US local lenders knew about the housing bubble

Among the main culprits of the recent boom and bust in the US housing market that have been identified, the lenders and their excessive pushing of mortgages have been prominently featured. As pushing mortgages to people who cannot afford it seems to be a losing proposition, some pretty weird incentives must be in place for this to work. In other words, their must be some pretty sophisticated scheme in the lending business for some to make a gain from this. Local lenders, though, are not that sophisticated, as they handle most of the steps in the lending process themselves. As it turns out, they saw the debacle coming and pretty much got out of lending mortgages as soon as they felt things were getting excessive.

This is what you can conclude from the the analysis of Kristle Romero Cortés. She finds that where home prices where rising the fastest, the share of local lenders on the mortgage market was declining the fastest. In the subsequent bust, home prices were declining less in areas where local lenders were more present during loan origination. And looking at California only, foreclosures rates were lower where local lending was more prevalent. And all these results are even stronger where local lenders did not securitize the mortgages. What this shows is that there is still good value in homegrown lending, where the lender knows the markets intimately and knows to back off where things are getting dicey. Or, this can also be an indictment of the national mortgage chains like Countrywide Financial that were lending without thinking or had twisted incentives in place.

Stevenson-Wolfers on Reinhart-Rogoff

They write:

In the end, all the corrections advocated by the critics shift the average GDP growth for very-high-debt nations to 2.2 percent, from a negative 0.1 percent in Reinhart and Rogoff’s original work. The finding remains that economic growth is lower in very-high-debt countries (see chart). It has been disappointing to watch those on the left seize on the embarrassing Excel errors but ignore this bigger picture.

Click on graphic to enlarge. 

Department size and research productivity

This is a bit late for the current job market for Economics PhDs, but say you have to choose among several job offers (lucky you). The departments are are all of equal prestige and working conditions, salary, and geographic environment are all comparable. The only difference is the size of the faculty. What offer should you take if you care about your future research output?

Clément Bosquet and Pierre-Philippe Combes say you should go for the uniformly good, more field diverse, and larger department. At least this applies to French academic economists. Even more interesting, they observe that department characteristics are as important as researcher characteristics. The initial placement of a researcher thus matters a lot for her future, and this may explain why there are so few success stories after an initially poor placement, at least in Economics. Of course, the academic market in France is very different from any other country, so I am not sure the results can generalize, but this is a start.

Snapshots from the Performance

 Photo credit:  JACOB BELCHER/HARVARD OFA

The President as Financial Planner

He and Michelle seem inattentive to their own finances:

The Obamas paid $45,046 in mortgage interest in 2012, which appears from the disclosure statement to be at a 5.625% interest rate with Northern Trust. That suggests an outstanding principal balance of about $800,000. 

On the other hand, the bulk of their investments are in Treasury notes. Based on the disclosures, I estimate they hold about $3 million in Treasury notes (also held by Northern Trust), yielding 0.71% if averaging a five-year maturity. 

By selling some of those Treasuries and paying off the mortgage, they would effectively be getting five more percentage points on the amount; they would also be about $40,000 better off each year before taxes, not to mention being less exposed to notes that could take a hit from possible rising rates. 

The Obamas would pay more in taxes but make much more after taxes -- especially since they aren’t getting the full deduction anyway, due to the AMT. That's more money going to the U.S. Treasury and more money for them; Northern Trust would be the loser.

Egypt's World Beggary Tour 2013 Goes On

The rise and millennia-long fall of the Egyptian Empire continues apace. From the giddy heights of empire catalogued in the Bible to its present penury, Egypt has come a long way--down, that is, with no end in sight. The latest humiliation of course is being flat broke after the "Arab Spring" broke its back financially as tourism and FDI have disappeared due to the very poor law and order situation in the country. That is, the very essential thing a country needs to move forward--political order--is elusive post-Mubarak.

What is happening should be known to almost all readers by now. Losing foreign exchange and unwilling to give up on politically popular food and energy subsidies in a context where even more civil unrest would emerge if these are removed, Egypt is going around the world--begging bowl in hand--to cadge foreign exchange to tide it over. But, for how long can it last without an IMF deal which would unlock further emergency funding? This being the IPE Zone, the "international" aspect comes from its never-ending search for money to tide it over, while the political one comes from its leadership delaying much-needed changes to set it on a more sustainable path in fear of losing in the polls. In a number of simple steps, then:

1. Egypt's foreign exchange reserves have been dwindling since the Arab Spring events since the emergent lack of political order has hurt tourism and FDI;
2. The natural lender would be the IMF but the institution is exceedingly unpopular at home due to Egypt being a repeat borrower during the Mubarak years;
3. Moreover, the IMF is asking for long-desired reforms to do away with foreign exchange-sapping food and energy subsidies;
4. Knowing the political fallout from scrapping these subsidies, the Muslim Brotherhood-dominated leadership has been wary of doing so while its leadership position remains tenuous;
5. Something the Brothers are awaiting to secure their leadership is another landslide victory in parliamentary elections set to be re-run in H2 2013 (a definite date has not yet been set);
6. In the meantime, Egypt is cadging any and all countries--especially energy exporters whose pricey products have caused the country so much difficulty in the first place such as Qatar, (supposedly) Libya and so on. 

The difficulty in lending to Egypt is that, on its own, it cannot conceivably repay its recent loans. It is banking on the IMF coming in after (a) the Brotherhood presumably wins parliamentary elections. With a firmer political base and to please the IMF, it is hoped that Egypt can then (b) remove these subsidies which will almost certainly result in even wider mass riots. It is further hoped that an IMF seal of approval will lead to (c) both tourist revenues and FDI coming back. That's a lot of "ifs" and "buts"--not encouraging stuff for would-be lenders. Before the IMF comes in, though, Egypt is using its recent loans to literally waste on rather pointless government spending including the aforementioned food and energy subsidies that do nothing to put in on a more sustainable economic path. Meanwhile uncertainties abound. It seems the latest cadging target is none other than Russia:

During a meeting in a Black Sea resort city, Egypt's president and members of his government turned to Russian President Vladimir Putin and asked for a sizable loan, according to Putin aide. Egypt's Mohammed Morsi appealed to Moscow and Cairo's past ties, recalling how the former Soviet Union stepped in to finance the building of the Aswan High Dam in the 1960s after the United States abruptly withdrew from the project, according to Russian media. 

Still, the Russians' response seemed rather equivocal: We'll talk later. Egypt has been knocking on doors around the region seeking billions of dollars in loans, bond purchases and grants, trying to fill rapidly draining coffers so it can keep power stations running and bakeries churning out cheap bread for the country's millions of poor. 

The AP gets most big picture details right:

The most crucial piece of aid, a $4.8 billion loan from the International Monetary Fund, has been delayed by months of negotiations over how Egypt will reduce its massive system of subsidies, which the poor rely on for cheap fuel and food but which suck up large portions of the budget. The government has taken some limited steps, but many economists believe it is postponing extensive reforms until after parliament elections to avoid austerity measures that could hurt Morsi's majority Muslim Brotherhood party at the polls. The problem is: No date has been set for elections, and they won't be held until the fall at the earliest. That could mean months of economic limbo, with foreign lenders and donors reluctant to give unless there is a clear economic plan. Securing the IMF loan is considered key to boosting investors' confidence in Egypt and unlocking further aid.

In the meantime, the government has been seeking injections of cash. Overall, Egypt has sought or is in talks for more than $30 billion since the fall of Mubarak — the vast majority since Morsi was inaugurated in June, according to a compilation by The Associated Press of what has been announced. In an email, an official in the president's office could not confirm exact numbers but said the figure is "close to accurate." The official, who was not authorized to talk to reporters and spoke on condition of anonymity, did not give further comment on economic policy...

