Quote Of The Week

From The Economist, in relation to the UK Government of Gordon Brown:

'...The Public is losing patience with him, and so is this newspaper'.

Definitely the most scathing critique I've ever read in The Economist!!

Cultures of Corruption or Selection Bias (wonkish)?

In a 2006 paper called "Cultures of Corruption: Evidence from Diplomatic Parking Tickets" Ray Fisman and Ted Miguel, two economists at Columbia and Berkley respectively, gave an intriguing answer to the question: is corruption by nurture or by nature? Are people corrupt because they have incentives to behave corruptly (nurture) or because they are born in environments where respecting the rule of law is an option (nature)? For those of you who did not read either the paper or their bestseller Economic Gangster yet, here is a summary of what they do:

"We exploit a natural experiment, the stationing of thousands of diplomats from around the world in New York City. Diplomatic immunity means there was essentially zero legal enforcement of diplomatic parking violations, allowing us to examine the role of cultural norms alone. This generates a revealed preference measure of government officials’ corruption based on real-world behavior taking place in the same setting. We find strong persistence in corruption norms: diplomats from high corruption countries (based on existing survey-based indices) have significantly more parking violations, and these differences persist overtime.”

The idea of the natural experiment sounds intriguing and the authors explain very neatly why this setup is useful for their purpose. However, when reading their entertaining explanation, I started to feel a little problem with their experiment: are we sure that diplomats are a representative un-biased sample of their population of origin? The selection process of "government officials" is likely to be biased toward "very honest" people in low corruption countries, and "very corrupt" people in high corruption country. Why? Very Corrupt People in Corrupt Country realize ex-ante how entering into politics will allow them to live above the law. They have more to gain from the practice of politics (think about BS somewhere down the alps...) Viceversa, Honest people are more likely to practice politics in Low Corruption Country, because of multiple reasons: 1) they live in a system with high public scrutiny; 2)conformity to the law is for honest people a public good and a personal benefit 3) people don’t want their country to be run by other people of dubious qualities; 4) if they are caught misbehaving, they are probably arrested. So high cost for dis-honest people, and low gains.

The bottom line is that the observations the authors deal with are a biased sample of the population of origin they want to study. This being said, this is not to say that their results are totally invalidated. Indeed, their econometrics result holds when correlating parking tickets with corruption. The problem I find is that parking tickets certainly do not represent an unbiased measure of a country corruption as much as survey-based measures of corruption fail the purpose. Diplomats are not anyone. Their selection process is long and costly. I don't think it's hard to imagine that only those who will benefit more from its practice will likely sort into it. And this sorting goes along the overall perception of how the system works. So although I find their conclusion somehow misled, I think the paper is terrific for the following conclusion: it is an international shame to give immunity from the law to people who don’t deserve it at all.

Barack, scrap the Cuban embargo

I am a bit disappointed at the pace of change Obama is bringing. Of course, he has to spend most of his time dealing with the worse crisis ever but still, he's too conservative on many issues. One of them is in dealing with Cuba. At a recent Summit of the Americas, where all countries except Cuba got together to talk about intra-continental cooperation, he decided to scrap all restrictions on visits and remittances to the island by Cuban-Americans, and that American firms would be allowed to provide telecoms services to Cubans, including telephone roaming and fibre-optic broadband connections with the United States (if Cuba agrees).

This doesn't make any sense. Why not make history right now and scrap the embargo? This is a chicken game you will never win. The US should put its own pride on the side (stop acting like a baby) and act responsibly (like an adult) by scrapping the embargo.

Economic sanctions in general never work, as summarized in Vox columns here and here. Actually, they result in the exact opposite of the desired outcome, where an oppresive regime gets even more powerful as the population is isolated, empoverished, and emptied of democratic power. And also, as The Economist puts it, "the embargo is unfair (it hurts Cubans rather than their government), illogical (America has normal relations with other communist countries such as China and Vietnam) and counterproductive (it gives the Castro brothers a pretext for tyranny)."

