In New York City, Hong Kong, Shanghai and London and Paris,  rich people live in apartments.  President Trump owns several apartments in Manhattan.  Poor people also live in apartments.  These apartments are of different sizes, located in different areas and in different buildings and apartments are of different quality levels as well.  In the United States, the vast majority of people live in spread out single family homes.

The majority's choice to not live in multi-family apartment buildings has social consequences.  If more of us lived in apartments in multi-family buildings, then we would walk more and use public transit more and our most productive cities would offer greater economic gains for more people. 

In this blog post, I want to sketch out a thought experiment.  For every American adult, let's consider what his/her willingness to pay for living in a house versus an apartment.  What elements of the structural utility function differ between the two?   What attributes are bundled into a house versus an apartment and why do the private attributes of a house offer greater utility than if the same attributes (such as a swimming pool) are part of an apartment complex where you share this club good with your neighbors.

1. Homes have private backyards  --- While this is true, the market indicates that people do not greatly value their backyard. When you run a hedonic pricing regression of;
home price =  controls + b1*indoor space  +  b2*outdoor space  + U  , where indoor space and outdoor space are measured in square footage;  b1 is much greater than b2.  This indicates that people do not pay much for outdoor space and that in the absence of zoning that a developer would convert the outdoor space into more indoor space.  There is an arbitrage opportunity that zoning does not allow to be engaged in.  

I am sure that in hot places that home buyers are willing to pay more for a backyard if they have a swimming pool there. There are scale economies with respect to such pools. If you trust your neighbors, you can have a common pool that you all enjoy together.  As crime falls in cities, more people (see central park in NYC) are willing to have their kids play in public rather than in private (i.e your own backyard).

So, note my key point here --- the same housing attribute (having a swimming pool) --- yields different marginal utility depending on whether you trust your neighbors or not.  If you trust them less, then your demand for your private pool is higher.  Structural IO economists do not explicitly model this "marginal utility" parameter.   They use revealed preference methods to estimate a single marginal utility parameter and perhaps allow it to vary by demographic groups.  But,  if you trust your neighbors then a public pool is close to a perfect substitute for a private pool and you will be more willing to live in an apartment complex where you share the pool with your neighbors.  Trust is an attribute that the home buyer knows he/she has but the econometrician does not observe this (so this is a case of Jim Heckman's essential heterogeneity).  Heckman's work on essential heterogeneity has not been incorporated into the Sherwin Rosen 2-step hedonic research.  I recognize that a BLP style researcher could estimate a "random effects" parameter for the home's pool attribute but this approach would not yield a microfoundation for why the marginal utility distribution changes over time.  My "model" sketched here predicts that the mean marginal utility and the standard deviation of this marginal utility from having your own pool shrinks as trust in neighbors increases.

2.  Homes have more privacy  ---  In apartment buildings, one may be subject to sounds from neighbors and smells of smoke and cooking.  An interesting question is how much progress has been made in designing windows, and walls that limit these negative interaction.  Of course, there are negative externalities associated with having neighbors but market products can offset these.

3.  No collective action issues arise with a single family home --- If you live in a multi--family apartment, you are either a renter or a member of a collective that has to make some group decisions and if people differ in their preferences for local public goods (such as what plants to plant around the property or whether to replace the building's boiler)--- some members of the group will not be happy with the majority decision.   I'm not sure that this is a big deal.

4.  Homes are larger than apartments   --- This is an arbitrage again.  If you want a large apartment, can you buy two adjacent smaller apartments and blow out some walls and turn two 2 bedroom apartments into a 4 bedroom apartment?

My point here is that I believe that for more and more Americans that apartments and single family homes are becoming close substitutes.  But, there is a supply side.  Since the housing supply is durable and we have built perhaps 80 million or more single family homes that each might last for 60+ years , the transition to an apartment complex cities will take a very long time.

When real estate developers build durable structures, they are locking society into a pattern of land use that remains for decades.


So, in a society featuring lower crime and trust between strangers --- I believe that apartments and single family homes become close substitutes and then the supply side (zoning and durable capital) together determine how our cities actually look in terms of urban form.

