Saturday, August 29, 2015

A New Book on the Risks Caused by Climate Change

The Risky Business Project is not a Tom Cruise vehicle.  Instead, it is a group of talented people who are deeply worried about the consequences that climate change will pose. This group has now released a new book.  Here is its Amazon webpage.    The authors provide a real service highlighting the challenges we are likely to face if we take no actions to protect ourselves from the serious threat of climate change.

In this sense, the authors provide a blueprint for how entrepreneurs can make money by developing new products (whether they are electric vehicles, floating homes, well functioning air conditioners, Apps that highlight emerging threats) that will help us to adapt.

This type of project implicitly assumes that people form myopic expectations of the future and that they expect that "tomorrow will be like yesterday". In such a "Homer Simpson" world, then the Risky Business Project is important because it hopes to "wake people up".    Such a project is a pinch elitist as it implicitly assumes that most people are idiots who are unaware of the risks we face while only a few "enlightened individuals" recognize the upcoming risks.

But, are we Homer?

In my more nuanced model of people, we are a mixture of types of people.  We are probably 5% Mr. Spocks and 40% Homer Simpsons and 55% distracted suburbanites who recognize that climate change is a challenge but have other short term worries.  In such a setting, climate change won't be a major focus of attention but don't forget the 5% Mr. Spocks. Elon Musk is one of them. This group through their venture capital and entrepreneurial spirit will build the next generation of products that will allow your kids to continue to prosper in tomorrow's cities.   Crisis creates opportunity and capitalism (just as it gave you your cell phone) will create the products you need to adapt to our hotter future.  This is free market adaptation.

Since the Risky Business Project seeks to shift the political equilibrium it must convince the median voter to get active but the 5% of Spocks are already thinking about how to make money and to invest to make more money in our hotter future.Since ideas are public goods, their entrepreneurship will broadly benefit all of us.

For some specific readings on this subject, read my NBER paper:

While this blog post has focused on how entrepreneurs respond to future anticipated business opportunities, but risk averse people will see out short run self protection measures to reduce their risk exposure.   Read my air pollution mask paper set in China today. This paper provides a simple credible story of investments households will make to protect themselves. Such adaptation isn't costless but it is much cheaper than what the doom and gloomers claim it is.

Imitation and the Diffusion of Good Management Techniques

Social learning is an important and interesting research and policy subject.  Suppose a big city mayor implements road pricing to mitigate the traffic congestion externality. Once this policy succeeds, do other mayors notice?  Does this success story nudge the other mayors to imitate the first mayor and introduce this pareto improving policy?  Or, do the other mayors convince themselves that you can't extrapolate from the first success story to predict that the same policy would succeed in another city?  
This example highlights the issue of "imitation and diffusion".   For a well known example of this phenomenon in development economics, read Conley and Udry's paper on Pineapples.

Here is their abstract


This paper investigates the role of social learning in the diffusion of a new agricultural technology in a developing country: Ghana. We use unique data on farmers’ communication patterns to define each individual’s information neighborhood, the set of others from whom he might learn. Our empirical strategy is to test whether farmers change their input decisions to align with those of their neighbors who were successful in previous periods. We present evidence that farmers adopt successful neighbors’ practices, conditional on many potentially confounding factors including the physical proximity of plots, credit arrangements, clan membership, and soil characteristics.  

Now let's turn to today's WSJ.   Ohio State has a prominent football coach named Urban Meyer. The point of this article  is that his past assistant coaches are exporting his ways to the new teams that they now coach.  The new coach of the University of Houston is a dude named Tom Herman and he is taking many of the motivational ideas he learned from Coach Meyer and transplanting them.

Economists like this narrative very much because "good management techniques" are public goods.  Such ideas can be broadly adopted leading to a more efficient use of scarce inputs in production.

But, imitation requires modesty on the part of the imitator. She must be humble enough to recognize that she knows that "doesn't know" the right way to proceed in achieving her goals and thus be willing to borrow from others.  In an economy where there is plenty we need to learn, the dangerous man is one who "doesn't know that he does not know" how to proceed.  

Humility is a key personality trait for adapting to a changing environment.  

Friday, August 28, 2015

A Career in Economics?

The AEA has posted a new 8 minute video making the case that a career in economics is both intellectually challenging and perhaps offers the prospect of having a job.  You can watch it here. 

A few thoughts;

1.  Unintended Consequences --- you don't have to be Sam Peltzman to recognize that almost all government policies have unintended consequences.   Since microeconomists can model substitution effects we are the right people to anticipate such consequences before well intended policies are implemented.

2. Big Data --- Economics offers better applied data analysis skills than any other field. Our courses are not watered down. They don't spend a lot of time "motivating" material. Instead, the professors get down to business explaining how to do applied econometrics for answering both "reduced form" and "structural" questions.  It is no accident that some of the best applied researchers such as Pat Bajari are such major stars at billion dollar companies such as Amazon.

3. Good Public Policy --- See point #1 above. Many young people are passionate about public policy. Well, what is "good" public policy?  After you start to think about Arrow's Impossibility Theorem and you think about Hicksian Pareto Improvements, you immediately see that economics is crucial here.  Example; How much would Los Angeles gain from introducing road pricing?  Given that the answer is huge, why hasn't LA already adopted this policy?  There is much to be done researching  urban political economy.  Researchers who are able and willing to implement field experiments live an exciting life as they actually can identify potentially valuable policies by piloting them to test if they are effective.  Policies that appear to be effective can then be scaled up.

4. Only Nixon can go to China (source)   -- What do I mean?    Economists have credibility (relative to other academics) because we have earned it through the rigor of our training and because our subject is transparent. Other researchers can (and should) replicate one's findings.  This potential for having one's work debunked through a failure to replicate creates strong incentives to get things right.

5.  Economics merges math, stats, and social science ----  Researchers such as Acemoglu and Glaeser have a wide toolkit that spans history, stats, basic math, econ and political science.  The ability to see the connections between fields is both exciting and really pays off.  By highlighting the synergies across fields, economics represents "Liberal Arts" at its best. No we don't spend any time discussing Plato but we get down to business and the profession rewards the Reese's Peanut Butter Cup!  (recall that company is built on the synergy between salt, chocolate and peanut butter).

