In this new 8 minute YouTube video,  I talk through one of the most important insights in modern transportation economics.   John Kain and Don Pickrell and Peter Gordon consistently pointed out the bad incentives that urban politicians face for "just saying no" to irreversible, highly costly infrastructure projects.   For those who wonder what is the source of my ideas, let me tell you a secret.  Listen to this 2005 live Cream concert and your mind will just flow.

The WSJ reports that Chinese investors are building residential housing in New York City targeted to Chinese mainland buyers.   This doesn't appear to be ethnic favoritism.  Instead, the developers want less risk where the risk is that they will build a building that will remain vacant and commitment by Chinese buyers to purchase units both reduces risk for the developer and creates a Chinese community  in the new building.  This is an example of endogenous attributes in differentiated products.  Consider the case of Mercedes cars. If this luxury car was only purchased by losers, would Mercedes be a "great brand"?  IO economists are still wrestling with how to model the demand for differentiated products in cases in which the average characteristics of the buyers of a product becomes another attribute of the product.  Multiple equilibria can arise in this case.  Pat Bayer and Chris Timmins of Duke have studied this problem.  See their Economic Journal paper.   The Chinese investors have figured out how to exploit this to their advantage.

There is also a piece about Los Angeles real estate focused on Playa Vista.  When you land at LAX, you see a huge vacant space with no economic activity.  I have often wondered why it didn't fill in with development. This piece focuses on this dynamic.   In the past, you could have argued that the airport is noisy and this is a major disamenity.  Dan McMillen has documented that new generations of airplanes are much quieter.  Quality can offset quality of life challenges in cities!  For an example, here is my paper on California air pollution trends.

UPDATE:  My short YouTube videos on key ideas in environmental and urban economics are posted here. 

Academic economists are well paid by their universities but many superstar academics do additional consulting.   If President Obama raises the marginal tax rate on the high earning economists,  some of these economists will act like economists and will substitute away from discretionary consulting as the after tax wage from consulting declines. Assuming the substitution effect dominates the income effect (i.e that labor supply slopes up), these academic stars may actually do MORE academic research.  I recognize that they could simply take more leisure but for most academics leisure and academic research are perfect substitutes. If these superstar economists return "to the game" and get the "eye of the tiger" back (think of Rocky III) , economic research progress will accelerate and there will be a positive externality for the academy and for society as a whole.   Junior faculty will learn more from their newly engaged senior colleagues and graduate students will learn from the Jedi Masters.  The stars had no incentive to internalize this Lucas/Romer externality but the rise in the marginal tax rate helps to correct this market failure.

So, the point of this blog post is that an unintended consequence of raising taxes on the rich will be an acceleration of progress in academic economics.  This excites me!

Permit me to make a bad analogy:   Abortion is to Consulting as Crime is to Economic Research.

Huh?

Donohue and Levitt famously argued that legalized abortion reduced crime.  They argued that a small set of criminals create a large share of crimes.  If these folks aren't born then less crime takes place.  In the case of academic economics,  a small set of economists produce most of the research.  If these men and women are diverted into consulting then total research declines sharply.  A tax increase has the reverse effect as the stars are nudged back into the game.

UPDATE:   I should have noted an implicit economic incidence assumption that I'm making here. In the discussion above, I assumed that the superstar consultants bear the full incidence of the marginal tax increase. I recognize that if their skills are inelastically demanded by law firms and by other firms who employ consultants then these firms will bear the incidence and the superstar consultants will experience no reduction in real wages when the marginal tax increases.   If both the superstars and the employers each bear part of the incidence then the academic research community will gain if the superstars have a large elasticity of labor consulting supply as a function of the real after tax consulting wage.

The NY Times reports that the great drought is causing the Mississippi River to retreat and this means that big boats can't use it to ship goods because they will hit the ground on the bottom of the river.  As the self appointed world's leading optimist about how capitalism evolves to help us cope with climate change's consequences, permit me to offer a few thoughts.

First, let's not forget increasing returns to scale.  The shippers of fertilizer and other products are attracted to shipping products to final consumers using this river because the transport cost per $ of sales is low.  If the option of shipping by boat vanishes, and no rail road tracks are around, how will fertilizer sellers adjust?  Truckers and smaller boats will fill the void and the profits of fertilizer sellers will fall and the price per pound of fertilizer will rise.  Who bears the incidence of this shock depends on the elasticity of these supply and demand curves.

