Abstract: In this paper I study how the make-or-buy decision of a firm depends on the organization of its peers. I consider a multi-firm framework in which firms choose whether to integrate into the supply of an intermediate input or to outsource its production, and choose the size of their supplier network if outsourcing. Firms find it optimal to share the same set of suppliers, as there are economies of scope in investment to suppliers taking multiple designs. These economies are due to spillovers of technical or operational know-how between projects and to savings in the setup costs on physical capital. The model admits multiple vertical equilibria that are Pareto-ranked, the one with the highest level of outsourcing being most efficient. Outsourcing is more likely in larger markets and when the economies of scope are stronger. The size of the optimal supplier network however typically decreases when the spillovers are stronger. These findings provide insight into the patterns of reorganization of vertical supply relations observed over the last two decades.

Keywords: Outsourcing, Vertical Integration, Spillovers, Supply relations

JEL Classification: L22, D23

[04-04] Gerald Marschke (with Pascal Courty). "A General Test of Gaming"

Abstract : An important lesson from the incentive literature is that explicit incentives may elicit dysfunctional and unintended responses, also known as gaming responses. The existence of these responses, however, is difficult to demonstrate in practice because this behavior is typically hidden from the researcher. We present a simple model showing that one can identify gaming by estimating the correlation between a performance measure and the true goal of the organization before and after the measure has been activated. Our hypothesis is that gaming takes place if this correlation decreases with activation. Using data from a public sector organization, we find evidence consistent with our hypothesis. We draw implications for the selection of performance measures.

Keywords: Performance Incentive, Performance Measurement, Gaming, Multitasking, Government Organization.

JEL Classification H72, J33, L14

Key words: Patents; Innovation; Labor productivity; Research; Firm size

JEL Classification: O30, O32, O34, J21, J24

Key words: Patents; Innovation; Labor productivity; Research; Firm size

JEL Classification: O30, O32, O34, J21, J24

Abstract: In this paper, a likelihood ratio approach is taken to derive a test of the economic convergence hypothesis in the context of the linear deterministic trend model. The test is designed to directly address the nonstandard nature of the hypothesis, and is a systematic improvement over existing methods for testing convergence in the same context. The test is first derived under the assumption of Gaussian errors with known serial correlation. However, the normality assumption is then relaxed, and the results are naturally extended to the case of covariance stationary errors with unknown serial correlation. The test statistic is a continuous function of individual t-statistics on the intercept and slope parameters of the linear deterministic trend model, and therefore, standard heteroskedasticity and autocorrelation consistent estimators of the long-run variance can be directly implemented. Building upon the likelihood ratio framework, concrete and specific tests are recommended to be used in practice. The recommended tests do not require the knowledge of the form of serial correlation in the data, and they are robust to highly persistent serial correlation, including the case of a unit root in the errors. The recommended tests utilize the nonparametric kernel variance estimators, which are analyzed using the fixed bandwidth (fixed-b) asymptotic framework recently proposed by Kiefer and Vogelsang (2003). The fixed-b framework makes possible the choice of kernel and bandwidth that deliver tests with maximal asymptotic power within a specific class of tests. It is shown that when the Daniell kernel variance estimator is implemented with specific bandwidth choices, the recommended tests have asymptotic power close that of the known variance case, as well as good finite sample size and power properties. Finally, the newly developed tests are used to investigate economic convergence among eight regions of the United States (as defined by the Bureau of Economic Analysis) in the post-World-War-II period. Empirical evidence is found for convergence in three of the eight regions.

Keywords: Likelihood Ratio, Economic Convergence, β-convergence Hypothesis, Joint Inequality, HAC Estimator, Fixed-b Asymptotics, Power Envelope, Unit Root, Linear Trend, BEA Regions.

Abstract: This paper proposes powerful and serial correlation robust test statistics that can be used to test for the presence of structural change in the trend function of a univariate time series. Four models are analyzed, each model corresponding to a different way in which a trend break might occur. Given a model, the proposed tests are designed to detect a single break at an unknown date. The tests do not require the knowledge of the form of serial correlation in the data, and they are made robust to the presence of highly persistent serial correlation and a unit root in the errors by using a more comprehensive version of the scaling factor approach of Vogelsang (1998b). The tests utilize the popular nonparametric kernel variance estimators. The fixed-bandwidth asymptotic framework, proposed by Kiefer and Vogelsang (2003), is used to approximate the effects of the variance estimators on the test statistics. The fixed-bandwidth framework makes possible the choice of kernel and bandwidth that deliver tests with maximal asymptotic power within a specific class of tests. For each of the proposed tests, concrete and specific recommendations are made for the bandwidth and kernel to be used in practice. The recommended tests are shown to have good finite sample size and power properties.

