Knowledge that Transforms

During the last four decades the average total fertility rate in OECD countries witnessed a dramatic fall: from 2.9 in 1960 to 2.0 in 1975 and then to 1.6 in the late 1990s (reaching 1.25 in Southern Europe). With the exception of the United States, all advanced countries now have fertility rates well below the replacement rate of 2.1. In the absence of either sharp changes in fertility behavior or large inflows of immigrants, their populations are set to shrink, particularly in Europe. Still, within this generalized fall, cross-national differences in fertility behavior have remained significant. By 2000, fertility rates ranged from 2.1 in the United States and over 1.8 in France and Norway to less than 1.3 in Greece, Italy, and Spain. Most standard accounts attribute the fall in fertility rates to a shift in personal preferences over the size of the family due to either changes in religious beliefs or growing female participation in the labor market. Yet, even though the ideal number of children for men and women 20–34 years old has declined, it is fairly similar across the European Union at around the replacement level of 2.1 (Eurostat, 2001). Hence, the sources of cross-national variation in fertility behavior must lie somewhere else. As women have joined the labor force, fertility rates have adjusted as a function of the institutional structures that shape the job market and determine its long-run unemployment rate. Exploiting the considerable variation of fertility rates and employment conditions across industrial countries, this paper shows that the current demographic transition is ultimately associated with the constraints of the labor market where fertility decisions are taken.

“Does increasing women's schooling raise the schooling of the next generation?” is the question posed by Jere R. Behrman and Mark R. Rosenzweig (2002). Their answer to the question is no. In fact, they conclude that raising women's schooling may lower the schooling of the next generation. We show that Behrman and Rosenzweig's results are not robust to alternative coding schemes and sample selection rules, and argue that their policy inference may be misguided.

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We show that individuals with identical preferences and abilities can self-organize into communities with starkly different civic environments. Specifically, we consider a multi-community city where community quality depends upon residents' efforts to prevent crime, improve local governance, etc. Homeownership raises incentives for such civic efforts, but is beyond the reach of the poor. Within-community externalities lead to segregated cities: the rich reside in healthy homeowner communities, while the poor live in dysfunctional renter communities. Tenure segregation in the United States accords well with our prediction. We study alternative tax-subsidy policies to expand homeownership and to promote integration of homeowners and renters.

New medical technologies hold tremendous promise for improving population health, but they also raise concerns about exacerbating already large differences in health by socioeconomic status (SES). If effective treatments are more rapidly adopted by the better educated, SES health disparities may initially expand even though the health of those in all groups eventually improves. Hypertension provides a useful case study. It is an important risk factor for developing cardiovascular disease, the condition is relatively common, and there are large differences in rates of hypertension by education. This paper examines the short and long-term diffusion of two important classes of anti-hypertensives - ACE inhibitors and calcium channel blockers - over the last twenty-five years. Using three prominent medical surveys, we find no evidence that the diffusion of these drugs into medical practice favored one education group relative to another. The findings suggest that - at least for hypertension - SES differences in the adoption of new medical technologies are not an important reason for the SES health gradient.

Using a new international dataset of trade-weighed exchange rates, this paper highlights a neglected adjustment mechanism in the classical gold standard literature. Since gold-pegged countries traded extensively with economies operating more flexible monetary regimes and where parity change was a common adjustment device to systemic shocks, we show that such parity adjustments induced worldwide swings in nominal effective exchange rates. These translated into real exchange rate variations to which trade balances responded with an average elasticity of unity and in the direction of restoring external disequilibria. We conclude that some nominal exchange rate flexibility thus present in the pre-1914 system was instrumental to international payments adjustment.

We analyze the political determinants of investor and employment protection. Our model predicts that proportional electoral systems are conducive to weaker investor protection and stronger employment protection than majoritarian systems. This prediction is consistent with international panel data evidence. The proportionality of the voting system is significantly and negatively correlated with shareholder protection in a panel of 45 countries, and positively correlated with employment protection in a panel of 21 OECD countries. Other political variables also affect regulatory outcomes, especially for the labor market. The origin of the legal system has some additional explanatory power only for employment protection.

