14/5/2013: Negative Equity and Entrepreneurship: Local Evidence from the US

I have written before about the role positive/negative home equity has on entrepreneurship and real economic activity. Remember, the Irish Government and media believe that negative equity matters only when/if the household wants or needs to move home and that it has no effect outside this scenario.

A recent (March 2013) paper (linked below) from NBER argues very clearly that positive/negative equity has a real positive/negative effect on employment and business creation and that this effect is local to property prices region. In other words, unlike FDI or other foreign investments, home equity impacts domestic investment, locally anchored, and with it - domestic jobs creation.

Adelino, Manuel, Schoar, Antoinette and Severino, Felipe paper "documents the role of the collateral lending channel to facilitate small business starts and self-employment in the period before the financial crisis of 2008. We document that between 2002 and 2007 areas with a bigger run up in house prices experienced a strong increase in employment in small businesses compared to employment in large firms in the same industries. This increase in small business employment was particularly pronounced in (1) industries that need little startup capital and can thus more easily be financed out of increases in housing as collateral; (2) manufacturing industries where goods are shipped over long distances, which rules out that local demand is driving the expansion. We show that this effect is separate from an aggregate demand channel that relies on home equity based borrowing leading to increased demand and employment creation."

Some more granularity to the top-level results [italics are mine]:

"Overall, the evidence we present in this paper identifies the causal effect house prices in the creation of new small firms. These results show that access to collateral allowed individuals to start small businesses or to become self-employed. We conjecture that without access to this collateral in the form of real estate assets, many individuals would not have made the transition from unemployment to starting a new business or self-employment.

We show that the effect of house prices is concentrated in small firms only and had no causal effect  on employment at large firms. [In other words, there is no measurable effect on location competitiveness from house prices. Irish Government claims that residential property prices declines improved Irish competitiveness are not supported by the evidence from the US.]

Importantly, our results also hold when we exclude industries that are most likely to be affected by local demand shocks and when we restrict our attention to manufacturing industries. The effect of house prices is also stronger in industries where the amount of capital needed to start a new firm is lower, consistent with the hypothesis that housing serves as collateral but is not sufficient to fund large capital needs." [This goes to the issue of which types of firms creation benefit most from collateral access. The evidence suggests that smaller firms do so. But the fact that capital constraints bind also suggests that by typology, services firms, which are human capital intensive and require low levels of physical capital, benefit also more than average. Now, Ireland is human capital intensive economy, so draw your own conclusions.]

Adelino, Manuel, Schoar, Antoinette and Severino, Felipe, House Prices, Collateral and Self-Employment (March 2013). NBER Working Paper No. w18868. Available at SSRN: http://ssrn.com/abstract=2230758

13/5/2013: Banks Reputation Matters... for Borrowers too

Why banks reputations matter outside the interbank funding markets and regulatory offices? A question that is, perhaps, somewhat distant for Irish bank zombies, but ultimately the answer is not. It turns out, bank's reputation matters to the corporate borrower. And it matters materially.

Here's an interesting paper on this from Ongena, Steven R. G. and Roscovan, Viorel (see link below). As usual, italics are my own.

The authors argue that "banks play a special role as providers of informative signals about the quality and value of their borrowers. [Which is sort of trivial, when considered on 'accept' vs 'reject' or 0:1 basis. A '0' or 'reject' loan application signal provides information to the firm and to investors when the latter can observe the outcome of an application that the firm might be not as credit worthy as previously believed.]

Such signals, however, may have a quality of their own as the banks' selection and monitoring abilities may differ. [In other words, here's the core hypothesis: take two banks. Bank A has a lower capacity to price risk inherent in the firm than bank B. Over time, bank A repetitional capital should be lower than bank B. Now, firm 1 applies for a loan with A and B and gets rejected by B and accepted by A. Another firm, call it firm 2, applies for same loan and get accepted by B. Clearly, if the quality differential between A and B are known to the market, information about firms 1 and 2 experiences in applying for loans should matter in valuing firms 1 and 2.]

