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Leverage Cycle Theory of Economic Crises and Booms  

John Geanakoplos

Traditionally, booms and busts have been attributed to investors’ excessive or insufficient demand, irrational exuberance and panics, or fraud. The leverage cycle begins with the observation that much of demand is facilitated by borrowing and that crashes often occur simultaneously with the withdrawal of lending. Uncertainty scares lenders before investors. Lenders are worried about default and therefore attach credit terms like collateral or minimum credit ratings to their contracts. The credit surface, depicting interest rates as a function of the credit terms, emerges in leverage cycle equilibrium. The leverage cycle is about booms when credit terms, especially collateral, are chosen to be loose, and busts when they suddenly become tight, in contrast to the traditional fixation on the (riskless) interest rate. Leverage cycle crashes are triggered at the top of the cycle by scary bad news, which has three effects. The bad news reduces every agent’s valuation of the asset. The increased uncertainty steepens the credit surface, causing leverage to plummet on new loans, explaining the withdrawal of credit. The high valuation leveraged investors holding the asset lose wealth when the price falls; if their debts are due, they lose liquid wealth and face margin calls. Each effect feeds back and exacerbates the others and increases the uncertainty. The credit surface is steeper for long loans than short loans because uncertainty is higher. Investors respond by borrowing short, creating a maturity mismatch and voluntarily exposing themselves to margin calls. When uncertainty rises, the credit surface steepens more for low credit rating agents than for high rated agents, leading to more inequality.. The leverage cycle also applies to banks, leading to a theory of insolvency runs rather than panic runs. The leverage cycle policy implication for banks is that there should be transparency, which will induce depositors or regulators to hold down bank leverage before insolvency is reached. This is contrary to the view that opaqueness is a virtue of banks because it lessens panic.

Article

Earnings Inequality in Latin America: A Three-Decade Retrospective  

Manuel Fernández and Gabriela Serrano

Latin American countries have some of the highest levels of income inequality in the world. However, earnings inequality have significantly changed over time, increasing during the 1980s and 1990s, declining sharply in the 2000s, and stagnating or even increasing in some countries since 2015. Macroeconomic instability in the region in the 1980s and early 1990s, as well as the introduction of structural reforms like trade, capital, and financial liberalization, affected the patterns of relative demand and relative earnings across skill-demographic groups in the 1990s, increasing inequality. Significant gains in educational attainment, the demographic transition, and rising female labor force participation changed the skill-demographic composition of labor supply, pushing the education and experience premiums downward, but this was not enough to counteract demand-side trends. At the turn of the 21st century, improved external conditions, driven by China’s massive increase in demand for commodities, boosted economies across Latin America, which began to grow rapidly. Growth was accompanied by a positive shift in the relative demand for less-educated workers, stronger labor institutions, rising minimum wages, and declining labor informality, a confluence of factors that reduced earnings inequality. In the aftermath of the global financial crisis, particularly after the end of the commodities price boom in 2014, economic growth decelerated, and the pace of inequality decline stagnated. There is extensive literature documenting and trying to explain the causes of recent earnings inequality dynamics in Latin America. This literature is examined in terms of themes, methodological approaches, and key findings. The focus is on earnings inequality and how developments in labor markets have shaped it.

Article

The Economic Benefits of Education for the Reduction of Crime  

Joel Carr, Olivier Marie, and Sunčica Vujić

Historically, social observers have repeatedly noted a correlation between education and crime, observing that individuals with lower levels of education are more likely to commit crime. However, the relationship between education and crime is complex, and it is important to clearly establish causality to determine if investing in education can effectively reduce crime. Merely observing persistent educational-attainment inequalities between offenders and non-offenders is not sufficient to make any causal claims about the underlying relationship between education and crime. Many other factors can influence an individual’s decision to stay in school or commit a crime, and these factors need to be accounted for when estimating the relationship between education and crime. Economists theoretically predicted in the late 1960s that education, via its positive effect on future earnings, would reduce the probability of criminal participation. Empirical studies have since used various econometric methods to establish that, on average, education has a strong causal crime-reducing effect. One strand of this literature has established in various contexts that individuals from cohorts forced by law to stay longer in school were much less likely to end up in court or prison. There is, however, still much to be discovered about the effect of education on crime, such as the underlying mechanisms related to income or non-cognitive effects, and heterogeneities by context, education level and quality, and individual characteristics. Overall, economists widely agree that investing in education is an efficient public-spending strategy to effectively reduce crime.

