May 30, 2008

Today's news make my life more interesting

"Brazil's government agreed to release stunning photos of Amazon Indians firing arrows at an airplane so that the world can better understand the threats facing one of the few tribes still living in near-total isolation from civilization, officials said Friday. Anthropologists have known about the group for some 20 years but released the images now to call attention to fast-encroaching development near the Indians' home in the dense jungles near Peru".

Check the news story here.

May 28, 2008

Mankiw on free trade

Mankiw argues on his blog in favor of free trade:
Some economists take the libertarian view that people should presumptively be allowed to engage in mutually advantageous trades, absent any externalities. Under this view, the restricted-trade equilibrium has no claim to moral superiority--indeed, just the opposite. The fact that some people lose when trade is opened up compared to a restricted-trade status quo is of little moral relevance.

I don't get it. Isn't the fact that some people lose with free trade an externality? He the writes:
The fact that some people lose when trade is opened up has no philosophical significance.

What the hell is he talking about? Does anybody know?

In other news, a very, very cool thing: Free documentaries on-line!

Demi-tarif and reimbursement of travel expenses

A recent post on Freakonomics was considering the opportunity-costs of buying a discount card for train travel in Germany, offering 25% reduction for an initial payment of € 55. The guy claims that his decision will be affected, inter alia, by whether the Universities he will visit reimburse the ticket or not. Is this really the case? In this post, I will show that the choice to buy the discount is unaffected by whether you get reimbursed or not, and – if you get reimbursed – is unaffected by the reimbursement policy (based on the discounted price vs. based on the full price).
The Conférence universitaire de Suisse occidentale (CUSO) organizes Gerzensee-style doctoral programs in Geneva, Lausanne and other French-speaking Swiss universities. They offer reimbursement of travel expenses based on the demi-tarif (DT) price. The DT costs 150 CHF and offers half-price tickets, so it makes sense to buy it if you plan to spend more than 300 CHF in train tickets. Equivalently, the threshold number of trips, T, on a trip that costs X CHF is determined by the equality T = (150/(1/2))/X = 300/X. If CUSO did not offer any type or reimbursement, the decision to buy the DT would still be determined by the equality T = 300/X, and the only effect of this policy would be to discourage some students from attending the course. By reimbursing only DT-tickets, CUSO minimizes reimbursement costs, while making it less costly to attend. Some institutions, however, are not as careful as CUSO in setting their policy. For example, the Italian MP of the European Parliament get automatic refund on the most expensive ticket (no comment on this). If politicians travel cheaper, there is a pure transfer from taxpayers to politicians. Since there are no fixed costs of travelling cheaper, like buying a DT card, smart politicians will do it and pocket the difference, on the condition that the monetary gain is bigger than the loss in comfort/time. The interesting question is: under a fixed cost of travelling cheaper, are the incentives of the traveller affected by the reimbursement policy? It turns out that they aren't. Back to the case of DT, the person will buy the DT if the planned number of trips exceeds 300/X, not buy it otherwise, irrespective of the reimbursement policy.
So, CUSO is right in setting a policy of DT-refund to minimize reimbursement costs, but potential attendants shouldn't care about whether they adopt a policy of no reimbursement, DT-based reimbursement or full-price reimbursement when deciding whether to buy the DT or not.

The dark birth of econometrics

People studying for Canova’s exam or running regressions every day….Do you know that the father of econometrics is also the guy that inspired the line of social studies that created the scientific fundamentals for Nazism? The movement is called Eugenics, his dark father Sir Francis Galton:

He systematized these ideas and practices according to new knowledge about the evolution of man and animals provided by the theory of his cousin
Charles Darwin during the 1860s and 1870s. After reading Darwin's Origin of Species, Galton built upon Darwin's ideas whereby the mechanisms of natural selection were potentially thwarted by human civilization. He reasoned that, since many human societies sought to protect the underprivileged and weak, those societies were at odds with the natural selection responsible for extinction of the weakest; and only by changing these social policies could society be saved from a "reversion towards mediocrity," a phrase he first coined in statistics and which later changed to the now common "regression towards the mean."

In his introduction to his book Hereditary Genius he wrote: “I propose to show in this book that a man's natural abilities are derived by inheritance, under exactly the same limitations as are the form and physical features of the whole organic world. Consequently, as it is easy, notwithstanding those limitations, to obtain by careful selection a permanent breed of dogs or horses gifted with peculiar powers of running, or of doing anything else, so it would be quite practicable to produce a highly-gifted race of men by judicious marriages during several consecutive generations”

In which conception of society are we basing our highly sofisticated economic "scientifics" studies?

May 26, 2008


Today an Inomics newsletter has announced the following conference:

The first Beeronomics Conference is meant to provide a forum to exchange ideas and high-quality economic research related to the economics of beer, brewing and related activities. It covers a wide array of topics, including, but not limited to: production, trade, industrial organization, economic history, law and economics, marketing, consumption, policy and regulation, macroeconomics, etc.

