Complicated Southern European recessions

On both sides of the Atlantic, the last recession was unconventional. This has meant that the mainstream business cycle models needed to be rethought to make good sense of what is happening. By that I mean, they need to be augmented or altered, not thrown out completely, as some have claimed. In doing so, one needs to identify new channels for the transmission of shocks, and possibly new shocks as well. And because this is unconventional, it is sometimes difficult to wrap one's head around some of those models.

One good example of that is the paper by Zhen Huo and José-Víctor Ríos-Rull that tries to understand the last Southern European recessions. They are looking for a model that would explain simultaneously an increase in savings while wealth and employment are decreasing. To make it work, they need frictions in the reallocation of resources across sectors, frictions on the labor market, and some shock that increases the savings rate. The latter generates then a paradox of thrift: even though savings are up, wealth is down. This comes by in the following way: as savings go up, consumption is down in a way that reduces the number of varieties of goods that are demanded. This leads to excess capacity, an apparent decrease in total factor productivity and thus the value of firms and capital decreases.

Now, the shocks triggering this are shocks to patience. Alternatively, it works as well with shocks to financial costs. Yet, I have a hard time believing that these were the triggers of the last recessions in Southern Europe. It seems to me that wealth decreased before the savings rate went up. And the reason of the former was a sudden recall of debt by Northern savers (in particular banks) that needed to cover losses in US mortgage instruments. In other words, it may have been as simple as a negative wealth shock triggering a standard decrease in consumption that gets the ball rolling. The financial costs came after. The labor market frictions and the reallocation frictions should also be enough to prevent labor to increase.

Risk management four centuries ago

I tend to think that financial management, and especially risk management, are modern creations that came about after the introduction of analytic accounting, information technology, and the rise of new financial instruments. In other words, you look one century back at firms and individual, they would have laughable financial setups by todays standards. How about some data?

Ann Carlos, Erin Fletcher and Larry Neal look at the financial marketplace four centuries ago in London. They look at firms that were discussed in the financial press at that time and reverse-engineer their ownership structure. Quite remarkably, they find that investors in those old times were not very financially literate. While there is no doubt they were among a very small elite of the population and should have known better, they were very poorly diversified. About 80% of them were investing in a single company, while there were ample opportunities to diversify. The authors think this may also have to do with shareholder voting rules, which required a minimum number of shares to be allowed to vote. But I think such rules could only emerge if shareholders were not aware of the benefits of diversification, which must have been quite large.

Reducing child labor with micro-insurance

Micro-insurance is insurance for the poorest against what sometimes seem trivial risks to us. Yet, for the poorest of this world small shocks can be devastating. It is also believed that such shocks are often the reason why parents have to send their children to work even though they know it is bad for their future. It is thus natural to study whether the introduction of micro-insurance reduces the incidence of child labor.

Andreas Landmann and Markus Frölich benefit from a randomized experiment in rural Pakistan, where a micro-credit enterprise is also offering micro-insurance to members that can be voluntarily extended to additional family members. We are talking about microscopic insurance here, like health insurance for a dollar a year. It turns out that in villages where the extension is offered the incidence of child labor is lower by up to a fourth, when combined with help filling claims. The authors interpret their results not to come from the mitigation of adverse shocks, but rather from the feeling of security.

As with all randomized experiments, the question on whether these results can generalize is open. One would need many more (costly) experiments to find assurance that micro-insurance is effective in reducing child labor. In addition, this kind of study cannot measure the aggregate impact of interventions. Imagine micro-insurance were available to everyone and child labor incidence is reduced. This is bound to increase adult wages, which may reinforce the decrease in child labor as even fewer parents need to send their kids to work. But for this to happen, we need more than a few villages.

The tax payer as a tax enforcer

I am fine with paying my fair share of taxes as long as the others do, too. I do not like it when people hide their income and thus have me pay the taxes for them. The ones gaming the system are the rich (especially where filing taxes is very complex) and the independents, who can skimp on both income and sales tax. And this is why I always insist for a receipt or an otherwise documented transaction.

