Knowledge that Transforms

In his recent work in this Review on the application of the Barro-Grossman model to centrally planned economies (CPEs), David Howard presents a relatively simple model of disequilibrium in a controlled economy together with some empirical results, which, he claims, strongly support the presence of repressed inflation in the USSR (1955-67). On the basis of his results, he confirms the predictive ability of the Barro-Grossman model, and he claims to have improved our knowledge of Soviet repressed inflation. Similar empirical investigations of other CPE countries, Howard also suggests, are of great importance in testing the general applicability of his model and his estimation technique. It is with this aim that a test of the Polish economy (1955-75) was undertaken (see my paper), but certain difficulties encountered in the process of estimation revealed several fundamental drawbacks in his methodology and estimation technique. The main technical problems are: 1) the identification of the model, and 2) the specification of the labor demand function and hence the endogeneity of prices and wages. These will be dealt with first. I shall then go on to discuss more basic problems. These are concerned with Howard's lack of any model of planners' behavior, the assumptions of his maintained hypothesis, and the unjustifiable claims he makes for his results.

This paper is concerned with evaluating the non-market-clearing (NMC) approach of Robert Barro and Herschel Grossman and others from a purely positive point of view. That is, it deals with the broad question of the extent to which the approach provides a theoretically satisfactory explanation of certain stylized facts characterizing the dynamic behavior of aggregate output and the price level. It does not deal with the important and difficult normative questions involving stabilization policy that are often associated with the approach. From this viewpoint the main strength of the NMC approach is its compatibility with the evidence that 1) fluctuations in aggregate output are closely (positively) correlated with fluctuations in aggregate demand, 2) output appears to respond with a much shorter lag than does the price level to changes in aggregate demand, and 3) changes in output are serially correlated from quarter to quarter. The main weakness of the approach is its failure to provide any satisfactory account of how markets are organized. For example, it offers no explanation of how prices are formed, beyond the crude hypothesis that they move in the direction of excess demands, despite the fact that the assumption that prices fail to respond quickly enough to clear markets lies at the heart of the approach. Nor does it explain why agents should be constrained to trade at these prices, even though these constraints are what ultimately produce the multiplier process of the approach. This inattention to the details of market organization also appears to be responsible for the curious multiplier, according to which an increase in aggregate demand, from an initial position of generalized excess demand or even of full employment equilibrium, causes a decrease in output-a prediction that threatens to undermine the compatibility of the approach with the positive correlation between aggregate demand and output unless some reason can be found why excess demand should be less common than excess supply. This shortcoming does not imply that the NMC approach is not useful for many purposes, nor that its predictions are inconsistent with the evidence (except for the predictions of the supply multipliers). But to be consistent with the evidence is not to explain it. What the approach lacks is a satisfactory theoretical underpinning that would at least make it consistent with the same notions of rational self-interest that underlie the rest of economic theory. This leaves us with the question of whether a satisfactory underpinning can be provided to the approach. In other words, can the approach be revised or replaced in such a way that the resulting theory contains a more satisfactory account of market organization, and explains the above mentioned stylized facts in a way that closely resembles the NMC approach. This question cannot now be answered with a great deal of confidence because no one has yet developed a satisfactory theory of market organization. However I think that an affirmative answer is likely, and that the key to developing the answer lies in recognizing that different markets are organized in different ways. In particular some markets, such as those for many labor services, personal credit, and heavy capital goods, are organized on a highly personal basis with individually negotiated contracts, whereas other markets, such as those for widely traded financial assets and for most consumer durables, are organized on a less personal basis by trading specialists like retailers, wholesalers, jobbers, brokers, and stock market specialists. The rest of this paper attempts to shed some light on the question of providing a satisfactory theoretical underpinning for the NMC approach by investigating how a market organized by such specialist *University of Western Ontario. I am indebted to David Laidler for helpful conversations on the topic of this paper, to Robert Solow for his critical comments, and to the Humanities and Social Sciences Research Council of Canada for financial support.

