This week from CEPR: November 14th

Thursday, November 14, 2019

Highlights from some of the latest research reports published in the Centre for Economic Policy Research (CEPR) network’s long-running series of discussion papers, as well as some other recent CEPR publications.

Also, links to some of the latest columns on Vox, the Centre’s policy portal, which provides ‘research-based policy analysis and commentary from leading economists’.

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Analysis of negative news coverage of firms’ environmental and social (E&S) practices reveals that customers and investors can impose their ethical standards on corporate policies. Among the findings of the new CEPR study by Nick Gantchev, Mariassunta Giannetti and Rachel Li: 

  • Investors sell firms with heightened E&S risk, especially if they are from E&S conscious countries or hold portfolios with high sustainability ratings.
  • Heightened E&S risk is associated with a drop in firms' sales in E&S conscious countries. 
  • The behaviour of E&S conscious investors and customers leads to declines in stock prices, which push firms to improve their E&S policies in the years following negative realisations of E&S risk.

The results of the study indicate that customers and shareholders are able to impose their social preferences on firms, suggesting that market discipline works.


Greater local autonomy in a region within Europe enhances the efficiency of its local government in providing public goods, such as schools, hospitals and transport networks. What’s more, local autonomy can be particularly important in times of crisis, as it can increase the ability of governments to counteract negative demand shocks like the one Europe experienced in the Great Recession.

These are among the findings of a new CEPR study by Markus Brueckner, Evi Pappa and Akos Valentinyi, which evaluates the effect of local autonomy on the size of the regional government spending multiplier across 268 European regions over the period 1990-2014. To explain the empirical findings, the authors analyse a model in which both local and central government spending contributes to a public good that enhances productivity of the private sector. 

The main empirical finding of the study is that the regional government spending multiplier is significantly increasing with the degree of local autonomy. But it is not the direct effect of local autonomy on output that is significant: rather, local autonomy only affects output via its interaction with regional government spending.

The output effect of local government spending is estimated to be considerable and positive during recessions, while it is negative during expansions, suggesting a bigger role for countercyclical policies at all government levels in the EU. 

The authors suggest that only when local autonomy is accompanied by the efficient production of public goods does it benefit the local as well as the aggregate economy of the EU as a whole.


New research explains why referendum decisions with long-term future consequences should not be taken by a simple majority at a single point in time. The CEPR study by Benny Moldovanu and Frank Rosar introduces a framework for analysing Brexit-like decisions in a polarised society in which the electorate decides repeatedly between a reversible alternative (REMAIN) and an irreversible alternative (LEAVE). Among the findings: 

  • Voting by super-majority dominates voting by simple majority. 
  • Decisions by simple majority and by a too small super majority can perform very poorly under circumstances where it is socially optimal never to LEAVE, as they can exhibit equilibria where LEAVE is chosen very quickly. 
  • Mechanisms where LEAVE requires (super)majorities in two consecutive periods avoid this problem without relying on fine-tuning, but this can lead to inefficient delays. 
  • If a final decision for either alternative requires winning by a certain margin, and if a new vote is triggered otherwise, both problems – choosing LEAVE too easily and inefficient delays – can often be avoided.

The main reason for the sub-optimality of a simple majority referendum like Brexit is the large asymmetry in reversibility potential: LEAVE is widely believed to be irreversible for the foreseeable future, maybe a whole generation or more. On the other hand, REMAIN defers the final decision and allows a new vote in the future – hence it is reversible.



HOW NEUTRAL COUNTRIES IN THE SECOND WORLD WAR MAINTAINED INDEPENDENCE BY OFFERING ECONOMIC CONCESSIONS

Eric Golson 
11 November 2019

Neutral countries in the Second World War – such as Portugal, Spain, Sweden and Switzerland – maintained independence by offering economic concessions to the belligerents to make up for their relative military weakness. That is one of the conclusions of Eric Golson’s contribution to the VoxEU Debate on 'The Economics of the Second World War: Eighty Years On'. 

Economic concessions took the form of merchandise trade, services, labour and capital flows. Depending on their position and the changing fortunes of war, neutral countries could also extract concessions from the belligerents, if their situation permitted. 

Golson argues that neutral states in the Second World War were being realist in approaching their defence to ensure their survival, despite their depiction by some as enablers. 


THE EFFECTS OF THE SECOND WORLD WAR ON THE AMERICAN ECONOMY 

Benjamin Born, Gernot Müller, Moritz Schularick, Petr Sedláček
29 May 2019

The United States became the ‘arsenal of democracy’ by producing a massive amount of military goods that raised real GDP by 72% between 1940 and 1945. Yet, as Price Fishback explains in his contribution to the VoxEU Debate ‘The Economics of the Second World War: Eighty Years On’, the multiplier for this expansicon in government spending was less than one and military spending was associated with small effects on per capita activity. 

