Launch Aid
Risk Shifting, Technology Policy and Sales Contingent Claims:
When is Launch Aid to the Aerospace Industry a Subsidy?
(co-authored with Paul Stoneman)
CEPR Discussion Paper no. 4798
This paper studies the criteria with which the presence or absence of ‘subsidy’ in sales contingent Launch Aid R&D support may be determined when payoff-relevant market incompleteness limits the precision of market-based pricing to non-trivial intervals. The criteria currently employed in WTO and EU proceedings are consistent with correct accounting for the opportunity cost of capital when markets are complete and frictionless, but fail in the presence of payoff-relevant market incompleteness where the interval between bid and ask prices may not be finessed away. An economic definition of subsidy must necessarily capture opportunity cost, and we develop a definition that fully incorporates government's opportunity cost in both complete and incomplete market settings. With this in hand we then revisit some commonly posed questions concerning the subsidy status of Launch Aid, giving indication of how they may be best resolved by those in possession of the relevant details.
Premise and Practice of U.K. Launch Aid
Journal of World Trade, June 2006, Vol. 40 Iss. 3, pp. 495--525.
Launch Aid has crucially facilitated civil aerospace product development efforts in the UK. Currently Launch Aid figures centrally in the charged international dispute over civil aerospace subsidies, in which it has been characterized variously as an instrument of infant industry policy, technology policy and strategic trade policy. Yet surprisingly little independent economic analysis has informed this debate. This paper’s modest aim is to utilize a longitudinal historical approach to facilitate in-depth analysis of the economic, institutional and legal premises of Launch Aid with a view to resolving, to the extent possible, inconsistencies apparent in the public policy and trade dispute debates.
Risk Shifting Performance of Royalty Contracts;
Airbus' Launch Aid is Better Still than Equity
The simple cash flow definition of profit, that is, the pass-through dividend payout policy, is a standard workhorse of economic analysis. Nevertheless it is well-established that firms smooth their dividend payouts and generally resort to dividend cuts only as a last resort. Thus far these empirically observed Lintner-style smoothed dividend equity shares have been omitted from analyses of risk shifting performance. This paper augments Sebenius and Stan's (1982) analysis of risk shifting performance with the empirically relevant category of smoothed dividend equity shares. Compared to the royalty vs. pass-through profit contrast, the revenue-cost covariance threshold at which it becomes risk-efficient to pay a royalty share (rather than a smoothed dividend) occurs at a lower, not necessarily positive level. This result provides further grounds fro understanding the effet of royalty-based contracts throughout the economy, including European 'Launch Aid' for Airbus.
UK Launch Aid Experience
Warwick Business School Research Papers No. 260
Compared with the amount of interest Launch Aid has generated over the years, disproportionately little factual data has informed public policy debate. Information entering the public domain has arrived in piecemeal fashion, resulting in considerable disparities between sources. While Launch Aid has figured prominently in post-war UK civil aerospace policy to date, the impending decisions over how to fund the Airbus Industrie A3XX super jumbo programme and more generally over how to respond to the US industry have once again returned Launch Aid to a position of particular relevance, importance and topicality. This paper aims to provide a systematic, consistent and independent account of UK Launch Aid experience drawing on all publicly available information. Emphasis is placed on a) the historical, legal and institutional development of UK Launch Aid policy, as well as on b) the accompanying factual questions relating to actual sums disbursed and repaid. The result is a considerable improvement over existing sources in terms of completeness and consistency, serving additionally to identify remaining areas requiring further investigation.
Technology Policy
Public Provision of Sales Contingent Claims Backed Finance to SMEs:
A Policy Alternative
(co-authored with Paul Stoneman)
Research Policy, June 2007, Vol. 36, No. 5, pp. 637--651.
