Greening the tax system works

It has been some time that I have not mentioned the virtues of greening the tax system. By that I mean levying taxes on activities that exert negative externalities on others, such as pollution or congestion, while reducing standard taxes such as the income tax and even subsidizing activities that have a positive externality, such as getting educated. Yet, despite that great virtues of greening the tax system, it happens only moderately. Maybe it is because it bears some short-term costs before yielding longer term benefits.

Walid Oueslati confirms this using an endogenous growth model. In the long run, growth and welfare are indeed enhanced by environmental taxes if the proceeds are used to reduce wages taxes (but not capital taxes, a surprise given the optimal capital tax literature). In the short run, however, the impact on both can be negative due to the reallocation of factors during the transition to the new steady state. These disruption are similar to the sort-term costs of freeing up international trade. If you add it some temporary transfers to those who suffer in the transition, all is good and current opponents trying to protect some rents should be willing to go along. So, what are we waiting for?

PS: This must be the worst-looking working paper cover I have seen so far. The abstract is unreadable. Why this choice of colors?

Is money a factor of production?

An easy trick question to ask students about factors of production is whether money is one. Of course it is not, unless you consider burning it to fuel an oven. A factor of production is an input to the production process, such as capital, labor, raw materials, energy, etc. Money is only a facilitator in the acquisition of those goods. And if money or credit are constraining production, this belongs in a separate constraint, not in the production function.

Why do I mention this? Because money is occasionally put in a production function, and Jonathan Benchimol makes it even the focus and title of his paper. Why does he do that? He wants to estimate a New-Keynesian model and see whether money would matter in such a way. It does not. But who could really blame him for trying, as these models either have money in the utility function (few people enjoy money per se, most people enjoy what you can do with it, and that is already in the utility function) or no money at all (at still manage to draw lessons for monetary policy). In the kingdom of the blind men, those who are blessed with one eye are kings.

Reduce inequality by increasing the number of school days

Some children have the bad luck to be born in a poor environment or a dysfunctional family. For them, school is the great equalizer that gives them a chance to still make in reasonably well in life. That works only if they can be in school and out of bad influence long enough (the "incarceration" hypothesis). Unfortunately, in areas where there are few school days and where especially the Summer break is long, all the good work is easily undone. In particular where there is inequality, we see the richer kids go to Summer camps to reinforce what they learned or learn some more, while the poor ones linger at home and forget a year's worth of school.

It is thus not surprising to see that Daiji Kawaguchi finds that fewer school days leads to more inequality. He looks at the 2002 school reform in Japan that abolished school on Saturdays. Comparing time diaries and test scores of students before and after the reform, he finds a dramatic change in the distribution. Students after the reform studied one third less at home, and the decline was even steeper in poor households. The impact on test scores is that the slope against socio-economic factors becomes 20-30% steeper. This is just from removing two half days of school a month. I wonder how this would translate in an international comparison where the school year ranges from 180 days in the US and France to 220 days in South Korea.

Finger length and altruism

Social scientists interested in the biological origins of human behavior have a strange obsession with finger length, and specifically with the ratio of second to fourth digit. Indeed, this ratio is an indicator to exposure to some hormones as an embryo, and any relation between this ratio and behavioral traits is a good hint that one is born with some behavioral variation. I have reported previously about entrepreneurship and risk taking in this regard, now it the turn of altruism.

Pablo Brañas-Garza, Jaromír Kovarík and Levent Neyse find that people with particularly high or low ratios are less altruistic than the norm. So, it seems that maximizing altruism is a delicate biological process, and that altruism is at least in part determined before birth. I am not sure where this paper leads us to next.

Natural disasters and economic growth

Recently, I discussed how being in a disaster-prone area may have consequences for economic growth and the ensuing costs from calamities. This discussion was largely theoretical, but there are some empirical papers out there that can provide some good insights.

