The NBER Reporter Fall 2002: Conferences
Tax Policy and the Economy
Inter-American Seminar on Economics
Economic Analysis of Government Expenditure Programs
The NBER, CEPR, CIRJE, and EIJS jointly organized a conference on the Japanese economy in Tokyo on September 13-14. The co-chairmen of the meeting were: Magnus Blomstrom, NBER and Stockholm School of Economics; Jennifer Corbett, Australian National Union; Fumio Hayashi, NBER and the University of Tokyo; and Anil K Kashyap, NBER and the Graduate School of Business, University of Chicago. The following papers were discussed:
The strong corporate affiliations in Japan have been cited as one of the major impediments to making the fundamental changes necessary to escape the economic malaise that has afflicted the Japanese economy over the past decade. While Japanese corporate affiliations during good economic times were heralded as an effective way to increase credit availability and reduce agency costs, these same affiliations may impede needed economic restructuring during difficult economic circumstances, insofar as they insulate firms from the market discipline that otherwise would be imposed by creditors. Peek and Rosengren show that corporate affiliations have contributed to significant misallocations of credit, because troubled borrowers with strong corporate affiliations with their lenders are more likely to obtain additional credit than their healthier brethren. In contrast, lenders who are not affiliated with the firm are less likely to extend additional credit as firms become more troubled.
McGuire asks whether bank ties are costly for mature and healthy firms, and whether banks continue to facilitate investment once non-bank financing options become available. He investigates the investment-cash flow sensitivity of Japanese firms, and finds it lowest for those firms known to have faced bond market constraints. He then estimates that the spread in sensitivity was much larger for main bank client firms, once bond market access is taken into account. This result, coupled with the results on the relative profitability and bond activity of bank-affiliated firms, is consistent with banks capturing the benefits of relationship lending. Finally, McGuire shows that the differences across bank-affiliated and independent firms (in performance and sensitivity) disappeared after deregulation, suggesting that relationship banking persisted only because of the capital market restrictions.
How long does a typical "market leader" in an industry maintain its position? One view associated inter alia with Alfred Chandler asserts that leadership tends to persist for a long time, while a rival, "Schumpeterian" view emphasizes the transience of leadership positions. The central problem with this debate is that no benchmark is proposed relative to which the duration of leadership might be judged long or short. Sutton introduces a formal model of market share dynamics, and uses it to provide a benchmark case, corresponding to a "neutral" situation in which neither positive ("Chandlerian") effects nor negative ("Schmupeterian") effects are present. Empirically observed patterns of persistence can be gauged against this view. He applies this benchmark to a study of 45 narrowly defined industries within Japanese manufacturing over the period 1974-99. A series of tests on the data indicates that he cannot reject the null hypothesis of simple Markovian behavior (that is, no bias in either the Chandlerian or Schumpeterian direction).
Japanese official intervention in the foreign exchange market is by far the largest in the world, although there is little or no evidence that it is effective in moving exchange rates. Up until recently, however, official data on intervention has not been available for Japan. Fatum and Hutchison investigate the effectiveness of intervention using recently published official daily data and an event study methodology. Focusing on daily Japanese and U.S. official intervention operations, they identify separate intervention "episodes" and analyze the subsequent effect on the exchange rate. They find strong evidence that sterilized intervention systemically affects the exchange rate in the short run. This result holds even when intervention is not associated with (simultaneous) interest rate changes and regardless of whether intervention is "secret" (in the sense of no official reports or rumors of intervention reported over the newswires). To some extent, intervention might be a useful policy instrument during the zero-interest rate policy period in Japan, but the effects are likely to be short term in nature.
Ito examines Japanese foreign exchange interventions from April 1991 to March 2001 using newly disclosed official data. All the yen-selling (dollar-purchasing) interventions were carried out when the yen/dollar rate was below 125, while all the yen-purchasing (dollar-selling) interventions were carried out when the yen/dollar was above 125. The Japanese monetary authorities, by buying the dollar low and selling it high, have produced large profits, in terms of realized capital gains, unrealized capital gains, and carrying (interest rate differential) profits, from interventions during the ten years. Profits amounted to 9 trillion yen (2 percent of GDP) in ten years. Interventions are effective in the second half of the 1990s, when daily yen/dollar exchange rate changes were regressed on various factors, including interventions. The U.S. interventions in the 1990s always were accompanied by the Japanese interventions. The joint interventions were 20-50 times more effective than the Japanese unilateral interventions. Japanese interventions were prompted by rapid changes in the yen/dollar rate and the deviation from the long-run mean (say, 125 yen). The interventions in the second half were less predictable than those in the first half.
Ogawa analyzes the extent to which financial distress in the 1990s affected employment behavior in Japan. Based on firm-level panel data that include small firms, he estimates a dynamic labor demand function, taking the impact of financial distress on employment into consideration. He finds that the firm's ratio of debt to total asset exerts a significantly negative effect on employment in small firms. He also finds that employment in small firms is sensitive to the lending attitude of financial institutions.
