Gone to Guatemala

In a few hours, I'll be leaving Durham for a trip to Guatemala, where I'll be studying Spanish for the next two and a half weeks.

Why I am I going to Guatemala? My reasoning is this:

1. I hardly remember any Spanish from my high school days, but the Duke foreign language requirement forces me to take either three semesters of a single language, or one "100-level" (i.e. fifth semester level or higher) course. The latter option will be much easier on my schedule, and Spanish 105, "Spanish for Oral Communication," is the most practical choice of class. Before starting the course, I need to drastically improve my Spanish skills.
   
2. The best way to become proficient in a language is intense immersion combined with ample one-on-one tutoring.
   
3. Guatemala enables me to achieve both at an incredibly low price. The cost per week of both extensive tutoring and living accommodations is no higher than my cost of living in Durham. The real cost of the trip, therefore, is the price of the plane ticket -- which, while not exactly cheap, isn't that much higher than the price of a ticket back home to Oregon.
   

All in all, it's a very good deal.

No doubt someone will claim that by choosing Guatemala for its extraordinarily cheap prices, I am somehow "exploiting" the poverty of the country. This is a good opportunity for me to say that I find such objections ludicrous. Yes, I am paying much less for tutoring than I would in America, or in a comparatively wealthy Spanish-speaking country like Spain or Costa Rica, but I am still paying a much, much higher wage than the typical Guatemalan receives. At market exchange rates, Guatemala's GDP per capita is about $2500, and due to the country's extreme inequality (with a Gini coefficient of 55), the median yearly income is far lower.
While my tutoring experience in Guatemala will be cheap by American standards, it will still provide a large and unambiguous benefit to those receiving the money.

On a more personal note, my internet use will be close to zero over the next few weeks. If I don't reply to your email, it's because I can't!

Fuzzy numbers

Perhaps the media's worst quality is its complete lack of quantitative savvy. Today I noticed two particularly shocking instances where credulous reporters at well-established outlets passed along figures that were clearly absurd.

Exhibit one was the Politico, where "chief lobbying and money correspondent" Jeanne Cummings reported that Obama raised $25 million on the last day in June. It turned out, of course, that this wasn't true: the FEC grouped unitemized small donations so that it looked like they all came on the last day, and the Politico eventually recanted its mistake. But this was after the Politico made Obama's haul its lead story.

Indeed, had the Obama campaign actually managed to collect $25 million on a single day, it would have been big news. Huge news. Such a sum would have been easily the largest total ever collected in a single day by any politician. Anyone who tracks campaign finance, however, should immediately realize that absent some decisive event on June 30, or some unprecedented effort to solicit donations on exactly that day, there is no chance that the campaign collected almost half its fundraising total for the entire month in 24 hours. (And had such a torrent of contributions occurred, you can bet that the campaign would have been overjoyed to spread the news long before anyone had the chance to plow through an FEC report!)

Yet the Politico, which presents itself as an outlet for savvy political reporting, made this its lead story, before bothering to check with the Obama campaign to see whether a transparently absurd figure was correct. I never had a high opinion of the Politico, but wow.

The other example is even worse. The Independent, a prominent British daily, currently has an article with this headline on its website:

"American inequality highlighted by 30-year gap in life expectancy."

It continues:

"The United States of America is becoming less united by the day. A 30-year gap now exists in the average life expectancy between Mississippi, in the Deep South, and Connecticut, in prosperous New England."

Let's think this through. Unless Connecticut has exclusive access to the Elixir of Life, its average life expectancy can't be much higher than 80; Japan, which has the highest life expectancy of any large nation, is at 82. A 30-year gap would therefore imply that Mississippi has an life expectancy of around 50.

Does that sound plausible to you? While Mississippi isn't exactly a beacon of healthy living, I have a hard time believing that any US state has a life expectancy below Cameroon, Bhutan, Senegal and Haiti. Leonard Doyle, Washington correspondent for the Independent, appears to disagree.

Do these people have editors?

Where oil is headed

Paul Krugman continues his excellent commentary on oil prices by making a basic economic point that's often ignored in the popular press:

"As I think I’ve written on several occasions, there’s a reasonable case for believing that oil prices will fall for a while — not because high prices were the result of runaway speculation, but because of the delayed effects of high prices on demand. And I thought it might be worth offering a moderately wonkish diagram.

So: the basic point is that the price elasticity of oil demand is very low in the short run, but gets bigger once people have time to adjust — to buy more fuel-efficient cars, to rearrange their commute, etc.. Right now we obviously face oil prices much higher than people were expecting when they made decisions about things like car purchase, so the quantity demanded will fall over time even if the price stays where it is. Meanwhile, the supply of oil seems to be highly unresponsive to price, in either direction."

Even if oil prices decline steeply over the next few years, it won't be because the recent increase is a result of "speculation." As I've mentioned several times before on this blog, oil markets have cleared at very high prices in the past few months, with no large expansion in inventories. There may be a sizable speculative component in the short-term futures market, which has been very volatile in the past few weeks, but we've already seen supply and demand match at very high spot prices, where any unnaturally inflated price will result in inevitable inventory growth. These prices will probably deflate a little over the next few years, but as Krugman notes, it won't be because they were the result of runaway speculation.

Further, while Krugman focuses on demand, I think that the difference between the short-term and the long-term elasticity of supply is also very important. Right now, the conventional wisdom is that all countries except Saudi Arabia (which has so much market power that releasing more oil might lose money) are producing at full capacity. Nevertheless, many sources of oil that weren't economical at $40 a barrel should become viable at $120. Expansion of supply doesn't happen instantly, because building new drilling capacity takes time, but it will happen in the long run and help to deflate prices.

The difference between short-run and long-run elasticities also helps to clarify my recent point about domestic drilling. As I mentioned, the increased revenues from selling the oil (or selling the right to drill for oil) will dwarf the indirect benefits of lower prices through increased world supply. It's important to note, however, that this wouldn't be true if drilling was a short-term decision. If the US government had a technology that could instantly conjure a billion barrels of oil and put them on the market, the direct money from oil sales might actually be less than the benefit to consumers from cheaper oil. This is because prices are much more sensitive in the short run to changes in supply and demand. The short-term price elasticities of supply and demand are so low that massive swings in price can be necessary to bring the market back into equilibrium.

Since drilling for offshore oil is an inherently long-term decision, however, the natural conclusion still stands: the direct benefits of oil revenues are much larger than the indirect consumer benefits associated with cheaper oil. Our policies should be measured accordingly.

Why teach mediocrity?

Russell Jacoby is angry that universities are abandoning the legacy of "Western thought":

"How is it that Freud is not taught in psychology departments, Marx is not taught in economics, and Hegel is hardly taught in philosophy? Instead these masters of Western thought are taught in fields far from their own. Nowadays Freud is found in literature departments, Marx in film studies, and Hegel in German. But have they migrated, or have they been expelled? Perhaps the home fields of Freud, Marx, and Hegel have turned arid. Perhaps those disciplines have come to prize a scientistic ethos that drives away unruly thinkers. Or maybe they simply progress by sloughing off the past."

Should we teach the phlogiston theory of fire to our chemistry students? Go on extended riffs about Ptolemy's epicycles before lecturing on astronomy? Preface math classes with a look at the geometric mysticism of Pythagoras?

Of course not.

But Freud and Marx occupy the same intellectual space: they were wrong, and they have long since been discredited. Freud's psychoanalysis was nonsense, an intentionally unfalsifiable mess with none of the basic empirical support that legitimate psychology demands. He might be valuable to students as an illustration of how not to do psychology, but that's it. Meanwhile, Marx's brand of pop economics is an interesting historical relic, if only because it spawned a real-world governing philosophy that impoverished millions. But it has literally nothing in common with the current science of economics.

Perhaps in a perfect intellectual world, where students would have the time to devour everything of even the slightest cultural or historical relevance, it would be beneficial to study Freud and Marx. We do not live in that world. Professors of economics have a difficult enough job prodding their students to understand supply and demand. They shouldn't have to waste their time lecturing about a mediocre theoretician whose only virtue was -- and is -- popularity.

On the minimum wage (warning: very long!)

Scanning some past discussions in the excellent Cato Unbound, I came across an exchange on the minimum wage that illustrates some of the important misconceptions surrounding the concept. Coincidentally, as with my last few posts, this discussion also involves Ed Glaeser being more knowledgeable and perceptive than the other participants in an exchange.

The general discussion is titled "Should Coercion Count? The Place of Liberty in Economic Theory." Daniel Klein, the lead essayist, discusses how the minimum wage is a coercive piece of legislation. In his response essay, Glaeser agrees that the minimum wage is coercive, but adds:

"But, as Klein notes, just because something is coercive, doesn’t mean that it is wrong. The coercive power of the state is useful when it protects our lives and property from outside harm. If we think that state-sponsored redistribution is desirable, then we are willing to accept more coercion to help the less fortunate...

What principles help us decide on the appropriate limits to government-sponsored coercion? Are minimum wage laws acceptable coercion or do they fall outside of the pale?...