Let me point out a silver lining from this climate change induced effect. I predict that farmers will use less fertilizer in the Midwest as the price rises and the nitrogen cycle problems and the Dead Zone in the Gulf of Mexico will be partially mitigated.  Farmers will figure out how to grow output with less fertilizer.    For environmentalists who haven't studied general equilibrium theory, this is an obvious prediction from standard supply and demand models.

History doesn't have to repeat itself. Just because farmers are used to buying their fertilizer from some guy who shipped it on this River doesn't mean that in the future this pattern must persist. Perhaps this shock will give a boost to organic farmers who don't use synthetic fertilizers. 

For you environmental economists, note that I'm making a Porter Hypothesis style point. In the Porter Hypothesis, regulation nudges profit maximizers to take a fresh look at their business choices and some of them discover new approaches that lower their cost of production.  In a similar spirit, I'm arguing here that climate shocks shake up the status quo and force firms within the farming industry to re-optimize.  In a diverse world, some will be more nimble than others but I don't care about such distributional effects.  The winner of this adaptation competition will have good produce for us and we will eat it.

This is a blog post about climate adaptation and a spatial separating equilibrium played out in a sequential game.  In this game, government must make a choice to either embrace benevolent paternalism or engage in tough love.   There are two types of people.  One type is called "Mr. Spock" and the other is called "Homer Simpson".   After government has chosen its actions and after each type has chosen its action, Mother Nature then makes a move (a Hurricane Sandy or no Sandy) and payoffs are observed.

To keep this non-peer reviewed blog post short, I assume that a person's type is exogenously determined and that 50% of the population are Spock and 50% of the population are Homer.  The Mr. Spocks are 'University of Chicago" rational expectations men and women who form actuarial probabilities over random variables.  The Homer Simpsons are UC Berkeley behavioral economics people who are naive and do not update their probabilities of disaster as new information about climate change arrives.

The Chronology of this game is the following;

1.  Government chooses to defend the coast or not.
2.  People choose whether to live on the coast or not
3.  Mother Nature chooses to inflict a "Hurricane Sandy" on the coast.


Case #1:  A Low Cost Adaptation  Equilibrium:

Government chooses to not defend the coast.
The Spocks are risk averse and aware of the risks that the coastal city faces and they move to the "Higher Ground" safe city.  (We could make this model fancier if we allowed the Spocks and Homers to differ with respect to their love of living near the coast.  In this case, the subset of Spocks who love coastal living might live there even as the climate risk increases).
The Homers are naive but they know that the Spocks are smart and they engage in Banjeree herding and follow Spocks to Higher Ground.
In this case, regardless of whether Mother Nature inflicts a Sandy, no real damage is caused because
of the private self protection of migrating to the safe city.    The losers in this case are the land owners in the coastal city who will suffer a loss in asset value as aggregate demand falls.


Case #2:  The Darwin Equilibrium  (the spatial separating equilibrium)


Government chooses to not defend the coast.
The Spocks are risk averse and they move to the "Higher Ground" safe city.
The Homers drink their beer and ignore the pending danger and remain in the pretty coastal city.
In this case, if Mother Nature doesn't inflict pain, the Homers laugh at the Al Goreish Spocks for being Chicken Littles.  If a nasty Sandy Storm does take place,  the Homers suffer and the Spocks repopulate the planet.

Fear of Equilibrium #2 nudges the benevolent paternalists to invest national $ to protect the coastal areas in step #1.  This nudges some Spocks to remain in the coastal area and this is the moral hazard margin.


Case #3:  Climatopolis Logic 

Critics of my Climatopolis book have argued that I believe in  "every man for himself" in a sort of law of the jungle.  This is false. I want men and women to use decentralized free markets (where people do interact) to work to help folks to adapt.

If the Spocks anticipate that the Homers have placed themselves at risk by ignoring the increased risk of a major Sandy Storm, then out of entrepreneurial self interest, they have strong incentives to develop products to help the Homers live on in their risky coastal area.  Depending on the timing of how the shocks arrive, these Homers will have the time and motivation to purchase such products. This is endogenous innovation at work as an adaptation tool.  Researchers and environmentalists have not explored this channel.

