It is perhaps natural human tendency to think that the big events that occur during our lifetimes — particularly if they involve us personally — are both unique and will change the course of history. Reality though is that most of us aren’t particularly good at predicting what future historians will consider important. Worse, we tend to dramatically exaggerate the importance of events that we have watched occur. Rogoff and Reinhart’s bestselling treatment of the history of sovereign debt has the ironic title This Time is Different precisely because of how often we are wrong in thinking that “this time is different.” Having provided these cautions, I am going to fall into the precise trap I warned against and assert that the period between March 2012 and March 2013 will go down in history as one of the most eventful ever in the history of sovereign debt. This time is different. Why?

There are a number of candidates in terms of potentially game changing events that occurred in the sovereign markets over these past twelve months. As a backdrop to these events, we are in the midst of what is likely one of the most biggest sovereign debt crises in history: the crisis of the euro area.  That crisis, which began with European politicians swearing up and down in 2010 and 2011 that no Eurozone country would ever default, saw Greece, in March 2012 impose one of the biggest and most severe haircuts on private sector creditors in history. Euro area politicians who (like me) seem to have little concern for how historians might subject their statements to ridicule in hindsight are now announcing loudly that the Greek restructuring was “unique and exceptional”.

So much happened within the Greek restructuring that was new, and even when not new, certainly eventful.  Foremost, there were the legislatively mandated Collective Action Clauses that were imposed on local law governed debt instruments. Then was the drama over whether the Greek restructuring was voluntary or not and whether the CDS contracts would be triggered (hard to imagine how anyone could think that a creditor taking a 70% haircut was doing so voluntarily; but that argument was made at various points). And if that was not enough, at the nth hour in the Greek restructuring, the European Central Bank demanded for itself, as a legal right, super priority over all other creditors — essentially the right to be exempt from the restructuring. As a matter of optimal rules for the system, there is probably an argument for Official Sector lending by institutions like the ECB and the IMF to be given super priority. But the ECB’s priority claim, unlike IMF claims in the past, was with respect to bonds that it had purchased on the market just as if it were an ordinary investor. There was a risk, therefore, that investors who had entered the Greek exchange would bring a legal claim against the ECB for having received an illegal priority. As of this writing it is not clear whether any of the claims that have been threatened will bear fruition, but the can of worms regarding the precise contours of Official Sector priority has been opened.

There was more that didn’t make the daily headlines, but will probably make the history books. There was the explicit inclusion of some of Greece’s sovereign guarantees in the restructuring (no one quite understands why some guarantees got ensnared and others escaped completely, but that is a matter for a different day). And then there were was the treatment of the foreign-law bonds in the Greek deal. There was some attempt to extract a haircut from them; but the attempt was half-hearted at best — much more could have been done to turn the screws. Which, in turn, raises the puzzle of why the holders of those foreign-law bonds (many of whom likely go under the moniker “hedge fund”) were treated with such solicitude Literally, the holders of some of these foreign-law bonds were just asked politely whether they would like to restructure and when they said no (some did say yes), they were paid in full and on time. By contrast, the holders of the local-law bonds got taken to the woodshed.

The events in Greece itself would have entitled the past twelve months to go down as one of the most eventful in periods in sovereign debt history. But so much more happened as well. In Ireland, to restructure the debts of one of the banking institutions at the center of that nation’s crisis, the authorities invoked a technique called the Exit Exchange. This technique, through the 1990s, had been used to successfully engineer multiple sovereign debt restructurings (among them, Ecuador, Uruguay and the Dominican Republic). The technique is one that is aimed at, to put it politely, incentivizing holdout creditors to accept a restructuring offer that a majority of other creditors like, but that the holdouts would rather not take. As a legal matter, utilizing the technique has always been a tricky matter, since there is a fine line between deterring holdout creditors from blocking a deal that is in the collective interest of the creditor group and coercing the whole group. In the transactions, the Irish authorities decided to go on an all out attack in terms of the “offer you don’t want to refuse” that they presented creditors with. The debt in question though was governed by English law and an English judge in Assénagon Asset Management v. IBRC decided that the aforementioned line had not only been crossed, but abused and trampled. So much so that he wrote an opinion that called into question the validity of all future uses of the technique. Whether the opinion is followed by other courts is yet to be seen. But I suspect that regardless of how much commentators complain about the Assénagon case, the Exit Exchange technique will never be the same.

In the meantime, while announcing that the Greek restructuring was “unique and exceptional”, the euro area authorities mandated, starting January 1, 2013, what is easily the biggest change in contract language in sovereign debt contracts ever. All Eurozone sovereign debt contracts, regardless of governing law or other provisions, will henceforth (with minor allowances for a transition period) will contain Collective Action Clauses or CACs. These E-CACs in question are the technical devices that Greece imposed on its bonds legislatively so as to be able to engineer its March 2012 restructuring. The Eurozone has put into effect in all bonds for all of its members, much the same mechanism that Greece utilized. There are at least two things about this Euro CAC initiative that are historically significant. First, the reform attempts to change the standard template for not just foreign-law governed bonds (the focus of prior contract reform attempts), but also local-law bonds. Second, the contract terms here are being mandated. Prior to this, sovereigns had always chosen the contract terms that they thought best suited their individual interests.  No longer; at least not in the euro area. The policy decision was made that one size should fit all. It might be a bit puzzling to some of us as to why, given the supposedly “unique and exceptional” character of the Greek restructuring these E-CACs are needed, but only time will tell.

To repeat myself, the foregoing should have been enough to conclude that the past twelve months were the most significant twelve month period in the history of the sovereign debt markets. But we have not gotten to the biggest event of them all — the holdout litigation against Argentina in the Second Circuit Court of Appeals in New York.

The defining feature of sovereign debt, for time immemorial, has been that such debt is near impossible to enforce. Sovereigns, pretty much, have always been able to thumb their nose at creditors whenever they wanted. They pay because they want to, not because they have to. On rare occasions, there have been creditors who were important or big enough that they could get their nation’s gunboats to act as enforcers, but these events have been few and far between. And, in any event, using gunboats to enforce debt isn’t really allowed these days. Indeed, in the academic literature, there is a cottage industry of articles asking the question of why, absent enforcement, anyone in the modern era lends to a sovereign.  Well, all of that may have changed. The seeds of this change were laid in an obscure case in Brussels from a decade ago. The case provided a radical interpretation of a standard provision in sovereign debt contracts that everyone used (the pari passu clause), but almost no one understood. For about a decade or so, the implications of that case were largely dismissed by the pooh bahs of the sovereign market. No one else would follow this outrageous Belgian decision, they said. That is, until October 26, 2012, when the theory from that Brussels litigation found favor with a three-judge panel of the Second Circuit in New York — arguably the most sophisticated court on business matters anywhere. That case, that has been occupying the pages of the financial papers for some time now, and is the centerpiece of the most recent issue of the Capital Markets Law Journal, is NML Capital v. Republic of Argentina.

To reiterate, the basic enforcement problem with sovereigns is that sovereigns themselves are hard to sue and harder still to enforce against (most of their assets tend to be on their home soil). Enterprising creditors though, figured out that while they might not be able to get at the sovereigns themselves, they could perhaps get at others who the sovereigns cared about, who were less able to protect themselves (any fan of movies about the mafia and its enforcement techniques will immediately grasp the basic idea). Ordinarily, we suspect that a court would not have gone down the path of enabling creditor action of this type. But the defendant in this case is special — it is the Republic of Argentina, that (some might say) has been doing its best to aggravate and annoy the federal courts in New York for over a decade where unpaid creditors have been litigation ever since Argentina’s mammoth default a decade ago. NML Capital v. Republic of Argentina allows the creditors to get at the third parties; in particular, financial intermediaries, but maybe also other creditors who the Republic is choosing to pay while stiffing the holdouts. If NML v. Argentina holds up on appeal — and, as of this writing, it has held up well — this will mark the most fundamental change in sovereign debt in multiple centuries. These debts will now be enforceable. It still won’t be easy to enforce, but it won’t be impossible.

