Firming Up Inequality

By Till von Wachter, Jae Song, David J Price, Fatih Guvenen and Nicholas Bloom

We use a massive, matched employer-employee database for the United States to analyze the contribution of firms to the rise in earnings inequality from 1978 to 2013. We find that one-third of the rise in the variance of (log) earnings occurred within firms, whereas two-thirds of the rise occurred due to a rise in the dispersion of average earnings between firms. However, this rising between-firm variance is not accounted for by the firms themselves but by a widening gap between firms in the composition of their workers. This compositional change can be split into two roughly equal parts: high-wage workers became increasingly likely to work in high-wage firms (i.e., sorting increased), and high-wage workers became increasingly likely to work with each other (i.e., segregation rose). In contrast, we do not find a rise in the variance of firm-specific pay once we control for the worker composition in firms. Finally, we find that two-thirds of the rise in the within-firm variance of earnings occurred within mega (10,000+ employee) firms, which saw a particularly large increase in the variance of earnings compared with smaller firms.

Read full paper here

 

Lee Ohanian on LA Teacher’s Strike

This article by Lee Ohanian originally appeared in The Hill.

Last week, 31,000 Los Angeles Unified School District teachers represented by the United Teachers of Los Angeles (UTLA) union went on strike for the first time in 30 years.

Substitute teachers and administrators make up a skeleton crew that is keeping schools open, and about one-third of the 640,000 district students are attending class.

The strike is exacting a tremendous toll on parents, many of whom are poor and who must decide whether to take time off of work to care for their children or send their children to grossly understaffed schools.

The issues underlying the strike highlight the challenges facing public school administration, teacher unions and school funding, and shows what must change if U.S. public schools are to increase student achievement.

The strike is about teacher pay, classroom size and increasing the number of school support staff, including counselors, librarians and nurses. But at a deeper level, the strike is really about suppressing the state’s charter schools, which are the major competition facing traditional schools.

Charter schools, which grew out of interest in having public alternatives to traditional schools, began in 1992 and now enroll over 600,000 students within California. Charters have become increasingly popular, and their number has doubled over the last decade.

Charters now enroll about 10 percent of all schoolchildren in the state but enroll about 20 percent of Los Angeles schoolchildren. The rapid growth of charters reflects parent dissatisfaction with some traditional schools as California school test scores are among the lowest in the country.

The dramatic growth of charters has been strongly opposed by traditional schools and their teacher unions because charter schools take students — and education dollars — away from traditional schools.

Lower student enrollment within LAUSD traditional schools is an important reason why the district does not have the funds to meet the union’s demands.

The structure and management of charter schools differs considerably from that of traditional schools. Charters do not face the same regulations as traditional schools, and 70 percent of charter teachers are not in a union.

The whole premise behind charter schools is that they have greater flexibility in hiring, human resources management and curriculum decisions, which gives them the freedom to develop new ideas and experiment with different teaching practices.

The key question is whether a child’s learning will improve if he or she attends a charter rather than a traditional school. While this is a difficult question to answer, several studies suggest that learning outcomes are significantly higher in charters.

One study of New York charters found that charter education could eliminate much of the achievement gap between schoolchildren in Harlem and schoolchildren in Scarsdale, an affluent New York suburb.

Traditional schools in LAUSD can’t afford to lose any more students to charters. The UTLA is trying to preserve school enrollment — and funding — by attacking charters. During negotiations, UTLA President Alex Caputo-Pearl stated:

“We’re here … to invest in our existing schools. We must do this instead of continuing the unsustainable, destructive practice of unregulated charter school growth,”

If the union gets its way, state legislators, several of whom have received support from teacher union campaign contributions, will severely limit the number of charters, and many parents will have no choice other than to keep their children in traditional schools.

Ironically, the UTLA’s strategy of castigating charters as the villains and asking government for protection from their competitor, is the same strategy that was used by the U.S. auto and steel industries in the 1970s and 1980s.

Those industries were rapidly losing market share to very efficient foreign competitors and sought — and received — protection from imports through voluntary export restraints.

California schoolchildren would be much better off if traditional schools retained students by implementing common-sense reforms rather than by capping the number of charter schools.

