NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

The NBER Reporter 2007 Number 3: Program and Working Group Meetings


The Economics of Crime
Entrepreneurship Working Group

China Working Group Meets

The Economics of Crime

The NBER's Working Group on the Economics of Crime held its fall workshop in Cambridge on September 14. The group's Directors, who also organized the meeting program, are: Philip J. Cook, Duke University; Jens Ludwig, University of Chicago; and Justin McCrary, University of Michigan. These papers were discussed:

Benjamin A. Olken, Harvard University and NBER, and Patrick Barron, World Bank, "The Simple Economics of Extortion: Evidence from Trucking in Aceh"(NBER Working Paper No. 13145) Discussants: Justin Wolfers, University of Pennsylvania and NBER, and David Abrams, University of Chicago Law School

Mark Duggan, University of Maryland and NBER; Randi Hjalmarsson, University of Maryland; and Brian A. Jacob, University of Michigan and NBER, "The Effect of Gun Shows on Gun Violence, Gun Suicides, and Accidental Gun Deaths" Discussants: Ilyana Kuziemko, Princeton University and NBER, and David Hemenway, Harvard University

Jonah E. Rockoff, Columbia University and NBER, and JJ Prescott, University of Michigan, "Do Sex Offender Registration and Notification Laws Affect Criminal Behavior?" Discussants: Anne Piehl, Rutgers University and NBER, and Justin McCrary

Rucker Johnson and Steven Raphael, University of California at Berkeley, "How Much Crime Reduction Does the Marginal Prisoner Buy?

Discussants: Thomas Miles, University of Chicago Law School, and Radha Iyengar, Harvard University

Manolis Galenianos, Pennsylvania State University; Rosalia Liccardo Pacula, RAND and NBER; and Nicola Persico, New York University and NBER, "A Search-Theoretic Model of the Retail Market for Illicit Drugs" Discussants: Dan Silverman, University of Michigan, and Jeffrey A. Miron, Harvard University and NBER

Steven D. Levitt, University of Chicago and NBER, and Sudhir A. Venkatesh, Columbia University, "The Economics of Street Prostitution" Discussants: Peter Reuter, University of Maryland, and Lawrence Katz, Harvard University and NBER

Olken and Barron test whether the behavior of corrupt officials is consistent with standard industrial organization theory. They designed a study in which surveyors accompanied truck drivers on 304 trips along their regular routes in two Indonesian provinces and they directly observed over 6,000 illegal payments to traffic police, military officers, and attendants at weigh stations. Using plausibly exogenous changes in the number of police and military checkpoints, they show that market structure affects the level of illegal payments, finding evidence consistent with double-marginalization and hold-up along a chain of vertical monopolies. Furthermore, they document that the illegal nature of these payments does not prevent corrupt officials from extracting additional revenue using complex pricing schemes, including third-degree price discrimination and a menu of two-part tariffs. Their findings illustrate the importance of considering the market structure for bribes when designing anti-corruption policy.

Thousands of gun shows take place in the United States each year. Gun control advocates argue that because sales at gun shows are much less regulated than other sales, such shows make it easier for potential criminals to obtain a gun. Similarly, one might be concerned that gun shows would exacerbate suicide rates by providing individuals considering suicide with a more lethal means of ending their lives. On the other hand, proponents argue that gun shows are innocuous because potential criminals can acquire guns quite easily through other black market sales or theft. Duggan and his co-authors use data from Gun and Knife Show Calendar combined with vital statistics data to examine the effect of gun shows. Their results provide little evidence to suggest that gun shows lead to any substantial increase in homicides. However, they do find some evidence that gun shows are associated with an increase in gun suicides, which is only partially offset by decreases in other methods of suicide.

