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NBER Reporter Online

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Suggested Citation: National Bureau of Economic Research (NBER) (Ed.) (1994) : NBER Reporter Online, Volume 1994, NBER Reporter Online, National Bureau of Economic Research (NBER), Cambridge, MA

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In This Issue Program Report: Program Report Corporate Finance 1 Research Summaries: The Political Economy of Corporate Finance Workers' Compensation in the Early Twentieth Century 5 Robert W. Vishny Health Insurance and Individual Labor Market Decisions 8 Executive Compensation 11 The NBER's Program in Corporate Finance was established in fall NBER Profiles 14 1991, and grew out of the eartier financial markets and monetary eco­ Conferences 17 nomics program. Traditionally, corporate finance is defined as "the study Bureau News 33 of the investment, financing, and dividend decisions of firrns.» To that tra­ Bureau Books 47 ditional list of topics, I would add "most fmancial or contractual issues CUrrent Working Papers 48 relating to the firm, including internal organization, ownership structure, and corporate governance." Corporate finance is institutionally oriented, with research often driven by issues of current importance. Most of the NBER's research on corporate finance consists of empirical studies on firm-level data motivated by relevant, applied theory. Recent work by NBER economists has centered on a variety of topics. Since the program is barely three years old, the origins of much of this re­ search predate its formal start. This is especially true of the extensive re­ search on corporate restructuring, but it is also true of some of the re­ search on bankruptcy and financial distress, and the research on banks and the role of credit. One new area beginning to attract attention is the cross­ country comparison of corporate governance and financing practices.

Corporate Restructuring NBER researchers began to study corporate restructuring in earnest in the late 1980s in the midst of a huge wave of mergers, acquisitions, and leveraged management buyouts. The total value of U.S. assets changing hands in the 1980s was approximately $1.3 trillion, with 143 of the 1980 Fortune 500 becoming ·acquired by 1989. This wave of activity sparked much public controversy. At issue were: the large number of hostile take­ overs; the perception that employees and communities were being hurt; the heavy use of debt in many transactions and the fear that basic Rand D was being sacrificed; and the large profits made by corporate raiders and corporate managements. NBER researchers have conducted extensive studies on the causes and consequences of these mergers and acquisitions. One important question

------NBER Reporter Winter 1994/5 addressed is: Has all of this restruc­ turing activity made the U.S. econ­ NBERReporter omy any more efficient or competi­ tive? While the evidence is far from NATIONAL BUREAU OF ECONOMIC RESEARCH definitive, the studies suggest that there is cause for optimism. Steven The National Bureau of Economic Research is a private, nonprofit research N. Kaplan fmds strong evidence of organization founded in 1920 and devoted to objective quantitative analysis improvements in operating profit in of the American economy. Its officers and board of directors are: a sample of 1980s leveraged buy­ President and Chief Executive Officer-Martin Feldstein outs. I VariOUS NBER researchers Executive Director-Geoffrey Carliner Director of Finance and Administration-Sam Parker have documented the role of the 1980s bustup takeovers in moving BOARD OF DIRECTORS firms away from the ill-fated diver­ sification of the 1960s toward great­ Chairman-Paul W. McCracken 2 Vice Chairman-John H Biggs er specialization. Arguably, this fa­ Treasurer-Gerald A. Polansky vorable reconfiguration of the econ­ omy has been made possible by DIRECTORS AT lARGE the more lenient antitrust policy Peter Aldrich George C. Eads Robert T. Parry followed in the United States since Elizabeth E. Bailey Martin Feldstein Peter G. Peterson 1982. John Herron Biggs George Hatsopoulos Richard N. Rosett Andrew Brimmer Karen N. Horn Bert Seidman Before jumping to the conclu­ Carl F. Christ Lawrence R. Klein Kathleen P. Utgoff Don R. Conlan Leo Melamed Donald S. Wasserman sion that the average merger entails Kathleen B. Cooper Merton H. Miller Marina v. N. Whitman huge synergies, however, it is im­ Jean A. Crockett Michael H. Moskow John O. Wilson portant to note that many acquisi­ DIRECTORS BY UNIVERSITY APPOINTMENT tions appear to be motivated by the welfare of bidding management, Jagdish W. Bhagwati, Columbia James L. Pierce, California, Berkeley rather than by the desire to in­ William C. Brainard, Yale Andrew Postlewaite, Pennsylvania Glen G. Cain, Wisconsin Nathan Rosenberg, Stanford crease shareholder wealth. Randall Franklin Fisher, MIT Harold T. Shapiro, Princeton M0rck, Andrei Shleifer, and I show Saul H. Hymans, Michigan Craig Swan, Minnesota Marjorie B. McElroy, Duke Michael Yoshino, Harvard that over 50 percent of acquisitions Joel Mokyr, Northwestern Arnold Zellner, Chicago in the 1980s were greeted by a negative reaction from bidding DIRECTORS BY APPOINTMENT OF OTHER ORGANIZATIONS shareholders.3 Kaplan and Jeremy Marcel Boyer, Canadian Economics Association C. Stein provide evidence that the Mark Drabenstott, American Agricultural EconomiCS Association second generation management Richard A. Easterlin, Economic History Association Gail Fosler, The Conference Board buyouts of the late 1980s were en­ A. Ronald Gallant, American Statistical ASSOCiation Robert S. Hamada, American Finance Association couraged by generous deals for Charles Lave, American EconomiC Association bidding management, overpriced Rudolph A. Oswald, American Federation ofLabor and Congress of Industrial Organizations junk bonds, and fee structures that Gerald A. Polansky, American Institute of Certified Public Accountants encouraged investment bankers to James F. Smith, National ASSOCiation ofBusiness Economists 4 Josh S. Weston, Committee for Economic Development suggest questionable deals. NBER studies also have found Contributions to the National Bureau are tax deductible. Inquiries concerning that the negative social impact of contributions may be addressed to Martin Feldstein, President, NBER, 1050 Massachusetts Avenue, Cambridge, MA 0213&5398. takeovers may be exaggerated. The Reporter is issued for informational purposes and has not been reviewed Frank R. Lichtenberg and Donald by the Board of Directors of the NBER. It is not copyrighted and can be freely Siegel, and Sanjai Bhagat, SWeifer, reproduced with appropriate attribution of source. Please provide the NBER's Public Information Department with copies of anything reproduced. and I find that the employment ef­ Preparation of the NBER Reporter is under the supervision of Donna Zerwitz. fects of hostile takeovers are not Requests for subscriptions, changes of address, and cancellations should be very large and are disproportion­ sent to Reporter, National Bureau of Economic Research, Inc., 1050 ately felt by highly compensated Massachusetts Avenue, Cambridge, MA 0213&5398. Please include the cur­ rent mailing label. white collar employees.5 Joshua

2. NBER Reporter Winter 1994/5 Rosett finds little evidence that credit in a monetary contraction nancing decr~ases the likelihood of union wage cuts are a major source are exciting. an out-of-court settlement. Philippe of gains in hostile takeovers.6 Final­ NBER researchers also have Aghion, Oliver Hart, and John ly, Bronwyn H. Hall finds that the been documenting the special role Moore have compared the efficien­ effect of takeovers on Rand D ex­ of banks in providing credit. Using cy properties of various bankruptcy penditures is limited because the Japanese data, Takeo Hoshi, Kash­ procedures including the current 14 most Rand D-intensive firms do yap, and David S. Scharfstein show Chapter 11 procedure. Their main not typically enter into highly lever­ that the sensitivity of investment to insight is the construction of alter­ 7 aged transactions. cash flow is much greater for firms native bankruptcy procedures that without a bank relationship than separate the decision about how for those with one. lO Using data the post-bankruptcy assets will be Banks and the Role from the National Survey of Small deployed from how the proceeds of Credit Business Finance, Mitchell A. Peter­ from the assets will be divided sen and Raghuram G. Rajan have among the various claimants. One open question in monetary been studying the importance of economics concerns the channel banking relationships, and how the for the transmission of monetary quality of those relationships de­ International policy. In particular, the link be­ pends on the concentration of tween monetary tightening and the Comparisons of lending institutions. 11 Interestingly, Corporate Financing contraction of credit made avail­ they find that typically more credit able by banks has not been firmly is available in highly concentrated and Governance established empirically using mi­ credit markets. They attribute this Practices crodata. NBER researchers Anil K. to the fact that high concentration A relatively new research area in Kashyap and Stein, in an interest­ increases the likelihood that the corporate finance is the cross­ ing series of papers, have brought borrower and lender will be deal­ country comparison of different fi­ us closer to understanding these is­ ing with each other for a long time, sues.8 Kashyap, Stein, and David nancial and governance systems. which gives the lender a greater in­ This area Originally was motivated W. Wilcox show that monetary centive to invest in the relationship. tightening appears to be correlated by the apparent differences be­ with a shift toward the use of com­ tween U.S., U.K., Japanese, and mercial paper and a decline in the Bankruptcy and German financial systems. Japanese use of bank financing. But, as Financial Distress and German corporate finance is Charles C. Calomiris, Charles P. dominated by banks, whereas the Himmelberg, and Paul Wachtel ar­ With the rise in leveraged buy­ United States and the United King­ gue, the large, well-capitalized outs and the use of junk bonds in dom have much bigger bond mar­ finns who issue commercial paper the mid- to late-1980s, the collapse kets. German banks typically also appear to be less affected by a of Drexel Burnham Lambert, and own equity in the firms they lend tightening of bank credit.9 If mostly the recession of the early 1990s, to, while this is prohibited in the smaller firms are being cut off from bankruptcy and financial distress United States. These differences are bank credit when the monetary au­ became a more focal issue in cor­ alleged to be important for corpo­ thority tightens, how does in­ porate finance research. Paul As­ rate governance, with the bank­ creased issuance of commercial pa­ quith, David Mullins, Jr., and Eric dominated systems purportedly per by large firms end up substitut­ Wolff have conducted the most providing superior overSight of ing for bank credit? Calomiris, Him­ careful study to date on the long­ management. Also, the close bank melberg, and Wachtel suggest that run default experience of junk relationships are hypothesized to the intermediation works as fol­ bonds.12 They find a significantly result in fewer credit constraints lows: During tight money periods, higher default rate than previous and a greater ability to take on lev­ banks cut loans to small and medi­ researchers after taking into ac­ erage. NBER researchers are just um-size firms. Large firms make up count unfavorable exchanges of­ starting to make progress on some for this by extending more trade fered to junk bondholders. Asquith, of these questions. credit to smaller firms and finance Robert Gertner, and Scharfstein Hoshi, Kashyap, and Scharfstein this through increase<;l issuance of study a large sample of junk bond have studied the banks versus commercial paper. While there is issuers to explore the determinants bond market trade-off in Japan.15 more empirical work to be done of a successful debt restructuring They find that Japanese corporate here, the prospects for better un­ after default.13 Among other things, finance is moving toward the U.S. derstanding the role of banks and their study suggests that bank fi- model. Rajan and Luigi Zingales

NBER Reporter Winter 1994/5 3. undertake an ambitious study of Economics 24, 2 (October 1989), pp. Scharfstein, "1be Role of Banks in Re­ leverage across countries.I6 They 217-254. ducing the Costs of Financial Distress find that the claim of greater lever­ 2S. Bhagat, A. Shleifer, and R. W Vish­ in japan, " NBER Working Paper No. 3435, September 1990, and Journal of age in bank-dominated countries is ny, "Hostile Takeovers in the 1980s: 1be Return to Corporate Specialization, " Financial Economics (September 1990), exaggerated. Differences in lever­ Brookings Papers on Economic Activi­ 11M. A. Petersen and R. G. Rajan, "1be age between countries are not that ty: Microeconomics (1990); S. N. Kap­ Effect of Credit Market Competition on large, although there are important lan and M. S. Weisbach, "1be Success of Lending Relationships," NBER Working differences in the average maturity Acquisitions: Evidence from Dives­ Paper No. 4921, November 1994, and of debt. Finally, they find that equi­ titures, " NBER Reprint No. 1742, August Quarterly Journal of Economics, forth­ 1992, and Journal of Finance (March coming. ty issuances by mature firms are 1992). 12p. AsqUith, D. Mullins, and E. Wolff, much more common abroad than 3R. MfiJrck, A. Shleifer, and R. W Vish­ "Original Issue High Yield Bonds: Ag­ they are in the United States. Jun­ ny, "Do Managerial Objectives Drive ing Analyses of Defaults, Exchanges, Koo Kang and Rene M. Stulz study Bad Acquisitions?" NBER Working Pa­ and Calls, "Journal of Finance (Septem­ the market's reaction to security is­ per No. 3000, june 1989, and Journal ber 1989). sues by Japanese firmsY Their evi­ of Finance (March 1990). 13p. AsqUith, R. Gertner, and D. S. dence suggests that the negative 4S. N. Kaplan and]. C. Stein, "1be Evo­ Scharfstein, "Anatomy of Financial lution of Buyout Pricing and Financial Distress: An Examination ofjunk Bond reaction to equity issues by mature Structure, " NBER Reprint No., 1835, De- . Issuers," NBER Working Paper No. firms is much less pronounced in cember 1993, and Quarterly Journal of 3942, December 1991, and Quarterly Japan than in the United States. Economics (May 1993). Journal of Economics (August 1994). Kaplan, in a series of papers, con­ 5F. R. Lichtenberg and D. Siegel, "1be 14p. Aghion, O. Hart, and]. Moore, trasts corporate governance in the Effect of Takeovers on the Employment "Economics of Bankruptcy Reform, " United States with that in Japan and Wages of Central Office and Other NBER Working Paper No. 4097, june 1992, and Journal of Law, Economics and Germany.I8 He finds that the Personnel," NBER Reprint No. 1539, March 1991, and Journal of Law and and Organization 8 (1992), pp. 523- probability of top management Economics (October 1990); S. Bhagat, 546. turnover in Japan is similar to that A. Shleifer, and R. W Vishny, "Hostile 15T. Hoshi, A. K. Kashyap, and D. S. in the United States, and shows a Takeovers in the 1980s: 1be Return to Scharfstein, "1be Choice Between Pub­ similar sensitivity to poor perfor­ Corporate Specialization, " Brookings lic and Private Debt: An Analysis of Post-Deregulation Corporate Financing mance. One apparent difference Papers on Economic Activity: Microeco­ nomics (1990). in japan, " NBER Working Paper No. between the countries is that top 6]. Rosett, "Do Union Wealth Conces­ 4421, August 1993. management turnover in Japan is sions Explain Takeover Premiums? 1be 16R. G. Rajan and L. Zingales, "What associated more strongly with neg­ Evidence on Contract Wages," NBER Do We Know About Capital Structure? ative earnings and less strongly Working Paper No. 3187, November Some Evidence from International with poor stock returns than in the 1989. Data, " NBER Working Paper No. 4875, October 1994. United States. This is consistent 7B. H. Hall, "1be Impact of Corporate 17]._K. Kang and R. M. Stulz, "How Dif­ with the relative importance of Restructuring on Industrial Research and Development," Brookings Papers ferent Is japanese Corporate Finance? debt-related discipline, which is on Economic Activity: Microeconomics A n Investigation of the Information triggered when operating earnings (1990). Content of New Security Issues, " NBER fall below required interest pay­ BA. K. Kashyap,]. C. Stein, and D. W Working Paper No. 4908, October ments. Corporate governance in Wilcox, "Monetary Policy and Credit 1994. Germany does not appear to be Conditions: Evidence from the Compo­ IBS. N. Kaplan, "Top Executive Rewards and Firm Performance: A Comparison too different from corporate gover­ sition of External Finance, " NBER Working Paper No. 4015, March 1992, of japan and the United States, " NBER nance in the United States. For ex­ and American Economic Review Reprint No. 1900, August 1994, and ample, Kaplan does not find that (March 1993);]. C. Stein and A. K. Journal of Political Economy Uune the sensitivity of executive turnover Kashyap, "1be Impact ofMonetary Poli­ 1994); S. N. Kaplan and B. A. Minton, to performance in Germany is af­ cy on Bank Balance Sheets," NBER "'Outside Intervention' in japanese Working Paper No. 4821, August 1994. Companies: Its Determinants and Im­ fected significantly by the degree of plications for Managers, " NBER Work­ 9c. W Calomiris, C. P. Him melberg, bank ownership of equity. ing Paper No. 4276, February 1993; S. and P. Wachtel, "Commercial Paper, N. Kaplan, "Top Executives, Turnover, Corporate Finance, and the Business and Firm Performance in Germany," Cycle: A Microeconomic Perspective," NBER Working Paper No. 4416, August NBER Working Paper No. 4848, Sep­ 1 S. N. Kaplan, "1be Effects of Manage­ 1993. ment Buyouts on Operating Perfor­ tember 1994. mance and Value, "Joumal of Financial lOT. Hoshi, A. K. Kashyap and D. S.

4. NBER Reporter Winter 1994/5 By contrast, when workers' Research Summaries compensation was enacted in vari­ ous states after 1910, nearly all workers' families received compen­ sation. The average compensation The Political Economy of ranged from about two to four Workers' Compensation times annual income, depending on the state. Social reformers saw in the Early Twentieth Century workers' compensation as a great victory for workers, presuming that Price V Fishback and twentieth century, so that policy­ the sharp rise in post-accident ben­ Shawn E. Kantor* makers will realize the conse­ efits actually represented a redistri­ quences of reversing the trend to­ bution of income. Over the last century the United ward more generous accident com­ However, increases in employ­ States and many other countries pensation for injured workers. Sec­ er-mandated benefits often led to have implemented a wide variety ond, in our historical investigation large enough wage declines to pay of social protection programs, in­ of the original purposes of enacting for the increase in expected bene­ cluding health care coverage for workers' compensation in the fits fully.3 Our analysis of the coal the poor and elderly, Social Securi­ 1910s, we wish to point out some mining, lumber, and construction ty, unemployment insurance, and of the potential pitfalls of returning industries in the early twentieth workers' compensation. The first to a form of negligence liability in century suggests that nonunion large-scale social insurance pro­ which workers would be held workers essentially "bought" the gram in the United States was more financially responsible for more generous and more certain workers' compensation, which was their workplace accidents. benefits mandated by workers' introduced at the state level during In their time, progressive re­ compensation laws through lower the 1910s. Workers' compensation formers hailed workers' compensa­ real wages. Union workers, on the shifted the tort rules governing tion widely as a financial boon for other hand, experienced much 4 workplace accidents from negli­ injured workers, providing them smaller wage offsets. gence liability to a form of strict lia­ and their families substantially high­ bility whereby the employer was er and more certain post-accident expected to replace up to two­ benefits than they would have re­ Wage Offsets thirds of a worker's lost earnings ceived under the negligence liabili­ We constructed three panel da­ for all serious accidents occurring ty system. Under negligence liabili­ tasets that included the primary oc­ in the workplace. This change in ty around the turn of the century, cupations in the coal, lumber, and the liability rules led to a substan­ relatively few workers received unionized building trades indus­ tial rise in the post-accident bene­ awards in court. Since a court deci­ tries, for over 20 states from 1907 fits that injured workers received. sion could take up to five years, to 1923. Our regression results im­ Like many other social insurance and the outcome was always high­ ply that workers in the nonunion­ programs, the modern workers' ly uncertain, most injured workers ized lumber industry experienced compensation system has been or their families accepted out-of­ roughly a dollar loss in annual plagued by escalating costS.l Nu­ court settlements. Because the em­ earnings for each dollar increase in merous reforms have been offered, ployer was not legally compelled expected accident benefits that including shifting more of the fi­ to pay anything if he had not been workers' compensation promised. nancial burden of workplace acci­ negligent, roughly 43 percent of In the nonunionized sector of the dents onto workers. In an effort to the families of fatal accident vic­ coal industry, the offset was larger, illuminate the public debate over tims received no payments prior to at about two to three dollars for workers' compensation, our re­ workers' compensation.2 The mean each dollar increase in expected search has two main objectives. levels of compensation for all fami­ benefits. However, unions appear First, we hope to improve the un­ lies of fatal accident victims ranged to have inhibited the employers' derstanding of the economic effects from about 38 percent of a year's fleXibility in passing their workers' of the law's adoption in the early 'income to 112 percent. compensation costs onto their or-

NBER Reporter Winter 1994/5 5. ganized workers. Workers in the Since measuring workers' de­ Impact on Saving unionized sector of the coal indus­ sired levels of accident insurance try and in the unionized building would be a difficult task, we use To test the impact of workers' trades experienced much smaller an indirect method that does not compensation on saving, we use a wage reductions than the nonunion require knowledge of workers' util­ sample of over 7000 households 6 workers. ity functions. A theoretical model surveyed for the 1917-9 Bureau of suggests that changes in workers' That such a large fraction of the Labor Statistics Cost-of-Living study. saving in response to a switch to work force would have experi­ These cross-sectional data are par­ workers' compensation can be used ticularly valuable because they al­ enced wage offsets helps to explain as a signal of the market availabil­ employers' widespread willingness low us to compare the saving be­ ity of private accident insurance. If havior of households in states that to embrace the idea of workers' insurance purchases were uncon- compensation. According- already had enacted workers' com- ly, what appeared to be a pensation with behavior in large-scale transfer of in­ states that had not. Our re­ come from employer to "[I)ncreases in employer-mandated bene­ sults suggest that households tended to save less, holding worker was, in fact, largely fits often led to large enough wage de­ illusory. If employers all else constant, if their could anticipate that work­ clines to pay for the increase in expected states had workers' compen­ ers would pay for the in­ benefits fully Our analysis of the coal sation in force. This finding, crease in post-accident mining, lumber, and construction indus­ in concert with qualitative benefits, then they were evidence drawn from con­ more likely to favor a no­ tries in the early twentieth century sug­ temporary insurance text­ fault compensation system gests that nonunion workers essentially books, periodicals, and man­ that was less acrimonious 'bought' the more generous and more cer­ uals, suggests that insurance than negligence liability. tain benefits mandated by workers' com­ companies were not able to Similarly, organized labor's effectively offer workplace diligent lobbying on behalf pensation laws through lower real wages." accident insurance to a wide of workers' coinpensation range of workers. Accident in- is understandable, given surance companies faced substantially greater informational that union members experienced strained, workers would not have relatively small wage declines. used saving to insure against work­ problems, and thus adverse selec­ What is less clear is why non­ place accident risk, because saving tion problems, in selling individual union workers, who constituted was a relatively costly means of in­ accident insurance than in selling the majority of the labor force, also suring their workplace accident liability insurance to employers. supported workers' compensation. risks. If accident insurance were Thus, by shifting the burden of After all, they could expect to pay widely available, the switch to insurance from workers to em­ fully for their new benefits in the workers' compensation would ployers, workers' compensation form of wage reductions. Workers have led to an increase in saving, benefited risk-averse workers who would have had little desire to as some of the income targeted for were rationed out of the insurance "buy" the higher accident benefits insurance purchases would have market, even if they paid for their been freed for consumption and under workers' compensation if more generous post-accident bene­ saving. If, on the other hand, insur­ they could just as easily have used fits through lower wages. More­ ance were rationed, imposing the risk premiums in their old over, insurance companies stood to binding constraints on the amounts gain from the passage of workers' wages to purchase their own work­ of accident insurance workers 5 compensation because the law en­ place accident insurance. A central could buy, then the workers' pri­ abled them to expand their cov­ question concerning the economic mary option was to use saving to erage of workplace accident risk. motivation for the adoption of protect against accident risk. Under workers' compensation, therefore, these conditions, the provision of In fact, the insurance industry ac­ is the extent to which workers had employer-provided accident insur­ tively supported the general idea access to their desired levels of pri­ ance would have led to a reduction of workers' compensation, as long vate accident insurance around the in the households' precautionary as the state did not compete in the turn of the century. saving. selling of the insurance.

6. NBER Reporter Winter 1994/5 Although workers, employers, vide the means for workers to re­ Insurers, on the other hand, may and insurers all publicly claimed to place a significant portion of their be reluctant to offer widescale sup­ favor the concept of workers' com­ lost earnings. While the early plemental coverage for workplace pensation, they fought bitter battles workers' compensation laws pro­ accidents because the problems as­ over the specific features of the vided injured workers with approx­ sociated with replacing the com­ legislation, such as maximum ben­ imately 50 percent of their lost pensation lost to reform will still efit levels, waiting periods, medical earnings, injured workers today re­ remain. benefits, and the issue of state in­ cover about 83 percent of their lost Of course, the outcome of any surance. Our preliminary research aftertax wages.8 As a result of these reform movement will depend on into the political origins of work­ relatively generous expected acci­ the distribution of political power ers' compensation has shown that dent payments, there have been among the competing interest employers, unions, insurers, law­ dramatic cost increases for the sys­ groups. While interest groups cer­ yers, and agricultural interests tem. Employers and insurers view tainly framed the political debate wrote the bills that framed the de­ the reduction of workers' compen­ over workers' compensation in the bate. Each lobbied for their version sation benefits as one step toward early twentieth century, our re­ of the legislation, but none was reform. search has discovered that broad strong enough to pass their own The lessons learned from our political coalitions ultimately deter­ bill unilaterally. Instead, the fea­ analysis of the origins of workers' mined the scope of America's first tures that were written into each compensation suggest that the dis­ social insurance program. If the state's workers' compensation law modern reforms of workers' com­ were the result of political compro­ tributional consequences ofshuting more of the financial burden of pensation follow the same political mises orchestrated through broad­ patterns as the law's origins, then based political coalitions, such as workplace accidents onto workers will be tempered by labor market the conservative shift seen in the the Progressives, who were inter­ November 1994 election will have adjustments. In other words, work­ ested in a wide range of economic a profound impact on the of ers can anticipate that their em­ typ~s and political reforms in the early reforms that will emerge from state ployers will "buy" the reduction in twentieth century. For example, legislatures in the next decade. monopolistic state insurance funds accident benefits in the form of typically were implemented in higher real wages. The question states where the legislature experi­ then becomes whether workers enced a substantial shift toward will be able to purchase private ac­ cident insurance coverage with *This research bas been supported by "progressive" political groups that National Science Foundation Grant No. believed that the government was their anticipated wage premiums. SBR-9223058, the Earhart uniquely qualified to alle- Foundation (Fishback), and viate market imperfections, the University ofArizona Foun­ either real or perceived.7 "While the early workers' compensation dation (Kantor). 1 Workers' compensation pay­ The results of our eco­ laws prOVided injured workers with ap­ ments have been rising at a nomic and political studies proximately 50 percent of their lost earn­ faster pace than even health of the origins of workers' ings, injured workers today recover about care costs, which have attracted compensation have impli­ much recent attention. From cations for the modern 83 percent of their lost aftertax wages. As a 1980 to 1990, workers' com­ policy debate on how to result of these relatively generous expect­ pensation payments grew by 181 percent, while private reform the system. The ed accident payments, there have been health care expenditures and modern workers' compen­ dramatic cost increases for the system." Medicare payments rose 170.5 sation crisis is almost a re­ and 195 percent, respectively. versal of the situation that By contrast, unemployment in­ led to the initial adoption surance payments increased by of workers' compensation. Work­ The answer is not clear. Group dis­ only 9 percent. These percentages repre­ sent increases in nominal spending. ers' compensation was enacted in ability and health insurance are The inflation rate over this period the early twentieth century because certainly much more widely avail­ (based on the CPI) was approximately the negligence liability system and able today than when workers' 59 percent. See U.S. Bureau of the Cen­ the insurance industry did not pro- compensation was ftrst introduced. sus, Statistical Abstract of the United

NBER Reporter Winter 1994/5 7. States, 1993, Washington, DC: GPO, 4p. V. Fishback and S. E. Kantor, "Did eschewed the intervention of govern­ 1993, pp. 108, 368, 379. Work~ Pay . .. ?", op. cit. ment in the insurance market and, 2p. V. Fishback and S. E. Kantor, "Did 5For evidence that workers received thus, flatly rejected state insurance in Work~ Pay for the Passage of Wor~' compensating wage premiums for in­ various referendums. See S. E. Kantor and P. V. Fishback, "Coalition Forma­ Compensation Laws?" NBER Working creased accident risk prior to work~' tion and the Adoption of Work~' Com­ Paper No. 4947, December 1994. compensation, see P. V. Fishback and S. pensation: The Case of Missouri, 1911 3For a summary of modern studies E. Kantor, "'Square Deal' or Raw Deal? to 1926," in The Regulated Economy: showing the impact of employer man­ Market Compensation for Workplace An Historical Approach to Political dates on wages, see M. j. Moore and W. Disamenities, 1884-1903," Journal of K. Viscusi, Compensation Mechanisms Economy, C. Goldin and G. D. Libecap, Economic History 52 (December 1992), eds. Chicago: University of Chicago for Job Risks: Wages, Workers' Com­ pp. 826-848. pensation, and Product Liability Press, 1994, pp. 25~297. 6p. V. Fishback and S. E. Kantor, "In­ (Princeton, NJ: Princeton University 8w. K. Viscusi, "Product and Occupa­ surance Rationing and the Origins of Press, 1990). Also see j. Gruber and A. tional Liability, " Journal of Economic Worker.5' Compensation, " NBER Work­ B. Krueger, "The Incidence of Mandat­ Perspectives 5 (Summer 1991), p. 81. ed Employer-Provided Insurance: Les­ ing Paper No. 4943, December 1994. Viscusi argues that the current workers' sons from Worker.5' Compensation In­ 7See P. V. Fishback and S. E. Kantor, '~ compensation benefit levels offer close to surance, "in Tax Policy and the Econ­ Prelude to the We!fare State: Compulso­ the optimal level of insurance, from the omy, Volume 5, D. F. Bradford, ed. ry State Insurance and Wor~' Com­ worker's perspective. From a social (Cambridge, MA: MiT Press, 1991), pp. pensation in Minnesota, Ohio, and point of view, however, the relatively 111-143, and j. Gruber, "The Inci­ Washington, 1911-9," NBER Historical generous benefits may be suboptimal dence ofMandated Maternity Benefits, " Paper No. 64, December 1994. Our re­ once moral hazard problems are con­ 82). American Economic Review 84 (June search on the origins of wor~' com­ sidered (p. 1994), pp. 62~641. pensation in Missouri found that voter.5

Health Insurance and Individual can lower administrative expenses and reduce the risks of high health Labor Market Decisions care costs faced by any individual employee. In addition, employer Brigitte C. Madrian there is growing interest in under­ expenditures on health insurance standing this relationship, first be­ are tax deductible, while individual It is well accepted that health in­ cause health insurance expendi­ expenditures generally are not. surance distorts the demand for tures constitute a significant frac­ Given these cost advantages, it is medical services. My research ex­ tion of total employee compensa­ not surprising that the delivery of plores a further margin along tion. Employers now spend more health care in the United States has which health insurance may affect on health insurance than on any evolved into a system based pri­ behavior: by changing the labor other employee benefit, including marily on employer provision of market decisions of individuals. pensions. Health insurance expen­ insurance. This distortion arises because in the ditures are also the fastest growing current system of provision of component of benefit payments, in­ health insurance in the United creasing at an average rate of 15.6 JOb-Lock 1 States, employers are the primary percent annually from 1948-90. One significant disadvantage of source of coverage for all but the Second, and perhaps more impor­ employer-provided health insur­ elderly. As rising medical costs tant, any health care reform that al­ ance, however, is that it is not typi­ make health insurance an increas­ ters the current relationship be­ cally portable: when an individual ingly valuable component of em­ tween health insurance and em­ quits his or her job, the insurance ployee compensation, we should ployment has the potential to affect coverage associated with that job expect coverage to be an important the labor market in significant usually ceases as well. For many consideration in the labor market ways. individuals, a change in insurers is decisions of individuals. The rationale for employer pro­ inconsequential, but for some, re­ There has been little previous vision of health insurance is straight­ linquishing their employer-provid­ research on the labor market ef­ forward. By pooling their employ­ ed health insurance may be very fects of health insurance. However, ees into large groups, employers costly. Exclusions on preexisting

