Are NBA coaches behavioral or neoclassical?

Snnk cost do not matter once spent. Yet, we just cannot help thinking that if we already paid so much for something, we should rather use it, even if it is inferior to something less expensive. With this reasoning, we deviate from neoclassical theory into behaviorial theory. Such attitudes are not well documented, and it is not quite evident how one would put together a dataset to study attitudes towards sunk costs.

Daniel Leeds, Michael Leeds and Akira Motomura found a way, and it is in front of everyone. Professional sports teams sometimes invest or commit considerable resources to recruit players, and a substantial amount can be considered sunk, as it is in the form of a signing bonus, guaranteed pay, or by using an early draft pick for new players. A neoclassical theorist would say that this sunk cost only allows the coach to expand his decision set, but who actually plays on the team should only depend on the players' current performance. This study shows that at least NBA coaches do follow this neoclassical thinking and are not more likely to let under-performing young player stay on the team if they were drafted in the early rounds. Indeed, the data focuses on players in the first five NBA seasons when they all have a uniform contract, thus only draft order should matter. However, there could have been a perfectly neoclassical justification for a bias on the part of the coaches: some players were drafter early because they have potential, and that potential is going to develop with playing time. If there is a puzzle it is thus rather why early draftees get so little playing time.

No need to ban incandescent lightbulbs

It is sometimes difficult for a shopper to understand all the consequences of purchasing choices. Take lightbulbs, for example. The variety in price is large, and so is the variety in expected life or energy consumption. When more efficient lightbulbs came on the market, they were massively more expensive than existing bulbs, yet in the long run worth it thanks to much lower energy consumption. Consumers did not seem to understand that, along with what this entails for pollution, hence the old bulbs were banned. Was this really necessary?

Hunt Allcott and Dmitry Taubinsky exploit two randomized experiments to look into this. The first is computer based and gives participants a budget and different information about lightbulbs. The second is a field experiment at a home improvement retailer where shoppers where given different information and discount coupons. They find that people do not undervalue energy costs that much, meaning that only minor, if any, subsidies were necessary to win them for next-generation lightbulbs. Once more, it looks like a ban is outdone by the nudging that the price mechanism can do with appropriate subsidies or taxes. They also find that there is a large fraction of shoppers that wants to stick with incandescent lightbulbs, indicating a substantial welfare loss from a ban that is similar to standard rationing. One more piece of evidence that bans need to be banned.

All that financial innovation has not lead to more transparency

What is the purpose of financial innovation? I would say it is to find new ways to insure against risk, to finance projects and to allocate funds optimally. We are taught that generally the price mechanism is the best way to do the latter, as long as it is contains all the available information. Thus, a good way to measure whether financial innovation has improved things is to measure whether prices have become more transparent.

Jennie Bai, Thomas Philippon and Alexi Savov take the idea that stock and bond prices should contain information about future earnings. Thus if you regress future earnings on current valuation (and some controls), errors should become smaller over time, because information costs have decreased and we have become more efficient at allocating financial resources. But over the last 50 years, no progress is to report. No matter how you decompose the errors, there is nothing to write home about. That is quite disappointing after all the increased financial sophistication of the financial industry. Or did this sophistication lead to more obfuscation?

Did home ownership made things worse in the Great Recession?

I have complained several times already that house ownership should not be encouraged by public authorities, mainly because it prevents diversification of risk by households and because there is slim evidence at best that home owners are happier and better contributors to society. It also quite obvious that high ownership rates have contributed to make the last recession worse in the United States. A recent trio of papers studies this last point.

Silvio Rendon and Núria Quella show that higher homeownership rates fed by easy financing lead to higher unemployment rates. This is because homeowners have higher reservation wages through a wealth effect. They find that in the US this has increased the unemployment rate by an incredible 6 percentage points. You may also want to add to this that homeowners are less willing to move for a new job, further increasing the unemployment rate, something the model does not capture.

Ahmet Ali Taṣkin and Firat Yaman look at unemployment duration in the US and find that renter stay unemployed the shortest and homeowners the longest, especially those who do not carry mortgages. Following this result, facilitating home financing would lengthen a little unemployment spells and increase the unemployment rate, under the hypothesis that job losing rates are unaffected.

Stijn Baert, Freddy Heylen and Daan Isebaert show that the unemployment spell length depends on the housing tenure situation in Belgium. The homeowners with mortgages exit the fastest, those without mortgages the slowest and renters lie in between. Easier home financing would thus reduce the unemployment rate here, again assuming it does not affect the rate at which people lose jobs. Keep in mind that Belgium is unique in that unemployment insurance benefits can last forever.

