Economic And Politic USA Today

Report delves into Gingrich's work for Freddie Mac

2011-11-15T20:15:00.001-08:00

A story today by Bloomberg News tries to flesh out the work Newt Gingrich did for Freddie Mac and his relationship with the mortgage company.

When Gingrich was asked at a GOP presidential debate about his Freddie Mac work, the former House speaker said he acted as a "historian," did no lobbying and warned of the company's "insane" business model.
The Bloomberg story says Gingrich was "asked to build bridges" with Republicans in Congress and "develop an argument on behalf of the company's public-private structure that would resonate with conservatives seeking to dismantle it."

The story cites unnamed sources.
If Gingrich concluded Freddie Mac's business was "risky," the story says, "he didn't share those concerns with Richard Syron," Freddie Mac's CEO at the time.

A statement posted on Gingrich's campaign website after the Nov. 9 debate says the Gingrich Group offered "strategic advice" on a number of issues, including "how to reach out to more conservatives."
Here's what the Gingrich statement said on that point:

The Gingrich Group stressed that Freddie Mac must be open to reform of their lending practices but that by stressing the historical success of public-private partnerships in achieving public goods at a minimum of taxpayer money and bureaucracy.

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2011-11-15T20:13:00.001-08:00

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Non-conformism in academia

2011-11-15T07:56:00.000-08:00

In economics, there is the mainstream and various heterodox fractions that do not identify with the mainstream or each other. Too many, the heterodox seem like annoying and useless chatter. But they fulfill an important role, which is to keep those in the mainstream on their toes. This is part of the scientific process: challenge long and widely held views to check whether they are still valid. And even if the challenge is wrong, it makes those in the mainstream think about the axioms the build their theories on.

Vela Velupillai makes the case that dissenters are typically silenced by the mainstream, but may prevail in the long-run, citing many examples of mathematical economics, in particular the work of Pietro Sraffa. And this is really what tenure is good for: a dissenter will have much trouble publishing but may ultimately still contribute a lot to scientific advances.

We are in times were dissenters seems to have a more receptive audience. Indeed, the current crisis is seen by some as a failure of Economics, thus it is easy to criticize it. But it also highlights that dissenting can be very distracting if it is poorly focused, uniformed and populist. In this regard the recent dissenting by Colander, Krugman and Stiglitz has, I think been counterproductive, as I have occasionally discussed here. It is good to criticize the fundamental assumptions of the mainstream. It is better, but not necessary to offer alternatives. But it is counterproductive to dissent on the basis of a old read of the literature, and a literature that has in the meanwhile evolved to address these supposedly new criticisms.

Heterodox Economics has thus gained a fresh wind, simply because it is different from the mainstream. But what does it have to offer? Peter Skott, a heterodox economist himself, argues that it is still far from being an viable alternative. While heterodox approaches usually reject microeconomic foundations in macroeconomics, they should not throw out the baby with the bath water, i.e., ignore microeconomics altogether. And while the heterodox analysis for income distribution has focused on the labor income share, the large changes in income inequality happened within labor income. Finally, the heterodox literature is just as guilty of ignoring many of the suddenly relevant intricacies of the world of finance.

There is still a lot of work to do, and instead of pursuing an excess of mutual accusations and claiming Economics is useless, it seems much more appropriate to put more resources into making it better, heterodox or mainstream. After all, medical research was not defunded when the HIV/AIDS epidemic made ravages.

About beer

2011-11-14T07:10:00.000-08:00

Beer has been an important part of human well-being, and this for thousands of years. While the economic literature has dealt rather little with it, many great papers have significantly evolved at the pub. Still, I have previously reported on a conference on the Economics of beer, and open source beer.

Now, let us talk about the economic history of beer, thanks to Eline Poelmans and Johan Swinnen. Brewing in the middle ages was he realm of monasteries, with rather small output and a lot of product diversity. With technological advances and reduction in transportation costs, commercial breweries took over and especially over the last hundred years they lead a remarkable trend towards consolidation. After all those mergers and acquisitions, product diversity was considerably reduced. This is all changing now, and tastes have become more sophisticated and local micro-breweries are on the upswing. In some ways, beer has become more like wine.

Why are school counselors so bad?

2011-11-13T07:07:00.000-08:00

Recent news articles following up on the Occupy X movement have focused on youth unemployment and student debt. One aspect of this that strikes me are the absurdly bad choices students make. And from discussions with undergraduate students I ahad over the years, school counselors shares share part of the blame.

For one, they keep sending students into supposedly easy majors, even if job prospects are slim. If a student cannot handle the rigors of a serious university education, he should not be in university. He is less likely to get grants, more likely to take longer to graduate and then be in debt, less likely to get well-paying jobs there after and thus will face students debts for many years. Also, students with ambitions in better majors are told to switch to easier majors when they face difficulties, instead of helping them to overcome these difficulties. This is in particular the case for ethnic minorities and women, and one then wonders why they are underrepresented in science and technology. The problem is that counselors perpetuate or even amplify prejudices. An example is Neil deGrasse Tyson who was told that as a black he should go to basketball, not physics, and was not offered the help white students were getting when he struggled with classes, when blacks are not expected to excel in physics.

Also, counselors seem to obsessed with finding the "right college," which often an obscure little university where every major has only two or three faculty, and turn out to be expensive. The usual explanation is that the students needs small classes. This seems like another case of someone who is going to be highly in debt for a long time. And to come to Economics, the major is filled with undergraduates who did not get in or got kicked out of the business school, most often for failing on business mathematics and statistics. And what do counselors tell them? Get into a similar major, like Economics (or Psychology), ignoring that those quantitative skills are even more needed.

Why do counselors give such bad advice? I do not have an answer beyond wild guesses. But my casual observation tells me that the best psychologists or education professionals do not espouse this career, and for a good reason: on average the entry salary for a graduate of a Masters program in school counseling is an astounding US$33,000. In some sense, this is the bottom of the barrel that is trying to give advice to people on how to avoid falling to the bottom of the barrel. That is hardly inspiring. Schools should hire at least a few people who had successful careers to show how it is done, for example retirees.

Miss sharing with future generations? You are not missing much

2011-11-11T09:11:00.000-08:00

Markets are not complete. Two major ways in whuch they are not complete is that we have borrowing constraints and that we cannot exchange with future generations. The latter can be a big deal when we think about the valuation of future amenities (like the environment) or long term risks. In particular, future generations could make us behave in certain ways if they could influence some of today's markets. This is precisely why the overlapping generation literature emerged, and a principal conclusion of it is that the government needs to intervene, in particular by providing an security that lives beyond generations: the government bond. While there is obviously a welfare cost to the lack of future generations on current markets, how large is it? The literature tells us the welfare benefit of the government bond is large.

Roel Mehlkopf just defended a dissertation on this topic, focusing on risk. In a nutshell, the cost is not that large, and it all has to do with distortions on the labor market. For one, those you ex-post need to transfer to another generation face a commitment problem in the sense that they want to reduce their labor supply, for example by retiring early. Once you take this into account, there is little to redistribute, and it can even be welfare-decreasing to transfer. This rationalizes why pension funds needs to be solvent at all times, even if they are solvent in the long run. One important implication is that when cuts are necessary in pensions, they should be larger for the young workers, as this reduces the labor market distortions.

Also, the dissertation points out that comparing to a situation with fictitious markets between non-overlapping generations can be misleading. Indeed, this implies that they all have the same weight in a social welfare sense. But there can be good reason for a social planner to deviate from this, and the analysis above, fr example, implies that future generations benefit more from risk sharing than current ones (who are at least partially locked in by past decisions). This should entice the social planner to give more weight to current generations, even beyond normal discounting of the future. And as only current generations for for the current government, we are not far from that optimum.

Physiology and Malthus

2011-11-10T09:08:00.000-08:00

The Malthus model of economic growth (or the lack thereof) is now standard fare in undergraduate education. Basically, it shows that there is a limit to the size of an economy that hinges on decreasing returns to labor in production and on mortality increasing as standards of living, as measured by GDP per capita, decrease. Those two critical assumptions are based on observations that were certainly valid at Matlhus' times, and are likely to still be true today.

Carl-Johan Dalgaard and Holger Strulik go a little bit further in this theory. As more food is available, people grow taller. But being tall requires more food to sustain the body, which provides an additional reason for stagnation. This makes it more difficult to break loose from this "development trap" and may explain why economies stagnated for so long. But as Malthusian theory, this dies not explain why the economy suddenly exploded in the 19th century.

Acquiring a firm for its workforce

2011-11-09T07:18:00.000-08:00

Why do firms get merged or acquired? In the end, the hope is that it increases firm value, although the stock market response is often negative. It may also be for (anti-)competitive reasons, as firm try to buy the challengers. Or it may be to acquire a patent portfolio, technology, or access to a client list or new markets. I may forget some other good reasons.

Paige Ouimet and Rebecca Zarutskie show that mergers and acquisitions can also be the result of a drive to get access to the other firm's pool of workers. This is particularly true when the labor market is tight and the workers carry high human capital. Interestingly, wage tend to increase and turnover tends to decrease after such mergers. Thus not all employees should be afraid of M&As.

Why is funeral insurance so popular in Africa?

2011-11-08T08:41:00.000-08:00

Probably the oldest form of insurance is existence is funeral insurance, which takes cares of burial (and now cremation) costs at death. In developed economies, its popularity has vanished, while it is still very common in Africa. One reason could be that when life insurance is available, people believe it is sufficient to cover funeral costs, and the beneficiaries are committed to take care of this. When life insurance is not available or when not commitment can be elicited from descendants, then funeral insurance ensure your body is properly disposed of.

Erlend Berg writes a model along those lines and finds that only middle income should favor funeral insurance. The rich do not face a tight budget constraint and the poor cannot afford it. Then using a marketing survey conducted in South Africa finds results that are consistent with the model. This lack of commitment in Africa for financial matters is pervasive. It is, for example, at the heart of the strange institution that ROSCAs are.

Why top MBA programs do not disclose grades

2011-11-07T08:36:00.000-08:00

I have always been puzzled by the policy of many top MBA programs not to disclose the grades of their students. Even more puzzling is that they by and large manage to enforce this policy even from their top students, who should obviously want to signal that they are at the top of their class.

Daniel Gottlieb and Kent Smetters wondered about this as well. Such policies are voted by the students (who in the US own the grades) on the argument that it allows them to take more difficult classes without adverse consequences. Yet the evidence is that they learn less when such a policy is in place, which explains the general opposition to it from faculty. So, one can conclude that students are lazy (nothing new here), but is such a policy limited to top MBA programs? Why not in lesser programs, or other professional schools?

Gottlieb and Smetters point out that students have two signals for potential employers: their grades and the selectivity of the program. They are also risk averse, and at the start of their studies do not know how well they will do. In top schools, the selectivity signal is very strong and the students rely on it, while the "average" grade is superior in expected terms. In lesser schools, the selectivity signal is much weaker, and hence students try to distinguish themselves on the labor market in other ways, for example with grades.

To some extend, the same is happening on the Economics PhD market. When you look at the recommendation letters form the top schools, all candidates are the best in a generation in their field (I am exaggerating on a little). Thus the letter looses a lot of its value, and all that remains is the entrance selectivity of the PhD program. Lower ranked programs are much keener to differentiate their students and push the particularly good ones.

Adaptive versus rational expectations

2011-11-04T07:20:00.000-07:00

There was a time where macroeconomics was ruled by adaptive (or backward-looking) expectations, like the much-ridiculed chartists. Then there was a revolution and rational (typically forward-looking) expectations were widely adopted, realizing that people are not stupid and will try to use the available information, including what other agents may do, to figure out what the future holds. Rationality, and in particular rational expectations, has recently come under attack because models failed to predict recent bubbles and crashes. I think this is mistaken, as detailed on several occasions on this blog.

Gregory Chow, however, longs for a return to adaptive expectations for three other reasons. The first is that it is empirically more plausible. Exhibit A is a regression of the stock prices of 50 blue chips in Taiwan on current dividends and past dividend growth. Despite a lowly R2 of 0.111, the fact that the coefficient on dividend growth is positive and significant is taken as evidence of adaptive expectations. I do not find this convincing, as a similar result could emerge with rational expectations if the dividend growth process is persistent.

The second reason is that "there is no reason to believe that the expected values [computed from an econometric model of the rational expectations] will have a sum, after discounting, which equals the actual current price." I think the underlying reasoning is that a statistician can only use a linear combination of past observations, thus economic agents will, too, and this all looks like adaptive expectations. But economic agents, and nowadays statisticians, are more sophisticated than that, and a gigantic literature in finance has shown that, for example, non-linearities and endogenous volatility, too name a few, are important. Even though statisticians have become much more sophisticated, they are still running behind economic agents and are far removed from being linearly backward-looking.

The third reason is that macroeconomists started using rational expectations simply because it was required to deal with the Lucas Critique, empirical evidence be damned. While I can be sympathetic to the argument that rational expectations was adopted without much direct empirical evidence, I also believe that economic agents do try and avoid systematic mistakes and that their expectations contain at least some rationality. And as much literature has shown, a modicum of rationality can bring markets darn close to prices that look like perfectly rational ones.

Is index-based weather insurance useful?

2011-11-03T07:14:00.000-07:00

Whenever you are facing a risk, you want to be able to hedge against it (at least if you are risk averse). For this, there are all sorts of insurance policies. There are also markets in all sorts of instruments that allow you to find the right contingent claim for your situation. This includes farmers (and others) who want to hedge against meteorological risks. If you crop yields depend on weather patterns, you are looking for securities that pay out depending on some weather statistic. And they are available and have been heavily pushed by aid agencies in developing countries.

Chiratan Banerjee and Ernst Berg say they may not be such a great idea. They take the examples of rice farmers in the Philippines who bought wind-speed based indexes on the hypothesis that rice yields are lower when there are typhoons. But rice is remarkably resistant to typhoons and wind in general, the reason why it is so popular in the region in the first place. This means that rice farmers are heavily over-insured. That is especially bad and farmers are now confused about the concept of insurance as it looks like they face more risk than before.

Unemployment insurance in developing economies?

2011-11-01T07:49:00.000-07:00

There is no doubt that absent moral hazard, insuring against unemployment shocks is welfare improving. But moral hazard, either through the unemployed not searching hard enough or rejecting job offers, can have a vicious effect on welfare if it is sufficiently widespread and successful. In addition, as unemployment insurance contributions typically do not depend on unemployment risk, only bad risks want to participate, and the insurance collapses without mandatory participation. With all this in mind, does it make sense to implement unemployment insurance in developing economies, where there is a large informal sector that makes mandatory contributions difficult to enforce and where moral hazard is, of course, rampant?

David Bardley and Fernando Jaramillo show that introducing unemployment insurance actually makes the formal sector more attractive and that we should thus not worry that much about the current level of informality. The presented model, however, does not allow for someone to collect UI benefits while working in the informal sector, a very real possibility that could easily overturn the results.

