Do not give carbon credits away!

Slowly, the idea of carbon credits is making its way into the minds of legislators. Market based solutions to pollution control are much better than regulation. However, there appears to be a risk than the initial allocation of carbon credits would simply be given to current polluters. This must be resisted.

Indeed, this has several adverse consequences: 1) it rewards polluters, 2) it gives incentives to pollute more ahead of the implementation, in order to obtain more credits, 3) the revenue from credit sales would be lost. The Southern Alliance for Clean Energy is currently inviting economists to sign a statement along those lines. I signed it.

Where are the Brazilian economists?

It has always struck me how large the diaspora of Argentinian economists is, especially in Macroeconomics. Speaking to them, I learned that a lot of them where motivated to study Economics by observing and living the chronic problems of Argentina. But then, why do they not return to fix this country? The typical answer is that the economy is beyond repair, and thus they stay in North America or Europe.

What about the Brazilians, then? Brazil also suffers from chronic problems, it is even larger, so it has the potential to provide many motivated economists. Yet, I rarely meet one, and it is not becasue they would all return home after graduation: there are very few Brazilian students in graduate programs.

So, where are they?

The Frankenstein Veto is as bad as is sounds

Local laws have sometimes original quirks that make the study of institutions interesting, at times even funny. But not all are cute, and I recently came across a particularly vicious one, the aptly called Frankenstein Veto in Wisconsin.

This allows the State Governor to veto "in whole or in part" appropriation bills passed by the local legislature. It turns out that "in whole or in part" is not interpreted like elsewhere as a line-item veto (which has its own disadvantages), rather it allows the governor to strike out words and numbers selectively, effectively enabling him to completely change the meaning of a bill. For example, the last budget was modified from:

[...] the secretary of administration shall lapse or transfer from the general fund to the unencumbered balances of appropriations of executive branch state agencies, other than sum sufficient appropriations and appropriations of federal revenues, an amount equal to $69,000,000 during the 2007-09 fiscal biennium and $69,000,000 during the 2009-11 fiscal biennium [...]

through selective deletions to:

[...] the secretary of administration shall lapse or transfer from the general fund to the unencumbered balances of appropriations of executive branch state agencies, other than sum sufficient appropriations and appropriations of federal revenues, an amount equal to $270,000,000 [...]

So, essentially, the Governor converted a $69,000,000 cut in the State budget, which was negotiated in the legislature, into a $270,000,000 cut by cutting words and using selected digits from 2007-09 to carve a new number. Had we lived in a different millenum, or where we following a different calendar, the cut would have been different. This is complete nonsense, as clearly the governor's decision do not follow an economic arguments.

Apparently, it was even worse before a recent amendment to the constitution, as the governor could form new words out of parts of old ones, and even perform modifications across sentences. My introductory sentence could therefore be modified into:

Local laws have sometimes original quirs that make the study of institutions interesting, at times even funny. But not all are cute, and I recently came across a particularly vicious one, the aptly called Frankenstein Veto in Wisconsin.

Visibly, I am not as well trained as Wisconsin governors.

On the optimal size of town government

How big should a town be? Should it merge with its suburbs? Should neighboring villages agglomerate? What is the best outcome for inhabitants?

Large towns may count on some economies of scale, say in policing and in task that require a substantial fix cost (administration, sports facilities, schools). However, they are more likely to have bloated bureaucracies, as voters have less influence to keep them in check.

Small towns often have the tendency to free ride on larger neighbors for facilities. This is especially true for suburbs, leading to the problematic situations of the core city providing services but be sucked dry of people moving for lower taxes or better taxes. This situation thus calls for a forced merger of suburbs with the core city. How much to merge needs to take into account the administrative inefficiencies mentioned above.

Instead of mergers, a two layered systems can be put in place, where towns remain largely independent but a still forced to participate in some regional structure for some tasks, like public transportation, police, environment and zoning. This avoids the free riding, allows to exploit economies of scale where they are and still leaves local control of most of the budgets.