If the "Homers" are too silly to recognize that they have made a risky choice that is growing riskier over time, then the Red Cross and other volunteer groups can work to help to protect this group.  The key issue here is whose $ is used to protect this group?  I do support benevolent paternalism in terms of using the zoning code to discourage individuals from living in the riskiest areas.   We are about to face a very interesting case of "buyer beware".  Do you view adults to be adults and thus responsible for their decisions?

In the second economy I presented above the Homers who live in the coastal city have their lifestyle subsidized by the Spocks who live in the safe city and pay national taxes.  The government Sea Walls are funded with national (not local) tax dollars.  When people go bungee jumping, do they expect a similar subsidy?  What is the difference between these different risk categories?

Academic geographers use remote sensing techniques to measure the "footprint" of growing cities.  From outer space, you can identify how much land area a metropolitan area such as Cairo or Boston takes up and how this changes over time.  Researchers such as Yale's Karen Seto track these footprints.

Today's NY Times has an article focused on urban growth in the Amazon Brazil's new cities.  In this case, there is a significant global environmental externality associated with urban growth.   Why?  Don't forget the concept of opportunity cost.  The land that is urbanized used to be tropical forests and these forests sequester significant amounts of carbon dioxide and this reduces global GHG emissions.  As these cities grow, a type of increasing returns to scale takes place and such growth may stimulate even more growth.  This is likely if the growing cities have increased political clout and can attract national subsidies for new infrastructure such as roads.

Given that there is a global negative externality associated with Amazon urban growth, what is good public policy?   Should the United Nations collect global funds and pay the Brazilian government to encourage urbanization away from the Amazon?  Should the UN help the Amazon cities to grow vertically so that their land footprint doesn't grow?  Cities such as Singapore and Hong Kong have shown how millions can be stacked in relatively small land areas.   Have urban planners in LDC nations been thinking about how to build vertical cities so that the city can achieve the win-win of urban growth without embodying a large land footprint?  

The incentive problem here is the property rights and protection for the Amazon's forests.  These are global public goods. If these were private property, the owner would internalize the $ benefits the world enjoys from carbon sequestration and he would be paid for these benefits.  Right now, the world is free riding on Brazil and the self interested urbanites in these growing cities have no incentive to internalize the externality their urban growth causes.    Public property gets trampled.  Even hippies now understand why we need fences.

Self interested people have an incentive to form their best guesses about the probabilities and impacts of different future scenarios.   Climate change poses some trouble here because it creates a "non-stationarity" in the sense that the random variables (the impacts of climate change) have means and standard deviations that change over time.   Intuitively, how do you plan to hit a moving target?    If the bullseye target never moves, where your darts land is still a random variable but you know how to practice.  How do we adapt as the target moves?   Professor Rumsfeld has taught us that when you "know that you don't know" what to expect, the prudent person builds some slack into their decision so that they don't regret their choice some time in the future.

With this background, let's consider two pieces in today's NY Times.  First, we hear from the President of Tulane University.  Universities are place based and his University is in New Orleans. He has strong incentives to argue that his University (which was horribly injured by Katrina) is back and is robust in the face of the next storm.

Source:




In my Climatopolis, I argue that it is fine for New Orleans to rebuild if the investors there use their own $.  President Cowen forgets that billions of federal tax payer dollars were used to rebuild his University's city.  That's bad incentives.

Note that at the end of his letter he engages in some public relations to signal to outsiders that New Orleans is now safe. I hope he is right.

A more salient and optimistic example of rational expectations is provided in this piece .  The boss of this firm was prudent enough to build his key floors 4 feet higher to reduce flood risk.  Here is a quote that highlights how we will adapt to climate change:




This case study highlights the key adaptation recipe.   Note that if we are "behavioral agents" who do not engage in forward planning then we have a problem.  Such individuals will not have taken the precautions that Sims Metal Management took.  This point has not been discussed by academic economists but in my Climatopolis I argued that climate change planning poses the ultimate test for distinguishing whether neo-classical economists or behavioral economists have the right model of predicting human behavior.   The "doom and gloomers" embrace both a behavioral economics view of individual rationality and a benevolent paternalistic view of government.  That's quite a statement.

