Development Bank Research Bulletin

Why are levels of welfare benefits lower in some states? Research shows that racism may be one of the reasons

Why are levels of welfare benefits higher in some American states and lower in others? Some may speculate that maybe residents in the former states are altruists and more moral than others.

Academic research however shows that the differences are the results of both financial self-interest and interpersonal preferences (well, we usually call it racism).

A study done by Harvard professor Erzo Luttmer and published in the Quarterly Journal of Economics shows that:
(1) Individuals decrease their support for welfare if there are more welfare recipients in their area
(2) Individuals increase their support for welfare spending if a larger fraction of welfare recipients in their area belongs to their racial group (Question: which  word with r as the initial do we usually use to describe such type of preference, thought, and behavior?)

He derives the results from nation-wide surveys as well as voting behaviors in California’s Proposition 165 in 1992 primaries, in which governor Pete Wilson proposed both cuts in welfare generosity and changes in the state budget process.

Professor Luttmer concludes that the results also help to explain why welfare benefit levels are relatively low in racially heterogeneous states. Actually, the results also help to explain why European countries redistribute more than we do, as they are usually racially more homogenous.

Group Loyalty and the Taste for Redistribution (PDF file)
Abstract: Interpersonal preferences - preferences that depend on the characteristics of others - are typically hard to infer from observable individual behavior. As an alternative approach, this paper uses survey data to investigate interpersonal preferences. The General Social Survey contains self-reported preferences for welfare spending, which I validate with voting behavior on cuts in welfare benefits. Using this preference measure, I show that preferences for income redistribution are not only determined by financial self-interest but also by interpersonal preferences. These interpersonal preferences are characterized by a negative exposure effect - individuals decrease their support for welfare if there are more welfare recipients in their area - and racial group loyalty - individuals increase their support for welfare spending if a larger fraction of welfare recipients in their area belongs to their racial group. My results hold when areas are defined as states, metropolitan areas or census tracts and are robust to various specification checks. Direct evidence that individuals' preferences for redistribution are partly determined by the effects of redistribution on the utility or lifestyle of others in their community is valuable for the development of more accurate theoretical models and for the design of redistributive policies. The results also help to explain why welfare benefit levels are relatively low in racially heterogeneous states.

Don't say “they steal our manufacturing jobs” before your children!

In last commentary "culture is your destiny", I mentioned that our own children will be influenced by our own culture, and it is our responsibility to teach them the good virtues and good work ethics for them to be able to compete with others when the grow up.

There is empirical evidence that even if we don’t teach them, they will learn from us. Professors Raquel Fernandez and Alessandra Fogli study the work and fertility behavior of women 30-40 years old, born in the U.S., but whose parents were born elsewhere, and find that past female labor force participation and total fertility rates from the country of ancestry have strong explanatory power on the work and fertility outcome of these second-generation immigrants.

So, please behave yourself before your children! If you always talk before them about “they steal our manufacturing jobs”, they will start thinking that “other people steal my high school graduate certificate” or lying about "The dog eats my college degree" when they don’t study hard and fail the tests.

Culture: an empirical investigation of beliefs, work, and fertility (PDF file)
Abstract: We study the effect of culture on important economic outcomes by using the 1970 census to examine the work and fertility behavior of women born in the U.S. but whose parents were born elsewhere. We use past female labor force participation and total fertility rates from the country of ancestry as our cultural proxies. These variables should capture, in addition to past economic and institutional conditions, the beliefs commonly held about the role of women in society (i.e., culture). Given the different time and place, only the beliefs embodied in the cultural proxies should be potentially relevant. We show that these cultural proxies have positive and significant explanatory power for individual work and fertility outcomes, even after controlling for possible indirect effects of culture. We examine alternative hypotheses for these positive correlations and show that neither unobserved human capital nor networks are likely to be responsible.

Culture is your destiny. We are successful because we have confidence in self-determinism!

