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Program Report IN THIS ISSUE

Program Report: DAE 1 The Development of the American Research Summaries: Impatience and Savings 6 Economy Bank Regulation and Supervision 9 Corporate Governance and …Globalization 13 Claudia Goldin* NBER Profiles 16 Conferences 17 Bureau News 23 The research interests of Development of the American Economy Bureau Books 39 (DAE) program members are expansive. Temporally, their work has Current Working Papers 41 spanned virtually all of recorded history; geographically, it has traversed much of the globe; by economic sub-field, it can be included in each of the other NBER programs. That said, most DAE members explore the economic history of the last two centuries. Much of their work places the United States at the center, although interest in comparative eco- nomic history has grown considerably. What is the field of economic history? Are economic historians “economists who use data from more distant periods”? Economic his- tory is a distinctive discipline that views issues from a long-term per- spective. History is a seamless cloth that can be unfolded to the present and that is regularly rewritten as the issues of the present change. In NBER Service Brings summarizing the research of DAE members, I will emphasize how the You New Data for Free work addresses current issues and concerns. The summary includes many, but could not include all, of the Working Papers and books pub- A new, free NBER email serv- lished in the past year or two by the more than 50 Research Associates ice gives you daily email links to all and Faculty Research Fellows of the DAE. U.S. government data releases, The research topics of DAE members can be grouped under four including unemployment, trade, broad headings: Political Economy; Labor and Population; Productivity; interest rates, GDP, etc. We keep track of your preferences and and Financial History and Macroeconomic Fluctuations. DAE members email you the requested links publish books in the Long-term Factors in Economic Development series, as when they are released. To sign up well as NBER Working Papers and conference volumes. for any or all of the government releases, visit www.nber.org/releases and register your choices. IT’S FREE!! * Goldin directs the Program on Development of the American Economy and is the Henry Lee Professor of Economics at Harvard University.

NBER Reporter Fall 2005 1 Political Economy NBER Reporter The area of political economy has been one of the most vibrant in the DAE Program. NATIONAL BUREAU OF ECONOMIC RESEARCH Corruption in the political sphere is a subject of great current interest. Was government in the United States once considerably corrupt, The National Bureau of Economic Research is a private, nonprofit research just as developing and transition economies organization founded in 1920 and devoted to objective quantitative analysis of the American economy. Its officers and board of directors are: are today, and did it subsequently become less President and Chief Executive Officer — Martin Feldstein corrupt as it underwent various reforms? Vice President for Administration and Budget — Susan Colligan Edward L. Glaeser and I, together with various Controller — Kelly Horak DAE members and others, assembled a con- BOARD OF DIRECTORS ference in July 2004 to explore these questions. Chairman — Elizabeth E. Bailey The resulting volume, Corruption and Reform: Vice Chairman — John S. Clarkeson Treasurer — Robert Mednick Lessons from America’s Economic History (University of Chicago Press, 2006), makes DIRECTORS AT LARGE several contributions in measuring the rise and Peter Aldrich Jessica P. Einhorn John Lipsky Elizabeth E. Bailey Martin Feldstein Laurence H. Meyer fall of corruption in the United States, exam- John Herron Biggs Jacob A. Frenkel Michael H. Moskow ining the factors that fostered reform (for Andrew Brimmer Judith M. Gueron Alicia Munnell John S. Clarkeson Robert S. Hamada Rudolph A. Oswald example, rules rather than discretion in New Don R. Conlan George Hatsopoulos Robert T. Parry Kathleen B. Cooper Karen N. Horn Richard N. Rosett Deal, strong and independent press), and George Eads Judy Lewent Marina v. N. Whitman exploring interrelationships between govern- Martin B. Zimmerman mental corruption and private fraud. The DIRECTORS BY UNIVERSITY APPOINTMENT weight of the evidence suggests that govern- George Akerlof, California, Berkeley Joel Mokyr, Northwestern ments at all levels in the United States were far Jagdish W. Bhagwati, Columbia Andrew Postlewaite, Pennsylvania Michael J. Brennan, California, Los Angeles Craig Swan, Minnesota more corrupt in the past and that a series of Glen G. Cain, Wisconsin Uwe Reinhardt, Princeton reforms and public awareness turned the tide. Ray C. Fair, Yale Nathan Rosenberg, Stanford Franklin Fisher, MIT David B. Yoffie, Harvard In a series of influential papers, Stanley L. Saul H. Hymans, Michigan Arnold Zellner, Chicago Marjorie B. McElroy, Duke Engerman and Kenneth L. Sokoloff have explored the enduring role of initial condi- DIRECTORS BY APPOINTMENT OF OTHER ORGANIZATIONS tions, such as colonial land-to-labor ratios and Richard B. Berner, National Association for Business Economics economic inequality, on later economic devel- Gail Fosler, The Conference Board Martin J. Gruber, American Finance Association opment. Greater inequality, which often Dr. Arthur Kennickell, American Statistical Association Thea Lee, American Federation of Labor and Congress of accompanied slavery, stifled investments in Industrial Organizations education and thus lowered economic growth. William W. Lewis, Committee for Economic Development Robert Mednick, American Institute of Certified Public Accountants The locus of government — why states, and Angelo Melino, Canadian Economics Association Jeffrey M. Perloff, American Agricultural Economics Association not the federal government, were once the John J. Siegfried, American Economic Association main spending units — has concerned John J. Gavin Wright, Economic History Association Wallis in several of his papers. In previous The NBER depends on funding from individuals, corporations, and private work, Wallis emphasized the fiscal angle and foundations to maintain its independence and its flexibility in choosing its research activities. Inquiries concerning contributions may be addressed to devised a theory of the lowest cost revenue Martin Feldstein, President & CEO, NBER 1050 Massachusetts Avenue, Cambridge, MA 02138-5398. All contributions to the NBER are tax raiser. But in a recent paper with Barry deductible. Weingast, he answers the question from a The Reporter is issued for informational purposes and has not been reviewed by political standpoint. When government is the Board of Directors of the NBER. It is not copyrighted and can be freely reproduced with appropriate attribution of source. Please provide the NBER’s small, the nation is geographically large, and Public Information Department with copies of anything reproduced. projects are lumpy, Congress cannot agree on Requests for subscriptions, changes of address, and cancellations should be spending; thus the funding of projects takes sent to Reporter, National Bureau of Economic Research, Inc., 1050 place at a lower level, for example the states in Massachusetts Avenue, Cambridge, MA 02138-5398. Please include the current mailing label. the early nineteenth century. Other work in political economy includes an examination of

2 NBER Reporter Fall 2005 ------the reasons for the adoption of state related work, Troesken and Joseph in the United States from the 1800s to fair housing laws prior to federal legisla- Ferrie show that clean water was the present. They find that there was tion in 1968 by William J. Collins, and responsible for the lion’s share of the greater intergenerational mobility in Gary D. Libecap’s reassessment of the mortality decline in U.S. cities in the America until about 1900, but about the celebrated purchase of water rights by nineteenth and early twentieth cen- same level from 1950 to the present. Los Angeles in the early twentieth cen- turies.3 Geographical mobility, however, was tury (shades of “Chinatown”).1 In other health related research, and still is considerably higher in the Robert Fogel has used historical trends United States, even after adjusting for Labor and Population to predict that fully one-half of the geographic differences in the two cohorts born in the 1980s will live to be nations. Lee Alston and Ferrie examine Several researchers in the DAE centenarians. Not only will lifetimes social mobility among agricultural Program have explored long-term continue to increase, but because the workers in the early twentieth century trends in women’s economic status. The onset of disabilities has risen, longer and find that the agricultural ladder was papers include my work on the career lifetimes will also be higher quality ones. not as slippery and grim as generally and family decisions made by college Although revisionist economic history depicted.5 graduate women across the past centu- has given the 1930s New Deal little Hundreds of riots struck major ry and, in a separate paper, the reasons credit for ending the Great Depression, American cities in the 1960s resulting in why women were able to break through and some have even credited the poli- death, injury, and often the complete barriers in the post-1970s era and enter cies with prolonging the downturn, the razing of the poorest sections. Parts of the most prestigious professions in good news is that New Deal policies these cities recovered rapidly but most large numbers. Collins and co-author were beneficial to the nation’s health, remained urban deserts for long peri- Martha Bailey reexamine the significant particularly infants, according to a study ods. Robert A. Margo and Collins assess narrowing of differences in earnings of by Price Fishback, Michael Haines, and the short- and long-run impacts of the women by race in the 1940s and find Shawn Kantor. According to work by riots and find that the employment that factors observable to the researcher Melissa Thomasson and co-author, the opportunities for African-Americans, are less important than changes in the shift from home to hospital births in and thus their incomes, suffered badly returns to those factors. the early twentieth century first even after several decades and that Dora Costa and co-author Matthew increased maternal mortality, and only property values remained depressed.6 Kahn have cleverly mined the Union after the introduction of sulfa drugs in Army records to understand various 1937 were hospital births beneficial to Productivity issues of current importance to a nation mothers. Richard Steckel, taking a at war, such as the consequences of Productivity as the engine of eco- longer view of the topic of health and desertion for the individual, the role of nomic growth and the institutions that using information from skeletal diversity in creating a cohesive fighting foster inventiveness are the subjects of remains, finds that Western unit, and the treatment of prisoners of B. Zorina Khan’s recent volume, The Hemisphere populations migrated into war.2 Democratization of Invention. In it she less healthy environments during pre- A significant body of work has explores the evolution of intellectual Columbian times, but the reasons for been produced by DAE members on property rights and the ways in which the moves are not yet understood.4 aspects of health, morbidity, and mor- U.S. policies and institutions, such as the Nineteenth century America, it is tality. Werner Troesken’s recent contri- patent and copyright systems, fostered generally believed, was a meritocracy bution, Water, Race, and Disease, exam- the expansion of markets and the cre- whereas much of Europe was an aris- ines the paradoxical increase in life ation of national wealth. In related tocracy. Americans were not prisoners expectation among African-Americans work, Khan and Sokoloff explore the of their family background. Rather, a in the early twentieth century U.S. South backgrounds of great inventors to person could do better (or worse) than at the same time that their civil rights understand how the U.S. patent system his parents (in addition to doing far bet- were being eviscerated. Troesken recon- fostered seemingly obscure individuals ter absolutely than in Europe). Joseph ciles these two divergent trends by not- to invent.7 P. Ferrie and co-author Jason Long con- ing that the close residential proximity The United States did not exceed front these widely held notions about of the two groups meant that clean the United Kingdom in per capita intergenerational mobility and compare water and sewerage separation were income until the late nineteenth century, economic mobility in England with that health issues for all in the South. In according to most economic history

------NBER Reporter Fall 2005 3 accounts. But its labor force was consid- sanctions,” such as the use of military NBER Working Paper No. 11397, June erably more agricultural than was action in the face of default, decreased 2005; W.J. Collins, “The Political Economy Britain’s throughout the nineteenth cen- ex ante measures of default.10 of Fair Housing Laws Prior to 1968,” NBER Working Paper No. 10610, July tury. These two facts raise the distinct yet Does trade foster democracy? That 2004; G.D. Libecap. “Transaction Costs: ironic possibility that America was more is the question Christopher M. Meissner Valuation Disputes, Bi-Lateral Monopoly productive in the fastest growing sector and co-author pose and answer in the Bargaining and Third-Party Effects in Water — manufacturing — than was the affirmative, for the post-1895 period, Rights Exchanges. The Owens Valley world’s first industrial economy. That using a gravity model of trade to identi- Transfer to Los Angeles,” NBER Working conjecture is explored by Douglas A. fy the causal impact of openness on Paper No. 10801, September 2004. 2 C. Goldin, “From the Valley to the Summit: Irwin and co-author Stephen N. democratization. Michael Bordo and The Quiet Revolution that Transformed Broadberry who find that Britain led the Meissner show that for 30 countries Women’s Work,” NBER Working Paper United States in labor productivity in from 1880 to 1913, foreign currency No. 10335, March 2004; C. Goldin, “The services, the two were about equal in debt increased debt crises and banking Long Road to the Fast Track: Career and agriculture, but America led in industrial crises. Richard E. Sylla, John J. Wallis, Family,” NBER Working Paper No. 10331, March 2004; M. J. Bailey and W.J. labor productivity from 1840. The catch- and co-author explore the causes of the Collins, “The Wage Gains of African up of the United States to Britain in per state defaults of the early 1840s when American Women in the 1940s,” NBER capita GNP came about mainly because eight states and the Territory of Florida Working Paper No. 10621, July 2004; D. of a shift out of low-productivity agri- reneged on their bonds. Contrary to Costa and M. Kahn, “Forging a New culture but also because service produc- popular wisdom, the authors dismiss an Identity: The Costs and Benefits of Diversity tivity increased relatively in the United explanation that blames the defaults on in Civil War Combat Units for Black Slaves 8 and Freemen,” NBER Working Paper No. States. the recession of 1837 and advance one 11013, December 2004; D. Costa and M. If a nation at war can mobilize rap- that emphasizes losses in land revenue Kahn, “Shame and Ostracism: Union Army idly, then productivity and national and fiscal irresponsibility for the delay Deserters Leave Home,” NBER Working income are less negatively affected dur- in raising property taxes.11 Paper No. 10425, April 2004. 3 ing and immediately after the conflict. In work that continues one of the W. Troesken, Water, Race, and Disease, (Cambridge: MIT Press), 2005; J.P. Ferrie Hugh Rockoff investigates the degree mainstays of NBER research, Joseph and W. Troesken, “Death and the City: to which the United States mobilized H. Davis has constructed a new (and Chicago’s Mortality Transition, 1850-1925,” during World War I and finds, contrary better) pre-World War I chronology of NBER Working Paper No. 11427, June to the conventional wisdom on this U.S. business cycles that alters more 2005. brief engagement, that mobilization than 40 percent of the peak and 4 R.W. Fogel, “Changes in the Physiology of was rapid and effective.9 troughs. How did Joe Davis improve Aging during the Twentieth Century,” NBER Working Paper No. 11233, March upon the pioneering works of Wesley 2005; P. Fishback, M. Haines, and S. Financial History and Macro- Mitchell, Geoffrey Moore, Willard Kantor, “Politics, Relief, and Reform: The economic Fluctuations Thorp, and Victor Zarnowitz, among Transformation of America’s Social Welfare others at the NBER and elsewhere? He System during the New Deal,” NBER A large and growing group of did it by unearthing new long-run, con- Working Paper No. 11246, April 2005; researchers in the DAE have been M.A. Thomasson and J. Treber, “From sistent industrial series for a lengthy list exploring U.S. financial history and the Home to Hospital: The Evolution of of goods. His remarkable achievement, impact of U.S. foreign policy and mili- Childbirth in the United States, 1927-1940,” on which the business cycle dating NBER Working Paper No. 10873, tary action on world financial markets. paper rests, can be found in the November 2004; R. H. Steckel, “The Best of One fascinating example is the demon- November 2004 issue of the Quarterly Times, the Worst of Times: Health and stration by Kris J. Mitchener and Marc Journal of Economics.12 Nutrition in Pre-Columbian America,” D. Weidenmier that the Roosevelt NBER Working Paper No. 10299, Corollary to the Monroe Doctrine— February 2004. 5 that the United States had the right to 1 S.L. Engerman and K.L. Sokoloff, J.P. Ferrie, “The End of American Exceptionalism? Mobility in the U.S. since intervene in Central America and the “Colonialism, Inequality, and Long-Run Paths of Development,” NBER Working 1850,” NBER Working Paper No. 11324, Caribbean—plus gunboat diplomacy Paper No. 11057, January 2005; J.J. Wallis May 2005; J. Long and J. Ferrie, “A Tale of stabilized debt markets and increased and B. Weingast, “Equilibrium Impotence: Two Labor Markets: Intergenerational trade. In a related paper the authors Why the States and Not the American Occupational Mobility in Britain and the U.S. measure the degree to which “super- National Government Financed Economic Since 1850,” NBER Working Paper No. Development in the Antebellum Era,” 11253, April 2005; J.P. Ferrie, “The End of

4 NBER Reporter Fall 2005 ------American Exceptionalism? Mobility in the Innovation during the Early Economic “The Globalization of Trade and Democracy, U.S. Since 1850,” NBER Working Paper Growth: Evidence from the Great Inventors of 1870–2000,” NBER Working Paper No. No. 11324, May 2005; L. J. Alston and J. the United States, 1790–1930,” NBER 11117, February 2005; M. Bordo and C. P. Ferrie, “Time on the Ladder: Career Working Paper No. 10966, December 2004. Meissner, “Financial Crises, 1880–1913: Mobility in Agriculture, 1890–1938,” 8 S.N. Broadberry and D. A. Irwin, “Labor The Role of Foreign Currency Debt,” NBER Working Paper No. 11231, March Productivity in Britain and America during NBER Working Paper No. 11173, March 2005. the Nineteenth Century,” NBER Working 2005; J.J. Wallis, R.E. Sylla, and A. 6 W.J. Collins and R.A. Margo, “The Labor Paper No. 10364, March 2004. Grinath III, “Sovereign Debt and Market Effects of the 1960s Riots,” NBER 9 H. Rockoff, “Until it’s Over, Over There: Repudiation: The Emerging-Market Debt Working Paper No. 10243, January 2004; The U.S. Economy in World War I,” Crisis in the U.S. States, 1839–1843,” W.J. Collins and R.A. Margo, “The NBER Working Paper No. 10580, June NBER Working Paper No. 10753 Economic Aftermath of the 1960s Riots: 2004. September 2004. Evidence from Property Values,” NBER 10 K.J. Mitchener and M. D. Weidenmier, 12 J. H. Davis, “An Improved Annual Working Paper No. 10493, May 2004. “Empire, Public Goods, and the Roosevelt Chronology of U.S. Business Cycles since the 7 B. Z. Khan, The Democratization of Corollary,” NBER Working Paper No. 1790s,” NBER Working Paper No. 11157, Invention: Patents and Copyrights in 10729, September 2004; K. J. Mitchener and February 2005; J. H. Davis, “A Quantity- American Economic Development, M.D. Weidenmier, “Supersanctions and Based Annual Index of U.S. Industrial 1790–1920, (Cambridge: Cambridge Sovereign Debt Repayment,” NBER Production, 1790–1915,” Quarterly University Press) 2005; B. Z. Khan and K. Working Paper No. 11472, July 2005. Journal of Economics 119, November L. Sokoloff, “Institutions and Technological 11 J. E. Lopez-Cordova and C. M. Meissner, 2004, pp. 1177–215.

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------NBER Reporter Fall 2005 5 Research Summaries

Impatience and Savings

David Laibson*

When making decisions with imme- — values immediate rewards but only when deciding how to invest during diate consequences, economic actors weakly responds to delayed rewards. flush times – these consumers buy illiq- typically display a high degree of impa- Whatever the underlying biological uid assets that offer a high rate of tience. Consumers choose immediate mechanism, the taste for instant gratifi- return and pay out slowly over many pleasures instead of waiting a few days cation can be incorporated into models decades. When making short-run deci- for much larger rewards. Consumers of human behavior. Several strands of sions, however, these consumers are want “instant gratification.” my work have attempted to do this. willing to pay a high price for immedi- However, people do not behave Chris Harris and I have proposed mod- ate gratification. impatiently when they make decisions els in which actors place a special pre- Repetto, Tobacman, and I show for the future. Few people plan to break mium on immediate pleasures.2 I also that the taste for instant gratification their diets next week. Instead, people have developed models that assume explains why households hold illiquid tend to splurge today and vow to exer- that people have biologically condi- assets and also frequently borrow with cise/diet/save tomorrow. From today’s tioned motivational states: when famil- credit cards that involve relatively high viewpoint, people prefer to act impa- iar cues are presented, consumers expe- interest rates.5 We also estimate the tiently right now but to act patiently rience a drive to consume the goods strength of the taste for immediate later. that they consumed in the presence of gratification.6 We find that consumers Data from neuroscience experi- those cues in the past.3 For example, a have a short-run discount rate of 30 ments provide a potential explanation cigarette smoker will urgently want a percent and a long-run discount rate of for these observations: short-run deci- smoke when he enters his favorite bar 5 percent. In other words, delaying a sions engage different brain systems (where he has smoked before). reward by a year reduces its value by 30 from long-run decisions. Using func- The drive for immediate gratifica- percent, but delaying the same reward tional magnetic resonance imaging tion has many empirical consequences an additional year only generates an (fMRI), Samuel McClure, George that my coauthors and I have studied. additional 5 percent devaluation. Loewenstein, Jonathan D. Cohen, and I Marios Angeletos, Andrea Repetto, Consumers with a taste for immedi- have shown that decisions that involve Jeremy Tobacman, Stephen Weinberg, ate gratification will avoid immediate at least some short-run tradeoffs recruit and I have run computational simula- disutility. Such consumers will repeated- both analytic and emotional brain sys- tions of consumers with a taste for ly delay finishing unpleasant tasks like tems, whereas decisions that only instant gratification (specifically, we enrolling in a 401(k) plan. James J. Choi, involve long-run tradeoffs primarily studied quasi-hyperbolic discount func- Brigitte Madrian, Andrew Metrick, and recruit analytic brain systems.1 These tions).4 We find that such consumers I have found signs of procrastination in findings suggest that people pursue quickly spend whatever liquid wealth a survey of employees.7 Over two thirds instant gratification because the emo- they have and are only able to save in of respondents say that they save too tional brain system — the limbic system illiquid assets. These consumers live little, and none say that they save too from hand to mouth in their checking much. Among the self-reported under- * Laibson is a Research Associate in the accounts, but hold large stocks of illiq- savers, over one third say that they plan NBER's Programs on Aging, Economic uid assets like home equity and defined to join the 401(k) plan or raise their sav- Fluctuations, and Asset Pricing. He is also a pro- contribution pension plans. When mak- ings rate in the next two months. Using fessor of Economics at Harvard University. His ing long-run choices – for example, administrative records, we find that profile appears later in this issue.