With revenues down, the government has been burning through its foreign currency reserves, which have fallen to just $13.4 billion, a third of the pre-uprising level. Much of that has gone to propping up the currency and importing fuel and wheat for the subsidy system. Egypt spends some $14.5 billion a year in subsidizing fuel and $4 billion in food subsidies, the bulk of which goes to bread. Nearly half of Egypt's 90 million people live near or below the poverty line of $2 a day. 

They have no pride for Brother Morsi will beg anywhere, anytime, anyhow. Such is the fate of modern-day Egypt. I'll bet the Pharaohs are turning in their graves:

How to contain housing bubbles

One cannot deny that housing bubbles can lead to nasty consequences, as shown in Japan, the US and Spain, for example. What can a policy maker do? Foremost, it is difficult to identify bubbles on the spot, and even in hindsight. Also, imagine the backlash when the government intervenes to rein in a booming industry. One thus needs a policy rule that kicks in automatically, or some policy that just reduces the volatility of prices. Natural candidates are transaction taxes and capital gains taxes for houses, and such taxes have been proposed not only for real estate markets, but also for financial markets in general (for instance, the Tobin tax).

Nicole Aregger, Martin Brown and Enzo Rossi exploits differences in such taxes across Swiss administrative divisions, as well as corresponding house price indices, to identify whether such taxes work. They do not. The capital gain taxes, especially those that apply to short-term gains, amplify prices movements. Why? Likely because house owners are reluctant to put their house on the market if such penalties apply, which drives prices even higher. As for transaction taxes, they have no impact whatsoever on price fluctuations. Thus such tax policies do not work, unlike you are willing to subsidize capital gains...

Why Americans spend so much on health: they work themselves sick

If you compare Americans to Europeans, you can come up with a few differences: they are richer, work more, pay less in taxes, spend a lot more on health, but are less healthy. Could all these facts somehow be related?

Yes, according to Hui He and Kevin Huang, who use a dynamic general equilibrium model to study the impact of labor income taxes on the labor supply and health outcomes. The resulting story they can tell follows essentially these lines: First, to be more likely to be healthy, you need a good amount of leisure, or not be overworked (which may explain why I have been sick the last few days). But if labor income tax is low, you tend to want to work more. This diminishes your health, which you compensate by buying more health services, which you can afford thanks to higher income. Due to high demand for these services, they also become more expensive. In the end, Americans end up with an outcome where they have more stuff to consume which they trade off with paying more for health services, enjoying lower health and less leisure. All this because of the labor income taxes. Whether they are better off is a matter of individual taste. I could certainly need a bit more leisure about now.

EU-US FTA & the Lameness of 'Cultural Exception'

There is already a certain desperation to the idea that trade can significantly be boosted between the US and EU FTA when they already have exceptionally low tariff levels. What more substantial trade barriers can be removed? Are these dynamic and growing markets? The answers, of course, are "few" and "no." Despite there being a number of obstacles to even this smallest of possible achievements--especially agriculture--one of the more interesting ones concerns trade in "audiovisual industries."

Today, I came across two interesting articles on US entertainment. The first concerns American firm director Michael Bay "apologizing" for his movie Armageddon. Alike the vast majority of US-based productions, Bay's films have next to no artistic merit despite having commercial appeal. So it's schlock, but it's schlock that finds a ready audience of gullible folks worldwide of the lowest common denominator variety [explosions! special FX! naked people! cussing!] I myself prefer watching documentaries, but that's beside the point.

Another article deals with the latest resurrected and utterly ridiculous trade grievance of the Europeans. It may seem to you that I usually side with the Europeans in trade disputes with Americans, but that's not always the case--especially over the non-issues of GM food, hormone-fed cattle, and so on. Here we have another blatant form of European protectionism waiting in the wings over the supposed cultural erosion that will occur if American films are allowed unfettered access to European markets:

The cultural exception has its roots in 1993 when a furor erupted as Hollywood, notably led by late MPAA chief Jack Valenti, wanted to include the audiovisual industries in the GATT (General Agreement on Tariffs and Trade) negotiations. Europe, led by France, balked. Member states claimed that including the arts would threaten their quota and subsidy systems and put them in danger of total Hollywood hegemony. Hours from the deadline, a deal was struck and Europe got its way.

In their current petition, Euro filmmakers say 20 years ago, “the cultural exception burst onto the international scene, leading to the recognition of a specific status for audiovisual works as they are not just goods like any others and must therefore be excluded from trade negotiations.” The group calls the proposed negotiations mandate “a renunciation,” “a capitulation” and “a breaking-point” which would “reduce culture to nothing more than a commodity.” The group further argues that the trade negotiations appear “strikingly like a conscious desire to bring European culture to its knees.”

The most vociferous opponents of this so-called cultural invasion are (surprise!) the French:

But that wasn’t quite good enough for France’s external commerce minister Nicole Bricq and culture minister Aurélie Filippetti, who said, “France has placed a sine qua non condition on its accord for trade negotiations with the United States: The full respsect of the cultural exception and in particular the pure and simple exclusion of audiovisual. The draft mandate must therefore be modified” to erase De Grucht’s “ambiguity.” They added, “France will not compromise. The exclusion of audiovisual services is not negotiable. A policy statement is not enough.”

This argument is quite frankly moronic in exactly the same way that French authorities acting as "guardians" of French language is: In a free market, no thought police are supposed to disapprove of your (exceedingly poor) taste in (lowbrow) American fare for as long as your (deplorable) viewing habits harm no one else. If people want to watch garbagey American films and don't hurt anyone in the process, then they ought to be free to do as they damn well please.

So here's a (backhanded) salute to Michael Bay and other directors of proto-garbage American entertainment from the IPE Zone. I certainly wouldn't want to watch their brand of Ameritrash, but I will strongly support the right of others to watch it. Heck, I'll even encourage you to play the archetypal American entertainer Whitney Houston's rendition of the Star Spangled Banner while you're at it ;-)

Mistakes

Several people have asked me to comment on the coding error found in one of the Reinhart-Rogoff papers. I have avoided the topic, since I don't think I have a lot to add to the discussion.  But because so many people have asked, here are a few observations:

1. Everybody makes mistakes. I once made an analytic error in one of my published papers and, after it was pointed out to me, subsequently wrote a correction (published version).  Finding and correcting errors is a part of the research process.  Sure, errors are embarrassing, but there is nothing dishonorable about making them.

2.  Policy should not be based on the results of a single study.  And my experience is that it never is.

3. I believe that high levels of debt and deficits are a negative for the economy in the long run.  My views on this issue have not changed substantially since I wrote about it with Larry Ball almost twenty years ago.

4. I never thought there was a magic threshold for the debt-to-GDP ratio above which all hell breaks loose.  The world is more continuous than that.

5. The coding error in Reinhart and Rogoff has gotten a lot more media attention than it deserves.  Some people on the opposite side of the policy debate have taken advantage of this opportunity to pound the drum for their views.  But just because someone in Team A makes an inadvertent excel error does not mean that everything Team B believes is true.  To suggest otherwise would be a truly egregious mistake.

A Reading for the Pigou Club

Europe's Cap-and-Trade Scheme Failing Spectacularly

Protestantism and economic growth

Among Christians, Protestants have a reputation of hard workers. This is motivated by the preachings of the early reformers who have emphasized literacy and hard work, to the disadvantage of wasteful fun and decorum. This was quite a break from Catholicism, where decorum and the arts are very important. I am likely not alone in thinking that this explains why the South of Europe, predominantly Catholic, is poorer than the North.