I start with the view that individual freedom is the ultimate goal for any government. The ultimate job of the state is to increase the range of options available to its citizens. To me, this is not a maxim, but an axiom that is justified by both philosophy and history. On a basic level, I believe that human beings are the best judges of what is best for themselves...

The minimum wage reduces the options available to the employer, who must pay his workers more. It also reduces the freedom of both employer and employee, both of whom lose the ability to contract at a lower wage. Opposing this loss of freedom is an increase in the options available to workers who remain employed and now earn a higher wage. While I am no fan of higher minimum wages, I can imagine settings in which the increase in the freedom of the still-employed workers could be more important than the offsetting losses to individual liberty. We cannot get to a clear answer on the minimum wage on the basis of an axiomatic desire to increase the range of choices available to individuals, because we are trading one person’s choices against the choices of another.

Perhaps one might come to a clear view on the minimum wage by hewing to an uncompromising belief in freedom to contract. While I certainly have sympathies for that belief, there are cases where freedom to contract is and should be imperfect..."

To a good economist like Glaeser, it is clear that the minimum wage has the potential to increase the freedom of workers who earn a higher wage. Still, comparing this gain in freedom with other losses in freedom is a complicated question, both empirically (how big are the respective gains?) and philosophically (how do we trade off choices?).

Law professor Richard Epstein's response displays a far shallower understanding of the question. He responds to a hypothesized series of philosophical challenges to establish that the minimum wage is indeed coercive. Here I have no argument, since wage rules necessarily do rest on some level of government coercion. The problem lies in the immediacy of his practical conclusions:

"If I threaten A against doing business with B, then I have limited B’s options as well, even if I purport to protect him. Indeed, an old precedent says that if a gun-wielding competitor scares off the pupils of an “antient school,” the schoolmaster can sue for the loss of his customers, even though the gun was not pointed at him. The same rule should surely apply here. One limits the choices of employees by directing force against the employer. The more effective the sanctions against employers, the less willing they will be to extend offers to workers. The law necessarily limits choices on both sides of the relationship. Its actual benefits most likely go to outsiders who face reduced competition from firms hobbled by the minimum wage law...

Within the classical liberal framework, therefore, there is no way to escape the conclusion that the minimum wage law is coercive. From that conclusion follows the presumption that it should be repealed. The prohibition of certain contracts limits voluntary actions and hence the gains from trade to both employers and employees. The winners are not the parties to the transaction, but those who face less competition from the regulated firm..."

Epstein thinks that since minimum wage laws reduce employee choice, it is clear that they hurt employees. To him, the fact that minimum wages are effectively coercive to workers is the decisive point in the debate.

This is actually a mundane and obvious point to anyone who thinks carefully about wage laws, and I have ample personal experience with it. Occasionally, in discussions about the minimum wage, I encounter someone who (with an evident smirk) declares that "Making it illegal for employers to pay lower than the minimum wage is the same as making it illegal for employees to work for less than the minimum wage!" Of course it is. Perhaps this is a revolutionary concept to demagogues who view wage laws as a way to tame evil corporations, but it is nothing new to the rest of us. And proceeding directly from this premise to the conclusion that minimum wage laws hurt workers reveals overwhelming economic naiveté.

Epstein misses a fact that is obvious to anyone who takes Game Theory 101: having limited choices can make you better off. If an employer is willing to hire you for up to $8 an hour, but you're willing to work at $4 an hour, you may end up with a wage much closer to $4. You can try to hold out and stubbornly insist that you won't work for anything less than $8, but if the employer is larger and more financially secure than you are, it will just call your bluff and withhold employment until you capitulate and agree to work for $4.

Now say that the government comes in and mandates that all employment contracts pay at least $8 an hour. With the force of law on its side, your once-empty threat to hold out until $8 becomes credible. The employer, who was always willing to pay you $8, no longer has any advantage in cajoling you to accept a lower wage. You win.

This simplistic example doesn't show that the minimum wage is an unimpeachably good idea. Perhaps the employer is only willing to pay up to $7 an hour; then a wage floor hurts both of you. But it is clear that, contra Epstein, one of the "parties to a transaction" can derive benefit from an enforced minimum wage. The debate now becomes a much more complicated matter of weighing the disemployment and efficiency problems of the minimum wage against the wealth transfer to a group (low-wage workers) that usually derives great benefit from the money.

With these considerations in mind, Glaeser concludes that the minimum wage is not the best way to redistribute wealth:

"The case against the minimum wage or other related restrictions on contracting does not, in my view, come from clear anti-coercion axioms or even maxims, but from other more technical reasons that have been emphasized for decades. If we want the state to redistribute income, we have sensible means for doing that like Friedman’s negative income tax or the Earned Income Tax Credit. These tax-based approaches are also coercive, but they can increase the choice set of the poor with less of a reduction in the freedom of others. Obviously, these tax-based solutions don’t restrict the set of available contracts and that is a great plus. The fact that American minimum wages are too low to create large-scale unemployment shouldn’t blind us to the fact that, across the Atlantic, far more aggressive minimum wages are accompanied by vast numbers of unemployed youths. The minimum wage is also bad redistribution policy because it imposes the costs of redistribution on the employers of the poor, and on their customers who will have to pay higher prices to make up for higher wages. If we want to redistribute income to the poor, then it is appropriate that everyone with resources pay, not just employers in sectors that employ the less fortunate."

I have a great deal of sympathy for Glaeser's argument, but I think that Brad DeLong's take on the matter is probably the best:

"Now I like the EITC. Come the Day of Wrath, my best pleading will be the role I played in 1993 in the Clinton administration in expanding the EITC. But the EITC is a program that uses the IRS to write lots of relatively small checks to tens of millions of relatively poor people who satisfy picky eligibility rules. This is not the IRS's comparative advantage. The IRS's comparative advantage is using random terror to elicit voluntary compliance with the tax code on the part of relatively rich people. The EITC is a good program, but it a costly program to administer, and it is administered imperfectly to say the least.

The minimum wage, on the other hand, is nearly self-enforcing: its administrative costs are nearly nil, for workers (legal workers, at least) have a very strong incentive to drop a dime on bosses who violate it. From a government-administrative and error-rate perspective, it's a very cost-effective program.

The right solution, of course, is balance: use the minimum wage as one part of your program of boosting the incomes of the working poor, and use the EITC as the other part. try not to push either one to the point where its drawbacks (disemployment on the one hand, and administrative error on the other) grow large. Balance things at the margin."

Obviously, balancing these two approaches at the margin is a difficult task, fraught with empirical uncertainty and political squabbling. It's difficult to estimate the severity of fraud and error in the EITC, and it's unclear just how large the disemployment effects of the minimum wage are. Still, I think that this is where we should be: acknowledging that all policies have their drawbacks, and committing ourselves to the hard work of balancing them correctly.

I should close by saying that I respect thinkers who have a strong anti-coercion philosophy, which naturally lends itself to opposition to the minimum wage. I disagree with their arguments, and am happy to point out what I perceive to be the evident flaws in their assumptions, but at least they have a cogent position that doesn't rest on naive assessments of economic logic. Epstein, unfortunately, crafts his beliefs around crude syllogisms (if a wage floor restricts worker choice, then it must hurt workers) that reveal his obliviousness to how markets actually operate.

The debate should be at a higher level.

Avent on Glaeser

After promoting Ed Glaeser's recent article in my last post, I find that Ryan Avent has a long and caustic post criticizing it:

"Ed Glaeser, font of much of the research that drives this blog, often confounds me. He’ll put together an excellent piece of academic research on urban issues, adding key insights to the way we view the organization of cities. Then he’ll turn around and write something in the New York Sun that looks like a press release from the desk of Randal O’Toole, a lazy, wrongheaded, and deeply ideological thumb of the nose to the rest of us urbanists."

I think Avent's response is deeply wrongheaded, as I'll explain in a minute. First we need to delve further into his complaint:

"Glaeser’s own research indicates real wages in New York are lower than might be expected from productivity alone, because amenity flows (Glaeser’s terminology) have been increasing. The opposite is true in the sunbelt. Real wages have had to increase there over time, in order to compensate residents for declining amenity flows. This corresponds to Glaeser’s research on the consumer city; lots of people want to be in New York not only because they earn more, but because it is an unrivaled consumer experience. This, too, is relevant to Glaeser’s disposable income argument. Money goes farther in Houston, sure, but there’s less to spend it on. If we assume a diverse set of middle-class tastes, it should be obvious that there will be many households for which less dough in New York will be preferable to more in Houston."

Of course there will be "many" households that put high monetary value on the amenities available in New York. So what? Glaeser is trying to explain the enormous difference in population growth between New York and Houston, and the natural conclusion is that low property prices are making cities like Houston increasingly attractive to middle-class Americans seeking a middle-class lifestyle. Given the numerical disparity in population growth, this can hardly even be an argument.

"Glaeser’s meditation on differences in transportation costs is particularly unfortunate. A few initial points. The Center for Housing Policy concluded in 2006 that for families with an income between $20,000 and $50,000, roughly the same share of household budgets was spent on combined housing and transportation costs in New York and Houston. That is, cheaper housing for working families in Houston was offset by more expensive transportation. The same report also noted that for those same families, average annual transportation costs were $10,262, not the $8,500 national average cited by Glaeser. That was in 2006.