How does culture affect economic prosperity? Which culture traits are conducive to development? Professor Guido Tabellini studies the history of Europe and finds that trust and respect for others, and confidence in individual self-determinism are important virtues that successful countries and regions share in common.

We are more familiar with “trust and respect for others”, but what is “confidence in individual self-determinism”?

“Confidence in individual self-determinism” is the conviction that individual effort is likely to pay off. If individuals are highly motivated to succeed and view economic success as related to their deliberate choices, they are more likely to work hard, to invest for the future, to innovate and undertake new economic initiatives. Conversely, if individuals regard success as due to luck or to uncontrollable external events, they are more likely to have a passive, resigned and lazy attitude towards economic activity. It is sometimes known as "attitudes towards Inequality" (The "An economist in Paradise" blog has a nice introduction of the concept)

To measure this cultural trait Professor Tabellini construct a variable from the following question in the survey: “Some people feel they have completely free choice and control over their lives, while other people feel that what we do has no real effect on what happens to them. Please use this scale (from 1 to 10) where 1 means “none at all” and 10 means “a great deal” to indicate how much freedom of choice and control in life you have over the way your life turns out”. The variable control is defined as the l average response in each sub-national region in Europe.

Based on this indicator, Professor Tabellini finds that regions characterized by “self-determinism” prosper in the long-run.

These cultural traits prevailed among early American settlers, immigrants, and citizens throughout the past centuries, and the prosperity of America is the result of them. Let’s however not be complacent, because such virtues are being eroded over time.

Nowadays, “thanks” to a certain populism movement led by among others Michael Moore, if you are rich, you are accused of being evil, exploitive, inconsiderate, cold-hearted, immoral, lucky, greedy.....  they never realize that you get rich because you use your brain and you work harder than they are. Some people are born smarter than others, but no one is born lazier than others; if you are lazy and in particular when you always think your failure is the society’s fault, that the society is unfair to you,  you will never succeed, neither will your children if they learn from you.

The populism movement never realizes that we get successfully because we work hard; even when we fail, we never blame the “evil corporations”, we simply work harder; when others become better in our jobs, we never accuse them of “stealing our jobs”, we try to learn from them; Even when we are total failure in our whole life, we never fail as parents, we give our children better education and teach them about self-determinism that everyone has the free choice to choose to work hard instead of relying on social welfare.

If you don’t study and work as hard as those teenagers in China and India, why do you think you deserve higher salaries. You say it is unfair for you to lose you job after 30 years of hard work, but why don’t you think it is unfair that for the past 30 years you are stealing from fellow workers in India in China who worked as hard as you did. Being lazy is your free choice, but you should be responsible for your own choice.

We have to stop this populism movement from poisoning our children and destroying our country!

Culture and Institutions: Economic Development in the Regions of Europe (PDF file)
Abstract: Does culture have a causal effect on economic development? The data on European regions suggest that it does. Culture is measured by indicators of individual values and beliefs, such as trust and respect for others, and confidence in individual self-determination. To isolate the exogenous variation in culture, I rely on two historical variables used as instruments: the literacy rate at the end of the XIXth century, and the political institutions in place over the past several centuries. The political and social history of Europe provides a rich source of variation in these two variables at a regional level. The exogenous component of culture due to history is strongly correlated with current regional economic development, after controlling for contemporaneous education, urbanization rates around 1850 and national effects. Moreover, the data do not reject the over-identifying assumption that the two historical variables used as instruments only influence regional development through culture. The indicators of culture used in this paper are also strongly correlated with economic development and with available measures of institutions in a cross-country setting.

China: the balance sheet. All you wanted to know but where afraid to ask.

