Thursday, February 28, 2013

The Preface to the Paperback Version of Climatopolis

Back in September 2010 when Climatopolis was first published, climate change adaptation was not a politically correct topic for conversation.    I wrote this book because I anticipated that neither the United States nor China nor any other growing nation would reduce its greenhouse gas emissions.  Urban growth causes greenhouse gas emissions to rise but city living offers us our best chance to adapt to the new challenges we will face.

Political conservatives dismissed my book as silly because climate change was not a serious issue.  Liberals dismissed my book as dangerous because any talk of successful adaptation would lull political moderates into opposing costly carbon mitigation strategies such as raising gasoline taxes.   

A silver lining of the horrible damage caused by Hurricane Sandy in late October 2012 is that a serious national debate has begun focused on how we protect urban people and urban places from the “known unknowns” posed by climate change.   To protect coastal urbanites, should we fortify coastal cities or encourage individuals to move to higher ground?  Should federal tax payer money be used to protect such cities?  What role will the private sector play in creating new products to help us to adapt to the “new normal”?   Will government efforts to protect cities potentially backfire and place more people at risk from “fat tail” events posed by Mother Nature?  Climatopolis embraces a free market environmentalism viewpoint to answer all of these questions.    At a time when free market capitalism has been blamed for causing the Great Recession and increasing income inequality, I argue that capitalism offers us the opportunity to rebuild our cities to increase our resilience and quality of life despite the serious challenge we have unleashed. 

Climate Change Adaptation: Places vs. People

Since people and cattle can migrate, if climate change causes increased drought risk and this injures Plainview Texas, then activity will migrate away to a safer, higher quality of life place.  As I discuss at length in Climatopolis, migration is an insurance strategy against placed based risk.  It creates incentives for areas to compete to climate proof themselves to attract resources.   The net effect of this spatial competition is that it will be easier for us to adapt to climate change than pessimists claim.

Here is a quote from the NY Times article cited above;
"Now those families have been fractured as some relatives stay in Plainview and others leave. Dozens of former plant workers have already moved, finding new jobs with the plant’s owner, Cargill, or other companies outside Plainview or outside the state, many pulling their children out of the town’s 12 public schools. When workers receive their last paychecks in three weeks, the question is whether they will stick around. And then, the more existential question, can the town survive without those who leave?"
Yes, shocks cause short run adjustment costs.  The NY Times is saying that there was place based social capital that has been dissolved as people leave the community.  There is truth to this statement but can the NY Times place a value on "town survival"?  Was Plainview such a great town?  This is similar to the exercise that environmental economists do when they conduct a contingent valuation study to price the existence value of some environmental asset such as the Grand Canyon.

The NY Times has a very pessimistic view of people's ability to change and adapt.  This newspaper appears to be saying that like was great in Plainview and that climate change ruined the Garden of Eden.  Was that true?  What evidence could be collected to substantiate this claim?    

Wednesday, February 27, 2013

Excellence in Refereeing

At the age of 47, I'm still sending about 6 different papers a year to journals for publication.  Yesterday, I had a paper rejected based on a truly silly referee report.  So, today I take some pride that the Quarterly Journal of Economics thinks that I'm a good referee.  Here is the list of the 2012 QJE Excellence in Refereeing team.

Would Dennis Rodman Be a Good Dean of the Fletcher School?

I spent several happy and productive years on the faculty at the Fletcher School at Tufts University.  As I understand it, the School is searching for a new dean.  This NY Times article about Dennis Rodman's visit to North Korea suggests that he could be a good candidate.  

Tuesday, February 26, 2013

Back to Work

Traffic congestion in LA is nasty.  In West LA, many people have nice homes that they have configured into their own pleasure palaces.   The road traffic and the nice homes have nudged many people to work at home.   Many LA workers have their own firms and the firm is based in their house.

But, what about workers who work for "real" companies?  In this age of the Internet, wouldn't you expect that many of them would want to telecommute?  There could be gains to trade between the firm and worker as both might want the worker to telecommute.  If such workers can be motivated to avoid shirking then the firm needs less real estate and the workers can be paid less (because they aren't losing time to commuting).

But,  today  Yahoo has announced that workers must come back to work.  This is another data point for Glaeser's 1990s vision that information technology would increase the demand for face to face communication and hence strengthen cities (i.e the corporate headquarters).   Nick Bloom et. al. have run a field experiment in China documenting the productivity gains for a call center that allowed workers to telecommute.