To show how this case has already had an impact on the direction of future events, on 4 March 2013, just a few weeks ago, the tiny Caribbean island of Grenada was on the receiving end of a request that third parties be enjoined, just as they were in NML. And this injunction was not sought by some hedge fund in Greenwich, Conecticut. It was requested by the Taiwanese Ex Im Bank. It may not be that long before we see suits against other nations who have long unpaid debts. Rumors of the potential impact of the NML decision seem to have even trickled down to the market for antique bonds. The owner of my favorite antique bond shop tells me that defaulted Chinese and Russian bonds from the early part of the twentieth century have increased in price in recent months; and particularly the ones with pari passu clauses (yes, she said “pari passu”). Somebody out there thinks that the probability of recovery on these bonds has just increased. I do wonder whether their excitement will wane somewhat when they tackle the statute of limitations issue.

And then there is Cyprus. On Friday, 15 March 2013, European leaders trespassed on consecrated ground. They insisted that Cyprus impose losses — euphemistically dubbed a “solidarity levy” — on insured depositors with Cypriot banks as a condition to receiving EU/IMF bailout assistance. Cyprus was in deep crisis thanks to its oversized banking sector. Contrary to anything anyone expected (other than perhaps the nincompoops in the room that Friday night), Cyprus decided not only to go after bank deposits, but also insured deposits. And at the same time, it also decided that it would pay its bonds — a sizeable portion of which were rumored to be held by foreign hedge funds — on time and in full. Faced with almost universal shock and criticism for its first decision, Cyprus quickly backed off its first plan (its legislature did not even give the plan a single vote), and has now put in place an alternate plan that primarily pursue uninsured depositors in some of its weakest banks (for some bizarre reason, the bondholders still get paid in full). It is not clear that the current plan will suffice, given the damage that the announcement of the first plan and the general move toward chasing deposits for debt relief has done to the Cypriot banking sector (the key industry for that small economy). In other words, Cyprus will probably need more debt relief than it had first calculated and the bondholders may yet get whacked. But, for purposes of this note, I’ll say just this: Wow.

This is an updated and expanded version of the Editor’s Note in the current issue of Capital Markets Law Journal.

Mitu Gulati is the North America Regional Editor (March 2013) for Capital Markets Law Journal. He is a Professor at Duke University. His research interests are currently in the evolution of contract language, the history of international financial law and the measurement of judicial behavior.

Capital Markets Law Journal is essential for all serious capital markets practitioners and for academics with an interest in this growing field around the World. It is the first periodical to focus entirely on aspects related to capital markets for lawyers and covers all of the fields within this practice area: Debt; Derivatives; Equity; High Yield Products; Securitisation; and Repackaging. With an international perspective, each issue covers articles and news relevant to the financial centres in the US, Europe and Asia.

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Short-term stock traders — such as hedge funds — have come under fire for pursuing their own profits rather than the long-run health of companies they invest in. The recent financial crisis added fuel to flames, but they had started burning several decades earlier. In the 1980s, many commentators argued that Japan’s economic success resulted from shareholders taking long-term stakes and thus having incentives to improve their firms’ long-run health. They thus pushed the government to take actions to reduce the stock market’s “liquidity” — the ease with which investors can trade their shares. These calls have resurfaced in the recent crisis, through calls for transactions taxes and short-sales restrictions to dissuade “excessive” trading.

The Costs of Liquidity — The Traditional View

The traditional view is that liquidity undermines a firm’s corporate governance. Under this view, blockholders (large shareholders) can improve governance through engaging in direct intervention, otherwise known as “voice” — for example, removing an underperforming manager or blocking a misguided acquisition. But intervention is costly. Thus, blockholders may choose to simply sell their shares and walk away from a troubled firm. Liquidity makes selling easier, and thus discourages blockholders from sticking around and improving the firm’s long-run health.

The Benefits of Liquidity — The Modern View

But it is far from clear that liquidity is detrimental to governance — and thus to society. Indeed, Japan’s “lost decade” of the 1990s raised doubts about the low-liquidity model. The theoretical literature has identified two major benefits of liquidity. First, liquidity makes it easier for shareholders to acquire a block to begin with (Kyle and Vila (1991), Kahn and Winton (1998), Maug (1998)). By encouraging large shareholders to form, it facilitates voice. Second, Admati and Pfleiderer (2009), Edmans (2009), and Edmans and Manso (2011) show that the act of selling one’s shares (engaging in “exit”), far from being the antithesis of governance, can be a governance mechanism in itself. Such sales drive down the stock price, which hurts the manager because his pay depends on the stock price. The threat of exit induces him to maximize value in the first place.

What Does The Data Say?

With theoretical arguments for the desirability of liquidity being on both sides, it is ultimately an empirical question. Thus, it is to the data to which we turn. We analyze how liquidity affects both the decision to acquire a block and the choice of governance mechanism (exit or voice) once the block has been acquired. We study a particular type of blockholder — activist hedge funds — because they are unconstrained by legal restrictions and thus have both voice and exit at their disposal. Overall, we uncover a positive effect of liquidity on governance.

First, liquidity increases the likelihood that an activist hedge fund acquires a block (a stake of at least 5%) in a firm. To address concerns that there could be reverse causality (governance causes liquidity, rather than liquidity causing governance), or omitted variables driving both governance and liquidity, we use the decimalization of the US stock exchanges in 2001 as a natural experiment. This event led to a sudden increase in liquidity that was not caused by changes in governance.

Second, liquidity reduces the likelihood that the hedge fund files a Schedule 13D (which conveys an activist intent) upon block acquisition, and correspondingly increases the likelihood that it files a Schedule 13G (which conveys a passive intent). This finding is consistent with the traditional view that liquidity weakens governance as it discourages voice. However, it is also consistent with the “exit” view that liquidity merely causes a blockholder to adopt a different form of governance — exit rather than voice.

Third, we find that a 13G finding indeed represents a governance mechanism. It leads to increases in both stock price and operating performance, particularly in liquid firms. These results support the “exit” view that the 13G filings, that are encouraged by liquidity, represent governance through exit rather than the abandonment of governance altogether (as argued by the traditional view).

Our final finding concerns voice. Our first result, stated earlier, was that liquidity increases the likelihood of block acquisition, but our second result was that it decreases the likelihood of a 13D, conditional upon block acquisition. We find that the first effect outweighs the second. Thus, liquidity increases the unconditional incidence of voice. Coupled with its positive effect on exit, liquidity has an overall beneficial effect on governance.

Conclusion

Our findings suggest that policymakers should not rush into regulations that inhibit trading. It is through trading that investors can acquire a large stake to begin with, and also punish an underperforming firm by selling their stake.

More broadly, our recent paper contributes to a recent literature on the real effects of financial markets. The traditional view (e.g. Morck, Shleifer, and Vishny (1990)) is that financial markets are simply a side-show, that passively reflect a firm’s fundamentals — for example, a fall in the stock price reflects a deterioration in firm performance. This newer literature, surveyed by Bond, Edmans, and Goldstein (2012), shows that stock prices actively affect a firm’s fundamentals — a fall in the stock price exerts governance on the manager by worsening his compensation and reputation; the threat of such a fall induces the manager to exert effort. Thus, policymakers should take into account the effects of financial markets on real economic activity when designing regulations.

Alex Edmans is an assistant professor of finance at The Wharton School, University of Pennsylvania, a Faculty Research Fellow of the National Bureau of Economic Research, and a Research Associate of the European Corporate Governance Institute. Vivian W. Fang is an assistant professor of accounting at the Carlson School of Management, University of Minnesota. Emanuel Zur is an assistant professor of accounting at the Zicklin School of Business, Baruch College. They are the authors of the paper “The Effect of Liquidity on Governance” in the new issue of The Review of Financial Studies, which is available to read for free for a limited time.

The Review of Financial Studies is a major forum for the promotion and wide dissemination of significant new research in financial economics. As reflected by its broadly based editorial board, the Review balances theoretical and empirical contributions. The Review is sponsored by The Society for Financial Studies.