The protests in France over raising gasoline taxes there highlights that middle class people understand that higher carbon taxes have income effects.  If you drive 15,000 miles a year and if your vehicle achieves 30 miles per gallon and if the price of gasoline increases from $4 to $4.40 due to a 10% increase in the gas tax, then your disposable income declines each year by (15000/30)*.4 = $200.

Economists celebrate the substitution effects induced by the carbon tax --- that people who drive will demand more fuel efficient vehicles and drive them less.  On the supply side, the tax will nudge firms such as Tesla to engage in induced innovation to create even more fuel efficient vehicles.

Since voters are smart and do not want to be poorer (as their purchasing power declines due to the tax),
economists have pondered how to offset the income effect through policies such as "tax and dividend" or by lowering income taxes and raising carbon taxes (see Gib Metcalf's 2007 Hamilton Project paper).

A deep issue arises here.  Who has the property rights to pollute?  If the incumbent polluters have this right, then the designed policy must fully offset the negative income effect I sketched above. Recall that in the 1990 Clean Air Amendments that created the so2 sulfur dioxide market that utilities received free allotments of permits. This meant that they had the property right to pollute and this must have angered some environmental groups. But, the tight cap on total emissions and the incentive effect of being able to sell unused permits created an incentive for these polluters to reduce their emissions.

In my work with Jonathan Eyer,  (see our 2017 paper)   ,  we explore how states and local governments have tried to protect their coal interests in the face of increased federal government regulation and market conditions favoring using natural gas for generating electricity.  On some level, this is a battle over property rights.

Do fossil fuel consumers and producers  have the property rights to engage in this activity?  If they do, then those who seek to mitigate the challenge of climate change must compensate them for their income loss associated with carbon pricing.  Are progressives willing to identify themselves and pay for this property?    If these polluters do not have this property right, then they will suffer an income loss from this new well intended policy and they will use their full arsenal of strategies (including protests) to oppose a change from the status quo.

Given that every American differs with respect to her current production/consumption of fossil fuels, how does  a smart public finance economist design a carbon tax and refund policy that induces the substitution effect of carbon pricing without the income effect?

The political economy of climate change mitigation and adaptation has not been fully explored by academic environmental economists who in recent years have focused on creating computable general equilibrium IAM models (see Nordhaus) or on reduced form empirical studies examining   the "cause and effect" relationship between climate effects and economic outcomes.  Such reduced form "cause and effect" studies should play a key role in determining which voters support carbon taxes. For example, if my home will be flooded because of climate change then I have strong asset protection incentives to vote in favor of a carbon tax.   The role of self interest (beyond ideology) in spurring support for carbon taxes should be explored more in new research.

What else do we know about the political support for carbon pricing?   Riley Dunlap has been the leader in environmental sociology studying long run trends in support among republicans and democrats.
Michael Greenstone released an optimistic contingent valuation study a few years ago.  I tend to be skeptical about such survey evidence.   I wish that his survey is right.  My results in my 2013 paper on the voting on the Waxman-Markey Carbon Tax bill in Congress and my 2015 paper  on California's voting on introducing carbon pricing tell a different story.   High carbon area voters oppose such taxes.  This dovetails with this blog post's main theme.

Soren Anderson has new research on this subject;  Here is his preliminary paper.   Read the abstract and you will see that his paper's findings are consistent with this blog post's main themes and with my past research findings. In studying recent voting on Washington state's proposed carbon tax he finds;

" Support (for carbon taxes) is weaker in precincts with larger shares of car commuters, bigger homes, and workers in carbon-intensive industries and stronger in precincts with larger shares of young people, racial and ethnic minorities, college educated adults, and voters that are ideologically aligned with the left’s broader policy agenda."

This is the challenge that we environmental economists face as we try to implement incentives to combat climate change.  Let the competition to design a proposal that induces substitution effects without negative income effects begin!

UPDATE;    A fundamental question in microeconomics asks;  "who is at the margin?" In the case of supporting carbon pricing a given person will support the policy if her expected present discounted value of benefits from the policy exceeds the expected present discounted value of the costs she will incur from the policy.

