Optimal unemployment insurance monitoring

Setting up a good unemployment insurance system is awfully difficult. You need to take into account that there may be significant moral hazard, as workers may shirk their effort to find a new job or hide job rejections. But you still want to provide some level of insurance. Hugo Hopenhayn and Juan Pablo Nicolini have realized in 1997 that "one dimension" is not sufficient to get closer to first best. In addition to benefits that decline with unemployment duration, they devise a tax and subsidy scheme once you have a job, a scheme that depends on your unemployment duration.

Ofer Setty adds a third dimension, monitoring. Specifically, the idea is to monitor the job-search effort with a probability that depends on some observables. Monitoring is costly, by provides a somewhat informative signal, on which insurance benefits depend. In other words, if a case worker thinks you are lazy, he can spy on you and depending on what he observes, he may penalize or supplement you. Knowing this, you provide more effort to look good. The result: significantly better insurance, measured by the variance of consumption that is divided by three, and half the cost of insurance. Not bad.

About books

A week ago, I argued that journals are dead. What about books? There are three types of books I want to distinguish.

Textbooks. They have turned into an abomination. They are expensive, too frequently revised, encourage both teacher and student to be lazy in class. I would do away with I were allowed.

Academic books. In economics, they rarely push the frontier of research. Over the last five years, I must not have read more than five. Were they to disappear, it would not be a big loss.

Entertaining books. By that I mean literary pieces in fiction mostly. This is a medium that is not going to disappear. Nothing beat being taken by a book and not be able to put it away. There is something physical about it that a Kindle cannot replicate. Something like what the following video describes.

Why third generation immigrants earn less

It is well known that second generation immigrants fit better in the host country. This is particularly true with respect to human capital, with the first generation being either less educated than the second, or not being able to exploit fully its existing human capital. What happens to further generations? If the second generation has converged to the local population, there should nothing interesting to see, right?

Wrong, according to Vincenzo Caponi. He observes on Mexican immigrants to the US that the third generation has significantly lower wages than the second. The way I understand it is that there is selection in migration decisions: only those with higher than average abilities (not necessarily realized human capital) go. Their children inherit some of those traits, and thus have higher than average abilities and human capital. While the first generation was not able to fully exploit this, while the second does, wages go up. But abilities of the third generation continue regressing to the mean, and the selection effect erodes. This generation ends up with lower human capital than their parents and thus lower wages.

How people pick a good wine

How do you pick your wine when you go to the store? DO you come with a list of recommendations? Do you ask personnel? Other shoppers? Do you come with a guidebook? Do you pick at random? Or do you always buy the same bottles?

Luiz de Mello and Ricardo Pires say that the average customer is mostly influenced, except for the price, by the shape of the label. Next most important factor is the color of the label. Isn't that disappointing? with the educated small talk people have about their preferred wines, all that matters in the end is the label?

How can we rationalize this? For one, many customers are not that sophisticated and just want a decent wine. Given the competition, a particular cru needs to distinguish itself. Somehow, having a distinctive bottle design is frowned upon, but the label is where free expression can attract a shopper's eye, like the banner ads with dancing girls. For the sophisticated wine drinker, the label will not matter anyway.

What do Economics graduate students think?

David Colander has made a series of illuminating surveys of graduate students in Economics that have given us a very interesting picture of our profession, or at least how these students view it. Much of his work was, however, performed with surveys sent to the top US PhD programs. He follows up now with a survey of what he compassionately calls the "median" range, the other US graduate programs.

David Colander, Tiziana Dominguez, Gail Hoyt and KimMarie McGoldrick report a few interesting results. Compared to top programs, median ones have proportionally more Americans, who are more likely to have chosen the program for geographical than prestige reasons. Students from median programs seem to be more interested in various fields of Economics, probably a reflection of the fact that they are on average two years older and have more of sense of purpose in their studies. I am pleased to read that about half the students consider Economics to be a tool set. It is also interesting to note that whether in a top or median program, students appear to have similar views of policy and of assumptions in Economics.

