Senior Distinction Papers: Class of 2015 · Africa, Egypt, France, ... as most efficient firms...

ΟΔΕOMICRON DELTA EPSILONJournal of Economic Research

The St. Olaf College Economics Department’s

Senior Distinction Papers: Class of 2015

2

Omicron Delta Epsilon International Honor Society in Economics

Beta Chapter: St. Olaf College

Executive Board 2015-2016 President: Alec Paulson

Vice President: Matthew Lasnier

ODE Journal Executive Editor: Joe Briesemeister

ODE Journal Associate Editor: Kelsey Myers

About Omicron Delta Epsilon

Omicron Delta Epsilon is one of the world’s largest academic honor societies.

The objectives of Omicron Delta Epsilon are recognition of scholastic

attainment and the honoring of outstanding achievements in economics, the

establishment of closer ties between students and faculty in economics within

colleges and universities, the publication of its official journal, The American

Economist, and the sponsoring of panels at professional meetings as well as the

Irving Fisher and Frank W. Taussig competitions.

Currently, Omicron Delta Epsilon has 578 chapters located in the United

States, Canada, Australia, the United Kingdom, Mexico, Puerto Rico, South

Africa, Egypt, France, and the United Arab Emirates. With such a broad

international base, chapter activities vary widely, ranging from invited

speakers, group discussions, dinners, and meetings, to special projects such

as review sessions and tutoring for students in economics. Omicron Delta

Epsilon plays a prominent role in the annual Honors Day celebrations at

many colleges and universities.

St. Olaf College’s Beta Chapter of Omicron Delta Epsilon aims to build a bridge

between the economics faculty and students, actively providing input and

assistance as needed to improve departmental events; they also publish an in-

house economics journal, encouraging, reviewing, selecting, and publishing

original work from economics students at the college.

3

The St. Olaf College Economics Department’s

Omicron Delta Epsilon Journal of Economic Research

___________________________________________________

Contents Fall 2015

___________________________________________________

Camille Morley: Sustainability Standards in

Agricultural Exports….....…………….………............4

Tim Tuscher: The Higher Education Predicament: An

Analysis and Solution…………………………....…..16

Erik Springer: Will Dodd-Frank Prevent the Next

Great Recession?.........................................................30

Audrey Kidwell: Post-Decision Regret and the Paradox

of Choice in the College Search..................................55

Brian Hickey: Argentina: The Justifications for which

Argentina Defaulted....................................................79

4

St. Olaf College’s Omicron Delta Epsilon Journal of Economic Research

Sustainability Standards in Agricultural Exports

Camille Morley

1. Introduction

Faced with vivid images of climate change and environmental

degradation present in the world, economists ponder over practical

instruments to fight the destruction of natural capital. Still, efforts must be

focused on changing the cycle of environmental abuse instead of

compensating its negative externalities. Given the lack of an international

sovereign with power to install universal sustainability and pollution

standards, constituents looking for real impacts in welfare improvement face

a convoluted path to distributive justice of natural resources. In pursuit of

international policy conducted by an independent nation, policymakers must

acknowledge if considerations should be made to the welfare of its future

citizens as well as citizens beyond national borders. These intergenerational

and interspatial boundaries are certainly present in all economic policies, yet

the immanent nature of climate change and exploitation of natural capital

makes this a pressing issue needing immediate response.

In light of global connectivity and the mass movement of food, I

argue that there is an opportunity and responsibility for private, transnational

companies to involve themselves in both efforts. Often time developing

countries, especially those in the Sub-Saharan African region, face low land-

productivity exasperated by lack of capital and education to address

5

“Sustainability Standards in Agricultural Exports” - Camille Morley

constraints placed on their natural resources. Potential investment to

exporting firms in this region could not only provide a steady, reliable supply

for the private companies in the developed world, but also provide poverty

alleviating opportunities through income and education in the developing

world. A study by Arne Bigsten et al. finds a positive stimulus in

productivity after farms begin exporting in the Sub-Saharan African region.

Their research begs the question of causation regarding efficiency and

exporting, as most efficient firms export.1 However, the Heckscher-Ohlin

theorem of international trade confirms that exporting agricultural goods

would be beneficial for the Sub-Saharan region because it uses their abundant

production factors (land and labor) intensively.2 In this paper I will present a

policy proposal for implementing sustainability standards in the Sub-Saharan

region and explain the welfare benefits for constituents involved. Section 1

will discuss a model for my strategy based on the sanitary and phytosanitary

standards (SPS) implemented by the GATT in 1994. Section 2 will explain

the necessary organizational improvements for the smallholder farms on the

supplier side. Section 3 will overview a strategy for private, transnational

supermarkets and food corporations on the buyer-side. The conclusion will

review the welfare implications for all constituents given a successful

1 Winters, A. L., McCulloch, N., McKay, A. (2004). Trade Liberalization and Poverty: The Evidence So Far. Journal of Economic Literature, 42(1), 72-115. http://www.jstor.org/stable/3217037 2 Yarbrough, B., Yarbrough, R. (2005). The World Economy: Trade and Finance. Mason, Ohio: Thomson/South-

Western.

6


duplication and implementation of the model and offer insight on the

possibility of future universal sustainability standards.

2. Sanitary and Phytosantary Standards (SPS) Model

During the 1994 Uruguay Round of the GATT, SPS standards were

universally agreed upon to ensure the safety of fresh food (meat, seafood,

vegetables, etc.) being transported and consumed around the world. These

standards included controls on pesticide residues, microbial contamination,

parasites, drug residues, zootomic disease, mycotoxins, and adulterants.3

Unfortunately, the GATT-regulated SPS standards were often the most basic

level of safety standards, promoting individual countries (and their major

supermarkets) to implement further safety standards of their own, as seen in

the example the zero-residue supermarkets in the United Kingdom.4 In many

cases, developing countries would export their fresh food product only to

have it detained and discarded at the ports of importing countries for violating

SPS standards. Many opponents to these standards argued that they acted as a

barrier to trade and discriminated against developing nations lacking the

infrastructure and capital to meet the standards. Because fresh food exports

accounted for around fifty percent of total value of agricultural exports from

3 Unnevehr, L. J. (2000). Food Safety Issues and Fresh Food Exports from LDCs. Agricultural Economics. 23(2000), 231-240. 4 Martinez, M. G., Poole, N. (2004). The development of private fresh produce safety standards: implications for

developing Mediterranean exporting countries. Food Policy. 29(2004), 229-255. Doi:10.1016/j.foodpol.2004.04.002

7


developing nations, the sellers from developing nations and buyers from

developed nations desperately needed organizational coordination.5

NGO certifying organizations met this need and became a way of

ensuring fresh food exports met these standards prior to leaving the

developing country; however, certification costs often limited smallholder

farm participation. In response, a wave of large private companies (Kraft

Foods, Proctor& Gamble, Jakobs Coffee, Ritter, Douwe Egberts) invested

and sponsored certification for these smaller farms, very similar to the

sponsorship movement for smallholder organic certification.6 A study

conducted by the Danish Institute of International Studies in collaboration

with the Sokine University of Agriculture in Tanzania examined the

implementation of these food safety standards on Lake Victoria. They found

that region doubled their fish exports between 1996 and 2005 because of

successful coordination of safety regulatory bodies.7 Private companies

provided credit to fisheries to improve their collection equipment, landing

sites, and temporary storage equipment (cooling buildings). Furthermore, the

establishment of new laboratories and inspection systems to ensured a

consistent, safe supply. Regional success was attributed to a multi-

5 Bolwig, S., Riisgaard, L. Gibbon, P., Ponte, S. (2013). Challenges of Agro-Food Standards Conformity: Lessons from East Africa and Policy Implications. European Journal of Development Research. 5, 411.

Doi:10.1057/edjr.2013.8 6 Bolwig, S., Riisgaard, L. Gibbon, P., Ponte, S. (2013). Challenges of Agro-Food Standards Conformity: Lessons from East Africa and Policy Implications. European Journal of Development Research. 5, 413.

Doi:10.1057/edjr.2013.8 7 Bolwig, S., Riisgaard, L. Gibbon, P., Ponte, S. (2013). Challenges of Agro-Food Standards Conformity: Lessons from East Africa and Policy Implications. European Journal of Development Research. 5, 416.

Doi:10.1057/edjr.2013.8

8


stakeholder organizational structure that promoted coordination between

NGOs, investing retailers (supermarkets), and a co-op of smallholder

fisheries, with minimal government involvement.8

3. Organizational Planning

Using the Lake Victoria study as a model, organizational restructuring

could offer similar success if implementing sustainability standards in the

Sub-Saharan region. The question remains, is the study transferable to

agricultural producers looking to improve sustainable practices? To answer

this question, I examine the influence of firm size for farms hoping to

improve their current agricultural techniques and expand their market for

crops.

In a study examining organic-certified smallholder farms in the

developing world that export food products to the EU, economists H.R.

Barret et. al. find that the smallholder farms have competitive prices in the

world market after certification. Additionally, the small size offers better

control on pests and weather fluctuations affecting the delicate crops. Yet the

expensive process of certification, knowledge of reputable certification

bodies, and need for a reliable marketing linkage often discourages

8 Bolwig, S., Riisgaard, L. Gibbon, P., Ponte, S. (2013). Challenges of Agro-Food Standards Conformity: Lessons

from East Africa and Policy Implications. European Journal of Development Research. 5, 410.

Doi:10.1057/edjr.2013.8

9


smallholder farms from even attempting to get certified.9 Essentially, small-

size farms operate well once they are certified organic and have reliable

buyers, but the process of becoming certified and finding buyers is difficult

when lacking capital and opportunities for loans. Connecting this study to

Ronald Coase’s theory of firm size, he would assert that the small farm size

increases its organizational costs. Larger firms will face lower transaction

costs in the market.10

In terms of transferability to agriculture, co-ops are already widely

used in Latin America to convert groups of farms to organic agriculture and

export their products in the growing international market for organic food.11

When implementing sustainable practices, a smaller farm size might also be

beneficial in reducing malpractice and environmentally degrading “mass-

farming”. Barret’s study of organic co-ops in the developing world also states

that self-governed organizing groups help smallholder farms develop

business and localized technical skills that accompany the certification

process.12

Education would be a positive externality and development benefit

for farms originally unable to afford certification, sustainable technology, or

education on their own.

9 Barret, H. R., Browne, A. W., Harris, P.J.C., & Cadoret, K. (2001). Smallholder Farmers and Organic Certification: Accessing the EU Market from the Developing World. Biological Agriculture and Horticulture. 19(2),

185. 10 Coase, R. H. (1937). The Nature of the Firm. Economica. 4(16), 397. http://www.jstor.org/stable/2626876 11 Barret, H. R., Browne, A. W., Harris, P.J.C., & Cadoret, K. (2001). Smallholder Farmers and Organic

Certification: Accessing the EU Market from the Developing World. Biological Agriculture and Horticulture. 19(2),

184. 12 Barret, H. R., Browne, A. W., Harris, P.J.C., & Cadoret, K. (2001). Smallholder Farmers and Organic

Certification: Accessing the EU Market from the Developing World. Biological Agriculture and Horticulture. 19(2),

184.

http://www.jstor.org/stable/2626876

10


Organization within a co-op is equally as important when considering

the diminishing return to the size of management presented in Coase’s theory.

Co-ops must use a thin management structure, essentially led by a single

“export specialist” who ensures compliance by each farm and works directly

with buyers. This structure reduces each individual farm’s transaction costs

while allowing them to maintain control over their small share of land. A

horizontal cooperation based on group responsibility and collective will

should offer better success and avoid administrative barriers caused by too

much vertical management. Furthermore, a cooperative agreement between

farmers gives the group more bargaining power when interacting with

international buyers. Collective power could prevent the exploitation of

smallholders by major “agriculturists”, the major agribusinesses not directly

involved in farming but dependent on the industry for selling products

(Monsanto, DuPont, etc.).13

4. Buyer-Side Incentives and Strategy

In his book, Ethics as Applied Ethics, Beckerman references the

emergence of cosmopolitanism, a notion that places moral equivalence and

impartiality focus on individuals regardless of national boundaries.14

Private

companies that have an international presence best address interspatial and

13 Tisdell, C. (2000). Coevolution, agricultural practices and sustainability: some major social and ecological issues.

International Journal of Agricultural Resources, Governance, and Ecology. 1(1), 6-16.

14 Beckerman, W. (2011). Economics as Applied Ethics: Value Judgments in Welfare Economics. New York, New

York: Palgrave Macmillan.

11


intergenerational welfare issues from this position because their power

transcends national boundaries and exists due to their involvement in the

market.

Why should private companies be interested in paying for sustainably

produced food, let alone invest in technology for smallholder farms to uphold

these practices? I argue the promise of consistent long-run supply through

sustainable practices gives an important edge to global logistics strategy.

Furthermore, due to the growing demand for transparent supply-chains,

corporate social responsibility platforms are having a larger impact on

consumption trends in the developed world. A marketable “sustainable

brand” in the developed world is an important asset for transnational food

corporations, as some consumers now admit through their purchases that they

would prefer to buy a slightly more expensive vegetable knowing that it

wasn’t grown with water full of pesticide.15

Business decisions based solely

on ethics and “do-good” values might not be enough motivation to make an

investment; however, consistent supply and marketing strategy offer financial

benefits incentivizing private companies to take a stake in these projects.

Certainly for the success of a sustainable agriculture policy, clear

objectives must be created and recognized by all constituents involved.

Buyer-end supermarkets must collaborate with certifying NGOs and supplier

co-ops to ensure that sustainable standards are universally recognized.

15 Bolwig, S., Riisgaard, L. Gibbon, P., Ponte, S. (2013). Challenges of Agro-Food Standards Conformity: Lessons

from East Africa and Policy Implications. European Journal of Development Research. 5, 413.

Doi:10.1057/edjr.2013.8

12


Collaboration will also prevent differing levels of standards seen in the

implementation of SPS standards. These sustainable practices must reflect the

environmental needs of a region and be localized to preserve natural capital

unique to its environment. A simulation study implementing carbon-

sequestration practices in Kenya and Peru demonstrated the importance of

localizing strategy to maximize improvements to land productivity and

poverty reduction. Terracing provided more productivity increases carbon

preservation in Peruvian land whereas fertilizer usage had a larger effect to

crop yields in Kenya.16

A study by the Copenhagen Business School asserts the importance of

multi-stakeholder involvement connecting the end-consumers, private

companies (supermarkets), NGOs, and supplying farms to ensure

accountability and transparency in the supply chain.17

This extensive

coordination offers the best probability of success for observable welfare

improvements and should ensure the protection of all constituents involved.

Emphasis must also be placed on coordination and communication between

public and private solutions. If public assistance and regulation of

sustainability standards is too centralized, implementation might suffer from

slowed administration and inconsistent government funding. For this reason,

16 Antle, J. M., Stoorvogel, J. J. (2008). Agricultural carbon sequestration, poverty, and sustainability. Environment

and Development Economics, 13 (1), 344. Doi:10.1017/S1355770X08004324 17 Bolwig, S., Riisgaard, L. Gibbon, P., Ponte, S. (2013). Challenges of Agro-Food Standards Conformity: Lessons

from East Africa and Policy Implications. European Journal of Development Research. 5, 408-427.

Doi:10.1057/edjr.2013.8

13


government involvement should only play a minor role and majority of

planning and implementation should be left to the private sector and NGOs.

5. Conclusion

A successful implementation of sustainability standards will offer

welfare benefits to all constituents involved instead of typical “winners” and

“losers”. In regards to supplier, smallholder farms, better practices will

preserve natural capital offering better crop yields and sustained income

through exporting. Organization into co-ops will promote communal support

for land-preserving practices and shared agricultural information and

education. These outcomes will diminish poverty at the micro-level. Buyer,

transnational companies will face a sustainable food supply that not only

ensures ease in supply-chain logistics, but also acts as a marketable aspect in

their corporate social responsibility platform. As sustainably-produced food

becomes a societal norm in the developed world that offers additional

poverty-reducing income to exporting farms in the developing world,

consumption preferences for sustainably produced food will accompany

poverty reduction in developing countries. Sustainability regulation will no

longer be viewed as a discriminating trade-barrier demanded by developed

countries.

