Knowledge that Transforms

This paper develops microfoundations for the role that diversified cities play in fostering innovation. A simple model of process innovation is proposed, where firms learn about their ideal production process by making prototypes. We build around this a dynamic general-equilibrium model, and derive conditions under which diversified and specialized cities coexist. New products are developed in diversified cities, trying processes borrowed from different activities. On finding their ideal process, firms switch to mass production and relocate to specialized cities where production costs are lower. We find strong evidence of this pattern in establishment relocations across French employment areas 1993–1996.

This paper introduces a new model of exchange: networks, rather than markets, of buyers and sellers. It begins with the empirically motivated premise that a buyer and seller must have a relationship, a “link,” to exchange goods. Networks—buyers, sellers, and the pattern of links connecting them—are common exchange environments. This paper develops a methodology to study network structures and explains why agents may form networks. In a model that captures characteristics of a variety of industries, the paper shows that buyers and sellers, acting strategically in their own self-interests, can form the network structures that maximize overall welfare.

E-commerce is a hot topic; however, little is known about the actual size and impact of ecommerce in the United States. In part this is because e-commerce is a recent and rapidly evolving phenomenon, but it is also because the measurement of e-commerce presents a number of challenges. Some of these challenges are essentially unique. Others are similar to, or extensions of, old economy measurement challenges.

Creating Modern Art: The Changing Careers of Painters in France from Impressionism to Cubism by David W. Galenson and Bruce A. Weinberg. Published in volume 91, issue 4, pages 1063-1071 of American Economic Review, September 2001

Why did the stock market decline so much in the early 1970's and remain low until the early 1980's? We argue that it was because information technology arrived on the scene and the stock-market incumbents of the day were not ready to implement it. Instead, new firms would bring in the new technology after the mid-1980's. Investors foresaw this in the early 1970's and stock prices fell right away. In our model, new capital destroys old capital, but with a lag. The prospect of this causes the value of the old capital to fall right away.

Research in Economic Education: Five New Initiatives by Michael K. Salemi, John J. Siegfried, Kim Sosin, William B. Walstad and Michael Watts. Published in volume 91, issue 2, pages 440-445 of American Economic Review, May 2001

Recent studies have shown that the dynamics of firms (growth, job reallocation, and exit) are negatively correlated with the initial size of the firm and its age. In this paper we analyze whether financial factors, in addition to technological differences, are important in generating these dynamics. We introduce financial-market frictions in a basic model of industry dynamics with persistent shocks and show that the combination of persistent shocks and financial frictions can account for the simultaneous dependence of firm dynamics on size (once we control for age) and on age (once we control for size).

As Edwin Leuven and Hessel Oosterbeek (2001) point out, rather than performing the comparative statics analysis on the effect of increasing uncertainty, my original study limited the analysis to degenerate cases and refrained from inferring a possible monotonic relationship between uncertainties and the share ratio (Hashimoto, 1981 pp. 479–80). Leuven and Oosterbeek do not dispute my conclusions for degenerate cases. Donald O. Parsons (1986 p. 826) later asserted such a monotonic relationship without reporting a comparative statics analysis. Leuven and Oosterbeek use a uniform distribution of productivity to dispute Parsons’ assertion. Hashimoto and Jeong-Geon Lee (1994) reached a similar conclusion to theirs. Given the Hashimoto-Lee comparative statics analysis, I view the most significant contribution of Leuven-Oosterbeek to be not so much their comparative statics as their explicit formulation to account for what has become known in the literature as enforceability of contracts. In the 1981 paper I was concerned with the enforceability issues, so I adopted a certaintyequivalent approach to the fixed-wage formulation in the face of double informational asymmetry between the employer and worker. I then focused on the Becker-type share determination of specific human-capital returns (Gary S. Becker, 1962). Leuven and Oosterbeek directly formulate the enforceability of employment contracts in terms of a fixed wage rather than in terms of the sharing ratio. By considering the enforceability (or the incentive compatibility) issues in a fuller perspective, I conclude that the certainty-equivalent formulation I adopted in my 1981 model has an internal infirmity. In my opinion, this infirmity is a point that a serious Comment on Hashimoto (1981) should underscore. I do not think that Leuven and Oosterbeek’s Comment (2001) is sufficiently articulate or structured to highlight this point. Space does not permit a full discussion, so let me remark briefly on an important point that Leuven and Oosterbeek should have highlighted, but did not. The explicit and direct determination of the incentive-compatible fixed wage w leads me to conclude that the joint maximand is not the unconditional expectation Ev (s) 2 Ey(s), as I originally formulated; rather it is the conditional expectation Estay(v (s) 2 y(s)), conditional on both parties not separating. In the latter formulation, the determination of the fixed wage w implies an ex ante determination of the share parameter to be a 5 {Estay(w 2 y(s))}/{Estay(v(s) 2 y(s))}, which is equivalent to Leuven and Oosterbeek’s definition of a. In spite of the difference in formulation between Leuven-Oosterbeek and Hashimoto-Lee, the two studies obtain essentially the same comparative statics results. This is because both formulations rely on incentive-compatibility conditions for separation decisions where the forces at work are basically the same. Thus, Leuven and Oosterbeek confirm the accuracy of the degenerate results reported in Hashimoto (1981). For nondegenerate cases, the comparative statics are generally ambiguous. Using a uniform distribution, Leuven and Oosterbeek do find that the optimal wage decreases with the uncertainty in the market and increases with the uncertainty in the firm (p. 345). These findings are equivalent to what Hashimoto and Lee (1994) found: that the optimal share ratio decreases with the uncertainty in the outside productivity and increases with the uncertainty in the inside productivity. The Leuven-Oosterbeek Comment contributes a technical advance, but it retains the essential economic logic * Department of Economics, 410 Arps Hall, Ohio State University, 1945 North High Street, Columbus, OH 43210. I am grateful to Hajime Miyazaki for extensive discussions that elucidated theoretical issues in modeling information asymmetric employment relations and for improving the exposition, and to Teresa Schoellner for her very competent research assistance. However, I bear full responsibility for any remaining shortcomings. 1 Further analytical details are available upon request.

Exchange-Rate Hedging: Financial versus Operational Strategies by George Allayannis, Jane Ihrig and James P. Weston. Published in volume 91, issue 2, pages 391-395 of American Economic Review, May 2001