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Economics Working Papers, 1996


"Taxation and Product Quality: New Evidence from Generic Cigarettes."

Abstract: This paper provides evidence supporting Barzel's theory that unit taxes and ad valorem taxes have different effects on product quality. Barzel originally validated his hypothesis by examining how these taxes affect the price of cigarettes. Several additional papers in this Journal have extended his results, the last of which rejected Barzel's hypothesis. These previous works suffered from data limitations and constraints in the cigarette market that can now be overcome with the arrival of generic cigarettes. New data allow a more direct test of Barzel's theory using the market share of premium cigarettes, rather than cigarette prices.

96-02 MITCHELL, DOUGLAS W. and Gregory M. Gelles.

"Comparative Portfolio Behavior with Multiple Risky Assets."

Abstract: We consider the partial ordering of von Neumann-Morgenstern utility functions to predict comparative portfolio features with two or more risky assets. First, we show that no utility ordering can predict comparative holdings of the riskier asset for any reasonable definition of the latter. Second, we reinterpret results of Arrow-Pratt and Ross as predicting comparative mean-seeking behavior. Third, we present a stronger utility ordering which predicts comparative portfolio means for two risk assets with no joint distribution restrictions. Finally we show that the latter utility ordering also predicts comparative portfolio means with n risky assets.


"Portfolio Response to a Shift in a Return Distribution: The Case of n Dependent Assets."

Abstract: Recent papers have shown utility function conditions which are sufficient, in a two-asset context with or without stochastic dependence, for a conditional first-order stochastically dominating shift (or a conditional mean-preserving contraction) of one asset's return distribution never to result in a decline in holdings of that asset. The present paper shows that these conditions are sufficient even when there are an arbitrary number of assets


"Demand Elasticities, Asymmetry and Strategic Trade Policy." (Revised version of 93-20) published in Journal of International Economics.


"Labor Unions and International Market Share Rivalry: Does Corporatism Matter?" (Revised version of 94-07) published in Journal of Economic Integration.


"Model Specification and the Robustness of Empirical Results from Migration Models."

Abstract: A characteristic of the empirical literature on internal population migration is widely varying results and often conflicting conclusions regarding relative importance of explanatory factors. There are a number of possible explanations for these conflicting findings, some of which have been noted in the literature. Model specification issues have received relatively little detailed attention. This paper focuses on three key issues: type of migration model, functional form, and consideration of spatial variables. First, I examine the extent to which these three considerations influence empirical estimates. Then I investigate how these specification issues affect the robustness of empirical results in the presence of other specification problems, focusing on omitted variable bias.


"Reevaluating Differences in Poverty among Central City, Suburban, and Nonmetropolitan Areas Using Distribution-Sensitive Poverty Measures."

Abstract: It is well known that metropolitan and nonmetropolitan poverty are different in many respects. The difference in the overall level of poverty, however, has generally been evaluated by the official poverty measure--the headcount ratio--which has several drawbacks. Official poverty statistics also suffer from use of an arbitrary poverty line. In this paper, we use newly developed distribution-sensitive poverty measures and 1990 Census data to reconsider the differences between central city, suburban, and nonmetropolitan poverty. Instead of using a single, arguable poverty line, we let the poverty line vary over an income range so that conclusions are more robust. We also divide the U.S. into four regions and examine the poverty within and across regions. The headcount ratio and new distribution-sensitive measures yield different results.

96-08 WU, YANGRU and Junxi Zhang.

"Uniqueness and Stability of Equilibria in a Model with Endogenous Markups and Labor Supply."

Abstract: The presence of public policy in models with multiple steady states is known to be capable of reducing the set of equilibria. This paper shows that in a simple growth model with endogenous markups developed by Gali (1995), introducing an endogenous labor-leisure choice also helps eliminate multiple steady state equilibria. Moreover, it alters the stability condition of the unique steady state as well; namely, the steady state may display damped oscillations and admit periodic orbits.

96-09 WU, YANGRU and Hua Zhang.

"Forward Premiums as Unbiased Predictors of Future Currency Depreciation: A Non-Parametric Analysis."

