Accounting for Changes in Inequality

The Berkeley macroeconomics reading group has three themes for this semester: (1) factor shares, wealth, and inequality, (2) misallocation, and (3) financial stability. Each week, a different student presents a paper from one of the topic areas. Today, as part of the first topic, I am presenting the paper "Accounting for Changes in Between-Group Inequality" by Ariel Burstein, Eduardo Morales, and Jonathan Vogel (2013).

Here are my slides. And here is the abstract:

We provide a framework with multiple worker types (e.g. gender, age, education), to decompose changes in aggregated and disaggregated between-group inequality into changes in (i) the supply of each worker type, (ii) the importance of different tasks, (iii) the extent of computerization, and (iv) other labor-specific productivities (a residual to match observed relative wages). The model features three forms of comparative advantage: between worker types and computers, between worker types and tasks, and between computers and tasks. We parameterize the model to match observed changes in worker type allocation and wages in the United States between 1984 and 2003. The combination of changes in the importance of tasks and computerization explain the majority of the rise in the skill premium as well as rising inequality across more disaggregated education types, whereas labor-specific productivity changes drive between-worker wage polarization.

The paper is motivated by the rise in the skill premium, fall in the gender premium, and rise in wage polarization (i.e. relative decline of wages in the middle.) The authors want to know about the role of computerization in these trends. An important idea of the paper is that certain types of workers (e.g. females) may either have a direct comparative advantage at using computers, or might have an indirect comparative advantage in the sense that they have a comparative advantage in occupations in which computers have a comparative advantage. In the first case, we would observe female workers using computers more than males within the same occupation. In the second case, we would observe females being over-represented in the occupations in which all workers use computers a lot.

Using data on computer use and occupations for several years between 1984 and 2003, the authors find that, while women use computers more than men, this is due to indirect comparative advantage. Women are more often in occupations in which all workers use computers more. In contrast, highly educated workers have direct comparative advantage with computers-- they use computers more than less educated workers within the same occupations.

As the price of computers falls, the relative wages of workers with direct comparative advantage in computers rises. So computerization can explain some of the rise in the skill premium (that is, the rise in wages of more educated compared to less educated workers.) A major part of the rise in the skill premium is also attributed to "task shifters," that is, factors like structural changes and international trade that alter the relative demands for workers across occupations.

Computerization does not raise the relative wages of workers with indirect comparative advantage in computers, so computerization does not explain the fall in the gender premium (that is, the fall in male compared to female wages). Both the fall in the gender premium and the relative decline of wages in the middle are attributed to changes in "labor productivity," which in this model is a residual term, meaning it is not actually explained by the model.

Suzanne Scotchmer (1950-2013)

Suzanne Scotchmer, an economics and law professor at Berkeley, recently passed away. From Brad DeLong, here is the note sent out to the Berkeley Law community. An excerpt:

"Suzanne was particularly inspirational as one of very few women writing in the field of theoretical economics. Friends, colleagues and students across the campus and across her disciplines shared a deep appreciation for Suzanne's tirelessly creative mind, her enthusiasm for intellectual engagement at the highest level, and her preternatural ability to see to the heart of a complex problem immediately and describe it with clarity and insight."

The Toulouse School of Economics, where Scotchmer sat on the Scientific Council since 2007, also wrote a very nice tribute.

Joshua Gans leaves a summary of Scotchmer's work in innovation economics. Gans' article also includes some moving recollections of Scotchmer from her former student Neil Gandal. Another of Scotchmer's former students, Diane Coyle, was a graduate student at Harvard in the early 1980s when Scotchmer was there as an assistant professor. Coyle writes, "Then, as now, economics was very male-dominated and it was unspeakably encouraging to have a female role model who was highly supportive of students – and a normal human being too, warm, funny, with outside interests."

In addition to her work in innovation economics and patent law, Scotchmer made numerous contributions in mathematical economics, game theory, and public finance. In one interesting paper, "On the Evolution of Attitudes towards Risk in Winner-Take-All Games" (1999) with Eddie Dekel, she studies endogenous preference formation:

"Economists typically take preferences as given. This sets them apart from other social scientists, such as psychologists, who often try to explain preferences. In this paper we explore an evolutionary model where preferences, in particular attitudes toward risk, are endogenously determined."

In another paper, "The short-run and long-run benefits of environmental improvement," she suggests a technique for calculating the social value of nonmarginal improvements to social goods such as environmental improvement. Another interesting paper is "Risk taking and gender in hierarchies" (2008), which sheds some light on the controversy about gender differentials labor market outcomes. Suzanne Scotchmer left a tremendous intellectual and personal legacy and will be greatly missed.

In with Foreign Currency, Out with Foreign Businesspeople: Trouble in Zimbabwe

In February 2009, facing 500 billion percent inflation, Zimbabwe abandoned its currency, replacing it with a multi-currency system. The U.S. dollar, South African rand, British pound, and Botswana pula were all made legal tender. On Wednesday, the Reserve Bank of Zimbabwe (RBZ) announced the addition of four more currencies to its legal tender collection: the Australian dollar, Chinese yuan, Japanese yen and Indian rupee.

