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A joint initiative of Ludwig-Maximilians University’s Center for Economic Studies and the Ifo Institute for Economic Research Bulletin Volume 14 No. 3 July 2004 WHAT PRICE THIS ASSET? Financial assets traded internationally usually have a different price at each location. Who or what determines these prices? Michael Melvin has taken a microscope to the issue. (page 3) DISSECTING EDUCATION IFO NEWS (p. 4) CESIFO DISTINGUISHED AFFILIATES (p. 8) TAPES FISCAL FEDERALISM CONFERENCE (p. 5) MUNICH ECONOMIC SUMMIT (p. 2) HANS MÖLLER SEMINARS (p. 3) With Germany –among other countries– still shuddering from the dismal results obtained in the PISA study, finding the root causes of the malaise and the factors that may contribute to improving student performance are priority undertakings. Eric Hanushek and Alessandro Balestrino are tackling the problem from two different angles. (pages 5 & 8) A NATION OF GREAT SIZE... When a dragon awakes, the entire neighbourhood sits up and pays attention. Well, China is economically waking up, and how to deal with it, in particular, how to integrate it into the regional and world economy, is a major question.That’s Yin-Wong Cheung’s turf. (page 6) ...AND THE SIZE OF NATIONS Does it make better economic sense to have a few big countries or many small ones? In these times of “deepening integration” and musings over common markets, political economists such as Enrico Spolaore have their hands full. (page 2) FEATURED RESEARCHERS Jonas Agell (p. 7) Alessandro Balestrino (p. 5) Markus K. Brunnermeier (p. 5) Yin-Wong Cheung (p. 6) Armin Falk (p. 8) Piero Gottardi (p. 6) Eric Hanushek (p. 8) Kai Konrad (p. 7) Ngo Van Long (p. 7) Jean-Marie Lozachmeur (p. 8) Jim Malley (p. 8) Michael Melvin (p. 3) Enrico Spolaore (p. 2) Jonathan Temple (p. 3) STILL HOLDING UP The world economy is growing at the fastest pace in fifteen years, with Germany (just) being towed along. Check out the findings of the April Ifo World Economic Survey in the Ifo News section. (page 4) MANAGERS’ COMPENSATION What with Enron and Mannesmann and the NYSE’s Richard Grasso, designing appropriate managers’ compensation has become something of an art form. Piero Gottardi is one of the foremost thinkers in this hot field. (page 6) TRADERS’ TRICKS Not only managers, but also stock traders have come under close scrutiny of late. Do they exacerbate stock market bubbles by riding along instead of blowing the whistle on time? Yes, says Markus Brunnermeier. (page 5) GROWTH AND FLUCTUATIONS Do electoral considerations influence economic performance? You bet. Jim Malley is developing a model to precisely measure that link. (page 8) Online version of this issue available at www.cesifo.de Vol. 14, No. 3 • July 2004 MUNICH ECONOMIC SUMMIT 2004 This year’s Munich Economic Summit, the third thus far, had an exclusive boutique quality to it: a small, highlydemanding circle of people gathered to examine premium wares in an intimate atmosphere. The emphasis was placed –rather than on celebrity-sounding names– on high-calibre experts leading their respective fields, which made for quite a lively exchange of opinions. While the heads of EU member governments hammered together a draft European Union Constitution in Brussels, the nearly 150 participants in the Munich Economic Summit –held on June 18– went one step further and discussed the risks that implementing such constitution could pose to the economies of the member countries. A welcome speech by BMW Foundation Herbert Quandt’s Kai M. Schellhorn and an introduction by Ifo President HansWerner Sinn set the tone and scope for the day’s discussions: would the European-style welfare state be able to sur- The liveliest Summit thus far vive the influx of immigrants from the new entrant countries? The constitution, after all, grants immigrants ample social rights. The proposed strategies were to leave immigration policy to the individual states, and to have the home country of unemployed immigrants foot the bill for their welfare until they find a job. The second panel, expertly moderated by The Economist’s John Peet, delved into Further info on this and previous summits at www.munich-economic-summit.com the question of whether immigration should be delayed or restricted, in order to avoid experiencing a stampede that could swamp the invididual labour markets. After what proved to be the most animated discussion in the entire summit, the experts were of the opinion that restricting immigration would have more disadvantages than the other way around: most European countries need immigrants for their economic performance to perk up. What can be done is to restrict welfare entitlements for a given period to allow for the respective labour markets to reform