Travel time and the border effect

The border effect describes a striking feature of the data on trade volumes. Volumes typically decrease with distance traveled, with a jump down when a border has to be crossed. The size of this effect is mostly estimated with distance data taken from straight lines between trading areas, and often by simply taking the center of those regions. With considerable work, one can do better.

Henrik Braconier and Mauro Pisu determine the distance along roads as well as travel time for within-Europe trade, and this for almost 50,000 city pairs. While this neglects cargo train traffic, which has a substantial share of international traffic in Europe, this is as precise as it can get, I suppose. The interesting bit is that once a border is involved, travel distance and time are about 10% longer for town pairs that are equidistant when measured as a straight line. That means that literature has over-estimated the border effect by about as much. One could, however, also argue that the border effect is precisely stemming from the fact that it leads to travel time losses, at least in part, and that there is therefore no over-estimation. It depends what you really mean by border effect.

Euro zone: the common cycle is strong

The general thinking is that if you want to create a monetary union, a strong prerequisite is that the business cycles in the involved economies should be well synchronized, among other criteria. The reason is obvious: it allows consensus regarding monetary policy. This synchronization may arise after the merger, though, facilitated by the currency area.

Periklis Gogas looks at the Euro-zone and comes to the conclusion that synchronization has increased, especially with the last global recession. While the paper has plenty of robustness exercises, I fail to be convinced, though. Indeed, this supposed trend is based on two, maximum three, business cycles. And the last recession was of a different kind, being global, so it is difficult to avoid having it more synchronized than any other in the sample. You may argue that there are 86 quarterly observations and this is sufficient for statistical significance. But when you look at such questions, it is turning points that matter, and you only have a handful, and they do not look like a random sample of the population.

Is an imperfect monetary union leading to more volatility?

The theory of optimal currency areas initiated by Robert Mundell states that a monetary union should be beneficial between regions that have labor and capital mobility, fiscal transfer mechanisms and synchronized business cycles, or at least something approaching these conditions. In the case of Europe, this is clearly not met, but I guess the hope was that these conditions would eventually be met. The literature has been been rather superficial on what it means to not quite meet these criteria and what the consequences are. Yet, we have now techniques to model this better and test policies that could improve outcomes.

Philipp Engler and Simon Voigts do this with a DSGE model where they explicit the market structure, following the situation in the current European Monetary Union: no labor mobility, imperfect goods market integration, incomplete financial markets, no fiscal transfers at business cycle frequency, and asymmetric shocks. They find that adding a monetary union to the mix increases the volatility of consumption and employment significantly, essentially because country-specific monetary policy cannot be enacted. What can be done then? Engler and Voigts show that area-wide fiscal policy can do a lot of good, and much more than isolated fiscal policy would. And this is exactly what is missing in Europe. Absent this, one could imagine increasing labor mobility, but the trend in Europe right now seems to go the other way, with several countries thinking about restricting immigration from member countries. European integration is hard.

What is an ordinary saver?

The banking crisis in Cyprus has been handled very poorly, few would disagree. There was foremost a deplorable approach to naming things, for example "deposit tax," and also the fact that it took so long to come to a solution, which allowed privileged people to escape losses imposed on others. However, one idea that I found rather strange was the concept that the "ordinary saver" should not be penalized.

Justina Fischer, in a paper whose length rivals this blog post, argues that ordinary savers need extra protection because they have fewer choices in savings vehicles and they may be suffering from information asymmetries. But who are the ordinary savers? Are these people with little savings? Those with undiversified savings? If household finance data taught us something, it is that there is extraordinary diversity in savings and wealth, and that the life cycle matters a lot. So it impossible to easily categorize people as ordinary by simply looking at their savings account.

That said, a deposit account bears risk and it is not a sacred cow that the government or someone else should insure at any cost. During the liquidation of a bank, depositors may be defined to be the first to be served (which is not even true in some countries, for example in the US holders of derivatives are first), but that does not mean that there is necessarily enough for them. That said, a country may decide to insure deposits up to an amount, and many do. But this is part of a financial contract that a country may not even be able to hold, as the Cypriot example shows us. And if we think a bit harder about it, this insurance should not apply to the account but to the person, like guaranteeing everyone that the first X euros in bank deposits anywhere cannot be taken in a bank bankruptcy. But anything above that is subject to usual bankruptcy proceedings.

Small countries are more right wing

Over the past decade or so, there has been a trend for European countries to drift toward the right on the political spectrum. Even nominally leftist governments have positive views of lean governments and austerity talk. Why this? I doubt this is because suddenly the United States has become a shining example. There is something more fundamental at work.