Pierre-Louis, you have already an idea?

May 25, 2008

The only thing that matters is the economy....

This is part of an article in a magazine cheering for the Chicago Boys, the group of economist that modeled Pinochet economic policy:

“Pinochet had no clue about economics,” Lüders (former finance minister under Augusto Pinochet) recalls, “and our country was in a desperate situation.” But when Pinochet asked Friedman, who had helped mold Chicago’s economics department, to provide solutions for hyperinflation, the great economist proposed just the right cure: monetary control. Harshly criticized in the U.S. for his “collaboration” with the dictator, Friedman responded by asking whether he should have let the patient—the Chilean economy—die instead.


This is a testimony of man tortured in October 1973 (one month after the military coup), contained in the report to the President prepared by the Commission of Political Imprisonment and Torture:

“They beat me especially in the testicles, with some kind of ruler, giving unbearable pain. All happened while I was completely naked and blindfolded. During the process of torture they also introduced a stick in my anus, and because of that I had internal hurts that made me bleed for several days, both anally and orally”

May 24, 2008

Economics of Love Part III - Will you marry me?

This summer I am going to attend three weddings. Ok, this is not an interesting fact, I know. But this is the reason why I started writing these posts about what I called the Economics of Love. In the end, what motivates people to enter the market for partners is the final intention to get married sooner or later (more or less explicit for women, but I think also latent for men). Why, then, do people want to get married, I asked myself?
Economists started to think about the Economics of Marriage almost 40 years ago with the seminal contributions of Gary Becker with his JPE article, “A Theory of Marriage”. Whenever I speak to non-economists about this literature, they look at me as if economists were immoral nerds. This attitude is widespread and maybe reflects the simple scepticism about the idea that economics can explain any realm of life, as Lazear explained in Economic Imperialism.
To understand the main contribution of that paper and the literature that followed, one needs to know that, at the time of writing, in the 70’s, many women were still out of the labor force. Thinking about the family as a small firm producing non marketable goods, let’s say warm coffee brought to you in bed when you are still sleeping, assistance when you caught a flu and you’re down, Becker’s insight was that, if the man was the provider of financial resources while the woman was the provider of childbearing and domestic activities, a marriage could only mean one thing: gains from specialization. This would have entailed advantages for both partners. You can say this is not a romantic argument for marriage, but still, it’s economically sound.
Since then, societies have undergone enormous changes and transformations. The most important ones are the woman slow but continuous emancipation and increasing government intervention. By providing explicit insurance schemes, like pensions and health care, the governments have reduced the incentive to build a family, which was traditionally the informal provider of such services. Governments have thus also increased the opportunity cost of women to stay out of the labor force while raising their returns from investing in education. In concomitance, formal markets have started producing goods that have reduced the comparative disadvantage of men in doing domestic activities. The combined effect of these transformations has been a constant, declining relevance of legal marriages. Since there are fewer gains from specialization, there are as well reduced incentives from getting married under the economic viewpoint of Becker.
What is driving then my friends’ decision to get married? Paradoxically as it may sound, the argument advanced is that, by these very same changes, today, marriage can only be a spontaneous decision driven by pure, romantic love. As you commonly observe, people tend to hang out with people with more or less the same background: economists with economists, lawyers with lawyers, Brad with Angelina…In a couple, a man and a woman do not gain by sharing resources anymore; they gain by sharing common values, interests, ideas. In the economists ‘jargon, a couple is not a unit of production anymore but a unit of consumption. People “merge” because they like to consume the same goods, and they like to do it together. This is what is called “Hedonic Marriage”, which basically means, you enjoy a marriage since you think you really are “two of a kind”.
The final remark is the following: if marriage is becoming a “hedonic” institution, when will we observe a marriage happening? When will people decide to get married? It is clear that such a decision is not only influenced by pure “love”, but also by people’s attitudes toward this institution, which are somehow determined by their relative cultural background. Depending on the type of society you come from, you may still enjoy the “hedonic” aspect of sharing your life with someone else, without feeling the need to get “married” in a legal sense. Vice versa, you may be forced to marriage by a society where pressure to get married is higher, without feeling completely involved. We will see in Part IV that these factors have important implications for currently observed phenomena of delayed marriage, cohabitation, and declining divorce rates.

May 21, 2008

Commitment Contracts

If you really want to finish your paper before this week-end, and stop delaying it because you are too lazy, you can buy a "Commitment Contract" from Stickk.