accordingly. This, as it happened, was the topic of the third panel. Surprisingly, there was no shortage of benchmark candidates: the Netherlands and its low unemployment rate, Ireland and its enviable growth rate, Finland and its productivity-furthering consensus. In the end, all agreed that liberalisation is not hopeless. It only lacks leadership. The Summit ended with a gala dinner in the Kaiser’s Room of the Munich Residence. SIZE OF NATIONS AND ECONOMIC PERFORMANCE Spolaore National states are among the most important political institutions in the world, but their borders have usually been considered as “given” (unexplained) by economists. Only recently have economists started to focus on questions such as: What determines the number and size of nations? How do national borders change over time? What are the economic consequences of border redrawing? Does it make better economic sense to have a few big countries or many small ones? The focus on national borders as important “endogenous” variables is a natural development within the growing field of contemporary political economy, as political economists' main goal is to understand political institutions and behaviour with the tools of modern economic analysis. 2 Enrico Spolaore, Kutayba Alghanim Assistant Professor of Political Economy at Brown University, has contributed to the recent literature on the number and size of nations with numerous publications, both theoretical and empirical, including his recent book The Size of Nations (MIT Press, Dec. 2003), coauthored with Alberto Alesina. In this work Spolaore argues that the size of nations is determined by a trade-off between the benefits of scale and the costs associated with more heterogeneous populations, and shows how both benefits and costs are affected by political and economic variables. For example, increasing international economic integration, by reducing the economic importance of a country’s domestic market, reduces the benefits of a larger size and therefore goes hand in hand with separatism and political disintegration. While visiting CES, Spolaore gave three lectures, covering issues such as the rela- Bulletin tionship between democratisation and break-up of countries, economic integration and political disintegration, and war, peace and the size of nations. While at CES he also gave a seminar presentation on his related research on the relationship between political borders and long-term income per capita and growth, which he has been pursuing jointly with Romain Wacziarg. Spolaore holds a Ph.D. in Political Economy from the University of Sienna, Italy, and a Ph.D. in Economics from Harvard University, where he received a National Science Foundation-sponsored doctoral fellowship from the Harvard-MIT Research Training Group in Positive Political Economy. After graduating he obtained a Human Capital and Mobility Fellowship from the European Commission and spent a year at the European Center for Advanced Research in Economics in Brussels. From September 2004 he will be at Tufts University in Boston. Vol. 14, No. 3 • July 2004 INTERNATIONAL FINANCIAL MARKET MICROSTRUCTURE Melvin What causes exchange rates to fluctuate? Where is the share price of stocks traded in multiple locations determined? To understand the behaviour of international financial asset prices, it has proven helpful to take a microscope to the issue and study prices and their determinants at the level of the individual trader. Temple its shares to be traded in the U.S.; and understanding the determinants of traders’ use of “icebergs” or hidden limit orders with an application to trading on the Frankfurt stock exchange. Michael Melvin CES visitor in October Michael Melvin has been an active participant in the microstructure approach to the foreign exchange market and global equity markets. His current foreign exchange research includes the following: the choice of trading venue foreign exchange dealers are confronted with in the face of growing popularity of electronic brokerages as an alternative to traditional bilateral direct dealing; explaining the fall and rise in the value of the euro as a result of Bayesian learning about ECB policy; and exchange rate dynamics during important policy meetings. During his time at CES, Melvin will continue his research in these areas and offer lectures on international financial market microstructure. Current equity market research includes delving into where price is discovered for European firms that are also traded in the U.S.; the effects on rival firms in the home market when a non-U.S. firm lists Michael Melvin is Professor of Economics and Dean’s Council Distinguished Scholar at Arizona State University. He also serves as the co-editor of the Journal of International Money and Finance, the leading