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Online Dating and Interracial Marriage

Online dating has already altered romance, and it may be on its way to altering society more broadly by changing the way that people from different groups make connections.  Josué Ortega and Philipp Hergovich provide some evidence and analysis in \”The Strength of Absent Ties: Social Integration via Online Dating\” (posted online October 2, 2017). Here\’s some striking evidence that they cite from another paper on the rise of online romance.

The top graph shows heterosexual couples; the bottom graph shows same-sex couples. In each case, the red line that starts shooting up a few years before 2000 shows the share that \”met online.\” Met in \”bar/restaurant\” has also rise, and one suspect that some of these meetings have an online component as well.Meanwhile, \”met through friends,\” \”met in church,\” and other categories have declined.

The Ortega and Hergovich working paper lays out a mathematical model of marriage matching that will be heavy going for most readers. But much of the intuition behind the model is fairly straightforward. Their focus is on the implications of online-dating for interracial marriage.

Here\’s a figure from their paper, showing the upward trend in interracial marriage (in this data, marriage of newlyweds) over time. As it explains under the diagram, \”The red, green, and purple lines represent the creation of Match.com, OKCupid, and Tinder, three of the largest dating websites.\” They argue that it is not a coincidence that the rate of interracial marriage rises faster than it\’s long-term trend as dating websites arrive.

A standard model of marriage markets works like this. Those on one side of the market propose marriage to those on the other side. Those who like a proposal they receive can retain their preferred proposal–without actually accepting that proposal. However, all of those who are turned down go make another proposal. Again, those who like the proposal they receive can retain it, without saying \”yes,\” and the cycle continues until no one wants to make any additional proposals. At that point, all those who have retained a desired proposal say \”yes.\” This is an application of the famous Gale-Shapley algorithm, which was part of justification behind the 2012 Nobel price in economics.  In the Ortega and Hergovich, people belong to certain communities, and at first you can only marry someone from within your community. Like the survey results above suggest, you are introduced by friends or an organization like your church. But online dating changes these dynamics. People can reach outside their usual community more easily, and a faster rate of increase in interracial marriage is one of the dynamics.

For a longer-term review of patterns related to interracial marriage, a useful starting point is Roland G. Fryer Jr., \”Guess Who’s Been Coming to Dinner?Trends in Interracial Marriage over the20th Century,\” in the Spring 2007 issue of the Journal of Economic Perspectives. 

My suspicion is that online dating affects marriage patterns in other ways, too. For example, people have become more likely to marry others with similar educational and socioeconomic background, as I discussed in \”Marriage: Homogamy or Heterogamy?\” (January 12, 2016).

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Learning, Not Just Schooling: World Development Report 2018

The World Development Report 2018, one of the flagship reports of the World Bank, focuses on the theme \”LEARNING To Realize Education\’s Promise.\” The thrust of the report is that school enrollments are up dramatically in developing countries across the world, but in a disturbingly high number of cases, the larger numbers of children attending school are not leading to a similarly high increase in actual student learning.

For example, here\’s a figure showing rises in school attendance by region, over the long run. Primary school attendance has become almost (if not quite) universal around the world. Secondary school attendance is rising sharply in Sub-Saharan Africa and South Asia.

But as the report says at the very start (footnotes omitted):

\”Schooling is not the same as learning. In Kenya, Tanzania, and Uganda, when grade 3 students were asked recently to read a sentence such as “The name of the dog is Puppy,” three-quarters did not understand what it said.1 In rural India, just under three-quarters of students in grade 3 could not solve a two-digit subtraction such as 46 – 17, and by grade 5 half could still not do so. Although the skills of Brazilian 15-year-olds have improved, at their current rate of improvement they won’t reach the rich-country average score in math for 75 years. In reading, it will take more than 260 years. Within countries, learning outcomes are almost always much worse for the disadvantaged. In Uruguay, poor children in grade 6 are assessed as “not competent” in math at five times the rate of wealthy children. … 

Although not all developing countries suffer from such extreme shortfalls, many are far short of the levels they aspire to. According to leading international assessments of literacy and numeracy—Progress in International Reading Literacy Study (PIRLS) and
Trends in International Mathematics and Science Study (TIMSS)—the average student in low-income countries performs worse than 95 percent of the students in high-income countries, meaning that student would be singled out for remedial attention in a class
in high-income countries. Many high-performing students in middle-income countries—young men and women who have risen to the top quarter of  their cohorts—would rank in the bottom quarter in a wealthier country.\”

Here\’s one of many striking figures along these lines. It shows a share of second-graders who cannot read a single word of text, or who cannot subtract two-digit numbers. The footnotes warn that these figures draw upon individual studies, and the ones in India are focuses on rural areas, so the numbers should not be treated as nationally representative. But national data aren\’t available, and the evidence from the partial data is worrisome.

Of course, the educational system in any country faces difficulties that the schools alone are ill-suited to address. As the report notes: \”[C]hildren often arrive in school unprepared to learn—if they

arrive at all. Malnutrition, illness, low parental investments, and the harsh environments associated with poverty undermine early childhood learning. Severe deprivations—whether in terms of nutrition,
unhealthy environments, or lack of nurture by caregivers—have long-lasting effects because they
impair infants’ brain development. Thirty percent of children under 5 in developing countries are
physically stunted, meaning they have low height for their age, typically due to chronic malnutrition.
The poor developmental foundations and lower levels of preschool skills resulting from deprivation mean many children arrive at school unprepared to benefit fully from it …\”
But with these outside issues and others duly noted, the report is also explicit and clear on the problems of teachers who lack skills and motivation, operating in a system of poor governance. education systems suffering under poor governance.  The report summarizes the needed policy reforms under three categories: 
  • Assess learning—to make it a serious goal. Measure and track learning better; use the results to guide action.
  • Act on evidence—to make schools work for all learners. Use evidence to guide innovation and practice.
  • Align actors—to make the whole system work for learning. Tackle the technical and political barriers to learning at scale.

