Public consumption and the business cycle

One aspect of government purchases the current crisis has highlighted is how volatile they can be. Quite obviously, they are influenced by politics, to the point of complete reversal between massive spending and severe belt-tightening within months as in the US and the UK. But there could also be a more systematic component that is linked to the business cycle. After all, the government may be trying to improve the welfare of its constituents and for example substitute public consumption for lacking private consumption, or the same for investment.



Ruediger Bachmann and Jinhui Bai look at this using an augmented real business cycle model. They claim that 25-40% of the variance of public consumption can be accounted for by shocks to total factor productivity once implementation lags and costs of public consumption, as well as taste shocks to public vs. private consumption. I am no particular fan of taste shocks, as they are the symptoms of a modeler who is giving up on trying to explain something and simply equates the error term in the Euler equation to a shock. Then much is driven by how this shock is calibrated, in this case to match a four year electoral cycle and some data moments. When I think about shocks in this context, I think indeed about who is in power to decide on public expenditures. But that is not completely exogenous. Indeed, the state of the economy has an impact on who gets elected or reelected. And this can be calibrated without trying to match the data moments one is trying to explain.

Public pensions are not sustainable, even in Norway

By now, everyone must be aware that populations are getting older and that this puts some serious strain on pension systems. Unless one plans far ahead or is blessed with substantial sustained growth, some problems in financing retirement will appear. But there must be some place that is going to do fine, say a country with a forward-thinking government, a recently reformed pension system, a well managed endowment of natural resources and a small and smart population, like Norway. Right?

Wrong, say Christian Hagist, Bernd Raffelhüschen, Alf Ering Risa and Erling Vårdal. To come to this conclusion, they use generational accounting, which measures the fiscal sustainability of the public sector and in particular the publicly funded retirement pensions. The latter went this year through a significant reform, which includes pension indexation below wage growth, benefits adjusted to be actuarially fair if life expectancy increases further, and work incentives for elderly. It turns out the pension reform has helped substantially for the sustainability, about as much as the presence of the endowment of oil and natural gas. But that is not going to be enough, even with higher oil prices and an exceptionally well managed petroleum wealth. And for those hoping that future growth of the economy or higher fertility would help, well at least in the case of Norway this would barely help. To close the gap, a 17% increase in taxes would be needed, and they are already very high in this country. So, if Norway cannot make it, how could countries with inactive governments and little or poorly managed endowments make it?

The Internet did not raise a generation of loners

The image of the basement-dwelling World-of-Warcraft-playing loner is often shown as an example of the adverse impact of the Internet on social capital and in particular social interactions. Whether this is true is not so obvious, as the Internet also makes possible social interactions that could not exist before, as this blog shows in a limited way.

Stefan Bauernschuster, Oliver Falck and Ludger Woessmann study the impact of broadband Internet on social capital using a natural experiment in Eastern Germany. There, some choice by the telecommunications provider resulted in 11% of East German households to be on OPAL lines instead of DSL, which better supports high speeds. Using the German Socio-Economic Panel, they measure social capital with the frequency of going out, visiting friends and performing volunteer work. They find that Internet access has no visible impact on social capital. To the contrary, for children it seems to enhance social capital, possibly because it makes them aware of new opportunities to interact in real life. This is in stark contrast with television use, which has many times been shown to be detrimental to social capital, likely because it is a one-way communication, while the Internet can build two-way communication.

State-owned banks in the US?

Many countries have state operated banks that support local development or other objectives that deviate somewhat from those of usual for-profit banks. No such institution exists in the US except for the Bank of North Dakota.

Yolanda Kodrzycki and Tal Elmatad study the Bank of North Dakota in the perspective of the feasibility of a similar bank in Massachusetts. They find that the BND is not a typical bank. While it favors local development, it rarely does so directly, but rather by helping local banks. It thus encourages a network of small and local banks, something that does not quite seem efficient to me. The BND was, however, not particularly useful in periods of crisis, like the agricultural crisis of the 1980s, because it also had financing difficulties. All in all, the bank of North Dakota is very different from state banks abroad, which offer all customer services like private banks and thus help regulate through competition some the excesses of private banking. The BND looks much more like existing development corporation that exist in most if not all US states. If Massachusetts just wants to em ulate North Dakota, it does not seem worth the large cost of the initial bond issue, especially in the current economics context.

