New textbook: Frictions and Institutions

My e-textbook, Frictions and Institutions is now downloadable online for free at

Click here to download Frictions and Institutions

This book is based on my lectures on labor market institutions at Humboldt University Research Training Group and IMT Lucca in August and September 2013. It is a textbook which also contains some original research; the latter is presented in a “raw form”, which is relatively close to the way the ideas were originally formulated. Hence there is little dressing up and sweeping under the carpet, which I believe has pedagogical advantages for an audience of graduate students expecting to develop a career in research.

The goal is to induce the student to work with matching models and to perform the required analysis. This is why many analytical results are presented as exercises for the reader. Also, there is substantial emphasis on proving analytical results as opposed to constructing and calibrating a dynamic stochastic general equilibrium model. Mastering the analytics is important because the economic effects being analyzed are explicitly present in the terms of the analytical equations, and interpreting them correctly is a crucial skill any applied theorist should have.

The book introduces the reader to the now largely standard Mortensen-Pissarides (1994) matching model of the labor market, and then builds a number of applications of this model that allow us to study the distributional effects of various labor market policies and institutions. The motivation is simple: many such institutions are considered as harmful for job creation, yet politically difficult to reform. We want to know why, and the framework developed in this book allows us to find out who gains and who loses from those “rigidities”. These rigidities generate conflicts of interest among workers who are otherwise identical but may be in different current situations in the labor market. The currently unemployed have different preferences from the currently employed, and the latter may also differ by the situation of their firm: Workers in firms that are doing well have different interests from workers in firms that are doing poorly.

After having introduced the basics of the matching model, the book considers a number of specific institutions. For each of those institutions, the effect on the welfare of different kinds of workers is computed. The outcome is also compared to the first best, which in most examples coincides with the market outcome if the famous “Hosios conditions” hold. These conditions state that the surplus from a match should be allocated between the two parties in proportion to the relative importance of their search input in generating new jobs, which turns out to be equal to the elasticity of that input in the matching function. That is, the more a given side of the market is important in the job creation process,
the greater the share of the surplus that we want to give it.

I start with employment protection. An important distinction is made between employment protection as a device that enhances the workers’ bargaining power versus employment protection as a tax on separations. I then study the gainers and losers from unemployment compensation. The analysis, by assuming risk neutrality, ignores the insurance dimension of such policies and focuses on its effects on welfare through wage formation and job search. Finally, I study the role of one specific active labor market policy – a subsidy to job search – in a model where workers differ by their productivity level. It is shown that in addition to the usual congestion externality, job search generates a externality on the average quality of the pool of unemployed.