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Wow! That is what my university’s former football coach wanted to hear from prospective student-athletes when touring the new $45 million football practice facility. Parts of my university need repair. Departments face resource constraints. But the new practice facility was to set the standard in the university’s fierce competition for talented recruits. So our former coach led reporters through the planned 145,000 square-foot building, with its grand team meeting room, custom-designed chairs, hydro-therapy room, restaurant, nutrition bar, and lockers equipped to charge iPads and cellphones. But as the tour concluded, our coach observed that several rival universities, upon seeing our planned facility, were planning even more expensive training facilities. As our rivals spend millions on elaborate facilities, none of the universities have a sustained competitive advantage. And other student needs remain unmet.

Competition is ordinarily viewed as good. It is, after all, the backbone of most developed countries’ economic policies. Promoting competition is broadly accepted as the best available tool for promoting economic well-being. Competition can yield lower prices, better quality, more choices, innovation, greater efficiency, increased productivity, and additional economic development and growth. Competition has its social and moral virtues, such as promoting individual initiative, liberty, and free association. Not surprisingly, competition can take a religious quality, especially among antitrust enforcers. They regularly try to protect the public from harmful special interest legislation, premised on complaints of excess competition.

Competition, although seen as good, is not pervasive. At times the laws and informal norms stress cooperation, rather than competition. We don’t want parishioners, after all, competing for pews, or children competing for their parents’ affection. Some areas aren’t subject to market competition (e.g. human organs) or are exempt from competition laws (e.g. labor). Even though competition is generally seen as good, not all forms of competition are necessarily good. So we distinguish between fair and unfair means of competing — to promote the soccer player’s artful pass while punishing the scoundrel’s rough elbow. But for most commercial activity, competition on the merits is the presumed policy. It is the glue that binds our economy.

While watching my university’s football coach tour the state-of-the-art facilities, I wondered whether competition always benefits society. When does competition devolve into its pejorative synonyms: arms race and race-to-the-bottom? When is competition the problem’s cause, rather than its cure? These questions expose competition policy’s blind spot. Few within antitrust circles ask these questions. Instead, their elixir often is more, rather than less, competition.

Interestingly, an economist examined over a century ago these questions. Competition, Irving Fisher found, works to society’s benefit under two assumptions: first, when each individual can best judge what serves his interest and makes him happy; and second, when individual interests are aligned with collective interests. These two assumptions often are valid; competition, as a result, reliably delivers. But when these assumptions don’t hold, as recent developments in the economic and psychology literature show, competition can worsen the problem. One scenario is where firms effectively compete to exploit overconfident consumers with imperfect willpower (think credit cards). Rather than compete to help consumers obtain or find solutions for their imperfect willpower, firms instead compete in devising better ways to exploit consumers.

A second scenario is where individual and group interests diverge. Competition benefits society when individual and group interests and incentives are aligned (or at least don’t conflict). But when individual interests diverge from collective interests, as in the case of testosterone, the competitors and society are worse off. Wall Street traders, the press reports, are boosting their testosterone levels. One study found that traders, with higher morning testosterone levels, were likelier to earn more profits that day. Higher testosterone levels can increase the traders’ appetite for risk and fearlessness. So traders, weighing the benefits and risks, can rationally decide to boost their testosterone levels to gain a relative competitive advantage (or at least not be competitively disadvantaged against higher testosterone traders). However, as other traders inject testosterone, the traders no longer enjoy a relative competitive advantage. They and society are collectively worse off.

We saw this race-to-the-bottom before the economic crisis. With the expansion of Fitch Ratings, the competitive pressures on the two entrenched ratings agencies increased. Their cultures changed. They increasingly emphasized greater market share and short-term profits. To gain a relative advantage, they lowered their rating requirements. Their ratings quality deteriorated. As the U.S. Financial Crisis Inquiry Commission found, Moody’s alone rated nearly 45,000 mortgage-related securities as AAA. In contrast, in early 2010, only six private-sector companies were rated AAA. So too nations compete for a relative advantage by relaxing their banking, environmental, safety, and labor protections. Their competitive race-to-the-bottom ultimately leaves them and their citizens collectively worse off.

So is competition in a market economy always good? If the answer is no, a separate issue is whether we should allow private parties to deal with these types of failures or whether legislation is required. Once we recognize that market competition produces at times worse results, the debate shifts to whether the problem of suboptimal competition can be better resolved privately (by perhaps relaxing antitrust scrutiny to private restraints) or with additional governmental regulations (which raises issues over the form of regulation and who should regulate).

So when you hear the policymaker’s refrain of making markets more competitive, competition likely is the solution. But as football coaches, Wall Street traders, ratings agencies, and nations realize, increasing competition at times worsens, rather than cures, the problem.

When he joined the University of Tennessee in 2007, Prof. Maurice E. Stucke brought 13 years of litigation experience as an attorney at the U.S. Department of Justice’s Antitrust Division and Sullivan & Cromwell. A Fulbright Scholar in 2010-2011 in the People’s Republic of China, he serves as a Senior Fellow at the American Antitrust Institute, on the boards of the Academic Society for Competition Law and the Institute for Consumer Antitrust Studies, and as one of the United States’ non-governmental advisors to the International Competition Network. His scholarship has been cited by the U.S. courts, the OECD, competition agencies, and policymakers. You can read his article “Is competition always good?” in the Journal of Antitrust Enforcement.

The Journal of Antitrust Enforcement is a new launch journal from Oxford University Press in 2013. All content is freely available online for a limited time and papers published ahead of the first print volume (April 2013) are available online now. The Journal of Antitrust Enforcement provides a platform for leading scholarship on public and private competition law enforcement, at both domestic and international levels. The journal covers a wide range of enforcement related topics, including: public and private competition law enforcement, cooperation between competition agencies, the promotion of worldwide competition law enforcement, optimal design of enforcement policies, performance measurement, empirical analysis of enforcement policies, combination of functions in the competition agency mandate, and competition agency governance. Other topics include the role of the judiciary in competition enforcement, leniency, cartel prosecution, effective merger enforcement, competition enforcement and human rights, and the regulation of sectors.

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Image Credit: (1) The University of Tennessee Pride of the Southland Marching Band performs pregame at the UT vs. California football game. Photo by Jordan3757, Creative Commons License via Wikimedia Commons.
(2) Arsenal’s Cesc Fàbregas (white shirt) duels with Anderson of Manchester United. Photo by Gordon Flood, Creative Commons Licence via Wikimedia Commons.

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As North Americans, should we have confidence that the products we purchase are safe? Should we trust that manufacturers and advertisers keep consumer welfare in mind during the marketing process — from product conception to point of purchase? Of course we should. One would hope that corporations would have a sense of moral responsibility to act in the best interest of their customers. If companies don’t recognize their moral obligations, legal entities exist to protect us…right?

Unfortunately this isn’t always the case, and historically speaking, corporate North America has a long history of knowingly producing dangerous products, making misleading, fraudulent claims, and harming the consumer. In some cases, these very products are still on store shelves. Take Lysol, for example. Today, millions trust it to clean their sinks and countertops without incident. But in the 1920s and 1930s — and until the 1960s — women across Canada and the United States suffered burns and scarring because they chose to trust the makers of Lysol. Lehn & Fink, interwar manufacturer of Lysol, said that their product could be used as a contraceptive vaginal douche. In other words, Lysol was advertised as a form of birth control (which was illegal in North America in the 1920s and 1930s), consumers believed them, some were seriously injured, and many became pregnant.

In researching how Lysol could possibly have got away with such irresponsible behavior for so long, two issues came to light. First, the company devised an advertising campaign that communicated to consumers that their product could be used to avoid unwanted pregnancies without actually saying it was a birth control product. The term “feminine hygiene” was a euphemism for birth control that illegal birth control manufacturers like Lysol coined in the 1920s. Unfortunately, it caught on, which is unsurprising since the ads using the phrase also included rhetoric surrounding aging caused by worry over using an ineffective feminine hygiene product (read worry over unwanted pregnancy) and invoked imagery of marital strife because women didn’t use feminine hygiene (meaning women failed to obtain birth control and were choosing abstinence, causing marital problems).

The second major issue was that legal authorities were powerless because of the euphemism the company used. Without actually saying it was intended for use as birth control, Lysol could, and did, deny that they were advertising the product as birth control, despite the fact that everyone knew they were lying. What’s more, neither Canada nor the US had any consumer protection laws to prevent this kind of dangerous false advertising. They had laws pertaining to unfair competition between firms and misbranding, but nothing that protected the consumer.