Property rights and natural resources

It is a firmly established conventional wisdom that natural resources are best preserved when there are well established property rights. It is the quintessential example of the tragedy of the commons that if everyone is allowed, say, to take water, water will be over-exploited. This wisdom takes, however, a crucial assumption: that once the resources is taken, property rights are well established and uncontestable. What would happen if not?

Louis Hotte, Randy McFerrin and Douglas Wills show that reverting this assumption can have a dramatic impact. Suppose that you took a freely available resource, but that now anyone can contest your ownership of that resource. Depending on the consequences, you may not want to extract in the first place. It thus matters in which way the state is weak. If it is weak in that it gives away rights to natural resources, then there will be over-exploitation. If it is weak in that it cannot enforce property rights in general, and in particular when it comes to bring product to the market, then it is the Wild West and under-exploitation may ensue. Theft is a powerful mechanism to kill markets.

Are military expenses good for growth?

It is obvious that federal fiscal deficits will have to be addressed sooner or later in the US, and seeing how difficult it is to raise taxes, one has to think about how to trim expenses. Of course, the biggest line item is defense, and one can ask what the consequences of cutting these military expenses could be. Critics of those cuts will point to WWII, where the military build-up has pulled the US out of the Great Depression. While I do not quite agree with this interpretation of this anecdote, it is worthwhile to study more generally the impact of military expenses.

Giorgio d’Agostino, Paul Dunne and Luca Pieroni do a literature review and note that out should not just look at the direct impact of expenses. Indeed, a military build-up is also more likely to generate conflicts, and after all a conflict is overall a waste of resources as much effort is spent blowing physical and human capital to pieces. The multiplier argument is also rather vacuous, as these funds could be used for other purposes as well with higher multipliers, in particular when you compare wars in foreign lands versus infrastructure at home. The same applies to the argument that military research has some positive impact on civilian technology (why not simply focus research on the latter?).

This clearly makes it difficult to make a case that military expenses are good for growth. Empirical work is really difficult, like so often with cross-country growth regressions, but d'Agostino, Dunne and Pieroni conclude that the evidence tends towards a negative impact. The only ones that obtain positive impacts are those that include supply-side effects, and those are of course rigged to provide a positive impact.

Starve the beast?

The Republican strategy in the US has been since Reagan to starve the government to prevent it from growing. The master at this has been Bush Jr., who to significantly increase expenses while cutting taxes. And the new crop of parliamentarians has vowed to make these tax cuts permanent, thus forcing even further government expense cuts in the near future. While there can be much disagreement about where to cut, one could first ask whether it is a good strategy in the first place to starve the beast like this.

Michael Kumhof, Douglas Laxton and Daniel Leigh use an elaborate model to come to the conclusion that this is a good strategy if government expenses are useless. But if they provide a public good, then it is not. That seems like a very trivial result, and one that can explain the disagreement between the left and the right in the United States. But there is more to the paper. It shows that for this strategy to be welfare enhancing, cuts need to be done very quickly, and cut services must have little impact, and the taxes that are reduced must be very distortionary. It is very unlikely that all three conditions can be satisfied.

In the pretense of protecting me, Emerald stiffles my research

I received a rather unsettling message from Emerald Publishers the other day:

As an Emerald author, you will know that Emerald is dedicated to protecting the copyright of your work. For this reason, we use the Attributor service. Attributor automatically searches cyberlockers for unauthorized copies of works or illegal hosting and then issues legally-binding takedown notices. We are increasing Attributor's searches to the full breadth of the internet, to ensure maximum copyright protection.

For this to run as smoothly and efficiently, we are asking that you provide us with (if applicable):

1. your personal website address
2. your institutional website address
3. the website address of your company

This is so we can exclude these sites from the Attributor searches, whilst protecting your copyright. Upon provision of this information, we will of course ensure full data protection.

We look forwards to hearing from you.

I find this very disturbing. This message is telling me that this publisher is trying to enforce my copyright while in truth it is the publisher's copyright. And it tells me that I better preemptively alert the publisher where I apply the fair-use provisions of copyright before I get automatically accused of violating copyrights on my own work.

Now looking at Emerald's Author Charter, I find another few gems:

Assigning copyright of your work to Emerald allows us to act on your behalf to:

* promote your rights
* facilitate dissemination of your work by granting permissions for educational use or republication
* target other Emerald journals whose readership would benefit from access to your work
* endeavour to protect your work from any infringement of your rights which are brought to our attention.

