Do countries fall together? (Professor Interview)

Most undergraduate economics students are familiar with the concept of spillover effects, i.e. when activity in one sector affects the activity or participants in another sector. For example, homeowners with property on a river are adversely affected when the factory up-river dumps its waste into the water. Professor Kent, a macroeconomist, is researching the spillover effects that occur internationally. How can a shock in one country’s business cycle affect another’s?

To answer this question, Kent has compiled a list of 35 countries with a wide variety of characteristics, including those of both middle- and upper-income. Low-income countries are not included because data does not exist for the measurements Kent focuses on (including cross-border asset holdings and Portfolio equity) in these countries. Each country is paired with the 34 others in the sample in order to determine possible spillover effects. 488ecc57-99a8-4bbf-91da-1c9a151b7046This grid shows all of the pairs in the sample. The yellower a pair’s box, the higher the likelihood of spillover effects.

Most of the action occurs between trading partners. For example, many French firms and households hold a lot of equity in German industries. A shock that begins in the German economy may spill over to France through that channel. Kent is not only looking at how financial holdings can link nations together, but also trading links, including the importing and exporting of several types of goods (such as goods for consumption and goods for production, i.e. inputs). Japanese firms import a lot of steel from South Korea. If South Korea experiences a shock, Japanese firms may suddenly find that the price of their inputs have increased, the effects of which may reverberate through the entire economy.

The latter is an example of an upstream shock. A downstream shock occurs in a country when one of their important export markets (a country they ship things to) experiences a shock, and demand for their product decreases. So far, Kent has found that the importing of goods for intermediate goods and consumption are more highly associated with these spillovers. It is important to note that this is not just considering correlation, but dynamic response and forecast– in other words, if there were a shock in South Korea tomorrow, we could predict the size and duration of its spillover in Japan given that South Korea is one of Japan’s important input markets.

Kent has also found that financial links between countries tend to be associated with spillovers that happen very quickly, rather than the prolonged ones that occur when there are shocks to trading links. We see the effects of these prolonged spillovers playing out over a longer period of time, with adjustments in trade and the economy as a whole. Thus, finance does not appear to be important when considering these long, slow effects.

So, broadly, Kent is studying how countries move together in the world economy. Specifically, he is looking to understand the forecasts of economies in partner countries following a shock, rather than the shock’s immediate impact. How do spillovers carry through into future quarters of the business cycle?

“Policymakers might want to know how holding certain kinds of foreign or linked assets may increase or decrease the risk of experiencing a spillover shock from another country. We wouldn’t want to stop countries from holding each other’s’ assets, since shutting down trade would lead to welfare losses, but it may help us learn how to react when spillovers occur,” said Kent.

 

Written by Lauren Hurley

Two early examples of economic thinking

Game theory, as a field concerned with strategic decision making, has been around for millennia.  One early example of the distribution of resources in a cooperative game is found in the Talmud, a Jewish legal text dated sometime between 0 and 500 CE.  If a man dies, the text specifies different divisions of his estate among his wives in the case where his estate is not large enough to give each wife what was originally agreed upon in their marriage contract.  The recommended divisions vary depending on how large the estate is, some equal, others not, all corresponding to what game theorists would call an equilibrium, where each player’s (wife’s) strategy is optimal given the strategies of the others.  Thus, the Talmud anticipates the modern theory of cooperative games.

As a formal field of study, game theory didn’t appear until the 20th-century.  However, there were others who anticipated some of its major ideas.  One of the most surprising of these is Charles Lutwidge Dodgson, better known by his pen name Lewis Carroll.  Dodgson/Carroll is famous for his children’s book Alice in Wonderland, and most know that he was a mathematician as well as a writer.  Few know of his interest in political science.  In 1884, Dodgson published The Principles of Parliamentary Representation, a booklet concerned with the fairness and efficiency of voting in national elections.*  Dodgson’s purpose is to find a simple method of conducting elections that results in the representation of Electors’ true choice of candidate (or, as economists would call it, their true preference).  To do so, he develops mathematical models specifying how best to construct electoral districts and the elections themselves.  As pointed out by Duncan Black, this is one of the earliest examples of a societal problem being recognized and dissected as a two-person zero-sum game (though Dodgson obviously did not refer to it as such).**  It is also noteworthy for its quantitative rather than qualitative nature.  Many aspects of this children’s author’s approach – including mathematical modeling and a concern with efficiency – would later become some of the major tenets of modern economics.   

