Barcelona GSE Trobada: The Future of Europe Roundtable – Finance (1/3)

A European (dis)Union

“What is going wrong in the European Union these days?” is probably the question that many European voters have been trying to answer in the past few years and all recent events keep pointing at it. First, the recent showdown between Bundesbank President Weidmann and ECB President Draghi on fiscal policy reminded us that even the monetary union, though initiated first to trigger political union, remains a far from smooth cooperation. Second, the theme of (im)migration has been at the very core of the Brexit campaign and added to the overall dissent among European political leaders. This brings us to a last topic of politics at the European level that will be key to deliver solutions.

In such a dense context, the 14^th BGSE Economics Trobada 2016 ended up with a very much welcome roundtable focused on “The Future of Europe” and chaired by Professor Jaume Ventura. To help us understand better these various challenges for the EU and its future, Professor Ventura gathered the affiliated Barcelona GSE professors Fernando Broner, Julian di Giovanni and Giacomo Ponzetto.

Breaking the Bank and Bailing out States: Finance in the EU

By Fernando Broner

European Financial Markets

Professor Broner first presented the financial structure of European capital markets, in opposition to that of the United States. Notably, he highlighted that while equity markets play a greater role than banking sector assets in the US, the relation is more than inverted in the EU where banking sector assets are almost six times the size of equity assets.

Equity markets are regulated by the European Securities and Markets Authority (ESMA), founded only recently in 2011. As pointed by Professor Broner, this young regulator still suffers from weak coordination which restrains its action and thus the extension and deepening of European equity markets. Similarly, the International Financial Reporting Standards (IFRS), adopted in 2002 to bring a unified framework and hence foster equity markets, has not been fully enforced. On top of these regulatory inefficiencies, two more reasons also weigh on European equity markets: a strong home bias (64% of EU and 61% of Eurozone equity is held domestically) instead of more interconnections between European countries; as well as the fact that banks mostly lend to each other through debt instruments.

Despite European banks having large activities abroad (18% vs 9% in the US), they are smaller and less diversified, in comparison to their American competitors. However, Professor Broner noted that the crisis prevention framework was today better articulated, under the ECB’s Single Supervisory Mechanism and an improved interaction between the European Commission and the European Banking Authority (EBA) at the rule-making level. The picture is less positive though for crisis management due to responsibilities shared at both the national (lender of last resort, deposit insurance) and European level (Single Resolution Mechanism (SRM) and European Stability Mechanism (ESM)).

Sovereign Debt and Bail Out control

Professor Broner then turned to sovereign debt, another highly sensitive topic for the EU. Prior to the global financial crisis, sovereign risk had almost disappeared in the Euro-area as spreads for all countries were trading in the same range. Part of this decline and convergence in spreads could be explained by expectations of “automatic” bail-outs and a higher cost of default, which proved both inefficient and inaccurate. Along the Eurozone debt crises, various packages were set up to address bail-outs: at the beginning the International Monetary Fund was very active along with European countries and progressively took a step back to let the EU new financial institutions (first the European Financial Stability Facility then the ESM) take over and manage the bail-outs packages. Even the ECB has been directly involved with its Security Markets Programme enacted in 2010 to purchase mostly sovereign bonds. Professor Broner highlighted the unclear role of the ESM: it is similar to a bank capitalized by Eurozone members, whose priority is to provide liquidity. However, it remains criticized by some countries as it offers a kind of transfer scheme, notably through its high maturity loans at very low interest rates. Another challenge is the “sovereign-bank embrace” generated by the current institutional setup, with Eurozone banks holding more and more government bonds. This has serious implications as it crowds out lending to the private sector and reinforces banks’ exposure to sovereign risk while reciprocally banks’ exposure affects also government on the fiscal side as the cost of banking crises significantly participated to the sharp increase of public debt ratios of these countries.

sovering-bank

Source: Professor Broner’s presentation

Professor Broner concluded his presentation with some recommendations for the future of European finance. First, remaining barriers to international diversification in the equity markets should be removed. Second, banks’ risk sharing should be improved by encouraging more equity exposure as well as consolidation across countries with more regulation of banks’ subsidiaries. Finally, there should some disincentive action against the current sovereign-bank embrace trend with a direct lender of last resort scheme, direct ESM funding for recapitalizing banks and limitations to the sovereign exposure.

Re-thinking Inequality and How to Measure it

Processed with VSCO with g3 preset

On 26 October 2016, Chilean economist Dr. José Gabriel Palma gave a lecture, organised by Institut Barcelona d’Estudis Internacionals (IBEI) – “Why is inequality so unequal in the world? Do Nations just get the Inequality they deserve?” During the lecture, he also presented his recently-published working paper, which re-examines the eponymous Palma Ratio [1].

Forces at work

In an earlier paper, published in 2011 [2], Dr. Palma had already highlighted the two forces pertaining to rising inequality across the world: ‘One is ‘centrifugal’, and leads to an increased diversity in the shares appropriated by the top 10 and bottom 40 per cent. The other is ‘centripetal’, and leads to a growing uniformity in the income-share appropriated by deciles 5 to 9’ (Palma, 2011). Decile 10 refers to the top 10 per cent, and deciles 5 to 9 can be interpreted as the middle-upper class. What this means is that the middle-upper class has been quite successful at protecting their shares, and anybody who genuinely wants to understand inequality within a country should really focus on the income-share of the top 10%. As Clinton’s campaign strategist put it crudely: “It’s the share of the rich, stupid.”

