The origin of the demographic transition

Compared to two centuries ago, today's world is much different, as the standard of living has dramatically increased, along with population. This has been in strong contrast with previous history, characterized by growth close to zero in both population and the standard of living. During this period, there has been a very strong demographic change, called Demographic Transition, with a large decrease in mortality followed by a decrease in fertility. This has implied that every country that went (or still goes) through this transition has a period of high population growth while mortality is low and fertility has not yet declined. Such major shift in demographics have large implications, but it is also important to understand what triggered the Demographic Transition, especially as some countries are now just at the start of it.

Oded Galor tries to disentangle to various triggers that have been proposed. As this is a dynamic process, obviously some triggers are going to be more important at different stages of the transition. There is too discussion in the paper about the various theories and the quantitative evidence for and against them for me to summarize it efficiently here. Galor concludes that the following theories hold water when plunged into the data: First there is the theory that the higher demand for human capital during industrialization lead to a decline in fertility as parents concentrated more on the quality of their children rather than their quantity. Second, as the wage gap between females and males decreased, the increase in female labor force participation and the associated higher opportunity cost of having children for mothers reinforced the decrease in fertility.

What is important here are the theories that did not passed the test of the data according to Galor: the theory that the emergence of financial markets made in less necessary for parents to have been adult children to support them in old age; the theory that a decline in mortality lead to a too high number of surviving children; and the theory that the general increase in income lead to a rising opportunity cost of raising children.

More on the credit card puzzle

Why do people simultaneously hold substantial cash and high interest credit card debt? I previously reported that this could be explained by the demand for liquidity as some goods cannot be purchased on credit. While that explanation seemed to be a good one quantitatively, it does not mean that thtere is no room for other ones as well.

Scott Fulford offers another one: liquidity is necessary for unexpected changes in borrowing limits. Basically, people keep cash or savings so that they have something to live from in case their credit line gets unexpectedly reduced. That seems to be a very poor strategy, though. Given the high interest rate on credit cards, why not lower the credit balance with those savings? You pay less interest, and you end up with exactly the same balance when you are the most constraint. If fact you are even better off in the latter situation, because past interest payments are lower and the balance is thus lower. The reason why household in this model still hold cash is that there is a very peculiar way in which the debt limit is stochastic: it is either zero or some fixed number. Thus it is not some reduction in credit lines, it is a complete cancellation out of the blue. That is important for household choices. In fact, this may give some ideas to credit card companies, because this implies that households will want to have high interest credit card debt while having low interest savings. Crazy.

Should human capital be taxed?

There is a long standing and quite robust result in the literature, originating with Christophe Chamley and Ken Judd, that physical capital should not be taxed. Larry Jones, Rodolfo Manuelli and Peter Rossi extend this reasoning to human capital. These are very strong results that are not borne by the data, thus either the models are missing something, or economists still have a lot of convincing to do.

Christoph Braun challenges the last result on a technicality. Jones, Manuelli and Rossi assumed that human capital exhibits constant returns to scale in its production function, that is, a doubling of current human capital doubles ceteribus paribus future human capital. Braun take the opposite extreme: current human capital has no impact on future human capital, as the latter is only dependent on the time dedicated to education. The first assumption was very convenient, because it made human capital disappear from key equations, but this also drives the no-tax result. The latter makes it simpler than an intermediate assumption (decreasing returns to scale), but give a very different result from the original paper: in particular, the return to human capital does not vanish from the taxation equation and thus should be taxed. However, the accumulation of human capital is encouraged through the tax deductibility of tuition. And in the end, physical capital is still not taxed.

Reflections about 10.10.10

Today is October 10, 2010, which is the binary equivalent of 42. I was looking forward to this day, as 42 is the "Ultimate Answer to the Ultimate Question of Life, The Universe, and Everything." Alas, my day was not fruitful in this respect, maybe we have to wait for another century for The Ultimate Answer. And then, the context could be very different, as human life may have few similarities with today's. Just think how life today compares to that of 1910, and how we now ridicule some aspects of everyday life then. If you still follow my train of thought here, what would people a century from now find ridiculous about our lives nowadays? Here are a few candidates, and only the far future will tell whether I am right.