Glaeser’s own research also indicates that lower income households prefer to live near public transportation, or, in the absence of public transportation, near the center. Glaeser notes that the recent rise in gas prices constitutes a small actual increase in transportation costs, but he, more than anyone, should recognize that this will significantly impact marginal households–the same ones being pushed from high cost places to low cost places by expensive housing. And since 31 percent of household budgets goes toward transportation, its reasonable to think that a doubling of gasoline prices will be painful for many working class Houstonians."

I'm not sure where Avent gets his statistics, but the usual source for such data is the Consumer Expenditure Survey from the Bureau of Labor Statistics. A quick look at the most recent survey tells us that in 2006, the average household expenditure on transportation was 17.6% of consumption. Admittedly, fuel costs have risen since 2006; the average price for a gallon of gasoline in 2006 was $2.60ish, while today it's around $4.10. But even if we bump up fuel costs by 58%, taking them from 4.6% of expenditures to 7.3%, total transportation costs are still only 20.3% of consumption. Where does "31 percent" come from? I have no clue.

This makes me awfully skeptical of the Center for Housing Policy report that he cites, which declares that in the income range between $20,000 and $35,000, transportation accounts for 21% of spending by households in the central city, 31% by those "near other employment center," and 37% by those "away from employment center." The Consumer Expenditure Survey dissects its data by income group, and the $20,000-$30,000 group spent 17.4% of its budget on transportation. Adjusting for increases in fuel prices, this rises to 20.5%. The $30,000-$40,000 group spent 19.3%, translating to 22.4% of consumption with higher fuel costs. These average costs for all households are close to the figure the Center for Housing Policy report provides for households living in the central city. Worse, the survey was actually published in 2006, meaning that its numbers shouldn't include the recent spike in gasoline prices for which I adjusted. The report should be consistent with the 2006 CES data without adjustment, and its figures for a group with very low transportation costs, central city households, are higher than the CES number for all households.

Clearly, there is something very wrong with the data in this report. As an "expert" on transportation policy, Avent should noticed this immediately, or at least before he used it as a prominent part of his argument that Glaeser -- the most respected urban economist of his generation -- had written a "lazy, wrongheaded, and deeply ideological" piece.

He continues:

"But the most egregious part of this whole piece is the ridiculous assertion that Houston’s growth has been driven by the free market alone, and that it would be wrong to boost places like New York by tying Houston down with regulation. Outrageous. Glaeser knows that were externalities like congestion and carbon emissions priced consistently in both places, Houston’s cost advantages would rapidly evaporate.

I know he knows this, because he just finished writing a report on green cities that praises places like New York for design features, including public transportation, that make them greener than places like Houston and greener than the national average. And this, of course, completely ignores the historical role of government policy favoritism for highways, suburban housing, and sprawl generally. Free market, indeed."

Avent's confident assertion that Houston's cost advantages would "rapidly evaporate" is more a declaration of faith than a result of any kind of data-driven analysis. In his article, Glaeser notes that if Houston residents use 500 more gallons of gasoline than New York residents each year, a $3 per gallon increase in gas prices will cause a $1500 decline in disposable income -- significant, but not enough to singlehandedly make Houston less economical. A very high $100 price on each ton of carbon dioxide would cause a further $1 increase in the price of gasoline, leading to $500 more in spending. Glaeser estimates that after housing, taxes, and transportation, a typical middle class Houston family is $11,200 richer than a typical Queens family. Does $500 make this cost advantage "rapidly evaporate"? No.

Air conditioning requires lots of carbon-intensive electricity, but heating isn't costless either. While air conditioning is inherently less efficient, heating in cold Northeastern climates operates against a much larger temperature gradient. This creates some ambiguity, and I don't have immediate access to the numbers necessary to settle the matter. I suspect that Houston homes do produce more carbon, but I doubt that even a large carbon tax would come close to eliminating the disparity in disposable income that Glaeser calculates. Certainly Avent shouldn't be making glib pronouncements about how huge amounts of money "evaporate" when he doesn't seem to have any numbers either.

Additionally, while some form of congestion pricing may be appropriate, Avent neglects to mention that Houston residents are precisely the ones that suffer from any congestion that occurs in their city. While transportation there might be more efficient with better congestion pricing (although Houston needs such pricing much less than New York), a congestion fee would just monetize the deadweight loss that Houston residents already suffer. If anything, it would make Houston more competitive.

And "government policy favoritism" for highways? First of all, most of our highways are actually funded through gas taxes, which effectively act as a form of road-usage toll. I am perfectly open to arguments that we need to invest more money in urban transit, especially with the recent increase in oil prices. But Avent's implication is that this is another "hidden cost" of the Houston model, and that simply isn't true. The vast majority of the cost is paid by the residents of Houston and other similar Texas cities, through a combination of gas taxes and local and state taxes. Glaeser includes all these costs in his estimates.

Most of all, Avent misses the fundamental point. Glaeser is not opposed to policies that confront global warming, and he's not a fanatical advocate of sprawl. Indeed, he's made an environmentalist case for streamlining growth restrictions, which often force new development further outside of urban centers, creating a more jumbled and carbon-intensive growth pattern.

Rather, Glaeser is making the simple point that differences in property prices are incredibly important for middle-class households seeking a comfortable life, and that since these disparities in price are often created by regulatory barriers to development, better growth policies in high-price locales have the potential to vastly improve quality of life. This isn't a reactionary scheme dreamed up by Exxon Mobil; it's a progressive policy aimed at bettering the livelihood of families striving to grasp the American Dream.

Matt's quirky views, part 2: Falling house prices are great!

Tyler Cowen receives a great email from his evil twin Tyrone:

"Tyler, cheer up! The decline in housing prices is a godsend. Isn't it a standard line -- from both left and right -- that we are spending too much on the elderly and not enough on the young? Isn't lack of upward mobility, for the generation on its way into the world, the new problem? Aren't the American poor to expect an even greater squeeze in the future? There's a simple remedy for all of these problems at once -- lower housing prices! Lower stock prices too! You don't even have to get a bill passed through Congress, or overcome AARP, and we all know how hard that is these days. The housing stock is still there, the relatively established homeowners are a bit poorer, and those poor strugglers on the way up can now buy their dreams at lower prices."

Exactly. Artificially high prices are a needless impediment to the affordability of housing, inflating costs for families struggling to move to better accommodations. Falling property values are a progressive godsend.

Of course, the financial crisis accompanying the rapid deflation of the housing bubble isn't so wonderful, and I'm sure that I would be upset if I invested my life's savings in a house whose value subsequently collapsed. With any luck, however, the painful fall in prices today will make investors less enthusiastic about bidding up prices in the future, freeing capital for more productive investments and making homeownership more accessible for everyone.

And make no mistake: cheap property is really valuable. Ed Glaeser's recent article in the New York Sun makes the case by comparing rapidly growing Houston to New York:

"If we exclude the areas that our two families have already paid for (housing and transportation) and average the remaining categories in the index (food, utilities, health, and miscellaneous), Queens is 24% more expensive than the average American area and Houston is 6% less expensive. Thus — again, after housing, taxes, and transportation — the Queens residents' real remainder is a little less than $21,000; the Houston family's is $32,200. The Houston family is effectively 53% richer and solidly in the middle class, with plenty of money for going out to dinner at Applebee's or taking vacations to San Antonio. The family on Staten Island or in Queens is straining constantly to make ends meet.

If the key factor making Houston a middle-class magnet is its plentiful and inexpensive housing, that raises the question: why is it so cheap? The low cost of homes reflects the low cost of supplying homes in Texas. Building an "economy" 2,000-square-foot house in Houston costs about $120,000, and a slightly larger "standard" one about $150,000.

Why is it so much more expensive in New York? For one, supplying housing in New York City costs much, much more — for a 1,500-square-foot apartment, the construction cost alone is more than $500,000. Also, part of the reason is geographic: an old port on a narrow island can't grow outward, as Houston has, and the costs of building up — New York's fate, especially in Manhattan — will always be higher than those of building out. And the unavoidable fact is that New York makes it harder to build housing than Chicago does — and a lot harder than Houston does.

The permitting process in Manhattan is an arduous, unpredictable, multiyear odyssey involving a dizzying array of regulations, environmental, and other hosts of agencies. A further obstacle: rent control. When other municipalities dropped rent control after World War II, New York clung to it, despite the fact that artificially reduced rents discourage people from building new housing....

The right response to Houston's growth is not to stymie it through regulation that would make the city less affordable. It's for other areas, New York included, to cut construction costs and start beating the Sunbelt at its own game."

The article is so packed with insight that I'm tempted to cut-and-paste almost everything. Glaeser doesn't deny that there are worries about Houston's style of development, including its carbon emissions, but insists that the central theme of his work still stands. Nothing is less progressive than a byzantine regulatory system that chokes supply and drives up the costs of shelter, which accounts for fully one-quarter of low-income households' spending.

