defending the articles of confederation a reply to dougherty this reply addresses the issues raised bydougherty in response to my 1999 article in this journal ialso develop a new graphical model of the optimal collectionrate under the articles where states made contributions andcontrast it to the revenue potential from direct taxation ibelieve that despite dougherty s criticisms my argumentremains valid while the articles were not perfect in anabsolute sense that when more properly viewed in acomparative manner that the system of state contributions forraising revenue under the articles was and still is superiorto a system of direct federal taxation

do the russians really save that much alternate estimates from the russian longitudinal monitoring survey we use a new independent survey of 4000 russian households the russian longitudinal monitoring survey or rlms to study their saving behavior the rlms household saving rate 12 is less than half the official figure 29 despite the massive changes of the transition the russian household saving rate of 1994 cannot be shown to be different from that of 1976 the patterns of russian household saving differ from international experience its paradoxical u shaped saving age relationship may be explained by the dramatic deterioration of life expectancies of middle aged russians

politics time and the laffer curve why should a rationally motivated political decision process generate an inverse relationship between tax rates and tax revenues there would never seem a logical reason for increasing tax rates beyond maximum revenue limits in this note we explain how such a position can emerge and show why once in such a position political decision makers may find it difficult to escape

reverse revenue sharing a modest proposal while no claim is made that reverse revenue sharing is even from a private interest perspective the best fiscal arrangement it has been argued that it represents an improvement over current arrangements in important ways still reverse revenue sharing surely will be seen by most as a rather extreme proposal for some this will come from the fact that it is the public interest model of government that remains dominant in structuring their view of the political process but even those who accept the private interest model of government will see the proposal as extreme in terms of its political infeasibility the very considerations that make the decentralization of the reverse revenue proposal desirable i e reducing the power of political interest groups make it unlikely that it will generate enthusiastic political support indeed few things would provide more compelling evidence that reverse revenue sharing is a badly flawed proposal than the formation of an effective coalition of political interests in favor of it i conclude this paper with confidence that the case for reverse revenue sharing is completely safe from this damaging prospect

price setting supergames with capacity constraints this paper examines the role of industry capacity in enforcing collusion in the context of repeated games for a fixed capacity per firm it is shown that changes in the number of firms have a non monotone effect on the best enforceable cartel price this is due to the fact that while an additional firm lowers the share that each of the other firms enjoys at the collusive price it also increases the losses to each firm should the cartel fail

analytical approximations in models of hysteresis decisions made under ongoing uncertainty and costly reversibility entail a range of the state variable where inaction is optimal which in turn produces hysteresis permanent effects of temporary shifts the range is usually defined by non linear equations that need numerical solutions in this paper a technique of analytical approximations is developed and applied to two models menu costs and investment the resulting explicit solutions help clarify why hysteresis is important even for small irreversibility in the menu cost model hysteresis is two orders of magnitude larger than under the akerlof yellen or mankiw assumptions when decisions that are costly to reverse are made under conditions of ongoing uncertainty the optimum policy usually entails a range of inertia the action should be taken only when the value of the underlying state variable becomes especially favourable and reversed only when it becomes especially unfavourable there is an intermediate range over which inaction is optimal this in turn gives rise to hysteresis starting from a value in the range of inertia if the state variable crosses the action trigger point and then returns to its original level the action will be taken but not reversed thus a temporary change will leave a permanent effect numerical solutions for models of irreversible investment show that the range of inaction is remarkably large even when the cost of reversal is small see brennan and schwartz 1985 constantinides 1986 and dixit 1989a b for examples of this unfortunately the equations tlhat determine the optimum policy are highly non linear they do not have analytical solutions therefore we lack a clearer and more general understanding of why hysteresis is numerically so important in this paper i derive analytical approximations for the solutions of more general problems of this kind when the costs of change are small the idea that small costs of change induce large amounts of inertia has been popularized in the model of akerlof and yellen 1985 mankiw 1985 and others in these models second order small costs of making price changes yield price stickiness in response to first order changes in the money supply this is a simple application of the envelope theorem but these models are static and their application to a dynamic reality must assume either permanent shocks or static expectations when there is ongoing uncertainty which is rationally expected by the decision maker the option value of the status quo enlarges the zone where inaction is optimal adding these features to the mankiw akerlof yellen may model i show that fourth order small costs of change generate first order inertia

