How costly is it for a "green" consumer to vote with her wallet? As this article reveals, the tax subsidy for buying a hybrid is being phased out for vehicles made by Toyota and Honda. Who will bear the incidence of this subsidy phaseout? In english, will the price of these vehicles fall? Will such vehicles be much less profitable? Were tax incentives really the reason that the Prius "took off"?
The article claims that the Prius "paysoff" in 18 years but this hinges on how many miles a household drives, their discount factor and the yearly price of gasoline. The article could have been more subtle about identifying different types of households; If I drive 20,000 miles per year and the interest rate is 0% and if the price of gasoline (inflation adjusted is $5 per gallon) and if the hybrid achieves 50 MPG and lives for 15 years, then over 15 years;
20000/50 = 400 gallons of gas per year if I own a Prius = $2000 a year in gas expenditure; the PDV of $2000 a year for 15 years = $30,000
In comparison , if the conventional vehicle I would have bought got 25 MPG, then
20000/25 = 800 gallons * 5 = $4,000 per year for 15 years = $60,000 gas bill
I realize that I'm ignoring the rebound effect here but I point is that the hybrid is a pretty good deal for this specific consumer in this price environment. How many consumers are like this guy? Note that he didn't need a tax incentive to buy the Prius. Note, that he wasn't an environmentalist! The guy was solving a cost minimization problem not a utility maximization problem. So, there are 2 types of hybrid buyers; the people who drive a lot and the environmentalists. This WSJ author hasn't thought enough about the heterogeneity here and how this aggregates to determine aggregate market shares for the "green" product.
Environment (A Special Report) --- The Economics of Hybrids: For most U.S. consumers, they're still a money-losing proposition
By Mike Spector
1706 words
29 October 2007
The Wall Street Journal
R5
English
(Copyright (c) 2007, Dow Jones & Company, Inc.)
It's getting a lot easier to buy a hybrid -- but not necessarily cheaper.
Amid heightening concerns over America's proclaimed oil addiction, skyrocketing fuel prices and global climate change, auto companies are making more gasoline-electric hybrid cars and giving consumers more choices than ever before.
But marketplace dynamics in the U.S. -- including higher prices charged by the car companies, dwindling tax credits given to fuel-efficient cars and low gasoline taxes -- haven't yet allowed a hybrid or other more-efficient vehicle to become an economical choice for many consumers.
In Europe, by contrast, several countries offer significant tax breaks to people who buy more-efficient vehicles. And high fuel taxes also are propelling Europeans to invest in a more-efficient ride.
There are several hybrids on the market now, using different technologies. But basically, a hybrid consists of a traditional internal-combustion engine paired with an electric motor. The electric motor gets its power from a storage battery, which is replenished by a recharging system within the car's powertrain. Electric motors boost power to the gas engine, allowing manufacturers to install smaller -- and thus more-efficient -- motors in these cars. Most hybrids sport four-cylinder engines as opposed to the six- or eight-cylinder motors found in many vehicles.
There are essentially two types of hybrids on the mass market today, often dubbed "mild" or "full" hybrids, each with fuel-sipping and emission-curbing features. A mild hybrid shuts off the engine at a full stop; uses regenerative braking, which utilizes dissipated energy from braking to recharge the battery; and uses the electric motor to help power the gas engine.
A full hybrid does all of those things, but adds another big fuel-saving feature: electric-only driving, in which a vehicle runs on the electric engine alone at low speeds. That's why hybrids get better mileage in city driving than high-speed highway cruising. The laws of physics still apply, so you shouldn't expect a hybrid SUV to get incredible mileage. But it
will get better mileage than its gasoline counterpart.
Hybrids are currently the most popular green vehicle choice in the U.S. In the first seven months of this year, new hybrid-vehicle registrations nationwide rose 49% from the year-earlier period to 215,997, according to R.L. Polk & Co., an automotive-research firm in Southfield, Mich. Hybrids make up about 2% of the U.S. light-vehicle market.
Economics are still getting in the way of greater adoption, however. One reason is the tax system. Americans get a tax break for buying hybrids -- the starting amount varies by model -- but the more hybrids an auto maker sells, the smaller the tax break becomes on any hybrid models from that maker. After a manufacturer sells its 60,000th hybrid, the tax break starts to phase out. Buyers can claim the full credit during the calendar quarter after the quarter in which the manufacturer reaches the 60,000 limit. Then, the credit is sliced in half. It is reduced by half again after another six months. Six months after that, the credit disappears.
Toyota Motor Corp.'s popular Prius, for instance, once garnered a $3,150 credit. But Toyota sold its 60,000th hybrid in the second quarter of 2006. So starting Oct. 1 of last year, the credit dwindled, and today it's gone. That means consumers no longer get the tax break for buying a Prius, or hybrid versions of some of the Japanese auto maker's other models: the Camry, Lexus GS 450h, Lexus RX 400h SUV, Highlander SUV and the Lexus LS 600h L sedan.
Honda Motor Co.'s credits also will decline soon as the Japanese auto maker has just recently exceeded the sales cap. Other hybrids from General Motors Corp. and Ford Motor Co. should retain their full credits for some time amid lower sales volumes.
In Europe, by contrast, several countries offer significant tax breaks. In Belgium, for example, drivers get 15% of a car's price back -- maxing out at 3,280 euros ($4,640) -- if the vehicle emits less than 105 grams of carbon dioxide per kilometer, according to the European Automobile Manufacturers Association. Cars that emit between 105 grams and 115 grams get a 3% break; vehicles emitting more than 115 grams don't get anything.
Europeans also face high fuel taxes, encouraging them to buy more-efficient cars. And diesel is specifically taxed at a lower rate -- diesel engines are about 30% more efficient than their gasoline-powered counterparts because of the higher energy content in diesel fuel and the more-efficient combustion process in the engine. Diesel autos make up about half of the European market, compared with about 1% in the U.S.
