Voluntary pollution restrictions do not work

The literature on international environmental agreements has established that when such agreement are only of the self-enforcing kind (not imposed by a supranational entity), they cannot exceed three participants. That is certainly disappointing, as we would need much more than that to get significant impact. This literature, however, looked at these countries in a vacuum, in particular the only interaction they would have is through pollution. Now it turns out that in reality they also trade with each other, and trade policy is also available as an instrument.

This is how Thomas Eichner and Rüdiger Pethig expand the extant literature. The addition of trade allows more countries to participate in a self-enforcing agreement. But this comes at the cost of an agreement with significantly less bite. These are interesting results, but I have a hard time finding intuition for this, and the authors are not of much help. Consider this to be an appeal for clarification.

Mathematics, Econometrics and the top economist's career outcomes

Some people have been complaining about the increasing mathematization of econonmics and how it leads to a disconnect of economics with real life (which I suppose is void of mathematics). I would argue that this is actually a good thing, first because it forces you to have rigorous arguments, second because you often need quantitative answers to questions that result in qualitatively ambiguous outcomes, and third because it simply allows us to look at more complex problems. But, has mathematization actually increased?

Miguel Espinosa, Carlos Rondon and Mauricio Romero look at the publications of top economists and look at how many equations or econometric outputs per article they produced. The analysis for the last century shows a gradual increase of mathematization throughout, except for the number of equations which went through a serious recession in the 1980's. And of course, econometrics started only seriously in the 1950's. It also appears that professional success as measured by prestigious prizes is certainly linked to the use of mathematics, but not the econometric kind.

How to make a profit through price obfuscation

The standard model of competition with a homogeneous good tells us that every supplier will apply the same, low price. This situation of perfect competition arises because there is no good differentiation and suppliers cannot exploit any market power, because they have none. They end up with little profit.

Suppose they can now artificially differentiate the good. Ioana Chioveanu and Jidong Zhou say this could happen in the way the price information is presented, for example by omitting taxes, or slicing the price in pieces for various components of the service, like for some flights, hotel nights or shipping fees. All this leads to price obfuscation. firms then start to compete on price and price "frame." Just look on Amazon.com how participating resellers can offer very different prices by adding wildly different shipping pricing. Or how sellers may add coupons for future purchases. And there are plenty of other examples.

Chioveanu and Zhou that within such a framework various competitive equilibria can result because consumer may get confused and fail to buy the best deal. This is equivalent to saying consumers are irrational, and of course anything can then happen. What is more interesting is that there is still competitive pressure, as suppliers may converge to more transparent pricing. Equilibria are such that firm randomize both price and price frames. If more firms enter the market (as it supports more profits), it becomes more difficult to obfuscate prices using price frames, so firms make those even more complex, resulting paradoxically in more profits.

I think it has been very welcome that in the US airline ticket prices now need to include all taxes and fees. It would not hurt if other prices could also include all taxes, but as this model shows, this needs to be initiated by the government, as the industry will not do it voluntarily. And this also shows that there is some good to say about the European Union's efforts into standardizing goods and price frames.

Why is there so little Economics in environmental policy?

A persistent frustration for economists is that policy makers do not listen to them, especially politicians. That they then accuse economists for bad outcomes is then the cherry on top. One area were has been the most evident is in dealing with the environment. Why is it that policy makers (and environmentalists) are reluctant to adopt market-based solutions to environmental issues?

Dallas Burtraw looks at the case of the United States and concludes that this all boils down to politics, and more precisely the federalist institutions. In other words, economists do not take into account the institutional framework where their policies need to fit in, a lament that has also resonated with implementers of development policies. In the case of environmental policy in the US, the issue is mostly that the states have to implement federal policy, and it is much easier to issue emissions caps, compared to coax them to manage honestly cap-and-trade market or collect carbon taxes. For example, consider electricity markets, which are heavily regulated in some states, which means the price signal has less value. Or a state may try to attract industries by circumventing the impact of environmental policies if they are price-based. All-in-all, a political economy of the environment is as much needed as environmental economics.

Why do Indian and Mexican plants not grow?

When a business is successful, it grows. Successful businesses also are more likely to survive and thus old business tend to be larger. Now define business. The business unit relevant for this is difficult to ascertain, for example because of mergers and acquisitions, or simply because the boundaries of a firm are hard to establish (are contractors part of it? Subsidiaries?). Thus the common way to measure a business is at the plant level.

Chang-Tai Hsieh and Peter Klenow show that plants in India and Mexico do not grow with age, or much less than, say, the United States. This points to a very inefficient allocation of resources, as successful plants should invest to grow: they are obviously better than the competition, thus can produce more efficiently or better goods. With a simple simulation exercise, Hsieh and Klenow show that this lack of plant growth leads to a 25% productivity loss compared to US plant growth.