Frictions and Institutions

The attack on meritocracy and the new oligarchy

Ever since Pierre Bourdieu stigmatized the “reproduction of elites”, these elites have felt guilty. That their children’s achievements compare to theirs is perceived as a sign of unfair privilege. And prominent members of those elites do not miss an opportunity to publicly complain about “reproduction” and lack of social mobility, even though privately they spare no money, effort, time and connections to lift their progeny as high as possible in the social ladder.
Reproduction is what life is made of. That social structures reproduce themselves should therefore come as no surprise. Parents transmit genetic, human, financial, and social capital to their kids; this is not only a natural “default” outcome but for many people such transmission is the most important purpose in their life.
For Marxists and partisans of “social justice”, this is unfair because you do not choose your parents. Some kids are lucky to be born in an educated, wealthy family; others are unlucky.
Traditionally this problem had been corrected by putting in place a public education system which was supposed to give everybody the ability to acquire human capital and to progress in society despite an unfavorable initial environment. This system was based on strict meritocratic criteria and was meant as giving opportunities to those who had the will and capacity to seize them; it was not meant to be evaluated on the basis of statistical data regarding the relative outcomes of various social groups.
The system was deemed fair because it was meritocratic, regardless of its outcomes. If indeed the elites reproduced themselves, this was just tough luck for the non-elites who had been on average incapable of seizing their opportunities. Whether or not the system is fair depends on its design and not on its outcomes.
In the era of political correctness, this perception is no longer tolerated. The system has to deliver “equality of outcome”, otherwise it is considered as biased. Furthermore, any person who would claim that the system is fair could be cornered into admitting that members of those groups who do comparatively worse are less deserving, and from them easily accused of racism, sexism, and so forth. This, despite that it is generally the Marxists, not the conservatives, who insist on categorizing individuals by sex, ethnicity, class and other collective characteristics.
As a result the guilty elites are gradually eroding the meritocratic system that brought them to the top, by introducing arbitrary criteria meant to promote “diversity” (a conveniently vague concept) in the recruitment process for elite schools and positions.
So what does it mean to promote “diversity”? To answer that question, we need to note that the criteria by which the system is being evaluated have changed. In 7th century China, participants in the Mandarinate contest had their exams copied by a bureaucrat, so as to make sure that the graders could not recognize the handwriting of the candidates and indulge in favoritism. In the 21th century West, instead, elite educational institutions boast of the proportions of various “disadvantaged groups” in their recruitment, while relying on increasingly opaque and arbitrary procedures.
The two processes go hand in hand: if I am targeting a given statistical distribution for the personal characteristics of my students, I cannot at the same time abide by strict rules that apply to all individuals equally.
The most transparent I could get is to have a segmented recruitment process, by which there would be a fixed number of slots for each group. In such a situation, though, it would be all too obvious that those who are admitted to school X in capacity of their belonging to some anatomical group, are not in the same category as the others. The equality of outcome agenda would simply defeat itself if it were to use such obvious means. Instead, it has to rely on opaque means in order to preserve the illusion that the preferred groups are thriving in a process which does not systematically favor them, but instead relies on criteria that are supposed to have less of a disparate impact on the disadvantaged.
These techniques range from having an admission meeting in order to demote members of the non-preferred groups who would have made it on meritocratic criteria, so as to make room for members of the preferred groups who would not have made it (up to the point where the statistical targets are met), to getting rid of some parts of an entrance exam on the grounds of their alleged disparate impact, and replace them by tests that leave considerably more discretion to the admission committee.
As an example of the first method, I once briefly participated in an NSF-style body in the French university system which was in charge of allocating an important set of grants. After discussing the academic merits of the candidates and ranking them, we then counted the number of people who resided outside Paris and the number of women. If the result was not deemed acceptable by the president of the jury, then some men and some Parisians were demoted from their ranking and replaced by provincials and women. Since I was very uncomfortable in contributing to a process that I do not approve of, I did not last long in that jury, especially given that the president greeted me and the other members by complaining that there were not enough women in the jury (I guess they appointed me just to let me know). This Darwinian elimination process guarantees that the jury will eventually be mostly made of yes-men (and women) who will never challenge its non-meritocratic criteria.
As an example of the second method, the French elite school Sciences-Po has decided to withdraw its general culture test from its entrance exam, on the grounds that “disadvantaged groups” — like recent immigrants — would perform poorly because their background made them less acquainted with mainstream higher French culture (similarly, Pierre Bourdieu advocated that selection at school should emphasize mathematics, which is less culturally loaded than humanities). There were also talks of getting rid of the English language test, on similar grounds that the disadvantaged groups were less proficient in foreign languages, having fewer opportunities to live and vacation abroad. Somebody must have pointed out that English is used to communicate in the modern professional world, and that maybe, just maybe, social mobility would not improve if the Sciences Po graduates, regardless of their family background, were incapable of speaking English. So the English test was finally maintained, but the general culture exam was suppressed.
Which brings the following interesting question: How long can an elite survive, if it recruits its members so as to get rid of any of the characteristics that make it legitimate as an elite? If these people are not more knowledgeable, more proficient in English, nor better at logical reasoning than the average Joe, on what grounds do they hold privileged positions in society? This is of course exactly the question that the eighteenth century enlightened liberals were asking on the eve of the French Revolution. We may speculate that competition in labor markets will do to educational institutions that abandon meritocracy what the French Revolution did to the aristocratic system.
The new criteria that Sciences Po uses heavily favor those applicants who have an “interesting” and “diverse” profile. The fair exam principles borrowed from the Chinese Mandarinate system were well received in a Catholic country for which salvation is a reward for good actions (the selective exams reward hard work, and all candidates who were admitted had “suffered” in preparing the exam; therefore they tend to believe that their suffering was rewarded). By contrast, recruiting “interesting people” is a neo-Calvinist concept borrowed from U.S. universities. Salvation is now an outcome of pre-destination, not of your actions. In fact Sciences Po is remarkably opaque in disclosing how you become an interesting person, because they do not want people to develop a fake personality in order to make it to the school. As a result of the new system, some 40 % of a class had to take no written exam [1] and was admitted on the grounds of a bogus motivation letter which was at best written by their parents, and a 20 minute interview on no specific topic.
The important point here, though, is that these loose criteria, while contributing to the goals of apparent equality of outcomes, at the same time provide the oligarchy with considerable discretion in order to co-opt its members. It is very easy to decide that members of influential networks (financial contributors, political acquaintances, colleagues’ children, media pundits…) just happen to have kids whose profile is wonderfully interesting and diverse. After all, nobody can disprove you and it may even be true! It is easy to imagine that a family located at the center of power has more opportunities for a challenging, original and diverse experience than the children of a regular electrical engineer or manager of a medium-size supermarket in some dull provincial city. And, when one compares these boring middle-class people, whose only claim to upward mobility is hard work and academic excellence, to the Chosen who cannot be bothered being asked demonstrating their skills, all talk of the elite reproducing itself suddenly vanishes [2]. One only opens Bourdieu’s grave when it is convenient.

