Category Archives: Other economic thoughts

What doesn’t fall into the other categories

How to effectively compensate labor facing technological innovation

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Many social and economics changes generate net benefits, but often there are big losers. The advent and adoption of automobiles led to the demise of horse stables and carriage makers as one example. Most of those workers were able to shift to other jobs, such as at car manufacturers, so everyone largely benefited. But that’s not necessarily true today. Automation is displacing manufacturing employment (much more so than imports [link]) and new well paying jobs are not being created that are accessible to those who lost those jobs. How could we compensate these workers for their lost opportunities?

We protect owners of intellectual property rights such as patents and copyrights from intrusion into their markets with similar products and services. If someone wants to invent a new communication device that uses the existing cell phone network, they almost certainly have to pay Qualcomm a licensing fee for chips that rely in part on the underlying technology invented by Qualcomm. This protects investors from outright appropriation of the economic value that an investor in Qualcomm has created. It also allows Qualcomm investors to share in the economic gains by another company so Qualcomm is much less likely to oppose such innovations.

We could create a similar labor property right that protects the current economic value of workers by giving them a share of the economic gains created by a new innovation. Amazon could pay a portion of its profits as a “licensing” fee to workers displaced by online ordering and deliveries, or Ford workers could receive payouts based on the added profits created by using robots for car assembly. These fees would better align the interests of existing labor with beneficial innovation rather than putting them in opposition.

This proposal also would address the problem of a growing income gap as greater returns accrue to investors. Displaced workers would share in growing wealth rather than being sidelined in search for a job that that they are less likely to be qualified for. In addition, this would reduce the downward pressure on wages created by automation.

The program could be established as a form of universal basic income (UBI) to pay those who are not yet retired a share of society’s wealth creation. Certainly capitalism is greased by creative destruction, but there are many who do not want and are not prepared for the extreme risks that go with rapid innovation. We do not need to give risk-taking investors all of the economic gains to incentivize innovation, and we would likely lessen political opposition to such changes.

Davis, like many communities, needs a long-term vision

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The Davis Vanguard published an article about the need to set out a vision for where the City of Davis wants to go if we want to have a coherent set of residential and commercial development decisions:

How do we continue to provide high quality of life for the residents of Davis, as the city on the one hand faces fiscal shortfalls and on the other hand continues to price the middle class and middle tier out of this community? A big problem that we have not addressed is the lack of any long term community vision. 

The article set out a series of questions that focused on assumptions and solutions. But we should not start the conversation with choosing a growth rate and then picking a set of projects that fit into that projection.

We need to start with asking a set of questions that derive from the thesis of the article:

  • – What is the composition that we want of this community? What type of diversity? How do we accommodate students? What are the ranges of statewide population growth that we need to plan for?
  • – To achieve that community composition, what is the range of target housing price? Given the projected UCD enrollment targets (which are basically out of our control), how much additional housing is needed under different scenarios of additional on campus housing?
  • – What is the jobs mix that supports that community composition under different scenarios? What’s the job mix that minimizes commuting and associated GHG emissions? 
  • – What’s the mix of businesses, jobs and housing that move toward fiscal stability for the City in these scenarios? 
  • – Then in the end we arrive at a set of preferred growth rates that are appropriate for the scenarios that we’ve constructed. We can then develop our general plan to accommodate these preferred scenarios. 

My wife and I put forward one vision for Davis to focus on sustainable food development as an economic engine. I’m sure there’s other viable ideas. We need a forum that dives into these and formulates our economic plan rather than just bumbling along as we seem to be doing now. This is only likely to get worse with the fundamental changes after the pandemic.

I’ll go further to say that one of the roots of this problem is the increasing opaqueness of City decision making. “Playing it safe” is the byword for City planning, just when that’s what is most likely to hurt us. That’s why we proposed a fix to the fundamental way decisions are made by the City.

There’s a long list of poor decisions created by this opaqueness that shows how this has cost the City tens of millions of dollars. He points out symptoms of a much deeper problem that is impeding us from developing a long term vision.

It may seem like so much “inside baseball” to focus on the nuts and bolts of process, but its that process that is at the root of the crisis, as boring as that may seem. 