Davide Cantoni makes me doubt that now but using a dataset that has fewer confounding factors than European national data: the Holy German Empire. Indeed, it was fractures in many fiefdoms of various religious orientations. Of course, economic data is rather limited for the sample periods of 1300 to 1900, so Cantoni does what economic historians typically do in such a situation: use population data, a presumably good proxy for economic development in a Malthusian world. There is rather good data for cities, and we know how they switched their religious denomination over time. And Cantoni finds nothings. No matter how he turns the data, Protestantism has no impact. Why? Maybe because we think of the teachings of Calvin when thinking about Protestantism, while Calvin was of limited impact? But what about the emphasis on literacy?

More Endorsements

From Megan Amram, Tommy Amaker, and Larry Summers. More to come at this link in the coming days.

Of Profits & Reconciliation: Kaesong Industrial Complex

They say the road to hell is paved with good intentions, and that certainly seems to be the case here: opened in 2004 as a manifestation of the late Roh Tae Woo's "sunshine policy" of South towards North Korea, it was hoped Kaesong Industrial Complex would herald closer economic ties between the two Koreas. Located in the North near the now-legendary 38th parallel, this (quasi-) export processing zone was modelled in part on the example of other successful EPZs in the region. Through trials and tribulations you are all well aware of including North Korea's penchant to throw tantrums every so often, Kaesong has not really lived to its billing. Not only has South Korean investment there been (wisely as it turns out) somewhat limited, but closer economic ties leading to better political ones did not emerge.

That said, there have been some South Korean investors who saw potential advantages in low-cost labour north of the border. It could even have led to knowledge transfer helpful to north Korean development. Many of them poured not-insubstantial savings into facilities in Kaesong, only to be stung this year as occasional short-lived evacuations and closures since 2004 have now led to full-scale desertion of the industrial estate. Can you say "mass expropriation"?

The South Korean entrepreneurs who invested up to 10 years and millions of dollars in the Kaesong industrial complex, a symbol of economic collaboration between the Koreas that is now shuttered by the North, have little more than hope to cling to as assembly lines sit idle day after day. They say they want to go back to work. The sooner the better. They say they cannot abandon their investments in factories, or the cheap North Korean labor that helped them put aside misgivings about doing business with the South's unpredictable neighbor. Some were just getting over their beginners' mistakes and were starting to see the fruits of their work. 

But North Korea has been unrelenting in its decision to bar South Koreans from entering the factory city just inside its border, and withdraw the 53,000 North Korean workers who manned assembly lines. As the lockout enters a third week, customers of the South Korean companies are growing impatient and losses are mounting. Some businesses are quietly mulling giving up on Kaesong altogether.

"We have built the Kaesong industrial complex by the sweat of our brows, believing in guarantees that we would be able to work freely," said Han Jae-kwon, chief of the association of South Korean factories in Kaesong. "We find the reality tragic and sad that we are unable to travel to our own factories." The Kaesong complex has been nearly deserted since early April, when Pyongyang pulled the plug on its last significant economic link with the South. Most of the nearly 900 South Korean managers and entrepreneurs left soon after. Some 200 remain and are getting by on whatever food they had stored.

It does not seem fair that positively-minded South Koreans who went there for non-economic reasons--especially a desire to bring about reconciliation--are being punished for their efforts. When only one side wants to talk it over regarding Kaesong, that's not going to work as firms located there keep losing international business. But then again, how did the saying go about the road to hell? One certainly hopes they will recoup their investments when North Korea again relents on its comic-fantasist-Leninist-Marxist stylings, but the damage has been irreparably done to the idea that the hermit nation would interfere less with this project that seemed so promising all those years ago.

UPDATE: Employing North Korean style hyperbole--don't ask me why--South Korea has made an ultimatum on re-opening Kaesong and releasing the South Korean managers held captive there:

After weeks of threatening rhetoric from the North, South Korea on Thursday promised its own unspecified "grave measures" if Pyongyang rejects talks on a jointly run factory park shuttered for nearly a month. The park in the North Korean border town of Kaesong is the most significant casualty so far in the recent deterioration of relations between the Koreas. Pyongyang barred South Korean managers and cargo from entering North Korea earlier this month, then recalled the 53,000 North Koreans who worked on the assembly lines.

South Korea's Unification Ministry on Thursday proposed working-level talks on Kaesong and urged the North to respond by noon Friday, warning that Seoul will take "grave measures" if Pyongyang rebuffs the call for dialogue. In a televised news conference, spokesman Kim Hyung-suk refused to say what those measures might be. Some analysts said Seoul would likely pull out the roughly 175 South Korean managers who remain at the complex.

UPDATE 2: On 2 May, aside from "repatriating" the remaining South Korean managers these past few days still keeping guard over their firms' plant, property and equipment, South Korea has decided to lend these pioneering firms emergency aid. Call it an unexpected but most certainly welcome form of "political risk insurance" insofar as outright grants cannot be given:

South Korea has offered 300 billion won ($272.41 million) million in special loans to companies affected by Pyongyang's decision last month to close a jointly run industrial zone in North Korea, a government official said on Thursday. A government taskforce will provide the assistance from May 6 in the form of loans with interest rates of 2 percent. More than 120 South Korean businesses have invested in the border complex at Kaesong.

"The government is currently trying to provide tailored support for these businesses and once we finish determining the current status of the companies, we will continue to make more support available," said Suh Ho, a director-general at the Unification Ministry which deals with inter-Korean affairs. Suh said cash handouts to the companies were legally impossible and that loans - money for which will be taken out of various government funds - were the only available solution in the short-term.

Arab Spring F1 (Ep III): 2013 Bahrain Grand Prix

For a third consecutive year, we have controversy over whether the Bahrain Grand Prix should proceed. In 2011, it was famously cancelled despite attempts by F1 bigwigs to insulate this event from the turmoil that engulfed the region via the Arab Spring of protests against authoritarian regimes (alike that of Bahrain)[1, 2, 3]. Despite many conscientious F1 drivers saying that F1 is simply a sport while what's going on in the country is a life-or-death matter to some, the race went ahead anyway in 2012.

This year, the protesters are back in action. To be sure, the protesters are smart in understanding that the travelling circus that is F1 has few peers in attracting the world's attention to their cause annually. They have barricaded routes to the F1 track, forcing the government to again vow for the safety of F1 personnel. Why waste such an opportunity to score easy publicity? On the other hand, F1 bigwigs are sticking to the tack they've had since last year: Instead of marginalizing the protesters as nuisances, their approach is to position the hosting the race as part of the reconciliation process. Which, of course, is rather superficial insofar as it is the government the protesters are up in arms against who pay Formula one its fees. As the saying goes, he who has the gold...

Activists have demanded that F1 bosses cancel the race due to Bahrain's poor human rights record. The race which was first run in Bahrain in 2004 was cancelled two years ago following the forcible clearance of an iconic Manama landmark, Pearl Roundabout. In the unrest that followed more than 50 people died, hundreds were arrested and thousands dismissed from their jobs. Last year's race went ahead in an atmosphere of heightened security. One protester was shot dead by police...

But in a joint statement on Friday, motorsport's world governing body and Formula One management said this year's race should proceed as planned. The Federation Internationale de l'Automobile (FIA) and Formula One Management (FOM) said they "also strongly believe sport can often be a force for good and that the staging of the Grand Prix in Bahrain will come some way in helping soothe some of the issues which have been raised in the media". Protests were reported across the kingdom on Thursday night, with demonstrators chanting "No Formula on Bahrain's occupied land", according to AFP news agency.
Protesters blocked roads with burning tyres, and police responded with tear gas and stun grenades.

I am still undecided on the matter of who's in the right here, but rest assured that the govenment's intentions to use the race as a showcase for Bahrain all those years ago has since backfired ever since protests spread throughout the Middle East. Indeed, the balance of public relations is arguably negative nowadays with no end in sight as this race is held year in and year out.

UPDATE: Being ever so politically incorrect, F1 ringleader Bernie Ecclestone has labelled Bahrain's leaders "stupid" for hosting the grand prix and in the process giving protesters free publicity as described above.