Pelle Ahlerup is the author of the latest one, and he finds that natural disasters have a positive impact on growth, and this result is largely driven by humanitarian aid. Does this mean we should wish for more disasters? Of course not, because just looking at economic growth is the wrong welfare measure. After all, a disaster leads to the destruction of life or goods, and the ensuing economic effort is replacing this loss. That effort could have been used for better purposes without the disaster. What is more interesting in the paper is that the impact on growth lasts well into the long run, beyond repairing the damage. This is where humanitarian aid comes in, as it may have helped give the economy the spark it needed to get back on rails. One can imagine that this could be associated with some foreign direct investment, or positive experience for foreign investors, or some long-term development project to prevent the consequences of such disasters in the future. Haiti comes to mind here. The fact that disaster have no impact on growth in developed economies reinforces my hpothesis.

How life events shape risk aversion

After an accident or near-accident, we all tend to become more careful. One can attribute this to the realization that the odds of an accident are higher than we thought. But there may be more that just Bayesian updating, we may also become more risk averse with each such event in ways that also affect our tolerance for other risks. From an economic point of view, it is not well known how the aversion to financial risk is formed, and experience with adverse shocks of some sort may play here.

Alessandro Bucciol and Luca Zarri look at the US Health and Retirement Study, where risk aversion can be inferred from portfolio choices. They find that two life events matters significantly for the increase of risk aversion: the loss of a child and being in a natural disaster. Yet, I cannot help thinking that the result is not about risk aversion, but Bayesian updating for probabilities of rare events. While I have not suffered from such events, I have heard others say how they realized the value of life as they recovered from them. Are these statements of risk aversion or statements of how lucky they have been to survive and that they should revise the probabilities? When looking at portfolio choices, can these two be distinguished?

How much money laundering is there in Italy?

It is well known that the underground economy in Italy is substantial, and that an important share of this is due to illegal activity. Hence, there should be an important amount of money laundering going on, an amount that seems to be impossible to measure given that these activities precisely try not to get detected. But economists can be resourceful and try to pull it off, for example à la Steve Levitt.

Guerino Ardizzi, Carmelo Petraglia, Massimilano Piacenza, Friedrich Schneider and Gilberto Turati try to pull that off, reasoning that money laundering is performed by depositing cash, and that if there are more cash deposits in financial institutions of an Italian province where there is more activity from illegal syndicates, one should be able to back out how much of these deposits are due to money laundering. Concretely, they regress across provinces over four years cash deposits on a few controls, the number of detected extortion crimes and the number of drug dealing, prostitution and possession of stolen goods. One may have some qualms in using detected crimes, which may be a very poor proxy for actual crime, especially for a country that is so corrupt, but I suppose this is all we have. However, this regression assumes that those illegal syndicates stay within the confines of their province when they deposit their proceeds. Given the size of an Italian province (median inhabitants: 375,000), that seems like a real stretch. I guess we still do not know how much money laundering is going on in Italy.

Much of observed income mobility is measurement error

Much of the discussion about income inequality and poverty is vacuous if it does not take into account some form of dynamics. Are the poor of today also the poor of tomorrow? If yes, we have a problem, if not, we have much less of a problem. It thus become quite important to measure properly income mobility, how people move from one part of the income distribution to an other. That is easier said than done. One can take two snapshot of the the income distribution, and then calculate some correlations. But there could be measurement error, always a problem, and income changes may be temporary, artificially biasing upwards mobility indicators.

Tom Krebs, Pravin Krishna and William Maloney make significant progress in this measurement by putting some structure to it. For example, a permanent change in income should be reflected in a change in consumption, while a temporary income change does not. Thus, building a consumption-saving model with an income process that has permanent and temporary components, tying this with income data from households in Mexico to calculate income mobility with the new methods and old ones. It turns out that most of the usually measured income mobility comes from measurement error or temporary income. In other words, there is at least in Mexico much less income mobility than we think there is. This is bad news for economies where we know income shocks have a tendency to be temporary, such as the US. The American Dream is farther that you think (previous exhibits I and II).

Could obesity rates be even worse than expected?

The rise of obesity rates is now being called an epidemic, in particular in Anglo-Saxon countries. The fact that such a large portion of the population is now considered obese is quite alarming, considering that this was minimal a generation ago, and that the proportion of obese children is even in the double digits in some countries is mind boggling. Could it be even worse?

