January 2003

We examine the interactions between different institutional arrangements in a general equilibrium model of a modernizing economy. There is a modern sector, where productivity is high but information asymmetries are large, and a traditional sector where productivity is low but information asymmetries are small. Consequently, agency costs in the modern sector make consumption lending difficult, while such lending is readily done in the traditional sector. The resulting trade-off between credit availability and productivity implies that not everyone will move to the modern sector. In fact, the laissez-faire level of modernization may fail to maximize net social surplus. This situation may also hold in the long run: in a dynamic version of the model, a “trickle-down” effect links the process of modernization with reduction in modern sector agency costs. This effect may be too weak and the economy may get stuck in a trap and never fully modernize. The two-sector structure also yields a natural theoretical testing ground for the Kuznets inverted-U hypothesis: we show that even within the “sectoral shifting” class of models, this phenomenon is not robust to small changes in model specification.

This paper studies the problem of experiment design by an ambiguity-averse decision-maker who trades off subjective expected performance against robust performance guarantees. This framework accounts for real-world experimenters’ preference for randomization. It also clarifies the circumstances in which randomization is optimal: when the available sample size is large and robustness is an important concern. We apply our model to shed light on the practice of rerandomization, used to improve balance across treatment and control groups. We show that rerandomization creates a trade-off between subjective performance and robust performance guarantees. However, robust performance guarantees diminish very slowly with the number of rerandomizations. This suggests that moderate levels of rerandomization usefully expand the set of acceptable compromises between subjective performance and robustness. Targeting a fixed quantile of balance is safer than targeting an absolute balance objective.