8. NBER Reporter Winter 1994/5 conditions are typical of almost all medical expenses. If job-lock is im­ a significant concern if there is a individual policies, and of many portant, the difference in mobility specific component of productivity employer-provided policies as rates between those with high and that makes workers more produc­ well. 2 In addition, half of full-time low expected medical expenses tive in some jobs than in others.8 workers face length-of-service re­ should be greater for those with The efficiency of the economy as a quirements before being eligible employer-provided health insur­ whole will suffer if individuals who for any insurance.3 Also, there is a ance than for those without it. would like to move to more pro­ growing trend toward medical un­ In recent research, I consider ductive jobs are constrained to derwriting, especially in small three different "experimental" keep their current positions simply firms, in order to exclude serious groups to estimate the extent of to maintain their health insurance. ailments from coverage entirely. As job-lock: married men who have an The actual magnitude of the wel­ a consequence, those with health alternative source of coverage in fare loss associated with job-lock is problems may find themselves addition to employer-provided something that has yet to be esti­ liable for many of their medical ex­ health insurance; heads of large mated empirically. penses that previously were cov­ families who are more likely to ered by in·surance. If these per­ have high expected medical ex­ ceived costs of changing insurers penses simply because of the size Retirement Decisions are great enough, then the labor of their family; and married men Closely related to job-lock is the market decisions that individuals whose wives are pregnant.4 I firid issue of how health insurance af­ otherwise might make may be dic­ that job-lock related to health in­ fects the retirement behavior of in­ tated instead by their needs for surance reduces the voluntary turn­ dividuals. The underlying issues health insurance. over rate of those with employer­ are the same: health insurance in Exclusions for preexisting condi­ provided health insurance by 25 the private market is much more tions and medical underwriting of­ percent, an effect that is both eco­ expensive than the health insur­ ten are cited as causes of "job­ nomically and statistically significant ance provided by employers, and lock": the tendency for individuals These results have been corrob­ individuals with preexisting condi­ to stay in jobs they would really orated in a follow-up study done tions may find themselves unable rather leave for fear of losing their with Jonathan Gruber that exam­ to secure equivalent coverage if health insurance coverage. While ines the effect of continuation cov­ they retire from their job and give the popular press on several occa­ erage mandates on job turnover.5 up the accompanying health insur­ sions has cited job-lock as a major Such mandates grant individuals ance. However, the incentives fac­ problem with the current health the right to continue purchasing ing older workers contemplating care system, until recently there health insurance through their for­ retirement are somewhat different was no empirical evidence on the mer employers for some period of from those faced by younger work­ magnitude of this problem. This is time after leaving their jobs, and ers changing jobs. in part because of the difficulty of thus should reduce the extent of First, all individuals become eli­ identifying exactly what job-lock is job-lock. We find that the availabil­ gible for Medicare upon reaching and when it occurs. ity of continuation coverage indeed age 65. Although Medicare is much Although it is impossible to ob­ increases the job turnover rate. Re­ less generous than most employer­ serve directly whether individuals cent research by other individuals provided policies, coverage is are locked into their jobs, in the also has found evidence of job- conditional only upon age and population as a whole the extent 10ck,6 although these results' have does not exclude preexisting con­ of job-lock can be inferred by com­ been disputed.7 ditions. Therefore, the costs of re­ paring the turnover rates of those To the extent that health insur­ linquishing employer-provided who are more likely to be affected ance does reduce mobility, there health insurance are diminished af­ by it with the turnover rates of may be important consequences ter reaching age 65. Second, many those who should not be affected for economic welfare. First, it will employers provide post-retirement by it. Job-lock should affect only directly affect the well-being of health insurance to their retirees. those with health insurance, and those who are locke d into their Thus, the possibility of losing the effect should be greater for current jobs. Second, and perhaps health insurance coverage should those who have high expecte d more importantly, job-lock may be not be a deterrent to retirement for

NBER Reporter Winter 1994/5 9. individuals who work in firms that by Medicare much less generous BE. Jovanovic, 'Job Matching and the offer this type of coverage. than what typically is provided by Theory of Turnover, "Journal of Politi­ Several recent papers suggest employer plans for retirees, but it cal Economy (1979), pp. 972-990. that health insurance is an impor­ also is available only to the individ­ 9B. C. Madrian, "The Effect of Health ual, while employer-provided Insurance on Retirement, " Brookings tant factor in the retirement deci­ Papers on Economic Activity 1 (1994), sion. My own work and studies by health insurance usually covers de­ pp. 181-252; L. A. Karoly and]. A. Ro­ Rogowski and Karoly both find evi­ pendents as well. gowski, "The liffect ofAccess to Post-Re­ dence that the availability of em­ tirement Health Insurance on the Deci­ ployer-provided health insurance sion to Retire Early, " Industrial and la­ bor Relations Review (October 1994), coverage after retirement is associ­ pp. 103-123. 9 ated with early retirement. Michael 10M. D. Hurd and K. McGarry, "The D. Hurd and Kathleen McGarry 1. S. Piacentini and]. D. Foley, EBRl Relationship Between Job Characteris­ find that such health insurance is Databook on Employee Benefits, tics and Retirement, " NBER Working correlated with expectations of ear­ Washington: Employee Benefits Re­ Paper No. 4558, December 1993. lier retirement among those who search Institute, 1992. 11]. Gruber and B. C. Madrian, "Health Insurance Availability and the Retire­ are not yet retired. lO Further work 2p. Cotton, "Preexisting Conditions 'Hold Americans Hostage' to Employers ment Decision, " NBER Working Paper by Gruber and me finds that the and Insurance, "Joumal of the Ameri­ No. 4469, September 1993. availability of continuation cover­ can Medical Association (1991), pp. 12B.C. Madrian, "The Effect of Health age encourages early retirement as 2451-2453. Insurance on Retirement," op. cit.;]. well as job turnover. 11 3U.s. Department of Labor, Bureau of Gruber and B. C. Madrian, ''Health In­ surance Availability and the Retirement The increased availability of Labor Statistics, Employee Benefits in Medium and Large Firms, Washington: Decision, " op. cit. both employer-provided retiree Government Printing Offtee, 1989. 13B.G. Madrian, "The Effect of Health health insurance and continuation 4B. C. Madrian, "Employment-Based Insurance on Retirement," op. cit.; R. S. coverage may be important expla­ Health Insurance and Job Mobility: Is Lumsdaine,]. H. Stock, and D. A. Wise, nations for the trend toward early There Evidence ofJob-Lockl" Quarterly "Pension Plan Provision and Retire­ ment: Men and Women, Medicare, and retirement that has been observed Journal of Economics (February 1994), pp.27-54. Models, " in Studies in the Economics of over the past several decades. The Aging, D. A. Wise, ed. Chicago: Univer­ 5]. Gruber and B. C. Madrian, "Health previously cited research suggests sity of Chicago Press, 1994. Insurance and Job Mobility: The Effects that these two sources of health in­ ofPublic Policy on Job-Lock, " Industrial surance may account for between and Labor Relations Review (October 10 and 50 percent of the decline in 1994) pp. 86-102. male labor force participation be­ 6p. F. Cooper and A. G. Monheit, 'Voes tween 1960 and the late 1980s. 12 Employment-Related Health Insurance Inhibit Job Mobility?" Inquiry (1993), The role of Medicare in the re­ pp. 400-416, and "Health Insurance tirement decision is less well un­ and Job Mobility: Theory and Evi­ derstood. My own research, as well dence, " Industrial and Labor Relations as that of Robin S. Lumsdaine, Review (October 1994), pp. 6~68; and T. C. Buchmueller and R. G. Valletta, James H. Stock, and David A Wise, "Employer-Provided Health Insurance finds little evidence to suggest that and Worker Mobility: Job-Lock' or Not?" the availability of Medicare helps unpublished paper, University of Cali­ explain the excess retirement that fornia, Irvine, February 1994. occurs at age 65, once the fmancial lJ. R. Penrod, "Health Care Costs, incentives associated with pensions Health Insurance, and Job Mobility, " unpublished paper, Princeton Universi­ and Social Security are taken into ty, November 1993, finds mixed evi­ account.13 This may be because dence infavor ofjob-lock; D. Holtz-Ea­ Medicare is a vastly inferior source kin, ''Health Insurance Provision and of health insurance, and therefore Labor Market Efficiency in the United does not affect retirement, even States and Germany, " in Social Protec­ tion Versus Economic Flexibility: Is though the availability of more There a Trade-Off? R. M. Blank, ed. generous health insurance might. Chicago: University of Chicago Press, Not only is the coverage provided 1994,finds little evidence ofjob-lock.

10. NBER Reporter Winter 1994/5 ------Executive Compensation provides an excellent overview of the results of these analyses, which investigate the structure and deter­ Nancy 1. Rose suIt of inadequate oversight by cor­ minants of executive compensa­ porate boards of directors. The po­ tion, the organization of manageri­ litical pressures created by this de­ al labor markets, and the effective­ The Controversy bate have given rise to a number ness of corporate governance in of policy responses. In 1992 the monitoring and controlling man­ The compensation of top corpo­ 2 Securities and Exchange Commis­ agerial behavior. rate executives in the United States sion substantially revised its disclo­ has attracted considerable attention sure rules for reporting executive over the last few years. Part of this compensation on annual proxy The Research is undoubtedly because of the high statements. It now requires more and rising pay levels reported for detailed information on compensa­ Two NBER colleagues, Paul L. CEOs of the largest U.S. corpora­ Joskow of MIT and Andrea Shepard tions. CEO salary and bonus at tion components, options awards, and shareholder returns relative to of Stanford University, and I recent­ these firms has risen by more than ly have applied an industrial orga­ 3 percent annually in real terms other firms in the market or a de­ nization perspective to the analysis over the past two decades, to a fined "peer group." After calls for a of executive compensation. We fo­ median of almost $890,000, accord­ cap on total CEO compensation, cused on three broad questions: ing to the Forbes survey of 1993 Congress passed legislation effec­ First, what is the role of regulatory CEO compensation. The explosion tive January 1, 1994 that eliminates and political pressure in constrain­ of stock options and stock awards the corporate tax deductibility of ing executive pay? Second, what is for CEOs, combined with overall CEO compensation in excess of $1 the relationship between firm di­ increases in the stock market dur­ million unless it is based on objec­ versification and CEO compensa­ ing this period, has meant even tive measures of firm performance. tion, and what are its implications greater increases in real total com­ The Financial Accounting Stan­ for models of corporate gover­ pensation (more than 6 percent per dards Board (FASB) also reviewed nance and the market for CEOs? year), and led to enormous varia­ the use of stock options in com­ Third, what do more complex em­ tion in executive compensation pensation. However, its original pirical models of incentive pay for across CEOs and over time. In the proposal to require the value of CEOs suggest about the overall Forbes 1993 compensation survey, stock options to be deducted from sensitivity and dynamic responses total compensation rose as high as corporate income when awarded of executive pay to firm financial $203 million for Michael Eisner of ran into such heated opposition performance? Walt Disney Corporation, with an that the FASB's final ruling simply overall median of $1.4 million. Al­ mo dified the reporting require­ though these substantial increases ments for options. Regulation in compensation are not unique to While it is difficult to determine CEOs-they echo similar trends whether U.S. CEOs are paid "too Our initial project on executive across a broad range of profession­ much," many of the issues in­ compensation explored the influ­ al occupations during the 1980s 1- volved in the policy debate over ence of economic regulation on the they have generated substantial me­ executive compensation have been level and structure of CEO pay. 3 dia attention and political debate. the subject of long-standing academ­ This work builds on a long-stand­ Much of this debate has focused ic interest and investigation. Al­ ing interest among regulatory econ­ on the equity implications of high though some of the early studies of omists in the interplay between la­ CEO pay levels, particularly as a managerial compensation and in­ bor markets and economic regula­ contributing factor to the overall centives were conducted by indus­ tion.4 Our analysis of CEO pay at increase in income inequality over trial organization economists, most over 1000 firms during the past two the past decade. There is also a of the recent work falls within la­ decades reveals substantial and concern in some circles that high bor economics, corporate finance, persistent differences in compensa­ pay levels may reflect CEOs bene­ organizational theory, and manage­ tion between firms subject to eco­ fiting at shareholder expense, a re- rial accounting. Sherwin Rosen nomic (price and entry) regulation

NBER Reporter Winter 1994/5 11. and those in unregulated industries. pensation arrangements. The large holders and top executives. This CEOs in the regulated electric and number of electric utilities, each suggests that the recent attention gas utility, gas pipeline, airline, and regulated at the state level, and the focused on executive compensa­ telecommunications sectors aver­ wide variation in the political activ­ tion more broadly may significantly aged considerably lower pay than ism and orientation of state public affect compensation even at unreg­ their counterparts in unregulated utility commissions provide an op­ ulated firms. industries. Moreover, their compen­ portunity to identify the direct ef­ sation tends to be weighted more fects of political constraints on ex­ heavily toward salary and cash, and ecutive compensation. This re­ Diversification away from incentive-based forms search confirms the general conclu­ of pay, including stock options. sions reached in our original, Shepard and I have investigated These patterns could result from cross-industry study. CEOs of firms the link between diversification of differences in the nature of the that operate in "pro-consumer" reg- firms into multiple lines of business CEO's responsibilities in and the compensation re­ the regulated sector, that ceived by their top execu­ reduce optimal compen­ tives.6 There has been sub- sation, or from the height­ "CEOs of firms that operate in 'pro-con­ stantial interest over the last ened susceptibility of regu­ decade in the motivation for lated firms to political sumer' regulatory environments are paid and effects of corporate di­ pressures to limit nominal less than CEOs of firms that operate In versification, particularly pay levels. While it is diffi­ more investor-friendly environments." given the popular view and cult to distinguish de­ emerging academic con­ cisively between these ex­ sensus that diversification is planations in the data, we associated with poor ex 7 argue that the pattern of com­ ulatory environments are paid less post financial performance. One pensation discounts across regulat­ than CEOs of firms that operate in explanation for this poor perfor­ more investor-friendly environ­ ed industries, over time and be­ mance is that managers pursue tween firms, is broadly consistent ments. Compensation is lower diversification to fulfill their own when electric utility rates are high with the presence of binding politi­ objectives rather than those of or rising. It is also lower in states cal constraints on executive pay, as shareholders. Andrei Shleifer and with publicly elected regulatory mediated through the regulatory Robert W. Vishny have argued that commissioners-situations in which process. diversification may even be a strat­ previous research has demon­ egy pursued for the explicit pur­ Joskow, Catherine D. Wolfram, strated that political pressures on pose of raising managerial com­ and I use variations in the political utilities are most intense. It appears pensation through increased man­ and regulatory environments of that economic regulation provides agerial entrenchment. 8 Shepard firms within the electric utility in­ an effective mechanism through and I use data on over 500 (unreg­ dustry to ascertain the potential im­ which public concern over execu­ ulated) CEOs during 1985-90 to pact of political pressure on com­ tive compensation can be translat­ analyze the relationship between 5 pensation patterns. Our initial ed into political and regulatory ac­ executive pay and firm diver­ study of regulation and compensa­ tion, and ultimately, to reduced sification. We find evidence of sub­ tion indicated that compensation CEO pay. stantial premiums for diversifica­ discounts are particularly severe in We cannot determine whether tion: CEOs of firms with two dis­ this sector, arguably the most tight­ the regulatory discounts we ob­ tinct lines of business average 10 to ly regulated industry in the U.S. serve reduce pay from "excessive" 12 percent more in salary and bo­ economy. CEOs of electric utilities levels in the unregulated sector, or nus and 13 to 17 percent more in average less than one-third to one­ distort CEO performance incentives total compensation than CEOs of half of the pay of CEOs in compa­ and limit managerial quality by re­ similar-sized but undiversified firms rable firms in the unregulated sec­ ducing compensation in the regu­ (all else equal). This corresponds tor. By analyzing pay variation lated sector below desirable levels. to average 1990 salary gains of within a single industry, we hope Our results merely imply that inter­ $115,000 to $145,000 for our sam­ to control for unobserved differ­ vention in the compensation pro­ ple. Diversification could raise pay ences in the nature of the CEO's cess by influential outsiders may af­ either because it is associated with job that might affect optimal com- fect the contracts between share- managerial entrenchment or be-

12. NBER Reporter Winter 1994/5 ------cause the CEO's job in a diversified er compensation over the entire re­ ed compensation increases equiva­ firm requires higher ability. If en­ maining career of the CEO. lent to roughly 15 percent of total trenchment explains the correla­ We find that CEO pay has be­ compensation. At the average 1990 tion, then we expect higher premi­ come substantially more sensitive compensation level of $1.25 mil­ ums for CEOs with longer tenure to firm performance over the past lion for our CEOs, this increase (who, on average, are likely to be two decades, even when those por­ would correspond to an additional more entrenched) and an increase tions of compensation derived from $193,000 in pay. in compensation when the CEO di­ stock options and related instru­ versifies the firm. If the premium is ments are excluded. Compensation a payment to greater ability, it is influenced by both accounting should not vary with tenure. We and stock market rates of return, ISee D. Bok, The Cost of Talent, New fmd that the diversification premi­ suggesting that boards of directors York: Free Press, 1993. um more likely is a payment for treat each of these performance 2S. Rosen, "Contracts and the Market higher ability, rather than a conse­ measures as a useful independent for Executives," NBER Working Paper quence of entrenchment: the pre­ signal of managerial performance. No. 3542, December 1990, and in Con­ mium is not affected by tenure, Moreover, failing to include both of tract Economics, L. Wernin and H. and increased diversification by these performance measures in a Wikjander, eels., O:iford, England: Ba­ incumbent CEOs reduces their model of compensation leads to a sil Blackwell, 1992. compensation. substantial understatement of the 3p. L. Joskow, N. L. Rose, and A. Shep­ pay-for-performance sensitivity. ard, "Regulatory Constraints on CEO Compensation, " NBER Reprint No. Financial Performance We find no evidence for the 1825, November 1993, and in Brook­ popular view that boards typically ings Papers on Economic Activity-Mi­ Finally, Joskow and I have ana­ fail to penalize CEOs for poor fi­ croeconomics 1 (1993), pp. 1-58 and 70-72. lyzed the sensitivity of executive nancial performance or reward compensation to firm financial per­ them disproportionately well for 4See, for example, W HendriCks, "Regu­ good performance. It does appear lation and Labor Earnings, "Bell Jour­ formance, in a project that grew nal of Economics 8 (1977), pp. 483- out of our first study of CEO pay.9 that boards may discount extreme realizations of performance-both 496; and N. L. Rose, "Labor Rent-Shar­ In that study, we found that execu­ ing and Regulation: Evidence from the tive pay in the unregulated sector high and low-relative to perfor­ Trucking Industry," Journal of Political became increasingly sensitive over mance that lies within some "nor­ Economy 95 (1987), pp. 1146-1178. time to variations in firm perfor­ mal" band, though. This could be 5p. L. Joskow, N. L. Rose, and C. D. mance. Compensation also seemed consistent with the view that ex­ Wolfram, "Political Constraints on Ex­ to be more responsive to variations treme performance realizations re­ ecutive Compensation: Evidence from in accounting rates of return than flect "noisy outcomes" that are the Electric Utility Industry, " NBER to stock market rates of return. more likely to be caused by events Working Paper No. 4980, December 1994. While a number of earlier papers beyond the influence or control of had estimated performance sensi­ management, or with efforts to lim­ 6N. L. Rose and A. Shepard, "Firm Di­ versification and CEO Compensation: tivities in CEO pay, most relied on it the extreme variability of com­ pensation in response to manageri­ Managerial A bility or Executive En­ simple, highly restricted models of trenchment?" NBER Working Paper No. the pay-for-performance relation­ al risk aversion. While our esti­ 4723, April 1994. mates of performance sensitivities ship. Joskow and I use a more 7See, for example, L. H. P. Lang and R. complex model of the compensa­ do not alter the general conclusion M. Stulz, "Tobin's Q, Corporate Diversi­ tion-performance relationship, and that changes in managerial com­ fication, and Firm Performance, " NBER uncover a number of interesting pensation resulting from superior Working Paper No. 4378, June 1993, features in the unregulated sector. financial performance of the firm and the studies they cite. First, we find that current compen­ are small in comparison with chan­ BA. Shleifer and R. W Vishny, "Man­ sation responds to past firm perfor­ ges in total shareholder wealth, the agement Entrenchment: The Case of mance, but that this effect decays compensation effects are nonethe­ Manager-Specific Investments, " Joumal substantially within two or three less economically significant. Dur­ of Financial Economics 25 (1989), pp. 123-139. years. This contrasts sharply with ing the 1980s, a CEO who in­ the standard models in the litera­ creased his or her firm's market 9p' L. Joskow and N. L. Rose, "CEO Pay and Firm Performance: Dynamics, 'and accounting returns by one-half ture, which assume that a one-year Asymmetries, and Alternative Perfor­ increase in a firm's market rate of standard deviation over the means mance Measures, " forthcoming as an return generates permanently high- in our sample would have generat- NBER Working Paper.

NBER Reporter Winter 1994/5 13. NBER Profile: Price V. Fishback

Price V. Fishback, who became History from 1991-4, and is a trus­ an NBER Research Associate in tee of the Cliometrics Society. He 1994, is a professor of economics has published numerous journal ar­ at the University of Arizona. He ticles on labor markets and safety holds a B.A. from Butler University at the turn of the century. His work and a Ph.D. from the University of on the coal labor market is summa­ Washington. rized in the 1992 volume, Soft Coal, Fishback began his teaching ca­ Hard Choices: The Economic Wel­ reer as an assistant professor at the fare of Bituminous Coal Miners, University of Georgia in 1983. He 1890 to 1930. was promoted to associate profes­ Fishback is married to Pamela sor in 1987, and moved to the Uni­ Slaten, the assistant department versity of Arizona as an associate head in the Management Informa­ professor in 1990. His research and tion Systems Department at the teaching interests are economic University of Arizona. She claims history, labor economics, and ap­ that he "risks too much bodily plied microeconomics. harm playing basketball, and flying Fishback served on the editorial around the country announcing board of the Journal of Economic swim meets."

NBER Profile: Shawn E. Kantor

Shawn Everett Kantor is a faculty spending on infrastructure, work research fellow in the NBER's Pro­ relief, and agricultural relief. This gram in Development of the Amer­ research will include analyses of ican Economy and an assistant pro­ the economic effects of the expen­ fessor of economics at the Uni­ ditures on various aspects of the versity of Arizona. He received his economy, and the economic and B.A. from the University of Roch­ political factors influencing the fed­ ester in 1987 and his Ph.D. in social eral and state governments' alloca­ science from the California Institute tion of New Deal funds. of Technology in 1991. Kantor and his wife, Jennifer Kantor's fields of research and West, have a two-year-old son, teaching include economic history, Quinn, and are expecting their sec­ labor economics, political economy, ond child in May. When he gets a and law and economics. Recently chance, Kantor enjoys hiking, scu­ he has begun a new project on the ba diving, and "four-wheelin' in political economy of New Deal the Arizona desert."

14. NBER Reporter Winter 1994/5 ------NBER Profile: Sam Parker

Sam Parker joined the NBER in A native of New York City, Par­ 1974 as its chief financial officer. ker was educated at the Bernard M. He is a CPA, and has a special un­ Baruch School of the City Univer­ derstanding of the accounting, aud­ sity of New York. He worked with iting, and management problems major public accounting firms for a of the not-for-profit sector. In 1991, number of years; formed his own he was appointed a member of the firm, Parker and Mulligan; and held Not-For-Profit Organizations Com­ a senior management position with mittee of the American Institute of a major retail company. He also Certified Public Accountants, for a served with the U.S. Army Corps of three-year period. Parker currently Engineers in a financial capacity. serves on the Board of the Massa­ Parker's wife, Mary, holds a Ph.D. chusetts affiliate of the American in Spanish literature and is a member Heart Association, and is a member of the faculty at St. John's Universi­ of its Budget, Finance, and Audit ty in New York. They enjoy music Committee. and the theater, and do a lot of walking and, of course, commuting.

NBER Profile:Joel Mokyr

Joel Mokyr, the Robert H. Strotz Mokyr received his B.A. from Professor of Arts and Sciences and Hebrew University of Jerusalem a professor of economics and his­ and his Ph.D. from Yale University. tory at Northwestern University, His work on economic history has has represented that institution on been published in a number of the NBER's Board of Directors journals and books, including the since 1993. Mokyr began his teach­ 1990 co-winner of the International ing career at Northwestern in 1974 Joseph A. Schumpeter Prize, The as an assistant professor, was Lever of Riches: Technological Crea­ named an associate professor in tivity and Economic Progress. Mo­ 1978, professor of economics in kyr is also a trustee of the Econom­ 1980, professor of economics and ic History Association, of which he history in 1981, and attained his was vice president in 1993-4, and current position in 1994. He also is coeditor of the Journal of Eco­ has taught at Stanford University, nomic History. the University of Chicago's Gradu­ Mokyr is married and has two ate School of Business, and Har­ children. vard University.

NBER Reporter Winter 1994/5 15. NBER Profile: Brigitte C. Madrian

Brigitte Condie Madrian is a fac­ her research focuses on health eco­ ulty research fellow in the NBER's nomics, though, and appears both Programs in Public Economics and in the NBER 'Working Paper series Health Care and an assistant pro­ and in the Quarterly Journal of fessor in Harvard University'S de­ Economics and the Industrial and partment of economics. She re­ Labor Relations Review. ceived her B.A. from Brigham Brigitte and her husband David, Young University in 1989 and her a systems engineer and accom­ ph.D. in economics from MIT in plished pianist, live in Belmont, 1993. MA. Together they enjoy anything Madrian currently teaches both musical, and vacations to their undergraduate and graduate cours­ mountain homeland in Utah. es in public economics. Much of

Margaret Levenstein Joshua Rosett Steven D. Levitt NourielRoubini beporah J. Lucas Cecilia E. Rouse Robin L. Lumsdaine John P. Rust Richard K. Lyons Xavier Sala-i-Martiri 4· C,):aig MacKinlay Andrew Samwick . . . Bxiffitte Madrian John K. Scholz '. '.' • Ropolfo Manuelli Andrea SheP3:rd · Kirilinori Matsuyama Nachum Sicherrn:ari ··'Miirk B. McClellan HilarySigman: ., . Kathleen M. McGarry Kathryn E. Spier David Meltzer Douglas O.Staiger .. Gilbert E. Metcalf .Federico A. StUIfZ€ne:gg~~f'q .' Naci:H. Mocan Valerie Y. Suslow . Deborah L. Swenson ~'g~~%:~on Alan Taylor . · Susan W. Nesbitt Linda Tesar 'Dii'ild Neumark Aaron Tornell .••.. St~Y~n Olley Daniel Trefler . ;Ii~s!ie E. Papke Robert Triest ·ChJ;iStina Paxson Peter Tufano Andres Velasco '~ih:J~~:~F Joel Waldfogel . Artdtew D. Racine James Walker Jiang Wang ~i~ra~ffRajan Shang-Jin Wei ·Va1:~rie A. Ramey David N. Weil ~rg!o Rebelo Ingrid M. Werner .t\lancy Reichman Holger C. Wolf Paur'Rhode Alwyn Young Richard Rogerson Stanley E. Zin jqshua Rosenbloom Luigi Zingales

16. NBER Reporter Winter 1994/5 ------Conferences

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Garber and Romer address the nology adopted. The high returns vaccines to several million dollars role of market structure in deter­ that the monopolist receives in a for the most labor- and capital-in­ mining the rate and type of techno­ fee-for-service market may be nec­ tensive interventions. Further, the logical innovation in health care. essary to pay the fIxed costs of de­ cost effectiveness of anyone treat­ They develop a model in which veloping a new technology. Garber ment can vary widely, depending there are multiple competing po­ and Romer apply this model to on the patient. Using a model of tential technologies in markets that speciHc issues in the development doctor-patient decisionmaking, provide care on a fee-for-service of technology, such as the produc­ Phelps analyzes a doctor's choice basis with a Hxed copayment, and er's decision to pursue a "break­ of treatment. He finds that cost in markets where "ideal" HMOs through" drug or medical device, containment is affected by accura­ provide care. Because new tech­ rather than a "me-too" drug that of­ cy of diagnosis, efficacy and costs nologies typically are introduced fers a higher probability of success of treatment, and the patient's pref­ by monopolistic suppliers, the but for which close substitutes erences regarding health and overutilization on the part of a fee­ exist. income. for-service market may offset the Escarce examines two underprovision of a mo­ phenomena that stand out nopolist. According to the in the adoption and diffu­ model, the rate of adop­ "The high returns that the monopolist sion of laparoscopic chole­ tion also depends on the receives in a fee-fOr service market may cystectomy (a new gall distribution of health en­ be necessary to pay the fixed costs of dowments across the pop­ bladder removal technique) ulation. The welfare im­ developing a new technology" in the United States: the re­ plications of the market markable speed with which structure on the demand practicing general surgeons side are ambiguous, because mar­ The cost effectiveness of med­ learned to perform the procedure ket structure influences both the ical treatments, measured in "quali­ and incorporated it into their ev­ quantity of a given technology that ty-adjusted life years," varies from eryday practice, and the increase in is adopted and the choice of tech- a few hundred dollars for some frequency of the procedure after

------NBER Reporter Winter 1994/5 17. the laparoscopic method was intro­ nizations (HMOs) do not lower the pital personnel to potential adverse duced. He finds that the principal growth in spending in a one-for­ drug interactions and laboratory factors in the rapid diffusion of lap­ one manner even when they actu­ evidence of deterioration. Some aroscopic cholecystectomy were: ally do save money. The authors systems, such as the Integrated vigorous patient demand; psychic believe that there are reasons for Academic Information System at benefits gained by surgeons who optimism about the future, though, Columbia, appear to save money adopted the technique; ac­ despite their high cost; cessibility of information maintenance costs alone about laparoscopic cho­ "[T]he increase in frequency of cholecys­ amount to 0.3 percent of lecystectomy; and low tectomy, and the accompanying changes in the medical center's annual adoption costs. Escarce budget. Another information also suggests that the in­ the characteristics of cholecystectomy pa­ system that has been exten­ crease in frequency of tients' are expected responses to a proce­ sively studied, the Ragen­ cholecystectomy, and the dure with less postoperative disability and strief Medical Information System in Indiana, seems to accompanying changes in lower patient costs." the characteristics of cho­ provide similar benefits and lecystectomy patients, are may reduce costs. Accord­ expected responses to a ing to Shortliffe, the "infor- procedure with less postoperative if consumers are willing to give up mation highway" may expand the disability and lower patient costs some costly medical technology: reach and value of such systems, HMOs have a tendency to econo­ but standardization of methods for In industries such as electronics encoding and retrieving informa­ mize, and might save more if they and computers, technical improve­ tion will be necessary. Although achieve greater market clout and ments generally lower prices. By more extensive evaluations of such face less government intervention. contrast, innovations in medicine systems are needed before they result in higher prices. Grossman Innovative clinical information can be confidently characterized as believes that this market imperfec­ systems have been developed and cost-saving technologies, the best tion stems from academic medi­ adopted with little assessment of of them are likely to increase pro­ cine's traditional single focus on their impact on costs, according to ductive effiCiency in the health care technical feasibility, rather than on Shortliffe. Hospitals have adopted sector. the broader concerns of cost, quality, a wide array of such systems, rang­ These papers and their discus­ and appropriateness of treatment. ing from computer networks that sions will be published in a confer­ How does managed care affect report laboratory data alone to ence volume by the University of the rate of growth in medical highly sophisticated systems that Chicago Press. The release of this spending? Pauly and Ramsey offer advice to physicians about volume will be announced in an show that health maintenance orga- patient management and alert hos- upcoming issue of the Reporter.

