Knowledge that Transforms

Abstract I propose a novel general equilibrium framework to quantify the impact of law enforcement on the internal organization of firms and thereby on aggregate outcomes. The model features an agency problem between the firm and its middle managers. Imperfect law enforcement allows middle managers to divert revenue from firms, which reduces delegation and constrains firm size. I use French matched employer–employee data for evidence of the model’s pattern of managerial wages. Relative to the French benchmark economy, reducing law enforcement to its minimum value decreases GDP (equivalently, total factor productivity; TFP) by 23% and triples the self-employment rate. Consistent with the model, I document cross-country empirical evidence of a positive correlation between law enforcement indicators and the aggregate share of managerial workers. Mapped across the world, the model explains 3–6% of the ratio in GDP per worker between the poorest and richest quintile of countries, and 6–11% of their TFP ratio.

Abstract We study the design of monitoring in dynamic settings with moral hazard. An agent (e.g. a firm) benefits from reputation for quality, and a principal (e.g. a regulator) can learn the agent’s quality via costly inspections. Monitoring plays two roles: an incentive role, because outcomes of inspections affect agent’s reputation, and an informational role because the principal directly values the information. We characterize the optimal monitoring policy inducing full effort. When information is the principal’s main concern, optimal monitoring is deterministic with periodic reviews. When incentive provision is the main concern, optimal monitoring is random with a constant hazard rate.

Abstract We study how the diffusion of being pivotal affects immoral outcomes. In our main experiment, subjects decide about agreeing to kill mice and receiving money versus objecting to the killing and foregoing the monetary amount. In a baseline condition, subjects decide individually about the life of one mouse. In the main treatment, subjects are organized into groups of eight and decide simultaneously. Eight mice are killed if at least one subject opts for killing. The fraction of subjects agreeing to kill is significantly higher in the main condition compared with the baseline condition. In a second experiment, we run the same baseline and main conditions but use a charity context and additionally study sequential decision-making. We replicate our finding from the mouse paradigm. We further show that the observed effects increase with experience, i.e., when we repeat the experiment for a second time. For both experiments, we elicit beliefs about being pivotal, which we validate in a treatment with non-involved observers. We show that beliefs are a main driver of our results.

Abstract This article incorporates banks and banking panics within a conventional macroeconomic framework to analyse the dynamics of a financial crisis of the kind recently experienced. We are particularly interested in characterizing the sudden and discrete nature of banking panics as well as the circumstances that make an economy vulnerable to such panics in some instances but not in others. Having a conventional macroeconomic model allows us to study the channels by which the crisis affects real activity both qualitatively and quantitatively. In addition to modelling the financial collapse, we also introduce a belief driven credit boom that increases the susceptibility of the economy to a disruptive banking panic.

Abstract An increasing number of police departments use information technology (IT) to optimize patrolling strategies, yet little is known about its effectiveness in preventing crime. Based on quasi-random access to “predictive policing,” this study shows that IT improves police productivity as measured by crime clearance rates. Thanks to detailed information on individual incidents and offender-level identifiers it also shows that criminals strategies are predictable. Moreover, the introduction of predictive policing coincides with a large negative trend-discontinuity in crime rates. The benefit–cost ratio of this IT innovation appears to be large.

Abstract How should macroprudential policy be designed when policymakers also have access to liquidity provision tools to manage crises? We show in a tractable model of systemic banking risk that there are three factors at play: first, ex post liquidity provision mitigates financial crises, and this reduces the need for macroprudential policy. In the extreme, if liquidity provision is untargeted and costless or if it completely forestalls crises by credible out-of-equilibrium lending-of-last-resort, there is no role left for macroprudential regulation. Second, however, macroprudential policy needs to consider the ex ante incentive effects of targeted liquidity provision. Third, if shadow banking reduces the effectiveness of macroprudential instruments, it is optimal to commit to less generous liquidity provision as a second-best substitute for macroprudential policy.

Abstract International financial integration helps to diversify risk but also may spread crises across countries. We provide a quantitative analysis of this trade-off in a two-country general equilibrium model with collateral-constrained borrowing using a global solution method. Borrowing constraints bind occasionally, depending upon the state of the economy and levels of inherited debt. We examine different degrees of international financial integration, moving from financial autarky, to bond and equity market integration. Financial integration leads to a significant increase in global leverage, substantially escalates the probability of crises for any one country, and dramatically increases the degree of “contagion” across countries. Outside of crises, the impact of financial integration on macroeconomic aggregates is relatively small. But the impact of a crisis with integrated international financial markets is much less severe than that under financial market autarky. Thus, a trade-off emerges between the probability of crises and the severity of crises. Using a large cross-country database of financial crises in developing and developed economies over a forty-year period, we find evidence in support of the model.

Abstract This article develops a search theory of labour unions in which the possibility of unionization distorts the behaviour of non-union firms. In the model, unions arise endogenously through a majority election within firms. As union wages are set through a collective bargaining process, unionization compresses wages and lowers profits. To prevent unionization, non-union firms over-hire high-skill workers— who vote against the union— and under-hire low-skill workers— who vote in its favour. As a consequence of this distortion in hiring, firms that are threatened by unionization hire fewer workers, produce less and pay a more concentrated distribution of wages. In the calibrated economy, the threat of unionization has a significant negative impact on aggregate output, but it also reduces wage inequality.

Abstract We document that postwar U.S. elections show a strong pattern of “incumbency disadvantage”: if a party has held the presidency of the country or the governorship of a state for some time, that party tends to lose popularity in the subsequent election. We show that this fact can be explained by a combination of policy inertia and unpredictability in election outcomes. A quantitative analysis shows that the observed magnitude of incumbency disadvantage can arise in several different models of policy inertia. Normative and positive implications of policy inertia leading to incumbency disadvantage are explored.

Abstract I empirically measure the welfare gains from optimal incentive regulation in the context of electric utilities facing both emissions and rate of return regulation (RORR). I provide evidence that RORR induces lower fuel efficiency, leading to greater coal consumption and higher emissions abatement costs. Replacing RORR with the optimal mechanism of Laffont and Tirole (1986) yields annual welfare gains of $686 million or a 11% reduction in electricity prices. I construct a much simpler two-contract menu that can achieve more than 65% of these welfare gains.