Past Issues

Volume 12, Issue 1, May 2017

The seemingly never-ending scandals in the world of finance, accompanied by their damaging effects on value and human welfare, make a strong case for an addition to the current paradigm of financial economics. We summarize here our new theory of integrity that reveals integrity as a purely positive phenomenon with no normative aspects whatsoever. Adding integrity as a positive phenomenon to the paradigm of financial economics provides actionable access (rather than mere explanation with no access) to the source of the behavior that has resulted in those damaging effects on value and human welfare, thereby significantly reducing that behavior. More generally we argue that this addition to the paradigm of financial economics will create significant increases in economic efficiency, productivity, and aggregate human welfare. Because integrity has generally been treated as a virtue (a normative phenomenon) the actual cause of the damaging effects of out-of-integrity behavior are hidden, resulting in assigning false causes to those effects. This keeps the actual source of these damaging effects invisible to us. As a result, in spite of all the attempts to police the false causes of these damaging effects, the out-of integrity actions that are the source of these effects continue to be repeated. This new model of integrity makes the actual source of the damage available for all to see, and therefore to act on. Integrity as we define it (or the lack thereof) on the part of individuals or organizations has enormous economic implications for value, productivity, and quality of life. Indeed, integrity is a factor of production as important as labor, capital, and technology. Without a clear, concise, and most importantly, an actionable definition of integrity, economics, finance and management are far less powerful than they can be.
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COMMENTS ON PAPER

By Colin Mayer
By Deirdre Nansen McCloskey

RESPONSE BY AUTHORS

To Deirdre Nansen McCloskey

This essay argues that more systematic consideration of market failures has the potential to change how we think about management and managerial failures. While economists disagree about the incidence of market failures and effectiveness of governmental attempts at remediation—cf. Harvard versus Chicago—they generally coincide in ignoring management failures. Conversely, management scholars tend to focus on management failures rather than market failures—as do those with higher education in management. This disconnect is unfortunate because it is at the intersection of market and management failures that “better” management is likely to matter most. One implication: “curricular social responsibility” involving more attention to market failures may be the educational equivalent of corporate social responsibility in the commercial world.
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COMMENTS ON PAPER

By Richard Schmalensee
By Sidney G. Winter

Modern life invaded societies in the 19th century: First in Britain and America, later in Germany and France. Increasing numbers were driven not just by a work ethic or a desire to accumulate: They were dreamers, tinkerers, and adventurers on a journey, exercising their imagination, creativity, and curiosity. The result was not simply a “take-off” into sustained growth; the economy was turned into a vast imaginarium in which people conceived new products, uses, and approaches, as well as methods of production. This indigenous innovation, coming from the grassroots up, was the foundation of modern life: The satisfaction of “succeeding” at what one is doing, the satisfactions one has from “flourishing,” and the thrill of the unknown. These “soft” rewards of work are important, as are material rewards. By now, however, “soft” rewards seem to have fallen off and growth has slowed. Have modern values narrowed to a trickle or has big business choked off the dynamism of old?
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COMMENT ON PAPER

By Carl Christian von Weizsäcker

Volume 11, Issue 2, December 2016

Impact investment is attractive to many because it seems to combine support for progressive causes with an apparent commitment to the principles of a market economy. In fact, however, a rational impact investor is not simply creating demand for certain types of corporate actions; he/she is attempting to use corporate governance mechanisms to influence fiduciary decisions of the management. The cost of this tactic for the health of the capitalist economy is potentially very considerable. The American capitalist system relies heavily on a relatively fragile corporate governance arrangement in which the agency problems of a modern corporation are minimized by making shareholder value into the ultimate objective of the management. A crucial assumption in this model is that shareholders are a homogenous group interested in the maximization of financial returns, which makes market price into a reliable criterion of corporate performance. The injection of a more complex corporate objective function – an inevitable consequence of impact investment – raises the potentially insoluble problem of aggregating the diverse interests of the shareholders and seriously weakens the ability of the shareholders to monitor management performance.
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Impact investing and socially responsible investing have attracted a great deal of attention from individual and institutional investors yet very little from scholars. This paper sketches some of the unmet empirical and theoretical challenges.
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In the process of admissions to selective colleges and universities, both the institutions and the applicants are trying to maximize. Applicants want to get into the “best” college and colleges want the “best” applicants. This paper argues that in this context, as in many others, maximizing is a fool’s errand, partly because no one knows what the best college (or student) is, and partly because differences among applicants are smaller than the error in the instruments used to assess them. Moreover, it is a fool’s errand with grave consequences, since it puts enormous pressure on students throughout their pre-college education and induces them to do what will impress rather than what they are actually passionate about. I propose, instead, a system in which all applicants who cross an acceptability threshold are entered into a lottery, with the winners (admitted students) chosen at random from that pool. Such a system might produce better, more engaged college students because they will be freer to pursue their passions and develop their intellects in high school. It might also teach students about the role of luck in many of life’s outcomes, making them more empathic when they encounter people who may be just as deserving as they are, but less lucky. Finally, I suggest that maximizing in general may be a fool’s errand, and that satisficing may produce better decisions, and greater satisfaction.
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COMMENT ON PAPER

By Emanuele Gerratana

 

Over the last decade, impact investing has become an increasingly-discussed topic in the realms of both business and public policy. Impact investors are motived by a desire to advance social or environmental goals and an intuition that pursuing two goals at once - investment returns and social or environmental returns - is more effective than keeping them separate. This article reviews the recent history of impact investing, addresses some of the issues confounding the nascent field, and offers a few definitions that might bring more rigor and clarity to what remains, as yet, a simultaneously confusing and promising investment strategy.
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Volume 11, Issue 1, June 2016

Using canonical-correlation analysis we find significant differences in social capital between European regions. Teaching children to be independent, imaginative, and tolerant contributes positively to social capital, as does a higher level of trust towards fellow citizens. These differences can account for differences in unemployment, male labor force participation, and average hours of work across regions.
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COMMENT ON PAPER

By Luigi Bonatti

This study was inspired by Piketty’s excellent and important book. It arose from the desire to explore the missing aspects of what claims to be a comprehensive analysis of capitalism. By comparison the author of this paper felt important aspects were lacking. The capitalist sys- tem has numerous inherent traits and innate tendencies, out of which the paper takes a clos- er look at three. 1. One basic feature is dynamism, innovation, and creative destruction. No picture of capitalism can be full if this basic aspect is ignored. 2. Capitalism inevitably brings about a high degree of inequality; this must be eased by reforms, but cannot be entirely over- come. 3. The basic characteristics of capitalism – private ownership and the dominance of market coordination – give rise to strong incentive mechanisms that encourage both owners and enterprise executives to innovate and cooperate effectively. One of the main incentives is competition, especially oligopolistic competition. There are strong mutual effects among these three important tendencies. It is impossible to understand well Piketty’s main subject, the distribution of income and wealth, if it is divorced from the other two tendencies. The study ends with the author’s own value judgements on both the favourable and the harmful, unjust attributes of the capitalist system.
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COMMENT ON PAPER

By Philippe Aghion

Volume 10, Issue 1, March 2015

For two decades Hungary, like the other Eastern European countries, followed a general policy of establishing and strengthening the institutions of democracy, rule of law, and a market economy based on private property. However, since the elections of 2010, when Viktor Orbán’s Fidesz party came to power, Hungary has made a dramatic U-turn. This article investigates the different spheres of society: political institutions, the rule of law, and the influence of state and market on one another, as well as the world of ideology (education, science and art), and describes the U-turn’s implications for these fields and the effect it has on the life of people. It argues against the frequent misunderstandings in the interpretation and evaluation of the Hungarian situation, pointing out some typical intellectual fallacies. It draws attention to the dangers of strengthening nationalism, and to the ambivalence evident in Hungarian foreign policy, and looks into the relationship between Hungary and the Western world, particularly the European Union. Finally, it outlines the possible scenarios resulting from future developments in the Hungarian situation.
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COMMENT ON PAPER