Iwaisako studies the relationship between portfolio choice and age for Japanese households, using micro data and paying particular attention to the interaction between decisions to hold stocks and real estate. His major findings are: Equity shares in financial wealth (S/FW) increase with age among young households, peaking in the fifties age group, then becoming constant. This peak comes much later in the life cycle than the peak Amerkis and Zeldes (2001) report for U.S. households. 2) The same age-related pattern exists for real estate shares in household total wealth (RE/TW). 3) With respect to both, S/FW and RE/TW, the age-related patterns are explained mostly by the decision about holding stocks versus real estate. 4) No age-related pattern in equity holding is observed for households that do not own real estate. In sum, the age-related pattern observed in stock holding appears to be explained mostly by the household's tenure choice of housing. Households about to purchase and having just purchased houses cannot take risky positions in financial investments because they are saving for down payments or have heavily leveraged positions in terms of housing loans. Therefore, any serious attempt at modeling Japanese households' dynamic portfolio choice should incorporate the effect of housing tenure choice.
The dramatic rise and fall of the Japanese equity market provides Hamao, Mei, and Xu with a unique opportunity to examine market-and-firm-specific risks over different market conditions. Unlike the U.S. experience, in Japan there is a surprising fall in firm-level volatility and turnover in stocks after the market crash. Accordingly, correlations among individual stocks have increased and the number of stocks needed to achieve a given level of diversification has declined. As a consequence, the authors suggest that it has become more difficult over the past decade for both investors and managers to separate high-quality from low-quality firms, making the Japanese market less efficient. Moreover, changes in firm-level volatilities are related positively to corporate bankruptcies, indicating that improvements in information efficiency occur when regulations on corporate bankruptcies are relaxed. These results suggest that the sharp fall in firm-level volatility during 1990-6 may be attributable to a lack of corporate restructuring. This is more evident for firms with business group and main bank affiliations, whose firm-level volatility is less dependent on economic conditions than that of firms with no affiliations. Thus, the authors argue that a lack of "creative destruction" may have led to Japanese market inefficiency and a vicious cycle of capital misallocation.
Using a newly constructed dataset, Mayer, Schoors, and Yafeh compare sources of funds and investment activities of venture capital (VC) funds in Germany, Israel, Japan, and the United Kingdom. Sources of VC funds differ significantly across countries, for example, banks are particularly important in Germany, corporations in Israel, insurance companies in Japan, and pension funds in the United Kingdom. VC investment patterns also differ across countries in terms of the stage, sector of financed companies, and geographical focus of investments. The authors find that these differences in investment patterns are related to the variations in funding sources -- for example, bank and pension fund backed VC firms invest in later stage activities than individual and corporate backed funds -- and the authors examine various theories concerning the relation between finance and activities. They also report that the relations differ across countries; for example, bank-backed VC firms in Germany and Japan are as involved in early stage finance as other funds in these countries, whereas they tend to invest in relatively late stage finance in Israel and the United Kingdom.
Theories of multiple equilibriums (ME) are now widespread across many fields of economics. Yet little empirical work has asked if such MEs are salient features of real economies. Davis and Weinstein examine this in the context of the Allied bombing of Japanese cities and industries in WWII. A key identifying test for MEs is the "ratchet effect": small shocks allow a full recovery while large shocks do not. The authors examine this theory for 114 Japanese cities in eight manufacturing industries. The data reject the existence of multiple equilibriums. In the aftermath of ever gargantuan shocks, a city recovers not only its population and its share of aggregate manufacturing, but also the specific industries it had before.
These papers will be available in the NBER Working Paper series. In addition, a Summary Report of the conference, including a transcript of the luncheon remarks by the Japanese Vice Minister for International Affairs at the Ministry of Finance, Haruhiko Kuroda, will be published and will also be available on the NBER's website.
The NBER's Seventeenth Annual Conference on Tax Policy and the Economy, organized by James M. Poterba of NBER and MIT, took place in Washington, DC on October 8. These papers were discussed:
The No Child Left Behind Act of 2001 established new national rules for school accountability, requiring mandated testing of all students in grades three through eight, mandated state grading of schools, and provided financial rewards and sanctions for schools based on their aggregate test performance. Figlio describes some of the key direct and indirect fiscal consequences of school accountability systems, focusing particularly on this new federal law. His analysis of the direct consequences suggests that the federal law likely will offset, perhaps considerably, school equalization systems in some states. The indirect fiscal consequences may exacerbate the effects of the direct fiscal consequences, because school accountability systems likely have effects on the classification (and attendant costs) of disabled students, as well as on input prices and on the property tax base.
Glaeser and Shapiro study the home mortgage interest deduction which creates incentives to buy more housing and to become a homeowner. The case for the deduction rests on the social benefits from housing consumption and homeownership. But there is little evidence of large externalities from the level of housing consumption, although there appear to be externalities from homeownership. The externalities from living around homeowners are far too small to justify the deduction. The externalities from home ownership itself are larger, but the home mortgage interest deduction is a particularly poor instrument for encouraging homeownership because it is targeted at the wealthy, who are almost always homeowners. The irrelevance of the deduction is supported by the time-series data which show that the ownership subsidy moves with inflation and has changed significantly between 1960 and today, but the homeownership rate has been essentially constant.