NB: [1] This ignores specific procedures for foreigners and applicants from “disadvantaged neighborhoods” who also waive any written exam.

[2] The trick is not to distinguish, in the statistics and in the rhetoric, between relatively high skilled workers earning a fair wage on their human capital, and the actual oligarchy in control of power. The dismantling of meritocracy benefits the latter at the expense of the former. 

New working paper (in French): Social networks and socialism

This new piece of research studies the role of social networks in a “socialist” economy where access to goods is rationed (in the paper, this is because of a price cap, but the argument may apply to other forms of regulations). In the model, social networks develop as an alternative device to access a trading opportunity for those goods. As a result, people overinvest in social networks — at the margin, they make friends with people they do not really like, or spend too much time with their relatives, because such networking may provide useful consumption opportunities.
The most interesting result is that regulation may be sustained as a self-fulfilling political equilibrium. This may hold provided some people benefit from it. Here regulation maintains prices below their market clearing level. It benefits the “poor” because they have to pay less for the goods. It harms the “rich” whose income is lower in the regulated society (in the model it is because they own shares in the firms that produce the rationed goods). These “rich” include the “average” individual, who is also harmed due to the price distortion brought about by regulation. Only poor enough people benefit, and that is only because more efficient forms of redistribution are not available.
If people’s ability to invest in their social network is heterogeneous, the expectation of a regulated economy will lead to the emergence of a social group who is well equipped in social capital (and therefore expects to do well in a regulated economy), but with relatively low income. This social class benefits from regulation because they have a privileged access to the goods that are rationed, thanks to their superior social network. They benefit from low prices while not suffering too much from rationing. On the other hand, they are not poor enough to support regulation should they have not invested in their social capital. Therefore, these people validate expectations: if it is anticipated that the economy will be rigid, they invest in social networks and, because they are winners in the social networking game, end up voting in favor of regulation. If it is anticipated that markets will be left unregulated, they do not invest in social networks and vote against it. If this group of people is large enough, both rigidity and flexibilty are self-fulfilling outcomes.
The argument applies to social-democratic societies where a wide range of publicly provided goods are subjected to a price cap (or even free) and rationed. We may mention access to social housing, day care, medical care, summer camps, pension homes, music conservatories, and good schools. The model tells us that the system is supported by a social class of people who are relatively modest economically but well positioned to access those goods thanks to these connections. This article by Eric Le Boucher laments how opacity and complexity in the French higher education system ultimately favors the well-connected (in particular high school teachers) who know how to get into the right track. Indeed, high school teachers are modestly paid, but they are in an excellent situation to use their connections to get their children in the right place. And they have more free time than others that they can use to develop connections and gather information. They match the caracteristics of the social group I have just described.
Along similar lines, this article by Capital points out the pervasiveness of favoritism in the allocation of social housing in France; while sheer bribing is rare, social connections (and affinities) with the key decision makers is essential. One does not need to be miserable to be eligible for social housing. According to the article, 50 % of households in the Paris region are eligible — the proportion of social housing is less than 20 %. It is easy to figure out that among those 50%, the more connected and least poor among the eligible would be better-off in a free market system where they would not have spent as many resources to establish connections. But these resources are sunk costs and they end-up locked in in a situation where they gain from rigidity.