What is an ordinary saver?

The banking crisis in Cyprus has been handled very poorly, few would disagree. There was foremost a deplorable approach to naming things, for example "deposit tax," and also the fact that it took so long to come to a solution, which allowed privileged people to escape losses imposed on others. However, one idea that I found rather strange was the concept that the "ordinary saver" should not be penalized.

Justina Fischer, in a paper whose length rivals this blog post, argues that ordinary savers need extra protection because they have fewer choices in savings vehicles and they may be suffering from information asymmetries. But who are the ordinary savers? Are these people with little savings? Those with undiversified savings? If household finance data taught us something, it is that there is extraordinary diversity in savings and wealth, and that the life cycle matters a lot. So it impossible to easily categorize people as ordinary by simply looking at their savings account.

That said, a deposit account bears risk and it is not a sacred cow that the government or someone else should insure at any cost. During the liquidation of a bank, depositors may be defined to be the first to be served (which is not even true in some countries, for example in the US holders of derivatives are first), but that does not mean that there is necessarily enough for them. That said, a country may decide to insure deposits up to an amount, and many do. But this is part of a financial contract that a country may not even be able to hold, as the Cypriot example shows us. And if we think a bit harder about it, this insurance should not apply to the account but to the person, like guaranteeing everyone that the first X euros in bank deposits anywhere cannot be taken in a bank bankruptcy. But anything above that is subject to usual bankruptcy proceedings.

Misallocation of human capital in developing countries

It is now well established and documented that capital and labor are very poorly distributed across and within sectors in developing economies. The impact of this misallocation is large enough to explain a non-negligible part of the gap between rich and poor countries. This analysis has, however, only pertained to worker counts and physical capital. What about human capital?

Dietrich Vollrath looks at the sectoral allocation of human capital in 14 developing economies, analyzing the marginal return by using wage data. He comes to the conclusion that the misallocation has an impact on GDP of at most 5%, more than in the US but clearly negligible to explain cross-country differences. I find this hard to believe from my casual observation. For example, in many developing economies, the brightest minds go into government administration because this is where they can extract the most rents (some call this corruption). They expand a bureaucratic machine at the expense of the productive sector. That cannot be good for GDP. Using wage data here can be misleading, as the marginal product of corrupt bureaucrats, at least in social terms, is certainly not reflected in their wage. Add to this important informal sectors where wages may be substantially mismeasured, even in household surveys, and I am not quite as confident in the data as Vollrath seems to be.

Help a Student!

A student I know (specifically, my older son) is trying to collect some survey data.  Click here if you are willing to participate.  The survey will take about 15 minutes.

Update: No more data is needed.  Thanks to the more than 1000 of you who participated.

LDC Marketing Lessons Selling to Brokebank Yanks

Here's an interesting feature I somehow missed given my interest in the intersection between marketing and international political economy. Nowadays the "American Dream" is a punch line to a sick joke only the most delusional and gullible of USA#1 cheerleaders actually fall for. (And the joke's on you, buddy, as they would say.)  But once upon a time, there was a shining idea of "America" before the world crushed its spirit of smug self-superiority. In reality, 20% of these impecunious wastrels are now worth less than zero.

Those were the days: In the commercial realm there was Raymond Vernon's "product life cycle" theory (PLC) in which the most advanced products would emanate from a highly industrialized nation (like the United States) before being sold as exports to other nations including less developed ones. Eventually, they would even be made there as the "lead" nation moved on to ever-newer innovations.

Unlike ever-decreasing living standards in the US of A, however, there is still lively debate about whether it continues to innovate. That said, it is no longer a given that whatever new products are developed in the USA and other developed countries will eventually "trickle down" to LDCs. For, the implicit assumption underlying PLC is that developed countries remain the most dynamic and cutting-edge of markets. Simply stated, when America and Europe are quite broke, there is not a whole lot of folks to buy all this innovation. It's all a bit Marxist in logic, but hey, I guess he was right about something after all.

Hence, the latest trend given (a) moribund consumer markets in the West and (b) dynamic, fast-growing markets in the developing world is that more innovations are emanating from the latter. What's more, since products coming from LDCs obviously are better attuned to the needs and wants of consumers of more modest means, hard-up Western consumers are increasingly becoming targets for products designed for LDCs and not the other way around as PLC theory and the like would suggest. Let us first remind ourselves of how badly America "existence" stinks before moving on to the opportunity...

But even in one of the world's richest countries the hard-up represent a huge and growing market. The average American household saw its real income decline between 2005 and 2009. Millions of middle-class Americans have been forced to “downshift”, as credit dries up and the costs of college and health care soar. Some 44m Americans live below the official poverty line ($21,954 a year for a family of four). Consumer spending per household fell by 2.8% in 2009, the first time it had fallen since the Bureau of Labour Statistics started gathering data in 1984.

In response, marketing to what I call Brokebank Yanks is not an entirely new skill. Firms from both developed and developing nations have become adept at meeting the needs of marginal-income consumers for the longest time, so why not transfer these valuable skills to hard-up America? It is an eminently transferable skill:

Adjusting to this new world can be hard. Companies have long assumed that America would always be a land of mass affluence and upward mobility. But the American economy was undergoing a structural shift even before the 2007 financial crisis, with galloping rewards at the top and stagnation for many of the rest. Some economists expect the malaise to last for years. Few companies have thought much about the implications of this...

The optimists' complacency creates opportunities for nimbler and gloomier competitors. It also creates an opening for companies from the emerging world, many of which have frugal innovation in their DNA. TracFone Wireless, a subsidiary of Carlos Slim's América Móvil, has sold more than 3m phones in America since 2008 to pre-paying customers. MedicallHome, a Mexican company that provides medical advice over the phone for $5 a month, as well as access to its network of 6,000 doctors, is expanding north of the border. Emerging giants such as India's Tata and China's Haier regard America as a natural market for their frugal products. The bottom of the pyramid is wider than most people realise. Firms that offer ultra-low prices will find themselves as much in demand in Detroit as in Delhi.

I guess you might as well make the best of what's around even if America is increasingly becoming a dissipated wasteland. Make no mistake: there is still money to be made if you're smart enough to cater to the American nouveaux pauvres (newly impoverished) as the Economist calls them. Those Brokebank Yanks are legion.

Are illegal drugs price elastic?

Without a doubt, the US has a huge illegal drug problem. Incarceration rates are astronomical, highlighting that prison is neither a good deterrent nor a good strategy against repeat offenses. And one can question whether prison is appropriate in the first place. In this context, it is surprising how little we know about illegal drug demand. How does it respond to enforcement, risk, penalties or prices? Good data is hard to come by and clean experiments are rare and not necessarily generalizable.

Scott Cunningham and Keith Finlay offer one case where we may have a clean case of exogeneity in that sudden scarcity for two components of methamphetamine occurred through a country-wide ban in 1995 (which quadrupled meth prices for a few months) and 1997. Using this as an instrument, they try to explain demand as measured by admissions to drug treatment facilities. The latter is the best proxy one can find for actual consumption, but is it good enough? Only if the proxy stays proportional to consumption despite severe disruptions on the markets, which I think is a heroic assumption. In any case, they find that the price elasticity of meth is very low, maxing at -0.25 after six months. Keep in mind that this is a relatively short-run elasticity, thus hardly surprising for an addictive good. Still, cross-price elasticities reveal that meth has in alcohol a pretty good substitute. Is then an intervention in meth markets really worth it, especially if it means making cough medicine difficult to buy for the rest of us?

A Message from Jason Alexander

Cannibalism in Ireland

Cannibalism within most animal species arises only in extreme circumstances. It is not clear to me why this is less prevalent than intra-species killing, as the latter has a clear negative impact on the survival of the species, whereas eating already dead fellows has no impact. In any case, there is a huge taboo on cannibalism, and humans are no different. But it happens in extreme situations, and famine may be one.

