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Political
Economy
The papers produced by the Political Economy Network fall under three main categories: Discussion Papers and Books produced by CEPR Joint papers produced under the framework of the network Other related publications from the network
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by Torsten Person (IIES and CEPR) and Guido Tabellini (IGIER and CEPR) CEPR Discussion Paper No. 2235, September 1999 Observed fiscal policy varies greatly across time and countries. How can we explain this variation? This paper surveys the recent literature that has tried to answer this question. We adopt a unified approach in portraying public policy as the equilibrium outcome of an explicitly specified political process. We divide the material into three parts. In Part I, we focus on median-voter equilibria that apply to policy issues where disagreement between voters is likely to be one-dimensional. We thus study the general redistributive programs, which are typical of the modern welfare state: redistribution between rich and poor, young and old, employed and unemployed, resident of different regions, and labour and capital. In Part II we study special interest politics. Here the policy problem is multidimensional and we focus on specific political mechanisms: we study legislative bargaining, lobbying, and electoral competition, as well as the possible interactions between these different forms of political activity. Finally, Part III deals with a set of questions that can be brought under the label of comparative politics, as we deal with policy choice under alternative political constitutions: we model some stylized features of congressional and parliamentary political systems, focusing on their implications for rent extraction by politicians, redistribution and public goods provision.
by Andrea Prat (CentER and CEPR) CEPR Discussion Paper No. 2152, May 1999 This paper investigates the role of campaign advertising and the opportunity of legal restrictions on it. An electoral race is modeled as a signalling game with three classes of players: a continuum of voters, two candidates, and one interest group. The group has non-verifiable insider information on the candidates' valence and, on the basis of this information, offers a contribution to each candidate in exchange for a favorable policy position. Candidates spend the contributions they receive on non-directly informative advertising. This paper shows that: (1) A separating equilibrium exists in which the group contributes to a candidate only if the insider information about that candidate is positive; (2) Although voters are fully rational, a ban on campaign advertising can be welfare-improving; and (3) Split contributions may arise in equilibrium (and should be prohibited).
Assessing the Political Viability of Labour Market Reform: the Case of Employment Protection by Gilles Saint-Paul (Universitat Pompeu Fabra and CEPR) CEPR Discussion Paper No. 2136, April 1999 We analyze the political support for employment protection legislation. Unlike my previous work on the same topic, this paper pays a lot of attention to the role of obsolescence in the growth process. In voting in favour of employment protection, incumbent employees trade off lower living standards (because employment protection maintains workers in less productive activities) against longer job duration. The support for employment protection will then depend on the value of the latter relative to the cost of the former. We highlight two key determinants of this trade-off: first, the worker’s bargaining power, second, the economy’s growth rate – more precisely its rate of creative destruction.
by Ramon Marimon (EUI Florence and CEPR) and Fabrizio Zilibotti (IIES and CEPR), CEPR Discussion Paper No. 2127, April 1999 We study the employment and distributional effects of regulating (reducing) working time in a general equilibrium model with search-matching frictions. Job creation entails some fixed costs, but existing jobs are subject to diminishing returns. We characterize the equilibrium in the de-regulated economy where large firms and individual workers freely negotiate wages and hours. Then, we consider the effects of a legislation restricting the maximum working time, while we let wages respond endogenously. In general, this regulation benefits workers, both unemployed and employed (even if wages decrease), but reduces profits and output. Employment effects are sensitive to the representation of preferences. In our benchmark, small reductions in working time, starting from the laissez-faire equilibrium solution, always increase employment, while larger reductions reduce employment. However, the employment gains from reducing working time are relatively small.
The Political Economy of Employment Protection by Gilles Saint-Paul (Universitat Pompeu Fabra and CEPR) CEPR Discussion Paper No. 2109, March 1999 This paper develops a model of job creation and job destruction in a growing economy with embodied technical progress, that we use to analyze the political support for employment protection legislations such as the ones that are observed in most European countries. We analyze the possibility of Condorcet cycles due to the fact that workers about to become unemployed prefer both an increase and a reduction in firing costs over the status quo. Despite this problem, we show the existence of local, and sometimes global majority winners. In voting in favour of employment protection, incumbent employees trade off lower living standards (because employment protection maintains workers in less productive activities) against longer job duration. We show that the gains from, and consequently the political support for employment protection (as defined by maximumjob tenure) are larger, the lower the rate of creative destruction and the larger the worker's bargaining power. Numerical simulations suggest a hump-shaped response of firing costs to these variables, as well as a negative impact of exogenous turnover on employment protection.
The Size and Scope of Government: Comparative Politics with Rational Politicians by
Torsten Persson (IIES and CEPR) and Guido Tabellini (IGIER
and CEPR), CEPR
Discussion Paper No. 2051, January 1999 The authors try to demonstrate how economists may engage in research on comparative politics, relating the size and composition of government spending to the political system. A Downsian model of electoral competition and forward-looking voting indicates that majoritarian – as opposed to proportional – elections increase competition between parties by focusing it into some key marginal districts. This leads to less public goods, less rents for politicians, more redistribution and larger government. A model of legislative bargaining and backward-looking voting indicates that presidential – as opposed to parliamentary – regimes increase competition between both politicians and voters. This leads to less public goods, less rents for politicians, less redistribution, and smaller government. In this paper, these predictions are confronted with cross-country data from around 1990, controlling for economic and social determinants of government spending. The authors find strong and robust support for the prediction that the size of government is smaller under presidential regimes, and weaker support for the prediction that majoritarian elections are associated with less public goods.
Theory of Haste with Applications to Construction of Nuclear Power Plants and Extinction of Endangered Species by Isabelle Brocas (ECARES) and Juan D Carrillo (ECARES and CEPR) CEPR Discussion Paper No 2027, November 1998 We consider the decision of an agent with time inconsistent preferences to undertake an irreversible investment that yields an uncertain current benefit and a delayed cost. We show that, if the flow of information revealed between periods when the investment is postponed is sufficiently high, there is an expected positive information value of waiting. Hence, as under time consistency, only projects with positive Net Present Value (NPV) are initiated. By contrast, if the amount of information transmitted is small, the agent's expected information value of waiting is negative. As a result, an individual may rationally decide to undertake an investment with negative NPV, only to prevent a future investment profitable from a future perspective but highly detrimental from the current viewpoint. We argue that this provides a rationale for haste, i.e. for the tendency of agents to embark on irreversible activities anticipating expected losses. We also discuss some applications of our theory such as impulse buying, destruction of the environment and preservation of endangered species.
by Juan D Carrillo (ECARES and CEPR) CEPR Discussion Paper No 2017, November 1998 We show that, by fear of overconsuming indefinitely, the agent may (optimally) decide to abstain after some periods, even in cases where moderate consumption always dominates abstention. This provides a rationale for why dieters, former smokers, or gamblers stick to strict personal rules of behaviour, such as total abstention, without invoking standard addiction arguments. We also study how urges modify the strategy of the agent and analyse some policy implications. Last, applications of this theory to other issues such as self-knowledge, willpower and habit formation are discussed.
by Avinash Dixit (Princeton University) and Gene M Grossman (Princeton University and CEPR) and Faruk Gul (Princeton University) CEPR Discussion Paper No 1935, July 1998 In this paper, the authors study political compromise founded on tacit cooperation. Two political parties must share a fixed pie in each of an infinite sequence of periods. In each period, the party in power has ultimate authority to divide the pie. Power evolves according to a Markov process among a set of political states corresponding to different degrees of political ‘strength’ for the two. The political strength of each party is a state variable, and the game is dynamic, rather than repeated. Allocations in an efficient, sub-game perfect equilibrium do not follow a Markov process. Rather, a party’s share reflects not only its current strength, but also how it got there in the recent history. Dixit, Grossman and Gul characterize the efficient division processes for majority rule and supermajority rule, and ask whether one regime allows greater compromise than the other.
by Torsten Persson (IIES and CEPR) and Guido Tabellini (IGIER and CEPR), CEPR Discussion Paper No. 1759, December 1997 (republished in the Handbook of Macroeconomics, edited by John Taylor and Michael Woodford, 1999) This
paper surveys the recent literature on the theory of macroeconomic policy.
