Month: November 2011

TGS for Britain

Britons will be worse off in 2015 than they were in 2002 as the nation grapples with a severe squeeze on living standards, the Institute for Fiscal Studies said on Wednesday.

Slow income growth before the downturn, the depth of the recession and the sluggishness of the recovery have combined to create easily the longest period of stagnation in real incomes since records began in 1961.

That is from the FT, via Michael Rosenwald.

The velocity of collateral

From a new paper (pdf) by M. Singh:

Using hand collected data, this paper shows that, post-Lehman, two effects have occurred: overall collateral availability has declined, and the intermediation chains have become much shorter.

The paper argues that a decline in the velocity of collateral is similar in some ways to a decline in the velocity of money.  Here is a related article (FT$).  These are not fun or easily digestible pieces, but they are good background reading for a deeper understanding of how money markets have changed and why there is still some risk they might break down.

CEOs and Marginal Product

I think Tyler is being unnecessarily opaque in his two posts (here and here) on CEO pay and marginal product.

Contra Tyler, it is, of course, perfectly reasonable to compare a CEO with his or her likely replacement. Board of Directors do this all the time. If the Board finds that revenues would be the same with a new CEO the theory doesn’t say that the current CEO should get a zero wage (as Tyler oddly suggests). It says that the current CEO should not be paid more than the wage necessary to hire the replacement. If the current CEO is paid more, he may be out a job. If the current CEO is paid less, he may move.

Tyler argues that CEOs are paid far too little (less than 1% of their marginal product). I say that as a result of the process described above CEOs are paid more or less their marginal product on average. Indeed, according to one astute writer, Gabaix and Landier find that replacing “replacing the No. 250 chief executive with the No. 1 will increase the value of the company by only 0.014 percent.” More or less means that principal agent problems, risk aversion and uncertainty also matter but they matter within a range determined by the usual process. I also believe that the case for some CEOs being overpaid because they choose friendly board members is far stronger than Tyler’s case that CEOs on average are radically underpaid.

Addendum: Tyler’s points about tax incidence are well taken and need not rely on an underpayment argument.

What is the marginal product of a CEO?

If you read carefully my post from yesterday, you may have noticed what a tricky question this is. “CEO” of course is a discrete position, and while there are companies with “zero” or “two” CEOs, those comparisons are not the correct ones to define marginal product; in any case they would give you two very different numbers.

Nor is it correct to compare “this CEO” to “his likely replacement.”  That difference could be zero, but it does not mean the CEO adds zero value or will or should receive zero pay.  Keep in mind that we are already juggling a few margins here, including “getting this CEO to work harder or better” and “this CEO vs. another.”

Alternatively, imagine there are ten firms in the economy, of differing size and import, all bidding for managers in a pool of fifty people.  A credible CEO offer has to satisfy a participation constraint, namely getting the candidate to take the job over CEO at a lesser firm or working in a lesser job.  But if a CEO can add 50 percent of value to a firm, that CEO will not in general be paid fifty percent of the firm’s value and need not be paid anything close to that.  The shareholders know he will take the job for less and there are other candidates who might add forty-seven percent of value.  The firm can make a credible offer of “two percent of value added” and it might be accepted.

Unlike hiring widget-makers for “less than their marginal product,” there is no subsequent disruption of equilibrium which must follow from this apparent disjunction of CEO pay and marginal product.  For instance there is no firm-level incentive to further expand output or hire extra CEOs.  There is one discrete slot, a wide range of potential compensation values, and the final sum is set by a bargain, determined by the context of principal-agent theory.

CEOS who can add so much value will try to start and grow their own firms, holding lots of equity from the very beginning, as Mark Zuckerberg has done.  Those CEOs will indeed be paid something like their traditional marginal product, but they are a distinct minority and wealth and risk constraints limit their number.

In general, it is confusing to suggest that CEOs will be paid their marginal product.  The traditional notion of marginal product does not apply to a CEO in the simple “widgets per worker” way.  There are ways you can define “marginal product” to make the claim “CEOs are paid their marginal product” more or less true, but that is not my preferred way forward.  Instead we should get more used to thinking intuitively within the principal-agent model, even though it is harder to do.