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18. NBER Reporter Winter 1994/5 ------Aiken, Harrison, and Lipsey ly. Eaton and Kortum develop a Klenow find that Sematech in­ explore the relationship between model of technological innovation duced members to cut their overall wages and foreign investment in at the national level and the trans­ Rand D spending by about $300 the United States, Mexico, and Ven­ fer of technologies between coun­ million per year. ezuela. They fmd that higher levels tries, which includes the decision Using data covering 1987-9 on of foreign investment are associat­ to patent, either domestically or value added, international exports, ed with higher wages across all abroad. They relate the number of patents, structural capital, and la­ three countries. However, in the patents taken out by U.S. inventors bor, Richardson and Smith find case of Mexico and Venezuela, the in other countries, and by foreign that factor endowments correlate overall wage increase is brought inventors in the United States, to a rather strongly with cross-state sec­ about by wage increases in foreign­ number of variables. They fmd that toral growth. Further, there are owned firms only. In Mexico and market size and the strength of in­ marked intersectoral differences in Venezuela, there are no positive tellectual property protection are productivity change, ranging from wage spillovers to domestic enter­ the most important factors affecting less than zero to annual rates over prises, which is consistent with sig­ patenting by U.S. inventors abroad. 10 percent. The authors find little nificant wage differentials between Research effort in the country of evidence of either unusual growth fo,reign and domestic enterprises. origin explains most of the varia­ linkages from sector to sector or Together with productivity differ­ tion in the amount of foreign pat­ state to state, or of a correlation ences, these wage differences are enting into the United States. between unusually strong sectoral also consistent with greater human Sparked by concerns about their growth and export performance. capital formation in foreign firms. shrinking market share, 14 leading Ben-David examines the rela­ While domestic patenting in the U.S. producers of semiconductors, tionship between trade and income United States and Europe has been with $100 million in annual subsi­ convergence by focusing on groups relatively constant since 1950, the dies from the U.S. government, of countries that comprise major fraction of innovations that are pat­ formed a joint Rand D consortium trade partners. The majority of ented abroad has risen dramatical- in 1987 called Sematech. Irwin and these groups exhibit significant

NBER Reporter Winter 1994/5 19. convergence. Furthermore, a com­ that unilateral tariff cuts have an not, lead to investment diversion in parison of the trade-based groups expansionary effect, resulting both EFTA. In all cases, when the Single with different, randomly selected in rationalization of industrial pro­ Mar-ket program is extended to in­ groups of countries shows that the duction and in new products sup­ clude EC and EFTA, investment crea­ former are more likely to exhibit plied by new firms entering the tion occurs in them, and the im­ convergence than the latter. Final­ market. Small export subsidies are pacts on the United States and Ja­ ly, the magnitude of growth in self-financing. The expansionary pan are negative, but trivially small. trade appears to be related to the effects and the welfare increases Blomstrom and Wolff examine degree of income convergence get magnified under monopolistic the sources of labor productivity among countries. competition, as compared to a growth in Mexican manufacturing. Brecher, Choudhri, and Schem­ more competitive case. They find that labor productivity bri develop a model that tests the Richard Baldwin, Forslid, and levels vary almost in direct relation­ links between trade policy and Haaland study the effects of the ship to establishment size, but that productivity growth through both R European Union (EU) Single Mar­ labor productivity growth shows no and D and international spillovers. ket program on investment creation systematic variation by size. In fact, Using data from Canadian and u.s. and investment diversion. There is small establishments have had the manufacturing industries, they find some evidence that the European same rate of labor productivity a positive long-term relationship Community's (EC's) Single Market growth as larger ones, partly be­ between productivity growth in program may have led to invest­ cause of the exiting of low-produc­ each country and total Rand D in ment diversion in the economies of tivity, small plants. Moreover, most both countries. Moreover, the dif­ the European Free Trade Associa­ of the variation in labor productivi­ ference in the scale of Rand D ac­ tion (EFTA) and investment crea­ ty across plant class sizes is attrib­ tivities between Canadian and u.s. tion in the EU economies. Using a utable to differences in capital industries does not cause rates of detailed computable equilibrium intensity. productivity growth to diverge model, though, the authors find These papers will be published internationally. some cases in which EC92 does, in a special issue of an academic Keuschnigg and Kohler find and other cases in which it does journal.

'.. ,Sra1'1f9rciUniversity .,1~!l~~~t@n~1·.·and:.socialJ1.~§p,()fl.$ibillty,. '". :. . Paul,M.Romer" NBER and ;;·;~~,q¢(9b.erT~nd8,an .NBER '. ;i~'~s~~,iq;/. ";'. .Urrlverstti of California, Berkeley; •·c6nfet~~ceQJ1"In,dividualand So~· ··ChriSt(j.phe~Jencks;·Northwestern·'· . ,"Preferences, Promises, and the tJruvetsiry',·, ' .. Pbliticsof Entitlement" .;'iid~~ii~~h~ifl~:~~IC~~~~,c~~ed. DiscUssant: I{pgerNoll, Sl4nford University "RoHe.ttfrank, .Cornell "Un:tverstty;"Cbnsumption Ilr~~i~· ····@:t¢01Mitiesan'dthe f'lnaneirigof' . S6ciai SerVices" . DiScussant: .A1hart)iaSen, Harvard University I~ellneth J. Arrow, Stanford 1~~:Rt University,"Information, SR~P(qEJ:Jiliv~rSity,"toQomfort;. Alw~ys:'Th~ p:rosreds ()f Resppnsibility, and Human ~a1!f!~~~~R ~d .·Exp~dded,Social·Responsibility Services" ~1:ikH@1,iShekiUniversity of fQrlO'r1g~:rerm Care" Discussant: Rb'd1.e$t~t,~'Efficiency, Equity, Disct:iSsartt:: ...... Glenn Loury, Boston University and the Rjsing Costs ofSchools" JohnB;Shbven, NBER and Henry Hansmann, Yale

20. NBER Reporter Winter 1994/5 ------Leibowitz focuses on the no­ the production of high-quality edu­ politically sustainable. Thus, the tion of child care as an investment cation. Finally, Hanushek analyzes solution must be to find ways in in the human capital of tomorrow's voting on school budgets in New which the baby boom generation adults. Her paper discusses various York state, and finds no systematic taken as a group saves the money types of child care, issues sur­ relationship between performance to pay for its future long-term care rounding the quality and financing of schools (measured in terms of needs. of such care, and the possible role student achievements) and willing­ Romer takes on the task of ex­ for government involvement. Leib­ ness to support proposed budgets. plaining why rational people may owitz points out that the gains may Aaron explores why health care have preferences that depend on be especially large for children reform proved such an intractable the promises made by others. He starting off on the bottom rungs of problem. Politics played a role, of tackles this question by examining America's socioeconomic ladder. course. But Aaron argues that the evidence from biology, and point­ Good-quality child care may pro­ key problems are central to the na­ ing out that in many situations, it vide a start in life that makes suc­ ture of the health care industry, will be useful for people to have cess in school more likely, and and to the inherited patterns of mechanisms that help enforce cor­ thus offers a start toward a middle­ how the United States provides porate behavior. Romer uses in­ class economic future. Moreover, health care. For example, new sights about why promises matter although there is less evidence on technology is driving up the cost of to reopen a set of long-standing ar­ this point, child care may serve as health care. Because of tax breaks guments over why people vote, an early intervention that helps to and limited information, house­ why negative campaigning works, counteract neighborhood patholo­ holds have a distorted perspective why commitments and promises gies of crime, abuse, and children on how much health insurance matter in politics, and more. In giving birth to other children. they need. A number of overlap­ particular, he uses his argument to Hanushek discusses issues of ping policies and institutions, both explain why the phrasing of prom­ quality in schooling, particularly public and private, determine how ises about Social Security has been the quality of elementary and sec­ health care is provided. Yet some taken to be so important, both by ondary schools. In particular, he group has a personal stake in those in favor of expanding the looks at efficiency and equity, every one of these institutions, and program and by those in favor of which are intertwined directly in thus is loath to see it changed. reining it back. His argument im­ education debates because of the Garber lays out what actually is plies that the design of social pro­ approaches commonly taken in involved in long-term care; what grams and the promises surround­ distributional assumptions. Efficient proportion of the population is ing their passage will influence the spending is assumed, so that varia­ likely to make use of such care; life expectancy of such programs, tions in expenditure can be used to how Medicare and Medicaid pres­ and whether they expand or con­ gauge the distribution of educa­ ently cover such care; and what the tract with time. tional services. If expenditure is options are for providing such care Frank explores the implications not a good measure of the quality to the baby boom generation. He of two plans for financing health of education, then equity discus­ argues that planning for a future care: the first provides for universal sions based on expenditure can be transfer program, from the work­ membership in a basic, no-frills misleading. The available evidence ing-age population to the elderly, health insurance plan financed out points to substantial inefficiency in is not likely to be economically or of general tax revenues. Consum-

NBER Reporter Winter 1994/5 21. ers are free to join more elaborate Hansmann lays out how the ad­ distributed widely to middle-class plans, but they must pay the full vantages and disadvantages of as well as less privileged citizens. cost of the alternative plan com­ public, nonprofit, and for-profit in­ Yet Americans are also deeply sus­ pletely out-of-pocket. The second stitutions determine how they are picious of, and occasionally antag­ provides a tax-financed voucher to used differently in child care, edu­ onistic toward, intrusive govern­ every consumer in the amount re­ cation, health, and long-term care. mental bureaucracy. Federal regu­ quired to purchase membership in He finds a strong expansion of for­ lations not accompanied by subsi­ "Plan 1." People then may either profit provision, and predicts that, dies are especially likely to be re­ join Plan 1 or supplement their just as a wave of for-profit provid­ sented. Social policies are political­ voucher with their own funds to ers revolutionized health care in ly viable only if they are broadly purchase membership in more the last 25 years, for-profits may al­ targeted, well-financed with public elaborate plans. Because the cost ter education dramatically in the revenues, and not highly intrusive of adding additional coverage to next 25. as regulators of families, individu­ the basic plan is much lower under Poterba examines how two als, or businesses. "Plan 2," it would induce more standard arguments for govern­ This summary was prepared people to upgrade. This will re­ ment intervention in private mar­ with the assistance of Timothy Tay­ duce the perceived adequacy of kets-market failure and redistribu­ lor, Journal of Economic Perspec­ the basic plan and, in turn, will tion-apply to the markets for edu­ tives. These papers and their dis­ generate political pressure to up­ cation and medical care. He then cussions will be published by the grade it. Under Plan 1, by contrast, considers the choice between inter­ University of Chicago Press in an fewer people elect to upgrade, and upcoming conference volume. Its so political pressure to upgrade the vention via price subsidies, man­ dates, and direct public provision availability will be announced in a basic plan will be weaker. Frank future issue of the NBER Reporter. argues that Plan 1 is likely to deliv­ of services in these markets. Eco­ er comparable health care out­ nomic arguments alone seem un­ comes at lower cost than Plan 2. able to explain the sharp diver­ He applies his findings to choice of gence between the nature of pub­ alternative plans for financing edu­ lic policies with respect to educa­ cation, child care, and long-term tion and medical care. Moreover, care. there is virtually no evidence on Services are difficult to measure. the magnitudes of many of the key Of course, one can count the parameters needed to guide policy amount of time a service provider in these areas, such as the social spends on certain tasks, or the externalities associated with prima­ amount of money spent on ser­ ry and secondary education, or the vices, but those aren't the same degree to which adverse selection thing. In principle, at least, if infor­ in the insurance market prevents mation on the quality of service purchase of private insurance. were describable and measurable, Skocpol offers an overview of then people and suppliers could four eras of U.S. social policymak­ make more rational choices, and ing from the nineteenth century to markets for services would work the present: the Civil War era; the much better. Arrow focuses on the Maternalist era; the New Deal era; economics of information, and re­ and the contemporary era of con­ inforces how markets will have dif­ troversies over the federal social ficulty dealing with a valuable, role. She concludes with a discus­ costly, intangible, nondepletable sion of recurrent patterns, and con­ good such as information about temporary constraints and opportu­ service quality. nities in U.S. social policymaking. Different institutional forms or­ History shows that Americans re­ ganize the incentives and flows of peatedly have been willing to pay information in different ways. taxes for generous social benefits

22. NBER Reporter Winter 1994/5 ------and Public Policy and the Housing Market Christopher Mayer, Federal Reserve Bank of Boston, An NBER conference. on "Pub­ Dennis Capozza, University of "Housing Price Dynamics Within·· lic Policy and the Housing Mar­ Michigan,. and a Metropolitan Area" ket," organized by Patric H. Hen­ James Carr, Federal National Discussants: dershott, of NBER and Ohio Mortgage Association (FNMA) the .. Donald R. Haurin, Ohio State StatelJniv~fsiiy, was held on Oc­ Andrw c. capllD, NBER and University, and . tober 21 and 22. The program was: Colufl1bia Univ~rsity, William Stephens, FHLMA Richal'd· K.. Green, University of ChaJ:les Freeman, Chemical . Sewin Chan, Columbia Wisconsin,'M~disonj "Should the Batrk,'and University, "Residential Mobility . Stagnan~Homeownership Rate Be Joseph Tracy, Columbia and Mortgages" University, "Housing Partnerships: a SourceofC0ncern?" Discussants: A NewSystemof Housing Discussants:· Jan Brueckner, University of Finance" PetetEnglurid;UppsaIa Illinois, and University,. and' Discussants: . Henry Buist, FNMA AnnSchnarej Federal Home Loan Susan. Gates and Wayne Archer, Mortgage Association (FHLMA) Peter Zorn, FHLMA David Ling, and Dixie BlaGldey, LeMoyne Dennis CapoZ7a and . Gary McGill, University of College; and Pau1J~ SegUin, University of Florida, "The Effect of Income James Follai'rl, Syracuse Michigan, "Expectations, and Collateral Constraints on Res­ University; "InSeatch of Empirical Efficiency, and Euphoria in the idential Mortgage Terminations" Evidence~at Links Rent and Housing Market" Discussants: UserCost" Discussants: Man Cho, FNMA, and Discussants: James Berkovec, FHLMA, and James Follain Ann Dougherty, FHLMA, and Nancy Wallace, University of Steven Grenadier, Stanford Michelle Whlte, University of California, Berkeley University, and Michigan Gary Engelhardt, Dartmouth Brian Hall, Harvard University, 'Yohghen:gDeng, College, "House Prices and "Risk-Based Capital Standards, John ~'~'QUigley, and Homeowner Saving BehaVior" Mortgage Demand, and Real RoberlVanOr'der, University of Discussants: Estate Markets" California, Berkeley, "Market Jesse Abraham, FHLMA, and . Discussants: BehaVior and Homeowner Jonathan S.Skinner, NBER and George Bentson, Emory Subsidies" University of Virginia University, and Discussants: Karl E. Case, Wellesley College, Tyler Yang, FNMA

Green asks why the homeown­ sidering that the actual rate in user cost is passed along as ership rate in the United States be­ dropped by only 0.2 percent, per­ higher rents. The adjustment pro­ tween 1980 and 1990 was stagnant. haps the stagnant homeownership cess also takes a long time; only He finds that predicted changes in rate should not be a major concern about half of the long-run effect is household composition based on after all. realized within 10 years of the in­ demographics alone could have Most models of the rental hous­ crease in user cost. They offer sev­ caused the homeownership rate to ing market assume a close linkage eral possible explanations for these drop by 2.1 percent. Changes in between the level of residential results. Among them is the possi­ the demand for owner-occupied rents and the aftertax cost of rental bility that the linkage between user housing within each household cat­ housing capital, that is user cost. cost and rents is too complex and egory could have caused the rate Using U.S. annual data for 1964 varied to be identified using 30 to drop another 1. 5 percent. In through 1993, Blackley and Fol­ years of national data. light of these predictions, and con- lain find that only half an increase Dang, Quigley, and Van Order

------NBER ReporterWinter 1994/5 23. analyze the costs of a current poli­ aging partner would have the con­ tent with, previous findings from cy proposal suggested by the Clin­ tractual obligation to maintain the aggregate data for the 1970s. Virtu­ ton administration: transferring re­ property in acceptable condition. ally all of the savings offset comes sources and stimulating homeown­ Upon sale of the property, the re­ from households with negative real ership by offering low downpay­ ceipts would be split between the capital gains on housing. ment loans. They find that if zero­ managing partner and the limited A number of studies have dem­ downpayment loans were onstrated that increases and priced as if they were decreases in single family mortgages with 10 percent home prices over the hous­ downpayments, then the "[H]ouseholds have offset real capital gains ing cycle have varied widely additional costs of the pro­ on housing through reductions in savings." within metropolitan areas. gram would be 2 to 3 per­ Case and Mayer show how cent of the funds made changes in a variety of fun­ available-when housing damental factors, including prices are increasing partner in proportion to their fixed amenities, incomes, and employ­ steadily. Under a stable or a mod­ ownership proportions. ment, affect the pattern of housing erately declining pattern of housing Capozza and Seguin study ex­ and land prices across jurisdictions. prices, though, the costs of the pectations of capital appreciation They base their findings on data on program would be much larger: as in the housing market They show price changes across 193 separate much as $67,000 to $92,000 per that expectations impounded in the cities and towns in Massachusetts million dollars of lending. If the rent/price ratio at the beginning of between 1981 and 1994. expected losses from such a pro­ the decade successfully predict ap­ gram were not priced at all, then Chan discusses how the accura­ preciation rates, but only after ad­ the losses from default alone could cy and detail of mortgage data can justing for cross-sectional differ­ exceed 10 percent of the funds be applied to important areas of ences in the quality of rental versus made available for loans. economics outside of mortgage fi­ owner-occupied housing. They nance, in particular, mobility and Caplin, Freeman, and Tracy also demonstrate that observed location choice. As a supplement to explore the feasibility of introduc­ rent/price ratios contain a disequi­ ing partnership agreements into the the variables from the application librium component that has the form, the self-selection of mortgage housing market, with households power to forecast subsequent ap­ and financial institutions each tak­ contracts has been used to infer ex­ preciation rates. Finally, they dem­ ing partial ownership of the resi­ pected mobility from the choice of onstrate that euphoria exists; that dence. They show that partnership points. Chan tests the points indica­ is, participants in housing markets contracts of this form have the po­ tor using the Chemical Bank data­ appear to overreact to income tential to reduce the financial bur­ set of mortgage loans. He finds that growth. dens to households of owner occu­ the points indicator is highly signif­ pation, and to reduce the cost to Engelhardt examines the link icant in predicting mobility for low taxpayers of the various subsidies between house price appreciation loan-to-value (LTV) borrowers, but to owner occupation. They envis­ and the savings behavior of home­ not for high LTV borrowers. This is age a limited partnership agree­ owners during the 1980s, when evidence for the presence of large ment, with the purchasing house­ there was rapid real appreciation constraints to mobility for the high hold as the managing partner and regionally and household savings LTV group, most likely because of the financial institution as the limit­ rates fell. Using household asset the recent collapse in property val­ ed partner. In the simplest such and debt data for a sample of ues, coupled with downpayment form of contract, ownership of the homeowning households under requirements for the purchase of property would be divided in fixed age 65 in 1984 and 1989, he finds another home. proportions between the house­ that households have offset real Archer, ling, and McGill ex­ hold and the financial institution. capital gains on housing through plore the influence of household­ As managing partner, the house­ reductions in saving: the estimated level characteristics on mortgage hold would get the sole right to marginal propensity to consume prepayment, both characteristics of live in the property and decide out of those gains is 0.025. This is the householder and of collateral when to sell it. In return, the man- somewhat smaller than, but consis- (house) value. They recognize im-

24. NBERReporterWinter 1994/5 ------portant interactions between the tributable to household demo­ 50 percent weight given to home status of the prepayment option graphic characteristics. mortgages is too high. In terms of and the influence of income and Bank risk-based capital (RBC) more general notions of asset riski­ collateral constraints on prepay­ standards require that banks hold ness, the RBC risk weightings are ment. Using a major source of data differing amounts of capital for dif­ seriously deficient In particular, the that has not previously been used, lack of consideration of interest risk ferent classes of assets. Grenadier the American Housing Survey, they may lead to an increase in bank and Hall fmd that after adopting find that when the household is riskiness, through the incentives RBC standards, banks changed constrained in terms of either col­ provided by the RBC regulations. their portfolios in ways that raised lateral or income, or the prepay­ Also in attendance were: Donald ment option is unlikely, then the their risk-weighted capital ratios. Bradley, Chester Foster, Susan influence of the option value on However, banks did not reduce Gates, Edward Golding, Vassilis P. prepayment is about half what it their holdings of home mortgages, Lekkas, and Donald Solberg, otherwise would be. When the sta­ which have an intermediate weight FHLMA; and Isaac Megbolugbe, tus of the option and the influence of 50 percent, in response to risk­ FNMA. of potential household constraints based capital standards. Their anal­ The conference papers and their are more appropriately recognized, ysis suggests that the ordering of discussions will be published in a these factors account for nearly all the risk weights is basically correct special issue of the journal Region­ explanatory power otherwise at- in terms of credit risk, but that the al SCience and Urban Economics.

Baldwin evaluates the Uruguay He judges the Uruguay Round as opening of purchases by govern­ Round Agreements in terms of having been very successful in ments to international competition, three economic criteria: the extent terms of all three. The reductions all of which are part of the agree­ to which they are likely to foster in duty, the elimination of volun­ ments, will bring substantial bene­ growth and raise living standards; tary export restraints, the return of fits in income and growth. Aspects the extent to which they satisfy agriculture and textiles to General of the agreements on safeguards noneconomic goals without reduc­ Agreement on Tariffs and Trade and subsidies also will reduce the ing economic efficiency; and the (GATT) discipline, the strengthen­ economic inefficiencies often asso­ extent to which they strengthen the ing of intellectual services, the lib­ ciated with the use of trade poli­ institutional mechanisms for achiev­ eralization of trade-related invest­ cies to promote noneconomic ob­ ing compliance with trading rules. ment measures, and the further jectives. Finally, the new arrange-

NBER Reporter Winter 1994/5 25. ments for disputes settlement, the Using the context of the Asia Pa­ vironment" agenda facing the new trade-policy review mecha­ cific region, Richardson concludes GATT and its successor entity, the nism, and, most importantly, the that competition policies are signif­ WTO. He suggests that both the provisions replacing the GATT icant irritants and cause significant GATT and WTO would benefit by with a permanent international in­ inefficiencies to global trade and undertaking environmental assess­ stitution, the World Trade Organi­ investment. However, the particular ments prior to future negotiations, zation (WTO) , significantly strength­ policies that inflame trade relations and by making their dispute resolu­ en the world trading system. in the Asia Pacific area are some­ tion procedures more open to par­ Deardorff and Jackson discuss what different from those that do ticipation by outside experts and the general problems that arise in­ so elsewhere. He further believes nongovernment organizations. Esty ternationally when separate gov­ that there is scope for modest "co­ concludes with the observation that ernments intervene in their econo­ operative unilateral" actions to alle­ much of the "trade and environ­ mies. They review some of the viate these problems in general and ment" dispute actually stemmed problems that have occurred with in the Asia Pacific region. Private from failures of environmental poli­ environmental policy and competi­ business practices can act as mar­ cy, which might be avoided by tion policy, and the questions these ket barriers that impede interna­ broader use of the Polluter-Pays have raised for international coop­ tional trade and investment. Also, Principle and market-based regula­ eration. Finally, they examine the in some areas the concerns of in­ tory programs, as well as by cre­ various forms that international co­ ternational commercial policy and ation of a Global Environmental operation might take, and the competition policy seem similar but Organization to reduce frictions be­ questions that arise in structuring practices differ widely. tween the international, environ­ international agreements and insti­ Esty reviews the "trade and en- mental, and trade regimes. tutions, such as the new WTO.

;·.Health.~suraIiceReform" (r,mER :{~ ~;:. '; ··; ..W:9 rkiQgia.per No, 4852): .. ··

The Earned Income Tax Credit also estimate that the EITC expan­ ical care and life insurance costs (EITC) is the cornerstone of the sion will cause labor force partici­ that smokers generate. Still, the Clinton administration's welfare re­ pation rates to rise for single-parent costs of environmental tobacco form agenda. But how well it will households. smoke, while highly uncertain, are work depends on workers' behav­ In assessing the appropriate fed­ potentially substantial. Even recog­ ior in the labor market. Dickert, eral tax on cigarettes, Viscusi finds nizing these costs, though, Viscusi Houser, and Scholz estimate that that the financial savings from pre­ concludes that current cigarette the 1993 expansion of the credit mature mortality, in terms of lower taxes are higher than the total of will lead to a modest overall reduc­ nursing home costs and retirement cigarettes' estimated costs to indi­ tion in hours worked by those who pensions, exceed the higher med- viduals and society. receive it. However, the authors

26. NBER Reporter Winter 1994/5 ------Using data from the National ter the major tax refonns enacted vestors in different income classes Medical Expenditure Survey, Feld­ in 1962, 1971, 1981, 1986. This ef­ facing various investment horizons, stein and Gruber study the impact fect was most pronounced for they find dramatic differences be­ of switching from existing types of firms that were not in tax-loss posi­ tween the relative rankings on a health insurance coverage to poli­ tions, and thus were more likely to before- and aftertax basis. This is cies with a 50 percent copayment face statutory tax rates and invest­ especially true for middle- and rate and a limit on out-of-pocket ment incentives. The authors also high-income investors. For in­ expenditures of 10 percent of in­ show that tax-induced variation in stance, one fund that ranks in the come, as well as several alterna­ the user cost of capital for different 19th percentile on a pretax basis tives. Their analysis is limited to classes of equipment is related ranks in the 63rd percentile for an the population under age 65. They negatively to asset-specific errors in upper-income, taxable investor. show that shifting to such a "major­ investment forecasts that follow Further, because of the failure of risk" policy could reduce aggregate major tax reforms. This suggests mutual funds to manage their real­ health spending by nearly 20 per­ that ex ante knowledge of an im­ ized capital gains in such a way as cent, and could raise aggregate na­ pending tax reform can improve to permit a substantial deferral of tional efficiency by $34 billion a forecasts of investment taxes, shareholders paid more than year. Dickson and Shoven take $1 billion extra in taxes in 1993. Cummins, Hassett, and Hub­ shareholder-level taxes into ac­ These papers and their discus­ bard find that tax policy had an count in determining the perfor­ sions will be published by the MIT economically important effect on mance of growth, and growth and Press as Tax Policy and the Econo­ firms' investment in equipment income, mutual funds during 1963- my, Volume 9. The publication through the user cost of capital af- 92. For a sample of funds, and in- date will be announced later in the NBER Reporter.

Prgq-q.ctivity, Social Prqgrams, and .' Comisi6hFederilde Compet~ncia,and\ , .' Labor' Markets in Latin. America , SwedervaliWijnbergen,

The NBERand InStituto Tecno- A1~eitFishlow, University of 16gico . .AtItoriom~deMexico California, Berkeley, "Poverty and (ITAM}jbirltlY'sp6nsor~d the sev­ InequaJitY in Latin America" ~~~ji~i~~ enthanriua[Intet:':Amencan Semi~ Distussa:~t: ..• Agreeinent;~ nar ort E(;<¥qinics, "Productivity, S~basti.anEdwards "Piscussarit: ...... SodaFPf.ograinS,andLabor Mar­ IU~doJ.Caballero, NBER and . .. MberLFkWciw kets, " whidl~asheldin 'Mexico MIT, and 'iJ()tg~'QWi:gs, IMRES/aii&;,.,·· CityorlNoVember 1~12~Sebas­ Mo~'ammed.L Hammour, . 'Mabel cabezas, GERENS, Ltd.,).,. tian Ed~a.r$,NBER, . UCLA, and CapitaJGuidance, "On the ills of . the' Wbrld, Ban~,' a.nd AlejandrQ Adjl,lstrtient" .'. ". '·~~~~:J~~~~;:~'c~ti~;ati~~'~' ' Hernandez, ITAM, organized the .Discussant: Ixer<;:ise'; follo\¥ing program: Manuel Santos, ITAM .• Discussant: Georg~J~ IJotias, NBER and . Eduardo Lora. and Luis Tellez; PRI UniversitY of California, San Roberto Steiner, Fedesarrollo, Susan M; Collins, NBER and Diego; "The Labor Market "Structural Reforms and Income GeorgetoWn University, "On' Performance ofMexican Distribution in Colombia" Becoming More Flexible: Imrnigrantsinthe United States" Discussant: Exchange Rate Regimes in Latin Discussant: Adalberto Garcia Rocha, EI America· and the Caribbean" Michael Cragg, Columbia Colegio de Mexico DiscUSsant: University Santiago Levy, President, Carlos Sales, SHCP

------NBER Reporter Winter 1994/5 27. ',': .. ' ",,', -':\~5\:;";'j'{~~~ -).::~ ~\?f/?~·iX·!.:}/·· :1DiS\::Ussaht:~ ;:: ,+,.;i,; ;'"", .',

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Borjas uses the 1970, 1980, and policy measures that potentially ductive structure, leading to a 1990 Public Use Samples of the can alleviate the situation of the surge in open or hidden unem­ U.S. Census to document what very poor, where the Asian coun­ ployment. Gradualism is not a use­ happened to the earnings of Mexi­ tries, because of their low incomes, ful remedy, because it does not can immigrants during the 1980s, are in a relatively much worse po­ synchronize creation and destruc­ and to determine whether pre-1980 sition; and the current research, tion, but rather drags inefficient ad­ immigrant flows have reached which builds on endogenous justment over a longer period. Pre­ earnings parity with natives. He . ~rowth theory, suggesting that venting a rise in unemployment re­ also investigates the extent to greater equality contributes to more quires an adjustment program that which Mexican immigration is re­ rapid expansion. combines vigorous creation incen­ sponsible for the declining skills of Caballero and Hammour ana­ tives in the expanding sector with successive immigrant waves. Borjas lyze impediments to the process of measures to support employment fmds that there has been a decline economic restructuring following in the contracting one. in the relative wage of successive In 1990, Colombia imple- Mexican immigrant waves mented a comprehensive in the past three decades, structural reform program and that little wage con­ "Borjas finds that there has been a decline involving the liberalization vergence occurs between in the relative wage of successive Mexican of trade and a tax reform the typical·Mexican immi­ immigrant waves in the past three de­ aimed at compensating for grant and the typical U.S.­ the decline in tariff revenue. born worker. Also, Mex­ cades, and that little wage convergence oc­ Lora and Steiner assess ican immigration accounts curs between the typical Mexican immi­ whether these reforms were for part of the decline in grant and the typical u.S.-born worker" responsible for recent chan- skills observed in the total ges in income distribution, immigrant population. particularly the widening of However, there has been a the rural-urban income gap decline in skills among non-Mexi­ reform. They argue that a major between 1990 and 1993. They con­ can immigrants, too. source of disruption is the "appro­ clude that, neither in the medium Fishlow focuses on three cen­ priability" that afflicts both labor nor in the short run, can the trade tral questions: the current state of and capital markets. The result is a or tax reforms be blamed for any economic inequality, noting the de­ depressed rate of creation of the deterioration in income distribu­ cline in Latin American perfor­ new productive structure, and ex­ tion. Instead, the surge in private mance in the last decade; relevant cessive destruction of the old pro- and public spending, the resulting

28. NBER Reporter Winter 1994/5 ------appreciation of the real exchange during the 1980s. At the beginning has been experiencing inflation rate, and the reduction in the pro­ of trade and market liberalization, levels well above 1000 percent a ducers' price of coffee caused by relative wages were misaligned by year since 1988 without entering the collapse of the external price as much as 40 percent as a result of the classical hyperinflation path. underlie the changes in income labor market interventions; adjust­ Two elements differentiate the Bra­ distribution. ment costs associated with migra­ zilian case from other hyperinfla­ Levy and van Wijnbergen dis­ tion flows were in the order of 1 tionary experiences: indexation, cuss the speed with which Mexican percent of total consumption. and the provision of a reliable do­ agriculture will be incorporated Overall, the authors find that labor mestic currency substitute (that is, into the North American Free Trade moves relatively freely and quickly the provision of liquidity to inter­ Agreement and the policies that between agricultural and nonagri­ est-bearing assets). Garcia claims will characte·rize the transition. cultural sectors. that this domestic currency substi­ They use Mexican agriculture as a Collins examines the determi- tute is the main SOurce of both the case study to analyze the inability of the Brazilian transition problems that central bank to fight infla­ arise in most major eco­ "[TJhere appears to have been a major tion and of the unwilling­ nomic reforms. They focus reduction in the perceived difficulty of ness of Brazilians to face the on: the implications for managing flexible rates during this period costs of such a fight. The policy design of the ab­ main macroeconomic conse- sence of efficient capital [1987-92J." quences of this monetary re­ markets; the welfare costs gime are: lack of a nominal of reforming only gradual- anchor for the price system ly; incentive problems created by nants and implications of the strik­ because of passive monetary pol­ trade adjustment policies; and the ing shift from fixed to mOre flexi­ icy; endogeneity of seignorage, un­ redistributive aspects of policy re­ ble exchange rate regimes among like in traditional models of hyper­ form in the presence of realistic countries in Latin America and the inflation; and ineffectiveness of limits on available intervention in­ Caribbean. For a sample of 24 very high real interest rates. struments. Their key point is that countries over 1978-92, she finds Economies that experience rapid adjustment should focus on in­ that misalignments (proxied by growth also experience major creasing the value of the assets current account deficits and moder­ changes in their consumption pat­ owned by the groups affected, and ate-to-high rates of inflation) were terns, especially in terms of con­ not on direct income transfers, or associated with a move to mOre sumer durables. Besley and Lev­ programs targeted on output, or flexible rates during 1978-86. Indi­ enson study the diffusion of dura­ other characteristics controlled by catorS of misalignments appear to bles in Taiwan between 1977 and the beneficiaries. They target ad­ have mattered less during 1987- 1991. They focus on the link be­ justment on what people have, as 92. However, there appears to tween household accumulation of opposed to what people do. have been a major reduction in the durables and participation in infor­ Quiroz and Cabezas ask how perceived difficulty of managing mal financial institutions. While quickly labor can move across dif­ flexible rates during this period. growth in per capita income in Tai­ ferent economic sectors, and in There is also some evidence that wan has been great, the emergence particular, the extent to which un­ after 1986 countries with very high of a developed financial system ap­ skilled labor· can migrate into or inflation opted for fixed rates. Col­ pears to have been slower: many out of the agricultural sector. In lins then cautions against attribut­ households still rely on traditional Chile, there was a wide and com­ ing differences in macroeconomic forms of finance. The authors find prehensive trade reform in the performance between groups of that rotating savings and credit as­ mid-1970s, and wide changes in countries to their exchange regime. sociations, which are found world­ relative price over the last 20 years. A classical hyperinflation is wide, exist to lower the cost of sav­ They find a reversal in migration marked by an acute acceleration of ing for durables. flows after the trade reform, and an the inflation level accompanied by Between 1987 and 1993, average increase in the real exchange rate rapid substitution away from do­ real urban full-time wages grew 30 that fostered agricultural growth mestic currency. However, Brazil percent and comparable employ-

NBER Reporter Winter 1994/5 29. ment grew 22 percent in Mexico. of monopoly power that they can in a less than proportional fashion. As in other developed countries, use to impose taxes on themselves, There are significant differences the wage premium for skills in and then use the resources to sub­ between the Latin American coun­ Mexico is rising. Cragg and Epel­ sidize unemployment in the South, tries and the rest of the sample, es­ baum ask why the demand for so as to prevent entrance into their pecially regarding demographic va- educated workers also is riables, growth, and social rising disproportionately security. Overall, the poor quickly. They conclude "Between 1987 and 1993, average real ur­ levels of private savings in that some labor is more ban full-time wages grew 30 percent and the region seem to be large­ complementary with capi­ ly a consequence on differ­ tal than other labor, and comparable employment grew 22 percent ent levels of their determi­ that shifts in demand are in Mexico." nants, rather than structural technologically based, and differences in the savings could result from skill- function. biased technological change. market. Trigueros analyzes the trade-off When a rich country (the North) Edwards considers the determi­ between risksharing and productiv­ integrates with a poorer country nants of savings in the world econ­ ity that results from legislated sev­ (the South), the result may be un­ omy, and analyzes why savings ra­ erance payments. He develops a employment in the South, as is the tios in Latin America traditionally simple analytical model for an case in Puerto Rico versus the Unit­ have been so low. Based on inter­ economy where restrictions on fir­ ed States, East versus West Germa­ national comparisons, with data ing adversely affect productivity, ny, South versus North Italy, or from 38 countries-both OECD and workers face risk. He then Spain and Ireland versus the Euro­ members and less developed na­ shows that unless fired workers pean Union. Moreover, there are tions-from 1970 to 1992, per capi­ face especially adverse conditions, significant fiscal transfers from the ta growth turns out to be the single which in the model is a long peri­ North to the South, mainly as sub­ most important determinant of od of time working for a relatively sidies to the unemployed. Haus­ both private and public savings. low wage rate, the productivity mann and Spilinbergo model Public savings tend to be lower in losses outweigh the riskspreading these facts assuming the presence countries with higher political in­ benefits of severance payments. of some fixed factors. This provides stability. Higher government sav­ The proceedings of this confer­ workers in the North with a degree ings crowd out private savings, but ence will be published in the jour­ nal ofDevelopment Economics.