Yes, according to David Madden who claims that most obesity statistics are based on self-reports for weight and height, from which the BMI (body-mass index) is calculated. Under current standards, a BMI of 30 is considered obese. He suggests that a threshold of as low as 26 should be used to account for the reporting bias in weight. As this bias seems to increase over time (at least in Ireland), the threshold could move down even further. Obviously, this bias will depend on the environment (local culture, context of survey, for example) and could make correct measurement very uncertain. I guess the best way is to actually measure people. One should look into that.

Parental involvement laws have no influence on teen sex behavior

Many jurisdictions have implemented parental involvement laws that require from physicians to discuss with or at least alert parents about a possible abortion with their minor daughter. The idea is to raise the stakes of unsafe teen sex in that parents get involved. The literature seems to point to the success of such laws in that regions that implement them have, other things being equal, lower rates of sexually transmitted diseases (specifically gonorrhea), which is a clear marker for unsafe sex.

Silvie Colman, Thomas Dee and Theodore Joyce claim we should be rethinking this statement. Indeed, they find no association between parental involvement laws and teen sex using better data than what was used in previous studies. In particular, they have data that includes finer age groups for the patients, something that seems essential for this type of claim as sexually transmitted diseases are much more caught by 18-19 years olds (who are not minors) than 15-17 years olds, who are subject to such laws. They also take into account race and ethnicity, as the reporting rate for gonorrhea vary considerably among them, and they add reports for chlamydia. The fact that the laws have no impact on teen sexual activity shows that they do not know about them or do not care. And a law that has no impact is a useless law.

A hesitant government may have good aspects

If you look at economic and especially fiscal policy in the US and in Europe these days, it can be characterized as hesitant. And this despite large challenges, or maybe because of these challenges as more is at stake and political forces dig in. It is widely regarded that a hesitant government is welfare worsening, but a case could be made for it to be welfare improving in situations where a the government lacks a necessary commitment device.

Jaromir Nosal and Guillermo Ordoñez discuss such a situation, namely bank bailouts. Quite obviously, the first best policy is to never allow bailouts, but once an opportunity arises, the government is much tempted to still use a bailout. This time-inconsistent policy translates into more risk-taking by banks, and more bailouts opportunities ensue. But if the government is hesitant, either because the information is not clear or because of internal or political constraints, then it does not authorize bailouts as easily, and banks behave better. Hesitating (or filibustering) acts like a commitment device. And this is good, in some situations.

Should managers be liable in court?

It is fair to say people are quite upset that managers are not criminally prosecuted for crimes their businesses do. As the latest case with HSBC shows, where the bank laundered massively money related to circumventing political embargoes and drugs trafficking, was convicted several times and faced only fines that were lower than the profit gained, it seems impossible to adequately punish corporate crime. While lawyers may have some justification for this, let us look at the economics of it.

Andreas Engert and Susanne Goldlücke claims it is difficult to find a case for managers being liable for their mistakes. This comes from the nature of their compensation contract and the reliability of court decisions. When managers take poor decisions, their compensation suffers from it. Thus, one has to be careful not to add too much risk for the manager when the courts add to the ill effects of poor decisions, especially as courts are not perfect either. Part of the argument has to do with the classical principal-agent problem: the performance signal is imperfect, and even if the manager was very careful, luck may be against him, his compensation already suffers, and courts should not pile it on. The nature of the compensation contracts thus matters a lot. With a linear contract, it is never good for the courts to punish the manager. If it non-linear (convex), then it depends on how precisely the courts can work.

Now this all applies to poor decisions, there is not necessarily a crime involved. But as a business is fined for a crime, the compensation of the manager is typically impacted. Is this then sufficient? I am not sure this paper helps completely in this regard. Indeed, crimes are punished with incarceration. The loss of freedom adds another dimension to the punishment which is difficult to reflect in a fine to a business and how this translates in loss of compensation. Someone should look into that.

Optimal deviations from inflation targeting

When a central bank adopts a monetary policy target, such as a targeted inflation rate, should it absolutely adhere to this goal, or are deviations from the goal tolerated? This is not necessarily a rehash of the "rules versus discretion" question, as it is a question about the formulation of the policy rule. In other words, is it OK for a central bank that has a specific inflation target to use a rule that deviates from the target under specific circumstances?