Tabellini and Persson study the effect of various incentive constraints on
the policy-making process, such as lack of credibility, political
opportunism, political ideology, and divided government. The survey is
organized in three parts. Part I deals with monetary policy in a simple
Phillips curve model, and focuses on credibility, political business
cycles, and optimal design of monetary institutions. Part II deals with
fiscal policy in a dynamic general equilibrium set up; the main topics
covered in this section are credibility of tax policy, and political
determinants of budget deficits. Part III studies economic growth in
models with endogenous fiscal policy. by André Sapir (ECARES and CEPR) CEPR Discussion Paper No 1739, November 1997 Many observers have noted a recent proliferation of regional trade agreements primarily centred in or on Europe. The paper analyses the causes and consequences of EC regionalism. It begins by examining the development and importance of the phenomenon. It finds that although the EC maintains preferential trade arrangements with virtually all countries, preferential trade accounts for no more than 25% of total EC trade. The paper investigates the causes of EC regionalism, focusing on the determinants of both the demand by third countries and the supply by the EC. Lastly, it examines future options.
Comparative Politics and Public Finance by Torsten Persson (IIES and CEPR), Gérard Roland (ECARES and CEPR) , Guido Tabellini (IGIER and CEPR CEPR Discussion Paper 1737, November 1997 A model of electoral accountability is elaborated to compare the public finance outcomes under a presidential-congressional and a parliamentary system. In a presidential-congressional system, contrary to a parliamentary system, there are no endogenous incentives for legislative cohesion, but this allows for a clearer separation of powers. These features lead to clear differences in the public finance performance of the two systems. A Parliamentary system has redistribution towards a majority, less underprovision of public goods, more waste and a higher burden of taxation, whereas a presidential-congressional system has redistribution towards a minority, more underprovision of public goods, but less waste and a smaller size of government.
by David Begg (Birkbeck College and CEPR), Francesco Giavazzi (IGIER and CEPR), Jürgen Von Hagen (University of Bonn and CEPR) and Charles Wyplosz (GIIS Geneva and CEPR), London: CEPR, 1998 The Report analyses the final steps of the transition to the single currency. It asks what institutional design is best suited to guarantee a smooth transition. The proposal the paper comes up with coincides with that actually chosen by the European Council in May 1998.
by Annick Laruelle (CEPR) and Mika Widgren (CEPR) CEPR Discussion Paper 1600, March 1997 Probabilistic measures of a priori voting power are useful tools to asses actors’ influence on collective decision-making either for the purpose of designing a voting organ or to model particular policy cases. This paper makes an attempt to reduce a dynamic voting process into a cooperative voting game and uses the EU as an example. The paper proposes a probabilistic reduced extensive form voting game. By subsequent specialization of power indices we are able to quantify, for example, to what extent the development of the decision-making procedures on the EU has changed the division of power among its main organs.
Electoral Institutions, Cabinet Negotiations, and Budget Deficits within the European Union by Mark Hallerberg (CEPR) and Jürgen von Hagen (CEPR) CEPR Discussion Paper 1555, January 1997 Two literatures in political economy argue that differences in political institutions help explain variation in the fiscal performance of countries. They indentify electoral systems and institutions that structure the formation of the budget as important that these two arguments complement one another. Electoral institutions matter because they restrict the type of budgetary institution a state has at its disposal to solve the coordination problem involved in the budget negotiations. The theory and the empirical results indicate a strong finance minister solutions on the one hand, and multi-party or minority governments and the use of formal budget targets on the other. Pooled time series regression supports our contention that the presence of one of these budgetary institutions matters more than the plurality/proportional representations dichotomy.
by Alberto Ades and Thierry Verdier (DELTA and CEPR) CEPR Discussion Paper 1495, November 1996 This paper analyzes how political institutions, wealth distribution and economic activities affect each other during the process of development. A simple general equilibrium model of rent-seeking political elites with two productive sectors (modern and traditional) is presented. Political participation is viewed as a costly activity. The paper shows what drives entry into politics and how the size of the elite affects the level of distortions. The model also highlights the role played by the initial distribution of wealth in determining the long-run pattern of political participation and economic performance. It shows why one society may converge to an equilibrium with low distortions and social equality, while others may end up with an institutional framework that brings about high distortions and social polarization. The model is then extended to account for the provision of public goods, to analyze the effects of rent-seeking on technological change, and to allow for random shocks in intergenerational transfers.
Towards Micropolitical Foundations of Public Finance by Torsten Persson (IIES and CEPR), Gérard Roland (ECARES and CEPR), Guido Tabellini (IGIER and CEPR) forthcoming in European Economic Review, 1998 Observed
fiscal policy reflects the incentives embedded in political institutions.
This paper illustrates the effects of two general institutional features:
separation of powers, which is common in Presidential-Congressional
political systems, and legislative cohesion, which is typical of
parliamentary systems. Compared to a simple legislative game, separation
of powers brings about a smaller size of government and lower waste,
whereas legislative cohesion induces a more equal distribution, but more
waste and higher taxes. Separation of Powers and Political Accountability by Torsten Persson (IIES and CEPR), Gérard Roland (ECARES and CEPR), Guido Tabellini (IGIER and CEPR) published in the Quarterly Journal of Economics November 1997, vol. 112, n. 4, pp. 1163-1202 Political
constitutions are incomplete contracts and therefore leave scope for abuse
of power. In democracies, elections are the primary mechanism for
disciplining public officials, but they are not sufficient. Separation of
powers between executive and legislative bodies also helps preventing the
abuse of power, but only with appropriate checks and balances. Checks and
balances work by creating a conflict of interests between the executive
and the legislature, yet requiring both bodies to agree on public policy.
In this way, the two bodies discipline each other at the voters'
advantage. Under appropriate checks and balances, separation of powers
also helps the voters elicit information. The Theory of Fiscal Federalism: What Does it Mean for Europe? by Torsten Persson (IIES and CEPR), Gérard Roland (ECARES and CEPR), Guido Tabellini (IGIER and CEPR) At
the core of the ongoing political and academic debate on European
integration lies the fundamental question of the assignment of policy
tasks to different levels of government. This paper takes as starting
point the classical theory of fiscal federalism developed by Musgrave and
Oates based on the pigovian approach. It argues that when the political
economy approach is taken into account, it is more difficult to make
clear-cut recommendations on the assignment of tasks. This is because the
traditional approach has neglected generalized second-best arguments
related to incentive constraints in the policy formation process. For
example, even though, according to the traditional approach, education
policies are best decentralized, European programmes that encourage
mobility of students and professors give better incentives to reform the
inefficient university systems that exist in some European countries.