Stickk, a company created by two Yale economists, Dean Karlan and Ian Ayres, forces its customers to think about their future selves by selling "Commitment Contracts," which require the completion of a specified task that you might otherwise put off (finishing a paper, quitting smoking, losing weight). When you sign the contract, you hand over a sum of money and get it back only if you keep your commitment by a particular date. So, rather than having a vague and distant motivation for finishing that dissertation, there's the much more immediate cost of seeing your $1,000 disappear. So is Stickk's business model to bet against our ability to resist procrastinating? Not quite. Stickk makes its money from advertising, not from its customers. If you fail to live up to the terms of your contract, your money goes to a randomly selected charity. Or, if you want some extra motivation, you can have your commitment payment go to an "anti-charity" of your choosing. They cater to all tastes—both Americans United for Life and the Pro-Choice America Foundation are possible recipients.

This paragraph was taken from

May 15, 2008

Advice from Joe Stiglitz on Central Banking

"Most importantly, both developing and developed countries need to abandon inflation targeting. The struggle to meet rising food and energy prices is hard enough. The weaker economy and higher unemployment that inflation targeting brings won’t have much impact on inflation; it will only make the task of surviving in these conditions more difficult."

I always knew that central banking was pure crap. There's no way they can be credited for keeping inflation low in the last decade. His article can be found here.

May 14, 2008

The Economics of Love-Part 2: Courtship

In the last post we saw that differences in gender preferences over the partner confirm old, stylized cliché: women like wealthy men, while men like physically attractive woman. If we consider that, roughly speaking, beauty is inversely related to age, while wealth profile increases positively over years, these ex-ante preferences seem to lead to an equilibrium where, within the couple, the man is older than the woman.

In this nice chart from the UN (2000) you find all the relevant statistics and the indication that it is indeed a world pattern. The smallest difference in mean ages was 0.3 years in Belize (Central America) and the largest difference was 8.6 years Congo and Burkina Faso (Middle, Western Africa). In 2000 in the United States it was 2.3. In western Europe it is about 2.5 years, and in southern and eastern Europe about 3.5 years, similar to that of Japan. In India and the Middle East is between 4 and 5 years. In Central America and South America between 3 and 4 years. In African countries, this gap ranges between 5 and 10 years.

It was argued that this equilibrium is consistent with explanation from evolutionary psychology according to which a younger female, from a men’s point of view, corresponds to a higher likelihood of successful pregnancy, while an older man, from a woman’s point of view, signals a higher potential in providing financial resources to raise the offspring.

The market for partners is dominated by informational asymmetries and you don’t want anybody, you want the right one, the best one. How do we find though the matching equilibrium? Let’s say there are two types of partners, high quality males and females (HQm,f) and low quality ones (LQm,f), and within each group, there is a ranking of qualities from highest to lowest. In a perfect information world, a HQm type will match with a HQf type; as long as all the same quality HQm,f’s have matched with each other, then the LQm,f will start matching, until everybody has found a partner. What happens when you don’t know what is the quality of your partner?How can you tell the difference between a HQm vs LQm?

In a paper published on the Journal of Political Economy (see reference), Theodor Bergstrom and Mark Bagnoli provide an answer that has to do with the concept of signalling. In a world where a male is considered the “resource provider” within the couple, then information about his own capabilities may be revealed only after he has spent some time in the workforce. From a woman point of view, where her main capabilities are related to childbearing, there is little additional signal to convey as time goes by. Men who expect to prosper, will delay marriage until they are able to attract the best available partners. The most desirable females will instead marry relatively earlier. In the long run, unsuccessful men will marry earlier in life than successful men. As all women marry relatively early, the best ones will marry older men, while the less desirable ones will merry young males with lower earning potential.

The model can explain the observed stylized facts cited above: both the equilibrium age difference between men and women, but also the differences observed across countries. Where labor market opportunities for women are higher (developed countries), the age difference should be smaller: as women also compete for the best partners, as their role become more similar to that of the men, thus becoming less specialized in childbearing, their earning potential also becomes a signal to the partner. The age gap in the couple would still be higher in developing countries, where this proximity is genders’ roles is far from achieved.

This model has another clear empirical prediction: more successful men should get married later in life. As such, it has some important implications for all the graduate students of the world: studying may be interpreted as a rational choice also from a dating perspective, since it increases your marketability to attract better partners. Good news, aren’t they? Well, however, since also finishing your studies on time is also a signal of future successfulness, then it is also rational to wait until you are really done with them before dating anybody, otherwise your signal may not be any good economic choice, there is always a trade-off!

  • Theodore C. Bergstrom and Mark Bagnoli , “Courtship as a Waiting Game”, The Journal of Political Economy, Vol. 101, No. 1, (Feb., 1993), pp. 185-202

May 13, 2008

Rigot Campus

I think we could have a kick ass cmapus right here in Rigot. Here's waht we should suggest to Burrin. If anyone wants to make a nice version of this, that would be cool.

Foreign Aid and remittances

Man, not only are remittances from the US to developing contries worth way more than official development assistance, they're also worth more than private capital flows! Makes it an intresting memoire topic!