Article

Economic History of the Middle East, 622–1914  

Timur Kuran

In the Middle Ages, the Middle East was an economically advanced region. Driving its successes were an essentially uniform legal system that supported intra- and interregional commerce, partnership rules that supported commerce among nonrelatives, and a form of trust known as waqf, which served as both a wealth shelter and a vehicle for endowing social services with protections against state predation. These same institutions disincentivized the institutional advances needed to generate the modern economy’s infrastructure indigenously. Home-grown innovations, such as the tradable equity known as gedik and a form of waqf used for moneylending (cash waqf), were ill-suited to large-scale and perpetual enterprises. Partnerships used to form small and ephemeral enterprises did not spawn organizational forms conducive to pooling resources on a large scale and perpetually. The waqf’s rigidities led to increasingly serious capital misallocation and misuse with changes in relative prices and the emergence of new technologies. Thus, the Middle East reached the Industrial Era institutionally unprepared. Sensing an existential threat from the West, its ruling elites launched massive economic reforms in the 1800s. These reforms involved transplanting Western economic institutions to the West in a hurry. Although the Middle East’s economic performance improved greatly in absolute terms, it remained underdeveloped in 1914, and the catch-up process has continued. Until the 1700s, the economic fortunes of the Middle East’s religious minorities generally tracked those of its Muslims. Thereafter, non-Muslims pulled ahead. As the global economy modernized, they benefited from a right that, from the early years of Islam, was denied to Muslims: choice of law. With the development of modern economic institutions by Europeans, choice of law enabled non-Muslims to increase the efficiency of their business operations. In the century preceding the Industrial Revolution, non-Muslims benefited also from international treaties that strengthened their property rights vis-à-vis those of Muslims.

Article

The History of Central Banks  

Eric Monnet

The historical evolution of the role of central banks has been shaped by two major characteristics of these institutions: they are banks and they are linked—in various legal, administrative, and political ways—to the state. The history of central banking is thus an analysis of how central banks have ensured or failed to ensure the stability of the value of money and the credit system while maintaining supportive or conflicting relationships with governments and private banks. Opening the black box of central banks is necessary to understanding the political economy issues that emerge from the implementation of monetary and credit policy and why, in addition to macroeconomic effects, these policies have major consequences on the structure of financial systems and the financing of public debt. It is also important to read the history of the evolution of central banks since the end of the 19th century as a game of countries wanting to adopt a dominant institutional model. Each historical period was characterized by a dominant model that other countries imitated - or pretended to imitate while retaining substantial national characteristics - with a view to greater international political and financial integration. Recent academic research has explored several issues that underline the importance of central banks to the development of the state, the financial system and on macroeconomic fluctuations: (a) the origin of central banks; (b) their role as a lender of last resort and banking supervisor; (c) the justifications and consequences of domestic macroeconomic policy objectives - inflation, output, etc. -of central banks (monetary policy); (d) the special loans of central banks and their role in the allocation of credit (credit policy); (e) the legal and political links between the central bank and the government (independence); (f) the role of central banks concerning exchange rates and the international monetary system; (g) production of economic research and statistics.

Article

Human Capital in a Historical Perspective  

Gabriele Cappelli, Leonardo Ridolfi, and Michelangelo Vasta

Human capital can be defined as the set of knowledge and skills that individuals accumulate over time. These range from basic competences to more sophisticated forms of knowledge (intermediate and upper-tail human capital). All of them entail complex measurement problems in historical perspective as sources are often too scarce, problematic, and unreliable to allow proper measurement. Human capital is usually measured relying on the extensive margin of education or the quantity of education, that is, how many people are able to read or count or how many people have a certain degree of schooling. Less is known about the effective acquisition of skills, for example, the quality of education. Human capital can affect labor productivity and innovative capacity and it is generally regarded as one of the most important determinants of economic growth, figuring prominently in debates on the origin of the Industrial Revolution and the transition from preindustrial to modern economic growth. The determinants of education are several and vary widely over time and across space, including economic, institutional, cultural, and social factors. Historically, the acquisition of skills has deeply changed in nature, passing from the largely decentralized and fragmented systems of the preindustrial period to the 19th-century systems of mass education, where education was more and more universal and free, and the accumulation of skills was largely coordinated by states and other public authorities. In several regards, literature on human capital is still limited. Few efforts, for instance, have been made to harmonize data, integrate them in a comparative and regional perspective, explore the potential of individual-level information, and assess if and to what extent different dimensions of human capital such as technical and higher education have affected long-term patterns in economic growth and development. Other aspects have long been neglected or remain virtually unexplored, such as gender differences in education, the efficiency of education systems and its determinants, and the analysis of human capital in developing countries.

