Behaviorial economics is futile so far

Neoclassical economics has taken a lot of flak recently, I think unjustly, for failing to predict the last economic crisis. For many critics, behavioral economics is the next big idea, because it is much more closely tied to empirics and has a special focus on irrational behavior. But beware of fads, of which there are unfortunately too many in Economics.

Nathan Berg and Gerg Gigerenzer say that behavioral economics is just as bad as neoclassical economics because they are both full of ad hoc assumption and build on axioms that are not tested. In particular, the deviations from rationality are never evaluated in how costly they are, for example whether people are then poorer or less happy. This is important as if those deviations are costly, people would likely do something about them and they may become less important. In other words, behavioral economics if far from being mature enough to be the panacea some are seeing in it.

On the emergence of money

Why are we using money? The answer we give to undergraduates is that money facilitates transactions and can be use as a store of value. But how do we get there? For money to be used, especially fiat money, there needs to be an agreement among many people that a particular commodity is the right one, and that we should all accept it for payment. How do you get there? If you look at the economic history of humanity, the use of money is in fact only a very recent phenomenon, and many previous attempts at introducing money failed. What makes money stick? All these are questions that are really difficult to answer and that will keep scholars busy for a long time. What we have so far are partial answers that are mostly of anecdotal nature.

Xue Hu, Yu-Jung Whang and Qiaoxi Zhang use a trading post approach to understand the emergence of money. A trading post economy includes households with heterogeneous endowments and wants who go to particular locations to meet and trade, and each trading post deals with only two goods. Under a monetary equilibrium, all trading posts deal with the same good, and another one that is different for each. The question is how to get there. The classic paper here is by Peter Howitt and Robert Clower, which was criticized for not having any maximization: this happened by pure chance, but eventually almost all experiments resulted in monetary equilibria. Hu, Whang and Zhang add to this utility maximizing households, but add substantial frictions to prevent convergence from happening too fast. These assume that there is a tâtonnement process that allows only 20% of households how want to switch trading posts to do so.

The conclusions are similar to Howitt and Clower, though. The good most likely to become money is the one that is the most saleable, either because there are large endowments and want for it, or because its trade is less costly. They also find that the absence of double coincidence of wants, traditionally used to justify the existence of money, actually makes the emergence of money more difficult. When money has not yet emerged, why would you experiment in trading your good for something you do not want?

Smokers and the smoking ban: some hate it because they quit

One of the most unusual and criticized theories in Economics is that of rational addiction, which states that smokers and druggies choose their addiction under full rationality and information. This can be rather surprising to a non-economist, but one can find data that supports (well, does not reject) such theory.

Timothy Hinks and Andreas Katsaros provide some evidence that could further validate the rational addiction theory by looking at public smoking bans in England, Wales and Northern Ireland. Using the British Household Panel Survey, which includes questions about happiness and smoking, they find that those who reduced their smoking show no change in happiness compared to those who did not change their smoking. But once public smoking bans were imposed, those who reduce smoking, in particular heavy smokers, exhibit decreases in happiness. In other words, they were forced to reduce smoking by being chased away from public places, and feel worse for it. That is consistent with the rational addiction theory in that imposing an unanticipated constraint makes people worse off. But one could also imagine irrational addiction theories that would be consistent with that result. Indeed, the critical aspect here is that you are locked into a state (addicted smoker). Whether you got there rationally or irrationally does not matter.

Breastfeeding and cognitive skills

Breastfeeding is now almost universally promoted as the healthiest way to feed a baby. And indeed, while breastfed babies are a little smaller and than bottle-fed ones and gain a little less weight, they are healthier, it is thought mainly because the mother milk transmits antibodies and relevant nutrients. But not every mother breast feeds, maybe because not every mother realizes all the benefits, or because some of the costs are high (time management for working mothers or aesthetic issues). Or there are some other benefits that are not well known.

