Comparative Advantage, Learning Curves and Streetcars

Faith Cathcart/The Oregonian

The news that the huge delays and problems with the locally built streetcars will cost Tri-Met a bunch of extra money to pay for oversight of the engineering work by United Streetcar brings me back to a post I wrote a while ago.  What I said then, and bears repeating now, is that by insisting on building our own streetcar we are ignoring comparative advantage and that could cost us.

Previously Portland bought streetcars built in the Czech Republic by Inekon Trams.  The Czech Republic has both more expertise in streetcar manufacturing and lower labor costs. Thus, there is good reason to suspect that they have a comparative advantage in streetcar manufacturing relative to the US.  Economic theory is clear that both the Czech Republic and the US are made better off by concentrating on manufacturing what we do best and buying the stuff that we don't from the other country.

The objection is that by buying local ones we are helping the local economy, putting local people to work, etc. And in this one specific case this is true.  But overall we are not doing ourselves any favors.  We are essentially wasting money buy buying a more expensive and potentially less reliable product.  That is money that could have been invested rather than wasted which would be a net gain to the economy.  We may have put a specific few lucky iron workers to work but the rest of the economy suffers.  [As a quick example think of the unemployed bus drivers who can't get work because Tri-Met has to cut back on busses thanks, in part, to the extra cost of the local streetcars]

I am pretty confident this is true at the moment and for the short term, but does it mean we made a mistake?  Not necessarily.  Once we look at a dynamic model it may turn out that investing in local streetcars was a good idea.  How? Well consider the idea of the learning curve.  Currently United Streetcar of Oregon is suffering from a decided lack of experience in building streetcars, but they are learning and eventually they could become a low cost provider.  Here is the basic model in a single graph from Krugman's International Economics text:

Suppose Inekon's cost curve is the upper one labeled L and United Streetcar is the one below labeled L*.  Currently, because they have been doing for a while and know a lot about building streetcars, they are at Q* and there unit cost is C1.  United Streetcar is just beginning and so their cost is C0, which is higher than C1.  Over time, however, they will learn, their costs will come down and they may actually be able to better Inekon in terms of cost. So by supporting a fledgling local industry now, you may create a competitive and viable industry later.  

But, and there is always a but, is there any reason to suspect the cost curve of United Streetcar to be below that of Inekon?  I suspect not from labor costs alone.  But there is also a similar model whose graph looks almost identical except instead of a learning curve it describes economies of scale.  

If you change the horizontal axis to total current output instead of cumulative output you get a story of economies of scale.  In fact with economies of scale, United Streetcar's cost curve can be the upper one and Inekon's the lower one, but if United Streetcar can grow to a sufficient size while Inekon stays relatively small, United Streetcar can gain the cost advantage purely through scale effects.    My doubt about this story is that it is hard to imagine the streetcar market growing to one where there is sufficient output to justify mechanization of a lot of manufacturing processes that is the source of a lot of economy of scale effects. 

I also doubt it because other communities are getting in on the act.  Seattle announced last year that their streetcar would also be manufactured locally - though you'll notice that it is in partnership with Inekon and the streetcars will be assembled locally but most of it will be manufactured in the Czech Republic.  Anyway the point is if all US cities doing streetcars start manufacturing locally, than there will be no great scale effects coming to United Streetcar.

So consider this a cautionary tale: what seems great for the local economy could just be doing it harm.

Of Learning Curves, Infant Industries and Streetcars

Photo Credit: Daniel Rosenbaum for The New York Times

Two interesting articles caught my eye this morning.

In the first, The New York Times reports that the streetcar fad appears to be waning:

Just a few years ago, the streetcar revival was all the rage in cities across the country. Portland, Ore., seemingly set the trend with its 11.5-mile system, which opened in 2001 and was said to spur economic development while carrying 16,000 passengers on weekdays.
Elsewhere, New Orleans is extending its streetcar lines, while Atlanta, Tucson and Salt Lake City have also moved ahead with similar systems, almost always pegged to the promise of transit-related economic growth.
...
Yet as several cities inaugurate new systems or expand older ones, the streetcar revolution, facing fiscal and operational challenges, has stalled elsewhere. Last July, San Antonio abandoned its planned streetcar system after changing mayors, reallocating the $92 million it had set aside.

