Why so much policy focus on home ownership?

Some have blamed the Community Reinvestment Act (CRA) for the too risky lending to US homeowners during the house price run-up. Actual evidence for this is hard to come by, though. In this previous post, I discuss that there was indeed more risk taken, but it is not clear whether that additional risk was priced in or not. And were we to blame CRA, it would show in banks giving loans to neighborhoods that should not have received them for economic reasons, only to satisfy CRA.

Patrick Bayer, Fernando Ferreira and Stephen Ross look at the history of mortgages that they can link to credit scores and demographic characteristics. They find that for the same credit score, blacks and Hispanics were much more likely to run into mortgage trouble. While the authors do not mention this, the CRA was clearly targeting neighborhoods with such populations, and banks had to lend more there to comply. This would indicate that there is at least some truth to the CRA blaming. The authors frame this result rather by writing that this is evidence that favoring homeownership is not a good way to reduce wealth disparities. I would agree, but also because owning a home is very poor diversification, especially when this is all the wealth you can have. And there is no evidence that homeownership is good anyway, to the contrary.

Culture War: Muslim Brotherhood v Cairo Opera House

 The scoreline reads: Muslim Brotherhood 1, Giuseppe Verdi 0.
 
It is no big secret that Egypt's currently ascendant Muslim Brotherhood has shown a knack for shooting itself in the foot with its fundamentalist proclivities. Without any real, organized opposition to it--least of all the ineffectual Twitter cyber-mobs--the Brothers have not exactly been reluctant about imposing control on the rest of society:

The row [over the Cairo Opera House] has opened a new front in the politically divided country, with performing artists joining a chorus of others who say they are fighting attempts by the Muslim Brotherhood and other Islamist allies of President Mohammed Morsi to impose their control. Other battles have raged in the judiciary, the education ministry, the agriculture ministry, and the media. Protests have erupted over fears that the Brotherhood has also tried to control the police and the Sunni world's pre-eminent seat of learning, Al-Azhar in Cairo.

How do you reconcile Islamic fundamentalism with (a) secularist voices in Egyptian society and (b) the economic necessity of tourism and foreign direct investment from foreigners? Unsurprisingly, the Brothers have failed to do either. After decades of being politically marginalized, it is no surprise that they are reacting to their ascendancy with gusto. That said, as an energy-poor Arab nation, they do not have inbuilt sources of foreign exchange to rely on which enable them to tell Westerners to shove it. Previously I wrote about an up-and-coming generation of leaders who recognize the need to cotton up to tourists by welcoming beer and bikinis. Unfortunately, it seems these progressive folks are few and far in between in the leadership ranks. Witness today's example of Alaa Abdel-Aziz, a censor [!] recently named Egypt's minister of culture who is currently rankling the obviously Westernized denizens of the Cairo Opera House:

In the case of the Opera House, those fears were fueled by comments by an ultraconservative lawmaker in parliament this week. Nour Party member Gamal Hamid called for the abolition of ballet performances in Egypt — which are usually held at the opera house — describing it as "immoral" and "nude art". So far, the culture minister, a professor in film editing who was appointed in a cabinet reshuffle three weeks ago, has not made any attempts to impose any overtly Islamist restrictions on the arts. But his opponents in the ministry fear his shakeup of staff aims to eventually do so.

Meanwhile, the show is not going on as the new culture minister's, well, ministrations have not met with favour among the opera house staff:

The Cairo Opera House has become a new battleground between supporters and opponents of Egypt's Islamist president, this time fighting over the direction of the Middle East's oldest music institution. The new culture minister fired the head of the opera house, part of a shakeup he said is aimed at injecting "new blood" across art and culture programs he says were stagnant and corrupt.

But staffers are refusing any other boss to replace Enas Abdel-Dayem. Tuesday night, they protested outside her office, accusing the minister of bending to pressure from Islamists, and some held a sit in overnight to prevent any replacement from entering. Staffers have also closed the curtain on all performances. For the first time in the opera house's history, the opera Aida — composed by Giuseppe Verdi and debuted to the world in 1871 in Cairo— was cancelled in protest. Singers instead held up posters on stage that said, "No to Brotherhoodization."

It's not clear whether the culture minister finds subject matter of the opera "corrupt"--as you would expect fundamentalists of any stripe to be--or just the management. Either way, don't hold your breath waiting for performances of Tasso's La Gerusalemme Liberata lauding the exploits of the first crusade to "liberate" Jerusalem from, well, you can figure the rest out.

 

Meanwhile, add this as another example to discourage foreign-exchange bringing tourists as the culture police make their presence felt. Avast with ye foreign affectations! Opera...such Western decadence!

