surface. For example, the game Tic-Tac-Toe is simple, and we can readily find a perfectly rational, minimax solution to it. But we do not find rational "solutions" at the depth of Checkers; and certainly not at the still modest depths of Chess and Go.

The Firm as an Incentive System

Abstract: The authors explore the twin hypotheses (1) that high-performance incentives, worker ownership of assets, and worker freedom from direct controls are complementary instruments for motivating workers, and (2) that such instruments can be expected to covary positively in cross-sectional data. They also relate their conclusions to empirical evidence, particularly that on the organization, compensation, and management of sales forces. Copyright 1994 by American Economic Association.

New product varieties and the measurement of international prices

Abstract: The high income elasticity of demand often estimated for U.S. imports may be a spurious result of omitting new product varieties from the import price indexes. The purpose of this paper is to demonstrate how to incorporate new product varieties into a constant-elasticity-of-substitution aggregate of import prices. This method is applied to U.S. imports of six disaggregate manufactured goods. It is shown that the corrected indexes are able to account for part--but not all--of the high income elasticities. (JEL C43, F14)

Risk-Taking, Global Diversification, and Growth

Abstract: This paper develops a continuous-time stochastic model in which international risk-sharing can yield substantial welfare gains through its effect on expected consumption growth. The mechanism linking global diversification to growth is an attendant world portfolio shift from safe low-yield capital to riskier high-yield capital. The presence of these two types of capital captures the idea that growth depends on the availability of an ever-increasing array of specialized, hence inherently risky, production inputs. Calibration exercises using consumption and stock-market data imply that most countries reap large steady-state welfare gains from global financial integration. Copyright 1994 by American Economic Association.

The Cleansing Effect of Recessions

Abstract: The authors investigate industry response to cyclical variations in demand. Production units that embody the newest process and product innovations are continuously being created and outdated units are being destroyed. Although outdated units are the most likely to turn unprofitable and be scrapped in a recession, they can be 'insulated' from the fall in demand by a reduction in creation. The structure of adjustment costs plays a determinant role in the responsiveness of those two margins. The calibrated model matches the relative volatilities of the observed manufacturing job creation and destruction series, and their asymmetries over the cycle. Copyright 1994 by American Economic Association.

The incidence of mandated maternity benefits.

Abstract: I consider the labor-market effects of mandates which raise the costs of employing a demographically identifiable group. The efficiency of these policies will be largely dependent on the extent to which their costs are shifted to group-specific wages. I study several state and federal mandates which stipulated that childbirth be covered comprehensively in health insurance plans, raising the relative cost of insuring women of childbearing age. I find substantial shifting of the costs of these mandates to the wages of the targeted group. Correspondingly, I find little effect on total labor input for that group. (JEL 118, J32, H51) In an era of tight fiscal budget constraints, mandating employer provision of workplace benefits to employees is an attractive means for a government to finance its policy agenda. Consequently, in recent years there has been a growth of interest in mandated benefits as a tool of social policy. For example, the centerpiece of President Bill Clinton's health-care proposal is mandated employer provision of health insurance, and more than 20 states have man

Beauty and the Labor Market

Abstract: The authors examine the impact of looks on earnings using interviewers' ratings of respondents' physical appearance. Plain people earn less than average-looking people, who earn less than the good-looking. The plainness penalty is 5 to 10 percent, slightly larger than the beauty premium. Effects for men are at least as great as for women. Unattractive women have lower labor-force participation rates and marry men with less human capital. Better-looking people sort into occupations where beauty may be more productive but the impact of individuals' looks is mostly independent of occupation, suggesting the existence of pure employer discrimination. Copyright 1994 by American Economic Association.

Dynamics of the trade balance and the terms of trade: The J-curve?

Abstract: The authors provide a theoretical interpretation of two features of international data: the countercyclical movements in net exports and the tendency for the trade balance to be negatively correlated with current and future movements in terms of trade but positively correlated with past movements. They document the same properties in a two-country stochastic growth model in which trade fluctuations reflect, in large part, the dynamics of capital formation. The authors find that their general-equilibrium perspective is essential: the relation between the trade balance and the terms of trade depends critically on the source of fluctuations. Copyright 1994 by American Economic Association.

Estimates of the Economic Returns to Schooling from a New Sample of Twins

Abstract: This paper uses a new survey to contrast the wages of genetically identical twins with different schooling levels. Multiple measurements of schooling levels were also collected to assess the effect of reporting error on the estimated economic returns to schooling. The data indicate that omitted ability variables do not bias the estimated return to schooling upward but that measurement error does bias it downward. Adjustment for measurement error indicates that an additional year of schooling increases wages by 12 to 16 percent, a higher estimate of the economic returns to schooling than has been previously found. Copyright 1994 by American Economic Association.

