The impact of poor climate

We often cannot choose where we live, especially as academics, and have to bite the bullet when we end up in places where the climate is less than favorable. You sometimes wonder why humans willingly decided to settle in numbers in uninviting places. And it matters, as people not like poor climate, but that may be compensate by other factors, like having a job. Still, climate matters for satisfaction.

David Maddison and Katrin Rehdanz document using the world values survey that poor climate has a significant impact on life satisfaction. The latter is defined by self-reported survey results, thus to be taken with a rock of salt, and poor climate is defined by a measure akin to a standard deviation from a comfortable temperature, 65F or 18C. How significant the impact is cannot be evaluated without seeing some statistics about the climate measure, but let us believe the authors for a moment. This means that, ceteribus paribus, people in Central America and some parts of Africa should be the happiest. Of course, all other things are not equal. And there may be others things that correlate with temperature variations that also have an impact of happiness. For example, long nights in the winter have a strong impact on depressions in Nordic countries.

Maddison and Rehdanz then proceed to look at the consequences of a climate change scenario which provides country specific temperature changes. From this exercise, they find that Europe will gain in satisfaction, the US will be unaffected and Africa will suffer tremendously. While this is an interesting first shot at the question, I am not quite sure I am willing to run with it. In particular because the initial elasticities may be tainted by correlates that do not vary with climate change (for example, length of night is not expect to change), and because climate change will have other important consequences, for example about the availability of fresh water. But at least, this paper gets us thinking about these issues, and it highlights that those who would suffer the most are those that have the least to do with the origin of climate change.

How to fight tax evasion

Tax evasion is a serious problem in developing countries because of the tiny administrative capacity of authorities and the size of the informal sector. Even in more developed economies, say, the Southern European ones, tax evasion is part of daily life. Again, administrative capacity is lacking. One could even argue it is a problem in the United States seeing the tiny auditing staff of tax authorities and the complexity of the tax code. Tax auditors have thus to define priorities.

Mirco Tonin studies the rules that Italy and Bulgaria instituted. In Italy, businesses and self-employed people reporting revenues below some level are subject to higher scrutiny. The idea is thus not to go after those who declare to be big fish, but rather those who may hide it. And making it known that there is such a threshold induces people to declare more to tax authorities. In Bulgaria, authorities are after employees and firms that declare too little in social security contributions. This is also forcing them to declare more to avoid scrutiny.

Tonin uses a model of imperfect monitoring to figure out whether such threshold rules make sense. And yes, they improve tax revenue, as those who have higher true income declare more than the threshold, and those below become more truthful. Now all you need to do is figure out where to put the threshold to equalize marginal tax revenue and marginal auditing cost, possibly adjusted by the dead-weight cost of taxation and for observable characteristics of the tax payer.

Are consumption taxes more equitable?

There is no doubt that consumption taxes are more efficient that labor income or capital income taxes, because they do not punish activities one would like to see promoted in an economy (labor supply, investment). But they are widely regarded as unfair, as the consumption share of income is higher for poor people. Hence the implementation of exclusions for essential goods where consumption taxes exist, in order the achieve some tax progressivity.

Isabel Correia claims that switching from income taxes to consumption tax can lead to less inequality even in the absence of lump sum transfers. This is a very counterintuitive result, and this is probably the reason why it made it into the American Economic Review (Yes, I know, I am breaking a trend here). But despite my best efforts, I still do not understand how this could happens, and the article provides very little in terms of explanation. Not only is no intuition provided, but the idea of using Gorman aggregation to reduce the model to a representative agent model seems wrong in this context. If anybody has read and understood the article, please help me here.

How not to encourage home ownership

Many governments try to encourage home ownerships by various means. I am not convinced this needs encouraging, as it leads to over-acucmulation of residential capital. Additionally, it is a myth that home ownners are happier and better citizens, as I reported previously. But suppose, for a moment, that a government really wants to increase the home ownership rate. How could this be best achieved. Two recent papers look at this.

First, Emre Ergungor compares mortgage interest subsidies to mortgage down-payment subsidies, and finds the latter work better. It is clear that down-payments are a significant hurdle for first time home buyers, and the recent crisis has at least partly been attributed to too easy down-payments, so one needs to be careful with this result. This is why Ergungor looks at loan performance for low to middle incomes. He finds that a one percent interest reduction is equivalent to a $3200 down-payment subsidy in that it leads to a 75 point reduction in default rates, and the latter is much cheaper to implement.

Second, Christian Hilber and Tracy Turner make the point that the tax deduction of mortgage interest makes mortgages more affordable but also raises house values. So in the end who benefits? Apparently only higher incomes in markets with few regulations. Hilber and Turner do not try to explain why this would happen, but I suppose this has to do with the high marginal rates on tax expenditures for high incomes, although I cannot explain the regulatory impact. In any case, there is more evidence that this type of subsidy should be abandoned.

ABM+NKDSGE=?

Agent-based models have a track record of generating stock market bubbles when they include agents that are not optimizing and use backward-looking decision rules. But they do not seem to have convinced the profession of their relevance because of the perceived arbitrariness of model components and the fact that they basically predict that a broken clock is right twice a day. Hence, it should be quite interesting to try to embed an agent-based model into a more widely accepted model and see how far this can bring us.

Matthias Lengnik and Hans-Werner Wohltmann do this by including two type of asset traders in a Neo-Keynesian model: fundamentalists, who are forward-looking and expect that price will get closer to the fundamental equilibrium, and chartists, who are backward-looking and obey some predefined rules based on past prices. This introduces some degree of history dependence and assumes that both types of agents are fooled every time. They never learn. And asset prices are thus essentially exogenously determined. The non-financial part of the model follows some old-fashioned model where inflation linearly impacts the output gap, and inflation is determined by the output gap and the evolution of stock prices. In other words, we are back the wind-generating hand-waving of 1980's macro, and not exactly something I would call DSGE.

Anyways, let's see what comes out of this. Of course, by the very nature of the model, there can be multiple equilibria, and an unstable equilibrium is possible. So one has to be very careful with simulations as potentially a lot of scenarios are possible. Yet, Lengnik and Wohltmann base their entire analysis on a single 40 quarter run of their model. They call is "representative." In which sense? Have all runs the same statistical properties? Or did the authors mine for the most convenient one? None of the results can be believed until this is clarified.

Suicide in happy places

It is quite baffling that the countries with the highest standards of living, and among several dimensions the happiest ones, also exhibit the highest suicide rates. Is it that places where material necessities are easily met other more psychological worries take over? Is it that somehow happiness is more volatile, or more diverse?

Mary Daly, Andrew Oswald, Daniel Wilson and Stephen Wu use two data sets that allow to compare suicide rates and happiness across US states to show that this paradox is also true within the United States. This thus invalidates the cultural or institutional explanations of the international paradox. This also allows to use all sorts of cross-state controls, but none makes the paradox disappear. Daly, Oswald, Wilson and Wu then conclude that there must be a direct causality from happiness to suicide: living among happy people is depressing for some. This may be consistent with the fact that suicide rates drop in war time. And it is difficult to imagine the reverse causality, that high suicide rates make survivors happy.

The economics of swinging

This is not about economic fluctuations or long cycles like Kondratieff cycles, this is about the sexual practice of partner exchanges or group sex. This practice that started in US military families in World War II has now spread world-wide, first as wife swapping than with women's emancipation into couple exchanges that a organized through websites or swinging clubs. Estimates vary widely, but somewhere between 1 and 15% of the population practices it.

Fabio d'Orlando tries to explore the economics of swinging. In the absence of much data and theory about it, he draws heavily on Jeremy Greenwood and Nezih Guner's theory of the emergence of premarital sex (discussed here) and modifies it to a theory of increasing kinkiness of sex. I did not think this was very inspiring in this paper, but a (long) footnote caught my eye.

Swinging clubs charge an entrance fee, which depends on who enters. Couples pay, say, $50, but single men $150. This is more than a night with a prostitute, but single men seem to value of having sex with a woman who does not fake it. Single women, however, are typically not allowed in on the premise that they are prostitutes. The interesting bit is how a swinging club owner should maximize profits, given that couples are more likely to come if there are fewer single men. Given the hidden nature of this market and thus the lack of information, it would interesting to see the diversity of outcomes.

Employer-provided health insurance is not that bad

Health insurance is, among OECD countries, uniquely organized in the United States. It is provided by employers, if they can, and is a benefit that is not taxable for employee. The others either buy individual insurance, which is much more expensive than group insurance, or simply bypass insurance. This reliance on insurance by the employer, instead of a group insurance for everyone independent from employment seems clearly suboptimal. For one, the implicit tax subsidy can only lead to over-insurance for the insured. And then, there is clear under-insurance for the others. And lack of mobility of the workforce.