As an anti-poverty measure, cheap housing is far more important than the minimum wage, and at a par with the Earned Income Tax Credit. The collapse in prices is causing financial unpleasantness today, but in the long run it will be a boon for families across the country.

Inflationary expectations

Nathan Newman over at TPMCafe applauds states for indexing the minimum wage to inflation.

From the perspective of an individual state, this isn't such a terrible decision. For those who make the minimum wage, inflation causes a continual decline in living standards, ended only by inconsistent legislative attempts to raise the wage floor. Indexation provides relief and consistency.

I am leery, however, of implementing this policy nationally. Indexing the minimum wage to inflation has great potential to embed inflationary expectations in the economy. Such expectations are responsible for ongoing, destructive bouts of inflation: if everyone expects prices to increase 10% in the next year, it's very difficult to stop their belief from becoming a self-fulfilling prophecy. Since the minimum wage provides a baseline for the entire wage structure, a policy that automatically matches it to recorded inflation (or, worse, expected inflation) will make inflationary expectations even more difficult to purge.

Once these expectations are embedded in the economy, they can only be removed using tight monetary policies. In the early 1980s, the Federal Reserve steeply raised interest rates, causing a recession deeper and more painful than any we have seen since. If an indexed minimum wage contributes to inflation and causes a similar episode to unfold, any beneficial effects will be vastly outweighed by the pain of the resulting recession. This may not happen often, or even at all, but the specter of inflation (and the contractionary policies necessary to defeat it) makes me unwilling to take the risk.

At the same time, of course, I do recognize that the declines in real wage income for minimum wage earners caused by inflation are exceptionally painful. Perhaps, then, there is a middle position: indexation with an explicit exception triggered by high inflation. Above a certain rate -- say, 7 percent -- the minimum wage increase becomes slightly less than the rate of inflation, and the disparity grows as inflation gets higher, in recognition of the increasing difficulty (and urgency) of combating price increases. The president may be vested with the authority to further suspend wage increases as part of an anti-inflation strategy.

Admittedly, this is a little hackish, and there are other problems with indexation that it leaves unaddressed. For instance, in cyclical downturns where aggregate demand is weak, we see recessions arise because prices are "sticky"; they don't decline enough for the market to slide back into equilibrium and use all its production capacity. Light inflation can be a nice way to relieve this problem, because it allows sticky nominal prices to decline in real value. Since automatic indexation of wages eliminates this channel for restoring balance to the labor market, in a steep recession it might lead to higher unemployment. That said, it's possible to address this problem with another tweak, by giving the president authority to suspend minimum wage increases when unemployment is particularly high, or even making such a suspension automatic.

Yes, this is a very clumsy policy, but I'm not sure that it's worse than the alternative. While I instinctively recoil at the byzantine legal framework it creates, with complicated adjustments and discretionary authority when inflation or unemployment is high, it may still be a step up from the completely arbitrary system that reigns today. I'd love to craft a simple, elegant system that addresses both the welfare of minimum-wage workers and the macroeconomic perils of indexation. This balancing act, unfortunately, is quite complicated.

Something doesn't seem right...

Here's the explanation of today's market movements from the New York Times:

"Concerns about a slowing economy and rising inflation pushed oil prices down sharply for a second day on Wednesday, an unusual dip in the oil price rally that began more than six years ago.

The two-day decline totaled more than $10.50 a barrel, but analysts cautioned that it was still unclear how far prices would fall and that the respite may be temporary.

The drop in oil price contributed to a jump on Wall Street, with most major markets rising more than 2.5 percent."

Let's see: concerns about a slowing economy pushed oil prices down, presumably because economic weakness is associated with a slackening in demand. Then the low oil prices pushed up the stock market because... what? They're such good news for the economy? Which would mean that the economy isn't in such bad shape after all, and that demand won't be heading down, and that oil prices shouldn't be falling? Which would mean... *head explodes*

In all seriousness, this story only makes sense if we assume radically inefficient markets. It is impossible for the second-order effect on stocks from lower oil prices caused by economic weakness to exceed the first-order effect on stocks from the economic weakness itself. The New York Times narrative is only consistent if oil traders were somehow late to acquire and digest the news of economic weakness that stock markets had already assimilated. This is remotely possible, but it's bizarre enough that reporters shouldn't breezily declare it the explanation for the day's events.

More likely, this is just another example of reporters overreaching to explain opaque movements in the market. You see the same tendency when slight bumps in political polls are associated with whatever trivial campaign spats occurred in the last week, when in reality they're probably just statistical noise.

Dear Larry Kudlow

Dear Larry Kudlow,

I knew you were stupid. After all, you wrote this in May:

"One of the things we’ve learned during the Democratic primary battle is that Hillary’s victories are bullish for stocks and Obama’s wins are bearish.

The clearest example was Hillary’s massive West Virginia victory. Stocks opened strong the following day. But after Obama’s big North Carolina win, a night he nearly carried Indiana, stocks opened way down.

Even though Hillary clocked Obama in Kentucky, since Obama took Oregon convincingly, he really carried last night’s elections and now stands on the verge of gaining the Democratic nomination. Not surprisingly, stocks opened down 80 points this morning.

Markets don’t like Obama."

This alone ought to disqualify you from pretending to offer serious commentary ever again. First of all, it's an absurd overreaction to a few variable data points. If you look at the markets after the Wisconsin primary, arguably Obama's decisive victory, you'll see that they went up.

But it would be idiotic even if it didn't depend on a few cherrypicked data points. Presumably you've heard about "efficient markets," the idea that market prices provide the best estimate of the present value of securities. I'm not a fanatical believer in efficient markets, but I have enough faith in the efficiency of Wall Street that I think it could have reacted at least a few days in advance to Obama's widely expected victory in West Virginia, if it thought Obama was really such a threat to capitalism. In fact, I think that a market with even a drop of efficiency would already have acknowledged the meaninglessness of West Virginia, Oregon, and Kentucky, since by that point Obama's delegate lead was strong enough to render those contests moot. Your assertion that "markets don't like Obama" only makes sense if markets moodily overreacted to widely predicted, meaningless results in the nomination race -- which, if true, hardly suggests that they were making a sober, intelligent judgment about the candidates' effect on the economy.

So yes, Larry, I already knew that you were a blowhard. But now you offer this to the poor readers of National Review:

"In a dramatic move yesterday President Bush removed the executive-branch moratorium on offshore drilling. Today, at a news conference, Bush repeated his new position, and slammed the Democratic Congress for not removing the congressional moratorium on the Outer Continental Shelf and elsewhere. Crude-oil futures for August delivery plunged $9.26, or 6.3 percent, almost immediately as Bush was speaking, bringing the barrel price down to $136.

Now isn’t this interesting?

Democrats keep saying that it will take 10 years or longer to produce oil from the offshore areas. And they say that oil prices won’t decline for at least that long. And they, along with Obama and McCain, bash so-called oil speculators. And today we had a real-world example as to why they are wrong. All of them. Reid, Pelosi, Obama, McCain — all of them.

Traders took a look at a feisty and aggressive George Bush and started selling the market well before a single new drop of oil has been lifted. What does this tell us? Well, if Congress moves to seal the deal, oil prices will probably keep on falling. That’s the way traders work. They discount the future. Psychology and expectations can turn on a dime."

This is so clueless that I barely know where to begin. Obviously, the offshore oil in question is not going to be ready for August delivery. Even you acknowledge that. Why would it affect the August crude oil futures? Your only explanation is that "traders work" by "discounting the future."

Why yes, Larry. Traders do discount the future, and this puts a limit on "contango," the upward slope of the futures curve. Futures prices at time T+1 can't exceed prices at time T by more than the cost of interest plus the cost of storage, because otherwise there would be an arbitrage opportunity: you could make guaranteed money by buying oil at time T and hoarding it until time T+1. If this was a binding constraint on the upward slope of the futures curve, then distant futures prices could affect prices today, and you might expect increases in the future supply of oil to cause lower near-term prices. Surely the small amount of extra supply provided by American offshore drilling wouldn't be enough to lower August delivery prices by $9, but one might imagine some effect.

Unfortunately, the futures curve isn't sloping upward at all. It is in a state of "backwardation": futures prices for delivery several years from now are actually lower than those for August. Investors already have an incentive to borrow oil from the future, but they're stopped by tiny inventories and tight constraints on drilling capacity. This means that perceived scarcity over the next decade isn't raising prices today at all, and there is no way that Bush's drilling announcement can affect futures prices for this August.

But hey, you're Larry Kudlow! You don't need to understand the oil market; you just have to scream drilling propaganda and back it up with a confused mention of discounting. After all, you write for Washington's premier conservative publication and host a show on a major cable network. No need to inform your audience, right?

Sincerely,
Matthew Rognlie

P.S.
I am a little curious how you managed to make it all the way through an economics program and earn a degree. Oh, wait...

Drilling doesn't lower prices; it raises money

When politicians are desperate to propose a "solution" to high oil prices, they inevitably make ridiculous claims. Bush and McCain's insistence that lifting the moratorium on offshore drilling will result in meaningfully lower prices is patent nonsense. Such production would be trivial in the vast world oil market, at most lowering prices by a few cents several decades from now.

