Karla Hoff

Moneylenders and bankers: price-increasing subsidies in a monopolistically competitive market

Abstract In many areas of the world, a significant part of the cost of obtaining a good or service is the cost of enforcing the contracts entailed in its provision. We present models of markets with endogenous enforcement costs, motivated by studies of rural credit markets. We show that subsidies may have perverse effects under monopolistic competition, increasing prices or inducing exit. Higher prices (interest rates) result from the loss of scale economies or from negative externalities among suppliers. The models are consistent with the puzzling evidence that infusions of government-subsidized formal credit have not improved the terms offered by moneylenders.

Discrimination, Social Identity, and Durable Inequalities

What are the mechanisms by which societal discrimination affects individual achievement, and why do the effects of past discrimination endure once legal barriers are removed? We report the findings of two experiments in village India that suggest that the mechanisms of discrimination operate, in part, within the individuals who are members of the groups who have been discriminated against. We demonstrate that publicly revealing an individual’s membership in such a group alters his behavior in ways that make the effects of past discrimination persist over time. A growing literature in social psychology on stereotype threat finds that stereotyped-based expectations affect individual performance in the domain of the stereotype. A study by Jeff Stone et al. (1999) is illustrative. When college students were asked to perform a task described as diagnostic of “natural athletic ability,” blacks—stereotyped as better athletes, but worse students than whites—performed better than whites. When the same test was presented as diagnostic of “sports intelligence,” the performance of blacks declined, that of whites improved, and the racial gap was reversed. Evidence suggests that a mediating factor in stereotype threat is a change in self confidence (Mara Cadinu et al., 2005) In our studies, we investigated whether the public revelation of social identity (caste) affects cognitive task performance and responses to economic opportunities by young boys in village India. Subjects were sixth and seventh graders drawn from the two ends of the caste hierarchy. We asked subjects to learn and then perform a task under incentives, and we manipulated whether their peers in the experimental session knew their caste. Caste is well-suited to this manipulation because, unlike race, gender, and ethnicity, there are no unambiguous outward markers of caste among young boys. Six subjects, generally from six different villages, participated in each experimental session. In the control condition, the subjects were anonymous within the six-person group. In the experimental conditions, the experimenter publicly revealed subjects’ names and caste. In the task—solving mazes—in which performance was studied here, the low-caste subjects in the anonymous condition did not perform significantly differently from high-caste subjects; but when caste identity was publicly revealed in a mixed caste group, a significant caste gap emerged. The caste gap was due to a 20 percent decline in the average number of mazes solved by the low caste. The study shows that publicly revealing the social identity of an individual can change his behavior even when that information is irrelevant to payoffs. Our results are a generalization of the literature on stereotype threat. Like that literature, we find that individuals’ performance is more in accordance with the stereotype of the group when group membership is made salient in some way. Unlike that literature, salience in our experiments depends on the public revelation of social identity and more importantly, we do not argue that the domain of the tasks undertaken by † Discussants: Rachel Croson, University of Pennsylvania; Iris Bohnet, Harvard University; Stefano DellaVigna, University of California-Berkeley.

Introduction: Tastes, Castes and Culture: the Influence of Society on Preferences

Economists have traditionally treated preferences as exogenously given. Preferences are assumed to be influenced by neither beliefs nor the constraints people face. As a consequence, changes in behaviour are explained exclusively in terms of changes in the set of feasible alternatives. Here, we argue that the opposition to explaining behavioural changes in terms of preference changes is ill‐founded, that the psychological properties of preferences render them susceptible to direct social influences and that the impact of ‘society’ on preferences is likely to have important economic and social consequences.

Bayesian learning in an infant industry model

Abstract Most analyses of the infant industry argument assume that production early on benefits subsequent production in deterministic fashion. This paper presents an alternative framework for evaluating the infant industry argument that focuses on imperfect information as a barrier to entry. Initial entrants provide information of social value by reducing uncertainty for potential followers about the suitability of local conditions. In contrast to earlier work, I show that factors that increase the informational barrier to entry may lower the optimal subsidy to the infant industry, and that the standard test of the success of infant industry policy is not always valid.

