Working papers

We show how to extend the construction of infinite hierachies of beliefs (Mertens and Zamir (1985), Brandenburger and Dekel (1993)) from the case of probability measures to the case of conditional probability systems (CPSs) defined with respect to a fixed collection of relevant hypotheses. The set of hierarchies of CPSs satisfying common certainty of coherency conditional on every relevant hypothesis corresponds to a universal type space. This construction provides a unified framework to analyze the epistemic foundations of solution concepts for dynamic games. As an illustration, we derive some results about conditional common certainty of rationality and rationalizability in multistage games with observed actions.

This work focuses on the political determination of a public education policy within the context of a general equilibrium macroeconomic model. The primary objective of this paper is to study whether publicly funded education can emerge and be sustained as a political and economic equilibrium in an economy where individual agents are selfish, rational and forward-looking. I construct an overlapping generations general equilibrium model that endogenizes the large involvement of the public sector in human capital investment. The agents work for the first two periods of their lives and then retire during the third period. The first generation agents may also allocate resources to the acquisition of human capital, but they cannot borrow against their future income. In a political equilibrium where the rational and forward-looking agents of the two oldest generations vote for a level of public funding of education, public financing of education is motivated by the complementarity between capital and labor in the production function and appears as an instrument to compensate for the absence of credit markets. Thus, public funding of education does not have to be chosen because of altruism or externalities. In an economy calibrated using U.S. data, I can match the high shares of GNP allocated to education observed in the U.S. economy. The share of publicly funded education is an increasing function of GNP which mirrors the observed disparities across countries with different levels of development. Furthermore, an increase in the social security tax rate reduces the share of GNP allocated to publicly funded education which might help explain differences across countries with similar levels of development. The constructed economy also supports the existence of poverty traps for relatively low levels of income per capita. An interesting feature is that, if we do not allow the young agents to work, the economy will get out of these poverty traps and will converge to a steady-state with high levels of physical and human capital.

I include the variables wives age and cohort and children in a participation equation to explore how the following two economic issues affect participation. First, a structural change in terms of participation over the life-cycle. Because a structural change does not affect all women of the young cohorts, I distinguish between long-run participating women (i.e. those whose participation behaviour resembles that found after the structural change) and a priori inactive women (i.e. those with a traditional behaviour). Second, it explores the impact of current social policies on mothers participation. Despite that a negative correlation between children and mothers participation (especially pre-scholars) is considered a stylized fact in the literature, long-run participating women may not withdraw from the labour market after maternity to avoid the likely experience loss (i.e. real wage decline) due to long absences. This analysis is carryed out by exploiting a longitudinal Spanish survey (the ECPF). Despite some lacking variables, the use of panel data methods yields to satisfactory results.

Much of the recent growth and development literature is based on the notion that economies may exhibit multiple equilibria, due to coordination failures. Surprisingly, little attention has been given to analyze which economic institutions may solve such failures. We examine the role of banks as 'catalysts for industrialization. When there are limits to contracting, and complementarities exist among investments of different firms, we derive coordination costs endogenously and show that banks can acts as catalysts provided that: (i) they are sufficiently large to mobilize a critical mass of firms, and (ii) they possess sufficient market power to make profits from coordination. We also show that the costs of coordination depend critically on the contracting instruments available to banks. In particular, allowing banks to hold equity reduces and sometimes eliminates the cost of coordination. We use our results to interpret the patterns of early industrialization of Belgium, Germany, and Italy in the late 19th century. These countries experienced quick industrialization with the active involvement of large and powerful universal banks, which engaged in both debt and equity finance.

Now in:
Quo Vadis Europe, Ed. by H. Sibert, Kiel

At the core of the ongoing political and academic debate on European integration lies a fundamental question: what is the appropriate assignment of policy tasks to different levels of government? This paper asks what economic theory has to say about this normative problem. Our starting point is traditional economic theory, which approaches the question of policy assignment from the perspective of social welfare maximization by a Pigovian benevolent planner. Then, we discuss the political economics approach to this same question. Two themes run through the paper. The first theme is that, when allowing for political economy considerations, straightforward normative conclusions on the appropriate degree of centralization are much more difficult to draw. The second theme relates to the existence of complementarities between policy dimensions. Complementarities imply that, in the absence of clear constitutional safeguards, the process of European integration is unstable and fragile. We conclude with a discussion of how to combine flexibility and commitment in the process of European integration.

Now in:
Quarterly Journal of Economics, November 1997

Political constitutions are incomplete contracts and therefore leave scope for abuse of power. In democracies, elections are the primary mechanism for disciplining public officials, but they are not sufficient. Separation of powers between executive and legislative bodies also helps preventing the abuse of power, but only with appropriate checks and balances. Checks and balances work by creating a conflict of interests between the executive and the legislature, yet requiring both bodies to agree on public policy. In this way, the two bodies discipline each other at the voters advantage. Under appropriate checks and balances, separation of powers also helps the voters elicit information.

