Showing papers in "The American Economic Review in 1998"

Financial Dependence and Growth

Abstract: This paper examines whether financial development facilitates economic growth by scrutinizing one rationale for such a relationship: that financial development reduces the costs of external finance to firms. Specifically, the authors ask whether industrial sectors that are relatively more in need of external finance develop disproportionately faster in countries with more-developed financial markets. They find this to be true in a large sample of countries over the 1980s. The authors show this result is unlikely to be driven by omitted variables, outliers, or reverse causality. Copyright 1998 by American Economic Association.

Stock Markets, Banks, and Economic Growth

Abstract: Do well-functioning stock markets and banks promote long-run economic growth? This paper shows that stock market liquidity and banking development both positively predict growth, capital accumulation, and productivity improvements when entered together in regressions, even after controlling for economic and political factors. The results are consistent with the views that financial markets provide important services for growth and that stock markets provide different services from banks. The paper also finds that stock market size, volatility, and international integration are not robustly linked with growth and that none of the financial indicators is closely associated with private saving rates. Copyright 1998 by American Economic Association.

The new institutional economics

Abstract: This outstanding book presents new original contributions from some of the world’s leading economists including Ronald Coase, Douglass C. North, Masahiko Aoki, Oliver E. Williamson and Harold Demsetz. It demonstrates the extent and depth of the New Institutional Economics research programme which is having a worldwide impact on the economics profession.

Predicting How People Play Games: Reinforcement Learning in Experimental Games with Unique, Mixed Strategy Equilibria

Abstract: We examine learning in all experiments we could locate involving 100 periods or more of games with a unique equilibrium in mixed strategies, and in a new experiment. We study both the ex post ( "best fit") descriptive power of learning models, and their ex ante predictive power, by simulating each experiment using parameters estimated from the other experiments. Even a one-parameter reinforcement learning model robustly outperforms the equilibrium predictions. Predictive power is improved by adding "forgetting" and "experimentation, " or by allowing greater rationality as in probabilistic fictitious play. Implications for developing a low-rationality, cognitive game theory are discussed. (JEL C72, C92)

Monetary Policy Rules Based on Real-Time Data

Abstract: In recent years, simple policy rules have received attention as a means to a more transparent and effective monetary policy. Often, however, the analysis is based on unrealistic assumptions about the timeliness of data availability. This permits rule specifications that are not operational and ignore difficulties associated with data revisions. This paper examines the magnitude of these informational problems using Taylor's rule as an example. I demonstrate that the real-time policy recommendations differ considerably from those obtained with the ex post revised data and are revised substantially even a year after the relevant quarter. Further, I show that estimated policy reaction functions obtained using the ex post revised data can yield misleading descriptions of historical policy. Using Federal Reserve staff forecasts I show that in the 1987-1992 period simple forward-looking specifications describe policy better than comparable Taylor-type specifications, a fact that is largely obscured when the analysis is based on the ex post revised data.

Intellectual Human Capital and the Birth of U.S. Biotechnology Enterprises

Abstract: We examine the relationship between the intellectual capital of scientists making frontier discoveries, the presence of great university bioscience programs, the presence of venture capital firms, other economic variables, and the founding of U.S. biotechnology enterprises during 1976-1989. Using a linked cross-section/time- series panel data set, we find that the timing and location of the birth of biotech enterprises is determined primarily by intellectual capital measures, particularly the local number of highly productive 'star' scientists actively publishing genetic sequence discoveries. Great universities are likely to grow and recruit star scientists, but their effect is separable from the universities. When the intellectual capital measures are included in our poisson regressions, the number of venture capital firms in an area reduces the probability of foundings. At least early in the process, star scientists appear to be the scarce, immobile factors of production. Our focus on intellectual capital is related to knowledge spillovers, but in this case 'natural excludability' permits capture of supranormal returns by scientists. Given this reward structure technology transfer was vigorous without any special intermediating structures. We believe biotechnology may be prototypical of the birth patterns in other innovative industries.

Are Technology Improvements Contractionary

Abstract: Yes. We construct a measure of aggregate technology change, controlling for varying utilization of capital and labor, non- constant returns and imperfect competition, and aggregation effects. On impact, when technology improves, input use and non- residential investment fall sharply. Output changes little. With a lag of several years, inputs and investment return to normal and output rises strongly. We discuss what models could be consistent with this evidence. For example, standard one-sector real-business-cycle models are not, since they generally predict that technology improvements are expansionary, with inputs and (especially) output rising immediately. However, the evidence is consistent with simple sticky-price models, which predict the results we find: When technology improves, input use and investment demand generally fall in the short run, and output itself may also fall.

