One rationale for the public provision of public goods

Amidst all the current talk about nationalization, it is worthwhile to think when the provision of private goods by public entities is indicated. Generally the argument is that the good is a natural monopoly and the particular industry is difficult to regulate. But are there other reasons?

Hanming Fang and Peter Norman provide an intriguing alternative explanation: when a government provides a private good, it learns more about the consumer and is thus better able to tax in the sense of optimal taxation. The basic idea is that it is difficult to configure properly a tax system because of information problems. In this particular case, there is private information about how much households value different goods, and the government tries to determine the optimal price à la Ramsey pricing. In addition, Fang and Norman show that the optimal pricing would call for a tax on the private good to subsidize the public good. This tax would be dependent on whether the household also consumes the public good.

While this is an interesting argument, one can question how this translate into practice. The authors suggest that the government should bundle the goods. This is something that is done aplenty in the private sector (think of bundling phone, cable TV and internet access), but this is done for similar goods. I cannot think of examples where public and private goods could be bundled in a reasonable way and that would be informative.

How to increase employment, and at what cost

Governments across the world have been scratching their head on how to increase employment, or decrease unemployment, and the question appears to become more urgent these days. History shows that they have been extremely creative, but with little impact. The main problem is that they have tried to force some people to work less in order to spread the total number of work hours among more people, as if this were a zero sum game. Particular fiascos are the French 35 hour week and countless early retirement programs.

Economists generally do not think it is appropriate to add constraints to a market that is not in equilibrium. One should rather work through prices by imposing taxes or subsidies in order to encourage people to take some actions while losing little efficiency. The question is then what to tax and what to subsidize. Victoria Osuna takes here an interesting perspective with a model economy incorporating commuting, team work and overtime. There are three policy tools: tax overtime, subsidize wages and subsidize employment. All make work cheaper, but the substitution of hours in the workweek becomes critical. This is embedded in a real business cycle model, thus general equilibrium effects influence capital accumulation and factor prices.

The experiments are quite interesting. First, tax overtime to bring hours from 40 to 35: you need a 12% tax, steady-state employment increases 7%, but GDP decreases 10.2%. The issue is that a lot of capital now lies idle. To get the same increase in employemnt, a wage subsidy is desastrous, as it reduces GDP by 12.7%. The problem is that the subsidy needs to be substantial, 16.5%, which leads to large misallocations of capital. An employment subsidy of 4.5% does better, dropping GDP by "only" 4.7%.

So, if you want to increase employment, be aware that there will be substantial costs in terms of output and lost productivity. I am not sure it is worth it.

Self-confidence and self-employment

Who decides to become self-employed? This can be an important question if one considers that entrepreurship is a major factor in economic growth, and entrepreneurs are largely self-employed. Ozkan Eren addresses this question using the US National Education Longitudinal Study data and comes to some surprising conclusions.

The extant literature has firmly established that wealth and the father's labor market choice are very important determinants in self-employment choices. And this seems to make sense: you need to be capable of overcoming financial hurdles and have a role model to follow. This literature neglected, however, the impact of cognitive and especially non-cognitive abilities. NELS data include measures at 8th and 12th grades like test scores, self-esteem and locus of control that Eren exploits here.

While it may not seem surprising that individuals with higher self-esteem tend to be more self-employed, but it is counter-intuitive that the impact of cognitive skills is negative. One can rationalize this, though, with the idea that high skills can be compensated with wages, and lower skilled people may find fewer opportunities on the labor market and work by themselves. Interestingly, the two abilities work rather independently, as only one fifth of the correlation between cognitive abilities and self-employemnt can be explained by non-cognitive abilities.

Americans stand out against Europeans because they exude self-confidence. This may explain why there are more entrepreneurs in the US and why income a higher, despite the fact that US test scores on abilities are lower.

Democracy and public good provision

Is democracy good for an economy? As discussed previously on this blog, there does not seem to be a link between income and democracy. But this does not mean that the political regime does not have an impact on an economy. For example, a democracy may care more about the provision of public goods.

