New insights on optimal unemployment insurance

Insurance is useful because it allows to prevent (at a price) the consequences of adverse, unpredictable events. However, the viability of insurance systems can be undone by asymmetric information, adverse selection and moral hazard. In the case of unemployment insurance, the insurer cannot reliably observe the search effort and in particular whether a job offer was turned down. The empirical evidence, starting with Robert Moffitt, shows that larger unemployment insurance benefits lead to longer unemployment spells, thus highlighting an apparent moral hazard issue.

Since Steven Shavell and Laurence Weiss, we know benefits should decrease with the length of the unemployment spell, and since Hugo Hopenhayn and Juan Pablo Nicolini we know that one should even get a wage subsidy during the first periods of a new employment spell, a subsidy that depends on the length of the preceding unemployment spell. The basic idea behind these schemes is that unemployed workers need to be encouraged to search and accept the first job opportunity.

Raj Chetty asks whether the patterns observed in the data by Moffitt and others are not a sign of moral hazard, but rather a sign of lack of liquidity. Households with little cash on hand need to accept any job when unemployment insurance benefits are low. With higher benefits, they can afford to look for a better matches, which lengthen the unemployment spells but leads to better outcomes, as previously argued by Daron Acemoglu and Robert Shimer. The key here is to allow households to accumulate assets, but not all can gather sufficient precautionary savings, as in the model pioneered by Gary Hansen and Ayse Imrohoroglu.

The novelty in Chetty's work is that he found a way to test this empirically and finds indeed that this liquidity effect is very important: 60% of the marginal effect of unemployment insurance benefits on unemployment duration. For example, severance payments lengthen unemployment duration, and cross-state variations of benefits indicate that this duration does increase with benefits for liquidity constrained households, but very little for others. The big consequence is high benefits in the range of 50% are now easier to justify, even if there potential for moral hazard issues, something Stéphane Pallage and Christian Zimmermann had already highlighted, but in the context of a political equilibrium.

Transfers: cash or in-kind?

Should government transfers be provided in cash or in-kind? Simple economics clearly states cash is better for welfare. Just think about how cash raises the budget constraint leading to higher indifference curves. With an in-kind transfer, however, you (potentially) impose a constraint on the basket of goods, thus (potentially) reducing utility compared to he cash case. This argument is reminiscent of the deadweight loss of Christmas, discussed a year ago on this blog.

Janet Currie and Firouz Gahvani have a nice survey of reasons to provide transfers in-kind, and the circumstances where they apply. The parternalistic argument is the most obvious and applies when the government wants the recipient to consume specific goods. This would be called for when one wants to make sure children are adequately fed or are followed by health professionals. This violates consumer sovereignty, but it the whole point in this case.

But there are other reasons beyond paternalism. Social programs are often targeted, and in the presence of imperfect information for recipient identification, offering in-kind transfers leads to self-selection. for example, only needy people will show up at a soup kitchen or health clinic providing free services. Also, offering social housing in small apartments offers better selection among recipients than cash allowances. Of course, some needy people may be erroneously screened out. Note, however, that targeting does not necessarily imply overprovision of in-kind goods like paternalism does.

Cash transfers do not encourage poor people to do something about their future, as future cash payment depend on them being poor. Providing in-kind transfers takes care of this problem by forcing them into consuming goods that will help them out (education, health screening, etc.).

Finally, another circumstance where in-kind transfers make sense is when the target recipient is a member of the household that has no decision taking power. Children are such an example in most societies, and women in many as well.

I am appalled

I am appalled by the policy decisions currently taken in Washington. There should not have been a recession if these politicians had not started talking, and implementing, these bailouts. Let us first think about the origin: people realized that their mortgage backed securities may not be worth their market price. Some institutions may thus not be liquid or solvent. There are standard procedures for this, which do not involve climbing on roofs and shouting that the world will go under if huge amounts of money are spent bailing out these institutions. Essentially, Bernanke and Paulson have panicked, and showed it. The media and the market then believed them and started panicking as well. This dramatically increased the cost of the problem.