Also, the traditional approach has neglected heterogeneity in preferences
and interests and the redistributive implications of centralization or
decentralization. by Jean Tirole (IDEI and CEPR) and Mathias Dewatripont (ECARES and CEPR) Journal of Political Economy,1999 This
paper studies the role of advocates in politics, the law, and more
generally in organizations. This paper argues that the use of enfranchized
advocates, who stand for specific causes and are not meant to internalize
social welfare, has two benefits. First, it avoids conflicts of interest,
by which an agent is asked to defend two contradictory causes. Second, it
creates superior incentives for appeal in cases where the decision-maker
does not use the available information from a socially optimal
perspective. The paper also unveils the costs of advocacy, and concludes
with applications to the recent controversy in political science on the
role of Congressional committees, and to the comparison between common and
roman law systems. Privatization and Managerial Efficiency by Olivier Debande (ECARES) and Guido Friebel (IDEI and CEPR) Discussion Paper, William Davidson Institute, University of Michigan Business School, Ann Arbor The
paper analyzes, in a framework of incomplete contracts, the effects of
privatization on the performance of loss-making state firms. A
conventional wisdom states that managers' incentives to restructure are
better in private ownership, and that subsidies to firms would be cut due
to privatization. However, the paper shows that this is but one possible
consequence of privatization. Unfortunately, there exists another in which
privatization makes things even worse. After privatization, managers have
more power vis-a-vis the government and they may abuse this power in order
to receive subsidies that are even higher than in state ownership, (for
instance by threatening to fire part of their workforce). The key to this
‘failure’ of privatization lies in the fact that due to political
reasons, governments can not afford too much unemployment, and this makes
them sensitive to lobbying efforts of various groups in the society. Electoral Competition and Politicians Turnover by Juan Carrillo (ECARES and CEPR) and Thomas Mariotti (IDEI), mimeo ECARES and IDEI This
paper analyzes the selection by opportunistic parties of the candidates
who run for election. They consider a setting with incomplete but
symmetric information about the candidates’ abilities, and where
electoral campaigns provide voters with additional information about
candidates. The authors first argue that, in order to defeat an
established very good candidate of its rival, a party may favour a new
candidate with highly uncertain ability, rather than an established good
candidate. They then show that the discrepancy between the objective of
parties (caring only about their own candidate winning the election) and
the objective of the electorate (interested in electing the best candidate
available) leads to social inefficiencies. More precisely, each party is
too conservative in its choice of candidates, i.e. it keeps its incumbents
too often from the voters’ viewpoint. Last, a dynamic version of the
model is analyzed with the conclusion that a far-sighted party who
internalizes the option value of keeping/replacing a candidate replaces
its incumbents more often than a myopic party. Wishful Thinking and Strategic Ignorance by Juan Carrillo (ECARES and CEPR) and Thomas Mariotti (IDEI), mimeo ECARES and IDEI The
paper analyzes the decision of an agent with time inconsistent preferences
to consume a good that exerts an externality on future welfare. The extent
of the externality is initially unknown, but may be learned via a costless
sampling procedure. It is shown that when the agent cannot commit to
future consumption and learning decisions, incomplete learning may occur
on a Markov perfect equilibrium path of the resulting intra-personal game.
In such case, each agent's incarnation stops learning for some values of
the posterior distribution of beliefs and acts under self-restricted
information. This conduct is interpreted as strategic ignorance. All
equilibria featuring this property strictly Pareto dominate the complete
learning equilibrium for any posterior distribution of beliefs. Last, the
efficient Markov perfect equilibrium is fully characterized. It is
emphasized that such manipulation of the information acquisition process
provides a rationale for one conduct usually labelled wishful thinking. The Optimal Speed of Transition: a General Equilibrium Analysis by M. Castanheira (IGIER and CEPR) and G. Roland (ECARES and CEPR) forthcoming in International Economic Review Castanheira
and Roland present a benchmark model for the optimal speed of transition
from a state-owned to a private market economy, based on the
consumption-savings decision in a closed economy. They abstract from
frictions to focus first on the macroeconomic conditions for accumulation
of private capital and restructuring of state-owned enterprises. Second,
they analyse how government intervention can improve or worsen transition.
They show that hardening firms' budget constraints compensates for too
slow speed of enterprise closure by the government. By contrast, an excess
speed of closure may lead to a slower transition because of contractionary
effects of output. This will especially be the case when the government
closes more enterprises at early stages of transition. Political Economics and Public Finance by T. Persson (IIES and CEPR) and G. Tabellini (IGIER and CEPR) in
preparation, to be published as a chapter of the Handbook of Public
Finance, Fiscal policy varies greatly across time and countries. In this survey the authors use economic analysis to contrast alternative collective choice procedures. The unifying theme of this line of research is that public policy is the equilibrium outcome of an explicit and detailed political process. Several common themes can be brought to the attention. Firstly, that observed economic policies are shaped by a redistributive conflict. Secondly, that political institutions generally do not deliver efficient policy outcomes, because there is a fundamental agency problem in representative democracy. A third common theme is the pervasiveness of the so called ‘common pool’ problem: concentration of benefits and dispersion of costs can distort individual incentives and lead to suboptimal equilibrium outcomes, with large government spending or distorted patterns allocative patterns. Lobbying and Legislative Bargaining by T Persson (IIES and CEPR) and E Helpman (Tel-Aviv University, the Sapir Center and CEPR) This
paper studies how economic policies depend on the political system, and looks at
a hitherto unexplored issue, namely how the activities of interest groups
interact with the bargaining over economic legislation in different kinds of
legislatures. The paper demonstrates within a game-theoretic framework that
lobbying tends to promote redistribution towards minorities within congressional
regimes, but redistribution towards majorities in parliamentary regimes. The Economics of Career Concerns, Part I: Comparing Information Structures by Mathias Dewatripont (ECARES and CEPR), Ian Jewitt (University of Bristol and CEPR) and Jean Tirole (IDEI and CEPR) forthcoming, Review of Economic Studies This
paper provides a general framework for the study of implicit (career concerns)
incentives in a multitasking environment. It applies this framework to
government agencies and shows that incentives are impaired by the agency
pursuing multiple missions. The lack of focus is even more problematic in the
case of fuzzy missions. The paper further shows that agencies pursuing multiple
missions should receive less autonomy, that professionalization creates a sense
of mission in an agency, and that the specialization of officials raises their
incentives. Party Governance and Ideological Bias by Jean Tirole (IDEI and CEPR) and Bernard Caillaud (CERAS and CEPR) Informed opinions are essential to a good functioning of democratic institutions. Political intermediaries, such as parties, make up the free riding voters' informational deficit. Public opinion and voting outcomes are shaped by those parties whom the voters trust. The
credibility of parties is fashioned by their internal organization. The paper
investigates one aspect of party governance, namely the allocation of control
rights over platform design. The party's leadership either selects a platform,
or simply recommends a platform for adoption by the rank-and-file. Under the
latter (democratic) institution, the leadership has no formal authority, but for
informational and procedural reasons may still have substantial real control
over the final platform, depending on the congruence between leadership and
rank-and-file. In particular, the rank-and-file is generally more concerned with
the ideological content of the platform than the leadership, who is motivated by
the benefits from electoral office. The paper argues that in centrist parties,
the high congruence of interest between the rank-and-file and office seekers
leads to systematic rubberstamping of the leadership's electoral platforms; the
resulting weak internal control mechanism hurts party credibility. Unemployment vs. Mismatch of Talents by Fabrizio Zilibotti (IIES and CEPR) and Ramon Marimon, (EUI Florence and CEPR), Economic Journal, April 1999 We
develop an equilibrium search-matching model with risk-neutral agents and
two-sided ex-ante heterogeneity.
