Knowledge that Transforms

We present identification and estimation results for the “collective” model of labour supply in which there are discrete choices, censoring of hours, and non-participation in employment. We derive the collective restrictions on labour supply functions and contrast them with restrictions implied by the usual “unitary” framework. Using the large changes in the wage structure between men and women in the U.K. over the last two decades, we estimate a collective labour supply model for married couples without children. The estimates of the sharing rule show that male wages and employment have a strong influence on bargaining power within couples.

This paper presents a model of international trade that features heterogeneous firms, relative endowment differences across countries, and consumer taste for variety. The paper demonstrates that firm reactions to trade liberalization generate endogenous Ricardian productivity responses at the industry level that magnify countries' comparative advantage. Focusing on the wide range of firmlevel reactions to falling trade costs, the model also shows that, as trade costs fall, firms in comparative advantage industries are more likely to export, that relative firm size and the relative number of firms increases more in comparative advantage industries and that job turnover is higher in comparative advantage industries than in comparative disadvantage industries.

Experts often collect and report information over time. What reporting protocol elicits the most information? Here, a principal receives reports sequentially from an agent with privately known ability, who observes two signals about the state of the world. The signals differ in initial quality and, unlike previous work, differ in quality improvement. The paper finds that “mind changes” (inconsistent reports) can signal talent if a smart agent improves faster. Also, sequential reports dominate when the principal's decision is very sensitive to information; a single report dominates if the mediocre agent's signals improve faster or the agent is likely mediocre.

During financial disruptions, marketmakers provide liquidity by absorbing external selling pressure. They buy when the pressure is large, accumulate inventories, and sell when the pressure alleviates. This paper studies optimal dynamic liquidity provision in a theoretical market setting with large and temporary selling pressure, and orderexecution delays. I show that competitive marketmakers offer the socially optimal amount of liquidity, provided they have access to sufficient capital. If raising capital is costly, this suggests a policy role for lenient central-bank lending during financial disruptions.

Towards developing a theory of systematic biases about strategies, I analyze strategic implications of a particular bias: wishful thinking about the strategies. Considering canonical state spaces for strategic uncertainty, I identify a player as a wishful thinker at a state if she hopes to enjoy the highest payoff that is consistent with her information about the others’ strategies at that state. I develop a straightforward elimination process that characterizes the strategy profiles that are consistent with wishful thinking, mutual knowledge of wishful thinking, and so on. Every pure-strategy Nash equilibrium is consistent with common knowledge of wishful thinking. For generic two-person games, I further show that the pure Nash equilibrium strategies are the only strategies that are consistent with common knowledge of wishful thinking, providing an unusual epistemic characterization for equilibrium strategies. I also investigate the strategic implications of rationality and ex-post optimism, the situation in which a player’s expected payoff weakly exceeds her actual payoff. I show that these strategic implications are generically identical to those of wishful thinking whenever each player’s payoff is monotone in others ’ strategies.

A Welfare-to-Work (WTW) program is a mix of government expenditures on various labour market policies targeted to the unemployed (e.g. unemployment insurance (UI), job search monitoring (JM), social assistance (SA), wage subsidies). This paper provides a dynamic principal—agent framework suitable for analysing chief features of an optimal WTW program, such as the sequence and duration of the different policies, the dynamic pattern of payments along the unemployment spell, and the emergence of taxes/subsidies upon re-employment. The optimal program endogenously generates an absorbing policy of last resort (“social assistance”) characterized by a constant lifetime payment and no active participation by the agent. Human capital depreciation is a necessary condition for policy transitions to be part of an optimal WTW program. The typical sequence of policies is quite simple: the program starts with standard UI, then switches into monitored search and, finally, into SA. The optimal benefits are decreasing during unemployment insurance and constant during both JM and SA. Whereas taxes (subsidies) can be either increasing or decreasing with duration during UI, they must decrease (increase) during a phase of JM. In a calibration exercise, we use our model to analyse quantitatively the features of the optimal program for the U.S. economy. With respect to the existing U.S. system, the optimal WTW scheme delivers sizeable welfare gains to unskilled workers because the incentives to search for a job can be retained even while delivering more insurance and using costly monitoring less intensively.

We consider a version of the Solow growth model where technological progress can be investment specific or investment neutral. The labour market is subject to search frictions, and the existing productive units may fail to adopt the most recent technological advances. Technological progress can lead to the destruction of technologically obsolete jobs and cause unemployment. We calibrate the model to replicate the high persistence that characterizes the dynamics of firms' neutral technology and the frequency of firms' capital adjustment. We find that neutral technological advances increase job destruction and job reallocation and reduce aggregate employment. Investment-specific technological advances reduce job destruction, have mild effects on job creation, and are expansionary. Hence, neutral technological progress prompts Schumpeterian creative destruction, while investment-specific technological progress operates essentially as in the standard neoclassical growth model. Using structural VAR models, we provide support to the key dynamic implications of the model.

A two-country model of oligopoly in general equilibrium is used to show how changes in market structure accompany the process of trade and capital-market liberalization. The model predicts that bilateral mergers in which low-cost firms buy out higher-cost foreign rivals are profitable under Cournot competition. As a result, trade liberalization can trigger international merger waves, in the process encouraging countries to specialize and trade more in accordance with comparative advantage. With symmetric countries, welfare is likely to rise, though the distribution of income always shifts towards profits.

Analyses of the effects of election outcomes on the economy have been hampered by the problem that economic outcomes also influence elections. We sidestep these problems by analyzing movements in economic indicators caused by clearly exogenous changes in expectations about the likely winner during election day. Analyzing high frequency financial fluctuations following the release of flawed exit poll data on election day 2004, and then during the vote count we find that markets anticipated higher equity prices, interest rates and oil prices, and a stronger dollar under a George W. Bush presidency than under John Kerry. A similar Republican-Democrat differential was also observed for the 2000 BushGore contest. Prediction market based analyses of all presidential elections since 1880 also reveal a similar pattern of partisan impacts, suggesting that electing a Republican president raises equity valuations by 2–3 percent, and that since Ronald Reagan, Republican presidents have tended to raise bond yields.

A committee makes a decision on a project on behalf of “the public.” Members of the committee agree on the a priori value of the project, and hold additional private information about its consequences. They are experts who care about the value of the project and about being considered well informed. Before voting on the project, members can exchange their private information simultaneously. We show that reputational concerns make the a priori unconventional decision more attractive and lead committees to show a united front. These results hold irrespective of whether information can be manipulated or not. Also, reputational concerns induce members to manipulate information and vote strategically if their preferences differ considerably from those ofthe member casting the decisive vote. Our last result is that the optimal voting rule balances the quality of information exchange and the alignment of interests of the decisive voter with those of the public.