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2005 abstracts

Relaxing Tax Competition through Public Good Differentiation
Ben Zissimos and Myrna Wooders

This paper argues that, because governments are able to relax tax competition through public good differentiation, traditionally high-tax countries have continued to set taxes at a relatively high rate even as markets have become more integrated. The key assumption is that firms vary in the extent to which public good provision reduces costs. We show that Leviathan governments are able to use this fact to relax the forces of tax competition, reducing efficiency. When firms can ‘vote with their feet’ tax competition leads firms to locate in ‘too many’ jurisdictions. A ‘minimum tax’ further relaxes tax competition, further reducing efficiency.

Current Account Reversals and Growth: The Direct Effect Central and Eastern Europe 1993-2000
Lubos Komarek, Zlatuse Komarkova and Martin Melecky

According to economic theory, the capital inflows reversal - so called sudden stop - has a significant effect on economic growth. This paper investigates the direct impact of current account reversals on growth in Central and Eastern European countries. Two steps to conduct the analysis are applied. In the first step we estimate the standard growth equation augmented by an effect of the current account reversal. We find that after a current account reversal the growth rate declines by 1.10 percentage points in the current year. The subsequent analysis of the adjustment dynamics builds upon the notion of convergence. We find the unconditional and conditional convergence coefficients to be -0.47 and -0.52, respectively. This implies that the consequences of the reversal are likely eliminated after 3.3 years when the actual growth rate is back at its equilibrium level, ceteris paribus. Finally, the cumulative loss associated with a sudden stop in capital flows is about 2.3 percentage points. We infer that Central and Eastern European countries are relatively flexible in terms of adjustment and reallocation of resources given the findings in similar literature examining either a more general sample or concentrating on rather different regions.

Currency Crises, Current Account Reversals and Growth: The Compounded Effect for Emerging Markets
Lubos Komarek and Martin Melecky

This paper investigates the possible negative effect of external crises, sudden stops in capital flows and currency crises in emerging market economies. We find that a current account reversal has an important effect, both direct and indirect, on economic growth, and depresses GDP by about 1 percentage point in the current year, when using a broad group of emerging markets. On the other hand, currency crises themselves, identified as a sharp depreciation, do not appear to have a significant direct impact on growth. Their overall effect on growth is positive, though rather insignificant from an economic point of view. The joint occurrence of the currency crisis and the current account reversal appears to be the most damaging event for economic growth. Both the direct and compounded effects are about 5 times larger than those of the reversal in the current year. The estimated cumulative losses for current account reversals and the joint crisis are 2 and 21 percentage points, respectively. The time necessary for the adjustment of actual growth back to its equilibrium rate is roughly 2.5 years after the current account reversal and 6.5 years after the joint occurrence of the currency crisis and the reversal.

The Law of Demand in Tiebout Economies
Edward Cartwright, John Conley and Myrna Wooders

We consider a general equilibrium local public goods economy in which agents have two distinguishing characteristics. The first is 'crowding type', which is publicly observable and provides direct costs or benefits to the jurisdiction (coalition or firms) the agent joins. The second is taste type, which is not publicly observable, has no direct effects on others and is defined over private good, public goods and the crowding profile of the jurisdiction the agent joins. The law of demand suggests that as the quantity of a given crowding type (plummers, lawers, smart people, tall people, nonsmokers, for example) increases, the compensation that agents of that type receive should go down. We provide counterexamples, however, that show that some agents of a given crowding type might actually benefit when the proportion of agents with the same crowding type increases. This reversal of the law of demand seems to have to do with interaction effect between tastes and skills, something difficult to study without making these classes of characteristics distinct. We argue that this reversal seems to relate to the degree of difference between various patterns of tastes. In particular, if tastes are homogeneous, the law of demand holds.

Status Equilibrium in Local Public Good Economies
A. Van den Nouweland and Myrna Wooders

We define a concept of status equilibrium for local public good economies. A status equilibrium specifies one status index for each agent in an economy. These indices determine agents' cost shares in any possible jurisdiction. We provide an axiomatic characterization of status equilibrium using consistency properties.

Correlated equilibrium and behavioral conformity
Edward Cartwright and Myrna Wooders

Is conformity amongst similar individuals consistent with self-interested behavior? We consider a model of incomplete information in which each player receives a signal, interpreted as an allocation to a role, and can make his action choice conditional on his role. Our main result demonstrates that `near to' any correlated equilibrium is an approximate correlated equilibrium `with conformity' -- that is, an equilibrium where all `similar players' play the same strategy, have the same probability of being allocated to each role, and receive approximately the same payoff; in short, similar players `behave in an identical way' and are treated nearly equally. To measure `similarity' amongst players we introduce the notions of approximate substitutes and a (delta,Q)-class games -- a game with Q classes of players where all players in the same class are delta-substitutes for each other.

