Designing countries that work for everyone: Incentive Contracts under Moral Hazard, the Evolution of ICT and Income inequalities

Many commentators of last year's referendum in the UK and the outcome of the US presidential election have pointed to the deep dissatisfaction of voters in both countries with the recent evolution of their economic system. These sentiments are reflected by Theresa May's first speech as Prime Minister where she promised to ``make Britain a country that works for everyone'' and not just for the ``privileged few''. Similarly, President Trump pledged in his inaugural speech that ``the forgotten men and women of our country will be forgotten no longer.'' According to the OECD data, the past couple of decades have seen an increase in average of Gini coefficient in the 36 OECD countries from 0.290 in the 1980s to 0.318 in 2014 or latest. Economic literatures have identified some explanations for the recent trend in income distribution, such as a skill-biased technological change and globalisation. The aim of my research is to build a theoretical framework to provide a channel between these exogenous changes in the economy and the prevailing phenomena of income inequality and derive an optimal institutional setup including unemployment benefits, tax redistribution system and the bargaining power of labour.

To achieve this, the first phase of the research builds a microfoundation of the model, which is represented by a labour contracting problem between a representative firm and worker under an environment characterised with moral hazard, resulting in an incentive contract. An important assumption to be made in the model is that a worker's preference features some behavioural economic findings. The equilibrium of the model is taken as an optimal structure of an organisation given a certain institutional setup. In this stage, I will conduct some comparative static analysis with respect to some of the relevant parameters, such as technological level.

The second phase of the research will embed the above model in a welfare maximization problem of a benevolent regulator to derive the welfare maximising level of institutional setup. Using MATHEMATICA, I will employ a numerical approach where the parameters of the model are initially chosen so that some of the characteristics of the model resemble the real-world. The objective here is to derive the optimal institutional response to changes in the underlying parameters. Moreover, to understand the implication of entrenchment, I intend to discuss the consequences of not adjusting the institutional arrangement.

The objective of final phase of the research is to insert the above institutional design problem in an international environment. Firstly, I will derive the Nash equilibrium across countries in the design of an institutional and legal framework when the decision maker maximises the welfare of their country. As is standard in the literature, I will assume that the capital is perfectly mobile. With respect to labour, I intend to distinguish between skilled and unskilled labour in terms of mobility. This is based on the assumption that the transaction costs for skilled labour is smaller than that of unskilled labour. In this stage, I also intend to analyse the case of a non-welfare maximising decision maker (for instance due to a regulatory capture) and examine whether an international competition for design of institutional system can function as a disciplining device.