Unemployment insurance has the standard effect of reducing employment, but also
helps workers to get a suitable job.
We show, through calibrations, how the mere difference on unemployment
insurance, when countries experience a common skilled-biased technological
shock, may result in differences in unemployment, productivity growth and wage
inequality. These results are consistent with the contrasting performance of the
labour market in Europe and the United States in the last twenty-five years. The
model is used to address some political economy issues. Information Accumulation in Development by Daron Acemoglu (MIT and CEPR) and Fabrizio Zilibotti (IIES and CEPR) Accepted for publication in the Journal of Economic Growth. This paper proposes a theoretical framework where economic relations and institutions are both related to the availability information. Specifically, the lack of information in less developed economies makes it hard to evaluate the performance of managers, and this leads to high ‘agency costs’ and low productivity.
by Daniel Gros (CEPS), Olivier Blanchard (MIT), Michael Emerson (CEPS and LSE), Thomas Mayer (Goldman Sachs), Gilles Saint-Paul (Universitat Pompeu Fabra), Hans-Werner Sinn (University of Munich), Guido Tabellini (IGIER and CEPR) This is the first Annual Report of the CEPS Macroeconomic Policy Group. The aim of this report is to carry out independent, in-depth research on current developments in the European economy. With a firm grasp of both strategic priorities and institutional mechanism this report wants to contribute to the growing debate about macroeconomic policy under EMU.
Other related publications from the network... Oligarchy, democracy, inequality and growth by Francois Bourguignon (DELTA) and Thierry Verdier (DELTA and CEPR) forthcoming in Journal of Development Economics This
paper analyses the dynamics of inequality, democratization and economic
development in a political economy model of growth where education is both the
engine of growth and a determinant of political participation. In a context with
imperfect capital markets, we investigate the incentives for an educated
oligarchy to subsidize the poor's education and to initiate a democratic
transition. We characterize, according to the initial income and inequalities,
the equilibrium patterns of political institutions, income distribution and
growth. In particular, we identify circumstances under which the Elite promotes
the endogenous emergence of a middle class for purely political economy reasons.
The model is then extended to a simple linear infinite horizon framework. In
such a setting, we discuss the importance of historical dependency for long run
social stratification and redistribution and give the conditions for the
existence of a ‘political Kuznets’ curve in the dynamics of inequalities. A Small Open Economy Model with Transaction Costs in Foreign Capital by Vanghelis Vassilatos (IMOP) and Tryphon Kollintzas (IMOP and CEPR) This paper develops a stochastic dynamic general equilibrium model for a small open economy in the real business cycle modelling tradition. Household preferences depend on private and public consumption and leisure. Production technology depends on public capital. Government finances its investment, consumption and transfer payments by means of a proportional income tax rate. Households buy and sell foreign assets in an international capital market with transaction costs and also receive transfer payments from abroad. Vassilatos and Kollintzas calibrate the model for the Greek economy. The volatility, persistence, and co-movement properties of the business cycle component of the data generated by the model are broadly consistent with the actual behaviour of the corresponding actual data. The authors use the model to investigate the response of major macroeconomic variables to temporary and permanent changes in government policy variables, foreign transfers, and the rate on return of foreign assets. They find that increasing government consumption and domestic transfers financed through distorting taxation lowers capital, labour (in most cases) and output while it increases foreign asset holdings, both in the short and the long run. Increasing government investment financed by distorting taxation eventually increases capital and output and decreases labour. Finally transfers from abroad decrease capital, labour and output, while they increase consumption.
by Konstantinos Gatsios (Athens University of Economics and Business, CEPR and IMOΠ), Panos Hatzipanayotou (Aristotelian University of Thessaloniki and IMOΠ), and Michael S. Michael (University of Cyprus and IMOΠ) Athens University of Economics & Business Discussion Paper No 86, May 1997. Forthcoming in: Faini, R., J. de Melo, and K. Zimmerman (eds.), Trade and Factor Mobility, CEPR and Cambridge University Press. The purpose of the paper is to examine the effects of free trade (e.g. lower import restrictions) on international migration, in light of some ‘public finance’ aspects of international labour movements. To this end, they construct a general equilibrium trade model of a small labour-exporting or labour-importing country with two private traded goods and a public consumption good. It is assumed that international labour mobility is perfect, and tariffs or quantitative import constraints restrict international goods trade. Within this framework, they determine conditions under which trade liberalization is likely to cause emigration and to reduce the level of public good provision .
by Konstantinos Gatsios (Athens University of Economics and Business, CEPR and IMOΠ), Panos Hatzipanayotou (Aristotelian University of Thessaloniki and IMOΠ), and Michael S. Michael (University of Cyprus and IMOΠ). Athens University of Economics & Business Discussion Paper No 87, July 1997. In this paper the researchers build a general equilibrium trade model of a small open economy with international labour flows, producing one exported, one imported and a non-traded public consumption good. Within this framework, they examine the effect of trade liberalization, through the reduction on the traffic rate, on domestic employment and public good provision when the government finances the provision of public good using (i) only income tax revenue, (ii) only tariff revenue, and (iii) tariff and income tax revenue. They show that trade liberalization could lead to lower employment through emigration, and lower public good provision.
by Tryphon Kollintzas (Athens University of Economics and Business, CEPR and IMOΠ) and Vanghelis Vassilatos (IMOΠ). Athens University of Economics & Business Discussion Paper No 89, August 1997. Forthcoming in European Economic Review. This paper develops a stochastic dynamic general equilibrium for a small open economy in the real business modeling tradition. Household preferences depend on private and public consumption and leisure. Production technology depends on public capital. Government finances its investment, consumption and transfer payments by means of a proportional income tax rate. Households buy and sell foreign assets in an international capital market with transaction costs and also receive transfer payments from abroad. They calibrate the model for the Greek economy. The volatility, persistence and co-movement properties of the business cycle component of the data. They use the model to investigate the response of major macroeconomic variables to temporary and permanent changes in government policy variables, foreign transfers and the rate of return of foreign assets. They find that increasing government consumption and domestic transfers financed through holdings, both in the short and the long run. Increasing government investment financed by distorting taxation eventually increases capital and output and decreases labour. Finally, transfers from abroad decrease capital, labour and output, while they increase consumption.
