A discussion of biofuel policies, as seen from Iowa

Biofuels have been presented as the solution to the ills of petroleum: locally produced, renewable, and sometimes cleaner. Hence they have been encouraged by many governments, but some advocates of biofuels now show some remorse. As they are produced from good used for food, biofuels may be responsible for the worldwide increase in food prices. What are then appropriate policies with respect to biofuels?

GianCarlo Moschini, Jingbo Cui and Harvey Lapan, all from Iowa and thus from a state that has been the major beneficiary of biofuel subsidies, write a survey of the Economics of biofuels. They seem to be quite worried about the limits to the expansion of biofuels. Indeed, blending ratios cannot be increased without major technological changes on both the production and user sides, which highlights that path dependence in technological choices is important, and always thinking about the individual explosion engine as a limits the horizon of possibilities. But this is more thinking about the Business of biofuels than the Economics of biofuels. The latter requires much more discussion about whether biofuel subsidies are the best option to reduce carbon emissions (they are not, and carbon taxes are much, much more efficient in this), whether there would be better ways to harness energy from the sun, and how competition with food production (which is much less subsidized, if at all) makes essential food too expensive for the poor. I am happy that even in Iowa, the Economics of biofuels can take precedence over the Business of biofuels.

Is the US ready for apprenticeship?

Not everyone is made for university, and good jobs do not require university education. Hence, I have a hard time understanding this general urge to increase the share of the college-educated population higher and higher. The example of the United States is telling, where many students leave the university with high debt and have to go for jobs that have nothing to do with their training. Possibly a better is the one of Germany, where many good jobs can be attained through apprenticeships: instead of US-style high school, students go part-time to a trade school part-time while holding an apprentice job training them toward a particular trade. This allows to combine classroom fundamentals with practice. Such apprentices become bank tellers, elementary school teachers, nurses or plumbers.

Could this work in the United States? Robert Lerman claims that discussion about reducing youth unemployment has been too focused on increasing college education, at great cost and little effectiveness, instead at looking at policies abroad. Yet, apprenticeship seems to go well with American values of pragmatism and the blending of private work into education. So why does this take a significant foothold? One reason is that American do not think it is a good idea to take crucial decisions about careers too early, and they may have a point as the usually higher unemployment rate in Europe has been attributed in part to a lack of flexibility of the workforce. But the more important reasons are that existing vocational high schools are considered a dumping ground for the academically challenged and parents resist sending their children there. Also, for-profit career colleges, which have no practical training aspect, are making very good money avoiding the apprenticeship system. Community colleges also provide mostly academic training and are no good substitute to apprenticeship. Also, unions seems to be acting like gatekeepers to their trades and actively prevent the creation of apprenticeship programs, likely to keep wages high.

As so often in the US, it comes down to lobbying. Lerman seems to see good perspectives in public subsidies for apprenticeship positions in businesses, I think public funds would be better used by not providing student loans to for-profit trade schools that provide little value. Use the savings to provide more trade and practice based programs in community colleges. And it is not clear why unions should have a say in the certification of an apprenticeship program.

Are international migrants happier after their move?

Why do people migrate? While there may be many motivations, it is very clear that migrants find much better material well-being in their new location. But they have to live away from their roots and traditions, and it is not clear their subjective well-being is better in the new location. Actually establishing this is very difficult, because migrants self-select themselves into migration. To do this properly, one would need a randomized experiment.

Steven Stillman, John Gibson, David McKenzie and Halahingano Rohorua have found this experiment with a migration lottery for Tongans interested in moving to New Zealand. The authors were able to interview both successful, unsuccessful and ineligible households one and four years after the lottery. They confirm that material well-being increases, but the matter of satisfaction is much more difficult to parse. Mental health is better, happiness lower. Interestingly, the study finds contradicting results when comparing recollection of welfare and static assessments. Despite this great dataset, we now only know better that we do not know.

Risk-taking and economic growth in natural disaster zones

An important determinant of economic growth is the willingness to take measured risks, i.e., entrepreneurship and capital accumulation. But an entrepreneurs could be adversely affected by external risks and economic growth could suffer. For example, does living in areas where there is significant risk from natural disasters matter with respect to economic growth?