Do MRSPs (manufacturer suggested retail prices) have an impact on prices?

In some countries, manufacturers are allowed to suggest to retailers how to price their goods. What does this do to prices? It may increase them if it reduces competition and the MRSP is set high. It could also increase competition if set low, as retailers may find it difficult to sell at a higher price than printed on the packaging.

Babur de los Santos, In Kyung Kim and Dmitry Lubensky report on a natural experiment in South Korea where MRSPs were banned and then allowed within a one-year span. The ban increased prices on average by 2.3%, the reintroduction reduced them by 2.6%, from which you can conclude that MRSPs increase competition. Prices were significantly below MRSPs, so it is not likely MRSPs acted as price ceilings. Rather, the authors conjecture that MRSPs help consumers in forming expectations of prices at other retailers once they see the mark-down at the current retailer. Absent the MRSP, the consumer faces higher search costs, and the retailers takes advantage by increasing the price. To be convinced of this argument, I would have liked to see some estimates by product category. Different mark-downs must have had different implications for price changes, and those should help us distinguish theories better than aggregate results.

Early marijuana use and educational outcomes

Marijuana use is getting more and more accepted by the public and lawmakers. Indeed, many studies have shown that its effects are no worse that allowed addictive goods such as tobacco and alcohol, that it may in some cases even have a positive impact (foremost example: tolerating consequences of various deceases), and it is not even clear that it is addictive. However, there has been little study about the consequences of using marijuana early, that is, by children or teenagers who are still growing up. It is known for a variety of goods that consuming too early can have sometimes dramatic results.

Deborah Cobb-Clark, Sonja Kassenboehmer, Trinh Le, Duncan McVicar and Rong Zhang look at early adopters of marijuana and their educational outcomes. Studying this is not straightforward, as those who smoke early are clearly not a random draw from the population. They likely share characteristics that have an impact of educational outcomes. The study focuses on those 14 years or younger in Australia and how they complete high school and obtain university entrance scores. Marijuana use is obtained by survey, which may introduce additional difficulties, and is linked to an administrative data set on welfare use by their parents. The authors find strong penalties in high school completion from early marijuana uses, and stronger ones for intensive use and for those coming from a disadvantaged background. The impact on university entrance scores is milder, and this applies of course only to those who managed to complete high school. The penalty for welfare-recipient families is, however, dramatically higher in that case. In other words, even if marijuana gets legalized, it needs to be treated like alcohol and tobacco and early use needs to be strongly discouraged with campaigns that can be efficiently targeted toward welfare-recipients.

Update: An email correspondent tells me I am over-eager to reach policy conclusions given the large endogeneity issue which the authors also acknowledge. I think I was indeed too eager. But I would still pursue this policy. The potential risk appears too large for me.

When countries manipulate economic data

Conspiracy theorists have a field day whenever official statistics look conveniently better just before elections. Whether statistics are really manipulated for political gain is hopefully less frequent than what they assume. We know it is currently done in Argentina, was done by the Soviets and their allies, and used to be done by some countries to qualify as poor in the United Nations' eyes. Those cases were rather obvious, but how could you recognize the more subtle ones?

Tomasz Michalski and Gilles Stoltz use Benford's Law, the distribution of first digits in economic figures, to determine the likelihood of manipulation across a large set of countries. While this does not catch a country red-handed, it gives probabilities, and one can analyze this against a set of indicators to determine what would drive them to cheat. Michalski and Stoltz find that higher likelihood of cheating is associated with fixed exchange rates, high negative assets, negative current accounts or subject to capital flow reversals. So it seems that this kind of cheating is not for internal consumption, but rather to deceive international financial markets. The authors did the analysis on balance of payments data, though, so the picture may be quite different when looking at unemployment, GDP or inflation data.

Reported returns on investment for artwork are too high

Art is something one may like to have for the enjoyment of it, but it is also often touted as an investment vehicle. Quite obviously, you would need to diversify heavily. "Experts" claim that art gets a good return on average and that it is viable investment option.

Arthur Korteweg, Roman Kräussl and Patrick Verwijmeren say it is not. The issue is that all the indexes out there are based on transactions, and art items that have higher returns tend to have a higher turnover. The resulting selection bias is not negligible: 7% instead of 11%. Given that high amount of risk, it thus does not look like art is a good investment, unless you enjoy it, of course.

