Dynamic stability and reform of political institutions

This paper examines endogenous institutional change in a class of dynamic political games. The political aggregation rules used at date t+1 are instrumental choices under rules at date t. Effectively, rules are “players” who can strategically delegate future policy-making authority to different rules. A political rule is stable if it selects itself. A reform occurs when an alternative rule is selected. The stability of a political rule is shown to depend on whether its choices are dynamically consistent. For instance, simple majority rules can be shown to be dynamically consistent in many common environments where wealth-weighted voting rules are not. The result extends to political rules that incorporate private activities such as extra-legal protests, threats, or private investment. The approach is one way of understanding various explanations of institutional change proposed in the literature. A parametric model of public goods provision gives an illustration.     

Equilibrium selection in common-value second-price auctions

This note considers equilibrium selection in common-value second-price auctions with two bidders. We show that for each ex post equilibrium in continuous and undominated strategies, a sequence of “almost common-value” auctions can be constructed such that each of them possesses a unique undominated and continuous equilibrium and the corresponding sequence of equilibria converges to that ex post equilibrium. As an implication, no equilibrium selection of this model based on perturbations seems to be more convincing than others.     

Von Neumann-Morgenstern solution social choice functions: An impossibility theorem

Recent literature has made significant progress in characterizing those social choice functions that can arise, or be “implemented,” as the equilibria of an underlying noncooperative game. This paper studies the implementability of social choice functions via cooperative games. Specifically, we show that if a social choice function arises, in each environment, as a Von Neumann-Morgenstern solution of an underlying cooperative game, whose dominance structure is monotonic and neutral, then the social choice function is essentially oligarchic, in exactly the same sense that “core” selecting choice functions are oligarchic.     

Toward Reasonable Capitalism: The Role of John R. Commons’s Price and Business Cycle Theories

Abstract

John R. Commons thought that prices should be stable and that the law of supply and demand should be controlled by the power of the state through patent law and by protecting bargaining equality. Commons also thought that prices should be stabilized by macro monetary policy. These means would allow the realization of a “reasonable price.” Commons called the objective and measurable value in money, which is determined by a court ruling, “reasonable value.” Analysis of Commons’s price and business cycle theories point toward the realization of both “reasonable price” and “reasonable value” and toward “reasonable capitalism” that can replace banker capitalism.     

Adam Smith's Entwurf eines politokonomischen systems

There are two core elements in Smith's draft of a politico-economic system, an individual-social orientated and a society-state orientated one. Economic actions and institutions have to bring both centres together so as to perform their main functions. Coming to self-autonomy, liberty and justice would be final goals of the Smithian “system of natural liberty”, for which Smith is famous. But he did not simply trust in self-fulfilling Natural Law. The “system of natural liberty” means a faculty, by which the society could develop, if the individual initiated actions might play their leading roles due to an ethical consensus in society, and if the state would be quite aware of his ordo-political task as a constructive matter. Smith gives no recipes. The generations have to find those for themselves. Thus, Smith cannot be called a determinist, but rather an evolutionist.The most exiting results can be found in a fundamental search for Smith as a master of politico-economical methods. The learned prejudice that the “grand classic” was somewhat eclectic and contradictious is to be forgotton. The master's “faults” might be analyzed as a genuine heterogeneous ones, essential for a realistic and pragmatic political economy. This would provide an urgent and modern message.     

The reasoning-based expected utility procedure

This paper presents a new iterative procedure for solving finite non-cooperative games, the reasoning-based expected utility procedure (RBEU), and compares this with existing iterative procedures. RBEU deletes more strategies than iterated deletion of strictly dominated strategies, while avoiding the conceptual problems associated with iterated deletion of weakly dominated strategies. It uses a sequence of “accumulation” and “deletion” operations to categorise strategies as permissible and impermissible; strategies may remain uncategorised when the procedure halts. RBEU and related “categorisation procedures” can be interpreted as tracking successive steps in players' own reasoning.     

Computation of search duration probabilities and the integral of the normal distribution function

The constraction of likelihood functions for data on individuals assumed to be sampling from a price distribution and operating a reservation price policy involves calculation of the probability that their duration of search exceeds, say, t periods, P( T > t). In this note we show how this calculation can be simply done by (a) working in continuous time, and (b) using a result on the integral of the Normal distribution function. We then use the result to study some properties of the model.     

