Working Papers

Authors: Christine Greenhalgh

Sep 2002

The thesis of this paper is that a free-market capitalist economy is biased against supplying basic needs of poor consumers and also biased against creating inventing and using green technology. We begin by identifying the patterns of perverse logic in the system of market supply and in the process of technological advance under capitalism. The first pivotal problem is that economic decision makers place too high a value on the time of the current generation of workers. Hence capitalist markets create and use technologies to produce goods and services that are geared to saving worker and consumer time, instead of being geared to conserving scarce non-renewable resources. A second bias arises because of the existing inequality of wealth and the differential price of time between the rich and the poor. Demands for positional goods for the rich, which are time saving and resource using, crowd out demands to meet basic needs of the poor. Entrepreneurs react by satisfying the dominant, but wasteful, market demands of the rich, both in current supply and by responding to incentives to invent new products and processes that appeal to the rich. This has a further consequence in accentuating inequality, as prices fall and quality rises for products subject to innovation, and in driving up the relative price of skilled labour yet further, refueling the cycle of labour saving innovation at the expense of the environment. Policy to redress these perverse pressures must be far more radical than those currently under discussion in either the `Green` or the `Poverty` forums. We argue for rethinking definitions of private property rights, to attach more importance to use rights than to ownership rights, where the corollary is that lack of use can cause loss of ownership. Although a wealth tax is an obvious first step in reducing the power of the rich to distort production towards resource intensive goods, it is never likely to be sufficient. Within consumption and production, policy should aim to increase the rate of utilisation of all durable consumer goods and productive capital. This requires incentives which promote rental markets for privately owned durables and restore shift working to ensure better capacity utilisation. The taxation of production could also change: incentives to business should be restructured to maximise the use of renewable resources, particularly of unskilled labour, and minimise the use of materials intensive techniques leading to the depletion of reserves and the creation of waste products. Finally the rewards to invention and innovation, whether through R&D tax credits or the award of intellectual property rights, must circumvent the present bias of invention for today`s rich in order to address the needs of today`s and tomorrow`s poor.

JEL Codes: O30, H20

Keywords: efficiency, equity, technology

Reference: 119

Individual View

Authors: Daniel John Zizzo

Sep 2002

Game harmony is a generic game property that describes how harmonious (non-conflictual) or disharmonious (conflictual) the interests of players are, as embodied in the payoffs. Pure coordination games are games of complete harmony,and constant-sum games are games of pure disharmony: the majority of games is somewhere in the middle. This paper provides measures of game harmony that can be used to classify normal form games, and analyzes their properties. Game harmony is positively associated with cooperation, and we review evidence that this is so. Framing effects increasing cooperation may work by increasing perceived game harmony.

JEL Codes: C72, H41

Keywords: game harmony, game classification, framing effects, social dilemmas.

Reference: 116

Individual View

Authors: Daniel John Zizzo, Jonathan H.W. Tan

Sep 2002

This paper presents an experimental test of the relationship between game harmony and cooperation in 2 x 2 games. Game harmony measures describe how harmonious (non-conflictual) or disharmonious (conflictual) the interests of players are, as embodied in the payoffs: coordination games and constant-sum games are examples of games of perfect harmony and disharmony, respectively, with most games being somewhere in the middle. In our experiment we consider a variety of 2 x 2 games, including amongst others the Prisoner`s Dilemma, the Stag-Hunt, the Chicken, a coordination game and three variants of trust games. We find that simple game harmony measures can explain 2/3 (or more) or the variance in mean cooperation rate across these games.

JEL Codes: C72, C91, H41

Keywords: game harmony, cooperation, 2 x 2 games, trust games, social dilemmas.

Reference: 117

Individual View

Authors: Oliver Grant

Sep 2002

This paper presents new estimates of income inequality derived from Prussian tax statistics for the years 1822-1914. Confidence intervals are also calculated. The results show a rise in inequality in the nineteenth century, with a peak around 1906, thus supporting the view put forward by Simon Kuznets that industrialisation will initially lead to a rise in inequality. The paper goes on to consider whether this was due to factors which were particular to Germany in the period, or whether the Kuznets curve is the result of forces which affect all industrialising societies. The conclusion reached is that the Kuznets curve is an avoidable trap, not an automatic consequence of industrialisation.

Reference: 048

Individual View

Financial conglomerates combine banking, insurance and other financial services within a single corporation. In this non-technical paper I consider the rationale for capital regulation in such firms and I examine some current policy questions in the light of this discussion. My first conclusion is that the different institutional structure of bank and insurance companies mitigates against harmonisation of capital requirements across different conglomerate businesses. I also question the received industry view that regulators should account for diversification effects at the holding company level.

