An empirical analysis of the impact of transaction costs on contracting shows that imperfect in formation can seriously limit the effectiveness of private contracting. The case under study is the widespread failure of private crude oil producing firms to use US oil fields to reduce rent dissipation. Rent dissipation follows as multiple firms compete for migratory oil in common oil pools. Unitization is the obvious private contractual solution to rent dissipation. The authors argue that, despite large net gains from unitization, imperfect information and information asymmetries among the negotiating parties regarding lease values prevents consensus on unit shares. As a result, contracts are often not completed or only fragmented units are completed. 9 references, 1 figure, 4 tables.
I have in the back of my mind a picture of the sort of discipline economics ought to be -or at least the sort of discipline I wish it were. If economics were practiced in that way there would be nothing problematical about its reciprocal relationship with economic history. It would be pretty clear what it is that economic theory offers to economic history and what economic history offers to economic theory. I will try to describe what I mean below. For better or worse, however, economics has gone down a different path, not the one I have in mind. One consequence, not the most important one, but the one that matters for this discussion, is that economic theory learns nothing from economic history, and economic history is as much corrupted as enriched by economic theory. I will come to that, too, later on. You will notice that I am using strong language. I am prepared to admit right away that I may be dead wrong in my judgements. But there is no point in pussyfooting. Bluntness may lead to an interesting discussion. After all, no one would remember the old German Historical School if it were not for the famous Methodenstreit. Actually, no one remembers them anyway. (There must be a lesson in that.) To get right down to it, I suspect that the attempt to construct economics as an axiomatically based hard science is doomed to fail. There are many partially overlapping reasons for believing this; but since that is not the topic under discussion today, I do not have to lay them out in an orderly way. I hope the following hodgepodge will convey what I mean. A modern economy is a very complicated system. Since we cannot conduct controlled experiments on its smaller parts, or even observe them in isolation, the classical hardscience devices for discriminating between competing hypotheses are closed to us. The main alternative device is the statistical analysis of historical time-series. But then another difficulty arises. The competing hypotheses are themselves complex and subtle. We know before we start that all of them, or at least many of them, are capable of fitting the data in a gross sort of way. Then, in order to make more refined distinctions, we need long time-series observed under stationary conditions. Unfortunately, however, economics is a social science. It is subject to Damon Runyon's Law that nothing between human beings is more than three to one. To express the point more formally, much of what we observe cannot be treated as the realization of a stationary stochastic process without straining credulity. Moreover, all narrowly economic activity is embedded in a web of social institutions, customs, beliefs, and attitudes. Concrete outcomes are indubitably affected by these background factors, some of which change slowly and gradually, others erratically. As soon as time-series get long enough to offer hope of discriminating among complex hypotheses, the likelihood that they remain stationary dwindles away, and the noise level gets correspondingly high. Under these circumstances, a little cleverness and persistence can get you almost any result you want. I think that is why so few econometricians have ever been forced by the facts to abandon a firmly held belief. Indeed, some of Fortune's favorites have been known to write scores of empirical articles without once feeling obliged to report a result that contradicts their prior prejudices. If I am anywhere near right about this, the interests of scientific economics would be better served by a more modest approach. There is enough for us to do without pretending to a degree of completeness and *Department of Economics, Massachusetts Institute of Technology, Cambridge, MA 02139.
Most pension-covered workers in the United States are covered solely or primarily by defined benefit plans.' In these plans, workers are typically promised a pension that is proportional to their years of service in the firm and their final wage. Depending upon how workers pay for it, the existence of a pension in the labor may play either an important role or no role at all in the worker-firm relationship. This paper addresses the issue, how workers pay for the cumulating pension benefit over their tenure cycle in the firm, and derives several economic implications for the worker-firm contract. While the theory itself has ambiguous implications, the data confirm the longstanding presumption that pensions offer strong incentives for the worker to complete the normal tenure cycle in the firm, not to quit early. But if this intuitive notion is accepted, it is shown that a perhaps less intuitive notion is also true: firms make workers longterm bondholders in the firm. The same flow of worker pension savings that tie workers to the firm are not accounted for in the pension trust fund: pension plans are significantly underfunded in a true economic sense. This is a peculiar characteristic of the labor which raises several unanswered questions. The paper also shows that the nature of the pension can play an important role in determining the wage-service profile and the capitalized value of the firm. Recent contributions to the literature pose an interesting and unconventional view of pensions, one which leads to the conclusion that pensions play a relatively minor role in the worker-firm contract. The argument has been implicitly made by Burt Barnow and Ronald Ehrenberg (1979) and William Sharpe (1976) but has recently been stated more directly by Jeremy Bulow (1982).2 In essence, their views rest on a interpretation of pension liabilities; namely, since the firm can legally terminate its pension plan anytime, the firm's pension liabilities cannot exceed the present value of the nominal pension promises it would owe workers if the firm terminated the plan immediately. If workers believe the firm will exercise its legal right, it is intuitively apparent and easy to show that workers will deposit only that amount of compensation into the pension plan that they expect to receive upon immediate termination. Using this interpretation of pension plan liabilities, pensions have no influence on whether the worker leaves or remains in the firm. Moreover, it will be shown that if the pension is written in nominal terms, reflecting the legal view, workers are not bondholders in the firm: pension plans are excessively overfunded. An alternative view is that the pension plan is an contract between the worker and the firm (see, for example, Jack Treynor, 1977). An implicit theory implies that workers anticipating careers with a firm will consider the package of wage and pension benefits they expect to collect over their life cycle. It is shown that these expectations lead quite directly to several implications: that the pension is written in real terms; that firms intend to meet their pension promises; and that the firm will re*U.S. Department of Labor, S-4521, Washington, D.C. 20210. The views expressed in this paper are my own and do not necessarily represent the views of the Department of Labor. The paper has substantially benefited from the comments of Pauline Ippolito and discussions with Jeremy Bulow. I am also indebted to Robert Clark, Gary Fields, Alan Gustman, Olivia Mitchell, James Pesando, John Turner, Michael Ward, and participants at the Labor Relations Workshop at Cornell University and the Law and Economics Workshop at the University of Chicago for comments. 'See my 1985a book. 2 The argument is also implicit in other related papers; see, for example, Martin Feldstein and Randall Morck (1982).