While Lysol is only advertised as a household cleaning product these days, there are companies that still try to take advantage of consumers and evade the legal ramifications. In 2012, for instance, the American Federal Trade Commission prosecuted huge corporations such as athletic wear and shoe producer Reebok for claiming one of their shoes would strengthen lower body muscles. Likewise, Nivea was prosecuted for falsely claiming one of their creams could reduce users’ body size.

Of course, these examples are not as extreme as Lysol’s interwar advertising and authorities today, armed with useful laws, stepped in to protect consumers. The trouble is, these products were advertised and made their way into the hands of consumers as Lysol and its birth control method once did. In Canada and the US, laws are in place to protect us, but the responsive nature of the legal system means that companies can go about telling us and selling us what they want until they get caught. But at least they can get caught.

So, should we have faith in the consumer market that has really come to define North American society? Well, we certainly shouldn’t be afraid of it, but both historical and contemporary examples suggest we should be vigilant. Perhaps the safest way to approach the market is with some consumer confidence, accompanied by a healthy dose of skepticism.

Kristin Hall is a graduate student in the history department at the University of Waterloo. She is the author of “Selling Sexual Certainty? Advertising Lysol as a Contraceptive in the United States and Canada, 1919-1939″ in the most recent issue of in Enterprise & Society, which is available to read for free for a limited time.

Enterprise & Society offers a forum for research on the historical relations between businesses and their larger political, cultural, institutional, social, and economic contexts. The journal aims to be truly international in scope. Studies focused on individual firms and industries and grounded in a broad historical framework are welcome, as are innovative applications of economic or management theories to business and its context.

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Image credit: Woman checking food labelling in supermarket. monkeybusinessimages via iStockphoto.

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The growing disconnect between the problems that bind us and the countries that divide is the greatest threat to humanity. Each day we are confronted by mounting evidence of the yawning governance gap. Recently, British people have been surprised to find their meat has been through the mincer of multiple legal jurisdictions through which beef has been blended with horse. Russians have been shocked by a meteorite that crashed unannounced into their territory, due to the failure of global coordination of space. In Tokyo, a bluefin tuna was auctioned in Tokyo for USD$1.7 million, raising concerns globally that market signals may be hastening the extinction of rare tuna. And in the United States, Hurricane Sandy’s impact on lower Manhattan and the New Jersey shore has raised interest in the work of scientists who identify freak storms as an early warning of climate change. Meanwhile, across Europe the aftermath of the financial storm continues to destroy jobs and livelihoods.

The past months highlight the rising impact of global developments on all our lives. Two forces have combined to mean that we are more interdependent than ever. The first is that the walls have come down. Only North Korea is now isolated. The changes unleashed with the destruction of the Berlin Wall have rippled around the world. There has been a political, economic, and technological convergence. Flows of information as well as finance, goods, services, and people across borders have transformed the nature of our societies and opportunities. Physical barriers have come down since the end of the Cold War, but so too have virtual barriers, with the internet providing the information system for hyper-globalization.

This is good news, and has been associated with the most rapid rise in incomes in history. Poverty more often than not is because people are disconnected from globalization, as they don’t have the infrastructure, education, or access to benefit from new opportunities. Increased integration of ideas and opportunities has been associated with the most rapid rise in population and urbanization in human history. There are two billion more people on the planet than when the Berlin Wall came down. As a species, we are more intimately connected physically and virtually than at any time since our distant ancestors left their collective East African communities over a hundred thousand years ago to flee dangers and explore our beautiful world.

The growth in incomes and people reflects the success of globalization. Unfortunately, while people and systems have become more integrated, increasingly making national boundaries almost irrelevant, politicians and governance systems are locked into fossilized national structures which have failed to keep pace with global developments. The result is that globalization is not being managed. The pressure is rising as problems fester and complexity gives way to cascading failures and collapse. Financial crises, pandemics, cyber attacks, climate change, and other global threats are the underbelly of globalization. The more connected we are, the more we need to accept that we need global management.

The financial crisis is the first of the 21^st century crises but will certainly not be the last. The lessons must urgently be learned. First, we need to recognise that technological and social change are evolving at an accelerated pace, and politicians and regulators need to map and understand the recent evolution of the key threats. Second, the most significant challenges that arise are likely to emerge from cross-border or global threats. If the primary purpose of governments is to protect us, this needs to be an urgent focus of attention. Third, none of these threats can be addressed by any one country alone. Even the most powerful and largest countries — such as the USA or China — will require increased international cooperation. Fourth, the existing global institutions are unfit for 21^st century purpose. Finance is the best endowed, most joined up and most powerful of the global institutional systems — and yet it proved itself incapable of moving beyond its Bretton Woods mandate. A core purpose of the global financial system is to guarantee global financial stability. This system, which is the best we have of the global institutions, proved itself unfit for 21^st century purpose. Urgent reform and renewal is required.

Better global institutions are only part of the solution. They can be only as good as the countries that govern them allow. Our politicians and public need to recognise the need for global action and provide the necessary political mandate for reform and resources that are required for effective governance, if this is to be achieved. Equally importantly, we need to think about alternatives and new models of governance. Professional networks, social accountability systems, the role of non-government organisations, together with the mobilisation of action by subsets of willing participants and other new methods of moving global governance forward, are required. We cannot rely on the slow melt of the icebergs or their institutional equivalents in the global governance system to initiate global action.

We have the power to act. Global actions require local and national participation. There is no necessary trade off. International cooperation and action requires community perspectives and legitimacy if it is to be effective. Nations are divided, but we as citizens need not be. Indeed, we cannot be, if we are to address the critical 21^st century challenges.

Ian Goldin is Professor and Director of the Oxford Martin School at Oxford University. Ian previously was Vice President and Director of Policy at the World Bank after serving as advisor to President Mandela and Chief Executive of the Development Bank of Southern Africa. He has published 17 books, the most recent of which is Divided Nations: Why global governance is failing and what we can do about it, published by Oxford University Press in March 2013. He will be at the Names, Not Numbers Ideas Festival 17-19 March, including the ‘Bright Ideas’ panel at 9:45 a.m. on 18 March 2013; the Sunday Times Oxford Literary Festival on 16 March , 12 noon (tickets £11); London School of Economics and Political Science (LSE) on 20 March, 18:30 – 20:00; and Blackwell’s Bookshop Oxford on 25 April, 19:00 – 20:00. Tickets £3 from Blackwell’s customer service department.

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The news that sections of the UK public may have been munching on horse, rather than beef, has prompted renditions of an all too familiar refrain from British politicians and their cohorts in the media. “Mafia gangs” and “mobsters” have apparently combined in an “international conspiracy” to doctor the rump of the British menu in the form of cheap frozen meals. However, the assertion that foreigners are at the heart of this problem has a lineage with origins extending far beyond the relatively recent construction of organised crime in the UK.

In the early 20th century, Jewish immigration from the Pale of Settlement was portrayed as a criminal problem connected to the vice trade, in particular “white slavery” with all of its connotations of international trade and global conspiracy. Despite anything approaching viable evidence, the British political class reacted with the Aliens Act of 1905, which was targeted specifically at Jews. They introduced immigration controls and registration for aliens, defining some groups of migrants as ‘undesirable’, and made entry to the UK discretionary rather than automatic.

Alien transgression continued to represent a particularly dangerous threat to British society and one that required extraordinary legislative measures. During the First World War, the threat of foreigners peddling drugs to London-based Allied servicemen caused a moral panic to spread, such that in 1914 the House of Commons passed the Defence of the Realm Act. This was a catch-all ‘ways and means’ law, utilized to impose a wide range of authoritarian measures, including making the possession of both opium and cocaine illegal in the wake of growing fears concerning off-duty soldiers being plied with drugs by foreigners. The Act drove the trade underground, inducing a form of amnesia upon the long relationship that Britain had with opium in particular — a relationship that had included a willingness to fight two wars in order to enforce opium trafficking. Historically, the louche dilettantism of imperially formed self-indulgence ensured that, as long as the working classes refrained, opium smoking had been an acceptable vice, particularly amongst ex-colonialists and London’s literary elite. However, in the wake of jingoistic sentiment instigated by the First World War, opium now became associated with illegal nightlife, and in particular as a substance that assisted devious Orientals in the seduction and degradation of white women. Consequently, opium prohibition was accompanied by a clamp down on the Chinese community as it became an ideal platform for the re-establishment of pre-war patriarchal values. The terrors that had been generated by images of Jewish sexuality were now being replayed against a backdrop of drugs and white slavery, involving international traffic controlled by yet another alien criminal conspiracy, and the moral panic regarding the Chinese provided yet another prototype for the idea of international organised criminal conspiracies.

