Annual Review of Economics - Volume 8, 2016

Consumers often find it hard to make correct value comparisons between market alternatives. Part of this choice complexity is the result of deliberate obfuscation by firms. This review synthesizes a theoretical literature that analyzes the role of choice complexity in otherwise competitive markets. I identify two general classes of market models in the literature: (a) The obfuscation strategy of firms is an independent framing device that affects the probability with which consumers make correct comparisons, and (b) market alternatives are multiattribute objects, and obfuscation is captured by lopsided location in attribute space, lowering the probability of being dominated by another market alternative. I address the following key questions: What determines the amount of choice complexity in market equilibrium? What is the relation between choice complexity and payoff-relevant aspects of the market outcome? What is the role of consumer protection measures? The models surveyed in this review suggest that equilibrium obfuscation and choice complexity increase in response to intensified competition, mitigating the positive effect of competition on consumer welfare. However, equilibrium effects can also attenuate the positive welfare effects of regulatory interventions.

Empirical models of differentiated products demand (and often supply) are widely used in industrial organization and other fields of economics. We review some recent work studying identification in a broad class of such models. This work shows that the parametric functional forms and distributional assumptions commonly used for estimation are not essential for identification. Rather, identification relies primarily on the standard requirement that instruments be available for the endogenous variables—here, typically, prices and quantities. We discuss the types of instruments that can suffice, as well as how instrumental variables requirements can be relaxed by the availability of individual-level data or through restrictions on preferences. We also review new results on discrimination between alternative models of oligopoly competition. Together, these results reveal a strong nonparametric foundation for a broad applied literature, provide practical guidance for applied work, and may suggest new approaches to estimation and testing.

Large factor models use a few latent factors to characterize the co-movement of economic variables in a high-dimensional data set. High dimensionality brings challenges as well as new insights into the advancement of econometric theory. Because of their ability to effectively summarize information in large data sets, factor models have been increasingly used in economics and finance. The factors, estimated from the high-dimensional data, can, for example, help improve forecasting, provide efficient instruments, control for nonlinear unobserved heterogeneity, and capture cross-sectional dependence. This article reviews the theory on estimation and statistical inference of large factor models. It also discusses important applications and highlights future directions.

Practices used to address economic forecasting problems have undergone substantial changes over recent years. We review how such changes have influenced the ways in which a range of forecasting questions are being addressed. We also discuss the promises and challenges arising from access to big data. Finally, we review empirical evidence and experience accumulated from the use of forecasting methods to a range of economic and financial variables.

This article reviews the literature on international comparative household finance. It presents summary statistics on household balance sheets for 13 developed countries and uses these statistics to discuss common features and contrasts across countries. It then discusses retirement savings, investments in risky assets, unsecured debt, and mortgages.

This article provides an overview of the application of behavioral public economics to energy efficiency. I document policy makers' arguments for “paternalistic” energy efficiency policies, formalize with a simple model of misoptimizing consumers, review and critique empirical evidence, and suggest future research directions. Although empirical results suggest that policies to address imperfect information and internalities may increase welfare in some cases, some existing policies may be mistargeted or miscalibrated.

The saving patterns of retired US households pose a challenge to the basic life-cycle model of saving. The observed patterns of out-of-pocket medical expenses, which rise quickly with age and income during retirement, and heterogeneous life span risk can explain a significant portion of US saving during retirement. However, more work is needed to distinguish these precautionary saving motives from other motives, such as the desire to leave bequests. Progress toward disentangling these motivations has been made by matching other features of the data, such as public and private insurance choices. An improved understanding of whether intended bequests left to children and spouses are due to altruism, risk sharing, exchange motivations, or a combination of these factors is an important direction for future research.