scholarly journal in its field. He holds a Ph.D. from UCLA and has been a visiting scholar at the Federal Reserve Board and the International Monetary Fund. He was a Fulbright Senior Scholar and visiting professor at the University of Frankfurt and has also been a visiting professor at the Kellogg Graduate School of Management, Northwestern University; Anderson Graduate School of Management, UCLA; Pacific Asian Management Institute, University of Hawaii; and Department of Economics, UC San Diego. HANS-MÖLLER SEMINARS RESEARCH SEMINARS 13 July 2004 12 July 04 Thomas Steger (ETH Zürich) Matthias Polborn University of Illinois A Rational Choice Model of Informative Positive and Negative Campaigning 20 July 2004 Markus Brunnermeier Princeton University Topic will be posted at http://www.vwl.unimuenchen.de/ls_marin/hmoeller1.html SHARING THE BENEFITS Economic Growth under Factor Reallocation Costs 19 July 04 Marco Caliendo (University of Frankfurt) info at www.vwl.uni-muenchen.de/ls_rady/ seminar.html Bulletin Analysing economic growth is no trivial matter. For every answer economists cobble together, a score of further questions immediately crop up: Are the benefits of economic growth widely shared? Can growth alleviate the underemployment that characterises many developing countries? What are the links between labour market institutions and aggregate productivity? What are the potential costs of misallocation of resources across sectors? To answer them successfully, economists need to develop new theoretical and empirical models. Jonathan Temple, a Professor of Economics at the University of Bristol and CESifo guest in August, has focused his research on this area. Drawing on ideas from development economics and trade theory, he has developed models that can be used to understand the distributional impact of different types of growth, the interaction of economic growth and labour markets, and the role of resource reallocation in aggregate productivity growth. With Ludger Woessmann, head of Ifo’s Human Capital and Structural Change department he is developing empirical growth models that incorporate a role for labour reallocation and structural change. Overall, this research has potential lessons for policy, and perhaps especially for the development of progrowth policies that are also “pro-poor”. Temple obtained his Ph.D. from the University of Oxford, and holds undergraduate and Masters degrees in Economics from the University of Cambridge. He is currently the holder of a Philip Leverhulme Prize Fellowship. FACULTY NEWS • Appointment: Joachim Winter, now at the University of Mannheim, accepted a C3 professorship at the Ludwig-Maximilians University. He will occupy the Empirical Economics chair, succeeding Prof. Stephan Klasen. He will take up his new post in the winter semester 2004/5. • Award: Georg Gebhardt has received the doctoral thesis award for his degree dissertation “Venture Capital, Takeovers, and TimeVarying Returns” by the Münchner Universitätsgesellschaft (Munich University Society). 3 Vol. 14, No. 3 • July 2004 IFO NEWS WORLD ECONOMY: STABILISATION ON THE CURRENT FAVOURABLE LEVEL The World Economic Survey (WES) indicator for the world economic climate maintained in April the high level reached in January 2004. At 110.1 (1995 = 100), it Just don’t look down now is above its long-term average (19902003: 93.0). Although the expectations for the coming six months have weakened slightly, the assessments of the current situation have again improved somewhat. The experts polled by the Ifo Institute expect the world economy to grow by 3.4% this year, in contrast to the 2.1% foreseen in the April 2003 survey. On the whole, the new survey findings confirm that the world economy is in a much better condition than twelve months ago. However, growth differs substantially from region to region: Whereas the economic recovery in western Europe is seen as moderate with no indications for growth acceleration, the economic climate indicator in Asia has strengthened further. The North American upswing is still judged to be robust. The increase in consumer prices will average 2.8% worldwide in 2004. In the euro area an inflation rate of just under the 2%level is expected (1.8%), which matches the target of the European Central Bank fairly precisely. For the US the WES experts see price increases in 2004 match- 4 ing that of 2003 (2.3%), thus remaining clearly within the 2.5% ceiling considered tolerable by the Federal Reserve. The experts expect a further stabilisation of the US currency in the coming six months. Only in such Asian countries as Japan, Singapore, India and Taiwan do the experts anticipate a further weakening of the US dollar. All in all, the world economy continues to recover. Growth is intensifying in Asia