Knowledge that Transforms

The essence of the regime of unmanaged floating that prevailed among the major currencies from March 1973 until the Plaza Agreement in 1985 was that the exchange rate was treated as a residual in the process of macroeconomic policy determination. Admittedly there were occasions-such as October 1976 in the case of the pound sterling and October 1978 in the cases of both the U.S. dollar and the Swiss franc-when particular countries became so concerned with a misalignment of their currency that they were forced to abandon benign (or malign) neglect, but such incidents were episodic. Views about a proper or desirable level of the exchange rate played no systematic role in policy formulation. Section I explains why I judge the performance of unmanaged floating to have been unsatisfactory. Section II lists the real social benefits that exchange rate flexibility can afford, which should be preserved by any reformed system. Section III describes the target zone proposal and explains why it would preserve the real benefits of flexibility while overcoming the weaknesses of unmanaged floating. Section IV sketches a possible set of comprehensive principles for policy coordination of which target zones would be one natural element.

In this Review (1983), Mark McBride reconsiders the Federal Trade Commission's (FTC) enforcement policy toward vertical mergers between cement and ready-mix concrete firms. In response to a significant increase in acquisitions of ready-mix concrete firms by cement manufacturers during the 1960's, the FTC undertook a series of legal actions to block or dissolve the mergers. The actions of the FTC constituted one of the most intensive efforts undertaken to date to challenge vertical mergers in a single industry.' McBride (p. 1012) notes that the actions of the FTC provoked considerable debate concerning the motivation for the mergers both in the industry and in academe. A significant number of articles were published advancing various reasons for the mergers. In addition to the FTC's main contention that the mergers were motivated by a desire for captive markets, it has been suggested that there were economies of integration or that the mergers were the outcome of an erroneous view of the potential benefits to foreclosure held by executives in the beleaguered cement industry.2 McBride's 1983 paper offers another explanation for the mergers. His argument is that vertical integration was undertaken to avoid rigid oligopolistic pricing in the cement industry.3 The empirical results presented by McBride suggest that vertical integration was a significant factor in the decline of cement prices in the 1960's. The purpose of this comment is to point out some of the problems with McBride's analysis. In particular, we show that the experimental design of his testing equation is faulty and does not offer a test of his hypothesis. As a result, McBride's analysis does not provide convincing evidence on whether cement firms vertically integrated to avoid rigid oligopolistic pricing, or if cement firms were merely reacting to prices that had already begun to decline. Our intent, however, is not to challenge McBride's contention that vertical integration can provide lower prices to consumers. Rather, we would argue that the evidence presented at the FTC hearings involving cement and ready-mix concrete firms as well as McBride's and others' analyses illustrate the problems in discerning the motives for mergers.4

It is by now well known that the sort of difference equations that characterize the equilibrium conditions of an infinite horizon competitive economy may have solutions in which the endogenous variables fluctuate in response to "sunspot" variables, that is, to random events that in fact have nothing to do with economic "fundamentals," and so do not directly affect the equilibrium conditions. It is possible to view such "sunspot equilibria" as a representation of an actual phenomenon economic fluctuations not caused by exogenous shocks to fundamentals, but rather by revisions of agents' expectations in response to some event, which revised expectations become self-fulfilling. Early discussions of such solutions sometimes suggested that a more rigorous derivation of the requirements for equilibrium might yield additional restrictions that would eliminate the sunspot solutions from the set of true equilibria. The demonstration by Karl Shell (1977), David Cass (1981), and Costas Azariadis (1981) that sunspot equilibria can exist in a rigorously formulated intertemporal equilibrium model, namely the overlapping generations model of Samuelson, has shown that this is not always the case. Nevertheless, many economists remain skeptical about the reasonableness of the sunspot hypothesis as a possible explanation of actual economic fluctuations, and for quite general reasons, independent of judgments about the empirical plausibility of any particular models. I discuss here three such general reasons for skepticism.

The market for ski runs or amusement rides often features admission tickets with no explicit price per ride. Therefore, the equilibrium i nvolves queues, which are systematically longer during peak periods s uch as weekends. Moreover, the prices of admission tickets are much l ess responsive than the length of queues to variations in demand, eve n when these variations are predictable. Despite the queues and stick y prices, the authors show that the outcomes are nearly efficient und er plausible conditions. They then show that similar results obtain f or some familiar congestion problems and for profit-sharing schemes i n the labor market.

If economists are united on anything, it is the proposition that monopoly prices reduce economic welfare by preventing the realization of the maximum gains from trade in any market. The extent of such distortions to efficiency are often called Harberger costs after Arnold Harberger's 1954 provocative attempt to measure the extent of these losses in the U.S. economy. More recent analysis has revealed that when monopoly power is achieved via regulation, at least part of the monopoly rents so gained will not be simple transfers from consumers to producers, but will be dissipated by producers' rent-seeking activity. Since such activity employs real resources, there are additional costs to monopolization beyond the Harberger costs as emphasized by Gordon Tullock (1967) and Richard Posner (1975). Indeed, Posner and others have argued that if competition for the monopoly rents is perfect, all of the expected rents from regulation will be converted to welfare losses. While Franklin Fisher's 1985 comment has qualified this conclusion somewhat, the upshot of the debate is that the rent-seeking, or Tullock, costs, may greatly exceed the Harberger costs.1 Another recent strand of the analysis concerns the time pattern over which monopoly returns are dissipated by competition to gain and hold the monopoly right. Robert McCormick et al. (1984) emphasize that to the extent such expenditures are sunk, they are forever lost and not recoverable by deregulation. While conceding the point, Martin Cherkes et al. (1986) argue that most rentseeking expenditures are recurring, not sunk, and therefore large gains from deregulation remain. The purpose of this essay is to point out that, recurring or sunk, even the largest specification of the Harberger and Tullock costs of regulatory monopolization may fall far short of the actual welfare costs. This is because the analysis concentrates on the rent-seeking Tullock costs and largely ignores the parallel rent-defending2 Tullock costs. A proper assessment of such rent-defending Tullock costs might more than double the maximum welfare costs of regulation suggested by Posner.

This paper compiles comparative measures of output per worker in 1975 in four socialist and seven Western market economy (WME) countries, and explores sources of observed differences between the two groups of countries in that regard. Such differences seem explicable only partially by reference to differences in per worker capital stock and farm land. A residual disparity of 25 to 34 percent in favor of WME countries appears to testify to superior efficiency in the latter.

This paper presents a new solution to the time-consistency problem that appears capable of enforcing ex ante policy in a variety of settings in which other enforcement mechanisms do not work. The solution involves formulating a social contract, institution, or agreement that specifies the optimal ex ante policy. The social contract is effectively sold by succesive old generations to successive young generations, who pay for the social contract through the payment of taxes. Both old and young generations have an economic incentive to fulfill the social contract. For the old generation, breaking the social contract makes the social contract valueless, and the generation suffers a capital loss by not being able to sell it. For the young generation the economic advantage of purchasing the existing social contract exceeds its price as well as the economic gain from setting up the a new social contract.