Wednesday, December 31, 2014

Government spending: What's the right amount?

Most pundits who talk about government spending do so as a percentage of gross domestic product (GDP). The long term average is roughly 20%, meaning that the amount of government spending in a year is equal to 20% of that year's nominal GDP. But it is not clear to me that government officials should be targeting that long term average as the "normal" level. Take a look at the graph below.

The red line is total federal government spending as a percentage of total GDP and is plotted using the right axis. As you can see it has fluctuated around 18 - 20% since the 1950's. The large spike is World War II. When people talk about maintaining a constant level of government spending they are usually referring to the relatively flat red line.

But why should government spending track productivity? A flat red line means that if GDP increases by 3% government spending increases by 3%. But GDP is a measure of the country's productivity; it does not measure the country's need for government. In fact, I can't think of a compelling reason why the government should spend a constant percentage of GDP.

This brings me to the blue line in the graph. The blue line is plotted using the left axis and it measures the per capita amount of government spending in inflation adjusted dollars. As shown in the graph, it has been increasing steadily from about $2,000 per person in 1950 to $10,000 per person in 2014. So the government spends five times more per person today than it did in 1950. By 1950 we already had the traditional public goods and services that most people think a government should provide: an army, parks, a tax collecting service, the post office and public education to name some of the most common things. Many of the regulatory agencies were also created and funded as well by that time, including the FDA and SEC. In fact, many government services such as national defense, drug and food testing, and parks experience economies of scale. So what have we gotten for this increase in spending?

Since 1950 the government has built and funded the interstate highway system, created the department of education, the EPA, and the Bureau of Alcohol, Tobacco, and Firearms to help fight the war on drugs. Even if you think all of these things should be funded by the government, it only took the government about $5,600 per person in 1980 to do so, about $4,400 less than the government is spending today.

The chart above shows what government spending would be as a percentage of GDP if it had maintained the 1980 per capita level of $5,663. The last row shows that government spending would only be 11.2% of GDP today at that level instead of 20.2%. Maintaining that level of spending would have drastically lowered the national debt, and in my opinion there would have been no reduction in the government services that many people (but not me) think that the government should provide. Looking at these numbers makes one really wonder what the government is spending that extra $4,400 per person on. (Remember, I am not arguing for a constant level of spending. I am arguing for pegging spending to population growth rather than output growth.)

As a country I think we would be better off maintaining a constant blue line at 1980 levels rather than a constant red line. Hopefully when the new Republican congress takes office they implement real spending cuts that bring the blue line down.

Saturday, December 13, 2014

Funding professional stadiums with public money

The Tampa Bay Rays are threatening to leave the city if a new stadium isn't built. This happens all the time throughout professional sports. Teams use the threat of re-location to get taxpayers to fork over some or all of the money required for a new stadium. But should taxpayers fund stadiums?

Some of the arguments made by government officials in support of funding a new stadium include increased attendance and tourism, new jobs, revitalizing downtown areas, and civic pride. There is little evidence that the first 3 reasons ever materialize. It is important to remember that the true cost of anything must include the opportunity cost, which is the value of the next best alternative. So if a government spends $240 million dollars on a stadium, which is what state and local government spent on the Arizona Diamondbacks stadium, the cost is not only the $240 million, but also whatever net benefits the next best use of those funds would have created. So if the next best alternative was better public schools, the true cost was $240 million plus the benefits residents would have gotten from having better public schools (or new museums, a new university, better parks, etc.). When the opportunity cost is included projects that look profitable on paper can turn out to be net losers.

When it comes to attendance, most new stadiums see a temporary bump that quickly dissipates. As an example, according to The Economics of Sports by Michael Leeds and Peter von Allmen when Miller Park in Milwaukee first opened in 2001 attendance for Brewer's games increased from 19,427 to 34,704 per game. By 2003 attendance had declined to 20,992 per game, nearly the same level as in the old ballpark. This trend is seen in other places as well. Shiny new stadiums provide a temporary attendance bump, but if the team fails to achieve success fans will quit going once the novelty of the experience wears off.