By Paul G. Hare

Myths about welfare states and their effects on economic development abound. In this paper, we rebut three central, related myths: that the current American welfare state is unusually small, that the United States has always been a welfare state laggard, and that the welfare state undermines productivity and economic growth. Very reasonable changes in measurement reveal that all three beliefs are untrue. The American welfare state appears relatively small only by restricting the comparison to rich nations, ignoring employer-provided health insurance, pensions, and public education, and measuring size relative to GDP, rather than on a real per capita basis. The inclusion of public education turns the United States from a laggard to a leader in welfare state development. Including public education and public health as well as cash benefits suggests that welfare state programs as a whole enhance the productivity of capitalism and spur economic development.
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COMMENT ON PAPER

By Gösta Esping-Andersen

Volume 9, Issue 2, March 2014

The United States receives more immigrants than any other country. Most of those immigrants are admitted under policies that were created decades ago, although a sizable share enters illegally. This article provides an overview of trends in immigration to the United States. It summarizes the literature on the economic effects of immigration in the United States and discusses how policy can be reformed to increase immigration’s economic contribution. The article argues that the country should increase the number of visas awarded to workers and adopt an auction-based system for admitting those workers.
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COMMENT ON PAPER

By Susan Martin

International monetary relationships have been under strain in recent years. This is largely because adjustment mechanisms are asymmetric; the IMF has no means of putting pressure on countries with large current account surpluses to adjust. But such countries' accompanying capital account outflows have often had disappointing returns.   So, we propose a method to impose symmetric constraints on the net capital flows both of deficit and surplus countries.
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COMMENT ON PAPER

By Harold James

If the criteria for an institution’s success are diffusion and longevity, then central banking has been hugely successful. But if the criterion is the degree to which it has achieved its goals, then the evaluation has to be more nuanced. Historically, those goals have included a changing mix of financial and monetary stability. Attaining monetary and financial stability simultaneously has proved elusive across regimes. Edging closer towards that goal calls for incorporating systematically long-duration and disruptive financial booms and busts – financial cycles – in policy frameworks. For monetary policy, this means leaning more deliberately against booms and easing less aggressively and persistently during busts. What is ultimately at stake is the credibility of central banking – its ability to retain trust and legitimacy.
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COMMENTS ON PAPER

By Axel A. Weber
By Marco Pagano

Volume 9, Issue 1, April 2014

China’s record-breaking economic growth is evoking increasing concern about unaddressed environmental problems. We show that, while city government spending on environmental infrastructure has a demonstrably positive environmental impact, city spending is nonetheless strongly tilted towards transportation infrastructure. City governments’ investment in transportation infrastructure is strongly positively correlated with real GDP growth, a measure of tangible economic growth that is found to raise city-level cadres’ odds of being promoted, and with land prices, which elevate city governments’ revenues from land lease sales and thus augment city-level cadres’ budgets. In contrast, city governments’ spending on environmental improvements is at best uncorrelated with cadres’ promotion odds, and is also uncorrelated with local GDP growth and land prices. These findings suggest that, were environmental quality explicitly linked to cadres’ chances of promotion, or were environmental quality to affect land prices substantially, city-level public investment in environmental improvement would rise.
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COMMENTS ON PAPER

By Yasheng Huang
By Matthew E. Kahn

This survey reviews how recent political economy literature helps to explain variation in governance, competition, funding composition, and access to credit. Evolution in political institutions can account for financial evolution, and, unlike time-invariant legal institutions or cultural traits, is critical to understanding rapid changes in financial structure, such as the Great Reversal in the early 20th century. Future research should model the sources and consequences of financial instability, and predict how major redistributive shocks will shape regulatory choices and financial governance.
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COMMENT ON PAPER

By Julian R. Franks

Volume 8, Issue 2, December 2013

An introduction to the three papers published in this issue.
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There cannot be a complete prescription for a good society and any set of values that are projected as a blueprint for a society will require revision, amendment and compromise, as well as limitations and extensions in their application to social and political reality. Limits to both the speed and the scope of social change must be justified in light of the large number of values, including many tacit values, that are operational or necessary for the functioning of any society. This paper explores, in particular, the tradeoff between the four values of individual freedom, consent of the governed, free markets, and economic development as well as tradeoffs between equality and justice. The limits of philosophy are drawn when such conceptual analysis seeks to arrive at resolutions of the conflict among plural values. The recurrent thesis has been that the priority among values held at the time and under the circumstances of decision-making, as well as the empirical facts available to decision-makers, provide the reasons for a decision among conflicting values.
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Much of the modern perception of the role of economic production in human life - whether on the Left or on the Right of the political spectrum – views it as an inferior, instrumental activity oriented toward self-preservation, self-interest, or profit, and thus as essentially distinct from the truly human action concerned with moral values, justice, and various forms of self-fulfillment. This widely shared worldview is rooted, on the one hand, in the Aristotelian tradition that sees labor as a badge of slavery, and freedom as lying in the domain of politics and pure (not technical) knowledge, and, on the other hand, in the aristocratic mediaeval Christian outlook, which – partly under Aristotle’s influence – sees nature as always already adapted (by divine design) to serving human bodily needs, and the purpose of life as directed toward higher, spiritual reality. Marx, although he attacked the Aristotelian distinction between “action” and “production,” also envisaged the undistorted production process in essentially collectivist Aristotelian terms. 

As against this, liberal thinkers, above all Locke, have developed an elaborate alternative to the Aristotelian worldview, reinterpreting the production process as a moral activity par excellence consisting in a gradual transformation of the alien nature into a genuinely human environment reflecting human design and providing the basis of human autonomy. Adam Smith completed Locke’s thought by explaining how production is essentially a form of cooperation among free individuals whose self-interested labor serves the best interest of all. The greatest “culture war” in history is to re-establish the moral significance of economic activity in the consciousness of modern political and cultural elites.
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This paper is divided into two parts. The first part traces the genesis of the modern interpretation of individual selfhood back to the Protestant Reformation. By privatizing, deregulating, and decentralizing religion, Luther prepared the way for what would eventually become the modern notion of the market. Educated in the Calvinist atmosphere of Scotland, Adam Smith translates Calvin’s notion of divine providence and the fortunate fall into the notion of the invisible hand and machinations of the market through which pursuit of personal ends serve the good of the whole.

The second part of the paper presents an analysis of the dynamics of individual decision through a consideration of theories of emergent complex adaptive systems. In this model, individuals function as something like nodes in intersecting social, cultural, technological and natural webs. The economy as a whole is a complex network that functions as a self-regulating, non-equilibrium system in which individuals must be understood as integral members of all-encompassing wholes. In this way, complexity theory counterbalances the excessive individualism of much recent economic theory. The Protestant interpretation of the individual subject informs the understanding of individual choice and decision that lies at the heart of contemporary capitalism.
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Volume 8, Issue 1, January 2013

Following an earlier article criticizing excessive uses of rational-choice modeling and statistical analyses in the social sciences, the present article argues that much of normative political theory, notably many theories of optimal institutional design, also suffer from various forms of overreaching. It is argued that both attempts to design democratic institutions that will track independently denied good outcomes and attempts to choose good democratic decision-makers are bound to fail. The article also presents a positive alternative, inspired by Jeremy Bentham's Political Tactics: institutional designers should reduce as much as possible the impact of self-interest, emotion, prejudice and cognitive bias on the decision-makers, and then let the chips fall where they may.
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COMMENTS ON PAPER

By Kenneth Binmore
By Donald Horowitz

As business leaders worry about the decline of American competitiveness, business schools are responding by changing their curriculums. But are the topics and approaches taught in today's business schools part of the solution or part of the problem? In this paper, I explore the possibility that four trends in current MBA curriculums - theory creep, mission creep, doing well by doing good, and the quest for enlightenment - are teaching students to be uncompetitive in today's global markets. If this hypothesis is true, I argue that business school curriculums should be re-centered around the tough choices needed to compete - and to win.
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COMMENT ON PAPER

