Are long-run incentive going to ruin healthcare reform in the US?

Insurance is a horribly complicated concept. While it provides benefits by preventing to a large extend the consequences of adverse shocks, it can also lead to sometimes severe moral hazard. Car insurance can lead to more dangerous driving. Health insurance can lead to more risky behavior. It is thus not obvious that introducing insurance is on the whole beneficial, especially if premiums cannot reflect risk.

Harold Cole, Soojin Kim and Dirk Krueger do such a welfare analysis for the upcoming US health insurance scheme. While there is a clear benefit in the short term, current conditions not having been perverted by the presence of insurance, the welfare outcome in the long-run needs to be determined once people have adjusted their behavior. They find that the negative impact of uniform insurance is severely amplified if other consequences of poor health choices are prevented from occurring, in their example prohibition of wage discrimination against workers with poor health. They find that this effect is so strong that cohorts become gradually of poorer health and overcome the positive impact of insurance stricto sensu. This means we need to incentivize good behavior, an example being sin taxes that have been the subject of several recent blog posts here.

The year ahead

It is not my style to opine on current events, and especially not to forecast. Yet, seems that there are some general trends that are worth mentioning that may not have been stated enough. So here we go with my take about what lies ahead.

Latin America

Latin America has done remarkably well lately, especially considering developed economies were not. Even more remarkable is the very rapid income growth of the poor population leading to a rapid reduction in inequality. There is still a lot of potential and things look good. Of course, the region is always good for bad political surprises.

Asia

This is a big continent, so it is difficult to generalize. Its economy has grown tremendously in the past years and this will continue. Unfortunately, there are risks. May a housing bubble burst in China? Will the very large number of underprivileged in China ask for its fair share of the new riches? Can India continue its liberalization? Contrast this with long-stagnating Japan, whose new government wants to get the economy kicking again by creating inflation (it is not clear how the government can do that). And politics will continue to dominate economic affairs in the western part of the continent.

Europe

Europe is a mess, and mostly of its own doing. Undoing this is not going to be easy, as credibility needs to be rebuilt. This is going to be another nerve-wracking year with empty promises. Greece will continue in its corrupt ways, inexplicably dragging everybody with it (and possibly collapsing for the second time a currency union). Italy will go through unnecessary instability thanks to Berlusconi again, and the French government will listen to the street instead of the experts. Watch out also for Norway, Sweden and Switzerland, where housing bubbles may burst. And Germany will continue posturing and lecturing the others, while everybody ignores the UK (and Russia, too).

North America

Speaking of unnecessary posturing, the US is the poster child right now. Republicans are hoping taxes will go up with the "fiscal cliff" and claim it is not their fault, then negotiate a compromise with taxes at midpoint and claim victory thanks to lowered taxes. And what did we gain from this? Uncertainty, frustration and unnecessary distractions. And unless Democrats (and the President) finally take a strong stand, politics will remain in flux and threaten a nascent recovery. Canada will watch all this, shake its head and go on, hoping for the best.

Africa

What to think of Africa? It is going to remain a basket case, with a few hopes that are quickly dashed. Rebels will be disrupting the normal course of things in several countries, corruption and rent-seeking will remain the principal industry, and foreign aid will continue to be wasted. Let us hope that manufacturing will finally take off on a continent that is not made for agriculture.

In summary

Politics will continue messing with economies (and economists).

There is no such thing as a real economy

Nothing beats a well-written abstract. You want in particular to use the right terminology, state clearly what you want to do and given a few good hints about your conclusions. A confusing abstract is a real put-off, but they do happen. They usually signal a really bad paper, and the chances that there is interesting content behind the veil of a obfuscating presentation is slim. Take this one:

There is no such thing as a real economy. The task, therefore, is to consistently reconstruct the fluctuations of employment and output from the interactions of real and nominal variables. The present paper does exactly this. No nonempirical concepts like utility, equilibrium, rationality, decreasing returns or perfect competition are applied. The analysis runs rigorously in objective structural axiomatic terms. Therefrom follows that it is the factor cost ratio, i.e. the relation of the nominal variables wage rate and price and the real variable productivity that, for any given level of effective demand, drives the fluctuations of employment and output.