Reference: 2002-FE-08

This paper presents estimates of agricultural productivity (net value added per full-time labour unit) for 21 German regions for the years 1880/4, 1893/7 and 1905/9. The estimates are derived from regional accounts for agricultural production and costs. The methods used to draw up these accounts are discussed, and there is also an analysis of Hoffmann’s national agricultural accounts. The estimates show that productivity in East-Elbian agriculture was growing rapidly in the period, and tending to converge on the German average. Productivity in southern Germany was not growing so fast. The reasons for this improvement east of the Elbe are examined using a Kreis-level data set. This shows that yield improvements were not limited to large farms and estates, but that smaller holdings also had access to new technology and improved husbandry methods. In short, East-Elbian agriculture should not be seen as backward or bound by tradition: it was a modern sector capable of rapid improvements in techniques and methods of production.

Reference: 047

Individual View

Authors: Simon GB Cowan, Simon Cowan

Jul 2002

The paper shows how commodity taxes can provide insurance to consumers when the producer price is volatile. Specific and ad valorem taxes have differing roles. The optimal specific tax is positive when demand has some elasticity. The optimal ad valorem rate is zero when demand is unit-elastic, negative when demand is inelastic and positive for elastic demand. When both types of taxes are used in general the specific tax is positive and the ad valorem rate is negative. The model also applies to the problem in public utility regulation of determining how retail prices should move with wholesale or fuel prices.

JEL Codes: H21, L51

Keywords: commodity taxation, price regulation

Reference: 110

Authors: Sujoy Mukerji, Jean-Marc Tallon, EUREQua, CNRS, Universite Paris I

Jul 2002

This paper analyzes optimal wage contracting assuming agents are not subjective expected utility maximizers but are, instead, ambiguity (or uncertainty) averse decision makers who maximize Choquet expected utility. We show that such agents will choose not to include any indexation coverage in their wage contracts even when inflation is uncertain, unless the perceived inflation uncertainty is high enough. Significantly, the exercise does not presume any exogenous costs (e.g. transactions costs) of including indexation links.

JEL Codes: D81, J31

Keywords: wage contracts, indexation, inflation, uncertainty

Reference: 111

Individual View

Authors: Sujoy Mukerji

Jul 2002

This paper provides a positive theory about the contractual form of procurement contracts under cost uncertainty. However, while the cost of manufacture is uncertain it can be reduced by an amount depending on the extent of effort exerted by the agent. The effort exerted by the agent is not verifiable but causes disutility to the agent, hence, its extent will ultimately depend on the power of incentives built into the terms of reimbursement agreed to in the contract. The analysis in the paper explicitly models the possibility that the agent’s beliefs are ambiguous and the agent is ambiguity averse. The principal finding is that the greater the ambiguity/ambiguity aversion of the agent, the lower the power of the incentive scheme incorporated in the terms of reimbursement included in the optimal contract.

JEL Codes: D800, D810, D820, D89

Keywords: procurement, incentive contracts, uncertainty aversion, cost-plus contracts, fixed price contracts

Reference: 112

Authors: Valerie Lechene, Martin Browning, Institute of Economics, Copenhagen, Denmark.

Jul 2002

It is universally accepted that children have important effects on household demand patterns. This is usually attributed to the direct effect of children; for example children are food intensive. Alternative inferences are that the observed correlations between children and demand patterns are due to non-direct effects, such as fixed effects, state dependence or intra-household effects. These non-direct effects make the consistent estimation of direct effects problematic. We employ a French family expenditure survey that has a number of unusual features to explore the source of the correlation between children and demands. In a first set of tests, we use a sample of older households (over-55`s) for whom we have the details of their completed fertility and whether or not they currently have children living at home. We consider only those who do not have children currently living at home. If there are only direct effects then the demand patterns of those who have had children should be the same as those who never had children. We find that this is not the case. For the second set of tests, we use a sample of couples aged up to 55 and test for the exogeneity of children variables using background variables as instruments for children. We find that children are not exogenous for some goods. These two findings together cast doubt on the usual practice of identifying direct children effects with the coefficients on the children variables in demand equations.

