New Economist

Is divorce such a disaster for kids?

Philip Larkin may have written that your mum and dad f*%k you up. But what, specifically, about divorce? The British tabloids regularly run features lamenting the "devastating" consequences of divorce on the "tots". But a recent paper by Shirley Liu from the University of Miami undermines some of those assertions.

Her paper, Is My Parent’s Divorce to Blame for My Failure in Life? A Joint Model of Child Educational Attainments and Parental Divorce (PDF), finds - like other research in the field - that children of divorced parents tend to have lower educational attainments. But is this caused by parental divorce?

Using annual data on a representative sample of children and their families since childbirth until the completion of their schooling, we model child’s schooling attainments and parents’ marital dissolution as joint decision processes, where unobservables triggering divorce and affecting child development are assumed to be correlated. After accounting for both observed and unobserved characteristics, we find no evidence that the lower educational attainments is attributable to parents’ divorce per se, but rather due to unobserved factors that are correlated with divorce.

...While further research is into the mechanisms through which parents’ divorce affects child attainments is needed, our findings provide some evidence that divorce in itself does not negatively affect children’s educational outcomes. The reasons for dissolving a marriage tend to be family-specific and usually observed only by the parties involved. Assuming that parents are altruistic and internalize potential gains (and costs) of dissolving their marriage on their children when deciding to divorce, on the margin there may be benefits to divorce (at least for some).

What implications for politicians and policy makers then?

If our goal is to help children from divorced families to become self-reliant adults, policy-makers need to be mindful that divorce in itself may be a consequence, rather than a culprit, of the same underlying mechanism that causes the inferior child outcomes. Simply restricting access to divorce without consideration of individual needs and circumstances can be irresponsible; it may also risk jeopardizing the welfare of many families and their children.

The 'family über alles' crowd won't like that.

UPDATE:
Undercover economist Tim Harford links to this post on his newish FT weblog, adding:

Interaction models - don't get caught!

In my naivety I had assumed most social scientists understood how to model interaction effects. Then I read this post by Omar on orgtheory.net, and realised maybe I was wrong:

So we are agreed interaction models are awesome. However, as your stats 101 teacher told you, you have to be careful about two things: (1) never omit the main effects. Thus you don’t test hypothesis 1 using any of these specifications:

Y=a+b1X+b2XZ+e

Y=a+b1Z+b2XZ+e

or Alanis forbid:

Y=a+b1XZ+e

And (2) when interpreting b1 and b2 in the fully specified model, remember that those effects are conditional on the value of the other variables. b1 is now the effect of X on Y when Z=0 and b2 is now the effect of Z on Y when X=0. If your variables don’t have a meaningful zero point (like a racial attitudes scale), center them at their mean so that you can say “b2 is the effect of being Southern on voting republican for those who have average levels of racial animus towards blacks.”

Seems simple. Everybody knows this. Why am I even explaining this to you? Well, as noted by Brambor, Clark and Golder (2006) in a recent article in Political Analysis, a survey of 156 articles published in the major Political Science journals shows that only 10% of researchers specified their interaction models correctly. A large chunk of them outright omitted main effects, which can lead to incorrect significance tests of the interaction term. In some of these articles the entire contribution was riding on the interaction term. So things are not so simple. Consider the horror:

In an award-winning article in the American Political Science Review, Boix (1999) examines the factors that determine electoral system choice in advanced democracies. He makes two main conclusions. First, ethnic or religious fragmentation encourages the adoption of proportional representation in small and medium-sized countries (621). He draws this conclusion based on a model that includes an interaction term between ethnoreligious fragmentation and country size. However, he does not include either of the constitutive terms. When these terms are included, there is no longer any evidence that ethno-religious fragmentation ever affects the adoption of proportional representation (italics added).

You should read the article to see other horror stories. The lesson: if your dissertation/paper is riding on an interaction effect, don’t be a fool. Estimate a fully specified model.

A salutory lesson. Here is a non-gated version of the Brambor, Clark and Golder paper, Understanding Interaction Models: Improving Empirical Analyses (PDF). NYU's Matt Golder has more useful material on interaction models on his web pages.

Nodding off in Beijing

Channel 4 News' China correspondent Lindsey Hilsum tried not to nod off while attending the 17th Party Congress in Beijing. She was not alone:

Never before have I felt at one with the former Chinese leader Jiang Zemin. But halfway through President Hu Jintao's two-and-a-half-hour speech at the 17th Congress of the Communist Party of China, as the 81-year-old's eyelids drooped and his head flopped on to his chest, I experienced a certain fellow feeling.

