Working Papers

Authors: Valerie Lechene, Ian Preston, University College London and Institute for Fiscal Studies

Dec 2000

Maximisation of utility by a single consumer subject to a linear budget constraint is well known to imply strong restrictions on the properties of demand functions. Empirical applications to data on households however frequently reject these restrictions. In particular such data frequently show a failure of Slutsky symmetry - the restriction of symmetry on the matrix of compensated price responses. Browning and Chiappori (1998) show that under assumptions of efficient within-household decision making, the counterpart to the Slutsky matrix for demands from a k member household will be the sum of a symmetric matrix and a matrix of rank k 1. We establish the rank of the departure from Slutsky symmetry for couples under the assumption of Nash equilibrium in individual demands with both partners contributing to all public goods. We show that the Slutsky matrix is the sum of a symmetric matrix and another of rank at most 2. This result implies not only that the Browning-Chiappori assumption of efficiency can be tested against other models within the class of those based on individual optimisation, but also that the hypothesis of Nash equilibrium in demands has testable content against a general alternative.

JEL Codes: D11, C72

Keywords: Nash equilibrium, intra-household allocation, Slutsky symmetry

Reference: 52

Individual View

Authors: Gavin Cameron

Dec 2000

The growth process for a technological leader is different from that of a follower. While followers can grow through imitation and capital deepening, a leader must undertake original research. This suggests that as the gap between the leader and the follower narrows, the follower must undertake more formal R&D and possibly face a slower overall growth rate. This paper constructs measures of relative total factor productivity for eleven Japanese manufacturing industries and uses dynamic panel data methods to test whether a smaller productivity gap leads to slower growth, and whether R&D takes over as the engine of growth as Japan approaches the technological frontier. The results suggest that Japanese and US productivity have been growing at similar rates since the mid-1970s, and that some of the Japanese growth slowdown is attributable to the exhaustion of imitation possibilities.

JEL Codes: C13, C23, O30, O47

Keywords: economic growth, total factor productivity, catch-up, innovation, heterogeneous dynamic panels

Reference: 45

Individual View

Authors: Abigail Barr, Truman Packard

Dec 2000

Using survey data and a field experiment to measure agents` risk and time preferences, we identify the agent-type that is free to reveal its preferences through decisions about pension system participation. Thus, we show that in Chile the appropriate focus for policy makers interested in the welfare-enhancing effects of such participation are the self employed. They are indistinguishable from other economically active agents with respect to time and risk preferences and sort into participants and non-participants in the pension system with reference to those preferences. In contrast, employees are rationed. The more patient and less risk averse self employed participate.

JEL Codes: C93, G23, J23

Keywords: field experiment, time preference, risk aversion, pension reform, self employment

Reference: 53

Individual View

Authors: Sujoy Mukerji, Jean-Marc Tallon, Université Paris I Panthéon-Sorbonne

Dec 2000

It is widely thought that incomes risks can be shared by trading in financial assets. But financial assets typically carry some risk idiosyncratic to them, hence, disposing incomes risk using financial assets will involve buying into the inherent idiosyncratic risk. However, standard theory argues that diversification would reduce the inconvenience of idiosyncratic risk to arbitrarily low levels. This argument is less robust than what standard theory leads us to believe: ambiguity aversion can exacerbate the tension between the two kinds of risk to the point that classes of agents may not want to trade some financial assets. Thus, theoretically , the effect of ambiguity aversion on financial markets is to make the risk sharing opportunities offered by financial markets less complete than it would be otherwise.

