Knowledge that Transforms

The Political Economy of Antiracism Initiatives in the Post-Durban Round by Samuel L. Myers Jr., Lajune Thomas Lange and Bruce Corrie. Published in volume 93, issue 2, pages 330-333 of American Economic Review, May 2003

I agree with the point made by Edoh Y. Amiran and Daniel A. Hagen (2003) that there can be a substantial, or even infinite, divergence between the WTA and WTP for a public good even where there is a nonzero elasticity of substitution between market goods and the public good, provided that the indifference curves are asymptotically bounded with respect to market goods in the manner they describe. This is an important point. They are also correct to point out that the elasticity of substitution is a local concept, whereas their asymptotic boundedness condition applies also for discrete changes. My 1991 paper used a local analysis because it was following the structure of the analysis in Robert D. Willig (1976) and Alan Randall and John R. Stoll (1980); I wanted to show that, while Randall and Stoll appeared to extend Willig’s local result on WTA versus WTP from price changes to changes in the quantity of a public good, the relevant elasticity was in fact different and involved the substitution elasticity as well as the income elasticity. I view these points by Amiran and Hagen as not two separate results but essentially the same result: their asymptotic boundedness condition generalizes my zero elasticity of substitution condition to discrete changes. The asymptotic boundedness condition can be expressed as follows: assuming a bivariate utility function u( x, q), and given a reference point ( x*, q*) associated with a reference utility level u* u( x*, q*), there exists some q q* such that, for all q q , there exists no x such that u( x , q) u*. In other words, no amount of x can substitute for the reduction in public good from q* to q q . In the case of a zero elasticity of substitution, q q* but, as Amiran and Hagen show in their Theorem 1, this is unnecessarily restrictive when dealing with a discrete reduction in q. Furthermore, their Theorem 2 can be viewed as a special case of their Theorem 1 in which q 0, which makes q an essential commodity. It is well known in consumer theory that the WTA to avoid the loss of an essential market good is infinite; their Theorem 2 extends this result to the case of an essential nonmarket good. But, as their Theorem 1 shows, essentialness is not necessary for an infinite WTA. The boundedness condition is the key, and this implies a fundamental lack of substitutability between money (market goods) and the public good.

I stand here with deeply conflicting emotions. I am honored to be delivering this prestigious lecture. I am profoundly sad that Rudi Dornbusch, who should have delivered the Ely Lecture, died in July last year and that I am here in his place. So I would like to start by talking about Rudi. Rudi was born and grew up in Krefeld, Germany. He was an undergraduate at the University of Geneva, and completed his Ph.D. at the University of Chicago in 1971, which is where we met. He was a student of Robert Mundell, and both the subject matter – the development of the Mundell-Fleming model – and the elegance and insights of his early work reflected Mundell’s influence. He taught at the University of Rochester and at the University of Chicago before accepting an offer from MIT in 1975. In 1976, soon after coming to MIT, Rudi wrote his most famous and influential theoretical article, “Expectations and Exchange Rate Dynamics”. As Ken Rogoff said in his celebratory lecture on the 25 th anniversary of its publication, “The ‘overshooting’ paper … marks the birth of modern international macroeconomics.” From the late 1970s, Rudi became increasingly interested in policy issues. Within

U.S. stock returns are large, predictable over time, and predictable across stocks. The average return on a diversified market portfolio has averaged 8 percent per year more than the return on a short-term treasury bill. The predictability of time variation in returns is modest at high frequencies (about 10 percent of the variation in returns one quarter ahead is predictable) and quite large over longer periods (just under half of the variation in returns over five-year periods is predictable). Finally, portfolios based on the intersection of quintiles of stocks ranked by market value and by the ratio of book value to market value have differences in average annual returns across stocks of several percent per year. The natural explanation for these variations in returns is risk. But variations in consumption risk have done a poor job of explaining these differences in expected returns (see e.g., Sanford J. Grossman and Robert J. Shiller, 1981; Shiller, 1982; Lars Peter Hansen and Kenneth J. Singleton, 1983; N. Gregory Mankiw and Mat

This paper reviews recent randomized evaluations of educational programs in developing countries, including programs to increase school participation, to provide educational inputs, and to reform education. It then extracts some lessons for education policy and for the practice and political economy of randomized evaluations. I. Increasing School Participation Education is widely considered to be critical for development. The internationally-agreed Millennium Development Goals call for universal primary school enrollment by 2015. However, until recently there were no good assessments of how best to achieve this goal or how much it would cost. Some argue that it will be difficult to attract additional children to school, since most children who are not in school are earning income their families need. Others argue that children of primary-school age are not that productive, and modest incentives or improvements in school quality would be sufficient. Some see school fees as essential for ensuring accountability in schools and as a minor barrier to participation, while others argue that eliminating fees would greatly increase school participation. The simplest way to increase school participation is to reduce the cost of school, or even

The economics of hunting and gathering must have driven the biological evolution of human characteristics, since hunter-gatherer societies prevailed for the two million years of human history. These societies feature huge intergenerational resource flows, suggesting that these resource flows should replace fertility as the key demographic consideration. It is then theoretically expected that life expectancy and brain size would increase simultaneously, as apparently occurred during our evolutionary history. The brain here is considered as a direct form of bodily investment, but also crucially as facilitating further indirect investment by means of learning-by-doing.

