Is fair trade unfair?

US colleges make big money from the sale of all sorts of items imprinted with their logo, in particular clothes. Of course, to maximize the margins on these goods, their production has been mostly outsourced off-shore, to factories that were often likened to sweatshops. Whether a large portion of those factories were indeed providing substandard working conditions is a debate I do not want to enter for now. The fact is that student activists demanded that those factories should not be retained for production. As universities and their suppliers complied, the poorest workers were out of a job, and the university gift stores are making less of a profit. Unintended consequences.

Aurélie Carimentrand and Jérôme Ballet explore a similar story with fair trade. Their case study is about quinoa from Bolivia. The goal of fair trade is to give local producers in developing countries a larger share of the retail price of their product. But beneficiaries need to get certified, and this process does not necessarily favor the most needy, in particular as they need to obey some rules. In the case of Bolivian quinoa, this works through the membership in a growers' association which markets crops to fair trade networks. As associations typically are, this one is dominated by the big producers. The latter are located in the big plains, where they could get the full advantage of mechanization. The small producers are on steep terrain and cannot use tractors. The latter are the poorest, but, as the authors argue, they benefit the least from fair trade, often even skipping membership. Indeed, the association pays the same unit price to all members, and given the differences in production costs, this exacerbates inequalities.

The authors claim that fair trade has failed here. It made inequities among producers worse. But was domestic income equality really the primary role? Isn't it really about world income inequality? There, clearly fair trade is transferring some rents to developing economies. Whether they are large enough to be worth the trouble is another question.

How to raise government revenue: tax bling bling, but subsidize hip hop?

Lost in the debate on how governments could be raising much needed revenue in our difficult times is that there are some goods that are just begging to be taxed: diamond goods. These goods are valued solely because they are expensive. The money spent on these goods is independent of their price. Thus taxing them all the way to infinity makes them even more attractive, as very little of the diamond good needs to be produced for the same satisfaction. Thus, everybody should agree diamond goods must be taxed heavily: the buyers because of the prestige of the high sticker price, the others for the tax revenue.

Per Engström adds a little nuance to this argument. Suppose there is a strong complement to the diamond good, like hip hop music is a strong complement to bling bling. As the diamond good constitutes a free lunch for the social planner, the latter would want to subsidize it. But that beats the purpose of taxation. However, one can subsidize the complement, which encourages the consumption of the diamond good.

Engström mentions other pairs of goods. Entry to the Sex and the City should be free and designer shoes should be taxed to the hilt. The same for James Bond movies and champagne. Any other examples?

Trade theorems revisited

International trade economics is a constant disappointment to me. It still relies on the Hecksher-Ohlin model, which is static and thus cannot say anything reliable about dynamics. And the vast majority of the empirical work uses linear reduced forms and is only out there to test signs, not to find out how large an effect is. It is then refreshing to see a paper that steps out of this morass, and into the right direction.

Yu Sheng and Xinpeng Xu get back to the foundations of the Hecksher-Ohlin model and integrate some frictions that go beyond the usual iceberg costs. Specifically, they take into account that the reallocation of labor across sectors takes a while by including a Mortensen-Pissarides search framework. Even in steady-state, it turns out some classic trade theorems may not hold. For example, factor price equalization does not hold for labor, as there is unemployment and the expected wage is equalized. Endowments determine the labor force, but employment is endogenous. This allows also to explain why countries with similar endowments still trade a lot: cross-country sectoral differences in unemployment mean the factor content of trade is not a sufficient statistic. All this also means that empirics of the Hecker-Ohlin model need to be adjusted, in particular unemployment needs to be factored in.

The problem with experimental economics: people are weird

Experimental economics is the up and coming new field, with plenty of interesting research going on. But many people criticize it because the experiments, while controlled, do not reflect real world situations. The stakes in the experiments are too small, the participants are not representative, the experiments not relevant. Add to these criticisms a new one.

Joseph Henrich, Steve Heine and Ara Norenzayan claim this literature, and others, concentrates on Western, Educated, Industrialized, Rich and Democratic (WEIRD) societies. And these societies, with 12% of the world population, are not representative of the rest of the world, in fact they are downright ... weird. To make their point, Henrich, Heine and Norenzayan look, among others, at the ultimatum game in all sorts of societies. This is a standard game that is in particular used to measure altruism ans spite: a prize is to be shared, one player proposes a split, and the other can reject the proposal, leading to both getting nothing. In "weird" societies, the standard result is a 48-50% for the second player, who accepts. Offer below 30% are typically rejected. Subgame perfection, however, would suggest that any amount above zero should be accepted, and the smallest possible is to be accepted.

What about in other societies, the "non-weird" ones? Small scale societies, where people are used to live face-to-face, make low offers and accept them. Worse, it appears that offers that are particularly high are rejected, something that also applies to European societies. Quite consistently, and the authors provide other examples, American experimental subjects end up at an extreme of outcome distributions

Does this mean that the US undergraduate, on whom the vast majority of experiments are performed, is misleading us thoroughly? Not necessarily, after all he may help us understand the homo economicus americanus, but even there one can have doubts. But we may need to rethink seriously how economic theory applies to other societies, at least for some research questions. Experimental economics has still a lot of work on its plate.