Abstract: A large body of literature employing regression analysis has reported that the forward premium is not an unbiased predictor of future currency depreciation. However, many studies have argued that the forward market unbiasedness hypothesis may be falsely rejected due to biased parameter estimates. Possible sources of bias include: the existence of a time-varying risk premium, systematic forecast errors and measurement errors. This paper investigates whether the forward premium can predict the direction of change in the future spot exchange rate using a distribution-free, non-parametric approach. Our tests strongly reject the unbiasedness hypothesis and conclude that the forward premium contains either no information or the "wrong" information about future currency depreciation.

96-10 Hai, Weike, Nelson C. Mark, and YANGRU WU.

"Understanding Spot and Forward Exchange Rate Regressions."

Abstract: Using the Kalman filter, we obtain maximum likelihood estimates of a permanent--transitory components model for log spot and forward exchange rates. The time-series model draws its motivation from economic theory and is consistent with stylized facts of exchange rate behavior. Spot and forward rates between the US dollar and the pound, the French franc, and the yen are modeled as sharing a common trend with transitory parts following a vector ARMA(1,1) process. This simple parametric model aids in understanding why the forward rate may be an unbiased predictor of the future spot rate even though an increase in the forward premia predicts a home currency appreciation. The model also provides estimates of the expected excess return on dollar denominated assets which fluctuate in sign, are persistent, reasonable in magnitude, and covary negatively with the estimated expected depreciation.

96-11 Mark, Nelson C. and YANGRU WU.

"Risk, Policy Rules, and Noise: Rethinking Deviations from Uncovered Interest Parity."

Abstract: This paper investigates why the forward premium predicts the future depreciation with the `wrong' sign and why the unobserved deviation from rational uncovered interest parity is negatively correlated with and is more volatile than the rationally expected depreciation. We examine the ability of three models to account for the data. They are, (i) the standard representative- agent asset pricing model, (ii) a model of monetary-policy with exchange-rate feedback, and (iii) a model of noise trading. Although it is highly stylized, the noise trader model may be the most promising approach.

96-12 SOBEL, RUSSELL S. and Robert A. Lawson.

"Will Term Limits Limit Government Spending."

Abstract: Proponents of congressional term limitations have suggested that as congressmen stay in office longer they become captured by special interests and begin to favor higher government spending. This paper empirically tests this hypothesis. Using data from the National Tax payers Union Foundation, the 1990 Census and other sources, we estimate the determinants of legislative spending. Our data include, for each congressman in the 103rd Congress, the dollar amounts of spending associated with every bill on which the legislator was a sponsor or co-sponsor, and the dollar amounts of spending associated with every bill the legislator voted in favor of. The aggregate spending preferences of the legislator are statistically correlated with the tenure of the legislator to test the term limits hypothesis. Control variables based on the personal characteristics of the legislator and the characteristics of the district from which the legislator was elected are included in the regression analysis. Our results find evidence supporting the term limits hypothesis. Specifically, it appears that members of the House of Representatives, and Republican members in particular, who have been in office longer vote to spend more than their less tenured colleagues, all other things equal. For both the House and Senate, increased spending as a result of time in office appears to manifest itself after members reach their fifth term in office. The marginal effect of limiting House members to three terms is predicted to be approximately $1 billion in lower spending preferences. The result suggest, however, that a four-term limit would not produce significantly different results than a three-term limit.


"Optimal Taxation in a Federal System of Governments."

Abstract: This paper explores the optimal structure of taxation in a federal system of government. It is shown that when more than one level of government has the power of taxation, it results in a higher excess burden of taxation, an inefficiency bias in government spending, and possibly lower total tax revenue. A preferable system is where only states have the power of taxation, and the federal government receives its revenues as contributions from the states. This was the system present in the early days of the U.S. under the Articles of Confederation and is how the United Nations raises its revenues


"Vibert's European Union: A United Nations or United States?" published in Constitutional Political Economy.


"Efficient Contracts and Strategic Export Policy."