Religion as an insurance mechanism against aggregate shocks

2011-10-31T07:26:00.000-07:00

I have never been fond of the claims that the world is better with religion. The principal claim is that religion gives hope for people in dire circumstances, and thus in Economic terms increases their utility despite having hit the budget constraint. But one could also argue that these people are being mislead, as religion provides them with subjective probabilities that are far off the objective ones, all the while making the budget constraint even tighter because of the tithe and other material donations.

Olga Popova studies whether this effect of religion on happiness not only applies to individual circumstances, but also for aggregate shocks. Looking at the transition countries, which each suffered through substantial falls in GDP after the collapse of the Soviet rule, more religious people suffered, in terms of happiness, less than others from the large economic reforms. Of course, it is easy to understand that for most, they were happier than circumstances would indicate because it was rather obvious that things would eventually improve, likely a lot. The question is why religious would believe this more? Because they are easily indoctrinated, and it is certainly true that there was a lot of excessive pro-market rhetoric at the time. Non-religious people were probably more among the skeptics. And they were also more likely to be among those who benefited from the previous regime, which definitely oppressed religion. Unfortunately, this study does not take (previous) party affiliation into account, which is likely very (negatively) correlated with religiosity. Too bad.

Individual characteristics are more important for academic success in university

2011-10-28T07:14:00.000-07:00

What makes a good college students? Looking at the admission criteria of universities can be insightful. Public universities in the United States basically just look for high school grades and standardized test results, with some adjustment background characteristics (race, high school characteristics), if any. European universities in the end just care about grades, in most cases that a student was above some level. And US private universities look at a large array of characteristics, with extracurricular activities and personal essays being of particular importance, grades in some cases being even ignored. While these different types of universities have obviously different motivations, ultimately they are looking for potential in students. So what determines academic success?

Martin Dooley, Abigail Payne and Leslie Robb use administrative data about a dozen entering cohorts in four Ontario universities to explain what makes students stay longer in tertiary education and have better college grades. It turns out that the high school grades are pretty much sufficient. At least for Canada, it is reassuring to see that individual performance matters more than where you are coming from. Of course, one could wonder whether all the other characteristics that private US schools consider would matter here. But this kind of data was presumably not available, as Ontario universities, all public, do not ask for such information during the application process. Also, there is no record in the study about individual standardized test results. Including those would only reinforce the results, but may have important policy implications: imagine they do not matter. Then it opens the door to grade inflation in high schools, and the grade signal gets diluted. And then admissions officers need to find something else to rely on, such as some of the characteristics that matter less.

Contracts with empty promises

2011-10-27T07:04:00.000-07:00

I always feel small talk has no specific purpose and is a waste of time. In fact, every time somebody asks me how I do, I launch into a well reasoned explanation of my current state of affairs, while my intelocutor is just expecting a "well-thanks-and you?" Yet, some people have found value in such chitchat, see a previous report. But what about contracts that have clause that have no chance of being met? Why would one allow empty promises in a legally binding contract?

David Miller and Kareen Rozen look at contracts that involve team work in a complex production environment, where opportunities for moral hazard abound. Performance clauses are hard to specify and you want to use peer monitoring and pressure rather than checking for the result of each individual task. Obviously, monitoring is costly, and along with statistical complementarities in the success rate, this implies that it could be optimal to delegate all the production to one person and the monitoring to another (the least productive one, according to the "Dilbert Principle"), and the latter may resort to wasteful punishment: naming and shaming, and even firing. It is wasteful, because it does not provide any direct benefit to the supervisor and it may not even be subgame perfect. Where are the empty promises? The one performing tasks can promise to fulfill them, but it obvious to all that they cannot be all successful because of some outside probability of failure. But the supervisor is willing to forgive failures, without knowing whether chance or moral hazard are at play.

Seemingly unrelated regressions and lamb carcasses

2011-10-26T07:01:00.000-07:00

The great thing about the Internet is that one can discover unexpected uses of familiar techniques. Or one can search for new applications with one's tool set. So what about SUR and lamb carcasses?

Vasco Cadavez and Arne Henningsen are responsible for this paper. I have nothing to add to the abstract: The aim of this study was to develop and evaluate models for predicting the carcass composition of lambs. Forty male lambs of two different breeds were included in our analysis. The lambs were slaughtered and their hot carcass weight was obtained. After cooling for 24 hours, the subcutaneous fat thickness was measured between the 12th and 13th rib and the total breast bone tissue thickness was taken in the middle of the second sternebrae. The left side of all carcasses was dissected into five components and the proportions of lean meat, subcutaneous fat, intermuscular fat, kidney and knob channel fat, and bone plus remainder were obtained. Our models for carcass composition were fitted using the SUR estimator which is novel in this area. The results were compared to OLS estimates and evaluated by several statistical measures. As the models are intended to predict carcass composition, we particularly focused on the PRESS statistic, because it assesses the precision of the model in predicting carcass composition. Our results showed that the SUR estimator performed better in predicting LMP and IFP than the OLS estimator. Although objective carcass classification systems could be improved by using the SUR estimator, it has never been used before for predicting carcass composition.

A market for IP addresses

2011-10-25T07:24:00.000-07:00

IP addresses face exhaustion, at the least those under the standard IPv4 format, and by some reports they should have been all used up already. What has helped delay the inevitable is probably the fact that there is now a market for IP addresses, yet it is not clear that the market is working efficiently. The reason is that IP addresses are allocated in blocks, and fragmenting the big IP allocation table makes it more difficult to manage it. For technical reasons, each allocation needs to be a square in the table. Thus, if a square is partially unused, it can only be split in multiple squares, increasing their number. Routers need to keep each possible square in memory, and their multiplication slows routing. And as IP addresses are privately owned and managed, there is no way to control this negative externality.

Benjamin Edelman and Michael Schwarz propose a market mechanism that should make the allocation of IP addresses more efficient. They suggest a "spartan rule:" in each bilateral trade, one of the two traders is designated as "extinguished," i.e., as prohibited from trading with other extinguished ones. As one can be extinguished only once, this implies that the number of cuts N in the IP table is limited to the number of initial holders of IP blocks. The analysis is static and under certainty, implying that the implicit rental price of an IP is zero as long as there is still a free one. But with the proposed rule, I do not see how one could necessarily reach exhaustion after the N cuts. It all depends on the initial allocation: one can end up with free IP addresses and no possible moves. In addition, once we add uncertainty and dynamics, there is going to be strategic behavior as being extinguished is a potentially costly absorbing state. I am thus not convinced of the arguments in this paper.

Of course, the easiest would be for everyone to switch to IPv6, which would give a sufficient number of IP addresses to last for a long time. But IPv6 devices cannot communicate with IPv4 devices (large scale IPv4 to IPv6 translation is cumbersome), which gives little incentive to switch until there is substantial critical mass. In other words, another situation like Y2K is approaching, and nobody has an incentive to do something about it. The more efficient market allocation will delay this, but also will make it even more urgent when it happens, because more addresses will need to switch, and they will have less time for it.

Women prefer cooperative work environments

2011-10-24T07:01:00.000-07:00

Girls (and women) tend to hang out in cliques, while boys (and men) tend to be more individualistic. This may have evolutionary origins. as women try to have have very good friends to insure that their offspring is taken care off should they die. Men do not directly have such a need, and may have several wives who continue to take care of their offspring should the man die. Does this attitude translate into the workplace?

Peter Kuhn and Marie Claire Villeval conduct a experiment where people need to exert effort, but can do it by choice individually or in a team. Women are then more likely to choose the team. Once there is an extra reward in efficiency for working in a team, both genders choose the latter in equal proportions. Still, the most able players tend to work alone. This can be interpreted as men being more responsive to incentives and women having more confidence in team work. Unfortunately, the study does not differentiate between same-gender and cross-gender pairings (gender was visible in the experiment).

On job loss estimates from regulation

2011-10-21T07:01:00.000-07:00

The current talk in Republican circles is that one can achieve significant job growth by deregulating. One may want to question this idea on two fronts. First, regulation has been initially imposed not for the fun of killing jobs, but because it improves the well-being of people. There is a trade-off, and sometimes it is worth having a little fewer jobs if it means improving the life of a lot of people. Second, the job loss numbers from regulation are often more fantasy than reality.

This is not a new question. Take the case of Australia, as discussed by Bruce Chapman. He looks at estimate of job loss in Australian mining from the implementation of an emission trading scheme. These 23,510 lost jobs are not as large as they appear. First, there would be job gains elsewhere, in particular in alternative energies. Second, when compared to normal job flows in the mining sectors, this number is quite negligible. Third, once you look at a somewhat longer horizon, say, ten years, a job loss is virtually undetectable. I would add finally, measurement of jobs losses has high uncertainty, and any result commissioned by one party in the debate needs to be taken as an extreme value.

So, do not have too high hopes that a sudden deregulation will create a job boom, especially in a country that has remarkably little regulation to start with.

Family firms are like public employers

2011-10-20T06:30:00.000-07:00

Family-owned businesses have good reputation with the public, for reasons that have never been clear to me. Indeed, it is even good marketing to mention that a firm is family-owned. Why? The products are not likely to be better. I suppose such firms are possibly smaller and younger, thus the likelihood of a product to be discontinued is higher. I guess such firms have stronger ties with the community, in case this matters.

Andrea Bassanini, Eve Caroli, Antoine Rebérioux and Thomas Breda find that there is an important distinction between family-owned business and other privately-owned ones. Looking at France, they observe that they pay there workers less, which does not seem like a big advantage in the public eye. However, families tend to offer more job security. This mirrors the public sector that in the end offers the same value as private enterprises, trading off job security and pay. So after all, family-owned are more involved in the community by providing more insurance to workers through job security, like so often the French government does by pursing rather Keynesian policies. I wonder whether this would apply to other countries where the public sector is not necessarily leading with such policies.

Using energy taxes to dampen energy price fluctuations

2011-10-19T08:24:00.000-07:00

Oil price fluctuations seem to preoccupy people less these days, maybe because they got used to higher prices or because other issues are hotter now. But remember how popular it was to call for the government, whatever the county, to reduce fuel taxes to ease the burden. Which bears the question whether this would be a good idea if you think harder about it.

Helmuth Cremer, Firouz Gahvari, and Norbert Ladoux did so and come to the conclusion that the fuel taxes should not move as much as the energy price. The reason is that the Pigovian motivation for imposing them, internalizing the externalities, has not changed, which would call for perfect smoothing. But this is to an important extend compensated by redistribution considerations as goods using energy are used by people of different incomes. In the end, a doubling of pre-tax energy prices lead to a post-tax increase of 64%. But that is only assuming that the tax was optimal to start with. In many countries it is currently much too low, thus the argument about reducing the tax in high price times is largely invalid, In fact, one should take advantage of reduction in world energy prices to increase the taxes, which would raise much needed money.

The imperfect market for re-insurance

2011-10-18T07:31:00.000-07:00

The insurance market is thought to be rather competitive, at least for the most common risks. That is in part because insurance companies are willing to take risks thanks to re-insurance, where they can insure large event risks and to some degree over-exposure. But there are rather few actors on the re-insurance market. Is this bad, and does it have an impact on the insurance market?

Sabine Lemoyne de Forges, Ruben Bibas and Stéphane Hallegatte play with a model of re-insurance and find that there is a trade-off. The lack of competition leads to sub-optimal re-insurance provision, obviously. But is also allows the few players to take on larger risks, some of which may not have been insured otherwise. And, the larger the re-insurers, the more resilient the market can be. As a regulator, this means that means that you may to let the re-insurance companies grow larger than want is optimal in terms of competition.

Spain: an eventful history of economic crises

2011-10-17T07:48:00.000-07:00

There is talk that Spain could get dragged into a financial crisis. While it is debatable whether this will happen or not, and whether it is inevitable, it is instructive to study Spain's economic history in this regard.

Concha Betrán, Pablo Martín-‐Aceña and María Pons look at a century and a half of data and basically do in more details for Spain what Carmen Reinhardt and Kenneth Rogoff did for many countries in their best seller. And as the latter book, the picture is depressing. Crises of all sorts were a rather regular occurrence, we have been just blessed with rather few of them over the last half century. For example, in the second half of the 2oth century, Spain experiences half a dozen currency crises, a couple of banking crises, three periods with negative stock returns over several years, and the IMF had to intervene three times for a debt crisis. It takes from this that while crises are becoming less frequent, they still occur, and the current one was long overdue.

Is this what Republicans are really about?

2011-10-14T07:26:00.000-07:00

Europeans have struggled for some time to understand the philosophy of the US Republican party, and especially how it manages to get such popular support in the electorate. On the surface, indeed, it all appears to be a platform that favors the rich at the expense of the more numerous poor, the latter having been indoctrinated for many years that governments are bad and, at the extreme, robber barons are better than a benevolent government. The consequence is a drive to increase inequalities in income and wealth.

John Roemer offers a glimpse into the American ideology for inequality. He says that "American philosophy" sees inequality as ethical, as it gives everyone what nature endows him with. That seems like a very fatalist argument (as in some religions) that ignores that redistribution is about the ex-post insurance of where someone is born. having the luck to be born in a good family and in a good country ought to be taxed to some degree to benefit the unlucky. A second argument is the old trickle-down one: if the most talented can keep all the fruits of their labor, they will work more (never mind decreasing marginal utility of consumption and how redistribution can improve global well-being). The third argument is that the government is good at nothing, and should thus be largely absent.

All these arguments are largely shared in the United States, and especially among Republicans. In fact, the latter are now going much farther in reversing redistribution than ever before. Just see how they they are vehemently opposed to any risk sharing through public health insurance, how they limit school funding and public goods in general. In fact, I am starting to wonder whether the hidden goal is to create a new underclass that would be in some ways reminiscent of the old slavery days. That would be consistent with the opposition to minimum wages, with the large prison population, and with keeping the poor uneducated. That would also be coherent with the Republicans willingness to increase the payroll tax (a flat tax applicable to everyone) while calling for a reduction in the income tax (a progressive tax). I hope I am wrong, though.

No convergence in the Caribbean

2011-10-13T07:46:00.000-07:00

I have always found the Caribbean fascinating because it is a microcosm of the world, with tiny countries trying to get a workable government without the economies of scale the rest of the world enjoys. But as a readers of Economics research, the presence of this myriad of too-small countries lead to many frustrations, as they bias results in cross-country regressions. But sometimes, these micro-countries can be useful for research.

Roland Craigwell and Alain Maurin use them to study whether there is convergence in the Caribbean. It is well established that there is no convergence on world-wide country data, but it is very visible on subsets, such as US states. In the later case, all US states are under the same currency and roughly the same laws and government systems, there is some cross-state redistribution and no trade barriers. As you drop these features, which one gets you lack of convergence. In the case of the Caribbean, there is a partial monetary and trade union, laws and governments are more dissimilar than in the US and there is no redistribution. And as Craigwell and Maurin show, that is sufficient to make convergence disappear. Once more, it looks like once more institutions and to a lesser extent globalization are the keys to development for the poorest economies.

