Three Perversities of Indian Law

I came across this fascinating paper (pdf) by Jacob T Levy, a political science professor at McGill University, after reading another excellent piece of his at the Niskanen Center on liberalism and identity politics (which I may go into at another time). Coincidentally, the EconTalk episode this week also dealt with this topic, though with a broader focus.

I’ve long had an interest in the Native American experience, which I suppose comes from being born and raised in South Dakota, where there is a relatively large (~8%) Native American population. (The state correctly replaced Columbus Day with Native American Day in 1990, for whatever it’s worth). Inescapable is the fact that American Indians are overwhelmingly poor; the poverty rate nationwide is higher than any other minority group, some of the poorest counties in the entire country are on the reservations in South Dakota, and my hometown had the highest poverty rate among American Indians of any city with substantial Indian population (over 50% in poverty!).

Being interested in economic development as well, the economics of the reservation system have always seemed quite understudied. The conditions on many reservations are comparable to the poorest of developing nations, despite being within the borders of the richest country on the planet, and yet it’s hard to find much good research on them. It’s easy to find journal articles about theories of economic development in Indonesia or Nigeria or what have you, but despite similar examples right in our own backyard we seem to have comparatively little research.

What I’m trying to say is, the reasons many reservations remain so poor seems criminally understudied, which is why I liked this paper. Even though it is primarily about the law, it lucidly demonstrates how the design of legal institutions can have powerful effects on economic incentives.

Indian law is notoriously complicated, because the Native American tribes exist in some legal superposition both inside and outside the jurisdiction of the United States Federal government. Tribes retain the sovereignty they possessed over their members before being incorporated into the United States, except when that conflicts with their status as “domestic dependant nations” or Federal law. As such, tribes are both foreign nations and wards of the federal government. As a body of law has developed around this curious status, it has led to the three perversities of the title, which are:

  1. Criminal jurisdiction
  2. Civil and regulatory jurisdiction
  3. Economic policy

 

  1. If a non-Indian commits a crime again an Indian on a reservation, jurisdiction lies only with the federal government. Why? The Supreme Court has decided that it would be unconstitutional to subject a citizen to the jurisdiction of a government to which they have not given, nor ever could give, consent. This means that tribal governments do not have complete sovereignty over their territory, only over their members.

 

  1.  This idea has been expanded beyond the criminal sphere, so that tribes don’t have sovereignty over commercial activities either. Beginning with Montana v United States in 1981, the Supreme Court began a rollback that has resulted in a shrinking of the jurisdictional boundaries for tribal governments in virtually every subsequent case. In essence, tribal governments have little to no ability to regulate any sort of activity from non-Indians on tribal lands, from the same logic as above.

 

  1. Finally, tax incentives and regulatory exemptions lead to strong preference for tribally (i.e. government) owned businesses, even over Indian owned private businesses.

 

Together, Levy argues these facts strongly favor, on the margin, less economic activity. Why?

Imagine an outside company is considering building a factory on the reservation lands. The tribal government would certainly consider this would bring in outsiders to the reservation, outsiders the tribe has no criminal jurisdiction over (and the federal government isn’t exactly chomping at the bit to enforce the laws on reservations, particularly in very rural areas). A lack of civil jurisdiction as well means they would have no ability to tax or regulate such activities. In general, then, we would expect they would tend to err on the side of caution and not allow the company to enter.

The terrible irony is that in a situation where economic development were to begin growing apace, the tribal government would be faced with the prospect of shrinking jurisdiction over the activity on its territory.  Additionally, there is considerable historical precedent for the shrinking of reservation boundaries once enough non-Indians had taken up residence. (Yes, the Federal government has essentially decided in instances that since so many non-Indians were living on particular land, it should no longer be considered as part of Indian territory.) On the margin, most governments don’t want to shrink their authority, and will avoid courses of action that would lead to such a situation. As Levy summarizes, “Tribes’ institutional incentives to discourage newcomers amounts to a disincentive for economic growth.” (p. 31)

Regarding the perversity of economic incentives, “The domination of reservation economies by firms owned by tribes has been occasionally remarked upon, but typically in connection with the ostensibly socialistic cultural inheritance of the tribes. I am agnostic as to the importance of that inheritance, but mean to point out that, regardless of cultural explanations, tribes have been left with strong legal and policy incentives to engage in government-led and government-owned development.” (p.41) These incentives include: tribally owned enterprises are exempt from federal corporate taxation (while private enterprises are not); non-Indians are exempt from tribal taxation; tribally owned enterprises have the potential for sovereign immunity.

