The Economics profession has been targeted on various fronts lately: one is for a lack of a code of ethics, as exposed by the documentary Inside Job, and another has been the lack of forecasting or warning about the current crisis. With respect to the first, the American Economic Association has convened a committee to create a code of ethics, although unfortunately with a rather narrow mandate. Regarding the second, I believe the accusations are overblown, in part because economists have warned about excessive house prices, because bubbles are by definition unobservable, and because the principal accused, modern macroeconomics, has addressed before the crisis many of the aspects it is being accused of missing. This latter point has mainly been put forward by some economists who have a rather antiquated knowledge of the field, as occasionally addressed here.
One of them is David Colander, who has an admirable art of getting into all the right committees at the AEA. This time, it is the Ethics Committee. In his latest paper, he argues that he is not too worried about the funding of economic research and the lack of disclosures. He is rather bothered by the fact that economists do not have the humility to declare how fragile their results may be. They should be more forthcoming about the risk of error, much as engineers do as they care a lot about failure.
I can see where Colander is coming from, but I do not think this is the fault of the economists, but rather of the public consuming economic research. From personal experience, nobody cares about alternative scenarios. Well many editors do, but people in the industry do not. All they want is a precise number to run with. And even if you include standard errors and such, all that is reported is the median. I am guilty of this on this blog as well, it would take too much time and space to report this for every paper, and it distract from the main message. Only when I think the authors have abused the simplification or neglected possible scenarios do I discuss this, and this does not happen too often. And I think it is very symptomatic how Thomas Sargent and Christopher Sims have recently been ridiculed in the press for refusing to provide instant answers to difficult questions. In short, I think the problem has less to do with the economists than with the readership.
Which childhood sport is more promising for labor market outcomes
Which sport should you encourage your child to adopt? My guess would be cross-country running, swimming and rowing, which have all the important characteristic of encouraging perseverance and long-term planning. They also make your child hang out with the "right people" as these athletes feature prominently among the best students. But these are just my impressions, let us see what can be done with more than anecdotal data.
Charlotte Cabane and Andrew Clark look at US schools, although not quite at the level of athletic detail I would have wished. Healthy students are more likely to participate in sports and later be successful in life. But those participating in sports are also more likely to be healthier. The direction of the causation is not clear. But of interest here is whether participation is sports is an important determinant in latter outcomes. Using the National Longitudinal Study of Adolescent Health, which looks at students who were in grades 7-12 in 1994-95, they can track how the students are doing as late as 2008. In the end, participating in team sports once a week as a student increases the hourly wage by 1.5%. Not a lot but still significant, especially as this for adults in their thirties, and gaps tend to widen later on. Individual sports seem only to have an impact for adult outcomes of girls.
Charlotte Cabane and Andrew Clark look at US schools, although not quite at the level of athletic detail I would have wished. Healthy students are more likely to participate in sports and later be successful in life. But those participating in sports are also more likely to be healthier. The direction of the causation is not clear. But of interest here is whether participation is sports is an important determinant in latter outcomes. Using the National Longitudinal Study of Adolescent Health, which looks at students who were in grades 7-12 in 1994-95, they can track how the students are doing as late as 2008. In the end, participating in team sports once a week as a student increases the hourly wage by 1.5%. Not a lot but still significant, especially as this for adults in their thirties, and gaps tend to widen later on. Individual sports seem only to have an impact for adult outcomes of girls.
The best solution: carbon taxes
When there is some externality, the best way to deal it is with a tax (for a negative externality like pollution) or a subsidy (for a positive externality like education). Yet, I am continuously amazed how this policy using the market mechanism has found little reception in the United States. And economists are also very fond of it: it is the most efficient way to reach an objective, and in the case of a negative externality it even allows to reduce other taxes that distort the wrong way, like income taxes.
Joseph Aldy and Robert Stavins writes a survey article about how to best deal with carbon pollution, comparing a cap-and-trade of pollution permits, clean energy standards and taxation of carbon content. And the latter is the easy winner. And as argued multiple times on this blog, alternative energy should not be subsidized.
Joseph Aldy and Robert Stavins writes a survey article about how to best deal with carbon pollution, comparing a cap-and-trade of pollution permits, clean energy standards and taxation of carbon content. And the latter is the easy winner. And as argued multiple times on this blog, alternative energy should not be subsidized.
How much tax evasion is there in the US?
As mentioned before, tax authorities are now especially eager to catch tax evaders. But how many of those are actually out there? One would suspect that there are relatively few of them in a low tax country like the United States. But again, the tax authority there has been given relatively few means to pursue investigations and audit rates are surprisingly low. And the tax code is so complicated that the line between tax evasion and confusion is rather blurred.
