Knowledge that Transforms

T HE purpose of this paper is to estimate a labor supply or participation rate function for period 1948 through 1968, for various age-sex groups that comprise secondary labor force.' There are three major findings of paper. First, participation behavior is primarily explained by real wages. There are, however, two hypotheses, relative and permanent wage models that may underlie wage variables. The relative wage variable is adapted from recent research in demography and is found to predominate over more traditional permanent wage effect for a number of female age groups. (As will be seen, in labor force equations, permanent and relative wage theories predict opposite signs for a wage variable so that a test of two hypotheses is possible.) Secondly, supply of labor responds positively to a variable that reflects rate of inflation. The inclusion of this variable follows a formulation proposed by Friedman (1968). He conjectures that a form of money illusion in supply function of labor is foundation of an empirically observable, short-run Phillips curve. Thirdly, labor supply is found to respond to changes in excess demand conditions in labor market only during period of chronic, high 1958-1966 and even during that period, effect observed is considerably smaller than that noted in earlier studies. The model is compared with more traditional labor force equation that contains rate and a time trend. Both equations are fitted for period 1948-1968 and are then used to forecast most recent data for quarters 1969.1 through 1970.3. The equation presented in this paper dominates alternative model in terms of adjusted R 2's and Durbin-Watson statistics (in estimated period) and it uniformly forecasts better. Finally, implications of labor force equation are explored. It is suggested that recently adopted concepts such as unemployment, the labor force, and potential need redefinition in light of findings presented here. There are, at present, two basic approaches to study of labor force participation. The first is generally associated with Tella (1965) and Dernburg and Strand (1966) (and will hereafter be referred to as unemployment model). They found that labor force participation rate varied inversely with rate. This finding was identified with worker effect. The model may be estimated in form (LIP)i = a( + a, U + a9T'a1 < 0 (1) where (LFP)i is labor force participation rate of subgroup i, and U is aggregate rate. The time trend, T, may be interpreted as representing gradual, sociological change of preferences which is sending women from home into labor force and older workers from labor force into home. This equation has gained wide acceptance in literature, and its results have had an important impact on public policy discussions. Thus finding that discouraged workers leave labor force when (measured) is high is used to adjust rate and level of output to take account of hidden unemployed. The adjusted series has become an independent variable in empirical wage equations since work of Simler and Tella (1968). The adjusted output series and resulting measure of GNP gap are used in planning fiscal and monetary policy. Clearly to extent, however, that equation (1) does not describe labor force behavior and overstates Received for publication May 17, 1971. Revision accepted for publication July 23, 1971. * The author thanks Richard A. Easterlin, Benjamin M. Friedman, Robert J. Gordon, Lawrence R. Klein, Thomas Sargent and Susan M. Wachter for helpful suggestions. ' The secondary labor force is defined here to include males 16-19 and 65+ and females 16 through 65+. The dependent variable is a form of participation rate and hours worked are not included. 2See, for example, Tella (1965), Dernburg and Strand (1966) and Bowen and Finegan (1969). Models of Barth (1968) and Vroman (1970) also found a low elasticity for labor force in terms of participation rate.

Center of Indiana University, to whom I would like to express my appreciation.' For instance, in an introduction to a presenitation of French concentration ratios, Jacques Loup ("La concentration dans l'industrie francaise," E~tztdes et con joncture, XXIV (Feb. 1969) expressly notes that the United States concentration ratios are lover but does not bother to carry out any actual empirical comparisons Nwhich vould, in point of fact, show the reverse conclusion (see table 2 ).2This point was emphasized to me in cori-espondence by Peter Pashigian; for a detailed analysis of certain other critical aspects of the relationships between market size and monopoly, see his "The Effect of Market Size on Concentration,"

Finally, for completeness we should note that later work (Harvard Discussion Paper No. 234, 1971) has shown that when investors' risk-aversions are functionally related to their ending wealth, the investor's personal equilibrium depends upon a combination of his risk-aversion and its first derivative, but the market price of risk aggregates the investor's more complex marginal rates of substitution of return and risk in exactly the same way as it aggregates investors risk-aversions per se in simple situations. iMoreover, all the statements made above on the basis of aggregations of risk-aversions are shown to be valid in the more complex analysis.