The question is of course why plant growth is stifled in India and Mexico. For India, it is rather obvious, with policies that favor small businesses and actively prevent them to grow "too large." Many of these policies, which are heavily promoted by owners of incumbent plants, are being revoked and can in part be credited for the large recent growth of the Indian economy. As for Mexico, it has been suggested that when plants grow from the informal to the formal sector of the economy, they are subject to more taxes and regulations. In both cases, inappropriate institutions are to blame.

Disclosing hospital quality works

Usually, better information leads to better outcomes (well except for those people who could exploit some information asymmetry). People can better evaluate their options, and they do not like uncertainty. The impact of information on behavior, however, is ambiguous. For example, I recently discussed the case of a supervision contract that needs artificial uncertainty to be constraint-efficient. Disclosing the quality of some goods provided by the state, such as schools, is contentious. In that case, it turns out to be beneficial.

The same seems to apply for hospitals. Lapo Filistrucchi and Fatih Cemil Ozbugday study data from German hospitals when mandatory quality reports were introduced. This new policy improved overall quality, and more so in hospitals that were initially graded inferior. Those that were initially better had more patients thereafter, thus the public looked at those grades. And where there was more hospital density, the authors can see more quality improvements, indicating that competition is at work in beneficial ways. An improvement in overall well-being is thus likely (we cannot be sure, as the use of resources to reach quality improvements is not measured).

A negative discount rate for climate policy?

Ever since the Stern Review on climate change came out, the debate has raged about what the appropriate discount rate should be to evaluate future environmental outcomes. Biologists do not see the point of discounting, but they have a biased view as they advocate preservation at any cost (much like doctors advocate preserving every life at any cost). In any case, computing future benefits of something at an infinite horizon is impossible if there is no discounting and the benefits do not decrease.

Marc Fleurbaey and Stéphane Zuber actually advocate that we should use a negative discount rate. Technically, that it is only possible to calculate the net present value with a negative discount rate only if the periodic values decrease at a faster rate than the absolute value of this negative discount rate. The key here is not to think of the discount rate as a fixed number, but rather as a result from the ratio of marginal utility from successive periods (or generations). If future generations are worse off, the discount rate becomes indeed negative. Whether future generations will indeed be worse off is is difficult to ascertain, but it could happen. But this is not how we should think about this.

The proper measurement is to use the marginal utility of the person alleviating today the impact of climate change versus the marginal utility of the person in the future benefiting from this action in the future. This is a person-to-person calculation. The present one is likely rich, the future one likely poor. Thus the discount rate should results from the comparison of these marginal utilities is negative, especially because the developing economies are likely to suffer the most from climate change.

Working times of spouses and well-being

It is now the norm that both partners of a couple work, and with that come issues about coordinating work time around children and allowing for "together-time." While everyone's circumstances are different, policy makers ought to be interested in which work time arrangements yield the most satisfaction, and if the marketplace is not providing for such arrangements, how policy can make it happen.

Christoph Wunder and Guido Heineck use this fantastic tool, the German Socio-Economic Panel, to determine which work schedules couples prefer. Overall, they prefer matching working hours. What I find more interesting is that females prefer it when their partner works full-time, while male are largely unaffected by the number of their partner's working hours. One can find several explanations for this asymmetry, but it is difficult to discount some form of sexism in seeing male work essential, while female work is not, and even females seem to agree with this. But if people are happy with this, why should policy intervene?

Do we want to curtail internal tax competition?

I mentioned only a couple of days ago that tax credits for economic development do not work. Yet, politicians cannot help it to grant such credits, in part because they want to show they are doing something to help the economy, and in part because they genuinely think it works. And obviously, they do not take into account that other politicians do the same thing, and thus a competition emerges that gives away more and more tax credits for no local gain and certainly no aggregate gain. How could this vicious circle be broken?

Timothy Hubbard and Justin Svec have a proposal. The idea is that these tax credits create a negative externality on other jurisdictions. Thus one could apply the same strategy as for pollution, where a limited number of pollution permits are sold or distributed (the former being the preferred way). Here politicians would have tax credit permits, which they could trade as well. The Federal government would provide these permits and could even determine a socially efficient number of them. Next: name-calling permits for bloggers.

When state-dependent pricing dominates time-dependent pricing

It should by now be obvious to anybody who has been following this blog that I do not like time-dependent pricing (aka the Calvo fairy) because it is applicable only under specific circumstances. Of course, this means that it is routinely abused because it is analytically convenient. What would it take for people to finally abandon this modeling strategy that influences so many results in the literature? The following paper?

Peter Karadi and Adam Reiff look at yet another micro-dataset (impact of large VAT changes in Hungary) and find that prices are flexible. Nothing new here. They find also that in response to large shocks, prices react in an asymmetric fashion, depending on whether the shocks are positive or negative. Calvo models are notoriously inadequate to deal with large shocks, by construction, but they are also not capable of getting any asymmetry. Take a state-dependent pricing model, and it can easily replicate these features of the data. Karadi and Reiff thus declare a clear winner among menu cost pricing models. I am not sure I would rule out information or search frictions like they do, however.