Cormac Ó Gráda studies the incidence of cannibalism during famines and focuses on Ireland. Unlike for other great famines elsewhere or before, conclusive evidence for cannibalism and especially murder-cannibalism seems difficult to find for 19th century Ireland. The famine was certainly severe enough for some hearsay about it to emerge, perhaps figuratively. Does the lack of a record imply that the Irish are more humane and principled? Or that the taboo is so strong that cannibalism is unmentionable? While the paper provides an interesting analysis of the historical record, answers to these questions would also be interesting.

A Message from John Lithgow

Something happening in reaction to nothing

Prices reflect information. We tend to test this by looking at how the revelation of new information has an impact on prices, in particular on the stock market. But the fact that no information is being revealed may also be informative, and this could lead to price changes. The question is then whether market participants are attentive enough to notice no information is coming.

Stefano Giglio and Kelly Shue study this by checking on price changes after a merger or acquisition proposal has been revealed. Sometimes they are not getting finalized, and the longer nothing happens, the longer it should become clear the fusion is off. Thus, prices should, all else equal, revert to pre-announcement levels. Looking at 5000 mergers, they find that prices underreact to the absence of news. Either there is a behavioral issues, such as Bayesian updating not working properly when there is no event to update, or there could be a rational explanation in that risk exposure, frictions or asymmetric information issues could be changing as the merger proceeds (or not). Giglio and Shue cannot exclude any of these explanations but show that the behavioral one is certainly consistent with the data. That would mean that there are opportunities to make money lying out there...

Beethoven's Fifth

A performance not to be missed.

The IMF is Unfair (Duh): Japan v Egypt

That the IMF has special and differential treatment for developed countries over developing countries is an unoriginal criticism of the institution. For whatever reason, rich donor countries do not get long sermons about fiscal profligacy, burgeoning deficits, and the need for belt tightening. On the other hand, poor borrower countries are given long sermons about fiscal rectitude, out-of-whack deficits, and the need for austerity. In other words, the poor need to bear the brunt of socially dislocating and harmful policies, while the rich go scot-free.

The recent global financial crisis has been an opportunity for the IMF to prove otherwise. As its recently disgraced and departed former leader suggested, this is supposedly no longer the big, bad IMF that prescribed "structural adjustment" as a "one size fits all" remedy to financial crises globally. Hah! To demonstrate continuing unfairness, let's begin with Japan whose national debt is beyond an unthinkable 200% of GDP. Would they receive a gentle warning from the IMF? Heck no--they are being encouraged to run even larger deficits by having the central bank purchase long-term JGBs:

Christine Lagarde has welcomed the huge monetary stimulus plan unveiled by Japan and says it will help to boost global growth at a time when the outlook is already starting to improve...Christine Lagarde has welcomed the huge monetary stimulus plan unveiled by Japan and says it will help to boost global growth at a time when the outlook is already starting to improve.

Could this "IMF [Hearts] Megadeficits" stance have something to do with Japan constantly filling the international lender's coffers?

In November 2008, in the wake of the Lehman collapse, then prime minister Taro Aso – now finance minister and deputy to prime minister Shinzo Abe – offered the IMF up to $100bn in temporary funds, while calling on other member countries to inject additional permanent capital. And when the IMF asked member states for more capital last year to boost its firepower, Japan was first to commit. Its $60bn pledge was also the largest from any country, helping to lift the total loans available to the IMF above $1tn.

“When the global economy faced its darkest hours, you stood by your fellow global citizens,” Ms Lagarde told a Tokyo forum last July. Japan’s actions, she said, had helped “stave off an even more dire global economic collapse”.

Yes, whatever--on to a national debt that's 300% of GDP (with IMF approval to boot). From Japan as a prime example of a rich nation that gets a free pass, let's turn our attention to Egypt as a repeat customer that gets a bum rap. I am certainly not a fan of the Islamist regime currently in power that has next to no understanding of world politics, international finance and so forth, but the contrast in how it is treated is stark given that the heart of the matter in both cases deals with fiscal irresponsibility. Does the IMF gladly advocate pump priming and other neo-Keynesian measures for Egypt? No. Instead, it's a Washington Consensus-like diet of killing subsidies, austerity and so forth that's held up a $4.8B deal:

Egypt is stalling on the terms of a $4.8 billion International Monetary Fund loan to help it fight a deepening economic crisis, and no deal is likely while an IMF team is in Cairo, diplomats said on Sunday. The IMF mission is set to leave on Tuesday after nearly two weeks of talks, and negotiations may continue on the sidelines of this week's IMF ministerial meetings in Washington, they said...

An IMF programme could help stabilise Egypt's economy in the rocky transition to democracy since the 2011 overthrow of former President Hosni Mubarak, unlocking up to $15 billion in aid and investment to improve a dismal business climate. But diplomats and politicians say Islamist President Mohamed Mursi had yet to endorse required tax increases and subsidy cuts that prompted him to halt implementation of an earlier IMF deal in December, two weeks after it was agreed in principle. "The mission said it is waiting until now for the government to present some of the roadmap related to reforming the economic system," Abdullah Badran of the hardline Islamist Nour party told Reuters after meeting the IMF team...

The news article also has interesting commentary on Egypt being too important to fail in Western eyes resulting in less harsh conditionalities than would otherwise be demanded by the IMF. That said, many Egyptians are clamouring for the ever-elusive conditionality-free loan. At this point, even the IMF is baulking at the suggestion. Just as before, I expect it all to end rather badly. Nevertheless, I am flummoxed by the suggestion that Japan can get away and is even encouraged to run megadeficits while Egypt gets the stick while its people are clearly suffering the effects of economic turmoil.

It's an unfair world where deficits matter for some but not for others according to international financial institutions, but hey, it was like that long before I got here. 

Rethinking Macro

The IMF is holding a conference "Rethinking Macro" on April 16-17.  You can watch a live webcast.  Click here for information.

Congratulations, Raj

My Harvard colleague Raj Chetty has won the John Bates Clark Medal.

Why is it so difficult to find a job in France?

For anybody thinking about labor market policy, France is a basket case of how you should not give in to the pressure from the street and rigidify the labor market to almost everyone's disadvantage. With such extreme job protections, do then labor market status transitions look markedly different from other countries?

Jean-Olivier Hairault, Thomas Le Barbanchon and Thepthida Sopraseuth use administrative and labor market survey data to build time series for job separation and job finding rates. While their analysis is somewhat limited by the fact that they cannot capture a third state, "not in the labor force," the results are strong enough to conclude that contrarily to, say, the US the job finding rate is the major driver in changes to the unemployment rate. In other words, employment protection is effective and the job separation rate fluctuates little with economic activity. However, hiring fluctuates a lot, and given the high average unemployment rate, it is a clear indication that employers are scared to hire workers they could not get rid of if necessary. This is a clear indictment of excessive employment protection.

Test statistics and the publication game

It is well known that journals do not like replications or confirmations of hypotheses. They are looking for the empirical results that contradict popular wisdom, and this must be influencing the way researchers look for test results. To increase your chances of success, you want to only mention highly significant results and ignore the so-so ones.

Abel Brodeur, Mathias Lé, Marc Sangnier and Yanos Zylberberg look at the distribution of p-values in articles published in the top three economics journals. I am not quite sure what the distribution of p-values would be if the publication process were unbiased, but it would probably look like a Poisson distribution and it would be monotonic on each side of the mode. What the authors find does not look at all like this. There is a distinct lack of test results that just miss the 5% or 10% significance, and distinctively more that just pass those thresholds, making the distribution bimodal. Interestingly, this problem is less present when stars are not used to highlight significance or when the authors are tenured.

