Monday, December 31, 2007

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!

Sunday, December 30, 2007

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'Ĺ“uvres. Oy.

Thursday, December 27, 2007

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.

Sunday, December 23, 2007

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.

Friday, December 21, 2007

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.


“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.


“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.

Thursday, December 20, 2007

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.

Wednesday, December 19, 2007

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.

Tuesday, December 18, 2007

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.

Friday, December 14, 2007

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.

Tuesday, December 11, 2007

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)

Monday, December 10, 2007

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?

Tuesday, December 4, 2007

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

Thursday, November 29, 2007

Prescription Drugs and Oregon

On December 7, 2006, the voters of Oregon passed Measure 44 by a 78% majority. The passage of this measure means that all Oregonians without prescription drug coverage can join the Oregon Prescription Drug Program which is a state-run program that buys prescription drugs in bulk and negotiates for lower prices using volume as leverage. I do not question the reasonableness of this measure or program - given the inadequate access to health insurance in the U.S. and Oregon it is incumbent for states to try and find reasonable solutions in the absence of sound federal policy. But it does raise a question that I think is important in how the government provides incentives to pharmaceutical companies and the perverse incentives programs such as the OPDP might provide.

The fact that the OPDP exists is evidence of the extremely high cost of prescription drugs. Why do drugs cost so much? Partly it is a function of the cost of research, development, trials and manufacturing, and partly it is a function of the fact that for most newer drugs the companies have a monopoly on the market. This monopoly power is granted to companies by the U.S. government in the form of patent protection precisely to incent these firms to invest in research on new drugs so that medical care and treatment can be ever improved. But what do profit maximizing drug companies focus on when exploring new drugs? Drugs for which they anticipate huge markets. These markets are where there are a lot of potential users of a drug and who have money or insurance to buy it. This means that the drugs that are important to the companies themselves (e.g. Viagra) may not be the ones that society might deem most valuable in term of, say, how many lives can be saved or extended (e.g. Anti-Malarial drugs).

So the question that seems important to ask is what drugs are the most commonly sought after drugs in the OPDP? I doubt, for example, that Viagra is one of them (though I would probably be surprised). I think the most commonly sought after drugs are those that treat diseases and illnesses that are more common among lower income individuals like, for example, heart disease. Are there others? Maybe ones that treat diseases associated with common income related illnesses like obesity and diabetes, liver disease, etc. I am not a health economist and I don't have the answers to these specific questions but here is the rub. If programs such as the OPDP lower the margin drug companies receive on these types of drugs it provides further incentives to devote even more resources to finding the next Viagra or drug that deals with health complications associated with aging. So, in a nutshell plans such as OPDP may lower the cost of these drugs but may also stunt the progress on finding better more effective drugs.

This is, of course, no reason to stop the OPDP, rather it is a reason to again think about how we may benefit from one comprehensive health care solution for all Americans rather than a patchwork of state and federal programs. Perhaps it is also time for the federal government to be more proactive in sponsoring research into drugs to combat less-profitable illnesses.

Tuesday, November 27, 2007

Beeronomics: Vertical Differentiation

The trusty John Foyston was back in the Oregonian on Sunday (on the front page no less) with what amounts to a very nice overview of the whole hop and barley shortage problem and what it means to Oregon breweries. It got me thinking, what would economics say about brewery strategies and how might strategic decisions already made affect breweries through this period?

One common product strategy that is often employed by macro-breweries is vertical differentiation. This is where you create different products or different varieties of products for consumers of varying income and affluence. Thus Toyota has its Lexus cars, the Apple iPod comes in cheap, stripped-down versions and sleek fully functional versions, and Budweiser makes Michelob. This is not a strategy we had seen from the micro-breweries until Full Sail introduced Session. Session is a light lager in the Bud tradition, and I have been critical of the decision to introduce it because I fear it blurs the line between craft and industrial brewing, which may cause an erosion of the loyal following craft breweries have created for themselves. (This is why, I believe, the Full Sail name and logo are not easy to find on a bottle of Session)

But this decision could end up being an inspired one if it turns out that consumers do not reduce consumption of beer in the face of higher prices, but instead turn to cheaper beers (as I suspect they will). It also could make sense in the chase for scale efficiencies. For these reasons I think the introduction of Session is probably a very shrewd short-run decision. However, I still fear the long-run consequences of this blurring of market boundaries.

