Knowledge that Transforms

We report market experiments in which human traders are replaced by "zero-intelligence" programs that submit random bids and offers. Imposing a budget constraint (i.e., not permitting traders to sell below their costs or buy above their values) is sufficient to raise the allocative efficiency of these auctions close to 100 percent. Allocative efficiency of a double auction derives largely from its structure, independent of traders' motivation, intelligence, or learning. Adam Smith's invisible hand may be more powerful than some may have thought; it can generate aggregate rationality not only from individual rationality but also from individual irrationality.

This paper models economic development as a process of institutional transformation by focusing on the interplay between agents' occupational decisions and the distribution of wealth. Because of capital market imperfections, poor agents choose working for a wage over self-employment, and wealthy agents become entrepreneurs who monitor workers. Only with sufficient inequality, however, will there be employment contracts; otherwise, there is either subsistence or self-employment. Thus, in static equilibrium, the occupational structure depends on distribution. Since the latter is itself endogenous, we demonstrate the robustness of this result by extending the model dynamically and studying examples in which initial wealth distributions have long-run effects. In one case the economy develops either widespread cottage industry (self-employment) or factory production (employment contracts), depending on the initial distribution; in the other example, it develops into prosperity or stagnation.

We investigate whether omitted family background variables are responsible for high returns to schooling estimated in Brazil. Returns to schooling fall by about one-third when parental schooling is added to wage equations. Surprisingly, the schooling of fathers-in-law has larger effects on wages than the schooling of fathers. On the basis of a model of assortative mating, we interpret this as evidence that parental characteristics represent unobservable worker attributes rather than nepotism in the labor market. We conclude that the "family background bias" in returns to schooling is modest and need not imply returns to family connections.

In this paper we formulate and estimate a finite-horizon, structural dynamic model of agricultural investment behavior that incorporates the major features of low-income agricultural environments: income uncertainty, constraints on borrowing and rental markets, and the use of investment assets to generate income and smooth consumption. The model is fit to longitudinal Indian household data on farm profits, bullock stocks, and pump sets. The estimated structural parameters are used to assess the effects on the life cycle accumulation of bullocks, agricultural profits, and welfare associated with complete markets and bullock liquidity and with second-best policies that provide assured sources of income to farmers and weather insurance.

We study the problem of optimal taxation in three infinite-horizon, representative-agent endogenous growth models. The first model is a convex model in which physical and human capital are perfectly symmetric. Our second model incorporates elastic labor supply through a Lucas-style technology. Analysis of these two models points out the danger of assuming that government expenditures are exogenous. In our third model, we include government expenditures as a productive input in capital formation, showing that the limiting tax rate on capital is no longer zero. In numerical simulations, we find similar effects on growth and welfare in all three models.

Dowries in South Asia have steadily risen over the last 40 years and now often amount to over 50 percent of a household's assets. This paper attempts to investigate the reasons behind this increase. It adapts Rosen's implicit market model to the Indian marriage market and tests predictions from the model with data from six villages in South Central India and from the Indian census. It is found that a "marriage squeeze" caused by population growth, resulting in larger younger cohorts and hence a surplus of women in the marriage market, has played a significant role in the rise in dowries.

This paper studies agents who consider the experiences of their neighbors in deciding which of two technologies to use. We analyze two learning environments, one in which the same technology is optimal for all players and another in which each technology is better for some of them. In both environments, players use exogenously specified rules of thumb that ignore historical data but may incorporate a tendency to use the more popular technology. In some cases these naive rules can lead to fairly efficient decisions in the long run, but adjustment can be slow when a superior technology is first introduced.

Many households in developing countries rely on seasonal agriculture for their incomes. This paper investigates whether household consumption expenditure tracks income across seasons. Using data from Thailand, I contrast the seasonal consumption patterns of households with different seasonal income patterns and estimate the responsiveness of seasonal consumption to seasonal income. I find little evidence that consumption tracks income over the course of the year. The findings suggest that observed seasonal consumption patterns are the result of seasonal variations in preferences or prices, common to all households, rather than an inability of households to use savings behavior to smooth consumption.