Economic growth,corruption and tax evasion

In this paper, we explore tax revenues in a regime of widespread corruption in a growth model. We develop a Ramsey model of economic growth with a rival but non-excludable public good which is financed by taxes which can be evaded via corrupt tax inspectors. We prove that the relationship between the tax rate and tax collection, in a dynamic framework, is not unique, but is different depending on the relevance of the “shame effect”. We show that in all three cases — “low, middle and high shame” countries, the growth rate increases as the tax rate increases up to a threshold value, after which the growth rate begins to decrease as the tax rate increases. But, for intermediate tax rates, the rate of growth for “low shame” countries is lower than that of “uniform shame” countries which is, in turn, lower than that of “high shame” countries. This happens because the growth rate is more sensitive to variations of t in an honest country rather than in a corrupt country.     

Saddle points of Hamiltonian systems in convex Lagrange problems having a nonzero discount rate

Problems are studied in which an integral of the form ∫₀^+∞L(k(t),k(t))e^?ptdt is minimized over a class of arcs k: [0, +∞) → Rⁿ. It is assumed that L is a convex function on Rⁿ × Rⁿ and that the discount rate ? is positive. Optimality conditions are expressed in terms of a perturbed Hamiltonian differential system involving a Hamiltonian function H(k, q) which is concave in k and convex in q, but not necessarily differentiable. Conditions are given ensuring that, for ? sufficiently small, the system has a stationary point, in a neighborhood of which one has classical “saddle point” behavior. The optimal arcs of interest then correspond to the solutions of the system which tend to the stationary point as t → +∞. These results are motivated by questions in theoretical economics and extend previous work of the author for the case ? = 0. The case ? < 0 is also covered in part.     

A semiparametric approach to value-at-risk,expected shortfall and optimum asset allocation in stock–bond portfolios

This paper investigates stock–bond portfolios' tail risks such as value-at-risk (VaR) and expected shortfall (ES), and the way in which these measures have been affected by the global financial crisis. The semiparametric t-copulas adequately model stock–bond returns joint distributions of G7 countries and Australia. Empirical results show that the (negative) weak stock–bond returns dependence has increased significantly for seven countries after the crisis, except for Italy. However, both VaR and ES have increased for all eight countries. Before the crisis, the minimum portfolio VaR and ES were achieved at an interior solution only for the US, the UK, Australia, Canada and Italy. After the crisis, the corner solution was found for all eight countries. Evidence of “flight to quality” and “safety first” investor behaviour was strong, after the global financial crisis. The semiparametric t-copula adequately forecasts the outer-sample VaR. These findings have implications for global financial regulators and the Basel Committee, whose central focus is currently on increasing the capital requirements as a consequence of the recent global financial crisis.     

Optimal collusion-resistant mechanisms with verification

We present the first general positive result on the construction of collusion-resistant mechanisms, that is, mechanisms that guarantee dominant strategies even when agents can form arbitrary coalitions and exchange compensations (sometimes referred to as transferable utilities or side payments). This is a much stronger solution concept as compared to truthful or even group strategyproof mechanisms, and only impossibility results were known for this type of mechanisms in the “classical” model.We describe collusion-resistant mechanisms with verification that return optimal solutions for a wide class of mechanism design problems (which includes utilitarian ones as a special case). Note that every collusion-resistant mechanism without verification must have an unbounded approximation factor and, in general, optimal solutions cannot be obtained even if we content ourselves with truthful (“non-collusion-resistant”) mechanisms. All these results apply to problems that have been extensively studied in the algorithmic mechanism design literature like, for instance, task scheduling and inter-domain routing.     

Credible communication in dynastic government

This paper studies information disclosure in a model of dynastic government. When information about past policy choices comes exclusively from the reports of previous administrations, each administration has an incentive to choose its (suboptimal) one-shot expenditure policy, and then misrepresent its choice to its successor. Consequently, it has been suggested that “horizontal accountability,” i.e., a system of governance where auditing functions lie outside the executive branch, can ensure credible disclosure of a government's activities. This paper suggests a cautious approach to that view.The baseline model examines the reporting incentives of an external auditor who can independently verify the information each period. Even with auditing, credible disclosure is shown to be problematic. Various extensions to this baseline model are examined. In one extension, “liberal” (i.e., those prefering larger government expenditures) and “conservative” (those prefering smaller expenditures) regimes and auditors evolve over time. It is shown that “conservative” (“liberal”) auditors are not credible when the current regime is also “conservative” (“liberal”). Moreover, because information transmission stops when the auditor's and the regime's biases coincide, effective deterrents even in the “good” periods (when the auditor's and the administration's biases differ) are difficult to construct. In all periods the equilibrium requirement of auditor neutrality constrains the dynamic incentives for efficient policy choices. These constraints are shown to bind away from optimal policies in standard constructions of equilibrium. Various ways in which auditing protocols can overcome these problems are discussed.     