In Europe (and elsewhere) governments intervene actively to stimulate innovation in the SME sector, and because SMEs face financial constraints in particular, governments encourage the provision of debt and equity (venture capital) finance to such firms. This paper discusses another form of finance - Sales Contingent Claim (SCC) backed finance, which is funding secured only on a claim written on sales - that offers a different repayment profile to debt and equity instruments. The attractiveness of such finance to firms as well as the behaviour of firms financed in this way are analysed in this paper. For various reasons SCC-backed financial instruments are generally not available to SMEs on the market, but it is argued that wider availability could further stimulate the growth and innovative activity of SMEs. The correction of this market incompleteness by the introduction of government schemes providing SCC-backed corporate finance for SMEs in higher risk (higher tech) sectors is thus recommended. The workability of such a scheme is explored by looking at existing examples aimed largely at project finance for larger firms. This is not a recommendation of a subsidy for SMEs.
Spin-Offs, Externalities, and the Economic Justification
of Public Expenditure on R&D
Frequently, public expenditure on R&D is justified with high-profile spin-off successes stories. Such arguments invariably commit to a particular, though not necessarily explicit sense of spin-off. Yet this choice is not inconsequential to the strength of such arguments. Notwithstanding spin-off arguments’ persuasive success in public discourse, their effectiveness in making the case for economic justification is dependent on the nature of the spin-offs they report. True (technological or real income) externality spin-offs lend support for public expenditure on R&D. Contrarily, pecuniary (distributional) externality spin-offs neither support nor falsify the economic justification underpinning public expenditure on R&D.
Relationship Finance
Informational Rent, Publicly-Known Firm Type,
and 'Closeness' in Relationship Finance
Economics Letters, June 2006, Vol. 91, No. 3, pp. 430--435.
Even if firm type is publicly known, relationship intermediaries obtain an informational rent, formalized as a compound quasi-option sequence, when each roll-over decision is conditioned on a private signal of next-period success. The relative performance of this signal extraction apparatus forms a natural measure of relationship 'closeness'.
Relationship Finance, Informational Rent,
and Observational Indistinguishability from Short-Termism
Relationship intermediaries specialise in alleviating information asymmetry, but the literature remains vague on precisely what information they acquire and how they put such information to use. This paper characterises explicitly a particular class of signal extraction and studies the optimal funding policy that maximises the associated informational rents. Because it strikes the optimal trade-off between present and future periods, this funding policy cannot be labelled short-termist. Yet if the relationship intermediary's ROC curve is kinked, this intertemporally optimal funding policy may nevertheless appear indistinguishable from short-termism to the uninformed outside observer.
Decision, Risk, and Uncertainty
Negative Recency, Randomization Device Choice, and Reduction of Compound Lotteries
Economics Letters, May 2012, Vol. 115, No. 2, pp. 263-–267.
We report an experiment in which subjects are not indifferent between real-money lotteries implemented with randomization devices that are equivalent under the Reduction Axiom. Instead choice behavior is consistent with subjective distortion of conditional probability, and this persists in treatment conditions that control for (i) computational limitations and (ii) possible confounding by ratio bias.
Alternation Bias and the Parameterization of Cumulative Prospect Theory
Ch 6 in: Mohammed Abdellaoui and John Hey (eds.) Advances in Decision Making Under Risk and Uncertainty, Theory and Decision Library C 42, Springer-Verglag Berlin Heidelberg, pp. 91-107.
Two recently published studies argue that conventional parameterizations of cumulative prospect theory (CPT) fail to resolve the St. Petersburg Paradox. Yet as a descriptive theory CPT is not intended to account for the local representativeness effect, which is known to induce 'alternation bias' on binary iid sequences such as those generated by coin tossing in St. Petersburg gambles. Once alternation bias is controlled for, conventional parameterizations of CPT yield finite certainty equivalents for the St. Petersburg gamble, negating the suggested need for reparameterization. Moreover, the associated willingness to pay estimates fall within the generally accepted empirical range.
Local Representativeness and the St. Petersburg Paradox
In the context of coin tossing, the local representativeness effect gives rise to alternation bias, whereby negatively autocorrelated sequences are perceived as maximally random and the runs characteristic of unbiased memoryless Bernoulli processes are perceived as being excessively regular to be random. Thus as a consequence of the local representativeness effect, a negative subjective autocorrelation is associated with tosses of fair, memoryless coins. Given this negative subjective autocorrelation, the expected value of the St. Petersburg prospect is finite. Moreover, this expected value falls within the empirically-determined range of what people are typically willing to pay for the St. Petersburg gamble.
