Knowledge that Transforms

It is now widely accepted that rent-seeking (Anne Krueger, 1974) or directly unproductive profit seeking (Jagdish Bhagwati, 1982) may cause inefficiencies in the context of public sector decisions. The possibility that government decisions (for example, about taxes, quotas, franchises, or standards) may create or redistribute rents induces private parties to spend valuable resources to influence that distribution, even when such expenditures carry no social benefit. Moreover, the social cost of rent seeking can exceed the value of the resources spent trying to gain and protect rents, for example, because the fear of losing wealth through redistribution reduces the incentives for wealth creation. Treating rent-seeking activities as characteristic of public sector decision processes ignores the fact that similar phenomena are to be found in firms, unions, and other private sector organizations. Our recent work (Milgrom, 1988; our 1988, 1990 papers) attempts to identify the advantages of decision processes (private or public) that permit rent seeking, and to incorporate these into a cost-benefit analysis of optimal decision processes. Our work begins with an analysis of why rents and quasi rents arise in organizations and of the forms that the rent seeking they engender may take. Some measures to insulate the decision process from rent seeking, such as limits on the provision of by interested parties or restrictions on the range of options considered, may degrade the quality of decisions, especially by blocking the flow of valuable information. Optimal decision processes balance the costs of rent seeking against the value of obtained. Several aspects of the rules affect the opportunities that members have to spend resources trying to alter the distribution of rents. To ascertain the possibilities for rent seeking, the analyst must ask questions like: Can the parties propose new initiatives at any time? Can they give volumes of testimony in a form of their own choosing? Can they appeal adverse decisions? Are decision makers obliged to respond to the parties' initiatives? Is the range of actions that they can take in response relatively broad, rather than being tightly constrained by property rights or other formal rules? More affirmative answers to these questions lead to opportunities or greater incentives for costly rent seeking. As a kind of shorthand, we call decision processes that have of these elements more processes. The very elements that make a process open to rent seeking may also add flexibility and responsiveness, helping to ensure that important ideas and proposals are fully considered. From this perspective, the benefits of openness can (in principle) be measured by a value of information calculation, in the usual manner of statistical decision theory. Weighing the costs and benefits, it follows that a open process is desirable when the rents available for redistribution are low, and the value of the that might be acquired is high. Conversely, when the potential for redistribution is high and the value of is low, the optimal decision process is less open. This kind of reasoning helps to illuminate the variations in the decision processes that are found in many organizations. We have discussed a number of examples in our earlier work, including the characteristics of personnel departments, the contrasting patterns of decision making, employment and compensation in U.S. and Japanese firms, *Professor of Economics, Stanford University, and Jonathan B. Lovelace Professor of Economics, Graduate School of Business, Stanford University, Stanford, CA 94305, respectively. This work was supported by the National Science Foundation.

This paper relates firm location choice and consumer search. Firms that cluster together attract consumers by facilitating price comparison, but clustering increases the intensity of local competition. The author constructs a simple model which shows that firms may choose head-on competition by locating together. Under reasonable conditions, this is the only equilibrium outcome.

A wide variety of empirical exchange rate mo.dels have been estimated over the years. But, despite the considerable energies that have been devoted to this work, the economics profession has remarkably little to show for itself. There is little evidence that conclusively links the bilateral exchange rates of typical OECD countries to fundamental macroeconomic determinants of exchange rates, such as money, output, relative prices, or interest differentials. Coefficient estimates are notoriously unstable and frequently mis-signed (compared with theoretical predictions); exchange rate equations do not fit particularly well, and forecast no better than the simplest naive alternatives. Recently, a new class of exchange rate models was introduced by Paul Krugman (1988). These models provide a potential reason for the poor performance of traditional exchange rate models, because they are nonlinear. If the exchange rate actually depends in a nonlinear way on exogenous macroeconomic fundamentals, linear exchange rate models may work poorly, even though the exchange rate is closely linked to fundamentals. In this paper we provide a brief sketch of some of this work, as well as some preliminary evidence on the actual performance of these nonlinear models. In our empirical analysis, we use a nonparametric estimator that can handle a wide variety of nonlinear phenomena. We examine fixed exchange rate regimes, where nonlinearities should be quite easy to detect. However, we do not find strong empirical support for the hypothesis that the incorporation of nonlinear effects significantly improves models of exchange rate determination. In Section I, we briefly review the theoretical literature on nonlinear target zone exchange rate models, linking this work to the tests for intrinsic bubbles (we draw heavily on recent papers by Kenneth Froot and Maurice Obstfeld, 1989a,b). Our methodology and data are discussed in Section II; Section III contains new empirical tests for nonlinearities in exchange rate models.

Claude d'Aspremont and Alexis Jacquemin (1988) employ a simple yet elegant symmetric duopoly model of R&D and spillovers to compare several equilibrium concepts. These concepts include (1) the two-stage noncooperative solution, (2) the two-stage mixed game,' (3) the two-stage fully cooperative solution,2 and (4) the social planner's optimum.3 For each of the cases stated above, they computed the equilibrium levels of output (Q=q1+q2) and R&D (xl=x2=x) and the required second-order conditions. They report (i) for large spillovers (i.e., /B > 0.5) x** > > x' > x* and Q**> Q> Q*> Q and (ii) for small spillovers (i.e., /3 x 2x*>x and Q**>Q*>Q>Q, where x denotes a firm's R&D level, Q denotes total industry output, ** denotes the social optimum, denotes the fully cooperative model, * the noncooperative two-stage case, and the mixed game. /3 is the spillover parameter. Here we show that comparing the pure cooperative and the pure noncooperative solutions as defined by d'Aspremont and Jacquemin is only meaningful when the noncooperative solution is stable, that is, when spillovers are not too small. We find that, for very small spillovers (in our example this occurs when 3 < 0.17), the d'Aspremont-Jacquemin observation holds because the noncooperative model is unstable. The importance of this result rests on the fact that even though the output reaction functions cross correctly when /3 < 0.17, the R&D reaction functions do not. When 0.17 < / < 0.41, stability obtains but R&D levels are higher in the noncooperative case than the fully cooperative one. For large spillovers the d'Aspremont-Jacquemin result is confirmed. Moreover, we find that the introduction of spillovers in the case of the noncooperative model tends to promote stability. In the case of the cooperative model, however, as the level of spillovers is increased, an equilibrium ceases to exist.