C{A|R}RA utility

When it comes to modeling preferences in uncertainty, the usual choice is usually between constant absolute risk aversion (CARA, with an exponential function) and constant relative risk aversion (CRRA, with a power function). That is somewhat limiting, especially when one needs to cover a rather wide domain, as there is then no reason to believe risk aversion remains constant.

Masako Ikefuji, Roger Laeven, Jan Magnus and Chris Muris come up with a mixture, which they name Burr utility. It is CRRA at the origin and CARA at infinity and is a function that has some familiarity for those who use subsistence consumption (Stone-Geary utility function) except that this constant term is added. This implies in particular that marginal utility is never infinite, which is a property I am not sure I want to miss.

Is Europe a third world country?

Following up on last week's rant, why would an American arriving for the first time in Europe think he arrived in a third world country?

1. Cars are tiny, many people use bicycles or walk.
   
2. Food portions are small and rationed.
   
3. People live on top of each other.
   
4. Lots of idle people in the streets.
   
5. Many places do not accept plastic money, including hotels.
   
6. Ethnic hatred going far back in time.
   
7. No shyness about being naked.
   
8. Many monarchies.
   
9. And... passports are checked when you leave.
   

Large plants and distance to customers

Understanding why some firms export and some others do not is important for industrial policy. In empirical studies, one factor that always appears to be important is plant size: larger plants have a higher propensity to export. This has been rationalized, for example, by some fix cost of exporting, for example learning about foreign markets and producing to their specifications. But there is more to the story.

Thomas Holmes and John Stevens find that the distance to domestic markets is also associated to plant size. As export markets typically also distant, the link is clear. In fact, Holmes and Stevens claim that 50% of the plant size-export relationship can be explained by distance. Then how are we going to rationalize this? But it is clear from this that it makes little sense to assist a plant in exporting if it does not ship across the country.

Bubbles with collateral and infinite credit

Rational bubbles occur when people believe that prices will increase into the infinite future, which makes that they invest in more assets and prices really increase. But equilibrium models have difficulties replicating such phenomena because this increased wealth also induces, at some point, people to consume more, and then the budget constraint bites and halts the bubble. So how could one still get a rational bubble? By relaxing the budget constraint.

This is what Christopher Reicher does in a way that is reminiscent of the US before the crisis: through the provision of unlimited credit, which is possible if real estate is used as collateral. This sounds rather intuitive, as long as lenders are willing to go along. What is more interesting is that the model shows that there are monetary and fiscal policies that can prevent bubbles from happening. One is to apply the fiscal theory of the price level to credit markets, that is, to make sure the price level instantaneously responds to land prices to deflate the debt. If this is difficult to implement, and it would, another way to deflate a bubble is the make sure the returns of assets are lower by increasing interest rates of bonds, which makes them more interesting than real estate. Of course, one could also tax away the bubble. And one has first to recognize that there is a bubble.

It is difficult to measure poverty

Measuring poverty is very difficult. First, it is a relative concept and requires the definition of a standard or threshold. Second, as people are usually not normally distributed, any single measure misses some aspect of the distribution. Third, the item whose distribution is measured may not be the appropriate one to represent poverty. Most of the time this is income, but temporary low income is very different from permanent low income, and in both cases, purchasing power may differ dramatically on location, social policies and period. All these difficulties have lead to a plethora of poverty measures. In fact, if you look at the program of any economic inequality conference, there will be plenty of papers on new measures by authors hopeful that their names will stick to a new index or coefficient.

Walter Bossert, Satya Chakravarty and Conchita d'Ambrosio come up with a new measure that emphasizes the persistence of poverty. They are very careful in making their measure following three axioms: the measure corresponds to static poverty in the one period-case, a measure is worse is poverty spells are longer ans spells out of poverty are shorter, and two decomposability axioms too complex to describe here.

The measure they propose is a weighted sum of per period poverty measures, where weight are proportional to the current poverty spell. Using the European Community Household Panel, they find that their measure does not change rankings much whether poverty spell weights are used or not. But I bet they would change quite a bit for the US.

The iPhone must have an exclusive carrier

Aren't you angry that the particular mobile phone you prefer has an exclusive contract with a carrier? This limitation of carrier choice seems anti-competitive, if not frustrating. US anti-trust authorities seem to be getting interested in these arrangements and may intervene. It turns out that maybe they should not.

Robert Hahn and Hal Singer say exclusivity contracts are in fact the best thing that could happen for consumer welfare. Indeed, they spur competition through innovation, and the fact that the smart phone industry is innovative is hardly an understatement. Indeed, the exclusive contracts allow manufacturers to share the risk with the carrier, they make sure that both want the success of the new phone, and thus insure better reception and coverage. All this taken together induces manufacturers to take more risk and go for even faster and bolder innovations, which ultimately benefits the consumer.

