Symposium on New Directions in Fiscal Federalism: An Introduction

Issues of fiscal federalism—broadly defined to includethe tax, expenditure, and debt policies of different levelsof government, as well their interaction—have attractedheightened attention from academics and policymakers alike.Global changes in institutional structures and economic conditionswithin and among countries, including fiscal, economic and politicalreforms, have highlighted the importance of the division offiscal and political responsibilities among governments. Competitionamong governments, as well as the development and evolutionof mechanisms of horizontal and vertical fiscal coordinationand cooperation among them, have been the subject of a rapidlydeveloping literature. Better understanding of the fiscal policiesand interactions of governments, and of their institutionaland political underpinnings, presents deep intellectual challengesas well as opportunities for useful policy applications. The five papers in this symposium are a selection of papersbased on keynote addresses presented at a September 2006 conferenceon "New Directions in Fiscal Federalism"     

Policymakers' horizon and the sustainability of international cooperation

This paper examines the impact of policymakers' horizon on the sustainability of international cooperation. We describe a prisoners' dilemma game between two infinitely-lived countries run by policymakers. We show that re-election incentives can act as a discipline device, making it easier to sustain cooperation between policymakers with finite but potentially renewable mandates than between infinitely-lived policymakers. We also show that, when voting suffers from a recency bias, policymakers may have incentives to “collude” to get re-elected and term limits may help international cooperation.     

U.S. immigration regulations and India's information technology industry

The export-led growth of India's information technology (IT) industry has been nothing short of phenomenal over the past half-dozen years. Other studies have provided a number of explanations for the growth. This paper proposes that a significant factor has been overlooked or understated in prior explanations. Specifically, the Indian IT industry has utilized U.S. immigration regulations for competitive advantage to accelerate its growth. The importance of this factor is estimated through quantitative data analysis at the macro and firm levels. The analysis helps to explain why India's IT industry grew while that of other developing countries, with similar human capital resources and wage rates, did not. The U.S. Congress is currently debating U.S. immigration policies and may change them in the near future. Any changes will have significant effects on the future growth pattern of the Indian IT industry. Many developing countries have recognized India's success, and policymakers in those countries are implementing strategies to replicate it. The results from this study may help those policymakers better understand a key factor of India's success in exporting IT.     

Time-frequency comovement among green financial assets and cryptocurrency uncertainties

The high energy consumption and carbon footprints have raised environmental and sustainable concerns of green investors and policymakers. This study explores comovements between three green and socially responsible financial assets, S&P global clean energy index (GCEI), S&P green bonds index (GB), DJ sustainability world index (DJSWI) and four cryptocurrency uncertainty/attention indices cryptocurrency policy uncertainty index, Central Bank Digital Currencies Uncertainty Index, Central Bank Digital Currencies Attentions Index and Index of Cryptocurrency Environmental Attention using the bivariate wavelet coherence approach. The findings show that GCEI, GB, DJSWI returns have consistent positive comovement with all cryptocurrency uncertainty/attention indices in the medium-term, suggesting their time-varying leading role. Evidence of negative coherences shows that higher cryptocurrency uncertainties/attentions lead to lower green financial asset returns, reflecting the adverse impact of higher uncertainties/attention on the trust of green and sustainable investors. The above empirical findings offer up-to-date insights for guiding policymakers, and regulators, enabling them in environmental policy development. Furthermore, socially responsible investors can make better investment judgments by considering the environmental concerns in the cryptocurrency marketplaces.     

Feasible taxation in advanced democracies

One usually considers tax pressure as the result of the policymakers’ efforts to increase public expenditure, while populism is resorted to in order to alleviate tensions among the taxpayers. This paper takes a different view. It assumes that populism is exogenous in the short run and defines the tolerable degree of tax pressure required to bring about redistribution; however, taxpayers also resent disappointing economic performances and low-quality public expenditure. Within this context, therefore, policymakers try to find a compromise between their desire to engage in rent-seeking and their electoral ambitions. This paper shows under which circumstances compromise is obtained, how tensions arise, and what outcomes the taxpayers’ reactions may generate.     

Positional concern and low demand for redistribution of the poor

The two observations that (1) some low-income citizens demand low redistribution and (2) as income inequality becomes more severe a larger proportion of citizens make less demand for redistribution (Kelly and Enns (2010)) are counter-intuitive because people oppose redistribution that could be beneficial to them. Understanding the main driving factor that leads to the economic conservatism of the poor is crucial: it guides how policymakers should design redistribution. I show that positional concern can be one of these main factors. When citizens care about their relative position on consumption and their labor productivity is slightly perturbed when a new tax policy is implemented, only middle-income citizens may vote for redistribution. Compared with the prospect of upward mobility hypothesis, I provide a testable prediction for the relationship between economic inequality and the economic conservatism of the poor. If positional concern is the main driving factor, policymakers should focus on increasing the low-income citizens’ standard of living to the middle class; and if the prospect of upward mobility is the main factor then they should focus on minimizing income gaps.     

