Social security in theory and practice (I): Facts and political theories

166 countries have some kind of public old age pension. What economic forcescreate and sustain old age Social Security as a public program? We document some of the internationally and historically common features of Social Security programs including explicit and implicit taxes on labor supply, pay-as-you-go features, intergenerational redistribution, benefits which areincreasing functions of lifetime earnings and not means-tested. We partition theories of Social Security into three groups: "political", "efficiency" and "narrative" theories. We explore three political theories in this paper: the majority rational voting model (with its two versions: "the elderly as the leaders of a winning coalition with the poor" and the "once and for all election" model), the "time-intensive model of political competition" and the "taxpayer protection model". Each of the explanations is compared with the international and historical facts. A companion paper explores the "efficiency" and "narrative" theories, and derives implicationsof all the theories for replacing the typical pay-as-you-go system with a forced savings plan.

Markups, gaps and the welfare costs of business fluctuations

In this paper we present a simple theory-based measure of the variations in aggregate economic efficiency: the gap between the marginal product of labor and the household s consumption/leisure tradeoff. We show that this indicator corresponds to the inverse of the markup of price over social marginal cost, and give some evidence in support of this interpretation. We then show that, with some auxilliary assumptions our gap variable may be used to measure the efficiency costs of business fluctuations. We find that the latter costs are modest on average. However, to the extent the flexible price equilibrium is distorted,the gross efficiency losses from recessions and gains from booms may be large. Indeed, we find that the major recessions involved large efficiency losses. These results hold for reasonable parameterizations of the Frisch elasticity of labor supply, the coefficient of relative risk aversion, and steady state distortions.

Do interregional transfers improve the economic performance of poor regions? The case of Spain

The 17 regional governments of Spain receive grants from both thecentral government and the European Union. The grants are generallyredistributive and are intended to stimulate economic activity inthe poorer regions. We evaluate the effectiveness of the grants bycomparing the economic performance of the regions before and afterthe implementation of the grant programs using a differences--in--differences approach. We find that these policies have not beeneffective at stimulating private investment or improving the overalleconomies of the poorer regions.

Adjustment to target capital, finance and growth

Does financial development result in capital being reallocated more rapidly to industries where it is most productive? We argue that if this was the case, financially developed countries should see faster growth in industries with investment opportunities due to global demand and productivity shifts. Testing this cross-industry cross-country growth implication requires proxies for (latent) global industry investment opportunities. We show that tests relying only on data from specific (benchmark) countries may yield spurious evidence for or against the hypothesis. We therefore develop an alternative approach that combines benchmark-country proxies with a proxy that does not reflect opportunities specific to a country or level of financial development. Our empirical results yield clear support for the capital reallocation hypothesis.

Productivity growth and the exchange rate regime: The role of financial development

This paper offers empirical evidence that a country's choice of exchange rate regime can have a signifficant impact on its medium-term rate of productivity growth. Moreover, the impact depends critically on the country's level of financial development, its degree of market regulation, and its distance from the global technology frontier. We illustrate how each of these channels may operate in a simple stylized growth model in which real exchange rate uncertainty exacerbates the negative investment e¤ects of domestic credit market constraints. The empirical analysis is based on an 83 country data set spanning the years 1960-2000. Our approach delivers results that are in striking contrast to the vast existing empirical exchange rate literature, which largely finds the effects of exchange rate volatility on real activity to be relatively small and insignificant.

Gross capital flows: Dynamics and crises

This paper analyzes the behavior of international capital flows by foreign and domestic agents,dubbed gross capital flows, over the business cycle and during financial crises. We show thatgross capital flows are very large and volatile, especially relative to net capital flows. Whenforeigners invest in a country, domestic agents invest abroad, and vice versa. Gross capital flowsare also pro-cyclical. During expansions, foreigners invest more domestically and domesticagents invest more abroad. During crises, total gross flows collapse and there is a retrenchmentin both inflows by foreigners and outflows by domestic agents. These patterns hold for differenttypes of capital flows and crises. This evidence sheds light on the sources of fluctuations drivingcapital flows and helps discriminate among existing theories. Our findings seem consistent withcrises affecting domestic and foreign agents asymmetrically, as would be the case under thepresence of sovereign risk or asymmetric information.

Trends in hours, balanced growth and the role of technology in the business cycle

The present paper revisits a property embedded in most dynamic macroeconomic models: the stationarity of hours worked. First, I argue that, contrary to what is often believed, there are many reasons why hours could be nonstationary in those models, while preserving the property of balanced growth. Second, I show that the postwar evidence for most industrialized economies is clearly at odds with the assumption of stationary hours per capita. Third, I examine the implications of that evidence for the role of technology as a source of economic fluctuations in the G7 countries.