Franto Ricka thinks it has all to do with increased tax competition. This became more prominent with the expansion from EU-15 to EU-25 around 2004, where a series of relatively small countries joined the union. Smaller countries have an interest of playing tough in tax competition, especially for capital tax rates, as they can increase revenue by lowering taxes. And this puts pressure on the larger ones. Thus, even though political preferences have not changed, political outcomes have become more right wing as Europe expanded, and voters elected as well more politicians from the right.

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.

How integrated are Eastern and Western Europe now?

25 years ago, it was very rare to see a car with Eastern European plates in Western Europe. Now, they are all over the place, including trucks (why are there so many from Romania?). This is a clear indication, even if you ignore history, that the East-West integration is stronger than it has been for a long time. But there are more aspects to integration than the movement of cars.

Catherine and Klaus Prettner basically look whether the two regions are cointegrated. They build two national aggregates, one with 12 European Community countries (unfortunately no UK) and 5 Central European countries. Using a vector error-correction model with restrictions from a standard open-economy business-cycle model with cash-in-advance. Output shocks to one area spill over to the other, surprisingly in similar magnitudes in both directions. Interest rate shocks are expectedly asymmetric though: West impacts East, but East does not impact West. But given that all this has been in transition mode over the 1995-2009 sample, I really wonder how these impacts have changed over time. A framework with time varying coefficients would have been helpful here.

What to do when people expect the government to default on its debt

The situation in Greece is rapidly getting worse, with clear signs that a bank run is in the works, mainly because there is no party majority that would avoid a default on the public debt. In such a situation, what should the fiscal policy be? Clearly, the budgets have to be reduced dramatically as no one would be willing to lend to the government and the government can only pay with cash (which is not the new drachma, as no one will trust that either and we would have immediate hyperinflation and the complete collapse of public services). This is why the government has no choice but to honor its debts if it wants to continue offering public goods, and this is what the Greeks want, I think.

So then, what should happen if the government is committed to pay the debt, but the public does not believe it? For advice, we can turn to the recent paper by Francesco Caprioli, Pietro Rizza and Pietro Tommasino. Suppose economic agents eventually and gradually learn about the good dispositions of the government. They also believe there is a positive correlation between the level of debt and the probability of default. The consequence of these very reasonable assumptions is that government expenses need absolutely to be reduced after a negative tax revenue shock. The first reason is that the interest rate goes up and worsens the situation, the second is that the government needs to keep the debt low to avoid fueling more default expectations, not just today but also in the future due to inertia of beliefs. This is in stark contrast from a situation where the government can credibly commit to repaying the debt: then, debt can effectively be used to smooth out fluctuations in tax revenue.

Greece is so screwed.

On the mobility of academics in Europe

Europe has suffered a brain drain of top academic scientists that it has tried to reverse by offering better work conditions. The main competitor in the United States, where top scientists are able to attract easy funding and universities are accommodating. While pertains to relatively few people, they are considered to be key, as their reputation can attract better colleagues and graduate students, ultimately improving the rankings administrators vie for. Given the large amounts of money spent by the European Commission and its country counterparts, it is important to understand what motivates scientists to move.

Edward Bergman does this using a survey of 1800 European academics considered to be among in the top institutions. Those who exhibit higher levels of loyalty or "voice" (opinionated on local affairs) tend to stay and try to improve things internally , if necessary. The others prefer to leave when local conditions worsen, and then they have no particular loyalty to stay in Europe when they are just looking for better working conditions. All this is not too surprising. What I find more interesting is that scientists top priority is research opportunities followed by salary, and language preferences is very minor. European universities cannot count on scientists coming home any more.

Entrepreneurs need an educated workforce

Entrepreneurship is the driver of growth and wealth, or at least an important driver. This is why so many initiatives are geared towards making life easier for entrepreneurs. And the champion in the US, with relatively little red tape, low taxes and especially very developed financial markets. One aspect that is much discussed right now is how low these taxes should be, especially as lowering them implies reducing some public benefits such as education. Is there a trade-off?

José María Millán, Emilio Congregado, Concepción Román, Mirjam van Praag and André van Stel use a panel dataset from several European countries to show that education matters for entrepreneurial performance, and it is not only the entrepreneur's own education, but also that of the workforce. An entrepreneur who cannot find appropriate workers or clients who are sophisticated enough for her products is not as successful. While the results are strong, I am a bit wary of using a short annual sample to tease anything out of education measures, but this is worth further investigation.

