Report

Teaser, summary, work performed and final results

Periodic Reporting for period 1 - FORENSICS (Illicit Markets, Unobserved Competitors, and Illegal Behavior)

Teaser

\"Many markets are characterized by unobserved behavior by agents. This can take the form of unobserved consumer behavior, for example the purchase of illicit products; unobserved firm behavior, such as illegal use of otherwise legal instruments (e.g., predation); or...

Summary

\"Many markets are characterized by unobserved behavior by agents. This can take the form of unobserved consumer behavior, for example the purchase of illicit products; unobserved firm behavior, such as illegal use of otherwise legal instruments (e.g., predation); or unobserved market agents, as in competition in markets with counterfeit producers. To the extent that the empirical economic framework does not incorporate these unobserved actions or control for them in estimation, the resulting models are likely to be mis-specified. Naturally, if the models do not contain all elements relevant for decision making, then predictions based on the estimates will be misleading, which could result in incorrect policy recommendations.

This project directly addresses three situations (themes) in which unobserved behavior plays a crucial role. It does so by (i) developing state-of-the-art empirical models that incorporate illicit behaviors and (ii) proposing novel estimation methods that can be used to detect illicit behavior. In this sense, the methodologies put forward are \"\"forensic\"\" in nature as they deal with uncovering illicit or illegal behavior.

The first theme concerns markets where consumers engage in illicit behavior. These markets are prevalent in society as they constitute the market for illegal drugs, which is estimated at more than $300 billion per year (UN, 2012). Marijuana is the world\'s most widely used illicit substance (ONDCP, 2004) with vocal advocates for legalization. Indeed this drug is now moving into the legal category at a rapid rate in many places in the world. Among other things, legalization makes the drug easier to find. In previous work (Jacobi and Sovinsky, 2016 (JS)) we found that selection into having access to illicit drugs is not random across consumers. JS show that if selection into access is not controlled for in estimation then demand estimates of the impact of legalization are biased resulting in incorrect policy conclusions. In this theme we consider the impact of legalization in a larger context by expanding the framework, in a non-trivial but crucial way, to incorporate the impact on licit and other illicit products. We also propose a novel way to control for unobserved prices, which is crucial for measuring price sensitivity. Substitutability between illicit and licit products is valuable information for policy makers, as is the extent to which users respond to prices, for these together will allow the authorities to gauge how, for example, an increase in marijuana taxes today will impact use across a portfolio of products in the future, which has both revenue and health implications.

The second theme concerns markets where firms must make strategic decisions in the presence of an unidentified competitor - a counterfeiter. According to the Organization for Economic Cooperation and Development (OECD) the global value of counterfeit products rivals that of illegal drugs, at more than $250 billion per year (OECD, 2007).
Many empirical models assume that firms observe (at least some) characteristics of their rivals. However, there are a number of markets where firms possess little information about their potential competitors. These are markets with counterfeit products, which are large and growing. To further complicate matters, consumers may be unaware that they have purchased a counterfeit. The impact of counterfeits on product development and consumer choice, as well as its relationship to enforcement of intellectual property rights is understudied. The objective of this theme is to learn how firms react to counterfeits and how this interacts with consumer choice. This information will enable policy makers to identify areas in which legislative intervention may be warranted and others in which firms are capable of coping with counterfeiters.

The third theme examines the impact of firms using legal tools for illegal purposes, for which the economic value is difficult to measur\"

Work performed

\"Below I summarize the work plan laid out in the proposal together with a description of what I have done during this first reporting period.

The papers in the first theme are joint with Liana Jacobi (University of Melbourne). These projects required data preparing, more development of the estimation procedure, programming, analysing, and writing. This theme involves a few papers each involving significant programming so I noted that I would devote time in all years of the grant to this theme. Since the receipt of the grant we have made substantial progress on the first main paper in this theme, which is now a working paper titled \"\"Legally High? Access, Dynamics and Complementarities among Sin Goods.\"\" Alessandra Allocca is a PHD student at Mannheim who was hired through this grant to clean the data. Her work was excellent so we decided to add her as a coauthor. I have visited the University of Melbourne twice to work with Liana and she has visited me as well. Liana presented the paper at the Australasian workshop on econometrics and health economics; I have upcoming presentations at the MaCCi/ZEW IO day and at the MaCCI Summer Institute.