May 12, 2008

A Note on the Euro Countries' Performance

Rodrik recently posted an article on his blog using a graph taken form Bruegel, which shows the excess export performance (over the euro average) of the respective euro members on the X-axis and the change in the real exchange rate relative to euro countries on the Y-axis. Not surprising to most of you Portugal, Spain, Italy and Greece showed up in the top left corner of the graph and Germany and Austria in the bottom right corner.

I agree, this is a nice graph. And although I generally sympathize with Rodrik’s ideas I think that this analysis is to much on the surface. In particular, he staes the following:

“The chart reveals an important reason behind Italy's poor performance: a large real exchange rate appreciation. Compare this for example to Germany, where significant real depreciation (an increase in external competitiveness) has stimulated export growth and has been an important driver of recent growth. [..] If the Eurozone was a country rather than a loose grouping of countries, workers would be migrating en masse from Italy to Germany. It's not clear that there are similar equilibrating mechanisms within the Eurozone.“

As many of the Italians in Rigot will be willing to ascertain, Italy’s poor performance roots in much deeper problems. Similarly, for Germany much of the real exchange rate depreciation is due to wage restraint over the last years.

I guess what I am tying to say is that the real exchange rate is endogenous and the outcome of underlying conditions, which are at the core of the problem. This is why part of the conclusion of Rodrik is wrong, Germany has had wage restraint over the last years and was (partly) therefore able to remain competitive. Hence, one would not expect people to move to Germany, but rather - what happened over the last years - see people leaving Germany to Switzerland (like me), Austria (like my cousin) and the Scandinavian countries (well none of my family members moved there yet…I should ask my brother what he thinks about moving there given that he is a (militant) non-smoker and the findings in the below post).

To Smoke or not to Smoke - Act Two

Now it is a month that I do not touch a single cigarette. The reason why I waited so long for the second part of this little investigation is the fact that I am currently in the posh seminar hotel of the Swiss National Bank. Why could this be a reason for delaying the posting of this article? Well, I refer you to part one and my understanding of commitment, or short: here I have the perfect environment of falling back into my old habit (i.e. nothing to do besides studying and no “outside control”) so I need a new commitment mechanism….

So here the second part of my little investigation into why I smoked and why I stopped to do so. The starting point for my investigation was the data of the “Nationmaster”, where I produced the following correlation:

The correlation is around 0.78. Though the result is based on a macro relationship, Cutler and Glaeser (2008) find a similar relation in a micro panel in their recent paper “Social Interaction and Smoking”. Now, what am I supposed to learn form this? The fact that I am doing a PhD in Economics, and have been running through the education system of various countries since nearly 20 years, finally shows some pay-off!?!. Mhh, I do not know exactly why this should be the case, since I do not believe that more educated people are more aware of the consequences of smoking. I would rather guess that more educated people have jobs that are more stressing and hence find it more difficult to stop smoking. A resolution may be that more educated people tend to behave more often in a rational manner, though I have no proof for this hypothesis. The authors argue that it might be due to the fact that “less educated groups might be more response to peer influences”, or in the case of young people, plainly speaking group pressure.

Another interesting scatter-plot is the following. This observation is in line with the paper above and the ideas on social interaction and smoking in the sense that if people who are more independent are also less affected by social benefits from the action of others, one would expect these individuals to smoke less.

Next, I would like to address the question which country was most successful in reducing the prevalence of smokers. Unfortunately, I could not find sufficiently long series’ for many countries. However, for the below countries there was sufficient information from the OECD Health data (Note that the rate is normalized to 100 in 1988 for all countries to focus on the relative change in the rates).

The three Skandinavian countries, led by Denmark belong to the best performing countries (together with the US). One has to wonder sometimes why Denmark is such a good country. It manages to half the rate of smokers within 15 years. Copenhagen, the capital, is frequently voted one of the cities in the world with the highest quality of life and Danish people tend also to be the happiest in the world, which according to Bo Honore is due to the European-soccer-cup-surprise-victory against Germany in the final in ‘92. Greece, France and the Netherlands seem to have performed much worse (not in terms of soccer though, except for the Dutch who won the last championship when again…???). Maybe the recent changes to forbid smoking in bars and restaurants in Ireland and since this year also in France may affect these numbers in the future. Given the available data it is to early to talk about the effects of the bans on smoking in bars and restaurants in various countries.

However, there is an another finding in the paper by Cutler and Glaeser. Accordingly, being married to a smoker increases the likelihood to smoke. Well this is not surprising and as the authors reckon most likely a biased result as of sorting, i.e. it is more easy to be together with (or ignore the fact that someone is) a smoker if you smoke yourself. Nevertheless, the more interesting result of the authors is that if a worker has quit smoking as a response to a smoking ban at work, the likelihood that the spouse quits as well is roughly 37%. Interestingly, men react more on their wife quitting (50%) then women reacting on their husband quitting. Now this does not surprise me! Anyways the funny thing about these findings is the policy implication: Make the women quit and you get the men to quit as well. So policies should be geared at women!