Abstract: We analyze a full blown two-stage equilibrium to determine optimal export policy for an international duopoly with a unionized domestic firm and a foreign firm facing a unionized labor market. The domestic union and the domestic firm conduct an efficient Nash bargain to determine wage and employment. The union may be wage oriented, wage neutral or employment oriented. While the foreign government always imposes an export subsidy under wage neutrality and employment orientation, a tax may be optimal under wage orientation. Contrary to the existing results in the literature, we find that employment orientation leads to lower market share (welfare) for the domestic firm (nation), in the policy equilibrium. Furthermore, under demand linearity, we find the surprising result that a rise in the union's bargaining power leads to a larger market share and welfare under wage orientation.


"Unionized Oligopoly: Strategic Substitutes or Strategic Complements?"

Abstract: We consider optimal trade policy in the context of an unionized international duopoly. Cournot-Nash reaction functions are assumed to be downward sloping, yet a strategic export tax may be optimal for the nation with the competitive labor market. For iso-elastic demand a tax is optimal for all reasonable elasticity values. The endogeneity of the union wage creates an additional dimension which breaks down the one-one relationship between strategic substitutability in output space and the optimality of export subsidies.


"Illegal Immigration - A Supply Side Analysis." Forthcoming in Journal of Development Economics.

Abstract: This paper analyzes the source country (supply side) determinants of illegal immigration in the context of a three-sector general equilibrium model. Liberalization of the agricultural sector increases illegal immigration while liberalization of the high tech sector reduces it. This result breaks down under capital mobility. Paradoxically, increased enforcement may raise unskilled wages in the source country, even though illegal immigration will surely fall.


"Unionization and International Market Share Rivalry: A Paradox." Forthcoming in Review of International Economics.

Abstract: Two exporting firms (domestic and foreign) are considered who are symmetric in all respects except that one is unionized while the other faces a competitive labor market. Under free trade the unionized firm has the lower market share. Paradoxically, in the policy equilibrium, the unionized firm has the larger market share. Consequently, the nation hosting the unionized firm has the higher welfare level.


"Unionized Bertrand Duopoly and Strategic Export Policy."

Abstract: We find that the degree of product differentiation is crucially linked to the optimality of a strategic export subsidy/tax in a unionized Bertrand duopoly. An export subsidy is generally optimal except for a very narrow range of extreme substitutability between the two products. If the rival firm is not unionized and the rival government follows free trade, a subsidy is always optimal. We also find that the nation with the lower alternative wage pursues the more aggressive policy. This lends further support to de Meza (1986) and Neary (1994). Finally, we find that for sufficiently differentiated products the union wage rises with a fall in the alternative wage.


"Price Rigidity under Menu and Convex Adjustment Costs." Published in Journal of Economics Research.


"Precaution and Liquidity in the Demand for Housing."


"Poverty in Central Appalachia: People Versus Place?"

Abstract: This study considers the issue of people characteristics versus place characteristics in explaining Central Appalachian poverty. Initially it focuses on which characteristics of Central Appalachia's population might lead to an unusually high rate of poverty. Then, by means of a logistic regression analysis, the paper determines whether the detrimental influence on poverty of some population characteristics tends to be exacerbated in Central Appalachia. Evidence of this latter effect would provide an initial indication that locational characteristics of Central Appalachia have an independent effect on poverty, i.e., something about Central Appalachia leads to higher rates of poverty for comparable personal characteristics.


"Racial Differences in the Migration Response to Social Welfare Benefits: Revisited."

Abstract: A large body of empirical research conducted during the past 30 years found that, at least during the 1950s and 1960s, the effect of welfare benefits on migration differed significantly by racial group. Blacks searched for higher welfare benefits while whites were repulsed by areas that provided high welfare benefits. This study revisits the issue of racial differences in attractiveness to interregional differences in welfare benefits. Using a comprehensive model of state-to-state migration that accounts for a variety of economic, amenity, and spatial factors, there is no statistically significant evidence that either origin or destination AFDC benefits affected migration decisions of blacks during the 1960s and 1970s. In the case of whites, origin AFDC benefits had no effect while higher destination benefit levels repulsed migrants.