Separation of Regulators against Collusive Behaviour by Jean Jacques Laffont (IDEI) and David Martimort (IDEI and CEPR) forthcoming, Rand Journal of Economics This paper proposes a theory of the separation of powers among government bodies based on its benefits in preventing regulatory capture. Information of regulators gives them discretion and power. Splitting the information among competing regulators reduces their power and reduces the threat of capture. The paper also addresses the distributive and allocative consequences of this institutional choice.
by Jean-Jacques Laffont (IDEI) and David Martimort (IDEI and CEPR) 1997, mimeo IDEI This paper continues the line of research pursued in paper 26 by applying their previous framework to the case of multiple interest groups. Designing precise responsibilities for the different agencies when dealing with only one interest group each may hinder the co-ordination of the interest groups. This raises social welfare.
by Laura Bottazzi (IGIER and CEPR) and Paolo Manasse (IGIER) The
delegation of monetary policy to a supranational bank creates a conflict of
interest between residents of different countries. For example, the country in
recession may favour more inflation to boost output, while the country in boom
prefers exactly the opposite. This conflict gives rise to an adverse selection
problem. Provided each government has private information about the current
state of the economy, it may try to exploit it in order to shift the common
monetary policy to his own preferred way. The paper shows that problems of this
kind can generate both an inflation and primary deficit bias (in line with the
worries of Workers’ Europe addressed by the ‘stability pact’) as well as
an excess monetary discipline and recession bias (in line with the worries
addressed by the Bankers’ Europe concern). When information problems are
particularly severe, monetary and fiscal policy becomes relatively insensitive
to business cycle conditions, and too little ‘smoothing’ is done over the
business cycle. Workers’ versus Bankers’ Europe (II): Policy Externalities and Credibility in EMU by Laura Bottazzi (IGIER and CEPR) and Paolo Manasse (IGIER) In this paper we analyze how the creation of a single currency regime changes the strategic relationship between policy makers, both within and across countries. In particular, we look at the role of cross-country externalities and lack of commitment. When labour taxation is excessive, due to terms of trade externalities, the ECB may be tempted to raise inflation above the flexible exchange rate equilibrium in order to induce governments to substitute seignorage for income taxes. Therefore the equilibrium rate of inflation in EMU typically exceed the flexible exchange rate level. When the ECB cannot credibly commit to inflation, multiple equilibria may arise, where inflation is excessive and labour taxes too low (Workers’ Europe), or viceversa, where taxation is excessive and inflation too low (Bankers’ Europe). Finally, if the ECB cannot commit to a fixed scheme for redistributing seignorage, the outcome is excess inflation and suboptimal taxation. Both governments anticipate that the ECB will redistribute seignorage in favour of the country with lower tax revenue, and tend to lower tax rates accordingly.
by Eliana la Ferrara (IGIER) and Alberto Alesina (Harvard University and CEPR) NBER Working Paper n. 7155, resubmitted to Quarterly Journal of Economics This paper studies both theoretically and empirically the determinants of group formation and of the degree of participation when the population is heterogeneous, both in terms of income and race or ethnicity. The authors are especially interested in whether and how much the degree of heterogeneity in communities influences the amount of participation in different types of groups. Using survey data on group membership and data on US localities, Alesina and La Ferrara find that, after controlling for many individual characteristics, participation in social activities is significatively lower in more unequal and in more racially or ethnically fragmented localities. They also find that those individuals who express views against racial mixing are less prone to participate in groups the more racially heterogeneous their community is.
by Roland Bénabou (IDEI and CEPR) He
proposes a theory of inequality and the social contract which explains how
countries with similar preferences and technologies, and equally democratic
institutions, can nonetheless sustain such different systems of social
insurance, fiscal redistribution and education finance as those of the United
States and Western Europe. With imperfect credit and insurance markets some
redistributive policies have a positive effect on ex-ante welfare, and this
implies a political support which decrease
with inequality, at least over some range. Conversely, with capital market
imperfections lower redistribution translates into more persistent inequality.
Hence the potential for multiple
steady-states, with mutually reinforcing high inequality and low
redistribution, or vice-versa. Social Mobility and the Demand for redistribution: the POUM Hypothesis by Roland Benabou (IDEI and CEPR) and Efe A. Ok (New-York University) Even people with below average income will not support high rates of redistribution, because of the prospect of upward mobility: they take into account the fact that they, or their children, may move up in the income distribution, and therefore be hurt by high tax rates. This ‘intuitive’ hypothesis is commonly advanced as part of the explanation for why democracies, where a relatively poor majority holds the political power, do not engage in large-scale expropriation and redistribution. But does it make sense, or does it require that some of the poor overemphasize the prospects of good outcomes relative to bad ones, due either to irrationally optimistic expectations or to a form of risk-loving? A key premise is that some individuals or families who are currently poorer than average – for instance, the median voter- expect to become richer than average. This ‘optimistic’ view clearly cannot be true for everyone. But is it possible for, say, a majority of the population to be simultaneously poorer than average in terms of current income, yet richer than average in terms of expected future income – especially when the income distribution is invariant over time? This paper establishes the formal basis for the ‘prospect of upward mobility’ (POUM) hypothesis concerning the political economy of redistribution. The key to the puzzle is surprisingly simple. The authors show that there exists a range of incomes below the mean where agents oppose lasting redistributions if (and, in a sense, only if) tomorrow's expected income is an increasing and concave function of today's income. Convergence of individual incomes to a common limiting distribution is not sufficient. The coalition in favor of laissez-faire is larger, the more concave the transition function, the longer the duration of the proposed tax scheme, and the more farsighted the voters. The authors construct an example where, in steady-state, three quarters of families have less than mean income, so that they would support contemporary redistributions. Yet, a two-thirds majority has expected future incomes above the mean, and will therefore vote down (or seek to prevent constitutionally) redistributive policies which impose high tax rates on their descendants. A calibrated version of this simple model matches the main features of the US income distribution and intergenerational persistence quite well. They also analyze empirical mobility matrices from the PSID to determine whether the POUM effect is present in the actual data. The proportion of agents who have expected future incomes above the mean is found to rise with the length of the forecast horizon, in conformity with the theory. Over a horizon of about twenty years, it reaches a strict majority. At the same time, the prospect of upward mobility effect is subject to limitations, which they also analyze. In particular, there must be sufficient inertia or commitment power in the choice of fiscal policy or institutions, and voters' risk-aversion must not be too large compared to the curvature of the transition function.
by Micael Castanheria (IGIER and CEPR) IGIER Working Paper No. 125, 1998 Voting Theory generally concludes that – in first-past-the-post elections – 1) All voters should go to effective candidates (Duverger's Law); 2) Parties' platform should converge (Median Voter Theorem). Observations, though, suggest that such predictions are not met in practice. The paper shows that divergence and dispersion of votes is a natural election outcome when there is uncertainty and repetition of elections. ‘Voting for Losers’ increases the informational content of elections, and forces main parties to relocate towards extremists. As a result, they maximise their probability of being elected, not by converging to the median but by diverging to a certain extent. Ideological behaviour results then from optimising considerations alone.
