Standard Neoclassical Model Research Articles

Efficient Bargaining and the Skill-Structure of Wages and Employment

This paper presents structural estimates for a bargaining model which nests the right-to-manage, the efficient wage bargaining, the seniority and the standard neoclassical labor demand model as special cases. In contrast to most existing models, our approach accounts for heterogeneous skill groups which differ in terms of productivity and representation in the bargaining process through union preferences. The paper introduces the concept of virtual firms which allows us to (i) test the efficient contract model against models implying that firms operate on the labor demand curve and to (i) overcome a potential misspecification of firms' output markets. Estimates of structural parameters are obtained from a novel cross-section of German firms of the business related service sector which includes information on skill-specific wage rates at the firm level. Central results of this paper are that unions do care about both wages and employment in the bargaining process and that firms operate on the contract curve. The bargaining power of unions in East Germany turns out to be much weaker than in West Germany.

Getting Big Too Fast: Strategic Dynamics with Increasing Returns and Bounded Rationality

Neoclassical models of strategic behavior have yielded many insights into competitive behavior, despite the fact that they often rely on a number of assumptions—including instantaneous market clearing and perfect foresight—that have been called into question by a broad range of research. Researchers generally argue that these assumptions are “good enough” to predict an industry’s probable equilibria, and that disequilibrium adjustments and bounded rationality have limited competitive implications. Here we focus on the case of strategy in the presence of increasing returns to highlight how relaxing these two assumptions can lead to outcomes quite different from those predicted by standard neoclassical models. Prior research suggests that in the presence of increasing returns, tight appropriability, and accommodating rivals, in some circumstances early entrants can achieve sustained competitive advantage by pursuing “get big fast” (GBF) strategies: Rapidly expanding capacity and cutting prices to gain market share advantage and exploit positive feedbacks faster than their rivals. Using a simulation of the duopoly case we show that when the industry moves slowly compared to capacity adjustment delays, boundedly rational firms find their way to the equilibria predicted by conventional models. However, when market dynamics are rapid relative to capacity adjustment, forecasting errors lead to excess capacity—overwhelming the advantage conferred by increasing returns. Our results highlight the risks of ignoring the role of disequilibrium dynamics and bounded rationality in shaping competitive outcomes, and demonstrate how both can be incorporated into strategic analysis to form a dynamic, behavioral game theory amenable to rigorous analysis.

Where enterprises lead, people follow? Links between migration and FDI in Germany

Standard neoclassical models of economic integration are based on the assumptions that capital and labor are substitutes and that the geography of factor market integration does not matter. Yet, these two assumptions are violated if agglomeration forces among factors from specific source countries are at work. Agglomeration implies that factors behave as complements and that the country of origin matters. This paper analyzes agglomeration between capital and labor empirically. We use state-level German data to answer the question whether and how migration and foreign direct investment (FDI) are linked. Stocks of inward FDI and of immigrants have similar determinants, and the geography of factor market integration matters. There are higher stocks of inward FDI in German states hosting a large foreign population from the same country of origin. This agglomeration effect is confined to higher-income source countries.

Does Financial Integration Spur Economic Growth? New Evidence from the First Era of Financial Globalization

Does international financial integration boost economic growth? The question has been discussed controversially for a long time, and a large number of studies has been devoted to its empirical investigation. As of yet, robust evidence for a positive impact of capital market integration on economic growth is lacking, as documented by Edison et al. (2002). However, there is substantial narrative evidence from economic history that highlights the contribution European capital made to economic growth of peripheral economies during the so-called first age of financial globalization before 1914. For this paper, we have compiled the first comprehensive data set to test econometrically if capital market integration had a positive impact on economic growth before WW1. Using the same models and techniques as contemporary studies, we show that there was indeed a significant and robust growth effect of international financial integration in the first era of financial globalization. Our temptative explanation for this marked difference between now and then stresses property rights protection as a prerequisite for the standard neoclassical model to work properly.

