Economist's Notebook: The US Economy

Three things prompted this post. The first was a letter to the editor in today's Oregonian from a Englishman, Clayton Jolly, who recently visted Portland and write the paper to tell everyone how much he liked it. I chuckled to myself thinking "I bet you liked it, everything was pennies to the Pound." The British Pound has been trasding for about two dollars for some time now, making jaunts in Portland seem like tremendous bargains to the Brits. The second was the return of my mother from a quick stay in Spain where she stayed in hostels, ate on the cheap and still managed to burn $1500 in less than a week. The third, and most interesting, thing however was this graph from Paul Krugman:

The blue line shows residential investment as a share of GDP (left scale). It has plunged impressively. The red line shows exports as a share of GDP (right scale).

You see, just as US vacations are incredibly cheap right now for Europeans, so are US goods and services. The law of demand tells us to expect increased demand with lower prices and so we see in this graph. What is equally interesting is this surge in demand for US exports has countered the fall in investments in housing that woudl have otherwise, most likely, plunged us into recession already.

So thanks Clayton Jolly!

Have You Ever in Your Life Seen So Many Economists...?

I'll get back to taxes soon, but I have been too busy to do much reading of the literature partially because I am preparing for a trip to New Orleans to attend the Allied Social Science Association's (ASSA) annual conference. This is primarily a conference for the American Economics Association (AEA) and it is huge. I was completely astounded the first time I attended it, back in 1999 when it was held in New York City. Apparently, for some unknown reason, attendance for this year's conference is much bigger than normal. So if you have ever wanted to find yourself in a crowd with literally thousands of economists (the horror....the horror...), get thee to the Big Easy January 4, 5 and 6. Or just keep tuned to this space, as I hope to do just a little bit of blogging from there. For you OSU students thinking of possibly pursuing a career in academics - here is a little inside look at how the sausage is made.

The reason I am going is because the Economics Department at OSU is hiring for two replacement positions and the main job market for mew economists is at the ASSA meetings. It works like this. By mutual agreement, all jobs for economists are listed in the AEA's Job Openings for Economists. The main ones (the ones with all most of the new jobs for a given academic year) are published in September, October and November. Newly minted PhDs (or those anticipating their PhDs by September) apply for jobs and, if selected, have initial interviews at the ASSA meetings. These are usually 30 to 45 minute meetings, in hotel rooms, where the candidate gets a brief opportunity to talk about their dissertation research, their teaching experience and themselves, and the department gets to tell the candidate a little bit about the wonders of life there. So, on top of thousands of regular attendees at the ASSA meeting, there are hundreds of (mostly) 25 to 35 year-olds running around looking anxious and stressed. You can tell who they are because they are the ones wearing the brand-new suits. I had 36 interviews in a four-day stretch when I was coming out of grad school and it is one of the worst experiences of my life. The interviews themselves are usually cordial and friendly, but the process is grueling: you are constantly stressed, tired from running from hotel to hotel and trying to keep your thoughts straight. You feel like a piece of meat being poked and proded and evaluated.

After the meetings are over, departments usually invite their top 3 to 5 candidates out to the campus for 'campus visits.' These are also gruelling: lots of travel in winter, all day interviews, hotel rooms and more travel. A typical visit starts before dawn for breakfast, meetings with faculty and deans, lunch, more meetings, a presentation of some part of your dissertation and then dinner. I had seven of these in a row and kept getting stuck with weather. Finally, top candidates are made offers, most of which expire in about a week.

Many economists are very proud of this market, considering it highly efficient. But you have already probably spotted the problem: with so many departments and so many candidates, finding the right matches is often confounded by the quick timing of it all. I had an offer that expired before another very attractive job was even making an offer, so I had to decide if I should take it or leave it in hopes the other place would make me an offer (I took it and it was a good thing: the other place decided not to make any offers). I had another offer on the table, however, that I didn't really want because of location - it turns out there was a woman from U of Virginia who really wanted the job and may have well been offered it if I had turned them down straight away, but I did not and she had to take another job. So the outcomes are decidedly not efficient.

So here I go off to sit in a hotel room for three days and interview 32 people. Though the stress is gone (whew!) the process is no less exhausting. And the worst part is if I even have the energy to go out and find a nice place for dinner - inevitably the place will be filled with economists loudly conversing about the marginal gain from spending the extra $10 for the better bottle of wine and the Pareto optimal allocation of hors d'œuvres. Oy.