Personally, I consider the importance of policy rather at the prevention level (more than three-quarters of smokers begin smoking before the age of 19). First it is cheaper. Second, it starts at the root of the problem and third it seems more effective to me since most smokers started smoking early in their lifetime.

According to my humble point of view an important advance in avoiding higher smoking rates under young people would be the following: Parents should credible commit to offer their children a predefined amount of money (or a world trip or whatever valuable thing that children at that age cannot obtain) if their child surpasses the age of 18 without having smoked (or only “randomly” smoked). Why is this the best strategy? Because, 1) it prevents instead of “curing”, 2) it is based on “equality” and 3) it minimizes social costs. Consider, instead the strategy which is more often observed: Parents pay their children a certain amount of money if the child stops smoking for at least a year. The problem with this policy is that the child that did never smoke may end up ex post worse-off since it will not be offered the “bet”.

So from all these unstructured random arguments the conclusion that I draw for myself is the following: The best way is to prevent people from smoking in the first place since this is much easier than making them stop afterwards. In particular in my case no policy is responsible for me stopping to smoke but only my own will. However, I realized in the last week that there is a high probability that I fall back since I feel from time to time the strong will to smoke. Had I never started smoking, I would never feel this temptation.

May 9, 2008

Football, Protectionism and Economics

Hey all,

although this post probably only seems very tangentially related to Economics, the German news magazine Der Spiegel reports here on urgent action taken by the Swiss Government to avert a potential crisis during the upcoming Euro 2008 tournament. Apparently there was the real risk that because of Swiss import restrictions on potatoes, and already high local potato demand, a critical shortage of hot chips at the football matches during the tournament could have occurred.

Now although it is encouraging to see that the Swiss Government has got their priorities right and are tackling the big important issues first (after all, a football match isn't a football match without hot chips and extra servings of mayonnaise and tomato sauce), this raises for me the wider issue of the harmful effects of Swiss agricultural protectionism in general. For example, the ridiculously high prices of meat here (compared with Australia) have been enough to almost turn me into a vegetarian, and even drove me to the lengths of illegally importing Kangaroo meat into Switzerland from France in order to get my red meat fix.

So if it takes a potential crisis at a football tournament to get the Government to rethink an import ban on potatoes, what will it take for a rethink on the issue of Swiss protectionism in general?

Would be interested in your thoughts and especially in some Swiss perspectives on the protectionism issue.


May 8, 2008

How do we write a great paper ?

What makes a good paper ? Sure we all wonder how to get our work published in a great journal. Personally, I think about it every day. Yet I dont really have a clue how to present my research nicely in a paper, such that something mediocre looks like experience. Sure part of this process is experience and some of us are probably better writers than others. Yet I feel ( and maybe I am just silly in the head) that grad school experience may have given me a ton of technical skills from log-linearizing DSGE models to estimating econometric models with Bayesian methods in Matlab, but presenting and writing a good paper does not seem to be one of them so far. While some of us are probably naturally better writers than others, surely some of the skills associated with writing the kind of great papers we read in JME, AER, EER, JIE, and so on can be learned. TO be honest maybe it is just me who feels like that and maybe most people are better writers than me, yet I think that it may be usefull if we share wirting and presentation tips among each other. So let me start. The website 'Tips for Economists' provides valuable tips for economists at all stages of their life, from the application status to becoming a tenured prof. Much of the stuff posted there is focused on great writing as well.

Light Relief

Hey all,

for some light relief from the daily grind, check out the following video, from an anonymous 'metrics Professor at the University of Michigan:


It's highly entertaining, although from a musical perspective excruciatingly, painfully out of tune. Surely we can do better with our very own potential smash hit, 'I Will Regress'??


For the benefit of our society, right?

The Swiss Confederation has made it compulsory for dog owners (any type of dog, obviously) to follow some training courses, 5 + 15 hours (theory + practice). An idiot on the TV was praising the initiative since it will give incentives to own a dog only to people who really want it and care about the dog's integration in the society (I swear: he really said so). As if people want dogs to integrate them in the society. "Why did you get a dog?" "Well, I felt that society could be better off with my Bill integrated into it"...Of course what will happen is that people who would like to have nice, inoffensive dog and would be caring and lovely, but whose opportunity cost of following the bloody 20 hours courses is too high, will not actually get their Fido. The opportunity costs will depend on the price of the courses, to be fixed at the Federal or Cantonal level (what else?, like George Clooney would put it) and – to a much bigger extent – on the amount of time that the potential dog owner would have to waste instead of spending a few relaxing weekends at home.
Next initiative: compulsory swimming licence for people who swim in the lake. You'd better make sure that people who jump in the lake can effectively swim, right? Then they will make it compulsory to follow State-dispensed courses for hikers. You cannot afford dummies to go get lost up in Jura and to be saved by helicopter, right? I am not sure, but I also think they are discussing measures to establish compulsory courses for pedestrians. They will have to know the rules, if they want to cross the street, right? To be sure, the price for all these useful and society-improving measures shall be irrevocably fixed by the central planners in Berne.

