Highlights 2012

WP 12/16

Jean-Paul L’Huillier (with Dan Cao) in “Technological Revolutions and Debt Hangovers: Is There a Link?” explores the possibility that technological revolutions lead to consumption slumps. To this aim he sets up a model where current production and spending are determined by anticipations about the future which are based on noisy information. He then compares the medium run dynamics of the Great Recession, the Great Depression and the Japanese crisis of the 1990s and shows that in all three cases a boom was followed by a slowdown in permanent productivity (the peak being reached about 10 years before the start of the recession), and that spending followed a similar pattern, but with a significant lag of about 5 years. Since in the model spending remains high when productivity has already slowed down, a large accumulation of debt ensues. When agents recognize the slowdown of productivity, a deleveraging process begins, dragging the economy into a long consumption slump. The whole cycle – from the increase of the productivity rate to the decline in consumption – takes about 25 years. In the three cases analysed, the acceleration of productivity coincides with well-documented economy-wide technological changes.

WP 12/15

Jeffrey Butler and Giancarlo Spagnolo (with Enrica Carbone and Pierluigi Conzo) in “Reputation and Entry” explore whether favoring suppliers with good past performance – a standard practice in private procurement - may hinder entry by new (smaller or foreign) firms in public procurement markets, which constitutes a reason of concern among regulators. The results from a laboratory experiment exploring the relationship between reputation and entry in procurement suggest that some reputation mechanisms may indeed reduce the frequency of entry, lending credence to regulators’ concerns about reputation hindering entry. However, the study also shows that appropriately designed reputation mechanisms actually stimulate entry and quality provision simultaneously. As quality increases but not prices, the results also suggest that the introduction of reputation mechanisms may generate large welfare gains for buyers.

WP 12/14

Franco Peracchi (with Giovanni Mastrobuoni and Aleksey Tetenov) in: “Price as a signal of product quality: Some experimental evidence” uses experimental data to disentangle the budgetary from the non-budgetary (or signaling) effects of prices on consumer demand. The paper focuses on the determinants of the choice among wines in a set of wine tasting experiments where nonprofessional tasters were asked to indicate which one of the tasted wines they preferred and which one they would buy. In addition to actually tasting several wines, that differ in terms of their intrinsic quality, tasters were randomly given fictitious information about their price and the environment where the grapes were grown and the wines produced. Three main results emerge from these experiments. First, the signaling effect of prices is present and is nonlinear: while it is strong and positive from low to medium prices (i.e. a price increase is perceived by consumers as indicator of better quality), it becomes hardly detectable from medium to high prices. Second, a similar nonlinear price-quality relationship is found also in a large sample of wine ratings from the same price segment, supporting the hypothesis that consumers’ behavior in the experiments is consistent with rationally using prices as signals of quality. Finally, price signals have greater importance for inexperienced consumers. An earlier version of this paper won the prize for the best paper presented at the Annual Conference of the American Association of Wine Economists held in Bolzano, Italy, in June 2011.

WP 12/13

Many would probably agree that if one lends 100 euro and gets back 98, he will feel cheated. What about if he receives back 103? Probably he would feel cheated if he was promised 105. But in many situations exchanges occurs without any declared promise, as when taking a cab and the driver makes no promise that he will follow the shortest route to destination. How is “cheating” defined in such circumstances? Do people have a notion of “cheating” and what is it? Does it matter? Jeffrey Butler and Luigi Guiso (with Paola Giuliano) in “Trust and Cheating” try to answer these questions by investigating them in the context of a trust game, where individuals’ subjective notions of “cheating” are elicited. The results of the experiments show that participants do have implicit “cheating” notions when playing the trust game and these do affect the behaviour of both sides of the exchange about whether to trust and by how much and whether to cheat and by how much. Interestingly, these notions differ across individuals: for some “cheating” occurs if they experience a negative return; for others only if they receive less than a half of the surplus created by trusting. The authors provide novel evidence that diversity across individuals in what constitutes “cheating” can be traced back to two classes of values instilled by parents: cooperative and competitive. While the former tend to soften the notion of “cheating”, the latter tighten it.

WP 12/12

Marco Pagano (with Marco Di Maggio) in “Financial Disclosure and Market Transparency with Costly Information Processing” analyzes whether the disclosure of information and the transparency of security markets can be detrimental to issuers. To this aim they set up a model where processing information is costly and not everyone is equally good at it. In particular, some investors (”hedgers”) process information badly, while others (”speculators”) trade purely to exploit their superior ability in information processing. The authors show that, in this context, enhancing information disclosure about fundamentals induces an externality: if speculators refrain from trading, hedgers will do the same, so further depressing asset prices; market transparency, by making speculators’ trades more visible to hedgers, may reinforce this mechanism. As a consequence asset issuers will tend to oppose both the disclosure of information and trading transparency. This may lead to socially inefficient outcomes and regulation is warranted. In particular, the paper shows that if a large fraction of market participants are speculators and hedgers have low processing costs, forbidding hedgers’ access to the market may dominate mandatory disclosure.