6.  While economists differ with respect to their political ideologies, we are more transparent about how such a worldview influences how we cook our cakes.   Two examples;

A macro economist who introduces frictions into her model is likely to find that the equilibrium is not a pareto optimum and Chicago guys such as me will scratch our heads but this then starts an honest discussion of why the frictions exist and whether capitalist entrepreneurs are taking any steps (because of the profit they could earn) to shrink these frictions. A real world example are internet websites that match workers to jobs (Monster?)  such innovations chip away at Diamond-Pissaderedes-Mortensen style search models as the matching converges to a Walrasian equilibrium.

A micro economist who seeks to "prove" that raising the minimum wage does not cause unemployment must be transparent about his econometric model and about the sources of variation that identify the model. If a city raises its minimum wage during a boom, the city may experience a reduction in its unemployment rate (not because the new law achieved this but because during a boom a leader can get away with inefficient policies).  Basic econometrics would allow the researcher to disentangle these various effects.

These two examples highlight that economists are more honest than scholars from other fields concerning our "biases". We are more explicit about our modeling assumptions and you can't hide when you write down your math.  Other fields use "big words" that mask what they are really saying as they write using code words.

Thursday, August 27, 2015

REPEC Fantasy Econ Departments Transactions: I Couldn't Sell Thomas Piketty

For a finite price, I tried to sell Thomas Piketty but I can't find a buyer.  Economists of the world sign up for REPEC Fantasy Economics. 

Matthew Edwin Kahn's IDEAS fantasy league portal

To dismiss the dated system messages, either make a change to your roster 

  1. 2015-08-25 13:32:02: You sold Marianne Baxter for 5. Congratulations!
  2. 2015-08-25 13:32:02: You sold Laurence Ball for 25. Congratulations!
  3. 2015-08-25 13:32:02: János Kornai's auction has expired and attracted no bid.
  4. 2015-08-25 13:42:02: Thomas Piketty's auction has expired and attracted no bid.
Don't read too much into my valuation of economists from my bidding strategy. These were my first four attempts at trading and I didn't know what I was doing.

According to the rankings , My team (Diesel) is ranked #29 and I'm in the 74th percentile.

My roster includes;  Franklin Allen, Alesina, David Canning, Charlie Kolstad, Piketty, Kornai,  Diebold, Jovanovic, and Lynn Zucker.

I offered to pay 12 units to purchase myself but I have not been allocated to any team yet and thus can't be sold.  I am sitting on 135 units of capital that I can use to purchase players.

First Impressions

USC's fall semester has just started and I have already taught for 4 hours, met with students and colleagues, attended lunches, seminars and cracked jokes and tried to teach the power of price theory applied to environmental and urban topics.   My undergraduate class has an enrollment of 24 students and USC has been kind enough to assign me a high quality TA who has already double checked my algebra for our first calculus based homework assignment.   The Department has already agreed to pay for my student lunches with my students.  This is a different experience than what I have been used to when I taught at that other Los Angeles university.

In a small classroom of 24 students, I can watch the whole room. I know who is paying attention and who is sleeping --- I know exactly what is going and this real time feedback is quite useful.  Like a quarterback in football who calls an audible if he doesn't like the defense he sees, I change gears and talk about new things if I sense that the room is bored.  

USC's Economics Department is small in terms of the count of faculty but it is a very high quality group of scholars.  The U.S REPEC rank for USC Econ (throwing out 2 business school departments) is #27 and that is not its steady state.   I predict it will be top 20 in 5 years and top 15 in 12 to 15 years.   USC takes great pride with respect to its professional schools and there are very strong economists at the Price School and Marshall School (such as Dana Goldman's health group).

Tuesday, August 25, 2015

Will China Transition to "Higher Quality" Growth?

Eduardo Porter makes some bold predictions in today's NY Times.  He writes;   "A totalitarian regime may be good at deploying capital and labor to deliver raw economic growth. Yet autocracies are not good at fostering innovation and creativity, which rarely flourish where there is no freedom of thought or speech. While “make the economy grow and don’t have demonstrations” might have worked in the past, a bureaucratic command and control structure will have a hard time handling the more complex demands of citizens in countries that reach middle-income status."

I believe that Mr. Porter underestimates the short term potential for innovation and creativity from young, educated and internationally savvy Chinese urbanites.    Walk UCLA's and USC's campuses and you will see many Chinese students. These students are not in Los Angeles simply to memorize and bring home everything they have seen and photographed. Instead, I believe that a more complex learning process is taking place.  China's leading universities are becoming more serious as more and more of their faculty are trained by leading Western Universities.  Even scholars who have done their graduate work in China have spent at least a year in the U.S learning our intellectual approach to research.

How will this diffusion of ideas affect China's medium term growth? Mr. Porter appears to believe that the Chinese government "controls" the economy.  Of course, the government influences the economy but the ultimate wealth of nations (both in the United States and China) is created based on human capital.  China's cities are transitioning from heavy industry to the mind and this will mean that "blue skies" will become a productive input in helping China to grow.

This was a key theme of my 2013 Journal of Economic Literature paper (joint with Siqi Zheng) and our forthcoming 2016 Princeton University Press book.

The NY Times should be honest and simply state that it wants a bloodless revolution to take place in China.  How much richer would China be in the long run if this occurs?  Daron Acemoglu and his co-authors continue to study the causal link between democracy and income.  

Returning to China's nascent entrepreneurship, take a look at this. Do you smell a future Uber or Snapchat?  This is the tip of the iceberg.

Monday, August 24, 2015

The Consequences of Durable Housing: Evidence from Tokyo's Suburbs

Back in 2005, Ed Glaeser and Joe Gyourko published an important paper on the asymmetric implications of durable housing.  Detroit was their favorite example. During the 1950s as the car industry boomed in Detroit, developers built houses that could last for 75 years. Flash forward to the 1980s and the jobs were gone but the houses were still there. From basic supply and demand, the price of these homes plummeted and Detroit became a poverty magnet in part because it had so much low quality housing.  This process fed on itself.

This process may now play out in the Tokyo Suburbs. This article provides the facts.    Japan is an aging society and this nation has built up much more housing than it now needs.  The article does a great job sketching the sources of the problem. The obvious "cure" for the problem would be to allow Chinese investors to buy this suburban housing but that is unlikely to occur in the short run.