Even taking a tax credit into account, U.S. consumers have to pay more when buying a hybrid because the vehicles use a lot of expensive technology. Between large battery packs and complex transmissions that join gasoline engines with electric motors, hybrids can cost anywhere from $2,000 to $7,000 more than comparable nonhybrid cars.
Take GM's Saturn VUE Greenline sport-utility vehicle, which sells for $1,300 more than its gasoline-engine only counterpart after factoring in a tax credit, according to Edmunds.com, an auto-research firm. (This and other specific comparisons are for 2007 models.) It would take nearly five years to recoup that premium in savings at the pump with gas around $2.79 a gallon, according to Edmunds, assuming you drove about 15,000 miles a year. If higher taxes increased gas prices to about $6 a gallon -- roughly the price in Europe -- it would take about two years.
The VUE Greenline gets about 27 miles per gallon in combined city and highway driving, a
good uptick from the four-cylinder, front-wheel drive gasoline-engine version, which gets about 23 mpg.
Toyota's Prius, which gets a leading 46 mpg combined but no longer qualifies for the tax credit, costs over $7,000 more than the auto maker's compact Corolla. It would take nearly 18 years to recoup the premium, or more than twice the time you might expect to own it. Even with a more favorable comparison to the less-efficient Camry sedan -- which costs about $4,200 more -- Prius owners would still need about 6.5 years to get their money back in fuel savings.
That means the Prius isn't necessarily an economical buy despite its superior mileage. "If you want to save money on fuel, just buy a car with better gas mileage," says Jeremy Anwyl, chief executive of Edmunds.
Some hybrids are geared more toward performance than efficiency. The prime example is the Lexus LS 600h L sedan, which has a V8 engine in its hybrid drivetrain. The car, priced at more than $100,000, marks Lexus' attempt to market a super-luxury car with added hybrid cachet for wealthy consumers who have a green streak. The sedan gets just 21 mpg in combined city/highway driving, better than a comparable BMW model but a bit worse than the less-expensive Lexus GS 450h.
Auto dealers say consumers had unrealistic expectations about the economics of hybrids two years or so ago, but have adjusted and now tend to buy the vehicles to make a statement.
Earl Hesterberg, chief executive of Houston-based Group 1 Automotive Inc., a large nationwide dealership chain, says a typical reaction from hybrid buyers used to be: "Hey, this thing really does still use fuel." But now consumers are more educated, he says. "The majority of people just want to feel better about themselves and that they're trying to make some effort to be more green, be more socially responsible, reduce their carbon footprint."
One long-term consideration when buying a hybrid is the relatively untested maintenance history of battery packs. If a hybrid battery fails, it will be quite expensive to replace -- likely at least $5,000 and perhaps as high as $10,000 depending on the drivetrain's complexity, says Jack Nerad, editorial director of auto research firm Kelley Blue Book.
Fortunately, hybrids have experienced few, if any, major repair problems over the past few years. And while consumers may consider these vehicles new, they've actually been in production for a while, giving manufacturers time to refine them. The first Prius hit the road in 1997 in Japan and came to the U.S. in 2000.
Most hybrids come with long warranties on their powertrain technologies -- eight years or 100,000 miles for the Prius -- that cover potential foul-ups. Still, after the warranties end, it's unclear what problems might crop up in an expensive battery pack. There's no experience with this since few, if any, people have owned a Prius for more than eight years.
A spokesman for Toyota says the company placed extended warranties on the Prius to address just such uncertainty but adds that issues with the vehicles' batteries have been "virtually nonexistent." He says the company actually expects Prius batteries to live well beyond the eight-year warranty.
Auto makers are gradually pushing toward electric plug-in hybrids, which will allow drivers to recharge a battery with a traditional outlet and go much further on electric power alone.
Such cars could be a "game changer" that eventually displaces conventional hybrids, says Mike Jackson, chief executive of AutoNation Inc., of Fort Lauderdale, Fla., a nationwide dealership chain.
Another fuel-saver on the horizon: diesel.
Many Americans think of diesel engines as noisy and dirty, but the introduction of cleaner diesel fuel in the U.S. that can meet tough emissions standards promises less pollution and wider use. Auto makers are ramping up plans to put diesels in light-duty pickup trucks and passenger cars. And auto companies eventually may employ diesel-hybrids to really boost fuel economy.
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Dear Readers, In recent months, I have posted my public writing to my free Substack. I have such fond memories of Google Blogspot, thus it deeply surprises me that Google's search engine does a terrible job in helping those who search to find past blog posts. This deeply surprises me. As I age, I'm trying to post more dignified material to my Substack. I am sticking to what I know based on my ongoing research in microeconomics. Thanks very much for reading my posts. Best Regards, Matthew E. Kahn
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I have moved my blog over to Substack (and I've lost many readers). Please join me there. Here is a recent column. The Wall Street Journal has published an important piece about how the high heat is reducing economic activity in Houston. The piece has a pessimistic tone that the heat melts the city’s infrastructure and shaves off economic activity as people don’t want to go outside. When microeconomists study consumer expenditure dynamics as people buy cars, go out to dinner and buy groceries. During hot spells, people are less likely to go out for dinner or to play multiple rounds of golf. A microeconomist would say that this evidence indicates that people have “state dependent preferences”. In English, this means that how much we enjoy a steak dinner at an outdoor restaurant depends on whether it is 75 degrees outside or 95 degrees outside (this is the “state of the world”). I certainly believe that hot and humid Houston is in a type of “macroeconomic Siesta” right now and this reduces economic activity. But, permit me to make some counter-points. #1 The money people in Houston do not spend on the hot July 28th 2023 is still in their bank account and they can spend it on a cooler November 5th 2023 day. Note this intertemporal substitution. The media focuses on the direct effect of the heat (that high heat is reducing economic activity today) but my counter-hypothesis is that it displaces expenditure to the future when it will be cooler later this year in Houston. So, will the New York Times write a piece saying that high summer heat causes a fall boom in Houston? I don’t think so. This type of cross-elasticity is ignored by the “climate crisis” focused media. #2 The WSJ interviewed a few people who want to leave Houston. As always, they are free to choose. As more workers can engage in WFH, those who hate the high heat will leave the city in summer. If they own a home, they can AirBNB it. WFH is a climate adaptation strategy as it makes people more geographically footloose. I discuss this in my 2022 book. #3 We have to live somewhere. Is Houston becoming more miserable to live in summer than other cities? If the answer is “yes”, then its home prices will fall. Here are some data from Zillow.Even with higher interest rates, I don’t see a collapse here in the Zillow index. Are you going to sell short Houston homes as your strategy to get rich? Incumbent home owners form a strong interest group to invest in adaptation strategies to protect their asset’s value. WHAT are possible adaptation strategies? #1 Road construction materials can be re-evaluated to reduce the urban heat island effect. Read this report. The City has strong incentives to embrace the cost-effective strategies discussed here. #2 Golf courses can open up part of the area and charge people to enter on hot days to use them as private parks. #3 Here are personal cooling strategies. On a personal level, of course the city needs access to strong air conditioning. Firms that make them and repair them will enjoy a boom. The Electricity GRID must remain reliable. The Climatopolis logic is that Houston competes with other cities to attract successful people and firms. The system of cities and the fear of brain drain gives Houston’s leaders and land owners strong incentives to be pro-active in adapting to climate change. Such efforts will be messy as there will be fights over who pays for such local public goods but the end result will be a more resilient Houston where the high heat causes less economic damage in the short term and medium term. This is the climate change adaptation hypothesis.
