Unilateral tariff liberalisation

by Richard Baldwin

Vox
May 30, 2012

In the late 1980s, developing nations that had eschewed all forms of liberalisation began to cut their import tariffs unilaterally. This column explains how the communication-technology revolution was the shock that altered the political-economy equilibrium against infant-industry protection and in favour of joining international supply chains which involved tariff liberalisation.

For most of the post-war period, trade liberalisation was slow, involved only rich nations, and occurred only in the context of reciprocal bargains – multilateral GATT Rounds or regional trade agreements.

The reciprocity was critical. Since foreign tariffs would fall only if domestic tariffs did, each nation’s exporters fought against the protectionists within their borders. In this way, governments found it politically optimal to cut tariffs that they had previously found optimal to impose (Moser 1990).1 Developed nations, who played reciprocally in the GATT, lowered their tariffs; developing nations who didn’t play reciprocally in the GATT – due to so-called special and differential treatment for developing nations – did not cut their tariffs.

All this changed in the late 1980s. Developing nations that had previously eschewed all forms of liberalisation began to cut their tariffs unilaterally as seen in Figure 1.

Figure 1. Tariff liberalisation

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How Political Clout Made Banks Too Big to Fail

by Luigi Zingales

Bloomberg
May 30, 2012

The U.S. has historically kept the financial sector in check through a combination of sound principles and serendipitous decisions. But as the financial system gained strength in recent years, it also gained political influence. In the last decade, it has become too concentrated and too powerful, which has damaged not only the economy but the financial sector itself.

How did it happen? In 1933, the Glass-Steagall Act erected a wall between two ways that banks could help customers borrow money. The idea was to keep commercial banks from exploiting their depositors, who might get saddled with the bonds of firms that could not repay the money they owed. One beneficial side effect of the Glass-Steagall Act was to fragment the banking sector and reduce the financial industry’s political power. Another was to foster healthy competition between commercial banks and investment banks.

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The Broken Legs of Global Trade

by Jagdish Bhagwati

Project Syndicate
May 29, 2012

The Doha Round, the latest phase of multilateral trade negotiations, failed in November 2011, after ten years of talks, despite official efforts by many countries, including the United Kingdom and Germany, and by nearly all eminent trade scholars today. While trade officials in the United States and the European Union blamed the G-22 developing countries’ excessive demands for the failure of earlier negotiations in Cancún in 2003, there is general agreement that this time it was the US whose unwarranted (and unyielding) demands killed the talks. So, now what?

The failure to achieve multilateral trade liberalization by concluding the Doha Round means that the world lost the gains from trade that a successful treaty would have brought. But that is hardly the end of the matter: the failure of Doha will virtually halt multilateral trade liberalization for years to come.

Of course, multilateral trade negotiations are only one of three legs on which the World Trade Organization stands. But breaking that leg adversely affects the functioning of the other two: the WTO’s rule-making authority and its dispute-settlement mechanism. The costs here may also be large.

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The on-going debate on natural resources and development

by Erwin Bulte

Vox
May 28, 2012

The so-called resource curse suggests that resource booms are bad for development. One reason put forward is that fighting over resource rents leads to armed conflict. This column argues the evidence identifying resources as a cause of conflicts is weak and that the policy focus should be on institutional reform, rather than on resources per se.

Prices of natural resource commodities have increased a lot in recent years. While the current commodity price index is not as high as it was during its peak in the spring of 2008, commodity prices have increased by 10% over the past 6 months, by 56% over the past 5 years, and by no less than 249% over the past 10 years. For certain specific commodities, price hikes are even larger. In 2002 a single DVD recorder cost as much as a hundred tons of iron ore. The current exchange rate is about one ton of iron ore per DVD recorder.