," ':"".,- :-::::.!~:~-e;>;;··,:~:·~·~· - . ".:". . Sll;¢tidan l'ittllan,BQ~tofi -:N"BBB-U:di'\ie:rsities,·Research C"Ollege, "The Debt/f:q\Iiti. ·;~~il~r~1;1¢~·ii)6·:;c;<>j;R() ~te.Finan.ce Choice: .An:Anjtlysis'8tlss wng . .. Firms" Discussants: ...... ; .. ."Jeffi"ey ZWiebel, Stanford Mich~el J. Barclay, univiisity-bf' University, "Dynamic Capital Rochester, and .' '. ..•...... ;. '•. - iIA~1fif~~ltib:;!~~ StructUre Under Manag~rlal Robert 1.' McDbnald,NBE.R and ,a:ttci;rtd~;d:·the •.. $~iliiartiniair4g~R~ Entrenchment" Northwestern UIliversity. DisCussants: Cn#g,iewiS, varideibiit . ~lli;'~~fg~~~c;l;!~~~ DilvidHirshleifer, University of Ufliyersity,and '.' ". Michigan, and Ri#dJ. Rog~ld,and '.' "C'i:YrJ).

30. NBERReporterWinter 1994/5 ------DiSqls$an~: .. ' Cooperatives. Versus Outside ~ill~.GortQn, .·NBE,R'?p-ci.> Pa,ul~qtIithanc;L .. ' ...,' " '.' OW,Ilership" . '. Pfi~i.ersity ofPennl>y!Y·a.niit, ~nd . .DiScil$sants: fr~A;. ScluDict; Fr(Ole' .' ". =:~re:;="an~ '" Fra.pklin Allen, University of ·'.Pen:ru;yivania",·and·. ~#~jnO!.!:lriir;~~~~~fX· •. .Mil,to!'l.Harris; University of r·· .Chica.gO . . :?~ Ni9-toJasBarb~ris,·.Hai'Vard ,.••.• :',i'fj'i'r!:e:::..!iijW~(~;:, .' ·~~~~rbt~er'NBERan(F.· .··•·.• ·;·f}:r.:. ;;~~Et~~~d~iaj~ri,;;;J~~~i;i~i;~~~;~ ".;'.;. ·'Hao/ardUI1iversity,.. ·.·(QNp~gQ;·· '.. ';.,~;~i:..,;';:f .' ./'<:" ······Na~haT~Q~B9ston·.'f)aHaKWeiristehi;ab.&· .. ,;.~\ Qonsultillg Gro4P,and .' y~tmyYafeh,;HarVaid> •.. ..- ···.;=~:!;~7£:~~s,. .S£~lTSI; from,theRmsian Shops" .. B~rtkRela.tionsiil Japan" ...... ••• "./ 'DisCussants: .. ' Discussants: "'>" >.,. "~Bep'gtHolrruttrom, MIT; and •$teven N~, Kaplan,NBER:a.no/C., "ie'i'i ]onallianKarpoff, University of University ofChicagp;arid'·,···':.: -Washi1lgton, ..••... J),a:vJd,$., ScharfStein;NBER.~i).d;;, •. ,-"3.VidJ" Dettis·arid MIT·....•. •,.. ,', .. D1fuie·'K.D~riis; Virginia. . ..Phili.]>~.llerget;· Urliveisit)t6f'i:'~i: Oiscus#ntS:"Pdtytechniclrtstituteand Stite . Pennsylvania, and '< >. R()naldW~Masulis, Vanderbilt "University, and EliOfek.,"Bustup Takeoversp{...... '. University{.a.nd ...... AtuiyaSarii1; Santa: Clara yalue~DestroyingDiyersif1ed: <.:: Krishna G,Palepu,· Han;ard" . University, "Ownership Structure Firms~ University . . . , and Top Management Turnover" Discussants: OliverO;Hart,NBERarid" .... \ ..•...... •.•. DiscUssants: . ·Henri.S~rvaes, UniversityofNbitfL Harvard Uruveisity,and . .:.Mk1ia.e1C::. Weisbach, University .... Carolina, and '.. .••... . .·t~/ Johnl\:lOOre, LoridonS,chooLo(\\ .•. '" '. of'Arizoiiaand '. . .' ,'. Robert Comment, .U;S;S~tiirjJi~$;) arid Excha,nge Co1lllllis~i0n' . .. '. Econoinics;"The G6vern:ance.or>: ...:.• •.· .•.•.. 1.·JuOnliri.·l.".eJ...·r.·sMl:n.c,Conndl, Purdue Exchariges:¥eri1bers' . . v.'.,

Zwiebel develops a model in tions for the level, frequency, and to issue equity after experiencing a which debt constrains any ineffi­ term structure of debt as a function rise in their share price. This sug­ cient investments on the part of of outside investment opportunities. gests that firms do not select their empire-building managers because Opler and Titman compare the capital structures by trading off tax bankruptcy would have serious im­ characteristics of U.S. firms that is­ and other advantages of debt fi­ plications for their continued cor­ sued equity between 1976 and nancing with financial distress and porate control. Management volun­ 1993 to those that increased their other costs associated with debt. tarily chooses capital structure, in a use of debt financing. They find Lewis, Rogalski, and Seward manner that ensures enough effi­ that firms that were very profitable study announcements of convert­ ciency to prevent a future takeover. prior to the debt issue were more ible debt issues by a sample of 503 Managers are free to readjust lever­ likely to increase their use of debt NYSE/AMEX firms and 303 NAS­ age each period. A policy of divi­ financing; those that accumulated DAQ firms. For both sets of firms, dend payments coordinated with losses instead tended to issue equi­ before the issue share price perfor­ decisions about capital structure ty. These results confirm previous mance is abnormally good, and follows naturally, as do implica- findings that firms are most likely during the announcement period,

NBER Reporter Winter 1994/5 31. returns are significantly negative. document that the operating per­ likelihood of turnover among top After the issue, performance is formance of issuing firms shows management. Managers become poor. The authors suggest that the substantial improvement prior to entrenched at very low levels of factors that govern the design of the year of the offering, but then ownership. Consistent with this, convertible debt are consistent deteriorates, espedally for smaller the stock price reaction to a with a conflict between bondhold­ issuers. The multiples at the time change in management is signifi­ ers and stockholders. Also, the fac­ of the offerings do not reflect an cantly greater in firms in which the tors that explain security price re­ expectation of deteriorating perfor­ departing manager owns more actions differ across NYSE/AMEX mance. This is consistent with the than 1 percent of the firm's shares. and NASDAQ firms. Although no hypothesis that the stock price run­ Moreover, in these firms, the in­ one theory appears to explain up reflects a capitalization of transi­ coming manager's fractional own­ share price reactions fully, informa­ tory improvements. ership is typically less than 1 per­ tion asymmetries do influence the Hart and Moore ask why there cent, and the firm is subject to a share price reactions of both sets is a difference in governance struc­ higher rate of post-turnover corpo­ of firms. However, the source of ture between stock exchanges rate control. The authors also find the information asymmetry differs (which are cooperative) and other that turnover rates are higher in between NYSE/ AMEX and NAS­ businesses. Outside owners typical­ firms with unaffiliated blockholders DAQ firms. ly are interested only in maximiz­ and lower in firms with blockhold­ Calomiris, Orphanides, and ing profit, and thus tend to make ers who are affiliated with incum­ Sharpe examine the responsive­ inefficient dedsions, tailored to the bent managers. ness of employment, investment, marginal user. Collective dedsion­ As an alternative to a stock mar­ and inventory accumulation to making, on the other hand, is typi­ ket, universal banking provides in­ changes in sales. They fmd that a cally ineffident because the views formation for guiding investment firm's leverage conditions the re­ of the pivotal voter are not neces­ and for contesting corporate gover­ sponse of all three variables to sarily the same as those of the nance. In Germany, banks hold changes in sales. They also find membership as a whole. Hart and equity stakes in firms and have that this effect varies depending on Moore find that outside ownership proxy voting rights over other the state of the economy. During becomes relatively more effident agents' shares. In addition, banks recessions, higher leverage clearly than a membership cooperative as lend to firms and have representa­ magnifies the contractionary effect the variation across the member­ tives on corporate boards. Taking of declines in sales on investment. ship becomes more skewed and account of banks' equity holdings, During times of positive growth in the exchange faces more competi­ the extent of banks' proxy voting sales, higher leverage may dampen tion. Changes in the environment rights, and the ownership structure the expansionary effect of growth suggest that it now may be more of the firms' equity, Gorton and in demand. Leverage effects are efficient for London's stock ex­ Schmid investigate the influence larger and more significant during changes to be sold off and run by of banks on the performance of recessions. Firms that use debt to outside owners. German firms. They find that the finance expansion during times of Barberis, Shleifer, Tsukanova, performance of German firms im­ increasing demand suffer a re­ and Boycko study 413 shops in proves to the extent that German duced ability to maintain growth seven Russian dties that were pri­ banks own the firms' equity. There is during recessions as a conse­ vatized in 1992 and 1993. They find no evidence of conflicts of interest. quence of their higher leverage. principally that restructuring re­ Weinstein and Yafeh examine Recent studies have demonstrat­ quires new people with new skills. the effects of a bank-centered fi­ ed that firms conducting seasoned The success of transition "relies nancial system on firm perfor­ equity offerings have inordinately critically on rapid turnover in hu­ mance in Japan. They find that low stock returns during the five man capital,» they conclude. Skills when access to bond and equity years after the offering, following a may matter more than incentives. markets is limited, close bank-firm sharp run-up in the year prior to Denis, Denis, and Sarin report ties increase the availability of cap­ the offering. Using a sample of a significant negative relationship ital but do not lead to higher prof­ 1406 seasoned equity offerings dur­ between the fractional equity own­ itability or growth. This is largely ing 1979-89, Loughran and Ritter ership of top executives and the because banks enjoy more market

32. NBER Reporter Winter 1994/5 ------power when firms do not have easy access to other sources of fi­ Bureau News nance; they can charge higher in­ terest rates in exchange for liquidi­ ty services and can influence firms to avoid risky but profitable proj­ Martin Neil Baily Named to the ects. Finally, the authors demon­ strate that the liberalization of fi­ Council of Economic Advisers nancial markets is important in re­ ducing the market power of banks Martin Neil Baily, who has been Senior Fellow at the Brookings In­ by enhancing the contestability of a research associate of the National stitution in 1979 and a professor of financial markets. Bureau of Economic Research, has economics at the University of Berger and Ofek find that a loss been nominated a member of the Maryland in 1989. In spring 1993, in firm value from diversification is President's Council of Economic he took a leave of absence from related to the probabilities of future Advisers. If confirmed by the Sen­ his academic work to become a takeover and of breakups. They ate, Baily will replace Alan S. Blin­ Fellow of the McKinsey Global In­ show that leveraged buyouts are der, the former Princeton Universi­ stitute, a research group within Mc­ more likely than other acquirers to ty economist and NBER Research Kinsey and Company. target value-destroying diversified Associate who is now Vice-Chair­ Baily's principal fields of interest targets. Finally, they find that for a man of the Federal Reserve Board. are productivity, macroeconomic subsample of large diversified tar­ Baily was educated at Cam­ and employment policy, and ap­ gets, half are broken up after they bridge University (England) and plied microeconomics. He has are acquired; the effect on mean MIT, where he received his Ph.D. served as an academic advisor to value of diversification is negative in economics in 1972. After teach­ the Congressional Budget Office 22 percent to negative 33 percent ing at MIT and Yale, he became a and the Federal Reserve Board. for these firms. In contrast, the half not broken up after takeover have a mean valuation effect from diver­ sification of negative 3 to positive 6 percent.

NBER Reporter Winter 1994/5 33. Contradicting quantity theorists, stabilization through price stability term premium, plus the assumption Woodford argues that price levels and a low targeted inflation rate, that monetary policy involves the can be determined without refer­ and how external and domestic smoothing of an interest rate ence to the money supply. In his factors affected the realization of instrument-the short rate-togeth­ model, at the equilibrium price lev­ those goals. He also discussed the er with responses to the prevailing el, aggregate demand equals aggre­ EMU, and in particular how the is­ level of the spread. gate supply. For a wide class of sue of inter-European monetary Rotemberg shows that a simple policies, there exists a unique, per­ convergence affected both the sticky price model is consistent fect-foresight equilibrium path for goals of the Bundesbank and the with a variety of facts about the the price level. This equilibrium is value of the DM. correlation of prices and output, in determined largely by fiscal policy. McCallum. addresses a promi­ particular, a negative correlation Woodford controls for predeter­ nent empirical failure of the expec­ between detrended levels of out­ mined prices, so that unexpected tations theory of the term structure put and prices. This negative corre­ variations in nominal aggregate de­ of interest rates under the assump­ lation between the predictable mand affect output, not the price tion of rational expectations, which movements in output and the pre­ level, in the short run. He also dis­ concerns the magnitude of slope dictable movements in prices is cusses policies to control inflation coefficients in regressions of short­ present (and very strong) in U.S. that do not require control of the rate (or long-rate) changes on long data. He uses these and other facts path of a monetary aggregate. or short spreads. He shows that the to shed light on the degree to Caplin and Leahy analyze the empirical findings can be rational­ which the Federal Reserve has pur­ search for an optimal monetary ized with the expectations theory sued a policy designed to stabilize policy in the context of a monetary by recognition of an exogenous expected inflation. authority lowering interest rates to end a recession while trying not to ignite inflation. They argue that the policy needs to be more aggressive than the reaction it seeks to elicit. If a reduction in interest rates fails to stimulate growth, then policy­ makers will be forced to reduce rates again, so agents have an in­ centive to wait. Gradual policy ini­ tiatives therefore may elicit very lit­ tle reaction and are more likely to Additional Papers 1050 Massachusetts Avenue, Cam­ fail. bridge, MA 02138-5398. Additional Papers are not official Through examination of COMP­ "Education Finance in a Federal NBER Working Papers but are list­ USTAT data on 12,000 firms for System: Changing Investment Pat­ ed here as a convenience to NBER 1956-92, Mulligan fmds that large terns in Mexico," by Alec Ian researchers and prospective read­ firms hold less M1 as a percentage Gershberg and Til Schuermann ers. Additional Papers are free of of sales than small firms do. charge to Corporate Associates. For "Reducing Supply-Side Disincen­ Whether within or across indus­ all others there is a charge of tives to Job Creation: A Comment," tries, the elasticity of M1 balances $5.00 per Additional Paper re­ by Martin Feldstein with respect to sales is about 0.75. quested (Outside of the United "Financial Markets and Inflation Firms headquartered in counties States, add $10.00 for postage Under Imperfect Information,» by with high wages hold more money and handling.) Advance pay­ Jose De Gregorio and Federico for a given level of sales, which is ment is required on all orders. A. Sturzenegger consistent with the idea that time please do not send cash. Request "Reforms from Within-The Role of can substitute for money in the Additional Papers by name, in writ­ External Factors," by Joshua Ai­ provision of transactions services. ing, from Additional Papers, NBER, zenman and Sang-Seung Yi Schlesinger briefly explained the Bundesbank's goal of monetary

34. NBER Reporter Winter 1994/5 ------Research Associates for 1994-5

Andrew B. Abel Hope Connan Michael Grossmari Thomas E. MaCurdy Myron S. Scholest John M. Abowd Robert E. Cumby Sanford]. Grossman Jacques Mairesse' Anna J. Schwartz. Katharine G. Abraham" Michael R Darby Alan 1. Gust:rnarr. N.Greg(jry M~w G. William. Schwert Joshua Aizenmai:l Lance E. Davis Michael R Haines CharlesF. ManskJ.. NevinS;Scrimsfuw George A. Akerlof Angus S. Deaton Bronwyn H. Hall Rob.eltAMargp . Carl Shapiro . '...... •.. Alberto F. Alesina Jorge de Macedo Robert E. Hall James RMarkusen .' Matthew D; .Shapiro Steven G. Allen Peter A. Diamond Daniel S. Hamenn<,:sh '. Richard C. .Marston StevenShavell .. Joseph G. Altonji William T .. DickenS Lars P. Hansen .BennettT, McCaJ,lum Robert ].Shiller . Albert Ando W. Erwin DieWel1 Jeffrey E.. Harris RobertL McDonald AndreiShleifer Joshua Angrist Michael P. Dooley . OliVer Hart Daniel L. McFadden. John B,Shoven Richard]. Amott Rudiger W. Dornbusch Campbell Harvey CharlesE. McLure, Jr; ChristopherA. siIils Orley C. Ashenfelter Allan Drazen Jerry A.Hausman James LMedoff. Jody L Sindelar Paul Asquith Bernard Dumas Furnio Hayashi RobertC Merton BurtonSmger Jeremy Atack Jonathan Eaton Geoffrey Heal Brucep; Meyer Kenneth]. SingletOn Alan]. Auerbach Sebastian Edwards" James]. Heckman '. Jacob Mincer Hans-Werner Sihri David Backus Ronald G. Ehrenberg John F. Helliwell Jeffrey:A; Miron Jonathan S. Skintier Martin Neil Baily" Martin Eichenbaum Elhanan Helpman Frederic s: Mishkin" Joel B .. Slernrod Robert E. Baldwin Barry Eichengreen Patric H. Hendershott Olivia s; MitChell' F~A .. Sloan .. Laurence M. Ball David T. Ellwood" ]. Vernon Henderson Robert A. Moffitt Kenneth 1. Sokoloff Robert]. Barro Charles M. Engel Robert]. Hodrick Edward B. Montgomery Barbara]. Spencer Robert B. Barsky Stanley 1. Engerman Douro.as Holtz-Eakin John Mullahy Robert W. Staiger . . . Ann P. Bartel Robert F. Engle, III Charles Y. Horioka Richard Murnane Robert F. Stambaugh .'. Marianne Baxter Henry S. Farber R Glenn Hubbard Kevin M. Murphy Richard H. Steckel Ben S. Bernanke Daniel R Feenberg Charles R Hulten Michael1. Mussa" Jeremy c. Stein Ernst R Berndt Robert C. Feenstra Michael D. Hurd Stewart: C. Myers Joseph E. Stiglitz" B. Douglas Bernheim Martin Feldstein Casey khniowski M. Ishaq Nadiri James H. Stock Jeffrey 1. Bernstein Raquel Fernandez Robert P. Inman William D; Nordhaus Alan C. Stockman Olivier]. Blanchard Stanley Fischer" Takatoshi Ito" Maurice Obstfeld Rene M. Stulz David G. Blanchflower Price Fishback Adam B. Jaffe Ariel Pakes Lawrence H. Summers" Rebecca M. Blank Marjorie Flavin Michael C. Jensen Torsten Persson Richard C. Sutch Francine D. Blau Robert P. Flood, Jr.. Paul 1. Joskow Charles E. Phelps Lars E. O. Svensson Alan S. Blinder" Roderick Floud Boyan Jovanovic Robert S. Pindyck Richard Sylla Magnus Blomstrom Robert W. Fogel Theodore]. Joyce A. Mitchell Polinsky Paul]. Taubman David E. Bloom Richard Frank: Kenneth 1. Judd Clayne 1. Pope John B. Taylor Michael D. Bordo Jeffrey A. Frankel Edward]. Kane Robert H. Potter PeterTemin Severin Borenstein Richard B. Freeman Louis Kaplow Richard Portes Richard H. Thaler George]. Borjas Kenneth R French Lawrence F. Katz James M. Poterba Marie C. Thursby Axel H. Borsch-Supan Jacob A. Frenkel" Miles S. Kimball Edward C. Prescott Robert H. Topel Michael]. Boskin Benjamin M. Friedman Mervyn A. King" James E. Rauch Manuel Trajtenberg John Bound Kenneth A. Froot Robert King AssafRaZin James Trussell David F. Bradford Victor R Fuchs Morris M. Kleiner Peter C. Reiss Steven F. Venti James A. Brander Don Fullerton Lawrence]. Kotlikoff ]. David Richardson Robert W. Vishny William H. Branson Melvyn A. Fuss Kala Krishna . Hugh T. Rockoff John]. Wallis . Timothy F. Bresnahan David W. Galenson Alan B. Krueger" Dani Rodrik Mark W. Watson Charles C. Brown Robert E. Gallman Anne O. Krueger Kenneth S. Rogoff Philippe Weil Warren Browner Alan M. Garber Paul Krugman Christina D. Romer Thomas]. Weiss Michael Bruno" Martin Gaynor Naomi R Lamoreaux David H. Romer Kenneth D. West Willem H. Buiter Mark 1. Gertler Robert Z. Lawrence Paul M. Romer John Whalley Jeremyl. Bulow Paul]. Gertler Edward P. Lazear Andrew K. Rose Michael D. Whinston Ricardo]. Caballero Francesco Giavazzi Edward E. Leamer Nancy 1. Rose Eugene N.White John Y. Campbell Robert S. Gibbons John B. Legler Harvey S. Rosen Jeffrey G. Williamson David Card Alberto Giovannini Richard M. Levich Sherwin Rosen Larry T. Wimmer Dennis W. Carlton Claudia Goldin James M. Levinsohn Julio]. Rotemberg David A. Wise Stephen G. Cecchetti Fred Goldman Karen K. Lewis Michael Rothschild Ann Dryden Witte Gary Chamberlain Robert]. Gordon Eugene Lewit Richard S. Ruback Frank A. Wolak Lawrence Christiano Roger H. Gordon Gary D. Libecap Christopher Ruhm Barbara 1. Wolfe Richard H. Clarida Gary B. Gorton Frank R Lichtenberg Jeffrey D. Sachs Mark A. Wolfson Charles T. Clotfelter Wayne Gray Robert E. Lipsey Henry Saffer Michael Woodford Douglas Coate Jerry R Green AndrewW. La David S. Salkever Victor Zarnowitz John H. Cochrane Zvi Griliches Robert E. Lucas, Jr. Garth Saloner Richard]. Zeckhauser Susan M. Collins Vittorio U. Grilli" Harold S. Luft Thomas]. Sargent Stephen P. Zeldes George M. Constantinides Gene M. Grossman Lisa M. Lynch David S. Scharfstein Lynne Zucker Russell Cooper Herschel I. Grossman Jeffrey K. MacKie-Mason Richard Schmalensee

"On Leave for Government Service tOn Leave for Nongovernment Service

NBER Reporter Winter 1994/5 35. Campbell and Cochrane pre­ Hall concludes that the prime industry setting where technologi­ sent a consumption-based model driving force in economic fluctua­ cal progress that augments skilled that explains the equity premium tions is shifts in the marginal rate labor can be distinguished from and the predictability of excess of substitution between goods and other sources of economic growth. stock returns over a long horizon. work. In recessions, people would Based on a panel of 21 U.S. manu­ Their model also predicts the varia­ rather consume smaller volumes of facturing industries, their results in­ tion over time in the volatility of market goods and services, and dicate that technological progress stock returns. Campbell and Coch­ work correspondingly less. Shifts in that augments skilled labor is the rane's model implies that fluctua­ technology and government pur­ significant factor in productivity tions have important welfare costs. chases have only a small role in growth. Growth in conventional to­ Alesina and Perotti study redis­ fluctuations in hours of work. tal factor productivity vanishes tribution in a world characterized Chevalier and Scharfstein pre­ once the role of skilled labor and by the presence of labor unions sent a model in which markups of the growth in its human capital are and distortionary taxation. They price over marginal cost are coun­ accounted for properly. show that an increase in transfers tercyclical because of imperfections to retirees, for example, which is Kremer and Maskin suggest in the capital market. During reces­ that recent increases in wage in­ financed by distortionary taxation, sions, liquidity-constrained firms can generate a loss of competitive­ equality have been accompanied try to boost short-run profits by ness, an appreciation of the rela­ by increased segregation of high­ raising prices to cut their invest­ tive price of nontradables, and a and low-skill workers into separate ments in market share. Chevalier decrease in employment in all sec­ firms. A model in which workers of and Scharfstein show that during tors of the domestic economy. An different skill are imperfect substi­ increase in transfers toward the un­ regional and macroeconomic reces­ tutes can account for both trends. employed, even if financed by non­ sions, for example, the most finan­ The model implies that increased distortionary taxation, would have cially constrained supermarket segregation and wage inequality the same effect. Moreover, these chains tend to raise their prices rel­ can be explained either by techno­ effects of labor taxation depend on ative to less financially constrained logical change, or, more parsimo­ the degree of centralization of the chains. niously, through observed increas­ wage-setting process in the labor Kahn and lim develop a gen­ es in skill dispersion. market. eral equilibrium model in a multi-

36. NBER Reporter Winter 1994/5 ------Peseran and Potter develop a gration that uses only information rent quarter predicts a low level of model of u.s. output that allows about mean reversion in the outer real economic activity two to four for floor and ceiling effects to alter regimes. Unfortunately, they find, quarters in the future. the dynamics of output growth. Us­ in small samples, tests for cointe­ Diebold, Ohanian, and Berko­ ing post-Korean War quarterly da­ gration that use only the region witz propose a constructive frame­ ta, they find that the turning points outside the thresholds are not sub­ work for assessing agreement be­ of the business cycle provide new stantially more adept at detecting tween (generally misspecified) dy­ initial conditions for the ensuing threshold cointegration than stan­ namic equilibrium models and da­ growth process. This dependence dard linear methods are. ta. They use their goodness-of-fit on history of economic behavior is The mechanisms governing the criteria to produce estimators that not present in linear or approxi­ relationship of money, prices, and optimize economically relevant loss mately linear models, such as stan­ interest rates to the business cycle functions, and whose finite-sample dard implementations of real busi­ are one of the most studied and properties are approximated using ness cycle theory. disputed topics in macroeconom­ bootstrap procedures. Finally, they Balke and Fomby model the ics. In this paper, King and Wat­ provide a detailed illustrative appli­ discontinuous adjustment to a long­ son first document some key em­ cation to modeling the u.s. cattle run equilibrium as threshold co­ pirical aspects of this relationship. cycle. integration. They examine the abil­ They then ask how well three Phillips discusses modeling, es­ ity of some well-known tests for benchmark rational expectations timation, inference, and prediction nonlinearity to detect threshold be­ macroeconomic models-~ real for economic time series. The first havior in cointegrating relation­ business cycle model, a sticky part of his paper is concerned with ships. In addition, they consider a price model, and a liquidity effect Bayesian model determination, fore­ test for linearity that specifically model-account for these central cast evaluation, and the construc­ casts the double threshold model facts. While the models have di­ tion of evolving sequences of mod­ as the alternative hypothesis. Final­ verse successes and failures, none els that can adapt in dimension and ly, they examine a test for cointe­ can explain the fact that real and form (including the way in which gration that uses only information nominal interest rates are "inverted any nonstationarity in the data is about mean reversion in the outer leading indicators" of real econom­ modeled) as new characteristics in regimes. Unfortunately, they find, ic activity, that is, that a high real the data become evident. He per­ in small samples, tests for cointe- or nominal interest rate in the cur- forms simulations in order to study