China's emergence as a great economic power has induced an epochal shift in patterns of world trade. Simultaneously, it has challenged much of the received empirical wisdom about how labor markets adjust to trade shocks. Alongside the heralded consumer benefits of expanded trade are substantial adjustment costs and distributional consequences. These impacts are most visible in the local labor markets in which the industries exposed to foreign competition are concentrated. Adjustment in local labor markets is remarkably slow, with wages and labor-force participation rates remaining depressed and unemployment rates remaining elevated for at least a full decade after the China trade shock commences. Exposed workers experience greater job churning and reduced lifetime income. At the national level, employment has fallen in the US industries more exposed to import competition, as expected, but offsetting employment gains in other industries have yet to materialize. Better understanding when and where trade is costly, and how and why it may be beneficial, is a key item on the research agenda for trade and labor economists.

A strong tradition in economic history, which relies primarily on qualitative evidence and statistical correlations, has emphasized the importance of patents as a primary driver of innovation. Recent improvements in empirical methodology—through the creation of new datasets and advances in identification—have produced research that challenges this traditional view. The findings of this literature provide a more nuanced view of the effects of intellectual property and suggest that when patent rights have been too broad or too strong, they have actually discouraged innovation. This review summarizes the major results from this research and presents open questions.

This article reviews recent advances in estimation and inference for nonparametric and semiparametric models with endogeneity. It first describes methods of sieves and penalization for estimating unknown functions identified via conditional moment restrictions. Examples include nonparametric instrumental variables (NPIV) regression, nonparametric quantile IV regression, and many more semi/nonparametric structural models. Asymptotic properties of the sieve estimators and the sieve Wald, quasi-likelihood ratio hypothesis tests of functionals with nonparametric endogeneity are presented. For sieve NPIV estimation, the rate-adaptive data-driven choices of sieve regularization parameters and the sieve score bootstrap uniform confidence bands are described. Finally, simple sieve variance estimation and overidentification tests for the semiparametric two-step generalized method of moments are reviewed. Monte Carlo examples are also included.

Over the past five decades, broad changes in the US health care system have dramatically influenced growth in health care expenditures. This review identifies the salient factors driving the growth of medical expenditures and how they influenced the trajectory of health economics research. We find that the research identified—and was strongly influenced by—four eras of expenditure growth: period 1, coverage expansion; period 2, experimentation with financial incentives; period 3, the managed care backlash; and period 4, a golden era of declining expenditure growth. We conclude by discussing some themes from this research suggesting optimism that, going forward, we can curb excess expenditure growth above GDP growth without harming population health.

Online marketplaces have become ubiquitous, as sites such as eBay, Taobao, Uber, and Airbnb are frequented by billions of users. The success of these marketplaces is attributed to not only the ease in which buyers can find sellers, but also the trust that these marketplaces help facilitate through reputation and feedback systems. I begin by briefly describing the basic ideas surrounding the role of reputation in facilitating trust and trade, and offer an overview of how feedback and reputation systems work in online marketplaces. I then describe the literature that explores the effects of reputation and feedback systems on online marketplaces and highlight some of the problems of bias in feedback and reputation systems as they appear today. I discuss ways to address these problems to improve the practical design of online marketplaces and suggest some directions for future research.

This article reviews recent significant progress made in developing estimation and inference methods for nonlinear models in the presence of mismeasured data that may or may not conform to the classical assumption of independent zero-mean errors. The aim is to cover a broad range of methods having differing levels of complexity and strength of the required assumptions. Simple approaches that form the elementary building blocks of more advanced approaches are discussed first. Then, special attention is devoted to methods that rely on readily available auxiliary variables (e.g., repeated measurements, indicators, or instrumental variables). Results relaxing most of the commonly invoked simplifying assumptions are presented (linear measurement structure, independent errors, zero-mean errors, availability of auxiliary information). This article also provides an overview of important connections with related fields, such as latent variable models, nonlinear panel data, factor models, and set identification, and applications of the methods to other fields traditionally unrelated to measurement error models.

