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Annual Review of Economics - Volume 1, 2009
Volume 1, 2009
- Preface
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Some Developments in Economic Theory Since 1940: An Eyewitness Account
Vol. 1 (2009), pp. 1–16More LessAny psychologist who has studied eyewitness accounts knows first of all how unreliable they are. I therefore submit this informal account of some developments in economic theory without research, just as a set of recollections. It is also not an autobiography, nor a systematic account of my own work. Rather, I consider primarily those developments in economic theory that have had both general interest in the field and special concern for me. For example, as social choice theory is still a specialized field, I am not going to discuss it at all. Further, as it has turned out, I emphasize the developments of technique, although to some extent I refer to some of the underlying visions of the economy to which they are applied. To evaluate my eyewitness testimony, I give the reader some idea of my background and, in particular, the path that led me to be an economist and that has influenced my work and my perception of the development of economics in general. (As my friend Paul David keeps on reminding me and the rest of the world, all development is path-dependent.) I then follow up with four major aspects of economic research in the last 60 years, the period of my scholarly activity. One, econometric methodology and practice, is of such fundamental importance that it cannot go unnoticed, although I played no role in it. With the other three, general equilibrium, dynamic processes, and uncertainty and information, I was more intimately involved.
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School Vouchers and Student Achievement: Recent Evidence and Remaining Questions
Vol. 1 (2009), pp. 17–42More LessIn this article, we review the empirical evidence on the impact of education vouchers on student achievement and briefly discuss the evidence from other forms of school choice. The best research to date finds relatively small achievement gains for students offered education vouchers, most of which are not statistically different from zero. Furthermore, what little evidence exists regarding the potential for public schools to respond to increased competitive pressure generated by vouchers suggests that one should remain wary that large improvements would result from a more comprehensive voucher system. The evidence from other forms of school choice is also consistent with this conclusion. Many questions remain unanswered, however, including whether vouchers have longer-run impacts on outcomes such as graduation rates, college enrollment, or even future wages, and whether vouchers might nevertheless provide a cost-neutral alternative to our current system of public education provision at the elementary and secondary school level.
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Organizations and Trade
Vol. 1 (2009), pp. 43–64More LessWe survey an emerging literature at the intersection of organizational economics and international trade. We argue that a proper modeling of the organizational aspects of production provides valuable insights on the aggregate workings of the world economy. In reviewing the literature, we describe certain predictions of standard models that are affected or even overturned when organizational decisions are brought into the analysis. We also suggest potentially fruitful areas for future research.
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The Importance of History for Economic Development
Vol. 1 (2009), pp. 65–92More LessThis article provides a survey of a growing body of empirical evidence that points toward the important long-term effects that historic events can have on economic development. The most recent studies, using microlevel data and more sophisticated identification techniques, have moved beyond testing whether history matters and attempt to identify exactly why history matters. The most commonly examined channels include institutions, culture, knowledge and technology, and movements between multiple equilibria. The article concludes with a discussion of the questions that remain and the direction of current research in the literature.
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Technological Change and the Wealth of Nations
Vol. 1 (2009), pp. 93–120More LessWe discuss a unified theory of directed technological change and technology adoption that can shed light on the causes of persistent productivity differences across countries. In our model, new technologies are designed in advanced countries and diffuse endogenously to less developed countries. Our framework is rich enough to highlight three broad reasons for productivity differences: inappropriate technologies, policy-induced barriers to technology adoption, and within-country misallocations across sectors due to policy distortions. We also discuss the effects of two aspects of globalization, trade in goods and migration, on the wealth of nations through their impact on the direction of technical progress. By doing so, we illustrate some of the equalizing and unequalizing forces of globalization.
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CEOs
Vol. 1 (2009), pp. 121–150More LessThis article starts with an overview of the characteristics of chief executive officers (CEOs). I discuss the rising importance of general skills over firm-specific skills and the growing share of externally recruited CEOs. I also discuss possible reasons for the underrepresentation of women and the overrepresentation of family members in the corporate suite. I then review the three main explanations that have been put forward to explain the surge in CEO compensation over the past 30 years: principal-agent view, rent extraction view, and market-based view. I assess the strengths and weaknesses of each of these explanations in light of the existing empirical research. Finally, I review work on how entrenched CEOs or cognitively biased CEOs may cause corporate practices to deviate from the maximization of firm value.
