Meeting registration was apparently a record, with more than 12,000 registered. Not everybody who was registered actually attended, as people from places like Chicago and Minneapolis were snowed in at home. As last year, there was little on development at the meetings. There continued to be a lot on financial crises, risk and uncertainty, and why things aren’t as simple as we thought, but with the addition of sessions on inequality and labor markets.
Philadelphia was cold and icy. I look with dread at the fact that three more of the next five meetings will be in inhospitable environments – Boston, Chicago and Philadelphia (again)-. San Francisco and Atlanta are the only respite until six years from now. Where is San Diego in all this? As usual, Asians and women seemed even more evident than ever to me, the latter evident everywhere except the head table for the plenary sessions. There, women managed to occupy only 3 of the 18 or so seats at the head table at the Friday and Saturday luncheons, even counting AEA President Claudia Goldin. Still, it was an improvement over plenary sessions in some recent years, where no women sometimes graced the head table. Quantitative indicators on this matter are elusive. My metric this year is the authors of those cited for the best papers this year in AEA journals, listed at the end of this paper. Of ten authors of those papers, three were women. This is a dramatic rise from when I went to graduate school, when women studying advanced economics were hard to find. Fortunately, my future wife was an exception.
I saw one ex-USAID colleague, Juan Buttari. As a labor economist, the overlap between the non-plenary sessions he attended and mine were close to the null set. I have asked him to circulate his notes on those sessions. I also saw Steve Payson (the fearless editor of a three-volume set of essays on economics in the U.S. government), due out in June. It includes my piece on economics at USAID.
I also saw Anne Krueger and Angus Deaton. Angus autographed my copy of his new book. He expressed mild surprise at my agreement with his denunciation of foreign aid in the book. I gave him the Myanmar report I co-authored with Lex Rieffel, (Too Much, Too Soon: The Dilemma of Foreign Aid to Myanmar/Burma) available at the Brookings website if you search for Myanmar. Anyway, our report reinforces Deaton’s view that donors often make things worse rather than better.
Next year’s meeting is in Boston. Also cold, but there is mostly no need to go outside, as the hotels are connected by passageways. Still, why not the sunny southland?
- The Presidential Address. “A Grand Gender Convergence: The Last Chapter”
Claudia Goldin, whose brilliant Ely lecture I summarized in my report on the 2006 meetings (sadly, it is apparently no longer available in my files) on the three revolutions in women’s workplace roles during the 20th century. (It is still available in the March 2007 AER, or in my PDF file.) Goldin argued in her presidential address that we have reached the final frontier on gender pay equality in the workplace. During the last couple of decades, she argued, women surmounted the previous obstacle to this goal – academic qualifications. The only remaining obstacle to earnings equality is due to work hours and the large differential between payments for those who work 40 hours or less and those who work more. The one profession where income equality between genders has been achieved is among pharmacists. Pharmacies can afford to provide employees with flexible hours, since the client typically has no interest in which individual filled a prescription. Not so with many other professions, where clients want to deal with someone they know and trust. That typically means long hours in the office. But other factors may also be significant. She notes that one of the biggest gender gaps is with airline pilots, “because women fly little planes and men fly big planes.” Her hope is that greater flexibility in the workplace about hours, or about job-sharing, will gradually get us to gender equality in the professions, to the benefit of both men and women.
- The AEA/AFA Joint Luncheon: Jeremy Stein, “Banks as Patient Fixed-Income Investors”
This luncheon yielded only meagre returns on my $60 investment. Stein argued that there were three theories about what banks did:
— they weredeposit-taking, creators of safe money-like claims
— their role was lending to information-intensive borrowers
— there was synergy between these two roles
This Glass-Siegel view of banking ignores the fact he noted that some banks have 50% of their assets in securities. He apparently views this as a bad idea, noting that the typical bank has 60% of its assets in mortgages. If banks only invested in T-bills they would lose money, as deposits earn 1% more than T-bills, but the cost of gathering deposits is 1.3%. Shadow banking uses less capital, but banks do better with assets that can experience temporary discounts, but without fundamental problems. They do not need to mark to market, so they can ride out temporary problems. [I am unable to explain what this lecture had to do with the financial innovations that caused our economy to almost collapse. I agree with Paul Volker that the last financial innovation that was useful was the ATM.]