To an economist, there are several interesting issues here.  Housing markets are interconnected because homes are substitutes for each other.   For young people starting their careers in Tokyo, how much cheaper will apartments in downtown Tokyo become because housing is basically free at the fringe?  This cheap housing (combined with bullet train access) helps to put pressure on rents in more desirable areas.  Similar to Detroit, the government should think about paying for demolishing the excess vacated homes.  How quickly will government engage in this activity?   For homes surrounded by vacant decaying homes, what is the negative externality on their home prices?   Japan has fewer drug and gang problems than in the United States.  Will this negative externality be smaller there than what occurred in the U.S when homes went into foreclosure during the Great Recession of 2008?

The article tells a "Richard Florida" story that artists and other hipsters who do not need to be in the Big City on a daily basis are seeking out the fringe cheap housing. This is a nice example of heterogeneity and arbitrage. According to Florida, such artists can jumpstart an area. The Japan case study will offer a nice test of his optimistic hypothesis.

Sunday, August 23, 2015

A Great Ken Arrow Celebration Video

Columbia University celebrates the contributions of Ken Arrow (a PhD graduate of the program). This video is worth watching.   You will see three Nobel Laureates and other superstars discuss his influence.

Saturday, August 22, 2015

Singapore at Night

How much do urbanites value "green space"? Do they value it less if it is very hot outside?  This article argues that Singapore's high daily heat reduces the joy that their urbanites gain from proximity to green space.   Given the impending challenge of climate change, I find this an interesting topic but I have several questions.

1.  The authors of the academic study rely on a survey rather than studying home prices close to green space. Does their survey responses suffer from "cheap talk"?

2.  Having lived in Singapore for a month of my life, I know that because of good public transit that everyone has pretty good access to "green space" in Singapore.  So, what is the control group?

3.  Singapore really comes to life at night when the temperature falls to merely 75 degrees to 80 degrees F.  At 10pm at night you can see vigorous kendo fighting and thousands of people walking along the river near the Marina Bay Sands Resort to see the evening fireworks.    Take a look at this picture to get a sense of the spectacle.

Yes, it is 90 degrees each day and people stay inside but at night this safe efficient city comes to life.  This is our future and Singapore shows how we will continue to thrive as urbanites.

If you seek to stimulate the local Singapore economy, then you should stay at this hotel.

Image result for marina bay sands resort fireworks

Managing Expectations

The NY Times has published a long piece making the case that China's President Xi has promised too much to his people.   While we all wish that there was an all knowing benevolent leader to protect us from risk,  such a leader doesn't exist.  The belief that such a person exists only creates moral hazard and excessive risk taking without investors doing their homework.

A quote:

"Before that, the authorities did nothing to disabuse the investing public of the notion that a rising stock market was a state-backed goal and integral to Mr. Xi’s promise to build “the China dream.”"

The NY Times appears to want to tell a story that China's economy is built on a "House of Cards" and that its fundamentals are weak.   One version of this story is that local leaders borrow money from the government and invest in projects that create jobs but not valuable output. When the projects fail, the local government simply borrows more money from the national government and this cycle just continues.   There is certainly some truth to this narrative but it misses the bigger picture.

China as an urbanizing, orderly nation, with a highly educated public has a very bright future.  The key for it to take the next step in its development is to foster developing its own San Franciscos.  
High human capital cities with "individuals" pursuing their dreams and interacting.  The next industrial "golden goose" will form around the brain. While I am not smart enough to tell you what will be the next Uber or Twitter these companies will start to form there. China has an enormous home market to sell to and the powerful government can build the infrastructure to facilitate these agglomerations.

The Chinese government needs to step back and subsidize basic research, early child investment and basic transport infrastructure.

President Xi causes a problem for himself if he succeeds in convincing the Chinese people that he is all knowing and all powerful (the big daddy).  China doesn't need a "daddy", instead it needs clear investment rules of the game that incentivize investment in human capital and entrepreneurship.
It also needs blue skies!

Here are 3 of my recent papers on these topics;

1. industrial parks

2. bullet trains

3. blue skies

Friday, August 21, 2015

The Tianjin Blast Highlights the Benefits of "Sprawl"

Somebody once said;  "the solution to pollution is dilution".  The NY Times reports that in Tianjin, China that people lived too close to noxious and risky chemical facilities.    One way to have a physical separation between industrial activity and people is to encourage suburbanization.   A "moat" is an old idea that helps the populace to reduce the risk they are exposed to.

When I was a young environmental economist, I would teach this basic idea based on an article published in the NY Times on November 28th 1990.  At that time, I was 24 years old and I was teaching Environmental Economics at the University of Chicago.  Here is the source:

Chemical Plants Buy Up Neighbors for Safety Zone

BATON ROUGE, La., Nov. 21— Prodded by lawsuits over pollution and damage claims from a number of explosions, several of the nation's largest oil and chemical companies are spending millions of dollars to create safety zones by buying up the homes around their plants.

Although some homeowners are eagerly grabbing the offers of up to $200,000 for a house, the efforts are coming under growing criticism from environmentalists who say the companies are dismantling communities rather than than dealing with the root problems of safety and pollution.

A quarter of the nation's chemicals and a sizable portion of its transportation fuels are processed in more than 75 large industrial plants along the 85-mile stretch of the Mississippi River between here and New Orleans. Some of the plants are a tangle of pipes and tanks covering more than a square mile. An Assortment of Concerns

Stirred by new medical findings and rising concerns about industrial accidents and environmental issues, Louisiana's river communities are aggressively pressing lawsuits and damage claims that are costing the companies tens of millions of dollars.

"There are some things you just should not mix, including houses near these industrial facilities," said Dr. Paul Templet, the state's top environmental official. While he generally supports the idea of the buyout programs, he said the issue has not yet received enough scrutiny from state officials.

Some of the relocation programs are new, and others are continuations of programs that have been under way for years but are attracting new attention because of accidents or lawsuits. A Variety of Programs

The Dow Chemical Company began a buyout program across the Mississippi River from here last year that could cost $10 million. Five miles south of the Dow plant, the Georgia Gulf Corporation completed a program last year to move 50 families away from its vinyl chloride plant, turning a community founded by freed slaves into a six-acre grove of oaks and pecan trees.

The Exxon Corporation has spent $4 million on a similar progam here in Baton Rouge, and the Shell Oil Company is in the middle of another one down the river. Separate explosions killed two workers last year at the Exxon plant and seven workers in 1988 at the Shell plant, but the companies each say that the purchases of nearby homes began earlier and are not related to the accidents.