and remains robust in the US. Europe is lagging remarkably far behind but can also look to a modest recovery. GERMANY TOWED ALONG BY THE WORLD ECONOMY The world economy is currently growing at the fastest pace in fifteen years. The main impulses are from the robust upswing in Asia and the US, as confirmed by Ifo’s World Economic Survey. In the US the economy is being stimulated by an expansive monetary and fiscal policy that is almost unprecedented. Here, Ifo expects the economy to expand by 4.7% in 2004 and 3.4% next year. The recent hikes in prices for oil and commodities will not dampen the upswing, as they are primarily due to the demand boost that has accompanied growth. The German economy is being towed along by the international trend, but its many structural problems prevent it from fully participating in the world economy upswing. These problems are caused by exogenous factors, such as German firms’ loss of interest-rate advantages under the euro and the loss of relative advantages of its own larger domestic market in the wake of European integration. Endogenous factors also play a role, such as the financial costs of German unification and Bulletin the well-known deficits in the German labour and social systems. For Germany, Ifo estimates that real GDP in the first half of 2004 grew over the comparable period last year by 1.6%. On average for 2004, economic growth will be 1.7%, although it must be kept in mind that some 0.5% is attributable to the unusually large number of working days. The mainstay of economic growth is exports, although investment in plant and equipment is now gradually expanding, and private consumption could recover this year and next. The labour market situation remains tricky, as the business conditions of the enterprises have become more and more uncoupled from the labour market. High labour costs have induced the enterprises to engage in rationalisation and outsourcing to other countries. Employment will continue to decline, with a slight improvement not coming until the end of the year. Government finances continue to be marked by the weak recovery and the failure to consolidate the budget. The deficit this year will be approximately euro 79 billion, or 3.6% of GDP, exceeding the Maastricht limit for the third time running. The national debt will be 67% of GDP at the end of 2004 and 66% at the end of 2005. IFO ANNUAL MEETING The 55th Annual Meeting of the Ifo Institute was a success. Czech President Václav Klaus gave an impressive speech on the Implications of the European Enlargement for Europe. In his view, while enlargement is a signal for the end of the post-communist era, he does not foresee radical changes resulting from it, such as huge financial benefits for the more developed accession countries. Another highlight was the tax reform discussion with prominent speakers: Paul Kirchhof, former constitutional judge, Friedrich Merz, deputy chairman of the CDU/CSU-Bundestagsfraktion, HansWerner Sinn, president of the Ifo institute, and Wolfgang Wiegard, chairman of the German Council of Economic Experts. Vol. 14, No. 3 • July 2004 FAMILY AND EDUCATION Balestrino In most countries, education has long been a responsibility of the government –despite the fact that education is hardly a public good. Understanding the process of human capital accumulation is key for answering important questions about productivity, growth and the pattern of inequality. Alessandro Balestrino, Professor of Public Economics at the University of Pisa, has been actively involved in this research field since the 1990s. He has mostly used a household economics approach, in which the interaction between family members is explicitly modelled. In fact, the well-know failures of the credit market that prevent children from borrowing against their future income for funding their educational investment turn the family into the main source of financial support. One line of approach has dealt with the “co-operative conflict” between parents and children in the decisional process leading to human capital accumulation; alternatively, the focus has been on the interaction between parents. It is argued that the need for corrective policy action lies in the inherent inefficiency of the intra-family arrangements, which in turn is due to the impossibility of reaching binding agreements among family members. This sort of argument is developed in both its normative and positive implications for public policy, and covers both taxation and spending issues. It can also be generalised to other publicly provided goods (such as care for the elderly or preventive health-care), thus yielding a rationale for the existence of the welfare state as a collectively rational response to inefficient family provision. Balestrino, who holds a