All in all, students in top and median schools do not look that different. Their expectations in terms of jobs are different, as they should be, as well as the way they get funded. Lower ranked schools cannot fund them as well as research assistants or provide them with fellowships. Colander and co. interpret the fact that more are teaching assistants at median schools as a choice by students, it seems more a funding constraint to me. No real surprises in this survey.

Policy inertia through educational elites

Some economists speak sometimes a language that is even difficult to comprehend by other economists. This happens in particular when they draw from other social sciences. An expert in this is Gilles Saint-Paul, whose major research agenda is to understand why France has chosen not to adhere to free market principles despite repeated evidence it could do better with less government intervention.

In his latest piece, he suggests that there is very strong institutional inertia that is fed by the institution itself. I see two major points in his discourse. The first is that there is an educational elite that is biased in some way and makes it thus impossible for the general public to really understand what is going on, "learn the parameters of the model." And in France this elite is anti free market. The second is that because policy choices are consistently made with a government intervention bias, people never have the opportunity to learn how good free markets actually are.

Saint-Paul certainly has a point with cultural elites being very influential in France. Where else can philosophers become TV stars? It is also true that this elite lives in some sort of utopia where the world can be perfected by intervention (and unlimited budgets). This borders sometimes on the naïveté elementary school kids display when they feel they solved the Darfur problem by writing a letter to the President (my kid did). It is also true that the French are repeatedly shown the problems of free capitalism, like in the US. And the exact reverse happens in the US, where free markets are taught and thought to be perfect, and any government intervention is evil.

Not that free markets or government control are perfect, but, as so often, there is a middle ground. And with Sarkozy, the French are getting more of a taste of free markets. And on the other side of the pond, Obama is putting options on the table that should alleviate some of the ill effects of free markets. Maybe we are now seeing this inertia crumbling.

On the optimality of longevity?

There are times where you come across an interesting title and a somewhat appealing abstract, and then you read the paper and you cannot believe the rubbish that is being presented. It is all elegant math, neat proofs, sometimes there is even good intuition, but the relevancy or the modeling assumptions are completely out of this world. The latest opus by Luciano Fanti and Luca Gori is one them.

So the purpose of this paper is to study how public expenditures for health impact savings and the current account through changes in longevity. That seems like a reasonable question, especially the longevity angle, as many studies before, some cited on this blog, have looked at the direct interaction between health expenses and savings, or at the indirect effect through changes in interest rates. From here it goes downhill, though.

First, prices are fixed. While may make sense for the interest rate, a small open economy is assumed after all, it makes no sense for the wage, as the whole point is to look what happens when population and aggregate savings change and thus should have an impact on the marginal product of labor. Second, aggregate capital is not defined, and thus the current account is not defined. Third, the paper claims that longevity is endogenous, but in fact it is just a function of health expenditures, which are exogenous. Fourth, when lifetime is endogenous, one cannot describe utility solely with consumption and assign zero utility when dead. As a consequence, any welfare measure is invalid.

Ironically, the cover page of the working paper series says "adhibe rationem difficultatibus", a quote from Seneca translating to, roughly, "let reason conquer your obstacles."

Journals are dead

You way have noticed that I have not reported about a journal article on this blog for months. In fact, it has been a while since I last opened a journal. Should I take this as a sign that journals have become irrelevant?

It is true that journals are considerably lagging behind the research frontier, at least in Economics. Our working paper culture makes that you rely on such pre-publications to keep up with what is going on. In other fields, conferences is the place to go to stay current. Journals are then just a confirmation about your evaluation of your readings. In this regard, I am eager to see how the papers I discuss here will be published (see the IDEAS reading list for this blog).

