Annual Review of Economics - Volume 12, 2020

This conversation between Nobel Laureates Amartya Sen and Angus Deaton, moderated by Annual Review of Economics Editorial Committee Member Tim Besley, focuses on bringing ethical issues into economics, and the implications that this has for the practice and teaching of economics. A video of this interview is available online at https://www.annualreviews.org/r/EconMoralCompass.

This article reviews the broad changes in US trade policy over the course of the nation's history. Import tariffs have been the main instrument of trade policy and have had three main purposes: to raise revenue for the government, to restrict imports and protect domestic producers from foreign competition, and to reach reciprocity agreements that reduce trade barriers. Each of these three objectives—revenue, restriction, and reciprocity—was predominant in one of three consecutive periods in history. The political economy of these tariffs has been driven by the location of trade-related economic interests in different regions and the political power of those regions in Congress. The review also addresses the impact of trade policies on the US economy, such as the welfare costs of tariffs, the role of protectionism in fostering US industrialization, and the relationship between the Smoot–Hawley Tariff Act and the Great Depression of the 1930s.

Data sets that are terabytes in size are increasingly common, but computer bottlenecks often frustrate a complete analysis of the data, and diminishing returns suggest that we may not need terabytes of data to estimate a parameter or test a hypothesis. But which rows of data should we analyze, and might an arbitrary subset preserve the features of the original data? We review a line of work grounded in theoretical computer science and numerical linear algebra that finds that an algorithmically desirable sketch, which is a randomly chosen subset of the data, must preserve the eigenstructure of the data, a property known as subspace embedding. Building on this work, we study how prediction and inference can be affected by data sketching within a linear regression setup. We use statistical arguments to provide “inference-conscious” guides to the sketch size and show that an estimator that pools over different sketches can be nearly as efficient as the infeasible one using the full sample.

This review presents an approach to modeling decision making under misspecified subjective models. The approach is based on the idea that decision makers impose subjective causal interpretations on observed correlations, and it borrows basic concepts and tools from the statistics and artificial intelligence literatures on Bayesian networks. While these background literatures used Bayesian networks as a platform for normative and computational analysis of probabilistic and causal inference, in the framework proposed here graphical models represent causal misperceptions and help analyze their behavioral implications. I show how this approach sheds light on earlier equilibrium models with nonrational expectations and demonstrate its scope of economic applications.

World Bank estimates put absolute poverty in Asia and Africa at 50–60% of the population in 1980 and at negligible levels in the developed world. This review investigates whether Asia was always so poor, as well as the history of poverty in today's rich countries. Poverty measurement methodologies are reviewed, and it is argued that a basic needs approach is the best way to tackle poverty measurement in the past. This approach is related to recent advances in the measurement of historical real wages. Estimates of poverty rates in England between 1290 and 1867 are presented, as are estimates for preindustrial India. About one-quarter of the English population was in extreme poverty in the late Middle Ages, and the proportion had fallen below 10% by 1688. About one-quarter of the people in northern India lived in extreme poverty in the early nineteenth century, and the proportion was likely lower in 1600. The very high poverty rates in India in 1980 were a development of the colonial era.

This article reviews the econometrics of static games, with a focus on discrete-choice cases. These models have been used to study a rich variety of empirical problems, ranging from labor force participation to entry decisions. We outline the components of a general game and describe the problem of doing robust inference in the presence of multiple solutions, as well as the different econometric approaches that have been applied to tackle this problem. We then describe the specific challenges that arise in different variations of these models depending on whether players are assumed to have complete or incomplete information, as well as whether or not nonequilibrium play is allowed. We describe the results in 2 × 2 games (the most widely studied games in econometrics), and we present extensions and recent results in games with richer action spaces. Areas for future research are also discussed.