In an economy where people differ on many attributes such as location, asset ownership, industry, education -- it is difficult to quantify these factors and include them in a voting regression. After all, we do not observe how individuals vote on election day; instead we rely on precinct level data and face the ecological regression fallacy.


This is a long winded way of saying that if the costs faced by suburbanites for voting in favor carbon taxes decline then more suburbanites will vote for carbon taxes and support Representatives who vote in favor of these policies. Our 2017 paper explored how the private choice of buying solar panels bundled with electric vehicles could flip some suburban voters toward supporting carbon pricing because the income effect they would face would shrink to zero.

The New York Times published an interesting piece about how U.S energy infrastructure might be affected by climate change.   At the end of the piece, there is a nuanced quote about whether the energy companies will experience large profit losses due to climate change.  For some, this would be a delicious irony but Sarah Ladislaw argues that this is wishful thinking.  Here is her quote:

"Yet energy analysts cautioned against expectations that the effects of climate change will cause irreparable harm to the fossil fuel industry or make oil, gas and coal production fundamentally unattractive to investors. Sarah Ladislaw, an energy analyst at the Center for Strategic and International Studies, noted that the oil and gas sector has a long history of managing risks, including figuring out how to operate in politically unstable countries and prodding governments to loosen regulations they find too burdensome.

Rhiannon Jerch is finishing her Ph.D. at Cornell. I serve on her dissertation committee and we have co-authored this JPUBE paper together.  This blog post will discuss her job market paper.

She studies the long run urban growth consequences of the Clean Water Act's mandate in the early 1970s that cities improve their water quality through treating their wastewater.

In the absence of this mandate, how would cities have set their budget expenditures?   Millions of Americans live in small cities (cities with fewer than 150,000 people) that are not suburbs of bigger cities.  The local government in such cities collects tax revenue and receives transfers from the federal government and state government and uses these resources to provide basic services to their constituents.   Basic economic logic posits that these local leaders will optimally allocate such expenditures. Thus the local "bang per buck" spent on each local public good will be equated.  This is the standard efficiency first order conditions.

This equilibrium would be a pareto optimum if there weren't cross-city externalities and if cities didn't face lumpy adjustment costs.  Rhiannon's starting point is that cities are not independent islands.  She is interested in water pollution externalities.  Given that rivers flow in one direction, some cities are upstream and some are downstream.  If an upstream city j does not invest in water treatment, then much of the costs of this under-investment are borne by city m downstream.    Such cross-boundary spillovers provide an immediate rationale for federal intervention.

Rhiannon has to work hard to create her spatial panel data set as she identifies which cities are upstream and downstream of whom.   Coasian logic helps her to create an instrumental variable for whether a city has already made wastewater treatment investments before the Clean Water Act.
Suppose that a major city is downstream from the polluter.  Such a city will use its clout (because of the total damage it is suffering under the status quo) to either compensate or sue the upstream city to take costly actions to mitigate the water pollution.    This means that the 1970s Clean Water Act was less likely to be binding for such an upstream city because it is connected to a major downstream city.  The modern LATE literature is subtle about who is the "marginal city" affected by an instrument or a surprise mandate and Rhiannon's paper has this flavor.

A direct quote from her paper concerning the findings;

"In aggregate, this change in cities’ amenity-tax bundles had insignificant impacts on population growth or housing prices, suggesting that the mandated infrastructure was at least valued at its marginal cost to local residents. However, the aggregate effects mask important sources of heterogeneity in city responses. Per capita compliance costs were 20% higher among smaller cities unable to exploit scale economies in infrastructure realized by larger cities. Despite having higher compliance costs, I show that smaller cities received less grant funding per resident and used those funds more efficiently relative to larger cities. These results suggest that both efficiency and equity could have improved under the CWA federal aid program if grant allocation followed city-specific abilities to benefit from scale economies. Lastly, I show that the value of mandate compliance to local residents is greater among cities with warmer summer climates, closer proximity to large waterbodies, and greater exposure to upstream abatement."


Rhiannon and I have often spoke about the complementarity between public capital upgrades and private capital investment.   Intuitively, if rich people are willing to pay more for a condo near the water if the water is clean and the air is not polluted then this is an example of such complementarity.   In my own research, I have explored this theme here.