- The Nobel Prize Luncheon honoring Al Roth and Lloyd Shapley
They were honored for their work on matching markets. Economists typically ignore several kinds of complexity. The simplest is ignoring time and distance. The implicit assumption is that transactions take place in a spot market, where money is paid and goods are delivered. In the real world, goods do not appear magically in the marketplace. They will come at some later time, and most likely at a different place. In this world, price still matters, but has to be modified by time and distance. In more complex matching markets, price may matter little or not at all. The earliest success of their matching efforts was with medical school residencies. Matching doctors and hospitals involves a two-way selection process that only occurs over time. If a hospital accepts a resident who chooses to go elsewhere, that slot needs to be offered to someone else, hopefully before the next-best candidate accepts a residency elsewhere that he/she would not have chosen if that position had seemed available.
Matching has great potential elsewhere, in college admissions, in the marriage market, etc., etc. And in many of these markets, as in medical residencies, price is not a factor. Important things are simply a lot more complicated. Dual couples of doctors (like two of my relatives) began to work outside the system until the matching algorithm was adjusted to take account of this complexity.
- The Richard T. Ely Lecture: James Poterba, “Retirement Security in an Aging Population”
Poterba noted that Richard T. Ely lived to be 89, surviving 99% of his age cohort. Of the cohort born in 2010, 35% are expected to live to be 89. More and more of the increase in life expectancy in the U.S. is due to increased longevity of old people, not, as in poor countries, to a fall in infant and child mortality. But this increase in life expectancy has been skewed toward upper income people. Life expectancy at 65 among the upper half of the income has increased by 6 years over the past 30 years, but only by 1.3 years for those in the bottom half. Lifestyle differences clearly play a role in the difference. (Lower-income people smoke more and drink more.)
The country’s demographics are also changing in important ways. In 1950, 32% of the population was under 18, while only 8% was over 65, and almost nobody was over 85. By 2050, he expects the under 18 and over 65 populations to be equal at 21% each, with nearly 5% of the population over 85.
Clearly, retirement savings is becoming a critical issue at the population ages. For the bottom quartile, this is not a big issue, as Social Security is likely to replace about 77% of their average annual earnings. The top quartile also has no problem, as they have healthy pension and private savings income, and besides they often work until well past 65.
The problem is with the middle 50%, for whom Social Security replaces a far smaller percent of their working income, and they typically have little from private pensions or private savings. These are the people who are most at risk from increasing life expectancy.
No great solutions are proposed, though Poterba claims that no dramatic changes resulted from the shift from defined benefit to defined contribution pension schemes. His best, if modest, suggestion is the nudge that would make enrollment in company 401(k)s automatic unless the employee opted out.
- The Econometric Society Presidential Address: James Heckman, “The Economics and Econometrics of Human Development”
Heckman noted the great increase in interest in inequality and human development. Does social inequality cause social immobility, or does social immobility cause social inequality?
He argues that childhood matters a lot in a person’s future, but that there is no simple way to measure it. There seem to be critical periods in each child’s development, but this varies among children. Econometrics is unlikely to unravel such issues. But there is a big gap before school starts, as shown by the table below:
Category Quantity of Words Affirmative Prohibiting
Welfare 616 5 11
Middle Class 1,251 12 7
Professional 2,153 32 5
This contrasts the pre-school environment of poor children with better-off ones. Better-off ones get more vocabulary, are given more encouragement than discouragement, and are simply better prepared for school and the world.
Heckman suggests that credit constraints are a possible source of continued inequality. (E.g., if you could make a loan to a poor but bright kid from the projects to finance his/her education in return for a share of future earnings, that might help.) Still, the effects of income transfers on child achievement seem to be very weak. Nevertheless, Heckman believes that more investment in low-endowment children would pay off for society.
Of course, the surest solution to this problem is Plato’s in The Republic. Take the kids away from their parents early, and raise them in common. They will eventually separate themselves on the basis of their knowledge and skill, rather than the advantage high-income parents give their children in our society. Of course, the main downside of the Platonic approach is that it deprives most parents of one of their main reasons for living. [Some, hopefully a small minority, would see this as a small price to pay for reduced inequality.]
Individual Sessions I Attended
Assessing the Welfare Impacts of Economic Integration: Evidence from the 19th and 20th centuries
My own prior was that economic integration was always good, harking back to Adam Smith’s observation that the division of labor is limited by the extent of the market. Unsurprisingly, the papers in this session confirmed this view. Most used large data sets and plenty of econometrics to reach this conclusion. Still, some of the work was ingenious.