Tax credits for economic development do not work

Every government, from the most local to the national one, touts its success in attracting business and creating jobs through well targeted tax credits. The latter obviously come at a cost, but that is supposed to be well-compensated by new tax revenue from increased income in the particular jurisdiction. Or so these public officials think.

Luc Behaghel, Adrien Lorenceau and Simon Quantin study the French tax credit initiatives that were supposed to bring more economic activity in some rather deserted rural areas. These tax credits were implemented in various ways across time and firms, which allows to estimate their impact. And no way which way you look at the data, there is nothing to be found. That is pretty bad. In they had found an impact, one could have discussed whether it was large enough to generate increased public revenue to fund the tax credits. But there is none of that. Pure waste.

How to best compensate a supervisor

Suppose you are a manager in a firm where it is difficult to observe the performance of workers, such as faculty, computer programmers or lawyers. You hire a supervisor for a team. How should you compensate the supervisor such that he puts his best effort and reports the truth to you? And how can you avoid that underlings bribe the supervisor for a good report card?

Even when being bribed is costless, Alessandro De Chiara and Luca Livio solve this seemingly impossible problem with an interesting idea: it matters when the supervisor files his report. If the supervisor has to file a report before outcomes can be observed, for example before a contract is finished, he can still make sure that workers do their job. If the report is submitted later, the supervisor can easily be bribed, and there is no incentive for workers to do well. The critical aspect here is that there is uncertainty in work outcomes and the supervisor is risk averse. Couple that with better compensation if the report corresponds to the subsequently observed outcome, and you are done.

When governments compete for lottery revenue

A state-sponsored lottery is a tax on stupid people, and one may not object on its existence for this reason. Except that people may be stupid for reasons beyond their control. But let us assume that it is a tax that enhances overall well-being, for example because it drives out more harmful taxes. Wouldn't all government want to offer a lottery, especially as they can have a monopoly on the market? That is without counting with other jurisdictions, such as the Canadian federal government that may want to participate where provinces already run lotteries.

Étienne Desjardins, Mélina Longpré and François Vaillancourt explain how the provinces got rid of this unwelcome competitor. At the end of the 1970's, Loto-Canada was encroaching on the provincial lotteries, and an cartel-like agreement was struck: the provincial lotteries bought out the federal one, and they are paying to this date for the privilege of this monopoly. And the provinces got very good deal, as the agreement did not foresee the growth of this market. Maybe the federal government should threaten to reintroduce Loto-Canada to tease out a better agreement.

Climate mitigation versus development aid

From what I can see, the countries that are going to suffer the most from climate change are developing ones. As we economists are constantly worried about the efficient use of resources, I am surprised no one asked before whether one should rather invest in mitigating climate change or in improving development aid for those most affected countries.

Lucas Bretschger and Nujin Suphaphiphat try to answer this question with a model where climate change leads to a faster capital depreciation (think: more hurricanes, flooding and tornadoes). The model has two countries, a rich, capital-intensive one and a poor one. The available policies are devoting resources to pollution control or directing transfers to the poor country, which could increase its capital. While the first is obviously better for the rich country, it turns out to be also better for the poor one under fairly general conditions. The reason is that transfers have only a mild effect on growth, whereas this is not-trivial if you can avoid a faster depreciation of capital. Indeed, if you know that your investment will last longer, you will do more of it. The availability of resources for savings and investment is secondary. And that is even without assuming that development aid is not effective, as many believe.

Prices are even less sticky when looking at households

Whether prices are sufficiently rigid to matter is an somewhat unsettled debate I have occasionally discussed on this blog. This is mostly a measurement issue. Once we know how it is in the data, we should know what model to use and how to calibrate it. The models that use price rigidity, the New-Keynesian, usually apply the concept in a rigid manner. For one, they use the much criticized Calvo fairy assumption. But they also assume that the same rigidity applies to the prices at which the firms sell their goods and to the prices at which households (or other firms) buy their goods.

As Olivier Coibion, Yuriy Gorodnichenko and Gee Hee Hong show, the reality is quite far from this last assumption. They use data from retailers in various US metropolitan areas which comprises both prices and quantities. They find that household switch easily retailers and take advantage of temporary sales. How much they do this varies through the business cycle, with an interesting implication: the effective household inflation rate is lower when unemployment is high. This implies that monetary easing becomes more difficult because household-level prices adjust 2.5 times faster than retailer-level prices.

The impact on the response of the output gap after a monetary stimulus is, however, almost identical to a model without retail switching. I suspect this is due to the fact that the model still uses Calvo pricing. Beyond the usual criticism of this assumption, here it also implies that retailers cannot take into account that households may want to switch retailers more frequently in a recession. Too bad that a very interesting result is poorly applied in this study.