Working Papers

Authors: Marcel Fafchamps

Jan 2003

Drawing insights from the literature on credit and labor markets and from the author`s own survey work on contractual practices among manufacturers and traders in Africa, this paper investigates the spontaneous emergence of markets in the presence of heterogeneous agents. Using a dynamic game setting, we derive precise conditions under which relational contracting spontaneously emerges and deters opportunistic breach of contract even in the absence of formal market institutions. Exclusion of cheaters from future trade is not required for exchange to begin. Markets at early stages of development are characterized by trade based on mutual trust and on the sharing of information among acquaintances. As markets develop, newcomers may be excluded from trade when screening costs are high and agents long lived. Reputational equilibria in which cheaters are permanently excluded from trade are not decentralizable unless markets are already developed and breach of contract is interpreted as a sign of impending bankruptcy. Market emergence is a path dependent process.

JEL Codes: O1, K0, P5

Keywords: market institutions, information sharing, networks, social capital, path dependence

Reference: 138

Individual View

Authors: Marcel Fafchamps, Forhad Shilpi,DECRG, The World Bank

Jan 2003

Theories of city formation typically revert around agglomeration externalities driven by returns to specialization. Using survey data from Nepal, we test these theories by examining the relationship between proximity to urban centers and the organization of labor. We show that wards located in and near cities have more diversified and more market oriented activities. This suggests returns to specialization harnessed through the market. Wage work, work away from home, and unemployment are more prevalent in and around cities. These effects are felt up to four hours of travel time from large cities. We also find evidence of a weak relationship between city size and firm size. Urban specialization, however, does not extend to household chores. Urbanization is associated with lower female labor market participation and with specialization of women in market-related activities or strictly home-based chores.

JEL Codes: R12, 018

Keywords: spatial specialization, urbanization, household chores

Reference: 139

Individual View

Authors: Marcel Fafchamps, Christine Moser, Cornell University.

Jan 2003

This paper investigates the relationship between criminal activity and geographical isolation. Using data from Madagascar, we show that, after we control for population composition and risk factors, crime increases with distance from urban centers and, with few exceptions, decreases with population density. In Madagascar, crime and insecurity are associated with isolation, not urbanization. This relationship is not driven by placement of law enforcement personnel which is shown to track crime but fails to reduce feelings of insecurity in the population. Other risk factors have effects similar to those discussed in the literature on developed countries. We find a positive association between crime and the presence of law enforcement personnel, probably due to reporting bias. Law enforcement personnel helps solve crime but appears unable to prevent it.

JEL Codes: K42, O18.

Keywords: criminal activity, distance from city, rule of law.

Reference: 140

Individual View

Authors: Marcel Fafchamps

Jan 2003

This paper examines how wealth accumulation and risk sharing affect the evolution of inequality over time. We first assume risk sharing away and examine how inequality evolves over time when agents accumulate an asset. If asset accumulation is unbounded and the asset yields a positive return, inequality converges to single value over time. If the asset yields a zero or negative return (e.g., grain storage), there is no persistent inequality but inequality is nevertheless correlated over time. If wealth yields a positive return but is in finite supply (e.g., land), persistent inequality arises if one agent is more thrifty than the other. Multiple equilibria may obtain. Societies might prevent polarization by closing down markets in such assets. We then introduce risk sharing. With perfect risk sharing, welfare inequality is constant across time. For continued participation to mutual insurance to be voluntary, asset inequality must remain `close` to welfare inequality. With imperfect commitment, the end result is a hybrid situation half-way between the risk sharing model and the pure accumulation model. If risk aversion is high for poor agents but low for rich ones, patronage arises whereby the rich on average take away from the poor.

JEL Codes: D31, O16

Keywords: dynamic inequality, poverty dynamics, risk sharing

Reference: 141

Individual View

Authors: Tim Jenkinson, Alan Morrison, William Wilhelm

Jan 2003

In contrast to practice in the U.S., European IPOs are very rarely priced outside the indicative price range, and frequently are priced at its upper bound. We develop a model that provides a rationale for this seemingly inefficient pricing behaviour. The model allows for the practice, observed in Europe but not in the U.S., whereby underwriters obtain information from investors prior to establishing the indicative price range. With this alternative staging of the information game, first studied by Benveniste and Spindt (1989), a commitment to not exceeding the upper bound is necessary to extract private information from investors. The model has important implications for empirical research based on European primary market data.