The report rewards reading with a number of examples of such policies in action. But it\’s worth noting two broader points as well. One is that the report suggests that lack of inputs to education is not the primary problem in most places: \”Public discourse often equates problems of education quality with input gaps. Devoting enough resources to education is crucial, and in some countries resources have not kept pace with the rapid jumps in enrollment. For several reasons, however, input shortages explain only a small part of the learning crisis. First, looking across systems and schools, similar levels of resources are often associated with vast differences in learning outcomes. Second, increasing inputs in a given setting often has small effects on learning outcomes. Part of the reason

is that inputs often fail to make it to the front lines.\”
The other issue is that all education-related policy reforms happen in a broader context. The report emphasizes over and over that education reforms happen in a context of whether a society is genuinely committed and dedicated to raising the educational performance of its young people. A society that is not committed will find numerous and ever-multiplying reasons to hesitate from any serious action: Can we really measure education outcomes accurately, after all? Is it worthwhile to track students? Might tracking make some students and teachers feel bad? Isn\’t experimenting with alternatives often a waste of time? Who decides what incentives should be built into the system, and will such incentives be allocated fairly or politically? Can\’t pretty much anyone teach young children, so there\’s no need to worry much about training? Shouldn\’t teachers be able to run their classrooms without outside interference? Shouldn\’t teachers or principals who have been in place for a long time receive considerable deference to their experience? 

These kinds of questions aren\’t wrong, or illegitimate. But they can very easily become an excuse for inertia. Only if a society is able to put the learning of children clearly first, in a way that makes flexibility and change imperative, will these kinds of questions turn into ways of usefully shaping new policies, rather than excuses for keeping the same system on track. The report notes various success stories.

\”When improving learning becomes a priority, great progress is possible. In the early 1950s, the Republic of Korea was a war-torn society held back by very low literacy levels. By 1995 it had achieved universal enrollment in high-quality education through secondary school. Today, its young people perform at the highest levels on international learning assessments. Vietnam surprised the world when the 2012 results of the Programme for International Student Assessment (PISA) showed that its 15-year-olds were performing at the same level as those in Germany— even though Vietnam was a lower-middle-income country. Between 2009 and 2015, Peru achieved some of the fastest growth in overall learning outcomes—an improvement attributable to concerted policy action.\”

It\’s difficult to overstate the importance of education in economic development and growth. To put it bluntly, there are zero examples of countries in the modern world economy that have experienced lasting growth and development without a workforce of growing educational attainment and skills. The report includes various comments like this:

\”When delivered well, education cures a host of societal ills. For individuals, it promotes employment, earnings, health, and poverty reduction. For societies, it spurs innovation, strengthens institutions, and fosters social cohesion. But these benefits depend largely on learning. Schooling without learning is a wasted opportunity. More than that, it is a great injustice: the children whom society is failing most are the ones who most need a good education to succeed in life.\”

It\’s easy to skim over such statements, and to view them as just another dose of overbroad feelgood boilerplate rhetoric. Except when you read it slowly, it\’s all true.

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Independent Workers and Policy: Krueger\’s Moynihan Lecture

Alan B. Krueger delivered the annual Daniel Patrick Moynihan Lecture on Social Science and Public Policy, on the topic of \”Independent Workers: What Role for Public Policy,\” for the American Academy of Political and Social Science on May 18, 2017. Video of the roughly hour-long actual lecture, which also shows the slides, is here. A revised and written-out version of the lecture, which I\’ll draw upon for this post, is posted here as Working Paper #615 for the Industrial Relations Section at Princeton University (September 2017). 

The issue here involves workers who do not have a \”traditional\” employment relationship: that is,  a job with a given employer and an expectation that the job is likely to continue into the future. Instead, independent workers work for themselves, and earn their living through a series of short-term interactions or time-limited contracts. As a result, they don\’t receive employer-provided benefits like health insurance, a pension plan, paid vacation, life insurance, and the like. 
How many workers fall into this category? Perhaps oddly enough, some main data sources disagree. Back around 1979, the tax data on people who reported self-employment income and the Census Bureau\’s Current Population Survey both suggested that about 8% of workers were self-employed. But since then, more people are reporting that they are self-employed on tax data, while fewer people are telling the survey that they are self-employed. On this one, I trust the tax data more! Krueger writes that this divergence \”suggests to me that the job market has changed so quickly that many workers are fundamentally confused about the nature of their employment relationship.\”
 

Krueger reports survey results that the employer-provided benefit which most concerns independent workers, far and away, is a lack of access to health insurance. While that concern is obviously immediate and foremost in people\’s minds, I\’ll add my own belief that many of the independent workers should probably also be quite concerned about longer-term issues, like a lack of retirement savings and a lack of ongoing job-training. What might be done here? Krueger suggests a number of small-scale policies, and one bigger policy. Without passing judgment on them, here are some of the options, with small-scale possibilities first:

\”One policy proposal that has gained some traction is to have a carve out for intermediaries that permits them to provide benefits without risk that their contractors will be deemed employees. Indeed, my sense is that many of the new online intermediaries would like to provide some benefits to their workers but they refrain from doing so because they are worried that they will be classified as an employer if they provided access to benefits, such as life insurance. …

\”For the self-employed, however, health insurance expenses are excluded from income taxes but not from payroll taxes. With payroll taxes of around 15 percent, this creates a significant additional tax on the self-employed. That could easily be rectified through tax policy.

\”As mentioned, the self-employed receive relatively little job training. The IRS is tough on the deductibility of training expenses for the self-employed. Particularly when it comes to safety-related training, it would make sense for the IRS to be more permissive in allow training deductions as a business expense. Congress could also enact tax credits to encourage job training, particularly for safety training, for self-employed workers. …

Extend coverage under Title VII of the Civil Rights Act of 1964 to independent contractors. The self-employed currently have few options if they face discrimination. The arguments in favor of this proposal are obvious: (1) it would extend protections that already exist for employees to the self-employed; (2) discrimination is plainly unfair and economically inefficient if it originates from personal animus or ignorant stereotypes; and (3) there is an administrative system in place to enforce the policy. …

Here’s a really ambitious, big idea: Hanauer and Rolf (2015) have proposed the idea of `Shared Security Accounts,\’ in which all workers would be covered by a universal system that provides health insurance, retirement benefits, paid leave, and so on. Employers and online platforms like Uber would contribute 25% of their workers’ compensation into a fund to pay for those benefits. Workers could choose which benefits they want. … I should also note that Shared Security Accounts are not a total head-in-the-sky idea. Washington State and New Jersey have considered legislation along these lines for self-employed workers.