Update: Though there are no studies I could find that looked at cross-price elasticity estimates between macro and micro brews, the short-run price elasticity estimates for macro brews is about -0.3. This is, I suspect, a lower bound for the more pricey craft beers, but means that for a 10% increase in price, brewers can expect about a 3.3% drop in demand. This is good news, but not, as I mentioned, what I consider the danger point for craft breweries - we need estimates of cross-price elasticity for that.

Wednesday, November 21, 2007

Happy Thanksgiving

Remember, economics says you should eat until the marginal benefit of one more bite equals the marginal cost of alka-selzer...and then you should eat some more - who cares about economics, its Thanksgiving!

Tuesday, November 20, 2007

Economist's Notebook: Opportunity Cost

Apropos of my post below on corporate taxes, a reader asks me to explain opportunity cost. The concept of opportunity cost is one of the most important basic concepts an economics student must master. Opportunity costs are what you give up when you undertake a specific activity. Suppose you decide to go to a concert on a Friday night. The explicit costs of doing so are the price of the ticket, what you pay for parking, etc. The opportunity cost of doing so is the value to you of the next best activity forgone. When you are making the decision to go to the concert you probably take opportunity costs into account naturally. You may say to yourself, "well, I really like to go bowling on Friday nights, but this is a one-time chance and I really like the it is worth it even when figuring in the expense of the ticket" Giving up bowling is the opportunity cost of the concert. Though we often naturally figure in opportunity cost when we make such decisions, we don't generally understand that we are doing so, and that by doing so we are making sure we make the right decision.

So when a business thinks about making an investment in, say, a new plant, they must think about the opportunity cost of this investment. What is the next best thing they could do with the money? Suppose it is to invest it in bonds. So the decision to invest in a new plant must yield a higher return than this investment in bonds. The decision to locate a new plant in Oregon therefore means that a firm is giving up the opportunity to locate in another state and thus giving up the opportunity to take advantage of the educated workers, health care system and infrastructure of another state.

Do Companies Really Only Care About Low Taxes?

No. In fact one of the more curious trends in recent years is how business leaders are pushing the government on health care, education, research funding, infrastructure, etc. (Here is but one example from a fairly conservative state) Why? Well, because while it may be true that taxes cut into the immediate bottom line, businesses require lots of social and physical infrastructure - especially modern high-tech industry. Think about what makes a successful business: a skilled and healthy workforce, good ideas and innovations and a reliable physical infrastructure. Its no use having incredibly low taxes if you don't have these, because you can't have a profitable, sustainable business. A skilled and healthy workforce comes from well-educated people who have access to good medical care and who are willing to locate near the company. So what should government do? Provide a good education system that will produce these workers and will attract them to stay when their children enter the school system. Provide a health care system that keeps people healthy and allows small businesses the ability to afford insurance for their workers. Provide the civic and cultural amenities that attracts skilled and educated people. Good ideas and innovations requires investment in higher education and research. Reliable physical infrastructure requires investment in roads, power grids and information networks. These are the things that modern, high-productivity, globally competitive companies want and need.

So if you are going to try and craft government policy to try and attract and spawn these kinds of cutting edge companies what would you do? Sure a low tax burden is desirable, but the first-order concerns are about the human capital environment and the physical infrastructure environment a state provides. To put it another way: paying 10% of my profits in taxes or 20% is immaterial when I cannot turn a profit in the first place. A lower marginal tax rate may be attractive now, but good firms are also very skilled at forecasting (or they wouldn't be so good) and can see if a tax base is unsustainable or is not likely to provide the kind of human capital and physical infrastructure in the future.

Economics is all about incentives and advocates of low taxes will talk constantly about the disincentives that high taxes create - and they are right. But sometimes they seem blind to the entire world of other incentives that exist out there. Good policy comes from understanding all incentives and weighing them carefully just like good economics comes from understanding opportunity costs, not just explicit costs. So what are the opportunity costs of a business locating in Oregon? Hint: it's not the taxes.