The unnecessary problems of the Euro

European leaders are currently struggling over a package to save the Euro, pouring large amounts of money into funds that should stabilize the fiscal situation in Greece, Portugal, Ireland and potentially other countries. It seems to me that this is a completely unnecessary problem, and all this grief could have easily been avoided with a simple change in policy.

Just look at what is happening in the United States. Several states are in serious financial difficulties and, as several times in the past, California is considering issuing IOUs, thereby essentially declaring it is insolvent. Is there any expectation that other states or the federal government will rush to California's aid because the dollar is threatened? Of course not, despite the fact that California is the largest state in the Union.

It should be the same for the Euro. None of the member countries can monetize its debt on its own, and the only reason that the Euro is threatened is that markets have an expectation that other countries will rush to help, thereby sending a message that monetary policy could be influenced by what is happening in those small countries. And why is this belief well anchored? Because European indeed rush to help (talk about a nice example of self-fulfilling expectations) and because of this silly concept that all national debt in Europe is fungible (talk about a nice example of the tragedy of the commons). Now of course it is a bit late to rectify those beliefs, but had it been clear no rescue package were in sight, those countries would probably not taken such a risky fiscal path in the first place (talk about a nice example of moral hazard). I guess that those silly policy decisions all boil down to European politics, once more (talk about a nice example where economists' advice has been ignored, and they will get blamed for it anyway).

The crisis and the loss of Bourgeois values

What triggered the Industrial Revolution has been the subject of debates for decades. While currently the emphasis is on the Unified Growth Theory, other interesting explanations exist. One of them is by Deirdre McCloskey, who claims that the wide adoption of Bourgeois values was critical. By that, she means that once innovators and capitalists were looked up to or were considered gentlemen, an economic transformation towards industrialization could happen.

Are there some lessons to be learned for the current economic situation? Gustavo Morles thinks that we are currently witnessing a loss of Bourgeois values, particularly in Europe where welfare states are strong and demographic shrinkage attracts people with different values. The United States are not immune, as shown by the election of Barack Obama. The consequences would be a prolonged economic crisis due, presumably, to disappearing entrepreneurship.

While there is indeed worldwide more anti-business and pro-regulation rhetoric than for a long time, I think it is too early to call this a permanent change in attitudes. And in an era so dominated by fads fed by the media, this may change as fast as it arose.

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%.

Explaining high unemployment and low mobility in Europe

There is an endless stream of papers trying to understand why, on average, unemployment rates are higher in Europe than in North America. I have reported here about several of the recent ones, and there seems no shortage of new explanations. In fact, if one were to build a model with all those explanations, one would probably be left to explain why after all the unemployment rate is not even higher in Europe...

So what is the latest explanation? Peter Rupert and Etienne Wasmer pick up the ball where several left it: high unemployment is due to low mobility: Europeans are much more attached to their region and are less willing to move for a new job. This begs the question as to why. This calls for a model that explains both unemployment and mobility, based on some friction that differentiates North America from Europe (and does not involve taste shocks, the catch-all for the unexplained). Rupert and Wasmer argue that differences in unemployment insurance benefits and taxes are not sufficient to explain the differential, one needs also to factor in commuting costs. While commuting time is a little shorter in, say, France, fuel costs are much higher, which explains the shorter commute and the lower mobility.

Calibrating this labor search model, Rupert and Wasmer find that indeed they can explain both the unemployment rate and mobility differentials. But I have a feeling this is not the end of the story. If the cost of commuting is so high, why not move closer to the job? European housing markets are much less liquid than in the US. Why? It seems the economic force discussed here should make them more liquid.

Institutions do not affect the business cycle

There is now much talk about reforming market institutions in order to prevent crises. Whether those reforms will have an impact remains to be seen. But does institutional change have an impact on business cycles? An obvious natural experiment in this regard is Europe, where a common currency and monetary policy, the Maastricht Treaty as well as the free movement of goods and people.

Fabio Canova, Matteo Ciccarelli and Eva Ortega look at this using a panel VAR with countries in and outside the European Union. They find that there is a slow change in terms of synchronization and transmission of business cycles, but this seems unrelated to institutional change and rather part of the long process of convergence that started over 100 years ago. The timing of change is simply not right. Does this mean institutions are not important? Not necessarily, as this study looked at fluctuations, not levels.

Why do Europeans work so little?

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

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

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

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

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

US still a leader on the policy front, unfortunately

Now that the US has passed this unfortunate bailout package, other governments around the world are eager to pursue similar policies. This is quite silly, as we seem to create a gigantic moral hazard problem at great cost.

