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April 19, 2015

Latest Posts from Economist's View

Latest Posts from Economist's View


The Lifelong Effects of Early Childhood Poverty

Posted: 19 Apr 2015 12:24 AM PDT

Links for 04-19-15

Posted: 19 Apr 2015 12:06 AM PDT

'Are We Kidding Ourselves on Competition?'

Posted: 18 Apr 2015 10:08 AM PDT

This seems implausible to me, yet there seems to be evidence for it:

Are we kidding ourselves on competition?, by Joshua Gans: ...Consider a situation where there are 10 firms in a market and they compete with one another. Now suppose that all shareholders — say because they are following the dicta of diversification — allocate their wealth in equal proportion across those 10 firms. That means that each owner of the firm — even if there are thousands of these — cares equally about each firm's profits.
So ask yourself: when those shareholders vote on the composition of boards or the management of the firm, or, importantly how the management of the firm is compensated, are they going to vote for managers who will care only about the profits of the firm they manage or about the profits more broadly? The answer is obvious: they will look to managers who manage in the interest of shareholders and so that means they care about all firm profits and not just the one of their own firm.
In a world where shareholders can get what they want, we won't have competition in this outcome but, more likely, a collusive outcome. What is more, the firms won't have to go to all the difficulty of violating antitrust laws to obtain this outcome, they will do it unilaterally. There are no laws against that. ...
Now this isn't just speculation. Jose Azar, an economist now at Charles River Associates, did his Princeton PhD on this topic. His theory paper is here and it builds on others including Gordon (1990), Hansen and Lott (1995) and O'Brien and Salop (2000). Frank Wolak and I came up with a similar set of issues related to cross-ownership and hedging in electricity markets (for vertical ownership) and verified anti-competitive consequences arising from this. But Azar, along with Martin Schmalz and Isabel Tecu have demonstrated that cross-ownership has anti-competitive impacts on the US airline industry. They find that cross ownership increases US airline prices 3–5%. When they use the event whereby BlackRock acquired Barclays Global Investors (a merger changing the shares of common ownership in airlines), they found such ownership could indicate 10% bumps in pricing with US airline ticket prices rising by 0.6% as a result of that merger alone. ...
The point here is that we cannot really ignore this issue as economists or as policy-makers. We have "known" about it for decades. Now's the time to take it seriously.

[There's a bit more in the original post.]

NBER Annual Conference on Macroeconomics: Abstracts for Day Two

Posted: 18 Apr 2015 06:01 AM PDT

First paper:

Declining Desire to Work and Downward Trends in Unemployment and Participation, by Regis Barnichon and Andrew Figura: Abstract The US labor market has witnessed two apparently unrelated trends in the last 30 years: a decline in unemployment between the early 1980s and the early 2000s, and a decline in labor force participation since the early 2000s. We show that a substantial factor behind both trends is a decline in desire to work among individuals outside the labor force, with a particularly strong decline during the second half of the 90s. A decline in desire to work lowers both the unemployment rate and the participation rate, because a nonparticipant who wants to work has a high probability to join the unemployment pool in the future, while a nonparticipant who does not want to work has a low probability to ever enter the labor force. We use cross-sectional variation to estimate a model of non-participants' propensity to want a job, and we find that changes in the provision of welfare and social insurance, possibly linked to the mid-90s welfare reforms, explain about 50 percent of the decline in desire to work.

Second paper:

External and Public Debt Crises, by Cristina Arellano, Andrew Atkeson, and Mark Wright: Abstract In recent years, the members of two advanced monetary and economic unions -- the nations of the Eurozone and the states of the United States of America -- experienced debt crises with spreads on government borrowing rising dramatically. Despite the similar behavior of spreads on public debt, these crises were fundamentally different in nature. In Europe, the crisis occurred after a period of significant increases in government indebtedness from levels that were already substantial, whereas in the USA state government borrowing was limited and remained roughly unchanged. Moreover, whereas the most troubled nations of Europe experienced a sudden stop in private capital flows and private sector borrowers also faced large rises in spreads, there is little evidence that private borrowing in US states was differentially affected by the creditworthiness of state governments. In this sense, we can say that the US States experienced a public debt crisis , whereas the nations of Europe experienced an external debt crisis affecting both public and private borrowers. Why did Europe experience an external debt crisis and the US States only a public debt crisis? And, why did the members of other economic unions, such as the provinces of Canada, not experience a debt crisis at all despite high and rising provincial public debt levels? In this paper, we construct a model of default on domestic and external public debt and interference in private external debt contracts and use it to argue that these different debt experiences result from the interplay of differences in the ability of governments to interfere in the private external debt contracts of their citizens, with differences in the flexibility of state fiscal institutions. We also assemble a range of empirical evidence that suggests that the US States are less fiscally flexible but more constrained in their ability to interfere in private contracts than the members of other economic unions, which simultaneously exposes the states to public debt crises while insulating them from an external debt crisis affecting private sector borrowers within the state. In contrast, Eurozone nations are more fiscally flexible but have a greater ability to interfere with the contracts, which together allow for more public borrowing at the cost of a joint public and private external debt crisis. Lastly, Canadian provincial governments are both fiscally flexible and limited in their ability to interfere, which allows both for more public borrowing and limits the likelihood of either a public or external debt crisis occurring. We draw lessons from these findings for the future design of Eurozone economic and legal institutions.

Explaining the Dearth of Private Investment

Posted: 18 Apr 2015 05:38 AM PDT

From Vox EU:

Explaining the dearth of private investment, by Aqib Aslam, Samya Beidas-Strom, Daniel Leigh, Seok Gil Park, Hui Tong: Business investment in advanced economies contracted sharply during the global crisis and has recovered little since. This column argues that the main factor holding back investment is overall economic weakness. In some countries other contributing factors include financial constraints and policy uncertainty. Fixing the investment dearth will require fixing the general weakness in economic activity.
The debate continues on why businesses aren't investing more in machinery, equipment, and plants. In advanced economies, business investment – the largest component of private investment – has contracted much more since the global financial crisis than after historical recessions. There are worrying signs that this has contributed to the erosion of long-term economic growth.
Getting the diagnosis right is critical for devising policies to encourage firms to invest more. If low investment is mainly a symptom of a weak economic environment – with firms responding to weak sales as some suggest1 – then calls for expanding overall economic activity could be justified.2 If, on the other hand, if special impediments are mainly to blame, – such as policy uncertainty or financial sector weaknesses, as others suggest (European Investment Bank 2013, and Buti and Mohl 2014, for example), – then these must be removed before investment can rise.
Weak economic activity key factor
Our analysis in chapter 4 of the IMF's April 2015 World Economic Outlook suggests that the weak economic environment is the overriding factor holding back business investment.
Investment contracted more severely following the global financial crisis than in historical recessions, but the contraction in output was also much more severe (Figure 1). The joint behavior of business investment and output has therefore not been unusual. The relative response of investment was, overall, two to three times greater than that of output in previous recessions, and this relative response was similar in the current context. If anything, investment dipped slightly less relative to the output contraction than in previous recessions.

Figure 1. Real business investment and output relative to forecasts: Historical recessions versus Global Financial Crisis (Percent deviation from forecasts in the year of recession, unless noted otherwise; years on x-axis, unless noted otherwise)

Sources: Consensus Economics; Haver Analytics; national authorities; and IMF staff estimates.
Note: For historical recessions, t = 0 is the year of recession. Deviations from historical recessions (1990–2002) are relative to spring forecasts in the year of the recession. Recessions are as identified in Claessens, Kose, and Terrones 2012. For the global financial crisis (GFC), t = 0 is 2008. Deviations are relative to pre-crisis (spring 2007) forecasts. Shaded areas denote 90 percent confidence intervals. Panels 1 and 2 present data for the advanced economies (AEs). GFC crisis and non-crisis advanced economies are as identified in Laeven and Valencia 2012.

At the same time, the endogenous nature of investment and output – that is, the simultaneous feedback from output to investment and then back to output – complicates the interpretation of these results. To correct for this endogeneity, we use an instrumental variables approach and estimate the historical relationship between investment and output based on macroeconomic fluctuations not triggered by a contraction in business investment. Our instruments are changes in fiscal policy motivated primarily by the desire to reduce the budget deficit and not by a response to the current or prospective state of the economy (Devries and others, et al 2011). We use the results to predict the contraction in investment that would have been expected to occur after 2007 based on the observed contraction in output. We then compare the predicted decline in investment after 2007 with the actual decline in investment.
Based on this estimated historical investment-output relation, business investment has deviated little from what could be expected given the weakness in economic activity (Figure 2). In other words, firms have reacted to weak sales – both current and prospective – by reducing capital spending. Indeed, in surveys, businesses typically report lack of customer demand as the dominant challenge they face.