Sovereign Risk: Constitutions Rule
Emanuel Kohlscheen

This paper models the executive's choice of whether to reschedule external debt as the outcome of an intra-governmental negotiation process. The executive's necessity of a confidence vote from the legislature is found to provide the rationale for why some democracies may not renegotiate their foreign obligations. Empirically, parliamentary democracies are indeed less prone to reschedule their foreign liabilities or accumulate arrears on them. Most of the democracies that have been able to significantly reduce their debt/GNP ratio without a 'credit incident' were parliamentary. Moreover, countries with stronger political checks on the executive and lower executive turnover have a lower rescheduling propensity. These results suggest that North and Weingast's account of the evolution of institutions in 17th century England gives substantial mileage in understanding the international debt markets in the contemporary developing world.

On the Coexistence of Smuggling and Trafficking in Migrants
Yuji Tamura

The revised version of this paper is available in 2007 - 791


Decentralization and Electoral Accountability: Incentives, Separation and Voter Welfare
Jean Hendriks and Ben Lockwood

This paper studies the relationship between fiscal decentralization and electoral accountability, by analyzing how decentralization impacts upon incentive and selection effects, and thus on voter welfare. The model abstracts from features such as public good spillovers or economies of scale, so that absent elections, voters are indifferent about the fiscal regime. The effect of fiscal centralization on voter welfare works through two channels: (i) via its effect on the probability of pooling by the bad incumbent; (ii) conditional on the probability of pooling, the extent to which, with centralization, the incumbent can divert rents in some regions without this being detected by voters in other regions (selective rent diversion). Both these effects depend on the information structure; whether voters only observe fiscal policy in their own region, in all regions, or an intermediate case with a uniform tax across all regions. More voter information does not necessarily raise voter welfare, and under some conditions, voter would choose uniform over differentiated taxes ex ante to constrain selective rent diversion.


How Does Marriage Affect Physical and Phychological Health? A Survey of the Longitudinal Evidence
Chris M Wilson and Andrew J Oswald

This paper examines an accumulating modern literature on the health benefits of relationships like marriage. Although much remains to be understood about physiological channels, we draw the judgement, after looking across many journals and disciplines, that there is persuasive longitudinal evidence for such effects. The size of the health gain from marriage is remarkable. It may be as large as the benefit from giving up smoking.


A Note on the Hybrid Equilibrium in the Besley-Smart Model
Ben Lockwood

This note shows that there is always a non-empty set of parameter values for which the hybrid in the Besley and Smart (2003) model is unstable in the sense of Cho and Kreps. This set may include all the parameter values for which a hybrid equilibrium exists. For these parameter values, it is shown that a fully separating equilibrium always exists, which is Cho-Kreps stable. In this equilibrium, the good incumbent distorts fiscal policy to signal his type. An implication is that equilibrium in their model is not (generically) unique.


Happiness and the Human Development Index: The Paradox of Australia
David G Blanchflower and Andrew J Oswald

According to the well-being measure known as the U.N. Human Development Indrx, Australia now ranks 3rd in the world and higher than all other English-speaking nations. This paper questions that assessment. It reviews work on the economics of happiness, considers implications for policymakers and explores where Australia lies in international subjective well0being tankings. Using new data on approximately 50,000 randomly sampled individuals from 35 nations, the paper shows that Australians have some of the lowest levels of job satisfaction in the world. Moreover, among the sub-sample of English speaking nations, where a common language should help subjective measures to be reliable, Australia performs poorly on a range of happiness indicators. The paper discusses this paradox. Our purpose is not to reject HDI methods, but rather to argue that much remains to be understood in this area.


Local Network Externalities and Market Segmentation
A. Banerji and Bhaskar Dutta

This paper models interaction between groups of agents by means of a graph where each node represents a group of agents and an arc represents bilateral interaction. It departs from the standard Katz-Shapiro framework by assuming that network benefits are restricted only amongst groups of linked agents. It shows that even if rival firms engage in Bertrand competition, this form of network externalities permits strong market segmentation in which firms divide up the market and earn positive profits. The analysis also shows that some graphs or network structures do not permit such segmentation, while for others, there are easy to interpret conditions under which market segmentation obtains in equilibrium.


Strategic Basins of Attraction, the Farsighted Core, and Network Formation Games
Frank H. Page Jr, and Myrna H. Wooders

We make four main contributions to the theory of network formation. (1) The problem of network formation with farsighted agents can be formulated as an abstract network formation game. (2) In any farsighted network formation game the feasible set of networks contains a unique, finite, disjoint collection of nonempty subsets having the property that each subset forms a strategic basin of attraction. These basins of attraction contain all the networks that are likely to emerge and persist if individuals behave farsightedly in playing the network formation game. (3) A von Neumann Morgenstern stable set of the farsighted network formation game is constructed by selecting one network from each basin of attraction. We refer to any such von Neumann-Morgebstern stable set as farsighted basis. (4) The core of the farsighted network formation games is constructed by selecting one network from each basin of attraction containing a single network. We call this notion of the core, the farsighted core. We conclude that the farsighted core is nonempty if and only if there exists one farsighted basin of attraction containing a single network. To relate our three equilibrium and stability notions (basins of attraction, farsighted basis and farsighted core) to recent work by Jackson and Wolinsky (1996), we define a notion of pairwise stability similar to the Jackson-Wolinsky notion and we show that a farsighted core is contained in the set of pairwise stable networks. Finally, we introduce, via an example, competitative contracting networks and highlight how the analysis of these networks requires the new features of our network formation model.