In 2001, many households received rebate checks as advance payments of the benefit of the new, 10 percent federal income tax bracket. A survey conducted at the time the rebates were mailed finds that few households said that the rebate led them to (mostly) spend more. A follow-up survey in 2002, as well as a similar survey conducted after the attacks of 9/11, also indicates low spending rates. Shapiro and Slemrod investigate the robustness of these survey responses and evaluate whether such surveys are useful for policy evaluation. They also draw lessons from the surveys for macroeconomic analysis of the tax rebate.
The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) greatly expands the limits on contributions to tax-deductible accounts, including 401(k), 403b, Keogh, and traditional IRA plans. It also raises the limit on contributions to non-tax-deductible Roth IRAs. But, most important for the issue of tax fairness, it provides a significant, but little known, non-refundable tax credit for qualified account contributions up to $2,000 made by low-earning workers. Gokhale and Kotlikoff review the pre-EGTRRA lifetime tax gains (or losses) available to low-, middle-, and high-lifetime earners from participating fully in 401(k) accounts, traditional IRA accounts, and Roth IRA accounts. They show how these subsidies have been changed by the new legislation. The authors' bottom line is that EGTRRA mitigates, but doesn't fully eliminate, the lifetime tax increases facing many low-income households from making significant contributions to tax-deferred retirement accounts. Additional research is needed to understand how many low- and moderate-income households are paying higher taxes, at the margin, because of their saving through tax-deferred accounts. Most low- and moderate-income households may be contributing less than the maximum possible amount to these accounts and, thereby, are limiting their losses. But even these households are being ill served in so far as they have been told by the government, their employers, and their financial advisors that saving in tax-deferred accounts will deliver major tax savings.
Shackelford and Collins attempt to estimate the tax costs of being a U.S. multinational. Their study is motivated by the increasing difficulties that the U.S. faces in attempting to tax multinationals in the presence of global capital markets, as recently was highlighted by WTO decisions and corporate inversions. They find that companies domiciled in the United States face higher tax burdens than U.S. domestic-only companies; higher tax burdens than Canadian multinationals; and similar tax burdens to British multinationals. Based on their review of prior evidence and the new evidence presented here, they conclude that at least some U.S. companies are facing heavier tax burdens because they are positioned globally.
Desai examines the evolution of the corporate profit base and the relationship between book income and tax income for U.S. corporations over the last two decades. This relationship has broken down over the 1990s, in a manner that is consistent with increased sheltering activity. Desai traces the growing discrepancy between book and tax income associated with: differential treatments of depreciation; the reporting of foreign source income; and in particular, the changing nature of employee compensation. For the largest public companies, the proceeds from option exercises equaled 27 percent of operating cash flow from 1996 to 2000 and these deductions appear to be fully utilized, thereby creating the largest distinction between book and tax income. While the differential treatment of these items historically has accounted fully for the discrepancy between book and tax income, this paper shows that book and tax income have diverged markedly for reasons not associated with these items during the late 1990s. In 1998, more than half of the difference between tax and book income -- approximately $154.4 billion or 33.7 percent of taxable income -- cannot be explained by these factors. Desai demonstrates that the breakdown in the relationship between tax and book income is consistent with increasing levels of sheltering during the late 1990s. He also explores an alternative explanation of these results -- coincident increased levels of earnings management -- and finds that the nature of the breakdown between book and tax income cannot be explained fully by this alternative explanation.
These papers will be published by the MIT Press as Tax Policy and the Economy, Volume 17. They are also available at "Books in Progress" on the NBER's website.
The NBER and ITESM in Monterrey, Mexico jointly organized the 2002 Inter-American Seminar on Economics, which took place in Mexico on November 15-16. Sebastian Edwards, NBER and University of California, Los Angeles, put together this program:
Aizenman explores the implications of the deepening presence of multinationals in emerging markets on the cost of macroeconomic volatility there. He finds that macroeconomic volatility has a potentially large impact on the employment and investment decisions of multinationals that produce intermediate inputs in developing countries. For industries with costly capacity, the multinationals tend to invest in more stable emerging markets. Higher volatility of productivity shocks in an emerging market that produces intermediate inputs will reduce the multinationals' expected profits. High enough instability in such a market induces the multinationals to diversify their production, investing in several emerging markets. This effect is stronger in lower margin industries. Diversification can be costly to emerging markets, though: it increases the responsiveness of the multinationals' employment in each country to productivity shocks, channels the average employment from more to less volatile locations, and reduces the multinationals' total expected employment in emerging markets.
Do workers in countries located far from global economic activity have less incentive to accumulate human capital than workers near the center? Schott and Redding model the relationship between countries' distance from global economic activity, endogenous investments in education, and economic development. Firms in remote locations pay greater trade costs on both their exports and their imports of intermediate inputs, reducing the amount of value added left to remunerate the domestic factors of production. As a result, the skill premium and the incentives to accumulate human capital will be depressed if skill-intensive sectors have higher trade costs, more pervasive input-output linkages, or stronger increasing returns to scale. Empirically, the authors demonstrate that countries with lower market access have lower levels of educational attainment and that the world's most peripheral countries are becoming increasingly remote over time.
