Economic wisdom at the CEA

Bush has just nominated Ed Lazear to replace Bernanke--who is about to take office at the Fed in lieu of Greenspan--at the Council of Economic Advisors.  You can say anything about dubya's wisdom on other issues but as far as his CEA nominations go, his record is remarkable: Mankiw, Bernanke, and now Lazear--are all truly heavy-weights of our profession.  It is also interesting that Lazear, a microeconomist, takes the place of Mankiw and Bernanke, both macroeconomists. 

One favorite Lazear piece--which surely pisses off many of my non-economist colleagues--is "Economic Imperialism" (QJE, 2000).  Yes, it is a bit (a lot?) pedantic but that does not make it any less true.

"The power of economics lies in its rigor. Economics is scientific; it follows the scientific method of stating a formal refutable theory, testing the theory, and revising the theory based on the evidence. Economics succeeds where other social sciences fail because economists are willing to abstract. The old joke about a stranded, starving economist assuming a can opener to open a can of food pokes fun at our willingness to assume away what we believe to be unimportant or difficult details. Economists are used to posing the counterfactual question to do analysis. What would one expect in the absence of the hypothesized effect? What would be observed? Do the data allow us to choose between various hypotheses? Economists are not alone among social scientists in following this method, but this form of inquiry has become the standard for economic research.

It is the ability to abstract that allows us to answer questions about a complicated world. As economists, however, we believe in comparative advantage. I have argued elsewhere that the strength of economic theory is that it is rigorous and analytic. But the weakness of economics is that to be rigorous, simplifying assumptions must be made that constrain the analysis and narrow the focus of the researcher. It is for this reason that the broader thinking sociologists, anthropologist and perhaps psychologists may be better at identifying issues, but worse at providing answers. Our narrowness allows us to provide concrete solutions, but sometimes prevents us from thinking about the larger features of the problem. This specialization is not a flaw; much can be learned from other social scientists who observe phenomena that we often overlook. But the parsimony of our method and ability to provide specific, well-reasoned answers gives us a major advantage in analysis."

Unemployment Insurance

Standard micro theory will tell you that "unemployment insurance" (UI) may have the unintended consequence of providing an incentive to work fewer hours.  Yet, typical micro students look at you in disbelief when they hear this.  After all, what kind of meanie-person can you be if you even pose this question--how come you don't care for the unemployed? Granted, UI may have a first-order effect in helping the unfortunately unemployed in the short-run but this does not preclude the disincentive to work in the long-run... Here is some evidence (definitely an example I will use in my future micro class):

The Long-Term Effects of a Generous Income Support Program:
Unemployment Insurance in New Brunswick and Maine, 1940-1991
by Peter Kuhn, Chris Riddell
http://papers.nber.org/papers/W11932
Abstract:
Using data spanning a half century for adjacent jurisdictions in the U.S. and Canada, we study the long-term effects of a very generous unemployment insurance (UI)program on weeks worked. We find large effects. For example, in 1990, about 6 percent of employed men in Maine's northernmost counties worked fewer than 26 weeks per year; just across the border in New Brunswick that figure was over 20 percent.
According to our estimates, New Brunswick's much more generous UI system accounts for about two thirds of this differential. Even greater effects are found among women and less-educated men. We argue that our longer-run, crossnational perspective generates more substantial estimates of program effects because it captures workers' abilities to make a wider variety of adjustments to programs they expect to be permanent.

 

Cognitive Dissonance and Voting

Ever heard about post-election polls (like the NES) showing that respondents claim to have voted for a winning candidate at a higher rate than the actual vote shares observed on election day?  Cognitive dissonance creates  may make voters claim that they supported the winner even when they didn't, thus biasing poll responses.  This paper found a clever way to test for such an effect: 

Sticking with Your Vote: Cognitive Dissonance and Voting
by Sendhil Mullainathan, Ebonya Washington - #11910 (PE)
http://papers.nber.org/papers/W11910

Abstract: In traditional models, votes are an expression of preferences and beliefs. Psychological theories of cognitive dissonance suggest, however, that behavior may shape preferences. In this view, the very act of voting may influence political attitudes. A vote for a candidate may lead to more favorable interpretations of his actions in the future. We test the empirical relevance of cognitive dissonance in US Presidential elections.

The key problem in such a test is the endogeneity of voter choice which leads to a mechanical relationship between voting and preferences. We use the voting age restrictions to help surmount this difficulty. We examine the Presidential opinion ratings of nineteen and twenty year olds two years after the President's election. Consistent with cognitive dissonance, we find that twenty year olds (who were eligible to vote in the election) show greater polarization of opinions than comparable nineteen year olds (who were ineligible to vote).

We rule out that aging drives these results in two ways. First, we find no polarization differences in years in which twenty and nineteen year olds would not have differed in their eligibility to vote in the prior Presidential election. Second, we show a similar effect when we compare polarization (for all age groups) in opinions of Senators elected during high turnout Presidential campaign years with Senators elected during low turnout non-Presidential campaign years. Thus we find empirical support for the relevance of cognitive dissonance to voting behavior. This finding has at least three implications for the dynamics of voting behavior. First, it offers a new rationale for the incumbency advantage. Second, it suggests that there is an efficiency argument for term limits. And finally, our results demonstrate that efficiency may not be increasing in turnout level.

Inefficient policies and inefficient institutions

Modeling Inefficient Institutions
by Daron Acemoglu - #11940 (EFG)

Abstract: Why do inefficient -- non-growth enhancing -- institutions emerge and persist? This paper develops a simple framework to provide some answers to this question. Political institutions determine the allocation of political power, and economic institutions determine the framework for policy-making and place constraints on various policies.
Groups with political power, the elite, choose policies to increase their income and to directly or indirectly transfer resources from the rest of society to themselves. The baseline model encompasses various distinct sources of inefficient policies, including revenue extraction, factor price manipulation and political consolidation. Namely, the elite may pursue inefficient policies to extract revenue from other groups, to reduce their demand for factors, thus indirectly benefiting from changes in factor prices, and to impoverish other groups competing for political power.
The elite's preference over inefficient policies translates into inefficient economic institutions. Institutions that can restrict inefficient policies will in general not emerge, and the elite may manipulate economic institutions in order to further increase their income or facilitate rent extraction.
The exception is when there are commitment (holdup) problems, so that equilibrium taxes and regulations are worse than the elite would like them to be from an ex ante point of view. In this case, economic institutions that provide additional security of property rights to other groups can be useful. The paper concludes by providing a framework for the analysis of institutional change and institutional persistence.
http://papers.nber.org/papers/W11940

Some other interesting NBER papers:

The Quiet Revolution that Transformed Women's Employment, Education, and Family
by Claudia Goldin #11953
http://papers.nber.org/papers/W11953

The Long Run Impact of Bombing Vietnam
by Edward Miguel, Gerard Roland #11954 (EFG)
http://papers.nber.org/papers/W11954

The Evolution of Top Incomes: A Historical and International Perspective
by Thomas Piketty, Emmanuel Saez #11955 (PE)
http://papers.nber.org/papers/W11955

The U.S. Health Care System and Labor Markets
by Brigitte Madrian #11980 (AG HE LS PE)
http://papers.nber.org/papers/W11980

The Median Voter and the Median Consumer: Local Private Goods and Residential Sorting
by Joel Waldfogel #11972 (IO)
http://papers.nber.org/papers/W11972