Meetings, Fall 2005
Japan Project Meets
The NBER together with the Center for International Research on the Japanese Economy and the European Institute of Japanese Studies held a project meeting on the Japanese economy in Tokyo on September 15–16. The co-chairs of the meeting were: Magnus Blomstrom, NBER and Stockholm School of Economics; Fumio Hayashi, NBER and the University of Tokyo; Anil K Kashyap, NBER and the Graduate school of Business, University of Chicago; and David Weinstein, NBER and Columbia University. The following papers were discussed:
Nobuyuki Oda, Bank of Japan, and Kazuo Ueda, University of Tokyo, “The Effects of the Bank of Japan’s Zero Interest Rate Commitment and Quantitative Monetary Easing on the Yield Curve: A Macro-Finance Approach” Discussant: Lars E. O. Svensson, NBER and Princeton University
Wilbur J. Coleman, Duke University, “Structural Transformation and Growth Slowdowns: Japan in the 90s” Discussant: Randall S. Kroszner, NBER and University of Chicago
R. Anton Braun, University of Tokyo; Toshihiro Okada, Kwansei Gakuin University; and Nao Sudou, Bank of Japan, “U.S. R&D and Japanese Medium Cycles” Discussant: Jonathan Eaton, NBER and New York University
Hiroshi Ono, Stockholm School of Economics, “Lifetime Employment in Japan: Concepts and Measurements” Discussant: Kenn Ariga, Kyoto University
Koji Sakai and Tsutomu Watanabe, Hitotsubashi University; and Uchiro Uesugi, Research Institute of Economy, Trade and Industry, Firm Age and the Evolution of Borrowing Costs: Evidence from Japanese Small Firms” Discussant: Steven J. Davis, NBER and University of Chicago
Chiaki Moriguchi, NBER and Northwestern University, and Emmanuel Saez, NBER and University of California, Berkeley, “The Evolution of Income Concentration in Japan, 1885–2002: Evidence from Income Tax Statistics” Discussant: Wojciech Kopczuk, NBER and Columbia University
Douglas J. Skinner, University of Chicago, “The Rise of Deferred Tax Assets in Japan: The Case of Major Japanese Banks” Discussant: Mitsuhiro Fukao, Keio University
Robert Dekle, Hyeok Jeong, and Heajin Ryoo, University of Southern California, “A Re-Examination of the Exchange Rate Disconnect Puzzle: Evidence from Japanese Firm Level Data” Discussant: Maurice Obstfeld, NBER and University of California, Berkeley
Oda and Ueda empirically investigate monetary policy in Japan in the zero- interest-rate environment that has held sway since 1999. In particular, they focus on the effects of the zero-interest- rate commitment and of quantitative monetary easing on medium-tolong- term interest rates in Japan. By applying a version of the macro-finance approach, involving a combination of estimation of a structural macro-model and calibration of time-variant parameters to the yield curve observed in the market, they can decompose interest rates into expectations and risk premium components and simultaneously extract the market’s perception of the Bank of Japan’s (BOJ’s) willingness to carry on its zero-interest-rate policy. Oda and Ueda tentatively conclude that the BOJ’s monetary policy since 1999 has functioned mainly through the zero-interest-rate commitment, which has led to declines in medium- to longterm interest rates. They also find some evidence that, until the end of 2003, raising the reserve target may have been perceived as a signal indicating the BOJ’s accomodative policy stance, although the size of the effect is not large. The portfolio rebalancing effect — either by the BOJ’s supplying ample liquidity or by its purchases of longterm government bonds — is found to be significant.
Coleman argues that the growth slowdown in Japan in the 1990s was a consequence of a structural transformation set in motion by the emergence of lower cost producers of manufactured goods. Prior to the 1900s, Japan had achieved a significant cost advantage in producing various goods, which led to an allocation of resources towards this sector. Indeed, the fraction of resources in the manufacturing sector in Japan exceeded that of other countries in a similar stage of development. The emergence of largely populated developing countries, such as China, lowered the profitability of the manufacturing sector in Japan. This required a substantial reallocation of labor and capital resources from the manufacturing to the service sector. This process of structural transformation led to the growth slowdown in Japan during the 1990s.
In the 30-year period between 1960 and 1990, Japan saw labor productivity rise from a level of 27 percent of that of the United States to 87 percent of that of the United States. This development miracle can be explained by an initial low capital stock and measured variations in Total Factor Productivity (TFP). These facts motivate the investigation into the sources of Japanese TFP variations by Braun, Okada, and Sudou. They consider Japanese and U.S. data that is filtered to retain medium- cycle events, such as the productivity slow down in the 1970s. An investigation of Japanese medium cycles reveals an important role for the diffusion of usable ideas from the United States to Japan. U.S. research and development (R and D) leads Japanese TFP by four years and accounts for as much as 60 percent of the variation in medium- term-cycle Japanese TFP. Japanese R and D, in contrast, is coincident with Japanese TFP. Simulations designed to isolate the roles of Japanese and U.S. R and D find that the diffusion of knowledge from the United States is a key driver of Japanese medium cycles.
Ono poses three fundamental questions about lifetime employment in Japan: How big is it? How unique is it? And, how is it changing? He examines various concepts and methods of estimating lifetime employment and concludes that it covers roughly 20 percent of the Japanese labor force. Job mobility remains considerably lower in Japan than in other economies (particularly that of the United States). Evidence regarding changes in lifetime employment is mixed. While the core workforce is shrinking, the proportion of lifetime workers in the labor force is expanding. Ono’s interpretation is that the population of workers who presumably are covered by the lifetime employment system may be declining, but the probability of job separations has remained stable for those who are already in the system. He also finds evidence that the incentives among workers, managers, and executives are aligned to preserve the lifetime employment system.
Sakai, Uesugi, and Watanabe investigate how a firm’s borrowing cost evolves as it ages. Using a new dataset of more than 200,000 bank-dependent small firms in 1997–2002, these authors find that the distribution of borrowing costs tends to become less skewed to
the right over time. Second, this shift in the distribution can be partially attributable to “selection” (that is, firms with lower quality and higher borrowing costs exit from markets), but is mainly explained by “adaptation” (that is, surviving firms’ borrowing costs decline as they age). Third, there is an age dependence of a firm’s borrowing costs, even after controlling for firm size, but no age dependence of the volatility of profits after controlling for firm size. The results suggest that age dependence of borrowing costs comes not from the (Diamond’s 1989) reputationacquisition mechanism, but rather from banks’ learning about borrowers’ true quality over the duration of the bankborrower relationship.