Did “race” cost Obama many votes?

Seth Stephens-Davidowitz, job market candidate from Harvard, has an interesting paper on this question:

Abstract: Traditional surveys struggle to capture socially unacceptable attitudes such as racial animus. This paper uses Google searches including racially charged language as a proxy for a local area’s racial animus. I use the Google-search proxy, available for roughly 200 media markets in the United States, to reassess the impact of racial attitudes on voting for a black candidate in the United States. I compare an area’s racially charged search volume to its votes for Barack Obama, the 2008 black Democratic presidential candidate, controlling for its votes for John Kerry, the 2004 white Democratic presidential candidate. Other studies using a similar empirical specification and standard state-level survey measures of racial attitudes yield little evidence that racial animus had a major impact in recent U.S. elections. Using the Google-search proxy, I find significant and robust effects in the 2008 presidential election. The estimates imply that racial animus in the United States cost Obama three to five percentage points in the national popular vote in the 2008 election.

The question and method of this paper are excellent.  I cannot in polite company reproduce the Google key word used to proxy for negative attitudes about Obama.  What Google key word might you try if you were looking for districts were the race factor boosted his vote total?  Laredo, Texas is the area with the least interest in the negative search word, but I am not sure that is the best proxy for “support because of race.”  (See the author’s p.19 for a discussion of related topics.)  How about searches for the title of his autobiography?

Page 29 ranks the states by their interest in “racially charged searches.”  West Virginia is the worst, Utah is the best, and Pennsylvania and Michigan and New Jersey are the worst northern states, coming in at #3, #6 and #10, respectively.  The graphs and charts at the end of the paper are all interesting, including p.36.

Addendum: You might think I got the pointer from @RovingBandit, but actually the paper led me to him rather than vice versa.

Melissa Dell on trafficking networks and the Mexican drug war

This is the abstract, from a very smart and brave woman:

Drug trade-related violence has escalated dramatically in Mexico during the past five years, claiming 40,000 lives and raising concerns about the capacity of the Mexican state to monopolize violence. This study examines how drug traffickers’ economic objectives influence the direct and spillover effects of Mexican policy towards the drug trade. By exploiting variation from close mayoral elections and a network model of drug trafficking, the study develops three sets of results. First, regression discontinuity estimates show that drug trade-related violence in a municipality increases substantially after the close election of a mayor from the conservative National Action Party (PAN), which has spearheaded the war on drug trafficking. This violence consists primarily of individuals involved in the drug trade killing each other. The empirical evidence suggests that the violence reflects rival traffickers’ attempts to wrest control of territories after crackdowns initiated by PAN mayors have challenged the incumbent criminals. Second, the study accurately predicts diversion of drug traffic following close PAN victories. It does this by estimating a model of optimal routes for trafficking drugs across the Mexican road network to the U.S. When drug traffic is diverted to other municipalities, drug trade-related violence in these municipalities increases. Moreover, female labor force participation and informal sector wages fall, corroborating qualitative evidence that traffickers extort informal sector producers. Finally, the study uses the trafficking model and estimated spillover effects to examine the allocation of law enforcement resources. Overall, the results demonstrate how traffickers’ economic objectives and constraints imposed by the routes network affect the policy outcomes of the Mexican Drug War.

The link to her papers — all of which look interesting — is here.  She is currently on the job market from MIT, and I will be serving up some further posts on a few of the more interesting job market papers this year.  The original pointer is from Chris Blattman.

Here is a good summary and discussion from Ray Fisman:

Dell conjectures—based on anecdotal evidence about the drug war—that police efforts tend to weaken a cartel’s grip on a town just enough that competing traffickers see an opening to come in and fight for control of the town. Indeed, when a rival cartel controls a neighboring town, the effect of a PAN win on the drug-related homicide rate is several times higher.


Drug confiscations in the communities where Dell predicts traffickers will relocate to following a crackdown increase by about 20 percent in the months following close PAN victories. It’s a reminder that crime fighting is a bit like Whac-A-Mole—smothering traffickers’ activities in one locale merely causes them to shift their operations elsewhere. Dell finds that drug-related homicides also go up in places that her model predicts will lie on traffickers’ new paths from Mexican drug labs to the U.S. border.