Regional Governance Infrastructure: The Positive Externality on the Inflow of Foreign Direct Investment

A standard neoclassical model of growth predicts convergence of income levels across countries and geographical regions. Recent empirical evidence, however, has shown that the gap between rich and poor countries has increased over the last thirty years. One of the key regularities that are at odds with the neoclassical theory is the lack of capital flows from rich to poor countries. Two competing, but not mutually exclusive theories that explain this regularity are new economic geography and institutional economics. The first theory emphasizes the importance of increasing returns and agglomeration to explain the divergence in economic development across different geographical regions. The second theory stresses the crucial role of good institutions that generate economic growth and improve investment climate inside the country. To investigate the role of institutions and geography on economic development, we look at inflows of foreign direct investment (FDI) in 24 transition countries from 1993 to 2003. We set up an econometric panel data model that takes into account spatial spillovers and spatially correlated error terms and estimated the model by applying a recently developed generalized method of moment (GMM) three-stage procedure. Our results show that the regional quality of institutions is an important factor that explains variations in FDI inflows. The positive effect of good regional governance dominates the effect of better developed regional markets. The effect of regional governance is both statistically significant and of the same order of magnitude as the effect of good governance inside the country. We also have found some evidence that EU membership and high oil and gas resources are important determinants of FDI inflows in transition countries.

Financial Crises and Total Factor Productivity

Total factor productivity (TFP) falls markedly during financial crises, as we document with recent evidence from Mexico and Asia. These falls are unusual in magnitude and present a difficult challenge for the standard small open economy neoclassical model. We show in the case of Mexico's 1994-95 crisis that the model predicts that inputs and output should have fallen much more than they did. Using models with endogenous factor utilization, we find that capital utilization and labor hoarding can account for a large fraction of the TFP fall during the crisis. However, these models also predict that output should fall significantly more than in the data. Given the behavior of TFP, the biggest challenge may not be explaining why output falls so much following financial crises, but rather why it falls so little.

Ethical decision making: some economic foundations

Ethical decision making is at crossroads. There is a strong need to provide reasoned foundations to the evaluation of policy decisions whether they are made in the public or the private sectors. The standard neoclassical model of economics, with its emphasis on equilibrium and efficiency, has limited value in providing such foundations. Welfare economics on the other hand has made significant contributions to the clarification of ethical principles used to evaluate decisions. Commitment and emotions, which are old ideas, provide valuable insights into the reasons for cooperation in moral communities.

Citizenship, Passports and the Brain Exchange Triangle

Recent evidence suggests that the traditional permanent bilateral flows of highly skilled immigrants are being replaced by a form of “brain circulation”. This paper offers a brain-exchange model in direct contrast to the standard neoclassical migration model limiting onward flows to disappointed immigrants. In this triangular model, movement occurs between three states: sending, entrepôt and final destination region. Individual agents in the entrepôt destination equip selected migrants from the sending region with subsidized human capital, which selectively encourages the most productive immigrants to return or move on to the rest of the world. A limited test of this model supports the major hypothesis of the model that the most productive move to an entrepôt destination (Canada) only to later selectively return home to their low tax environment (Hong Kong) to exploit the subsidized human capital they acquired in the entrepôt country (Canada).

The Impact of Taiwan's WTO Entry on Its Domestic Agriculture Sector

This study used a multi‐sector CGE model, derived from ORANI and implemented by the GEMPACK software, to evaluate the impact of 44.67%, 35.9% and 40.8% tariff reductions on agriculture, livestock, and fishery, respectively, two years after Taiwan's accession to the WTO in 2002. Results show that the value of domestic agricultural, livestock and fishery production would be reduced by NT$45.2, 24.1 and 3.9 billion, respectively, under the standard neo‐classical model. Since it is difficult for industrial sectors to hire the unskilled elderly workers who lost their jobs in the agricultural, livestock, and fishery production sectors, a partial equilibrium model, specified in this study by restricting transferability of primary input from agriculture, livestock, fishery, and processing sectors to the secondary industrial sectors, will be more realistic for Taiwan's social‐economic structure after entering WTO. The results from the structuralist model show that the value of domestic agricultural, livestock, and fishery production will ber‐educed by NT$47.4, 26.4 and 4.4 billion, respectively, suggesting that those sectors in Taiwan would suffer more severely if their primary input (i.e. labor) lacked mobility.

