Annual Review of Economics - Volume 4, 2012

Paul Samuelson is probably the most important economist of the second half of the twentieth century. His research publications; his introductory textbook; his articles on topical questions of economic policy; and his interactions with numerous students, colleagues, policy makers, and the wider public have all contributed to fundamental changes in economics as a science and as a profession. This article attempts to give a brief overview of his career spanning eight decades and to recapitulate and celebrate his legacy.

There is growing concern over the rising share of the US economy devoted to health care spending. Fueled in part by demographic transitions, unchecked increases in entitlement spending will necessitate some combination of substantial tax increases, elimination of other public spending, or unsustainable public debt. This massive increase in health spending might be warranted if each dollar devoted to the health care sector yielded real health benefits, but this does not seem to be the case. Although we have seen remarkable gains in life expectancy and functioning over the past several decades, there is substantial variation in the health benefits associated with different types of spending. Some treatments, such as aspirin, beta blockers, and flu shots, produce a large health benefit per dollar spent. Other more expensive treatments, such as stents for cardiovascular disease, are high value for some patients but poor value for others. Finally, a large and expanding set of treatments, such as proton-beam therapy or robotic surgery, contributes to rapid increases in spending despite questionable health benefits. Moving resources toward more productive uses requires encouraging providers to deliver and patients to consume high-value care, a daunting task in the current political landscape. But widespread inefficiency also offers hope: Given the current distribution of resources in the US health care system, there is tremendous potential to improve the productivity of health care spending and the fiscal health of the United States.

We provide an overview of the growing literature that uses microlevel data from multiple countries to investigate health outcomes, and their link to socioeconomic factors, at older ages. Because the data are at a comparatively young stage, much of the analysis is at an early stage and limited to a handful of countries, with analysis for the United States and England being the most common. What is immediately apparent as we get better measures is that, between countries, health differences amongst those at older ages are real and large. Countries are ranked differently according to whether one considers life expectancy, prevalence, or the incidence of a specific condition. Moreover, the magnitude of international disparities may vary according to whether measures utilize doctor-diagnosed conditions or biomarker-based indicators of disease and poor health. But one key finding emerges—the United States ranks poorly on all indicators, with the exception of self-reported subjective health status.

The potential for rare macroeconomic disasters may explain an array of asset-pricing puzzles. Our empirical studies of these extreme events rely on long-term data now covering 28 countries for consumption and 40 for GDP. A baseline model calibrated with observed peak-to-trough disaster sizes accords with the average equity premium with a reasonable coefficient of relative risk aversion. High stock-price volatility can be explained by incorporating time-varying long-run growth rates and disaster probabilities. Business-cycle models with shocks to disaster probability have implications for the cyclical behavior of asset returns and corporate leverage, and international versions may explain the uncovered-interest-parity puzzle. Richer models of disaster dynamics allow for transitions between normalcy and disaster, bring in postcrisis recoveries, and use the full time series on consumption. Potential future research includes applications to long-term economic growth and environmental economics, and the use of stock-index options prices and other variables to gauge time-varying disaster probabilities.

Extreme events in financial markets are often generated by shocks that come from within the system, rather than those that arrive from outside the system. The combination of risk-sensitive behavior rules and the coordinated actions implied by market-to-market accounting can result in outcome distributions with fat tails, even if the fundamental shocks are Gaussian. We illustrate such endogenous extreme events through the pricing density resulting from dynamic hedging of options and the flash crash of May 2010.

It has become commonplace to measure teacher quality in terms of teacher value-added. Operationally, this means evaluating teachers according to the learning gains of students on various achievement tests. Existing research consistently shows large variations in teacher effectiveness, much of which is within schools as opposed to between schools. The policy implications of these variations are dramatic. But the underlying statistical modeling has become the subject of intense research, in part because of this direct use of value-added measures in policy discussions.

The analysis of educational vouchers has evolved from market-based analogies to models that incorporate distinctive features of the educational environment. These distinctive features include peer effects, scope for private school pricing and admissions based on student characteristics, the linkage of household residential and school choices in multidistrict settings, the potential for rent seeking in public and private schools, the role of school reputations, incentives for student effort, and the intergenerational dynamics of human capital accumulation. Research has also elucidated features of voucher design, including income and ability targeting, restrictions on private school pricing and admissions, and the potential for garnering political support. We review these research advances.

Motivated by the large differences in labor market outcomes across college majors, we survey the literature on the demand for and return to high school and postsecondary education by field of study. We combine elements from several papers to provide a dynamic model of education and occupation choice that stresses the roles of the specificity of human capital and uncertainty about preferences, ability, education outcomes, and labor market returns. The model implies an important distinction between the ex ante and ex post returns to education decisions. We also discuss some of the econometric difficulties in estimating the causal effects of field of study on wages in the context of a sequential choice model with learning. Finally, we review the empirical literature on the choice of curriculum and the effects of high school courses and college major on labor market outcomes.

We review studies of the impact of credit constraints on the accumulation of human capital. Evidence suggests that credit constraints have recently become important for schooling and other aspects of households' behavior. We highlight the importance of early childhood investments, as their response largely determines the impact of credit constraints on the overall lifetime acquisition of human capital. We also review the intergenerational literature and examine the macroeconomic impacts of credit constraints on social mobility and the income distribution. A common limitation across all areas of the human capital literature is the imposition of ad hoc constraints on credit. We propose a more careful treatment of the structure of government student loan programs and the incentive problems underlying private credit. We show that endogenizing constraints on credit for human capital helps explain observed borrowing, schooling, and default patterns and offers new insights about the design of government policy.

