Behavioral Bounds, Society, and the Economy

I’m currently reading The Great Upheaval, a history of the last decade of the 19th century in America, France, and Russia. The author, Jay Winik, has a writing style that does a really good job of conveying the the way events at the time must have felt to the participants. I’m generally skeptical of histories that focus too much on individuals at the expense of the wider social and economic context in explaining historical events, but I think there is real value in getting an emotional understanding of the past as long as it’s tempered with that big picture understanding.

[For example, the history of American conservatism series written by Rick Perlstein does a similarly excellent job of taking us inside the minds of of historical actors like Barry Goldwater and Richard Nixon, making the history more intelligible, but also risks leaving the reader with the impression that history is primarily driven by the psychology of individuals rather than broader forces.]

Now, one thing you notice when you read these personality based histories is that there are a lot of important people that we today would consider mentally ill in some way.

Take Grigory Potemkin, consort of Catherine the Great:

He cared little for social decorum: Famed throughout Europe for his palaces, his jewels, his parties, and his women, he wandered around the empress’s apartments naked under an open bareskin dressing gown, baring his hairy chest and munching on apples and raw vegetables, usually turnips or radishes, or obsessively chewing his nails…More often than not, he might look as though he had just woken up, or had been sleeping off a hangover, only suddenly then to burst into fits of manic activity…

From the moment he awoke, his every day was unpredictable. While still in bed, he received visitors in his dressing gown, then roused himself for a cool bath and a short morning prayer. But after that, his moods swung from unrestrained highs…to crippling lows… When he was depressed, he retreated into a near paralytic silence. He refused to sign papers, machinations of the state would grind to a halt, and a significant part of the Russian government would simply stop. Sometimes he sat along, like a catatonic Gulliver, soothing himself with music and pouring emeralds and rubies from hand to hand.

Such behavior would seem to be today called bipolar, yet Potemkin was one of the most powerful people in Russia at the time. Could we imagine such an individual in the same position today? I think not; if nothing else, the continuous scrutiny public figures face these days means he wouldn’t last long (although Donald Trump may be a strong counter example).

The particular example here isn’t so important though; what I want to explore is the proposition that the increased formalization of the economy leaves behind many people who are wired a little bit differently.

Continue reading “Behavioral Bounds, Society, and the Economy”

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Tourist Economics

I recently spent the weekend in a classic mid-Atlantic beach town, Ocean City, Maryland. While there, I couldn’t help but put on my economist hat, as there were some things about the town that stood out to me.

First of all, the geography of the area means the town is set up like the classical economic thought experiment of a linear market: there’s basically one long road with all the businesses, and water just a couple blocks away on either side. The entire stretch is a mix of hotels & condos, restaurants, beach accessory stores, and grocery/liquor stores, with the occasional pharmacy. There was very little geographic differentiation, i.e. restaurants weren’t mostly clustered in one area.

What was striking to me was the near total absence of popular chain restaurants. In the city itself, I didn’t see any Starbucks, Chipotle, McDonalds, Panera, etc., which seemed very strange. In any other similarly populated area you’d find quite a few; and indeed, just outside the city there were several such establishments in outlet malls. So what could explain this? I have some potential explanations:

  • Consumer preference: Tourists prefer different types of restaurants when they are on vacation; they’d rather not go to the same places they go at home. Usually, the appeal of chain restaurants is that they are the same wherever you go, so you know what to expect. Being on vacation may flip that preference sufficiently that there isn’t enough demand for many such establishments.

 

  • Regulation: The local government has provisions that make it difficult for large chains to get established. You see this often enough in municipalities. Several years ago, when Wal Mart was first looking to expand into DC, the city council tried to pass a law that, while not naming Wal Mart, was obviously targeted at them. The already established players in the town have a strong incentive to prevent new competition, and it’s pretty easy to get this kind of stuff passed in small towns. The fact that just outside of the city limits you find plenty of Paneras and Dunkin Donuts, etc., suggests this might be a big factor, though it could be there’s more stable demand further inland.

 

  • Seasonal Demand: According to Wikipedia the actual residential population of Ocean City is around 7,000 people, but during the summer months the number of people swells to the hundreds of thousands. As such, the vast majority of businesses are probably shuttered during the off season. It could be that large chains just don’t do seasonal hiring very well; often hiring in such companies is an arduous process. I know from experience with a large retail chain that it often takes weeks to onboard just a cashier. I noticed that at most restaurants the staff working were from Russia/Eastern Europe, which reminded me that I often saw that at the tourist attractions in my home state of South Dakota. So in addition to short time hiring, the fact that most labor has to be imported from abroad through visas to meet demand might be a step too far for most large chains. Another related explanation could be that large chains don’t break even unless they’re open longer than seasonally. But if anything, I’d think the opposite would be true, since smaller businesses don’t have the economies of scale to reduce costs.