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The New Economic Geography of WFH Matthew E. Kahn Over the last three years, companies from all over the world have learned valuable information about how their firm’s productivity and worker satisfaction is affected when workers can engage in Work from Home (WFH) on at least a part-time basis. Each firm faces fundamental tradeoffs in not requiring workers to return full time to the office. On the one hand, WFH accommodates worker lifestyles and responsibilities at home. WFH workers gain from commuting less often and some may choose to live further from their place of work because they commute in on fewer days. Firms with happier workers are less likely to face retention challenges and will pay less retraining workers. Given that WFH is a non-taxed perk, firms that offer this job amenity can be less generous in giving workers pay raises. Firms located in expensive areas can economize on expensive commercial real estate. If a firm requires that workers be in the office just half the week, then a firm can reduce its space requirements by 50%! On the other hand, firms benefit from face to face communication. Younger workers gain more from such mentoring. Building up the firm’s culture and monitoring worker effort is easier to do if workers are on site. Each company has a strong incentive to experiment with different workplace practices to learn what works best for their organization. The pursuit of profit actually accelerates this learning process. Economists are always looking for new ways to study firm dynamics. The rise of the WFH economy opens up many questions related to what types of firms will encourage their workers to engage in WFH. Famous executives such as Elon Musk at Tesla and Jamie Dimon at JP Morgan have been encouraging workers to return to the office. Why? Up until now, a lack of data has hindered the systematic analysis of what types of firms prioritize allowing workers to engage in WFH on at least a part-time basis. The newly released Flex Index provides a unique opportunity for researchers. As an urban economist, I am especially interested in the geographic determinants of why different firms engage in hybrid-WFH. The Flex Index provides data on each firm’s headquarters’ location. I focus on those that are based in the United States. I use data for 2528 of them. For this set of firms, I merged in three geographic variables. The first variable is the Zillow Median Home Price Index. Zillow uses a repeat home price index methodology to create a standardized “apples to apples” measure of home prices that can be compared across cities at a point in time or within a given city over time. In the analysis I present below I use Zillow data from December 2022. The second variable I merge in to the Flex Index is the percent of voters in the Headquarters State that voted for Joe Biden in the 2020 Presidential Election. The third variable I merge in from the Zillow data base is the city’s size. So, New York City is the first ranked city in the nation because it is the largest city. I use these data to test two hypotheses; Hypothesis #1: All else equal, firms are more likely to engage in WFH work if home prices are higher in the HQ City. Hypothesis #2: All else equal, firms are more likely to engage in WFH in more Progressive states. To test these hypotheses, I use a linear multivariate regression framework. To standardize the firms, I include industry fixed effects (this variable is in the Flex Index database). The dependent variable is a dummy variable that equals one if the firm’s workers all work on site. In the database, 39% of the firms report having the workers work fully on site. Table One reports four regressions with each column reporting a separate regression. I use the regression output to test the hypotheses presented above. Main Results All else equal, firms are more likely to engage WFH work if home prices are higher in the Headquarter (HQ) City. Based on the results in columns (1) and (3), I find that for the full set of industries and for the Healthcare and Biotechnology industry that workers are more likely to be engaging in WFH if home prices are higher in the HQ’s city. Based on the results in column (2), a doubling of home prices is associated with a log(2)*-.088 = -.06 or a six percentage point reduction in workers working solely on site. This effect is even larger for the Health Care industry. For this subset of firms, a doubling of local home prices is associated with a 12.7 percentage point increase in WFH. For the other two industries, I fail to reject the hypothesis that firms are not more likely to allow workers to engage in WFH as a function of local home prices. All else equal, firms are more likely to engage in WFH in more Progressive states. The test of this hypothesis is based on the coefficient on the 2020 Joe Biden vote share. Across all four specifications presented in Table One, I find consistent evidence that firms are more likely to allow their workers to engage in WFH when the HQ is located in a more liberal state. A ten percentage point increase in Joe Biden’s vote share is associated with a 3 percentage point increase in the probability that a firm allows its workers to engage in WFH on at least a part-time basis. Conclusion The Flex Index is a terrific new data source that allows empirical researchers to study how different firms are incorporating WFH into their work routines. In my 2022 Going Remote book, I hypothesized that the rise of WFH would benefit workers in high home price areas. The evidence presented here supports this hypothesis. Here, I also find a Red State/Blue State divide such that firms located in Blue States are more likely to allow their workers to engage in WFH. Future research should explain why we observe this fact. Are such firms in progressive states more concerned about work/life balance and gender equality issues? There are many open questions that improved data access will allow for us to provide credible answers.
