Monday, July 13, 2009

The case for public transportation

Daniel comments on my post about the "subsidy fallacy":
Well, in subsidizing transportation's defense, it's very difficult to provide good, alternative public transportation (I'm assuming you're referring to public transit) only through the direct revenues of riders. Nevertheless public transit is a very important system to have.
This is definitely true, and if my poor readers will forgive me for droning in lecture mode for a minute, I think it's valuable to discuss just why this is.

Certain kinds of public transportation, like subways, have very high fixed costs but marginal costs that are close to zero. In such circumstances, the efficient economic prescription is to charge near-zero fares. This unfortunately means a loss of market discipline, and it's complicated a little by the fact that using taxes to fund transportation has its own negative effects, but from the perspective of sheer economic efficiency, using tax dollars to set fares closer to marginal cost is overwhelmingly positive.

Moreover, as Daniel points out, it can be difficult or impossible to support public transit on fares from ridership alone. This does not mean that public transit is an economic loss. In fact, it's easy to explain how a transit system might be unable to support itself through fares even if it's a large benefit overall. Consider the New York City subway, which I've used every day for the last two months. The alternatives for commuting to work are slim: taxis are far too expensive, cycling is slow and miserable in bad weather, and the costs of owning and parking a car in Manhattan are prohibitive. All in all, I'd be willing to pay at least $10 for each leg of my daily commute, and there are many more like me. But if MTA jacked up its fares to $10, the vast base of other customers who are willing to pay $3 or $4 would dry up, even though they cost almost nothing to transport. It's completely conceivable that there is no single price where MTA could raise enough money to fund its operations, even though there would be an enormous surplus if it could charge each individual customer the true value of the service.

Now, as Megan McArdle points out in a different context, it's important to recognize when we're just rehashing generic arguments in favor of socialism. After all, there are a lot of superficially good arguments for socialism, but in most cases they're far outweighed in practice by its negatives. For transportation within cities, however, I think there's often a perfect storm of high fixed costs, near-zero marginal costs, and the practical need to set a single price (i.e. an inability to price discriminate) that compels public investment.

This all ties back to my earlier post about the subsidy fallacy, the commonplace argument that because we have such large subsidies for roads and other forms of traditional transportation, almost any change in spending should be welcome. This frequently degenerates into hand-wavy rhetoric that justifies new projects in the absence of any cost-benefit analysis whatsoever. As I hope this post illustrates, there are strong economic arguments available to justify public subsidies for transit, which makes it all the more important that we avoid the weak ones.

The right kind of stimulus

Felix Salmon is skeptical of proposals for a new stimulus package:
But the problem is that spending trillions of dollars is actually extremely difficult, and it’s even harder if you try to front-load it. Government, by its nature, moves slowly, and I get the impression that the “easy” spending — and then some — was all included in the initial stimulus bill. The “shovel-ready projects” have already been funded, and any extra stimulus might well take years to kick in.
All too often I think we abstract away the details of stimulus, thinking only in multipliers and macroeconomic aggregates when we really need to be considering the details. Felix is right to say that pushing through government spending isn't simple, and it's possible that in many areas we've passed the point where the marginal returns justify the costs. There's only so much that we can spend on massive new infrastructure projects without running up against fundamental supply constraints and pushing up prices in the sector. Sure, if we could wave a wand and distribute $500 billion of spending in exact proportion to unemployed resources, it would be a great idea, but in practice rapid increases in government spending tend to be concentrated in a much narrower swath of the economy.

There is, however, one kind of stimulus that we can be certain will decrease unemployment, in almost direct proportion to the amount we spend: aid to states. Lacking the ability to issue long-term debt during a downturn, states are forced to make massive cuts to their budgets, and the effects are devastating. Laid-off employees go onto the jobless rolls (costing the government in unemployment benefits), no longer provide vital services, and damage the broader economy by cutting spending. Yet some "budget hawk" Senators decided to remove a large fraction of this singularly effective measure from the last stimulus bill, when almost every other part of the bill was clearly less effective.