*Available online through Swem library: https://catalog.libraries.wm.edu/Record/3492939

**http://www.jstor.org/stable/1823671?seq=1#page_scan_tab_contents

A chronology of game theory, though Dodgson’s pamphlet isn’t included: http://www.econ.canterbury.ac.nz/personal_pages/paul_walker/gt/hist.htm

Written by Lauren Hurley

Interview with Professor Weber

Most undergraduate economics courses focus on traditional markets in which participants legally transact with one another, resulting in an efficient allocation of resources. Bryan Weber, a new professor at W&M who specialises in applied microeconomics, studies illegal transactions.

“Crime is a job, a type of employment. You can get your income from it. It can be harder to study than other types of employment, but it is still a valid way of analyzing how people get things done,” said Weber when I spoke with him about his research. He recently conducted a study at the University of Milwaukee (his alma mater) and Marquette University in Milwaukee, Wisconsin in order to determine how public transportation systems affect crime. Both of these universities are located downtown and provide transportation for their students. 30-40% of four-year urban universities have similar transportation programs in place. They are popular, but expensive.

“I looked into this because our university was facing budget cuts and I wanted to see if the program was actually working. There is a concern that this type of transportation, which provides easy access to bars, may promote drinking among students even of illegal age, which could in turn increase crime,” said Weber.

Weber reached the opposite conclusion. He found that these transportation systems were associated with about a 25% reduction in campus-related crime, a result that suggests they are worth funding. College campuses are not the only places where people are concerned about the effects of public transportation. As Weber explained to me, many people are concerned that fixed routes can create crime. Particularly, people who live in suburban areas often believe that expanding commuter railways will attract criminal activity from the inner city. Research done by Keith Ihlanfeldt at Florida State University suggests that commuter rails do not increase crime in wealthy areas, though it does seem to have an effect in poorer areas.

“Most of my research suggests that transit systems don’t have as many negative effects as we think, so concern about expanding these networks is not well-founded. They actually work to reduce crime,” said Weber.

Currently, Weber is working with the University of Maryland’s START, The National Consortium for the Study of Terrorism and Responses to Terrorism, to study a more unconventional type of crime. At the heart of the issue, the same age-old economic motivations are at work.

“We are analyzing why terrorists act the way they do, what attacks they choose to carry out– in other words, how they allocate their resources and make strategic decisions,” said Weber. “We are looking at broad collective data collected on US attacks. Many attacks are small, and most fail. Over half the time there are no casualties and the attack is prevented. This indicates terrorist attacks are hard to pull off. We should pay attention to the large attacks that are successful. These are terrorists’ ultimate goal, after all. Studying these attacks can help us prevent them in the future.”

I asked Professor Weber why he studies criminal activity.

“I like the challenge of trying to figure out what to do when information is hard to come by. For example, it’s tough to find good information on sexual assaults and criminal activity in general. Transactions aren’t monitored; one-half of the equation is trying to hide what’s going on. A lot of the information is hidden, so we need to take very educated guesses and use the best techniques available to figure out what happens next.”

For his next project, Weber hopes to study the relationship between education and crime. He specifically wants to look at the unintended effects of school voucher programs, which are popular in his home state of Wisconsin and are spreading across the country. They allow parents to take back their tax money that would have funded a public school and instead use it to enroll their child in a private school. The basic argument in favor of these programs is that they increase competition among schools and give kids access to a better education. However, Weber and others are concerned about the students who are left behind. Generally, these students have less-involved parents and come from disadvantaged backgrounds. Could leaving these students behind increase the likelihood of them participating in criminal activity in the future?