Maria Iacovou and Almudena Sevilla-Sanz report that breastfeeding has significant positive impacts on cognitive skills (reading, writing and mathematics). While this correlation is well known, it may be spurious because mothers who breastfeed are more likely to be well educated (Irish example), and their children are also more likely to be well educated as well. The obvious way to overcome this statistical issue, a randomized trial, is not feasible on ethical grounds. What Iacovou and Sevilla-Sanz do is use propensity score matching, which essentially matches babies that have the same characteristics but breastfeeding and then compare their cognitive skills. What is particularly impressive in this study is that the retained characteristics are very broad beyond baby demographics and health, including parent characteristics such as education, job, income, and even pre-birth attitude towards breastfeeding or home and neighborhood. And even after controlling for all these variables, the impact of breastfeeding is still significant on babies from Bristol (England), and it may even grow with age.

Unskilled workers stay unskilled

Learning is a lifelong experience, as one has to adapt to new technologies and circumstances. Those who are the most flexible in the acquisition of human capital do best. This is not only a private benefit, employers also realize that it is important that their workforce continues training and give opportunities for training to their employees. While employers appear to give equal opportunities for such training to high and low skilled workers, it turns out low skilled workers disproportionately do not take advantage of them. Why so?

Didier Fouarge, Andries de Grip and Trudie Schils find this has nothing to do with lower returns, in fact returns to training are about the same for high and low skill workers, at least in the Netherlands. It appears it has much more to do with personal preferences. Low skill workers have in particular a higher preference for leisure (or, they do not like their job as much), exhibit more exam anxiety and dislike trying new things. In other words, they find it welfare reducing to get more training. Should policies still try to get them into training?

How not to distribute research funds

Citation counts are often used to proxy for the quality of an article, researcher or journal. They are not a perfect measure, everybody agrees on that, but they have proven to be a useful starting point for evaluation. Sometimes they are taken very seriously, too seriously, for the distribution of funds and pay. But at least this is done within a field, as it is obvious that citing conventions and in particular frequencies differ from field to field.

Javier Ruiz-Castillo goes further in trying to infer how budget priorities should allocated across research fields by using citations counts. Of course, for this one first needs to have a good understanding of how citations are distributed. Roughly, citations are distributed following power laws with fields and subfields. This means that few articles garner a lot of citations, while many go empty (especially in Business, Management and Political Science). And if I understand the paper right, one can apply readily a multiplier to compare the citation frequencies across fields. And these multipliers then make it possible to compare researchers or research units across fields within, say, a country, as long as one assumes that an adjusted citation is equally worth citing. For example, is political science worth the same support as biomedical engineering after using these multipliers, to take two randoms fields? And the "size" of the field is important as well. Here the author makes an attempt at some definitions of size which I frankly did not understand.

That said, I wonder why I forced myself in reading this paper. First is it indigestible because it is poorly written and uses very bad analogies. Second, because trying to compare fields and use citations for the allocation of funds or prizes across then is impossible because you have no identification: in statistical speak, the fixed effects capture all the variance. You can only compare how well a field does in a country compared to the rest of the world, but this cannot measure how important the field is. You need more information than just citations.

Optimal aging

While there is some amount of uncertainty in the length of our lifetime, we have the means of influencing it with various choices, such with different diets, occupations, investment in prevention and physical activities. But as these choices all have a cost, whether monetary or in utility, people face trade-offs and there is something of an optimal age. How should we think about it?

Carl-Johan Dalgaard and Holger Strulik make a first attempt at answering this question by positing an "aging law of motion" that defines how a human body become more frail over time and how this can be influenced by various costly choices. They use some recent insights from medicine and biology on the speed of aging and build a model that is able to replicate the impact of medical progress on life expectancy, or the relationship between labor productivity and life expectancy, or cross-country differences in life expectancy. This is all exciting stuff, but I am puzzled that individuals have only utility from consumption. One would expect that the value of life goes beyond just consumption, and empirical studies confirm this. This is not important when the lifetime is fixed, but when someone can influence it, it becomes critical. I am looking forward to a revision of this paper.

Revenue sharing in rock bands

Rock bands are often volatile associations. While there may often be conflicts about the creative orientation of the band, conflicts are too often about jealousies regarding free riders or members who attract too much attention. Fundamentally, these are issues about contracting who does what and who gets what. In particular, when a band member is doing more creative work, should he also be getting a larger share of income (to reward creativity) or the same as the others (to avoid some jealousies)?