Charity Dhliwayo, acting Governor of the RBZ, remarked that "Trade and investment ties between Zimbabwe, China, India, Japan and Australia have grown appreciably...It is against this background of growth in trade and investment ties that in the 2014 national budget, the minister of finance and economic development underscored the importance of including other currencies in the basket of already circulating currencies."

The lip service to international trade and investment ties sounds less than sincere in the context of Zimbabwe's "indigenisation policy." Last year, President Robert Mugabe announced that retail business should be owned and run by indigenous Zimbabweans from the start of 2014. The majority of foreign shop owners in Zimbabwe are Nigerian and Chinese-- so although the Chinese yuan is given a status boost as a new legal tender, Chinese business owners are told to get out. Not exactly a great signal for trade and investment ties.

The inclusion of additional currencies as legal tender may actually be a feeble attempt to address what is becoming a fairly severe liquidity crisis. As investors pull funds out of emerging markets, the crisis is deepening. Maybe the idea is that more kinds of money means more money. Critics say that more kinds of money will only mean more chaos.

What makes the whole situation a lot scarier, in my opinion, is that when Zimbabwe gave up its own currency, the RBZ gave up its role as lender of last resort (LOLR). If I remember one thing from Brad DeLong's economic history class, it is "Lend freely, at penalty rate." The RBZ plans to restore its LOLR function by March, but is struggling to recapitalize the LOLR facility in the amount of $150 to $200 million. (Yep, million with an m. Startling when there are 1,426 billionaires in the world.) Possibly too little, probably too late.

Inflation Stories of the Week (January 31, 2014)

1. Rajan Signals India Inflation Target Amid Vote Tension (Bloomberg): India central bank Governor Raghuram Rajan may attempt to make inflation the bank's primary priority. Rajan says, "If the government policies in aggregate prove to be expansionary, we will have to adjust policies ourselves to meet the overall disinflationary process. We can’t throw up our hands in some sense and say there is nothing we can do because of the fiscal dominance."

2. Hungary Rate-Cut Resolve Challenged by Investors as Forint Drops (Bloomberg): Inflation in Hungary is at its lowest since 1970. Central banks in Turkey and South Africa are raising rates to try and stop falling currencies, but the Hungarian central bank faces a challenge because monetary easing is more appropriate to its inflation and growth conditions.

3. Inflation in Euro Zone Falls, and a 12% Jobless Rate Doesn’t Budge (NYT): The 0.7 percent inflation rate may have surprised the ECB.

4. Japan’s Inflation Accelerates as Abe Seeks Wage Gains (Bloomberg): Japan's inflation has inched up, but the real test will come at the annual wage talks in April. Prime Minister Shinzo Abe has met five times since September with business and union leaders to encourage them to raise salaries, which have risen slower than prices.

Inflation Stories of the Week Archive

Inflation Stories of the Week (January 24, 2014)

1. Should We Worry about Deflation? (The Economist): Professor Paul DeGrauwe says that the Euro zone already suffers from debt-deflation dynamics: "Inflation in the euro zone has been declining since early last year and now stands at 0.8%. This disinflation exerts debt-deflation dynamics, which are of the same nature as those analysed by Irving Fisher... It is not yet catastrophically intense, but surely it should be stopped before it gets worse when inflation turns negative."
2. Plunging Rand, Soaring Maize Price to Stoke South African Inflation (Reuters): A weakening rand and record-high maize prices resulting from rain shortfall are causing concerns about upside inflation risks in South Africa. The central bank may raise rates in the next few months.

3. Narcos-Versus-Farmers Feud Spurs Inflation Wagers (Bloomberg): In Mexico, conflict between vigilante farmers and drug gangs in Michoacan state’s lime-growing valleys is expected to increase agricultural prices and inflation.

4. Soaring Rural Wages Created Low-Growth, High Inflation: Morgan Stanley (Economic Times)

"We believe the National Rural Employment Guarantee Act (NREGA) Scheme has been one of the key factors pushing rural wages without matching gains in productivity...

Read more at:
http://economictimes.indiatimes.com/articleshow/29122893.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst

: A note by Morgan Stanley India blames the National Rural Employment Guarantee Act for pushing up rural wages in India without a corresponding rise in productivity. The note says that rural wages grew an average of 18.7% per year over the past 3 years, contributing to a stagflationary environment.

5. Bank of Japan Sticks to Record Easing as Inflation Picks Up (Bloomberg): The recent BOJ statement says the rate of increase in core consumer prices is expected to be around 1.25% "for some time." Interestingly, unlike the previous statement, this one did not include the comment that “there remains a high degree of uncertainty concerning Japan’s economy.” Sales taxes will increase from 5% to 8% in April. Base wages excluding bonuses and overtime fell for the 18th straight month.

6. The Mystery of China's Fading Inflation, Explained (Quartz): Here's a theory about China's slowing CPI inflation rate: "What makes China unlike Western economies is that the government, not the market, determines the interest rates—in other words, the cost of money—on both deposits and loans. By setting them both artificially low, the government shifts wealth from savers to borrowers...As for China’s hapless savers, the closed capital account leaves them unable to invest in much else, so despite lousy rates, they keep stashing their cash in banks. This unfair distribution is why the money supply can surge without juicing consumer inflation."