It does NOT, in any way, restrict your right or academic freedom to contribute to the wider distribution and readership of your work. This includes the right to:

1. Distribute photocopies of your own version of your article to students and colleagues for teaching/educational purposes within your university or externally. Please note, this does not refer to the Emerald branded, published version.
2. Reproduce your own version of your article, including peer review/editorial changes, in another journal, as content in a book of which you are the author, in a thesis, dissertation or in any other record of study, in print or electronic format as required by your university or for your own career development.
3. Deposit an electronic copy of your own final version of your article, pre- or post-print, on your own or institutional website. The electronic copy cannot be deposited at the stage of acceptance by the Editor.

Note that Emerald may publish your article in another journal, if it thinks it increases its dissemination (or increases the impact factor). Nothing is said about the author agreeing to it. But Emerald is also fine if you try to publish your article elsewhere, although the condition of "for your own career development" is open to interpretation.

That said, all this business with copyright on academic research is really sad. These commercial publishers try to tell us that they do their possible to disseminate research while all they is the exact opposite: they gate the research and chase down ungated versions. Let's all move to open access. Much simpler, much less costly, and much better dissemination!

The AEA is missing a golden opportunity

The American Economic Association is asking its membership to approve a drastic restructuring of its dues. There are two reasons for this. One, the AEA is swimming in money (despite last year's fiasco with the Economists calendars) and would have difficulties maintaining its non-profit status with fiscal authorities. Two, by default members get hard copies of the journals and need to opt out to reduce their membership fee. By making the default membership without journals, the AEA hopes to save on printing costs and thus can lower the average membership fee even more.

I will vote against the change not because I dislike a decrease in the fee, but because I believe the AEA has missed here a tremendous opportunity of putting its journals in open access. This is a society with a sound financial basis that could set an example for the rest of the publishers by showing that good research should not be gated. Would this be a money losing proposition? I do not think so, first because the AEA will always have good income from its meeting registrations, and second because it would not need to maintain anymore a whole infrastructure to keep outsiders away from its journals. The AEA could probably cancel membership fees altogether and still make it work.

NB: I realize that the Journal of Economic Perspectives was recently partially put in open access. This shows that the AEA is open to the concept.

An economic model of God

To publish in Economics, marketing your paper is unfortunately very important. And it all starts with a catchy title. Some subjects can inspire you to absolutely great titles, like this one: "An Economist's Guide to Heaven." Dan Hamermesh could have penned that, but it is a paper by Nick Muller, Jo Anna Gray and Joe Stone.

The paper is not about how you can make sure the Pearly Gates are open to you, but rather it "offers an economic model of God and humanity as optimizing agents in the context of concrete belief archetypes (religious ‘contracts’) in Judeo-Christian theology." In plainer words, they study how belief about God influences the behavior of optimizing agents. In this paper, God optimizes, too, and believers know that. People care about private consumption, public goods and what God does to them, if they are believers. God benevolent, as He cares about public goods and likes to reward people instead of punishing them. Believers have a contract with God that entices them to provide public goods in exchange of godly rewards or punishments. Contracts can take four different forms, depending on the archetype within the Judeo-Christian belief system, which lead to different outcomes that can be tested using the General Social Science Survey.

Results are consistent with the model: strength of faith is irrelevant if there is no penalty in the contract, believers renege if there is no penalty, and contracts with penalty work, even if penalties are never exercised. What remains to be understood, though, is why there are believers in the first place.

Does voting for an inefficient government make sense?

Given a distribution of skills and interest in public service in the labor force, would it be best if the public-minded workers go into government or to the private sector? Essentially, this is what Esteban Jaimovich and Juan Pablo Rud ask. If the better ones go private, then the unmotivated ones go into government and wreak havoc: they seek rents, hire more public (low-skilled) employees, thus inflating their wages and depressing the returns of the most skilled private workers, which lessens their incentives to do better in terms of entrepreurship. Jaimovich and Rud also claim that this outcome is actually preferred by the (low-skilled) working class, because of the higher wage. They also support the outcomes of their model with observations from the data.

While it seems obvious that a government with more public-minded officials is better, the point about the wage inflation in the market for low-skilled workers is interesting. It also highlights once more that a good mechanism for the self-selection of workers into public and private jobs is essential. If public wages and side benefits (bribes included) are such that public-minded workers are better off going private, the whole economy suffers. That means, you need to pay civil servants well, but not necessarily better than private workers. But at least, remove incentives to complement wages with bribes.

