Wednesday, September 30, 2009

The efficient allocation of slaves in Korea

As the subtitle of this blog indicates, there is economics in everything. Even in activities that are illegal, immoral or banned. Slavery is one such activity, but at some time it was considered legal and moral in many parts of the world. The slavery market is in fact akin to a financial market, as a slave is an investment good that yields dividends in the form of labor, and depending on the country, also in the form of offspring. Now what is the first thing a financial economist would check when he encounters a new market? Verify whether this market is efficient.

This is what Elise Brezis and Heeho Kim do for the slave market in Korea in the 18th and 19th century, the period during which the existence of money and slavery overlapped. They compile data from several markets and deflate nominal prices using the price of rice, a proxy for the general level of prices. Given that slaves were typically farm workers, and thus their yield is probably correlated with the price of rice, this may not be the best choice for a deflator. But there may be no other price data to draw on consistently.

Brezis and Kim then use the arbitrage asset equation and find that the market is efficient most of the time, the exception being towards the end. The authors claim this is because monitoring costs became too high and hiring free workers became more economical. I wonder though whether the looming repeal of slavery may have something to do with this.

Tuesday, September 29, 2009

Fair labor income tax and human capital accumulation

The big problem with labor income taxation is that it discourages effort. What you would really want to do it tax luck (being born intelligent and rich) and encourage effort no matter your abilities (or even encourage it more if you are abler). There is a tax scheme that does the latter, the so-called ELIE taxes suggested by Serge-Christophe Kolm: taxing people on, say, IQ, is not distorting and brings more equality.

But removing the distortions on the labor supply may not be the only impact of ELIE taxes. There may also be an impact on the accumulation of physical and human capital. David de la Croix and Michel Lubrano build an overlapping generation model with people of heterogeneous skills and show that if markets are complete, ELIE taxes indeed reduce inequalities but reduce growth because less human capital is accumulated. The reason is that the taxes cannot solely be based on exogenous elements, and the endogenous parts is ties to education, which is then discouraged. Now prevent people from borrowing for education, and the growth penalty becomes less severe because the taxes redistribute resources towards those that are borrowing constrained. Of course, one can get education (and growth) back to the desired level by subsidizing education. Thus, tax the intelligent, but make education free, which is mostly used by the intelligent anyway.

Monday, September 28, 2009

Terrorism reduces crime

One could consider terrorism to be the ultimate crime, yet an argument can be made that terrorism is the best thing that could happen to reduce crime. Why? Eric Gould and Guy Stecklov argue that terrorism increases police presence and keeps people at home. They use data from Israel and analyze various types of crime and show that property crimes and assaults, even domestic assaults, are down after a terrorist event. But would this be the same in Europe or even the United States.

The type of terrorism Israel faces is a different threat than the one Western countries face. It is what I would call "petty terrorism", the bomb carried by a single person to areas otherwise of no particular interest. It appears Western Europe and especially the United States faces a more organized terrorism towards high-profile targets. A threat in the latter case would thus draw police away from the neighborhoods to the airports and landmarks, thus leading to higher crime.

Imagine if all those airport security personnel were cruising the bad neighborhoods in the US. Far fewer people would die violently.

Friday, September 25, 2009

Hurricane insurance needs to be government run

Insurance is a difficult business in the presence of moral hazard. While an insurance company can make a profit by exploiting the risk aversion of its policy holders, this profit may be annihilated if moral hazard drives the insured to increase the risk. And if policies cannot discriminate by risk category, then only bad risks can be insured, at a loss. But I do not see where there could be moral hazard in the case of hurricane insurance, as policy holders cannot influence the path of a hurricane. If they fail to strengthen their house, this is something that is easy to inspect and price into a policy. So why did private insurance companies leave the hurricane insurance market in Florida?

Mario Jametti and Thomas von Ungern-Sternberg describe how the state of Florida had to step in and provide coverage to all homeowners at a cost ultimately much lower than what private companies offered. While the state may be able to better diversify over the area of the whole state, it is not like it does not face substantial risk. A hurricane can have severe consequences for a significant part of the state. Private companies can diversify with other geographic areas or coverage types, they can even re-insure, two means that are not available to the state. But the latter can make up any loss with federal help or, gulp, taxes. And it cannot simply declare bankruptcy if it takes a big hit, like a poorly covered insurance company would.

Thursday, September 24, 2009

On the advantage of marriage over cohabitation

Why marry when cohabitation can provide the same benefits of economies of scale and companionship? One may even think that cohabitation is superior because it allows a break up with less consequences. That is exactly wrong. The fact that divorce is costly makes that one is more careful in committing to marriage and, once married, one puts more effort into the marriage. The key here is that marriage is a commitment device that gives strong incentives to make a marriage work.