As an alternative to examining the effect of trade openness on economic growth, Wei and Wu investigate the connection between openness and a society's health status. There are a number of advantages with this approach, including a more direct link with welfare and a more comparable data definition across countries. The authors report several pieces of evidence suggesting that higher trade openness (especially when measured by a lower tariff rate) is associated with a longer life expectancy and lower infant mortality. On the other hand, financial openness does not seem to help promote better health.
After signing ten free trade agreements between 1993 and 2001, Mexico is becoming a world leader in foreign trade policy. Are multiple Regional Trade Areas (RTAs) building blocs towards freer trade with transparent rules of the game? Mexico's multiple agreements generally have used the principle of NAFTA consistency, after the acceptance that NAFTA has become a broader and deeper accord than the Uruguay multilateral achievements. Ibarra-Yunez analyzes the pros and cons of multiple RTAs by Mexico and includes a game model of equilibrium and a political economy approach to the non-economic reasons for Mexico's foreign trade stance.
In recent years, there has been a rapid increase in wage inequality between skilled and unskilled workers in Mexico. This increment in the wage gap has coincided with a period of rapid technological change and with the process of trade liberalization in Mexico that began in 1985. The wage gap also has increased in several other countries, and the academic literature suggests two main explanations for this trend: trade liberalization (or globalization) and skill-biased technological progress. Esquivel and Rodriquez-Lopez separate out the effects of globalization and technological progress on the evolution of real wages of skilled and unskilled workers in Mexico's manufacturing industry. They find that technological progress played a major role in the increase in wage inequality in Mexico between 1988 and 2000. They also find that trade liberalization pressed for a decrease in the wage gap in the period 1988-94, but that effect was offset by the relatively large negative impact of technological progress on the real wage of unskilled workers.
Wage inequality in Argentina increased during the 1990s. During this period, a rapid and deep process of trade liberalization was implemented. Galiani and Sanguinetti ask whether trade liberalization played any role in shaping the Argentine wage structure during the 1990s. Specifically, they test whether those sectors where import penetration deepened are also the sectors where a higher increase in wage inequality is observed. They find evidence that supports this hypothesis. However, similar to what has been found for some developed economies, trade deepening can only explain a small proportion of the observed rise in wage inequality.
The post-civil war experience of El Salvador provides an opportunity for examining the impact of parental budget constraints on children's schooling. In 1997, 14 percent of rural and 15 percent of urban households received remittances from family members living abroad, and the modal amount of remittances was US $100. Edwards and Ureta examine the impact of remittances on school attendance. They find that remittances have a significant effect on school retention. This result suggests that subsidies to the demand for schooling, particularly in poor areas, may have a large impact on school attendance and retention, even if parents have low levels of schooling. However, two aspects of this experiment likely affect the observed outcome, and deserve more study before the potential impact of school subsidies is fully understood. First, the case studied here involves direct transfers to specific households whose budget allocation decisions can be monitored by the grantor. Second, the institutional setting in El Salvador is such that the expansion of school facilities is driven primarily by the active participation of parents in the allocation of public and private funds. Parents have played a leading role in financing the expansion of private schools in urban areas, and the Ministry of Education allocates resources to parents' associations, enabling them to hire teachers and buy teaching materials in rural areas.
Goldberg and Pavcnik study the relationship between trade liberalization and informality. It is often claimed that increased foreign competition in developing countries leads to an expansion of the informal sector, defined as the sector that does not comply with labor market legislation. Using data from two countries that experienced large trade barrier reductions in the 1980s and 1990s, Brazil and Colombia, the authors examine the responses of the informal sector to liberalization. In Brazil, there is no evidence of a relationship between trade policy and informality. In Colombia, there is evidence of such a relationship, but only for the period preceding a major labor market reform that increased the flexibility of the Colombian labor market. These results point to the significance of labor market institutions in assessing the effects of trade policy on the labor market.
In the presence of uncertainty about what a country can be good at producing, there can be great social value to discovering the costs of domestic activities, because such discoveries can be imitated easily. Hausmann and Rodrik develop a general-equilibrium framework for a small open economy to clarify the analytical and normative issues. They highlight two failures of the laissez-faire outcome: there is too little investment and entrepreneurship ex ante, and too much production diversification ex post. Optimal policy consists of counteracting these distortions: to encourage investments in the modern sector ex ante, but to rationalize production ex post.
These papers will be published in a special issue of the Journal of Development Economics.