Optimal consumption and the timing of the resolution of uncertainty

As is well-known, consumers want to accumulate precautionary savings in the face of income risks when their marginal utility is convex (prudence). In this paper, we explore the effect of the timing of the resolution of income uncertainty on savings. An agent faces uncertainty about his income at date t+2. What is the effect of being informed that the uncertainty will be resolved at date t+1 on the consumption at date t? We show that the effect is positive, if and only if, marginal utility is convex (prudence), when either the risk free rate is equal to the rate of pure preference for the present, or when the utility function is HARA. The intuition is that an early resolution of uncertainty allows for time-diversifying the risk. It therefore plays a role similar to a reduction of the income risk, whose effect on savings is negative under prudence.     

The principle of political-economic assignment

This paper formulates a macroeconomic model of disposable income, unemployment, inflation, and the balance of payments; a theory of qualitative choice to explain government popularity in terms of these variables; and a satisficing formulation of political-economic policy. This approach to economic policy relies on the promotion of ideology and satisficing popularity and gives rise to an interdependent system of political-economic reaction functions for the tax rate and state spending. Using a theorem for the stability of “patched-up” systems, the principle of political-economic assignment is derived.     

Terrorism and the closure of society: A social-impact projection

A social-impact projection of terrorism in the United States is presented in the ligth of recent conceptual and methodological developments. The projections proper explore the effect of a terrorist climate on: demography,security, and the cost of living, letter and spirit of the law, paramilitary groups, and mental health. It is suggested that the most effective way of halting terrorism rests in the formula of “mass times velocity equals impact.” This entails a swift and massive application of force that leaves society vulnerable to militarization, the possibility of a “garrison state,” and an overall closure of society in general.     

Determinacy of Equilibrium in an Overlapping Generations Model with Heterogeneous Agents

We study the determinacy of perfect foresight equilibrium near a steady state in an overlapping generations model with production and both altruistic and non-altruistic agents having distinct utility functions. The proportion of each type of consumer is exogenously given. Our main results show that when there are positive stationary bequests, some standard assumptions on preferences and technology rule out local indeterminacy for any positive value of the proportions. In the particular case of a separable utility function for altruistic agents, we prove that the determinacy property does not depend on the size of the “infinite lived” altruistic dynasties. Journal of Economic Literature Classification Numbers: C62, D91, O21, O41.     

Spanning and completeness in markets with contingent claims

We characterize financial markets that are “complete” or that contain portfolios which “span” all measurable functions of a particular asset payoffs, either finite and infinite dimensional. These results are then employed to describe the extent to which options trading is sufficient to complete markets, to investigate the existence of “efficient funds,” and to establish the extent of market completeness required to ensure the unanimity and irrelevance results of modern corporation finance.     

A note on incomplete factor taxation

Optimal capital taxes may be positive in the steady state in Ramsey models with an incomplete set of factor taxes. I show this possibility crucially depends on how fiscal policy is constrained at date t = 0. If the government is barred from manipulating the value of initial assets, the Chamley–Judd result reappears: the optimal capital tax is always zero in the steady state.     

Temporal risk and the nature of induced preferences

It has been known since the work of H. Markowitz (“Portfolio Selection: Efficient Diversification of Investments,” Yale Univ. Press, 1959) and J. Mossin (Amer. Econ. Rev.59 (1969), 172–174) that even an individual whose underlying preferences satisfy the von Neumann-Morgenstern axioms will not choose over delayed (i.e., “temporal”) risky prospects in a manner which can be modelled as expected utility maximizing. Since most economically important instances of risk taking (insurance, real investment, agriculture, career training) involve delayed as opposed to immediately resolved risk, the standard use of expected utility theory to model such decisions must be questioned. In this paper the technique of “generalized expected utility analysis” (M. J. Machina, Econometrica50 (1982), 277–323) and the theory of support functions (R. T. Rockafellar, “Convex Analysis,” Princeton Univ. Press, 1970) are applied to exactly model and hence determine the nature of preferences over temporal risky prospects.     

The ‘minimal’ state reconsidered: governance on the margin

Classical liberal scholars have defined a “minimal state” as performing certain basic functions that include the provision of policing, courts, and national defense. We argue that these functions need not be fully provided by the state. Private provision of all three of these functions exists. Thus a truly minimal state would provide these functions only on the margins where private provision fails. Thus, a truly minimal state is much more minimal than scholars have traditionally envisioned.