Monthly Archives: October 2016

Laissez-faire vs. regulation – which colonial legacy is better?

Since the very beginnings of market economies, there have been two general views of how things should be done; how the governments should behave. Laissez-faire vs. regulation, right vs. left, liberalism vs. social state, republicans vs. democrats, keep-your-money-and-use-it-however-you-want vs. give-us-your-money-and-we-will-redistribute-it. One might think that by now, we should have known for a long time which system works better. We can just compare two nations that each use one of the systems, right? However, comparing two nations with different systems shows to be a very difficult task due to great heterogeneity in virtually all other characteristics that affect the outcome. In the words of the theory of treatment econometrics, constructing a counterfactual is incredibly difficult. In the words of a normal person, we don’t know what economies would look like had they adopted a different system.

Alexander Lee and Kenneth A. Schultz of Stanford have used a unique natural experimental setting in Cameroon in their 2011 paper to shed more light on this agelong discussion. Cameroon was first colonized by the German empire in 1884. After the defeat of Germany in World War I, it became a League of Nations mandate territory and was artificially divided between the French and British colonial powers until Cameroon gained independence in the beginning of the 1960’s. During the more than 40 years of colonial regime, the French and the British took a very different approach as to which institutions to put in place to ensure effective economic development of their part of Cameroon. While the French flooded their part (East) of Cameroon with investment into infrastructure and made the public sector in general very powerful, the British (West Cameroon) preferred letting the economy work largely on its own.

This situation made for a very promising experimental setting, but large regional differences remained an issue. That is why the authors focused on pairs of rural towns that are close to each other geographically, but divided by the French-British border. This method is called local average treatment effect and it is an integral part of regression discontinuity design. To see its fundamental idea on a simpler example, suppose you want to estimate the effect of studying at the best law school on post-university wage as compared to studying at a worse (less challenging) law school. Taking a simple difference in wage between the two groups leads to a huge selection bias, as more skilled people usually get to the best school, because they score better on the entrance exam. Using the local average treatment effect in this example means to compare people who scored close to the cut-off level but below, and those who scored close but above. These two groups are roughly the same (since entrance exams are only rough approximations of your true skills), but one of them got the treatment (i.e. the best law school) and the other did not (i.e. they went to a worse law school). Similarly, in Cameroon, two villages that are close to  the French-British border are roughly the same (in geographical and other characteristics), but they received different treatment (i.e. the French vs. the British colonial legacy).

And the result? As shown in the figure below, the British part appears to have higher levels of economic dynamism, evidenced by greater household wealth, and better functioning local government institutions, evidenced by its higher level of public goods provision. These findings are consistent with the hypothesis that the mix of institutions and practices associated with British colonial rule generated superior outcomes. This does not imply, of course, that British-colonized areas always perform better or that West Cameroon is an elysia of wealth and strong institutions. But for the rural areas in this particular case, it seems that the British way was the better one to go with.

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Reference: Lee, A., & Schultz, K. A. (2012). Comparing British and French Colonial Legacies: A Discontinuity Analysis of Cameroon. Quarterly Journal of Political Science, 7(4), 365-410. Available here.

Do we work less than we did a century ago?

Valerie Ramey and Neville Francis developed comprehensive measures of time spent doing different activities – working, doing housework (cooking, cleaning etc.), being at school and enjoying leisure time – in the U.S. since the beginning of the 20th century. The research question was initially motivated by economic theory which suggests that as the society is getting richer, we should be able to afford more leisure time and work less. This is called the income effect.

Interestingly, at the aggregate level, hours devoted to work have changed only mildly. In particular, our generation works, on average, 23 hours per capita per week, which is 4 hours less than in 1900. The overall home production does not change at all – we still work at home around 22 hours per week. Not surprisingly, there has been a huge increase in hours devoted to formal schooling by those aged between 10 and 17 years old. When it comes to leisure, the effect is of a similar magnitude as the change in work hours, but the direction is opposite. We now enjoy four hours more of leisure every week than people who lived a century ago.

Even though the results may seem boring as we observe slight or no changes at all, there are underlying stories which are indeed interesting. During the last century, we have witnessed significant gender convergence. While men tend to work less in market production and more at home, the opposite is true for women. As a result, the gap between male and female hours spent working in work and at home seems to disappear.

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Reference: Ramey, V. A., & Francis, N. (2009). A Century of Work and Leisure. American Economic Journal: Macroeconomics, 189-224. Available here.

Migration: Another side, another story

The debate about the effects of migration on economy and society in Central, Eastern, and Southeastern Europe (CESEE) is uninformed and emotional, but it also misses a phenomenon that has economically influenced the CESEE region more than both the civil war in Syria and dire socioeconomic conditions in Maghreb. A recent IMF study shows that the post-communist countries have been affected by emigration more than it was previously thought and that the associated brain drain had significant negative effects on their economies.