When thinking about public policy for such workers, Krueger describes some of  his objectives this way: 
  • Policy should be neutral with respect to self-employment vs. traditional W-2 employment (e.g., tax treatment of health insurance should be equivalent).
  • Policy should avoid creating incentives for employers to convert W-2 jobs into self-employed jobs. … 
  • Self-employed workers should be covered by the same essential protections and benefits as W-2 employees (i.e., social compact applies equally).
It should be noted that these objectives are debatable. For example, consider a household with two adult workers: one has a job with health insurance, pension, and all the rest, while the other is an independent worker without such benefits. It\’s not obvious that public policy should seek to assure the same benefits for both workers. But it is obvious that if public policy does not make some efforts in this direction, we will end up–either when independent workers don\’t have a partner to provide benefits, or when our hypothetical two-person household separates or divorces–with a substantial number of workers who lack health insurance, life insurance, and retirement saving. If or when this happens, it will be a problem for the political system, not just for those workers. Better to think about some ways to address these issues in advance. 

Readers who would like more on the \”gig economy\” and independent jobs might start with these posts: 

(Full disclosure: Krueger was the Editor of the Journal of Economic Perspectives, and thus my boss, for the six years from 1996-2002.)
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The Lost US Lead in Education

In the middle of the 20th century, the US economy had the enormous advantage that its workforce was by far the most skilled in the world. That advantage has largely dissipated. Alexander Monge-Naranjo of the St. Louis Fed provides some basic facts in the short article \”Workers Abroad Are Catching Up to U.S. Skill Levels\” (Regional Economist, Third Quarter 2017, pp. 6-7). The underlying data here is from Robert Barro and Jong-Wha Lee, \”A New Data Set of Educational Attainment in the World, 1950-2010,\” Journal of Development Economics, 2013, Vol. 104, pp.184-98.

Here\’s a comparison for 1950, showing what share of the workers in each country are in a given education group. The US is the light blue bars on the right of each cluster. Notice that the light blue bars are typically lower in the lower education categories, but higher in the higher education categories. Also, if you do a bit of mental addition, you see that countries like France, Germany, Japan, and South Korea had two-thirds or more of their population in the broader category of \”primary school education or less\” circa 1950.

The next comparison is different in two ways. It looks at data for 2010, and it focuses only on workers in  the 25-35 age bracket. By leaving out older workers, the focus is on what education level workers are likely to have in decades ahead. The light blue bars showing the US levels of education have clearly risen, but the other countries are now much more similar. Even in cases where a country like Germany looks lower in college degrees, it\’s worth remembering that Germany has an aggressive and far-reaching apprenticeship program that help to provide future workers with job-related training. One can of course raise the possibility that those South Korean college degrees might not be equal in quality, on average, to US college degrees. But the size of the changes is so enormous that quibbling over quality is not going to alter the main pattern.

The catch-up in education levels is also apparent, if not as pronounced, in emerging market economies. Here\’s a similar figure, for workers age 25-35 in 2010, comparing the US to emerging market economies of Brazil, China, India, Mexico and Russia.

I suppose there are a few themes to draw from this.

First, catch-up in education levels by the rest of the world is broadly a good thing, because it\’s a good thing for a range of reasons from economic to self-determination when more humans have a higher level of education.

Second, 1950 was a unique time, and it\’s implausible that the US would have maintained its status of dramatically higher education levels indefinitely.

Third, with those previous points acknowledged, the US has not done a good job in the last half-century of fostering the incentives, institutions, and culture that would have helped it to keep a lead in human capital. I\’m not talking only or even mostly about the public schools here, but about the many contexts in which schools, colleges and universities, employers, and individuals make decisions about providing and working on their education.

Those interested in more details about the ongoing loss of the US position as the clearcut world leader in an educated workforce might be interested in a couple of previous posts:

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Snapshots of the Global Robotics Industry

The International Federation of Robotics is an industry group. Each year, it publishes a World Robotics Report, and while you need to pay big money for the full report, the Executive Summary and some illustrative slides are freely available. Here are some snapshots of the global robotics industry, released in the last few weeks from the World Robotics Report 2017.
 For industrial robots, \”There are five major markets representing 74% of the total sales volume in 2016: China, the Republic of Korea, Japan, the United States, and Germany. Since 2013 China has been the biggest robot market in the world with a continued dynamic growth.\” Here\’s the pattern of industrial robot sales in the last 10 years by region.

When categorized by industry, most industrial robots are in the automotive or the electrical/electronics industries.

The stock of robots refers to the total number in service, rather than the sales in a given year. \”The total worldwide stock of operational industrial robots at the end of 2016 increased by 12% to about 1.8 million units. Since 2010, the stock has been increasing considerably by 10% on average per year.\”

How does the number of industrial robots in the US compare to other countries? The answer presumably tells something about the potential for future expansion of the use of robots. One measure is to look at the number of robots in relation to the number of manufacturing jobs. By that measure, the US does not rank among the world leaders. The report explains (footnotes omitted):

\”The average global robot density is about 74 industrial robots installed per 10,000 employees in the manufacturing industry in 2016. The most automated countries in the world are the Republic of Korea, Singapore, Germany and Japan. The Republic of Korea has by far the highest robot density in the manufacturing industry since 2010. 631 industrial robots were in operation in 2016 per 10,000 employees. The rate has been increasing from 311 units in 2010 due to continued installation of a large volume of robots since 2010 particularly in the electrical/electronics industry and in the
automotive industry. … Up to 2009 Japan had the highest robot density worldwide. But since 2010 the Republic of Korea and since 2015 Singapore have topped Japan in this respect. Japan’s robot density has been declining since 2009. In 2016, 303 robots were installed per 10,000 employees in the manufacturing industry.

