Working Papers

Authors: Chloe Qianzi Zeng

Nov 2012


This paper studies a marriage market with two-sided information asymmetry in which
the gains from marriage are stochastic. Contracts specify divisions of ex-post realized
marital surplus. I first study a game in which one side of the matching market offers
contracts. I show that when expected marital surplus is strictly monotonic in agents

JEL Codes: C78, D82, J12, D13

Keywords: Matching, two-sided information asymmetry, endogenous sharing rule, marriage market, stochastic marital surplus

Reference: 630

Individual View

Authors: Rick Van der Ploeg

Nov 2012

The political economy of natural resource extraction is analysed in three different contexts. First, if an incumbent faces a threat of being removed once and for all by a rival faction, extraction becomes more voracious, especially if the rebel faction shares rents much more than the incumbent. Second, perennial political conflict cycles are more inefficient if cohesiveness of the constitution or the partisan in-office bias is large and political instability is high. Third, resource wars are more intense if the political system is less cohesive, there is a partisan in-office bias of the incumbent, oil reserves are high, the wage is low, governments can be less frequently removed from office, and fighting technology has less decreasing returns to scale. Resource depletion in such wars is more rapacious if there is more government instability, the political system is less cohesive, and the partisan in-office bias is smaller.

JEL Codes: D81, H20, Q31, Q38

Keywords: political conflict; cohesiveness; partisan bias; dynamic resource wars; contests; rapacious depletion; exploitation investment; hold-up problem

Reference: 97

Individual View

Authors: Margaret Stevens

Nov 2012

Vocational training systems differ markedly between countries. A model of firm-based human capital investment predicts equilibria characterised by particular patterns of training and job-to-job mobility, consistent with observed cross-country differences. Incentives to invest in human capital are determined jointly with labour turnover and the intensity of competition between employers for skilled workers, and the dependence of labour market conditions on human capital leads to strategic complementarity between training decisions. Depending on the extent of market frictions and match heterogeneity, we may expect to see either equilibria characterised by general training, steep wage profiles and high mobility; or equilibria in which both general and specific investment may occur, but turnover is low and wage profiles are relatively flat. Multiple equilibria are possible, in which case high turnover equilibria generate higher welfare.  

JEL Codes: J24, J63

Keywords: Human capital, labor turnover, specific training, general training, search, matching

Reference: 629

Individual View

Authors: Donna Harris, Benedikt Herrmann, Andreas Kontoleon

Nov 2012

Using a laboratory experiment with minimal groups, we examined the extent to which the threats of costly punishments affect in-group favouritism behaviour. We studied three types of punishment separately: in-group, out-group, and third-party punishments. In line with previous studies, the majority of the allocators favoured their own group by allocating more money to each of the in-group members at the expense of the out-group in the baseline without punishment. In the in-group punishment treatment, we observed a slight increase in in-group favouritism behaviour. On the contrary, when only the out-group could punish the allocators, there was a significant drop in in-group favouritism behaviour as well as an increase in the equal division option. Finally, when faced with an independent third-party punisher the allocators continued to favour their own group. The threat of third-party punishment appeared to have no effect on their decisions. Our paper contributes to the literature on in-group favouritism and the nature of social norms by showing that the decision whether to favour one

JEL Codes: D70, D73, C92

Keywords: In-group favouritism, Group behaviour, Social identity, Social norm, In-group punishment, Out-group punishment, Third-party punishment, Favour game

Reference: 628

Individual View

Authors: Robert Metcalfe, John Feddersen, Mark Wooden

Nov 2012

We investigate the impact of short-term weather and long-term climate on self-reported life satisfaction using panel data. We find robust evidence that day-to-day weather variation impacts life satisfaction by a similar magnitude to acquiring a mild disability. Utilizing two sources of variation in the cognitive complexity of satisfaction questions, we present evidence that weather bias arises because of the cognitive challenge of reporting life satisfaction. Consistent with past studies, we detect a relationship between long-term climate and life satisfaction without individual fixed effects. This relationship is not robust to individual fixed effects, suggesting climate does not directly influence life satisfaction. 

