Saturday, September 26, 2009

The Remarkable Century and the Future

I recently came to a rather obvious, yet remarkable insight. The 20th century was a truly unique and remarkable moment in human history. There is not a single aspect of human civilization that changed less during the 20th than in any of the centuries that came before. Population, economic output, life expectancies, oil consumption, meat consumption and international travel are just a few of the countless factors that changed more between 1900 and 2000 than in any other prior hundred years.

Expectations for the future are with few exceptions rooted in this period of explosive change. Some scholars have traced a variety of trends back into the more distant past, but these works are largely viewed as curiosities on the fringe of economic and social thought. For better or worse most of us are happy to assume the order of things that emerged after the Second World War will hold steady throughout ours and our children’s lives.

Economic growth has been both the great cause and great consequence of the recent pasts explosive change. By rapidly expanding the total available wealth, this expansion has allowed the general population to enjoy unheard of prosperity, without threatening the comfort of the elites.

Growth can be broken into two pieces; basically more people consuming more stuff. Population growth has obviously been the major driver of the first component of growth. From 1900 to 2000 the number of people on the planet rose nearly 4- fold to approximately 6 billion. Just as dramatic was the increase in the number people actively engaged in the globalized economy.

For all the wonders of the Pax-Britannica, world trade really only impacted a small percentage of humanity, in Europe North America and a handful of aristocrats scattered around the rest of the world. Today, only a small number of subsistence farmers are cut off from globalization.

If population growth were the primary driver of economic expansion, we would be living in Malthus’s world. The miracle of the 20th century was the dramatic rise in living standards that accompanied population growth. I don’t have time to recount all the ways in which living standards have improved since 1900. Look around you, the growth is obvious.

Is the 20th century repeatable? In 2100 will our heirs see 2000 through the same eyes that we see 1900? Our entire understanding of the future depends on the answer to this question. It is clear, that attempts to preserve the rate of growth for the next hundred years will smash into the physical limitations of the planet.

Technology is frequently cited as the magical solution to square this circle. Yet, there has never been a major innovation that has shrunk humanities lust for resources.

Adapting to a world of limited growth will be the profound challenge of the next hundred years. The impacts will be both positive and negative, but will shake the very core beliefs of society. This post is the first in a series that I will publish laying out the implications of a limited growth world on our expectations.

Thursday, September 17, 2009

Flawed Market in College Football Scheduling

As a Badger football fan it’s pretty hard to get excited about Wofford this weekend. But it’s not hard to understand why the school schedules games like this. As this article from Sports states, the extra home game is worth millions of dollars to the athletic department. Wofford does not expect the Wisconsin to make the return trip.

A simple change in market structure could net millions for the University and provide fans infinitely more excitement. Currently, the school charges the same price for every game. But as anyone who has every tried to buy a ticket from a scalper, not all games have equal value. Charging more for games against marquee opponents would give the school incentive to schedule tougher non-conference opponents.

Can Private Health Insurance Work?

Efforts to fix our health insurance system have found no found shortage of critical flaws in the “market”. I have yet to hear a coherent argument for the continued existence of private health insurance. Health care differs in three critical ways from traditional markets. Taken together I doubt that it is even conceivable for a private market to exist for health insurance.

In a true free market those who got sick and couldn’t afford care would be left to die or suffer the consequences of their conditions. This is a rational, yet morally abhorrent policy. Even the most die hard free marketers don’t advocate this. The unwillingness to condemn the poor to preventable death is the first significant obstacle to a functioning private health insurance market.

The second critical obstacle is the great variation in expected health care costs. Insurance markets are designed to protect individuals from significant deviations from expected costs. Consider auto insurance, every driver faces some risk or an accident, but few expect to total their car in a given year. By pooling risk, the small percentage of drivers that do suffer serious crashes can avoid financial ruin.

But this logic in no way applies to health insurance. Many people suffer conditions that have high known costs. If you are HIV positive or have Diabetes or are paraplegic medical costs are not an unexpected catastrophe, they are a known expense of life. Only the richest individuals can cover these costs out of pocket. Insurance can’t solve this problem only subsidies can.