6 NBER Reporter Fall 2005 ------almost none follow through in the next Under the automatic enrollment system, that message. Company stock alloca- four months. new employees are automatically tions never budged. The high allocation It is typically difficult to determine enrolled in the 401(k) and may opt out to company stock is linked to the fact whether households save optimally. of the plan. If employees do nothing that many employer-matching contribu- Even asking a respondent -— as we did they are enrolled at a default savings rate tions are automatically invested in com- above — yields ambiguous evidence, (typically 2 or 3 percent of their wages) pany stock. These matched contribu- since it is not clear what it means to say, and their investments are allocated to a tions stay in employer stock, even when “I save too little.” But in some cases, default portfolio (typically a money mar- employees have the option to reallocate savings incentives are strong enough to ket, although increasingly, automatic the money. In contrast, when an make very sharp predictions about opti- enrollment systems are using lifecycle employer asks its employees to choose mal 401(k) contribution rates. Choi, funds as the default). Under automatic their own portfolio allocation, employ- Madrian and I have analyzed employees enrollment, about 90 percent of ees invest a much lower share in compa- who receive employer-matching contri- employees accept default enrollment, ny stock. butions in their 401(k) plan and are and about 75 percent of these enrollees Asking employees to make their allowed to make discretionary, penalty- accept the default savings rate and the own decisions — by discouraging free, in-service withdrawals.8 For these default asset allocation. reliance on a default action or removing employees, contributing below the The consequences of passivity and the default altogether — also provides match threshold is an unambiguous status quo bias affect a wide range of a good system for 401(k) enrollment.13 mistake. Nevertheless, half of employ- 401(k) outcomes. Choi, Madrian, For example, one firm asked new ees with such clear-cut incentives do Metrick, and I find that 401(k) plan par- employees to tell the firm their enroll- contribute below the match threshold, ticipants follow the path of least resist- ment decision — including their enroll- foregoing match payments that average ance in every investment decision that ment savings rate and asset allocation — 1.3 percent of their annual pay. In our they make.11 For example, the match within 30 days of their hire date. sample, making this mistake correlates threshold is the maximal (employee) Naturally, the employees can change with other types of procrastination. contribution rate at which the employer their mind later, but they are supposed to Finally, providing these “undersavers” provides a match (at the margin). Most make an initial decision within 30 days. with specific information about the free employees who enroll in 401(k) plans Enforcement works the same way that lunch they are foregoing fails to raise contribute up to the match threshold. the choice of a medical insurance plan contribution rates. When an employer raises the match works at most companies: employees Such savings problems suggest that threshold, employees who join the plan who do not make the decision are economists should think about the after the change exploit the higher match reminded to do so. We call this an active effectiveness of existing savings institu- threshold, but employees hired before the decision enrollment system, since employ- tions. In particular, economists should change typically take three years to raise ees are encouraged to decide for them- ask why new employees take so long to their savings rate. selves. We find that such active decision enroll in 401(k) plans. Madrian and Evidence on company stock also enrollment produces very good results. Dennis Shea started this literature by supports the conclusion that savers are A few months after hire, employees showing that defaults play a critical role.9 remarkably passive.12 In 401(k) plans hired under an active decision regime Their original paper shows that the typ- with the option to invest in company have a 70 percent enrollment rate in the ical employee sticks with the default stock, nearly half of the assets are 401(k). Moreover these employees seem option – whether the default is enroll- invested in company stock. Moreover, to be making smart savings choices. In ment or non-enrollment – for years after this pattern of investment was unaffect- particular, the distribution of savings joining a new firm. Follow up papers ed by the prominent bankruptcies of rate at three months of tenure under an have replicated these findings in a large Enron, Worldcom, Global Crossing, active decision regime matches the distri- number of firms.10 and many other firms in the aftermath bution of savings rates at three years of In a typical company with a stan- of the collapse of the technology bub- tenure under a standard enrollment dard default of non-enrollment, only about ble. Employees who lost their entire life regime. However, active decisions are one third of employees enroll on their savings in the Enron debacle were fre- unlikely to work as well as defaults when own during the first six months of quently discussed in the media at the people are relatively uninformed about employment. Even after a year, only half time of the Enron bankruptcy, but the decision they are being asked to of employees enroll in the 401(k) plan. American workers have not generalized make.14

------NBER Reporter Fall 2005 7 The power of defaults implies that 2 D. Laibson, “Golden Eggs and Hyperbolic A. Metrick, “Saving for Retirement on the policymakers and 401(k) plan design- Discounting,” Quarterly Journal of Path of Least Resistance,” in E. McCaffrey ers should pick defaults very carefully, Economics, 62 (May 1997), pp. 443–77; and J. Slemrod, eds., Behavioral Public C. J. Harris and D. Laibson, “Instantaneous Finance, 2005; J. J. Choi, D. Laibson, B. even though they are non-binding. My Gratification,” Harvard mimeo (2005); C.J. Madrian, and A. Metrick, “Plan Design and coauthors and I have developed a Harris and D. Laibson, “Hyperbolic 401(k) Savings Outcomes,” National Tax framework for analyzing this prob- Discounting and Consumption,” in M. Journal, 57(2) (June 2004), pp. 275–98; J. lem.15 We calculate the socially optimal Dewatripont, L. P. Hansen, and S. Choi, D. Laibson, B. Madrian, and A. 401(k) enrollment regime. Three dif- Turnovsky, eds., Advances in Economics Metrick, “For Better or For Worse: Default ferent 401(k) enrollment procedures and Econometrics: Theory and Appli- Effects and 401(k) Savings Behavior” in D. cations, Eighth World Congress, Vol. 1 Wise, ed., Perspectives in the Economics endogenously emerge from the model. (2002), pp. 258–98; and C. J. Harris and of Aging, Chicago, IL: University of We derive conditions under which the D. Laibson, “Dynamic Choices of Chicago Press (2004), pp. 81–121; and J. J. optimal enrollment regime is: automat- Hyperbolic Consumers,” Econometrica, Choi, D. Laibson, B. Madrian, and A. ic enrollment (that is, default enroll- 69(4) (July 2001), pp. 935–57. Metrick, “Defined Contribution Pensions: 3 ment); standard opt-in enrollment D. Laibson, “A Cue-Theory of Plan Rules, Participant Decisions, and the Consumption,” Quarterly Journal of Path of Least Resistance.” (that is, default non-enrollment); or an Economics, 66(1) (February 2001), pp. 11 J. J. Choi, D. Laibson, B. Madrian, and A. active decision (that is, no default and 81–120. Metrick, “Saving for Retirement on the Path of compulsory choice). The active deci- 4 G. Angeletos, D. Laibson, A. Repetto, J. Least Resistance”; J. J. Choi, D. Laibson, B. sion regime is socially optimal when Tobacman, and S. Weinberg, “The Madrian, and A. Metrick, “Defined consumers have a large degree of vari- Hyperbolic Consumption Model: Calibration, Contribution Pensions: Plan Rules, ation in their savings needs and a Simulation, and Empirical Evaluation” Participant Decisions, and the Path of Least Journal of Economic Perspectives Resistance”; J. Choi, D. Laibson, and B. strong tendency to procrastinate. In (August 2001), pp. 47–68. Madrian, “Are Empowerment and this case, a single default will not work 5 D. Laibson, A. Repetto and J. Tobacman, Education Enough? Under-Diversification in well for all consumers and households “A Debt Puzzle,” in P. Aghion, R. 401(k) Plans,” NBER Working Paper, won’t enroll on their own without a Frydman, J. Stiglitz, M. Woodford, eds., forthcoming. 12 deadline. Default enrollment is optimal Knowledge, Information and J. J. Choi, D. Laibson, and B. Madrian, Expectations in Modern Economics: “Are Empowerment and Education when consumers have relatively similar In Honor of Edmund S. Phelps, Enough? Under-Diversification in 401(k) savings needs and a moderate tenden- Princeton: Princeton University Press Plans.” cy to procrastinate. In this case, a one- (2003), pp. 228–66. 13 J.J. Choi, D. Laibson, B. Madrian, and size-fits-all default is not a problem 6 D. Laibson, A. Repetto, and J. Tobacman, A. Metrick, “Active Decisions,” NBER because households do not differ “Estimating Discount Functions with Working Paper No. 11074, January 2005. 14 greatly in their savings needs. Consumption Choices over the Lifecycle,” See Cronqvist and Thaler, “Design Choices NBER Working Paper, forthcoming. in Privatized Social-Security Systems: Moreover, households will not wait 7 J. J. Choi, D. Laibson, B. Madrian, and Learning from the Swedish Experience,” too long to opt out of the default if it A. Metrick, “Defined Contribution American Economic Review, 94(2) is not right for them. Pensions: Plan Rules, Participant Decisions, (May 2004), pp. 424–28. My collaborators and I continue to and the Path of Least Resistance,” in J. M. 15 J. J. Choi, D. Laibson, B. Madrian, and study the foundations of instant grati- Poterba, ed., Tax Policy and the A. Metrick, “Saving for Retirement on the Economy, 16 (2002), pp. 67–113. Path of Least Resistance”; J.J. Choi, D. fication, the consequences for savings 8 J. J. Choi, D. Laibson, and B. Madrian, Laibson, B. Madrian, and A. Metrick, behavior, and the implications for the “$100 Bills on the Sidewalk: Failing to Save “Active Decisions”; J. J. Choi, D. Laibson, design of optimal savings institutions. Optimally in 401(k) Plans,” NBER B. Madrian, and A. Metrick, “Optimal Working Paper No. 11554, August 2005. Defaults,” American Economic Review 9 1 B. Madrian and D. Shea, “The Power of Papers and Proceedings (May 2003), pp. S. McClure, D. Laibson, G. Loewenstein, Suggestion: Inertia in 401(k) Participation 180–5. and J. D. Cohen, “Separate Neural Systems and Savings Behavior,” Quarterly Journal Value Immediate and Delayed Monetary of Economics, Vol. 116 (4) (2001), pp. Rewards,” Science, 306 (October 15, 1149–87. 2004), pp. 503-7. 10 J. J. Choi, D. Laibson, B. Madrian, and

8 NBER Reporter Fall 2005 ------Bank Regulation and Supervision

Ross Levine*

A large body of research suggests World Bank, and other international the world. In terms of defining “sound that banks matter for human welfare. agencies have developed extensive banking,” many take for granted that Most noticeably, banks matter when checklists of “best practice” recommen- stability is the primary objective of they fail. Indeed, the fiscal costs of dations that they urge all countries to bank regulation. While we study stabili- banking crises in developing countries adopt. Most influentially, the Basel ty, my co-authors and I also examine the since 1980 have exceeded $1 trillion, Committee on Bank Supervision recent- impact of banking policies on bank and some estimates put the cost of ly revised and extended the 1988 Basel development, efficiency, corruption in Japan’s banking problems alone over Capital Accord. lending, and corporate governance of this threshold.1 Recent research also banks. Banks are not simply safe places finds that banks matter for economic Data to stash funds. Banks play pivotal roles growth.2 Banks that mobilize and allo- in mobilizing and allocating resources, Until recently, the absence of data cate savings efficiently, allocate capital monitoring firms, and providing liquid- on bank regulation and supervision to endeavors with the highest expected ity and risk management services. Thus, made it impossible to conduct broad social returns, and exert sound gover- bank regulation and supervision should cross-country studies of which regula- nance over funded firms foster innova- be judged by more criteria than stability tions and supervisory practices pro- tion and growth. Banks that instead alone. mote sound banking. While analysts funnel credit to connected parties and used models, country-studies, and the the politically powerful discourage A Political Economy Approach experiences of supervisors to make pol- entrepreneurship and impede economic icy recommendations, there were simply Consistent with research on the development. Recent work further insufficient data with which to conduct political economy of banking policies, shows that banks matter for poverty extensive international comparisons the patterns we observe in the data sug- and income distribution.3 Well-func- and to test the validity of Basel II or gest that countries do not choose indi- tioning banks that extend credit to other proposals for reform. Clearly vidual regulations in isolation; rather, those with the best projects, rather than expert advice and evidence from indi- individual choices reflect broad to the wealthy or to those with familial, vidual countries should inform banking approaches to the role of government political, or corrupt connections, exert policies; but just as clearly, cross-coun- in the economy.5 Some governments an equalizing affect on the distribution try econometric evidence can provide a choose an active, hands-on approach, of income and a disproportionately valuable input. where the government owns much of positive impact on the poor by de-link- Consequently, James Barth, Gerard the banking industry, restricts banks ing good ideas and ability from past Caprio, and I assembled an internation- from engaging in non-lending activities accumulation of wealth and associa- al database on banking policies. We con- such as securities underwriting, insur- tions. ducted two surveys. The first was con- ance, real estate, and non-financial serv- The important relationship between ducted in 1998–9 and involved over 100 ices, limits the entry of new banks, and banks and economic welfare has led countries and included information on creates a powerful supervisory agency researchers and international institutions almost 200 regulations and supervisory that directly oversees and disciplines to develop policy recommendations con- practices. The second covered 2003–4 banks. Other countries rely substantial- cerning bank regulation and supervision. and included 50 more countries and 100 ly less on direct government control of The International Monetary Fund, additional questions, many of which banks. These countries place compara- were recommended by users of the first tively greater emphasis on forcing * Levine is a Research Associate in the survey.4 banks to disclose accurate information NBER's Program on International Finance Using these data, I am working with to the public as a mechanism for facili- and Macroeconomics and the Curtis L. Carlson others to assess which banking sector tating private sector governance of Professor of Finance at the University of policies promote sound banking around banks. Thus, some of my research can Minnesota. His profile appears later in this issue.

------NBER Reporter Fall 2005 9 be viewed as using the laboratory of regulation of bank activities and direct, Thorsten Beck, Asli Demirgüç-Kunt, bank regulation and supervision to hands-on influence over banks is and I estimate that the probability that a assess the historic debate about the unlikely to promote sound banking. firm reports bank corruption as a major proper role of government in the econ- Rather, the private interest view holds obstacle to firm growth would decrease omy. that the most efficacious approach to by over half if a country moved from Given these observations, my coau- bank supervision relies on using gov- the 25th percentile of our measure of thors and I have framed our initial inter- ernment regulations and institutions to the degree to which regulations force national investigations of bank regula- empower private monitoring of banks. information disclosure and foster pri- tion and supervision within the context Specifically, the private interest vate sector monitoring to the 75th per- of two views of government. The pub- approach advocates effective informa- centile.7 Furthermore, information dis- lic interest approach stresses that mar- tion disclosure rules and sound contract closure rules have a particularly strong ket failures — information and contract enforcement systems so that private effect on reducing corruption in lend- enforcement costs — interfere with the investors can use this information to ing in countries with well-functioning incentives and abilities of private agents exert sound corporate governance over legal institutions. Thus, private investors to monitor and discipline banks effec- banks with positive ramifications on need both information and legal tools tively. From this perspective, a powerful bank operations. This is not a laissez- to exert sound governance over banks. supervisory agency that directly moni- faire approach. To the contrary, the pri- Results on banking system crises tors and disciplines banks can improve vate interest approach stresses that also advertise the importance of the bank operations. The public interest strong legal and regulatory institutions incentives facing private investors. approach assumes that there are market are necessary for reducing information While we do not find a relationship failures and official supervisors have the and contract enforcement costs. My between information disclosure rules incentives and capabilities to ameliorate research is beginning to provide cross- and bank fragility, there is a strong link those market failures by directly over- country empirical evidence on these dif- between deposit insurance design and seeing, regulating, and disciplining ferent approaches to bank regulation crises. The results are consistent with banks. and supervision, including analyses of the view that generous insurance The private interest view, however, the role of legal and political institu- schemes reduce the incentives of pri- questions whether official supervisory tions in determining the effectiveness of vate investors to monitor banks and this agencies have the incentives and ability different banking sector policies. increases the ability of bank owners to to fix market failures and enhance the take on excessive risks, increasing the socially efficient operation of banks. Initial Results on What Works probability that the country suffer a sys- The private interest view holds that and What Does Not temic crisis.8 For example, James R. politicians and government supervisors Barth, Gerard Caprio, and I estimate Using different cross-country, do not maximize social welfare; they that if Mexico changed its very gener- bank-level, and firm-level datasets and maximize their own welfare. Thus, if ous deposit insurance to the sample employing different econometric tech- bank supervisory agencies have sub- average, then its probability of suffering niques, the initial results are broadly stantial influence over bank decisions, a systemic crisis would drop by 12 per- consistent with the predictions from a then politicians and supervisors may centage points.9 private interest view of bank regulation. abuse this power to force banks to In contrast, the results across a Bank regulations and supervisory prac- divert the flow of credit to ends that range of studies do not support the tices that force banks to disclose accu- satisfy the private interests of politi- public interest view of regulation and rate information to the public tend to: cians and supervisors, not the interests raise a cautionary flag regarding reliance 1) boost the development of the bank- of the broader public. Thus, strength- on direct official oversight of banks, ing system as measured by private cred- ening official oversight of banks might government ownership of banks, regu- it relative to Gross Domestic Product; reduce bank efficiency and intensify lations restricting bank activities, and 2) increase the efficiency of intermedia- corruption in lending. impediments to the entry of new tion as measured by lower interest mar- According to the private interest domestic and foreign banks. We never gins and bank overhead costs; and 3) view, most countries do not have politi- find that giving official supervisors reduce corruption in lending as meas- cal and legal systems that induce politi- greater powers (to force a bank to ured by survey information from firms cians and government officials to act in change its internal organizational struc- around the world.6 For example, the best interests of society. Thus heavy ture, suspend dividends, stop bonuses,

10 NBER Reporter Fall 2005 ------halt management fees, force banks to sistent with the private interest predic- efficacy of Basel II’s third pillar: market constitute provisions against actual or tion that regulatory restrictions on discipline. Regulations that require potential losses as determined by the activities, impediments to entry, limits informational transparency and that supervisory agency, supersede the legal on investing abroad, government own- strengthen the ability and incentives of rights of shareholders, remove and ership, and strengthening the discre- the private sector to monitor banks tend replace managers and directors, obtain tionary power of official supervisors to promote sound banking. information from external auditors, and increase cronyism, corruption, and col- take legal action against auditors for lusion with adverse ramifications on the Extensions negligence) enhances bank operations efficiency and effectiveness bank inter- Finally, I have also begun to exam- or reduces bank fragility. Similarly, mediation. In analyses, however, we ine the determinants of bank supervi- greater government ownership of find that well-functioning political and sory and regulatory choices.12 Perhaps banks, regulatory restrictions on bank legal institutions negate the negative not surprisingly, the data indicate that activities, or limitations on the entry of effects of empowering direct official countries with more open, competitive, new banks never has positive effects. oversight of banks. But even in these democratic political systems that have While some theories predict that cases, the results do not indicate that effective constraints on executive power strengthening direct official oversight empowering direct official oversight tend to adopt an approach to bank and regulation of banks will promote improves bank operations. supervision and regulation that relies social welfare in countries with well more on private monitoring, imposes functioning political and legal institu- Basel II and Beyond fewer regulatory restrictions on bank tions, we do not find support for this This research has implications for activities and the entry of new banks, hypothesis either.10 the three pillars of Basel II. Regarding and has less of a role for government- Across the different studies that I pillar one, my coauthors and I did not owned banks. In contrast, countries have conducted thus far, the bulk of find a significant impact of capital reg- with more closed, uncompetitive, auto- “hands on” government policies lowers ulations on bank development, efficien- cratic political institutions that impose bank development, induces less effi- cy, stability, or corruption. Many factors ineffective constraints on the executive cient banks, exacerbates corruption in may explain this result. The harmoniza- tend to rely less on private monitoring, bank lending, and intensifies banking tion of national capital regulations impose more restrictions on bank activ- system fragility. Specifically, countries makes it difficult to find a relationship ities and new bank entry, and create a that grant their official supervisors between capital regulations and bank bigger role for government banks. greater disciplinary powers have lower performance. Or, the lack of clear evi- These findings underscore the difficulty levels of bank development and greater dence on the beneficial effects of cur- in deriving uniform best practice guide- corruption in lending. Governments rent capital regulations may reflect the lines for countries around the world. that heavily regulate bank activities and inadequacy of the Basel I capital regula- Much work remains, though. We have restrict entry into banking have banks tions and the need for implementing not exploited all aspects of the database with bloated interest rate margins and Basel II. Or, banks may evade capital on bank regulation and supervision and larger overhead costs. For example, regulations. considerably more research is needed Demirgüç-Kunt, Luc Laeven, and I The findings support Basel II’s on designing strategies for reforming compute that if Mexico had the same third pillar, but not its second. For most banking policies in ways that enhance level of restrictions on bank activities as countries, the data indicate that the operation of banks and improve Korea, its interest rate margins would strengthening official supervisory pow- social welfare. be a full percentage point lower.11 ers will make things worse, not better. Furthermore, countries with greater 1 Unless the country is “top ten” in terms J. Barth, G. Caprio, and R. Levine, government ownership of the banking of the development of its political insti- Rethinking Bank Regulation: Till Angels industry have less banking system Govern, Cambridge University Press, forth- tutions, the evidence suggests that development. We also find that restrict- coming. strengthening official supervisory pow- 2 ing banks from diversifying into non- R. Levine, “Finance and Growth: Theory ers hurts bank development and leads and Evidence,” NBER Working Paper No. lending activities and prohibiting banks to greater corruption in bank lending 10766, September 2004, and Handbook of from lending abroad increases banking without any compensating positive Economic Growth, Philippe Aghion and system fragility. effects. Instead, the results advertise the Steven Durlauf eds., forthcoming. Thus, the evidence is broadly con- 3 T. Beck, A. Demirgüç-Kunt, and R. Levine,