One paper analyzed Japanese productivity from 1865 to 1876. (The Meiji Restoration occurred in 1868, with its rejection of previous feudal practices.) Overall, the authors concluded that productivity increased by 5-7%, with reductions in needed labor inputs, and increased land productivity.
A paper on U.S. agriculture from 1880 to 2002 used a data set from 1,500 counties in the U.S. to conclude that the impact of economic integration was about equal to that from technological progress, increasing productivity by 0.5-1.5% per year.
A third paper looked at Germany after 1834, as German states gradually were drawn into a customs union. The paper emphasizes that increased trade led to faster institutional change (more ability to sell feudal lands, more capacity to work without guilds). The longer German states had been under French rule, the faster was the institutional change.
The final paper addressed the more issue of the impact of China’s recent entry into the world trading system. Using techniques opaque to me, they conclude that welfare gains in China were significant (up 3.7%), but small for the world (+0.13%) and slightly negative for some countries producing textiles and apparel, notably Honduras and El Salvador. (Given that these countries continue to do well in this area, apparently due to their proximity to the United States, I doubt their conclusion.
Is Neglect Benign? U. S. Housing Policy
Robert Shiller chaired this session and gave the first paper. It argued that there has been a remarkable lack of innovation in mortgage finance since self-amortizing mortgages were introduced in 1933. Until that time, mortgages were typically 3-5 years, with a balloon payment at the end. When, as in the 1930’s, refinancing was not available when the balloon was due, disaster ensued.
Shiller asked why there are no inflation-adjusted mortgages in the marketplace. He was also troubled by the fact that many (most?) households have most of their savings in their house, meaning their risk is very undiversified. He recommends subsidies for financial advisors to help ordinary people cope with financial issues. [Note here Richard Thaler address I summarized three years ago, where he identified biggest decisions (marriage, buying a house) people face where expert advice would seem to be most valuable, people seldom look for such help.] I have appended my summary of Thaler’s lecture to this report as Annex 2.
Another paper disputed the requirement under Dodd-Frank that lenders retain 5% of any mortgage that they sell off, in order that the bank have “some skin in the game.” His argument against the rule was reasonably convincing, but the high point was his listing of 5 propositions about the rule. He said that anyone answering the first two propositions as True would be an F on the test. Someone in the audience piped up, “We don’t give F’s any more. Those people would now get an A-.” There was general laughter, some perhaps uncomfortable.
Women and Development
The big paper in this session dealt with a randomized experiment in Bangladesh to provide assets, notably cows, to very poor families. Ownership of a cow led to a significant increase in household assets, especially when the woman owned the asset. A second paper, involving the Ultimatum game in India, suggests that women are more likely to hide assets from the household resource pool than their husbands. [IMHO, a sensible strategy.]
Economics of Revolution
I went to this session because it was chaired by Daron Acemoglu. Aside from Acemoglu’s individual brilliance, this was a disappointment. Clearly, revolutions have something to do with economics, but the prediction of when revolutions might happen is a fool’s game.
One paper addressed the isolation of the capital city. Where the capital city is also the primary city in the country, it argues that control of the capital leads to control of the country. The Burmese military understood this when they decided to move the capital from Rangoon to Naypydaw, in the center of the country. To prevent demonstrations even there, Naypydaw was laid out as the worst urban planning experiment ever. To date, no mass demonstrations in Naypydaw have been reported. Overall, an isolated capital is associated with misgovernance except in democracies (think Canberra).
Two other papers in this session were interesting. They dealt with mass protests and business cycles. Both noted the role of contingent or unexpected events in such revolutions. Of any help in Syria today (or two years ago)? Probably not.
Despite the promising title, I abandoned this session after the first paper in favor of the always-interesting Salvatore session. (Reading abstracts of the other papers later, I was not disappointed not to have been there.)
The first paper was one on business literacy for women in micro-businesses in Mexico. The treatment was 48 hours of business education spread over 6 weeks, with follow-up 6 and 30 months later. The classes emphasized simple accounting and price setting. The results suggested significant improvements in the 60% of participants that completed the courses, with increased profits and revenues, and better accounting. Still, their analysis of the cost of the training suggested that the results barely, if at all, justified the expenditures for the training.
The Salvatore Session: The Future of the U.S. Economy
This session had the usual collection of stars, including Martin Feldstein, Ed Prescott, John Taylor, and Dale Jorgenson. Larry Summers was a late replacement for Robert Barro, who was stuck in the Chicago blizzard.