Sex offenders have been the targets of some of the most far reaching and innovative crime legislation in the United States over the last twenty years. Unlike most criminal laws, which attempt to reduce illegal activity by explicitly increasing expected punishment levels for all potential offenders, recent sex offender legislation focuses on reducing "same crime" recidivism of those already convicted of sex offenses. Two primary examples are registration and notification laws. Registration laws require that convicted sex offenders provide valid contact information to law enforcement authorities, while notification laws require that sex offender information be released to members of the public who are likely to be targeted if a sex offender recidivates (for example, neighbors and former victims). Using detailed information on the variable timing and scope of state law, Rockoff and Prescott study how this type of legislation has affected the overall frequency of sex offenses, the incidence or mix of sex offenses across victims, and the response of police to reported crimes. In line with a simple model of criminal behavior, they find that registration laws reduce crime frequency by providing local law enforcement with information on local sex offenders, and that active community notification laws deter crime, most likely by raising the expected punishment to individuals not currently registered. Importantly, they also find some evidence that notification laws may increase repeat offenses committed by registered offenders, perhaps by making non-criminal activity relatively less attractive.

Johnson and Raphael present new evidence on the effect of aggregate changes in incarceration on changes in crime, accounting for the potential simultaneous relationship between incarceration and crime. Their principal innovation is to develop an instrument for future changes in incarceration rates, based on the theoretically predicted dynamic adjustment path of the aggregate incarceration rate in response to a shock (from whatever source) to prison entrance-or-exit transition probabilities. Given that incarceration rates adjust to permanent changes in behavior with a dynamic lag (because only a fraction of offenders are apprehended in any one period), one can identify variation in incarceration that is not contaminated by contemporaneous changes in criminal behavior. The authors isolate this variation and use it to tease out the causal effect of incarceration on crime. Using state level data for the United States covering the period from 1978 to 2004, they find that crime-prison elasticities are considerably larger than those implied by OLS estimates. For the entire time period, average crime-prison effects have implied elasticities of between -0.06 and -0.11 for violent crime and between -0.15 and -0.21 for property crime. They also present the results for two sub-periods of their panel: 1978 to 1990 and 1991 to 2004. Their IV estimates for the earlier period suggest much larger crime-prison effects, consistent with elasticity estimates presented in Levitt (1996), who analyzes a similar time period with an entirely different identification strategy. For the latter period, however, the effects of changes in prison on crime are much smaller. These results indicate that recent increases in incarceration have generated much less bang-per-buck in terms of crime reduction.

Galenianos and her co-authors develop a search-theoretic model of the retail market for illegal drugs. The model produces testable implications regarding the effect of interdiction and enforcement on: 1) the distribution of purity offered in equilibrium; and 2) the duration of the relationships between buyers and sellers. Their model is consistent with evidence from two datasets taken from the System to Retrieve Information from Drug Evidence and the Arrestee Drug Abuse Monitoring Program.

Combining transaction-level data on street prostitutes with ethnographic observation and official police force data, Levitt and his co-author analyze the economics of prostitution in Chicago. Prostitution, because it is a market, is much more geographically concentrated than other criminal activity. Street prostitutes earn roughly $25-$30 per hour, roughly four times their hourly wage in other activities, but this higher wage represents relatively meager compensation for the significant risk they bear. Prostitution activities are organized very differently across neighborhoods. Where pimps are active, prostitutes appear to do better, with pimps both providing protection and paying efficiency wages. Condoms are used only one-fourth of the time and the price premium for unprotected sex is small. The supply of prostitutes is relatively elastic, as evidenced by the supply response to a Fourth of July demand shock. Although prostitution is technically illegal, prostitutes' and johns' punishments are minimal. A prostitute is more likely to have sex with a police officer than to get officially arrested by one. The authors estimate that there are 4,400 street prostitutes active in Chicago in an average week.

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Entrepreneurship Working Group

The NBER's Working Group on Entrepreneurship met in Cambridge on October 6. Director Josh Lerner of Harvard Business School organized this program:

Edward L. Glaeser, Harvard University and NBER, "Entrepreneurship and the City" Discussant: Jeff Furman, Boston University and NBER

Umit Ozmel, Columbia University; David T. Robinson, Duke University; and Toby Stuart, Harvard University, "Strategic Alliances, Venture Capital, and the Going Public Decision"

Discussant: Sean Nicholson, Cornell University and NBER

Ola Bengtsson, Cornell University, and John R. M. Hand, University of North Carolina, "CEO Compensation in Private Venture-Backed Companies" Discussant: Paul Oyer, Stanford University and NBER