The data clearly shows that the emigrants are more educated than the average population, and thus may be taking the economic potential of their home countries with them. The researchers estimate that an increase of 1 percentage point of immigrants’ share on indigenous population can be associated with 2 percent of GDP per capita growth. On the other hand, the adverse effect of skilled labor migration in the original countries translates itself to lower labor productivity. That in turn results in the convergence gap between Western Europe and CESEE region being 7 percentage points higher than it would have been without the massive emigration.

The standard economic theory suggests that such migration pushes wages of skilled labor in CESEE up and thus motivates the unskilled labor to move up in the labor hierarchy which results in higher GDP per capita. Although the wages had been pushed up by the migration, the output per capita had not grown due to that. The authors turn to endogenous growth models putting more emphasis on agglomeration effects of skilled labor: its abundance only increases its returns. Clearly, as educated people leave the economic hubs of the post-communist countries, they hardly make them more performing.

It would be foolish though to consider only the economic effects. Exodus of educated people surely influences also the domestic institutions and the quality of public life in general. Although it is difficult to quantify this effect, it should be taken into account in the analysis and in the plans of how to counter this issue. The authors suggest to improve the rule of law and other institutions in order to cut the vicious circle. Moreover, they cite Ireland’s success of engaging with diasporas all over the world and bringing back workforce that obtained its qualification elsewhere.

Such paper is a refreshing read in the world where only the issues of unskilled immigration are considered. True, the effects seem negative for the CESEE region, which can hardly improve the case for free movement of labor. However, since both the respective migrants and Europe as a whole are better off thanks to the migration, the report ends on a cheerful note after all.

Reference: Atoyan, M. R., Christiansen, L. E., Dizioli, A., Ebeke, M. C., Ilahi, M. N., Ilyina, M. A., … Raei, M. F. (2016). Emigration and Its Economic Impact on Eastern Europe. International Monetary Fund. Available here.

Letting others do the work will not get you a Nobel

You have probably done this at some point in your life, be it school, work, or organizing a party – you are part of a group assigned to a task, and while working on it, you realize you might as well just let others do the hard part. In the end, you all get the same credit for the final outcome anyway, right? Congratulations, you have just become the so-called free-rider of the group.

The seminal work of one of the two men woken up this morning by a call from the Nobel committee, Bengt Holmstrom, shed more light on this phenomenon. One of his most famous papers, published in 1982, shows that the free-rider problem described above can largely be resolved if ownership and labor are partly separated, which gives capitalistic firms an advantage over partnerships. In other words, if you are in a partnership, it is more likely that there will be a free-rider among your co-workers (partners) than when you own the company yourself and hire workers with assigned jobs. The rather technical paper also discusses some other issues arising due to such moral hazard questions. For example, it assesses the consequences of relative performance evaluation of workers and suggests ways to improve risk-sharing in entrepreneurship in general.

This is is one of the founding works in contracts theory, for which The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel was awarded this year to Bengt Holmstrom and Oliver Hart.

Reference: Holmstrom, B. (1982). Moral hazard in teams. The Bell Journal of Economics,13(2), 324-340. Available here.

Bitcoin mining: Should I do it?

Is it worth it to mine bitcoins? Should I do it on my computer? The short answers would be: it depends and definitely no, respectively. To shed more light on the issue of bitcoin mining, Karl O’Dwyer and David Malone published a short study which analyses the costs of electricity used to mine bitcoins. It is commonly known that bitcoin mining is more and more difficult as there is more of the virtual currency already in circulation. Therefore, computers have to solve more complicated mathematical problems and use more electricity. As a result, mining has become more expensive.

The authors calculated that it has never been profitable to mine bitcoins even with Core i7 950 processors or with a Sony Playstation 3. Moreover, they argued that the only way to mine bitcoins profitably, taking into account only electricity usage as a cost, is to employ special hardware – Monarch BPU 600 C (ASIC) – which was constructed specifically for bitcoin mining. Note, however, the profit gap is closing even for such advanced hardware. Equally interestingly, the authors estimated how much electricity is used to mine and administrate the bitcoin currency and found out that it is comparable with the electricity usage of Ireland. The picture below depicts the development of the cost of bitcoin mining and the value of bitcoins in US dollars.

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Reference: O’Dwyer, K. J., & Malone, D. (2013). Bitcoin mining and its energy footprint. In Irish Signals & Systems Conference 2014 and 2014 China-Ireland International Conference on Information and Communications Technologies (ISSC 2014/CIICT 2014). 25th IET (pp. 280-285). IET. Available here.