On the art of clientelism

Besides the train strike (which is basically over), there is another protest movement by the so-called “intermittents du spectacle” (henceforth “intermittents”). These are employees of the cultural/media industry who enjoy a specific unemployment benefit system. Essentially this system allows them to move back and forth between temporary employment and unemployment benefits, while other temporary workers (say in the tourism industry) would have to spend a larger fraction of their time in employment in any given year to be eligible for benefits. Beyond the eligibility rules, being on benefits has become a way of life for the intermittents. As a result, their specific unemployment benefit system has an annual deficit of about 1 billion euros, which is about the same, for 250.000 contributors, as that of the general system, which covers 16 million people. This is a transfer from the rest of society (including poorer people and people who have far less enjoyable jobs) to the intermittents.

As a result, the social partners, who are supposed to negotiate the financing of the welfare state, have regularly tried to cut on these conditions. In general there has been enough consensus between unions and employers on these reforms, because the intermittents are perceived by regular working class employees as privileged, while employers want to cut on labor costs and social security contributions. Thus the main private sector labor union, CFDT, has generally gone along with the employers’ proposals to cut the benefits. By contrast, the CGT labor union which represents mostly public sector employees is opposed to the cuts, and is active in organizing the intermittents. This is rational: While the CFDT median voter has to finance the intermittents scheme by paying higher contributions to the unemployment benefit system, public sector workers have job security and therefore do not contribute to the system.
In 2003 a reform was implemented and met by protests that perturbed a number of summer cultural festivals, up to the point that a sacred cow of French cultural mythology, the Avignon theater festival, had to be cancelled.

The same scenario is being played out right now as another agreement by the social partners has managed to put some mild cuts into place for the intermittents’ specific system. The movements should be less popular than ever, given the punitive tax increases that have been inflicted on most of the population since 2011. Nevertheless the Valls government has already yielded to the intermittents by transferring part of the costs to the tax payer; the agreements between the social partners is, then, purely cosmetic. The financing of the system is being put into the general government budget instead of the “social accounts”.

[Quite remarkably, exactly the same trick was played after the 2003 reforms. But you have to read the austere report of the "Cour des Comptes" (a committee of Cassandrae who open closets and lift carpets, then write reports on what they have found, and whose wise recommendations are invariably ignored by the politicians) to figure out how. The 2003 reform made eligibility rules stricter. But a special fund, financed out of the government budget, was put in place to guarantee a smooth landing for those who were no longer eligible. The fund was supposed to be temporary (like the jobs of the intermittents), but never trust a temporary measure.]

The existence of the intermittents is a remarkable example of political clientelism. Over the years, the eligible population has been multiplied by 10. This reflects the explosion of “cultural” spending by successive governments. Short-time unemployment compensation is a way of life for most people involved in “spectacle vivant” (theater, dance, clowns, happenings) and is also used by television and radio channels, including the State-owned ones, to pay their technicians.

The rise in the number of people working in the “cultural” sector, maintained by subsidies at an artificially large size, is a way for the political left to recruit its own electorate. The intermittents are a captive electorate, because the excess size of the entertainment sector puts them constantly under theat. They know that a substantial fraction of them would have to relocate to other industries (and lose part of their human capital) should the subsidies be cut. They also know that employers, and more generally union representatives for private sector employees, have targeted the intermittents benefit scheme as a priority for implementing cuts in social spending. This means that the threat they face is associated with the political right, implying that they need the left to be in power so as to protect their rents.

Distributing rents is not sufficient for successful clientelism. If the beneficiaries of the rents think that the opposite political party will treat them just as well, they have little incentives to reward your clientelism with votes. The rent must therefore be designed in such a way that your political opponents will try to eliminate it. By having the intermittents UB scheme being financed out of the UB system instead of the general budget, one makes the cost to other workers more apparent. That is, as you create the rent, you create a constituency against that rent at the same time. And that constituency is important in convincing your clientele that your opponents will attempt to eliminate their rent. The price to be paid for it is that the scheme will come regularly under attack; but these attacks secure loyalty among your supporters.

While the rent has to be fragile, it has to be resilient at the same time. You will need your clientele as an army to reconquer power if your opponents win the next election. But this army will not be around should the next government eliminate the scheme by a stroke of pen. To prevent that, make sure that the rent is not a discretionary subsidy scheme. Instead, it should be embodied in some form of entitlement.

The clientelism scheme will also work better if you can recruit more people into it. This means that the rent should be relatively small, so as to save resources for raising the number of beneficiaries. And if your clientele is an occupation or an economic sector, entry into it should be relatively easy (of course entry cannot be costless because that would simply eliminate the rent). Indeed many of intermittents are relatively mediocre artists who would have elected a different occupation in the absence of the scheme. Lowering standards and promoting amateurism goes hand in hand with the ability to enroll many people. Conversely, one would not go very far politically by promoting “excellence” in the arts instead.