Barbara Annicchiarico and Lorenza Rossi say this is OK, and these circumstances do not need to be extraordinary. The reason here is the often neglected impact of economic shocks, in particular technology shocks, on the growth potential of economy. Without the endogenous growth mechanism, the optimal policy of the central bank is to stick to the target. With it, it can deviate because the dynamics of the economy and the intertemporal trade-offs make it optimal to give a little bit of slack now to be in better shape in the future.

This reminds me about the silly debate about the ineffectiveness of central banks when inflation is below target when unemployment is still high. It is all about the dynamics of adjustment of the economy after a shock. Economic variable do not go back to long-run equilibrium in one shot, it takes time and they can be off long-run values even in equilibrium and under optimal policy.

Should we see more university mergers?

When should universities merge? The recent examples I have witnessed were due to economic hardship, where one college could simply not meet ends and was taken over by another one. There is also a new trend in France to merge universities that had previously been split apart, as part of the eternal higher education reform in this country. Many universities grew so large that they were split along sciences lines (natural, engineering, social sciences, humanities), only to realize that French universities were then really hurting in international rankings. But none of this follows any reasoning about what is best from a social point of view.

Marisa Hidalgo-Hidalgo and Guadalupe Valera try to get to this by using a bit of theory, comparing a university monopoly to a duopoly. A monopoly can bargain better for lower wages and better faculty, and it can create synergies. But a duopoly encourages better competition for excellence. The overall results is that the more heterogeneous universities are, the easier a merger will turn a societal benefit. The current merger craze in France is thus appropriate, but for a different reason.

Yet the model does not allow to take into account some very important aspects of education. Think for example about the diversity of classes than can be offered in a larger institution. And that includes the French mergers, as now there is a potential for students to take classes outside of their field and thus emulate something like a liberal arts education. After all a big drawback of European and especially French education is the excessively specialized education, leading to a workforce lacking flexibility.

American colleges could also benefit from mergers. Think about all these tiny colleges that can barely offer a halfway complete curriculum for the most popular majors. These micro-colleges are expensive for students and pay actually very little to faculty who have to teach extremely varied classes and struggle to do tat well. There is definitely scope for taking advantage of some economies of scale here. But merging large, complete universities, like what the authors have in mind, is definitely less advantageous. Imagine if Columbia University and New York University were to merge. There would be little to gain in a programmatic sense, and I do not think there would much pressure on faculty wages. After all, the market for good faculty is national, if not international.

Imagine Chinese growth rates without misallocations

China has been growing at a very rapid pace, and many have studied how this has happened and why. Yet, when you look at the economy now, it is still remarkably inefficient, especially with a financial sector that is very far from potential. In particular, the state-controlled banks do not provide loans for the best investment opportunities, but rather disproportionately to state-owned enterprises, which obviously are not as productive as the private sector.

Robert Cull, Wei Li, Bo Sun and Lixin Colin Xu use a survey of manufacturing firms that the World Bank conducted in China in 2005 to document what determines the firm;s financial constraints. To no one's surprise, state-owned enterprises have a big advantage. But among them, those who have CEOs that are well connected with the government or the Party have is even markedly easier. This points of course to the massive misallocations within China that people are still complaining about. Imagine how much richer China could be with a better allocation of its financial resources.

But of course, one can argue that China is growing like crazy because it is transitioning from even worse misallocations, where there weren't even private savings to sustain a more productive manufacturing sector. This argument has been made, among others, by Zheng Song, Kjetil Storesletten and Fabrizio Zilibotti. Not only is China growing through rapid investment in more productive technologies, it is doing so while getting more efficient in distributing financing. And seeing how inefficient it is, there is a lot of potential growth for many more years.

How much did the Gulf Oil Spill cost to shrimp consumers?

When the Deepwater Horizon oil platform exploded in 2010 and polluted much of the Gulf of Mexico Coast, some of the loudest complaints came for shrimpers fearing rightfully for their livelihood. The subsequent debate on how much the polluters should pay has been in part fueled by the question of how high the economic costs of the spill are, with a focus on repairing the pollution on the coast and in the water, as well as the economic costs to those living in the area. Ignored in all of this are damages to people outside of the region, for example shrimp consumers.