Gini or Palma?

The Gini coefficient, developed by Corrado Gini, is an index measuring income inequality, with 0 implying perfect equality, and 1 meaning perfect inequality. The Gini coefficient has been in use for a long time, but is not without its limitations. Atkinson (1970) [3] pointed out that the ‘Gini coefficient attaches more weight to transfers affecting middle income classes and the standard deviation weights transfers at the lower end more heavily.’ In other words, the Gini index is more sensitive to changes in the middle of the distribution, and less sensitive to changes at the top and bottom. Cobham and Sumner (2013) [4] have also echoed similar sentiments and criticised the use of the Gini index. They have in fact coined the term ‘Palma ratio’, which is ‘the ratio of the top 10% of population’s share of gross national income (GNI), divided by the poorest 40% of the population’s share of GNI’ (Cobham and Sumner, 2013).

Why might the Palma ratio be a more relevant indicator of the extent of income disparity in an economy? Why is there a growing consensus that the use of the Palma ratio is more appropriate in formulating policies that aim at reducing poverty? The answer is obvious – if an economy has a high Palma ratio, policy-makers can immediately focus on measures to narrow the gap between the top 10% and the bottom 40%. In Palma’s own words: ‘… … it measures inequality where inequality exists; it is also simple, intuitive, transparent and particularly useful for policy purposes’ (Palma, 2016). In contrast, the Gini index is likely to engender distortions because it reflects changes in the distribution where the probability of such changes (i.e. in the middle-upper class) is the lowest. This is such an important consideration that, during the lecture at IBEI, Dr. Palma cautioned his audience to ponder about norms versus distortions. Indeed, if we are often fixated on the middle-upper class, whose homogeneity is evident across the world, we might just be turning a blind eye to more serious concerns – the norms, that is, the (widening) gap between the extreme ends of the spectrum. In light of this, an inclusion of the Palma ratio in policy design will lead to desirable outcomes.

Other revelations

It is interesting to note that the Palma index has also revealed certain stylised facts.

Source: Palma, 2016

Using the Palma index, the figure shows how inequality increases in an almost linear fashion quite steadily until about the 100th ranking, the point at which most Latin American countries come into the picture (as indicated by the red circles – with the exception of Uruguay), and where inequality starts increasing exponentially.

Moreover, we also need to reconsider the correlation between education and income distribution. Dr. Palma has noted that most of the diversity in educational attainment (especially in terms of tertiary education) across the world is found in the deciles 5 to 9 group. However, ‘why does one find extraordinary similarity across countries in the shares of national income appropriated by this educationally highly diverse group?’ (Palma, 2016). Chile is a case in point. With a rate of 71% of gross tertiary enrolment, the income share generated by deciles 7 to 9 in the country is about the same as that of the Central African Republic, which has a gross tertiary enrolment at only 3.1% (Palma, 2016). Hence, is it really all about education? Or is it that the positive externalities and effects of education will truly manifest themselves only in certain institutional settings? Ostensibly, more research has to be done to unravel the intricacies of the relationship between income disparity and educational attainment.

“We know very little.”

That was what Dr. Palma emphasised, during the lecture, to a sea of concerned faces amongst the audience. However, that is undoubtedly the right attitude to adopt as we challenge certain mainstream ideas in economics. Apart from being assiduous in the journey of constantly refining our tools of analysis, as demonstrated by the shift from the Gini index to the Palma ratio, we should also make a conscientious effort in reflecting about norms versus distortions. Indeed, from time to time, one must always make a critical assessment of the aspects on which one should focus.

References:

[1] Palma, J. G. (2016) ‘Do Nations just get the Inequality they Deserve? The ‘Palma Ratio’ Re-examined’, Cambridge Working Paper Economics, no. 1627, University of Cambridge.

[2] Palma, J. G. (2011) ‘Homogenous middles vs. heterogeneous tails, and the end of the ‘Inverted-U’: the share of the rich is what it’s all about’, Cambridge Working Paper Economics, no. 1111, University of Cambridge.

[3] Atkinson, A. B. (1970) ‘On the Measurement of Inequality’, Journal of Economic Theory 2. p.244-263.

[4] Cobham, A., and Sumner, A. (2013) ‘Is it all about the tails? The Palma Measure of Income Inequality’, CGD Working Papers, no. 343, Center for Global Development.

In favor of a mixed pension system: a review of the Chilean case

Written by: Fernando Fernandez and Mario Giarda

photo credit: Reuters

Some weeks ago, The Economist published an article about the state of the pension system in Chile. The article focused on the discontent that the system has generated since it was implemented back in 1981, under the military dictatorship of Augusto Pinochet.