This is the work of Egmont Kakarot-Handtke, whose paper mirrors the abstract. It hinges on absurd assumptions which are not justified in any way, and some sort of logic is applied from there. For example, it is stated as a basic premise that profits are not real, only monetary, and this was completely overlooked by all economists. I wonder how economies worked before the introduction of money. The paper continues with "axioms" which are in fact three definitions, whose equations do not share a single variable, and a law of motion for yet another variable. After seeing how prices are determined by accounting identities, I stopped reading. Yet, I somehow felt compelled to write this. It must be the holiday spirit.

European tourism and the Euro

If you have traveled across Europe before the introduction of the Euro, you have certainly been annoyed by the frequent changing of currencies. Not only did you need to worry about getting cash at the border, you also had tp learn about new denominations, rethink the prices you see, and end up with unused loose change (ignoring the exchange risk one faces as well). With the introduction of the Euro, all this has been greatly simplified, even if not all countries joined. Beyond the convenience for the tourist, has this spurred additional tourism.

María Santana Gallego, Jorge Vicente Pérez Rodríguez and Francisco Jos&e;eacut Ledesma Rodríguez ask this question and find that, yes, it had a positive impact, to the tune of 20 to 40% for EMU country tourist arrivals, and mostly so after 2002 (when Euro coins and notes were introduced) in contrast to 1999 (when the exchange rates were fixed). In addition, there is evidence of tourism diversion: The stated increases occurred to the detriment of non-EMU countries. In other words, tourists substituted away from countries that are not carrying the Euro.

PS: Things seem to be looking a bit better for Greece right now. But if it were still to be dropped from the Euro-zone, consider a substantial negative impact on its vital tourism industry.

The economics of yoga

I appreciate yoga because it helps my stiff body to loosen up, and because it forces me to take some time off the multiple things I do to calm down. But I would not call this meditation, although many people do. I chat during the moves, thus for me it is a purely physical experience. Many others do it for the opportunity to free up and "purify" your mind, although I have been suspicious about such claims. It would take me an economist to convince me otherwise, and maybe the following study does.

Giovanni Di Bartolomeo, Stefano Papa and Saverio Bellomo look at how yoga and supposed meditation changes the way people trust each other and cooperate. They exposed some participants to yoga meditation (with Tibetan singing bowls no less) before an investment experiment. The "pre-meditated" participants showed lower risk aversion and more trust than the non-exposed ones. I wonder how this small experiment would scale up. Do countries with cultures based on meditation also have higher levels of trust and risk tolerance? Do they have institutions that rely more on trust? Something to ponder over the holidays.

Sin taxes and liberty

I have discussed quite a few times sin taxes that are instituted to redress some individual behavior. Indeed, people make choices that harm others or themselves directly or indirectly. They create congestion and pollution by driving a care, they increase tax- or insurance-financed health care cost by smoking or becoming obese, they also become public hazards by being drunk. This is one reason why we often tax automotive fuels, unhealthy foods, tobacco and alcohol more than other goods.

But some people object to such sin taxes because they infringe on personal liberties. One of them is Gilles Saint-Paul, whose work I have several times discussed here in a positive light (I, II, III), but this time I have to disagree. His view is that the state is too paternalistic when it intervenes in otherwise free markets with sin taxes, and this has become worse since behavioral economics has highlighted choice patterns that deviate from standard utilitarianism. Well, this is exactly the point. Behavioral economics has brought forward that there are situations were people take actions that they later regret. This is precisely when they would appreciate (at least later) some paternalism in the sense that the state can provide them with a commitment device.

So why does Saint-Paul object to this? His argument is that one should not object to personal choices, and that people should only blame themselves for poor choices. But what if one can help them? Should this not happen only because it is the state? He complains that economists have abandoned utilitarism, which maximizes the sum of individual utilities. I do not think that is correct, but he seems to completely ignore that there are externalities out there, that there is regret, that there are temptations, and that there is lack of commitment. and all this should not be myopically ignored when computing utilities. He is going as far as comparing this supposed abandonment of utilitarianism to eugenics. In other words, he sees excessive government intervention. I agree that there is potential for this, but I see no demonstration that this is happening, and the mere fact that there is intervention is not sufficient, as Saint-Paul seems to imply in a rather puzzling paper.