So next time you wanna deal with an oppresive regime, do the exact opposite of what you did with Cuba. Don't even think about economic sanctions, you should do the exact opposite: do business in any possible way. Promote internet connectivity as much as you can, promote tourism there, promote buying their products, promote investment there etc...This will empower people and bring down the oppresive regime. Power to the people.

Vote Your Economic Word of the Year....

It is pretty simple, you get one vote and you register it here:

http://doodle.com/2us6pkfkkg85r2n6

I will give results soon. If I understood the thing right you will not get to see the other people's vote...just to ensure that there is no herd behavior!

is not too LATE for empirical development!!!

As was correctly pointed out by the Rigotnomic's observers (here and here), the debate about empirical methods in development economics and policy evaluation is on fire, and the flames were lit by Deaton and Heckman-Urzua (the good chilean econometrician), deeply questioning the main methodologies of impact evaluation like randomization and instrumental variables ....

As expected, the aswer did not take much time to come. Mr. Guido Imbens took the lead with the motto "better LATE than nothing" . Some highlights:

- "The fact that two such distinguished economists so forcefully question trends in current practice, may suggest to those not familiar with this literature that it is going seriously awry. In these comments I will argue that this is not the case".

- "Curiously, Deaton exempts the leaders of this movement from these charges, by declaring them 'too talented to be bound by their own methodological prescriptions' ”

- "conditional on the question of interest being one for which randomized experiment is feasible, randomized experiments are superior to all other designs in terms of statistical reliability".

- "But of course Deaton’s statements are wrong. Deaton is both formally wrong, and wrong in spirit"

- "The causal literature has emphasized internal validity over external validity, with the view that a credible estimate of the average effect for a subpopulation is preferred to an estimate of the average for the overall population with little credibility."

LATE = Local Average Treatment Effect

my name is what???

In today's New York Times the article reports an interesting China fact. To change the current hand-written chinese identity card, with modern computer-readable ones, the Government has to ask some citizens to change their name. Since the modern computers are able to read only 32, 252 of the 55,000 Chinese characters, some names will be un-recognizable, so they have to be changed. Steven Levitt will be happy to use this data as a natural experiment to consider whether his theory of impact of names on people's life resist with adults...

Pop Quiz

I never thought I would see my introductory macroeconomics final in the New York Times, and I really never thought I would take it again for "fun". All I'll say is that I passed... take the quiz for yourselves here.

It's not wine for cloth anymore!

More American Workers Outsourcing Own Jobs Overseas

ht: Mankiw

Fighting pirates

Freakonomics has a Q&A with "Invisible Hook: The Hidden Economics of Pirates" author Peter T. Leeson, professor of economics at George Mason University. The book looks fascinating...well especially if you are a fan of pirates stories.. But I find his answer to the last question rather disappointing. It reflects what is wrong with economists in general. When asked what kinds of lessons can we draw from The Invisible Hook in dealing with modern pirates, he answers:

"We have to recognize that pirates are rational economic actors and that piracy is an occupational choice [...] Since we know that pirates respond to costs and benefits, we should think of solutions that alter those costs and benefits to shape the incentives for pirates and to deter them from going into a life of piracy".

No shit. Economists are good at saying that solutions need to take into account incentives but they rarely go further than that...this is not a policy recommendation...no way.

What good are economists anyway?

Business Week has a cover story on the usefulness of economists.

"The rap on economists, only somewhat exaggerated, is that they are overconfident, unrealistic, and political. They claim a precision that neither their raw material nor their skill warrants. Too many assume that people behave like the mythical homo economicus, who is hyperrational and omniscient. And they take sides in quarrels that freeze the progress of research. Those few who defy the conventional wisdom are ignored."

ht: Levitt, who replaces the word economists by macroeconomists...

Are doctors good presidents?

We at rigotnomics really want to know what makes a good country leader. We already wondered many times, here for example. One particular question of interest is if the leader's profession matters...seems like The Economist gathered the reuqired data...