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A majority of American adults live in owner occupied housing. As an economist, I celebrate the logic of revealed preference. While many poor people are renters, many non-poor people reveal that the benefits of ownership exceed the costs. In this entry, I would like to delve into the details here. Up front, let me say that I don’t want to discuss the tax code and the nitty gritty of mortgage interest deductions, the GSEs, etc. Instead, I want to talk about why people gain life satisfaction from ownership and what are some of the hidden costs of ownership under our current “rules of the game”. As an urban economist, I want to contrast the private benefits to an adult of owning a home and the local social benefits conveyed to a community when it consists of home owners. Portfolio Risk from Home Ownership Let’s start with a personal example. Back in 2000, We purchased a home in Belmont, MA (a Boston suburb), we paid 1/2 in cash and got a loan for the rest. The cash we invested in the home had a next best alternative. We could have invested in a diversified portfolio of assets rather than making a place based bet. By buying this home, we were raising our migration costs for moving away from Boston and thus were losing some option value if the local economy performed worse than the rest of the nation. A strange feature of the housing market is that owners hold an undiversified portfolio. Imagine an alternative world where I could own 36% of my Belmont home and own 2% of 32 other homes scattered around the United States. This would be a more diversified portfolio. Of course there would be contracting issues in designing this contract. My friend and co-author Joe Tracy co-authored a MIT Press book on implementing these contracts. The Past Rate of Return on Housing for African-Americans In 2021, I released an NBER Working Paper where I use several data sets to make a simple point. Here is my paper’ abstract: “The racial and ethnic composition of home buyers varies across geographic locations. For example, Asians and Hispanics are much more likely to buy homes in California than Blacks and Blacks are more likely to buy homes in Georgia than other demographic groups. Home prices grow at different rates across geographic units such as counties or zip codes. Hedonic bundling inhibits buyers from purchasing shares of different homes and forming a spatially diversified housing portfolio. Spatial variation in purchases suggests that the average rate of return to housing varies across racial and ethnic groups. To test this claim, I construct a geographic shift-share index by combining Zillow geographic specific home price index data with HMDA micro data. The shift share calculations yield the average rate of return to home ownership by purchase year, and sale year for different demographic groups. Over the years 2007 to 2020, Blacks earned a lower rate of return on home purchases than Asians and Hispanics and the sample average. Within geographic areas, average loan differences across racial and ethnic groups are very small.” Let’s unpack this. Over the last 25 years, cities such as San Francisco, Boston, Portland, Seattle, San Jose, Malibu, and Santa Monica have boomed. None of these cities is known to be an African-American city. African-Americans tend to buy in other cities such as Baltimore, Cleveland and Detroit. What is going on here? (and of course I am telling an Average story —- LeBron James lives close to me in Los Angeles’s Brentwood). African-Americans on average have lower wealth than Whites and are less likely to be able to afford the down payment to buy housing in Superstar Cities. African-Americans are less likely to work in Tech than Whites and Asians and this reduces the likelihood that they are living in the major tech hubs. In the areas where African-Americans have ties, house prices have not appreciated much and this means that the AVERAGE African-American homeowner has earned a lower rate of return on housing over the last 25 years. Going forward (from 2023 to 2040) will Baltimore’s housing market outperform San Jose’s? This is possible. In my recent WFH Going Remote book, I present microeconomic arguments for why this is possible if Baltimore improves its quality of life. In closing this section, I want my readers thinking about opportunity cost. If an African-American family owns housing in Baltimore then that money is not invested in the SP500 stock market index. Opportunity cost for asset investments always exist. What About the Consumption Value of Home Ownership? When we teach Econ 101, we introduce our students to the utility function. This is the economist’s “thermometer” measuring how much pleasure we gain from different consumption bundles such as consuming beer or pizza. The consumer knows herself and knows her budget constraint and makes the right (affordable) consumption choice. Assuming people are consistent over time, we learn about their priorities from the choices they make as market prices and their income changes. With this preamble, why does home ownership raise one’s utility? One hypothesis is “pride of ownership”. But what do these words mean? Economists have struggled with modeling the demand for “status”. Economists have taken Veblen seriously and have sought tests of which subgroups of people seek to own and display luxury goods to signal that they are special. Here is a paper about cars and jewelry ownership. Of course, I understand the desire for status. I continue to submit papers to Top 5 journals and to track my Twitter Follower count! But, the point of this 1/2 joke is that there is an ever increasing number of strategies for producing “status”. As I age, I gain pride by reaching my Google Fit target of 10,000 steps a day. During my life time, I have lived in fancy rental housing in Manhattan, Singapore, and Baltimore. Given the changing demographics of our population, real estate suppliers will offer rental properties if there is demand. Don’t Renters Face Displacement Risk and Gentrification Risk? Yes, but if this is a serious concern then renters can sign longer term contracts up front. Scottie Pippen signed a 10 year contract with the Chicago Bulls at the start of his career because of his fear of injury. In a renter economy, there would be less support for local NIMBYism and real estate developers would build more housing and this would reduce rent rise risk. The ongoing conversion of commercial urban real estate into residential housing also reduces the likelihood of medium term rent spikes. I claim that it is time to visit this important paper by Todd and Nick. Sinai, Todd, and Nicholas S. Souleles. "Owner-occupied housing as a hedge against rent risk." The Quarterly Journal of Economics 120, no. 2 (2005): 763-789. Neighborhood Social Capital Boosts Due to Home Ownership? Ed Glaeser and Denise DiPasquale have posited a positive spillover that when real estate is owner occupied that the owner has the right incentives to maintain the property (to maintain the resale value) and to not free-ride in terms of neighborhood attributes such as safety and neighborhood greenness. Their empirical strategy in their applied research was to use panel data at the individual level and observe how the same person behaves before and after she becomes a home owner. A field experiment researcher would want to go a step further and randomly assign similar people at the baseline to renting versus owning and then observe how their home is treated and how their neighborhood’s quality of life changes over time. I greatly admire their work here but I want to be provocative and argue that their work is out of date due to technological change. I want to return to a paper by Baker, George P., and Thomas N. Hubbard. "Contractibility and asset ownership: On-board computers and governance in US trucking." The Quarterly Journal of Economics 119, no. 4 (2004): 1443-1479. These authors tell the following story. Back in the 1970s, truck drivers bringing stuff from California to Baltimore markets had private information about their routes and effort. The food company gave the truck driver a share of the profits to incentivize them to not shirk with respect to effort. The advent of cheap GPS computers meant that the food company could easily monitor the trucker and could now pay him a fixed wage. The same idea holds in 2023 for rental housing. The big data monitor era allows the property manager to have a very good sense of how the tenant is using the property and what is going on in the local neighborhood. If crime rises, the property manager can hire private guards. If litter increases, a crew can be hired to pick up the trash. Markets substitute for social capital and volunteering! Conclusion The modern Economy’s Big Data revolution and climate change risk both create incentives for more of us to be renters. Going forward if more of us are renters in the year 2040; then we gain the following adaptation benefits; #1; Our assets are less exposed to place based shocks (i.e Hurricane Ian), #2 we hold a real option to move away from areas that turn out to be at greater risk from shocks, #3 There is less lobbying for place based subsidies using national subsidies because “victims” have fewer place based assets at risk (i.e we are each holding a more diversified portfolio). If government steps back from insurance markets, the private sector will step up its game and insurance innovation will further spur the pace of climate change adaptation. If these ideas interest you, read my 2021 Yale Press book Adapting to Climate Change.