He shows that military spending crowded out private consumption and investment and forced people into the military. In essence, Americans sacrificed heavily to win the war, while their Allies sacrificed even more. 


RELAUNCH THE EURO AS A DIGITAL CENTRAL BANK CURRENCY

David Cuberes, Jennifer Roberts, Cristina Sechel
02 June 2019

Relaunching the euro as a digital central bank currency could help reduce the debt of the Eurozone states and end the sovereign-bank doom loop. It would also create a formidable competitor for other global digital currencies likely to emerge in the future.. 

That is the argument made by Thomas Mayer contributing to the Vox debate on euro area reform.

20 YEARS OF EUROPEAN ECONOMIC AND MONETARY UNION: Selected takeaways from the ECB’s Sintra Forum

Philipp Hartmann, Glenn Schepens 
06 November 2019

Philipp Hartmann and Glenn Schepens, two of the organisers of the European Central Bank’s annual forum, highlight key issues including the diverse progress with economic convergence and how it may relate to the geographical agglomeration of industries, the role of fiscal policies relative to monetary policy for macroeconomic stabilisation in the still incomplete monetary union and selected key determinants of future growth in the euro area. 

HOW THE 1997 CRISIS TRIGGERED A TRANSFORMATION OF THE KOREAN ECONOMY

Philippe Aghion, Sergei Guriev, Kangchul Jo 
07 November 2019

The Korean government's chaebol reforms in the late 1990s transformed the economy from an investment-based to an innovation-based model. The transformation moved Korea from low- to high-income status, effectively escaping the middle-income trap, according to new research by Philippe Aghion, Sergei Guriev and Kangchul Jo. There are important lessons here for China.   

A CHALLENGING PATH AHEAD: The European Commission’s Autumn 2019 forecast

Reuben Borg, Marco Buti, Oliver Dieckmann, Björn Döhring, Alexandru Zeana 
07 November 2019


 

Marco Buti and colleagues from the European Commission introduce the Autumn 2019 Forecast, which suggests that while a recession is not on the cards unless major risks materialise in the near future, a prolonged period of very low growth and inflation might loom for the medium term. 

The authors argue that a more supportive economic policy mix is needed to stabilise the economy in the near term, to prevent the risk of protracted sluggishness in the medium term and to provide impetus to the transition towards an environmentally and socially sustainable economy. 

The current weakness of GDP growth and low inflation in the euro area are unlikely to be reversed, by themselves, in the next two years. The near-term outlook will much depend on whether the rest of the economy, in particular the services sector, will remain resilient to the persistent slowdown in manufacturing and on the continued robustness of employment.  


THE BENEFITS OF ‘VESTED’ CONTRACTS: Insights from a Nobel laureate

David Frydlinger, Oliver Hart  
07 November 2019

‘Vested’ contracts, in which each party agrees to shared goals, guiding principles and structured communication to fall back on when conflicts arise, are used by growing number of organisations worldwide. 

These contracts build trust and encourage parties to respect one another’s interests, facilitating communication and problem-solving, write David Frydlinger and economics Nobel laureate Oliver Hart. They argue that shading and other deadweight losses occur under standard contracting and that adopting guiding principles such as loyalty and equity can mitigate these losses. 


SHORT-TERM EFFECTS OF THE TRADE WAR ON THE US ECONOMY 

Pablo Fajgelbaum, Pinelopi Goldberg, Patrick Kennedy, Amit Khandelwal 
07 November 2019

World Bank chief economist Pinelopi Goldberg and colleagues examine the impact of the 2018 tariff hikes and the resulting trade war on the US economy. They estimate a $51 billion annual loss to US consumers and firms from higher import prices, with an aggregate annual loss of $7.2 billion when producer gains and tariff revenues are factored in. The authors also demonstrate that US tariffs protected politically competitive counties, whereas retaliations by other nations targeted strongly Republican counties. 

EARLY 20TH CENTURY AMERICAN EXCEPTIONALISM IN PRODUCTION AND TRADE WAS ACHIEVED WITHOUT DOMESTIC TARIFFS: Evidence from the automobile industry

Dong Cheng, Mario Crucini, Hyunseung Oh, Hakan Yilmazkuday 
08 November 2019

The loss of US manufacturing jobs has been blamed on increased competition from China and has led to increased tariffs and a return to protectionism for the United States. Mario Crucini and colleagues argue that in the case of the automobile industry, history shows exactly the opposite occurred. 

In the early 20th century, the United States achieved exceptionalism in innovation, production and trade in automobiles without domestic tariff protection, while foreign nations languished behind high tariff walls designed to protect their fledgling domestic automobile industries.  


SHOULD EAST ASIAN COUNTRIES PRIORITISE REGIONAL CURRENCIES AGAINST THE DOLLAR?

