Knowledge that Transforms

In trade liberalization between a large country and a small one, if production requires irreversible investments, anticipated negotiations may make the small country strictly worse off than a fully anticipated trade war, and indeed worse off than autarchy. The reason is that investors, anticipating liberal trade, will invest in the export sector, making the small country dependent on trade with the large one and thus ruining its bargaining power. This effect is dominated by conventional effects, so that anticipated bargaining benefits the small country on balance, if there is sufficient: (i) dissimilarity between the economies, and (ii) substitutability between goods.

In all industrial countries, fiscal policy is increasingly about redistribution. In this paper, we study redistribution across different types of agents in a world characterized by the presence of labor unions and distortionary taxation. We show that an increase in transfers financed by distortionary taxation has nonlinear effects on unit labor costs relative to the other countries, depending on the degree of centralization of the wage-setting process in the labor market. We find considerable empirical support for the model in a sample of 14 OECD countries.

Two fundamentally different subcontracting systems arise as distinct solutions to the quality control problem facing an input buyer. The "American" system involves competitive bidding on each contract, large orders, and inspections. The "Japanese" system involves repeat purchases from a supplier who earns a premium, small orders, and no inspections. Both systems may coexist as local solutions, but the global optimum is determined by the ratio of set-up to inspection costs. This suggests that the adoption of flexible manufacturing equipment and rising product complexity may be responsible for the shift from the American to the Japanese system observed in many industries.

When a series of individuals with private information announce public predictions, initial conformity can create an "information cascade" in which later predictions match the early announcements. This paper reports an experiment in which private signals are draws from an unobserved urn. Subjects make predictions in sequence and are paid if they correctly guess which of two urns was used for the draws. If initial decisions coincide, then it is rational for subsequent decision makers to follow the established pattern, regardless of their private information. Rational cascades formed in most periods in which such an imbalance occurred.