Murat Iyigun shows that this logic gives marriage a large surplus than cohabitation through spousal commitment, as long as men and women are available in roughly equal numbers and commitment costs are symmetric across genders. Otherwise, marriage surpluses collapse and cohabitation dominates.

The fact is that commitment costs are not equal, mostly because of children and traditional roles in the household and the labor market. In fact, the countries where women are the most equal to men (say, Scandinavia) are those where cohabitation is the most prevalent. That evidence goes exactly counter to the predictions of the Iyigun model. Unfortunately, the paper provides absolutely no empirical support for its results. In fact, it is not even motivated by any empirical fact that would need to be explained. What is it then good for?

Wednesday, September 23, 2009

Entry on the labor market and social beliefs: the impact of recessions

Do the economic conditions in which you grew up have an impact on beliefs and opinions about the economy? We all have notice how our grand-parents, having lived through the restrictions of the Great Depression or the Second World War, lived in a more thrifty way than us, never throwing away something. But could this experience also have an impact of beliefs about markets and social issues?

Paola Giuliano and Antonio Spilimbergo use the General Social Survey and exploit regional and chronological differences in economic conditions where respondents grew up to look at this question. They find that growing up in a recession makes you believe more that personal success is due to luck rather than effort, you support redistribution more but without believing government is there to help you. While should not be too surprising, how persistent such beliefs are is astonishing.

Now imagine that the current recession last longer than usual (some say there could be a double-dip) and this could plant the seeds of a profound change in the US. This country is the most capitalistic and the least relying on government at the moment. But attitudes could change over the next generation and indeed bring major reforms like public health care, more redistribution and more regulation of business as those in their formative years now experience (relative) hardship.

Tuesday, September 22, 2009

Sweatshop equilibrium

Westerners complain about sweatshops in Asia for two reasons: they produce at much lower labor costs, thus undercutting the Western labor force; and the labor conditions are inhumane due to long hours and poor environment. One answer to these critics is that without those sweatshops, the local labor force would not have jobs and that eventually conditions and wages will improve, as it has happened during the Industrial Revolution in the West.

Nancy Chau does not seem to share this vision as she shows sweatshop conditions could be permanent due to an unfortunate outcome in a multiple equilibrium. Think of the search and matching framework used nowadays to study the labor market. People need time to explore and find new jobs. But this time is not available in a sweatshop. In other words, on-the-job search is impossible and workers end up in a situation akin to slavery. The way out? Enforce shorter hours, even if this means temporarily reducing the workers welfare. The latter may oppose it, but it is only because they do not know what their outside options are.

The scenario I describe above is only one of several possible ones, but it is somehow reminiscent of European labor history. But Chau shows that there are also equilibria where an economy can grow out of sweatshop conditions without intervention. The big question is then: in which equilibrium are Asian sweatshops currently?

Monday, September 21, 2009

Is hyperbolic discounting rational?

In dynamic economic models, future periods are typically discounted geometrically, i.e., at a constant rate. There is, however, mounted evidence from experiments that people discount hyperbolically: there is much discounting the first period, and then it is geometric again. This evidence has been put forward as an argument against the rationality of individuals.

Doyne Farmer and John Geanakoplos argue that hyperbolic discounting is observationally equivalent to geometric discounting with uncertainty about future discount rates. While this may rescue rationality, one has to ask oneself whether this makes any empirical sense. And for that there is little support at the moment.

Friday, September 18, 2009

Predicting oil prices from interest in electric cars

You have heard or read the public opinion theories that the oil companies are acting like monopolies (i.e., they conspire) to manipulate gas prices. While I have yet to see hard evidence that they collude, I find it troubling that little production capacity has been added despite higher prices. But that could be due to environment regulation, as is credibly claimed.

Jose Azar adds a troubling observation to the debate. He finds that whenever interest in electric cars increases, oil prices happen to decline. And not just a little, half of oil price changes can be explained by the frequency of Google searches about electric cars. But that can also show that markets really work: when there is interest in substitute goods, prices decline.

Thursday, September 17, 2009

Child labor and trade liberalization

There are two simple prerequisites to get of child labor: high returns to education and sufficient parental income. The difficulty is to satisfy these conditions. Would the trade liberalization that comes with globalization help?

Krisztina Kis-Katos and Robert Sparrow study child labor outcomes in Indonesia as a consequence of heterogeneous decreases in tariffs. As the latter have different impacts on difference districts, and they measure child labor in those districts, they can identify the impact of trade liberalization on child labor. It turns out the advantages of globalization play through and help reduce child labor. The dynamics are tricky, though, as there may be a short term burst in child labor after a tariff decrease. One can imagine that a sudden increase in labor demand tempts children to work, but as parent income increases and future income prospects improve, children go back to school for good.