Since its conception, the current Chilean pension system was built on two values: long-run sustainability and individual responsibility. These characteristics should be the building blocks of any pension system, and we think that most people would agree with them. Nowadays, the discontent comes from the low pensions this system is delivering, and the disproportionately high commission/fees charged by pension managers. In our view, given the current parameters of the system (retirement age, monthly individual contributions, return on funds), pensions would be hardly increased without incurring in higher public costs or higher individual effort. So, any scheme (individual accounts, pay-as-you-go, etc.) would face serious challenges in delivering acceptable pensions.

In what follows, we briefly describe the history of the system and analyze its current state. Then we discuss the main issues of recent debates. We argue that the first policy action is to change the parameters the system is working with. Finally, we discuss that the best pension system should be a mixed system based on two pillars: individual contributions and a solidarity pillar, the former financed with individual accounts and the latter funded by the State. This is exactly the current Chile’s pension system. In this piece, we aim to defend it and propose some policies to enhance its performance given the current state of the Chilean economy. Moreover, this article would be helpful to analyze other pension systems that are being stressed by the same developments taking place in Chile, like most European economies and countries have adopted similar systems like Peru.

A brief history of the system

The Chilean pension system was reformed during Augusto Pinochet’s dictatorship (1973-1988). In 1981, the reform meant to go from a pay-as-you-go system to a private individual accounts system. The system was later reformed twice, in 2002 and 2008, under democracy.

The previous system was composed by institutions called “Cajas de Previsión” (union pension funds and banks), which collected contributions from workers in order to deliver a set of benefits to their affiliates. These Cajas were in charge of providing health services, disability pensions, and retirement pensions. By 1979 the system had 35 Cajas and 150 retirement plans. Cajas were based on workers’ occupations (or industries) so individuals from different occupations were allocated into different Cajas. Benefits were fairly similar within each caja, but there were important differences in pension benefits across Cajas. Not surprisingly, given the heterogeneity between Cajas, the overall system was highly segregated and its was especially bad for low income workers.

The system relied on high contributions from both workers and employers. These contributions ranged from 9.5% to 18.8% of workers’ income and from 7% to 44.4% of workers’ salaries charged to employers. These previous rates were much higher than current figures, even when retirement ages were 60 for women and 65 for men, and life expectancy was lower than today. Thus, the system seemed to be sustainable for itself.

The pension reform of 1981 was part of a broader set of reforms conducted under Pinochet’s dictatorship. It went from the old system to a system based on individual accounts. The new system was mandatory for new workers and voluntary for workers that were already in the pay-as-you-go system[1] (i.e. once you changed, you could not go back). In the new system, contributions were made only by workers. In order to make the system attractive, the contribution rate was reduced to 10% of the labor income. These funds enter into an individual account that is managed by a Pension Fund Administrator (AFP, in Spanish). In the beginning, these AFPs charged a high monthly fee to manage the funds; however, they had fallen from 5% of labor income to only 0.47% in more recent times. Retirement ages remained the same despite improvements in life expectancy, but an early retirement scheme was introduced.

The AFPs can invest in domestic or foreign capital markets. Their investments are highly regulated by type of asset, risk level, or countries. Since 2002, affiliates can choose to invest in up to five different funds with different risk profiles.

In 2008, because of low pension benefits, a state-funded solidarity system was introduced using fiscal revenues. These public funds are used for two purposes: to ensure that pension benefits are higher than or equal to a minimum pension and to provide pension benefits to the elderly who did not contribute enough to the system. Finally, the reform also added a voluntary contribution to the pension fund, complemented by a state-provided subsidy. Hence, the current system is a mixed one based on three pillars: the compulsory contribution pillar, the voluntary contribution pillar, and the solidarity pillar.

The current state of the system

The functioning of any pension system is mainly determined by two factors: how the labor market works and the demographic structure.

The first factor is the Chilean labor market, which is characterized by low participation rates, especially among women, the young, and the elderly (above 60 years old). These low rates are concentrated among unskilled workers who are more likely to earn both lower and more volatile incomes. According to CASEN 2013[2], labor force participation was 71% for men and 48% for women. Moreover, only 53.3% of employed men held job contracts and this figure is 29.1% for women. Low labor market participation means lower pension benefits, regardless of the system (pay-as-you-go or individual accounts).

Another feature of the Chilean labor market is the low proportion of workers that contributes to the pension system at any time. Only workers with a formal contract contribute to the pension system. One third of the population hold such contracts. This low proportion implies that, for a given worker, the average time of contributing to the system is 22 years for men and for 15 women. Evidently, this period is not long enough because pension benefits are supposed to finance retirees’ consumption for 19 years in men and 29 years in women, according to current life expectancy figures. With these figures in mind, it is easy to see that in the long run, pension benefits will not be higher unless effective policies are implemented to address the weaknesses of the labor market.

The second factor is an ageing population, which is challenging every pension systems around the world and Chile is not the exception. Rapid reductions in fertility rates, coupled with increases in life expectancy, imply that the share of the elderly would steadily grow. This age group has rapidly increased its relative size in recent decades. In 1990, the population of 60+ years was only 9% of the entire population. It increased to 15% in 2015; and it is expected to reach 30% in 2050. This rapid growth means that the quantity of elderly will increase from 2.7 to 6.3 million, making the ratio of active to old to fall from 5 to 1.8. To get a sense of the consequences of an ageing population, consider the following hypothetical scenario: If the active population needed to contribute 20% of their income to a pay-as-you-go scheme in 1990, then in 2050, it would be necessary for active workers to finance it with more than 50% of their income. This is clearly unfeasible.