Key words: National Survey of Veterans, Health Care Demand, Two Stage Count Data Model, Nested Logit, Copayments, Shadow Cost, Consumer Surplus, CBOCs.

JEL classification: I12, I28, C35.

Abstract: In this paper we solve a continuous-time model of investment with uncertainty, irreversibility and a broad class of lumpy adjustment costs. In addition to being general, our solution is quite tractable and intuitive. We show that, in contrast to standard results, the marginal value of capital jumps when investment is undertaken. We also find that firms facing higher uncertainty let their capital stock depreciate further before they invest, but increase their capital by a similar proportion once they do invest. We extend both the user cost and q theories of investment to incorporate lumpy investment. We confirm that with lumpy investment, a variant of Tobin's q can be a better predictor of investment than marginal q.

Abstract: Using data from the Health and Retirement Survey (HRS) and Assets and Health Dynamics of the Oldest Old (AHEAD), this paper presents estimates of the stochastic process that determines both the distribution and dynamics of health costs. We find that the data generating process for health costs is well represented by an ARMA(1,1). Furthermore, innovations to this process are close to lognormally distributed. In any given year, .1% of our sample receives a health cost shock that costs at least $80,000 in present value. Lastly, we discuss the accuracy of numerical solutions when integrating over health costs. Assuming lognormality, simple approximation rules work well.

Abstract: In August 1996, Congress passed the Personal Responsibility Work Opportunities Reconciliation Act (PRWORA). This act eliminated Aid to Families with Dependent Children (AFDC), the largest source of cash assistance available to needy families, and replaced it with Temporary Assistance to Needy Families (TANF), a time-limited program with stringent work requirements. Because one of the elements vital to the success of welfare reform is the ability of mothers to transition from the welfare rolls into the labor market, states are investing a great deal of money in childcare. In this paper, we find that the decision to participate in covered-sector jobs of former welfare recipients is responsive to both the cost of childcare as well as the density of available childcare. The elasticity with respect to density is around 0.5, whereas the elasticity with respect to the price paid is about -0.4. There is no statistically significant impact of childcare variables on the decision to participate in jobs that are not covered by unemployment insurance (UI). Since jobs not covered by UI are likely to be lower paid and less durable than jobs in the covered sector, our results suggest that both the price and availability of childcare are important determinant of transitions from welfare to stable employment.

Keywords: Childcare availability, childcare elasticity, welfare reform

JEL Classification: I38, J22

Abstract: The current paper looks at the nonmarital teenage childbearing behavior of two cohorts of NLSY women. It constructs a monthly panel of information for the teens from the time they are twelve years old until they have a nonmarital birth, reach the end of their third survey without giving birth, get married, or reach age 18. The research attempts to identify the factors that have contributed to the differences in teenage childbearing behavior that we observe across the cohorts of women by estimating a Cox proportional hazard model, stratified on race, age of mother a the birth of her first child, and the rate of marriage in the state. The model identifies education, living situations, religion, and welfare policy as factors. Specifically, for the youths of the 1990s, the introduction of restrictions on living conditions, the so-called minor parent provisions, act as a retardant to nonmarital childbearing. The model also shows that higher education for the youth and her mother delay childbearing for both cohorts of women. Finally, living with one's biological father at age 14 is linked with delayed childbearing, with hazard rates nearly 60 and 40 percent lower for teens of the two cohorts.

Keywords: Nonmarital childbearing, NLSY79, NLSY97

JEL Classification: J13, I38

Abstract: This paper studies a particular kind of gaming responses to explicit incentives in a large government organization. The gaming responses we consider occur when agents strategically report their performance outcomes to maximize their awards. An important contribution of this work is to examine whether this behavior diverts resources (e.g. agents' time) from productive activities or whether it simply reflects an accounting phenomenon. We evaluate the efficiency impact of the behavior we identify and find that it has a negative impact on the true goal of the organization.

JEL Classification: J33, L14

Abstact: This paper examines the effects of performance incentives in a federal job training program for the economically disadvantaged. I find that job training bureaucrats respond to incentives in ways that are consistent with a simple model of bureaucratic behavior. Additionally I am able to test whether attempts by the program's incentive designers to improve the precision of performance measures in the late 1980s increased or decreased efficiency. I discuss my results in the context of the greater incentive literature, as well as the literature on incentives in job training programs.

JEL Classification: J41, J33, D73, I38

Abstract: Despite the broad interest in performance measurement during the past 20 years, few state and local governments actually use performance measures as a management tool. A possible reason for this puzzle is that performance measurement systems are difficult to successfully implement. In this paper we consider a case study of a public organization that uses performance measurement to influence decision making, and we analyze local decision makers' responses. We identify a dynamic process by which local decision makers respond in unanticipated and unintended ways, and the designer has to adapt the system to try to eliminate these responses. These results show that performance measurement systems have to be continuously monitored. We argue that this need for constant monitoring may make the use of performance measures uneconomical because they may generate more management problems than they actually solve.