Why do I write about this? Observing the huge income and service disparities within metropolitan areas in the United States, one has to wonder how such ghettoization could happen. People vote with their feet, and in most cases they did this by fleeing to the suburbs, where lower taxes and better demographics reinforced each other and attracted the good risks. This is only possible if the remaining poor city core is small enough. By agglomeration, the city core becomes less poor, and the attraction towards the periphery lessens. Merging is the only chance for the American city to become attractive again.

Argentina: How not to handle food price increases

Argentina is blessed with a very rich agriculture. A century ago, its standard of living was among the highest of the world thanks to this sector. Nowadays, the fiscal health of the country relies crucially on export taxes levied on agricultural products, and we all know how the fiscal health of this country is important. All of this is getting undone right now, with a poor handling by the government of food price increases.

First some context. Soya prices have, much like other food prices, increased significantly over the last years, in a large part due large demand for cattle feed in Europe and Asia. What would any sane grower do in such a situation? Grow more soya. Within a few years, the land dedicated to soya in Argentina went fron 5 million to 15 million acres, bringing a lot of income to growers and to the state, which levies a 35% export tax. The substitution means, however, that other food staples are now much less grown, and the price of, say, tomatoes and potatoes has significantly increased.

Consumers obviously complain when prices go up, so the government tries to find a way to increase the supply of food for local consumption. How? By increasing the export tax to 44%. As everything is already planted, this changes nothing to production, increases further world soya prices, leads growers to demonstrate and shut down roads, to the point of generating serious supply problems across Argentina and increasing prices further.

If the price of tomatoes is high, let the market do its job and adjust the production for next season. Fluctuations in prices may be higher than optimal (à la cobweb model), but with good information, growers can predict them and plan accordingly (that is what agricultural economics departments are for, right?).

Where are the female economists?

The RePEc blog laments how few women register for its services. I would like to take this opportunity to ask where the women are disappearing in the profession. According to the quoted CSWEP report, 34.5% of graduating female students are female, but only 8.1% of full professors are women. There is considerable leakage.

These numbers need some qualifications, though. First, they pertain to PhD granting institutions in the US. Thus, the missing women may have moved to non-PhD granting universities along their careers, but they are visibly doing this more than men. The figures for liberal arts colleges are slightly better, with 20.5%. Second, these numbers do not reflect a steady state, as full professors are from a generation where women were less numerous in graduate programs.

But there is still no doubt that the ranks of women are thinning faster than for men throughout careers. Why? I doubt expectations are higher for women, but it is true that many have ambitions more tilted towards family than men. For example, a female graduate student once volunteered to me that her career goal was to teach for a few years, then take care of her family. You would not hear that from a male student.

There may also be some truth to the Larry Summers conjecture: men and women have the same mean ability, but the variance is larger for men. Thus there is a larger proportion of them as you move to the top (or the bottom). This would certainly be consistent with the data, but this does not necessarily prove the conjecture.

Finally, many departments are under a lot of pressure to hire women. The average quality of a female hire has to be lower under such circumstances, and it should not surprise fewer reach tenure and promotion.

The new (Canadian) Liberal tax plan

The Liberal Party of Canada, official opposition, just presented its new tax reform, entitled the Green Shift. It is a very pleasant read, not the least because there is a lot of sound Economics in it. It also addresses a lot of the issues discussed on this blog.

Here is a summary of the executive summary: to address environmental issues and improve incentives to work, the tax system is shifted away from income towards pollution. Carbon emissions are taxed, at increasing rates over four years, and tax rates on household and corporate income are reduced in parallel to render this reform tax neutral. As we advocated before, we need to truly tax "sins" at the appropriate level so that user take correctly into account the externalities they exert on others. The revenue can then be used to remove taxation on activities that are good, like earning an income, hiring people, etc.

A very good read, with only little political pandering. Too bad the Liberals are currently in the opposition.

Becoming President of the US: a good face is enough

It is well known that in a political with two candidates, they become indistinguishable. Irrelevant matters then become important. Thus, good teeth and big hair are thought to be essential for a presidential run in the US. It turns out there is more truth to this statement then one would think.