\”The development of the robot density in China was the most dynamic one in the world due to the significant growth of robot installations in recent years. Particularly between 2013 and 2016, the rising rate of robot density accelerated in China, from 25 units to 68 units. Due to the dynamic development of robot installations since 2010, the robot density in the United States increased significantly from 114 installed robots per 10,000 employees in the manufacturing industry in 2009 to 189 robots in 2016.\”

The raw numbers seem to suggest that there is substantial potential for higher use of industrial robots in the United States, perhaps especially in industries not currently making much use of them. 

There is also a separate category, smaller but faster-growing, of \”service robots.\” 

\”It is not possible to estimate how many of these robots are still in operation due to the diversity of these products resulting in varying utilization times. Some robots (e.g. underwater robots) might be more than 10 years in operation (compared to an average life time of 12 years in industrial robotics). Others like defence robots may only serve for a short time. The main applications are: 

  • Logistic systems [that is, automated guided vehicles]
  • Defense robots 
  • Field robots (milking robots)
  • Public relations robots 
  • Powered human exoskeletons 
  • Medical robots. … 

In professional applications, service robots are already having a significant impact in areas such as agriculture, surgery, logistics and underwater applications and are growing in economic importance. Driven by evolving security threats, there is a growing need to monitor everyday environments, which results in increased and difficult-to-manage workloads and data flows. To help meet this need, robots will play an even greater role in the maintenance, security and rescue market. Robotics in personal and domestic applications has experienced strong global growth with relatively few mass-market products: floor cleaning robots, robo-mowers and robots for edutainment. Future product visions point to domestic robots of higher sophistication, capability and value, such as assistive robots for supporting the elderly, for helping out with household chores and for entertainment.\”

Robots are coming to the global economy. If you are someone who worries about slow productivity and wage stagnation, as I do, it\’s a trend to be embraced. Moreover, the US economy and political system has only very limited control over how fast the robots come. If robots aren\’t embraced here, it will in no way stop them from being embraced elsewhere around the world. New technology involves change, pretty much by definition, but over time, the best course of action is to figure out how to work with the change.

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Formal Jobs and Decent Work

Most people in the world work for some kind of private-sector business enterprise. The quality of these jobs varies enormously: for example, working for a medium or large and well-established employer in the US or another high-income country is a lot different from working for a small informal employer in a low-income country. The International Labour Organization explores the importance of formal enterprises to provide decent work in its recent report, \”World Employment and Social Outlook 2017: Sustaining enterprises and jobs – Formal enterprises and decent work.\” It begins (footnotes omitted):

\”Private sector enterprises account for the bulk of global employment: in 2016, 2.8 billion individuals were employed by the private sector, which represents 87 per cent of total employment, with the remaining 13 per cent in non-market services. Although pr
ivate enterprises’ share of employment differs across countries, a strong private sector is the foundation for growth, job creation and poverty reduction. … While it is true that private sector enterprises are a major source of employment – 87 per cent of total employment, as stated previously – this includes employment generated by informal enterprises, which can be substantial, especially for some developing and emerging economies. According to ILO estimates, about half the world’s workforce is employed in the informal economy, the bulk of which isin the emerging and developing world.\”

The \”nonmarket services\” to which the report refers are \”the common public sector (education,
health and social services, public administration and defence).\”

A key insight of the report is that most employment in the formal sector of most countries occurs in large companies. Specifically companies with more than 100 employees make up 10% or less of total firms, but are typically 50-60% of formal sector employment. 
There does seem to be evidence that the share of employment as small and medium enterprises is rising modestly, from about 31% of total formal employment jobs in 2003 to more like 34% at present. In a number of countries, smaller firms may also function as a way for women to enter the (paid) labor force. 
But in some ways, the line between small, medium, and larger firms can be a little artificial. A friend of mine used to say: \”You know what most small companies do? They sell to bigger companies.\” The point was that large firms make choices about what to do inside their company, and what to hire from outside the company–which in turn affects the opportunities for small and medium enterprises. There are certainly plenty of cases where a large firm drives smaller competitors out of the market, but there are also plenty of cases where a contract from a big firm is what gets a smaller firm off the ground. 
The policy challenge in many countries across the world is how to encourage the aspects of firms that provide decent employment and goods and services to buyers, while discouraging the anticompetitive or exploitative possibilities of firms. The report refers to the need of firms for \”numerical and functional flexibility\”– meaning the ability to adjust quantities of workers, hours worked, worker training, and the production process in response to shifts in market conditions. The hard question here is one that is arising in labor markets all over the world, not just in emerging and developing economies. 
Extremely flexible jobs are often part-time or short-term or both. In this setting, employers don\’t worry much about putting time and resources into training workers: after all, those flexible workers might not be there next month or next week. Production processes are designed for interchangeable low-skill or maybe medium-skill workers. As a result, highly flexible job markets can also be markets which don\’t invest much in improving the skills of workers. As the report notes: \”Particularly in the case of women, but also among youth, flexibility can come at the cost of lower wages and limited opportunities for career advancement …\” 
Indeed, the ILO report offers evidence that while informal jobs are more common in developing countries, if one focuses on the formal sector, part-time and temporary jobs are more common in developed economies. In addition, the report notes that while share of firms that provide training to full-time formal-sector employees is higher in developed economies, it is still not the most common practice.
The ILO report points to some evidence that firms which offer more training to employees also have higher profits, but of course, this correlation doesn\’t prove that if all firms offered training to employees, they would all have higher profits. Similarly, the report offers evidence that firms which export tend to be more productive and pay higher wages, but again, this correlation doesn\’t prove that if all firms tried to export, they would all pay higher wages. 
The underlying challenges here are a difficult ones. In a number of countries around  the world, especially in Africa, the Middle East, and south Asia, the working age population is still growing substantially. In these countries, a key social question is how to encourage or facilitate (or at least not to block) the growth of a very large number of private-sector employers. The US economy has also suffered in the last couple of decades from a slowdown in the rate of formation of new firms. 
An intertwined question is the incentives that a labor market provides for ongoing training and education. If firms do not perceive that a substantial numbers of employees are likely to remain for a period of years, then firms will not perceive it as worthwhile to spend time and energy on training employees. But prospective employees will have a hard time knowing what training would be useful to firms, and perhaps also a hard time raising funds to pay for the training themselves. As I\’ve argued here in the past (\”What is a `Good Job?\’ April 5, 2016), many people would like a job that offers a degree of stability and security, along with building skills so that over time you can assume greater responsibilities and receive higher pay. In our current economic environment, with the high value that it places of flexibility, thinking about the labor market institutions and practices that would help create this kind of decent work is a hard and necessary task. 
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Richard Thaler: The 2017 Nobel Prize in Economics

