Luminosity as an indicator of economic activity

When working with worldwide data, it si often frustrating that data quality and availability is far from uniform across countries. Especially for developing countries, or those with large informal sectors or notable self-sustenance, we have a very imperfect idea of how much economic activity there is. Hence, looking at other indicators that GDP can give us interesting clues.

Xi Chen and William Nordhaus make the case for luminosity. By looking at how brightly various locations shine at night, it allows you to infer something about economic activity and the level of development. Also, it allows to say something about regional distribution of economic activity. Of course, this is not going to be perfect, especially for developed economies where data is of much better quality to start with.

The standard data set for international macroeconomics data is the Penn World Tables. It also grade grades to its data, telling us how reliable it is. Unfortunately, these grades are largely ignored in empirical work. Chen and Nordhaus ask whether they can increase the quality of output measured with their luminosity data and they claim this is only useful for those labeled D and E. Yet they do not advocate using luminosity data for countrywide analysis. Indeed, data collection methods will eventually improve and traditional data will move up in the quality ladder. Luminosity data is far from perfect, it is just that in some countries official data is even worse at the moment. Chen and Nordhaus are more confident with luminosity as a proxy for regional activity in some cases, even if measurement error is even larger there.

Overinvestment in financial expertise

One conventional story about the 2007-2008 financial crisis is that some bright financial bankers created complex financial instruments that have then been traded by people who did not understand them, thus leading to mispricing and ultimately to a major market correction. In other words, financial advisors were not too bright. No, Wall Street has hired a lot of PhDs, so how could this happen?

Vincent Glode, Richard Green and Richard Lowery present a theory that would yield identical outcomes, but because there is too much investment in financial expertise. They build a model where financial intermediaries hire experts to create, manage and trade complex financial instruments. This allows them to extract some of the consumer surplus created by these instruments. But the intermediaries are competing with others that do the same thing. The fact that this investment in expertise is made may make the surplus disappear under some circumstances, for example some information shocks.

Thus the competition between financial intermediaries boils down to an arms race, where each move is privately beneficial but socially neutral, and sometimes even harmful. All the bright people hired by Wall Street have created very complex instruments and information systems that lead to adverse-selection problems. When a shock occurs, the fact that they have more information makes that others think they are going to sell lemons, and nobody trusts them. Markets come to a halt. In a sense, the financial intermediaries suddenly wish they would not have all this expertise, so that they do not come under the suspicion of offering bad assets. Maybe firing all of them is the solution.

Women stay longer

It is widely documented that women have a much higher tendency to drop out of the labor force than men and that they quit jobs more often. It is obvious that fertility and marriage have a major impact here. And nobody disputes that. But apparently nobody looked into more details by differentiating genders for job market transitions.

Boris Hirsch and Claus Schnabel do it for Germany using excellent panel data that included many job and workplace characteristics along with some details about the workers. Hence, they can factor in a good chunk of heterogeneity. The interesting results is that once you control for the wage, women are less likely to quit their job for another one or non-employment. As women take jobs that pay less, a composition effect is hiding the loyalty of women to their employer.

Men last longer

Women live longer, yet paradoxically they can claim pension benefits earlier in many countries, where there is strong resistance to equalizing the retirement age (let alone increasing it, see last week's post). Would true believers in markets and efficient politics still find an explanation of this paradox?

Wolfgang Maennig and Michael Stobernack offer one: the physical performance of men declines much slower with age than for women. They base this on the worldwide top performers by age on rowing machines. The latter are of uniform quality, thus environmental factors do not matter and everyone competes on level ground. This is better than previous studies relying on track-and-field records, that more susceptible to whether influences (and doping). From the 40's to the 60's, the physical performance of men declines by about 15%. This is less than the productivity decrease that would be implied from wage changes (and labor productivity does not depend solely on physical performance, one could think older workers have in fact better non-physical qualities like experience). For women, this is more in the order of 20%. The difference is even more pronounced for those in the "lightweight" category.

The study does not go beyond the 70's (and I suppose the records pertain to the younger ones among those). So it must be that at some point the men start declining really fast. It also be that the age differences among the best rowers are simply not representative of the age differences among the general population. These elite athletes maintain their body, whereas the general population may not, and especially there may strong gender differences in doing so.