The speech had the pithy title "Hold High the Great Banner of Socialism with Chinese Characteristics and Strive for New Victories in Building a Moderately Prosperous Society in All Respects". It was delivered in a monotone. President Hu clapped himself at the best bits, as a cue for his audience of apparatchiks. Two frail and elderly delegates had to be ushered off the stage, presumably for resuscitation.

The speech contained not a single new thought, but rehashed a dozen tired slogans: "Harmonious Society", "Scientific Outlook on Development", "Socialism with Chinese Characteristics". China-watchers - an even more specialised and possibly eccentric bunch than birdwatchers - will now be analysing all 64 pages for clues to what it all means for China's future.

Why so dull?

Chinese leaders don't have to spark excitement among the public, because they are not courting anyone's vote. As I sat in the Great Hall, trying not to nod off like Jiang, I thought of how China's leaders have brought prosperity to hundreds of millions. Universities are graduating well-qualified students; the stock market is soaring; the trade surplus has reached $1.4trn. Yet the party still claims to be following Marxism-Leninism and Mao Zedong Thought. Real achievements are submerged in mind-deadening verbiage. No wonder the Chinese people aren't listening.

And yet, despite the stale Marxist rhetoric and lack of democracy, the economy is booming. Hilsum's piece in the New Statesman contains am apt analogy of the Chinese leadership:

The Chinese economy is like a runaway horse - the government is torn between trying to rein it back, or just clinging on and hoping that it slows down of its own accord. The leaders' main fear is of falling off.

Has world poverty really fallen?

The short answer is: maybe, maybe not. Here's a slightly longer answer:

We evaluate the claim that world consumption poverty has fallen since 1990 in light of alternative assumptions about the extent of initial poverty and the rate of subsequent poverty reduction in China, India, and the rest of the developing world. We use two poverty indicators: the aggregate headcount and the headcount ratio, and consider two widely-used international poverty lines ($1/day and $2/day).

We conclude that, because of uncertainties in relation to the extent and trend of poverty in China, India, and the rest of the developing world, global poverty may or may not have increased. The extent of the estimated increase or decrease in world poverty is critically dependent on the assumptions made. Our conclusions highlight the importance of improving the quality of global poverty statistics.

That comes from an article of the same title by Barnard College's Sanjay Reddy and Columbia University's Camelia Miniou in the latest issue of the Review of Income and Wealth (Vol. 53, No. 3). For now at least, it is available to download free.

Caste out

Tyler Cowen of Marginal Revolution is unimpressed by the paper by Northwestern University's Kripa Freitas on the Indian caste system that I posted about just over a week ago. Here are the key points from his post, Was the Indian caste system efficient?

I have a few points:

1. No way should this paper spend so much time on a formal model.

2. The tests proffered on p.36 are related only tangentially to the paper's main propositions.

3. When it comes to normative issues, the author can do no better than to write: "This should not be interpreted as saying that the case system was free of inefficiencies."  And that comes only on p.46.  Ha!

4. The paper commits the fallacies of excess functionalism.

5. Virtually any destructive institution which keeps economic transactions on a smaller scale may make contract enforcement "easier" in some regards.

6. This is nonetheless interesting work, and many more people should do research on this and related topics.  But in terms of emphasis this paper is way off base.

Also worth reading some of the comments on this post.

Outsourcing India

It was bound to happen, but it's a remarkable story nonetheless. Thousands of jobs taken by India from the west are being re-exported as wages shoot up. The Guardian's Randeep Ramesh reports that India outsources outsourcing:

From his tree-top-high office, Kris Gopalakrishnan, the head of India's giant software company Infosys, explains the rise of an economic phenomenon about to engulf the world: outsourcers are outsourcing themselves.

Once known for sucking jobs out of call centres and IT departments in the west, Indian technology firms are re-exporting them to wealthier nations as wage inflation and skills shortages at home reverse the process.

Infosys spent $250m this year buying the Polish call centres of Philips, the electronics group, manned by workers who speak half-a-dozen European languages. The company is building up a network of offices stretching from Mexico to eastern Europe to China to provide an "anytime, anywhere" solution to its clients. "Our customers are global, so we have to become so," says Mr Gopalakrishnan.

Infosys is not alone. Wipro, another hi-tech titan, has been on a spending spree, buying up companies in America, Finland, Portugal and Europe for hundreds of millions of dollars. Azim Premji, Wipro's chairman, raised eyebrows on Wall Street when he talked this year of setting up divisions in Idaho, Virginia and Georgia - US states he said were attractive because they were "less developed".