This review summarizes and connects recent work on the foundations and applications of statistical decision theory. Minimax models of decisions making under ambiguity are identified as a thread running through several literatures. In axiomatic decision theory, these models motivated a large literature on modeling ambiguity aversion. Some findings of this literature are reported in a way that should be directly accessible to statisticians and econometricians. In statistical decision theory, the models inform a rich theory of estimation and treatment choice, which was recently extended to account for partial identification and thereby ambiguity that does not vanish with sample size. This literature is illustrated by discussing global, finite-sample admissible, and minimax decision rules for a number of stylized decision problems with point and partial identification.

This article reviews the empirical evidence on firm heterogeneity in international trade. A first wave of empirical findings from microdata on plants and firms proposed challenges for existing models of international trade and inspired the development of new theories emphasizing firm heterogeneity. Subsequent empirical research has examined additional predictions of these theories and explored other dimensions of the data not originally captured by them. These other dimensions include multiproduct firms, offshoring, intrafirm trade and firm export market dynamics.

Many countries have failed to use natural resource wealth to promote growth and development. They have been damaged by the volatility of revenues and have failed to save a sufficiently high proportion of their resource revenues and failed to make high-return investments to support diversification of their economies. This review explores the reasons for these failures and discusses policies to improve performance.

Women's rights and economic development are highly correlated. Today, the discrepancy between the legal rights of women and men is much larger in developing compared with developed countries. Historically, even in countries that are now rich, women had few rights before economic development took off. Is development the cause of expanding women's rights, or conversely, do women's rights facilitate development? We argue that there is truth to both hypotheses. The literature on the economic consequences of women's rights documents that more rights for women lead to more spending on health and children, which should benefit development. The political-economy literature on the evolution of women's rights finds that technological change increased the costs of patriarchy for men and thus contributed to the expansion of women's rights. Combining these perspectives, we discuss the theory of Doepke & Tertilt (2009), who find that an increase in the return to human capital induces men to vote for women's rights, which in turn promotes growth in human capital and income per capita.

The proliferation of new data sets and their harmonization with the older data sets have allowed researchers to make significant progress in our understanding of how individuals allocate their time away from market work. We highlight how these new data can be used to test theories of time use and we review recent developments in long-run trends in time use, life-cycle patterns of expenditures and labor supply, and the allocation of time over the business cycle.

Wages grow rapidly for young workers, and the human capital investment model is the classic framework to explain this growth. While estimation and the theory of human capital have traditionally focused on general human capital, both have evolved toward models of heterogeneous human capital. In this article, we review and evaluate the current state of this literature. We exposit the classic model of general human capital investment and extend it to show how a model of heterogeneous human capital can nest previous models. We then summarize the empirical literature on firm-specific human capital, industry- and occupation-specific human capital, and task-specific human capital and discuss how these concepts can explain a wide variety of labor market phenomena that traditional models cannot.

Monetary incentives can backfire while nonstandard interventions, such as framing, can be effective in influencing behavior. I review the empirical evidence on these two sets of anomalies. Paying for inherently interesting tasks, paying for prosocial behavior, paying too much, paying too little, and providing too many options can all be counterproductive. At the same time, proper design of the decision-making environment can be a potent way to induce certain behaviors. After presenting the empirical evidence, I discuss the relative role of beliefs, preferences, and technology in the anomalous impacts of incentives. I argue that inference, signaling, loss aversion, dynamic inconsistency, and choking are the primary factors that explain the data.

Although both economists and psychologists seek to identify determinants of heterogeneity in behavior, they use different concepts to capture them. In this review, we first analyze the extent to which economic preferences and psychological concepts of personality, such as the Big Five and locus of control, are related. We analyze data from incentivized laboratory experiments and representative samples and find only low degrees of association between economic preferences and personality. We then regress life outcomes (such as labor market success, health status, and life satisfaction) simultaneously on preference and personality measures. The analysis reveals that the two concepts are rather complementary when it comes to explaining heterogeneity in important life outcomes and behavior.

Recent years have seen a remarkable expansion in economists' ability to measure corruption. This in turn has led to a new generation of well-identified, microeconomic studies. We review the evidence on corruption in developing countries in light of these recent advances, focusing on three questions: how much corruption is there, what are the efficiency consequences of corruption, and what determines the level of corruption? We find robust evidence that corruption responds to standard economic incentive theory but also that the effects of anticorruption policies often attenuate as officials find alternate strategies to pursue rents.

Research in behavioral public finance has blossomed in recent years, producing diverse empirical and theoretical insights. This article develops a single framework with which to understand these advances. Rather than drawing out the consequences of specific psychological assumptions, the framework takes a reduced-form approach to behavioral modeling. It emphasizes the difference between decision and experienced utility that underlies most behavioral models. We use this framework to examine the behavioral implications for canonical public finance problems involving the provision of social insurance, commodity taxation, and correcting externalities. We show how deeper principles undergird much work in this area and that many insights are not specific to a single psychological assumption.

This review surveys recent research on the economics of patents. The topics covered include theoretical and empirical evidence on patents as incentives for innovation, the effectiveness of patents for invention disclosure, patent valuation, and the design of patent systems. We also look at some current policy areas, including software and business method patents, university patenting, and the growth in patent litigation.