It should not be shocking that government run enterprises tend to be less efficient than privately owned ones, particularly when there is no other economic activity as competition. Furthermore, the casino based economy that has come to dominate many tribal areas is not altogether different from finding oil or diamonds: a single, lucrative resource in a small area. As such, the ‘resource curse’ present in many developing countries is likely also a contributing factor to poor governance and more robust economic activity.

To conclude (and Levy puts it better than I ever could), “If the rule of law, private sector-led and broad-based economic development, and effective democratic institutions are worthwhile goals for reservations, they ought not to be set in conflict with one another.” (p.48) While Levy does not intend his argument to be a complete explanation of the generally poor conditions on reservations, it certainly serves as a useful point of inquiry for more serious research.

Why Do Cities Matter? Local Growth and Aggregate Growth

This is a working paper by Chang-Tai Hsieh and Enrico Moretti that examines how growth in cities relates to the growth of the nation writ large. The upshot is that, according to their model, if workers were allowed to move more freely to high productivity cities, such as New York and San Francisco, the US could have a substantially higher level of GDP. Let’s walk through the argument.

To start, we can safely assume that there is variation in the productivity of individuals, which is to say we have differing marginal products of labor (MPL). But this productivity does not exist in a vacuum; ultimately a worker’s output also depends on the environment into which they are inputting labor. A mathematics PhD may have a very high potential MPL, but if they are inputting that human capital into a retail cashier production function, there won’t be much difference in output from someone with only a high school diploma.

The second part is that there is geographic, or spatial, variation in productivity as well. It’s well documented that high density urban areas have far higher productivity than rural areas. Now, this could be due to sorting: high productivity workers tend to move to cities so of course cities have higher average productivity. But there is research that suggests density itself leads to higher productivity, as explained in this paper, through phenomenon like knowledge spillovers.

So we have variation in productivity across individuals and across space. In equilibrium, we would see workers distributed spatially such that the marginal product of labor would be equal across the country. Now of course we will never actually reach equilibrium because the economy is made of so many moving parts, but this gives us a frame of reference to look at data and see what direction things are moving in. If the US were moving closer to equilibrium, we would expect to generally see convergence in the spatial distribution of wages; recall that it is assumed that wages and the MPL are linked.

What the authors find is the opposite, however: after controlling for factors like worker characteristics, the geographic variation in wages across cities in the US has increased since 1964. This suggests that differences in worker productivity across cities are growing.

The natural follow up question is, why? Land use regulations seem to be the culprit. Over the past several decades, there has been a huge increase in demand for finance and tech skills, which are concentrated in New York City and the Silicon Valley areas. In other words, these local labor markets have undergone a large positive shift in demand. However, stringent land use regulations have made the labor supply curve in these areas highly inelastic, meaning the demand has primarily resulted in an increase in wages instead of employment.

The key here is to realize that the consequences of this are lot merely local; this affects the country as a whole. There are workers with high potential MPLs that are prevented from fully realizing them, and are stuck in lower productivity jobs in lower productivity areas simply due to the fact they cannot physically move to the region that would best use their talents. This means that the US has a lower level of output, and social welfare, than in the counterfactual reality where housing policy was more flexible.

I’m increasingly convinced that these stringent land use regulations and related NIMBYism are responsible for much of the economic pain of the past few decades. Mobility in the US has declined significantly since the 1980s, and the increased social sorting such policies encourage has only exacerbated racial and class differences, leading to a horrible generational feedback cycle and overall loss of opportunity.

Moving the locus of land use policy away from the local level is low hanging fruit with huge potential upside, and yet the national conversation on economic growth pays essentially zero attention to this. This needs to change.

 

 

Firming Up Inequality

Another day, another NBER paper. ‘Firming Up Inequality’, by Jae Song et al., is about a year old, but the latest version is from this summer (pdf). This paper uses a comprehensive matched employer-employee data set to investigate just how changes in inequality have played out between and within firms.