JEL Codes: D81, D52

Keywords: ambiguity aversion, incomplete markets, sub-optimal risk sharing

Reference: 46

Individual View

Authors: George Speight

Dec 2000

Although the high level of private house-building in the 1930s was an important episode in Britains economic and social development, the literature has not addressed adequately the nature of the demand for these houses. In particular, the class and income characteristics of their purchasers are poorly understood. The conventional wisdom in this area is due to Swenarton and Taylor, who have argued that the vast majority of house buyers were middle class and that few manual workers could afford to buy. In fact their argument contains several important flaws. This paper uses a broader and more reliable collection of evidence to show that working-class households broadly construed bought a large proportion of new houses from 1932-3 onwards. (The six years 1933 to 1938 account for well over half of all houses built privately in the interwar period.)

Reference: 038

Individual View

Authors: Tarun Khanna, Yishay Yafeh

Dec 2000

Researchers commonly assume that business groups, a ubiquitous organizational form in emerging markets, permit affiliated firms to share risk by smoothing income flows and by reallocating money from one affiliate to another in times of distress. This view has received support in the literature on Japanese keiretsu. To examine the generality of these findings worldwide, we amass a new data set on business groups in 15 emerging markets, and couple this with historical and modern data from Japan. Our results, using multiple estimation techniques, corroborate the existing evidence on risk sharing within the Japanese keiretsu. In addition, in some emerging markets such as Brazil, Korea, Taiwan and Thailand, we find evidence suggesting that group affiliation is associated with a 20 – 30 percent reduction in the standard deviation of operating returns. We also find evidence of substantial â€

Reference: 2001-FE-02

Authors: Richard Mash

Dec 2000

The paper is concerned with foreign investment in developing countries and the incentives offered to attract that investment in relation to the use of a possible future multilateral investment agreement as a commitment device over incentive levels. The existing literature has identified two sources of benefit from such commitment, firstly to avoid time inconsistency problems whereby incentives are less effective than otherwise because investors fear that they may be reduced once sunk costs have been incurred, and secondly to avoid excessive competition for foreign investment. This paper demonstrates a third benefit from commitment which arises from low host country bargaining power when negotiating incentive levels with foreign investors. If bargaining power is low, incentives agreed under bargaining will be generous to the investor and host country welfare will be lower than otherwise. It is shown that this consequence of low bargaining power may be avoided if host countries can commit themselves in advance to provisions that limit the incentives they may subsequently agree with foreign investors. It is argued that provisions of this kind should be optional from a host country perspective since those with low bargaining power will gain from them but those with high bargaining power would not.

JEL Codes: H25, F21, C78

Keywords: foreign investment, bargaining, MFN, multilateral investment agreements

Reference: 47

Individual View

Authors: Tony Syme

Dec 2000

This paper introduces an empirical model of the French interwar labour market that is comparable to models developed for the British labour market for this period, yet incorporates specific extensions in order to capture the peculiarities of the French case. The result is a model that can very accurately stimulate the movement of unemployment in the 1920s and 1930s and this is used to run a series of counterfactual simulations to estimate the labour market effects of various public policies adopted at the time. Of particular note is the result that the repatriation drive of the early 1930s had no significant effect on the size of foreign labour force by 1936 and that the decision to remain on the Gold Standard until 1936 raised unemployment each year by more than primary policies introduced to combat unemployment - public works and repatriation of foreign workers - reduced it.

JEL Codes: J2, J6, N34

Keywords: France, unemployment, gold standard, repatriation, public works, 1930s, Popular Front

Reference: 55

Individual View

Authors: Alan Beggs

Dec 2000

This paper considers a model of endogenous growth with two sectors. It shows that it may be desirable to concentrate research in one sector, and so have unbalanced growth, but that the pressure of competition in research may cause the private sector to spread research too widely, and so have growth that is too balanced. It is also shown that even if private agents concentrate research in one sector, they may do so in the wrong one.

JEL Codes: O41, O31

Keywords: growth, two sector, unbalanced growth

Reference: 48

Authors: Daniel John Zizzo

Dec 2000

A positive correlation between relative position and the neurotransmitter serotonin exists in non-human primates, within an optimal range. This paper explores the reasons of this correlation. The main function of serotonin appears cognitive: it determines how optimally agents perceive and behave in game theoretical interactions, and this can explain the correlational finding. Among humans, within the optimal range serotonin works as a form of human capital, capable of improving the work functioning of agents who respond to serotonergic promoter treatment. Limitations of the existing evidence are also discussed.