Some progress in Haiti

Haiti backers heralded some good news Monday for the earthquake ravaged Haiti: 44 miles of newly asphalted road, a new 605-acre industrial park in the north that will attract 65,000 jobs and a marquee hotel brand [Marriott].

“This is a very special day. It is truly a day of change,” Luis Alberto Moreno, the head of the Inter-American Development Bank said Monday.

The bank, which invests hundreds of millions of dollars in Haiti, is sponsoring a two-day investment forum in Port-au-Prince beginning Tuesday. So far, 1,000 people have registered, 500 of them business people from 29 countries.

Here is more and I thank B. for the pointer.

From the comments (pleasing David Wright)

There seem to be an awful lot of arguments floating around the economic blogosphere lately that try to use “credibility” as a kind of magic trick to claim that some institution can get some desired result without having to do the yucky things it would have to do to, you know, actually get that result. I would love to see a post on this topic from our host.

That was from David Wright…and now he has his post.

Eurozone puzzles from Karl Smith

Some odd key facts though:

  • German Bunds trade below the deposit facility rate at the ECB and well below the Overnight Rate. I tell my students that this can’t happen. But, it is happening.
  • Auctions for Sovereign debt are not only over-subscribed but more over-subscribed as the yields rise. Implying that the appetite for debt increases as the yield does. This makes sense if you are planning to Repo the bond. What doesn’t make sense is why this doesn’t drive down the actual yield
  • Generally speaking there is enormous divergence in at the short end of Sovereign Debt curve and its not clear what theory of the world supports this.

p.s. None of these are good news!  Here is further comment, very useful.

Small samples mean statistically significant results should usually be ignored

Size really matters: prior to the era of large genome-wide association studies, the large effect sizes reported in small initial genetic studies often dwindled towards zero (that is, an odds ratio of one) as more samples were studied. Adapted from Ioannidis 2001 et al., Nat Genet 29:306-309.

Genomes Unzipped: In October of 1992, genetics researchers published a potentially groundbreaking finding in Nature: a genetic variant in the angiotensin-converting enzyme ACE appeared to modify an individual’s risk of having a heart attack. This finding was notable at the time for the size of the study, which involved a total of over 500 individuals from four cohorts, and the effect size of the identified variant–in a population initially identified as low-risk for heart attack, the variant had an odds ratio of over 3 (with a corresponding p-value less than 0.0001).

Readers familiar with the history of medical association studies will be unsurprised by what happened over the next few years: initial excitement (this same polymorphism was associated with diabetes! And longevity!) was followed by inconclusive replication studies and, ultimately, disappointment. In 2000, 8 years after the initial report, a large study involving over 5,000 cases and controls found absolutely no detectable effect of the ACE polymorphism on heart attack risk.

The ACE story is not unique to the ACE polymorphism or to medical genetics; the problem is common to most fields of empirical science. If the sample size is small then statistically significant results must have big effect sizes. Combine this with a publication bias toward statistically significant results, plenty of opportunities to subset the data in various ways and lots of researchers looking at lots of data and the result is diminishing effects with increasing confidence, as beautifully shown in the figure.

For more see my post explaining Why Most Published Research Findings are False and Andrew Gelman’s paper on the statistical challenges of estimating small effects.

Addendum: Chris Blattman does his part to reduce bias. Will journal editors follow suit?

Are CEOs paid their value added?

Remember Paul Krugman’s forays into “the wage reflects what the top earners are really worth” topic, and the surrounding debates?  Why should this discussion be such a fact-free zone?  Why so little discussion of tax incidence?

Let’s start with the literature.

Read this paper by Kevin Murphy (pdf), especially pp.33-38.  Admittedly the paper is from 1999 and it won’t pick up the more recent problems with the financial sector.  But most of the data are from plain, ol’ garden variety CEOs.  In many of the estimations we see CEOs picking up less than one percent of the value they create for the firm, and all of the estimates of their value capture are impressively small, albeit rising over time.  Never is the percentage of value capture anything close to one hundred percent.  “One percent value capture” is an entirely plausible belief.