Ph.D. in Economics from the University of Siena, has published in leading economics journals. He studied also in Florence and Oxford, and is currently Chairman of the Joint Sub-Faculty Board of the Undergraduate and Graduate Programmes in Government Studies of the Faculty of Political Sciences at the University of Pisa. TAPES FISCAL FEDERALISM CONFERENCE was also welThe implications come. that differences in tax and expendiWhile each paper ture programmes was discussed by across jurisdictwo formal distions have for the cussants, the location of real ample time allotand financial ted for debate activity, as well as gave all particithe consequences pants a chance to of such mobility The organisers, Hans-Werner Sinn (CESifo, left), take part in what and migration for and Roger Gordon (NBER, right) turned out to be a governments, rank very lively discussion. Well into the high on the Public Economics research evenings, at the conference dinners and agenda nowadays. during social activities, discussions kept going unabated. Undoubtedly, the conIn order to bring together economists ference succeeded in bringing together from North America and Europe to diseconomists from both sides of the cuss these issues, CESifo hosted this Atlantic to exchange their ideas and fosyear’s Trans-Atlantic Public Economics tering co-operation. Seminar (TAPES) jointly with the National Bureau of Economic Research Papers from the conference will be con(NBER) at the CESifo Conference Censidered for a special issue of the Journal tre in Munich. On May 20-22, 2004, thirof Public Economics, subject to the norty participants –including Tim Besley, mal refereeing process. For those who do Dennis Epple, Roger Gordon, Jim Hines not want to wait until publication of this and Jim Poterba– from ten countries met special issue, the papers presented can to analyse twelve papers on fiscal federalso be downloaded from our TAPES alism, six each from North America and conference site (www.cesifo.de/home -> Europe. The emphasis was laid on Conferences & Events -> Past Conferempirically oriented research by younger ences; papers are in PDF-format). authors, but applied theoretical research UH PUNCTURING BUBBLES Brunnermeier Somehow, we had sort of suspected it: sophisticated traders prefer to ride a stock market bubble rather than to attack it, thereby making bubbles persist. Now this has been confirmed by Markus K. Brunnermeier’s research on stock market bubbles, limits to arbitrage, financial and liquidity crisis, and behavioural finance. An Assistant Professor in the Department of Economics and member of Princeton’s Bendheim Center for Finance and the International Economics Section, Brunnermeier shows in his work on financial crisis and risk management that “predatory trading” exacerbates a liquidity crisis and can cause systemic risk. His Bulletin current research proposes a shift away from the rational expectations paradigm towards “optimal expectations.” During his visit at CES he will continue his work on liquidity. It shows the linkage between a security’s market liquidity –i.e., the ease of trading the security– and dealers’ funding liquidity –i.e., their ability to obtain funds. Both liquidity concepts reinforce each other and give rise to a multiplier effect: Improved funding of dealers enhances their trading activity and makes markets more liquid. This in turn improves the collateral values of assets, which again eases funding restriction of the dealers. 5 Vol. 14, No. 3 • July 2004 MANAGERS’ COMPENSATION Gottardi Designing managers’ compensation so as to simultaneously retain precious talent and properly safeguard shareholders’ interests is no trivial exercise. That’s where the work of Piero Gottardi, Professor of Economics at the University of Venice, comes in handy. He has devoted part of his research to the analysis of the interrelation between contractual arrangements and the structure of existing markets. He has investigated the design of executive compensation when managers have access to anonymous hedging instruments in financial markets. It has been observed that managerial hedging undermines incentives in executive pay schemes, significantly alters the executives’ effective ownership of the firm, and hence has adverse effects on performance. At the same time, disclosure rules regarding managerial transactions of hedging instruments are relatively lax, and only few of their trades are effectively disclosed to investors and shareholders. Moreover, financial markets have proved quite effective in designing instruments which overcome regulation and tax schemes. While little data exist, off-therecord interviews with investment bankers reported in the press suggest that the market for executive hedging instruments is sizable. In this situation, monitoring