Logarithmic Opinion Pools Violate
the Unanimity Preservation Property
The aggregate of CARA individuals' beliefs takes the form of a logarithmic opinion pool in both market (composite market beliefs) and non-market (syndicate surrogate beliefs) settings. This paper shows that logarithmic opinion pools violate a minimal consistency requirement between individual- and aggregate-levels: the unanimity preservation property.
Endogenously Non-Additive Aggregate Probabilities:
Syndicate Surrogate Functions and Composite Market Beliefs
The formalization of Knightian uncertainty in terms of non-additive set functions has allowed numerous advances in the modeling of economic, financial and decision making behaviour. Although these developments are underpinned by axiomatic theories giving rise to a Choquet Expected Utility (CEU) representation of the preference relation, the requisite existence of ‘sufficient’ uncertainty in the economic environment and agents’ aversion to this uncertainty typically rests on hypothesis or assumption. Whereas these assumptions are supported by experimental evidence as well as qualitative and quantitative observational evidence, the wider salience of models in this tradition would be enhanced if it could be shown that non-additive probabilities arise endogenously within familiar and relevant theoretical frameworks.
Indeed this paper shows that non-additive probabilities are naturally generated by classical models of market and non-market aggregation. Heterogeneity of individual additive probability beliefs is sufficient for Rubinstein’s (1974) ‘composite’ market beliefs and for Wilson’s (1968) syndicate ‘surrogate’ beliefs to be non-additive. Specifically, these aggregate belief functions take the form of convex capacities, where the associated level of ambiguity is an increasing function of individual heterogeneity. This convexity of aggregate-level beliefs is necessary for preserving and reflecting unanimity, insofar as it exists, among individual-level preferences (beliefs). Furthermore, where individual agents’ density functions are known and belong to the same class, the associated aggregate-level ambiguity can be derived explicitly. Here the intuitively appealing notion is that persistent differences of opinion between individuals become manifest as Knightian uncertainty on the aggregate level. As the non-additivity of surrogate functions and composite belief functions holds generally, by implication CEU is the appropriate rationality construct for models employing these types of aggregation functions.
Other Topics
Trade-Related Job Loss, Wage Insurance, and Externalities:
An Ex Ante Efficiency Rationale for Wage Insurance
The World Economy, June 2007, 30(6), pp. 962--971.
The extension of adjustment assistance to those who have suffered trade-related job displacement is widely supported on both sides of the economics of globalisation debate. The form that such assistance should take, namely wage insurance, is also the subject of wide agreement. Nevertheless, the formal economic rationales offered for such a policy are varied, including political economy arguments, equity arguments, and market failure / ex post efficiency arguments.
This note proposes an ex ante efficiency-based rationale for the provision of adjustment assistance in the specific form of wage insurance. Job displacement imposes pecuniary externalities on displaced workers, which, in a complete markets setting, induce only a shift along the ex ante Pareto efficient frontier. However when markets are incomplete, pecuniary externalities become welfare-relevant. Without the possibility of diversifying or hedging the risk of pecuniary external diseconomies of job displacement using contingent claims, welfare is reduced ex ante. Wage insurance---whether publicly underwritten, privately underwritten (as in Shiller's (2003) 'livelihood insurance'), or supplied on a mixed public/private basis---completes the market for contingent claims, allowing workers to diversify or hedge the risk of trade-related pecuniary external diseconomies. By facilitating risk sharing, wage insurance removes an impediment to ex ante Pareto efficiency. Moreover, wage insurance affects not only post-displacement behaviour by increasing the incentive to reacquire employment quickly, but it also affects pre-displacement consumption and investment behaviour, in particular, lowering the threshold at which workers will be willing to undertake irreversible investment in industry-specific skills.
An Alternative Model of Pro-Cyclical Absenteeism
Economics Letters, 1997, 54(1), p. 29-34.
Current economic models of absenteeism derive pro-cyclical properties from cyclical variations in the costs and consequences of absence. Through an extension of the household production model, this paper proposes a complementary approach based on variations in foregone earnings associated with work-commodity itself.