The creation of jobs is usually lackluster as well. The aforementioned $240 million dollar investment in Arizona led to 340 full time jobs. The is a cost of $706,000 per job. The Maryland Department of Business and Economic Development calculated that the Baltimore Ravens stadium created jobs at a cost of $127,000 to $331,000 each depending on the estimates. While this is cheaper than Arizona, it is much more expensive than other job creating programs. For example, Maryland's Sunny Day Fund for economic development created 5,200 jobs at a cost of $6,250 per job in the same time period (Leeds & von Allmen). (A more subtle point but one that I think is important is to remember that jobs are a cost, not a benefit, and thus any project that is promoted based on the jobs it will create should be viewed with suspicion.)

As for revitalizing downtown, there are many projects that can do that. If a new stadium is built it often crowds out spending that would occur at other places. Most of the people who attend sporting events are local citizens who would spend their time and money doing other things within the city if the stadium was not there. It is incorrect to attribute all of the spending that occurs at new stadiums as a net benefit, since much of that spending would have taken place at other areas within the city. The increased business that occurs in and around new stadiums is usually accompanied by decreased business in other areas of the city.

There are also many different ways to fund a stadium with public money. In the article above about Tampa Bay, local officials are thinking about using a tourism development tax. The reason for this is that it pushes the cost of the new stadium on to tourists rather than locals and thus it is easier for government officials to justify. The problem with this is that tourism taxes crucially rely on the number of tourists. The Ramsey rule of taxation says that higher taxes should be applied to goods that have relatively more inelastic demand. One of the main things that affect demand elasticity is the availability of substitutes. It seems to me that there are a lot of good substitutes for vacationing in the Tampa Bay area, including other areas of Florida, South Carolina, Georgia, southern California, etc. This means that the elasticity of demand for vacations in the Tampa bay area is probably relatively elastic and that a tax will have a relatively large, negative effect on the amount of tourists. Thus any tax revenue projections that ignore this effect will be overstated. Local officials may project that an increase in the tourism tax will lead to enough money to fund the stadium, but if they ignore or under-estimate the effect that higher prices have on quantity their projections could be wildly off, leaving local taxpayers to make up the difference.

Perhaps the best argument for publicly funding sports stadiums is that it increases civic pride. This means that sports teams act like a public good. So while there may be no monetary benefits, there is a utility benefit that accrues to local residents. People rally around their sports teams during difficult times and take great pride in them when they are doing well. Look at the Saints after hurricane Katrina. That is probably why when most sports fans talk about their team they use the pronoun "we". Fans feel as if they are part of the team, and this is worth something to them. If that is the case I can see why citizens fund some portion of stadiums. But they should probably ignore the other promises.

Sunday, December 7, 2014

How will technology affect cities?

The declining costs and quality advancements of video conferencing over the last several years, and information transmission costs in general, has stimulated more talk about the decline of cities. Other technologies such as the phone, email, and multi-line/conference calling led to similar statements. Yet the city remains.

In 1977, urban geographer Jean Gottman wrote that:

"The telephone provides, when needed, quasi-immediate verbal communication between all the interdependent units at minimum costs...It would have been very difficult for all these complex and integrated networks (in cities) to work in unison without the telephone, which made possible the constant and efficient coordination of all the systems of the large modern city. The telephone helped to make cities bigger and more exciting."

When I read this I wondered if new advancements in transmitting information will have a similar effect. Instead of making cities obsolete, cities will get larger and more complex. Video conferencing will make non-verbal communication quasi-immediate. Many people think that this will eliminate the need for workers to be near each other, but what if it has the opposite effect? I am not sure what form this would take, but if history is a guide it is a possibility.

As information becomes more readily available, people will be able to make decisions quicker and more accurately. User ratings will help us decide immediately who deserves our business and who doesn't; there will be little need to personally know any entrepreneur you interact with in order to build a rapport. City traffic will be alleviated by self-driving cars and smart traffic systems that can adjust on the fly. All of the urban amenities will be available with much lower congestion costs. Of course, if traffic into the city is also reduced it will allow people to liver further away while having similar commuting times, which would have the opposite effect.

I am inclined to believe that cities will continue to thrive along with advancements in technology. Technology has been advancing continuously and at a rapid rate for nearly 300 years and cities continue to grow. It will be interesting to see if this continues in the future.