Thomas B. Astebro, University of Toronto, and Peter Thompson, Florida International University, "Entrepreneurs: Jack of All Trades or Hobos?" Discussant: Per Stromberg, University of Chicago and NBER

Marcos A. Mollica, BlackRock Inc., and Luigi Zingales, University of Chicago and NBER, "The Impact of Venture Capital on Innovation and on the Creation of New Business" Discussant: Manju Puri, Duke University and NBER

David H. Hsu, University of Pennsylvania, and Rosemarie H. Ziedonis, University of Michigan, "Patents as Quality Signals for Entrepreneurial Ventures" Discussant: Iain Cockburn, Boston University and NBER

Why do levels of entrepreneurship differ across America's cities? Glaeser presents basic facts on two measures of entrepreneurship: the self-employment rate and the number of small firms. Both of these measures are correlated with urban success, suggesting that more entrepreneurial cities are more successful. There is considerable variation in the self-employment rate across metropolitan areas, but about half of this heterogeneity can be explained by demographic and industrial variation. Self-employment is particularly associated with abundant, older citizens and with the presence of input suppliers. Conversely, small firm size and employment growth attributable to unaffiliated new establishments is associated most strongly with the presence of an appropriate labor force. Glaeser also finds support for the Chinitz (1961) hypothesis that entrepreneurship is linked to a large number of small firms in supplying industries. Finally, there is a strong connection between area-level education and entrepre

Ozmel, Robinson, and Stuart study the tradeoffs that young, private biotechnology firms face in the private equity market when they choose between raising capital from VCs or raising capital from strategic alliance partners. Increased alliance activity makes future alliances more likely, but future VC activity less likely. In contrast, VC activity makes both future alliance and future VC activity more likely. Both types of private capital raise the hazard of going public, and indeed alliances often play a larger role than VC activity in the IPO process. Acquisition as an alternative to IPO is made more likely by increased VC activity, but the link between acquisition probabilities and alliance activity is less clear cut. These results highlight both the importance of alliance partners in resolving asymmetric information problems in the capital acquisition process and the potential conflict of interest between different sources of private equity.

Bengtsson and Hand study CEO compensation in private venture-backed companies. They examine a previously unexplored survey-based employee compensation dataset collected by VentureOne that covers 1,585 U.S. companies in the period 2002-6. They show that CEO compensation is tied to company performance. Not only do CEOs hold relatively large equity ownership stakes, but their cash compensation is linked to both operating growth and fundraising success. These results suggest that even for venture-backed companies that are already subject to a range of strong governance mechanisms, executive compensation contracts are structured to minimize agency problems. The researchers also find that there are large differences in compensation between founder CEOs and non-founder CEOs.

Human capital investment theory suggests that entrepreneurs should be generalists, while those who work for others should be specialists; it also predicts higher incomes for entrepreneurs with generalist skills. An alternative view predicts that those with greater taste for variety are more likely to become entrepreneurs and that entrepreneurs will see their incomes decrease with greater skill variety. Astebro and Thompson use data from a survey of 830 independent inventors and 300 individuals from the general population to confirm that inventor-entrepreneurs typically have a more varied labor market experience. However, the more varied their experience, the lower their household income. These results support the interpretation that both choice of entrepreneurship and investment in generalist skills are driven by a taste for variety.

Mollica and Zingales exploit the cross-section, cross-industry, and time-series variability of venture capital (VC) investments in the United States to study the impact of VC activity on innovation and the creation of new businesses. As a measure of the quality of research in a certain area, they use the number of citations of academic papers produced by faculty in the area. As an instrument for the size of VC investments, they use the size of state pension fund's assets. Even with these controls, they find that VC investments have a significant positive effect on the production of patents and the creation of new businesses. A single standard deviation increase in the VC investment per capita generates an increase in the number of patents of between 4 and 15 percent. An increase of 10 percent in the volume of VC investment increases the total number of new business by 2.5 percent.