This is what Sebastian Vollmer and Maria Ziegler explore empirically. Using a panel data analysis, they find that life expectancy and literacy are positiviely affected by democracy. This can be explained that as schools and health are publicly provided in most countries, the major dimension of change is how much (not if) governments care about schools and health, and democracies care more. Of course, there are always exceptions, such as the US where the government does not care that much and it is reflected in outcomes (after controlling for GDP, of course).

If democracies care so much, why are they not richer? It may be because redistribution, which the provision of public goods essentially is, is not necessarily growth enhancing. Autocracies care only for the elite (but not too much, or the common people will revolt), and the elite's income is mostly driven by aggregate GDP. But the large level of rent seeking in such economies drives GDP down. The point of my rambling here is that GDP should not be the focus of the analysis anyway. Thus, inequality and redistribution will matter for social welfare, and democracies appear to deliver this.

Minimum wages and optimal taxes

The analysis of the impact of minimum wages is usually limited to empirical studies of the employment or unemployment elasticity. Theory is believed to be rather straightforward. In this respect, the work of David Lee and Emannuel Saez is refreshing. They study the interaction of a binding minimum wage with income tax policy and find that minimum wages are beneficial as long as taxes are sufficiently redistributive and the resulting rationing is efficient: the workers with the lowest surplus do not get jobs.

The analysis is perfomed within the context of optimal taxation theory and allows for non-linear taxation. Then, minimum wages essentilally become part of tax policy and they allow to disciminate by labor efficiency. This is essentially the argument that Pierre Cahuc and Guy Laroque have made: minimum wages become redundant once optimal taxes are in places, or you can assume minimum wages and optimal taxes will work around them.

The two papers have an important distinction. The first assumes perfect competition, the second monopolistic competition. As argued before on this blog, minimum wages can lead to monopolistic competition due to implicit collusion that they favor. So all in all, I am not sure the Lee and Saez results are that exciting...

Gender based taxation

If governments need to raise revenue, it is well known that the best thing they can do is through sin taxes, such as for carbon emissions in general, gas in particular, alcohol, tobacco or workalcoholism (or subsidize fitness). If this is not sufficient, the most inelastic goods should be taxed, i. e., goods whose quantity is little influenced by changes in its after tax price. In the context of labor income taxation, this means men should be taxed more than women. Indeed, the female labor supply is much more responsive to after tax wages, as men work anyway.

Alberto Alesina, Andrea Ichino and Loukas Karabarbounis expand on this idea, noting first that is common to discriminate by gender, say through affirmative action, different retirement policies or maternal leaves. So why not discriminate more efficiently through the price system instead of quotas? From an economic point of view, this seems obvious. But somehow this is not popular with the general public. Is it because the basic economic model is missing something?

Alesina, Ichino and Karabarbounis test the robustness of gender based taxation to all sort of bells and whistles, and its optimality remains. In particular, they assume that men and women have identical characteristics and preferences but for the fact that men have higher bargaining power at home and can thus avoid household chores by working in the market. As long as household chores are unbalanced, taxing men makes more sense and improves overall welfare.

That said, there is no reason to stop at gender. I have argued before that luck at birth should be taxed, such as for tall people. Others have made similar argument for beauty. In fact, the strongest argument for development aid can be made on the grounds that where you are born is not something you have earned, and one should share one's luck with unlucky ones. And your birth place certainly is inelastic.

Subprime borrowers make stupid financial decisions

Much has been written and said about some ill-informed decisions that subprime borrowers have taken with respect to the housing market, in particular taking mortgages that they cannot afford in the longer run. Some of this has been attributed to being ill-informed about the terms of the loans rather than irrationality. Mortgages can be complex contracts with lots of fine print. What about more straightforward financial instruments?

Sumit Agarwal, Paige Skiba and Jeremy Tobacman merge data from a credit card company and a payday loaner, the latter often charging interest rates that annualize to several hundred percents. They notice that people borrow from payday loaners while still having significant liquidity of their credit cards. An amazing two-thirds of those taking a pay-day loan have more than $1000 available on their credit card, and the loan they are taking averages at $300. Over the two week life of such a loan, $52 would have been saved by putting it on the credit card. Considering that payday loans are often repeat businees, we are talking about substancial amounts.

I reported earlier on the puzzle that some people have credit card debt while also having significant amounts in checking accounts. That puzzle could be explained by liquidity needs for transactions that need to be paid by cash. But this new puzzle is really baffling: both credit card and payday loan provide the same service at a very different price, and people use both even if unconstrained. Are people really that stupid? And so many people?