Another program is beginning in Ponca City, Okla., where Conoco settled a lawsuit over pollution last July and is preparing to spend $18 million to buy 377 homes along the eastern boundary of its refinery there. Reducing Risk, on Both Sides

The property purchases are defended by company executives as a sensible approach to moving people out of harm's way. A consultant who helps design the programs said that in addition to reducing the companies' legal risk, it is also good citizenship.

Guy S. Barone, a spokesman for Dow's plant at Plaquemine, La., across the river from Baton Rouge, said: "We have a large manufacturing plant and we have operated it safely. At the same time there is a risk of an acute accident and we want to protect people living adjacent to the fence lines."

Michael J. Lythcott is a consultant for Moran, Stahl & Boyer, the New York relocation company that helped design the program in Ponca City for Conoco and Dow's effort in Morrisonville, a small community adjacent to the plant in Plaquemine. He said that relocation was a new trend in the chemical and oil industries and that such programs were being planned in California, Louisiana, Virginia and West Virginia, though he declined to identify the companies involved.

"From a business sense, it is economically sound," he said. "There are potential toxic torts and if there is an accident it has an impact on worldwide sales. It makes sense in putting a program together instead of waiting for an accident, and lives to be lost." He acknowledged that one problem with relocation is that companies cannot "compensate people for emotional attachment to land or their homes." Criticism by Environmentalists

Environmental leaders have criticized Dow's program and several others. "Companies are reducing their problems by moving people instead of reducing accidents and pollution," said Mary Lee Orr, the executive director of the Louisiana Environment Action Network, a coalition of environmental groups based in Baton Rouge.

Property owners are also divided by the buyout projects. Most who sold their homes did not have much in the first place and view the offers as the break they needed to move into new and larger homes. But there is also anguish in some communities as neighbors who have lived together for decades are separated.

Nowhere is this more true than in Plaquemine, along the western banks of the Mississippi River just south of here, where Dow is breaking up Morrisonville, a community of 87 white and black property owners, and 110 homes, that was founded after the Civil War by freed slaves.

Morrisonville is situated on 200 acres along the eastern boundary of the 1,800-acre plant, Dow's third largest. The site is the second for Morrisonville. In 1931 it was moved a mile and a half west after the Army Corps of Engineers refused to continue maintaining the levees that protected the town, then 50 years old, from the Mississippi River.

In May 1989, Dow began a novel program to pay landowners $20,000 an acre, and homeowners at least $50,000, and up to $200,000, to get control of the ground for a safety zone.

Thursday, August 20, 2015

Does Water Scarcity Pose a "Limit to California's Growth"?

Adam Nagourney appears to be an adherent of the ideas of the Club of Rome.  In his NY Times front page piece today, he worries that California cities that encourage growth are exacerbating the "water crisis" by increasing demand during a drought that is likely to persist.  What is the fallacy in his logic?

He implicitly assumes that policy reform will not take place in California.  Farmers consume roughly 80% of the state's water.  According to this article, farmers now pay $.0033 per gallon.   Yes, that's .3 cents per gallon.  Residential households such as myself pay .5 cents per gallon.  A gallon of water is a gallon of water. Suppose that the Water Authorities raised the price of water for farmers so that it equals the price that urbanites pay.  Or, allow the farmers to sell their water allocation to urbanites.  This 66% increase would incentivize the sector that consumes 80% of the water to be more efficient and to substitute away from water intensive agricultural output that yields a low market price.

If the state's farming sector could figure out a way to reduce its water consumption by 25%, how many urbanites could move to California?  For a 66% price increase to induce a 25% consumption decline implies a price elasticity = -.38 which strikes me as quite plausible in the medium term and perhaps too inelastic.

 34.1 million acre-feet is used by California agriculture each year.  A 25% reduction in CA agriculture water consumption = roughly 8 million acre feet =  8 million *326,000  =  2.6 trillion gallons of water not used.

Suppose that 10 million new people moved to California's cities (so this is a 25% increase in the state's population).  The 2.6 trillion/10 million =   260000 gallons per new person per year = 712 gallons per new person per day.

See how we adapt by introducing market incentives to allocate scarce resources?  The challenge of adaptation is mainly political (not economics). Allow free markets to operate and the NY Times will have to find new doom and gloom headlines.

Wednesday, August 19, 2015

Investing in Natural Capital to Offset the Challenge of Sea Level Rise

Professor Ed Barbier has published an important policy piece in a new issue of Nature.  He discusses his involvement with an entity created after Hurricane Katrina.  "The Louisiana state legislature created the Coastal Protection Restoration Authority (CPRA) and tasked it with coordinating the local, state and federal efforts."   

The general question is:  in geographic areas located in low elevation coastal zones (LECZ); what are the optimal land use patterns?  How much of this land should remain "natural" as wetlands so that natural capital and Mother Nature's flood protection can flourish? How much of this land should be used for resource extraction? How much of this land should be transformed into a concrete impermeable urban city?

To an economist, we would need more information;

1. How many people live and work in the geographic area?
2. Is the value of proximity to the coast due to productivity (i.e the people are fishing) or is because the coast is a high amenity area? (think of San Francisco)
3. Do the urbanites, and the rural resource extractors have equal political clout in determining the land use decisions in the LECZ area? I would think in a democracy that the urbanites would have more votes because there won't be that many "resource extractors" and this group is likely to be poorer and less politically influential.
4. How risk averse are the people? How much do they lose if a severe flood occurs?

5. If experts make a suggestion concerning what land should be set aside as wetlands, does the government compensate the people who are currently using that land or does it engage in eminent domain and simply seize it?  Compensation respects property rights but it is more costly.

6. If engineers recommend certain "hard investments" such as Sea Walls, who should pay for them?

My own preference is that local public goods intended to provide a city with a defense against sea level rise should be paid for using local property tax funds. Land owners in the affected cities are the residual claimants on "new news" and thus they should finance the defense.

If National tax dollars are used to subsidize a risky city's defense then this is spatial redistribution and this introduces Moral Hazard.   To adapt to climate change, we need to discourage economic growth in risky places.  Subsidies have the opposite effect.

7.  What is the marginal productivity of an extra acre of wetland on reducing flooding risk?  In microeconomics, we talk about the marginal product of labor and capital but for this specific "production function", how do we estimate this key parameter? If we can't estimate it , then how do we solve for the optimal amount of land to set aside as wetland?