Reference: 2003-FE-05

Authors: Christine Greenhalgh, Mark Longland, Oxford Intellectual Property Research Centre

Dec 2002

We construct a unique panel dataset to examine how R&D and intellectual property (IP), via patents and trade marks, increase firm productivity. Knowledge has public good characteristics of non-depletability and non-excludability. Even with IP, imitation and inventing around other firm`s products is possible, so we examine the size and duration of benefits to IP protection. If non-depletion is correct, this implies that absolute R&D, or total IP assets are important. We examine this hypothesis against the alternative of depletability, where innovative intensity relative to the size of the firm matters. The results support rapid depletability and poor ability to exclude.

JEL Codes: L11, L60, O33, O34

Keywords: intellectual property, R&D, value added, manufacturing

Reference: 134

Individual View

Authors: Christine Greenhalgh, Padraig Dixon

Dec 2002

This paper reviews the literature on the economics of intellectual property rights (IPR), with a particular focus on the main industrial property rights of patents and trade marks. Intellectual property rights arise from the legal protection accorded to certain inventions or creations. We begin with a review of studies of innovation and IPR incidence, including their relationship with market structure. Our second topic is the valuation of IPR, which has been attempted via cost-based methods and econometric studies of productivity and market value. The cost incurred in the enforcement of IPR is a growing practical concern, but the literature here is less rich than for valuation. Our fourth topic is the relationship between public science and industry, which has been evolving rapidly in recent years. We then examine policy for the promotion of IPR both in the domestic policy arena and in the international context of the TRIPS agreement. We conclude with a list of suggested questions for future research.

JEL Codes: K0, L0, O3

Keywords: intellectual property, R&D, patents, trade marks, technology

Reference: 135

Individual View

Authors: Juan ToroNatalia Fabra, Universidad Carlos III de Madrid

Dec 2002

We analyze the time-series of prices in the Spanish electricity market by means of a time varying-transition-probabilities Markov Switching model. Accounting for demand and supply conditions, we show that the time-series of prices is characterized by two significantly different price levels. Based on a Green and Porter type of model that specifically introduces the rules of the bidding process, we construct several triggers for price wars. The triggers considered are statistically significant and report the predicted signs. In particular, price wars are triggered by unexpected changes in the major generators` market shares and revenues. We obtain more empirical support to Green and Porter`s model than previous studies.

JEL Codes: C22, L13, L94

Keywords: electricity markets, tacit collusion, Markov Switching

Reference: 136

Individual View

Authors: Oliver Board

Dec 2002

The standard model of an extensive form game rules out an important phenomenon in situations of strategic interaction: deception. Using examples from the world of ancient Greece and from modern-day Wall Street, we show how the model can be generalized to incorporate this phenomenon. Deception takes place when the action observed by a player is different from the action actually taken. The standard model does allow imperfect information (modeled by non-singleton information sets), but not deception: the actual action taken is never ruled out. Our extension of extensive form games relaxes the assumption that the information sets partition the set of nodes, so that the set of nodes considered possible after a certain action is taken might not include the actual node. We discuss the implications of this relaxation, and show that in certain games deception is inconsistent with common knowledge of rationality even along the backward induction path. `You are to hear now how the Greeks tricked us. From this one proof of their perfidy you may understand them all` (Aeneas).

JEL Codes: C72, D82

Keywords: deception, extensive form games, information

Reference: 137

Individual View

Authors: Colin Mayer, Julian Franks, Stefano Rossi

Dec 2002

In the first half of the twentieth century, the UK capital markets were marked by an absence of investor protection; by the end of the century, there was more extensive protection there than virtually anywhere else in the world. The UK therefore provides an exceptional laboratory for evaluating how regulation affects the development of securities markets and corporations. We investigate this question by tracing the ownership and board composition of firms incorporated around 1900 over the subsequent 100 years and comparing the pattern of ownership and control with a sample incorporated around 1960. We find that at the beginning of the century there were active securities markets, firms were able to raise substantial outside equity finance, and there was rapid dispersion of ownership even in the absence of investor protection. The introduction of investor protection in the second half of the century was not associated with greater dispersion of ownership but with more trading in share blocks. We offer an explanation as to how U.K. capital markets could flourish in the absence of investor protection.