Post-World War II, concerns about prostitution in London once again focused upon foreigners – this time the Maltese. In 1953 a Sunday tabloid journalist wrote a six-week exposé of “the most complicated and certainly the most powerfully organized gang of vice this nation has ever known” who “controlled vice in London for a period of over ten years” and ran a “vice empire.” Although conveniently labelled as Maltese, the five Messina brothers were of mixed Egyptian, Sicilian, and Maltese decent, and had operated brothels in Sicily, Malta, Egypt, Morocco, and Spain. However, the tabloid journalist was the close friend and biographer of Billy Hill, one of the Messinas’ many rivals in post war Soho, and historian Stephan Slater has recently questioned the notion of London’s vice trade being dominated by a foreign monopoly, pointing out that these “emperors of a vice empire in the heart of London” had, at the peak of their careers, only 20 women working for them. Rather than operating a pervasive, transgressive network, the Messinas were one of many groups controlling prostitutes, and were in fact paying protection money to a wide range of white indigenous predators, including Billy Hill and members of the Metropolitan Police. However, the Messinas’ case confirmed in the British imagination the direct association between vice and foreigners, contributing considerably to the implementation of the 1960 Street Offences Act, which took prostitution off of the streets and into premises owned predominantly by white British “businessmen”.

Back to another kind of meat market, and early in 2013 organised criminals from Eastern Europe were identified as the culprits for making British dinner time a covert equestrian event. The story, occasionally accompanied by pictures of herds of wild Romanian horses, appeared cheek by quivering jowl alongside concerns that Bulgarian and Romanian citizens constituted a gathering wave of criminality, one that was about to break upon these beleaguered shores when they acquire free movement across the EU in 2014. As we can see above, we have been here before, and when the alleged sources of some of the horsemeat was later identified as emanating no further east than West Wales and West Yorkshire, the slaughterhouse owners came across less like Tony Soprano and more like extras from Emmerdale.

Organised crime made its debut in UK policy circles in the 1980s with the end of the cold war, alongside increasing pressure from the USA and the United Nations to engage in the War on Drugs. The problem of organised crime in the UK was constructed during the 1990s and the early 21st century, within institutions designed specifically to police a convenient, demonic catch-all of foreign instigated transgression that is central to both media and law enforcement narratives of unlicensed capitalism. However, this focus upon the alleged international character of the supply side misses the point. The illegal trades that serve market society depends upon the unremarkable quest for a bargain by competent consumers: those seeking an ounce of this, a gram of that, 200 ‘Albanian Marlboro’, and a DVD of a Hollywood blockbuster courtesy of a extremely polite Chinese youth who delivers the goods at 9 p.m. every Friday. But the entitlements of affluence that are central to Western society also value cheap commercial sex, somebody to pick up the kids from school and do a little light dusting, or for the increasingly impoverished population of early 21st century Britain, a cheap frozen lasagne.

Beef, horsemeat, human flesh or temporary oblivion all have a price, but blaming strangers with difficult to pronounce names for their provision merely obscures the banality of our desires and the timidity of our resolve to address the racism that rests at the heart of the UK’s interpretation of organised crime.

Dick Hobbs is Professor of Sociology and Director of the Criminology Centre at the University of Essex, and Professor of Sociology at the University of Western Sydney. He is the author of Lush Life: Constructing Organized Crime in the UK. He previously held Chairs at the University of Durham and the London School of Economics. An ethnographer by trade, he is sceptical of the rise of criminology and has published widely on the sociologies of deviance, of East London, organized and professional crime, the night-time economy and the 2012 Olympics.

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The Findings

Agriculture in North America traditionally has had its comparative advantage in having access to abundant low-skilled labor from Mexico. Around 70% of the United States hired farm workforce is Mexico-born, according to the National Agricultural Worker Survey (NAWS). Fruit, vegetable, and horticultural farms in the US have enjoyed an extended period of farm labor abundance with stable or decreasing real wages. However, new panel data reveal a declining long-term trend in the farm labor supply in rural Mexico. In coming years, US farmers will need to offer higher wages to induce new workers to migrate northward to US farm jobs.

The Evidence

Migration within Mexico and to the US increased in the years prior to the recession; however, with the onset of the recession there was a sharp decrease in migration to the US (see Figure 1). The combined shares of the workforce migrating to agriculture either within Mexico or to the US decreased between 2007 and 2010. In contrast, the percentage of the workforce working in the Mexican non-farmwork sector grew steadily.

Figure 1. Number of workers that migrate to each sector by survey round. Taylor, J.E., D. Charlton, and A. Yúnez-Naude. 2012. “The End of Farm Labor Abundance.” Applied Economic Perspectives and Policy. 34(4):587-98.

Mexico is following the pattern of countries around the world: as its income rises, workers shift out of farm work into other sectors. Mexico’s per-capita income, adjusted for the cost of living, now exceeds $15,000 per year. Growth in Mexico’s non-agricultural employment began before the recession and persists now. As non-farm opportunities increase, the Mexican workforce will continue moving out of agriculture.

Why do we see decreases in the supply of Mexican farm labor?

The received wisdom in development economics is that the domestic supply of agricultural labor starts out being relatively elastic (i.e., abundant), but the farm labor supply shifts inward and becomes less elastic as countries’ per-capita incomes increase and people shift from farm to nonfarm jobs. In order to induce domestic workers to supply their labor to farm jobs, agricultural wages must rise apace with nonagricultural wages. This is all the more true if non-farm jobs bring non-pecuniary benefits compared to farm jobs and/or workers associate farm jobs with drudgery.

Tighter border enforcement and drug-related violence along the border may deter migration, but our analysis suggests that for US agriculture their main effect is largely secondary, reinforcing a negative trend in rural Mexicans’ willingness to do farmwork. For example, after the “great recession” in 2008, the share of Mexican immigrants working in agriculture decreased more than the share working in non-agriculture. The recession had a large negative impact on construction and service jobs in the non-farm sector while labor demand in the farm sector remained steady and commodity prices rose. If unemployed workers in the non-farm sector sought jobs on US farms during the recession, then one might expect the supply of agricultural labor to increase. Data show that some immigrants did shift from non-farm to farm work after the recession, but more shifted from farm to non-farm in the US. If the decrease in immigration in recent years were the result of increases in border patrol or drug-related violence, then the decrease in farm labor supply should be similar to the decrease in non-farm labor supply, but the data show the opposite.

US agriculture appears to be doubly adversely affected by the decline in the supply of immigrant labor and a shift in the Mexican labor supply away from farmwork.

Implications for US agriculture

A declining farm labor supply in rural Mexico and competition from Mexico’s farmers combine to raise the reservation wage of migrating to the United States—that is, the minimum US farm wage needed to induce new workers to migrate northward to farm jobs. US growers must look for substitute inputs to agricultural production as the supply of agricultural workers is declines.

Potential solutions for US farmers

One solution is to seek migrant workers from other countries with lower reservation wages. However, the US-Mexico situation is unique, with two countries at vastly different levels of income sharing a common border. Central American countries are small compared to Mexico and they too are changing. The cost of importing low-skilled labor increases progressively as one looks farther afield, say, to Asia. Consequently, importing agricultural labor into the US from more distant countries does not appear plausible.

Another solution is to invest in labor-saving agricultural technologies and transition away from labor-intensive crops. Under this scenario, capital improvements in farm production will increase the marginal product of farm labor, and US farms will change their labor-management practices, hiring fewer workers at higher wages. In the years 2007-2009, 23% of US farmworker families had income below the poverty line (Martin, 2012). Improvements in agricultural production technology are a necessary input to increase farm wages, allowing farmworker families to rise above the poverty line. Simultaneously, rising farm wages create an incentive for farmers to make the necessary investments to raise farmworker productivity.

