When the facts change, I change my mind

About a year ago, I illustrated the standard debt-sustainability calculations with the case of Greece. If you plug in plausible numbers for growth, for interest rates, and for the debt stock, you get to a need for fiscal adjustment that is frightening. Indeed, it is so large – compared to, say, the fiscal tightening that undid the Weimar Republic – that one had to say “no way”. The necessary swing in the fiscal balance – from primary deficit to surplus – was around 10% of GDP.

Now, I am starting to think that this may not be mission impossible after all. The reason? It’s not what you think. For a while, much of the profession and, to a surprising degree, policy-makers seemed to have decided that the Alesina et al. view of fiscal adjustment was right – that you can cut yourself back to growth. The IMF has done some painstaking work last year, and this argument now looks pretty doubtful.

However, there is another story that can create a bit more hope. There is no question that countries that tax more are richer. Any scatterplot shows correlation is strong. Is it causal? Recent work by Besley and Persson says so. They look at the part of variation in tax capacity that can be explained by the history of military conflict after 1816. States with a history of lots of (expensive) wars still tax more; and that part of the variation is also strongly associated with being richer. Now, Dincecco and Prado (2010) have a new working paper in which they show that the number of battle deaths in the early modern period is also a good predictor of the taxman’s take today – and that this also explains how rich a country is. This strongly suggests that the link is causal – taxation is good for you.

Why? A lot of economics implies that high taxes should be bad. Disincentives for work and entrepreneurial activity are large; a bloated state is as likely as not to waste precious tax dollars. And yet, taxes also generate benefits. Besley and Persson show that capital markets work much better in countries where the government is more capable overall – enforcing laws, investing in education, building infrastructure, protecting property rights, ensuring that debts are collected. All of this costs money. Also, high tax revenue mostly means that everyone pays. The more uneven the tax burden, the lower the overall yield is likely to be. That would also imply that a high tax take is often associated with FEWER distortions.

It’s these kind of distortions in the PIIGS experiencing problems today that seem to suggest that maybe, there is a silver lining to the issue of excessive debts. In countries like Greece, Spain, and Portugal, the self-employed effectively escape taxation on a staggering scale. Many transactions take place with black money. Buying a house is often akin to a scene from a Hollywood gangster film – the buyer first goes to his or her bank, and exits with a suitcase full of cash. The cash is then exchanged at the notary’s office, before being paid in again by the seller. None of it is declared to the authorities. This is not some occasional, half-criminal type of transaction – this is the norm for house buyers today, in a Southern European EU country I know well. Taxation is hence not just too low relative to debt; it is also highly uneven, and hence, distortionary. For example, you end up with an awful lot of people working in property who should be working elsewhere.

As Spain, Greece, and Portugal, desperate to plug their fiscal holes, are scrambling to find fresh funds, they will have to go after the areas of the economy they have largely far left alone – such as construction, property transactions, and the self-employed. Many of the citizens that should, by rights, have been working in large companies in the taxed part of the economy are today working in the self-employed sector; only tax fraud makes this worthwhile, since it compensates for the low productivity of their labor. As that gap narrows, overall output will increase, and the tax take will rise. In the short term, austerity may spell hard times for the Club Med and Ireland. And yet, tax reform done right may very well pay rich rewards, not just in terms of revenue, but also in terms of economic efficiency. Maybe, Greece can pull it off after all.

finally... a radio program I have been waiting for for over a decade

If you visit a British bookstore, you can find the European history corner by looking for a monumental collection of swastikas on the shelves... It used to amuse me as a student in Oxford, and then became a curiosity. A normal weekend in the UK will include some re-run of a World War II movie, a documentary about the last Spitfire pilot alive, and a few book reviews in the Sunday papers. Apparently, 850 books on the Third Reich were published in the UK in 2010 alone, including one on Collectible Spoons of the Third Reich. Now, the BBC actually has a clever radio documentary about why this is - over here. It's pretty good, but I would say that - my own working hypothesis (Britain can't get enough of being reminded of the last time it was actually Great) gets a pretty strong endorsement. The journalist even gets close to spoofing my all-time I-hope-this-is-never-actually-written-title Hitler's Willing Gardeners.

First UPF doctoral candidate to go on the RES tour

The Economist recently profiled some interesting research showing that European output of scholarly articles was growing faster than that of US departments. Maybe Europe is also catching up in terms of producing PhDs? One swallow does not make a summer, but here is a nice leading indicator... even abstracting for the parental pride factor.

The Review of Economic Studies does a nice thing - every year, it brings seven of the most promising young PhD students who did well on the US academic market over to Europe, where they give seminars at a number of universities. This year, my doctoral student Peter Koudijs  will join the RES tour. If I am not mistaken, he is the first UPF doctoral candidate to do so. This is not a small thing - it's equivalent to semi-official confirmation that you were a star of the market in a particular year. What makes this particularly nice is that,  until now, there were only a handful of Europeans (meaning, economists with doctorates from European schools) who were on the RES tour until now (Dave Donaldson, now at MIT, and Markus Brunnermeier, now at Princeton, come to mind). Before he goes, he will have to make a decision on where to start his career as an assistant professor, having received a string of top offers, from NWU-Econ and Chicago-Booth to Stanford GSB, LSE-EcHist, and Columbia GSB.