Optimal Environmental Taxation in the Presence of Other Taxes: General Equilibrium Analyses

Abstract: This paper examines the optimal setting of environmental taxes in economies where other, distortionary taxes are present. We employ analytical and numerical models to explore the degree to which, in a second best economy, optimal environmental tax rates differ from the rates implied by the Pigovian principle (according to which the optimal tax rate equals the marginal environmental damages). Both models indicate, contrary to what several analysts have suggested, that the optimal tax rate on emissions of a given pollutant is generally less than the rate supported by the Pigovian principle. Moreover, the optimal rate is lower the larger are the distortions posed by ordinary taxes. Numerical results indicate that previous studies may have seriously overstated the size of the optimal carbon tax by disregarding pre-existing taxes.(This abstract was borrowed from another version of this item.)

Poverty, human development and growth : an emerging consensus?

Abstract: This paper considers several issues relevant to the debate on the extent to which poverty, or development progress in general, should be measured by income or by a broader set of objectives Issues covered here are: practical implications of the two approaches for poverty reduction efforts; the impact of growth on basic social indicators; and how national achievement on social indicators is best measured Sri Lanka and Pakistan, countries often cited in this debate, are used as examples

The interaction of population growth and environmental quality.

Abstract: An important question for policy is whether holding constant per capita income and other relevant factors population pressures have a significant effect upon environmental degradation. The authors examine the effect of population pressures upon deforestation in 64 developing countries in an attempt to provide relevant empirical findings. Data on deforestation were drawn from the Food and Agriculture Organizations Production Yearbook. Results suggest that a relationship exists between per capita income and deforestation and that for Africa rural population density shifts the relationship upward. The increase in the rate of deforestation levels off as income increases. The rate of growth in per capita income also has a significant negative impact upon deforestation although the magnitude of the effect is small. The authors close in stressing that reducing the rate of population growth is not necessarily the best way to reduce the rate of deforestation. Deforestation in developing countries is really a problem of market failure. Since property rights are often neither defined nor enforced there is essentially no private cost of deforestation. With no long-term stake in the land people have no incentive to use land efficiently. This situation must be addressed in conjunction with the problems of poverty and population growth.

A Unified Model of Investment Under Uncertainty

Abstract: This paper extends the theory of investment under uncertainty to incorporate fixed costs of investment, a wedge between the purchase price and sale price of capital, and potential irreversibility of investment. In this extended framework, investment is a non-decreasing function of q, the shadow price of installed capital. There are potentially three investment regimes, which depend on the value of q relative to two critical values. For values of q above the upper critical value, investment is positive and is an increasing function of q, as is standard in the theory branch of the adjustment cost literature. For intermediate values of q, between two critical values, investment is zero. Although this regime features prominently in the irreversibility literature, it is largely ignored in the adjustment cost literature. Finally, if q is below the lower critical value, gross investment is negative, a possibility that is ruled out by assumption in the irreversibility of literature. In general, however, the shadow price q is not directly observable, so we present two examples relating q to observable varieties.

Equilibrium in auctions with entry

Abstract: The authors model entry incentives in auctions with risk-neutral bidders and characterize a symmetric equilibrium in which the number of entrants is stochastic. The presence of too many potential bidders raises coordination costs that detract from welfare. The authors show that the seller and society can benefit from policies that reduce market thickness (i.e., the relative abundance of buyers). Their analysis extends well-known revenue-equivalence and ranking theorems but also demonstrates that variations in the auction environment affect optimal policies (e.g., reservation prices) in ways not anticipated by models that ignore entry. Copyright 1994 by American Economic Association.

Does Consumer Sentiment Forecast Household Spending? If So, Why?

Abstract: In the three months following the Iraqi invasion of Kuwait, the University of Michigan's Index of Consumer Sentiment (ICS) fell an unprecedented 24.3 index points, to its lowest level since the 1981-1982 recession.' This collapse in household confidence became the focus of a great deal of economic commentary and, indeed, frequently was cited as an important-if not the leading-cause of the economic slowdown that ensued. Concern was fueled by the well-known contemporaneous correlation between the ICS and the growth of household spending. Figure 1 shows quarterly averages of the index, 1978-1993, together with the quarterly growth in real personal consumption expenditures as measured in the national income accounts (Bureau of Economic Analysis). The correlation is impressive. Of course, it is not surprising that sentiment and the growth of spending are positively correlated. This correlation may simply reflect that, when economic prospects are poor, households curtail their spending and also give gloomy responses to interviewers. Thus, the contemporaneous correlation between sentiment and spending does not refute traditional life-cycle or permanentincome models of consumption. Nor does it necessarily make the job of forecasting changes in consumption any easier. From the point of view of an economic forecaster, the questions of interest are first, whether an index of consumer sentiment has any predictive power on its own for future changes in consumption spending, and second, whether it contains information about future changes in consumer spending aside from the information contained in other available indicators. In Section I, we present evidence that the answer to the first question is a clear yes: we find that lagged values of the ICS, taken on their own, explain about 14 percent of the variation in the growth of total real personal consumption expenditures over the post1954 period. Further investigation shows that the answer to the second question is probably yes as well, though here the margin is narrower and the evidence more murky. The ICS contributes about 3 percent to the R2 of a simple reduced-form equation for total personal consumption expenditures in the longer of the two sample periods we examine, but nothing in the shorter sample period (though the latter result is heavily influenced by the observation for 1980:2). For the major subcategories of spending, the contribution generally ranges between 1 percent and 8 percent. Overall, we read the evidence as pointing toward at least some significant incremental explanatory power. Therefore, we take as given for the remainder of the paper that sentiment forecasts spending, and we turn to the issue of how that statistical relationship should be interpreted. One possible interpretation is that sentiment is an independent driving factor in the economy, and that changes in * Carroll: Division of Research and Statistics, Stop 80, Federal Reserve Board, Washington, DC 20551: Fuhrer: Research Department, Federal Reserve Bank of Boston, Boston, MA 02106: Wilcox: Division of Monetary Affairs, Stop 71, Federal Reserve Board, Washington, DC 20551. We have benefited from the research assistance of Stephen Helwig and Christopher Geczy and the comments of an anonymous referee. The views expressed in this paper are those of the authors and not of the Federal Reserve Board, the Federal Reserve Bank of Boston, or the other members of the staff of either institution. IThe Conference Board's Consumer Confidence Index also plunged at the same time.