Certainly implementing such sustainability standards as a WTO

technical- barrier-to-trade would enforce a unified front against

14


environmental degradation; however, the current stagnation in the Doha

rounds of the GATT proves this will not be possible anytime soon. The

plethora of issues regarding agricultural subsides in the developed world,

labor standards, and price stability already pose too much controversy

between developing and developed nations. For this reason, sustainability

standards implemented and demanded by private companies offer more

immediate response to interspatial and intergenerational welfare promotion,

but act as an important guide for an eventual universal recognized

sustainability standard.

15


6. References

Antle, J. M., Stoorvogel, J. J. (2008). Agricultural carbon sequestration,

poverty, and sustainability. Environment and Development

Economics, 13 (1), 327-352. Doi:10.1017/S1355770X08004324

Barret, H. R., Browne, A. W., Harris, P.J.C., & Cadoret, K. (2001).

Smallholder Farmers and Organic Certification: Accessing the EU

Market from the Developing World. Biological Agriculture and

Horticulture. 19(2), 183-199.

Beckerman, W. (2011). Economics as Applied Ethics: Value Judgments in

Welfare Economics. New York, New York: Palgrave Macmillan.

Bolwig, S., Riisgaard, L. Gibbon, P., Ponte, S. (2013). Challenges of Agro-

Food Standards Conformity: Lessons from East Africa and Policy

Implications. European Journal of Development Research. 5, 408-

427. Doi:10.1057/edjr.2013.8

Coase, R. H. (1937). The Nature of the Firm. Economica. 4(16), 386-405.


Martinez, M. G., Poole, N. (2004). The development of private fresh produce

safety standards: implications for developing Mediterranean exporting

countries. Food Policy. 29(2004), 229-255.

Doi:10.1016/j.foodpol.2004.04.002

Tisdell, C. (2000). Coevolution, agricultural practices and sustainability:

some major social and ecological issues. International Journal of

Agricultural Resources, Governance, and Ecology. 1(1), 6-16.

Unnevehr, L. J. (2000). Food Safety Issues and Fresh Food Exports from

LDCs. Agricultural Economics. 23(2000), 231-240.

Winters, A. L., McCulloch, N., McKay, A. (2004). Trade Liberalization and

Poverty: The Evidence So Far. Journal of Economic Literature, 42(1),

72-115. http://www.jstor.org/stable/3217037

Yarbrough, B., Yarbrough, R. (2005). The World Economy: Trade and

Finance. Mason, Ohio: Thomson/South-Western.



16


The Higher Education Predicament: An Analysis and

Solution Tim Tuscher

1. Introduction

For students in America, the rising costs of college tuition and the

burden of student loan debt may be deteriorating the personal value of a

college degree. On one hand, the cost of earning a college degree has never

been so steep, but on the other, the cost of failing to do so has never been so

severe. This is the great predicament of modern higher education that

confronts our society, and the effects of this intensifying situation have been

substantial. As the support system has fallen off, who pays for the cost of

higher education has dramatically shifted from the university and the state to

students and their families. So far policy makers and the decision making

bodies of higher education institutions alike have failed to resolve this

predicament.

What must first happen is a thorough investigation of the drivers of

rising costs of tuition in order to identify areas for improvement. After this

has been done, the role of government must be examined to determine how to

more efficiently support higher education. This paper explores these issues

comprehensively, relying on empirical analysis and the concept of

distributional fairness in order to propose a solution.

17

“The Higher Education Predicament: An Analysis and Solution” - Tim Tuscher

2. Analysis of the Current State of Higher Education

The Rising Price of Higher Education in America

College tuition rates in the United States have increased at a break

neck pace in the last forty years making it more difficult for many Americans

to pay for higher education. In the last forty years, average tuition rates at

private colleges and universities rose an astonishing 1,400 percent.

Meanwhile, public colleges and universities saw average tuition rates

skyrocket 1,700 percent over that same timeframe (The College Board,

2014). Today the cost of attendance, which includes tuition and fees and

room and board, at many four-year private colleges and out-of-state public

universities exceeds $250,000. For residents attending state universities, the

average four-year cost of attendance tops $80,000. These sums do not include

the opportunity cost of forgone earnings. The fact that college tuition has

risen nearly five times as fast as the consumer price index in the last 35 years,

and twice as fast medical care in the last decade further highlights how drastic

these tuition hikes have been (Belkin, 2013). So why has higher education

become so expensive?

18


Source: The College Board (2014)

The Drivers of Rising Tuition

Rising tuition in recent decades has been blamed on many factors

ranging from campus construction booms to administrative bloat. As a result

of competition amongst colleges and universities for national eminence and

high rankings, we have seen extensive investments in elaborate new

construction projects and the number of administrative staff employed by

colleges and universities balloon – leading many to believe that rampant

tuition escalation is a consequence of increases in college spending. But

funding for these ventures comes from two sources – tuition revenue and

state funding. If tuition hikes over the past decade were in line with

$2,1

30

$3,2

25

$5,5

56

$8,6

63

$11,7

19

$15,5

18

$20,0

45

$2

5,7

39

$3

1,2

31

$512

$738

$1,2

28

$1,6

96

$2,7

05

$3,3

62

$5,1

26

$7,0

73

$9,1

39

1 9 7 4 -

7 5

1 9 7 9 -

8 0

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8 5

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9 0

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9 5

1 9 9 9 -

0 0

2 0 0 4 -

0 5

2 0 0 9 -

1 0

2 0 1 4 -

1 5

AVERAGE COLLEGE

TUITION AND FEES IN

CURRENT DOLLARS

(1974-75 TO 2014-15)

Private Nonprofit Four-Year Public Four-Year

19


expenditure increases, causality could be concluded. Yet, tuition prices in the

last decade rose 24 percent, three times as fast as overall expenditures per

student. These great tuition increases, coupled with low expenditure growth,

suggest that excessive spending cannot account for the degree to which

tuition prices have increased. The driving force behind tuition escalation over

the last decade, as it turns out, is declining state appropriations for higher

education (Hiltonsmith, 2015).

As tuition prices continue to soar, state appropriations for higher

education are deteriorating. The volatile economic environment put

tremendous strain on state budgets across the nation, and governments

decided they could no longer afford to bankroll universities as generously as

they had in previous years. As the figure below shows, state support for

master’s and bachelor’s universities fell 25 percent, $2,067 per student, in the

last decade in lockstep with tuition increases. This lack of funding has

resulted in an inability for colleges universities to offer the same level of

financial aid they had offered in the past. And thus, the depletion of state

funds forced universities and colleges to generate revenue elsewhere.

Elsewhere, as it turns out, came in the form of tuition increases to students.

The depletion of state caused a dramatic shift in the share of expenses paid

for by students and governments. The reality is that as of 2011, a public

higher education no longer exists. Over half of the costs of higher education

are paid for by tuition, a private source of capital. Internationally, the US

20


spends less money on higher education proportionally than 23 other nations

(See Appendix). This shift from a collective funding of higher education to

one borne increasingly by individuals has had severe implications, namely a

dramatic increase in national aggregate student debt.

Source: Desrochers, Donna M., and Steven Hurlburt. Trends in College Spending: 2001-2011 via

Hiltonsmith (2015)

The Escalation of Student Loan Debt to Finance Higher Education

For decades students have relied on aid packages to finance higher

education. Aid packages consist of a combination of grants, work study

awards, and loans. When computing a student’s aid package, the college

starts by deducting the student’s expected family contribution from the

sticker price in order to determine a student’s need, then it allocates the

$4,154 $5,556 $6,617

$7,957 $6,468

$5,998

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

$14,000

2001 2006 2011

SHARES OF EDUCATION AND RELATED

SPENDING AT MASTER'S AND

BACHELOR'S UNIVERSITIES

(2001-2011)

Net Tuition State Support

21


federal money the student is eligible for, and then and only then will the

university pull from its own resources to complete the student’s aid package.

For students, the portion of the bill that is left over after a student receives his

or her aid package has increased substantially in recent decades.

While the cost of going to college is rising, the cost of not going to

college has never been higher. “On virtually every measure of economic

well-being and career attainment—from personal earnings to job satisfaction

to the share employed full time—young college graduates are outperforming

their peers with less education. And when today’s young adults are compared

with previous generations, the disparity in economic outcomes between

college graduates and those with a high school diploma or less formal

schooling has never been greater in the modern era” (The Rising Cost of Not

Going to College, 2014).

These factors – the high cost of tuition, the shift from a collective

funding of higher education to one borne increasingly by individuals, and the

high cost of not going to college – have come at a time when average real

income growth has been stagnate in the United States, meaning higher

education is becoming increasingly less affordable for most Americans

(Lorin, 2014). American households faced the same budgetary pressures that

states faced during the recession, but one outcome of the recession and the

slow economic recovery is the stress that it has placed on household’s ability

to pay for college from their income and savings. This means families must

22


now rely increasingly on outside sources of funding. Americans cut back on

borrowing in all consumer debt categories from 2008 to 2012 – except for

student loans. Americans now hold a staggering amount of college debt –

$1.2 trillion in aggregate to be exact. The average borrower owes nearly

$30,000 in debt (The Institute for College Access & Success, 2014).

Alarmingly, the active number of borrowers, that is the number of students

taking out new debt each semester, declined even as aggregate debt grew.

Source: The Federal Reserve Bank of New York (2015)

The weight of debt from student loans substantially impacts American

households. Student loans are one of the few financial obligations an

individual can’t discharge in bankruptcy, and currently, over half of

outstanding student loans are presently in deferral, delinquency, or default.

Specifically, 27.3 percent of borrowers in repayment are in delinquency on

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

IN T

RIL

LIO

NS

(U

SD

)

Non-Mortgage Consumer Debt HE Revolving Auto Loan Auto Loan Student Loan

23


student loans, a percentage far higher than for other forms of consumer credit

including credit cards, mortgages and auto loans (Sánchez, 2015). Student

loan delinquencies and repayment problems create a very difficult downward

spiral and reduce a borrower’s ability to form their own households and

engage in the economy (Lee, 2015). There is, without question, cause for

growing concern over the debt burden many students take on to get a college

education because the ramifications of failing to keep tuition and debt loads

in check could be severe.

3. Friedman’s Solution

Significant effort must be made to reduce the costs of college tuition

or Americans will continue to borrow in order to finance higher education.

Declining state appropriations for higher education mean that many students

today have no choice but to take on significant debt to finance their

educations, the negative effects of which are becoming increasingly evident.

While there is no single course of action that the Federal Government can

take to deter the reliance on student debt, it can however implement several

policy measures to alleviate the burden of student debt. First, the government

must start viewing higher education as a priority. The government should

increase grants for students with the greatest financial need, adjust the

expected family contribution formula to encourage colleges and universities

24


to create more realistic aid packages, and restructure the student loan system

to make the debt burden more sustainable.

A more innovative approach, as proposed by Milton Friedman in The

Role of Government in Higher Education (1955), could transform the way we

think about higher education, but more importantly – the way we finance it.

To Friedman, the issue is that we as taxpayers socialize the losses associated

with student loans while at the same time privatizing the gains. When a low-

income borrower cannot service their student loan debt, they default, leaving

taxpayers to foot the bill. On the other hand, high-income borrowers

successfully service their loans then continue to individually benefit from the

dividends of the initial loan. His remedy to this dilemma isn’t for the

government to become a more favorable lender, but for it to become a savvy

investor.

Under Friedman’s plan, the government would provide students with

financial backing to pay for college and, in return, the students would pay a

percentage of their income back to the government each year – regardless of

the amount of money initially invested in them. The way things are currently,

when the government issues a loan it is agreeing with the borrower that it will

get back the principal plus interest, no more, no less. Once the borrower

repays the loan plus interest, he or she is free of the debt obligation. Under

this new system, a student who generates a big return on his or her education

investment shares it with taxpayers by repaying more than the original

25


investment. A student who doesn’t generate as great as a return, never pays

back the total amount invested in him or her. So rather than socializing the

losses and privatizing the gains, Friedman’s plan would socialize both the

losses and gains. Private arrangements could work towards the same ends.

The benefits of a private initiative are significant, as it would allow the

government to, according to Friedman, “serve its proper function of

improving the operation of the invisible hand without substituting the dead

hand of bureaucracy” while “eliminating existing imperfections in the capital

market and so widen the opportunity of individuals to make productive

investments in themselves.”

If we were to hold up the current American higher education system

to the Rawlsian ideal, we would discover a system that systematically

disadvantages the poor. Higher education, in its current state, does not

increase social mobility, but rather reinforces existing barriers. While there is

little common ground between social liberalists like John Rawls and free

market capitalists like Milton Friedman, there is reason to believe Rawls

would support a higher education solution packaged as an equity investment.

Friedman’s proposal would have significant impact on the equality of

opportunity in America and go a long way in eliminating the economic

barriers to higher education. However unlikely that it may be to return

ourselves to the original position and negotiate a new social contract behind a

veil of ignorance, we can negotiate a new way of financing higher education.

26


4. Conclusion

Higher education is a true public good – we depend on the system to

produce doctors, nurses, teachers, accountants and other professionals, as

well as to help us develop the critical thinking skills needed to succeed in a

very competitive global economy. Yet, it has become increasingly difficult to

afford higher education in America ever since states decided that they would

no longer bankroll as generously as they previously had. Tuition has spiraled

out of control. State funding on a per student basis has fallen off. And so the

burden of funding our higher education system has shifted from the university

and the state to students and their families. The result has been the debt-for-

diploma system in which most students fill the gap between what their

parents can pay, available grant aid and their earnings from part-time work,

by taking on student debt.

We must find a way out of this predicament. To do so, we must first

demand that the government appropriates more funding for higher education.

This will combat rising tuition fees. But restoring state support for higher

education is only a start. We need to establish new ways for families to

finance higher education without relying on massive loads of student debt.

One such way which Milton Friedman proposes is for the government and

private enterprises to engage in equity investments in students, so as to widen

access to higher education without leveraging their futures.

27


5. References

"A Flagging Model." The Economist. The Economist Newspaper, 28 March,

2015. Web. 18 April, 2015.

<http://www.economist.com/news/special-report/21646988-americas-

higher-education-system-no-longer-delivering-all-it-should-flagging-

model>>.

Beckerman, Wilfred. “Economics as applied ethics: value judgements in

welfare economics.” Palgrave Macmillan, 2010.

Belkin, Douglas. "How to Get College Tuition Under Control." WSJ. 8 Oct.

2013. Web. 3 May 2015.

Christensen, Clayton M., and Henry J. Eyring. The innovative university:

Changing the DNA of higher education from the inside out. John

Wiley & Sons, 2011.

Dewan, Shaila. "Wage Premium From College Is Said to Be Up." Economix.

11 February, 2014. Web. 21 April,

2015.<http://economix.blogs.nytimes.com/2014/02/11/wage-

premium-from-college-is-said-to-be-up/?_r=0>>.

Eberly, Jane and Martin, Carmel. “The Economic Case for Higher

Education” The Treasury Notes Blog. Web. 2 May 2015.

<http://www.treasury.gov/connect/blog/Pages/economics-of-higher-

education.aspx>.

Friedman, Milton. "The Role of Government in Education (1955)." The

Friedman Foundation for Educational Choice

RSS.<http://www.edchoice.org/The-Friedmans/The-Friedmans-on-

School-Choice/The-Role-of-Government-in-Education-

%281995%29.aspx>.

Hiltonsmith, Robert. "Pulling Up the Higher-Ed Ladder: Myth and Reality in

the Crisis of College Affordability." Demos.org. 5 May 2015. Web.

