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."

Tuesday, October 21, 2014

Worker's compensation has tracked productivity

Economic theory predicts that worker's compensation should reflect their productivity. Many charts find that this has not been the case for the last 30 years or so, but these studies are flawed. Scott Winship from Economics 21 corrects for the flaws of other studies and shows that compensation has tracked productivity quite well. A good read and very informative.

Monday, October 6, 2014

Declining unemployment rate obscures real problems

I received this sunny message from the White House yesterday glamorizing September's unemployment rate of 5.9%.

But even though the unemployment rate is falling there are still real problems in the economy. The graph below shows the year over year September unemployment rate, employment population ratio, and labor force participation rate from 2006 - 2014. (click on graphs to enlarge)

The unemployment rate is plotted on the left vertical axis and the labor force participation rate and employment/population ratio are on the right vertical axis. While it is true that the unemployment rate is down, the labor force participation rate also continues to fall, from 66.1% in 2006 to 62.7% in 2014. A lower percentage of the population is working and paying taxes than at anytime in the last 8 years and it shows no signs of recovering. I am no fan of taxes, but with the way our government spends money you would think that they would want more people to contribute. Instead people are choosing home production or are working in the underground economy. Too much regulation and uncertainty is making firms reluctant to hire and is preventing a robust recovery.

The employment/population ratio tells the same story, as it is down from 63.1% to 59%. It has leveled off and appears to be rising slightly, but there is a long way to go before it is back to its previous level. The Obama administration is doing nothing to solve these fundamental problems.

And in case someone wants to attribute the falling labor force participation rate to retiring baby boomers, the graph below shows the labor force participation rate for the same time period but for people aged 25 - 54 i.e. the prime working years.

The labor force participation rate for people in their prime working years has also been steadily declining, from 90.4% to 88%.  A lower unemployment rate in light of these numbers simply means that people are leaving the labor force, not that they are getting jobs.

The Obama administration can spin the numbers, but the fact is there are relatively less people working today than before the recession and there are no signs of a real recovery in sight.

Saturday, September 27, 2014

Wage inequality vs. compensation inequality

Some of my fellow grad students at Clemson are doing research on wage inequality. At a seminar yesterday one of them stated that wage inequality between high skilled workers and low skilled workers, where skill is measured by educational attainment with a bachelor's or more being considered high skilled, is still increasing but since the 1990's is doing so at a declining rate. The diagram below shows what this looks like:

The Y axis is the ratio of a high skilled person's wage to a low skilled person's wage. The X axis is time. Two things could be happening to cause this trend; either the high skilled wage could be decreasing over time or the low skilled wage could be increasing over time.

My criticism of wage inequality is that it measures the wrong thing. No economic actor, neither workers nor firms, cares about wages. Firms care about the total cost of hiring a worker and workers care about the total compensation they receive for their labor. Any analysis that ignores other forms of compensation such as health insurance, paid vacation, paid sick leave, paid maternity leave, and other pecuniary and non-pecuniary benefits is incomplete and could be very misleading.

For example, let's just look at compensation as the sum of the wage and the portion of a worker's health insurance premium that is paid by the employer, W + H. Also, let's assume that the insurance premium is not correlated with skill type, but instead only varies by the personal health and family characteristics of the worker. What this means is that a firm will pay the same health insurance premium for a high skilled male who is 50 years old, makes $150K/yr, doesn't smoke, and has 2 teenage children living at home as it will for a lower skilled male in the same circumstances except the low skilled person only makes $45K/yr. I think this is a reasonable assumption, as risk pooling is done based on the risk factors of the individual, not their degree or IQ (of course if IQ is strongly correlated with healthy living this may not be true, but I don't think that is the case).

The wage inequality between these two workers, 150/45, is 3.33. If we set the portion of health care paid by the employer at H = $8K/yr, which appears to be on the low side, then the compensation ratio is 158/53 =  2.98. The addition of a fixed cost to each worker that does not depend on their wage or value added to the firm makes the low skilled worker relatively more expensive than the high skilled worker and decreases the inequality measure that real people actually care about. If health insurance costs to the firm are increasing over time, as the Forbes article linked to above shows, then over time we would expect to see inequality decreasing when total compensation is used instead of wages.

What this means is that inequality may not be as high as people think. The addition of other forms of compensation that stay relatively constant across skill levels decreases the real inequality of the two skill levels.

Some people are probably thinking that most "low skilled" people e.g. high school graduates do not get insurance, paid vacation, sick days, etc. and this is true. So let's think about adding a third category, medium skilled. These are white collar or high skilled blue collar workers who have technical degrees, associates degrees, or bachelor's degrees but are not on an executive management track and earn between $35K/yr and $80K/yr with little prospect of ever earning above the high end of that scale. They are solidly in the middle class and often receive health insurance, paid vacation, etc.

Let's use the $150K for the high skilled worker, $60K for the medium skilled worker, and $30K for the low skilled worker. Let's assume that only the high skilled and the middle skilled receive compensation other than wages. So the high skilled/medium skilled wage ratio is 150/60 = 2.5 and the medium skilled/low skilled wage ratio is 60/30 = 2.

Now let's add insurance and calculate the compensation ratios. The high skilled/medium skilled is 158/68 = 2.32 and the medium skilled/low skilled is 68/30 = 2.27. So when insurance is included the medium skilled worker has become more expensive relative to both the high skilled worker AND the low skilled worker. The addition of other forms of compensation makes medium skilled workers the most expensive workers of the firm from a value added perspective.

If this is happening it can help explain the hollowing out of middle income jobs. Middle income jobs have not recovered since the recession but both low and high skilled have. Employers may have been waiting for an opportunity to reduce their middle income workforce because of the compensation dynamics I just described above and the recession presented the opportunity to do so. Now they are reluctant to create those jobs again because they are relatively more expensive than both high and low skilled jobs due to the fixed forms of compensation that stay relatively constant across skill level.

I am not claiming that this is precisely what happened but it is one story. I would like to see some more evidence but unfortunately there is not much data available on total compensation which is why nearly all of the inequality studies use wage. But that is an incomplete measure and ignores the story I just told.