Towards a non-Darwinian Theory of Institutional Change

The paper emphasizes two flaws in mainstream economics: the failure to understand actual human behavior in many real contexts and the failure to take account of transaction costs. By emphasizing the role of knowledge, institutions, transaction costs and path dependence, new institutional economics has provided a powerful answer to these shortcomings. Nevertheless, a number of questions remain open. In particular, path dependence is far from being a continuous process. Its dynamics and its irregularities are by and large unexplained. Hence, a strong need for a convincing evolutionary theory of environmental change. This article does not deny the validity of the Darwinian view applied to the theory of the firm and of competition in a free-market economy. The paper, however, maintains that the natural-selection process that characterizes the Darwinian approach is ill suited to describe economic evolutionary processes. It is shown that a combination of functional analysis and natural selection may indeed be a better solution, for it solves some of the puzzles raised by public choice theory without violating the fundamental tenets of the new institutional economics approach. Still, although this combined view may well explain why the institutional features are retained by the system, it does not clarify why they are introduced in the first place. A third possibility is put forward in the second part of the paper, where a new evolutionary theory is suggested. Within this framework, agents are assumed to behave according to their preferences within the existing rules of the game. At the same time, new ideas and sometimes new ideologies may influence their behavioral patterns. The combination between needs and ideologies generates environmental change, especially if so-called ideological entrepreneurs are able to transform latent and shared beliefs into an institutional project and enforce it.     

Indeterminacy, underground activities and tax evasion

This paper introduces underground activities and tax evasion into a one-sector dynamic general equilibrium model with aggregate external effects. The model presents a novel mechanism driving the self-fulfilling prophecies, which is characterized by well behaved (downward sloping) labor demand schedules. This mechanism differs from the customary one, and it is complementary to it. Compared to traditional labor market income, the income derived from underground labor activity is subject to a lower expected tax rate when considering both the probability of detection and the evasion penalty. During a belief-driven expansion, the household allocates more time to both traditional and underground labor supply. In equilibrium, this action serves to lower the effective labor tax rate faced by the household, thus providing stimulus to aggregate labor supply so as to make the initial expansion self-fulfilling. The mechanism here is akin to a “regressive tax”; the household's effective tax rate depends negatively on the level of total labor income. We argue that an underground sector, and the associated tax evasion, offer a good economic rationale for a regressive tax rate.     

Diversification preferences in the theory of choice

Diversification represents the idea of choosing variety over uniformity. Within the theory of choice, desirability of diversification is axiomatized as preference for a convex combination of choices that are equivalently ranked. This corresponds to the notion of risk aversion when one assumes the von Neumann–Morgenstern expected utility model, but the equivalence fails to hold in other models. This paper analyzes axiomatizations of the concept of diversification and their relationship to the related notions of risk aversion and convex preferences within different choice theoretic models. Implications of these notions on portfolio choice are discussed. We cover model-independent diversification preferences, preferences within models of choice under risk, including expected utility theory and the more general rank-dependent expected utility theory, as well as models of choice under uncertainty axiomatized via Choquet expected utility theory. Remarks on interpretations of diversification preferences within models of behavioral choice are given in the conclusion.     

Keeping Some Skin in the Game: How to Start a Capital Market in Longevity Risk Transfers

The recent activity in pension buyouts and bespoke longevity swaps suggests that a significant process of aggregation of longevity exposures is under way, led by major insurers, investment banks, and buyout firms with the support of leading reinsurers. As regulatory capital charges and limited reinsurance capacity constrain the scope for market growth, there is now an opportunity for institutions that are pooling longevity exposures to issue securities that appeal to capital market investors, thereby broadening the sharing of longevity risk and increasing market capacity. For this to happen, longevity exposures need to be suitably pooled and tranched to maximize diversification benefits offered to investors and to address asymmetric information issues. We argue that a natural way for longevity risk to be transferred is through suitably designed principal-at-risk bonds.     

Civil conflict and secessions

This paper studies secessions as the outcome of conflict between regions. We study under what conditions regions will divert costly resources to fight each other over political borders. We derive the probability of secession and the amount of resources diverted to separatist conflict, and show how those variables depend on factors such as heterogeneity costs, economies of scale, relative size, and external threats. We also model civil conflict over types of government, after borders have been determined, and study how this political conflict affects the incentives to secede. This paper has been written in memory of Herschel Grossman, and owes much to his inspiration. I am grateful to Michelle Garfinkel and David Weil, who co-organized a conference in Herschel’s honor at Brown in April 2006, for their encouragement. I thank Michelle Garfinkel and an anonymous referee for useful comments and suggestions. The usual disclaimer applies.     

Innovation,formal vs. informal R&D,and firm size: Some evidence from Italian manufacturing firms

On the basis of data from two recent surveys on innovation diffusion in Italian manufacturing industry, this paper shows that informal R&D is an important part of the total R&D undertaken by small and medium sized firms. Nevertheless, when an output indicator such as the number and the nature of the innovations introduced by firms of different size is used, it emerges that small firms have introduced mainly incremental rather than major innovations. The paper therefore suggests that systematic R&D undertaken by large firms within structured laboratories is more effective (in terms of product innovations) than occasional R&D carried out by small firms.     

Collaboration for innovation and project failure. A dynamic analysis

The aim of this paper is to investigate the hypothesis that there is a complex and bidirectional relation between collaboration and failure in innovation projects. On the one hand, collaboration in innovative activities may increase the likelihood of project failure. At the same time, the failure in innovation projects may induce the firm to collaborate in order to overcome the problems that determined the failure of innovation projects (induced collaboration). Up to now, we are not aware about the existence of any empirical paper analysing the interaction between these two mechanisms. This paper aims at filling this gap by providing a motivation for the induced collaboration and testing its empirical relevance in a dynamic framework. The empirical analysis is carried out by using two consecutive German Community Innovation Surveys referring to the period 2006–2010. The empirical results support the hypothesis of a bidirectional causal relationship between collaboration and failure.