Unless we're absolutist opponents of stimulus, I can't see why we would oppose another dose of aid to states. Sure, California should be forced to account for its structural deficits. But we can design aid that won't reward individual states for budgetary irresponsibility: simply make it proportional to their population or share of federal revenue. And although aid during recessions lowers the incentive for states to save during better times, I don't think this is a very strong point. It is politically impossible for states to sustain more than a small surplus, and assuming that we can coax them into doing so with tough love today is deeply naive.

Most importantly, the benefits of aid are enormous. In a deep recession, it is unfathomable that we are passing up a simple, efficient way to avoid further downturn. There is legitimate room for debate about the effectiveness of most kinds of stimulus. I just can't see any legitimate debate about this.

Blog note

Apologies to all for the light posting recently. I'm on vacation this week, and will be in Japan on a trip for my summer job the next, meaning that the slow pace is likely to continue for a while.

If any of you want to keep up without revisiting the site every day, you can add my feed to Google Reader or any blog aggregator.

Monday, July 06, 2009

The subsidy fallacy

Ezra Klein approvingly cites the argument that subsidies for "urban farming" are justified because industrial agriculture is already heavily subsidized.

You see this argument all the time, especially with transportation policy. There's a valid sense that roads and other traditional forms of transportation are oversubsidized, and to the extent that this makes us aware that our existing model didn't develop in a perfect market vacuum, it's useful. But all too often it morphs into "eh, since roads and highways are subsidized, I'm just going to wave my hands and assert without doing any arithmetic that any subsidy of alternative transportation is justified and merely levels the playing field." This can lead to some very bad conclusions.**

In fact, this is a common fallacy among even very smart people, which suggests that we should be especially careful to avoid it...



*Ezra updates to say that he never meant his post as a suggestion that urban farming should be subsidized. Since it's abundantly clear that urban farming is uneconomical without subsidies or many volunteer hours, I think this equates to dismissing urban farming. Of course, if anyone can demonstrate a viable business model that doesn't rely on massive donations or inputs that clearly won't scale up, more power to them...

**First, obviously, we need to compare the levels of the two subsidies, and a little arithmetic often suggests far greater disparities than hand-waving rhetoric will acknowledge. On a more subtle point, it's not necessarily optimal to create new subsidies in an attempt to "level the playing field." Depending on the situation, this can either increase or decrease efficiency. For instance, if X and Y are near-perfect substitutes, and the combined demand for the two of them is very inelastic, increasing the subsidy on Y to bring it in line with X will bring us to the optimal tradeoff between production of X and Y without inefficiently increasing total production much further. If demand is highly elastic, on the other hand, even if we get the tradeoff between X and Y right, raising the subsidy on Y might (inefficiently) increase overall demand so much that the total effect on efficiency is negative.

The strange contradictions of Thomas Friedman

In his most recent op-ed, Thomas Friedman claims that if we don't pass firm economywide environmental standards, we will fall behind other nations in the development of new technology. Ending in a bizarre flourish, he even says that there is otherwise "no way" we will be "able to afford decent health care for every American."

Now, as readers of this blog know, I strongly support aggressive carbon policy, and maybe it's best to keep my mouth shut and placidly agree with whoever seems to be on the same side. But as Jason Furman might say, the collateral damage to rational thought from Friedman's columns is simply too great...

