Politicians and leisure

When you think about leisure in the utility function, for most applications you need to take a stand on some properties: is the income effect larger than the substitution effect? Is leisure a normal good in the first place? Convincing empirical evidence is surprisingly difficult to find: read the endless debate between microeconomists and macroeconomists about the size of the wage elasticity. This may be an aggregation issue, but maybe we are lacking a clear natural experiment.

Naci Mocan and Duha Altindag report on an interesting change in the way members are paid in the European parliament. Whereas previously they were compensated at wildly different levels by there home countries, since July 2009 they get money according to a uniform rule: 38.5% of a European judge's salary as a base, plus a per diem when present. Mocan and Altindag then use the difference between and with the previous schemes to highlight that an increase in the base reduces attendance (yes, the income effect! Leisure is normal!) and an increase in the per diem increases attendance (the substitution effect is larger than the income effect). Politicians are rational after all.

Economic freedom and prisons

Americans are proud of their freedoms, political or economic ones. Yet, they are very trigger happy when it comes to takes one's freedoms, say by taking voting rights from felons, throwing people into prison or even executing them. How could such an apparent disconnect be explained? Why is the US different from Europe, where there is less economic freedom, but also much less punishment?

Rafael di Tella and Juan Dubra note that this apparent paradox does not only appear across countries, but also over time within the United States. For example, over the 30 years including the "Reagan Revolution" that considerably deregulated the economy, incarceration rates were multiplied by seven. They explain this with a theory that states the following. People view that when there are ample opportunities for legal activities in a system where there are many economic freedoms, people who still commit illegal acts must be "meaner" than the average criminal in a world with fewer economic freedoms. This can be supported with some limited empirics, but this is quite an appealing explanation. Indeed, Americans strongly believe that effort, not luck, is the root of success, and thus offer few excuses to those who become criminals out of necessity, an opinion that interestingly more and more African-Americans share.

Why September 11 is remarkable

Amid the commemoration of the 10th anniversary of the terrorist attacks of September 11, 2001, I cannot help thinking how successful theses attacks have been. For an organization that wanted the United States to pay for sending troops to Saudi Arabia during the first Gulf war, a relatively little investment paid huge dividends. Indeed the cost of the operation, including training, must have cost only something to be measured in millions of dollars and the lives of 19 volunteers. The return was getting the United States involved in two wars that have costs amounting to trillions, brought the federal government in major financial difficulties, have lead authorities to neglect essential infrastructure investment for a decade, has kept the population in a nevrotic state for a decade, has given us higher oil prices (with revenue going you-know-where) and has lead to major setbacks in civil liberties. And that is just for the United States, as Europe has also been affected. And the costs will continue to mount, as the US is none the wiser and will have to face in addition the costs of care for veterans.

The impact of fiscal uncertainty

Current US fiscal policy is absolutely frustrating. There does seem to be a clear direction, in particular because policy making is rather irrational due to a set of unduly influential and crazy lawmakers. In the end, this means considerable uncertainty about future fiscal policy, in particular because it may not react to economic events in ways that make economic or historic sense. What is the impact of such uncertainty?

Jesús Fernández-Villaverde, Pablo Guerrón-Quintana, Keith Kuester and Juan Rubio-Ramirez address this with a New Keynesian business cycle model that feature variable volatility in fiscal policy. Their conclusion is that the current uncertainty lowers activity and has the policy equivalent of a 25 basis point increase in the federal funds rate, which I find rather minor. The model rightfully yields that the main mechanism is through investment and the uncertainty on capital return taxation. I find it interesting that it leads to stagflation, as firm opt for higher prices to reduce miss-pricing costs. In the end, the authors show that if one removes the usual automatic stabilizers and assume very persistent fiscal shocks, which may be a good characterization of the current situation, the prediction is a 0.5% reduction in output, which I am ready to believe.

Tax reform: Politics has more weight than Economics

One of the great frustration as an economist is to know what is best and being told it is "politically unfeasible." And why is it typically unfeasible? Because the "right" people do not like it, because it sounds complicated, and because populists would have a feast opposing it, or a combination of the three. How much is this frustration really justified?



Micael Castanheira, Gaëtan Nicodème and Paola Profeta look at the reform of labor income taxation in Europe and find that it is very consistent with the theory that politics shapes taxes more than economists. Indeed, the size of the ruling party or coalition is the main factor: instead of a compromise, which would likely be close to the outcome a social planner to choose, the rulers select what is best for them without regard for the others, or just enough regard to prevent a revolt (that is my interpretation). And then people blame economists when things do not go right.