Finally, make sure to “leverage” your clientelism by designing it so as to enroll indirect supporters in addition to direct ones. Suppose you are the mayor of a small city; you get more support by giving municipal jobs to members of large families than small families. By hiring one employee, you not only make him happy, but also his parents, sister, cousins, and so forth. In that respect, targeting the entertainment industry is a clever idea, since they can potentially enroll the audience. By targeting artists and intellectuals for your clientelism, you also achieve leverage. By virtue of their profession, these people influence public perceptions; and a dog does not bite the hands that feed him. Indeed each election a cohort of artists and intellectuals duly endorse the left in the media, while the right has to content themselves with a handful of athletes, movie stars and popular singers (who in fact reach out to far more people than the artists and intellectuals, but the point here is that many of the latter benefit from government subsidies).

I can only speculate about why over the years the right-wing governments have proven impotent in reducing the size of a scheme which, in addition to being considered unfair by many people, runs against them politically. Perhaps an explanation is that the educated bourgeoisie, who consume a substantial amount of “elite” cultural products, does not want their music and theater festivals to be sabotaged. This is a form of hostage taking but the hostages seem to be struck by some sort of Stockholm syndrome, perhaps rationally so. They contribute more to the system than they get, but as consumers of cultural products they do get part of their taxes back in the form of low prices and an abundant supply. They expect to lose more from a less profligate and more expensive cultural sector than they would gain from reduced social security contributions if the cuts were to be implemented.

Remarks on quantitative easing

The following post is a bit long and can be downloaded in pdf here.
The issues discussed in this text are, quite naturally, the subject of a lively online debate among US economists. See here for an entry point into the discussion.

The so-called “Great Recession” has led, almost overnight, to a new conventional wisdom in macroeconomics. This new conventional wisdom roughly amounts to the view that monetary and fiscal stimulus are costless and should be used without restraint. One justification is that interest rates are stuck at a zero lower bound and the economy runs the risk of a deflationary spiral: As inflation becomes negative, real interest rates go up and the central bank is unable to reduce them because its policy rate cannot go below zero. What should be done to lift the economy off this deflationary spiral, the conventional wisdom goes, is to raise inflationary expectations. This will prompt people to get rid of the money they are hoarding by spending more. How do you raise inflationary expectations, since this is not a policy variable? The answer is that it is not easy. But the dominant view, it seems, is that “Quantitative Easing” — increasing the money stock by massive purchases of government securities — is likely to raise inflationary expectations and get us out of the dreaded liquidity trap. The argument is fuzzy because it is rational to believe that once one gets out of the liquidity trap, the central bank will resume its usual monetary policy, and will not let inflation go beyond its target. The central bank’s supposed virtue and consistency is running against its attempt to raise inflation expectations. For it to work, we would need that people irrationally believe that the central bank has shifted to (for example) a constant money growth policy starting from a new inflated money stock. Conversely, appointing an inflation-prone central banker (as Russia has in the 1990s) should be enough to raise inflationary expectations without having to resort to QE.
Besides the fact that the government simply does not control them, the idea that one should raise inflationary expectations, even in a liquidity trap, is highly dubious.
For one thing, inflationary expectations is the worst way to raise aggregate demand, because at the same time it reduces aggregate supply. The effect may be weak if in a recession the aggregate supply curve is locally very flat, as would be the case if, for example, there is also a zero lower bound on nominal wage increases; that is, there could be so much slack in the economy that a rise in inflationary expectations would not be reflected in increased wage pressure. Even so, it is always a better idea to move along the aggregate supply curve than to shift it in the wrong direction. Thus using fiscal policy looks like a better idea than QE (my preferred option being public infrastructures, since they do not commit future expenditures as compared to, say, hiring government workers). Indeed, mainstream economists believe that the fiscal policy multiplier is quite large at a zero lower bound (a view that was present in macro 101 textbooks already in 1970). So why insist on pushing monetary stimulus further when it has reached its “physical” limit?
Furthermore, QE may even fail to raise aggregate demand, because it is likely to raise future uncertainty about inflation and therefore activity. If consumers make precautionary savings, then they will react to that uncertainty by reducing current consumption, and the stimulus policy will in fact contract aggregate demand. This criticism applies, of course, to any stimulus strategy which raises uncertainty about the future; for this reason, transparency, predictability, and credibility are a crucial component of any successful stabilization policy.
The purported motivation for QE (the risk of a deflationary trap) is also dubious and vastly exaggerated . In the monthly inflation series shown below, inflation has been negative only three times. It is around 2 % since April 2011 and the most recent data indicate an acceleration.

fed funds

Despite these developments, the policy rate remains stuck at zero.

fed funds

As a result, short-term real rates remain largely negative. This is not unusual, as this was also the case in the preceding recession, although they are even lower since then the Fed did not indulge in zero rates. The following graph shows how volatile real interest rates are due to the Fed’s active stabilization policy.