The Internal Revenue Service, the US federal tax authority, has estimates about how much it is missing in revenue, but as far as I know these numbers are kept well hidden, except for a study in the eighties. Academics have tried to replicate this exercise, obviously with poorer data than the IRS, but with less political pressure. The latest attempt is by Edgar Feige and Richard Cebula. They use a technique similar to one used to calculate the size of an informal economy, a technique based on the quantity of currency in circulation and of check deposits, adjusting for currency suspected abroad and financial innovation. Indeed, tax evaders try to hide income from reporting by using cash transactions. This ignores though those who use tax havens, and I welcome informed guesses on how large a factor that may be.
In any case, Feige and Cebula come to the conclusion that about 20% of reportable income is not properly reported, leading to lost revenue in the order of $400-500 billion every year. They even compute a time series that allows them to figure out what makes the non-compliance rate change. It will not surprise that it increases when national income is higher, when tax rates are higher or when nominal interest rates are higher. It is interesting to see that higher unemployment rates lead to higher non-compliance. That may have to do with more people getting informal income while on unemployment insurance. Still, I cannot shake the feeling that all these results are shaky themselves, as this data is essentially made up.
The Internal Revenue Service, the US federal tax authority, has estimates about how much it is missing in revenue, but as far as I know these numbers are kept well hidden, except for a study in the eighties. Academics have tried to replicate this exercise, obviously with poorer data than the IRS, but with less political pressure. The latest attempt is by Edgar Feige and Richard Cebula. They use a technique similar to one used to calculate the size of an informal economy, a technique based on the quantity of currency in circulation and of check deposits, adjusting for currency suspected abroad and financial innovation. Indeed, tax evaders try to hide income from reporting by using cash transactions. This ignores though those who use tax havens, and I welcome informed guesses on how large a factor that may be.
In any case, Feige and Cebula come to the conclusion that about 20% of reportable income is not properly reported, leading to lost revenue in the order of $400-500 billion every year. They even compute a time series that allows them to figure out what makes the non-compliance rate change. It will not surprise that it increases when national income is higher, when tax rates are higher or when nominal interest rates are higher. It is interesting to see that higher unemployment rates lead to higher non-compliance. That may have to do with more people getting informal income while on unemployment insurance. Still, I cannot shake the feeling that all these results are shaky themselves, as this data is essentially made up.
Hurrican damage and climate change
Global climate change is not only supposed to bring higher average temperatures on earth but also more extreme weather. The latter is possibly the more important consequence, as it has an impact on agriculture and more generally can destroy property. One example is the incidence of hurricanes in the United States, with more and stronger hurricanes likely. What would be the economic impact of this?
Robert Mendelsohn, Kerry Emanuel and Shun Chonabayashi study this using historical data from hurricanes and estimating a damage function. Then they use this function to estimate damages from two scenarios, with and without climate change, taking into account that various US states will have higher populations and incomes in the following decades. In the end, some of the increase in damages is due to this growth, but climate change would have twice that impact. Yet, at $40 billion a year, it still proves to be relatively affordable compared to US GDP. But it is concentrated around the Gulf of Mexico, which shall become even less hospitable with higher temperatures anyway. The outlook for Florida is not too good...
Robert Mendelsohn, Kerry Emanuel and Shun Chonabayashi study this using historical data from hurricanes and estimating a damage function. Then they use this function to estimate damages from two scenarios, with and without climate change, taking into account that various US states will have higher populations and incomes in the following decades. In the end, some of the increase in damages is due to this growth, but climate change would have twice that impact. Yet, at $40 billion a year, it still proves to be relatively affordable compared to US GDP. But it is concentrated around the Gulf of Mexico, which shall become even less hospitable with higher temperatures anyway. The outlook for Florida is not too good...
Why more bad mortgages? Too much reliance on credit scores
The current financial crisis is at least partially blamed on lax lending practices in the US mortgage industry. More mortgages were provided to less credit-worthy individuals with smaller down-payments than ever before, until this house of cards fell apart. Of course, this is not the whole story, but at least there is some partial truth to it, right? Now I am not so sure.
Indeed, Geetesh Bhardwaj and Rajdeep Sengupta look at a large fraction of the sub-prime mortgages originated from 2000 to 2006. And they find that the credit-worthiness of their holders, as measured by the FICO score, actually increased (and more so than the general population). How could this be possible? One hypothesis is that mortgage issuers have gradually relied more and more on simple metrics they could enter into some software instead on analyzing other details on an application file. And if you end up relying on a single criterion, the selected applicant will look much better according to this criterion. But if this criterion is not well correlated with actual credit-worthiness and relevant information is neglected, your loan pool becomes more risky.
Indeed, Geetesh Bhardwaj and Rajdeep Sengupta look at a large fraction of the sub-prime mortgages originated from 2000 to 2006. And they find that the credit-worthiness of their holders, as measured by the FICO score, actually increased (and more so than the general population). How could this be possible? One hypothesis is that mortgage issuers have gradually relied more and more on simple metrics they could enter into some software instead on analyzing other details on an application file. And if you end up relying on a single criterion, the selected applicant will look much better according to this criterion. But if this criterion is not well correlated with actual credit-worthiness and relevant information is neglected, your loan pool becomes more risky.
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