Manage Research Papers

Francine Lafontaine and Margaret Slade

Understanding what determines firm boundaries and the choice between interacting in a firm or a market is not only the fundamental concern of the theory of the firm, but it is also one of the most important issues in economics. Data on value added, for example, reveal that in the US, transactions that occur in firms are roughly equal in value to those that occur in markets.2 The economics profession, however, has devoted much more attention to the workings of markets than to the study of firms, and even less attention to the interface between the two. Nevertheless, since Coase’s (1937) seminal paper on the subject, a rich set of theories has been developed that deal with firm boundaries in vertical or input/output structures. Furthermore, in the last 25 years, empirical evidence that can shed light on those theories has been accumulating.

Ben Lockwood

This paper revisits the fiscal "decentralization theorem", by relaxing the role of the assumption that governments are benevolent, while retaining the assumption of policy uniformity. If instead, decisions are made by direct majority voting, (i) centralization can welfare-dominate decentralization even if there are no externalities and regions are heterogenous; (ii) decentralization can welfare-dominate centralization even if there are positive externalities and regions are homogenous. The intuition is that the insensitivity of majority voting to preference intensity interacts with the different inefficiencies in the two fiscal regimes to give second-best results. Similar results obtain when governments are benevolent, but subject to lobbying, because now decisions are too sensitive to the preferences of the organised group

Charles Blackorby and Sushama Murty

Blackorby and Murty [2007] prove that, with a monopoly and under one hundred percent profit taxation and uniform lump-sum transfers, the utility possibility sets of economies with unit and ad valorem taxes are identical. This welfare-equivalence is in contrast to most previous studies. In this paper, we relax the assumption of one hundred percent profit taxation and allow the consumers to receive profit incomes from ownership of shares in the monopoly firm. We find that, for any fixed vector of profit shares, the utility possibility sets of economies with unit and ad valorem taxes are not generally identical. But it does not imply that one completely dominates the other. Rather, the two utility possibility frontiers cross each other.

Carlo Perroni and Eugenio Proto

We analyze a two-sector, general-equilibrium model of productive matching and sorting, where risky production is carried out by pairs of individuals both exerting effort. Risk-neutral (entrepreneurial) individuals can match either with other risk-neutral individuals, or – acting as employers/insurers – with risk-averse (nonentrepreneurial) individuals. Although the latter option has the potential to generate more surplus, when effort is unobservable and risk is high, the moral hazard problem in mixed matches may be too severe for mixing to be attractive to both risk aversion types, leading to a segregated equilibrium in which risk-averse individuals select low-risk, low-yielding activities. An increase in the return associated with the riskier sector can then trigger a switch from a mixed to a segregated equilibrium, causing aggregate output to fall.

Paola Conconi, Carlo Perroni and Raymond Riezman

We consider a setting in which capital taxation is characterized by two distortions working in opposite directions. On one hand, governments engage in tax competition and are tempted to lower capital tax rates. On the other hand, they are unable to commit to future policies and, once capital has been installed, have incentives to increase taxes. In this setting, there exists a tax that optimally trades off the two distortions. We compare three possible tax harmonization scenarios: no tax harmonization (all countries set taxes unilaterally), global tax harmonization (all countries coordinate their capital taxes), and partial tax harmonization (only a subset of all countries coordinate capital taxes). We show that, if capital is sufficiently mobile, partial tax harmonization benefits all countries compared to both global and no harmonization.

Vítor Castro

This study intends to provide an empirical answer to the question of whether Maastricht and SGP fiscal rules have affected growth of European Union countries. A growth equation augmented with fiscal variables and controlling for the period in which fiscal rules were implemented in Europe is estimated over a panel of 15 EU countries (and 8 OECD countries) for the period 1970-2005 with the purpose of answering this question. The equation is estimated using both a dynamic fixed effects estimator and a recently developed pooled mean group estimator. GMM estimators are also used in a robustness analysis. Empirical results show that growth of real GDP per capita in the EU was not negatively affected in the period after Maastricht. This is the case when the recent performance of EU countries is compared both with their past performance and with the performance of other developed countries. Results even show that growth is slightly higher in the period in which the fulfilment of the 3% criteria for the deficit started to be officially assessed. Therefore, this study concludes that the institutional changes that occurred in Europe after 1992, especially the implementation of Maastricht and Stability and Growth Pact fiscal rules, should not be blamed for being harmful to growth in Europe.

Andrew J. Oswald and Nattavudh Powdthavee

Is affluence a good thing? The book The Challenge of Affluence by Avner Offer (2006) argues that economic prosperity weakens self-control and undermines human well-being. Consistent with a pessimistic view, we show that psychological distress has been rising through time in modern Great Britain. Taking over-eating as an example, our data reveal that half the British population view themselves as overweight, and that happiness and mental health are worse among fatter people in both Britain and Germany. A 10-point move up in body mass index (BMI) is associated in the cross-section with a drop in psychological health of approximately 0.3 GHQ points. Comparisons also matter. For a given level of BMI, we find that people who are educated or who have high income are more likely to view themselves as overweight. We discuss problems of inference and argue that longitudinal data on BMI are needed. We suggest a theory of imitation -- where utility depends on relative weight -- in which there can be obesity spirals after only small drops in the price of food.

A modern statistical literature argues that countries such as Denmark are particularly happy while nations like East Germany are not. Are such claims credible? The paper explores this by building on two ideas. The first is that psychological well-being and high blood-pressure are thought by clinicians to be inversely correlated. The second is that blood-pressure problems can be reported more objectively than mental well-being. Using data on 16 countries, the paper finds that happier nations report lower levels of hypertension. The paper’s results are consistent with, and seem to offer a step towards the validation of, cross-national estimates of well-being.

Yuji Tamura

We analyze the migrant smuggling market where smugglers differ in their capacities to exploit their clients labor in the destination. We show that when exploitation capacities are private information, the equilibrium may be characterized by adverse selection. In such a case, policies that diminish the availability of smuggling services to potential migrants inevitably raise the mean exploitation of smuggled labor.

Monica Giulietti, Jesús Otero & Michael Waterson

This paper investigates the evolution of electricity prices for domestic customers in the UK following the introduction of competition. The empirical analysis is based on a panel data set containing detailed information about electricity supply prices over the period 1999 to 2006. The analysis aims to test theoretical hypotheses about the nature of consumers’ switching and search costs. The econometric analysis of persistence and price dispersion provides only limited support for the view that the market is becoming more competitive and also indicates that there remain significant potential benefits to consumers from searching alternative suppliers.