of managers’ portfolios, even if costly, can nonetheless help to align shareholders’ and managers’ objectives within an optimal incentive compensation scheme. Another line of his recent research concerns the role of social security in enhancing intergenerational risk sharing. More precisely, the fact that agents are unable to trade before being born so as to insure against the shocks affecting them in the initial phase of their lifetime generates a natural form of market incom- pleteness. In this situation, a Pareto-improving pay-as-you-go social security system may be welfare improving, if we use an ex-ante welfare criterion, even when agents can find in the market a sufficiently rich set of financial assets so as to insure against all possible risks and the presence of long-lived assets ensures the economy is dynamically efficient. What are then the effects of the introduction of social security on the prices of long-lived assets and the level of output? Gottardi obtained his Ph.D. in Economics at the University of Cambridge in 1991. In addition to his post at the University of Venice, he is an associate editor of the Journal of Economic Theory and the Journal of Public Economic Theory. WATCHING THE DRAGON AWAKE Cheung cooperation since the turn of the millennium. During his visit at CES, Cheung will continue his recent research project on integration between China and selected Pacific Rim economies. The last quarter-century has witnessed the re-emergence of China in the international economic arena. Not only is China becoming rapidly integrated into the global economy, but its weight in world economic affairs is also changing the landscape of the international economic nexus. The integration of this populous country will have profound effects upon the efficiency of resource allocation and the efficacy of macroeconomic policy, a fact that is keeping economists awake at night in east and west alike. Few economists are as well placed as Yin-Wong Cheung to shed some light into the shape of things to come in this respect. A professor of economics at the University of California, Santa Cruz, Cheung straddles comfortably the cultural divide between China and the rest of the world, being equally at home in either quarter. Cheung has sought to overcome the fact that there is no perfect empirical measure of economic integration by using some well-founded parity conditions in international finance, in addition to 6 Yin-Wong Cheung measures based on flows in assets, goods, and services, to evaluate the degree of real and financial integration between China and some selected Pacific Rim economies. He has also assessed the desirability of a currency union in the Pacific Rim. This assessment is of particular interest given the enthusiasm displayed by East Asian economies in promoting regional trade and financial Bulletin In addition to the above issues, Cheung’s research interests include econometric theory, international finance, macroeconomics, and learning theory. On testing for purchasing power parity, for instance, Cheung demonstrated the imprecision of a typical real exchange rate persistence measurement and investigated the sources of persistence. In addition to drawing inferences from existing economic data, he generated some survey data on foreign exchange markets to investigate some issues in exchange rate economics. His work on the finite sample critical values is incorporated in the econometrics package TSP. After graduating from the University of Pennsylvania in 1990, Cheung joined the University of California in Santa Cruz. He serves in several editorial boards and has recently been conferred the Guest Professorship from Shandong University. Vol. 14, No. 3 • July 2004 PLAYING DIFFERENTIAL GAMES OBITUARIES Long Internet service providers grant customers access to their servers for a monthly fee. How would such fees be set if new subscribers had rational expectations about future congestion at each firm? Do firms make more profits if customers have greater valuation of time loss due to congestion? analyse problems in industrial organisation and in capital flight when agents care about both consumption and wealth per se. In a joint paper with Didier Laussel and Maxime de Montmarin (accepted for publication in the International Journal of Industrial Organization), Long modelled the behaviour of rival firms that sell services subject to congestion. One good way to find that out is to analyse a suitably Ngo Van Long formulated differential game, So, the answer Long found to which happens to be one of the second question at the Ngo Van Long’s foremost specialties. beginning of this article, somewhat surprisingly, is in the affirmative. The reason, A professor of Economics at McGill Unihe explains, is that when firms compete