long run competition in capacity short run competition in price and the cournot model in this article we investigate the nature of equilibrium in markets in which firms choose the scale of operation before they make pricing decisions we analyze a duopoly model in which firms choose their capacities before engaging in bertrand like price competition we demonstrate that the cournot outcome is unlikely to emerge in such markets and that the equilibrium tends to be more competitive than the cournot model would predict in addition our results indicate a tendency toward asymmetric firm sizes and price dispersion that results from the mixed strategies firms use in equilibrium

income distribution and price controls targeting a social safety net during economic transition abstract during the ongoing post communist economic transitions the relative well being of many people is changing rapidly and governments are not well positioned to accurately measure individual living standards under such circumstances continued price controls over basic consumer goods within the state sector and the associated queuing can form a serviceable device for targeting poor people for subsidies with a fixed price state sector and free price parallel markets rich people might choose to avoid queues and shop in the free markets while poor people would prefer to pay low nominal prices and queue in the state sector the targeting of subsidies through queues therefore can be accomplished even if the government has no information concerning individual income or living standards when the alternative to price controls is a poorly targeted explicit social safety net the resource cost of queues might be more than offset by an improvement in the targeting of subsidies

privatization in eastern europe irreversibility and critical mass effects abstract this paper proposes a model to shed light on two important policy features of privatization in central and eastern europe the idea of a necessary critical mass of privatization on one hand and the great difficulties encountered in the actual privatization process on the other the model incorporates a positive externality related to the size of the private sector multiple equilibria may arise for political and economic reasons policies of free distribution are analysed with the model they may eliminate the danger of policy reversals due to excess unemployment but may at the same time increase the relative cost of restructuring leading in some cases to pareto inferior outcomes

price distortion and shortage deformation or what happened to the soap the model of this paper generalizes the classical theory of consumer behavior to the more general case of prices that are not necessarily market clearing suppose that in addition to the money cost some sort of search waiting or other quasi fixed effort cost is needed to obtain goods the presence of this quasi fixed cost element will trigger an inventory policy a shortage equilibrium occurs when effort costs are such that in the corresponding inventory policy the flow of desired consumption does not exceed the available supply flow stock hoarding a critical phenomenon in the economics of shortage emerges as a natural component of this model a complete characterization of a stationary shortage equilibrium is given comparative statics and welfare analysis are performed the dynamic transition between steady states is analyzed to give insight into the mechanics of how shortages develop copyright 1991 by american economic association

on the persistence of rationing following liberalization a theory for economies in transition abstract many economic theorists and policy makers argue that a rapid liberalization in which prices are allowed to equilibrate supply and demand is critical for a successful transition in the formerly socialist economies yet despite the advantages of market clearing prices many local governments in these economies have kept their prices for basic goods low and induced rationing in the state sector this paper develops a theory explaining why a local government chooses either a low state price that induces rationing or a higher price that clears the market the theory predicts that a necessary condition for a local government representing its constituents interests to set a market clearing price is that the private sector is monopolistic while a market clearing price in the state sector curtails private monopoly power it also implies that the state price is higher than in the rationing regime it is shown that a local government s marginal benefit of restraining private monopoly power is higher than the marginal costs of higher state prices when there is an increase in either state sector costs or private capacity this implies that a local government is more prone to set a market clearing price as its costs increase and as private capacity grows furthermore when there are at least two private firms and the private sector is monopolistic a local government that sets a market clearing price also stabilizes private sector pricing

profit efficiency for spanish savings banks abstract frontier profit efficiency is examined for spanish savings banks over 1986 1991 a period in which the spanish banking has seen considerable deregulation in spain the standard assumption that firms operate in a perfectly competitive output market is unlikely to be met thus we use an alternative profit function specification which allows for market power in the output market profit efficiency is determined using the thick frontier approach and estimated using both alternative and standard profit function specifications to illustrate the effect of different assumptions regarding the competitiveness of the output market estimation of the alternative profit function suggests that the profit inefficiency of spanish savings banks which averaged 28 fell by forty percent between 1986 to 1991 the standard profit function which we believe yields less reliable results generated greater average inefficiency there was no significant shift up or down in the profit frontier itself

intertemporal speculation shortages and the political economy of price reform price controls often focus on commodities that are storable and can thus be used in intertemporal speculation second opposition to dismantling of controls is often based on claims of low supply response and greatly bolstered if a strong supply response fails to materialise this is especially relevant in eastern europe where experience with markets is limited we show the difficulties that these two factors create for gradual decontrol of prices we endogenise the probability of a collapse of the reform programme and show that such endogeneity in the presence of intertemporal speculation leads to a strong case against gradualism the smaller the initial price increase the lower the observed supply elasticity and the greater the probability that the programme of reform will be abandoned this implies that the policy that makes most sense from a microeconomic point of view decontrol immediately is also advisable from a macroeconomic point of view credibility problems which are at the core of the transitional output losses that characterise most stabilisation programmes will be much less under a cold turkey approach and so will therefore transitional unemployment