Indentifying human capital externalities: Theory with an application to US cities

The identification of aggregate human capital externalities is still not fully understood. The existing (Mincerian) approach confounds positive externalities with wage changes due to a downward sloping demand curve for human capital. As a result, it yields positive externalities even when wages equal marginal social products. We propose an approach that identifies human capital externalities whether or not aggregate demand for human capital slopes downward. Another advantage of our approach is that it does not require estimates of the individual return to human capital. Applications to US cities and states between 1970 and 1990 yield no evidence of significant average -schooling externalities.

The political consequences of unemployment

We analyze the channels by which an ill-functioning labor market changes the preferences of the people for public policy and therefore the decisions that are made. We not only discuss labour market reform but other important aspects of policy making such as the size and structure of government spending. Theclass of mechanisms that we highlight can be summarized as the very existence of unemployment generating political support for "sclerosis". This may help to explain the timid pace of reform, in particular the fact that any recovery sends them at the backfront of the political agenda, and the sometimes violent opposition generated by some measures, as we have seen mostly in France.

Economic shocks and civil conflict: A comment

Miguel, Satyanath, and Sergenti (2004) argue that lowerrainfall levels and negative rainfall shocks increase conflictrisk in Sub-Saharan Africa. This conclusion rests on theirfinding of a negative correlation between conflict in t andrainfall growth between t-1 and t-2. I argue that this findingis driven by a positive correlation between conflict in t andrainfall levels in t-2. If lower rainfall levels or negativerainfall shocks increased conflict, one might have expectedMSS s finding to reflect a negative correlation betweenconflict in t and rainfall levels in t-1. In the latest data,conflict is unrelated to rainfall.

Nominal debt as a burden on monetary policy

We study the effects of nominal debt on the optimal sequential choice of monetary policy. When the stock of debt is nominal, the incentive to generate unanticipated inflation increases the cost of the outstanding debt even if no unanticipated inflation episodes occur in equilibrium. Without full commitment, the optimal sequential policy is to deplete the outstanding stock of debt progressively until these extra costs disappear. Nominal debt is therefore a burden on monetary policy, not only because it must be serviced, but also because it creates a time inconsistency problem that distorts interest rates. The introduction of alternative forms of taxation may lessen this burden, if there is enough commtiment to fiscal policy. If there is full commitment to an optimal fiscal policy, then the resulting monetary policy is the Friedman rule of zero nominal interest rates.

Setting standards: Information accumulation in development

We propose a model in which economic relations and institutions in advancedand less developed economies differ as these societies have access to different amounts of information. This lack of information makes it hard to give the right incentives to managers and entrepreneurs. We argue that differences in the amount of information arise because of the differences in the scale of activities in rich and poor economies; namely, there is too little repetition of similar activities in pooreconomies, thus insufficient information to set the appropriate standards for firm performance. Our model predicts a number of institutional and structural transformations as the economy accumulates capital and information.

Gerontocracy, retirement, and social security

Why are the old politically successful? We build a simple interest group model in which political pressure is time-intensive, showing that in the political competitive equilibrium each group lobbies for government policies that lower their own value of time but the old do so to a greater extent and as a result are net gainers from the political process. What distinguishes the elderly from other political groups (and what makes them more succesful) is that they have lower labor productivity and/or that we are all likely to become elderly at some point, while we are relatively unlikely to change gender, race, sexual orientation, or even ocupation, The model has a variety of implications for the design of social security programs, which we test using data from the Social Security Administration. For example, the model predicts that social security programs with retirement incentives are larger and that the old are more "single-minded" in their politics, implications which we verify using cross-country government finance data and cross-country political participation surveys. Finally, we show that the forced savings programs intended to "reform" the social security system may increase the amount of intergenerational redistribution. As a model for evaluating policy reforms, ours has the attractive feature that reforms must be time time consistent from a political point of view rather than a public interest point of view.

Flexibility vs. rigidity: Does Spain have the worst of both worlds?

In this paper we study the structure of labor market flows in Spain and compare them with France and the US. We characterize a number of empirical regularities and stylized facts. One striking result is that the job finding rate is slightly higher than in France, while the jon loss rate is much higher, putting Spain half-way between France and the US. This suggests that while Spain has borne the full cost of its labor market reforms in terms of job precarity, the benefits in terms of job creation have been quite modest. We hypothesize that this has been due to the reform s credibility being imperfect, which leads toexpectation of reversal.

Asset prices and the measurement of wealth and saving

The paper defines concepts of real wealth and saving which take into account the intertemporal index number problem that results from changing interest rates. Unlike conventional measures of real wealth, which are based on the market value of assets and ignore the index number problem, the new measure correctly reflects the changes in the welfare of households over time. An empirically operational approximation to the theoretical measure is provided and applied to US data. A major empirical finding is that US real financial wealth increased strongly in the 1980s, much more than is revealed by the market value of assets.