Portland Home Prices: Update

Here is the latest Case-Shiller monthly home value index for Portland. The local media are still on the 12 month overall appreciation story of Portland home prices, but the recent trend is not looking good, October is again lower than September. Home prices continue on the downward slide that they began after peaking in July. Part of this is seasonal for sure, a depreciation happened last fall and winter as well, which is why the 12 month figures are considered a better index, but this microtrend is troubling. The key will be whether the spring market corrects this - we shall see.

Long-Term Stability of Sales Taxes - An Example

As I have said, the empirical evidence on sales tax volatility has shown sales taxes to be not significantly less volatile than income taxes in the short-run. These estimates come from deviations around a trend. So sales tax revenues seem to stray from their long-run trends about as much as income taxes do. Income taxes have steeper trends though, meaning they tend to rise faster then do sales tax revenues as aggregate incomes increase. The best estimates I have seen are about a 1.8 long-run elasticity for income taxes and a 0.8 elasticity for sales (see this post). Many public economists argue that short-run volatility is what we should be focusing on - how quickly to the revenues crash due to a sudden downturn in the economy - and I agree that this is an essential component. However, I also think the long-run elasticities are very important as well and have said so, but perhaps have been not as clear as I would have liked as to why. The basic point is that since income tax revenues grow faster in the long-run, they will slow down faster as well when income growth slows down.

To make this point more clearly using a real recent episode in Oregon's economic history, I did a quick little back-of-the-envelope calculation based on the actual State of Oregon quarterly personal income figures from the Bureau of Labor Statistics. First off, understand that, in general, aggregate personal incomes increase over time due to inflation, population increases, productivity improvements, etc. So long-run trends in incomes are always positive as are tax receipt growth figures. But in 2001 and 2002 Oregon experienced a very significant slow down of income growth, so I decided to see what receipts of the two types of taxes would look like using those national estimates of elasticities. Based on the average growth rate over the period 1987 to 2007 we could have expected personal income to grow by about 9.2% over that two year span (2001-2002), in reality it grew 3.6%. So from the estimates elasticities we find that based on these expectations v. reality figures, income tax revenue would have fallen about 10% below 'normal', while sales tax revenue would have fallen 4.5% short of 'normal'. This seems quite a significant difference. Of course you can make the opposite argument as well, that once personal incomes started growing at normal rates again the income tax would have more quickly regained the lost revenues than would a sales tax. But, it would have more ground to make up anyway. So though I think the short-run is quite important, I think this long-run differential is important too.

Finally, two comments on the previous post. First, a few people, I think, misunderstand the quote from the Feldstein and Wrobel paper. It does not say anything about whether a progressive tax structure is good or bad - it simply says that the US job market is quite fluid and so employers have to compensate for high taxes. Full stop. So if your aim is to reduce inequality in a state through a highly progressive income tax, it won't work. It has nothing to say on whether inequality reduction is a good goal, or on who should or shouldn't pay tax, or whether the relatively wealthy should pay more, etc. I found this an absolutely fascinating paper - who would have thought that the US job market is that fluid, or that employees respond so strongly to net incomes, not just gross? Wow. But I guess the fact that I find this so fascinating is why I am an economist that does not get invited to many parties...

Second, if you care about poverty and unemployment you should care deeply about economic growth.

Some Snippets of Economic Research on Taxes

Sure to enlighten and enrage, I offer them without comment at this point. Food for thought.

“The Effect of Personal Income Tax Rates on Individual and Business Decisions - A Review of the Evidence”
By Mark Rider
Andrew Young School of Policy Studies
International Studies Program Working Paper 6-15

“…there is a large body of evidence that high state [personal income tax] rates have a negative effect on business and individual decisions and thus slow the growth of state employment and personal income. Consequently, states must use care in setting state [personal income tax] rates to make sure they are not out of line with those of their neighbors and other competitor states.”

Page iv.

“Tax Policy and Entrepreneurial Entry”
By William M. Gentry; R. Glenn Hubbard
The American Economic Review, Vol. 90, No. 2 (May, 2000), pp. 283-287.

“While progressive taxation could in principle encourage entry via insurance for risk-averse entrepreneurs through the tax system or through offering greater incentive to avoid taxes on self-employment income, we find no evidence to support such channels. Our empirical results imply a significant increase in entrepreneurial entry when tax rates are less progressive; whether such encouragement is efficient (that is, stimulating the most talented entrepreneurs) is a topic for future research.”