The fact of dramatic increases in wage inequality in the US is well documented, but there is considerable disagreement on its root causes. As we’ve seen argued in books like The Wealth of Humans, skills biased technical change is one hypothesis, which boils down to changes in markets rewarding a particular subset of workers. Another hypothesis is that changes in inequality are mostly due to the powerful members of society extracting economic rents.  A common example of this is the relative rise in American CEO pay vs other developed countries. If this rent seeking hypothesis were true, we would expect to see increasing inequality within firms, as CEOs and other top managers captured greater shares of firms’ profits.

What they find is that the majority of the increase in income inequality is actually explained as a between-firm phenomenon, not a within-firm phenomenon. Furthermore, this finding holds across industry sectors, region, demographics, firm size (with one exception; see below), etc. It’s not the case that there has been any sort of differential growth leading to this.

Finally, they find that there has been one type of firm that has seen increases in within-firm inequality: the ‘mega-firm’, i.e. a firm with more than 10,000 employees. In the US there are around 800 mega-firms that employ about 20% of the workforce, and these have seen both decreases in the lower end and increases in the higher end of the income distribution. In the authors’ estimates, the median worker in such firms saw earnings fall around 7% from 1981 to 2013; in contrast, the top 10% saw increases averaging around 11%. And the managers at the very top in these firms have realized real earnings increases of 137%.

So what’s going on here? Most firms are becoming more equal internally, yet firms as a whole are becoming less equal.  And at the same time, the very largest firms are seeing the opposite pattern.

Song et al. propose two potential explanations for the increased in interfirm inequality: a ‘widening firm premium’ story, or a ‘worker segregation’ story. In the former, firm inequality is driven by the fact that some firms are winners and others losers in the economy; winners may end up distributing their increased gains to their employees, while losers cannot. In the latter story, workers are increasingly being sorted into firms by ability; high-ability and low ability workers are clustering into separate firms, rather than mixing together.

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Recessions and Skill Biased Technical Change

A very fascinating and topical NBER paper (ungated pdf here) recently came out which investigates the connection between skill biased technical change (or routine-biased technological change, as these authors prefer to call it), which has been a major theme in the posts on The Wealth of Humans, and recessions.

One curious fact about the last several recessions is that their recoveries have been largely jobless. If we eyeball the growth in employment over the last several decades, it’s obvious we never returned to trend even after the 2001 recession.

employment

Furthermore, unemployment continued to rise even after the technical end of the post-1990 recessions.

fredgraph

The reasons for this have not been well understood, but the authors take an adjustment cost theoretical framework as a starting point.

We can imagine that as technology makes certain jobs less relevant while creating others, there are costs to employers in making the appropriate adjustments. Recessions can provide the necessary ‘oomph’ to reallocate labor and capital that wouldn’t happen in normal times. In this understanding, labor market adjustment to RBTC occurs episodically, not gradually.

I’m sure it’s not hard to visualize that person at the office who isn’t really necessary anymore since that new software can do 70% of their work, but is still around since the boss is a human being and can’t find a compelling reason to fire them. In these models, economic downturns provide the excuse to clear out inefficiencies that have built up over time.

While this makes intuitive sense, the question is whether there is data to back it up. Other authors have found that the vast majority of declines in middle skill employment have occurred during recessions, and subsequent recoveries have been jobless in precisely these occupations.

Still, these studies have lacked direct evidence on how firms were restructuring. That’s where this paper comes in: they’ve obtained a data set that contains huge amounts of online job postings in major metropolitan areas for the years 2007 and 2010-15.

They find first that employers in metropolitan statistical areas (MSAs) that were hit harder by the Great Recession had an increase in skill requirements in jobs ads relative to both those same areas before and MSAs less affected by the shock. Now, there are two possible causes of this: one could be that employers simply increased the asking skill levels for all jobs, or happened to be posting mostly high skill levels jobs and less low skill jobs. The authors find the former explains most of this ‘upskilling’: in a weak labor market, employers were able to demand higher skill levels for the same jobs relative to a few years prior or to MSAs with better economic conditions.

This leads to the next question: are these firms actually changing what they do, or are they merely changing the type of people they hire? The former implies Shumpeterian idea of a recession as a cleansing activity (and consistent with the adjustment cost explanation above), whereas the latter is more like taking opportunity of a slack labor market to get the type of people you wouldn’t normally be able to. The latter is temporary; the former, permanent.

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