Monday, November 19, 2007

Here Comes Your Kicker - Thank the Dismal Scientist

The kicker is a strange piece of public policy in a number of ways, but I want to talk about one way in particular: counting on people like me (economists) to determine future economic conditions in the state and thus the amount of the kicker. Can this possibly be a good idea? I don't think so. Economic forecasts are educated guesses that are generally pretty good in the short-run but are pretty unreliable in the long-run. Why? Well in the short-run, risk is low, much is known and economic conditions are slow to change. But trying to predict the state of the Oregon economy two years out is a fool's errand. Consider the US economy and the subprime mess. The US economy is intensely studied, but until recently there were not many economists who thought 'softness' in the housing sector was that big a deal, now suddenly there is a crisis that could lead to recession soon (yet, again, no one is quite sure). Markets in general are not that wise either, had they been so smart, the price of citigroup stock, for example, would have fallen long ago. So the point is, relying on long range economic forecasts is simply silly.

But I have another concern, one that my be a bit far fetched (but I am not so sure how far fetched). In relying on forecasts instead of outcomes we are relying on something that can itself change economic conditions. What we would call an endogenous process. Here is what I mean: suppose the economic forecast is very pessimistic, this means a lower likely tax burden through a kicker return. This should spur investment in the Oregon economy as people act on expectations of the future and thus this should create even better economic performance and even bigger kicker refunds. Now consider an optimistic economic forecast, this will depress investment and may cause poor economic performance of the Oregon economy. Perhaps this counter-cyclical effect of the kicker is desirable, but I don't think it is understood and I don't think it is a first-best policy. If you want to restrain state spending, why not just limit state spending using some index based on economic outcomes? Or, if you want the state to act counter-cyclically, why not save part of the money collected in good years for lean years and then have the government spend these reserves in bad times as a counter-cyclical influence? (OK, I am speaking like a Keynesian here, but in the short-run, guess what? The Keynes model works incredibly well)

If you don't think my endogeneity story is very plausible then you must believe that people and businesses don't form opinions about the relative pessimism of the forecast. That means we are basically introducing uncertainty into the eventual tax burden of Oregon taxpayers. Uncertainty is not a good thing. Most people and many businesses are risk averse, which means that adding uncertainty will depress investment. If the goal of the kicker is to spur investment in Oregon, than this is counter productive.

Friday, November 16, 2007

Income Mobility in the US

Keith Chu of the Bend Bulletin wrote a very nice article on the new US Treasury Department study of income mobility in the US. He called me to chat but I don't think he learned anything from me - he seemed to grasp the whole thing already. Perhaps he'll become an economics reporter, goodness knows we need more good ones (I once spent an exasperating 20 minutes with an editor of the Denver Post trying to explain the CPI and I still don't think he got it). Anyway, I think he does a nice job explaining the evidence, so I'll let him tell it. Here is an excerpt of his article (which is not available to non-subscribers):

U.S. Treasury notes trend of upward economic mobility
Some labor experts say findings represent natural earning cycles
By Keith Chu / The Bulletin

WASHINGTON — Nearly half of the poorest Americans moved into a higher income bracket over the past 10 years, according to a study released this week by the U.S. Treasury Department.

The department and conservative commentators touted the study as proof that the American dream is alive and well. Two labor market experts said the latest numbers say more about how a person’s earnings change over a lifetime than whether they can climb the economic ladder.

The study compared individuals’ earnings on tax returns from 1996 to their earnings in 2005. It showed that 77 percent of people in the lowest 20 percent of earners saw their incomes increase from 1996 to 2005. About half of the people in the top 20 percent of earnings saw their incomes decrease in that time. All incomes in the study were adjusted for inflation.

“It’s basically saying that the rich are not staying rich and the poor are not staying poor,” said Treasury Department spokesman Andrew DeSouza.

“I think it definitely shows that with the strong economic growth that we saw over the past decade and in recent years of this millennium, (economic growth) contributed significantly for people to move between income groups, whether it is up or down.”

That’s true, but misleading, said Patrick Emerson, assistant professor of economics at Oregon State University. Rather, he said, the Treasury study shows that people naturally make different amounts of money at different points in their lives.

A 62-year-old who is in the top quarter of earners in 1996, for example, would likely be retired in 2005.

Meanwhile, a student leaving grad school at age 25 would probably make significantly more 10 years later.