But back to the topic. Why do we keep insisting on sending our papers to journals and suffer through the tyranny of referees who cannot appreciate our work or just have personal agendas? We can get the recognition we need from citations, especially now that RePEc does citation analysis from working papers, much faster than ISI could ever do. Unfortunately, tenure and promotion committees want to see peer-reviewed publications, because of inertia.

And what if blogs like mine could take the role of peer review? They establish a reputation, and then (positive) mentions can become an asset. But for this to happen, we need more blogs like that, and especially more specialized ones that can better dissect papers. And we need more readership so that research blogs actually get a chance at become reputable. From what I see from my readership and the amounts of comments, we still have a way to go, although some others listed at Econ Academics (link corrected) appear more successful.

Are school uniforms useful?

Urban schools are often tempted to impose school uniforms on the presumption that this resolves some discipline problems linked to clothing and gangs. The counterpart of this supposed benefit is that those uniforms are costly. Thus, the improvement in discipline better be worth it, including indirect effects on student performance.

Scott Imberman and Elisabetta Gentile look at a school district where some schools have adopted uniforms. And it turns out the gains are minimal: none in elementary school, and only slight improvements in attendance and language skills in higher grades. And these small positive impacts are limited to female students. Is this worth the cost of the uniforms? I do not think so.

Are ethnic differences across nations relevant?

It is well know that ethno-liguistic diversity is bad for the development of an economy, for example because it leads to leaders favoring their ethnicity, thus members of an ethnicity only vote for their own, and the political and economic process only is about rent seeking. I am exaggerate, but in some countries this unfortunately close to the truth. The negative impact of ethno-linguistic diversity has been shown over and over in cross-country regressions.

Could ethno-liguistic similarity across countries also matter? For one, one could imagine that it could foster closer ties and thus lower trade barriers, which is good for development. It is also likely to has spurred fewer interethnic wars, thus leading to more trust that is necessary for commerce. On the other hand, civil unrest can spill over to a country with ethnic or linguistic affinity. In any case, before this can be studied, one needs a good measure of ethno-linguistic similarity.

Olaf de Groot delivers this by measuring the percentage of shared identity characteristics of two individuals randomly drawn from two different populations. And using this measure to study conflict spillovers, it appears to be a very good predictor. Let's see whether this measure will be useful for other studies.

Do big boxes displace mom-and-pop stores?

When Wal-Mart moves into town, is this good or bad? It is commonly perceived that this is bad for local businesses, and especially for small "mom-and-pop" stores. In reality, that depends on whether big-box stores like Wal-Mart are complements or substitutes. Intuitively, they should be largely substitutes with respect to the shops they directly compete with, while there may be complementarities with other shops as they attract more customers to town.

John Haltiwanger, Ron Jarmin and C.J. Krizan confirm this intuition. Surprisingly, this was not a clear result from the previous literature. The difference here is that establishment level data is used, and that employment dynamics within a metropolitan area are studied.

That being said, what is so bad about seeing mom-and-pop stores closing? These are high inefficient retailers, and if similar retailing services can be provided at lower cost, we should go for it. If people value a different retailing experience, they should be willing to pay for it, and visibly they are not. Banning big boxes only provides rents to existing inefficient businesses.

Play with your colleagues, and write a paper about your experience

Who has not dreamed of playing a crank on one's colleagues? And then get a paper out of it? This paper is not quite about a crank, it is about an experiment that João Ramos and Benno Torgler played on their colleagues. Many departments have a common room for people to get coffee, chat and hang out. Ramos and Torgler used their common room at Queensland University of Technology to play a game unbeknown to their colleagues, namely test the Broken Window Theory.

The theory states that if a building has a broken window, it will soon have more broken windows, because the first one signals neglect and thus breaking a window has no consequences. The particular experiment is interesting because participants were unaware they were being observed. It went as follows: usually the common room is cleaned every morning, with all dishes washed in a dishwasher. It is expected from everyone to put dirty dishes in the dishwasher. The experiment is to put a controlled number of dirty dishes in the sink and mess up further the place with newspapers and sugar packs.