Moriguchi and Saez construct the long-run series of top income shares and wage income shares in Japan using income tax statistics and investigate the evolution of income concentration in Japan from 1885 to 2002. They find that: the degree of income concentration was extremely high throughout the pre-WWII period during which the nation underwent rapid industrialization; a drastic de-concentration of income at the top had taken place during and immediately after WWII; a degree of income concentration has remained low throughout the post-1950 period despite high economic growth; and, a major component of the top income in Japan has shifted dramatically from capital income to employment income over the course of the twentieth century. They attribute the dramatic fall in income concentration primarily to the collapse of capital income attributable to wartime taxation, war destruction, hyperinflation, and to a lesser extent, postwar occupational reforms. They argue that the fundamental change in the institutional structure after WWII made the one-time income de-concentration difficult to reverse. In contrast to the sharp increase in wage income inequality observed in the United States since 1970, the top wage income shares in Japan have remained remarkably stable over recent decades. The authors show that the change in technology or tax policies alone cannot account for the comparative experience of Japan and the United States. Instead, they suggest that institutional factors, such as corporate governance and union structure, are important determinants of wage income inequality.
Skinner describes the role of accounting for deferred taxes in the ongoing financial crisis among major Japanese banks, as dramatized most vividly by the recent collapse of Resona Bank. He argues that the Japanese government, including bank regulators, used deferred tax accounting to help give the major banks the appearance of financial well being in spite of their economic difficulties. Further, managers of these banks used deferred tax accounting to bolster their banks’ regulatory capital levels when their economic circumstances deteriorated. Skinner shows that, generally consistent with these arguments, accounting has played a role in helping the Japanese government to postpone the politically difficult task of reforming the major banks.
The empirical literature that examined data at the aggregate or macroeconomic level generally has found small or insignificant effects of exchange rate fluctuations on export volumes. This lack of association between real quantities — such as export volumes — and the exchange rate is the so-called “exchange rate disconnect” puzzle. Studies using microeconomic or firmlevel data, however, have been more successful in finding relationships between export volumes and exchange rates. In their paper, Dekle, Jeong, and Ryoo attempt reconciliation between the macroeconomic, aggregate evidence and the microeconomic, firm-level evidence. They estimate their consistently aggregated, microeconomic model of exports and show that an exchange rate appreciation properly reduces export volumes.
The Chinese Economy
The NBER’s Working Group on the Chinese Economy, organized by Shang-Jin Wei, NBER, University of Maryland, and International Monetary Fund, met in Cambridge on September 30. This Working Group provides a forum for discussing recent research related to various aspects of Chinese economic development, including China’s macroeconomic policies, trade and financial interactions with the rest of the world, reform strategies, lessons from China for other developing and transition economies, and lessons from other countries for China. The program for this meeting was:
Xuepeng Liu, Jan Ondrich, and Mary Lovely, Syracuse University, “How Much Do Low Wages Matter for Foreign Investment? The Case of China” Discussant: Lee J. Branstetter, NBER and Columbia University
Nancy Qian, Brown University, “Missing Women and the Price of Tea in China: The Effect of Sex-Specific Earnings on Sex Imbalance” Discussant: John Giles, Michigan State University
Hongbin Cai, University of California, Los Angeles; Hanming Fang, Yale University; and Colin Xu, World Bank, “Eat, Drink, Firms and Governments: An Investigation of Corruption from Entertainment and Travel Costs of Chinese Firms” (NBER Working Paper 11592) Discussant: Thomas Rawski, University of Pittsburgh
Raymond Fisman, NBER and Columbia University; Peter Moustakerski, Booz Allen Hamilton; and Shang-jin Wei, “Outsourcing Tariff Evasion: A New Explanation for Entrepot Trade” Discussant: Mihir A. Desai, NBER and Harvard University
Marcos Chamon and Eswar Prasad, IMF, “Determinants of Household Savings in China” Discussant: Chang-tai Hsieh, NBER and University of California, Berkeley
Hui Huang and Shunming Zhang, University of Western Ontario; Yi Wang, Shanghai University; Yiming Wang, Peking University; and John Whalley, NBER and University of Western Ontario, “A Trade Model with an Optimal Exchange Rate Motivated by Current Discussion of a Chinese Renminbi Float” Discussant: Aart Kraay, World Bank
Albert Hu, National University of Singapore, and Gary Jefferson, Brandeis University, “The Great Wall of Patents: What is Behind China’s Recent Patent Explosion? Discussant: Wei Li, University of Virginia
Liu, Ondrich, and Lovely examine the provincial location choices of firms investing in China during 1993–6. First, using data on 2,884 equity joint venture (EJV) projects in manufacturing, they find strong support for the attractiveness of low wages. Their estimates indicate a downward bias of 50–120 percent in the wage coefficients estimated with standard techniques. Second, they find that low-wage locations are more attractive to unskilledlabor- intensive plants than to skillintensive plants, although this effect is significant only for investors from OECD countries. The attraction of low wages for investors from ethnically- Chinese-economies, in contrast, is sensitive to the intensity of competition from other low-income countries for exports to the United States. This study provides the first estimates of how skill intensity and competition for export markets influence the probability a multinational firm will choose a given location.
Qian uses plausibly exogenous increases in sex-specific agricultural income caused by post-Mao reforms in China to estimate the effects of total income and sex-specific incomes on the sex ratios of surviving children. Her results show that increasing income alone has no effect on sex ratios. In contrast, increasing female income while holding male income constant increases the survival rates for girls; increasing male income while holding female income constant decreases the survival rates for girls. Moreover, increasing the mother’s income increases educational attainment for all children while increasing the father’s income decreases educational attainment for girls and has no effect on boys’ educational attainment.