Jenkins, Jay. "The Ugly Truth Behind the Student Loan Crisis." 25 April,

2015. Web. 27 April, 2015. <http://www.fool.com/how-to-

invest/personal-finance/credit/2015/04/25/the-ugly-truth-behind-the-

student-loan-crisis.aspx>>.

Johansson, Per-Olov. “An introduction to modern welfare economics.”

Cambridge University Press, 1991.

Lee, Donghoon. "Household debt and credit: student debt." Federal Reserve

Bank of New York. February 28 (2013).

28


Lorin, Janet. "College Tuition in the U.S. Again Rises Faster Than Inflation."

Bloomberg.com. Bloomberg, 12 Nov. 2014. Web. 4 May 2015.

Mitchell, Josh. "The Student-Loan Problem Is Even Worse Than Official

Figures Indicate." Real Time Economics RSS. The Wall Street

Journal, 14 Apr. 2015. Web. 11 May 2015.

<http://blogs.wsj.com/economics/2015/04/14/the-student-loan-

problem-is-even-worse-than-official-figures-indicate/>.

Rawls, John. “A Theory of Justice.” Harvard university press, 2009.

Sánchez, Jaun. "Student Loan Delinquency: A Big Problem Getting Worse?" -

St. Louis Fed. N.p., n.d. Web. 11 May 2015.

<http://research.stlouisfed.org/publications/es/article/10344>.

Sharp, Ansel Miree, Charles A. Register, and Paul W. Grimes. “Economics of

social issues”. Plano, TX: Business Publications, 1988.

“The Institute for College Access & Success.” 2014. Quick Facts about

Student Debt. http://bit.ly/1lxjskr.

"The Rising Cost of Not Going to College." Pew Research Centers Social

Demographic Trends Project RSS. N.p., 11 Feb. 2014. Web.

<http://www.pewsocialtrends.org/2014/02/11/the-rising-cost-of-not-

going-to-college/>.

College Board. "Trends in College Pricing." Trends in College Pricing.

College Board, n.d. Web. 25 Apr. 2015.

<http://trends.collegeboard.org/sites/default/files/2014-trends-college-

pricing-final-web.pdf>.

29


6. Appendix

Proportions of Expenditures on Higher Education Institutions from Public,

Household, and Other Private Sources, 2010

Country Average Cost

of Tuition Public Household

Other

Private

1 Norway $19,050 96% 3% 1%

2 Finland $16,714 96% 4% 0%

3 Denmark $18,432 95% 5% 0%

4 Iceland $8,728 91% 8% 1%

5 Sweden $19,727 91% 0% 9%

6 Belgium $14,776 90% 5% 6%

7 Austria $15,007 88% 3% 10%

8 Slovenia $8,517 85% 11% 5%

9 France $14,699 82% 10% 8%

10 Ireland $15,911 81% 16% 2%

11 Czech Republic $7,338 79% 9% 12%

12 Spain $13,300 78% 18% 4%

13 Estonia $5,715 75% 18% 7%

14 Netherlands $17,254 72% 15% 13%

15 Poland $6,714 71% 23% 7%

16 Slovak Republic $6,768 70% 12% 18%

17 Mexico $7,872 70% 30% 0%

18 Portugal $9,498 69% 23% 8%

19 Italy $9,501 68% 24% 8%

20 New Zealand $10,418 66% 34% 0%

21 Canada $24,704 57% 20% 24%

22 Israel $10,876 54% 30% 16%

23 Australia $16,020 46% 39% 15%

24 United States $25,576 36% 48% 16%

25 Japan $18,191 34% 52% 14%

26 Korea $11,218 27% 47% 26%

27 United Kingdom $15,206 25% 56% 19%

28 Chile $6,794 22% 70% 8%

Source: The College Board (2014)

30


Will Dodd-Frank Prevent the Next Great Recession? Erik Springer

1. Abstract

This paper revisits the purported goals of the Dodd-Frank Wall Street

Reform and Consumer Protection Act of 2010, examining the strengths and

weaknesses of the law and concluding that the law is a framework from

which to build but ultimately weighed down by the complexity of its

piecemeal approach. The current literature will be surveyed and policy

recommendations proposed as guiding principles for successful future reform

and efficient regulation to prevent another financial crisis like the Great

Recession of 2008.

2. Introduction

The 2008 financial crisis was caused in large part by the bad banking

practices of Wall Street and poor oversight by government agencies. The

gruesome details are familiar: repo markets dried up in a liquidity crisis,

bonds including mortgage-backed securities lost value, Bear Stearns

collapsed, Lehman Brothers went bankrupt, government loan agencies Fannie

Mae and Freddie Mac went into receivership, and systemically important

firms like AIG received a massive bailout (Brunnermeier, 2009). Risky

decisions had few consequences as the U.S. federal government doled out

exorbitant sums of cash to stabilize the financial sector to prevent the Great

31

“Will Dodd-Frank Prevent the Next Great Recession?” - Erik Springer

Recession from becoming the Great Depression II. But taxpayers were

angered by having to prop up industries that paid huge bonuses to executives

even after the same individuals drove the world economy into the ground.

While it is clear that intervention was necessary, many argue it should have

come much earlier and some wanted Glass-Steagall reinstated.

In response, Congress passed the Dodd-Frank Wall Street Reform and

Consumer Protection Act of 2010 to prevent a similar scenario from

happening again. Better known as Dodd-Frank, the bill as originally written

left many of the finer details unresolved. Some of the specifics are still being

hashed out by regulatory agencies with Congressional oversight, but much of

the bill is finally in place. Early assessments of the bill were heavily

weighted toward speculation and outright partisanship rather than reasoned

evaluation. Now, more than four years after the passage of Dodd-Frank, it is

important to objectively appraise the law on its actual merits and limitations.

In 2011 Christopher Dodd—for whom the bill was named along with

Barney Frank—wrote an opinion editorial dispelling some myths about his

piece of legislation. Congressman Dodd (2011) responded forcefully (and

accurately) to his critics that it was the “uncertainty inherent in a non-

transparent and reckless financial system” that brought the economy to its

knees in the first place, not excessive regulation. In setting this record

straight, it is important to acknowledge that political demagoguery often

surrounds conversations about reform. As informed and outcome-oriented

32


citizens we must set aside ideology and focus instead on what works. Dodd-

Frank is not an intrusive market-stifling force or the answer to all problems.

Regulation is needed, and Dodd-Frank has an important role to play in

resetting the balance of power in the markets to prevent unscrupulous

practices in mortgage-backed securities, secret derivatives trading, and Catch-

22 situations with too-big-to-fail institutions. The legislative solution must

be evaluated in its ability to execute the objective for which Dodd said it was

ostensibly created. He claimed that “repealing it would return us to a time

when nobody knew what the Wall Street gamblers were doing until it was too

late,” and it is hard to argue that repeal would be a better idea than keeping

the law (Dodd, 2011). But this is not quite the right issue. Taxpayers and

voters need to know if the law can not only predict but also prevent the next

Great Recession. That is what this paper will explore.

This study of the law will show how Dodd-Frank establishes a

meaningful framework for reform but ultimately lacks the teeth necessary to

stop another collapse like 2008. To support this thesis I will first survey the

current literature on the topic, assess the strengths and weaknesses of Dodd-

Frank, and then present relevant case studies, policy implications, and

recommendations. Lastly the conclusion will include a summary discussing

how the next great recession can be prevented through straightforward rule

making, streamlined regulating bodies, and aggressive oversight of

systemically important institutions.

33


3. Literature Review

The difficulty in surveying the current literature on Dodd-Frank stems

from the fact that few of the details were worked out when the law was

written in 2010 and many are still being argued over today. New regulatory

bodies have been formed and new practices adopted, but the legislation

remains largely untested. By all measures financial institutions are thriving

today, but it is difficult to attribute the absence of a financial meltdown to a

particular piece of legislation. Even if it were easy, catastrophic systemic

failure can take a while to materialize (there was after all a 79-year gap

between the beginning of the Great Depression and the Great Recession).

Despite the shortcomings listed above, Acharya et al. (2011) did an

effective job of explaining the accomplishments and limitations of Dodd-

Frank in its early days. They found that the law charges depository banks

with building firewalls, demands an orderly resolution to fires, and stops

taxpayers from footing the bill to put out financial fires. But Dodd-Frank

does not go far enough in regulating the shadow banking system, fails to

explain how to put out fires, and is weakened by organizations like Fannie

Mae and Freddie Mac that do not have enough protections in place and could

end up in receivership again. Furthermore, the bill does not strongly

disincentivize private individuals and institutions from putting the system at

risk and depends too heavily on coordination between the new CFPB and

other established regulatory agencies, many of which failed in their duties in

34


the lead up to 2008. Regulators deserve blame just like bankers; legislation

will not guarantee that regulators do their job in the future. These concerns

still exist today. But the authors also commented realistically on the

misguided opinion that re-implementing Glass-Steagall would solve all

problems related to modern financial markets and risk. Acharya et al. (2010)

concluded that Dodd-Frank is a meaningful framework for reform with

limitations that can be remedied in time.

Kroszner and Strahan (2011) followed up on earlier work and

examined the importance of writing sound rules that prevent fraud and risk

from being shuffled around to new markets. Their arguments are best left in

their own words: “First, reform should avoid the next round of regulatory

arbitrage in which business moves ‘into the shadows,’ where risks may

slowly accumulate like dead wood ready to ignite the next wildfire. Second,

reform ought to improve market transparency to reduce the uncertainty of

counterparty exposures and interlinkages between major players, thereby

lowering contagion risk” (Kroszner and Strahan, 2011, p. 243). They

expressed concern that Dodd-Frank is ineffective in its regulation of the

housing market and will incent banks to change their practices individually

without actually getting rid of risky practices across the industry. I will look

at their work by focusing on two separate issues: the lack of changes to

regulation in the housing market brought about by Dodd-Frank and the future

efforts that will likely be undertaken in parallel banking to avoid regulation.

35


This last point is crucial. All rules and regulations must be assessed in terms

of their effectiveness at creating transparency. If rules have workarounds and

only encourage regulatory arbitrage, banks will inevitably restructure in order

to maintain opacity, leverage, and excessively risky profit-seeking activities.

By the time Robert Prasch analyzed Dodd-Frank, he came to very

different conclusions than Acharya and his colleagues had about a year prior.

Prasch (2012) argued that the lack of clear and explicit rules in Dodd-Frank

undermines any lasting impact on financial regulation and opined that the bill

was based on flawed premises in the first place. Contrary to Acharya, he

found that Dodd-Frank did not end too-big-to-fail institutions. Greater

consensus exists around the fact that excessive risk-taking still takes place.

Prasch advanced new solutions, notably suggesting the government employ a

similar budgetary process for regulatory agencies to that used by drug

agencies: allow the agencies to keep a percentage of the fines they impose.

This would immediately alter the goals of regulatory agencies and the fervor

with which they imposed major penalties. He also discussed Martin Shubik’s

suggestion that a “stress test” competition be put forth to motivate top

lawyers and economists to identify problems before they occur. Lastly, the

author noted that fraud is prevalent and rarely prosecuted. To his analysis I

would add that implicitly sanctioned fraud (like shadow or parallel banking)

is even worse. The parallel banking system has expanded greatly over the

past three or four decades and remains a significant source of economic risk.

36


Nazareth and Rosenberg (2013) continued this train of thought by

exploring the complexity of the U.S. regulatory system and the failure of

Dodd-Frank to improve the inefficiencies of government regulation. The

authors noted that numerous disparate regulatory agencies have grown up

through a piecemeal approach to regulation that has only grown in

complexity over the last 100 years. In this sense, Dodd-Frank missed an

opportunity to reform an archaic and convoluted system of regulation.

Congress’ inability to consolidate regulatory organizations—namely the SEC

and the Commodity Futures Trading Commission but also a number of

others—prohibits nimble regulation and effective communication between

regulators. I will use the example of the regulation of securities, futures, and

swaps as a case study of the problems associated with Dodd-Frank, a bill that

faces an uphill battle both politically and systemically. These difficulties will

be addressed toward the end of the paper as I explain the realities of

governing banks and financial markets with an eye towards suggesting

meaningful reform beyond Dodd-Frank.

Prager (2013) expressed great skepticism of future regulatory success

in exploring CEO compensation structures and their impact on risk-taking.

He outlined how compensation and incentives work to show that chief risk

officers could not restrain CEOs from overly-risky behavior in the lead up to

2008 and success by CEOs was largely based upon luck rather than skill.

Nothing has changed on this front, and CEOs remain incentivized to do more

37


business—even if it means accepting opportunities with dangerous risk

profiles. When one investment bank begins offering innovative (and

reckless) services, others must follow suit to stay competitive. In Prager’s

view, this reality invalidates the effects of broad reforms like Dodd-Frank. It

will have limited value as the same bad incentives remain in the system and

markets are inherently difficult to predict, leaving even the best of bankers

ultimately at the whimsy of luck. However, the author’s claim that history

tells us that we cannot stop another panic is weakened by the fact that we

managed to do so relatively well from the 1930s into the early 2000s. A

more important set of tasks is to diagnose what was sacrificed with the repeal

of Glass-Steagall, what can be improved within Dodd-Frank, and how

regulators can stay one step ahead of developments in parallel banking.

While there are many different ways to deal with systemic risk across

the literature, Yellen (2011) discussed the weakness of monetary policy as an

instrument for systemic risk management because it has its own

macroeconomic goals of price stability and maximum employment.

Additionally, it is a very blunt instrument to handle systemic risk and

regulation is the key. Despite these facts, Yellen admitted that there are

occasions on which it could be appropriate to use monetary policy to stem

risk-taking behavior. Macroprudential policies are the primary driver of

security in the financial system (in accordance with Acharya and Richardson)

but Yellen notes that this is most effective when not working at odds with

38


monetary policy. Unfortunately, the economic environment of today is one

such situation in which the goals of macroprudential policies might be at odds

with the goals of monetary policy. For example, the Fed remained skittish

about stemming the flow of easy money for far too long and artificially

propped up the economy with QE3. Yellen’s analysis included policy

implications much like Prasch, but gave a more nuanced perspective: there is

no single method for stemming systemic risk. Yes, the Fed must work with

the CFPB, SEC, and many other agencies to predict and prevent another

Great Recession. And yet, the Fed has separate responsibilities. After

weighing the evidence, the author concluded that dramatic Congressional

action is the best solution for stemming systemic risk. For this reason

monetary policy will not play a major role in policy implications outlined

towards the end of this study.

4. Strengths of Dodd-Frank

Given the complexity of Dodd-Frank it is important to set the stage

for future discussion of the law with some background on the major aspects

and accomplishments of Dodd-Frank. Acharya et al (2011) highlight the

major achievements of the bill, which are reproduced in a slightly altered and

refocused list below:

Identifying and regulating systemic risk under auspices of the

Systemic Risk Council and the U.S. Treasury

39


Recommending an end of too-big-to-fail by redirecting wind-down

costs onto shareholders and creditors

Broadening the responsibility and authority of the Federal Reserve to

include all systemic institutions

Imposing the Volker Rule, a limited version of Glass-Steagall

Increasing regulation and transparency in derivatives markets through

central clearing and oversight

Creating the Consumer Financial Protection Bureau to protect

consumer interests in lending practices and financial services

Each of these topics will be addressed with varying degrees of depth

depending on overall relevance to long-term reform. After considering the

accomplishments of the bill, I will turn to the weaknesses and future policy

improvements to be made.

At its core, Dodd-Frank takes a significant step forward in providing

insight into systemic risk. The creators of the legislation recognized that

banks are not the only organizations that can induce widespread risk into the

economy and therefore gave regulators the authority to deem certain

institutions to be of such consequence. Those who claim that the repeal of

Glass-Steagall was responsible for the 2008 crisis overlook the fact that the

Banking Act of 1933 did not have the authority to oversee many key financial

players today because the structure of our banking system has changes so

drastically in the ensuing eighty years. The new Systemic Risk Council

40


provides a private-sector perspective and research on a range of issues,

notably pursuing meaningful solutions for reform of the financial sector and

encouraging efficient government regulation. This additional oversight will

be critical moving forward in predicting risk within the United States and in

holding regulators accountable for identifying structural cracks in our

economy.