Persistence over the very long run.

I am over at Harvard for a few days, giving a talk tomorrow. Nico Voigtländer and I have a bunch of papers on the long-run consequences of the Black Death. Since I have done some other work on Nazi Germany, one day, we wondered if there wasn't a parallel between the two periods worth exploring. As the plague sweeps through Europe, causing unprecedented mortality, people look for causes - and many blame the Jews for poisoning the wells. In many - but not all - towns and cities in Europe, the Jewish population is brutally murdered in 1348-50. We were wondering if there is some logic to the geographical pattern of violence - and in particular, if we can find the same pattern in the 20th century. It turns out that there seems to be a huge degree of persistence - areas where Jews were burned in the 14th century were much more antisemitic in the 20th. Here is the abstract of our paper [download HERE]:

Persecution Perpetuated: The Medieval Origins of Anti-Semitic Violence in Nazi Germany
How persistent are cultural traits? This paper uses data on anti-Semitism in Germany and finds continuity at the local level over more than half a millennium. When the Black Death hit Europe in 1348-50, killing between one third and one half of the population, its cause was unknown. Many contemporaries blamed the Jews. Cities all over Germany witnessed mass killings of their Jewish population. At the same time, numerous Jewish communities were spared these horrors. We use plague pogroms as an indicator for medieval anti-Semitism. Pogroms during the Black Death are a strong and robust predictor of violence against Jews in the 1920s, and of votes for the Nazi Party. In addition, cities that saw medieval anti-Semitic violence also had higher deportation rates for Jews after 1933, were more likely to see synagogues damaged or destroyed in the Night of Broken Glass in 1938, and their inhabitants wrote more anti-Jewish letters to the editor of the Nazi newspaper Der Stürmer.

With this, we are trying to contribute to the burgeoning literature on the long-run persistence of culture. Guiso, Sapienza and Zingales found that Italian cities with a history of independence had higher rates of trust and income even today; Jha shows that Indian cities with a mercantile past show less violence between Hindus and Muslims over a horizon of 300 years. Relative to these papers, we show a) persistence over a much longer horizon b) the survival of a pure cultural trait without obvious economic benefit, especially since Jews largely vanished from Germany after 1500.

*** Jonathan Haskel, whose intellectual judgement I hold in high esteem, actually called our results "the most amazing correlation he has ever seen". The title of his post? "Are the experts wrong?" ;-)

I should be more careful what I work on...

you see, first I worked on (historical) bubbles, and then NASDAQ blew up... then I did research on the sovereign debt defaults, and Greece imploded. In the fall, for a conference at the Bank of Chile, I did a paper on social and political unrest - assassinations, riots, anti-government demonstrations, violent overthrows of the government... and look what we get in the Middle East. The pejorative term for scholars changing research focus as events unfold is "intellectual ambulance chasers"... but what is this? A reverse Midas touch? At any rate, for a sample of South American countries, I looked at what drove levels of unrest. In particular, I show that budget cuts have a strong effect on the likelihood of instability - over and above the effects of an economic downturn. Here is a link and the abstract:

Efforts at fiscal consolidation are often limited because of concerns over potential social unrest. From German austerity measures during the 1930s to the violent demonstrations in Greece in 2010, hard times have tended to go hand in hand with antigovernment violence. In this paper, I assemble cross-country evidence from eleven South American countries for the period 1937 to 1995 about the extent to which societies become unstable after budget cuts. The results show a clear positive correlation between austerity and instability. I examine the extent to which this relationship simply captures the fact that fiscal retrenchment and economic slumps are correlated, and conclude that this is not what is driving the effect. Finally, I test for interactions with various economic and political variables. While autocracies and democracies show a broadly similar response to budget cuts, countries with a history of stable institutions are less likely to see unrest as a result of austerity measures.

The paper will be out later in the year in a volume edited by Jordi Gali and Luis Felipe Céspedes. Right now, with a doctoral student from UPF, Jacopo Ponticelli, I am working on a related paper to see how much of this holds over the long run in a wider set of countries.

ITFD => Yale PhD program

One of our graduates, Moritz Lenel (ITFD 2010) just got admitted to the Ph.D. program at the Yale Economics Department. All the faculty in our program thought very highly of him, and he really hit some impressive home runs when a student here. Remarkably, in addition to being an academic star, he is also a genuinely nice guy, and I think our letters reflected that! Of course, we are enormously pleased that the admissions committee at Yale did the right thing, and I would bet real money that some other top schools will follow suit. This is also great news for the program, since it shows that the training here is actually pretty decent preparation for entry into highly competitive doctoral programs in economics...

*** March 10 update **** Moritz also got into Stanford, and is waitlisted at Harvard and MIT. Congratulations again, and fingers crossed...

After you, please (it's only a matter of life and death)

Bruno Frey and friends have written a wonderful piece in the Journal of Economic Perspectives on who survived on the Titanic. They argue that social norms (women and children first) and class explain survival well. Being British, on the other hand, was bad for your chances to make it -- the downside of too much civilized queuing up...