8. If a city sets aside much land as wetlands, then it has less land to urbanize.  What is the disutility of city residents for living at higher density like Hong Kong? This would appear to be  key parameter in judging the cost of investing in wetland natural capital.

Tuesday, August 18, 2015

Should the United States Morph Into Sweden?

The NY Times appears to be on a crusade to transform the U.S economy into a kinder and gentler Sweden.  Read this article and judge for yourself.  While doting dads and working soccer moms would appreciate the flexibility and peace of mind that such European work rules would offer, would overall productivity suffer as our top companies choose to change their ways?  Why has Jeff Bezos created a "stressful" work culture at Amazon?  What benefits does stress and high powered incentives offer?

Economics has something interesting to say here.  Jobs are bundles of attributes that include; the salary, the physical location, the tasks required at work, the hours and schedule flexibility, the work conditions (i.e pollution exposure, heat exposure, health safety).  The theory of compensating differentials predicts that nastier jobs will have to pay combat pay  in order to attract and retain workers.   This creates an incentive for bosses to consider repackaging attributes bundled into the job.  For example, if workers hate "stress" then jobs that are stressful will have to pay a large wage premium to attract and retain talent.

This logic raises the question of why a firm would make a job stressful if it is costly to the firm (because it must pay more for such a job).  An obvious answer is that a competitive culture at a firm increases worker effort as they avoid shirking and try their best. The CEO of the firm must believe that such effort is essential to achieve continued consumer demand.

Now, in a free country workers have choice of who they work for. If you are burned out after 5 years at Amazon, there are many other companies even in the Seattle area who would consider hiring you. An Amazon worker is not a captive pawn of the "large corporation". Instead, in an era of perfect competition --- workers have a menu to choose from. If a worker wants to spend more time with her young children, then there are other jobs that provide this freedom.  For those of you who know linear algebra, we need a labor market with complete spanning so that you can find your favorite bundle of job attributes in an accessible job.

Of course workers want the free lunch of working at Amazon with low stress and high prestige but you don't have to be Mick Jagger to recognize that you can't always get what you want. Those with scarce skills are more likely to achieve this. Hone your comparative advantage and even Jeff Bezos will be nice to you.

Economists such as Robert Frank want to tell another "rat race" story here that we would all be better off if we collectively agreed to stop competing against each other. He would say that in this prisoner's dilemma game that we are in the "bad equilibrium". I would counter that the greatness of the United States today is tied to a handful of firms including Amazon, Facebook, Google, Apple and startups who I can't even name.  Work rules that hinder their grown and ambitions would slowly transform the U.S into a Southern European nation. The NY Times means well but its editors need to take a course in economic growth theory.

Monday, August 17, 2015

My New Start at USC

This blogged stopped for two weeks as I was on vacation.   This morning I took an Uber to USC and the person who drove me was the 1st round NFL pick by the NY Giants back in 1991.   Given that I used to follow that team, we had a good talk about many issues including the permanent income hypothesis. He argued that many young players think they will play forever and do not plan their savings behavior according to Friedman's hypothesis.

Over the last two weeks, I have visited the following places;  Stanford University,  Half Moon Bay  and the Carmel Valley Ranch.   and the People's Republic of Berkeley.  I recommend all of them.

Now, I'm back at the office with many letters to write and papers to revise.  My first USC lecture is next Monday.  People are asking me why I have moved.  I am on leave from UCLA but I want to see what my intellectual quality of life is like at USC. USC is an ambitious university with big plans and I think I can help.  At the University of Chicago, Columbia, Harvard and Stanford -- I have had the opportunity to see how the best places use their scarce resources.  We will see if my wisdom is valuable here.

Wednesday, August 05, 2015

A PERC Conference on Climate Change Adaptation

Terry Anderson's book Free Market Environmentalism played a key role in my early thinking about Coase and environmental economics.   For years, Terry was in charge of PERC and I greatly benefited from my first visit to PERC in Bozeman MT a few years ago.  Today, some very serious economists will be meeting at Stanford for a 1.5 day conference on the economics of climate change adaptation.  The broad themes of this PERC conference are listed here.

Tuesday, August 04, 2015

The Economics of Agricultural Adaptation to Climate Change

Michael Roberts is a top agricultural economist.  Here is his Google Scholar page.    He earned his Ph.D. at the UC Berkeley. UC Berkeley is a major trainer in agricultural and environmental economics and it is center of behavioral economics.  This blog post will touch on both of these topics. Keep in mind that the University of Chicago is neither a center of agricultural economics nor behavioral economics (Dr. Thaler doesn't train that many students and the department has not made a large investment in behavioral studies).

As I continue to think about the economics of climate change adaptation, I now recognize that much of the "doom and gloom" is based on a type of behavioral economics model of investment under uncertainty.  As a product of the Lucas and Prescott "Investment under rational expectations", I have a much different view point.

For those who are interested in the economics of agricultural adaptation to climate change take a look at Yale's Robert Mendelsohn's many relevant papers.

Returning to Dr. Roberts, take a look at his blog post about farmer adaptation.   Here is my response;

Hi Michael,

I am a great admirer of your research but I must pose a few questions for you to ponder.

1. This paper will be published soon by the JPE. Costinot, Arnaud, Dave Donaldson, and Cory B. Smith. Evolving comparative advantage and the impact of climate change in agricultural markets: Evidence from 1.7 million fields around the world. No. w20079. National Bureau of Economic Research, 2014. 

It strongly suggests that adaptation will play a key role protecting us. Which parts of their argument do you reject and why?

2. If farmers know that they face uncertain risks due to climate change, what portfolio choices can they engage in to reduce the variability of their earnings? What futures markets exist to allow for hedging? If a risk averse economic agent knows "that he does not know" what ambiguous risks she faces, she will invest in options to protect herself. Does your empirical work capture this medium term investment rational plan? Or do you embrace the Berkeley behavioral view of economic agents as myopic?

3. If specific farmers at specific locations suffer, why won't farming move to a new area with a new comparative advantage? How has your work made progress on the "extensive margin" of where we grow our food in the future?

4. The key agriculture issue in adapting to climate change appears to be reducing international trade barriers and improving storage and reducing geographic trade costs. Are you pessimistic on each of these margins? Container ships and refrigeration keep getting better, don't they?

5. With regards to my Climatopolis work, recall that my focus is the urbanized world. The majority of the world already live in cities and cities have a comparative advantage in adapting to climate conditions due to air conditioning, higher income and public goods investments to increase safety.

