Trust in government and preferences for redistribution

Scandinavia is puzzling for Americans or Southern Europeans. Taxes are very high, yet people are happy about paying their taxes and there is surprisingly little tax fraud or evasion. Why is there such tax morale? Of course, these taxes buy you services that you do not need to obtain on the market, such as social assistance, low crime, and health insurance. But even high incomes, who should prefer a model of market goods with little redistribution, are happy. What could one do to get this apparently Pareto improving outcome?

Eiji Yamamura does not provide directly insights about Scandinavia, but what influences regional tax morale in Japan. It turns out that if you have high trust in government, and you share it with your neighbors, you are more willing to accept income redistribution through taxation, and you perceive the tax burden to be lower. Thus, there is no miracle. You need a better government if you want higher tax morale.

On the benefits of multinational firms

Multinational companies are the scorn of the anti-globalization movement, and some of it is well deserved. Often, their size allows them to push governments around, especially poorer ones, and they can exploit tax loopholes in ways domestic firms cannot. But multinational firms can also bring benefits to economies. After all, they are just one manifestation of largely free trade, which is in general welfare-enhancing. The benefit mentioned the most often is that multinationals enhance the transfer of new technology between countries. A second benefit is that they shake up local competition and thus encourage Schumpeterian creative destruction. Of course, the fact that inefficient firms get hurt is not Pareto dominant, hence the grief from protectionists.

Using a big panel of firms across 60 countries (over a million firms!), Laura Alfaro and Maggie Chen find that the second impact of multinationals is significant. They are in particular interested in the domestic distribution of productivity and revenue. In theory, knowledge transfer shifts both distributions to the right. Market reallocation, though, shifts the distribution of revenue to the left and truncates the left of the productivity distribution. Looking at the data, it is not clear which effect dominates. The experience differs from country to country, with developing ones benefiting more from knowledge transfer and developed ones from increased competition. And about two-thirds of the average productivity increase can be attributed to knowledge transfer.

Do the Greek retire earlier because of their occupations?

A common complaint within the current acrimonious debate about the Greek debt situation is that the Greek retire much earlier than, say, the Germans. This is considered unfair, and the Greek should not enjoy such privileges. It is, however, a fact that people in different occupations retire at different times, and Greece may simply have a labor force with an occupational compositions that yields a lower retirement age. If this were the case in a magnitude corresponding to the observed differences in average retirement ages, the criticism would not be warranted.

Philip Sauré and Hosny Zoabi look at this in the following way. They take the retirement age by occupation for males in the United States, then apply this to the occupational composition of 28 OECD countries. Looking at the effective average retirement age, it turns of occupational differences can explain about 10% of the cross-country variation. Add in another 10 non-OECD countries, and you explain about 16%. Not huge numbers, but occupational composition matters. Transforming the data to account for category mismatches and the impact of state pension plans, one can explain 28% to 39% of the variation, though.

And, by the way, the effective age of retirement of males is higher in Greece than in Germany.

Exchange rates and scapegoats

It is notoriously difficult to understand exchange rate fluctuations, especially in the shorter term. Predicting them is even worse, to the point that a random walk has consistently been shown to be the best predictor (with isolated exceptions). Consistently beating the random walk is seen as the holy grail in international finance.

Philippe Bacchetta and Eric Van Wincoop came up with an intriguing theory: there is no point in trying to relate exchange rate movements to observable fundamentals. Market participants react to rate changes by rationalizing them with some observed fundamental even when the true reason may be unobservable. And market participants keep changing the variables they look at. Everyone has made fun of press reports that explain that the dollar went up because of some event, and then the same event explains why the dollar went down the next day. This is what Bacchetta and Van Wincoop call scapegoating.

This is pretty much all theory. Marcel Fratzscher, Lucio Sarno and Gabriele Zinna have now found a way to test empirically this theory of scapegoats. The reason it took so long is that you need the right data: first a monthly survey of market participants on what they think is driving exchange rate movements, second the order flow data of a major market participant. The data supports remarkably well the scapegoat theory. When there is a large volume of orders, which are not public information and should thus be treated as unobservables that influence market outcomes, and one of the fundamentals moves more than usual in one way or the other, markets participants often link the latter to exchange movements. This is purely after the fact rationalizing, or as used in other contexts, superstition. How this is going to help us in forecasting exchange rate movements is not clear, though.

Use state banks to stabilize the business cycle

The standard way to think about banking in the business cycle is that financial frictions amplify economic fluctuations. There are various mechanisms that make this happen. For example, the lower value of collateral during a recession makes lending more difficult. Or the value of the bank's assets decreases and it can lend less due to risk regulation. But does this always have to be so?

Ata Can Bertay, Asli Demirgüç-Kunt and Harry Huizinga take the example of state-owned banks. Given their public mission, they may actually try to become more active during recessions, possibly because public guarantees allow them top take on more risk during those times, or because they are more defensive in good times when they are less needed. Whatever the reason, by just looking at the data their study finds that state-owned banks are indeed lending against the cycle, especially in high-income countries with good-governance. Expanding the role of these banks could thus be beneficial, although one has to keep in mind that state banks are not necessarily the most efficient ones or the best at identifying good lending opportunities.

What I've been watching

I am a latecomer to this, but a friend suggested to me that I would enjoy the TV show Breaking Bad, and boy was he right. It has occupied me almost every evening for the past month, as I have caught up to the current season five.

The show tells the story of a particularly destructive mid-life crisis, as a mild-mannered high school teacher slowly descends into the underworld of drug manufacturing. It is not the best TV drama of all time (I would probably vote for The Wire), but it is close. It is important to watch in sequence, so be sure to start with season one.

How to report Fed uncertainty

Any good research reports qualifications and uncertainties about the results. Unfortunately, the non-scientific reader is not interested in those, he wants certainties. A good example is the issue of global climate change. Of course there is some uncertainty about it, but climate scientists did not report it because the public would otherwise discredit their findings. And indeed, once it was "revealed" global climate change is not 100% sure, an uproar resulted. It is not different in Economics.

Recently, the US Federal Reserve started publishing the differences of opinion of its FOMC members regarding its forecasts. There are good reasons for that. The market needs to understand when policy may change course because the data do not tell us enough about the future course. But will the public actually listen to this piece of information? Ray Fair does not think so because the wrong information is disseminated. Indeed, the dispersion of median forecasts has rather little information, especially if there is the group think the Board is sometimes accused of, compared to the statistical variance in the forecasts of a single model. Using historical errors as a basis, one could simulate whatever model(s) the Fed uses, draw out for each potential future history policy reactions, and then report the dispersion in future federal fund rates. Much better than the current dispersion of median opinions. And maybe the public will look at it.