Kevin Huang and Greg Huffman argue that the US system may have advantages that overcome its disadvantages. The basic reasoning is that through this tax subsidy and the fact that insurance is better provided by employers, there is a clear incentive not to fool around and get a job. This decreases unemployment, increases output and possibly welfare despite higher consumption of medical services than optimal.

They argue this welfare improvement through the tax subsidy is possible. But it may also not. It all depends on how much health and leisure are valued, and how risk averse people are. So not everybody prefers the current regime, probably. And the public debate about the subsidy provision while a removal was mulled during the Bush Junior administration clearly shows that. Huang and Huffman, however, argue against using heterogeneous agents, because it is unlikely to have a macroeconomic impact. I am not convinced. Indeed, just look how diverse the insurance packages are that people choose. This highlights fundamental diversities in the perception of risk, and actual risk, in the value of life and health and attachment to work. This has clearly an impact on optimal policy because marginal utilities vary, and there are winners and losers for every policy. This becomes a political economy problem, and heterogeneity is crucial.

The international flow of doctorates

With globalization, the trade of goods has considerably increased. But the substitution to international trade, international migration has also increased. While the migration of low-skilled workers draws headlines, the most "globalized" are the high-skilled ones. In particular, those holding doctorates are very mobile and in particular they move frequently.

Laudeline Auriol has analyzed for the OECD the flow of doctorates across its members countries. For examples, across European countries, 15 to 30% of all doctorate holders has moved across a border over the last 10 years. This is a remarkable transformation for Europe, where language and cultural barriers were much much higher a few decades ago.

This high mobility reflects the particular labor market for doctorates. Positions and candidates are very specialized, thus often need to move far to fond a match. This is compounded by the large increase in new doctorates across the OECD: from 140'000 in 1998 to 200'000 in 2006. But this growth has been very uneven, low in Germany, France and the US, very high for some of the poorer OECD countries, and for women. Currently, the US has the most doctorates (340'000) with Germany not far behind, which explains why a professorship there requires a second doctorate (habilitation).

Unemployment rates are low, 2-3%, but it usually takes several years after graduation until a doctorate finds a stable job, and this after graduating at a much higher age than other workers. While this sort of indicates a healthy labor market, it hides considerable heterogeneity. Women and doctorates in humanities face much higher unemployment rates. The latter are much less mobile because their research (and teaching) topic is much more closely related to the local cultural context, and can thus not take advantage of international opportunities like, say. natural scientists. It is then not surprising that in some countries a fifth hold jobs that are not related to their doctorates. There is also considerable uncertainty about job security. For example, post-docs (which include temporary visiting positions) now outnumber full-time faculty at US academic institutions.

Coming back to international mobility, it is remarkable how in most counties over a fifth of doctorate holders are foreign born, over half in Canada. Half of the foreign born doctorates in the US are from Asia, and two-thirds of the graduate students as well. And in the countries that have lower proportions of foreign born considerable share has stayed abroad recently. A truly international workforce.

Syphilis cannot be eradicated

Syphilis is back. As the most widespread venereal disease in the 1930's it was curtailed after huge efforts, both in developed and developing countries. And ten years ago a push was made to finally eradicate it. But syphilis is quietly making a comeback, hidden in the shadows of AIDS. And because the transmission of this disease is primarily driven by risky sexual behavior, it can be a leading indicator of other sexually transmitted diseases on the rise.

David Aadland, David Finnoff and Kevin Huang use a model of human behavioral response to study this resurgence and come to the conclusion that there is a fundamental cycle that cannot be broken. The point is that the transmission model that epidemiologists use has constant parameters tracing back to biological features of the disease, but these parameters can change through human intervention, and they do. Call this a Lucas Critique of epidemiology. The key here is that when prevalence is low, individuals in a riskier fashion and in particular have more sexual partners. No reasonable policy can overcome this.

Given free Internet to the unemployed

It is of general benefit that people do not stay unemployed too long and that those who are unemployed exert a reasonable effort to find a new job. While it turns out that they spend surprisingly little time looking for a job, the efficiency of this search can be improved in various ways. One, rather costly, is to provide more counseling and coaching, provide child care, another less costly is to give more search means.

This is what Randolph Beard, George Ford, Richard Saba and Richard Seals Jr. study by looking out the availability of the Internet impacts job search. They highlight one particular aspect of job search: discouragement. Indeed, nothing is worse than someone who is not even trying to find a job. Well, it turns out that having Internet access at home reduces the occurrence of discouragement in job search. Internet access at public locations like libraries have a similar effect. This is not unimportant, because becoming unemployed, especially a longer time where you may become tempted to abandon, lets you rethink budget priorities and Internet access may be among the first items to go. In such circumstances, it may make sense to offer free Internet access.

Trying to justify IS-LM

The IS-LM model is still not dead. Created to reflect the interaction of aggregate markets, it suffered from the rise of dynamics and microfoundations in macroeconomics, yet remained the staple of undergraduate macroeconomics because a generation of teachers knowing nothing else needs first to die out. Yet, even people in research have clung to it, trying to find the microfoundations of IS-LM, which seems to me completely backward. The scientific method should indicate that you build a theory from observations, then create its graphical representation (if possible), and not trying to justify a graphical representation with some theory.

But anyway, I was thinking about these vain efforts while reading a paper by Ingrid Größl and Ulrich Fritsche, whose goal is to show that the standard Neo-Keynesian DSGE model cannot be represented appropriately in the IS-LM framework. So what? Life is more complex than IS-LM, so deal with it and drop IS-LM. But anyway (again), let us see what their arguments is.

First, the claim is that a Taylor Rule is a poor substitute for the LM curve, because it neglects the store of value role of money. And the DSGE model cannot capture the IS curve because is assumes that savings always equal investment, and people never save in unproductive money. The final claim is that an overlapping generation model is better for the IS curve. Now let us see how these claims are formally made. The model starts with a standard Neo-Keynesian representative agent, who has intertemporal preferences over consumption, leisure and real money holdings. Real Money holdings? Why not question that while you are arguing about the role of money in a model? Why would I care about how much money I carry? Not because I need it for transactions, because current consumption is already there. Not because of the wealth it represents, because future consumption is also there. It is simply there because otherwise the LM curve would not exist. How wrong is that?

Then what about the firm? It produces goods proportionally to the number of employees. Where is capital? Are we now trying to derive an IS curve (where I stands for investment) without investment? Not very convincing. Does the resulting model have anything to do with observed facts? Nothing is offered by Größl and Fritsche. What do I take from this paper? To justify LM, one needs to force people to demand money just because, and to justify IS, one needs to assume away investment. Great.

Property rights and the tragedy of the commons

The tragedy of the commons is a well studied and understood problem. When property is shared, the owners tend to abuse it because individual actions and only a small individual impact. Typical examples are overfishing, air and water pollution, and the need for the government to tax to provide public goods. The typical solution is to assign exclusive property rights to the shared good. Do this always work to solve the tragedy of the commons?

No, say Preston McAfee and Alan Miller. The problem is that the exclusive property rights lead to underutilization of the good. This was the purpose of the property rights in the first place, but McAfee and Miller argue that this often goes too far. First, if a good become unavailable, there is a waste of resource trying to find other ways to consume. Second, there could be underutilization if social benefit differs from the private benefits of the owner. The problem is not trivial, for example think about the attribution of radio, phone or wifi frequencies that lead to significant underuse of some frequencies others would love to use. The solution? A part from just abandoning property rights (in the right situations), it is not clear to me what could be done.

How to measure governance

There is now a cottage industry trying to measure how well countries are governed, in particular how bad corruption is, or how well the rule of law is imposed. These indicators are important, they can determine where foreign direct investment is taking place, whether development aid is disbursed, or whether policy reform has been successful. Thus, it is critical that governance be well measured.

Charles Oman and Christiane Arndt point out that most measures are based on perceptions, which are notoriously biased and difficult to change in the face of hard facts. But their is also substantial danger in that users tend to misread these indicators. For one, they are not precise and should only be interpreted as giving a rough picture. Even when intervals of error are provided, they are often ignored by users. Second, international comparison is difficult because the sources used to construct the index differ widely from one country to the next. Third, a single index is used for many different purposes, and each of those purposes should weigh differently the components of the index. Finally, there is no theory that tells us how to scale the measured before or during the determination of a governance index. And let us not forget most measures are subjective, as they are based on opinions. It frightens me when such an index is used in a regression, especially without any robustness test.