What this literature needs is to investigate the productivity effects of working from home for different types of jobs.  If higher wage workers have a higher value of time, then they should prefer working at home more.  Conversely, it is possible that higher wage workers already live closer to their jobs because they value their time more and can afford more expensive housing.  This raises the question of how workers jointly choose their place of work and place of residence. If they knew they could unbundle the two because they could work from home, would they have lived in a very different neighborhood and home?

Sunday, February 24, 2013

Acemoglu vs. Henry: Institutions vs. Policy

This NY Times profile of NYU Dean Peter Henry nudged me to track down his 2009 AER P&P paper that contrasts the economic performance of Barbados vs. Jamaica.   Here I quote the paper's witty conclusion:
"It may be tempting for readers to regard this paper as a quaint tale of two exotic islands better known for their beaches, music, and Olympic sprinters than their significance in the global economy."
Peter argues that macro policy (not institutions) explains why Barbados has outperformed Jamaica.   The Acemoglu research agenda needs more data points.   There were only 63 colonies studied in the original AJR paper.     If researchers start to test for "heterogeneous effects" of institutions by continent and other observable factors then the "large sample" of 63 colonies will suffer from a curse of dimensionality and there won't be enough data to test hypotheses.

If you'd like to see another pairwise comparison, here is a paper that contrasts Croatia and Latvia.

Saturday, February 23, 2013

A Saturday at USC

I don't drive.  I have a license but I haven't driven 1 mile in the last 5 years.   Los Angeles is a car town so this means that when I have to go somewhere somebody gives me a lift.  At 815am this Saturday morning,  I took a 25 minute cab ride from Westwood to USC.  As I walked the USC campus, I took this photo.

I sat down at a bench and graded ten of my students' essays (there are 100 registered students).  Each of them had written a memo related to a REEP paper they had read and thought about.  I could have graded more but I got tired of reading them.  I walked into the lobby at the Sol Price School of Policy at USC and was immediately recognized by one of my past UCLA students who is now a graduate student at USC. She asked me if I had joined the USC faculty and wanted to know why I was there at 845am on a Saturday.  I told her that I didn't think that I had joined the USC faculty but that there certainly exists an offer such that I would.   Having been one of my students, she knows that I think "at the margin".  I then went up to the third floor and participated in the morning Agglomeration Conference.   Jenny Schuetz presented the first paper of the morning.  She presented new research findings investigating the determinants of where retail stores open in California metropolitan areas.  Under what circumstances would a Walmart open near the Staples Center?  I then presented the last paper of the morning focused on urban governance in China.  Here is the paper's title page:

Incentivizing China’s Urban Mayors to Mitigate Pollution Externalities: The Role of the Central Government and Public Concern

Siqi Zheng
Tsinghua University

Matthew E. Kahn

Weizeng Sun
Tsinghua University

Danglun Luo
February 2013

This paper will soon be submitted to the Regional Science and Urban Economics issue that honors John Quigley.  The USC Seminar participants offered some terrific feedback and our paper will be stronger because of it.  Richard Green was the paper's discussant and several of my other old friends made a number of great points that we are now working to incorporate into our revision.   As I argued in the seminar, empirical studies of "leadership" will become a growing research topic.  Think of your own University, how do you know that your Dean or President is a good leader?  What empirical evidence would convince you of this (besides for receiving a raise!)?   In our paper, we explain why China's new rules of the game raise our optimism about Mayors stepping up and being better leaders with respect to environmental protection.  


Friday, February 22, 2013

Face to Face Interaction and the Creation of New Ideas

First, I want to plug my new Ziman Center short piece on commercial electricity consumption.  Now, I'd like to turn to a quick case study of why amenities and conferences are complements.  Over the last two days, the Federal Reserve Board of San Francisco and UCLA have partnered to throw a very successful conference focused on "Housing and the Macroeconomy".    For the last two days it has been 70 degrees, sunny and blue skies in Westwood.  Perhaps because of this, an excellent set of economists showed up.   My old friend and co-author Joe Tracy participated.   As Joe and I talked throughout the conference, we sketched out a new paper we are planning to write together. He taught me a couple of things related to the social cost of the Great Recession as the plunge in home owner equity affects their investment patterns.  This got me thinking and now we have a plan to write something serious.  If we hadn't started talking at the conference, we wouldn't have written this paper.  Progress not regress!

Tuesday, February 19, 2013

Conflicts of Interest and the Scientific Discovery Process

The Journal of Economic Perspectives has published a fascinating piece about a high stakes competition that took place in the early 1950s in academic economics.  The author concludes that Lionel McKenzie merits much more credit for his research on general equilibrium than he has received.  The good news is that in this age of Google and "thick international markets" in economics that this "inside baseball" couldn't happen again.    