Perhaps the most popular element of Dodd-Frank is the creation of the

Consumer Financial Protection Bureau, an agency focused solely on

protecting consumers in the finance sector. Elizabeth Warren realized that

regulators too often saw their job as protecting banks, leading to the predatory

lending practices in home mortgages allowed in the years preceding 2008. As

Paul Krugman (2014) noted, this group is “doing much more to crack down”

than other agencies have in the past.

The Volcker Rule is another trend in the right direction. Acharya and

Richardson (2012) argued that the Volcker Rule could be an effective policy

tool in managing the systemic risk of firms. It has two levers that can be

pulled to stop banks from making risky decisions: capital requirements and

asset holding restrictions. First proposed by Paul Volcker, this component of

Dodd-Frank prevents banks from engaging in volatile proprietary trading and

investing clients’ money in hedge funds. It also limits bank holding

companies’ ability to bail out these kinds of risky investments (Acharya and

Richardson, 2012, p. 3). While partially stripped down from its original

41


version at the behest of special interests, the Volcker Rule is finally going

into effect in 2014. It is already playing a role in separating investment from

commercial banking despite some shortcomings and loopholes.

Other largely unregulated areas of banking in the lead up to 2008

were derivatives markets. Academics almost universally agree that Dodd-

Frank is a monumental leap forward in the transparency of derivative trading.

Bear Stearns’ large derivatives practice made its collapse all the more

surprising because regulators did not understand the derivatives markets or

exposure risk. This occurred in part because of the Commodity Futures

Modernization Act of 2000, a bill that placed undue trust in the markets and

prohibited the regulation of derivatives. Under the new law enacted in 2010,

centralized clearing of many derivatives and transparency of over-the-counter

derivative trading will enable markets to be aware of counterparty risk.

Everyone will have an understanding of personal exposure to the risks taken

on by firms (Acharya et al, 2010, p. 46).

To many taxpayers, the most important (and contentious) purpose of

Dodd-Frank is preventing too-big-to-fail institutions from requiring

government funding. On front the law is a partial success. Regulators can

now designate systemically important financial institutions (SIFIs) and

increase scrutiny and capital requirements for these institutions. Such

companies must now prepare funeral plans and organized liquidation

procedures in case of institutional failure. Dodd-Frank also removes taxpayer

42


funding as an option for supporting wind-downs. This pushes the costs—and

responsibility—for poor management onto shareholders and creditors with

additional stipulations that management be fired in the event of disaster. To

encourage good behavior, any remaining costs are to be borne by large

surviving financial firms. In a way, this demands that firms act as their

brothers’ keeper and discourages bad banking practices on behalf of the

collective of firms. Better awareness of what is going on at SIFIs and

accountability to each other will theoretically decrease counterparty risk,

forcing firms to understand the ways that they are interlinked and all share

risk from the collapse of a company like Lehman Brothers. Despite these

steps forward, the law does not achieve the goal of eliminating too big to fail

institutions, a controversial goal but likely one that could address systemic

risk more thoroughly. It is optimistic to believe that firms will self-regulate

and hold each other in check; it just does not play out in reality and this

strategy does not adequately eliminate systemic risk.

5. Weaknesses and Omissions of Dodd-Frank

Dodd-Frank calculates individual institutions’ risk on an independent

basis, raising an important concern about the possibility of unchecked

systemic risk in the future. By its very nature, systemic risk is large-scale and

interconnected. HR 4173 Title I, Subtitle A, Sec. 113 (US Congress 2010)

discusses the stringency standards for assessing risk among systemically

43


important financial institutions (SIFIs) but focuses regulatory practices

entirely on the bank-by-bank risk. There is no mention of the interaction

between a bank and other banks or the “comovement of that firm’s assets

with the aggregate financial sector in a crisis” (Acharya and Robinson 2012,

p. 10). Each firm’s risk is analyzed in a vacuum. Acharya and Robinson

neglect to mention that this is much like counterparty risk, when firms are not

aware of the interconnected nature of their hedging practices. And hedging is

ineffective when comovement of assets is incredibly strong (like it was in

2008). Imagine a scenario where Goldman Sachs buys CDOs from

Wachovia and buys insurance against them from Bear Stearns. Due to

counterparty risk and the comovement of assets, the investment is not

protected at all. Similarly, regulation is ineffective when it considers

financial institutions independent—particularly when they are actually as

interconnected as they have proven to be over the past decade.

Robert Prasch (2012) made a significant observation about the

intertwined nature of the financial system in criticizing Dodd-Frank’s efforts

at ending too-big-to-fail institutions. The current legislative solution

identifies these companies but does nothing to prevent them from existing.

Ultimately it is their very existence that endangers stability. It may sound

harsh, but forcing SIFIs to make funeral plans does not prevent the next

Lehman Brothers collapse from crushing the entire financial system and

tanking the economy. Certainly the government could take over SIFIs in a

44


crisis and resurrect them much like it did with General Motors. However

there is no guarantee that such a scenario would play out as profitably as the

GM deal, and the near misses of 2008 only made the largest banks bigger and

more systemically vital as J.P. Morgan Chase bought Washington Mutual,

Wells Fargo purchased Wachovia, and Bank of America acquired Merrill

Lynch. The government nearly begged to get some of these deals done to

protect the economy from further implosion. But the result was terrible for

limiting systemic risk. A slew of academics including Bair, Black, Galbraith,

and Johnson have found that massive banks are inherently hazardous to

economic stability (Prasch, 2012). The Great Recession should have taught

us that banking was too complicated; a comprehensive, modern form of

Glass-Steagall needed to be implemented in the wake of the Great Recession.

Instead the government turned to the largest financial institutions to save their

peers and in the process the government created even more bloated

systemically important companies.

Even the Volcker rule has shortcomings that damage its effectiveness.

In plain terms, the Volcker rule was emasculated by special interests. For

starters, it does not encompass all institutions. The concerns of many banks

were voiced effectively and as a result a number of institutions will be able to

dodge the policy. Loopholes crippled a policy that should have been enacted

as a blanket ban proprietary trading by bank holding companies. As it stands,

even the definition of “proprietary” is nebulous, endangering the Volcker

45


Rule’s potential relevancy in the future. Banks may very well manage to

adapt to circumvent the policy by employing new techniques for leveraging

their assets. Kroszner and Strahan worry that selective regulatory arbitrage

will incentivize institutions to move risk to new markets and institutions,

which will only serve to “increase interlinkages and market opaqueness”

(2011, p. 244). This is an ominous thought and one with significant meaning.

Dodd-Frank may have redefined the rules of the game, but it did not prevent

banks from inventing their own entirely new games without rules.

Future regulatory success depends upon the oversight of financial

instruments that have not yet been created in the parallel (or shadow) banking

system. Federal deposit insurance, required reserve ratios, and capital

requirements are nonexistent in parallel banking. Since Dodd-Frank focuses

on censuring only the specific bad behaviors of the past, banks will adapt and

devise the next version of derivatives or credit default swaps to avoid the

current rules. This will hopefully be mitigated by the law’s ability to

designate SIFIs and increase regulation for these companies, but legislating

symptoms is a weak alternative for addressing systemic disease. It could take

ten or more years to understand if regulators are nimble enough under the

current laws to counteract new financial instruments. One thing is certain:

Dodd-Frank did not end the risks involved in the parallel banking system.

The parallel banking system remains completely interconnected with

traditional banking and risk is widespread.

46


6. Policy Recommendations

There are inherent dangers in assuming that policy-makers can create

fail-safe structures to avert economic downturns. To that end I will provide

some words of caution through the narrative and research of Jonas Prager

before outlining some proposals that may help prevent the next Great

Recession. Prager (2013) charted the path of Lehman Brothers and Goldman

Sachs through the course of the financial crisis to illustrate the similarities of

the firms. He found that risk management and boards of directors had no role

in whether firms weathered the storm or collapsed; misaligned incentives also

did not play the central role that some economists have envisioned. Luck

determined outcomes. Prager demonstrated that financial markets will

always be a bit like gambling. When the gamblers get too much money to

play with, somebody will inevitably lose big. Regulators can certainly

mitigate a recurrence of 2008, but prevention may be impossible.

Even strong banking legislation like Glass-Steagall has never been

entirely effective. While the Banking Act of 1933—Glass-Steagall as it came

to be known—did create the FDIC to insure deposits and separated

commercial banking from investment banking, it was never fail-safe

(Acharya et al, 2011). The regulation was sound for a time, but development

in financial systems made the law irrelevant within a few decades. Fragile

shadow (or parallel) banking grew up in the 1970s and 1980s, bringing with it

systemic risk that Glass-Steagall was incapable of addressing. Even the

47


Volcker Rule, a modern version of the law, is insufficient due to watering

down and limited jurisdiction. To improve Dodd-Frank, the first change that

should be made is a blanket rewrite of the Volcker Rule to allow it unlimited

jurisdiction with zero loopholes. Banking interests crippled the policy’s

effectiveness by 2014 when the final language was solidified. In response,

Congress should amend Section 619 of Dodd-Frank by removing all

qualifiers and loopholes, stripping the Volcker Rule down to the following:

A banking entity shall not

(A) engage in proprietary trading; or

(B) acquire or retain any equity, partnership, other ownership interest in

or sponsor a hedge fund or private equity fund.

This is what Paul Volcker intended and this is the simplest and most

meaningful way to protect consumers’ assets held at banks.

The current complexity of the Volcker Rule highlights a major issue

with the larger financial system and rulemaking. Special interests obstruct

meaningful lawmaking and legislators’ piecemeal approach to regulation only

complicates oversight. Consider Dodd-Frank’s structure for a moment: the

law “implicates 25 regulators and creates 2 new ones” over the course of 849

pages of legislation and 398 open-ended rulemaking requirements (Nazareth

and Rosenberg, 2013). Regulation is not lean or coordinated. Overlapping

jurisdiction creates overregulation and underregulation within different parts

of the financial system. Sometimes both occur simultaneously, leading to

inconsistent regulation that drives undue costs onto the private sector. For

example, the regulation of securities, futures and swaps is split between the

48


Securities and Exchange Commission (SEC) and the Commodity Futures

Trading Commission (CFTC) because of an archaic remnant of legislation

written in the 1970s that started the CFTC. Nazareth and Rosenberg (2013)

thoroughly explained the disorganized history of the CFTC, but all that is

worth noting here is that Dodd-Frank makes the problem worse through

provisions that impact both the SEC and the CFTC in interrelated ways. Dual

compliance causes a “timing mismatch that leaves market participants to

build systems to implement the CFTC’s rules without knowing whether those

systems will also satisfy the SEC’s rules for related instruments” (Nazareth

and Rosenberg, 2013, p. 541). When regulatory arbitrage is too complex,

businesses are faced with uncertainty and may migrate risky operations

offshore. This makes it even more difficult for regulators to deal with

systemic risk as exposure floats abroad.

The most definitive oversight of Dodd-Frank is its failure to

adequately address systemic risk. It seems sensible to attempt to regulate

critical institutions on a case-by-case basis, but the reality is that the law fails

to impose a tax on financial institutions and by extension fails to internalize

the systemic risk created by each firm. Such a tax, called a Pigouvian tax,

has the potential to limit the costs to the rest of the economy when a firm like

Lehman Brothers fails. Firms would not have to try to act as their brother’s

keeper and would prevent other firms from having to bear the liquidation

costs of a SIFI. This fee or premium would also have additional benefits

49


from stipulations around capital and liquidity requirements that would incent

financial institutions to choose less leverage and hold assets with less

aggregate tail risk. In turn, this would cause these firms to be less systemic,

further mitigating concerns over the defaulting of individual firms. Congress

missed a crucial opportunity in failing to include a Pigouvian tax in Dodd-

Frank. While this may have been ignored on grounds of political expediency,

any true effort at overhauling systemic risk needs to disincentivize financial

institutions from taking on bad assets or high levels of leverage that—upon

in-depth analysis—are dangerous to the whole economy.

The new Financial Stability Oversight Council (FSOC) created by

Dodd-Frank is designed to prevent systemic risk through coordination

between all the major regulatory bodies of the federal government. But will

one more regulatory really address systemic risk? Hoshi (2011) found that

the FSOC is not taking dramatic action beyond the purview of other agencies.

SIFIs need a greater degree of regulation that the organization is willing to

enact. The “living will” component of Dodd-Frank does force SIFIs to have

funeral plans and will prevent taxpayers from footing the bill, but forcing

other firms to bear the costs is an inefficient solution. No firms are equipped

to address systemic risk, particularly in light of the international nature of

modern finance. Cline and Gagnon (2013) cautioned that the “living will”

provision is untested and acknowledge that international financial institutions

50


have little oversight because regulators from different countries have not

reached consensus. Basel III does little to tackle this difficulty.

Basel III is underwhelming in that it does not set capital requirements

according to illiquidity of assets and liquidity of liabilities (Hoshi, 2011).

Liquidity risk regulations only apply to a subset of banks, which will only

encourage movement into parallel banking and underregulated financial

markets. The Fed and the FSOC should address this by building standards

around leverage ratios in the 8 to 10 percent range rather than the 6 percent

ratio required of SIFIs that the Fed originally announced. And the new

standards should be applied to a much greater proportion of banks. This

would be a solid start, although it would be even better policy to risk-weight

assets and build leverage ratio requirements around the specific balance

sheets and risk classes of individual systemically important firms. Lastly,

standardized haircuts should be imposed on collateralized financing

agreements to protect creditors holding collateral backing repurchase

agreements. This could prevent asset fire sales like the one seen in 2007,

when institutional investors withdrew funds and repo dried up (Kroszner and

Strahan, 2011). These policy recommendations are non-exhaustive but

provide an outline of some of the main priorities when it comes to giving

regulators the tools that they need to prevent the next Great Recession.

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7. Conclusion

As Dodd-Frank nears full implementation, critical evaluation becomes

more meaningful. The logistics of operating the FSOC and Consumer

Financial Protection Bureau are solidified and further appraisal of the law’s

successes and failures is warranted. Dodd-Frank establishes a framework for

successful regulation by identifying too-big-to-fail institutions, improving

transparency in derivatives markets, protecting consumers, and establishing

the Volcker Rule, among other things. Despite the progress made with the

bill’s passage in 2010, the legislation was weakened by lobbyists and

unarticulated rules. Parallel banking still exists and the behavioral-based

rulemaking approach does not anticipate future risk. The policies of Dodd-

Frank may actually contribute to future market risk as firms pursue profits by

devising new financial vehicles that escape current regulation policy. Further

analysis of Dodd-Frank’s effectiveness may not be possible until we can

assess regulators responsiveness to these sorts of developments that could

introduce excessive risk into the economy.

Opportunities exist for improving the regulatory framework and

process. Having 25 regulatory agencies only increases the problems of

coordination and consistent corporate governance. Despite gridlock in

Congress, bipartisan reform could take shape if Democrats were willing to

cut back the number of regulatory agencies to simplify the regulatory process.

Systemic risk could be tackled if Republicans also embraced the idea of a

52


Pigouvian tax for financial services firms to encourage personal

responsibility, one of the tenants of the modern conservative movement.

Other reforms can be undertaken with no political will or action; the Fed

could increase leverage requirements and the FSOC could designate more

banks as SIFIs and increase oversight. The Systemic Risk Council could

sound the alarm about the interconnectedness of the financial system and

enact new standards for measuring risk based on firms’ exposure to

counterparty risk. Clearly the academic literature is ripe with ideas about

how to improve upon the steps taken since 2008.