Evil signalling

If an elected leader tries to change the constitution to stay longer in power he must be some kind of evil...Chavez scares me for example; not being able to let go power...But Mike Bloomberg did exactly that in New York. He amended the law to stay a third 4-year term in office...strangely he does not seem evil at all, he rides the subway and receives only 1$ in salary per year...

The Economic Word of the Year

Economics is all over the news in the last months, the whole profession is in a major overhaul with new and outdated words mushrooming in the popular press. So we thought it is about time to give a prize to the best word of our current semester. The potential list already includes the following words

1) Decoupling

2) Tail-Risk

3) Global Imbalances

4) Nouriel Roubini

5) Toxic Assets

6) Recovery

7) Macroeconomics

8) DSGE

9) Quantitative Easing

10) Moral Hazard

11) Financial Meltdown

12) Doha Round

13) Ricardian Equivalence

If you think that we missed words that should be added to the list please post them in the comment section within the next 10 days until the 26 of April. The voting will be initiated with the column that follows the 27^th of April. The voting will be organized over doodle and the relevant link will be provided in the post of the 27^th of April.

Econometrics vs. knowledge

The undercover economist has an interesting review of Economic Gangsters on reason online where he wonders if parking tickets explain why poor countries are poor, or, in other words, if precise econometric studies can help us answer big questions about development. As he writes, "because a randomized trial offers compelling evidence on what works but not why it works, the lessons from such evaluations tend to be hard to transport to a different context".

He goes on saying that "famous “tectonic” results, such as Levitt’s findings on abortion and crime or Acemoglu’s study of institutions and settler mortality, are fiercely contested by other researchers. That is not surprising: They are inherently open to challenge because of the scope of the question and the need for sophisticated statistical techniques and careful interpretation of raw data. Nobody is arguing about the statistical analysis performed in the parking ticket paper."

Wait a second. He thinks these papers are fiercely contested because of the shaky econometrics? I seriously doubt so. It's always an ideological issue. If you are a conservative economist, you are against abortion as it is a matter of "life" and hence you are against Levitt's thesis and try to destroy it in the Review of Economics and Statistics. If you are more liberal, you don't bother, you like the idea.

About the Acemoglu story, everybody knew that Europeans had settled in Canada, the US, Australia and New Zealand, and even South Africa, because of the hospitable climate before their paper came out. Everyone knows these countries are rich because they are a continuation of European institutions combined with indigenous population apartheid or genocide. To say that income differences between this group and Congo is due to the different colonial institutions is obviously the academic and politically correct hypothesis. But to attribute the economic success to the institutions and not to the transplantation of a rich society and mass killing of a primitive one is not convincing. This paper gives more answers.

To show that institutions are the key to growth we need a natural experiment that is quite opposite to what Acemoglu et. al. exploit. We need colonies that acquired good institutions without European settlement. But anyway, as Tim says, economists can provide precise answers to small questions, but only vague answers to the big questions. But to determine how Africa will get rich we don't need to answer big questions. It will.

Battle in Seattle

I just saw the movie. It makes you think. As Stolper and Samuleson would tell us, the demonstrators were right to protest, they were the losers of globalization. That protests end in burnin’ and lootin’ and violent clashes with the police is nothing new, or so I learned by reading “A splendid exchange” which traces back the anti-globalization episodes of the last 2000 years. You cannot blame the violence on the misunderstanding of free trade…even economists are still confused about it…As Bernstein, the author of the book, writes in the final chapter,

"the history of the 19th century casts doubt on the notion that trade is an engine of growth. Were free trade the path to national wealth, then the US, which for most of its history had sky-high tariffs, would never have prospered. The “golden era” of tariff reduction in Europe, from 1860-1880, should have been a time of much higher growth than between 1880 and 1900, a period of protectionism; in fact growth was higher during the later period. Also, after 1880, the economy of protectionist northern Europe grew faster than that of free trading England."

As Krugman, Rodrik and even Samuelson recently challenged the economic benefits of free trade (the Sachs and Warner results), advocates of free trade fall back on the peace theory argument, whereas trade reduces the probability of conflict (the EU being the best example)…and so does Bernstein himself who, after almost 400 pages of facts and informed stories on how trade has led to prosperity, writes a confused chapter on the recent economic papers on the trade and growth link!?! That came as a surprise.