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel for 2017 has been awarded to Richard Thaler \”for his contributions to behavioural economics.\” What is behavioural economics, and why does it merit the prize? The Nobel committee offers some useful resources for addressing these questions, including a  short  and readable \”popular information\” essay

\”Easy money or a golden pension?Integrating economics and psychology,\”  and a longer \”advanced information\” essay that digs a little deeper into the economics, \”Richard H. Thaler: Integrating Economics with Psychology.\”
The committee writes: \”Richard Thaler has contributed to expanding and refining economic analysis by considering three psychological traits that systematically influence economic decisions – limited rationality, perceptions about fairness, and lack of self-control.\” Here, I\’ll say a few words about each of these, and about the state of behavioral economics as a whole.
As an example of limited rationality, consider a survey question from one of Thaler\’s studies. 

\”(a) Assume you have been exposed to a disease which if contracted leads to a quick and painless death within a week. The probability you have the disease is 0.001. What is the maximum you would be willing to pay for a cure?
(b) Suppose volunteers would be needed for research on the above disease. All that would be required is that you expose yourself to a 0.001 chance of contracting the disease. What is the minimum you would require to volunteer for this program? (You would not be allowed to purchase the cure.)\”

Notice that in both (a) and (b), you are asked to put a monetary value on facing a 0.001 probability of death. However, for people who took this survey in 1980, a common answer to question (a) was $200, while a common answer to question (b) was $10,000. But the scenarios are framed differently, and Thaler often finds himself digging into \”framing effects.\” He refers to this an example of an \”endowment effect,\” which is that that when you already have something, you tend to set a price differently than if you don\’t have something. If you are selling your own house, you ask for a higher price than you would offer if buying an essentially similar house.

\”Mental accounting\” is another example of a limited rationality. \”One example is how many people divide their household budget into one account for household bills, another for holidays, etc., with rules that prevent using money from one account to pay for something in another.\” As one example, may people have both a savings account, where they receive a low rate of interest, and a credit card overdraft, on which they are paying a high rate of interest. However, they don\’t use the savings account to pay off the credit card, because a \”savings account\” is separate in their minds from their consumption spending. And of course, this separation may be good thing, if it helps people discipline themselves to pay off their credit card debt without eliminating their saving. 
In another well-known example of mental accounting, found that taxi drivers in New York City seem to think of each working day as a separate mental account, in which they try to earn a target amount of money. As a result, in days with high demand, taxi drivers reach their target daily income sooner and quit early, while in days with low demand, taxi drivers work longer hours.  \”In other words, each working day seems to correspond to a separate mental account. Drivers therefore drive less on days with high demand and more on days with low demand, which is the opposite of what standard economic theory would predict.\”
 On the importance of perceptions of fairness in economic transactions, there is a body of evidence pointing out that if workers feel that they are paid at an unfairly low rate, their motivation may decline in a way that reduces their productivity. The recent storms in Texas, Florida, and the Caribbean have offered an example of perceptions of fairness in consumer markets: should stores raise the prices of highly-desired items during a disaster? Of course, economic analysis sees both sides of these issues. Unmotivated workers with low productivity is problem, but in some cases, a firm that can\’t limit or cut pay will instead find that it needs to lay off substantial numbers of workers, or even go broke. Charging higher prices around the time of a storm may seem unfair, but if charging low prices means that the first wave of buyers completely empties the shelves, leaving nothing for those who come later, then that\’s a problem, too. As the Nobel committee writes:

\”Large-scale experiments conducted by Richard Thaler and other behavioural economists, have shown that notions about fairness play a major role in decision-making. People are prepared to refrain from material benefits to maintain what they perceive as just distributions. They are also prepared to bear a personal cost for punishing others who violate basic fairness rules, not only when they themselves are affected but also when they see someone else affected by injustice.\”

On the issue of self-control, \”we are tested by short-term temptations that threaten long-term well-being. This could be food and drink, smoking, consumption, saving for distant goals, or post-retirement planning. A person who chooses a longer education has a lower income during their studies, but can in return look forward to benefits in the future.\”  Thus, rational people who know they have weak self-control may try to commit themselves to a course of action that they know will make them happier in the future. Signing up and pre-paying for an exercise class or a diet program are examples (after all, if you need to exercise or diet, why not just do it on your own?)
But probably the most prominent example of Thaler\’s work on self-control is about saving for retirement. Many people don\’t put aside nearly enough for retirement; of those who do put aside enough, many put a large share of their assets in something that is safe but has a very low return, rather than recognizing that a saver with a long-term perspective should probably put funds in the stock market–because over a long period of several decades they are extremely likely to come out ahead. To alter behavior, consider a policy in which instead of having people try to save on their own, they are instead automatically enrolled in a saving program, where the money is invested in a stock market index fund. Anyone who wants to opt out of the program would be allowed to do so! But the evidence strongly suggests that most people will stick with the automatic savings plan, and will end up later in life feeling very pleased that they did so. 
Thaler and a co-author have pushed for what they call the “Save More Tomorrow” (SMarT) plan, where after you sign up, the contribution you make to your retirement savings increases gradually each year. For example, the plan could specify that when you get a raise, half of the raise goes into additional saving, until your saving has increased to some desired level. 
Behavioral economics and the interaction of psychology and economics has been offering a rich array of insights across many areas of economics for several decades. Indeed, some of the early exposure for Thaler\’s work happened though a series of columns he wrote in the late 1980s and into the 1990s for the Journal of Economic Perspectives, where I labor in the fields as Managing Editor. The Nobel committee even gives a little shout-out to JEP, writing about the \”well-known `Anomalies\’ series in the Journal of Economic Perspectives.\” The existence of behavioral effects in economics is extremely well-established, and research in this area has also opened up some ongoing big-picture questions. 
For a first example, the subject of economics has for a long time offered a battleground between those who emphasized the advantages of market forces and those who countered with the situations where government intervention seemed potentially useful. It may seem at first glance that behavioral economics should offer a substantial boost to those arguing for additional government intervention, which might aim at helping people accomplish what they would actually prefer–if they weren\’t struggling with issues of self-control, fairness, mental accounting, endowment effects, and other issues. In a 2008 book called Nudge: Improving Decisions About Health, Wealth, and Happiness,\”
Thaler and co-author Cass Sunstein discussed these possibilities. In earlier work, they had referred to a philosophy of \”libertarian paternalism,\” which may sound like an oxymoron, but refers to a policy of thinking seriously about the default options and information that will be offered to people–and then letting people make up their own minds after that.

