National drought insurance

Some aggregate shocks can have a very large and costly impact. Not your typical business cycle in a developed economy, but rather shocks like earthquakes, droughts or major hurricanes. They put a lot of strain on affected regions, who would clearly gain from acquiring some sort of insurance against such adversities. Robert Shiller has been advocating cross-country insurance mechanisms against GDP fluctuations (say ... markets), but it calamities would have an even more pressing need for that.

Joanna Syroka and Antonio Nucifora explore this in the case for draught insurance in Malawi. With the help of the World Bank, this country is now offering a derivative contract based on index computed from the measurements of 23 weather stations in the country. The hope is that if international markets buy these instruments, the financial consequences of weather fluctuations will be born outside of the country, and macroeconomic stability will help growth and poverty alleviation.

It will be interesting to see whether there will be demand for these derivatives. Experiments have run in Ethiopia and Mexico, but in both cases it was with re-insurers. This time, a government is directly involved. If this works, there are many other candidates for this, think for example Bangladesh, whose GDP depends crucially from the yearly monsoon. And once such markets are well developed, smaller risks like GDP fluctuations in GDP countries may be insurable as well for governments.

Open platforms versus cartels in professional sports leagues

What makes a sports league more competitive? More interesting? And more profitable? We have two basic models out there. The European model, with open entry, promotion and relegation on mostly athletic grounds, and the American model, a cartel with regulated entry and no exit except on economic grounds. Basic economics should tell us that an American league should be more profitable but of lesser athletic quality, while the European one should be providing more value, both in terms of quantity and the quality of the good (say, athleticism and entertainment).

Helmut Dietl and Tobias Duschl confirm this conjecture. Indeed, the six top revenue generating teams are European, but some of them are still not profitable, and as in the case of Manchester United, despite significant athletic success. Dietl and Duschl use platform organization, a form of two-sided market theory, to get some better understanding of sports league organizations. In this regard, European leagues can be compared to open source like Linux, open and performing, while American leagues are like Windows, underperforming but most profitable.

Table 2 from the paper summarizes well the differences between the leagues. In European ones, most clubs are members' associations that try to maximize wins. Leagues are open (promotion/relegation), there is full market coverage, hardly any relocations (I cannot think of one), and no salary caps. As a consequence, value (as defined by athleticism or entertainment) is maximized. Contrast this with American leagues, where clubs are privately owned and maximize profits. League are closed, there is rationing, frequent relocation and a salary cap. Thus, American leagues maximize value appropriation.

Smoking bans versus tobacco taxation

It is now pretty well established that second hand smoke is bad. How do you handle it though? Apparently, the solution is to ban smoking from public places, in the hope non-smokers will not be affected. Now, are bans truly effective? The economist would respond that ban are generally not the solution to a problem of externalities, and that using taxes or subsidies is a much more effective way to address this problem.

Jérôme Adda and Francesca Cornaglia come to exactly this answer as well. They notice that bans are even worse than you think, because smokers smoke as much as before, but more in a private setting, thus exposing more the more vulnerable ones, children. How can you try to reach smokers in their private setting? Not by a ban, which is unenforceable. But by increasing the tax on tobacco products, one can achieve this, even if this means increasing the tax massively. But given that the tax-elasticity of passive smoking is larger than for active smoking, the tax increase need not be as large as you think. And besides, smokers are actually in favor of tax increases, as they see it as a commitment device to quit (Jonathan Gruber and Botond Kószegi).

Discouting with uncertain discount rates

How should one discount future events when they are far into the future and there is uncertainty? This seems to be a rather odd question, given that we have the von Neumann-Morgenstern framework. The reason this is still a valid question is that the choice of a discount rate matters a lot for questions regarding the distant future, such as climate change, and even small changes can lead to dramatically different policy recommendations. Thus uncertainty does not necessarily pertain to uncertain future outcomes, but to uncertain future discount rates. Are they going to remain at historic interest rates? And which interest rates?

