Knowledge that Transforms

When economists contemplate the invisible hand at work, they generally think of competitive markets. But there are some circumstances in which markets are not supposed to operate well (i.e., in which the invisible hand is thought to falter). A leading cause of market failure, many argue, is the presence of significant externalities. With such externalities, the first welfare theorem does not apply, and so competitive equilibrium-if it exists at all-is not typically Pareto optimal. In the tradition of A. C. Pigou (1932), the typical response to this lack of optimality is for the government to step in and introduce corrective policy, usually in the form of taxes or subsidies. There is, of course, a strong antiPigouvian tradition, as well. Specifically, proponents of the Coase theorem (Ronald Coase, 1960) have contended that, despite externalities, unrestrained bargaining and contracting ought to be sufficient to generate an efficient outcome. (Indeed Coase's own celebrated example was a case of externalities.) Thus, even if formal markets themselves fail, the invisible hand nevertheless succeeds, and outside intervention or design is not required. Recently, Joseph Farrell (1987) argued that, even when free bargaining is permitted, the laissez-faire conclusion inherent in the Coase theorem may founder if agents have incomplete information about one another's relevant characteristics. I shall show, however, that the problem that Farrell identified is due only to monopoly power and is not peculiar to externalities. Indeed, in this paper, I shall take a modified Coasian stance. I shall attempt to show that, in spite of externalities and incomplete information, private contractual agreements suffice to achieve efficiency, as long as no agent is big enough to have significant market power. This conclusion must be qualified, however, with the proviso that, if the externality is (i.e., no one can be excluded from its effects), the government must intervene to prevent free-riding on the agreements. Intervention, in this case, amounts to establishing the right of an agent providing a positive external effect to collect a fee for increasing the effect from all who enjoy it, even if they are not parties to a contract with the provider. Symmetrically, providers of a negative externality can collect a fee for diminishing the effect from all their victims. In either case, however, the fee is set endogenously, that is, it is determined by the contractual arrangements rather than by the government. This result for nonexcludable externalities (which include pure public goods) provides support for a fairly laissez-faire stance toward externalities but turns on an important assumption, namely, that parties always write contracts so as to maximize their social surplus (subject to incentive and individual-rationality constraints). I will return to this assumption in the final section.

From the standpoint of economic theory, the difficulty in regulating workers' performance distinguishes labor markets from commodity markets. Commodities do not respond to incentives. Workers, in contrast, can quit, steal, be hung over, refuse to cooperate with other workers, or generally work at low effort levels. Since direct monitoring is often costly and unreliable, it may not be the profit-maximizing solution to this problem. Economists have discussed various schemes to make productive behavior incentive-compatible for workers. The most frequently discussed schemes fall into two broad categories: efficiency wages and deferred compensation or bonding schemes.! These schemes have been suggested as explanations for a wide variety of labormarket features that appear anomalous from the conventional supply-and-demand perspective. Efficiency-wage models can generate equilibria in which there is involuntary unemployment and in which identical workers are paid different wages in jobs that are otherwise equally attractive. George A. Akerlof and Janet L. Yellen (1985) have argued that they can provide an important component of a model of business cycles. Deferred-compensation schemes have been proposed as explanations for upward-sloping age-earnings profiles, mandatory retirement, pensions, and hierarchical (tournament) promotion structures.2 Because bonding is costless to firms, efficiency-wage and bonding strategies are often viewed as mutually incompatible; profit-maximizing firms should offer efficiency wages only in situations where bonding is impossible. One widely held view argues that in labor markets where agency issues arise, these problems are effectively solved by various bonding arrangements (and moreover, that this observation helps to explain otherwise peculiar features of some labor markets, as mentioned above). It follows that efficiency wages do not generally exist. Proponents of efficiency-wage theory argue that there is considerable evidence of widespread agency problems (e.g., large expenditures by many firms on monitoring) and that there are barriers to the use of bonds, notably moral hazard on the part of firms or legal constraints. Efficiency wages cannot therefore be ruled out a priori as an equilibrium solution to these agency problems.3 In this paper we study these issues surrounding efficient worker compensation in a framework that allows heterogeneity among firms and integrates the financial and

Imagine two models of rural poverty distribution. One (which might be called the model) pictures the poor as confined to poverty regions of great natural adversity, separate and apart from regions. In the normal areas, on the other hand, there might be growing inequality, but there is little or no absolute poverty. The second model (the socioeconomic model) sees poor, rich, and middle class physically interspersed or living in proximity to one another. Which of these models more closely approximates reality is an important question. It affects the visibility of extremes of wealth and poverty, which is a politically sensitive matter. Also, characteristics of antipoverty policy will be very different according to whether it is necessary to identify and treat individual households and neighborhoods widely scattered among the nonpoor population or whether it is possible to target entire poor regions. In China, the ecological model is official

Research joint ventures (RJV's) between private firms and government bureaus play a central position in the Clinton Administration's R&D strategy to promote productivity and of American firms. The government's role in the programs varies from subsidizing private projects to providing the expertise and facilities of the federal research laboratories. A substantial literature now exists that investigates the economic efficiency of private RJV's. The purpose of this paper is to expand the debate to consider the conditions under which the government will choose to subsidize RJV's and whether these conditions are likely to yield desirable economic results. It is useful to characterize the government as a consortium member who differs from the private venturers in several critical ways. First, these programs are based on the presumption that private firms are far better than government at choosing projects with commercial merit. Even in those programs where the government contributes scientists and facilities, industry partners usually have primary responsibility for initiating projects. Second, the objective function of the government differs from industry members. Indeed, it is in part because government actors have goals other than competitiveness that these programs are intended to keep government bureaucrats at arm's length from technical choices. Finally, the financial contribution of the government is usually a set share of the total bill. Introducing this form of subsidy changes the research investment strategies employed by a joint venture, and the incentives facing firms either to participate in a consortium or to oppose its establishment. The basic premise of this analysis is that a subsidized joint venture will persist only when all members, including the government, are satisfied. A viable policy depends on economic consequences to member firms, and to the extent that they have access to policy-making, to nonmember firms and consumers. Furthermore, some of the relevant consequences follow predictably from market and technology characteristics.