Entertainment and Travel Costs (ETC) is a standard expenditure item for Chinese firms, annually equaling about 20 percent of total wage bills. Cai, Fang, and Xu use this objective accounting measure as a basis for analyzing the composition of ETC and the effect of ETC on firm performance. 28 NBER Reporter Fall 2005 They rely on the predictions from a simple but plausible model of managerial decisionmaking to identify components of ETC, examining how total ETC responds to different environmental variables. They find strong evidence that firms’ ETC consists of a mix that includes bribery to government officials, both as grease money and protection money; expenditures to build relational capital with suppliers and clients; and managerial excesses. ETC overall has a significantly negative effect on firm performance, but its negative effect is much less pronounced for those firms located in cities with low quality government service, those subject to severe government expropriation, and those who do not have strong relationships with suppliers and clients.
Traditional explanations for indirect trade carried out through an entrepot have focused on savings in transport costs and on the role of specialized agents in processing and distribution. Fisman, Moustakerski, and Wei provide an alternative perspective based on the possibility that entrepots may facilitate tariff evasion. Using data on direct exports to mainland China and indirect exports to it via Hong Kong SAR, the authors find that the indirect export rate rises with the Chinese tariff rate, even though there is no legal tax advantage to sending goods via Hong Kong SAR. The authors then undertake a number of extensions to rule out plausible alternative hypotheses.
Using a subset of the Urban Household Survey from 1986–97, Chamon and Prasad analyze the patterns and determinants of saving behavior among Chinese households. They show that young households tend to have relatively high saving rates, possibly so that they can self-finance purchases of major durables and housing — there are severe constraints (or were, until recently) in China on borrowing for these purchases. Saving rates then decline with the age of the household head until age 45 or so, when they begin to bounce back sharply, presumably as retirement approaches. The cohorts with household heads in their 40s during the 1980s tend to save the most. This group may be the most vulnerable to the market-oriented reforms that began in the early 1980s, which could have increased uncertainty about their future incomes while not yielding them as much of a benefit in terms of rising incomes as younger groups. The authors combine these results with an analysis of demographic projections to show that demographic shifts actually may contribute to higher household saving rates over the next decade or two. However, the data indicate that past savings constitute the dominant source of financing for durable goods purchases. This suggests that, as the demand for durables rises with rising income levels, and as consumer credit develops, the saving rate, especially for younger households, could decline.
Huang, Wang, Wang, Whalley, and Zhang combine a model of interspatial and inter-temporal trade between countries — recently used by Huang, Whalley, and Zhang (2004) to analyze the merits of trade liberalization in services when goods trade is restricted — with a model of foreign exchange rationing from Clarete and Whalley (1991) in which there is a fixed exchange rate with a surrender requirement for foreign exchange generated by exports. In the combined model, when services are not liberalized, there is an optimal trade intervention, even in the case of a small, open, price-taking economy. Given monetary policy and an endogenously determined premium value on foreign exchange, an optimal setting of the exchange rate can provide the optimal trade intervention. The authors suggest that this model has relevance to the current situation in China where services have not been liberalized and tariff rates are bound in the World Trade Organization. Because there is an optimal exchange rate, a move to a free Renminbi float can worsen welfare. The authors use numerical simulation methods to explore the properties of the model, because it has no closed-form solution. Their analysis provides an intellectual counter argument to those presently advocating a free Renminbi float for China.
Over the past 20 years, patenting in China has grown at an annual doubledigit rate, having further accelerated since 2000. China’s patent explosion is seemingly paradoxical given the country’s weak record of protecting intellectual property rights. Using a firm-level data set that spans the population of China’s large and medium size industrial enterprises, Hu and Jefferson seek to understand the conditions that account for China’s patent boom. While the overall intensification of research and development (R and D) in the Chinese economy tracks with patenting activity, it is not the principal cause of the patent explosion. Instead, the authors find that the growing intensity of foreign direct investment at the industry level, enterprise restructuring, and a shift toward complex-product R and D are raising R and D productivity and the propensity to patent. Amendments to the patent law that favor patent holders also emerge as a significant source of China’s surge in patent activity.
Entrepreneurship Working Group
The NBER’s Entrepreneurship Working Group met in Cambridge on October 7. NBER Research Associate Josh Lerner, Harvard Business School, organized the meeting, at which the following papers were discussed:
Naomi Lamoreaux and Kenneth Sokoloff, University of California, Los Angeles and NBER, and Margaret Levenstein, NBER and University of Michigan, “Financing Invention during the Second Industrial Revolution: Cleveland, Ohio, 1870–1920” Discussant: Steven Klepper, Carnegie Mellon University
David Hsu, University of Pennsylvania, and Edward Roberts and Charles Eesley, MIT, “Entrepreneurs from Technology-Based Universities: An Empirical First Look” Discussant: David Blanchflower, Dartmouth College and NBER
Nick Bloom, Stanford University, and John Van Reenen, London School of Economics, “Measuring and Explaining Management Practices across Firms and Countries” Discussant: Belen Villalonga, Harvard University
Simeon Djankov, The World Bank; Gerard Roland and Ekaterina Zhuravskaya, University of California, Berkeley; and Yingyi Qian, NBER and University of California, Berkeley, “Who Are China’s Entrepreneurs?”
Amar Bhidé, Columbia University, “What Holds Back Bangalore Businesses?”
Esther Duflo, MIT and NBER; Michael Kremer, NBER and Harvard University; and Jonathan Robinson, Princeton University, “Understanding Technology Adoption: Fertilizer in Western Kenya” Academic Discussant: Ray Fisman, Columbia University and NBER Practitioner Discussant: Runa Alam, CEO, Kingdom Zephyr Africa
For those who think of Cleveland as a decaying rustbelt city, it may seem difficult to believe that this northern Ohio port was once a hotbed of hightech startups, much like Silicon Valley today. During the late nineteenth and early twentieth centuries, Cleveland played a leading role in the development of a number of second-industrial- revolution industries, including electric light and power, steel, petroleum, chemicals, and automobiles. In an era when production and inventive activity were both increasingly capital-intensive, technologically creative individuals and firms required greater and greater amounts of funds to succeed. Lamoreaux, Levenstein, and Sokoloff explore how the city’s leading inventors and technologically innovative firms obtained financing, and find that formal institutions, such as banks and securities markets, played only a very limited role. Instead, most funding came from local investors who took long-term stakes in start-ups formed to exploit promising technological discoveries, often assuming managerial positions in these enterprises as well. Business people who were interested in investing in cutting-edge ventures needed help in deciding which inventors and ideas were most likely to yield economic returns, and these authors show how enterprises such as the Brush Electric Company served multiple functions for the inventors who flocked to work there. Not only did they provide forums for the exchange of ideas, but by assessing each other’s discoveries, the members of these technological communities conveyed information to local businessmen about which inventions were most worthy of support.
