On Modes of Economic Governance

I consider transactions involving asymmetric prisoners’ dilemmas between pairs of players selected chosen from two large populations. Games are played repeatedly, but information about cheating is not adequate to sustain cooperation, and there is no official legal system of contract enforcement. I examine how profit-maximizing private intermediation can supply the information and enforcement. I obtain conditions under which private governance can improve upon no governance, and examine why it fails to achieve social optimality.

Lawlessness and Economics: Alternative Modes of Governance

How can property rights be protected and contracts be enforced in countries where the rule of law is ineffective or absent? How can firms from advanced market economies do business in such circumstances? In Lawlessness and Economics , Avinash Dixit examines the theory of private institutions that transcend or supplement weak economic governance from the state. In much of the world and through much of history, private mechanisms--such as long-term relationships, arbitration, social networks to disseminate information and norms to impose sanctions, and for-profit enforcement services--have grown up in place of formal, state-governed institutions. Even in countries with strong legal systems, many of these mechanisms continue under the shadow of the law. Numerous case studies and empirical investigations have demonstrated the variety, importance, and merits, and drawbacks of such institutions. This book builds on these studies and constructs a toolkit of theoretical models to analyze them. The models shed new conceptual light on the different modes of governance, and deepen our understanding of the interaction of the alternative institutions with each other and with the government's law. For example, one model explains the limit on the size of social networks and illuminates problems in the transition to more formal legal systems as economies grow beyond this limit. Other models explain why for-profit enforcement is inefficient. The models also help us understand why state law dovetails with some non-state institutions and collides with others. This can help less-developed countries and transition economies devise better processes for the introduction or reform of their formal legal systems.property rights, contracts, law, business, economic governance, private mechanisms, arbitration, social networks, norms, sanctions, reform

Political Polarization

Failures of government policies often provoke opposite reactions from citizens; some call for a reversal of the policy while others favor its continuation in stronger form. We offer an explanation of such polarization, based on a natural bimodality of preferences in political and economic contexts, and consistent with Bayesian rationality.polarization; voting; information

Risk - adjusted rates of return for project appraisal

Incorporating risk assessment into public project appraisal makes sense when project risk is significantly correlated with uncertainty about national income. It is especially important in countries that specialize in particular agricultural or resource sectors. This report presents the following conclusions: (a) risk corrections can be substantial; (b) the intuition that risk is great for further investment in a crop or sector that constitutes a large part of a country's GNP is not invalid, but the effect may be offset by other forces in operation; (c) risk corrections can be negative because of a negative correlation between project return and GNP; (d) risk premia vary greatly across countries and sectors - so recognizing the risk correction needed for each project on its own merits makes more sense than including a common general risk premium in the rate of return required for all lending; (e) risk corrections are small for many sectors and countries - so efforts can be concentrated on the other categories, where the proposed treatment of risk makes a big difference; (f) risk affects investment projects in many different, subtle ways; and (g) resource requirements for this are not great.Environmental Economics&Policies,Health Economics&Finance,Banks&Banking Reform,Statistical&Mathematical Sciences,Crops&Crop Management Systems

Two-Tier Market Institutions

This paper models a hierarchical system for market governance. A monitoring agency detects any opportunistic behavior in each small sub- market or lower tier, using the superior information available at that level. Trade can occur across sub-markets. A small upper-level group of sub- market monitors arranges communication of the news of any cheating in one sub-market to all other sub-markets. I examine when and how such a system can overcome the diminishing returns to information acquisition and communication that have limited the scope and size of self-governing trading communities in the past. I then offer tentative suggestions for governance of globalized markets

Trade and Protection with Multistage Production

This paper analyzes trade in manufactured goods that are produced via a vertical production structure with many stages, where some value is added at each to an intermediate product to yield a good-in-process ready for the next stage. We consider the stage at which a good is traded to be an economically endogenous variable, with comparative advantage determining the pattern of production specialization by stages across countries. We study how endowment changes and policy shifts move the margin of comparative advantage, which thus provides a channel for resource allocation adjustment that is additional to the usual ones of factor substitution and changes in the quantity of output.

Irreversible Investment with Uncertainty and Scale Economies

This paper analyses optimal irreversible investment policy when profits are subject to a multiplicative geometric Brownian motion shock. The marginal product of capital is increasing initially and decreasing thereafter. In the latter range, optimal policy is familiar: capacity is added gradually as the shock rises to a threshold where the expected return on the marginal unit is a required multiple of the cost of capital. The multiple reflects the option value of waiting. The optimal policy in the increasing marginal product range obeys the same multiple, now applied to the total return on the discrete increase in capital. Implications for economic growth, and suboptimal equilibria under external economies, are examined.Scale economies, uncertainty, optimal irreversible investment policy, capital, economic growth, profits.

Environmental catastrophes and mitigation policies in a multiregion world

In this paper we present a simple model for assessing the willingness to pay for reductions in the risk associated with catastrophic climate change. The model is extremely tractable and applies to a multiregion world but with global externalities and has five key features: (i) Neither the occurrence nor the costs of a catastrophic event in any one year are precisely predictable; (ii) the probability of a catastrophe occurring in any one year increases as the levels of greenhouse gases in the atmosphere increase; (iii) greenhouse gases are a worldwide public bad with emissions from any one country or region increasing the risks for all; (iv) there is two-sided irreversibility; if nothing is done and the problem proves serious, the climate, economic activity, and human life will suffer permanent damage, but if we spend large sums on countermeasures and the problem turns out to be minor or even nonexistent, we will have wasted resources unnecessarily; and (v) technological progress may yield partial or even complete solutions. The framework that we propose can give a sense of the quantitative significance of mitigation strategies. We illustrate these for a core set of parameter values

Special-Interest Lobbying and Endogenous Commodity Taxation

This paper offers an initial exploration of a positive counterpart to the normative Ramsey-Diamond-Mirrlees theory of optimal commodity taxation. A model of lobbying for taxes and subsidies on production and consumption in an open economy is constructed, generalizing the Crossman-Helpman model of protection. It is found that the equilibrium of the lobbying process generally violates aggregate production efficiency, contrary to the normatively optimal policy. The outcome also differs markedly from the model of lobbying for protection: the equilibrium policy involves mostly production subsidies, not import tariffs.Equilibrium; Lobbying; Subsidies; Taxation; Taxes