Who is rational?

Much of the experimental economics literature is about finding situations where some of the fundamental axioms of rational utility theory are violated. And you are always going to find someone who does not act rationally. But this literature often understates how often people are actually rational and how this translates into better outcomes.

Syngjoo Choi, Shachar Kariv, Wieland Müller and Dan Silverman study the characteristics of rational people. Specifically, they conducted a field experiment on 1182 households in the Netherlands to find whether they behaved consistently with revealed preference theory. They then combine these results with a large array of socio-demographic and economic characteristics. They find that the more rational people are, the higher income and education they have. Nobody will be surprised to learn that men are more consistent, but I am shocked to see that young people are more rational. Why would life experience make you deviate from rationality? Finally, the impact of rationality on outcomes is substantial: a one standard deviation increase in consistency is associated with a 15-19% increase in wealth.

Fraud cycles

The evolution of crime over time is much studied, and there is a lot of agreement that demographics are very important for many crime categories that are the "specialty" of young adults, like violent crimes. Fraud, however, cannot be tied to a particular age category, yet fraud statistics exhibit a remarkable cyclical pattern, a pattern that is not correlated across fraud categories or with the business cycle. What could give rise to such cycles?

Jiong Gong, Preston McAfee and Michael Williams come up with a theory that can rationalize these cycles. Once a lot of fraud cases make the news, people become more careful and new laws are put in place, which makes fraud more difficult. As fraud then disappears from the picture, people become less careful, and fraudsters find new and innovative ways to make money, and statistics show a comeback. That reminds me of privatization-nationalization cycles.

Of course, fraud statistics are not perfect. Indeed, they only measure fraud arrests, not fraud occurrence. One could argue that more people get arrested for fraud when victims are more vigilant, not less. That would be an entirely different story of fraud cycles.

Which are the most efficient universities?

University rankings are not particularly useful because they only measure the output and hardly the input. And if they measure the input, having more inputs is better. This means that rankings reflect size and resources, not how well resources are used, and how much students improve from when they started their studies. This implies that any university that does not have a medical school or an engineering school starts with a disadvantage. Internationally, university rankings have become very important, to the point that, for example, France is now reversing the splitting of its large universities in field specific institutions. The new monster universities, now again covering all fields, will rank much better thanks mostly to their sheer size.

To counteract all this, you need to measure the efficiency of universities. Thomas Bolli does this for 273 universities across the world by estimating a production possibilities frontier. Unfortunately, the sole measured input it full-time equivalents of staff, while possible outputs are FTE of undergraduate and graduate students, and citation numbers. But it is a start. Universities in Switzerland and Israel appear to be very efficient (and indeed they are small are generate a good amount of research) while those in the UK seem particularly inefficient. That should fan some flames in the debate on university financing there.

Fertility differences and agricultural techniques

There are times when you read a paper and you really wonder how the authors came up with the idea to check out a particular correlation in the data, because it seems to be so far-fetched. But thus a correlation can be beautiful if it also has a nice theory that comes with it.

The correlation that Alberto Alesina, Paola Giuliano and Nathan Nunn study is between current fertility and adoption of plough agriculture in history. OK, I did not think about that one. But now that they find a nice positive correlation, how could one explain it? They argue that this has to do that women and children are not particularly useful when ploughing, as strength is required. The traditional task of weeding, that fell on women and children, is not necessary with ploughing. Thus, there is a preference for fewer children that is ingrained in the culture of these regions to this day.

The unnecessary problems of the Euro

European leaders are currently struggling over a package to save the Euro, pouring large amounts of money into funds that should stabilize the fiscal situation in Greece, Portugal, Ireland and potentially other countries. It seems to me that this is a completely unnecessary problem, and all this grief could have easily been avoided with a simple change in policy.

Just look at what is happening in the United States. Several states are in serious financial difficulties and, as several times in the past, California is considering issuing IOUs, thereby essentially declaring it is insolvent. Is there any expectation that other states or the federal government will rush to California's aid because the dollar is threatened? Of course not, despite the fact that California is the largest state in the Union.

It should be the same for the Euro. None of the member countries can monetize its debt on its own, and the only reason that the Euro is threatened is that markets have an expectation that other countries will rush to help, thereby sending a message that monetary policy could be influenced by what is happening in those small countries. And why is this belief well anchored? Because European indeed rush to help (talk about a nice example of self-fulfilling expectations) and because of this silly concept that all national debt in Europe is fungible (talk about a nice example of the tragedy of the commons). Now of course it is a bit late to rectify those beliefs, but had it been clear no rescue package were in sight, those countries would probably not taken such a risky fiscal path in the first place (talk about a nice example of moral hazard). I guess that those silly policy decisions all boil down to European politics, once more (talk about a nice example where economists' advice has been ignored, and they will get blamed for it anyway).

What influences Fed presidents?

The European Central Bank is still a recent creation, so you can excuse its national governors for putting their country's interest first in the conduct of monetary policy. What about another federal central bank that is much older and whose governors territory does not necessarily coincide with political boundaries, the Federal Reserve System of the US?

Bernd Hayo and Matthias Neuenkirch have analyzed the speeches of Federal Reserve presidents over the span of twelve years and come to the conclusions that they equally represent the national and regional interests, except when it is not their turn to vote, when their region comes first. They find this by trying to fit a Taylor Rule to their positions, using a price index, a national and a regional unemployment rate. Unfortunately (and surprisingly), there are no regional price indexes in the US, which could have reinforced the regional focus of the presidents. Still, I am surprised how much they lobby for the general interest. After all, they are selected to represent their region.

You want to restrict bankers' pay

There has been and there still is much outrage about the large bonus payments bankers get. What the public does not understand is that bonus pay is a very large part of total pay, and it is so to encourage bankers to perform really well. And they certainly put in the hours. For example, bonus pay has been criticized because there is most often no "malus," but given that base pay is relatively low, this should capture it. The main criticism is aimed at the disparity of these bonus payments with respect to the average pay of a worker. This is, however, not something that should be regulated at the level of bonus pay, but through redistribution with income taxes. In this regard, whether it is regular pay or bonus pay makes no difference. So, should then bonus pay in banking be left unregulated?

John Thanassoulis does not think so. He argues that as bank compete for top bankers and try to shift the risk on them, they end up paying them too much and all in bonuses. This is optimal for the bank as it lowers its costs right when things get critical. But as a consequence, the bank gets too much into risky activities, as competition for bankers drives bonuses up higher than socially optimal, especially if there is a contagion risk of default for other banks. So you want a regulator to limit bonuses, but in a flexible way, or the benefit of having bonuses in the first place gets eroded. Indeed, it is the top brass that sets the bank level risk, whereas other employees all the way down to secretaries (who also get bonuses) are less influential, even collectively, on the aggregate risk. Thus the idea is not to cap bonuses individually, but at the bank level as a proportion of the balance sheet (which is what matters in terms of default). The pay structure would then presumably be readjusted by the bank, relying more on bonuses where it matters the most. Taxing bonuses has no risk impact, though, except for reducing bankers' pay.

Another possibility could be the dynamic incentive accounts I mentioned before.