Page 283


Can state taxes redistribute income?
By Feldstein, Martin & Wrobel, Marian Vaillant
Journal of Public Economics, Vol. 68(3), (June1998), pp. 369-396.

Abstract

“The evidence presented in this paper supports the basic theoretical presumption that state and local governments cannot redistribute income. Since individuals can avoid unfavorable taxes by migrating to jurisdictions that offer more favorable tax conditions, a relatively unfavorable tax will cause gross wages to adjust until the resulting net wage is equal to that available elsewhere. The current empirical findings go beyond confirming this long-run tendency and show that gross wages adjust rapidly to the changing tax environment. Thus, states cannot redistribute income for a period of even a few years. The adjustment of gross wages to tax rates implies that a more progressive tax system raises the cost to firms of hiring more highly skilled employees and reduces the cost of lower skilled labor. A more progressive tax thus induces firms to hire fewer high skilled employees and to hire more low skilled employees. Since state taxes cannot alter net wages, there can be no trade- off at the state level between distribution goals and economic efficiency. Shifts in state tax progressivity, by altering the structure of employment in the state and distorting the mix of labor inputs used by firms in the state, create deadweight efficiency losses without achieving any net redistribution of income.”


“The Effect of State and Local Taxes on Economic Growth: A Time Series--Cross
Section Approach”
By L. Jay Helms
The Review of Economics and Statistics, Vol. 67, No. 4. (Nov., 1985), pp. 574-582.

Abstract

“Results based on pooled time series and cross section data are presented, which indicate that state and local tax increases significantly retard economic growth when the revenue is used to fund transfer payments. However, when the revenue is used instead to finance improved public services(such as education, highways, and public health and safety) the favorable impact on location and production decisions provided by the enhanced services may more than counter balance the disincentive effects of the associated taxes. These findings underscore the importance of considering the incentives provided by a state's expenditures as well as by its taxes.”

Tax Reform in Oregon: A Research Agenda

So far I have discovered that revenue stability may be aided marginally by a sales tax during extended downturns in the economy, but that short-term volatility is generally not much better and may even be worse than income tax revenue. So I am now pretty well convinced that if decreasing volatility it the main motive, sales taxes don't appear to be much of an answer. I do believe they can add, largely through diversification, slightly more stability to the tax structure, but this is not likely to reduce overall volatility significantly. Also, sales taxes are regressive and even with exemptions of things like food and medicine they remain recessive. The only way to preserve a non-regressive tax structure is through the implementation of other methods like tax credits or graduating the income tax. I certainly don't believe, and never have, that a sales tax should replace the income tax. My working hypothesis is that a lower income tax with a sales tax is beneficial to Oregon and I am trying to see how that hypothesis fares.

My goal here is only to explore the economic aspects of tax reform, not political aspects, so I will not digress into questions of political motives, political viability, etc. I wish only to see if economic theory and empirical evidence supports the notion that tax reform could be potentially beneficial to the Oregon economy. Though I started this series of posts with the statement that I thought sales taxes would be a good addition to the tax structure, I have no particular bias, and if, after subsequent research, I find that the supporting case is weak, I am just as happy with that conclusion as any other.

Now that my toe is wet, it seems I have a lot more work to do. Here are a list of pertinent economic questions that seem important to explore, to the extent possible, to help figure out what is best in terms of tax reform (in no particular order):

-How sensitive are personal and business location and investment decisions to high income taxes and high sales taxes?

-How big a portion of sales tax revenue would be generated from tourist dollars as opposed to 'domestic' spending (i.e. is there a free lunch)?

-Is there a relationship between tax progressivity and economic growth?

-Is there relationship between tax systems and overall tax rates and economic growth?

-Is there a dead weight loss associated with the difficulty of consumers and businesses having to deal with transactions with sales taxes?

More questions will arise, but if there are others you can think of in the interim, do chime in. 'Tis the holiday season, but I shall try to start delving into the research soon and shall report on what I find whenever I have something of any importance.

Sales Taxes: Lessons Learned so Far...

I had been avoiding posting about Oregon's revenue system for quite a while now because I have a real job and spending time digging into the evidence on tax systems was not a high priority. However, the opinion piece in the Oregonian by Scott Bruun finally prompted me to make a first foray into the debate and I considered a kind of commitment device to finally get my hands dirty. So I decided to start a discussion and over the next month or so I could start to see what the evidence was. After all I have only three readers and they are all pretty patient. Then comes Jeff, who throws gasoline on my nice slow burning fire, and here I am, spending half the night looking at income/sales tax revenue elasticities! Thank you and curse you Jeff Alworth!