But the insights of behavioral economics–like limited rationality and lack of self-control–apply with equal force to the actions of legislators, regulators, and politicians. For an example, I\’ve written about a study of behavioral biases among development professionals in \”Focusing Behavioral Economics on Development Professionals\” (December 10, 2014). In \”Who Will Nudge the Nudgers?\” (July 21, 2015), I describe an essay arguing that less-than-rational biases may well be even prevalent among government decision-makers. Cass Sunstein, a frequent co-author of Thaler\’s, has made similar points. The case that behavioral economics should lead us toward rethinking a lot of government policy is easy to make; the case that it should lead to a greater degree of intervention in markets is far from proven. 

A second big-picture topic is that while psychology and behavioral economics is often focused on the decision-making of individuals, the field of economics typically looks at the outcomes when individuals interact in markets, which may be rather different. For example, consider a person who for some psychological and behavioral reason would be willing to pay triple the market price for any food that is labelled \”fat-free.\” If we conducted a study, we might find a few such people. But for economists, the key point is that just because such people would be willing to pay triple the market price doesn\’t mean they have to do so; instead, such people can just pay the market price, like everyone else. In other words, market forces resulting from the large-scale interaction of buyers and sellers will in some cases make behavioral leanings moot. An active area of research looks at markets that have some behavioral participants and some rational participants, and considered what outcomes arise. 
Finally,  in many cases, the effects from behavioral economics are meaningful, but small. For example, consider the issue that many people buy the extended service warranty on large appliances like refrigerators or washing machines. Viewed strictly as insurance policies, these are often a bad deal, but people are paying for peace of mind and to reduce a fear of a later case of buyer\’s regret. This phenomenon is interesting, but it\’s a relatively small-scale. Similarly, the observation that retail stores or gas stations are more likely to post a \”cash discount\” sign than a \”credit card surcharge\” sign is an interesting application of applied psychology, but it probably doesn\’t have a big effect on quantity or price of gasoline in the market as a whole. Many of the insights of behavioral economics can be viewed as a very useful warning to be wary of how choices and information are framed and presented, of how marketing is trying to influence your behavior. 
To this point, the \”killer app\” for behavioral economics–that is, the area of the economy where these effects are especially large and meaningful–are the settings in financial market, like how much people save, how they save it, and how financial markets can at times act irrationally. But researchers are on the lookout for other killer apps for behavioral economics, and I wouldn\’t be at all surprised if others emerge over time.  
Those who follow this blog will have some prior familiarity with Thaler and his work. For example, interviews with Thaler and one of his talks were discussed at:

conversableeconomist

Interview with Ricardo Hausmann: Venezuela\’s Economy

Ricardo Hausmann is a Harvard economics professor, but he\’s also from Venezuela–and in fact worked in Venezuela\’s government for a couple of years back in the early 1990s. For the present government of Venezuela, his criticisms have made him persona non grata, and his brother-in-law, a journalist in Venezuela, recently spent seven months in jail and remains under house arrest. In \”How did Venezuela get to this point?\” Cardiff Garcia interviews Hausmann for the Financial Times (October 3, 2017). A full transcript of the interview is here, or you can listen to it here.  Here are a few points that caught my eye:

Venezuela was one of the fastest-growing economies in the world from 1925-1975

\”[O]il became Venezuela’s largest export in 1925, and Venezuela became the largest exporter in the world in 1929. And it remained so until about 1965. In that period, say between 1925 and 1975 call it, that 50 year period, Venezuela was the fastest growing country in the world, and it went from being a very poor Latin American country with an income similar to that of say Central American countries at that time to being the richest Latin American country. And that reflected itself in the fact that it attracted massive immigration. It attracted some 700,000 Spaniards, Italians and Portuguese in a country that at the time had something like seven million people. It attracted probably something like a million Colombians and so on. So it was a magnet. It was wealthy, prosperous. It used massively its resources to invest in infrastructure. When democracy came along it prioritised education, health, public housing. And it was a fairly prosperous place. University education was free. Not only primary and secondary but university education was free. There was very cheap access to electricity, water and so on. So it was a fairly prosperous place.\”

Venezuela has hobbled its own golden goose, the oil industry

\”Let me just give you a sense of the magnitude of the mismanagement of the oil industry. In 1998, the year before Chávez got elected, or the year in which in December of that year Chávez got elected and he took power in February 1999. In 1998, Venezuela produced 3.7 million barrels of oil [per day]. Today it’s producing about two. If Venezuela had maintained its market share in the world oil industry — which it could have because it had infinite reserves, it had the largest reserves in the world — it would be producing two million barrels more than it is currently producing. With the same market share. So the collapse is immense relative to history, and it’s immense relative to this opportunity cost of where it should have gone had it just kept its market share the way it was. 