------NBER ReporterWinter 1994/5 37. the forecasting performance of Quah finds that the much-her­ productivity while other sectors, these model determination proce­ alded uniform 2 percent rate of especially services, are driving ag­ dures in some multiple time-series convergence could arise for rea­ gregate convergence. They intro­ models with cointegration. The fi­ sons unrelated to the dynamics of duce a new measure of multifactor nal part of the paper reports on an economic growth. Further, the usu­ productivity that avoids problems empirical application of these ideas al empirical analyses-cross-section inherent to traditional total factor and methods to u.s. and u.K. mac­ (conditional) convergence regres­ productivity measures when com­ roeconomic data. sions, time-series modeling, panel paring productivity levels. They West develops procedures for data analysis-can be misleading also develop a model of trade, inference about the moments of for understanding convergence; a learning-by-doing, and spillovers smooth functions of out-of-sample model of polarization in economic that can explain convergence in predictions and prediction errors, growth clarifies those difficulties. some sectors and divergence in when there is a long time series of Third, the data, more revealingly others. predictions and realizations, and modeled, show persistence and im­ Also attending the meeting each prediction is based on regres­ mobility across countries: some were: Jushan Bai and Whitney sion parameters estimated from a evidence shows the poor getting Newey, MIT; Olivier J. Blanchard, long time series. The aim is to pro­ poorer, and the rich richer, with NBER and MIT; Russell Cooper, vide tools for inference about pre­ the middle class vanishing. Finally, NBER and Boston University; Su­ dictive accuracy and efficiency and, Quah observes convergence across zanne Cooper, Harvard University; more generally, about predictive u.s. states. Jesus Gonzalo, Boston University; ability. West allows for nonlinear Bernard and Jones examine the Bruce Hansen, Boston College; models and estimators, as well as role of sectors in aggregate con­ John Kennan, University of Wis­ for possible dependence of predic­ vergence for 14 OECD countries consin; Serena Ng, University of tions and prediction errors on esti­ from 1970-87. Their major finding Montreal; and James H. Stock, mated regression parameters. His is that manufacturing shows little NBER and Harvard University. simulations indicate that the proce­ evidence of convergence in either dures work well. labor productivity or multifactor

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38. NBER Reporter Winter 1994/5 ------Backus, Foresi, and Zin ex­ Allen and Karjalainen use a Grossman and Zhou consider a plore the practitioners' methodolo­ genetic algorithm to find technical fmancial market with two types of gy of choosing time-dependent pa­ trading rules for Standard & Poor's risk managers: insurers and nonin­ rameters that can fit a bond model Composite Stock Index in 1%3-89. suters. A noninsurer's objective is to selected asset prices. They show Compared to a simple buy-and­ to maximize the expected utility of that this can lead to systematic mis­ hold strategy, these trading rules his terminal wealth; an insurer's ob­ f pricing of some assets. For exam­ led to positive excess returns in the jective is the same, but is subject to I ple, the Black-Derman-Toy model out-of-sample test period of 1970- the constraint that his portfolio is likely to overprice call options 89. In addition, the rules appear to wealth never fall below a certain ~ on long bonds when interest rates reduce the variability of the re­ percentage of his initial capital (the exhibit· mean reversion. This mis­ turns. The authors also find that floor). The authors find that the pricing can be exploited, even the excess returns are both statisti­ equilibrium price is lower and the when no other traders offer the cally and economically significant, Sharpe ratio is higher with insurers mispriced assets. The authors argue even when transaction costs are than without them in states where more generally that time-depen­ taken into account. the insurers suffer losses. Good news lowers the Sharpe ratio, while dent parameters cannot substitute Andersen and Bollerslev study for sound fundamentals. bad news raises it. Price volatility the intra day seasonality in the vola­ also is higher in the presence of in­ tility Bekaert and Harvey propose a of returns in foreign exchange surers than it is in the absence of conditional measure of integration and equity markets. They show insurers. When good news comes, of the capital market that allows that pervasive seasonal patterns volatility falls; bad news raises vol­ characterization of both the cross have a strong impact on the dy­ atility. When the price goes up, in­ section and the time series of ex­ namic properties of high-frequency surers buy the risky asset; a fall in pected returns in developed and returns. Consequently, traditional the price will prompt the insurers emerging markets. Their measure time-series models developed for to sell it. The changes in the price allows them to describe expected the analysis of daily or lower-fre­ level, Sharpe ratio, and volatility all returns in countries that are seg­ quency returns turn out to be are most dramatic around the point mented from world capital markets grossly inadequate, and may give at which the wealth of the insurers in one part of the sample and be­ rise to very misleading conclusions is expected to equal the floor. come integrated later in the sam­ when estimated directly on raw Also attending the meeting were: ple. Their results suggest that a high-frequency returns. The explicit Andrew B. Abel, David S. Bates, number of emerging markets ex­ seasonal modeling procedure that Francis X. Diebold, Janice Eberly, hibit time-varying integration. Inter­ the authors develop sets the stage Karen K. Lewis, Robert F. Stam­ estingly, some markets appear to for formal integration of standard baugh, and Stephen P. Zeldes, be more integrated than one might volatility models with market mi­ NBER and University of Pennsylva­ expect based on prior knowledge crostructure variables. This allows nia; Marshall Blume, Urban Jer­ of investment restrictions. Other for a more comprehensive empiri­ mann, and Krishna Ramaswamy, markets appear segmented, even cal investigation of the fundamental University of Pennsylvania; and though foreigners have relatively determinants behind the volatility Rene M. Stulz, NBER and Ohio free access to their capital markets. clustering phenomenon. State University.

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NBER Reporter Winter 1994/5 39. that the drop in mean earnings is transitory for all demographic groups: for most groups, mean earnings exceed their pre-dip level within 18 months The dip in mean earnings results from the overrepre­ sentation of recent job losers among training program partidpants; Berman, Machin, and Bound document changes in employment structure in the manufacturing sec­ Whether an individual smoked cational attainment, wages, and test tors of a number of developed at age 18 is strongly correlated with scores. With school choice, im­ countries between 1970 and 1990. years of education. Evans and provements in student performance They find that in (almost) all cases, Montgomery show that the smok­ are concentrated among white there have been shifts toward in­ ing/education link varies systemati­ non-Hispanics, males, and students creased use of relatively skilled cally across age groups, and that who have a parent with at least a workers. This increased use of smoking also is correlated with high school degree, but perfor­ skilled labor is much more consis­ other life dedsions, such as home­ mance does not decline among tent with technology-based argu­ ownership. Their results hold in other students. Finally, in areas ments than with explanations three different datasets, and for where choice among public based on increased international both males and females. schools is easier, a smaller share of trade. Most of the observed shifts Hoxby finds that making it easi­ students attend private schools. in skill structure occur within er for parents to choose among The average earnings of partid­ industries. public schools for their children pants in government training pro­ Neal and Johnson use scores leads to better performance by stu­ grams decline during the period on the Armed Forces Qualifying dents relative to school costs. Areas prior to participation. Heckman Test, for persons who took the test with greater opportunities for and Smith use unique data from at age 18 or younger, as a measure choice among public schools have the recent experimental evaluation of skill. They have independent lower spending per pupil, lower of the training programs funded evidence that this measure is radal­ teacher salaries, and larger class under the Job Training Partnership ly unbiased. They show that differ­ sizes. However, the same areas Act to learn more about the dip, ences in family background and have on average better student and to identify the partidpants' de­ school environment contribute to performance, as measured by edu- cisions that underlie it. They show the racial gap in test scores.

40. NBER Reporter Winter 1994/5 ------Needleman examines the evi­ health care providers ta administer the paar by abaut 15 percent far dence far cast shifting and cast treatments that have minimal med­ preventive services and abaut 27 cutting by nanprofit and far-profit ical benefit, then the liability sys­ percent far curative services. In haspitals in Califarnia between tem may impase sadal casts far in summary, they find, expanding 1986 and 1990. He finds that nan­ excess .of the valume .of transfers it health insurance amang the nan­ profit, but nat far-prafit, haspitals administers. Using a unique langi­ paar in Jamaica will reduce public did shift casts fram fully paying ta tudinal dataset that matches infar­ expenditures an health care sub­ nanpaying patients during this pe­ matian an state tart laws with inpa­ stantially, dramatically imprave the riad. There is na substantial evi­ tient recards callected an elderly efficiency with which public ex­ dence .of cast cutting by haspitals Medicare recipients treated far a penditures are targeted ta the paar, with high uncampensated care, heart attack in 1989, Kessler and and increase access ta medical thaugh, and na evidence .of eca­ McClellan shaw that dactars da care. namic rents amang nanprofit has­ practice defensive medicine. Pa­ Extending subsidized health in­ pitals. Further, the ability .of nan­ tients fram states with relatively surance caverage ta certain papula­ profit haspitals in Califarnia ta shift lawer levels .of medical malpractice tian groups cauld cast substantially casts appears ta have declined be­ tart liability receive less intensive mare than anticipated, because tween 1986 and 1990, as did the treatment, but suffer na warse public caverage wauld be substitut­ ability .of far-prafit haspitals ta health autcames, than patients in ed far existing private insurance. charge higher prices than nanprof­ ather states, they find. Using the experience .of large ex­ its. Needleman's analysis suggests Using data from Jamaica, Gert­ pansians .of the Medicaid program that .one "service" pravided by ler and sturm estimate the exist­ in the late 1980s and early 1990s­ nanprafits is lawer prices. Nan­ ing demand far public and private which made almast .one-third .of prafits increase prices ta private medical care, and the likely impact children and aver 40 percent .of payers in the face .of high uncam­ an demand .of expanding health in­ pregnant wamen eligible far Med­ pensated care, but .otherwise their surance amang wage earners. They icaid caverage-Cutler and Gru­ prices wauld remain bel.ow thase calculate that expanded insurance ber .observe a reductian in private .of camparable far-profits far all but wauld result in a saving .of abaut insurance caverage amang chil­ a small grau p .of haspitals with 16 percent .of public expenditures dren, wamen, and warkers wha very high uncampensated care far curative services and abaut 14 caver them as dependents. They laads. The value .of these lawer percent .of public expenditures far estimate that raughly .one-third .of prices approximates the taxes that preventive services. In additian, the increase in Medicaid caverage in nanprofits might pay if they priced Gertler and Sturm estimate that in­ this era can be accaunted for by de­ and were taxed as far-profits. surance wauld increase the share clines in private insurance cave rage. If the fear .of liability drives .of public expenditures captured by

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NBER Reporter Winter 199415 41. Sinn studies the trade-off be­ Slem.rod develops a simple and over time and by location in writ­ tween average income and inequal­ general model of the behavioral re­ ten eligibility rules has relatively ity in an optimal welfare state. He sponse to income taxation, allow­ minor effects on the size and com­ shows that because of constant re­ ing the individual to choose both position of the eligible population, turns to risktaking, more redistribu­ labor supply and tax-avoiding ac­ but that stable rules have important tion could result in more, not less, tivities. He draws implications of consequences. Stable eligibility inequality. In general, optimal taxa­ the model for the study of labor rules discriminate on the basis of tion either will imply this paradox, supply, and for the incidence and income sources and family status. or that the economy is operating at effiCiency of taxation. Gokhale, Kotlikoff, and Sabel­ a point where more inequality im­ Henderson uses three panel haus find that the decline in U.S. plies a lower average income. datasets to investigate the relation­ saving over the past two decades Between 1980 and 1990, health ship between regulation of ground or so can be traced to two factors: insurance costs per covered worker level ozone and changes in both the redistribution of resources doubled in real terms, from $2000 air quality and industrial location toward older generations, which per worker to $4000. Cutler and patterns. For 1977-87, he finds consume much of their incomes, Madrian find that, over the same that: 1) a change in status within a from younger ones, which con­ time, hours of work increased for county in terms of national air sume very little; and increases in those with health insurance com­ quality standards leads to a wors­ the desire for consumption among pared to those without health in­ ening of air quality, as counties the elderly. Most of the redis­ surance by about 0.8 per week. and states relax enforcement; 2) tribution to the elderly reflects the This represents an increase of 1.5 counties in states that typically growth in Social Security, Medi­ to 2 percent in labor input over the spend more (controlling for the care, and Medicaid benefits. The time period. Further, hours in­ level and composition of economic increase in the elderly's desire to creased more rapidly in industries activity) on pollution abatement consume also may reflect govern­ with high health insurance costs have cleaner air; and 3) polluting ment policy, especially the fact that than in industries with low health industries tend to locate in counties Social Security benefits paid are in insurance costs. One explanation that have attained national air qual­ the form of annuities, and Medi­ for this is that health insurance is a ity standards. Further, in heavily care and Medicaid benefits are pro­ proxy for differences in skills polluted and congested areas, eco­ vided directly as medical goods among individuals. Using data from nomic activity over the day has and services. the 1984-8 panels of the Survey of been rescheduled to dampen the Income and Program Participation, height of daily ozone peaks. Cutler and Madrian also show that Heckman and Devine examine the increase in hours worked ap­ the structure and consequences of pears to be caused by increases in eligibility rules for a major social health insurance costs, rather than program: the Job Training Partner­ other factors. ship Act. They find that variation

42. NBER Reporter Winter 1994/5 ------Angrist and Lavy use special be biased by omitted factors in sizes, and are in larger classes with­ disability questions from the school family background. However, the in schools. enrollment supplement to the 1992 effects of IQ appear to be biased Manski and Dominitz design Current Population Survey to esti­ upward, and the effects of parents' and apply an interactive computer­ mate the relationship between ma­ socioeconomic status biased down­ administered personal interview ternal age at birth, children's dis­ ward, in Herrnstein and Murray's survey that asks high school stu­ ability status, and school progress. work. They may have greatly un­ dents and college undergraduates They find little association between derstated the influence of family what they would expect to earn if maternal age at birth and children's background on later income, there­ they were to complete different disability status. But there is a fore leaving a false impression that levels of schooling. The authors strong association between disabili­ family background is less impor­ find that the respondents, even as ty and grade repetition, and be­ tant to income and behavior than young as high school sophomores, tween maternal age at birth and IQ is. are both willing and able to answer grade repetition, conditional on For their study, Boozer and meaningfully. Despite wide varia­ disability status. The children of Rouse rely on two datasets that tion, there is a common belief that young mothers are much more measure overall pupil-teacher ra­ the returns to a college education likely to repeat one or more grades tios and individual class sizes with­ are positive, that earnings rise be­ than other children. Also, having a in schools: a survey that they con­ tween ages 30 and 40, and that father in the household is associat­ ducted on 500 New Jersey teachers one's own future earnings are rath­ ed with lower prevalence of dis­ from all grade levels; and the Na­ er uncertain. Moreover, respon­ ability and fewer grade repetitions. tional Longitudinal Survey of eighth dents tend to overestimate the cur­ rent degree of earnings inequality However, both of these effects ap­ graders in 1988. They find that in American society. pear to be explained almost entire­ both the pupil-teacher ratio and ly by higher household incomes in average class size may obscure im­ two-parent families. portant variation in class size with­ Korenman and Winship pre­ in schools. Compensatory educa­ sent preliminary results from their tion classes are small, and black project on IQ versus family back­ students are more likely than other ground, a reanalysis of Herrnstein students to be assigned to those and Murray's The Bell Curve. They classes. This reduces the potential reach three tentative and prelimi­ racial difference in average class nary conclusions. In general, the size. However, the authors find that in estimated effects of IQ on a youth's general, black students are both in economic success do not appear to schools with larger average class

NBER Reporter Winter 1994/5 43. I' i

Bewley interviewed 334 busi­ rational, dynamically consistent de­ riages and increasing the rate of ness people, labor leaders, unem­ cisionmaker who responds to stim­ out-of-wedlock births. ployment counselors, and manage­ uli associated with disturbances in Diamond, Shafir, and Tversky ment consultants to learn why the past. The behavior that arises present the results of survey ques­ wages and salaries do not decrease from this model is characterized by tions designed to shed light on the during recessions in response to sensitivities to external cues, costly psychology that underlies "money increased unemployment. He management of these cues, com­ illusion," regarding people's reac­ found that employers say that they mitment, and impatience based on tions to variations in inflation and resist cutting the pay of existing cues. prices. They propose that people employees largely out of fear that Lamont tests a cross-sectional often think about economic trans­ the shock of a reduced living stan­ implication of models of reputation actions both in nominal and in real dard, and the insult implied by and information revelation. He terms, and suggest that money illu­ lower pay, would hurt morale. Em­ finds that older, established fore­ sion arises from an interaction be­ ployers do not reduce the pay rates casters produce more radical fore­ tween these representations, which of new hires because they would casts. This indicates that reputa­ results in a bias toward a nominal resent being treated less favorably tional factors are at work in profes­ evaluation. than existing employees. Bewley sional macroeconomic forecasts. Using data from the Panel Study also finds that the unemployed Akerlof, Yellen, and Katz ex­ of Income Dynamics, Shiller and usually are rejected as overquali­ plicitly model out-of-wedlock birth Schneider create indexes of in­ fied if they apply for jobs paying a as the consequence of a sequence come for groupings of individuals. good deal less than what they of decisions-about premarital sex­ People are grouped into job clus­ earned before they were unem­ ual activity, the use of contracep­ ters based on occupations and in­ ployed. Employers fear that they tion, abortion in the event of preg­ dustries; the job clusters are de­ will be discontent, will be a threat nancy, and marriage and the use of fmed so that relatively few people to their supervisors, or that they AFDC in the event of birth. They ever move between them. For each will leave as soon as they find bet­ conclude that the legalization of of the job clusters and education ter work. abortion may have had a role in levels, the authors generate an in­ Laibson constructs a model of a decreasing the rate of shotgun mar- come index. These indexes may be

44. NBERReporterWinter 1994/5 ------used in settlement formulas for and Brookings Institution; William inson, University of Pennsylvania; contracts that promote income risk C. Brainard, Yale University; Pierre Xa vier Sala-i-Martin, NBER and management. Fortin, University of Quebec, Mont­ Yale University; and Martin L. Also attending this meeting real; Anil K. Kashyap, NBER and Weitzman, Harvard University. were: William T. Dickens, NBER University of Chicago; James Rob-

A considerable body of empiri­ data from a study of the productivi­ labor.) Larger firms, as evidenced cal research suggests that many ty of pharmaceutical research. by the number of plants owned by firrns respond slowly, if at all, to a They find little support for the hy­ the firm, spend a smaller fraction changing business environmental pothesis that "badly managed" of cost on white collar labor and a condition. Agency theorists have firms suffer from agency problems. larger fraction on equipment. In suggeste d that such apparently Adams studies the impact of in­ general, the price of equipment substandard performance may re­ dustrial Rand D on the composi­ discourages Rand D, the price of flect a divergence between the ob­ tion of inputs, and the reverse im­ white collar labor has no effect, jectives of the owners of the firm pact of factor prices and factor sav­ and prices of structures and blue and those of the firm's managers. ing on the demand for industrial R collar labor encourage firm Rand The organizational literature, on and D. He fmds that total Rand D D. Finally, the pool of industry R the other hand, argues that differ­ and D in the same state appears to ences in performance and sluggish is biased toward white collar labor substitute for firm Rand D in that response may reflect limits on ra­ and equipment. Rand D in the state, while the pool of industry R tionality of managers coupled with same state as a plant is biased to­ high information costs, the high ward white collar labor more than and D in the same product appears psychological costs of change, and toward equipment, while the re­ to stimulate Rand D of the firm. the importance of accountability verse is true for firm Rand D in Hellerstein, Neumark, and and reproducibility in the long­ the same applied product as the Troske combine U.S. data on indi­ term survival of firms. Cockburn plant. (Here Rand D is strongly bi­ vidual workers with data on ~he and Henderson contrast these two ased toward equipment capital, but plants in which they are employed, explanations using internal firm has a lesser effect on white collar and compare estimates of the rela-

NBER Reporter Winter 1994/5 45. tive wages of different workers to have not, but in most cases, this significant productivity or wage dif­ estimates of their relative marginal productivity premium exceeds the ferential between black and white productivities. They find that mar­ wage premium. Although workers workers. On the other hand, wom­ ried workers are both paid more aged 35 to 54 are as productive as en are paid significantly less than and are more productive than nev­ their younger counterparts, their men in nearly all cases, with the er-married workers. Workers who relative wage in some cases is sig­ wage differential estimated at be­ have attended college also are nificantly higher than their relative tween 27 and 43 percent. more productive than workers who productivity. The authors find no

Reprints Available A. Minton (NBER Working Paper 4299) No. 4276) 1923. "Multinational Corporations The following NBER Reprints, 1915. "How Long Do Unilateral and Productivity Convergence in intended for nonprofit education Target Zones Last?" by Bernard Mexico," by Magnus Blomstrom and research purposes, are now Dumas and lars E. O. Svensson and Edward N. Wolff (NBER available. (Previous issues of the (NBER Working Paper No. 3931) Working Paper No. 3141) NBER Reporter list titles 1-1911 and 1916. "Nominal Income Targeting," 1924. "What Explains the Growth contain abstracts of the Working by Robert E. Hall and N. Gregory of Developing Countries?" by Mag­ Papers cited below.) Mankiw (NBER Working Paper nus Blomstrom, Robert E. Lip­ These reprints are free of charge No. 4439) sey, and Mario Zejan (NBER to Corporate Associates. For all 1917. "Are Industrial-Country Con­ Working Paper No. 4132) others there is a charge of $5.00 sumption Risks Globally Diversi­ 1925. "Federal Reserve Policy: per reprint requested (Outside fied?" by Maurice Obstfeld (NBER Cause and Effect," by Matthew D. of the United States, add $10.00 Working Paper No. 4308) Shapiro (NBER Working Paper for postage and handling.) Ad­ 1918. "[The Taxation of Income No. 4342) vance payment is required on from Capital in the] United States," 1926. "Patterns in Exchange Rate all orders. please do not send by Don Fullerton and Marios Ka­ Forecasts for 25 Currencies," by cash. Reprints must be requested by rayannis (NBER Working Paper Menzie Chinn and Jeffrey A. number, in writing, from: Reprints, No. 2478) Frankel (NBER Working Paper NBER, 1050 Massachusetts Avenue, 1919. "Tax Policy and Urban Devel­ No. 3807) Cambridge, MA 02138-5398. opment: Evidence from the Indiana 1927. "Credit and Deferral as Inter­ Enterprise Zone Program," by Les­ national Investment Incentives," by 1912. "Inputs to Tax Policymaking: lie E. Papke (NBER Working James R. Hines, Jr. (NBER Work­ The Supply Side, the Deficit, and Paper No. 3945) ing Paper No. 4191) the Level Playing Field," by Don 1920. "The Importance of Precau­ 1928. "Intergenerational Altruism Fullerton (NBER Working Paper tionary Motives in Explaining Indi­ and the Effectiveness of Fiscal Poli­ No. 3507) vidual and Aggregate Saving," by cy-New Tests Based on Cohort 1913. "The Effects of Public Infra­ R. Glenn Hubbard, Jonathan S. Data," by Andrew B. Abel and structure and Rand D Capital on Skinner, and Stephen P. Zeldes Laurence J. Kotlikoff (NBER the Cost Structure and Performance (NBER Working Paper No. 4516) Working Paper No. 2490) of U.S. Manufacturing Industries," 1921. "Corporate Restructuring and 1929. "The Internationalization of by M. Ishaq Nadiri and Theofa­ Investment Horizons in the United Equity Markets," by Jeffrey A. nis P. Mamuneas (NBER Working States, 1976-87," by Bronwyn H. Frankel (NBER Working Paper Paper No. 3887) Hall (NBER Working Paper No. No. 4590) 1914. "Appointments of Outsiders 3794) 1930. "What Ends Recessions?" by to Japanese Boards: Determinants 1922. "Human Capital Under an Christina D. Romer and David and Implications for Managers," by Ideal Income Tax," by Louis Kap­ H. Romer (NBER Working Paper Steven N. Kaplan and Bernadette low (NBER Working Paper No. No. 4765)

46. NBER Reporter Winter 1994/5 ------Bureau Books

! . Reform, Recovery, Growth Theories and Growth in Light of the East Asian Experience Riform, Recovery, and Growth, edited by Rudiger Dornbusch and Sebastian Edwards, will be avail­ Growth Theories in Light of able this winter from the University the East Asian Experience of Chicago Press for $60.00. This (NBER-East Asia Seminar on Eco­ nomics, Volume 4) will be avail­ more technical sequel to the au­ able from the University of Chicago thors' The Macroeconomics of Press in January. This volume ana­ Populism in Latin America ex­ lyzes the phenomenal growth of amines why some countries have the last few decades in the newly recovered from the 1982 debt crisis, industrializing countries (NICs) in while others have stagnated. The East Asia. It examines the outward­ papers explore the effects of struc­ orientation (in contrast to closing tural reforms on trade liberaliza­ and protecting their home markets, tion, and the impact of stabilization as prescribed by earlier develop­ programs on the poor in Argentina, ment economists) adopted by the Bolivia, Brazil, Chile, Mexico, Peru, NICs, which has fostered growth and also Israel and Turkey. through exporting. The authors Dornbusch is the Ford Interna­ also look at the supportive role of tional Professor of economics at government policy vis-a.-vis trade, MIT and a research associate in the exchange rates, and the accumula­ international finance and macro­ tion and promotion of physical and economics program at the NBER. human capital. Edwards is Chief Economist for Lat­ The volume begins with an in­ in America and the Caribbean at troduction and two overview pa­ the World Bank, the Henry Ford II pers, continues with case studies of Professor of International Business the specific experiences of China, Economics at the University of Cal­ Taiwan, Korea, and Japan, and ifornia, Los Angeles, and a research concludes with several papers that address the broader question of the associate in the international trade relevance of outward-oriented and investment program at the growth theory for understanding NBER. the region's development. The price of this volume is $65.00. Its editors, Takatoshi Ito and Anne O. Krueger, have both been re­ search associates in the NBER's Program in International Trade and Macroeconomics. Ito is currently on leave from the NBER in the Re­ search Department of the Interna­ tional Monetary Fund. Krueger is a professor of economics at Stanford University.

NBER Reporter Winter 1994/5 47. Current Working Papers

.;~ :.;, .- competitive crash, and then test them. The most popular theories are far wrong, while the correct "~,~~~< view emphasizes the "internal" ad­ justment costs to organizations making IT investments. Under­ standing buyer behavior illumi­ nates not only the competitive crash, but also the factors underly­ ing the slow realization of the so­ cial gains to IT in large, complex applications more generally. 'delin~ated'by program, arealso'avauable.· ..... '., .' .' ',... . .~ .••. :': .•·· •. ·'i;.;;, Free Trade Taxation and "t~;~:~~~;rJJ!~~J!SE~~'tii%~{i~i~ii! Protectionist Taxation ;':te.a~~ly;.· the" tlumb~r(s) of "any 'W9fk{ng:: pap.~t($}: Y·9,1J.:;:~sl1. ·t~r <>f·-g¢.t:;.;·-. .;:::.;~./:~~:., Joel B. Slemrod >,.. _... : _ \ .' '.' .,:-: ... :._ ...- .. _: ..... ; ... -: "C_,," <'..:-:0-.,-: -...... ,..,:;'.:,:'.:-<. ,"', NBER Working Paper No. 4902 October 1994 JEL Nos. H20, F21 International Trade and Investment, ..' .d~tn~kof Ecooomic Lfteraturi;:(;a) sUbject.c()de~;wh~fl;~vail~bl~,hll·e. Public Economics listed after the date oLthepaper;.followed by tlie'p.rQ~ra:m.(s)of.res~:~r.G!:i'" represented· by .each paper.P.apersnotassociat~d;,witha4 .'. N:&~~~I1l".8g~;:t.M This paper explores the norma­ ar,e.listed as Miscellaneous. All H1st()riCal :Fa,ctprs jn.long~Jlllngr()~;;.ga~c. tive theory of international taxation pers are in the De~elopment ·of t;h~ J\merkanEcoDpmipr()gr.~W,:;,.'. '.. by recasting it in parallel with the •..• A comple~e lisLof NBER WbrldtlgPapers and~epr.i!1ts.c.i,nbea.cc~~,~~~· theory of international trade. I first on the Internet by using ourgpP:!:ier atnber.ha.1'Yard,edll:.A.p~tfa'c~;R.(~lL . set out a definition of "free trade P~P~l"s.·· issu~d sinc.E! .. Octoberrt:9.?~tare. pres.e!l~@cl·.bl1loyv-:,:t;(jr.1ii~'9?u,s. taxation," in the global context and ·.···p::l,p'~rs,se.epast issues of the .IVBERRejJotter ..• Yi o.tl®-gpal?etsate,ii1,t~9Jj$t:l· then in the unilateral context. I . to rilake results of NBER resean:h,avajJableto6therecon6triistSjii'p~no;l.@U,:; then evaluate against this standard . n.atYfortn encourage ·discussiorland.·.suggestiq!ls,·.f()rreVisiOnlj~fore~fthar.··· to.' both the existing international tax 'Pllblicatiofl.. 1heyare not revitiv.:-edl)y the BoaidofDirectgrs. ofth~ N~~R: , .;. " " . , " '. <.: " . " . , .', ~' .. ' . _ . , ...... : . ',1 regime and the U.S. international tax policy. I characterize which as­ pects of tax policy are free trade NBER Working Papers formation Technology" (IT) solu­ tions in an attempt to understand and which are protectionist; I dif­ the competitive crash in large-scale ferentiate between the "predatory protectionism" of tax havens and The Competitive Crash commercial computing. We study individual buyer data from two pe­ the "ownership protectionism" of in Large-Scale tax policies that favor domestically Commercial Computing riods: the mid-1980s, late in the pe­ riod of a mature and stable large­ resident multinational corporations. Timothy F. Bresnahan and Shane Greenstein systems market; and the early 1990s, very early in the diffusion of Resisting Migration: The NBER Working Paper No. 4901 a new, competitive technology­ Problems of Wage October 1994 client/server-when many buyers Rigidity and the Industrial Organization, Productivity chose to wait for the new technol­ Social Burden We examine the factors that un­ ogy to mature. We clarify the impli­ Assaf Razin and Efraim Sadka derlie buyer demand for large "In- cations of different theories of the NBER Working Paper No. 4903

48. NBER Reporter Winter 1994/5 ------October 1994 JEL Nos. D43, L65, M3 October 1994 JEL Nos. F2, H2, F22 Industrial Organization, Productivity JEL Nos. H23, H42, H71 International Finance and Public Economics The introduction of Tagamet in Macroeconomics, Labor Studies the United States in 1977 represent­ This paper develops a model of Like any trade activity in markets ed both a revolution in ulcer thera­ household choices regarding gar­ that function well, migration tends py and the beginning of an impor­ bage disposal, recycling, and litter­ to enhance the efficiency of the tant new industry. Today there are ing. In particular, we consider the allocation of resources. With non­ four Prescription Hz-antagonist impact of a user fee for garbage distortionary policy instruments for drugs: Tagamet, Zantac, Pepcid, collection on heterogeneous house­ income distribution that can com­ and Axid. They comprise a multi­ holds with different preferences for pensate losers, migration generates billion-dollar market for the treat­ recycling. Our model explains why income gains. But the gains tend to ment of ulcers and other gastric some households participate in be rather small. However, when acid conditions. curbside recycling programs even the labor market malfunctions and In this paper, we examine the without a user fee, while others do wages are rigid, migration exacer­ determinants of sales in this mar­ not participate, even with a user bates imperfections in the market. ket, using a carefully constructed fee, and why certain households Consequently, it may lead to losses dataset made possible by IMS litter. We find that an increase in to the established population that America. We concentrate particu­ the user fee could decrease aggre­ can be quite sizable. larly on the marketing of these gate recycling. Migration also imposes a toll on drugs to physicians through detail­ the welfare state. Being unable to ing and medical journal advertis­ Aging and Productivity, exclude migrants completely from ing. We also make an innovative Rationality and Matching: various entitlement programs and attempt to distinguish between "in­ Evidence from Economists public services, the modem welfare dustry-expanding" and "rivalrous" Daniel S. Hamermesh state finds it more and more costly marketing efforts. NBER Working Paper No. 4906 to run its various programs. We find that the impact of total October 1994 These two economic considera­ marketing on the expansion of JEL No. J41 tions may help to explain the overall industry sales declines as Labor Studies strong resistance to migration. Con­ the number of products on the Economists' productivity, as mea­ sequently, improvements in the market increases. In addition, we sured by publication in leading functioning of the labor market find that the stock of industry-ex­ journals, declines very sharply with (with possible compensation to panding marketing depreciates at a age. This is a rational response to wage earners who compete with near-zero rate, while the stock of economic incentives and/or chang­ unskilled migrants), and more se­ marketing oriented toward rival­ ing physical or mental abilities: lectivity in the scope of and eligi­ rous market share competition de- there is no difference by age in the bility for state entitlement pro­ . preciates at a 40 percent annual probability that an article submitted grams, may potentially ease the re­ rate. We also find that the prod­ to a leading journal will be accept­ ucts' sales are affected significantly sistance to migration from the es­ ed. The probability of acceptance tablished population to a large by price, quality attributes (such as does show increasing heterogene­ extent. the number of FDA-approved indi­ ity with age, which is related to the cations and the number of adverse quality of the author. This is con­ drug interactions), and order of en­ The Roles of Marketing, sistent with models of optimal in­ try into the market. Product Quality, and vestment in human capital, and es­ Price Competition in the pecially with occupational match­ Growth and Composition How a Fee Per Unit of ing models. of the u.s. Anti-Ulcer Garbage Affects Aggregate Drug Industry Recycling in a Model with Ernst R. Berndt, Linda Bui, Heterogeneous Households David Reiley, and Glen Urban Thomas C. Kinnaman and NBER Working Paper No. 4904 Don Fullerton October 1994 NBER Working Paper No. 4905

