Bilgehan Karabay

Lobbying Under Asymmetric Information

We analyze an informational theory of lobbying in the context of strategic trade policy. A home firm competes with a foreign firm to export to a third country. The home policy-maker aims to improve the home firms profit using an export subsidy. The optimal export subsidy depends on the demand conditions in the third country, which are unknown to the policy-maker. The home firm can convey this information to the policy-maker via costly lobbying. Surprisingly, the presence of lobbying costs can be advantageous for both: it makes the home firms lobby effort credible and eases the policy-makers information problem. We identify the conditions under which lobbying is beneficial on balance and the conditions under which it is harmful.

Pareto-Improving Firing Costs?

We examine self-enforcing contracts between risk-averse workers and risk-neutral firms (the ‘invisible handshake’) in a labor market with search frictions. Employers promise as much wage smoothing as they can, consistent with incentive conditions that ensure they will not renege during low-profitability times. Equilibrium is inefficient if these incentive constraints bind, with risky wages for workers and a risk premium that employers must pay. Mandatory firing costs can help, by making it easier for employers to promise credibly not to cut wages in low-profitability periods. We show that firing costs are more likely to be Pareto-improving if they are not severance payments, or (for affluent economies) if the economy is open.

Fast-Track Authority: A Hold-Up Interpretation.

A central institution of US trade policy is Fast-Track Authority (FT), by which Congress commits not to amend a trade agreement that is presented to it for ratification, but to subject the agreement to an up-or-down vote. We offer a new interpretation of FT based on a hold-up problem. If the US government negotiates a trade agreement with the government of a smaller economy, as the negotiations proceed, businesses in the partner economy, anticipating the opening of the US market to their goods, may make sunk investments to take advantage of the US market, such as quality upgrades to meet the expectations of the demanding US consumer. As a result, when the time comes for ratification of the agreement, the partner economy will be locked in to the US market in a way it was not previously. At this point, if Congress is able to amend the agreement, the partner country has less bargaining power than it did ex ante, and so Congress can make changes that are adverse to the partner. As a result, if the US wants to convince such a partner country to negotiate a trade deal, it must first commit not to amend the agreement ex post. In this situation, FT is Pareto-improving.

Optimal Regulation of Multinationals under Collusion

This paper analyses the optimal collusion-proof mechanism for the regulation of multinational firms (MNFs) in foreign direct investment (FDI) projects. There is a host country with a profitable investment opportunity. Either a multinational firm (MNF) or a local firm (LF) can undertake this project; nonetheless due to its firm-specific advantage, and the MNF has the potential to create a larger surplus. The host government faces an informational constraint such that it cannot observe the extra surplus the MNF can generate. Using this set-up, Karabay (2010) shows that employing foreign ownership restrictions to force a joint venture (JV) can help the host government to partially overcome its information disadvantage. In this paper, we extend Karabay (2010) by studying the host governments optimal regulatory policy when the MNF and the LF can collude. It turns out collusion imposes no cost on the host government and the expected welfare attained in the absence of collusion can still be secured under collusion.

Labor Market Regulation Under Self-Enforcing Contracts

This paper examines the effects of various labor market institutions on the welfare of workers and employers. We consider self-enforcing contracts between risk-averse workers and risk-neutral employers in a labor market with search frictions. Employers promise to smooth out shocks to wages while workers promise long-term commitment to employers. In this environment, any regulatory policy can make it easier or harder for employers to keep their promise of wage smoothing, thus influencing the benefit accruing to each party. In our approach, we analyze the joint effect of policies by distinguishing between the financing and spending of funds used in the regulation of the labor market. With regard to financing, firing taxes strictly dominate hiring and payroll taxes on efficiency grounds, whereas the relative ranking of hiring and payroll taxes depend on the type of equilibrium that realizes. On the spending side, while unemployment payment increases workers’ welfare at the expense of employers, in-work benefit in the form of a one-off wage subsidy leaves workers’ welfare intact but may increase the welfare of employers.

Vertical Fragmentation and International Sourcing

In a North-South model of international trade, we analyze the ways firms procure their inputs in the presence of relationship-specific investments and incomplete contracts. There are heterogenous final-good producers that are located in the North and compete in monopolistic competition. Production entails a well-defined sequence of highly complementary stages such that a failure in any one of them destroys the whole project. In this environment, we first characterize an equilibrium in which based on their productivity, firms decide where to buy their inputs in each production stage. While doing so, they also choose their ownership structure in order to alleviate the hold-up problem they face due to contract incompleteness. Next, we examine how within sectoral heterogeneity and variations in industry characteristics affect the relative prevalence of firms that choose to (i) procure inputs from different locations, and (ii) form different organizational structures.

Market Thickness, Labor Market Flexibility and Wage Dynamics

We study the role of search efficiency on wage dynamics and welfare. There are two sectors in the economy: a risk-free sector that employs workers only, and a risky sector with matching frictions that employs both workers and employers. Workers are risk-averse, whereas employers are risk-neutral. In the risky sector, contracts are incomplete; hence self-enforcing contracts are the only means to share risk. We show that improvements in search efficiency in the risky sector increases the average real wage and wage volatility in that sector as well as raising the (expected) real wage and wage volatility in the whole economy. Further, while the increase in search efficiency makes workers better off, its effect on employers depends on the parameters of the model. If the welfare of employers also improves, then this is a Pareto improvement.