 

Davis Should Set Its Utility Reserve Targets with a Transparent and Rigorous Method

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The City of Davis Utilities Commission is considering on February 19 whether to disregard the preliminary recommendations of the Commission’s Enterprise Fund Reserve Policies subcommittee to establish a transparent, relatively rigorous and consistent method for setting City reserves. The Staff Report, written by the now-departed finance director, ignored the stated objectives of both the Utilities and Finance and Budget Commissions to develop a consistent set of policies that did not rely on the undocumented and opaque practices of other communities. Those practices had no linkage whatsoever to risk assessment, and the American Water Works Association’s report that the Staff relied on again to reject the Commission’s recommendation again fails to provide any documentation on how the proposed targets reflect risk mitigation—they are simply drawn from past practices.[1]

The City’s Finance & Budget Committee raised the question of whether the City held too much in reserves over five years ago, and the Utilities Commission agreed in 2017 to evaluate the status of the reserves for the four City enterprise funds—water, sanitation/waste disposal, sewer/wastewater, and stormwater. A Utilities Commission subcommittee reviewed the current reserve policies and what is being done by other cities. (I was on that subcommittee.) First, the subcommittee found that the City was using different methods for each fund, and that other cities had not conducted risk analyses to set their targets either. The subcommittee conducted a statistical analysis that allows the City to adjust its reserve targets for changing conditions rather than just relying on the heuristic values provided by consultants.

The subcommittee’s proposal adopted initially by the Utilities Commission achieved three objectives that had been missing from the previous informal reserves policy. Two of these would still be missing under the Staff’s proposal:

  1. Clearly defining and documenting the reserves held for debt coverage. While these amounts were shown in previous rate studies, the documented source of those amounts generally not included and the subcommittee’s requests brought those to the fore. The Staff method appears to accept continuance of that practice. The Staff proposes to keep those separate, which differs from past practice which rolled all reserves together.
  2. Reserve targets are first set based on the historic volatility of enterprise net income. In other words, the reserves would be determined transparently with a rigorous method on the basis of the need for those reserves. The method uses a target that is statistically beyond the 99th percentile in the probability distribution. And this target can be readily updated for new information each year. The Staff report rejects this method to adopt a target that refers to the practice of other communities, and none of those practices appear to be based on analytic methods from research done by the subcommittee.
  3. Reserve targets are then adjusted to cover the largest single year capital improvement/replacement investment made historically to ensure enough cash for non-debt expenditures. Because the net income volatility is a joint function of revenues, operating expenditures and non-debt capital expenditures, the latter category is not separated out of the analysis. However, an added margin can be incorporated. That said, the data set for the fiscal years of 2008/2009 to 2016/2017 used by the subcommittee found that setting the target based on the volatility has been sufficient to date. The Staff report appears to call for a separate, unnecessary reserve fund for this purpose based on annual depreciation that has no relationship to risk exposure, and implicitly duplicates the debt payments already being made on these utility systems. This would be a wasteful duplication that sets the reserves too high.

The Finance and Budget raised at least two important issues in its review:

  1. Water and sewer usage and revenues may be correlated so that the reserves may be shared between the two funds. However, further review shows that the funds have a slight negative correlation, indicating that the reserves should be held separately.
  2. The water fund already has an implicit reserve source when a drought emergency is declared because a surcharge of 25% is added to water utility charges. I agree that this should be accounted for in the historic volatility analysis. This reduces the volatility in fiscal years 2014/2015 and 2015/2016, and reduces the water fund volatility reserve from 26% to 21%.
  3. Working cash reserves are unnecessary because the utility funds are already well established (not needing a start up reserve), and that the volatility reserves already cover any significant lags in the revenues that may occur. This observation is valid, and I agree that the working cash reserves are duplicative of the other reserve requirements. The working cash reserves should be eliminated from the reserve targets for this reason.

Finally, the Staff proposal raises an issue about the appropriate basis for determining the sanitation/waste removal reserve target. The Staff proposes to base it solely on direct City expenses. However, the enterprise fund balance shows a deficit that includes the revenues and expenses incurred by the contractor, first Davis Waste Removal and then Recology. We need more specificity on which party is bearing the risk of these shortfalls before determining the appropriate reserve target. Given the current City accounting stance that incorporates those shortfalls, I propose using the Utility Commission’s proposed method for now.

Based the analysis done by Utilities Commission subcommittee and the recommendations of the Finance & Budget Committee, the chart above shows the target % reserves for each fund without the debt coverage target. It also shows the % reserve targets implied by the Staff’s proposed method.[2] The chart also shows corresponding dollar amount for the proposed total target reserves, including the debt reserves, and the cash assets held for those funds in fiscal year 2016/2017. Importantly, this new reserve target shows that the City held about $30 million of excess reserves in 2016/2017.

[1] It appears the Staff may have misread the Utilities Commission’s recommendation memorandum and confused the proposed targets policies with the inferred existing policies. This makes it uncertain as to whether the Staff fully considered what had been proposed by the Utilities Commission.

[2] The amounts shown in the October 16, 2019 Staff Report on Item 6B do not appear to be consistent with the methodology shown in Table 1 of that report.