pervasive shortages under socialism we present a new theory of pervasive shortages under socialism based on the assumption that the planners are self interested because the planners meaning bureaucrats in the ministries and managers offirms cannot keep the official profits that firms earn it is in their interest to create shortages of output and to collect bribes from consumers the theory implies that 1 an increase in the official price of a good might reduce output 2 market socialism is bound to fail even without computational complexities facing the planners and 3 price liberalization will succeed only iffirms get to keep their profits

the culture of policy making in the transition from socialism price policy in mongolia in this article we argue that the history of policy making can deeply influence current economic policy decisions in reforming socialist countries history s impact lies beyond the rigidity of inherited organizations it acts separately from the inherited allocation of power and property rights notions and practices that are a product of past historical experience are an autonomous force in the development of policy and they endure even when policymakers deeply desire change many labels could be attached to the phenomena we describe we have chosen the word culture because the most common interpretation of that term captures the essence of what we hope to convey the central element of culture a common set of beliefs and practices resulting from a shared historical experience is exactly the phenomenon on which we focus as explained in section ii our treatment of culture is consistent with standard methodology applied to a setting in which informational and learning processes are all important in fact our conclusions on mongolian price policy exemplify douglass c north s point that the historically derived perceptions of the actors shape the choices that they make and the imperfect and fumbling efforts of the actors reflect the difficulties of deciphering a complex environment with the available mental constructs ideas theories and ideologies 2 the article s stimulus was provided by observation of the tortuous progress of price reform in mongolia with much fanfare mongolia s government proclaimed a policy of rapid and complete price liberalization the commitment to liberalization was both genuine and widespread there was a general aspiration within society to move to a market economy however in the turn from abstraction to action the details of legislation the rules embodied in regulations and policy

a near rational model of the business cycle with wage and price inertia this paper presents a model in which insignificantly suboptimal behavior causes aggregate demand shocks to have significant real effects the individual loss to agents with inertial price wage behavior is second order in terms of the parameter describing the shock while the effect on real economic variables is first order thus significant changes in business activity can be generated by anticipated money supply changes provided that some agents are willing to engage in nonmaximizing behavior which results in small losses

the effects of wage distortions on the transition abstract before the reforms the chinese government had strong distributional objectives which it pursued mainly by direct controls over state enterprise wage rates and hiring decisions during the reform period similar controls over state enterprises continued but use of them had to reflect competition with the new nonstate sector that was mostly free from these controls based on these distributional considerations alone we can explain 1 a decline in the skills of workers in the state sector as the most able workers leave 2 higher productivity in the nonstate sector which consists of the most able workers 3 accounting losses in the state sector reflecting the transfer of tax revenue to finance higher wage payments to the unskilled and 4 restructuring within the state sector to reduce the distortions to relative wage rates

the power to tax analytical foundations of a fiscal constitution preface 1 taxation in constitutional perspective 2 natural government a model of leviathan 3 constraints on base and rate structure 4 the taxation of commodities 5 taxation through time income taxes capital taxes and public debt 6 money creation and taxation 7 the disposition of public revenues 8 the domain of politics 9 open economy federalism and taxing authority 10 toward authentic tax reform prospects and prescriptions epilogue notes selected bibliography index

marginal cost sharing and the articles of confederation between 1781 and 1789 the american states attempted to share the costs of national public goods through a system of requisitions this paper uses a simple public goods analysis to show why rational states would not share costs as intended by the articles of confederation this normative argument illustrates a potential flaw in the constitutional design of the articles and provides insight into the decline of the american confederation

an explicit solution for dynamic menu costs with zero discounting abstract in a dynamic stochastic environment small menu costs generate considerable inertia this paper uses the average cost criterion to analyse a model with zero discounting and considers the relationship between the discounted and zero discounting models of dynamic menu costs

economic crisis in a shortage economy it is not unusual for reforming socialist economies to relax wage controls without hardening budget constraints on enterprises or freeing consumer goods prices this policy can be dangerously destabilizing while higher wages permit workers to purchase more of some goods they also tend to exacerbate shortages and to breed waste and corruption beyond a certain level economywide wage hikes will worsen worker welfare this is true regardless of whether deficit goods are strictly rationed are sold randomly at official prices to queuing workers or are offered to workers by insiders only at black market prices however the form of allocation does influence the levels of output and welfare