My optimism about our ability to adapt is based on migration, competition and innovation. For a non-"cheeky" sketch of the argument --- please read

I view adaptation and mitigation as complements not substitutes. I am a pessimist about mitigation because of my work on the political economy of serious mitigation. Please read;

Cragg, Michael I., Yuyu Zhou, Kevin Gurney, and Matthew E. Kahn. "Carbon geography: the political economy of congressional support for legislation intended to mitigate greenhouse gas production." Economic Inquiry 51, no. 2 (2013): 1640-1650.

Holian, Matthew J., and Matthew E. Kahn. "Household Demand for Low Carbon Policies: Evidence from California." Journal of the Association of Environmental and Resource Economists 2, no. 2 (2015): 205-234.


Kahn, Matthew E. Climate Change Adaptation: Lessons from Urban Economics. No. w20716. National Bureau of Economic Research, 2014.

best, matt

It appears to me that general equilibrium theorists need to teach partial equilibrium empiricists about their core model.  Partial equilibrium thinkers implicitly assume that production will continue to take place at its current location and that price signals do not guide investment choices. With these restrictions, they can focus on "one equation" models analyzing how output co-moves with temperature.   By zeroing out thousands of behavioral responses (such as moving farming to another location or growing a more robust crop or hedging risk), such an analysis is bound to yield scary numbers in terms of "costs from BAU". Once one begins to think about the spatial location of economic activity, then whole new possibilities appear.  

Now, an interesting issue relates to the industrial organization of future farming.  Will small farmers vanish as large industrial farms will have the human capital and the financial capital to be more nimble in the face of climate change?  If these small farmers move to the cities, could this trend actually accelerate a nation's economic growth?  

UPDATE:  For those who say that farmers have "locked in" with their knowledge and capital (think of a tractor) to engage in one type of farming activity ---- keep in mind the Over Lapping Generation model. There is always a new generation who have not sunk their human capital yet and can "globally optimize".  There will be a locked-in cohort (think of the generation who lost their jobs in manufacturing as the Rust Belt deindustrialized). This group bears costs but a serious structural researcher would seek to quantify these and then figure out an efficient and equitable policy to help them to cope with the changing world.  

Monday, August 03, 2015

Paul Krugman's Revealing Review of an Early Piketty Book

Back in the 1990s, Tomas Piketty wrote a short book about economic inequality.  Harvard University Press has now published an English translation. Paul Krugman reviews it in today's NY Times  and declares that the book is out of date and no longer reflects the profession's consensus about the causes and consequences of income inequality.   One paragraph in his review are worth quoting and then studying.

DIRECT Krugman Quote:

"In the 1990s, professional analysis of this issue was dominated by the theory of skill-biased technological change, which asserted that information technology was raising the relative demand for more highly educated workers. In this book Mr. Piketty offers a mild critique of this doctrine, but ends up asserting that it “surely explains a significant part of the increase in wage inequality.” Readers won’t learn that modern researchers have become highly skeptical of the whole theory, partly because it’s inconsistent with much of what has happened since 2000, like the stagnation of earnings among the college educated. Broadly speaking, the trend of inequality research since Mr. Piketty wrote this book has involved de-emphasizing supply and demand while giving more attention to privilege and power."

When economists "de-emphasize" supply and demand, you immediately know that these are "Strange Days".     You don't need to be Kevin Murphy or Gary Becker (watch at the 4 minute mark for his discussion of increasing returns and specialization) to be skeptical about Dr. Krugman's skepticism.  Who are these "modern researchers" that Dr. Krugman refers to?  Are they from the new University of Chicago?

Permit me to make two nuanced points;

Point #1:  Dr. Krugman has a strong incentive to de-emphasize the "traditional" concept of supply and demand as the determinants of inequality.   If labor markets are perfectly competitive and high labor earnings reflect a superstar worker's marginal product (see the work of Stephen Kaplan and Xavier Gabaix) , then the policy solutions are to build up the human capital of those who lag behind.  Jim Heckman's pre-K agenda is likely to be the best way to achieve this but this will take decades to achieve as it takes time (time to build) to create a functioning adult.

Recognizing this point, Dr. Krugman, as a leading progressive, has a strong incentive to emphasize that the "true cause" of high earnings is privilege and power.  If these are the key data generating mechanisms then it is much easier to make an intellectual case for massive redistribution.   Dr. Krugman can convince himself that his policy agenda will achieve both equity and efficiency goals.  Chicago economists would counter that by sharply increasing taxes on the 1% that overall economic growth and innovation will stagnate and our nation would begin to resemble our Southern European cousins.

Point #2:  While Krugman has only recently entered the field of labor economics, he rejects the human capital theory of income inequality based on his fact that college graduates are experiencing stagnant earnings.  But is this true?  If you look at the subset of those in STEM majors, is that true? How much of the "stagnant earnings" he sees is due to a composition shift of who is now attending college and what they are majoring in?  Do we have a standardized "apples" to "apples" comparison over time?

Permit me to offer a single data point refuting Dr. Krugman's thesis.  Let me introduce you to Paul Minton.   A recent NY Times article told his uplifting story.

"After Paul Minton graduated from college, he worked as a waiter, but always felt he should do more.

So Mr. Minton, a 26-year-old math major, took a three-month course in computer programming and data analysis. As a waiter, he made $20,000 a year. His starting salary last year as a data scientist at a web start-up here was more than $100,000.

“Six figures, right off the bat,” Mr. Minton said. “To me, it was astonishing.”"


Internet giants like Google and Facebook have long fought over the top software engineers in the country, and that continues. But now, companies in most every industry, either by necessity or to follow the pack, are pursuing some sort of digital game plan — creating lucrative opportunities for computing-minded newcomers who, like Mr. Minton, want to reboot their lives.

Companies cannot hire fast enough. Glassdoor, an employment site, lists more than 7,300 openings for software engineers, ahead of job openings for nurses, who are chronically in short supply. For the smaller category of data scientists, there are more than 1,200 job openings. Demand is highest in San Francisco. Nationally, the average base salary for software engineers is $100,000, and $112,000 for data scientists.

So, my friends --- do you see my point about "old fashioned" econ 101 supply and demand in the labor market?  Does Mr. Minton represent a spoiled brat whose "daddy" got him his lucky job?