This is one more reason people should stop blaming child labor on globalization. While the latter is a new phenomenon, child labor was always present. And if you want poor countries to benefit from world wealth, the barriers should be reduced.

Wednesday, September 16, 2009

The punishment of unemployment insurance cheaters

A worker on unemployment insurance is supposed to actively look for a job and accept suitable job offers. If caught cheating, one is subject to penalties, going from forfeiting future eligibility to repaying received benefits and more. But there could be indirect consequences as well.

Gerard van den Berg and Johan Vikström use Swedish data to study the impact of cheating on the future labor market history of a cheater. It looks like a stigma is at work, as future jobs are likely to be paying less and even in a lower occupational level. The latter is quite important, as it implies a human capital loss that has consequences throughout the remaining working life.

The analysis is based on comparing he jobs before and after the unemployment spells. Van den Berg and Vikstr&oum;l also observe the job several years later to see whether there is any persistence, and there is. I am, however, not sure on how to interpret the results. One could view them as the consequence of a stigma, that the worker is not reputable and only worse jobs get offered to him. But it could also be that he scrambles to accept the first offer after being sanctioned, either because of the reduction in benefits or as a natural reaction after being caught with the hand in the cookie jar. The first interpretation means that the sanction leads to a societal welfare improvement: there is a clear signal about the quality of the worker. The contrary applies to the second interpretation, as it seems a mis-allocation of talent is at work. It would be important to sort that out.

Tuesday, September 15, 2009

Family environment and IQ

There has been a long discussion in the literature on whether intelligence is inherited or acquired, the nature versus nurture debate. The traditional empirical strategy has been to look at twins separated at birth and raised in different families. While this seems to be a perfect data set for this kind of study, it suffers from at least two drawbacks: samples are very small, and there could be a selection bias, as twins given for adoption may not be representative of twins, and furthermore, twins may not be representative of the general population.

Anders Björklund, karin Hederos Eriksson and Markus Jäntti focus on the correlation of IQ across siblings as it compares with father-to-son IQ correlation. For Sweden they find that they are 0.473 respectively 0.347 from a data set of military conscripts (all male). As siblings share genes and environment, whereas father and son only share genes, they argue that this is evidence that the environment is important. An environment that may include the mother and her genes, by the way.

These results look interesting, but I do not quite know where to go from there. Does this mean that we have less to worry about the intergenerational persistence of skills? Or that the high correlation of earnings within a family is OK and not a sign of mis-allocated opportunities in society?

Monday, September 14, 2009

How to select presidential candidates based on their biography

Every party would like to find a way to find the perfect candidate to run for office. In some way, this is the goal of primaries in the United States. But in most states, this only determines the preferred candidate among sympathizers, but the most electable in the general population may be different. Any other criteria we could use?

Scott Armstrong and Andreas Graefe looked at detailed biographies of US presidential candidates and claim to have found the formula that works 25 times out of 28. You can start now looking for the perfect candidate: coming from a political family, first-born, single-child, lost a parent in childhood, is still married with children, some adopted, went to a military academy, then received a graduate degree from an Ivy League school, is a member of Phi Beta Kappa, held political office (the more the better) and was never defeated in an election, has written books, was a movie or sports celebrity, has military experience, survived a major disease, is tall and heavy, has common first and last names, is attractive and looks competent, comes from a large state and is affiliated with a large region. All in all, the paper mentions 34 criteria. My score is 15, so I am afraid politics is not for me.

The unpredictable ones? Truman, Carter and Clinton (first term).

Friday, September 11, 2009

Cattle as self-insurance in modern economies

We have all used this example in class: in economies with no credit markets or serious banking, people may use cattle as a means of storage of value and to self-insure against future eventualities. But could such a thing happen in a modern economy with well-functioning financial markets?

Anne Borge Johannesen and Anders Skonhoft study Saami reindeer herding in northern Norway. The idea is to look at reactions to price fluctuations. For example, if meat prices increases and herders slaughter only few animals, it means that they keep them for other reasons than simply revenue: self-insurance or status. But one has to be careful. Price increases that are perceived to be permanent should lead in fewer slaughters in the short term, as herders beef up their animals. One needs to looks at temporary price changes.

Borge Johannesen and Skonhoft come to the conclusion that the price response is indeed weak for Saami herders. They also find that herd size is relevant for status, but that it does not appear to matter for slaughter decisions. Thus, there is a strong self-insurance component.

