How to reform North Korea

The economics profession is being criticized these days because it was unprepared for the recent crisis. Few people had thought about the fact that liquidity problems of such dimensions could appear in interbank markets. Thus it is now very welcome to think about hypothetical situations instead of studying past phenomena. One such hypothetical is what to do if North Korea would suddenly abandon its Juche system (self-reliance).

Scott Bradford, Dong-jin Kim and Kerk Phillips tackle this with a simulated dynamic general equilibrium model, pretty much the only solution given that there is no history to draw on and no reliable data. Also, this is definitely a situation where reduced forms would not teach us anything. So, structural they go. First, they try to emulate the current situation with massive mis-allocation of resources and little infrastructure. It is quite obvious that from this starting point almost any reform is beneficial. But suppose the reform is purely internal: no opening of the economy, and no touching the military. Then introducing market forces, but this still be of limited extend given the immense lack of infrastructure, Massive investment in infrastructure is needed much more urgently than market reform. And serious commitment to reform that would benefit residents is likely to attract significant foreign aid, which makes it much more affordable.

Did modern growth kill inheritances?

There is a literature that tries to understand bequests, in particular whether they are accidental or voluntary. This is an important question as it has strong implications on savings motives, and thus on aggregate savings. With the development and sophistication of financial markets, one should see the accidental bequest to become less important. People can insure themselves against uncertain life times with annuities and life insurance, thus reducing the need to have excess savings in the case of unexpectedly long life. Voluntary bequests may go either way with development, depending on whether parents prefer to make inter-vivos transfers, which they can afford given the above.

Now all this is put into question after a great data digging initiative byThomas Piketty, who compiled bequest data for France from 1850 to 2008. He notices that while the size of bequests has decreased until the 1950s, this trend is now reversed. Concretely, as a fraction of national income, bequests amounted to 25% in the late 1800s, 5% in 1950 and 15% nowadays. Piketty measures this in two ways, once using wealth data and mortality tables, and once using actual bequests as recorded by fiscal authorities. The second measure is somewhat lower, as expected, but shows the same pattern through time.

The important question is now, what is the new incentive that would make households to leave larger bequests now (and even more in the future, as Piketty suggests)? The old argument of the new growth regime that came with Industrialization is clearly not valid. Piketty proposes that the difference between the rate of return and the growth rate mostly drives the aggregate size of inheritances. But there surely are also important microeconomic aspects, like the wealth distribution, borrowing constraints, the correlation of income between generations and subtleties of the tax code.

Energy taxes and employment

It seems quite obvious that the United States will have to increase energy taxes, first because energy prices need to better reflect the negative externalities they exert on the economy (pollution, wars, congestion, etc.), and second because the government will need to raise revenue from somewhere. So it is of particular interest to verify what consequence this would have, for example on labor markets. If the cost of an input increases, and it is cheaper elsewhere (or if not, the gap with elsewhere is reduced), one should expect labor demand to be reduced. But how much?

Olivier Deschenes does such an empirical exercise by exploiting the cross-state variation in energy prices and finds a price elasticity of 0.15. Given that the electricity prices are supposed to rise by 4%, a reduction in employment of 0.6% or 460,000 people is inferred. Unfortunately, these estimates cannot be relied on for several reasons. First, estimates are based on employment differences across states due to energy price differences. Imagine that electricity prices increase in Michigan, and this drives some jobs to Wisconsin. This is what this elasticity measures. But when electricity prices increases in all states, cross-state movements of jobs should not happen. They may move abroad, but this is not measured with this procedure, which certainly overestimates the correct elasticity.

Second, these are reduced form estimates that give us very little understanding how various agents in the economy would react to those price changes, especially if they are larger that the one observed in the data. One needs here some structural model to understand what would happen, a model that would, for example, include the industrial structure of each state. Computable general equilibrium (CGE) models have been used extensively for similar exercises, and should be much more reliable than this reduced form (Lucas Critique anyone?). Third, if you do not increase energy prices, it is quite obvious that some other tax will have to increase. An obvious candidate is labor income tax. Now that is certainly going to reduce employment as well, and possibly more than the 0.6% from above. In other words, the energy tax can very well be a lesser evil (on top of reducing pollution).