Tata, India's largest firm, is running call centres in Britain. ABN Amro, the Dutch bank recently bought by an RBS consortium for £48bn, will pay Tata Consultancy Services $200m to send work halfway across the globe to Brazil, where software programmers will run computer systems.

Indian software companies' skill is that they have been able to take complex tasks from multinational firms, pull them apart and put them together more efficiently. This expertise has reached a stage where it can be done anywhere across the globe - grafting Indian technical knowhow onto white-collar workers in Brazil or Saudi Arabia or even back to the US.

 

Why should men care about women's rights?

UCLA's Matthias Doepkey and Stanford's Michèle Tertilt ask a good question about women's rights and development: Women’s Liberation: What Was in It for Men? (PDF). Here is their answer:

Women’s rights are closely related to economic development. This is true both across countries, where women have most rights in the richest countries, and in time series data: women have slowly improved their legal position in parallel with fast improvements in the standard of living. In most cases, the initial extension of rights to women amounted to a voluntary renouncement of power by men.

In this paper, we investigate the economic incentives for men to share power with women. We show that men may want to voluntarily relinquish some of their power once technological change increases the importance of human capital. The reason is that men face a tradeoff between how they would ideally like to treat their own wives and how they want other women to be treated. While men might want little rights for their own wives, they may prefer their daughters to have a better bargaining position with future husbands. In addition, a wife’s education matters for producing high-quality children. A husband prefers his children to find high-quality mates, and therefore stands to gain from increasing the power of his children’s mothers-in-law.

Men have wives - but they also have daughters. Indeed, seeing the world through a daughters' eyes can make even the most macho or chauvinistic man reconsider their attitudes on gender equality.

For those near Yale, Michèle Tertilt is presenting the paper there on Monday 15 October to their Development Workshop

Explaining the T-bond 'conundrum'

In February 2005, then Fed Chairman Alan Greenspan referred to the decline in long-term rates in the wake of the Fed increasing the target for the federal funds rate by 150 basis points as a "conundrum" St Louis Fed's Daniel L. Thornton has investigated Greenspan's remarks and provides an answer, in a new working paper: The unusual behavior of the federal funds and 10-year Treasury rates: a conundrum or Goodhart's Law?

I show that the relationship between the 10 year Treasury yield and the federal funds rate changed dramatically in the late 1980s, well in advance of Greenspan's observation. I argue that the marked change in the relationship between the federal funds rate and long-term yields is a natural consequence of Goodhart's Law.

Here is what happened:

Once the Fed began targeting the funds rate for policy purposes and the funds rate remained close to the target, the behavior of the funds rate is necessarily different from what it would have been had it been free to respond to market fundamentals. This implies that the relationship between the funds rate and rates that are less closely linked to the funds rate would necessarily change. Since long-term yields are much less affected by the funds rate than other shorter-term rates, it is reasonable that the relationship between the funds rate and long-term rates would be most affected.

This hypothesis is supported by the fact that there was a marked change in the relationship between changes in the 10-year Treasury bond yield and changes in the federal funds rate that occurred in the late 1980s. The change in the relationship is statistically significant at monthly and quarterly frequencies. Moreover, an analysis of the levels of these rates indicates that the change persists at lower frequencies as well.

Some of you may not have heard of Goodhart's Law. It was coined by British economist Charles Goodhart in the mid-1970s, when he was was Chief Adviser to the Bank of England. The basic idea is that when a government attempts to regulate any particular set of financial assets, these become unreliable as indicators of economic trends. This proved prophetic when Margaret Thatcher was elected Prime Minister in 1979, and sought - disastrously - to conduct monetary policy on the broad and narrow money supply targets.

UPDATE:
Almost as soon as this post went up, another paper on the same subject appeared. Cracking the Conundrum, by the Stern School's David Backus and Federal Reserve economist Jonathan H. Wright, has just been published as Finance and Economics Discussion Series No. 2007-46. The authors hedge their best a little more than Thornton, citing several possible contributing factors:

From 2004 to 2006, the FOMC raised the target federal funds rate by 4.25 percentage points, yet long-maturity yields and forward rates fell. We consider several possible explanations for this "conundrum." The most likely, in our view, is a fall in the term premium, probably associated with some combination of diminished macroeconomic uncertainty and financial market volatility, more predictable monetary policy, and the state of the business cycle.