JEL Codes: D12, J13

Keywords: children, demand, fixed effects, state dependence, intra-household effects

Reference: 16

Authors: Sujoy Mukerji, Peter Klibanoff, Northwesern University Massimo Marinacci, Dip. di Satistic e Matematica Applicata, Universita di Torino and ICER

Jul 2002

We propose and axiomatize a model of preferences over acts such that the decision maker evaluates acts according to the expectation (over a set of probability measures) of an increasing transformation of an act`s expected utility. This expectation is calculated using a subjective probability over the set of probability measures that the decision maker thinks are relevant given her subjective information. A key feature of our model is that it achieves a separation between ambiguity, identified as a characteristic of the decision maker`s subjective information, and ambiguity attitude, a characteristic of the decision maker`s tastes. We show that attitudes towards risk are characterized by the shape of the von Neumann-Morgenstern utility function, as usual, while attitudes towards ambiguity are characterized by the shape of the increasing transformation applied to expected utilities. We show that the negative exponential form of this transformation is the special case of constant ambiguity aversion. Ambiguity itself is defined behaviorally and is shown to be characterized by properties of the subjective set of measures. This characterization of ambiguity is formally related to the definitions of subjective ambiguity advanced by Epstein-Zhang (2001) and Ghirardato-Marinacci (2002). One advantage of this model is that the well-developed machinery for dealing with risk attitudes can be applied as well to ambiguity attitudes. The model is also distinct from many in the literature on ambiguity in that it allows smooth, rather than kinked, indifference curves. This leads to different behavior and improved tractability, while still sharing the main features (e.g. Ellsberg`s Paradox, etc.). The Maxmin EU model (e.g., Gilboa and Schmeidler (1989)) with a given set of measures may be seen as an extreme case of our model with infinite ambiguity aversion. Two illustrative applications to portfolio choice are offered.

JEL Codes: D800, D810

Keywords: ambiguity, uncertainty, ambiguity aversion, uncertainty aversion, Ellsberg Paradox

Reference: 113

Individual View

Authors: Sujoy Mukerji, Jean-Marc Tallon, CNRS-EUREQua, Universite Paris I

Jul 2002

Results in this note relate the observation of an interval of prices at which a DM strictly prefers to hold a zero position on an asset (termed `bid-ask behavior`) to the DM`s perception of the underlying payoff relevant events as ambiguous, as the term is defined in Epstein and Zhang (2001). The connection between bid-ask behavior and ambiguity is established without invoking a parametric preference form, such as the Choquet expected utility or the max-min multiple priors model. This allows us to draw an observable distinction between bid-ask behavior that may arise purely due to first-order risk aversion type effects, such as those which could arise even if preferences were probabilistically sophisticated, and the bid-ask behavior that involve ambiguity perceptions.

JEL Codes: D810

Keywords: Ellsberg Paradox, bid-ask spread, testing for ambiguity aversion, uncertainty aversion, unforeseen cointingencies, subjective state spaces.

Reference: 114

Authors: M. Asghar ZaidiKlaas de Vos, CentER Applied Research, Tilburg University, The Netherlands

Jul 2002

This paper presents an empirical analysis of the income mobility of older people in Great Britain and the Netherlands, using longitudinal data from the British Household Panel Survey (BHPS) and the Dutch Socio-Economic Panel (SEP) for the period 1991 to 1997. Using the full potential of the panel data and applying appropriate regression analyses, we aim to quantify the impact of various life transitions and attributes on the income of older people in the two countries. An introductory perspective is provided by a brief investigation of the relative economic status of the older population in both countries. We find that the Dutch elderly are on average better-off than their British counterparts, and that the relative position of the elderly has improved in both countries during the 1990s. This improvement, however, was almost entirely due to the better economic status of newly retired people who retire with incomes in addition to the basic state pension. We also provide a brief comparison of the pension systems operating in the two countries. The Dutch basic pension scheme is more generous than the British and, in general, the occupational pension schemes in the Netherlands also appear to be more rewarding in terms of earnings` replacement, in provisions for early retirement and in their coverage for survivors. The empirical analysis on income mobility makes use of appropriate bivariate and multivariate tools. Equivalised household income is used to measure income mobility, and is smoothed over two years in order to reduce the impact of transitory fluctuations. Explanatory variables based on demographic and labour market attributes, as well as income, time–period, and sample attributes, are used to identify factors associated with income mobility in old age. The results show that British elderly are more likely to experience income mobility than their Dutch counterparts. The mobility differential between the two countries is observed for both upward and downward income mobility. This differential is particularly noticeable for long-range upward income mobility (i.e. rises in annual income exceeding 15%). Undoubtedly, some of the income mobility and the differences between both countries may be artefacts due to measurement errors, but it can be safely concluded that for most people old age is not a period of stable fixed incomes. The multivariate analysis of income mobility suggests that a number of demographic, labour market and income attributes significantly correlate with income mobility. In particular, the events of widowhood and changing living arrangements appear to have a notable impact on incomes of older people in both countries. The transition into widowhood is associated with both upward and downward income mobility in the Netherlands, but only with downward income mobility in Great Britain. This differential effect will largely be a consequence of differences in individual entitlements to basic pension for women in the two countries. A change in living arrangements of older people is associated with a higher likelihood of upward as well as downward income mobility in both countries. This empirical exercise highlights the benefits and pitfalls of cross-national research on income dynamics within old age. Improvements in data quality and comparability as well as in methodology are necessary before clear scientific and policy conclusions may be drawn. This study should therefore be considered as a first step in our work on analysing income mobility in old age. Nonetheless, the results provide some pointers towards how the different social security systems affect the income risks associated with various attributes and life-course transitions experienced by older people.