Some press will pick up this paper and rail against energy taxes. That is most unfortunate.

Globalization and the size of the public sector

To finance public goods, taxes need to be levied. But with globalization and international tax competition, the ability of governments to levy taxes is curtailed. Indeed, raising taxes may increase the cost of labor compared to other locations, and outsourcing takes over. The same reasoning applies to other taxes, which become more distortionary with globalization. Of course, it is never bad to put some pressure on governments to keep taxes as low as possible and thus remain efficient, but one may hit a feasibility constraint here.

Torben Andersen and Allan Sørensen think we should not worry too much, though. First, one consequence of globalization is that increased trade leads to a lower cost of goods. This decreases the marginal cost of public funds. Second, there is not necessarily a race to the bottom among tax authorities because terms of trade work to counteract the after-tax disadvantage of higher taxes, apparently for a wide set of parameter values. In other words, gains from trade and general equilibrium effects can absorb the increased distortions from taxes.

Immigrants and crime

Immigrants are often held responsible for increased crime rates, or crime in general. As these accusations occur in every country one has to wonder whether people immigrate because they are criminal, yet immigration authorities typically vet criminal records. So are immigrants really more criminally inclined than native populations? A recent paper should help shed some light.

Brian Bell, Stephen Machin and Francesco Fasani look at two recent immigration waves to the United Kingdom and find no difference between natives and immigrants. Specifically, they look at the surge of asylum seekers in the 1990s and the large influx of Eastern Europeans in 2004. They key is that immigrants have different demographic and labor market characteristics than natives. Once you control for this, there is no discernible difference. This means also that providing better work perspectives to immigrants reduces both their crime and victimization rates, as it is the case for locals. In particular, forbidding asylum seekers to hold a job seems counterproductive.

Social conflict and endogenous growth

The standard endogenous growth model assumes that markets are perfectly competitive, and thus factors are paid at their marginal product, and Cobb-Douglas production function parameters corresponds to factor income shares. But looking at the real world, there clearly are economies where "capitalists" or "unions" have more bargaining power. Beyond the semantics, is there something to gain from imperfect competition on factor markets

Christopher Tsoukis and Frédéric Tournemaine take a fairly standard AK model, except that they impose that workers not only derive utility form their consumption, but also from capitalists getting less consumption. Then they look at four different equilibria: perfect competition, Stackelberg, Nash and non-cooperative. They show that the resulting factor shares and growth rates differ across equilibria, Labor income shares are lowest in the competitive equilibrium, highest with Stackelberg, and the opposite for growth rates. Unfortunately, no attempt is done to relate this to any data. This would have been probably very difficult anyway. Indeed, labor income shares vary surprisingly little across economies, with only one outlier: China, with a very low labor income share, opposite the prediction of the model.

Even worse, the paper concludes with some major hand waving finding some conclusions about inflation and unemployment, in a model without money and an inelastic labor supply. Too bad.

Deviations from PPP: a micro-macro disconnect?

Purchasing power parity (PPP) implies that adjusted for exchange rates, similar goods should have the same price across countries. However, this does not hold true, and for extended periods. Why this happens is a puzzle, which is even more confounding considering that deviations from aggregate PPP have a longer half-life than deviations from good-level PPP. Jean Imbs, Haroon Mumtaz, Morten Ravn and Hélène Rey have claimed that this apparent micro-macro disconnect can be explained by a composition effect.

Not so fast, say Paul Bergin, Reuven Glick and Jyh-Lin Wu. Their point is that macro- and micro-PPP follow different processes, the first following aggregate shocks and the second mostly relative-price shocks. Using a vector error correction model, which controls for these shocks, they show then that the remaining deviations are consistent between macro and micro data and have very similar half-lives. This means that the previous explanation based on the heterogeneity of goods and different price stickiness does not hold water. Back to the drawing board...