This paper measures the relation between job flows and stablishment size applying econometric techniques best suited for analysing the dynamics of large cross-section. Using a balanced panel from the Mexican Manufacturing sector, it shows that, in line with cross-country evidence, initially small firms create proportionally more jobs than large firms. Since these results suffer from regression toward the mean, the paper applies an alternative technique and it does not find long-run tendency of small establishment to converge toward the mean. Furthermore, it shows how cross-sectional dynamics varies across industries and how it is linked to gross and net flows in each sector. We observe convergence to the mean in relatively stable sectors and asymmetric dynamic behaviour between expanding and declining industries.

Now in:
Quintieri B. (a cura di), Finanza, Istituzioni e Sviluppo Regionale, Il Mulino, 1997

A literature has developed to substantiate Rosenstein-Rodans intuition that coordination of a critical mass of investments may induce industrialization through a big push. This literature has essentially ignored the question of what economic institutions may overcome the coordination failures which give rise to an underdevelopment trap. In this paper we propose that banks may act as a catalyst for the big push. Our work is motivated by historic evidence that suggest an association between a big push and the emergence of large banks. We develop a model based on Murphy, Shleifer and Vishny (1989) and show that a large bank with sufficient market power can induce the big push by coordinating the investments of a subset of firms in the economy. This creates a critical mass of demand that induces other firms to invest as well. A bank may coordinate firms directly, but more importantly indirectly, that is through the terms of its loans, offering either a low interest rate or investment guarantees. We also show that a overnment might in principle improve on the private market outcome (by subsidizing a banks coordination activities), but that problems of incentives, credibility and dynamic efficiency makes this difficult.

In this paper we focus on the post Bretton Woods period and analyze whether a PPP relationship holds and what is the speed of adjustment to it. We adopt a multivariate system approach in which, initially, we test for cointegration and then we try to identify a cointegration space in which we have the PPP relationship (the "Johansen approach"). The studies that have adopted this approach have always rejected the PPP in favour of a long run relationship between the real exchange rate and the interest rate differential. On the contrary, our conclusions are in favour of the PPP for all the cases considered when we allow for a structural break in the data. We arrive to this conclusion, after having identified the cointegration space in two different ways: one in which we have the PPP as a cointegrated vector and one in which the real exchange rate plus the interest rate differential is a cointegrated vector. Adopting a dominance criterion we choose the former identification. We al so address the Rogoffs (1996) puzzle on the excess volatility of real exchange rate and the slow convergence to PPP. On the basis of persistence profiles obtained from a constrained VECM, we dont find any evidence in favour of the puzzle since we estimate a relatively fast speed of adjustment.

Now in:
American Economic Review, May 1997 (shorter version)

How can monetary policy in stage III of European Monetary Union be coordinated between the "ins" and the "outs"? This paper compares alternative institutional mechanisms, and concludes that a generalized system of inflation targets at the European level has several merits. It strengthens domestic credibility of monetary policy. It rules out deliberate attempts to gain competitiveness through devaluations. It forces monetary policy to respond automatically to various macroeconomic shocks which is stabilizing for the real exchange rate. It distributes these shocks symmetrically across countries. On the basis of a simple theoretical model of policy coordination, the paper shows that a system of inflation targets approximates an optimal policy of international cooperation. Preliminary empirical evidence supports these theoretical results.

This article analyzes married womens labour force transitions in a Male Breadwinner Regime in the context of an Insider-Outsider economy. The argument of the article is that transitions behave differently when wives are in insider rather than outsider households, and when they are long-run participating wives rather than a priori non-participant wives. In other words, the puzzle is that the standard predictions of womens behaviour in a Male Breadwinner regime may not apply if the initial conditions change: 1) mothers may not respond as expected if they are in outsider households, and 2) highly educated mothers may not respond as expected if they studied because they intend to participate in the long run. The model is a simple Transition Model that assumes a First Order Markov Process. This model is convenient because it allows us to capture mover-stayer effects in combination with effects promoting participation and promoting inactivity. Spain turns to be an ideal case to apply the analysis. The data used is the Household Income and Expenditures Survey (ECPF, 1985-90).

Now in:
European Economic Review 42, 1295-1316, July 1998.

This paper uses the common agency approach to analyze the joint determination of product and labor market distortions in a small open economy. Capital owners and union members lobby the government on both tariffs and minimum wages, while other factors of production are not organized. The paper shows that product and labor market distortions always move in the same direction, and that their level is not modified by social pacts between capital and labor. It also shows that labor market distortions are second best. Hence, conditionality by foreign organizations should target distortions in product markets but not in labor markets.

This paper studies optimal redistribution among two different regions in a federal state. Regional governments supply local public goods financed with distorting local taxes. They have better information on their tax bases than the federal government. We model this both as an adverse selection problem on the size of local tax bases and/or as moral hazard problem on local tax enforcement. Moral hazard alone does not affect the first best redistribution rule, which is a lump sum transfer from the rich to the poor region. In all other cases the optimal transfer rule involves a lump sum tax on the rich regions and a premium for fiscal effort by the poor regions, with the transfer falling short of the first-best level. In the equilibrium with moral hazard and adverse selection, tax evasion occurs only in the poor region, even though the possibility of lax tax enforcement benefits the rich and harms the poor region because it reduces equilibrium redistribution.