Better GDP estimates

2011-10-12T07:28:00.000-07:00

GDP equals C+I+G+X-M. It also equals national income, at least in theory. But estimates differs widely, even for the United States, which is rather disturbing. How do you conduct proper economic policy when estimates of GDP, even after revisions can differ by more than 2% points and their growth rates have a correlation coefficients of only 0.63 (see the work of Jeremy Nalewaik)?

Boragan Aruoba, Francis Diebold, Jeremy Nalewaik, Frank Schorfheide and Dongho Song make the old diversification of risk argument: why not combine both estimates? After all, this is often done with forecasts, and the two estimates can be treated like forecasts of the true GDP. And consistently with this literature, the weights on each should depend on the variance of the errors. Of course, they are not observed, but the authors have some guesstimates, based on correlations with variables not used to construct either GDP measure that are supposed to be correlated with the true GDP. They then show that measurement matters, for example in dating business cycles. We'll see whether the US will adopt such averaging, as some other countries already do.

Addendum: I wonder how the recent major revisions to US GDP would have fared with this scheme.

Has the Internet reduced job market frictions?

2011-10-11T07:17:00.000-07:00

When we teach about how the Internet has improved the efficiency of the economy, one typical example we give is about job search: the Internet makes vacancy postings instantly available and searchable. And job applicants can send CVs with little cost and time, or even have them available in CV banks. The problem is that Peter Kuhn and Mikal Skuderud have proven that this is not true. But that was with data from 1998-2000. What about today?

Peter Kuhn and Hani Mansour replicate the exercise, but with data from 2008-2009. They concentrate on young job seekers and find that those who use the Internet for job search reduce their unemployment duration by 25%, which is considerable (and makes us teachers prescient). And this is not just because of a particular group or specification. Running the same regressions in the earlier sample provides no noticeable effect. This means that somehow people have learned to use the Internet effectively, which is consistent with the success of the Monster Board or Craiglist and the proportion of those using the Internet for job search.

Economists' political bias and model choice

2011-10-10T08:10:00.000-07:00

One can count on Gilles Saint-Paul for innovative research topics. During his career, he has addressed and impressive array of topics that range far beyond Economics strictu sensu. For this reason, I have reported several times about his latest research.

His latest opus is an introspection in our profession and how our political biases influence our modelling choices. He claims that an economist with conservative inclinations will favor a model with smaller fiscal multipliers. While the ethical thing to do would be to be driven by empirical evidence, this may just be a subconscious choice. But at least economists strive to be logically consistent, and if one choose a large multiplier, then then must also claim that demand shocks are substantial, as models with large multipliers rely on this. Looking at evidence from the Survey of Professional Forecasters, Saint-Paul finds that forecasters who believe that expansions are more inflationary also adhere to the belief that public expenses are less expansionary.

Saint-Paul goes further, though. His claim is that we live in a self-confirming equilibrium. We devise theories to understand our surrounding and take decisions, and those decisions then shape the economic environment. Theories can thus survive even if they deviate from the true structure as long as the decisions make it conform. This is a statement about a lack of uniqueness of the path to the rational expectations equilibrium. In a sense, this is not too disturbing, as long as decisions are still optimal and outcomes do not differ too much from the rational expectations first best. And if this true, we will never know what the rational expectations first best is. Of broader implications would be if the political agenda of an economist would lead an economy on an different path, on a different self-confirming equilibrium. Is this why Europe and the United States are different? Were Keynes and von Hayek that influential?

The next Nobel Prize

2011-10-08T07:44:00.000-07:00

Monday, the next "Nobel Prize" in Economics will be announced and everybody is playing a game of predictions, so why not me? I have a wish that happens to coincide with my prediction: William Nordhaus.

Why? Because environmental economics has been long rumored to get it and it deserves to be recognized. Within that field, Nordhaus has made major contributions that brought this field to the mainstream. And he is a genuinely good guy, always helpful and willing to listen to you or help you out. Also, the signals I have been receiving from members of the Prize committee is that they really like his work.

I am afraid, though, that he may have to share his work with Martin Weitzman. Who has made the more seminal contributions to the field can be discussed, but Weitzman is all the opposite in terms of attitude. In addition, I do not like his way of trying to make a name of himself, like I showed previously. He has also been caught and punished for stealing horse manure, so his ethical standards are definitively not up to par.

Marx and Solow

2011-10-07T06:30:00.000-07:00

For all the justified criticism one can have about the work of Karl Marx and the economic system that resulted from it, old Karl was onto something. The Industrial Revolution saw the rise of a new class, the capitalist, that generates a smaller share of its income from manual work and instead uses its brain and capital. That is in terms of welfare a positive evolution, were it for the fact that workers hardly had it better compared to their previous agricultural life and thus did not get a share of the new riches. What especially irked Karl Marx was the lot of the workers could not improve, either because they were not getting a larger share of income, or because there was no path to become capitalists themselves in large numbers, something later termed as a lack of social capilarity.

Jørgen Heibø Modasli finds some of these features in a model inspired by the Solow growth model, augmented by incomplete markets that require that one cannot borrow to become a capitalist entrepreneur and that the entrepreneur can only work for himself. This introduces a non-convexity and quickly a two-class system emerges, with workers not having any reason to save much as they have no chance to become capitalists. Also, the class division persists over time, even when credit and capital markets improve.

Yet, this is not entirely convincing. Indeed, economies with less incomplete markets, say, the United States, should see less inequalities, and inequalities should have declined over time as markets developed. This is hardly what we can see in the United States, where access to credit is widespread, yet income inequalities are high and growing, and social capilarity is largely absent.

Politicians and leisure

2011-10-06T07:26:00.000-07:00

When you think about leisure in the utility function, for most applications you need to take a stand on some properties: is the income effect larger than the substitution effect? Is leisure a normal good in the first place? Convincing empirical evidence is surprisingly difficult to find: read the endless debate between microeconomists and macroeconomists about the size of the wage elasticity. This may be an aggregation issue, but maybe we are lacking a clear natural experiment.

Naci Mocan and Duha Altindag report on an interesting change in the way members are paid in the European parliament. Whereas previously they were compensated at wildly different levels by there home countries, since July 2009 they get money according to a uniform rule: 38.5% of a European judge's salary as a base, plus a per diem when present. Mocan and Altindag then use the difference between and with the previous schemes to highlight that an increase in the base reduces attendance (yes, the income effect! Leisure is normal!) and an increase in the per diem increases attendance (the substitution effect is larger than the income effect). Politicians are rational after all.

Mandatory health insurance and informality

2011-10-05T07:00:00.000-07:00

Insurance suffers chronically from the problem that only bad risks want to get insured, which makes the cost of insurance prohibitive and the insurance market often collapses while its presence would be a clear welfare improvement. A workaround is to force everyone to participate, thereby avoiding that good risks could weasle out. This is the principle behind health insurance mandates in most of the Western world, and it is part of the so-called Obamacare. But such mandates are difficult when there is a large informal economy, as it makes difficult tracking people, especially if access to government services, paying taxes, etc. are the way the mandate is enforced. Could in fact a mandate increase informality?

Reyes Aterido, Mary Hallward-Driemeier and Carmen Pagés look at Mexico and ask a somewhat different question, but it is still informative: Does the provision of health insurance to those without social security (mostly informals) increase informality? They find the formal sector decreased by 0.4 to 0.7% points because fewer people join it. It is not surprising that fewer people see the need to be cover by social security and thus declared their jobs, yet I find it interesting that the effect on formality is so low in a country where it is so easy to disappears from the books. Transpose that to, say, the US, where having a job is currently pretty much a requirement for health insurance coverage. Would then a health insurance mandate lower the incentive to have job? Most likely yes, but seeing how small the impact was in Mexico and considering that the lower elasticity of the formal/informal margin in the States, that effect is very likely to be very small.

About a (partial) return to the gold standard

2011-10-04T07:22:00.000-07:00

In difficult times, it is easy to blame central banks for everything. Part of their role, after all, is to play the scape goat for policies the politician do not dare implementing. But then, there is only so much the central banks can do, as Europe and the United States no "nicely" show now. A substantial ingredient in the blame game is a call for a return to the gold standard, a nostalgia for supposedly better and easier times.

Olivier Ledoit and Sébastien Lotz echo this call and study what our current understanding is about the coexistence of fiat and commodity money. In principle, we can start from the idea that currency competition is good: this would force the central bank to be more careful with its fiat money. Indeed, we have learned from money search theory that bad money does not necessarily chase good money (the old Gresham's Law). Also, if the commodity has a positive return, its monetization is beneficial as long as its storage and transaction cost is sufficiently low. The question is then on how to find a commodity that has a real return from just sitting there. There is a larger problem, though, with small denominations. How do you mint coins measured in cents when the commodity is, for example, gold? Either the coins need to be very small or they have very small commodity content, to the point that they become ... fiat money. Monetary policy also becomes tricky, as quite obviously temporary easing becomes difficult if it risks driving fiat money out.

But in the end, isn't a commodity like gold only valuable because people believe it is valuable? Gold, to take an extreme and popular case, has little intrinsic value, as I argued before, and is thus just another fiat currency. It is all a question of perception.

Monetary and fiscal policy cooperation in a liquidity trap

2011-10-03T07:39:00.000-07:00

We are living interesting times in terms of macroeconomic policy: the world faces big shocks and substantial challenges, and many current circumstances have no historical precedents. This means that policy makers cannot draw from experience and need to invent new policies from somewhere better than their guts. And after a few hesitations, theory is now in much better shape to answer questions from policy makers. For example, what should one do when there is a liquidity trap in a globalized economy, especially if the trap itself is globalized?

David Cook and Michael Devereux show how, and it borders on a political miracle. Not only does one need to get the cooperation of fiscal and monetary authorities (something the US is not close to achieving) but one needs the cooperation across countries even if it entails some costs to the "winners" (something the Chinese have so far refused and the Swiss recently abandoned).

Specifically, Cook and Devereux show that with so many countries currently with negative real interest rates, we have a worldwide liquidity trap. In an open economy, the policy prescription differs from a closed economy. If there is a negative demand shock, fiscal policy needs of course to raise aggregate demand, but with a global economy, this can come from anywhere in the world and thus a coordinated fiscal policy is due. But to channel the impulse to the relevant countries, monetary policy coordination is necessary to raise interest rates in the foreign countries, even if they are in a liquidity trap. And this takes some serious courage. One can always dream.

Should small businesses be encouraged?

2011-09-29T07:17:00.000-07:00

Small businesses are thought to be rather inefficient because of fix and because of other issues that hamper the exploitation of increasing returns to scale in their size range. Yet, policies keep popping up that try to protect them. Why? Is it nostalgia, throwing us back to times were "better?" Or do we want to protect (inefficient) employment? Even this may be moot according to a previous post.

Ben Craig, William Jackson, and James Thomson claim that small businesses should be encourage because they have an inherent disadvantage on credit markets: there are information problems, more acute in downturns, that make access to credit more difficult for small businesses. Thus, it is good for a government agency to provide loan guarantees. Still, this does not address why we would want to have small businesses in the first place. If inefficient firms are getting rationed on credit markets, I am fine with that.

On the size of cities

2011-09-28T07:08:00.000-07:00

There is an active literature that tries to explain the size distribution of cities. It is based on a strong regularity, that the distribution follows a Zipf law (population rank times population is constant). Models try to explain this fact with rather simple structures and then back out what assumptions are needed to obtain the Zipf law, with little regard whether these assumptions make much sense. This is not how someone usually proceeds. While you indeed want to explain a fact, you use believable assumptions and then draw a theory and check whether it can replicate the fact. Also, you not want to have a model with many degrees of freedom to explain a single fact, you want to check on many aspects from the data.

Marcus Berliant and Hiroki Watanabe share this concern. They point out that the current theories assume that households cannot insure against city-level shocks, which are at the heart of the models. This is important, because insurance and moving can be considered substitutes. If some insurance is available for example through self-insurance, then there is little reason to move, especially given the empirically large costs of doing so, and all that matters are the initial conditions. In order to obtain more sensible results, Berliant and Watanabe assume that city-specific shocks leads to a winner-takes-all outcome: the best city gets to produce everything within a sector. Then insuring is inferior to moving, as the first yields only a partial wage while the latter a full wage. The availability of partial insurance does not change this. In some sense, the presence of insurance does not matter in this model, while it matters in others. But this relies on the extreme risk that is assumed. Have we progressed? I am not sure.

Bruno Frey's academic utopia

2011-09-27T07:38:00.000-07:00

Bruno Frey has fallen into disgrace these days as he has been shown to play dangerous games of self-plagiarism, submissions to multiple journals and hypocrisy in describing the perverse incentives facing researchers. I have argued recently that he is living in a bubble that has now popped.

Apparently not. With this wife Margit Osterloh, he just authored a paper about the impact of rankings on academic publishing. Their argument is that the current emphasis on rankings pushes academicians to privilege publication to science. They want to decouple funding, tenure and promotion from any evaluation metric. Rather, scientist should be carefully selected at their initial appointment and then be given guaranteed funding and only be asked to evaluate themselves. This strikes as a very utopian view of academia, and in particular a view that surprisingly ignores the impact of incentives on motivation. While the Frey and Osterloh utopia may yield in a few cases the expected very innovative researchers willing to take substantial risks along new paths, most would free-ride to a large degree. The best example of this is the French system of "research associates" on the national research foundation, who are appointed right after their doctorate for a lifetime position of researcher with no other significant duties. While this system has yielded some success stories, the research impact of these associates is rather dismal compared to researchers elsewhere who are subject to regular evaluations using publication metrics.

Reading through the paper, I could not resist to see the irony in many of the arguments, where Frey could be really writing about himself. A few quotes:

In academia, examples can be found (e.g. the ‘slicing strategy’) whereby scholars divide their research results into a ‘least publishable unit’ by breaking the results into as many papers as possible in order to enlarge their publication list.

Of course, Bruno Frey and his students are big specialists in slicing.

there is evidence showing that academics with the highest score in publication rankings score only modestly in a ranking based on their contributions in editorial boards (Rost and Frey, 2011).

Note that Frey was kicked off an editorial board for resubmitting a published paper elsewhere.

For example, a broad and international selection of reviewing peers is necessary in order to avoid cronyism.

Frey's colleague Ernst Fehr recently anointed one of his students with the most prestigious prize for an European economists. Frey and Osterloh argue that awards cannot be manipulated, while citations metrics can. I do not think this is true, in fact awards are easier to manipulate because they are determined by small committees. Citations come from the whole research community.

Another example is editors who encourage authors to cite their respective journals in order to raise their impact rankings

Frey requires this for acceptance in the journal he co-edits, Kyklos. At least, the paper does not mention self-plagiarism this time.

Is this paper a mea culpa? It certainly does not read that way. As in his previous writings on the publishing game, he comes across as someone about it all, who tell everyone how things should be while claiming the moral high ground. The paper was completed on August 24, 2011, thus well after all the conflagration about the hypocrisy of Bruno Frey, yet it does not show anything about it. Bruno Frey has not learned a thing. And, do you want to bet that he is submitting this to journal, taking away space that young researchers need to get publications for tenure, as he has argued before? In fact this particular paper would fit much as a blog post than into a journal.