The combination of a weak labor market and a rising elderly population implies that pensions have been disappointingly low (relative to the promise made when the system was introduced). The coverage (workers that actually contribute) of the system reaches to 65% of the workforce. Contributions are highly unequal. Workers in the tenth income decile contributed 87% of their working life, while individuals in the bottom quartile contributed only 12%. This is mainly because of a precariousness of the labor market, in which low wages are associated with informality, self-employed workers and unemployed.

In 2013, the system delivered pension benefits to 84% of the elderly population. This figure increased from 79% in 2006 following the introduction of the Basic Solidary Pension (BSP), the minimum level of pension any elderly should receive.

The replacement rate measures the pension benefit as a fraction of the mean income in the ten years before retirement. The current rates are 60% for men and 31% in women if we include the BSP. The corresponding figures without the BSP would be 48 and 24%, respectively. A commission of experts -gathered to analyze the pension system – projected that these figures will be 41% and 34% for the period 2025-2035.[3] These levels are low compared to the average OECD country which is around 60%.[4]

The discussion

Any policy reform to the pension system should consider safety nets for the elderly, including improved health care and housing assistance. Apart from that, the pension system must follow some criteria. The two most important ones are that it must deliver reasonable pensions and be sustainable.[5]

Chile must move to a State owned and managed pay-as-you-go system and the funds we have already accumulated should go to a common single fund to finance high pensions.

Supporters of this proposal do not want to go back to the old system of “Cajas”. Instead, they propose to concentrate all contributions in a unique state-managed fund, so that the government is in charge of collecting taxes or contributions and delivering pension benefits to retired people. This proposal may be feasible in the short-run (as the system is already funded) but will be unsustainable in the long-run, because the demographic structure implies that at some point in the near future, the total amount of pension benefits would require working people to contribute, at least, 50% of their earnings, as we mentioned before. Hence, the only way to have a sustainable pension system is to increase savings of young workers now. In fact, the whole Chilean economy should start saving more now.

Also, we must decide how and where to save. Some people argue that is not morally acceptable to invest pension funds in the private sector, financing large or foreign firms because these companies usually collude with competitors or pay low wages to their employees. In the first argument, we assert that companies that engage in illegal practices of any type should be sued and prosecuted by the law regardless of whether they receive pension funds or not. In the second argument, we think that their analysis on wages is flawed. They claim that it is not acceptable to invest in firms that pay low wages because this exacerbates the problem of low wages which, in turn, perpetuates low pensions. This is hardly true. On the one hand, employees of large companies usually earn higher wages and are much more likely to have a formal job contract than workers in smaller firms. On the other hand, pension funds flowing to large companies may reduce their financial costs (through better cost structure) which could mean that these firms can pay higher wages, and not the other way around. In any case, the objective of supporting small firms and funding entrepreneurs is desirable but it is not the goal of pension systems in any part of the world. Promoting entrepreneurship is beyond the scope of any pension system and hence governments should have tailored policies for this end (one tool for one target). If we want higher pension benefits, funds should go to companies with high returns, independent of their ownership or size.

We think that these funds should be mostly privately managed. In order to ensure profitability and sustainability, we need professionals in charge of them. Since these funds determine not only economic stability for each individual, but also for the whole economy, managers must be experts, with solid technical skills. In this way, we prevent politicians from using these funds for short-run purposes that go beyond the scope of the pension system. Having said this, we acknowledge that the management of funds must be highly regulated, even though it may go against maximizing economic returns.

Finally, we argue that the state must be in charge of complementing the pensions that do not reach a minimum level. This must be financed with part of the individual contribution pillar (not all) and fiscal revenues.

It is a problem of parameters and not of how the system is organized.

Even after solving the problems related to the labor market (low participation, low coverage) and demographic structure, we claim that, at least in the short run, it is necessary to change the parameters of the system.In our opinion, the system does not have enough funds. More money is going out than coming in. And this gap will widen as time goes by.

The contribution rate of 10% of income is too low. We propose to gradually increase this rate to between 15 and 20%. These additional funds would go into both individual accounts and the solidarity pillar, in order to ensure higher pension benefits for everybody.

Efforts should be made in order to ensure that independent workers, who account for 25% of the labor force, contribute to the system. This implies that contributions should be based on total personal income and not only labor income. AFPs must provide innovative contribution schemes for independent workers, taking into account that their incomes are relatively more volatile than that of employees. Given that most new workers are entering the labor market later (the time they need for college and post-graduate education) and have higher life expectancy, we also propose to progressively extend retirement ages from 65 to 70 for men and from 60 to 70 for women.

We also need to encourage competition among AFPs in order to obtain higher efficiency and better performance. In order to lower the administration fees, we would maintain the public bids of new workers to the system. As more workers join the system, we could expect lower fees and higher returns due to economies of scale.