Ultimately Dodd-Frank represents a significant step forward, but it

will not prevent the next Great Recession on its own. One overarching

problem remains: systemic risk. Dodd-Frank may have lessened risk in the

housing market, derivatives trading, and commercial banking, but the law

fails to address counterparty risk and the interconnectedness of banks. In

treating financial institutions like individual players in a game of chance,

legislators showed either a great level of ignorance or a lack of willpower to

pry into the relationships between financial services companies. Congress

also missed a golden opportunity to reform the regulatory system by

consolidating agencies and responsibilities. Instead they left the United

States with an antiquated and complex system burdened by increasing layers

of rules. It will be up to policymakers, legislators, and regulators to build on

the successes of Dodd-Frank and anticipate future developments in traditional

53


and parallel banking. Risk will only be mitigated through vigilant but

pragmatic oversight. With that, and possibly a bit of luck, we can prevent

another Great Recession.

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8. References

Acharya, V. V., Cooley, T., Richardson, M., Sylla, R., & Walter, I. (2011).

The dodd-frank wall street reform and consumer protection act:

Accomplishments and limitations. Journal of Applied Corporate

Finance, 23(1), 43-56.

Acharya, V. V., Richardson, M. (2012). Implications of the dodd-frank act.

Annual Review of Financial Economics 4, 1-38.

Brunnermeier, M. (2009). Deciphering the liquidity and credit crunch 2007-

2008. Journal of Economic Perspectives 23(1), 77-100.

Cline W.R. and Gagnon, J.E. (2013). Lehman died, bagehot lives: why did

the fed and treasury let a major wall street bank fail? Peterson

Institute for International Economics, PB13-21.

Dodd, C. J. (2011, Oct 28). FIVE MYTHS ... dodd-frank new law fends off

disaster. Journal – Gazette. Retrieved from

http://search.proquest.com/docview/900875799?accountid=351

Hoshi, T. (2011). Financial regulation: Lessons from the recent financial

crises. Journal of Economic Literature, 49(1), 120-128. Retrieved

from http://www.jstor.org/stable/29779754

Kroszner, R. S., & Strahan, P. E. (2011). Financial regulatory reform:

Challenges ahead. The American Economic Review, 101(3), 242-246.

Krugman, P. (2014). In defense of obama. Rolling Stone. Retrieved from

http://www.rollingstone.com/politics/news/in-defense-of-obama-

20141008

Mandated risk retention in mortgage securitization: An economist's view.

(2014). The American Economic Review, 104(5), 82-87.

Nazareth, A. L., & Rosenberg, G. D. (2013). The new regulation of swaps: A

lost opportunity. Comparative Economic Studies, 55(3), 535-548.

Posner, E., & Weyl, E. G. (2013). Benefit-cost analysis for financial

regulation. The American Economic Review, 103(3), 393-397.

Prasch, R. E. (2012). The dodd-frank act: Financial reform or business as

usual? Journal of Economic Issues, 46(2), 549-556. Retrieved from


Vasudev, P. M. (2014). Credit derivatives and the dodd-frank act: Is the

regulatory response appropriate? Journal of Banking Regulation,

15(1), 56-74. Retrieved from


Yellen, J. L. (2011). Macroprudential supervision and monetary policy in the

post-crisis world. Business Economics, 46(1), 3-12.




55

“Post-Decision Regret and the Paradox of Choice in the College Search” - Audrey Kidwell

Post-Decision Regret and the Paradox of Choice in the

College Search Audrey Kidwell

1. Introduction

College graduates are at a great advantage in the U.S. because they

have access to much wider job opportunities and tend to earn higher salaries

than non-college graduates. But according to the National Center for

Education Statistics, only “59 percent of full-time, first-time students who

began seeking a bachelor's degree at a 4-year institution in fall 2005

completed the degree at that institution within 6 years” (U.S. Department of

Education, 2013). The remaining 41 percent transferred to another school or

dropped out of college entirely. Someone who drops out of college may end

up in debt without enjoying any of the benefits a college degree confers.

Many factors contribute to the decision to drop out, including the regret a

student can incur during the college search process. A student who regrets his

choice of college may feel dissatisfied or out of place, or he may believe that

attending a different college would have given him a better experience. These

feelings of unhappiness will, at best, prevent the student from getting the

most out of the college experience at her chosen school and, at worst, may

contribute to her decision to transfer or drop out.

In this paper, I construct a theoretical model to explore the

determinants of post-decision regret in the college search. This will not only

help college admissions officers and administrators predict and improve

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graduation rates, it will also inform changes to the college search aiming to

decrease student regret. I suggest that the paradox of too much choice and the

practice of “keeping doors open” pose the greatest threats in increasing

regret. Sagi and Friedland (2007) linked the paradox of choice with post-

decision regret. The authors suggest that, rather than rationally comparing

their chosen college with the next-best foregone option, students compare

their chosen college with the combined advantages of every foregone option.

When applied to the college search, this theory stipulates that the student acts

as if she is giving up the added utilities she would have gained from all the

rejected colleges. The more schools the student applies to, the more severe

the regret from the paradox of choice becomes. Moreover, the earlier the

student begins the application process, the longer he has to become attached

to the positive attributes of each college he is considering. The model

explores which factors influence the two determinants of regret: the paradox

of choice and “keeping doors open”.

Scholars have found that satisficers, people who use a heuristic to

narrow their options, experience greater satisfaction with their decision than

maximizers, people who seek to make the best possible choice and thus draw

from more options. But while a number of studies examine this phenomenon

in the job search, scholars have not yet applied it to the college search. Few

economists have examined the college decision and extant models do not

consider the role of the paradox of choice or post-decision regret. I aim for

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this paper to introduce post-decision regret and the paradox of choice into the

college decision and to suggest that satisficing may produce more satisfaction

with the college choice than maximizing because satisficing narrows the

student’s options. I constructed a game theory model in which the student

strategically chooses a commitment signal to show to the college. The student

can do various things to signal feelings of commitment: he can visit campus,

participate in an optional interview, begin his application early, apply to

fewer colleges, or apply early decision. The signal impacts the determinants

of regret, including the number of colleges to which the student applies. The

model assumes that a student who applies to a larger number of schools sends

a lower commitment signal to each one. Therefore, in order to effectively

satisfice in the college search, the student must choose a higher commitment

signal. If people who guide students in the college process such as parents

and admissions officers urge students to narrow down their choices before

applying, students may experience less post-decision regret.

My empirical analysis grants new insight into factors impacting the

number of colleges to which a student applies and how early the student

begins his application, which are the two determinants of post-decision

regret. Students who tend to succeed in academics and extracurricular

activities seem more prone to maximizing in the college search and thus may

feel less satisfaction with their choice than satsificers. Broadly, this analysis

contributes to scholarly understanding of the college search because it

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explores how different types of students employ different decision-making

tactics, which in turn may produce different levels of post-decision regret.

This paper also provides grounds for more detailed research into the effects

of post-decision regret on students’ college experiences, as well as the links

between regret and graduation rates. Admissions officers will find this study

useful in identifying students who may regret their choice and decide to

transfer or drop out. The administration may create programs to target

students of this type who are already enrolled to try to mitigate their regret

and increase their likelihood of graduating from the college. Parents of this

type of student may encourage their child to narrow down her choices before

applying so that she will feel more confident when she makes her final

decision. I hope that by shedding light on regret in the college decision, my

study will contribute to changes in the college search that reduce post-

decision regret, thereby reducing dropout rates of undergraduate students.

2. Literature Review

This study explores the relationship between three behavioral

economics concepts that factor into a student’s college decision: paradox of

choice, post-decision regret, and satisficing. Traditional economics holds that

a choice set with many options allows decision-makers more opportunity to

make the best choice. The paradox of choice suggests just the opposite, that

more options may cause the person to make a sub-optimal choice because the

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larger set complicates the decision process. In this theory, behavioral

economics draws on the psychological concept of cognitive load, which holds

that humans’ limited mental capacity can only handle a certain amount of

information at once (Wilkinson, Klaes 2012). Iyengar and Lepper (2000)

refer to this concept as “choice overload” and find that “although the

provision of extensive choices may sometimes still be seen as initially

desirable, it may also prove unexpectedly demotivating in the end”. Students

may feel overwhelmed by the huge number of choices in the college search,

leading them to feel stressed or even make decisions that do not maximize

utility.

Post-decision regret is the regret a person feels for giving up one or

more options in choosing another. Traditionally, scholars argued that the

number of choices should not affect the amount of regret a person feels after

settling on one option. Regret should be based only upon the next-best

foregone option. However, Sagi and Friedland (2007) suggest that human

psychology leads decision-makers to compare their chosen alternative with

the combination of all the rejected alternatives, thus drawing a connection

between choice set size and post-decision regret. According to this argument,

more choices lead to more disutility in the form of regret, lending weight to

the theory of the paradox of choice.

This study explores satisficing as a strategy for minimizing post-

decision regret by reducing the number of options available. Satisficing is a

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form of heuristics in which a decision-maker sets an acceptable benchmark

rather than seeking to maximize, or make the best possible decision.

According to Schwarz et al (2002), a satisficer evaluates options in the order

he encounters them until one option exceeds the acceptable benchmark. The

satisficer then chooses that option and ends his search there. By setting a

benchmark, satisficing narrows the choice set and thus reduces the impact of

choice overload. This study proposes that satisficing may also reduce post-

decision regret in the college decision.

Scholars have examined the paradox of choice in a variety of

decision-making situations. One classic experiment testing this concept

offered grocery store customers either a large or a small variety free jam

samples (Iyengar and Lepper, 2000). The experimenters found that the

customers given a smaller variety purchased more jam than those given a

larger choice set. The authors asserted that the complexity of the decision in

the larger choice set discouraged customers from making any choice at all.

Tversky and Shafir (1992) conducted a similar experiment in which one

group of subjects had the opportunity to exchange cash winnings for a more

valuable pen. When an inferior pen was added to the choice, the percentage

of people who made the trade decreased. Both of these examples illustrate

that when decisions become more complicated with the addition of more

options, people opt out from making any decision at all.

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Like the paradox of choice, post-decision regret and maximizing

versus satisficing can apply to a wide variety of situations. For example,

scholars have applied both concepts to the job search. Whereas satisficers end

their search after encountering an option that meets an acceptable benchmark,

maximizers keep searching until they find the best possible option. Iyengar,

Wells, and Schwartz (2006) found that maximizers received objectively

better outcomes in the job search than satisficers did, but that satisficers felt

less regret about their decision. Through a series of surveys, the authors

found that, “despite their relative success, maximizers are less satisfied with

the outcomes of their job search, and more pessimistic, stressed, tired,

anxious, worried, overwhelmed, and depressed throughout the process”

(Iyengar et al, 2006). In a similar study, Giacopelli et al (2013) looked for

connections between maximizing and job satisfaction, employing multiple

theoretical measures of maximization. The authors found that “maximizing

was negatively related to job satisfaction and positively related to intentions

to quit” when using one measure. Many papers that compare maximizers with

satisficers note that maximizers seem to experience more post-decision

regret, perhaps because they are deciding from a larger choice set.

Scholars have explored the concepts of paradox of choice, post-

decision regret, and satisficing, but my study applies them in a relatively new

way. Little work has been done on the role of choice set size in the college

search, which is the contribution this study aims to Few economists have

62


examined the college choice process; most studies on this decision fall into

the field of education. Cabrera and La Nasa (2000) note that an “economic

perspective [on the college choice] regards enrollment as the result of a

rational process in which an individual estimates the economic and social

benefits of attending college, comparing them with those of competing

alternatives.” According to their analysis, however, the economic perspective

chiefly considers the perceived affordability of the institution and does not

take regret into account. The College Entrance Examination Board has also

published work by scholars in the field of education. At least one economics

paper, written by Long in 2004, develops an economic model predicting how

students decide whether and where to go to college. However, Long’s paper

focuses mostly on price and quality of the institution and does not take into

account how many schools the student applies to. The most analogous studies

have been done on the job search and have been published in psychology

journals. This study aims to examine whether applying to a greater number of

colleges has an impact on satisfaction similar to applying for a greater

number of jobs.

63


3. Theoretical Model

𝐶𝑜𝑙𝑙𝑒𝑔𝑒: max𝑎𝐸,𝑎𝐿

𝑁𝐸(𝑎𝐸)𝑉𝐸(𝑎𝐸 , 𝑐∗( 𝑓)) + 𝑁𝐿 (𝑎𝐿)𝑉𝐿(𝑎𝐿, 𝑐∗(𝑓))

subject. to. 𝑁𝐸(𝑎𝑒) + 𝑁𝐿(𝑎𝐿) = 𝑌

𝑆𝑡𝑢𝑑𝑒𝑛𝑡: max𝑐

𝑎∗(𝑞 (𝑔, 𝑒, 𝑐)) − 𝑅 (𝑛(𝑐, 𝑔, 𝑓), 𝑑(𝑐, 𝑔, 𝑓))

𝑁𝐸 = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠𝑡𝑢𝑑𝑒𝑛𝑡𝑠 𝑎𝑐𝑐𝑒𝑝𝑡𝑒𝑑 𝑒𝑎𝑟𝑙𝑦 𝑑𝑒𝑐𝑖𝑠𝑖𝑜𝑛 𝑉𝐸 = 𝑆𝑐ℎ𝑜𝑜𝑙′𝑠 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑎𝑟𝑙𝑦 𝑑𝑒𝑐𝑖𝑠𝑖𝑜𝑛 𝑠𝑡𝑢𝑑𝑒𝑛𝑡𝑠 𝑎𝐸 = 𝐴𝑐𝑐𝑒𝑝𝑡𝑎𝑛𝑐𝑒 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑒𝑎𝑟𝑙𝑦 𝑑𝑒𝑐𝑖𝑠𝑖𝑜𝑛 𝑠𝑡𝑢𝑑𝑒𝑛𝑡𝑠 𝑐∗ = 𝐶𝑜𝑚𝑚𝑖𝑡𝑚𝑒𝑛𝑡 𝑠𝑖𝑔𝑛𝑎𝑙 𝑠𝑡𝑢𝑑𝑒𝑛𝑡 𝑠ℎ𝑜𝑤𝑠 𝑡𝑜 𝑐𝑜𝑙𝑙𝑒𝑔𝑒 𝑓 = 𝐼𝑛ℎ𝑒𝑟𝑎𝑛𝑡 𝑓𝑒𝑒𝑙𝑖𝑛𝑔 𝑜𝑓 𝑐𝑜𝑚𝑚𝑖𝑡𝑚𝑒𝑛𝑡

𝑁𝐿 = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠𝑡𝑢𝑑𝑒𝑛𝑡𝑠 𝑎𝑐𝑐𝑒𝑝𝑡𝑒𝑑 𝑟𝑒𝑔𝑢𝑙𝑎𝑟 𝑑𝑒𝑐𝑖𝑠𝑖𝑜𝑛 𝑉𝐿 = 𝑆𝑐ℎ𝑜𝑜𝑙′𝑠 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑟𝑒𝑔𝑢𝑙𝑎𝑟 𝑑𝑒𝑐𝑖𝑠𝑖𝑜𝑛 𝑠𝑡𝑢𝑑𝑒𝑛𝑡𝑠 𝑎𝐿 = 𝐴𝑐𝑐𝑒𝑝𝑡𝑎𝑛𝑐𝑒 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑔𝑢𝑙𝑎𝑟 𝑑𝑒𝑐𝑖𝑠𝑖𝑜𝑛 𝑠𝑡𝑢𝑑𝑒𝑛𝑡𝑠 𝑌 = 𝑇𝑎𝑟𝑔𝑒𝑡 𝑐𝑙𝑎𝑠𝑠 𝑠𝑖𝑧𝑒

𝑎∗ = 𝑆𝑡𝑢𝑑𝑒𝑛𝑡′𝑠 𝑝𝑟𝑜𝑏𝑎𝑏𝑖𝑙𝑖𝑡𝑦 𝑜𝑓 𝑎𝑐𝑐𝑒𝑝𝑡𝑎𝑛𝑐𝑒 𝑐 = 𝑆𝑡𝑢𝑑𝑒𝑛𝑡′𝑠 𝑐𝑜𝑚𝑚𝑖𝑡𝑚𝑒𝑛𝑡 𝑠𝑖𝑔𝑛𝑎𝑙 𝑞 = 𝑄𝑢𝑎𝑙𝑖𝑡𝑦 𝑜𝑓 𝑡ℎ𝑒 𝑠𝑡𝑢𝑑𝑒𝑛𝑡 𝑔 = 𝐺𝑟𝑎𝑑𝑒𝑠 𝑒 = 𝐸𝑥𝑡𝑟𝑎𝑐𝑢𝑟𝑟𝑖𝑐𝑢𝑙𝑎𝑟𝑠 𝑅 = 𝑅𝑒𝑔𝑟𝑒𝑡 𝑛 = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑜𝑡ℎ𝑒𝑟 𝑠𝑐ℎ𝑜𝑜𝑙𝑠 𝑎𝑝𝑝𝑙𝑖𝑒𝑑 𝑡𝑜 𝑑 = 𝐷𝑢𝑟𝑎𝑡𝑖𝑜𝑛 𝑎𝑝𝑝𝑙𝑖𝑐𝑎𝑡𝑖𝑜𝑛 𝑤𝑎𝑠 𝑜𝑝𝑒𝑛 (𝑖𝑛 𝑑𝑎𝑦𝑠)

This game theory model ultimately describes the student’s decision

about how great a level of commitment to make to a particular college. The

two players, the student and the college, make interdependent decisions. The

college chooses early decision and regular decision acceptance rates, thinking

strategically about how the student uses the commitment signal to

demonstrate feelings of commitment to the school. The student strategically

chooses the commitment signal, considering its impact on his acceptance

chances. The commitment signal is a combination of various activities such

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as visiting campus, participating in an optional interview, beginning the

application early, applying to fewer colleges, or applying early decision. The

model shows how a student perceives the traits a college is looking for and

how his perception impacts his choice about how committed to be to one

college.