THE COMPLEX RESPONSE OF MONETARY POLICY TO THE EXCHANGE RATE

We estimate a flexible non‐linear monetary policy rule for the United Kingdom to examine the response of policymakers to the real exchange rate. We have three main findings. First, policymakers respond to real exchange rate misalignment rather than to the real exchange rate itself. Second, policymakers ignore small deviations of the exchange rate; they only respond to real exchange under‐valuations of more than 4% and over‐valuations of more than 5%. Third, the response of policymakers to inflation is smaller when the exchange rate is over‐valued and larger when it is under‐valued. None of these responses is allowed for in the widely used linear Taylor‐type rules, suggesting that monetary policy is better analysed using a more sophisticated model, such as the one suggested in this paper.     

Gini’s transvariation analysis: an application on financial crises in developing countries

The damage and the recurrence of financial crises have increased the concern of investors and policymakers on one hand and the interest of macroeconomists on the other. This paper presents an original non parametric methodology, whose aim is to give a very intuitive and rigorous method for variable selection in order to analyse financial crises. Transvariation analysis compares the distributions of two different groups of countries (sound and distressed) with respect to a single macroeconomic variable and selects the indicators on the basis of a low transvariation probability index. The current account deficit to GDP ratio, differently from other studies on financial crises, seems to be a suitable variable in discriminating distressed countries from sound ones, and the case of Argentina and Turkey confirms this finding.     

Intergovernmental competition,voice and exit options and the design of fiscal structure

Taxpayers may reveal their assessment of policy through exercise of available voice and exit options within the fiscal constitution. The voice option is utilized when taxpayers remain within political boundaries and attempt to communicate their assessments regarding the institutionalstatus quo to policymakers. Exercise of the exit option occurs when taxpayers signal discontent with thestatus quo by purchasing from another government supplier. This paper discusses and contrasts theconventional andconstitutional economics views toward fiscal design and argues that a major difference exists regarding the issue of who should be awarded primary responsibility in the policy process: taxpayers or policymakers? Because voice and exit options determine the relative leverage of taxpayers and policymakers in the policy process, it is argued that the design of voice and exit options in the fiscal constitution exerts a predictable influence on policy. The paper concludes that one's view toward the design of voice and exit options is affected by one's perception of the appropriate size of government. Competitive fiscal structures tend to be advocated by those who believe that government tends to overexpand and monopolistic structures tend to be advocated by those who believe that government tends to be too small.     

Do domestic firms learn to export from multinationals?

Attracting inward investment is a major preoccupation of policymakers worldwide, and a wide range of instruments, including direct subventions, are deployed to attract multinational enterprises (MNEs). Intervention is predicated on the assumption that there are direct productivity spillovers associated with the presence of MNEs and the policy of attracting them is targeted at capturing these externalities. Yet robust evidence on direct spillovers is hard to find. An underexplored indirect channel for productivity spillovers is via exports. Exporting firms are more productive than nonexporting firms. Thus, if the presence of MNEs results in more indigenous firms exporting, an indirect productivity spillover will result. In this paper, we identify possible transmission mechanisms for export spillovers and test for their existence on a large panel of firms in the UK. Our results confirm positive spillover effects from MNEs on the decision to export of UK-owned firms as well as on their export propensity.     

Romanians,Hungarians and their wages,in transition,in Romania

Legally binding treaties or memorandums have been used over time to regulate the issue of national borders of many European countries. As a result, relatively large groups of people have become ethnic minorities in other countries. They may conserve their ethnic identities, and therefore their children may accumulate ethnic human capital (e.g., language, culture, and religion) in addition to the general human capital of the country. Therefore, they can get access to an appropriate occupation linked by tradition or other factors to their ethnic group. This paper uses estimates from a selection model with an endogenous switch among three broad types of occupational groups to analyze the composition of the wage gap between Romanians and ethnic Hungarians in Romania before and during the transition from a planned to a market economy. The results suggest that the institutional settings of the controlled economy allowed Romanians to work in occupations that gave them the best returns, while the changes during the transition years allowed ethnic Hungarians to work in occupations that gave them the best returns.     

Scientific Numerology,Preference Anomalies,and Environmental Policymaking

Recently an abundance of experimental evidence has been gathered that is consonant with the notion that individual preferences are inconsistent and unstable. These empirical results potentially undermine the theoretical foundation of welfare economics, as the degree of preference lability claimed suggests that perhaps no optimization principles underlie even the most straightforward of choices. Yet policymakers in the environmental arena continue to prescribe policies based on economics-based methods that are constructed on the very principles that have been directly refuted. Are policymakers creatures of habit that move at glacial speed or is there something deeper behind their inertness? In this study, I explore this issue within the U.S. context and argue that there is some rationality behind current public policy decisionmaking. I then explore whether the empirical evidence supports the view that policymakers should take preference anomalies seriously. As a case study, I focus on some of my recent findings on preference inconsistencies in the marketplace.     