NBER Reporter Winter 1994/5 49. Investment Opportunities, accompanied by a significant posi­ suIts allow for predictions about Managerial Discretion, and tive abnormal return of 1.05 per­ which countries will become more the Security Issue Decision cent. The announcement of equity or less democratic in the future. Kooyui]ung, Yong-Cheol Kim, issues has a positive abnormal re­ and Rene M. stutz turn of 0.45 percent, Significant at Crime and the Job Market NBER Working Paper No. 4907 the 0.10 level, but this return can Richard B. Freeman October 1994 be attributed to one year in our NBER Working Paper No. 4910 Corporate Finance sample and is offset by a negative October 1994 abnormal return of 1.01 percent on Law and Economics, Labor Studies Given the agency costs of man­ the issue date. The abnormal re­ agerial discretion, equity finandng turns are related negatively to firm This paper presents evidence on is advantageous for the sharehold­ size; for equity issues (but not for the relationship among incarcera­ ers of firms with valuable invest­ convertible debt issues), large Japa­ tion, crime, and the economic in­ ment opportunities but not for the nese firms have Significant negative centives to crime, ranging from un­ shareholders of other firms. Ac­ abnormal returns at the announce­ employment to income inequality. cordingly, we find that firms with ment date. Our evidence is consis­ It makes three points: good investment opportunities: 1) tent with the view that Japanese 1) The United States has incar­ are more likely to issue equity than managers decide to issue shares cerated an extraordinarily high pro­ debt; 2) have a smaller abnormal based on different considerations portion of men of working age. In return (in absolute value) when the than American managers. 1993, 1.9 percent of the male work issue is announced; and 3) experi­ force was incarcerated; among ence substantial asset growth fol­ Democracy and Growth black males, 8.8 percent of the work force was incarcerated.. lowing the issue. Firms that issue Robert]. Barro equity, even though they do not 2) The rising trend in incarcera­ NBER Working Paper No. 4909 have good investment opportuni­ tion should have reduced the rate October 1994 ties, experience a larger abnormal of crime, through the incapacita­ JEL Nos. 010, 040 tion of criminals and through the return (in absolute value) when the Growth issue is announced, and invest deterrent effect of potential arrest more after the issue than compara­ I analyze growth and democracy and imprisonment. But administra­ ble firms that issue debt. (subjective indexes of political free­ tive records show no such drop in dom) for a panel of about 100 crime, and the victims' survey How Different Is Japanese countries from 1960 to 1990. The shows a fall far below what could Corporate Finance? An favorable effects on growth include be expected on the basis of inca­ Investigation of the maintenance of the rule of law, pacitation by itself. Information Content of free markets, small government 3) The implication is that, New Security Issues consumption, and high human cap­ among the noninstitutional popula­ ]un-Koo Kang and ital. Once these kinds of variables tion, there was an increased pro­ Rene M. stutz and the initial level of real per-cap­ pensity to commit crime. ita GDP are held constant, the NBER Working Paper No. 4908 The paper focuses on the possi­ overall effect of democracy on October 1994 bility that the continued high rate growth is weakly negative. There is Corporate Finance of crime in the United States, de­ a suggestion of a nonlinear rela­ spite massive imprisonment of We study the shareholder wealth tionship, in which democracy en­ criminals, may be one of the costs effects associated with 875 new se­ hances growth at low levels of po­ of the rising inequality in the coun­ curity issues in Japan from January litical freedom but depresses try, and in particular of the falling 1, 1985 to May 31, 1991. Our sam­ growth when a moderate level of real earnings of the less educated. ple includes public equity, private freedom has been attained already. While we lack a "smoking gun" for equity, rights offerings, straight Improvements in the standard of such a relationship, the preponder­ debt, warrant debt, and convertible living-measured by GDP, life ex­ ance of evidence suggests that eco­ debt issues. Contrary to the u.s. pectancy, and education-substan­ nomic incentives have played a experience, the announcement of tially raise the probability that polit­ role in the increased propensity to convertible debt issues in Japan is ical freedoms will grow. These re- commit crime.

50. NBER Reporter Winter 1994/5 ------The Dynamics of The socioeconomic performance Economic Conditions Part-Time Work of to day's workers depends not and Alcohol Problems Rebecca M. Blank only on their parents' skills, but Christopher ]. Ruhm NBER Working Paper No. 4911 also on the average skills of their NBER Working Paper No. 4914 November 1994 parents' ethnic group (or ethnic November 1994 ]EL No. ]22 capital). This paper investigates the ]EL No. Il2 Labor Studies link between that ethnic externality Health Economics and ethnic neighborhoods. The This paper uses 14 years of data evidence indicates that residential This study investigates the rela­ from the Panel Survey of Income segregation and the external effect tionship between macroeconomic Dynamics to explore choices made of ethnicity are linked, partly be­ conditions and two alcohol-related by adult women regarding full­ cause ethnic capital summarizes outcomes: liquor consumption, and time, part-time, or no labor market the socioeconomic background of highway vehicle fatalities. I esti­ work. A variety of models indicate the neighborhood where the chil­ mate fixed-effect models for the 48 that past choices should be impor­ dren were raised. Ethnicity has an contiguous states from 1975-88 and tant in predicting current labor sup­ external effect, even among per­ focus on within-state variations. Al­ ply choices. I compare the effec­ sons who grow up in the same cohol consumption and traffic deaths tiveness of several estimation strat­ neighborhood, when children are vary pro cyclically, with a major egies that require varying amounts exposed frequently to persons who portion of the effect of economic of historical information. My results share their ethnic background. downturns attributed to reductions indicate that past history is very im­ in income. The intake of hard li­ portant in predicting current labor quor is the most sensitive to the supply. Given the lack of data in Who Leaves? The state of the macro economy. How­ many cases, I then explore how Outmigration of ever, there is no evidence that fluc­ much is lost when little or no lon­ the Foreign Born tuations in economic conditions gitudinal information is available. George]. Borjas and have a disproportionate impact on In addition, I consider the sub­ Bernt Bratsberg the drunk driving of young adults. stantive role of part-time work in NBER Working Paper No. 4913 the labor market. Part-time workers November 1994 Cadillac Contracts and are a very heterogeneous group, in ]EL No.]l Up-Front Payments: the midst of very different labor Labor Studies Efficient Investment Under supply patterns. Most women use Expectation Damages We analyze return migration of Aaron S. Edlin part-time work as a temporary al­ foreign-born persons from the ternative to full-time work or to be­ NBER Working Paper No. 4915 United States. We argue that return November 1994 ing out of the labor market; few migration may have been planned ]EL No. KOO women use it as a transitional step as part of a life-cycle goal for some Law and Economics into full-time employment. I carry immigrants. Return migration also out simulations suggesting the po­ occurs because immigrants base This paper shows that up-front tential impact on future labor sup­ their initial migration decision on payments can playa crucial role in ply of mandating that low-skilled erroneous information about op­ providing efficient investment in­ women who are out of the labor portunities in the United States. We centives when contracts are incom­ market accept part-time work. use the 1980 Census, and adminis­ plete: they can eliminate the over­ trative data from the Immigration investment effect identified by Rog­ Ethnicity, Neighborhoods, and Naturalization Service, and erson (984) and Shavell (980) and Human Capital find that immigrants tend to return when courts use an expectation Externalities to wealthy countries that are not damage remedy. This method ex­ George]. Borjas too far from the United States. tends to complex contracting situa­ NBER Working Paper No. 4912 Moreover, return migration accen­ tions if parties combine up-front November 1994 tuates the characteristics of the payments with what we call "Cadil­ ]EL No.]l immigrant population left in the lac" contracts: contracts for a very Labor Studies United States. high quality or quantity. This com-

NBER Reporter Winter 1994/5 51. bination provides efficient invest­ of services in these markets. Eco­ taken into account, are more pro­ ment incentives in complex con­ nomic arguments alone seem un­ ductive and more profitable. They tracting problems when an expec­ able to explain the sharp diver­ are also more capital intensive, but tation damage remedy is accompa­ gence between the nature of public do not use more high-skilled labor. nied by a broad duty to mitigate policies with respect to education We also find that person-effects ex­ damages. An expectation remedy and medical care. Moreover, there plain 92 percent of interindustry appears well-suited to multidimen­ is virtually no evidence on the em­ wage differentials. sional, but one-sided, investment pirical magnitudes of many of the problems, in contrast to specific key parameters needed to guide An Economic Analysis performance, which Edlin and Reich­ policy in these areas, such as the of Works Councils elstein (1993) showed is well-suit­ social externalities associated with Richard B. Freeman and ed to two-sided, but unidimension­ primary and secondary education, Edward P. Lazear al, investment problems. or the degree to which adverse se­ NBER Working Paper No. 4918 lection in the insurance market November 1994 Government Intervention prevents the purchase of private Labor Studies in the Markets for insurance. Education and Health Works councils, mandated by Care: How and Why? High-Wage Workers and law and found in most Western Eu­ ropean economies, are elected James M. Poterba High-Wage Firms bodies of employees, with rights to NBER Working Paper No. 4916 John M. Abowd, Francis Kramarz, and David N. Margolis information, consultation and, in November 1994 some cases, codetermination of NBER Working Paper No. 4917 JEL Nos. H10, H51 employment conditions at local November 1994 Health Care, Labor Studies, workplaces. Many European em­ JEL Nos. J31, C23 Public Economics ployers and unions believe that Labor Studies Education and health care are councils improve communication the two largest government expen­ We study a longitudinal sample between workers and management, diture items in the United States. of over one million French workers raising social output, while reduc­ The public sector directly provides and more than 500,000 employing ing the speed with which decisions the majority of educational ser­ firms, decomposing real total annu­ are made. vices, through the public school al compensation per worker into This paper analyzes the opera­ bureaucracy, while most public components related to observable tion of councils as a means of im­ support for health care is chan­ characteristics, worker and firm proving social output by creating neled through a system of tax-sup­ heterogeneity, and residual varia­ more cooperative labor relations. ported government payments for tion. Except for the residual, all the We argue that councils are mandat­ services furnished by private pro­ components may be correlated in ed because: 1) the incentive for viders. The contrast between public an arbitrary fashion. companies to institute them and policies in these markets raises a We find that at the level of the delegate power to them falls short host ·of questions about the scope individual, "person-effects"-espe­ of the social incentive; 2) workers of government in a mixed econo- cially those not related to such ob­ provide more accurate information . my, and the structure of policies servables as education-are the to employers about preferences for market intervention. most important source of wage when councils have some say over This paper examines how two variation in France. Firm-effects, how that information is used; and standard arguments for government while important, are not as impor­ 3) the communication from em­ intervention in private markets­ tant as person-effects. ployers to workers produces social­ market failure and redistribution­ At the level of firms, we fmd, en­ ly desirable worker concessions in apply to the markets for education terprises that hire high-wage work­ bad times that would not occur and medical care. It then considers ers are more productive but not without this institution. We also the problem of "choice of instru­ more profitable. They also use compare a jury-style random selec­ ment": the choice among interven­ more capital and high-skilled em­ tion of works councilors with selec­ tion through price subsidies; man­ ployees. Enterprises that pay high­ tion via elections. dates; and direct public provision er wages, after person-effects are

52. NBER Reporter Winter 1994/5 ------A Model of Fiat Money with higher HMO market share. In Wage Differentials in and Barter addition, the quantity of services Italy: Market Forces, Fumio Hayashi and provided, measured by the number Institutions, and Inflation Akihiko Matsui of hours worked and the number Christopher L Erickson and NBER Working Paper No. 4919 of patients seen per week, is not Andrea Ichino November 1994 higher in these areas. While it is NBER Working Paper No. 4922 JEL Nos. D51, E42, E52 possible that physicians induce de­ November 1994 Monetary Economics mand to change the volume or mix Labor Studies of services provided to patients in During the 1970s, Italy experi­ We present an infinite-horizon ways that do not affect the number enced an extreme compression of model with capital in which fiat of hours worked or patients seen, it wage differentials, similar to the money and barter are two compet­ is also possible that FFS physicians better-known situation in Sweden. ing means of payment. Fiat money respond to competition from HMOs Most evidence suggests that this has value because barter is limited by adopting strategies in which the compression came to a stop around by the extent of a double coinci­ price for an office visit is reduced 1982-3, coincident with a major in­ dence of wants. The pattern of ex­ but prices for other services are stitutional change (the escalator change generally involves both raised. money and barter. We find that the clause in Italian union contracts), a major economic change (the slow­ Chicago rule is sufficient for Pareto The Effect of Credit efficiency, while nominal interest down in inflation), a major techno­ Market Competition on logical change (industrial restruc­ smoothing is necessary. For a spe­ Lending Relationships cific utility function, we provide a turing and the computer revolu­ Mitchell A. Petersen and tion), and a major political change complete characterization of the Raghuram G. Rajan patterns of exchange, and calculate (the loss of support for unions and NBER Working Paper No. 4921 their egalitarian pay policies). the range of inflation rates over November 1994 which a stationary monetary equi­ While we cannot distinguish defini­ JEL Nos. G21, G28, G32 tively among the relative influences librium exists. Corporate Finance of institutions, market forces, tech­ nology, and politics, our analysis of Does Competition from We show that the extent of com­ petition in credit markets is impor­ skill-level wage differentials and HMOs Affect Fee-for­ our comparisons at the individual Service Physicians? tant in determining the value of lending relationships. Creditors are level with the more laissez-faire Laurence C. Baker more likely to finance credit con­ U.S. system suggest that both infla­ NBER Working Paper No. 4920 strained firms when credit markets tion and egalitarian wage-setting November 1994 are concentrated because it is easi­ institutions have influenced Italian JEL Nos. 11, L8 er for these creditors to internalize wage compression importantly in Health Care the benefits of assisting the firms. the regular sector of the economy. This paper develops estimates of Our model has implications about Yet, this very compression may HMO market share for all counties the availability and the price of well have contributed to the flight in the United States, and then ex­ credit as firms age in different mar­ away from the regular sector of the amines the relationship between kets. We offer evidence for these economy at both ends of the skill HMO market share and the fee for implications from small business distribution, plausibly leading to a a normal office visit with an estab­ data, and conclude with conjec­ greater overall degree of inequality for the whole economy than is ap­ lished patient that 2845 fee-for-ser­ tures on the costs and benefits of parent from our analysis of wage vice (FFS) physicians charge. I esti­ liberalizing financial markets, as differentials in the regular sector. mate that increases of 10 percent­ well as the timing of such reforms. age points in HMO market share are associated with decreases of approximately 11 percent in the normal office visit fee. However, the incomes of the physiCians in the sample are not lower in areas

NBER Reporter Winter 1994/5 53. Tests of Three Parity of the 1986 change in U.S. interest bor supply. Combined with evi­ Conditions: Distinguishing allocation rules on the investment dence on changes in labor force Risk Premiums and and finandng decisions of Ameri­ participation rates with age, this pat­ Systematic Forecast Errors can multinationals. The 1986 change tern makes it unlikely that broad­ Richard C. Marston reduced the tax deductibility of the ened pension coverage explains a NBER Working Paper No. 4923 interest expenses of firms with ex­ substantial portion of the trend November 1994 cess foreign tax credits. The result­ toward earlier male retirement. JEL No. F31 ing increase in the cost of debt International Finance and gives firms incentives to substitute Technology and Trade Macroeconomics away from debt finance. Further­ Gene M. Grossman and more, to the extent that perfect fi­ Ellianan Helpman Two explanations typically are nancing substitutes are not avail­ NBER Working Paper No. 4926 given for why nominal or real re­ able, the overall cost of capital rises November 1994 turns differ across currencies: for­ as well. JEL Nos. FlO, 030, D41 eign exchange risk premiums and Our empirical tests indicate that International Trade and Investment systematic (rational) forecast errors. the loss of tax deductibility of par­ This study reexamines three parity ent-company interest expenses sig- We survey research on the rela­ conditions in international finance . nificantly reduces borrowing and tionship between technology and -uncovered interest parity, pur­ investing by firms with excess for­ trade. We begin with the old litera­ chasing power parity, and real in­ eign tax credits. The same firms ture, which treated the state of terest parity-to determine the rel­ tend to undertake new lease com­ technology as exogenous and ative importance of these two fac­ mitments, which may reflect that asked how changes in technology tors. I develop joint tests of the par­ leases are alternatives to capital affect the trade pattern and welfare. ity conditions by relating nominal ownership. In addition, ftrms affect­ Recent research has attempted to and real interest differentials and ed by the tax change tend to scale endogenize technological progress inflation differentials to the same back their foreign and total opera­ that results either from learning-by­ set of variables currently known to tions. These results are consistent doing or from investments in re­ investors. I then test parameter re­ with the hypothesis that firms sub­ search and development. This al­ strictions based on knowing that stitute away from debt when debt lows one to examine not only how risk premiums affect only nominal becomes more expensive, and that technology affects trade, but also and real interest differentials, but the loss of tax shields on interest how trade affects the evolution of not inflation differentials, while increases a firm's cost of capital. technology. We emphasize the par­ systematic errors in forecasting ex­ allels between the models with change rates affect only nominal Do Pensions Increase the learning-by-doing and those with interest differentials and inflation Labor Supply of Older Men? explicit Rand D, and highlight the differentials, but not real interest Christopher J. Ruhm role that the geographic extent of differentials. NBER Working Paper No. 4925 knowledge spillovers plays in me­ November 1994 diating the relationship between Interest Allocation Rules, JEL No. J26 trade and technological progress. Financing Patterns, and Aging, Labor Studies the Operations of Foreign-Owned Firms U.S. Multinationals This paper investigates the rela­ and U.S. Wages tionship between pension coverage Robert E. lipsey Kenneth A. Froot and and the retirement behavior of old­ James R. Hines, Jr. NBER Working Paper No. 4927 er men. Pensions are associated NBER Working Paper No. 4924 with higher rates of job holding for November 1994 November 1994 males in their late fifties and early JEL Nos. F23, J31 JEL Nos. H25, F23, G30 sixties, but with lower rates for International Trade and Investment, International Finance and those aged 65 through 69. The age Labor Studies Macroeconomics, International Trade at which one becomes employed Foreign-owned establishments and Investment, Public Economics at a job with pension coverage is in the United States pay higher This paper examines the impact correlated pOSitively with future la- wages, on average, than domesti-

54. NBERRepOrlerWinter 1994/5 ------cally owned establishments. The Health and Labor Force Physician Payments and foreign-owned establishments tend Participation of Older Infant Mortality: Evidence to be in higher-wage industries and Men, 1900-91 from Medicaid Fee Policy also to pay higher wages within in­ DoraLCosta Janet Currie, Jonathan Gruber, dustries. They tend to locate in NBER Working Paper No. 4929 and Michael Fischer lower-wage states, but to pay more November 1994 NBER Working Paper No. 4930 than domestically owned firms with­ JEL Nos. J26, N31 November 1994 in industries within states. Wages Aging, Development of the American JEL Nos. 118, H51 in general, and wages in domesti­ Economy, Health Economics, Health Care, Public Economics cally owned establishments, tend to be higher in states and indus­ Labor Studies While efforts to improve the tries in which foreign-owned estab­ I investigate how the relation­ health of the uninsured have fo­ lishments account for a larger pro­ ship between health status and re­ cused on demand side policies portion of employment. tirement among older men has such as increasing insurance cover­ Foreign-owned es tablishments changed since 1900, using weight age, supply side changes may be that were new in 1990, mostly adjusted for height, or Body Mass equally important. Yet there is little takeovers, had lower-than-average Index (BM!), as a proxy for health. direct evidence on the effect of • policies designed to increase the wage levels in that year, but larger I ftnd that both in 1900 and again supply of Medicaid services to the increases between 1990 and 1991. in 1985-91, the relative risk of la­ poor. We provide such evidence by Increases in sales per worker and bor force nonparticipation increases examining the relationship between average wages were larger where for the exceSSively lean and obese. infant mortality and the ratio of employment growth was lower, The BM! level that minimizes the Medicaid fees to private fees for possibly an indication that lower­ relative risk of labor force nonpar­ productivity, lower-wage workers obstetri cians/gynecolo gists. tidpation remains unchanged. were dropped by the new owners. We build a state- and year-spe­ However, in 1900 both the rela­ ciftc index of the fee ratio for 1979- Fixes: Of the Forward tive risk of nonparticipation among 92, a period of substantial variation Discount Puzzle men at low and high BMI levels, in relative Medicaid fees. We ftnd and the elasticity of nonparticipa­ Robert P. Flood and that increases in fee ratios are asso­ Andrew K. Rose tion with respect to BMI, were ciated with signiftcant declines in greater than today. This suggests NBER Working Paper No. 4928 the infant mortality rate. We also that health is now less important to November 1994 ftnd that higher fees raise payments the retirement decision than it was JEL No. F31 made to physicians and clinics un­ in the past. The difference in the International Finance and der the Medicaid program, but re­ Macroeconomics relative risk of nonparticipation is duce payments to hospitals. especially pronounced at high BM! Regressions of ex post changes Finally, we compare the cost ef­ levels. Declining physical job de­ fectiveness of reducing infant mor­ in floating exchange rates on ap­ mands and improved control of propriate interest differentials typi­ tality by increasing fee ratios to the chronic conditions may explain the efftcacy of reducing mortality by cally imply that the high interest difference. rate currency tends to appreciate: expanding the Medicaid eligibility The ftndings suggest that the im­ that is the "forward discount puz­ of pregnant women. Although our zle." Using data from the European pact of improvements in health on results are sensitive to the time pe­ Monetary System (EMS), we find participation rates is increasingly riod used, we conclude that raising that a large part of the forward dis­ more likely to be outweighed by fee ratios is at least as cost effective count puzzle vanishes in regimes the impact of other factors. Greater as increasing eligibility. with ftxed exchange rates. That is, efforts made to increase the incor­ deviations from uncovered interest poration of the old and disabled parity appear to vary depending into the labor force therefore may upon the exchange rate regime. By have a minimal impact on retire­ using the many EMS realignments, ment rates. The ftndings also imply we are also able to quantify the that in the past the economic costs "peso problem." of poor health were substantial.

NBER Reporter Winter 1994/5 55. International Patenting Taxes, Technology Transfer, gue that the 13.5 percent fall in fer­ and Technology Diffusion and the R and D Activities tility over 1970--82 increased the in­ Jonathan Eaton and of Multinational Firms come pressure on ob/gyns, and led Samuel Kortum James R. Hines, Jr. them to substitute from normal NBER Working Paper No. 4931 NBER Working Paper No. 4932 childbirth toward a more highly re­ November 1994 November 1994 imbursed alternative: cesarean de­ JEL Nos. F43, 014, 031 JEL Nos. H25, F23, H87 livery. Using a nationally represen­ Growth, International Trade and International Trade and Investment, tative microdataset for this period, Investment, Productivity Productivity, Public Economics we show that there is a strong cor­ relation between within-state de­ We model the invention of new Multinational ftrrns that use do­ clines in fertility and within-state technologies and their diffusion mestic technologies in foreign loca­ increases in cesarean utiliZation. across countries. Our model pre­ tions are required to pay royalties dicts that, eventually, all countries from foreign users to domestic will grow at the same rate, with Contagion and Bank owners. Foreign governments often Failures During the Great each country's productivity ranking tax these royalty payments. High determined by how rapidly it Depression: The June 1932 royalty tax rates raise the cost of Chicago Banking Panic adopts inventions. The common imported technologies. This paper growth rate depends on research Charles W. Calomiris and examines the effect of royalty taxes Joseph R. Mason efforts in all countries; research on the local Rand D intensities of effort is determined by how much NBER Working Paper No. 4934 foreign affiliates of multinational November 1994 inventions earn at home and corporations, looking both at for­ abroad. Patents affect the return to Development of the American eign-owned afftliates in the United Economy invention. States and at American-owned afftl­ We relate the decision to patent iates in other countries. The results Studies of banking before the an invention internationally to the indicate that higher royalty taxes Depression argue that panics were cost of patenting within a country, are associated with greater Rand D the result of depositor confusion and to the expected value of pat­ intensity on the part of affiliates, about the incidence of shocks, and ent protection in that country. Thus suggesting that local Rand D is a that interbank cooperation avoided we can infer the direction and substitute for imported technology. unwarranted failures. The Great magnitude of the international dif­ Depression-with its concentration fusion of technology from data on Physician Financial of bank failures at particular times international patenting, productivi­ Incentives and Cesarean and places-has been viewed as an ty, and research. Section Delivery exception. The June 1932 Chicago panic was a dramatic example of a We fit the model to data from Jonathan Gruber and banking panic during the Great the five leading research econo­ Maria Owings mies. The parameters indicate how Depression. NBER Working Paper No. 4933 much technology flows among We use individual bank data to November 1994 these countries, and how much address the question of whether JEL No. 111 each country earns from its inven­ solvent Chicago banks failed during Health Care, Public Economics tions domestically and elsewhere. the panic because of confusion by Our results imply that foreign The "induced demand" model depositors. We divide Chicago countries are important sources of states that, in the face of negative banks into three groups: panic fail­ technology even though countries shocks to income, physicians may ures; failures outside the panic win­ earn most of their return to innova­ exploit their relationship with pa­ dow; and survivors. We compare tion at home. For example, about tients by providing excessive care the characteristics of these three half of u.s. productivity growth de­ in order to maintain their incomes. groups to determine whether the rives from foreign technology, yet We test this model by analyzing a banks that failed during the panic u.s. inventors earn 98 percent of change in the financial environ­ were similar ex ante to those that the revenue from their inventions ment facing obstetrician/gynecolo­ survived the panic, or whether they domestically. gists during the 1970s: declining shared characteristics with other fertility in the United States. We ar- banks that failed.

56. NBER Reporter Winter 1994/5 ------Each category of comparison­ "Keynesian" models can account ferent levels of schooling. We also the market-to-book value of equity; for the most obvious cyclical pat­ elicit respondents' beliefs about the estimated probability of failure terns in all historical periods, while current earnings distributions. or duration of survival; the compo­ "new classical" models cannot. Whereas a scattering of earlier sition of debt; the rates of with­ Nominal wage rigidity was impor­ studies have elicited point expecta­ drawal of debt during 1931; and tant historically, and some models tions of earnings unconditional on the interest rates paid on debt­ of wage rigidity receive more sup­ future schooling, we elicit subjec­ leads to the same conclusion. port from history than others. A tive earnings distributions under al­ Banks that failed during the panic shortcoming of both Keynesian ternative scenarios for future earn­ were similar to others that failed and new classical approaches is ings. We find that respondents, and different from survivors. The the assumption that low-frequency even ones as young as high school special attributes of failing banks change is exogenous to demand. sophomores, are willing and able were distinguishable at least six The history of the Kuznets cycle il­ to respond meaningfully to ques­ months before the panic, and were lustrates how aggregate-demand tions eliciting their earnings expec­ reflected in stock prices, probabili­ shocks can produce endogenous tations in probabilistic form. Re­ ties of failure, debt composition, changes in aggregate supply. Econ­ spondents vary considerably in and interest rates at least that far in omies of scale, learning effects, their earnings expectations, but advance. We conclude that failures and convergences of expecta­ there is a common belief that the during the panic reflected relative tions-many within the spatial returns to a college education are weakness in the face of common contexts of city building and fron­ positive, and that earnings rise be­ asset value shock, rather than con­ tier settlement-seem to have been tween ages 30 and 40. There also is tagion. Other evidence points to especially important in making the a common belief that one's own fu­ cooperation among solvent Chica­ aggregate supply "path-depen­ ture earnings are rather uncertain. go banks as a key factor in avoid­ dent." Institutional innovation (par­ Moreover, respondents tend to ing unwarranted bank failures dur­ ticularly government regulation) overestimate the current degree of ing the panic. has been another source of endog­ earnings inequality in American enous change in aggregate supply. society. Historical Macroeconomic The historical view's emphasis and American on endogenous structural change Using Expectations Data Macroeconomic History pOints in the direction of a greater to Study Subjective Charles W. calomirls and use of panel and cross-section Income Expectations Christopher Hanes analysis over short sample periods JeffDominitz and NBER Working Paper No. 4935 to identify the sources and conse­ Charles F. Manski November 1994 quences of macroeconomic shocks. NBER Working Paper No. 4937 Development of the American November 1994 Economy, Economic Fluctuations Eliciting Student Labor Studies Macroeconomic history offers Expectations of the We have collected data on the more than longer time series or Returns to Schooling special "controlled experiments." It one-year-ahead income expecta­ Jeff Dominitz and tions of members of American suggests a historical definition of Charles F. Manski households in our Survey of Eco­ the economy, which has implica­ NBER Working Paper No. 4936 tions for macroeconometric meth­ nomic Expectations (SEE), a mod­ November 1994 ule of a national continuous tele­ ods. The defining characteristic of Labor Studies the historical view is its emphasis phone survey conducted at the on "path dependence": ways in We report here on the design University of Wisconsin. The in­ which the cumulative past, includ­ and first application of an interac­ come-expectations questions take ing the history of shocks and their tive computer-administered person­ this form: "What do you think is effects, change the structure of the al interview (CAP!) survey eliciting the percent chance (or what are economy. We review American from high school students and col­ the chances out of 100) that your macroeconomic history to illustrate lege undergraduates their expecta­ total household income, before its potential uses, and to draw out tions of the income they would taxes, will be less than Y over the methodological implications. earn if they were to complete dif- next 12 months?" We use the re-