Reference: 2003-FE-01

Authors: David P. Myatt, Stephen D. Fisher

Dec 2002

Simple plurality election systems (commonly known as `First-Past-The-Post`) are often associated with the dominance of two political parties. Such systems tend to reward leading parties with too many seats (known as the `mechanical` effect) and provoke tactical voting, where voters switch away from trailing parties (known as the `psychological` effect). We view tactical voting as a coordination problem. A group of voters wish to prevent a win by a disliked party (such as the Conservatives in recent UK elections) and must partially coordinate behind a single challenger (such as Labour or the Liberal Democrats) in order to do this. Crucially, voters have limited information on the situation within their constituency and hence there is no common knowledge of the game being played - tactical voting is a global game. We show that in this setting, voters will only partially coordinate. Furthermore, tactical voting exhibits negative feedback - tactical voting by others reduces the incentive for an individual to vote tactically, since they become concerned that they may switch in the wrong direction. We calibrate our model, and apply it to the UK General Election of 1997. Throughout England, we find that the `mechanical` and `psychological` effects tend to offset each other: Tactical voting serves to reverse the Conservative bias that results from the geographic distribution of votes.

JEL Codes: D72

Keywords: strategic voting, tactical voting, Duverger`s Law, plurality rule, elections

Reference: 133

Individual View

Authors: Mary Silles, Peter Dolton, Department of Economics, University of Newcastle

Nov 2002

The massive transition to higher education and the large number of university graduates taking school-leavers` jobs has led many to question the widely held view that a university education is a good investment and a guarantee of economic success. This paper using data from one large civic university in the UK to consider the determinants and consequences of over-education. Approximately one in five graduates genuinely have more education than their jobs require. This study tests and rejects the hypothesis of non-random selection into over-education among graduates who have been in the labour market for some time. In addition, the evidence strongly suggests that ordinary least squares systematically underestimate the magnitude of the negative effects of over-education of earnings.

JEL Codes: I21, J31

Keywords: educational economics, wage differentials

Reference: 126

Individual View

Authors: Mary Silles, Peter Dolton, Department of Economics, University of Newcastle

Nov 2002

Several studies for the UK and other countries have shown that a significant number of university graduates are in jobs that do not require a university degree i.e., over-educated. This paper using data from one large civic university in the UK investigates the true incidence and determinants of over-education. The results indicate that previous studies have largely over-stated the extent of over-education in the graduate labour market. Various labour market constraints as well as the vocational orientation of educational qualification were shown to be among most important factors that influence graduate placement.

JEL Codes: I21, J31

Keywords: educational economics, wage differentials

Reference: 127

Individual View

Authors: Katsushi Imai, Raghav Gaiha, University of Delhi

Nov 2002

This paper focuses on vulnerability of rural households to poverty when a negative crop shock occurs. Of particular concern is the possibilty of some sections experiencing long spells of poverty as a consequence of such shocks. The analysis is based on the ICRISAT panel survey of households in a semi-arid region in south India during 1975-84. Using alternative specifications that take into account direct effects of crop shocks as well as their indirect effects through asset adjustment, an assessment of vulnerability of different groups of households (e.g. classified on the basis of caste affiliation) is carried out. Whether transfers of land and non-land assets would reduce significantly their vulnerability is also examined. A reorientation of anti-poverty strategy is necessary to avoid welfare losses from negative crop shocks that are frequent and occasionally large.

JEL Codes: H53, I32, Q15

Keywords: shocks, dynamics, vulnerability, transfers, poverty

Reference: 128

Individual View

Authors: Alan Beggs

Nov 2002

This paper uses the theory of large deviations to analyse equilibrium selection in one-dimensional games with large populations where the system evolves according to a jump Markov process. The equilibria selected maximise a quasi-potential function which can be determined by solving a polynomial equation. Estimates of waiting times are also given. It shows that equilibria about which there is more noise are less likely to be selected and clarifies the role of the limiting deterministic dynamic in selection.

JEL Codes: C72, C73

Keywords: equilibrum selection, large deviations, large populations, games

Reference: 129

Authors: Gavin Cameron, Chris Wallace

Nov 2002

During the Bretton Woods era, OECD countries grew at historically unprecedented rates. This Golden Age has many possible explanations, ranging from the return to liberal policies in international trade to a backlog of profitable growth opportunities after the neglect of the 1930s and war-time damage. Eichengreen (1996) has argued the the proximate cause of the rapid growth was high investment, and that this high investment was made possible by certain institutions that were particularly well suited to reconstruction and growth. On the domestic side, these institutions led to high investment rates and moderate wage claims. This paper interprets the interaction between unions and firms as a coordination game. The risk-dominant equilibrium is selected via a global game argument. Only small changes to the payoffs are necessary to explain a change in the selected equilibrium, and therefore, the growth slowdown.