 

  • Search Costs: Search costs are relatively high when your hotel is across the street from the primary attraction, The Beach. There’s a high opportunity cost of time; every second you’re out looking for food is a second that you’re not on the sand. This would explain why there’s a pretty even mix of types of establishments all along the main corridor. Yeah, you could go searching for the best burrito place in town, but the pizza+burger place next to the hotel is probably good enough. This could lead to a situation where already established, mediocre independent restaurants are able to survive and hold onto their turf, but doesn’t explain why a Chipotle or whoever couldn’t eventually get in on the action as well.

 

Any explanation has to account for the fact that there are some chain restaurants present, but they’re mostly smaller regional chains, like Ledo Pizza or Grotto Pizza. I probably lean towards the regulation and seasonal demand explanations, but would love to know if there’s a literature on this.

How Much Can Economists Know?

There’s been a good back and forth on the econ blogosphere lately regarding the epistemology of economics. The public perception of economists is not the greatest for a variety of reasons: we (mostly) didn’t see the financial crisis coming (despite the old saw that economists have predicted 9 out of the last 5 recessions); we underestimated the size of the ensuing recession; and whatever the policy, you can almost always find economists on both sides of the issue (in other words, there seems to be little shared agreement).

To an extent, this is unfair, and largely biased due to the outsize popular fascination with macroeconomics, which is still a very new science with little data and an inability to run experiments. Still, macroeconomics is more popular for a reason: the macroeconomy is central to our livelihoods. If the country enters recession, we may not have a job any longer. I doubt there are many people who would not be interested in making the field more scientific. But can economics ever really be a science?

This type of dialogue is what makes the economics blogosphere so interesting to follow. While I won’t say *all* are required reading, I would definitely recommend the initial Roberts piece and Noah Smith’s Bloomberg column at the bare minimum.

 

Democracy for Realists, Part IV

Why do we vote the way we do? So far, the authors of Democracy for Realists have shown that neither the individualist framework of the folk theory nor the managerial retrospective theory can explain historical election outcomes. What is it then? Do we vote randomly, or is there a different motivating force we have neglected?

The authors argue we need to look back to the once popular realist political tradition, which was largely discarded in favor of rationalist Enlightenment liberalism. In particular, we need a group theory of politics that accounts for “the powerful tendency of people to form groups, the ensuing construction of ‘us’ and ‘them’, and the powerful role of emotion rather than reason in directing group activity.” (p. 215)

In their view, a model of elections as being motivated by group forces will have far more explanatory power than those previously considered. Some key factors to note:

  • We are socialized into groups through family and culture; our sense of identity “serves to distinguish groups to which [we] belong that are not central to [our] self-concept from those that are a more integral part of the personality” (p. 228)
  • “Identities … are emotional attachments that transcend thinking” (p. 228), and this extends to membership in political parties. We identify with a party from an emotional level, not as the party that we agree with most on arts funding or foreign aid spending.
  • People take their views from the groups to which they belong. As such, we get our ideas on policy and ideology from political parties, not the other way around (as in the folk theory).
  • Most people “organize political thinking around social groups and their role in competing political parties. They see political and racial clashes as group conflict” (p. 221) In other words, a political fight about the marginal tax rate is not really about the appropriate level of taxation for a society; it is about Democrats versus Republicans, nothing more.

In this understanding, elections are about activating and mobilizing different parts of our identities. We all have many parts of our identity; we claim membership in many different groups simultaneously. We obtain aspects of our identity from parents, peers, regional culture, national culture, education, religion, employment, and so on.

Continue reading “Democracy for Realists, Part IV”

The Real Outsourcing Problem

An article in the New York Times the other day highlights an issue I have written about before, that of the changing nature of firms as a source of continued low wages and increasing inequality between workers.

In the eyes of the current administration, a major problem for American workers has been outsourcing. What this article points out is that most outsourced jobs actually remain here in the US; they are instead of leaving to low wage countries, they are subcontracted out to specialized low wage firms within the country.

 

As research has shown, the increase in inequality in the US is being driven mostly by interfirm inequality, not intrafirm. The latter would be appear as, within any given company, the CEOs at the top getting big raises and the entry level workers getting pay cuts. And while this is the case at the biggest firms, like large retail companies, it isn’t so for the rest of the economy. For most firms, pay structures have actually become more equal.

This change is largely a result of firms reorganizing their structure. It used to be that an organization, say a newspaper, would employ everyone who worked in their building. Yes, of course the journalists and editors and managers; but also the janitors, the electricians, the tech support, etc. This is rarely the case any longer. Instead, firms are increasingly organized around their core mission, and secondary and support tasks are spun off and subcontracted out. So now the janitor works for a separate company, as do the electricians and computer people. Even secretaries and HR are increasingly subcontracted out.