By Derek Bok

Volume 7, Issue 1, January 2012

With a concentrated supply of broadband Internet access, will the future of the Internet be as innovative as the past? This essay reconsiders contemporary debates that view broadband providers as gatekeepers. Instead, it offers an alternative perspective, viewing carriers as platform leaders. That framework focuses attention on the importance of platforms for innovation, and highlights issues missed in contemporary debates. The essay stresses the differences between open and proprietary systems, and between systems with overlapping but competing leadership. Viewed through this lens, platform leadership leads to lower transactions for affiliated partners, but a narrowing of the range of innovation by young firms in comparison to an open and unrestricted structure, a process labeled as "entrepreneurial truncation." Platform leaders with market power also provide uneven degrees of transparency, use more discriminatory practices, and put unaffiliated business partners at disadvantages, which can deter entrepreneurial innovation as well. The essay concludes that innovation arises in all systems, so the exaggerated claims of contemporary debate lack merit. However, contemporary debate also misses the key point addressed by this essay: that open platforms are superior at addressing a wider and unexpected set of exploratory activities, and that policy can, and should, play an important role in fostering openness.
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COMMENT ON PAPER

By Timothy Bresnahan

Why is it that the wealthiest people are not the most materialistic; that the most successful businesses are not the most profit-oriented; and that the happiest people do not directly pursue happiness? Using a diverse range of examples, from the Messenger spacecraft to French architecture, this essay explains why complex goals are best achieved when they are pursued indirectly; this is the concept of obliquity.
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COMMENT ON PAPER

By George Wu

For capital markets to function, political institutions must support capitalism in general and the capitalism of financial markets in particular. Yet the shape, support, and extent of capital markets are often contested in the polity. Powerful elements - from politicians to mass popular movements - have reason to change, co-opt, and remove value from capital markets. And the competing capital markets' players themselves have reason to seek rules that favor their own capital channels over those of others. How these contests are settled deeply affects the form, extent, and effectiveness of capital markets. And investigation of the primary political economy forces shaping capital markets can lead us to better understand economic, political, and legal institutions overall. Much important work has been done in recent decades on the vitality of institutions. Less well emphasized, however, is that widely-shared, deeply-held preferences, often arising from the interests and opinions that prevail at any given time, can sometimes sweep away prior institutions, establish new ones, or, less dramatically but more often, sharply alter or replace them. At crucial times, preferences can trump institutions, and how the two interact is well-illustrated by the political economy of capital markets. Since North's [1990] famous essay, academic work has focused on the importance of institutions for economic development. Here, I emphasize the channels by which immediate preferences can trump institutional structure in determining the shape and extent of capital markets.
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COMMENT ON PAPER

By Dennis Mueller

Volume 6, Issue 2, December 2011

The term 'animal spirits' has returned to academic and public discourse in a way which departs significantly from the original use of the term by Keynes. The new behavioural economics literature uses the term to refer to a range of behaviour which falls outside what is normally understood as rational. This treatment follows from the mainstream dichotomisation between rationality and irrationality. However, Keynes explained that, given fundamental uncertainty, rationality alone was insufficient to justify action. Animal spirits was the name he gave to the (psychological) urge to action which explained decisions being taken in spite of uncertainty; animal spirits for him were neither rational nor irrational. Nor are they beyond analysis. We explore how the nature and role of animal spirits can vary according to context (as between different sectors, types of firm and within firms). This analysis indicates ways in which policy can promote structural change to strengthen animal spirits in the long term as well as offset short-term weakening in animal spirits.
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COMMENT ON PAPER

By Robert Skidelsky

This essay offers an alternative way to look at macroeconomics. The current standard approach uses aggregate supply and aggregate demand (AS-AD). I call the alternative approach patterns of sustainable specialization and trade (PSST). The PSST approach combines many old and new strands in economics. It suggests that the economy is a highly complex system that is constantly adapting to new circumstances, especially opportunities created by technological innovation. We can view employment fluctuations as a reflection of the difficulty that markets sometimes have in making the necessary adjustments, so that for a period of time some workers have extremely low marginal revenue product and as a result become unemployed.
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COMMENT ON PAPER

By Peter Howitt

Art and money have always been inseparable. During the past several decades, however, this relationship has been transformed by a new form of capitalism - finance capitalism, which has been made possible by the networking of new information, media and communication technologies. This is a genuinely novel phenomenon whose global impact has become undeniable. In previous forms of capitalism (agriculture, industrial and consumer), people made money by buying and selling labor and material goods; in finance capitalism, by contrast, wealth is created through the circulation of signs backed only by other signs. The structure and development of financial markets mirror each other. As art becomes a progressively abstract play of nonreferential signs, abstract financial instruments increasingly create an autonomous sphere of circulation whose end is nothing other than the endless proliferation of monetary and financial signs. When the art of finance becomes the finance of art, art is no longer merely a commodity to be bought and sold, but becomes the currency of exchange fabricated for hedge funds and private equity funds, where it is traded like any other financial asset.
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COMMENT ON PAPER

By Noah Horowitz

Volume 6, Issue 1, January 2011

There is now a broad consensus in the policy community that strengthening the macroprudential orientation of regulatory and supervisory frameworks is essential for the promotion of financial stability. The window of opportunity to put in place fully fledged macroprudential frameworks should not be missed. Meeting this challenge calls for a finely balanced blend of boldness and realism. Boldness is required to face the hard design questions head-on; realism to avoid overreach and to manage expectations. Policymakers should be as ambitious as possible, but no more. In all this, research has an important role to play in allowing the framework to grow at a pace commensurate with our knowledge. This speech considers how to strike the balance between boldness and realism in several aspects of the framework: in the criterion for judging its success; in how closely systemic risk should be tracked; in the mix between an aggregate and a sectoral approach; in that between rules and discretion; and in governance arrangements. It also highlights some key questions for research.
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COMMENT ON PAPER

By Charles W. Calomiris

The ideology of how economic activity is organized in capitalist economies is sharp and simple - markets. However, in reality, economic activities in capitalist economies are organized in a variety of different ways, market organization prominent among them but not totally dominating. The basic argument of this paper is that capitalist economies should be understood as mixed economies.
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COMMENT ON PAPER

By Rogers Hollingsworth

This article discusses the impact of national policies and institutions on the strategies that companies adopt when they are faced with disruptive changes in their external environment. The article focuses on the man-made fibres industry in the U.S., Western Europe and Japan between 1980 and 2010 and describes the different ways in which the leading fibre manufacturers in those regions responded to the shift in textile, clothing and later fibre production to low-cost countries, principally in Asia. These companies had to decide whether they could continue to compete profitably in the man-made fibres industry, and, if not, what non-fibre businesses they should invest in. In countries such as the U.S. and the UK, where capital markets are powerful and companies are under pressure to enhance shareholder value, virtually all the former leaders have withdrawn from the industry and a set of new entrants, including private equity firms, have taken their place. In Japan, by contrast, leading companies such as Toray and Teijin remain committed to man-made fibres, although they have also diversified in other directions. Despite the increasing role of Anglo-American investors in Japan, Japanese companies see themselves as responsible to a broad range of stakeholders, not just to shareholders; the continuity of the enterprise and of employment is given a higher priority than in the U.S. or the UK. In Continental Europe, the restructuring of the man-made fibres industry has involved numerous divestments and demergers, and this partly reflects the growing influence of Anglo-American investors, but in some of these countries the stakeholder view of the enterprise continues to carry considerable weight. Lenzing in Austria, which is now the largest European man-made fibre manufacturer, is an example of a company which has combined commercial success with a strong sense of responsibility to the region where its main factory is based. In reviewing these different strategies the article shows how Japanese-style "long-termism" can be a source of strength in certain industries such as carbon fibre, but has the disadvantage of allowing companies to persist for too long with low-return businesses which might do a better under different owners. Some further movement towards the Anglo-American model is likely in Japan and in Continental Europe, but these countries have a different view of what companies are for, and this will continue to affect how their companies respond to industrial change.
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COMMENT ON PAPER

By John Sutton

Volume 5, Issue 3, December 2010

Improving economic welfare requires that society's scarce savings be allocated among proposed real investment projects in a way that appreciates the prospects of promising new innovations. Corporate and securities law help structure important elements of this process of allocation. This article sketches out an approach based upon a seemingly paradoxical analogy of a market economy's overall finance process to the way a hierarchical organization gathers and processes relevant bits of information dispersed among many individuals in order to make decisions. It thereby takes advantage of important thinking in communications and organizational theory about how to make organizations sensitive to the potentialities of new information and ideas.