JEL Codes: D31, D63, H55, I32, J14

Keywords: income mobility, old age, life-course events, Great Britain, The Netherlands

Reference: 107

Individual View

Authors: David P. Myatt, Stephen D. Fisher

Jul 2002

Intuition tells us that strategic voting is most likely in marginal constituencies where the preferred party is a long way behind the second placed parity. Some formal theories suggest there should be complete desertion of all but two candidates (Palfrey 1989), or additionally that the second and third will have similar vote shares (Cox 1997). Unfortunately, these theories fail to account for uncertainty over the strength of candidates. We present a model that allows for such uncertainty. It generates interesting and original comparative statics. All three approaches are tested against English voting data from 1987, 1992 and 1997. Our model fits the data; the standard intuition and Cox hypothesis do not. Thus formal theory can improve on intuition. But, this depends on the realization that voters are uncertain, and it is only uncertainty that matters for strategic voting.

JEL Codes: D72

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

Reference: 115

Individual View

Authors: Richard Mash

Jul 2002

The paper presents a monetary policy model with an endogenous capital stock when a backward looking element in wage setting causes inflation persistence. We analyse how the endogeneity of the capital stock changes the macroeconomic dynamics with which policy interacts and its implications for optimal policy and time inconsistency. Capital stock endogeneity makes inflation more persistent in reduced form. This makes the optimal contemporaneous policy response to shocks more vigorous but the subsequent return to steady state more gradual. Observed output becomes more serially correlated. Capital endogeneity can also give rise to disinflation bias under discretion for some parameter values.

JEL Codes: E52, E58, E22, C61

Keywords: monetary policy, time inconsistency, inflation persistence, investment, capital stock

Reference: 108

Individual View

Optimal monetary policy is sensitive to the Phillips curve specification used to represent the dynamics of inflation and output. Most recent literature has used a new Keynesian Phillips Curve based on Calvo pricing. This paper shows that this workhorse model is not robust to relatively minor changes in its microfoundations, in particular allowing for time varying probabilities of a firm being able to reset its price. We derive a general model that nests Calvo and the Taylor staggering model as special cases and analyse its implications for optimal policy, including the relative desirability of inflation and price level targeting.

JEL Codes: E52, E58, E22, C61

Keywords: New Keynesian Phillips Curve, Stabilisation Bias, Forwarding Looking Expectations, Inflation Targeting, Price Level Targeting

Reference: 109

Individual View

Authors: Ariel Buira

Jun 2002

Conditionality is the most controversial aspect of the IMF`s policies. It has been said to be intrusive and coercive and considered to disregard effects on growth, employment and income distribution. In the 1990s, following a sharp increase in the number of conditions required by programs, Fund conditionality became increasingly ineffective. The paper reviews the nature and purpose of conditionality; its origin and evolution over time. It considers whether conditionality is required to safeguard the resources of the Fund. It looks into the reasons for the increase in structural conditionality, relates the increase in conditionality with the marked fall in the rate of compliance with Fund programs and with the relative decline in Fund resources. The paper notes the revision of conditionality recently undertaken at the instance of the Managing Director and considers progress on that front. Finally, certain difficult political questions arising from conditionality are posed and some suggestions presented for increasing country ownership of programs, the key to making conditionality more acceptable and effective.

JEL Codes: F32, F33, F34

Keywords: International Monetary Fund, conditionality, Balance of Payments Adjustment Stand-by agreements

Reference: 104

Individual View

Authors: David P. Myatt, Justin P. Johnson, Johnson Graduate School of Management, Cornell University

Jun 2002

Firms selling multiple quality-differentiated products frequently alter their product lines when a competitor enters the market. We present a model of multiproduct monopoly and duopoly using a general `upgrades` approach that yields a powerful analytical framework. We provide a simple theoretical explanation for the common strategies of using `fighting brands` and of product line `pruning`. We also present a general condition that guarantees that a monopolist will forsake market segmentation opportunities and sell but a single product. A number of previously studied issues can be addressed by our model, including inter-temporal price discrimiation and `damaged goods`.