But wait a minute -- why should the debate be about lowering oil prices at all? To borrow a favorite term of economists, lower prices are a "second-order" benefit of domestic oil production. They're extremely indirect: you sell oil to try to bring the price on the much larger world market down a smidgen, which will then have a positive but vanishingly small impact on consumer welfare in your country.

On the other hand, the money you get from actually selling the oil, or auctioning off the rights to drill, is a "first-order" benefit. As a rule, it should be much larger. The debate, therefore, shouldn't be about whether offshore production is justified by its effect on oil prices (it's not), but whether the profits from leasing the land outweigh the negative social and environmental consequences of increased drilling. Even if the government spends most of those profits on building toothpick museums, whatever portion of the proceeds makes it into lower taxes or higher Social Security benefits will still be much more meaningful to consumers' pocketbooks than an infinitesimal change in oil prices.

Matt's quirky views, part 1: Defund NASA

Apparently NASA has a budget of $17.6 billion:

"The NASA budget includes $5.78 billion for the space shuttle and space station programs, $4.44 billion for science, $3.5 billion for development of new manned spacecraft systems and $447 million for aeronautics research."

The press release (from February) goes on to mention that "with the increase, NASA still accounts for less than 1 percent of the federal budget." Well, sure. Many large government expenditures are still trivial in size when you compare them to massive entitlement programs like Social Security and Medicare. Agricultural subsidies, almost universally condemned by the intelligentsia, are also "less than 1 percent" of the budget, but this doesn't excuse their wastefulness.

The arguments for massive government spending on the space program fall into three general categories:

"Research in the space program leads to improved technologies that are beneficial to the economy"

I'm sure that some technologies originally developed by NASA have indeed found applications here on Earth. I'm also sure that any massive research effort involving a cumulative expenditure of several hundred billion dollars will have some useful byproducts. This doesn't mean that it's efficient.

If you take a look at the federal budget, you'll find that NASA receives almost three times as much funding as the National Science Foundation. Anyone with even a peripheral awareness of science and technology in the United States knows that the NSF is responsible for far more useful progress than NASA. The moral is clear: if you are interested in developing commercially productive technologies, spending billions to shoot rockets into space is probably not your best bet.

"Space is the future of humanity"

Perhaps. I can assure you, however, that it will be a very long time before humans begin colonizing other worlds, and that such voyages will require technology fundamentally different from anything NASA is developing today. It is difficult to see any scenario in which building clunky chemical rockets to travel short distances in our solar system will lead to the efficient, long-haul systems that are necessary for real human exploration of the galaxy. Platitudes about "humanity's future" might be a good justification for space exploration a hundred years from now, but they are not sensible today.

"We have an advanced, wealthy society. Why shouldn't we spend a small fraction of our budget pushing the boundaries of our world? Doesn't everyone love the space program?"

Maybe. But before we blow billions of dollars sending probes on missions with hazy scientific and societal value, we might want to think about funding a vastly cheaper prize fund for a malaria vaccine, which could save millions of lives with no downside risk to the government. We might also want to consider that Medicare is hurtling toward insolvency in 2019. Blithe talk about an "advanced society" doesn't justify wasteful spending, especially when our "advanced society" appears unable to deal with fiscal disaster looming on the horizon, and spending billions on a useless space program only makes the situation worse.

Who pays for carbon permits?

After a depressing battle in the comments section of a recent Megan McArdle post about who pays for carbon permits, I feel that it's necessary to expand on my case against allocating carbon emission permits without an auction. This is one of the many issues where economic intuition is essential to understanding the effects of policy, and there are two myths that are particularly important to confront.

Myth:
Requiring polluters to pay for emissions permits in an auction raises consumer prices, but giving them away allows consumers to avoid increased prices.

Reality:
In any cap-and-trade system, the effect on consumer prices depends on how many permits are handed out, not on how they are initially allocated. The reason is that if permits are given away, the quantity allocated to each company cannot be set according to current emissions. By allowing polluters to receive more free permits by emitting more carbon, such a policy would defeat the entire point of a carbon price.

Therefore, permits must be determined by some set variable that has no relation to current emissions. One common choice is past emissions. Since a company cannot do anything to change its level of past emissions, giving it a quantity of free carbon permits based on past emissions will not alter its incentives in any way.

The only element of a cap-and-trade regime that does affect the company is the market carbon price, but this price is determined by the aggregate supply of carbon permits, not their initial allocation. At a given carbon price X, the cost to the company of emitting an additional ton of carbon dioxide is the same whether or not you have 0 permits or 1,000,000 permits. If you've taken introductory economics, you are probably familiar with the concept of a sunk cost. A free allocation of carbon permits based on past behavior is meaningless in exactly the same way: it is a sunk benefit, and has no impact on the cost of production or any other variable relevant to market equilibrium.

This is the key point. Since a sunk benefit doesn't impact any variable relevant to market equilibrium, it won't affect the key outcomes of that equilibrium: price and quantity. As far as consumer prices are concerned, it doesn't matter whether the permits are auctioned off or handed to random people on the street. This makes our choice quite clear. Government can rebate the money from an auction back to taxpayers, or use it to offset undesirable, distortionary taxes. If permits are given away, any companies lucky enough to receive them will just use the additional revenue to improve profits. Either way, the existence of a carbon price will force consumer prices up; the only question is where all the money will go.

Now, there is one exception: highly regulated utility markets, where profit margins are either implicitly or explicitly restricted. If companies in these markets receive free permit allocations, some of the money will probably go back to consumers in the form of lower prices, or at least less of a price increase.

Maybe, then, free allocations aren't so bad? No, because lower consumer prices defeat much of the purpose of a carbon price. In a utility market, a carbon price acts in two ways: first, to make the utility provide its service in a less carbon-intensive way, and second, to encourage residential, commercial, and industrial users of the utility to use its service more efficiently. Lower prices through free permit allocations leave the first channel of carbon reduction intact, but they destroy the second one, which is arguably just as important.

Additionally, even if you want to avoid increases in consumer prices at all costs, the highly regulated utility markets I discuss account for less than half of carbon emissions, and even there only some of the money from free permit handouts is likely to find its way into reducing consumer prices. At best, the division of gains from a handout of carbon permits will be around 25% to consumers, and 75% to whatever industry incumbents are lucky enough to receive the permits. Since consumers will pay almost 100% of the increased costs that come with a carbon price, this is clearly not a good deal. The vast majority of people will be better off if the government holds an auction to distribute the permits and rebates the revenues back to taxpayers.

Myth:
Giving away permits will help insulate carbon-intensive industries from the pain that comes with a carbon price.

Reality:
In a narrow sense, this is true. Giving away permits will improve the profitability of companies who have historically emitted lots of carbon. Almost no one, however, thinks that improving the cash flow of polluting corporations is an inherently worthwhile goal. Instead, people are worried about the effect on jobs, and this is where permit giveaways are completely irrelevant.

Say that you are the CEO of PollutaCorp. In the past, you've produced 1 million widgets and 1 million thingamajigs each year, and manufacturing each widget and thingamajig causes the emission of one ton of carbon dioxide. Your profit margin on each widget is $100, while your profit margin on each thingamajig is only $25.

Now a cap-and-trade system is imposed, and you don't receive any free permits. The market price for carbon turns out to be $50 per ton, and the impact on your business is clear: widgets are still profitable, but thingamajigs now lose you money. Since you lead a profit-maximizing corporation, you decide to shut down production of thingamajigs and lay off all the workers in that part of your company.

Now let's consider a slightly different scenario. The market price for carbon is still $50 per ton, but you received 2,000,000 permits as part of the initial allocation process, enough to cover the emissions created by every widget and thingamajig. What do you do? The exact same thing. You can make $25 on each thingamajig and cover your emissions with free permits, but you can make $50 for each thingamajig you once produced by halting production and selling the permits. The profit-maximizing choice is the same, and all the thingamajig assembly line workers are laid off anyway.

We're left with a single, basic point: as I said earlier, free permit allocations are sunk benefits. They do not change company incentives in any way, and this applies both to the market for products and the market for labor. Handing away permits to existing polluters simply won't save any jobs.

What's the effect of carbon prices?

There's a common misconception that oil-fueled transportation will be the main front in the fight against global warming. In reality, carbon prices will make far more of a difference in the electricity market.

Consider a price of $200 per ton of carbon dioxide. While this is ludicrously high, it's an interesting thought experiment. Such a price roughly translates into a $2 increase in gas prices. To be sure, this is a significant jump, but we've experienced the same runup in price over the past several years, and automobile transportation has hardly been wiped off the face of the Earth.

Meanwhile, that same carbon price causes a 20 cent per kilowatt hour increase in the cost of coal-fired electricity. The current wholesale price of coal power is 4-5 cents per kilowatt hour; a 20 cent jump would make coal decisively less economical than almost every alternative source of power, including solar thermal, wind, combined-cycle gas, and nuclear. Unless coal plants implemented thorough carbon capture and sequestration, coal electricity would be wiped off the face of the earth.