The analysis suggests that established firms should pay out a relatively high portion of their cash flows. There should be a substantial venture capital sector and an active market for IPOs. Primary and secondary market prices should be relatively accurate. Incumbent managers of established firms should be judged in part by the medium term share price performance of their firms and poor performers should be under threat of replacement.

A comparison of four moments in economic history - the United States in the 1970s and 1980s, Japan since 1995, continental Europe since the 1995, and the United States since the 1995 - supports these conclusions. The United States since 1995, relative to the other three moments in economic history, has had the least capital deepening and the fastest rate of growth in productivity per hour worked. It has also had, relative to the other three moments, a finance system most closely resembling what is called for here. 

Achieving such a system requires rigorous, effectively enforced securities disclosure and anti-fraud laws. Corporate law must leave poorly performing incumbent management vulnerable to removal by hostile tender offer, or shareholder or independent board vote. Share price based compensation must be legally practical. And there must be serious constraints on non-pro-rata distribution among shareholders of the wealth created by the firm.
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COMMENT ON PAPER

By Mark Blyth

An economic system called corporatism arose in the late 19th century, promoted by Anti-Cartesian French intellectuals dismayed with the "disenchantment of the world" Weber attributed to capitalism, and by a Roman Catholic church equally dismayed with both liberalism and socialism. Corporatism recognizes the innate inequality of human beings and their need for secure places in a legitimate hierarchy and thus puts the police power of the state behind officially sanctioned Corporations, elite-controlled industrial group cartels empowered to set wages, prices, employment, and quotas, to regulate entry, and to limit imports. Corporatism was to end the class struggle by guaranteeing workers their accustomed jobs and incomes and by delegating traditional authority through a principle of subsidiarity. We argue that countries that adopted corporatism most fully - those with Roman Catholic majorities or French-educated elites - experienced substantial financial development reversals and retain legacy Corporatist institutions that continue to retard financial development and growth.
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COMMENT ON PAPER

By Mark Blyth

The constitutional structures and traditions that promote corporatism are the main obstacles to economic dynamism and inclusion in societies. Corporatism is the cause of Argentina's "reversal of development" from the 1930s to the present. If the normative and imperative rules in Constitutions change both incentives and culture, some questions arise: how should we design Constitutional rules that promote economic dynamism? At the same time, is a bad political economy, as occurs in a corporatist economy, promoted by government officials because it allows their perpetuation in government? A corporatist economy could be the basis of a perverse political culture where utility-maximizing leaders will embark on destructive economic policies to enhance their own personal power unless they are appropriately constrained. The Argentine Constitutional economy has both poor incentives and a poor Constitutional culture, which prevent the development of both dynamism and inclusion. Strategic political considerations push rulers into bad economic policies. At the same time, a strong corporate culture favours the resulting mix of authoritarianism, stagnation and social exclusion.
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COMMENT ON PAPER

By Mark Blyth

Volume 5, Issue 2, October 2010

Is there a theoretical basis for the view that the end of a period of over-investment necessarily leads to a period of below-normal employment as the excess capital stock is run down? We study the repercussions of a false boom in housing driven by prior expectations of future housing prices not justified by fundamentals. When these expectations are corrected, the result is a precipitous drop in housing prices and, on that account alone, some drop in employment. There is also a bulge in the housing stock. In the case of a closed economy, the downward shift of the term structure of interest rates due to the excess housing stock props up housing prices above the normal steadystate level, so the drop of housing prices "undershoots." Although this transient elevation of housing prices has a positive demand-wage effect on employment, we show that the wealth effect from owning a higher housing stock and a negative Hicks-Lucas-Rapping effect of lower interest rates dominate, so employment drops initially to a below-normal level. The slump gradually subsides as the housing overhang wears off. In the case of a small open economy that faces a world of perfect capital mobility and takes as given the world interest rate, there are two possibilities. If housing services are instantaneously tradeable and perfect substitutes for foreign ones so that purchasing power parity holds, the end of the bubble causes housing prices to drop precisely to the steady-state level. Since there is no undershooting, the wealth effect of the housing overhang is unopposed and the slump is deeper. If domestic and foreign housing services are imperfect substitutes, the country will suffer a period with a weak real exchange rate, thus leading to a drop of housing prices that "overshoots" the normal level. Here, the slump in employment is worsened by the exaggerated fall in housing prices below the steady-state level.
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COMMENT ON PAPER

By Andrew J. Oswald

The powerful downswing in economic activity in the past two years is not the first powerful downswing experienced in the western world since the Great Depression of the 1930s. The long slump that took hold in the U.S. and western continental Europe from the early 1970s into the 1980s had a profound impact. It was disturbing in part because – as in the Great Depression of the 1930s – there was at first little insight into its causes.
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COMMENT ON PAPER

By Andrew J. Oswald

Financial crises follow a pattern that consists of changes in asset prices, real exchange rates, investment and employment. One noteworthy feature of this pattern is the "jobless recoveries" that often follow such crises. This was the experience of Finland and Sweden in the aftermath of their financial crises in the early 1990s and currently appears to be the case in the United States and many other countries. The behavior of unemployment during the crises mirrors that of investment, which is consistent with models of the natural rate of unemployment that make labor demand depend on investment in physical capital, new workers and customers. The implication is that the natural rate of unemployment falls during the investment boom that precedes a crisis and rises in its aftermath.
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COMMENT ON PAPER

By Andrew J. Oswald

Volume 5, Issue 1, January 2010

This paper considers the drivers of the structure and evolution of the life sciences innovation system, a remarkable success story for public support of science. The growth and performance of this system reflect the interaction between abundant scientific and technological opportunity, a reasonably effective and adaptive institutional and property rights framework, and a reservoir of unmet demand for therapies and technologies that significantly enhance human health care. Examining the evolution and dynamism of the life sciences innovation system, we emphasize three central foundations: a long-term and relatively stable commitment of financial and human resources by both the public sector and for-profit organizations, market and non-market institutions that encourage competition on the basis of innovation across multiple dimensions, and the promise of significant financial rewards for private sector innovators leveraging publicly funded scientific discoveries.
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COMMENT ON PAPER

By Ashish Arora

Price discrimination is an extremely common type of pricing strategy engaged in by virtually every business with some discretionary pricing power. The issue of whether price discrimination reduces or increases social welfare has been considered by economists since at least 192'3 At that time, it was demonstrated that, under certain (restrictive) conditions, price discrimination will reduce social welfare. Subsequent research has shown that price discrimination can increase social welfare, and that a necessary (but not a sufficient) condition for welfare to rise is that total output with discrimination exceeds the no-discrimination level.

First, we present evidence about international drug price differentials. Drug prices in the top 5 countries are almost five times as high as they are in the bottom five countries. Certain features of the drug price distribution are surprising. For example, according to our drug price index, the price of drugs in Mexico (which has the second-highest drug prices) is 24% higher than it is in the U.S. (which ranks sixth out of 38 countries). There is a highly significant positive correlation between per capita income and the drug price index: on average, the price of drugs is lower in low-income countries. However, there are large deviations from the regression line. Countries (particularly low-income countries) with similar levels of income pay vastly different prices for drugs.

Next, we examine income-related price differentials in the U.S. When price is defined as the amount paid by the patient, there is an inverted-U-shaped relationship between income and price. People in the lowest income category pay 25% less than high income people (16% less if cases when the patient paid nothing are excluded), but people in the middle income category (whose income is 125-200% of the poverty line) pay 6% more than high income people (whose income exceeds 400% of the poverty line).