JEL Codes: C72, C99, D10

Keywords: serotonin, relative position, categorization, human capital

Reference: 56

Authors: Martin West

Oct 2000

By anachronistically attributing the origin and growth of popular education entirely to state intervention, standard histories of state education have failed to delimit sufficiently the states role in educational development. This paper offers a theoretically based examination of the British states intervention in the emerging market for popular education in England during the nineteenth century. It complements conventional neoclassical analysis with recent developments from the fields of methodological individualism and new institutional economics to identify the specific reasons the state first became involved in mass education. The eventual national system of state-provided, free elementary schools, managed by local representative bodies and funded in part through local rates is re-conceptualized as an imperfect solution to problems inherent in achieving an optimal level of schooling in the emerging mass market for education.

Reference: 037

Individual View

Authors: Marcus Rebick

Oct 2000

I examine recent changes in labour markets and employment practices in Japan. I find little evidence that Japan is converging towards an Anglo-American type labour market. Mobility rates continue to be low, and there is little indication that this will change greatly in the future. Large firms will continue to be reluctant to hire women into line management positions, and women will continue to dominate the continent workforce in Japan. There is likely to be a change in the nature of assessment and rewards leading to greater dispersion in pay, especially for managers.

JEL Codes: J0, J3

Keywords: Japan, labour, economy, personnel, employment

Reference: 21

Authors: Michael Bacharach, Oliver Board

Oct 2000

We examine some of the factors that might influence the quality of information produced in discussion groups on the internet, such as USENET and the WELL. In particular, we look at the impact of various different pricing structures, and compare regimes in which anonymity is enforced with regimes in which all contributors must identify themselves. Our main finding is that the flow of quality-weighted information within the group is maximized by a regime which front loads the cost of sending messages, and identification is required. If there is a positive spillover from the intra-group transmission of good quality information, however, benefiting society at large, then the social value of the flow of quality-weighted information may be maximized by a different regime, in which all replying is anonymous. Reputation effects play a key role in our analysis: posters who have sent high quality messages in the past are considered more likely to send high quality messages in the future, and are thus more likely to be taken notice of.

JEL Codes: C72, C73, L15, L86

Keywords: internet economics, discussion groups, reputation

Reference: 25

Individual View

Authors: Alan Beggs

Oct 2000

This paper studies the extent to which diffusion approximations provide a reliable guide to equilibrium selection results in finite games. It is shown that they do for a class of finite games with weak learning provided that limits are taken in a certain order. The paper also shows that making mutation rates small does not in general select a unique equilibrium but making selection strong does.

JEL Codes: C73, C72.

Keywords: equilibrium selection, diffusion approximation, evolutionary game theory, risk dominance

Reference: 33

Authors: Stefan De Wachter, Sebastian Galiani, Universidad Torcuato Di Tella, Argentina

Oct 2000

This paper considers the practical problem of distributing a fixed budget for poverty alleviation to a population whose poverty status is not directly observable. Some information on the relationship between poverty status and a number of observable and verifiable characteristics is assumed to be available in the form of a household survey. The solution we propose differs from other academic work in that it explicitly accounts for administrative constraints on the shape of the transfer function and is computationally more straightforward. It improves on the techniques that are commonly used in practice by taking both the concavity of the social welfare function and the entire conditional distribution of poverty status into account, and by endogenously determining the optimal transfer levels. Although the superiority of our allocation rule over other techniques is tautological, we explore the magnitude of the improvement in an artificial dataset. Finally, we provide an intuitive discussion of the defects of currently operational methods.