in versity, Montreal, Canada, Long’s prices, greater congestion cost tends to research interests lie on modelling situasoften price competition. tions where economic agents choose strategic behaviour in a dynamic context, Ngo Van Long is James McGill Professor in which the state of the system (such as of Economics at McGill University, Monthe stock of customers’ goodwill, the treal, Canada. He obtained his Ph.D. at the stock of pollution, etc.) is changing over Australian National University, where he time, partly due to the actions of the taught for more than a decade (1975agents. He expounded methods for analy1988). He has held visiting positions at sis of such differential games in his recent Harvard University, Mannheim Universico-authored book Differential Games in ty, University of Toulouse, Kobe UniverEconomics and Management Science sity, Hitotsubashi University, and CES (Cambridge University Press, 2000). (1996). He serves as co-editor of the Canadian Journal of Economics, associHis research agenda while at CES will be ate editor of the Review of International to formulate differential games that Economics and the International Game involve the building up of social trust, and Theory Review, and is a member of the to analyse conditions under which there editorial board of the Journal of Environexists a multiplicity of equilibrium stratemental Economics and Management, the gy profiles in such games. European Journal of Political Economy, Long has used differential games to and the Australian Economic Papers. NEW RESEARCH AREA CO-ORDINATOR The Employment and Social Protection Area of the CESifo Research Network has a new co-ordinator. As of July, Kai Konrad (left) took over from Jonas Agell (right), now one of the editors of the Scandinavian Journal of Economics. Agell described his stint as co-ordinator as a “fascinating experience” that was both professionally and personally rewarding for him. From these pages, we wish his successor, who is also Director of the Market Processes and Governance Unit at the Social Science Research Center Berlin (WZB) and Professor of Economics at the Free University of Berlin, the best success and fun in this new task. Bulletin Dieter Bös An active member of the CESifo Research Network right from the start, Dieter Bös died on 20 June, 2004. Many in the CESifo community had the pleasure of working with him at the University of Bonn, where he was employed, and meeting him at several of our conferences. He was an outstanding economist, with the gift of making issues understandable without abandoning precision. In particular, his seminal contributions to public enterprises economics and privatisation rank as cornerstones of our understanding of public economics. In 1973 he took over the leading position in the former German-language Journal of Economics/ Zeitschrift für Nationalökonomie and turned it into an international platform. With admirable courage he fought against cancer and continued to hold his lectures even up until two weeks before passing away. We owe him much and we will remember him with warmth. Wilhelm Krelle The most important German economist of his generation, Wilhelm Krelle died the same week as Dieter Bös. He was 87. His long and productive life saw him develop his price theory in 1960 and do much writing, including many books, his outstanding production theory, and a myriad articles on macro- and microeconomic problems. He made great contributions to our discipline. Starting as a natural scientist, Krelle was something like the German Samuelson, using rigorous mathematical tools to analyse economic problems. He exerted a substantial influence in all of us. As was typical for his generation, he published most of his work in German, thus receiving less international recognition than he deserved. Wilhelm Krelle was an honorary member of the CESifo Research Network from its very beginning. Hans-Werner Sinn 7 Vol. 14, No. 3 • July 2004 STUDYING STUDENT PERFORMANCE GROWTH AND FLUCTUATIONS Hanushek Malley The German preoccupation with the PISA study findings is warranted. Substantial evidence points to the importance of skills for individual productivity. More importantly, the skills of workers directly affect the growth of nations and thus the future well-being of society. As a result, a country that can improve its schools will reap future rewards, while a country that lets its schools slip will forego substantial future income. These relationships have been studied by Eric Hanushek, a senior fellow at the Hoover Institution of Stanford University. His work on the subject has investigated differences in cognitive skills both within and across nations. These findings justify national attention to student performance, but they do not indicate what determines the