Keith Cowling and Rattanasuda Poolsombat

Americans are working much longer hours in the paid labour market than workers in Western Europe. Much of the debate focuses on whether this is the result of voluntary worker choice or whether this is a decision imposed on workers by their employers. This paper shows that American hours of work have become more or less stabilised as a result of the rising intensity of advertising in the U.S.: advertising may raise the desired amount of marketed goods and services for which workers find it necessary to work long hours.

Orla Doyle, Colm Harmon and Ian Walker

This paper investigates the robustness of recent findings on the effect of parental education and income on child health. We are particularly concerned about spurious correlation arising from the potential endogeneity of parental income and education. We adopt an instrumental variables approach and our results suggest that the parental income and education effects are generally larger than are suggested by the correlations observed in the data. Moreover, we find strong support for the causal effect of income effect being large for the poor but small at the average level of income.

Charles Blackorby, Daniel Primont and R. Robert Russell

We show that the Hotelling-Lau elasticity of substitution, an extension of the Allen-Uzawa elasticity to allow for optimal output-quantity (or utility) responses to changes in factor prices, inherits all of the failings of the Allen-Uzawa elasticity identified by Blackorby and Russell [1989 AER]. An analogous extension of the Morishima elasticity of substitution to allow for output quantity changes preserves the salient properties of the original Hicksian notion of elasticity of substitution.

Robin Naylor, Jeremy Smith and Abigail McKnight

We exploit individual-level administrative data for whole populations of UK university students for the leaving cohorts of 1985-1993 (together with that of 1998) to investigate the ináuence of degree performance on graduate occupational earnings. We Önd that there is a signiÖcant premium associated with a good performance at university. We also Önd that this premium increased between 1985/6 and 1993/4, a period of substantial expansion in the graduate population. Among other results, we Önd that there are signiÖcant di§erences in the occupational earnings of leavers according to university attended, subject studied, and pre-university educational and social background, ceteris paribus.

Matthew D Rablen and Andrew J Oswald

It has been known for centuries that the rich and famous have longer lives than the poor and ordinary. Causality, however, remains trenchantly debated. The ideal experiment would be one in which status and money could somehow be dropped upon a sub-sample of individuals while those in a control group received neither. This paper attempts to formulate a test in that spirit. It collects 19th-century birth data on science Nobel Prize winners and nominees. Using a variety of corrections for potential biases, the paper concludes that winning the Nobel Prize, rather than merely being nominated, is associated with between 1 and 2 years of extra longevity. Greater wealth, as measured by the real value of the Prize, does not seem to affect lifespan.

Monica Giulietti, Jesus Otero and Jeremy Smith

This paper presents two alternative methods for modifying the HEGY-IPS test in the presence of cross-sectional dependency. In general, the bootstrap method (BHEGY-IPS) has greater power than the method suggested by Pesaran (2007) (CHEGY-IPS), although for large T and high degree of cross-sectional dependency the CHEGY-IPS test dominates the BHEGY-IPS test

Massimiliano Bratti. Robin Naylor and Jeremy Smith

As in many other countries, government policy in the UK has the objective of raising the participation rate of young people in higher education, while also increasing the share of the costs of higher education borne by students themselves. A rationale for the latter element comes from evidence of a high private return to university undergraduate degrees. However, much of this evidence pre-dates the rapid expansion in the graduate population. In the current paper, we use evidence from a cohort of people born in 1970 to estimate hourly wage returns to a university degree. Among other results, we find (i) that compared to an earlier 1958 birth cohort the average returns to a first degree for men changed very little, while the return for women declined substantially and (ii) substantial evidence of differences in returns to a first degree according to subject area of study and class of degree awarded.

Bernt Bratsberg, Knut Røed, Oddbjørn Raaum, Robin Naylor, Markus Jäntti, Tor Eriksson and Eva Österbacka

We show that the patterns of intergenerational earnings mobility in Denmark, Finland, and Norway, unlike those for the US and the UK, are highly nonlinear. The Nordic relationship between log earnings of sons and fathers is flat in the lower segments of the fathers’ earnings distribution – sons growing up in the poorest households have the same adult earnings prospects as sons in moderately poor households – and is increasingly positive in middle and upper segments. This convex pattern contrasts sharply with our findings for the United States and the United Kingdom, where the relationship is much closer to being linear. As a result, cross-country comparisons of intergenerational earnings elasticities may be misleading with respect to transmission mechanisms in the central parts of the earnings distribution, and uninformative in the tails of the distribution.

Markus Jäntti, Bernt Bratsberg, Knut Røed, Oddbjørn Raaum, Robin Naylor, Eva Österbacka, Anders Björklund and Tor Eriksson

We develop methods and employ similar sample restrictions to analyse differences in intergenerational earnings mobility across the United States, the United Kingdom, Denmark, Finland, Norway and Sweden. We examine earnings mobility among pairs of fathers and sons as well as fathers and daughters using both mobility matrices and regression and correlation coefficients. Our results suggest that all countries exhibit substantial earnings persistence across generations, but with statistically significant differences across countries. Mobility is lower in the U.S. than in the U.K., where it is lower again compared to the Nordic countries. Persistence is greatest in the tails of the distributions and tends to be particularly high in the upper tails: though in the U.S. this is reversed with a particularly high likelihood that sons of the poorest fathers will remain in the lowest earnings quintile. This is a challenge to the popular notion of ’American exceptionalism’. The U.S. also differs from the Nordic countries in its very low likelihood that sons of the highest earners will show downward ’long-distance’ mobility into the lowest earnings quintile. In this, the U.K. is more similar to the U.S..

Dezso Szalay

I study covert information acquisition and reporting in a principal agent problem allowing for general technologies of information acquisition. When posteriors satisfy local versions of the standard First Order Stochastic Dominance and Concavity/Convexity of the Distribution Function conditions, a first-order approach is justified. Under the same conditions, informativeness and riskiness of reports are equivalent. High powered contracts, that make the agents informational rents more risky, are used to increase incentives for information acquisition, insensitive contracts are used to reduce incentives for information gathering. The value of information to the agent is always positive. The value of information to the principal is ambiguous.