How does this drive inequality? When that janitor worked for the newspaper, he shared in the firm’s successes, and  probably out of a human sense of fairness it’s difficult to have huge differences in pay  between people who are working together daily. But when those roles are contracted out to outside firms, that is no longer the case. The janitorial subcontractor can pay far less, and isn’t subject to the workplace regulations of the newspaper firm. This isn’t trivial: the article cites research showing significant pay cuts for many roles (up to a 24% reduction for security guards, for example). Additionally, these subcontracted jobs are often temporary and lack health insurance or other benefits.

The article points to the shocking statistic that over the last decade, 94% of the jobs added to the economy were in this temporary/contracted sector. While this trend may be more ‘efficient’, in the strictly economic sense, an economy does not make a society. Many conservatives talk about the dignity of work as a positive good for people, and I’m inclined to agree. But as our economy shifts to this model, it would seem to be very hard to find dignity and purpose in a growing low wage, dead end, high uncertainty sector of the economy. Sure, if you were a janitor at the New York Times, it wasn’t particularly glamorous. But you were connected in some way to the mission of that organization. Nowadays, you’re just a janitor; probably working on demand, hours not guaranteed, maybe in a different building every week. Your work is now cleaning, nothing more.

Of course, there is no easy solution to this problem. Banning such subcontracting would be lunacy, and other types of mandates would be too heavy handed. But if the administration wants to be serious about American jobs, this is an area that demands focus, not trivial sectors of the economy like coal mining or immigrant labor.

Wages and Productivity

One of the major assumptions of many economic models is that workers’ pay and productivity are linked: wages are determined by the marginal product of labor. On the other hand, some economists have pointed out a growing divergence between wages and productivity in the US economy, which suggests the link is not so close. This chart is a common example:

divergence

Who’s right? Well, this very topic is the subject of one section of a new AEI book, simply titled ‘The US Labor Market: Questions and Challenges for Public Policy’ (free pdf available). The contributor list is a veritable who’s who of economists whose analyses I find invaluable, and it looks to hit on many themes I’m interested in, so I’m excited to dig into this. But for today I’ll stick with wages and productivity.

One the side of divergence is Dean Baker of the Center for Economic and Policy Research. He argues that the top and bottom of the income distribution exhibit a disconnect between wages and productivity. He starts with the example of CEO pay, which as I noted in my post on inequality in firms, has pulled away from the rest of workers in very large firms. If pay were linked to productivity, this would indicate American CEOs have become an order of magnitude more productive than they were decades ago (as well as more productive than similar CEOs in other rich countries). What this suggests is really going on is that due to poor corporate governance structures, CEOs are commanding wages far out of line with what they would earn in a truly competitive marketplace.

Next Baker turns to the minimum wage, and basically argues that a combination of a wage floor and firms’ desire to have a differentiated wage structure means there is another disconnect between wages and productivity. If the minimum wage increases, there is an incentive to raise other workers’ pay as well to maintain distinctions based on seniority, skills, etc. He also argues this means that these workers are being paid less than their productivity already, using a monopsony model as a base. There’s a decent explanation here, but basically a monopsony is the opposite of a monopoly; i.e. one buyer and many sellers, so the buyer (employer) has power over pricing (wages), and in these models wages are well below what they would be in a competitive marketplace.

I don’t find this particular part of the argument so convincing based on my experience in a city that has raised the minimum wage. Over the last few years, the DC minimum wage has gone from $8.75/hr prior to 2014 to $11.50/hr as of July this year, and will reach $15/hr by 2020. In that time, at the (large) retail company I work for, there have been no raises beyond regular cost of living for workers between cashiers and salaried managers. So now workers employees with decades of experience are at the same level as fresh cashiers, and the wage difference between a supervisor (who is typically hired around $12/hr) and a regular cashier has basically disappeared. It still suggests there is disconnect between wages and productivity, just not the way he envisions it.

Moving on, Robert Lawrence of Harvard argues that looking at charts such as the one above is misleading because the deflators used in measuring compensation and output across time are used improperly. The real compensation series uses the CPI deflator, while the real output series uses an implicit price index for GDP. The CPI has some problems; many believe it overstates the real cost of living, and Lawrence argues that in this context an output price index should be used to deflate compensation. Why? Because using a consumption index includes factors that domestic workers do not produce, such as imports and housing. As such, a ‘product wage’ should be used, and doing so accounts for a significant chunk of the observed gap. Using his estimates of productivity, he find that productivity and compensation track each other closely until about 2001, and it’s not until the Great Recession and its aftermath that a real divergence opens up, though not a massive one.

Something that’s often implicit in arguments in this space is that productivity/pay divergence is the main source of inequality. I think the reason for this is that it implies an easy solution: if we can just control the greed of the top 1% and make companies pay workers more, then everything will be ok. If it turns out that people really are broadly being paid their ‘fair’ share, then solving the problem of inequality becomes much harder (as we’ve seen described in The Wealth of Humans).

Where do I come down on this? While I do think there’s something ‘unfair’ going on with things like CEO compensation, I also just don’t see that playing out at the scale required to explain the levels of inequality in the US. And so we’re left to grapple with far more difficult questions.

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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