------NBER Reporter Fall 2005 11 “Finance, Inequality, and Poverty: Cross- Regulation and Supervision: What Works Journal of Banking and Finance, forth- Country Evidence,” NBER Working Paper Best?”, and Rethinking Bank Regulation: coming. No. 10979, December 2004; and T. Beck, Till Angels Govern,. 9 J. Barth, G. Caprio, and R. Levine, “Bank A. Demirgüç-Kunt, L. Laeven, and R. 6 J. Barth, G. Caprio, and R. Levine, “Bank Regulation and Supervision: What Works Levine, “Finance, Firm Size, and Growth,” Regulation and Supervision: What Works Best?” NBER Working Paper No. 10983, Best?”; A. Demirgüç-Kunt, L. Laeven, and 10 G. Caprio, L. Laeven, R. Levine, December 2004. R. Levine, “Regulations, Market Structure, “Governance and Bank Valuation,” NBER 4 J. Barth, G. Caprio, and R. Levine, Institutions, and the Cost of Financial Working Paper No. 10158, December 2003; “Banking Systems Around the Globe: Do Intermediation,” NBER Working Paper No. J. Barth, G. Caprio, and R. Levine, “Bank Regulation and Ownership Affect Performance 9890, August 2003, and Journal of Money, Regulation and Supervision: What Works and Stability?” in Financial Supervision Credit, and Banking, 36 (2004), pp. Best?”; A. Demirgüç-Kunt, L. Laeven, and and Regulation: What Works and What 593–622; T. Beck, A. Demirgüç-Kunt, and R. Levine, “Regulations, Market Structure, Doesn’t, F. Mishkin ed., Chicago, IL: R. Levine, “Bank Supervision and Corporate Institutions, and the Cost of Financial Chicago University Press, (2001), pp. 31–88; Finance,” NBER Working Paper No. 9620, Intermediation”; T. Beck, A. Demirgüç-Kunt, “The Regulation and Supervision of Banks April 2003, and “Bank Supervision and and R. Levine, “Bank Supervision and Around the World: A New Database,” in Corruption in Lending,” mimeo (June 2005). Corporate Finance”; T. Beck, A. Demirgüç- Robert E. Litan and Richard Herring, eds., 7 T. Beck, A. Demirgüç-Kunt, and R. Levine, Kunt, and R. Levine, “Bank Supervision and Integrating Emerging Market Countries “Bank Supervision and Corruption in Corruption in Lending”; T. Beck, A. into the Global Financial System, Lending”. Demirgüç-Kunt, and R. Levine, “Bank Brookings-Wharton Papers on Financial 8 A. Demirgüç-Kunt and E. Enrica Concentration and Crises”; and J. Barth, G. Services, Washington, DC: Brookings Detragiache, “Does Deposit Insurance Caprio, and R. Levine, Rethinking Bank Institution Press (2001), pp. 183–241; Increase Banking System Stability? An Regulation: Till Angels Govern. “Bank Regulation and Supervision: What Empirical Investigation,” Journal of 11 A. Demirgüç-Kunt, L. Laeven, and R. Works Best?” NBER Working Paper No. Monetary Economics, 49, (2002), pp. Levine, “Regulations, Market Structure, 9323, November 2002, and Journal of 1373–406; and T. Beck, A. Demirgüç-Kunt, Institutions, and the Cost of Financial Financial Intermediation, 13, (2004), pp. and R. Levine, “Bank Concentration and Intermediation”. 205–48; and Rethinking Bank Crises,” NBER Working Paper No. 9921, 12 J. Barth, G. Caprio, and R. Levine, Regulation: Till Angels Govern. August 2003, and “Bank Concentration, Rethinking Bank Regulation: Till Angels 5 J. Barth, G. Caprio, and R. Levine, “Bank Competition and Crises: First Results,” Govern.

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12 NBER Reporter Fall 2005 ------Corporate Governance and Financial Globalization

René M. Stulz *

In his recent book, Thomas L. from 1996 to 2004 is a negative $67.4 these rights are meaningful. Second, Friedman makes the case that globaliza- billion. corporate governance has an internal, tion leads to a flat world.1 By that, he What then are the obstacles left that firm-level, dimension. Firms can organ- means that it removes obstacles that, in make the financial world full of ridges ize themselves so that they are well gov- the past, would have prevented firms and mountains, so that capital does not erned. For instance, they can commit and individuals from competing with flow where the physical marginal prod- themselves to good disclosure, which each other across the world. Such com- uct of capital is highest? The answer is makes it harder for corporate insiders to petition improves welfare not only by that poor corporate governance stands take advantage of other investors. The insuring that goods are produced at the in the way of countries getting the full quality of a firm’s governance depends lowest cost but also by making sure that benefit of financial globalization. With both on the quality of internal, firm- consumers get access to new and better poor governance, firms are valued less level, and external, country-level, gover- goods. Assuredly, the world is not flat by the capital markets, so that entrepre- nance. There has been considerable yet. Nevertheless, the metaphor is help- neurs are more limited in their abilities research on these two dimensions of ful for understanding the forces that to raise money to finance their activities. governance in recent years. In the fol- shape our world. It is even more apt to As a result, firms are smaller and growth lowing paragraphs, I discuss some of describe the financial world than the is stymied. the contributions I have made with my world of trade in goods. For many An investment of $100 might be co-authors in examining the interaction countries, the most significant explicit more productive in Indonesia than in between financial globalization and cor- barriers to trade in financial assets have the United States, but the investment porate governance. been knocked down. will not take place in Indonesia if Lee Pinkowitz, Craig Williamson, In a paper with Andrew Karolyi, I investors expect to receive a higher and I provide a useful way to under- describe how the financial world would return on their investment in the United stand the importance of the gover- look if it were flat.2 The most striking States. Poor governance prevents nance problem as an obstacle to finan- counter-factual is that, despite the investors from receiving the full return cial globalization.5 One would expect, if removal of barriers to trade in financial on their investment, because third par- governance works well, that a dollar of assets, capital does not flow to countries ties pick off the fruits of those invest- cash would be worth a dollar when the with low-capital stocks as strongly as ments before they are received. For capital markets value a corporation. If a one would expect.3 As Robert Lucas instance, controlling shareholders in a dollar of cash were worth less than a once pointed out forcefully, differences company in Indonesia might siphon off dollar, then it would mean that man- in the marginal product of capital earnings for their own profit rather than agers or controlling shareholders are between industrialized countries and using them to provide a return to out- wasting cash. We investigate how capital emerging countries are large. In fact, side investors. markets assess the value of cash in 35 over the recent past, capital has come As I emphasized in a paper with countries from 1988 through 1998. Our rushing into the United States, when Craig Doidge and Karolyi, corporate sample includes more than 6,000 com- one would expect it instead to flow to governance has two dimensions.4 First, panies per year on average. We find that emerging countries. Using data from it has an external, country-level, dimen- if we split the countries according to an the IMF, the cumulative sum of net sion. The institutions of the country in index of corruption, the value of a dol- equity flows to less developed countries which a firm is located affect how lar of cash is worth $0.91 in countries investors receive a return from investing with low corruption and $0.33 in coun- * Stulz is a Research Associate in the NBER's in the firm. Perhaps most importantly, a tries with high corruption. While the Programs in Corporate Finance and Asset country’s laws specify the rights that value of a dollar of cash inside the cor- Pricing and the Everett D. Reese Chair of investors have, and the enforcement of poration is worth an amount not signif- Banking and Monetary Economics at The the laws determines the extent to which icantly different from $1 in countries Ohio State University.

------NBER Reporter Fall 2005 13 with low corruption, it is worth signifi- Rohan Williamson and I emphasize the worth 16.5 percent more on average cantly less in countries with high cor- importance of culture as a determinant than comparable firms that were not ruption. How do we know that poor of institutions. We show that a coun- cross-listed. This cross-listing premium governance explains this result? We also try’s religion helps predict a country’s was even more dramatic for firms listed find that dividends are worth a lot more shareholder rights, creditor rights, and on NYSE, where it was 37 percent on in countries with high corruption than enforcement of property rights. In par- average. In recent work, not yet circu- they are in countries with low corrup- ticular, we find that protestant countries lating as a working paper, we show that tion. In other words, investors value typically have much stronger creditor this cross-listing premium persists cash paid out by the corporation in rights than catholic countries. In the through time. countries with high corruption because paper with Doidge and Karolyi, I also In the United States and a few they have good reasons to expect that show that a country’s economic and other countries, ownership of large cor- cash kept within the firm will be wasted financial development affect gover- porations is dispersed. In contrast, in or stolen. nance. At the firm level, good gover- most other countries, ownership of In the paper just discussed, we used nance reduces a firm’s cost of capital. large corporations is concentrated and country indices of governance. In other This advantage is of limited use if cap- corporations have controlling share- words, we classified as poor-governance ital markets are underdeveloped, how- holders. This difference in how corpo- countries those in which investors are ever. Consequently, the incentives of rations are owned across the world has poorly protected, so that they are less firms and countries to invest in gover- much to do with differences in gover- likely to receive a return on their invest- nance are limited when financial mar- nance. I show that ownership is much ment. This focus raises the question of kets are poorly developed. more concentrated in countries with how important countries are for corpo- The evidence suggests that it is dif- high corruption.11 The reason for this is rate governance. Could it be that firms ficult for firms to find ways to offset the straightforward. Everything else equal, can adopt good governance practices in disadvantages resulting from being insiders would rather diversify their countries that protect investors poorly located in a country with poor institu- wealth, so that concentrated ownership so that they would be on a level playing tions. However, I make the point that is costly for them. In countries with field with firms from countries that firms can rent institutions from coun- high corruption, it is easier for corpo- protect investors well? It turns out that tries with better institutions.9 In particu- rate insiders to steal from minority countries have a determinant influence lar, foreign firms that list their shares in shareholders. However, when corporate on governance. Doidge, Karolyi, and I the United States benefit from some insiders have a large stake in the corpo- investigate three corporate governance U.S. institutions. For instance, they have ration, they end up stealing mostly from rankings.6 One example of such rank- to meet various disclosure requirements themselves. If stealing from minority ings is S&P’s Transparency and that U.S. firms have to meet and their shareholders has costs for corporate Disclosure ratings, which evaluate the investors can use the U.S. courts and insiders, less stealing takes place when disclosure practices of corporations in benefit from U.S. laws and regulations. corporate insiders have a larger stake in emerging and industrialized countries. Doidge, Karolyi, and I examine the corporation. Consequently, in coun- We find that most of the variation in whether the evidence is consistent with tries where governance is poor, insiders corporate governance rankings can be the hypothesis that firms cross-list in have to co-invest more with other explained by country characteristics. In the United States to take advantage of shareholders. Since the resources of other words, for the corporate gover- the U.S. institutions that protect insiders are limited, it follows that firms nance rankings we observe, just know- investors.10 We find strong support for are smaller and more levered in coun- ing a firm’s country of origin explains this hypothesis. Our paper identifies a tries where governance is poor. most of the variation in rankings across striking result, which we call the “listing The literature has shown that capi- firms. premium.” We find that foreign firms tal markets are weak when investors are An important question is why gov- that list in the United States are worth poorly protected. In a paper with Jean ernance differs across countries. The lit- substantially more than foreign firms Helwege and Christo Pirinsky, I show erature has provided a number of that do not list in the United States. The that capital markets play a key role in hypotheses. La Porta et al. point to the paper examines the valuation of 712 how U.S. companies evolve after their importance of a country’s legal origins.7 cross-listed stocks and 4,078 non-cross- IPO so that their ownership becomes Johnson et al. focus on how a country’s listed stocks in 1997. It finds that the dispersed.12 In that paper, we show that endowments shape its institutions.8 valuation of cross-listed stocks were the corporations whose ownership

14 NBER Reporter Fall 2005 ------becomes dispersed quickly after their resources of the insiders, firms could be Finance,” NBER Working Paper No. 5661, IPO benefit from a liquid market for larger, more investment could take July 1996, and Journal of Political their stock. In other words, ownership place, and consumption would be less Economy, 106 (6), December 1998, pp. 1113–55. becomes dispersed only for the firms volatile. Hence, good governance is the 8 D. Acemoglu, S. Johnson, and J. A. Robinson, that benefit from a well-functioning key to a flat financial world. “The Colonial Origins Of Comparative market for their stock. Development: An Empirical Investigation,” American Economic Review, 91(5), If the financial world were flat, we 1 Thomas L. Friedman, The World is Flat, would expect investors to be more December 2001, pp. 1369–401. New York, N.Y: Farrar, Strauss, and 9 R. M. Stulz, “Globalization, Corporate internationally diversified than they are. Giroux, 2005. 2 Finance, and the Cost of Capital,” Journal The home bias in equity holdings has G. A. Karolyi and R.M. Stulz, “Are of Applied Corporate Finance, 8 (3), garnered much attention from econo- Financial Assets Priced Locally or Globally?” Fall 1995, pp. 30–8. A longer version of the mists. Karolyi and I review much of the NBER Working Paper No 8994, June 2002, paper appeared as NBER Working Paper and in The Handbook of the Economics evidence on the home bias and report No. 7021, March 1999. of Finance, G. Constantinides, M. Harris, 10 that it is still substantial.13 Magnus R.M. Stulz, C. Doidge, and G.A. Karolyi, and R.M. Stulz, eds. Elsevier-North “Why Are Foreign Firms Listed in the U.S. Dahlquist, Pinkowitz, Williamson, and I Holland, 2003. 3 Worth More?” NBER Working Paper No. tie the home bias to governance.14 In For a review of issues concerning capital 8538, October 2001, and Journal of small countries, foreign investors would flows, see R.M. Stulz, “International Portfolio Financial Economics, 71(2), 2004, pp. Flows and Security Markets”, in hold most shares if the financial world 205–38. International Capital Flows, M. Feldstein, 11 were flat. We argue that a major reason R.M.Stulz, “The Limits Of Financial ed. Chicago: University Chicago Press, 1999, Globalization,” NBER Working Paper No. why this is not the case is that in coun- pp. 257–93. 4 11070, January 2005, and Journal of tries with poor governance, corporate See C. Doidge, G. A. Karolyi, and R. M. Finance, 60(4), 2005, pp. 1595–638. insiders have to hold large stakes in Stulz, “Why Do Countries Matter so Much 12 J. Helwege, C. Pirinsky, and R.M. Stulz, their sharesfirms. The shares that cor- for Corporate Governance?” NBER “Why Do Firms Become Widely Held? An Working Paper No. 10726, September 2004. Analysis of The Dynamics of Corporate porate insiders hold cannot be held by 5 L. Pinkowitz, R. Williamson, and R. M. foreign investors. With this argument, Ownership,” NBER Working Paper No. Stulz, “Does the Contribution of Corporate 11505, August 2005. there is an upper limit to the fraction of Cash Holdings and Dividends to Firm Value 13 G. A. Karolyi and R.M. Stulz, “Are shares that can be held by foreign Depend on Governance? A Cross-Country Financial Assets Priced Locally or investors. This upper limit is inversely Analysis,” Journal of Finance, forthcom- Globally?” ing. An earlier version was circulated as 14 R. M. Stulz, L. Pinkowitz, and R. related to the quality of governance in a NBER Working Paper No. 10188, country. Williamson, “Corporate Governance and the December 2003. Home Bias,” NBER Working Paper No. If all countries had good gover- 6 C. Doidge, G. A. Karolyi, and R. M. Stulz, 8680, December 2001, and Journal of nance, then firms could be held by “Why Do Countries Matter so Much for Financial and Quantitative Analysis, diversified investors. Since firm size Corporate Governance?” 7 38(1), 2003, pp. 87–110. would not be limited in part by the R. La Porta, F. Lopez-de-Silanes, A. Shleifer, and R. W. Vishny, “Law And

------NBER Reporter Fall 2005 15 NBER Profile: David I. Laibson

David I. Laibson is a Research Laibson is a member of the Russell Associate in the NBER’s Programs on Sage Behavioral Economics Round- Aging, Economic Fluctuations, and table, the MacArthur Foundation Asset Pricing. He is also a Professor of Preferences Network, the Data Moni- Economics at Harvard University. toring Committee of the Health and Laibson received his A.B. in Retirement Survey, the Board of the Economics from Harvard in 1988, his Pension Research Council, and the edi- MSc from the London School of torial boards of the Journal of the Economics in 1990, and his Ph.D. in European Economic Association and the Economics from MIT in 1994. He Journal of Risk and Uncertainty. joined the Harvard economics depart- Laibson lives in Cambridge with his ment as an assistant professor in 1994 wife Nina Zipser, the Director of and was promoted to full professor in Institutional Research at Harvard 2002. He was also a Fellow of the University. Occasionally they find time NBER’s Aging Program in the academ- to hike, snorkel, cross-country ski, and ic year 1997–8. snow shoe. Laibson also plays tennis with Harvard graduate students who let him win a few games.

NBER Profile: Ross Levine

Ross Levine is a Research Associate between financial sector policies, the in the NBER’s Program on International operation of financial systems, and the Finance and Macroeconomics and the impact of financial arrangements on Harrison S. Kravis University Professor growth, poverty, income distribution, and Professor of Economics at Brown and corporate performance. His recent University. Also at Brown, Levine is the book with James Barth and Gerard Paul Dupee Faculty Fellow at the Watson Caprio, Rethinking Bank Regulation: Till Institute for International Studies. He Angels Govern, challenges the efficacy of received his Ph.D. in economics from many policy recommendations regard- UCLA and worked for the Board of ing bank supervision and regulation. Governors of the Federal Reserve Levine lives in Providence, Rhode System, the World Bank, and the Island with his wife, an economist who University of Virginia. Before moving to directs the Commerce, Organization, Brown University in 2005, Levine was the and Entrepreneurship Program at Curtis Carlson Professor of Finance at Brown University, and two children. His the University of Minnesota’s Carlson hobbies include running, swimming, School of Management. tennis, bicycling, and trying to make the Levine’s research examines the perfect cup of coffee. determinants of economic growth and focuses on understanding the linkages

16 NBER Reporter Fall 2005 ------Conferences

Economic Regulation

NBER Research Associate Nancy Discussant: Joseph Farrell, University Gregory Crawford, University of L. Rose of MIT organized a confer- of California, Berkeley Arizona, “Cable Television: Does ence on Economic Regulation that Cable Need to be Regulated Any took place on September 9 and 10 in Frank Wolak, Stanford University More?” Cambridge. The following papers and NBER, “Regulating Competition Discussant: Tasneem Chipty, CRA were discussed: in Wholesale Electricity Supply” International Discussant: Catherine Wolfram, Dennis Carlton, University of University of California, Berkeley and Patricia Danzon, University of Chicago and NBER, and Randal NBER Pennsylvania and NBER, and Eric Picker, University of Chicago, Keuffel, University of Pennsylvania, “Antitrust and Regulation” Severin Borenstein, University of “Regulation of the Pharmaceutical Discussant: Timothy Bresnahan, California, Berkeley and NBER, and Industry” Stanford University and NBER Nancy L. Rose, “Regulatory Reform Discussant: Ernst Berndt, MIT and in the Airline Industry” NBER Paul Joskow, MIT and NBER, Discussant: Steven Berry, Yale “Incentive Regulation in Theory and University and NBER Eric Zitzewitz, Stanford University, Practice: Electricity Distribution and “Financial Regulation in the After- Transmission Networks” Randall Kroszner, University of math of the Bubble” Discussant: David Sappington, Chicago and NBER, and Philip Discussant: Jonathan Macey, Yale University of Florida Strahan, Boston College and NBER, University “Regulation and Deregulation of the Jerry Hausman, MIT and NBER, U.S. Banking Industry: Causes, Roberton Williams, University of and J. Gregory Sidak, American Consequences, and Implications for Texas at Austin and NBER, “Market- Enterprise Institute, the Future” Based Environmental Regulation” “Telecommunications Regulation: Discussant: Charles Calomiris, Discussant: Erin Mansur, Yale Current Approaches with the End in Columbia University and NBER University Sight”

The past thirty years have wit- or state ownership has been replaced by recent years, however, some have chal- nessed an extraordinary transformation market-based institutions. Much of this lenged the wisdom of those policies, of government intervention in broad reform movement was supported by even proposing the reintroduction of segments of the economy, both in the economic analyses that highlighted the regulation in some sectors. United States and in many other inefficiencies of historical regulatory This National Bureau of Economic nations. Many industries historically policies and suggested the prospect of Research project analyzes the perform- subject to economic regulation, particu- substantial gains from regulatory ance of regulatory reform and restruc- larly those in multi-firm sectors such as reform. Early studies of the aftermath turing across a broad group of indus- trucking, airlines, and banking, have of deregulation confirmed many of the tries and settings. The papers at this been largely deregulated. “Natural anticipated benefits, particularly in conference provide an overview of key monopoly” industries, such as electrici- structurally competitive sectors, and issues surrounding economic regulation ty and telecommunications, have been may have spurred extension of regula- and assessment of the economic conse- restructured, and traditional regulation tory reform to other industries. In quences of regulatory reforms over the