In the second, the Oregonian has a post-mortem of sorts on United Streetcar, the troubled nascent streetcar builder in Clackamas that finally called it quits.

United Streetcar, the Clackamas company expected to put hundreds of Oregonians to work manufacturing a new generation of streetcars, has all but closed up shop without meeting job projections.
...
In the years since, United Streetcar landed contracts and built 18 vehicles for Portland, Washington, D.C., and Tucson, Arizona. But the company shut down manufacturing in late 2014 when orders dried up.

While it is true that the market for streetcars has slowed I think United Streetcar's problems were more fundamental.  It was trying to learn streetcar manufacturing from scratch in an industry that has high fixed costs.  There was a big learning curve to surmount and it is quite clear that they did not do so with nearly enough speed.  There are many instances of infant industries that, spurred on by initial government support, ended up becoming globally competitive.  Take Airbus as example number one.

But streetcars to me seemed to be a losing proposition from the start.  And without emergence into a viable ongoing concern without government support there was little to recommend spending taxpayer dollars on streetcars from the USA rather than more reliable, timely and cheaper streetcars from the Czech Republic.

I am sad to report that I was right.

Oh and as a coda to this whole thing, the idea of streetcars (without the ability to engage in avoidance manouvers) commingling with regular car traffic easily appears to be wishful thinking.

Comparative Advantage and Increasing Returns

Busy, busy, busy Friday - jumping from one meeting to the next.  So a late post about this article in the Portland Business Journal:

TriMet has been awarded $2.4 million from the Federal Transit Administration to research a U.S.-produced streetcar propulsion system.

The work will be led by Clackamas-based Oregon Iron Works Inc., whose subsidiary, United Streetcar LLC, is the only U.S.-based manufacturer of streetcars.

In a news release Friday, the Federal Transit Administration said the funds represent its 80 percent share of a $3 million project in which $600,000 will come from a local match.
The goal of the project is to fill a major hole in the U.S. streetcar supply chain. Propulsion systems account for about 20 percent of a streetcar’s cost, but the only manufacturers are based outside the U.S.

United Streetcar, which last year unveiled the first U.S.-built streetcar in 58 years, uses a propulsion system made by Czechoslovakia-based Skoda Electric S.A.

Chandra Brown, United Streetcar’s president, said the federal funds will be used to test a propulsion system developed by Milwaukee, Wisc.-based Rockwell Automation.

Once installed, 90 percent of the streetcar’s components will be made domestically, up from 70 percent today, Brown said.

So I am going to sound like a typical economist here - but guess what I am a fairly typical economist (atypical in my wit, wisdom and good looks but that is another matter). Why do we care so much about having our streetcars totally made in the US? What if we are not terribly good at it? Perhaps the Czechs are real experts and can produce a more reliable propulsion system for less money. Wouldn't it be better to focus on what we are good at - like designing iPhones, making good beer (Pilsner - pah!), making Hollywood blockbusters - and then trading them to the Czechs for streetcar propulsion systems?

Almost 200 years of economic theory suggests that we should and that if we do we will be better off.

Is there a counter-argument? Actually yes, and it is essentially what Paul Krugman won the Nobel Prize for. If the source of the Czechs comparative advantage in streetcar engines is from economies of scale, or if the source of their comparative advantage is from having gotten really good at it through experience (i.e. that there is a strong learning curve effect) than this type of government intervention can actually help, over time, the US become better comparatively than the Czechs. In other words, no private firm would do it themselves because they could not compete at first, but over time would grow big enough or learn enough to be competitive if only they had the support to make it there.

Does this argument hold water in this case? Hard to say for sure, perhaps we have more skilled electrical engineers and manufacturers so that if we set our minds to it we would be better and more efficient at it - but we would also have to overcome our relatively expensive labor.

I am skeptical, but of streetcars become the rage in the US, perhaps...

