Rent control and home ownership

A new and recent trend in the United States has been the decline in the homeownership rate. While I have mentioned before that homeownership (the "American Dream") is not necessarily a good thing, both privately and socially, it is heavily favored by government policies. And while obviously the recent housing debacle has reduced homeownership, the trend started before that. To understand why the trend is down, it may be of interest to understand how it went up.

Daniel Fetter looks at the period where the nationwide homeownership rate went up the fastest, World War II. Paradoxically, this was a period were home construction was actually severely restricted. Yet, the 10 percentage point increase (half the increase over the entire century) happened in the context of widespread rent control. Exploiting differences in rent reductions through control across cities, Fetter finds that a majority of the increase in the homeownership rate was indeed due to rent control. I suppose it was renters somehow coerced by their landlords to buy the home they lived in, with no alternatives available. Would this mean that imposing rent control now would reverse the decline in ownership? I doubt it, as the market has now segmented between owned homes and rented apartments, and they are not close substitutes for the most part. And you would not want rent control anyway.

The role of marginal non-participants in the labor force

While the unemployment situation in the US is gradually getting better, the numbers on the labor force participation continue to decline. This worries a lot of people because this can be a sign that some of the unemployed are getting discouraged and drop out entirely out of the labor force. But it may also simply be the continuation of a trend for a few decades already of a steady decline in the labor participation rate, in which case this would be much less worrisome.

Regis Barnichon and Andrew Figura add to this discussion that we should not only think about three categories (employed, unemployed, and not in the labor force), but four by adding the marginally not in the labor force. They are not in, but are close to getting in the labor force, an typical case being a discouraged formerly unemployed. These people tend to join by being unemployed first, while other nonparticipants join the the labor force by transitioning straight to employment, because they value not being in the labor force (students, retirees, mothers) and can only be attracted with a job. Barnichon and Figura document that the numbers of marginals has declined for quite some time, which can explain of decline of a half percentage point in the unemployment rate from 1976 to 2010. This cuts across all demographic groups, so a demographic shift can be ruled out as an explanation. The last recession may have unraveled all that, though, we will need a few more years of data and a full recovery to determine whether the trend continues.

Policy and academic macro

Academics are in their ivory tower and have little real world or policy impact. That is the view that is often conveyed by those who do not know what those academics are up to. It is also a common justification by policymakers for ignoring any advice coming from academia. I have lamented many times that politicians routinely disregard advice from scientists (including economists), particularly by focusing law-making on the means instead of on the goals. That said, I recently mentioned work that argued that Keynesian policies will always appeal more to policymakers than Hayekian ones, because it gives them a reason to do something in times of crisis.

Michel De Vroey compares rather Lucas to Keynes. Lucasian macroeconomics relies a lot on internal consistency. This disciplines the theory a lot, but this acts also a straitjacket that in unappealing to policy makers. Keynesian theory has a lot more hand-waving regarding consistency but seems to have an answer for everything because it can cut corners (even if answers may turn out to be wrong). The fact that it appears to be so flexible and know-it-all (like those "economists" that are willing to answer any question journalists may have, I would add) makes Keynesian theory a magnet for policymakers, especially in terms of crisis. And this is why, with the last recession, macroeconomics has been declared to be in crisis, because it listened to Lucas and not Keynes for three decades and did not always immediately have answers.

This is an argument written by someone in the ivory tower. Contrast this with someone involved in policymaking. The very recent interview of James Bullard seems to say the exact opposite. Policymakers, at least monetary policymakers, are very much looking at Lucasian theory for help. In his words, "there is still no substitute for heavy technical analysis to get to the bottom of these issues" (speaking of the financial crisis) and that is happening with structural, internally consistent modeling. Hand-waving does not cut it. And I agree.

Pioneers of the static interest rate

When an author describes his work in the abstract or the introduction, it is common to highlight what is "new," "novel," "unique," an "improvement," or "better." But you do not write that your paper is "pioneering" or "seminal," as this can only be established by others in hindsight.