This is the question that Cédric Ceulemans, Victor Ginsburgh and Patrick Legros ask. The trade-off is clear: you want to attract more creative band members for its success, and you want to give them credit for this by giving them a larger share of the pie. So you may want to associate one creative musician with less creative ones (in a complete contract) or only creative ones (in a incomplete, uniformly sharing contract) depending on what it means for the probability of achieving a hit, and the type of contract will determine who wants to form a band and whether the band will outsource song writing (and how much effort each member puts into it). The theoretical analysis shows that under a complete contract, the more disperse the credits are, the more successful the band is (reflecting very much the winner-takes-all features of show business?). The relationship is negative for incomplete contracts, which is apparently true in the data. This means that bands are driven to write incomplete contracts.

Spain: how to mess with the labor market

Spain has long been a puzzle because of its abnormally high employment rate, in particular among the young. But things seem to have rectified themselves somewhat since Spain got more integrated into the European market, which unemployment rates comparable to France. But the last recession turned out to be a disaster, with the unemployment rate increasing by 11% points, compared to 2% points in France. What is wrong with Spain? For one, there was a spectacular drop in activity in th construction sector, which initially accounted for a sixth of GDP and was basically divided by six.

Samuel Bentolila, Pierre Cahuc, Juan Dolado and Thomas Le Barbanchon claim that there is also a serious issue with labor market institutions. While both France and Spain have extensive employment protection legislation, and severance pay is formally higher in France, Spain requires, for example, administrative approval for collective dismissals of over 10% of the workforce. Such approval can only be obtained by collective bargaining and much higher severance pay. While severance pay is usually not problematic (it is accounted for in wages), it is the red-tape associated with this and the hoops firms that firms need to go through to dismiss that become economically relevant, because these are transfers that captured by a third party: administration. This makes it then very costly to hire someone, given expected firing costs, and especially so in uncertain times.

Using a search and matching model, Bentolila, Cahuc, Dolado and Le Barbanchon find that the unemployment gap between France and Spain would have been reduced by 45% had Spain adopted French labor market institutions. And I surmise it would be much more with other laws, as France has quite high employment protection in international comparison. No wonder that Spain recently scrapped much of its employment protection regulation in the midst of a deep recession, which may sound counter-intuitive at first. But if you want firms to hire in a recession, they should not have to commit for long-term employment.

Towards better growth accounting

There are some literatures that I find very frustrating, and the empirical growth literature is among them. The initial idea to take a production function to see the contribution of labor and capital to the average growth rate of an economy and then also to compare this way differences in income levels was initially very instructive, in particular because it highlighted how total factor productivity was important. It went all downhill from there, as people started wildly regressing whatever they could get their hands on across countries, mostly with poor data. TFP can be influenced by many things, and there is no way one can identify anything without applying some structure, even with good data.

Gino Gancia, Andreas Müller and Fabrizio Zilibotti use a model to distinguish the contributions of factors (labor, human capital and physical capital), barriers to technology adoptions and technology inadequate for local conditions. The results are interesting, too. Removing these barriers would increase per capita income by 24% in the OECD and 36% elsewhere. And given that a model was estimated, it can be used for various scenario analyses. For example, they find that globalization increases skill premia and thus world income disparities, but this can be reversed by coupling trade liberalization with a reinforcement of intellectual property rights. These latter results are somewhat counterintuitive, but are justified by the fact that with stronger IP rights, there can be a transfer of technology to the South.

Should food prices influence monetary policy?

Central banks care about inflation, but not about the inflation people care about. Because energy prices are volatile, they are not included in the price index a central bank typically looks at, because including it would made the indicator less informative. At they also include food prices, because those fluctuate a lot as well, in particular because of seasons. That can make sense for a rich country, where food represents only a small portion of the budget. For poorer countries, excluding food is more controversial.

Luis Catão and Roberto Chang note that world food prices seem to cause worldwide inflation, and this should have implications for inflation in small open economies that take food prices as given. The question is then whether central banks should react to such terms of trade shocks. For a net food importer, Catão and Chang find that including food in the price index relevant to the central bank is welfare enhancing. The reason is that if food has a larger weight domestically than in the rest of the world, the real exchange rate and the terms of trade can move in opposite directions following a food price shocks. The welfare improvement comes from a change in the correlations in aggregates leading to smoother consumption, but it possibly results in higher inflation and higher volatility of output and employment. It is thus not obvious including food prices would then be an easy sell.