Momentum traders and the housing market bubble

Bubbles are very difficult to recognize, by definition: you need prices to depart from fundamentals, and in the case of housing, expectations of fundamentals play the most important role. Determining whether expectations are overblown is thus quite subjective. But I think we have now a wide consensus that there has been a bubble in the housing market for several countries. The question is obviously how this could happen.

Monika Piazzesi and Martin Schneider argue that very little is required to get a bubble. A small number of so-called momentum-traders is sufficient. Using the Michigan Survey of Consumer, they find that there are always households who think is to a good idea to buy because price will rise further, but there number doubled during the bubble. They then proceed to write down a simple search model where they demonstrate that these momentum traders, even if outnumbered, have a strong impact on prices.

This is not unlike the rise of chartists on stock and currency markets who believe that future asset prices can be determined by past trends. Eventually markets started behaving in the way they were predicting once a sufficient, but not large, number of investors where following these rules. But once these self-fulfilling propecies start deviating too far from fundamentals, the markets correct themselves and get back to fundamentals. We have seen this again and again, but some people are always going to follow Mickey Mouse financial strategies, and unfortunately they seem to influence markets.

Who bears the cost of fluctuations?

Now we are in a recession, who are those who will reduce their consumption the most? There are two obvious candidates: those who get unemployed and those were consuming a lot to start with. We know since the work of Jonathan Gruber, that consumption drops by 7% at the start of an unemployment spell despite unemployment insurance, and with a recession more people are unemployed. But, usually, those most likely to become unemployed in a recession are lower-skilled workers, who earn and consume less than average. A drop in aggregate consumption cannot be solely attributed to them.

Jonathan Parker and Annette Vissing-Jorgensen argue that those at the top of the consumption distribution suffer from very large fluctuations in consumption. Why would we care about the very rich? Because they influence aggregates and we seem to care about those. Also, this means that consumption inequality will be reduce considerably during this recession, even more than usual as the incomes of the very rich appear to be more affected than typically.

In their study, Parker and Vissing-Jorgensen find that the high correlation of individual and aggregate consumption of the very rich is a recent phenomenon. This is not due to the composition of their income, which is increasingly wage-based, as both individual capital and labor income are procyclical, and became more so recently. This should lay to rest the idea that rich households are able to smooth much better their consumption over the business cycle.

What households are financially sophisticated?

In the current crisis, some blame has been put on households who took rather strange financial decisions, especially with respect to house purchases and mortgage products. Essentially, they were lacking financial sophistication (or even common sense). This begs the question, what are the characteristics of financially sophisticated and unsophisticated households?

Laurent E. Calvet, John Y. Campbell and Paolo Sodini answer this question using household finance panel data from Sweden. They distinguish three types of mistakes: under-diversification, inertia in risk taking and disposition effect (the unwillingness to realize losses and too high willingness to realize gains). It would not surprise you to learn that richer households are more sophisticated in financial matters, after all this is probably the reason they got rich. But, interestingly, other factors are more important. Household size matters a lot: the more children, the more sophisticated the finances. Education and financial experience matter less. Of course, exception abound, like the California octuplets mom proves. But is shows that people are much more careful when financial decisions matter: you have children, you have some wealth, you have perspectives of future wealth (being educated). If the worst that can happen to you is foreclosure and you have little to start with, foolish financial decisions will not matter much.

Private charity vs. government support

Europeans prefer the state to help needy causes, Americans have a preference for charities to take care of this. Are government support and philanthropy substitutes or complements? If they are perfect substitutes, then it would not matter what the source is. If they are complements, you would want both to be in play.

James Andreoni and Abigail Payne point out that there is more to the story than simple crowding out. Suppose that a government provides some resources to an organization, say $100. Then people will contribute $56 less. But not all this crowding out is coming from people feeling they are not needed any more. $38 of this $56 reduction are due to lower fund raising effort. This makes it particularly important that any money the government gives should have a matching requirement from private funds to maintain the fund raising effort.