So first lesson: a blog is a public forum and so you had better be prepared to engage the public.

But, now that I have looked at a number of studies and have updated my knowledge from my policy student days (gosh, can it really be 15 years ago already?) I am left with two conclusions about the variability of sales taxes.

Second lesson: sales tax revenue is not significantly less volatile than income taxes in the short run and may, in fact, be more volatile.

In a number of studies, short run volatility is actually greater for sales than income tax revenue. Its volatility can change depending on the exemptions and other specifics of the tax, and for some states it is quite stable while in others it is quite volatile, but overall the evidence is simply not there to support the lower volatility claim. What this means is that is the case of short-run income shocks the state is potentially as bad off or worse off with a sales tax.

There is, however strong and consistent evidence that the long-run income elasticity from sales taxes is lower than income. This is not questioned anywhere in the literature, but the interpretations differ. The evidence cited in a previous post show a a fairly significant difference between long-run elasticities for sales and income taxes. This is argued to be largely reflective of the growth rates of the two taxes as incomes in general grow and does not tell us that much about stability. (Which, by the way, is one reason fiscal conservatives don't like income taxes as they grow too fast in their view) In other words, it is argued that this is mostly an indication of a trend and not about variability around that trend. But I am not entirely convinced: it does inform us about, for example, the effects of an extended recession - suppose a three year span of low state income (sound familiar?) - a sales tax should fall less severely in that case.

Third lesson: a sales tax might mitigate the downturn in government revenue during an extended downturn in the economy.

So what does this tell us? Well, it probably says that volatility itself should not be a determining factor in choosing a sales tax. How likely are short-run fluctuations v. long-run downturns and how much each matter seem to be pertinent questions. Oregon has been severely hurt by extended slowdowns of the economy but has also struggled with more short-term economic variation as well.

Forth lesson: with whatever revenue source you have, excepting somewhat property taxes, there is going to be significant volatility.

Whether income or sales are more or less volatile in the short- and long-runs, the essential fact is that they are both volatile and mechanisms for smoothing, rainy-day funds if you will, are necessary if the government really wants to reduce volatility significantly. Sales taxes will not do it. A rainy day fund requires restraint when revenues are high and a reserve to draw on when times are good.

So finally what I am left with is a belief that diversification of revenue sources may help somewhat but that volatility is simply not a particularly compelling case for sales taxes.

Two Other Factors to Throw Into the Equation

1- State income taxes can be deducted from federal income returns but sales taxes cannot - score one for income taxes. (Correction: through this tax year only - though it may be extended -you can choose to deduct either state sales tax or state income tax but not both. With a new sales tax and reduced income tax however, it likely means a lower deduction on your federal return)

2- However, income taxes that are too high can (and apparently do) influence wealthier households' location decisions and can make it harder for businesses to hire in a national job market. Oregon has one of the highest income tax rates in the country: 9% for income above $6,850 (only Vermont has a higher upper tax rate, 9.5%, but it is for over $330,000. California can get higher on income in excess of $1 million).

How Volatile are Sales Taxes Compared to Income Taxes?

This is a good question and one on which I have been challenged in the comments. My knowledge of this issue, I have found, is based on evidence that is a bit old and the newest data suggests that the difference is not as great as I had believed. The newest and best evidence I could find comes from an analysis of all states actual tax revenues and is quite interesting to a real wonk. But here are the citation and the relevant results:

"Tax Base Elasticities: A Multi-State Analysis of Long-Run and Short-Run Dynamics"
by Donald Bruce, William F. Fox, and M.H. Tuttle
Southern Economic Journal
Volume 73, Issue 2 (October 2006), pp. 315–341

Table 1: Sales Tax Elasticities
Mean Variance
Long Run Sales Tax Elasticity
0.811 0.048
Short Run Sales Tax Elasticity Above Equilibrium
1.804 7.179
Short Run Sales Tax Elasticity Below Equilibrium
0.149 0.880

Table 2: Income Tax Elasticities
Mean Variance
Long Run Personal Income Tax Elasticity
1.832 0.427
Short Run Personal Income Tax Elasticity Above Equilibrium
2.663 5.014
Short Run Personal Income Tax Elasticity Below Equilibrium
0.217 2.180