The NBER held a conference on "Organizational Economics" in Cambridge on November 22-23. NBER Research Associate Robert Gibbons, also of MIT, organized the two-day meeting. The following papers were discussed:
The literature on firms, based on incomplete contracts and property rights, emphasizes that the ownership of assets -- and thereby firm boundaries -- is determined so as to encourage relationship-specific investments by the appropriate parties. This approach applies to owner-managed firms better than to large companies. Hart and Holmstrom attempt to broaden the scope of the property rights approach by developing a simpler model with three key ingredients: decisions are non-contractible, but transferable through ownership; managers (and possibly workers) enjoy private benefits that are non-transferable; and owners can divert a firm's profit. With these assumptions, firm boundaries matter. Nonintegrated firms fail to account for the external effects that their decisions have on other firms. An integrated firm can internalize such externalities but it does not put enough weight on the private benefits of managers and workers. The authors first explore this trade-off in a basic model that focuses on the difficulties companies face in cooperating through the market if benefits are distributed unevenly; therefore, they sometimes may end up merging. Hart and Holmstrom then extend the analysis to study industrial structure in a model with intermediate production. This analysis sheds light on industry consolidation in periods of excess capacity.
Baldwin and Clark seek to explain the location of transactions (and contracts) in a system of production. Systems of production are engineered, and the question of where to place "transactions" is one of the basic engineering problems that face the designers of such systems. The authors characterize a system of production as a network of tasks that agents perform and the transfers of material, energy, and information between and among agents. They then argue that although transfers between agents are absolutely necessary and ubiquitous in any human-built system of production, transaction costs make it impossible for all transfers to be transactions. The particular transaction costs they are concerned with are the so-called "mundane" costs of creating a transactional interface: the costs of defining what is to be transferred, of counting the transfers, and of valuing and paying for the individual transfers. The authors argue that the modularity of a system of production determines the system's pattern of mundane transaction costs. In this fashion, the engineering design of a system of production necessarily establishes where transactions can go and what types of transactions are feasible and cost-effective in a given location.
Hansmann, Kraakman, and Squire note that the law's critical contribution to the evolution of organizations has been the creation of legal entities -- firms that can serve as credible contracting actors in their own right. Affirmative asset partitioning has been at the core of this contribution. The affirmative partitioning typically established by organizational law involves giving firm creditors a prior claim on those assets that are used by the firm in its productive processes. That has required both that the necessary legal rules be in place, and that the commercial environment be such that those assets can be credibly monitored. With the accommodation of corporate subsidiaries at the end of the 19th century, and the development of ever more sophisticated forms of secured financing in the 20th century, it has become increasingly possible to differentiate between the pool of assets that a firm uses in production and the pools of assets that it pledges as security to its creditors. This allows, among other things, for far greater flexibility in designing the scope of the firm as a nexus of contracts. The future is likely to continue to take us further in this direction, with the possibility that the contractual part of organizational law will come to be increasingly divorced from the asset partitioning part of organizational law, and that the latter function will come to be merged ever more with the general law of secured transactions.
Ichniowski, Shaw, and Gant use a unique, personally collected database to investigate how a firm's human resource management (HRM) policies can create organizational capital by developing structures that promote productive exchange of knowledge among employees. In short, HRM practices can get employees to "work smarter" by getting them to work together more effectively. The authors investigate precisely how innovative HRM practices might change workers' behavior to make them more productive. They present a simple model that incorporates an organization's "connective capital" - that is, the stock of human capital that employees can access through their connections to other workers-- as an input in its production function. Employees develop connective capital through communications links with other employees in order to tap into the knowledge of their co-workers as they seek to solve problems together. The authors find that HRM practices aimed at promoting greater levels of employee involvement substantially increase interaction among employees, particularly among production workers, relative to more traditional HRM practices. Employees in plants with new HRM practices are working in environments with higher levels of connective capital, because the richer set of inter-worker linkages in these plants give workers access to the knowledge, ideas, and experience of a wide array of co-workers. Given the technological similarity of the production lines the authors investigate in this study, the high levels of connective capital appear to be an important reason for the productivity gains realized under new HRM practices.
Many firms issue stock options to all employees. Oyer and Schaefer consider three potential economic justifications for this practice: providing incentives to employees; inducing employees to sort; and helping firms to retain employees. They gather data from three distinct sources on firms' stock option grants to middle managers, and use two methods to assess which theories appear to explain the observed "granting" behavior. First, they directly calibrate models of incentives, sorting, and retention, and ask whether observed magnitudes of option grants are consistent with each potential explanation. Then they conduct a cross-sectional regression analysis of firms option-granting choices. They reject an incentives-based explanation for broad-based stock option plans, and conclude that sorting and retention explanations appear to be consistent with the data.
One of the defining characteristics of organizations -- as opposed to markets -- is the presence of a managerial hierarchy that coordinates economic activity by use of authority. However, organizations also frequently delegate decisions to groups of agents -- committees, cross-functional teams -- as opposed to managers. Dessein proposes a model of organizational decisionmaking with endogenous communication costs and puts forward a theory of why and when authority is a superior coordination device relative to some form of consensus (that is, majority rule or unanimity). He argues that coordination by authority results in faster decisionmaking and a less distorted aggregation of information. However, this comes at the expense of a narrowness in decisionmaking, where the agents in control are biased in favor of their own ideas. Authoritative coordination tends to be indicated for problems that are urgent or complex, or where the variance in the quality of potential solutions is limited. Finally, Dessein shows how imposing a unanimity rule as opposed to a majority rule can alleviate some of the drawbacks of consensus.