Timing is the third critical difference between health insurance and traditional health markets. For insurance to function a claim must be tied to a specific instance. A fire, a car accident, a death are all discrete events that can be placed at a specific moment in time. The bulk of health care spending is spent treating chronic conditions. Who’s to say exactly when a person developed high blood pressure or depression. Furthermore, health conditions incur costs that continue long beyond the length of an insurance contract.

Efforts to twist private insurance around these three restraints are destined to produce warped markets and twisted incentives. The regulations currently oozing through congress will make life better for many people, but they do not address the fundamental incoherence of private health insurance.

Tuesday, June 16, 2009

Act Now Before California Forces the Issue

Sometime in the next couple of months The Federal Government is going to give the state of California a lot of money. After lavishing more than a trillion dollars on Banks, Insurers and Auto Companies, there is a 0% probability that the government will sit idly while the largest state collapses.
There real question is how do we go about propping up California. Whether we like it or not, California will set a precedent for the rest of the country. Believe it or not California is not the only State struggling to keep its head above water. Congress and the administration need to have a strategy ready before Arnold comes crawling cap in hand to Washington.
Rather than putting together an ad-hoc plan for California, we should develop a national strategy for dealing with insolvent states. The plan that I am proposing is simple, non-intrusive and will ensure that Federal Government gets back every penny that it spends bailing out the states.
Federal loans should be made available to any state that chooses to accept them. In exchange, the state will be required to levy a 1% sales tax, whose revenue would be directed to the Federal government until the loan is repaid.
While, no one would enjoy paying the extra tax, it wouldn’t be nearly as devastating as the massive budget cuts currently facing states across the country. By securing a dedicated revenue stream the loan would be virtually risk free for the Federal Government. Furthermore, enacting a national policy would assure investors that state bonds were a safe investment, reducing borrowing costs for every state.
The greatest advantage of this plan would be in avoiding the political circus of negotiating a special bailout for every state in need. My plan would not solve the underlying problems facing California, but that is intentional. It is up to voters and politicians in California to find a long term solution to the state’s budget crises. Allowing Washington to interfere in the fine details of the State budget would be far worse.

Thursday, April 30, 2009

Starbucks Overdose

If you have ever been to the loop area of Chicago you have probably noticed that there are a fair number of Starbucks locations. OK, that was a slight understatement. I can’t think of a single location in the Loop that is not within sighting distance of a Starbucks. Given the scarcity of retail space in Downtown Chicago, having three or four Starbucks locations on a single block hardly seems like an optimal allocation.
I am struggling to see the economic logic of extreme chain concentration. Surely the marginal revenue of an independent establishment would be greater than that of the 50th Starbucks within a relatively small area.
Since every location within the Loop is within two blocks of a Starbucks, I can’t imagine that a new location would attract many new customers. However, if one of the Starbucks were converted to an independent shop it would likely attract a large share of customers who preferred not going to Starbucks. Thus you would think that an independent shop would be willing to pay more to lease a location than Starbucks.
I can think of two possible explanations:
1. The major chains that dominate the area are engaged in an implicit price fixing. Basically, Starbucks and the other chains (I am looking at you Dunkin and Caribou) fear that any independent shops would significantly diminish there business. Thus when they open a new location they are really acting to freeze out any independent competitors.
2. Even though the expected return on investment is higher for an independent coffee shop the high price of commercial real estate may scare off many entrepreneurs. For a company like Starbucks committing to an expensive lease is not a great risk, but a local entrepreneur may be unwilling to take the same risk, preferring to locate to a cheaper neighborhood.

I don’t think that these two explanations tell the whole story, so I would be very curious to hear what other people think.