Communication Networks with Endogeneous Link Strength
Francis Bloch and Bhaskar Dutta

This paper analyzes the formation of communication networks when players choose endogenously their investment on communication links. We consider two alternative definitions of network reliability; product reliability, where the decay of information depends on the product of the strength of communication links, and min reliability where the speed of connection is affected by the weakest communication link. When investments are separable, the architechure of the efficient network depend crucially on the shape of the transformation function linking investments to the quality of communication links. With increasing marginal returns to investment, the efficient network is a star; with decreasing marginal returns, the conflict between maximization of direct and indirect benefits prevent a complete characterization of efficient networks. However, with min reliability, the efficient network must be a tree. Furthermore, in the particular case of linear transformation functions, in an efficient network, all links must have equal strength. When investments are perfect complements, the results change drastically: under product reliability, the efficient network must contain a cycly, and is in fact a circle for small societies. With min reliability, the efficient network is either a circle or a line. As in classical models of network formation, efficient networks may not be supported by private investment decisions. We provide examples to show that the star may not be stable when the transformation functions is strictly convex. We also note that with perfect substitutions and perfect complements (when the efficient network displays a very symmetric structure), the efficient network can indeed be supported by private investments when the society is large.


Strategy-proof Cardinal Decision Schemes
Bhaskar Dutta, Hans Peters and Arunava Sen


Fiscal Decentralization: A political Economy Perspective
Ben Lockwood

This paper surveys recent contributions to the study of fiscal decentralization which adopt a political economy approach. It is argued that this approach can capture, in a variety of formal models, the plausible and influential ideas (increasingly, supported by empirical evidence) that fiscal decentralization can lead to improved preference-matching and accountability of government. In particular, recent work on centralized provision of public good provision via bargaining in a legislature shows how centralization reduced preference-matching, and recent work using "electoral agency" models formalizes the accountability argument. These models also provide insights into when decentralization may fail to deliver these benefits.


Voting Power Implications of a Unified European Representation in the IMF
Dennis Leech and Robert Leech

We consider some of the implications of a proposed reform of the voting system of the IMF in which the EU countries cease to be separately represented and are replaced by a single combined representative of the European bloc. The voting weight of the EU bloc is reduced accordingly. We analyse two cases: the Eurozone of 12 countries and the European Union of 25. Using voting power analysis we show that the reform could be very beneficial for the governance of the IMF, enhancing the voting power of individual member countries as a consequence of two large countervailing voting blocs. Specifically we analyse a range of EU voting weights and find the following for ordinary decisions requiring a simple majority: (1) All countries other than those of the EU and the USA unambiguously gain power (measured absolutely or relatively); (2) The sum of powers of the EU bloc and USA is minimized when they have voting parity; (3) The power of every other non-EU member is maximized when the EU and the USA have parity; (4) Each EU member could gain power - despite losing its seat and the reduction in EU voting weight - depending on the EU voting system that is adopted; (5) The USA loses voting power (both absolutely and relatively) over ordinary decisions but retains its unilateral veto over special majority (85%) decisions (as does the EU bloc).

Who really wants to be a Millionaire? Estimates of Risk Aversion from Gameshow Data
Roger Hartley, Gauthier Lanot and Ian Walker

There is a considerable variation in estimates of the degree of risk aversion in the literature. This paper analyses the behaviour of contestants in one of the most popular TV gameshows ever to estimate a CRRA model of behaviour. This gameshow has a number of features that makes it well suited for our analysis: the format is extremely straightforward, it involves no strategic decision-making, we have a large number of observations, and the prizes are cash and paid immediately, and cover a large range - up to £1 million. Our data sources have the virtue that we are able to check the representativeness of the gameshow participants. While the game requires skill, which complicates our analysis, the structure of the game is very simple so that complex probability calculations are not required of the participants.
The CRRA model is complex despite its restrictiveness because of the sequential nature of this game - answering a question correctly opens the option to hear the next question and this has a value that depends on the stage of the game and the player's view about the difficulty of subsequent questions.
We use the data to estimate the degree of risk aversion and how it varies across individuals. We investigate a number of departures from this simple model including allowing the RRA parameter to vary by gender and age. Even though the model is extremely restrictive, in particular, it features a single RRA parameter we find that it fits the data across a wide range of wealth remarkably well and yields very plausible parameter values.