Hsu, Roberts, and Eesley provide an initial analysis of major patterns and trends in entrepreneurship among technology-based university alumni since the 1930s. They describe findings from two linked datasets joining information on MIT alumni and company founders. The rate of forming new companies by MIT alumni has grown dramatically over seven decades, and the median age of first-time entrepreneurs has declined gradually from about age 40 (in the 1950s) to about age 30 (in the 1990s). Women alumni lag their male counterparts in the rate at which they become entrepreneurs, and alumni who are not U.S. citizens enter entrepreneurship at different (often higher) rates than their American classmates. New venture foundings over time are correlated with measures of the changing external entrepreneurial and business environment, suggesting that future research in this domain may
wish to more carefully examine such factors.
Bloom and Van Reenen use an innovative survey tool to collect management practice data from 732 mediumsized manufacturing firms in the 30 NBER Reporter Fall 2005 United States and Europe (France, Germany, and the United Kingdom). Their measures of managerial best practice are strongly associated with superior firm performance in terms of productivity, profitability, Tobin’s Q, sales growth, and survival. They also find significant inter-country variation, with U.S. firms on average better managed than European firms, but a much greater intra-country variation with a long tail of extremely badly managed firms. This presents a dilemma – why do so many firms exist with apparently inferior management practices, and why does this vary so much across countries? The authors find that this is because of a combination of: low product-market competition and family firms passing management control down to the eldest sons (primo geniture). European firms in the sample report facing lower levels of competition and substantially higher levels of primo geniture. These two factors appear to account for around half of the long tail of badly managed firms and half of the average U.S.-Europe gap in management performance.
Social scientists studying the determinants of entrepreneurship have emphasized three distinct perspectives: the role of institutions, the role of social networks, and the role of personal characteristics. Djankov, Qian, Roland, and Zhuravskaya conduct a survey from five large developing and transition economies to better understand entrepreneurship in view of these three perspectives. Using data from a pilot study with over 2,000 interviews in seven cities across China, they find that entrepreneurs are much more likely than non-entrepreneurs to have family members who are also entrepreneurs, and childhood friends who became entrepreneurs. This suggests that social networks play an important role in entrepreneurship. Entrepreneurs also differ strongly from non-entrepreneurs in their attitudes towards risk and their work-leisure preferences: they are more willing to take risks and are more greedy.
In underdeveloped economies as in the United States, the number of small low-growth enterprises is large. But what about the developing economy counterparts of U.S. high-growth businesses? In what way do differences in technological, institutional, and cultural factors matter? Do they make highgrowth businesses more or less numerous in under-developed economies than in the United States? How, if at all, do they lead to differences in characteristics, growth rates, and the economic role of high growth businesses? Bhidé focuses on businesses operating in the city of Bangalore, India. Data compiled from statutory regulatory filings suggest that the number and proportion of businesses that expand rapidly are much lower than in the United States. Indepth interviews with over 100 entrepreneurs in Bangalore suggest that deficiencies in the performance of basic governmental functions (such as in collecting taxes and the maintaining land records) play a significant role in discouraging businesses from starting at or expanding to an economically efficient scale of operation.
In developing countries outside of Africa, the use of fertilizer has been estimated to account for 50–75 percent of the increase in crop yields since the mid-1960s. Yet the usage of fertilizer in Busia and Teso districts in Western Kenya remains quite low: only about 20 percent of farmers in the area use fertilizer in a given year. Duflo, Kremer, and Robinson attempt to explain this low level of usage by analyzing the results of a set of randomized experiments that allow farmers to experiment with a small amount of fertilizer on their own farms or to commit to save their harvest income towards the purchase of fertilizer. The main results from these interventions are that: 1) fertilizer is profitable even in the farmer’s conditions; 2) providing information about the costs and benefits of fertilizer goes part of the way towards increasing fertilizer adoption; and 3) programs that help farmers to commit their harvest income towards the purchase of fertilizer have a large impact on adoption. Preliminary evidence on spillovers through geographical and social networks does not indicate diffusion, however.
Market Microstructure Meeting
The NBER’s Working Group on Market Microstructure, directed by Research Associate Bruce Lehmann of University of California, San Diego, met on October 7 in Cambridge. The meeting was organized by Lehmann; Duane Seppi of Carnegie Mellon University; and Avanidhar
Subrahmanyam, University of California, Los Angeles. The following papers were discussed:
Robert Bloomfield, Maureen O’Hara, and Gideon Saar, Cornell University, “The Limits of Noise Trading: An Experimental Analysis” Discussant: Shimon Kogan, Carnegie Mellon University
Ekkehart Boehmer, Texas A&M University; Charles Jones, Columbia University; and Xiaoyan Zhang, Cornell University, “Which Shorts are Informed?” Discussant: Amy Edwards, U.S. Securities & Exchange Commission
Karl Diether, Kuan-hui Lee, and Ingrid Werner, Ohio State University, “Can Short-Sellers Predict Returns? Daily Evidence” Discussant: David Musto, University of Pennsylvania
Allaudeen Hameed and Wenjin Kang, National University of Singapore, and S.Viswanathan, Duke University, “Asymmetric Comovement in Liquidity” Discussant: Ioanid Rosu, University of Chicago
Elizabeth Odders-White and Mark Ready, University of Wisconsin, Madison, “The Probability and Magnitude of Information Events” Discussant: Lei Yu, University of Notre Dame
Asani Sarkar, Federal Reserve Bank of New York, and Robert Schwartz and Avner Wolf, Baruch College, “Inter-Temporal Trade Clustering and Two-Sided Markets” Discussant: Eugene Kandel, Hebrew University
Bloomfield, O’Hara, and Saar report the results of a laboratory market experiment that allows them to determine not only how noise traders fare in a competitive asset market with other traders, but also how the equilibrium changes if a securities transactions tax (“Tobin tax”) is imposed. The authors find that noise traders lose money on average: they do not engage in extensive liquidity provision, and their attempt to make money by trend chasing is unsuccessful because they lose most in securities whose prices experience large moves. Noise traders adversely affect the informational efficiency of the market: they drive prices away from fundamental values. The further away the market gets from the true value, the stronger this effect becomes. With a securities transaction tax, noise traders submit fewer orders and lose less money in those securities that exhibit large price movements. The tax is associated with a decrease in market trading volume, but informational efficiency remains essentially unchanged and liquidity (as measured by the price impact of trades) actually improves. The authors find no significant effect, however, on market volatility, suggesting that at least this rationale for a securities transaction tax is not supported by their data.