Prospects of tariff increases and manufacturing employment

US manufacturing is on the decline, and the obvious reason is pressure from globalization. This is not necessarily bad as it means a better use of resources, except for some potentially large transition costs. Globalization has been encouraged by decreases in tariffs, thus one should find a strong correlation between tariff reductions and declines in US manufacturing. That does not seem to be the case, though, and a sharper decline in manufacturing since 2001 cannot be traced to any major change in tariffs.

Justin Pierce and Peter Schott find that it is not the actual tariffs that matter, but the potential for tariff increases. Indeed, there was a change in 2001 that removed potential increases especially for sectors in competition with China, and once these sectors lost this potential tool for protection, they withered. There was no such change in Europe, where no sharper decline in manufacturing occurred.

Political polarization and the business cycle

It is difficult for politicians to have much of an impact on economic outcomes when policy is set by consensus. Any fluctuation in power changes a policy a little, and the economy is in a rather flat portion around the optimum. In a polarized government where any power shift implies dramatic policy changes, not only are they never close to the optimum policy, they yank the economy around significantly. There are two losses here: first the average is substantially lower in the second case due to the concavity of outcomes, second there are significant fluctuations for the same reason.

This is essentially the explanation of Marina Azzimonti and Matthew Talbert why emergent economies have such wild business cycles, and I suspect this is even more so for developing economies. All they need to do to obtain such results is to take an off-the-shelf real-business-cycle model and add uncertainty to the returns of private investments. Let this be a lesson for more developed economies that are showing tendencies for political polarization.

How politicians lie

We all know politicians lie, no surprise here. What we do not quite know is how and why they lie. Indeed, they generally do not tell outright lies. They exaggerate or add some "extra spice" to their statements. How badly they lie likely depends on the political context.

Alessandro Bucciol and Luca Zarri, from a country long lead by a professional liar, decide to focus on politicians from the United States. They use data from PolitiFact.com about 7000 claims by 1000 national politicians from 2007 to 2012. They determine that Republications lie more than Democrats, which should not surprise given the influence of the Tea Party on Republicans. I am thus not sure this ranking will last once the Republican Party gets back to its roots. More interesting are variations across party lines. Politicians lie less in battleground states (when the stakes, or scrutiny, are higher), in more educated states, and in the South. And health-related issues are the subject of the most lies.

I am not quite sure how to generalize these results. As mentioned, the current context for the Republican Party is out of the ordinary. Also, health care has been a central issue on the national political agenda over these years. All this can change, and it may be different in other countries. But it is interesting to see that definite patterns are emerging. If we can rationalize them, maybe we can then think about policies that would minimize lying. And hope for politicians to adopt them. A good resolution for the new year.

Is there a small-state effect?

In countries where some parliament chamber allocates the same number of seats to each member state regardless of its population, small states are deemed to enjoy a disproportionately strong influence. One paper that analyzes whether this small-state effect is empirically significant is by Gary Hoover and Paul Pecorino which shows that US states with higher per capita representation also get more federal funding. Does this mean that the open question is now closed? Of course not, as the scientific process would tell us to revisit this to test whether it holds more generally, whether the effect disappears with time, or whether it is robust to different specifications.

Stratford Douglas and Robert Reed (link corrected) address the latter question. They run a robustness exercise that is unfortunately too rare in Economics. They confirm the results of Hoover and Pecorino, but find that when you switch from ordinary least squares to cluster robust standard errors and include population growth that small-state effect vanishes. So we are not done with this question.

We should have more replication studies in Economies. It saddens me that Douglas and Reed felt the need to add the following footnote on the front page: "we wish to express our special appreciation to Gary Hoover and Paul Pecorino for their willingness to allow their study to be subject to critical analysis. Openness and integrity such as theirs is the basis by which science advances." This should be obvious.

Soviet general equilibrium theory

When we think about a social planner that maximizes welfare by assigning optimal allocations without an explicit price system, we are really describing a Soviet economy. History has shown that this utopia does not quite work out for a variety of reasons. Yet, Soviet economies were following this doctrine and their governments must have acted on some principles that must have come from somewhere: what should one allocate where, how should allocations change according to changes in exogenous factors, etc. Russia actually has a rich history of economic theoreticians who have worked out models to guide the policy makers, who liked to think themselves as technocrats. These theoreticians were mostly mathematicians working on various optimization techniques.

