Stuff I Say at School – Part VII: The Importance of Institutions

This is part of the Stuff I Say at School series.

Summary & Commentary on Week’s Readings

Acemoglu et al argue that inefficient institutions persist for a number of major reasons. First, the lack of third-party enforcement of commitments prevents elites from relinquishing their monopoly on political power. Furthermore, the beneficiaries of the economic status quo are usually unwilling to risk their economic welfare through competition. This leads them to promote protectionism and further engage in rent-seeking activities. Institutions that encourage these kinds of activities fail to grow. We see this kind of conflict manifest in various areas of the economy, from labor and financial markets to regulations in pricing. The more institutions concentrate political power in the hands of the few, the more incentives are warped and distort paths to economic growth.

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In their book Why Nations Fail: The Origins of Power, Prosperity, and Poverty, Daron Acemoglu and James Robinson distinguish between inclusive and extractive institutions, with the former creating the conditions for prosperity. “Inclusive economic institutions,” they write,

…are those that allow and encourage participants by the great mass of people in economic activities that make best use of their talents and skills and that enable individuals to make the choices they wish. To be inclusive, economic institutions must feature secure private property, an unbiased system of law, and a provision of public services that provides a level playing field in which people can exchange and contract; it also must permit the entry of new business and allow people to choose their careers…Inclusive economic institutions foster economic activity, productivity growth, and economic prosperity (pg. 74-75).

On the other hand, extractive economic institutions lack these properties and instead “extract incomes and wealth from one subset of society to benefit a different subset,” empowering the few at the expense of the many (pg. 76).

The importance of getting institutions right is highlighted by Rodrik and Subramanian’s study. Three theoretical culprits have been blamed for the vast income inequality between countries: (1) geography, (2) integration (globalization, international trade), and (3) institutions. Regression analyses indicate that institutions trump all other explanations. This is also shown from the outset of Acemoglu and Robinson’s Why Nations Fail, in their story of Nogales, Arizona (United States of America) and Nogales, Sonora, (Mexico). Acemoglu and Robinson lay out their archetype story of two towns with the same essential culture, geography, and relative free trade (NAFTA), in most ways they are the same place. The only reason they are two towns is an institutional barrier between two separate countries. Yet one is rich and one is poor because of institutions. The direct effects of geography are weak at best, while there were no direct effects from integration. However, there were indirect effects of integration: institutions have significant, positive effects on integration, while integration has a positive impact on institutions. This, in some sense, creates a virtuous, growth-enhancing cycle. Rodrik and Subramanian point out that the institutional factors emphasized the most have largely been market-oriented (e.g., property rights, enforceable contracts). Yet, factors such as regulation, financial stabilization, and social insurance also matter in getting institutions right.

The interaction between political and economic institutions is an important insight. For example, even though most research finds that seemingly liberal political institutions like democracy have no direct impact on economic growth, more recent evidence from Acemoglu and colleagues suggests that they may in fact contribute to growth. What’s more, the evidence strongly suggests that economic openness—particularly international trade—contributes to growth. A 2010 study used data from 131 developed and developing countries and found that reductions in trade protections led to higher levels of income per capita. A World Bank study found that between 1950 and 1998, “countries that liberalized their trade regimes experienced average annual growth rates that were about 1.5 percentage points higher than before liberalization. Postliberalization investment rates rose 1.5-2.0 percentage points, confirming past findings that liberalization fosters growth in part through its effect on physical capital accumulation…Trade-centered reforms thus have significant effects on economic growth within countries” (pg. 212). A 2016 IMF paper found that trade liberalization boosts productivity through increased competition and greater variety and quality of inputs. All this suggests that Sachs and Warner were correct when they found “that open policies together with other correlated policies were sufficient for growth in excess of 2 percent during 1970-89” (pg. 45; fn. 61). Their findings also suggest “that property rights, freedom, and safety from violence are additional determinants of growth” (pg. 50). Acemoglu and Robinson in a 2005 paper found “robust evidence that property rights institutions have a major influence on long-run economic growth, investment, and financial development, while contracting institutions appear to affect the form of financial intermediation but have a more limited impact on growth, investment, and the total amount of credit in the economy” (pg. 988).

In short, inclusive institutions are necessary to fully reap the benefits of an open economy.