Stéphane Hallegatte studies this with a growth model including two types of capital: a general one that can be located anywhere, and a specific ones that has to be located in hazard-prone areas. Hazards destroy part of the latter, but protective investments can reduce the probability of the hazard having consequences. Protection and hazard losses thus make investing in risky areas more expensive. Under fairly general conditions, economic growth then leads to fewer catastrophic events, but they are larger. And comparing this economy to a hazard-free one, the economic surplus is lower but grows faster until both scenarios converge. In the end, living in a hazard zone does not matter, except for preparing oneself for rare, large catastrophes. There is hope, New Orleans.

Taking care of free-riders in global warming policies

By now, global warming (or rather global climate change) seems inescapable, with many, many indicators showing a definite trend towards a rapidly changing environment. Given the large scale of this evolution, it is difficult to believe that a simple trick would stop or even reverse it.

David Martimort and Wilfried Sand-Zantman think they found it: get countries to contribute to a general fund and to reduce pollution, but only the most efficient ones at reducing pollution significantly do it. The design of this mechanism is build to solve a double problem: free-riding in participation and effort. The key is to provide a fixed menu of options to countries. This is allows to separate them according to their heterogeneous preferences and abilities, much like insurance companies separate policy holders by offering a menu of policies. In this case, countries would contribute to a green fund more or less, trading this off against subsidies for pollution reduction that are financed from this green fund. The key is that the non-participation of any country would make the whole agreement fail, thus making everyone willing to pay. That is of course under the assumption that no country would actually benefit from climate change. And that it is not too late.

Quantum money

It has been a while since we last discussed then latest developments in econophysics, the field trying to blend the methods of Physics (and sometimes its lessons) into Economics. The most mysterious and often counter-intuitive field of Physics is Quantum Physics. The same could be say of Monetary Economics within Economics. So why not study the Quantum Physics of Money?

Stephen Ternyik does this for us, and the result is expectedly disturbing and unintelligible. I spent more time than I should on trying to understand the abstract, and the paper itself was not too helpful. SO here is the abstract, and maybe a reader can translate this into something that makes sense to me:

The marginal minimization of the reserve requirement on demand deposits is the single cyclical cause behind the long-term crises of the monetary production economies and progressively decreases the time value of money on economic productivity. The total economic cost of this monetary and banking system (fiat credit a priori via private commercial banks; fiat money a posteriori via public monetary police) is the loss of dynamic efficiency in the space-time production structure, i.e. the quantitative increase of entropic volatility in the
monetary production economy equals the quantitative increase of the fiat credit quantum (mechanically and thermodynamically). A radical maximization of the reserve requirement on demand deposits is the basic economic remedy for the temporal monetary stabilization of the space-time production structure, according to the natural/physical laws of human economic productivity.

The richer we are, the less crime there is

People have an unusual nostalgy for old times. "Things were simpler." "there was less crime," "people lived lives in tune with nature." But this idealization ignore that people were living short lives, their living environment was filthy, they enjoyed none of the amenities that we currently enjoy, lives were tough and stressful, and crime was much higher. While the latter holds true through time along the development process into modern economies, it holds also across space, where poor countries have considerable higher crime rates than rich ones (one notable exception for violent crime may be the United States).

Carlos Bethencourt and Fernando Perera-Tallo try to rationalize this correlation with a growth model where people choose how much time to devote to production or predation. The more time is dedicated to predation, the higher is the share of output diverted to them, and the lower is total output, as predators can be considered as idle resources for national accounting purposes. An important aspect of the model is the interaction between predation time and capital accumulation. Suppose the elasticity of substitution between labor and capital is lower than one. The labor income share then increases as the economy grows. This decreases the incentive to predate, and more time is devoted to production and capital is accumulated faster, increasing the growth rate further. One can then imagine a rapid drop in predation, and possibly an explanation for the role of "institutions" in the growth process. All that remains is to convince us that the assumed elasticity is indeed below one.

The missing North-South flow of technology

Why doesn't technology flow from rich to poor countries? This question means that countries should be adopting the best technologies for their circumstances such as their factor endowmnets. Yet, this does not seem to happen. One striking example is that India, despite being abundant in labor, does not adopt manufacturing methods that would utilize large plants with lots of workers. This question is possibly related to the one why capital does not flow from rich to poor countries. This is because adopting technologies may imply significant investments that need to come from abroad.