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Climate change adaptation refers to our individual and collective ability to cope with Mother Nature’s more intense weather punches in terms of extreme heat, drought, fire, flood and many other place based risks. My microeconomics research, as sketched out in my 2010 Climatopolis book and my 2021 Adapting to Climate Change books, argues that capitalism accelerates our ability to adapt as market price signals encourage substitution and innovation. Whether government policy complements the private sector muffles the private sector’s efforts continues to be a major research topic. In my 2010 Climatopolis book, I asked; “If Milton Friedman ran the U.S FEMA (and thus committed to no generous ex-post bailouts to shocked places) how much faster would adaptation occur?” In my ongoing empirical work, I continue to study how extreme weather affects our economy. I see evidence of adaptation progress as the “climate damage function” flattens and this means that the same punches thrown by Mother Nature cause less damage over time. My students are studying this hypothesis in the developing world and investigating what frictions (such as government policy) inhibit adaptation from taking place. An example would be government price supports for agriculture that create a moral hazard effect. See this 2015 paper set in the United States. My Thoughts About the Work by Two Talented New York Times Journalists The New York Times continues to be the paper of record. Two of the leading authors for the Times are Christopher Flavelle and David Wallace-Wells. I link to their work so you can read it on your own. David recently published a huge New York Times Magazine piece that you can read here. I want to keep this entry short but I plan to expand upon the themes I present below. I must acknowledge upfront that I have not interviewed either of them about their climate change adaptation pessimism. My points I present here are based on my reading of their work. How Does a “Climate “Crisis” Emerge? Global greenhouse gas emissions will continue to rise. Read our 2022 NBER paper. We do not know how much global average temperatures will rise due to rising emissions and we do not know what “crazy” weather will emerge because of what we have collectively unleashed. In a series of case studies, Flavelle argues that we have built up billions of dollars of place based capital in increasingly risky areas such as Florida that face more severe disaster risk. He emphasizes the moral hazard effect that the expectation that there will be Federal Bailouts of struck areas encourages more rebuilding in these areas. So, he is telling a story that we do not learn from our mistakes. He does not explain who is the “adult in the room”? Why don’t city urban planners, the mortgage lending industry, the real estate development industry, the insurance industry adopt new “rules of the game” so that new real estate development is nudged to “higher ground” or if we build in risky places that private actors are incentivized to invest in pre-cautions that reduce the damage caused by the next storm. Starting with my Climatopolis book, I have argued that if people make place based bets (such as investing in Miami real estate), then they should flip two sided coins. They get to keep the upside appreciation if local prices rise but they also must “eat” the downside loss if local prices decline because of rising risk and better opportunities in other real estate markets such as Boston or Houston or Buffalo. I do respect his point that the public sector activism in insurance markets is causing an important free market distortion. As the social cost of this distortion rises, economic theory predicts that political reform will take place. Why should tax payers on “higher ground” bail out risk takers over and over again? Why reward “bad behavior”? As we saw with the economy’s reorganization during the COVID crisis of 2020, markets adapt and change when new news occurs if government does not distort price signals. The rise of the Zoom WFH experiment was an amazing example of adaptation. David Wallace-Wells argues that adaptation is costly and will exacerbate existing inequality. A quote “Talk enough about adaptation, and you drift into technical-seeming matters: Can new dikes be built, or the most vulnerable communities resettled? Can crop lands be moved, and new drought-resistant seeds developed? Can cooling infrastructure offset the risks of new heat extremes, and early warning systems protect human life from natural disaster? How much help can innovation be expected to provide in dealing with environmental challenges never seen before in human history? But perhaps the more profound questions are about distribution: Who gets those seeds? Who manages to build those dikes? Who is exposed when they fail or go unbuilt? And what is the fate of those most frontally assaulted by warming? The political discourse orbiting these issues is known loosely as “climate justice”: To what extent will climate change harden and deepen already unconscionable levels of global inequality, and to what degree can the countries of the global south engineer and exit from the already oppressive condition that the scholar Farhana Sultana has called “climate coloniality”?” These are great questions but note that these are economics questions. What is the quality adjusted price of the goods we need to continue to be safe, comfortable and healthy? David Wallace-Wells owns a computer and a cell phone. These products didn’t exist in 1940. Every day they grow cheaper and become of higher quality. This is what market competition does. More poor people in the developing world can afford these products as quality adjusted prices decline. Note that Wallace-Wells is rightly concerned with poverty and the challenges that poor people will face going forward. An economist would reply to his pessimism; “okay, you are not worried about Elon Musk’s ability to adapt to new risks. Let’s rank all of the world’s population with respect to their income. Who are the people who currently do not have the capacity to adapt to the serious challenges that wacky weather is posing? What income growth would give them the opportunity to adapt? Why isn’t this income growth occurring? “ Note that David Wallace-Wells is saying that economic growth in the developing world is the key to adapting to climate change. We need poverty alleviation to help everyone to be able to adapt. Here we agree. Economic growth is the key tool for adapting to climate change. Such economic growth reduces poverty. Here is a study of global poverty alleviation by a leading macro-economist. I recognize that I am positing that national economic growth reduces poverty. Is this a controversial claim?