The lesson? While high carbon prices affect all carbon-intensive parts of the economy, the impact is far more radical for electricity than for oil-fueled transportation.

Hoarding oil

As I noted in my last post, the lack of massive speculative hoarding of oil is prima facie evidence that private speculators have not caused the bulk of the recent increase in oil prices.

Admittedly, there is one other way that oil may be "hoarded": producers may intentionally keep large amounts of oil in the ground, betting that the price will rise enough to make waiting worthwhile. This way, oil is effectively being stored, even if we can't see any large increase in private stockpiles.

Is this plausible? Well, as I mentioned before, it's not consistent with the trajectory of futures prices, which are actually lower for deliveries in the next few years. In this case, if a producer wants to bet on a large increase in oil prices, it is more efficient to sell oil now and use the money to purchase oil futures. If a producer is integrated into the market enough that it can buy and sell futures, it's foolish to leave oil in the ground as a means of speculation when there is a clearly more profitable alternative.

Perhaps this is airy efficient-markets theorizing on my part, and there are producers out there who somehow aren't able to purchase oil futures but still want to make a bet on increasing oil prices. I'm skeptical, however, that any such producers would have the patience to wait for higher oil prices. If you're leading an oil-producing regime that is so financially unsophisticated that it can't make bets involving futures prices, you probably want to cash in the returns from high oil prices as quickly as you can.

When will we stop blaming "speculators"?

Today I find this completely uninformative analysis of high oil prices through a link on the Washington Post's main page:

"For two days this week, oil was looking like a typical bubble market. The price slid more than $10 a barrel in two days. Had supply and demand changed that much? Was this the beginning of the end of high oil prices?

Then on Thursday, the oil price bounced up at the end of the trading session. It’s hard to see what news might have triggered that. The day’s major developments – the firing of missiles by Iran and an e-mail from Nigerian insurgents calling off their self-declared ceasefire – were known at the beginning of the day. Brazilian oil workers were planning a strike, but the International Energy Agency lowered consumption forecasts. Go figure.

That led some analysts to say that the oil market is indeed a bubble."

No, no, no. In the face of potential supply disruptions, the price of short-term futures contracts on oil may bounce around quite a bit. If the market estimates that there is a 10% chance Iran will block the Strait of Hormuz in a showdown with the West, causing oil to shoot up to $400 per barrel, the price will be around $25 per barrel higher than it otherwise would be. By contrast, if there is only an estimated 5% chance, the impact is half as much. Since such estimates are subjective and dependent on the complicated psychology of the Iranian and Israeli regimes, we can expect them to move around significantly in response to seemingly trivial events, like the short-term aftermath of a missile launch. This will result in price swings that have nothing to do with a "bubble."

In any case, declaring that the oil market is a "bubble" is highly misleading. Even if investors are overestimating the risk of short-term supply shocks, causing the price of short-term futures contracts to be inflated by $10 to $15, the bulk of the increase in oil prices is not a result of any such speculation. In the past few months, markets have cleared at very high oil prices. If these oil prices over the past year had been the result of "speculation," we would have seen massive hoarding of oil by private investors. It's a conventional story of supply and demand: if the price of oil was really inflated beyond what the market was able to support, then supply must have exceeded demand and the excess must have been stored somewhere. This has not happened. At most, therefore, any "speculation" has been limited to relatively small, short-term changes in the prices of oil futures, and this may be a perfectly rational response to the changing probability of geopolitical supply shocks. Hardly a "bubble"!

Yet another politician who doesn't understand economics

Taking another look at the New York Times article I cited in my recent post about Congress's response to high oil prices, I find another gem of economic illiteracy:

"Senator Harry Reid of Nevada, the majority leader, has made a refrain in recent weeks of saying, 'We cannot drill our way out of this problem.' But he opened his news conference on Tuesday with a different approach: 'Let’s begin the discussion here by saying, Democrats support domestic production.' He also hinted at a potential element of compromise legislation: that any oil produced from wider access to federal lands off shore be reserved for domestic use and barred from export. At the same time, he noted that Senator John McCain of Arizona, the Republican presidential candidate, had opposed similar restrictions in the past."

Wow. In an integrated world market, oil prices are determined by world supply and demand. If the market determines that it is efficient to export domestically produced oil, it is signaling that it is actually cheaper to send domestic oil overseas and import foreign oil to make up the difference. This seems unlikely, but it's certainly possible: different oil is of different quality, and perhaps some of the oil produced offshore is better suited to refinement elsewhere.

What happens if Harry Reid gets his way and bars the export of domestically produced oil? Probably nothing, but if there is any price response, it will actually be a tiny increase in the price of oil. At the margin, a less efficient oil market makes drilling hard-to-recover oil a little less desirable, and that can only lead to an increase in oil prices.

Your world in maps

Check out the download map for Firefox 3. The country-by-country variation in downloads is stupefying, and it demonstrates just how technologically isolated many countries remain.

There are exactly three countries that have zero downloads: French Guiana, Western Sahara, and North Korea. French Guiana is a little surprising, since it is an overseas department of France and actually isn't poor at all -- its GDP per capita is around $18,000. Since it has a population of less than half a million people, however, zero downloads is a little more understandable, even if that puts it behind information-age superstars like Chad, Afghanistan, and Bhutan.

Western Sahara, of course, is an impoverished desert region with no clear government, currently split under a ceasefire between Morocco and a rebel group. It also has fewer than 500,000 residents, and it's easy to see why Firefox 3 isn't a pressing concern for most of them.

Then there is North Korea, with a population of 23 million people. Zero downloads. Beneath it lies South Korea, an economically advanced democracy with 150,000 downloads and one of the highest broadband penetration rates in the world. Have any two nations divided by an artificial partition ever diverged in this way? It is the most astonishing experiment on the effects of market economics in human history.

Don't blame speculators

I'm convinced that most politicians lack even the rudiments of economic understanding, and the their response to high gas prices is a case in point:

Neither Republicans nor Democrats are being spared in the minds of voters, one said. “They blame ‘the government,’ ” said Ms. Collins, who noted that many Maine residents were panicked at the possibility of paying $5,000 to heat their homes this winter. She and other lawmakers said they could see the contours of a deal that included new incentives for renewable fuels, more freedom for drilling in waters off states that sanction the drilling and a potential crackdown on speculation in the oil-futures market.

Are "speculators" in the oil-futures market causing high oil prices? If you take the ten seconds necessary to actually look up oil-futures prices, you will find out that they are not. In fact, the futures market expects oil prices to experience a slight decline over the next several years. No speculative bubble there!

There are two reasons for the increase in oil prices: a weak dollar, and rapid growth in demand from developing countries, especially China. Malicious speculators and greedy oil executives play no role.

A meta-post on blogging

Ever wonder why I keep posting on this blog, even in the face of extremely low readership? (To anyone reading this sentence: I love you!)

It's simple: I find that blogging is a good way to achieve self-comprehension. My mind is often clogged with disembodied facts and ideas, too disorganized to get any clear picture of an issue. Writing forces me to assemble the relevant facts in one place, explaining them cogently enough that my few loyal readers don't leave in disgust. After I'm done, my posts become useful references for the future, brimming with links and numbers and argumentation that I don't have the presence of mind to summon on my own.

This is why I plow ahead, maintaining this inconsistent and questionably literate blog against all odds. Occasionally I'll look back and grimace: did I actually write that? But as anyone who knows me will attest, my writing here shines in comparison to the extemporaneous stammering I employ in conversation. Blogging may not be my strength, but it's the most effective means of communication I have.

Solar tax credits now!

This is ridiculous. Congress needs to extend, and indeed expand, the solar tax credit immediately.

I've already discussed the compelling economic case for subsidizing critical infant energy technologies, especially solar power. Yale economist William Nordhaus, hardly a raging leftist on the topic of climate change, estimates in his report that a low cost carbon-free technology has a present discounted value of $17 trillion. Certainly we can afford to spend $2 billion, or 8500 times less, encouraging the development of the main plausible carbon-free alternative available to us.

In fact, we should be investing much, much more, and not just in solar power. Although "clean coal" is still a laughable oxymoron, cheap carbon sequestration would be a brilliant breakthough, revolutionizing the fight against climate change overnight. Of course, I hope that solar thermal will someday provide the vast majority of our baseload power capacity, but if it fails to be versatile or economical enough, we'll be wise to hedge our bets. And we can certainly do better than a few billion a year when our energy and environmental future depends on developing better technology.

More on efficient campaigning

The indispensable FiveThirtyEight.com has come out with an interesting new feature, an estimate of the "return on investment" from allocating campaign resources to each state. This estimate takes the probability of each state providing the "tipping point" for an Electoral College victory, as calculated by the site's already existing model, and divides it by population. Assuming that population is a good proxy for the costs of affecting the tally in each state, this calculation provides a good indication of the return from campaigning. This is a topic I discussed extensively in a recent post.