JEL Codes: H2, C4

Keywords: targeting, discriminant analysis, poverty

Reference: 41

Individual View

Regulation in the UK is undergoing fundamental change. Dissatisfaction with self-regulation and the self-regulatory organizations intensified steadily during the 1990`s. The failure of regulation to avert the Maxwell pension collapse and the widespread selling of inappropriate pension policies were viewed as serious deficiencies of what many people had already come to regard as inadequate and expensive regulation. The Labour administration came to office with the clear intention of overhauling and strengthening the system.

Reference: 2001-FE-09

Authors: James Forder

Oct 2000

The theory of policy credibility has been influential in both the design of monetary policymaking institutions and in the implementation of policy. In particular, the idea that `reputation` is important has been widely accepted. However, careful attention to its assumptions and implications of the theory reveals many sources of doubt as to its empirical value. First, the theory is implausible, and even if taken seriously does not point to many of the conclusions frequently supposed to be based on it. Second, evidence suggests the theory is false. Third, even policymakers who profess themselves concerned about the maintenance of credibility do not behave consistently in the way the theory says they should. Although many policy proposals ostensibly based on the theory of credibility therefore seem to lack persuasive support, the idea of credibility still poses a danger to effective policymaking since it creates motives for excessively contractionary policy. Although it is frequently asserted that monetary policy can have no long-term effects on economic performance, the idea that a loss of `reputation` will have lasting detrimental effects appears to motivate much policy. In the absence of convincing arguments that reputation - in its technical sense - is important, this would seem to be undesirable and probably dangerous.

JEL Codes: E52, E58

Keywords: central bank independence, policy credibility, deflation

Reference: 22

Individual View

Authors: James Malcomson, James A. Fairburn, University of Sussex

Oct 2000

This paper considers why organizations use promotions, rather than just monetary bonuses, to motivate employees even though this may conflict with efficient assignment of employees to jobs. When performance is unverifiable, use of promotion reduces the incentive for managers to be affected by influence activities that would blunt the effectiveness of monetary bonuses. When employees are risk neutral, use of promotion for incentives need not distort assignments. When they are risk averse, it may - sufficient conditions for this are given. The distortion may be either to promote more employees than is efficient (the Peter Principle effect) or fewer.

JEL Codes: J33, J41, D82

Keywords: work incentives, influence activities, job assignments, promotion, Peter Principle

Reference: 26

Authors: Alan Beggs

Oct 2000

This paper examines the optimal structure of hierarchies when workers differ in the range of tasks they can perform. A hierarchical system may reduce costs by allowing most tasks to be handled by unskilled workers. This may however increase delay for those tasks which must pass through several layers before reaching the appropriate level. The paper characterises an optimal hierarchy when such a trade-off exists.

JEL Codes: D23, L22

Keywords: queues, hierarchies, organizations, submodularity

Reference: 34

Authors: James Forder

Oct 2000

Measures of central banks` independence and central banks` accountability which are based on an interpretation of their statutes provide, in themselves, no guidance for the assessment of legislative proposals. In the effectiveness of monetary policy, the crucial considerations relate to how central banks and other policymakers behave. The pattern of incentives is not determined by the statutes, which may be wholly irrelevant, and therefore one cannot discover the effectiveness of policy by inspecting the statutes. On the other hand, an assessment of the democratic acceptability of an arrangement requires a normative argument. Depending on that argument, statutory characteristics may be the crucial ones, but for the assessment to be worthwhile, the argument must be explicit.

JEL Codes: C80, E58

Keywords: central bank independence, measurement problems, political accountability

Reference: 23

Individual View

Authors: Mary Gregory, Adriaan S. Kalwij, Department of Economics, University of Oxford.