Addendum: And they are doubling up with another paper, entitled "Input Control and Random Choice - Improving the Selection Process for Journal Articles" with the following abstract:

The process by which scholarly papers are selected for publication in a journal is faced with serious problems. The referees rarely agree and often are biased. This paper discusses two alternative measures to evaluate scholars. The first alternative suggests input control. The second one proposes that the referees should decide only whether a paper reaches a minimal level of quality. Within the resulting set, each paper should be chosen randomly. This procedure has advantages but also disadvantages. The more weight that is given to input control and random mechanism, the more likely it is that unconventional and innovative articles are published.

You read it right: instead of peer review, they advocate complete tyranny by editors who randomize over a select set or, alternatively, to decide early who is worthy publishing and then let the chosen few do as they wish. Which is how Bruno Frey and his lackeys have been operating. But at least Frey and Osterloh have had the decency to withdraw that last paper (which is why I print the abstract above).

Ethnic heterogeneity and natural disasters

2011-09-26T07:25:00.000-07:00

Some countries seems to be very poorly located, as they are in the path of all sorts of natural disasters. But some do better than others in coping with their perilous situation. In particular, death tolls from cataclysms seems to be, in general, of an order of magnitude larger in developing countries. What else could influence such numbers?

Eiji Yamamura, from a rich and homogeneous country that does quite well with earthquakes, tsunamis and typhoons, studies ethnic heterogeneity in two different ways in this regard. The first is ethnic polarization, which describes how close the distribution of ethnic group is from a fifty-fifty one, and ethnic fractionalization, which can be interpreted as the probability that two random people are from the same ethnic group. Once one adds the miracle instrument of cross-country regressions, legal origins, the first indicator has shows that heterogeneity has a positive impact on natural disaster deaths (meaning more of them), while the second has none.

Now Yamamamura takes this as a sign that ethnic polarization is a better indicator of ethnic heterogeneity than ethnic fractionalization. This looks like some seriously flawed reasoning here, which is repeated several times in the papers: the fact that some indicator tests favorably some hypothesis does not necessarily mean that it measures what the hypothesis says. What if in really the hypothesis is false? And in any case, on what theory would this hypothesis be based? I can easily imagine good reasons why homogeneity would lead to fewer deaths, a better social cohesion that leads to better institutions coping with disasters, like in Japan.

How to publish prolifically

2011-09-24T07:54:00.000-07:00

I dedicated several posts to Bruno Frey and his chronic self-plagiarism. In retrospect, one should have seen that something was fishy from the mere fact that he was simply publishing too much for it to be normal, 600 articles by his own count. It is not possible for an academic, at least in Economics to be that productive. Yet, there are some who seem to be on a similar path.

Take, for example, Michael McAleer. He is an Australian econometrician who had a very respectable career in the 1980's, publishing in the AER with Adrian Pagan (and a homophone of Paul A. Volcker), four Review of Economic Statistics, a Review of Economic Studies, an Economic Journal and plenty of other decent publications. McAleer get elected into the Academy of Social Science in Australia in 1996. Then the quality of the publications dips, as he must be facing the same loss in productivity so many in the profession suffer in their forties. Still a good stream of publications.

Then suddenly, a burst of historic proportions.

Let us first look at working papers. According to his RePEc page (that is all I could find, a 2004 CV has 32 pages despite having no publications listed): 12 in 2008, 45 in 2010, 39 in 2010, and so far 15 in 2011. And these are according to their titles, at least, distinct papers. How can one do this? First McAleer has many co-authors, but he is no Paul Erdős, as his has a small set of regular collaborators. Second, many of the papers are about the same theme, with small variations: journal impact, with applications to neuroscience, tourism studies, econometrics, and economics in general, including one that I discussed. There is nothing wrong with this, except that entire sections are copy-and-pasted from one paper to the next. His other papers, for example on tourism demand in the Far East, are incredibly thin slices of research.

But these are all working papers, and he is free to write all this as long as he does not pretend this is all original and substantially new work when submitting to journals that have such requirements. McAleer is, however, also publishing avidly, although luckily few of the papers mentioned above get placed, and then only poorly. In terms of publishing, he has found another niche, the Journal of Economic Surveys:

2011, issue 2: 1 article
2011, issue 1: 2 articles
2010, issue 1: 2 articles
2009, issue 5: 2 articles
2007, issue 5: 1 article
2006, issue 4: 3 articles
2005, issue 5: 1 article

The journal has 5 issues a year, averaging 7 articles in each issue. That is a remarkable publishing success in a generalist journal. It turns out frequent co-author Les Oxley is the editor, who himself does not hesitate to frequently publish in his own journal. I counted 17 articles of non-editorial nature, several over 60 pages long, as well as 7 reports on conferences he attended.

A good number of those articles are titled "The Ten Commandments of ...", which I find rather pretentious. I was curious about The Ten Commandments for Academics, which could reveal some of the motivations of McAleer. They are:

choose intellectual reward over money;
seek wisdom over tenure;
protect freedom of speech and thought vigorously;
defend and respect intellectual quests passionately;
embrace the challenge of teaching undergraduate students;
acknowledge the enjoyment in supervising graduate students;
be generous with office hours;
use vacation time wisely;
attend excellent conferences at great locations;
age gracefully like great wine.

What I find interesting here is what was not considered. I think a better alternative, and one that would condemn much of what McAleer is doing, are due to Wesley Shrum:

Thou shalt not work for deadlines;
Thou shalt not accept prizes or awards;
Honor thy forebears and colleagues regardless of status;
Thou shalt not compete for recognition;
Thou shalt not concern thyself with money;
Thou shalt not seek to influence students but to convey your understandings and be honest about your ignorance;
Thou shalt not require class attendance or emphasize testing;
Thou shalt not worry about thy own intelligence or aspire to display it;
Thou shalt not condemn those with different perspectives;
SEEK TO UNDERSTAND THE WORLD.

These are principles about integrity, about changing the world and putting the scientific interest ahead of oneself. McAleer, rather, seems keen on clogging journals and working paper series with useless drivel, showing off and self-plagiarizing. At least for the latter part of his career, I do not see a positive externality from his efforts.

To come back to my initial question, to be prolific: find willing co-authors and editors, slice thinly, copy-and-paste, and do not think too hard what academia is about.

The Internet makes you happy

2011-09-23T07:43:00.000-07:00

We have previous established that the Internet, contrarily to conventional wisdom, makes people more social. Does this also mean that people with Internet access are happier? Of course, one should take into account that those without Internet, at least nowadays, are likely to face hardships like low income and education.

Thierry Pénard, Raphaël Suire and Nicolas Poussing do such an analysis for Luxembourg and find indeed that Internet users are happier, especially among those with lower incomes. This is also true when taking into account the intensity of Internet use. This implies that making the Internet accessible to lower socio-economic classes can improve welfare, possibly significantly. Of course, one has to take with a grain of salt studies of happiness based on surveys that ask for subjective self-evaluations. That grain of salt may be bigger when one considers who small Luxembourg is. The approach then becomes similar to the randomized experiments in the development literature where results for a small set of villages are difficult to apply to other contexts. Yet, Luxembourg is surprisingly diverse, so maybe these results are generalizable. Readers, you can now safely that you are now happier from being on the Internet and reading this.

One more perversion of employer-based health insurance

2011-09-22T07:41:00.000-07:00

Whenever you see risk, you think insurance. And there are different ways to insure yourself. This may be by buying some contingent claims, often bundled into an insurance policy. Or this may be through self-insurance, whereby you build some assets for eventualities beyond savings needs. Formal insurance and self-insurance sure look like substitutes. For the case of health risk, this means that people with formal insurance should have less assets, other personal characteristics being controlled for. This statement is, however, factually wrong: insured people, ceteribus paribus, have more assets. That is difficult to square with standard theory.

Minchung Hsu makes a good attempts at solving this puzzle. The major assumption here is that health insurance is provided through employment (there is also private health insurance, but it is of minor importance, as in the data because it is crowded out by social programs). This means that the loss of employment bears a larger risk for someone who formally insures: one may loose income and insurance. Then, ironically, more self-insurance is needed than for someone who self-insures, but one has also to keep in mind that a self-insurer typically has lower income and is partially covered by social programs. Thus Hsu performs the same regressions as done in the literature and still finds the fact mentioned above. Interestingly, his regression also rejects the existence of precautionary savings, while it is the central element of the model. So much for the power of this test.

The fall of internal migration

2011-09-21T07:03:00.000-07:00

It is costly to move, and those costs vary by culture and economic circumstances. International migration is of course hampered by immigrations laws and cultural barriers. But in most countries, internal migration is free and only restrained by costs and some degree of local attachment. In this respect, Americans are considered to be the most mobile, as they are very willing to drop everything to pursue better opportunities while the housing market is, usually, very fluid. In fact, the perception is that this mobility has even increased in the US and that it has been hampered only in the last few years, due to the current difficulties in selling homes.

Raven Molloy, Christopher Smith and Abigail Wozniak take a close look at the data and dispel some of those perceptions as myths. In fact, US internal migration has been in a steady decline for thirty years, a decline that in apparent whichever way you look at the data: by socioeconomic household characteristics and distance moved. And this has change little with the current crisis, probably because the additional incentive to move (as there is substantial evidence that some structural mismatch, including a geographic mismatch, has increased the unemployment rate recently) has been roughly compensated by the poor saleability of homes. Still, internal migration rates are still higher than almost everywhere else.

Pricing Asian options

2011-09-20T07:02:00.000-07:00

Options are securities that are difficult to price. In particular American options, which can be exercised at any time posed a serious challenge that could only be solved in approximation with some Nobel Prize winning work. European options are simpler because they can only be exercised at maturity. Today, I learned there are also Asian options. Asia seem really to catch up in all aspects of economic life. Asian options are American options with the difference that the exercise price is some form of average of the underlying price.

Paolo Foschi, Stefano Pagliarini and Andrea Pascucci provide a way to price Asian options in a first approximation under local volatility, that is the price volatility depend on the current price level, and provide an algorithm for higher order approximations. As you may guess, it is not straightforward. Along the way, I also learned about the Greeks in option pricing. They measure various aspects of the sensitivity of option prices to underlying parameters, and they are usually represented by Greek letters. Now that I have learned that, I'll leave the actual pricing of Asian options to others.

Greening production through information

2011-09-19T07:04:00.000-07:00

People in general prefer green products, although they are not always ready to pay a significant markup for a greener product. If they know that a product has been manufactured using green procedures, there will attach more value to it if the claim is credible. Several green labels, supposed to certify such claims, have emerged, but none have much recognition, in fact one sometimes wonders whether some of them are really weak.

Another approach is voluntary disclose of pollution emissions and other environmental disclosures by the industry. This is reviewed by, take a deep breath, Venkatachalam Anbumozhi, Qwanruedee Chotichanathawewong and Thirumalainambi Murugesh with a focus on Asia. They highlight that the final consumer is not necessarily the one targeted by this information. For example, some investment funds, in particular sovereign wealth funds, are under pressure to invest in ethical firms. Or potential employees may avoid polluters, and local planning may benefit form the available information, thus encouraging local investment.

The authors argue that there is little environmental regulation in most of Asian, with makes the price of environmental benefits close to zero. If you want firms to start abating, you need regulation, and then they also be willing to should how well they abate, leading to more abatement. In some larger Asian countries, a few modest disclosure programs have started, and they have shown excellent prospect in increasing environmental compliance.

Economic freedom and prisons

2011-09-16T07:02:00.000-07:00

Americans are proud of their freedoms, political or economic ones. Yet, they are very trigger happy when it comes to takes one's freedoms, say by taking voting rights from felons, throwing people into prison or even executing them. How could such an apparent disconnect be explained? Why is the US different from Europe, where there is less economic freedom, but also much less punishment?

Rafael di Tella and Juan Dubra note that this apparent paradox does not only appear across countries, but also over time within the United States. For example, over the 30 years including the "Reagan Revolution" that considerably deregulated the economy, incarceration rates were multiplied by seven. They explain this with a theory that states the following. People view that when there are ample opportunities for legal activities in a system where there are many economic freedoms, people who still commit illegal acts must be "meaner" than the average criminal in a world with fewer economic freedoms. This can be supported with some limited empirics, but this is quite an appealing explanation. Indeed, Americans strongly believe that effort, not luck, is the root of success, and thus offer few excuses to those who become criminals out of necessity, an opinion that interestingly more and more African-Americans share.

More on institutions and growth

2011-09-15T07:41:00.000-07:00

There a large belief in the development community that institutions matter. This has emerging from a large number of cross-country regressions, regressions that one should always take with a grain of salt because of methodological issues and data quality. However, this result has emerged so frequently that it must indeed matter. But the precise mechanism through which institutions matter of the course of development is still rather unexplored.

Ines Lindner and Holger Strulik come up with an interesting theory. When the economy is fragmented into small regions, entrepreneurial behavior is governed by local and informal enforcement. But as economies become more integrated, through specialization and/or the reduction in transportation costs, "connectivities" go from local to global, and informal enforcement is not sufficient. Formal institutions need to arise, and if they are weak, entrepreneurship will be weak. I wonder, though, how such a theory of networks could be tested in the data.

Who spent the 2001 Bush tax rebate?

2011-09-14T07:37:00.000-07:00

Do tax rebate such as those implemented at various times by the Bush II administration work? Measuring this is not obvious. Previous studies have typically exploited the timing of the receipt of the rebate checks to see how expenses have changed. But most people have anticipated these payments, thus the marginal propensity to consume is mismeasured: it measures the propensity to consume due to short-term liquidity considerations beyond the consumption response from the announcement of the program.

Greg Kaplan and Giovanni Violante go a step further in this analysis and build a model that replicates the measurements found in the literature and the large share of hand-to-mouth households using an economy of liquid and illiquid assets with transaction costs. They define hand-to-mouth households as those who hold less that half their periodic pay in liquid assets. That seems very shaky to measure, as the timing of the relevant survey matters a lot here. But assuming there is no systematic error, they then extrapolate through the model what the response from the announcement of the rebate should have been. This adds 7-8% to the marginal propensity to consume. Interestingly, this come in large part form rich household who have only little liquid wealth because their assets are mostly in real estate and retirements funds. An important consequence of this is that larger tax rebates would have little impact, as they would make it more interesting to bear the costs of putting them into illiquid wealth. In fact, the marginal propensity to consume could even turn negative.

Why is blackmail costly?

2011-09-13T07:55:00.000-07:00

Blackmail is a strange concept. Threatening to reveal information is legal. Asking money for a service is legal. But doing both at the same time is illegal. Even stranger, when the transaction is initiated by the one who could be harmed by the revelation, this is technically a bribery, it is legal. So why this difference? The conventional answer is that blackmail is about rent-seeking. But if the damaging information is freely available, there is no welfare loss justifying the criminalization of blackmail.