PS: Robert Wiblin at Overcoming Bias has recently made a similar argument to libertarians in favor of paternalism and also finds it "incredibly obvious." Yet, it needs to be made.

The short-run impact of taxing saturated fats

Saturated fats are bad, and we should avoid them. But they are cheaper than non-saturated fats, and if they are that bad, the obvious solution is to impose a tax on the bad ones so that they become more expensive than the good ones. Or you could inform users so that they make the best choice, but you still need to tax if the consumption of bad fats has an impacts on others, as in increased demand for health care that is paid at least in part by public funds. One way or the other, you need to tax saturated fats. The question is how much do you need to tax, and before answering that question you need to know how responsive people are to such taxes.

Jørgen Dejgård Jensen and Sinne Smed study this last question for Denmark, where a tax was introduced in October 2011. That was very recently, so they can only figure out the short-term elasticity. They find that for the products containing the most saturated fats, such as butter and oils, quantities sold decreased by 10-20% for an increase of tax in the order of 8 to 22% (it varies because the nutrient is taxed, not the food class). That looks a significant elasticity for foods that are quite essential to cooking. But as I mentioned in the introduction, another way of reduction consumption of "bad" foods is to inform the public. I suspect this what also happened with the introduction of this tax, as the media must have written about it and made many people aware of the adversarial effects of saturated fats. With the current empirical strategy, there is no way the authors can identify the impact of the tax from the impact of information, and that is likely why the elasticity is so high.

How randomized experiments can go very wrong

Randomized experiments are all the rage in some circles, for example labor economics and especially development economics. The principle is simple: create some intervention in some market, randomly draw a group of economic agents that has access to the intervention, leave the others out, compare outcomes. In all that, you hope the behavior of the non-participants is not affected by the presence of the program to the others. This can be a heroic assumption, for example because market prices may respond for everyone to the intervention.

Pieter Gautier, Paul Muller, Bas van der Klaauw, Michael Rosholm and Michael Svarer show an example where this assumption was violated. The intention was to see how helping Danish unemployed workers find jobs through enhanced guidance was successful. Those who were non-selected had to deal with the job search as usual. In that case, there were some regions where the experiment was not conducted but data still collected. In the two counties where the experiment was conducted, the number of vacancies markedly increased, which logically leads the treated and untreated to have a better shot at finding a job. But, of course, there is also a congestion effect: for the same number of vacancies, if some workers are getting better probabilities for finding jobs, it is getting worse for the others. In the Danish case, overall this turned out to get worse for the non-participants.

Several papers had previously looked at this experiment and concluded the intervention was a great success because participants fared so much better. But the result can of course not be generalized. What if everyone searches more for the same number of vacancies? Nothing changes much, except that vacancies may be filled faster. And what if the number of vacancies increased in those two counties because of the treatment, to the detriment of the other counties? Then applying the program to the whole country should not make a difference. Given the cost of these studies, this is a very disappointing result.

Do state scholarships keep graduates in the state?

Many US states provide special study scholarships reserved to state residents which be applied to any in-state university, including private ones. This goes beyond the lower tuitions at state universities for state residents. The idea is that students tend to stay for work (and pay taxes and improve human capital) where they studied, thus you want to get them to study in-state. If every state does this, the macroeconomic impact is zero on work location, no matter what the mobility, and negative on state budgets. But this is a game hat states play, like they do with tax competition, thus it is interesting to see whether a state gains from playing this if all others already do.

Maria Fitzpatrick and Damon Jones find that the impact of these programs can be found, but it is quite small. That money is thus mostly going to either students who move out-of-state after their studies or to students who would have stayed within state boundaries anyway. This result is obtained by looking at the expansion of these program in 15 states from 1990 to 2010 and how they impacted residential patterns. It would of course be better to have information from the students themselves (and a control group), but you got to start somewhere.

Limit gas price changes to once a day?

For some reason that is unclear to me, fuel for cars is in most countries the most flexible price, sometimes changing several times a day. As demand is rather inelastic and the raw commodity supply comes from politically volatile regions, the price also fluctuates over a wide range. And this wide range leads to a lot of grief, especially when prices go up, with calls from the public for politicians to do something about it. The latter then usually do something stupid, and they are never short of ideas.

