Knowledge that Transforms

Understanding the effects of uncertainty over any decision variable has fascinated economists for a long time. Risk aversion and incomplete markets are likely to make the investment-uncertainty relationship negative (e.g., Roger Craine, 1989; Joseph Zeira, 1989). What happens in the absence of risk aversion and incomplete markets is, however, ambiguous. Richard Hartman (1972) and Andrew B. Abel (1983, 1984, 1985) found that in the presence of (symmetric) convex costs of adjustment, mean-preserving increases in price uncertainty raise investment of a competitive firm as long as the profit function is convex in prices. On the other hand, the recent literature on irreversible investment (e.g., Robert S. Pindyck, 1988; Giuseppe Bertola, 1988) has shown that increases in uncertainty lower investment. All these results have been derived under either risk neutrality or complete markets.' Intuition suggests that the explanation for such a difference lies with the asymmetric nature of adjustment costs in the irreversible-investment case, as compared with the symmetry of the adjustment-cost mechanisms proposed by Abel and Hartman. Although this intuition is confirmed in this paper, asymmetric adjustment costs are shown not to be sufficient to explain why the results differ. In fact, a more hidden but at least as important difference between these two literatures is that the former assumes perfect competition and constant returns to scale, whereas the latter assumes either imperfect competition or decreasing returns to scale (or both).2 The purpose of this paper is to highlight the role of the decreasing marginal return to capital assumption (due to either imperfect competition or decreasing returns to scale [or both]) in determining the effects of adjustment-cost asymmetries on the sign of the response of investment to changes in uncertainty (under risk neutrality). For this, the paper develops a simple model with a cost-of-adjustment mechanism general enough to consider both symmetric-convexity and irreversibility as special cases. One of the most important findings is the lack of robustness of the negative relationship between investment and uncertainty under asymmetric adjustment costs3 to changes in the degree of competition. In fact, when firms are nearly competitive, the conclusion of Hartman and of Abel holds no matter how asymmetric adjustment costs are. Studying adjustment-cost mechanisms has a central role in understanding the dynamics of investment and its business-cycle implications, but conclusive results about the sign of the instantaneous relationship between uncertainty and investment should not be *Department of Economics, Columbia University, New York, NY 10027. I am grateful to Giuseppe Bertola, Prajit Dutta, Glen Hubbard, Anil Kashyap, Richard Lyons, and the referees for their useful comments. 1The financial literature on investment has considered risk aversion through a premium in the discount rate determined by the CAPM, (capital asset pricing model), intertemporal CAPM, or consumption CAPM. However, often this discount rate is left unchanged when studying the response of investment to uncertainty changes (e.g., Pindyck, 1988 pp. 974-5), thereby omitting the effect of changes in uncertainty on investment due to risk aversion (and incomplete markets). 2In the typical version of the irreversible-investment problem, there is no cost of upward adjustments; thus, imperfect competition and (or) decreasing returns to scale are required to bound the size of the firm. 3In this paper, asymmetric adjustment cost refers to the case in which it is more expensive to adjust downward than upward. Certainly, the opposite case is a trivial extension of the case studied in this paper.

This paper investigates whether workers suffer lasting scars following job displacements. Using David T. Ellwood's (1982) terminology, scars represent persistent effects, whereas blemishes are transitory adjustments which dissipate over time. More precisely, dislocated individuals are defined as scarred if they continue to earn less or to be unemployed more than their nondisplaced counterparts, even after the conclusion of a several-year adjustment period

A number of studies (e.g., Robert J. Shiller, 1981; Olivier J. Blanchard and Mark Watson, 1982; Kenneth D. West, 1988) have argued that dividend and stock price data are not consistent with hypothesis, in which prices are given by present discounted values of expected dividends. These results have often been construed as evidence for existence of bubbles or fads. (Related arguments have been made with respect to gold, bonds, and foreign exchange). A major problem with such arguments (e.g., James Hamilton and Charles Whiteman, 1985) is that apparent evidence for bubbles can be reinterpreted in terms of market fundamentals that are unobserved by researcher. Behzad T. Diba and Herschel I. Grossman (1984, 1988b) and Hamilton and Whiteman (1985) have recommended alternative strategy of testing for rational bubbles by investigating stationarity properties of asset prices and observable fundamentals.1 In essence, argument for equities is that if stock prices are not more explosive than dividends then it can be concluded that rational bubbles are not present, since they would generate an explosive component to stock prices.2 Using unit-root tests, autocorrelation patterns, and cointegration tests to implement this procedure, Diba and Grossman (1988b p. 529) state that the analysis supports conclusion that stock prices do not contain explosive rational This paper shows that above battery of tests is in fact unable to detect an important class of rational bubbles. The point is demonstrated by constructing rational bubbles that appear to be stationary when unitroot tests are applied, even though they are explosive in relevant sense. Simulations show that, when such bubbles are present, stock prices will not appear to be more explosive than dividends on basis of these tests, even though bubbles are substantial in magnitude and volatility. The presence of rational bubbles in actual stock prices thus remains an open question.

Recent laboratory studies of alternating-offer bargaining find many empirical regularities that are inconsistent with the standard theory. In this paper, the author postulates that bargainers behave as if they are negotiating over both "absolute" and "relative" money. Absolute money is measured by cash, relative money by the disparity between absolute measures. The resulting model is consistent with previously observed regularities. New experiments provide further support as well as evidence against several alternative explanations. Also finding some support is an extension that predicts that the equilibrium of the standard theory will be observed when bargaining is done in a "tournament" setting.

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The relationship between age and the publishing productivity of Ph.D. scientists is analyzed using data from the Survey of Doctorate Recipients (National Research Council) and the Science Citation Index. The longitudinal nature of the data allows for the identification of pure aging effects. In five of the six areas studied, life-cycle aging effects are present. Only in particle physics, where scientists often speak of being on a "religious quest, " is the indication that scientific productivity is not investment-motivated. Vintage effects are also considered. The expectation that the latest educated are the most productive is not generally supported by the data.

This paper develops a positive theory of insurrections that treats insurrection and its deterrence or suppression as economic activities that compete with production for scarce resources. The general equilibrium analytical framework reveals how the allocation of labor time among insurrection, soldiering, and production and the probabilistic distribution of income between the peasant families and the ruler's clientele both depend on the technology of insurrection. A central result is that equilibria with more time allocated to insurrection and a higher probability of a successful insurrection have lower production and total income, but nevertheless can have higher expected income for the peasants.

This paper analyzes a real-business-cycle model of a small open economy. The model is parameterized, calibrated, and simulated to explore its ability to rationalize the observed pattern of postwar Canadian business fluctuations. The results show that the model mimics many of the stylized facts using moderate adjustment costs and minimal variability and persistence in the technological disturbances. In particular, the model is consistent with the observed positive correlation between savings and investment, even though financial capital is perfectly mobile, and with countercyclical fluctuations in external trade.