Currently, each fund manager must reach a capital requirement of 1% of the total amount it is administering, and invest it in the same portfolio of their clients. We think this is not enough to align the incentives of the managers with their client’s, so instead, we propose to link monthly fees to AFP’s performance. This is because sometimes returns could be negative due to mismanagement of the AFP. Also, managers must improve the information delivered to their clients, regarding how their funds are invested and the fees payment. Hopefully, this increased transparency, coupled with better incentives, will improve the returns and the alignment of AFP profits with individual returns. However, these measures would imply that AFPs will not take enough risks and may reduce the returns on funds. To overcome that, we propose to open pension funds investments to a broader set of assets, and an obvious example of this is Public Works.

Finally, we propose to enhance the capabilities of the permanent committee for the evaluation of the pension system. The goal of this committee should be to assess the performance and sustainability of the system on a regular basis. It should be in charge of setting the parameters: amount of contributions, retirement age, and the way the system invests the resources. This committee should be independent of the regulator and the government.

[1] Military personnel had a special different treatment.

[2] CASEN: Encuesta de Caracterización Socioeconómica, in English “Socioeconomic Characterization Survey”.

[3] Its report is the source of most of the figures shown in this article. http://www.comision-pensiones.cl/Documentos/Informe

[4] According to “Pensions at a Glance”, OECD 2015. See the report in http://www.oecd.org/publications/oecd-pensions-at-a-glance-19991363.htm

[5] Respect to OECD pensions’ levels.

The 2016 Nobel Prize in Economics and how to ensure kids do their chores

As any child promised a weekly allowance in return for chore completion can tell you: details matter. When does the trash need to be taken out? What counts as a completely made bed? What happens if someone else makes a mess after that area has been cleaned? The parent wants the chores completed well and timely while the child wants to achieve sufficiency for her weekly candy money. All of these questions that immediately race through the mind of our young adolescent form, little to her knowledge, the basics of contract theory.

These frictions between parent and child, the insurer and the insured, the employer and the employee, and almost any professional relationship between two or more agents, provide the research area of the winners of the 2016 Nobel Prize in economic sciences. Doctors Oliver Hart and Bengt Holmström, both of whom are current members of the BGSE Scientific Council, were awarded the prize for their work focusing on the trade-offs in setting contract terms earlier this week.

The central question plaguing contracts is not what specific form they should take, as there seem to be an infinite number of qualifications even a simple chore contract might inspire, but rather how to regulate the behavior of the agents involved. Applying our example to the case of the firm and its workers, it is clear the firm desires excellent work from the employee, and the employee seeks to know exactly what constitutes the work needed to earn the incentive.

Dr. Holmström’s research on performance-based pay of management and executives directly considers this. His findings suggest pay should be tethered to measures such as company share performance relative to that of direct competitors as opposed to the more commonplace linking to share price alone. Further, his analysis of the insurance market sought to bridge the gap between insurance providers and their clients. Despite the more optimal state of the individuals purchasing full insurance, co-payments still exist. This is because insurers are seeking to disincentivize costly, unnecessary doctor trips. In essence: how can the parent avoid being taken advantage of and how much should our young teenager be paid for her household work?

The work of Dr. Hart attempts to resolve the infinite questions regarding how our teenager can warrant the weekly allowance or how workers will earn their salary. Rather than laboriously delineate every potential scenario a worker may face and how they should respond, Dr. Hart would suggest decision rights be pre-determined amongst agents. This would allow unilateral decisions through a pre-agreed framework to be made when frictions arise. Additionally, the granting of ownership rights, contends Dr. Hart, greatly alters agent behavior. The ice-cream shop manager granted an ownership stake is ostensibly more motivated to work hard. On the other hand, cutting costs by purchasing lower quality ice-cream ingredients might accomplish the same goal at the expense of the shop’s reputation. The important takeaway from the research is that how the rights of ownership and decision-making are divided greatly affects the behavior of actors.

The duo may not have completely quieted all the concerns of the parent or child in the chore contract (or in any of the infinitely many contracts that span our daily lives). However, they have provided a framework to better understand relationships between the agents represented in these little documents so fundamental to society.

You can also read about the 2016 Nobel Prize recipients on the BGSE main website. https://bse.eu/news/nobel-prize-economics-scientific-council-oliver-hart-bengt-holmstrom

Markets or organisations? UPF guest lecture by Robert Gibbons

Image source: UPF

If an alien came to earth from outer space wearing glasses that show organizations in pink, and markets in green, what would it see? Would it see more green, and describe our activities on earth as a market economy, or more pink, pointing to an organizational economy? What systematic differences would it notice between underlying circumstances that give rise to green systems, and circumstances that give rise to pink, and would the quality of the outcomes differ for markets and organizations? Finally, would the alien be able to give any advice on how to improve outcomes where we try to solve problems by means of organizations?

Continue reading “Markets or organisations? UPF guest lecture by Robert Gibbons”

Vaccine-preventable Childhood Disease and Adult Human Capital: Evidence from the 1967 Measles Eradication Campaign in the United States

Editor’s note: This post is part of a series showcasing Barcelona GSE master projects by students in the Class of 2016. The project is a required component of every master program.