Football has an impact on college quality

US faculty members are currently quite frustrated with sports programs on their campuses as the swallow substantial budgets at the expenses of academics. Very very programs yield a profit, even (American) football is in deficit save for a handful of colleges. And coaches get salaries that are completely disproportionate to the academic mission of universities. Then why are universities willing to invest all this money in sports? The standard answer that this builds alumni loyalty cannot be good, as they typically donate to the athletic foundation, which is run independently from academic budgets. The only advantage, so to speak, are that they reduce the deficit that needs to be covered by academic funds. Another argument is that it attracts better students. I can believe that for some sports, where student athletes are better than the general student population. But there should be better ways to attract good students, like merit scholarships.

Sean Mulholland, Aleksandar Tomic and Samuel Sholander claim that even the football program improves the academic quality of the student body. It is not that the football player are academically gifted, they are certainly not, but it is all about attracting other students. Their assessment is not based on actual fact, but rather on peer evaluation of faculty and university administrators, as they are records in the US News and World Report college rankings. And the better a sports team is, also from peer evaluation by football coaches, the better is the academic reputation of the student body. Now that the rumors have been established, it would be good to back this up with facts...

Maximizing the Human Development Index

We all recognize GDP per capita is far from a perfect measure of wellbeing in an economy, hence the Human Development Index (HDI) was developed. It aggregates indicators of health, education and income. The idea is to evaluate how well an individual can function in such an economy. But the elaboration of the HDI did not follow any formal theory in the selection of the precise indicators and their weighting. So what about doing the reverse: take the HDI seriously in theory?

Merwan Engineer and Ian King use a standard growth model, calibrated following Mankiw, Romer and Weil, and look for what it takes to maximize the HDI. And they find massive overinvestment into physical and human capital, which saving rates so much higher than what the Golden Rule would call for that consumption is almost reduced to zero. Because consumption is not part of HDI! That looks a crass oversight, as we generally assume, correctly I think, that people care about consumption for their standard of living.

Employment protection and migration

One big big aspect of resistance to immigration has to do with how immigrant might exploit social safety nets. One of them is employment protection. Thus a natural question is to ask whether emigrants choose to move to countries where jobs are better protected. Theoretically it is not that obvious, as employment protection tends to depress wages, as workers bear the cost of protection, and reduce the probability to find employment, but it could also go the other way if it leads to higher bargaining power for workers.

Rémi Bazillier and Yasser Moullan try to sort this out empirically and come to the conclusion that it is really the protection differential between sending and receiving country that matters: migrants like to enjoy the same kind of protection as at home. This is particularly the case for high-skill workers, the ones you actually want to attract. Finally, Bazillier and Moullan also find that employment protection in receiving countries matters more than in sending countries.

Why is the Chinese savings rate so high?

The current global imbalances, at least those between the US and China, are only possible because China is currently saving a historically high share of its income. Various theories have been advanced to explain this surge in the savings rate: 1) Economic reform has increased household-level uncertainty and thus precautionary savings. 2) Forces have shifted from consumption-oriented households to savings oriented businesses. 3) Demographics and the life-cycle combined with the growth in income lead currently to high savings rates because savings change through the life cycle and thus fluctuations in the dependency ratio become important.

As Carl Bonham and Calla Wiemer point out, the savings rate has not been uniformly high and is in fact consistent with the changes in the dependency ratio. The savings rate increased through the 1980s to peak at 41.9% in 1995, then "bottomed" at 37.7.% in 2000, before surging back to 51.4% in 2008. The current global imbalance occurs in part because, unlike before, investment rates are restricted by policy, and stand at 43.5%. A modest decrease in the savings rate can rebalance things.

To test the three theories against these staggering numbers, Bonham and Wiemer use a structural VAR and determine the latter one is the most important, while the others cannot be dismissed. I am not particularly fond of VARs to test theories, they should rather just describe the data, but the evidence is quite compelling in this case. Of particular interest is that one can forecast the savings rate, as the dependency ratio is quite predictable. And this forecast shows that Chinese savings rates have peaked last year and will decrase quite significantly over the next decade. If true, this should reduce considerably the pressure on China to do something about current imbalances.

The Dalai Lama effect on international trade

Since the Nobel Peace Prize was announced this year, the Chinese government has been putting heavy pressure on many foreign authorities to prevent them from showing up at the award ceremony. China has been in particular been using the threat of trade sanctions to ruin the party of Liu Xiaobo. Is this effective?

Andreas Fuchs and Nils-Hendrik Klann note that China is a regular with these tactics, but regarding contacts with the Dalai Lama. Are those threats carried out? Using a gravity model, they find exports to China have been curtailed after high-level visits only recently, and this effect vanishes after two years. This is quite interesting, as it confirms the existence of a "Dalai-Lama effect." But I wonder how this effect could appear at a time where the Chinese government has less control over imports with the liberalization of the economy. Is it that it cares that much more about the Dalai Lama?

Are military expenses good for growth?

It is obvious that federal fiscal deficits will have to be addressed sooner or later in the US, and seeing how difficult it is to raise taxes, one has to think about how to trim expenses. Of course, the biggest line item is defense, and one can ask what the consequences of cutting these military expenses could be. Critics of those cuts will point to WWII, where the military build-up has pulled the US out of the Great Depression. While I do not quite agree with this interpretation of this anecdote, it is worthwhile to study more generally the impact of military expenses.

Giorgio d’Agostino, Paul Dunne and Luca Pieroni do a literature review and note that out should not just look at the direct impact of expenses. Indeed, a military build-up is also more likely to generate conflicts, and after all a conflict is overall a waste of resources as much effort is spent blowing physical and human capital to pieces. The multiplier argument is also rather vacuous, as these funds could be used for other purposes as well with higher multipliers, in particular when you compare wars in foreign lands versus infrastructure at home. The same applies to the argument that military research has some positive impact on civilian technology (why not simply focus research on the latter?).

This clearly makes it difficult to make a case that military expenses are good for growth. Empirical work is really difficult, like so often with cross-country growth regressions, but d'Agostino, Dunne and Pieroni conclude that the evidence tends towards a negative impact. The only ones that obtain positive impacts are those that include supply-side effects, and those are of course rigged to provide a positive impact.

Money demand: financial adjustment cost, not cash-in-advance

I find monetary models very frustrating. While there is empirical evidence that money is not completely neutral over the range of a couple of years, theory has so far not come up with a believable way to understand why this would happen. The models that come closest have completely outrageous assumptions, such as the infamous Calvo pricing hypothesis I was venting about just a few days ago. This is usually accompanied by money-in-the-utility-function (sure, we all love to walk around with a lot of cash) or with the cash-in-advance constraint. Let us consider the latter a bit more closely.

Essentially, this constraint assume that households have to carry cash for some purchases. Often these models are calibrated to quarterly frequency, because this is what the data bears. This implication is that people have to carry cash for all their purchases in the next three months! How reasonable is that? Or the constraint is imposed on firms for their investment or wage payments, which about as outrageous. Yet, cash-in-advance is used all over, either blindly or because it easily generates a money demand. Of course, as people are forced to demand money.

What monetary urgently needs is a better theory of money demand. People hold money in small amounts because it facilitates transactions. They also hold some as a store of value, as any principles of economics student can recite. But this is not a good solution, as money is dominated in return by almost any asset. People hold money due to some frictions on financial markets, and these holdings are temporary. Now having both these features makes it difficult for the model builder. Which one is more relevant?

Xavier Ragot tells us financial frictions are. For one, looking at data, the distribution of money across households looks much more like the distribution of financial assets than that of consumption. He tries to match both distributions using a model with cash-in-advance for consumption (slightly modified to account for the fact that the rich can buy more on credit), a fixed cost for financial transactions, borrowing constraints and idiosyncratic shocks to household productivity. The model has two degrees of freedom to match the distributions of money, consumption and financial assets: the fixed cost for adjusting your portfolio and the transaction technology parameter from the cash-in-advance constraint. Two values are then obtained, and by turning each of them to zero, Ragot concluded that 85% of money demand comes from financial frictions, and 15% from cash-in-advance transactions. Conclusion: if you want a simple model of money demand, do not rely on cash-in-advance.

How to manage rents from non-renewable resources

Some countries are blessed with natural resources, although this turns too often into a curse as rent seeking can turn the economy into a corrupt hell-hole. To make things worse, this type of revenue is highly volatile and there is much incentive to extract rapidly with little thought for smoothing income or investing for the future. Hence, international organizations have pushed very hard for a more sensible management of resources incomes, and their advice has been to extract or invest income in a way to obtain a constant permanent income.