These are income elasticities meaning by how much do tax receipts change in percentage terms, from a 1% change in income. Note that sales taxes in the long-run (between year) change quite a bit less than income taxes (0.811 v. 1.832). The authors argue that this is not terribly informative when thinking about volatility. I am not so sure - their point is about maximizing revenue streams not stabilizing revenue collection. Anyway, the short-run (within year) elasticities were found to be quite asymmetric, meaning that they varied a lot depending on if incomes were above equilibrium (basically above average) or below equilibrium. So in good times and bad, in other words. In good times income tax receipts go up quite a bit faster than sales tax receipts (2.663 v. 1.804) and in bad times income taxes fall faster than sales taxes (0.217 v. 0.149) the the difference is small. Notice how small the elasticities are for the bad times. It should be noted that these are based on all states and thus are average effects. States have big differences in their sales tax schemes in terms of what is included and excluded and how much local municipalities tax as well. Most states however, have some exemptions for necessities like non-pre-prepared food.

So the overall picture is that there are higher income elasticities, especially in the long-run, for income taxes than for sales taxes, but that in the short-run the picture looks pretty similar. So is it the long or short-run that we care about? The authors of the study say the short-run is more important because the long-run trend in income is always up. But I disagree, this is exactly what it says: an income elasticity, so when annual aggregate income falls by 5% we should see about a 4% drop in sales tax receipts, but about a 9% drop in income tax receipts. The reverse is true as well. Annual tax revenue is critical in Oregon and this is what these elasticities address. Short term fluctuations in income will not cause the same magnitude of differences, but the differences are there. One thing is clear - income taxes do better in extended periods of income growth, but as we are not worried about growing revenue streams, but lowering volatility, I am not sure this matters much. The conclusion here is probably that it doesn't differ that much though - and going back over other studies that are perhaps not quite as good as this in that they don't utilize as good a data set as this one find that there is little difference in volatility.

Oh, and one other interesting little tidbit of info from the study:

The percent of revenue raised from the sales tax in 2000 varied from 19.5 percent in Virginia to 61.6 percent in Washington. The percent of revenue raised by the personal income tax in 2000 ranged from 16.9 percent in North Dakota to 68.9 percent in Oregon.

I did not know both Oregon and Washington were so extreme and on opposite ends of the spectrum.

Sales Tax Poll

As I prepare my magnum opus on sales taxes, it is time for another poll. I would like to know if you think Oregon should have one. My opinion is already known, but I would like to know yours - my faithful three readers. Winter quarter is on its way, so I am going to keep the poll open for a few weeks to allow the fresh and unencumbered minds of OSU undergrads to weigh in as well.

Vote over there on the right, and comment here.

The Time for Tax Reform in Oregon is Now

I am going to use the opportunity of an opinion piece by Scott Bruun in today's Oregonian to finally talk about something I have been putting off for too long: the state's tax system. Or more to the point: why does Oregon not have a sales tax? The basics are pretty well known to most people by now: Oregon relies heavily on income taxes to fund its government and income taxes fluctuate widely with economic cycles. This cyclical revenue stream lends itself to inefficiencies, prohibiting many long-term investments, forcing closure of half-done programs and causes uncertainty that leads to underinvestment in general. Oregon does not have a sales tax. Sales taxes are sometimes characterized as regressive, but with exemptions of common necessities like food, clothing and medicine sales taxes can be made neutral or even made progressive with means-tested tax rebates. It is simply not at all hard to make sales taxes progressive. More importantly, the incentives with sales taxes are toward greater savings and investment and lower consumption. This is a good thing for the economy. But the best part is that sales tax revenues are much more stable than income taxes. Certainty in tax revenue leads to better planning, better investments and thus better government for Oregon.

Now, the obvious rejoinder is that a sales tax will hurt Oregon retail businesses. First, I don't think that elasticities will be that high to cause much of a reduction in revenues, but whatever reductions there are could easily be offset by a business credit. However, I don't really think this will matter that much in the end to businesses. Look at all of the states that have sales taxes, some go as high as 9% and over, and I don't see much correlation in the health of the economy, the presence of retail businesses and such with the tax rate. To put it another way, do you think that Oregon would look much different today if there had been a sales tax in place 50 years ago? Perhaps we would have better schools and such, but I doubt the retail climate would be much different. But I will search for evidence of the effect of sales taxes on businesses and report what I find when I do a post just on sales taxes soon.