Is Student Loan Forgiveness for the Marginalized?

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I saw this floating around Facebook recently with the news of Elizabeth Warren’s student loan plan. For those unfamiliar with what Mayfield is referencing, here’s the entry from the HarperCollins Bible Dictionary:

As another Bible dictionary clarifies, “Though Leviticus 25 does not explicitly discuss debt cancellation, the return of an Israelite to his land plus the release of slaves implies the cancellation of debts that led to slavery or the loss of land.”

So does Warren’s plan benefit “the marginalized”?

According to Adam Looney at the Brookings Institution, Warren’s proposal is “regressive, expensive, and full of uncertainties…[T]he top 20 percent of households receive about 27 percent of all annual savings, and the top 40 percent about 66 percent. The bottom 20 percent of borrowers by income get only 4 percent of the savings. Borrowers with advanced degrees represent 27 percent of borrowers, but would claim 37 percent of the annual benefit.”

E Warren Distribution of benefit

He continues,

Debt relief for student loan borrowers, of course, only benefits those who have gone to college, and those who have gone to college generally fare much better in our economy than those who don’t. So any student-loan debt relief proposal needs first to confront a simple question: Why are those who went to college more deserving of aid than those who didn’t? More than 90 percent of children from the highest-income families have attended college by age 22 versus 35 percent from the lowest-income families. Workers with bachelor’s degrees earn about $500,000 more over the course of their careers than individuals with high school diplomas. That’s why about 50 percent of all student debt is owed by borrowers in the top quartile of the income distribution and only 10 percent owed by the bottom 25 percent. Indeed, the majority of all student debt is owed by borrowers with graduate degrees.

Drawing on 2016 data from the Federal Reserve’s Survey of Consumer Finances, Looney’s final analysis

shows that low-income borrowers save about $569 in annual payments under the proposal, compared to $900 in the top 10 percent and $2,653 in the 80th to 90th percentiles. Examining the distribution of benefits, top-quintile households receive about 27 percent of all annual savings, and the top 40 percent about 66 percent. The bottom 20 percent of borrowers by income get 4 percent of the savings…[W]hile households headed by individuals with advanced degrees represent only 27 percent of student borrowers, they would claim 37 percent of the annual savings. White-collar workers claim roughly half of all savings from the proposal. While the Survey of Consumer Finances does not publish detailed occupational classification data, the occupational group receiving the largest average (and total) amount of loan forgiveness is the category that includes lawyers, doctors, engineers, architects, managers, and executives.  Non-working borrowers are, by and large, already insured against having to make payments through income-based repayment or forbearances; most have already suspended their loan payments. While debt relief may improve their future finances or provide peace of mind, it doesn’t offer these borrowers much more relief than that available today.  

The Urban Institute’s analysis has similar findings (though their tone is more optimistic):

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I’m not sure whether or not Warren’s plan is a good one (I’m skeptical, especially given some of the results abroad). But I’m not big on acting like college graduates in a rich country are the marginalized of society.

Is Contract Enforcement Important for Firm Productivity?

Contract enforcement is a major player in measuring the ease of doing business in a country. A new working paper demonstrates the importance of enforceable contracts to firm productivity:

In Boehm and Oberfield (2018) we study the use of intermediate inputs (materials) by manufacturing plants in India and link the patterns we find to a major institutional failure: the long delays that petitioners face when trying to enforce contracts in a court of justice. India has long struggled with the sluggishness of its judicial system. Since the 1950’s, the Law Commission of India has repeatedly highlighted the enormous backlogs and suggested policies to alleviate the problem, but with little success. Some of these delays make international headlines, such as in 2010, when eight executives were convicted in the first instance for culpability in the 1984 Bhopal gas leak disaster. One of them had already passed away, and the other seven appealed the conviction (Financial Times 2010)

These delays are not only a social problem, but also an economic problem. When enforcement is weak, firms may choose to purchase from suppliers that they trust (relatives, or long-standing business partners), or avoid purchasing the inputs altogether such as by vertically integrating and making the components themselves, or by switching to a different production process. These decisions can be costly. Components that are tailored specifically to the buyer (‘relationship-specific’ intermediate inputs) are more prone to hold-up problems, and are therefore more dependent on formal court enforcement.