JEL Codes: Q51, C23, C81, C83

Keywords: Life satisfaction, Subjective well-being, Climate change, Weather

Reference: 627

Individual View

Authors: Niko Jaakkola

Oct 2012

Mitigating climate change by carbon capture and storage (CCS) will require vast infrastructure investments. These investments include pipeline networks for transporting carbon dioxide (CO2) from industrial sites ('sources') to the storage sites ('sinks'). This paper considers the decentralised formation of trunk-line networks when geological storage space is exhaustible and demand is increasing. Monopolistic control of an exhaustible resource may lead to overinvestment and/or excessively early investment, as these allow the monopolist to increase her market power. The model is applied to CCS pipeline network formation in northwestern Europe. The features identi ed above are found to play a minor role. Should storage capacity be effectively inexhaustible, underinvestment dueto the inability of the monopolist to capture the entire social surplus is likely to have substantial welfare impacts. Multilateral bargaining to coordinate international CCS policies is particularly important if storage capacity is plentiful.

JEL Codes: L50, Q31, Q58

Keywords: carbon capture and storage, exhaustible resources, network formation,spatial networks

Reference: 98

Individual View

Authors: Niko Jaakkola

Oct 2012

I develop a differential game between an oil cartel, and an importer investing in R&D to reduce the cost of a substitute to oil. The equilibrium dynamics mirror the recent oil price collapse: prices first increase, but eventually fall as the cartel is forced to deter unconventional (shale) oil. Interpreting the substitute as clean energy, I assess future climate policy. Credible carbon taxes are below the Pigovian level, implying the importer certainly cannot capture resource rents. Without a tax instrument, the importer curtails long-run pollution using a costly R&D programme. Normatively, carbon taxes are necessary to tackle climate change efficiently.

JEL Codes: D42,O32,Q31,Q40,Q54

Keywords: exhaustible resources, OPEC, oil prices, alternative fuels, limit

Reference: 99

Individual View

Authors: Gregg Huff, Shinobu Majima

Oct 2012

This paper analyzes how Japan financed its World War II occupation of Southeast Asia, the transfer of resources to Japan, and the monetary and inflation consequences of Japanese policies. In Malaya, Burma, Indonesia and the Philippines, the issue of military scrip to pay for resources and occupying armies greatly increased money supply. Despite high inflation, hyperinflation hardly occurred because of a sustained transactions demand for money, because of Japan’s strong enforcement of monetary monopoly, and because of declining Japanese military capability to ship resources home. In Thailand and Indochina, occupation costs and bilateral clearing arrangements created near open-ended Japanese purchasing power and allowed the transfer to Japan of as much as a third of Indochina’s annual GDP. Although the Thai and Indochinese governments financed Japanese demands mainly by printing large quantities of money, inflation rose only in line with monetary expansion due to money’s continued use as a store of value in rice-surplus areas.

Keywords: War, Financial and macroeconomic crises, Resource transfer, Occupation costs, Bilateral clearing arrangements, Seigniorage, Hyperinflation, Greater East Asia Co-Prosperity

Reference: 109

Individual View

Authors: James Fenske

Oct 2012

Although Nigeria’s Benin region was a major rubber producer in 1960, the industry faltered before 1921. I use labour scarcity and state capacity to explain why rubber did not take hold in this period. The government was unable to protect Benin’s rubber forests from over-exploitation. Plantations found it difficult to recruit workers, and the government was unwilling to allow expatriates to acquire land. Colonial officials promoted the development of “communal” plantations, but these suffered due to labour scarcity and a state that was short on staff and equipment, and dependent on local chiefs. 

