Highlights

WP 17/09

In “Strategic Entry and Potential Competition: Evidence from Compressed Gas Fuel Retail“, Andrea Pozzi, with Giulia Pavan and Gabriele Rovigatti, study how competition affects the incentives to preempt entry. It is well known that in markets with expanding demand or declining costs entry occurs inefficiently early if there are too many potential entrants rather than a single one. However there is lack of both theoretical analysis and empirical evidence on whether a higher number of firms potentially able to enter the market further exacerbates such inefficiency. The authors exploit a shift in regulation in the retail fuel industry in Italy that allows both to identify the potential entrants in each geographical market and to create exogenous variation in their number. They find that areas with more potential entrants witness significant earlier entry than similar areas with fewer competitors. Evidence is provided to tie this result with an underlying preemption race whose intensity raises with the number of potential entrants.

WP 17/08

In “From Weber to Kafka: Political Instability and the Rise of an Inefficient Bureaucracy“, Luigi Guiso and Claudio Michelacci, with Gabriele Gratton and Massimo Morelli, propose a simple dynamic model which relies on a two-way relationship between legislation and bureaucratic performance: too many laws mechanically jam up the bureaucracy; at the same time, an inefficient bureaucracy gives incentives to politicians to sponsor laws in order to gain the reputation of capable reformers, leading naturally to the possibility of multiple steady states. On the one hand a country may end up in a Weberian steady state characterized by efficient bureaucracy and economic prosperity, on the other hand it may end up in a Kafkian one characterized by inefficient bureaucracy and stagnation. The authors show that a surge in political instability that results in short legislatures, strong public pressure for reforms, or short-lived technocratic governments tends to cause an excessive production of new laws, which can determine a permanent shift to a Kafkian steady state. Italy’s experience since the early 1990s fits some features of the model well: the sharp increase in political instability due to the end of Cold War induced a sharp increase in legislative activism, accompanied by a deterioration in bureaucratic efficiency and poor economic performance. By using micro level data for Italian MPs, the authors also provide evidence that, when political instability is high, politicians signal their competence through legislative activism, which leads to overproduction of laws and norms.

WP 17/07

In “Local Crowding Out in China“, Marco Pagano, with Yi Huang and Ugo Panizza, claim that in China, between 2006 and 2013, massive local public debt issuance crowded out the investment of private manufacturing firms by tightening their funding constraints, but it did not affect state-owned and foreign firms. The paper, using novel data for local public debt, establishes this result in three ways. Firstly, local public debt is inversely correlated with city-level investment by domestic private manufacturing firms. Secondly, this finding is stronger for private firms that depend more heavily on external funding. And thirdly, in cities where public debt is high, firms’ investment is more sensitive to internal cash flow, even when cash-flow sensitivity is estimated jointly with the probability of being credit-constrained. These results suggest that the huge post-2008 fiscal stimulus, which focused on investment in state-owned firms, suffered from a major drawback: it induced a reallocation of investment from the private to the public sector which is likely to undercut China’s long-run growth potential, especially in the areas where local governments have issued the largest amount of debt.

WP 17/06

In “Corporate Leverage and Employees’ Rights in Bankruptcy“, Marco Pagano, with Andrew Ellul, investigate how corporate leverage responds to employees’ legal protection in bankruptcy depending on whether leverage is chosen to curtail workers’ bargaining power (strategic debt model) or is driven by credit constraints (credit constraints model). In particular they test if and to what extent workers’ effect on leverage depends on the protection afforded under bankruptcy law to employees’ versus creditors’ claims, and specifically on their relative seniority in liquidation and the balance of their rights in restructuring. Using newly collected cross-country data on employees’ rights in corporate bankruptcy, the authors estimate the impact of such rights on firms’ capital structure, applying triple-diff strategies that exploit time-series, cross-country and firm-level variation. The estimates show that leverage increases more substantially in response to rises in corporate property values or in profitability at firms where employees have strong seniority in liquidation and weak rights in restructuring, thus giving empirical support to the strategic debt model.