The great contribution of Stephen Hymer's seminal dissertation (1960) was to escape from the intellectual straightjacket of neoclassical-type trade and financial theory, and move us towards an analysis of the multinational enterprise (MNE) based upon industrial organization theory. The magnitude of this breakthrough can be put into perspective by considering the state of the art when Hymer wrote twenty-five years ago. In 1960 the prevailing explanation of international capital movements relied exclusively upon a neoclassical financial theory of portfolio flows. In this frictionless world of perfect competition, with no transaction costs, capital moves in response to changes in interest rate (or profit) differentials (see Carl Iversen, 1936). According to this arbitrage theory, capital is assumed to be transacted between independent buyers and sellers, that is, there is no role for the MNE. At the time there was no separate theory of foreign direct investment (FDI). The work did not even ask the question, of Why is there FDI?, despite the evidence of sectoral cross investments and the existence of large MNEs with intra-industry trade. If anything, the early work on FDI focused upon the where of investment in a particular nation or industry, for example, Dunning (1958) was chiefly interested in explaining U.S. FDI in Britain. There was little interest in understanding the reasons for the MNE, or the nature of its operations. The pioneering conceptual insight of Hymer was to break out of the arid mold of international trade and investment theory and focus attention upon the MNE per se. This permits us to treat FDI as a modality by which firms extend their territorial horizons abroad. The unique feature of FDI is a mechanism by which the MNE maintains control over productive activities outside its national boundaries, that is, FDI means international production. In this view, FDI is more than a process by which assets or claims are exchanged internationally (see Robert Aliber, 1970; 1983). Hymer's great insight was in focusing attention upon the MNE as the institution for international production, rather than international exchange. Until Hymer articulated the process of FDI as an international extension of industrial organization theory, it was not possible to understand why the MNE transfers intermediate products such as knowledge or technology among its units across different nations while still retaining property rights over such assets. Today it is widely recognized that the theory of FDI (i.e., international production) is primarily about the transfer of nonfinancial and ownershipspecific intangible assets by the MNE, which needs to appropriate and control the rate of use of its internalized advantage(s), see Rugman (1981), David Teece (1981; 1982), Richard Caves (1982) and Mark Casson (1983). In this paper we first acknowledge Hymer's contribution to the theory of FDI and then move on to reinterpret his dissertation in the light of the modern theory of the MNE. We tDiscussants: Raymond Vernon, Harvard University; Robert Z. Aliber, University of Chicago; Paul Streeten, Boston University.
Do laws coordinate or restrain? A number of recent papers discuss the optimality of the 55 mph national maximum speed limit (NMSL), and evaluate the tradeoff of timelost vs. lives-saved resulting from the lowered speed (James Jondrow et al., 1983; Dana Kamerud, 1983; Thomas Forester et al., 1984). These papers all implicitly accept the conventional wisdom-speed kills, slower is safer. This conventional wisdom leads to laws designed as limits on behavior, whereas . . . the crucial element is often coordination. People need to do the right things at the right time in relation to what others are doing (Thomas Schelling, 1978, p. 121). There are indeed some traffic laws that establish conventions of expected conduct: we ask that motorists drive to the right, not because driving on the left is evil, but because it is important that the direction of flow be commonly agreed upon. Likewise, traffic lights are best viewed as a coordinating device: allowing free flow to alternating lanes of traffic to reduce the confusion and loss of time in unsignalized intersections. For peculiar historical reasons, speed laws evolved as limits on driver behavior, rather than as signaling devices meant to coordinate it. Guided by the limit-rationale, police concentrate on those drivers who exceed the legal speed, and tend to ignore those drivers who disrupt coordination by traveling much slower than the norm. This paper tests these differing views of the law by examining the current effects of the 55 mph NMSL-should it be viewed as a coordinating mechanism or a limiting mechanism? I measure the effects of limit-defying behavior (speeding), and absence of coordination (speed variance) on the fatality rate. Based on analysis of 1981 and 1982 state cross-section data, I find that there is no statistically discernable relationship between the fatality rate and average speed, though there is a strong relationship to speed variance. When most cars are traveling at about the same speed, whether it is a high speed or a low one, the fatality rate will be low-presumably because the probability of collision will be low. Variance kills, not speed.
Since interpretations of past and future oil price patterns depends on the model chosen, the author tests and compares alternative theories of OPEC as a first step in validating the choice on any one model. The results show that among OPEC countries, the partial market-sharing cartel model is the only model not rejected by at least some of the 11 members and gives the best explanation of production. In comparison with 11 non-OPEC countries, the competitive model could not be rejected for 10 of the 11 non-OPEC producers. This raises the question of why, if OPEC is a cartel, Friedman's predictions have not come true, and introduces new questions for future research. 19 references, 3 tables.