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.