Welfare‐improving adverse selection in credit markets*

A model of simultaneous adverse selection and moral hazard in a competitive credit market is developed and used to show that aggregate borrower welfare may be higher in the combined case than in the moral‐hazard‐only case. Adverse selection can be welfare improving because in the pooling equilibrium of the combined model, high‐quality borrowers cross subsidize low‐quality borrowers. The cross subsidization reduces the overall moral hazard effort effects, and the resulting gain in welfare may more than offset the welfare loss stemming from distorted investment choices. The analysis focuses on pooling equilibria because model structure precludes separating equilibria.     

Welfare‐ and Revenue‐Enhancing Tariff and Tax Reform under Imperfect Competition

We examine welfare and revenue effects of tariff and tax reform in a country importing final and intermediate goods, both of which are produced under imperfect competition. We consider two reform strategies. First, lower the sum of a consumption tax and a tariff on the intermediate good, and leave the sum of the consumption tax and a tariff on the final good unchanged. Second, lower the former and change the latter to leave government revenue unchanged. We specify conditions under which each reform strategy raises welfare without decreasing government revenue.     

Coordinating Tariff Reduction and Domestic Tax Reform under Imperfect Competition*

A major constraint on trade liberalization in many countries is the prospective loss of government revenue. Recent results, however, have established a simple and appealing strategy for overcoming this difficulty, whilst still realizing the efficiency gains from liberalization, in small, competitive economies: combining tariff cuts with point‐for‐point increases in destination‐based consumption taxes unambiguously increases both national welfare and total government revenue. This note explores the implications of imperfect competition for this strategy. Examples are easily found in which this strategy unambiguously reduces domestic welfare.     

Welfare‐improving Coordinated Tariff and Sales Tax Reforms under Imperfect Competition

This paper studies the welfare effects of coordinated domestic sales tax reform associated with a reduction of the import tariff under imperfect competition. We set up a simple oligopoly trading model where domestic and exporting firms compete in the home market. We show that, if the initial levels of import tariff and sales tax are positive, there always exist welfare‐improving sales tax reforms. In some cases, a reduction of the sales tax accompanied by a reduction of the import tariff increases social welfare, whereas in other cases, raising the sales tax can increase social welfare.     

Welfare‐Worsening Aid Flows To Small Countries: The Role of Nontraded Goods

This paper presents the circumstances under which foreign aid can immiserize a small, tariff‐distorted economy, highlighting the role played by the nontraded sector in generating this outcome. An inflow of aid, provided in the form of an increase in the capital stock, can reduce real income of a small, tariff‐distorted economy if: (i) the inflow results in an increase in the price of the nontraded good and the nontraded good and imports are sufficiently strong complements in demand; or (ii) if the inflow leads to a reduction in the price of the nontraded good and the nontraded good and imports are substitutes in demand, provided the degree of substitutability is not too large.     

Strategic Cost Reduction and Cost Revelation

Strategic cost reduction requires cost transparency. When unilateral cost revelation is feasible, strategic cost reduction indeed arises as equilibrium. If it is not feasible, however, credible revelation has to be organized, possibly by a trade association. Then, firms face a prisoners' dilemma: in Cournot duopoly, cost revelation arises as an equilibrium, but hurts firms; in Bertrand duopoly, cost concealing is the equilibrium, while firms would be better off with cost revelation. Since cost revelation is socially desirable (undesirable) in Cournot (Bertrand) competition, it should be encouraged (discouraged).     

Self‐Fulfilling Early‐Contracting Rush*

In markets for entry‐level professionals, the insurance motive drives some participants to sign early contracts. The rush to early contracting can be self‐fulfilling, as both its effect on expectations about demand–supply balance in the subsequent spot market and the effect on it from changes in the demand–supply balance can be nonmonotone. Matching markets with more risk‐averse participants, a greater uncertainty regarding relative supply of positions, or a more polarized distribution of applicant qualities are more vulnerable to self‐fulfilling early‐contracting rushes. Employers can have a collective interest in preventing early offers to a few promising applicants from starting the rushes.     

THE BROTHER‐IN‐LAW EFFECT*

When a firm is forced to pay abnormally high wages, hiring transfers rents. This effectively endows the employer with the ability to grant favors, and he may wish to do so even at some cost to efficient production. We refer to this as the brother‐in‐law effect. This article analyzes its consequences. When the brother‐in‐law effect is due to unionization, decisions regarding both the number and type of workers employed could be inefficient; overemployment could obtain even relative to the workforce that would be employed without unionization. We also identify cases in which nepotism improves efficiency.     