We perform an empirical investigation of whether the necessary condition for price discrimination to increase welfare - that it increase total output - is satisfied in the case of international pharmaceutical prices, by analyzing the relationship across drugs between total output growth and growth in international price dispersion. Drugs that had larger increases in international price dispersion had larger increases in total utilization, controlling for the growth in the mean price of the drug and the drug's vintage. Numerous studies have shown that increased prescription drug use results in improved health outcomes, or the converse: reductions in drug use result in worse health outcomes, such as higher risk of hospitalization and death.

In addition to increasing the output of existing products, the ability to engage in price discrimination is likely to increase the number of new products. Contrary to the assumptions of some theoretical models, some markets that would not be served under uniform pricing will be served under price discrimination. This would be the case whenever there are fixed production costs, and the pharmaceutical industry has much higher fixed costs (especially R&D expense) as a percentage of sales than most other industries. Studies have shown that the amount of pharmaceutical R&D investment is influenced by factors (other than the ability to price discriminate) that determine the expected profitability of investment. Studies have also provided evidence that the development and use of new drugs has resulted in significant increases in longevity and health, and that overall, new drugs have been highly cost-effective.
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COMMENT ON PAPER

By Richard L. Schmalensee

Throughout its history, the United States has been the beneficiary of a worldwide immigration of entrepreneurial talent. This article surveys finance, one of the many sectors in which immigrants made a conspicuous impact. Part I demonstrates the dominant role of immigrants in forming public financial policies from 1775 to 1817. Part II surveys 12 merchant and investment banking firms founded during the nineteenth century by individual immigrants or family groups, and traces their histories until 1914. Part III suggests, from this small sample, a series of hypotheses and tentative conclusions about their experiences and influence. Part IV compares the financial environment of the nineteenth century with that of the late twentieth and early twenty-first centuries. The article ends with a supporting appendix that describes 19 additional immigrants or immigrant families and their firms.
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COMMENT ON PAPER

By Harold James

Volume 4, Issue 3, October 2009

The fall of the Berlin Wall in November 1989 was the defining economic event of our lifetime. It marked the end of the most extensive controlled experiment in the history of social sciences – the division of Germany into two economic zones, one centralised and planned, the other a market economy. After forty years, the gap in living standards between the two was so extreme that the experiment was terminated. 

This outcome is counterintuitive. A striking formulation by Ken Arrow and Frank Hahn spells out the issues. The immediate 'common sense' answer to the question 'what will an economy motivated by individual greed and controlled by a very large number of different agents look like?' is probably: 'There will be chaos'. Even in the 1960s, most countries – developed and developing – outside the United States believed that central planning should be at the centre of their economic management. The US itself was concerned that the Soviet Union might achieve technological superiority. 

So why did markets perform so well? A popular caricature of the market economy sees greed as the dominant human motivation, and economic progress best achieved by acknowledging that behaviour and imposing as few restrictions as possible on what these greedy people do. This is the economic environment of Nigeria and Haiti, and it does not work: it is the commercial environment of the Ik tribe described by the anthropologist Colin Turnbull and of Lehman described by the inmate Laurence McDonald, and it does not work there either. 

Greed must be constrained, but it is inadequate to describe that constraint simply as 'the rule of law'. The property rights that are critical to 'the rule of law' are not given by nature, but are socially constructed. Information asymmetry is endemic in modern economies with complex products, and that asymmetry is handled mainly through the mechanisms of trust relationships and reputation. Market economies operate with far more coordination and cooperation than the model of unrestricted greed allows. The simplistic account of human motivation based on self interest comprehensively fails to recognise the real complexities of human behaviour. 

So what are the real strengths of the market economy? There are three components. Prices act as signals; the operation of the price mechanism is a better guide to resource allocation than central planning. Markets function as a process of discovery – the chaotic process of experimentation through which a market economy adapts to change. And markets yield benefits from the diffusion of political and economic power. Prosperity and growth require that entrepreneurial energy should be focussed on the creation of wealth rather than the appropriation of other people's wealth. Decentralisation of authority and deconcentration of activity limit rent seeking.
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The lesson drawn from the crash of 1929 was the need for regulatory reform. In the United States, regulations were enacted to reduce the vulnerability of investors, lenders, banks, companies, and workers to unanticipated swings in financial markets. The lesson drawn from the recent spectacle – by some governments at any rate – was the need for intervention of a different sort. Recently envisioned legislation in the U.S. would supplement the capitalist system with new programs for health care, climate control and energy conservation. Yet the recent experience – the "speculative excesses" and the ensuing collapse – reveal a perverse financial sector and a dysfunctional business sector that are not well treated by enlarged regulation or enlarged public expenditure. In the felicitous term of President Sarkozy, the need is to refound capitalist systems in ways that will make them well-functioning again. This need is acute in the United States, where the perversion and deterioration of capitalist mechanisms appear to have left the economy with less dynamism as well as less business activity. It is profound in Europe, where capitalist mechanisms have long been hamstrung by Italian corporatism, French statism, German socialism, Scandinavian welfarism and the rest. 

Over the past decade I have maintained that countries would still benefit from the innovative activity of original thinkers, visionary entrepreneurs, canny investors, pioneering managers and devoted employees that – starting in the 19th century and in some countries ending in the 20th – drew an ever widening share of people in an ever-growing number of nations into engaging jobs, exciting explorations and remarkable commercial advances. I will try to explain, leaving for the last section the issues of instability and their resolution.
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The crash of 2008 exposed deep failures at the core of macroeconomic policymaking and macroeconomic thinking in the United States. The crisis's rapid spread from its epicenter on Wall Street to nearly the entire world underscored the interconnectedness of the global economy. The American purveyors of the ancien régime hope that a few superficial fixes will get us back on our way. This is not to be. Sustained and widespread future prosperity will require basic reforms in global macroeconomic governance and in macroeconomic science. Such reforms are never easy, as they require new ways of thinking. Yet business as usual could prove calamitous. This essay describes the reform path.
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Volume 4, Issue 2, October 2009

The current financial crisis has brought out a fatal flaw in the foundations of the economic theories that guided economic agents and regulators: the unwarranted claim to precision and robustness. In this article I try to diagnose this flaw and discuss possible remedies. I argue that actual agents are intrinsically less sophisticated than the models assume they are, and that the various proposals to sustain the models by appealing to as-if rationality all fail. I next consider behavioral economics as an alternative to the standard models, claiming that while they may allow for successful retrodiction, they do not hold out much promise for prediction. I also discuss the use of statistical models, arguing that they are subject to so many traps and pitfalls that only a handful of elite practitioners can be trusted to use them well. Finally, I offer some speculations to explain the persistence in the economic profession and elsewhere of these useless or harmful models.
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COMMENTS ON PAPER

By Pierre-André Chiappori
By David Hendry

The paper makes use of an Imperfect Knowledge Economics (IKE) approach to examine the rationale and scope of state intervention in asset markets. IKE recognizes that policy officials and market participants must cope with ever-imperfect knowledge of the causal mechanism driving market outcomes. In our IKE-based model of asset markets, price swings arise from participants' diverse interpretations of the effects of fundamentals on outcomes. Under IKE, the market is an imperfect mechanism for setting values. However, the paper argues that, within a range of prices, the market's allocation is superior to the allocation that would result if the state actively intervened into the price-setting mechanism. During periods of non-excessive prices, swings play an indispensible role in helping society to allocate scarce capital and the state should confine its intervention to setting the rules of the game, that is, ensuring transparency and eliminating other market failures. However, price swings can sometimes move far from levels consistent with most perceptions of longer-term fundamental values. If they do, the IKE approach calls for active intervention to dampen excessive movements. The paper proposes the use of official guidance ranges and discusses problems with their estimation. It also proposes an array of other excess countering measures and concludes with ideas on how regulators can better measure and manage systemic risk in the financial system.
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COMMENT ON PAPER