May 7, 2008

Are Instrumental Variables useful for policy making?

A few weeks ago, Bernard Hoekman, a World Bank “expert”, presented a paper on trade in services and growth here at IHEID. He started with a critique of instrumentals variables (IVs) in the recent literature on institutions and growth, quoting a paper by Dixit. I thought that he had no idea what he was talking about, being a World Bank employee, and as this literature is much praised in the academic world. His critic was that instruments for institutions or openness, such as settler mortality, origin of the legal system, Protestantism, or geographic ones such as ruggedness, climate or distance to the equator, were not helpful for policy making, being things you cannot affect. That is definitely not the point of an IV I thought. He must be all wrong.

But then yesterday, Verdier was making the same comment in the PhD Micro Seminar, which lead to a unsatisfying class discussion. This must be a World Bank paradigm I thought. One important guy says something, everybody repeats it, without understanding, it gets distorted, and it spreads out of the World Bank into the entire economics world, as a new, but false, paradigm.

To test my hypothesis, I looked at the Dixit paper, called “Evaluating Recipes for Development Success”, published in the World Bank Research Observer, in 2007. His critic was that these IVs, even though they identify causality, do not tell you how to affect your instrumented variable. In the literature, the policy recommendation is to create good institutions, as they are the key to growth. However, IVs do not tell you how to change institutions. This is the point made by Dixit. But that is not due to IVs at all. If you want to affect something more precise than institutions, such as bureaucrats’ salaries, put that variable in your regression!

The IVs certainly don’t tell you to affect geography or settler mortality, nor that a country’s future is completely pre-determined. (see Jared Diamond for a geographic deterministic approach). “Of course, this is not the interpretation the researchers intend; they intend many of their history and even geography variables to have only indirect effects on economic outcomes through some other proximate determinant of success or to be mere econometric instruments used for identifying the direction of causation”, Dixt writes. Indeed, IVs are used only to extract the exogenous component of your explaining variables, so that you can econometrically evaluate the causation effect.

So the problem with this literature is that it doesn’t tell you how to enhance institutions or openness, it just tells you this is what you have to do. This critique, however, has nothing to do with IVs, it has to do with your choice of explaining variables. Dixit wasn’t clear and he was misinterpreted.

On the UBS letter

About a week ago, my father, worried about the financial trouble at UBS, asked me, his “economist” son, if he should take out the money he has there. “Yes”, I answered. Obviously, I was kidding. It’s all gonna turn out fine I thought.

Well, not so fast. Yesterday, we all received that letter from UBS’ Wealth Management & Business Banking to let us know that they had the situation under control. Are they fearing a serious bank run à la Northern Rock? If anything, this letter will make people even more worried, and could instore panic, as Sebastian explained below.

The rational behaviour, after receiving a letter like this, would be to go the bank, withdraw all your money, and put it in another bank. This would obviously be the non-cooperative outcome, leading to a series of unfortunate events. This letter is meant to achieve the optimal outcome, the cooperative one, where people leave there money there and it gradually becomes business as usual for UBS.

As Sebastian pointed out, this is Switzerland, not England or the US. I don’t see people running to the bank like crazy. People seem to trust their bank, or their government, who would take the situation under control so no one would be affected.
Where else could I put my money anyway? Credit Suisse? Gimme a break!

A Lesson (not) Learnt from Self-Fulfilling Crisis: Be Careful What You Say!

I recently received a letter from my bank (so did Pierre-Louis who makes his opinion known in the next post – is this now a first or a second mover advantage here…). This, I mean the letter form the bank, itself can be reason for worry, but of a very different kind. In this case the “Head of Wealth Management & Business Banking” (no, I do not have any wealth!) as well as the “Regional Head” wanted to let me know the following:

“For some time now our bank has been heavily impacted by the turbulence in the financial markets and our substantial US real estate exposure. We fully understand your concern and disappointment over the information we have been providing during the last few months, and we thank you for your continued loyalty in these difficult times [..] We have also markedly improved our financial and risk management and repositioned the Investment Bank. In conjunction with these measures we have added more experienced professionals to the Group Executive Board and Board of Directors [..]”

Now if anything this makes me worry even more than I did before. How bad must it be that a bank writes to it’s clients (in my case, a client which does not really have any savings) to reassure them that the little savings they have, are actually save with them! Something that should be normal becomes worth pointing out in these days! The fact that “more experienced professionals” have been hired is not really comforting me.

