conversableeconomist

Journal of Economic Perspectives, Fall 2015 issue, Available Online

Since 1986, my actual paid job (as opposed to my blogging hobby) has been Managing Editor of the Journal of Economic Perspectives. The journal is published by the American Economic Association, which about four years ago made the decision–much to my delight–that the journal would be freely available on-line, from the current issue back to the first issue in 1987. The journal\’s website is here. I\’ll start here with Table of Contents for the just-released Fall 2015 issue. Below are abstracts and direct links for all of the papers. I will probably blog about some of the individual papers in the next week or two, as well.

Here are abstract and links to the articles.

Symposium on Overconfidence

\”On the Verges of Overconfidence,\” by Ulrike Malmendier and Timothy Taylor

This symposium provides several examples of overconfidence in certain economic contexts. Michael Grubb looks at \”Overconfident Consumers in the Marketplace.\” Ulrike Malmendier and Geoffrey Tate consider \”Behavioral CEOs: The Role of Managerial Overconfidence.\” Kent Daniel and David Hirshleifer discuss \”Overconfident Investors, Predictable Returns, and Excessive Trading.\” A number of insights and lessons emerge for our understanding of markets, public policy, and welfare. How do firms take advantage of consumer overconfidence? Might government attempts to rule out such practices end up providing benefits to some consumers but imposing costs on others? How are empirical measures of CEO overconfidence related to investment and the capital structure of firms? Can overconfidence among at least some investors help to explain prominent anomalies in stock markets like high levels of trading volume and certain predictable patterns in stock market returns?
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\”Overconfident Consumers in the Marketplace,\” by Michael D. Grubb
The term overconfidence is used broadly in the psychology literature, referring to both overoptimism and overprecision. Overoptimistic individuals overestimate their own abilities or prospects. In contrast, overprecise individuals place overly narrow confidence intervals around forecasts, thereby underestimating uncertainty. These biases can lead consumers to misforecast their future product usage, or to overestimate their abilities to navigate contract terms. In consequence, consumer overconfidence causes consumers to systematically misweight different dimensions of product quality and price. Poor choices based on biased estimates of a product\’s expected costs or benefits are the result. For instance, overoptimism about self-control is a leading explanation for why individuals overpay for gym memberships that they underutilize. Similarly, overprecision is a leading explanation for why individuals systematically choose the wrong calling plans, racking up large overage charges for exceeding usage allowances in the process. Beyond these market effects of overconfidence, this paper addresses three additional questions: What will firms do to exploit consumer overconfidence? What are the equilibrium welfare consequences of consumer overconfidence for consumers, firms, and society? And what are the implications of consumer overconfidence for public policy?
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\”Behavioral CEOs: The Role of Managerial Overconfidence,\” by Ulrike Malmendier and Geoffrey Tate
In this paper, we provide a theoretical and empirical framework that allows us to synthesize and assess the burgeoning literature on CEO overconfidence. We also provide novel empirical evidence that overconfidence matters for corporate investment decisions in a framework that explicitly addresses the endogeneity of firms\’ financing constraints.
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\”Overconfident Investors, Predictable Returns, and Excessive Trading,\” by Kent Daniel and David Hirshleifer
The last several decades have witnessed a shift away from a fully rational paradigm of financial markets toward one in which investor behavior is influenced by psychological biases. Two principal factors have contributed to this evolution: a body of evidence showing how psychological bias affects the behavior of economic actors; and an accumulation of evidence that is hard to reconcile with fully rational models of security market trading volumes and returns. In particular, asset markets exhibit trading volumes that are high, with individuals and asset managers trading aggressively, even when such trading results in high risk and low net returns. Moreover, asset prices display patterns of predictability that are difficult to reconcile with rational expectations-based theories of price formation. In this paper, we discuss the role of overconfidence as an explanation for these patterns.
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Symposium on the Future of Retail