Should I Stay or Should I Go? Poisson Games and the Paradox of Voting by M. Castanheria (IGIER and CEPR), mimeo, 1998 Why do people vote? This question has received a lot of attention for more than thirty years and is still unresolved. Neither theory nor empirical work has been able to disentangle ‘instrumental’ motivations from other (psychological, moral, etc...) factors. This paper tries to push the idea of voting as a purely rational act as far as possible, by studying closely the importance of each assumption in the model that is generally used to explain voting. We show which of these assumptions are unreasonable and that, once they are discarded and replaced with more micro-founded ones, several supposedly ‘unexplainable'’ observations turn out to actually fit the model quite well.
by Michele Polo (IGIER),mimeo, 1998 We consider a probabilistic voting model in which candidates compete for the office offering electoral platforms specifying a tax rate and the supply of a public good, without imposing a balanced budget constraint. Hence political rents can arise if the tax revenue is higher than the cost of the public good. We find that the nature of competition is deeply influenced by the kind of uncertainty of the candidates on voters' preferences. Voters are heterogeneous in their evaluation of each candidate's platform, with a common bias that shifts the mean of their distribution. If the candidates observe these biases, they know which is the median platform and competition is à la Bertrand, entailing rent dissipation. If, however, candidates are uncertain on which is the bias of the population of voters, i.e. they don't know which is the median platform, competition is relaxed and positive rents emerge in equilibrium.
by Jacques Crémer (IDEI and CEPR) and Thomas Palfrey (California Institute of Technology) This paper proposes a new framework for studying federal mandates regarding public policies in areas such as environmental quality, public health, highway safety, and the provision of local public goods. Voters have single-peaked preferences along a single policy dimension. There are two levels of government, federal and local. The federal level can constrain local policy by mandating a minimum (or maximum) policy. Localities are free to adopt any policy satisfying the constraint imposed by the federal mandate. The authors generalize the model to allow for the possibility that federal provision of the public provided good may be more efficient than local provision. They establish existence of and study the efficiency properties of majority rule equilibrium.
by Alfredo Baldini (DELTA) In parliamentary democracies, fiscal policies may be threatened by the unexpected termination of government tenure or by budget amendment procedures. Our model implies that electoral rule and the type of the budgetary process help explain some of the striking differences observed in public finance and government stability in post-war democratic countries. We provide new evidence for 17 OECD countries during the post-war period: in multi-party governments, economic variables that create redistributive effects are harmful for government tenures while economic growth and weak budgetary procedures are beneficial for government tenures.
by Alfredo Baldini (DELTA) The paper analyses the time default of governments in 17 parliamentary democracies over the period 1945 to 1990. The dataset is new and consists of various time-varying economic variables and indicators of legislative structures drawn by different sources and specifically adapted for the duration analysis. This study tests if legislative structures and the randomness of the economic environment affect life of governments and the electoral renewal for the incumbents. Legislative structures with strong parties provide a more stable political environment. The increasing survival probability of the incumbent over time gives robust evidence of incumbent advantage. Inflation and real exchange depreciation significantly increase the probability of leaving office. Economic growth increases the survival probability of policymakers.
by Thierry Verdier (DELTA and CEPR) This paper surveys the literature on political economy if growth and inequality. It reviews the recent results and discuss potential avenues for future research. After presenting into an integrated framework, the basic elements of a model of political economy of growth, the paper considers the key questions and issues of this approach. Then it focuses on one particular aspect recently explored by the literature: the issue of endogenous political participation and the relationships between political transition (democratization) and economic growth. Finally the paper discusses two potential lines for future research. First, integrating growth and political transition into open economy contexts and second, extensions of the basic framework of political economy of growth to analyze the dynamics of the process of regional or national integration and disintegration.
by Alberto Bisin (NYU) and Thierry Verdier (DELTA and CEPR) In this paper we present a model of cultural transmission of preferences on goods some of which being provided publicly through simple majority voting. We emphasize the existence of a two way causality between socialization decisions and political outcomes. This generates the possibility of indeterminacies and multiple self fulfilling equilibrium paths in cultural change and politics.We provide then a rationale for ideologies and collective socialization institutions as coordination mechanisms allowing cultural groups to preserve or shift political power in favour of their preference profile in the long run.
by T. Boeri (IGIER and CEPR) and M. Pellizzari (Bocconi University) mimeo, 1998 This paper investigates how the structure and incentives of Italian non-employment benefits will change after the introduction of a means-tested social assistance scheme of the last resort, such as the ‘reddito minimo d’inserimento’ (RMI), currently being run on an experimental basis in a few municipalities, mainly in the southern part of Italy. This new cash transfer mechanism will modify the Italian unemployment benefit system introducing a third level of benefits after the Cassa Integrazione- Liste di Mobilità and the ‘ordinary’ unemployment benefits. The disincentives to work for the unemployed are analysed by relating the amount of transfers in each program to the potential income from work of persons with characteristics like those of the person whose income is below that established for access to social assistance. The analysis suggests that this new scheme should be carefully designed (e.g., with an appropriate system of earning disregards) in order to avoid unemployment and poverty traps. It is also argued in the paper that the RMI could affect the distribution of unemployment across households increasing the polarisation of employment and unemployment. A positive correlation between the relevance of means-tested cash transfers and polarisation of unemployment is indeed observed across countries.
by E. Frontini (Bocconi University) and G. Tabellini (IGIER and CEPR) mimeo, 1998 During the 90's some European countries have introduced important changes in the protection systems for unemployed income. Which lessons could be taken from these experiences? Which are the more effective reforms? Which problems remain unsolved? These are the main questions faced in the paper. At present, it seems evident that these questions are of extreme significance in Italy, where there is no effective and comprehensive protection system of unemployed income. In order to learn from different experiences of countries similar to Italy, the authors have carefully analysed the experience of six European countries: Denmark, France, The Netherlands, United Kingdom, Spain and Sweden.
by Anouk Riviere (ECARES) This paper studies the number of candidates, their ideology and the policy outcome, in a citizen candidate model with uncertainty and endogenous formation of parties. In a simple citizen candidate model without parties, each ideology is represented by a candidate if the cost of candidacy is sufficiently low. There are fewer candidates if this cost is higher. If, in order to share the cost of candidacy, citizens are allowed to create and become members of parties before the candidacy stage, results are different. Surprisingly, with a coalition-proofness refinement, under reasonable assumptions, all ideological groups are not represented: there are generally two candidates, a centrist and an extremist. The centrist citizens form a party whose size is chosen strategically: it is large enough to finance its president against one extremist, but not against two. And extremists prefer not to be represented rather than not to have a centrist candidate. Therefore, the paper proposes an alternative explanation for Duverger’s law: the two party system can be a result of the party formation process.
by John Hassler (IIES) and José Vicente Rodríguez Mora (UPF Barcelona) preliminarily accepted for publication by the Journal of Public Economics. This paper is based on a search model of the labour market. The paper shows that low labour market turnover (as in Europe) leads to high political pressure for generous unemployment insurance, whereas high turnover (as in the US) leads to low political demand for public assistance.
by John Hassler, José Vicente Rodríguez Mora, Kjetil Storesletten and Fabrizio Zilibotti (all IIES) This paper is a more ambitious attempt to explain the observed differences between Europe and the US. This preliminary paper shows how essentially identical economies can end up in either of two very different equilibria, one with high endogenous unemployment insurance, unemployment and low turnover and one where the opposite is true.