At some point he writes, “The Danish experience remains to this day a powerful, though nearly forgotten, lesson on the appropriate government reaction to the challenge of global competition: support and fund, but do not protect”, talking about how the Danish government encouraged pork coops in the 1880s. But what does this mean in terms of today’s agricultural subsidies in the US and EU? Are they support or protection?

So what have I learned from this book? Trade has shaped the world we live in. I’ve learned about the mysteries of early refrigerated shipping, the Caribbean sugar trade, the corn laws debates, Vasco Da Gama’s violence, the silk routes, the historic importance of the straits of Hormuz and Malacca, the slave trade, the Boston Tea Party, the Opium trade, the Greek trade diasporas, the East-India company, the quest for the Spice Islands etc… All in all, fascinating.

Free trade is the worst system, except all the others that have been tried from time to time…And it will be challenged constantly over the next decades as "History does not repeat itself, but it does rhyme”

The Undervaluation of Uncertainty: A Defense of Capitalism

I just read this interesting piece by Phelps in the FT. Though it is certainly worth to read all of it here some lines:

Capitalism is not the “free market” or laisser faire [..] In essence, capitalist systems are a mechanism by which economies may generate growth in knowledge [..] Any modern economy, capitalist or state-run, is a great soup of private “know-how” dispersed among the specialised participants. No one, he said [referring to Hayek], not even a state agency, could amass all the knowledge that each participant “on the spot” inevitably acquires. The state would have no idea where to invest. Only capitalism solves this “knowledge problem”. [..] Well-functioning capitalist economies, with their high propensity to innovate, could arise only when serviceable institutions were in place. Now capitalism is in the midst of its second crisis [the firts being in the interwar period].

But why did big shareholders not move to stop over-leveraging before it reached dangerous levels? Why did legislators not demand regulatory intervention? The answer, I believe, is that they had no sense of the existing Knightian uncertainty. So they had no sense of the possibility of a huge break in housing prices and no sense of the fundamental inapplicability of the risk management models used in the banks. “Risk” came to mean volatility over some recent past. The volatility of the price as it vibrates around some path was considered but not the uncertainty of the path itself: the risk that it would shift down. The banks’ chief executives, too, had little grasp of uncertainty. Some had the instinct to buy insurance but did not see the uncertainty of the insurer’s solvency.

If we still have our humanist values we will try to restructure these sectors to make capitalism work well again – to guard better against reckless disregard of uncertainty in the financial sector while reviving innovativeness in business. We will not close the door on systems that gave growing numbers rewarding lives.

False economy

Damn it. I am barely finishing reading a splendid book on the economic history of the world that another one is coming out and seems to be a must read. Well, that is the impression that I get from reading Easterly's review (in today's FT) of "False Economy: A Surprising Economic History of the World" by Alan Beattie, the FT’s world trade editor.

Easterly thinks "the book is rife with interesting conundrums: the Nile river valley is one of the most fertile places on earth, yet Egypt imports half of its wheat; Peru rather than California has captured the US asparagus market; West Africa is the perfect location and climate to produce cocaine for Europe, but coke is instead made in distant Colombia – then routed through West Africa.

Beattie’s explanations, the best parts of the book, are on his home turf: international trade. In a wonderful exposition that should make it into all undergraduate economics classes, Beattie argues that, fertile Nile or not, Egypt is not so much importing wheat as importing water. Only the Nile provides water for the mostly desert country. Wheat takes much water to grow, so the water imports are contained in the wheat imports. By importing wheat, Egypt conserves its own water for drinking and uses other countries’ water to grow wheat shipped to Egypt. This is a wonderful illustration of how trade allows countries to import scarce resources, buying in the goods that would use them, and export their abundant resources, by selling the goods that use those.