Iceland reached heights in silliness by taking over much of its banking sector. Icelandic banks had been very aggressive on European financial markets, in particular pursuing depositors with high interests rates. This means the banking sector is much larger than the country in that a majority of its customers are abroad. Why would the government then step in to save foreign customers? This is especially questionable as the Icelandic government is now itself in a situation of default as a consequence and is begging for money in Russia, of all places.

The only explanation I can think of for this decision is that Iceland just imitated US policy action without thinking too much. And other European governments are following suit as well, except for Switzerland. The latter is an interesting case, as UBS has been particularly bad hit by the subprime-mortgage situation. But knowing the government would not help, it recapitalized several months ago with funding from Asia, and it seems to be in relatively good shape now. The other big Swiss bank, Credit Suisse, is fundamentally healthy and has announced plans to hire 1000 investment bankers in anticipation of a rush of new customers. So much for preventing moral hazard problems: not intervening leads to a healthier financial sector.

The rise of Europe, the standstill of Asia

One of the big challenges of Economic history is to explain why, a thousand years ago, Asia, and in particular China, suddenly stagnated and why in the following centuries Europe started growing, leading eventually to the Industrial Revolution before any other continent. Of particular interest here is that even when you abstract from the leaders of the Industrial Revolution and look at, say, Bulgaria, Norway and Portugal, they have done much better than the rest of the world. Why?

Some of the standard answers have been that this is due to 1) cultural aspects, but within the time line we are talking about here, this is endogenous; 2) chance events (steam engine, proximity of coal), but European countries away from such events also grew faster than Asian ones; 3) resource grab from America, but would Asia really have benefited from such manna?

Cem Karayalçin argues that this divergence in growth is due to the political competition in Europe. States were fragmented and small, and people could escape there policies by migrating. This was impossible in Asia once the Ottoman, Chinese and Mughal empires were created. The latter essentially had monopoly power over fiscal matters, and thus could exploit their trapped population without further harm to the rulers. Contrast this with Europe, where sovereigns had to be careful not to tax too much, to provide services for the taxes and even had to dole out incentives to attract farmers.

A particularly important aspect of this competitive environment in Europe was that sovereigns were careful to give sufficient guarantees for ownership, that is, not expropriate at will. This made the accumulation of capital favorable. The same cannot be said for Asian empires, where for example the 122 top ranking nobles received 1/8 of the national product of India at the time of Akbar. Bequests were typically confiscated. In the Ottoman empire, wealthy traders would be stripped of their assets if not killed. It is difficult to muster any aggregate savings necessary for capital accumulation in such a hostile environment.

Karayalçin's paper has two parts: one theoretical that demonstrates his points, the other historical where he justifies the assumptions underlying his results, for example evidence on mobility in Europe since medieval times, the lack thereof in the Asian empires, and the differences in taxation burdens. This paper makes Economic history exciting.

Monaco set to expand

Monaco has a tiny territory and is bursting. To expand, it seems to have nowhere to go but the sea, à la the Netherlands. And this seems exactly to be the plan: filling up parts of the Mediterranean sea on the shores of Monaco at a cost of €5 billion, to deliver 275,000 square meters of land. This is about US$ 3,000 a square foot. Monaco can do better than that.

The area around Monaco is quite hilly, so I suspect the water is not shallow. This makes it particularly difficult to fill. Also, there may be environmental issues with marine life. I think it would be much simpler to simply expand into existing land, i. e., buy it from neighboring France. And France should be happy to sell.

France should be able to get a good price for it. And it is not losing much. Monaco is a tax tax haven, but not for French nationals. Indeed, after France embargoed Monaco in 1963 because of tax cheats, Monaco had to give in and let France tax its citizens living in Monaco. So no tax revenue loss for France, a apart from the non-French residents that would fall out of its jurisdiction.

Slovakia and the Euro

Slovakia is now a virtual lock for joining the Euro next year, missing just a formality (a ministerial meeting). But the approval comes with serious reservations. Indeed, while the current economic numbers fit the requirements, it is clear to everyone this will not last, especially for inflation. Then why approve?

The problem is that precise rules have been established for entering the Euro-zone, and to avoid politicizing the process, these rules are strictly applied. To the point of absurdity, like in the Lithuanian case two years ago: inflation was to high by a minuscule amount, and the application was rejected despite the fact that Lithuania has no monetary policy as it is in a currency board with the ... Euro. Yet, Slovenia got in the same year with OK numbers on the very application date, but not before (or after).

It looks like the rules for entering the club have not been thought through. But it is nevertheless a good idea to apply rules. I only wish they would be applied for those already in the monetary union, where especially the large economies seem to be doing pretty much what pleases them.