Figure 2. Real business investment in advanced economies: Actual and predicted based on economic activity (Percent deviation of investment from spring 2007 forecasts)

Sources: Consensus Economics; Haver Analytics; national authorities; and IMF staff estimates.
Note: Prediction based on historical investment-output relation and post-crisis decline in output relative to pre-crisis forecasts. Shaded areas denote 90 percent confidence intervals.

Factors beyond output
Beyond this general pattern, we find a few cases of investment weakness that go beyond what can be explained by output – particularly in Eurozone countries with high borrowing spreads during the 2010-2011 sovereign debt crisis. After controlling for financial constraints and policy uncertainty, the degree of unexplained investment weakness declines for these economies, suggesting a role for these factors beyond the weakness in output. At the same time, identifying the effect of these factors is challenging based on macroeconomic data, particularly given the limited number of observations for each country since the crisis.
Confirmation of these additional factors at play comes from our analysis of investment decisions by different types of firms. Investment by firms in sectors that rely more on external funds (such as machinery producers) has fallen more since the crisis than investment by other types of firms. And firms whose stock prices typically respond more to measures of aggregate uncertainty have cut back more on investment – even after the role of weak sales is accounted for. This suggests that, given the irreversible and lumpy nature of some investment projects, uncertainty has played a role in discouraging business investment.
Figure 3 provides a simple illustration of this finding by reporting the evolution of investment for publically-listed firms in the highest 25% and the lowest 25% of the external dependence distribution for all advanced economies since 2007. By 2009 investment had dropped by 50% (relative to the forecast) among firms in more financially dependent sectors – about twice as much as for those in less financially dependent sectors. In the case of policy uncertainty, investment had dropped by about 50% by 2011, relative to the forecast, in sectors more sensitive to uncertainty – more than twice as much as in less sensitive sectors.

Figure 3. Firm investment since the Crisis, by firm type (Percent; impulse responses based on local projection method)

Sources: Thomson Reuters Worldscope; and IMF staff calculations. Note: Less (more) financially dependent and less (more) sensitive firms are those in the lowest (highest) 25 percent of the external dependence and news-based sensitivity distributions, respectively, as described in the chapter. Shaded areas (less dependent/sensitive) and dashed lines (more dependent/sensitive) denote 90 percent confidence intervals.

Policies to boost investment
We conclude that a comprehensive policy effort to expand output is needed to sustainably raise private investment. Fiscal and monetary policies can encourage firms to invest, although such policies are unlikely to fully return restore investment fully to pre-crisis trends. More public infrastructure investment could also spur demand in the short term, raise supply in the medium term, and thus 'crowd in' private investment where conditions are right. And structural reforms, – such as those to strengthen labor force participation, – could improve the outlook for potential output and thus encourage private investment. Finally, to the extent that financial constraints hold back private investment, there is also a role for policies aimed at relieving crisis-related financial constraints, including through tackling debt overhang and cleaning up bank balance sheets.
References
Buti, M and P Mohl (2014), "Lacklustre Investment in the Eurozone: Is There a Puzzle?", VoxEU.org.
Chinn, M (2011) "Investment Behavior and Policy Implications", Econbrowser: Analysis of Current Economic Conditions and Policy (blog).
Devries, P, J Guajardo, D Leigh, and A Pescatori (2011) "A New Action-Based Dataset of Fiscal Consolidation in OECD Countries", IMF Working Paper 11/128, International Monetary Fund, Washington.
European Investment Bank (2013), Investment and Investment Finance in Europe, Luxembourg.
Krugman, P (2011), "Explaining Business Investment." The New York Times, 3 December.
Lewis, S, N Pain, J Strasky, and F Mankyna (2014), "Investment Gaps after the Crisis", Economics Department Working Paper 1168, Organisation for Economic Co-operation and Development, Paris.
Footnotes
1 See Chinn (2011) and Krugman (2011) for example.
2 Lewis and others (2014) find that, although it has been a major factor, low output growth since the crisis cannot fully account for the weak investment weakness in some of the major advanced economies.

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