This article presents a selective review of economic research on attentional choice, taking an observation of Block & Marschak (1960) as its starting point. Because standard choice data conflate utilities and perception, they point out that it is inadequate for research in which attention is endogenous. The review focuses on their thesis that advances in our understanding of attention require modeling of novel choice-based data sets, and corresponding methods of measurement. By way of example, recent attentional research based on measuring and modeling state-dependent stochastic choice data is detailed. Next research steps in relation to strategic attention and the dynamics of learning are outlined. If the thesis of Block & Marschak is valid, engineering of new data sets will become an increasingly essential professional activity as attentional research advances.

Women in developed economies have made major advancements in labor markets throughout the past century, but remaining gender differences in pay and employment seem remarkably persistent. This article documents long-run trends in female employment, working hours, and relative wages for a wide cross section of developed economies. It reviews existing work on the factors driving gender convergence, and novel perspectives on remaining gender gaps. Finally, the article emphasizes the interplay between gender trends and the evolution of the industry structure. Based on a shift-share decomposition, it shows that the growth in the service share can explain at least half of the overall variation in female hours, both over time and across countries.

Recent years have seen a surge of applied work using bunching approaches, a development that is closely linked to the increased availability of administrative data. These approaches exploit the incentives for bunching created by discontinuities in the slope of choice sets (kinks) or in the level of choice sets (notches) to study the behavior of individuals and firms. Although the bunching approach was originally developed in the context of taxation, it is beginning to find applications in many other areas, such as social security, social insurance, welfare programs, education, regulation, private sector prices, and reference-dependent preferences. This review provides a guide to bunching estimation, discusses its strengths and weaknesses, surveys a range of applications across fields, and considers reasons for the ubiquity of kinks and notches.

US labor and total factor productivity have historically been procyclical—rising in booms and falling in recessions. After the mid-1980s, however, total factor productivity became much less procyclical with respect to hours while labor productivity turned strongly countercyclical. We find that the key empirical “fact” driving these changes is reduced variation in factor utilization—conceptually, the workweek of capital and labor effort. We discuss a range of theories that seek to explain the changes in productivity's cyclicality. Increased flexibility, changes in the structure of the economy, and shifts in relative variances of technology and “demand” shocks all play key roles.

Countries rarely hit the zero lower bound (ZLB) on interest rates, but when they do, these episodes tend to be very long-lived. These two features are difficult to incorporate jointly into macroeconomic models using typical representations of shock processes. We introduce a regime-switching representation of risk premium shocks into an otherwise standard New Keynesian model to generate a realistic distribution of ZLB durations. We discuss what different calibrations of this model imply for optimal inflation rates.

Active labor market policies are massively used with the objective being to improve labor market outcomes of individuals out of work. Many observational evaluation studies have been published. In this review, we critically assess policy effectiveness. We emphasize insights from recent randomized controlled trials. In addition, we examine policy effects that have not been the primary object of most of the past evaluations, such as anticipatory effects of advance knowledge of future treatments and equilibrium effects, and we discuss the actual implementation of policies. We discuss the importance of heterogeneity of programs and effects and examine the extent to which potential participants are interested in enrollment. We also discuss the assessment of costs and benefits of programs.

The Great Recession has renewed interest in unemployment insurance (UI) programs around the world. At the same time, there have been important advances in both theory and measurement of UI. In this review, we first use the theory to present a unified treatment of the welfare effects of UI benefit levels and durations and derive convenient expressions of the full disincentive effect of UI. We then discuss recent estimates of the effect of UI benefit levels and durations on labor supply based on newly available administrative data and quasi-experimental research designs. Although our review of the new estimates confirms the range of negative labor supply effects of the previous literature, we show, based on the model, that these estimates are imperfect proxies for the actual disincentive effects. We also discuss several active areas of research on UI. These include the effect of UI on aggregate labor market outcomes, its effect on job outcomes, its long-term effects, its effects under nonstandard behavioral assumptions, and its interactions with other programs. We isolate several additional areas in need of further research, including estimates of the social value of UI, as well as the effects of UI in less developed countries.