Take this passage, where he approvingly quotes from an advisory board report:
Here’s the key point on energy from the draft report of the president’s Economic Recovery Advisory Board: “If the U.S. fails to adopt an economywide carbon abatement program, we will continue to cede leadership in new energy technology. The U.S. is now home to only two of the ten largest solar photovoltaic producers in the world, two of the top ten wind turbine producers and one of the top ten advanced battery manufacturers. That is, only one-sixth of the world’s top renewable energy manufacturers are based in the United States. ... Sustainable technologies in solar, wind, electric vehicles, nuclear and other innovations will drive the future global economy. We can either invest in policies to build U.S. leadership in these new industries and jobs today, or we can continue with business as usual and buy windmills from Europe, batteries from Japan and solar panels from Asia.”
Let's break this down. If the United States enacts carbon restrictions, the domestic demand for green technologies will increase. How do US manufacturers gain "leadership" (a relative status) in the industry as a result? This is only possible insofar as there exist barriers to trade that cause businesses and consumers to be disproportionately likely to purchase goods from their own country, so that when new demand is created in the US, it benefits US manufacturers more than it benefits firms in other countries.

Such barriers can be substantial, although I suspect that they are relatively small when we're dealing with photovoltaic panels or batteries (the kinds of tradeable items where relative status might be relevant, if it ever is). But in any case, the irony is impossible to ignore: Friedman's arguments about how carbon policy in the US will affect American "leadership" only make sense to the extent that the world is not flat.

Friday, July 03, 2009

Chart for the day: Mobile subscriptions in North and Central America

Take a look at which countries in North and Central America had the most cell subscriptions per 100 people in 2007:


The lack of any clear correlation between these numbers and the wealth of each nation is striking. Mexico is above Canada, Nicaragua is above Costa Rica, and El Salvador is above the United States. This reveals, I think, the awe-inspiring performance of mobile telephony as a technology accessible to the entire world, one that has spread to the point where even vast gaps in income don't necessarily mean a gap in accessibility, as developing nations with primitive land lines jump to the new medium of communication. (And remember that these statistics are from two years ago—I am sure that today they are even more impressive.)

It's easy to be drawn into pessimism about the prospects of many developing countries. Sure, China and India are doing extraordinarily well, but less fortunate nations remained mired in political and economic dsyfunction, and many don't display strong prospects for growth. Amid all the cause for gloom, however, I think that advances in communications provide a very real source of hope. Mobile phones are already improving the lives of innumerably many poor across the globe, and as their mobile subscriptions start providing an outlet to the internet over the next few decades, the potential benefits are vast.

Countries are poor for many reasons, particularly bad governments and institutions, but there's also often a simple inability to connect with the developed world and share in the knowledge and technology that make it so prosperous. The internet will provide entrepreneurs countless new opportunities to learn and bring new businesses to their countries, and also make it easier for corporations from the developed world—much vilified but indispensable in helping nations climb out of poverty—to enter once-forbidding markets. There's no cause for blind optimism, but perhaps in 50 years we'll look back at the communications revolution as the key that brought our confused patchwork of rich and poor nations together in common prosperity.

(Stats from the World Bank's World Development Indicators service)

It really is that bad

Thinking about Palin's sudden decision to resign the governorship, I can't help noticing a pattern. When a prominent political figure does something utterly insane, you get two reactions from each side of the ideological spectrum. First, from the opposing side, there's a mix of mockery and despairing cynicism, as most observers assume that it's a good development but a few can't shake themselves of the notion that it will somehow redound to the other side's benefit. This is exactly what we've seen: while most Democrats are hopeful that this will be the end of Sarah Palin, there's a minority so jaded by the fact that Palin ever attracted any support that they imagine her as some kind of twisted political genius, with every move carefully calculated to win the support of gun-toting, SUV-driving Real Americans.

From supporters of the figure, on the other hand, you get a mix of honest skepticism and contorted rationalization. Many Republican pundits admit that resigning in the middle of her only term as a major elected official will crush any hopes of Palin selling herself as a credible Presidential candidate in 2012, and that her rambling press conference did her no favors. Yet others reflexively insist that it will be beneficial. (It's a bad time to be a governor! She'll be able to start her campaign earlier!)