The second subproject in this theme concerned how to control for unobserved prices in illegal markets. I have one paper that is forthcoming on this topic titled “Forensic Econometrics: Demand Estimation when Data are Missing” which is joint with Julian Hidalgo (KU Leuven). In addition, we have completed another paper regarding missing data (in this case missing data on market size). This working paper is titled “Internet (Power) to the People: The Impact of Demand-side Subsidies in Colombia.” We have presented this paper at Banco de la República in Colombia), EARIE (Athens), Universidade NOVA de Lisboa, University of Vienna, and at the MaCCI Summer Institute. We plan to submit it to a journal within the next reporting period. The projects in this theme are on track as laid out in the proposal.

The second theme is joint with Andreas Guenster (ETH) and Stefan Bechtold (ETH). With the help of a research assistant hired on this grant we have made progress on cleaning the data and putting together preliminary results. The projects in this theme are on track as laid out in the proposal.

The projects in third theme are joint with Alon Eizenberg (Hebrew University) and Andras Pechy (University of Zurich). As indicated in the proposal, we completed the first paper. It is titled “Exclusionary Restrictions and Technology Adoption: Interrelated and Dynamic Effects.” I have visited Hebrew University to work with Alon on finishing up the paper and discussing the next project in this theme. We have presented this paper at multiple workshops and seminars and are planning to submit to a journal. The projects in this theme are on track as laid out in the proposal.

I have also completed a paper that was not foreseen in the grant but that involves the nature of my project as it describes unintended consequences of firm behavior regarding advertising (thus is relates to theme 3). This paper is titled “Advertising as a Major Source of Human Dissatisfaction: Cross-National Evidence on One Million Europeans“ (with C. Michel, E. Pronto, and A. Oswald) and is forthcoming in a book titled The Economics of Happiness.
\"

Final results

\"The previous subsection details the progress that I have made on this project as it relates to the timeline. I provide a bit of detail on a few papers to highlight the advances made over the literature to date.

The paper \"\"Legally High? Access, Dynamics and Complementarities among Sin Goods\"\" (with Alessandra Allocca and Liana Jacobi) estimates a dynamic structural demand models for illicit goods that incorporate product substitution and correct for selection into access. To determine the impact of legalization on tax revenues and health outcomes, our approach allows for i) substitution of marijuana with alcohol and tobacco, ii) addictive components, iii) and potential accessibility issues for products that remain illegal. Each of these additions is beyond state of the art. Our results will inform the policy debate on the the long-run impact of legalization on use and tax revenues.

In two other papers, “Forensic Econometrics: Demand Estimation when Data are Missing” (with Julian Hidalgo) and “Internet (Power) to the People: The Impact of Demand-side Subsidies in Colombia” (with Julian Hidalgo) we propose a novel way to control for unobserved prices as well as market size. Both of these additions are beyond state of the art and are crucial for obtaining correct measures of price sensitivity. This is again critical to obtain correct policy evaluations.

Regarding the expected results, the following papers have been produced during the first reporting period. I expect to publish these and additional papers generated in the final 3 years of the grant by the end of the project period.

\"\"Legally High? Access, Dynamics and Complementarities among Sin Goods.\"\" (with Alessandra Allocca and Liana Jacobi), Working Paper.
“Forensic Econometrics: Demand Estimation when Data are Missing” (with Julian Hidalgo) forthcoming Japanese Economic Review.
“Internet (Power) to the People: The Impact of Demand-side Subsidies in Colombia” (with Julian Hidalgo), Working Paper.
“Exclusionary Restrictions and Technology Adoption: Interrelated and Dynamic Effects.” (with Alon Eizenberg and Andras Pechy), Working Paper.
“Advertising as a Major Source of Human Dissatisfaction: Cross-National Evidence on One Million Europeans“ (with C. Michel, E. Pronto, and A. Oswald) Forthcoming, Chapter 10 in The Economics of Happiness, Editors Springer Nature Switzerland AG. DOI: 10.1007/978-3-030-15835-4_10
\"

Website & more info

More info: https://www.vwl.uni-mannheim.de/sovinsky/.