Monday, February 18, 2013

When Do Economists Oppose Shovel Ready Infrastructure?

Matt Turner and Giles Duranton wrote a nice AER paper arguing that in the absence of road pricing that new urban infrastructure (such as highways and bridges) does not reduce traffic congestion.  In today's NY Times,  Turner has a smart quote focused on his pessimism that a billion dollar investment linking Kentucky and Indiana will have a key quality of life impact. This is a nice example of "trickle down" economics.  Turner's nerdy AER paper has real world policy implications.   Too many cynics seem to think that economists focus on abstract issues.  In reality, our work is highly policy relevant but it is often the case that policy makers have already made up their minds about which ribbon cutting events they want to participate in and they are looking for fancy Ph.D. economists to rubber stamp their dogmatic vision.   Simple common sense suggests that irreversible costly infrastructure is most valuable in growing areas.  I'm not convinced that this part of the U.S is growing slowly because it doesn't have infrastructure.      Even in this age of Keynes, we still need to double check that the expected PDV of Benefits of a given project > Expected PDV of costs

Friday, February 15, 2013

Eric Cantor's Corner Solution for the NSF's Social Science Budget

House Majority Leader Eric Cantor wants to offer the social scientists a NSF budget of $0.  He is a smart man who argues that there is an opportunity cost to giving the "wacky" social scientists $250 million a year.  He argues that the scarce $ could be handed to "real scientists".   He writes:

Republicans and ScienceTo the Editor:Paul Krugman paints Republicans as anti-science (“The Ignorance Caucus,” column, Feb. 11). Unfortunately for Mr. Krugman, facts don’t support the allegations. The effort to double funding for medical research at the National Institutes of Health began with Congressional Republicans. It was the Republican House alone that in November passed legislation ensuring that foreign-born students educated in the sciences at American colleges and universities have the opportunity to remain in this country and contribute to our nation’s scientific endeavors.
Mr. Krugman singled me out for criticism because I proposed increasing medical research funding to help save lives by reducing funding for lower-priority programs like social and political science research. Government can’t afford to pay for everything, and governing is about making choices. 
The National Science Foundation finances important research helping find cures for devastating diseases. But the foundation has only enough funds to support 15 percent of the applications it receives for research grants in the biological sciences. Yet we spend nearly $250 million annually on research in the social, behavioral, economic and political arena, such as a recent $266,821 grant to figure out why voters chose the candidates they did in the 2010 election. This money could fund another 1,000 grants in life sciences!
Reprioritizing government’s existing spending to favor saving lives over more political science research is not anti-science; it’s common sense.
ERIC I. CANTORWashington, Feb. 14, 2013The writer is the House majority leader.

So, the issue here is whether the best economics project is better than the marginal science project.  This raises a fascinating point.  The cost to the NSF of a science grant or an economics grant is measured in $ but the benefits of both types of grants are hard to measure and are they comparable?  This is a classic "apples" to "oranges" comparison issue.

Recall the definition of a corner solution.

Suppose that you gain utility from eating pizza and drinking beer so that your utility = pizza + beer

Suppose that you can use your scarce time to make pizza or to make beer.  God has given you 1 hour of time and your production function of pizza = 10*minutes spent making pizza while your beer production function = beer = 2*minutes spent making beer, your time constraint = 60 = minutes spent making beer + minutes spent making pizza.

You can immediately see that the solution is a corner solution. You will spend 60 minutes making pizza and will devote 0 minutes to beer.  Eric Cantor is making the analogy that life sciences is to pizza as economics is to beer.   Is he right?

While I can't speak for the other social sciences, I think that the economist have earned their small pie.  Milton Friedman taught the world how to fight hyperinflation.   Prescott and Kydland taught the world about the power of credible rules over discretion.   Heckman has offered some social value through his research on human capital formation.   By funding economics, the NSF raises the probability that excellent minds enter the field and remain academics (rather than becoming full time consultants) --- this creates some option value that some future economics superstar may help to elevate our humble craft to being a "real science".

I actually think that Cantor's remarks will create a healthy marketing approach as economists will be forced to explain how we are socially useful people versus just being another set of rent seekers.  Fellow economists, how do you increase the pie?