Anthony Venables thinks this is not appropriate for developing countries that have pressing needs right now, like poverty alleviation or a shortage of public infrastructure. In addition, one has to realize that sustained growth is not going to come from the public sector, but through private investment. And making private investment worthwhile can be helped by good, but limited government. This Venables thinks that revenue management should put more emphasis on current expenses than future ones, in order to make sure the country get out of a development trap and can continue growing on its own latter, with relying on its resource income.

PS: the paper's abstract was much more intriguing that the paper turned out to be. The reason is that the abstract make promises about the proper management of income from renewable resources, which would seem much less problematic, unless I was missing something.

On the consequences of slavery

I reported now long ago on the consequences of slavery in Africa, where it is shown that countries where more slaves were taken still have lower levels of development. It is quite amazing that this can have an impact on average income for so long. But what about the receiving end of the slave trade?

Graziella Bertocchi and Arcangelo Dimico look at county data for the US and find that current average incomes are not related to the inflow of slaves. However, income inequality is. Why would that be? It could be because slave could not own land, and this still has an impact today. Or it could be because of discrimination. Or it could be because of persistent differences in human capital.

Now using a panel data set, Bertocchi and Dimico find the last one is the most likely one. The education gap between blacks and whites has never recuperated, and segregation was certainly part of it. But this strongly persistent effect means that affirmative action still has a reason to be.

Price rigidity all wrong

Much of macroeconomics, and in particular New Keynesian Macroeconomics keeps relying on price rigidities to get anything monetary to have any relevance. That is not necessarily bad, but it becomes problematic when this is implemented with Calvo pricing which essentially states that no matter what the state of the economy or how long ago a firm has last changed its prices, firm change their prices with the same probability. This is an utterly ridiculous assumption against which I have already railed often, but people keep using it because it is analytically convenient. I am still looking for a good model of price rigidity, beyond the ones already discussed here. (Previous posts: I, II, III, IV)

The latest candidate is by Paul Middleditch. When I saw the title, A New Keynesian Model with Heterogeneous Price Setting, I was very hopeful to finally see a NK model where firms are heterogeneous and decide when and how much to change prices, leading to fluctuating proportions of price changing firms. My hopes were quickly dashed. The heterogeneity here is simply that there are three types of firms, each blindly obeying to a different Calvo probability. Nothing to see here.

Financial development and fertility

Why an economy's financial development matter for its fertility? For one, if there is little in terms of savings technology, then households need to find other ways in which they can save for old age, and children have traditionally been a good way to do this. But as long as property rights are reasonably well established, this should be that important, as there are many ways beyond financial assets to accumulate wealth, such as land, real estate, jewelry and cattle. Where a financial system can really bring change is when it gives access to credit for households.

Valerio Filoso and Erasmo Papagni study this with a life-cycle model where there is altruism from parents to offspring and vice-versa. They show that all depends on whether children are an inferior or a normal good, like in poor respectively rich countries. In addition, a relaxation of borrowing constraints allows greater investment in children. There is therefore ambiguity, which is compounded by price and second order effects. To sort it all out, Filoso and Papagni use cross-country data to estimate the sum of all these effects and find indeed that financial development decreases notably fertility in poor economies and increases it in rich ones. This may be an explanation for a fact that puzzled me for some time, why the US has a higher fertility than other rich countries.

Being rationally agnostic

What religion should people adopt if there is uncertainty about the existence of deity? If there were only one choice, to believe or not in a god, the choice would be rather simple as Pascal's wager taught us: believe in the god just in case he turns out to exist. Things become a bit more complex if one has also to choose in which god to potentially believe. First, the fact that they are multiple candidate gods means all but at most one may turn out to be frauds, and choosing the wrong one may have serious adverse consequences. What to believe then? Luckily, economists have you covered.

Tigran Melkonyan and Mark Pingle use decision theory to come to the conclusion that agnosticism, which is to not take a stand, is an optimal choice if any combination of the following hold sufficiently strongly: 1) in-life benefits of agnosticism are higher than "other" religions, 2) the after-life benefits of agnosticism are not too much lower, 3) none of the religions is very likely to be correct, 4) life is not too long or too short, or 5) transition costs from agnosticism to a religion are lower than between religions. These all make intuitive sense, except the fourth, which has to do with the fact that if life is short, you want to believe in a god right away. If life is still expected to be long, you want to believe in no god. Agnosticism is in the middle, where you postpone a choice when you can afford to do so.

It would thus seem that many more people should be agnostic then there are (1-10% in the US). Why so? I would think this has to do with the fact that we do not make such choices from a clean slate: we are conditioned by the environment we grew up in, and kids are easily impressionable. Once they have been told to believe in a particular god, switching to agnosticism is very difficult: you face the disapprobation of the immediate family and peers. But their is also the fact that in any situation, it is very difficult to change the opinion of a person, even if the person is wrong. We are all conditioned that way, and while we easily adopt a first opinion, we rarely change it. This inertia will keep agnosticism, and atheism, a minority in the US for a long time still.

A balanced budget in the US constitution, really?

Europe and the United States are a story of contrasts these days. While the Obama Administration is pushing for fiscal stimuli at the cost of large deficits, Europe is severely putting the brakes on its public expenses to bring public budget back in order. This is quite ironic, as European governments have in the past used public deficits quite liberally, while the US has always been wary of deficits, and most US states in fact have balanced budget requirements. This makes the proposal that the federal government adopt a balanced budget amendment a hot topic again.

Marina Azzimonti, Marco Battaglini and Stephen Coate use a political economy model to contrast the short time costs of the debt reduction (with lower public services and higher taxes) against the long term benefits of a lower debt burden and the long term cost of higher volatility in tax rates and public services.

In such an analysis, the first order of business is to establish why the Ricardian Equivalence would fail in a quantitatively meaningful way. If it does not, then deficits do not matter as they internalized as future taxes by all agents, and a balanced budget rule has no impact. My reading of the literature is that there certainly no agreement, but overall we are not that far away form the Ricardian Equivalence. Well, let us assume it does not hold, because labor income tax is sufficiently distorting, as Azzimonti, Battaglini and Coate implicitly assume. They also calibrate the model to the US, which is quite tricky as one needs to take a stand on the utility of public goods.

This is where the paper becomes rather strange. At least at the state level, a balanced budget rule is usually thought to be challenging because income and expenses vary with the business cycles. This is not the approach taken here, whereas the fluctuations stem from changes in the taste for public goods. The authors' argument is that one needs to distinguish normal times to unusual times where the government wants to spend massively more, like wars. I do not think this is the real issue. If wars are the problem, then an amendment to the rule can be that properly declared wars can be financed with war bonds.

Well, let us assume this is what we want to care about. The quantitative analysis indicates that a balanced budget rule would indeed be beneficial in the long run, because it imposes lower taxes, and thus less distortions, which are more valuable than the missing public services according to the calibration. But one must point out that there are serious costs in the transition, as one starts with rather high levels of debt. But these transition costs cannot be evaluated with the present model, as it does not feature growth and thus cannot take into account the debt/GDP ratio declines naturally as an economy grows. All in all, I am not sure what we learned with this paper.

How to compensate the short-lived

It is very unfortunate if you die early, and knowing this it would be optimal to compensate you for this misfortune. But this is difficult to achieve as your death is not predictable, and compensation after death is not very helpful to the deceased.

Marc Fleurbaey, Marie-Louise Leroux and Grégory Ponthière have figured out a scheme that would achieve this. First, they need to define a social welfare function that would make it desirable to compensate people for shorter lives. Second, they find a policy that would achieve such a compensation. The policy is to essentially cancel social security while putting the mandatory retirement earlier.

Basically it is all about getting people to consume early, so that the different between being dead or alive is not that large later in life. This seems very difficult to achieve given that life valuation studies indicate that people value life at a multiple of consumption. Furthermore, if we discourage people from saving that much, this must have large negative consequences for the accumulation of capital in a macroeconomic sense, something that has been neglected here, and should not.

The welfare gain from age-dependent taxation

There is now a substantial body of literature that advocates for tax rates that would depend on the age of the individual. The logic is simple: the dispersion of wages increases over age, thus the scope for redistribution increases. And if you want to encourage human capital accumulation, you want to tax high incomes more when young than when old. And the uncertainty about outcomes decreases considerably with age. Finally, the source of income varies over time, with capital income taking over labor income at retirement. And, by the way, I previously reported that age-dependent taxation could allow a transition from a pay-as-you-go social security system to a fully funded one.

Spencer Bastani, Sören Blomquist and Luca Micheletto add to this literature in two ways: first they take into account within cohort heterogeneity, second they quantitatively evaluate the welfare gain from a linear age-dependent tax on income. In their overlapping-generation economy, agents face uncertainty about future outcomes and can save. They find that one does not need to tax capital, which is very useful as one does not need to worry about incentive compatibility (it is difficult to lie about one's age) when trying to reach golden rule capital accumulation. Calibrating to Sweden and the United States, they find that a nonlinear age-dependent income tax provides a welfare gain corresponding to about 2-3% respectively 2-2.5% compared to an age-independent one. That is certainly not negligible.