So why all this talk about investment and efficiency? Well, economists know that uncertainty means risk and risky investments require higher rewards. Thus if you increase the risk and keep the reward the same, investment will suffer. So, suppose you think about funding an early intervention program that takes at risk youth during their high school years and tries to keep them out of trouble by offering counseling, after school activities. This might be a great deal for the state, leading to less burden on the criminal justice system, the state health insurance plan for children and increasing college enrollments. But suppose that after two years the plan runs out of money due to a downturn in state revenues. Two years is not enough to see one cohort through high school and so the program has no measurable effect. Well, if you are thinking of funding this program and know that there is a reasonable probability that the funding will fall through, leading to a waste of the initial investment you may devote the money elsewhere even though, if funded, the state will actually save money in the end. Funding and defunding programs is a waste of money and many good programs would end up saving the state in the long run. This is why I think such instability in the state's revenue stream is such a problem and should be fixed.

Portland Home Prices

I am going to piggyback on Paul Krugman, whose column today in the NY Times about the drying up of credit and the subprime mess is quite informative and not at all political. Paul argues that the credit crunch is not just a temporary problem caused by panic, but a serious fundamental problem of insolvency. He does a good job explaining it, but the basics are this: banks and other investors have a lot of debt paper collateralized by homes whose values are dropping below the level of debt owned on their mortgages.

Fortunately for Oregonians, we live in a state that has largely been immune to the falling housing market. Not that it matters much it terms of access to credit as it is drying up nationally and internationally. It does matter in that if a lot of foreclosures happen Oregon homeowners could be in for a bit of a rocky time seeing their investment in property (which they may have leveraged for more credit) tank. Some good news for me, the Corvallis market has one of the lowest subprime rates in the country. But is the good news going to last? There are troubling signs that it isn't. Below is a little snippet of data from the latest S&P/Case-Shiller Home Price Indices for Portland, Oregon (the figures are median home values in thousands of dollars). What is so good about this data is that it is not about median home prices from transactions data which we see all the time in the newspaper but are of little use, but about repeat sales of the same properties. So it really gives a very accurate description of home price appreciation. What we see from this data is that the Portland market looks like it is turning south. It is a little too early to tell, you can see a downturn last winter that corrected, but unlike the slow winter months then, the current downturn started in the summer.




With credit drying up and the potential of a glut of foreclosures on the horizon, I am becoming a little worried about the near future in the Oregon housing market. I am late to the party. When friends asked about the booming housing market a couple of years ago, I was very sanguine because houses are a funny product, generally the supply is very counter cyclical: when house prices are not appreciating or even falling, people tend not to sell, but when they are increasing, people tend to start selling. This is why it is so rare to see house prices go down, Just look at this next picture:



But what I didn't know that the time was how big the subprime business was and how the paper was so poorly scrutinized. Now, a lot of people who banked on 10% annual appreciation are in trouble and I don't think Portland, and Oregon in general, are immune.

Beeronomics: Product Variety and Spatial Economics

When thinking about product variety in a tractable model, economists often rely on spatial models, the classic being Hotelling's linear boardwalk model. If you think of consumers tastes as being spread out on a line, like a boardwalk where one end might, in the case of beer, be very light pilsner beer and the other be very dark stout ale, then you can conceptualize it in terms of distance from one spot to the next. In other words, suppose my preferred beer is a medium bodied IPA, then if you are only offering light pilsners I would not be willing to pay as much for that beer as I would an IPA. Similarly if I were at a particular spot on a boardwalk, and the only hot dog vendor was a quarter of a mile away, I would not pay as much for that hot dog as I would if the hot dog vendor were only steps away. Having to travel the half mile there and back is costly to me and thus I figure it in when thinking how much a hot dog is worth to me. Now obviously it is a gross simplification to describe beer varieties along only one dimension (light-dark), but that is precisely the point of modeling, stripping away a lot of real world complications (as long as none are fundamental) to come up with a description of reality that is tractable and that can inform us about the real world (think Newtonian physics).

The point is, that in these models, often the equilibrium strategy if you can only offer one variety is the locate in the very middle of the spectrum: this minimizes the distance between you and the mass of customers and allows you to sell more at a higher price. This is why, in my opinion, Pale Ale/IPA is the most common flagship beer among Oregon Breweries and the one beer most often found on the supermarket shelves.