Inequality at Birth

Emmanuel Saez’s work on income inequality has been getting a lot of attention recently, for good reason. He has shown the extent to which inequality has grown rapidly in recent years. The benefit of economic growth this decade has gone almost exclusively to the extremely rich. The top 1% of the population now earn 25% of all income.
Yet I fear that this work may underestimate the true nature of inequality in our society. One of the flaw of much of the work on income and wealth distribution is that it fails to account for age. For example, my income is currently below the median household income; yet as a 23 year old with no dependents I am financially better off than the average American. The way that income and wealth distribution vary throughout the lifecycle of an age cohort is an important area where further research is needed.
In a perfect world everyone would start at the same place, as time passed differences would emerge due to talent, hard work and other elements of the meritocracy. Of course, that is not the world that we live in. Children born in wealthier families start life with a huge head start.
Marion Nestle recently noted that half of the infants in America received food aid last year. It is no secret that fertility rates in America are negatively correlated with income and education. Given the stark level of inequality present in America today, it stands to reason that inequality is even greater among newborns and young children than among the population at large.
This reality could have severe consequences for the future of the American economy and society. Numerous studies have shown how growing up in poverty can adversely affect a persons prospects for life. Is the future generation of Americans going to disproportionately suffer these consequences. Will the relative scarcity of Children from affluent backgrounds give those fortunate few an even larger advantage than the well off currently enjoy. Or will new opportunities open up to the children of the poor.
More research needs to be done to uncover the rates of inequality among households with young children, and to see how this rate has changed over time. A cohort based approach to income and inequality studies would provide a better understanding of how our society and economy is likely to evolve.
While more research is needed, I think it is clear that a significant commitment needs to be made to ensure that our future generation does not disproportionately grow up in poverty.

The bloated private sector vs. the starved public sector

For the past 3 decades faith in the free market powers of the private sector have led to a massive misallocation of resources away from public sector investment. A careful reading of price signals reveal a severe under investment in public goods relative to private sector goods. I would further argue that the unstable bubbly nature of financial markets is the result of excessive capital being allocated to the narrow range of goods and services in which the market works well.
The following contrasting sets of investments opportunities demonstrate how the private sector has become bloated while the public sector has been starved of necessary resources.

Public Education vs. Information Technology

The development and rapid proliferation technologies such as the internet, cell phones and other communication tools has brought undeniable benefits. But is the market calling for more resources to be dedicated to these industries. Not really. Over the past couple of decades, the price of computing power and communication technologies has been in nearly continuous free fall. New innovations quickly become commodities while many of the best and most popular innovations from Youtube to Facebook have failed to find a revenue stream.
If some of the investment in IT has been misplaced, what would be a better use of the bright mathematically inclined minds. Over the long run, human capital is the limiting factor in innovation and growth. The wage differential between educated and uneducated workers is a clear price signal indicating demand for education. Yet we have ignored this rapidly rising price signal by failing to provide adequate support to schools at all levels. The rapidly rising tuitions at public universities is another indicator of declining public support for education at precisely the time when this sort of investment is most needed.

Public Health vs. Processed food

Public health spending is one of the ultimate public goods as it benefits the society as a whole. There is no doubt that American’s spend a lot on healthcare, more per capita than any other country. Yet our health outcomes are hardly impressive. Investing a little more in creating an environment that promotes health could save far more in future healthcare and lost productivity due to preventable disease. From teaching basic nutrition principles to providing safe places for people to be physically active to preventing outbreaks of food borne illnesses our public health efforts have been pathetic due to a lack of commitment.
While, we have barely attempted to create a healthy environment, the food industry has had no trouble bringing new food like substances to market. Given this failure it is not surprising that today’s young people may be the first generation in American history that fails to outlive their parents.

Urban Infrastructure vs. Suburban housing

The housing collapse of the last couple of years makes the misallocation of resources in the housing sector abundantly clear. Yet the market has been sending out the same signals for years. Developers always justified suburban car based residential development as providing what the market. Yet a simple look at price data tells a different story. Real estate prices in walkable urban areas have consistently been far higher than in suburban car oriented areas. In the current crises real estate markets in places like Manhattan, DC and San Francisco have held up far better than the rest of the country.
Yet it would be impossible for private developers to recreate high quality urban environments. These places require significant investment in transit, law enforcement, parks and other amenities that require government support. Without public investment private developers could only create a limited range of housing options. Hence the appreciation of urban real estate prices relative to suburban areas.

The market is incapable of providing the full range of investments needed to maintain a healthy growing society. If we come out of the current economic crises with a more balanced distribution between public and private investment we will be in a better position to maintain long term growth.