Knowledge that Transforms

Editor's Note The Journal of Economic Literature (JEL) regularly reviews books of interest to the economics profession. The Economic Report of the President (ERP) falls under that purview. I have asked a handful of very prominent economists to review the 2006 ERP. Reviewers were chosen to reflect expertise on what I guessed would be key issues. The ERP in principle should provide an accurate assessment of the consensus professional views of economists on any given issue, based on the research to date. Reviewers were asked to evaluate whether the discussion in the ERP in fact accurately summarizes what we as economists know? Reviewers were given free rein over what material they would review in the ERP but were urged to focus on their areas of particular expertise. In the reviews that follow, Martin Feldstein reviews the overview chapter as well as topics relating to macroeconomics. Alan Auerbach reviews the ERP's discussion of tax-related issues, while Ken Rogoff reviews the ERP's discussion of international economic topics. Rebecca Blank writes on labor market issues in the ERP, and Michael Katz reviews the ERP's discussion of health care issues. Many thanks to the reviewers for the quick turnaround.

Following George Stigler (1964), many economists assume that incentive problems undermine attempts b firms to collude to raise prices and restrict output. But the potential profits from collusion can create a powerful incentive as well. Theory cannot tell us, a priori, which effect will dominate: whether or when cartels succeed is thus an empirical question. We examine a wide variety of empirical studies of cartels to answer the following questions: (1) Can cartels succeed? (2) If so, for how long? (3) What impact do cartels have? (4) What causes cartels to break up? We conclude that many cartels do survive, and that the distribution of duration is bimodal. While the average duration of cartels across a range of studies is about five years, many cartels break up very quickly (i.e., in less than a year). But there are many others that last between five and ten years, and some that last decades. Limited evidence suggests that cartels are able to increase prices and profits, to varying degrees. Cartels can also affect other non-price variables, including advertising, innovation, investment, barriers to entry, and concentration. Cartels break up occasionally because of cheating or lack of effective monitoring, but the biggest challenges cartels face are entry and adjustment of the collusive agreement in response to changing economic conditions. Cartels that develop organizational structures that allow them the flexibility to respond to these changing conditions are more likely to survive. Price wars that erupt are often the result of bargaining issues that arise in such circumstances. Sophisticated cartel organizations are also able to develop multipronged strategies to monitor one another to deter cheating and a variety of interventions to increase barriers to entry.

Most of us need the services of an expert when our apartment's heating or our washing machine breaks down, or when our car starts to make strange noises. And for most of us, commissioning an expert to solve the problem causes concern. This concern does not disappear even after repair and payment of the bill. On the contrary, one worries about paying for a service that was not provided or receiving some unnecessary treatment. This article studies the economics underlying these worries. Under which conditions do experts have an incentive to exploit the informational problems associated with markets for diagnosis and treatment? What types of fraud exist? What are the methods and institutions for dealing with these informational problems? Under which conditions does the market provide incentives to deter fraudulent behavior? And what happens if all or some of those conditions are violated?

New developments in the world economy have triggered research designed to better understand the changes in trade and investment patterns, and the reorganization of production across national borders. Although traditional trade theory has much to offer in explaining parts of this puzzle, other parts required new approaches. Particularly acute has been the need to model alternative forms of involvement of business firms in foreign activities because organizational change has been central in the transformation of the world economy. This paper reviews the literature that has emerged from these efforts. The theoretical refinements have focused on the individual firm, studying its choices in response to its own characteristics, the nature of the industry in which it operates, and the opportunities afforded by foreign trade and investment. Important among these choices are organizational features, such as sourcing strategies. But the theory has gone beyond the individual firm, studying the implications of firm behavior for the structure of industries. It provides new explanations for trade structure and patterns of foreign direct investment, both within and across industries, and has identified new sources of comparative advantage.