Soaring rural wages created low-growth, high-inflation: Morgan Stanley

Read more at:
http://economictimes.indiatimes.com/articleshow/29122893.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst

Soaring rural wages created low-growth, high-inflation: Morgan Stanley

Read more at:
http://economictimes.indiatimes.com/articleshow/29122893.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst

Lance Davis (1928-2014)

Lance Edwin Davis passed away this week. A renowned economic historian with major contributions in financial history and institutional economics, Davis was a professor at Caltech from 1968 to 2005.

Davis is associated with cliometrics, a quantitative and systematic approach to analyzing economic history. The term cliometrics--combining Clio, the muse of history, with metrics from econometrics--was coined in the 1950s by a group of economic historians and mathematical economists at Purdue University. Davis was a key member of this group, along with Jonathan Hughes and Stanley Reiter. This group obtained funds from Purdue to start a new conference series, originally called the Conference on the Application of Economic Theory and Quantitative Methods to the Study of Problems of Economic History, and later called the Cliometric Conference, or just Clio.

The Cliometrics Conferences helped bring about a renewal in the economic history field. The new generation of economic historians in the 1950s and 60s began integrating economic theory and empirical evidence more rigorously and creatively than before. Often, this involved extensive efforts to uncover and tabulate historical data. Davis and Louis Stettler's "The New England Textile Industry, 1825-60: Trends and Fluctuations" (1966) is an example of this type of work.

Davis' efforts to integrate theory and empirical evidence are particularly valuable in the area of financial history. In "The Investment Market, 1870-1914: The Evolution of a National Market" (1965), Davis notes that the classical assumption of perfect capital mobility implies that rates of return on capital should be equal across regions and industries. Interest rate differentials provide information about the barriers to capital mobility. Davis' paper gathers data on interest rate differentials among six regions of the United States from 1870-1914 and analyzes the institutional innovations that reduced barriers to capital mobility over that period.

The cliometric approach also brought about a new way of thinking about economic institutions and institutional change. Neoclassical institutional theory flourished in the 1960s, led by Davis and Douglass North, who developed a model of the logic and incentives that shape the institutional environment. Davis and North's hugely influential book, Institutional Change and American Economic Growth (1971), outlines their model and applies it to American economic history.

In other work, Davis focuses on British financial markets and British imperialism. He and Robert Huttenback wrote the book Mammon and the Pursuit of Empire: The Political Economy of British Imperialism, 1860-1912 (1986). They examine the economics of imperialism, including the returns on investment in empire-building and the social costs of maintaining the empire. The analysis portrays British imperialism as a mechanism to that transferred income from the tax-paying middle class to the elites.

Among Davis' other works are In Pursuit of Leviathan: Technology, Institutions, Productivity, and Profits in American Whaling, 1816-1906 (1997) with Robert Gallman and Karin Gleiter, and Evolving Financial Markets and International Capital Flows: Britain, the Americas, and Australia, 1870–1914 (2001) with Robert Gallman.

An interview with Davis in 1998 is full of interesting stories about his life and work, including his naval service in WWII and the Korean War. The interview tells of his role shaping the Caltech social sciences division. He was there when Caltech admitted its first social sciences PhD student, Barry Weingast, in 1974. There is a strong sense of community among economic historians in California, of which Davis was a central part.

Inflation Stories of the Week (January 17, 2014)

I'm adding something new to the blog. Every Friday, I'll post a round-up of the week's most interesting news and research about inflation around the world. Send me story tips during the week on twitter or by email. Or add stories I've missed in the comments.

1. McDonald’s Agrees to Cut the Price of a Venezuelan Big Mac Combo (Bloomberg): McDonald's lowered the price of a Big Mac combo by 7.5% at its 139 restaurants in Venezuela. The decision was made a week after the government came to inspect company offices. In Venezuela, where inflation is the highest in the world, military-backed price regulators have forced 1000 businesses to lower prices. The Big Mac price cut is noteworthy because of the "Big Mac Index," a lighthearted but widely referenced gauge of currency misalignment.

2. Sri Lanka to Change Inflation Index to Cover Whole Nation (Daily Mirror): In May, the IMF said that Sri Lanka’s national accounts “suffer from insufficient data sources and undeveloped statistical techniques.” The current index only represents the capital city, Colombo. The new index will cover the whole nation. Sri Lanka recently cut a policy rate by 50 bpt, against the advice of the IMF.

3. Brazil Signals Inflation Will Extend World’s Biggest Rate Rise (Bloomberg): Concerns about inflation led to the sixth straight 50 bpt increase in Brazil's benchmark policy rate.

4. Make Inflation-Indexed Bonds More Attractive (New Indian Express): India is trying to issue inflation-indexed bonds, in part to wean investors away from gold and real estate. But investor response was tepid and the bonds are undersubscribed, so the government has extended the subscription deadline by 3 months.

5. Government Studies Ways to Modernize Inflation-Data Collection (WSJ): In the United States, a new BLS project is attempting to get price data directly and electronically from businesses for use in the Consumer Price Index.