Oleg Yerokhin claims the justification can lie within the bargaining power structure between the two parties. Indeed, when the information holder is a monopolist, he will have more power than socially optimal, and should thus be punished to internalize this cost. But when the target is a monopolist, then the outcome reverses, and the blackmailer should be subsidized rather than punished. Yet, I hardly find this argument convincing on the grounds that blackmailers are certainly less likely to be monopolists than victims. Indeed, information is duplication at zero or close to zero cost, making it difficult for a monopoly to arise in such a situation. But this information can easily be about one particular person only.

Near rational agents and house price booms

2011-09-12T07:17:00.000-07:00

House price run-ups, especially when they appear excessive, are difficult to explain. It is it even more difficult to explain how they are not coordinated across countries in a globalized world. Indeed, right now house prices are severely depressed in the United States, while you can have strong suspicions of bubbles in China, Norway and Switzerland. Bubbles are substantial deviations from fundamentals that could be due to some deviations from rationality or herd behavior, or both. But "rationalizing" this is a major challenge because of the apparent randomness of the occurrence of such house price booms.

Klaus Adam, Pei Kuang and Albert Marcet think they have a way to explain this using the concept of internally rationally agent. Such a agent, like the economist, does not know the true process of prices but tries to infer it from past observation using Bayes' rule. The belief about prices then becomes part of the state space and leads to some sort of path dependence. With shocks that are not perfectly correlated, it is then possible for different countries to experience different paths for house prices.

Why September 11 is remarkable

2011-09-11T10:59:00.000-07:00

Amid the commemoration of the 10th anniversary of the terrorist attacks of September 11, 2001, I cannot help thinking how successful theses attacks have been. For an organization that wanted the United States to pay for sending troops to Saudi Arabia during the first Gulf war, a relatively little investment paid huge dividends. Indeed the cost of the operation, including training, must have cost only something to be measured in millions of dollars and the lives of 19 volunteers. The return was getting the United States involved in two wars that have costs amounting to trillions, brought the federal government in major financial difficulties, have lead authorities to neglect essential infrastructure investment for a decade, has kept the population in a nevrotic state for a decade, has given us higher oil prices (with revenue going you-know-where) and has lead to major setbacks in civil liberties. And that is just for the United States, as Europe has also been affected. And the costs will continue to mount, as the US is none the wiser and will have to face in addition the costs of care for veterans.

The impact of fiscal uncertainty

2011-09-09T07:07:00.000-07:00

Current US fiscal policy is absolutely frustrating. There does seem to be a clear direction, in particular because policy making is rather irrational due to a set of unduly influential and crazy lawmakers. In the end, this means considerable uncertainty about future fiscal policy, in particular because it may not react to economic events in ways that make economic or historic sense. What is the impact of such uncertainty?

Jesús Fernández-Villaverde, Pablo Guerrón-Quintana, Keith Kuester and Juan Rubio-Ramirez address this with a New Keynesian business cycle model that feature variable volatility in fiscal policy. Their conclusion is that the current uncertainty lowers activity and has the policy equivalent of a 25 basis point increase in the federal funds rate, which I find rather minor. The model rightfully yields that the main mechanism is through investment and the uncertainty on capital return taxation. I find it interesting that it leads to stagflation, as firm opt for higher prices to reduce miss-pricing costs. In the end, the authors show that if one removes the usual automatic stabilizers and assume very persistent fiscal shocks, which may be a good characterization of the current situation, the prediction is a 0.5% reduction in output, which I am ready to believe.

The polygyny-slave trade connection

2011-09-08T07:54:00.000-07:00

Polygyny, a male marrying several females, is now rare except for Africa and especially Western Africa. Why would it be so prevalent in West Africa? To sustain polygyny, one needs an unbalanced sex-ratio, which is not the case there.

John Dalton and Tin Cheuk Leung claim that this is just a matter of very persistent institutions. Indeed, the sex-ratio used to be unbalanced for extensive periods in West Africa, and in a more pronounced and persistent way than anywhere else, due to the slave trade. Indeed, it took away many males from the region through the actual forced emigration, but also because of the many tribal wars associated with slave capture raids (which Dalton and Leung do not take into account).

Econophysics: an introduction

2011-09-07T07:53:00.000-07:00

I have criticized a number of times Econophysics as a rather naive venture of physicists into Economics, where there is too much focus on "automatic" data exploration and too little use of theory and understanding of what the data measure. But may it is just my prejudice against and my ignorance of Econophysics.

B. G. Sharma, Sadhana Agrawal, Malti Sharma, D. P. Bisen and Ravi Sharma offer in six pages an account of what Econophysics is, what its goals are, what it can contribute and where it is headed. The basic idea is that economic agents are like particles in that they are in large numbers and interact in complex ways. The dynamics of such complex processes are studied with powerful statistical tools in Physics, and physicists think that this should also apply to Economics. The focus is very much on the stock market, probably because physicists have realized where money can be made. There is no sense that there would be an attempt to improve welfare. They are also much more likely to completely discard a model in one set of observations does not corroborate it. Physicists are especially critical of how economists stick to rejected dogmas and of their inability to explain how small shocks can pan out into large crises.

The focus is really on the description of data process and documenting there statistical properties. In particular, econophysicists want to find ways to exploit even the smallest opportunities for arbitrage by finding, often through obscure and complex black box processes, the right price of an asset at any moment in time. However, there is no attempt at understanding why these arbitrage opportunities arise, say because of some form of irrationality, asymmetric information or perverse interactions in the price mechanism. From this I conclude that Econophysics can be interesting to make money on the stock market, but at least at this point, does not help us in any way in understanding why the world is like it is. Which I find rather ironic for Physics.

Progesa: a success story thanks to academics

2011-09-06T07:50:00.000-07:00

I have written a few times about the frustration when policy makers ignore the advice of economists. Yet, there are a few cases where economists were given free reign over the design of policy interventions, which not only allowed to obtain positive outcomes but also useful information for further study.

Nora Lustig reports about Progresa, the Mexican cash transfers program designed to elicit parents to send their kids to school and make sure necessary health check-ups were attended. From the start, the program was designed and administrated by people with an academic background. Progresa has worked remarkably well, to the point that it was not only not scrapped, as is usual, with presidential changes, its coverage also kept increasing. The only setback was a name change to Oportunidades. The critical ingredient to this success was the scholarly involvement, that not only designed it for success, but also provided the tools to measure this. And along with that a wealth of data that has allowed to understand even better what makes good intervention in practice.

Emotions in economic interactions

2011-09-05T08:21:00.000-07:00

How do you get people to cooperate. By increasing utility, of course, but that is difficult to measure, obviously, and there may some components beyond rationality in emotional contexts. However, we have some interesting ways to get some neurological hints about positive and negative emotions by measuring the conductance of skin. This may help to explain why people are sometimes willing to hurt themselves in order to punish others.

Mateus Joffily, David Masclet, Charles Noussair and Marie-Claire Villeval conduct an experiment where cooperation, free-riding and punishment can happen. They measure skin conductance to reveal the intensity of emotions and let players reveal whether their emotions are positive or negative. Cooperation and punishment of free-riding elicit positive emotions, the latter indicating that emotions can override self-interest. That is also because punishment relieves some of the negative emotions from observing free-riding. And one does not like being punished, which lends one to cooperate more in the future. Finally, people like being in a set-up where sanctions are possible, in particular because it allows a virtuous circle of emotions that reinforce each other and lead to more cooperation.

The Bruno Frey Bubble

2011-09-03T07:01:00.000-07:00

About four months ago, I reported about the apparent self-plagiarism by Bruno Frey, David Savage and Benno Torgler. I found the case particularly ironic, as Bruno Frey repeatedly wrote about the fact that the pressure to publish to get tenure can lead to scholar to unethical behavior, and about the lack of space in journals for young scholars to publish the articles needed for tenure.

The case has taken a much larger dimension now, as many more cases of self-plagiarism by Bruno Frey and his students have appeared (see many links in the comments on the post mentioned above). This raises two very important questions: 1) how could such a culture of self-plagiarism arise? 2) How could they get away with it for so long?

To answer the first question, I think we need to put Bruno Frey is the context of the German(-speaking) academic environment. At least in Economics and Business, the typical German professor publishes a lot of rather insignificant articles, in particular book chapters and "Festschrifts." These works are rarely original, and are not expected to be so. There is also a tradition of writing "educational" pieces that explain economic concepts, say the Edgeworth box or voluntary export restraints, for journals targeted towards professionals in industry and government (as well as students). Again, there is nothing original in there, except maybe the way something is explained.

Bruno Frey works within this paradigm. His work lacks creativity in the sense that he recycles a lot of his ideas for multiple publications, often copying extensively his own words. The differences is that he does that at a higher level than his German colleagues, in international journals that are actually read. And many of his original papers are in fact not that original it appears. If we take the Titanic paper as an example, the empirical exercise he performs is routinely done in undergraduate statistics classes with the same dataset. His contribution is pedagogical, he found a good and interesting way to explain something already present in the body of knowledge.

Like a bubble that keeps getting fed by self-fulfilling expectations, Bruno Frey built on his initial success and continued with this strategy and encouraged his students to do the same. And several of them have assembled remarkable portfolios that way. I mentioned that of Benno Torgler in my original post, but there are several others who got into positions that seem beyond the usual reach of a Swiss doctoral program.

There is another way in which this resembles a bubble. The Economics department at the University of Zurich has made considerable efforts over the past decade or so to become a program that can compete with the better departments in the world. It is certainly among the best in Europe. It did so by americanizing itself: dropping to a large extend the rigid chair structure so prevalent in German speaking universities, hiring internationally respect scholars and creating a proper PhD program with courses and exams. Bruno Frey has not followed this trend at all. In fact, he insisted on exempting his students from the course and exam requirements. The Frey group lives in a cocoon apart from the rest of the department, and lives entirely following the role model of Bruno Frey. Call this living in a bubble.

Or a cult. The interaction of Bruno Frey and his students is reminiscent of a prophet and his disciples who follow him everywhere and write down every word he utters. Well, I exaggerate somewhat, but this does definitely not look like a standard interaction between a mentor and his students. It looks like they follow him blindly, and with his everlasting confidence, he makes them follow his example in publishing.

But this bubble is now popping under the assault of widespread scrutiny from editors, the Economics community and an internal investigation at the University of Zurich. The second question of course is how it was possible for Bruno Frey to act so unethically for so long (he is 70). It appears that he has been caught in the past, but it never became public, or at least explicitly. For example, he has been booted out of an editorial board, but there was no mention of why, his name just disappeared from the list. Also, the journals he has been publishing in are often not prominent and thus not that well read. In fact, it looks like he targeted them so that the audience would not overlap, including editors and referees (the added bonus of this strategy that it satisfies the goal of increasing the pedagogical reach by reaching very different audiences).

Hiding this unethical may have been helped by the fact that Bruno Frey actually tried to present himself as an expert on publishing ethics in Economics. He has written about the perils of publication pressure and how this can lead to slicing papers into insignificant bits, to self-plagiarizing and other unethical behavior. He has complained loudly about the ranking craze which he has been so adept to exploit, both with his self-plagiarism and by requiring authors to cite other works in Kyklos to increase its impact factor. While he is certainly not the only editor to do so, it is ironic that he openly campaigned against such practices. Bruno Frey abused the moral high ground in which he pictured himself.

But as every lie that grows too big over time, this is unsustainable. And it will be less likely to happen in the future with initiatives like this one. Making this unethical behavior more visible will prevent it.

That said, self-plagiarism is not limited to the Bruno Frey group or German speaking economists. I will discuss soon another case that I find particularly enraging.

Taking peak oil seriously

2011-09-02T07:44:00.000-07:00

For about forty years now, individuals and organizations have warned of peak oil and predicted a particular date for this event, which is inevitably associated with some sort of impeding doom. Yet, their predictions have not come to fruition (yet). Indeed, there is very little economics in those predictions beyond extrapolating trends. Economics has much more to offer in this regard.

Indeed, theory would tell you that an exhaustible resources would be used up at a decreasing rate as long as there is a positive discount rate, thanks to increasing prices for this commodity. Yet we seem to observe increasing consumption. Stephen Holland offers several explanations why peak oil may arise as an equilibrium and optimal outcome. There are four ways that can lead to upward-trending oil production, at least for some time: increasing demand, increasing reserves, technological change and site development. Demand and reserves are easy to understand, the other two need explanations.

Technological change can lead to increasing production through a decrease in the cost of drilling. The end effect is similar to discovering accessible reserves. As for site development, the idea is that the most promising sites are developed first for extraction, and the next ones come online while the previous ones are not done yet, yielding a temporary increase in production. And I would add a fifth reason for a temporary increase in production: the introduction on alternative fuels. Overall, the general picture that emerges is that in the long run production decreases, but there may be bumps along the way. But if price play their role, their is nothing evil in peak oil.

Are income-contingent loans for higher education feasible?

2011-09-01T07:21:00.000-07:00

There is considerable discussion, in particular in the UK, about making education loans contingent on realized income after completion of education (and those who do not graduate have the loan paid by general taxes). On the face of it, it makes much sense as those who reap the most benefits from their education pay the most for it. But the bigger advantage is thought to come that such a scheme would help overcome risk-aversion, educational outcomes are risky after all, and thus help more people to get higher education. Also, because education then does not require upfront payments, it helps alleviate liquidity problems young people typically face.

Elena del Rey and María Racionero see that this is not that easy to implement. Indeed, some people would loose if such loans would be implemented, foremost those who do not need loans (but this can be reversed if they are very risk averse) and those who are little risk averse. Regarding education subsidized from general taxation, those who can afford private education are again opposed, as well as those who are less able to acquire higher education. If one were to choose between the two financing schemes, it would all depend on the political power. If we assume everyone has a vote of equal weight, then all boils down the level of risk aversion of the population, the distribution of which we know very little about, and the aptitude to education, which is rather uncertain at the individual level. So in the end, we are not much wiser.

Make social security contributions more visible

2011-08-31T07:02:00.000-07:00

Any tax on labor income reduces the labor supply depresses the labor supply, this is no secret. Theory also tells us that whether the employer or the employee pays any withheld tax does not matter. Contributions to pension plans, which are typically paid by both employers and employees, look like a tax on the pay stub and should thus obey the same principle. Well not quite.

Iñigo Iturbe-Ormaetxe argues that the size of the pension fund contribution says something about the future benefits. If the employer contribution remains hidden, the employee is not aware what great benefit he is getting. Were he to pay the whole contribution, after a corresponding pay rise that is revenue neutral to the employer, the employer would be happier about his pay and would increase his labor supply. It would work similarly if the employer would simply indicate on the pay stub her contribution. This assertion is backed with a crude cross-country regression of employment rates in the OECD which shows that at least male employment rates a negatively affected by employer contributions, but not by employee contributions.

Tax reform: Politics has more weight than Economics

2011-08-30T07:44:00.000-07:00

One of the great frustration as an economist is to know what is best and being told it is "politically unfeasible." And why is it typically unfeasible? Because the "right" people do not like it, because it sounds complicated, and because populists would have a feast opposing it, or a combination of the three. How much is this frustration really justified?