\”The Ongoing Evolution of US Retail: A Format Tug-of-War,\” by Ali Hortaçsu and Chad Syverson
The past 15-20 years have seen substantial and visible changes in the way US retail business is conducted. Explanations about what is happening in the retail sector have been dominated by two powerful and not fully consistent narratives: a prediction that retail sales will migrate online and physical retail will be virtually extinguished, and a prediction that future shoppers will almost all be heading to giant physical stores like warehouse clubs and supercenters. Although online retail will surely continue to be a force shaping the sector going forward and may yet emerge as the dominant mode of commerce in the retail sector in the United States, its time for supremacy has not yet arrived. We discuss evidence indicating that the warehouse clubs/supercenter format has had a greater effect on the shape of retail over the past 15-20 years We begin with an overview of the retail sector as a whole, which over the long term has been shrinking as a share of total US economic activity and in terms of relative employment share. The retail sector has experienced stronger-than average productivity growth, but this has not been accompanied by commensurate wage growth. After discussing the important e-commerce and warehouse clubs/supercenters segments, we look more broadly at changes across the structure of the retail sector, including scale, concentration, dynamism, and degree of urbanization. Finally, we consider the likely future course of the retail sector.
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\”Adolescence and the Path to Maturity in Global Retail,\” Bart J. Bronnenberg and Paul B. Ellickson
We argue that, over the past several decades, the adoption and diffusion of \”modern retailing technology\” represents a substantial advance in productivity, providing greater product variety, enhanced convenience, and lower prices. We first describe modern retailing, highlighting the role of modern formats, scale (often transcending national boundaries), and increased coordination with upstream and downstream partners in production and distribution. In developed markets, the transition to modern retailing is nearly complete. In contrast, many low-income and emerging markets continue to rely on traditional retail formats, that is, a collection of independent stores and open air markets supplied by small-scale wholesalers, although modern retail has begun to spread to these markets as well. E-commerce is a notable exception: the penetration of e-commerce in China and several developing nations in Asia has already surpassed that of high-income countries for some types of consumer goods. To understand the forces governing the adoption of modern technology and the unique role of e-commerce, we propose a framework that emphasizes the importance of scale and coordination in facilitating the transition from traditional to modern retailing. We conclude with some conjectures regarding the likely impact of increased retail modernization for the developing world.
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Symposium on Online Higher Education

\”Online Higher Education: Beyond the Hype Cycle,\” by Michael S. McPherson and Lawrence S. Bacow
When two Silicon Valley start-ups, Coursera and Udacity, embarked in 2012 on a bold effort to supply college-level courses for free over the Internet to learners worldwide, the notion of the Massively Open Online Course (MOOC) captured the nation\’s attention. Although MOOCs are an interesting experiment with a role to play in the future of higher education, they are a surprisingly small part of the online higher education scene. We believe that online education, at least online education that begins to take full advantage of the interactivity offered by the web, is still in its infancy. We begin by sketching out the several faces of online learning—asynchronous, partially asynchronous, the flipped classroom, and others—as well as how the use of online education differs across the spectrum of higher education. We consider how the growth of online education will affect cost and convenience, student learning, and the role of faculty and administrators. We argue that spread of online education through higher education is likely to be slower than many commenters expect. We hope that online education will bring substantial benefits. But less-attractive outcomes are also possible if, for instance, legislators use the existence of online education as an excuse for sharp cuts in higher education budgets that lead to lower-quality education for many students, at the same time that richer, more selective schools are using online education as one more weapon in the arms race dynamic that is driving costs higher.
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\”How Economics Faculty Can Survive (and Perhaps Thrive) in a Brave New Online World,\” by Peter Navarro
The academy in which we toil is moving rapidly towards a greater role for online delivery of higher education, and both fans and skeptics offer strong reasons to believe this technological shock will have substantial disruptive effects on faculty. How can we as economic educators continue to provide sufficient value-added to justify our role in a world where much of what we now do is effectively being automated and commoditized? In this brave new online world, many successful and resilient faculty will add value (and differentiate their product) not by producing costly and elaborate multimedia lectures in which they become a superstar professor-celebrity, but rather through careful, clever, and innovative choices regarding both the adoption of the online content of other providers and the forms of online interactions they integrate into their course designs. Possible forms of faculty-to-student and student-to-student interactions run the digital gamut from discussion boards and electronic testing to peer assessments, games and simulations, and virtual office hours. This article explores basic descriptive and prescriptive questions economic educators and their administrators are likely to face as the online education tide rises. For example, how much does it cost to develop online content and how much time does it take? What are the key \”ingredients\” for a pedagogically sound online course? Throughout, I will draw on both the extant literature as well as my own experience at the University of California, Irvine, where the online evolution is advancing rapidly. [This article is available for download in audio (MP3) format from the journal website.]
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Articles

