|OLITICIANS around the world love to promise better educa tion systems. Proposals for reform come in many flavours. ‘Some tout the benefits of more competition among schools; oth- ‘ers im to train more teachers and reduce class sizes. till others plump for elaborate afterschool programmes or for linking teachers'pay tohow wel pupils do. ‘Atelatively recent adehtion to this menu isthe idea of paying students directly for performance. Boosters argue that pupils ‘may filo invest enough time and effort into education because the gains~better jobs and higher incomes~are nebulous and dis: tant, Cash payments, on the other hand, reward good perfor: ‘mance immediately. Link payments to test results or graduation rates, the argument goes, and test scores should increase and ‘drop out rates decline. Two new papers’ describe the effect of ‘such schemesin israel and America. Their results will disappoint those who hope fora silver bullet, But they also suggest that cash ‘payments may have their uses in some situations. “Joshua Angrist of the Massachusets Insitute of Technology and Victor Lavy of the Hebrew University in Jerusalem studied high-school studentsin 4o Israel schools where few pupils went ‘on to get their schooLTeaving certificate (the Bagrud. tn half the schools students were offered a chance to earn nearly $1,450 if they passed all the tests and got the certificate. The economists found that completion rates in “payment schools” increased by abouta third~but only for gis and mainly forthose whoneeded todo only atiny bitmore to graduate. ‘in America Roland Fryer of Harvard University carried outan ambitious set of experiments involving 38,000 students who ‘went to state-run schools in New York, Chicago, Dallas and ‘Washington, Dc. Over four fifths were ftom poor families:nearly 90% were black or Hispanic, These ae the schools thatreformers in America most urgently need to fix. Students in inner-city schools do particularly poorly in national tests. Less than 20% of ‘their &th-graders(914-year-olds) have better-than-basic reading skis for their age. The national averages 29%. In each city about half the participating schools were ran~ domly selected to be ones where students received money; their ‘progress was then compared with that oftheir peersin the other schools. Pupilsin New York and Chicago were paid fortestscores ‘or grades, The children in Dallas and Washington, pc, were paid for specific tasks, ike reading books or wearing uniforms. ‘The results ofthe experiments where scholastic performance was rewarded were uniformly disappointing. In New York fourth: and seventh-grade students in payment schools could ‘earn up to $25 and $50 respectively, depending on their score on, teach of ten standard maths and reading tess. In Chicago ninth: grade students were rewarded on a sliding scale for good grades, in ive courses, including English, maths and science. Getting an “a was worth $50; a "b" meant no money. In theory a student could earn up to$2,000 year. Plenty of money was paid out, but Mr Fryer found absolutely no evidence that paying students led them to doetter than their peersin the control schools. Neither girls nor boys gained, and t did not seem to matter how students had previously performed. ‘What explains this disappointing result? Some argue that the ‘external push provided by money erodes an inherent love of learning. But participating studentsalso tooktests that measured ‘how mulch they enjoyed studying. There was no indication that, ‘the payments affected those sentiments. Nor was it the case that, students were uninterested inthe programme. (Mr Fryer has a different explanation. Most would agree that school facilites, teachers’ skills, and the effort both students and teachers putin all matter. But how precisely these inputs are con- verted into a test score isa mystery and without knowing which lever to pull itis dificult to design an effective incentive scheme. Butleaving it upto participant to find the best way to earn goo: dies will not work eltherif, as Mr Fryer believes, pupilshave very litle idea how to go about improving their own scores. Grade expectations When students in New York or Chicago were asked how they ‘would eam the rewards on offer, they came up with all sorts of ideas about test taking strategies, but not one mentioned reading the textbooks or doing practice questions. On the other hand, those whose performance improved in the Israell experiment hhad clear ideas about how to go about making sure they graduat ed. They took more practice tests and were much more likely to attend free coaching sessions. If students do not know how to improve their own perfor- ‘mance, the best strategy may be to pick asimple task, reward pu- pilsfor doing i, and hope that this translates into higher grades. ‘This was the approach Mr Fryer took in Dallas, where second: grade students were simply given $2 for every book they read if ‘they passed a computerised comprehension test on i. Predict: ably this spurred them to read more books and improved their ‘vocabularies, But it also improved their school grades substan: tially although thisisnot whatthey were paidfor.A yearafterthe payments had stopped, students inthe schools that had offered. ‘money were still outperforming those in control schools, al~ ‘though the gap had narrowed. Itmay have helped thatthe Dallas, students were younger. Middie-school students in Washington, 'bo, gained litte from being paid for inputs like attendance, But ‘the results from Dallas suggest that payments can help atleast, somestudents getmore outof school. “The ects of gh tales gh Scho tnd ior tay Frtenming in tbe Anton Ecromi Rein, "ancl nts sn ter eben by Rn 6 yeu, NBER Working ape 8996, Api 20.Rai as ironore swap deal with CreditSusse. ‘Along with Deutsche Bank, the Swiss bank vasa plonerof iron ore derivatives, launching