------NBER Reporter Fall 2005 17 past three decades, and discuss some of turing has led to vertical disintegration of They concentrate on the outcome in the most significant contemporary con- firms, and increased competition with three countries: the United States, the cerns about these reforms. incumbents in many industry segments. United Kingdom, and New Zealand. More than a century ago, Carlton The tension between antitrust and regu- Their general conclusion is that in both and Picker note, the federal government latory solutions to these problems con- the United States and the United started regulating competition, first rail- tinues. The Supreme Court’s decision in Kingdom unbundling may have caused roads through the Interstate Commerce Trinko suggests that antitrust will not be an increase in competition, if one meas- Act and then the general economy under viewed as a substitute for regulation of ures competition by market share of the Sherman Act. The former assigned interconnection in network industries entrants. However, adverse effects primary responsibility to the Interstate and that firms seeking interconnection occurred in terms of investments by Commerce Commission (ICC), while will need to look outside of antitrust for both incumbents and new entrants. the Sherman Act relied for its imple- help. Further, the “goals” put forward by reg- mentation on federal courts. Since that One of the most significant ulators in terms of unbundling have not time, there has been an ongoing struggle reforms within economic regulation has been met. In the last section of their to define the appropriate substantive been a move away from cost-based paper they consider whether, with scope for regulating competition and to price setting toward incentive-based increased facilities-based competition, determine the right mechanism for mechanisms. Joskow first describes especially in the United States, the “end implementing that policy. As the modern theoretical principles govern- of regulation” in telecommunications antitrust laws evolved and harmed cer- ing the benefits and design of incentive should occur. They explain that in an tain interest groups, these groups often regulation mechanisms. Mapping these industry with high fixed costs and low sought and got explicit exemptions and theoretical models into regulatory variable costs, the incumbent will not be even legislation protecting them from design in specific industry settings can able to increase prices above competi- entry. Other interest groups wound up be difficult, however, and Joskow iden- tive levels profitably if it loses a rela- with regulation as an alternative to facing tifies a number of issues associated with tively small amount of business. Thus, antitrust liability and had to share the applying these principles in practice. the entry of cable television providers benefits of regulation with other interest His work then moves to a discussion of offering telephone service should serve groups. Many exemptions and regulatory actual applications of incentive regula- to constrain incumbents from increas- agencies were formed as responses to tion mechanisms to the regulation of ing prices above competitive levels at a unfavorable antitrust decisions. For prices and service quality for “unbun- quite early stage. No economic reason example, the railroads certainly had the dled” electricity transmission and distri- exists for the incumbent’s share to fall incentive, and perhaps even good eco- bution networks. Joskow describes the to, say, 50 percent before price deregu- nomic reasons, to agree on rates and challenges, and reviews the evidence lation should follow. Emerging facili- could do so prior to the Sherman Act regarding the performance of incentive ties-based competition should allow the without fear of federal prosecution. The regulation for electric distribution and end of price regulation and the regula- Supreme Court’s decision in Trans- transmission networks. Finally, he iden- tory burden that it creates for both con- Missouri changed that, as it made clear tifies issues for future research. sumers and the economy. that the Sherman Act condemned pri- Early telecommunications regulato- The experience of the past ten vate collective rate setting. But if private ry reform moved toward incentive reg- years of electricity industry reform pro- collective rate setting was forbidden, it ulation, in part because of recognition vides further evidence that market insti- was left unclear how to implement pub- of adverse effects of traditional regula- tutions can significantly enhance or lic rate setting, because the ICC lacked tion on innovation. During the late limit the potential benefits of regulato- the power to set rates. The Interstate 1990s and the early 2000s, however, ry reform and restructuring. Wolak Commerce Act itself needed a series of cost-based regulation has reappeared suggests that electricity industry amendments before the ICC received because of the necessity to set prices restructuring is an evolving process that true rate-setting power. The core issue in for unbundled network elements requires policymakers to choose network industries today, whether (UNEs) sold by incumbent firms to between an imperfectly competitive telecommunications, transportation, or their competitors. Hausman and market and an imperfect regulatory electricity, is interconnection and manda- Sidak consider the outcomes so far of process to provide incentives for least- tory access. The salience of these issues the new regulatory approach to cost supply at various stages of the pro- has increased as reform-induced restruc- unbundling the incumbents’ networks. duction process. The probability of a

18 NBER Reporter Fall 2005 ------costly market failure in the electricity 9/11. While deregulation yielded sub- for both the financial services industry supply industry, often because of the stantial benefits to consumers, three sig- and the economy. The industry adapted exercise of unilateral market power, nificant concerns confront the present to the regulatory constraints imposed in appears to be significantly higher than industry: 1) is an unregulated competi- the 1930s, thus partially reducing the costs in other network industries, and quite tive airline industry economically of regulatory distortions. Nevertheless, sensitive to market design. There are a viable? 2) Is market power likely to be a banking efficiency improved following number of ways the regulator can limit persistent problem? And 3) has govern- deregulation, and this improvement gen- the ability of suppliers to exercise uni- ment-controlled infrastructure con- erated substantial real benefits for the lateral market power: 1) alter the market tributed significantly to the difficulties economy as a whole. structure, 2) change market rules, 3) the industry has recently encountered? Economic regulation has ebbed impose penalties and sanctions on mar- The authors show that market power and flowed in the cable television sector ket participants for their behavior, and probably peaked in the mid-1990s and over the past two decades. These expe- 4) explicitly set the prices that market has declined significantly since then, riences have highlighted the potentially participants receive for their produc- accompanied by growth in low-cost car- important interplay between price regu- tion. Wolak uses examples from whole- riers that now challenge the legacy air- lation and quality provision by firms. sale markets in industrialized and devel- lines in virtually all parts of the country. Crawford surveys the empirical record oping countries to illustrate the impor- This surge in competition, along with on the (dismal) consequences of price tance of effectively addressing each adverse demand shocks, high fuel regulation in cable and the more aspect of the market design process. prices, and high labor costs have led to encouraging (but incomplete) evidence Although there is no single optimal financial distress among many legacy on the consequences of competition. In wholesale market design, all successful airlines. This has been costly for share- the last ten years, the market for multi- market designs appear to have ade- holders and high-wage workers, though channel video programming has under- quately addressed each of these dimen- there is no indication of significant gone considerable change. Direct sions of the market design process in a adverse consumer impact. Perhaps the Broadcast Satellite service, spurred by manner suited to the initial conditions greatest long-run challenge to the air- 1999 legislation that leveled the playing in the industry and the political con- line industry is the performance of gov- field with cable television systems, has straints the restructuring process faced ernment-controlled airport, air traffic grown from 3 percent to 25 percent of when the wholesale market was formed. control, and security infrastructure, the U.S. cable and satellite market and He uses his framework to understand which has not in general kept pace with now accounts for virtually all net new the causes of the disappointing experi- the growth and changes in the industry. subscribers. Crawford considers the ence with wholesale electricity restruc- The banking industry historically implications of satellite competition for turing in the United States. This discus- was subject to extensive government reg- regulatory policy and performance in sion points to a number of ways to ulation covering what prices (that is, cable television markets. He concludes increase the likelihood of a restructur- interest rates) they can charge, what with a consideration of two open issues ing process that ultimately benefits con- activities they can engage in, what risks in cable markets: horizontal concentra- sumers. they can and cannot take, what capital tion and vertical integration in the input In many industries, economic regu- they must hold, and what locations they (programming) market and bundling by lation was eliminated rather than can operate in. Kroszner and Strahan both cable systems and programmers. reformed during the late 1970s and summarize the evolution of these regula- The latter is especially worth of atten- early 1980s. Borenstein and Rose tions, with a focus on those put into tion by policymakers concerned with describe the institutions and economic place in the 1930s and later removed in market power and diversity in media performance of the airline industry as it the last part of the twentieth century. markets. has evolved from restrictive govern- They argue that regulatory change was The conference included an analy- ment regulation to economic deregula- driven by macroeconomic, technological, sis of sectors subject to regulations tion. They show that consumers overall and legal shocks that affected competi- beyond the traditional economic price have benefited not only from reduced tion among interest groups. As they and entry controls. Danzon and fares, but also from increases in flight show, the role of both private interests Keuffel note that the pharmaceutical- frequencies and in the number of and public interests are key in the analy- biotechnology industry is subject to routes that receive nonstop service. sis. They also analyze the consequences three major types of regulation. First, This pattern has continued even since of banking regulation and deregulation all industrialized countries require that

------NBER Reporter Fall 2005 19 new drugs, biologics, and vaccines meet not understanding the rather central con- toward convergence remains open. regulatory requirements for safety, effi- cept of price. Consumer behavior gives Finally, Williams considers the cacy, and manufacturing quality as a rise to market failures, and, especially fol- penetration of market- or incentive- condition of market access. In the lowing the stock market boom and bust, based regulation into environmental 1990s, the adoption of user fees, fast there is increasing interest in refining policy, focusing primarily on the most track, and priority review have acceler- financial regulation to address these fail- widely used, tradable emissions permits. ated drug approval, especially for prior- ures. Zitzewitz provides an overview of Market-based regulations provide pol- ity drugs. Basing regulatory decisions the major laws and institutions regulating luters with an incentive to reduce pollu- on post-launch observational data, finance and then discusses three issues tion emissions, while allowing far more appropriately integrated with pre- with parallels in other industries: the reg- flexibility in how to achieve those emis- launch clinical trial data, is a high prior- ulation of price, collusion and antitrust sions reductions than do more tradi- ity for regulators, payers, and con- policy, and the interaction of firm tional command-and-control regula- sumers, as a strategy to accelerate avail- boundaries and conflicts of interest. In tions. That flexibility can substantially ability of new drugs while increasing asset management and financial advice, reduce the cost of achieving a given the information base for evaluating firms discriminate according to cus- reduction in emissions. As a result, trad- drug risks and benefits. Second, most tomer sophistication, offering low-price, able permits have become a popular countries with universal national health high-quality products to sophisticated option for environmental regulation. insurance regulate pharmaceutical clients and high-price, low-quality prod- However, practical experience has prices, revenues, and/or profits. ucts to the less sophisticated. Given this, shown that the tradable permit system’s Danzon and Keuffel discuss the exist- the traditional side effects of downward design and the details of a particular ing criteria for price regulation, includ- regulatory pressure on price may be mit- pollution problem greatly influence the ing internal benchmarking, external ref- igated, since the regulation-induced exit effectiveness of tradable permit regula- erencing, and profit regulation. The evi- of high-price, low-quality products may tion. Permit trading can produce exces- dence shows that these regulatory sys- improve the welfare of their current sive concentrations of pollution in tems have controlled prices but also consumers. As the NASDAQ market some locations. Transaction costs and have contributed to delays in the launch makers antitrust case, and arguably the market power can reduce the cost sav- of new drugs. Third, pharmaceutical pricing of underwriting services, illus- ings from trading. And, permit alloca- regulation intersects with the definition trate, multi-market contact, price trans- tions can produce an inefficient or of patents and criteria for generic entry. parency, and opportunities for targeted inequitable distribution of the costs of In the United States, the 1984 Hatch punishments can make collusion easier regulation. Thus, tradable permits are Waxman Act has led to some gaming by to sustain in financial services than in not always the best policy options. But both originator firms and generic com- other industries. Such collusion is often in many cases, careful regulatory design panies. Defining a regulatory frame- accompanied by non-price competition, can limit these potential problems. work for approving biogenerics is an which dissipates rents but often in ways The University of Chicago Press important evolving regulatory concern that introduce distortions. Finally, the will publish these papers and discus- in industrialized countries. integration of financial businesses cre- sions in an NBER Conference Volume. Potential informational failures are ates opportunities to tradeoff the inter- Its availability will be announced in a also significant in the regulation of many ests of one client for another. The ques- future issue of the NBER Reporter. Also, financial services. Many consumers of tion of whether these conflicts can be the papers will be available at “Books in financial services suffer from informa- successfully managed or whether they Progress” on the NBER’s website. tional disadvantages that often include will call into question the 1990s trend

20 NBER Reporter Fall 2005 ------Tax Policy and the Economy

The NBER’s Twentieth Annual University of Illinois at Urbana- University of Kansas, and Daniel Conference on Tax Policy and the Champaign, and James M. Poterba, Schneider, Harvard Business School, Economy, organized by James M. “Household Demand for Variable “Splitting Tax Refunds and Building Poterba of NBER and MIT, took Annuities” Savings: an Empirical Test” place in Washington, DC on September 15. These papers were dis- Nada Eissa, NBER and George- Roger H. Gordon and Julie Berry cussed: town University, and Hilary W. Cullen, NBER and University of Hoynes, NBER and University of California, San Diego, “ Tax Reform Jagadeesh Gokhale, Cato Institute, California, Davis, “Behavioral Res- and Entrepreneurial Activity” and Kent Smetters, NBER and ponses to Taxes: Lessons from the University of Pennsylvania, “Fiscal EITC and Labor Supply” Alan J. Auerbach, NBER and and Generational Imbalances: An University of California, Berkeley, Update” Peter Tufano, NBER and Harvard “Who Bears the Corporate Income Business School; Sondra Beverly, Tax? A Review of What We Know” Jeffrey R. Brown, NBER and

Gokhale and Smetters provide an have been one of the most rapidly importance of tax incentives in con- update of the U.S. Fiscal and growing financial products of the last tributing to variable annuity ownership. Generational Imbalances that they orig- two decades. Between 1990 and 2004, The probability of owning a variable inally calculated for a 2003 paper. They annual sales of variable annuities in the annuity rises with the marginal tax rate find that a lot has changed in a few United States grew from just over $5 throughout most of the income distri- years. In particular, the nation’s fiscal billion to nearly $130 billion. bution, but is lower for households in imbalance has grown from around $44 Variable annuities now account for the top tax bracket than for those with trillion dollars as of fiscal yearend 2002 approximately half of all private market slightly lower tax rates. to about $63 trillion dollars, mostly annuity sales. They resemble mutual Twenty-two million families cur- because of the recent adoption of the funds, but qualify for special tax treat- rently receive a total of $34 billion dol- prescription drug bill (Medicare, Part ment as insurance products because lars in benefits from the Earned Income D). The imbalance also grows by more they offer buyers an option to convert Tax Credit (EITC). In fact, the EITC is than $1.5 trillion (in inflation adjusted to a life annuity. Brown and Poterba the largest cash transfer program for terms) each year that action is not taken describe the tax treatment of variable lower-income families at the federal to reduce it. This imbalance now equals annuities, present summary information level. One unusual feature of the credit about 8 percent of all future GDP and on their ownership patterns, and is its explicit goal of using the tax sys- could, in theory, be eliminated by more explore the importance of several dis- tem to encourage and support those than doubling the employer-employee tinct motives for household purchase of who choose to work. A large body of payroll tax from 15.3 percent of wages variable annuities. Using household data work has evaluated the labor supply to over 32 percent immediately and for- from the 1998 and 2001 waves of the effects of the EITC and has generated ever — assuming, quite critically, no Survey of Consumer Finances, they several important findings regarding the reduction in labor supply or national find that variable annuity ownership is behavioral response to taxes. Perhaps saving and capital formation. highly concentrated among high the main lesson learned from the evi- Equivalently, massive cuts in govern- income and high net wealth sub-groups dence, Eissa and Hoynes note, is the ment spending would be required to of the population. Variable annuity confirmation that real responses to achieve fiscal balance: the total federal ownership is less concentrated, howev- taxes are important; labor supply does fiscal imbalance now equals 77.8 per- er, than ownership of several other respond to the EITC. The second cent of non-Social Security and non- types of financial assets. Brown and major lesson is related to the nature of Medicare outlays. Variable annuities Poterba find mixed evidence on the the labor supply response. A consistent

------NBER Reporter Fall 2005 21 finding is that labor supply responses Gordon and Cullen forecast the about how to assign the corporate tax are concentrated along the extensive effects of plausible tax reforms on the burden. Among the lessons from the (entry) margin, rather than the intensive extent of entrepreneurial activity in the recent literature are: 1) for a variety of (hours worked) margin. This distinction United States. To do so, they draw on reasons, shareholders may bear a certain has important implications for the recent work they have done assessing portion of the corporate tax burden. design of tax-transfer programs and for the many routes through which the tax They may be unable to shift taxes attrib- the welfare evaluation of tax reforms. structure affects the amount of entre- utable to a discount on “old” capital, Families are more likely to save if preneurial activity, and estimating the taxes on rents, or taxes that simply they can commit to savings before funds responsiveness of behavior to these reduce the advantages of corporate are in hand (and subject to spending incentives. Using these estimates, the ownership. In the short run, they also temptations). For low- and moderate- authors forecast that the effect of tax may be unable to shift taxes on corpo- income U.S. families, an important sav- reforms on entrepreneurial activity can rate capital. Thus, the distribution of ings opportunity arises annually, during be very sensitive to whether current tax share ownership remains empirically income tax season. Beverly, Schnieder, provisions aimed to encourage risk-tak- quite relevant to corporate tax incidence and Tufano study a group of low- ing in small firms remain part of the tax analysis, though attributing ownership income individuals in Tulsa, Oklahoma code. If they are left in place, Gordon is itself a challenging exercise. 2) One- who, at the time of tax filing, were and Cullen forecast that a shift to a dimensional incidence analysis — dis- encouraged to save parts of their federal Hall-Rabushka flat tax will leave the tributing the corporate tax burden over refunds. Those who agreed directed a overall amount of entrepreneurial activ- a representative cross-section of the portion of their refund to a savings ity largely unaffected, but lead to a drop population — can be relatively uninfor- account, and arranged to have the rest in activity among the high skilled and an mative about who bears the corporate sent to them in the form of a check. offsetting increase in activity among the tax burden, because it misses the ele- Eligible individuals also could open low- less highly skilled. However, if in the ment of timing. 3) It is more meaning- cost savings accounts. The authors doc- process of fundamental tax reform, ful to analyze the incidence of corpo- ument the demand for these services, the “net operating loss” carrybacks are dis- rate tax changes than of the corporate characteristics of those who sought to allowed and section 1244 (allowing cap- tax in its entirety, because different participate, the savings goals of those ital losses on equity in small businesses components of the tax have different who participated, the immediate savings to be reclassified as ordinary losses) is incidence and incidence relates to the generated by the program, and the dis- repealed, then overall entrepreneurial path of the economy over time, not just position of savings a few months after activity could fall by more than half. in a single year. receipt. This pilot study suggests that Auerbach reviews what we know These papers will be published by there may be demand among low- from economic theory and evidence the MIT Press as Tax Policy and the income families for a refund-splitting about the burden of the corporate Economy, Volume 20. They are also avail- program that supports emergency needs income tax. While the ultimate inci- able at “Books in Progress” on the as well as asset building, especially if a dence of the tax remains somewhat NBER’s website. basic savings product is available to all at unresolved, there have been many the time of tax filing. advances over the years in thinking

22 NBER Reporter Fall 2005 ------Bureau News

Bernanke: Long-Time NBER Researcher

Former NBER Research Associate first in 1980 and the most recent in 2004. University. In that capacity, he also Ben S. Bernanke has been nominated by Bernanke also co-organized the became a member of the NBER’s President George W. Bush to become the NBER’s Annual Conference on Business Cycle Dating Committee. next Chairman of the Federal Reserve Macroeconomics with Professor Julio Bernanke’s most recent NBER vol- Board of Governors. If confirmed, he Rotemberg of MIT from 1995–8. They ume, The Inflation Targeting Debate, co- will replace Chairman Alan Greenspan served as co-editors of the Macro- edited with Research Associate Michael when his term expires in early 2006. economics Annual volume, published by Woodford, was published this year by the Bernanke, who holds a Bachelors’ the MIT Press, during those years. University of Chicago Press. Information degree in Economics from Harvard and a In the fall of 2000, Bernanke became about that volume, and Bernanke’s Ph.D. from MIT, was an NBER Research Director of the NBER’s Program of NBER Working Papers, is available at the Associate for many years. He authored a Research in Monetary Economics, suc- NBER’s website. total of 34 NBER Working Papers, the ceeding N. Gregory Mankiw of Harvard

Two NBER Research Associates to Join CEA

NBER Research Associates the NBER’s Program of Research in School of Business Administration, Katherine Baicker and Matthew J. Public Economics. She served as a senior Dartmouth College, is a member of the Slaughter will join the President’s Council economist at the CEA in 2001–2. Baicker NBER’s Program of Research on of Economic Advisers (CEA) if con- received her Ph.D. in Economics from International Trade and Investment. He is firmed by the U.S. Senate. Harvard University in 1998 and previous- also a Visiting Fellow of the Institute for Baicker, an Associate Professor in ly taught at Dartmouth College. International Economics. Slaughter Public Policy at the University of Slaughter, an Associate Professor of received his Ph.D. in Economics from California, Los Angeles, is a member of Business Administration at the Tuck MIT in 1994.