Why Greece will never make it: self-fulfilling expectations about social security

Mediterranean countries have many things in common, one of them is an early retirement age. You certainly read about the uproar when the Germans learned that they had to bail out the Greeks who enjoy retirement many years earlier. Now there is much pressure on Greece to lower and delay pensions, but there is tremendous resistance from the street. The same is happening right now in France as well. Yet, initiative to delay retirement in Northern Europe or North America, where retirement age is already higher, do not generate much discussion.

Ryo Arawatari and Tetsuo Ono may have an explanation for this dichotomy: self-fulfilling expectations. The story is very intuitive. If you expect pensions to be generous, there is no point in accumulating savings for retirement, and you do not invest in education either. And once you are low skill, you will vote for generous pensions. The opposite happens with expectations of small pensions. And once you are in such an equilibrium, it is very very difficult to get out of it: people want generous pensions, and the newcomers know this and thus expect this not to change, and make the appropriate (non)investments. To change this, you need to massively lower expectations during a whole generation or more. No Greek government can have that much staying power. And neither does the French one.

When should amniocentesis be performed?

Every pregnant woman past some age is recommended to perform an amniocentesis to check whether her fetus suffers from Down syndrome. The reason is that the risk of this syndrome increases with the age of the mother. But the test is risky, as it can lead to miscarriage, thus it is only performed for higher (syndrome) risk pregnancies.

Eduardo Fajnzylber, Joseph Hotz and Seth Sanders tell us that the logic that the medical profession has adopted is wrong. The basic idea is that the risk of miscarriage is constant with the mother's age, while the risk of Down syndrome is increasing. At first sight you would only want to test older women. That is the logic from the perspective of the physician. They now propose to see this from the perspective of the mother. An older women will have fewer opportunities to conceive, thus a miscarriage is much more costly to her compared to a young woman. This would make her to want to avoid the risk of miscarriage. The recommended strategy becomes much less obvious and could in fact be that young women carry out the test and older ones bypass it. It all boils down to a personal evaluation of the cost of miscarriage, Down syndrome and abortion. Not as easy as the physicians say it is.

Worker overconfidence and unemployment duration

The current (well, some say it is over now) recession is different from others because it has unusually long unemployment durations, among other things. This can be explained by a really poor labor market. But there could also be other reasons.

René Böheim, Gerard Thomas Horvath and Rudolf Winter-Ebner explore using Austrian data the components of a wage: one part comes from firm fixed-effects and the other from worker fixed-effects. In other words, the wage depends on the productivity of the firm and of the worker. They find then that those workers who had larger firm fixed-effects later end up having longer unemployment durations. This means that they misinterpreted their high wage as their own doing, and became overconfident and set a reservation wage that is too high.

In the current US context, it is clear that real wages need(ed) to decrease to clear the labor market. But many of those who were laid off may not have been understanding this and have (had) too high reservation wages, and thus have been at least initially rejecting some job offers, thus prolonging the duration of their unemployment. I have no hard evidence for this conjecture, may be someone has for or against it.

Pennsylvania liquor stores are welfare maximizing

In many countries, and in particular North America, the state holds a monopoly on the sale of alcoholic products. And in those areas, everybody complains how inconvenient the purchase of alcohol is. Of course, this inconvenience is part of the purpose of these state monopolies, along with keeping prices high and keeping the margin for government coffers. But discouraging the consumption of alcohol does not need to be done this way, simply taxing it would achieve the same goals.

Katja Seim and Joel Waldfogel claim that at least in the case of Pennsylvania, the state monopoly is beneficial. Indeed, the layout of the network of stores, and the number of stores is much closer to maximize welfare than maximize profits. Now, of course, we need to define welfare. They measure it à la Hotelling: consumer surplus is based on the price of liquor and the distance between stores and customers, the producer surplus is based on profits, and there is a fix cost of operating a store. In other words, Seim and Waldfogel treat this problem like it would apply to any good. But we are taking about liquor here. And there is a reason we want to regulate it: it generates negative externalities.

Thus, if they find that in Pennsylvania the outcome is close to welfare maximizing according to their criterion, it tells me that there are too many stores if that social welfare measure included the negative externality of alcohol.

How big are welfare stigma?