That does not stop Sarbajit Chaudhuri and Manash Ranjan Gupta, who start their abstract with "This paper makes a pioneering attempt to provide a theory of determination of interest rate in the informal credit market in a less developed economy in terms of a three-sector static deterministic general equilibrium model." OK. So we have a static model to determine the interest rate. That is pioneering. I always thought the interest rate was tied to the relative price of commodities in different periods. I guess the genius here is that with a static model, one needs not to worry about future shocks and even current shocks are instantaneously resolved so the model is also deterministic! This allows to simplify everything to a great extend, but apparently still provides a major improvement of Gupta (1997), that was, however, already pioneering the static determination of the interest rate. So the pioneership of this paper must lie elsewhere. I think the pioneering aspect is rather in the assumption that there is no flow across regional informal markets and moneylenders have a local monopoly. Imagine the pioneering strides we are now making towards a closed-form solution of the model!

Paid maternity leaves are regressive

Quite a few countries guarantee paid leaves for new mothers that not only allow them to get back the same job they left, but also gives them the financial wiggle-room to well take care of their new offspring. This time at home without worries is good both for the mother and the child, although one can suspect that this time off work can have adverse implication on human capital and the future career path for the mother. Paid maternity leaves are also often promoted as a way to conduct social policy across all social strata, as they apply to everyone.

Not so fast, say Gordon Dahl, Katrin Løken, Magne Mogstad and Kari Vea Salvanes. They look at Norwegian data, where the paid leave was increased from 18 to 35 weeks between 1987 and 1992. As it did not crowd out unpaid leave and expanded the time spent at home for the mothers, we should see some positive effects on child development in the country. None of that seems to have happened, not even on parental earnings, labor market participation, fertility, marriage and divorce. So it seems to be a rather useless reform. Worse, this expansion redistributed resources the wrong way. Indeed, in the absence of crowding out unpaid leaves, the reform corresponds to a pure leisure transfer to upper and middle income families (lower income families tend to have fewer working mothers in Norway). The reform is thus regressive. And we have not mentioned that there are obvious costs to someone for paying mothers while they do not work.

Lack of transparency at the American Economic Association

I have complained several times on this blog about how the American Economic Association is run, particularly how its executive and committees are constituted almost exclusively of faculty from the very top universities, and mostly private universities, see the current slate of officers (Past posts: 1, 2, 3, 4). This lack of representation leads to apparent nepotism in the distribution of awards, and this can lead to suspicions of the same for acceptances to its annual meeting program (especially the printed, unrefereed proceedings) and to its journals. I have called in the past to write in at the elections a candidate that does not fit the profile of current AEA officers, but rather a common member of the association. But the AEA has only announced the winner of the election, with no vote tally. As this does not look very transparent, I enquired with the AEA Secretary-Treasurer, Peter Rousseau, whom I asked about full election results and how they are certified. Here is what he answered:

The long-standing policy of the AEA in reporting election results is to report only names of those elected. This policy was re-visited by the Executive Committee several years ago. The minutes of that meeting state:

"A member requested that the number of votes for each candidate in the annual election of officers be reported publicly. Current policy is for the Secretary-Treasurer and Administrative Director to certify the vote counts, which are tabulated electronically, and to report only the names of the successful candidates. After an interesting economic and psychological analysis of the advantages and disadvantages of reporting individual vote counts, it was decided to retain the Association's policy of reporting only the qualitative outcome of the annual election of officers."

The bylaws clearly state that the Secretary certifies the results. Please be assured that it is my fiduciary responsibility to the membership as its agent to report those qualitative results accurately.

Thank you for supporting the AEA and its mission of encouraging economic research worldwide.

So it is the very executive committee that is suspect of inbreeding that is at the origin of this policy of obfuscation of the election results. And it is a member of the executive committee, the unelected Secretary, that certifies election results and only releases part of them. This is how dictators run sham elections.

High Japanese debt will become a problem

Japan has been able to sustain unusually high debt levels for a long time, even when other countries were facing debt crises despite having lower debt to GDP ratios, and more sustained GDP growth. What makes Japan so different, and what does this imply for the sustainability of Japan's debt?