Open science in commercial firms

Universities engage in research and put result in the public domain because it fosters the public good. In recent years, though, they have put more focus on patenting research results in order to obtain more revenue in the face of dwindling income from public sources. For-profit firms, though, seem to follow the opposite evolution. They hire more and more researchers to let them publish their results in scientific journals instead of patenting them. This even happens to economists who get hired, for example, by Google, Microsoft, Yahoo, AT&T, and commercial banks to conduct research. For the economists, I kind of understand it as a way to secure top talent when needing advice in complex markets. For hard sciences and engineering, my prior is that these firms have realized that patenting has become very inefficient as seeking exclusivity is now more of a lawyer's than a scientist's job.

Markus Simeth and Julio Raffo have another interpretation of what is happening in for-profit firms, and it looks like what is happening for economists. Using a dataset of R&D performing firms in France that they match with academic publications, they find that the old way of just collaborating with academics is not sufficient to acquire knowledge from the technology frontier, you need to hire them full-time. Adopting the academic discourse and disclosure allow to also benefit from it. And like firms participating in the open source movement, I suppose participating in the open dissemination of science also buys you some academic credibility that can attract top talent.

A Critique of Utilitarianism

Pithy and funny.

Unemployment benefits extensions and unemployment spells

During the last recession in the US, the maximum duration of unemployment insurance benefits has been extended several times. The justification has been that as the unemployment rate is higher, it is more difficult for the unemployed to find jobs, and they should not be blamed for not finding one in due time. Of course, this raises the specter of moral hazard, as they may not be enticed to search for a job as avidly as before. The question is then, how much has the unemployment rate increased due to this extension and the associated moral hazard? I reported previously on a nice paper that used extensive theory and calibration to come to the conclusion that about a quarter of the increase in the unemployment rate can be attributed to this. By now, though, we have good data that should allow an empirical analysis.

Henry Farber and Robert Valletta provide the first serious estimations I have seen. They exploit cross-state variations in the extensions to identify their impact on job market transitions. They find little effect from the extensions on re-employment probabilities. Rather, they have prevented people from exiting the labor force, which is surprising given the severe decline in the labor force even after the recession was declared over. This means that the impact on unemployment duration is rather modest on average, but larger for the long-term unemployed. In the end, only a tenth of the increase in the unemployment rate can be traced to the benefit extension.

CEA Chair

Rumor has it that my friend and former student Jason Furman will be the next chair of the Council of Economic Advisers.  If true, that is great news.  Jason is smart, knowledgeable, and sensible.  He does not come to the job with as long an academic track record as other recent picks, but he has far more policy-relevant experience and expertise.

Foreclosure procedures last too long

The handling of foreclosures in the recent housing crisis in the US has been a serious disaster. The drop in household income made that many households could not service their mortgage obligations and had to default. In addition, the drop in house values meant that many mortgages were worth more that the house that serves as collateral. This encouraged owners to walk away from payments. The mass of defaults lead mortgage servicers to resort to automatic treatment of foreclosures, leading to many errors, in particular foreclosing houses that not at issue. The reaction of many US states was to require longer foreclosure delays, first to make sure procedures are properly followed, second to allow owners to renegotiate, recoup and still make payments. The latter did not work out, as reported here previously. Were these state interventions worth it, in the end?

Larry Cordell, Liang Geng, Laurie Goodman and Lidan Yang use extensive databases of foreclosure procedures to quantify the lengthening of foreclosure delays and what this has cost. An important consideration is how foreclosures happen across states. In some, courts need to get involved (judicial states), in others the procedures only follow the stipulations of the mortgage contract (statutory states). In the former, the length of the procedure went from 26 to 44 months, in the latter from 16 to 22 months. During all this time, both parties are left in limbo, owners have incentives not to pay at all and neglect house maintenance, and lenders get no return on investment and may try to find whatever means to get any money out of the house, including reselling the mortgage. Also, there are externalities on neighborhoods as they get blighted. This is costly. The cost went up from 8% to 12% oh house value in statutory states, while it is from 17% to 30% in judicial states. These costs are estimated by adding unpaid property taxes, excess depreciation and unpaid insurance. This is thus the cost to the mortgage servicer, and does not even include capital costs. For a cost to society, one would also have to add the impact on other property values and deduct the fact that owners are living for free in these homes. There is no doubt the costs are considerable.

Why are children not the focus of our preferences?

In biology, all is about the survival and dominance of the species. It would then be logical that we only care about our offspring and its potential to have further offspring. But somehow, evolution made also care about ourselves, in fact we care a lot about ourselves. And lately we care also a fair amount about other species, but I guess modern culture is beyond the survival motive of evolution.

Luis Rayo and Arthur Robson find good reasons why we care about ourselves and how well we consume and enjoy leisure beyond fitness: ignorance. Specifically, think of the relationship between nature and an individual as that of a principal and an agent. The principal can choose the preferences of the individual, but cannot change them in light of transient circumstances. The agent is oblivious to what happens. The preferences need then to include goods that are not the primary focus of nature, for example means to ultimate goals. This is like placing money in the utility function. We do not care about money per se, but what we can buy with it, and the fact that having more leads us to save more. In the case of evolution, liking to sit in the sun makes us create a sufficient amount of vitamin D and makes us fitter for survival and procreation. But now that we know the effect of the sun and how vitamin D is important, we tend to sit too much in the sun for nature's liking. We are too informed for our preferences and should only care about our children.