Boehmer, Jones, and Zhang use proprietary system order data from the New York Stock Exchange to examine the incidence and information content of various kinds of short sale orders. For the average stock, 12.9 percent of NYSE volume involves a short seller. As a group, short sellers are extremely well informed. Stocks with relatively heavy shorting underperform lightly shorted stocks by an average of 1.07 percent in the following 20 days of trading (over 14 percent on an annualized basis). Large short sale orders are the most informative. In contrast, when more of the short sales are small (less than 500 shares), stocks tend to rise in the following month, indicating that informed short sellers tend to submit large orders. The authors partition short sales by account type: individual, institutional, member firm proprietary, and other, and can distinguish between program and non-program short sales. Institutional non-program short sales are the most informative. Compared to stocks that are lightly shorted by institutions, a portfolio of stocks most heavily shorted by institutions on a given day underperforms by 1.36 percent in the next month (over 18 percent annualized). These alphas do not account for the cost of shorting, and they cannot be achieved by outsiders, because the internal NYSE data that the authors use are not generally available to market participants. But these gross excess returns to shorting indicate that institutional short sellers have identified and acted on important value-relevant information that has not yet been impounded into price. The results are strongly consistent with the emerging consensus in financial economics
that short sellers possess important information, and their trades are important contributors to more efficient stock prices.
Diether, Lee, and Werner test whether short-sellers in Nasdaq-listed stocks are able to predict future returns based on new SEC-mandated data for the first quarter of 2005. There are a tremendous number of short-term trading strategies involving short sales in the sample: short sales represent 25 percent of Nasdaq share volume, while monthly short interest is 3.3 percent of shares outstanding (4.7 days to cover). Short sellers are on average contrarian: they sell short following positive returns. Increasing short sales predict future negative returns, and the predictive power comes primarily from small trades. A trading strategy based on daily short-selling activity generates significant returns, but incurs costs large enough to wipe out any profits. More binding short-sale constraints result in reduced short selling, but there is only a significant effect on future returns among low priced stocks.
Recent theoretical work suggests that commonality in liquidity and variation in liquidity levels can be explained by supply side shocks affecting the funding available to financial intermediaries. Consistent with this prediction, Hameed, Kang, and Viswanathan find that liquidity levels and commonality in liquidity respond asymmetrically to positive and negative market returns. Stock liquidity decreases while commonality in liquidity increases following large negative market returns because the collateral value of the aggregate market-making sector falls. The authors show that a large drop in aggregate value of securities creates greater liquidity commonality because of interindustry spillover effects of the capital constraints. They also show that the commonality is higher for high volatility stocks.
Models of adverse selection risk generally assume that market makers offset expected losses to informed traders with expected gains from the uninformed. Odders-White and Ready recognize that the expected loss captures a combination of two effects: 1) the probability that some traders have private information, and 2) the likely magnitude of that information. They use a maximum-likelihood approach to separately estimate the probability and the magnitude of private information and then test their procedure on a simulated dataset. Then they estimate the parameters for NYSE-listed stocks from 1993 through 2003, and show that their estimates can be used to predict future extreme returns. Finally, they examine the time-series and cross-sectional properties of the probability and magnitude of information. Their results shed light on the price discovery process and have implications for many areas of finance.
Sarkar, Schwartz, and Wolf show that equity markets are two-sided and that trades cluster in certain half-hour periods for both NYSE and Nasdaq stocks under a broad range of conditions: news and non-news days, different times of the day, and a spectrum of trade sizes. By “two-sided,” the authors mean that the arrivals of buyer-initiated and seller-initiated trades in half-hour intervals are positively correlated; by “trade clustering” they mean that trades tend to bunch together in certain halfhour intervals with greater frequency than would be expected if their arrival was a random process. Controlling for trading volume, news, and other microstructure effects, the authors find that two-sided clustering leads to higher volatility but lower trading costs. Their analysis has implications for trader behavior, market structure, and the process by which new information is incorporated into market prices.
Economic Fluctuations and Growth Research
NBER Research Associates Susanto Basu of Boston College and Miles S. Kimball of the University of Michigan organized the fall research meeting of NBER’s Program on Economic Fluctuations and Growth. It took place on October 21 at the Federal Reserve Bank of Chicago. The following papers were discussed:
Michael Kremer, Harvard University and NBER, and Stanley Watt, Harvard University, “The Globalization of Household Production” Discussant: Valerie Ramey, University of California, San Diego and NBER
David N. Weil, Brown University and NBER, “Accounting for the Effect of Health on Economic Growth” (NBER Working Paper No. 11455) Discussant: Hoyt Bleakley, University of Chicago
Raquel Fernández, New York University and NBER, and Alessandra Fogli, New York University, “Culture: An Empirical Investigation of Beliefs, Work, and Fertility” Discussant: Casey Mulligan, University of Chicago and NBER
Mark Bils, University of Rochester and NBER, “Deducing Markup Cyclicality from Stockout Behavior” Discussant: Robert E. Hall, Stanford University and NBER
Robert J. Barro, Harvard University and NBER, “Rare Events and the Equity Premium” Discussant: Lars Hansen, University of Chicago and NBER
Daron Acemoglu, MIT and NBER, “Politics and Economics in Weak and Strong States” Discussant: Scott Page, University of Michigan
Immigration restrictions are arguably the largest distortion in the world economy and the most costly to the world’s poor. Yet, these restrictions seem firmly in place because of fears in rich countries that immigration would exacerbate inequality among natives, fiscally drain the welfare state, and change native culture. Many “new rich” countries are creating a new form of immigration that Kremer and Watt argue may help overcome these obstacles. Foreign private household workers, primarily female, constitute more than 6 percent of the labor force in Bahrain, Kuwait, Hong Kong, Singapore, and Saudi Arabia, and about 1 percent in Taiwan, Greece, and Israel. Providing temporary visas for these workers can potentially allow high-skilled native women to enter the market labor force. This increased labor supply by native high-skilled workers can increase the wages of low-skilled natives and provide a fiscal benefit by correcting distortions toward home production created by income taxes. The welfare gains to natives from a Hong Kong-style program may be equivalent to those from a 2 percent increase in income. However, multicultural societies with a norm of extending citizenship to long-term residents may find this type of migration inconsistent with ethical norms. Programs with temporary, non-renewable visas may be more acceptable in these countries.