Comparative Advantage and Streetcars, Redux

Photo credit: Faith Cathcart, The Oregonian

The news, reported today by The Oregonian, that United Streetcar, the Clackamas based subsidiary of Oregon Iron Works, is months behind schedule on their streetcar manufacturing seems like a good opportunity to revisit an old blog post I wrote a couople of years ago when the contract was awarded.

First yesterday's news:

Officials for Clackamas-based United Streetcar acknowledged this week that work on their first five streetcars is months behind schedule. Representatives for the city's streetcar division remain hopeful that at least one of the vehicles will be ready for the line's Sept. 22 opening.

The setback is just the latest as United Streetcar, a subsidiary of Oregon Iron Works, attempts to break into a sector that's traditionally been monopolized by European companies. Design problems already prompted city leaders to delay the line's opening by five months and reduce the number of cars from six to five, while barely trimming the $19.5 million budget.

"We're not on the schedule we'd like to be," said Carter MacNichol, a consultant with Shiels Obletz Johnsen, which is managing the project for Portland. But, he added, "it's an extremely challenging effort. I just can't emphasize that enough. There's a reason there haven't been car builders in the United States for decades. It's difficult, difficult work."

Now here is what I wrote more than two years ago:

Why do we care so much about having our streetcars totally made in the US? What if we are not terribly good at it? Perhaps the Czechs are real experts and can produce a more reliable propulsion system for less money. Wouldn't it be better to focus on what we are good at - like designing iPhones, making good beer (Pilsner - pah!), making Hollywood blockbusters - and then trading them to the Czechs for streetcar propulsion systems?

Almost 200 years of economic theory suggests that we should and that if we do we will be better off.

In fact it appears that we are not very good at it - yet - and we will pay a pretty high price for insisting on USA built streetcars.

But this is not the end of the story.  As I mentioned at the time, for industries where there is a lot of learning-by-doing (and the O's article suggests that there is a lot of learning-by-doing going on at United Streetcar) there is a reasonable argument to be made for supporting them in their infancy.  But the rationale imagines a future where they have learned, become competitive, and don't need support or preferential treatment.  For this to be true in this case would mean a future where there is a large demand for streetcars. I was a little skeptical, but United Streetcar has racked up a bunch of orders - apparently streetcars are becoming something of a trend.

I am still skeptical it will last.  How many streetcar manufacturers can the world support, and why shouldn't we expect that the Czech Republic has a comparative advantage?

Only time will tell - maybe in ten years we can look back and pass judgement, but I am not ready to do so now.

Game Theory and Public Policy: SoloPower, United Streetcar & Nike

Molly Young has an excellent article in The Oregonian explaining the downfall of SoloPower and the various incentives bestowed upon them by the feds, the state and the City of Portland and related agencies.  It wasn't long ago at all that the state was still doubling down on its investment in SoloPower.

This investment appears to be a complete bust.

Over the weekend The Oregonian's Brad Schmidt had a similarly excellent article about the troubles at United Streetcar, another beneficiary of public largess.

This investment appears troubled and its success seems entirely dependant on other municipalities being forced to source streetcars domestically.

These two stories along with the ultimately failed efforts to lure Nike to build on the South Waterfront point out a particularly risky aspect of public policy: proactive interventions in the local economy.

I have been weary of investments in specific industries and especially for ones in which it seems dubious that the region has a comparative advantage.  I do not like all the investment in manufacturing of solar cells as it seems highly unlikely that without government subsidy there would be any economic reason for manufacturing to stay here.  The counter-argument is, I suppose, that after initial manufacturing here, the operation could morph into more local R&D and engineering while the bulk of manufacturing got shipped overseas.

I never liked the streetcar for this same reason especially because the counterargument is not really credible in this case.  The logic of the streetcar investment rests on the creation of a self-sustaining industry in the future.  It could happen - but I suspect that the streetcar demand domestically is not going to be enough to see it mature and scale up to something viable.