Using an event study methodology, we study the importance of the geographical origin and organization of the banks for the investors' assessments of firms' credit quality and economic worth following loan announcements. Our sample comprises 986 announcements of bank loans to US firms over the period of 1980–2003.

We find that investors react positively to such announcements if the loans are made by foreign or local banks, but not if the loans are made by banks that are located outside the firm's headquarters state. Investor reaction is, in fact, the largest when the bank is foreign.

Our evidence suggest that investors value relationships with more competitive and skilled banks rather than banks that have easier access to private information about the firms. [Confirming the core hypothesis above]"

Which is yet more bad news for Irish banks and the corporates stuck with them... and another reason why the banks reforms should deal with reputational fallout of this crisis as much as with macroprudential risks and regulatory capital cushions.


Ongena, Steven R. G. and Roscovan, Viorel, Bank Loan Announcements and Borrower Stock Returns: Does Bank Origin Matter? (June 2013). International Review of Finance, Vol. 13, Issue 2, pp. 137-159, 2013. http://ssrn.com/abstract=2262145

13/5/2013: Work Hours, Education Years and Wages

A fascinating fact: "An average person born in the United States in the second half of the 19th century completed 7 years of schooling and spent 58 hours a week working in the market. In contrast, an average person born at the end of the 20th century completed 14 years of schooling and spent 40 hours a week working. In the span of 100 years, completed years of schooling doubled and working hours decreased by 30%."

Restuccia, Diego and Vandenbroucke, Guillaume ask "What explains these trends?"

Their paper (link below) quantitatively assessed "the contribution of exogenous variations in productivity (wage) and life expectancy in accounting for the secular trends in educational attainment and hours of work."

And the result? "We find that the observed increase in wages and life expectancy accounts for 80% of the increase in years of schooling and 88% of the reduction in hours of work. Rising wages alone account for 75% of the increase in schooling and almost all the decrease in hours in the model, whereas rising life expectancy alone accounts for 25% of the increase in schooling and almost none of the decrease in hours of work."

Restuccia, Diego and Vandenbroucke, Guillaume, A Century of Human Capital and Hours (July 2013). Economic Inquiry, Vol. 51, Issue 3, pp. 1849-1866, 2013. http://ssrn.com/abstract=2261571

Aside 1: note that higher wages (when aligned with higher productivity) imply higher human capital intensity and lower hours of wrok supplied.

Aside 2: there seem to be no control for the reporting of hours supplied. In mid-19th century and even in first half of 20th century, most of work performed was time-sheeted. Today, majority of us do not have time cards, so on the surface, our contracts say 40 hours per week, in reality this means 60 hours per week.

13/5/2013: Unionisation and Innovation: Firm-level Data

A very interesting paper on the effects of unionisation of the workforce on firm-level innovation (italics are mine).

The authors find that "patent counts and citations, proxies for firms’ innovativeness, decline significantly after firms elect to unionize and increase significantly for firms that vote to deunionize. To establish causality, we use a regression discontinuity design relying on “locally” exogenous variation in unionization generated by union elections that pass or fail by a small margin of votes. The market reaction to firms that elect to unionize is negatively related to firms’ past innovation output [So if a firm had above average innovation output before the unionization, market reacts to bid down the firm value post-unionization in anticipation of the adverse impact]. Our evidence suggests unionization stifles innovation."

Slightly more specifically: "For instance, innovation quantity (quality) of firms that pass union elections within a margin of 2 percentage points is 42.8% (40.4%) lower than that of firms that do not pass union elections within a margin of 2 percentage points three years subsequent to union elections. We also estimate RDD on a sample of private firms over the same period. Consistent with our results for public
firms, we find that private firms’ innovativeness is negatively related to unionization."

Interestingly: "we attempt to identify possible underlying economic channels through which unionization impedes firm innovation. Inconsistent with the conventional view, we find little evidence that investment in R&D changes as a result of unionization. Our results suggest that the channel through which unionization impedes innovation is not an underinvestment in innovation input (i.e., R&D), but rather a decline in innovation productivity."