“[..] In the first quarter we were able to achieve acceptable results in most business areas [..] ”

Now let me look at this again: “acceptable…in most business areas”. What is this supposed to mean now? If anything then this should alarm me even more. Given the big losses of my bank (which are primarily due to a few particular business areas), this tells me that the other areas did “acceptable”? What does this mean? Losses were acceptable, or did they make gains but below expectations? This sounds not very motivating and does not help a lot in addressing the issue raised in the first paragraph (“..disappointment over the information we have been providing..”).

“[..] It is important for us that you are able to form your own opinion about the current situation and the measures we have initiated […]”

Well, to build the own opinion one needs to rely on information which generally can not be gathered by the individual himself as of the mass of the available (mis-)information. Hence, a bank, like a central bank, should have a high incentive in clearly communicating its actions/policies. In particular, it is important to leave no room for interpretation, at least not towards the downside. This becomes extremely important in times of “turmoil”. When economic conditions are weak, believes have a big role to play. If coordination on the good outcome fails self-fulfilling crises can be the outcome and turn today’s “minor” solvency/liquidity problem into a bank run, which ex-post verifies believes.
Though, I certainly regard the letter I received as intentionally good, it lacks the use of the right wording in its realization since it left me more worried than reaffirmed in the strength of my bank. If times would be even worse, such a piece of information could achieve the opposite of its intention. Luckily, we live in Switzerland….but then again, Swiss Air went bankrupt as well!

May 6, 2008

The Economics of Love- Part 1: Dating

Finding the perfect mate is one of the crucial attainments in someone’s life. We look for a partner pulled by different motives. Depending on circumstances, we are sometimes egoistically driven by possessiveness and the quest for personal satisfaction; sometimes it is the altruistic need to give birth (or adopt) a child that leads us into the “business” of dating. As difficult as this process can be, people invest a lot of energy and effort in selecting his/her “best half”. Does the perfect match really exist? Some studies find that people often marry somebody from their same environment, like people with whom you have grown up, or people you have met at work. While still motivated by attraction and love, this piece of evidence contrasts the romantic view of unconditioned, unconstrained, unbounded love: it seems to point out instead that people select rationally those who fit better their priors about how a mate should be, and “hedonically” adapt to it. But what actually are these priors about preferred mate across gender? Are there some consistent differences between men and women? The answer to this question is problematic since it is always possible to find some “relevant attributes” that are compatible with the observed outcome. So if we look at the list of all married couples in the world to find out what are the most recurring attributes would ass little insight. The ideal setting would be one where people randomly met, have the opportunity to know his/her partner’s attributes and then finally express a preference. This is what you normally have during a speed dating night: you are confronted with a certain number of potential partners, have the opportunity to talk to them for a reasonable period of time to make an informed judgement and then decide whether or not you want his/her email address and meet again in the future. Some economists used this set up on a big sample, collected the results and gave the answer in a paper published on the Quarterly Journal of Economics: men value physical attractiveness while women value intelligence. Nothing really new on this ground. The next findings were that men don’t like women who are more intelligent or more ambitious than they are, while women like men who have grown up in wealthier neighbourhood. These findings are consistent with explanations taken from Evolutionary Psychology, according to which men select the partner according to women’s limited reproductive capacity, while women select men according to their ability to provide aid when it is time to raise their offspring. If these are the preferences, then in equilibrium, as earning potential increases linearly with age, we should expect to see women married to older men. This would be the outcome of a “rational” selection of the mate and, extremes aside, this is indeed the most common pattern found in modern societies. Is this outcome also the one bringing the level of highest individual well-being? Once your partner is chosen according to the above criteria, what you need is to find also empathy and coincidence in the level of sexual satisfaction. And here comes the problem: age gap of the above mentioned type entails a loss of intimate satisfaction. Why so? We will discuss the implications of this phenomenon in the next post, when analyzing the economics of lovemaking.

R. Fisman, S. S. Iyengar, E. Kamenica, I. Simonson “Gender Differences in Mate Selection: Evidence from a Speed Dating Experiment”, Quarterly Journal of Economics, 2006, 121, 673-697

May 5, 2008

Participation as a Prisoners Dilemma

Though this article (hopefully) starts to loose its relevance as time passes here it is:

The Prisoners Dilemma is probably one of the most influential (political) economic concept. Not only is it quickly understood, but also is it applicable to so many circumstances (See for example a nice article by Pierre-Louis on his and Salvatore's blog). I want to offer another application of this concept in the hope to stimulate the desired outcome (what else should theory serve?).

To start, let me tell you that – whether you believe it or not – before I came to HEI, I used to belong to the group of students that sit in the classroom (and listen concentrated) and neither ask questions nor make comments. Part of the reason that motivated this behaviour related to the fact that I just did not have too many questions regarding the material. On the other hand, I also did not see too much of a reason to raise any (critical) comment. The latter derived to some extent from the following line of reasoning: If the comment turns out to be wrong or even worse silly I make a bad figure. If it turns out to be right, well, my initial guess is affirmed but I did not really learn something new, since it was me at the first place coming up with the idea.