Unique Equilibrium in a Model of Self-Fulfilling Currency Attacks

Abstract: Even though self-fulfilling currency attacks lead to multiple equilibria when fundamentals are common knowledge, we demonstrate the uniqueness of equilibrium when speculators face a small amount of noise in their signals about the fundamentals. This unique equilibrium depends not only on the fundamentals, but also on financial variables, such as the quantity of hot money in circulation and the costs of speculative trading. In contrast to multiple equilibrium models, our model allows analysis of policy proposals directed at curtailing currency attacks.

Competition between Private and Public Schools, Vouchers, and Peer-Group Effects

Abstract: A theoretical and computational model with tax-financed, tuition-free public schools and competitive, tuition-financed private schools is developed. Students differ by ability and income. Achievement depends on own ability and on peers' abilities. Equilibrium has a strict hierarchy of school qualities and two-dimensional student sorting with stratification by ability and income. In private schools, high-ability, low-income students receive tuition discounts, while low-ability, high-income students pay tuition premia. Tuition vouchers increase the relative size of the private sector and the extent of student sorting, and benefit high-ability students relative to low-ability students.

The Economics of Child Labor

Abstract: If child labor as a mass phenomenon occurs not because of parental selfishness but because of the parents' concern for the household's survival, the popular argument for banning child labor loses much of its force. However, this assumption about parental decision making, coupled with the assumption of substitutability in production between child and adult labor, could result in multiple equilibria in the labor market, with one equilibrium where children work and another where adult wage is high and children do not work. The paper establishes this result and discusses its policy implications. Copyright 1998 by American Economic Association.

Gender Differences in the Allocation of Assets in Retirement Savings Plans

Abstract: In 1995, 40 percent of working men and 32 percent of working women were covered by a defined contribution (DC) plan A distinguishing characteristic of these plans is that workers can generally choose how their assets are invested Using data from the 1992 and 1995 Surveys of Consumer Finances (SCF), this paper examines whether workers differ systematically by gender in the allocation of assets in DC plans Previous researchers have reported that many workers tend to invest their retirement assets too conservatively, and in particular that women are less likely than men to invest in risky assets such as stocks In the presence of an equity premium, a lower propensity by women to invest in stocks could translate into large differences in the accumulation of financial wealth for retirement We establish that gender differences in investment decisions exist, though they are more complicated than previous studies have suggested We show that these differences are not completely explained by differences in individual or household characteristics A few studies have examined gender differences in investment decisions (Vickie L Bajtelsmit and Jack L VanDerhei, 1997; Richard P Hinz et al, 1997) These studies use administrative data and report that women tend to invest their retirement funds in less risky vehicles than men Michael Haliassos and Carol C Bertaut (1995) use the 1983 SCF to examine why such a large fraction of households do not own any stock They report that gender does not have a significant effect on the probability of owning stock, though gender differences are not the focus of their paper What these data sources lack (Haliassos and Bertaut being the exception) is a rich set of demographic and other variables on households that theory predicts should affect investment behavior This paper adds to the literature by examining gender differences in investment decisions conditioning on such variables The results highlight the importance of including marital status, risk-aversion measures, and the portfolio of assets held outside DC plans when examining gender differences in investment decisions in these plans

Multidimensional Uncertainty and Herd Behavior in Financial Markets

Abstract: The authors study the relationship between asset prices and herd behavior, which occurs when traders follow the trend in past trades. When traders have private information on only a single dimension of uncertainty (the effect of a shock to the asset value), price adjustments prevent herd behavior. Herding arises when there are two dimensions of uncertainty (the existence and effect of a shock), but it need not distort prices because the market discounts the informativeness of trades during herding. With a third dimension of uncertainty (the quality of traders' information), herd behavior can lead to a significant, short-run mispricing. Copyright 1998 by American Economic Association.

Regulatory Discretion and the Unofficial Economy

Abstract: Johnson, Kaufmann, and Shleifer (1997) find that the share of the unofficial economy in GDP is determined by the extent of control rights held by politicians and bureaucrats in post-communist economies. Exploring in more detail the role of bribes and using a broader data set from the OECD, Latin America, and transition economies, we find that the unofficial economy accounts for a larger share of GDP when there is more corruption and when the rule of law is weaker. While these findings are consistent with the earlier results for transition economies, in the larger country sample we find it is not necessarily the case that more regulation or higher taxes directly increases the size of the unofficial economy. The problem appears to be not regulation or taxation per se, but whether the state administrative system can operate without corruption. A high level of regulatory discretion helps create the potential for corruption and drive firms into the unofficial economy.

Endogenous growth without scale effects

Abstract: This paper presents a simple R&D-driven endogenous growth model to shed light on some puzzling economic trends. The model can account for why patent statistics have been roughly constant even though R&D employment has risen sharply over the last 30 years. The model also illuminates why steadily increasing R&D effort has not lead to any upward trend in economic growth rates, as is predicted by earlier R&D-driven endoge- nous growth models with the "scale effect" property.