While I don't know Mr. Minton, he appears to be a talented duded who learned quant skills in College and has the ability to adapt to changing market conditions. This is evidence in favor of the human capital hypothesis.  All college majors are not created equal.  There is a high return in the 2015 economy to quant and stats skills.

How did Mr. Minton acquire his skills? Did he go to an elite private school? Did he attend a well funded suburban public school? This raises the issue of access to high quality K-12 education and human capital formation.  But, now we are back to classic labor economics and the need for more competition in the educational market.  Dr. Krugman --- what part of this logic is incorrect?

Sunday, August 02, 2015

Achieving Accountability Through DNA Testing of Dogs and Dog Poop

One Brooklyn apartment building has solved its Commons Problem by having its 175 dogs all be registered and DNA tested.  This has created a database that can be cross-checked when a new unwanted sample of poop is left in the commons areas. Those dog owners who are caught are fined and publicly shamed.  The commons is now cleaner.   Note that this externality has been mitigated through credible threats of punishment rather than appeal to the owners to "be nice to all".  

Would privacy advocates oppose this "invasion" of privacy? Or does the protection of the commons justify this surveillance and enforcement?  

Cities are subject to a series of insults;  smoking, litter, poop, noise, crime, smells, vague uncertain threats from the homeless, dope smoking in common places, graffiti.  For each of these, how can "Big Data" collection help  to achieve accountability to reduce these disamenities? Those cities that can achieve progress on each of these will become "green cities" and will attract more tourists and more commercial, residential and retail real estate dollars.   

The interesting urban economics issue here is that increased population density in a given geographic area scales up each of these effects. For example, if 5 out of every 100 people smokes then an area with 10,000 people per square mile features 500 smokers.  But, this scale effect of density is not a law of physics.  As the dog poop example shows, there are ways to configure incentives and Big Data to mitigate these tragedy of the commons challenges. For example, would the next Mayor Bloomberg have drones fly NYC patrolling for issues?  Or will a strange coalition of the ACLU and drug dealers and owners of dogs who don't like to pick up work together to block such new technologies from holding them accountable?  

Green Cities can be produced but we must pay for them.   You might say that Singapore has been willing to make these choices and then declare that you don't want to live in Singapore.  I have spent 4 weeks of my life in Singapore and I like it there very much.  Despite the high daily heat and humidity, it is a very livable city.  Go there and experience what is it is like to live in a city that enforces "rules of the game".   

Saturday, August 01, 2015

Do Supply Curves Slope Steeply Up? If "Yes", then Why?

Cornell's Robert Frank has written many times about the "arms race" for status goods.  Such goods, such as slots at Harvard, are inelastically supplied and thus a doubling of everyone's effort (through studying and SAT prep courses) simply cancels out because relative performance is what supposedly matters.  

I found similar logic posted as a comment on John Cochrane's blog.  


" MartonSeptember 30, 2014 at 11:17 AM

DIRECT QUOTE (not me speaking)

"John, as a seasoned economist I thought you would take into account positional goods and their relationship to inequality here.

A large part of what determine's most people's happiness are positional goods - choice of their spouse and their friends, choice of university spots etc. The 99% don't care too much that trustfund babies, bankers or whatever other "undeserving rich" have private jets and fancy cars. They care very much that these people have access to a pool of marriageable people, to university spots, to , to a pool of chefs etc that others are unfairly "priced out of".

In a meritocratic society with equality of opportunities, if you work hard enough and contribute enough to society, you have a chance to go to Harvard or Chicago and you stand a chance to marry a high-status spouse - actor, supermodel, anything. Therefore you are incentivised to contribute to society and better yourself in order to raise your wealth and status.

In an unequal society (I don't mean high gini, I mean low intergenerational mobility in SES) there is much less incentive for meritocratic competition. Your parent's wealth will get you into Harvard, your last name will get you into the "right" parties where the people with money hang out, and the Lambo you got for your high school graduation will get you into any lady's panties. For everyone else, this is a disincentive to strive - since they are doomed to lose out from the get-go.""

Note the words; "unfairly priced out" --- this must mean that the supply curve for such a good is quite steep because if a product such as pizza is produced with constant returns to scale technology at average cost of $2 a slice, then everyone can enjoy a slice of pizza for $2. My demand does not "crowd you" out of the pizza market.

For "positional goods" such as nice homes in San Francisco or slots at Harvard, a new question arises. Why is supply upward sloping? If zoning laws change in San Francisco or if new excellent universities enter the market then the supply of elite products increase. What hinders the entry of such new supply? In the case of San Fran housing , the answer is incumbent zoning.  Change the zoning laws and supply will be more elastic. Why doesn't Harvard double in size? Why don't excellent competitor universities rise in quality to match Harvard and thus to expand the supply of excellent slots? That's  an open question --- but for many products such as using Google Facebook or going to Starbucks there is an elastic supply curve of services and we can all use it.

Implicit in the doom and gloom of Frank and others regarding the cost of income inequality is the belief that the supply curve of key attributes in our utility function is inelastically supplied.  But is this statement true? If it is true in the short run, then doesn't some entrepreneur have an incentive to introduce a substitute?  Welcome to econ 101.

The Chore Wars Revisited: Contrasting the Perspective of Sociologists and Economists

Millennial Men are dudes ages 18 to 35.  In surveys, they have stated that they would like to live a balanced lifestyle of working but also spending significant amounts of time at home rearing their children.  The NY Times has a long piece today arguing that this group has not achieved this worth goal and extensively quoting sociologists  saying that the configuration of jobs is causing the problem.   The author of this piece didn't interview any economists.  Sociologists often view choice as an outcome of binding constraints that only government can remove. Economists counter that work conditions evolve as a function of demand and supply conditions.  If workers demand more flexible work conditions, then many firms will have an incentives to change the work environment to make it more family friendly. Such firms will have an easier time recruiting and retaining workers and will be able to pay them less.

A few quotes from this "sociology" article:

DIRECT Quote #1

  Millennial men — ages 18 to early 30s — have much more egalitarian attitudes about family, career and gender roles inside marriage than generations before them, according to a variety of research by social scientists. Yet they struggle to achieve their goals once they start families, researchers say. Some researchers think that’s because workplace policies have not caught up to changing expectations at home. “The majority of young men and women say they would ideally like to equally share earning and caregiving with their spouse,” said Sarah Thébaud, a sociologist at the University of California, Santa Barbara. “But it’s pretty clear that we don’t have the kinds of policies and flexible work options that really facilitate egalitarian relationships.”