Reference: 108

Individual View

Authors: James Fenske

Oct 2012

At the start of the Second World War, British policies restricted rubber planting in Nigeria’s Benin region. After Japan occupied Southeast Asia, Britain encouraged maximum production of rubber in Benin. Late in the war, officials struggled with the planting boom that had occurred. The war was a period of both continuity and change. Producers gained experience and capital. Forestry policies restricting planting survived, and output quality continued to occupy officials after the war. The colonial state was hindered by a lack of knowledge and resources, and by its pursuit of conflicting objectives in giving incentives to both producers and traders. 

Reference: 107

Individual View

Authors: Kevin Hjortshøj O'Rourke

Oct 2012

This chapter provides a brief introduction to the history of Britain’s engagement with the international economy between 1870 and 2010. It begins by discussing long run trends in the integration of the British economy with the rest of the world over time. Economic historians are typically interested in four types of flows between economies: trade in goods and services; flows of capital; migration flows; and flows of ideas and technology. The last flow is probably the most important one for countries hoping to catch up to the international technological frontier. While this was not the right way to characterise the British economy in 1870, it probably was at various points after World War II. Unfortunately, such flows are also the most difficult to quantify, and so I follow the bulk of the literature in concentrating on trade, capital flows and migration. 

Reference: 106

Individual View

Authors: Arthur Downing

Oct 2012

Participation in ‘friendly societies’ (or other cooperative organisations) is often used as proxy for measuring the stock of social capital. This is too simplistic. Friendly societies underwent radical changes over the nineteenth century and contemporaries regularly bemoaned that sociability, member participation and conviviality had been in steady decline over the second half of the century. This paper investigates the social relations between friendly society members. Part one looks at the importance of lynchpin ‘social capitalists’ in the functioning of lodges. Parts two and three examine how lodges generated social capital and how they relied on social network ties between members to function. Part four applies network analysis to proposition books to assess ‘intra’ lodge relationships between members. As friendly societies grew in size they became more business like. In turn the emphasis shifted from sociability and conviviality to insurance provision. In the process social capital was squandered, but the welfare function of these organisations was temporarily safeguarded.

Reference: 105

Individual View

Authors: H Peyton Young, Gabriel E. Kreindler

Oct 2012

The diffusion of an innovation can be represented by a process in which agents choose perturbed best responses to what their neighbors are currently doing.  Diffusion is said to be fast if the expected waiting time until the innovation spreads widely is bounded above independently of the size of the network.  Previous work has identified specific topological properties of networks that guarantee fast diffusion.  Here we apply martingale theory to derive topology-free bounds such that diffusion is fast whenever the payoff gain from the innovation is sufficiently high and the response function is sufficiently noisy.  We also provide a simple method for computing an upper bound on the expected waiting time that holds for all networks.  For the logit response function, it takes on average less than 80 revisions per capita for the innovation to diffuse widely in any network, when the error rate is at least 5% and the payoff gain (relative to the status quo) is at least 150%.  Qualitatively similar results hold for other smoothed best response functions and populations that experience heterogeneous payoff shocks.

JEL Codes: C72, C73

Keywords: Innovation diffusion, Convergence time, Local interaction

Reference: 626

Individual View

Authors: Aled Davies

Oct 2012

How far were monetary targets imposed on the post-1974 Labour Government by international and domestic financial markets enthused with the doctrines of ‘monetarism’? The following paper attempts to answer this question by demonstrating the complex and contingent nature of the ascent of British ‘monetarism’ after 1968. It describes the post-devaluation valorisation of the ‘money supply’ which led investors to realign their expectations with the behaviour of the monetary aggregates. The collapse of the global fixed-exchange rate regime, coupled with vast domestic inflationary pressures after 1973, determined that investors came to employ the ‘money supply’ as a convenient new measure with which to assess the ‘soundness’ of British economic management. The critical juncture of the 1976 Sterling crisis forced the Labour Government into a reluctant adoption of monetary targets as part of a desperate attempt to regain market confidence. The result was to impose significant constraints on the Government’s economic policymaking freedom, as attempts were made to retain favourable money supply figures exposed to the short-term volatility of increasingly-globalised and highly-capitalized financial markets.

