There was a great turnout for the 2016 Harcourt Lecture hosted by the School of Economics, with many braving the weather to hear from Professor David Vines from the University of Oxford. Professor Vines gave a special lecture on ‘Individuals, Institutions and Ideas: Australia’s Macroeconomic Policy-making System from Federation to 2020.
This year’s Nobel Prize in Economic Science was awarded to Oliver Hart of Harvard University and Bengt Holmström of MIT for their contributions to contract theory. Contracts play an important role in many economic relationships between employers and employees, firms and consumers, and etc. Contract theory studies the optimal way to design contracts to ensure that both parties take mutually beneficial decisions when they have different interests.
Holmström’s theories in the 1970s considered the so-called “principal-agent problem” where a principal (e.g. an employer) hires an agent (e.g. an employee) to perform a work for him, and the agent’s action cannot be observed and performance cannot be perfectly measured. Holmström developed the “informativeness principle” which suggests that optimal contracts should structure compensation based on “all outcomes that can potentially provide information about actions that have been taken.”His later work studied this problem in more realistic setting, for example, when an agent works on many tasks; and when many agents work as a team. He also analyzed this problem in a dynamic setting where the principal can reward the agent not only with current pay but also future potential promotions.
Hart in the 1980s made a major contribution to contract theory in analyzing the “incomplete contracts.” Since the future is uncertain, the contracting parties cannot specify every possible future outcome. Therefore, a contract should also spell out who has the right to decide what to do when an unforeseen event happens. The research went on to develop new theoretical tools for questions “such as which kinds of companies should merge, the proper mix of debt and equity financing, and when institutions such as schools or prisons ought to be privately or publicly owned.”
Hart and Holmström’s work provides us the tools to analyze the designing of contracts’ financial terms, the allocation of control rights, property rights, and decision rights between parties. These tools can be applied to the design of many contracts in practices, from CEO compensation to the level of pay for workers overall.Their research “lays an intellectual foundation for designing policies and institutions in many areas, from bankruptcy legislation to political constitutions,” as the Academy states.
Paul Kerin appeared on Alan Jones’ radio program yesterday making the case for free trade and the need to improve governance arrangements that would help ensure that future Free Trade Agreements deliver more of the considerable benefits that are potentially available. This follows on from the article that 7 leading economists (including former Industries Assistance Commission chief Bill Carmichael and the University of Adelaide’s Richard Pomfret and Paul Kerin) published in The Australian on August 24 (more on that article is available here). You can listen to an audio of Paul’s interview with Alan Jones here.
Today’s Australian contains a piece by Mike Fitzsimmons and Paul Kerin. The authors note the substantial increase is household leverage over the last quarter of a century, particularly the rise (more than tripling) of household debt relative to cash disposable income. While this may in part be a good thing (reflecting better credit access in […]
There is an atmosphere of cautious waiting in the Brussels air. Major elections to come in France, Germany, as well as here in the Netherlands. But already some very worrying first drops start to come down. A very undecided ‘State of the Union’ speech by European Commission President Jean-Claude Juncker succeeded in the goal of […]
Although last week’s taxation decision by the European Commission (EC) was widely anticipated, the €13bn size of the Apple ruling last week caused a shockwave within the European Union (EU) as well as between the EU and the US. As a university professor at the start of the academic year, the Apple case provides for […]
I was honoured to be one of the economists who put their names to a major feature in today’s Australian, titled “Free trade mythology”. Despite the title, we are very much pro free trade – but we call for a number of reforms to our trade negotiation and communication governance processes and a renewed emphasis on […]
The NAB’s June quarter survey of SME businesses (released today) shows both business conditions and confidence up in all states, although SA and WA (in particular) lag behind other states. Nationally, multiple measures of business conditions – particularly trading and profitability – were up, although employment conditions remain “lacklustre”. The business confidence index is up […]
The NAB’s latest State Update for South Australia and State Economic Handbook (the latter covering all states) both indicate that some “green shoots” are emerging in SA, but SA’s economic fundamentals remain “soft” relative to other states. Both reports are available here. The green shoots include improvements in business conditions, business confidence, household income and […]
A few weeks ago, the EU extended its sanctions against Russia for another 6 months. However, some days before that move Russia had already extended its sanctions on the EU for one and a half years. So, this fight is turning out to be a battle of wills or, better, a War of Thrones. Currently, […]