Now that the government seems to be in the mood of giving money left and right, with the blessing of the incoming administration, what is the reaction of banks? Wait until they see how much funds will come their way. Of course, they are not going to commit to anything until it is clear what they get. Even, they do not want to show that business as usual is possible, or they get nothing. With respect to banks, the bailout has achieved exactly the contrary of what it was supposed to trigger, get banks to lend again after the initial panic.

And why stop at banks? Now that the car industry is getting money, a provision that was not even in the bailout bill, any industry that somehow suffers will line up for more. And the US car industry should not get the money in the first place: it is structurally unsound. We are not talking about an emergency loan to a company that usually flourishes put goes through a temporary liquidity problem, we are talking about an industry that has had repeatedly losses even in good times, that never bothered to reform because of a "too big to fail" mentality and counted on its influence in Washington to postpone any adjustment.

And the current deal is money just thrown away: it gives a loan to the Big Three for three months, and by then it should have reformed. The car industry is incapable of doing so for several reasons: 1) it never did before, 2) part of the necessary adjustment is cost reform, and this money takes away any negotiating power against unions, 3) everyone is realizing that this throw-away money will be reflected in higher taxes, saves accordingly, and does not buy cars (and other things), 4) everybody realizes that this is just postponing the eventual bankruptcy, and you do not want to buy a car from a manufacturer who is soon incapable of honoring its warranty. If anything, the government should have imposed a transition form the Big Three to, say, a Mid-Sized One, and now, not after pushing this task onto the next administration at great cost.

This recession was completely unnecessary. By its declarations and its actions, the government talked the US into it. And unfortunately, no one, in the current or the future administration, seems to realize the impact of such short-sighted policy moves whose costs will linger for a long time.

What if one could buy votes?

Until secret votes were imposed throughout democracies, outright vote buying was not uncommon. Even today, there are suspicions that some elections or referendums are influenced by vote buying. In fact, delivering campaign promises to particular segments of the polity is a particular form of vote buying that is openly practiced today. So what if vote buying were generalized and accepted?

Eddie Dekel, Matthew Jackson and Asher Wolinsky at this question under two scenarios: outright vote auctioning and campaign promises, both compared to a status quo scenario where the electorate honestly votes according to its preferences. Campaign promises can only be delivered upon successful election, whereas vote buying implies payment is contingent only on (observable) votes. Two parties compete in a sequential and alternating bidding process.

The two scenarios lead to dramatically different distributions of favors: with campaign promises, only the electors close to the median voter matter, and those get substantial promises. Vote buying is substantially cheaper for the winning party and is not influenced by voter preferences. This implies that vote buying is inefficient: the richer party wins no matter what.

The impact of leader assassinations on institutions

Zimbabwe is a mess and voices are growing louder that only a violent overthrow of Robert Mugabe can solve the humanitarian, political and economic crisis of the country. While the leader is clearly a problem, would his disappearance really change institutions?

Benjamin Jones and Benjamin Olken ask this question in a broader framework: does assassinating a leader matter? In the case of autocratic leaders, it increases the probability to democracy if the assassination attempt is successful, but decreases it if not. In ex-ante expectation, attempts only increase the likelihood of democracy by 2-3%. Democracries, however, seem to be robust to this kind of violence.

The empirics exploit the randomness of the success of an attempt. But is this randomness truly random? For example, is the leader really ripe for an attempt and/or is not protected. Thus the optimal control group should be leaders who die in office, at least among autocrats. This may make the slim positive anticipated effect on autocracies vanish.

So, all in all, it does not appear to be appropriate to call for the assassination of Mugabe. But once his reign is over, here is how to fix hyperinflation.

Economic Logic is one year old!

I have already been posting for a year, and it has been fun doing so. While I started by commenting on the world around me from the perspective of an economist, I soon started discussing research. I guess it is just in my blood.