Nakahara Prize Goes to Hoshi

Takeo Hoshi, an NBER Research Since the founding of the award in 1995, nomics and monetary economics by cre- Associate from the University of Hoshi becomes the fourth NBER econo- ating innovative original models and, California, San Diego, won the Japan mist to win it. thereby presenting new insights to old Economic Association’s 2005 Nakahara In 1995, Fumio Hayashi of the questions.” In 2001, Charles Y. Horioka Prize. The prize is awarded every year to University of Tokyo was chosen by the of Osaka University was selected for honor one outstanding Japanese econo- committee for his work in macroeconom- “several outstanding contributions in the mist under the age of 45. The committee ics, particularly for making a “major con- areas of international capital flows and cited Hoshi’s work on the Japanese bank- tribution to our understanding of the saving and consumption in Japan.” ing system. They said “he has been the rational expectations hypothesis by creat- It is quite remarkable that four forefront of analyzing both theoretical ing new inference methods and applying NBER Research Associates have won and empirical issues of the Japanese them to U.S. and Japanese data on con- this important prize in the ten years since banking problem in the 1990s. He ana- sumption.” In 1997, Nobuhiro Kiyotaki it began, as there are only a small number lyzed how the once highly regarded bank- of the London School of Economics was of Japanese NBER researchers who are centered Japanese financial system has chosen for making “several outstanding eligible for this prize. become a liability to the entire economy.” contributions in the areas of macroeco------NBER Reporter Fall 2005 23 Twenty-sixth NBER Summer Institute Held in 2005

In the summer of 2005, the NBER papers presented at dozens of different are available on the NBER’s web site by held its twenty-sixth annual Summer sessions during the four-week Summer clicking Summer Institute 2005 on our Institute. More than 1300 economists Institute covered a wide variety of top- conference page, www.nber.org/confer. from universities and organizations ics. A complete agenda and many of the throughout the world attended. The papers presented at the various sessions

Japan Project Meets

The NBER together with the “Structural Transformation and Chiaki Moriguchi, NBER and Center for International Research on Growth Slowdowns: Japan in the 90s” Northwestern University, and the Japanese Economy and the Discussant: Randall S. Kroszner, NBER Emmanuel Saez, NBER and European Institute of Japanese Studies and University of Chicago University of California, Berkeley, held a project meeting on the Japanese “The Evolution of Income economy in Tokyo on September R. Anton Braun, University of Tokyo; Concentration in Japan, 1885–2002: 15–16. The co-chairs of the meeting Toshihiro Okada, Kwansei Gakuin Evidence from Income Tax Statistics” were: Magnus Blomstrom, NBER and University; and Nao Sudou, Bank of Discussant: Wojciech Kopczuk, Stockholm School of Economics; Japan, “U.S. R&D and Japanese NBER and Columbia University Fumio Hayashi, NBER and the Medium Cycles” University of Tokyo; Anil K Kashyap, Discussant: Jonathan Eaton, NBER Douglas J. Skinner, University of NBER and the Graduate School of and New York University Chicago, “The Rise of Deferred Tax Business, University of Chicago; and Assets in Japan: The Case of Major David Weinstein, NBER and Columbia Hiroshi Ono, Stockholm School of Japanese Banks” University. The following papers were Economics, “Lifetime Employment in Discussant: Mitsuhiro Fukao, Keio discussed: Japan: Concepts and Measurements” University Discussant: Kenn Ariga, Kyoto Nobuyuki Oda, Bank of Japan, and University Robert Dekle, Hyeok Jeong, and Kazuo Ueda, University of Tokyo, Heajin Ryoo, University of Southern “The Effects of the Bank of Japan’s California, “A Re-Examination of the Zero Interest Rate Commitment and Koji Sakai and Tsutomu Watanabe, Exchange Rate Disconnect Puzzle: Quantitative Monetary Easing on the Hitotsubashi University; and Uchiro Evidence from Japanese Firm Level Yield Curve: A Macro-Finance Uesugi, Research Institute of Data” Approach” Economy, Trade and Industry, “Firm Discussant: Maurice Obstfeld, NBER Discussant: Lars E. O. Svensson, Age and the Evolution of Borrowing and University of California, NBER and Princeton University Costs: Evidence from Japanese Small Firms” Berkeley Discussant: Steven J. Davis, NBER Wilbur J. Coleman, Duke University, and University of Chicago

Oda and Ueda empirically investi- est-rate commitment and of quantita- estimation of a structural macro-model gate monetary policy in Japan in the tive monetary easing on medium-to- and calibration of time-variant parame- zero- interest-rate environment that has long-term interest rates in Japan. By ters to the yield curve observed in the held sway since 1999. In particular, they applying a version of the macro-finance market, they can decompose interest focus on the effects of the zero-inter- approach, involving a combination of rates into expectations and risk premi-

24 NBER Reporter Fall 2005 ------um components and simultaneously ations in Total Factor Productivity evolves as it ages. Using a new dataset extract the market’s perception of the (TFP). These facts motivate the investi- of more than 200,000 bank-dependent Bank of Japan’s (BOJ’s) willingness to gation into the sources of Japanese TFP small firms in 1997–2002, these authors carry on its zero-interest-rate policy. variations by Braun, Okada, and find that the distribution of borrowing Oda and Ueda tentatively conclude that Sudou. They consider Japanese and costs tends to become less skewed to the BOJ’s monetary policy since 1999 U.S. data that is filtered to retain medi- the right over time. Second, this shift in has functioned mainly through the um-cycle events, such as the productiv- the distribution can be partially attribut- zero-interest-rate commitment, which ity slow down in the 1970s. An investi- able to “selection” (that is, firms with has led to declines in medium- to long- gation of Japanese medium cycles lower quality and higher borrowing term interest rates. They also find some reveals an important role for the diffu- costs exit from markets), but is mainly evidence that, until the end of 2003, sion of usable ideas from the United explained by “adaptation” (that is, sur- raising the reserve target may have been States to Japan. U.S. research and devel- viving firms’ borrowing costs decline as perceived as a signal indicating the opment (R and D) leads Japanese TFP they age). Third, there is an age depend- BOJ’s accomodative policy stance, by four years and accounts for as much ence of a firm’s borrowing costs, even although the size of the effect is not as 60 percent of the variation in medi- after controlling for firm size, but no large. The portfolio rebalancing effect um-term-cycle Japanese TFP. Japanese age dependence of the volatility of — either by the BOJ’s supplying ample R and D, in contrast, is coincident with profits after controlling for firm size. liquidity or by its purchases of long- Japanese TFP. Simulations designed to The results suggest that age depend- term government bonds — is found to isolate the roles of Japanese and U.S. R ence of borrowing costs comes not be significant. and D find that the diffusion of knowl- from the (Diamond’s 1989) reputation- Coleman argues that the growth edge from the United States is a key acquisition mechanism, but rather from slowdown in Japan in the 1990s was a driver of Japanese medium cycles. banks’ learning about borrowers’ true consequence of a structural transfor- Ono poses three fundamental quality over the duration of the bank- mation set in motion by the emergence questions about lifetime employment in borrower relationship. of lower cost producers of manufac- Japan: How big is it? How unique is it? Moriguchi and Saez construct the tured goods. Prior to the 1900s, Japan And, how is it changing? He examines long-run series of top income shares had achieved a significant cost advan- various concepts and methods of esti- and wage income shares in Japan using tage in producing various goods, which mating lifetime employment and con- income tax statistics and investigate the led to an allocation of resources cludes that it covers roughly 20 percent evolution of income concentration in towards this sector. Indeed, the fraction of the Japanese labor force. Job mobili- Japan from 1885 to 2002. They find of resources in the manufacturing sec- ty remains considerably lower in Japan that: the degree of income concentra- tor in Japan exceeded that of other than in other economies (particularly tion was extremely high throughout the countries in a similar stage of develop- that of the United States). Evidence pre-WWII period during which the ment. The emergence of largely popu- regarding changes in lifetime employ- nation underwent rapid industrializa- lated developing countries, such as ment is mixed. While the core work- tion; a drastic de-concentration of China, lowered the profitability of the force is shrinking, the proportion of income at the top had taken place dur- manufacturing sector in Japan. This lifetime workers in the labor force is ing and immediately after WWII; a required a substantial reallocation of expanding. Ono’s interpretation is that degree of income concentration has labor and capital resources from the the population of workers who presum- remained low throughout the post-1950 manufacturing to the service sector. ably are covered by the lifetime employ- period despite high economic growth; This process of structural transforma- ment system may be declining, but the and, a major component of the top tion led to the growth slowdown in probability of job separations has income in Japan has shifted dramatical- Japan during the 1990s. remained stable for those who are ly from capital income to employment In the 30-year period between 1960 already in the system. He also finds evi- income over the course of the twentieth and 1990, Japan saw labor productivity dence that the incentives among work- century. They attribute the dramatic fall rise from a level of 27 percent of that ers, managers, and executives are in income concentration primarily to of the United States to 87 percent of aligned to preserve the lifetime employ- the collapse of capital income attributa- that of the United States. This develop- ment system. ble to wartime taxation, war destruc- ment miracle can be explained by an ini- Sakai, Uesugi, and Watanabe tion, hyperinflation, and to a lesser tial low capital stock and measured vari- investigate how a firm’s borrowing cost extent, postwar occupational reforms.

------NBER Reporter Fall 2005 25 They argue that the fundamental Japanese banks, as dramatized most insignificant effects of exchange rate change in the institutional structure vividly by the recent collapse of Resona fluctuations on export volumes. This after WWII made the one-time income Bank. He argues that the Japanese gov- lack of association between real quanti- de-concentration difficult to reverse. In ernment, including bank regulators, ties — such as export volumes — and contrast to the sharp increase in wage used deferred tax accounting to help the exchange rate is the so-called income inequality observed in the give the major banks the appearance of “exchange rate disconnect” puzzle. United States since 1970, the top wage financial well being in spite of their eco- Studies using microeconomic or firm- income shares in Japan have remained nomic difficulties. Further, managers of level data, however, have been more remarkably stable over recent decades. these banks used deferred tax account- successful in finding relationships The authors show that the change in ing to bolster their banks’ regulatory between export volumes and exchange technology or tax policies alone cannot capital levels when their economic cir- rates. In their paper, Dekle, Jeong, and account for the comparative experience cumstances deteriorated. Skinner shows Ryoo attempt reconciliation between of Japan and the United States. Instead, that, generally consistent with these the macroeconomic, aggregate evidence they suggest that institutional factors, arguments, accounting has played a role and the microeconomic, firm-level evi- such as corporate governance and in helping the Japanese government to dence. They estimate their consistently union structure, are important determi- postpone the politically difficult task of aggregated, microeconomic model of nants of wage income inequality. reforming the major banks. exports and show that an exchange rate Skinner describes the role of The empirical literature that exam- appreciation properly reduces export accounting for deferred taxes in the ined data at the aggregate or macroeco- volumes. ongoing financial crisis among major nomic level generally has found small or

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26 NBER Reporter Fall 2005 ------The Chinese Economy

The NBER’s Working Group on “Missing Women and the Price of Tea Marcos Chamon and Eswar the Chinese Economy, organized by in China: The Effect of Sex-Specific Prasad, IMF, “Determinants of Shang-Jin Wei, NBER, University of Earnings on Sex Imbalance” Household Savings in China” Maryland, and International Monetary Discussant: John Giles, Michigan Discussant: Chang-tai Hsieh, NBER Fund, met in Cambridge on September State University and University of California, 30. This Working Group provides a Berkeley forum for discussing recent research Hongbin Cai, University of Cali- related to various aspects of Chinese fornia, Los Angeles; Hanming Fang, Hui Huang and Shunming Zhang, economic development, including Yale University; and Colin Xu, World University of Western Ontario; Yi China’s macroeconomic policies, trade Bank, “Eat, Drink, Firms and Wang, Shanghai University; Yiming and financial interactions with the rest Governments: An Investigation of Wang, Peking University; and John of the world, reform strategies, lessons Corruption from Entertainment and Whalley, NBER and University of from China for other developing and Travel Costs of Chinese Firms” Western Ontario, “A Trade Model transition economies, and lessons from (NBER Working Paper No. 11592) with an Optimal Exchange Rate other countries for China. The pro- Discussant: Thomas Rawski, Uni- Motivated by Current Discussion of a gram for this meeting was: versity of Pittsburgh Chinese Renminbi Float” Discussant: Aart Kraay, World Bank Xuepeng Liu, Jan Ondrich, and Raymond Fisman, NBER and Mary Lovely, Syracuse University, Columbia University; Peter Albert Hu, National University of “How Much Do Low Wages Matter Moustakerski, Booz Allen Singapore, and Gary Jefferson, for Foreign Investment? The Case of Hamilton; and Shang-jin Wei, Brandeis University, “The Great Wall China” “Outsourcing Tariff Evasion: A New of Patents: What is Behind China’s Discussant: Lee J. Branstetter, NBER Explanation for Entrepot Trade” Recent Patent Explosion? and Columbia University Discussant: Mihir A. Desai, NBER Discussant: Wei Li, University of and Harvard University Virginia Nancy Qian, Brown University,

Liu, Ondrich, and Lovely exam- sensitive to the intensity of competi- constant increases the survival rates for ine the provincial location choices of tion from other low-income countries girls; increasing male income while firms investing in China during 1993–6. for exports to the United States. This holding female income constant First, using data on 2,884 equity joint study provides the first estimates of decreases the survival rates for girls. venture (EJV) projects in manufactur- how skill intensity and competition for Moreover, increasing the mother’s ing, they find strong support for the export markets influence the probabili- income increases educational attain- attractiveness of low wages. Their esti- ty a multinational firm will choose a ment for all children while increasing mates indicate a downward bias of given location. the father’s income decreases educa- 50–120 percent in the wage coefficients Qian uses plausibly exogenous tional attainment for girls and has no estimated with standard techniques. increases in sex-specific agricultural effect on boys’ educational attainment. Second, they find that low-wage loca- income caused by post-Mao reforms in Entertainment and Travel Costs tions are more attractive to unskilled- China to estimate the effects of total (ETC) is a standard expenditure item labor-intensive plants than to skill- income and sex-specific incomes on for Chinese firms, annually equaling intensive plants, although this effect is the sex ratios of surviving children. about 20 percent of total wage bills. significant only for investors from Her results show that increasing Cai, Fang, and Xu use this objective OECD countries. The attraction of income alone has no effect on sex accounting measure as a basis for ana- low wages for investors from ethnical- ratios. In contrast, increasing female lyzing the composition of ETC and the ly-Chinese-economies, in contrast, is income while holding male income effect of ETC on firm performance.

------NBER Reporter Fall 2005 27 They rely on the predictions from a — there are severe constraints (or were, value on foreign exchange, an optimal simple but plausible model of manage- until recently) in China on borrowing setting of the exchange rate can provide rial decisionmaking to identify compo- for these purchases. Saving rates then the optimal trade intervention. The nents of ETC, examining how total decline with the age of the household authors suggest that this model has rel- ETC responds to different environ- head until age 45 or so, when they begin evance to the current situation in China mental variables. They find strong evi- to bounce back sharply, presumably as where services have not been liberal- dence that firms’ ETC consists of a retirement approaches. The cohorts ized and tariff rates are bound in the mix that includes bribery to govern- with household heads in their 40s dur- World Trade Organization. Because ment officials, both as grease money ing the 1980s tend to save the most. there is an optimal exchange rate, a and protection money; expenditures to This group may be the most vulnerable move to a free Renminbi float can build relational capital with suppliers to the market-oriented reforms that worsen welfare. The authors use and clients; and managerial excesses. began in the early 1980s, which could numerical simulation methods to ETC overall has a significantly negative have increased uncertainty about their explore the properties of the model, effect on firm performance, but its neg- future incomes while not yielding them because it has no closed-form solution. ative effect is much less pronounced for as much of a benefit in terms of rising Their analysis provides an intellectual those firms located in cities with low incomes as younger groups. The counter argument to those presently quality government service, those sub- authors combine these results with an advocating a free Renminbi float for ject to severe government expropria- analysis of demographic projections to China. tion, and those who do not have strong show that demographic shifts actually Over the past 20 years, patenting in relationships with suppliers and clients. may contribute to higher household China has grown at an annual double- Traditional explanations for indi- saving rates over the next decade or digit rate, having further accelerated rect trade carried out through an entre- two. However, the data indicate that since 2000. China’s patent explosion is pot have focused on savings in trans- past savings constitute the dominant seemingly paradoxical given the coun- port costs and on the role of special- source of financing for durable goods try’s weak record of protecting intellec- ized agents in processing and distribu- purchases. This suggests that, as the tual property rights. Using a firm-level tion. Fisman, Moustakerski, and Wei demand for durables rises with rising data set that spans the population of provide an alternative perspective based income levels, and as consumer credit China’s large and medium size industrial on the possibility that entrepots may develops, the saving rate, especially for enterprises, Hu and Jefferson seek to facilitate tariff evasion. Using data on younger households, could decline. understand the conditions that account direct exports to mainland China and Huang, Wang, Wang, Whalley, for China’s patent boom. While the indirect exports to it via Hong Kong and Zhang combine a model of inter- overall intensification of research and SAR, the authors find that the indirect spatial and inter-temporal trade development (R and D) in the Chinese export rate rises with the Chinese tariff between countries — recently used by economy tracks with patenting activity, it rate, even though there is no legal tax Huang, Whalley, and Zhang (2004) to is not the principal cause of the patent advantage to sending goods via Hong analyze the merits of trade liberaliza- explosion. Instead, the authors find that Kong SAR. The authors then undertake tion in services when goods trade is the growing intensity of foreign direct a number of extensions to rule out restricted — with a model of foreign investment at the industry level, enter- plausible alternative hypotheses. exchange rationing from Clarete and prise restructuring, and a shift toward Using a subset of the Urban Whalley (1991) in which there is a fixed complex-product R and D are raising R Household Survey from 1986–97, exchange rate with a surrender require- and D productivity and the propensity to Chamon and Prasad analyze the pat- ment for foreign exchange generated by patent. Amendments to the patent law terns and determinants of saving exports. In the combined model, when that favor patent holders also emerge as behavior among Chinese households. services are not liberalized, there is an a significant source of China’s surge in They show that young households tend optimal trade intervention, even in the patent activity. to have relatively high saving rates, pos- case of a small, open, price-taking sibly so that they can self-finance pur- economy. Given monetary policy and chases of major durables and housing an endogenously determined premium

28 NBER Reporter Fall 2005 ------Entrepreneurship Working Group

The NBER’s Entrepreneurship David Hsu, University of Pennsyl- Berkeley; and Yingyi Qian, NBER and Working Group met in Cambridge on vania, and Edward Roberts and University of California, Berkeley, October 7. NBER Research Associate Charles Eesley, MIT, “Entrepreneurs “Who Are China’s Entrepreneurs?” Josh Lerner, Harvard Business from Technology-Based Universities: School, organized the meeting, at An Empirical First Look” Amar Bhidé, Columbia University, which the following papers were dis- Discussant: David Blanchflower, “What Holds Back Bangalore cussed: Dartmouth College and NBER Businesses?”