In the tidy common room, 18% of users littered, defined by not putting their dishes in the dish washer. With the messed up common room, 59% littered. Older faculty tend to litter more, surprisingly, and there is less littering when more people are present (peer effects) and on Mondays (habit from not littering at home over the week-end).

Oh, how I wish I had the idea of hanging out in the common room for a full month and get a paper out of it...

The international movement of euro coins

We know rather well how frequently bank notes change hands, simply by computing the velocity of money from the money supply and some aggregate measuring transactions (although not all are done with cash nowadays). But as they change hands, how much do they travel?

Franz Seitz, Dietrich Stoyan and Karl-Heinz Tödter follow € coins. Each country participating in the European Monetary Union issues its own coins, and they are valid currency everywhere. So they eventually cross borders as people themselves cross borders. They look at German €1 coins and find that they exit the country at a rate of 4 to 5% a year. And Germany is the largest participating country, so I find this to be a surprisingly large flow. In the long term they expect the proportion of German coins in Germany to be around 50%.

The new Dutch car tax is great!

The Netherlands just decided to revamp their car tax. First the taxes on the acquisition of cars, currently 25% of the sales price) and the yearly car tax are scrapped. This is replaced by a base tax of €0.03 per driven kilometer, an amount that is increased for gas-guzzlers, heavy vehicles and rush-hour traffic. Distances and times are determined by GPS in every vehicle.

I absolutely love this system. It is almost exactly how cars should be taxed. The current system does not penalize enough for the externalities of driving (pollution, road wear and congestion) because the marginal cost is fixed (not zero, because there is also the gas tax). This system allows to vary the cost according the intensity of the externality. Only small flaw I see: one should still have a periodic tax on cars, to account for the public space they take by being parked. Or even better, have parking fees levied by GPS as well.

On the impact of religion on social trust

All religions I know of advocate that one should care and trust others. But "others" needs definition: in many cases it means others from the same religion, to the exclusion of other religions. Thus, if religiosity is higher, does this lead to higher social trust? It is not obvious as more religious people may trust more their own and less the others. To give a parallel in internation trade: are free trade unions good? Yes, because they reduce tariffs, but no if they increase tariffs for trade outside of the "club."

Niclas Bergren and Christian Bjørnskov study the religiosity and social trust question using survey data that, among others, asks to questions: "Is religion an important part of your daily life?" and "Can people in general be trusted?" They perform cross-country regressions using 105 countries and all US states. The outcome: reliogisity reduces social trust, both internationally and with the US states. Why? I can only speculate here, but humans are social beasts that operate at the level of clans. Religious affiliation is one expression of this. And for a religious person, anybody who does not share the same values is suspicious.

Does this mean the world would be better without religions? For one, less resources would be spent in demonstrating how my god is netter than yours. Also, this study shows that we would have more trust, an essentail ingredient of trade. But as Malthus said, I paraphrase, materialism is not the only element in happiness, spiritualism can be important, too.

Are school lunch subsidies useful?

I have always found it puzzling that so many American children qualify for school lunch subsidies. It seems that in the richest country of the world at a time where the world was never this rich, no children should go hungry. Yet many apparently are. And it seems that these school lunch programs are doing them good, both in terms of putting something in their stomach and something healthy in their regimen. Which is important in the context of the obesity "epidemic."

This is what I understand from the paper by Larry Howard and Nishith Prakash. In particular, they observe that pure fruit juice, fruit and salad intake increases for those who are subsidized. This implies in particular that parents are not substituting away from these foods when they are supplied in school. Encouraging. Now, what about removing hamburgers, pizza and fries from school cafeteria menus for everyone?

Do remittances help growth back home?