Weil uses microeconomic estimates of the effect of health on individual outcomes to construct macroeconomic estimates of the proximate effect of health on GDP per capita. He uses a variety of methods to construct estimates of the return to health, which he
combines with cross-country and historical data on several health indicators including height, adult survival, and age at menarche. His preferred estimate of the share of cross-country variance in log income per worker explained by variation in health is 22.6 percent, roughly the same as the share accounted for by human capital from education, and larger than the share accounted for
by physical capital. He presents alternative estimates ranging between 9.5 percent and 29.5 percent. His preferred estimate of the reduction in world income variance that would result from eliminating health variations among countries is 36.6 percent.
Fernández and Fogli study the effect of culture on important economic outcomes by examining the work and fertility behavior of U.S.-born women 30-40 years old whose parents were born elsewhere. The authors use past female labor force participation and total fertility rates from the country of ancestry as their cultural proxies. In addition to past economic and institutional conditions, these variables should capture the beliefs commonly held about the role of women in society, that is their culture. Given the different time and place, only the beliefs embodied in the cultural proxies should be potentially relevant to women’s behavior in the United States in 1970. The authors show that these cultural proxies have positive and significant explanatory power for individual work and fertility outcomes, even after controlling for possible indirect effects of culture (for example, education and spousal characteristics). Further, they show that unobserved human capital — at the individual level or embodied in the ethnic network — does not explain the correlations. Also, the effect of these cultural proxies is amplified as the tendency for ethnic groups to cluster in the same neighborhood increases.
In models with a stockout constraint on sales, stockouts bear an important relation to the price markup. Bils examines stockout behavior for 63 durable goods using CPI microdata. The behavior of stockouts over goods’ shelf lives requires relatively small markups, on the order of 10-15 percent. For the past 17 years, stockouts have been extremely acyclical. This suggests that markups have been acyclical, which runs directly counter to explanations for cyclicality of employment based on countercyclical price markups, including sticky-price models.
Barro notes that the allowance for low-probability disasters, suggested by Rietz (1988), explains a lot of assetpricing puzzles, including the high equity premium, low risk-free rate, and the volatility of stock returns. Another mystery that may be resolved is why expected real interest rates were low in the United States during major wars, such as World War II. The rare-disasters framework achieves these explanations while maintaining the tractable framework of a representative agent, timeadditive and iso-elastic preferences, and complete markets. The results hold with i.i.d. shocks to productivity growth in a Lucas-tree type economy and also when capital formation is considered.
While much research in political economy points out the benefits of “limited government,” political scientists have long emphasized the problems created in many less developed nations by “weak states” that lack the power to tax and regulate the economy and to withstand the political and social challenges from non-state actors. Acemoglu constructs a model in which the state apparatus is controlled by a self-interested ruler, who tries to divert resources for his own consumption, but who also can invest in socially productive public goods. Both weak and strong states create distortions. When the state is excessively strong, the ruler imposes such high taxes that economic activity is stifled. When the state is excessively weak, the ruler anticipates that he will not be able to extract rents in the future and underinvests in public goods. Acemoglu shows that the same conclusion applies in the analysis of both the economic power of the state (that is, its ability to raise taxes) and its political power (that is, its ability to remain entrenched from the citizens). He also discusses how, under certain circumstances a different type of equilibrium, which he refers to as “consensually strong state equilibrium,” can emerge whereby the state is politically weak but is allowed to impose high taxes as long as a sufficient fraction of the proceeds are invested in public goods. The consensually strong state might best correspond to the state in OECD countries where taxes are high despite significant control by the society over the government.
International Finance and Macroeconomics
The NBER’s Program on International Finance and Macroeconomics met in Cambridge on October 21. NBER Research Associates Charles M. Engel, University of Wisconsin, and Linda Tesar, University of Michigan, organized this program:
Gita Gopinath, Harvard University and NBER, and Roberto Rigobon, MIT and NBER, “Sticky Borders” Discussant: Ariel Burstein, University of California, Los Angeles
Fernando E. Alvarez, University of Chicago and NBER; Andrew Atkeson, University of California, Los Angeles and NBER; and Patrick Kehoe, University of Minnesota and NBER, “Time-Varying Risk, Interest Rates and Exchange Rates in General Equilibrium” Discussant: David Backus, New York University and NBER
Philippe Bacchetta, University of Lausanne, and Eric Van Wincoop, University of Virginia and NBER, “Rational Inattention: A Solution to the Forward Discount Puzzle” Discussant: Nelson Mark, University of Notre Dame and NBER
Yan Bai, Arizona State University, and Jing Zhang, University of Michigan, “Can Financial Frictions Account for the Cross-Section Feldstein-Horioka Puzzle?” Discussant: Vivian Yue, New York University
Anusha Chari, University of Michigan, and Nandini Gupta, Indiana University, “The Political Economy of Foreign Entry Deregulation” Discussant: Galina Hale, Yale University
Irina Tytell, IMF, and Shang-jin Wei, IMF and NBER, “Global Capital Flows and National Policy Choices” Discussant: Simon Johnson, MIT and NBER
Gopinath and Rigobon use a novel dataset to present evidence on price stickiness at the U.S. border. Using unpublished microdata on import and export prices collected by the Bureau of Labor Statistics for the United States for 1994–2005, they find a tremendous amount of dollar price stickiness in both imports and exports. The weighted average price duration is 12.26 months for imports and 14.11 months for exports. These numbers are about three times the Bils-Klenow (2004) estimates for consumer prices. Goods traded on organized markets and reference priced goods have less sticky prices. However, there is little evidence that the price stickiness of goods traded intra-firm differ from those goods traded at arms-length. Finally, the authors explore the relationship between exchange rate movements and the probability and size of price change in imports.