To Beattie, the surprising and sad thing is that there are so few “water” exchanges and other such beneficial trades. This is partly because special interests distort trade. For example, the US preaches free trade to Africa, but prefers to keep out African cotton and give $4bn in subsidies to 10,000 American cotton farmers instead. Why? Senators in those farming states would block any reform of the cotton subsidy.

Is importing Peruvian asparagus a happy counter-example of US free trade policy? Unfortunately not, Beattie tells us. It was part of a drug war programme to subsidise Peruvians to grow asparagus rather than coca leaves, giving them privileged access to the US market.

And the cocaine still pours out of Colombia, not West Africa, because even an illegal export needs good roads to get the coca leaves to the factory and then to the port. West Africa’s lack of good roads, Beattie points out, costs it much more in lost exports than even trade policies such as those on cotton."

I'm adding it to my shopping cart...obviously.

The Quiet Coup

In recent months it has been fascinating to observe policymakers' responses to the financial tailspin. However, according to Simon Johnson (former Chief Economist of the IMF) in this article ('The Quiet Coup', from The Atlantic Monthly) two further major responses are necessary: nationalise the banks; and break up the financial oligarchy that rules in America.

Whilst the former suggestion has been much discussed, it is the latter notion, of breaking the financial oligarchy in the US, that is perhaps Johnson's most interesting and controversial point. Drawing a parallel with his experiences with emerging markets during his IMF days, Johnson posits that there exists a 'revolving door' between Wall Street investment banks and the political establishment, to the point where a stint at Goldman Sachs is almost a prerequisite for public service at the highest level. Below an interview with Mr Johnson concerning his article:





Thus the essential message behind Johnson's article is that - like many emerging markets - the US government has been captured by the finance industry. Until the government frees itself from the influence of those whom it is supposed to be regulating, efforts at recovery will fail.

All in all, a fascinating piece from a guy who has been up close and personal with his fair share of banana republics!!!


**Thanks to Daniela Benavente for pointing me in the direction of this article!!

Inspiration Needed??

The middle of semester can often be the time when one tends to enter a bit of a funk and get disheartened about (a lack of) research progress.

In the case that you need a bit of inspiration, you should definitely watch the following video:




This is a lecture by the late Dr Randy Pausch, of Carnegie Mellon University. Diagnosed with terminal cancer and given 6 months to live, Dr Pausch gave an amazingly inspirational speech on how to achieve your childhood dreams and to get past the 'brick wall' blocking your progress. Although watching the whole thing is a bit of a time investment (circa and hour), it is well worth it if you have the time (even if you don't, watching a bit of it can give you the flavour of what he is on about).

Usually I'm a bit sceptical of these kind of motivational speeches, but I found the lecture brilliantly compelling and inspiring. Especially given his circumstances, this is quite an exceptional lecture.

Ponzi Schemes 101

One of the best explanations I have seen yet of the Bernie Madoff Scandal and Ponzi schemes:

The Formula That Shook the World

We all know how central mathematics has become to contemporary economics (and finance), but who would have thought that a (seemingly innocuous) mathematical function could be downright lethal to the world financial and economic systems??

Up until I read this article about the 'Formula That Killed Wall Street', if you had said to me that maths could be responsible for the mess we are in today, I would never have believed you. This all changed when I read about the way in which the 'Gaussian Copula' function was used by the bankers to price the risk of the assets they were acquiring (more specifically, it was used to boil default correlations down to one simple, elegant and irresistible parameter).

Not only is this article is fascinating in terms of shedding light on the detailed mathematical mechanism behind the calamity we are currently involved in, but it also raises a broader, more philosophical question about science and the eventual responsbilities of those engaged in scientific activities for the consequences of their inventions. That is, whilst the inventor of the formula, a math whiz kid by the name of David X. Li (it was Li's paper which pioneered the use of the Gaussian copula function), isn't quoted directly in the article, some mention that Li himself shouldn't be blamed for the way in which his invention was (ab)used by the bankers, and therefore should escape blame for the world's problems. On the other hand, the bankers might say that they, acting in good faith, trusted the formula to be correct in its pricing of risk and therefore should be absolved of their actions.