Paul Beaudry, Charles Blackorby, and Dezso Szalay

This paper explores how to optimally set tax and transfers when taxation authorities: (1) are uninformed about individuals’ value of time in both market and non-market activities and (2) can observe both market-income and time allocated to market employment. We show that optimal redistribution in this environment involves distorting market employment upwards for low wage individuals through decreasing wage-contingent employment subsidies, and distorting employment downwards for high wage individuals through positive and increasing marginal income tax rates. In particular, we show that whether a person is taxed or subsidized depends primarily on his wage, that is, the optimal program involves a cut-off wage whereby workers above the cutoff are taxed as they increase their income, while workers earning a wage below the cutoff receive an income supplement (an earned income tax credit) as they increase their income. Finally, we show that the optimal program transfers zero income to individuals who choose not to work.

Dennis Novy

Trade costs are known to be a major obstacle to international economic integration. Following the approach of New Open Economy Macroeconomics, this paper explores the effects of international trade costs in a micro-founded general equilibrium model that also allows for pricing to market. Trade costs are shown to create an endogenous home bias in consumption and reduce cross-country consumption correlations. In addition, trade costs magnify exchange rate volatility in response to monetary shocks and typically turn a monetary expansion into a beggar-thy-neighbour policy. It is striking that trade costs generally lead to these results both under producer and local currency pricing.

Michael P. Clements, Ana Beatriz Galvo & Jae H. Kim

Quantile forecasts are central to risk management decisions because of the widespread use of Value-at-Risk. A quantile forecast is the product of two factors: the model used to forecast volatility, and the method of computing quantiles from the volatility forecasts. In this paper we calculate and evaluate quantile forecasts of the daily exchange rate returns of five currencies. The forecasting models that have been used in recent analyses of the predictability of daily realized volatility permit a comparison of the predictive power of different measures of intraday variation and intraday returns in forecasting exchange rate variability. The methods of computing quantile forecasts include making distributional assumptions for future daily returns as well as using the empirical distribution of predicted standardized returns with both rolling and recursive samples. Our main findings are that the HAR model provides more accurate volatility and quantile forecasts for currencies which experience shifts in volatility, such as the Canadian dollar, and that the use of the empirical distribution to calculate quantiles can improve forecasts when there are shifts.

Ashoka Mody and Mark P Taylor

In a case study of six East Asian economies, we use dynamic factor analysis to estimate a regional component of the exchange market pressure index (EMPI) as a measure of regional financial stress. The extent to which this indicator is explained by regional economic and financial factors is interpreted as regional vulnerability to crisis. We find that regional external liabilities and exuberance in domestic stock and credit markets, as well as the US high yield spread, were positively correlated with regional vulnerability. Individual country EMPIs are also explained by regional factors, with country-specific factors and trade linkages playing little role.

Giuseppe Migali

In a world where graduate incomes are uncertain and higher education is financed through governmental loans, we build a theoretical model to show whether an income contingent loan (ICL) or a mortgage loan (ML) is preferred for higher levels of uncertainty. Assuming a single lifetime shock on graduate incomes, we compare the individual expected utilities under the two loan schemes, for both risk neutral and risk averse individuals. The theoretical model is calibrated using real data on wage uncertainty and considering the features of the UK Higher Education Reform to observe the implications of the switch from a ML to an ICL and the effect of the top-up fees. Different scenarios are simulated according to individual characteristics and family background. We finally extend the initial model to incorporate stochastic changes of income over time.

Michael P Clements and David I Harvey

We consider tests of forecast encompassing for probability forecasts, for both quadratic and logarithmic scoring rules. We propose test statistics for the null of forecast encompassing, present the limiting distributions of the test statistics, and investigate the impact of estimating the forecasting models’ parameters on these distributions. The small-sample performance of the various statistics is investigated, both in terms of small numbers of forecasts and model estimation sample sizes. Two empirical applications show the usefulness of the tests for the evaluation of recession probability forecasts from logit models with different leading indicators as explanatory variables, and for evaluating survey-based probability forecasts.

Michael P Clements and Ana Beatriz Galvao

Although many macroeconomic series such as US real output growth are sampled quarterly, many potentially useful predictors are observed at a higher frequency. We look at whether a recently developed mixed data-frequency sampling (MIDAS) approach can improve forecasts of output growth and inflation. We carry out a number of related real-time forecast comparisons using various indicators as explanatory variables. We find that MIDAS model forecasts of output growth are more accurate at horizons less than one quarter using coincident indicators ; that MIDAS models are an effective way of combining information from multiple indicators ; and that the forecast accuracy of the unemployment-rate Phillips curve for inflation is enhanced using the MIDAS approach.

Michael P Clements

We ask whether the different types of forecasts made by individual survey respondents are mutually consistent, using the SPF survey data. We compare the point forecasts and central tendencies of probability distributions matched by individual respondent, and compare the forecast probabilities of declines in output with the probabilities implied by the probability distributions. When the expected associations between these different types of forecasts do not hold for some individuals, we consider whether the discrepancies we observe are consistent with rational behaviour by agents with asymmetric loss functions.

Monica Giulietti, Jesus Otero and Jeremy Smith

This paper extends the cross-sectionally augmented IPS (CIPS) test of Pesaran (2006) to a three-dimensional (3D) panel. This 3D-CIPS test is correctly sized in the presence of cross-sectional dependency. Comparing its power performance to that of a bootstrapped IPS (BIPS) test, we find that the BIPS test invariably dominates, although for high levels of cross-sectional dependency the 3D-CIPS test can out-perform the BIPS test.

Norman Ireland and Michael Waterson

This paper unifies two significant but somewhat contradictory ideas. First, search costs potentially influence market price equilibria significantly; in many equilibria consumers do not search despite above-competitive prices. Second, cartels must guard against individual members offering lower prices, thereby creating incentives for consumers to search. We develop a simple framework, and then an example, in which whether search takes place depends upon the magnitude of search costs. Three potential equilibria result, dependent upon model parameters. These include a tacit cartel agreement exhibiting price variance and volatility. A policy conclusion is that such market characteristics do not always guarantee non-cartelisation.

Lukas Menkhoff and Mark P. Taylor

Technical analysis involves the prediction of future exchange rate (or other asset price) movements from an inductive analysis of past movements. A reading of the large literature on this topic allows us to establish a set of stylised facts, including the facts that technical analysis is an important and widely used method of analysis in the foreign exchange market and that applying certain technical trading rules over a sustained period may lead to significant positive excess returns. We then analyze four arguments that have been put forward to explain the continuing widespread use of technical analysis and its apparent profitability: that the foreign exchange market may be characterised by not-fully-rational behaviour; that technical analysis may exploit the influence of central bank interventions; that technical analysis may be an efficient form of information processing ; and finally that it may provide information on nonfundamental influences on foreign exchange movements. Although all of these positions may be relevant to some degree, neither non-rationality nor official interventions seem to be widespread and persistent enough to explain the obstinate passion of foreign exchange professionals for technical analysis.