And how the taxes look like? The marginal labor income tax rates are decreasing. That is consistent with this model, as one tries to increase the savings rate to the golden rule level and savings should be encouraged. And the old are systematically paying higher labor income taxes than the young at the same level of income. This is because, I think, capital income taxes are then much lower, and older workers have much more capital income. I wonder how this would look like if human capital accumulation were included as well...

Mergers and tax competition

With increased mobility of labor and capital, Europe is currently struggling with tax competition that keeps taxes lower than is deemed healthy, in particular because of some small entities trying to poach on larger ones by attracting the larger tax payers. A response to this problem would be to merge fiscal authorities so as to reduce competition and thus get higher taxes and also allow a fairer distribution of the tax burden across jurisdictions. While this is not (yet) feasible at the European level (there is no talk of a European tax), there is plenty of evidence of within country mergers. What are they expected to bring?

Marie-Laure Breuillé and Skerdilajda Zanaj note that mergers have not only an impact on regional tax rates, but on local ones as well. Mergers are expected to a) reduce tax competition, b) increase tax bases and c) take into account tax externalities of cities. The impact on tax rates differs, however, by level: regional taxes increase, while local ones decrease. That seems like a trivial results, as mergers are suppose to reduce the influence of local jurisdictions. The tax changes are direct consequences of effects a) and b), but c) counteracts it, and an ambiguity may arise. But it turns out from the Nash equilibrium of the game the regions play, c) is always smaller than a) and b). The impact on welfare, though, is difficult to establish before first saying something about public goods and tax distortions. Indeed, some level of tax competition is not always bad.

Privatization-nationalization cycles

The past two decades have seen an impressive wave of privatizations all around the world, especially in utilities and resources. This trend has recently been reversed though, with several large nationalization waves, in particular Latin America. This kind of cycle is not new, as especially the gas industry has gone through several waves each way during the last century. Why all this back and forth?

Roberto Chang, Constantino Hevia and Norman Loayza observe that nationalizations typically happen when the price of the output of reference is high and inequality of wages is also high. The opposite is the case for privatizations. They can explain this with a model of a benevolent government that maximizes a social welfare function represented by the average utility of workers. Under nationalization, all workers are paid the same and exert little effort. Under privatization, firms can discriminate workers, who then put more heart at work, creating wage differentials. When prices for the commodity increase, this generates larger rents for the most productive, and inequality increases.

The story is then of a inequality-efficiency trade-off for the government. In the naturalized state, inequality is low, but so is efficiency. If prices are low, it is more important to increase efficiency, and the firm is privatized. But as it becomes more efficient and discriminates its workers, inequality becomes more important, and the firm is nationalized back. And the cycle continues, with an average of 12 years of privatization and 25 years for nationalization. While this is a very stylized story, after all the model assume an economy with a single sector that has no impact on world prices, it is still a compelling story.

Online dating and the business cycle

During an unemployment spell, people spend significantly more time on leisure and may thus be more interested in social activities like dating. It is simply a matter of available time. But for those who suffer from a reduction in wages during a recession, things are not so clear: the income effect would lead to a reduction in leisure, while the substitution effect would favor an increase. And this interest in dating is not trivial, as 10% of people in the US a registered with an online dating service at any time, while this is 18% in Europe.

Véronique Flambard, Nicolas Vaillant and François-Charles Wolff point out that this ambiguity is even stronger with the demand of dating services, as some would want to find more solace in a partner during hard times, while other feel less secure in dating. The impact of a recession on dating services thus needs to be sorted out empirically. They do this for France with a short monthly times series on economic sentiments, an indicator of dating services (searches for a popular online service on Google) and lagged fertility (as a proxy for those leaving the dating market for good). I am not completely convinced that 56 months of data are sufficient to capture what happens over business cycles (of which there is only one in the data), but let us take this seriously. Using a VECM using four lags (thus we are down to 41 degrees of freedom, they find evidence that dating services demand increases during a downturn. That should hardly surprise us given the impact of the unemployed. Using microeconomic data that distinguishes between the employed and the unemployed would have delivered more interesting results. In fact, using more direct observations of what is to be measured would make results credible.

Marginal returns of education policies

It is well-known that the returns to education are high, higher than financial returns in fact. Especially for primary education, estimation of Mincer equations has yielded returns over 12% a year, returns that decline somewhat with additional years of education. These are personal returns, that is, how much one's wage increases with an additional year of education. This indicates that one should choose more education than less. From a policy point of view, it is, however, not clear that one should try to stretch as much as possible education. Indeed, higher education is more costly and its returns may differ by individual.

Pedro Carneiro, James Heckman and Edward Vytlacil address this heterogeneity by estimating returns from the National Longitudinal Survey of Youth of 1979. They are certainly not the first ones to do so with this dataset, but the innovation is in the use of instrumental variables. Indeed, they identify a serious shortcoming in interpreting the latent (Corr: local) average treatment effect because the people induced to go to school by a change in an instrument may not be the same that are induced to go to school by a given policy change. As a consequence, the returns for the two types of people can be quite different, and they are in this case. They improve the estimation technique by identifying what sections of an economically interpretable mean marginal benefit surface are identified by different instruments.

Carneiro, Heckman and Vytlacil conclude from their analysis that returns of higher education differ indeed from individual to individual, and in a way that is highly predictable by both the econometrician and the individual. In other words, people who sort themselves into higher education are those who have already experienced high returns and are likely to experience high ones in the future. This indicates that with current policies the right people go to higher education, and that encouraging more to go to college would not yield returns as high as for those who already go there.

Irregular phenomena and the macroeconomics research agenda

Many see the Great Recession, as it is now called, as a dual crisis: an economic crisis and a crisis of economics, and more specifically macroeconomics. We have lived over the past twenty years or so through a period of remarkable economic stability, which also got a fancy name, the Great Moderation, and which gave us the illusion that this stability was to last. The fact that substantial recessions are still possible is a rude awakening, in particular because this one is worse than usual. And economists are the prime suspects because first they did not see it coming, and second they did not know how to react to it.

This is a view that is shared by Alessandro Vercelli who, like others, claims that macroeconomics has had a research agenda that was fundamentally flawed because it only studied regular phenomena, and not irregular ones. Indeed, the real business cycle agenda was centered around model economies in general equilibrium at all times, economies designed to replicate salient features of past data.

Hindsight is always 20/20. The research agenda should have focused on including more features about interbank relations, creation of new assets, moral hazard and adverse selection. But one has to understand that it is very difficult to think ahead what could happen and it is easy to criticize after the fact, and especially without offering alternatives. In fact, the DSGE agenda is remarkably well suited to address new situations: it is based on fundamentals, and these micro-foundations allow to study policies and situations not observed in history. This is something the previous agenda largely based on reduced forms could not address without considerable hand-waving (remember the Lucas Critique?). And if you look at the papers written nowadays, macroeconomics seems to have picked up the ball very nicely.

At first, macroeconomists did not have answers ready, or rather they did not have the answers that politicians wanted to hear, namely that something needed to be done. In the face of a crisis, every politician wants to do "something" to show "action". If the economist says that that one should let nature run its course, that one has to bite the bullet and let some banks fail, in particular so as to avoid future moral hazard risk, then the politician will bypass the economist and fall back on the first one that will satisfy him, and he is Keynesian.

Macroeconomics did not suddenly turn Keynesian, politics did. And doing so it compounded the problem and then lead to a crisis of Keynesian nature where nobody trusts anybody and aggregate demand is seriously lacking because nobody in the economy dares to invest due to huge policy uncertainties. Is the central bank still independent from the politicians or not? Seeing Bernanke and Paulson go hand in hand to testify to Congress was the worst possible image of this crisis. What is up with fiscal policy? Are the public deficits going to be taken care of through major tax increases or inflation? The policy prescription seems quite simple: decide once for all, should some courage to impose your policy and be done with it.

US house prices have to fluctuate more than elsewhere

In retrospect, the recent swing in house prices in the US a unusually large by international comparison. And it is not just the last swing, if you look at local markets, there have been many episodes before the current one where house prices went through a wild ride up or down. What is so special about the US? Is it irrational exuberance, like Robert Shiller has claimed? Or does this have to do with some characteristics of the US economy?