These reforms include modifying teacher tenure by increasing the tenure review period beyond its current 18 months of teaching and by making it less costly to dismiss poorly-performing teachers.

Firing a tenured teacher for poor performance can take several years and cost over $250,000 per case. Accordingly, only .0007 percent of California teachers are dismissed for poor performance. Other reforms include replacing seniority-based pay and layoff policies with merit-based pay and layoff policies.

Research by Stanford University economist Eric Hanushek suggests that implementing these reforms would move California schooling outcomes from near the bottom among U.S. state rankings to near the top.

Existing tenure and layoff policy practices are so costly that several Los Angeles schoolchildren filed an equal protection lawsuit against the LAUSD in 2012, arguing that they were being deprived of their right to an education by an effective teacher.

One of the plaintiff’s expert witnesses presented research findings that showed that students lost more than nine months of learning when taught by an ineffective teacher. This is particularly striking when one considers that the school year is only nine months long.

Judge Rolf Treu, who ruled in favor of the schoolchildren, remarked that the evidence presented regarding ineffective teachers was not only compelling, but it “shocks the conscience.” The verdict, however, was overturned by the California Supreme Court on appeal.

The UTLA strike provides policymakers with a unique opportunity to address the underlying issues that are depressing the quality of California schools. It is time to stop protecting California’s largest monopoly and implement reforms that will improve student learning.

Lee E. Ohanian is a professor of economics at UCLA and a senior fellow at the Hoover Institution, Stanford University.

Sam Peltzman on Harold Demsetz

I have just learned of Harold Demsetz’s death.  I knew he had been in decline for some time, but the news still occasioned a great sadness.  Harold was a major influence on me and on the world at large.  It is this larger significance of his work that I want to emphasize here.  We have lost one of the giants of economics in the past century.

Many will rightly cite his 1972 AER paper with Armen Alchian on team production or the 1967 AER paper on property rights.  Either would have been sufficient for the Nobel Prize that he inexplicably didn’t get.   I want to highlight here a couple of other papers that also had an outsized influence.  Here the influence was as much outside the profession as within. Harold’s work had profound effects on public policy, or at least on the framework of how policy is analyzed and discussed.

His 1973 Journal of Law and Economics paper, “Industry Structure, Market Rivalry, and Public Policy” fundamentally altered our understanding of the relation between market structure and market performance, and it had a significant impact on how economists think about competition policy.  This paper represents a continuing challenge to the intellectual basis for that policy in the field of mergers. The prior orthodoxy about how market structure affected competition reigned from the time of Edward Mason’s work in the late 1930s until well into the 1970s. It was embedded in a “structure-conduct-performance” (SCP) paradigm whereby market performance was ultimately determined by a market structure that was treated as exogenous.  A large empirical literature developed that generally showed a positive correlation between price-cost margins and the concentration of output among sellers.  Since concentration was treated as given, the correlation was interpreted as demonstrating the price-enhancing effects of oligopolistic interaction.  If merger policy has any factual basis today it would be rooted in this empirical SCP literature.  The “Demsetz critique” of this literature in the 1973 JLE paper showed how the same profit-concentration correlation could arise from the cost and price reducing effects of competition in innovation. He also showed that much of the previous literature was more consistent with the competitive interpretation, whereby concentration was not a given but the result of innovative “winners” taking market share from other firms.  This work dramatically altered empirical research in industrial organization: the search for cross-sectional correlations between profit margins and concentration ratios basically ended, and few industrial organization economists today would draw the kind of causal inferences from such correlations as in the SCP literature.  Competition policy makers would also today be less likely to infer harm to competition solely from evidence that sellers’ profitability was above some norm. Merger policy has evolved away from a mechanical restriction on market concentration to a more “rule-of-reason” approach, whereby evidence of efficiencies from mergers can be weighed in the balance.   I think this quite profound change in how both economists and policy makers think about market concentration is Harold’s legacy.