Marcelo Arbex and Enlinson Mattos consider my behavior like that of an auditor looking out for tax evasion. Except that I would need to be rewarded in some way for my requesting receipts, as I guess not everyone is a crusader like me. SO they come up with a system where I would be rebated part of the sales tax I just paid in return of me filing the receipts. The government then figures out how to best set the sales tax, the tax rebate and the audit expenses. It turns out that you can do without auditing because the tax rebates have a sufficient income effect. Interesting system. Let us call it value-added tax.

(I know, it is not a VAT, but the underlying mechanism is the same as in the VAT, which is not mentioned once in the paper. And still, both the VAT and the system described above require auditing as people could file fake receipts.)

Reduced form welfare

It is not uncommon to find theory papers that assume quadratic utility or loss functions. They are the most tractable functions that allow to find an optimum, yet there is no reason to believe they have anything to do with reality. If you are designing an optimal policy where trade-offs are important, the results hinges quite a bit on the functional forms you choose.

Jasper Lukkezen and Coen Teulings look at optimal fiscal policy and go a step further. They attach a VAR (vector autoregression) to a quadratic welfare function. Not only do they assume an analytically tractable but very likely unrealistic welfare function, they also assume the rest of the economy is entirely linear with relationships that are policy invariant (it is a VAR). For their application, welfare is determined over GDP and the unemployment rate, which may be fine to determine the loss function of a policy maker but has nothing to do with the well-being of economic agents. They care about risk, uncertainty, consumption and time off work, all of which are absent from the model. Hence I do not really understand what the results mean, especially as the optimal policy rules are all over the place. A very confusing paper.

Immediate rewards prompt dishonest behavior

How can one entice people to behave more honestly? An economy where people trust each other works much better, and deals come by more easily. But if no one trusts each other, one has to post collateral for every transaction and contracts need to specify everything. One could also find ways to elicit more honest behavior from people, for example by transacting in a specific context.

Bradley Ruffle and Yossef Tobol find that providing rewards later prompts more honest behavior. This conclusion comes from a neat experiment that must have necessitated a lot of arm-twisting to realize: Israeli soldiers were allowed to roll a dice, and for every scored point they could go home a half hour earlier they day of the next release. The outcome could be observed by the experimenters, but not by their superiors. When they just returned from the previous release (Sunday), the soldiers are much more honest then when the release gets closer. This should not be surprising: as the rewards is getting more discounted further in the future, one is naturally less likely to be dishonest. The real question is whether the effect the authors identify here is stronger than discounting, factoring in that there may be hyperbolic discounting. To be honest, they look at the willingness to pay for early release, but it is negligible and seems not to corroborate the experiment results.

How efficient is net neutrality?

Net neutrality, the fact tat no one has priority over the use of the Internet, may sound very democratic, but it is also potentially inefficient. A Skype communication, which cannot afford much latency, has the same priority as an email, which can definitely afford to wait a few seconds. The obvious solution is market based: let people pay if they want less latency. This should also make the broadband hogs who need to watch videos absolutely everywhere realize how they are affecting the Internet use of others. But that would give up the ideal that the Internet is free for all and whichever way you use it.

Nicolas Curien points out that net neutrality does not imply that Internet use should remain free, both for end users and content providers. It only implies that the price does not discriminate in any way. Curien goes on to formalize in a rather convoluted way neutrality and efficiency, showing that the most efficient outcome in many situations implies some imperfection in neutrality. This is hardly surprising. Maybe more interesting is the discussion in the conclusion, unfortunately not backed up by formal analytics, that competition makes neutrality easier to enforce, and thus Europe is in a better position in this respect than the United States. I am curious whether is true.

All hail news aggregators!