The Center for Stategic and International Studies (CSIS) along with the Institute of International Economics (IIE), two of Washington's most influential think thanks, have just published China: the Balance Sheet, in perfect timing for President Hu's visit.  The small book is wonderful.  It is intended as a convenient "one stop shop" for all you wanted to know about China --it extraordinary rise and future--, and is authoritatively well written. The main argument of the book is that a prosperous and stable future for the US, and the world, crucially depends on how US handles the "China Question".  Hence, "getting China right" is and will be the challenge for policymakers not only in the United States, but in Europe and the rest of the world as well.  To acomplish such a feat, requires understanding of the profound changes that have been taking place in China, as well as the challanges it faces.  Is this the tipping point for China: Growth or collapse? Democratization or disorder? Opportunity or threat? Partner or rival?

China everyday becomes more complex and more contradictory.  Its rise will be the story and driver of the XXI century.  It's more important than ever to understand and ask the right questions.

John Snow blames it on the rest of the world

Today John Snow, US Secretary of theTreasury, published an article in the Post that tries --again-- to blame the huge US twin deficits on the rest of the world.  The problem he implies, is not that the United States is the only economy in the history of the world to fight a war and reduce taxes at the same time; nor the unbeleivable fiscal profiglacy of this administration (remember the "bridge to nowhere"?).  Blame it on the Asians for their huge savings, low investment and government spending.  Yours truly saw him this morning walking on the street after a meeting part of the bi-annual IMF-WB spring meetings, where thousands of journalists, policymakers, and yes, bloggers, converge.  Being an innefectual secretary of the Treasury, with little understanding of economics, it was no surprise that he looked gloomy and weary.  What a difference with Rubin.

Vietnam kicks off political reforms? Competitive election for national party boss?

The 10th Congress of Vietnamese Community Party started on April 18th and will last for one week. Unprecedentedly, there are two candidates for the post of Communist Party secretary general (the big boss of Vietnam).

Nong Duc Manh, the incumbent, was expected to hold the post for another term. The large scale corruptions in the transport ministry (the PMU18 scandle) that was uncovered  recently however anger the whole nation. Both within and outside the party, the call for Nong Duc Manh’s resignation is gaining momentum. Recently, three famous retired generals that gained their reputations from Vietnam war publicly denounced the government and pushed for reforms.

The communist party eventually decided that another candidate would be nominated to compete for the position, and whether Nong Duc Manh or the other candidate Nguyen Minh Triet (63 years old, who is the party boss of the South Vietnamese boom town Ho Chi Mihn City, and currently ranks the 4th in the national leadership) will become leader of the nation will be decided by Party’s Congress. The results will  be out within one week, and it is clear that both candidates have substantial supports from various fractions within the Vietnamese Communist Party.

The news is being widely cited in Chinese mainstream newspapers, and some comment that: for the past twenty years, Vietnam has been following the footstep of China’s economic reforms, and maybe China can learn from Vietnam too. As coverd by the Bulletin last month, a heated public debate over soicalism vs capitalism, and better privision of public goods through government reforms has been ongoing for some time in China.

Update (4/25/2006): the incumbent Nong Duc Manh has been re-elected.

The two candidates (the new candidate Nguyen Minh Triet on the right)

Chinese GDP grows by 10.2% in first quarter, highest in ten years; Domestic politics and boom-bust cycle in China

New Chinese growth statistics has come out (still not offiical as of today, but it was leaked by the Chinese president himself). In the first quarter of 2006, Chinese economy grew at 10.2%, which is the fastest in the past ten years. Morgan Stanley’s Steve Roach was wrong again (In March he forecasted that there was going to be a slow down)

Anyone who is familiar with the political-business cycle in China, however, will be even more surprised by this new development.

In China, there has been a five-year business cycle coincident with the Communist Party’s national plenary meeting, in which new five-year plans will be discussed and ratified, and most importantly, major personnel decisions will be made.

According to a study done by Chinese economist Fan Gang: during 1977-2003 period, the average GDP growth rate in the Party national meeting year is 10.3%, compared to 11% in the second  year, 9.3%, 8.7%, and 8% in subsequent years. The reason for faster growth rates in first and second years is that local provincial bosses (newly appointed in the meeting) usually tried to impress the national leader by boosting up investment rates, and more than completing their assigned tasks. Such incentives usually fade away gradually over the five year cycle.