The whole paper is available here: Bradley, Daniel J., Kim, Incheol and Tian, Xuan, Providing Protection or Encouraging Holdup? The Effects of Labor Unions on Innovation (May 10, 2013). http://ssrn.com/abstract=2232351

13/5/2013: Cyprus CDS

It doesn't look like anyone (save for Olli Rehn) is betting on Cyprus' 'vast gas wealth' to be anywhere near its current account anytime within the next 5 years...

13/5/2013: Kauffman Index of Entrepreneurial Activity, 2012

Some absolutely fascinating data and insights on entrepreneurship in the US over the period of 1996-2012 in Fairlie, Robert W., Kauffman Index of Entrepreneurial Activity 1996-2012 (April 2013) (http://ssrn.com/abstract=2256032 or http://dx.doi.org/10.2139/ssrn.2256032)

The paper is based on the Kauffman Index of Entrepreneurial Activity - an "indicator of new business creation in the United States. Capturing new business owners in their first month of significant business activity, this measure provides the earliest documentation of new business development across the country. The percentage of the adult, non-business owner population that starts a business each month is measured using data from the Current Population Survey (CPS). In addition to this overall rate of entrepreneurial activity, separate estimates for specific demographic groups, states, and select metropolitan statistical areas (MSAs) are presented. The Index provides the only national measure of business creation by specific demographic groups."

The paper extends the Index to 2012 data "with consideration of trends in the rates of entrepreneurial activity over the seventeen-year period between 1996 and 2012."

Key findings for 2012 data update:

• "The rate of business creation declined from 320 out of 100,000 adults in 2011 to 300 out of 100,000 adults in 2012. 
• "The business creation rate of 0.30 percent translates into approximately 514,000 new business owners each month during 2012; it was 543,000 in 2011. 
• "The decline in the business creation rate to 0.30 percent in 2012 is …only slightly higher than pre-recessionary and long-term levels. The decline in business creation over the past year may be due to improving labor market conditions putting less pressure on individuals to start businesses out of necessity.
• "The overall decline in business creation rates was entirely driven by a substantial decline in business creation rates among men. Entrepreneurial activity remained unchanged in 2012 for women.
• "Immigrants were nearly twice as likely as were the native-born to start businesses each month in 2012. The immigrant rate of entrepreneurial activity decreased from 0.55 percent in 2011 to 0.49 percent in 2012.

• "Over the past seventeen years, Latinos, Asians, and immigrants experienced rising shares of all new entrepreneurs, partly because of rising rates of entrepreneurship, but also because of increasing populations. The oldest age group (ages 55–64) also experienced a rising share of all new entrepreneurs, mainly because it represents an increasing share of the population.
• "Although the entrepreneurship rate declined for high school dropouts from 2011 to 2012 (0.57 percent to 0.52 percent), this group has the highest rate of business creation, which may be due to more limited labor market opportunities than for more highly educated groups.

• "The construction industry had the highest rate of entrepreneurial activity of all major industry groups in 2012 (1.43 percent). The second-highest rate of entrepreneurial activity was in the services industry (0.41 percent).
• "The states with the highest rates of entrepreneurial activity were Montana (530 per 100,000 adults), Vermont (520 per 100,000 adults), New Mexico (520 per 100,000 adults), Alaska (430 per 100,000 adults), and Mississippi (430 per 100,000 adults). 
• "The states with the lowest rates of entrepreneurial activity were Minnesota (150 per 100,000 adults), Nebraska (170 per 100,000 adults), Michigan (180 per 100,000 adults), Wisconsin (180 per 100,000 adults), and Ohio (190 per 100,000 adults).

• "The states experiencing the largest increases in entrepreneurial activity rates over the past decade were Nevada (0.21 percentage points), Georgia (0.16 percentage points), Vermont (0.13 percentage points), California (0.12 percentage points), Louisiana (0.12 percentage points), and Massachusetts (0.12 percentage points).
• "States that experienced the largest decreases in entrepreneurial activity rates were Wyoming (-0.13 percentage points), Wisconsin (-0.12 percentage points), and South Dakota (-0.10).
• "Among the fifteen largest MSAs in the United States, Miami (0.56 percent) had the highest entrepreneurial activity rate in 2012, and Detroit (0.10 percent) had the lowest rate.