There is some literature that has tried to establish how large the stigma of participating in welfare programs are. Indeed, the fact that not all those that can obtain welfare benefits actually take them is an indication that feel bad about it, as long as they are aware of the relevant programs.Just how bad do people feel about this? The problem is that another factor comes in: time costs. Getting welfare benefits typically takes time: getting to the welfare office, waiting, filling forms and getting interviewed. This implies that the econometrician has a hard time figuring out the psychological costs of welfare participation. Indeed, time and psychological costs have very different policy implications. Time costs have a good reason: to select against welfare cheaters who are more likely to be discouraged by lost time. Psychological costs, however, are lower for the cheater. Also, discovering that the latter costs are high for the intended recipients is detrimental to the success of a program.

Colleen Flaherty Manchester and Kevin Mumford build a model of labor supply with an additive, one-time cost to welfare program participation in the utility function. Using structural estimation, they infer what the time cost as well as the psychological cost are, using the example of food stamps and WIC (healthy food checks for small children and pregnant mothers-to-be) in the US. They conclude that time costs amount to 0.5 hours a week for food stamps and 3 hours a week for WIC. The psychological costs are larger, about 3 hours for each program, but incurred only in the first week of participation, by assumption.

I am a big fan of structural estimation because it gives us the right quantitative framework for policy experiments. But the inferences in this case seem rather heroic to me. Indeed, there is no direct observation of the time cost. It is inferred from estimating a labor supply equation on a population where many do not work, for reasons beyond observables, and for them virtual wages are inferred. And the psychological cost amounts to a residual, and accordingly is estimated with a very large standard error. With all these caveats, I am surprised that there is no data that would measure the actual time lost through participation in those programs. This would considerably tighten estimates.

Video review in football/soccer

The Australian Football Association has started to implement post-match video reviews to help in refereeing games and in particular uncover things the field referee may not have seen. The most striking example so far has been the reversal of an added-time penalty kick that followed a dive by an attacker. The diver is now suspended for two games, and the goalie got his red card reversed.

After the multiple controversies in the last World Cup about outcome determining refereeing errors, FIFA has been adamant that it is not considering overriding the authority of the referees on the field. The Australian initiative is definitively a thorn in the eye of FIFA, and it will be interesting to see how the football politics pan out.

But beyond this, this could lead to particularly interesting behavior on the field. Suppose a penalty kick is awarded on a dive. The diver, knowing that the decision could be reversed after the fact and new punishments could be handed out, could volunteer and ask the referee not to give the penalty kick. Should the referee accept this plea that undermines his authority on the field? Obviously his authority off the field is lost with post-match video reviews, but his decisions still have an impact.

In any case, I would love to see this implemented in Southern European leagues or in South America. It would make football strategy even more interesting.

Is fair trade unfair?

US colleges make big money from the sale of all sorts of items imprinted with their logo, in particular clothes. Of course, to maximize the margins on these goods, their production has been mostly outsourced off-shore, to factories that were often likened to sweatshops. Whether a large portion of those factories were indeed providing substandard working conditions is a debate I do not want to enter for now. The fact is that student activists demanded that those factories should not be retained for production. As universities and their suppliers complied, the poorest workers were out of a job, and the university gift stores are making less of a profit. Unintended consequences.

Aurélie Carimentrand and Jérôme Ballet explore a similar story with fair trade. Their case study is about quinoa from Bolivia. The goal of fair trade is to give local producers in developing countries a larger share of the retail price of their product. But beneficiaries need to get certified, and this process does not necessarily favor the most needy, in particular as they need to obey some rules. In the case of Bolivian quinoa, this works through the membership in a growers' association which markets crops to fair trade networks. As associations typically are, this one is dominated by the big producers. The latter are located in the big plains, where they could get the full advantage of mechanization. The small producers are on steep terrain and cannot use tractors. The latter are the poorest, but, as the authors argue, they benefit the least from fair trade, often even skipping membership. Indeed, the association pays the same unit price to all members, and given the differences in production costs, this exacerbates inequalities.

The authors claim that fair trade has failed here. It made inequities among producers worse. But was domestic income equality really the primary role? Isn't it really about world income inequality? There, clearly fair trade is transferring some rents to developing economies. Whether they are large enough to be worth the trouble is another question.

How to raise government revenue: tax bling bling, but subsidize hip hop?