Long‐run Specialization*

Constructing a dynamic Heckscher–Ohlin model, we examine long‐run specialization patterns in the presence of international technological differences. Even a slight difference in technology causes at least one country to specialize. Either the case of perfect specialization in both countries or the case of perfect specialization in one country and imperfect specialization in the other occurs, depending on the subjective discount rate, relative preference for two commodities, labor endowments, and technological conditions. A necessary and sufficient condition for each case to hold is provided. Structural differences between the Ricardian model and ours are also emphasized.     

Foreign Firms,Domestic Wages*

Three types of theories have been used to explain the wage premium in foreign firms: the theories of heterogeneous workers, heterogeneous learning, and heterogeneous firms. We set up a model that explicitly encompasses two of these theories, and that can illustrate the third. This unifying framework allows us to rigorously compare the predictions of the different theories. Thus, it is a useful tool for interpreting new and existing empirical evidence. We illustrate the usefulness of the model on matched employer?employee data, and we find considerable support for all three theories. In particular, the theory of heterogeneous workers can explain up to 75 percent of the premium.     

Multilateralism and Hub‐and‐Spoke Bilateralism*

This paper studies sequential negotiations of bilateral free‐trade agreements in an oligopoly model. The expansion of trading blocs through overlapping trade agreements allows the option of hub‐and‐spoke systems and achieves multilateral free trade as the equilibrium path, even if the expansion of trading blocs through the acceptance of new members is not feasible. The results suggest that free‐trade areas (FTAs) tend to expand more than customs unions (CUs). Lobbying by a producer can either promote or undermine the achievement of multilateral free trade through overlapping FTAs.     

ASSET‐BASED UNEMPLOYMENT INSURANCE*

This article studies a model of consumption, savings, and job search in which a borrowing constraint limits self‐insurance. The government administers the unemployment insurance program that may condition on an individual’s asset position, but not on her efforts of finding a job. To compensate for the impediments to self‐insurance, benefit payments should optimally be set higher at lower wealth levels and peak for borrowing‐constrained individuals with zero liquid funds. A quantitative exercise reveals that the U.S. unemployment insurance program is surprisingly close to optimal for the asset poor, but far too generous for wealthier individuals.     

COMPETITION‐ACCELERATING PUBLIC INVESTMENTS*

We investigate the effects of infrastructure investments that reduce transport costs. We use a spatial model of Salop (1979). It is well known that the number of firms is excessive at free‐entry equilibrium (excess entry theorem). We find that the optimal investment level exceeds the ex post cost‐minimising level because investments accelerate competition and reduce the number of entering firms; resulting in the improvement of welfare. We also show that, in cases where the excess‐entry theorem is true, the desirable policy is the one accelerating, rather than restricting, competition.     

Low‐inflation Targeting and Long‐run Unemployment*

The model of Akerlof, Dickens and Perry (2000) (ADP) predicts that low inflation may cause unemployment to persist at high levels. When applied to U.S. data, their results strongly rejected the conventional NAIRU model. We apply the ADP model to Swedish data. The fact that our Swedish data also reject the NAIRU model has a number of interesting implications for the Swedish economy and, potentially, for other European countries as well. The results indicate that raising the Swedish inflation target from 2 to 4 percent would bring long‐run unemployment down by several percentage points. The possibility of ADP‐type long‐run Phillips curves also across the euro countries may raise some concern about the EMU project. While detailed studies on other countries are needed, there is nothing to suggest that these non‐vertical Phillips curves would not differ considerably across the euro countries. Any single inflation level targeted by the ECB would then generate excess unemployment in individual member states.     

LACK‐OF‐RECALL AND CENTRALIZED MONETARY TRADE*

We introduce lack‐of‐recall of past transactions as an alternative assumption to anonymity in a model where trade is centralized. In environments where there is an intertemporal lack‐of‐double‐coincidence of wants problem and lack‐of‐commitment, lack‐of‐recall can give rise to monetary equilibria that dominate nonmonetary outcomes in terms of welfare.     

Dynamic Multi‐Activity Contests*

We develop a model of dynamic multi‐activity contests. Players simultaneously choose efforts in long‐run activities, observe each other's efforts in these activities, and then simultaneously choose efforts in short‐run activities. A player's long‐run and short‐run efforts complement each other in determining the player's probability of winning. We compare the outcomes of this two‐stage model to those of the corresponding model in which players choose efforts in all activities simultaneously. Interestingly, effort expenditures are always lower in the sequential multi‐activity contest than in the simultaneous multi‐activity contest. The implications of this result for the organization of military, litigation, innovation, academic, and sporting contests are highlighted.     

TURNPIKE PROPERTIES OF A MONEY‐IN‐THE‐UTILITY‐FUNCTION MODEL*

This study establishes the global stability of a long‐run stationary state in a money‐in‐the‐utility‐function model. The major finding is that the constant money supply rule results in a stable allocation and price system if consumers discount their future utilities sufficiently weakly. Nominal and real interest rates will be in the neighbourhood of the inverse of the consumers’ discount factor β^‐1.