The other paper I want to discuss also lives on in public policy.   His 1968 JLE paper “Why Regulate Utilities?” showed how “competition for a market” could marshal private information to achieve the public policy objective of price regulation more efficiently than direct price regulation.  Utilities are of course the canonical price regulated natural monopoly. Harold proposed to substitute a “Demsetz auction” for the government price regulation.  This was an auction whereby bidders competed for the right to be the monopoly supplier by specifying the lowest price they would accept for output.  Such an auction would mobilize private information on who was the low cost supplier.  The real innovation here is to clarify greatly the distinction between the objectives of public policies on market failure (in this case the objective would be the lowest price consistent with efficient supply) and the mechanisms that could implement these objectives most efficiently.  While the “Demsetz auction” has had limited applicability in the precise form he proposed, the essential logic appears in much of the subsequent wave of privatization, in the vertical restructuring of natural monopolies such as electricity, and in the provision of public services. To mention just one example, those London double decker buses used to be government run. They are now run by private operators who compete to bid the lowest acceptable subsidy (positive or negative) to run the buses on the terms specified by the government.  Very Demsetzian.  Perhaps such innovation would have occurred with or without Harold’s paper, but the fact is that such marshaling of competition for provision of public services was virtually unknown before.

Few of us who analyze and debate public policies leave a mark on the practical affairs of the world.  Harold’s work did so, and we are all the poorer for losing him.

Sam Peltzman

Booth School, University of Chicago (Emeritus)

Lee Ohanian in the Wall St Journal

Nearly half of millennials say they prefer socialism to capitalism, but what do they mean? “My policies most closely resemble what we see in the U.K., in Norway, in Finland, in Sweden,” Rep. Alexandria Ocasio-Cortez told “60 Minutes.” Yet Sweden’s experiment with socialist policies was disastrous, and its economic success in recent decades is a result of market-based reforms.

Until the mid-20th century, Sweden pursued highly competitive market-based policies. By 1970 Sweden achieved the world’s fourth-highest per capita income…. Read full story on The Wall Street Journal

Ben Klein on Harold Demsetz

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Harold Demsetz

Harold Demsetz, UCLA Professor of Economics since 1971, died on January 4, 2019 at the age of 88.  A grandchild of immigrants from eastern Europe, Harold grew up in a poor neighborhood on the west side of Chicago, where he met his surviving and loving wife Rita.  He originally attended forestry school at the University of Washington but, as he described it, returned home after he got lost because the rule of looking at the side of the tree moss grows on for directions sent him around in circles.  He had no such problems with economics, where he was able to navigate with ease through difficult issues.

When he ultimately decided to return to live on the West Coast by accepting a position at UCLA the department was at the forefront of price theory that, rather than formal analysis, focused on questions of how alternative property rights and institutional arrangements affected competitive behavior and market outcomes.   Harold was a major intellectual force in this tradition.

When he was named a Distinguished Fellow of the American Economic Association in 2013 he was described as “one of the most creative and deep microeconomists of the 20th century.”  The fact that Harold was at UCLA had the effect of moving the department to the center of research on these issues.  His continual penetrating and insightful comments at workshops forced everyone, both faculty and students, to think in fundamental economic terms.  When visiting with him a number of months ago he still wanted to talk about economics and had retained his sharpness.  Harold was a treasured friend and colleague for over 40 years and I will surely miss him.

In Memory of Harold Demsetz

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Harold Demsetz

Harold Demsetz was a Professor of Economics at UCLA from 1971 until his retirement (if he ever really retired). He was the Arthur Andersen Chair in Business Economics and chaired the UCLA Department of Economics from 1978-1980. He was also elected fellow of the American Academy of Arts and Sciences. But the most important thing about Harold was his energy and his ideas.

Considered one of the most creative and deep microeconomists of the 20th century, Harold was one of the pioneers of “New Institutional Economics”. His most famous paper (“Production, Information Costs, and Economic Organization,” written with fellow UCLA professor Armen Alchian for the American Economic Review in 1972) was featured as one of American Economic Review’s Top 20 articles of the 20th Century. Over his illustrious career Harold’s many contributions to his field have stood the test of time.  He will be greatly missed.

Here are some tributes that have been written about Harold:

John Riley, Professor, UCLA

Ben Klein, Professor, UCLA

Tom Hubbard, Professor, Kellogg School of Management.