JEL Classification: J41, J33, D73

Abstract: We present a model of how organizations manage performance measures when gaming is revealed over time. The incentive designer does not know when it selects a performance measure whether it will communicate the right behavior. Only over time does the principal find out the agent's responses and then uses this additional information to update and finetune the incentive system. Using data from a government organization, we test the model's main prediction that the correlation between the performance measure and the true goal of the organization should change after the performance measure is included in the incentive system and we find some evidence consistent with this hypothesis.

Keywords: Performance Incentive, Performance Measurement, Gaming, Multitasking, Government Organization.

JEL Classification: H72, J33, L14

Abstract: We present a model of how organizations manage performance measures when gaming is revealed over time. The incentive designer does not know when it selects a performance measure whether it will communicate the right behavior. Only over time does the principal find out the agent's responses and then uses this additional information to update and finetune the incentive system. Using data from a government organization, we test the model's main prediction that the correlation between the performance measure and the true goal of the organization should change after the performance measure is included in the incentive system and we find some evidence consistent with this hypothesis.

Key words: Patents; Innovation; Technology, Research productivity

JEL Classification: O30, O32, O34

Abstract: We introduce a model in which agents' sentiments toward others are determined endogenously on the basis of how they perform relative to a standard of appropriate behavior. As sentiments change, so too does the optimal behavior of each individual, which in turn affects other agents' sentiments toward them. We focus on fixed points of this reciprocal adjustment process. To demonstrate the potential use and implications of such a model, we present an extended example involving team production. We consider various standards of behavior, and we examine stationary patterns of behavior and sentiments under each.

JEL Classification: D64, D60, A13

Abstract: In this paper we present a model in which an individual's sentiments toward others are affected by how they behave relative to the societal norm. This, in turn, affects the individual's own behavior and hence other agents' sentiments toward her. We focus on stationary patterns of utility interdependence. To demonstrate the effects of such endogeneity, we consider an example of a production economy with redistributive taxation. There are two types of stationary equilibria: one in which all agents conform to the societal norm, and a second involving social stratification on the basis of productivity into two or three groups. The main conclusion is that the tax structure, in that it affects behavior which in turn affects sentiments, plays a crucial role in determining which type of equilibrium occurs and its characteristics as well as the extent of altruism and social cohesion in society.

JEL Classification: D64, Z13, H23

Key words: Endogenous Trade Policy; Portfolio Diversification; International Financial Markets; Liberalization

JEL classification: F13, F3, D52.

Abstract: Increases in a society's knowledge stock through educational investments, human capital accumulation, and learning by doing provide one foundation for achieving long-run growth. This paper examines the adverse influence of occupational risk on this foundation, and does so with specific attention paid to the role played by a country's trade policy regime. With occupational risk arising from stochastic productivity and a labor market search friction, the trade policy regime will influence the distribution of job opportunities for the talented segment of the population. These changes will affect individual education choices and the knowledge accumulated by society as a whole. In addition to determining the growth implications of alternative trade policy regimes, the paper provides further insight into the continuing debate regarding the impact of trade liberalization on employment opportunities.

Key words: TradePolicy; Growth; Education; Uncertainty; Employment

JEL classification: O4, F4, F13.

Abstract: We develop and test a model of the patenting and R&D decisions of an innovating firm whose researcher-employees sometime quit to join or start a rival. In our model, the innovating firm patents to protect itself from its workers. We show theoretically that the risk of a scientist's departure raises the firm's propensity to patent an innovation and reduces its research expenditures, which is confirmed in our empirical study of firm-level panel data. Our results suggest that the scientists' turnover partly explains cross-industry patenting variation, recent increases in patenting, and why small firms have high patent-R&D ratios.

Key words: Labor market for scientists and engineers, patents, research and development, job turnover, mobility of scientists

JEL classification: J63, O32, O34.

Abstract: In this paper, we provide a theoretical explanation of why financial liberalization is likely to generate financial crises in emerging market economies. We first show that under financial repression the aggregate capital stock and bank net worth are both likely to be low. This leads a newly liberalized bank to be highly levered, because the marginal product of capital---and thus loan interest rates---are high. The high returns on capital, however, also make default unlikely, and they encourage the bank to retain all of its earnings. As the bank's net worth grows, aggregate capital rises, the marginal product of capital falls and a banking crisis becomes more likely. Although the bank faces conflicting incentives toward risk-taking, as net worth continues to grow the bank will become increasingly cautious. Numerical results suggest that the bank will reduce its risk, by reducing its leverage, before issuing dividends. We also find that government bailouts, which allow defaulting banks to continue running, induce significantly more risk-taking than the liability limits associated with standard bankruptcy.