One recent innovation comes from Austria: in the belief that higher prices come from frequent changes, gas stations have been limited to one price change a day. Martin Obradovits analyzes this policy and comes to the obvious an obvious answer: it is a stupid policy. For one, it is not like gas companies are bound by fixed increments and this would reduce fluctuations. Second, it introduces new frictions in the market that go to the detriment of the consumer: you get the same profits and the same expense for the same quantities, there is only some intertemporal rejuggling that inconveniences the buyers. I would add that if prices end up too low during the day, gas stations may simply close and ration out buyers until they can adjust prices. Ah, politicians...

Five years of blogging

The Economic Logic blog is now five years old. At every anniversary, I reevaluate whether it is worth continuing in this effort. After all, there is little reward in blogging anonymously, rather the opposite, and writing here competes with my real world duties. And it has become more difficult since I took on some new responsibilities (some readers may have noticed that my posts were sometimes a bit short). However, readership has been steadily increasing and I have some sense of duty to keep posting. Stopping now cold turkey would definitely leave me empty. But I may consider skipping days here and there when my real world duties keep me away from my "second life."

So, I will keep posting for another year. There is still a lot of interesting research going on in Economics. And there is still a lot of papers that may not get published in the best journals but merit mentions because they have interesting implications. And sometimes there are some really bad papers that need to be pointed out before they do more damage.

Traditionally, I have pointed out with posts were the most read during the last year. For a variety of reasons, I can only find the three that were posted during 2012. By far the most popular was a very recent post, "How to make your children intelligent". The two next were "The Harvard Economics Department's Nobel problem" and "Mathematics, Econometrics and top economists' career outcomes".

I hope you will read Economic Logic for another year. I will be there.

Complicated auctions are more proftable

There was a time where auction theory limited itself to studying very simple auction, where the subtleties were whether the first or second price should be paid (or the first less an increment). Now, auction theory looks at much more complex mechanisms, for example where bidders may or may not reveal their bids, or whether they are bidding, or where bidding comes with a fix price. Not all these mechanisms try to obtain a surplus maximizing outcome. Some maximize the profits of the seller, sometimes by confusing or even misleading the seller. The most extreme example are penny auctions, about which I posted before (I, II).

Andrea Gallice discusses a variation of the Dutch auction where the current winning bid price remains hidden but can be observed against a fee. This so-called price reveal auction has an additional twist: paying that fee makes the winning bid fall by a predetermined amount. An auction so complex must be designed to maximize someone's surplus. It is the seller. And his profits are even higher if he manages to keep the number of bidders secret. This is not unlike penny auctions, where the profits come from the fees, not the winning bid.

OK, this maximizes profits, but I do not think this maximizes overall well-being. Obfuscation is not likely to be beneficial, and I am quite surprised the author does not address this. Until convinced of the contrary, I am going to assume that such obfuscation is detrimental for society and should be outlawed. And with rules so complex, it would not surprise me that bidders would have a hard time behaving rationally.

Why corruption will always be with us

How would one define corruption. In economic terms, one definition could that two parties engage in a mutually beneficial transaction to the detriment of an other and society in general, and this despite rules put in place to prevent this. I am not sure everyone will agree with this definition, as it includes everyday situations that one may not generally associate with corruption, such as small gifts we offer to superiors or teachers.

Ulrike Malmendier and Klaus Schmidt study, without calling it corruption, such behavior in an experimental setting. They find that subjects of a gift do reciprocate even if they have no incentive to do so. Worse, they reciprocate more if it is at the expense of a third party, and everybody knows that the third party is affected. Finally, participants correctly assess how their behavior was influenced by gifts, but believe others are much more influenced. It is difficult to square any standard theory with these results. It also implies that such gift-giving is going to be difficult to stamp out, at least when it is relatively small such as in these experiments.

Japan's lost demographic decades

Since the asset bubble burst in Japan in 1990, the economy has stagnated despite significant policy efforts. Interest rates have been very low all along and fiscal policy has certainly not been austere. What was once labeled a lost decade has now become a pair of lost decades. Can only the burst bubble and the issues with the Japanese financial system be blamed?