Zitzewitz exploits nationalistic biases in the judging of Olympic winter sports to study the problem of designing a decisionmaking process that uses the input of potentially biased agents. Judges score athletes from their own countries higher than other judges do, and they appear to vary their biases strategically in response to the stakes, the scrutiny given the event, and the degree of subjectiveness of the performance aspect being scored. Ski jumping judges display a taste for fairness in that they compensate for the nationalistic biases of other panel members, while figure skating judges appear to engage in vote trading and bloc judging. Career concerns create incentives for judges: biased judges are less likely to be chosen to judge the Olympics in ski jumping but more likely to be chosen for figure skating; this is consistent with judges being chosen centrally in ski jumping and by national federations in figure skating. The sports truncate extreme scores to different degrees: both ski jumping and, especially, figure skating truncate too aggressively; this may contribute to the vote trading in figure skating. These findings have implications for both the current proposals for reforming the judging of figure skating and for designing decisionmaking in organizations more generally.
Van den Steen starts from the most prevalent definition of corporate culture in the management literature: "shared beliefs or assumptions." He shows that corporate culture evolves from the common experiences of a firm's members. His model captures a number of important stylized facts: the culture of the firm is heavily influenced by the initial beliefs of the founder(s) or early leader, and can persist even long after that founder or early leader is gone. External succession of the CEO is more likely to lead to a change in corporate culture than to internal succession. Otherwise identical firms may develop very different cultures. Older firms tend to have stronger cultures. Suboptimal cultures may persist, even if the members of the organization know that their culture is almost surely suboptimal. By focusing on the dynamics, Van den Steen further concludes that firms with a stronger cultures on average will perform better even though, in this model, the strength of corporate culture does not have any effect on performance. After a radical change in the environment, on the other hand, firms with a stronger culture may tend to underperform other firms, although again the strength of corporate culture has no effect on performance.
MacLeod extends the standard principal-agent model to allow for subjective evaluation. The optimal contract results in more compressed pay relative to the case with verifiable performance measures. Moreover, discrimination against an individual implies lower pay and performance, suggesting that the extent of discrimination as measured after controlling for performance may underestimate the level of true discrimination. Finally, the optimal contract entails the use of bonus pay rather than the threat of dismissal; hence neither "efficiency wages" nor the right to dismiss an employee are necessary ingredients for an optimal incentive contract.
Lafontaine and Masten consider functions of contracting other than the protection of relationship-specific investments and the provision of marginal incentives, and apply the theory to explain variation in the form of compensation of over-the-road truck drivers in the United States. Specifically, they argue that contracts in this industry serve to economize on the costs of price determination for heterogeneous transactions. They show that the actual terms of those contracts vary systematically with the nature of hauls in a way that is consistent with the theory. By contrast, they find that vehicle ownership, which defines a driver's status as an owner operator or company driver, depends on driver, but not on trailer or haul characteristics.
Elfenbein and Lerner examine from a contract theory perspective the structure of more than 100 alliances by Internet portals and other firms between 1995 and 1999. In justifying the assumption of incompleteness, models of incomplete contracts frequently invoke unforeseen contingencies, the cost of writing contracts, and the cost of enforcing contracts. The setting in which Internet portals formed alliances was rife with these sorts of transaction costs. The authors argue that these alliances can be viewed as incomplete contracts; they find that the division of ownership and the allocation of control rights are consistent with the incomplete contracting literature.
Acemoglu, Kremer, and Mian examine the relative merits of markets, firms, and governments in environments where high-powered incentives can stimulate both productive effort and unproductive effort to signal ability. In a pure "market environment," workers have strong incentives to distort the composition of effort. Firms may be able to flatten incentives and improve efficiency by obscuring information about workers' output and thus reducing their willingness to signal. However, firms themselves may not be able to commit to failing to provide greater compensation to employees who distort their efforts to improve observed performance. Government organizations, on the other hand, often have flatter wage schedules, thereby naturally weakening the power of incentives. The authors suggest that there are also endogenous reasons for why governments, even when run by self-interested politicians, may be able to commit to lower-powered incentives than firms; in the presence of common shocks, governments internalize the negative externality of higher observed output from one employee on the evaluation of the rest of employees. This model may help to explain the widespread role of governments in the provision of pensions, education, health care, and law enforcement.
Public sector officials typically are not rewarded for performance by explicit pay mechanisms. Instead, they often are monitored by sporadic investigation, where the relevant issues for oversight are who oversees performance and what triggers an investigation. Prendergast considers a choice between internal and external monitoring of public agencies. He argues that a drawback with internal oversight is that officials have (efficiently) different preferences from the population whose objectives they implement. Specifically, they are biased against consumers, and are unwilling to investigate their legitimate complaints. But external parties are usually less well informed than are insiders, and often rely on a consumer complaint to pique their interest. As a result, bureaucrats become excessively worried about the prospect of an investigation, where external monitoring may result in a failure to efficiently deny benefits to consumers. Prendergast provides evidence from the Los Angeles Police Department to show that officers appear to have responded to increased external oversight by reducing crime-fighting activities in an attempt to avoid investigation.