Authors:
Philipp Barteska, Sonja Dobkowitz, Maarit Olkkola, Michael Rieser, Pengfei Zhao

Master’s Program:

Economics

Abstract:

Measles is currently one of the leading causes of death for young children worldwide. We analyze the impact of measles prevention on later-life human capital outcomes by taking advantage of a measles eradication campaign implemented in 1967 in the United States. We provide evidence with a difference-in-differences design from the 2000 US census micro-sample for the following statistically significant results: the campaign increased completed years of schooling by two weeks, the probability of completing high school by 0.32 per cent and decreased the probability of being unemployed by 4.26 per cent. Due to the exogenous timing of the eradication campaign, we argue that these results can be interpreted causally. To the best of our knowledge our paper is the first one to document adult human capital impacts of early-life measles exposure using a natural experiment.

chart — Figure 1: Yearly Cases of Measles in the United States

Empirical strategy:

The 1967 measles eradication campaign led to an unprecedented drop in reported measles exposure in the US, as depicted in figure 1.

Our empirical strategy uses the fact that there is variation in measles exposure between states prior to the eradication campaign: the decrease in incidence is highest in those states with the highest incidence rates, as depicted in the first stage relationship in figure 2. This allows for a difference-in-differences design, exploring whether the states that had higher prior exposure to the disease gained more in human capital outcomes than the states with less exposure, controlling for pre-existing state-level linear time trends and state fixed-effects among other controls.

We also perform placebo interventions to test the robustness of our results. As depicted in figure 3, the only positive and statistically significant impacts are found for 1967, the actual intervention year. This lends more support to the causal interpretation of our results.

Conclusion:

In this paper we show suggestive evidence that exposure to a previously common childhood disease can have negative impacts on educational attainment in adulthood, although the effect sizes are not large. This finding strengthens the literature on the early-life origins of human capital.

Our results are for the most part relevant for developing countries, many of which have not yet achieved the vaccination levels required for herd immunity.

Full project available here

Data sources:

IPUMS-USA, University of Minnesota, www.ipums.org.

Project Tycho, University of Pittsburgh, www.tycho.pitt.edu

Aspirations and Academic Achievement: The Spillover Effects of Beca 18 on Educational Outcomes of Younger Students

Elena Costarelli, Rosamaría Dasso Arana, and Bárbara Sparrow Alcázar analyze the effect of being near a Beca 18 beneficiary -a new scholarship program for high school students- on the academic achievement of second grade children.

Editor’s note: This post is part of a series showcasing Barcelona GSE master projects by students in the Class of 2016. The project is a required component of every master program.

Authors:
Elena Costarelli, Rosamaría Dasso Arana, Bárbara Sparrow Alcázar

Master’s Program:
Economics

Abstract:

Using administrative data from the Ministry of Education in Peru, we analyze the effect of being near a Beca 18 beneficiary -a new scholarship program for high school students- on the academic achievement of second grade children. Previous literature suggests that information about the potential returns to education plays an important role on students’ achievement. Our hypothesis is that having a fellow nearby might change the perception of younger children and of their parents about returns to education, thus leading them to invest more on it. We use a difference in difference approach to test this hypothesis in a school panel data setting. As we are interested in the effect of information transmission, we use GPS location data to identify which schools are near a Beca 18 beneficiary. We test for several distance specifications with consistent results. Our findings suggest a positive spillover effect of the program on younger children in both reading and math performance.

Introduction:

Access to tertiary education is a well-known motivation for students to perform better at school. Good students are usually the ones that are able to attend better universities which in turn allows them to improve their living conditions. This is true in most developed countries, where access to good quality higher education is a possibility for most students. However, in the case of many developing countries, market failures and government limitations do not allow students to consider this possibility.

When facing the decision of educating their children, many families may consider it to be an unprofitable investment. Little information about the benefits of education in terms of higher future income and the lack of success stories among people close to them may all contribute to this perception. In this regard, the impact of a program that makes access to tertiary education may possibly affect the way people value education in a significant way. If parents and children are aware that been a good student may have a tangible future reward, their investment decisions may change.

Access to tertiary education is greatly limited to children from poor families in Peru. To address this issue, the Peruvian government recently created the Beca 18 program. Beca 18 is a merit/need based scholarship program that targets students applying to higher education institutions such as universities and technical institutes. The program gives selected students the opportunity of attending the best tertiary schools in the country. Before the program existed, even access to public universities was very limited. Beca 18 can be considered as one of the first real opportunities for children of low resources in Peru to access high quality tertiary education.

Current literature suggests that there is a positive relationship between policies that increase the perceived returns of education and educational outcomes among children. There is also evidence that supports that future access to scholarships and merit based programs may encourage better school performance. In this paper, we will analyze the impact of Beca 18 on the school performance of second grade children. To do this, we use test score data from the Ministry of Education and administrative records from the Beca 18 program. Using a difference in difference approach, we were able to identify a positive impact of being near a program beneficiary on both math and reading proficiency outcomes.

Conclusions:

Our results suggest that the Beca 18 program has relevant spillover effects on the educational outcomes of younger children. Guided by our conceptual framework, we would expect this result to be a consequence of the fact that children and parents exposed to Beca 18 beneficiaries update their information about perceived returns to education, leading them to invest more time and resources in obtaining better educational results.