Micael Castanheira, Gaëtan Nicodème and Paola Profeta look at the reform of labor income taxation in Europe and find that it is very consistent with the theory that politics shapes taxes more than economists. Indeed, the size of the ruling party or coalition is the main factor: instead of a compromise, which would likely be close to the outcome a social planner to choose, the rulers select what is best for them without regard for the others, or just enough regard to prevent a revolt (that is my interpretation). And then people blame economists when things do not go right.

I'll go weep in a corner now.

Market failure and political outcomes

2011-08-29T07:28:00.000-07:00

In a perfect economic world, perfect competition and the lack of frictions or externalities make it possible to obtain the most efficient outcome. But once any of those assumptions is lost, outcomes are going to be worse than the first best. In particular, once there are rents to be obtained, from frictions or imperfect competition, the beneficiaries of those rents will try to protect them. And they will try to influence political outcomes in their favor.

Madhav Aney, Maitreesh Ghatak and Massimo Morelli argues that this influence peddling reinforces the market failures. As an example, they take a model of misallocation of entrepreneurial talent due to the imperfect observability of that talent. The resulting power structure then votes on institutions that reinforce such a class structure and thus amplify misallocations and market failures.

Now think about the apparently ever-increasing proportion of lawyers in the political class.

Was medieval seigniorage welfare improving?

2011-08-26T07:18:00.000-07:00

The presence of coins improves social welfare, as it allows for more trades than barter would allow. Coin minting also provides income to the minting authority, as it can buy stuff with coins that have more value than their production cost. This is called seigniorage. This was also the case in medieval times, where "seigneurs" would mint gold or silver coins with somewhat less metal content than indicated and thus get income. One would thus think that these minters would be profit maximizing, and thus enhance welfare only as a by-product.

Angela Redish and Warren Weber say this is not quite true. They build a random matching model of commodity money, where the supply of silver is exogenous. They derive the welfare maximizing size and quantity of coins as a function of the quantity of silver and the probability of acceptance of cash. Using data from medieval Venice and England, they find that the model predictions follow remarkably well the historical record. This probably means that authorities were benevolent. I say probably because they may have acted in the same way out of selfishness, but that is not documented in the paper. Indeed, the model assumes than any holder of silver can mint, while in reality a limited number of people could do that.

How to tax addictions

2011-08-25T07:18:00.000-07:00

Addiction is most often a problem of self-control. If one is not capable of factoring in the future consequences of one's actions, one way to make this is taken into account is to distort prices appropriately. This is what taxes (and subsidies) are good at. While we know rather well how to design taxes on externalities born by others or the community, the case is more difficult for externalities inflicted on future selves.

Luca Bossi, Paul Calcott and Vladimir Petkov get on the case i the context of externalities, self-control issues and imperfect competition, as applicable for cigarettes and their highly concentrated industry. They also implement time-consistent taxes to accommodate the addiction, which means that people or government would not want to deviate from the social optimum. Taxes are thus state dependent and described by a rule. One important result is that combining addiction and imperfect competition leads to lower taxes that previously reported, because prices are already higher to start with if providers are oligopolistic. Were some drugs to be legalized, one has thus to keep in mind that the new market structure matters in the design of the new taxes.

Keep CEOs off outside boards

2011-08-24T07:25:00.000-07:00

Should CEOs take outside mandates? For share holders the question boils down to firm performance. If this allows the CEO to peak in management practices at better places or even collude, then this is good for the bottom line. If the CEO dilutes his efforts by being unfaithful, then this hurts the company. In the end, we needs to see what the data says.

Benjamin Balsmeier, Achim Buchwald and Heiko Peters look at CEOs from the 100 largest German firms in a panel dataset. And it does not look good. Firms with CEOS directors elsewhere have a return on assets over one percentage point lower. You would think that this should have consequences. Yet, such CEOs are less likely to be ousted than loyal ones. This may corroborate the entrenchment hypothesis, as I discussed before. The lack of competition at top clearly shows.

Teenage achievement and the house price bubble

2011-08-23T07:25:00.000-07:00

The general economic context of where and when you grow up matters. Think, for example, of those raised during the Great Depression in the US or World War II in Europe who are likely to be very careful with their spending, never through anything away and finish their plates. In this regard, what should we expect from those reaching adulthood in the past years?

Daniel Cooper and María José Luengo-Prado study the impact on teenagers of the house price boom before the current crisis in the United States on educational outcomes. Using the Panel Study of Income Dynamics (PSID), they find that a 1% higher house price at age 17 leads to a 0.8% higher income as adult if the parents owned the home, 1.2% lower if they were tenants, after conditioning for socio-economic characteristics. These are big numbers. They can be justified by the observation that higher house prices allows more collateral to borrow for education. Indeed households with a below median non-housing wealth saw even a 1.6% boost in their child's future income. To explain the impact on tenants, I suppose one can explain it with higher tuition in reaction to larger loans, which tenants cannot afford as well.

The consequences from the recent house price crash are daunting in this context. And given that state are disengaging themselves from financing their public colleges, leading to even higher tuition, the outlook is even worse.

File sharing and the structure of the music market

2011-08-22T07:14:00.000-07:00

For as long as music has existed, artists have lived from performing. The advent of packaged music (radio, TV, disk, tape or CD) has changed little to this, as the new medium has been more about promoting the artist than making money for the artist, with few exceptions. The ones making money from sales are the record companies, and the appearance on file-sharing is challenging their business model while not affecting the artist's way of living. In fact, the latter appreciate the zero marginal cost promotion. But the record companies want to survive.

Ralf Dewenter, Justus Haucap and Tobias Wenzel study the interaction of record and ticket sales under the assumption that both benefit from each other. Clearly, the impact of file sharing is ambiguous: it may increase record sales if people discover an artist through file-sharing and attend a show. But some potential sales are lost when a very close substitute is available for free. The solution for the record companies to to take over the management of concerts as well. Whether the artists want to go along with that is another question.

Do we need awards in Economics?

2011-08-20T07:30:00.000-07:00

I do not like awards. They always create jealousies, and one cannot help that whenever a committee is involved, something may not have gone right. I am thus quite happy that economists give very few awards. It makes their CVs look bad compared to other scientists, but that is the price for a relative peace in the profession.

But we still have some prizes. The Nobel one, which is not really part of the Nobel family but is still attributed much prestige is always under much scrutiny. And in the end, the right people tend to win it. There have been a few controversial cases, Myrdal, Hayek, Buchanan and Ostrom come to mind as example where quite a few eyebrows were raised, but overall this award works well.

The American Economic Association gives an award that is considered to be even more difficult to get than the Nobel Prize: the Clark Medal, given to an American aged under 40. It is difficult to get because only one is awarded every year (no joint winners) and until recently it was given every second year. When comparing to the Nobel Prize, it is relevant to understand that American get a vast majority of them.

Now let us have a look at the past few year for the Clark award:

2011: Jonathan Levin, PhD MIT, Faculty at Stanford

2010: Esther Duflo, PhD MIT, Faculty at MIT

2009: Emmanuel Saez, PhD MIT, Faculty Harvard then Berkeley

2007: Susan Athey, PhD Stanford, Faculty at MIT then Stanford and Harvard

2005: Daron Acemoglu, PhD LSE, Faculty at MIT

2003: Steven Levitt, PhD MIT, Fellow at Harvard then faculty at Chicago

2001: Matthew Rabin, PhD MIT, Faculty at Berkeley

1999: Andrei Shleifer, PhD MIT, Faculty at Princeton, Chicago and Harvard

Do you see a pattern? Well I do, and others have, too. I am not saying these awardees are not bright and promising economists, but is there really no other qualifying economists that could have received it? Of course, John List comes to mind, who has no connection with MIT (or Harvard). But it actually worse than that. The award is given by a small committee, designated by the AEA. The AEA leadership is stacked with people with MIT and Harvard connections, so they also nominate their friends to the various committees, and you see the result.

It is even worse. In 2010, Ester Duflo was considered to be in the pool of strong candidates for the award. Guess who was on the awarding committee? Abhijit Banerjee, her PhD advisor, frequent co-author and colleague at MIT. In such a situation, an ethical person would decline the invitation to serve on the committee. That does not seem to have crossed the mind of Banerjee, who may be used to this cronyism.

There is another award, this time given by the European Economic Association: the Yrjö Jahnsson Award, to an European economist under age 45. It is given every two years, but can have several recipients. This awards has looked much cleaner because the committees and awardees have been distributed all over Europe. Europeans are indeed very sensitive to this. The last one was a shocker, though. Armin Falk won it to the surprise of many. And guess who chaired the awarding committee? His advisor, Ernst Fehr. Again, ethics would have indicated that if Falk had a chance of winning it, Fehr should have recused himself not just from chairing the committee, but from participating in it. In retrospect, this is not Fehr's first wrongdoing: two years earlier he was also on the committee when Fabrizio Zilibotti co-won the award. Zilibotti is a colleague of Fehr in Zurich.

I think we should do away with these two awards. It simply does not work.

Trust in private money

2011-08-19T07:11:00.000-07:00

Money does not have to be supplied by government. Private money could work under some circumstances, and it has in particular been argued that competition should be beneficial. While previous attempts have failed, the wider availability of information, rating agencies (gasp) and information technology could make it happen. So it is of interest to find out what those circumstances are.

Ramon Marimon, Juan Pablo Nicolini and Pedro Teles say that money is an experience good, as you only observes its quality after the exchange is performed. This leads to serious limitations. If issuer of currency cannot commit to not inflate in the future, then competition over currency in the present has no bite. Building a reputation can solve this to some degree, but building the necessary trust means that future rewards must be larger that immediate gains from inflating. That implies that full efficiency cannot be attained: inflation needs to remain positive, while full efficiency implies negative inflation so that money has the same return as a risk-free bond. Unfortunately it also implies that there is indeterminacy and any inflation rate could happen. Oh well, may be the government could step in to help achieve efficiency...

Public consumption and the business cycle

2011-08-18T07:49:00.000-07:00

One aspect of government purchases the current crisis has highlighted is how volatile they can be. Quite obviously, they are influenced by politics, to the point of complete reversal between massive spending and severe belt-tightening within months as in the US and the UK. But there could also be a more systematic component that is linked to the business cycle. After all, the government may be trying to improve the welfare of its constituents and for example substitute public consumption for lacking private consumption, or the same for investment.

Ruediger Bachmann and Jinhui Bai look at this using an augmented real business cycle model. They claim that 25-40% of the variance of public consumption can be accounted for by shocks to total factor productivity once implementation lags and costs of public consumption, as well as taste shocks to public vs. private consumption. I am no particular fan of taste shocks, as they are the symptoms of a modeler who is giving up on trying to explain something and simply equates the error term in the Euler equation to a shock. Then much is driven by how this shock is calibrated, in this case to match a four year electoral cycle and some data moments. When I think about shocks in this context, I think indeed about who is in power to decide on public expenditures. But that is not completely exogenous. Indeed, the state of the economy has an impact on who gets elected or reelected. And this can be calibrated without trying to match the data moments one is trying to explain.

Job referrals can be more efficient than open search

2011-08-17T07:59:00.000-07:00

I a perfect world with heterogeneous workers and jobs, the matches are those that maximize efficiency. But when information about the quality of either is private and cannot be revealed credibly, the economy quickly looses efficiency. The solution is then to make hiring and firing easy, so that good matches can be found by trial and error. Employers also try to gather information about their potential employees, and their socio-demographic characteristics are certainly among them. While this looks like discrimination, it is OK if it is only statistical discrimination. But one can improve on this.

Christian Dustmann, Albrecht Glitz, and Uta Schönberg study job referrals from co-workers. They find that typically shunned minority workers are more likely to be hired the more other minority workers are already present, a clear sign of job referral. In addition, these workers earn on average higher wages and are more likely to stay in such firms. In some sense, this shows that job search networks can be better than open competition under some circumstances. One could even stretch the argument to claim that favoritism could be beneficial.

Penis size and growth

2011-08-16T07:24:00.000-07:00

Understanding why some countries are poor and why some grow than others is probably one of the most important questions in Economics. The traditional tool to tackle this challenge has been growth regressions: use cross-country data and regress the GDP growth rate on various indicators that could be relevant in order to find which matter most. These regressions have been abused over the years, especially as there are obvious endogeneity and collinearity issues. Also, the results are driven by a multitude of (poor) countries where data quality is quite horrendous. The worst is probably all the data mining that is going on in this literature, which culminated with Xavier Sala-i-Martin's two million regressions.

Tatu Westling uses a variable the previous literature completely ignored: the average length of the erect human penis. Adding this variable to the regression shows a U-shaped relationship for the GDP level, explaining 15% of its variation. The optimal penile length is 13.5 cm, and 16cm is disastrous. For GDP growth, the relationship is negative, explaining 20% of the dispersion. This is not negligible, and more than institutional variables that are thought to be the key to growth and convergence.

I wonder how many people will take these results seriously and try to get policy recommendations from it. Westling hypothesize about the impact of self-confidence. The paper is very well written, taking the 'male organ hypothesis' very seriously, but in truth tongue-in-cheek. Very different from this study on flag colors I wrote about previously.

Sustainable retirement pension reform?

2011-08-15T07:42:00.000-07:00

With increasing longevity, it is obvious that something needs to be done to keep pension systems around the world sustainable. The main options are postponing the normal retirement age, lowering retirement benefits or increasing contributions. The typical studies that compare these options and are thrown around in the public arena are done by accountants and actuaries, who do not take into account the changing incentives of market participants. Economists can do better.

Peter Haan and Victoria Prowse take up the challenge and estimate a very complex life-cycle model for Germany. It includes idiosyncratic risk, consumption and labor supply decisions and a complex tax structure. They find that the 6.4 year increase in life expectancy over the next 40 years needs to be met either by an increase in the full-pension age by 4.3 years or a reduction of benefits by 38%. The first approach markedly increases the unemployment rate. This is ironic in Europe where a reduction of that age is typically viewed as a way to reduce chronic unemployment among the young. The other option would markedly increase savings, as people have to fend for themselves more. Consumption of retirees is higher in the first option though.

Am I satisfied with this study? It is much better than what you typically see, yet I want more. The easy bit is that one could actually determine whose welfare increases under which option. That could help in understanding the (political) feasibility of such reforms. And maybe a combination of them turns out best. More critically, the model does not attempt to consider the consequences in the changes in aggregate supply. Lengthening the work age this much increases the work force dramatically and must have consequences for aggregate, and thus individual, wages. Also, while the matching probabilities and wages of retirement age workers are estimated from current data, I do not think these estimates apply once more previous retirees are forced into this pool. The new ones have different qualities compared to those who would have continued working anyway. Therefore, I see more work to be done.

Procrastination in team work

2011-08-12T07:03:00.000-07:00

Teamwork can turn out very bad when moral hazard is present: if people do not trust each other or care about each other, nothing gets done. When doing research, we are lucky to be able to choose our co-authors, but even then things can turn for the worse if a team member looses interest. And we remember how bad it is when a team is forced upon you during our studies. Now, this is all very loose reasoning, let us get on firmer ground.