Underlying economics of polarization

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Matthew Kahn, USC economics professor, writes about a new book, Why We’re Polarized,

Rising polarization is taking place because there is now a fundamental disagreement across our society concerning who has the property rights to different resources.

While Kahn is correct about property rights being at the core of the dispute, he glosses over the real issue by going off to discuss game theory and bargaining. That real issue is how different groups in society gained those property rights, whether its entitlement to jobs or use of natural resources or control of social mores. Much of these property rights were gained through coercion of some form, such as slavery, land grabs or paternalistic social structures. Resolving these requires agreeing first on basic societal morality and ethics, and then turning to how to resolve the redistribution of those rights, rather than just plunging straight into bargaining.

Commentary on the “The Road from Serfdom”

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Danielle Allen writes eloquently in the December issue of the Atlantic Monthly in the “The Road from Serfdom” about how too many Americans rightfully feel disenfranchised today and many of the reasons why they feel that way. Her description of how we got here is well worth the read. However, she misattributes the roles of economists (and lawyers) and errors in their recent prognostications on how economic progress would unfold.

Allen blames much of the current economic woes on the rise of economists in policymaking. She talks about how economists superseded lawyers in that role, implying that lawyers were somehow better connected to society. The real transformation happened several decades earlier when lawyers took over from the broader set of general citizenry. Just as she identifies how economists (of which I am one) are trained to think in one fashion, lawyers are similarly taught to think in another way that tends to focus on identifying constraints and relying on precedent. Lawyers are also taught that the available solutions require directives through laws and contentious conflict resolution. Lawyers are rarely instructed in how actual institutions work, contrary to Allen’s assertion–lawyers usually learn that as on-the-job training. In fact, it is economists who developed institutional economics that studies the role of such organizations. Economists arrived to propose solutions that could work through incentives and choice and negotiated solutions. So we traded one set of technocrats for another set. Perhaps we have not done well by either set, but we also should not ignore why we chose those professions guide us.

The mistakes that economists made were not as simplistic as Allen describes. She points to a claim that economists did not understand how disruption would impact specific communities and what two decades of disruption would look like in those communities. As contrary examples, I wrote here about how climate change will impact communities, and about how we need to compensate coal mining communities as part of our reductions in greenhouse gas emissions, and even the shaky foundations of benefit-cost analysis.  Instead economists did not foresee two important transformations since the 1970s. (Economists made a similar mistake after the fall of the Berlin Wall, failing to acknowledge that markets need well functioning institutions and laws to facilitate beneficial transactions.)  The first was that agglomeration of knowledge industries (technological and financial) would be so geographically intensive and that these industries would accrue so much wealth. The second was that Americans would become so much less mobile, both geographically and socially. There are many social and policy factors that have led to these trends, but these stories are much more complex than Allen describes. No one could have foreseen these unprecedented changes that have shattered the lives of too many people that have remained behind in communities emptied of economic purpose.

That said, identifying the rise of the ideologies of Nobel Prize winners Friedrich Hayek and Milton Friedman (who were economists) as a key source of our conundrum is accurate. Allen does not discuss the parallel rise of the fantasies of Ayn Rand that fueled the mythologies of Hayek and Friedman. Rand’s work was a surprising path for spreading those ideologies, particularly given how bad her writing was. We now have a core of elites who believe that they somehow are “self made” with no outside help and even overcoming the “parasites” of society. That will be a difficult self image to overcome.

Technology and a running breakthrough

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On one weekend in October, Kip Kipchoge ran the first sub-two hour marathon, and Brigid Kosgei broke the women’s record. These races, and a spate of others, were won with versions of the Nike Vaporfly that apparently adds at least a carbon fiber plate and returns 4% to 5% more energy to a runner’s stride. (I have a particular interest in this sport, having set a some school records and trained with an Olympic medalist.) The media reaction has generally been to call for some sort of limitation on the use or development of the shoes.

I view these shoes as just another technological innovation on the continuum in track & field that stretches back to the first spiked shoes to starting blocks in the 1930s (Jesse Owens dug holes in the track) to fiberglass poles (that work much like these shoes) to synthetic tracks (which catalyzed the world record onslaught in Mexico City). We can’t imagine the sport today without these innovations. Of course, there also has been the unwelcome use of performance enhancing drugs (PEDs – think steroids) that threaten athletes’ health. The question is how should we decide what innovations are acceptable and which go to far or give an unfair advantage.

I propose that we use two criteria (which are consistent with the IAAF’s current rule):

  1. Is the innovation widely available at an affordable cost? While some of the past innovations had limited availability, that usually was for a short period. Most were available to all competitors as a specific competition and spread from there.
  2. Can the innovation create physical harm, either immediately or at a future date? PEDs are the most salient example of an innovation that fails this test. In the case of PEDs, that certain individuals decide to take on the health risk forces other athletes to take on the same risks if they want to be competitive.

