Should Economics adopt methods from Physics?

In their quest for universal laws, physicists use data mining methods on large datasets and uncover regularities that beg for a theory. Should economic adopt similar methods?

Austin Gerig thinks so, and he bases his entire argument on the distribution of daily returns of the stock market. It is true that Wall Street is full of Physics PhDs who do data mining, looking to beat arbitrage and the efficient market hypothesis. But that is not Economics. There is much more to Economics than studying the daily returns on the stock market, even if your family or neighbors think this is what you do as an economist. In particular, Economics is about studying how agents' behavior changes as the environment changes, something purely statistical methods will never uncover. And do not get me started on theory-less data mining. We already have too much of that in Economics, so do not let physicists do it, too.

Now that the Olympics are over

Now that the Olympics are over, Vancouver is stuck with infrastructure it will not use, and the town will soon discover that not everything is paid for and a substantial debt will need to be serviced. It is like this after every Olympic Games. And inevitably, there are calls that the Olympic Games should find a permanent home.

I agree. The is considerable waste in providing oversized infrastructure for a few weeks and the be left with while elephants. The best example is the Olympic stadium in Montreal, or the ski-jumping and luge/bobsleigh installations in most Winter game locations. If games happen in a location that needs an infrastructure push, the money is better spent in installation that are needed in the long run.

And where should the permanent home of the Olympics be? For the Summer Games, Athens seems to be an obvious choice. This is where they originated, they where held there recently, and thus the infrastructure is already in place. Summers are really hot, though, so holding them in September is probably better. And Greece could use some revenue.

As to the Winter Games, they should be held in Switzerland, and more precisely in St. Moritz. Games were there already twice, again, there is infrastructure in place. Also, Switzerland has the advantage of being neutral and thus less subject to boycotts. And do not forget that the Swiss are very efficient, have an excellent transportation system and a top tourism industry. And the International Olympic Committee has its seat in the country.

My voice does not count for much in this decision, but add me to the chorus that is calling for an end to this waste of resources.

Growth and democratic change: there is no free lunch

There is considerable evidence of a positive correlation of standard of living and democracy across countries. Given this, it would seem natural that growth in the standard of living would be positively correlated with democratic change. One could even conjecture that there is a causation from growth in GDP to democratic change. Theory, though, indicates that this causation could be positive or negative: sluggish growth may lead to popular uprising and democratization, or booms may raise political expectations.

Paul Burke and Andrew Leigh explore this question with data from a large set of countries. Causation is not that obvious to measure well, because of the obvious endogeneity problem: democratization may also cause growth. They use some well-reasoned instruments to cover this problem, but I want to retain here only results with temperature as an instrument, as it is the only one that does not turn out to be statistically weak. And the causation is negative: You cannot expect that healthy growth can also lead to democratization. While there are always exceptions, do not keep your hopes of democratization in China too high.

Inequality and growth

The empirical literature on the relationship between growth and inequality is a mess, because of the obvious endogeneity problem, the measurement issues and the fact that cross-country regressions are always reduced form, at least as far as I know. And the literature is inconclusive on the causation and its sign. Maybe a bit of theory would help here.

Gustavo Marrero and Juan Rodríguez argue that the observed inequality is the result of two inequalities: inequality of opportunity and inequality of returns to effort. The first has a negative impact on growth, because good entrepreneurship opportunities get lost. The second has a positive impact on growth, because what really matters for growth is the success of the most productive people, and this encourages investment in physical and human capital. Marrero and Rodríguez verify these conjectures using PSID data and compare across US states, and it works. No wonder people find inconclusive results if they lump all inequalities together.

Price discrimination drives industry leaders to further innovate

Quality-ladder models in the innovation literature describe how firms try to outdo each other in research and development in order to become market leaders by producing the most advanced products. One log-standing result of this literature is that leaders have no incentives to innovate because it would cannibalize their own business, a result that flies in the face of overwhelming evidence to the contrary.

Hélène Latzer builds a model where firms can price discriminate in a specific market. The difference with standard quality ladder models is that consumers differ by wealth, preferences are non-homothetic and only full units of technology goods can be consumed. In standard models, it is always winner-takes-all. Here, because a slightly obsolote product still has a market, a market leader may still want to innovate to capture also the market for the second-best good.

Lowering crime: police versus redistribution

It is well known that African-American males underperform in the Univted States according to a lot of economic dimensions: they work less, are paid less, are more and longer unemployed, and they are much more involved in crime, in particular property crime. While these are all important problems, let us focus on the last one for a moment. What could be done to reduce the property crime rate among blacks? One could increase policing, or one could improve their economic condition through redistribution.

Marco Cozzi builds a dynamic general equilibrium model where agents differ by race and education and have the opportunity to commit crimes to supplement their income. Employment opportunities differ by education and race, both of which are exogenous, and agents can turn down job offers. The government supplies unemployment insurance, which is redistributive, and fights crime at a cost, wherein caught criminals are incarcerated. Cozzi claims this model, calibrated to the United States, replicates the basic features of the distribution of crime and employment. He then proceeds to policy experiments.

First, give $481 to every highschool dropout every year, that is 2.5% of their non-asset income. This costs $73 to every citizen and reduces property crime by 6.8%. Second, use those $73 to increase policing, from $127. The crime rate drops by 18.6%. Thus policing is more effective than redistribution in reducing the property crime rate. It would nice to know how sensitive this result is to various assumptions, because it is an important result.

Tall people get paid more despite sedentary work

I have reported previously that tall people have an edge on the labor market, and about some speculation why this would be the case. One theory is that they are better at performing some tasks because they are tall, or at least appear to because height is associated with strength and health.

Petri Böckerman, Edvard Johansson, Urpo Kiiskinen and Markku Heliövaara use a Finnish survey and find that smaller people are doing more strenuous work, while taller people typically have jobs where they sit. The height premium does vary with the strenuousness of the job, after controlling for all sorts of indicators that typically determine wages. Would this mean that the wage premium does not come from actual strength used, but rather from intimidation? That would surprise me from Finns, who seem to be leaders in equal opportunity. Is it that they are healthier, as my original post seemed to indicated. May be, but this data had no other indicators of health.