These results indicate that there is more than a selection bias. This is an inflation bias by the researcher when he only presents the most significant results, which were obtained by finding the specification that allows to pass the magic significance thresholds. I do not think this is ethical, but the publishing game makes it unavoidable, so the profession is apparently fine with it. I guess we have to tolerate this and take it into account when reading papers much like we know there is grade inflation when looking at transcripts or there is similar inflation when reading recommendation letters.

PS: This paper is a strong candidate for the best paper title of the year. Bravo!

PS2: What is really unethical is claiming results are significant when they are not. The case of Ulrich Lichtenthaler comes to mind, who added "significance stars" to his results when they were not warranted. The fact that he still managed to publish widely is an indictment of the quality of research in business journals, too.

Economics Teaching Conference

For information about submitting papers or registering, click here.

Fathers are drinking away their time with their children

It is no secret that growing up with an alcoholic parent is no fun. It is even worse for single parents. How bad this is is difficult to evaluate, as one would need data on alcohol consumption by parents and a measure of outcomes for children. Maybe some proxies can help here.

Gianna Claudia Giannelli, Lucia Mangiavacchi and Luca Piccoli take time spent with the children as a proxy for child wellbeing. They use a Russian survey and look at how much time each parent spends with the children, along with their alcohol consumption. They find that fathers care less about their children when they drink more, but there is no effect for mothers. In some ways, this reminds me of the paper by Siwan Anderson and Jean-Marie Baland that shows that mothers in Kenya use ROSCAs to keep money away from their (drinking) husbands, despite the fact that ROSCAs are a very inefficient savings technology.

But let us get back on topic. Is time spent with your children the best measure of child wellbeing? Certainly not, but it is supposed to be a proxy. But on theoretical grounds, I need a lot of convincing here. Indeed, if my parents had been alcoholic, I would have preferred, all else being equal, that they spent the least possible time with me. This would reverse the conclusion of the paper ("negative impact of fathers' alcohol consumption on child welfare," implying no impact of the mothers' alcohol consumption).

"Overfinance": Iceland, Cyprus...Now Luxembourg?

The modern world has enabled many things to grow far larger than they ought to be through rather unnatural processes. Below is an alleged photo of a 30 pound "goldfish" supposedly caught in a lake in France. I still cannot believe my eyes so many weeks after first seeing this photograph, but if it's real and not Photoshopped, I am truly gobsmacked.

In a similar way, financial crises in Europe are roiling countries whose banking sectors have grown unnaturally large relative to the "real" economy. What does it matter if your financial services industry is unusually large compared to GDP? Well, go ask Iceland from a few years back or Cyprus now. Interestingly enough, the tiny country of Luxembourg which has the highest GDP per capita in the world according to some is being placed in the same category. Despite Luxembourg having an AAA credit rating, however, several European Union members have complained about its status as a low-tax destination alike Lichtenstein or Cyprus. I've even coined a term for the phenomenon that you, dear readers, ought to appreciate: "overfinance."

Now there's another "giant goldfish" sort of complaint going on among EU members that with a similarly outsized financial services sector, Luxembourg is another Cyprus-in-waiting. Luxembourg naturally disdains the comparison--we're a different case, we're special, etc--but the concern is understandable: In one sense it's highly derivative of portfolio theory or that an economy should not put all of its eggs in one basket since, if that industry becomes moribund, it will take the rest of the nation along with it. Hence the usual calls for economic diversification. But still...

As the European Union's wealthiest country, Luxembourg could have been forgiven for thinking that it would never find itself on the bloc's financial risk list. With just half a million people living on a tiny patch of lush land nestled between Belgium, France and Germany, Luxembourg is as tranquil as a buzzing financial center gets. Still, some of Europe's regulators and politicians have started wondering aloud whether its banks might be holding the 17-nation eurozone's next ticking bomb.

Following the chaotic bailout for Cyprus last week, European officials have been drawing worrying comparisons between the two countries' oversized financial industries. Mario Draghi, president of the European Central Bank, cautioned on Thursday that "the recent experience shows that countries where the banking sector is several times bigger than the economy are countries that, on average, have more vulnerabilities." 

"Financial shocks hit these countries stronger, simply because of the size of their banking sector." The increased scrutiny has taken Luxembourg's government by surprise and put it on the defensive. It has rejected calls to shrink its country's main source of wealth to a more manageable size, claiming that its banking industry is much more secure than Cyprus's and any crackdown would not only harm its own economy but that of the wider eurozone...

In comparison, the balance sheets of the banks in Luxembourg have swollen to about 22 times the country's annual economic output of 44 billion euros — making it Europe's richest country per capita. The country is also the world's second-largest center for investment funds, with about 3,800 funds holding assets worth €2.5 trillion ($3.2 trillion) — about 55 times the country's gross domestic product. It has 141 banks based there, with five of them domestic institutions and the remainder being mainly divisions of foreign banks. "There are no parallels between Cyprus and Luxembourg, and we don't allow any parallels to be forced on us," Prime Minister Jean-Claude Juncker said last week. "Cyprus is a special case; other financial hubs in Europe don't have these problems."

Just as the UK keeps complaining that the EU is trying to suffocate its financial services industry, so does Luxembourg:

Stung by the comparison with Cyprus and concerned for the future of its banking industry, Luxembourg's leaders have begun to fight back. They have accused EU officials, and Germany in particular, of bullying smaller countries and seeking to "strangulate" its financial industry — which represents 27 percent of the country's annual economic output, a third of the tax revenues and employs 20 percent of the workforce. German Finance Minister Wolfgang Schaeuble, representing Europe's biggest economy, openly wondered last month whether a business model relying too heavily on banks can still be seen as viable after the Cyprus debacle. That immediately prompted an outcry in Luxembourg.

"Germany does not have the right to define the business models for other countries in the EU," said Foreign Minister Jean Asselborn. Luxembourg's government says its financial sector "acts as an important gateway for the euro area by attracting investments, thus enhancing the eurozone's competitiveness as a whole while being effectively supervised".

The government rejects the idea of looking at the size of its financial sector only in relation to its GDP. "What matters are primarily two aspects: while the first aspect touches on the quality and solidity of the financial sector, the second element relates the size of the financial sector not to a national economy but to the euro area or single market as a whole," it said.

And there is still lingering resentment about how Luxembour's financial services industry grew so large in the first place. Call it "overfinance" meets "giant goldfish":

The success of Luxembourg's financial sector was initially fueled by lax regulation, secrecy and low taxes. This made it a popular tax haven and money-laundering spot. The country later changed many of its laws following pressure by its European partners. But critics say the financial industry still lacks the necessary transparency.

"The name Luxembourg always comes up when companies try to move profits across borders, through the so-called aggressive tax planning, to avoid paying taxes," said the president of the German tax inspectors' association, Thomas Eigenthaler. "It lacks transparency and quite often there's nothing we can do about it." Luxembourg rejects those charges and says it complies with all relevant laws. But on that front too, the pressure is increasing. 

In the wake of the publication of details on wealthy people's offshore bank accounts by several international media this week, some of which included references to shell companies based in Luxembourg, Frieden is now signaling the country's willingness to agree for the first time to automated information exchanges with other countries' tax authorities. "Unlike in the past, we no longer strictly reject that idea. We want a strengthened cooperation with the foreign tax authorities," he was quoted as telling Germany's FAS newspaper. 

Tax cheaters never win, eh?

Solow on Bernanke

In The New Republic, with thoughtful and thought-provoking commentary on the financial system.

The construction sector is key to the business cycle

It is well known that the construction sector is a very important indicator of the business cycle. In fact, residential construction has been a reliable early indicator of economic activity for many decades and this characteristic is occasionally rediscovered. What is there still to learn about the construction sector?