the commodity’ fist overthe- counter csheted wapein May 2008 theexpectaion thatthe benchmark would {0 Derivatives teding could account for fomtonnes of ore some 7 oftheintema- tionally traded market bythe end of 2000 Cecit Suse rectons that fron oe fo} Towsthe same paths coal, which was un Buttonwood | hacked from # Semin spateso some ai narpcarpamees col isd Sal Dua ‘gan Stanley isnow offering swaps. Brokers such as 1cAP and Freight Investor Services are piling in, too. On July auth Chicago- based ome, the world'sbiggest derivatives ‘exchange, will join .cH.Clearnet in Lor don, Singapore’Exchange and New York's IntercontinentalExchange in offering cleared iron-ore swaps. But for the market to takeoff in earnest steelmakers,a conservative bunch, needto be convinced of their usefulness. When ‘Equities are stil suffering froma valuation hangover [isis beta gies buy shares and hold ont them. That wat ‘helessonhammeredintotheheadsof in ‘estors nthe 9908 when the “elt of the ety” as ats peak. Unfortunately, they absorbed the message at precisely thewrongtime. The past decade has been disastrous for equities. Over the ten yeas to June s8th 010 investors in developed-maret equities earned a cumulative total return of minus 79% By contrast medium dated “reasury bonds rtumed 953% and high- yield American bonds soa2%. Richard Cookson, the chiet investment officer at ‘it Prvate Bank (and a former journalist at TheEsonomis),pointsout thatthe cur ulative outperformance of high-yield bonds overequitiesdatesbackto199. 't fs lance this seems rather od Bondholders have fist claim onthe cor. porate sectors cashlow and. share- holders take whatis let In theoryshare- holders should ear the best ems over the longterm provided profits keep grow ing. After slimping in 2008 profs have recently rebounded and, in the case of America, are close to a post-war high as a. proportion of ope. Even if prois had been terrible, owners of high-yield bonds ‘wouldhavesufferedtoo because of alike: Jyjump in corporate defaults. ‘The answerto the conundrum is vah- ation. As the cul of equity gained more and more adherents in the9908 share prices were bit stratospheric levels.n the best longterm measure, Robert Shiller's cyclically adjusted price-earn- ings ratio which averages profs over ten years valuationsinz999 were more than third higher than ther previous peak, just before the great crash of 1929. eas a nie ion. Investors bought shares be- cause they desired high returns but their tnthusiasm pushed prices to aleve rom ‘which high returns became impossible. ‘Exactly thesame thing happened in the ‘American housing matket. A naive belief thathouse prices could neverfall atthe na- tional level encouraged excessive specula- tion and laxlending, thereby precipitating aneventual collapse, It's tempting to assume that because ‘equities have performed so badly over the past decade, they must be a sure thing to pperform well over the next ten years. But ‘that argument failed in Japan By the time the market there peaked in the late 980s, historic price-earnings ratios were in the 50-200 range. Western valuation measures, sceptics were told, were irrelevant in the ‘Tokyo market. The result of that bubble ‘was a bear market tha is already into its third decade, ‘Wall Street never quite matched To- skyo's valuation excesses. Nevertheless, a- ‘though the cyclically adjusted ratio has fallen from a heady 44 in 1999, itis still around2o, level well above the historical average of1.S0 future returns are likely to ‘belowerthan the previousnorm. ‘A higher‘than-average valuation. im- plies that investors expect better-than-av- SS TTT ee er ess came from ivestors SUGH a8 PTE Rusia: reunite Sha ere Joolung ir epost ‘were not traded on exchanges. Big trading hhouses also use derivatives to manage risk ina business where margins are slender. ThyssenKrupp, one of Europe's biggest steelmakers, said in April that it was con sidering using derivatives. Japanese and ‘Chinese mills may soon take the plunge. A recent threat by Rio Tint that it could give ‘up quarterly pricing and eave steelmakers at the mercy ofthe spot market may per suade them tolose theirinhibtions. m erage profits growth. But this week’s equ: ity-market wobbles illustrate that {investors are unconvinced that the global economy can manage a v-shaped recov- ery, especially now that fiscal stimulus is being withdrawn in Europe and else- where. The commitment to continued ‘monetary stimulus, in the form of near- ero interest rates, is @ double-edged sword. It may drive investors out of cash in earch of higher returns butit also indi- cates how anxious central banks contin- tuetobe about the economic outlook. Despite these worries, there may still be some segments of the stockmarket that perform well. According to Dhaval Joshi. of nam Capital, pharmaceutical firms’ dividends have grown at an aver age of 12% a year over the past 40 years, five percentage points above general divir ddend growth rates and eight percentage points above inflation. Total dividend in- ‘come from the industry has fallen very rarely, even in recessions. That remark- able performance reflects ising share of health-care spending within Gb, partic- ularly in America, where a wealthier and agreying population places ahigh valueon accesso health care, Pharmaceutical shares have under- performed the global market this year. ‘The industry's giants trade on a discount: ed price-earnings multiple, reflecting fears that the days of blockbuster drugs are over, Globally the sector yields 3% higher than the yield on inflation linked ‘Treasury bonds, despite its history of of fering teal income growth. Reliable sources of dividend income are becom: ing searce (shareholders were let down firstby the banks, then by xP).So itis sur- prising that pharmaceutical socks are so lite cherished. ‘omit com ops/butonwoed