12/5/2013: Open Europe on Trade in Services

A very interesting piece of research from Open Europe thinktank, focusing on the potential economic impact from liberalising services trade within the EU: http://www.openeurope.org.uk/Content/Documents/Pdfs/kickstartinggrowthEUservices.pdf

Here are some highlights:

Chart below shows gains from the full implementation of the rather limited EU Services Directive:

And on to the extension of the EU Directive (notice that Ireland is in the higher benefits group of countries as our exports of services are both growing at the faster rate than EU average and constitute already a higher proportion of total external trade than EU average).

Also, recall that "The Economic Adjustment Programme for Ireland, February 2011 [states]: “Enhanced competition in the services sector modelled in the simulations…translates into a 0.1% increase in employment and a 0.5% increase in GDP over a 10-year period.” “[The Irish] Government will introduce legislative changes to remove restrictions to trade and competition in sheltered sectorsincluding: [the legal profession, medicalservices and the pharmacy
profession]”.

Lastly, comparing the relative significance of trade in services liberalisation to other potential means for boosting economic growth in Europe:

This is the debate that has, unfortunately, stalled in Europe with the onset of the crisis, as did the reforms under the Services Directive.

12/5/2013: How Bitcoin works

Good infographic on bitcoin: http://thumbnails.visually.netdna-cdn.com/bitcoin-infographic_5029189c9cbaf.jpg

h/t to @mbauwens

12/5/2013: On euro's future...

A very interesting contribution from Niall Ferguson to the debate about the future of the euro: here. Interestingly, one can juxtapose Ferguson's article against the list of most recent news briefings from the PressEurop:

12/5/2013: What Greek OSI will mean for IMF?

While this story is still speculative, the very idea that IMF can be forced to take a haircut on its holdings of Greek bonds is very much significant. In my view:

1. IMF will be dragged into OSI on Greek bonds, although the timing of this uncertain;
2. IMF deserves to be dragged into OSI on Greek bonds because the Fund has - begrudgingly - agreed to the EU formula for dealing with the Greek crisis that involved no OSI from ECB / EU which would have been required early on to ensure IMF gets repaid;
3. When IMF takes a hit, this will signal much more than the simple 'first time ever' precedent. Because the IMF's close links to the EU leadership have been directly implicated in the botched structuring of the Euro area member states rescues, the IMF leadership will undoubtedly start actively migrating away from the EU dominance toward the BRIC(S).

The disastrous decisions underwritten by the current and the pervious IMF heads in the case of EU will mean, in the end, the vanishing of the relatively unbiased and transparent international lender of last resort to be replaced by the geopolitically-motivated leadership of the BRIC(S).

This will stand in stark contrast to the reformed and much more transparent functioning of the World Bank, started under the leadership of Paul Wolfowitz.

12/5/2013: Much austerity? Not really... & not of the kind we needed

A week ago I published a blogpost exploring IMF data on austerity in Europe, based on a sample of 20 EU countries with advanced levels of economic development (excluding Luxembourg). You can read that post here. The broad conclusions of that post were:

1. There is basically no austerity in Europe, traceable to either changes in deficits, changes in Government spending or changes in debt. If anything, the European fiscal policies can be characterised by a varying degree of fiscal expansionism during the current crisis, relative to the pre-crisis 2003-2007 period.
2. This, of course, does not account for transfers between one set of expenditures (e.g. public investment reductions) and other lines of spending (e.g. banking sector measures).
3. The only area of fiscal policy where austerity is evident is on taxation burden side, which rose in the majority of sampled economies.

The numbers got me worried and in this post I am looking solely on deficits side of Government spending. If there is savage austerity in EU27, so savage it is killing European economies, surely it would show up in General Government deficit numbers. As before all data reported is based on averages and comparatives computed by me from IMF's WEO data as reported in April 2013 edition of the database.

Let's take a closer look.