Reiko Aoki thinks the demographic change in Japan has a large role in this extended stagnation. As is well know, Japan is aging considerably, and this has of course a dramatic impact of the savings picture. Financial institutions that were built to accommodate rapid growth and a young population looking to safeguard massive amounts of savings struggle to deal a much older population that is in the phase of eating its savings. Worse, as institutions need to adapt to the new situation, reform is hindered by the large voting block of the elderly whose interest lies in the short-term provision of their pensions.

Quite obviously, the current imbalance in the demographic pyramid is the problem. Aoki thinks that fertility must be encouraged. This has worked little in other economies, but may be much easier to implement politically than the best solution, get people to retire later. Immigration is another solution, but as other countries are looking to embrace similar solutions, we may run out of willing young migrants. And Japan is not the obvious choice for a migrant, given the high entry cost in terms of integration.

Are immigrant nurses better than domestic ones in the US?

All industrialized economies suffer from a chronic shortage of nurses. Demand for health care is very high, yet nurses are relatively poorly compensated for grueling schedules, important responsibilities and thankless work. It is thus not surprising that the domestic supply of nurses is limited despite major efforts in broadening nursing school opportunities. One has to rely on immigration to fulfill the needs, with potentially the risk of attracting lower quality nurses, as they come from countries with lower human capital and different cultures or traditions.

Patricia Cortés and Jessica Pan study the quality of immigrant nurses and compare them to US native ones using wages and a measure for quality. The half of the nurses migrating to the United States in the last two decades come from the Philippines. They tend to take on harder tasks and tougher schedules (i.e., hospital work), yet they get higher wages than natives even after controlling for education, demographics, location and job characteristics. Non-filipino immigrant nurses fare, however, worse than natives. So is it that Filipinos are that much better? What is certain is that getting educated as a nurse is now done in the Philippines with the explicit goal of emigrating. As green cards for Filipinos are otherwise impossible to obtain (the waiting list is about 40 years long), getting employment sponsorship is essential. I suspect people who would be well qualified for other jobs choose nursing because of the inside track they get for emigration to the US, call that a network effect similar to when entire villages from Italy, Spain or Mexico migrating North for the same occupations, following a few pioneers.

Unstable matching functions in search theory

The matching function is at the heart of many of labor search models. It has been estimated many times, with a striking empirical regularity: the coefficient that represents matching efficiency appears to decline over time. While it may make sense to see less efficient matching in times of structural change, as it may be happening with the last recession, one would not suspect this over longer samples. Why would labor market performance deteriorate when the information revolution should have reduced matching frictions?

Friedrich Poeschel thinks this is at least in part due to omitted variable bias in the estimation of the matching function. The extant literature relies too much on stocks and neglects various flows, in particular vacancy creation and job seekers beyond the unemployed. Of course, it is not that easy to find such series, or reliable ones. Thus, Poeschel constructs such series from US data using a model of labor market flows. Then, he estimates the matching function using the traditional set variables and then augmenting it with flow variables on the labor supply side. Half of the downward trend in the matching efficiency is taken care of by the new variables. The trend completely disappears once vacancy dynamics are also included. That is reassuring, and maybe one can obtain improving matching efficiency once we get our hands on better data for this.

How Japan financed WWII

71 years today, Japan attacked Pearl Harbor and opened a new front in its global war. Why would a relatively small country take on a much larger adversary when it is already stretched with other wars and occupations? In particular, how do you find the resources to wage such wars, and by resources I mean not just the financing but also the physical resources?

Gregg Huff and Shinobu Majima offer part of the answer by looking at the financing of the Japanese occupation of Southeast Asia. Japan had a strategy that invading troops needed to be self-sufficient. This means that they had to either confiscate (tax) or acquire goods through money creation. To a large extend, the latter was performed through the issuance of military scrip, which is unbacked military notes, along with bilateral clearing arrangements with the occupied countries. This allowed not only to finance local occupation but also transfer substantial resources to Japan, in the case of Indochina up to a third of its GDP.

