Economic Issues Volume 12

ECONOMIC ISSUES

Volume 12 (2007)

Part 1, March

Please select from the titles below:

J Cullis and P Jones, The Welfare Economics of Public Sector Targets: Towards an ‘Expenditure Constitution’
J Cullis and P Jones, ‘Politically (In)Correct’ Targeting: A Public Choice Analysis
M Bahmani-Oskooee and Y Wang, The Impact of Exchange Rate Volatility on Commodity Trade between the US and China
D Harvie, M A Kelmanson and D G Knapp, A Dynamical Model of Business-Cycle Asymmetries:Extending Goodwin
D Nocetti, Optimal Monetary Policy under Risk and Uncertainty

Part 2, September

Please select from the titles below:

Part 1, March

The Welfare Economics of Public Sector Targets: Towards an ‘Expenditure Constitution’ (p.1)

by J Cullis and P Jones

Abstract: With the advent of New Labour, numerical targets have become ubiquitous in the public sector. They are used to monitor and assess performance by government agencies; but how helpful are targets if couched only in numerical terms? In this paper the proposition is that targets must be set in context: targets must be set with reference to a social welfare function. Pressures in 'political markets' are quite different to incentive structures that ensure that targets will maximise welfare. If targets are inappropriate in Paretian terms, welfare loss might be magnified, the more ‘successfully’ government agencies hit targets. Misallocation of resources is gauged against a Paretian benchmark and illustrated with reference to waiting in the NHS. Analysis of a welfare critique of target-setting suggests a policy rule capable of mitigating distortion.

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‘Politically (In)Correct’ Targeting: A Public Choice Analysis (p.19)

by J Cullis and P Jones

Abstract: Targets have become a key instrument in UK economic policy. Numerical targets, such as the UK target for waiting list times for inpatient treatment, have a rationale in terms of public choice analysis. They appear to be premised on politicians' pursuit of getting elected. However, increasingly they are a target for criticism. This paper provides an assessment of targets in the public sector. It considers the rationale for adopting targets and actors' responses to incentives created by NHS targets. Whilst targets may make short-run political sense and therefore be 'politically correct', from other perspectives they look 'incorrect'. The analysis indicates that, in political processes, credibility gains contingent on target setting are likely to be short-lived and counter-productive.

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The Impact of Exchange Rate Volatility on Commodity Trade between the U.S. and China (p.31)

by M Bahmani-Oskooee and Y Wang

Abstract: Exchange rate uncertainty is said to have negative or positive effects on the trade flows. A Large body of the empirical research that tries to address the issue has used aggregate trade data between one country and rest of the world, or bilateral total trade data between two countries. The support for a significant relation between a measure of exchange rate volatility and trade flows is negligible from these studies. In this paper, when we use disaggregated data between the U.S. and China at commodity level (88 industries) and a bounds testing approach to cointegration, we find that almost half of the industries are sensitive to a measure of exchange rate uncertainty.

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A Dynamical Model of Business-Cycle Asymmetries:Extending Goodwin (p.53)

by D Harvie, M A Kelmanson and D G Knapp

Abstract: A rarely noted, economically unrealistic feature of Goodwin’s (1967; 1972) celebrated ‘growth-cycle’ model is that its state variables — the wage share of output and the employment proportion — can exceed unity. We propose a novel extension of the two-variable dynamical system which ensures that its solutions remain within the economically feasible region, i.e. the unit square of the wage-share–employment-proportion phase plane. In a further extension, we obtain a model which, besides possessing a richer economic interpretation than the original, is able to generate asymmetric solution cycles. We use numerical techniques to investigate the new model’s properties; in particular, we examine business-cycle deepness and steepness.

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Optimal Monetary Policy under Risk and Uncertainty (p.93)

by D Nocetti

Abstract: This paper seeks to characterise optimal monetary policy rules in the presence of risk and uncertainty. I explore a situation in which the true parameters and the true structure of the economy are unknown to the policymaker, and he is reluctant to make a decision based on a single distribution estimate (i.e. he faces Knightian uncertainty). I show analytically that if the policymaker does not know the true structure of the economy he will be more cautious than in the case of only parameter risk. Further, I show that Knightian uncertainty can also lead to an extra precautionary motive when one considers its interaction with parameter risk. In a simple exercise, I provide empirical estimates that demonstrate that adjustments due to parameter and structural risk and Knightian uncertainty can potentially be quite large.