We also find that effects on math test scores are stronger and more robust to several specifications than effects on reading test scores. This result is consistent with findings of other studies suggesting that math scores are more quickly affected by changes in study behavior. We also find that the effect of being near a beneficiary decreases as the distance to the school of the beneficiary increases. This result is consistent with our hypothesis that the improvements in educational outcomes are a result of information transmission.

Another result worth discussing is that we found that the effect of the program is larger when the number of beneficiaries nearby increases. This suggests that investment decisions are affected by how likely it is to get the scholarship. It may also suggest that the investment decision may vary if there are more people acting as role models.

Overall, our results are relevant from a policy perspective. We present evidence that the program has relevant spillover effects that should be considered when evaluating its benefits. As public programs in Peru are under continuous scrutiny, further evidence that supports the program’s effectiveness is of greatly useful to ensure its continuity. Also, as our results suggest that the number of beneficiaries matter for investment decisions, the expansion of the program could lead to even greater spillover effects.

It is still important to note that the effects found here are not the main intended effects of Beca 18: the scholarship program was designed as a supply side policy intervention. Our findings support the idea that this program can have important demand side effects worth considering. We would also expect for these effects to increase over time: the success stories of current beneficiaries in the labor market could lead to an even greater increase of the expected returns of education.

Pulling together or tearing apart? Ethnic heterogeneity, natural shocks and common pool resources in rural Malawi

Editor’s note: This post is part of a series showcasing Barcelona GSE master projects by students in the Class of 2016. The project is a required component of every master program.

Authors:
Andrea Bacilieri, Abhijeet Khanna, Irene Pañeda Fernandez, Jonathan Stern

Master’s Program:
Economics

Abstract:

This paper examines how ethnic heterogeneity may affect the ability of Malawian rural households to solve collective action problems. The collective action challenges are natural shocks -floods, droughts, and irregular rain and availability of common pool resources – an irrigation system, a forest, and common pasture land. We measure household welfare through maize harvest and annual consumption. We find that ethnic polarization and fractionalization are unambiguously bad for maize harvest but, under natural shocks, the size of this negative relationship is reduced. This may be due to the way natural shocks cross ethnic lines and facilitate the overcoming of ethnic differences. The bad effects of polarization remain unchanged in the presence of a shock, suggesting that this is a more intransigent problem. With respect to consumption, we find diminishing returns to increased polarization, becoming negative for high levels of polarization. Results are strongest in the presence of a communal forest. This may be due to the repeated and continuous nature of communal forest management, and the way that polarization may facilitate the formation of coherent bargaining factions.

Summary:

In this paper we explore the effects of ethnic fractionalization and polarization in the presence of natural shocks and common pool resources. By greater fractionalization we mean a smaller probability that any two individuals come from the same ethnic group. Polarization is a related concept which also takes into account the size of the bargaining factions- polarization being highest with two equally sized groups.

Our hypotheses were that ethnic heterogeneity would worsen the impact of shocks, and affect detrimentally the economic benefit derived from common pool resources. We sought to test these hypotheses by constructing a novel dataset for Malawi which combines indices of ethnic fractionalization and polarization calculated at the Territorial Authority level using the 2008 census and the Malawi Integrated Household Panel Survey for the year 2013. We argue for the exogeneity of our heterogeneity indices based on the low level of change in the ethnic makeup of Malawi over the past four years and the low level of migration within the country.

In the first part of our analysis we regress the log of maize harvest on the presence of shocks such as drought, flood and irregular rain interacted with our ethnic heterogeneity indices and a set of agricultural, climate, household and community controls. We find that ethnic polarization and fractionalization are unambigiously bad for maize harvest. Counter to our expectations, we find that fractionalization appears to lessen the impact of a drought or irregular rain on harvest, although the net effect of increases in fractionalization remains bad for harvests. We posit tentatively that the reduction in the effect of fractionalization in the presence of a shock could be due to the way natural shocks may cross ethnic lines and facilitate the overcoming of ethnic diff erences. The bad effects of polarization remain unchanged in the presence of a shock, suggesting that this is a more intransigent problem, and potentially a cause of enduring local level conflict.

In the second part of our analysis we regress the log of consumption on the presence of common pool resources such as forests, irrigation systems and common pasture land. We find no signicant relationship between consumption and fractionalization after testing both linear and quadratic specications. For polarization we find a quadratic relationship with consumption, which is strongest in the presence of a communal forest. This suggests that a certain degree of polarization could help communal forest management, with diminishing returns to increased polarization, becoming negative for high levels of polarization. We posit that this may be due to the repeated and continuous nature of communal forest management, and the way that polarization may facilitate the formation of coherent bargaining factions.

Through an exploration of the correlations between our ethnic heterogeneity indices and a set of community characteristics we find that greater heterogeneity is negatively correlated with school quality and the availability of agricultural inputs. These results cast some doubt on the exogeneity of ethnic heterogeneity. However given that the ethnic indices are slow moving over time, these correlations may also suggest some of the mechanisms by which fractionalization and polarization aff ect economic development in rural Malawi. Further work might seek to explore further these mechanisms, and whether the empirical findings of this paper can be replicated in other countries and contexts.