Patents and copyrights are an abomination

Over the past few days, I finally came around reading Michele Boldrin and David Levine's Against Intellectual Monopoly. I had read bits and pieces from the on-line version (still available) and followed their blog (see my blogroll in the sidebar), but reading it from cover to cover makes their case more convincing.

Essentially, the book challenges the conventional view that temporary monopolies like patents and copyrights are necessary for innovation. This is the mantra you hear everywhere: if there weren't patents on drugs, the pharmaceutical companies would never be able to recoup their investment in research, their stratospheric returns on investment notwithstanding. Or that without copyright, artists cannot make a living.

Boldrin and Levine show plenty of examples that demonstrate that it is possible to make an absolutely decent living without monopoly protection. For example, the early US book industry did not have copyright protection, yet publishers and authors were make more profits than in Britain, where protection pushed prices up and print runs down. US printers, however, flooded the market with cheap books and thus contributed to the increase in literacy.

This brings me to the fact that monopoly is rarely good for social welfare. The book goes through numerous instances where patents actually inhibit progress by preventing innovations based on a current patent. Also, they have been many example where an industry expanded greatly while it was free from patents, but once some big players started feeling threatened by new innovators, they pushed Congress to extend the coverage of patent laws, and innovation and expansion comes to a standstill.

This is a great book. I bought a copy, but you did not need to, as it is not copyrighted and available for free download. But I guess I contributed to demonstrate that you can make a buck without copyright, and the authors deserve to be rewarded.

Better rankings of economists

RePEc has been providing rankings for the economics profession for several years, but one aspect that was severely undermining their credibility was that the country rankings were in many cases meaningless. The problem was that economists with multiple affiliations in several countries were ranked equally in all countries. The German rankings, for example, were dominated by Americans with courtesy appointments in local institutes.

This month's rankings appear to have fixed this problem by attributing to each affiliation some weight, penalizing such courtesy appointments. National rankings now look much more reasonable, and the worldwide ranking of institutions is not dominated by these institutes any more. Now if these rankings could cover all economists, not just those who bothered to register...

What can we learn from Barbados?

That institutions matter is well known, empirically from many cross-country growth regressions, as well as from twin countries like North and South Korea or East and West Germany. The latter examples highlight situations where countries started roughly at equivalent levels of development and thereafter diverged massively. Could policy differences achieve the same? Zimbabwe is an obvious example, but let us exclude implosions.

Peter Blair Henry and Conrad Miller have an interesting look at Jamaica and Barbados. Both are small Caribbean islands, former British colonies with typical institutions, populated mostly by former slaves brought in for the sugar cane plantations. Jamaica was blessed by valuable bauxite deposits, yet soon after independence, the unemployment rate shot up, due to a combination of high and rigid wages and a flight to the city. The other difference is how these island states have reacted to the oil shock: Jamaica went on a spending spree financed by debt and inflation, intervening massively in markets, while Barbados had a much more moderate fiscal policy. During that period the growth rate differential was 3.5% in favor of Barbados. And nowadays, the GDP per capita in Barbados is a multiple of that in Jamaica.

In there something to learn for the current situation. Quite obviously, these are economies quite different form the large ones now looking for rescue policies. But quite obviously, Barbados benefited tremendously from having a government with foresight that was trusting markets.

Credit card payment fees need regulation

Buyers have several means of payments available: cash, debit cards, credit cards. Merchants are obliged to accept cash, but can choose to accept other media. Most banks offer simultaneously debit and credit cards to both, the latter often with some incentives. Wonder why?

Wilko Bolt and Sujit Chakravorti show that banks are the big winners while both merchants and consumers are losers. The reason is that banks can rig the payment fees in such a way to force merchants to accept credit cards that bear higher fees. The key here is that merchants are not allowed to differentiate prices by type of payment medium.

The analysis is performed with an elaborate model where all three players make endogenous decisions on what to accept, offer or use, and takes into account the consumer's worry about theft the timing mismatch of income and expense, the merchant's worry about getting sales and the banks worry about bad credit. This allows to be more explicit about the welfare gains (or losses of each agent). Unfortunately though, risk neutrality is assumed for consumers. Risk aversion will make them willing to pay even higher card fees, leading even further away from a social optimum. So it looks like some strong regulation is needed here. Or allow merchants to charge different prices by type of payment.