For those interested in blogging: it is quite a commitment to write on a regular basis, but it is rewarding in the sense that putting thoughts on "paper" allows one to put them in order, and sufficiently well for them to sustain the criticism of others. It is, however, somewhat time consuming. If I continue at this rhythm, it will cost me a paper a year, but I still think it is worth it.

While there are fewer comments than I anticipated, and while the readership is still rather confidential (although being featured on Econ Academics gave it a bump), I still hope I make some impact and get people interested in the topics I approach. Some posts had indeed some impact, here is a list:

The most viewed posts: Who will win the Olympics?, Why do people vote?, 2008=1929?

The most commented: Gas taxes are much too low, Illegal immigrants have rights that need to be defended, What is wrong with today's undergraduates?,

The most linked to: What is the FDIC thinking?, Blanchard's sad state of macroeconomics, I am upset.

In the comments section, I encourage you to state what you liked or disliked about the blog so far. It may or may not influence what I post in the future. But one thing is for sure: I will continue posting about research.

Optimal bureaucratic hassle

This week-end I had a conversation with a person complaining about the seemingly useless bureaucracy and hold times to obtain social assistance, and in that particular case unemployment insurance. He then went on railing against those inefficient bureaucrats. But what if they did that on purpose?

I am not saying that those civil servants have a manic pleasure at seeing all those applicants despair in their impatience. They rather follow rules within a system that purposely makes people wait and spend time applying for privileges. The bureaucratic hassle is essentially a discrimination tool. Indeed, those who really need help are those that have plenty of time on their hands (think unemployed) and can afford, even if they do not like it, to go through this hassle. But those, for example, who already have a job and try to defraud the unemployment insurance system will not want to go through the hassle, or at least they will be discouraged to do so.

Monitoring who can and who cannot obtain government services that are destined to the needy is difficult. Part of the bureaucracy is about monitoring, but it also has this added side effect that it allows people to self-select. Those who do not need help will not bother.

Why do Europeans work so little?

Over the last fifty years, the labor market of the major European countries went through a remarkable transformation: while Europeans worked 15% more than Americans in 1956, as measured by total hours of work per capita (15-64 years old), they now work 30% less. Richard Rogerson looks at this evidence, details it further and offers some explanations.

Looking more closely at the data by sector, he observes that while the service sector saw no change in relative hours between both regions, the good producing sector saw large shifts in Europe. Thus understanding the structural reallocation of labor across sectors during this period is crucial.

In early stages of development, an economy devotes more hours to good producing and less to services. As it catches up, like Europe did in the post-war period, it shifts labor from the goods sector to the service sector. By 2000, output per hour is similar in both regions, yet the European service sector is 35% smaller. Why?

Richard Rogerson ties this to the development process and taxation. Using a calibrated model with a home service sector (production of services at home as an alternative to buying them on the market), he shows that while technological progress allows a greater allocation of labor into the service sector, the increasing taxes drive this additional labor into the home service sector instead of the market service sector.

Is this good? Before arguing that "Europeans have a better quality of life," consider this: who is more efficient at producing goods and services, an autarky or a specialized economy with trade? At least since Adam Smith we know that specialization is better. So, unless the provision of home services entails particular enjoyments compared to buying those services on the market, the American situation is better.

Cost of default on sovereign debt

Now that various governments seem committed to increasing their debt drastically, it may become appropriate to investigate whether it could be optimal for them to default on this debt. What would this entail? Eduardo Borensztein and Ugo Panizza discuss this and identify four costs to default. This is based on an empirical exercise using 200 years of default data.

They find that reputation costs, as measured by credit ratings and rate spreads are significant, but short-lived. Indeed, consider how many times Argentina has defaulted yet managed to get decent credit conditions. International trade also is negatively affected, and this beyond what can be explained by a reduction in trade credit. The impact on GDP is also significant, especially when the cause for default was not very compelling. The impact on the economic activity is, however, short-lived. Finally, defaults may cause banking crises, but not vice-versa. And absent a banking crisis, the financial industry is not more affected than the rest of the economy.