Naomi Lamoreaux and Kenneth Nick Bloom, Stanford University, Esther Duflo, MIT and NBER; Sokoloff, University of California, Los and John Van Reenen, London Michael Kremer, NBER and Harvard Angeles and NBER, and Margaret School of Economics, “Measuring University; and Jonathan Robinson, Levenstein, NBER and University of and Explaining Management Princeton University, “Understanding Michigan, “Financing Invention during Practices across Firms and Countries” Technology Adoption: Fertilizer in the Second Industrial Revolution: Discussant: Belen Villalonga, Harvard Western Kenya” Cleveland, Ohio, 1870–1920” University Academic Discussant: Ray Fisman, Discussant: Steven Klepper, Carnegie Columbia University and NBER Mellon University Simeon Djankov, The World Bank; Practitioner Discussant: Runa Alam, Gerard Roland and Ekaterina CEO, Kingdom Zephyr Africa Zhuravskaya, University of California,

For those who think of Cleveland long-term stakes in start-ups formed to findings from two linked datasets join- as a decaying rustbelt city, it may seem exploit promising technological discov- ing information on MIT alumni and difficult to believe that this northern eries, often assuming managerial posi- company founders. The rate of form- Ohio port was once a hotbed of high- tions in these enterprises as well. ing new companies by MIT alumni has tech startups, much like Silicon Valley Business people who were interested in grown dramatically over seven decades, today. During the late nineteenth and investing in cutting-edge ventures and the median age of first-time entre- early twentieth centuries, Cleveland needed help in deciding which inven- preneurs has declined gradually from played a leading role in the develop- tors and ideas were most likely to yield about age 40 (in the 1950s) to about age ment of a number of second-industri- economic returns, and these authors 30 (in the 1990s). Women alumni lag al-revolution industries, including elec- show how enterprises such as the their male counterparts in the rate at tric light and power, steel, petroleum, Brush Electric Company served multi- which they become entrepreneurs, and chemicals, and automobiles. In an era ple functions for the inventors who alumni who are not U.S. citizens enter when production and inventive activity flocked to work there. Not only did entrepreneurship at different (often were both increasingly capital-intensive, they provide forums for the exchange higher) rates than their American class- technologically creative individuals and of ideas, but by assessing each other’s mates. New venture foundings over firms required greater and greater discoveries, the members of these tech- time are correlated with measures of amounts of funds to succeed. nological communities conveyed infor- the changing external entrepreneurial Lamoreaux, Levenstein, and mation to local businessmen about and business environment, suggesting Sokoloff explore how the city’s leading which inventions were most worthy of that future research in this domain may inventors and technologically innova- support. wish to more carefully examine such tive firms obtained financing, and find Hsu, Roberts, and Eesley pro- factors. that formal institutions, such as banks vide an initial analysis of major pat- Bloom and Van Reenen use an and securities markets, played only a terns and trends in entrepreneurship innovative survey tool to collect manage- very limited role. Instead, most funding among technology-based university ment practice data from 732 medium- came from local investors who took alumni since the 1930s. They describe sized manufacturing firms in the

------NBER Reporter Fall 2005 29 United States and Europe (France, stand entrepreneurship in view of these ciencies in the performance of basic Germany, and the United Kingdom). three perspectives. Using data from a governmental functions (such as in col- Their measures of managerial best pilot study with over 2,000 interviews in lecting taxes and the maintaining land practice are strongly associated with seven cities across China, they find that records) play a significant role in dis- superior firm performance in terms of entrepreneurs are much more likely couraging businesses from starting at or productivity, profitability, Tobin’s Q, than non-entrepreneurs to have family expanding to an economically efficient sales growth, and survival. They also members who are also entrepreneurs, scale of operation. find significant inter-country variation, and childhood friends who became In developing countries outside of with U.S. firms on average better man- entrepreneurs. This suggests that social Africa, the use of fertilizer has been aged than European firms, but a much networks play an important role in estimated to account for 50–75 percent greater intra-country variation with a entrepreneurship. Entrepreneurs also of the increase in crop yields since the long tail of extremely badly managed differ strongly from non-entrepreneurs mid-1960s. Yet the usage of fertilizer in firms. This presents a dilemma – why in their attitudes towards risk and their Busia and Teso districts in Western do so many firms exist with apparently work-leisure preferences: they are more Kenya remains quite low: only about 20 inferior management practices, and why willing to take risks and are more percent of farmers in the area use fer- does this vary so much across coun- greedy. tilizer in a given year. Duflo, Kremer, tries? The authors find that this is In underdeveloped economies as in and Robinson attempt to explain this because of a combination of: low prod- the United States, the number of small low level of usage by analyzing the uct-market competition and family low-growth enterprises is large. But results of a set of randomized experi- firms passing management control what about the developing economy ments that allow farmers to experiment down to the eldest sons (primo geniture). counterparts of U.S. high-growth busi- with a small amount of fertilizer on European firms in the sample report nesses? In what way do differences in their own farms or to commit to save facing lower levels of competition and technological, institutional, and cultural their harvest income towards the pur- substantially higher levels of primo geni- factors matter? Do they make high- chase of fertilizer. The main results ture. These two factors appear to growth businesses more or less numer- from these interventions are that: 1) fer- account for around half of the long tail ous in under-developed economies than tilizer is profitable even in the farmer’s of badly managed firms and half of the in the United States? How, if at all, do conditions; 2) providing information average U.S.-Europe gap in manage- they lead to differences in characteris- about the costs and benefits of fertiliz- ment performance. tics, growth rates, and the economic er goes part of the way towards increas- Social scientists studying the deter- role of high growth businesses? Bhidé ing fertilizer adoption; and 3) programs minants of entrepreneurship have focuses on businesses operating in the that help farmers to commit their har- emphasized three distinct perspectives: city of Bangalore, India. Data compiled vest income towards the purchase of the role of institutions, the role of from statutory regulatory filings suggest fertilizer have a large impact on adop- social networks, and the role of person- that the number and proportion of tion. Preliminary evidence on spillovers al characteristics. Djankov, Qian, businesses that expand rapidly are much through geographical and social net- Roland, and Zhuravskaya conduct a lower than in the United States. In- works does not indicate diffusion, how- survey from five large developing and depth interviews with over 100 entre- ever. transition economies to better under- preneurs in Bangalore suggest that defi-

30 NBER Reporter Fall 2005 ------Market Microstructure Meeting

The NBER’s Working Group on Ekkehart Boehmer, Texas A&M Comovement in Liquidity” Market Microstructure, directed by University; Charles Jones, Columbia Discussant: Ioanid Rosu, University Research Associate Bruce Lehmann University; and Xiaoyan Zhang, of Chicago of University of California, San Cornell University, “Which Shorts are Diego, met on October 7 in Informed?” Elizabeth Odders-White and Mark Cambridge. The meeting was organ- Discussant: Amy Edwards, U.S. Ready, University of Wisconsin, ized by Lehmann; Duane Seppi of Securities & Exchange Commission Madison, “The Probability and Carnegie Mellon University; and Magnitude of Information Events” Avanidhar Subrahmanyam, University Karl Diether, Kuan-hui Lee, and Discussant: Lei Yu, University of of California, Los Angeles. The fol- Ingrid Werner, Ohio State Notre Dame lowing papers were discussed: University, “Can Short-Sellers Predict Returns? Daily Evidence” Asani Sarkar, Federal Reserve Bank Robert Bloomfield, Maureen Discussant: David Musto, University of New York, and Robert Schwartz O’Hara, and Gideon Saar, Cornell of Pennsylvania and Avner Wolf, Baruch College, University, “The Limits of Noise “Inter-Temporal Trade Clustering and Trading: An Experimental Analysis” Allaudeen Hameed and Wenjin Two-Sided Markets” Discussant: Shimon Kogan, Carnegie Kang, National University of Discussant: Eugene Kandel, Hebrew Mellon University Singapore, and S.Viswanathan, University Duke University, “Asymmetric

Bloomfield, O’Hara, and Saar market trading volume, but informa- (less than 500 shares), stocks tend to report the results of a laboratory mar- tional efficiency remains essentially rise in the following month, indicating ket experiment that allows them to unchanged and liquidity (as measured that informed short sellers tend to sub- determine not only how noise traders by the price impact of trades) actually mit large orders. The authors partition fare in a competitive asset market with improves. The authors find no signifi- short sales by account type: individual, other traders, but also how the equilib- cant effect, however, on market volatil- institutional, member firm proprietary, rium changes if a securities transac- ity, suggesting that at least this rationale and other, and can distinguish between tions tax (“Tobin tax”) is imposed. The for a securities transaction tax is not program and non-program short sales. authors find that noise traders lose supported by their data. Institutional non-program short sales money on average: they do not engage Boehmer, Jones, and Zhang use are the most informative. Compared to in extensive liquidity provision, and proprietary system order data from the stocks that are lightly shorted by insti- their attempt to make money by trend New York Stock Exchange to examine tutions, a portfolio of stocks most chasing is unsuccessful because they the incidence and information content heavily shorted by institutions on a lose most in securities whose prices of various kinds of short sale orders. given day underperforms by 1.36 per- experience large moves. Noise traders For the average stock, 12.9 percent of cent in the next month (over 18 percent adversely affect the informational effi- NYSE volume involves a short seller. annualized). These alphas do not ciency of the market: they drive prices As a group, short sellers are extremely account for the cost of shorting, and away from fundamental values. The well informed. Stocks with relatively they cannot be achieved by outsiders, further away the market gets from the heavy shorting underperform lightly because the internal NYSE data that true value, the stronger this effect shorted stocks by an average of 1.07 the authors use are not generally avail- becomes. With a securities transaction percent in the following 20 days of able to market participants. But these tax, noise traders submit fewer orders trading (over 14 percent on an annual- gross excess returns to shorting indi- and lose less money in those securities ized basis). Large short sale orders are cate that institutional short sellers have that exhibit large price movements. the most informative. In contrast, identified and acted on important The tax is associated with a decrease in when more of the short sales are small value-relevant information that has not

------NBER Reporter Fall 2005 31 yet been impounded into price. The by supply side shocks affecting the eters for NYSE-listed stocks from 1993 results are strongly consistent with the funding available to financial intermedi- through 2003, and show that their esti- emerging consensus in financial eco- aries. Consistent with this prediction, mates can be used to predict future nomics that short sellers possess Hameed, Kang, and Viswanathan extreme returns. Finally, they examine important information, and their trades find that liquidity levels and commonal- the time-series and cross-sectional are important contributors to more ity in liquidity respond asymmetrically properties of the probability and mag- efficient stock prices. to positive and negative market returns. nitude of information. Their results Diether, Lee, and Werner test Stock liquidity decreases while com- shed light on the price discovery whether short-sellers in Nasdaq-listed monality in liquidity increases following process and have implications for many stocks are able to predict future returns large negative market returns because areas of finance. based on new SEC-mandated data for the collateral value of the aggregate Sarkar, Schwartz, and Wolf show the first quarter of 2005. There are a market-making sector falls. The authors that equity markets are two-sided and tremendous number of short-term show that a large drop in aggregate that trades cluster in certain half-hour trading strategies involving short sales value of securities creates greater liq- periods for both NYSE and Nasdaq in the sample: short sales represent 25 uidity commonality because of inter- stocks under a broad range of condi- percent of Nasdaq share volume, while industry spillover effects of the capital tions: news and non-news days, differ- monthly short interest is 3.3 percent of constraints. They also show that the ent times of the day, and a spectrum of shares outstanding (4.7 days to cover). commonality is higher for high volatili- trade sizes. By “two-sided,” the authors Short sellers are on average contrarian: ty stocks. mean that the arrivals of buyer-initiated they sell short following positive Models of adverse selection risk and seller-initiated trades in half-hour returns. Increasing short sales predict generally assume that market makers intervals are positively correlated; by future negative returns, and the predic- offset expected losses to informed “trade clustering” they mean that trades tive power comes primarily from small traders with expected gains from the tend to bunch together in certain half- trades. A trading strategy based on daily uninformed. Odders-White and hour intervals with greater frequency short-selling activity generates signifi- Ready recognize that the expected loss than would be expected if their arrival cant returns, but incurs costs large captures a combination of two effects: was a random process. Controlling for enough to wipe out any profits. More 1) the probability that some traders have trading volume, news, and other binding short-sale constraints result in private information, and 2) the likely microstructure effects, the authors find reduced short selling, but there is only a magnitude of that information. They use that two-sided clustering leads to high- significant effect on future returns a maximum-likelihood approach to sep- er volatility but lower trading costs. among low priced stocks. arately estimate the probability and the Their analysis has implications for trad- Recent theoretical work suggests magnitude of private information and er behavior, market structure, and the that commonality in liquidity and varia- then test their procedure on a simulated process by which new information is tion in liquidity levels can be explained dataset. Then they estimate the param- incorporated into market prices.

32 NBER Reporter Fall 2005 ------Economic Fluctuations and Growth Research Meeting

NBER Research Associates David N. Weil, Brown University and and NBER, “Deducing Markup Susanto Basu of Boston College and NBER, “Accounting for the Effect of Cyclicality from Stockout Behavior” Miles S. Kimball of the University of Health on Economic Growth” (NBER Discussant: Robert E. Hall, Stanford Michigan organized the fall research Working Paper No. 11455) University and NBER meeting of NBER’s Program on Discussant: Hoyt Bleakley, University Economic Fluctuations and Growth. of Chicago Robert J. Barro, Harvard University It took place on October 21 at the and NBER, “Rare Events and the Federal Reserve Bank of Chicago. Raquel Fernández, New York Equity Premium” The following papers were discussed: University and NBER, and Alessandra Discussant: Lars Hansen, University of Fogli, New York University, “Culture: Chicago and NBER Michael Kremer, Harvard University An Empirical Investigation of Beliefs, and NBER, and Stanley Watt, Harvard Work, and Fertility” Daron Acemoglu, MIT and NBER, University, “The Globalization of Discussant: Casey Mulligan, University “Politics and Economics in Weak and Household Production” of Chicago and NBER Strong States” Discussant: Valerie Ramey, University Discussant: Scott Page, University of of California, San Diego and NBER Mark Bils, University of Rochester Michigan

Immigration restrictions are to natives from a Hong Kong-style pro- by physical capital. He presents alterna- arguably the largest distortion in the gram may be equivalent to those from a tive estimates ranging between 9.5 per- world economy and the most costly to 2 percent increase in income. However, cent and 29.5 percent. His preferred the world’s poor. Yet, these restrictions multicultural societies with a norm of estimate of the reduction in world seem firmly in place because of fears in extending citizenship to long-term resi- income variance that would result from rich countries that immigration would dents may find this type of migration eliminating health variations among exacerbate inequality among natives, fis- inconsistent with ethical norms. countries is 36.6 percent. cally drain the welfare state, and change Programs with temporary, non-renew- Fernández and Fogli study the native culture. Many “new rich” coun- able visas may be more acceptable in effect of culture on important econom- tries are creating a new form of immi- these countries. ic outcomes by examining the work and gration that Kremer and Watt argue Weil uses microeconomic estimates fertility behavior of U.S.-born women may help overcome these obstacles. of the effect of health on individual 30-40 years old whose parents were Foreign private household workers, pri- outcomes to construct macroeconomic born elsewhere. The authors use past marily female, constitute more than 6 estimates of the proximate effect of female labor force participation and percent of the labor force in Bahrain, health on GDP per capita. He uses a total fertility rates from the country of Kuwait, Hong Kong, Singapore, and variety of methods to construct esti- ancestry as their cultural proxies. In Saudi Arabia, and about 1 percent in mates of the return to health, which he addition to past economic and institu- Taiwan, Greece, and Israel. Providing combines with cross-country and his- tional conditions, these variables should temporary visas for these workers can torical data on several health indicators capture the beliefs commonly held potentially allow high-skilled native including height, adult survival, and age about the role of women in society, that women to enter the market labor force. at menarche. His preferred estimate of is their culture. Given the different time This increased labor supply by native the share of cross-country variance in and place, only the beliefs embodied in high-skilled workers can increase the log income per worker explained by the cultural proxies should be potential- wages of low-skilled natives and pro- variation in health is 22.6 percent, ly relevant to women’s behavior in the vide a fiscal benefit by correcting dis- roughly the same as the share account- United States in 1970. The authors tortions toward home production creat- ed for by human capital from education, show that these cultural proxies have ed by income taxes. The welfare gains and larger than the share accounted for positive and significant explanatory

------NBER Reporter Fall 2005 33 power for individual work and fertility Rietz (1988), explains a lot of asset- who also can invest in socially produc- outcomes, even after controlling for pricing puzzles, including the high equi- tive public goods. Both weak and strong possible indirect effects of culture (for ty premium, low risk-free rate, and the states create distortions. When the state example, education and spousal charac- volatility of stock returns. Another is excessively strong, the ruler imposes teristics). Further, they show that unob- mystery that may be resolved is why such high taxes that economic activity is served human capital — at the individ- expected real interest rates were low in stifled. When the state is excessively ual level or embodied in the ethnic net- the United States during major wars, weak, the ruler anticipates that he will work — does not explain the correla- such as World War II. The rare-disasters not be able to extract rents in the future tions. Also, the effect of these cultural framework achieves these explanations and underinvests in public goods. proxies is amplified as the tendency for while maintaining the tractable frame- Acemoglu shows that the same conclu- ethnic groups to cluster in the same work of a representative agent, time- sion applies in the analysis of both the neighborhood increases. additive and iso-elastic preferences, and economic power of the state (that is, its In models with a stockout con- complete markets. The results hold with ability to raise taxes) and its political straint on sales, stockouts bear an i.i.d. shocks to productivity growth in a power (that is, its ability to remain important relation to the price markup. Lucas-tree type economy and also when entrenched from the citizens). He also Bils examines stockout behavior for 63 capital formation is considered. discusses how, under certain circum- durable goods using CPI microdata. While much research in political stances a different type of equilibrium, The behavior of stockouts over goods’ economy points out the benefits of which he refers to as “consensually shelf lives requires relatively small “limited government,” political scien- strong state equilibrium,” can emerge markups, on the order of 10-15 per- tists have long emphasized the prob- whereby the state is politically weak but cent. For the past 17 years, stockouts lems created in many less developed is allowed to impose high taxes as long have been extremely acyclical. This sug- nations by “weak states” that lack the as a sufficient fraction of the proceeds gests that markups have been acyclical, power to tax and regulate the economy are invested in public goods. The con- which runs directly counter to explana- and to withstand the political and social sensually strong state might best corre- tions for cyclicality of employment challenges from non-state actors. spond to the state in OECD countries based on countercyclical price markups, Acemoglu constructs a model in which where taxes are high despite significant including sticky-price models. the state apparatus is controlled by a control by the society over the govern- Barro notes that the allowance for self-interested ruler, who tries to divert ment. low-probability disasters, suggested by resources for his own consumption, but

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34 NBER Reporter Fall 2005 ------International Finance and Macroeconomics

The NBER’s Program on Inter- NBER, “Time-Varying Risk, Interest Feldstein-Horioka Puzzle?” national Finance and Macroeconomics Rates and Exchange Rates in General Discussant: Vivian Yue, New York met in Cambridge on October 21. Equilibrium” University NBER Research Associates Charles M. Discussant: David Backus, New York Engel, University of Wisconsin, and University and NBER Anusha Chari, University of Linda Tesar, University of Michigan, Michigan, and Nandini Gupta, organized this program: Philippe Bacchetta, University of Indiana University, “The Political Lausanne, and Eric Van Wincoop, Economy of Foreign Entry Gita Gopinath, Harvard University University of Virginia and NBER, Deregulation” and NBER, and Roberto Rigobon, “Rational Inattention: A Solution to Discussant: Galina Hale, Yale MIT and NBER, “Sticky Borders” the Forward Discount Puzzle” University Discussant: Ariel Burstein, University Discussant: Nelson Mark, University of California, Los Angeles of Notre Dame and NBER Irina Tytell, IMF, and Shang-jin Wei, IMF and NBER, “Global Fernando E. Alvarez, University of Yan Bai, Arizona State University, Capital Flows and National Policy Chicago and NBER; Andrew and Jing Zhang, University of Choices” Atkeson, University of California, Michigan, “Can Financial Frictions Discussant: Simon Johnson, MIT and Los Angeles and NBER; and Patrick Account for the Cross-Section NBER Kehoe, University of Minnesota and

Gopinath and Rigobon use a novel force driving nominal interest rate dif- The uncovered interest rate parity dataset to present evidence on price ferentials on currency-denominated equation is the cornerstone of most stickiness at the U.S. border. Using bonds. This finding is an immediate models in international macroeconom- unpublished microdata on import and implication of the fact that exchange ics. However, this equation does not export prices collected by the Bureau of rates are roughly random walks. hold empirically because the forward Labor Statistics for the United States for Alvarez, Atkinson, and Kehoe show discount, or interest rate differential, is 1994–2005, they find a tremendous that a general equilibrium model with negatively related to the subsequent amount of dollar price stickiness in both an endogenous source of risk variation change in the exchange rate. This for- imports and exports. The weighted aver- and a variable degree of asset market ward discount puzzle is one of the most age price duration is 12.26 months for segmentation can produce many of the extensively researched areas in interna- imports and 14.11 months for exports. features of interest rates and exchange tional finance and implies that excess These numbers are about three times the rates. The endogenous segmentation returns on foreign currency investments Bils-Klenow (2004) estimates for con- arises from a fixed cost for agents to are predictable. Bacchetta and Van sumer prices. Goods traded on organ- exchange money for assets. As inflation Wincoop propose a new explanation ized markets and reference priced goods varies, the benefit of asset market par- for this puzzle based on rational inat- have less sticky prices. However, there is ticipation varies, and that changes the tention. They develop a model in which little evidence that the price stickiness of fraction of agents participating. These investors face a cost of collecting and goods traded intra-firm differ from effects lead the risk premium to vary processing information. Investors with those goods traded at arms-length. systematically with the level of infla- low information processing costs trade Finally, the authors explore the relation- tion. One attractive feature of this actively, while other investors are inat- ship between exchange rate movements model is that it produces variation in tentive and trade infrequently. The and the probability and size of price the risk premium even though the prim- authors calibrate the model to the data change in imports. itive shocks have constant conditional and show that: 1) inattention can Time-varying risk is the primary variances. account for most of the observed pre-

------NBER Reporter Fall 2005 35 dictability of excess returns in the for- popular incomplete markets model — to a 10 percent probability for a eign exchange market; 2) the benefit the bond model with natural borrowing monopoly. The results also suggest that from frequent trading is relatively small constraints — cannot account for the politicians are more receptive to the so that few investors choose to be cross-section Feldstein-Horioka puzzle. interests of some incumbent firms over attentive; 3) average expectational Next, the authors propose the bond others. Industries that are state-owned errors about future exchange rates are model with enforcement constraints in monopolies face a 13 percent probabil- predictable in a way that is consistent which uncontingent debt contracts are ity of being opened to foreign entry in with survey data for market partici- enforced by the threat of permanent comparison to a 52 percent probability pants; and, 4) the model can account for exclusion from the markets. This model for industries with no state-owned the puzzle of delayed overshooting of generates endogenous borrowing con- firms. When foreign entry is allowed in the exchange rate in response to interest straints, which capture the incentives of an industry, incumbent firms experi- rate shocks. countries to repay their debts instead of ence a significant decline in market Bai and Zhang study the famous their abilities to repay under natural bor- share and profits. The results are con- Feldstein-Horioka finding that long peri- rowing constraints. It accounts for the sistent with the hypothesis that incum- od averages of savings and investment cross-section Feldstein-Horioka puzzle. bent firms oppose foreign entry to pro- rates are highly correlated across coun- Chari and Gupta investigate the tect monopoly profits. tries. The authors first confirm the influence of incumbent firms on the Tytell and Wei study whether Feldstein-Horioka finding with a more policy decision to allow foreign direct changes in global financial environment recent dataset and then show that a cali- investment. Using firm-level data from have induced governments to pursue brated complete-markets model gener- India, the authors find that the likeli- better policies (the “discipline effect”). ates a cross-section savings-investment hood of barriers to foreign entry being The evidence indicates that financial correlation that is close to zero. Thus, reduced in an industry is inversely relat- globalization has induced countries to further research is needed to account for ed to its concentration. The least con- pursue lower inflation rates, but not to Feldstein-Horioka’s cross-section find- centrated industry in their sample faces succeed in lowering budget deficits. So, ing. The authors explore the role of an 80 percent probability of being the strength of the discipline effect financial frictions, but find that the most opened to foreign entry in comparison varies across different public policies.