W HILE many aspects of conglomerate firms have been studied, empirical tests of their performance remain limited. Most of the studies to date test aspects of mergers generally.' Professor Eamon Kelly (1967) compared a sample of 21 firms which grew 20 per cent or more by acquisitions during the period from 1946 to various terminal dates through 1963, with firms of similar size and products but with growth mainly internal (Kelly, 1967). He found no significant difference in profitability between the two groups. Gort and Hogarty (1970) also examined a number of general aspects of mergers. Their statistical analysis indicated that the stockholders of acquired firms gained on the average, while the owners of acquiring firms lost on the average. They found that mergers have an approximately neutral effect on Ithe aggregate worth of firms that participated in them (Hogarty, 1970). Reid's studies (1968) included data evaluating a sample of conglomerate firms for the decade ending in 1961. He utilized three measures which he characterized as reflecting the interests of managers, and three reflecting the interests of stockholders. Reid concluded that more actively merging firms and firms that diversified to a greater extent in their merging activity scored higher on the criteria related to managers' interests and lower on criteria related to stockholders' interests. Lorie and Halpern (1970) studied the performance of 117 mergers taken from the Federal Trade Commission listing for 1954-1967 of all mergers in manufacturing and mining in which the acquired firm had assets greater than 10 million dollars. In the Lorie and Halpern study, the focus was particularly on the possibility of deception of investors. The mergers which they studied, therefore, were ones in which the shareholders of the acquired company received relatively complex instruments such as convertibles or warrants.2 The investment return to, stockholders of the acquired firms was analyzed on various bases measured in the period six months prior to the merger to two years after the merger. In general, the investment return performance to stockholders of the acquired firms was superior to the market performance of broad market indexes for comparable periods of time. For example, the mean rates of return for the 12and 14-month periods subsequent to the mergers were 9.34 per cent and 9.52 per cent, respectively, while corresponding rates for the market index were 7.73 per cent and 7.38 per cent. Hogarty (1970) analyzed the success of 43 mergers by the criteria of post-merger investment performance (capital gains plus dividend returns) adjusted by an Investment Performance Index (IPI) for the industry of the acquiring company. Using measurements including reinvestment of dividends, he classified 14 failures (F), 24 ambiguous (A), and 5 successes (S). For an IPI of 10 per cent, a failure was defined as a return of 9 per cent or less, a success was a return of 11 per cent or more, and the ambiguous category represented returns between 9 and 11 per cent. Not assuming reinvestment of dividends, the distribution was 3 S, 19 A and 21 F. Hogarty found these Received for publication April 5, 1971. Revision accepted for publication June 21, 1972. * This study was supported by the Research Program in Competition and Business Policy, UCLA. We appreciate the helpful suggestions of the reviewer. ' The 1171-page special edition of the Spring 1970 St. John's Law Review on conglomerate mergers contains no article with empirical data on the comparative performance of conglomerate firms. Two empirical articles in the volume deal with other aspects of performance. The S. E. Boyle paper analyzes the premerger growth and profitability characteristics of acquired companies. The paper by T. F. Hogarty reviews earlier historical studies of the success of mergers generallv. 2 Since this kind of funny money (Lorie and Halpern's term) was alleged to be characteristic of conglomerate mergers, their sample of firms is presumed to be of conglomerates. However, no formal criteria for selection were emnlnved .

'N our society work is invariably prescribed as the path out of poverty. However, for a significant proportion of the poor this remedy falls on deaf ears, since they work but are poor. The working poor earn their poverty! Perhaps this segment of the poor has been neglected precisely because its existence belies our belief that work is the panacea for all social ills.' The focus of this study is the individual full-time wage earner and the forces affecting his/her wage income. In particular, we are interested in evaluating the relative importance of the individual characteristics of workers and the structure of the labor market in which they work. The first section contains a review of the theory of individual wNage dete-rmination in prep)aration for the exposition of the model of wage determination (section II). In section III we p)resent the empirical results of the investigation, and in section IV we evaluate public policy as it has been applied to the poor and the low-wage worker in our society.