James Heckman's 30 Second Media Clip on Investing in Kids

Who can oppose a public policy that causes economic growth and reduces income inequality?  In this NBC clip, Jim Heckman concisely makes his case for early interventions.   The only problem with Dr. Heckman's solution is that the investment's effects will only be observed in the medium term and policy makers want instant results.   I would suggest sharply raising the gas tax and using this revenue to finance Heckman's field experiment.

A Natural Experiment on the Value of Electricity

Back in the 1990s, academic economists had a great time publishing "natural experiments" papers.   In a similar spirit, take a look at this article about the Cruise Line with no electricity.   The structural industrial organization economists can write about their attempts to measure the consumer surplus from new products but I'd suggest that we gain plenty of benefits from "old products" (such as electricity).   The cruise line disaster provides a case study of what happens to a city's quality of life when the power goes out and basic sewage services are lost.    A cruise ship is like a floating city and we now take for granted the basic services that our cities provide us with (I should caveat that statement by noting that as a LADWP customer that I'm used to losing electric power for a few hours a day every month or two).   The cruise ship's problems offer a counter-factual about day to day life.

Wednesday, February 13, 2013

Climate Adaptation: Evidence from Holland

What can the Dutch teach us?  Erzo G. J. Luttmer has taught me plenty of economics and has been my friend for 25 years.  His cousin, Erzo F. P. Luttmer, has taught me plenty over the 15 years that I've known him and read his stuff.   My co-author Nils Kok teaches me plenty and my friend Piet Eichholtz always offers wisdom.  That's everyone I know from that nation but I calculate that the four of them represent 12% of the nation's total population.   Today, the NY Times has a great piece on what coastal cities can learn about with regards to flood control from the Dutch experience.    This is human ingenuity at its best. I'm sorry to say that we aren't doomed!

Tuesday, February 12, 2013

Mao's Love for Ping Pong and His Disgust with Capitalism

Some things change and some things remain the same. My friends in China now like ping pong and capitalism.  But, read this obituary.  Here is what Mao said: "“Regard a Ping-Pong ball as the head of your capitalist enemy,” the chairman was quoted as saying. “Hit it with your socialist bat, and you have won the point for the fatherland.”   You have to admit that he had a good sense of humor?  This was a joke wasn't it?

Monday, February 11, 2013

A Blog Post for my Mom

As Basic Books prepares to release the paperback version of my Climatopolis, I thought that my mom would enjoy this.  She didn't like the book but maybe she will like the back cover (see below)?  This book is going to age well.  Folks are waking up that adaptation is a rational response to an ambiguous threat.  We are not passive victims. Instead, we control our destiny.  Individuals and firms, not governments, will lead this effort and all urbanites will enjoy a better standard of living because of these self interested efforts.  This is the ultimate test of the "invisible hand"!  
How Our Cities Will Thrive in the Hotter Future
Matthew E. Kahn

Climatopolis documents the thinking of a first-rate economist on one of the most pressing issues of our time.”Nature



Cities are the engines of economic growth and the foundation of our prosperity. But what will become of them as our world gets hotter? In Climatopolis, Matthew E. Kahn, one of the world’s foremost experts on the economics of the environment and of cities, argues that our future lies in our ability to adapt. Cities and regions will slowly transform as we change our behaviors and our surroundings in response to the changing climate, whether that means coping with rising sea level or annual hundred-year floods. Taking the reader on a tour of the world’s cities—from New York to Los Angeles, Beijing to Mumbai—Kahn presents a clear-eyed, optimistic picture of what our urban future will look like.

“Climate change is being driven by economic activity and will have to be tackled by economic measures. Kahn discusses these with enthusiasm and energy.”Financial Times


“Vivid and accessible.”—Science News

Matthew E. Kahn, one of the world’s leading experts on both cities and the economics of the environment, is a Professor at the UCLA Institute of the Environment, the UCLA Department of Economics, and the UCLA Department of Public Policy. He is also research associate at the National Bureau of Economic Research. He lives in Los Angeles.

Business & Economics / Environment
$16.99 US / $19.99 CAN

Basic Books, A Member of the Perseus Books Group

Sunday, February 10, 2013

Al Gore Changes His Mind on the Beneficial Role of Climate Change Adaptation

Circa 2009, it was politically incorrect to speak of climate change adaptation.  Hurricane Sandy and the inability of the U.S Congress to make progress on climate change mitigation and India and China's ongoing growth have all shifted the discussion to climate change adaptation.  Like a minor league Hari Seldon from the Foundation, I anticipated all of this and this is why I wrote Climatopolis.

Today, Michael Lind reviews Al Gore's new book and the Vice President has some reasonable things to say about the potential for climate change adaptation.