Michele Boldrin, Carlos Garriga, Adrian Peralta-Alva and Juan Sánchez build a business cycle model including an input-output table. Looking at the last business cycle and putting in the model only variations in housing demand, they find that the construction sector contributed to 30-60% of the increase of employment before the recession, and 8-15% for GDP. But during the recession, the importance of this sector was even more massive: 30-40% respectively 45-60%. Part of it comes from the size of the shock, and part for the inter-linkages with other sectors.

Now think about the consequences for policy: if a major part of the recession of the recession is driven by a single and relatively small sector, it makes no sense to rely solely on monetary policy as it is currently the case. Monetary policy cannot distinguish by sector (and if it does, it loses independence). One would need active fiscal policy, like what was initially intended with the stimulus program. The current austerity mood, however, goes exactly in the other direction, as public investment programs are of course the first ones to suffer from cuts. Or you can just declare that this is all a structural shift, and keep any policy out of this.

Competitive behavior by gender: jumping to conclusions

Men are more competitive than women. Whether this is genetic or nurtured is much studied and occasionally discussed here (I, II, III). I do not think there are definitive answers because it is very difficult to find an environment where one can pursue a truly controlled experiment. If we keep adding varied studies, however, we could get to a clearer picture and finally understand whether girls are at a disadvantage in a competitive environment and need to be helped.

An interesting recent study is by René Böheim and Mario Lackner who study jumping competitions. In high jump and pole vault competitions, athletes fail out after three successive misses and need to choose heights strategically as the competition evolves. They do not want to jump too much, especially as they need to keep their best jumps for last. But it is also risky to skip many heights, as one may start with three misses on a bad day. Interestingly, the strategic choices of men and women differ. Men take more risky decisions despite the fact that the return to risk is lower. What is particularly interesting here is that men and women differ in a context where they do not interact. Were they to compete against each other (applying the appropriate handicap), women would appear to be less competitive.

So is this study compelling evidence of innate differences? No. First, the women competing in jumping competitions were still raised in an uncontrolled environment. Second, we are only looking at elite athletes here, and analyzing the extreme tail of an unknown distribution does not help in making conclusions about the general population. And third, I think even the membership in this distribution tail is not equivalent. It is well-known that much fewer women participate in competitive sports, and they likely face less competition. In a winner-takes-all context, as a consequence you do not need to be that risk-taking.

The President's Latest Bad Idea

Apparently, President Obama's budget is going to include some kind of penalty for people who have accumulated more than $3 million in retirement accounts.  The details are not yet known, but I think we know enough to say that this is a terrible idea.

A sizable body of work in public finance suggests that consumption taxes are preferable to income taxes.  Completely replacing our tax system with a better one is, however, hard.  Retirement accounts, such as IRAs and 401k plans, are one way our tax code has gradually evolved from an income tax toward a consumption tax.  The use of these accounts should be encouraged, not discouraged.

By the way, exceeding $3 million in such accounts is not very difficult for an individual who is financially successful and frugal.  Under current law, a self-employed person can put about $50,000 a year in a SEP-IRA.  If he does that every year for 40 years, and his savings earn a return of 5 percent per year, he will retire with about $6 million.

So, yes, President Obama's $3 million constraint would be a significant disincentive for saving.  It would move the tax code in the wrong direction.

A Hyperinflation Vacation

From The Atlantic.

Loser's Lament: Delta Air Sues US Ex-Im Bank

The hapless and pathetic US carrier Delta Airlines seems less interested nowadays in running a viable business than in taking on quixotic wild goose chases. A few months ago it made the headlines by buying an oil refinery to help bring its costs under control. Nevermind that it's the cost of crude oil that's particularly high and not that of refining it, but hey, it made for a pretty good 5-minute publicity stunt if it did not neccessarily improve Delta's bottom line.

Now we have another act of desperation with virtually no chance of paying off: Delta has filed a case against the American Export-Import Bank for allegedly providing "subsidies" to foreign carriers it is in competition with by offering export finance to Boeing when it sells jetliners abroad. Aside from the sheer chutzpah of believing that the US government would prioritize the interests of a constant drag on its purse alike the airline industry at the expense of a viable export industry alike commercial jet exports, the term "subsidy" is arguably being abused here.

How does export finance effectively reduce the purchase price of aircraft to foreign carriers? That is the question Delta will have to build a case on. Export finance is exceedingly common especially in countries with sizeable exports. And, of course, the WTO would not entertain a case in which a domestic firm sued its own government--it's always a government taking a case against another country or countries on behalf of a firm domiciled in its boundaries. At any rate, here's to Delta for the comic relief in an otherwise bleak Stateside airline industry:

Delta Air Lines Inc has sued the Export-Import Bank of the United States over loan guarantees given to support purchases of Boeing Co's widebody planes by certain foreign airlines, according to a court filing. Delta said that Ex-Im bank's subsidies to foreign airlines, including Emirates Airlines, Etihad Airways and Korean Air Co Ltd, to help them buy Boeing planes would cause adverse economic effects on airlines and their employees.

Delta said in the filing that the bank did not properly analyze the adverse economic impact and has requested the district court in Washington D.C. block any loan guarantees...In a complaint filed in federal court in Washington D.C. late on Wednesday, Delta said one of the types of exports that Ex-Im Bank subsidizes is the export of aircraft by U.S. manufacturers, especially ones made by Boeing.

"In 2012, the bank's total exposure to outstanding financial commitments was $106.6 billion. About 46 percent of this amount was for air transportation loans and loan guarantees, more than the three next largest industrial sectors combined," Delta said in the filing.

Delta said the Ex-Im Bank loan guarantees help lower the cost of capital for foreign airline companies. "These foreign airlines will recoup their investment in their new aircraft faster or reduce ticket prices on competing routes without adversely impacting their relative rate of return on those investments," Delta said in the filing. Delta argued that unsubsidized U.S. airlines will be forced to respond by "reducing their prices and reducing or altogether eliminating their capacity to serve those routes where they compete with bank-subsidized foreign airlines."

The whole point of trade finance is to make goods alike American-made jetliners available for purchase in LDCs where commercial finance is not sophisticated enough. To brand this kind of activity "illegal" would hurt any number of American exporting industries by precedent.

Why would the US sacrifice substantial exports to satisfy the (protectionist) interests of an utterly substandard airline like Delta? Even in present-day America, rewarding mediocrity has its limits.

Who cares about the median voter? Not the politicians, maybe

Most implementations of political economy in economic modeling assume that the median voter is the determinant voter. Some studies may take into account that the likelihood of voting is not the same for everyone, but the basic principle is that politicians adjust their proposals according to some sort of median in a universe where every man and woman has roughly equal weight.

Pablo Torija tests this by looking at which parties were in power in OECD countries. Assuming that voter preferences are quadratic in income and depend on the distance of the individual's policy preference to the one of the party in power, one can then determine for which household this policy would be optimal, and then see where this household is in the empirical income distribution. The actual implementation is a bit more involved than that, as parties' ideology is coded on a linear scale, and this is interacted with income. All this is then regressed on happiness indicators from surveys to proxy for utility.

The results are striking. Right-wing parties' median voter is at the 99th percentile. For left-wing parties, it is at the 95th percentile. That is for 2009. Extrapolating the empirical model, it is much closer to the median in the 1970s. But are these results believable? For one, the policy preferences of the individual somehow vanish between the simple theoretical model and the empirical implementation. And more generally, static preferences that only depend on income and ideology seem rather crude. Is this income before or after taxes? That can have a tremendous impact. And people may care about other things, see for example the recent debate about the importance of leisure and working conditions in US and French tire plants. I suspect that results are biased upwards by all this.

A Nice Example of Technological Progress

Is kidnap insurance a good thing?