Newspapers have been fighting a losing battle with news aggregators on the grounds that the latter allow readers to bypass the newspaper front pages by deep linking to news articles, thereby reducing advertising income. This argument has always puzzled me, as news aggregators allow readers to discover these articles in the first place. It appears, though, that news aggregators have a different and so far neglected impact on the newspaper industry: the content of newspapers is changing.

Doh‐Shin Jeon and Nikrooz Nasr Esfahani imagine a world where newspapers try to steal readers from each other by exploiting the presence of news aggregators. Readers are interested in a number of issues, and newspapers write articles about them. They may try to cover many issues and choose how much quality to put into the reporting. Suppose the news aggregator identifies the highest quality article for each issue. When readers switch from following the local newspaper to following the news aggregator, the newspapers are forced to specialize into a few issue and perform much higher quality reporting. As a result the readers get much better news, newspapers make get less profits, though, but only if there were few competitors to start with. If you have many small newspapers, they become niche providers on very few topic and take great advantage from the news aggregator. And we are all happy for it.

On the virtues of honest apologies

Apologizing can be very hard, especially when your pride is hurt. And sometimes one opts for a fake apology, not really meaning it. But this does not really fool the apologizee, doesn't? Is the latter then unlikely to forgive? Of course, an economist has an answer to this question.

Verena Utikal performs a laboratory experiment wherein the dictator game is manipulated to sometimes keep outcomes out of the control of the dictator, who can send a message. The receiver can then act on outcome and message, but without knowing whether the outcome was a choice of the dictator. Dictators do send different messages depending on what happened, and receivers do detect lying and punish it. If you considering that there is a mental cost in lying, there does not seem to be much of a point in providing fake apologies. Yet people do it. And consider that in this experiment, all players were anonymous and did not see each other. Imagine in the real world, where they know and face each other. The cost of lying and faking must be even higher. Yet it still happens.

Too much legalese at the WTO

The World Trade Organization exists to foster free trade and to resolve disputes about unfair trade practices. It is thus an organization that treats with legal issues over an eminently economic matter. How much is Economics used in the process? Or has the WTO been captured by lawyers.

Thomas Prusa looks at three recent decisions in the dispute process. While it is not possible to see what happened inside the WTO, it seems pretty clear from the decisions that the Economics in them is lacking. It just looks like a situation where economists have been bypassed and the decision may make legal sense, but certainly not economic sense. Prusa argues that lawyers should not have been afraid of complex, abstract economics in the cases he looks at, as simple Masters' or even undergraduate level economics would have helped reach a better decision. While there is no doubt the cases have a strong legal aspect. at least some economics would have been good.

Strict environmental policy through tax competition

Tax competition is a double-edged sword: it keeps government on their toes regarding their expenses, but it also saps their ability to provide public goods. Generally, you would want some level of cooperation across authorities, like in a cartel, as pure tax competition is not believed to reach optimal outcomes. This is particularly true with environmental regulation and taxation.

Cees Withagen and Alex Halsema claim that tax competition may lead to a first best in an environment with cross-border pollution. The important word here is "may" as it still needs to be established that it can happen in practice. The innovation to their approach is to include endogenous capital to the model: capital can flee to other jurisdictions if it is taxed too high. Governments then play against each other. This pushes them to keep capital tax rates low. With more capital and income, demand for environmental quality is higher and emission tax rates are higher. With some luck, the latter may get exactly at the first best. It all depends on the environmental demand parameters, which are hard to estimate, though. A good opportunity to find some better measurements.

Blog mentions: are they citations?

RePEc is putting up for vote some modifications to its rankings, including whether blog mentions should be counted as citations. The blog mentions are taken from EconAcademics, to which the present blog seems to be the largest contributor. So my opinion may matter whether I consider my mentioning of a paper to be equivalent to a citation.