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This has been a very hot summer. For every person on the planet, what is her willingness to pay to avoid this hot summer? So, on a day when it s 93 degrees on average --- how much is Sally in Seattle willing to pay for this day to have been 78 degrees instead?
In a "make versus buy" economy, one can either pay God to not face the 93 degree day in Seattle or one can use a suite of adaptation strategies to cope with the high heat. Basic economic logic teaches us that one's willingness to pay to avoid the heat is bounded by what it would cost you to adapt to the heat. This blog post focuses on the microeconomic determinants of adapting to the heat.
I will argue that at any point in time, this adaptation strategy set is almost infinite dimensional and that the dimensions of the adaptation strategy set grow over time so that it gets ever easier for us to adapt to the high heat. This means that our willingness to pay to avoid facing the extreme heat actually declines over time because it is getting cheaper for us to adapt on our own to the heat. In my 2021 Adapting to Climate Change book, I expand on this point that the Social Cost of Carbon can actually decline over time for many people as their adaptation choice set grows.
Let's start with the marginal cost curve that is familiar to anyone who has taken Econ 101.
Case #1: A firm produces pizza using a linear production function such that pizza=10*Labor and the price of Labor = 2 each.
Given the linear production function, the firm can always make one more pizza if it hires .1 workers. It costs $2 per worker so the marginal cost to the firm of producing an extra pizza =2*.1 = 20 cents and this is a constant function.
Case #2: A firm produces pizza using a concave production function such that pizza=10*square root of Labor and the price of labor is .4 each.
In this case the amount of labor needed to make a pizza can be expressed as = Pizza*Pizza/100 and the $ expenditure to purchase this labor equals Pizza*Pizza/25 . This mechanical marginal cost function is convex.
Given this definition of marginal cost, now let's turn to the marginal cost of avoiding heat. Consider a person in Spain today confronted with high heat where she currently lives and works. Here is her strategy set for adapting;
#1 Move to a cooler place (either outdoors or inside such as below ground). Such migration can be permanent or temporary in an economy featuring cross-city transportation services and AirBNB short term housing.
#2 seek out a shady place with a breeze
#3 turn on air conditioning or go to a public place with air conditioning, A theme in my 2010 Climatopolis book was that if an area is known to face rising summer heat then people will change their durables and their home and work place architecture to be better prepared for the heat. We are not passive victims!!
#4 wear lighter clothing
#5 use a damp towel
#6 drink water
#7 take a Siesta and stop working during the hottest hours
#8 Eat lightly
Each of these adaptation strategies has a financial cost and a time cost. As Gary Becker taught us the full price equals the financial cost + your wage*time cost. For example, migrating will require more time and for high value of time people, this will mean incurring a larger cost.
I will stop here but note the following. Taking permutations of these various options yields an almost infinite dimensional adaptation choice set. Modern climate economics assumes that this choice set is stationary. In truth, it expands on a daily basis as we make progress building higher quality durables such as housing and air conditioning units and as we retire older capital and install newer capital. Modern economics is weak on capital updating problem. John Rust wrote a famous bus engine replacement paper but climate economists haven't incorporated this logic into the updating of the spatial capital stock. My paper with Devin Bunten is one attempt to address this issue.
Once we acknowledge that we have an ever growing set of adaptation strategies that are becoming cheaper and cheaper to use then one becomes more optimistic about the ability of the rich and the poor to adapt to the new serious challenges we face.
One example of the rising permutations. More and more educated people now have the opportunity to engage in Work from Home. These individuals can now more easily take a Siesta on a hot day. This is an example of the permutations of the strategy set listed above.
My critique of modern climate economics is that so many researchers are content to estimate reduced form empirical regressions of the form;
Person i's suffering on day j in location q = constant + b*Extreme heat on day j in location q + U
and take "b" as a physics constant. Assume that "suffering" is measured by lost income and that this can be measured by the statistician.
"b" is an interesting reduced form parameter. It represents a slope that measures at a point in time how much suffering extreme heat has caused to the average person who lives at location q at day j.
My Point is that "b" is determined by all of the factors I discussed above. As society's innovation and urban planning continues; "b" converges to zero over time and this pace of "b" shrinking from a positive number towards zero over time is a measure of our adaptation progress.
I want to see more climate economists exploring the microeconomic determinants of when does "b" change over time and when does it remain constant. Government policies that distort adaptation decisions such as subsidies will likely turn out to be a major determinant of slowing down adaptation.
As the marginal costs of climate adaptation decline, simple economics predicts that more individuals and firms will engage in adaptation (as they compare the benefits to the costs of adaptation) and as they engage in such self protection, the empirical reduced form researcher will estimate climate damage functions showing an ever declining amount of damage caused by climate change.
The Climate Change adaptation literature needs to take basic microeconomic logic about rational choice more seriously and then we will make more progress understanding the pace of adaptation and the frictions that slow down adaptation.