Philipp Weinscheink studies team production in a dynamic game with moral hazard. If all players are rewarded equally, they will all wait until the last moment to participate. This is very like what we often see in political negotiations with a deadline, where nothing happens until the last moment, and player consciously wait for the last moment. The same often happens at collective agreement bargaining. And of course, the outcomes are far from optimal, as the debt ceiling mess in the US has recently shown.

If the rewards are not equally distributed, the outlook is better. Quite obviously, those who are rewarded better will tend to procrastinate less. But they are not necessarily better off that those less rewarded, as they put more effort. Thus, second-best contracts are unequal ones. But all this falls apart if some players have limited liability (which means they have better outside options) or if some can sabotage. Then everyone will wait until the last moment and very little gets done. Think about the US situation again...

Has the US economic policy been Keynesian for centuries?

2011-08-11T07:40:00.000-07:00

Suppose the abstract of a paper starts with "It is demonstrated that the US economy has on the long-term in reality been governed by the Keynesian approach to economics independent of the current official economical policy." My first reaction is that of puzzlement, as I would not have thought as the US being particularly keen on Keynesian policy, except for the recent years (which are not considered in the quoted study). But again, data may speak differently from policy intentions, so let us dig deeper.

A. (Agung?) Johansen and Ingve Simonsen come to this stunning conclusion by looking at the correlation between (nominal?) (federal?) public debt and the Dow Jones Industrial Average. One can first question whether public debt is a good indicator of Keynesian policy. Public deficits or even public expenses would be better. And does the DJIA represent the US economy? It is certainly not an indicator of current activity, but rather of expected present value of future profits from a particular class of firms.

Whatever. Let us go with that. The analysis is done by computing over the 1791-2000 sample a sliding correlation between these two indicators over a five-year window. Surprise, the correlation is zero most of the time, except during some wars when it is strongly positive (and strongly negative during the second war with the Seminole Indians). From this they conclude the Keynesian policy was mostly pursued during wars. Now let us take a step back: the authors show that there is by their definition no Keynesian policy during peacetime. But during wartime, the government is credited with a policy geared towards expansion of the DJIA. They, one may ask, if this is the government overwhelming policy, as the authors seem to believe, why did the US wait so long to get into the two World Wars when the opportunity was there? I cannot make sense of all this.

Land titling and access to credit

2011-08-10T06:58:00.000-07:00

It is widely believe that a key ingredient of economic development is the accessibility of credit. Indeed, entrepreneurs typically need credit to develop their business plans, and much of capital accumulation is performed through credit. But no one is going to grant credit on a promise, some collateral is needed. And that is a problem in many developing economies, as people hold little property and even land is communal or without clear property rights. Hence the idea that distribution of untitled land, with well-established property rights, should provide collateral to a large fraction of the population and make credit possible. How does this work in practice?

Caio Piza and Maurico Moura study the case of a major land titling initiative in Brazil. They use an interesting natural experiment. Two neighboring and very similar communities of the city of Corosco (correction: Osasco) were to get property titles for every inhabitant, but five year apart (2007 and 2012). This leads to a nice control group, which allows to overcome the problem of the endogeneity of ownership rights of a typical study by using a difference-in-difference approach. Indeed, the authors conducted a survey in 2007 before the titling, and another one in 2008. In addition, the context here is urban, which is unusual for a titling study. It appears access to credit increases by 22 percentage points, or about a half, within 18 months of titling. This is major. I do not think such large estimates have been found in rural studies. And given that developing countries become increasingly urbanized, this is very interesting.

Convergence in recessions

2011-08-09T07:15:00.000-07:00

Growth theory and data teach us that, at least in developed countries, economies tend to converge in the long run: the dispersion across regions or nations of per capita income (or similar indicators) tends to decline. While this is a long term phenomenon, there is a priori no reason to believe this is a constant process.

Eldon Ball, Carlos San Juan and Camilo Ulloa study total factor productivity in agriculture across US states. While they indeed find a general trend towards convergence, it turns out that its speed is much faster during recessions. Why would this happen? If we follow Schumpeter, the worst firms should be dropping out during a recession, thereby relatively increasing TFP in the worst areas. And voilà, you have faster convergence. But only farm-level data would tell whether my conjecture is true.

What if the US looses its reserve currency privilege?

2011-08-08T07:16:00.000-07:00

Since the Bretton Woods agreement in 1945, the United States have enjoyed the so-called "Exhorbitant Privilege." During the fixed exchange rate regime, the US could conduct monetary policy without regard to what was happening in other countries. The US dollar was a reserve currency, which also helped the US maintain low interest rates and a guarantee that US dollars (and Treasury bonds) would always find a buyer. With flexible exchange rates, not much has changed. But with the recent shenanigans in a Congress that considered reneging on its debt, the likelihood of this advantage changing has dramatically increased. What would the consequences of the loss of the Exhorbitant Privilege be?

Wenli Cheng and Dingsheng Zhang study this scenario using a general equilibrium model where a peripheral country (say, the Asian economies) pegs its currency to the money of a central country (say, the United States), the latter being used as the vehicle currency for international trade. In addition, the foreign exchange reserves of the periphery are invested in government bonds of the center. This means that no matter what current account deficit of the center, it is always financed by the periphery. Yet the center may be tempted to inflate it away. This limitless and to some extend free borrowing is the Exhorbitant Privilege.

Now remove it by assuming that the periphery does not want to invest in the center, either because it views the Treasury bonds are excessively risky or because it does not peg to the dollar any more. This would lead to a dramatic readjustment of the terms of trade to favor the tradable sector of the center. This decpraciation of the dollar would be more pronounced of the center is incapable of raising taxes and finances its debt with inflation. This already all sounds familiar.

About very large risk aversion estimates

2011-08-05T07:59:00.000-07:00

The equity premium puzzle is an enduring challenge to our estimates of risk aversion. Indeed, as Rajnish Mehra and Edward Prescott have highlighted, the only way to reconcile a standard model with the observed long-term equity premium is to assume a risk aversion coefficient of 10, while micro-estimate hover around two. This puzzle has been resolved a little bit in various way, most prominently by taking into habit persistence and some other deviations of the standard CRRA or CARA utility functions. But all this still boils down to a risk aversion parameter that is linked by an identity to the intertemporal elasticity of substitution (it is the inverse). But we know how to disentangle the two.

Xiaohong Chen, Jack Favilukis and Sydney Ludvigson estimate a model with the recursive preferences of Larry Epstein and Stanley Zin and Philippe Weil. This is not obvious to do because to estimate the coefficient of risk aversion in this context, one needs a measure of claims to future consumption. Here this is overcome by estimating nonparametrically the continuation value of the consumption process from within the model. The result is that the elasticity of intertemporal substitution is above one, and the coefficient of risk aversion is somewhere between 17 and 60. These are huge numbers. But they still imply a rather modest and sometimes even negative risk premium.

Aid and remittances as hedges against food price shocks

2011-08-03T07:21:00.000-07:00

Food is a substantial part of household expenses in developing economies, and in many of the latter foreign aid and remittances from emigrants provide a substantial part of national income. As world food prices have been subject to large fluctuations lately, causing much grief and even riots, it is natural to ask whether aid and remittances can provide some smoothing against the effects of these fluctuations.

Jean-Louis Combes, Christian Ebeke, Mireille Ntsama Etoundi and Thierry Yogo use a cross-country panel data set to study this question. First, they confirm that food fluctuations have a notable impact on aggregate consumption, especially in the poorest economies. Second they find that aid and remittances do help, and remittances seem to be more efficient at hedging. Indeed, an aid-to-GDP ratio of 29% is theoretically necessary to absorb food price fluctuations, while 9% is sufficient is for remittances. Only Mozambique and Nicaragua satisfy the first, while a few more countries satisfy the second.

How is China now planning its economy?

2011-08-02T07:19:00.000-07:00

Since 1978, China has undergone a fundamental and very successful reform from a planned economy towards a market economy. But one should still keep in mind that this is still an autocratically governed country where technocrats call the shots at all levels. China is still working with five-year plans and the economy is still tied to administrative goals. SO how does economic planning work in China nowadays?

Gregory Chow offers some insights, in particular on how this planning has recently become more important due to the global economic crisis. Administratively, policy is guided by the five-year plans, which interestingly have recently included new sections on welfare and management of society, making apparent some worries about the adverse effects of market economies and rapid development (or democracy when people can complain?). The remarkable part of these plans is that explicit targets are set, and policy is in a major way oriented towards these targets. Of course, the government still controls directly a considerable number of state-owned enterprises. And it has the traditional tools of policy in a market economy at its disposal to influence the rest of the economy. These policies are coordinated at all levels thanks to the very central nature of government.

In some sense it would also be good for market economies to also set some targets for policy. In fact, this is what politicians should be arguing about and then let technocrats put policy in place to achieve these targets. I would not mind targets like putting a man on Mars by 2020, making sure everyone in covered by health insurance by 2015, get 50% of commuting kilometers on public transportation, or defense expenses being completely dedicated to defense (and not attack) by 2015, for example. In fact, the World Bank has well-defined targets for developing economies. In do not see why this should not be applicable for developed ones. At least it would make governments capable of rallying support for some goals and be explicitly accountable.

Policy risk and the business cycle

2011-08-01T07:16:00.000-07:00

The US economy seems stuck in its tracks, and many blame uncertainty about future public policy, including me. Indeed, private firms are currently sitting on a lot of cash and are making very good profits, yet they are not investing or hiring. This really looks like a wait-and-see game. But it this justification well-founded or is it just a cheap excuse to justify higher than usual profits in the face of high unemployment?

Benjamin Born and Johannes Pfeifer put some structure into these arguments by taking a standard New Keynesian model and adding uncertainty about monetary and fiscal policy. They measure this by looking at tax rates and monetary policy shocks with time-varying volatility. Previous literature already looked at the impact of aggregate uncertainty, which policy makers can do little about. But policy uncertainty is another matter. And there is hope, as Born and Pfeifer show that the impact of policy uncertainty is not that important (but much larger than uncertainty about productivity shocks) thanks to monetary policy reaction through a Taylor Rule. So that is somewhat reassuring, but then the size of the current policy uncertainty is an order of magnitude larger than when this paper was written, and monetary policy is bound by non-negative nominal interest rates.

The debt ceiling circus is another media debacle

2011-07-30T07:09:00.000-07:00

If you compare the media coverage about the current debt ceiling "discussions" in the US to abroad, it is a stark contrast of style. While the US media is focused on the power haggling of politicians, ignoring completely policy matters, foreign media puzzle why such a silly policy the Republicans are proposing is even being discussed. And once more, it makes me wonder why the US media is sleeping.

Roughly, the Republicans want to erase the public deficit from one day to the next, in the middle of difficult times, and without raising taxes, cutting anything to defense expenses and farm subsidies or closing corporate tax loopholes. This is mathematically simply impossible and must results in partial default on public debt, a major increase in interest rates and in then more public expenses to service the debt. In other words, this is an own goal. To top it, the policy uncertainty is severely hurting the US economy which does not seem to be able to get back on track.

The saddest aspect of this is that the media is completely oblivious to this. It is so obsessed to present both views that it shows without critical discussions complete absurdities from the Republicans. I have a hard time understanding the motivations of the right, except hurting the economy ahead of elections or participating in some grand scale insider trading, and nobody in the media is pointing this out. In fact it is relaying the arguments that decreasing taxes will increase revenue, especially if the rich get those breaks. To repeat myself, this is so wrong, especially now. If you want to improve the economy and insist on reducing the deficit, give tax breaks or transfers to the poor and tax the rich significantly more.

The worst is that there are some serious negative externalities on many who have absolutely no say here, and not just the US tax payers, but also foreign economies. Rarely have I seen such a policy kamikaze, say since Saddam Hussein invaded Kuwait. But at least the US media was then on top things.

Referee home bias

2011-07-29T07:14:00.000-07:00

Referees are supposed to be impartial. In academics, this is most of the time helped by the fact that they are anonymous. In sports, referees are public and meeting participants, including spectators, try to influence them. This becomes particularly relevant when the referee has to take a decision against the home team than leaves spectators irate. They could retaliate against him. Does this influence referees?

Andrés Picazo-Tadeo, Francisco Gónzalez-Gómez and Jorge Guardiola Wanden-Berghe look at first division football in Spain, carefully taking into account stadium capacity, how full it is, how far spectators are from the pitch, and referee experience. They find that awarding a free kick does not have a home bias, which is consistent with the fact that this is a split-second decision. The ensuing decision to give the offending player a caution is, however, affected by home bias. This decision is not instantaneous, and social pressure can be exerted on the referee, especially when the stadium is full. The presence of a running track that separates the local supporters form the action does not seem to matter, though. I wonder whether some teams have a larger home bias than others, as the fans' reputation could also influence referees.

Do unemployed and employed compete for the same jobs?

2011-07-28T07:01:00.000-07:00

In times like now, it is easy to forget that job seekers are not only the unemployed, but also the currently employed. On-the-job search is rather common but difficult to measure, as it is often not openly conducted. But it is important to understand it for policy, for example to evaluate the impact of job creation programs.

Simonetta Longhi and Mark Taylor just finished a couple of papers that offer some insights about these two types of job seekers in the United Kingdom. In the first one, they compare their characteristics and search behavior and conclude that employed and unemployed job seekers are different. My reading is that the unemployed are often stuck in a sequence of low paying jobs and drift in and out of employment. The employed job seekers are rather on the way up and improve their situation at each change. Thus these two types are not substitutes and do not compete for the same jobs.

In the second paper, they compared the job finding probability of both types. Consistently for search theory, they observe that on-the-job seekers take much longer to find jobs, reflecting that they can afford to wait for the perfect match. The unemployed, however, have content themselves with the first offer, especially since unemployment insurance criteria have tightened in the UK. The presence of the former has no impact on the search success of the latter, confirming that they are not substitutes.

Kuznets in a post-industrial world

2011-07-27T08:05:00.000-07:00

The Kuznets curve traces the evolution of inequality as an economy develops. It is based on Kuznets observation that income and wealth inequality increased and then subsided as economies get richer. While this was established on a cross-section of countries, it has been proven right in the time dimension in some cases, like England and Wales through the Industrial Revolution. But what happens thereafter, when an economy further develops into one where the service sector dominates or globalization becomes most relevant?

Jordi Guilera asks this question noting that most developed economies have recently experienced a sharp increase in inequality. Is thus Kuznets' inverted-U becoming a N? Beyond simply observing this, one would also need a theory with predictions about other correlations to make some progress. The theory here is that skill-biased technological change generates increasingly large education premia, and evidence from long-term wage inequality in Portugal seems to corroborate this hypothesis. In particular it shows that inequality between sectors was the leading determinant of inequality until the 1980s, while inequality within sectors has taken over now.

Trade constraints of developing countries

2011-07-26T07:14:00.000-07:00

With all the current posturing in the US and Europe, while addressing doubtlessly important problems, it is easy to forget that there are much bigger issues that need to be solved: how to get the poor and especially the poorest economies to a decent standard of living. We have been blessed to be born in the right families and in the right countries, and we should share this luck with those who were no so fortunate. This does not necessarily mean to give to the poor, just giving them a fair chance may be enough.