“This is exactly what you would expect to see just from a standard life cycle of earnings,” Emerson said.

The Treasury study found that 55 percent of people in the bottom 20 percent of earnings remained in that category 10 years later. But about 24 percent in the bottom level moved up one rung, while 11 percent reached the middle 20 percent of earners. About 4 percent of people in the lowest 20 percent reached the top 20 percent of earners, with 7 percent of the lowest category reaching the second-highest level.

Another study released this week, by Julia Isaacs, a fellow at the Brookings Institution, a think tank in Washington, D.C., showed that about two-thirds of U.S. residents live in households with higher incomes than their parents.

That’s probably good news, Isaacs said, but the reason for that mobility is an increase in families with two wage-earners, not higher wages.

“We see some signs that things are good, that there’s been a rise in incomes over generations,” Isaacs said. “Men’s incomes, though, have been stagnant.”

Things like the difference in earnings between rich and poor and income across generations are better gauges of people’s chances of improving their lot than the Treasury report, Emerson said. By those measures, the U.S. ranks behind some European countries, especially Scandinavian ones. Some European countries are much more likely to have residents move up and down the income scale, according to a study by the Organisation for Economic Co-operation and Development, an international think tank.

“It turns out the U.S. actually does worse in those sorts of income-mobility comparisons,” Emerson said.

Mark Thoma has the Wall Street Journal Editorial Page's take on the data.

Beeronomics: Polling Results and You

I deliberately made the question, "what is the best Oregon brewery?," vague and open to interpretation. I didn't, for example, ask for "your favorite" brewery, or the "highest quality." I did this because I wanted, in a completely unscientific way, to examine some economic theories about consumer preference. What led me to think about this was the thought experiment: if you were starting up a new brewery, what would you do for your first offering. You have some choices, go for a style that is well known and liked in Oregon (IPA) or try something distinct and unique (like Hair of the Dog). Obviously, as I mentioned before, brewing is not all about business for many Oregon brewers, but you can't live the dream if you are not making a living.

Economists believe that consumers like variety in what they consume (you don't have the same meal for dinner every day of your life). They also believe that consumer's tastes vary depending on the person and that income matters a lot in the types of goods you consume - higher income individuals have preferences for higher quality or luxury goods. So what is a producer to do given these stylized facts? Well the fact that individual consumers love variety may lead you to try and offer them many beers of many styles (Rogue and Deschutes come immediately to mind), but this is expensive. It is hard to brew in smaller batches, have many different products for which you have to find tap handles and shelf space, and have to market many different beers. Other breweries seem to concentrate on a 'flagship' brew and hope that leads consumers to their other offerings (Widmer and Bridgeport come to mind here). The fact that there are also many different types of consumers out there has two competing effects for which there is often no equilibrium. Do you try and stake out as big a section of consumers by offering them a product somewhere in the middle of the spectrum? Doing so almost assuredly mans you will face tough competition (Terminal Gravity's IPA). Or do you go for a niche market that may be smaller but you have all to your own (HotD Fred)?

Once a brewery is established if faces another set of questions: do we try and grow sales of our established beers or create even less distinct beers to appeal to a wider audience to take advantage of economies of scale, or do we grow our variety to appeal to more customers and to keep current customers happy? I think the trend toward macro-style lagers (Full Sail Session) is a strong move toward the former, while Rogue, for example is a clear example of the other strategy. Finally, I think there is a reputation effect that is hard to break. Widmer is a clear example. When Rob and Kurt started Widmer, they were pioneers brewing styles no one had ever heard of before. In those early days of green palettes what became a hit was what are now considered less-distinct beers. So it is hard to break that early reputation a brewery establishes.