JEL Codes: D420, D430, L110, L150, L630

Keywords: multiproduct quality competition, fighting brands, product line pruning, focus on quality, price discrimination

Reference: 105

Individual View

Authors: Valerie Lechene, Orazio Attanasio, University College London, Institute for Fiscal Studies and NBER

Jun 2002

Using the Progresa data from Mexico, we investigate intra-household decision making using a variety of outcomes. We exploit both the experimental nature and the (short) panel dimension of the data to measure the impact of exogenous changes in the intra-household distribution of resources on household decisions. We test for global pooling of resources within households, which would correspond to the unitary model of household decision making. We also exploit a set of questions about power and the decision making process in the household to investigate aspects of strategic interactions between household members. Our findings confirm previous rejections of income pooling. We also cannot reject that the wife`s relative income share is a significant determinant of the wife`s decision making power in the household, with a higher share of income associated with more decision making power.

JEL Codes: D12

Keywords: social welfare program, intra-household allocation, unitary model

Reference: 106

Authors: Elaine Tan

Jun 2002

This paper proposes that one function of the open fields was to reduce the transaction costs of cow-keeping by lowering commoners costs of bulling. At enclosure, cow-keeping fell among small owners who, unlike large farmers, had difficulty obtaining bulling services and were not substantial enough to own both the bull and the cow; they were therefore worse off with enclosures. The minimum acreage required to restore cow keepers to their pre-enclosure economic position indicates that even commoners who were given some land at settlement lost out with the change in property rights.

Reference: 046

Individual View

Authors: Simon GB Cowan, Simon Cowan

May 2002

The regulator of a natural monopoly that sets a two-part tariff and whose marginal cost is stochastic will generally want the price to vary less than marginal cost when the lump-sum charge in the tariff is fixed. A trade-off exists between efficient pricing and an optimal allocation of risk. Pricing at marginal cost is only optimal when the consumer`s marginal utility is independent of the price. When marginal utility increases with the price the mark-up falls monotonically as marginal cost rises. The lump-sum element of the tariff should exceed the fixed cost when demand is inelastic and equals the fixed cost only with unit elasticity. The model may also be applied to optimal commodity taxation.

JEL Codes: L51, D42, H21

Keywords: price risk, regulation, Ramsey pricing

Reference: 102

Authors: Natalia Mora Sitja

May 2002

This paper examines labours organisation and labours reward in Catalonia before the first Industrial Revolution. Using new quantitative evidence on urban wages, it first shows that agricultural and urban real wages did not decrease during the last five decades of the pre-industrial period, despite increasing commodity prices. Secondly, it performs an econometric test that shows that wage responses reflected a condition of labour market integration, with occupational and spatial mobility. New data on the characteristics of immigration in Barcelona have been assembled to reinforce previous findings, and to provide new information on the push factors that inclined labourers to migrate. The papers aim is both to test issues long discussed in the literature on labour markets (taking Catalonia as the case study), and to provide new data that may help future research.

Reference: 045

Individual View

Authors: David Bevan

May 2002

Probably the most enduring result in the theory of optimum income taxation is that, for a sufficiently thin upper tail to the skill distribution, the marginal tax rate should fall rather than rise with income. This paper shows that this result is highly sensitive to a very strong informational assumption, namely that earnings exactly reflect a worker`s contribution to output. While the formal structure of the optimum problem is altered only slightly when earnings are allowed to be less than perfectly correlated with productivity, the shape of the optimum schedule is very sensitive to this relaxation. For high but imperfect correlation, optimum schedules look rather like those traditionally chosen by governments, with the marginal rate rising over high incomes and possibly U-shaped over the whole distribution.

JEL Codes: H21, D82

Keywords: income taxation

Reference: 101

Individual View

Authors: William Wilhelm, Alexander Ljungqvist

Apr 2002

IPO initial returns reached astronomical levels during 1999-2000. We show that the regime shift in initial returns and other elements of pricing behavior can be at least partially accounted for by a variety of marked changes in pre-IPO ownership structure and insider selling behavior over the period, which reduced key decision-makers` incentives to control underpricing. After controlling for these changes, the difference in underpricing between 1999-2000 and the preceding three years is much reduced. Our results suggest that it was firm characteristics that were unique during the dot-com bubble and that pricing behavior followed from incentives created by these characteristics.

Reference: 2002-FE-07

Authors: David P. Myatt

Mar 2002

Reference: 94

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