Federalism and the Soft Budget Constraint

Abstract: The government's incentives to bail out inefficient projects are determined by the trade-off between political benefits and economic costs, the latter depending on the decentralization of government. Two effects of federalism are derived: first, fiscal competition among local governments under factor mobility increases the opportunity costs of bailout and, thus, serves as a commitment device (the 'competition effect'); second, monetary centralization, together with fiscal decentralization, induces a conflict of interests and, thus, may harden budget constraints and reduce inflation (the 'checks and balance effect'). The authors' analysis is used to interpret China's recent experience of transition to a market economy. Copyright 1998 by American Economic Association.

Competition, Policy Burdens, and State-Owned Enterprise Reform.

Abstract: One of the most important remaining issues in China's transition to a market economy is the reform of state-owned enterprises (SOE's) When reforms started in late 1978, SOE's dominated China's industrial sectors in every aspect After 18 years of gradual transition, the SOE share in China's total industrial output has declined from 776 percent in 1978 to 288 percent in 1996 However, in 1996 SOE's still employed 574 percent of urban workers and possessed 522 percent of total investment in industrial fixed assets Improving SOE performance is crucial for social stability and sustained growth in China However, over 40 percent of SOE's are losing money In this paper, we will argue that the root of the SOE problem is the separation of ownership and control and that the oftencriticized soft-budget constraints arise from various state-imposed policy burdens, which make the state accountable for the poor perfornance of SOE's The key for a successful SOE reform is to remove the policy burdens and to create a level playing field so that market competition can provide sufficient information for the managerial performance of the SOE's and make the managers' incentives compatible with those of the state)' Io Competition and the Performance of Large Corporation in a Market Economy

Iterated Dominance and Iterated Best-Response in Experimental P-Beauty Contests

Abstract: Picture a thin country 1000 miles long, running north and south, like Chile. Several natural attractions are located at the northern tip of the country. Suppose each of n resort developers plans to locate a resort somewhere on the country's coast (and all spots are equally attractive). After all the resort locations are chosen, an airport will be built to serve tourists, at the average of all the locations including the natural attractions. Suppose most tourists visit all the resorts equally often, except for lazy tourists who visit only the resort closest to the airport; so the developer who locates closest to the airport gets a fixed bonus of extra visitors. Where should the developer locate to be nearest to the airport? The surprising game-theoretic answer is that all the developers should locate exactly where the natural attractions are. This answer requires at least one natural attraction at the northern tip, but does not depend on the fraction of lazy tourists or the number of developers (as long as there is more than one).

Incomplete Contracts and Strategic Ambiguity

Abstract: Why are observed contracts so often incomplete in the sense that they leave contracting parties' obligations vague or unspecified? Traditional answers to this question invoke transaction costs or bounded rationality. In contrast, the authors argue that such incompleteness is often an essential feature of a well-designed contract. Specifically, once some aspects of performance are unverifiable, it is often optimal to leave other verifiable aspects of performance unspecified. The authors explore the conditions under which this occurs, and investigate the structure of optimal contracts when these conditions are satisfied. Copyright 1998 by American Economic Association.

The Prestige Motive for Making Charitable Transfers

Abstract: If people are so self-interested, why do they give their money away to charities? One possibility is that people care about the level of the public good their donations provide. But this is not a good explanation: free-riding typically dominates donating even for people who care a great deal about the good in question, and even in groups that are substantially smaller than those in which people contribute. An alternative explanation for giving is that the benefit comes from the donation itself, not from the good it buys. This idea is ancient. In the Old Testament, God promises those giving to the temple that he will

Monetary policy and multiple equilibria

Abstract: In this paper, we characterize conditions under which interest rate feedback rules whereby the nominal interest rate is set as an increasing function of the inflation rate generate multiple equilibria. We show that these conditions depend not only on the fiscal regime (as emphasized in the fiscal theory of the price level) but also on the way in which money is assumed to enter preferences and technology. We analyze this issue in flexible and sticky price environments. We provide a number of examples in which, contrary to what is commonly believed, active monetary policy in combination with a fiscal policy that preserves government solvency gives rise to multiple equilibria and passive monetary policy renders the equilibrium unique.

Education-Finance Reform and the Distribution of Education Resources

Abstract: Between 1971 and 1996 opponents of local funding for public schools successfully challenged the constitutionality of school-finance systems in sixteen states. Using the variation across states in the timing of these cases the authors investigate the impact of reform on the distribution of school resources. Their results suggest that court-ordered finance reform reduced within-state inequality in spending by 19 to 34 percent. Successful litigation reduced inequality by raising spending in the poorest districts while leaving spending in the richest districts unchanged, thereby increasing aggregate spending on education. Reform led states to fund additional spending through higher state taxes. Copyright 1998 by American Economic Association.