What we end up doing is overpaying in both time and money for streetcars whose quality is probably not as good as the Slovakian ones currently in operation.  But local jobs!, cry the critics - what about all the great jobs.  To which the rejoinder is familiar: pay a whole lot less in public money for the streetcar and invest the extra in education, infrastructure, etc. that will lead to overall economic improvement.

Finally there is Nike, which shared a little of the same policy question: should you bet public money on this risky venture.  To which I argued yes (from the perspective of the City of Portland).  With Nike you were on as safe territory as you can get company-wise, the bet was on how other private investments in the surrounding areas would evolve. I thought it a pretty good gamble.

Which all leads back to the modern reality that policy makers are increasingly involved in game-theoretic decisions - how much public investment to make in trying to lure companies, sustain companies, and create companies.   The reality is the world now works this way and taking the high road and not offering anything will probably mean communities lose out on investment.  

But it will always be a game and a risky one at that.  And in the press we will hear disproportionately about the failures, because they are easy to notice. But policy makers don't want to get caught chasing their tail, always offering greater and greater incentives because in game theory reputation matters and if you get a reputation as an easy mark, the other players will start holding out for more.

Economist's Notebook: Lake O Streetcar and Accounting v. Opportunity Costs

An article in The Oregonian discusses the new and improved cost figures for the proposed Lake Oswego Streetcar extension. In it, there is a discussion about whether the cost of the land that was purchased years ago should be included. This is a classic lesson in accounting versus opportunity costs in economics:

The new figure also does not include land owned by the government that originally had been included with capital costs. That alone reduced the price tag now being promoted by $80.3 million.

"I don't think it's disingenuous at all," said Obletz, who argued that the land is "not a cost to the project."

It may be correct to say the land is not an accounting cost for the project going forward, but it is entirely incorrect to say it is not a cost of the project. The reason economics makes the distinction is that the opportunity cost includes the next best alternative usage for the land and thus deciding to use the land for this project makes it unavailable for other uses.

In other words, if the land can be sold say for $100 million than utilizing it for this project denies that $100 million for any other use.  So, if you are doing a cost-benefit analysis of a project you have to include this cost as well, it is just as important as any real accounting cost going forward.

I kinda hope the streetcar guts built, it'd be pretty cool, but let's be real about the cost.

Economist's Notebook: How Far Should Portland Go to Land Nike?

Rough concept drawing for the Zidell's proposed mixed-use development

Pretty far.

There is no clear answer to this question, but that is my personal off-the-cuff opinion. The Oregonian is reporting that Portland is pondering about $80 in incentives that could rise to $140 if Mult. Co. kicks in tax incentives.  Whatever is invested in Nike is a gamble, there is no guarantee that related development will occur ex-post, but it has got to be about the safest bet around.  It is also a gamble with a huge potential social return: given the investment in the South Waterfront, the light rail, streetcar and so on, having Nike provide a workforce anchor would be a huge boon to the development of the entire downtown.  It accentuates the focus on density and transit and backs one of the few Portland area companies whose future is totally secure.

Critics will point out that you may end up overspending for Nike, that they would come for less or that the value of their presence is too little.  It is entirely possible.  But even if so, it is probably a good bet to take.  Remember that Nike is Oregon's only Fortune 500 company, that its presence in Oregon, along with good old Columbia, has led to a cluster of sportswear and apparel firms in Portland, and that, all things considered, it is a pretty nice industry to have.  Such a huge business employs a huge range of people from management, to design, to engineering and sales there is a lot of demand for a wide array of local graduates.  They are a forward-thinking company that is not belching out lots of waste.  In may ways, they are an ideal company to lure to the south waterfront.

It may not be the über-cool biotech firm that was dreamed about long ago when the south waterfront district was conceived, but it is a pretty good alternative.

Now there are some caveats: Nike's fortress mentality expressed so effectively in Beaverton would have to change.  I would hope that any potential Nike presence would be an open, accessible area welcoming to outsiders.  It would have to be given the light rail and streetcar links, I should think.

So is $80 to $140 million in incentives and tax breaks the right amount? Who knows, but it does not seem extreme given the potential benefits.  

Anyway, these are my initial reactions from afar, but I'd love to hear from others - what do you think?