\”Rewriting Monetary Policy 101: What\’s the Fed\’s Preferred Post-Crisis Approach to Raising Interest Rates?\” by Jane E. Ihrig, Ellen E. Meade and Gretchen C. Weinbach
For many years prior to the global financial crisis, the Federal Open Market Committee set a target for the federal funds rate and achieved that target through small purchases and sales of securities in the open market. In the aftermath of the financial crisis, with a superabundant level of reserve balances in the banking system having been created as a result of the Federal Reserve\’s large-scale asset purchase programs, this approach to implementing monetary policy will no longer work. This paper provides a primer on the Fed\’s implementation of monetary policy. We use the standard textbook model to illustrate why the approach used by the Federal Reserve before the financial crisis to keep the federal funds rate near the Federal Open Market Committee\’s target will not work in current circumstances, and explain the approach that the Committee intends to use instead when it decides to begin raising short-term interest rates.
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\”Household Surveys in Crisis,\” by Bruce D. Meyer, Wallace K. C. Mok and James X. Sullivan
Household surveys, one of the main innovations in social science research of the last century, are threatened by declining accuracy due to reduced cooperation of respondents. While many indicators of survey quality have steadily declined in recent decades, the literature has largely emphasized rising nonresponse rates rather than other potentially more important dimensions to the problem. We divide the problem into rising rates of nonresponse, imputation, and measurement error, documenting the rise in each of these threats to survey quality over the past three decades. A fundamental problem in assessing biases due to these problems in surveys is the lack of a benchmark or measure of truth, leading us to focus on the accuracy of the reporting of government transfers. We provide evidence from aggregate measures of transfer reporting as well as linked microdata. We discuss the relative importance of misreporting of program receipt and conditional amounts of benefits received, as well as some of the conjectured reasons for declining cooperation and for survey errors. We end by discussing ways to reduce the impact of the problem including the increased use of administrative data and the possibilities for combining administrative and survey data.
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\”Seven Centuries of European Economic Growth and Decline,\” by Roger Fouquet and Stephen Broadberry
This paper investigates very long-run preindustrial economic development. New annual GDP per capita data for six European countries over the last seven hundred years paint a clearer picture of the history of European economic development. We confirm that sustained growth has been a recent phenomenon, but reject the argument that there was no long-run growth in living standards before the Industrial Revolution. Instead, the evidence demonstrates the existence of numerous periods of economic growth before the nineteenth century—periods of unsustained, but raising GDP per capita. We also show that many of the economies experienced substantial economic decline. Thus, rather than being stagnant, pre-nineteenth century European economies experienced a great deal of change. Finally, we offer some evidence that, from the nineteenth century, these economies increased the likelihood of being in a phase of economic growth and reduced the risk of being in a phase of economic decline.

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\”Recommendations for Further Reading,\” by Timothy Taylor
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The Window Tax: A Tale of Excess Burden

For economists, the \”excess burden\” of a tax refers to the idea that the cost of a tax isn\’t just the amount of money collected–it\’s also the ways in which taxpayers alter their behavior because the tax has changed their incentives. A moderately well-known classroom and textbook example is the \”window tax,\” first imposed in England in 1696 by King William III, and not definitively repealed until 1851. The excess burden of the window tax was that lower-income people ended up living in rooms with few or no windows.

Wallace E. Oates and Robert M. Schwab review the history of the window tax and provide actual estimates of how it affected the number of windows per house in their article, \”The Window Tax: A Case Study in Excess Burden,\” which appeared in the Winter 2015 issue of the Journal of Economic Perspectives (where I have toiled in the fields as Managing Editor since 1987). The article popped back into my mind earlier this week when I learned that Oates, a highly distinguished economist based at the University of Maryland since 1979, died last week.  One of Oates\’s specialties was the area of local public finance, and his 1972 book on Fiscal Federalism,  is a classic of that subfield.

Here are some facts about the historical window tax, courtesy of Oates and Schwab.