Although this is undeniably even more bizarre, it reminds me of McCain's disastrous attempt to suspend his campaign and postpone the debates in order to "focus" on the financial crisis. At first, talking heads were mixed about the prudence of McCain's strategy, and even some Democrats worried that his latest "maverick" move might gin up support in the polls. But in time, of course, the absurdity of this interpretation became clear. The public might be easily misled on factual matters, but it's a good enough judge of basic plausibility to call bullshit on ducking out of debates in a histrionic attempt to pitch yourself as above the fray, or quitting the only position of public responsibility you've ever held because it's "best for Alaska."

Wednesday, July 01, 2009

Why does John Taylor blame the Fed?

John Taylor is a monetary economist of extraordinary eminence. His eponymous Taylor rule, along with the underlying "Taylor principle," is a mainstay of discussion in monetary policy, and in overall policy influence he is arguably one of the top economists in the world.

He also has recently written a book blaming the government, and in particular the Greenspan Fed's monetary policy in the early-to-mid 2000s, for the housing bubble and our recent financial collapse. It is hard to imagine anyone better equipped to make this case, and yet I remain completely unconvinced.

The problem is simple: we have a large mass of theory and empirical observation that explains how the Fed should target rates to stabilize broad macroeconomic indicators—GDP growth, inflation, and so on. We do not have any compelling body of theory that tells us how "unnaturally" low rates (whatever those are) can produce massive relative price distortions and bamboozle banks into mispricing risk. John Taylor has been vocal in his belief that the Fed "caused" the crisis, but his modeling basis for these claims is much thinner than the rhetoric suggests. To my knowledge, he has never moved beyond the line of argument in this 2007 paper, where he runs a few simulations:
For the purposes of this policy panel I took a more straightforward approach. I estimated a simple housing starts equation with the federal funds rates as the explanatory variable. The equation was estimated with quarterly data over the nearly 50 year period from the second quarter of 1959 to the second quarter of 2007. The model shows a strong, statistically significant effect of the federal funds rate on housing starts which occurs with a lag. The interest rate elasticity is similar to those found in more complex models such as Topel and Rosen (1988); the semi-elasticity is about -8.3. (The estimated semi-elasticity was -8.9 in the post 1984.1 period and -8.6 in the pre-1984.1 period.)

I simulated this model under two assumptions: (1) the federal funds rate follows its actual path and (2) the federal funds rate follows a Taylor rule, smoothed to have the 25 basis point increment adjustments used by the Fed in recent years. Figure 1 shows the two paths for the federal funds rate.
At this point, I'm already skeptical. By running regressions on historical data, you're inevitably going to come up with negative relationships between interest rates and various kinds of investment activity. Then you can "simulate" what would happen with a more contractionary monetary policy, and you will always find that there is less activity. Ex post facto, you can blame any bubble on insufficiently tight monetary policy in this way; it's almost a tautology. The results don't seem very impressive either, as this graph displaying the simulated trajectory of housing starts demonstrates:


The simulations fail to capture any real "bubble" behavior. In fairness to Taylor, when he adds another wrinkle to his model—an interactive relationship between housing price inflation and construction, based on measured two-way Granger causality—the picture looks a little better. But I think it's revealing that we don't see any direct results from simulation of housing prices themselves compared against the historical data. Why? Probably because there isn't any existing, robust model can explain the price trajectory as a result of monetary policy. Yet the massive spike in housing prices is certainly a more important part of our crisis than the change in housing starts alone.

The correct line, I think, isn't "the Fed's lax monetary policy caused the housing bubble." Instead, it's "some mix of mistaken demand expectations, consumer irrationality, and dysfunctional financial institutions interacted in ways we don't completely understand to produce the bubble, and although perhaps early contractionary policy by the Fed could have abated it at lower cost, we don't really know, and it's much harder to set policy in real time."

If we fall for simplistic explanations of the crisis—it was the Fed! or the Chinese!—I'm afraid that we won't have the will to address the very real market failures at its core, and that would be a serious mistake.