NBER Reporter Winter 1994/5 57. sponses to a sequence of such mestic violence, but that the effect Disability Insurance questions posed for different in­ wears off quite quickly. We also Rejection Rates and come thresholds Y to estimate each find that current employment for the Labor Supply respondent's subjective probability the male is associated with lower of Older Workers distribution for next year's house­ levels of violence. However, like Jonathan Gruber and hold income. We use the estimates arrest, the effect of employment is Jeffrey D. Kubik to study the cross~sectional varia­ transitory. If the male becomes un­ NBER Working Paper No. 4941 tion in income expectations for employed, the level of violence November 1994 one year into the future. will increase quite rapidly. Vio­ JEL Nos. H55, J26 lence in one period is associated Aging, Health Care, Labor Studies, Monetary Policy and the with higher probabilities of vio­ Public Economics lence in subsequent periods. Term Structure of Disability Insurance CDI), which From a methodological perspec­ Interest Rates provides income support to dis­ tive, our results suggest that policy Bennett T. McCallum abled workers, has been criticized evaluation and deterrence research NBER Working Paper No. 4938 for inducing a large fall in the labor would benefit from using models November 1994 force participation rate of older that allow examination of the dy­ JEL Nos. E43, E58 workers. We study the effects of namic path of intervention effects. Economic Fluctuations, one policy response designed to The effect of private and social Monetary Economics address this moral hazard problem: programs need not be constant raising the rate at which DI claims This paper addresses a promi­ over time, and applying traditional, are denied. Initial DI applications nent empirical failure of the expec­ static models that necessarily im­ are decided at the state level, and, tations theory of the term structure pose such an assumption may pro­ in response to a funding crisis for of interest rates under the assump­ duce misleading results. For Minne­ the DI program in the late 1970s, tion of rational expectations: the apolis, static models produced the the states raised their rejection rates magnitude of slope coeffidents in re­ result that "arrest works." The dy­ for first-time applicants by 30 per­ gressions of short-rate Cor long-rate) namic model suggests a different cent on average. However, the ex­ changes on long-short spreads. I conclusion: "arrest buys us a little tent of this rise varied substantially show that the anomalous empirical time." findings can be rationalized with across states. We use this variation to estimate the reduction in labor the expectations theory by recog­ International Trade force nonparticipation among older nizing an exogenous random (but Theory: The Evidence workers in response to increases in possibly autoregressive) term pre­ Edward E. Leamer and the denial rate. A 10 percent in­ mium, plus assuming that monetary James Levinsohn crease in denial rates led to a 2.7 policy involves smoothing an inter­ NBER Working Paper No. 4940 percent fall in nonparticipation est rate instrument-the short rate November 1994 among 45-64-year-old males; be­ -along with responses to the pre­ JEL No. FlO tween 1/2 and 2/3 of this effect is a vailing level of the spread. International Trade and Investment true reduction in labor force leav­ ing, with the remainder accounted The Dynamics of This paper provides a critical look at recent empirical work in for by the return to work of denied Domestic Violence: international trade theory. We ask applicants. We find some support Does Arrest Matter? why empirical work in international for the notion that increases in de­ Ann Dryden Witte and trade perhaps has not been as in­ nial rates effectively target their in­ Helen V. Tauchen fluential as it could have been. We centive effects to more able indi­ NBER Working Paper No. 4939 also provide several suggestions on viduals; the fall in labor force non­ November 1994 directions for future empirical re­ participation was much stronger JEL Nos. K42, C32 search in international trade. among more able workers, accord­ Labor Studies ing to an anthropometric measure Using data collected by the Min­ of disability. neapolis Domestic Violence Experi­ ment, we find that arrest deters do-

58. NBER Reporter Winter 1994/5 ------Can Having Fewer primary option would have been to that took place during the immedi­ Partners Increase use their savings to protect against ate postwar period, beyond that of Prevalence of AIDS? the risk of accident. Under this an effective supporting actor. The Michael Kremer market condition, workers' com­ principal contribution of the GATT NBER Working Paper No. 4942 pensation should have caused a re­ during its first decade of operation December 1994 duction in households' precaution­ rests more in se curing binding JEL Nos. 110, 112 ary saving. Based on a sample of agreements on early tariff reduc­ Health Care, Health Economics over 7000 households surveyed for tions. This prevented countries the 1917-9 Bureau of Labor Statis­ from instituting higher tariffs as, If information about sexual his­ tics Cost-of-Living Study, our anal­ under the gUidance of other inter­ tory is not known equally by po­ ysis suggests that households did national institutions, import quotas tential partners, then sexual activity tend to save less, holding all else and foreign exchange controls has repercussions: abstinence by constant, if their states had work­ were being phased out during the individuals with few partners actu­ ers' compensation in force, This 1950s. ally increases the average probabil­ finding, together with information ity of HN infection in the pool of about the insurance industry, pro­ available partners. Since this in­ vides some evidence that insurance Generating Equality and creases the prevalence of HIV companies were not able to ef­ Eliminating Poverty, among high-activity people, who fectively offer workplace accident the Swedish Way disproportionately influence the fu­ insurance to a wide range of work­ Richard B. Freeman and ture spread of the disease, it also ers. By shifting the burden of insur­ Anders Bjorklund may increase the long-run preva­ ance from workers to employers, NBER Working Paper No. 4945 lence of AIDS. Preliminary calcula­ workers' compensation benefited December 1994 tions suggest that most people risk-averse workers who were ra­ Labor Studies have few enough partners that fur­ tioned out of the insurance market, ther reductions would increase the even if they paid for their more Sweden has a remarkable record prevalence of AIDS overall. There­ generous post-aCCident benefits in reducing inequality and virtually fore, public health messages will through lower wages. eliminating poverty. This paper be more likely to reduce the preva­ shows that: lence of AIDS and create positive The GATT's Contribution 1) Sweden achieved its egalitari­ results if they stress condom use, to Economic Recovery an income distribution and elimi­ rather than abstinence. in Postwar Western nated poverty largely because of its Europe system of earnings and income de­ Insurance Rationing Douglas A. Irwin termination, not because of the ho­ and the Origins of NBER Working Paper No. 4944 mogeneity of the population, nor Workers' Compensation December 1994 its educational system. Price V. Fishback and JEL Nos. F02, F13 2) In the job market, Sweden is Shawn Everett Kantor International Trade and Investment distinguished by a relatively egali­ NBER Working Paper No. 4943 This paper examines the role of tarian distribution of hours of work December 1994 trade liberalization under the Gen­ among those employed (which JEL Nos. D45, J38, N32 eral Agreement On Tariffs and may be an interrelated part of the Development of the American Trade (GATT) in promoting eco­ Swedish economic system) and, Economy nomic recovery and growth in Eu­ until the recent recession, by a high A central question concerning rope in the decade after World War employment rate. the economic motivation for the II. The formation of the GATT does 3) Tax and transfer poliCies con­ adoption of workers' compensation not appear to have stimulated a tribute substantially to Sweden's is the extent to which workers had particularly rapid liberalization of overall distribution record. In COn­ access to their desired levels of pri­ world trade in the decade after trast to many social welfare sys­ vate accident insurance around the 1947. Therefore, it is difficult to at­ tems, Sweden's is largely a work­ turn of the century. If insurance tribute much of a role to the GATT fare system, providing benefits for were rationed, then the workers' in the dramatic economic recovery those with some work activity.

NBER Reporter Winter 1994/5 59. 4) Part of Sweden's historic suc­ graphically localized effects occur Prices, Output, and Hours: cess in maintaining jobs for low­ for scientific discoveries character­ Empirical Analysis Based wage workers while raising their ized by natural excludability: those on a Sticky-Price Model wages was the result of polides that that can be learned only by work­ Julio J. Rotem.berg directly or indirectly buttressed de­ ing with discoverers or others who NBER working Paper No. 4948 mand for low-skill workers, notably have received the knowledge December 1994 through public sector employment through working together in the JEL Nos. E3, E5 5) Sweden's tax and transfer pol­ laboratory. Natural excludability re­ Economic Fluctuations, ides have maintained the position sults in intellectual capital, a transi­ Monetary Economics of lower-income workers and fami­ tory form of human capital, em­ I show that a simple sticky-price lies, including those with children, bodied in particular scientists whose model based on my 1982 work is during its recent economic decline. services must be employed in or­ der to practice the discovery. Con­ consistent with a variety of facts Intellectual Capital and tractual and/or ownership relation­ about the correlation of prices, the Firm: The Technology ships occur between firms and the hours, and output. In particular, I of Geographically university scientists with intellectu­ show that it is consistent with a Localized Knowledge al capital, and importantly deter­ negative correlation between the Spillovers mine firm productivity and growth. detrended levels of output and pri­ ces when both the price and out­ Lynne G. Zucker, Michael R. Darby, andJeff Armstrong Did Workers Pay for the put data are detrended by the Bev­ NBER Working Paper No. 4946 Passage of Workers' eridge-Nelson method. There is a December 1994 Compensation Laws? negative and very strong correla­ Productivity Price V. Fishback and tion between the predictable Shawn Everett Kantor movements in output and the pre­ We examine the effects of uni­ NBER Working Paper No. 4947 dictable movements in prices in versity-based "star" scientists on December 1994 U.S. data. Consistent with the mod­ three measures of performance for JEL Nos. J31, J38 el, this correlation is stronger than biotechnology enterprises in Cali­ Development of the American the correlations between prices fornia: the number of products in Economy, Labor Studies and hours of work. development; the number of prod­ I also study the size of the pre­ Market responses to legislative ucts on the market; and changes in dictable price movements associat­ reforms often mitigate the expected employment The star concept that ed with predictable output move­ gains that reformers promise in leg­ Zucker, Darby, and Brewer (1994) ments, and the degree to which islation. Contemporaries hailed demonstrated was important for there are predictable movements in workers' compensation as a boon the birth of U.S. biotechnology en­ monetary aggregates associated to workers because it raised the terprises also predicts geographi­ with predictable movements in out­ amount of post-accident compensa­ cally localized knowledge spill­ put. These facts shed light on the tion paid to injured workers. De­ overs, at least for products in de­ degree to which the Federal Reserve spite the large gains to workers, velopment. However, when we has pursued a policy designed to employers often supported the leg­ break down university stars into stabilize expected inflation. those who have collaborated on islation. Several wage samples from publications with scientists affiliat­ the early 1900s show that employ­ ed with the firm, and all other uni­ ers were able to pass a significant Education and Health: versity stars, there is a strong posi­ part of the added costs of higher Where There's Smoke tive effect of the linked stars on all post-accident compensation onto There's an Instrument three firm-performance measures, some workers in the form of re­ William N. Evans and Edward Montgomery and little or no evidence of an ef­ duced wages. However, the wage fect from the other university stars. offsets were smaller for union NBER Working Paper No. 4949 December 1994 We develop a new hypothesis workers than for nonunion workers. JEL Nos. J30,J31, 12 of geographically localized effects Health Economics, Labor Studies of university research that is con­ sistent with market exchange: geo- Fuchs has suggested that the

60. NBER Reporter Winter 1994/5 ------persistent positive correlation be­ similarities are caused primarily by lerns or learning, and market ineffi­ tween education and health habits preferences, rather than by labor ciencies. While the research to date can be explained by interpersonal supply responses to family similari­ has been able to better define the differences in the discount rate. If ties in wages. The wages of the "predictable excess return puzzle," he is correct, then some health father and mother influence the and to suggest the most likely di­ habits can be used as instruments wages of both sons and daughters. rections for future progress, no one for education in standard wage A "sibling" wage factor also plays explanation has provided a full an­ equations. We use "whether an in­ an important role in the detennina­ swer to the puzzle. dividual smoked at age 18" in such tion of wages. We find that inter­ Second is the "home bias puz­ a fashion. This instrument is corre­ generational correlations in wages zle." Empirical evidence shows that lated strongly with years of educa­ substantially overestimate the direct domestic residents do not diversify tion. We are not able to reject tests influence of fathers, and espedally suffiCiently into foreign stocks. This that show how the smoking/educa­ mothers, on wages. This is because evidence is clear whether in mod­ tion link varies systematically across the father's and mother's wages are els based on portfolio holdings or age cohorts and income groups. correlated positively. For the vari­ in consumption realizations across We do demonstrate that smoking at ance in earnings, the relative im­ countries. I examine several possi­ age 18 is correlated with other de­ portance of the direct effect of ble explanations, including non­ cisions made over time, such as wages, the labor supply response traded goods and market inefficien­ about homeownership. We repli­ induced by wages, and the effect cies, although even after consider­ cate the results in four additional of hours preferences varies by gen­ ing these possibilities, the puzzle datasets, and for both males and der, and by age in the case of remains. females. women. For all groups, most of the effect of wages on earnings is di­ Perspectives on PPP An Intergenerational rect, rather than through a labor and Long-Run Real Model of Wages, Hours, supply response. Exchange Rates and Earnings Kenneth A Froot and Joseph G. Altonji and Puzzles in International Kenneth Rogoff Thomas A Dunn Financial Markets NBER Working Paper No. 4952 NBER Working Paper No. 4950 Karen K. Lewis December 1994 December 1994 NBER Working Paper No. 4951 JEL Nos. Fl, F4 JEL Nos. DIO, J22, J3 December 1994 International Trade and Investment, Labor Studies Asset Pricing, International Finance and International Trade and Macroeconomics We develop and estimate a Macroeconomics model of the earnings, labor sup­ This paper presents a survey of This paper reviews the literature ply, and wages of young men and two basic puzzles in international on purchasing power parity (PPP) young women, their parents, and finance. The first is the "predictable and other models of the long-run their siblings. We estimate the excess return puzzle." The returns real exchange rate. We distinguish model using data on matched sib­ on deposits of foreign currency rel­ three stages of PPP testing, and fo­ ling and parent-child pairs from ative to deposits of domestic cur­ cus on what has been learned from the National Longitudinal Survey of rency should be equal because of each. The most important overall Labor Market Experience. We mea­ uncovered interest parity. However, lesson has been that the real ex­ sure the extent to which a set of researchers not only fmd that devi­ change rate appears stationary over unobserved parental and family ations from uncovered interest par­ suffiCiently long horizons. Howev­ factors that drive wage rates and ity are predictable, but also that er, we argue that tests that ask work hours independent of wage their variance exceeds the variance whether any linear combination of rates lead to similarities among in expected changes in the ex­ prices and exchange rates is sta­ family members in labor market change rate. I describe different ex­ tionary have not necessarily reject­ outcomes. planations of this phenomenon, in­ ed nonstationarity. We find strong similarities with­ cluding the view that excess re­ We also review a number of in the family in work hours run­ turns are driven by a foreign ex­ theories of the long-run real ex­ ning along gender lines. These change risk premium, peso prob- change rate-including the Balas-

NBER Reporter Winter 1994/5 61. sa-Samuelson hypothesis-as well effects, but the welfare implications but it also suggests that usury laws as the evidence supporting them. of their effects are more ambiguous. have had different functions over We argue that the persistence of Tax deductions and subsidies for time (for example, rent seeking; real exchange rate movements can child care have similarly ambiguous limiting agency problems within be generated by a number of sensi­ effects on welfare. For example, the church; limiting overcommit­ ble models, and that Balassa-Sam­ households that take a tax deduc­ ment of debts; and attacking com­ uelson effects seem important, but tion for child care pay higher prices merce generally). mainly for countries with widely for care, consume more hours of disparate levels of income growth. care, and consume higher-quality The Economic Benefits Finally, we present new evi­ daycare. from Immigration dence testing the law of one price GeorgeJ. Borjas on 200 years of historical commod­ Neither a Borrower nor a NBER Working Paper No. 4955 ity price data for England and Lender Be: An Economic December 1994 France. We also use a century of Analysis of Interest JEL No. J6 data from Argentina to test the pos­ Restrictions and Labor Studies sibility of sample-selection bias in Usury Laws tests of long-run PPP. Natives benefit from immigration Edward L G1aeser and mainly because of complementari­ Jose A. scheinkman Economic Effects of ties in production between immi­ NBER Working Paper No. 4954 grant workers and other factors. Quality Regulations in December 1994 the Daycare Industry These benefits are larger when im­ JEL Nos. G28, 010 migrants are suffiCiently "different" Ann Dryden Witte and Growth Tasneem Chipty from the stock of native inputs to NBER Working Paper No. 4953 Interest rate restrictions are production. The available evidence December 1994 among the most pervasive forms of suggests that the economic benefits JEL Nos. K23, L51 economic regulation. We explain from immigration for the United Labor Studies, Public Economics that these restrictions are a means States are small, on the order of $6 of primitive social insurance. Limits billion, and almost certainly less We estimate reduced-form mod­ on interest rates improve economic than $20 billion annually. However, els to discern the effect of state reg­ welfare, because agents borrow these gains could be increased con­ ulation on the quality of center and when they have temporary nega­ Siderably if the United States pur­ family daycare. Specifically, we tive shocks to income: interest rate sued an immigration policy that at­ consider the effects of the number restrictions transfer wealth to agents tracted a more skilled immigrant of mandated inspections, limits on flow. group size and staff! child ratio, and who have experienced those nega­ staff training requirements on equi­ tive shocks and whose marginal librium price and hours of care, utility of income is high. and on the quality of care as mea­ We assume that these shocks sured by the actual staff!child ratio. are not otherwise insurable, be­ Timothy Besley and Anne C. Case Our results indicate that child cause of problems related to asym­ NBER Working Paper No. 4956 care regulations do affect equilibri­ metric information, or the difficul­ December 1994 um price, hours of care, and staff! ties inherent in writing complex JEL Nos. H73, J38 child ratios. Child care regulations contracts. Our model predicts that Labor Studies, Public Economics are binding. In equilibrium, only interest rate restriction will be tight­ regulations about staff training ap­ er when income inequality is high The U.S. federal system provides pear to have consistently desirable (and not permanent) and when great potential for estimating the effects. Such regulations decrease growth rates are low. effects of policy on behavior. If equilibrium price and hours of Data from U.S. states support a state policymaking is purposeful care, and increase the staff/child ra­ connection between inequality and and responds to economic and po­ tio for both centers and family day­ usury laws. History suggests that litical conditions within the state, care. Regulations of group size and this social insurance mechanism is then it may be necessary for analy­ the staff/child ratio have significant one reason why usury laws persist, ses to identify and control for the

62. NBERReporterWinter 1994/5 ------forces that lead policies to change ing of devaluation. Using cross-sec­ well as a sample of OECD coun­ in order to obtain unbiased esti­ tional data on 80 peg episodes from tries, we find that countries with mates of a policy's incidence. In 17 Latin American countries from higher volatility have lower growth. this paper, we investigate how rec­ 1957-90, we find empirical support Adding standard control variables ognition of policy endogeneity af­ for the model's main predictions. strengthens the negative relation­ fects attempts to analyze policy in­ ship. We also fmd that volatility in­ cidence. Our context is workers' Hedging Options in a duced by goverrunent spending is compensation benefits. We believe GARCH Environment: assodated negatively with growth, that the analysis illustrates why it Testing the Term even after we control for both may be important to consider the Structure of Stochastic time- and country-ftxed effects. implications of policy endogeneity Volatility Models more generally. Robert F. Engle and The Effects of Joshua Rosenberg Unemployment Insurance The Size and Timing of NBER Working Paper No. 4958 Taxes and Benefits on Devaluations in December 1994 Layoffs Using Firm Capital-Controlled Asset Pricing and Individual Data Developing Economies Patricia M. Anderson and Robert P. Flood and We develop a methodology for Bruce D. Meyer Nancy P. Marion testing the term structure of volatil­ NBER Working Paper No. 4960 NBER Working Paper No. 4957 ity forecasts, and analyze models of December 1994 December 1994 the volatility of the S&P 500 index. JEL No. J65 JEL No. F3 We compare volatility models by Labor Studies, Public Economics Intemational Finance and their ability to hedge options posi­ We examine the effects of un­ Macroeconomics tions that are sensitive to the term structure of volatility. Overall, the employment insurance CUI) experi­ A developing country often pegs most effective hedge is a Black­ ence rating on layoffs, and fmd that its exchange rate to a single curren­ Scholes CBS) delta-gamma hedge, incomplete experience rating is cy, such as the U.S. dollar, even while the BS delta-vega hedge is responSible for over 20 percent of though it faces a higher inflation the least effective. The most suc­ temporary layoffs. The results are rate than the country to which it is more mixed when UI is seen as a cessful volatility hedge is "GARCH pegged. As a consequence, it expe­ components delta-gamma," sug­ firm adjustment cost, or a compo­ riences misalignments of the real nent of the worker compensation gesting that the GARCH compo­ exchange rate and a series of easily package. While the evidence favors nents estimate of the term structure antiCipated devaluations. While the the adjustment-cost model, some of of volatility is most accurate. The chaotic capital market events sur­ the predictions of each model we success of the BS delta-gamma rounding anticipated devaluations test are rejected by at least one of hedge may be attributable to can be avoided through capital our specifications. Using new data, mispricing in the options market controls, the country is still left we also confirm the correlation over the sample period. with the classic devaluation prob­ found in past studies between lem: when should it devalue, and experience rating proxies and lay­ by how much? Cross-Country Evidence offs. However, the differences In this paper, we consider a pol­ on the Link Between between these proxies and state icymaker who pegs the nominal Volatility and Growth a verage firm tax costs and the exchange rate and adjusts the peg Garey Ramey and anomalous instrumental variables Valerie A. Ramey periodically so as to minimize a set estimates that we fmd suggest that of costs. The future times for deval­ NBER Working Paper No. 4959 it may be inappropriate to interpret uations are not currently known. December 1994 this correlation causally. The size and timing of devaluations JEL Nos. E32, 040 are determined jointly. Growth, International Finance and Macroeconomics, This framework shows how Economic Fluctuations changes in the stochastic environ­ ment affect both the size and tim- In a sample of 92 countries, as

NBER Reporter Winter 1994/5 63. A Fundamental Objection I review and synthesize several nomic costs for debtor countries, to Tax Equity Norms: of the currents of a growing litera­ even if changes in the economic A Call for Utilitarianism ture concerned with these ques­ environment generate similar loss­ Louis Kaplow tions. I have three objectives: 1) to es for investors. NBER Working Paper No. 4961 describe the basic structure of in­ December 1994 ternational trade agreements as Getting Interventions JEL No. H21 they exist in practice; 2) to explore Right: How South Korea Public Economics theoretically the normative conse­ and Taiwan Grew Rich quences of actual and alternative DaniRodrik Anti-utilitarian norms often are trade agreements; and 3) to offer NBER Working Paper No. 4964 used in assessing tax systems. Two some theoretically based explana­ December 1994 motivations support this practice. tion for the structure of trade JEL Nos. 011, 040 First, many believe utilitarianism to agreements that we observe. I tack­ Growth, International Trade and not be suffiCiently egalitarian. Sec­ le the first objective by describing Investment, International Finance and ond, utilitarianism does not give in­ the important features of the Gen­ Macroeconomics dependent weight to other equit­ eral Agreement on Tariffs and able principles, notably concerns Trade, and the latter two objectives Most explanations of the eco­ that reforms may violate horizontal by reviewing a body of literature nomic growth of Korea and Taiwan equity or result in rank reversals in and drawing out its implications. since the early l%Os emphasize ex­ the income distribution. This inves­ port orientation. However, it is dif­ tigation suggests that a policymak­ A Retrospective on ficult to see how export orientation er who believes in the Pareto prin­ the Debt Crisis could have played a significant caus­ ciple-that any reform preferred by Michael P. Dooley al role in these countries' growth. The measured increase in the rela­ everyone should be adopted­ NBER Working Paper No. 4963 tive profitability of exports during cannot adhere conSistently to any December 1994 the l%Os is not Significant enough of these anti-utilitarian sentiments. JEL No. F34 to account for the phenomenal ex­ Moreover, the affirmative case for International Finance and port boom that ensued. Moreover, utilitarian tax policy assessment is Macroeconomics stronger than generally is appreciated exports initially were too small to In this paper, I argue that the in­ have a significant effect on ag­ International Rules ternational debt crisis of 1982 can gregate economic performance. and Institutions best be understood as a prolonged A more plaUSible story focuses for Trade Policy negotiation between commercial on the investment boom that took banks and their own governments Robert W. Staiger place in both countries. In the early about who would bear the eco­ 1960s, both economies had an ex­ NBER Working Paper No. 4962 nomic losses generated by loans tremely well-educated labor force December 1994 made to developing countries. I relative to their physical capital Intemational Trade and Investment contrast this interpretation of the stock, rendering the latent return to What are the potential benefits debt crisis with the more familiar capital quite high. By subsidizing from establishing intemational rules approach that emphasizes conflict and coordinating investment deci­ for the conduct of trade policy, and between debtor countries and their sions, government policy managed how should these rules be de­ creditors. to engineer a significant increase in signed? These questions are of cen­ My main conclusion is that the the private return to capital. An ex­ tral importance to the evolution of failure of governments of industrial ceptional degree of equality in in­ national trade policies in the post­ countries to resolve this conflict come and wealth helped, by ren­ war era, when an elaborate system with their banks transformed an dering government intervention ef­ of international rules has evolved unremarkable financial crisis into a fective and keeping it free of rent­ to facilitate the process of recipro­ decade-long economic crisis for seeking. The outward orientation cal trade liberalizion. Yet the theo­ debtor countries. My analysis also of the economy was the result of ry of trade policy traditionally has suggests that recent capital inflows the increase in demand for import­ had little to say about these rules to developing countries are less ed capital goods. and the issues that underlie them. likely to generate the same eco-

64. NBER Reporter Winter 1994/5 ------Market Underreaction random process, and therefore is in can manufacturing plants, we fmd to Open Market the spirit of the models of time de­ evidence consistent with spillovers Share Repurchases formation initially proposed by: from the export activity of multina­ David Ikenberry, Tauchen and Pitts (1983); Clark tional enterprises, but not with JosefIakonishok, and (1973); and more recently dis­ general export activity. Theo Vermae1en cussed by Stock (988); Lamoureux NBER Working Paper No. 4965 and Lastrapes (992); Muller et al. The Dynamics of Dual-Job December 1994 (1990); and Ghysels and Jasiak Holding and Job Mobility Corporate Finance (994). We do not require auxiliary Christina H. Paxson and data or assumptions on the causes Nachum Sicherman We examine long-run firm per­ of time flow. We provide strong NBER Working Paper No. 4968 formance following announce­ evidence for duration clustering be­ December 1994 ments of open market share repur­ yond a deterministic component for JEL Nos. J22, J63 chases that occurred during 1980 the financial transactions data we Labor Studies to 1990. We find that the average analyze. We show that a very sim­ This paper concerns the inci­ abnormal four-year buy-and-hold ple version of the model can ac­ dence and dynamics of dual-job return measured after the initial an­ count successfully for the signifi­ holding, and its link to job mobili­ nouncement is 12.1 percent. For cant auto correlations in the ob­ ty. The first section presents evi­ "value" stocks, companies more served durations between trades of dence on patterns of dual-job hold­ likely to be repurchasing shares IBM stock on the consolidated mar­ ing, changes in hours, and job mo­ because of undervaluation, the av­ ket. A simple transformation of the bility in the United States, based on erage abnormal return is 45.3 per­ duration data allows us to include data from the Panel Study of In­ cent. For repurchases announced volume in the model. by "glamour" stocks, in which un­ come Dynamics and the Current Population Survey. Our results indi­ dervaluation is less likely to be an Spillovers, Foreign important motive, no positive drift cate that most workers experience Investment, and dual-job holding sometime during in abnormal returns is observed. Export Behavior Thus, at least with respect to value their working lives, and that there Brian Aitken, Gordon H. Hanson, is a great deal of movement into stocks, the market errs in its initial re­ and Ann E. Harrison sponse and appears to ignore much and out of dual-job holding. Mobil­ NBER Working Paper No. 4967 ity into and out of second jobs is of the information conveyed through December 1994 repurchase announcements. associated with large changes in JEL Nos. F13, F23 weekly and annual hours, and there International Trade and Investment is evidence that dual-job holding is Forecasting Transaction Case studies of export behavior prompted by constraints on hours Rates: The Autoregressive on the main job. Conditional Duration suggest that firms that penetrate Model foreign markets reduce entry costs The second section of the article turns to theories of dual-job hold­ RobertF. Engle and for other potential exporters, either ing. Much of the empirical litera­ Jeffrey R. Russell through learning-by-doing or ture on second jobs is motivated by NBER Working Paper No. 4966 through establishing buyer-suppli­ er linkages. We pursue the idea a simple model of labor supply in December 1994 that spillovers associated with one which workers face upper con­ Asset Pricing firm's export activity reduce the straints on main-job hours: a work­ We propose a new statistical cost of foreign market access for er who would like to work more model for the analysis of data that other firms. We identify two poten­ on his main job, but cannot, will do not arrive in equal time inter­ tial sources of spillovers: export ac­ take a second job provided that the vals, such as financial transactions tivity in general, and the specific second-job wage is high enough. data, telephone calls, or sales data activities of multinational enterpris­ These models do not account for on commodities that are tracked es. We use a simple model of ex­ the fact that workers also may electronically. In contrast to fixed port behavior to derive a specifica­ avoid hours constraints by finding interval analysis, our model treats tion for the probability that a firm new main jobs with higher hours. the time between observations as a exports. Using panel data on Mexi- We develop a model of dual-job

NBER Reporter Winter 1994/5 65. holding and job mobility in which ent short-term debt instruments in duction of a new cereal brand by decisions to take second jobs and! investors' portfolios, and highlights General Mills in 1989: Apple Cin­ or change main jobs are made si­ the burdens associated with using namon Cheerios. I find that the vir­ multaneously. This model is consis­ relative interest rate relationships tual price is about twice the actual tent with our findings, and pro­ as business cycle indicators. price of Apple Cinnamon Cheerios. vides new insights into the eco­ Based on some simplifying approx­ nomics of dual-job holding and la­ Valuation of New Goods imations, I fmd that the CPI for ce­ bor mobility. Under Perfect and real may be overstated by about 25 Imperfect Competition percent because it neglects the ef­ Indicator Properties of Jerry A Hausman fect of new brands. the Paper-Bill Spread: NBER Working Paper No. 4970 I then extend the classical theory Lessons from December 1994 to the more realistic situation of im­ Recent Experience ]EL Nos. D43, C43 perfect competition among multi­ Benjamin M. Friedman and Productivity product firms. I then find that the Kenneth N. Kuttner increase in consumer welfare is NBER Working Paper No. 4969 The Consumer Price Index (CPI) only 85 percent as high as in the December 1994 attempts to answer the question of perfect competition case, so that ]EL Nos. E52, E32, E44 how much more (or less) income a the CPI for cereal still would be too Monetary Economics consumer requires to be as well off high by about 20 percent. in period one as in period zero, One feature of U.S. postwar busi­ given changes in prices, changes in ness cycles that by now is widely The Operation and the quality of goods, and the intro­ documented is the tendency of the Collapse of Fixed duction of new goods (or the dis­ spread between the respective in­ Exchange Rate Regimes appearance of existing goods). How­ terest rates on commercial paper Peter M. Garber and ever, the CPI has not attempted to and Treasury bills to widen shortly lars E. o. Svensson estimate the effect of the intro­ before the onset of recessions. By NBER Working Paper No. 4971 duction of new goods, despite the contrast, the paper-bill spread did December 1994 not anticipate the 1990-1 recession. recognition of their potential im­ ]EL Nos. F31, F33, F41 portance in a cost-of-living index. International Finance and This paper supports two (not mu­ Macroeconomics tually exclusive) explanations for In this paper, I first explain the this departure from past experi­ theory of cost-of-living indexes and This paper reviews the recent ence. First, at least part of the pre­ then demonstrate how new goods literature on exchange rate target dictive content of the paper-bill should be included. The correct zones and speculative attacks on spread with respect to business cy­ price to use for a good in its pre­ fixed exchange rates. The influen­ cle fluctuations stems from its role introduction period is the "virtual tial Krugman model of exchange as an indicator of monetary policy: price," which assumes that demand rate target zones has two main re­ the 1990-1 recession was unusual is zero. Estimating this virtual price sults: credible target zones stabilize in postwar U.S. experience in not requires estimation of a demand exchange rates more than funda­ being immediately precipitated by function, which in turn provides mentals (the "honeymoon effect"); tight monetary policy. Second, the expenditure function, which al­ and exchange rates depend on movements of the spread during lows exact calculation of the cost­ fundamentals according to a non­ the few years just prior to the of-living index. The data require­ linear uS-curve" with "smooth past­ 1990--1 recession were influenced ments are extensive, and the need ing." Yet almost all of the model's strongly by changes in the relative to specify and estimate a demand empirical implications have been quantities of commercial paper, function for a new brand among rejected overwhelmingly. bank CDs, and Treasury bills that many existing brands requires Later research has reconciled the occurred for reasons unrelated to some new econometric methods theory with the empirical results by the business cycle. that may have been obstacles to allowing for imperfectly credible This latter finding in particular the inclusion of new goods in the exchange rates and for intramargin­ sheds light on the important role of CPI up to this point. al central bank interventions. That imperfect substitutability of differ- As an example, I use the intro- research also has shown that non-