Only 2 countries out of 20 have recorded a reduction in average deficits during the crisis period (2008-2012) compared to the pre-crisis average (2003-2007). These were Germany, where annual average deficits declined by 0.95 percentage points (pretty significant) and Malta, where annual average deficits fell 0.79 percentage points (also pretty sizeable drop).

On average, EU20 sample annual deficits have increased by a massive 3.44 percentage points over the pre-crisis period. In  non-Euro area states, the average increase was 3.16 percentage points. But in 'savagely austerian' Euro area, the increases averaged 3.51 percentage points.

So far, the Euro area analysts' rhetoric opposing austerity has been focused on 2012 as the year of highest - to-date - cuts. Was this so? Not really:

Again, as above, there is scantly any evidence of deficit reductions, and plenty of evidence that deficits are getting worse and worse. Again, the comparative is not to the absurd levels of spending during peak spending years of the crisis, but to pre-crisis averages. After all, stimulus is not measured by an ever-escalating public spending, but by increase in spending during the recession compared to pre-recession.

The same conclusion can be reached if we look at 2007 deficit compared to 2012 deficit.

In other words, folks, Europe has had, so far, only 3 measurable forms of austerity, none comfortable to the arguments we keep hearing from European Left:

1. Tax increases (remember, we want to soak the rich even more, right?)
2. Revenue re-allocations to banks measures (remember, no one on Europe's official Left has come out with a proposition that banks should not be bailed out) and to social welfare (clearly, the Left would have liked to spend even more on this)
3. Germany

Note: we must recognise the simple fact that social welfare spending will rise in a recession for a good reason. The argument here is not that it should not (that's a different matter for different debate), but that when it does increase, the resulting increase is a form of Government consumption stimulus.

So let's make the following argument: Euro area did not experience 'austerity' in any pure form in the reductions in deficits. Instead, it experienced a 'stimulus' that was simply wasted on programmes and policies that had nothing to do with growth stimulus (e.g. banks supports). Here are two charts to illustrate:

What the charts above clearly show is that Euro area can be divided into three types of member states:

• Type 1: states where cumulated 5 year surpluses over pre-crisis period gave way to cumulated 5 year deficits. These are: Estonia, Finland, Spain and Ireland.
• Type 2: states where cumulated 5 year deficits over the pre-crisis period were replaced by more benign deficits over the crisis period period. These are Germany and Malta.
• Type 3: all other euro area states where cumulated 5 year deficits over pre-crisis period were replaced by even deeper cumulated deficits over the 5 years of the crisis.

The only two types of fiscal policy that Euro area is missing in its entirety is the type where pre-crisis deficits gave way to crisis period cumulated surpluses (no state in the sample delivers on this) and the type where pre-crisis surpluses gave way to shallower crisis-period surpluses (only one European state - Sweden - qualifies here).

Oh, and one last bit relating to the chart above: all of the peripheral countries, save Italy, had a massive increase in deficits on cumulated basis during the crisis compared to pre-crisis period. Apparently this is the savage austerity that has been haunting their economies.


Updated:
An interesting issue raised by one of the readers:

And my response:

8/5/2013: Thomas Sowell on Language, Evidence & Inquiry

Thomas Sowell doing what he does best: asking uncomfortable questions. http://townhall.com/columnists/thomassowell/2013/05/08/words-that-replace-thought-n1588497?utm_source=thdaily&utm_medium=email&utm_campaign=nl

This got me thinking: there are, as Sowell puts it 'words that replace thought', but there are even more detrimental to inquiry 'words that prevent thought'. In fact, his example of word 'diversity' is one. It is virtually impossible to challenge anything relating to the thesis that 'diversity is intrinsically good' without being shut down on the grounds that any argument to the contrary of the thesis is automatically an argument in favour of some exclusion (racism, anti-semitism, sexism, and so on...).  The only possible by-pass to this problem is to argue that 'diversity has no effect'.

But this falls into the trap discussed briefly here http://andrewgelman.com/2013/05/06/against-optimism-about-social-science/
under the file-drawer bias in publishing.