Charles Yuji Horioka, Takaaki Nomoto and Akiko Terada-Hagiwara analyze the recent evolution of Japanese debt and have a grim outlook. Up to a few years ago, the debt was largely financed by Japanese households saving towards retirement. But as Japan is continuing through its demographic transition toward an older population, this source of funding is going to quickly dry up, if not reverse itself as an older population requires more transfer payments. During the few last years, an increasing share of debt was bought from abroad by investors looking for safe alternatives during times of financial turmoil. This temporary funding allows to mask the underlying drying up of internal funding. This foreign debt also carries a shorter maturity, so we may expect soon some problems in Japan, especially if other investment opportunities start looking better. Unless the Japanese government gets its fiscal house quickly in order, we may see again a country struggling with its debt.

Is France less distorted than we think?

When you think about market distortions through regulation and taxation in a developed economy, you think first about France. It is the prime example of how excessive government intervention can lead to disincentives for production and to major misallocations of resources across firms and sectors. This all accepted wisdom, except nobody actually measured the misallocation part.

Flora Bellone and Jérémy Mallen-Pisano do this using the Chang-Tai Hsieh and Peter Klenow methodology which consists of using a model of firms heterogeneous in their use of capital, labor and technology. Taking this to data, distortions in the use of factors at the firm or the sector level translate into lower aggregate total factor productivity. Hsieh and Klenow showed that there were massive distortions in China and India relative to the USA. Bellone and Mallen-Pisano show that for France, there are no more distortions that in the United States. Thus, there are no misallocations across firms or sectors, but it remains that there can still be a uniform misallocation across the entire economy, say, because of distortions on the labor market applying equally to all firms.

How the Internet is changing our daily lives

There is no doubt that the Internet has changed the lives for many of us, both at home and at work. Email, online retail, online news and plain googling around have transformed the way we communicate, inform ourselves, work and shop. How much this happened is an open question, and it must be very heterogeneous.

Scott Wallsten offers some important insights thanks to the American Time Use Survey. Comparing survey responses from 2003 to 2011, he figures out what time spent online must have crowded out. One third of it comes out of leisure, mostly TV viewing, another third of it working, one eighth less sleep, one tenth less traveling, and the rest from household chores and education time. Can we consider that this mix also represents what we do on the Internet (except for the sleeping part)? Not necessarily, as it must also have transformed the productivity at doing things. For example, news reading is now much more efficient, in my case working, too, but it is easy to wander off during surfing, and this must be increasing leisure time.

Note that the ATUS measures only "computer use for leisure" but I figure that a survey respondent working at home on the Internet must have be confused what to answer. Indeed this is the only way it would make sense that online time would have reduced work time. As far as I can see it, online time at work is not measured.

Avoiding the Lewis path

In the best of all worlds, improvements in agriculture productivity leads to surpluses that allow capital accumulation and the development of industry, which then provides better inputs for agriculture. This is a virtuous circles that eventually leads to agriculture using only a tiny fraction of the workforce and representing a minuscule portion of GDP. This so-called Lewis path to growth has happened in many western economies, but does not seem to take off in Africa, in particular.

Bruno Dorin, Jean-Charles Hourcade and Michel Benoit-Cattin show that the Lewis path is not the unique equilibrium path in a growth model. A particular concern is the so-called Lewis trap that would result from a lack of additional agricultural land, where agriculture keeps growing in the labor force for little gain in output. But why insist on farming where land is no good? We have a global economy now and can produce goods where the comparative advantage is highest. Many areas of Africa are simply no good for agriculture, so we should stop insisting that they should go through all the motions of the Lewis path. Go straight to manufacturing and import food (my previous rant on this). This would also imply that other areas would specialize in agriculture, which is good even though the authors complain that this would lead to urban poverty there. People will move where the jobs are, for example to charter cities.

The fundamental equation of economics

It is every physicist's dream to find a formula so powerful that it can explain everything (and carry the inventor's name). Such hopes are not as prevalent in Economics, first as we realize that we cannot find such a fundamental equation (we are just not smart enough), second because an economy is so complex that it defies any attempts to reduce it to one equation.