Sam Peltzman, Professor (Emeritus), University of Chicago

Jonathan Adler, Professor, Case Western Reserve University School of Law

Peter Boettke, Professor, George Mason University

Frederic Sautet, Professor, George Mason University

Chicago’s Lesser-Known Free Marketer” appeared in The Wall Street Journal

American Economic Association background on distinguished fellow Harold Demsetz remarkable intellectual career.

Forbes

If you have a memory of Harold that you would like us to post, please email: stewart@econ.ucla.edu

 

John Riley On Harold Demsetz

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Harold Demsetz

Professor Harold Demsetz will be greatly missed by all who were either his friends, his students, his colleagues, or, in my case, all three!

Harold grew up on the West Side of Chicago. He received his B.A. (1953) and MBA (1954) from the University of Illinois.  In 1958 he was awarded a Ph.D. in Economics from Northwestern University. He taught at the University of Michigan (1958–60), UCLA (1960–63), and the Chicago Business School (1963–71) before returning permanently to UCLA’s Economics Department.

Harold was a true giant of the profession. He was a leading figure in the Chicago school, and was one of the pioneers of the approach now called New Institutional Economics. He is a founder of the field of managerial economics. He expanded the theory of property rights now prevalent in law and economics. Even though Harold never employed game theory, he is a major figure in industrial organization through his writings on the theory of the firm, antitrust policy, and business regulation.

Over his lifetime, his papers garnered over 63,000 citations. This is a stunning number. Harold’s most famous paper (“Production, Information Costs, and Economic Organization,” written with his colleague Armen Alchian for the American Economic Review in 1972), has over 18,000 citations. It is one of the most cited papers in all of economics.  His next nine most cited papers were all cited over 2000 times.  The titles of some of these papers provide a glimpse of the depth of his research on the theory of the firm:

I arrived at UCLA in 1973. Harold had just started UCLA’s first field focused research (the IO workshop) and a string of luminaries were invited to make their presentations.  It would not take many minutes before Harold would ask his first question and usually there was a follow-up question as well.  This was exciting stuff for students and faculty and as an assistant professor it was an essential part of each week.

Knowing that I was writing on the theory of signaling, Harold arranged for me to give a talk on the topic at the Chicago Business School. It was understood that surviving this was a necessary condition for earning his respect as an economist. A talk on competition with private information of course generated a huge amount of discussion at the workshop so I did not have to talk too much. It was a huge confidence boost for a young assistant professor!

Not surprisingly, Harold attracted a large number of students to his graduate classes and deeply influenced many of their doctoral dissertations.  He also had a strong influence on undergraduate education. Around 1980 he stimulated on ongoing lunchtime faculty club debate on how to best teach economics to undergraduates.  If the vast majority were seeking jobs in business, why were we not offering a program designed to prepare them to understand finance, theories of firm boundaries, the regulation of monopoly, and so on?  Not only would this be good for the students but it might also attract funding for the department.  In 1983, as a result of Harold’s determined leadership, a new major in Business Economics was born and it proved wildly popular.  Very high entry barriers were established and it quickly became a quasi-honors program for the economics undergraduates. Businesses took notice both in their recruiting efforts and in their financial support. In particular Arthur Anderson funded the Arthur Andersen UCLA Alumni Chair in Business Economics.  Of course Harold was by far the most distinguished candidate! Thirty-five years later, the Business Economics Major continues to attract exceptional students.

I will conclude with another vivid personal memory.  It begins with Harold carrying his sneakers as he headed down the elevator at lunchtime. “Off to run at the track!” he told me. I was invited to join him some day. I agreed and as we arrived at the starting point he said, “John this is your first time, so don’t feel you have to keep up with me.”  While it was a crisp pace I realized that I could keep up with my very senior (42 year old) colleague. I decided to do some training with the goal of being able to lap him in a 2 mile race. I completed my preparations and challenged him.  It seems stupid now! The day arrived.  I had a simple plan. Sprint the first lap, get a big lead and watch Harold give up. Away I flew. 440 yards later he was still right on my heels.  I was the one who knew I was going to fall short and so I did.  Harold always recalled this event with great satisfaction even though he admitted it was one of the hardest things he had done in his life!  But that day proved much more important. It was the beginning of a long and close relationship.  We were often competitive but always good friends.