James R. Lothian and Mark P Taylor

Using data since 1820 for the US, the UK and France, we test for the presence of real effects on the equilibrium real exchange rate (the Harrod-Balassa-Samuelson, HBS effect) in an explicitly nonlinear framework and allowing for shifts in real exchange rate volatility across nominal regimes. A statistically signifcant HBS effect for sterling-dollar captures its long run trend and explains a proportion of variation in changes in the real rate that is proportional to the time horizon of the change. There is significant evidence of nonlinear reversion towards long-run equilibrium and downwards shifts in volatility during fixed nominal exchange rate regimes.

Margaret Slade

I discuss the use of simulation techniques to evaluate unilateral effects of horizontal mergers and the pitfalls that one can encounter when using them. Simple econometric models are desirable because they can be implemented in a short period of time and can be understood by non experts. Unfortunately, their predictions are often misleading. Complex models are more reliable but they require more time to implement and are less transparent. The use of merger simulations and the sensitivity of predictions to modeling choices is illustrated with an application to mergers in the UK brewing industry. There have been a number of brewing mergers that have changed the structure of the UK market, as well as proposed but unconsummated mergers that would have had even more profound effects. I assess two of them: the successful merger between Scottish&Newcastle and Courage and the proposed merger between Bass and Carlsberg–Tetley.

Paul Beaudry and Charles Blackorby

This paper explores how to optimally set tax and transfers when taxation authorities: (1) are uninformed about individuals’ value of time in both market and non-market activities and (2) can observe both market-income and time allocated to market employment. In contrast to much of the optimal income taxation literature, we show that optimal redistribution in this environment involves distorting market employment upwards for low net-income individuals through phased-out wage-contingent employment subsidies, and distorting employment downward for high net-income individuals through positive and increasing marginal income tax rate. We also show that workfare may also be used as part of an optimal redistribution program.

Dennis Novy

The choice of invoicing currency for trade is crucial for the international transmission of macroeconomic policy. This paper develops a three-country model that endogenizes the choice of invoicing currency and that allows for a share of firms' costs to be denominated in foreign currency, consistent with the empirical evidence on the high degree of pass-through to import prices. Invoicing decisions are driven by firms' desire to hedge costs but also by exchange rate volatility and currency comovements. The model is tested empirically with a data set that spans ten currencies and 24 reporting countries, confirming the importance of currency comovements for the decision to invoice in vehicle currency. The findings also imply that if the U.S. share of world output continues to fall, other currencies will increasingly replace the U.S. dollar as an international vehicle currency.

Dennis Novy

International trade costs are of vital importance because they determine trade patterns and therefore economic performance. This paper develops a new micro-founded measure of international trade costs. It is based on a multi-country general equilibrium model of trade that incorporates bilateral "ice-berg" trade costs. The model results in a gravity equation from which the implied trade costs can be easily computed. The trade cost measure is intuitive, takes multilateral resistance into account and yields empirical results that are economically sensible. It is found that during the post-WorldWar II period trade costs have declined markedly. The dispersion of trade costs across countries can best be explained by geographical and historical factors like distance and colonial linkages but also by tariffs and free trade agreements

Francis Bloch and Bhaskar Dutta

This paper proposes new concepts of strong and coalition-proof correlated equilibria where agents form coalitions at the interim stage and share information about their recommendations in a credible way. When players deviate at the interim stage, coalition-proof correlated equilibria may fail to exist for two-player games. However, coalition- proof correlated equilibria always exist in dominance-solvable games and in games with positive externalities and binary actions.

Kalyan Chatterjee and Bhaskar Dutta

We study the relationship between bargaining and competition with incomplete information. We consider a model with two uninformed and identical buyers and two sellers. One of the sellers has a privately-known reservation price, which can either be Low or High. The other seller’s reservation price is commonly known to be in between the Low and High values of the privately-informed seller. Buyers move in sequence, and make offers with the second buyer observing the offer made by the first buyer. The sellers respond simultaneously. We show that there are two types of (perfect Bayes) equilibrium. In one equilibrium, the buyer who moves second does better. In the second equilibrium, buyers’ expected payoffs are equalised, and the price received by the seller with the known reservation value is determined entirely by the equuilibrium of the two-player game between a single buyer and an informed seller. We also discuss extensions of the model to multiple buyers and sellers, and to the case where both sellers are privately informed.

Amrita Dhillon and Alexander Herzog-Stein

Following recent empirical evidence which indicates the importance of rank for the determination of workers’ wellbeing, this paper introduces status seeking preferences in the form of rank-dependent utility functions into a moral hazard framework with one firm and multiple workers, but no correlation in production. Workers’ concern for the rank of their wage in the firm’s wage distribution may induce the firm to offer discriminatory wage contracts when its aim is to induce all workers to expend effort.

Javier Garcia-Fronti, Marcus Miller and Lei Zhang

The stylised facts of currency crises in emerging markets include output contraction coming hard on the heels of devaluation, with a prominent role for the adverse balance-sheet effects of liability dollarisation. In the light of the South East Asian experience, we propose an eclectic blend of the supply-side account of Aghion, Bacchetta and Banerjee (2000) with a demand recession triggered by balance sheet effects (Krugman, 1999). This sharpens the dilemma facing the monetary authorities - how to defend the currency without depressing the economy. But, with credible commitment or complementary policy actions, excessive output losses can, in principle, be avoided.

Amrita Dhillon and Alexander Herzog-Stein

Following recent empirical evidence which indicates the importance of rank for the determination of workers’ wellbeing, this paper introduces status seeking preferences in the form of rank-dependent utility functions into a moral hazard framework with one firm and multiple workers, but no correlation in production. Workers’ concern for the rank of their wage in the firm’s wage distribution may induce the firm to offer discriminatory wage contracts when its aim is to induce all workers to expend effort.

Monica Giullietti, Jesus Otero and Jeremy Smith

The panel variant of the KPSS tests developed by Hadri (2000) for the null of stationarity suffers from size distortions in the presence of cross section dependence. However, applying the bootstrap methodology we find that these tests are approximately correctly sized.