Thursday, September 10, 2009

About estate subsidies and capital income taxation

There is an endless debate about estate taxation, especially in the United States. One side wants to repeal it because it discourages entrepreneurship, the other side wants to expand it, for fairness' sake. Here comes a paper that claims that both sides are wrong. Estates should be subsidized.

Carlos Garriga and Fernando Sánchez-Losada are the ones making this surprising claim. The logic is the following. Imagine that there are three potential sources of taxation: estates, capital income and labor income. You want to optimize the tax mix in order to minimize the distortions from raising taxes and maximize equity as measured by the distribution of wealth across agents. Factor also in that there is some cross-generational altruism and that one cannot bequest more than one has. One also has to realize that bequest have an important positive externality that the donor only partially takes into account: its effect on the recipient. Logically, the donor needs to be encouraged, hence the estate subsidy. But this needs to be financed somehow, hence the capital income tax. It is usually found that capital income should not be taxed, but here the pressure to raise taxes is too strong. In fact, capital income tax is significantly higher than labor income tax.

All this is done with a model that gets reasonably close to mimicking the existing distribution of skill, income and wealth in the population. Garriga and Sánchez-Losada even look into tax progression in their analysis, but qualitative results remain with constant tax rates. What I learned from this is that despite equity concerns, one has to factor in that people leave too little bequests. And that the combination of estate subsidy with capital income taxation essentially alters the intertemporal profile of wealth holding to a more egalitarian one.

Wednesday, September 9, 2009

Religiosity and risky behavior

Teenagers tend to engage in risky behavior, and many reasons have been identified for this. Still, there are large differences across teenagers, and some literature seems to have identified religiosity as a powerful explanatory variable for less risk taking. But as so often, correlation is not causation. "Nice" kids who follow their parents' advice and behave may also be more likely to follow their parents to church, for example. Perhaps more importantly, individual religiosity may be influence by religious fervor in the social circle beyond the family.

Jennifer Mellor and Beth Freeborn try to disentangle this by using data from the National Longitudinal
Study of Adolescent Health and consider binge drinking, smoking and marijuana use. One may discuss whether the latter is truly risky, but this is not the topic here. Mellor and Freeborn use county-level religious density, a measure that takes into account the proportion of people of a same religious group in the same area, as an instrument to control for the social environment. For religiosity, they use the frequency of church attendance.

Measuring religiosity is tricky business. Density measures depend on the size of the area and how one fragments religious groups (split protestants apart or not, for example). And church attendance may be more a social event than anything else in some areas. I prefer measures like "Do you believe in hell?" to measure this. But let us assume the authors do the right thing (I wished they would supply some robustness exercises).

The results? Marijuana use is robust to taking into account the endogeneity in religiosity. So religious teenager indeed smoke less pot. But smoking cigarettes and binge drinking is a frequent as for less religious teenagers.

Tuesday, September 8, 2009

Placement officers can lower unemployment

From my casual observation, it appears that in countries where the unemployment rate is rather high, unemployed workers tend to rely more on government run employment offices to find jobs. I do not think there is causation in this correlation though. But this makes it more important to understand whether employment office are good at anything.

Jens Hainmueller, Barbara Hoffmann, Gerhard Krug and Katja Wolf discuss an experiment in Germany where the case load of some employment officers was halved, which would be equivalent to doubling the number of employment officers. Does this help in increasing the placement of the unemployed? The above four claim that yes: the unemployment rate is reduced and so is the number of people registered in employment offices. But these results are obvious, except maybe that they are statistically very significant. What matters more is that they are economically significant.

Is a 0.5%-point reduction in the unemployment rate economically significant? Probably yes. Is it worth the cost? Remember, you double the number of case workers and you increase taxes to pay them. In fact, some of the unemployed may have been hired as case workers. It is much less obvious that the experiment is positive look at it this way.

This is what should have been studied. I am too often frustrated by studied that just look at the statistical significance of an effect, ignoring the economic significance and especially how this fits in the rest of the economy. And this happens too often with labor economics papers. If there is one thing that distinguishes economists from other social scientists is that we tend to think more in a general equilibrium way, and this papers for sure does not do justice to economics.

Monday, September 7, 2009

Optimal deposit insurance

With the current financial crisis, the question of the optimality of bank deposit insurance has flared up again. Figuring out how much deposit insurance should cover is not an obvious exercise. Indeed, one has to think this as a game between bank managers, who want to take advantage of moral hazard through excessive risk taking, bank owners, looking maximize bank value, depositors, who decide whether to run and withdraw funds, and regulators, who want to prevents crises, but also want to liquidate banks that should be liquidated.