Econo-Champions League: All Germany, No Spain

Yesterday evening the de facto Queen of Europe, Angela Merkel, sat in the VIP section of London's Wembley Stadium as two German teams--perennial European giants Bayern Munich and upstarts Borussia Dortmund--contested the Champions League final. That Bayern Munich finally succeeded in its third attempt at winning the biggest prize in club football in four years was no doubt a relief to their fans after losing the final to Inter Milan in 2010 and Chelsea last year. However, for the rest of Europe, a German champions League lockout is symbolically quite worrisome. As the European debt crisis has firmly revealed who wears the pants in the EU (Mrs. Merkel and company), is it not overwhelming that the Germans dominate sports as well? Just as Bayern Munich annihilated Barcelona FC to reach the final, Borussia Dortmund humiliated the world's largest football club, Real Madrid.

Nobody doubts that Bayern Munich were deserved winners this year given their supreme domination. After two years of losing out on the Bundesliga title to Borussia Dortmund, their offseason rebuilding in the wake of losing the Champions League final at home last year was fruitful. How dominant were Bayern Munich? They had an astounding goal differential of 80, having scored 98 goals to 18 conceded. In ratio form, they scored a scarcely believable 5.44 goals for every one conceded. Truly, it's a team for the ages. Borussia Dortmund aren't slouches, either, and back-to-back titles before this year bear witness to their ability to reconstruct themselves despite high-profile defectors leaving for greener pastures (or so they think). Just as Bayern Munich learned the hard way that winning this European title is no walk in the park, their German counterparts are likely to rebuild and come back stronger enough to win in the near future.

Anyway, back to the worrisome symbolism of all-German domination. It bears remembering that despite hammering Barcelona FC an aggregate 7-0 during the semifinals, the Spanish national team which it largely draws from won the 2010 World Cup as well as Euro 2008 and 2012. Over this entire period, the German system has been as much lauded as the Spanish system--especially in identifying and developing young talent. Having just yesterday (partially) shed the "choker" tag of advancing in tournaments but not winning them, the Bayern-stocked national team must now prove itself on the even bigger stage of World Cup 2014. So, there is a long way for Germany to go before it can be said to dominate football in the same way the Spaniards have in club and international competition in recent crisis-laden years. Worries of Bayern Munich domination to come are likely exaggerated [1, 2].

There is the lack of "consolation prizes" to economic losers to contemplate for Italy (winners of the 2006 World Cup and 2010 Champions League c/o Inter Milan) and Spain (the aforementioned international silverware in addition to Barcelona winning the Champions League in 2006, 2009 and 2011). While Europe seems to have become thoroughly secular in recent years, you can argue that one of today's balms for crisis-hit nations remains sport. Witness F1 driver Fernando Alonso of Ferrari (a Spaniard driving for an Italian team; how appropriate!) constantly referring to his race wins as his consolation for a crisis-hit nation. Have these famous sporting victories not consoled the Italian and Spanish? Having pondered what the psychic boost to economic performance these represent, their unending woes--from towering youth unemployment to an inability to nurture world-class industries as opposed to world-class footballers--the answer is evident to me at least:

None. Nada. Zip. Zilch.

Getting spanked hard by Germans--heck, I (foolishly) believed Juventus had a chance against Bayern Munich--is not the most edifying spectacle in 21st century, crisis-hit Europe. Given their already unassailable economic dominance, must the Germans lord it over in every other aspect as well? Still, you cannot say that the economic virtues of Germany are not reflected in its teams, too. Despite earning and spending big, Bayern Munich does not throw away money. Meanwhile, Borussia Dortmund is the "Moneyball" team of the football (soccer) world in rarely splurging on outside purchases but focusing on player development since their resources are comparatively limited compared to those of European giants (albeit still substantial).

As the final proved, Borussia Dortmund is the only team that could reasonably stand up to the Bayern Munich bully boys circa 2013. Instead of lamenting German domination in sports as well as European political economy, perhaps it's time the others also learned from the German example. Heaven knows, it was not so long ago that the Germans had an inferiority complex in football that they have now surmounted to a certain extent. Persistence, hard work, strength in depth, prudent expenditure...gee, footballing virtues sound an awful lot like German economic ones, don't they?

Dear Paul

My Harvard colleagues Carmen Reinhart and Ken Rogoff have written an open letter to Paul Krugman. (pdf version)

Addendum: Jim Hamilton and David Warsh weigh in.