Year 2006, however, is the last year of the 2002-2006 political cycle, and based on past experience, should grow at the lowest speed. The economy however grew at the highest speed in ten years. Something must have changed. One speculation is that the incentive structure has changed. In the past, provincial heads worked hard in the first and second year of the cycle to impress their national boss. Now they work hard in the last year to pro-actively build up political capital for their future career which will be decided in the 2007 national meeting of the Communist Party, and the best political capital in China is GDP, GDP, GDP!  At national level, central government wants to slow down the investment boom, but provincial bosses have made up their own minds.

Year 2006 is going to be an exciting year!

Update: Minxin Pei from the Carnegi Endowment also has similar views in its WSJ article: "China is still far from being a free-market economy". A very nice article!

China’s conservative middle class blocks the way to democracy

Will the rise of middle class in China necessarily lead to relaxation of political control? In media discussions that I am aware of, this is at worse taken as a hope, and at best taken as granted, while for most of us the real question is simply “how long will it take?” 

China expert Professor Ken Lieberthal's view is very representative. When interviewd by New York Times, he said: "The spread of middle-class affluence and education across more of the Chinese population should eventually be a force for democratic liberalization, following the pattern of Taiwan and South Korea.'Am I a hundred percent sure I'm right? No, but that's the long-term bet I'd make' "

Jonathan Unger’s article “China’s conservative middle class” in the April issue of Far Eastern Economic Review, however, argues that Chinese middle class is actually a negative force in this process

“The educated middle class is elitist. Many of its members do not want democracy-that is, multiparty elections for the nation's top leaders. Nor did they want this at Tiananmen a decade and a half ago. They did not and do not want China's peasant majority to play a decisive hand in deciding who rules. Most of them hold the rural populace in disdain, and their fear is that the peasants would be swayed by demagogues and vote-buying. They believe that the rural populace is not yet ready to participate in elections. This is ironic, since villagers have been the only ones in China who have been allowed to cast secret ballots to elect their locality's leader.”

Jonathan Unger concludes that Chinese middle class is not the solution, but a barrier.

“The Chinese educated middle class has become a bulwark of the current regime. Summarizing a large survey of political attitudes in Beijing, a recent book by the political scientist Chen Jie concludes that, among all urban groups, "those who perceive themselves to belong to the middle class and who are government bureaucrats are more likely to support the incumbent authorities." Don't expect regime change or democratization any time soon. The rise of China's middle class blocks the way.”

Is Poland the next Spain? Is China the next Spain?

In the 1970s and early 1980s, income level in southern European countries such as Spain rapidly converged to the rest of the Western Europe. As central and eastern European countries are joining the common market, it is natural to ask “is Poland the next Spain?” Will they catch up with their western neighbors? And how long will it take?

Professors Francesco Caselli and Silvana Tenreyro analyze the case and bring one piece of bad news and one piece of good news.

The bad news is: as the income gap between agriculture and industry is quite small in Eastern Europe, it is unlikely that they could raise income dramatically by massive reallocation of labor from agriculture to manufacturing and services (which was what happened in Spain in 1970s). The only option for Eastern European countries is to increase productivity in manufacturing as the productivity gaps in this sector compared to Western European countries are still enormous. This is more complicated a task and will take a long time.

The good news is: Eastern Europe already has levels of human capital similar to those of advanced Western Europe. Human capital gaps have proved very difficult to overcome in the experiences of Southern European countries such as Spain. Eastern European countries however start out without the handicap, and they may catch up even faster because higher human capital enables them to emulate their western neighbors’ frontier technologies and best practices without inventing the wheel.

New questions: Is China the next Spain? Is India the next Poland?

In China, increase of per capita income is evidently achieved through mass reallocation of labor from unproductive agriculture sector into urban manufacturing sector.This happend in Spain too. In India, the higher education system produces higher quality graduates as competitive as their Eastern European counterparts.........