Stephen J. Turnovsky, Michael L. Wachter, A Test of the "Expectations Hypothesis" Using Directly Observed Wage and Price Expectations, The Review of Economics and Statistics, Vol. 54, No. 1 (Feb., 1972), pp. 47-54

EMPIRICAL analyses in the private sector have disclosed significant economies of scale (e.g., Adams (1967) and Johnston (1960)). Interest naturally turned to an examination of the possibilities for scale economies in the public sector. This issue is particularly important as local governments encounter greater difficulties in financing the services demanded by their residents.1 The increased financial pressures arise from a larger number of residents demanding services of a better quality as well as the limited ability of fragmented governmental units to raise revenue. Likewise, inflation has taken a heavy toll on municipal budgets (Walzer 1971). Municipal services are largely of a personal nature and significant increases in productivity may not be easily achieved (Baumol 1967). This is especially important in police protection where wages and salaries account for almost 90 per cent of total expenditures. The labor-intensiveness of police services has led researchers to doubt the presence of significant scale economies. The claim has been made that extra costs of maintaining substations and precinct headquarters will offset cost reductions from mass purchases, etc.2 However, a large police department can concentrate more resources on a particular neighborhood during critical periods such as during expected criminal activity. Also, neighborhoods can be sealed off after a crime has been committed and research has suggested that immediate investigation by police officers substantially increases the likelihood of apprehending the offender (Challenge of Crime, 1967). Since lengthy investigations are time-consuming and thus very expensive, large police departments should have a decided cost advantage. Larger departments are also able to employ computerized data storage-retrieval systems and specialized personnel to a greater extent. On an a priori basis, one might expect specialized investigators to solve cases more quickly than would relatively inexperienced officers. This paper reviews some of the earlier findings on scale economies in police protection, suggests a new measure of scale, and reports the results of an empirical investigation on a sample of Illinois cities. Finally, an expenditure per capita and population analysis is conducted on the same sample to determine whether the observed declining average cost curve results from sample differences or variations in measurement techniques.

T HE of the role of foreign assistance in economic development in terms of two gaps a savings gap and a trade gap has by now become quite commonplace among development economists.' The basic notion underlying analysis is that there are at least two independent resource constraints on the growth of an underdeveloped economy. The first of these is the savings constraint: the growth of the economy is limited by the availability of savings for investment. The second is the trade constraint: the growth of the economy is also limited by the availability of foreign exchange for importing specific commodities required for current production and investment. Since foreign assistance can add both to the availability of savings and to the availability of foreign exchange, and since in a two-gap disequilibrium situation only one of the two constraints is likely to be binding at any particular time, the productivity of foreign assistance depends critically on which constraint is in fact binding. The determination of the binding constraint is also essential for the empirical implementation of two-gap planning models. Such models involve among other things aggregative functions describing the savings behavior and the import requirements of an economy. In a twogap situation, observed savings may or may not equal desired savings, and observed imports may or may not equal required imports, depending on whether the savings or the trade constraint is binding. In order to estimate savings and/or import functions from historical time series data, one must make a judgment about which constraint was in fact binding during the period used for estimation.2 Accepting the general framework of two-gap analysis, this paper is addressed to the problem of determining statistically which of the two constraints was dominant in a given country during a given historical time period. The objective of the paper is to develop and apply an econometric method that can be used systematically to classify countries according to their dominant constraint over varying periods of time. Given the importance of the problem for twogap analysis, it is surprising that very few attempts have been made to test systematically for the dominant constraint. Case studies of individual countries have often led to conjectures about binding constraints, but this author is aware of only three attempts to classify a large number of countries by dominant constraint.1 The present paper attempts to develop a more satisfactory method of classification. In