J. Edward Taylor and Diane Charlton are the authors of “The End of Farm Labor Abundance” in the Applied Economic Perspectives and Policy, which is available to read for free for a limited time. Edward Taylor is Professor of Agricultural and Resource Economics and Director of the Center on Rural Economies of the Americas and Pacific Rim (REAP) at the University of California, Davis, where he teaches courses on international development economics and econometric methods. He is also co-editor of the American Journal of Agricultural Economics and founder of the alternative textbook initiative, RebelText.org. Taylor has written extensively on the economy-wide impacts of agricultural and development policies and on immigration.  He co-authored Village Economies: The Design, Estimation and Use of Villagewide Economic Models (Cambridge University Press) and Worlds in Motion: Understanding  International Migration at the End of the Millenium (Oxford University Press). He is listed in Who’s Who in Economics and has advised a number of foreign governments and international development agencies on matters related to economic development. Diane Charlton is a PhD student in Agricultural and Resource Economics at the University of California, Davis. Her areas of focus are agriculture and international development.

Applied Economic Perspectives and Policy aims to present high-quality research in a forum that is informative to a broad audience of agricultural and applied economists, including those both inside and outside academia, and those who are not specialists in the subject matter of the articles. In addition, AEPP publishes specially-commissioned featured articles focusing on the synthesis and integration of applied research and on future research agendas.

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Have you ever wondered if your car mechanic is charging you too much? Or been worried about taking your laptop to a computer specialist, because that might cost you almost as much as a new computer? Have you ever suspected that your taxi is driving you in circles when you were visiting a tourist destination? For most people the answer to at least one of those questions is a loud “yes”! So, what is it that makes us consumers so vulnerable in these – and other – kinds of situations? The answer is straightforward: it’s all about information.

The above are all examples of so called credence goods markets: the seller has superior information, in other words she knows more than the consumer about the good or service that the latter needs. For instance, when a car mechanic tells me that my brakes need to be replaced, I tend to believe them – who wants to take the risk of driving without functional brakes? To make things worse, consumers are frequently not even ex post able to observe the quality that they have received. Did my mechanic really replace those brakes with new ones? To sum up the problem, we often have to rely on the judgment of an expert who is also the seller of a good or service, and this opens the door to fraud.

Taxi rides are no different. In an unfamiliar city, the passenger often has no clue (or only a vague idea) about the shortest route to a destination. So it’s in the driver’s interest to increase the fare by taking a longer route. Or, even worse: some drivers charge higher fares than they should, by means of manipulated taximeters or other methods. Most of us have experienced such events, or at least heard of others who have. For instance, I have recently seen news reports on taxi fraud in New York City, Berlin, or a number of other cities such as Prague or Buenos Aires – see the exciting new documentary series on city scams in the National Geographic channel.

This is where our study comes in. Anecdotal stories abound, but our aim was to undertake a systematic investigation into fraud on a real credence good market by means of a field experiment. Our pick was the market for taxi services in Athens, Greece. Five undercover experimenters took 348 taxi rides on 16 different routes throughout the city and, rotating in groups of three, assumed different “information roles”: in the role of a local native passenger, the experimenter entered a taxi and simply asked to be taken to a given destination. In the role of a non-local native passenger, the experimenter would add that he is not familiar with the city and ask if the driver knew the destination. This is a clear signal that the passenger has inferior information, allowing the driver to infer that he can get away with taking a circuitous route to the destination – we refer to this type of fraud as overtreatment. In a third role, that of a foreigner, a passenger would repeat the “non-local” scenario, but in English. This is then a clear indication that the passenger is not only unfamiliar with the city’s roads, but also with the taxi fare system, which is regulated nationwide in Greece! This opens the door to an additional type of fraud through manipulated bills, bogus surcharges and the like. We call this overcharging, because it means that an excessive fare is charged for a given distance.

What did we find? Well, first of all, it’s not a good idea to let the driver know that you don’t know your way about – unless you enjoy being taken for a ride! Our local passengers were hardly ever taken on detours, while the other two roles (non-Athenian Greeks and foreigners) were taken on detours of about double length on average. On top of this, passengers acting as foreigners fell victims to overcharging much more often than native passengers, who presumably know how fares work in the country: about every fifth foreigner ended up paying more than they should for a given ride, while the frequency was around 5% for the other two types of passengers. Hence, we detected a very systematic pattern of fraud, relating to a passenger’s perceived information. In addition to the information dimension we manipulated the passengers’ perceived income in our experiment, alternating their appearance and exact destination and thereby distinguishing between those with high and low perceived income. We did not find strong evidence for an effect of income on fraud, although “rich” passengers did appear to be somewhat more susceptible to detours. The good news is that, notwithstanding the systematic nature of fraudulent behavior, its occurrence is relatively infrequent in Athens. Indeed, the majority of taxi drivers in our sample provided an honest service and charged the correct amount for it.

We can draw some specific lessons from these findings. The obvious implication is that a buyer should convey, if possible, the impression that they are not clueless. For instance, in the case of medical treatments – another prominent credence good – it may be worthwhile mentioning a (fictitious) doctor in the family; or, with car repairs, memorizing and using some technical terms might help, and asking the mechanic to put the replaced parts back in the car’s boot can guard against false charges. For taxi rides, one possibility is to use navigation systems (available in many mobile phones) to verify the optimal route to a destination. In a nutshell, as in many other economic situations, information is the key.

Loukas Balafoutas is Assistant Professor in the Department of Public Finance at the University of Innsbruck. He holds a Ph.D. in Economics from the University of Edinburgh and has also worked at the OECD Development Centre. His research focuses on the behavioral underpinnings of economic activity and he has used laboratory and field experiments to study behavior in areas such as tournaments, public goods, property rights, corruption, and social norms. He is the co-author, along with Adrian Beck, Rudolf Kerschbamer, and Matthias Sutter, of the paper ‘What drives taxi drivers? A field experiment on fraud in a market for credence goods’ in full and for free in The Review of Economic Studies.

The Review of Economic Studies aims to encourage research in theoretical and applied economics, especially by young economists. It is widely recognised as one of the core top-five economics journal, with a reputation for publishing path-breaking papers, and is essential reading for economists.

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There are many policies around the world designed to encourage ethnic desegregation in housing markets. In Chicago, the Gautreaux Project (the predecessor of the Moving To Opportunity program) offered rent subsidies to African American residents of public housing who wanted to move to desegregated areas. Germany, the United Kingdom, and Netherlands, impose strict restrictions on where refugee immigrants can settle. Many countries also have “integration maintenance programs” or “neighborhood stabilization programs” to encourage desegregation. These policies are often controversial as they are alleged to favor some ethnic groups at the expense of others. Regardless of the motivation behind these policies, knowing the welfare effects is important because these desegregation policies affect the location choices of many individuals.

I am interested in one such desegregation policy in Singapore: the ethnic housing quotas. Using location choices, I analyzed how heterogeneous households sort into neighborhoods as the ethnic proportions in the neighborhood change. To do this at such a local level I had to assemble a dataset of ethnic proportions by hand-matching more than 500,000 names to ethnicities using the Singapore residential phonebook.

The ethnic housing quotas policy in Singapore is a fascinating natural experiment. It was implemented in public housing estates in 1989 to encourage residential desegregation amongst the three major ethnic groups in Singapore: Chinese (77%), Malays (14%), and Indians (8%). The quotas are upper limits on the proportions of Chinese, Malays, and Indians at a location. Locations with ethnic proportions that are at or above the quota limits are subjected to restrictions designed to prevent these locations from becoming more segregated. For example, non-Chinese sellers living in Chinese-constrained locations are not allowed to sell to Chinese buyers because this transaction increases the Chinese proportion and makes the location more segregated.

Using transactions data close to the quota limits and controlling for polynomials of ethnic proportions calculated using the phonebook, I documented price dispersion across ethnic groups that is consistent with theoretical predictions of the policy’s impact. The findings suggest a model where Chinese and non-Chinese buyers have different preferences for Chinese neighborhoods.