The second theorem of the second best

Abstract This paper interprets many results from the literature on incentive compatibility and cost-benefit analysis as illustrations of a second theorem of the second best. The theorem states that if there exists any restriction on transactions required for first-best efficiency, then there is no presumption that a social welfare maximum entails equal marginal social utilities of income across individuals. One reason is that incentive constraints shift with redistributions of wealth, so that redistributions have an instrumental role in relaxing constraints that make the economy second best. Two examples relate such wealth effects to countervailing incentives and hostage-taking .

Exiting a Lawless State

An earlier paper showed that an economy could be trapped in an equilibrium state in which the absence of the rule of law led to asset-stripping, and the prevalence of asset-stripping led to the absence of a demand for the rule of law, highlighting a coordination failure. This paper looks more carefully at the dynamics of transition from a non-rule-of-law state. The paper identifies a commitment problem as the critical feature inhibiting the transition: the inability, under a rule of law, to forgive theft. This can lead to the perpetuation of the non-rule-of-law state, even when it might seem that the alternative is Pareto-improving.

A reexamination of the neoclassical trade model under uncertainty

Abstract This paper presents a model that pinpoints the exact places and reasons that the propositions of the Heckscher-Ohlin-Samuelson model break down under uncertainty. Within the model, if preferences exhibit decreasing absolute risk aversion, (i) a capital-poor country tends to obtain lower revenues from its resources than the same resources would yield in capital-rich countries, (ii) if there is one riskless and one risky sector, a capital-abundant country tends to have a comparative advantage in the risky sector, and (iii) the pattern of trade depends on the intra national as well as the inter national distribution of endowments.

The Transition from Communism: A Diagrammatic Exposition of Obstacles to the Demand for the Rule of Law

In earlier work we presented a mathematical exposition of a theory that demonstrated that mass privatization without institutions to limit asset-stripping may not lead to a demand for the rule of law. The present note makes the same argument in terms of simple diagrams. The central idea is that economic actions (to build value or strip assets) and political positions of individuals are interdependent. Big Bang privatization may give individuals an interest in taking what they can quickly, rather than waiting for the establishment of property rights protection that would permit them to build more valuable assets. Asset stripping gives some of these individuals an interest in prolonging the absence of the rule of law so that they can enjoy the fruits of stripping without the constraint of government enforcement of property rights. Each individual, in attempting to influence society’s choice of the environment, focuses on the impact on himself, not the impact on others. In choosing their economic actions, individuals ignore the effect of their economic decisions on how they themselves vote, how other people believe the system will evolve, and thus how others invest and vote. Thus two distortions of individual behavior are associated with the public good nature of votes. The functionalist position that if the rule of law is good for the group, then a political constituency for it will always emerge, is misleading because the argument abstracts from spillovers mediated by the political environment. We use this framework to make one further point. Because of the interdependence between individuals’ economic and political choices, demand for and opposition to the rule of law cannot be sepa rated from macroeconomic policy. A too stringent macroeconomic policy can lower the returns to building value relative to stripping assets and thereby weaken the e quilibrium demand for the rule of law. Macroeconomic policies and institutional evolution are not independent issues. * We have benefited from comments of two anonymous referees and from discussions of the formal models on which this paper is based at seminars at Berkeley, Harvard (PIEP), the NEUDC, the Oslo Meetings of the ABCDE 2002, Pennsylvania State University, Princeton, UCLA, the World Bank, and meetings of the American Political Science Association and the MacArthur Research Network on Inequality and Economic Performance.

Joseph E. Stiglitz

Joseph E. Stiglitz, 2001 Nobel Laureate in Economics, helped create the theory of markets with asymmetric information and was one of the founders of modern development economics. He played a leading role in an intellectual revolution that changed the characterization of a market economy. In the new paradigm, the price system only imperfectly solves the information problem of scarcity because of the many other information problems that arise in the economy: the selection over hidden characteristics, the provision of incentives for hidden behaviors and for innovation, and the coordination of choices over institutions.

Political Alternation as a Restraint on Investing in Influence: Evidence from the Post-Communist Transition

The authors develop and implement a method for measuring the frequency of changes in power among distinct leaders and ideologically distinct parties that is comparable across political systems. The authors find that more frequent alternation in power is associated with the emergence of better governance in post communist countries. The results are consistent with the hypothesis that firms seek durable protection from the state, which implies that expected political alternation is relevant to the decision whether to invest in influence with the governing party or, alternatively, to demand institutions that apply predictable rules, with equality of treatment, regardless of the party in power.