The college seeks to maximize the quality of the student body, given

by its value for each type of student (VE and VL), by choosing the acceptance

rate of each type of student. The college has two choice variables, the

acceptance rate of early decision students (aE) and the acceptance rate of

regular decision students (aL). The college is constrained in how many

students it can accept, given by NE + NL = Y in which Y is the target class

size. The model assumes that a student’s value to the school varies by the

level of commitment the student reveals to that college. Students who

demonstrate higher commitment most likely inherently feel more committed

and are therefore more likely to become highly involved in college life. Thus,

the college may have a higher acceptance rate of early decision students than

of regular decision students because the former signal higher levels of

commitment. Regular decision students may have to prove that they are of

particularly high quality to offset their relatively lower commitment level in

order to be accepted.

The student seeks to maximize the chance that a college will accept

him given his individual level of quality. In this model, quality is a function

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of grades, extracurricular activities, and commitment to the school. The

student choses the level of commitment to signal to the college based on the

other determinants of his level individual quality, extracurricular involvement

and grades. Commitment is a continuous variable in this model because a

student can do various things to signal feelings of commitment which

combine to create a spectrum of commitment signals. A student who has poor

grades may signal a higher level of commitment to bolster his quality, hoping

to make himself a more appealing candidate for acceptance. This student may

apply early decision to his top choice in order to signal a higher commitment

level and thus may apply to fewer colleges. Conversely, a student with good

grades may be able to afford to signal a lower commitment level because he

does not need to supplement his already appealing traits. He may be able to

“keep doors open”, signaling a lower commitment by applying regular

decision to a larger number of colleges, without harming his chances of being

accepted.

In choosing a commitment signal, the student sets himself up to

experience some amount of regret after he makes his college choice. For

example, if the student signaled high commitment by attending many events

for prospective students for one college but ultimately chose a different

college, he may experience more regret than if he had signaled low

commitment. In this model, regret is a function of the number of schools to

which the student applied and the duration his application was open. These

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variables depend in turn upon strategic commitment and inherent

commitment to the college; inherent commitment is how invested the student

feels in attending a particular college whereas strategic commitment is what a

student does to demonstrate how serious she is about attending the college. In

some cases, the student may signal higher commitment than he inherently

feels in order to make himself a stronger candidate.

This model implies that the larger the choice set, the stronger the

feeling of post-decisional regret. A longer application duration may also

increase regret; the student has more time to picture himself attending each

college to which he applies, increasing his regret at letting some go. Regret is

also a function of the inherent level of commitment the student actually feels

towards the school. If the student signals a level of regret different from her

inherent level, she may experience more regret. For example, a student might

signal more commitment than she feels by applying early decision in order to

make herself a more appealing candidate. This could lead to regretting her

decision to apply early decision. Applying early decision may also cause

regret because it restricts the student’s ability to “keep doors open”, thereby

limiting the number of colleges to which he applies.

This model is compelling because it explores the way both students

and colleges value commitment in the college decision process. Colleges

value commitment because it indicates the students want to be at the college

and will make the most of their time there. The constraint on the number of

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students enrolled creates a trade-off for the college in choosing early decision

students versus regular decision students and impacts the way they value each

group. Students know that colleges value commitment, so they decide which

level to choose when applying to schools. However, commitment also plays a

role in post-decisional regret. On one hand, a student with low commitment

towards any one school may apply to lots of colleges and suffer from the

paradox of choice. On the other hand, a student who commits to applying

early decision at one school may regret that decision if their inherent

commitment did not reflect their strategic commitment. The student must

strike a balance between how attractive a choice he is for the college and the

regret he feels after he makes the decision.

4. Empirical Analysis

I used data from the St. Olaf Admissions Office from the 2013

incoming freshman class to test relationships between variables in my model.

Only one year of data is available, which limits its power to explain

relationships between factors in the college choice. However, this dataset lists

all 2,381 students who St. Olaf admitted, of whom 786 actually enrolled. The

dataset provides demographic and academic information about each student

as well as details about his or her college search. St. Olaf constructed a

ranking of academic performance (g) from multiple measures, including

GPA, test scores, class rank, and quality of the student’s high school. St. Olaf

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also constructed a ranking of extracurricular involvement (e) from measures

including leadership positions, awards, or other outstanding participation.

Early Decision, application start date, and the number of colleges to which a

student applied serve as indicators of strategic student commitment (c). I ran

linear and logistic regressions to examine the relationship between

demographic factors and the two determinants of regret (R), duration of the

application (d) and number of colleges to which the student applied (n).

Duration is the length of time from which the student began her application to

the deadline of her chosen decision round. In other words, duration captures

how early in the process the student established a relationship with St. Olaf.

While application duration and number of colleges influence regret, a broken

Early Decision contract directly indicates regret, so I also examined which

factors impacted this behavior.

Applying Early Decision implies a high level of commitment (c)

because it is a binding contract which forces the student to disregard all other

options, perhaps causing him to feel regret (R). Using early Decision as the

dependent variable, I ran a logistic regression to determine what type of

student would be more likely to signal this high level of commitment to a

college (see Appendix Table 1). Students with high academic rankings (g)

were less likely to apply Early Decision (see Appendix Figure 1). These

students may be able to afford to keep their options open and do not wish to

tie themselves to one college too early. Conversely, a student without top-tier

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academic qualifications may apply Early Decision to make himself a more

attractive candidate by demonstrating a high level of commitment. In this

way, the student alters his strategic level of commitment to enhance his

quality, hoping to increase the college’s likelihood of accepting him (a*). This

may lead him to signal a higher level of commitment than he actually feels

(f), which could lead to greater regret.

Like applying early decision, starting an application early signals high

commitment (c) to the college. However, a student who starts her application

early will have the application open for a longer duration (d) which may

cause that student to experience more post-decision regret (R). Because

duration is one of the determinants of regret, I ran a linear regression using

duration as the dependent variable to determine which demographic factors

impacted this aspect of the commitment signal (see Appendix Table 2).

Students with higher academic (g) and extracurricular (e) rankings began

their applications earlier and thus had longer application durations. This

supported the intuition in my model that students with good grades approach

the college search more proactively and also provided an additional,

unexpected insight that extracurricular involvement has a similar effect. This

may suggest that students who are more involved either in their studies or in

extracurricular activities take more time to deliberate on the college decision.

They may be more serious about higher education and thus want more time to

consider each option. However, the longer the student allows himself to

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consider his options, the more attached he may become to each one, adding to

his regret when he eventually has to choose a single college.

The number of schools a student applies to (n) also determines how

much post-decision regret (R) he will feel because applying to more colleges

will increase the magnitude of the paradox of choice he experiences. A

majority of students who applied to St. Olaf also applied to six other colleges

(see Appendix Figure 2). I ran a linear regression with number of colleges as

the dependent variable to examine which demographic factors impacted the

number of schools to which a student applied (see Appendix Table 3).

Students who began their St. Olaf application earlier ultimately applied to

more colleges, perhaps because they had more time to consider additional

schools. This suggests that, contrary to my model, duration (d) has a direct

effect on number of colleges and that the two are not separate determinants of

regret. A student who begins his application earlier and thus applies to more

colleges may experience significant post-decision regret because he not only

gives up the combined positive aspects of all the schools he applies to, he also

has more time to think about and become attached to those positive aspects.

However, a longer relationship with one college (d) does not necessarily

cause a student to apply to a larger number of schools. The student may have

started all of her applications on the same day; it may be that students who

tend to start earlier are also the kind of students who apply to many schools

from the beginning, perhaps in response to parental pressure. Nevertheless, a

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student who begins the application process early has more time to apply to

additional schools than a student who waits until the last minute. Even

students who apply to a large number early in the process may use the time

before the deadline to consider and apply to additional schools.

Students who were highly involved in extracurricular activities (e)

also applied to greater numbers of colleges (n), which is the first determinant

of post-decision regret (R). Students with outstanding extracurricular

involvement may rely on that as an indicator of their quality (q), deciding that

a strong commitment signal (c) to one school is less important. A student of

this type probably also values higher education more and thus participates in

the college search more vigorously. Because she has a variety of interests, the

student may research more colleges to determine which ones have the best

extracurricular opportunities, ultimately leading her to apply to more.

However, outside factors may simultaneously influence both extracurricular

involvement and number of colleges to which a student applies. For example,

perhaps families that can afford for their child to be highly involved in

extracurricular activities can also pay for the student to visit and apply to

larger numbers of colleges. Similarly, parents who push their child to excel in

extracurricular activities may also push their child to apply to many colleges.

However, students who are high achievers in extracurricular activities likely

tend to over-achieve in the college search by applying to a larger number of

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colleges, not realizing that this will ultimately increase their post-decision

regret.

While applying to a larger number of colleges (n) and keeping his

application open for a longer duration (d) may cause a student to experience

post decision regret (R), backing out of an Early Decision commitment may

indicate that a student is actually experiencing post-decision regret. This

student has agreed to attend St. Olaf if admitted and has thus already made

her decision. Backing out of the Early Decision contract after being admitted

shows that she has changed her mind about St. Olaf being the best fit for her,

which amounts to regretting her decision to attend. I ran a logistic regression

with backing out as the dependent variable and found that students who

applied to a larger number of colleges were less likely to back out of an Early

Decision agreement (see Appendix Table 4). If backing out signifies regret,

this relationship seems to contradict the hypothesis that applying to more

schools increases regret. However, students who applied to a larger number

of schools were less likely to apply Early Decision in the first place, thus

making it impossible for them to back out. Alternatively, perhaps students

who apply to a larger number of schools ultimately face too much choice and

use an Early Decision commitment to one college to mitigate the paradox of

choice. Scholars will need to conduct more research on the determinants of

backing out to fully understand this relationship.

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The commitment signal (c) a student shows to a college should reflect

his inherent feelings of commitment (f) to that school. However, the college

choice is a strategic decision, so the student chooses a level of commitment

based on how attractive a candidate it makes her (q), hoping to increase her

chances of being accepted (a*). This means that the commitment signal may

not always match the student’s inherent feeling of commitment. The resulting

discrepancy may contribute to post-decision regret (R). The student may

signal very strong commitment by applying early decision, but if she actually

feels a lower level of commitment, she may regret limiting her options.

Conversely, a student may feel attracted to a certain college, but because he

thinks he should keep his options open, he applies to many more schools. As

a result, he signals a lower level of commitment to his top-choice school than

what he actually feels. Furthermore, applying to so many extra colleges

increases the magnitude of the paradox of choice he experiences. Thus, a

student must pick the ideal commitment signal which will maximize his

chances of being accepted but minimize his post-decision regret.

5. Conclusion

Post-decision regret plagues every major decision we make in our

lives. Even when the choice we made confers significant benefit, we may still

wonder what our lives would have been like if we had chosen a different

alternative. In the college decision, this may lead students to feel dissatisfied

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with their choice and, in extreme cases, may cause the student to drop out.

The factors in the college decision that contribute to post-decision regret are

the number of colleges the student applies to and the promptness with which

he starts his application. Applying to more colleges initiates the paradox of

choice and beginning early allows the student more time to become attached

to each of his options. This paper has explored which factors impact these

two determinants of post-decision regret in the college search. College

admissions offices will find this information useful because it grants insight

into the tactics different types of students use when deciding which college to

attend. They may seek to mitigate student regret by encouraging students to

apply to fewer colleges or by requiring stronger commitment signals from

them. This study may also help college admissions officers predict graduation

rates and perfect their enrollment strategies in order to increase the

satisfaction of the student body.

The fact that students experience regret after choosing a college

shows that they have chosen a sub-optimal commitment signal. Changes to

the college search mindset may help students choose commitment signals

which more successfully minimize regret. For example, students could

satisfice instead of maximizing, thereby setting a benchmark of acceptable

characteristics and then ending their search once they have identified a certain

number of colleges with those characteristics. This will reduce the impacts of

the paradox of choice. Admissions officers could discourage students from

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applying to a large number of schools on the grounds that this sends an

unfavorable commitment signal to each college. This would further

incentivize students to satisfice rather than maximize in the college search

and application process, helping them to choose optimal commitment signals

and reducing their post-decision regret.

While this study furthers understanding of students’ decision-making

process in choosing a college, it is limited in scope and allows room for much

future research. The available dataset included only one year of data from one

undergraduate college. To fully understand the relationships between

demographic factors and decision-making strategies, future scholars must

perform more comprehensive studies. While this study examined various

indicators of student commitment, it did not include a very rigorous measure

of regret. Future researchers may find that administering surveys asking

students directly about their feelings of regret may yield clearer results.

Furthermore, while intuition suggests that regret may lead a student to drop

out, exploring this relationship was outside the scope of this study. Future

research should directly examine the link between post-decision regret and

college graduation rates. The college decision is important because it impacts

the student’s future career, salary, values, and relationships. The number of

college graduates impacts the country’s economy and society. Because the

college decision is so crucial, scholars should seek to understand the process

and its outcomes, including post-decision regret.

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6. Appendix

Table 1: Regression on Applying Early Decision

Table 2: Regression on Application Duration

Table 3: Regression on Number of Colleges

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Table 4: Regression on Backing Out of Early Decision

Figure 1: Applying Early Decision by Academic Ranking (g)

Regular DecisionEarly Decision

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Applying Early Decision by Academic Ranking (g)

Figure 2: Histogram of Number of Other Colleges (n)

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800

700

600

500

400

300

200

100

0

Other Colleges

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Histogram of Other Colleges

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7. References

Cabrera, Alberto F. and Steven M. La Nasa. “Understanding the College-

Choice Process.” New Directions for Institutional Research 2000.107

(2000): 5-22.

Giacopelli, Nicole M. et al. “Maximizing as a Predictor of Job Satisfaction

and Performance: A

Tale of Three Scales.” Judgment and Decision Making 8.4 (2013):

448-469.

Iyengar, Sheena S., Rachel E. Wells and Barry Schwartz. “Doing Better but

Feeling Worse: Looking for the “Best” Job Undermines Satisfaction.”

Psychological Science 17.2 (2006): 143-150.

Iyengar, Sheena S. and Mark R. Lepper. “When Choice is Demotivating: Can

One Desire Too Much of a Good Thing?.” Journal of Personality and

Social Psychology 79.6 (2000): 995-1006.