Armstrong, Green, Jones and Wright perform an interesting experiment. Looking for a population that would not recognize candidates, they went to Australia, New Zealand and ... Oklahoma. Students were asked to rank candidates by competence from photographs, discarding those they recognized. The winners were Clinton and Obama for the Democrats, and McCain for the Republicans. Not bad for an experiments conducted in the early Summer 2007, when McCain was just #4 in the polls...

So much for the usefulness of the platforms and endless debates.

No real estate tax breaks for seniors

Many US towns have programs that give tax breaks to seniors when they pay their real estate tax. Many seniors have little income, and those taxes make a substantial portion of their income. However, in most circumstances, they should not be taking these breaks.

Indeed, they mostly likely own a mortgage free home. In other words, they are sitting on a substantial amount of equity, something that younger households do not have. They need not pay down their mortgage. And they typically do not have to put children in college.

The problem seniors have is a problem is lack of liquidity, not lack of funds. Instead of forgiving part of the tax, towns should be putting a lien on the property to the amount of the forgiven tax. Seniors should also explore reverse mortgages, which allow to cash in on the savings they have made through their house. Why die leaving an unexploited fortune?

Syndicating this blog?

I just receive a message, also sent to 50 other bloggers, from Nouriel Roubini to become a contributor to RGE Monitor. His team would pick my post from this blog, vet them, and publish them on his blog, with attribution.

What is in it for me? A link back to my blog, a free subscription to the fee-based part of the RGE Monitor (valued at a whooping US$5000 a year), publicizing Economic Logic on the blog, and a "bio page" with a picture.

Note that there are already plenty of blog agregators out there, and anybody is free to create a blogroll like the one I have in the sidebar... I do not particularly value a subscription to something I was never tempted to read. A blog is to a great extend done for the readers, so I'll let my readers decide whether I should participate. I have added a poll in the side bar to that effect.

Energy policy: taxing or subsidizing?

How should one encourage to use of alternative energy sources? There are essentially two market based means: subsidizing the good sources, and taxing the bad ones. So what would be optimal to do?

Essentially, the goal is to create a price wedge between good and bad, so that consumers are encouraged to choose more frequently good energy sources. So at first sight, taxing or subsidizing does not make a difference. However, subsidizing has several drawbacks. First, as the average price of energy decreases, the overall use of energy increases, which may be an unintended consequence. Second, the subsidy must be financed with some other revenue, which is typically through some distortionary taxation that generates a deadweight loss.

Thus: tax fossil fuels, do not subsidize renewable energies. Use the revenue to offset distortionary taxes.

The impact of credit constraints

How important are credit constraints for households? This is not obvious to determine empirically due to a host of issues: one observes only successful applications, data centers typically on consumption, or it is about loans, it is based on opinion surveys that Economists are rightfully uneasy about. In a paper just published in the International Economic Review, Attanasio, Goldberg and Kyriazidou found a nifty way to address better the question.

Specifically, they exploit data in the Consumer Expenditure Survey that includes auto loans contracts. Credit constrained households are limited by how much they can borrow, and are little affected by interest rates. Those that are not constrained are able to optimize how much to borrow and are responding more strongly to interest rates. Think about it: the choices of the first is really determined by the kink in the budget constraint, and by its slope for the latter. The data they use contains large heterogeneity in interest rates and maturities, the latter being highly correlated with the size of the loan.

Results? Increasing maturity by one year increases loan demand by about 90%, and the demand elasticity with respect to the interest rate is undistinguishable from zero. These results are very strong and indicative of strong aggregate credit constraints. Age does not matter, surprisingly, but income does, obviously.

What does this mean? We know the permanent income hypothesis does not hold strictly due to credit constraints. A model with such constraints, however, should not pile them on the young, but on the poor.

A Stern Review of Pascal's Wager

The Stern Review on the Economics of climate change has generated considerable controversy, not the least among economists. The way the model is calibrated, for example with respect to risk aversion, the discount rate or the way pollution translates into temperature changes. Having just read his Ely lecture, where Nicholas Stern addresses his critics, I come away unconvinced by either side, but still convinced about the crucial matter.