Several factors explain the reversal of fortune for miners –– conditions have been favourable both on the supply side (e.g., market power in the mining industry) and on the demand side (e.g., economic development in India and China). An important question concerns the degree to which these economic gains trickle down beyond the shareholders of international mining companies. Do high commodity prices translate into enhanced prospects for peaceful economic development for poor resource-exporting countries? This turns out to be a contested issue.

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Why We Lie

by Dan Ariely

Wall Street Journal
May 26, 2012

Not too long ago, one of my students, named Peter, told me a story that captures rather nicely our society's misguided efforts to deal with dishonesty. One day, Peter locked himself out of his house. After a spell, the locksmith pulled up in his truck and picked the lock in about a minute.

"I was amazed at how quickly and easily this guy was able to open the door," Peter said. The locksmith told him that locks are on doors only to keep honest people honest. One percent of people will always be honest and never steal. Another 1% will always be dishonest and always try to pick your lock and steal your television; locks won't do much to protect you from the hardened thieves, who can get into your house if they really want to. The purpose of locks, the locksmith said, is to protect you from the 98% of mostly honest people who might be tempted to try your door if it had no lock.

We tend to think that people are either honest or dishonest. In the age of Bernie Madoff and Mark McGwire, James Frey and John Edwards, we like to believe that most people are virtuous, but a few bad apples spoil the bunch. If this were true, society might easily remedy its problems with cheating and dishonesty. Human-resources departments could screen for cheaters when hiring. Dishonest financial advisers or building contractors could be flagged quickly and shunned. Cheaters in sports and other arenas would be easy to spot before they rose to the tops of their professions.

But that is not how dishonesty works. Over the past decade or so, my colleagues and I have taken a close look at why people cheat, using a variety of experiments and looking at a panoply of unique data sets—from insurance claims to employment histories to the treatment records of doctors and dentists. What we have found, in a nutshell: Everybody has the capacity to be dishonest, and almost everybody cheats—just by a little. Except for a few outliers at the top and bottom, the behavior of almost everyone is driven by two opposing motivations. On the one hand, we want to benefit from cheating and get as much money and glory as possible; on the other hand, we want to view ourselves as honest, honorable people. Sadly, it is this kind of small-scale mass cheating, not the high-profile cases, that is most corrosive to society.

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Frauds, Swingers and the Odd Early Days of Credit Cards

by Louis Hyman

Bloomberg
May 24, 2012

As credit cards came into greater use in the late 1950s and early ’60s, the financial press closely followed their emergence, especially when the wrong sorts got access to them.

Consider, for example, Joseph Miraglia. In one month of orgiastic spending, Miraglia ran up a $10,000 bill entertaining himself across three countries, four girlfriends and one rhinestone-collared cocker spaniel. Miraglia was no scion: He was a clerk from the Lower East Side of Manhattan earning $73 a week. How did he get into the then-exclusive credit-card club?

In 1959, travel and entertainment charge cards, such as Diners Club, were just beginning to lose their ground to bank cards, such as BankAmericard. But the use of credit was still subject to very real technological and moral constraints. Miraglia nicely illustrated how both would soon change -- and foreshadowed some of the consequences.

His adventure began in September 1959, when he ducked into a fancy New York restaurant and saw a pile of Travel and Entertainment card applications for “men of responsibility.” He filled out the Hilton Hotels’ Carte Blanche paperwork, complete with his real pittance of a salary, and, to his surprise, received a card a few weeks later with a letter that said “this card is your key to every luxury Hilton has to offer.”

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Let Data, Not Politics, Guide Regulation

by Tobias J. Moskowitz

Bloomberg
May 24, 2012

Several years after the global financial crisis, the fierce debate over regulation continues to be driven by strong beliefs -- largely uninformed ones -- rather than hard facts.

Some believe more regulation is necessary, others that it would cause the downfall of our markets. No one, however, seems to be talking about the evidence for or against regulation.