Christian Gollier and Martin Weitzman have written several papers with a similar premise but dramatically different results: discretize the space of discount rates and then assign probabilities to each. Then, the "average" discount rate to use should either be the highest or the lowest in the distribution. Now, they sat together and produced a paper that resolved this apparent puzzle. They both forgot about marginal utilities! Suddenly, they remembered von Neumann-Morgenstern and that the objective probabilities they where using needed to be adjusted for the intertemporal ratio of marginal utilities. In other words, they finally are using the standard Euler equation that is the basis of asset pricing. And they find that one should use a rather low discount rate.

PS: How do you get something named after you, or reinforce that it should be named after you? Apparently by repeatedly drawing the attention of the reader to it. Gollier and Weitzman do this in this paper, and it is very annoying, especially when their "puzzles" come from a failure to use the appropriate framework. Oh, and did I mention von Neumann-Morgenstern?

Lottery wins and health

Who has not dreamt of winning big at the lottery? Not only would one be able to afford all sorts of goodies, one would have less worries. This translates into better mental health and better physical health, knowing how the two are closely linked. It appears, however, that lottery winner do not enjoy better health. Why?

Bénédicte Apouey and Andrew Clark are not particularly interested in lottery winners, but studying them allows to understand the consequences of exogenous income changes on health. They use British data, which avoids the problems with US data, where income has a direct effect on health because of limited access to health care (and because also some lottery winners get murdered). But the problem is that lottery players have different characteristics to begin with. For example, they are less risk averse than others. This implies that they are also indulging in other risky behaviour, like drinking or smoking. Also, we all know lotteries are an institutionalized scam, so beyond being risk taking, lottery players must not be able to understand the consequences of playing. This impairment can have also implications regarding unhealthy behaviour.

So what do we learn from all this? These results are important in the context of the literature discussing more generally the consequences of income fluctuations (macro and micro) on health. The problem in this literature is that everything is endogenous and cannot properly be instrumented for. Thus the idea of using lottery winning, which should be exogenous. But as Apouey and Clark show, that only works if 1) one makes the distinction between physical and mental health, 2) one needs to take into account that lottery players have a different attitude with regard to health to begin with, 3) any aggregate comparisons are going to be fruitless. In other words, looking at lottery players is the wrong avenue unless you have a lot more information about them then we currently have.

PS: This is a FEEM working paper. FEEM specializes in environmental economics. I am still looking for a link between the topic of this paper and environmental economics.

Why families?

Why do humans life in families, while examples of families in the rest of the animal kingdom are extremely rare? Yes, economists have an answer to that.

Marco Francesconi, Christian Ghiglino and Motty Perry say when the evolutionary objective is to maximize the dissemination of one's genes and 1) paternity is uncertain, 2) children need a long time to develop and they overlap during that time, then families are optimal. Why? Because fathers will only care for the children they recognize as theirs. Fidelity of the mother is crucial for this. Add the fact that children need to stay with the parents for a long time, and you have a family.

All this hinges on the assumption that paternity in uncertain. Why did evolution not solve this? It did in a way, as it seems babies resemble more their fathers than their mothers, at least initially, as mothers naturally bond with their children and fathers need a little more "help" (Abstractless reference). Why did such a mechanism not reinforce itself? Probably because the emergence of the family made it less necessary. And maybe the family emerged for other reasons than this, as evolution had found a solution to this problem.

Even producer prices are flexible

It seems that I am on a vendetta against the myth of rigid prices, but I find it frustrating that macroeconomics keeps insisting on models where price rigidity is crucial despite the evidence that prices are not rigid. I have given plenty of evidence on this blog that retail prices are indeed flexible, in the United States and elsewhere, and even evidence that wages are more flexible than assumed. Too many links to list them here.

But there is also an argument out there that retail prices are only part of the question, producer prices are where the real action is, and those are definitely rigid. If you are such a firm believer is price rigidity, you are in for a big surprise that should make you lose your faith. Pinelopi Koujianou Goldberg and Rebecca Hellerstein show that producer prices are about as flexible as consumer prices that include temporary sales, and more flexible than consumer prices excluding sales periods. So, what is going to be the next line of defense of the religion of price rigidity?