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The Experimental Approach to Development Economics
Vol. 1 (2009), pp. 151–178More LessRandomized experiments have become a popular tool in development economics research and have been the subject of a number of criticisms. This paper reviews the recent literature and discusses the strengths and limitations of this approach in theory and in practice. We argue that the main virtue of randomized experiments is that, owing to the close collaboration between researchers and implementers, they allow the estimation of parameters that would not otherwise be possible to evaluate. We discuss the concerns that have been raised regarding experiments and generally conclude that, although real, they are often not specific to experiments. We conclude by discussing the relationship between theory and experiments.
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The Economic Consequences of the International Migration of Labor
Vol. 1 (2009), pp. 179–208More LessIn this paper, I selectively discuss recent empirical work on the consequences of global labor mobility. I examine how international migration affects the incomes of individuals in sending and receiving countries and of migrants themselves. Were a social planner to choose the migration policies that would maximize global welfare, she would need to know, among other values, the elasticities of wages, prices, taxes, and government transfers with respect to national labor supplies as well as how these parameters vary across countries. My goal is to evaluate the progress of the literature in terms of providing these inputs.
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The State of Macro
Vol. 1 (2009), pp. 209–228More LessFor a long while after the explosion of macroeconomics in the 1970s, the field looked like a battlefield. Over time, however, mainly because facts do not go away, a largely shared vision both of fluctuations and of methodology has emerged. Not everything is fine. Like all revolutions, this one has come with the destruction of some knowledge, and it suffers from extremism and herding. None of this is deadly, however. The state of macro is good.
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Racial Profiling? Detecting Bias Using Statistical Evidence
Vol. 1 (2009), pp. 229–254More LessWe review the economics literature that deals with identifying bias, or taste for discrimination, using statistical evidence. A unified model is developed that encompasses several different strategies studied in the literature. We also discuss certain more theoretical questions concerning the proper objective of discrimination law.
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Power Laws in Economics and Finance
Vol. 1 (2009), pp. 255–294More LessA power law (PL) is the form taken by a large number of surprising empirical regularities in economics and finance. This review surveys well-documented empirical PLs regarding income and wealth, the size of cities and firms, stock market returns, trading volume, international trade, and executive pay. It reviews detail-independent theoretical motivations that make sharp predictions concerning the existence and coefficients of PLs, without requiring delicate tuning of model parameters. These theoretical mechanisms include random growth, optimization, and the economics of superstars, coupled with extreme value theory. Some empirical regularities currently lack an appropriate explanation. This article highlights these open areas for future research.
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Housing Supply
Vol. 1 (2009), pp. 295–318More LessResearch on housing supply has grown owing to improved data combined with heightened interest in policies such as local land use regulations. Heterogeneity in supply conditions across markets is shown to be essential to understanding the growing price dispersion across metropolitan areas, as well as to understanding whether positive growth shocks to a metropolitan area manifest themselves more in terms of expanding population and homebuilding or in terms of higher wages and house prices. The nature of supply obviously also influences local housing-market dynamics. Recent research has shown that differences in the elasticity of housing supply can account for the wide variation in new construction volatility (but not price volatility) across markets over time. The extraordinary nature of the recent boom only increases the need to understand how housing-market fundamentals and supply and demand affect the functioning of this huge asset market.
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Quantitative Macroeconomics with Heterogeneous Households
Vol. 1 (2009), pp. 319–354More LessMacroeconomics is evolving from the study of aggregate dynamics to the study of the dynamics of the entire equilibrium distribution of allocations across individual economic actors. This article reviews the quantitative macroeconomic literature that focuses on household heterogeneity, with a special emphasis on the “standard” incomplete markets model. We organize the vast literature according to three themes that are central to understanding how inequality matters for macroeconomics. First, what are the most important sources of individual risk and cross-sectional heterogeneity? Second, what are individuals' key channels of insurance? Third, how does idiosyncratic risk interact with aggregate risk?