By John Riley

Rodrigo Pinto Paper Makes “Best of 2018”

Each year Quartz, a digital publication that’s part of Atlantic Media, publishes a list on Economics Research That Shaped Our World. This year include Professor Rodrigo Pinto’s paper on “Noncompliance as a Rational Choice”. This paper finds that growing up in an affluent neighborhood leads to better economic outcomes as an adult.

Nobel prize winner Jim Heckman writes: “Randomized control trials are considered the “gold standard” of economic evaluation research. Yet, many people assigned to treatment status do not comply. Noncompliance compromises simple interpretation of experimental evidence. Using basic economic choice theory, Pinto shows how to enhance the information from experiments. He applies his tools to the analysis of the Moving to Opportunity experiment, which offers low-income families the opportunities to move to better neighborhoods. Pinto shows that, contrary to influential claims based on results from naïve application of experimental methods, there are substantial impacts on neighborhoods of the outcomes of both the adults and children of families. His work greatly bolsters the evidence on the power of place and the ability of policy to reduce inequality within and across generations.”

Moritz Meyer-ter-Vehn appointed Editor of Review of Economic Design

The UCLA Department of Economics is very happy to announce that Associate Professor Moritz Meyer-ter-Vehn has been appointed as an Editor for the Review of Economic Design!

The Review of Economic Design explores the art and science of inventing, analyzing, and testing economic, social, and political institutions and mechanisms.

The journal applies normative and positive economics and the strategic analysis of game theory, using novel ideas for designing and assembling diverse legal-economic instruments. Among these instruments are constitutions and other assignments of rights; mechanisms for allocation or regulation; tax and incentive schemes; contract forms; voting and other choice aggregation procedures; markets; auctions; and a variety of organizational forms.

Congratulations, Moritz!

Learning Dynamics in Social Networks

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Moritz Meyer-ter-Vehn

How do societies learn about the quality of innovations? How does the structure of social interactions affect their diffusion? These questions are critically important to modern economics, and to social science more broadly. They are relevant for the diffusion of new innovations, production techniques, and new business models. For example, consider how consumers learn about a new brand of electric car from their friends purchasing decisions. Or, how farmers who learn about new crops by observing neighbors’ planting choices. Or, how new financial products diffuse across villages in developing countries.

Over the last thirty years, researchers have studied such processes via sequential learning models and have identified important forces that impact whether or not societies eventually learn the truth. However, in the words of a recent survey: “A significant gap in our knowledge concerns short-run dynamics and rates of learning in these models.”

Professor Meyer-ter-Vehn’s research fills this gap. In “Learning Dynamics in Social Networks” (with Simon Board), he proposes a tractable model where the full learning dynamics are described by a differential equation, enabling him to study the effect of network structure on learning and diffusion. The model is simple, and is inspired by a classic “purchasing funnel”. First, each agent develops a need for a product at a random time (e.g. their car breaks down). Second, the agent sees which of her friends have already adopted. Third, she chooses whether to inspect the product (e.g. taking the car for a test-drive) and adopts it if the quality is high and it fits her needs.

Networks are very complicated objects, with each agent making inferences from the adoption decisions of their neighbors who, in turn, make inferences from them. To make progress on the problem, the paper first considers tree networks (e.g. a corporate hierarchy, or a large random network) and provides conditions under which all direct and indirect links contribute to an agent’s learning.  That is, an agent benefits if she has more friends, if her friends have more friends, and so on. This may sound obvious but, beyond trees, not all links are beneficial: An agent’s learning decreases when her neighbors are linked to each other, and when her neighbors learn from herself. Looking across all feasible networks, the paper shows that an agent’s favorite network is the directed star with herself at the center. These results also imply that learning is better in “decentralized” networks than “centralized” networks.

Professor Meyer-ter-Vehn’s research contributes to our understanding in three ways. First, it develops intuition for how network structure affects learning. Second, it can be used to structurally estimate diffusion in arbitrary, real-world networks while maintaining standard Bayesian rationality assumptions. Third, it informs policy experiments that affect network structure and the information of participants.