There is a risk, probably substantial, but maybe low, that there could be catastrophic consequences from climate change. If nothing happens, great. But if there is a risk, even if it is small, that we have rapid and important changes to climates and landscapes, we need to do something to prevent or slow them down. In a way, this is Pascal's Wager: doing something about climate change costs little compared to not having done anyhting and facing the catastrophic consequences. And it is not that clear to doing something about pollution is that costly anyway, in terms of quality of life.

PS: several papers have been published commenting on the Stern Review. You got to love this title: A Stern Reply to the Reply to the Review of the Stern Review.

On low probability catastrophic events

Robert Barro has been pushing recently the old idea that expectations of catastrophic events with low probability can matter substantially in a economy. For example, he demonstrates that this could explain the equity premium puzzle. What matters here is how to define a catastrophic event.

Initially, Barro defined a catastrophic event as a reduction of GDP by 15% from a previous peak. In more recent studies, he lowered that to 10% and is now looking at agregate consumption instead of GDP, which makes sense, as this is what really matters to people.

This makes me wonder: in recent years data has shown that economic fluctuations have considerably lost in amplitude (the "Great Moderation"). The origin of this is not clear, but one consequence may have been that people have let their guards down with respect to risk, i. e., they discounted more the likelihood of downturns or catastrophic events. This would be consistent with the reduction in the equity premium, and the rise in sub-prime loans.

The stop sign and the tragedy of the commons

Whenever I drive in the United States, I am really annoyed by the repeated stopping of traffic. There is a stop sign almost on every corner, and sometimes there is not even a corner. Stop signs proliferate in the name of security, but cannot be convinced that it increases security.

This article in the Atlantic relates my thoughts on this: the stop sign forest reduces the alertedness of drivers, who are then not able to judge driving conditions. That could explain why the United States has the highest traffic related death rate in the OECD (save for Korea, Poland and Greece), despite having wider lanes and less dense population. American drive like sheep just obeying signals.

Why tragedy of the commons? While an additional stop sign increases safety where it is put, it leads drivers overall even more into passive driving and make them more dangerous everywhere.

That said, GPS systems start having the same impact. People blindly follow what the GPS says, even against the reality outside. Britain is considering introducing a ... new sign that would alert truck drivers that a road is no good, despite what the GPS says.

Russia wants to host the new Wall Street

In his first economic speech, new Russian president Dmitry Medvedev makes it clear that the US are at fault for the current financial market mess and that Russia will establish itself as the new financial center of the world, the ruble becoming a leading currency. Dream on.

For a financial market to truly develop, let alone become the world leader, Russia needs to straighten a few things that are currently heading exactly in the wrong direction:

1. Fix corruption. It is estimated even by Russian authorities themselves that bribes currently amount to about a third of the government's budget, and it is increasing. There is no way a financial market can efficiently function, especially if Russia claims to be regulating better that the US, if corruption is so rampant.
   
2. Stop government meddling. Foreign businesses suffer from constant harassment from the government trying to influence them. Nowhere is this more obvious than in the energy sector, where the government is trying to create anew the old monopolies by pushing foreigners out. Most large firms are now again under state supervision.
   
3. Have a consistent immigration policy. You do not build a world leading financial sector without foreign labor, especially in a sector that has no tradition in the country. Thus, deciding to suddenly refuse any work permit application does not help.
   
4. Have a workforce that is savvy in Economics and Finance. While their is now an elite that can be described as such, the fact that the general population hates anyone making a profit is not encouraging.
   

Politicizing markets: the India example

India is facing rising crude oil costs like other nations, but very differently. Indeed, the retail price of gas is set by the government, and as this price has been adjusted only once in 20 months, refineries that have to pay the market costs for their input face big losses. And the fact that the government is postponing meetings to solve the issue makes the problem just worse and worse. The longer it waits, the more brutal the price increase will be, and the more people will revolt. Because there, people have a reason to blame the government for price changes as the latter sets them...