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A Behavioral Account of the Labor Market: The Role of Fairness Concerns
Vol. 1 (2009), pp. 355–384More LessIn this paper, we argue that important labor market phenomena can be better understood if one takes (a) the inherent incompleteness and relational nature of most employment contracts and (b) the existence of reference-dependent fairness concerns among a substantial share of the population into account. Theory shows and experiments confirm that, even if fairness concerns were to exert only weak effects in one-shot interactions, repeated interactions greatly magnify the relevance of such concerns on economic outcomes. We also review evidence from laboratory and field experiments examining the role of wages and fairness on effort, derive predictions from our approach for entry-level wages and incumbent workers' wages, confront these predictions with the evidence, and show that reference-dependent fairness concerns may have important consequences for the effects of economic policies such as minimum wage laws.
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Learning and Equilibrium
Vol. 1 (2009), pp. 385–420More LessThe theory of learning in games explores how, which, and what kind of equilibria might arise as a consequence of a long-run nonequilibrium process of learning, adaptation, and/or imitation. If agents' strategies are completely observed at the end of each round (and agents are randomly matched with a series of anonymous opponents), fairly simple rules perform well in terms of the agent's worst-case payoffs, and also guarantee that any steady state of the system must correspond to an equilibrium. If players do not observe the strategies chosen by their opponents (as in extensive-form games), then learning is consistent with steady states that are not Nash equilibria because players can maintain incorrect beliefs about off-path play. Beliefs can also be incorrect because of cognitive limitations and systematic inferential errors.
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Learning and Macroeconomics
Vol. 1 (2009), pp. 421–449More LessExpectations play a central role in modern macroeconomic theories. The econometric learning approach models economic agents as forming expectations by estimating and updating forecasting models in real time. The learning approach provides a stability test for rational expectations and a selection criterion in models with multiple equilibria. In addition, learning provides new dynamics if older data are discounted, if models are misspecified, or if agents choose between competing models. This paper describes the expectational stability (E-stability) principle and the stochastic approximation tools used to assess equilibria under learning. Applications of learning to a number of areas are reviewed, including the design of monetary and fiscal policy, business cycles, self-fulfilling prophecies, hyperinflation, liquidity traps, and asset prices.
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Sufficient Statistics for Welfare Analysis: A Bridge Between Structural and Reduced-Form Methods
Vol. 1 (2009), pp. 451–488More LessThe debate between structural and reduced-form approaches has generated substantial controversy in applied economics. This article reviews a recent literature in public economics that combines the advantages of reduced-form strategies—transparent and credible identification—with an important advantage of structural models—the ability to make predictions about counterfactual outcomes and welfare. This literature has developed formulas for the welfare consequences of various policies that are functions of reduced-form elasticities rather than structural primitives. I present a general framework that shows how many policy questions can be answered by estimating a small set of sufficient statistics using program-evaluation methods. I use this framework to synthesize the modern literature on taxation, social insurance, and behavioral welfare economics. Finally, I discuss problems in macroeconomics, labor, development, and industrial organization that could be tackled using the sufficient statistic approach.
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Networks and Economic Behavior
Vol. 1 (2009), pp. 489–511More LessRecent analyses of social networks, both empirical and theoretical, are discussed, with a focus on how social networks influence economic behavior, as well as how social networks form. Some challenges of such research are discussed as are some of the important considerations for the future.
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Improving Education in the Developing World: What Have We Learned from Randomized Evaluations?
Vol. 1 (2009), pp. 513–542More LessAcross a range of contexts, reductions in education costs and provision of subsidies can boost school participation, often dramatically. Decisions to attend school seem subject to peer effects and time-inconsistent preferences. Merit scholarships, school health programs, and information about returns to education can all cost-effectively spur school participation. However, distortions in education systems, such as weak teacher incentives and elite-oriented curricula, undermine learning in school and much of the impact of increasing existing educational spending. Pedagogical innovations designed to address these distortions (such as technology-assisted instruction, remedial education, and tracking by achievement) can raise test scores at a low cost. Merely informing parents about school conditions seems insufficient to improve teacher incentives, and evidence on merit pay is mixed, but hiring teachers locally on short-term contracts can save money and improve educational outcomes. School vouchers can cost-effectively increase both school participation and learning.
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