Ivan Boldyrev and Olessia Kirtchik describe the life of Victor Polterovich, who expanded Walrasian theory to non-market economies in the 1970s and was the only active Soviet economist with visibility in the West during that period: he has an Econometrica in 1983 and another one in 1993, and a few articles in the Journal of Mathematical Economics in between (see his page on IDEAS) and is a fellow of the Econometric Society. While Polterovich started as many others his academic career of Marxist planning theories, his move to general equilibrium theory may seem puzzling. Indeed, the welfare theorems have often been touted as a victory for the market economy, and Polterovich would certainly have been ill-advised to promote a market economy.

The paper is largely based on interviews of Polterovich that reveal interesting anecdotes, such as the unique history of his first Econometrica and how some of his most important results never got translated. The other Soviet economists did not go through the trouble of integrating with the international research community, and I am sure their are still interesting results that are ignored by the wider general equilibrium theory community. Polterovich came to general equilibrium theory by realizing that one needs at least as many instruments as objectives to manage optimally an economy. That did not seem feasible to him, hence his interest in decentralization. In his early models, agents interact, possibly forming coalitions. Keep in mind that to Soviets, agents were not individuals but political entities or firms. Later, price constructs are introduced, and they are helpful in understanding coordination among agents.

And on to the seventh year

Yes, this is the seventh year of blogging. Will I enter a a prolonged slump like some faculty do after obtaining tenure? Am I due for a sabbatical? Unfortunately, both may happen. As announced last Summer, my new responsibilities make it difficult for me to maintain the pace I have had in previous years. And it has shown in the last six months: I have missed days, I have been wrong on at least one occasion, and my posts have become shorter. Yet, I am more and more impressed by the following this blog is receiving and I hope the same will hold to Economic Logic, Too, where I invite others to post comments about papers they read.

Traditionally, I have reviewed the most popular posts of the year. For reasons I do not quite understand, this year's lists only contains posts from this year. So here they are:

1. Top Economics graduate programs are not as good as you think
   
2. Teen sex: are females dropping scruples due to the lack of men?
   
3. Are economists really uneasy about studying inequality?
   
4. The fundamental equation of economics
   
5. Is money a factor of production?
   
6. Five universal laws of economics
   
7. Forecasting the weather using the market
   
8. Test statistics and the publication game
   
9. How econophysics describes the income distribution
   
10. Overconfident NBA players are lead to their financial demise
    
11. Lack of transparency at the American Economic Association
    
12. Can IKEA replace the BigMac or the Ipod?
    
13. Procrastination is a strong predictor of academic performance
    
14. The price of diamonds
    
15. Flying in Europe and North America, puzzling differences
    
16. Which academic field contributes the most to economic growth
    
17. The obscure economics of vampires
    
18. homo socialis
    
19. The experimental macroeconomics of monetary policy
    
20. AEA elections are on, you know for whom to vote
    
21. Why are prices sticky?
    
22. What kind of jobs are academic scholars looking for?
    
23. Large GDP shocks are permanent
    
24. Reconciling macro and micro estimates of the Fischer labor supply elasticity
    
25. Some people go to classical concerts to cough
    
26. The AEA executive is still not representative
    
27. New responsibilities
    
28. Leaning against publication bias: about the experiments that do not work out
    
29. Why Keynes dominates Hayek
    
30. The brain drain from financial liberalization
    

Family wealth persistence over several centuries

Social mobility has been much studied to understand how the poor have a shot at becoming rich and how the rich manage to preserve their status. Such studies are usually limited to mobility during a lifetime for a single individual or for a family from one generation to the next. Going beyond this time frame is virtually impossible, because there is no panel dataset for wealth or income that spans over several generations. One can, however, discover some interesting proxies that allow to create such a dataset.

This is what Gregory Clark and Neil Cummins do in a pair of papers that exploit the fact that people with rare surnames are highly likely to be from the same family. Using national birth and death registries for England and Wales as well as probate registries that recorded wealth at death, they gather records for 21,618 people over about 150 years in the first paper. The second paper focuses on educational status instead of wealth over eight centuries and uses registries of students at Cambridge and Oxford universities as well as censuses for the rest of the population. In both cases, intergenerational correlations are estimated to be much higher than in studies with shorter samples. It can take 20 to 30 generations for an initial status to disappear. This may be indicative that social mobility has increased in recent generations in England and Wales (my interpretation, although Clark and Cummins argue that intergenerational persistence is stable over centuries despite stark changes in inheritance taxation) or that families have an underlying social status that changes much more slowly than characteristics that are easier to observe (the authors' interpretation).

PS: If you are looking at the papers, do not be surprised to see the same abstract on both. Very negligent LSE staff posted similar cover pages on both papers.