Intermediation costs and capital flows

In this paper, we modify the standard neoclassical model by incorporating financial intermediation in order to deliver returns consistent with the observation that capital primarily flows to middle income countries. We build a static contracting framework where costly intermediation together with an adverse selection problem have quantitatively important effects on capital flows. When intermediation costs are ignored, the model behaves like the neoclassical model in terms of capital returns. However, when intermediation costs are considered, returns to capital in middle income countries could exceed those in poor and rich countries—high costs of intermediation cause poor countries to concentrate their investments in projects with low returns, while the standard neoclassical effect lowers returns in capital-rich countries. When we embed the return function from the static analysis in a two-country dynamic model, there is capital outflow from a poor country that removes capital controls and becomes open. Even though the closed economy dominates in terms of capital employed in production, it is the open economy that dominates in terms of income, consumption and welfare.

Fiscal shocks and their consequences

This paper investigates the response of hours worked and real wages to fiscal policy shocks in the post-World-War II US. We identify these shocks with exogenous changes in military purchases and argue that they lead to a persistent increase in government purchases and tax rates on capital and labor income, and a persistent rise in aggregate hours worked as well as declines in real wages. The shocks are also associated with short lived rises in aggregate investment and small movements in private consumption. We describe and implement a methodology for assessing whether standard neoclassical models can account for the consequences of a fiscal policy shock. Simple versions of the neoclassical model can account for the qualitative effects of a fiscal shock. Once we allow for habit formation and investment adjustment costs, the model can also account reasonably well for the quantitative effects of a fiscal shock.

Frictionless Technology Diffusion: The Case of Tractors

Many new technologies display long adoption lags, and this is often interpreted as evidence of frictions inconsistent with the standard neoclassical model. In this paper we study the diffusion of the tractor in American agriculture between 1910 and 1960 – a well known case of slow diffusion – and show that the speed of adoption was consistent with the predictions of a simple neoclassical growth model. The reason for the slow rate was that tractor quality kept improving over this period and, more importantly, that only when wages increased did it become relatively unprofitable to operate the alternative, labor-intensive, horse technology.

Frictionless Technology Diffusion: The Case of Tractors

Many new technologies display long adoption lags, and this is often interpreted as evidence of frictions inconsistent with the standard neoclassical model. We study the diffusion of the tractor in American agriculture between 1910 and 1960—a well-known case of slow diffusion—and show that the speed of adoption was consistent with the predictions of a simple neoclassical growth model. The reason for the slow rate of diffusion was that tractor quality kept improving over this period and, more importantly, that only when wages increased did it become relatively unprofitable to operate the alternative, labor-intensive, horse technology. (JEL L62, N51, N52, N71, N72, O33, Q11)

A note on the changing relationship between fertility and female employment rates in developed countries

In this paper we look at a panel of OECD aggregate fertility and labor market data between 1970 and 1995 and we report some striking recent developments. Total Fertility Rates (TFR) were falling and Female Participation Rates (FPR) were increasing, conforming to a well known long-run trend. Along the cross-sectional dimension, the correlation between TFR and FPR was negative and significant during the 1970's and up to the early 1980's. This seemed consistent with secular comovements. However, by the late 1980's the correlation had become positive and equally significant. We discuss our findings within the framework of standard neoclassical models of fertility and labor supply adapted to macro data, as in Butz and Ward (1979).

A Model of Capital Accumulation and Rent-Seeking

A simple model incorporating rent-seeking into the standard neoclassical model of capital accumulation is presented. It embodies the idea that the performance of an economy depends on the efficiency of its institutions. It is shown that welfare is positively affected by the institutional efficiency, although output is not necessarily so. It is also shown that an economy with a monopolistic rent-seeker performs better than one with a competitive rent-seeking industry.