Reference: 104

Individual View

Authors: Abi Adams

Oct 2012

This paper develops a revealed preference methodology for exploring whether time inconsistencies in household choice are the product of nonstationarities at the individual level or the result of individual heterogeneity and renegotiation within the collective unit.  An empirical application to household-level microdata highlights that an explicit recognition of the collective nature of choice allows the vast majority of household behaviour to be rationalised by theory that assumes preference stationarity at the individual level.  For our particular short panel data set, simply permitting limited intrahousehold heterogeneity in time preferences allows the choices of 98.4% of the sample to be rationalised by a model that assumes exponential discounting at the individual level.  We also find that couples characterized by lower divergece in spousal discount rates are older, more likely to have children and wealthier, which we take as indications of experiencing higher match quality.

JEL Codes: D11, D12, D13, C14

Keywords: Time consistency, Collective choice, Full efficiency, Renegotiation, Revealed preference

Reference: 625

Individual View

Authors: Mark Armstrong

Sep 2012

This paper discusses the incentive to bundle when consumer valuations are non-additive and/or when products are supplied by separate sellers.  Whether integrated or separate, a firm has an incentive to introduce a bundle discount when demand for the bundle is more elastic than the overall demand for products.  When separate sellers coordinate on a bundle discount, they can use the discount to relax competition, which can harm welfare.

JEL Codes: D11, D43, D82, D86, L13, L41

Keywords: Price discrimination, Bundling, Discrete choice, Oligopoly, Common agency

Reference: 624

Individual View

Authors: Rick Van der Ploeg, Armon Rezai, Cees Withagen

Sep 2012

In a calibrated integrated assessment model of Ramsey growth and climate change in the global economy we investigate the differential impact of additive and multiplicative global warming damages for both a socially optimal and business-as-usual scenario. Fossil fuel is available at a cost which rises as reserves diminish and a carbon-free backstop is supplied at decreasing cost. If damages are not proportional to aggregate production and the economy is along a development path, the optimal

carbon tax is smaller. The economy switches later from fossil fuel to the carbon-free backstop and leaves less fossil fuel in situ. By adjusting climate policy in this way there is very little difference on the paths for global consumption, output and capital, and thus very little difference for social welfare despite the higher temperatures. For all specifications the optimal carbon tax is not a fixed proportion of world GDP but must follow a hump shape.

JEL Codes: H21, Q51, Q54

Keywords: climate change, multiplicative damages, additive damages, integrated assessment models, Ramsey growth model, fossil fuel, carbon-free backstop

Reference: 93

Individual View

Authors: Raphael Espinoza

Sep 2012

GDP growth in the GCC has been considerably higher than in advanced economies or other oil exporters since 1986. The paper shows that the GCC countries have swiftly accumulated large stocks of physical capital but the population increase and the shift away from oil meant that capital intensity actually decreased or remained roughly constant. On the other hand, the efforts that have been made to improve human capital would have had positive effects on growth, though educational attainment remains below what is achieved by countries with similar levels of income. A growth accounting exercise suggests as a result that the development of Bahrain and Saudi Arabia was hampered by declining TFP, while TFP growth in Qatar and the U.A.E. would have been low. One potential explanation is that the kind of capital that has been accumulated in the region (aircraft, computer equipment, electrical equipment) is not fully productive because the labor force is not educated enough. The paper also discusses the lessons from the empirical growth literature for the GCC. The poor quality of institutions and the large size of government consumption, both of which are possible symptoms of a resource curse, could explain the disappointing TFP growth.