Dividend taxation and intertemporal tax arbitrage

We analyze the effects of changes in dividend tax policy using a life-cycle model of the firm, in which new firms first access equity markets, then grow internally, and finally pay dividends when they have reached steady state. We find that unanticipated permanent changes in tax rates have only small effects on aggregate investment, since macroeconomic dynamics are dominated by mature firms for which dividend taxation is not distortionary. Anticipated or temporary dividend tax changes, on the other hand, create incentives for firms to engage in inter-temporal tax arbitrage so as to reduce investors' tax burden. For example, a temporary tax cut – the type most likely to be enacted by policymakers – induces firms to accelerate dividend payments while tax rates are low, which reduces their cash holdings and makes them capital-constrained when large investment opportunities arise. This can significantly lower aggregate investment for periods after the tax cut.     

Leadership in Public Good Provision: A Timing Game Perspective

We address in this paper the issue of leadership when two governments provide public goods to their constituencies with cross‐border externalities as both public goods are valued by consumers in both countries. We study a timing game between two different countries: before providing public goods, the two policymakers non‐cooperatively decide their preferred sequence of moves. We establish conditions under which a first‐ or second‐mover advantage emerges for each country, highlighting the role of spillovers and the complementarity or substitutability of public goods. As a result, we are able to prove that there is no leader when, for both countries, public goods are substitutable. When public goods are complements for both countries, each of them may emerge as the leader in the game. Hence a coordination issue arises. We use the notion of risk‐dominance to select the leading government. Finally, in the mixed case, the government for whom public goods are substitutable becomes the leader.     

Future issues of science and technology

The Millennium Project involved 237 scientists, futurists, and policymakers around the world in a two-round Delphi on the future issues of science and technology (S&T) over the next 25 years. This is the first of a 3-year study. The study began by asking science attaches to Washington, DC, what questions were worth asking to their leading scientists and issues that were important to explore on an international basis. A series of questions were identified and rated. Actions to address the questions were also suggested and rated. The results are presented in this paper with some regional differences discussed. The next year of the study interviewed S&T policymakers for the management and policy implications of these findings, and the third year developed scenarios based on these implications.     

Keynesian Economics, Monetary Policy and the Business Cycle - New and Old

After a brief review of the main differences between New andOld Keynesian economics from the sixties this paper focuseson a tension between traditional sluggish measures of potentialoutput commonly used by policymakers and the New Keynesian (NK)notion of this variable which conceptualizes it as the levelof output that would have been produced under perfect competitionhad all prices and wages been flexible. The paper shows that,under monopolistic competition, NK potential output is oftenmore volatile than the level of output produced under stickyprices and wages implying either of the following. Real lifepolicymakers mistakenly target smooth versions of output or(since actual economies are monopolistically rather than perfectlycompetitive) the flexible price and wage equilibrium does notnecessarily maximize welfare. The paper shows, that dependingon the shape of the utility function and of the distributionof productivity shocks either case is possible and proposesa criterion for discriminating between them. (JEL E3, E4, E5,E6)     

Multiple equilibria in dynamic rational expectations models: A critical review

Multiple equilibria are a ubiquitous feature of dynamic rational expectations models. Researchers have been divided on the implications of this phenomenon. Some have viewed this as a reflection of reality and a possible explanation of a wide range of economic phenomena. Others have suggested various selection criteria for choosing one among the many equilibria. This paper reviews the major selection criteria that have been proposed, and through application to three well-known models shows under what circumstances one might expect them to choose the same or different equilibria. In addition, this paper proposes a new criteria based on the limit of finite-horizon equilibria and investigates its relation to the other criteria.     

The Economics of Organization Structure Changes: a US perspective on demutualization

Abstract The objective of this study is to contribute to the current debate on demutualization from a US perspective. We document waves of demutualization and review the empirical literature examining the economics of organizational structure changes that have occurred in the US savings and loan and insurance industries since the 1980s. Based on the review of the literature on the economics of conversions, we generate a set of general observations that might inform private and public policy perspectives on the future role of user owned and controlled organizations in market economies. In doing so, the paper may serve as a platform for further discussion among scholars, policymakers, practitioners, and cooperative leaders in their quest to understand and affect the ongoing process of demutualization .     

Reforms and confidence

We examine the choice of economic reforms when policymakers have present-biased preferences and can choose to discard information (maintain confidence) to mitigate distortions from excess discounting. The decisions of policymakers and firms are shown to be interdependent. Confident policymakers carry out welfare-improving reforms more often, which increases the probability that firms will invest in restructuring. While policymakers in different countries can be equally irrational, the consequences of bounded rationality are less severe in economies with beneficial initial conditions. We also examine how present-biased preferences influence the choice between big bang versus gradualist reform strategies. Our findings help explain differences in economic reform success in various countries.