Indeed, my estimates show that all groups have strong preferences for living with members of their own ethnic group but the shapes of the preferences are very different across the three ethnic groups. All groups have ethnic preferences that are inverted U-shaped but with different turning points. This means that once a neighborhood has enough members of their own ethnic group, households want new neighbors from other ethnic groups. Finding tastes for diversity and differences in the shapes of ethnic preferences is consistent with previous research using data on racial attitudes from the General Social Survey in the United States and also surveys of ethnic relations in Singapore.

I used these estimates of ethnic preferences to perform welfare simulations. The seminal work by Thomas Schelling on tipping showed that externalities exist in a model with ethnic preferences because a mover affects the utility of his current and future neighbors by changing the ethnic composition of the neighborhood. Due to these externalities, Schelling showed that policies such as the ethnic quotas could potentially be used as a coordination mechanism to achieve equilibrium with integrated neighborhoods. My welfare estimates show that under the quota policy, about one-third of neighborhoods are close to the optimal allocation of Chinese, Malays, and Indians respectively.

Maisy Wong is Assistant Professor in Real Estate at Wharton, University of Pennsylvania. Her paper, ‘Estimating Ethnic Preferences Using Ethnic Housing Quotas in Singapore’ can be read in full and for free in The Review of Economic Studies.

The Review of Economic Studies aims to encourage research in theoretical and applied economics, especially by young economists. It is widely recognised as one of the core top-five economics journal, with a reputation for publishing path-breaking papers, and is essential reading for economists.

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Image credit: HDB flats at Tampines New Town. By Terence Ong. [Creative Commons], via Wikimedia Commons.

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In the United States, around 25% of households tend have a substantial amount of expensive credit card debt that they carry over multiple months or even years, while also holding significant liquid assets, i.e. balances in checking and savings accounts.

For example, in 2001 data, such households paid an average 14% interest rate on the credit card, while earning nearly no return on the bank accounts. A median such household had $3800 in credit card debt, and $3000 in the bank.  The average amounts were about $5800 and $7200, respectively.  This behavior is quite persistent with age, as the picture below shows. It is also persistent over time, at least over the last two decades. The statistics for 2010 are very close to those for 2001.

It may seem that given the cost of revolving credit card debt, people should pay it off if they have any money in the bank. Hence, the phenomenon has been termed the “credit card debt puzzle”. Much of the discussion of it in the literature interpreted it as evidence that people lack self-control, or that they lack the financial sophistication to plan properly. In my study, I instead focused on a more familiar idea: that people hold on to money in the bank because they may need it for expenses for which credit cannot be used, and such expenses could be large and unexpected.  Not only do we pay our rents and mortgages still largely by check or electronic payment from the bank, but if we have a large car or home repair to take care of, the contractor might give preferential pricing to a cash payment or simply not accept credit cards. Indeed I find that homeowners are more likely to simultaneously have debt and money in the bank, and that home repairs are an important source of large and unpredictable expenses for most households. Then, even if a household has credit card debt, it may not be optimal to draw down the bank account to zero to repay the debt.  Incidentally, this idea has been advanced in the past by those who have studied the same behavior on the side of firms.

The story is intuitive; the difficult part is measuring how well this explanation can account for the puzzle, because we do not have good data on how people pay for things during a typical month, and because it is difficult to disentangle which expenses are unpredictable. Nevertheless, using several household surveys and a model of household portfolio choice, I measured both typical monthly liquid expenses (i.e. those done by cash, check, debit and other ways that require the bank account to have a positive balance), and the extent of uncertainty in them. I find that for the median person, there appears to be enough uncertainty to warrant holding on the order of $3,000 of liquid assets, even if she has credit card debt as well. In other words, many people who simultaneously have credit card debt and money in the bank are behaving without violation of self-control or rationality, under the constraint that they do not have enough money both to pay off their debt and attend to their expected monthly expense needs.

While the story accounts for the median amount of money held in the bank by those who also have credit card debt, the average household has a lot more money in the bank, and more money than credit card debt. This means that there are people who have very large amounts of liquid assets while still revolving credit card debt. While such households may face more severe risks than the average case that I measured, and while some may hold money in the bank because they foresee a possibility of a job loss and want to be able to pay at least their average expenses, it does suggest that some people may be able to improve their financial positions by examining their bank and credit card balances, and the interest costs that they pay on the credit card debt, to see if they can pay off some of their debt using their money in the bank.

Irina A. Telyukova is an assistant professor of economics at the University of California, San Diego. Her research focuses on different aspects of household saving. She has several publications on credit card debt and money demand. Her current research is about the use of home equity in retirement, in the United States and across countries, including a study about reverse mortgages. She is the author of the paper ‘Household Need for Liquidity and the Credit Card Debt Puzzle’, which appears in The Review of Economic Studies.

The Review of Economic Studies aims to encourage research in theoretical and applied economics, especially by young economists. It is widely recognised as one of the core top-five economics journal, with a reputation for publishing path-breaking papers, and is essential reading for economists.

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Image Credits: (1) Graph produced by the author. Do not reproduce without permission. (2) Credit Card. By Gökhan ARICI, iStockphoto

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If you become wealthier tomorrow, say through winning the lottery, would you spend more or less time working than you do now? Standard economic models predict you would work less. In fact a substantial segment of American society has indeed become wealthier over the last 40 years — married men. The reason is that wives’ earnings now make a much larger contribution to household income than in the past.  However married men do not work less now on average than they did in the 1970s.  This is intriguing because it suggests there is something important missing in economic explanations of  the rise in labor supply of married women over the same period.

One possibility is that what we are seeing here are the aggregate effects of bargaining between spouses. This is plausible because there was a substantial narrowing of the male-female wage gap over the period. The ratio of women’s to men’s average wages; starting from about 0.57 in the 1964-1974 period, rose rapidly to 0.78 in the early 1990s.  Even if we smooth out the fluctuations, the graph shows an average ratio of 0.75 in the 1990s, compared to 0.57 in the early 1970s.

The closing of the male-female wage gap suggests a relative improvement in the economic status of non-married women compared to non-married men. According to bargaining models of the household, we should expect to see a better deal for wives—control over a larger share of household resources – because they don’t need marriage as much as they used to. We should see that the share of household wealth spent on the wife increases relative to that spent on the husband.

Bargaining models of household behavior are rare in macroeconomics. Instead, the standard assumption is that households behave as if they were maximizing a fixed utility function. Known as the “unitary” model of the household, a basic implication is that when a good A becomes more expensive relative to another good B, the ratio of A to B that the household consumes should decline.  When women’s wages rose relative to men’s, that increased the cost of wives’ leisure relative to that of husbands. The ratio of husbands’ leisure time to that of wives should therefore have increased.

In the bargaining model there is an additional potential effect on leisure: as the share of wealth the household spends on the wife increases, it should spend more on the wife’s leisure. Therefore the ratio of husband’s to wife’s leisure could increase or decrease, depending on the responsiveness of the bargaining solution to changes in the relative status of the spouses as singles.

To measure the change in relative leisure requires data on unpaid work, such as time spent on grocery shopping and chores around the house.  The American Time-Use Survey is an important source for 2003 and later, and there also exist precursor surveys that can be used  for some earlier years. The main limitation of these surveys is that they sample individuals, not couples, so one cannot measure the leisure ratio of individual households.  Instead measurement consists of the average leisure of wives compared to that of husbands. The paper also shows the results of controlling for age and education. Overall, the message is clear; the relative leisure of married couples was essentially the same in 2003 as in 1975, about 1.05.

One can explain the stability of the leisure ratio through bargaining; the wife gets a higher share of the marriage’s resources when her wage increases, and this offsets the rise in the price of her leisure.  This raises a set of essentially  quantitative questions: Suppose that marital bargaining really did determine labor supply how big are the mistakes one would make in predicting labor supply by using a model without bargaining?  To provide answers, I design a mathematical  model of marriage and bargaining to resemble as closely as possible the ‘representative agent’ of canonical macro models.  I use the model to measure the impact on labor supply of  the closing of the gender wage gap, as well as other shocks, such as improvements to home -production technology.