Willem Thorbecke 
29 May 2019

As the trade surpluses of East Asian countries have continued to exist in regional value chains despite the US-China trade war, one possible tool such economies could employ are currency appreciations. 
Writing at Vox, Willem Thorbecke shows how exchange rates in upstream countries affect China’s exports. No single economy wants to appreciate its currency against the US dollar for fear of losing competitiveness, but a concerted effort to prioritise regional currencies could benefit the set of countries as a whole.

THE IMPACT OF NEGATIVE INTEREST RATES ON BANKS AND FIRMS

Carlo Altavilla, Lorenzo Burlon, Mariassunta Giannetti, Sarah Holton 
08 November 2019

Economists and policy-makers continue to question the effectiveness of monetary policy when an economy faces near-zero or sub-zero interest rates. Sceptics argue that central banks cannot stimulate lending and may indeed decrease the loan supply, by setting negative interest rates. 

Mariassunta Gianetti and colleagues shows that negative rates do not impede the transmission of monetary policy from banks to deposit holders because firms do not withdraw cash in response to negative rates the way households might. In fact, they argue that sub-zero rates may even stimulate the economy by encouraging firms to invest.


THE COSTS OF USING A REGIONAL TRADE AGREEMENT

Kazunobu Hayakawa, Naoto Jinji, Toshiyuki Matsuura, Taiyo Yoshimi 
09 November 2019 

Why don’t all firms use regional trade agreement schemes that offer lower tariff rates?  

Naoto Jinji and colleagues argue that firms need to incur both variable and fixed costs to comply with rules of origin, which isn’t always worth the benefits. Reducing fixed costs can be more effective and feasible in enhancing the use of regional trade agreements than a decrease in variable costs. 

RETHINKING EQUALITY OF OPPORTUNITY ACROSS COUNTRIES: The relationship between homeownership and social mobility in the US, Germany and Australia

Sergey Alexeev 
09 November 2019 

Despite the extensive evidence on intergenerational mobility, few studies have investigated the effects of non-monetary income from housing, or ‘imputed rent’, on intergenerational income mobility. 

Writing at Vox, Sergey Alexeev demonstrates the significance of such an omission. Using national panel data sets for Australia, the US and Germany, he finds that only Australia sees a noticeable reduction in mobility when imputed rent is accounted for in the measure of income. According to Alexeev, these findings challenge Australia’s basic claim of providing equality of opportunity. 


WHAT CAUSED THE 'GREAT INFLATION' IN RENAISSANCE EUROPE?

Anthony Edo, Jacques Melitz 
10 November 2019

Economists mostly argue that the Great Inflation in Renaissance Europe was caused by an inflow of silver. Historians counter that it was caused by population growth.

Anthony Edo and Jacques Melitz use long-run economic data to argue that the historians' position is credible and that both phenomena contributed equally to inflation during this period.


CONVENTIONAL TRADE STATISTICS GREATLY EXAGGERATE THE US TRADE DEFICIT WITH CHINA: The case of the iPhone X

Yuqing Xing  
11 November 2019

A new study by Yuqing Xing argues that conventional trade statistics greatly exaggerate the United States trade deficit with China. He uses the iPhone X as an example to demonstrate how the trade deficit is inflated and why value-added should be used to assess the bilateral trade balance. 

According to Yuqing, if multinational enterprises shift part of their value chains out of China, China may no longer play a central role in global value chains targeting the US market. Depreciation of the yuan will be insufficient to counter the effect. 


RESOLVING THE MISSING DEFLATION AND INFLATION PUZZLES

Jesper Lindé, Mathias Trabandt  
12 November 2019 

The alleged breakdown of the Phillips curve has left monetary policy researchers and central bankers wondering if we need to develop completely new models for price and wage determination. 

Jesper Lindé and Mathias Trabandt argue that a relatively small alteration of the standard New Keynesian model, combined with using the nonlinear instead of the linearised solution, is sufficient to resolve the two puzzles – the ‘missing deflation’ during the recession and the ‘missing inflation’ during the recovery – underlying the supposed breakdown.


TRUMP'S FISCAL POLICY AND DEBT ACCUMULATION FOLLOW THE REPUBLICAN TRADITION

Fabrizio Zilibotti, Andreas Müller, Kjetil Storesletten  
12 November 2019 

A new study by Fabrizio Zilibotti, Andreas Müller and Kjetil Storesletten challenges the claim that Republicans adhere to fiscal conservatism in debt policy. Instead, it shows that Republican administrations since the Second World War have been more prone to expand government debt than their Democratic counterparts. Broadly speaking, the same pattern emerges in a panel of OECD countries. 


HOW TO IMPROVE CONSUMER CREDIT RATINGS

Stefania Albanesi interviewed by Tim Phillips, 31 May 2019

Doing a good job of deciding who can borrow is fundamental for the global economy. Stefania Albanesi tells Tim Phillips that current consumer credit ratings do a poor job at predicting which of us will default and explains how she has used machine learning to improve them.