  • William III intended it as a temporary tax, just to help out with the overhang of costs from the Glorious Revolution of 1688 and the most recent war with France. But it ended up lasting 150 years. 
  • \”An important feature of the tax was that it was levied on the occupant, not the owner of the dwelling. Thus, the renter, not the landlord, paid the tax. However, large tenement buildings in the cities, each with several apartments, were an exception. They were charged as single residences with the tax liability resting on the landlord. This led to especially wretched conditions for the poor in the cities, as landlords blocked up windows and constructed tenements without adequate light and ventilation …\”
  • The window tax was thought of as improvement on the \”hearth tax,\” that Charles II had imposed in 1662. \”The tax was very unpopular in part because of the intrusive character of the assessment process. The `chimney-men\’ (as the assessors and tax collectors were called) had to enter the house to count the number of hearths and stoves, and there was great resentment against this invasion of the sanctity of the home. The window tax, in contrast, did not require access to the interior of the dwelling: the “window peepers” could count windows from the outside, thus simplifying the assessment procedure and obviating the need for an invasion of the interior.\”
  • The window tax was intended as a visible measure of ability to pay: that is, a high-income person would live in a place with more windows than a low-income person. But at the time, it was widely recognized that windows were a very imperfect proxy for wealth. Adam Smith wrote about this problem of window tax in 1776 in The Wealth of Nations: “A house of ten pounds rent in the country may have more windows than a house of five hundred pounds rent in London; and though the inhabitant of the former is likely to be a much poorer man than that of the latter, yet so far as his contribution is regulated by the window-tax, he must contribute more to the support of the state.”
  • When the rates on the window tax went up, it was common for owners of homes and apartments to block or build over many or all of their windows. The results on human well-being were severe. \”A series of studies by physicians and others found that the unsanitary conditions resulting from the lack of proper ventilation and fresh air encouraged the propagation of numerous diseases such as dysentery, gangrene, and typhus. … A series of petitions to Parliament resulted in the designation of commissioners and committees to study the problems of the window tax in the first half of the 19th century. In 1846, medical officers petitioned Parliament for the abolition of the window tax, pronouncing it to be `most injurious to the health, welfare, property, and industry of the poor, and of the community at large\’.\”
  • Here\’s Charles Dickens writing in 1850 about the window tax in Household Words, a magazine that he published for a number of years: “The adage ‘free as air’ has become obsolete by Act of Parliament. Neither air nor light have been free since the imposition of the window-tax. We are obliged to pay for what nature lavishly supplies to all, at so much per window per year; and the poor who cannot afford the expense are stinted in two of the most urgent necessities of life.” 

Oates and Schwab work with a mix of data on the number of windows in a sample of houses in Shropshire and economic theory about household behavior when confronted with taxes to generate an admittedly rough estimate that on average, collecting a certain amount of money through the window tax created an excess burden–in terms of the costs of living in a place with fewer windows–equal to an additional 62% of the value of the tax.

Oates and Schwab ask why the window tax lasted so long, give its many problems, and offer an appropriately cynical answer: \”Perhaps the lesson here is that when governments need to raise significant revenue, even a very bad tax can survive for a very long time.\”

I didn\’t know Oates personally, but I had one other job-related interaction with him back. Along with his work in local public finance, Oates was also well-known as an environmental economist. His 1975 book, The Theory of Environmental Policy (written with William Baumol) was highly influential in setting the direction of what at the time was a fairly new and growing field. In 1995, Oates was a co-author in one of the most downloaded and cited exchanges the JEP has ever published on the subject of what is sometimes called the \”Porter hypothesis.\”

Michael Porter made the argument–bolstered by a large number of case studies, that when environmental goals are set in a strict way, but firms are allowed flexibility in how to achieve those goals in the context of a competitive market environment, firms often become quite innovative in meeting those environmental goals. Indeed, Porter argued that in a substantial number of cases, the innovations induced by the tough new environmental rules save enough money so that the rules end up imposing no economic costs at all. In the Fall 1995 Journal of Economic Perspectives, Michael E. Porter and Claas van der Linde make their case in \”Toward a New Conception of the Environment-Competitiveness Relationship,\” (9:4, 97-118). The authorial team of Karen Palmer, Wallace E. Oates, and Paul R. Portney respond in \”Tightening Environmental Standards: The Benefit-Cost or the No-Cost Paradigm?\” (9:4, 119-132). Oates and his co-authors took the position that while the costs of complying with environmental regulations do often turn out to be lower than industry predictions that were made when the rule was under discussion, it goes too far to say that environmental rules usually or generally don\’t impose costs. I wrote about some more recent evidence on this dispute in \”Environmental Protection and Productivity Growth: Seeking the Tradeoff\” (January 8, 2015).