The results are fascinating: in order, the 15 states with the highest current "return on investment" are New Mexico, Ohio, Colorado, Michigan, North Dakota, Iowa, New Hampshire, Oregon, Montana, Virginia, Pennsylvania, Alaska, Delaware, Nevada, and Wisconsin. Many of these are predictable, but a few unlikely "swing" states like North Dakota, Montana, New Hampshire, Alaska and Delaware only make the cut thanks to their low populations. Such inclusions raise an important question -- just how valid is the "return on investment" logic?

First, I think it's most appropriate for ad spending. As a first approximation, the costs of investing in a media market are indeed roughly proportional to the population. This makes blanketing the airwaves in North Dakota more economical than one might think. Even if there is an extremely low chance of the state affecting the election outcome, the costs of advertising are similarly low. That said, there are also some important special cases. Many viewers in Delaware are covered by the Philadelphia media market, dramatically inflating the costs of airtime. The same is true for southern New Hampshire (Boston) and northern Virginia (DC).

For more personal investments like campaign visits, the calculus changes dramatically. Here, the costs aren't proportional to population at all. It is much easier for Obama to move around between swing states in the Great Lakes region -- Ohio, Michigan, and Pennsylvania -- than to head all the way out to Montana. You might argue that it's easier to influence political opinion in states with low population, but you could just as easily argue that it's harder to make headway in a geographically large state with few people. In the end, when planning his personal itinerary, Obama should probably rely on the absolute chances of a state providing the "tipping point." His decision may be colored by a range of considerations -- the malleability of a state's electorate, the density of population, and so on -- but should primarily be about the likelihood that a state will swing the election.

Combining this with some of the discussion in my previous post, I think that the basic outline of an optimal campaign strategy emerges:

1. Allocate plenty of advertising dollars and organizational money to standard swing states: Ohio, Michigan, New Mexico, and Colorado in particular, and to a lesser extent Virginia, Pennsylvania, Iowa, and Nevada.

2. Place some additional advertising money in states with a low chance of affecting the race but a similarly low cost: North Dakota, Montana, Alaska, and perhaps Oregon. This is made even more appealing by the public image benefits of running a "broad" campaign. Possibly also spend in New Hampshire and Delaware, but stay clear of the pricey Boston media market. (As a longtime Oregon resident, I am disinclined to admit that the state could possibly go for McCain in any circumstances other than a nationwide McCain landslide, but I should try to avoid letting this color my objective analysis...)

3. Finally, make token investments in other states like Missouri, Indiana, and West Virginia to see if the McCain campaign will waste more significant resources in response. Discontinue if McCain is smart enough to avoid taking the bait.

4. Spend most time "on the ground" in the key Midwestern region -- Ohio, Michigan, and Pennsylvania -- and in the key Southwestern region -- Colorado, New Mexico, and Nevada. Make a few visits to other possible swing states, especially Virginia. (Obama will be "in the neighborhood" anyway whenever he visits DC to perform Senatorial duties.)

5. Make token visits elsewhere both to promote the idea that those states are "in contention," thus drawing McCain to devote resources in response, and also to cheer up local party organizations that might otherwise feel ignored.

6. Adjust the strategy if an Obama landslide becomes likely. In this case, it may be better both (1) to seek to maximize the popular vote victory and (2) to concentrate attention on historically Republican states that have zero chance of affecting the outcome of the election but may still "swing" to Obama and reinforce the image of a landslide.

All in all, I think it's a pretty compelling electoral recipe.

Safety valves

In a recent post Matthew Yglesias unleashes a puzzling attack against the concept of a "safety valve," a guaranteed maximum price for carbon in a cap-and-trade regime:

"Now Marc cunningly made his "safety valve" link to a Climate Progress article explaining why it's a bad idea. But to put it briefly, a safety valve is a great provision to add if you don't care at all about mitigating climate change... If you add on a provision that prevents the price of carbon emissions from rising too high, then you're not taking action to reduce emissions."

This makes no sense. Yes, if the safety valve is set at an extremely low price, there will be little "action to reduce emissions." But this is not inherent in the concept of a safety valve; it is merely a poor implementation of the idea. In fact, over the past few weeks, I've come to the conclusion that a cap-and-trade system with a maximum permit price (a "safety valve") is actually the optimal response to the multiple uncertainties involved in fighting climate change.

There are two main sources of uncertainty involved. First of all, there is uncertainty about the level of damage associated with a given level of carbon emissions. With high carbon emissions, this uncertainty grows. As we move farther away from our current climate, it becomes harder to estimate exactly how Earth's exceedingly complicated weather systems will respond, and the possibility of unpredictable, cataclysmic damage expands.

Second, there is uncertainty about how expensive it will be to achieve each particular level of reduction in carbon emissions. Again, this uncertainty grows as we move farther away from the norm: it's clearer how we might reduce emissions 20%, for instance, than how we might accomplish a 90% decrease. If we develop dirt-cheap solar power or cost-effective carbon sequestration, the cost will be low; if not, such an extreme reduction in emissions may be impossibly expensive.

In a 1974 article, renowned economist Martin Weitzman explored the effectiveness of price controls versus quantity controls. These correspond neatly to the current debate over global warming: a carbon tax is a price control, while a cap-and-trade system is a quantity control. His insight was that the appropriateness of these systems depends on the two types of uncertainty I discussed above. When there is high uncertainty in the damages from each pollution level, but low uncertainty in the costs of reducing emissions, Weitzman found that a quantity control was optimal policy. In the opposite situation, where damage is easily predictable but the costs of preventing it are not, a price control is superior.

This makes a great deal of intuitive sense. If you know that lowering emissions will cost a fixed rate of X dollars per ton, while damage becomes steadily more uncertain and dangerous as we approach high emissions rates, it's reasonable to limit the latter uncertainty by setting a solid quantity cap. In the opposite case, where damages are simple to predict but the costs of prevention are not, a price target is the optimal route. Just set the price of emissions equal to the damages, and the market will work its magic.

The problem with climate change, of course, is that we have both kinds of uncertainty. In this case, how can we choose between the price and quantity approaches? The answer is reassuring: we might not have to choose at all! If we implement a quantity target (a cap-and-trade system) with a maximum price, we can limit both kinds of uncertainty with a higher level of efficiency.

The key is that the two main uncertainties associated with climate change occur at different emissions levels. When projected emissions are high, our main concern is that unpredictable, disastrous consequences will spring up. This is the basis of another excellent Weitzman paper. On the other hand, if we're contemplating dramatic reductions in emissions, the unknown cost of reducing emissions looms larger as a source of uncertainty.

A cap-and-trade system with a high safety valve price is appropriate on both ends. It sets declining emissions caps, limiting the uncertain effects of high-end emissions. Since we have a better understanding of the costs of lowering emissions at the current margin -- rather than, say, the cost of going from 30% to 10% of current emissions -- we can set the safety valve price so that it is unlikely to come into effect in the near future, unless the costs of reduction prove massively higher than anticipated.

Then, once we've reduced emissions well below current levels, rendering the most extreme and unpredictable disaster scenarios unlikely, the safety valve price comes into the picture. At a lower level of emissions, the marginal damage from each ton of carbon is easier to predict, but the costs of further reduction become unclear, at least from our perch as circa-2010 policymakers. Thus, in case it proves devastatingly expensive to reduce carbon emissions from 25% to 20% of current levels (a difference that won't be as meaningful from a climate perspective), we create a maximum price. This fusion of price and quantity instruments effectively limits uncertainty on both ends.

In formulating my opinion, I relied upon the vaguely quantitative intuition I outlined above. As it happens, I later found that two great economists, Mark Roberts and Michael Spence, formalized the exact same intuition 30 years ago. In fact, Spence won the Nobel Prize in 2001 -- how cool is that? So don't take the superiority of a safety valve from me: take it from two much smarter economists who figured everything out years ago.

Repeat after me: oil is a world market

All the political chatter about "energy independence" misses one basic and incredibly important point: oil is traded on the world market.

As long as oil is traded on the world market, the price of oil in the US will be determined by world supply and demand, and it will make virtually no difference whether we produce 20%, 80%, or even 100% of our oil domestically.

How widely should campaigns disperse advertising dollars?

Obama is placing his ads in an aspirational mix of 18 states, including generally Republican climes like Alaska, Georgia, Indiana, Montana, North Carolina, and North Dakota. It's not clear exactly how much he is spending in each state: perhaps the long-shot ad buys are small and symbolic, allowing the campaign to claim big ambitions while spending the real money in a much more concentrated set of markets. Regardless, the scope of this purchase raises an interesting question -- how broadly should campaigns distribute their funding?

For the purposes of winning a single election, I think the answer is clear: spending should be very targeted. Why? Absent intense attention to particular states, poll results tend to move roughly in tandem across the country. If Obama sees a 5-point bounce nationwide, he's likely to see similar changes in his results in each state. Occasionally, changes in the dynamic of a race appear to be more pronounced in some areas than others, but years of election-watching have convinced me that the assumption of similar changes across states provides a mostly correct first approximation. Moreover, even when changes in support are not consistent across the country, they are almost never localized to particular states. At the very least, they occur in regions and across places with similar demographic profiles.