This is partly because very little evidence exists on the effects of regulation or its efficacy. It is extremely difficult to isolate the impact of any proposed regulatory change from everything else that is occurring simultaneously within financial markets. Studies claiming to analyze those effects are almost always confounded by other factors, such as the environment that led to a given regulation; the response of market participants to regulation or anticipated regulation; the selection of securities targeted for regulation; and the timing of regulation.

To overcome these problems and identify an effect unrelated to other possible effects, it would be useful to run a controlled experiment, as medical research does with clinical trials. Is that feasible in financial markets? My colleagues Steven Kaplan, Berk Sensoy and I recently conducted such an experiment to get a better understanding of one type of financial regulation: bans on short selling certain stocks, a very simple measure that was put in effect worldwide for financial stocks during the crisis.

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Rethinking the ‘war on drugs’: Insights from the US and Mexico

by Ernesto Zedillo

Vox
May 22, 2012

Illegal drugs are one of the planet’s most pressing problems. They shatter hundreds of millions of lives and wreak untold social, economic and political damage in both consuming and producing nations. In this column, ex-President of Mexico Ernesto Zedillo introduces an eBook he edited on the issue that points very strongly in the direction of a serious reconsideration of drug policy.

America’s most loved economics textbook (Mankiw 2012) uses the ‘war on drugs’ to illustrate how restricting supply when demand is inelastic increases the total cash spent on illegal drugs. Every anti-smuggling tactic makes each consignment more profitable. No wonder the US war on drugs is not going so well. Yet despite 40 years of violence, corruption and continuing addiction, the US is in no mood to alter course.

At the Summit of the Americas last month, the Colombian and Guatemalan Presidents called for a new approach. The US flatly rules out any change. Dan Restrepo, the National Security Council's senior director for Latin America, said in a press conference on the summit: “US policy on this is very clear. The President doesn't support decriminalisation, but he does consider this is a legitimate debate. And it's a legitimate debate because it helps to demystify this as an option”. (Rogin 2012)

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Trade and inequality: From theory to estimation

by Elhanan Helpman, Oleg Itskhoki, Marc Muendler and Stephen Redding

Vox
May 20, 2012

What is the effect of trade on inequality? This column presents a unique study examining wage inequality in Brazil after liberalisation. Starting from a closed economy, the column finds that wage inequality will initially rise as only some firms take advantage of the new opportunities. But as trade costs continue to fall and more firms start to trade, wage inequality peaks and begins to fall back.

Until recently, research on the labour market effects of international trade has been heavily influenced by traditional theories such as the Heckscher-Ohlin and Specific Factors models. Those theories provide predictions about relative wages across skill groups or across occupations and sectors. In contrast to predictions of those theories, empirical studies find increased wage inequality in both developed and developing countries, growing residual wage dispersion among workers with similar observed characteristics, and increased wage dispersion across plants and firms within sectors. In a large part due to this disconnect, previous studies have concluded that the contribution of international trade to growing wage inequality is modest at best (see for example the survey by Goldberg and Pavcnik 2007).

We argue that these apparently discordant empirical findings are in fact consistent with a trade-based explanation for wage inequality, but one rooted in recent models of firm heterogeneity and trade. In Helpman et al. (2012) we begin by documenting a number of stylised facts about the level and growth of wage inequality in Brazil that provide support for these recent theories.

• First, much of overall wage inequality occurs within sectors and occupations rather than between sectors and occupations. We document this fact with a decomposition of the variance of the log wage into the variance within sector-occupations and the variance between sector-occupations. We find that the within sector-occupation component of wage inequality accounts for over two-thirds of both the level and growth of wage inequality in Brazil between 1986 and 1995, as illustrated for the growth of wage inequality in Figure 1.
• Second, a large share of the wage inequality within sectors and occupations is driven by wage inequality between rather than within firms.
• Third, both prior findings are robust to controlling for observed worker characteristics. This robustness suggests that wage inequality between firms within sector-occupations is largely residual wage inequality.