Tuesday, November 18, 2014

Subsidizing city farms is not a good use of resources

This past weekend I attended the 2014 North American Regional Science Conference in Bethesda, MD. At the conference one attendee presented some research they had done on local and state urban farming policy. Apparently many states and municipalities are subsidizing urban farms, gardens, and farmers markets in an effort to get more healthy food to city residents. Cleveland is one city that is taking part in this trend and getting subsidies from the federal and state government.

I am all for allowing people to use their land how they see fit. I think that if neighborhoods want to start gardens and local farms on unused lots they should not be prevented from doing so by any rules or regulations. However, I don't think that those lots should be specially zoned for farming or that people who want to use them for farming should get any special treatment. Getting rid of silly rules that prevent farming from occurring is a good thing, but promoting farming over other productive uses is wasteful.

The reason it is wasteful is because of comparative advantage. Having a comparative advantage means that you can produce something at a lower opportunity cost than someone else. In the case of farming, rural areas have a comparative advantage over cities because the land used for farming in a city usually has a more productive use than it does in a rural area. For example, let's compare Franklin county Ohio, where Columbus is located, to a nearby rural county, Logan county. Below are the production possibility frontiers (PPF) for both areas. F stands for financial services and the dollar value produced per hour is on the Y axis. A stands for agricultural output and the dollar value produced per hour is on the X axis.

Notice that Franklin county can produce $300/hr of financial services compared to $50/hr in Logan county. Franklin county has an absolute advantage in financial services. If you have ever been to Columbus this make sense. Cities often have agglomeration economies in white collar work due to the lower cost of transferring ideas and information, which makes workers more productive than they are in rural areas. Columbus has several major banks located in it's borders and this makes financial service workers more productive. Both Franklin and Logan can produce $100/hr in agricultural production, so neither has a comparative advantage in A (I could have chose a higher number for Logan but the analysis would be unchanged). 

The opportunity cost of producing another dollar of A in Columbus is $3 of F ($300F = $100A reduces to $3F = $1A). The opportunity cost of producing another dollar of A in Logan is only $0.50 (50F = 100A so 0.5F = 1A) This means that Logan has a comparative advantage in A since they give up less F to produce another dollar of A. Franklin has a comparative advantage in F (1F = 0.33A vs. 1F = 2A). Franklin gives up less A to produce another dollar of F. In this case Logan should specialize in A and Franklin should specialize in F and the two economies should trade with one another. Specialization and trade maximizes production due to the different comparative advantages.

For example, one terms of trade could be $1A = $2F. Franklin, who is specializing in F, would agree with this because if they want to produce another A on their own (called autarky) they have to give up 3 F. With trade they only give up 2. Logan, who is specializing in A, would agree with this because if they wanted 2 more F on their own they would have to give up 4 A. With trade they only give up 1. So both countries can get the good that they don't specialize in cheaper with trade. This is how trade creates value and makes us all better off.

Now suppose the politicians in Ohio decide to subsidize A in Franklin county so that they can be "self sufficient" and "understand where food comes from" and "eat healthier". They do this by taxing another region, like Greene county, and then using those tax dollars (i.e. resources) to subsidize the production of A in Franklin county. If they subsidize it enough, they can eliminate the gains from trade. For example, suppose the subsidies allow Franklin county to increase their production of A to $600/hr. Their new PPF is:

Now the opportunity cost of A is the same in both Franklin and Logan county. The gains from trade between the two have been eliminated. Franklin county can grow their own food, hurrah! But remember that to do this Franklin county needed a subsidy, which can only be raised by taxing some other area. So resources have to be moved from one area to another by the government tax apparatus to make Franklin county as efficient as Logan county in A.

That is what urban farming policy does; it attempts to increase the productivity of urban farms so that it makes economic sense to grow their own food rather than import it from rural areas. This is a waste of resources. Specialization and trade make us rich. The government should not try to create industries or pick winners and losers. If an abandoned lot in Cleveland is put to its highest valued use as a farm then so be it. But if its highest valued use is as a bank, or convenience store, or bar, or bicycle shop then that is what it should be. Government subsidies distort markets and lead to inefficient allocations of resources. Urban farm policy is just one example of this activity that occurs far too often.

Monday, November 10, 2014

How will education impact location choices?