Marcus Miller and Dania Thomas

What role did the US courts play in the Argentine debt swap of 2005? What implications does this have for the future of creditor rights in sovereign bond markets? The judge in the Argentine case has, it appears, deftly exploited creditor heterogeneity – between holdouts seeking capital gains and institutional investors wanting a settlement – to promote a swap with a super majority of creditors. Our analysis of Argentine debt litigation reveals a ‘judge-mediated’ sovereign debt restructuring, which resolves the key issues of Transition and Aggregation - two of the tasks envisaged for the IMF’s still-born Sovereign Debt Restructuring Mechanism. For the future, we discuss how judge-mediated sovereign debt restructuring (together with creditor committees) could complement the alternative promoted by the US Treasury, namely collective action clauses in sovereign bond contracts.

Sushama Murty

By distinguishing between producible and nonproducible public goods, we are able to propose a general equilibrium model with externalities that distinguishes between and encompasses both the Starrett [1972] and Boyd and Conley [1997] type external effects. We show that while nonconvexities remain fundamental whenever the Starrett type external effects are present, these are not caused by the type discussed in Boyd and Conley. Secondly, we find that the notion of a “public competitive equilibrium” for public goods found in Foley [1967, 1970] allows a decentralized mechanism, based on both price and quantity signals, for economies with externalities, which is able to restore the equivalence between equilibrium and efficiency even in the presence of nonconvexities. This is in contrast to equilibrium notions based purely on price signals such as the Pigouvian taxes.

E. Kohlscheen

Presidential democracies were 4.9 times more likely to default on external debts between 1976 and 2000 than parliamentary democracies. This paper argues that the explanation to the pattern of serial defaults among a number of sovereign borrowers lies in their constitutions. Ceteris paribus, parliamentary democracies are less likely to default on their liabilities as the confidence requirement creates a credible link between economic policies and the political survival of the executive. This link tends to strengthen the repayment commitment when politicians are opportunistic. I show that this effect is large and statistically significant in the contemporary world even when comparison is restricted to countries that are twins in terms of colonial origin, geography and economic variables. Moreover, the result persists if OECD or Latin American democracies are excluded from the sample. Since the form of government of a country is typically chosen at the time of independence and highly persistent over time, constitutions can explain why debt policies in developing countries are related to individual histories.

Jonathan Gardner and Andrew J. Oswald

One of the famous questions in social science is whether money makes people happy. We offer new evidence by using longitudinal data on a random sample of Britons who receive medium-sized lottery wins of between £1000 and £120,000 (that is, up to approximately U.S. $200,000). When compared to two control groups -- one with no wins and the other with small wins -- these individuals go on eventually to exhibit significantly better psychological health. Two years after a lottery win, the average measured improvement in mental wellbeing is 1.4 GHQ points

Bishnupriya Gupta

This paper uses firm level data from all the textile producing regions in India to examine the relation between wages, unionization and labour productivity. We find that fewer workers were employed per machine in the unionized mills in Bombay and Ahmedabad, as compared to non-unionized regions implying that low labour productivity was not due to union resistance to increased work intensity. Our findings suggest that while low wages in India encouraged overmanning, higher wages, prompted by unionization, had productivity enhancing effects. We explore alternative explanations for low labour productivity, arising from the managerial and institutional structure of Indian cotton mills.

Emanuel Kohlscheen and Mark P. Taylor

We analyze the network of bilateral liquidity swaps (BSAs) among the ASEAN+3 countries. We find that the network has taken the correlation of capital flows in the region into account, in the sense that countries with lower correlation of reserve growth have engaged in larger BSAs. All else equal, a decimal point increase in the correlation of international reserve growth decreases the size of a bilateral swap agreement between 18 and 27%. Moreover, we find that the approximatedly $ 60bn of BSAs have had a limited impact, if any, on government bond spreads so far. Finally, we identify potential gains from inter-regional BSAs.

Lucia Buenrostro, Amrita Dhillon and Myrna Wooders

Protests take place for a variety of reasons. In this paper we focus on protests that have a well defined objective, that is in conflict with the objectives of the government. Hence the success or failure of a protest movement depends crucially on how the government responds. We assume that government types are private information so that governments have an interest in building a reputation to deter protestors. We extend the standard reputation framework to one where potential protesters in the domestic jurisdiction are competing in a common market with protestors of a foreign jurisdiction, resulting in a situation where domestic governments care about the decisions of foreign governments. We derive conditions under which an equilibrium with "contagion" in protests might exist: protests that start in one jurisdiction spread to others. Finally we use our results to interpret the Fuel tax protests in France and England that took place in 2000 as well as the three successive pro-democracy revolutions in Georgia, Ukraine and Kyrgyzstan in 2003-05.

Sayantan Ghosal and Eugenio Proto

Does power sharing between competing elites result in franchise extension to non-elites? In this paper, we argue that competing, risk-averse elites will enfranchise non-elites as insurance against future, uncertain imbalances in relative bargaining power. We show that negligibly small changes in the bargaining power of non-elites, conditional on enfranchisment, via coalition formation, constrains the bargaining power of the stronger elite and result in discontinuous changes in equilibrium surplus division. Our results are robust to public good provision following enfranchisement when there is reference heterogeneity over the location of the public good across the different elites. We conclude with a comparative analysis of Indian democracy and show that our model is able to account for some of the distinctive features of Indian democracy.

Laura Blow, Ian Walker and Yu Zhu

Over much of the developed world governments make significant financial transfers to parents with dependent children. For example, in the US the recently introduced Child Tax Credit (CTC), which goes to almost all children, costs almost $1billion each week, or about 0.4% of GNP. The UK has even more generous transfers and spends about $25 a week on each of about 8 million children – about 1% of GNP. The typical rationale given for these transfers is that they are good for our children and here we investigate the effect on household spending patterns. The UK is an excellent laboratory to address this issue because such transfers, known as Child Benefit (CB), were simple lump sum universal payments for a period of more than 20 years. We do indeed find that CB is spent differently from other income – paradoxically, it appears to be spent disproportionately on adult-assignable goods. In fact we estimate that more than half of a marginal pound of CB is spent on alcohol. We resolve the puzzle by showing that the effect is confined to unanticipated variation in CB so we infer that parents are sufficiently altruistic towards their children that they completely insure them against shocks

Amrita Dhillon and Jamele Rigolini

We examine how institutions that enforce contracts between two parties, producers and consumers, interact in a competitive market with one-sided symmetric information and productivity shocks. We compare an informal enforcement mechanism, reputation, the efficacy of which is enhanced by consumers investing in “connectedness,” with a formal mechanism, legal enforcement, the effectiveness of which can be reduced by producers by means of bribes. When legal enforcement is poor, consumers connect more with one another to improve informal enforcement; in contrast, a well-connected network of consumers reduces producers’ incentives to bribe. In equilibrium, the model predicts a positive relationship between the the frequency of productivity shocks, bribing, and the use of informal enforcement, providing a physical explanation of why developing countries often fail to have efficient legal systems. Firm-level estimations confirm the partial equilibrium implications of the model.