This article therefore raises an interesting question - to what extent do those involved in scientific endeavours, such as ourselves, bear responsibility for the later consequences of the use of our research? For example, Einstein came to regret the way in which his theory was used in the development of the atomic bomb (although he was not directly involved in the Manhattan Project himself, - he only coauthored a letter urging Roosevelt to commission the project - his theoretical advances were used by his colleagues to develop nuclear weapons and wreak havoc on the world).

So should we as scientists bear any responsbility for the way in which people use our research advances, or is it up to those who twist our research for their own ends to bear the blame?

Interested in your thoughts!!

Larry Summers

We had the chance to see Summers in person last year when he came for a speech at HEI...I wonder how much the school paid him for his speech.
According to Financial disclosure forms released by the White House Summers was paid more than $2.7 million last year in speaking fees by several troubled Wall Street firms and other organizations. He also collected roughly $5.2 million in compensation from hedge fund D.E. Shaw and made $586,996 in salary from Harvard University...The article mentioning this in the Washington Post is here.

Does this make him a bad guy? Not yet I guess. But I did notice something weird about him...I've never seen him smile or make a joke here and there...Beware of people that never smile.

Animal spirits

It's funny that no one mentioned the new book by Akerlof and Schiller during yesterday's debate on macroeconomics. Animal spirits is discussed in this week's economics focus and i really feel like reading it...The Economist write that "Macroeconomists need to apply some new lessons and relearn some old ones!"

Five classes of spririts to take into accout
"Akerlof and Shiller spin five classes of spirit. First and closest to the original is confidence. This goes beyond a rational estimate of next week’s share price, or the price in ten years’ time of what a new factory might produce. And confidence, or the lack of it, builds on itself—in a way similar to Keynes’s multiplier, but defying easy quantification. Second is fairness. Even if economists know that fairness matters, too little of their work reflects it [as I had explained here] . Third is corruption, or bad faith: what explains a Charles Ponzi or an Enron? Fourth is money illusion: economists have come to assume that people see through inflation, but they don’t, especially when it is low. The fifth they call “stories”. Economists are loth to suppose that people are irrational enough to latch onto plausible tales and forecasts—for example, that house prices will never go down. So their models won’t spot the consequences of misplaced belief until it is too late."

Does anybody think this is not gonna be a good book?

Moyo's book - Sexism and twisted incentives

I read Dead Aid and I liked it a lot, almost as if I had written it. Not only does she explains clearly the multiple mechanisms through which aid causes underdevelopment (Easterly doesn't), half of her book is devoted to explaining how new ways of financing Africa's development, that do not involve aid, like government bonds, microfinance, remittances, and the Chinese can be the solution. She explains convincingly how ending aid(except humanitarian and emergency aid) in the next 5 years could work .

And now I'm reading how most of the reviews (collected here) are discrediting her ideas, including The Economist, who was so nice with Calderisi's "The trouble with Africa" whose suggestion was to limit aid to 5 countries, or with Collier or Easterly. Everyone (except Easterly) gives her shit for a lack of objectivity and selectivity that is true of any book and is never mentioned in reviews of books written by men…This is sexism big time.

But the worst review comes from Roodman at the Center for Global development. He says that "the book is sporadically footnoted, selective in its use of facts, sloppy, simplistic, illogical, and stunningly naive" and that he has "probably done more than anyone to challenge studies showing that aid “works” on average." Really? What does he know about development except the blah blah he hears in DC and reads on the internet and writes in papers using xtabond2 to show that aid works?

A huge part of the negaitive reaction from the development community is also explained in her book and here by Ross Levine. In the aid industry, incentives to keep the lending money flowing trumps any incentive to get the advice right on important issues.

So do read her book.

Stimulating consumption

What about a negative VAT? Like a 10% reimbursement on everything you buy. The measure would be temporary and funded the same way as the stimulus bill. And unlike tax cuts the income would not be saved but spent for sure since it is only after consuming that you get your money back. Could it work?