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Is face to face interaction over-rated? I am not talking about participating in the service economy (i.e getting a haircut), romance, friends and family interaction. I am talking about workplace face to face interactions and the vaunted "Water Cooler" (WC).The cliche WC story has focused on serendipity and spontaneity that occurs when people casually chat about this and that. This is not "directed search".POINT #1; Pessimists claim that the rise of WFH-HYBRID work will tax the Water Cooler such that organizations will become less productive.Counter-Point: The pessimists forget what they learned about self-selection. Workers know themselves, they know when they want to be social and when they want to be left alone. Such workers also respond to incentives. If the boss says; "hey , let's get our creative juices flowing". Workers will respond and be charming and engage on those days.I claim that there is quantity and quality of F2F interactions. The lazy urban economics productivity literature implicitly assumed that F2F interactions are homogeneous and are just a question of their count. So, if you meet with me 1000 times; the probability we have a breakthrough is 10 times higher than if we only meet 100 times face to face. I reject this. Anyone who has met me knows that sharp diminishing returns kick in -- -in speaking with me!POINT #2; The Water Cooler is a pre-AI, pre-UBER entity. I am interested in directed search. UBER matches drivers and riders to achieve efficiency criteria. Why can't successful firms introduce a type of UBER AI matching to bring different workers together? Why can't a boss make some recommendations about such matching?Point #3 Given successful within firm AI matching of Water Cooler Workers, why do they have to meet at work? Is the firm afraid of romance? That would be a funny reason for the persistence of the office!Point #4; Pessimists claim that we will get into a bad Nash Equilibrium such that social workers will go to the office and discover nobody to chat with as everyone else will be engaging in WFH on that day. In this age of AI Matching, can this misallocation really persist?So, to summarize this blog post; The Quality versus Quantity tradeoff always exists. Organizations have strong incentives to experiment here to see how to maintain their productivity under different organizational rules. How firms adapt to the new opportunity created by WFH is fascinating.FINAL POINT: Note that I set up this blog post such that the spontaneous face to face interactions occur by workers who work at the same firm. In this case, there is a residual claimant who has an incentive to get the rules of engagement right.What happens when workers work at different firms but work in the same city? I doubt that spontaneous F2F is that important for these folks. There isn't that much time in the day. You might say that a Harvard economist and a MIT economist can have coffee and make research magic happen if they both go to work. I accept this example but this is a special example. Do Elon Musk's Tesla engineers hang out at the local bar looking to chat with engineers from other firms?Since urban and labor economists do not have a real understanding of the production function of knowledge firms , we don't understand how the time allocation equilibrium induced by WFH will evolve over time.Of course, I do think that small firms will want to agglomerate close to each other for Labor pooling reasons but this is distinct from the gains from F2F interaction.
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Millions of American workers engaged in Work from Home (WFH) during the pandemic. WFH helped us to adapt to the risk of disease contagion. Going forward, WFH will also helps us to adapt to the rising climate risks we now face. Given that global greenhouse gas emissions are likely to continue to rise as the world’s population and per-capita income grows faster than the decarbonization of the world economy (declining GHG emissions per dollar of GNP), the climate change challenge will grow more severe over time.New climate risk modelling firms such as First Street Foundation and Jupiter are mapping the risks of flooding and fire risk that every land parcel may face over the next decades. Of course, these science based models cannot offer certainty about emerging risks but they do play a “Paul Revere” role in educating both firms and workers about new place based climate risks. You can type in any residential address here and First Street Foundation reports the property's expected fire risk and flood risk for free! Going forward, more and more property buyers will "do their climate risk homework" before making a large $ investment in a property.Before 2020, only the super rich and senior citizens were “footloose” and able to move to an area solely based on its amenities (or on its absence of risk). The rise of WFH allows more and more American workers to live where they want to live as their daily commute to work is no longer looming over where they choose to live. In our recent past, the expectation that one would commute to work 5 days a week for 48 weeks a year pinned down a worker and her family to specific locations near the corporate headquarters.Perceptions and concerns about emerging climate risks will influence where workers choose to live. Those who are risk lovers will actually be attracted to risky areas because property prices will be lower there! For those WFH eligible workers who are risk averse, their menu of locational choices will expand as they can live further from where they work.While no two WFH workers are identical, climate change will influence their locational choices. For those WFH workers who are especially sensitive to air pollution, they will anticipate that elevated fire risk in the American West will create PM2.5 spikes during summer months. They will figure out how to avoid these areas at those times. For those WFH workers who are especially risk averse, they will be willing to pay more for housing in places where climate risk modelers predict that they face less risk. Those WFH workers with niche preferences for leisure and exercise will have increased opportunity to live where they can engage in their hobby and meet like minded people.As different workers choose their own best “climate niche”, this will improve their mental and physical health and raise their workplace productivity. Surveys of young people have documented extreme ecological anxiety. The ability to choose one’s own favorite location that will be likely to attract like minded people will help them to better cope in the face of the new risks we face.If WFH workers choose to cluster in relatively safer parts of the U.S that feature less extreme heat, less drought risk, less flood and fire risk then firms will have an incentive to locate their future HQ2s and HQ3s closer to these areas. Firms will benefit from lower turnover from less burnout and greater worker satisfaction. Firms that expect that workers will stay with the firm longer have a greater incentive to mentor and invest in such workers. Firms will use their corporate data on the location of their workforce and can use this information to decide where to open up HQ2s and HQ3s. An old idea in urban economics focuses on the “chicken and egg” issue of whether people go where the jobs are or whether jobs move to where the people are. In our emerging economy where more WFH are footloose, they will increasingly take into account the emerging climate risks and move to relatively higher quality of life areas. As firms see these spatial clusters, the leadership can open up HQ2s closer to these worker hubs to increase face to face interaction and to buildup the company’s corporate culture.Some worry that the rise of WFH is elitist. As new WFH clusters form in climate resilient places, there will be an increased local service sector demand. This creates a local multiplier effect. Well paid WFH workers will need local teachers living nearby, dentists, repair people, and there will be jobs in construction. This increased local labor demand in a relatively high quality of life area featuring lower rents than in the Superstar Cities offers new opportunities for non-WFH eligible workers.Today, more educated people are more likely to work in industries and occupations that are WFH “friendly”. If WFH facilitates adapting to climate change and facing less climate risk, then this creates an extra imperative for improving American education so that more young people can have the option to engage in WFH when they are older.Before 2020, America’s most productive places were located in areas that face emerging risks. There are worries about flooding in New York City and wildfire risk affecting the American West. WFH accommodates our diversity. Millions of workers will have the personal freedom to live where they want to live and this will reduce their stress during a time of rising risk.Matthew E. Kahn is the Provost Professor of Economics at USC and the author of the New Book Going Remote. This piece presents some ideas from his new book.A Postscript: Back in 2016, a prominent University of Chicago economist (who does not have a PHD from Chicago!) told me that snowstorms disrupt Chicago's productivity. I countered that I bet that he is even more productive on those days because he didn't go to work and nobody bugged him on such a day. He just looked at me. Flash forward to 2022 and I am even more confident about my 2016 comment. The WFH option is now available to more and more highly educated people and they can "reoptimize" when a day turns out to be nasty to still be able to "seize the day" and get work done. Of course a snowstorm can disrupt a dentist appointment but for more and more of the key tasks in the modern economy, these can be done "anywhere" and a footloose population will each make decentralized decisions for how to make the best of that day before the weather goes back to normal. The reduced form empirical researcher then observes that the same Chicago snowstorm causes less economic damage and this is the empirical benchmark test that adaptation is taking place! Mother Nature's punches cause less damage over time in an economy enjoying adaptation progress.