Jean-Jacques Hallaert, Ricardo Cavazos Cepeda and Gimin Kang consider the consequences of trade barriers on developing economies. The latter should be able to benefit greatly from selling on world markets goods produced with the factor they are relatively rich of, unskilled labor and to some extend land, while importing the complementary goods, likely capital-intensive investment goods. This OECD study finds that developed economies cannot do much more in terms of reducing import tariffs. Where there is more potential is with home-grown issues: unreliability of electricity, high transportation costs, poor education, bad governance, and instability. These results have been obtained by regressing exports, imports or their sum on a number of indicator for a panel of data. I am not particularly keen on these exercises due to poor data quality, gigantic endogeneity and especially the fact that proxies for essentially unquantifiable variables are used, like property rights and governance. But I suppose this is the best one can do, and the results appear to be rather stark. Now as to how to solve these economic problems, that is a gigantic task that we should be really talking about these days, instead of posturing for political gain.

How not to think about class struggles

2011-07-25T07:52:00.000-07:00

Depending on the research question being asked, some degree of heterogeneity is required in a model. Sometimes this modeling requires distinguishing between those who provide capital and those who work. This is obviously an abstraction, because in reality these "capitalists" may just be shareholders who also work on the labor market. In fact, they often are, and they save and invest for various purposes, like self-insurance, retirement or bequests. But making households purely capitalists and workers can sometimes prove useful in making a result emerge more clearly, as long as one is conscious of the abstraction. In some circumstances, it is useful to explain why these "classes" emerge, like differences in access to credit or in subjective discount rates. But again, these are abstractions useful for modeling.

Alberto Russo takes this abstraction very seriously. In his model, people are born capitalists or workers, which translates in households either investing in an activity with a multiplicative risk or working for a wage with additive risk. Why that is so and what should be achieved with this is left unexplained. Households face an additional risk: they randomly switch between classes, the probability depending on wealth. The model is "closed" with exogenous and distinct propensities to consume for both classes. The model is then calibrated with parameters values not related to anything observable. The simulations reveal that if one starts with everyone having the same wealth, wealth heterogeneity then emerges. Well, that was unexpected... Even back in 1993, Mark Huggett had a much better model to explain heterogeneity in wealth.

We are turning into a rentier society again

2011-07-22T07:29:00.000-07:00

Wouldn't it be nice to live on old money? One does not really need to work, or at least on a regular basis, one is worry free, and one gets to enjoy life at its fullest. But this is only a dream that is reserved to a preciously small elite.

Thomas Piketty, Gilles Postel-Vinay and Jean-Laurent Rosenthal show that about a century ago in Paris close to 10% of the population were in fact rentiers, that is, people who consume more than their labor income during their lifetime. They thrived in an economy where the return of wealth was substantially higher than the growth rate. And by the looks of it, it appears that we are heading into a similar situation, as a small proportion of the population is generating substantial wealth from labor income, wealth that cannot be spent in a lifetime and will be inherited by happy an idle descendants. Perhaps more importantly, existing wealth is enjoying far better returns than average wages are growing at, laying the seeds of a new rentier society. History repeats itself.

Obesity on the German labor market

2011-07-21T07:55:00.000-07:00

Being obese makes you a social outcast, especially in countries were obese people are relatively rare. This can have consequences on the labor market, as there is plenty of evidence that handsomeness matters, for example. So are obese people discriminated against on the labor market?

Marco Caliendo and Wang-Sheng Lee look at newly employed people in Germany and find that there is not much evidence of discrimination there. Only obese (but not overweight) women may be suffering in the land of beer and wurst. Of course, one may question the validity of a study that must be relying on very few observations for a subgroup of the sample. Yet, surprisingly, half of the men and 37% of the women are considered overweight or obese, proportions I would never have imagined from walking around German towns. And with sample ages averaging in the thirties, they are relatively young too. As the survey sample is based on people who have been unemployed, I wonder whether the discrimination is rather in unemployment rather than employment.

Is it cheaper to live in poor economies?

2011-07-20T07:01:00.000-07:00

If you are a rich country resident and travel to a poor country, you are continuously amazed how inexpensive life is there. One rationalizes this with the lower local wages which make domestic goods (and price discriminating imports) cheaper. Is this anecdotal evidence true in general? Does it hold across all countries?

Fadi Hassan finds that indeed rich countries have higher price levels. But once you go further down the development ladder, the statistical evidence is not that clear, and once you reach the lowest rungs, the cost of things could be increasing again. This analysis is performed using the ratio of purchasing power parity to the exchange rate, as measured in the Penn World Tables and finds that the best non-linear fit of the price-income relationship is not increasing for 40% of the countries. The challenge is now to understand why it is so.

Public pensions are not sustainable, even in Norway

2011-07-19T07:58:00.000-07:00

By now, everyone must be aware that populations are getting older and that this puts some serious strain on pension systems. Unless one plans far ahead or is blessed with substantial sustained growth, some problems in financing retirement will appear. But there must be some place that is going to do fine, say a country with a forward-thinking government, a recently reformed pension system, a well managed endowment of natural resources and a small and smart population, like Norway. Right?

Wrong, say Christian Hagist, Bernd Raffelhüschen, Alf Ering Risa and Erling Vårdal. To come to this conclusion, they use generational accounting, which measures the fiscal sustainability of the public sector and in particular the publicly funded retirement pensions. The latter went this year through a significant reform, which includes pension indexation below wage growth, benefits adjusted to be actuarially fair if life expectancy increases further, and work incentives for elderly. It turns out the pension reform has helped substantially for the sustainability, about as much as the presence of the endowment of oil and natural gas. But that is not going to be enough, even with higher oil prices and an exceptionally well managed petroleum wealth. And for those hoping that future growth of the economy or higher fertility would help, well at least in the case of Norway this would barely help. To close the gap, a 17% increase in taxes would be needed, and they are already very high in this country. So, if Norway cannot make it, how could countries with inactive governments and little or poorly managed endowments make it?

Should we encourage business ownership?

2011-07-18T07:02:00.000-07:00

Politicians claim left and right that small business owners are critical to the success of an economy. They woo them with various tax credits and by turning a blind eye to their opportunities to hide income from taxation. Yet, politicians also rewards large companies with generous tax abatements, especially when the relocate or just promise not to move away. So, in the end, who should be encouraged. the small business owner or the big conglomerate? In part, this is a question about whether it is better to have many self-employed workers or many employed workers.

Mirjam van Praag and André van Stel address this question by trying to determine the optimal business ownership from a sample of 19 OECD countries over 26 years. They proceed by estimating a Cobb-Douglas production function augmented with a business ownership rate, its square, tertiary education, as well as interactions of the latter with the formers. This is not a production function that has an interpretation for factor shares, it is rather a test of some relationships in the data. And by the implied non-linearity, it allows to computed from the regression coefficients what the optimal business ownership rate would be. On average, it is 12.5%, which is definitely not high, and it declines over time.

Furthermore, van Praag and van Stel find that countries with a higher proportion of workers with tertiary education enjoy a lower optimal business ownership rate, converging towards 11% when everyone has a university education (no gravediggers?). The interpretation they offer is that better educated people run larger firms. As business owners are a minority in a developed economy anyway and only the top business owners really matter for economic performance, I am not quite convinced by this argument, but it is apparently supported by microeconomic evidence. I would have rather thought that a more educated workforce is more specialized, and under such circumstances it is more difficult to be a business owner. The only exception are start-ups, which then either fails or are gobbled up by a larger firm.

Razor innovation in macroeconomics

2011-07-15T07:13:00.000-07:00

Macroeconomics is sometimes like Gillette razors. There is regularly an innovative razor that happens to have more blades than the previous one. And once it gets out of hand, the new razor goes back to fundamentals and has only one blade, before the cycle starts again. In macroeconomics, there was this fad of adding more an more shocks to models until everything became very confusing and unidentifiable. So we returned to simple models (Occam's razor was the innovation) that became more powerful because of the presence of a market friction. Now, these search frictions are appearing everywhere, one-by-one or in pairs, and the latest generation of models has three frictions.

In a pair of papers, Etienne Wasmer alone and then with Nicolas Petrosky-Nadeau introduces search frictions on labor, credit and goods markets. The first is more of an exercise of style, showing it can be elegantly solved in steady-state thanks to block-recursiveness. The second paper is more interesting, as it looks at the dynamic properties of the model and shows that is can better account for the persistence of fluctuations in the data (what frictions are good at) and the volatility of labor flows. Interesting results, especially in the light of the pronounced lag in the recovery of employment in the US these days.

I am waiting for the four-friction model now.

Should immigration quotas be traded?

2011-07-14T07:32:00.000-07:00

We all want to end world poverty, and a particularly efficient way to do this is to allow the free movement of people. Unfortunately, this often puts a burden on the receiving country, and thus immigration limits are set. But there is clearly a positive externality on the other countries from allowing immigrants in, as long as the others also care about world poverty. This implies that immigration quotas should be set higher.

To make this happen, Jesús Fernández-Huertas Moraga and Hillel Rapoport suggest a system of tradable immigration quotas, that mimics the market for pollution quotas. There is one difference, though, as migrants have preferences on where to go. Thus, there is a global number of migration slots put on the market and countries can trade them, paying for a slot elsewhere if local costs of immigration are particularly high. A central assignment authority attributes migrants to countries following their preferences and a particular assignment scheme.

This market allows to extract the price of immigrants to the host country as well as price the benefit of migration to world social welfare. Unfortunately, it does not appear immune to strategic behavior, as most bilateral assignment problems. But it seems to be a very promising step towards a better world, especially in the light of potentially large migration following climate change.

The welfare gain from inflation targeting

2011-07-13T07:29:00.000-07:00

It is rather well accepted that transparency is preferred for policy, because it anchors better expectations, people generally do not like uncertainty, and discretion can lead to adverse biases compared to set policy rules. Yet, the United States exhibit little transparancy, with the Federal Reserve being one of the few western central banks not to declare some explicit policy target, and fiscal policy being as uncertain as ever. That would not be a big deal if the welfare costs were low, but you can think that there are high and in the case of fiscal policy are currenctly holding back the recovery.

Giorgio Di Giorgio and Guido Traficante are taking a closer look at the welfare benefits of inflation targeting. For this they use a model where households observe policy interest rates and do not know whether their changes are due to reactions to output gaps or shocks to the inflation target. Households are sophisticated, they use a signal extraction device to estimate the latent, unobservable variable. Yet, they still face substantial costs from the uncertainty. Money is not neutral because of Rotemberg pricing, a variant of Calvo pricing. Oh well, I guess this is what you need to do to get a result with some bite.

Households know there is a policy rule that determines the interest rate from the output gap (unobservable) and the inflation target (stochastic and persistent) as well as known preference and cost-push shocks. In other words, households know a lot about the structure of the economy and the shocks, except for the policy shock, but then somehow cannot figure out what the output gap is. The central bank can, though, but then has for obscure reasons a trembling hand when it comes to set its inflation target. That seems to be quite the opposite of what I would have thought: everyone is confused about the output gap, and only the central bank knows what the inflation target is. Instead of a story of households trying to disentangle output gap and inflation target from the interest rate signal, one would have a story of a central banker not quite sure what to do given the circumstances. Too bad, this could have been an interesting paper.

The military draft, mortality and education

2011-07-12T07:01:00.000-07:00

The data sometimes work in mysterious ways and provide puzzling correlations that lead to interesting research questions. One such correlation is that exemption from military service leads to lower mortality later in life.

Piero Cipollone and Alfonso Rosolia find this while looking at a natural experiment following the 1981 earthquake in Southern Italy. Boys from the affected region were exempted from military service, and they were followed, along with non-exempted neighbors, to track their life and education. By concentrating on boys both sides close to the border of the exempt region, they find that those exempt ended up being more educated. I can easily believe that, as they were not spending some of their prime learning years hiding in bushes and peeling potatoes, and they were expecting a longer work life. But the exempt also have lower mortality. This is not due to a lower incidence of military accidents, it is rather linked to the higher school completion rates. In fact, the authors conclude that raising high school completion by 10 percentage points would lower mortality by one or two percentage points in the decade thereafter. That is impressive at that age.

The Internet did not raise a generation of loners

2011-07-11T07:53:00.000-07:00

The image of the basement-dwelling World-of-Warcraft-playing loner is often shown as an example of the adverse impact of the Internet on social capital and in particular social interactions. Whether this is true is not so obvious, as the Internet also makes possible social interactions that could not exist before, as this blog shows in a limited way.

Stefan Bauernschuster, Oliver Falck and Ludger Woessmann study the impact of broadband Internet on social capital using a natural experiment in Eastern Germany. There, some choice by the telecommunications provider resulted in 11% of East German households to be on OPAL lines instead of DSL, which better supports high speeds. Using the German Socio-Economic Panel, they measure social capital with the frequency of going out, visiting friends and performing volunteer work. They find that Internet access has no visible impact on social capital. To the contrary, for children it seems to enhance social capital, possibly because it makes them aware of new opportunities to interact in real life. This is in stark contrast with television use, which has many times been shown to be detrimental to social capital, likely because it is a one-way communication, while the Internet can build two-way communication.

How should I lie?

2011-07-08T07:54:00.000-07:00

Is it OK to lie? The usual answer is that it depends. Big lies are frowned upon, while small lies are somewhat tolerated. Does this necessarily mean I should avoid lying?

Gerald Eisenkopf, Ruslan Gurtoviy and Verena Utikal study the size of lies in an experimental setup. Their first observation is that it depends whom you are lying to. Honest people punish according to lie size, while chronic liars really do not care. Their second is that big lies are punished more than small lies. This is hardly surprising. What would have been more interesting to learn would be whether the punishment function is concave or convex, that is, whether the returns to scale are increasing or decreasing. In some sense we already have some idea about this by looking at tax penalties, which are usually proportional to the offense, plus a fix cost. And ultimately, one would want to compare the shape of the penalty function to that of the benefit function. Then I would finally know whether I should lie big or small.

State-owned banks in the US?

2011-07-07T07:26:00.000-07:00

Many countries have state operated banks that support local development or other objectives that deviate somewhat from those of usual for-profit banks. No such institution exists in the US except for the Bank of North Dakota.

Yolanda Kodrzycki and Tal Elmatad study the Bank of North Dakota in the perspective of the feasibility of a similar bank in Massachusetts. They find that the BND is not a typical bank. While it favors local development, it rarely does so directly, but rather by helping local banks. It thus encourages a network of small and local banks, something that does not quite seem efficient to me. The BND was, however, not particularly useful in periods of crisis, like the agricultural crisis of the 1980s, because it also had financing difficulties. All in all, the bank of North Dakota is very different from state banks abroad, which offer all customer services like private banks and thus help regulate through competition some the excesses of private banking. The BND looks much more like existing development corporation that exist in most if not all US states. If Massachusetts just wants to em ulate North Dakota, it does not seem worth the large cost of the initial bond issue, especially in the current economics context.