This does not stop James Wayne, who as a physicist is still pursuing his dream. And he claims to have found the Fundamental Equation Of Economics (FEOE), thereby finally proving that Economics is truly part of Physics. What a relief. And what is this equation that can, as the author forcefully argues, explain all observed economic phenomena and solve all economic problems, without exception? What is this formula that shows that equilibrium, the laws of supply and demand, DSGE and SL/ML (whatever that is) models are all deeply flawed? Here it is: The change in time of the joint probability distribution of future valuation of assets and liabilities is a function of its current distribution. We do not know yet what this function is, because it is currently too difficult to figure it out at the atomic level, but we know it exists. Now we can go revolutionize Economics and solve the world's problems.

Long live the Wayne Equation!

Why do some bikers not wear helmets?

There are no laws mandating helmet use for motorcyclists in many developing countries and some US states. In the first case, such laws are likely unenforceable, in the second I suppose the American urge for "freedom" makes such laws inappropriate and the hope is that motorcyclists would have the common sense to use helmets. So what determines why some choose not to wear a helmet?

Michael Grimm and Carole Treibich went to Delhi and surveyed motorcyclists, focusing on helmet use and speeding. Some of the answers are not surprising: the bare-headed ones are less risk-averse, younger, less educated and less informed about accident and fatality rates. More interesting is that speeding and not using a helmet seem to be strong substitutes. Imposing helmets alone would thus not necessarily improve safety. One would have to impose helmets and enforce speed limits. That is likely too much to expect from India though, where just informing about the true risks may be more effective.

Why severance pay?

In many countries, it is customary or even mandated that firms should pay employees they let go a severance package. While that may make sense as compensation for a labor contract that is getting broken, mandating it under all circumstances may make little sense on a first glance. It adds to firing costs and may lead firms to retain less productive workers too much. And from having witnessed that first hand, this can induce an employee to become a poison for everyone else to tease out severance pay after getting fired.

Donald Parsons goes through the rationale of mandating severance pay and compares it to a labor market where no such pay is mandated. It turns out there would be not much difference, as firms do voluntarily offer severance pay, as mentioned to break a contract, but also to avoid having an employee move to the competition. On a aggregate level, such pay does slow down worker movement a little bit, but it also has its advantages. For example, it can substitute for unemployment insurance for some time and it can insure against wage loss in reemployment. This is good, especially if moral hazard or administrative costs in these programs are high.

Self-delusion in Basel II

The Second Basel Accord was put in place to more effectively prevent bank failures. The first one imposed some rather rigid rules that where not taking into account the true risk exposure of the banks, which obviously varies according to the particular activities of the bank and overall economic conditions. Basel II is more flexible in that it allows banks to used their risk models and scenarios to determine how much capital they need to secure. The goal is to have sufficient capital in 99.9% of cases of unexpected losses, or a failure once every 1000 years. That is pretty safe.

Except it is not. The first exhibit is of course what happened during the last recession. The second is a paper by Ilkka Kiema and Esa Jokivuolle that shows that in fact only a fraction of the regulatory capital needs to be loss absorbing capital. Indeed, half can be subordinated debt and thus not available when needed. According to the authors, this means that the true risk of bank failure is every 20 to 100 years. Not very reassuring, and Basel III does not seem to really address this.

The price of long-run risk

In dynamic stochastic models, standard utility function specifications imply that the curvature of this function determines directly both the risk aversion and the elasticity of intertemporal substitution. When calibrating this, modelers have a tendency to be waving hands a bit too much, as they focus more on one than the other. In addition, their calibration seems to be immune to changes in data frequency. Those who are careful about this use Epstein-Zin preferences which disentangle risk aversion and the elasticity of intertemporal substitution. They think they have done all they could to address a proper calibration.

Well, not quite. Larry Epstein, Emmanuel Farhi and Tomasz Strzalecki show there is a third dimension in play, the temporal resolution of long-run risk. Indeed, the interaction of risk aversion and elasticity determines whether economic agents prefer early or late resolution of risk. This matters. Indeed, long-run risk is priced by markets differently than short-term risk, typically higher. Indeed, people are willing to pay to know uncertain outcomes earlier. But we do not know how much so far. An opportunity for additional research.