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Part 2, September

Excise Taxation and Product Quality: The Gasoline Market (p.1)

by T Nesbit

Abstract: Following Barzel (1976), product quality increases in response to unit taxation but remains unchanged by ad valorem taxation. While many tax theorists agree this argument is theoretically sound, empirical support of Barzel's theory is limited to the cigarette market. This paper tests and confirms his theory in the gasoline market, a market in which Barzel failed to find supporting evidence in his original article. Using a direct test and improved data, the estimates suggest that the market share of premium-grade gasoline increases in response to both unit taxation and ad valorem taxation.

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Do fat tails matter in GARCH estimation: testing market efficiency in two transition economies (p.15)

by B Harrison and D Paton

Abstract: The use of the GARCH-class of models is commonplace when examining stock market returns. In this paper we use data on stock markets in two transition economies, the Czech Republic and Romania, to demonstrate the importance of using the correct GARCH specification. When residuals are characterised by ‘fat tails’ or kurtosis, the use of a GARCH-t specification is appropriate. Diagnostic tests suggest that the GARCH-t specification is appropriate for modelling stock market returns in Romania, whilst the standard GARCH specification is adequate for the Czech Republic. Using a standard GARCH specification leads to rejection of the null hypothesis of market efficiency in Romania, whereas this null hypothesis cannot be rejected using the GARCH-t specification. The null hypothesis of efficiency cannot be rejected in the Czech Republic using either specification. Thus, we find that the presence of ‘fat tails’ can have important implications for inference in the analysis of stock market returns.

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Determinants of Credit Risk in Indian State-owned Banks: An Empirical Investigation (p.27)

by A Das and S Ghosh

Abstract: The determinants of the credit risk of banks in emerging economies have received limited attention in the literature. Using advanced panel data techniques, the paper seeks to examine the factors affecting problem loans of Indian state-owned banks for the period 1994-2005, taking into account both macroeconomic and microeconomic variables. The findings reveal that at the macro level, GDP growth and at the bank level, real loan growth and bank size play an important role in influencing problem loans. The study performs certain robustness tests of the results and discusses several policy implications of the analysis.

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Using Cooper’s Approach to Explore the Extent of Congestion in the New British Universities (p.47)

by A T Flegg and D O Allen

Abstract: This paper uses data envelopment analysis (DEA) to explore the issue of congestion in British universities. The focus is on 41 former polytechnics that became universities in 1992, and the analysis covers the period 1995/6 to 2003/4. These new universities differ from the older universities in many ways, especially in terms of their far higher student:staff ratios and much lower research funding per member of staff. The primary aim is to examine whether this under-resourcing of the new universities has led to ‘congestion’, in the sense that their output has been decreased as a result of having too many students. This phenomenon is measured using the method proposed by Cooper et al. in a series of articles. To check the sensitivity of the results to different specifications, three alternative DEA models are formulated. The results reveal that a substantial amount of congestion was present throughout the period under review, and in a wide range of universities. An overabundance of undergraduate students is identified as the largest single cause of congestion in the former polytechnics. Less plausibly, the results also suggest that academic overstaffing was a major cause of congestion. By contrast, postgraduates and ‘other expenditure’ are found to play a noticeably smaller role in generating congestion.

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Expanding Product Variety and Human Capital Formation in an Ageing Economy (p.83)

by H Noda

Abstract: Population ageing is a significant demographic phenomenon facing many countries. The present paper aims to ascertain the relationship between population ageing and macroeconomic performance, within the framework of an economic growth model endogenously incorporating innovation and human capital. Consequently, the present model implies that the rate of innovation and the ratio of skilled to unskilled workers would decline over the long run as populations aged further, because of increases in life expectancy. The present model also suggests that, in general, the effect of changes in the retirement age on the rate of innovation and the ratio of skilled to unskilled workers is inconclusive.

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