People in the model use their share of household’s resources to buy themselves leisure and private consumption.  They also allocate time to unpaid labor at home to produce a public consumption good that both spouses can enjoy together.  We can therefore calibrate the  model to exactly match the average time-allocation patterns observed in American time-use data. The calibrated model can then be used to compare the effects of the economic shocks in the bargaining and unitary models.

The results show that the rising of women’s wages can generate simultaneously the observed increase in married women’s paid work and the relative stability of that of the husbands. Bargaining is critical however; the unitary model, if calibrated to match the 1970s generates far too much of an increase in the wife’s paid labor, and far too large a decline in that of the men; in both cases, the prediction error is on the order of 2-3 weekly hours, about 10% of per-capita labor supply. In terms of aggregate labor, the error is much smaller because these sex-specific errors largely offset each other.

The bottom line therefore is that if, as is often the case, the research question does not require us to distinguish between the labor of different household or spouse types, then it may be reasonable to ignore bargaining between spouses.  However if we need to understand the allocation of time across men and women, then models with bargaining have a lot to contribute.

John Knowles is a professor of economics at the University of Southampton. He was born in the UK and schooled in Canada, Spain and the Bahamas. After completing his PhD at the University of Rochester (NY, USA) in 1998, he taught at the University of Pennsylvania, and returned to the UK in 2008. His current research focuses on using mathematical models to analyze trends in marriage and unmarried birth rates in the US and Europe. He is the author of the paper ‘Why are Married Men Working So Much? An Aggregate Analysis of Intra-Household Bargaining and Labour Supply’, published in The Review of Economics Studies.

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Walmart now has stores in more than fifteen developing countries in Central and South America, Asia and Africa. A glimpse at the scale of operations: Nicaragua, with a population of approximately six million, currently has 78 Walmart retail outlets with more on the way. That’s one store for every 75,000 Nicaraguans; in the United States there’s a Walmart store for every 69,000 people. The growth has been rapid; in the last seven years, the corporation has more than doubled the number of stores in Nicaragua (see accompanying graphs — Figure 1 from the paper).

When a supermarket chain like Walmart moves into a developing country it requires a steady supply of fresh fruits and vegetables largely sourced domestically. In developing countries where the majority of the poor rely on agriculture for their livelihood, this means that poor farmers are increasingly selling produce to and contracting directly with large corporations. In precisely this way, Walmart has begun to transform the domestic agricultural markets in Nicaragua over the past decade. This profound change has been met with both excitement and trepidation by governments and development organizations because the likely effects on poverty and inequality are not known, in particular:

• What existing assets or experience are required for a farmer to sell their produce to supermarkets?
• Do small farmers who sell their produce to supermarkets benefit from the relationship?
• What is the role of NGOs in facilitating small farmer relationships with supermarkets?

Supermarkets require that farmers meet standards related to production, post-harvest processing, and delivery; for example, the use of specific pesticides and fertilizers and the cleaning and packaging of vegetables. Moreover, supermarkets generally require farmers to guarantee production year round, which requires planning (sometimes across multiple farmers), irrigation and capital. These requirements can present significant challenges to small farmers with little capital and it is thought that such challenges could strongly effect which farmers sell produce to supermarkets.

Generally, researchers have studied the inclusion of farmers in supply chains by measuring the income, assets and welfare of a group of farmers selling a crop to supermarkets (“suppliers”) with a similar group of farmers selling the same crop in traditional markets (“non-suppliers”). This research has provided important insights but has struggled with two persistent challenges.

First, because most existing studies rely on surveys of farmers living in the same area, we do not know how important farmer experience or assets such as farm machinery or irrigation, are for inclusion in supply chains in comparison to other farmer characteristics like community access to water or proximity to good roads.

Second, without measurements on supplier and non-supplier farmers over time it is difficult for a researcher to isolate the effect being a supplier has on the farmer. For example, if Walmart excels at choosing higher-ability farmers as suppliers, a study that just compared supplier and non-supplier incomes would overestimate the supermarket effect because Walmart’s high-ability farmers would earn more income even if they had not contracted with the supermarket.

With these two challenges in mind, I implemented a research project in Nicaragua in which I first identified all small farmers who had had a steady supply relationship with supermarkets for at least one year since 2000 (see accompanying graphs — Figure 2 from the paper). I also revisited 400 farmers not supplying supermarkets but living in areas where supermarkets were buying produce. My team and I surveyed farmers about their experiences over the past eight years: the markets where they had sold, the farming, land, and household assets they had owned. Since my study included farmers selling a variety of crops to supermarkets and measured how their assets, and supermarket relationships, changed in time, I was able to more rigorously address how these markets affected small farmers. The project was part of a collaboration between researchers Michigan State University, Cornell University, and the Nitlapan Institute in Managua.

Results

Farmer participation

Farmers located close to the primary road network and Nicaragua’s capital, Managua, where the major sorting and packing facility is located, and with conditions that allow them to farm year round were much more likely to be suppliers. Remarkably, this effect was much stronger than other farmer characteristics such as existing farm capital or experience.

Farmer welfare

Suppliers do benefit from selling their produce to supermarkets. The assets of farmers that sold to supermarkets for at least one year between 2000 and 2008 were 16% higher than for farmers that did not sell to supermarkets.

One way to think of income is as a flow of financial resources based, in part, on a farmer’s assets. By statistically relating a change in assets to a change in income I find that a 16% increase in assets corresponds to an average increase in annual household income of about $200 — or 15% of the average 2007 income for the farmers I studied.

Our previous work discovered that supermarkets don’t pay farmers a higher mean price than traditional markets but they do offer a more stable price. This analysis suggests a reason that household assets – and thus income — increase among farmers who sell to supermarkets; shielded from price fluctuations in the traditional markets by the supermarket contract, farmers invest in agriculture, in some cases moving to year-round cultivation. Farmers finance these investments through higher and more stable incomes and new credit sources. Income increases are attributable not to higher average prices but likely to increased production quantities.

NGOs

NGOs have played an important role in small farmer access to supermarket supply chains all over the world. In Nicaragua, a USAID program funded NGOs to help small farmers sell to supermarkets. These NGOs established farmers’ cooperatives and provided technical assistance, contract negotiation, and financing. Do NGOs change farmer selection or outcomes? Do they choose farmers with less wealth or experience? Or do farmers working with NGOs benefit in a special way from supermarkets because of the services NGOs provide?

We find, on average, that NGO-assisted farmers start with similar productive assets and land as those who sell to supermarkets without NGO assistance. Nor do we find a special effect on the assets of NGO-assisted farmers. However, we do find that NGOs play a critical role in keeping farmers with little previous experience in vegetable production in the supply chain. Low-experience farmers who are not assisted by NGOs are more likely to drop out of the supply chain than those assisted by NGOs.

Conclusions

These findings offer grounds for optimism and also a measure of caution with respect to the effects of supermarkets operating in developing countries. Supermarket contracts improve farmer welfare, and the improvements are detectable in farmers’ assets. However, since being close to roads and having the ability to farm year round is so critical to inclusion in the supply chain, not all farmers will be afforded these opportunities. Moreover, because these trends are still nascent in Nicaragua and in many other parts of the developing world, it remains to be seen what the broader effects will be for the agricultural sector and development. For example, as NGOs invest in preparing more small farmers to supply supermarkets, the gains to farmers from joining supply chains may be lost to increased competition. Our results in Nicaragua suggest that, given the small number of supplier farmers, changes in rural poverty related to supermarket expansion will be modest, but how will these supply chains, and the benefits they represent for farmers, change over time? I am currently a part of a team studying Walmart supply chains in China, which will interrogate these questions on a much larger scale in the context of a global and rapidly expanding economy.

Hope Michelson is a postdoctoral fellow at Columbia University’s Earth Institute in the Tropical Agriculture and Rural Environment program. She completed her doctoral research in the Economics of Development in 2010 at Cornell University’s Department of Applied Economics. She is the author of “Small Farmers, NGOs, and a Walmart World: Welfare Effects of Supermarkets Operating in Nicaragua” in the American Journal of Agricultural Economics, which is available to read for free for a limited time.

The American Journal of Agricultural Economics provides a forum for creative and scholarly work on the economics of agriculture and food, natural resources and the environment, and rural and community development throughout the world.

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The post What happens when Walmart comes to Nicaragua? appeared first on OUPblog.