by Per Petterson (IIES) This paper reports on empirical work on the so called strategic debt hypothesis, using a panel data set for 275 Swedish municipalities, which makes it possible to hold constant a number of institutional factors (unlike earlier studies based on cross-country data). The paper finds strong support for incumbents choosing budget deficits so as influence the spending decisions by succeeding governments. Specifically, right–wing governments who anticipate a greater likelihood of electoral defeat run larger deficits, whereas left-wing governments run smaller deficits, as one version of the theory predicts.
by David Strömberg (IIES and CEPR) Academic research of mass media's role in politics has mainly been empirical and concerned with the effects on voting intentions and public opinions. In this paper Strömberg presents a model where mass media has an effect on public policy without changing either voting intentions or public opinion. Economic incentives force mass media to provide less news to small groups of voters-because of increasing returns to scale- and voters who are not valuable to advertisers. This news bias translates into a bias in public policy, since mass media is the channel that conveys campaign promises to the electorate. The model is used to analyze the effects of a decline in newspapers and the rise of broadcast media as the main information source in the society: this change increases the proportion of rural, low-income and low-education media consumers, and should thus be accompanied by an expansion in programs that benefit these groups. The model predicts further that spending on services used by poor groups will increase when a duopolistic newspaper market becomes a monopoly, since a monopolistic newspaper will attempt to expand its customer base, poorer on average, rather than competing over existing readers. Partial empirical evidence in support of the predictions is presented.
by David Strömberg (IIES and CEPR) In this paper Strömberg tests the related hypothesis that voters who use mass media more receive more redistributive transfers. The paper successfully explains the allocation of money across US counties in large federal New Deal programs in the 1930s, a period where the use of radios was very unevenly distributed over the country. Controlling for a large number of variables, the study shows that counties where the population had better access to radios indeed received significantly more money; furthermore, the channel of influence appears largely to have run through higher electoral turnout.
by Gilles Saint-Paul (Universitat Pompeu Fabra and CEPR) Saint-Paul constructs a model in which government debt, while deterring capital accumulation, may at the same time positively affect the efficiency of capital because it affects the efficiency of the financial sector. By increasing private wealth, public debt can make it easier for entrepreneurs and firms to borrow because it can be used as collateral. This is analyzed in the context of an overlapping generations model where financial contracts involve costly state verification, so that collateral then reduces the severity of the financial problem by lowering the amount of resources spent on monitoring. The overall effect of debt on output is the net of two contributions: on the one hand capital accumulation is directly reduced, on the other hand, this capital is better allocated as less resources are spent on monitoring. The latter effect declines however as debt increases, because private wealth increases with debt, which reduces the severity of the monitoring problem; thus at high levels of debt, the first effect is bound to dominate. Finally, faster growth eases the tax burden required to maintain a constant debt GDP ratio, which in turn increases the collateral of entrepreneurs, thus improving the financial sector and further increasing growth. This may potentially generate multiple equilibrium growth paths.
by Tryphon Kollintzas (IMOP and CEPR) This paper studies the conduct of optimal fiscal policy in an economic union from a positive and a normative perspective. The author proves existence and characterizes both the qualitative and quantitative properties of equilibria in a multi-stage dynamic game, where national governments follow time-consistent Ramsey policies vis-à-vis the private sectors, and at the same time they either cooperate or play Nash vis-à-vis each other. Cooperation takes place either at an intergovernmental level or at a supra- national level .
by George Alogoskoufis (IMOP and CEPR) Greece is not going to enter the EMU automatically once she has satisfied the deficit and inflation criteria. She will enter after being judged on all of the criteria, and possibly on the essence of the facts she presents to the proper services of the E.U. These facts have neither been sufficiently examined, nor are they especially reliable. What is of first importance now for Greece is to set out her priorities, in a way to insure participation even on the second wave. The nominative convocation demands a quicker and more direct fiscal adjustment, emphasizing the reduction of public consumption expenditures. The deficit’s reduction policy needs to be based exclusively on the reduction of current public expenditure, for two years, on the avoidance of anti-growth choices such as the increase of taxation, but also on the brave adoption of growth policies, as for example the privatization and the opening of the markets. Privatization is especially important as far as the banking system is concerned, where the introduction of the euro demands a dramatic improvement of the Greek banks’ competitiveness. If the big public banks are not privatized as well, the Greek banking system will be significantly shrunk and will remain bringing up the rear in the European developments. The opening of the labour market is of great importance for the competitiveness. This is imperative, in order to help the businesses grow, especially the minor ones. Once the euro is introduced, there will no longer be possibilities of improving the competitiveness through devaluation and because of that the flexibility of the labour market becomes more important for the increase of unemployment to be avoided.
by F. Collard and Tryphon Kollintzas (IMOP and CEPR) In this paper the authors look at the behaviour of physical depreciation over the business cycle. They do so within the context of a real business cycle model where the decisions of firms about physical capital utilization, maintenance, improvement and scrapping are endogenous. The model encompasses the baseline real business cycle model, where the depreciation rate (δ) is fixed. It also encompasses a version of the Greenwood, Hercowitz and Huffman [1998] model of endogenous physical capital utilization, while it shares features with the Burnside, Eichenbaum and Rebelo [1993] variable work effort model. Thus, it is capable of providing a unified explanation of several stylized facts of business cycle behaviour, including a low correlation between labour productivity and output. Making the business cycle propagation richer, reduces the variance of the Solow residual needed to match output volatility. It supports the Feldstein and Rotschild [1974] view on the non-constancy of δ.
by David Martimort (IDEI and CEPR) forthcoming, Review of Economic Studies This paper provides a dynamic theory of capture explaining why agencies become more bureaucratized over time. This theory also provides foundations for the endogeneity of transaction costs in side contracting. Therefore, it explains how institutional design helps to hinder regulatory capture.
by David Martimort (IDEI and CEPR) forthcoming, Journal of Economic Theory This paper investigates the raison d’être of multiple regulators, and explains this organizational choice as coming from the government’s limited ability to commit. The separation of powers between two regulators is modelled as a Stackelberg common agency game. With respect to the single regulator case, allocative efficiency and the regulated firm’s informational rent are both reduced in the unique equilibrium of this game. However, when regulators have a limited ability to commit to their regulatory contracts, this static cost of the separation of regulatory powers becomes a dynamic benefit. Separation of regulators hardens renegotiation and improves commitment.
by Elise S Brezis (Bar-Ilan University), Jacob Paroush (Bar-Ilan University) and Avi Weiss (Bar-Ilan University) .