JEL Codes: N14, C70, E22

Keywords: coordination games, global games, risk-dominance, Bretton Woods, macroeconomic performance, institutions

Reference: 130

Individual View

Authors: Kathryn Graddy, Orley Ashenfelter, Princeton University and NBER

Nov 2002

This paper contains a review of the burgeoning research that has been designed to shed light on how the art auction system actually works and what it indicates about price formation. First, we find that in recent years returns on art assets appear to be little different from returns on other assets. In addition, some researchers have found that because of the weak correlation between art asset returns with other returns, there may be a case for the inclusion of art assets in a diversified portfolio. Second, we find evidence of several anomalies in art market pricing. The evidence clearly suggests that, contrary to the view of the art trade, masterpieces underperform the market. In addition, there is considerable evidence that there are fairly long periods in which art prices may diverge across geographic areas and even auction houses. Third, we review the public record of the criminal trial of Sotheby`s former Chairman, who was accused of price fixing, to show how the collusion with Christie`s, the other great public auction house, was actually engineered. Contrary to the way the proceeds from the settlement of the civil suit in this case were distributed, we show that buyers were almost certainly not injured by the collusion, but that sellers were. In addition, based on the public record of settlement, it appears that the plaintiffs in the civil suit were very handsomely repaid for their injury. Finally, we review the extensive research on the effects of the auction institution on price formation. There is now considerable theoretical research on strategic behavior in auctions, much of it in response to empirical findings, and we review three key findings. First, the evidence suggests that art experts provide extremely accurate predictions of market prices, but that these predictions do not optimally process the publicly available information. Second, high reserve prices, and the resulting high unsold (buy-in) rates are best explained as optimal search in the face of stochastic demand. Third, extensive research has documented that the prices of identical objects are more likely to decline than to increase when multiple units are sold, and this has led to considerable theoretical research. Subsequent empirical research has tended to document declining demand prices even when the objects are imperfect substitutes.

JEL Codes: D44, G11, L12

Keywords: auctions, art, price anomalies, asset returns, price fixing

Reference: 131

Individual View

Authors: Ernesto Dal Bo

Nov 2002

When optimal policymaking is subject to dynamic inconsistencies (Kydland and Prescott, 1977), but shocks hit the economy after private agents form expectations, there is a trade off between the need to commit to a policy, and the need to retain discretion so as to respond to shocks. Rogoff (1985) shows that a way to strike the right balance between commitment and flexibility in monetary policy is to appoint a conservative central banker. I show that a rationale for using a committee to make decisions through voting is that a commitment device can be created out of it, without totally renouncing flexibility to respond to unexpected contingenices. Appropriate voting procedures and a well chosen supermajority rule can make a randomly sampled committee behave like Rogoff`s optimally conservative central banker. The model is developed for the case of monetary policy but these insights are more general (extending to capital taxation and patent protection). Supermajority rules can mitigate time inconsistency by introducing a status quo bias. When voting institutions (ie. the committee`s constitution) are endogenously chosen by simple majority voting, the emerging majority rule is the supermajority yielding the mix of commitment and flexibility preferred by the median voter. A corollary to this provides a theory of why constitutional reform typically requires the approval of a supermajority.

JEL Codes: D71, D72, E58, H11

Keywords: supermajorities, committees, commitment versus flexibility, voting, endogenous institutions, endogenous constitutions

Reference: 132

Individual View

Authors: Oliver Board

Nov 2002

The epistemic program in game theory uses formal models of interactive reasoning to provide foundations for various game-theoretic solution concepts. Much of this work is based around the (static) Aumann structure model of interactive epistemology, but more recently dynamic models of interactive reasoning have been developed, most notably by Stalnaker[39] and Battigalli and Siniscalchi [6], and used to analyze rational play in extensive form games. But while the properties of Kripke structures are well understood, without a formal language in which belief and belief revision statements can be expressed, it is unclear exactly what are the properties of these dynamic models. Here we investigate this question, by defining such a language. A semantics and syntax are presented, with soundness and completeness theorems linking the two.

JEL Codes: C73, D82, D83

Keywords: interactive epistemology, belief revision, semantic, syntactic

Reference: 125

Individual View

Authors: Christopher Adam, David Bevan

Oct 2002

This paper examines the relation between fiscal deficits and growth for a panel of 45 developing countries. Based on a consistent treatment of the government budget constraint, it finds evidence of a threshold effect at a level of the deficit around 1.5% of GDP. While there appears to be a growth payoff to reducing deficits to this level, this effect disappears or reverses itself for further fiscal contraction. The magnitude of this payoff, but not its general character, necessarily depends on how changes in the deficit are financed (through changes in borrowing or seigniorage) and on how the change in the deficit is accommodated elsewhere in the budget. We also find evidence of interaction effects between deficits and debt stocks, with high debt stocks exacerbating the adverse consequences of high deficits.

