Institutions and Economic Performance

‘Leaks, Sabotage, and Information Design,’ Madsen, E.(with A. Kolb), 2019.

We study optimal dynamic information disclosure by a principal to an agent of uncertain loyalty who may engage in hidden undermining, for instance through damaging leaks or sabotage. The agent requires information to correctly perform a task but may also covertly commit destructive acts which are only stochastically detectable. The principal optimally provides inconclusive incremental guidance until a deterministic time when the agent is deemed trusted and given a conclusive final report. Disloyal agents are never given incentives to feign loyalty, and in the unique time-consistent implementation undermine with variable, non-monotonic intensity over the lifetime of employment.

‘Information acquisition and strategic investment timing∗,’ Madsen, E.(with R. Kirpalani), 2018.

We study a model of strategic investment timing with costly dynamic information acquisition. Two firms investigate a nonrival investment opportunity, by expending costly effort to stochastically uncover signals about its quality. Each firm can acquire at most one signal, and signals are conditionally independent across firms. Effort and signals are private, while investment is public and provides a channel for social learning. We characterize the set of perfect Bayesian equilibria, and find that social learning can lead to both reductions in effort (the traditional free-rider effect) and delay in investment even after a positive signal is acquired. We show that investment delay can actually mitigate the inefficiency of free-riding: when signal acquisition costs aren’t too high, equilibria exhibiting investment delay improve aggregate welfare or even Pareto-dominate those which don’t.

‘Expert Advice and Optimal Project Termination,’ Madsen, E., 2019.

I analyze how a firm should elicit advice from an expert on terminating a project with a stochastic lifespan. The firm cannot directly observe the project’s lifespan, but imperfectly monitors its state by observing incremental output. The expert directly observes the state of the project, but collects on-the-job benefits and so prefers to prolong operation as much as possible. He possesses no capital and enjoys limited liability, preventing efficient trade even in case the expert has no initial private information. The optimal long-term contract involves a stochastic project deadline and a completion bonus to the expert which declines as the deadline approaches. The deadline is responsive to good and bad runs of output, and exhibits variable output sensitivity over the lifetime of the project, in particular becoming more sensitive the closer the project is to termination. Elicitation of expert advice increases the ex post operational efficiency of the project, but asymmetrically – late terminations are completely resolved, while early terminations are mitigated but not entirely eliminated. These features are robust to extensions in which expert has limited initial capital, can be replaced, or can have his on-the-job benefits dissipated by busywork.

‘Estimating the Structure of Social Interactions Using Panel Data,’ Manresa, E., 2016.

I consider the problem of quantifying externalities in settings in which an outcome depends on own characteristics and on the characteristics of other individuals. In contrast to existing approaches, which require a priori knowledge of who interacts with whom, I propose a method that estimates both the structure of interactions and spillover effects using panel data. The method is useful when the structure is stable and few individuals or groups of individuals generate spillovers of a different magnitude from the rest. I introduce the Pooled Lasso estimator, a panel data counterpart of the Lasso estimator for high-dimensional, sparse random coefficients models. While spillover aeffects are estimated at the rate √s log N/T, average marginal effects, which can be interpreted as policy parameters, are estimated at the rate √s log N/(NT) under mild cross-sectional dependence, even under imperfect model selection. In addition, I also introduce the Double Pooled Lasso estimator, which makes use of the double selection procedure proposed in Belloni, Chernozhukov, and Hansen (2014) to ensure that common parameters achieve the optimal rate of convergence, √1/(NT). I apply this methodology to study R&D spillovers in productivity using the NBER matched Compustat-USPTO firm data. I find evidence that throughout the period 1980-2001, establishments engaged in the commercialization of the internet were able to generate productivity gains for the rest of the firms in the economy. In addition, I provide evidence that spillovers arising from small, R&D-intensive firms are underestimated when quantified using only patent data.

‘Reestablishing the Income-Democracy Nexus,’ Benhabib, J. (with A. Corvalan and M. Spiegel), 2011.

A number of recent empirical studies have cast doubt on the “modernization theory” of democratization, which posits that increases in income are conducive to increases in democracy levels. This doubt stems mainly from the fact that while a strong positive correlation exists between income and democracy levels, the relationship disappears when one controls for country fixed effects. This raises the possibility that the correlation in the data reflects a third causal characteristic, such as institutional quality. In this paper, we reexamine the robustness of the income-democracy relationship. We extend the research on this topic in two dimensions: first, we make use of newer income data, which allows for the construction of larger samples with more within-country observations. Second, we concentrate on panel estimation methods that explicitly allow for the fact that the primary measures of democracy are censored with substantial mass at the boundaries, or binary censored variables. Our results show that when one uses both the new income data available and a properly non linear estimator, a statistically significant positive income-democracy relationship is robust to the inclusion of country fixed effects.

‘On the Joint Evolution of Culture and Institutions,’ Bisin, A. (with T. Verdier), 2017.