Estimating the Knowledge-Capital Model of the Multinational Enterprise: Reply by David L. Carr, James R. Markusen and Keith E. Maskus. Published in volume 93, issue 3, pages 995-1001 of American Economic Review, June 2003

An Examination of the Influence of Theory and Individual Theorists on Empirical Research in Microeconomics by Pierre-André Chiappori and Steven D. Levitt. Published in volume 93, issue 2, pages 151-155 of American Economic Review, May 2003

The energy crisis of 1973–1974 coincided with a dramatic decline in U.S. stock market capitalization. Real energy prices jumped by 80 percent from 1973 to 1974. At the same time, the market value of nonfarm, nonfinancial corporations plunged by 40 percent. Because the two events coincided, the energy price hike is often considered a potential explanation for the stock market decline. One of the leading advocates of a causal link, Martin Neal Baily (1981), holds that the jump in energy prices made a substantial fraction of the capital stock obsolete. Energy inefficient machines were shut down, and expected profits of machines in operation declined. The value of existing capital decreased because it was not technologically suited to new economic conditions. This link between rising energy prices and capital obsolescence may explain the low level of stock market prices during that period. Despite the link, there has been no modern general-equilibrium evaluation of the extent to which the energy price shock was responsible for the dramatic drop in the market value of firms in 1974. I construct a dynamic generalequilibrium model with production and capital accumulation to examine the magnitude of the energy price effect. Contrary to the conventional wisdom, I find that an 80-percent increase in the real energy price causes the stock market value to decline by only 2 percent. Labor compensation, not claims to the capital stock, bears the brunt of the energy cost increase. The key element of the model is a putty-clay production technology. The neoclassical production function allows for smooth substitutability between factors after installation and conversion of capital to consumption goods at little cost. By contrast, the putty-clay production technology features ex ante substitutability of production factors, while there is no substitutability across them after machines are installed. Melvyn A. Fuss (1977) provides empirical evidence supporting the notion that capital and energy are complementary in the short run and substitutable in the long run. Because the technology is embodied in the capital stock in a putty-clay framework, changes in factor prices cause capital obsolescence and a decline in the value of capital. As a result, the putty-clay model is particularly suitable for studying the hypothesis put forward by Baily (1981). This paper adapts the putty-clay model developed by Simon Gilchrist and John C. Williams (2000) to include energy as a factor of production. I take the production technology ex ante to be Cobb-Douglas with constant returns to scale, but for capital goods already installed, production possibilities take the Leontief form: there is no substitutability of capital, energy, and labor ex post. An energy price shock affects the market value of firms through three channels. The first channel is the endogenous depreciation of the old vintage machines from both decreases in capacity utilization and declines in expected profits; the second channel is the effect of the energy price shock on investment; and the third channel is the effect on the interest rate. The impact of the fundamental shocks on the securities market depends on the resulting movement of price variables, such as the wage and the interest rate. Only a full general-equilibrium model can sort out all the interactions. * Department of Economics, CB#3305 University of North Carolina at Chapel Hill, Chapel Hill, NC 27599 (e-mail: [email protected]). This paper is based on my Ph.D. dissertation (2001) at Stanford University. I owe a substantial debt to Robert Hall and Thomas Sargent for their invaluable advice and encouragement. Thanks also to Victor Chernozhukov, Tim Cogley, Simon Gilchrist, Kenneth Judd, Hanno Lustig, Sergei Morozov, Beatrix Paal, Michael Salemi, Stijn Van Nieuwerburgh, the Sargent group members, two anonymous referees, and numerous seminar participants. The financial support of the Dissertation Fellowship from the John M. Olin Foundation is gratefully acknowledged. Any errors are my responsibility.

This paper analyzes the relationship between economic reform and the democratic process to ask the following question: Does the likelihood of adoption of an economic reform increase with an increase in the efficiency benefits from that reform? A priori we might expect that this likelihood should increase monotonically, for two reasons. First, economic reform results in an increase in the size of the national pie. If the government has the ability to make compensatory tax-transfers, an increase in each citizen's income is possible. Second, a larger economic reform results in a greater number of winners. This might also be expected to reinforce the political support for economic reform. So we should expect a reform with greater efficiency benefits to a larger population to have a greater chance of adoption by the government. However, in this paper we show that this intuition is mistaken. In particular, we demonstrate that there exists a certain non-monotonicity between the distribution of winners from economic reform and the probability of its adoption. An increase in the number of winners may lower, rather than increase, the likelihood of adoption of economic reform. In particular, even though reforms that benefit a minority or an overwhelming majority are adopted, reforms that benefit a smaller majority are not adopted.