Addison Ellis, Jaclyn Kropp and Michael Norton identify for this case three sources of damages: higher prices, substitution to less liked goods, and added stigma from consuming Gulf shrimp (because it was perceived to be more risky). For the two first, they estimate the loss of consumer surplus to about US$100 million. For the third, they performed a series of experiments in 2010 to elicit from participants their willingness to pay for various types of shrimps. The stigma is reflected in a willingness to pay US$1.10 less per half-pound for Gulf shrimp. In terms of overall cost, my calculation indicates this would increased it by a little less than US$400 million, as 80,000 metric tons of shrimp were produced in the Gulf in 2010 (note the spill occurred on the 10th of April). Not small potatoes.

Monetary stimulus in high-inflation regimes

In countries where inflation is high and highly variable, you would not expect that monetary policy is optimal in a social-welfare sense. After all, such inflation is a sign of political influence, and from politicians that do not have the good of the people in mind: strongly expansionary monetary policy before elections, financing government expenses with a hidden inflation tax instead of other visible taxes, and even just pocketing monetary injections. Still suppose that for some exogenous reason inflation is high and highly variable, is their still scope for optimal monetary policy (beyond working toward a long-term goal of getting this under control)?

Wojciech Charemza, Svetlana Makarova and Imran Shah claim that yes, the central bank still can do good. They claim that output can be stimulated with a monetary stimulus when inflation expectations are much higher than output-neutral inflation. The latter is obtained with a two variable VAR, and then the sign of the residuals is used to interpret asymmetric impulse responses. Like many VAR analyses, this is a little bit voodoo science, especially when you look at countries whose data records are poor if not manipulated. Of course, following this policy will not help in solving the inflation problem of these economies (defined as at least 4.8% inflation at least 25% of the time). But if expectations are much lower, then one can tighten monetary policy without big consequences. Unfortunately, a VAR cannot tell us why all this would be happening, only that there is a statistical coincidence.

The obscure economics of vampires

There is a certain appeal to study the economic aspects of something that on first glance has nothing economic. Following the motto of this blog, I have reported on quite a few of those, such as boobs, beer, toilet seats and the scruples of teens. It is almost always good to stretch the boundaries of what we can do with Economics, what I have called the imperialism of Economics. But in rare cases this is going too far.

Daniel Farhat presents us with such a case, wherein he studies the Economics of vampires. The paper uses an agent-based model to follow the interactions of humans and vampires and draws inferences about aggregate phenomena. I have had my issue in the past with agent-based models, in a large part because they are build on unjustified assumptions with no robustness tests, and this papers makes me most concerned about these issues. Indeed, the model is built in a complete empirical vacuum, and none of the modeling assumptions are tested for robustness. Furthermore, because vampires never existed, and with current medical knowledge never will, the paper is pointless.

Should firemen and police officers retire earlier?

Workers in some occupations get to retire with full benefits much earlier than others, for example firemen, police officers and jail guards. The justification is that they have dangerous or even life threatening occupations, and thus should be able to enjoy as much retirement as others. Does this argument really hold water?

Pierre Pestieau and Maria Racionero look at this question from the angle of optimal taxation and social security. Those with harsh occupations have shorter expected lifetimes (on average) and should be given early retirement by a utilitarian social planner so that they can consume more in early years. But the social planner needs to prevent the others from doing the same, and thus taxes heavily the savings of those in harsh occupations. Why would the social planner need to do this? It observes only the occupation, and thus has imperfect knowledge about expected lifetime. The worker knows better and can choose when to retire. Thus the issue the social planner faces is not that workers would choose the wrong occupation, it is rather that the workers who expect a longer lifetime would fake having a short one when they are in the harsh occupation.

Thus the paper is not at all about giving earlier retirement to people in harsh occupations. It is about giving that to people who expect to live a shorter life, using a signal from the occupation they are in, because it so happens that their is some correlation. It would be more interesting to see people sorting into those occupations once they learn what their expected lifetime is. To me this opens another question: if someone works in a dangerous occupation that has no long-lasting health effects expect sudden death (examples: police officer), conditional on having survived, should one still get early retirement? Probably not. But it matters when people decide what occupation to take.