Knowledge that Transforms

The front matter of the December 2008 issue contains the Table of Contents as well as information about Oliver E. Williamson, Distinguished Fellow, 2007.

Large Japanese banks often engaged in sham loan restructurings that kept credit flowing to otherwise insolvent borrowers (which we call zombies). We examine the implications of suppressing the normal competitive process whereby the zombies would shed workers and lose market share. The congestion created by the zombies reduces the profits for healthy firms, which discourages their entry and investment. We confirm that zombie-dominated industries exhibit more depressed job creation and destruction, and lower productivity. We present firm-level regressions showing that the increase in zombies depressed the investment and employment growth of non-zombies and widened the productivity gap between zombies and non-zombies. (JEL G21, G32, L25)

A large empirical literature has documented that firm-level differences in productivity, size, ownership status, and other characteristics are crucial to understanding differences in firms’ decisions to export. The evidence strongly supports the self-selection of more productive firms into export markets, but there has been more mixed evidence on the subsequent feedback effects of exporting on the future path of firm productivity. Several recent papers have introduced a new dimension into this export-productivity relationship: firm-level investments in productivity-enhancing activities such as R&D. James A. Costantini and Marc J. Melitz (2007), Alla Lileeva and Daniel Trefler (2007), and Paula Bustos (2006) explore the linkages between investments in innovation, productivity, and the decision to export in the context of the liberalization of trade regimes. Aw, Roberts, and Tor Winston (2007) have also found a significant role for firm R&D investments in explaining Taiwanese firm export patterns, as well as interaction effects between firm R&D and export choices in explaining productivity change. In this paper we summarize some empirical results from our research project to develop an estimable structural model of the joint exportinvestment decision. In the theoretical model, firms invest in R&D and physical capital, which can affect the path of future productivity for the firm. R&D investment, through its effect on future productivity, increases the profits from exporting, and participation in the export market raises the return to R&D investments. The theoretical model yields equations for the policy functions for R&D investment, physical investment, and the exporting decision, as well as the evolution of firm-level profitability, that can be estimated with micro datasets containing R&D Investments, Exporting, and the Evolution of Firm Productivity

The focus of policy reform in developing countries has moved from getting prices right to getting institutions right, and accordingly countries are increasingly being advised to move towards "best-practice" institutions. This paper argues that appropriate institutions for developing countries are instead "second-best" institutions --those that take into account context-specific market and government failures that cannot be removed in short order. Such institutions will often diverge greatly from best practice. The argument is illustrated using examples from four areas: contract enforcement, entrepreneurship, trade openness, and macroeconomic stability.

If the received wisdom is right, the EU's rapid economic integration should have been asso? ciated with a transfer of economic policy sov? ereignty to the supranational level. This paper marshals several strands of evidence in support the received wisdom, although the relationship in the EU is clearly two-way. Economic inte? gration makes governments more interested in international cooperation, but the institutional reforms that facilitate such cooperation also facilitate deeper economic integration.

Workers act in the interests of their employ? ers for a host of reasons. Sometimes money is the motivation, but often it is because they care about what they do. Despite the importance of such intrinsic motivation, the economic litera? ture has offered little in terms of understanding relevant trade-offs when alignment of inherent preferences (rather than monetary interests) is what motivates people.1 Instead, the literature has focused largely on the efficiency gains that arise from agents sharing the preferences of their employers.2 This paper offers such a theory of intrinsic motivation, where firms partially solve agency problems by hiring agents with particu? lar preferences. Unlike the previous literature, I show that firms, in general, hire agents who do not share their interests?instead, agents are disproportionately motivated to carry out a sub? set of what the firm cares about. Specifically, I show that the institution hires the agent with similar preferences to himself only in the limit? ing case where the agent's preferences are irrel? evant?namely, when output can be perfectly contracted on. Instead, the optimal response of the institution is to hire biased agents, with the degree of bias increasing as mea? sures get worse. The reason for this is rather simple?that jobs within firms are specialized. So, for example, some people make things, others design them, yet other sell them, and so on. Similarly, aca? demics do research, deans raise money, admin? istrators do the books, social workers provide services to clients while their superiors are charged with cost control, etc. The principal novelty of this paper is to show how hiring practices?and specifically the intrinsic moti? vation of those hired?changes as the ability to contract worsens in a world where tasks are specialized. In doing so, it paints a picture of firms responding to noncontractibility by hiring agents with very extreme interests, at the cost of their ignoring other aspects of their jobs. So, for example, if the output of a social worker cannot be measured, a natural response will be to hire agents who are highly motivated to get benefits to clients, at the cost of their ignoring things like cost control. Simple though this observation is, it illustrates a cost to using intrinsic motiva? tion?namely, the endogenous hiring of those who increasingly care only about one aspect of their job. In this way, the simple model outlined here lays the foundation for a view of poor contracting firms as fiefdoms, where those with extreme competing interests reside, a point I elaborate on elsewhere (Prendergast 2008). For a theory of intrinsic motivation to be use? ful, firms must have some control over it. The central assumption here is that firms have some ability to hire employees based on these intrin? sic preferences. I build a model of an institution that carries out two activities?say, service pro? vision and cost control. It employs two agents to do so. The tasks are somewhat specialized, in that one agent primarily (but not exclusively) does service provision and the other primarily does cost control. The institution has an objec? tive that trades off these two components and has a performance measure that can reward agents. The firm also chooses whom to hire. Potential * Discussant: Robert Gibbons, Massachusetts Institute of Technology.