I accept there was a decline in the term premium (the expected return on long-term bonds). But surely this begs the obvious question: 'why?'. A post by James Hamilton of Econbrowser fame provides some discussion: The term premium and reduced volatility

The economics of happiness: a progress report

Little by little, psychology's insights into happiness and well-being are being integrated into economic theory and debate. Happiness has become one of the hot topics in economics over the last decade, with both the size and depth of the literature increasing at a rapid rate.

Though US-based psychologists Daniel Kahneman and Ed Diener and economists Richard Easterlin and Alan Krueger can take much credit, so too can the British 'brat pack' consisting of Warwick's Andrew Oswald, Paris-based Andrew Clark, Dartmouth's Danny Blanchflower and (as an honourary elder statesman), the LSE's Richard Layard. The two Andrews were writing about this stuff years ago, when 'respectable' academic economists thought the topic barking.

What is particularly encouraging is that economists are starting seriously to tackle the major empirical and the theoretical challenges that this literature has uncovered. A new paper by Andrew Clark, Paul Fritjers and Michael A Shields, prepared for the Journal of Economic Literature, ups the ante. Relative Income, Happiness and Utility: An Explanation for the Easterlin Paradox and Other Puzzles (PDF) takes as its starting point Easterlin's seminal 1974 paper which posed a paradox - that happiness does not appear to increase with income, once basic needs are fulfilled. The paper covers a lot of ground, including adaptation, social comparisons, relative income, utility and much more besides. There is a short but insightful description of the key challenges for empirical work. And to wrap it up, the authors explore some implications for economic theory and policy design. As a sampler, here are the authors concluding remarks:

The interaction between economic theory and happiness is therefore the next milestone for the developing economics of happiness literature. However, it is clear that the empirical literature on happiness still faces several challenges, many of which are shared with other empirical literatures. Two of the key challenges are to deal with a general inability of survey data to precisely time changes in income with changes in happiness over long time periods, and the difficulty in mapping incomes into current and expected consumption. It is also the case that most datasets do not contain reliable (if any) ex ante information regarding the group (the reference point) to which individuals compare themselves. Similarly, no dataset can contain all the variables of importance, so that researchers will continue to face the issue of endogeneity with respect to income and other variables such as marriage, education, and the reference group. Finally, natural experiments producing exogenous variation in income are only rarely observed, making the issue of establishing the causal effect of income on happiness a major challenge.

Our final conclusion is that taking relative income seriously is an important step towards greater behavioural realism in Economics, such that our models and empirical analysis move closer to how real people feel and behave. Some may not like the insertion of additional arguments into individual utility, and remark that any behaviour can be rationalised by an appropriate manipulation of the utility function. While this is formally true, it does not apply wholesale to the issue of relative income. As we have tried to demonstrate, utility functions including relative income terms produce a wide variety of testable predictions regarding both well-being (measured by survey or neurologically) and observable behaviours: it is not true that “anything goes”. To our mind, this is precisely why we need to appeal to both direct measures of utility and observed behaviour in order to obtain a better idea of what the utility function looks like, and make policy recommendations in the best interest of society. Testing these predictions not only allies theory and empirical analysis in economics, it also spills across many disciplines in the social and natural sciences; it is arguably the most important and the most promising of the research avenues open to this thriving literature.

This is no light summer reading, but for those seeking to advance the debate, it's a big step forward.

Monetary policy transparency - what impact?

Monetary policy transparency is generally considered these days to be a 'good thing' - though it was not always so. But what impact has greater transparency had? Carin van der Cruijsen and Sylvester Eijffinger from Tilburg University have reviewed the literature. Their paper, The Economic Impact of Central Bank Transparency: A Survey (PDF), provides an up-to-date overview of research on the desirability of central bank transparency from an economic viewpoint. Here are their main findings:

1) The theoretical literature does not come to a unanimous conclusion. Although the more recent theoretical literature argues in favor of more transparency, exceptions are procedural and political transparency.
2) Differences in outcomes occur because of differences in the models used. There is a tendency of more recent, micro-directed research to favor transparency.
3) The empirical literature shows that more transparency is indeed desirable. The only remaining question mark is procedural transparency.
4) There is still scope for some more research on transparency.

What direction might future research take?

..now that most central banks have already become more transparent, it is likely that the research will shift more towards communication, a trend that is already observable. As Winkler (2002) pointed out, the release of asymmetric information is not enough: communication should provide clarity to make sure that the re lease of information leads to common understanding between the public and the central bank.

The authors also argue that although central banks have increased their level of transparency, "there is still some room left for further improvements".