Knowledge that Transforms

Reputation effects and other-regarding preferences have both been used to predict cooperative outcomes in markets with inefficient equilibria. Existing reputationbuilding models require either infinite time horizons or publicly observed identities, but cooperative outcomes have been observed in several moral hazard experiments with finite horizons and anonymous interactions. This paper introduces a full reputation equilibrium (FRE) with stereotyping (perceived type correlation) in which cooperation is predicted in early periods of a finitely repeated market with anonymous interactions. New experiments generate results in line with the FRE prediction, including final-period reversions to stage-game equilibrium and noncooperative play under unfavorable payoff parameters.

“A clear conscience is a good pillow.” Why does this old proverb contain an insight? The emotion of guilt holds a key. Psychologists report that “the prototypical cause of guilt would be the infliction of harm, loss, or distress on a relationship partner” (Roy Baumeister, Arlene M. Stillwell, and Todd F. Heatherton 1994, 245; June Price Tangney 1995). Moreover, guilt is unpleasant and may affect behavior to render the associated pangs counterfactual. Baumeister, Stillwell, and Heatherton state, “If people feel guilt for hurting their partners ... and for failing to live up to their expectations, they will alter their behavior (to avoid guilt) in ways that seem likely to maintain and strengthen the relationship.” Avoided guilt is the down of the sound sleeper’s bolster. How can guilt be modeled? How are human interaction and economic outcomes influenced? We offer a formal approach for providing answers. Start with an extensive game form which associates a monetary outcome with each end node. Say that player i lets player j down if as a result of i’s choice of strategy, j gets a lower monetary payoff than j expected to get before play started. Player i’s guilt may depend on how much he lets j down. Player i’s guilt may also depend on how much j believes i believes he lets j down. We develop techniques to analyze equilibria when players are motivated, in part, by a desire to avoid guilt. The intellectual home for our exercise is what has been called psychological game theory. This framework—originally developed by John Geanakoplos, David Pearce, and Ennio Stacchetti (1989) and recently extended by Battigalli and Dufwenberg (2005) (henceforth B&D)—allows players’ utilities to depend on beliefs (about choices, states of nature,

Interaction in small groups is often affected by concerns for fairness and reciprocity. These effects have to be taken into account in the design of optimal incentive schemes. In Fehr and Schmidt (2004) and Fehr, Alexander Klein and Schmidt (2007, henceforce FKS) we have shown experimentally that “bonus contracts ” that rely on fairness and trust as an enforcement device can be more efficient and more profitable than “incentive contracts ” that are enforced by the courts. In the current paper we consider contracts that combine a voluntary bonus with enforceable incentive payments. The question is whether the combination of these two instruments improves efficiency or whether the use of explicit incentives undermines the functioning of implicit incentives such as voluntary bonus payments. Voluntary bonus payments are frequently used in situations where the principal and the agent both observe some aspects of the agent’s performance, but where it is impossible to contract explicitly on this information because it is not verifiable to the courts. In a one-shot relationship a purely self-interested principal would never pay the bonus and thus the agent would have no incentive to work. However, our previous experiments (FKS 2007, Fehr and Schmidt 2004) show that many principals make substantial voluntary bonus payments, even if the interaction with the

Why did Western Europe industrialize first? An influential view holds that its exceptionally well-functioning markets supported with a certain set of institutions provided the incentives to make investments needed to industrialize. This paper examines this hypothesis by comparing the actual performance of markets in terms of market integration in Western Europe and China, two regions that were relatively advanced in the preindustrial period, but would start to industrialize about 150 years apart. We find that the performance of markets in China and Western Europe overall was comparable in the late eighteenth century. Market performance in England was higher than in the Yangzi Delta, and markets in England also performed better than those in continental Western Europe. This suggests strong market performance may be necessary, but it is not sufficient for industrialization. Rather than being a key condition for subsequent growth, improvements in market performance and growth occurred simultaneously.

While neoclassical models assume static cost-minimization by firms, agency models suggest that firms may not minimize costs in less-competitive or regulated environments. We test this using a transition from cost-of-service regulation to market-oriented environments for many US electric generating plants. Our estimates of input demand suggest that publicly owned plants, whose owners were largely insulated from these reforms, experienced the smallest efficiency gains, while investor-owned plants in states that restructured their wholesale electricity markets improved the most. The results suggest modest medium-term efficiency benefits from replacing regulated monopoly with a market-based industry structure.

The carry trade strategy involves selling forward currencies that are at a forward premium and buying forward currencies that are at a forward discount. We compare the payoffs to the carry trade applied to two different portfolios. The first portfolio consists exclusively of developed country currencies. The second portfolio includes the currencies of both developed countries and emerging markets. Our main empirical findings are as follows. First, including emerging market currencies in our portfolio substantially increases the Sharpe ratio associated with the carry trade. Second, bid-ask spreads are two to four times larger in emerging markets than in developed countries. Third and most dramatically, the payoffs to the carry trade for both portfolios are uncorrelated with returns to the U.S. stock market.

In the past 30 years, more and more women have become physicians, receiving training that is indistinguishable from that of their male counterparts. This standardization of human capital accumulation, together with the existence of well-defined specialty categories and clear productivity measures, renders the physician labor market well suited to economic analysis of gender discrimination. The literature indicates that gender gaps in income have faded somewhat, but still persist even within medical specialties. Much of this literature, however, uses older data, does not look at trends over time, or does not take appropriate account of medical specialties or shifts in the age and gender composition of physicians. This paper focuses on the specialty of obstetrics and gynecology (ob-gyn) to gain insight into gender discrimination among highly educated men and women and its evolution in the last 20 years. Ob-gyn is an attractive choice for a number of reasons. First, human capital and production can be measured consistently and accurately. Second, the number of women in the specialty has grown dramatically. While only 12 percent of ob-gyns were female in 1980, the share of women in the field reached 22 percent by 1990 and 40 percent by 2005. Third, ob-gyn is a surgical specialty with an arduous training process. Such specialties have been traditionally male dominated, stressful, and challenging (Janet Bickel 2000). Fourth, there may be discrimination in favor of females on the part

The paper explores strategies that the sponsor of a proposal may employ to convince a qualified majority of members in a group to approve the proposal. Adopting a mechanism design approach to communication, it emphasizes the need to distill information selectively to key group members and to engineer persuasion cascades in which members who are brought on board sway the opinion of others. The paper shows that higher congruence among group members benefits the sponsor. The extent of congruence between the group and the sponsor, and the size and the governance of the group, are also shown to condition the sponsor's ability to get his project approved.

Why is there little robust evidence that foreign aid significantly enhances the economic growth of poor countries? The search for an explanation is becoming immensely important as industrial countries are being exhorted to increase their aid budgets in order to help developing countries achieve the Millennium Development Goals. Perhaps one should not expect an impact on growth from the mere infusion of additional capital into a country. But, perhaps, any beneficial effects are offset by adverse spillover effects, and academic focus should shift to determining what these are and how to mitigate them. In this regard, Figure is suggestive. We plot the log of the manufacturing to gross domestic product (GDP) ratio in a country against the log of the ratio of aid received to GDP for that country for two separate time periods (the late 990s and the early 980s), conditional on a number of variables. As the figure suggests, the more aid a country has received, the smaller its share of manufacturing. The coefficient estimate suggests that a percentage point increase in the ratio of aid to GDP is associated with a reduced share of manufacturing in total GDP of about 0.2 to 0.3 percentage points.