This article critically assesses prevailing measures of global poverty. A welfarist interpretation of global poverty lines is augmented by the idea of normative functionings, the cost of which varies across countries. In this light, current absolute measures are seen to ignore important social effects on welfare, while popular, strongly relative measures ignore absolute levels of living. It is argued that a new hybrid measure is called for, combining absolute and weakly relative measures consistent with how national lines vary across countries. Illustrative calculations indicate that we are seeing a falling incidence of poverty globally over the past 30 years. This is mainly due to lower absolute poverty counts in the developing world. While fewer people are poor by the global absolute standard, more are poor by the country-specific relative standard. The vast bulk of poverty, both absolute and relative, is now found in the developing world.

This article addresses the modern optimal tax progressivity literature, which clarifies the key role of the behavioral response to taxation and accounts for the incomes of the superrich being qualitatively different from others. Some of the superrich may be “superstars” for whom small differences in talent are magnified into much larger earnings differences, while others may work in winner-take-all markets, such that their effort to climb the ladder of success reduces the returns to others. We stress that pivotal tax-rate elasticities are not structural parameters and will be smaller the broader and less plastic is the tax base and the more effective is the enforcement of tax evasion. For this reason, normative analysis of tax rates should be accompanied by attention to the tax base, with a special focus on capital gains, which comprise a large fraction of the taxable income of the superrich.

Substantial research in development economics has highlighted the presence of weak institutions, market failures, and distortions in developing countries. Yet much of the knowledge generated in international trade comes from workhorse models that abstract from these frictions. This review summarizes the recent literature that assesses how these characteristics interact (or may interact) with trade reforms, resulting in different impacts in developing countries relative to what we would expect in developed countries. We discuss understudied areas that warrant further research.

This review uses the empirical analysis of portfolio choice to illustrate econometric issues that arise in decision problems. Subjective expected utility (SEU) can provide normative guidance to an investor making a portfolio choice. The investor, however, may have doubts on the specification of the distribution and may seek a decision theory that is less sensitive to the specification. I consider three such theories: maxmin expected utility, variational preferences (including multiplier and divergence preferences and the associated constraint preferences), and smooth ambiguity preferences. I use a simple two-period model to illustrate their application. Normative empirical work on portfolio choice is mainly in the SEU framework, and bringing in ideas from robust decision theory may be fruitful.

The fast and often chaotic urbanization of the developing world generates both economic opportunity and challenges, like contagious disease and congestion, because proximity increases both positive and negative externalities. In this article, we review the expanding body of economic research on developing-world cities. One strand of this literature emphasizes the economic benefits of urban connection, typically finding that agglomeration benefits are at least as high in poor countries as they are in rich countries. Yet there remains an ongoing debate about whether slums provide a path to prosperity or an economic dead end. A second strand of research analyzes the negative externalities associated with urban density, and the challenges of building and maintaining infrastructure to moderate those harms. Researchers are just beginning to understand the links between institutions (such as public–private partnerships), incentives (such as congestion pricing), and the effectiveness of infrastructure spending in addressing urban problems. A third line of research addresses the spatial structure of cities directly with formal, structural models. These structural models seem particularly valuable when analyzing land-use and transportation systems in the far more fluid cities of the developing world.

This article reviews recent developments in revealed preference theory. It discusses the testable implications of theories of choice that are germane to specific economic environments. The focus is on expected utility in risky environments, subjected expected utility and maxmin expected utility in the presence of uncertainty, and exponentially discounted utility for intertemporal choice. The testable implications of these theories for data on choice from classical linear budget sets are described and shown to follow a common thread. The theories all imply an inverse relation between prices and quantities, with different qualifications depending on the functional forms in the theory under consideration.

The analysis of dynamic economic models routinely leads to the mathematical problem of determining an unknown function for which no closed-form solution exists. Economists must then resort to methods of numerical approximation when analyzing such models. Among the computational methods that have been successfully applied in economics and finance, one set of techniques stands out due to its flexibility and robustness: projection methods. In this article, we describe the basic steps of these methods for several different applications, surveying many successful applications of projection methods to dynamic economic models. Importantly, we emphasize that the ever-increasing complexity and dimensionality of dynamic models have made the previously used simpler methods obsolete and the applications of projection methods all but mandatory. We closely examine the most recent endeavors in the literature on solving economic models with projection methods.