The economics of governance is an effort to implement the “study of good order and workable arrangements,” where good order includes both spontaneous order in the market, which is a venerated tradition in economics (Adam Smith, 1776; Friedrich Hayek, 1945; Kenneth A. Arrow and Gerard Debreu, 1954), and intentional order, of a “conscious, deliberate, purposeful” kind (Chester Irving Barnard, 1938 p. 9). Also, I interpret workable arrangements to mean feasible modes of organization, all of which are flawed in comparison with a hypothetical ideal (Avinash Dixit, 1996 pp. 4–9). The object is to work out the efficiency logic for managing transactions by alternative modes of governance—principally spot markets, various long-term contracts (hybrids), and hierarchies. Interest among social scientists, economists included, in the study and practice of good order and workable arrangements has been steadily growing. In contrast with the orthodox lens of choice (prices and output, supply and demand), the economics of governance is a lens of contract construction, broadly in the spirit of James Buchanan’s (2001 p. 29) observation that “mutuality of advantage from voluntary exchange ... is the most fundamental of all understandings in economics.” The economics of governance, as herein described, is principally an exercise in bilateral private ordering, by which I mean that the immediate parties to an exchange are actively involved in the provision of good order and workable arrangements. To be sure, the need for private ordering varies with the rules of the game as provided by the state. Distinctions between lawlessness where the state provides limited or unreliable protection for property and contract (Dixit, 2004) and lawfulness, where the state undertakes to protect property and enforce contracts in a principled way, are pertinent. The first of these applies mainly to primitive and transition economies. The second is commonly associated with Western democracies. Recourse to private ordering under conditions of lawlessness is altogether understandable: given the absence of state support, the * Walter A. Haas School of Business, University of California, Berkeley, CA 94720-1900. The paper has benefited from workshop presentations at the University of California–Berkeley, the University of Valencia, INSEAD (Fountainebleau), and the 2004 annual conference of the International Society for New Institutional Economics. An abbreviated version was also given as the Horst Claus Recktenwald Lecture at Nuremburg on 4 November 2004. Comments and suggestions from Fred Balderston, Ernesto Dalbo, Avinash Dixit, Robert Gibbons, Witold Henisz, Ian Larkin, Steven Tadelis, and Dean Williamson are especially acknowledged. 1 Lon Fuller’s (1954 p. 477) definition of “eunomics” as “the science, theory, or study of good order and workable arrangements” is very much in the spirit of what I refer to as governance. 2 One of the immediate ramifications of insistently comparing feasible alternatives, all of which are flawed, is that the purported inefficiencies that are ascribed to failures to achieve “first best” optimality are not dispositive, but invite the query “As compared with what?” I return to this issue in Section IV. 3 Excluding “corporate governance,” the numbers of articles that used the word “governance” during the period 1998–2000 as compared with the period 1977–1979 in selected economics, business/management, sociology/organization, and political science journals were 60 vs. 1, 76 vs. 4, 79 vs. 18, and 60 vs. 25, where the journals surveyed were: the American Economic Review, Journal of Political Economy, Quarterly Journal of Economics, Rand Journal of Economics, and Journal of Economic Perspectives in economics; Strategic Management Journal, Management Science, Academy of Management Journal, and Academy of Management Review in business/management; Administrative Science Quarterly, Organization Science, American Journal of Sociology, American Sociological Review, and Annual Review of Sociology in sociology/organization; and American Political Science Review, Political Science Quarterly, Journal of Politics, and Political Research Quarterly in political science. Combining these four categories, articles using the word governance increased from 48 to 275 over this 20-year interval. Dixit (2004 pp. 149–50) reports that the number of web pages that turn up under the search for “governance” is huge.

We examine the misallocation of credit in Japan associated with the perverse incentives faced by banks to provide additional credit to the weakest firms. Firms are more likely to receive additional bank credit if they are in poor financial condition, because troubled Japanese banks have an incentive to allocate credit to severely impaired borrowers in order to avoid the realization of losses on their own balance sheets. This “evergreening” behavior is more prevalent among banks that have reported capital ratios close to the required minimum, and is compounded by the incentives arising from extensive corporate affiliations.