In some countries, kidnapping for ransom has become a common and profitable business. It does not strike as an added-value generating activity, but one has to live with it. One way in which markets have responded to this is that it is now possible to by kidnap insurance that pays ransoms. Is this a good thing? Indeed, kidnapping frequency may increase if there is a higher likelihood that a ransom is going to be paid. That is not unlike US colleges that charge higher tuitions because they can, as public funds for students grants and loans have been ramped up. But let us keep talking about criminal kidnapping.

Alexander Fink and Mark Pingle look into this issued. The first question one may ask is whether this kind on insurance is sustainable in the first place. Indeed, many insurance markets fail due to adverse selection or moral hazard issues. In this case, risk aversion on the insureds is high enough that they are willing to pay premiums sufficiently above what would be actuarially fair. Indeed, there is a risk of getting somebody killed, and optimal kidnappers would want to randomize over this just to make sure that they can extract the most. The presence of insurance will increase the number of kidnapings, but if it does not do this too much, one should see a reduction in killings. We can thus not unambiguously say that kidnap insurance should be allowed.

Dating Advice from Ed Glaeser

Believe it or not.

Are economists really uneasy about studying inequality?

Economists are often misunderstood. People do not understand what we do. They think we spend all our time forecasting the stock market. And the whole profession has been accused of not foreseeing the recent recession. Some economists have redirected this criticism and made a name for themselves by complaining that economic models do not take this or that into account. That is true, but this is often irrelevant, as models are abstractions and they cannot take everything into account. You want to build the right model for the particular question at hand. I have mentioned a few of those essays on this blog, in part because they frustrate me as they are ignoring the very literature they are calling for. There is a lot more to Economics than the principles with perfect markets we tend to teach as an introduction to the field.

The latest paper to frustrate me is by Brendan Markey‐Towler and John Foster. They claim the Economics profession is uncomfortable with issues about inequality to the point of ignoring them. To support this, they quote extensively from the introduction of the Handbook of Economic Inequality, which of course is going to try to make the case that inequality is underrepresented in the literature. Why so? Markey-Towler and Foster claim this has to do with the profession's adherence to Arrow-Debreu markets, welfare theorems, the Hicks-Kaldor efficiency-equity trade-off, and Arrow's impossibility theorem. Because the profession is so enamored in these theorems, it views the impact of inequality to be political only, but of no economic consequence. Never mind that you can still have inequality in such economies. Never mind that every issue of the top journals has papers with such properties and inequality. Never mind that many papers go through great lengths in trying to model observed inequality while studying many issues. I agree not every paper does this, far from this, but then not every answer hinges on inequality. Again, models are an abstraction, and one cannot include everything. One keeps what is most likely to matter. Occam's razor is still valid today.

Markey-Towler and Foster have this distorted and unfortunately common view that economists believe markets are always complete and perfect, and thus inequality cannot happen. This sounds a lot like those who criticize Economics after taking one class, where they learned that free markets and free trade are good. But economists have long realized that things are much more complicated than that, and the study of the departures from this perfect world dominates current research in Economics. In fact, read this blog and you should see that I hardly mention such perfect markets. The authors' solution? Complex systems theory, which I liken to modeling the actors of an economy being linked by a giant plumbing system with leaks, plugs and bottlenecks. That sounds much like the frictions, information asymmetries and imperfect competition we put in our models, except that complex systems theory is much more detailed, requires gigantic amounts of data to calibrate or estimate, and has gone nowhere so far. So researchers had to resort to heroic assumptions to show something could happen, without any ability to validate it empirically.

I do not think this is the way to go, and we can agree to disagree on that. But I take offense at the idea that economists are somehow uncomfortable, even scared of dealing with inequality. That is just not true.

Efficient raffling of public goods

How to provide for a public good is a classic problem, because of the free-rider problem. If you cannot compel users, say, by forced taxation, it is very difficult to recoup the cost of a public good, unless the cost is very low and the benefit to each user very large. That rarely happens. So how can you solve this conundrum when philanthropy is not available?

Jörg Franke and Wolfgang Leininger propose an algorithm based on raffling the cost of the public good. This ideas is due to John Morgan: you create a lottery for the benefit of a socially beneficial public good. Then, people are willing to pay more for the public good. But this is not yet sufficient for the efficient amount of public good. To get there, Franke and Leininger propose an unfair raffle. The raffle tickets are sold at prices that look like Lindahl pricing, but unlike in the Lindahl model, there is no coercion. While there are already many charity raffles that would fit the Morgan model, I cannot think of an unfair public-good raffle in practice, though.

Five Lessons from the Financial Crisis

From Olivier Blanchard.

Obama's Anti-China Free Trade Area of Free People [sic]

Question: What do you get when you cross the EU-US FTA with the Trans-Pacific Partnership?
Answer: The Free Trade Area of Free People (FTAFP)[sic]

During the Cold War, older readers will remember that the United States began funding pro-democracy propaganda via Radio Free Europe, Radio Free Asia, and so forth. Now that the Cold War is over, we are, er...supposedly returning to that same sort of mentality from the Yanks. Or, at least news sources are telling as alike the Financial Times. Maybe it was a slow day at the world's premier financial newspaper, but it too has succumbed to this temptation of portraying US FTA initiatives as those meant to "bandwagon against" China in the economic realm.

I am honestly wary of this characterization since it, first of all, brings us back to the framing of trade as inherently conflictual when it's supposed to be mutually beneficial as per the theory of comparative advantage. Moreover, hasn't China pursued FTAs of its own especially in Asia that pointedly exclude the US and other Western nations? At any rate, an argument being marshaled is of China's exclusion helping to appease trade-phobic American lawmakers:

But much of the substance of the EU talks and of TPP points to China. The agenda includes state subsidies for business and protecting intellectual property – precisely the sorts of issues that are becoming huge bones of contention with Beijing. If the US can get enough important countries to sign up, it hopes to establish global trading standards that China would feel obliged to respect. On Capitol Hill, where free trade is not an easy sell in an era of unemployment of more than 7.5 per cent, the China angle is being used to rally support. “This is very much part of our China strategy,” an aide to a leading Republican senator puts it, talking of the discussions with the EU. 

And speaking of my admittedly, ah, tortured title, there is supposedly an emergent coalition of the WTO-plus trade willing to paraphrase a former American leader:

TPP and the US-EU trade talks represent an alternative strategy, an attempt to forge fresh rules by appealing to smaller groups of like-minded nations, in this case working around China rather than with Beijing. Supporters say this is not an abandonment of global institutions such as the World Trade Organisation but simply a realistic assessment of how to get things done.

You're either with us or against us in trade. Where have we heard something similar before? That said, I am doubtful whether joining up the TPP and US-EU FTA really is an American goal to isolate China in trade. After all, both American-led initiatives are hardly done deals and both face formidable obstacles to completion, so we cannot even begin to speculate about their merger.

That said, you must admit that Free Trade Area of Free People [sic] has a nice ring to it.

Overconfident NBA players are lead to a financial demise

Some professional athletes manage to amass amazing fortunes only to file for bankruptcy a few years after their retirement from sports. How can such large wealth go to waste so quickly? The typical explanation is that poor investments were made. Why does it happen so frequently to them? My take has been that either their wealth attracts swindlers, or the comparative advantage of these athletes is not human capital, or both.

Ruby Henry thinks this has to do with over-confidence. He builds a database of NBA players drafted in the 1990's and collects from various Internet source information about their personalities and their professional characteristics. The first sign of trouble is that most of those venturing into entrepreneurial undertakings do it in food services or real estate, two sectors were bankruptcies are particularly common. The second sign is that they do not seem to diversify much. One can interpret this as the consequence of over-confidence in one's ability and luck. Ruby measures the level of confidence of a player with the number of 3-point shots attempted per playing minute. And it appears that shooting for more 3-pointers later leads to more business ventures, and more bankruptcies. That would explain the variation across NBA players. But does that explain why NBA on average have more bankruptcies, and especially more spectacular ones?