I'll go weep in a corner now.

Market failure and political outcomes

In a perfect economic world, perfect competition and the lack of frictions or externalities make it possible to obtain the most efficient outcome. But once any of those assumptions is lost, outcomes are going to be worse than the first best. In particular, once there are rents to be obtained, from frictions or imperfect competition, the beneficiaries of those rents will try to protect them. And they will try to influence political outcomes in their favor.



Madhav Aney, Maitreesh Ghatak and Massimo Morelli argues that this influence peddling reinforces the market failures. As an example, they take a model of misallocation of entrepreneurial talent due to the imperfect observability of that talent. The resulting power structure then votes on institutions that reinforce such a class structure and thus amplify misallocations and market failures.



Now think about the apparently ever-increasing proportion of lawyers in the political class.

Procrastination in team work

Teamwork can turn out very bad when moral hazard is present: if people do not trust each other or care about each other, nothing gets done. When doing research, we are lucky to be able to choose our co-authors, but even then things can turn for the worse if a team member looses interest. And we remember how bad it is when a team is forced upon you during our studies. Now, this is all very loose reasoning, let us get on firmer ground.



Philipp Weinscheink studies team production in a dynamic game with moral hazard. If all players are rewarded equally, they will all wait until the last moment to participate. This is very like what we often see in political negotiations with a deadline, where nothing happens until the last moment, and player consciously wait for the last moment. The same often happens at collective agreement bargaining. And of course, the outcomes are far from optimal, as the debt ceiling mess in the US has recently shown.



If the rewards are not equally distributed, the outlook is better. Quite obviously, those who are rewarded better will tend to procrastinate less. But they are not necessarily better off that those less rewarded, as they put more effort. Thus, second-best contracts are unequal ones. But all this falls apart if some players have limited liability (which means they have better outside options) or if some can sabotage. Then everyone will wait until the last moment and very little gets done. Think about the US situation again...

Policy risk and the business cycle

The US economy seems stuck in its tracks, and many blame uncertainty about future public policy, including me. Indeed, private firms are currently sitting on a lot of cash and are making very good profits, yet they are not investing or hiring. This really looks like a wait-and-see game. But it this justification well-founded or is it just a cheap excuse to justify higher than usual profits in the face of high unemployment?

Benjamin Born and Johannes Pfeifer put some structure into these arguments by taking a standard New Keynesian model and adding uncertainty about monetary and fiscal policy. They measure this by looking at tax rates and monetary policy shocks with time-varying volatility. Previous literature already looked at the impact of aggregate uncertainty, which policy makers can do little about. But policy uncertainty is another matter. And there is hope, as Born and Pfeifer show that the impact of policy uncertainty is not that important (but much larger than uncertainty about productivity shocks) thanks to monetary policy reaction through a Taylor Rule. So that is somewhat reassuring, but then the size of the current policy uncertainty is an order of magnitude larger than when this paper was written, and monetary policy is bound by non-negative nominal interest rates.

The debt ceiling circus is another media debacle

If you compare the media coverage about the current debt ceiling "discussions" in the US to abroad, it is a stark contrast of style. While the US media is focused on the power haggling of politicians, ignoring completely policy matters, foreign media puzzle why such a silly policy the Republicans are proposing is even being discussed. And once more, it makes me wonder why the US media is sleeping.

Roughly, the Republicans want to erase the public deficit from one day to the next, in the middle of difficult times, and without raising taxes, cutting anything to defense expenses and farm subsidies or closing corporate tax loopholes. This is mathematically simply impossible and must results in partial default on public debt, a major increase in interest rates and in then more public expenses to service the debt. In other words, this is an own goal. To top it, the policy uncertainty is severely hurting the US economy which does not seem to be able to get back on track.

The saddest aspect of this is that the media is completely oblivious to this. It is so obsessed to present both views that it shows without critical discussions complete absurdities from the Republicans. I have a hard time understanding the motivations of the right, except hurting the economy ahead of elections or participating in some grand scale insider trading, and nobody in the media is pointing this out. In fact it is relaying the arguments that decreasing taxes will increase revenue, especially if the rich get those breaks. To repeat myself, this is so wrong, especially now. If you want to improve the economy and insist on reducing the deficit, give tax breaks or transfers to the poor and tax the rich significantly more.

The worst is that there are some serious negative externalities on many who have absolutely no say here, and not just the US tax payers, but also foreign economies. Rarely have I seen such a policy kamikaze, say since Saddam Hussein invaded Kuwait. But at least the US media was then on top things.

Do Italians trust the television or the judges?