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36 NBER Reporter Fall 2005 ------Public Economics Program Meeting

The NBER’s Public Economics William Gale and Peter Orszag, Hanming Fang, Yale University and Program met in Cambridge on Brookings Institution; Jeffrey NBER; Hongbin Cai, University of October 27–28. NBER Faculty Liebman, Harvard University and California, Los Angeles; and Lixin Research Fellow Raj Chetty and NBER; and Emmanuel Saez, Xu, World Bank, “Eat, Drink, Firms NBER Research Associate Emmanuel “Savings Incentives for Low- and and Government: An Investigation of Saez, both of the University of Middle-Income Families: Evidence Corruption from Entertainment and California, Berkeley, organized the from a Field Experiment with H&R Travel Costs of Chinese Firms” program. These papers were dis- Block” (NBER Working Paper No. (NBER Working paper No. 11592, cussed: 11680) September 2005 — see “The Chinese Economy” earlier in this issue for a Alan J. Auerbach, University of Francine D. Blau, Cornell University description of this paper.) California, Berkeley and NBER, and NBER, and Lawrence M. Kahn, “Budget Windows, Sunsets, and Fiscal Cornell University, “Changes in the Roger Gordon, NBER and Control” (NBER Working Paper No. Labor Supply Behavior of Married University of California, San Diego, 10694) Women: 1980–2000” (NBER Working and Wei Li, University of Virginia, Paper No. 11230) “Tax Structures in Developing Kevin S. Milligan and Thomas Countries: Puzzle and Possible Lemieux, University of British Daron Acemoglu, MIT and NBER; Explanations” Columbia and NBER, “Incentive Michael Golosov, MIT; and Aleh Effects of Social Assistance: A Tsyvinski, Harvard University, Susan Dynarski, Harvard University Regression Discontinuity Approach” “Markets Versus Governments: and NBER, “Building the Stock of Political Economy of Mechanisms” College-Educated Labor” (NBER Esther Duflo, NBER and MIT; Working Paper No. 11604)

Governments around the world objective is to understand a phenome- benefits reduce employment. The esti- have struggled to find the right method non that has grown in importance in mates exhibit little sensitivity to the of controlling public spending and U.S. legislation: the sunset. Auerbach degree of flexibility in the specification, budget deficits. In recent years, the argues that, with an appropriately and perform very well when the authors United States has evaluated policy designed budget window, the incentive control for unobserved heterogeneity changes using a ten-year budget win- to use sunsets to avoid budget restric- using a first difference specification. dow. The use of a multi-year window is tions will evaporate, so that temporary Finally, they show that commonly used intended to capture the future effects of provisions can be taken at face value. difference-in-differences estimators policies, the notion being that a budget His analysis also has implications for may perform poorly with inappropri- window that is too short permits the how to account for long-term budget ately chosen control groups. shifting of costs beyond the window’s commitments. Duflo, Gale, Liebman, Orszag, endpoint. But a budget window that is Before 1989, childless social assis- and Saez analyze the effects of a large too long includes future years for which tance recipients in Quebec under age 30 randomized field experiment carried current legislation is essentially mean- received much lower benefits than out with H&R Block, offering matching ingless, and gives credit to fiscal bur- recipients over age 30. Lemieux and incentives for IRA contributions at the dens shifted to those whom the budget Milligan use this sharp discontinuity in time of tax preparation. About 14,000 rules are supposed to protect. This sug- policy to estimate the effects of social H&R Block clients, across 60 offices in gests that there may be an optimal assistance on various labor market out- predominantly low- and middle-income budget window, and seeking to under- comes using a regression discontinuity neighborhoods in St. Louis, were ran- stand its properties is one of approach. They find strong evidence domly offered a 20 percent match on Auerbach’s main objectives. Another that more generous social assistance IRA contributions, a 50 percent match,

------NBER Reporter Fall 2005 37 or no match (the control group). The there was a dramatic reduction in problem in which the ex ante utility of evaluation generates two main findings. women’s own wage elasticity. And, con- an agent is maximized subject to incen- First, higher match rates significantly tinuing past trends, women’s labor sup- tive compatibility constraints, as well as raise IRA participation and contribu- ply also became less responsive to hus- two additional constraints on the total tions. Take-up rates were 3 percent for bands’ wages. Between 1980 and 2000, amount of consumption and labor sup- the control group, 8 percent in the 20 women’s own wage elasticity fell by 50 ply in the economy. Second, the authors percent match group, and 14 percent in to 56 percent, while their cross wage characterize the conditions under which the 50 percent match group. Average elasticity fell by 38 to 47 percent in the best sustainable mechanism will lead IRA contributions (including non-con- absolute value. These patterns hold up to an asymptotic allocation where the tributors, excluding the match) for the under virtually all alternative specifica- highest type faces a zero marginal tax 20 percent and 50 percent match tions correcting for: selectivity bias in rate on his or her labor supply as in the groups were 4 and 7 times higher than observing wage offers; selection into classical Mirrlees setup and there are no in the control group, respectively. marriage; income taxes and the earned aggregate capital taxes as in the stan- Second, several additional findings are income tax credit; measurement error in dard dynamic taxation literature. In par- inconsistent with the full information, wages and work hours; and omitted ticular, if the government is sufficiently rational-saver model. In particular, the variables that affect both wage offers patient (typically as patient as the authors find much more modest effects and the propensity to work; as well as agents), the Lagrange multiplier on the on take-up and amounts contributed when education groups and mothers of sustainability constraint of the govern- from the existing Saver’s Credit, which small children are analyzed separately. ment tends to zero, and marginal distor- provides an effective match for retire- Acemoglu, Golosov, and Tsyvinski tions arising from political economy ment saving contributions through the investigate the political economy of (cen- disappear asymptotically. In contrast, tax code; they suspect that the differ- tralized) mechanisms and compare when the government has a small dis- ences may reflect the complexity of the these mechanisms to markets. In con- count factor, the authors show that Saver’s Credit as enacted, and the way in trast to the standard approach, they aggregate distortions remain, and there which its effective match is presented. assume that the mechanism is operated is both positive marginal labor tax on Taken together, these results suggest by a self-interested agent (ruler/govern- the highest type and positive aggregate that the combination of a clear and ment) who can misuse the resources capital taxes even asymptotically. The understandable match for saving, easily and information he or she collects. The authors also investigate when markets accessible savings vehicles, the opportu- main contribution of the paper is an are likely to be less desirable relative to nity to use part of an income tax refund analysis of the form of mechanisms centralized mechanisms. to save, and professional assistance that insures idiosyncratic (productivity) Tax policies in developing countries could generate a significant increase in risks, as in the classical Mirrlees setup, are puzzling on many dimensions, given contributions to retirement accounts, but in the presence of a self-interested the sharp contrast between these poli- including among middle- and low- government. The authors construct cies and both those seen in developed income households. sustainable mechanisms whereby the countries and those forecast in the opti- Using March Current Population government is given incentives not to mal tax literature. In their paper, Survey (CPS) data, Blau and Kahn misuse resources and information. One Gordon and Li explore how forecasted investigate married women’s labor sup- important result of their analysis is that policies change if firms can successful- ply behavior from 1980 to 2000. They there will be truthful revelation along ly evade taxes by conducting all business find that the labor supply function for the equilibrium path; this shows that in cash, thus avoiding any use of the annual hours shifted sharply to the right truth-telling mechanisms can be used financial sector. The forecasted policies in the 1980s, with little shift in the despite the commitment problems and that result are much closer to those 1990s. In an accounting sense, this is the different interests of the govern- observed. the major reason for the more rapid ment and the citizens. Using this tool, Half of college students drop out growth of female labor supply the authors characterize the best sus- before completing a degree. These low observed in the 1980s, with an addition- tainable mechanism. A number of fea- rates of college completion among al factor being that husbands’ real wages tures are interesting to note. First, under young people should be viewed in the fell slightly in the 1980s but rose in the fairly general conditions, the best sus- context of slow future growth in the 1990s. Moreover, a major new develop- tainable mechanism is a solution to a educated labor force, as the well-educat- ment was that, during both decades, quasi-Mirrlees problem, defined as a ed baby boomers retire and new workers

38 NBER Reporter Fall 2005 ------are drawn from populations with histor- college degree by 3 percentage points. analysis indicates that tuition reduction ically low education levels. Dynarski The effects are strongest among can be a socially efficient method for establishes a causal link between college women, with white women increasing increasing college completion. However, costs and the share of workers with a degree receipt by 3.2 percentage points even with the offer of free tuition, a college education. She exploits the intro- and the share of nonwhite women large share of students continue to drop duction of two large tuition subsidy attempting or completing any years of out, suggesting that the direct costs of programs, finding that they increase the college increasing by 6 and 7 percentage school are not the only impediment to share of the population that completes a points, respectively. A cost-benefit college completion.

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Tax Policy and the Economy, Volume 19

Tax Policy and the Economy, Volume sector without making specific policy rate tax liability; and the relationship 19, edited by James M. Poterba, will be recommendations. between pyramidal structures and the available this fall from the MIT Press The topics discussed in this vol- taxation of intercorporate dividends. for $25.00 in paperback and $58.00 ume include: a comparison of federal, Poterba directs the NBER’s clothbound. Volume 19 of this NBER state, and local pre-kindergarten educa- Program on Public Economics and is series continues the tradition of tional programs; the cost-effectiveness the Mitsui Professor of Economics and addressing issues that are relevant to of different health insurance reform the Associate Head of the Economics current policy debates as well as to proposals; economic growth in coun- Department at MIT. questions of longer-term interest. The tries with low marginal corporate papers included provide important income tax rates; the disparity between background information for policy corporate income as reported to analysts in government and the private investors and as calculated for corpo-

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Measuring Capital in the New Economy

Measuring Capital in the New Economy, available now from the University of and Wealth, the contributors — includ- edited by Carol Corrado, John C. Chicago Press for $99. ing both academic economists and for- Haltiwanger, and Daniel E. Sichel, is In this NBER Study of Income mer government officials — offer new

------NBER Reporter Fall 2005 39 approaches for measuring capital in an and Product Accounts affects Gross and a professor of economics at the economy that is increasingly dominated Domestic Product. This book should University of Maryland. Corrado is by high-technology capital and intangi- be of interest to economists, policy- Chief of the Industrial Output Section, ble assets. They consider, among other makers, and members of the financial and Sichel is Assistant Director of the topics, the valuation of intangible capi- and accounting communities. Division of Research and Statistics, of tal, the relationship of human capital Haltiwanger is an NBER Research the Federal Reserve Board of and productivity to market value, and Associate in the Program on Governors. how R and D in the National Income Productivity and Technological Change

A History of Corporate Governance around the World: Family Business Groups to Professional Managers

A History of Corporate Governance France, Germany, Italy, Japan, the research also suggests that in some around the World: Family Business Groups United Kingdom, and the United other capitalist countries, arrangements to Professional Managers, edited by States; larger developing economies like concentrate corporate ownership in the Randall K. Morck, will be available China and India; and alternative models hands of a few wealthy families. from the University of Chicago Press such as those of the Netherlands and Morck is an NBER Research in November 2005. This NBER Sweden. In this volume, leading Associate and a member of the Faculty Conference volume costs $90. research economists present new of Business at the University of Alberta The book includes historical stud- empirical research that suggests that (Canada). ies of the patterns of corporate gover- free enterprise and well-developed nance in several countries, including the financial systems produce growth in large industrial economies of Canada, those countries that have them. The

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40 NBER Reporter Fall 2005 ------Current Working Papers

NBER Working Papers On-Line A complete list of all NBER Working Papers with searchable abstracts, and the full texts of Working Papers (issued since November 1994) are available at http://www.nber.org/wwp.html to anyone located at a university or other organization that sub- scribes to the (hard copy) Working Paper series. If you believe that your organization subscribes, but you cannot access the online Working Paper service, please e-mail the NBER at [email protected] for more information and assistance. * Individual copies of NBER Working Papers, Historical Factors in Long-Run Growth Papers, and Technical Papers are avail- able free of charge to Corporate Associates. For all others, there is a charge of $10.00 per hardcopy or $5.00 per downloaded paper. (Outside the United States, add $10.00 per order for postage and handling.) Advance payment is required on all orders. To order, call the Publications Department at (617)868-3900 or visit www.nber.org/papers. Please have ready the num- ber(s) of any Working Paper(s) you wish to order. Subscriptions to the full NBER Working Paper series include all 700 or more papers published each year. Subscriptions are free to Corporate Associates. For others within the United States, the standard rate for a full subscription is $2525; for academic libraries and faculty members, $1475. Higher rates apply for foreign orders. The on-line standard rate for a full subscription is $1750 and the on-line academic rate is $725. Partial Working Paper subscriptions, delineated by program, are also available. For further information, see our Web site, or please write: National Bureau of Economic Research, 1050 Massachusetts Avenue, Cambridge, MA 02138-5398. * Titles of all papers issued since August 2005 are presented below. For previous papers, see past issues of the NBER Reporter. Working Papers are intended to make results of NBER research available to other economists in preliminary form to encourage dis- cussion and suggestions for revision before final publication. They are not reviewed by the Board of Directors of the NBER.

NBER Working Papers Paper Author(s) Title 11516 Lee Branstetter Do Stronger Intellectual Property Rights Increase Raymond Fisman International Technology Transfer? Empirical Evidence C. Fritz Foley from U.S. Firm-Level Data 11517 Elena Tchernykh Regime-Switching Behavior of the Term Structure of William H. Branson Forward Markets 11518 B. Douglas Bernheim Behavioral Public Economics: Welfare and Policy Antonio Rangel Analysis with Non-Standard Decision Makers 11519 César Alonso-Borrego Evaluating Labor Market Reforms: A General Equilibrium Jesús Fernández-Villaverde Approach José E. Galdón-Sánchez 11520 Michael P. Dooley Savings Gluts and Interest Rates: The Missing Link to David Folkerts-Landau Europe Peter M. Garber 11521 Menzie D. Chinn A Primer on Real Effective Exchange Rates: Determinants, Overvaluation, Trade Flows, and Competitive Devaluation 11522 Anna Aizer The Impact of Child Support Enforcement on Fertility, Sara McLanahan Parental Investment, and Child Well-Being

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11523 Andrew T. Levin Monetary Policy Under Uncertainty in Micro-Founded Alexei Onatski Macroeconometric Models John C. Williams Noah Williams 11524 Laura Bottazzi The International Dynamics of R&D and Innovation in the Giovanni Peri Short and in the Long Run 11525 Ilya Segal Antitrust in Innovative Industries Michael Whinston 11526 Andrea Frazzini Dumb Money: Mutual Fund Flows and the Cross-Section Owen A. Lamont of Stock Returns 11527 Robert Fairlie Mexican Entrepreneurship: A Comparison of Self- Christopher Woodruff Employment in Mexico and the United States 11528 Benjamin F. Jones The Anatomy of Start-Stop Growth Benjamin A. Olken 11529 Jay Bhattacharya Health Insurance and the Obesity Externality Neeraj Sood 11530 Bruce Sacerdote How Do Friendships Form? David Marmaros 11531 Alberto Alesina Why Do Politicians Delegate? Guido Tabellini 11532 Yooki Park Digital Rights and the Pricing of Digital Products Suzanne Scotchmer 11533 Bruce N. Lehmann Notes for a Contingent Claims Theory of Limit Order Markets 11534 John Y. Campbell How Do House Prices Affect Consumption? Evidence Joao F. Cocco from Micro Data 11535 Roland Bénabou Incentives and Prosocial Behavior Jean Tirole 11536 Michelle J. White Economic Analysis of Corporate and Personal Bankruptcy Law 11537 Lars E.O. Svensson Social Value of Public Information: Morris and Shin (2002) is Actually Pro Transparency, not Con 11538 Andrew Ang Do Macro Variables, Asset Markets, or Surveys Forecast Geert Bekaert Inflation Better? Min Wei 11539 Joshua Aizenman The Collection Efficiency of the Value Added Tax: Theory Yothin Jinjarak and International Evidence 11540 Yosuke Okada Competition and Productivity in Japanese Manufacturing Industries 11541 Sebastian Edwards Is the U.S. Current Account Deficit Sustainable? And If Not, How Costly is Adjustment Likely To Be?

42 NBER Reporter Fall 2005 ------Paper Author(s) Title

11542 Philippe Aghion Academic Freedom, Private-Sector Focus, and the Process Mathias Dewatripont of Innovation Jeremy C. Stein 11543 Jaume Ventura The Dot-Com Bubble, the Bush Deficits, and the U.S. Aart Kraay Current Account 11544 James J. Heckman Earnings Functions, Rates of Return, and Treatment: The Lance J. Lochner Mincer Equation and Beyond Petra E. Todd 11545 David W. Galenson The Methods and Careers of Leading American Painters in the Late Nineteenth Century 11546 Dale T. Mortensen An Empirical Model of Growth Through Product Rasmus Lentz Innovation 11547 David Card Is the New Immigration Really So Bad? 11548 Robert J. Gordon Apparel Prices 1914-93 and the Hulten-Brueghel Paradox 11549 Andrew Epstein The Formation and Evolution of Physician Treatment Sean Nicholson Styles: An Application to Cesarean Sections 11550 Hélène Rey Globalization and Emerging Markets: With or Without Philippe Martin Cash? 11551 Francesco Caselli The Marginal Product of Capital James Feyrer 11552 David Card The Diffusion of Mexican Immigrants During the 1990s: Ethan G. Lewis Explanations and Impacts 11553 Ye Feng Vehicle Choices, Miles Driven, and Pollution Policies Don Fullerton Li Gan 11554 James Choi $100 Bills on the Sidewalk: Suboptimal Saving in 401(k) David Laibson Plans Brigitte Madrian 11555 Lucia Foster Reallocation, Firm Turnover, and Efficiency: Selection on John Haltiwanger Productivity or Profitability? Chad Syverson 11556 Lance E. Davis The Highest Price Ever: the Great NYSE Seat Sale of Larry Neal 1928-9 and Capacity Constraints Eugene N. White 11557 Ernst R. Berndt Real Output in Mental Health Care During the 1990s Alisa B. Busch Richard G. Frank Sharon-Lise Normand 11558 James Banks Work Disability is a Pain in the ***, Especially in Arie Kapteyn England, the Netherlands, and the United States James P. Smith Arthur van Soest

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11559 Jessica A. Wachter Solving Models with External Habit 11560 Midori Wakabayashi Borrowing Constraints and Consumption Behavior in Charles Yuji Horioka Japan 11561 Lee Branstetter Is Academic Science Driving a Surge in Industrial Yoshiaki Ogura Innovation? Evidence from Patent Citations 11562 Marvin Goodfriend The Incredible Volcker Disinflation Robert King 11563 Pierre-Olivier Gourinchas From World Banker to Venture Capitalist: U.S. External Hélène Rey Adjustment and the Exorbitant Privilege 11564 Hanno Lustig The Returns on Human Capital: Good News on Wall Stijn Van Nieuwerburgh Street is Bad News on Main Street 11565 Reuven Glick Collateral Damage: Trade Disruption and the Economic Alan M. Taylor Impact of War 11566 Daniel S. Hamermesh The Economics of Workaholism: We Should Not Have Joel Slemrod Worked on This Paper 11567 Janet Currie Biology as Destiny? Short- and Long-Run Determinants of Enrico Moretti Intergenerational Transmission of Birth Weight 11568 Mark Duggan The Impact of Child SSI Enrollment on Household Melissa Kearney Outcomes: Evidence from the Survey of Income and Program Participation 11569 Raquel Fernandez Fertility: The Role of Culture and Family Experience Alessandra Fogli 11570 Raquel Fernandez Diversity and Redistribution Gilat Levy 11571 Diego Puga Wake Up and Smell the Ginseng: The Rise of Incremental Daniel Trefler Innovation in Low-Wage Countries 11572 Aviv Nevo Why Does the Average Price of Tuna Fall During Lent? Konstantinos Hatzitaskos 11573 Simi Kedia The Economics of Fraudulent Accounting Thomas Philippon 11574 Qiang Dai Fiscal Policy and the Term Structure of Interest Rates Thomas Philippon 11575 Peter K. Schott Products and Productivity Andrew B. Bernard Stephen J. Redding 11576 Rajeev Dehejia Insuring Consumption and Happiness Through Religious Thomas DeLeire Organizations Erzo F.P. Luttmer 11577 Jeffrey R. Kling Experimental Analysis of Neighborhood Effects Jeffrey B. Liebman Lawrence F. Katz

44 NBER Reporter Fall 2005 ------Paper Author(s) Title

11578 Jordi Galí Understanding the Effects of Government Spending on J. David López-Salido Consumption Javier Vallés 11579 Bernadette Minton How Much Do Banks Use Credit Derivatives to Reduce René M. Stulz Risk? Rohan Williamson 11580 Andrew K. Rose Fiscal Divergence and Business Cycle Synchronization: Zsolt Darvas Irresponsibility is Idiosyncratic György Szapáry 11581 Steven Kaplan What Are Firms? Evolution from Birth to Public Per Stromberg Companies Berk Sensoy 11582 Michael Grossman Education and Nonmarket Outcomes 11583 Hamid Faruqee Smooth Landing or Crash? Model-Based Scenarios of Douglas Laxton Global Current Account Rebalancing Dirk Muir Paolo Pesenti 11584 Inas Rashad The Super Size of America: An Economic Estimation of Michael Grossman Body Mass Index and Obesity in Adults Shin-Yi Chou 11585 J.V. Henderson Determinants of City Growth in Brazil U. Deichmann S.V. Lall H.G. Wang D. Da Mata 11586 Michael D. Bordo Seventy Years of Central Banking: The Bank of Canada in Angela Redfish International Context, 1935-2005 11587 Philip Oreopoulos The Intergenerational Effects of Worker Displacement Marianne Page Ann Huff Stevens 11588 Stephen H. Shore Commitment, Risk, and Consumption: Do Birds of a Todd Sinai Feather Have Bigger Nests? 11589 Philip R. Lane A Global Perspective on External Positions Gian Maria Milesi-Ferretti 11590 Isaac Ehrlich Endogenous Fertility, Morality, and Economic Growth: Jinyoung Kim Can a Malthusian Framework Account for the Conflicting Historical Trends in Population? 11591 Steven D. Levitt Evidence that Seat Belts are as Effective as Child Safety Seats in Preventing the Death for Children Aged Two and Up 11592 Hongbin Cai Eat, Drink, Firms, and Government: An Investigation of Hanming Fan Corruption from Entertainment and Travel Costs of Chinese Lixin Colin Xu Firms

