Tuesday, March 19, 2013

The Portland Economy and a Lesson in General Equilibrium

The Oregonian today contains a fascinating article on an equally fascinating report about the Portland economy from the Value of Jobs Coalition (and prepared by ECONorthwest).  It is fascinating reading and something that will now stick in my head as I sit and ponder what characterizes the Portland economy.  And the conclusion that we should focus better on eduction and work to increase the number of STEM graduates is spot-on and universally correct no matter what the economy looks like.

But there is a big problem in the interpretation that what we are seeing is the result of how we have engineered the economy and that by increasing the locally produced STEM graduates we will increase the tax revenues we take in.  The problem is that this is a partial equilibrium analysis - where we assume lots of other things stay fixed (like for example, the wage differentials, and the migration of workers). In fact this snapshot is of a general equilibrium.  You may not like it but it is hard to engineer away and it is easy to come to false conclusions if you don't consider the wider general equilibrium implications.

Let's take a step back and look at the 'puzzle' they are trying to solve:

Figure 1 from: Higher Education and Regional Prosperity

Portland has fared poorly in terms of per capita personal income relative to other US metro areas.  Looks pretty bad but a better comparison would be to look at cost of living adjusted personal income and apparently if you take away a couple of outliers like Washington DC and NYC, Portland is pretty close to average.  In a general equilibrium, prices rise with incomes as upward pressure is put on the demand for goods and services.

But to the extent that Portland is below the national average it is very important to remember that wages are also an equilibrium price.  The first thing you should ask is that if STEM graduates are so scarce and needed why aren't their salaries above the overage?  And if local salaries are low to what extent does that reflect a compensating wage differential where people are willing to accept less to live and work here.

This is what I mean about general versus partial equilibrium.  You can look at the figures and say we need more of those high paid engineers, but if you make more wages could just as easily decline.  And certainly there is nothing in theory that suggests that MORE STEM types will raise local within occupation pay to something closer to the national average!

The worry that lower incomes mean lower tax bases also seems misguided - from recent poll results folks are also willing to pay more in taxes to support public goods and I suspect that the two are related: the same folks that are willing to take less to work less and enjoy the Portland area are also willing to contribute more to public goods.

Really the story that is being suggested is a long term growth effect: that by investing more in education and focusing more on STEM areas the local economy will evolve in a way that creates high-tech industries that will employ folks at relatively high salaries.  I agree with that but looking at current relative wages isn't entirely appropriate - or I guess I should say ONLY looking at current salaries is not appropriate.  This is an general equilibrium growth story not a static, partial equilibrium story.  Yes the former is much harder to communicate to lay folk so I am not prepared to condemn the exercise but the point should be made by someone somewhere (thank goodness for blogs!).  I support investments in education in general for growth reasons and I support emphasizing STEM fields for the same reason.  There is not much in this report however, that confirms or undermines my conviction.

And finally, circling back to cost of living and tax revenues.  Higher local wages are no guarantee of funding anyway.  When local costs go up you have to pay teachers more, principals more, and so on.  What is most important is the willingness of the electorate to pay for such things and I would argue (as above) that the self-selection that is bringing all the humanities-types to Portland is probably hugely positive for future funding of schools.

Okay, this is a bit disjointed because I am rushed and now I have to get back to work!  Apologies.


Michael Andersen said...

I too loved the Hammond article and this post is a very smart exploration of the dynamics in the search for STEM workers. But isn't this whole post based on a misreading of the article? The article doesn't report a shortage of STEM graduates; in fact, it reports that we have more STEM grads than the U.S. average.

What the article says is that we have a shortage of accounting and business majors. Seems to me that this is a different problem with different solutions, and you're squeezing this article into the wrong box.

Michael Andersen said...
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Patrick Emerson said...

I am not sure I made myself very clear. First I was being a bit too lazy only talking about STEM - good point. But what I was really trying to get at was the idea that you can't look at current wage distributions and say that changing the supply of workers will not change the wages. That the idea that we want to grow the tax base is a long-run growth story and not a static partial equilibrium story. Really that is my main point.

Michael, Portland Afoot said...

Got it. Thanks, Patrick.

I don't know if there's a theoretical framework that supports my intuitive sense that the labor market for entrepreneur types -- which seem to be the ones Hammond is suggesting we lack? -- is more complicated than the labor market for a STEM graduate.

As a humanities major (who both runs a small business and hates QuickBooks!) I find the whole binary Atlas Shrugged notion of "job creators" icky. But I do think there's something to it: seems like businesses, and cities, need a supply of ambitious entrepreneurs (i.e. people more ambitious than me) if they're going to grow economically. And compared to, say, an engineer, an entrepreneur's personal wage per hour worked might be a relatively small factor behind her choice of where to live.

Patrick Emerson said...

I think one way to look at it is that Portland has an abundance of one type of talent (or a few) but a scarcity of another that could add lots of value. As an economist who believes in markets that suggests that there should be above average returns for entrepreneurial activity here.

Take for example an MBA-type who is in Silicon Valley. Sure you are close to Page Mill Road (innovation and tech) and Sand Hill Road (venture capital) but you are also competing with tens of thousands of budding entrepreneurs. There are lots of success stories from there but are there relatively more successes there? SO what is your expected payoff to going to Palo Alto to start your company versus Portland?

Which sort of gets to my point - if Portland really does need entrepreneurs, prices (or expected payoffs) should rise and attract them.

Anyway, I really don't have any beef with the message just that what we are really talking about here is a equilibrium story and a long-run growth story.

Michael Andersen said...

I think we agree! I definitely think Portland is waiting for a few aggressive business majors to move in, hire a bunch of disproportionately happy creative workers, and make an equilibrium-restoring killing.