economic reform and dynamic political constraints in this paper we examine the impact of political constraints on economic reform plans with special reference to the transition from centrally planned to market economies we analyse the problem of an agenda setting reform minded government facing a bureaucracy or industrial sector for which allocative efficiency requires redundancies and an increase in work intensity the government also tries to minimize the rents conceded to its heterogeneous workforce we examine two types of political constraints unanimity rule and majority rule both in a one period and a two period horizon the main results are the following first of all we show how adverse selection and time consistency may generate the widely observed feature of gradualism as an ingredient of an optimal reform second under a majority rule it is shown to be possible for the government to obtain a majority vote for a reform scheme that intertemporally hurts majority interests indeed the government can improve rent extraction through the strategic use of the threat of future proposals the group which expects to be in the minority tomorrow may accept concessions while its votes can be used to extract rents from another group these results suggest that in a dynamic context democratic constraints should not be overestimated as an obstacle against efficiency enhancing economic reforms the results of this paper may throw some light on the political economy of current reforms in eastern europe governments and political decision makers in general always face political constraints when elaborating reform proposals they know that the need to overcome potential opposition from various groups of the population constrains proposals for change political constraints vary depending on the specific institutional structure of society and are clearly different under a military dictatorship than under a parliamentary democracy the role of political constraints seems particularly important in eastern europe today where new democratic governments face the huge task of achieving the transition to a market economy while the introduction of democracy may have removed some important obstacles to economic change namely the veto power of a powerful nomenclatura under communist one party rule fears are expressed that it could potentially jeopardize economic reforms which may during the transition period hurt a majority of the population what can economic theory tell us about optimal economic reform under political constraints this paper starts addressing this ambitious question by looking at structural reform focusing on a restructuring of economic sectors which requires massive redundancies and a significant rise in labour productivity our model illustrates the case of planning

small menu costs and large business cycles a macroeconomic model of monopoly i introduction the conflict between modern neoclassical and traditional keynesian theories of the business cycle centers upon the pricing mechanism in neoclassical models prices are fully flexible they represent the continuous optimization of economic agents and the continuous intersection of supply and demand in keynesian models prices are often assumed to be sticky they do not necessarily equilibrate all markets at all times one of the reasons for the resurgence of the equilibrium approach to macroeconomics has been the absence of a theoretical underpinning for this keynesian price stickiness this note shows that sticky prices can be both privately efficient and socially inefficient the business cycle results from the suboptimal adjustment of prices in response to a demand shock to the extent that policy can stabilize aggregate demand it can mitigate the social loss due to this suboptimal adjustment in some keynesian models prices are simply exogenously fixed 2 in others agents must set their prices in advance of the transaction date the act of altering a posted price is certainly costly these costs include such items as printing new catalogs and informing salesmen of the new price yet these menu costs are small and therefore generally perceived as providing only a weak foundation for these fixed price models however this inference is flawed small menu costs can cause large welfare losses the claim that price adjustment costs are small does not rebut the claim that they are central to understanding economic fluctuations

why are prices sticky the dynamics of wholesale gasoline prices the menu cost interpretation of sticky prices implies that the probability of a price change should depend on the past history of prices and fundamentals only through the gap between the current price and the frictionless price we find that this prediction is broadly consistent with the behavior of nine philadelphia gasoline wholesalers nevertheless we reject the menu cost model as a literal description of these firms behavior arguing instead that price stickiness arises from strategic considerations of how customers and competitors will react to price changes

when higher incomes reduce welfare queues labor supply and macro equilibrium in socialist economies starting from a micro model of consumer behavior under rationing by queuing that utilizes gary becker s allocation of time framework we develop a simple macroeconomic model of a socialist economy the length of the queue is the key endogenous variable that equilibrates aggregate supply and aggregate demand comparative statics analysis shows that an increase in wages over money prices brings about longer queues that reduce labor supply output and welfare when shortages grow beyond a certain critical level queues fail to sustain aggregate equilibrium in the economy

in defense of the articles of confederation and the contribution mechanism as a means of government finance a general comment on the literature i attempt to dispel several widely held myths regarding government finance under the articles of confederation some of which were reiterated in dougherty and cain 1997 i defend the contribution mechanism as a method of government finance that is superior to direct taxation by the federal government and present evidence contradicting the belief that revenue collections under the articles were poor a proper comparison is with alternatives at that time such as state tax collections and the federal governments own tax collections under the new u s constitution both of which were lower than the collection rate from states under the articles