What is the role of firms and markets in mediating the division of labor? Garicano and Hubbard use confidential microdata from the Census of Services to examine law firms' boundaries. They first examine how the specialization of lawyers and firms increases as lawyers' returns to specialization increase. The authors then ask which pairs of specialists tend to work in the same versus different firms; this provides evidence on the scope of firms that are not field-specialized. They find that whether firms or markets mediate the division of labor varies across fields in a way that corresponds to differences in the value of cross-field referrals, consistent with Garicano and Santos' (2001) proposition that firms facilitate specialization by mediating exchanges of economic opportunities more efficiently than markets.
Theories based on incomplete contracting suggest that small organizations may do better than large organizations in activities that require the processing of soft information. Berger, Miller, Petersen, Rajan, and Stein explore this idea in the context of bank lending to small firms, an activity that typically is thought of as relying heavily on soft information. They find that large banks are less willing than small banks to lend to informationally "difficult" credits, such as firms that do not keep formal financial records. Moreover, controlling for the endogeneity of bank-firm matching, large banks lend at a greater distance, interact more impersonally with their borrowers, have shorter and less exclusive relationships, and do not alleviate credit constraints as effectively. All of this is consistent with small banks being better able to collect and act on soft information than large banks.
Using a detailed database of managerial job descriptions, reporting relationships, and compensation structures in over 300 large U.S. firms, Rajan and Wulf find that the number of positions reporting directly to the CEO has gone up significantly over time. They also find that the number of levels between the lowest managers with profit-center responsibility (division heads) and the CEO has decreased and that more of these managers are reporting directly to the CEO. The authors do not find that divisions within the firm are becoming larger, so the proximate explanation of these findings is not that organizational restructuring is making more divisional heads important enough to report directly. Instead, the findings suggest that layers of intervening management are being eliminated and the CEO is coming into direct contact with more mangers in the organization, even while managerial responsibility is being extended downwards. Consistent with this, the authors find that the elimination of the intermediate position of Chief Operating Officer accounts for a significant part (but certainly not all) of the increase in CEO reports. Accompanying the flattening of organizations is a change in the structure of pay. Pay and long-term incentives are becoming more like those of a partnership. Salary and bonus at lower levels are lower than in comparable positions in a tall organization, but the pay differential is steeper toward the top. At the same time, employees in flatter organizations seem to have more long-term pay incentives, like stock and stock options, offered to them.
Jacob and Lefgren examine the short-term effect of school on juvenile crime. They bring together daily measures of criminal activity and detailed school calendar information from 27 jurisdictions across the country and find that the level of property crime committed by juveniles decreases by 15 percent on days when school is in session, but that the level of violent crime increases by nearly 20 percent on such days. These results do not appear to be driven by inflated reporting of crime on school days or substitution of crime across days. These findings provide evidence for both incapacitation and concentration models of schooling -- when juveniles are not provided with constructive activities, they are more likely to engage in certain anti-social behaviors; at the same time, the increase in interactions associated with school attendance leads to more interpersonal conflict and violence. These results underscore the social nature of violent crime. Furthermore, they suggest that youth programs -- particularly those with no educational component, such as midnight basketball or summer concerts -- may entail important tradeoffs in terms of their effects on juvenile crime.
Ellen, Schwartz, and Voicu analyze the external effects of subsidized housing on the value of surrounding properties. In particular, they estimate the spillover effects of the new, publicly-assisted housing units produced in New York City as part of the Ten Year Plan program. Their results suggest that the city's investment in new housing generated significant external benefits and that these benefits were sustained over time. The magnitudes of the external effects increase with project size and decrease with the proportion of units in multi-family, rental buildings. Consistent with expectations, spillover effects diminish with distance from the housing investment sites. Further, spillovers are typically larger in the more distressed neighborhoods, and smaller projects are likely to be less effective if surrounded by high levels of blight. The spillover benefits also reflect, at least to some extent, the elimination of a disamenity. In addition, some of the external benefits of new housing seem to be occupancy effects, occurring through the number and characteristics of inhabitants.
Fishback, Horace, and Kantor find that the economic effects of the various forms of New Deal spending were quite different. These contrasts help to answer questions in today's political debates about the role of fiscal policy. The authors' strongest finding is that the public works programs that built large-scale civil infrastructure projects had strong positive effects on the economy. At the margin, an additional dollar spent on dams, roads, schools, and buildings by the PWA, PRA, and PBA had an income multiplier over two for the entire decade of the 1930s. The short-term effects of the public works projects through 1935 were somewhat smaller, which suggests that some of the most dramatic effects of these projects were not felt until completion when they were able to stimulate productivity in the private sector. The relief programs' effect on the growth of retail sales over 1929-39 is estimated to be somewhat smaller, with a multiplier effect of around 1.7. These grant programs had much stronger positive effects than the loan programs, probably because the actual and anticipated repayment of the loans from state and local governments and private borrowers to the federal government limited their impact. Federal spending on the AAA program, the basis for our modern farm programs, had at best a small positive effect on local economies and possibly a negative effect. The Federal Housing Administration's insurance of home mortgages and home improvement loans also may have contributed to stimulating local economies.