Economist's Notebook: Western Cities

I spent the weekend at the American Economics Association annual meetings being held this year in San Diego. As has been the case for the last few years, I saw none of the actual conference because I spent the entire weekend in a hotel room interviewing candidates for two open positions in the department (not new - we had two departures from the department at the end of the academic year).  But it was my first time in San Diego and I did a fair amount of wandering the downtown, and though downtown is not really where you want to be when you go to San Diego, it was still quite interesting to me.

To me downtown San Diego felt just like downtown Denver from the new downtown baseball stadium to the historic district turned into a bar and restaurant spot, the broad avenues devoid of traffic to the distinct absence of residential hosing.  It felt nice and relaxed but a little bit marginal.  The Gaslamp district to me was a little bit scuzzy (more so than LoDo in Denver) but the revitalized waterfront was pretty nice (though mostly dominated by big hotels).  My take on these western ghost town downtowns in the west is quite different than the de-urbanization that happened in the east.

In places like Denver and San Diego I have this impression of early cities that were developing an urban core around stockyards and ports, respectively, when the automobile and the increased mobility of American society had a transformative effect.  Western cities have beautiful landscapes and the automobile allowed folks to live in more picturesque suburbs and close to the natural beauty that surrounded them (yes, Denver sits on a dry arid high plain by the mountain views are spectacular and thus folks spread out along the front range), perhaps despite the pleasant livable downtown areas rather than because of urban blight as in the eastern city.   Later, more and more folks moved to these cities by choice precisely because of the allure of the natural beauty and climate, and these folks were not looking for urban amenities as much as suburban space and nature.  Thus the massive sprawl took off.  In Denver it is vivid and impressive, and San Diego seems equally so.

It is only now that these downtowns are starting to infill residential and mixed use amenities in an effort to create more vibrant and lively spaces.  This process is slow.  I was very amused to see the San Diego Streetcar that circulates the downtown area as well as the number of new condo towers that I imagine sprung up in the early 2000s like they did everywhere including Portland.  The streetcar has become the darling of urban renewal (thanks in part to Portland) but I am not sure how strong an effect it has - it certainly has some.  [By the way, at $2.50 a ride I was not terribly surprised to see half full streetcars at best]

Back in Portland now but ready to go off to Brazil for 6 months - not sure how this will impact the blog exactly, but it has been hard to keep it up during this period.  I hope I can chime in on Oregon topics from afar and post occasionally about Brazil.

Eco-nomics: The Streetcar and the Incentives of Fixed-Route Transit

[Photo Credit: Jamie Francis, The Oregonian]

The Oregonian reports that the Feds have approved $75 million for the east-side streetcar project.  This begs the question, why fixed-route surface transit?  It is no faster than busses, much more costly to implement, less flexible in terms of scheduling and cannot adapt its route to changing ridership patterns.  I suppose the best answer is that it is a commitment device that can spur development in areas in which such activity is considered desirable.  In so doing it can promote even more density, which is generally a good thing for local economies and the environment.  I suppose it might be more energy efficient, but I am a bit skeptical, especially relative to electric busses like those in SF that get power from overhead lines.  I am no expert or even much of a casual student of transit, so I am wondering why the feds are endorsing it so enthusiastically.  What have I missed or what should be added to the discussion?      

Peak Car?

The economist has a nifty little discussion about the decline of the car in high income countries.  Here are two provocative graphs:

The first is a bit of an awkward stat: if folks are buying more cars the amount of work each has to do would presumably decline.  But the economist assures us that the trend remains if you look at total distance, distance per driver or total trips made. Also true is the fact that the youngsters are driving less: what once was a right of passage in the US is no longer - the percentage of teens with a driving license has declined dramatically since the early eighties (whew!).   On the other hand, older folks are driving in greater proportion (watch out!).  (Maybe road safety is a wash....)

All this makes me think of the criticism of the new streetcar line and the new MAX line - perhaps it is all justified, but the urban world in changing and the more we credibly commit to transit (read: fixed route transit) the more we may see such long term shifts in habits.  I am not ready to subscribe to this line of thinking but I am willing to consider it.