1. We drive cars ourselves. How inefficient and, especially, dangerous.
   
2. We can pollute mostly for free.
   
3. Water is essential, yet cheap.
   
4. Nationalism.
   
5. The amount of garbage we generate, in particular paper and plastic.
   
6. Major projects are funded and conducted at the national level: space exploration, fundamental research.
   
7. Smoking tobacco.
   
8. Transportation centered on individual fuel engines.
   
9. How religious people are.
   
10. Circumcision.
    
11. We tolerate a huge dispersion in standards of living across the Earth.
    
12. Life-time insurance contracts between people of the same gender are illegal is many places.
    
13. Private and exclusive health care provision.
    
14. Immigration laws.
    
15. Patents and copyright.
    
16. Intelligent design.
    
17. We kill sociopaths.
    
18. We pay to put drug users in jail instead of taxing them.
    
19. We need new flu immunization every year.
    
20. TV and celebrity oriented leisure.
    
21. That abortion needs to be an option.
    
22. The catholic church can get away with child molestation on a grand scale.
    
23. We use toilet paper and flush with water.
    
24. We devote lots of resources to lawns.
    
25. We prefer pumping expensive carbon into the atmosphere rather than using free solar energy.
    
26. We expect physicians to know everything on the spot without looking it up.
    
27. The USA is a country, while Europe is not one.
    
28. Government officials are poorly paid and are expected to outdo themselves for the common good.
    
29. The right to privacy is somewhat enforceable.
    
30. Lawyers are powerful.
    
31. Prostitution often involves sex.
    
32. One needs to dress well to be respected (artists excepted).
    
33. Few babies with birth defects are born.
    
34. Farmers receive substantial subsidies, sometimes in areas not suitable for farming.
    
35. Many people know how to spell.
    
36. Rogue states.
    
37. Invasive surgery.
    
38. The belief that one needs to exercise to lose weight.
    
39. The waste of time in commuting.
    
40. Chemotherapy.
    
41. We eat animals.
    
42. How bad our lives are.
    

What makes people save?

The saving behavior of people is heterogeneous, and what drives it is important for policy. In particular, there is a strong belief that people do not save enough, either because they know the state will bail them out in old age or because their intertemporal preferences are not aligned with the social planner. In any case, what drives people to particular saving behaviors?

Henrik Cronqvist and Stephan Siegel use data from identical twins in Sweden and conclude a little bit over everything is contributing. Of course, results will depend on whether people have faced circumstances that make saving difficult. 35% of the differences in saving propensity can be explained by genes, more so for men, educated and wealthier people. Parental influence is stronger when other siblings are present, which the authors interpret as a situation with less competition for parental resources (why? they are also competing for the parents' attention). But all this means there is still 65% of the variation that can be educated. Which is a lot.

Economic thinking in Bulgaria after the fall of the Berlin Wall

Economic thought, especially in macroeconomics, goes through episodic changes. These changes are very slow to occur, and historians of economic thought try to analyze what brought these changes and how they happened. The recent doctrinal changes in Eastern Europe offer in this respect a particularly interesting exercise, because everything happened very fast. In particular, you did not even have to wait for an old generation to retire or die for fundamental changes to happen.

Nikolay Nenovsky studies, from personal experience, what happened in Bulgaria. The evolution there was particularly dramatic there because the Russian Perestroyka was largely ignored by the political and intellectual class, and thus change had to happen much faster thereafter. Also, the economic transition happened in a theoretical vacuum, as only transition to communism was researched. Subsequently, economic research was largely event driven, reacting to price liberalization, restructuring of state ownership, foreign debt issues and the currency board.

Previous to reforms, economists were in two camps: those who studied socialism, and those who were to point out the ills of capitalism. The latter were much more ready to understand the transition and emerged as intellectual leaders. The first found refuge in Keynesianism and institutional economics. Bur all lacked empirical skills, and, ironically, sociologists took this over. But the big agents of change were the World Bank and the IMF, through their missions and advice, and imported western textbooks. Nowadays, western thinking has been adopted without much discussions about its fundamentals. Microeconomics is largely neo-classical, and macroeconomics mostly Keynesian. The latter is not surprising, given where Bulgaria is coming from.

How good is the Big Mac index?

The Big Mac index, created in 1986 by the Economist to estimate the over- or under-evaluation of currencies, is based on the price comparison of a uniform good across countries. In the best case, purchasing power parity would hold, and it typically does not. But the choice of McDonald's Big Mac always struck me as poor for such an exercise. Its major ingredient, meat, is subject to regulation and subsidies that vary considerably across countries, including trade barriers. And a major part of its price is the "service" which is offered by the restaurant, which is non-tradable. In short, it would even be a surprise were purchasing power parity to hold.

Kenneth Clements, Yihui Lan and Shi Pei Seah have looked at this more formally than I just did. They find that the Big Mac index indeed suffers from biases, and thus its predictions are biased. But they can be corrected. The index even beats the best predictor of exchange rates, at least at medium to long range, the random walk. This should not surprise us, however. After all, if there are strong deviations from purchasing power parity, they should correct themselves in the long run.

I prefer the iPod index that the Commonwealth Bank of Australia computes periodically. iPods are traded, identical (once you choose which one to index), and widely available. Only drawback: Apple has the ability to price to market thanks to its market power. I am waiting for someone to use it to see whether it beat the Big Mac index.

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.