So at last, to the poll results: In a strange and suspicious flurry of voting Rogue surged ahead in the space of a few hours. But I am extremely pleased as I am taking a group of OSU students to meet with Jack Joyce, the owner, and I can share with him the exciting news. He will be so pleased. Deschutes, Full Sail and HotD also garnered much support. For big breweries, Widmer and MacTarnahans (which had for most of the poll had zero votes) had few votes, quite obviously because their beers are not generally considered on par with the others. But I think if I were to try and make something out of them I would say that the strategy of trying to produce a variety of quality beers is what begets a reputation as a great brewery. I voted for Deschutes for this reason. With the exception of Quail Springs, which has now been replaced by the excellent Inversion IPA, every single one of their beers is, in my opinion, a absolutely exceptional, flawless beer. I am stunned at how well they have achieved this feat and thus my vote. Rogue is perhaps a more interesting brewery, always trying out new beers and new takes on old styles, but their offerings, while generally exceptional, have a few less than stellar examples. Terminal Gravity, by contrast makes what may be my favorite IPA, but is not known as a great brewery by my voters probably because that is about the full extent of customers experience with them. Since they have decided to compete on such a popular style, I fear for their continuing success (they have already lost their taps in two local joints here in Corvallis). The most surprising outcome, in my opinion, is Bridgeport. I have such fond memories of the old Bridgeport brewery in the Pearl, when I was an undergrad and the Pearl was still industrial, and I was appalled when I returned after the big remodel. Perhaps this is such an iconic part of Bridgeport's identity that I am not the only one that cannot forgive the injustice. But their IPA is perhaps the quintessential NW beer. Blue Heron was perhaps the pioneering bottled NW micro-brew. What gives, no love for the Ponzis?

Thanks for everyone who participated in the poll and now, go buy some great NW beer and rethink your choice.

Wednesday, November 14, 2007

Beeronomics: Widmer and Red Hook Merger

Its all happening too fast! I had planned, after the close of voting for your favorite Oregon brewery (one day left!!), to write about craft brewers and strategy. I was going to talk about more mainstream strategies like Widmer and less mainstream like Rogue. I was going to talk about product variety strategies, like Full Sail bringing Session to market and Ninkasi's Schwag. And I still will. But the merger between Widmer and Red Hook, as reported in today's Oregonian has forced my hand early, so be prepared for a few days of Beeronomics. (Drat, that monumental post on stabilizing Oregon's revenue collection will have to wait another week it seems)

So what does the Widmer/Red Hook merger signify? One thing is that it may perhaps signify a trend in craft brewing toward larger scale to capture efficiencies. I am fortunate to have Vic and Carol Tremblay as colleagues, for they are experts on the economics of the beer industry. One of the things they have studied is what is known as "Minimum Efficient Scale" (MES) in the beer industry. This is how economists refer to the exhaustion of economies of scale - you know, how things become cheaper per unit as you produce more. It turns out that MES in beermaking has rapidly increased in the past 50 years. In 1960, they estimate, MES was 1 million barrels but had reached 23 million barrels by 2001. (And, by the way, we generally do not think that you can get too big as you can always divide operations between different plants so 23 million barrels is a target to meet or surpass). Why?, well increased mechanization, better transportation and bigger capacity for a start. To give one specific example, in 1987 a high speed canning line in a large brewery could fill 2,000 cans per minute! So to operate just one of these lines efficiently, you would need to produce at least 2.18 million barrels of beer. Methinks Caldera is just a wee bit under that target. This has nothing to do with quality, variety, honor...whatever. These are the cold, hard facts: economies of scale exist in beer brewing, they can be quite large and thus the economic incentive is to grow bigger and become more profitable and/or more competitive.

So where does Widmer/Red Hook fit in all of this? According to the always excellent John Foyston of the Oregonian, the combined brewery will produce 650,000 barrels a year. Far form MES, but probably a significant enough improvement in scale efficiency to make this venture worthwhile. This is about what Sierra Nevada produces, but is still quite far behind Boston Brewing - the craft beer king. It is perhaps no coincidence that Widmer, perhaps the most commercially minded brewery (consumer-driven?), is at the forefront of consolidation. (Both Widmer and Red Hook also have Anheuser-Busch as a minority owner)

This is a troubling trend for the craft brewing industry in Oregon, in my opinion, because there are competing economic forces at work. Consumers love variety, but producers love scale. The question will be, do consumers love variety enough to shell out $9 for a six pack of Dead Guy versus $5 for a six of Broken Halo? (Psst...go for the Dead Guy) I fear the answer to that question, for it is one thing to have brew-pubs where you can find quality, interesting craft beer, but it is another thing to find it in supermarkets (especially when you have two young kids and pubs are not so easy to frequent). This and the shortage and expense of hops and barley make me fearful of what may happen to Oregon's wonderful craft breweries over the next few years. There may be more pressure on economizing on ingredients and reducing the variety of offerings in the years to come.