What are missing for both China and India, however,  are geographic neighbors that are as rich and as responsible as Western European countries. I don't see Japan can play such a role in the near term. Rich EU countries have a well-designed package of programs to help their Eastern neighbors to harmonize their system and converge to Western standards.This isn't ready for Asia yet; the income and institutional gaps are too big in Asia!

References:
Is Poland the next Spain? (PDF file)
Professor Jeffrey A. Frankel wrote an interesting piece of  comment titled “Is Slovakia the next Portugal?” (PDF file)

A tale of two Chinese provinces: “Indians” in China

China is known to have adopted a “Federalism, Chinese style” decentralization approach, by which local governments are given substantial discretion in economic decision making. An interesting consequence of this is that some provinces are adopting polices that are very “Indian”, according to the study “A tale of two provinces” done by professors Yasheng Huang and Wenhua Di (MIT).

Jiangsu and Zhejiang are two neighboring Chinese provinces, one to the north of Shanghai, the other to the south. They started with similar conditions at the beginning of economic reform in 1980s, but ended up with different institutional environment and economic structure.

Jiangsu is very “Chinese”. In Jiangsu, “government plays a heavy sponsorship role in enterprise management and supported collectively-owned town-and-village enterprises (TVEs) rather than, or even to the detriment of, genuinely private firms.”  The Jiangsu economy now is heavily dependent on foreign investment in its numerous industrial parks, very representative of the typical “Chinese model”.

Zhejiang, in contrast, is the “India” in China, where local economy “heavily relies on private initiatives, a non-interventionist style by the government in the management of firms, and as supportive credit policy stance toward private firms.”  Both starting from scratch, in 1995, domestic private firms generated 38.7% of Zhejiang’s industrial output value, compared to 10.5% in Jiangsu. By 2001, the ratio was 69.3% and 44.7%, respectively. The two professors also  find that the more liberal institutional environment for domestic private firms in Zhejiang is associated with less foreign ownership of the joint ventures operating there.

I don’t want to conclude whether the “Chinese model” or the “Indian model” is superior. They both have strength and weakness. But the advantage of the Chinese decentralization approach is that, she never keeps all eggs in one same basket. Some provinces rely more on foreign investment, while the others rely more on private initiative. No matter which approach turns out to work better, the losers can learn from the winners and quickly adjust, which was exactly what happened in mid-1990s in Jiangsu when they realized the importance of private sector development. “Heads, I win. Tails, I still win.”, such is the wonderful “Federalism, Chinese style”

When India will have a “Chinese province” within its border? I am expecting. Indians spend so much time debating whether and how “Indian model” is better than “Chinese model”. The right way forward however is to start experimenting. Talking will take you nowhere.

References (Hat tip: PSD World Bank blog)
What can China learn from India, by Yasheng Huang (a Chinese) (PDF file)
What can India learn from China, by Sridhar Ramasubbu (an Indian) (PDF file)

Also, the research paper by Yasheng Huang:

A Tale of Two Provinces: The Institutional Environment and Foreign Ownership in China    (PDF presentation file in the World Bank)
Abstract:   In this paper, we use a unique dataset covering joint ventures in two provinces of China, Jiangsu and Zhejiang, to test the effect of the institutional environment for domestic private firms on ownership structures of FDI projects. Unlike many studies on this subject, we approach the issue from the perspective of local firms seeking FDI rather than from the perspective of foreign firms seeking to invest in China. Applying the prevailing bargaining framework in studies on ownership structures of FDI projects, we find that a more liberal institutional environment for domestic private firms is associated with less foreign ownership of the joint ventures operating there. Several mechanisms can contribute to this outcome. One is that a more liberal institutional environment may enhance the bargaining power of those domestic firms negotiating with foreign firms to form alliances (the capability effect). The other mechanism is that a more liberal institutional environment may reduce some of the auxiliary benefits associated with FDI - such as greater property rights granted to foreign investors - and thereby attenuate incentive to form alliances with foreign firms (the incentive effect).