…Our results suggest that courts may be important in shaping aggregate productivity. For each state we ask how much aggregate productivity of the manufacturing sector would rise if court congestion were reduced to be in line with the least congested state. On average across states, the boost to productivity is roughly 5%, and the gains for the states with the most congested courts are roughly 10% (Figure 3).

Are Immigrants a Threat?

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From a new working paper:

The empirical evidence comes down decidedly on the side of immigrants being less likely to commit crimes. A large body of empirical research concludes that immigrants are less likely than similar US natives to commit crimes, and the incarceration rate is lower among the foreign-born than among the native-born (see, for example, Butcher and Piehl 1998a, 1998b, 2007; Hagan and Palloni 1999; Rumbaut et al. 2006). Among men ages 18 to 39—prime ages for engaging in criminal behavior—the incarceration rate among immigrants is one-fourth the rate among US natives (National Academies of Sciences, Engineering, and Medicine 2015).

…There is some evidence that the lower propensity of immigrants to commit crimes does not carry over to immigrants’ children. The US-born children of immigrants—often called the “second generation”— appear to engage in criminal behavior at rates similar to other US natives (Bersani 2014a, 2014b). This 4 “downward assimilation” may be surprising, since the second generation tends to considerably outperform their immigrant parents in terms of education and labor-market outcomes and therefore might be expected to have even lower rates of criminal behavior (National Academies of Sciences, Engineering, and Medicine 2015). Instead, immigrants’ children are much like their peers in terms of criminal behavior. This evidence mirrors findings that the immigrant advantage over US natives in terms of health tends to not carry over to the second generation (e.g., Acevedo-Garcia et al. 2010).

Although immigrants are less likely to commit crimes than similar US natives, they are disproportionately male and relatively young—characteristics associated with crime. Does this difference in demographic composition mean that the average immigrant is more likely than the average US native to commit crimes? Studies comparing immigrants’ and US natives’ criminal behavior and incarceration rates tend to focus on relatively young men, leaving the broader question unanswered. However, indirect evidence is available from looking at the relationship between immigration and crime rates. If the average immigrant is more likely than the average US native to commit crimes, areas with more immigrants should have higher crime rates than areas with fewer immigrants. The evidence here is clear: crime rates are no higher, and are perhaps lower, in areas with more immigrants. An extensive body of research examines how changes in the foreign-born share of the population affect changes in crime rates. Focusing on changes allows researchers to control for unobservable differences across areas. The finding of either a null relationship or a small negative relationship holds in raw comparisons, in studies that control for other variables that could underlie the results from raw comparisons, and in studies that use instrumental variables to identify immigrant inflows that are independent of factors that also affect crime rates, such as underlying economic conditions (see, for example, Butcher and Piehl 1998b; Lee, Martinez, and Rosenfeld 2001; Reid et al. 2005; Graif and Sampson 2009; Ousey and Kubrin 2009; Stowell et al. 2009; Wadsworth 2010; MacDonald, Hipp, and Gill 2013; Adelman et al. 2017). The lack of a positive relationship is generally robust to using different measures of immigration, looking at different types of crimes, and examining different geographic levels.2 Further, the lack of a positive relationship suggests that immigration does not cause US natives to commit more crimes. This might occur if immigration worsens natives’ labor market opportunities, for example.

The few studies that examine crime among unauthorized immigrants have findings that are consistent with the broader pattern among immigrants—namely, unauthorized immigrants are less likely to commit crimes than similar US natives (apart from immigration-related offenses).4 Likewise, studies that examine the link between the estimated number of unauthorized immigrants as a share of an area’s population and crime rates in that area typically find evidence of null or negative effects (pg. 3-5).

Comparatively, the effects of border control on crime is mixed. The authors conclude,

A crucial fact seems to have been forgotten by some policy makers as they have ramped up immigration enforcement over the last two decades: immigrants are less likely to commit crimes than similar US natives. This is not to say that immigrants never commit crimes. But the evidence is clear that they are not more likely to do so than US natives. The comprehensive 2015 National Academies of Sciences, Engineering, and Medicine report on immigration integration concludes that the finding that immigrants are less likely to commit crimes than US natives “seems to apply to all racial and ethnic groups of immigrants, as well as applying over different decades and across varying historical contexts” (328). Unauthorized immigrants may be slightly more likely than legal immigrants to commit crimes, but they are still less likely than their US-born peers to do so. Further, areas with more immigrants tend to have lower rates of violent and property crimes. In the face of such evidence, policies aimed at reducing the number of immigrants, including unauthorized immigrants, seem unlikely to reduce crime and increase public safety (pg. 11).