"He shows a willingness to rethink positions and admit errors that is as rare among prophets and pundits as among politicians. In speaking, for example, about the possibility of adapting to global warming even while trying to minimize it, he writes: “For my own part, I used to argue many years ago that resources and effort put into adaptation would divert attention from the all-out push that is necessary to mitigate global warming and quickly build the political will to sharply reduce emissions of global warming pollution. I was wrong — not wrong that deniers would propose adaptation as an alternative to mitigation, but wrong in not immediately grasping the moral imperative of pursuing both policies simultaneously, in spite of the difficulty that poses.”"

Note that the Vice President places "policy" front and center here.  For a man who has made tens of millions of dollars from capitalism, why does he narrowly focus on government as the key to adaptation?  Where is the free market as the key innovative source for helping us to adapt to climate change?  

In my ongoing research, we argue that there are cases where well meaning government policy can impede climate change adaptation and that government price ceilings on water and electricity prices and land use zoning certainly do impede adaptation. I discuss all of this in Climatopolis.  

Saturday, February 09, 2013

Markov: The Man Who Thought Hard About Probability

Markov processes pop up all over economics.  This is a simple way to characterize how a random variable such as oil prices or whether you have a job evolves over time.  But, do you know Markov's first name or why he was working on these issues 100 years ago?  His name was Andrey and here is his story.    

Now that I'm getting older, I will solely write about the history of economic thought.    This is what old guys do and I plan to do it well.

Friday, February 08, 2013

Commercial Building Electricity Consumption Dynamics

The next time you drive to a suburban mall or stare at an office building ask yourself the following question; how much electricity consumption do these buildings consume?   Given the unpriced environmental externalities associated with such consumption, this is a mildly interesting question.  In this new NBER Working Paper, Nils Kok, John Quigley and I provide some answers.  This paper took us 3 years to write.  There is always a silver lining and in this case --- we eventually figured out how we wanted to tell our story.

So, I hope you see the continuity to my research agenda.  I have studied the urban pollution created by urban cars, residential housing, electric utilities, and now I've moved on to commercial real estate.   With my co-authors in China, we are re-examining similar questions there.    There is a certain continuity to my Green Cities research agenda.

Commercial Building Electricity Consumption Dynamics: The Role of Structure Quality, Human Capital, and Contract Incentives

Matthew E. KahnNils KokJohn M. Quigley

NBER Working Paper No. 18781
Issued in February 2013
NBER Program(s):   EEE 

Commercial real estate plays a key role in determining the urban sustainability of a metropolitan area. While the residential sector has been the primary focus of energy policies, commercial buildings are now responsible for most of the durable building stock’s total electricity consumption. This paper exploits a unique panel of commercial buildings to investigate the impact of building vintage, contract incentives, and human capital on electricity consumption across commercial structures. We document that electricity consumption and building quality are complements, not substitutes. Technological progress may reduce the energy demand from heating, cooling and ventilation, but the behavioral response of building tenants and the large-scale adoption of appliances more than offset these savings, leading to increases in energy consumption in more recently constructed, more efficient structures.

Macro Policy Activism and Alan Blinder's New Book

You do not have to be as smart or articulate as the Nobel Laureate Ed Prescott to see that the intersection of macro policy activism and individual and firm choices under uncertainty can lead to multiple equilibrium and chaos for "experts" whose job it is to predict the consequences of macro policy.   Yet, leading economists such as Princeton's Alan Blinder appear to view the subject as tidy and well understood.  In today's NY Times, Professor Blinder's new book receives a highly favorable review.

Here is a quote:

"Mr. Blinder, a professor of economics and public affairs at Princeton and a former vice chairman of the Federal Reserve Board, reminds us that the disaster was years in the making. Starting in the late 1990s and continuing through 2007, he writes, Americans had “built a fragile house of financial cards” that was just waiting to be toppled: “The intricate but precarious construction was based on asset-price bubbles, exaggerated by irresponsible leverage, encouraged by crazy compensation schemes and excessive complexity, and aided and abetted by embarrassingly bad underwriting standards, dismal performances by the statistical rating agencies and lax financial regulation.”"

Where are the game theorists here?  If by backwards induction, we know that this will happen --- why didn't this unravel earlier?  Or was there an expectation that there would be a Federal bailout so that moral hazard lurked everywhere here?  

The interplay between Wall Street investment and Federal Reserve Policy and bailouts creates quite a game that the best game theorists would have trouble solving.