There is also, however, a strong incentive to offer more variety, the closer you are to customers' tastes, the more you can charge them. So it is not surprising for the major Oregon breweries to offer a standard line up of 4-6 beers. This, of course, creates a tension between continuing to increase variety versus selling a lot of the most popular beers. However, it appears from casual observation that the equilibrium is about 5 varieties.

So it does not surprise me when, for example, Terminal Gravity enters the market with an IPA (or at least that's all I can ever find on supermarket shelves). It does surprise me, however, when a whole segment of boardwalk is ignored. It could be that there are not many people sitting on that end so it does not make sense to add a hot dog cart there given the cost and the limited demand. But in Oregon, the part of the boardwalk that is not served is the lager market, and I have a hard time, given the success of Sam Adams, that there is not a strong demand for lagers, even here in Oregon. I, for one, am a huge lager fan and bemoan the fact that I generally have to look to the east coast for tasty lagers.



Well finally, we have a new entrant in the Oregon beer market that is making lagers: Heater|Allen of McMinnville. They are not producing much beer yet so I have yet to sample the wares, but I anticipate a strong demand if they do ramp up production as long as the product it good and it appears to be. Let's hope they ramp up soon.

Payday Loans Redux

A new staff report by the Federal Reserve Bank of New York seems to confirm my fears about the regulation of payday lenders. As an economist, I believe that things like payday loan businesses arise due to some missing market, and to simply shut down that market does not address the original lacuna that caused it to arise. As payday borrowers are mostly lower income individuals, eliminating payday loans could end up making them worse off. Payday loans, as much as they seem usurious to us, seemed to be providing essential liquidity to a population that has a limited access to credit. Preliminary results are that credit troubles have worsened in areas where payday lenders were prohibited.

Beeronomics: Rogue and the Business of Art

On Friday last, the OSU Economics Club visited with Jack Joyce, owner of Rogue, at the brewery in Newport. Jack was an amazingly gracious host and we all had a wonderful time, and it made me extremely pleased that Rogue was chosen by you, my 3 readers (somehow voting over 60 times) as the best Oregon brewery. Whether this is true or not, it must qualify as the friendliest. Jack certainly fits the bill as a Rogue - he is an independent thinker and businessman and my first thought was that his approach to the beer business was unconventional from an economics standpoint. But the more I thought about it the less I am sure that I am right. Perhaps his approach is the more conventional given his product and that the 'widget' based economic approach to business such as his is just all wrong. In fact, viewing beer as a commodity product is exactly what makes me fear for the long term survival of independent craft breweries in Oregon.

Allow me to explain. When you consider Rogue Brewing next to other major players in the Oregon craft brewing industry, like Widmer, Deschutes, Full Sail and Bridgeport one thing immediately stands out. Whereas the others have clearly been heavily influenced by marketers and have done serious branding, offer a carefully selected range of beer styles, engage in a fair amount of mass media advertisement, etc., Rogue shares none of these characteristics. So one of the main questions I had when we talked to Jack was whether there was a method to the madness of Rogues many product offerings, unconventional packaging and lack of advertising. To be sure the other breweries are using the standard playbook: solidify your brand identity, lead with a popular range of styles, try and grow your markets through advertising - you see it all the time. Let's call it the Boston Beer Company strategy.

What Jack said to us is that he thinks about none of that. His philosophy is that beer is art and, just like art in the 19th century, it needs wealthy sponsors so that it can flourish. He sees his role as that of a wealthy sponsor, not in the sense that he is bankrolling a failing business, but that his job is to find a way to sell enough of the art to keep the artisans in food, clothing and shelter. So he has absolutely no say in what beer gets made, how it gets made or even if it should be made. He gives complete control to John Maier, his brewmaster, and when John has come up with a new beer has only one question for him: "is it beautiful?" If the answer is 'yes,' then Rogue puts it out and Jack finds a way to sell it. This has made Rogue arguably the most creative, diverse and interesting of the major craft brewers in the world. They may not have grown nearly as fast as Deschutes or Widmer, but they have seen stable, constant growth and have a following all over the US and the world. (Interesting fact: according to Jack, Rogue is the #1 selling foreign beer in Japan)

So this begs the question, what is the difference between commodity and art markets? Commodity markets assume a fair amount of homogeneity while the lifeblood of art markets is distinct products. The attitude that you are operating in a commodity market is what drives the marketing arm of Boston Brewing (even though they try an stress the distinctiveness of their beer, the fact is they want customers to view it as a better Budweiser, not some entirely different product). If you take the art market attitude then the product itself has an essential value that comes from the careful crafting of a unique beer. The truth is that economically speaking the former attitude is probably the 'right' one in terms of profit maximization. But the latter attitude is not foolish or naive, it is simply another way of viewing the market in which you operate. What I am entirely sure of is that Jack, John and all the rest of the Roguers are maximizing their own utility by creating a successful business based on the art of brewing. And the rest of us get to enjoy the wonderful results.