New responsibilities

Starting this Summer, I will be taking on new responsibilities. I expect this new challenge to take some time away from my usual activities. As I am not paid or otherwise recognized for the work I do on this blog, the logical conclusion is that my posts will not be as regular as they have been. I hope that the quality of the posts will not suffer. While I may have become more efficient over the years at reading papers and writing about them, looking back I notice that I have become less detailed in my writing. Maybe if I do not feel the internal pressure to post almost every day, this will change. In any case, I expect the frequency of postings to change.

And if you are still reading this through Google Reader, think about moving to a different reader or bookmark this site soon, GR will close on July 1st.

Incomplete contracts can be optimal

When you write a contract, you want to lay out what happens in all circumstances. The intuition that this is best comes from the idea that complete markets are ex-ante optimal for everyone. If some circumstances have been left out, then the contract has to be renegotiated, which may lead to issues for example if there is a hold-up problem or worse if lawyer and courts need to get involved. The uncertainty may also lead to insufficient effort by contracting parties. The accepted wisdom is thus that incomplete contracts are bad.

Well, not always. Maija Halonen-Akatwijuka and Oliver Hart argue that one may not want too complete contracts. While there is no denying that it may be costly to draw a complete contract, their argument is that any contingency that is specified may acts as a reference point that may make negotiating for unspecified contingencies more difficult. If I understand this right, complete contracts may still be optimal, but if you have to have an incomplete one, you better not make it too complete. This non-monotonicity stems from the fact that contracted contingencies act as reference points. If there are too many contingencies and a state of the world is realized that is not accounted for, the parties will disagree which contingency should be taken as reference (each party will take the one that suits its interests best). Renegotiation becomes then costly. Have fewer contracted contingencies, and this is less likely to happen.

Weitzman on Climate Change

Wisdom from my Harvard colleague Marty Weitzman.

Women's emancipation: more education and more divorces

Divorce rates are at an all-time high, and many blame a lack of morals. That is not a good explanation. There is always an economic argument in the background of societal change, and it is no different here. There is more divorce because the incentives are right for that. And if the incidence of divorce has changed, it must be because it now makes more sense for people to divorce, not because sentiments have changed.

Fatih Guvenen and Michelle Rendall argue that the cost of divorce used to be very high for the women. They have a natural bond to their children and want the best for them. But the lack of education and thus earning potential made it difficult for women to raise them on their own. With the increase of education among women, who have now overtaken men in this regard, plus the narrowing of the gender wage gap, the outlook is now much better for a single woman, mother or not. Thus she is more likely to seek divorce under the same circumstances as before. It also implies that women are less likely to seek marriage as they can better fend for themselves. Recall that the female labor supply has dramatically increased over the last half-century. The institution of unilateral divorce laws in the 1970s in the US also contributed to this evolution. Using a carefully calibrated model, the authors can actually quantify this with counterfactual experiments. 25% of the increase in education and half the increase of the female labor supply can be traced back to this divorce law reform. And this increase in education has a very substantial impact on well-being, corresponding to $11,000 a year. The model is rich enough to also quantify how good this education improvement is for attracting a better spouse, which is worth about $4,000 a year.

Complicated Southern European recessions

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

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

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

Language Games: Should French Unis Teach in English?

I have long been fascinated with the France's Academie Francaise, a body intended to guard the French language from the barbarisms of other, uncouth languages. The erstwhile linguistic barbarians have changed over the centuries: whereas the Academic Francaise was developed as a bulwark to Spanish, nowadays it's English, of course, that needs to be guarded. Recently, French higher education minister Genevieve Fioraso caused an uproar by suggesting that more courses need to be offered in English to attract international students. To this the traditionalists were of course up in arms. However, this reaction neglects the fact that several elite institutions alike the Sciences Po already provide instruction in English:

Elite French business schools, and Grandes Ecoles such as the Institute of Political Studies also known as Sciences-Po, have been teaching in English for the last 15 years. Why, she asks, shouldn't other less prestigious universities follow suit?

The crux of the counterargument goes like this: if part of the attraction of studying in France is learning French, why dilute this by offering second-rate English-language instruction? Another is the ever-popular idea that speaking French lends the speaker a different worldview from that of English speakers, making (surprise!) French education incommensurate with English education:

Teaching English is very different, they argue, from teaching in English. They support the teaching of foreign languages, and suggest starting it even earlier - in nursery schools - but they oppose the teaching of subjects such as mathematics, history and literature in any language but French.
 

Antoine Compagnon, a distinguished French scholar who taught at Columbia University and is a member of the American Academy of Arts and Science, maintained in a public letter that it would be better to teach foreign students French than tolerate "Globish" (the primitive English of non-English-speakers) and the dumbing down of teaching that would inevitably follow.

Foreign students who choose France over Britain, Compagnon says, are not only choosing the French lifestyle but also its culture and language. Teaching them Proust in English, in France, would be a travesty.

French MP Pouria Amirshahi, who represents French expats in North and West Africa, backed him up. "The signal given out to those everywhere who learn French abroad and in francophone countries throughout the world is not reassuring," told The Daily Telegraph.