NB: Jack Joyce of Rogue will be hosting the OSU Economics Club at the Brewery in Newport where we'll get to ask him about all of this stuff. OSU students: contact me if you are interested in joining.

Tuesday, November 13, 2007

Income Disparities: What Does This Mean?

Michele Draeger of the Oregonian created this nifty little graphic which she informed me was drawn from Census data for an article about income gaps in today's O. I suspect it was from the Annual Social and Economic Supplement of the Current Population Survey. In case you are wondering what a Household by Ethnic Group is (as I was), it appears that it is based on the ethnicity of the self-reported "householder." Beyond that I cannot say (if you know more, do share) . Anyway, back to the point: in Oregon there is quite significant income disparity among households of different ethnicity. But what are we to make of such numbers? I think there are a number of competing (and perhaps complementary) explanations. I will restrict myself to what I think are the three big ones.

One, it could be a sign of discrimination by ethnicity and race in the labor market. Two, it could be a symptom of inequality by race and ethnicity in access to health care, educational quality, living environment, etc. Anything that may reduce human capital outcomes (human capital is simply anything that makes you a more productive person like education and experience). Third, it could be a self-selection story: perhaps many African American and Latino families have come to Oregon to take up low-paying jobs. So it is not, in other words, a reflection of unequal access to quality education, but that it just so happens that the African Americans and Latinos that have moved to Oregon are low educated ones. Conversely, as migration from Asia is hard, only the most educated ones make it to Oregon. (There is another argument about racial differences in innate ability but research has shown this to be false).

Where does this leave us in terms of policy? Well the policy implications are quite different. In the fist case it means that more needs to be done in the promotion and enforcement of anti-discrimination laws and perhaps even more affirmative action policies should be enacted. In the second case, it is not about the job market (people are paid based on productivity), but the human capital acquisition that happens in childhood and thus attention should be paid the making school quality more uniform, creating programs that improve childhood nutrition, etc. The third case suggests that there is no problem and therefore any policy intervention is a waste of time.

So which of these explanations seems to be the case? Well, economists, including myself, have studied discrimination in many different areas and found that it still exists and is quite strong. In an act of shameless self-promotion I will assert that workplace discrimination is perhaps the toughest to uncover, but that my paper with Mike Conlin of Michigan State uses a very clever technique to provide an answer, and the answer is yes - even in a place you might not expect it. The second explanation has a lot of empirical evidence as well - students from poor school districts fare less well on standardized tests, for example, and poor childhood nutrition has been shows to have adverse affects on ability. The third explanation is a curious one, it has been made on a national immigration level, but I have not heard in made in these cases, probably because the number of households that have moved to Oregon is probably a small percentage of all households - but who knows, maybe it is bigger than I think.

So this is why we should all be thankful that there are economists in the world to help us find answers to these questions so we can better target our resources and create more effective policy.

Monday, November 12, 2007

Economist's Notebook: Why Doesn't OSU Pay Me to Get a Flu Shot?

Consider the external costs of my getting the flu: I could infect a number of students through my in-class interaction with them, I could miss class meaning that many students will miss out on vital learning (and will suffer mental anguish at the prospect of having a two-hour class on international economics cancelled - the horror!) and I may infect other professors and staff at OSU. The multiplier effect of my getting the flu means I would be a super-infector spreading influenza far and wide across the OSU campus. Surely the cost to OSU of all of this is more than the $20 they are charging me for the flu shot - so why oh why don't they give it to me for free.

Students: I did shell out the $20, so you can thank me now. No worries about me cancelling those two-hour international classes at 8am!

(NB: I have been made aware that Alex Tabarrok at Marginal Revolution has a similar post - see the list of 'Economics Blogs'. OK, but I am sure I thought of it first!)

Economist's Notebook: Do Economists Vote?