\”That collapse of the oil industry happened in two steps. First, all the know-how of that industry, centuries of man-years of experience was lost in the firing of these people. They were not only fired but persecuted, so most of them left the country. Many of them left the country. And they caused, for example, an oil boom in Colombia [where many of them moved to]. Colombia went from producing 200,000 barrels of oil [per day] to a million barrels of oil thanks to the fact that Venezuelans knew how to extract much more oil from the fields that Colombia was already exploiting. So there was a massive loss of human capital. 

\”They also wanted to create a politically conscious oil company, so they started to put an enormous amount of social programmes and other things on the books of PDVSA, the oil company. And as a consequence they starved the company from investment and they ran the company in an amazingly corrupt way, and this is really not just talk about corruption but evidence of corruption in massive ways. … So they really destroyed the hen that laid the golden eggs …\”

And it wasn\’t just the oil industry that was taken over and ruined … 

\”So he [Chavez]took over significant chunks of the Venezuelan economy, and the typical thing is that the moment they took over a company, they ran it to the ground. Production collapsed. They nationalised the steel company. The steel company at the time of nationalisation was producing 4.5 million tons of steel with 5,000 workers. It now has 22,000 workers but it’s producing something like 200,000 tons of steel. So they ran those companies to the ground. Aluminium is almost not done any more, when Venezuela was producing about a million tons of aluminium back when…\”

The size of Venezuela\’s economy has fallen by about half since 2013

\”So official numbers would suggest that GDP in per capita terms since 2013 has fallen 37%. If you add to that the impact of the decline in the price of oil to income, national income has declined by over 50%. But if you exclude from that the GDP generated by the government itself which is just estimated by the number of employees the government has, or if you disregard other parts of the economy that are grossly mismeasured, just look at goods like agriculture, manufacturing, mining, even construction and so on, that part of the economy declined by in excess of 55%. So there’s been this massive collapse in output, massive collapse in incomes.

\”If you look at the minimum wage, which in Venezuela given this incredibly fast inflation and so on has become the median wage, the median wage if you estimate it at the black market rate is something like $20 a month. But you might say: Well, but, what is this black market rate? What does that mean? So we have been measuring the minimum wage in calories. We look at the market prices of things and we calculate what is the cheapest calorie a family could buy? And if you do that calculation in 2012, a family could buy 55,000 calories a day with the minimum wage. And now a family can buy 7,000 calories. So if you think that a median wage has to sustain a family of five, well five people could not eat enough calories if they spent 100% of their income in the cheapest calorie and no income in housing, footwear, transportation or anything else.

\”So as a consequence, incomes per capita have collapsed to a degree that it is hard to transmit and understand, and that collapse in private incomes is accompanied by a collapse in public services like healthcare for example. They are just beyond belief. People have been writing pieces that I’m sure are going to win a Pulitzer Prize, because it’s just astonishing how life expectancy rates, how the prevalence of diseases that had been eradicated… Venezuela was the first country to eradicate malaria back in 1961. Even before the US did. And malaria is back big time. Measles is back big time. There are no drugs for HIV. There are no drugs for hypertension. There are no machines to do dialysis. There are no cancer drugs.\”

While it may  be useful or necessary at some point to restructure Venezuela\’s debts, current lending to Venezuela seems exploitive such that Hausmann refers to it as \”hunger bonds\”

\”So usually you think that the capital markets are there to provide capital for good ideas that are going to generate value and pay back the loans and create other benefits for the borrower. So you think of capital markets as being angels for good in the world. But when capital markets have to deal with a government that is willing to compromise future cash flows for any cash up front, and it’s not using the resources to create any good things for the future, then you’re giving money to an authoritarian regime to mismanage in the short run and you are condemning the future of the country with obligations that they will not be able to afford to pay. So that’s why I call them hunger bonds.

\”A very clear example that prompted this was Goldman Sachs lending the government $850 million at an interest rate of 50%. No-one has a project that pays 50%. So the government has $850 million now, then they have to pay an amount going forward that they will not have the resources to pay it with. Because they’re not using the money in any investment programme that will be able to pay for that debt. That debt is just to prop up the current regime, and in my mind that makes that debt odious. It’s a debt of the regime, it’s not a debt that should bind the people of a country, because the regime does not represent the people and the regime cannot commit the future of the country.\”

Here\’s an post from last year on \”Hyperinflation and the Venezuela Example\” (April 28, 2016). Steve Hanke notes that while the official inflation rate in Venezuela was 741% as of February 2017, the unofficial inflation rate implied by the black-market exchange rate is more like 2500%.

conversableeconomist

Foreign Direct Investment in the US: Size and Effects

Foreign direct investment refers to a situation when a foreign firm invests in an affiliate in a substantial enough way that it gains some voice in the management of the enterprise. This is often defined in terms of having ownership of at least 10 percent of the company. The US is quite open to foreign direct investment from abroad. Michael Cortez tells the story in \”Foreign Direct Investment in the United States,\” published by the Economics and Statistics Administration of the US Department of Commerce (ESA Issue Brief #06-17, October 3, 2017). The quick overview of 2016 sounds like this:

\”FDI inflows on a historic cost basis in 2015 were the largest on record at $465.8 billion while 2016 inflows, though slightly lower at $457.1 billion, were at the second highest level on record. FDI in these two years was more than double the average annual inflows of roughly $200 billion for 2012-2014. Increased investment in manufacturing, specifically in chemical manufacturing, accounted for most of the investment gains for both 2015 and 2016.