Hsu and Ziedonis examine the patenting and venture financing activities of 370 semiconductor startups that received more than 800 rounds of funding from 1980 through 2005. They find a significant effect of patents on investor estimates of start-up firm value, with a doubling in patent application stock associated with a 24 percent boost in funding-round valuations beyond what would otherwise be expected. They also find that the signaling value of patents is greater in earlier financing rounds and when funds are secured from prominent investors. Finally, their results suggest that having larger patent application stocks increases both the likelihood of sourcing initial capital from a prominent venture capitalist and of achieving liquidity through an initial public offering. They find little evidence, however, for the role of start-up affiliations with prominent partners once patenting activities are taken into account. These findings highlight the important interplay between external resource pro and the patent signaling strategies of entrepreneurial ventures.

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China Working Group Meets

The NBER's Working Group on China, directed by NBER Research Associate Shang-Jin Wei of Columbia Business School, met in Cambridge on October 12. The program was:

Galina Hale, Federal Reserve Bank of San Francisco, and Cheryl Long, Colgate University, "Labor Market Imperfections and the Effects of FDI Presence in China" Discussant: Wei Li, University of Virginia

Julan Du, Chinese University of Hong Kong, and Chenggang Xu, London School of Economics, "Regional Competition and Regulatory Decentralization: The Case of China"

Discussant: Paul Wachtel, New York University

Joseph P. H. Fan, Chinese University of Hong Kong; Jun Huang, Shanghai University of Finance and Economics; Randall Morck, University of Alberta and NBER; and Bernard Yeung, New York University, "Institutional Determinants of Vertical Integration: Evidence from China" Discussant: Zhiwu Chen, Yale University

James Harrigan, Federal Reserve Bank of New York and NBER, and Geoffrey Barrows, Federal Reserve Bank of New York, "Testing the Theory of Trade Policy: Evidence from the Abrupt End of the Multifibre Arrangement"

Discussant: Amit Khandewal, Columbia University

Panel Discussion on China's Transformation, Finance, and Growth: Loren Brandt and Xiaodong Zhu, University of Toronto, "Accounting for Growth and Structural Transformation in China, 1978-2004" Dwight Perkins, Harvard University, and Thomas Rawski, University of Pittsburgh, "Forecasting Growth over the Next Two Decades"

Hale and Long study the relevance of labor market competition effects in the presence of FDI. They develop a theoretical model to specify the implications of such effects and then apply it to China where some firms face restrictions on the wages they can pay. The results of their empirical analysis of firm-level data are consistent with the model's predictions and suggest that foreign firms compete with domestic firms for skilled labor. Specifically, these researchers find that when FDI presence is higher, average wages of engineers and managers in private domestic firms are higher, while the average quality of engineers in state-owned enterprises facing wage constraints is lower. In addition to providing the first piece of direct evidence of FDI-related competition effects on the host country's labor market, these findings highlight the relevance of labor market institutions in determining FDI spillovers.

Chinese regulatory decentralization has evolved since regulation was first introduced in the transition process. The quota system is an important instrument in China's regulatory regimes; the stock issuance quota system for regulating public offerings in securities markets is a major example of it. Du and Xu argue that under certain conditions quotas can generate proper incentives to induce regional governments to cooperate in implementing regulations nationwide. They provide four types of evidence that regulatory decentralization in China's financial market has created incentives for regional competition and for decentralized information collection in stock issuance. They also discuss the weaknesses and limitations of Chinese regulatory decentralization.

Using Chinese data, Fan and his co-authors find that vertical integration is importantly affected by institutional factors – it is more common in Chinese regions with weaker property rights protection, poorer local government quality, and stricter local regulation of market trades (which hampers market forces). Moreover, companies led by insiders with political connections are more likely to be vertically integrated. Vertical integration is negatively associated with share value if the top corporate insider is politically connected, but is positively associated with share value if the firm is independently audited.

Quota restrictions on U.S. imports of apparel and textiles under the multifibre arrangement (MFA) ended abruptly in January 2005. This change in policy was large, predetermined, and fully anticipated, making it an ideal natural experiment for testing the theory of trade policy. Harrigan and Barrows focus on simple and robust theory predictions about the effects of binding quotas, and also compute nonparametric estimates of the cost of the MFA. They find that prices of quota constrained categories from China fell by 38 percent in 2005, while prices in unconstrained categories from China and from other countries changed little. They also find substantial quality downgrading in imports from China in previously constrained categories, as predicted by theory. The annual cost of the MFA to U.S. consumers was about $100 per household.

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