As Robert Lucas has highlighted, it is a puzzle why capital does not flow in much larger quantities to poor countries. There, capital is scarce and has high returns. A counterpart of this is that labor should be moving away from poor countries to where it is mopre scarce. This is indeed happening, although rich countries put restrictions to this flow. But when it happens, it turns out that rather large remittances are sent back home by migrants workers, to the point that it now surpasses other capital flows. It becomes then important to understand whether this capital influx is put to good use.

Michael Gapen, Adolfo Barajas, Ralph Chami, Peter Montiel and Connel Fullenkamp study te impact of remittances on economic growth. It is weel known that they have a positive impact on poverty alleviation or consumption smoothing at the household level, but the macroeconomic impacts are not well understood.

It turns out remittances have no positive impact, and it may even have a negative impact on growth. The authors obtain this result performing panel growth regressions on 84 countries. How would this result be obtained? Remittances can have a positive impact, through relaxing credit constraints, providing more resources and insurancing macroeconomic stability. However, they are probably directed towards households with a high propensity to consume, and thus not contribute to investment. And for other households, it may also increase consumption significantly if remittances are perceived to be permanent income. Finally, remittances may adversely affect labor force participation and total factor productivity.

One important consequence of this is that one should not take remittances as a substitute for foreign direct investment. Also, remittances can have positive and negative effects, and policy makers should find ways to direct them towards positive channels, like improving credit markets and building collateral for productive loans.

Program evaluation: estimation vs. simulation

Simulations are a tool that is more and more used to evaluate policies. This is in particular important when these policies have never been implemented before and thus there is no historical data to draw on. How good are such simulations? One way to check this is to do an ex-ante simulation of a policy change that has actually been implemented thereafter, and then estimate ex-post its effect.

Fabian Bornhorst does this with the PROGRESA program in Mexico. There, some families receive transfers if their children go to school. Bornhorst first draws a model of occupational choice and then estimates it using data that was available before PROGRESA was implemented. He then looks at outcomes if PROGRESA is applied in this model economy. This is then compared to actual outcomes. How well does the simulation fare? Not bad at all, but not perfectly either. It tends to indicate somewhat stronger outcomes than those actually observed. Also, it does not capture some differences across groups, but this can mainly be attributed to the level of heterogeneity within the simulated model, so this is fixable. Overall, very encouraging.

How to forecast inflation in Sudan

We tend to get interested in large developed economies because this is where we live and where loads of data are available to make interesting observations and run empirical exercises. But there are also lots of issues elsewhere that need to be studied and that are relevant, at least locally. Those are harder, because data is scarce and also because theory that could guide us may not be available.

Take as an example a study by Kenji Moriyama and Abdul Naseer that tries to forecast inflation in Sudan. This is very important in an economy as disrupted as this one, because the lack of efficient financial markets and banking leaves only currency as a tool for savings. If inflation is high or uncertain, using it for savings is not likely either. The problem is that there is very little data available for Sudan. The authors use ARMA techniques, which at least rely on a limited number of series but require rather long samples. But they can rely only on eight years of monthly data.

Another way to work this out would be to have a structural model, but this requires quite a few additional data series, which are not likely to be available. Maybe then, letting theory guide us could be a solution. This is particularly important in a country where shocks are very important and regime changes are likely. The Lucas Critique has a lot of bite here, and you want to go as deep as possible in the structure in order to study the reactions of agents and markets to situations that may never have happened before. But do we really have a good theory to describe Sudan, with its civil war, population displacement, humantarian aid, etc.? This is the kind of theory that needs development, as this is where the marginal return of theory to real-world well-being is the highest. And this is not just about inflation in Sudan.

Many people do not plan ahead

It is a well know story: people do not save enough for retirement, which is inconsistent with standard theory. Hyperbolic discounting comes here to the rescue, justifying this with the twisted preferences people have: they just value the present a lot. And what if people are just not planning ahead?

John Bone, John Hey and John Suckling conduct an experiment that allows to separate preferences from planning ahead. In particular, players should be anticipating what other players are doing. It turns out about a third do not. And asking them to pre-commit does not change this.