If you don't believe me, consider Board Governor Jeremy Stein's remarks in today's NY Times. When he was a Harvard Professor,  Stein was a world famous academic.   I see that he has generated 10,000s of thousands of citations for his economic research.  In St. Louis yesterday, he was quoted on "bubbles" in the junk bond market; read this.

"We are seeing a fairly significant pattern of reaching-for-yield behavior emerging in corporate credit,” Mr. Stein said in St. Louis. He added, however, “It need not follow that this risk-taking has ominous systemic implications.”
Mr. Stein gave no indication that Fed officials were contemplating any change in their aggressive efforts to hold down interest rates. Rather, he described the signs of overheating as an emerging trend that might require a response if it intensified over the next 18 months.
But the speech nonetheless underscored that the Fed regards investment bubbles, rather than inflation, as the most likely negative consequence of its push to reduce unemployment by stimulating economic growth."

So, this is a game within a game. If you are a Wall Street guy and you read this, do you now short these bonds? How have your expectations changed? If government's cheap talk affects individual firm behavior does this roil markets? How do individual changes in expectations aggregate up?   The game theorists and the macro economists need to spend more time together because macro just keeps getting harder.    

UPDATE:   How do policy makers make policy when they learning about how the economy works at the same time that the investment community is forming expectations over the likely policies that the policy makers will make.  The investment community recognizes that the policy makers are divided between Congress, the President and the Fed and that these 3 entities may have shifting priorities over "fighting inflation versus promoting growth".  In the midst of this mist, you can see how many reasonable economists can become "rules over discretion" guys.    Discretion offers the policy makers a chance to have a lot of fun but it creates a lot of equilibrium and this retards investment through the uncertainty channel. 

Thursday, February 07, 2013

How Do Rats Adapt to Natural Disasters?

The NYC rats must have read my Climatopolis or at least they are acting as if they read my book!  The NY Times profiles the rats and documents that in the midst of Hurricane Sandy that they moved to higher ground.   I'm not surprised but I'm surprised that you are surprised.

Migration is a big piece of the adaptation solution.  We are always rebuilding our cities. Depreciation is always taking place and we are always investing.  For those who have invested in infrastructure and real estate in areas that are now at risk, I say;   "You made this bet --- you bear the incidence of the "new news"."  Had the coastal property gone up in value these asset owners would have kept the capital gains.  U.S capitalism will be much stronger if investors flip two sided coins.  Right now we have two many default options embedded in our system with bankruptcy for firms, loan default for home owners, and FEMA and Cuomo bailouts for coastal residents.  This is the danger of behavioral economics -- it allows adults to pretend to be innocent children when the team they bet on loses the Super Bowl  , the "victim" can say;  "I didn't know what I was doing".  Yes, a subset of people are in this category but there are other who can solve a strategic game and mask their true "type" so that they too can receive a bailout.  This mixture of government moral hazard and free market capitalism is ugly and tends to retard adaptation efforts and efficient investment in our overall economy.  Place based politicians (such as Coastal Governors) have strong incentives to embrace benevolent paternalism as they seek to rebuild in the risky areas (their area).  Let my people go!

Wednesday, February 06, 2013

NBA Great Allen Iverson Rejects the Permanent Income Hypothesis

Allen Iverson's consumption profile might puzzle Milton Friedman.

UPDATE:  I could be wrong.  Here is a direct quote from the Friedman article.

"Yet from another point of view, the assumption seems highly
implausible. Will not a man who receives an unexpected windfall use
at least some part of it in "riotous living," i.e. in consumption
expenditures? Would he be likely to add the whole of it to his wealth?"  (see page 28).

Clearly, Milton Friedman was so smart that he anticipated back in 1957 how Allen Iverson (born in 1975) would live his life!

Monday, February 04, 2013

An Idea for Saving Downton Abbey

Has anyone noticed that Downton Abbey is becoming a pinch stale.  The "upstairs" crew is flat out boring and predictable. To inject some life into this sinking ship, I suggest that Downton take a page from the Simpsons and start to introduce some celebrities.  Given that the show is supposed to take place in roughly 1925, could Hitler or Stalin or Mao or Charles Lindbergh or Babe Ruth make a guest appearance?   By a "six degrees of separation" argument, the Maggie Smith character must know all of these folks?    Now that I live in West LA, I often have these kinds of ideas.  Call my agent if you'd like to work with me on something big.

New Economic Research on Adapting to Climate Change

Three recent economics studies offer some optimism about our future in a hotter world.  Is economics really the "dismal science"?    Study #1 on Agriculture, Study #2 on air conditioning , Study #3 on regional impacts.