UPDATE:  Contrast the company I discussed above, with the New Jersey Transit Authority.   Here is my source and here is a quote:

"Less than a month after Hurricane Sandy damaged nearly a quarter of its rail cars and locomotives, New Jersey Transit is facing withering criticism this week for keeping much of its equipment in low-lying yards during the storm, despite forecasts of potential flooding."

Do you have to be a genius to think about choosing another site for the rail cars?  A cynic might ask if the NJT would have been more likely to have figured this out ex-ante if it had been using its own $ rather than tax payer $.   Moral hazard lurks and the absence of moral hazard (i.e using your own $) tends to focus the mind!!  

You don't have to be Darwin to see that forward looking companies and decision makers will be rewarded by Mother Nature for being smart.  This is evolutionary capitalism at work.   Sink or swim sounds rough but such "tough love" creates strong incentives to change your game and adapt.

Three days on the beach in Carpinteria, California is a good way to clear one's mind.   While there was some fog today, the other two days featured blue skies and 70 degree days.  For a guy from NYC, I'm not used to that weather in late November.

For those of you who don't live in California,  this photo will provide some insights into the view and the life.


With my three days on the beach now behind me, I'm ready to work.  I will fly to Boston in early December and this will provide me with a sense of what I'm missing on the other coast.

There are three very good articles in today's NY Times focused on climate change adaptation.  First, there is an article on how to use solar power as a backup electricity provision technology when power lines fall down. Second, the Arts section discusses several ideas related to flood barriers.   Finally, the Science Section discusses engineering solutions using balloons to protect the under ground subways from future flooding.   I see endogenous innovation and experimentation taking place. This is the "small ball" of climate change adaptation.  This is the "micro foundation" for how our cities will continue to thrive in our hotter future.  

The World Bank's core mission is to foster equitable economic growth in the developing world.   I have always assumed that its research team were fans of free markets and capitalism's amazing ability to provide opportunities and possibilities.   But, I have now read this report on climate change's impacts and I can't find a single sentence focused on how capitalism will help LDC nations to adapt to climate change.  Strange!   It is also noteworthy that Section 6 (which focuses on sectoral impacts) discusses Agriculture, Water Resources, Ecosystems and Biodiversity, and Human Health but skips urbanization!  Yet in 15 years, over 60% of the world's population will be living in cities.

International trade in goods, ideas, agricultural products, capital and labor will help many nations  to adapt to the new climate realities.  I have spoken at the World Bank about these topics but apparently my work has not influenced the Bank's thinking on this topic. I will repeat again my key thought.   The World Bank should focus on supporting free international markets and then it can be more confident that the costs of climate change will be lower.

As I read this WB document, I see a science document with no discussion of how the 7 billion self interested people on the planet will respond to the "news" embodied in this report.  The anticipation of a challenge gives rise to ex-ante investments and coping strategies that mitigate the sting of the blow.  Intuitively, if you see the punch coming you duck!   At least based on this publication, the World Bank views the developing world as passive victims here.    Here is a direct quote from the piece:


"Largely beyond the scope of this report are the far-reaching and
uneven adverse implications for poverty in many regions arising
from the macroeconomic consequences of shocks to global agricultural production from climate change. It is necessary to stress  here that even where overall food production is not reduced or is  even increased with low levels of warming, distributional issues  mean that food security will remain a precarious matter or worsen  as different regions are impacted differently and food security is  further challenged by a multitude of nonclimatic factors."

I will let you explain to me what this vague paragraph means.

A brief examination of the references to the report indicates that only 4 economists are cited in this report. I congratulate Josh, Matt, Wolfram and Michael for being cited here!


Schlenker, W., & Roberts, M. J. (2009). Nonlinear temperature
effects indicate severe damages to U.S. crop yields under
climate change. Proceedings of the National Academy of Sciences, 106(37), 15594–15598. doi:10.1073/pnas.0906865106


Zivin, J. G., & Neidell, M. J. (2010). Temperature and the Allocation
of Time: Implications for Climate Change. Cambridge, MA.
Retrieved from http://www.nber.org/papers/w15717



Apparently 200 years of economics research has yielded only 2 relevant papers on this subject!  Interesting!

To my many friends at the World Bank I must ask,  given how many talented Ph.D. economists you have on payroll, do any of you have anything to say about applying basic logic from microeconomics to thinking about climate change adaptation?  I know that you can buy a cheap copy of Climatopolis on Amazon.  Should I subsidize such a mass purchase?