Knowledge that Transforms

In this paper, a model of optimal employment contracting describes differences across countries in firing restrictions and short-time compensation systems for workers forced to work shorter hours to avoid layoff. The model predicts that the existence of a short-time compensation (STC) system will generate major fluctuations in working hours only if the STC system is more generous than the traditional unemployment insurance system. A test performed for 10 OECD countries shows that in countries with generous STC systems, the speed of adjustment of total hours worked is higher than in the United States, despite a much slower adjustment in the number of workers employed. On the other hand, in countries with less generous STC systems, hours adjustments are far from compensating the slower employment adjustments.

This paper tests an optimal (S, s) rule in household durable purchases and examines directly the resulting aggregate expenditure dynamics. The observed decision rule responds to income uncertainty and growth as predicted by an (S, s) model resulting from transactions costs. Tests against liquidity constraints find that about half the households purchase according to an optimal (S, s) rule. Aggregating the (S, s) rule over households produces a cross-section distribution of durables holdings. The empirical distribution is similar to that predicted theoretically, as is its response to aggregate shocks. Furthermore, simulations of aggregate expenditure based on the household distribution exhibit dynamics consistent with those observed in the 1980s.

Bequest to and marriage of children can lead to a Pareto-inefficient allocation. The inefficiency (or market failure) arises because one family, making a bequest to its own child, ignores the contribution to the utility of the other family whose child enters the marriage. This note shows that an assortative mating rule based on bequests can improve or even restore Pareto efficiency when parents take account of the rule in deciding the amount of bequests to their own children.

Productive consumption adds to utility and income at the same time. The shadow price of a productive good is equal to its money price less its marginal product. As more of the good is consumed, its shadow price rises because of diminishing productivity, and the consumer's full income also rises because the marginal product is positive. This paper uses a simple method to derive the comparative statics of the demand system when shadow prices and full income are endogenous. The direction of the overall bias induced by endogenous prices and income is found to be determinate. We demonstrate that the demand for productive goods tends to be relatively unresponsive to exogenous changes in prices and income. We also show that labor supply will be relatively unresponsive to wage and unearned income if market work causes fatigue.

This paper analyzes a model of social interaction in which individuals care about status as well as "intrinsic" utility (which refers to utility derived directly from consumption). Status is assumed to depend on public perceptions about an individual's predispositions rather than on the individual's actions. However, since predispositions are unobservable, actions signal predispositions and therefore affect status. When status is sufficiently important relative to intrinsic utility, many individuals conform to a single, homogeneous standard of behavior, despite heterogeneous underlying preferences. They are willing to conform because they recognize that even small departures from the social norm will seriously impair their status. The fact that society harshly censures all nonconformists is not simply assumed (indeed, status varies smoothly with perceived type); rather, it is produced endogenously. Despite this penalty, agents with sufficiently extreme preferences refuse to conform. The model provides an explanation for the fact that standards of behavior govern some activities but do not govern others. It also suggests a theory of how standards of behavior might evolve in response to changes in the distribution of intrinsic preferences. In particular, for some values of the preference parameters, norms are both persistent and widely followed; for other values, norms are transitory and confined to small groups. Thus the model produces both customs and fads. Finally, an extension of the model suggests an explanation for the development of multiple subcultures, each with its own distinct norm.

Self-reporting--the reporting by parties of their own behavior to an enforcement authority--is a commonly observed aspect of law enforcement, such as in the context of environmental and safety regulation. We add self-reporting to the model of the control of harmful externalities through probabilistic law enforcement, and we characterize the optimal scheme. Self-reporting offers two advantages over schemes without self-reporting: enforcement resources are saved because individuals who report their harmful acts need not be detected, and risk is reduced because individuals who report their behavior bear certain rather than uncertain sanctions.

Lacking an appropriate theoretical framework, economists and economic historians have paid little attention to the relations between culture and institutional structure. This limits the ability to address a question that seems to be at the heart of developmental failures: Why do societies fail to adopt the institutional structure of more economically successful ones? This paper integrates game-theoretical and sociological concepts to conduct a comparative historical analysis of the relations between culture and institutional structure. It examines cultural factors that have led two premodern societies--one from the Muslim world and the other from the Latin world--to evolve along distinct trajectories of institutional structure. It indicates the theoretical importance of culture in determining institutional structures, in leading to their path dependence, and in forestalling successful intersociety adoption of institutions. Since the distinct institutional structures found in the late medieval period resemble those differentiating contemporary developing and developed economies, the paper suggests the historical importance of distinct cultures in economic development.

In this paper, we show that Tobin's q and firm diversification are negatively related throughout the 1980s. This negative relation holds for different diversification measures and when we control for other known determinants of q. Further, diversified firms have lower q's than comparable portfolios of pure-play firms. Firms that choose to diversify are poor performers relative to firms that do not, but there is only weak evidence that they have lower q's than the average firm in their industry. We find no evidence supportive of the view that diversification provides firms with a valuable intangible asset.

We interpret historical evidence in light of a repeated-game model to conclude that merchant guilds emerged during the late medieval period to allow rulers of trade centers to commit to the security of alien merchants. The merchant guild developed the theoretically required attributes, secured merchants' property rights, and evolved in response to crises to extend the range of its effectiveness, contributing to the expansion of trade during the late medieval period. We elaborate on the relations between our theory and the monopoly theory of merchant guilds and contrast it with repeated-game theories that provide no role for formal organization.