You would think that money creation on such a massive scale would create hyperinflation or at least high inflation. That does not seem to be the case, at least in the sense that the price levels increased as much as the money supply. One could have expected that given the circumstances inflation would have been significantly higher than money growth if market participants were forward-looking and money velocity would increase (think of hyperinflation à la Cagan). Huff and Majima trace this missing hyperinflation to the fact that money was needed to act as a medium of exchange and store of value, despite very substantial seigniorage taxes. There was not viable alternative, in part because of Japanese coercion. I think this would not have worked in more modern economies where more assets are available.

Good weather and absenteeism

Ah, the weather is so nice outside, yet I am stuck inside working. If only I could take a vacation day. But wait, I could declare myself sick for a day, would not need a doctor's note because it is just a day, and enjoy life! Well, this is not that easy in my case, as I still need to get the work done, but the temptation is there. And many likely cross that line.

Jingye Shi and Mikal Skuterud use absenteeism data for Canada and find indeed that good weather encourages people to take sick leaves. Given the harsh winter climate in Canada, they limit the analysis to non-winter months and indoor workers, so that the temptations are maximized. Yes, they find that short-term "sickness" increases with good weather, but strangely it affects more workers who do not enjoy sick pay benefits or are on probation. The authors suggest this is because they cannot capture some implicit agreement that one can use short sick leaves for other purposes. That does not convince me.

Longevity increased much before the Industrial Revolution

There is no doubt that average human lifetimes have considerably lengthened since Antiquity (except, maybe, Biblical times...). Improvements in living standards through better nutrition, salubrity and medicine likely were the major factors in this dramatic evolution. When this improvements started kicking in is a subject of debate, which is not helped by the fact that good data about lifetimes is difficult to come by. Written genealogical records go only so far back, and their quality and comprehensiveness declines considerably with age. And working from cemeteries is also quite unreliable, especially for longer horizons.

David de la Croix and Omar Licandro provide a very significant step towards a better understand of longevity in human history by compiling a database of 300,000 famous people spanning 25 centuries. The data includes information about location, religion, occupation, and nationality, which should take care of the major selection biases. They find that longevity was mostly flat throughout human history until it started increasing with the cohort born in the 1640s. This is before Malthus, whose assumption of stagnation is thus wrong. And this is much before the Industrial Revolution and has happened across the world and across occupations, thus the two events seem unrelated.

Are smart meters worth it?

Smart meters that allow you to monitor and manage electricity consumption are all the rage now. Power companies push them to consumers as the best deal that has ever been offered. And it looks enticing, as it promised more flexibility and the possibility of applying peak pricing in areas where this is not yet current. But is there really that much to gain? After all, these meters are not inexpensive technology.

Thomas-Olivier Léautier helps us here. He estimates how the responses of French households would be once they have smart meters and they can adjust their consumption to market prices. The outcome is humbling: the yearly savings would amount to 1-4€, which is likely less than forgetting to close a window one day in winter and much less than the 25 &euro/year cost of a smart meter. I see two reasons for this result. First, most households consume little energy. Second, their consumption pattern is not that flexible.

But would this result extend to other countries? North American households use a lot more electricity than French households due harsher climates and more carelessness about energy consumption. A smart meter there may in particular make people more aware of their power consumption and how one can reduce it to save money. This is much like a car that shows current gas consumption entices the driver to use less fuel. And this effect may make it worth it.

Dealing with congestion: fast lane or toll booth?

In densely populated areas, road congestion is a fact of life. As time lost in traffic has an economic value, it is then quite obvious that road pricing with flexible tolls that depend on the current level of demand should provide for the most efficient allocation of cars through time and space. But there are some logistic problems with this, and depending on the actual implementation, some privacy issues as well.

Mogens Fosgerau claims one can get a Pareto improvement with a toll lane that is reserved for particular users if demand is inelastic. The lane set-up is similar to airport check-in, where privileged people get their own lane and others can use it if it is available. I question, though, that demand is inelastic. That may well be the case in the short-run, but people do adapt to road prices on a longer horizon by changing schedules and locations. Also, I find the comparison to tolls unfair in the sense that the benchmark is a coarse toll: there is a single toll price that is only activate when there is congestion. Obviously, it creates peak loads right before and after it is in place. That can easily be improved with more flexible pricing.