Roger Hartley, Gauthier Lanot and Ian Walker

This paper analyses the behaviour of contestants in one of the most popular TV gameshows ever to estimate risk aversion. 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 – from £100 up to £1 million. Our data sources have the virtue that we are able to check the representativeness of the gameshow participants. Even though the CRRA model is extremely restrictive we find that a coefficient or relative risk aversion which is close to unity fits the data across a wide range of wealth remarkably well.

Mark B. Stewart and Joanna K. Swaffield

This paper estimates the impact of the introduction of the UK minimum wage on the working hours of low-wage employees using difference-in-differences estimators. The estimates using the employer-based New Earnings Surveys indicate that the introduction of the minimum wage reduced the basic hours of low-wage workers by between 1 and 2 hours per week. The effects on total paid hours are similar (indicating negligible effects on paid overtime) and lagged effects dominate the smaller and less significant initial effects within this. Estimates using the employee-based Labour Force Surveys are typically less significant.

Liam Graham and Andrew J. Oswald

This paper proposes a new way to think about happiness. It distinguishes between stocks and flows. Central to the analysis is a concept we call ‘hedonic capital’. The paper sets out a model of the dynamics of wellbeing in which bad life-shocks are smoothed by the drawing down of hedonic capital. The model fits the patterns found in the empirical literature: the existence of a stable level of wellbeing and a tendency to return gradually towards that level. It offers a theory of hedonic adaptation.

Andrew J. Oswald

In universities all over the world, hiring and promotion committees regularly hear the argument: “this is important work because it is about to appear in prestigious journal X”. Moreover, those who allocate levels of research funding, such as in the multi-billion pound Research Assessment Exercise in UK universities, often come under pressure to assess research quality in a mechanical way by using journal prestige ratings. This paper’s results suggest that such tendencies are dangerous. It uses total citations over a quarter of a century as the criterion. The paper finds that it is far better to publish the best article in an issue of a medium-quality journal like the Oxford Bulletin of Economics and Statistics than to publish the worst article (or often the worst 4 articles) in an issue of a top journal like the American Economic Review. Implications are discussed.

Emanuel Kohlscheen and Stephen A. O'Connell

This paper analyzes sovereign debt in an economy in which the availability of short-term trade credit reduces international trade transaction costs. The model highlights the distinction between gross and net international reserve positions. Borrowed reserves provide net wealth and liquidity services during a negotiation, as long as they are not fully attachable by creditors. Moreover, reserves strengthen the bargaining position of a country by shielding it from a cut-off from short-term trade credits thereby diminishing its degree of impatience to conclude a negotiation. We show that competitive banks do lend for the accumulation of borrowed reserves, which provide partial insurance

Paula Gonzales, Jean Hindriks, Ben Lockwood and Nicolas Porteiro

In this paper, we study a model à la Rogoff (1990) where politicians distort fiscal policy to signal their competency, but where fiscal policy can be centralized or decentralized. Our main focus is on how the equilibrium probability that fiscal policy is distorted in any region (the political budget cycle, PBC) differs across fiscal regimes. With centralization, there are generally two effects that change the incentive for pooling behavior and thus the probability of a PBC. One is the possibility of selective distortion: the incumbent can be re-elected with the support of just a majority of regions. The other is a cost distribution effect, which is present unless the random cost of producing the public goods is perfectly correlated across regions. Both these effects work in the same direction, with the general result that overall, the PBC probability is larger under centralization (decentralization) when the rents to office are low (high). Voter welfare under the two regimes is also compared: voters tend to be better off when the PBC probability is lower, so voters may either gain or lose from centralization. Our results are robust to a number of changes in the specification of the model.

Mark Stewart

This paper examines the extent of state dependence in unemployment and the role played in this by intervening low-wage employment. A range of dynamic random and fixed effects estimators are compared. Low-wage employment is found to have almost as large an adverse effect as unemployment on future prospects and the difference in their effects is found to be insignificant. Evidence is presented that low-wage jobs act as the main conduit for repeat unemployment and considerably increases its probability. Obtaining a higher-wage job reduces the increased risk of repeat unemployment to insignificance.

Giuseppe Migali

In a world where graduate incomes are uncertain (observation of the UK graduate wages from 1993 to 2003) and the higher education is financed through governmental loan (UK Higher Education Reform 2004), we build a theoretical model to show which scheme between an income contingent loan and a mortgage loan is preferred for higher level of uncertainty. Assuming a single lifetime shock on graduate incomes, we compare the individual expected utilities under the two loan schemes, for both risk neutral and risk averse individuals. We extend the analysis for graduate people working in the public sector and private sector, to stress on the extreme difference on the level of uncertainty. To make the model more realistic, we allow for the effects of the uncertainty each year for all the individual working life, assuming that the graduate income grows following a geometric Brownian motion. In general, we find that an income contingent loan is preferred for low level of the starting wage and high uncertainty.

Jan Frait, Luboš Komárek & Martin Melecký

The paper focuses on the developments of real exchange rates and their fundamental determinants in the five new EU Member States (Czech Republic, Hungary, Poland, Slovakia, and Slovenia). First, the approaches that can be used for estimation of equilibrium real exchange rates are briefly discussed. Then, we use well-established determinants of real exchange rates associated with the behavioral equilibrium exchange rate (BEER) approach to assess misalignments of the real exchange rates for the five new EU Member States. The estimates of the equilibrium exchange rates are obtained by means of both purely statistical approaches (HP filter, band-pass filter) and applying several multivariate estimation methods to our reduced-form BEER model. The results obtained indicate that the tendency towards appreciation of real exchange rates in the economies under consideration have been driven primarily by fundamental determinants.

Jan Frait and Luboš Komárek

The paper deals with the relationship between monetary policy and asset prices. Besides surveying the general discussion, it attempts to extend it to recent developments in the new Member States of the EU (NMS), namely the Czech Republic, Hungary, Poland and Slovakia (the EU4). After a brief description of the current macroeconomic situation in the NMS, the appropriate reaction of monetary policy to asset price bubbles is dealt with and the main pros and cons associated with this reaction are summarised. Afterwards, the risks of asset market bubbles in the EU4 countries are evaluated. Since the capital markets are still underdeveloped and the real estate price boom seems to be a natural reaction to the initial undervaluation, the risks are viewed as rather small. The conclusion is thus that it is crucial for central banks in mature economies as well as in the NMS to conduct their monetary policies as well as their supervisory and regulatory roles in a way that does not promote the build-up of asset market bubbles. In exceptional times, central banks of small open economies must be ready to use monetary policy steps as a kind of insurance against the adverse effects of potential asset market bubbles.