WP 12/11

Andrea Pozzi and Fabiano Schivardi in “Demand or Productivity: What Determines Firm Growth?” disentangle the contribution of unobserved heterogeneity in idiosyncratic demand and productivity to firm growth. They use a model of monopolistic competition with Cobb-Douglas production and a dataset of Italian manufacturing firms containing unique information on firm-level prices to reach three main conclusions. First, demand shocks are at least as important as productivity shocks for firm growth. Second, firms respond to shocks less than a frictionless model would predict, suggesting the existence of some frictions. Finally, the degree of under-response is much larger for productivity shocks. This implies that, unlike typically assumed by the literature on factor misallocation, frictions may have differential effects according to the nature of the shock. Hurdles to reorganization are then considered as a source of frictions: it is shown that they hamper firms’ responses to productivity shocks but not to demand shocks.

WP 12/10

Jeffrey Butler and Luigi Guiso (with Paola Giuliano) in “Trust, Values and False Consensus” suggest that the tendency of individuals to extrapolate the behavior of others from their own type (false consensus) may explain why trust beliefs are persistent over age and across generations, but at the same time also quite heterogeneous across individuals. To this aim they conduct two experiments. In the first, a measure of participants’ own (initial) trustworthiness is obtained, which is shown to have substantial impact on trust beliefs even after considerable opportunities of learning from the population are offered to individuals. At the same time it is shown that initial trustworthiness can be traced back to the values instilled by parents during the participants’ upbringing. In the second experiment the economic consequences of false consensus are investigated. The results show that individuals who extrapolate the beliefs of others from their own beliefs tend to have miscalibrated beliefs and earn 18% less than individuals with properly-calibrated beliefs.

WP 12/09

Jean-Paul L’Huillier in “Consumers’ Imperfect Information and Price Rigidities” provides a strategic microfoundation of price rigidities by developing a model of a decentralised economy where firms are better informed than consumers regarding the aggregate state of the economy. He then studies how information is transmitted and derives the aggregate response of output and prices to exogenous monetary shocks. First, he shows that the informational asymmetry between firms and consumers endogenously induces price rigidity, as firms are better off delaying the adjustment of prices. Second, the aggregate learning dynamics is non linear: learning is initially slow, and then accelerates as the degree of informational asymmetry between firms and consumers declines. Third, the model features an informational externality, as firms do not take into account the impact of price adjustment on aggregate consumers learning. Fourth, following a monetary shock the model generates the typical hump-shaped responses of output well documented in the literature.

WP 12/08

Francesco Lippi and Luigi Paciello (with Fernando Alvarez) in “Monetary Shocks in a Model with Inattentive Producers” study a model in which prices respond sluggishly to shocks because firms must pay a fixed cost to observe the determinants of the profit maximizing price, so that prices are changed only when the relevant information is gathered. In particular the paper analyses the implications of random transitory variation in the firm’s observation cost.
The paper shows that the real output response to a monetary shock is increasing in the coefficient of variation of observations costs, though the elasticity is very small, so that it is possible to conclude that transitory variation in observation costs has a modest effect on the aggregate response of the economy to a monetary shock.

WP 12/07

Luigi Guiso, in “Trust & Insurance Markets”, argues that in the literature the importance of trust in insurance markets has been overlooked partly because of an implicit assumption that misbehaviour in insurance markets receives full legal protection. However, as legal protection is never likely to be perfect, even when legal institutions are particularly efficient, exchanges in insurance markets are affected by trust. Trust is required both on the side of the company providing insurance and on the side of insurer. The paper documents that the ‘amount of trust’ people have on the players in insurance markets affects their decisions to insure and how much insurance to buy; it then proposes some ‘trust-enhancing’ policies of two types: company-level policies, aimed at raising the trust people have in a particular company (i.e. protect the company reputation from internal abuses); industry-level policies, aimed at raising the perceived trustworthiness of the whole industry (i.e. support the enforcement of punishment of single companies misbehaviour).

WP 12/06

Facundo Piguillem in “Dynamic Bargaining over Redistribution in Legislatures”, with Alessandro Riboni, introduce dynamic bargaining with endogenous status quo in the Neoclassical Growth Theory. In modern democracies most policy decisions are taken by elected representatives who negotiate changes to the policies that are currently in place (the status quo). Yet, these two key ingredients, bargaining and status quo, are absent in the current Macro-political-economy literature. To fill this gap they set up a model where agents are heterogeneous in their initial capital. Redistribution is decided in post-election bargaining rather than by the median voter: this point of departure from the existing literature is key to generate quite novel results. In particular, the paper finds that policymakers may not propose (or accept) high capital taxes because doing so may improve, via a change of the status quo, the bargaining power of low wealth agents in future negotiations. Taking this future cost into account, it is shown that, as opposed to the standard results in the literature, equilibrium capital tax rates are reasonably low – below 35%. In addition, the model is suitable to analyze the consequences of modification to the political institutions.

