Knowledge that Transforms

That firms employ internal labor markets, in which wages and careers are partly shielded from the vagaries of external labor markets, seems well accepted. Yet, Peter Doeringer and Michael Piore's (1985) seminal work on internal labor markets has had a rather limited impact on the economics profession. In contrast to textbooks on human-resource management, which have adopted their paradigm wholeheartedly, labor economics texts tend to pay only cursory attention to internal labor markets. The competitive model, in which wages reflect an individual's marginal product, remains the paradigm of choice. There are many reasons for this lackluster reception, including intellectual convenience. A more acceptable excuse is that while Doeringer and Piore's study, which was based on interviews with 75 companies, identified several key regularities (ports of entry, career ladders, etc.) that have come to shape our perception of internal labor markets, the book never presented a theory to explain these findings. With the advent of information economics and contract theory, models of internal labor markets-or at least selected features of these markets-have begun to emerge. The objective of these theories is to show that internal-labor-market outcomes can be construed as second-best solutions to contracting problems under incomplete information. For instance, tournament theory (Edward Lazear and Sherwin Rosen, 1981) sees the attachment of wages to jobs as part of an efficient incentive scheme. Michael Waldman (1984) explains the same phenomenon as an insurance arrangement against variations in individual productivity. Seniority rules in promotion and wagesetting can be understood as responses to problems of collusion or influence activities (Paul Milgrom and John Roberts, 1988). The list could be extended. At this point, there is hardly any feature of internal labor markets that cannot be given some logical explanation using the right combination of uncertainty, asymmetric information and opportunism. Doeringer and Piore (1985), in the preface to the second printing of their book, take exception with this line of theoretical research. They believe that internal labor markets are inherently a social (group) phenomenon and that something fundamental is missed by pursuing individualistic models. Be that as it may, we think there is another, more serious problem with the direction that this research has taken: too much of it relies on the old empirical stereotype. The original study was done 25 years ago and focused almost exclusively on blue-collar, male, unionized, manufacturing workers. One might rightly wonder how relevant these findings are in today's environment and whether they extend to white-collar work as most discussions seem to assume. Before proceeding with the theory, it is prudent to ask: do we have the facts right? In this paper we report on two recent case studies of individual firms that use personnel records to analyze wage and career paths of managerial workers: Lazear (1992) and Baker et al. (1994a,b).1 Person-

One way in which corporate financial structure affects macroeconomic performance is by creating debt overhang. Debt overhang occurs when existing debt deters new investment because the benefits from new investment will go to the existing creditors, not to the new investors. If the economy is booming, debt overhang will not bind because the returns to investing are high. If the economy is stagnant, debt overhang will bind because the returns to investing are low. As a result, high levels of debt can create multiple expectational equilibria in which 'animal spirits' determine economy activity.

The authors study the implications for shareholder wealth of interfirm antitrust litigation and how the costs of the dispute affect the propensity to settle. Upon filing, defendants experience significant wealth losses that are ten million dollars larger than the wealth gains of plaintiffs. Financial distress, behavioral constraints, and follow-on suits are sources of wealth leakage and influence settlement behavior. Since the threat of a monetary transfer has little power to explain either wealth effects or the likelihood of settlement, the central concern of defendants may be the potential prohibition of profitable business practices.

Economists view talk as cheap and culture as insignificant. Yet humans are talking animals, talking in their markets. The talk probably matters: why else would the human animals bother doing it? The usual economic view of the talk is that it issues orders and conveys information. Workers at GM are ordered to report for work tomorrow; credit ratings are conveyed. Economic analysis takes these parts of the talk into account without fuss. Production theory can be viewed as the theory of one mind issuing orders. Much of game theory is concerned in one way or another with information (though game theory, as Joseph Farrell (1995) and others have found, requires more than bits of information). But issuing the orders and conveying the information does not account for all of the talk. The third part of the economic talk is persuasion.

The case for central-bank independence (CBI), while not a new one, has been strengthened by a growing body of empirical evidence, by recent developments in economic theory, and by the temper of the times. The case is a strong one,1 which is becoming part of the Washington orthodoxy. The purposes of this paper are both to make more precise the type of CBI that is likely to enhance economic performance, and to point to some remaining open issues and anomalies. I start with the two theoretical approaches to CBI.

This paper takes issue with two basic conclusions prevalent in the literature on central bank behavior. First, the paper argues that it is inappropriate to presume that central banks will, in the absence of any precommitment technology, necessarily behave in a 'discretionary' fashion that implies an inflationary bias. Since there is no functional connection between average rates of money creation (or inflation) and policy responsiveness to cyclical disturbances, it is entirely feasible for the bias to be avoided. In other words, there is no necessary tradeoff between 'flexibility and commitment.' Second, to the extent that the absence of any absolute precommitment technology is nevertheless a problem, it will apply to a consolidated central bank plus government entity as well as to the central bank alone. Thus contracts between governments and central banks do not overcome the motivation for dynamic inconsistency, they merely relocate it.

Just how important a determinant of economic growth is the efficacy with which markets are organized? It is clear that in order to answer this question it is necessary to have both a well-articulated theory of economic growth and a precise notion of what it means for one market to be better organized than another. The newly developed theory of endogenous growth (pioneered by, among others, Paul M. Romer [1986], Robert E. Lucas [1988], Nancy Stokey [1988], and Gene Grossman and Elhanan Helpman [1991]) has equipped economists with a rigorous microeconomic foundation of the growth process. Since its original inception, research in this area has bifurcated: one strand of work has continued to emphasize the importance of capital accumulation (both physical and human) in environments in which agents are competitive price-takers; the other strand has a distinctly neo-Schumpeterian flavor, in which firms are price-setters and purposive innovative activity leads to technological advancement. But what of the role played by market organization? The growth literature has remained relatively silent on this issue. The reason is that the canonical growth model is one in which trade-either competitive or monopolisticly competitive-is coordinated by the Walrasian auctioneer. Given that ex hypothesi trade is frictionless, it is meaningless to use this framework to discuss issues pertaining to improvements in market organization. However, beginning with the seminal contributions of Peter Diamond (1982), Dale T. Mortensen (1982), and Christopher Pissarides (1985), economists have begun to construct models that dispense with the auctioneer's coordinating function. In this setting it is possible to make precise the notion of an improvement in market efficacy, since search and bargaining frictions are explicitly incorporated as an integral part of the trading environment. Yet, it is only very recently that this literature has begun to explore the consequences for perpetual economic growth.

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