Professor Weber’s paper, “Can safe ride programs reduce urban crime?”, is linked here: http://www.sciencedirect.com/science/article/pii/S0166046214000416. Ihlanfeldt’s research was featured on CityLab last year: http://www.citylab.com/crime/2014/12/the-myth-that-mass-transit-attracts-crime-persists-in-atlanta/383609/. In addition, Professor Weber has a blog, http://bryansweber.com/, where he recently applied statistical analysis to make predictions about the outcome of “The Button” social experiment hosted on Reddit last spring.

Written by Lauren Hurley

“Who Gets What — and Why” by Alvin Roth

In 2012, Alvin E. Roth was awarded the Nobel Prize alongside Lloyd Shapley in the field of applied game theory for his work concerning stable allocations in market design. In June of this year, Roth published Who Gets What — and Why: The New Economics of Matchmaking and Market Design, a book that sounds like a general introduction to the study of matching markets but often reads like a listing of case studies. Roth spends most of his time explaining research and projects he himself has been involved in, adding definitions and explanations of concepts as an aside. This approach is not bad in and of itself, but it does make the title seem a little misleading.

Roth explains that a matching market is a market in which price is not the sole determinant of who gets what. An obvious example of this is the marriage market: usually you can’t simply pay someone a sum of money and expect them to marry you. Any functioning market, matching or otherwise, has three basic characteristics. They are thick, meaning there are lots of people participating and transacting with each other. They have the means to deal with congestion, meaning they make it possible for lots of people to transact together in a timely manner. And they are safe, meaning lots of people trust the marketplace and are willing and eager to participate. At heart, these three aspects are all concerned with the transmission of essential information. We use marketplaces to gather information about market participants (relayed by their preferences) in order to efficiently allocate society’s resources. An efficient allocation is one in which no participant could be made better off by transacting outside the marketplace (what Roth calls a “blocking pair”). For this collection of information to occur, there must be many participants willing to reveal their true preferences. Markets fail when they are thin, congested, or unsafe. These markets allocate resources inefficiently, and thus we often find people transacting outside the official marketplace in the knowledge that they can find themselves a better deal.

Without the market-clearing power of prices, matching markets are especially prone to these failings. Roth gives an example we can all relate to: the college admissions process. It is no secret that the rate of college applications has been growing over the past several decades. The Common App was created in order to deal with this congestion. Many colleges now use the Common App in their application process because of the thick market it provides. However, there is a downside. With just one application form, it is easy for students to apply to many colleges, even if they aren’t all that interested in attending. How do colleges get information on which students they actually have a chance at enrolling? The supplemental essays– only a student truly interested in attending will take the time to write yet another 500 words. Thus, the Common App wasn’t enough to ease this market’s congestion. While it made it possible for the students to apply to more schools, it forced the colleges to find a way to gather better information on their applicants’ preferences.

Markets naturally evolve this way, through gradual changes that allow participants to make better transactions. Of course, markets still exhibit many inefficiencies. The relatively new field of market design studies the aspects of natural markets that work well in the hopes of tweaking these markets to make them run even smoother or of solving the failings of hopelessly inefficient markets. Roth points out that markets are a human invention, meaning we have more control over them than the processes of biological evolution. Still, when tweaking or designing markets we cannot forget that we are fiddling in a process built by the collective action of billions of people. We cannot simply impose our will: we must accept human nature as it is and carefully examine the effect a particular market design will have on an individual’s incentives and strategies (this is where game theory comes in). Only then can we be sure we will have a thick market with eager and willing participants. In Roth’s words, “The lesson of market design for political debate is that to understand how markets should be operated and governed, we need to understand what rules particular markets need.” (pg. 227)

In the interests of keeping this post short, I won’t discuss any of Roth’s detailed case studies here. However, you can go to http://www.nobelprize.org/mediaplayer/index.php?id=1879

to watch his Prize Lecture, where he explains his work in medical field labor markets, school choice in US cities and kidney exchanges, all subjects he writes about in the book. If you are interested in a more general approach to the study of markets, John McMillian’s Reinventing the Bazaar: A Natural History of Markets is a great introduction. Both of these books were recommended to me by Professor Campbell.

Written by Lauren Hurley