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On work hours in the US and Europe

by Indraneel Chakraborty, Hans Holter and Serhiy Stepanchuk

Vox
May 18, 2012

It is no secret that Americans work more than Europeans – 30% more according to recent studies. Many economists point to higher taxes in Europe as a major cause. This column suggests that divorce rates also play a role, particularly for women's labour supply.

According to recent research, Americans work 30% more than Europeans (Prescott 2004 and Rogerson 2006). This was not the case in early 1970s when Western Europeans worked more than Americans. What accounts for the large differences between countries today? Our study finds that divorce rates and tax rates together on average explain 58% of the difference in terms of hours worked between the US and 17 European countries.

Our research starts by trying to uncover the determinants of cross-country differences in work hours through analysing the hours worked by different demographic subgroups (Chakraborty et al. 2012). We find that women are typically the largest contributors to the aggregate differences. European women work less than American women, irrespective of whether we look at single or married women, or women with and without children.

Cross-country variation in tax systems is one of the most popular proposed explanations for the observed discrepancy in work hours between the US and Europe. The basic intuition here is straightforward – higher labour income taxes reduce the incentives to work. However, for the 18 countries in our sample, we find that, while there is indeed a negative correlation between various measures of taxation and hours worked by men, the corresponding correlation for women is close to 0. Figure 1 below plots the correlation between male and female labour supply and the "average effective tax rate", a measure that combines the average labour income tax and consumption tax in each country into a single tax rate.

Figure 1. Tax rates and labour supply by gender

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What Makes Countries Rich or Poor?

by Jared Diamond

New York Review of Books
June 7, 2012

The fence that divides the city of Nogales is part of a natural experiment in organizing human societies. North of the fence lies the American city of Nogales, Arizona; south of it lies the Mexican city of Nogales, Sonora. On the American side, average income and life expectancy are higher, crime and corruption are lower, health and roads are better, and elections are more democratic. Yet the geographic environment is identical on both sides of the fence, and the ethnic makeup of the human population is similar. The reasons for those differences between the two Nogaleses are the differences between the current political and economic institutions of the US and Mexico.

This example, which introduces Why Nations Fail by Daron Acemoglu and James Robinson, illustrates on a small scale the book’s subject.* Power, prosperity, and poverty vary greatly around the world. Norway, the world’s richest country, is 496 times richer than Burundi, the world’s poorest country (average per capita incomes $84,290 and $170 respectively, according to the World Bank). Why? That’s a central question of economics.

Different economists have different views about the relative importance of the conditions and factors that make countries richer or poorer. The factors they most discuss are so-called “good institutions,” which may be defined as laws and practices that motivate people to work hard, become economically productive, and thereby enrich both themselves and their countries. They are the basis of the Nogales anecdote, and the focus of Why Nations Fail. In the authors’ words:

The reason that Nogales, Arizona, is much richer than Nogales, Sonora, is simple: it is because of the very different institutions on the two sides of the border, which create very different incentives for the inhabitants of Nogales, Arizona, versus Nogales, Sonora.

Among the good economic institutions that motivate people to become productive are the protection of their private property rights, predictable enforcement of their contracts, opportunities to invest and retain control of their money, control of inflation, and open exchange of currency. For instance, people are motivated to work hard if they have opportunities to invest their earnings profitably, but not if they have few such opportunities or if their earnings or profits are likely to be confiscated.

The strongest evidence supporting this view comes from natural experiments involving borders: i.e., division of a uniform environment and initially uniform human population by a political border that eventually comes to separate different economic and political institutions, which create differences in wealth. Besides Nogales, examples include the contrasts between North and South Korea and between the former East and West Germany. Many or most economists, including Acemoglu and Robinson, generalize from these examples of bordering countries and deduce that good institutions also explain the differences in wealth between nations that aren’t neighbors and that differ greatly in their geographic environments and human populations.