Stuff I Say at School – Part VI: Economic Freedom & Corruption

This is part of the Stuff I Say at School series.

The Assignment

Response to a group’s summary of Jakob Svensson’s “Eight Questions About Corruption.”

The Stuff I Said

The Fraser Institute’s Economic Freedom of the World (EFW) Index, published in its annual Economic Freedom of the World reports, defines economic freedom based on five major areas: (1) size of the central government, (2) legal system and the security of property rights, (3) stability of the currency, (4) freedom to trade internationally, and (5) regulation of labour, credit, and business. According to its 2018 report (which looks at data from 2016), countries with more economic freedom have substantially higher per-capita incomes, greater economic growth, and lower rates of poverty. Drawing on the EFW Index, Georgetown political philosophers Jason Brennan and Peter Jaworski point to a strong positive correlation between a country’s degree of economic freedom and its lack of public sector corruption.

Granted, a lack of corruption could very well give rise to market reforms and increased economic freedom instead of the other way around. However, recent research on China’s anti-corruption reforms suggests that markets may actually pave the way for anti-corruption reforms. Summarizing the implications of this research, Lin et al. explain,

Reducing corruption creates more value where market reforms are already more fully implemented. If officials, rather than markets, allocate resources, bribes can be essential to grease bureaucratic gears to get anything done. Thus, non-[state owned enterprises’] stocks actually decline in China’s least liberalised provinces – e.g. Tibet and Tsinghai – on news of reduced expected corruption. These very real costs of reducing corruption can stymie reforms, and may explain why anticorruption reforms often have little traction in low-income countries where markets also work poorly. China has shown the world something interesting: prior market reforms clear away the defensible part of opposition to anticorruption reforms.Once market forces are functioning, bribe-soliciting officials become a nuisance rather than tools for getting things done. Eliminating pests is more popular than taking tools away … A virtuous cycle ensues – persistent anticorruption efforts encourage market-oriented behaviour, which makes anticorruption reforms more effective, which further encourages market oriented behaviour.

Interesting enough, there is some evidence that suggests that more government hands in the pies increases corruption. For example, a 2017 study found that larger municipality councils in Sweden result in more corruption problems. A 2009 study found that more government tiers and more public employees lead to more bribery. Finally, a 2015 study showed that high levels of regulation are associated with higher levels of corruption (likely because of regulatory capture).

Do Most Americans Really Want What They Say They Want?

I hear a lot about how “most Americans” are in favor of “Policy XYZ.” The problem is that the social science shows that most Americans don’t know what they’re talking about. Do opinions change with more information or when costs are introduced? Two surveys from the Cato Institute seem to answer this in the affirmative.

The first is on federal paid leave. Seventy-four percent of the 1,700 Americans surveyed “a new federal government program to provide 12 weeks of paid leave to new parents or to people to deal with their own or a family member’s serious medical condition…Support slips and consensus fractures for a federal paid leave program, however, after costs are considered.” A 20 percentage point drop in support occurs when a $200 price tag is attached. Less than half are willing to pay $450 more in taxes for the program. When other potential costs are introduced (e.g., smaller future raises, reduction in other benefits, women less likely to be promoted, cut funding to other government programs), the majority of Americans find themselves opposing the program.

Less than half of men would be willing to pay even $200 more, while 55% of women would still be willing to pay $450 more. Support for the program drops across all political parties as costs are introduced, with 60% of Democrats still willing to fork over $1,200 a year to implement it (but only 22% of Republicans and 45% of Independents). “In sum,” writes Cato researcher Emily Ekins, “Democrats have a much higher tolerance threshold for taxes than the average American.”

Another survey looked at support for the Affordable Care Act’s pre-existing condition regulation. Out of the 2,498 Americans questioned, 65% support this aspect of the ACA. However, when costs are introduced, support drops. Furthermore, wealthier Americans are more willing to entertain trade-offs than lower-income ones.