Andrew Cuomo's Effort to Shift the Incidence of Climate Change Adaptation

Andrew Cuomo is a smart man.  He seeks for people like me (residents of California) to subsidize his coastal voters!  To adapt to climate change, we will need to retreat from coastal areas where people now have homes.  But, a fundamental property rights issue arises.  What compensation should they be paid to move?  An economist would say; "the current market price".  But, Gov. Cuomo views this price in Hurricane Sandy ravaged areas to be too low so he wants to pay the incumbents the "pre-Storm" value of the homes and he wants Federal $ to pay for the transfer!  Smart, Smart, Smart!  May I ask a question?  If the coastal homes on the Atlantic had gone up in value would Gov. Cuomo have agreed to tax these homes more?  Do you see the asymmetry?    Who bears the incidence of "new news"?  I say that the asset owner does. As I discuss in Climatopolis, we can't allow one sided coins to be flipped. This leads to bad incentives and funky transfer.

UPDATE:  I recognize that there is a positive adaptation externality achieved by creating a natural capital coastal buffer zone.  Gov. Cuomo's effort will create this but the question is whether he is "over-paying" for purchasing the land because he is using other people's money (i.e. Federal $).  The irony here is that those who took the risk (the coastal home owners) are being offered the chance for a "do-over" and won't face any asset downside risk for taking their gamble of betting their lifetime savings on a coastal home as climate change unfolds.

For those who prefer video, here is my Lecture #37 that focuses solely on this weighty subject!

Sunday, February 03, 2013

The Homeless in Cities

On Superbowl Sunday, I want to talk about the urban homeless.  The NY Post alerts us that this problem is growing worse again in NYC's Grand Central Station.  This is a typical "tragedy of the commons".  Who owns Grand Central Station?   When one group tries to "privatize it", how are other groups affected?    Columbia's Dan O'Flaherty has done the best economics research on homelessness.  It is clear that many of these individuals do not want to live in homeless shelters.  If the quality of these shelters improve, would more be willing to live there? Are the homeless rational utility maximizers?   Have experimentalists played games with them to learn about their degree of patience and whether their preferences are transitive and satisfy WARP axioms?  

I have argued that researchers are not running enough field experiments in cities.  Have any Cambridge field experiment scholars implemented a field experiment in a city with the homeless to see if the homeless do respond to financial incentives? If they do, would the middle class of such cities be willing to scale up such programs (and pay for them) in order to protect themselves and improve the quality of life of the homeless?

Saturday, February 02, 2013

The Social Cost of Income Inequality

Robert Frank and I are discussing the important topic of the cost of income inequality in these three posts available here.  In this blog post,  I'd like to make a few technical points.   To start, there are three broad reasons to be concerned about rising income inequality in capitalism.  First, the usual point about inequality stoking envy, and equity concerns as we all aspire to "Keep Up With the Joneses".  Second, is the political economy research line that extreme income inequality allows the super rich to purchase political power.   This is exciting work but I have nothing new to say here.  Third, is the Robert Frank "Arms Race" hypothesis that returning to the ugly Nash Equilibrium --- in an unequal world --  people are spending more and more money and time on goods they don't want in order to compete for scarce slots (jobs at Facebook, admission to elite private schools and Ivy League schools).   If we could solve this arms race, he argues, this would be a Pareto Improvement.   I will focus my remarks on this claim.

Consider the following stylized example:

Suppose that a UCLA graduate can purchase a $400 suit.  He prefers to wear jeans and he will never wear this suit again.  The graduate is aware that he is competing for a specific slot at a firm and he anticipates that his rival competitors for the job are going to wear the fancy suits.   Frank sets up a Prisoner's Dilemma and argues that "wasteful spending" will occur because these two young guys can't collude to both not wear the suit.  Professor Frank argues that rising income inequality makes this situation even worse as the rich wear better suits and the middle class have to waste more money buying a $600 suit to allow them to compete.   So, the equilibrium of this game is that the UCLA guy will waste his $ on a suit. He gains no direct utility from the suit but purchasing the suit is an input in raising the probability that he gets the job.

But, markets have two sides.  Why does the firm expect that the worker wears a suit and looks good?   A fan of non-cognitive skills might argue that looking good sends a signal that you are sane, poised person so these are inputs in a signalling game.    Alternatively, the firm may not solely seek to maximize its profit --- it may seek attractive people because the boss enjoys being surrounded by beauty.   Alternatively, the firm --- say it is in management consulting, might be able to charge clients more if its employees are very attractive.