In several countries, mass media have become, at least from my viewpoint, a dominant means of forming public opinion on just about anything. In the US it is particularly apparent that experts are less trusted by the public than media, or even less than people's prejudice. In politics, this is even more widespread, where media make or brake a politician, and politicians cater directly to the media. Imagine how things could turn when the politician owns the media. This is the current situation in Italy, where Prime Minister Silvio Berlusconi heads a formidable media empire and tries to fend off numerous accusations of corruptions and abuse of power (loosely speaking) that emanate from the judiciary.

Fabio Sabatini studies how much the Italian Prime Minister is trusted by the public. He finds that trust in television is by far the cleared determinant for trust in Berlusconi, and the second is lack in education, the third distrust in the judiciary. So much for Berlusconi claiming his empire has nothing to do with his repeated elections.

About the bastardization of news

Earlier this week, I have has the "opportunity" to spend significant time in a US hotel room. The town being of little interest, I used my time to get some work done and to watch some TV. There was the opportunity to see two interesting events, on the same day: the press conference of Ben Bernanke and the statement of Barack Obama about the war in Afghanistan. What a huge disappointment both were.

This is not Bernanke's or Obama's fault, though. The big news channel were treating this like an American Idol contest, with personalities (or journalists, what is the difference now anyways) doing instant ratings on how well they perceived the speakers. Which was then followed by an analysis of some random tweets.

The sad truth is that people will form their opinion from this circus. Never mind that Bernanke and Obama are experts in their field, have thought very hard about their issues with a lot of expert advice, these journalists know on the spot what is best and will dismiss without justification any argument by the push of a button.

This brings me back to the idea that Economics needs some way to certify people to separate those who pretend to know something about Economics and those who do. The latter are mostly unwilling to talk in sound bites and instant opinion, thus the media rushes to the pretend economists. And I wonder how many of the journalists I saw judging Bernanke have any degree in Economics, let alone a graduate degree.

Should voting be compulsory?

Should one force people to vote? While there are clear incentives for people not to vote because it is very unlikely their individual vote would matter, there may be a social benefit to make sure that everyone, or at least many people, votes. Clearly, public decision-making is difficult when people do not voice an opinion. But imagine you are forced to vote, how should you vote? Selfishly, or for the public good? And how should that public good be defined? Your family, the neighborhood, your clan, your country? Indeed, if you force someone to vote, you must have an idea for what purpose you impose this.

Dan Usher tries to make sense of all this focusing on the idea of the duty to vote, the duty being an unenforceable obligation. The paper is impossible to summarize without making a massacre of it, so I will abstain. It is full of ideas on how to think about the duty to vote, abstention, and mandatory voting. Read it if you are interested.

Trust and the business cycle

Public distrust in institutions (government, business justice and media) seems to be at an all time low in the United States, especially for banks. While conspiracy theorists have always been poplar in the US, they seem to have a field day now. It this just an impression, or it there some truth to it?

Betsey Stevenson and Justin Wolfers run a very simple exercise: they regress opinion poll results against the unemployment rate and a time trend. Except for the media, it appears that such an economic indicators explains very well confidence in institutions, both in the US and in Europe. That is not too surprising, people are quick to blame someone for a recession.

Unfortunately, the paper does not report the results for the time trends. The figures seems to indicate that confidence has a downward trend, and it would have been interesting to see whether this trend is statistically and economically significant.

How to kill growth: corruption and large military

While it is not a slam dunk, there is pretty good empirical evidence that corruption and government expenses that are not tied to public infrastructure are not good for economic growth. This evidence comes largely from linear cross-country regressions of the kind that anybody with a little sense of theory or econometrics shudder. But sometimes this is done a little bit better.

Giorgio d'Agostino, John Dunne and Luca Pieroni take a simple growth model where government expenses are divided in public infrastructure, public consumption and military expense. Along with private capital, all three enter the production function for reasons that are not entirely clear, but we can let the data speak here. In addition, each expense is adorned with a multiplier that identifies how much is lost through corruption. The result is an equation for the growth rate that can be brought to the data, specifically a set of 53 African countries over 5 years. This is were things become iffy, as it is by now well-known that using panel data in growth regressions leads to very spurious results, especially when African data is considered. Using instruments and GMM will not help you much when data is of poor quality, especially from one year to the next. And taking lags of growth rates will make things even worse.

Results show coefficients "of the right signs" and a particularly strong interaction between corruption and military expenses. I am not sure I can believe these results given the above problems, but they make sense. And if one can extrapolate this African result to other countries, I would be especially worried for the US, where military expenses are always high and bribery of politicians is common and legal.