Politicizing an economy is always a bad idea, and India is a prime example in this respect. For example, lobbies have been successful in enforcing protection for small manufacturers by preventing big plants to establish. This has especially hurt India in the textile sector, for which it is perfectly suited but has abandoned the world market to others to preserve inefficient mom and pop operations. By some accounts, the Indian GDP could be close to tripled by simply removing this kind of government meddling. Since this account, the Indian government has taken this seriously, deregulating substantially, leading to growth rates similar to China. But the new government ruled by the Congress Party does not seem eager to pursue this policy at all, unfortunately.

The Fed was wrong, and knows it

The Fed has done lately a few moves that were out of the ordinary lately, and has been heavily criticized for it. It seems to start acknowledging now that it was wrong. Bernanke is dropping hints that interest rates will go up sooner than later due inflationary pressures. But the biggest head turner was the episode with Bear Stearns.

Now, Richmond Fed president Jeffrey Lacker acknowledges in a speech that bailing out Bear Stearn is counterproductive, as it has radically changed the expectations of the financial sector. You do not need to be a genius to figure that out, as much of banking theory is centered exactly on this concept and its related moral hazard issues, but it is nice to see an official concede he messed up.

This is the perfect opportunity to undo the damage. Acknowledge now big time that it was a mistake, and find some way for the Fed to commit itself not to do this in the future. For example by having some heads roll.

Subsidizing the brain drain

Plenty of studies have documented the brain drain: Highly educated workers migrate to richer countries, thus reducing the domestic return of education in poor countries. This phenomenon applies to all levels, within developing economies, from developing to developed economies and within developed economies. But it turns out some are actually subsidizing the brain drain.

Indeed, many countries would provide grants to their best students to study in the best universities, knowing full well that many of them will not return. The hope is that at least some will return, and this is worthwhile enough. The same applies to the high tech sector. For example, Finland encourages through FinNode young Finnish entrepreneurs to set up shop in the Bay Area and find collaborations there. The hope again is that some will return to Finland, knowing full well that some will stay in the United States and would not have tried without this help.

Of course, the United States is a net beneficiary in this, as it get free human capital. But the moral here is that subsidizing the brain drain can be a win-win sutuation.

Airlines should not be bailed out again

The International Air Transport Association (IATA), representing most airline companies in the world, just adopted a resolution calling all governments to help this industry. It is asking for lower taxes, more cross-border merger flexibility, lower wages and lower fuel costs. But why should governments bother?

Airlines have at numerous times received substantial help from governments. Some can be justified, like when the US government curtailed air traffic after 9/11. But the fact that this industry has overcapacity and cannot sell tickets to cover its own costs calls for a market correction (bankruptcies, reducing capacity) not government intervention. This industry is already subsidized (explicitly: security agencies, tax breaks; and implicitly: gas priced lower than what externatilities would call for), it should not ask for more.

Is it of national interest to have this much capacity in the air? No. Is it of national interest to have some airlines? Possibly, but this does not mean the whole industry should be bailed out.

The peer review system is broken

No, I did not receive a rejection from a journal this morning. I still want to argue that the peer review system is fundamentally broken in Economics. And Economists should really know better.

Referees write reports that are anonymous to everyone but the editor. They can make claims that are not open to scrutinization. They can abuse the author by asking her to modify paper to suit their agenda (cite them, in particular). They are also not held accountable if they do a lousy job, take forever, or do not care.

Of course, the identity of referees is open to editors. But in many cases, the editors have no way to identify whether referees do a good job, the latter are supposed to be the experts, after all. This is a typical agency problem, where often the principal has little idea of what is going on. The consequence is that journal publications correlate little with quality, and in particular that good works get rejected for flimsy reasons.

The only way out I see is to make referee names public. To some extend this is already done for some institutional working papers, for example at the IMF where the person authorizing the publication is listed on the paper. But this should also apply to rejections. Journals typically acknowledge their referees in one issue a year, but it is difficult to judge them on this.

Rating agencies for financial products are under scrutiny these days. Referees in Economics should as well.