A central issue in dynamic political economy is to understand how political frictions affect fiscal policy and economic performance over time. The recent literature has focused almost exclusively on characterizing symmetric equilibria in which parties behave identically. A main result is that re-election uncertainty introduces a wedge in intertemporal decisions when governments lack commitment. This wedge distorts economic allocations; thereby reducing long-run output and consumption.
Small firms are a vital part of the macroeconomy, producing more than 50 percent of non-farm private U.S. GDP, employing half of all private sector employees and paying 45 percent of total private payroll. They are a source of “good jobs,” generating 60 to 80 percent of net new jobs annually over the last decade, employing 41 percent of high tech workers (scientists, engineers and computer workers) and producing almost 14 times more patents per employee than larger patenting firms. Among all U.S. employer firms, 89 percent have less than 20 employees. Unlike large firms, they are closely associated with their owners. We quantify the effects of two owner traits, risk aversion and optimism, and policies regarding bankruptcy and credit access, on firm size, capital structure and default. The distinction between policies and owner traits is important because policies can be changed but innate characteristics cannot.
We construct a model economy with a risk neutral representative lender and many long-lived agents who differ in willingness to bear risk. Each period, agents choose consumption and whether to run a firm with risky returns. If they run a firm, they choose its size, capital structure (mix of personal funds and outside loans), and whether to default ex-post. Firm risk is non-tradable (i.e., the owner runs a single firm, not a portfolio of firms) and firms may be credit constrained. Default occurs in equilibrium, with the lender recovering only a fraction of the loan and the firm unable to obtain credit for several periods. Firms weigh the effect of default today against access to future credit. We show that modest differences in risk interact with institutions to generate significant welfare effects that affect firm legal status. The less risk-averse run larger firms with higher future value and this limits their incentive to default, hence they incorporate to protect current personal assets. In contrast, if the more risk averse run firms they are small with lower future value. It may be optimal for such owners to leave some personal assets at risk in bankruptcy by remaining unincorporated. The fact that these assets would be seized credibly limits their default ex post.
One of the main consequences of the process of globalisation is the increasing international fragmentation of production. This phenomenon is likely to have important implications for both the composition and the pattern of international trade.
International fragmentation of production leads to the establishment of international production networks, which are associated with trade in intermediates. Some recent studies have provided evidence of the growing importance of trade in intermediates (Campa and Goldberg, 1997; Yeats, 2001). From the data for the UK used in this paper it follows that total outsourcing in terms of value-added increase from 38% in 1984 to 53% in 1995, while outsourcing within the same industry increased from 11% to 16% over the same period.