Interest-Group Competition and the Organization of Congress: Theory and Evidence from Financial Services' Political Action Committees

Abstract: We develop a positive theory of how interest-group competition shapes the organization of Congress and use it to explain campaign contribution patterns in financial services. Since interest groups cannot enforce fee-for-service contracts with legislators, legislators have an incentive to create specialized, standing committees which foster repeated dealing between interests and committee members. The resulting reputational equilibrium supports high contributions and high legislative effort for the interests. Contribution patterns by competing interests in the congressional battle over whether banks can enter new businesses support the theory, which also has implications for term limits and campaign reform.

Caps on Political Lobbying

Abstract: The cost of political campaigns in the U.S. has risen substantially in recent years. For example, real spending on congressional election campaigns doubled between 1976 and 1992 (Steven D. Levitt [1995]). There are many reasons why increased campaign spending might be socially harmful. First, increased spending means increased fund-raising, which may keep politicians from their legislative duties.1 Second, a lobbyist who makes a large campaign contribution may have undue influence on electoral outcomes, on the shaping of legislation, or on the outcome of regulatory proceedings.2 That is, the socially preferred candidate or legislation may not prevail. Likewise, a lobbyist involved in a regulatory matter or a competition for a government contract may benefit unduly from a legislator's intervention.3 Third, a perception that campaign contributions purchase influence may lead to increased tolerance of corruption in the private sector. A desire to control campaign spending has spawned many initiatives to limit both campaign contributions and spending, beginning with the passage of the Federal Election Campaign Act (FECA). Political Action Committees (PACs) can contribute at most $5,000 per election to a candidate, while individuals can contribute at most $1,000. (Restrictions have also been put on in- kind contributions, making it more difficult to circumvent these limits.)4 While direct restrictions on campaign spending have proven difficult to implement, recent initiatives aim to impose voluntary spending limits and stricter limits on contributions.5 Despite the existing legislation and the proposals to limit contributions, little is known about the impact of contribution limits on aggregate expenditures. While it is intuitively appealing that aggregate expenditures would drop, we challenge that intuition here. We study a lobbying game and show that a cap on individual lobbyists' expenditures may have the perverse effect of increasing aggregate expenditures and lowering total surplus. This result suggests that a cap on campaign contributions may increase aggregate contributions.6 The next section presents the model and describes the equilibrium when lobbyists are unconstrained. We then solve for the equilibrium when lobbyists face a cap on individual expenditures. When a cap constrains the high-valuation lobbyist, a lobbyist with a lower valuation for the political prize becomes relatively more aggressive. As a consequence, total lobbying expenditures may rise. Since the high-valuation lobbyist's probability of winning the prize drops, the cap reduces total surplus if private and social valuations coincide. Concluding remarks are contained in the final section.

Winners and losers in Russia's economic transition

Abstract: The transition to a market economy has produced a substantial and rapid change in the wage structure in Russia. Household surveys taken before and after the transition indicate that overall wage inequality nearly doubled from 1991 to 1994 and has reached a level higher than that in the United States. Returns to both measured skills (education, occupation) and unmeasured skills within groups have increased considerably. Skill premiums across experience groups, however, have become more compressed and relative wages of older workers have declined. In addition, female wages have declined relative to male wages across all percentiles of the wage distribution. Copyright 1998 by American Economic Association.

Aging and Inequality in Income and Health

Abstract: In our earlier work, we used data from the National Health Interview Survey (NHIS) to examine life-cycle patterns in health status and in the joint distribution of health status and income (Deaton and Paxson, 1998). In this paper we summarize and extend those results, and provide new evidence from the Panel Study of Income Dynamics (PSID). Both surveys contain a measure of household income, and collect information on an ordinal measures of self-reported health status (SRHS) that ranges from 1 (excellent) to 5 (poor). Section I concerns problems related to the measurement of inequality in health. Section II presents evidence from the two surveys on health and income inequality.(This abstract was borrowed from another version of this item.)

The Market for Sulfur Dioxide Emissions

Abstract: The 1990 Clean Air Act Amendments initiated the first large-scale use of the tradable permit approach to pollution control The theoretical case for this approach rests on the assumption of an efficient market for emission rights The authors' empirical analysis shows that the emission rights market created by the 1990 Amendments had become reasonably efficient by mid-1994 They also show that the auctions specified in the Amendments to jump-start trading had become a small part of the overall market Finally, the authors demonstrate that the strategic bidding behavior discussed in the literature has had no effect on market prices Copyright 1998 by American Economic Association