Knowledge that Transforms

Deadlines and late penalties are widely used to incentivize effort. Tighter deadlines and higher penalties induce higher effort, but increase the agent's risk. We model how these contract terms affect the work rate and time-to-completion in a procurement setting, characterizing the efficient contract design. Using new micro-level data on Minnesota highway construction contracts that includes day-by-day information on work plans, hours worked and delays, we find evidence of ex post moral hazard: contractors adjust their effort level during the course of the contract in response to unanticipated productivity shocks, in a way that is consistent with our theoretical predictions. We next build an econometric model that endogenizes the completion time as a function of the contract terms and the productivity shocks, and simulate how commuter welfare and contractor costs vary across different terms and shocks. Accounting for the traffic delays caused by construction, switching to a more efficient contract design would increase welfare by 22.5% of the contract value while increasing the standard deviation of contractor costs—a measure of risk—by less than 1% of the contract value.

Firms spend substantial resources on marketing and selling. Interpreting this as evidence of frictions in product markets, which require firms to spend resources on customer acquisition, this article develops a search theoretic model of firm dynamics in frictional product markets. Introducing search frictions generates long-term customer relationships, rendering the customer base a state variable for firms, which is sluggish to adjust. This affects: the level and volatility of firm investment, profits, value, sales and markups, the timing of firm responses to shocks, and the relationship between investment and Tobin's q. We document support for these predictions in firm-level data from Compustat, using cross-industry variation in selling expenses to quantify differences in the degree of friction across markets.

Job protection and cash benefits are key elements of parental leave (PL) systems. We study how these two policy instruments affect return-to-work and medium-run labour market outcomes of mothers of newborn children. Analysing a series of major PL policy changes in Austria, we find that longer cash benefits lead to a significant delay in return-to-work, particularly so in the period that is job-protected. Prolonged parental leave absence induced by these policy changes does not appear to hurt mothers' labour market outcomes in the medium run. We build a non-stationary model of job search after childbirth to isolate the role of the two policy instruments. The model matches return-to-work and return to same employer profiles under the various factual policy configurations. Counterfactual policy simulations indicate that a system that combines cash with protection dominates other systems in generating time for care immediately after birth while maintaining mothers' medium-run labour market attachment.

We use micro data on Irish producer prices to provide clean evidence on pricing-to-market across a broad range of manufacturing sectors. We have monthly observations on prices charged by the same plant for the same product to buyers in Ireland and the UK, two markets segmented by variable exchange rates. Assuming that relative marginal cost is constant across markets within a plant and a product, this allows us to observe the behaviour of the markup in the UK market relative to the home market. To identify pricing-to-market that goes beyond what is mechanically due to price stickiness, we condition on episodes where prices change. When prices are invoiced in local currency, conditional on prices changing, the ratio of the markup in the foreign market to the markup in the home market increases one-for-one with depreciations of home against foreign currency and decreases one-for-one with appreciations of home against foreign currency, a very particular form of pricing-to-market.

This article studies empirically the links between international trade and labour income risk faced by manufacturing sector workers in the U.S. We use longitudinal data on workers to estimate time-varying individual income risk at the industry level. We then combine our estimates of persistent labour income risk with measures of exposure to international trade to analyse the relationship between trade and labour income risk. We also study risk estimates from various subsamples of workers, such as those who switched to a different manufacturing industry (or out of the manufacturing sector altogether). Finally, we use these estimates to conduct a welfare analysis evaluating the benefits or costs of trade through the income risk channel. We find import penetration to have a statistically significant association with labour income risk in the U.S. Our welfare calculations suggest that these effects are economically significant.

This article studies optimal Ramsey taxation when risk sharing in private insurance markets is imperfect due to limited enforcement. In a limited commitment economy, there are externalities associated with capital and labour because individuals do not take into account that their labour and saving decisions affect aggregate labour and capital supply and wages, and thus the value of autarky. Therefore, a Ramsey government has an additional goal, which is to internalize these externalities of labour and capital to improve risk sharing, in addition to its usual goal—minimizing distortions in financing government expenditures. These two goals drive capital and labour taxes in opposite directions. It is shown that the steady-state optimal capital income taxes are levied only to remove the negative externality of the capital, whereas optimal labour income taxes are set to meet the budgetary needs of the government in the long run, despite the presence of positive externalities of labour.

I extend multi-unit auction estimation techniques to a setting in which firms can express cost complementarities over time. In the context of electricity markets, I show how the auction structure and bidding data can be used to estimate these complementarities, which in these markets arise due to startup costs. I find that startup costs are substantial and that taking them into account helps better explain firm bidding strategies and production patterns. As in other dynamic settings, I find that startup costs limit the ability of firms to change production over time, exacerbating fluctuations in market prices. These fluctuations can induce estimates of market power that ignore dynamic costs to overstate markup volatility, with predicted markups that can be even negative in periods of low demand. I show how accounting for startup costs can provide a natural correction for these markup biases.

We study the effects of fiscal policy interventions in a liquidity trap in a model with nominal rigidities and an interest rate rule. In a liquidity trap caused by a self-fulfilling state of low confidence, higher government spending has deflationary effects that reduce the spending multiplier when the zero lower bound is binding. Instead, cuts in marginal labour tax rates are inflationary and become more expansionary when the zero lower bound is binding. These findings contradict a popular view, based on a liquidity trap caused by a fundamental shock such as a taste shock, that higher government spending is inflationary and can therefore be associated with large multipliers at the zero lower bound, while lower marginal tax rates are deflationary and therefore counterproductive.

Wage inequality has been significantly higher in the U.S. than in continental European countries (CEU) since the 1970s. Moreover, this inequality gap has further widened during this period as the U.S. has experienced a large increase in wage inequality, whereas the CEU has seen only modest changes. This article studies the role of labour income tax policies for understanding these facts, focusing on male workers. We construct a life cycle model in which individuals decide each period whether to go to school, work, or stay non-employed. Individuals can accumulate human capital either in school or while working. Wage inequality arises from differences across individuals in their ability to learn new skills as well as from idiosyncratic shocks. Progressive taxation compresses the (after-tax) wage structure, thereby distorting the incentives to accumulate human capital, in turn reducing the cross-sectional dispersion of (before-tax) wages. Consistent with the model, we empirically document that countries with more progressive labour income tax schedules have (i) significantly lower before-tax wage inequality at different points in time and (ii) experienced a smaller rise in wage inequality since the early 1980s. We then study the calibrated model and find that these policies can account for half of the difference between the U.S. and the CEU in overall wage inequality and 84% of the difference in inequality at the upper end (log 90–50 differential). In a two-country comparison between the U.S. and Germany, the combination of skill-biased technical change and changing progressivity of tax schedules explains all the difference between the evolution of inequality in these two countries since the early 1980s.

This article considers a two-sided search market where firms and workers are paired to bargain over a unit surplus. The matching market serves as an endogenous outside option for the agents. The market includes inflexible commitment types who demand a constant portion of any match surplus. The frequency of such types is determined in equilibrium.An equilibrium where there are significant delays in reaching an agreement and where negotiations occasionally break down on the equilibrium path is constructed. Such an equilibrium exists and commitment types affect bargaining dynamics even if the equilibrium frequency of such types is negligible. If the inflows of firms and workers into the market are symmetric, then bargaining involves two-sided reputation building and reputation concerns lead to delays and inefficiency. Access to the market exacerbates bargaining inefficiencies caused by inflexible types. If the inflows of workers and firms are sufficiently asymmetric, then bargaining involves one-sided reputation and commitment types determine the terms of trade.