It looks as though, in France, if you want to teach students in English, you have to do it quietly like the elite universities which never asked permission but never boasted about it either.

I believe that some market research is truly in order to enlighten this debate:

1. Do international students come to France purposely to study in French?
2. How many more international students can France realistically hope to attract if it had more course offerings at the university level in English?

Both questions are certainly worth investigating.if France is serious about addressing the needs and wants of international students.Either way, it's better to proceed from a position of knowledge than from one of ignorace in addressing these language games.

Risk management four centuries ago

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

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

Reducing child labor with micro-insurance

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

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

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

Geopolitics of Eurovision: Echoes of Yugoslavia

Formerly known as the Cold War Studies programme, LSE IDEAS has always been focused on post-1989 events in that part of Europe. As out founders keep saying, understanding the Cold War is key to understanding the current era of globalization. I need not remind anyone that the wars there were especially long and awful after the collapse of the former Yugoslavia. Although Western commentators tend to uniformly portray Soviet-era strongmen in a negative light, I have always had a more sanguine view of Josep Broz Tito. Say what you will about his methods, but centuries-long ethnic hatreds that were again to erupt after the Iron Curtain's demise were mitigated to a significant extent during his reign. It was not uncommon, for instance, for Serbs and Croats to train side by side for international sporting competition and regard it as unexceptional. But then came the deluge.

Fortunately, there remain commonalities amongst these erstwhile rivals that gives you hope in humanity. For, in recent times, former Yugoslavs have stuck by each other in voting for the Eurovision Song Contest. The 2013 event held yesterday night in Malmo, Sweden was like always--small-"n" European nationalisms thrown together with talent and no small amount of cheesiness, It's perhaps not such a big deal in the rest of the world, but Europeans have always loved the competition's mixture of good-natured fun and Euro-kitsch. In more jovial surroundings, it turns out that the former Yugoslavs have no small amount of love for their neighbours despite everything (and Ukrainians and Georgians for Russians elsewhere, etc.):

In addition to media analyses, serious academic studies have been conducted on Eurovision Song Contest (phone in) voting patterns. While geographic proximity alone may not decide how Europeans vote--studies suggest talent plays a part, too--it does help a contestant to do better when they both come from a prominent "voting bloc" and show some real skill. Even this year the former Yugoslavs were active this year despite being depleted of contestants in the later rounds:

We all know that this bloc has been particularly one of the most predictive blocs voting-wise. Hypothetically speaking, if one former Yugoslavian country qualified, the Scandinavian and ex-Soviet blocs would not be affected because that lone former Yugoslavian qualifier would maximize its monopoly from its bloc as much as possible.

Perhaps a better demonstration of their affection for one another came last year when Serbia finished third:

Serbia came third with a very good ballad sung by a very good international performer, his voice was strong and powerful. Four countries gave Serbia 12 votes [the number of points given to a song receiving the most votes in a particular country], all are geographical neighbours. Ten countries gave Serbia 10 or 8 votes - only two of those countries are anywhere near Serbia.

The Swedish hosts understand the appeal of Eurovision along these lines in IR terms:

Swedish Foreign Minister Carl Bildt, who watched the competition in Malmo Saturday, called it a unique event that unites Europe. "We see the old Yugoslavia, now independent states, after a decade of war they always vote for each other in Eurovision, " Bildt told The Associated Press. "That I think is fun."

Indeed, the voting table from 2012 says it all: eventual third-place finisher Željko Joksimović of Serbia received maximum points from Bulgaria, Croatia, Monenegro and Slovenia. Amidst the rubble of even the worst of conflicts, there is always hope that old enmities can be transcended by the better part of human nature. As my previous intuition suggested, let Eurovision show us the way forward for European Union. Where most EU initiatives fail to create a sense of "Europeanness," Eurovision succeeds--at least in part. In this day and age when the whole integration project is in question, studying successful examples should help.

On Stock Investing

Click here to read my column in Sunday's NY Times.

The tax payer as a tax enforcer

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

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

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

Reduced form welfare

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

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

Christy Romer on Japan

Last month, I had the pleasure of hearing Christy Romer give a great talk about Japanese monetary policy at the NBER Macro Annual conference.  You can now read it here.

The ZLB in My Favorite Textbook

In a recent blog post, Paul Krugman writes:

As far as I know, among basic textbooks only Krugman/Wells even talks about the liquidity trap.

This is probably a true statement.  It is not that other books don't cover the topic, however.  It is just that Paul Krugman doesn't know it.

FYI, here is what the leading introductory text says about the topic:

The Zero Lower Bound

 

As we have just seen, monetary policy works through interest rates. This conclusion raises a question: What if the Fed’s target interest rate has fallen as far as it can? In the recession of 2008 and 2009, the federal funds rate fell to about zero. What, if anything, can monetary policy do then to stimulate the economy?