It is a beautiful thing.

NB: The attitude that they are producing art also carries over to their packaging of which Jack is very proud. He views their bottles as beautiful works of art as well.

NB2: The craft brewing culture of Oregon is starting to create a new generation of young beer drinkers in Oregon. Something my friend Jeff has noted elsewhere. When Jeff and I were in college together, Ranier pounders and suitcases of Hamms were the typical beers of choice. I was surprised that the OSU undergrads that came to Rogue clearly knew much of the entire Rogue line up and were quite enthusiastic Rogue drinkers. (Though these are students who have chosen to be a part of the Economics Club, so they are clearly a sample of the more discerning and sophisticated OSU student)

Open Letter to the Oregonian

Given what I have written in this blog previously, it should come as no surprise that the front page article in the O about a libertarian critic of Portland's planning should set me off:

Dear Editor,

RE: "Contrarian unabashedly bashes Portland," Page A1, December 10, 2007.

For an ‘economist,’ it is surprising that Mr. O’Toole seems to have forgotten that high prices are a function of both supply and demand. It is not just the relatively slow pace of new homes being built within the urban growth boundary that has led to price escalation; it is also the very strong demand for homes in Portland. It doesn’t take an ‘economist’ to figure out that this strong demand is largely due to the vibrant and livable city that has been engendered by exactly the type of careful planning that Mr. O’Toole decries. Furthermore, Mr. O'Toole's libertarian fantasy has no answer to the externality problem familiar to economics. To wit, if everyone builds homes where they wish, this imposes a cost on everyone else in the community in terms of extra time spent stuck in traffic, money needed for new roads, etc. This is why good planning is good economics.

Yours sincerely,

Patrick Emerson

I did not write this to the editors, but it alarms me, as an economist (not by self-description but by the fact that I hold a PhD in economics), that the Oregonian would describe someone as an economist simply because they say they are. I think the Oregonian should have an editorial policy that requires some kind of credential or degree in order to label someone an ‘economist’. I took a biology class once, can I call myself a biologist and be thus described in the pages of the Oregonian? I shouldn’t think so. This is not just a question of semantics but a serious reportorial issue. Readers need to be able to judge and weight opinions based on the qualifications of those that express them. Saying that he does not hold a degree in economics in the last quarter of the article is not good enough.

That said, if someone is making money as an 'economist' perhaps they are a 'professional' economist and it doesn't matter. If I started a business as a biological consultant and I could find someone silly enough to hire me, does that make me a biologist? Or if the Cato institute hired me and gave me the label of 'biologist' would that suffice?

Anyone know the O's editorial policy on professional labels?

Economist's Notebook: Markets do not Exist in a Vacuum

One of the themes I have been harping on in the short life of this blog is that you cannot evaluate markets in a vacuum - markets exist in a time and place and work only as well as the structures that support them. As a development economist I am acutely aware of this fact. Markets constantly spring up where there were none before, but without good institutional underpinnings, these markets are badly organized and often inefficient. A case in point is rural credit markets. In developing countries where credit histories do not exist and collateral is scarce, formal credit markets often do not exist. The informal markets that spring up are often usurious and exploitative.



I bring this all up because of the rather dramatic storm that has just disrupted a huge network of infrastructure and services in Oregon and Washington that are vital for a market based economy and society to function and function well. We need road and rail networks, telecommunications, power, water and sewer networks, police and fire protection and on and on and on. (For example, above is I-5 in Centralia, Washington that is likely to be closed for about a WEEK!) I think that we too often believe that these things are part and parcel of the markets they serve, but the fact is that these are public goods and that no one markets would ever provide enough for the efficient running of society. How much is enough and what is the appropriate level of government involvement are all important questions but simply saying let the market take care of everything is no answer at all.

Erudite Discussion of the Subprime Meltdown

I think they could have done without the slightly racist overtures (although they ARE in character), but this is funny in the most classic way: because it is so accurate - especially the very end, so stick with it.



HT: Greg Mankiw