Now you might ask where is the Prisoners Dilemma here? Well very simple, if my payoff of saying something wrong is negative, the payoff of saying something right is only marginally positive and - since I am not a genius - I say 50% of the times something wrong, it will be better for me to be quiet. However, I generally benefit from others saying something smart since it makes me learn or see things from a different angle. Even if others say something wrong I might still gain since I might have thought the same thing, but now I learned I was wrong without making a bad impression. Hence, if others say something I will gain on average. So everyone’s dominant strategy is to be quiet, but it might well be that it is socially optimal that we all rather give our comments. This is even more the case when the group is big and/or we tend to say more often something right.

The same logic applies to this blog. Even if our articles or comments are from time to time not ingenious and we make ourselves subject to critique the fact that at other times they will be entertaining, interesting, stimulating or even enlightening makes it worthwhile to be wrong at some occasions.

So if I did a reasonable job and you believe my argument you might say: “Why is it then that some people write on this blog while others do not? And why is it that often the same people ask questions in class while others are mute?” Again there is a simple explanation at hand. No, I do not mean that it is the case that those making comments or those writing articles are so convinced about themselves that they think they are always write and hence benefit always from speaking/writing. It is rather the case that those that speak/write have a lower personal cost of saying something wrong (or the others have a lower gain from saying something right).

You might still say “so what”? In the end, I just gave you a perfectly rational reason why not to write here. Well, unfortunately that is how it is with the Prisoner’s Dilemma. Without changing the incentive structure only coordination can lead to the socially optimal outcome. Now guess what I have been trying to do here in the last three minutes!

May 2, 2008

A Little Riddle

Who turned 10 years old today but is already mature?

Globalization, jobs and...laziness

If you ask people what's bad about globalization, they will most probably answer: a) it flattens out cultural differences; b) it threatens job security. The first issue was addressed in a recent post. Let's consider the second issue through the lenses of a paper that attracted my attention some time ago. The trade economists Donald Davis and Jim Harrigan (some of you may have attended the latter's presentation during the recruitment week) recently wrote a paper that shows how globalization (read: trade liberalization) can increase unemployment and destroy 'good jobs', defined as the higher-wage jobs. Yes, the ones that pay well and require the employee to wear a tie (or a tailleur). They use the theory of efficiency wages. If unchecked or poorly monitored, the workers will shirk and watch youtube videos on the job, so the firm needs to set efficiency wages to induce the worker not to shirk. Since wages are above productivity, the labor market does not clear, and involuntary unemployment emerges in equilibrium. So what? They assume that monitoring costs are firm-specific. If this rings the bell of Melitz's model (or paradigm, if you want) you are on the right track. Workers with the same productivity working for different firms earn different wages. The 'good jobs' are the one associated with firms whose monitoring costs are high, because they pay higher wages. Conversely, the 'bad jobs' are in firms with more efficient monitoring technology, because these firms can afford to pay a lower premium to fulfil the no-shirking constraint.
What are the effects of globalization? If firms have the same productivity, and only differ in monitoring costs, trade liberalization makes firms with the highest monitoring costs exit. Since these firms were paying the highest wages, trade destroys 'good jobs' because it destroys rents associated with the cost of monitoring shirking. As a result of the exit of high-wage firms, the average wage in the economy falls, as so does the rate of unemployment. Thus, under this scenario, trade destroys good jobs but reduces unemployment. Interested empirical readers would then test the hypothesis that, controlling for productivity, trade kills good jobs. That cannot be too bad, except for the guys who were paid a lot of extra money not to play minesweeper. Consider now the general case in which firms are heterogeneous both in productivity and monitoring costs. Believe it or not, there are good empirical reasons to consider that firm size is positively correlated with the wage. This means that larger firms face higher monitoring costs and thus set higher efficiency wages to prevent shirking. In this case, a trade liberalization that leads to a contraction of small firms and an expansion of large firms will increase the average wage. While a rise in the average wage makes job loss less costly, it also leads to more unemployment. So there is a trade off between good jobs and unemployment. And globalization might increase good jobs at the cost of more unemployment!
Now, you might argue that workers are heterogeneous, so that the good jobs are the ones accruing to the most productive workers. I won't wrestle with this, it makes perfect sense and Yeaple wrote a nice paper showing what happens in this case. But if the "good" jobs are good just because of rent extraction by the lazy guys, the society as a whole should prefer less unemployment to more good jobs. This makes a case against globalization. However, we all know that governments respond both to society and – probably to a larger extent – to interest groups. Will the interest group of lazy guys start lobbying hard in favour of globalization? Who wants to join?

What life is all about