I missed the initial presentations by Feldstein and Prescott, but was there for Larry Summers to summarize his secular stagnation hypothesis that the economy will be demand-constrained for a long time, with employment well below the long-term trend.
John Taylor followed with his preference for the Taylor Rule, arguing that the Obama Administration had opted for more discretion in monetary policy, with consequent reduced predictability of government policy. This is exacerbated by regulatory policy, where government bail-outs of companies, uncertainties about Freddy and Fannie, the numerous regulations yet to be written to implement Dodd-Frank, and discretionary fiscal policy create great uncertainties in the private sector. He recommended a return to regulatory stability, including the Taylor Rule.
In his next turn, Feldstein called for an expanded public investment program, though noting that “shovel-ready” investment projects seldom exist. He argued that fiscal policy should involve spending, not tax abatements or gimmicks like cash for clunkers.
In his second turn, Summers launched into something closer to an ad hominem attack on a fellow panelist than I have ever witnessed at these meetings, suggesting that the Taylor rule was stupid. When his turn, Taylor reciprocated in kind. My hope that it would come to fisticuffs was disappointed.
Developing Country Lessons for Advanced Economy Growth
This session was chaired by Michael Spence. His paper was on the U.S. economy. Like any World Bank/IMF advisor to a developing country, he recommended improving the U.S. fiscal position, and improving the current account balance. The latter should be achieved by shifting production from non-tradeables to tradeable goods and services. And, by the way, there is also a need to worry about income distribution.
A more interesting paper addressed lessons for the European Union from Asia’s financial crisis. The author noted the conundrum in a crisis: will austerity be expansionary or contractionary?
Both views, he argues, ignore the country experience of the last two decades. The initial reaction to the Asian financial crisis was fiscal consolidation to rebuild the balance of payments. But this was quickly replaced by a course reversal that allowed for fiscal expansion. For the EU, the prescription given by the IMF was the opposite. In 2008, the IMF recommended fiscal expansion, reversing course in 2010 to austerity. While Asia quickly rebounded from the crisis, Europe is still in the doldrums. The author did add that Asian recovery was hastened by currency devaluation.
Note: my economist wife offers what seems to me to be the best solution to the EU crisis: kick Germany out of the Euro, and make it go back to the Deutschmark. The Euro would quickly fall to a level that would allow the rest of the EU to become competitive with Germany and the rest of the world.
An Aside: Albert O. Hirschman
Albert Hirschman died in 2013. Even though we never met until late in my career, he was my mentor throughout my professional life. I learned theory in graduate school, but his three early books on development were my guide to thinking about the practice of making poor countries less poor. At his death The Economist suggested that he would have gotten a Nobel Prize in Economics if his interests had not wandered into so many areas of human endeavor.
Not until I began reading Adelman’s biography Worldly Philosopher did I appreciate the depth and breadth of his contributions to civilization. As a German Jew, he judged early that he should emigrate. He fought in the Spanish civil war against the fascists, and enlisted in the French army at the start of that war. After France surrendered, he worked with another person to forge passports, exit visas, etc., etc., that allowed about 2,000 potentially doomed individuals to escape to freedom. These included Hannah Arendt and a collection of noted artists, including Marc Chagall, Marcel Duchamp, and Jacques Lipchitz. When he escaped himself a few steps ahead of the Gestapo, he got to America. Here he enlisted in yet another army to fight the fascists.
The part of his career that I know about came from his being denied a security clearance to work at the Treasury, which serendipitously sent him to Colombia as part of the World Bank’s first venture into the third world. He spent five years there doing the observing, learning, and interpreting that led to my primer on development, The Strategy of Economic Development. What an amazing life.
Isaiah Berlin once divided writers into two categories: foxes and hedgehogs. Foxes know many things, while hedgehogs know one big thing. Most Nobel economists, like Lawrence Klein, are hedgehogs. A few, like Tom Schelling, have been foxes. Schelling, one of Hirschman’s mentors still confined his ruminations to a limited area – thinking about decisions. Hirschman was much broader, encompassing every aspect of human activity. He was the supreme fox.
Annex 1: Special Awards, etc.
The President-Elect is Richard Thaler. [Hurrah. His lecture I summarized several years ago made clear that financial markets, and we ordinary people, are prone to make financial decisions that are quite irrational.] I attach below my summary of that presentation, for those interested and unable to access my previous summaries.