 

Some economists describe this situation as a liquidity trap. According to the theory of liquidity preference, expansionary monetary policy works by reducing interest rates and stimulating investment spending. But if interest rates have already fallen almost to zero, then perhaps monetary policy is no longer effective. Nominal interest rates cannot fall below zero: Rather than making a loan at a negative nominal interest rate, a person would just hold cash. In this environment, expansionary monetary policy raises the supply of money, making the public’s asset portfolio more liquid, but because interest rates can't fall any further, the extra liquidity might not have any effect. Aggregate demand, production, and employment may be "trapped" at low levels.

Other economists are skeptical about the relevance of liquidity traps and believe that a central bank continues to have tools to expand the economy, even after its interest rate target hits its lower bound of zero. One possibility is that the central bank could raise inflation expectations by committing itself to future monetary expansion. Even if nominal interest rates cannot fall any further, higher expected inflation can lower real interest rates by making them negative, which would stimulate investment spending. 

A second possibility is that the central bank could conduct expansionary open-market operations with a larger variety of financial instruments than it normally uses. For example, it could buy mortgages and corporate debt and thereby lower the interest rates on these kinds of loans. The Federal Reserve actively pursued this last option during the downturn of 2008 and 2009.

Some economists have suggested that the possibility of hitting the zero lower bound for interest rates justifies setting the target rate of inflation well above zero. Under zero inflation, the real interest rate, like the nominal interest, can never fall below zero. But if the normal rate of inflation is, say, 4 percent, then the central bank can easily push the real interest rate to negative 4 percent by lowering the nominal interest rate toward zero. Thus, moderate inflation gives monetary policymakers more room to stimulate the economy when needed, reducing the risk of hitting up against the zero lower bound and having the economy fall into a liquidity trap.

Immediate rewards prompt dishonest behavior

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

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

Liberation Theology, Leonardo Boff & 'Fixing' Catholicism

What is the difference between a socially active priest and one who dabbles in leftist politics? The dividing line was much clearer during the Pope John Paul II and Benedict XVI eras when the latter was strictly verboten and priests were discouraged from engaging directly--especially in electoral politics. A few weeks ago I discussed the changes that may be in store at the Vatican given that someone from Latin America-- homeland of liberation theology spurred by the world's highest rates of inequality--has become pope. While Pope Francis has disavowed liberation theology in speech, in practice, many alienated (former) Latin Catholics believe that the hardline of the past will be replaced by a more tolerant and receptive outlook.

The highest profile critic of the Catholic Church so far as liberation theology is concerned is of course Leonardo Boff. Yet even he believes that while rhetorical disdain for godless Marxist elements of liberation theology may remain, in practice we may have a more nuanced and socially aware church emerging. Boff is positive, while the many priests killed in Latin America during the liberation theology period may even be regarded positively once more:

"Pope Francis comes with the perspective that many of us in Latin America share. In our churches we do not just discuss theological theories, like in European churches. Our churches work together to support universal causes, causes like human rights, from the perspective of the poor, the destiny of humanity that is suffering, services for people living on the margins."

The liberation theology movement, which seeks to free lives as well as souls, emerged in the 1960s and quickly spread, especially in Latin America. Priests and church laypeople became deeply involved in human rights and social struggles. Some were caught up in clashes between repressive governments and rebels, sometimes at the cost of their lives.

The movement's martyrs include El Salvador's Archbishop Oscar Romero, whose increasing criticism of his country's military-run government provoked his assassination as he was saying Mass in 1980. He was killed by thugs connected to the military hierarchy a day after he preached that "no soldier is obliged to obey an order that is contrary to the will of God." His killing presaged a civil war that killed nearly 90,000 over the next 12 years. The case for beatification of Romero languished under popes John Paul II and Benedict XVI due to their opposition to liberation theology, but he was put back on track to becoming a saint days after Francis became pope.

Boff narrates the familiar difference between theory and practice, with the idea that Pope Francis is oriented towards social action in a way his predecessors were not, really, despite lip service supposedly being paid to its features palatable to the Church (i.e., the non-Marxist ones):

While even John Paul embraced the "preferential option for the poor" at the heart of the movement, most church leaders were unhappy to see intellectuals mixing doses of Marxism and class struggle into their analysis of the Gospel. It was a powerfully attractive mixture for idealistic Latin Americans who were raised in Catholic doctrine, educated by the region's army of Marxist-influenced teachers, and outraged by the hunger, inequality and bloody repression all around them.

In the late 1960s and early 1970s, hundreds of Argentine priests were affiliated with a movement that proclaimed Christian teaching "inescapably obliges us to join in the revolutionary process for urgent radical change of existing structures and to reject formally the capitalistic system we see around us ... We shall go forward in search of a Latin American brand of socialism that will hasten the coming of the new man."

John Paul and his chief theologian, Cardinal Joseph Ratzinger, drove some of the most ardent and experimental liberation theologians out of the priesthood, castigated some of those who remained, and ensured that the bishops and cardinals they promoted took a wary view of leftist social activism.