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.

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.

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.

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.

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.

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.

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.

Yuji Tamura

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

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.

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.

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.

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.

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.

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.

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.

Bhaskar Dutta, Hans Peters and Arunava Sen

The classic results of Gibbard [6] and Satterthwaite [13] have shown that unless preferences are restricted, the only decentralized mechanism which induces truth-telling behaviour by individual agents is the dictatorial one. This impossibility result has induced a huge literature which analyzes the possibility of constructing strategy-proof mechanisms under various alternative frameworks. One variant, due to Gibbard [7,8], which is the main focus of this paper is the extension of the original impossibility result to mechanisms which assign a probability distribution over the set of feasible outcomes for each profile of preferences. Gibbard [7] characterized the class of such strategy-proof probabilistic mechanisms or decision schemes. He showed that a strategy-proof decision scheme must be a convex combination of duples and unilaterals. A duple is a mechanism which assigns positive probability to at most two alternatives, the pair of alternatives being independent of the profile of preferences, while a unilateral is one where the preference ordering of a single individual dictates the social lottery over feasible alternatives

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.

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).

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.

Dennis Leech and Robert Leech

The constitutions of the Bretton Woods Institutions require decisions to be taken by weighted voting: each member country possesses a number of votes, depending on its quota allocation, all of which must always be cast as a bloc. This leads to a problem of democratic legitimacy since a member's influence or voting power within such decision-making systems does not necessarily correspond to its voting weight. In previous work is has been shown that the present system of weighted voting in the IMF gives disproportionate influence to the USA at the expense of all other members. This effect occurs in both the board of governors and the executive board. This paper looks at the power implications of the structure of the IMF and World Bank executive boards (in which members are grouped into constituencies that cast their combined weighted votes as a bloc) from the point of view of formal voting power (using the Penrose power index). A criticism that is frequently made is that the present constituency structure and voting weights work to enhance the power of the developed and creditor countries at the expense of the poor, and that many countries are effectively impotent; we show that the weighted voting system adds to this anti-democratic bias and produces some unintended effects (for example the disfranchisement of Estonia in the Nordic/Baltic constituency and of five Central American republics in the Spanish/Mexican/Venezuelan constituency, even though in neither case is there a dictator). We argue generally that the voting power approach is more than just the calculation of power indices and can in fact produce solid facts by identifying cases where members of weighted voting bodies are actually disfranchised.

Martin Besfamille and Ben Lockwood

In fiscally decentralized countries, sub-national governments (SNGs) may face soft budget constraints and consequently invest and borrow too much. The policy literature claims that, with competitive capital markets and central governments imposing hard budget contraints (HBCs), inefficient investment by SNGs should not arise. We present a model where this is not the case: HBCs can be too "hard" and discourage investment that is socially efficient. The model combines a dynamic commitment problem in Kornai, Maskin and Roland (2004) for central government with a moral hazard problem between central and SNG. The HBC over-incentivises the SNG to provide effort by penalizing it too much for project failure, thus leading ultimately to the possibility that socially efficient projects may not be undertaken.

Dennis Leech and Robert Leech

We investigate the applicability of voting power indices, in particular the Penrose index (aka absolute Banzhaf index), in the analysis of voting blocs by means of a hypothetical voting body. We use the power of individual bloc members to study the implications of the formation of blocs and how voting power varies as bloc size varies. This technique of analysis has many real world applications to legislatures and international bodies. It can be generalised in many ways: the analysis is a priori (assuming formal voting and ignoring actual voting behaviour) but can be made empirical with voting data; it examines the consequences of two blocs but can easily be extended to more.

Alexander Kovalenkov and Myrna Wooders

Eric Le Borgne and Ben Lockwood

This paper studies a principal-agent model of the relationship between officeholder and the electorate, where everyone is initially uninformed about the offoceholder’s ability. If office-holder effort and ability interact in the determination of performance in office, then an office-holder has an incentive to learn i.e. raise effort so that performance becomes a more accurate signal of her ability. Elections reduce the learning effect, and the reduction in this effect may more than offset the positive “career concerns” effect of elections on effort. Moreover, when this occurs, appointment of officials may welfare-dominate elections.

Yuji Tamura

Majority voting outcomes over different immigration levels of lowskilled workers are examined in a two-period overlapping-generation model in which the labour market and intra- and intergenerational transfer schemes translate the impact of immigration into preferences of heterogeneous citizens. In most of the cases being examined, the model predicts a unique policy choice. However, a voting cycle can also arise in certain circumstances, subjecting the referendum outcome to manipulation.

Ben Lockwood and Miltiadis Makris

We re-examine, from a political economy perspective, the standard view that higher capital mobility results in lower capital taxes - a view, in fact, that is not confirmed by the available empirical evidence. We show that when a small economy is opened to capital mobility, the change of incidence of a tax on capital - from capital owners to owners of the immobile factor - may interact in such a way with political decision-making so as to cause a rise in the equilibrium tax. This can happen whether or not the fixed factor (labour) can be taxed.

Charles Blackorby and Walter Bossert

This paper, which is to be published as a chapter in the Oxford Handbook of Political Economy, provides an introduction to social-choice theory with interpersonal comparisons of well-being. We argue that the most promising route of escape from the negative conclusion of Arrow's theorem is to use a richer informational environment than ordinal measurability and the absence of interpersonal comparability of well-being. We discuss welfarist social evaluation (which requires that the levels of individual well-being in two alternatives are the only determinants of their social ranking) and present characterizations of some important social-evaluation orderings

Charles Blackorby, Walter Bossert and David Donalson

This paper characterizes welfarist social evaluation in a multi-profile setting where, in addition to multiple utility pro.les, there may be more than one profile of nonwelfare information. We prove a new version of the welfarism theorem in this alternative framework, and we demonstrate that adding a plausible and weak anonymity property to the welfarism axioms generates welfarist social-evaluation orderings that are anonymous.