JEL Codes: O43; O53

Keywords: Gulf Cooperation Council; Growth Accounting; Middle East and North Africa; Resource Curse

Reference: 94

Individual View

Authors: Raphael Espinoza

Sep 2012

Public investment and subsidies are typically inefficient but in the GCC these are crucial engines of growth. Subsidies are also used to redistribute oil windfalls in the region, and the problem of a government that wants to „distribute‟ oil money is a problem fully symmetric to the one analyzed by Ramsey (1927) of optimal taxation. The second-best policy (when lump-sum transfers are not available) is to use subsidies across a wide range of goods (as opposed to the focus on energy chosen by the GCC). In addition, the „inverse‟ Ramsey model implies that commodities for which demand is least elastic to prices should be subsidized at higher rates. This suggests subsidizing basic needs at higher rates, in particular food, healthcare and education. In addition, when subsidies are very large, they create additional distortions because households prefer to queue for subsidies (e.g. public service jobs, subsidized mortgages in Saudi Arabia) rather than participate in private markets. As an example, we draw a model where recruitment of public servants can induce a large disincentive to take private sector positions and compute the conditions under which the disincentive is so strong that overall employment is actually decreased as public servants are being hired.

JEL Codes: Q32; Q38; O53

Keywords: Gulf Cooperation Council; Middle East and North Africa; Resource Curse

Reference: 95

Individual View

Authors: John Muellbauer

Sep 2012

In many countries, house prices are subject to boom/bust cycles and in some these are linked to severe economic and financial instability.  Overheating can have both a price and a quantity dimension, but it is likely that they are linked by common drivers.  However, much depends on the land-use planning regime which profoundly affects the supply response.  It is helpful to make the distinction between overshooting of house prices due to extrapolative expectations and 'frenzy', given fundamentals, and shifts in possibly fragile fundamentals.  The contribution of careful econometric modelling to estimating the effects of the former is demonstrated: central banks or other policy makers should institute quarterly surveys of house price expectations of potential housing market participants to help assess the first type of overshooting.  Assessing the fragility or otherwise of the economic fundamentals is more complex.  Credit supply conditions in the mortgage market are the 'elephant in the room'.  Without taking a credit conditions measure into account, one simply cannot understand the behaviour of house prices, housing debt and consumption in countries such as Australia, the UK, the US, South Africa or France or understand vulnerability of some economies to high levels of household debt.  Other financial and economic indicators of vulnerability are discussed, including high bank leverage ratios, high ratios of loans to deposits, debt, deficit and current account of ratios.  Models of early warning of financial and economic crises estimated on large country panels need to be quite complex, for example, including some important interaction effects since shock transmission is very institution dependent.

JEL Codes: R21, R31, G18, G21, E21, E51, C51, C52

Keywords: Financial crisis, Financial accelerator, House price determination, Credit boom, Credit standards, Subprime mortgages, User cost, Risk premia, Construction boom

Reference: 623

Individual View

Authors: John Muellbauer, John Duca

Sep 2012

After the global financial crisis, there is greater awareness of the need to understand the interactions between the financial sector and the real economy and hence the potential for financial instability.  Data from the financial flow of funds, previously relatively neglected, are now seen as crucial to the data monitoring carried out by central banks.  This paper revisits earlier efforts to understand financial-real linkages, such as those of Tobin and the Yale School, and proposes a modelling framework for analysing the household flow of funds jointly with consumption.  The consumption function incorporates household income, portfolios of assets and debt held at the end of the previous period, credit availability, and asset prices and interest rates.  In a general equilibrium setting, these all have to be endogenised and since households make consumption and housing purchase decisions jointly with portfolio decisions, there is much to be gained in modelling a household sub-system of equations.  Major evolutionary structural change - namely the evolving credit architecture facing households - is handled by our 'Latent Interactive Variable Equation System'.  A by-product is improved understanding of the secular decline in US saving rate, as well as of the household financial accelerator.  Moreover, the models discussed in this paper offer new ways of interpreting data on credit, money and asset prices, which are crucial for central banks.