differences that are seen. While visiting CES, Hanushek will work with Ludger Woessmann to delve more deeply into international differences in student performance. Specifically, they intend to use the several different international tests given over the past decade to investigate how individual differences and governmental policy interact to affect student outcomes. Hanushek has a Ph.D. in Economics from the Massachusetts Institute of Technology. He has previously taught at the US Air Force Academy, Yale University, and the University of Rochester. He has also been Deputy Director of the U.S. Congressional Budget Office and a Senior Staff Economist at the President’s Council of Economic Advisors. He has produced a dozen books and over 100 professional articles on the economics and finance of education and on other subjects. CESIFO DISTINGUISHED AFFILIATES For the third year running, the CESifo Distinguished Affiliate award was granted at the CESifo Area Conference on Public Sector Economics, held on 7-9 May. This year’s prize went jointly to Jean-Marie Lozachmeur (left), University of Toulouse, for his paper Disability Insurance and Optimal Income Taxation and to Armin Falk (right), University of Bonn, for his paper Charitable Giving as a Gift Exchange – Evidence from a Field Experiment. According to the awarding committee, comprised of Helmuth Cremer, Rick van der Ploeg and Peter Sørensen, both papers rated excellent in all respects. Jean-Marie Lozachmeur extended the wellknown two-period theory of optimal taxation developed by Peter Diamond and Jim Mirr- Bulletin lees to allow for optimal disability insurance. Agents’ productivity and health status are not observable, but age and earnings are. Lozachmeur demonstrated that disability insurance should be conditioned on past earnings. Armin Falk showed, on the basis of a highly original field experiment on donations to charity, that people are as motivated by gift exchange as by “warm glow”. Ten thousand people received solicitation letters to donate, with no gift, a small gift or a slightly larger gift randomly assigned. People with a gift gave up to 75% more to the charity. Gift exchange is thus important, not only in the laboratory but also in the field. This insight reflects reciprocity and has crucial implications for the welfare state. SÜ Political and technological shocks undoubtedly influence business cycles. Developing models to analyse this influence lies squarely within Jim Malley’s fields of interest, which also include monetary and fiscal policy evaluation using dynamic stochastic general equilibrium (DSGE) models. A Professor of Economics at Glasgow University, Malley plans to work on two projects while at CES. One, in collaboration with Campbell Leith, involves the further development and estimation of DSGE models under varying assumptions regarding distortions in goods and factor markets. Existing research by Malley and Leith theoretically accounts for nominal inertia in both price and wage setting, as well as for habits in consumption, and provides estimates for the US and Europe which imply significant differences in the responses to monetary policy between the two economies. The natural extension to this work involves estimating models which allow for the simultaneous evaluation of both monetary and fiscal policy. Regarding the latter, they will attempt to quantify the distortionary effects on equilibrium output and prices resulting from alternative tax and spending policies. The second project, in collaboration with Apostolis Philippopoulos and Ulrich Woitek, seeks to further explore the link between elections, fiscal policy and economic growth and fluctuations. Existing research by these authors, using a DSGE model augmented with electoral uncertainty and competition, predicts that forward-looking incumbents, with uncertain prospects of re-election, find it optimal to follow relatively short-sighted fiscal policies, which in turn lower economic growth. Their existing research will be extended by developing a growth model which allows for uncertainty in both productivity and electoral outcomes so as to econometrically assess the contribution that each makes to cyclical variation in aggregate output. Munich Society for the Promotion of Economic Research (Münchener Gesellschaft zur Förderung der Wirtschaftswissenschaft, CESifo GmbH) is the international platform of Ludwig-Maximilians University and the Ifo Institute for Economic Research. President and CEO: Hans-Werner Sinn Address: CESifo, Poschingerstr. 5, 81679 Munich (Germany) Telephone +49 (89) 9224-1410, Fax: +49 (89) 9224-1409 Chief Editor: Silke Uebelmesser (SU), CESifo Editor: Julio C. Saavedra (JS). Ifo News Editor: Annette Marquardt (AM). Contributors: Ulrich Hange (UH) and Silke Uebelmesser (SÜ).