Time-varying risk is the primary force driving nominal interest rate differentials on currency-denominated bonds. This finding is an immediate implication of the fact that exchange rates are roughly random walks. Alvarez, Atkinson, and Kehoe show that a general equilibrium model with an endogenous source of risk variation and a variable degree of asset market segmentation can produce many of the features of interest rates and exchange rates. The endogenous segmentation arises from a fixed cost for agents to exchange money for assets. As inflation varies, the benefit of asset market participation varies, and that changes the fraction of agents participating. These effects lead the risk premium to vary systematically with the level of inflation. One attractive feature of this model is that it produces variation in the risk premium even though the primitive shocks have constant conditional variances.
The uncovered interest rate parity equation is the cornerstone of most models in international macroeconomics. However, this equation does not hold empirically because the forward discount, or interest rate differential, is negatively related to the subsequent change in the exchange rate. This forward discount puzzle is one of the most extensively researched areas in international finance and implies that excess returns on foreign currency investments are predictable. Bacchetta and Van Wincoop propose a new explanation for this puzzle based on rational inattention. They develop a model in which investors face a cost of collecting and processing information. Investors with low information processing costs trade actively, while other investors are inattentive and trade infrequently. The authors calibrate the model to the data and show that: 1) inattention can account for most of the observed predictability of excess returns in the foreign exchange market; 2) the benefit from frequent trading is relatively small so that few investors choose to be attentive; 3) average expectational errors about future exchange rates are predictable in a way that is consistent with survey data for market participants; and, 4) the model can account for the puzzle of delayed overshooting of the exchange rate in response to interest rate shocks.
Bai and Zhang study the famous Feldstein-Horioka finding that long period averages of savings and investment rates are highly correlated across countries. The authors first confirm the Feldstein-Horioka finding with a more recent dataset and then show that a calibrated complete-markets model generates a cross-section savings-investment correlation that is close to zero. Thus, further research is needed to account for Feldstein-Horioka’s cross-section finding. The authors explore the role of financial frictions, but find that the most popular incomplete markets model — the bond model with natural borrowing constraints — cannot account for the cross-section Feldstein-Horioka puzzle. Next, the authors propose the bond model with enforcement constraints in which uncontingent debt contracts are enforced by the threat of permanent exclusion from the markets. This model generates endogenous borrowing constraints, which capture the incentives of countries to repay their debts instead of their abilities to repay under natural borrowing constraints. It accounts for the cross-section Feldstein-Horioka puzzle.
Chari and Gupta investigate the influence of incumbent firms on the policy decision to allow foreign direct investment. Using firm-level data from India, the authors find that the likelihood of barriers to foreign entry being reduced in an industry is inversely related to its concentration. The least concentrated industry in their sample faces an 80 percent probability of being opened to foreign entry in comparison to a 10 percent probability for a monopoly. The results also suggest that politicians are more receptive to the interests of some incumbent firms over others. Industries that are state-owned monopolies face a 13 percent probability of being opened to foreign entry in comparison to a 52 percent probability for industries with no state-owned firms. When foreign entry is allowed in an industry, incumbent firms experience a significant decline in market share and profits. The results are consistent with the hypothesis that incumbent firms oppose foreign entry to protect monopoly profits.
Tytell and Wei study whether changes in global financial environment have induced governments to pursue better policies (the “discipline effect”). The evidence indicates that financial globalization has induced countries to pursue lower inflation rates, but not to succeed in lowering budget deficits. So, the strength of the discipline effect varies across different public policies.
Public Economics Program Meeting
The NBER’s Public Economics Program met in Cambridge on October 27–28. NBER Faculty Research Fellow Raj Chetty and NBER Research Associate Emmanuel Saez, both of the University of California, Berkeley, organized the program. These papers were discussed:
Alan J. Auerbach, University of California, Berkeley and NBER, “Budget Windows, Sunsets, and Fiscal Control” (NBER Working Paper 10694)
Kevin S. Milligan and Thomas Lemieux, University of British Columbia and NBER, “Incentive Effects of Social Assistance: A Regression Discontinuity Approach”
Esther Duflo, NBER and MIT; William Gale and Peter Orszag, Brookings Institution; Jeffrey Liebman, Harvard University and NBER; and Emmanuel Saez, “Savings Incentives for Low- and Middle-Income Families: Evidence from a Field Experiment with H&R Block” (NBER Working Paper 11680)
Francine D. Blau, Cornell University and NBER, and Lawrence M. Kahn, Cornell University, “Changes in the Labor Supply Behavior of Married Women: 1980–2000” (NBER Working Paper 11230)
Daron Acemoglu, MIT and NBER; Michael Golosov, MIT; and Aleh Tsyvinski, Harvard University, “Markets Versus Governments: Political Economy of Mechanisms”
Hanming Fang, Yale University and NBER; Hongbin Cai, University of California, Los Angeles; and Lixin Xu, World Bank, “Eat, Drink, Firms and Government: An Investigation of Corruption from Entertainment and Travel Costs of Chinese Firms” (NBER Working paper 11592,September 2005 — see “The Chinese Economy” earlier in this issue for a description of this paper.)
Roger Gordon, NBER and University of California, San Diego, and Wei Li, University of Virginia, “Tax Structures in Developing Countries: Puzzle and Possible Explanations”
Susan Dynarski, Harvard University and NBER, “Building the Stock of College-Educated Labor” (NBER Working Paper 11604)
Governments around the world have struggled to find the right method of controlling public spending and budget deficits. In recent years, the United States has evaluated policy changes using a ten-year budget window. The use of a multi-year window is intended to capture the future effects of policies, the notion being that a budget window that is too short permits the shifting of costs beyond the window’s endpoint. But a budget window that is too long includes future years for which current legislation is essentially meaningless, and gives credit to fiscal burdens shifted to those whom the budget rules are supposed to protect. This suggests that there may be an optimal budget window, and seeking to understand its properties is one of Auerbach’s main objectives. Another objective is to understand a phenomenon that has grown in importance in U.S. legislation: the sunset. Auerbach argues that, with an appropriately designed budget window, the incentive to use sunsets to avoid budget restrictions will evaporate, so that temporary provisions can be taken at face value. His analysis also has implications for how to account for long-term budget
commitments.