Nobuhiro Kiyotaki, Alexander Michaelides and Kalin Nikolov design a life-cycle DSGE model of the house market with land and mortgages. There is also capital that is used to build residences on land, as well as commercial real estate. The interest rate is exogenous, which allows to observe what happens when the world interest rate changes. It turns out that real estate prices then fluctuate more if land is a larger share in it value. The same happens with fluctuations in productivity. Why is that so?

The reason is a change in fundamentals leads to large reallocations towards real estate. If land is plentiful, so you want to use it, but this requires large amounts of capital to build all those houses, and in the meanwhile house prices go up. Things are much smoother when land is less important for real estate, like it is in Europe. And interestingly, the downpayment to obtain a mortgage has no impact on this volatility of prices, countering some recent claims.

Academia vs. university

I have recently opined on the status of academia, and I am more pessimistic about the survival of the current model in the United States than in Europe, in particular with respect to their research and teaching missions. I find it interesting to see that Bruno Frey seems to share some of this pessimism. But for somewhat different reasons.

Frey longs for the old model where the university is an untouchable and well-funded institution where academics spend their day thinking about research with little regard to what happens around them, While I think some ultra-talented researchers should have such privileges, this does not apply to the very vast majority of current university faculty whose research contributions are very marginal at best. While it important that they carry out research to get their teaching current, research should not be a resource draining focus.

Frey is afraid that his utopia of university is falling apart not because of market forces and costs, because of internal governance. He complains that research is nowadays too specialized. I am afraid this is unavoidable at the frontier, yet in Economics it is probably the least so as many publish in very different fields (and even outside of Economics). I agree with him that there is too much pressure to publish in mid-range universities where teaching should be the focus. He also claims that academia is rife with fraud, something I cannot testify to, but maybe I am naive. He finds also that academia is withering because universities admit too many students (I fully agree) and because people do not need to network within a physical university location to conduct research.

But the main reason for which academia is falling apart is, according to Frey, the emphasis ("mania") on rankings. While I agree that rankings are abused, they have a major justification: holding the university and its members accountable. Every university can (and does) claim it has the best teachers and researchers, but rankings put some realism in this. But what surprises me most in Frey's claim is that he is himself ranking obsessed to the point of venturing in unethical behavior. Indeed, he is managing editor (with his brother) of Kyklos, an old journal that has considerably lost in reputation. To improve its impact factor, he requires that accepted papers cite other articles from Kyklos...

The impact of Oprah's book club

It is well known that celebrity endorsement can have a very significant impact on the sale of products, and nowhere is this more true than with the Oprah Winfrey book club. If Oprah endorses a book, not only club members buy it en masse, but also non-members who see the endorsement on television or in the New York Times. But the spill-over does not stop here.

Indeed, Eyal Carmi, Gal Oestreicher-Singer and Arun Sundararajan show that when potential buyers go to Amazon.com to make their purchase of their endorsed book, they are presented with recommendations, which they may also buy, and then get further recommendations. It turns out that these recommendations are followed quite a bit, which generates something like a network contagion effect. The authors find that over several days after the endorsement, such a contagion effect can be significant through five levels. I would have expected this to happen when an academic click through a literature by looking at a paper's references and citations, but I would not have expected this to be so important for laypeople purchasing books, especially within days.

Was Malthus wrong about mortality?

One of the critical assumptions in the Malthusian model of growth that the mortality rate depends inversely on the standard of living. While this is not that obvious to replicate with data we have from Malthus' times, such a relationship ship is even more difficult to establish for previous centuries.

Morgan Kelly and Cormac Ó Gráda have dug up some inheritance records from England which allowed them to link wealth and age of death. What they find is quite interesting: all strata of society where affected by agricultural conditions. So if there were some poor crops, rich and poor were more likely to die. This fits right into the Malthusian model where the aggregate standard of living matters. The only subtlety is that the rich die a little later. Indeed, the authors do not attribute this mortality to hunger, but rather vagrancy following some poor crop that spreads epidemics. But such a relationship seems to have disappeared by the 17th century, which the authors justify by government intervention to help the poor. This makes it unclear why Malthus made it such a crucial component of his theory.

Starve the beast?

The Republican strategy in the US has been since Reagan to starve the government to prevent it from growing. The master at this has been Bush Jr., who to significantly increase expenses while cutting taxes. And the new crop of parliamentarians has vowed to make these tax cuts permanent, thus forcing even further government expense cuts in the near future. While there can be much disagreement about where to cut, one could first ask whether it is a good strategy in the first place to starve the beast like this.

Michael Kumhof, Douglas Laxton and Daniel Leigh use an elaborate model to come to the conclusion that this is a good strategy if government expenses are useless. But if they provide a public good, then it is not. That seems like a very trivial result, and one that can explain the disagreement between the left and the right in the United States. But there is more to the paper. It shows that for this strategy to be welfare enhancing, cuts need to be done very quickly, and cut services must have little impact, and the taxes that are reduced must be very distortionary. It is very unlikely that all three conditions can be satisfied.

In the pretense of protecting me, Emerald stiffles my research

I received a rather unsettling message from Emerald Publishers the other day:

As an Emerald author, you will know that Emerald is dedicated to protecting the copyright of your work. For this reason, we use the Attributor service. Attributor automatically searches cyberlockers for unauthorized copies of works or illegal hosting and then issues legally-binding takedown notices. We are increasing Attributor's searches to the full breadth of the internet, to ensure maximum copyright protection.

For this to run as smoothly and efficiently, we are asking that you provide us with (if applicable):

1. your personal website address
2. your institutional website address
3. the website address of your company

This is so we can exclude these sites from the Attributor searches, whilst protecting your copyright. Upon provision of this information, we will of course ensure full data protection.

We look forwards to hearing from you.

I find this very disturbing. This message is telling me that this publisher is trying to enforce my copyright while in truth it is the publisher's copyright. And it tells me that I better preemptively alert the publisher where I apply the fair-use provisions of copyright before I get automatically accused of violating copyrights on my own work.

Now looking at Emerald's Author Charter, I find another few gems:

Assigning copyright of your work to Emerald allows us to act on your behalf to:

* promote your rights
* facilitate dissemination of your work by granting permissions for educational use or republication
* target other Emerald journals whose readership would benefit from access to your work
* endeavour to protect your work from any infringement of your rights which are brought to our attention.

It does NOT, in any way, restrict your right or academic freedom to contribute to the wider distribution and readership of your work. This includes the right to:

1. Distribute photocopies of your own version of your article to students and colleagues for teaching/educational purposes within your university or externally. Please note, this does not refer to the Emerald branded, published version.
2. Reproduce your own version of your article, including peer review/editorial changes, in another journal, as content in a book of which you are the author, in a thesis, dissertation or in any other record of study, in print or electronic format as required by your university or for your own career development.
3. Deposit an electronic copy of your own final version of your article, pre- or post-print, on your own or institutional website. The electronic copy cannot be deposited at the stage of acceptance by the Editor.

Note that Emerald may publish your article in another journal, if it thinks it increases its dissemination (or increases the impact factor). Nothing is said about the author agreeing to it. But Emerald is also fine if you try to publish your article elsewhere, although the condition of "for your own career development" is open to interpretation.

That said, all this business with copyright on academic research is really sad. These commercial publishers try to tell us that they do their possible to disseminate research while all they is the exact opposite: they gate the research and chase down ungated versions. Let's all move to open access. Much simpler, much less costly, and much better dissemination!

Public pensions should not be fully funded

Many governments are currently struggling to fund the future liabilities stemming from the retirement benefits of their civil servants. For many of those, the fact that they are significantly falling behind, especially as those funds lost value during the crisis, is seen as a very serious problem that could jeopardize those commitments and/or lead to significant tax hikes. But is this really a problem?

Henning Bohn claims that it is not necessarily so. First, most taxpayers are debtors, thus they would prefer not paying taxes now for future pension payments, as they discount at their borrowing rate, which is higher than the return of the pension funds. The violation of the Ricardian Equivalence thus stems from the intermediation costs. This means that governments should actually not fund at all their future pension liabilities. The only exception may be if they need those funds for collateral, which may be quite important in the case of sovereign debt, as I reported recently.

An unexpected consequence of crises: birth weight loss

Periods of crisis generate hardship, in particular if people do not have good ways to insure against these kind of shocks. In theory, temporary losses in income should not have much of a permanent impact, but in practices they may. For example, losing a job entails a wage loss in the next job, because one may have lost human capital, firm specific skills or good outside options. And those wage losses are quite persistent.

Carlos Bozzoli and Climent Quintana-Domeque identify a different persistent effect of a crisis by looking at Argentina. They notice that babies born around 2002 have had a birth weight 30 grams lower than usual, a non-trivial difference that corresponds to a difference between the US and Pakistan. Now, birth weight has been identified to be a remarkably good predictor of future outcomes for a population in terms of health, education and income. Thus, the effects of the 2002 crisis could linger in Argentina for decades.