Monsignor Chavez of San Salvador may make liberation theology more palatable by saying that there are many varieties of liberation theology (eat your heart out, Hall and Soskice), with Pope Francis being on the least extreme end in terms of Marxist overtones--Catholic social vision instead of Marxist social vision, if you will:

"There are many theologies of liberation," he said. "The pope represents one of these currents, the most pastoral current, the current that combines action with teaching." He described Francis' version as "theologians on foot, who walk with the people and combine reflection with action," and contrasted them with "theologians of the desk, who are from university classrooms."

Then again, even the would-be Pope Francis acknowledged that there are certain leftist overtones one can readily read into the Gospels if one is not careful:

"The option for the poor comes from the first centuries of Christianity. It is the Gospel itself," said then-Cardinal Jorge Mario Bergoglio during a 2010 deposition in a human rights trial. He said that if he were to repeat "any of the sermons from the first fathers of the church, from the 2nd or 3rd century, about how the poor must be treated, they would say that mine would be Maoist or Trotskyite."

In other words, leftist critics hope that Pope Francis will ask the faithful to do as he does, not as he says.

How efficient is net neutrality?

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

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

All hail news aggregators!

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

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

Stocks are cheap

...say two NY Fed economists. 

 

On the virtues of honest apologies

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

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

Too much legalese at the WTO

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

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

Larry Summers on Reinhart and Rogoff

Here.

Strict environmental policy through tax competition

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

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

Divorces of (Real-Estate) Convenience in China

To paraphrase Steely Dan, this is not your Haitian but your Hainan divorce. Recent regulations in China intended to tamp down real-estate speculation have had an unintended consequence of separating happily married couples to take advantage of better tax benefits accruing to single persons:

Long queues of happy couples waiting to get married might be a common sight in Las Vegas. But lines of happily married couples waiting to get divorced? Only in China. In major cities across the country last month, thousands of couples rushed to their local divorce registry office to dissolve their marriages in order to benefit from fast-expiring tax breaks on property investments for unmarried individuals.

Local media reported long waits at registries in Beijing, Shanghai, Guangzhou and elsewhere as savvy investors sought to buy or sell a second home before the government introduced strict new regulations that would force married homeowners to pay hefty taxes on the sale of second properties.

The new regulations are designed to cool speculation in China’s feverish property market and are part of a package of measures that would require couples to pay up to 20% capital gains tax on the sale of second homes. But for determined investors, nothing gets in the way of a good bargain, and some quickly noticed that the 20% impost didn’t apply if the second home was bought before the couple were married — or after they got divorced.

It seems the authorities have caught on, though, and singles are increasingly unable to take advantage of the breaks sought after by the divorcees-of-convenience:

The divorce solution is extreme but it’s the kind of solution to which China’s put-upon middle classes have become accustomed...Of course, the country’s regulators have also taken notice of the long queues outside divorce registries and have acted to put a stop to the practice. In recent weeks, the government revised its regulations to increase the taxes payable by unmarried individuals selling a secondhand property, effectively cutting the most speculative investors out of the market.

Don't you just love it when marriage, profitology and authoritarianism collide?

Fiscal consolidation: At what speed?

From Olivier Blanchard and Daniel Leigh.

Brokebank USA: Living Paycheck to Paycheck

Gillian Tett of the FT has an interesting article that seemingly contradicts all of the happy talk about how "America is back" with stock markets hitting all-time highs. There is no particular difficulty understanding stock market speculation and bubbles: with the Federal Reserve practically giving money away, those who still have access to credit have parked the proceeds in stocks. With the last two rounds of all-time highs coming right before the dot-com bubble burst and the subprime crisis, let's say its implications may not be welcome.

Outside of the casino economy, however, there appears to be a new way to measure the desperation of Americans living in and with the real economy. When people are strapped for cash--and American personal savings rates are once more headed to zero--it is only to be expected that business activity peaks during paydays. That is, quite a lot of these Brokebank Yanks Americans are living, as the saying goes, from paycheck to paycheck:

“Consumers are living pay check by pay check, and they tend to spend accordingly. Then you have 50 million people on food stamps and that has cycles too. So for our business it has become critical to understand the cycle – when pay [and benefit] checks are arriving.” Sadly, it does not yet seem possible for outsiders (or journalists) to crunch the numbers across the entire economy. Large companies are very secretive about their big-data projects (this particular company, which produces many of America’s best-loved snacks, would not let me reveal its name). And though economists monitor macro trends in retail spending, they have not traditionally analysed micro spending swings.
Nevertheless, this story is not unique. Executives at Walmart, for example, have recently noted the rising impact of the “pay check cycle”; Kroger, another retailer, notes that the proportion of customers using food stamps has doubled, creating additional swings. And as these anecdotal tales mount up, they are interesting for at least two reasons. First, and most obviously, they should remind us of the silent, dark underbelly of economic pain that is stalking America’s current “recovery”. Most notably, it seems that the financial fragility of the poorer section of US society has risen sharply in recent years, as unemployment remains high and real incomes and household wealth fall. (A revealing survey published last week, for example, suggested that the wealth of Hispanic and black families declined by 44 per cent and 31 per cent respectively between 2007 and 2010.)