Thomas Sowell has written, “There are no solutions; there are only trade-offs.” What “most Americans” want depends on whether or not trade-offs are kept in the dark.

The Economic Consequences of Tariffs

From a recent IMF working paper:

We use impulse response functions from local projections on a panel of annual data spanning 151 countries over 1963-2014. The main analysis on aggregate data is complemented with industry-level data.

Our results suggest that tariff increases have an adverse impact on output and productivity; these effects are economically and statistically significant. They are magnified when tariffs are used during expansions, for advanced economies, and when tariffs go up. We also find that tariff increases lead to more unemployment and higher inequality, further adding to the deadweight losses of tariffs. Tariffs have only small effects on the trade balance though, in part because they induce offsetting exchange rate appreciations. Finally, protectionism also leads to a decline in consumption; this, together with our findings, suggests that tariffs are bad for welfare.

All this seems eminently sensible and bolsters the arguments that mainstream economists make against tariffs; our results can be regarded as strong empirical evidence for the benefits of liberal trade. And given the current global context, we take special note of the negative consequences when advanced economies increase tariffs during cyclical upturns (pg. 25-26).

Does Populism Reduce Economic Inequality?

The above comes from a recent study of The New Populism project. This reduction in economic inequality may lead some populist supporters to feel vindicated. However, the study continues by pointing out that “the fiscal policies of populists are less progressive than non-populists. This is what we might have expected; they are not reducing inequality as a result of government taxation or welfare structures.” The mechanism remains unknown, “maybe minimum wage policies, maybe moves towards formalization of the labour force, or limits on income generation of the very wealthy (or even possibly in the case of Venezuela, the very wealthy leaving, thereby reducing overall levels of market inequality). But they do reduce overall levels of market inequality” (pg. 5).

However, this isn’t the only effect of populists:

  • Populist leaders increase indirect (regressive) taxation.
  • Populism has no real impact on corruption, despite corruption often bringing populists to power.
  • “[P]opulist chief executives are more likely to infringe on the freedom and fairness of the electoral process than their non-populist counterparts” (pg. 14).
  • “[B]oth right and left populist chief executives seem more likely to embark on a mission to cut back on civil liberties” (pg. 15).
  • “We confirm a strong, negative effect of populism on press freedom. Not every decline can be attributed to populists, but almost every strong or moderate populist registers some decline” (pg. 17).
  • “Finally, populism in government is often associated with the centralization of power under the chief executive” and the erosion of executive constraints (pg. 18-19).


So giving power over to populist authoritarians who undermine democratic institutions and civil liberties is one successful avenue to economic equality. The others, according to historian Walter Scheidel, are “mass-mobilization warfare, violent and transformative revolutions, state collapse, and catastrophic epidemics. Hundreds of millions perished in their wake, and by the time these crises had passed, the gap between rich and poor had shrunk.”

What Was the Cost of Trump’s Trade War in 2018?

A new working paper confirms what economists have been saying about tariffs all along:

Economists have long argued that there are real income losses from import protection. Using the evidence to date from the 2018 trade war, we find empirical support for these arguments. We estimate the cumulative deadweight welfare cost (reduction in real income) from the U.S. tariffs to be around $6.9 billion during the first 11 months of 2018, with an additional cost of $12.3 billion to domestic consumers and importers in the form of tariff revenue transferred to the government. The deadweight welfare costs alone reached $1.4 billion per month by November of 2018. The trade war also caused dramatic adjustments in international supply chains, as approximately $165 billion dollars of trade ($136 billion of imports and $29 billion of exports) is lost or redirected in order to avoid the tariffs. We find that the U.S. tariffs were almost completely passed through into U.S. domestic prices, so that the entire incidence of the tariffs fell on domestic consumers and importers up to now, with no impact so far on the prices received by foreign exporters. We also find that U.S. producers responded to reduced import competition by raising their prices.

Our estimates, while concerning, omit other potentially large costs such as policy uncertainty as emphasized by Handley and Limão (2017) and Pierce and Schott (2016). While these effects of greater trade policy uncertainty are beyond the scope of this study, they are likely to be considerable, and may be reflected in the substantial falls in U.S. and Chinese equity markets around the time of some of the most important trade policy announcements (pg. 22-23).