Steven Levitt (of "Freakonomics" fame) has a little video on the NY Times' web site explaining why economists don't vote. First, the fact that economists don't vote is news to me, I cannot think of a single example of a colleague who doesn't vote as a principle, and most of my colleagues in the departments of which I have been a part have all voted en-masse. Second, Levitt's explanation for this behavior (which I don't observe) is a familiar one in economics: that the marginal impact of one single vote is zero so there is no reason to vote given its non-zero cost. Now, of course, if you have been well-conditioned and believe in your civic duty to vote you may get utility from doing so, which may explain why some people vote, but in general it does not make sense for most people to vote. Economists, wise as they are, understand this and so don't vote. QED

But I find fault with this reasoning. It may be true that my vote is insignificant, but I believe in markets. And voting on a candidate, measure, etc. is a way of allowing the 'market' to decide on an idea or set of ideas. The only way for this outcome to be efficient is for there to be mass participation in this market and I understand that, while I may be mostly insignificant, I play an important role in making the market efficient. And I, like most economists, believe in efficiency. So I think economists believe in as much information and participation as possible in an election and thus understand that we all do have a small but significant role to play.

Oh and by the way, voting on blog polls is an entrely different matter - your vote is crucial to the well being of all humanity, so make haste and vote!

Thursday, November 8, 2007

Economist's Notebook: Winner-Take-All Markets

One interesting graph that the OCPP produced regarding income inequality in Oregon that really caught my eye was this:

It caught my eye because of the title. Winner-Take-All (WTA) markets are one economic explanation for some of the income inequality we see in the current economy, especially at the very top. The OCPP uses the term in a negative way, but there is a very interesting economic theory behind the term.

The WTA market theory cannot explain all of the observed inequality, but it does go a long way to explain the increasing rewards to the very top of the income distribution, and it is very interesting. The story goes like this: in a modern economy where performance is easily recorded, duplicated, shared or otherwise increasingly impactful, the rewards to being the very best are dramatically higher than being second best. The recording industry is a good example. Before recorded music, musicians were travelling live performers. Being the best may have brought a few more people to each show, but overall the ability to leverage being the very best was small. With the advent of recorded music that was easily duplicated and distributed, being the very best suddenly meant potentially millions more records sold. Professional sports are another example, with increasing media coverage and distribution of live performances, the difference between the best performers in the MLB, say, versus the minor leagues has become humongous even though the difference in ability of a MLB player may be ever so slight relative to a AAA player. But this is not just an entertainment story. You can tell the similar stories with software programming, journalism, investment banking and even corporate leadership. These are all markets where the rewards at the top are hugely different then the rewards just below the top. In cases like CEO pay the theory says that while the difference between the best production line worker and the second best is a pretty small difference in corporate earnings, the difference between the best and second best CEO can mean tens of millions of dollars in corporate earnings. In software the theory says that the rewards grow as one product becomes the standard through something known as network externalities (think of the domination of Windows in the PC market). Finally, instances where there is reward by contest like in litigation can mean that the top litigators can reap most of the spoils.

So the key to WTA markets is the fact that though human capital differences may be small, the rewards are not. And, by the way, despite the title, there does not have to be a single winner in these markets, MLB players in general, top recording artists, top CEOs are all groups of people rewarded disproportionally to the difference in their skill relative to those just below them.

In the next post I take this theory to a local example in my favorite subject: Beeronomics

Beeronomics: What is John Harris Worth?

This here is John Harris - Brewmaster at Full Sail. John Harris is a master brewer - I mean master brewer. The trail of exceptional and iconic beers he has created, first at McMenamins, then at Deschutes and now at Full Sail is truly extraordinary. There are now many craft breweries in Oregon, most producing wonderful beer, but there are only a handful of truly exceptional beers being produced in Oregon and perhaps half are John Harris' creations. These are not only exceptional beers but also exceptionally popular.

So the question is, what is John Harris worth? I mean this to be provocative, but think: now that the craft beer market is exceptionally crowded what is the potential difference in sales from having an almost great beer versus an exceptional beer? It is quite likely a few orders of magnitude. So if you were starting a new brewery as a purely business venture (I am aware and grateful that most breweries are started from other motivations) the difference between a good brewmaster and a great one can mean millions in sales. Like the post above, craft brewing in Oregon seems increasingly to be a winner-take-all market, where a few exceptional breweries get the majority of the shelf space, taps, and overall market share. Someone with John Harris' talents should make disproportionately more than most other brewmasters according to the theory. I don't think it has happened yet, but I would not be surprised to start seeing this in the future (especially as the macro brewers start to try and battle in the micro segment).