Measuring this financial fragility – like measuring micro-level spending swings – is tough, since it is not an issue that economists have traditionally tracked. But one in seven Americans (about 50 million) are now thought to be living in poverty and a similar number in “food insecure” households. Meanwhile, six million are using food banks and 47 million are on food stamps. And when the Brookings Institution tried to look at this fragility issue a couple of years ago, by analysing how many households could find $2,000 in a hurry, it concluded that a quarter of families had no access to ready, rainy-day funds. “Although financial fragility is more severe among low-income households, a sizeable fraction of seemingly middle-class Americans are also at risk,” the study concluded. 

Make no mistake: Americans are worse off now than they were under Bush, and in turn worse off under Bush than they were under (Bill) Clinton. Althoug retailers are naturally wary of disclosing the timing of their sales based on paycheck cycles, it could be gathered anonymously by an impartial entity alike the Bureau of Economic Analysis. Summing it up merely solidifies an image of growing discontent as income and wealth slide and cause changes in consuming habits as a reflection.

Once massive Fed purchases of bonds are discontinued, who knows how far down this entire edifice of casino economy will fall. Certainly, there is no foundation of a real economy to fall back on. 

Blog mentions: are they citations?

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

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

Preventing the Next Catastrophe

Wisdom from David Romer.

Is better rewarding experience the solution to Third World development?

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

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

The elderly are not decumulating their wealth fast enough

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

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

German (Randian?) Solution: No Minimum Wage

Sometime ago, I remember watching former Fed Chairman Alan Greenspan testifying before the US Congress when he was asked about his views about the minimum wage. "There should be none," I reflexively blurted out. Knowing that Greenspan was a libertarian former acolyte of Ayn Rand, the answer was obvious and, true to form, that's what he said to the surprise of this congressman. This same debate is being played out in Europe as those championing reform of ossified economies point out that one of the features that makes German unemployment comparatively low to other European nations is its lack of a minimum wage. To be exact, there is no general minimum wage but sector-specific minimum wages arrived at through collective bargaining in the German corporatist system.

That is, would Portugal, Italy, Greece and Spain which are all suffering from very high unemployment be better off if they moved to a German-ish system? Many conservative commentators certainly think so, but it's important to point out that even Germans themselves are considering a EUR 8.5/hour minimum wage as pushed by the opposition Social Democratic Party (SPD). Indeed, it has already been passed in the upper house (Bundesrat):

The SPD is in favour of introducing a statutory minimum wage. On the official SPD website, they talk about the introduction of “humane” minimum wages. Indeed, after the regional elections in Lower Saxony in January, the changed majority situation in the Bundesrat permitted, according to the SPD website, to present a law proposal together with the Green Party for a minimum wage. It has been passed on 1 March 2013. This proposal demands € 8.5 for every employee in each industry sector – as enforceable right. They argue that this minimum wage is necessary in a social market economy and is, moreover, one essential element of human dignity. A minimum wage, according to Malu Dreyer, Prime minister of Rhineland-Palatinate (SPD), would bring both flexibility to the employers and security to the employees. It is now up to the Bundestag to approve this law proposal. 

In the FT, Alexander Privitera further argues that there is remorse on the social democrats' part for having pushed employment reforms that many cite for making Germany more competitive post-unification.: 

Mr [Gerhard] Schröder’s reforms helped this process. Limiting unemployment benefits pushed many to look for jobs. But the unintended consequence was that, today, the low-wage sector accounts for a remarkably high 20 per cent of all jobs. Germany’s victory in the battle against unemployment came at the cost of creating a two-tiered labour market – it has a flexible, low-wage sector and a higher-skilled, better-paid one that continues to be extremely rigid to this day.

Despite the fact that the Germans are promoting their reforms as a model to follow abroad, at home political parties still debate their benefits. Mr Schröder’s Social Democrats are convinced that the reduction in welfare benefits led to rising inequality, and argue that they should be partially reversed. Even some Christian Democrats now admit that a minimum wage might be necessary. One of the main lessons of the Schröder reforms is that timing matters. Pushing Europeans too hard, too quickly and all at the same time will not make them stronger. It could drive them over the cliff. 

Given what's happening in Germany, you have to wonder if the current CDU/FDP advocacy for the rest of Europe holds water. Not economically--you can have an endless debate on that, and people do--but politically insofar as left-leaning parties seem keen on introducing a "wage floor" that definitely is not in tune with the "Germany is a model for Europe--no pain, no gain" line of reasoning.

Is an imperfect monetary union leading to more volatility?

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

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