\”The United States had an inward FDI stock of $3.3 trillion and $3.7 trillion, on a historical-cost basis, for 2015 and 2016 respectively. The United States’ FDI stock in 2015 ($5.6 trillion on a current-cost basis) was more than three times larger than that of the next largest destination country. Total inward stock in the United States grew at an average annual rate of 7.8 percent per year from 2009-2016.\”

A common reason for foreign direct investment is that it helps a company be more confident about its international supply lines. Another reason for FDI in the United States is to take advantage of US-based expertise and R&D, Thus, it\’s no surprise that US-based firms with foreign direct investment are active in exports and in research and development. Cortez writes:

\”Majority-owned U.S. affiliates of foreign entities exported $352.8 billion in goods, accounting for over 23 percent of total U.S. goods exports in 2015 (the most recent year for which this data is available). They are also a catalyst for research and development, spending $56.7 billion in 2015 on R&D and accounting for 15.8 percent of the U.S. total expenditure on R&D by businesses.\”

Given that FDI emphasizes manufacturing, R&D, and exports, it\’s not a surprise that the jobs with US affiliates of foreign firms tend to pay well.

\”Majority-owned U.S. affiliates of foreign entities employed 6.8 million U.S. workers in 2015, up from 6.6 million in 2014, and provided compensation of nearly $80,000 per U.S. employee in 2015. That is higher than the U.S. average of $64,000 in the economy as a whole for the same year.\”

conversableeconomist

The Gherkin Story: For Explaining Exchange Rate Risk

I\’ve long believed that exchange rates can be the single toughest subject to teach to introductory economics students. Talking about travelling abroad and exchanging currency can help understand how someone can benefit or lose from movements in exchange rates. But when trying to explain exchange-rate risk for nations or private firms who have borrowed in one currency and need to repay in a different currency, more practical examples are a big help, too. Adam T. Jones,William H. Sackley and Ethan D. Watson have a very nice example all worked out and ready to be plugged into your reading list or lecture notes. It appears as \”Teaching exchange rate risk using London\’s Gherkin building: How investors were in (and out of) a pickle,\” in the Journal of Economic Education (2017, 48:4, 276-287). (The JEE is not freely available online, but many readers will have access through a library subscription.)

The Gherkin is the nickname for an iconic office building in London, built in the early 2000s. As the authors note (citations and footnotes omitted): \”Sir Norman Foster, a world-famous British architect known for innovative and sustainable designs, scaled back the design to the 41-story structure that is the current Gherkin building. Construction on the building began in 2001 and was completed in 2003. Foster’s client was Swiss Reinsurance Company, Ltd. (Swiss Re), a global insurer and reinsurer. Swiss Re invested a total of 228.6 million pounds sterling (GBP) in land and construction cost. Swiss Re occupied just over half of the Gherkin as their British headquarters, and leased out the remainder. In late 2006, Swiss Re began seeking a purchaser in hopes of executing a sale-leaseback of the Gherkin building, near the top of the real estate market cycle. …\”

Here\’s a picture of the Gherkin.

  
Essentially, the problem arose because part of the deal was financed with debt, some in British pounds and some in Swiss francs. This arrangement made some sense. Swiss Re, which was continuing to lease space in the building, was paying rent in Swiss francs. So the new owners could use rent from the British tenants to pay the debt that was denominated in pounds, and the rent from Swiss Re to pay the debt denominated in francs. However, the purchase contract also had a rule that the ratio of the loan to the value of the building could not exceed 67%. Notice that the value of the loan was in pounds and francs, while the value of the building was solely in pounds. So when the value of the Swiss franc rose substantially against the pound, the loan-to-value ratio rose well above the 67% limit. As a result, the lenders of the debt demanded more collateral, and ended up foreclosing on the building. Here\’s how Jones, Sackley and Watson tell it (again, citations and footnotes omitted):

\”Unfortunately, the structure of the deal eventually led to financial implosion. There were two important aspects to the structure of the deal. First,GBP 396 million of the GBP 600 million purchase price was financed with debt, and the rest was equity investment from the IVG Euro Select 14 Fund and Evans Randall’s equity investment. The GBP 396 million loan was denominated in two currencies: GBP 212 million worth was borrowed in British pounds, and GBP 184 million worth (CHF 447 million) was borrowed in Swiss francs. Second, the deal structure also included a loan-to-value clause, which required the group to not exceed a 67 percent loan-to-value ratio. …

\”[I]n reality the financing of the building in two currencies was reasonable, because the lease paymentswere being collected in pounds sterling and Swiss francs. Swiss Re occupied approximately half the building and paid their rent in francs. The other tenants were British firms paying rent in pounds sterling. Therefore, the lease payments were providing a partial hedge of the foreign exchange risk for interest payments but not the principal value of the loan. Thus, despite some rent being paid in francs, IVG was exposed to a less than fully hedged, foreign exchange risk.

\”At the time the deal was struck, the CHF per GBP exchange rate was approximately 2.4 Swiss francs per British pound.After the deal was struck, the value of the pound relative to the franc dropped (franc’s value appreciated) significantly from late 2007 until late 2011. In the end, the franc appreciated over 60 percent causing the value of the debt to increase by approximately GBP 100 million. … [T]he increased loan value triggered the 67 percent loan-to-value (LTV) limit clause in the financing because the new ratio would have exceeded 79 percent under the new exchange rate. 

\”As a result of the increased LTV ratio exceeding the contractual limit, the consortium of financing banks, led by BayernLB, demanded more collateral and blocked the flow of rental income. Thus, in a twist of irony, the owners of a building leased to a firm that mitigates risk were unable to navigate the risks of a complicated financial structure and defaulted on their debt. The Gherkin building was placed into receivership in 2013, and was sold in foreclosure to Brazil’s Safra Group for GBP 726 million in 2014 …\”

Jones, Sackley and Watson offer a detailed description of how to walk through this example in a classroom setting. To me, the example is especially interesting because it\’s a vivid example of the subtle ways that exchange rate risk can arise. One of my standard examples of exchange rate risk involves working through what would happen to a bank in Thailand that borrowed in US dollars, but loaned in Thai baht. A sharp depreciation of the baht can then make it impossible to repay the US dollar loan, as in the east Asian financial crisis of 1998-99 (for discussion, see Ch. 31 of my principles of economics textbook). But apparently, the rent from the tenants of the Gherkin was enough to continue paying off the debts involved in its purchase. In this case, the foreign exchange risk instead arose from how the exchange rate movements affected the loan-to-value ratio in the contract.