JEL Codes: B22, B31, E01, E21, E32, E44, E51, G11, G12, G21

Keywords: Finance and the real economy, Financial crisis, Consumption, Credit constraints, Financial frictions, Household portfolios, Wealth effects, Modeling the flow of funds

Reference: 622

Individual View

Authors: Mike Mariathasan, Ouarda Merrouche

Sep 2012

In this paper, we analyse a novel panel data set to compare the relevance of alternative measures of capitalisation for bank failure during the 2007-10 crisis, and to search for evidence of manipulated Basel risk-weights.  Compared with the unweighted leverage ratio, we find the risk-weighted asset ratio to be a superior predictor of bank failure when banks operate under the Basel II regime, provided that the risk of a crisis is low.  When the risk of a crisis is high, the unweighted leverage ratio is the more reliable predictor.  However, when banks do not operate under Basel II rules, both ratios perform comparably, independent of the risk of a crisis.  Furthermore, we find a strong decline in the risk-weighted asset ratio leading up to the crisis.  Several empirical findings indicate that this decline is driven by the strategic use of internal risk models under the Basel II advanced approaches.  Evidence of manipulation is stronger in less competitive banking systems, in banks with low initial levels of Tier 1 capital and in banks that adopted Basel II rules early.  We find tangible common equity and Tier 1 ratios to be better predictors of bank distress than broader measures of capital, and identify market-based measures of capitalisation as poor indicators.  We find no relationship between the probability of a bank being selected into a public recapitalisation plan and regulatory measures of capital.

JEL Codes: G20, G21, G28

Keywords: Banks, Basel risk-weights, Capital, Regulation

Reference: 621

Individual View

Authors: Karlygash Kurlbayeva, Samuel Malone

Sep 2012

Fat-tailed commodity price innovations are well-documented in the literature and long recognized as disruptive for consumers and producers, yet little is known about what factors drive such extreme events. Utilizing a wide range of factors from the economics and finance literature and quantile regression techniques, we shed light on this issue. Our models explain more variation in extreme than in median price innovations. Common global financial and demand factors account for a greater proportion of extreme daily spot price variations than do commodity-specific factors such as basis and open interest. Financialization of commodity markets, via significant and increasing co-variation of extreme spot price innovations with US equity market and trade-weighted US dollar returns, appears to be a major driver of extreme events in the 2000-2009 period.

JEL Codes: G13, G15, E31

Keywords: commodities price returns, extreme dependence, quantile regressions

Reference: 96

Individual View

Authors: John Knight

Sep 2012

Social instability is a concept that economists rarely analyse, and yet it can lurk behind much economic policy-making.  China

JEL Codes: O15, O20, O43, P26

Keywords: China, Civil unrest, Corruption, Developmental state, Economic growth, Governance, Happiness, Inequality, Social instability

Reference: 619

Individual View

Authors: Rick Van der Ploeg

Aug 2012

We show how a monopolistic owner of oil reserves responds to a carbon-free substitute becoming available at some uncertain point in the future if demand is isoelastic and variable extraction costs are zero but upfront exploration investment costs have to be made. Not the arrival of this substitute matters for efficiency, but the uncertainty about the timing of this substitute coming on stream. Before the carbon-free substitute comes on stream, oil reserves are depleted too rapidly; as soon as the substitute has arrived, the oil depletion rate drops and the oil price jumps up by a discrete amount. Subsidizing green R&D to speed up the introduction of breakthrough renewables leads to more rapid oil extraction before the breakthrough, but more oil is left in situ as exploration investment will be lower. The latter offsets the Green Paradox.

JEL Codes: D81, H20, Q31, Q38

Keywords: Hotelling principle, exhaustible resources, carbon-free substitute, regime switch, oil stock uncertainty, hold-up problem, green R&D, Green Paradox

Reference: 91

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