Article

Financial Bubbles in History  

William Quinn and John Turner

Financial bubbles constitute some of history’s most significant economic events, but academic research into the phenomenon has often been narrow, with an excessive focus on whether bubble episodes invalidate or confirm the efficient markets hypothesis. The literature on the topic has also been somewhat siloed, with theoretical, experimental, qualitative, and quantitative methods used to develop relatively discrete bodies of research. In order to overcome these deficiencies, future research needs to move beyond the rational/irrational dichotomy and holistically examine the causes and consequences of bubbles. Future research in financial bubbles should thus use a wider range of investigative tools to answer key questions or attempt to synthesize the findings of multiple research programs. There are three areas in particular that future research should focus on: the role of information in a bubble, the aftermath of bubbles, and possible regulatory responses. While bubbles are sometimes seen as an inevitable part of capitalism, there have been long historical eras in which they were extremely rare, and these eras are likely to contain lessons for alleviating the negative effects of bubbles in the 21st century. Finally, the literature on bubbles has tended to neglect certain regions, and future research should hunt for undiscovered episodes outside of Europe and North America.

Article

The Early Origins of the Civil Rights Movement in the United States: An Analysis of the Growth of the NAACP  

Daniel Aaronson, Jala Abner, Mark Borgschulte, and Bhashkar Mazumder

A newly digitized panel of county-level branch activity of the National Association for the Advancement of Colored People (NAACP) is used to describe the potential factors underlying the expansion of political participation in the American South, with a particular emphasis on the short period from the late 1930s through the 1940s. This period has long been recognized for its significant progress in reducing sizable racial gaps in labor market outcomes. But little work in economics has considered the role of political participation in shaping that progress. As the preeminent civil rights organization prior to the 1950s, the NAACP provides a natural lens in which to explore the expansion in political activism during this crucial period. Associative evidence suggests that a few potential channels could be especially worthy of future study, including the role of demographics, increased human capital, expansion in labor demand driven by wartime efforts, reduction in racial violence, latent political activism, and expansions in political and social networks, all of which have been highlighted in a variety of history and social science literatures. However, careful causal empirical work does not currently exist on these factors. Filling in this hole is important for providing compelling evidence on the origins of the 20th century’s most important U.S. political movement, as well as adding to a growing literature in political economy and development economics which examines the role that grassroots activism has played on economic growth and income inequality around the world.

Article

Modern Swedish Economic History  

Svante Prado and Jakob Molinder

The Swedish growth trajectory began in the mid-19th century as external demand for its staples added an important impetus to industrialization and structural transformation. Since then, GDP per capita has increased by a factor of 21, which means that GDP per capital has doubled 4.4 times. At the same time, the population has increased from about 3.5 million to 9.5 million. The manufacturing industry has been the outstanding force propelling the economy forward since the 1870s. It was early on based on the exploitation of the domestic supply of raw materials. From the 1890s, it was gradually producing products higher up in the value-added chain, manifested by the growth of the mechanical engineering industry and the emergence of the electro-mechanical industry. The share of manufacturing in employment terms peaked at about 35% in the 1960s but then declined to about 18% in the 2010s. Yet, the importance of it as a locomotive for economy-wide growth has not declined by nearly as much. Another principal characteristic of Swedish development is large public sector-spending, implying high taxes and ambitions welfare state arrangements. Much of the expansion in social spending occurred in the post-World War II decades by the emergence of the welfare state based on universal principles and income-related benefits. A third attribute of the Swedish economic history is far-reaching compression of incomes. Thanks to wide-spread unionization and centralized agreements between the major organizations in the labor markets, the road was paved for far-reaching compression of the wage structure, which occurred in brief episodes during the 1940s, the late 1960s, and the 1970s. The joint force of these compressions and the welfare state produced a remarkable flat income distribution by the early 1980s, testified by a Gini of about 0.2, perhaps unparalleled among developed countries. As in many other similar countries, the income distribution has widened since the early 1980s, and the other Nordic countries had lower Gini coefficients than Sweden by the mid-2010s. Migration has set a deep mark in Swedish society. Whereas the latter half of the 19th century witnessed a massive outflow of Swedes going to the United States, two different waves of immigration dominated population movements after World War II. The first wave comprised workers from Finland, former Yugoslavia, and South Europe seeking employment in the prospering labor markets of the post-World War II period. This wave ebbed out in the 1970s. The second one comprised mostly asylum seekers from conflict-ridden countries. It began in the 1980s, and it continues. Combined, these waves of immigrations have transformed the Swedish population from being very homogenous into a blend of different origins.

Article

The Historical Evolution of Canadian Living Standards  

Vincent Geloso

Canada is one of the richest countries in the world. It stands above most countries in the Americas. It is also noticeably poorer than its closest neighbor, the United States, despite considerable geographic similarity. These two facts have been true since as early as the 17th century. Why? An understanding of the historical path of Canada’s economic growth can be acquired by focusing on three important gaps in living standards within Canada: First Nations versus the rest of Canada, French Canadians versus English Canadians, and Atlantic Canada versus the rest of Canada. These three gaps allow an understanding of the crucial role of institutions in determining why Canada is rich on a global perspective and why it is poorer than the United States. However, explanations as to why Canada grew faster than Latin America are more speculative.