The John Bates Clark Award. Since 2010, this has been awarded annually, rather than bi-annually, apparently in response to the increasing numbers of smart economists under 40. Raj Chetty, at Harvard, won it this time, for his work on numerous issues involving incentives, taxes, student performance, etc., etc.
Distinguished Fellows Awards went to:
Stanley Fischer (one of my heroes, and I will never forgive Joe Stiglitz for his calumny)
Awards for Best Papers in AEA Journals went to:
Philip Oreopolulos, Till von Wachter, and Andrew Heisz for “The Short- and long term Career Effects of Graduating in a Recession,” AEJ, Applied Economics.
Gabriel Chodorow-Reich, Laura Feiveson and Zachary Liscow, “Does State Fiscal Relief During Recessions Increase Employment: Evidence from the American Recovery and Investment Act.”
AEJ: Economic Policy.
Jennifer Hunt and Marjolaine Gauthier-Louiselle, “How Much Does Immigration Boost Innovation?” AEJ: Macroeconomics.
Michael Ostovsky and Michael Schwarz, “Information Disclosure and Unraveling in Matching Markets.” AEJ: Microeconomics.
Annex 2: The 2012 AEA/AFA Joint Luncheon Speech by Richard Thaler
“How Much Rationality is Rational?”
Richard Thaler, a finance economist, gave the address, but offered important insights for both the economics and finance professions.
He first asked the question about what model to use. Conventional wisdom is that it depends on the difficulty of the problem, its frequency, and the quality of feedback we receive from previous experiences with the problem. He suggests that the extremes in using rationality might be that homo economicus, Robert Lucas, and that anecdotal thinker, Homer Simpson.
While common sense suggests that we would look to experts for advice on the most difficult and infrequent problems, we typically do otherwise. Our most common high-stakes decisions in life are both difficult and infrequent:
- Career choices
- Buying a home
- Saving for retirement
- Choosing a mortgage
Thaler suggests that people faced with these decisions consult an expert no more than 5% of the time. People do not act rationally in the way economists think about it for their most important life questions. Similarly, Ricardian equivalence is a nice piece of economic theorizing, but it has nothing to do with how people behave.
An annual survey at the beginning of the year has asked CFOs to predict the S&P 500 at the end of that year, but also to add an 80% confidence level estimate for that prediction. The predictions of only 33% of the forecasts fell within the 80% confidence range of these financial “experts”.
The NFL draft provides more evidence. With some fascinating details about the models used to value potential draftees, a study concludes that the first person drafted costs the team six times as much as the 40th draftee, but is likely to be of less net value to the team. The top pick consistently costs more than he is worth.
People in general expect things to keep rising (e.g., housing prices) when they are going up, and expect them to keep falling when they are on a downtrend. They regularly identify the current trend as permanent – despite the obvious falsity of this from looking at the historical record.
For housing, a sensible regulator would impose limits when a bubble was suspected. These might include requirements such as proof of income or increased down payments in such cases. Sadly, sensible regulators were outnumbered by cheerleaders in the last bubble.
The crown jewel of irrationality was described in Lamont and Thayler, JPE 2003, relating to separating the then-hot Palm from its parent 3Com. 3Com thought that setting Palm free would help its stock price, so it arranged an IPO to sell 6% of Palm. The initial offering price was $38, but Palm quickly rose to $160 (this was the dot.com bubble era). The other 94% of Palm was to be offered to 3Com stockholders at 1.5 shares of Palm for each share of 3Com. So investors had the choice to acquire Palm by buying it directly at its inflated price, or by buying 3Com shares that would have the added advantage of giving them 1.5 shares of Palm for each 3Com share. During the period between the announcement and the actual issuance of the Palm stock to 3Com stockholders, the gap between the benefit of buying Palm directly and buying it by acquiring shares of 3Com grew so large that if one subtracted the market value of the Palm shares soon to be owned by 3Com shareholders from the value of 3Com stock, 3Com’s market value was a negative $23 billion! Somehow, investors were making idiotic choices. And the shortage of Palm stock made arbitrage by selling short difficult, though one of Thayler’s students was able to make $100,000 by finding shares to borrow.
The bottom line:
- Markets are not efficient;
- Expectations are systematically overconfident and biased; and
- Most mistakes create no arbitrage opportunities (e.g., if an acquaintance thinks your marriage will be a disaster, he has no way to bet against it.)
Or, in many cases, the appropriate model is Homer economicus, not homo economicus.