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I joined the USC Economics faculty in 2015 and Romain Ranciere also joined that year. Permit me to list the impressive scholars who have subsequently joined our faculty.
In July 2022, a star theorist will join our department as our newest hire.
USC fascinates many people. This list highlights that the hype about us is earned. Note that we continue to build up strength in micro theory, macro, econometrics and applied micro. A balanced, optimistic department.
The next piece of the jigsaw puzzle is to build up a PHD program that trains and places students to achieve their career goals.
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The Los Angeles Times rejected my piece that I present below. Of course, I'm trying to sell my new 2022 Going Remote book!!
The New New Geography of Jobs
LeBron James joined the Los Angeles Lakers in 2018. He wanted to live and work in Los Angeles. How many of us have compromised as we live in a place because our work is nearby?
Going forward, a silver lining of the pandemic is that more and more of us will have the option to live where we want to live as we engage in WFH on either a part-time or full time basis. How will this new freedom affect our quality of life?
More educated workers are more likely to be working in occupations and industries that are WFH “friendly”. While a surgeon cannot work from home, a book author can. More and more people have learned due to our experience we gained from the COVID lockdown that we can be quite productive while working at home.
WFH workers reduce their weekly commute time. The rise of WFH allows for staggered work hours removing many peak commuters off the roads. The typical WFH worker saves perhaps 5 hours a week in commute time. Will traffic speeds increase for everyone else? This depends on whether more drivers take non-work related trips when road speeds increase.
WFH workers will have increased freedom in their lives to exercise more, to spend more time with children, to participate in family chores and to co-ordinate their leisure time with their nearby neighbors and friends. This opens up the possibility of new civic engagement. On days when a child is sick or bad weather days, the WFH worker can be productive and caring while at home. This opportunity reduces one’s stress and improves one’s mental health.
In 2021 and 2022, economists have used U.S Postal Service change of address data to study migration patterns. We are already spreading out. People have been moving to the exurbs and bidding up home prices there. People will move to areas where they want to be now that they are “untethered” and can live where they want to live. People who love to ski will move to such areas. Those with an aging mother may move closer to her without facing the same labor market penalty as before the rise of WFH. The ability to seek out cheaper housing will allow families to achieve their goals. One economic study argued that when people live in larger housing that this causes them to have more children!
During this time of deep concern about inequality, will WFH be elitist such that those who are not WFH eligible will be left behind and housing will become unaffordable in areas far from the cities? While these are open questions, economic logic offers several insights. First, with the rise of new WFH communities, there will be a local demand for the service economy as construction workers, teachers and restaurants will be in demand. For those non-WFH workers with a taste for the area’s lifestyle, new opportunities will emerge. Second, home prices do not have to soar in the medium term if real estate developers are allowed to build new housing in these places that have plenty of land. American’s NIMBYism could be a key constraint on how the rise of WFH affects our nations’ geography.
Consider California. Our state is suffering from drought right now and features extremely high home prices. Farmers consume over 75% of the state’s water. If some farmland could be rezoned as suburban housing, then water consumption would decrease and the supply of affordable housing would increase as that land is converted into housing. The rise of WFH helps our state to adapt to climate change and to increase the supply of affordable housing!
Third, our cities feature many durable buildings. If many WFH workers “head for the hills”, this opens up new possibilities for those who want to live in a San Francisco or a Boston to find housing there. This possibility only grows if commercial real estate in these areas is converted into residential buildings.
In the medium term, the rise of WFH opens new opportunities for parents of young children. In the past, many women opted out of the workforce to raise children. WFH opens up the possibility of working part-time for one’s firm while the kids are young. A firm that anticipates this dynamic will continue to mentor such young female workers and this will close the gender earnings gap. In the past, women disproportionately entered fields such as being a pharmacist because of the job’s flexibility. WFH opens up the possibility of more flexibility and thus accommodates our diversity.
In the past, African Americans were under-represented in the Tech Sector. Relatively few African-Americans live in tech cities such as San Francisco and Seattle. Few tech companies have headquarters in Baltimore or Detroit. The rise of WFH raises the possibility of the “best of both worlds”. One can live in Baltimore and work and physically appear from time to time at Amazon HQ2 or a future HQ3. Such tech firms will be able to attract a more diverse workforce and depressed cities such as Baltimore will attract role models who boost the local tax base.
A “New” New Geography of Jobs is now emerging. Those firms that recognize this point will build a stronger, more diverse and more loyal workforce. Those places that compete to attract such workers will enjoy growth and an influx of new blood.’. A stronger America emerges as people can live where they want to live and change their schedules to meet their goals and responsibilities.