Download the paper

Misallocation Dynamics in Europe: Germany versus South

Editor’s note: This post is part of a series showcasing Barcelona GSE master projects by students in the Class of 2016. The project is a required component of every master program.

Authors:

Alexandros Georgakopoulos, Sampreet Singh Goraya, Viraj Rajeev Jorapur, Barrett William Owen, Jurica Zrnc

Master’s Program:

Economics

Motivation:

After the start of the Great Recession in Europe, the countries of the South (e.g. Spain) entered into a protracted stage of negative growth, amounting to an average decline in output of 1.6 perecent between 2008 and 2013, while Germany grew 0.8 percent on average in the same period. Furthermore, the decline in economic growth was accompanied by the under performance of total factor productivity growth in the South (-2.3%) relative to almost stagnant productivity growth in Germany (-0.5%). This points to some underlying factors which are not solely attributable to the demand shocks and the financial crisis.

KEY FINDINGS

Data and Measurement of Misallocation

Using a rich firm-level dataset we calculate various dispersion measures of marginal revenue products of production factors. We find that marginal revenue product of capital was increasingly more dispersed in the South, but not in Germany. A large part of this increase can be explained by the weakening link between capital and productivity. This implies that capital was increasingly allocated to less productive firms.

However, we also document increasing dispersion in marginal revenue product of labor, albeit of much smaller magnitude. This points to the possibility of common drivers behind the changes in both meassures. We argue that the common factor might be increased dispersion of TFP shocks during the recession. Similarly to Bloom et al. (2012) we interpret this as an increase in uncertainty. Furthermore, we calculate the potential gains by equalizing marginal revenue products of factors of production across firms in sectors, following Hsieh and Klenow (2007) methodology. Supporting our previous analysis, we find that gains from reallocation of resources increased considerably in the South but remained flat in Germany.

Determinants of Misallocation

In the next section, we explore different determinants of misallocation and relate it to different trends in South and Germany. First, we pool the data for six countries to explore general determinants of misallocation dynamics during the recession. Results point towards the importance of rising uncertainty during the recession, public sector influence and financial frictions in explaining the increase in misallocation during the recession. Furthermore, we find that sectors characterized with more business dynamism experienced more misallocation during the recession. This result is in accordance with Foster et al. (2014) which find that the intensity of reallocation fell rather than rose during the recent financial crisis in the US.

Secondly, we explore the differences between Germany and the South. We find that sectors with larger financial intensity were characterized by higher misallocation in the South, while not in Germany. This points to larger financial frictions in the South being important to explain the increase in misallocation. We find evidence that sectors prone to cronyism saw increased misallocation of capital in the South, while not in the North. We also find some evidence of benefits from product market reforms during recession in the South. We perform a number of robustness checks which generally support our results, although in some specifications, some parameters are not significant.

The Italian Productivity Slump: A Tale of Zombies

Editor’s note: This post is part of a series showcasing Barcelona GSE master projects by students in the Class of 2016. The project is a required component of every master program.

Authors:
Andrea Fabiani, Enrico Frezzini, Federico Morescalchi, Willy Scherrieble, and Ugur Yesilbayraktar

Master’s Program:

Economics

Paper Abstract:

During periods of low productivity and stagnation, banks develop incentives to renew loans at subsidized rates to firms that would otherwise be insolvent. Proliferation of these firms, which we label as Zombies, have ramifications on the economy. Theoretical models predict that industries with a large share of zombies should experience productivity slowdowns in conjunction with lackluster employment and investment trends.

In this paper, we try to document whether this form of capital misallocation prevails between 2007-2014, by analyzing balance sheet data for more than 19,000 non-financial companies from the AMADEUS database. In fact, Italy’s productivity growth has been ailing since the early 2000’s and the volume of non-performing loans increased dramatically after the 2008 financial crisis. Moreover, prevalence of relationship banking and lack of loan loss provisioning in the country created a breeding ground for zombie lending. We identify zombies by comparing the yearly interest rate payments for the companies in our sample with those implied by a weighted average of Italian sovereign yields.

Our main contribution to the literature is to extend the seminal work by Caballero et al. (2008) to Italy, so to quantify the statistical association between zombie lending and several indicators of economic performance. Up to our knowledge, we are the first to carry a similar exercise for an economy different from Japan, whose experience in the 1990’s gave rise to the literature on zombie lending.

The descriptive analysis of our data reveals the increasing trend in the number of zombies in the aftermath of the financial crisis of 2008; this phenomenon appears to be widespread across different sectors of economic activity.

Figure 1: Pre and post-crisis average fraction of zombies (Overall economy)

Figure 2: Pre and post-crisis average fraction of zombies (Asset weighted – Industry-level)

Furthermore, by means of OLS regressions, we show that TFP is lower and more unequally distributed in sectors with a relatively higher fraction of zombie firms, in accordance with theoretical predictions. However, the same exercise hints to a positive partial correlation between employment in healthy firms and zombie-lending, at odds with the theory.

We call for future research to explain this finding, either by enriching the underlying theoretical model so to account for realistic features of labor market or by testing the same hypothesis for other countries.