Her core question of "who benefits and who loses from federal mandates?" is important.  My prior had been that the affected cities would lose because this mandate would be a binding constraint that would force them to substitute away from activities that were privately beneficial.   Her result suggest that one must  be a bit more nuanced here. There are cases in which a federal mandate imposed on a locale may improve quality of life in the affected place (as well as in the downstream areas that have been suffering from the Pigouvian spillovers).

Rhiannon's work makes an original contribution to environmental, urban and public finance economics.  The field is moving forward!

The 2018 Nobel Laureate (Paul Romer) has published a great opinion piece in the WSJ today.    While he doesn't offer a quantitative analysis of how much extra growth we would achieve, he does deliver 3 constructive suggestions for accelerating economic growth.

His proposals all focus on idea generation and reducing the barriers for such ideas to flow across people.  The "privatization" of knowledge slows down economic growth because certain permutations of these ideas are not discovered and acted upon as quickly in these closed-loop systems.  For those who know some mathematics, read Erzo Luttmer's papers to see how ideas and learning stimulate firm level economic growth and thus macro-growth.  My old friend Dr. Luttmer is the leader in developing the new generation of economic growth models.  

Dr. Romer's core ideas;

1.  He supports government investment in scientific infrastructure for accelerating "building on the work of others".  Python is an example of such open source technology.   I was a pinch surprised here that he didn't endorse a larger budget for NSF and NIH.

2.    Transparency --- Paul argues that the private sector needs incentives to innovate but when such innovations occur that such firms must reveal enough details about their breakthroughs to allow other "outsiders" to build on these insights.  The Devil will be in the Details here.   Romer argues that learning will occur more quickly under these rules.  Will such required "revelations" slow down the initial research?   

Paul is also concerned about data monopolies.  Firms such as Uber sit on a treasure trove of data. If you are interested in transport questions in cities, their data is much better than the Department of Transportation's National Household Transportation Surveys but Uber's research incentives are solely focused on making $ for that company.  This means that their data will be under-utilized and the research will focus on topics that boost Uber's profits.  From the perspective of learning about transportation in cities (and the sharing economy's labor market) , this is a shame and this has economic growth consequences (I admit that this last link is a pinch murky).

3.  Romer wants to preserve the firewalls between government agencies and politics.  The Federal Reserve has been able to do its job because the Fed Chief is independent of politics. If the EPA and other agencies also enjoy such "independence" then the rules of the game will be such that high quality individuals will choose to work for government and higher quality government will help us to achieve higher economic growth.  Again, I agree with this point, but it will difficult to quantify.


Permit me to build on #2;

Suppose that for a representative set of Americans that IRS (Chetty data), Amazon, Bank of America, E-Trade, Equifax, Google, Facebook, Zillow, Uber, Netflix, and Twitter created an integrated daily data based with anonymous identifiers detailing all daily activity.

Such a data set would facilitate research on numerous fronts.  Research on climate change adaptation would be greatly aided as the researchers would merge in temperature, pollution and natural disaster risk and actually test how different people respond to exogenous events.

Would we need national income accounts if we had such merged micro-data?  In real time, for many people we could track the evolution of key state variables related to credit, health, well being. 

The Repec rankings are out for October 2018.  In the name of full disclosure, here is mine.  I see that my "strength of students" puts me in the 4th percentile.  I need to improve on that category.   I'm happier with my score in this category.  Here are my peers according to REPEC.

Similarly ranked authors

These peers are ranked around you and are listed in random order:

• Michael Steven Weisbach
• Giovanni Dosi
• Varadarajan Chari
• Takatoshi Ito
• Glenn Paul Jenkins
• Richard H. Clarida
• Harvey Rosen
• Lucrezia Reichlin
• Edward E. Leamer
• Ivo Welch
• Thomas R. Palfrey
• Giancarlo Corsetti
• Richard Schmalensee
• Alan Manning
• David M. Cutler
• John C. Quiggin
• Fabio Canova
• Steven J. Davis
• Jong-Wha Lee
• Yuriy Gorodnichenko

Alfie Kohn has written a provocative opinion piece for the NY Times in which he argues that standard "pay for performance" incentives do not matter and often create a backlash effect.   Economists should take note because his piece is an implicit jab at 98% of the ideas embodied in economics research.  If "incentives do not matter", then this has many implications for the progressive agenda.  The minimum wage can be raised without employers substituting away from labor.  Taxes on the rich can be raised without them fleeing to a low tax haven or reducing their Silicon Valley effort to devise the next "big thing" (think of Musk or the Zuck). 