Real short rate

From those data I was tempted to conclude that the monetary policy regime has changed and that the Fed has shifted from an inflation targeting rule to a debt monetization rule. But it is too early to draw such a conclusion. The reality is that the Fed is willing to engineer enormous swings in real interest rates in order to fulfill its targets — which of course makes it more likely to hit the zero lower bound, compared to the ECB which is less reactive. Despite the steady fall in unemployment, the Fed has maintained its zero-rate policy. But the unemployment rate is still relatively high (6.3 %); this is about its peak level during the preceding recession, during which real rates were reduced to similar negative levels, and the zero lower bound was not hit because inflation was a bit higher than now.

civilian unemployment

An interesting way to look at the Fed’s monetary rule is to correlate the short-term real rate with the unemployment rate. We see a steep negative relationship, which confirms the very strong reaction of the Fed; we may ask whether it is a good idea to have so wide fluctuations in real rates, an important allocative price. We also note that the relationship shifts down at some point; the shift takes place somewhere around mid-1997, after which a lower real rate is tolerated. In my view, this captures a more expansionary monetary policy rule (there was a view at the time that potential output growth has improved, but inflation crawls up after this shift until the collapse of the Internet bubble).
The circled zone represents the crisis period during which monetary policy hits the zero lower bound and interest rates cannot be reduced further; the Fed is then compelled to deviate from its real rate/unemployment schedule. The graph makes clear that we have exited this zone; the last available point is not far from the usual rule. Hence my conclusion that we can’t conclude that the rule has changed, although we may ask whether it is not too expansionary (is -2 % at 6 % unemployment sending the right signals to the economy?). Another reason to believe so is the sharp acceleration of inflation in the run-up to the crisis, which suggests that 4.5 % is below the natural rate of unemployment, and therefore that the U.S. economy may not be that far from it.

unemployment vs real rate

Some people believe that the unemployment rate is a poor indicator of slack because participation has fallen during the crisis. According to this argument, there are discouraged workers out there who do not bother to register as unemployed but would be happy to hold a job should they find one. Therefore, these people say, the Fed is justified in pursuing the zero interest rate policy despite that the unemployment rate is only one point above the natural rate.
Just because something evolves during a crisis does not make it cyclical. The distinction between trend and cycle may be misleading. A crisis is a situation where actions are highly correlated across agents, and these actions may be permanent and indicate structural change. For example, the Spanish construction sector collapsed during the crisis, but will probably never recover to the same levels. The structural change in the sectoral composition of Spanish economic activity is taking place during, and being facilitated by, the crisis. This is the (painful) way the economy “learns” its sectoral allocation of activity is inadequate.
Looking at participation rates separately for men and women confirms that the evolution of participation is mostly structural. The female participation rate is flat and has been so (at 75 %) since 1996. There is no surge in female discouraged workers during the crisis. The male participation rate is trending downwards from the mid-sixties. The trend was indeed slowing down before the crisis, and has sharpened since the onset of the crisis. Interestingly, the process continues despite the steady recovery of the American economy.