Pre-industrial revolution England did not grow, but was rich

Some people have an idealized image of the centuries before the Industrial Revolution, an image fed by pictures of elegant aristocracy and chivalrous knights. Others are more realist and see these times as a period of utter misery, filth and stagnation. Research on the standard of living in this period does not have conclusive answers because the evidence is sketchy and ranges from complete stagnation and misery à la Malthus to sustained growth. Gregory Clark has recently issued a pair of exciting papers that should set a few records straight, at least for England.

In the first, with Joseph Cummins and Brock Smith, he shows that England was surprisingly rich before the Industrial Revolution. This assertion is based on the fact the a small share of the population was engaged in farming. The primary sector accounted for 52% in 1817, and even 60% in 1560. These measurements are based on the occupations listed in men's wills and indicate that a substantial fraction of people living in rural areas were in fact not engaged in farming. Thus measuring the urban population share can be misleading in this respect.

In the second, Gregory Clark shows that there has been relatively little growth over these centuries, which means that way back in 1381, England was much richer than we thought. At that date, only 55% of the population was engaged in farming, based on records of the Poll Tax. This is very close to the number quoted above for 1817. Thus standards of living were not that different four and a half centuries apart.

Employer-based health insurance and growth

The United States, so far, is rather unique in that health insurance is typically provided through employers, and not all do. But whether an employer does provide insurance is an important consideration in the job decisions of employees. So this hurts labor mobility and the efficient allocation of labor. But what about entrepreneurship? This cannot be bad, seeing that the US is a global leader in this regard. Not quite.

Robert Fairlie, Kanika Kapur and Susan Gates use the Current Population Survey and find that people that do not benefit from health insurance through a spouse's employer are less likely to start a business. Also, those who are just a little older than 65, when coverage through the government sponsored Medicare program starts, are more likely to start a business than those a little younger than 65. Such an effect is not detectable for any other age.

I find it really strange that those who were most opposed the new health insurance regime were those favoring business interests. They should be happy that employer sponsored health insurance will not stand in the way of entrepreneurship anymore.

About envy

Homo Ĺ“conomicus is greedy, but why? One explanation is that he is envious, and this makes him competitive, leading to the positive outcomes of market economies that we often tout.

Not so fast, says Boris Gershman. Envy can lead to alternative equilibria, some virtuous, some vicious. We are familiar with the virtuous ones, where people "keep up with the Joneses", and thus exert effort towards getting better. Too much effort in fact. But things can also go dramatically the other way, where the best endowed people restrain their efforts to prevent the destructive envy of the poor. This suboptimal effort is likely to occur when there is large inequality and poor property rights.

This last point is important. For example, Russia right after the fall of communism came almost to a standstill because many were envious of successful people in a very negative way. The successful ones later overcame this by hiring their own security forces, a very inefficient use of resources. And this gave the opportunity to organized crime to take hold. Another example can be found in many developing economies where successful members of a family are expected to contribute significantly to the family. This lowers incentives for effort considerably.

There is now a lot of talk of how the increasing inequality in incomes and wealth could have negative consequences. While this paper shows that inequality will get reduced, it comes at the cost of having the most efficient in the society providing less effort than they would be willing to provide otherwise. Gershman suggests this can be avoided by protecting this elite more.

Why insist so much on political rights?

Last week, I suggested that democracy is not as good as many people think. I want to add on this that democracy should not be the first item on a list of priorities. In a broader sense. when the United Nations adopted the Universal Declaration of Human Rights, it put way too much emphasis on political and civic rights, and too little of economic rights. According to this document, having the right to vote is more important to have enough to eat.

But putting absolute priority on political rights, this Declaration and the ensuing foreign policies of most western nations have wasted precious resources in trying to impose democracy to countries that were rather longing for a better living standard. In particular, I find it obscene that western nations tell developing countries to democratize while at the same time denying poor farmers proper access to export markets by subsidizing domestic agriculture.

One has to recognize that there are trade-offs. Democracy and political rights should be enjoyed, no question about it. But the priority, at least to me, should be on a decent economic life. And even if it is not a priority to others, they should recognize that democracy and political rights should not be imposed at all costs.

Sovereign debt and the age pyramid

The papers about sovereign debt I come across always assume that the debt is held by some social planner who implicitly is acting on the behalf of representative and identical agents. But not all international debt is held by governments, and not everyone in a country has the same opinions regarding this debt.

Martín Gonzalez-Eiras deviates from this literature by including demographics, and in particular how there can be intergenerational conflict about the handling of debt. Obviously, reneging has different consequences whether you are young or old. He also looks at how outcomes can differ if the demographic structure of a country changes.

The paper highlights one interesting mechanism that should provide larger incentives to prevent default. Important transfers between generations are welfare improving, and they can further improved by having access to international insurance. This implies that these intergenerational transfers act as international collateral, and thus make it possible to obtain self-enforcing contracts. A country with a large retirement pension system provided by the state is this less likely to default and more likely to obtain gains in efficiency through participation in international insurance.

Public employees are better paid for a reason

You have heard the complaint before: public sector employees enjoy job security, large benefits and on top of that they are better paid than private sector employees. And this is particularly upsetting right now where the latter are asked to accept pay cuts and face the prospect of higher tax rates. Now does the complaint hold water?

Jeffrey Thompson and John Schmitt show that is does not. While it is true that public sector employees enjoy higher pay, looking at such big average is misleading. Indeed, civil servants are on average also better educated and older. If you take this into account and determine the wage premium for different levels of education across public and private sector workers in New England, Thompson and Schmitt find that civil servants are in fact paid 5% less than comparable other workers at the bottom of the wage distribution, 3% less in the middle and 13% less for high wage workers. If you just concentrate on education, those with at least an undergraduate degree face a 7% penalty in the public sector, while those who have just a high school degree get a 1.6% premium. In other words, there is a substantial compression of wages in the public sector compared to the private sector, and averages are lower, at least in part reflecting the job security premium.

Are we born altruistic?

Greed has been put forward a one the main reasons for the current crisis, yet there is plenty of evidence for altruistic behavior around us. In fact, plenty of experiments have shown that people are willing to share with complete strangers, because of some sense of fairness. There is also evidence, reported here recently, that altruism can differ quite a bit across populations. This raises the question of why altruism differs across people.


Kirsten Häger performs some experiments on seven to ten year olds in Germany and comes to an interesting conclusion: altruism is more prevalent among the older children, which would lead us to think that altruism is acquired. From casual observation on playgrounds, it is certainly so that toddlers are very egoistic and need to be reminded to share with others. Over the years, this idea seem to stick with them.

But if education is important for altruism, the there should be some explanatory power in socio-economic indicators, yet there seem to be none according to Häger. It then altruism not acquired after all, but rather something hard-coded that reveals itself as one grows up? Or is it something that one acquires not from one's direct environment (family and school), but from a larger environment? That would explain differences across societies.

Why do so few people buy long-term care insurance?

On a regular basis, my employer offers workshops and sign-up drive for long-term care insurance. I have never bothered with it, and I do not think any of my colleagues has. Yet, it makes perfect sense to participate: the likelihood that one needs long-term care, either with a visiting nurse or in a nursing home, is high and expensive. Yet, this is an eventuality that is so far away that it is discounted heavily from our minds.

Pierre Pestieau and Grégory Ponthière say the problem goes beyond this discounting. It is a multiple equilibrium situation. Currently, very few people buy this type of insurance, which makes it more expensive, hence few people buy it. If there were a larger market, it could be sustained by lower costs.

This seems to be a simpler explanation than what people have come up for the lack of an annuity market or one for reverse mortgages.

So, how large is the equity premium?

The equity premium puzzle is probably one of the most controversial puzzle in economics. For one, it is rather difficult to measure properly the equity premium, second the puzzle is about a risk aversion parameter that is itself difficult to measure, and third the literature is pretty much all over the place.

Casper van Ewijk, Henri L.F. de Groot and Coos Santing perform a meta-analysis on the topic: they gathered all the papers about the equity premium they could, could the premises and the results and tried to make some sense from all this. They conclude that the equity premium tends to disappear with time and development, and with lower GDP volatility. Thus is should be normal that the equity premium kind of vanished during the Great Moderation. Now get a theory to replicate this. Assume that financial markets develop as time goes, and you can easily obtain a reduction in the equity premium in any sensible model. No need for strange preferences, complex arguments about taxes, or large improbable events.

That said, the equity premium puzzle is about the size of the premium, not how it changes. But given the fact that it seems to be shrinking, the puzzle may soon be moot.

Is democracy really worth it?