Women have been outpacing men in degrees earned for several years now. As the graphs below show, women earn more bachelor's degrees, master's degrees, and doctorates than men do (click on graphs to enlarge).

It will be interesting to see what impact this has on the labor force, child bearing, and location choices in the future. Married couples in which both individuals have a bachelor's degree or more are called "power couples" in the economics literature and there is strong evidence that power couples are more likely than other couples to locate in the largest and most educated cities. As power couple formation increases will these effects hold up? Or will they diminish as more and more power couples are formed? 

Even though women are outpacing men when it comes to degrees earned, both groups are getting more educated over time. My research shows that a bachelor's or advanced degree increases the probability that a person will locate in a central city within a metropolitan statistical area. As more people earn degrees it could mean more city living. Or perhaps the effect dissipates as more people earn degrees. There is evidence that a bachelor's or advanced degree has a causal effect on locating in a city, which means the effect of education is unlikely to disappear over time. If that is true it means that we should see a larger proportion of people living in cities in the future, all else equal. I am looking forward to seeing whether or not this is true as the data becomes available.

Friday, November 7, 2014

More evidence that the minimum wage harms low skilled workers

In a new NBER working paper analyzing the minimum wage, economists David Neumark, J.M. Ian Salas, and William Wascher conclude that " the best evidence still points to job loss from minimum wages for very low-skilled workers - in particular, for teens." You can find a link to the paper as well as more analysis here.

Even if you think that the minimum wage is too low, it still makes little sense to raise it at the national level. Costs of living vary dramatically by region, state, and city. A national minimum wage set at $10/hr without adjusting for the cost of living will have a larger effect on employment in a low cost place like Easley, SC than it will in San Francisco, CA, where it may not even be binding in many industries.

I am against any minimum wage, but the best bad policy would be to let local voters decide what the minimum wage should be rather than a top down solution from Washington that unevenly harms low skilled workers in low cost areas.

Tuesday, November 4, 2014

The least productive Congress in history?

Several articles have been written about how the current 113th Congress is on track to be the least productive in history. But what does this really mean?

The articles and funny men like John Oliver lament this lack of productivity. It appears that they think that Congress is only useful if it is passing laws that restrict somebody from doing something, because that is what most laws do. Sure every once in a while Congress will repeal a law that is no longer necessary (if it ever was...) but that kind of legislation is rare. If you think that the objective function of Congress is to maximize legislation then I am glad to see an unproductive Congress. Most of the laws enacted today benefit some people at the expense of others. They do not promote a competent or efficient justice system, help provide basic infrastructure, or protect us from foreign enemies. Instead they micro-manage our everyday affairs, waste taxpayer money on special interests, and start wars we have little reason to be engaged in (oh wait, Obama doesn't need legislation for that)

Unfortunately I think that the lack of enacted legislation does not mean that there are less restrictions on individuals. I have not researched this thoroughly but it would not surprise me if the legislation that is passed today is larger and more complex than legislation in the past. For example, the Dodd-Frank financial reform bill is 3,200 pages long and regulators are still writing the rules even though the law was passed in 2010. Obamacare has approximately 10,000 pages of regulations associated with it and counting. Even though these are only two enacted bills, the amount of actual regulation associated with them is enormous. If some people are worried that the 113th Congress is not doing enough to restrict our freedom, please don't worry so much. This Congress is following its predecessor's footsteps nicely. Here is a useful website created by some scholars at the Mercatus Center that shows the amount of regulations passed by various government agencies.

But again, I have to go back to the way news organizations judge a Congress' productivity. The purpose of the legislature is to improve the country, not to simply pass bills. If the standard is legislation that improves the country as opposed to legislation that results from rent-seeking behavior then almost all Congress's have been unproductive. Counting the number of laws enacted is a naive, uninformative way of gauging the productivity of Congress and the people who spout this nonsense should be ignored.

Reasonable people will disagree as to what improves the country, but I think that it is simple laws that create a competent and efficient justice system, protect our borders, and provide some basic infrastructure. Other than that, Congress should leave people alone and let them voluntarily interact with one another. The great Adam Smith stated this in The Wealth of Nations:

"Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism but peace, easy taxes, and a tolerable administration of justice: all the rest being brought about by the natural course of things."