Mr. Kohn does make a series of interesting points.  I certainly believe that there are cases when paying people for a specific task does not yield a large response. He also points out based on some field experiments that a short term experiment (such as paying a person for a task for a few months and then stopping the payments) does not have a long term effect.

There are two separate questions here; First, when do incentives matter?  Second, why do incentives matter?   In our Econ 101 classes, we teach our students that in a world featuring considerable diversity of talents and our own "conception of the good life", there will always be a set of individuals who are  "at the margin".  This set of people will change their behavior if they receive a nudge.  This nudge might be a $ incentive or it might a social incentive such as community celebration or shaming. 

For example, if we need more young men to sign up for the Army --- how do we achieve this? Do we increase the pay for serving in the military? Or do we increase the prestige of serving? Do we increase the "on the job training" that such men receive? Or do we increase the later life health and retirement benefits from serving?  The military has strong incentives (since it faces a budget constraint) to pilot different strategies to identify the most cost effective ways of recruiting prospective troops.

A deeper question is why are some people "at the margin"?  In the aftermath of James Heckman's Nobel Prize win in the year 2000, more and more economists work on the economics of heterogeneity.  Why do we have different goals and aspirations?  Does the same person have the same goals as she ages?  How do life experiences and one's own choices interact with each other to shift "who you are and what you want"?   A given individual knows what motivates her to choose where to live or whether to quit her job, the economist seeks to learn this person's willingness to  substitute one choice for another.   Mr. Kohn's piece suggests that economists are looking to the wrong motivating factors when we crassly focus on $.  In truth, $ matters more than ever because in this Internet economy there are a huge number of ways to use $.  You can buy private goods or donate it to a cause you are passionate about.

Paul Sullivan has written an interesting piece that details his investment advice to help NY Times readers continue to earn a good rate of return in a world facing increased climate risk.   He really has in mind that carbon taxes will soar over the next few decades and this will punish firms with a large carbon footprint and favor firms that produce low carbon substitutes or whose cost structure is such that they economize on carbon emissions (see his Walmart discussion).

So, his piece is really about investing in a world featuring rising carbon taxes.  I'm not convinced by his investment advice.  There is considerable uncertainty about the future of carbon mitigation policy and the future price path of energy used for transportation and the price of electricity.

An even more interesting piece would investigate what is the right investment portfolio to reduce exposure to climate risks induced by climate change (not by energy price dynamics and policy dynamics).  Here there are questions about which pieces of real estate have a comparative advantage in handling future shocks? Will new REITs specialize in Canadian and Northern U.S properties and earn high rates of return?  Is Warren Buffet correct that the insurance industry will make higher profits because of climate change?  Are there credit default securities that will have higher probabilities of soaring if "fat tail" risk is as bad as climate scientists claim?  If fat tail risks become increasingly likely due to climate change, which assets will be at risk?  I would like to teach a business school course on this in the future.  Devin Bunten and I discuss some of our ideas in this 2017 paper.  

Marc Benioff throws a punch at Milton Friedman (calling him "myopic") in his interesting NY Times Opinion Piece today.  Recall that back in 1970 that Milton Friedman argued that the responsibility of corporations is to maximize profits and allow their shareholders to spend their money as they please.  Read Tom Coleman's remarks here .  Mr. Benioff implicitly calls Friedman selfish and "outdated".

As an enlightened businessman who has long lived in San Francisco, Mr. Benioff argues that businesses are located in a specific geographic area and thus have a responsibility to boost that area and to help the less fortunate in that area.  He calls for political support for Proposition C   (and read this) that would tax rich local companies to pay for services for the homeless.