Harold Cole, Jeremy Greenwood and Juan Sanchez think this has all to do with the efficiency of the financial system. Investors have more limited information than developers (who may also misappropriate funds), and financial institutions are supposed to bridge that information gap and monitor developers. Concretely, they model firms as located on a productivity ladder, and this location is private information and changes stochastically, the stochastic schedule being a choice of the developer. Financial intermediaries offer dynamic contracts that reward good outcomes but acknowledge that there is a costly state verification problem. The intermediary can pick the probability of audit and this is where financial development enters: audits are more efficient and less costly in some countries. If a country is rather backward in this regard, financial intermediaries have a hard time figuring out where the developers stand, and thus cannot reward them appropriately. The best effort to get the best technologies then does not happen, and this because the feasible set of technologies is reduced. Have more efficient audits, and more is invested more confidently towards better productivity schedules. And as I reported a few days ago, once these reforms are adopted, the country may actually need less foreign capital than before.

Here we go again: ABM versus DSGE

The last recession has lead to a lot of questioning about the economics profession and in particular macroeconomics. Sadly, a lot of this is rather ill-informed, including from within the profession. It is a fact that the most popular models have unique equilibria, but I remain unconvinced that what we have observed is the economy switching from one equilibrium to the other. Models that include no significant banking sector were the norm, but others were available when the need came, and more were quickly developed.

But what irks me most is that because DSGE models have somehow failed, they would need to be scrapped altogether and replaced by agent-based models, as last argued by Giorgio Fagiolo and Andrea Roventini. First, you want to improve on what we have, not throw out the baby with the bathwater. When the AIDS epidemic erupted, did we throw the whole medical profession under the bus and start from scratch with a new medical paradigm (say, aromatherapy)? No, we devoted a lot of resources to understand what is happening with the current scientists using their established methods. With this recession, some vocal people have called to scrap most of existing macroeconomics, defund research and even defund statistical agencies that try to understand what is going on.

Second, the claim that agent-based computing is any better is ludicrous. Modern macroeconomic theory is abundant in models with heterogeneous agents, learning, information issues, and perturbations. While agent-based models can potentially offer all this, they do it in a very ad hoc fashion. the modeler has to set how agents behave, and you can obtain virtually any results depending on what you assume. Sadly, there is very little effort devoted to relate the assumption with anything found in reality. The calibration based on some data is virtually absent, thus nothing can be learned. Unless you put some discipline in those models, they are useless. And once they have that discipline, I guess they are going to be quite close to heterogeneous DSGE models.

PS: Beyond having an old-fashioned view of the standard DSGE model, Fagiolo and Roventini portray the DSGE model as a three equation IS-LM model with Calvo pricing. That is definitively not a DSGE model. And ABM models are only now starting to include a very simple banking sector. So much for claiming to be able to answer current questions.

What drives the size of the shadow economy?

Why is the size of the informal sector larger in some countries than others? While it is easy to think what can drive off formal activities is easy, quantifying the contribution of each is difficult, foremost because we do not have much information about the informal sector, it is escaping the vigilance of the government, after all.

Friedrich Schneider and Andreas Buehn have a go at it. Schneider has made a living in computing and improving proxies for the size of the informal sector. They use his latest estimates for 39 OECD countries and regresses them on various indicators. While one may have doubts about the power of such estimates given the small sample lengths and the obvious uncertainty about the validity of the data, especially in a time series, one can still learn a few things, hopefully. In order of importance, these are the major factors for informality: indirect taxes, self-employment, unemployment, income tax and tax morale. But beyond doubts about sample size and degrees of freedom (what fixed factors are used in the panel regressions?), I am mostly concerned that the informality proxy used here (MIMIC) is constructed with some of the very variables (or close correlates) that are used in the regressions of the paper, namely the tax burden. I would have expected that you would use a different measure in this context, like a survey-based one or currency demand. Or used a different method than plain old OLS.

Financial reform need not increase capital flows to emerging markets

Firms in emerging markets have a hard time getting foreign capital to expand and improve, and this includes the best ones. The issue is that debt enforcement in those countries is generally weak, and few investors are willing to take such risks. But once legal and financial institutions are reformed toward better enforcement, the general understanding is that we should see foreign direct investment shooting up.

Wrong, say Alberto Martin and Jaume Ventura. Indeed, you need to think in terms of general equilibrium. Once you have put through your reform, the least efficient firms should disappear and all the funding they were attracting should become available to the most efficient ones. With this "new" internal funding source, foreign direct investment becomes less necessary, and FDI may actually decrease. And one should not be disappointed if a reform does not translate into a surge of FDI, quite to the contrary.

How much do spouses suffer from unemployment?