ing from economic growth, we infer life cycle incomes from cross-section data by assuming that as a cohort ages it will occupy the income chairs now held by the older cohorts. But we also need information about the expected degree of intracohort mobility as a cohort ages. Zero mobility is indicated by perfect rank-order correlation of incomes across all years: a person occupying the nth income rank in his cohort at 30 would always occupy the nth income rank as the cohort moved through the life cycle. Individual life cycle curves would never cross and lifetime income inequality would be at a maximum, given the cohort income distributions. Under these conditions Wertz's ADJG or its proxy, the average of the cohort Ginis weighted by income shares, would closely measure lifetime inequality.5 Once we allow some intracohort mobility, lifetime inequality typically will drop, and if the rank-order transition matrix exhibits very high mobility, lifetime incomes will converge toward equality. Three recent studies show the importance of intracohort mobility for inequality. Bradley Schiller found that rank-order changes occurred across the entire range of the income scale and mobility could be viewed as a pervasive dynamic characteristic of our distribution. Donald Parsons' longitudinal income and autocorrelation study bears more directly on the issues raised here. Using male earnings from the National Longitudinal Surveys, Parsons found that: distribution of lifetime human wealth depends not only on the distribution of annual earnings but also on the consistency with which individuals maintain their economic position in the distribution from to year (p. 551). His results that the actual standard deviation 4By contrast, PG does not attempt to adjust actual incomes across cohorts to find the age-equivalent incomes since to do this properly requires knowledge of each individual's life cycle income; instead PG simply compares the average of the actual differences between two cohorts with the average of the ideal differences. This also seems crude, but with limited cross-section data it is less biased and provides better estimates of long-term inequality than does ADJG. 5For CPS income distributions, ADJG values are 97 percent of the weighted average of the cohort Ginis. This content downloaded from 157.55.39.186 on Tue, 12 Apr 2016 08:53:49 UTC All use subject to http://about.jstor.org/terms 676 THE AMERICAN ECONOMIC REVIEW SEPTEMBER 1979 of lifetime human wealth is only 60 percent of what the standard deviation would be if individuals were frozen into a given spot in the income distribution from one to the next (p. 559). This condition of zero mobility is, as we have seen, implicit in ADJG, and therefore Parsons' data indicate the degree of upward bias likely in ADJG. Finally, Parsons estimated the effect of high mobility: actual measure (standard deviation of lifetime earnings) is almost three times larger than it would be if earnings in each were generated by a random draw (p. 559). Lee Lillard's longitudinal study of human wealth reinforces these conclusions. Although his National Bureau of Economic Research sample of white males showed less income dispersion than family units, the relative spread which he found among the Gini coefficients has general significance. Lillard's cohort Ginis averaged .28 while the Gini of lifetime earnings was only .19. He states that Inequality in earnings at any stage of the life cycle for men over 30, as measured by either the coefficients of variation or the Gini coefficient is 50 percent larger than inequality in human wealth. This conclusion is not affected by changes in the discount rate (p. 49). Note that my estimate of lifetime income inequality for families in 1972 (using PG) was .239 while the average of the cohort Ginis was .334 and the Lorenz-Gini .359 (see my 1975 paper). The last two coefficients are 40 and 50 percent higher than PG, or alternatively, my PG figure and Lillard's Gini of lifetime inequality are both in the range of 67-72 percent of the conventional cross-section Gini coefficients. However, ADJG is .324 or 90 percent of G. Thus the longitudinal estimates of lifetime inequality offer striking confirmation that PG does not understate inequality but yields estimates in the correct range. These findings also enable us to resolve a question which has long puzzled researchers: why, if life cycle effects are important, do cohort Ginis average 90 percent of the overall Gini? The reason is now clear: the cohort Gini measure reveals what lifetime inequality would be if persons within a cohort were fixed in rank order throughout the life cycle of the cohort; hence it always overstates inequality in societies where significant intracohort mobility exists. Wertz's ADJG coefficient, as noted above, shares the same weakness. There remains one question. Why and how does PG yield closer estimates of lifetime inequality than ADJG although neither formula explicitly uses mobility data? The answer briefly is this: the investment in human capital and the stochastic process which generate a society's curved age-income profile also generate the variety of individual income profiles which determine the rankorder transition matrix. Larger mean income differences between age cohorts go hand in hand with increased mobility within a cohort as it moves across the parabolic life cycle path. The ADJG is invariant with respect to changes in the average age-income profile since mean income differences between cohorts are removed from the actual income differences (see Wertz, equation (2)). But PG responds in an appropriate way. Consider a square matrix, with age cohorts listed top and side, showing in each cell the average of the differences resulting from the income pairings. The main diagonal of the matrix will show the within-cohort pairings while the off-diagonal elements represent income pairings across cohorts (see my 1977 paper, p. 522, Table Ic, for a PG matrix in expected gain terms). Given a flat age-income profile, the PG and ADJG matrices will be the same. With a parabolic profile PG and ADJG will only be alike in the main diagonal; the offdiagonal elements of PG will be smaller than ADJG for the reason given by Wertz, namely I A l I B I ' I A B 1. The greater the mean income spread between cohorts, the greater the difference in the terms of the above inequality. The ADJG based on the right-hand term is unresponsive to changes in the shape of the life cycle curve and also to mobility; PG, however, varies directly with intracohort inequality and inversely with the mean difference between cohorts, and hence inversely with the degree of mobility. This is a valuable attribute in a coefficient with minimal data requirements, and the evidence from longitudinal income studies supports the conclusion that PG provides better estimates of lifetime inequality than other Gini formuThis content downloaded from 157.55.39.186 on Tue, 12 Apr 2016 08:53:49 UTC All use subject to http://about.jstor.org/terms VOL. 69 NO. 4 PAGLIN: MEASUREMENT OF INEQUALITY 677 las based on cross-section data. If equity judgments are conditioned by long-term rather than by transitory inequality, then PG can also be used as one element of an equity