A libertarian dream?

Libertarians, at least the most extreme ones, dream of a world without a government. The only example of such a society nowadays is Somalia, and it certainly is not a shining example. However, I came across this BBC story about the Ivory Coast that could provide a second, better example of a society without a government.

The Ivory Coast went recently through a brief civil war with the outcome that the government has lost control over the northern part of the country, held by "rebels." Civil servants, including teachers, have left this area which is now not governed and does not received any tax-funded public goods. Didi this turn into Somalia? Not quite, as people spontaneously stepped in and started teaching in schools as volunteers, or provide some postal service and policing. Is this how a libertarian society would look like?

There is one big difference between Somalia and the Ivory Coast: a reunification and a return of government will happen in a foreseeable future in the latter. The volunteers have thus stepped in temporarily to bridge the lack of government. In fact, they may be hired in their current roles once things return to "normal." Consider this as a variation of the open source movement where people contribute freely to show their skills and the be hired for pay. Would the Ivorian volunteers have done this forever? Most likely not, as they would still need to make a living. I am afraid Somalia is still the most appropriate example of extreme libertarianism.

Charities: competition vs. the social planner

Charities need to raise funds, and it is costly doing so. As the number of charities increases, so do these costs. This raises the question whether there is an optimal number of charities and whether some sort of regulation can bring us closer to this optimal number.

Murat Mungan and Yoruk Barls should that free competition leads to a suboptimal number of charities, in particular because some donors are solicited by several charities. In this respect, is a regulated monopoly the solution? One would think this is not optimal because charities pursue very diverse goals. Mugan and Barls show that in a spatial model this charity "ideologies," some extent of competition is good for maximizing net charity revenues as long as the fixed costs is sufficiently low. That seems like a trivially simple result, but it one worth pointing out. The way charities are regulated is by restricting entry and then taxing or subsidizing them to get the "right" fix cost.

Life expectancy, quality of the environment, and mutliple equilibria

The recent debacle in Copenhagen over a climate change treaty has highleghted a large rift between developing and developed economies over what should be done and how. The way it was presented, the issue was about a right to develop like the currently rich ones did, by polluting your way to wealth. Thus, the rich should either allow the poor to pollute, or compensate them for avoiding the pollution they would entitled to.

But reading a paper by Fabio Mariani, Agustín Pérez-Barahona and Natacha Raffin got me thinking that there is another reason. Think about why we care about the environment. It is because we live in it. Now, life expectancy is markedly shorter in developed economies, thus it would make only sense that they would care less about the environment. What the paper highlights is that there is a potential for multiple equilibria; As people living in polluted environments have shorter lives they care less about the environment, which is then more polluted. This makes it even more necessary to provide them with a transfer to entice them out of this loop.

Local authorities under-invest in disaster prevention

In the United States, the individual states and local authorities are supposed to be in charge of disaster prevention and protection, while the federal government provides insurance against disaster occurrence. And as this insurance is fully with perfect commitment, prevention is sub-optimal.

Timothy Goodspeed and Andrew Haughwout look at the second-best insurance contract where the states provide prevention in a non-cooperative fashion and cannot be monitored. It turns out it is really difficult to coax states to provide appropriate prevention. Fundamentally, this is because of the time consistency problem of the federal government and its soft budget constraint. Once disaster has happened, it is difficult to say no to immediate aid. This is not unlike the problem of humanitarian aid, that keeps going to the same places because they provide no effort for prevention as they know they are insured. Or the banking system.

As long as the insurer wants good things for people, this time-consistency problem will remain. But it can be mellowed by applying a hard budget constraint. This takes strong commitment, which is unlikely in a democracy, as politician cannot afford to refuse emergency aid. Then, why not let the federal government be in charge of prevention investment as well?

File sharing is welfare enhancing

Intellectual property for music is rapidly eroding, and the big music labels are complaining loudly about this. They argue that file sharing and other illicit duplication is eroding their revenue and thus the artists' (and some other people's) income. We have shown previously that less copyright is better for artistic creation, and thus welfare, But let us abstract from this and ask whether file sharing in itself is bad for society.