WP 17/05

In “Short-run effects of lower productivity growth. A twist on the secular stagnation hypothesis“, Jean-Paul L’Huillier, with Olivier Blanchard and Guido Lorenzoni, offer a novel explanation of the weak GDP growth observed in the U.S. in the current decade. In their view, while the effects of the legacies of the past (i.e. a weak financial system and fiscal consolidation) have been fading away, expectations about future potential growth have become much less optimistic leading to a temporarily weaker demand. Regression and simulation results suggest that downward revisions of productivity growth may have decreased demand by 0.5% to 1% a year since 2012. If this explanation is correct, it has important policy implications. In particular, as this adjustment comes to an end, demand will pick up and interest rates will increase substantially, more than currently anticipated by financial markets.

WP 17/04

In “Credit Misallocation During the European Financial Crisis“, Fabiano Schivardi, with Enrico Sette and Guido Tabellini, address the question of whether banks with low capital extend excessive credit to weak firms, and whether this matters for aggregate efficiency and economic growth. Using a unique data set that covers almost all bank-firm relationships in Italy during the period 2004-2013, they find that undercapitalized banks were more reluctant to cut credit to non-viable firms. Credit misallocation increased the failure rate of healthy firms and reduced that of non-viable firms. Nevertheless, the negative effects of credit misallocation on the growth rate of healthier firms were negligible. These results show that while banks with low capital can be an important source of aggregate inefficiency in the medium run, they cannot be blamed for having aggravated or prolonged the recession induced by the European financial crisis.

WP 17/03

In “Demand and Supply of Populism“, Luigi Guiso, Helios Herrera, Massimo Morelli and Tommaso Sonno study the determinants of the demand and supply of populism in Europe by making use of individual level data from multiple waves of the European Social Survey. Regarding the demand side, they find that lower income, financial distress and higher economic insecurity, due to exposure to globalization and competition from immigrants, drive the populist vote. Economic insecurity also has an indirect effect on populist voting because it lowers the trust in incumbents. All these variables induce voters to either abstain from voting or, if they do participate, to vote more for populist parties. Aggregating all effects, the authors show that strong negative economic shocks (such as the 2008 crisis still ongoing in several countries) and the collapse of trust in traditional parties they induce, boost the demand for populist policies. Regarding the supply, the paper shows that the same economic variables also caused the entry of populist parties in the political arena. In response to the consensus the populist parties have gained, traditional parties have gradually shifted their platforms towards more populist oriented policies.

WP 17/02

In “Firm-Related Risk and Precautionary Saving Response“, Luigi Guiso, Andreas Fagereng and Luigi Pistaferri , develop a strategy that allows them to simultaneously identify the strength of the precautionary motive and the degree of self-insurance of labor income risk. To address endogeneity problems, they use Norwegian administrative data to identify a credible instrument for consumption risk, that is the variance of firm-specific shocks. At the same time, they provide a framework for studying the precautionary saving response of structural changes in wage insurance provided by the firm. They find a strong precautionary motive, a partial ability to self-insure labor income risk and a large reduction of precautionary savings in response to firm adoption of high powered wage contracts.

WP 17/01

In “Ambiguous Policy Announcements“, Claudio Michelacci and Luigi Paciello study the effects of monetary policy announcements in a New Keynesian model, where ambiguity-averse households with heterogeneous net financial wealth use a worst-case criterion to assess the credibility of the announcements. In this framework, an announcement of a future monetary tightening is always contractionary, while an announcement of a future loosening is less expansionary than under full credibility, and it can even be contractionary if the inequality in wealth is sufficiently pronounced. This occurs because wealthy creditor households are more prone to believe the announcement of loosening than poor, indebted households. Hence there is a fall in perceived aggregate wealth, which, if large enough, can cause a contraction in aggregate demand. To assess the relevance of this mechanism the authors analyze the start of the ECB’s practice of offering forward guidance in July 2013. They show that households’ inflation expectations have responded in accordance with the theory. Calibrating their model to match the entire distribution of European households’ net financial wealth, they find that forward guidance is contractionary, and particularly so when households do not feel liable for the public debt.