66. NBERReporterWinter 1994/5 ------linearities and smooth pasting are nored the existence of competition High Tech R and D probably empirically insignificant, policy when investigating trade Subsidies: Estimating the and that a linear managed-float policy. The two interact in impor­ Effects of Sematech model is a good approximation to tant ways, and pretending that Douglas A. Irwin and exchange rate target zones. trade policy in imperfectly compet­ Peter J. Klenow The literature on speculative at­ itive markets takes place in the ab­ NBER Working Paper No. 4974 tack has developed models built sence of any competition policy may December 1994 on the prindples of no antidpated lead to inadvertent policy outcomes. JEL Nos. 03, L63 price discontinuities, endogenous International Trade and Investment timing of the speculative attack, Bureaucracy, Infrastructure, and the attack occuJring when a fi­ and Economic Growth: Sparked by concerns about their nite amount of foreign exchange Evidence from u.s. Cities shrinking market share, 14 leading reserves remain. These models During the Progressive Era U.S. semiconductor producers, y.rith the financial assistance of the U.S. have been extended to include James E. Rauch government in the form of $100 random timing of attacks and alter­ NBER Working Paper No. 4973 million in annual subsidies, formed native post-attack regimes. In con­ December 1994 a joint Rand D consortium, Sema­ trast to target zone models, specu­ JEL Nos. D73, H54 lative attack models have been in­ Growth, Public Economics tech, in 1987. Using Compustat da­ fluenced by empirical results only ta on all U.S. semiconductor firms, to a small extent. Recent work in the sociology of we estimate the effects of Sematech economic development has em­ on members' Rand D spending, phasized that estab 1ishing a pro­ Competition Policy and profitability, investment, and pro­ fessional bureaucracy instead of ductivity. In so dOing, we test two International Trade political appointees is important to James A. Levinsohn hypotheses: the "commitment" hy­ the institutional environment in potheSiS, that Sematech obligates NBER Working Paper No. 4972 which private enterprise can flour­ member firms to spend more on December 1994 ish. I hypothesize that the estab­ high-spillover Rand Dj and the JEL No. F10 lishment of such a bureaucracy will International Trade and Investment "sharing" hypothesis, that Sematech lengthen the period that public de­ reduces duplication of member This paper presents a nontechni­ cisionmakers are willing to wait spending on Rand D. The commit­ cal discussion of economic issues before realizing the benefits of ex­ ment hypothesis provides a ratio­ that arise because of links between penditures. This leads to allocation nale for the government subsidies, competition (or antitrust) policy of a greater proportion of govern­ but the sharing hypothesis does and international trade. While re­ ment resources to projects with not. We find that Sematech did in­ long gestation periods, such as in­ cent advances in international trade duce members to cut their overall R theory have borrowed heavily from frastructure. Using data generated and D spending by about $300 mil­ the industrial organization litera­ by a "natural experiment" in the lion per year, which provides sup­ early part of this century, when a ture, this work has a schizophrenic port for the sharing hypothesis. quality to it. One of the inSights wave of municipal reform trans­ formed the governments of many that motivated the new trade theo­ Business Cycles and ry was the observation that many u.s. dties, and controlling for the effects of dty and time, I fmd that the Asset Structure markets were not perfectly compet­ of Foreign Trade itive. For the case of purely domes­ the adoption of Civil Service in­ Marianne Baxter and tic markets, the industrial organiza­ creases the share of total municipal Mario J. Crucini tion literature provided a founda­ expenditure allocated to road and NBER Working Paper No. 4975 tion for policy advice and most sewer investment. This increased December 1994 countries now have well-estab­ share raises the growth rate of dty lished public policy regarding com­ employment in manufacturing by JEL Nos. FH, F30, F41 petition between firms. While trade 0.5 percent per year. International Finance and theorists have borrowed heavily Macroeconomics from the theory of industrial orga­ International financial market nization, they seem to have ig- linkages are believed by many to

------NBER Reporter Winter 1994/5 67. be important for the international Both accounting and market borrower and lender is needed to transmission of business cycles, performance influence compensa­ resolve this question. since these linkages govern the ex­ tion. The salary and bonus compo­ tent to which individuals can nent of pay has become more sen­ Do Private Schools smooth consumption despite coun­ sitive to firm fmancial performance Provide Competition try-specific shocks to income. We over the past two decades, as has for Public Schools? develop a two-country, general total compensation. Further, there Caroline Minter Hoxby equilibrium model with restricted is no evidence that boards fail to NBER Working Paper No. 4978 asset trade, and provide a detailed penalize CEOs for poor financial December 1994 analysis of the channels through performance, or to reward them Public Economics which these financial linkages af­ dispropotionately well for good fect international business cycles. performance. Finally, the data sug­ Arguments in favor of school Our central finding is that the ab­ gest that in setting compensation, choice depend on the idea that sence of complete financial integra­ boards may discount extreme per­ competition between schools im­ tion may not be important if the formance-both high and low-rel­ proves the quality of education. shocks to national economies are ative to performance that lies with­ However, we have almost no em­ of low persistence, or are transmit­ in some "normal" band. pirical evidence on whether com­ ted rapidly across countries over petition actually affects school time. However, if shocks are highly Is There a "Credit Channel" quality. In this study, I use exoge­ persistent, or are not transmitted nous variation in the availability internationally, then the extent of for Monetary Policy? and cost of private school alterna­ financial integration is central to R. Glenn Hubbard tives to public schools to examine the international transmission of NBER Working Paper No. 4977 the effects of interschool competi­ business cycles. December 1994 JEL Nos. E4, E5 tion on public schools. CEO Pay and Firm Monetary Economics Because low quality in the pub­ lic schools raises the demand for Performance: Dynamics, This paper argues that the terms private schools, we cannot simply Asymmetries, and "money view" and "credit view" compare the outcomes of public Alternative Performance are not always well defined in the­ school students in areas with and Measures oretical and empirical debates over without substantial private school Paul L. Joskow and the transmission mechanism of enrollment. Such simple compar­ Nancy L. Rose monetary policy. Recent models of isons confound the effect of greater NBER Working Paper No. 4976 information and incentive prob­ private school competitiveness with December 1994 lems in financial markets suggest JEL Nos. G3, J3 that it is useful to decompose the the increased demand for private Industrial Organization transmission mechanism into two schools in areas where the public schools are poor. We explore the dynamic struc­ parts: one related to the effects of ture of the pay-for-performance re­ policy-induced changes on the I derive measures of the effect lationship in CEO compensation, overall level of the real costs of of private school competition from and quantify the effect of introduc­ funds; and one related to the "fi­ data on religious schools that are ing a more complex model of firm nancial accelerator" effects stem­ less expensive and difficult to set financial performance on the esti­ ming from the impact of policy ac­ up in areas densely populated by mated sensitivity to performance of tions on the financial positions of members of the affiliated religion, executive pay. We find that current borrowers or intermediaries. My re­ and represent nine out of ten pri­ compensation responds to past sults support the idea that the vate school students in the United performance, but that the effect de­ spending decisions of a significant States. I find that greater private cays considerably within two years. group of borrowers are influenced school competitiveness significantly This contrasts sharply with models by their balance sheet condition. raises the quality of public schools, of infinitely persistent effects of However, whether a bank lending as measured by the educational at­ performance that are implicitly as­ channel is operative is less clear. tainment, wages, and high school sumed in much of the empirical lit­ More micro evidence at the level of graduation rates of public school erature on compensation. individual transactions between students. In addition, I find some

68. NBER Reporter Winter 1994/5 ------evidence that public schools react spending, lower teacher salaries, ranked as more friendly to inves­ to greater competitiveness of pri­ and larger class sizes. The same tors. Second, CEO pay is lower for vate schools by paying higher areas have better average student utilities with relatively high or ris­ teacher salaries. performance, as measured by stu­ ing rates, or a higher proportion of dents' educational attainment, industrial sales. This is consistent Does Competition Among wages, and test scores. with earlier research that describes Public Schools Benefit I also find evidence of increased political pressures on electric rates. Students and Taxpayers? sorting, but no evidence that disad­ Finally, attributes of the commis­ Caroline Minter Hoxby vantaged groups are harmed by sion appointment and tenure rules affect CEO compensation in ways NBER Working Paper No. 4979 that sorting. Improvements in stu­ December 1994 dent performance are concentrated consistent with the political con­ straint hypothesis: for example, Public Economics among white non-Hispanics, males, and students who have a parent pay is lower in states with elected Many school choice proposals with at least a high school degree. commissioners than in states where would enable parents to choose However, student performance is commissioners are appointed by among public school districts in not worse among Hispanics, Afri­ the governor. Despite apparently their area, but not among private can-Americans, females, or stu­ effective pressure to constrain pay schools. Three reactions to easier dents who do not have a parent levels in this sector, however, we choice among public schools are with a high school degree. Also, fmd no evidence of related intrain­ predicted: First, there will be in­ student performance improves at dustry variation in the sensitivity of creased sorting of students and both ends of the distribution of pay to firm financial per~ormance. parents among schools. Analysts educational attainment and test instinctively worry that, with great­ scores. Finally, I find strong evi­ The Demand for er sorting, advantaged students will dence that a smaller share of stu­ Post-Patent Prescription gain at the expense of disadvan­ dents attend private schools in Pharmaceuticals taged students. areas where choice among public Judith K. Hellerstein Second, easier choice will en­ schools is easier. NBER Working Paper No. 4981 courage competition among December 1994 schools, forcing them to be more Political Constraints on JEL No. III productive (that is, to have better Executive Compensation: Health Care, Productivity Evidence from the Electric student performance per input). This paper asks why physicians Third, easier choice among public Utility Industry continue to prescribe trade-name Paul L Joskow, Nancy L Rose, schools will give parents less in­ drugs when less expensive generic and Catherine D. Wolfram centive to send their children to pri­ substitutes are available. I use a da­ NBER Working Paper No. 4980 vate schools. However, there is very taset on physicians, the multisource December 1994 little empirical evidence to sub­ drugs they prescribe, and their pa­ stantiate any of these predictions. JEL Nos. L5, L2, G3 tients, to study doctors' prescrip­ Industrial Organization This study attempts to fill that tion of generic versus trade-name gap. I examine easing choice This study explores the effect of drugs. I find that almost all physi­ among public schools using exoge­ regulatory and political constraints cians prescribe both types of drugs nous variation, generated by top­ on the level of CEO compensation to their patients. However, some ography, in the concentration of for 87 state-regulated electric utili­ physicians are always more likely public school districts in metropoli­ ties in 1978-90. The results suggest to prescribe trade-name drugs, tan areas. I derive measures of con­ that political pressures may con­ while others prescribe generics centration based on natural boun­ strain top executive pay levels in more often. While much of this be­ daries (rivers) that partially deter­ this industry. First, CEOs of firms havior cannot be explained by ob­ mine district size. I find that easier operating in regulatory environ­ servable characteristics of the choice does lead to greater produc­ ments characterized by investment physicians or their patients, it ap­ tivity. Areas with greater opportu­ banks as relatively "pro-consumer" pears that patients who are treated nities for choice among public receive lower compensation than by physicians with large numbers schools have lower per-pupil do CEOs of firms in environments of HMO or prepaid patients are

NBER Reporter Winter 1994/5 69. more likely to be prescribed gener­ out that even rules of origin that der flow generates an inverse rela­ ics. There is also a wide regional are not restrictive, namely those tionship between intensity and in­ variation in the propensity of phy­ that do not raise the costs of pro­ formation content. Empirically, sicians to prescribe generic drugs. I duction, have very pronounced ef­ low-intensity trades are more in­ conclude that physicians' behavior fects on trade and investment formative, supporting the hot-pota­ regarding prescriptions seems to be flows. We then look at some differ­ to hypothesis. based on habit persistence. ent ways of spedfying rules of ori­ gin under perfect competition. We The Swedish Experience Explaining Forward compare price- and cost-based of an Inflation Target Exchange Bias ... Intraday ROOs, and show that even if they lars E. O. Svensson Richard K. Lyons and are eqUivalent in the long run, they NBER Working Paper No. 4985 Andrew K. Rose are not eqUivalent in the short run January 1995 NBER Working Paper No. 4982 where capacity constraints can ex­ JEL Nos. E52, F33 January 1995 ist. We also show that some kinds International Finance and JEL Nos. G15, F31 of ROOs can be ranked in terms of Macroeconomics, Monetary Economics International Finance and their implications for producer This paper gives a brief account Macroeconomics profits. Further, under certain cir­ cumstances, making a ROO more of the Swedish experience with an Intraday interest rates are zero. stringent could even raise· welfare. inflation target in a floating ex­ Consequently, a foreign exchange Finally, we show that in the pres­ change rate regime. I identify, doc­ dealer can short a vulnerable cur­ ence of imperfect competition, ument, and discuss the current rency in the morning, close this po­ ROOs may raise output and reduce problems in Swedish monetary sition in the afternoon, and never prices as they become more stringent. policy and their origins. I then con­ face an interest cost. This tactic sider what can be done to remedy might seem especially attractive in Foreign Exchange Volume: those problems, and draw some times of crisis, since it suggests an SOWld and Fury general conclusions. The two main immunity to the central bank's in­ Signifying Nothing? current problems are the lack of terest rate defense. However, in Richard K. Lyons credibility of the target and the sig­ equilibrium, buyers of the vulnera­ NBER Working Paper No. 4984 nificant risk that the target will be ble currency typically must be com­ January 1995 missed. The reasons for the lack of pensated with an intra day capital JEL Nos. G15, F31 credibility include the fiscal situa­ gain as long as no devaluation oc­ International Finance and tion, the institutional setup of mon­ curs. That is, currencies under at­ Macroeconomics etary policy, the political division tack typically should appreCiate in­ about monetary policy, and the in­ traday. Using data on intraday ex­ This paper asks whether curren­ sufficient transparency of and com­ change rate changes within the Eu­ cy trading volume is informative, mitment to the current inflation-tar­ ropean Monetary System, we find and under what circumstances. geting policy. that this prediction is borne out. Specifically, I use transactions data to test whether trades occurring The Effect of Uncertainty Implementing Free Trade when trading intensity is high are on Investment: Some Areas: Rules of Origin more informative-dollar for dol­ Stylized Facts lar-than trades occurring when in­ and Hidden Protection John V. Leahy and tensity is low. The theory admits Kala Krishna and Toni M. Whited both possibilities, depending pri­ Anne O. Krueger NBER Working Paper No. 4986 marily on the posited information NBER Working Paper No. 4983 January 1995 structure. I present what I call a January 1995 JEL No. E2 hot-potato model of currency trad­ JEL No. F13 Economic Fluctuations ing, which explains why low-inten­ International Trade and Investment sity trades might be more informa­ The theoretical relationship be­ This paper focuses on the ef­ tive. In the model, the wave of in­ tween investment and uncertainty fects of rules of origin (ROOs) in ventory-management trading among is ambiguous. This paper briefly Free Trade Areas. We first point dealers following innovations in or- surveys the insights that theory has

70. NBER Reporter Winter 1994/5 ------to offer, and then runs a series of are driven by many forces other such as squared returns, is approxi­ simple tests aimed at evaluating the than government amenities, prop­ mately zero for squared returns empirical significance of various erty taxes lose their value as incen­ with past and future volumes, and theoretical effects. Our results from tive devices. positive for squared returns with a panel of U.S. manufacturing firms current volumes; and 4) abrupt indicate a negative effect of uncer­ A Dynamic Structural changes in prices and returns oc­ tainty on investment, consistent Model for Stock Return cur, and are hard to attach to with theories of irreversible invest­ Volatility and "news." This last feature is ob­ ment. We find no evidence for a Trading Volume tained by a version of the model in positive effect via the convexity of William A. Brock and which the Law of Large Numbers the marginal product of capital, Blake D. LeBaron fails in the large economy limit. and no evidence for the presence NBER Working Paper No. 4988 of a Capital Asset PriCing Model­ January 1995 based effect of risk. Asset Pricing We develop a structural model Historical Factors in The Incentive Effects that uses data on asset returns and of Property Taxes trading volume to determine wheth­ Long-Run Growth on Local Government er the autocorrelation in volatility Edward L. Glaeser comes from the fundamental being NBER Working Paper No. 4987 priced by the trading process or The Great Depression January 1995 from the trading process itself. In Peter Temin JEL Nos. H21, R50 the context of our model, the data NBER Historical Paper No. 62 Growth, Public Economics suggest that persistent volatility is November 1994 This paper applies the ideas of caused by traders experimenting JEL Nos. N12, N22 with different belief systems that Brennan and Buchanan (1977, 1978, This history of the Great Depres­ are based on both past and esti­ 1980) to local property taxes. sion was prepared for The Cam­ mated future profits. When local governments maximize bridge Economic History of the their revenues, property taxes pro­ We introduce adaptive agents, United States. It describes real and vide incentives for adequate provi­ in the spirit of Sargent (1993), imagined causes of the Depression; sion of amenities. Local provision whose strategies adapt more slowly bank failures and deflation; the Fed of amenities determines property than the trading process itself. This and the gold standard; the start of values, which then determine local leads to positive autocorrelation in recovery; the first New Deal; and tax revenues. As long as the de­ volatility and volume during the the second New Deal. I argue that mand for housing is inelastic, prop­ trading process; the positive auto­ adherence to the gold standard erty taxes will provide stronger in­ correlation is caused by persistence caused the Depression, that aban­ centives for local governments than of strategy patterns that are associ­ doning gold started the recovery, lump-sum taxes do. As current ated with high volatility and high and that several of the New Deal property values reflect expectations volume. measures adopted in the recovery about future amenity levels, prop­ At a rough level, our model is lasted in good order for half a centwy. erty taxes create incentives for able to reproduce qualitatively the even the most myopic government following features of the data: 1) The Price of Housing in to invest for the future. Local prop­ the autocorrelation function of a New York City, 1830-60 erty taxes also can act to limit the measure of volatility, such as Robert A. Margo incentives of localities to tax; there squared returns or absolute value NBER Historical Paper No. 63 are cases in which higher levels of of returns, is positive with a slowly November 1994 local property taxes lead to lower decaying tail; 2) the autocorrelation JEL Nos. N31, N61 overall tax burdens. I apply these function of a measure of trading ideas to the tax reform in the late activity, such as volume or turn­ The trend in the price of hous­ 1970s; one reason that tax reform over, is positive with a slowly de­ ing before the Civil War is one of may have been so successful is that caying tail; 3) the cross-correlation many unsolved mysteries of Ameri­ in a period in which land prices function of a measure of volatility, can economic history. The reasons

NBER Reporter Winter 1994/5 71. for the mystery are simple. Existing State insurance gained broad sup­ Factor Endowments, time series of antebellum housing port in these states because a coali­ Institutions, and prices are either not true price in­ tion of progressive legislators took Differential Paths of dexes, or else do not extend back control of their respective legisla­ Growth Among New World before 1850. tures, bringing with them the idea Economies: A View from This paper presents new archiv­ that government had the unique Economic Historians al evidence on the rental price of ability to correct imperfections in of the United States housing before the Civil War. The the market. The political environ­ Stanley L. Engerman and evidence is for the New York City ment in which state insurance Kenneth L. Sokoloff metropolitan area from 1830 to thrived in the 1910s provides im­ NBER Historical Paper No. 66 1860, and is drawn from newspa­ portant insights into the growth of December 1994 per advertisements. The advertise­ government in the 1930s and Many scholars are concerned ment are sufficiently detailed to al­ 1960s. The major social insurance low the construction of price in­ programs of the New Deal and the with why the United States and Canada have been so much more dexes that control for some hous­ Great Society were supported ing characteristics, as well as for lo­ widely at the time because the pri­ successful over time than other cation within the metropolitan vate market was seen as unable to New World economies. Since all New World societies enjoyed high area. solve a particular problem, such as levels of product per capita early in The most important finding is unemployment compensation, or their histories, the divergence must that the relative price of housing poverty in old age. This paper ar­ stem from the achievement of sus­ increased between 1830 and 1860. gues that the government's dramat­ tained economic growth by the Incorporating the new housing ic expansion after the 1932 federal United States and Canada during price indexes into existing antebel­ election had precedents; in fact, the the eighteenth and early nineteenth lum cost-of-living deflators (which ideological roots of New Deal ac­ centuries, while the others did not generally exclude housing) sug­ tivism were planted during the de­ manage to attain this goal until the gests that economic historians have bates over compulsory state insur­ late nineteeth or twentieth cen­ overestimated real wage growth ance and workers' compensation in turies. Although many explanations before the Civil War. the 1910s. have been offered, this paper high­ Cliometrics and the Nobel lights the relevance of substantial A Prelude to the Welfare differences in the degree of in­ State: Compulsory State Claudia Goldin NBER Historical Paper No. 65 equality in wealth, human capital, Insurance and Workers' and political power in accounting Compensation in December 1994 JEL No. NO for the variation in the records of Minnesota, Ohio, growth. Moreover, we suggest that and Washington In October 1993, the Royal Swe­ the roots of these disparities in in­ Price V. Fishback and dish Academy of Sciences awarded equality lay in differences in the Shawn Everett Kantor the Nobel Prize in Economics to initial factor endowments of the re­ NBER Historical Paper No. 64 Robert William Fogel and Douglass spective colonies. Of particular sig­ December 1994 Cecil North "for having renewed nificance were the suitability of the JEL Nos. H11, G28, N42 research in economic history." The country for the cultivation of sugar Dissatisfied with the high costs Academy noted that "they were and other crops, in which there of compensating workers for their pioneers in the branch of econom­ were economies of production in injuries, seven states enacted ic history that has been called the the use of slaves, and the presence legislation in the 1910s requiring 'new economic history,' or 'clio­ of large concentrations of Native employers to insure their workers' metrics.'" In this paper, I address Americans. Both of these condi­ compensation risks through exclu­ what cliometrics is, and how these tions encouraged the evolution of sive state insurance funds. This pa­ two Nobel Prize winners furthered societies in which relatively small per traces the political-economic the discipline of economics. elites of European descent could history of compulsory state insur­ hold highly disproportionate shares ance in three states in the 1910s: of the wealth, human capital, and Minnesota, Ohio, and Washington. political power-and establish eco-

72. NBER Reporter Winter 1994/5 nomic and political dominance Technical Papers is generated by a stochastic volatili­ over the mass of the population. ty model: that is, there is an unob­ Conspicuously absent from the Reported Income in the servable state variable that controls nearly all-inclusive list of New NLSY: Consistency Checks the volatility of the innovations in World colonies with these condi­ and Methods for the series. As Nelson (1992) and tions were the British settlements Cleaning the Data Nelson and Foster (1994) show, a in the northern part of North Amer­ Janet Currie and Nancy Cole misspecified ARCH model often will be able to estimate consistently ica. After demonstrating the impor­ NBER Technical Paper No. 160 (as a continuous time limit is ap­ tance of the early factor endow­ July 1994 ments for generating major differ­ proached) the unobserved volatility JEL No. C81 process, using information in the ences in inequality and in the Labor Studies structure of economies, we call at­ lagged residuals. This paper shows tention to the tendencies of gov­ The National Longitudinal Sur­ how to estimate such a volatility ernment policies to maintain the vey of Youth collects information process more efficiently using in­ formation in both lagged and led basic thrust of those initial condi­ about more than 20 separate com­ residuals. In particular, I expand to tions, or the same general degree ponents of respondent income. smoothing the optimal filtering re­ of inequality along the respective These disaggregated income com­ sults of Nelson and Foster, and economy's path of development. ponents provide many opportuni­ Nelson (1994). Finally, we explore the effects of ties to verify the consistency of the the degree of inequality on the data. We outline the procedures we evolution of institutions conducive have used to identify and "clean" Asymptotic Filtering to broad participation in the com­ measurement error in the disaggre­ Theory for Multivariate mercial economy, markets, and gated income variables. After clean­ ARCH Models technological change during this ing the income data at the disag­ Daniel B. Nelson specific era. We suggest that their gregated level, we reconstruct the NBER Technical Paper No. 162 greater equality in wealth, human measure of "family income" and re­ August 1994 capital, and political power may evaluate poverty status. While peo­ JEL No. C32 have predisposed the United States ple may not agree with all of our Asset Pricing and Canada toward earlier realiza­ methods, some of them may be ARCH models are used widely tion of sustained economic growth. useful to other researchers. to estimate conditional variances Overall, we argue that the role of We also highlight the value of and co variances in financial time­ factor endowments has been un­ the disaggregated data; without it, it series models. But how successfully derestimated, and the indepen­ would be impossible to improve can ARCH models carry out this es-· dence of institutional develop­ on the reported totals. Finally, we timation when they are misspeci­ ments from the factor endowments hope that with the advent of com­ fied, and how can they be con­ exaggerated, in theories of the dif­ puterized interviewing technology, structed optimally? Nelson and Fos­ ferential paths of growth among checks on the internal consistency of ter (1994) used continuous-record New World economies. the data of the kind that we propose asymptotics to answer these ques­ eventually may be built into inter­ tions in the univariate case. This viewing software, thereby improv­ paper considers the general multi­ ing the quality of the data collected. variate case. I am able to construct an asymptotically optimal ARCH Asymptotically Optimal model for estimating the condition­ Smoothing with al variance or conditional beta of a ARCH Models stock return given lagged returns Daniel B. Nelson on the stock, volume, market re­ turns, implicit volatility from op­ NBER Technical Paper No. 161 tions contracts, and other relevant August 1994 data. I also allow for time-varying JEL No. C32 shapes of conditional densities (for Asset Pricing example, "heteroskewticity" and Suppose an observed time series "heterokurticity").

NBER Reporter Winter 1994/5 73. Continuous-Record to ascertain whether various adap­ the researcher has sharp a pnon Asymptotics for tive forecasting techniques success­ knowledge about p and 1(. We de­ Rolling Sample fully handle any such instability. velop methods for constructing Variance Estimators We compute formal tests for insta­ confidence intervals for ~ that ac­ Dean P. Foster and bility and out-of-sample forecasts count for uncertainty in p and 1(. Daniel B. Nelson from 16 different models using a We use these results to estimate NBER Technical Paper No. 163 sample of 76 representative U.S. growth rates for real per capita August 1994 monthly postwar macroeconomic GDP in 128 countries. JEL No. C32 time series, constituting 5700 bivar­ Asset Pricing iate forecasting relations. The tests Accounting for Dropouts indicate widespread instability in Conditional covariances of asset in Evaluations of univariate and bivariate autoregres­ Social Experiments returns change over time. Research­ sive models. However, adaptive ers adopt many strategies to ac­ James J. Heckman, forecasting models, in particular Jeffrey Smith, and commodate conditional heteroske­ time-varying parameter models, Christopher Taber dasticity. Among the most popular have limited success in exploiting NBER Technical Paper No. 166 are: 1) chopping the data into short this instability to improve upon September 1994 blocks of time, and assuming ho­ fixed-parameter or recursive auto­ JEL Nos. C81, C34 moskedasticity within the blocks; regressive forecasts. Labor Studies 2) performing one-sided rolling re­ gressions, in which only data from, Estimating Deterministic This paper considers the statisti­ say, the preceding five-year period Trends in the Presence of cal and economic justification for are used to estimate the condition­ Serially Correlated Errors one widely used method (Bloom, al covariance of returns at a given Eugene Canjels and 1984) of adjusting data from social date; and 3) two-sided rolling re­ MarkW. Watson experiments to account for drop­ ping out. We generalize the meth­ gressions that use, say, five years NBER Technical Paper No. 165 of leads and five years of lags. September 1994 od to apply to distributions, not GARCH amounts to a one-sided JEL Nos. C22, D40 just means, and then present tests rolling regression with exponential­ Economic Fluctuations of the key identifying assumption. ly declining weights. We derive Reanalyzing the National ]TPA ex­ asymptotically optimal window This paper studies the problems periment base vindicates the appli­ lengths for standard rolling regres­ of estimation and inference in the cation of Bloom's method. sions, and optimal weights for linear trend model: Yt=a+~t+ut' weighted rolling regressions. As an where ut follows an. autoregressive Optimal Prediction example, we model empirically the process with largest root p, and ~ Under AsymmetriC Loss S&P 500 Stock Index. is the parameter of interest. We Peter F. Christoffersen and contrast asymptotic results for the Francis X. Diebold absolute value of p less than one Evidence on Structural NBER Technical Paper No. 167 or equal to one, and argue that the Instability in October 1994 most useful approximations come Macroeconomic JEL No. C1 from modeting p as local-to-unity. Time-Series Relations Economic Fluctuations We derive asymptotic distributions James H. Stock and Prediction problems involving Mark W. Watson for the OLS, first-difference, infeas­ ible GLS, and three feasible GLS asymmetric loss functions arise rou­ NBER Technical Paper No. 164 estimators. These distributions de­ tinely in many fields, yet the theory September 1994 pend on the local-to-unity param­ of optimal prediction under asym­ JEL Nos. C32, E37 eter, and on a parameter that gov­ metric loss is not well developed. Economic Fluctuations erns the variance of the initial error We study the optimal prediction We perform an experiment to term, K. The feasible Cochrane­ problem under general loss struc­ assess the prevalence of instability Orcutt estimator has poor prop­ tures, and we characterize the opti­ in univariate and bivariate macro­ erties, and the feasible Prais-Win­ mal predictor. We then compute economic time-series relations, and sten estimator is preferred unless the optimal predictor analytically in

74. NBER Reporter Winter 1994/5 ------two leading cases. Analytic solu­ Comparing Predictive as multiple treatment and com­ tions for the optimal predictor are Accuracy parison groups, and multiple pre­ not available in more complicated Francis X. Diebold or post-intervention observations. cases, so we develop numerical and Roberto S. Mariano procedures for computing it. We il­ NBER Technical Paper No. 169 Testing for Cointegration lustrate the results by forecasting November 1994 When Some of the the GARCH(1,l) process, which, al­ JEL Nos. C1, C53 Cointegrating Vectors though white noise, is non trivially Economic Fluctuations Are Known forecastable under asymmetric loss. Michael T. K. Horvath and We propose and evaluate expli­ Mark W. Watson cit tests of the hypothesis that there Estimating Multiple­ NBER Technical Paper No. 171 is no difference in the accuracy of Discrete Choice Models: December 1994 two competing forecasts. In con­ An Application to JEL Nos. C13, C32, F31 trast to tests that were developed Computerization Returns Economic Fluctuations, IgalHendel previously, ours use a wide variety Monetary Economics NBER Technical Paper No. 168 of accuracy measures (in particular, In this paper, we develop tests October 1994 the loss function need not be qua­ for cointegration that can be ap­ Productivity dratic, nor even symmetric), and the forecast errors can be non­ plied when some of the cointegrat­ This paper develops a multiple­ Gaussian, not have a zero mean, ing vectors are known under the discrete choice model for the anal­ and be both serially and contem­ null or alternative hypotheses. We ysis of demand of differentiated poraneously correlated. We pro­ construct these tests in a vector er­ products. Users maximize profits pose, evaluate, and illustrate both ror correction model and motivate by choosing the number of each asymptotic and exact finite sample them as Wald tests in the version brand to purchase. Multiple-unit as tests. of this Gaussian model. When all well as multiple-brand purchases of the cointegrating vectors are are allowed. These two features Natural and Quasi­ known under the alternative hy­ distinguish this model from classi­ Experiments in Economics pothesis, the tests correspond to cal discrete choice models that the standard Wald tests for the in­ Bruce D. Meyer consider only a single choice clusion of error correction tenns in among mutually exclusive alterna­ NBER Technical Paper No. 170 the vector autoregression. Modifi­ December 1994 tives. I estimate the parameters of cations of this basic test must be the model using the simulated JEL Nos. C1, C9, JOO developed when a subset of the method-of-moments technique. Labor Studies cointegrating vectors contains un­ Both requirements of the model­ Using research designs patterned known parameters. We derive the micro foundations and estimabili­ after randomized experiments, asymptotic null distribution of the ty-are imposed in order to exploit many recent economic studies ex­ statistics, determine critical values, the available microlevel data on amine measures of outcome for and study the local power proper­ personal computer purchases. I use treatment groups and comparison ties of the test. Finally, we apply the estimated demand structure to groups that are not assigned ran­ the test to data on foreign ex­ assess welfare gains from comput­ domly. By using variation in ex­ change future and spot prices to erization and technological innova­ planatory variables generated by test the stability of forward-spot tion in peripherals industries. The changes in state laws, government premium. estimated return on investment in draft mechanisms, or other means, computers is 90 percent. Moreover, these studies obtain variation that is a 10 percent increase in the perfor­ examined readily and is plausibly mance-to-price ratio of micropro­ exogenous. This paper describes cessors leads to a 4 percent gain in the advantages of these studies, the estimated end user surplus. suggests how they can be im­ proved, and aids in judging the va­ lidity of the inferences they draw. I advocate design complications, such

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