Lost in the debate on how governments could be raising much needed revenue in our difficult times is that there are some goods that are just begging to be taxed: diamond goods. These goods are valued solely because they are expensive. The money spent on these goods is independent of their price. Thus taxing them all the way to infinity makes them even more attractive, as very little of the diamond good needs to be produced for the same satisfaction. Thus, everybody should agree diamond goods must be taxed heavily: the buyers because of the prestige of the high sticker price, the others for the tax revenue.

Per Engström adds a little nuance to this argument. Suppose there is a strong complement to the diamond good, like hip hop music is a strong complement to bling bling. As the diamond good constitutes a free lunch for the social planner, the latter would want to subsidize it. But that beats the purpose of taxation. However, one can subsidize the complement, which encourages the consumption of the diamond good.

Engström mentions other pairs of goods. Entry to the Sex and the City should be free and designer shoes should be taxed to the hilt. The same for James Bond movies and champagne. Any other examples?

Trade theorems revisited

International trade economics is a constant disappointment to me. It still relies on the Hecksher-Ohlin model, which is static and thus cannot say anything reliable about dynamics. And the vast majority of the empirical work uses linear reduced forms and is only out there to test signs, not to find out how large an effect is. It is then refreshing to see a paper that steps out of this morass, and into the right direction.

Yu Sheng and Xinpeng Xu get back to the foundations of the Hecksher-Ohlin model and integrate some frictions that go beyond the usual iceberg costs. Specifically, they take into account that the reallocation of labor across sectors takes a while by including a Mortensen-Pissarides search framework. Even in steady-state, it turns out some classic trade theorems may not hold. For example, factor price equalization does not hold for labor, as there is unemployment and the expected wage is equalized. Endowments determine the labor force, but employment is endogenous. This allows also to explain why countries with similar endowments still trade a lot: cross-country sectoral differences in unemployment mean the factor content of trade is not a sufficient statistic. All this also means that empirics of the Hecker-Ohlin model need to be adjusted, in particular unemployment needs to be factored in.

The problem with experimental economics: people are weird

Experimental economics is the up and coming new field, with plenty of interesting research going on. But many people criticize it because the experiments, while controlled, do not reflect real world situations. The stakes in the experiments are too small, the participants are not representative, the experiments not relevant. Add to these criticisms a new one.

Joseph Henrich, Steve Heine and Ara Norenzayan claim this literature, and others, concentrates on Western, Educated, Industrialized, Rich and Democratic (WEIRD) societies. And these societies, with 12% of the world population, are not representative of the rest of the world, in fact they are downright ... weird. To make their point, Henrich, Heine and Norenzayan look, among others, at the ultimatum game in all sorts of societies. This is a standard game that is in particular used to measure altruism ans spite: a prize is to be shared, one player proposes a split, and the other can reject the proposal, leading to both getting nothing. In "weird" societies, the standard result is a 48-50% for the second player, who accepts. Offer below 30% are typically rejected. Subgame perfection, however, would suggest that any amount above zero should be accepted, and the smallest possible is to be accepted.

What about in other societies, the "non-weird" ones? Small scale societies, where people are used to live face-to-face, make low offers and accept them. Worse, it appears that offers that are particularly high are rejected, something that also applies to European societies. Quite consistently, and the authors provide other examples, American experimental subjects end up at an extreme of outcome distributions

Does this mean that the US undergraduate, on whom the vast majority of experiments are performed, is misleading us thoroughly? Not necessarily, after all he may help us understand the homo economicus americanus, but even there one can have doubts. But we may need to rethink seriously how economic theory applies to other societies, at least for some research questions. Experimental economics has still a lot of work on its plate.

C{A|R}RA utility

When it comes to modeling preferences in uncertainty, the usual choice is usually between constant absolute risk aversion (CARA, with an exponential function) and constant relative risk aversion (CRRA, with a power function). That is somewhat limiting, especially when one needs to cover a rather wide domain, as there is then no reason to believe risk aversion remains constant.

Masako Ikefuji, Roger Laeven, Jan Magnus and Chris Muris come up with a mixture, which they name Burr utility. It is CRRA at the origin and CARA at infinity and is a function that has some familiarity for those who use subsistence consumption (Stone-Geary utility function) except that this constant term is added. This implies in particular that marginal utility is never infinite, which is a property I am not sure I want to miss.