I review evidence that individuals associate themselves—or identify—with groups in two fundamental ways: ingroup bias and conformity to group norms. The evidence spans many spheres of economic activity, including consumption, production, hiring, promotion, education, cooperation, financial investments, and law enforcement. Group identities are not fixed, even when it comes to ethnic and religious identities. I argue that the choice of identity can be captured by a simple trade-off between gains from group status and costs to distance from the group. I outline a simple conceptual framework that captures the main empirical regularities and illustrate how it can be used to study the two-way interaction between economic policy and social identity. The analysis implies, e.g., that inequality and immigration of low-skilled workers can strengthen nationalism and reduce redistribution, and that changes in the economic environment can produce shifts in identification patterns that feed into trade policy. Finally, I discuss open theoretical questions and domains where the interaction between identity and economic activity is not well understood. This includes the provision of public services, the evolution of gender norms, and the use of identity to motivate workers.

This article offers a review of the recent empirical literature on lobbying within political economy. In surveying extant research, we emphasize quid pro quo and informational issues in special interest politics and highlight crucial open questions in both. The two main unresolved methodological issues remain (a) how to account for the impact of lobbying on which equilibrium policies are chosen and advanced and (b) how distorted those equilibrium policies are relative to the social optimum. Of the principal open questions within political economy, a comprehensive, quantitative assessment of the welfare effects of lobbying remains one of the most elusive.

How do the Internet and social media affect political outcomes? We review empirical evidence from the recent political economy literature, focusing primarily on work that considers traits that distinguish the Internet and social media from traditional off-line media, such as low barriers to entry and reliance on user-generated content. We discuss the main results about the effects of the Internet in general, and social media in particular, on voting, street protests, attitudes toward government, political polarization, xenophobia, and politicians’ behavior. We also review evidence on the role of social media in the dissemination of fake news, and we summarize results about the strategies employed by autocratic regimes to censor the Internet and to use social media for surveillance and propaganda. We conclude by highlighting open questions about how the Internet and social media shape politics in democracies and autocracies.

We review the discontinuous games literature, with a sharp focus on conditions that ensure the existence of pure and mixed strategy Nash equilibria in strategic form games and of Bayes-Nash equilibria in Bayesian games.

Preferences for schools are important determinants of equitable access to high-quality education, effects of expanded choice on school improvement, and school choice mechanism design. Standard methods for estimating consumer preferences are not applicable in education markets because students do not always get their first-choice school. This review describes recently developed methods for using rich data from a school choice mechanism to estimate student preferences. Our objectives are to present a unifying framework for these methods and to help applied researchers decide which techniques to use. After laying out methodological issues, we provide an overview of empirical results obtained using these models and discuss some open questions.

The frictions that restrict migration are among the largest sources of inefficiency in the global economy. The first step in designing policies to address these frictions is to understand the fundamental forces that drive migration. However, the Roy model—the workhorse model of migration in economics—does a poor job of explaining many important features of this phenomenon. This limitation can be rectified by adding migrant networks to the Roy model. A rich qualitative literature in the social sciences has documented the role played by social networks in supporting migrants in their new locations. Economists have advanced this literature by identifying and quantifying the contribution of these networks to migration. Although much progress has been made over the past two decades, important gaps in the literature remain: Migrant assimilation has received little theoretical or empirical attention, and a richer characterization of the social interactions that support these networks is needed to tie research on migration to the economic literature on networks.

This article reviews the economic literature on informality, its causes, and its consequences for development. It covers a comprehensive body of research that ranges from well-identified experimental studies to equilibrium macro models, and which more recently includes structural models that integrate both micro and macro effects. The results available in the literature indicate that lowering the costs of formality is not an effective policy to reduce informality but may generate positive aggregate effects, such as higher output and total factor productivity (TFP). The most effective formalization policy is to increase enforcement on the extensive margin but not on the intensive margin of informality. The former generates substantial gains in aggregate TFP and output, without necessarily increasing unemployment. However, the overall welfare impacts are likely to depend on the transitional dynamics between steady states, which remains an open area for future research.