DIRECT Quote #2

With millennial men and women too, life hasn’t hit the fan, so we’re still seeing more idealized expectations,” said Pamela Stone, a sociologist at Hunter College. “These are couples that are negotiating a work and family world grounded on an old model that really called for men to step up to the breadwinning role big time, and women to step back from employment and into more traditional roles.” “It’s not that they’ve thrown over their ideals, it’s just enacting those are much harder given the workplace and cultural structures they’re encountering,” she said.

Direct Quote #3

In their study, Ms. Thébaud and Mr. Pedulla suggested that workplace policies might have a greater effect on men if they were specifically aimed at them, such as paternity leave policies that reward men for using them. Another approach might be to create policies that change work for both sexes, like reining in long hours.
Changes in the way Americans work come more slowly than shifts in personal expectations. But now that millennials are the largest generation in the work force, and as they climb the executive ranks, they might shape policies that more fully reflect the way they want to balance their lives.

Observation #1;

The NY Times seeks to transform the United States into Sweden.  Would there be any long run costs from this transition?

Observation #2;

If young people greatly demand flexible employment, why don't startup firms that offer such conditions pop up and employ these individuals?   The article is naive in its absence of discussion of the "supply side".  What attributes are bundled into a job? Why do jobs offer health insurance? (this benefit isn't taxed)  Why do some firms have long hours, while others have short hours?  A more subtle analysis would discuss what types of employment can have workers swapping out for each other. For example, in tag team wrestling you can clap your partner and he comes into the ring and takes over for you.  Do you get my half joke?   For what jobs are workers perfect substitutes so that they are interchangeable?  Consider medicine. My father handles some very complicated cases. It would take him hours to explain the details of a case to another doctor. Such transaction costs means that it is efficient for my father to work the long hours rather than wasting time training his replacement.  There may be other jobs where the task can be simply described (find the bugs in the 2nd page of computer code) and this could be broken into piece work allowing people to work just a few hours and then handing it off to the next person.

If there are talented dudes age 32, who want to spend more time at home with their family --- then employers will emerge who will hire these guys at a discount and provide the job flexibility. There will be a culture at that work place that "family matters". Such a firm will self select "nice guys" to work there and the culture will be good.

Kandel and Lazear studied this a long time ago.

Kandel, Eugene, and Edward P. Lazear. "Peer pressure and partnerships."Journal of political Economy (1992): 801-817.

Their work is an extension of my mentor Sherwin Rosen's hedonic research. Rosen studied the creation and pricing of differentiated products. A differentiated product such as a job or a car has many attributes bundled into it. For profit firms will choose what to bundle into it. A job is a wage, vacation schedule, work hours, work conditions (such as air conditioning) and the rational firm will tradeoff the profit incentives in offering each of these attributes. If potential workers value flexibility, they will pay for it through receiving lower wages. This is the compensating differentials model.  The NY Times isn't honest that the workers seek a free lunch.  They want their current wages with better work conditions.  In competitive labor markets, they will only receive this if they are really productive. No government mandate will bring this about.

To get a better sense of Rosen's thinking read his 2002 AEA Presidential Address.  

So, note that implicit in Sociologists' logic is that workers do not have a choice over who they work for.  Implicit in this monopoly-capitalism model is that only government intervention can protect the exploited worker. Economists dismiss this view. People who live in Los Angeles have hundreds of potential employers. This competitive labor market means that no one employer controls a worker's fate.  Profit maximizing firms will offer "better" work conditions if this saves them money through having happier, more productive workers who they can pay less (because the workers are happy with their work conditions). In this sense, competition for attracting talent in the labor market protects the workers.  Sociologists tend to ignore this point and call for the government to step in.

Friday, July 31, 2015

Is Neo-Classical Economics on the Ropes?

In Summer 2015 we are witnessing a mildly interesting phenomena that economists are less respected than we used to be.   Part of this shift may be due to the fact that leading economists appear to reject Econ 101 logic.   Several Nobel Laureates in Economics are lining up to endorse sharp increases in the minimum wage.   Sharp increases in capital gains taxes are being proposed by progressive economists advising policy makers. If we take a leading Econ 101 textbook such as Greg Mankiw's, what % of the book are now being reconsidered?  How did this reformation take place? In what ways did the "old" model fail?

As a 49 year old Ph.D. in Economics (from Chicago), I am an interested party. My human capital is locked in. Did I make the wrong bet? Is the spot market price of economic knowledge about to decline?

Milton Friedman was born 103 years ago today. If he were alive, I think he would be really surprised by the success that Dr. Krugman and Stiglitz and Piketty have had in seizing the higher intellectual ground.  Where are the new generation of University of Chicago economists?  Take a look at their current roster;  which of these important scholars will step into the ring and defend sensible Econ 101 ideas?

Take a sober look at David Brooks' column today.  He is a smart guy and it is mildly interesting that he thought that he needed to even write this piece defending the benefits of capitalism.

Now take a look at my twitter feed featuring another smart guy.  Matt Yglesias knows enough economics to make him dangerous.  Here is what he recently posted.

    1. The Council of Economic Advisors is a weird idea. Where’s the council of IR scholars? Or sociologists? Or normative ethicists?
    2. my old friend & teacher Bill Nordhaus said the CEA's job was similar to good gardening: 10% planting seeds, 90% pulling weeds

My answer to Matt is that the CEA exists because there is a  demand for such "in house" consulting services.   While macro economics remains a work in progress, micro economists have made tremendous intellectual progress and have a keen understanding of how free market economies operate and how to design experiments to learn about those parameters that we know that we do not know.

These other phantom groups he mentions would exist if there was similar demand.  Demand creates supply!   Implicit in his cute tweet is that economists are no better than any other scholars.  While I respect his call for equality, at the end of the day researchers do differ with respect to our marginal product.  You would not watch NBA Cavs games if I replaced LeBron James.

It appears to me that much of the attack on "free markets" and "free market economists" is due to the rise of income inequality.  What is the root source of this income inequality? I believe that it is different investments in human capital across familes.

You do not need to be Milton Friedman to appreciate that our K-12 public schools have not delivered the educational quality that children need.  Progressives need to ask themselves  a hard question about why this has been the case.  Economists call for experimentation, competition and accountability.  If the private sector was allowed to educate poorer kids, then more effective long run human capital would be built up and our macro economy would be stronger.