(What) do unions maximise? Evidence from survey data

Highly formalised models of union behaviour have been developed and are widely used within neoclassical economics. This approach is justified by the argument that most goals pursued by unions can be reduced to a wage (or wage-equivalent) employment trade-off. However, the strong assumptions made about union goals and preferences, how these are determined and the range of issues over which a union will seek to bargain with a firm are not supported by extensive empirical evidence. This paper explores these issues through a survey of union leaders to ascertain the range of union goals and their preferences, and the types of issues over which unions bargain with employers. The results of the survey present convincing evidence that standard neoclassical models do not adequately capture union bargaining behaviour, or union goals and preferences. The findings presented here also throw open, but do not resolve, the question of whether unions are 'rational maximisers'. The most inter esting result—not widely found within the economics or industrial relations literature—concerns the nature of union bargaining preferences. Union bargaining over employment appears to be asymmetric around current levels of employment, in that unions appear to care more about the employment implications of their bargain ing strategies when they are likely to result in employment decreases.

Institutions, Property Rights, and Growth

This paper presents a growth model in which property rights are insecure and costly to enforce. Losses of property provide the impetus to establish institutions which seek to enforce property rights. Institutions are shown to implement policies that enforce property rights. The model establishes that economies in which the institutional structure does not adequately protect property rights grow slowly, or not at ail, while countries with better property rights protection grow in accordance with the standard neoclassical model. Because income inequality is a primary incentive to violate another's property rights, the model also provides a positive theory of income redistribution. Empirical tests of the model's predictions demonstrates that government expenditures that enforce property rights raise per capita income growth.

The new institutional economics and the theory of the firm

Concepts of importance in the literature of the New Institutional Economics, such as transaction costs and bounded rationality, have been used to extend the standard neoclassical model of the firm, but the hybrid models created have failed to provide adequate explanations of enterprise behavior. An alternative, “neoinstitutional,” model of the firm is developed in the paper that differs from the pure neoclassical model and hybrid models in respect to both the nature of the solution it yields and the process by which it reaches a solution. The neoinstitutional firm cannot be expected to achieve either the hypothetical allocative efficiency promised by the frictionless neoclassical model, or the relatively efficient (constrained Pareto optimal) solutions predicted by the largely frictionless hybrid models. The orthodox marginal rules of neoclassicism can only be used to solve lower-level problems that appear within the firm.

Willingness to Accept, Willingness to Pay and the Income Effect

The disparity between willingness to pay and willingness to accept in experimental and survey settings remains a troubling anomaly. Willingness-to-accept is almost always higher than WTP, often substantially higher. Our interest lies with the neoclassical explanation of Hanemann, who demonstrates that for exogenous quantity changes, the difference between WTP and WTA depends ratio of the ordinary income elasticity of demand for the good to the Allen-Uzawa elasticity of substitution between the good and a composite commodity. When the elasticity of substitution is low, this ratio will be large. The ratio WTA/WTP will then also be large. We use a result of Sugden to formulate the WTA/WTP ratio as a function of the income effect on WTP. We find that the WTA/WTP ratios provided by our comprehensive literature search imply income elasticities and income effects that are implausibly high; much higher than income effects found in the literature; and much higher than income elasticities estimated in the set of studies from which the WTA/WTP results are drawn. Based on the evidence, it is difficult to accept the idea that the observed ratios of WTA/WTP, garnered from a remarkably large and diverse set of studies, are consistent with a standard neoclassical model. Substitution among goods seems an inadequate explanation for the divergence between WTA and WTP.

Uncertainty, the Lemon Problem, Asymmetric Information and Countertrade

Abstract A review of the International Trade literature suggests that uncertainty caused by the lack of perfect information and/or asymmetric information provides a motivation for countertrade (Hennart, 1990; Mirus & Yeung, 1986; Yavas & Vardiabasis, 1988). After presenting the most prevalent forms and examples of countertrade, this study shows how uncertainty can lead to some of the most common forms of countertrade; counterpurchase, buyback and offset. The paper compares and contrasts two strategies facing the management team of a profit-maximizing firm. The standard neoclassical mathematical model developed and presented shows that countertrade strategy may be superior to standard money-mediated trade strategy when there is uncertainty. Therefore, countertrade (particularly, buyback, counterpurchase and offset) may be a rational response to conditions that restrict standard trade. As such, countertrade can supplement standard money-mediated trade and contribute to the growth of international business.