You might think this sounds whacky but it makes theoretical sense.  For instance often CEO performance is motivated by equity and options, but few CEOs are wealthy enough to own more than a very small chunk of the company (risk-aversion may be a factor too), and that will mean their pay won’t reflect value created at the margin.  It’s a standard result of agency theory, stemming from first principles.

Maybe you’re suspicious of this work but the way these estimates are done is quite straightforward, and results of this kind have not been overturned.  You can formulate a “pay isn’t closely enough linked to performance” critique from these investigations, but not a “they’re paid as much as they contribute” conclusion or anything close to that.  (And, if it matters, the “conservative” and also WSJ Op-Ed page view has embraced these results for almost two decades, at least since the original Jensen-Murphy JPE piece; Krugman identified the conservative position with the Clarkian perfect competition w = mp stance but that is incorrect.)

You might be thinking “Ha!  Burn on Krugman!,” but not so fast.  Like Wagner’s music, Krugman’s position here is “better than it sounds,” though not nearly as strong as Krugman would like it to be.

Let’s turn to taxation of the top 0.1 percent, and focus on these CEOs.  If the tax rate on their income/K gains goes up, the firm will compensate by giving them more equity/options, to keep them working hard.  In other words, the tax rate on the top earners can be hiked without much effect on CEO effort because there is an offset internal to the firm.  At some margin the firm’s shareholders will be reluctant to chop off more equity/options to the CEO, but the marginal value created by maintaining the incentive seems to be very high, for reasons presented above, and so the net CEO incentives will be maintained, even in light of new and higher taxes on CEO earnings.

But here’s the problem, if that’s the right word.  The incidence of that tax is going to fall on shareholders in general and thus on capital in general.  These top CEOs could even get off scot-free, if the shareholders up the equity/options participation of the CEO to offset completely the effects of the new and higher tax rate.  This is also relevant to the Piketty-Saez-Stantcheva analysis that everyone has been talking about; they don’t see these mechanisms with sufficient clarity.

Moral of the story: it’s harder to tax the top earners than you think.

The second moral is that tax incidence remains a neglected topic, even among top economists.

The third moral is that too many people, including both Krugman and his critics on this point, have been neglecting the literature.

By the way, other assumptions can be made and other results generated, but I am focusing on one of the core cases.

First independent look at the Millennium Village project

You will find it summarized here, excerpt:

Working on her own, without the collaboration or endorsement of the MVP, Kenyan economist Bernadette Wanjala of Tilburg University collected data on households in or near the site at Sauri, Kenya, where the project was launched in 2005. She interviewed 236 randomly-selected households that had been exposed to the MVP’s large package of agriculture projects, education programs, infrastructure improvements, and health/sanitation works. She also interviewed 175 randomly-selected households from an area of the same district (called Gem) that was not exposed to the intervention. She wanted to compare the two groups to see for herself whether or not the project had done what it promised: to lift the treated households out of poverty in a few years’ time and spark “self-sustaining economic growth”.

In their just-released paper, Wanjala and her colleague Roldan Muradian of Radboud University use the new survey data to measure the project’s impact on poverty. They carefully compare treated and untreated households that were otherwise similar in many ways—such as household composition, adults’ education, fertility, economic sector, and land holdings. Because this project is large and intensive, spending on the order of 100% of local income per capita, it is reasonable to hope that it might substantially raise recipients’ incomes, at least in the short term.

Wanjala and Muradian find that the project had no significant impact on recipients’ incomes.

How is this possible? While Wanjala and Muradian find that the project caused a 70% increase in agricultural productivity among the treated households, tending to increase household income, it also caused less diversification of household economic activity into profitable non-farm employment, tending to decrease household income. These countervailing effects are precisely what one might expect from a large and intensive subsidy to agricultural activity. On balance, households that received this large and intensive intervention have no more income today than households that did not receive the intervention.

I would gladly publish or link to a response from Sachs or others at MVP.