Michael Manz develops a nice and rich model that attack the problem from the perspective of global games. This has the advantage of resolving the issue of multiple equilibria in the standard bank run models. Among the many results, several stand out. If the bank risk is exogenous, coverage should not be high as it prevents necessary and efficient runs. Also, liquidity requirements are a good substitute to deposit insurance. Finally, coverage should not increase in the event a financial crisis hits. The reason is that the financial risk increases with the scope of deposit insurance because, if I understand right, while higher coverage protects better deposits in banks of systemic importance, it leads to more moral hazard in others and then increases the likelihood of a run on all banks. The only way out is to discriminate coverage by bank, which is a completely different regulatory game.

Friday, September 4, 2009

Rational procrastination

So you have a deadline to submit a project. Your cost, in terms of utility for example, for working on the project is stochastic with a known distribution. When should you start working on it? The solution to this problem is a stopping rule, which will of course depend on the way you discount future disutility.

Alberto Bisin and Kyle Hyndman look at this with three different types of discounters and come up with interesting solutions. Agents with a standard exponentially discounted utility will choose to work on their project when it is most convenient, which may be before the deadline. Agents with hyperbolic discounting will delay until the last moment. But hyperbolic discounter may not be that naïve. Sophisticated ones realize they have a procrastination problem and will end up completing their project before the deadline.

This last result is important because sophisticated hyperbolic discounters and exponential discounter end up being, potentially, observationally identical. However, looking at me and around me, there are many hyperbolic discounters who are aware of their problem, but still cannot do anything about it except complaining. I am thus not quite convinced of the empirical relevance of this result. Of course, my empirics are anecdotal, but I saw no empirical evidence at all in the paper.

Thursday, September 3, 2009

People are nasty

We all know that doing better then others is an integral part of our satisfactions. Thus when we think about utility functions, at least in some contexts, it is important to consider not just absolute outcomes but also relative ones. Indeed, there is for example evidence that people are willing to lose something only to hurt (more) others. Presumable this raises their utility.

Klaus Abbink and Benedikt Herrmann push this further with an interesting experiment. They let people chose to pay in order to probabilistically hurt someone else in a game where Nature may hurt the other anyway. And when Nature is in play, people hurt much more each other, and also expect this to happen more. The moral cost is clearly lower, as one can always defend oneself by pretending Nature did it. Strangely, this is even prevalent when there is complete anonymity.

Wednesday, September 2, 2009

Optimal irrationality

One can safely say that the assumption of rationality is central to economics. One idea behind it that economic agents must be trying there best. But what if it were optimal to behave in an irrational way? Surely, one could build some twisted example where irrationality would be preferable, same some game theoretic environment where being unpredictable is superior. But this is still a rational choice, called mixing strategy. Would there be some truly irrational behavior that could at least weakly improve outcomes?

James Feigenbaum, Frank Caliendo and Emin Gahramanov come up with such an example. They use an overlapping generation economy where one can improve on the permanent income rule. Now, we know OLG models can quirky and lead to strange results, but this is still an interesting example. They key here is that there is a publicly shared rule of thumb, say, "save more now" that can alter aggregate outcome, in this example increase labor income and thus wealth. Households are not just price takers, but they consider that if everybody deviates, it will have consequences. All you need it to have some trigger that lets everyone converge on this new focal point. In short, animal spirits at work.

Tuesday, September 1, 2009

Why all the fuss about business cycles?

There is a surprising amount of research on business cycles, and also public concern about recessions, if your consider the most influential work on the topic. In his 1987 book, Robert Lucas claimed that the welfare cost of business cycle was minimal. The model he used was utterly simple, in particular with a represntative household and has been attacked many times since. But in his 2003 AEA presidential address, Lucas claims that all modifications to his model from the literature taken together are not able to give a significant welfare improvement from the elimination of business cycles.

In recent years, there has been much progress in working with heterogeneous agent models with business cycles. And these models can highlight costs from business cycle fluctuations in the order of 1% of consumption. Their more important result is that this cost is very unequally distributed, which makes it very significant to some. Take two examples. Tom Krebs argues that the real cost of business cycles is in the long-term job displacement of workers. The reason is that short-term fluctuations can have long-term consequences. Or Per Krusell, Toshihiko Mukoyama, Ayşegül Şahin and Anthony Smith show that the elimination of business cycles not only smooths variables, but also changes their average level. The latter happens because of changes in precautionary savings and through the resulting changes in prices. Both papers also show that there are strong redistribute forces at work, and the welfare impact of aggregate fluctuations is worth several percents of consumption in some worker categories, something worth caring about.