University of Chicago research offers some optimistic push back against Frank's concern. Gary Becker's work on the economics of discrimination predicts that if the industry is perfectly competitive then a firm that only hires attractive people will eventually go bust because it will be paying them a higher wage.   Sherwin Rosen's work on two sided matching models would predict that if there are counter-culture people with tattoos and long hair and no suit that seek jobs that they won't lose the "Arms Race'.  There will be other counter-culture firms who will hire these individuals.  Implicit in Frank's work is that there is a single index of worker quality and that all firms rank workers on this index in the same way.  Diversity among firms reduces the social cost of Frank's employment Arms Race.  In Frank's single index model, workers must purchase the expensive market input (the suit) to rise in the rankings.  But there are other ways to rise. Steve Jobs didn't wear a suit!

I believe that Dr. Frank's concern is that households are working more and more hours to purchase goods they don't directly want.  This is his "rat race" competition.  In typical economics, we teach that you know your utility function and go to the market to purchase these good.  In contrast, Frank is telling a household production function story that you purchase some goods such as SAT test tutors, big home, fancy suit because these are inputs in your "status function" and "find a job function".   So, your utility function is defined over status and finding a job.  You hire the SAT tutor for your kid to achieve these goals not because you gain direct pleasure from the lesson. He argues that if we could all pre-commit not to buy these goods, we would all be happier because this is "relative competition".   He is arguing that reduced income inequality would help to slow down the Arms Race for relative status commodities.

Implicit in his work are a series of single index assumptions of quality. He implicitly is assuming that all firms rank workers using the same single index model and that all consumers achieve their status (how big is your house, where did your kid go to college?) using the same single index of producing self respect.  In a diverse world, this isn't right.   The onus is on him to produce empirical evidence documenting this strong claim.  Industrial organization economists contrast vertical single index models of quality with horizontal models of quality that admit comparative advantage and multi-dimensional sorting.   Frank's fixation on the single index approach merits serious empirical research.  I can be the ugliest guy in the world but if play chess well or if I'm respected at my church , I may have plenty of self esteem.  This is an example of multi-dimensional attributes that Frank's approach can't handle.

He is also taking his "zero sum game" very seriously.    Why aren't there more good school districts? Why can't the number of excellent universities and their number of slots increase? What is the limit to growth?  Professor Frank needs to team up with an industrial organization economist to study this issue.  He focuses on the demand for status, the demand for schools and neighborhoods but doesn't bother to model supply. In the labor market he talks about the supply of job seeking workers but doesn't discuss labor demand and equilibrium outcomes.  His theory focuses on one side of each market he considers.

 So, Dr. Frank is advancing a very interesting hypothesis that challenges standard neo-classical logic but he is  having too much fun.  If he sits down and thinks about firm heterogeneity and worker heterogeneity, two sided matching, equilibrium, and supply responses then he will reconsider how seriously he takes his core push.

For Dr. Frank to convince me that his thesis is correct, I would need to believe the following conditions;

1. There is a vector of consumption goods such as business suits and SAT tutors that people purchase even though they offer no direct utility to consumers.

2. This vector of consumption goods is growing more expensive over time because the super rich are creating a ratchet effect (i.e wearing better suits to interviews for Harvard Admissions).

3.   Those who control the scarce slots of jobs at firms or Harvard Admissions, rank individuals with respect to the same index of "quality" and this index of quality is mainly based on purchased consumer goods (such as suits and SAT tutors) rather than by personal investments in cognitive and non-cognitive skills.

4. Building on #3, all allocators of the scarce slots use the same single quality index for judging individuals.  This assumption eliminates the possibility that a kid who is  a great chess player but doesn't have a suit can be accepted at University of Chicago but rejected at Harvard.

5.  There is no arbitrage opportunity for a new set of private universities or private firms to enter the industry and hire those who scored low on the original "quality rule".  (This rules out the Becker theory of discrimination optimism).  This also rules out certain shapes of the supply curve such as constant returns to scale. By denying the possibility of entry of firms, Frank assumes a vertical supply of "slots".

6.  For individuals in the rat race, the only way to achieve self esteem is to score high on the societal single index of quality.  (This rules out comparative advantage and people gaining respect from their local community that celebrates a specific skill an individual may have.)  For example, if I'm a terrible researcher at UCLA but fun to have lunch with; my colleagues may enjoy having me around.

If these 6 conditions hold, then I agree with Dr. Frank about the social cost of inequality in the #3 rat race case.   Relax any of these assumptions and I disagree.