Explanations of economic growth and prosperity commonly identify a unique causal effect, e.g., institutions, culture, human capital, geography. In this paper we provide instead a theoretical modeling of the interaction between culture and institutions and their effects on economic activity. We characterize conditions on the socio-economic environment such that culture and institutions complement (resp. substitute) each other, giving rise to a multiplier effect which amplifies (resp. dampens) their combined ability to spur economic activity. We show how the joint dynamics of culture and institutions may display interesting non-ergodic behavior, hysteresis, oscillations, and comparative dynamics. Finally, in specific example societies, we study how culture and institutions interact to determine the sustainability of extractive societies as well as the formation of civic capital and of legal systems protecting property rights.

‘The Political Economy of Debt and Entitlements,’ Lizzeri, A. (with L. Bouton and N. Persico), 2016.

This paper presents a dynamic political-economic model of government obligations. The focus is on the interplay between debt and entitlements. In our model both are tools for temporarily powerful groups to extract resources from groups that will be powerful in the future. Debt transfers resources across periods; entitlements directly target the future allocation of resources. We prove four main results. First, debt and entitlement are (imperfect) substitutes in the sense that constraining debt increases entitlements (and vice versa). Second, if debt is unconstrained, it is beneficial to limit entitlements but not to eliminate them. Third, debt and entitlements respond in opposite ways to political instability, and, in contrast with prior literature, political instability may even reduce debt when entitlements are endogenous. Finally, we identify two possible explanations for the joint growth of debt and entitlements.

‘Price Setting Under Uncertainty About Inflation,’ Perez, D. (with A. Drenik), 2018.

We use the manipulation of inflation statistics that occurred in Argentina starting in 2007 to test the relevance of informational frictions in price setting. We estimate that the manipulation of statistics had associated a higher degree of price dispersion. This effect is analyzed in the context of a quantitative general equilibrium model in which firms use information about the inflation rate to set prices. Not reporting accurate measures of the CPI entails significant welfare losses, especially in economies with volatile monetary policy.

‘Tax Avoidance in Firms,’ Rotemberg, M. , 2019.

Corporate tax codes can have notches; values where after-tax profits decrease in before-tax sales. Firms endogenously respond to notches, leading to excess mass in the firm-size distribution. We study a 1997 policy reform in which the French government implemented a transient tax reform that increased profit taxes by 15% for firms with over 50 million Francs in turnover. We use two distinct and complementary approaches to estimate the extent of tax avoidance: (a) using firms far away from (and therefore unlikely to be responsive to) the tax notch in the same year and (b) the entire firm size distribution before the tax reform. Both strategies generate similar results for the extent of tax avoidance. We show that the firms who avoid the tax are the ones with the lowest calibrated adjustment costs and those with the larger profits. The tax avoidance behavior comes mostly from increases in inventories and decreases in sales.

‘Equilibrium Effects of Firm Subsidies,’ Rotemberg, M. , 2018.

Subsidy programs have two countervailing effects on firms: direct gains for eligible firms and indirect losses for those whose competitors are eligible. In 2006, India changed the eligibility criteria for small-firm subsidies, and the sales of newly eligible firms grew by roughly 35 percent. Competitors of the newly eligible firms were also affected, with almost complete crowd-out within products that were less internationally traded, but little crowd-out for more traded products. The newly eligible firms had relatively high marginal products, so relaxing the eligibility criteria for subsidies increased aggregate productivity. I estimate the gains to aggregate productivity have been around 1-2%, although targeting different firms could have led to similar gains.

‘Communication and Investment: Evidence from the expansion of postal services,’ Rotemberg, M. (with J. Feigenbaum) , 2014.

When acquiring information about potential buyers is costly, sellers will be unable to make the best possible match. We capture the consequences of this in a model where producers make investment decisions anticipating their future response to search costs. When one good has higher information frictions than another, decreasing those frictions increases production of that good along the extensive and intensive margins, and given specialization constraints production of the other good will decrease. Using a novel dataset on the roll-out of free postal delivery in rural communities in the US at the turn of the 20th century, we find evidence in line with the predictions of the model, as investment in manufacturing signicantly increased in counties which got more free delivery routes, while investments in agriculture signicantly decreased.

‘Model Secrecy and Stress Tests,’ Williams, B., (with Y. Leitner), 2018.

Conventional wisdom holds that the models used to stress test banks should be kept secret to prevent gaming. We show instead that secrecy can be suboptimal, because although it deters gaming, it may also deter socially desirable investment. When the regulator can choose the minimum standard for passing the test, we show that secrecy is suboptimal if the regulator is sufficiently uncertain regarding bank characteristics. When failing the bank is socially costly, then under some conditions, secrecy is suboptimal when the bank’s private cost of failure is either sufficiently high or sufficiently low. Finally, we relate our results to several current and proposed stress testing policies.

‘Stress Tests and Bank Portfolio Choice,’ Williams, B., 2017.

How informative should bank stress tests be? I use Bayesian persuasion to formalize stress tests and show that regulators can reduce the likelihood of a bank run by performing tests which are only partially informative. Optimal stress tests give just enough failing grades to keep passing grades credible enough to avoid runs. The worse the state of the banking system, the more stringent stress tests must be to prevent runs. I find that optimal stress tests, by reducing the probability of runs, reduce the optimal level of banks’ liquidity cushions. I also examine the impact of anticipated stress tests on banks’ ex ante incentive to invest in risky versus safe assets.