JEL Codes: H3, H6, O4

Keywords: fiscal defcits, growth, threshold effects, developing countries

Reference: 120

Authors: John Knight,Linda Yueh

Oct 2002

Social capital is thought to play an economic role in the labour market. It may be particularly pertinent in one that is in transition from an administered to a market-oriented system. One factor that may determine success in the underdeveloped Chinese labour market is thus guanxi, the Chinese variant of social capital. With individual-level measures of social capital, we test for the role of guanxi using a data set designed for this purpose, covering 7,500 urban workers and conducted in early 2000. The basic hypothesis is supported. Both measures of social capital - size of social network and Communist Party membership - have significant and substantial effects in the income functions. Indeed, social capital may be just as important as human capital: remarkably, one additional reported contact contributes more than one additional year of education. Social capital can have influence either in an administered system or in one subject to market forces. We find that it does so in both parts of the labour market, but some of the evidence suggests that it is more important in the latter.

JEL Codes: J30, J40

Keywords: labour markets, wages, social capital, social networks, China

Reference: 121

Authors: David Vines, Gordon Douglas Menzies, Economic Research Department, Reserve Bank of Australia.

Oct 2002

We develop a stylized real model of the Asian crisis where an adverse extenal shock can lead to real exchange rate overshooting. Domestic borrowers of foreign capital are bound by debt contracts even when the capital is unable to earn the world rate of return. Following an adverse shock, the requirement to honour these debt contracts leads to a debt overhang. In the long run, when capital becomes mobile, extra-marginal projects are shut down as capital departs, and the real exchange rate falls by more than the terms of trade shock. In the short run, the real exchange rate is partly determined by demand conditions by means of what we call the wage and overhang multipliers. For reasonable production and consumption parameters, the short run real exchange rate - driven by the wage and overhang multipliers - overshoots its long run value.

JEL Codes: F11, F31

Keywords: Asian crisis, exchange rate overshooting, mulitplier, overhang

Reference: 122

Individual View

Authors: Christian List

Oct 2002

Drawing on the so-called `doctrinal paradox`, List and Pettit (2002a) have shown that, given an unrestricted domain condition, there exists no procedure for aggregating individual sets of judgments over multiple interconnected propositions into corresponding collective ones, where the procedure satisfies some minimal conditions similar to the conditions of Arrow`s theorem. I prove that we can avoid the paradox and the associated impossibility result by introducing an appropriate domain restriction: a structure condition, called unidimensional alignment, is shown to open up a possibiity result, similar in spirit to Black`s median voter theorem (1948). Specifically, I prove that, given unidimensional alignment, propositionwise majority voting is the unique procedure for aggregating individul sets of judgments into collective ones in accordance with the above mentioned minimal conditions.

JEL Codes: D71, D72

Keywords: aggregation, beliefs, propositional logic, domain restriction, unidimensional alignment

Reference: 123

Individual View

Authors: Natalie Gold, Christian List

Oct 2002

A `framing` effect occurs when an agent`s choices are not invariant under changes in the way a choice problem is formulated, e.g. changes in the way the options are described (violation of description invariance) or in the way preferences are elicited (violation of procedure invariance). In this paper we examine precisely which classical conditions of rationality it is whose non-satisfaction may lead to framing effects. We show that (under certain conditions), if (and only if) an agent`s initial dispositions on a set of propositions are implicitly inconsistent, her decisions may be path-dependent, i.e. dependent on the order in which the propositions are considered. We suggest that different ways of framing a choice problem may induce the order in which relevant propositions are considered and hence affect the decision made. This theoretical explanation suggests some observations about human psychology which are consistent with those made by psychologists and provides a unified framework for explaining violations of description and procedure invariance.

JEL Codes: D11, D80

Keywords: framing, preference reversal, path-dependence, rationality, deductive closure

Reference: 124

Individual View

Authors: Daniel John Zizzo

Sep 2002

The experiment presented in this paper employs 3x3 games to analyze how perception of a game affects behavior in the presence or absence of a minimal framing effect and of uncertainty about the values of some game payoffs. We vary the harmony of practice stage games, and explain how this changes later behavior. We employ techniques, such as payoff integration and similarity evaluations, that could be used in further research to open the black box of framing effects. Game harmony is a measure summarizing how harmonious the interests of the players are in the game. It is associated with cooperation.

JEL Codes: C72, C91, D83

Keywords: 3 x 3 games, game harmony, cooperation, cognitive game theory

Reference: 118

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