WP 12/05

Fabiano Schivardi in “Export and Wages: Rent Sharing, Workforce Composition or Return to Skills?”, with Mario Macis, exploits the large and unexpected devaluation of the Italian lira in 1992 to explore the relationship between exports and wages. By using matched employer-employee data he could distinguish between workforce composition effects, changes in the market value of workers’ unobservable skills and an actual export wage premium enjoyed by workers above and beyond what they would get in non-exporting firms. The results indicate that the increase in the export shares induced by the 1992 devaluation did cause wages to rise and that this effect was due to both exporting firms paying a wage premium (“rent-sharing” effect) and to changes in the market value of workers’ unobservable skills (“skill composition” effect). The paper documents that the former is larger for workers with more export-related experience and that the latter only emerges when the value of individual skills is allowed to differ in the pre- and post-devaluation periods. Both findings represent novel contributions to the literature on the effects of international trade on wages.

WP 12/04

Luigi Guiso in “Household Finance. An Emerging Field”, with Paolo Sodini, surveys the fast-growing research in household finance and explains why the study of how households use financial markets to achieve their objectives has attracted a lot of attention over the last decade and gained the status of an independent field in financial economics. He stresses three reasons. First, the size of financial services and products used by households has grown larger than that of corporate finance in many advanced countries. Second, newly available rich and comprehensive data on household finance have given impulse to research in this area, allowing to investigate issues that could not be studied before. Finally, the increased complexity of the products that households face in financial market paired with a documented lack of financial sophistication by many households raises concerns about households ability to cope with financial decisions. This challenges existing regulatory frameworks aimed at protecting households from making mistakes and from being exploited by intermediaries aware of their un-sophistication.

WP 12/03

Valentino Dardanoni in “Incentive and Selection Effects of Medigap Insurance on Inpatient Care”, with Paolo Li Donni, studies the Medigap insurance market in the United States. The Medicare program, which provides insurance coverage to the elderly, does not protect them fully against high out-of-pocket costs. Therefore private supplementary insurance (Madigap) has been available to cover Medicare gaps. The paper estimates how much the utilization of inpatient care is affected by Medigap, separating its incentive and selection effects. To this aim two alternative estimation methods are used: a standard recursive bivariate probit and a discrete multivariate finite mixture model, proposed by the authors. Using data from the Health and Retirement Survey, they find that estimated incentive effects are modest and quite similar across models: individuals who buy Medigap insurance increase, on average, their probability of having an inpatient stay by 4 percentage points. They also find a substantial degree of selection in the market, driven mainly by two residual heterogeneity variables capturing attitude to buy insurance and health care utilization. The latter result points out that Medigap is an insurance market with substantial multidimensional residual heterogeneity and heavy cross-subsidization of high risk types at the expense of low risk ones.

WP 12/02

Luigi Guiso in “Democratization and Civic Capital”, with Paolo Pinotti, using historical data on democratization and voting turnout in Italy, documents that prior to the 1912 franchise electoral turnout was higher in the South than in the North of Italy. They find that the 1912 franchise led to a decrease in the participation in political elections that was much larger in the South than in the North to the point that a reversal emerged and the gap has since never been bridged. These findings suggest that a process of democratization through the concession of voting rights to a larger segment of the population does not lead to higher political participation if the beneficiaries of the new rights lack, as people in the South did, the civic culture necessary to exert them. Moreover, concession of voting rights seems unlikely to develop a civic culture, as the gap between the two areas of the country has never been filled even after decades of democratic rights.

WP 12/01

Giancarlo Spagnolo in “Reputation, Competition, and Entry in Procurement” reviews some recent research of his with other co-authors aimed at better understanding the role of long-term relationship and reputational mechanisms in procurement. He focuses on how these forces interact with supplier competition, entry, buyer’s discretion and the regulatory framework. Public procurement is particularly interesting because – besides sharing the governance problems of private procurement - it is highly regulated for accountability reasons. For instance in Europe regulation constraints the use of past performance information to select contractors while in the US this use is encouraged, though there is a lively debate on whether this behavior reduces the ability of new contractors to enter the market. The paper presents some novel evidence on the benefits of allowing buyers to use reputational indicators based on past performance and concludes reporting preliminary results from a laboratory experiment showing that reputational mechanisms can be designed to stimulate rather than to hinder new entry.

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