By Jeffrey D. Sachs

This is a theoretical paper in which we attempt to present an economic and sociological theory of entrepreneurship. We start from Schumpeter's idea in Theory of Economic Development that the economy can be conceptualized as a combination and innovations as new combinations. Schumpeter also spoke of resistance to entrepreneurship. By linking the ideas of combination and resistance, we are in a position to suggest a theory of capitalist entrepreneurship. An existing combination, we propose, can be understood as a social formation with its own cohesion and resistance – what may be called an economic order. Actors know how to act; and profit is low and even in these orders. Entrepreneurship, in contrast, breaks them up by creating new ways of doing things and, in doing so, produces entrepreneurial profit. This profit inspires imitators until a new order for how to do things has been established; and profit has become low and even once more. Entrepreneurship is defined as the act of creating a new combination that ends one economic order and clears the way for a new one. The implications of this approach for a number of topics related to entrepreneurship are also discussed.
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COMMENT ON PAPER

By Mark Granovetter

Driven by industrial innovation, in the last half of the 20th century the population of the United States attained, on average, a very high standard of living. Yet, in the first decade of the 21st century, large numbers of Americans are economically insecure. In this paper, I summarize the findings of my research into the ways in which over the past three decades the transformation of the dominant business model that prevails in the information and communication technology industries has contributed to the rise of economic insecurity in the United States. I describe how the Old Economy business model (OEBM) that was in place in the immediate post-World War II decades gave way to the New Economy business model (NEBM) that is now ubiquitous in U.S. high-tech industry. Under OEBM, an employee could hold the realistic expectation of a career with one company. Under NEBM, career employment depends much more on interfirm labor mobility, which in and of itself makes continuous employment less certain. Nevertheless, in the ICT industries, NEBM has been an engine of economic growth so that a strong demand for high-tech labor can potentially offset a lack of employment security with one company. Since the early 199'0s, however, this demand for high-tech labor has tended to be a demand for qualified lower-wage labor, which has meant that ICT companies have favored the employment of younger workers over older workers and of workers in developing nations over workers in the United States. At the same time, acting as both a motive for employing lower-wage labor and as a rationale for laying off experienced workers has been the adherence of U.S. corporate executives to the ideology that their companies should be run to “maximize shareholder value." The most important manifestation of the influence of this ideology on corporate resource allocation is the extent to which U.S. companies repurchase their own stock to support their stock prices. I conclude this essay by arguing that neither the ideology of maximizing shareholder value nor the practice of stock repurchases has any economic merit. Indeed both must bear the blame for contributing to the rise of economic insecurity in the United States.
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COMMENT ON PAPER

By Margaret M. Blair

Volume 4, Issue 1, January 2009

Hume's contribution to modern economics is normally thought of in terms of his early statement of the quantity theory of money, and to a lesser extent his views on trade and development. At a methodological level the influence from his empiricism is commonly traced to the development of econometrics. But if we explore his philosophy more fully, we find a much richer set of ideas which can illuminate the way we approach issues in modern economics. Here therefore we explore Hume's theory of human nature and his theory of knowledge in order to understand how he viewed economic behaviour as inherently bound up in other aspects of life. From this follows a perspective on the relations between economics and other disciplines (notably history, sociology and psychology) which may inform current explorations of these relations. This reading of Hume's approach to economics is illustrated by revisiting his theories of money and growth, and his approach to empiricism. Hume holds the potential for a much richer contribution to modern economics than is normally understood.
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COMMENT ON PAPER

By Carl Wennerlind

Freud supposedly said that Nietzsche knew himself better than anyone who ever lived or is likely to live in the future. If the story is true, it's one of the best compliments of all time. Yet Nietzsche's psychological theories remain largely unknown to psychologists, philosophers and certainly to economists. These theories, taken together, constitute a profound attack on the foundations of neoclassical models in which individuals maximize the discounted flow of gratification they expect to receive. Scattered through Nietzsche's writings, we can find an alternative description of intertemporal choice motivated by overcoming obstacles. A principal objective of this paper is to show how Nietzsche's theory of overcoming can explain a great deal of observable behavior and solve important problems in economics.
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COMMENT ON PAPER

By James J. Heckman

RESPONSE BY AUTHOR

To James J. Heckman

Volume 3, Issue 3, November 2008

We have recently proposed an alternative approach to economic analysis, which we call Imperfect Knowledge Economics (IKE). Although IKE builds on the methodology of contemporary macroeconomics by modeling aggregate outcomes on the basis of mathematical representations of individual decision making, it jettisons models that generate sharp predictions. In this paper, we elaborate on and extend the arguments that led us to propose IKE. We show analytically that in order to avoid the fundamental epistemological flaws inherent in extant models, economists must stop short of fully prespecifying change. We also show how acknowledging the limits of their knowledge may enable economists to shed new light on the basic features of observed time-series of market outcomes, such as fluctuations and risk in asset markets, which have confounded extant approaches for decades.
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COMMENT ON PAPER

By Edmund S. Phelps

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COMMENT ON PAPER

By Edmund S. Phelps

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COMMENT ON PAPER

By Edmund S. Phelps

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COMMENT ON PAPER

By Edmund S. Phelps

Volume 3, Issue 2, July 2008

This article explains the basis for a theory of economic forecasting developed over the past decade by the authors. The research has resulted in numerous articles in academic journals, two monographs, Forecasting Economic Time Series, 1998, Cambridge University Press, and Forecasting Nonstationary Economic Time Series, 1999, MIT Press, and three edited volumes, Understanding Economic Forecasts, 2001, MIT Press, A Companion to Economic Forecasting, 2002, Blackwells, and the Oxford Bulletin of Economics and Statistics, 2005. The aim here is to provide an accessible, non-technical, account of the main ideas. The interested reader is referred to the monographs for derivations, simulation evidence, and further empirical illustrations, which in turn reference the original articles and related material, and provide bibliographic perspective.
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COMMENT ON PAPER

By Neil R. Ericsson

The 2008 U.S. financial upheaval raises important questions about the sources of household consumption and debt growth, along with their macroeconomic effects. We argue that spending and financial preferences evolve as social norms interact with both cultural trends and institutional changes in household finance. We identify historical forces that raised consumption and debt over the past quarter century and interpret these events with Hyman Minsky's financial cycle framework. Strong consumption helped moderate recessions and boost growth since the mid 1980s. But unprecedented household debt has now culminated in a financial crisis that threatens to cause a deep recession.
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COMMENTS ON PAPER

By George A. Akerlof
By Doug Korty (from Volume 3, Issue 3)

This essay examines the economics of patronage in the production of knowledge and its influence upon the historical formation of key elements in the ethos and organizational structure of publicly funded 'open science.' The emergence during the late sixteenth and early seventeenth centuries of the idea and practice of 'open science' was a distinctive and vital organizational aspect of the Scientific Revolution. It represented a break from the previously dominant ethos of secrecy in the pursuit of Nature's Secrets, to a new set of norms, incentives, and organizational structures that reinforced scientific researchers' commitments to rapid disclosure of new knowledge. The rise of 'cooperative rivalries' in the revelation of new knowledge, is seen as a functional response to heightened asymmetric information problems posed for the Renaissance system of court-patronage of the arts and sciences; pre-existing informational asymmetries had been exacerbated by the claims of mathematicians and the increasing practical reliance upon new mathematical techniques in a variety of 'contexts of application.' Reputational competition among Europe's noble patrons motivated much of their efforts to attract to their courts the most prestigious natural philosophers, was no less crucial in the workings of that system than was the concern among their would-be clients to raise their peer-based reputational status. In late Renaissance Europe, the feudal legacy of fragmented political authority had resulted in relations between noble patrons and their savantclients that resembled the situation modern economists describe as `common agency contracting in substitutes' - competition among incompletely informed principals for the dedicated services of multiple agents. These conditions tended to result in contract terms (especially with regard to autonomy and financial support) that left agent client members of the nascent scientific communities better positioned to retain larger information rents on their specialized knowledge. This encouraged entry into their emerging disciplines, and enabled them collectively to develop a stronger degree of professional autonomy for their programs of inquiry within the increasingly specialized and formal scientific academies (such the Académie royale des Sciences and the Royal Society) that had attracted the patronage of rival absolutist States of Western Europe during the latter part of the seventeenth century. The institutionalization of 'open science' that took place within those settings is shown to have continuities with the use by scientists of the earlier humanist academies, and with the logic of regal patronage, rather than being driven by the material requirements of new observational and experimental techniques.
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COMMENT ON PAPER

By Kenneth J. Arrow

Volume 3, Issue 1, January 2008

This paper describes the strategies and tactics that Oxford University has developed over a ten-year period to address the conflicting demands of the traditional university responsibilities of teaching and research, with the so-called third stream needs of more direct economic development.