In a sudden rush of unilateral declarations the 200-mile fishing limit in 1977 became the accepted norm in world practice and thus in international law. The Third Law of the Sea Conference-deadlocked on nonfisheries issues-so far has failed to produce a new international convention. But from its deliberations has emerged an Informal Composite Negotiating Text (ICNT), the fisheries provisions of which have been received with nearuniversal support or acquiescence. Several countries-including Canada and the United States-have indicated that they will adhere to the rules of the ICNT in administering their 200-mile fishing zones. H. Scott Gordon's analysis that open access exploitation of a common property fish stock attracts excessive effort, leading to dissipation of resource rents, is now widely accepted. A major justification for extended jurisdiction is that it gives coastal states property rights over fish stocks that previously were international common property. By limiting access and managing effort wisely, coastal states may stop overexploitation and regenerate net economic benefits. Increasing pressure on the world's resources has greatly enhanced the potential value of the available fish stocks and thus the incentive for coastal states to claim the benefits of exploitation for their own nationals (see Francis Christy).

The economic gradient method is designed to provide guidance for the analysis and recommendation of change when information is available only over so narrow a range as to preclude a credible calculation of the global optimum. Using as data the gradients of the relevant functions evaluated at the current point of operation, the procedure calculates the direction of change from the status quo that yields the greatest feasible local rate of increase in the objective function of the decision maker. The calculation should be viewed as a benchmark because proposed movements of practical size must be assessed for feasibility. Under structural assumptions (standard for second-order conditions), the procedure can also be used to obtain an upper bound on the gain from effecting any particular (nonlocal) set of feasible changes in the decision variables. In Section I, we present the economic gradient method in a general form. We specialize the formulae in Section II to apply to pricing under a budget constraint with aggregate consumer welfare as the objective function.' Pilot empirical applications to U.S. Postal Service and long distance telephone rates are summarized in Sections III and IV.