A new omnibus package of farm legislation (the 2002 Farm Bill) will provide in excess of $190 billion in financial support to U.S. agriculture, an increase of $72 billion over existing programs. Goodwin, Mishra, and Ortalo-Magne study the distribution of such benefits. Farm subsidies make agricultural production more profitable by increasing and stabilizing farm prices and incomes. If these benefits are expected to persist, farm land values should capture the subsidy benefits. Using a large sample of individual farm land values to investigate the extent of this capitalization of benefits, the authors confirm that subsidies have a very significant impact on farm land values. Thus, landowners are the real beneficiaries of farm programs. As land is exchanged, new owners will pay prices that reflect these benefits, leaving the benefits of farm programs in the hands of former owners who may be exiting production. Approximately 45 percent of U.S. farm land is not operated by its owner. Farm owners benefit not only from capital gains but also from lease rates which incorporate a significant portion of agricultural payments even if the farm legislation mandates that benefits must be allocated to producers. Finally, there is evidence that farm programs that are meant to stabilize farm prices provide a valuable insurance benefit.
Title I, which allocates money for compensatory education to school districts based on their child poverty, is seen as the single most important federal education program. This is largely because of its size: it cost $9.6 billion in 2001 and represents 35 percent of the Department of Education's elementary and secondary spending. Whether Title I is actually important is controversial, however, because it is not clear that it raises the spending of schools that serve poor children. Title I money must make its way through as many as three other levels of government (states, local parent governments such as counties or municipalities, and school districts), each of which can offset changes to Title I so that spending on poor students changes less than the federal government intends. Gordon overcomes the simultaneity problems inherent in estimating the effect of Title I by using sharp changes in per-pupil grant amounts resulting from the release of decennial census data to identify how state and local education revenues and school district spending react to changes in Title I. She finds that state education revenue and school districts' own revenue efforts initially are unaffected by Title I changes so that Title I raises instructional spending dollar for dollar. Three years later, however, local governments have offset changes in Title I, so that the federal spending has only small and statistically insignificant net spending effects on schools.
Over the past four decades there has been a rapid growth in both the number and size of state lotteries in the United States. Many states deposit lottery profits into their general funds, but 16 states earmark lottery profits for primary and secondary education. Evans and Zhang use a panel data set of the states with lotteries to examine the impact of earmarking lottery revenues on state educational spending. They have two primary results. First, they find that about 50 to 80 cents out of an earmarked dollar is spent on public education. Second, states with lotteries spend a higher share of the marginal lottery dollar on education than income generated from other sources such as alcohol and cigarette taxes. Each dollar of lottery profit increases school spending by about 30-50 cents. The authors find a high likelihood that a dollar of earmarked lottery profits generates less than a dollar of spending on K-12 education, but more than the spending generated from a dollar of lottery profits put into the general fund.
Dafny investigates whether hospitals respond in profit-maximizing ways to changes in diagnosis-specific prices, as determined by Medicare's Prospective Payment System and other cost-conscious insurers. She exploits an exogenous 1988 policy change that generated a relative price increase of 7 percent (around $300) for 43 percent of all Medicare admissions. Using the unaffected admissions as a control group, she finds that hospitals did not increase the intensity of care provided to affected admissions, with intensity measured by total costs, length of stay, number of surgical procedures, number of intensive-care-unit days, and in-hospital death rate. Neither did hospitals increase the volume of patients admitted to more remunerative diagnoses, notwithstanding the strong a priori expectation that such a response should prevail in fixed-price settings. However, hospitals did exhibit a strong nominal response to the policy change, "upcoding" patients to diagnosis codes associated with large reimbursement increases, and earning $300-$410 million in extra reimbursement annually. This response was particularly strong among for-profit hospitals. Taken together, these findings suggest that hospitals do not alter their treatment or admissions policies based on diagnosis-specific prices; however, they employ sophisticated coding strategies in order to maximize total reimbursement.
While most countries are committed to increasing access to safe water and thereby reducing child mortality, there is little consensus on how to actually improve access to water. One important proposal under discussion is whether to privatize water provision. In the 1990s Argentina embarked on one of the largest privatization campaigns in the world including the privatization of local water companies covering approximately 30 percent of the country's municipalities. Using the variation in ownership of water provision across time and space generated by the privatization process, Galiani, Gertler, and Schargrodsky find that child mortality fell 8 percent in areas that privatized their water services overall; the effect was largest (26 percent) in the poorest areas. While privatization is associated with significant reductions in deaths from infectious and parasitic diseases, it is uncorrelated with deaths from causes unrelated to water conditions.