Knowledge that Transforms

A Picture Is Worth a Thousand Symbols: A Sociologist's View of the Economic Pursuit of Truth by Joel M. Podolny. Published in volume 93, issue 2, pages 169-174 of American Economic Review, May 2003

This paper develops an extremely simple formulation of the Laffont-Tirole principal agent model of cost-based procurement and regulation which is suitable for applied uses by restricting the principal to using a two item menu where one item is a cost-reimbursement contract and the other item is a fixed price contract.Menus of this form are called fixed-price-cost-reimbursement (FPCR) menus.In the case where the agent's utility is quadratic and the agent's type is distributed uniformly, it is shown that the optimal FPCR menu always captures at least three quarters of the gain that the optimal complex menu achieves.Therefore, at least for the uniform quadratic case, extremely simple menus with low informational requirements perform nearly as well as the fully optimal complex menu.

Physical telecom networks are costly and few, traditionally to the point of monopoly. Innovation thrives with many independent minds. So one might hope independent innovators, not only its proprietor M, can offer innovative services on a network, as has been true on the Internet. This issue is central in telecom policy; it also arises elsewhere, including complaints about Microsoft. I try to expound the following key points. Often an unregulated M has ex ante incentives to organize service innovation efficiently. But this incentive breaks down ex post as M can extract an independent J’s quasi-rents (Farrell and Michael Katz 2000). Even ex ante, the one monopoly rent theorem (Ward Bowman 1957) fails when M’s bottleneck access business is more regulated than its competitive services (e.g., Jean-Jacques Laffont and Jean Tirole 2000). This tempts M to sabotage J’s innovations. Quarantining M from the service sector solves these problems, but excludes the firm with (often) the best opportunities and the strongest incentives to innovate. Parity pricing or ECPR (Robert Willig 1979) purports to get the best of both worlds (BoBW). But it seems so hard to implement in innovation markets that one might construe ECPR analysis as reductio ad absurdum for BoBW.

Equity market liberalizations are like IPOs, but they are IPOs of a country's stock market rather than of individual firms. Both are endogenous events whose benefits are limited by poor investor protection, agency costs, and information asymmetries. As for stock prices following an IPO, there are legitimate concerns about the efficiency in the period following the liberalization of the stock market returns of countries that liberalize their equity markets. Equity markets of liberalizing countries experience extremely strong performance immediately after the liberalization, but then go through a period of poor performance. This pattern of stock returns is more dramatic for countries with poorer financial development before the liberalization.

The Carrot or the Stick: Rewards, Punishments, and Cooperation by James Andreoni, William Harbaugh and Lise Vesterlund. Published in volume 93, issue 3, pages 893-902 of American Economic Review, June 2003

Standard incentive theory models provide a rich framework for studying informational problems but assume that contracts can be perfectly enforced. This paper studies the design of self-enforced relational contracts. I show that optimal contracts often can take a simple stationary form, but that self-enforcement restricts promised compensation and affects incentive provision. With hidden information, it may be optimal for an agent to supply the same inefficient effort regardless of cost conditions. With moral hazard, optimal contracts involve just two levels of compensation. This is true even if performance measures are subjective, in which case optimal contracts terminate following poor performance.

Collusive Practices in Repeated English Auctions: Experimental Evidence on Bidding Rings by Owen R. Phillips, Dale J. Menkhaus and Kalyn T. Coatney. Published in volume 93, issue 3, pages 965-979 of American Economic Review, June 2003

The use of modern microeconomics in policy is illustrated by the markets for spectrum, electricity, greenhouse-gas reductions, defense procurement, and Treasury bills. Further examples are antitrust divestiture rules, market-based redistribution, fishery conservation, and privatization. The limits of the use of theory are also discussed, by reference to China's economy-wide reforms. Lessons on the policy use of theory are drawn.