The role of independent fiscal watchdogs

As discussed a few days ago, politicians have a rational tendency to lie. One remedy against this is to improve information. One area where political lies hurt the most is when politicians distort (or blatantly ignore) the consequences of their actions or policy proposals. The starkest recent examples come from the second Bush Administration with the Iraq war ("it pays for itself with Iraqi oil") and the prescription-drug plan for the elderly. How do you improve the information of the public in this regard? And you may also want to inform politicians as well as they may be ignorant or easily influenced (many are lawyers after all, and certainly not economists who can gain their own insights). Finally, you want to redress short-sighted politicians and find a way to commit them to long-term policies and outcomes. One way is to institute some fiscal watchdogs. There are plenty of think tanks willing to take this role, but they usually have some vested interests in the debate and rely on funds from interest groups to function. The fiscal watchdog thus needs to be independently funded.

Lars Calmfors makes the case for independent fiscal watchdogs in a report to the Prime Minister of Finland. He forcefully argues that the rules vs. discretion problem of central banks is just as valid for fiscal authorities, if not more as political terms are typically shorter than those of central bank governors. The ideal would be to have an independent fiscal authority, but this is clearly not feasible, so an independent fiscal watchdog is the next best solution. The paper focuses on the example of the Swedish Fiscal Policy Council, but there are others. They work as long as people are willing to listen to them. One example where it does not seem to work as well as before in the United States, where the Congressional Budget Office is not viewed as being credible due to the general attitude against scientific evidence in the country, and due to partisan bickering. But beyond criticizing fiscal policy, fiscal watchdogs can help with the formulation and enforcement of fiscal rules, like the German one that forces the government to act once deficits exceed some level.

In any case, this paper is a good read for anybody who is worried about the unsustainability of fiscal practices and who wants politicians to think harder about the consequences of their actions.

Why American politicians lie

Many advertisements are misleading, with the intend of making people buy goods they would not buy had they known the truth. This overconsumption leads to welfare losses, which is why you would want to regulate truth in advertising. But, in a market that is not competitive, households tend to consume less than optimal. Does this mean we should then avoid regulating ads, or regulate them less, in order to get to the optimal quantity of consumption?

This is the question Keisuke Hattori and Keisaku Higashida ask with a model of false advertising in a duopoly. They suppose that consumers are easily fooled and ads of one firm also increase demand for the other firm's good. They show that prohibiting truth in advertising (or educating consumers) may have negative welfare consequences if the goods are close to homogeneous because of the resulting under-provision of goods. But taxing misleading or joint advertising is welfare improving. In an interesting extension where there are smart and naive consumers, smart consumers suffer because the naive ones induce more misleading ads and higher prices.

Now think about politicians. There are only two parties who offer goods that are after all little different from each other. Voters are easily fooled. The model above implies that politicians will lie extensively and deliver very few goods. Draw your conclusions.

Feet vs. ballots in local policy choices

When you are unhappy about public policy where you are you can either influence it by voting, or you can vote with your feet and move to an area that follows your ideals. But what if you could do both? It is not obvious that this would be welfare improving as the fact that one can move away makes that poorer choices could be offered. And moving implies costs that can be substantial.

Alessandro Innocenti and Chiara Rapallini take the experimental approach. They compare two games, one where dictators impose local payouts and people can move, and one where people vote on payouts and then can decide to move. It appears voting with the opportunity of moving is better than only moving, which makes sense if there are no moving costs: it gives more degrees of freedom and better outside options. And this is what Tiebout's theory was all about. However, I would have loved to see results of experiments with moving costs. This makes people captive, and strategies become more complex as arbitrage by moving is more difficult.

A driving median voter reduces gas taxes

If you own a car, you are not too happy when gas taxes go up: it is more money out of you pocket, however you benefit from a reduction in congestion and lower pollution as long as this tax increase also implies a reduction in gas consumption. If you do not own a car, you would view positively the increase in gas taxes, as the state can now provide more services or reduce other taxes you may be paying. However, some goods with a high share of transportation costs may be become more expensive. Does this reasoning make sense in a political equilibrium, i.e., is the level of gas taxes determined by whether the median voter is a car driver or not?

Fay Dunkerley, Amihai Glazer and Stef Proost show that it does and figure out that in the OECD a car driving median voter leads to a gas tax that is 20% lower than a walking median voter. Of course any such estimate is fraught with endogeneity: the median voter is walking because the tax is high. To overcome this problem, the authors use a dynamic setup that takes into account when a median voter starts to drive.