Oct 2000

Around 40% of the male workforce regularly works 8 to 9 hours a week of paid overtime. This paper investigates the determinants of overtime hours in Britain over the period 1975-1999. For this purpose a panel data Tobit model is estimated using the very large panel of employees from the National Earnings Survey Dataset. The empirical results show that changes in the job-mix across the economy, from high to low overtime jobs rather than within-job changes in the use of overtime, account for most of the apparent decline in the extent of overtime working over the 1990s. Within jobs, the GDP cycle has a significant impact on overtime work, while labour market conditions, represented by the unemployment rate, do not. The elasticity of total working hours with respect to wages is found to be close to zero and with respect to contractual hours close to unity. Furthermore the results show that the decline of unionisation has not altered the use of overtime.

JEL Codes: C23, C33, C44, J00

Keywords: overtime work, contractual hours, panel data Tobit model.

Reference: 27

Individual View

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

Oct 2000

Most recent studies on poverty and inequality in developed countries focus on income. In contrast, this paper presents trends in consumption-based poverty and inequality in nine member countries of the European Union. During the 1980s, both poverty and inequality increased in Italy, France, the United Kingdom, Germany and Belgium, while decreases in both poverty and inequality are observed for Spain and Portugal. In Greece only inequality increased. For most countries for which income-based results are available, these move in the same direction as the consumption-based results. However, this sensitivity analysis yields considerable differences in the ranking of countries and the magnitude of the changes.

JEL Codes: I32, D31

Keywords: poverty, inequality, European Union

Reference: 35

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

Oct 2000

If agent`s (subjective) beliefs are ambiguous then the beliefs may not be represented by a unique probability distribution in the standard Bayesian fashion but instead by a set of probabilities. Roughly put, an ambiguity averse decision maker evaluates an act by the minimum expected value that may be associated with it. Inspite of wide and long-standing support among economists for indexation of loan contracts there has been relatively little use of indexation, except in situations of extremely high inflation. The object of this paper is to provide a (theoretical) explanation for this puzzling phenomenon based on the hypothesis that economic agents are ambiguity averse. The present paper considers a competitive general equilibrium model of goods, money and bond markets populated by agents with Choquet expected utility preferences, where both nominal and indexed bonds are available for trade and prices of all goods and bonds are determined endogenously. We obtain conditions which promote an endogenous cessation of trade in indexed bonds: i.e., conditions under which there is no trade in indexed bonds in any equilibrium; only nominal bonds are traded.

JEL Codes: D8, D23

Keywords: Choquet expected utility, ambiguity aversion, Knightian uncertainty, contracts, indexed bonds, indexation

Reference: 28

Individual View

Authors: Howard Smith, Simon Latcovich

Oct 2000

This paper evaluates alternative strategic models of competition and market structure in online retailing, and makes comparisons with traditional retailing. Online consumers are less concerned than traditional consumers about spatial characteristics and more concerned about hidden quality characteristics. Online retailers rely more on advertising than traditional retailers do, to inform consumers and to signal hidden quality attributes. Price competition may be imperfect, because of vertical product differentiation, incomplete consumer awareness, and perfect information exchange between retailers. Advertising and revenue data for the online book market reveal that consumers respond to advertising rather than low prices. As the market increases, advertising costs escalate and there is no new entry. Advertising to sales ratios and market concentration ratios are much higher than for traditional retailers. Using price and demand information for individual books over a number of weeks, we find counter-cyclical and cross-sectional price variation inconsistent with perfect price competition.

JEL Codes: L13, L15, L81

Keywords: advertising, books, e-commerce, endogenous sunk costs, Internet, market structure, price discrimination, price dispersion, retailing

Reference: 36

Individual View

Authors: Kirsten Bindemann

Oct 2000

This study examines the response of oil contracts to extreme price movements. The chosen contract form is a Production-Sharing Agreement (PSA) which is the oil industry`s equivalent of sharecropping and one of the most commonly used contractual agreements. We show that only the two significant price increases in the 1970s and only the price falls in the early 1980s and the early 1990s triggered a response in the terms offered by PSAs.

JEL Codes: L14, L71, Q4

Keywords: prices, petroleum, contracts

Reference: 29

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