This has powerful implications. For instance, it is inconceivable for Obama to win Montana or North Dakota yet fail to have enough national support to win Ohio, Michigan, and Pennsylvania. The distribution of support nationwide never shifts so radically over the course of a campaign. Yet if he wins those three states, victory is already certain. According to polls, the race in Indiana is closer than in either Montana or North Dakota, but it is still impossible to imagine an Obama victory in Indiana without similar victories in Ohio, Michigan, and Pennsylvania. There is no way that the dynamics of a race will be so inconsistent within the same region.

If there is zero chance that a state will provide the "tipping point" for an Electoral College victory, a strategy devoted exclusively to producing such a victory shouldn't allocate any funds there. This radically narrows the scope of an efficient campaign. In fact, according to this logic, Obama should only spend money on eight states: Ohio, Pennsylvania, Michigan, Colorado, New Mexico, Nevada, Iowa, and Virginia. The other "swing" states have essentially zero chance of providing the critical 270-elector margin. Almost all of them have poll margins at least 9 points more in McCain's favor than do the critical core of states (Ohio, etc.) that currently define the Electoral College landscape. There is no way that we'll see such regional variation in the results going forward that these McCain states will increase 9 points to become the new swing-state battlegrounds. I can certainly see Obama winning them, but only if he has the kind of broader victory that already makes an Electoral College triumph certain. The only state with a smaller margin is Indiana, but as we already discussed, a victory in Indiana absent victories in the already decisive Midwestern core is unthinkable.

So why might Obama want to spread his advertising money more widely? First, targeting such an ambitious set of states generates positive buzz for the campaign: "look at Obama --is he so transformative that he might win Montana?" Still, I think that this is a pretty small effect. The tiny subset of political nerds who track these campaign decisions doesn't have any real voting power. Perhaps the hope is to tint media coverage, thereby affecting popular perceptions of the candidate, but this is such an indirect and subtle way of promoting a campaign that I can't see it making much difference.

Another possible justification is to build the party for the future. Even though North Carolina won't be useful this year, the idea goes, it may prove to be a decisive Democratic acquisition in 8 or 12 years. I'm skeptical that 30-second television ads will leave much residual influence on political culture, but it's plausible that the excitement associated with being a "swing state" will invigorate local activists and benefit state parties in the long term. Some degree of investment in local party infrastructure may pay dividends as well. Active state parties help to produce entry-level politicians that may grow to national prominence, and they also help to make state politics a little more liberal. These aren't the most imminent concerns for a national-level politician like Obama, but they're arguably still quite important.

Note that both these justifications implicitly rest on the premise that in ad-saturated markets, the marginal benefit of additional spending isn't that great. After all, using ads to encourage red-state party activists to prepare for the future might be nice, but if you can redirect the same funds to build your edge in a swing state, the political imperative is clear. This is a difficult question, because there isn't much hard evidence on the value of ad spending. A famous paper by Steven Levitt suggests that campaign spending isn't as effective as one might think. Unfortunately, the clever methodology, which examines repeat U.S. House candidates to see whether they do better when they spend more, leaves the applicability of the result to other circumstances unclear. In general, the political science literature on the issue is mixed, and since there is such a small sample size of presidential elections, essentially all research on the subject deals with more numerous, less important contests like House races. This is problematic, because the dynamics of a presidential race are so singular that any analogy to lower-scale elections is probably flawed.

My suspicion is that past a certain level of media saturation, additional spending doesn't do much good. Of course, this partially depends on the implementation. Campaigns often fill the airwaves with a single advertising spot, so that viewers see the same ad again and again. I don't think that this is productive. Maybe the first few viewings are useful to establish a firm message in a voter's mind, but incessant repetition provokes more annoyance than anything else. It's far better to craft a set of many advertisements, each directed toward a broader theme present in other ads, but also presenting a new set of facts to further convince the voter. While burying a single idea in voters' minds can be powerful -- witness "dishonest" Al Gore or "flip-flopper" John Kerry -- it's more convincing to do so with a range of arguments, not by endlessly repeating a single canned 30-second spot.

Unfortunately, diversifying advertisements takes both cleverness and persistence, and it's not clear that campaign operatives have either in abundance. If the marginal ad dollar's only effect is to show the same tired spot an additional time in an already saturated market, I don't think it's very useful.

Regardless, one thing should be clear: spending on such a wide range of states cannot be justified on immediate, electoral grounds. There is zero chance that any states outside the eight I listed -- Ohio, Pennsylvania, Michigan, Colorado, New Mexico, Nevada, Iowa, and Virginia -- will prove decisive in the presidential contest. The only reason to spend so widely is to produce the image of a broadly-based campaign, to build local parties for the long run, or to fatten an already secure national margin.

Why is trade skepticism "progressive"?

As I sent some more money to Obama last night, I spent a moment considering my greatest worry about an Obama presidency: his apparent willingness to use anti-trade rhetoric on the campaign trail, coupled with the resurrection of anti-trade politics as a dominant force in the Democratic Party.

Of course, there are more favorable signs, like Obama's appointment of Jason Furman as economic policy director. But the brouhaha that erupted after Furman's appointment, with well-known voices like Dean Baker assaulting the Obama camp for its lack of "progressivism," made me angry about the terms used to frame the debate. How, exactly, do trade skeptics get off claiming that economic isolationism is the true "progressive" policy?

There are, of course, theoretical reasons to suppose that trade might hurt the poor in the United States. In a simple economic analysis, trade may lower the returns to unskilled labor in a developed country: such labor is abundant in developing countries but relatively rarer (compared to capital) in a mature economy. While a superficial look at inequality data suggests that this may have happened, careful examination reveals a more complicated picture. The supposed growth in inequality is actually a relic of our measurement techniques, which use a single price deflator (the CPI) that fails to account for differences in inflation among different income groups. Once we adjust for different consumption baskets, the increase in inequality vanishes. Lower prices for manufactured goods, disproportionately consumed by the poorest Americans, match the relative decline in bottom-decile wages. And, of course, these lower prices are due in no small part to trade.

In other words, the evidence is messy. As we might predict, nominal wages for low-income workers have fallen relative to nominal wages for high-income workers. To some extent, this is probably a result of trade. But the goods consumed by the poor have also fallen in price relative to the goods consumed by the rich, and this is largely also a result of trade. (In fact, the paper linked above explicitly traces one-third of this effect to Chinese imports.) Given that trade is not causing any apparent increase in real inequality, and that trade is known to benefit participating economies in the aggregate, the best conclusion is that trade is good for the poor and the country as a whole. It is possible that trade is damaging the income distribution in America, but a rigorous analysis of the evidence offers no support for the possibility.

It gets worse. Even if "trade skeptics" decide that increased trade is hurting American workers, how do they translate this dissatisfaction into an actionable policy critique? We can wildly throw around new tariffs, but this is unlikely to be efficient. How can we separate the "good" trade restrictions, which prevent the outsourcing of low-skilled labor, from truly pernicious barriers like the Brazilian sugar quota? Does anyone think that politicians are capable of deciding exactly which kinds of trade it is optimal to keep, and then implementing effective trade policies to accomplish their goals? Can anyone pretend that they will escape the grip of rent-seeking lobbyists, whose institutional heft and ability to craft legislation is particularly devastating to trade policy?

Most of the time, skeptics advocate a halt in new trade deals until certain "labor and environmental" standards are met. In theory, I'm in agreement, at least with the need for environmental standards. If we implement strong climate change policies, only to find that carbon-intensive industrial activity migrated overseas to less prudential countries, we will have reason to be upset. I'm worried, however, that it is too easy to use such standards as a cover for simple protectionism. If we are to implement any environmental rules, they should be clear and narrowly targeted -- not a mishmash of regulations whose true effect is to stifle trade.

And labor standards? I do not think that it is the right of American politicians to decide what labor standards are appropriate for nations on the other side of the world, which have to deal with vastly different social and economic realities. While it is fashionable in the West to assail "sweatshop" labor, millions of workers in developing countries are voting with their feet and taking jobs in sweatshops. Conditions in third-world garment factories are deplorable by Western standards, but they are still preferable to the main alternative, rural poverty and starvation.

I cannot see an experiment with labor standards turning out anything but badly. Allowing comfortable Western legislators to dictate the working conditions of people halfway around the globe, whose lives and dreams are utterly alien to them, means subjugating billions' hopes of escaping poverty to the whims of political convenience.

And this is the part that really maddens me: if, even when we restrict ourselves to the welfare of our own country, the arguments for restricting trade are thin at best, shouldn't we consider the other side of trade? The fact that in the last several decades, growth through labor-intensive exports has been the primary means of lifting hundreds of millions of people out of crushing poverty? Here the evidence is so overwhelming that there is little room for debate. In China, India, and elsewhere, the most spectacular improvements in human welfare have come directly through growth created by what is often the only resource available to impoverished economies: a cheap pool of unskilled labor. If progressivism has any global conscience at all, it is folly to let anti-trade demagoguery stifle the dreams of billions around the world.

I refuse to accept a political discourse where economic isolationism is viewed as the progressive policy of choice.