Long, Bridget Terry. “How Have College Decisions Changed over Time? An

Application of the Conditional Logistic Choice Model.” Journal of

Econometrics 121 (2004): 271-296.

Sagi, Adi and Nehemia Friedland. “The Cost of Richness: The Effect of the

Size and Diversity of Decision Sets on Post-Decision Regret.”

Journal of Personality and Social Psychology 93.4 (2007): 515-524.

Schwartz, Barry et al. “Maximizing Versus Satisficing: Happiness Is a Matter

of Choice.” Journal of Personality and Social Psychology 83.5

(2002): 1178-1197.

Tversky, Amos and Eldar Shafir. “Choice Under Conflict: The Dynamics of

Deferred Decision.” Psychological Science 3.6 (1992): 358-361.

U.S. Department of Education. 2013, Digest of Education Statistics

2012.Washington: National Center for Education Statistics,2013.

Web.

Wilkinson, Nick and Matthias Klaes. An Introduction to Behavioral

Economics. London: Palgrave Macmillan, 2012.

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“Argentina: The Justifications for which Argentina Defaulted” - Brian Hickey

Argentina: The Justifications for which Argentina

Defaulted Brian Hickey

1. Abstract

Argentina’s macroeconomic monetary and fiscal policies coupled

with differing political regimes and exposure to financial crises that

reverberated throughout the economy left Argentina to default on it sovereign

debt in 2001. However, it was the confluence of these internal and external

factors that led Argentina to restructure and mend both political and

economic policies. It is my supposition that these effects led to Argentina’s

ultimate insolvency and drift from economic stability.

2. Introduction

What has led Argentina, a once prolific country that experienced

sustained growth and considered to be one of the richest countries in the

world, to default on its external debt seven times and its internal debt five

times since its independence from Spain almost 200 years ago? It is my

supposition that Argentina has defaulted on its debts because of inconsistent

monetary and fiscal policies enacted by differing political regimes,

participating in the Lost Decade of the 1980s in addition to suffering the

effects of the East Asian Crisis of 1998. This paper is structured as an

economic timeline and seeks to identify the primary contributing factors as to

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why Argentina has defaulted three times in the past 64 years and

predominately how it defaulted in 2001. I find that the confluence of these

economic, political and social factors make the Argentine Crisis one of the

most severe emerging market crises in history.

3. Supplementary Theories and Research

Gaining insight into the reasons why Argentina underwent severe

economic challenges and the policies and decisions that are attributed to be at

the crux of that outcome are imperative to understanding and navigating

current crises. In this section, I present two congruent arguments with my

own analysis for why Argentina experienced three defaults in a 64-year

period and most notably why they defaulted on $93 billion in 2001.

In 2005, Paul Blustein wrote a book that argued bankers and brokers,

the lack of fiscal prudence and responsibilities combined with international

regulators lenient oversight were the mechanisms that caused Argentina to

experience defaults in 2001. Blustein sights that bulge bracket investment

banks and brokerage firms had collected $1 billion underwriting Argentine

bonds from 1990 to 2000 and were therefore reluctant to admit the

investment quality and riskiness of these investments to clientele.

Additionally, Blustein notes that the index used to measure money managers’

performance attributed the most weight to highly leveraged countries, which

incentivized irresponsible investments in Argentina.

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Furthermore, the convertibility plan that pegged the peso to the dollar

at a 1:1 exchange rate put Argentina in a straightjacket even though the policy

resulted in economic growth and cured the hyperinflationary period on the

late 80s and early 90s. The strict peg made it difficult to quell the imminent

recession in the late 90s with monetary policy because it was a source of

pride and proved to be an effective mechanism in the early 90s to cure

hyperinflation. The Argentine government faced two differing approaches:

either maintain the 1:1 peg, watch the current account deficit increase and the

economy sink or devalue the currency—something the Argentines were

reluctant to consider. This decision was cataclysmic in Argentina defaulting

on its sovereign debt.

Lastly, Blustein argues that the IMF lacked the backbone to cease

payments and demand restructurings sooner. The IMF agreed to lend

Argentina $14 billion in December of 2000 even though Argentina’s GDP

was shrinking and its debt-to-GDP ratio was climbing. Moreover, there was

severe skepticism that Argentina could not generate sufficient economic

growth to improve its debt-to-GDP ratios, pay off its debts and maintain

fiscal responsibility. More controversial was the IMF’s $8 billion loan in the

summer of 2001 after Argentina conducted a “mega-swap” where old bonds

were replaced with new bonds conditional on a longer time horizon.

However, this enactment increased Argentina’s risk rating and borrowing

costs.

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A second theory emphasizing that a fixed exchange rate creates an

overvalued currency, borrowing in foreign dollars proves to be very risky and

adopting barriers to trade are inefficient are held by economist by Martin

Feldstein. Because the exchange rate was pegged at too high a level,

Argentina exported too little and imported too much. This subsequently made

it improbable for Argentina to earn the foreign exchange it needed to pay the

interest on its foreign debt. Argentina opted to finance these interest

payments by borrowing even more, which exacerbated the situation and

increased debt-to-GDP to 50% by 2001. Had Argentina relinquished the fixed

exchange rate sooner and adopted a floating rate to the dollar that would have

devalued the peso to a more competitive level and stabilized the trade

balance, the default could have been avoided.

Feldstein sites three reasons for why Argentina did not devalue the

peso sooner. First, many bankers and economists involved in the decision

making bodies believed that the abandonment of the peg would bring back

high inflation as experienced in the late 1980s and early 1990s. Secondly,

many businesses and households had accumulated dollar-denominated debt

and were fearful that a discontinuation of the peg and a devaluation of the

peso would cause business bankruptcies and personal defaults. In addition,

policy makers were fearful that a devaluation would affect central and

provincial governments because, they too, had dollar-denominated debt tied

to foreign investors. Lastly, there was some speculation—hope, rather—that

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the dollar might depreciate relative to the yen and European currencies

because of large U.S deficits in 2000 and 2001. This would have made

Argentine products more competitive globally, however, this did not occur.

4. Background

In 1900, Argentina was among the richest nations not only in Latin

America but also in relation to the world. Specifically, from 1900-1960 the

region’s GDP per capita grew as fast as or faster than other countries in

Europe, North America and Asia. However by the mid-1900s, their good

fortune was not to last as the per capita GDP fell behind those of Europe and

North America. The Great Depression in the 1930s caused many countries to

alter economic policies away from export led growth and initiate import

substitution industrialization policies that focused on a mercantilist point of

view. Secondly, many countries borrowed money in the 1970s and

accumulated a lot of debt in 1980s. In 1989, Argentina experienced a decline

in GDP and a sharp increase in inflation resulting in an extreme annual rate of

more than 5000% per year(Feldstein). Policy reforms began to take place

throughout Latin America in the 1980s into the twenty-first century, which

gave countries the opportunity to achieve economic growth and prosperity

once again. Argentina is no exception to the Latin America norm of policy

and decision-making, but was plagued by two severe financial economic

crises and afflicted with poor management from the likes of the president and

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the legislative bodies. Relative to Argentina’s Mercosur partners, the Lost

Decade of the 1980s and the contagion effect of the East Asia Crisis in 1998

coupled by political animosity and social instability, left Argentina vulnerable

and susceptible to financial crises.

5. ISI Policies

Before GDP fell behind those of European and North American

countries, the Great Depression of the 1930s caused Argentina and most

Latin American countries to adopt ISI policies. Countries in this region

predominately relied on exports of agricultural commodities like coffee,

cotton, and fruit in addition to minerals such as copper and tin in order to

generate revenues from foreign countries. In many instances, these sectors

were owned by the state that increased the wealth of a small concentrated

number of people and increased the inequality of the population. As World

War I was fought in 1914 and the Great Depression of the 1930s occurred,

Latin American countries experienced a reduction in the amount of their

exports, which in turn depleted revenues. In contrast, World War II increased

the exports of Latin American countries because the demand for agricultural

commodities and minerals increased as European and North American

countries could not produce these goods domestically. In addition, they

lacked the labor needed to develop these goods as most of the men and

women were fighting in the war. The Great Depression caused Latin

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American countries to focus on internal industrial development by

domestically producing manufactured goods because the market for exported

raw materials was lost as people and companies no longer had the reserves

and capital to purchase exports from abroad.

While ISI policies generated current account surpluses there were

several problems that hinged on adopting the model as well. First,

governments became too involved in economic policy by making decisions

that induced bureaucratic officials who shaped policies in their own self-

interest as opposed to what was best for the national economy. Political

influence had a negative effect on economic efficiency because government

officials prolonged the process of decision-making, as it had to filter through

many channels for the policy to receive the go-ahead. ISI policies were not

completely inefficient but it certainly overestimated the ability of government

officials to correctly diagnose and solve market failures with correct

solutions.

Secondly, problems came about when countries deliberately

overvalued their exchange rates, while others suffered from overvalued rates

by maintaining fixed exchange rates under high inflation conditions. The

decision to keep high exchange rates bolstered relations between the

government and the urban working class as they experienced higher living

standards and access to cheaper foreign imports. However, with these

benefits also came costs. Overvalued exchange rates made it more difficult to

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export domestic goods because the foreign price of the good was higher. This

specifically affected the agricultural and mineral industries that accounted for

the majority of exports in Argentina as this made exports less profitable. As a

result, capital was allocated to other sectors of the economy leaving rural

areas sluggish in growth, which increased the inequality among the urban and

rural populations.

ISI policies also heavily favored some industries over others and

protected them at all costs. Countries even went so far as to develop

monopolies that eliminated competition both domestically and

internationally. Without competition driving prices down to equilibrium

levels, encouraging new innovations, and competing for market share,

monopolies had no incentive to reinvest in new pieces of capital and thus

remained inefficient.

A final inefficiency with the ISI policy is that it encouraged rent-

seeking behavior when trying to gain import licenses and foreign exchange

subsidies (Gerber 367). When the government created something of value,

the private sector jumped at the chance to gain any bit of advantage. In effect,

corruption and bribes became part of the process and only hindered economic

growth as these resources could be allocated elsewhere.

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6. Perón Regime

Perón, the Argentinian President from 1946-1955, utilized ISI policies

and encompassed leadership qualities that can be characterized as

authoritarian and populist. Perón’s macroeconomic model had three

intentions: the expansion of public spending and redistribution, the adaptation

of relative prices, and the shift from production for international markets to

production for internal markets also known as import substitution

industrialization policies (Wylde). Perón’s economic populist political

movement intended to gain support from labor and domestic businesses, rural

elites and foreign interests. His populism ideology hinged on income

redistribution and economic growth; however, a problem arose when the use

of expansionary fiscal and monetary policies lacked the consideration of

budget deficits, inflation risks and foreign exchange restraints.

Perón’s populist regime was prompted by slow growth while policy

decisions rejected the traditional constraints on macroeconomic policy by

printing money to finance the budget deficits. These decisions were justified

because of high unemployment and sluggish factory production. With the

implementation of import substitution industrialization policies, policymakers

restructured the economy by expanding the domestic production of imported

goods decreasing the reliance of foreign exchange, trade and capital. Perón’s

policies were successful and popular not only because Argentina initially

experienced an impressive amount of growth, but also because of the

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redistribution of income and favorable legislation toward worker rights.

Perón’s political popularity lay within his ability to, “redefine the notion of

citizenship within a broader, and ultimately social, context. Citizenship was

not defined in terms of individual rights and relations within political society,

but was redefined in terms of the economic and social realms of civil society.

Citizenship, therefore, was more about social equity than the individual

pursuit of wealth” (Wylde 441). However, his popularity soon began to erode

because his social policy neglected the rural population and the poorest

groups of society. He solely focused on developing the relationship between

the government and the trade unions while the social equity favored and

protected the working class. This further deepened the inequality between the

rural and urban populations. As a result, in 1955 Perón was ousted in a coup

that resulted in a new wave of economic turmoil as a new deal had to be

reached and constructed with the Paris Club, a group of leading creditor

nations, so an immanent default could be avoided.

7. Latin American Debt Crisis

Like most Latin American countries during the 1970s, Argentina took

advantage of loose credit restrictions and accumulated a large amount of debt,

which caused Argentina to discontinue payments on its external debt in 1982

and default on its internal debt in 1989. It would take 10 years before

Argentina emerged from default by issuing Brady Bonds—dollar

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denominated bonds named after U.S Treasury Secretary under the Bush Sr.

administration. The 1970s proved to be an ample opportunity to lend and

borrow money because financial institutions in developed countries were

wealthy and had cash on hand. The rise of oil prices in 1973 and 1974

contributed huge bank deposits of oil rich nations, which is one of the reasons

why banks of developed nations became eager to loan and the reason why

commercial banks aggressively sought new borrowers beginning in 1974.

Over a span of ten years, from 1973-1983, debt in Latin America increased

from $37 billion to $261 billion. Argentina was among the largest indebted

countries registering $43,634 million of debt only behind Brazil, who

accumulated $92,961 million of debt and Mexico, who had amassed $86,081

million of debt. The net external debt as a percentage of GDP in Argentina

was 75.3 percent and the net interest payment as a percentage of exports was

62.8 percent. The latter indicating that 63 percent of the revenue generated by

exports went to pay interest on the debt (Gerber 374). These are staggering

considering this left less than 40 percent of the revenue generated from

exports to be allocated to internal sectors or used for reinvestment.

The initial response of international institutions like the IMF figured

the debt crisis could be characterized as a short term liquidity problem and

the solution lied within the ability to increase capital flows in order to

stimulate economic growth and eventually grow out of the debt they owed.

The U.S first offered the Baker plan, named after U.S Treasury Secretary

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James Baker in 1985, which aimed to organize an altered lending program by

commercial banks. However, commercial banks were skeptical of Latin

American credibility and did not want to allocate more capital and resources

in an investment that they believed already warranted a huge risk with vast

amounts of leverage. Without the addition of foreign capital and investment

into Latin American, countries’ current account deficits continued to increase.

Large trade surpluses would be required to repay the interest and the

principal. In order to fulfill these repayments, countries would have to enact

contractionary policies that would lead to deep recessions throughout the

region. Between the years of 1982 and 1986 the average growth of real per

capita GDP was -1.8 percent per year (Gerber 375). Moreover, Latin

American countries printed money in order to keep government expenditure

high. As long as national expenditure was higher than national income,

countries in the region were not going to escape the debt crisis—a new plan

had to implemented because capital flows into Latin America were not

enough to supersede debt that countries had accumulated.

The Brady Plan, named after the U.S Treasury Secretary during the

Bush administration in 1989 was devised to relieve debt levels. The Brady

Plan created more assistance to the countries by having creditors of

commercial banks increase the debt into longer-term maturities with lower

interest rates in addition to making some new loans. The Brady Plan also

asked that the IMF provide additional loans conditional on the borrowing

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countries to implement systemic economic reform. The IMF would issue

loans in tranches, or installments, to borrowing countries barring completion

of a set of economic reform policies. Borrowing countries agreeing to these

terms essentially enhanced the credibility of their nations by having stable

financial assistance from international institutions.