by Elise S Brezis (Bar-Ilan University) and Adi Schnytzer (Bar-Ilan University)
by Elise S Brezis (Bar-Ilan University)
by Alex Cukierman (Tel-Aviv University) with Miller and Neyapti
by Alex Cukierman (Tel-Aviv University) and Yossi Spiegel (Tel Aviv University)
by Alex Cukierman (Tel-Aviv University) and Francesco Lippi (Banca d'Italia)
by David Genesove (Hebrew University of Jerusalem) and Mullin Wallace
by Mark Gradstein (Ben-Gurion University in the Negev)
by Mark Gradstein (Ben-Gurion University in the Negev) and Moshe Justman (Ben-Gurion University)
by Mark Gradstein (Ben-Gurion University in the Negev) and Moshe Justman (Ben-Gurion University)
by Mark Gradstein (Ben-Gurion University in the Negev) and Moshe Justman (Ben-Gurion University)
by Arye L Hillman, (Bar-Ilan University and CEPR) and Heinrich W. Ursprung (Universität Konstanz)
by Moshe Justman (Ben-Gurion University in the Negev)
by Moshe Justman (Ben-Gurion University in the Negev) with J. F. Thisse (Université Catholique de Louvain and CEPR)
by Oren Sussman (Ben-Gurion University in the Negev) with Joseph Zeira (The Hebrew University of Jerusalem and CEPR)
by Elisabetta Falcetti (LSE) and Alessandro Missale (IGIER and CEPR) This paper examines the interactions between monetary regimes and public debt management. The analysis shows that delegation of monetary policy to an independent central bank is more effective to contain inflationary expectations than foreign currency or price-indexed debt. If delegation of monetary policy is viable, conventional debt should be issued to absorb supply shocks. Implications for debt management change when a fixed exchange regime is considered: foreign currency debt tends to enhance the credibility of a peg. However, as such debt cannot completely avert the devaluation outcome, if a crisis nevertheless materializes, it would be worse than had foreign debt not been issued. New empirical evidence on the EMS experience appears to support this result. Probit estimates show that the decision to issue foreign currency debt significantly reduced the likelihood of an official realignment within the ERM. However, conditional on a crisis taking place, those countries that increased their share in foreign currency denominated debt experienced larger devaluation sizes.
by Paolo Manasse (IGIER) and Christian Schultz (University of Copenhagen) We study a model with free migration between a rich and a poor region. Since there is congestion, the rich region has an incentive to give the poor region a transfer in order to reduce immigration. Faced with free migration, the rich region voluntarily chooses a transfer, which turns out to be equal to that a social planner would choose. Provided migration occurs in equilibrium, this conclusion holds even in the presence of moderate mobility costs. However, large migration costs will lead to suboptimal transfers in the market solution.
by Eliana la Ferrara (IGIER) IGIER Working Paper n. 161 This paper studies the determinants of group membership, in particular income inequality, and the impact of heterogeneity on group functioning. The author presents a model in which heterogeneous individuals can choose to join a group which provides a nonrival, excludable good to its members. She derives predictions on the equilibrium composition of the group and on its size under different access rules. La Ferrara shows that an increase in income inequality has an ambiguous effect both on group composition and on aggregate levels of participation. The question is then taken to the data using a sample of rural households from Tanzania. The author finds that higher inequality at the village level has a negative impact on the likelihood that the respondents are members of any group. This effect is particularly significant for relatively wealthier people, both when relative wealth is `objectively' measured, and when it is `subjectively' defined. Group functioning in more unequal communities displays the following features: decisions are less likely to be taken by vote; members tend to sort into homogeneous income and ethnic groups; they more often report poor group performance and misuse of funds; they interact less frequently, and in general they feel less encouraged to participate.
by Francesco Daveri (IGIER) As the process to EMU reaches completion, it is often argued that a government of the Union should parallel the newly established European Central Bank. This is patently at odds with the actual attitudes of EU national governments, which appear highly resilient to transferring any type of fiscal sovereignty to the Union. This paper explores whether and how an EFU (European Fiscal Union) may take place, and evaluates its likely consequences in the G-4 European countries.
by Eliana La Ferrara (IGIER) and Robert H. Bates (Harvard University) This paper analyzes the behavior of two political rivals, who can be thought of as competing warlords. Each is endowed with valued regional or cultural attributes; both behave opportunistically and seek to amass private rents from political service. The authors focus on their use of military expenditure and public good provision in recruiting tax paying citizens into their rival political camps. From this analysis, they gain insights into the behavior of political elites and the patterns of political competition in weak states. They learn how, in competing for supporters, elites allocate resources between the provision of public goods and the use of political violence. Bates and La Ferrara investigate the political value of ethnic identity and into the links between ethnic identities and political violence. And they gain a deeper insight into the possibilities of peace keeping in weak states.
by Graziella Be rtocchi (Universitá di Modena and CEPR) and Michael Spagat (Royal Holloway College and CEPR)CEPR Discussion Paper No. 2156 Group 1 holds political power. Group 2 threatens this power. Group 1 decreases the upheaval probability by co-opting some agents from Group 2 into a more benign Group 3. Improvements in upheaval technology lead to less co-optation. Increasing the relative size of Group 1 implies larger co-optation payments to a smaller group, decreasing the total resources committed to co-optation. In an extension in which Group 3 also threatens Group 1, although less destructively than does Group 2, co-optation transfers are reduced. Growth causes political stabilization. The theory applies to the origin of the welfare state, post-communist privatization and other situations.
Tryphon Kollintzas (Foundation for Economic and Industrial Research and CEPR), Apostolis Philippopoulos (IMOP) and Vanghelis Vassilatos (IMOP) CEPR Discussion Paper No. 2212 This paper provides a coherent, logical framework that connects the main issues concerning fiscal policy in an economic and monetary union. The focus is on normative issues within the European Union.
by Isabelle Brocas (ECARES) and Juan Carillo (ECARES and CEPR) CEPR Discussion Paper No. 2213 We analyze the investment decision of a population of time inconsistent entrepreneurs who overweight current payoffs relative to future returns. We show that, in order to avoid inefficient procrastination, agents may find it optimal to keep optimistic priors about their chances of success and 'blindly invest'. This explains entrepreneurial boldness and entry mistakes (or an excessive level of investment in the economy) without assuming the existence of boundedly rational, 'intrinsically optimistic' managers. We also prove that: (i) there is a negative correlation between the risk free rate and theproportion of bold entrepreneurs in the economy, (ii) realist and bold agents can coexist and achieve the same payoff and (iii) entrepreneurs with highest ability are most likely to keep optimistic prospects and make entry mistakes.
by Isabelle Brocas (ECARES) and Juan Carillo (ECARES and CEPR) CEPR Discussion Paper No. 2237 We analyze the decision of individuals with time inconsistent preferences who undertake irreversible activities yielding either a current cost and a future benefit or a current benefit and a future cost. We first show that, when benefits come earlier than costs, the individual faces a coordination problem with himself that results in multiple, rankable equilibria. Some of these equilibria may exhibit rush, in the sense that the activity is undertaken 'too early' (i.e. with a negative payoff). Multiplicity explains why individuals succeed or not in avoiding temptations, depending on 'the degree of trust in their future decision'. Second, we prove that competition between agents for the same activity can be beneficial for them both when costs come before and after benefits: it decreases the agents' incentives to procrastinate (i.e. to undertake the activity 'too late') in the former case and to rush in the latter. Last, complementarity of tasks exacerbates the tendency to rush and to procrastinate. Under procrastination, it may even imply that projects which are valuable for all agents are never undertaken.
by Carlo Favero (IGIER), Francesco Giavazzi (IGIER, CEPR), Fabrizio Iacone (IGIER) and Guido Tabellini (IGIER), IGIER working paper n.113, 1997 forthcoming in European Economic Review,1999 This paper analyses how to extract market expectations from asset prices, with a particular example: using the term structure of interest rates to estimate the probability the market attaches to the event that a country, Italy, joins |