Unemployment spells not only reduce income, they can have lasting consequences. The next job has a lower wage than the preceding one. Unemployed workers lose human capital. They are less healthy, in particular in terms of mental health.

Jan Marcus shows that an unemployment spell also has lasting consequences on others: the spouses. Using data from the apparently inexhaustible German Socio-Economic Panel, he finds that spouses of workers who have bee laid off suffer from worse mental health outcomes. Specifically, he looks at plant closures, where the layoff should not correlate with previous private conditions of the worker or spouse (although I can imagine a plant closure is not a complete surprise and may influence their mental state). While it is understandable that the unemployed worker may suffer, for example, from depression, it is interesting to see that spouses suffer almost as much from adverse mental health. This means not only that the cost of unemployment is higher than we think, but also that spouses should also have access to the mental health benefits the unemployed get.

Should the government help in case of natural catastrophes

With the recent calamity that descended on the Northeast coast of the United States, an old claim of presidential candidate Mitt Romney resurfaced: emergency operations in such cases should be left to the private sector. Now that it has happened, this statement is viewed as embarrassing. Is it really?

It is clear that there is a case of intertemporal inconsistency here. Imagine that as a government you assert you will not help people in a flood plain, but once there is a flood, you are compelled to help. The same holds for Romney, he now stands there as a politician without compassion. But he still has a point: why should the public sector take over something that the private sector could do as well?

Well, does it? A very significant part of the rescue and clean-up operations are already being performed by the private sector. Reconstruction of homes and rebuilding the electrical grid are tasks for private contractors. The public part in this is mostly the financing of it all, through grants, subsidies and preferred loans, which are of course financed from taxes. This looks very much like an insurance scheme, thus the question boils down to whether there would be a market for private insurance against natural events, and whether this market would do better than the current situation.

Most insurance policies actually have exclusions for natural events, and for a good reason. It becomes very difficult for an insurance company to credibly cover such costs, especially if it were to include transportation infrastructure. As, say, an earthquake causes widespread destruction, the insurance company cannot spread the risk. It is an aggregate risk, and there are very few counter-parties to absorb this type of risk. Especially now that natural events are becoming more frequent and more costly, re-insurance companies have themselves a hard time providing credible guarantees.

A government is in a better position here: it can leverage its power to tax in the future to obtain lots of resources. It can confiscate goods and time (through an army) to mobilize cheaply resources towards immediate relief that is of higher social than private value. It can change the rues of the game to provide help to everyone. All this the private sector cannot do.

And, finally, if private insurance were so much better, why is there no such insurance in place, especially for governments?

The Taylor Rule does not always work

The Taylor Rule is held in exceedingly high esteem in policy circles for two decades now. Initially meant to describe the actions of the Federal Reserve after it tamed the post oil-shock inflation, it has become a policy prescription that even members of the FOMC refer to when setting policy interest rates. And this almost blind following of the Taylor Rule is not limited to the United States.

Yet, it does not seem to work that well in other countries. Rodrigo De-Losso looks at Brazil and finds that while the country was experiencing hyper-inflation, the central bank was actually following a Taylor Rule. To stabilize prices, it decided to deviate significantly from it by actually reverting the Taylor principle: to maintain inflation in check, the reaction of the policy rate to inflation became smaller, In retrospect, that was a gutsy move of the central bank, but then, there was not much to lose.

The vanishing independence of central banks

As I have claimed recently, central banks have lost considerable independence in the current crisis. Indeed, both the US Federal Reserve and the European Central Bank engage in quasi-fiscal policy because the corresponding governments do not or cannot apply proper fiscal policy. This means that what the politicians do not do, the central bank has to. This is almost as if the politicians would tell the central bank what to do.

But is central bank independence really what we need? As Marvin Goodfriend highlights, a central bank that is completely independent can leads to stop-and-go monetary policy and inflation bursts, as past history has shown. This has been fixed by imposing on central banks a price stability mandate. But central banks have no bounds on their credit policy. Look at the Fed now: it increased its balance sheet to proportions never seen before. That may be OK under some very special circumstances, but the current ones violate the principles that Walter Bagehot set for the Bank of England: the central bank should stand ready to stabilize the financial markets by lending any required amount at an interest rate above market rates. And now they are certainly below market, and for a long time. The solution is to get back to Bagehot's principle and imposing that the central bank cannot lend below market. And this will force the politicians to conduct proper fiscal policy, because the central bank will not.