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Origins of the Sicilian Mafia

by Arcangelo Dimico, Alessia Isopi and Ola Olsson

Vox
May 13, 2012

If it were a business, the Mafia would be one of Italy’s most successful and one of the largest in Europe. But how did it come to be so powerful? This column argues that it began with control of the international lemon trade in the 19th century.

The Italian Mafia can be seen as one of the largest and most successful businesses in Italy. In one of the latest reports from the Italian Minister of Home Affairs, it has been estimated that revenues from just the informal sector related to the Mafia amount to almost €180 billion. In terms of GDP, revenues from Mafia-related businesses represent almost 12% of the total Italian GDP and are equal to the sum of the GDPs of Estonia, Croatia, Romania, and Slovenia (Ruffolo et al. 2010). To date, the Italian Mafia is the most successful form of organised crime in Europe and comparable to the Chinese, Japanese, Russian, and South American crime organisations in terms of business.

Given the economic and social relevance of the issue, it is natural to wonder why these forms of organised crime develop and what factors explain the cross-regional variation of Mafia. Both institutional and historical explanations have been proposed in the literature. Fiorentini (1999), Grossman (1995), and Skaperdas (2001) focus on weak institutions, predation, and enforcement of property rights. On the other hand, with regard to the Sicilian Mafia, Villari (1875), Sonnino and Franchetti (1877) and Colajani (1885) focus on the legacy of feudalism, the development of latifundism and a loss of social capital and public trust.

Even though the above literature provides plausible explanations for the origin of organised crime, it is still difficult to understand why we observe a huge variation across regions experiencing very similar conditions. Organised forms of crime normally appear only in a small number of localities and then expand through the entire region. It is therefore important to understand what is specific to these few localities where the Mafia appears.

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Giving the Well-Performing State Its Due

by Ana Palacio

Project Syndicate
May 9, 2012

The triumph of democracy and market-based economics – the End of History, as the American political philosopher Francis Fukuyama famously called it – which was proclaimed to be inevitable with the fall of the Berlin Wall, soon proved to be little more than a mirage. However, following China’s intellectual pirouette to maintain one-party rule while embracing the capitalist credo, history’s interpreters shifted their focus to the economy: not everybody would be free and elect their government, but capitalist prosperity would hold sway worldwide.

Now, however, the economic tumult shaking Europe, the erosion of the middle class in the West, and the growing social inequalities worldwide are undermining capitalism’s claim to universal triumph. Hard questions are being asked: Is capitalism as we know it doomed? Is the market no longer able to generate prosperity? Is China’s brand of state capitalism an alternative and potentially victorious paradigm?

The pervasive soul-searching prompted by such questions has nurtured a growing recognition that capitalism’s success depends not only on macroeconomic policy or economic indicators. It rests on a bedrock of good governance and the rule of law – in other words, a well-performing state. The West overlooked the fundamental importance of this while it was fighting communism.

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Facebook’s Organ Donation Success Needs Follow-Up

by Sally Satel

Bloomberg
May 8, 2012

Facebook Inc. took a momentous action last week. And I don’t mean its announced intention to sell shares for $28 to $35 in an initial public offering later this month.

Of more importance to at least one segment of the population was the company’s invitation to users to register to become organ donors. Forty-eight hours later, more than 100,000 people had indicated, on Facebook Timeline, their wish to be a donor when they die.

As a result, online state donor registries experienced a remarkable 23-fold surge, according to Donate Life America, a nonprofit alliance of national donor advocate organizations.

Better yet, a week later, the traffic was sustained. Typically, Web-based promotions lead to a spike of interest that dissipates within hours.

For the 114,000 people waiting for a kidney, liver, heart or lung -- 7,000 to 10,000 of whom die each year -- Facebook has performed a great public-health service. For more than two decades, advocates have been urging people to sign up as donors when they renew their driver’s license, yet only about 43 percent have done so. Facebook has made registering much easier.

And although this impressive achievement won’t be enough to fill the great demand for transplantable organs, it may also help show the way forward to encourage live donations.

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