female participation

male participation

The downward trend in male participation is due to the decomposition of family structures. Statistically, half of households will be dissolved by divorce and custody will be awarded to the mother in the vast majority of cases. The return to labor market participation for men is much lower than in the past; the need for their earnings is reduced both due to marital instability and rising female participation. On the other hand, divorce is associated with a substantial tax on those earnings, with little counterparts. The contrary holds for women who can expect to end up as a sole provider in a single-headed household with substantial probability. For those reasons we may even think that female participation will end up being higher than male participation. At present this is not the case, though.
Hence, the case for a purely cyclical downturn in participation rates seems rather weak to me.
How effective is the Fed at raising inflationary expectations (remember it is not a good idea)? The following graph shows some consumer survey data. The median inflationary expectation is remarkably stable around 3 %. Despite a little blip in 2011, agents return to that level; if the goal of quantitative easing is to raise those expectations above their normal secular value, this goal has not been achieved. On the other hand, these numbers have been above realized inflation since the beginning of the crisis, so perhaps QE has indeed raised inflation expectations a little bit (and we don’t really know why).
Finally we may believe that the zero lower bound rhetoric is just an ideological justification for monetary financing of the deficit. I am quite tempted to believe that, but if the economy is in a liquidity trap, then money and bonds are perfect substitutes. Therefore, in principle the public is willing to hold government bonds at the going, zero, interest rates, and it is not clear why the central bank should purchase them instead. While one may dispute the merits of monetary policy, at the end of the day what matter is the equilibrium interest rate, not the way in which money is injected into the economy. If, say, the zero lower bound were reached by massive injections of liquidity into banks instead of bond purchases, the government would not find it difficult to float its debt on the market at the going rate.
Things are different, of course, in the case of purchases of troubled member states debt by the ECB. While part of these purchases act by killing the expectation that the country might leave the Euro, the other reason why they act is by indirectly mutualizing the debt between member states. The seignoriage revenues paid by a member state to the ECB are more or less proportional to the share of the monetary base that is present in that state. But if the proceeds are used to purchase Portuguese debt, those revenues accrue disproportionately to the Portuguese state (and this indirect transfer, and the associated implicit guarantee, naturally reduces the cost of borrowing for the Portuguese government).

Inflation expectations

The non-employment society: two anecdotes

There is a musical theater near where I live which has a very active and wonderful season. It produces a number of operas. We all know that operas are long and theater halls pretty hot. As a result there are intermissions, during which the thirsty people rush to the bar. At the bar there is a single waiter who is visually impaired. Despite that, he does an extraordinary job at attenting everyone he can, delivering the drinks at an incredible speed. Managing all these customers in the limited intermission period is a stressful and physical activity. Despite all his efforts, there is so much congestion that many people give up on the possibility of buying a drink. The price of a glass of Champagne is 10 Euros. There are perhaps 8 glasses in a bottle, and let’s say the bottle costs 20 Euros to the theater. The theater makes 7.5 Euros per glass sold. The hourly cost of an employee (who could for example be a student) is around 10 Euros. Make it 20 with payroll taxes. This means that the theater would recoup the cost of an extra employee, paid one hour, if only that person sold 3 extra glasses of Champagne. While space is limited, the bar can accomodate more than one waiter — at least 3, perhaps 4. 

I can only speculate why this highly profitable transaction does not take place. Presumably the new recruit will only be employed a few hours per week. While regulation makes this increasingly difficult (what’s the point of having a socialist government if it does not reduce economic freedom?), it is not impossible. It is possible that local unions block such hirings, out of an ideological stance against “precarious” forms of labor (they prefer people to be on the dole). It could be employment protection, which makes it difficult to get rid of the worker if something goes wrong. It could be a lack of managerial incentives, since the theater is indirectly State owned and has little incentives to maximize profits. Or it could be the general cultural aversion toward hirings which pervades French society. Since the early eighties, when a host of restrictive labor laws was implemented, rationally inattentive managers have adopted this simple strategy: only hire when strictly necessary.

My other example comes from a TV program, which described how French driving schools were being opened in Barcelona. The French driving license is aberrantly difficult and costly to obtain. I was supposed to know the formula for kinetic energy, the meaning of signs that were only relevant for trucks my potential license did not allow me to drive, and many other irrelevancies. Things do not seem to have improved since then. In particular, according to the TV program, the administration in charge of running the practical part of the exam is under-staffed, an ironical feature in a country where 25% of employees work for the government. As a result, people have to apply for that part months in advance, and, if they fail (which is frequent), they lose another six months. Many people, especially among the low skilled, cannot find a job because they do not have a driving license. Furthermore, while waiting for the exam, people continue to take regular driving lessons. At the end of the day, their driving license has cost them a fortune. The extent to which the driving school is coercing them into taking all those lessons is unclear to me. Why don’t people apply six months in advance and start taking driving lessons, say, two months before the exam? The sector is somewhat open to competition but once one has elected a school, it processes your application to the exam, so it has some power over its clients.