Charles Blackorby and Craig Brett

In a simple finite-horizon overlapping-generations model where the government has the power to levy commodity taxes and to implement uniform lump-sum transfers, and individuals as well as the government can purchase units of a storable good in order to transfer resources from the present to the future, we derive the equations that implicitly define the taxes and subsidies that are part of the second-best Pareto optima. In this context we first show that there is production efficiency. We then show that taxes on capital income/savings are required at almost all Pareto optima. Finally we show that there are no restriction on preferences or technologies that are consistent with a general exemption of capital income/savings from the tax base.

Paul Beaudry and Charles Blackorby

This paper explores how to optimally set tax and transfers when taxation authorities: (1) are uninformed about individuals' value of time in both market and non-market activities and (2) can observe both market-income and time allocated to market employment. In contrast to much of the optimal income taxation literature, we show that optimal redistribution in this environment involves distorting market employment upwards for low net-income individuals through phased-out wage-contingent employment subsidies, and distorting employment downward for high net-income individuals through positive and increasing marginal income tax rate. We also show that workfare may also be used as part of an optimal redistribution program.

Charles Blackorby, Walter Bossert and David Donaldson

This note reexamines the single-profile approach to social-choice theory. If an alternative is interpreted as a social state of affairs or a history of the world, it can be argued that a multi-profile approach is inappropriate because the information profile is determined by the set of alternatives. However, single-profile approaches are criticized because of the limitations they impose on the possibility of formulating properties such as anonymity. We suggest an alternative definition of anonymity that applies in a single-profile setting and characterize anonymous single-profile welfarism under a richness assumption.

Greg Kaplan, Alissa Goodman and Ian Walker

This paper examines the socio-economic consequences of teenage motherhood for a cohort of British women born in 1970. We employ a number of methods to control for observed and unobserved differences between women who gave birth as a teenager and those who do not. We present results from conventional linear regression models, a propensity score matching estimator, and an instrumental variable estimator that uses miscarriage data to control for unobserved characteristics influencing selection into teenage motherhood. We consider the effects on equivalised family income at age 30, and its constituent parts. We find significant negative effects of teenage motherhood using methods that control only for observed characteristics using linear regression or matching methods. However once unobserved heterogeneity is also taken into account, the evidence for large negative effects becomes much less clear-cut. We look at older and younger teenage mothers separately and find that the negative effects are not necessarily stronger for teenagers falling pregnant before age 18 compared with those falling pregnant between 18 and 20, which could further suggest that some of the negative effects of teenage motherhood are temporary.

Nattavudh Powdthavee

This paper is the first of its kind to study utility interdependence in marriage using information on subjective well-being of a large sample of people living in the UK over the period 1991-2001. Using “residual” self-rated health to provide instrument for spouse’s well-being and allowing controls on individual fixed effects, we find strong evidence of altruism represented by interdependent relationships in the reported well-being found only among spouses, and not by partners in cohabiting union. Panel data also show that the well-being impact resulting from “caring” can be used to predict future income, unemployment, and marital status for the individuals

Michael Devereux, Bel Lockwood and Michela Redoano

This paper provides a simple theoretical framework for analyzing simultaneous vertical and horizontal competition in excise taxes, and estimates equations informed by the theory on a panel of US state and federal excise taxes on cigarettes and gasoline. We also examine the role played by smuggling. The results are generally consistent with the theory, when the characteristics of the markets for the goods are taken into account. For neither good do federal excise taxes affect state taxes. Taxes in neighboring states have a significant and large effect in the case of cigarettes, and a much weaker e.ect in the case of gasoline. we also find that in the setting of cigarette taxes, concerns about cross-border shopping play a more important role than concerns about smuggling

David de Meza and Ben Lockwood

This paper shows that coordination failure and contractual incompleteness can lead to socially excessive investment. Firms and workers choose investment levels then enter a stochastic matching process. If investment levels are discrete, then if match frictions are low enough, high investing workers (firms) impose a negative pecuniary externality on any worker (firm) who cuts investment, even by one unit. Specifically, if a worker cuts investment, he subsequently bargains with a firm which has a high outside option due to the fact it can easily match with another highinvesting worker; this lowers the private net benefit to cutting investment below the social net benefit. A similar argument establishes that over-investment can occur when agents are heterogenous i.e. differ in their cost of investing, even if investments are continuous. Then, over-investment occurs because low-cost investors have a private incentive to invest to shift rent away from high-cost investors. Our model can also explain some recent trends in graduate/non-graduate wage differentials.

Frank H Page, Myrna H Wooders and Samir Kamat

We make two main contributions to the theory of economic and social network formation. First, we introduce the notion of a network formation network or a supernetwork. Supernetworks provide a framework in which we can formally define and analyze farsightedness in network formation. Second, we introduce a new notion of equilibrium corresponding to farsightedness. In particular, we introduce the notion of a farsightedly basic network, as well as the notion of a farsighted basis, and we show that all supernetworks possess a farsighted basis. A farsightedly basic network contained in the farsighted basis of a given supernetwork represents a possible final resting point (or absorbing state) of a network formation process in which agents behave farsightedly. Given the supernetwork representation of the rules governing network formation and the preferences of the individuals, a farsighted basis contains networks which are likely to emerge and persist if individuals behave farsightedly.

Edward Cartwright and Myrna Wooders

We demonstrate that if any realization for a Bayesian game is, with high profitability, an approximate Nash equilibrium of the induced game of complete information, then there is a purification of that strategy that is an approximate equilibrium of the original Bayesian game. We also provide two examples demonstrating, amongst other things, that the bound we obtain on the distance of the purification from satisfying the requirements for an exact equilibrium is tight.

Manuel G. Flores-Romaro

The objective of this paper is to oer an answer to the question: why do some entrepreneurs wish to own another firm in the future after having closed an unsuccessful one? We first show this question is relevant because making use of a sample of entrepreneurs in the UK who have experienced a business closure, we show that 45% of them have the desire to own another firm in the future, despite having an unsuccessful experience in small firm ownership. To tackle our question we develop a model where the profits of the small firm depend on two firm-specific parameters: the efficiency parameter, which represents the skills of the entrepreneur to manage and cope efficiently with the everyday tasks of the small firm, and the demand parameter, which denotes the success of the firm’s product to attract demand or capture a market niche. It is found that our model answers our initial question by revealing the existence of a mechanism of entrepreneurial self-selection. Under such mechanism, skilful entrepreneurs are the only ones who wish to own another firm in the future, regardless of the degree of success in their previous venture, whereas unskilful entrepreneurs prefer to go to wage work. We show this mechanism accounts not only for the empirical evidence relevant to our initial question, but also for the rest of cases of entrepreneurs’ attitudes after experiencing a business closure.