Jean-Jacques Herings, Ronald Peeters and Michael Yang address this using a model where consumers can choose the medium of the music they acquire every period, and music label are forward looking in their pricing strategy, as consumers lock into their medium choice, to some extent. There is thus an incentive to keep CD prices low, both to attract current sales, but also to entice consumers to buy CDs is the future as well. Also, file sharing keeps monopolistic behavior of the music industry at bay. The results: while file sharing reduces the music industry's profits, it increases the amount of music enjoyed by the population, and thus welfare. We should do not the same with our research in Economics. Wait, we already do

Shorter copyrights stimulate artistic creation

As I have expressed before on this blog, I am no big fan of patents and copyrights, and monopoly power in general. I am particularly annoyed, on a personal level, by copyrights on music that have been menacing Internet radio for a while now. I have always believed that the fact that artists have a free medium that allows them to be discovered is much better for them than being fed on commercial radio what the big labels deem good for the general public.

So it is refreshing to see that there are other arguments that show that copyrights are bad for artists. Francisco Alcalá and Miguel Gonzalez-Maestre model the artist market taking into account that it is close to a winner-take-all tournament, that the number of artists worth listening to depends on the number of them starting out (in other words, there is hidden talent that reveals itself with time), and promotions matter a lot. They find that lengthening copyrights, while increasing profits of superstars, does not necessarily encourage more people to become artists. And increasing the pool of talent is what we really care about. The key intuition here is that with longer copyrights, superstars will provide more effort in the form of promotions in order to capture a larger share of the markets. Less is left ofr other talent, who then do not bother starting a career.

Hurricane insurance needs to be government run

Insurance is a difficult business in the presence of moral hazard. While an insurance company can make a profit by exploiting the risk aversion of its policy holders, this profit may be annihilated if moral hazard drives the insured to increase the risk. And if policies cannot discriminate by risk category, then only bad risks can be insured, at a loss. But I do not see where there could be moral hazard in the case of hurricane insurance, as policy holders cannot influence the path of a hurricane. If they fail to strengthen their house, this is something that is easy to inspect and price into a policy. So why did private insurance companies leave the hurricane insurance market in Florida?

Mario Jametti and Thomas von Ungern-Sternberg describe how the state of Florida had to step in and provide coverage to all homeowners at a cost ultimately much lower than what private companies offered. While the state may be able to better diversify over the area of the whole state, it is not like it does not face substantial risk. A hurricane can have severe consequences for a significant part of the state. Private companies can diversify with other geographic areas or coverage types, they can even re-insure, two means that are not available to the state. But the latter can make up any loss with federal help or, gulp, taxes. And it cannot simply declare bankruptcy if it takes a big hit, like a poorly covered insurance company would.

Intellectual protection should be decreasing, not increasing

Have you noticed how the grip on intellectual property law keeps expanding: copyright periods lengthen, the scope of patentable "innovations" widens, and the enforcement of intellectual property become the topic of international trade negotiations. But should we expect this?

Michele Boldrin and David Levine look at this using the age-old trade-off in intellectual property protection: long protection provides the innovator with monopoly rents and thus incentives to create more innovations, whereas should protection allows society to benefit earlier and more widely of these innovations. As you move the protection duration (or scope or enforcement), the question really is how many new innovations one gains or loses at the margin. The distribution of innovation thus matters a lot as the marginal idea (in terms of quality) will be pursued. Ultimately, you want to measure the elasticity of revenue with respect to the marginal idea.

Boldrin and Levine do this with various empirical strategies that all come to a similar conclusion: the elasticity mentioned above increases a lot with the quality of the marginal idea. Also, they find that the growth rate of ideas is lower that that of population, there are decreasing returns to scale. What this means is that protection for intellectual property should be decreasing with the scale of the market. And as globalization has dramatically increased that scale, protection should be decreasing rather than being reinforced.

Open source and private firms can coexist

Open source is a mystery to many, given that contributors give away their innovations and competitors can just scoop them up. One would thus think that an industry would either be proprietary or open source, but not both at the same time.

Gastón Llanes and Ramiro de Elejalde show that it is possible. The critical features are that the open and proprietary goods not be perfect substitutes and that open source firms need to sell for a price a complementary good to the open one. That does not seem to be very constraining, as they need this anyway to survive, even without competition from proprietary goods. A perfect example for this is the database management industry, where the free MySQL is doing very well despite Oracle and Microsoft SQL.

One consequence of this is that some industry associations that like to pretend they represent the whole industry should stop chasing those that support an open source model. The music industry seems to be a perfect example here.