The empirical evidence on the economic impact of democracy is really mixed. While the literature tends to show that democratization is good for the poorest economies, the opposite is true for rich ones. My hunch is that the poorest economies are in such a state because of massive mismanagement, in particular corruption, and a democracy can avoid the brunt of this.

But for a rich country, why insist on democracy? Look for example at the Southern European countries, where reforms are very obviously necessary, their pension systems come first to mind. Yet, governments have a very very hard time wringing these reforms through and may even fail to do so. The public is easily manipulated and governments have to give in for their own sake.

Look also at the United States. Elections there are now determined by who can hammer the most frequently his version of the facts on televisions ads, with the media failing to fact check anything because it needs all this ad revenue. This is populism to the extreme, nobody bothers to explain trade-offs and politicians on both side advocate impossible policies. The realist has no chance.

What is the solution? A benevolent dictator would be ideal, but how to make sure the dictator is and stays benevolent? Or maybe the problem is really with representative democracy, that is politicians depend on popularity contests for their livelihood and those contests are easily rigged. A solution then could be direct democracy, which gives much more responsibility to the electorate, who may they seek to get more educated about issues before voting. But this could also go horribly wrong if it fails to do so.

I am really torn. But I am sure about one thing: democracy is certainly not the panacea civics textbooks seem to teach.

Why should marriages be eternal contracts?

Risk sharing contracts are good contracts, and they can have an important welfare benefit. However, it is not quite clear that these contracts should be valid for a life-time. Indeed, this is what marriage is. Aside from the fact that these contracts are restricted to be signed between people of opposite gender, one can also question why not more people could be included in them. That would be good risk diversification. The problem is that a marriage contract is not just about risk sharing (and for that we have a market for insurance contracts nowadays), it is also about limiting sex choices and commitments to supporting children. But all this could be achieved without marriage.

Anyway, Stefania Marcassa and Grégory Ponthière ask whether marriage contracts should be eternal and find that in most cases they should not. Their argument has nothing to do with risk and uncertainty, rather with declining match quality and unequal bargaining power. Indeed, when one potential partner has little bargaining power, marriage gives an important veto power. But when bargaining powers are rather equal, like they are nowadays, long-term contracts become more interesting because no one has an incentive to veto a marriage due to unequal power.

Minimum wages and youth unemployment

On average (but not now), unemployment rates in most European countries are higher than in the United States. This has been blamed on more generous unemployment insurance, high firing costs, lack of mobility, high taxes, union power, too specific education, and measurement. One possibly neglected aspect, at least as far as I know is the impact of minimum wages. Few people actually work at or close to the minimum wages, but these tend to be entrants on the labor market, and what happens to the young tends to persist for many years after the look for work.

Aspen Gorry uses a suddenly popular labor search model that differentiates between those seeking a first job (the young) and those that have experience (the old). Varying the level of the minimum wages from American to French levels, he finds that about 50% of the gap between youth unemployment rates can be explained. What this is implies is that the minimum wage prevents some of the young workers to find their first job. And this lack of experience implies that they enjoy only later the job stability of an incumbent. Thus the impact of the minimum wage adds up quickly for the aggregate unemployment rate.

Two additional comments. First, this model does not explain European countries that have high unemployment yet no minimum wage, such as Germany. Second, while the minimum wage is binding for very few jobs in the US in normal times, it may be more binding now, thus giving another reason for the strong surge in unemployment (and presumably its rapid shrinking once things get back to normal).

Copyright and the lack of competition in academic publishing

The official story is that copyright encourages creators by giving them temporary monopoly rights. The unofficial story is that copyright prevents the diffusion of art and knowledge, and nowhere is it as frustrating as with academic publishing. Commercial publishers sell the research others paid for, and can extract substantial rents because researchers have to publish in established outlets for reputation, tenure and promotion.

Giovanni Ramello remarks that there is another unfortunate consequence of copyright in academic publishing: having been granted some market power, the monopolist will seek to extend this market power through acquisitions and thereby obtain even more dominance. The obvious example is Elsevier, which has reached now a market share that should trigger anti-trust investigations along with profit margin in the order of 30%. The situation is quite bad in Economics, as scholarly societies have done little to prevent Elsevier taking hold of the major field journals, thereby making it essential to any tenure file. And given this, research libraries have no choice but subscribe to those journals, falling in the trap of the monopolist.

In other sciences, I hear the situation is not much better. And I have reported previously about horror stories that still seem to have little impact (1, 2).

In any case, journals are dead to me, for reasons cited above and also because the publishing process is broken, starting with refereeing.

Rethinking college tuition and student loans

Britain and Ireland currently go through much soul searching on how to reform the financing of higher education. As for health care, education is becoming more expensive as it is a service, which we do not know yet to scale well, while manufacturing has benefited from tremendous improvements in mass-production and can be relocated to where it is the most efficient. If higher education is becoming more expensive, who should pay for it? Obviously, there is a large private benefit to getting an university degree. Thus the student should also pay a large share. There is a social benefit as well, as a well educated workforce brings all sorts of positive externalities, which means that society should subsidize higher education as well. But not too much, as these subsidies are regressive: while rich people pay more taxes, they benefits even more from higher education subsidies, as their children are more likely to attend university and stay there longer. But if university tuition is so expensive, what to do with those students who are credit constrained? Should they get subsidies, loans, or just deal with it?

Neil Shephard suggests a complete overhaul of the system. Here are its components:

  1. Students are charged the full cost of their education by universities.
  2. They get an explicit scholarship from the government for part of this tuition. This makes is visible that the state is helping.
  3. Students have the option of deferring the payments to the universities. As the universities are taking the risk when a student could default or make little money, they will make sure students will get a good education (and not admit students who should not go to college).
  4. This means that universities will make loans to their students. These loans should also cover living expenses.

I think this is a very good programme. It essentially boils down to students borrowing against future income, and seeing how the return to education is vastly superior to the financial cost, they should want to take this opportunity as long as there is a market. Universities are the ones providing this market and they are incentivized to provide a good educational product.

The suggestion is in fact very similar to the credit products that MyRichUncle offered before the financial crisis in the United States: it gave loans to students against a share of future income for a set time. The loan amount was determined by student performance and major, thus taking into account the expected value of a university degree. With the Shephard proposal, it is up to the university to provide this value.

Household size heterogeneity and the representative agent

A large, but shrinking, proportion of models in macroeconomics assume the existence of a representative agent. While there is clear evidence that households are heterogeneous, under some conditions aggregation may still hold. But even if it does not, what matters is whether it makes a quantitative difference.

Christos Koulovatianos, Carsten Schröder and Ulrich Schmidt address the question from a different angle. They ask whether differences in household size matter. They show it does not, theoretically, if the utility functions exhibit household-size economies (beyond subsistence consumption) that are invariant with income. I think that what the authors want to say here is that household size does not matter as long as preferences are such that consumption demand is linear in household size, which in fact does not imply that preferences are heterogeneous. Household size is just an argument in the household utility function. Or: household utility can be aggregated for individual utilities if the decisions rules can be aggregated, which is the case when they are linear.

Anyway, beyond these semantic issues, Koulovatianos, Schröder and Schmidt then provide survey evidence documenting that preferences have indeed the required property, namely that households perceived that the income necessary to maintain a given standard of living is linear in the number of its members. What is interesting here is that the survey covers many countries, possibly preempting the criticism I mentioned the other day.

On a separate note, this paper is particularly painful to read. It runs for 89 pages, and it is very confusing (even more than my post) because the authors do not use the right terminology. Also, they need to learn the virtues of conciseness and precision. I hope they did not send it to a journal in such bad shape. And of course they assume that all households have the same time preference, against which there is ample evidence and which matters much more as it has strong implications for savings.

Brawn, gender and human capital investment

Females are now more numerous than males in most levels of education, and they perform better in school. Why is that? One hypothesis is that there are biological differences that make that men are better at tasks that require force, while women are better when reasoning is asked for. This is the brawn versus brain hypothesis, and as todays economies indeed ask for more intelligence than brute force from their workers, women find more opportunities and better pay.

Mark Pitt, Mark Rosenzweig and Nazmul Hassan build a model of investment in human capital that differentiates genders. Better nutrition improves strength and education improves skills. Individuals make these choices, as well as in which activities to work. Using panel data from rural Bangladesh, they find that model is a reasonable description of reality. That is particularly interesting, because rural Bangladesh does not strike me as an economy where brain would dominate brawn. Also of interest is that improvements in health do not increase education for men, it may even reduce it, while women education clearly benefits from them. Thus policies that focus on health improvements are likely to improve women's schooling more than men's, lead to more occupational differentiation across genders, and a larger gender wag gap.