In any case, according to the TV program, in Barcelona one can take the exam 12 days after applying. Furthermore, wages, labor taxes, and gasoline taxes (an important cost item for such a business) are substantially lower there. And by virtue of the European Single Market, Spanish driving licenses are, I suppose, recognized in France. So people find it worth to purchase a low cost plane ticket (thanks to air transport deregulation), rent a room for a month there, and take the exam. Hence, some clever French people opened a driving school, thus giving lessons in French to their French clients. And the Single Market, again, guarantees that the Spanish or Catalan authorities cannot prevent them from running their business. 

Why are French trains on strike this time?

The main Marxist unions are going on strike as a protest against the merger between “Réseau Ferré Français”, the rail operator, and “SNCF”, the train operator. I was not aware of this merger plan, for the simple reason I did not think it would even be possible. The rail operator had been split from the train operator, following guidelines from the European Union, to introduce competition in train services. While the infrastructure per se is considered a natural monopoly, the business of operating trains is not, and therefore the European Commission has tried to introduce competition there, as was done long ago in the U.K.
Indeed, private operators have been allowed in the freight business (the SNCF market share in that sector is around 85 %), but no government has dared to confront the unions by introducing competition in the passenger business. As a result, SNCF has been able to reap substantial rents. According to a report, the price of a train ticket has been rising twice faster than inflation between 2002 and 2009. The celebrated TGV often costs almost as much as an Air France ticket on the same route. In a country obsessed with sustainable development, travelling by car is generally more economical than using the train.[1]
The monopoly power of SNCF (and therefore its unions) is supported not only by restrictions on intramodal competition, but also on intermodal competition. It is illegal to operate a bus route between two places that are served by SNCF. A famous trick to go from Paris to Strasbourg by bus consists in purchasing a Paris/Warsaw bus ticket and ask the driver to drop you while passing through Strasbourg. And of course the Paris/Warsaw bus ticket is cheaper than the Paris/Strasbourg train ticket.
While the French governments’ going along with the Brussels deregulation plans has always been mostly cosmetic, I would not have thought that it could openly go backwards and engineer a merger between the network operator and the national train company. Any future operator who believes it could compete fairly with a publicly funded rival which has captured the network operator has to be a fool (similar considerations explain why Air France has a 96 % market share on domestic flights).
The European Commission does not plan to remain idle in response to this insult, but how many divisions does it have?
Why do those unions oppose the merger? It should make it easier for them to preserve their rents in the long term. It is in particular making sure that any private operator will be bound by the same collective agreements regarding wages and working conditions as SNCF. But the unions fear that the merger could make SNCF more efficient, which would of course destroy some jobs and even allow management to keep labor costs down. So the unions are not against the merger per se but they would have liked further provisions to make sure productivity cannot go up. For example they asked for a plan to “re-humanize” train stations, i.e. replacing ticket vending machines by people, although they are probably content with keeping the machines while having those people sitting idle at some information booth instead of selling tickets.
In any case, it is hard to believe that these fears are sincere. Mergers lead to efficiency gains only in a reasonably competitive environment. As long as the system is rigged to maintain a very high market share for SNCF, the conglomerate will prefer to buy social peace, knowing the taxpayer will eventually foot the bill. In particular, the reform has a provision to involve the regional governments in the management of SNCF. These regional governments generally insist to maintain lines that have very few customers but that they deem essential for “territorial development”. This provision is making it less likely that SNCF will shut those politically sensitive, but inefficient train lines.
It is more likely that the strike is part of the general offensive against the Valls government, which is highly suspected by left-wingers of being a “social-liberal” modernist one, economically aligned with Brussels. Indeed the same unions are also organizing taxi drivers and temporary workers in the cultural industry (who have a specific unemployment benefit regime). Their nightmare is to have to deal with a French variant of Felipe Gonzalez, a deregulating, privatizing and tax-cutting socialist. And where would such a hybrid individual be born, if not slightly south of the Pyrénées?

[1] There are, however, other explanations for the drift in ticket prices. One is that ticket prices were initially too low, for political reasons; they ended up being high because at the end of the day rail transport is not a very efficient technology. The other is that ticket prices simply reflect the upward trend in the fees charged by RFF to SNCF for using its network. This may sound incredible: how can a publicly owned operator charge a markup to its public client, despite that its mandate should be to keep prices close to marginal costs and that double marginalization is highly inefficient? The answer, I believe, lies with the under-researched issue of government schizophrenia. The bureaucrats in charge of RFF do not internalize the wider social welfare or even the wider government budget constraint; some government representative on the board considers it as his job to raise the profits of RFF, independently of the net effect of RFF’s pricing policy on the economy and the general government budget.