------NBER Reporter Fall 2005 45 Paper Author(s) Title

11593 Francesco Giavazzi Searching for Non-Monotonic Effects of Fiscal Policy: Tullio Jappelli New Evidence Marco Pagano Marina Benedetti 11594 Severin Borenstein Wealth Transfers from Implementing Real-Time Retail Electricity Pricing 11595 Jennifer Hunt Why Are Some Public Officials More Corrupt Than Others? 11596 Valerie A. Ramey Declining Volatility in the U.S. Automobile Industry Daniel J. Vine 11597 David N. Figlio Do Accountability and Voucher Threats Improve Low- Cecilia Elena Rouse Performing Schools? 11598 Davin Chor The 2004 Global Labor Survey: Workplace Institutions Richard B. Freeman and Practices Around the World 11599 Judith Hellerstein Workplace Segregation in the United States: Race, David Neumark Ethnicity, and Skill 11600 Alberto Alesina Why is Fiscal Policy Often Procyclical? Guido Tabellini 11601 Mark Aguiar Lifecycle Prices and Production Erik Hurst 11602 Darius Lakdawalla Insurance and Innovation in Health Care Markets Neeraj Sood 11603 David S. Evans The Industrial Organization of Markets with Two-Sided Richard Schmalensee Platforms 11604 Susan Dynarski Building the Stock of College-Educated Labor 11605 Amitabh Chandra Disability Risk and the Value of Disability Insurance Andrew A. Samwick 11606 Martin Lettau Euler Equation Errors Sydney C. Ludvigson 11607 Jean Imbs “Aggregation Bias” DOES Explain the PPP Puzzle Haroon Mumtaz Morten O. Ravn Hélène Rey 11608 James O’Brien Estimating Bank Trading Risk: A Factor Model Approach Jeremy Berkowitz 11609 Amy Finkelstein What Did Medicare Do (And Was It Worth It)? Robin McKnight 11610 George J. Borjas Native Internal Migration and the Labor Market Impact of Immigration

46 NBER Reporter Fall 2005 ------Paper Author(s) Title

11611 Craig Landry Toward an Understanding of the Economics of Charity: Andreas Lange Evidence from a Field Experiment John A. List Michael K. Price Nicholas G. Rupp 11612 Steven J. Haider Recent Trends in Resource Sharing Among the Poor Kathleen McGarry 11613 Jeff DeSimone The Effect of Child Access Prevention Laws on Non-Fatal Sara Markowitz Gun Injuries 11614 Petia Topalova Trade Liberalization, Poverty, and Inequality: Evidence From Indian Districts 11615 Jesse M. Shapiro Smart Cities: Quality of Life, Productivity, and the Growth Effects of Human Capital 11616 John A. List The Behavioralist Meets the Market: Measuring Social Preferences and Reputation Effects in Actual Transactions 11617 Christopher R. Berry The Divergence of Human Capital Levels Across Cities Edward L. Glaeser 11618 Ricardo J. Caballero Bubbles and Capital Flow Volatility: Causes and Risk Arvind Krishnamurthy Management 11619 Amy Finkelstein The Aggregate Effects of Health Insurance: Evidence from The Introduction of Medicare 11620 Peter Lorentzen Death and Development John McMillan Romain Wacziarg 11621 Jeffrey Grogger Welfare Reform, Returns to Experience, and Wages: Using Reservation Wages to Account for Sample Selection Bias 11622 Shinichi Nishiyama Does Social Security Privatization Produce Efficiency Kent Smetters Gains? 11623 Richard B. Freeman Supporting “The Best and Brightest” in Science and Tanwin Chang Engineering: NSF Graduate Research Fellowships Hanley Chiang 11624 Zsuzsanna Fluck Venture Capital Contracting and Syndication: An Kedran Garrison Experiment in Computational Corporate Finance Stewart C. Myers 11625 Barry Eichengreen Can a Rapidly Growing Export-Oriented Economy Mariko Hatase Smoothly Exit an Exchange Rate Peg? Lessons for China from Japan’s High-Growth Era 11626 Marianne P. Bitler Distributional Impacts of the Self-Sufficiency Project Jonah B. Gelbach Hilary W. Hoynes

------NBER Reporter Fall 2005 47 Paper Author(s) Title

11627 David H. Autor Trends in U.S. Wage Inequality: Re-Assessing the Lawrence F. Katz Revisionists Melissa Kearney 11628 David H. Autor Rising Wage Inequality: The Role of Composition and Lawrence F. Katz Prices Melissa Kearney 11629 Jeremy Greenwood Hours Worked: Long-Run Trends Guillaume Vandenbroucke 11630 Benjamin M. Friedman Deficits and Debt in the Short and Long Run 11631 John J. Donohue III The Law and Economics of Antidiscrimination Law 11632 Jose Manuel Campa Exchange-Rate Pass-Through to Import Prices in the Euro Linda S. Goldberg Area Jose M. Gonzalez-Minguez 11633 Philippe Bacchetta Rational Inattention: A Solution to the Forward Discount Eric van Wincoop Puzzle 11634 Barry Eichengreen Current Account Reversals: Always a Problem? Muge Adalet 11635 Jennifer Hunt Bribery: Who Pays, Who Refuses, What Are the Payoffs? Sonia Laszlo 11636 David Neumark Do School-To-Work Programs Help the “Forgotten Half ”? Donna Rothstein 11637 Paul R. Bergin Tradability, Productivity, and Understanding International Reuven Glick Economic Integration 11638 Ariel Burstein Modeling Exchange-Rate Pass-through After Large Martin Eichenbaum Devaluations Sergio Rebelo 11639 Assaf Razin Bilateral FDI Flows: Threshold Barriers and Productivity Efraim Sadka Shocks Hui Tong 11640 Ilan Goldfajn Capital Flows and Controls in Brazil: What Have We Andre Minella Learned? 11641 Assaf Razin Globalization and Inflation-Output Tradeoffs Prakash Loungani 11642 Chris Forman Technology Adoption In and Out of Major Urban Areas: Avi Goldfarb When Do Internal Firm Resources Matter Most? Shane Greenstein 11643 Charles Himmelberg Assessing High House Prices: Bubbles, Fundamentals, and Christopher Mayer Misperceptions Todd Sinai 11644 David W. Galenson Who Are the Greatest Living Artists? The View From the Auction Market

48 NBER Reporter Fall 2005 ------Paper Author(s) Title

11645 Dennis W. Carlton Barriers to Entry 11646 Eric M. Leeper Monetary-Fiscal Policy Interactions and the Price Level: Tack Yun Background and Beyond 11647 David Neumark Employment Dynamics and Business Relocation: New Junfu Zhang Evidence from the National Establishment Time Series Brandon Wall 11648 Luigi Guiso Trusting the Stock Market Paola Sapienza Luigi Zingales 11649 Jean M. Abraham Entry and Competition in Local Hospital Markets Martin S. Gaynor William B. Vogt 11650 Richard Baldwin Heterogeneous Firms, Agglomeration, and Economic Toshihiro Okubo Geography: Spatial Selection and Sorting 11651 Robert E. Hall Separating the Business Cycle from Other Economic Fluctuations 11652 Joshua Aizenman Pegged Exchange Rate Regimes — A Trap? Reuven Glick 11653 Linda Goldberg Trade Invoicing in the Accession Countries: Are They Suited to the Euro? 11654 Naomi R. Lamoreaux The Decline of the Independent Inventor: A Schumpterian Kenneth L. Sokoloff Story? 11655 Russell Cooper Is It Is or Is It Ain’t My Obligation? Regional Debt in a Hubert Kempf Fiscal Federation Dan Peled 11656 Marcela Eslava Factor Adjustments After Deregulation: Panel Evidence John Haltiwanger from Colombian Plants Adriana Kugler Maurice Kugler 11657 Raghuram G. Rajan What Undermines Aid’s Impact on Growth? Arvind Subramanian 11658 Adriana Kugler Effects of Employment Protection on Worker and Job Giovanni Pica Flows: Evidence From the 1990 Italian Reform 11659 Thomas J. Kniesner How Unobservable Productivity Biases the Value of a W. Kip Vicusi Statistical Life Christopher Woock James P. Ziliak 11660 Thomas S. Dee Teachers and the Gender Gaps in Student Achievement 11661 Roger Gordon Puzzling Tax Structures in Developing Countries: A Wei Li Comparison of Two Alternative Explanations

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11662 Yu-Chu Shen Hospital Ownership and Financial Performance: A Karen Eggleston Quantitative Research Review Joseph Lau Christopher Schmid 11663 Eli Berman Religious Extremism: The Good, The Bad, and The Laurence R. Iannaccone Deadly 11664 Matthew Gentzkow Media Bias and Reputation Jesse M. Shapiro 11665 Gilbert E. Metcalf Tax Reform and Environmental Taxation 11666 Loriana Pelizzon Pillar 1 vs. Pillar 2 Under Risk Management Stephen Schaefer 11667 Howard F. Chang The Effect of Joint and Several Liability Under Superfund Hilary Sigman on Brownfields 11668 Hans Fehr Will China Eat Our Lunch or Take Us to Dinner? Sabine Jokisch Simulating the Transition Paths of the U.S., EU, Japan, and China 11669 Sebastian Edwards The End of Large Current Account Deficits, 1970-2002: Are There Lessons for the United States? 11670 Claudia Uribe Expanding School Enrollment by Subsidizing Private Richard J. Murname Schools: Lessons from Bogotá John B. Willett Marie-Andrée Somers 11671 Patrick Bajari Complementarities and Collusion in an FCC Spectrum Jeremy T. Fox Auction 11672 Gianmarco I.P. Ottaviano Rethinking the Gains from Immigration: Theory and Giovanni Peri Evidence from the U.S. 11673 Leemore S. Dafny Estimation and Identification of Merger Effects: An Application to Hospital Mergers 11674 Alessandra Casella Minorities and Storable Votes Thomas Palfrey Raymond Riezman 11675 Charles F. Manski Fractional Treatment Rules for Social Diversification of Indivisible Private Risks 11676 Julie Holland Mortimer Price Discrimination, Copyright Law, and Technological Innovation: Evidence from the Introduction of DVDs 11677 M. Kate Bundorf Health Risk, Income, and the Purchase of Private Health Bradley Herring Insurance Mark Pauly 11678 Robert E. Hall Job Loss, Job Finding, and Unemployment in the U.S. Economy Over the Past Fifty Years 11679 Steven J. Davis The Climate for Business Development and Employment Luis Rivera-Batiz Growth in Puerto Rico

50 NBER Reporter Fall 2005 ------Paper Author(s) Title

11680 Esther Duflo Saving Incentives for Low- and Middle-Income Families: William Gale Evidence from a Field Experiment with H&R Block Jeffrey Liebman Peter Orszag Emmanuel Saez 11681 Hilary Hoynes Poverty in America: Trends and Explanations Marianne Page Ann Stevens 11682 Jeffrey Grogger Markov Forecasting Methods for Welfare Caseloads 11683 Stefano DellaVigna Investor Inattention, Firm Reaction, and Joshua Pollet Friday Earnings Announcements 11684 Robert E. Hall The Labor Market and Macro Volatility: A Nonstationary General-Equilibrium Analysis 11685 Heitor Almeida The Risk-Adjusted Cost of Financial Distress Thomas Philippon 11686 Alan J. Auerbach Who Bears the Corporate Tax? A Review of What We Know 11687 Hanno Lustig Fiscal Hedging and the Yield Curve Christopher Sleet Sevin Yeltekin 11688 James Harrigan Airplanes and Comparative Advantage 11689 Robert Shimer Liquidity and Insurance for the Unemployed Ivan Werning 11690 Antonio J. Trujillo Race and Health Disparities Among Seniors in John A. Vernon Urban Areas in Brazil Laura Rodriguez Wong Gustavo Angeles 11691 Enrique G. Mendoza Real Exchange Rate Volatility and the Price of Nontradables in Sudden-Stop-Prone Economies 11692 Dale T. Mortensen More on Unemployment and Vacancy Fluctuations Eva Nagypal 11693 Joseph G. Altonji Work Hours, Wages, and Vacation Leave Emiko Usui 11694 Neville Francis Measures of Per Capita Hours and their Implications Valerie A. Ramey for the Technology-Hours Debate 11695 Robert Cull Historical Financing of Small- and Lance E. Davis Medium-Sized Enterprises Naomi R. Lamoreaux Jean-Laurent Rosenthal 11696 Laura Alfaro Capital Flows in a Globalized World: The Role of Sebnem Kalemli-Ozcan Policies and Institutions Vadym Volosovych

------NBER Reporter Fall 2005 51 Paper Author(s) Title

11697 Kee-Hong Bae Do Local Analysts Know More? A Cross-Country Study Rene M. Stulz of the Performance of Local Analysts and Foreign Analysts Hongping Tan 11698 Philipp Hartmann Banking System Stability: A Cross-Atlantic Perspective Stefan Straetmans Casper G. De Vries 11699 Ariel Burstein The Importance of Nontradable Goods’ Prices Martin Eichenbaum in Cyclical Real Exchange Rate Fluctuations Sergio Rebelo 11700 Alberto Alesina Good bye Lenin (or not?): The Effect of Nicola Fuchs Schuendeln Communism on People’s Preferences 11701 Martin D. D. Evans International Capital Flows, Returns, and Viktoria Hnatkovska World Financial Integration 11702 Jens Ludwig Does Head Start Improve Children’s Life Chances? Douglas L. Miller Evidence from a Regression Discontinuity Design 11703 Sydney C. Ludvigson Macro Factors in Bond Risk Premia Serena Ng 11704 Grant Miller Contraception as Development? New Evidence from Family Planning in Colombia 11705 Sujoy Chakravarty Does the Profit Motive Make Jack Nimble? Martin Gaynor Ownership Form and the Evolution of the U.S. Steven Klepper Hospital Industry William B. Vogt 11706 Yuriy Gorodnichenko A Re-Examination of the Border Effect Linda Tesar 11707 Jason R. Barro The Effects of Cardiac Specialty Hospitals on the Robert S. Huckman Cost and Quality of Medical Care Daniel P. Kessler 11708 Raj Chetty Income Risk and the Benefits of Social Insurance: Adam Looney Evidence from Indonesia and the United States 11709 Raj Chetty Consumption Smoothing and the Welfare Consequences Adam Looney of Social Insurance in Developing Economies 11710 Bruce Fallick Job Hopping in Silicone Valley: Some Evidence Charles A. Fleischmann Concerning the Micro-Foundations of a High James B. Rebitzer Technology Cluster 11711 Esther Duflo Dams Rohini Pande 11712 Daniel S. Hamermesh Changing Looks and Changing “Discrimination:” The Beauty of Economists 11713 William H. Branson Monetary and Exchange Rate Policy Coordination in ASEAN+1 11714 Michael D. Bordo A Review of A History of the Federal Reserve, Volume 1 (2003), by Allan H. Meltzer 52 NBER Reporter Fall 2005 ------Paper Author(s) Title

11715 David W. Galenson Do the Young British Artists Rule (or: Has London Stolen the Idea of Postmodern Art from New York?): Evidence from the Auction Market 11716 Giovanni Maggi A Political-Economy Theory of Trade Agreements Andres Rodriguez-Clare 11717 Mihir A. Desai Foreign Direct Investment and Domestic C. Fritz Foley Economic Activity James R. Hines 11718 Devashish Mitra Y2K and Offshoring: the Role of External Economies Priya Ranjan and Firm Heterogeneity 11719 Menzie D. Chinn Supply Capacity, Vertical Specialization, and Tariff Rates: The Implications for Aggregate U.S. Trade Flow Equations 11720 Stephen Calabrese Local Public Good Provision: Voting, Peer Effects, Dennis Epple and Mobility Thomas Romer Holger Sieg 11721 David S. Lee Training, Wages, and Sample Selection: Estimating Sharp Bounds on Treatment Effects 11722 Xavier Gabaix Institutional Investors and Stock Market Volatility Parameswaran Gopikrishnan Vasiliki Plerou H. Eugene Stanley 11723 David C. Grabowski Moral Hazard in Nursing Home Use Jonathan Gruber 11724 Tomas J. Philipson Assessing the Safety and Efficacy of the FDA: Ernst R. Berndt The Case of the Prescription Drug User Fee Acts Adrian H. B. Gottschalk Matthew W. Strobeck 11725 Eric Bettinger Using Experimental Economics to Measure the Robert Slonim Effects of a Natural Educational Experiment on Altruism 11726 Olivia S. Mitchell Turning Workers into Savers? Incentives, Liquidity, Stephen P. Utkus and Choice in 401(k) Plan Design Tongxuan (Stella) Yang 11727 David S. Evans U.S. v. Microsoft: Did Consumers Win? Albert L. Nichols Richard Schmalensee 11728 Raghuram G. Rajan Has Financial Development Made the World Riskier? 11729 Nada Eissa Behavioral Responses to Taxes: Lessons from the EITC Hilary Hoynes and Labor Supply 11730 David Clingingsmith Mughal Decline, Climate Change, and Britain’s Jeffrey G. Williamson Industrial Ascent: An Integrated Perspective on India’s 18th and 19th Century Deindustrialization

------NBER Reporter Fall 2005 53 Paper Author(s) Title

11731 Erik Hurst Precautionary Savings and the Importance of Arthur Kennickell Business Owners Annamaria Lusardi Francisco Torralba 11732 Howard Bodenhorn Colorism and African American Wealth: Evidence Christopher S. Ruebeck from the Nineteenth Century South 11733 Lars E. O. Svensson Monetary Policy with Model Uncertainty: Noah Williams Distribution Forecast Targeting 11734 Howard Bodenhorn Usury Ceilings, Relationships, and Bank Lending Behavior: Evidence from Nineteenth Century New York 11735 David K. Musto A Portfolio View of Consumer Credit Nicholas S. Souleles 11736 Francis X. Diebold Stock Returns and Expected Business Conditions: Half a Century of Evidence 11737 Philip J. Cook Underground Gun Markets Jens Ludwig Sudhir Venkatesh Anthony A. Braga 11738 Christine Jolls Debiasing through Law Cass R. Sunstein 11739 Bronwyn H. Hall Identifying Age, Cohort, and Period Effects in Jacques Mairesse Scientific Research Productivity: Discussion and Laure Turner Illustration Using Simulated and Actual Data on French Physicists 11740 Eli Berman Hard Targets: Theory and Evidence on Suicide Attacks David Laitin 11741 Gunter Franke Default Risk Sharing Between Banks and Markets: Jan Pieter Krahnen The Contribution of Collateralized Debt 11742 David Autor Temporary Agency Employment as a Way out of Poverty? Susan Houseman 11743 David Autor Do Temporary Help Jobs Improve Labor Market Susan Houseman Outcomes for Low Skilled Workers? Evidence from Random Assignments 11744 Ryan M. Johnson “The War for the Fare”: How Driver Compensation David H. Reiley Affects Bus System Performance Juan Carlos Munoz 11745 Irene Brambilla A Customs Union with Multinational Firms: The Automobile Market in Argentina and Brazil 11746 Ricardo Reis A Cost-of-Living Dynamic Price Index, with an Application to Indexing Retirement Accounts

54 NBER Reporter Fall 2005 ------Paper Author(s) Title

11747 Henry Hongho Jin Socially Responsible Investment in Japanese Pensions Olivia S. Mitchell John Piggott 11748 Martin D. D. Evans Understanding Order Flow Richard K. Lyons 11749 Fumio Hayashi Can IT be Japan’s Savior? Koji Nomura 11750 Olivier Blanchard European Unemployment: The Evolution of Facts and Ideas 11751 Maria Enchautegui Why Don’t More Puerto Rican Men Work? Richard B. Freeman The Rich Uncle (Sam) Hypothesis TECHNICAL PAPERS 313 James H. Stock Inference With Weak Instruments Donald W.K. Andrews 314 Joshua Angrist Instrumental Variables Methods in Experimental Criminological Research: What, Why and How? 315 Jesus Fernandez-Villaverde Convergence Properties of the Likelihood of Juan F. Rubio-Ramirez Computed Dynamic Models Manuel S. Santos 316 James J. Heckman Dynamic Discrete choice and Dynamic Treatment Effects Salvador Navarro 317 George W. Evans Generalized Stochastic Gradient Learning Seppo Honkapohja Noah Williams 318 Martin D. D. Evans Solving General Equilibrium Models with Viktoria Hnatkovska Incomplete Markets and Many Assets 319 Lan Zhang Edgeworth Expansions for Realized Volatility Per A. Mykland and Related Estimators Yacine Aït-Sahalia

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