This edition of the Test of Understanding of College Economics (TUCE-4) is a revision of a test that was developed 40 years ago, and has a long history of use by teachers and researchers in the economics profession. The previous editions and their uses have been described in earlier studies (e.g., Rendigs Fels 1967; Phillip Saunders, Fels, and Arthur L. Welsh 1981; Saunders 1991) and in research in economic education (e.g., William E. Becker 1997). As with past editions, the TUCE-4 has two main objectives: to offer a reliable and valid assessment instrument for students in principles of economics courses; and to provide norming data for a national sample of students in principles classes so instructors can compare the performance of their students on a pretest and a posttest with this national sample. Separate exams were prepared in microeconomics and macroeconomics. Both exams consist of 30 multiple-choice items and can be administered within the time constraints of a single class period for most course formats. What follows is a description of the revision process, the content and cognitive specifications, the norming sample, and the statistical characteristics of the TUCE-4.

The quantal response equilibrium (QRE) notion of Richard D. McKelvey and Thomas R. Palfrey (1995) has recently attracted considerable attention, due in part to its widely documented ability to rationalize observed behavior in games played by experimental subjects. However, even with strong a priori restrictions on unobservables, QRE imposes no falsifiable restrictions: it can rationalize any distribution of behavior in any normal form game. After demonstrating this, we discuss several approaches to testing QRE under additional maintained assumptions. (JEL C72, D84)

German reunification was a large, unexpected shock for East Germans. Exploiting German reunification as a natural experiment, I analyze the validity of the life-cycle consumption model. I derive three stylized features concerning the saving behavior of East versus West Germans after reunification: (i) East Germans have higher saving rates than West Germans; (ii) this East-West gap is increasing in age at reunification; and (iii) for every cohort, this gap is declining over time. I show that a comprehensive life-cycle model can replicate these features. The precautionary saving motive is essential for the success of the model. (JEL D14, D91, E21)

A household’s vehicle purchases are among its largest expenditure outlays. Moreover, unlike housing purchases, which a typical household may make once or twice over a lifetime, a household may well buy several cars over the same interval. The magnitude and relative frequency of vehicle purchases suggest that differential treatment by race in the vehicle market may have important implications for differences in wealth and financial wellbeing by race. Yet, whereas a robust literature in economics has studied virtually all aspects of racial treatment in the housing market, corresponding work about vehicles has been relatively sparse, with most work focusing on racial differences in prices paid (Pinelopi Goldberg (1996) and Fiona Scott-Morton, Florian Zettelmeyer, and Jorge Silva-Risso (2003)). Very little previous attention has been paid to whether there is differential racial treatment in another important outcome in the vehicle market: the interest rates that households pay on the loans used to purchase vehicles.1 Calculations using data from the Survey of Consumer Finances indicate that loans for vehicle purchases are primarily obtained from one of two sources. Roughly two-thirds of vehicle loans originate from the traditional banking sector: commercial banks, savings institutions, or credit unions. Vehicle manufacturers finance the remaining one-third of auto