Studying migration with experiments

One of the big difficulties with Economics is that one cannot perform controlled experiments like in the physical sciences. While experiments exist, they all have major drawbacks: they may be of too small a scale (although this does not deter medical research to have ridiculous samples), the stakes in the experiment may not be real-life-relevant, controls are to come by, or results may not be easy to generalize. And the larger the problem, the more difficult it is. Think macro-policy, for example.

So I am surprised to find a paper that reviews the literature on migration experiments. You cannot randomize people on whether they migrate or not, or where to. But, as David McKenzie and Dean Yang point out, visa lotteries are exactly that (and decisions of visa officers seem just as random to me...). But only few of those lotteries have been studied, Natural experiments are more common, but about migration per se, rather its impact. For example, the Asian crisis led sharp and unexpected changes in the value of migrant remittances, which impacted families at home. But, of course, one can have questions about how random the "assignment" is across migrants.

As to field experiments, again it is about the impact of remittances. McKenzie and Yang cite as an example a randomized trial where some migrants had access to a savings account in their home country in their name only. This experiment corroborated that migrants have a much stronger savings motive than their families back home. The survey also mentions a paper I discussed before about seasonal famines and migration in Bangladesh.

These are not the experiments I had first in mind, but an interesting introduction nonetheless.

Is the US a third world country?

Of course it is not. But for a European who sets foot on the continent for the first time, several observations would lead to this conclusion:

1. Urban ghettos, homeless people, trailer parks are certainly not a showcase of an advanced and rich civilization.
   
2. High criminality and violence.
   
3. Rampant corruption, which is even legal. Politicians can be bought openly, and few people see a problem with that.
   
4. Crumbling infrastructure. Roads are full of potholes, in particular urban highways.
   
5. Telephone and electricity are still supplied through overhead cables that are high in maintenance.
   
6. Cellphones cannot be used to pay in stores.
   
7. Credit cards do not have chips.
   
8. No sidewalks in many places.
   
9. A quarter of all homes still use septic tanks.
   
10. Idle police officers watching every construction site on roads.
    

Growth success in Africa: firms become smaller

How could one characterize a developing economy with little growth? Large informal sector, small firms, lots of red tape in the formal sector. As the informal sector typically has low productivity (before red tape), a typical prescription for growth is to move its activity into the formal sector. This can be achieved, for example, by reducing regulation in the formal sector.

Justin Sandefur looks at Ghana, which has recently experienced solid growth following some deregulation, and remarks that average firm size was halved over a 17 year period, while the share of the informal sector has increased. Using a manufacturing survey covering 1987 to 2003, Sandefur finds that aggregate growth did not come from firm growth, but from firm creation. These microenterprises stay tiny until they die, while the existing big firms stay as big.

While the growth experience of Ghana seems encouraging, one needs to realize that small informal firms stay small and informal. Thus once all entry opportunities have been used, growth will petter out.

Why so few drug innovations?

Research and development has an inherent tendency to have a decreasing growth rate. As the pool of things to discover continuously shrinks, it becomes harder to innovate. But we a groundbreaking discovery is made, this opens a lot of new opportunities and one should see a lot of new innovation. But with molecular biology and genomics, the pharmaceutical industry should have seen a burst of innovation, and in particular a jump in innovation productivity. Yet the contrary happened. One argument could be similar to the one that has been made about the productivity slowdown of the seventies, that an groundbreaking innovation like information technology needs time and resources to be understood.

Fabio Pammolli, Massimo Riccaboni and Laura Magazzini claim that this effect is very important. They observe that all the low hanging fruit have been picked in pharmacology and that first have shifted their investment portfolio towards more difficult problems. They suggest that one particular reason to do so is that improving current drugs is not profitable as generics are close substitutes and little rents can be extracted. Thus new classes of molecules are sought.

I would add another development in the field of R&D in general. It has become increasingly difficult and costly to file patents, as the field is littered with "predators" who file vague patents to prevent other from innovating, or to claim royalties. Not only does this increase the cost of innovating, it also increases its uncertainty, as any discovery can be subject to litigation even if it was a genuine discovery. This also encourages laboratories to find new molecules that are much different from existing ones.

The Great Depression: demand or supply shocks?

The fact that we are in a big recession has renewed interest in the Great Depression, and this has revived the questions about its origin. In particular, the eternal question on whether demand or supply shocks have driven it is back.

This time it is asked by Mark Weder, who runs a horse race between tow versions of a real business cycle model: one with only shocks to total factor productivity (supply shocks) as measured by Solow residuals, one with only preference shocks (demand shocks), measured as residuals of an Euler equation. The latter, though, are not associated with monetary or fiscal variables. Both types of shocks are the evaluated in their ability to forecast what happened to GDP, and none is a clear winner.

But is this really the best one could do? Clearly the models are way to simple to 1) forecast anything, 2) to capture the changing policy environment during this period, as highlighted by Milton Friedman, Anna Schwartz, Harold Cole, Lee Ohanian and many others. Also, the relative importance of the two shocks may have shifted over time, something that would have been worthing looking at.