Economist's Notebook: Agglomeration Externalities and Portland

Ed Glaeser has another in his continuing series of excellent posts on agglomeration externalities in The New York Times' Economix Blog.  Here is an excerpt:

Jed Kolko’s essay in the “Agglomeration Economics” volume reminds us that the delivery of services often involves face-to-face contact, whether in a barber shop or a law office. While the costs of moving goods has declined steadily over time, the cost of moving people has not because time has gotten more valuable and you need time to travel. This explains why business services, which generally rely on face-to-face contact, are disproportionately prone to locate in cities. Mr. Kolko finds that the most skilled service industries are most likely to locate near each other and to locate in dense urban areas.

Mr. Kolko’s paper also shows that customers and suppliers that rely most on information technology are also most likely to locate near one another.

Perhaps unexpectedly, information technology seems to be associated with a greater desire for geographic proximity. After all, Silicon Valley — the home of information technology — is the most famous example of a geographic cluster in the world today. One reason new technologies make face-to-face contact and proximity more valuable is that technological change increases the returns to being smart, and human beings get smart by hanging around other smart people.

Cities, like New York, thrive as places of pleasure as well as work. Urban proximity enables people to connect with one another by creating, among other things, urban marriage markets. Large urban scale can also cover the fixed costs of urban amenities like museums and live music venues and clubs.

The Joel Waldfogel essay in “Agglomeration Economics” emphasizes the benefit that comes from being around people who share your own tastes.

If you live in a county of vegetarians, then your local supermarket is likely to be short on beef. If you live surrounded by voracious (and prosperous) carnivores, then you are much more likely to find U.S.D.A. prime at the butcher counter. The shopping options in Manhattan are tremendous by world standards, because of the vast number of customers on the island, and that is part of New York’s appeal.

Cities are a natural topic for economists because urban density can magnify markets, like the markets for workers and balsamic vinegar and spouses. That urban strength also explains why cities have proved to be so robust, and so fun.

This has direct application to Portland. Portland has gained a reputation for a number of things: progressive politics, urban planning, local food, beer, art and design and outdoor amenities. The fact that prople decide to move here because they are attracted by these things makes these things more prevalent and cheaper. I wrote about a version of this in a beeronomics post on economies of scale: more and more local breweries make it cheaper to brew for all of the breweries in town. [A more specific version of this is the organic beer movement - it used to be very hard to find organic ingredients, especially malts, and choices were limited and often available only from Germany.  But now with Roots, HUB and lots of other breweries brewing at least one organic beer, local suppliers are beginning to provide organic malts in increasing varieties]

Portland also has a tech sector, but it is mostly the lower end production stuff that is cheaper here and doesn't need to be so close to the 'brains.'  This is, in my mind, the key to the continued success of Portland: having enough of the really smart and creative tech types locate here and create new businesses.  So far it hasn't happened in sufficient scale.  It is a hard thing to engineer and trying to specifically target the types, the specific industry, etc. is a mug's game.  Which is why I am generally both optimistic about the future of the city and a little less skeptical than some of otherwise hard-to-defend public investments.  They are hard to defend because the data that establish a causal link between, say, an MLS team or a streetcar and general economic development are simply unobtainable.  But absence of evidence in support is not evidence for the negative and it is hard to believe that these things about Portland that people like so much don't have a long-term economic impact.  It is slow and amorphous, but it is real.  I think Portland is, and will continue to be, a jewel in the American urban landscape and this will, through time, yield real and substantial economic results.

Agglomeration externalities also provide an economic explanation for the observed sorting of people by ideologies as argued in the book "The Big Sort."  Perhaps it is to find more and cheaper things that we value that really determines our location choices and the fact that these are correlated with ideology is accidental.  So we are not seeking the comfort of the people we agree with, but seeking the material things we like and prefer them to be accessible, plentiful and cheap.  The fact that they are things like local organic food, green energy solutions, mass transit, etc., correlate to our political and policy preferences but these non-material political preferences are not what made us self-sort.  Perhaps.