Sometimes, I point out bad papers, and this should obviously not count as a citation. Of course, people often cite rather bad works because they want to improve on them, so nothing unusual here. Also, people often cite other works for strategic reasons, because the cited author is the editor, a potential referee, or otherwise powerful. Yet we still count that as a citation. A blog post, however, is entirely dedicated to a paper. I do not discuss it because I somehow want to gain favors with someone, as I am incognito. For other bloggers that may be different, though. What you get from my confused statements is that I am not quite sure blog mentions should count as citations. What I observe, though, is that authors do treat them differently. Never do you see an author listing a particular citation on a CV or homepage, but they sometimes do it for blog mentions. For this last reason, I tend to think a blog mention is even more than a citation, as long as there is some control over which blogs count, something EconAcademics does.

Is better rewarding experience the solution to Third World development?

We all know that developing countries lag far behind developed ones, and that the usual factors of production are not sufficient to explain this difference. Hence the emphasis in policy circles on "institutions" and other vaporous concepts. Incentives for the accumulation of capital mysteriously do not seem to work either, as first highlighted by Lucas. What about incentives for accumulation of human capital?

David Lagakos, Benjamin Moll, Tommaso Porzio and Nancy Qian do not quite address human capital as in education, but rather experience. They document with micro-data from 36 countries that returns to experience are high in developed economies, but essentially flat in developing ones. With a growth accounting exercise, they then show that this difference accounts for a third of the remaining gap after having factored in human and physical capital differences. The question is then, why is experience not rewarded in developing economies? The classical explanation of why seniority pays revolves around job-worker match quality that improves over time, job-specific human capital accumulation, and the nature of dynamic job contracts. Why would this not apply? The authors this this is because total factor productivity and experience accumulation are complements. Some literature points out this may be true: Andrés Erosa, Tatyana Koreshkova and Diego Restuccia and Rodolfo Manuelli and Anand Sheshadri.

The elderly are not decumulating their wealth fast enough

According to the standard life-cycle model, you are supposed to accumulate assets while working and then decumulate them once retired. The optimal outcome is to die with nothing left, but bequest motives and uncertain lifetimes make that difficult. Still, assets should get reduced over time. Does this square with the data? No it does not, as the elderly cling to their wealth, especially their illiquid wealth such as housing, for which they make little attempts to extract any cash from, for example through reverse mortgages or annuities (previous posts I, II).

Agnese Romiti and Mariacristina Rossi try to understand why using European data on retirees. It turns out that financial literacy is a major factor here. Financially sophisticated households (identified by numeracy tests in the survey) have a more balanced portfolio, in particular with less illiquid real estate. They also make ends meet more easily, which the authors interpret as having a consumption path closer to optimal. Finally, they are actually decumulating their housing wealth, thus more likely to actively doing something about the illiquid wealth they are sitting on. As the paper is exploiting a data set that has several cohorts, it would be good to see whether the situation is actually improving, that is, whether younger cohorts do better.

Is an imperfect monetary union leading to more volatility?

The theory of optimal currency areas initiated by Robert Mundell states that a monetary union should be beneficial between regions that have labor and capital mobility, fiscal transfer mechanisms and synchronized business cycles, or at least something approaching these conditions. In the case of Europe, this is clearly not met, but I guess the hope was that these conditions would eventually be met. The literature has been been rather superficial on what it means to not quite meet these criteria and what the consequences are. Yet, we have now techniques to model this better and test policies that could improve outcomes.

Philipp Engler and Simon Voigts do this with a DSGE model where they explicit the market structure, following the situation in the current European Monetary Union: no labor mobility, imperfect goods market integration, incomplete financial markets, no fiscal transfers at business cycle frequency, and asymmetric shocks. They find that adding a monetary union to the mix increases the volatility of consumption and employment significantly, essentially because country-specific monetary policy cannot be enacted. What can be done then? Engler and Voigts show that area-wide fiscal policy can do a lot of good, and much more than isolated fiscal policy would. And this is exactly what is missing in Europe. Absent this, one could imagine increasing labor mobility, but the trend in Europe right now seems to go the other way, with several countries thinking about restricting immigration from member countries. European integration is hard.