Reading this, it does not seem that defaulting is that bad. In fact, it seems better than a personal bankruptcy, even US style, where establishing decent credit conditions is a long and hard battle. So, who is going to be the first to default? Not so quick, because it seems that some people suffer greatly from sovereign debt default: governments, and especially their finance ministers.

Sexism and university administrators

If you are currently in one of the few university departments that are hiring, you are probably getting frustrated by all the hoops you need to jump through to prove that you are not discriminating against various populations. These exercises imposed by the university administrations are sometimes silly, like asking you to figure out whether job candidates have certain characteristics, while you are supposed to take decisions while being blind to these characteristics.

Now, it is then a good question how the practices of the administrators are. Information on hiring practices of administrators is hard to come by, but it is easier to figure out how much they are paid. This is what Alison Booth and Jeff Frank set out to do with British university administrators, looking and gender differentials as well as the influence of sexual orientation or marital status. It turns out academics exhibit no bias in wages, but male administrators are significantly more paid than females. Hmmm. Do as I say (not as I do).

The cost of corruption

Today is anti-corruption day, and today is also when Daniel Kaufman gives his farewell speech at the World Bank. He is leaving the World Bank Institute for the Brookings Institute frustrated about the lack of progress in recent years in the fight against corruption. This obviously begs the question: is corruption really that bad?

The classic paper in this regard is that of Paolo Mauro, which documented in cross-country regressions how corruption was significantly and negatively affecting GDP and investment. Such an exercise is, however, subject to concerns of endogeneity that this paper does not address properly, as documented by Philip Shaw, Marina-Selini Katsaiti and Marius Jurgilas. The latter find that with a statistically adequate instrument, corruption has no effect on investment or GDP. Zvika Neeman, Daniele Paserman and Avi Simhon also show a no impact result, this time limited to financially closed economies, while corruption is bad in financially open economies. Toke Aidt, Jayasri Dutta and Vania Sena show that corruption does not matter if institutions are of low quality to start with.

Costas Azariadis and Amartya Lahiri argue that the causality runs the other way: rich countries elect good and honest governments. Cesar Calderon and Alberto Chong make a similar argument. Jac Heckelman and Benjamin Powell claim that corruption is in fact growth enhancing when economic freedom is limited.

Obviously, this survey is heavily tilted to demonstrate that corruption is not bad. There is also good evidence that shows the opposite. My point is, do not take for granted that corruption is necessarily bad.

What are unemployed people doing with their time?

When we model unemployment, we like to think that unemployed workers enjoy more leisure, but still spend a significant time searching for jobs. This modeling choice has important implications as it means that it is normal for the start of an unemployment spell to lead to lower consumption, as market consumption is substituted for home consumption and leisure. Do these choices by theorists make sense?

This is one question that Alan Krueger and Andreas Mueller can answer in a pair of papers that use the American Time Use Survey (which still needs saving) and other surveys. Overall, unemployed people behave in expected ways: they sleep more, they spend more time in home production, including care of children, and have more leisure, in particular TV watching. They also spend more time shopping and, of course, looking for a job.

This is where it becomes interesting. On a weekday, an American spends 40 minutes looking for a job. While this is surprisingly low, consider that Scandinavians bring it down to 5 minutes. These numbers hide considerable within country variation as, for example, only about 20% unemployed Americans actually spend time looking for a job. For those that actively search, the time spent is determined by the "urgency" of the job search: being married or female leads to less job search time. Educated people search more. But again, this is conditional on searching at all.

Unemployment insurance benefits do not seem to explain the cross-country variation in time spent searching, except maybe the change in benefits as the unemployment spell last over six months. However, in the US, cross-state variation can be explained by UI benefits. And for those eligible, search time increases as the end of eligibility approaches.