A few points.

1.  Publicly traded companies located in San Francisco have shareholders who do not live in San Francisco.  These individuals are being asked to sacrifice some capital gains to provide for San Francisco's homeless population.  Such individuals would have used their capital gains in part for their own charities that they support (and for their own private consumption).  Who owns these big companies, the shareholders or the people of San Francisco?  Friedman would call this spending "other people's money".

2.  The San Francisco Chronicle opposes Prop C with an interesting economic argument as it argues that by "throwing more money at the problem" that this diminishes the incentive to be scientific here and learn what actually is a cost effective solution for helping the homeless.  Necessity is the mother of invention in solving challenging urban social problems!

3.  In fairness to Mr. Benioff,  prior California research has documented that you can tax rich people without them moving away. Texas is not a close substitute for Malibu read Brueckner and Neumark 2014.  

But, if San Francisco City adopts Proposition C, an urban economist would posit that economic activity will migrate to just outside the city boundary and this represents a type of "tax haven".  Mr. Benioff is implicitly assuming that the productivity and amenity effects of working in San Fran City will outweigh his tax hike.   Economists call this the cross-elasticity effect.

So, what would Milton Friedman say here?  There is a real homelessness challenge and what can be done?

Let's start in the labor market. Fewer people would be homeless if they had higher incomes. Friedman would repeal minimum wage laws, anti-firing laws and unionization to provide incentives for firms to be willing to take a chance on hiring workers whose quality is difficult to certify ex-ante.  Working builds up human capital and non-cognitive skill

Turning to the housing market;  Friedman favored housing vouchers but are the homeless able to make "good choices" for themeslves?  Which geographic areas would accept these vouchers? Would these receiving areas deteriorate in quality because crime would rise as more homeless move there?    Friedman favored the decriminalization of drugs.  Would such an approach help the homeless receive treatment and alter their drug regimen?    Friedman would have embraced Gary Becker's crime and punishment of patrolling the streets and enforcing laws.  These policies would have costs but they would protect the general public against emerging threats to their safety and quality of life issues.  Friedman would support the enforcement of property rights here. What are the rights of the homeless and what are the rights of the non-homeless?

Friedman would also argue (as did John Quigley) that low housing supply caused by NIMBY land use regulations raises rents and home prices and artificially inhibits gains to trade between middle class people and real estate developers.  If more middle class housing is built then rents fall and some homeless people could afford housing in San Fran.  Market solutions to the homeless challenge have been inhibited.

To quote Quigley's 2001 RESTAT paper; "Furthermore, rather modest improvements in the affordability of rental housing or its availability can substantially reduce the incidence of homelessness in the United States."  Milton Friedman would agree.

While the USC Football team is not playing as well as usual, things are humming along at USC Economics.   On Tuesday October 23rd 2018, USC Economics will host an interesting panel focused on "
The Economist’s Perspective on the Future of Silicon Valley, AI and Innovation".  I will moderate a panel that will include Preston McAfee, Simon Wilkie, Guofu Tan, and Pai-Ling Yin.  I will ask the following questions;

1.  How has the rise of the “new economy” affected consumer well being?
2. Does the growth of such firms as Amazon portend future “price gouging” as such firms exploit their “Big Data”?
3. What has Amazon done right as it has entered new markets such as Amazon Video?
4. What are the labor market implications of the rise of these major firms? What jobs do we gain and lose? Why are so many economists talking about monopsony power in labor markets? 
5. Does the rise of AI (artificial intelligence) threaten to create more unemployment and increased inequality in the labor market?
6. What regulatory challenges does the rise of New Economy  firms pose?
7. What regulatory rules would promote greater innovation and the growth of the New Economy?
8. Does Europe have “better rules” for regulating these firms?  Why does Europe have different New Economy regulation than the U.S?
9. What will be the next "Big Things" we will see achieved by the introduction of  AI in the modern economy?
10. Could anti-globalization trends disrupt Silicon Valley?
11. If Silicon Valley is disrupted, does California and the U.S lose? How much?  What about the rest of the world?  Would China gain from the decline of Silicon Valley?