The approach has been based on a clear policy definition of the ownership of Intellectual Property Rights, and the allocation of university resources to encourage, and support researchers in protecting and commercialising inventions.

The result has been a marked increase in disclosures and successful commercial development, through licences, consultancy and spinout companies, generating returns to the researchers, university and regional economy.

The increasing tide of publications reporting threats to academic freedom from commercialisation and the generation of liabilities and any number of other dangers to universities, have led us to investigate the possibility of balancing the apparently conflicting objectives of maintaining a vibrant, curiosity-led research university whilst at the same time increasing its contribution to local, and national, economic development.
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COMMENT ON PAPER

By Richard K. Lester

Family firms are very prominent in many parts of the world, including in many of the most dynamic emerging markets. They are often thought to be associated with poor corporate and political governance. This article examines the debate about their durability and efficiency, using material drawn from the long experience of continental Europe and sketches out an ideal type of the family, in which there is a historical experience of entrepreneurship, a brand, and a network built around family enterprise. It then tests various common explanations for the prevalence of family firms, including Roman law versus common law traditions, tax incentives, share voting privileges, and inheritance law; and finds that each applies only in a quite particular historical epoch. Finally, the article suggests that family businesses offer advantages that are most apparent at times of shocks and discontinuities, and that they are thus a response to uneven development.
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COMMENT ON PAPER

By Randall Morck

In this work we discuss the impact of the new ICT techno-economic paradigm upon the vertical and horizontal boundaries of the firm and ask whether the change in the sources of competitive advantage has resulted in changes in the size of distribution of firms and also in the degree of concentration of industries. Drawing both on firm-level and national statistical data we assess the evolution of the overall balances between the activities which are integrated within organizations and those which occur through market interactions.

While the new paradigm entails revolutionary changes in the domain of technology, the modification in industrial structures has been somewhat more incremental. Certainly, the vertical and horizontal boundaries of firms have changed and together one is observing a turnover in the club of biggest world firms, accounting also for a shift in the relative importance of industrial sectors. Nonetheless, we do not observe any abrupt fading away of the Chandlerian multidivisional corporation in favour of smaller less-integrated firms.
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COMMENTS ON PAPER

By William Lazonick
By Richard N. Langlois (from Volume 3, Issue 2)

Volume 2, Issue 2, November 2007

The conventional wisdom is that the surge in productivity growth which has surged in the United States over the past 15 years has been attributed almost wholly to advances in the production and use of information technology. While this is certainly evident from the statistics, a driving force behind the IT revolution has been the development and growth of new firms. Indeed, the U.S. economy has achieved a remarkable transformation over the last several decades from an economy characterized by large, bureaucratic firms into one increasingly powered by entrepreneurial innovation. The challenge ahead therefore is to cement and strengthen the entrepreneurial form of capitalism. In this paper, we provide a framework for policymaking to achieve this objective.
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COMMENT ON PAPER

By Benjamin M. Friedman

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COMMENT ON PAPER

By Jean-Laurent Rosenthal

 

Volume 2, Issue 1, March 2007

A rapidly expanding empirical literature has addressed the widely accepted claim that employment-unfriendly labor market institutions explain the pattern of unemployment across countries. The main culprits are held to be protective institutions, namely unemployment benefit entitlements, employment protection laws, and trade unions. Our assessment of the evidence offers little support for this orthodox view. The most compelling finding of the cross-country regression literature is the generally significant and robust effect of the standard measure of unemployment benefit generosity, but there are reasons to doubt both the economic importance of this relationship and the direction of causation. The micro evidence on the effects of major changes in benefit generosity on the exit rate out of unemployment has been frequently cited as supportive evidence, but these individual level effects vary widely across studies and, in any case, have no direct implication for changes in the aggregate unemployment rate (due to "composition" and "entitlement effects"). Finally, we find little evidence to suggest that 1990s reforms of core protective labor market institutions can explain much of either the success of the "success stories" or the continued high unemployment of the large continental European countries. We conclude that the evidence is consistent with a more complex reality in which a variety of labor market models can be consistent with good employment performance.
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COMMENT ON PAPER

By James J. Heckman

Economists have a great deal of influence on the legislative and judicial branches of government. This is good. But, the dominance of economics in Washington has led to the undervaluation of other social sciences. This paper explores the limitations of a traditional economics approach, the benefits of the consideration of behavioral decision research and behavioral economics, and an analysis of how this pattern affected decision making in three distinct episodes.
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COMMENT ON PAPER

By Jonathan Baron

Corrupt politicians, and poor government more generally, are commonly viewed as a primary barrier to economic progress. The roots to these problems run deep in many political systems across the developing world, and attempts at reform have rarely found much success. To combat this impasse, we suggest a radical new approach to local politics that, instead of proposing reforms to the electoral process, focuses on the political actors that might enter into this process. Specifically, we suggest that private firms be allowed to compete in elections to hold public office. That is, a corporate entity (e.g., Ernst and Young), rather than an individual representative of the firm, would be permitted to contest a local election. We argue that this is feasible: sufficient economic incentives could be put in place to induce firms to run for office, particularly if company office-holders prove to be competent in revenue collection. More importantly, we claim that there are many channels through which company politics should improve government, from breaking up entrenched old boys' networks to leveraging a company's existing organizational expertise. Private firms have realized efficiency and performance gains in areas such as infrastructure and many bureaucratic functions; we argue that the private sector can also attain results in politics, the most public of all realms.
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COMMENT ON PAPER

By Niall Ferguson

Volume 1, Issue 3, December 2006

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COMMENT ON PAPER

By Rakesh Khurana and Scott Snook

Over the course of the nineteenth and twentieth centuries, the United States evolved from a colonial backwater to become the pre-eminent economic and technological power of the world. The foundation of this evolution was the systematic exploitation and application of technology to economic problems: initially agriculture, transportation, communication and the manufacture of goods, and then later health care, information technology, and virtually every aspect of modern life.

From the beginning of the republic, the patent system has played a key role in this evolution. It provided economic rewards as an incentive to invention, creating a somewhat protected economic environment in which innovators can nurture and develop their creations into commercially viable products. Based in the Constitution itself, and codified in roughly its modern form in 1836, the patent system was an essential aspect of the legal framework in which inventions from Edison's light bulb and the Wright brothers' airplane to the cell phone and Prozac were developed. 

In the last two decades, however, the role of patents in the U.S. innovation system has changed from fuel for the engine to sand in the gears. Two apparently mundane changes in patent law and policy have subtly but inexorably transformed the patent system from a shield that innovators could use to protect themselves, to a grenade that firms lob indiscriminately at their competitors, thereby increasing the cost and risk of innovation rather than decreasing it.

Examples of dysfunctional patent behavior have become staples of the business and popular press. They range from the amusing and economically irrelevant, to not-so-funny cases that seriously threaten important technologies in important industries:

• Patents on inventions that are trivially obvious, such as the "Method for Swinging on a Swing," "invented" by a five-year-old, and "User Operated Amusement Apparatus for Kicking the User's Buttocks" ("invented" by a supposed grown-up);
• Patents in areas new to patenting, but covering purported discoveries familiar to practitioners and academics alike, such as Amazon.com's attempt to prevent Barnesandnoble.com from allowing customers to buy books with a single mouse-click, and a bright MBA student's patents on an option-pricing formula published in the academic finance literature two decades earlier;
• Patents that have become weapons for firms to harass competitors, such as the decade-long effort by Rambus, a semiconductor designer, to control computer memory technology by making sure that a long string of patents, all derived from a single 1990 patent application, incorporated important features of an industry-wide standard developed through a voluntary industry standard-setting association.