All in all, it looks like unemployed workers are behaving as theorists would expect. Except that the length of time spent looking for a job is an order of magnitude shorter that what is generally assumed.

Looking for Giffen

Everyone has heard of Giffen goods in their first Economics class: goods whose demand increases with their price. But do they exist? Marshall, who introduce the concept had the example of bread for poor families, but no such case was found in reality. Samuelson popularize the idea that potatoes in the Great Irish famine were Giffen goods, but again, there is no evidence. So, do Giffen goods exists at all?

Robert Jensen and Nolan Miller claim to finally have found a Giffen good, or rather Giffen behavior, as the good has a regular demand in normal circumstances. After running some field experiments in China by subsidizing some goods, they find that if 1) households are very poor and face subsistence nutrition concerns, 2) households consume a very simple diet of a staple good and a fancy good, 3) the staple good provide cheap calories, comprises a large part of the budget and has no substitute, 4) households are not so poor they only consume the staple good, then one can observe Giffen behavior. In the particular case in Hunan, household eat mostly rice with supplements of meat. When the price of rice increase, households seek to maintain caloric intake by eating less meat (which is even more expensive) and more rice.

We are impatient because our brains are schizophrenic

There is ample evidence that humans are impatient. The traditional assumption in Economics has been to assume that we have preferences that exogenously feature a discount factor. Isabelle Brocas and Juan Castillo claim to explain endogenously impatience by thinking about how the brain functions.

Essentially, the brain is composed of competing entities. Say that there is a principal maximizing undiscounted intertemporal utility on a finite horizon. Then, there are distinct agents in each periods, all myopic in the sense that only contemporaneous utility matters. The principal can impose choices on agents, but the latter have private information on marginal utilities. The problem is closed with an intertemporal budget constraint with a strictly positive interest rate.

Impatience emerges as a result of this asymmetric information. Each agent has independent valuation, so there is no information to be gained from one agent that would be useful on the others. However, the principal can elicit some valuation revelation by granting more immediate utility to the agent. Thus, impatience is the result of asymmetric information between the principal and the independent agents.

In the particular implementation of this problem, the only intertemporal binding is the interest rate. This is the reason why the principal wants some savings. In the model, this positive interest rate is exogenously imposed. If it is zero, there is no impatience. Then, why would the interest rate be positive in the first place? Isn't it to reward patience among impatients? Aren't we going in circles here?

The case against student evaluations

It is time again for student evaluations and the biannual ritual where students are given the authority to judge how well they were treated in their classes. While I agree that it is useful to have some indicators about the quality of teaching, I do not think students are the best people to ask about this.

As Walter Bossert argues, the facts that students are obviously no experts in the taught material, that they perform the evaluation anonymously without having to justify their marks and they have no guidelines on what the marks are worth makes this a highly dubious effort. Imagine if teachers were evaluating students this way!

From my own experience and from pouring through others' evaluations (a sad exercise), students reward those who make it easy on them. Just look how students discuss their teachers on Professor Performance or Rate My Professors. A committed teacher who wants her students to really learn and pushes them to work hard is doomed.

Then, how should teachers be evaluated? By their peers, and by students who have graduated. These are the people that can best evaluate how the teacher masters the material and how it has an impact.

Talking up recessions

The NBER has now decided, the US is in a recession. It is, however, my impression that this recession is totally unnecessary and has been mostly talked up. Indeed, banks have all the necessary liquidity, they just look each at other and wait for the first one to move. To make things worse, now that this bailout plan has been decided, they are waiting for money to flow before doing anything. Think of it is terms of living on anticipated profits. Without the bailout, they would have given loans by now as they cannot afford to sit idle on cash.

But when I say this recession has been talked up (much like the Gulf War recession), that does mean that economist should continue telling things like they are, instead of feeding the fear mongering of the media. And if things are truly fundamentally bad, they should not hesitate to say so, as in most countries they will not face the consequences they would face in Latvia...