What should we take from this? The conclusion of the three Johns may only apply to the experimental environment, but not when it really matters, like planning for retirement. But there is plenty of evidence that many do not plan. While it may be rational for some (who do not expect to stop working or live long enough), many are still caught empty-handed at retirement. Should government then plan for them?

Are children a source of happiness or not?

I think that in every model with fertility choice, children are modeled as beneficial but costly. The number of children enters positively in the utility function, and there is some cost, either monetary or in time, of raising them. Yet, it appears that quite consistently empirical studies on the happiness of people reveal that the number of children has a negative impact on happiness indicators. Then why would people have children? Social pressure, bad luck with contraception or stupidity? What if the empirics are flawed?

Leonardo Becchetti, Elena Giachin Ricca and Alessandra Pelloni find that the typical way the empirical studies are conducted is flawed. Among the controls, there is usually income. But this make it difficult to disentangle the monetary for the non-monetary impact of children. Using equivalised household income (income adjusted for the number of people in the household) allows to focus only on the impact on happiness, and children now have a positive impact. Decomposing their sample (the German Socio-Economic Panel), they find that opportunity costs do matter. Theory is saved.

Is crime a habit?

Why are there repeat offender and career criminals? The obvious answers would be that this is where there comparative advantage is, or that they have nothing to lose once they served the first sentence. But what about crime being addicting?

This is what Vladimir Kuhl Teles and Joaquim Andrade explore what would happen if utility exhibit habit formation. Note surprisingly, it affects positively criminal activity. Note sure that this is very convincing. But the authors also embed an interaction with capital: Higher capital increases the rewards of crime, but also increases the opportunity cost of crime, the latter less apparently. Thus one should see more crime in capital-intensive locations, say cities, where habit formation is also easier. We should thus see more career criminals in cities. And I thought it was all about the anonymity that cities provide.

Growth leads to savings, not vice-versa

Fast-growing countries, like currently China, have very high savings rates. Data indicates that causality runs from growth rates to savings, and not the reverse. In theory, this is puzzling. Such high growth rates originate in rapid productivity improvements. This leads to high returns for capital and thus one should see high investment (and savings). However, returns for savings in such countries are very low. Why are people savings so much then?

Yi Wen finds one way to justify this: precautionary saving. We know that whenever there is a motive for precautionary savings, this can be rewarded with interest rates below the discount rate. And this is triggered by borrowing constraints. And it is well known that the Chinese financial sector is still severely underdeveloped.

The actual mechanism at play is obscure to me. The paper reasons that when permanent income increases, it is savings that increase instead of consumption, because of the borrowing constraint. The only way I can see this happening is when the uncertainty increases faster than incomes, or if utility is twisted in some way. But I do not seem to see either. While the author claims to have made a model that is tractable and analytically solvable, it does not appears to help in any way to understand what is going on. And Yi Wen does not seem to offer any explanation either.

Houses are a poor way to share risk

Owning a house is a terribly risky investment, not only because of the volatility of its value, but also because of the high correlation between house value and local economic conditions which also determine labor income. In other worth, owning a house you live in is among the worst things one can do in terms of diversification. Two recent papers revisit some aspects of this.

Dmytro Hryshko, María José Luengo-Prado and Bent Sørensen show that houses still provide substantial consumption smoothing ability to households suffering from a job loss. Obviously, when there is job loss and house equity loss, things look bad, but home owners still do better than renters. What this means is that the fact of holding some equity is more important that the lack of diversification. But it remains that better diversified households would still do better.

Todd Sinai and Nicholas Souleles argue that the risk is not that bad once you consider that when you sell a house you need to buy another one. So if you have to sell low, you are likely to buy low as well. This works obviously if you move locally, but appears also to work quite well for moves to another metropolitan area, as house prices across such areas in the US have an expected correlation between 0.35 and 0.60. So things are not as bad as one would have thought.