To major recent policy studies by the Federal Trade Commission (U.S. Federal Trade Commission, 2003) and the Board on Science, Technology and Economic Policy of the National Research Council (Merrill, Levin and Myers, 2004, cited hereinafter as "STEP Report") have recommended significant changes to address these issues. In this paper, we provide an overview of the issues and discuss possible changes to address the widely perceived shortcomings of the current system.
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COMMENT ON PAPER

By Lee Branstetter

During the Second Industrial Revolution of the late nineteenth and early twentieth centuries, Midwestern cities were important centers of innovation. Cleveland, the focus of this study, led in the development of a number of key industries, including electric light and power, steel, petroleum, chemicals, and automobiles, and was a hotbed of high-tech startups, much like Silicon Valley today. In an era when production and invention were increasingly capital-intensive, technologically creative individuals and firms required greater access to funds than ever before. This paper explores how Cleveland's leading inventors and technologically innovative firms obtained financing. We find that formal financial institutions, such as banks and securities markets, were of only limited significance. Instead our research highlights the vital role played by a small number of successful local enterprises that both exemplified the wealth-creation possibilities of the new technologies and served as hubs of overlapping networks of inventors and financiers. We conclude by suggesting that such nodal firms have spawned important clusters of innovative enterprises in other places and times as well.
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COMMENT ON PAPER

By Steven Klepper

Volume 1, Issue 2, August 2006

This essay falls into three parts. The first reviews the Second Industrial Revolution based on the commercializing of electrical and steam power and lasted from the 1880s through the 1920s. The leaders here were concentrated along the Rhine Valley from Basel in Switzerland to the Low Countries. That technology permitted these pioneering enterprises to market their products worldwide. Because World War I cut the Rhine Valley off from most markets, high technology enterprises in the United States and much of Europe were forced to build their own research and development units. The Rhine Valley re-entered global markets in the 1920s and precipitated what Joseph Schumpeter has termed "The decade of creative destruction." The 1929 Wall Street crash and the coming of the 1930s' Great Depression marked the close of the Second Industrial Revolution.

The second part is based on the new science of electronics and had its beginnings in the 1920s. The Radio Corporation of America commercialized new audio and video technologies. In the 1960s, RCA became a conglomerate and self-destructed allowing the Japanese firms Matsushita and Sony to capture markets world wide. In the 1950s, International Business Machines Company (IBM) commercialized four new electronic devices which led to the creation of Information Technology (IT) in the 1960s with the System 360 followed by the System 370 that dominated world markets. Then in the 1980s, largely by accident, four leading Japanese computer manufacturers successfully challenged the U.S. in the world market for computers.

The third part rests on the fact that high technology industries continue to depend on the commercializing of scientific learning as had occurred in the field of chemistry in the 1960s. Chemical companies in the 1960s were forced to commercialize new products based only on existing technologies. Biology, on the other hand, was creating the wholly new disciplines of microbiology and enzymology and then new sciences arose with the discovery of the double helix. Molecular biology and its offshoots of biotechnology and genetic engineering are just beginning to evolve.

I close with a review of four recent articles with a heading High Technology Ignored. Historical reality is reviewed here.
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COMMENT ON PAPER

By Richard Sylla

AUTHOR RESPONSE

To Richard Sylla

This lecture interprets the great tectonic shifts in the global economy that I have witnessed since I began studying economics in the 1950s. There are three stories of gaining ground ("catching up") on the world's lead economy and one of losing ground. This experience can help us to get right our international macroeconomics: Progress and prosperity in a country are mainly driven by envisaged openings for innovation or imitation of new things, not human capital formation or tax cuts. The experience also help us get right the political economy of economic performance: Dynamism is not required for episodes of high growth: Any economy can grow fast up to its potential and enjoy temporary prosperity in the effort. Yet it cannot pull up to the productivity level nor sustain the prosperity of the lead economy without having the latter's dynamism. Dynamism requires that innovation be ample, aimed in good directions and finding managers and consumers open to novelty. Some dissenters deny the premise, claiming that the Continent could not have its "glorious years" of rapid growth and high activity without commensurate dynamism: the two are yoked together. They view that rapid growth in Germany, France and Italy as the fruit of economies that in the '40s got back their dynamism back when Ludwig Erhard unshackled them from the corporatist institutions erected in the interwar years and that lost their dynamism in the '70s when interest groups reacquired their stranglehold on economic change. I take a simpler view. The glorious years were the result not of a brief rebirth of dynamism but rather the fortunate result of one-time opportunities to pluck at low cost the technologies and commercial successes developed in the U.S. and elsewhere overseas. My view need not suppose that the Continent has had much dynamism at any time since corporatist ideas took root in the late 1920s – only enough to imitate or adapt overseas advances, plus long enough study of them. For the moment, such advances may be still be so new that such a modicum of dynamism is not yet sufficient to spark imitation.
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COMMENT ON PAPER

By Axel Leijonhufvud

 

From David Ricardo making a fortune buying British government bonds on the eve of the Battle of Waterloo to Warren Buffett selling insurance to the California earthquake authority, the wisest investors have earned extraordinary returns by investing in the unknown and the unknowable (UU). But they have done so on a reasoned, sensible basis. This essay explains some of the central principles that such investors employ. It starts by discussing "ignorance," a widespread situation in the real world of investing, where even the possible states of the world are not known. Traditional finance theory does not apply in UU situations. Strategic thinking, deducing what other investors might know or not, and assessing whether they might be deterred from investing, for example due to fiduciary requirements, frequently point the way to profitability. Most big investment payouts come when money is combined with complementary skills, such as knowing how to develop real estate or new technologies. Those who lack these skills can look for "sidecar" investments that allow them to put their money alongside that of people they know to be both capable and honest. The reader is asked to consider a number of such investments.

Central concepts in decision analysis, game theory, and behavioral decision are deployed alongside real investment decisions to unearth successful investment strategies. These strategies are distilled into eight investment maxims. Learning to invest more wisely in a UU world may be the most promising way to significantly bolster your prosperity.
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COMMENTS ON PAPER

By Lawrence H. Summers
By Richard G. Robb

Volume 1, Issue 1, May 2006

Entrepreneurs may undertake bad projects because they unwittingly rely on defective or incomplete information to estimate the returns. Investors' concerns about such misjudgements are relatively low when the entrepreneurs' knowledge about their projects has been well calibrated. But if the novelty of the project (or some other unusual circumstance) makes calibration impossible, investors may reject the entrepreneur's funding request. This `novelty aversion' effect helps explain why ventures that are initially self-financed can subsequently attract outside financing without any decrease in standard 'incentive' or moral hazard problems. It also provides new insights about the differences in the investment preference and procedures of individual 'angel' investors, venture capital partnerships and large public companies.
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COMMENT ON PAPER

By Robert M. Solow

This paper analyzes how interacting financial development with initial income, macroeconomic volatility and policy variables, can improve our understanding of convergence and divergence across countries, and also restore the significance of correlations between growth and volatility and therefore between growth and macropolicy, even when controlling for country fixed effects or when eliminating countries with extreme policies or bad institutions.
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COMMENT ON PAPER

By Robert M. Solow

This paper argues that a number of "unorthodox" analyses of capitalism can be understood from the point of view of orthodox economic theory. Our argument is based on the assumptions of monopolistic competition and that utility derived from consuming an individual good is bounded. The model's predictions are consistent with some popular heterodox views, such as "In modern capitalist society, productivity is so high that many people are nearly saturated with goods;" "Productivity growth reduces the real consumption wage of workers;" and "The benefits from growth are appropriated by symbol manipulators." Furthermore, depending on relative levels of product diversity and physical productivity, globalization may harm poorer workers in LDCs, rather than unskilled workers in developed countries, as is usually predicted.
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COMMENT ON PAPER

By Robert M. Solow