Before 1989, childless social assistance recipients in Quebec under age 30 received much lower benefits than recipients over age 30. Lemieux and Milligan use this sharp discontinuity in policy to estimate the effects of social assistance on various labor market outcomes using a regression discontinuity approach. They find strong evidence that more generous social assistance benefits reduce employment. The estimates exhibit little sensitivity to the degree of flexibility in the specification,
and perform very well when the authors control for unobserved heterogeneity using a first difference specification. Finally, they show that commonly used difference-in-differences estimators may perform poorly with inappropriately chosen control groups.
Duflo, Gale, Liebman, Orszag, and Saez analyze the effects of a large randomized field experiment carried out with H&R Block, offering matching incentives for IRA contributions at the time of tax preparation. About 14,000 H&R Block clients, across 60 offices in predominantly low- and middle-income neighborhoods in St. Louis, were randomly offered a 20 percent match on IRA contributions, a 50 percent match, or no match (the control group). The evaluation generates two main findings. First, higher match rates significantly raise IRA participation and contributions. Take-up rates were 3 percent for the control group, 8 percent in the 20 percent match group, and 14 percent in the 50 percent match group. Average IRA contributions (including non-contributors, excluding the match) for the 20 percent and 50 percent match groups were 4 and 7 times higher than in the control group, respectively. Second, several additional findings are inconsistent with the full information, rational-saver model. In particular, the authors find much more modest effects on take-up and amounts contributed from the existing Saver’s Credit, which provides an effective match for retirement saving contributions through the tax code; they suspect that the differences may reflect the complexity of the Saver’s Credit as enacted, and the way in which its effective match is presented. Taken together, these results suggest that the combination of a clear and understandable match for saving, easily accessible savings vehicles, the opportunity to use part of an income tax refund to save, and professional assistance could generate a significant increase in contributions to retirement accounts, including among middle- and low-income households.
Using March Current Population Survey (CPS) data, Blau and Kahn investigate married women’s labor supply behavior from 1980 to 2000. They find that the labor supply function for annual hours shifted sharply to the right in the 1980s, with little shift in the 1990s. In an accounting sense, this is the major reason for the more rapid growth of female labor supply observed in the 1980s, with an additional factor being that husbands’ real wages fell slightly in the 1980s but rose in the 1990s. Moreover, a major new development was that, during both decades, there was a dramatic reduction in women’s own wage elasticity. And, continuing past trends, women’s labor supply also became less responsive to husbands’ wages. Between 1980 and 2000, women’s own wage elasticity fell by 50 to 56 percent, while their cross wage elasticity fell by 38 to 47 percent in absolute value. These patterns hold up under virtually all alternative specifications correcting for: selectivity bias in observing wage offers; selection into marriage; income taxes and the earned income tax credit; measurement error in wages and work hours; and omitted variables that affect both wage offers and the propensity to work; as well as when education groups and mothers of small children are analyzed separately.
Acemoglu, Golosov, and Tsyvinski investigate the political economy of (centralized) mechanisms and compare these mechanisms to markets. In contrast to the standard approach, they assume that the mechanism is operated by a self-interested agent (ruler/government) who can misuse the resources and information he or she collects. The main contribution of the paper is an analysis of the form of mechanisms that insures idiosyncratic (productivity) risks, as in the classical Mirrlees setup, but in the presence of a self-interested government. The authors construct sustainable mechanisms whereby the government is given incentives not to misuse resources and information. One important result of their analysis is that there will be truthful revelation along the equilibrium path; this shows that truth-telling mechanisms can be used despite the commitment problems and the different interests of the government and the citizens. Using this tool, the authors characterize the best sustainable mechanism. A number of features are interesting to note. First, under fairly general conditions, the best sustainable mechanism is a solution to a quasi-Mirrlees problem, defined as a problem in which the ex ante utility of an agent is maximized subject to incentive compatibility constraints, as well as two additional constraints on the total amount of consumption and labor supply in the economy. Second, the authors characterize the conditions under which the best sustainable mechanism will lead to an asymptotic allocation where the highest type faces a zero marginal tax rate on his or her labor supply as in the classical Mirrlees setup and there are no aggregate capital taxes as in the standard dynamic taxation literature. In particular, if the government is sufficiently patient (typically as patient as the agents), the Lagrange multiplier on the sustainability constraint of the government tends to zero, and marginal distortions arising from political economy disappear asymptotically. In contrast, when the government has a small discount factor, the authors show that aggregate distortions remain, and there is both positive marginal labor tax on the highest type and positive aggregate capital taxes even asymptotically. The authors also investigate when markets are likely to be less desirable relative to centralized mechanisms.
Tax policies in developing countries are puzzling on many dimensions, given the sharp contrast between these policies and both those seen in developed countries and those forecast in the optimal tax literature. In their paper, Gordon and Li explore how forecasted policies change if firms can successfully evade taxes by conducting all business in cash, thus avoiding any use of the financial sector. The forecasted policies that result are much closer to those observed.
Half of college students drop out before completing a degree. These low rates of college completion among young people should be viewed in the context of slow future growth in the educated labor force, as the well-educated baby boomers retire and new workers are drawn from populations with historically low education levels. Dynarski establishes a causal link between college costs and the share of workers with a college education. She exploits the introduction of two large tuition subsidy programs, finding that they increase the share of the population that completes a college degree by 3 percentage points. The effects are strongest among women, with white women increasing degree receipt by 3.2 percentage points and the share of nonwhite women attempting or completing any years of college increasing by 6 and 7 percentage points, respectively. A cost-benefit analysis indicates that tuition reduction can be a socially efficient method for increasing college completion. However, even with the offer of free tuition, a large share of students continue to drop out, suggesting that the direct costs of school are not the only impediment to college completion.