Resolving Differences in Willingness to Pay and Willingness to Accept: Reply

Abstract: Gwendolyn C. Morrison (1997) raises a logical point regarding our experimental test of the divergence between willingness to pay (WTP) and willingness to accept (WTA) measures of economic value (Shogren et al., 1994). She argues that our design does not provide a true test of the existence of a fundamental endowment effect since we did not control for the potential of a pivoting indifference map (Daniel Kahneman et al., 1990). She concludes that even though our ev- idence shows that the mean WTP and WTA bids for market goods with close substitutes (e.g., candy bars and coffee mugs) converge after market experience, the endowment effect might still be alive and well, albeit at statisti- cally insignificant levels

Debt and Seniority: An Analysis of the Role of Hard Claims in Constraining Management

Abstract: We argue that long-term debt has a role in controlling management's ability to finance future investments. A company with high (widely-held) debt will find it hard to raise capital, since new security holders will have low priority relative to existing creditors. Conversely for a company with low debt. We show there is an optimal debt-equity ratio and mix of senior and junior debt if management undertakes unprofitable as well as profitable investments. We derive conditions under which equity and a single class of senior long-term debt work as well as more complex contracts for controlling investment behavior.

Is the Glass-Steagall Act justified? A study of the U.S. experience with universal banking before

Abstract: The Glass-Steagall Act of 1933 removed commercial banks from the securities underwriting business. We evaluate the argument for the separation of commercial and investment banking, that conflicts of interest induce commercial banks to fool the public into investing in securities which turn out to be of low quality. A comparison of the performance of securities underwritten by commercial and investment banks prior to the Act shows no evidence of this. Instead, the public appears to have rationally accounted for the possibility of conflicts of interest, and this appears to have constrained the banks to underwrite high-quality securities. (JEL G21, G24, N22)

Productivity Under Group Incentives: An Experimental Study

Abstract: This paper presents an experimental examination of a variety of group incentive programs. We investigate simple revenue sharing and more sophisticated, targetbased systems such as profit sharing or productivity gainsharing, as well as tournament-based and monitoring schemes. Our results can be characterized by three facts: (I) history matters; how a group performs in one incentive scheme depends on its history together under the scheme that preceded it; (2) relative performance schemes outperform target-based schemes; and (3) monitoring can elicit high effort from workers, but the probability of monitoring must be high and, therefore, costly. (JEL J33, C92)

Expropriation and Inventions: Appropriable Rents in the Absence of Property Rights

Abstract: The authors analyze the problem faced by a financially weak independent inventor when selling a valuable, but easily imitated, invention for which no property rights exist. The inventor can protect his or her intellectual property by negotiating a contingent contract (with a buyer) prior to revealing the invention or, alternatively, the inventor can reveal the invention and then negotiate with the newly informed buyer. Despite the risk of expropriation, the authors find that, in equilibrium, an inventor with little wealth can expect to appropriate a sizable share of the market value of the invention by adopting the latter approach. Copyright 1994 by American Economic Association.

Why is Capital so Immobile Internationally?: Possible Explanations and Implications for Capital Income Taxation

Abstract: The evidence on international capital immobility is extensive, including the lack of international portfolio diversification, real interest differentials across countries, and the high correlation between domestic savings and investment. The authors develop a model with asymmetric information between countries that helps rationalize all the above observations and then examine the implications of this model for optimal domestic tax policy. Without asymmetric information, past work showed that small open economies should not impose corporate income taxes. With asymmetric information, the optimal policy instead involves government subsidies to capital imports. Some omitted factors that argue against subsidizing capital imports are explored briefly. Copyright 1996 by American Economic Association.