Knowledge that Transforms

This paper examines how capital tax competition affects jurisdiction formation. We describe a non-cooperative locational model of public goods provision choices, where the levels of taxation and the local public good varieties provided within jurisdictions are selected by majority voting, and where equilibrium jurisdictions consist of consumers with similar tastes. We show that interjurisdictional tax competition results in an enlargement of jurisdictional boundaries, and, even in the absence of intrajurisdictional transfers, can raise welfare for all members of a jurisdiction.

I develop a dynamic political economy theory of optimal taxation and budget distortions in a model with partisan politics. Under asymmetric information, politics affects the distribution of utilities in the economy. Political regime switching introduces fluctuations of this distribution. These fluctuations justify strategic budget distortions by governments currently holding office and willing to favour their redistributive concerns against future majority. Under quite general assumptions on preferences, these distortions take the form of budget deficits (resp. surpluses) with leftist (rightist) governments. Endogenizing the probabilities of getting elected may reverse this result.

This paper considers the problem of identification and estimation in panel data sample selection models with a binary selection rule, when the latent equations contain strictly exogenous variables, lags of the dependent variables, and unobserved individual effects. We derive a set of conditional moment restrictions which are then exploited to construct two-step GMM-type estimators for the parameters of the main equation. In the first step, the unknown parameters of the selection equation are consistently estimated. In the second step, these estimates are used to construct kernel weights in a manner such that the weight that any two-period individual observation receives in the estimation varies inversely with the relative magnitude of the sample selection effect in the two periods. Under appropriate assumptions, these "kernel-weighted" GMM estimators are consistent and asymptotically normal. The finite sample properties of the proposed estimators are investigated in a small Monte-Carlo study.

On the international scene, away from national legal rules, the use of different currencies is largely due to the operation of the “Invisible Hand” The paper develops a three-country model of the world economy. This links real trade patterns with currency exchange structures in a general equilibrium framework which includes transaction costs on foreign exchange markets. In the presence of strategic complementarities, there are multiple equilibrium structures of currency exchange for a given underlying real trade pattern. The existence conditions of these different equilibria are characterized, using the trade links between countries as the key parameters. Finally, repercussions on world output of the choice of a currency exchange structure are analysed.

This paper explores tests of the hypothesis that the tail thickness of a distribution is constant over time. Using Hill's conditional maximum likelihood estimator for the tail index of a distribution, tests of tail shape constancy are constructed that allow for an unknown breakpoint. The recursive test is shown to be inconsistent in one direction, and only a one-sided test is recommended. Specifically, the test can be used when the alternative hypothesis is that the tail index decreases over time. A rolling and sequential version of the test is consistent in both directions. The methods are illustrated on recent stock price data for Thailand, Malaysia and Indonesia. The period covers the recent Asian financial crisis and enables us to assess whether breakpoints in domestic asset return distributions are related to known changes in institutional arrangements in the foreign currency markets of these countries.

This paper provides an analysis of aggregate behavioural outcomes when individual utility exhibits social interaction effects. We study generalized logistic models of individual choice which incorporate terms reflecting the desire of individuals to conform to the behaviour of others in an environment of noncooperative decisionmaking. Laws of large numbers are generated in such environments. Multiplicity of equilibria in these models, which are equivalent to the existence of multiple self-consistent means for average choice behaviour, will exist when the social interactions exceed a particular threshold. Local stability of these multiple equilibria is also studied. The properties of the noncooperative economy are contrasted with the properties of an economy in which a social planner determines the set of individual choices. Finally, a likelihood function based on the theoretical model is given and conditions for the econometric identifiability of the model are established.

This paper considers discounted repeated games with boundedly rational players. In each period, player i chooses his current action on the basis of his forecast about the forthcoming n(i) action profiles; his assessment of the payoffs he will obtain next depends on his state of mind, which is non-deterministic. A limited forecast equilibrium is such that after every history the limited horizon forecasts formed by the players are correct. The set of all limited forecast equilibria is characterized and constructed. Application to the repeated prisoner's dilemma shows that limited foresight may sometimes induce purely cooperative paths while purely non-cooperative paths cannot arise.

The rules under which jurisdictions (nations, provinces) can deny immigration or expel residents are generally governed by a constitution, but there do not exist either positive or normative analyses to suggest what types of exclusion rules are best. We stylize this problem by suggesting four constitutional rules of admission: free mobility, admission by majority vote, admission by unanimous consent, admission by a demand threshold for public goods. In a simple model we characterize the equilibria that result from these rules, and provide a positive theory for which constitutional rules will be chosen.

Administrative and political reorganization is being actively debated even in the mature, stable economies of Western Europe. This paper investigates the possibility that such a reorganization is tied to the integration of economic markets. The paper describes a model where heterogeneous individuals form coalitions for the provision of a public good and shows that the number and composition of these jurisdictions depend on the overall size of the market. The range of economic activities engaged in by jurisdiction members increases when the size of the market increases, and so does the range of their preferences over the public good. The result is a change in the endogenous borders of the jurisdictions, and a reorganization of all coalitions. The optimal number of jurisdictions is unique and increases with market size. In the absence of compensating transfers, however, the decentralized equilibrium need not be optimal and is not unique, although there is no restriction on individuals' ability to coordinate the formation of coalitions. It remains true that a large enough increase in market size will trigger an increase in the number of jurisdictions.

We examine the optimal design of contracts when an agent is privately informed about his wealth, his ability, and his effort supply. We find that the agent's wealth and ability act as perfect complements in determining the power of the incentive scheme under which he operates. Only if his ability and his wealth both increase can an agent be assured of operating under a more powerful scheme. Consequently, severe under-utilization of wealth and ability arise in equilibrium.