8. Menem Presidency

President Menem presided over Argentina from 1989-1999 serving

two terms and whose presidency can be characterized as having been

bookmarked by two economic crises. At the onset of his presidency, Menem

dealt with the Latin America debt crisis and at the end of his presidency he

handed Argentina over to President Rúa while the East Asian Crisis affected

Latin America. Menem implemented what is commonly known as the

Neoliberal model that stressed three main reforms: stabilization plans to stop

inflation and control budget deficits, privatize state owned businesses, open

up trade polices and engage in more foreign transactions (Gerber 378). These

reforms were termed the Neoliberal model because it favored free markets

and marginal government intervention. In addition, President Menem, in

1991, made the radical decision to fix the Argentinian peso to the dollar at a

1:1 rate and restricted the creation of new money (Wylde 445). This strategy

made it imperative for the central bank to have a dollar back up every peso in

order to retain the ratio. The peg could have succeeded if the peso became

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competitive enough to increase more exports than imports and whose

proceeds could have been used to facilitate the interest payments on the

outstanding sovereign debt (Feldstein). One concession that should be noted

is how the peg achieved price stability—a goal of the fixed rates from the

very beginning; “to the average Argentine, the convertibility law made the

peso as good as the dollar” (Feldstein). Even though the central bank had

enough dollars to back the pesos in circulation, it did not have enough dollars

to back the amount of pesos in savings and deposit accounts (Feldstein). The

currency board, a government board that strictly regulated the creation of new

money, was there to oversee and enforce the ratio. The currency board

guaranteed that as Argentines converted their pesos to dollars they would

decrease the money supply, causing interest rates to hike up. The rationale

was that there would never be a reason for Argentines to convert all deposit

and saving accounts into dollars. As long as the central bank never ran out of

dollars, the high interest rates would incentivize depositors to hold their

currency in pesos. In addition, high interest rates would weaken domestic

demand, causing wages and prices to fall to a competitive level extinguishing

investor speculation (Feldstein). However, this was more theoretical hope

than it was empirical justified. If the currency board did not hike interest rates

high enough to curb speculation, and if wages and prices did not react

accordingly and fall to competitive levels, then the current account deficit

would remain.

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The currency board worked well throughout the 1990s as they

witnessed low levels of inflation and sustained growth, although problems

arose once again in 1998 when the East Asia crisis occurred and spread to

Latin America. A tipping point emerged when Argentina’s primary trading

partner, Brazil, devalued its currency in 1999 causing Argentine exports to be

more expensive than Brazilian goods and services, giving Brazil an absolute

economic advantage. Brazil’s decision enacted a recession for Argentina

where they experienced a large budget deficit. Furthermore, Argentina’s

international competitiveness decreased when the dollar sharply appreciated

against the yen and other European currencies in 1999 and 2000 after the East

Asian Crisis (Feldstein).

Menem’s first action of President was to attack the severe levels of

inflation. The average inflation rate for Argentina between 1982-1987 was

316 percent; between 1987-1992 the average increased to 447 percent

(Gerber 377). To stop the levels of hyperinflation, Argentina cut government

spending and stopped printing money. However, one question remained: what

was the cause of the initial inflation? Some believed that inflation was

ongoing and was always going to be high, which caused producers to increase

prices in lieu of the inevitable. Others believed it was a result of the debt

crisis and the borrowing habits Argentina pursued. Nevertheless, in 1985 the

Argentine government prescribed the Heterodox model to control for

inflation. Both a Heterodox and Orthodox model cut government spending,

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reform the tax system to increase revenues and cease the printing of new

money. However, the Heterodox model also freezes prices and wages. The

additions of these policies were enforced because inflation was expected to

increase, driving up prices even though government spending and the printing

of money discontinued. The Heterodox plan turned out to be a very short-

term solution as inflation rose even higher after the plan was implemented in

1987-1992. In order to cease the rising inflation once and for all, Menem took

the radical step in fixing the exchange rate to a 1:1 ratio to the U.S dollar

(Wylde 445). This policy combined with the strict creation of new money

created economic growth and low levels of inflation throughout the majority

of the 1990s.

Secondly, Menem enacted structural reform policies such as the

privatization of businesses and firms. Unlike Perón who encouraged

government owned enterprises, Menem discouraged them and favored a

reduction in government intervention. Menem transferred ownership from the

Argentine government to private business in the, “telecommunications sector,

water and sewage, natural gas distribution, electricity generation and

distribution, state firms in the manufacturing sector including steel and

petrochemicals, ports, airports, railways, the postal service, the national

airline, and a number of provincial banks” (Wylde 445). The privatization of

sectors generated vast amounts of revenues that could be used to fund the

deficit and pay down Argentine interest and principal of debt. Furthermore,

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the privatization also created a strong likeable reputation for Menem among

the population considering he had taken the reigns at a time of economic

turmoil.

Furthermore, Menem encouraged the liberalization of trade by

decreasing tariff rates and nontariff barriers, eliminating nearly all import

licensing agreements and quotas while increasing Argentina’s openness to

world markets and competition. In comparison, Chile, in 1985, began the

reforms in their trade policy and soon thereafter other Latin American

countries like Mexico and Bolivia followed suit. By the late 1980s and early

1990s, a majority of Latin American countries reduced both tariff levels and

nontariff barriers. The average tariff rate in 1985 for Argentina was 28% and

by 2007 the average tariff rate was 12% (Gerber 379). Menem decreased the

average tariff rate to 19% in 2001 (Wylde 445). In comparison, Brazil’s

average tariff rate in 1985 was 80% and by 2007 was 12%. In addition,

Chile’s average tariff rate in 1985 was 36% and by 2007 was 6% (Gerber

379).

The main goals of trade reform was to reduce the negative

connotations associated with anti-export trade policies that protected and

favored internal domestic markets over foreign trade. It also aimed to raise

the growth rate of productivity and to make consumers better off by opening

up markets to foreign competition to decrease the cost of goods and services.

After Menem introduced these policies, the openness index—which measures

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a countries affinity to trade—of Argentina and other Latin American

countries increased by significant amounts. The openness index of Argentina

in 1985 was 18 and by 2007 was 45 accounting for a 148.9% change. In

comparison, Brazil’s openness index in 1985 was 19 and by 2007 had

increased to 26, a 35.8 % change. Lastly, Chile’s openness index in 1985 was

54 and by 2007 had increased to 76, a 41.1 % change (Gerber 380). The

decision to break down barriers before their peers proved to be beneficial in

gaining more trade partners, however, because their current account deficits

loomed larger than their immediate bordering countries, Argentina kept tariff

rates a bit higher in order to generate more revenue to fund interest and debt

payments.

Trade reforms encouraged Latin American countries to negotiate

regional trade agreements in an effort to harness potential economic benefit

and help stimulate the region. In 1991, the culmination of negotiations

between Brazil, Uruguay, Paraguay and Argentina ended with the creation on

Mercosur, which stands for Mercado Común del Sur or common market of

the south. A common market implies that the region is a free trade area with a

common external tariff toward nonmembers in addition to the free mobility of

capital and labor across member countries. The regional trade agreement

made the movement of cross-border capital, labor, goods and services more

accessible and promoted greater integration regionally and globally (Jones

60).

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9. The Contagion Effect and Rúa’s Presidency

Despite rebounding from low levels of GDP by implementing

Neoliberal reforms, The East Asian Crisis of 1997-1998 severely affected

Argentina and the surrounding region. The crisis began in Thailand in July of

1997 and spread throughout the region to neighboring countries including

Malaysia, the Philippines, Indonesia, and South Korea. The financial crisis

stemmed from currency speculation, recessions, capital flight and financial

bankruptcies. There are a few rationales as to how the contagion spread as far

as Latin America. One theory suggests that investors became skeptical of

their investments in foreign countries, re-evaluated their holdings and

liquidated their investments. Another theory implies that the Thai devaluation

caused other countries exports to become less competitive so they too

manufactured competitive devaluations—the latter supporting the case of

Argentina. In response to the Thai devaluation, Brazil, Argentina’s main

trading partner, abandoned the peg of the real to the U.S dollar, which

devalued the real making Argentine exports more expensive. The reduction of

export competitiveness coalesced with decreasing prices of Argentine

agricultural exports resulted in a steep reduction in exports causing the

current account deficit to rise and a recession to emerge in the fall of 1998.

In a recession, conventional macroeconomic policy calls for an

increase in the money supply, a reduction in taxes or an increase in

government spending; however, the Argentine government did not want to

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enable any policy that would affect the 1:1 exchange rate. The decision not to

increase spending or cut taxes stemmed from the fear that budget deficits

would loom too large and become unmanageable. In addition, monetary

expansion was out of the question because an influx of pesos in circulation

would undermine the peg to the dollar, creating an unbalanced proportion of

pesos to dollars.

Furthermore, currency devaluation would increase the burden of debt

on firms and businesses that borrowed sums of money during the growth

years of the 1990s to invest in land, labor and capital to grow their

businesses. Devaluation was unattractive because international debts were

measured in dollars and Argentine firms earned revenues in pesos. Therefore,

anything that caused the value of the peso to decline imposed a high price for

repayment because the dollar value of the debt would not change but the

domestic currency would fall (Feliz 84).

At this time, Argentina needed a vocal, assertive, and direct leader but

Rúa failed to exhibit any of the needed characteristics to bring growth and

stability to Argentina. Rúa’s decision making can be illustrated as to, “rely

only on an inner circle of close advisors. The circle was neither efficient nor

trustworthy. It consisted of some members of his family, old friends, and a

few young party members with little influence within the RCU power”

(Llanos 92). The political atmosphere that Rúa walked into was divided and

controversial which made his decision making process all the more

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controversial. The Peronist party had a majority representation in the Senate,

held 14 out of the 24 provinces including the three most urban and influential

cities—Buenos Aires, Santa Fé and Córdoba where 1.9 million workers are

registered—and the Supreme Court making executive decision making all the

more bureaucratic (Llanos 88). At the onset, Rúa had the support of his

constituents as he advocated for government transparency, accountability and

solutions although these objectives would soon be underachieved.

His support began to deteriorate and his popularity dwindled after he

enacted budget cuts that included wage reductions from 8 percent to 20

percent for public employees, military and police forces and members of the

legislative and judicial branches. The Argentine people were caught off guard

to hear this because in public statements Rúa was, “vague and contradictory,

with public statements denying further budget cuts that would nevertheless be

implemented later” (Llanos 89). The Peronist party sensed the popular unrest

with Rúa and deliberately blocked and filibustered finance bills as they

accounted for a majority of the Senate. In 2000, a labor reform law was

passed; however, it was soon discovered that Senators and Congressmen were

bribed. The corruption would induce a protest vote during the 2001

legislative elections where voter participation declined to less than 75 percent

of the electoral roll and blank votes increased from 4.5 percent to 9.4 percent

(Llanos 90).

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Curious as to the where the corruption began, Rúa’s vice president

Álvarez, started asking questions and conducting a bit of reconnaissance of

his own and soon realized that he could not condone the behavior of the

Senate and the president and resigned. This sent a strong message to the

international financial community that increased the risk factor of Argentina

being able to balance its current account deficits, pay its debt and generate

growth.

President de la Rúa had a very difficult and important policy decision

to legislate: either devalue the currency and increase the burden of debt or

maintain the 1:1 exchange rate and watch the current account deficit grow

and the economy sink. In other words, De la Rúa could cut government

spending to spark confidence in the fiscal security of the government or use

expansionary fiscal policy to combat the recession and undermine the

commitment to the 1:1 exchange rate. In summation, de la Rúa could either

ignore the ongoing recession and continue the commitment to the 1:1 ratio or

combat the recession knowing that devaluation of the peso was imminent.

In December of 2000, the IMF stepped in and agreed to allocate

$14,000 million in financial assistance to Argentina (Blustein); however, the

“replacing of the minister of finance twice in the same month indicated the

failure of the government to neither manage the economic crisis or solve the

fiscal problem” (Llanos 94). Cavallo, who replaced López Murphy and

Machinea as the minister of finance, proposed to peg the peso to both one

101


dollar and one euro so as to reinforce monetary stability and fiscal security.

Cavallo contacted the IMF again and asked for more help and direction. The

IMF agreed to help under the condition that Argentina employ a zero deficit

rule implying that they would not spend any money above and beyond what

they earned in tax revenues. The IMF issued $8 billion in additional reserves

(Blustein). Argentines as well as outsiders realized that devaluation was

forthcoming and in an attempt to protect themselves, Argentines liquefied

their assets as soon as possible from local banks. Withdrawals of deposits and

international reserves surmounted $14.5 billion or 17 percent of all bank

deposits (Llanos 96). Rúa quickly froze all bank accounts in an effort not to

lose any more reserves while economists restructured debt payments. The

action to freeze bank accounts justified that the Convertibility Plan—the

policy that pegged the peso to the dollar—was unsustainable and meaningless

because Argentines could no longer freely convert pesos to dollars because

their assets were frozen. After keeping a pulse on the fragility of the situation,

the IMF surmised that Argentina could not meet the demands of their initial

agreement stated in 2000 as Argentina continuously failed to meet the

necessary benchmarks associated with the rescue plan and ceased monetary

aid. As a result, Argentina lost its only and last source of foreign capital and

defaulted on $93 billion of sovereign debt in December of 2001. When the

banks reopened in January of 2002, the peso lost as much as three-quarters of

its value where ultimately 3.4 pesos were equal to one dollar (World Bank).

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10. Conclusion

In this article, I examined the validity of two arguments that stressed

the 2001 Argentine default resulted from irresponsible fiscal and monetary

policy, banker and broker malfeasance exacerbated by the IMF’s inability to

cap the situation. These arguments supplement the belief that Argentina was

also affected by poor political guidance, differing political regimes,

participating in the Lost Decade and experiencing the reverberations of the

East Asian Crisis. The convertibility plan proved to be effective before it

created more problems than it solved. Having circumvented the inflationary

period of the late 1980s and early 1990s, the fixed peg to the dollar was a

policy backed by pride and fiercely protected. Decision makers were

concerned that because many households, businesses and provinces had

dollar-denominated debt, devaluation would bankrupt a majority of the 35

million citizens living in Argentina. In addition, the creditors of this

sovereign debt were reluctant to reveal the riskiness of Argentine debt to

investors because they had accumulated lucrative fees from issuing Argentine

bonds. Creditors were acting in their own self-interest, as they were more

interested in receiving the lucrative fees that became synonymous with bond

traders than divulging accurate ratings to clients. Lastly, the IMF clung too

long to the notion that the convertibility plan was a viable strategic policy that

could assist Argentina in becoming solvent. The central bank lacked

sufficient dollars to match every peso in Argentine deposit and saving

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accounts. Furthermore, interest rates were not high enough to incentivize

depositors to hold pesos, causing wages and prices to remain high, making

the peso uncompetitive and not sufficiently extinguishing the belief that the

peso was overvalued. The IMF was reluctant to cease assistance because

Argentina had adopted Neoliberal policies, increased openness metrics and

adopted many of the Washington Consensus ideals, which blinded the IMF in

thinking that they could avoid insolvency. Argentina was reactive as opposed

to proactive. If Argentina had made the collective decision to leave the fixed

exchange rate and exercise a floating rate, the peso would have fallen making

exports more competitive internationally. They then could have used the

proceeds to fund interest payments and start to deplete the rising current

account deficit. The confluences of these economic, political and social

dynamics illustrate how and why Argentina defaulted on its debt in 2001 and

three times in the last 64 years.

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Omicron Delta Epsilon

St. Olaf College: Beta Chapter

Class of 2016 Amanda Bauer

Joe Briesemeister

John Bruer

Shelby Goudey

Maija Johansen

Zequn Li

Brian Klein

Chloe Mitchell

Alec Paulson

Abigail Schnaith

Simon Scholten

Mara Stutzman

Priyanka Subramanian

Heather Wolf

Class of 2017 Alexander Aristides

Erik Berthelsen

Elliot Knuths

Katherine Kroening

Matthew Lasnier

Evan Lebo

Kelsey Myers

107

Omicron Delta Epsilon Journal of Economic Research

St. Olaf College: Beta Chapter

Executive Editor Joe Briesemeister

Associate Editor Kelsey Myers

Class of 2015 Distinction Recipients Sara Anderson

Alex Everhart

Brian Hickey

Audrey Kidwell

Camille Morley

David Skandera

Erik Springer

Timothy Tuscher

Omicron Delta EpsilonDepartment of Economics

Saint Olaf CollegeNorthfield, MN

Original Cover Design by Megan Reishus ‘09

Senior Distinction Papers: Class of 2015 · Africa, Egypt, France, ... as most efficient firms...

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Transcript of Senior Distinction Papers: Class of 2015 · Africa, Egypt, France, ... as most efficient firms...