Swimming faced a similar existential question when the LZR suits a decade ago. FINA effectively banned that innovation, on the basis that the suits added undue buoyancy.

The Vaporfly doesn’t appear to add any outside aid–it just makes the shoe more effective at returning the energy put into it. It’s just a step further in the long trail of new tracks and shoes that have made runners faster. At the heart of improving athletic performance is new technology, sometimes in new products and sometimes in new training methods. So on that basis the new shoe should be allowed.

But the other key question remains–will the technology be widely available at a reasonable cost? Nike holds the patent and has not announced whether it will license it to other manufacturers. If Nike decides that it will only allow runners that sign agreements with the company can wear the shoes, then the shoes should not be allowed. Such exclusivity clauses can lead to damaging the sport in other ways, such as narrowing the sponsorship base.

This issue highlights a larger problem in our world economy–the rise of the dominance by intellectual property owners. Patent and copyright laws are a core cause of the undue accumulation of wealth that has characterized the last four decades. It’s not clear why Walt Disney’s great grandchildren should still be benefiting from Fantasia 80 years later. Drug patents block important innovations, and may even be suppressing research and development. Does such longevity really incent innovation?

Nike’s control of this new running technology, while in a seemingly frivolous pursuit, highlights this issue as a society-wide problem.

Two parts to these questions: First, do you think that this technology breakthrough should be barred from running competition, and why? Second, do you think that current intellectual property protections are too strict and lead to undue accumulations of wealth? Let us know your thoughts and add any useful references.

 

 

Housing can’t escape economics

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One aspect of the debate over housing policies is whether increased housing supply or some type of demand management will mitigate create a more affordable housing market. Davis is one of the centers of this debate, where strict load growth controls has led to lower income households being closed out of the market. But contrary to assertions by those who want direct interventions, the housing market isn’t immune from economics.

One problem is that critics in Davis of relying on market mechanisms work from the false premise that the housing markets across the region were all in equivalent equilibriums in 2010, immediately after the Great Recession. The fact is that the Davis housing market, due to a combination of its restrictive housing policies and education value premium, had not declined as much in price as other communities in the region. The amount of surplus housing stock that was available in 2010 had a wide variation across many cities. So of course the towns which were hit the hardest in 2008 have typically had higher price appreciation since 2008, no matter what their housing policies have been.

Here’s a few studies that support the proposition that housing supply and demand drive prices:

A transparent municipal utility’s reserve target

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Reserves chart

As one of my civic activities, I sat on the City of Davis Utility Rates Advisory Commission. In my final action with that commission, along with Elaine Roberts-Musser and Lorenzo Kristov, we prepared what might be a first-of-its kind enterprise fund reserve policy for the four utilities managed by the city. Up to this point, the URAC had been presented with rates development reports that appeared to use somewhat arbitrary, and inconsistent, methods of setting reserve targets. The city also appeared to be holding tens of millions of dollars in those funds that might be unneeded to meet expected reserve requirements.

With the City Council’s approval and support from the staff and the Finance and Budget Commission, we identified the elements that needed to be covered by reserves, including working capital, debt covenants, unanticipated capital replacements, and revenue-expense volatility. The first two elements were fairly straightforward to calculate, and unanticipated replacements didn’t appear to be significant. It was the analysis of the relationship of revenue and expense volatility where the report innovates. Previous studies had used some variation of a percentage of capital assets with no underlying explanation. Our solution was to derive an estimate of the outerbound of an annual revenue shortfall for a utility as buffer to allow rate or management adjustments.

In the end, the target reserves generally didn’t change much, but the City now has a transparent target that it can use to determine when it has excess funds that might be used in different fashions instead.

Soda tax really works in Berkeley

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soda-pop

A just released study on the effects of the Berkeley, California soda tax of one cent per ounce found that soda consumption has fallen 52% over the last four years. That is a remarkable price elasticity. Assuming a 20-ounce bottle costs $1.99, with a tax of 20 cents, that implies a price elasticity of -5. In other words, for every 1% o price increase, demand falls 5%. The study relied on household surveys, which are not always reliable about consumption quantities, so it would be interesting to see actual sales data.

Mismatch in job openings and the unemployed

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automation-potential-share

Evidence of how job training is lagging behind job needs. The U.S. Labor Department reported 7.3 million openings, but only 6.3 million people were actively seeking jobs and unemployed. Employers are not able to find the technically-trained individuals that they need for the changing economy. Only a small portion of this shortfall can be met through training in our standard educational institutions. We should be looking for other retraining solutions such as those in Europe.