Right in the Short Run

Reading Robert Frank’s reply to Greg Mankiw’s post, I came across a really interesting passage. I’ve always wondered how we could say that a nation “prefers” to supply labor in some way or another when the options individuals face on the labor market are so dependent on the simultaneous (and competitive) actions of others. It turns out that there’s an economic concept addressing this very issue, called “context externalities”.

For present purposes, by far the most important externalities are those stemming from the link between context and evaluation. As decades of behavioral evidence clearly demonstrates, virtually every evaluation is heavily shaped by local context. As Richard Layard put it, “In a poor society a man proves to his wife that he loves her by giving her a rose, but in a rich society he must give a dozen roses.” Because evaluation drives consumer choice, context is an important determinant of consumer demand. The upshot is that almost every consumer choice generates significant context externalities.
Consider, for example, a job applicant’s decision about how much to spend on an interview suit. His goal is to make a favorable impression. But his ability to do so depends far less on the absolute quality of his suit than on how it compares with those worn by other applicants. And when he spends more on a suit, he shifts the context within which other candidates will be evaluated.

Context externalities are pervasive. A good school, for instance, is one that compares favorably with other schools in the same local environment. The amount parents must spend to ensure that their children attend such a school is thus an increasing function of the amounts spent by other parents. The evaluations that guide an employer’s promotion decisions are similarly dependent on context. A worker’s odds of promotion depend less on his absolute performance than on how well he performs relative to his coworkers.

The dependence of evaluation on context lays waste to any presumption that individual decisions about how many hours to work or how much to spend on interview suits will be socially optimal. The general result predicted by theory is that if context shapes evaluation more heavily in some domains than others, too many resources will flow to the most context-sensitive domains and too few to the least context-sensitive domains. In my forthcoming book, Falling Behind, I summarize what available evidence says about the extent to which context differs across domains. For the discussion at hand, the relevant finding is that evaluations of leisure tend to be far less context-sensitive than evaluations of income. The implication is that individual valuations of leisure tend to understate social valuations. Thus people work longer hours in the hope of moving higher on the income ladder, only to discover that when others do likewise, their position remains unchanged.

Just wow!

Greg Mankiw and Robert Frank are going back and forth about one of Frank’s recent columns, in which he claimed that reducing marginal tax rates on the rich wouldn’t increase their work effort. I was reading through a review of the debate at Economist’s View and came across this statement by Greg Mankiw:

Bob is perfectly free to believe whatever he likes and to advocate increasing the top marginal tax rate. But to suggest that there is neither theory nor evidence to support the beneficial effects of lower marginal tax rates on high-income taxpayers indicates a lack of appreciation of the academic literature in public finance.

I will agree with Professor Mankiw here — lower marginal tax rates are definitely beneficial for high-income taxpayers!

Most people who live in New York love the fact that subways run 24/7. Although it might take a long time, it is possible to get to every single subway stop in New York city at any time of day, any day of the year.

It always seemed to me that the big winners from this service were the poor. Certainly anyone who would like to work flexible shifts without owning a car — and it seems reasonable to me that many people in this boat are relatively poor — benefits greatly. Without late night subway service, a lucrative overtime shift could entail a cab ride back home, which could easily eat up most of the benefit of the shift itself.

Looking at it from another direction, 24/7 subway service means that it is feasible to work strange shifts without owning a car. Everyone benefits from that, but the poorest, for whom the car purchase means the most sacrifice, benefit the most.

Lastly, the guarantee of being able to pay $2 for a ride means that people can work strange hours far from home. It is not hard to imagine that the poor stand to gain from having a wider array of jobs open to them, particularly if the neighborhoods they live in are less hospitable at night or tend to offer lower wages.

Things to read up on:

1. Relative utility functions. Let’s go find the literature on u_1(x_1) = f_1(x_1,x_-1) where x_-1 = vector of others’ wealth or consumption vectors.

2. Addiction literature. Under what conditions does it make sense to describe drug consumption in the expected utility framework?

3. Causal inference tools employed in labor economics. See this text by Angrist (MIT) and Krueger (Princeton).

Last Thursday, New York City held its ceremonial groundbreaking for the Second Avenue subway line. The line was first proposed as part of the IND Second System, an ambitious plan by New York City to increase the coverage of its subway lines. Only problem is, the Second System was proposed in 1929.

Yes, it’s a subway line 80 years in the making. The Second System went the way of the dinosaur within a few years (the Great Depression didn’t leave much money for new subway lines) but the Second Avenue Subway was never quite taken off the table. Interest in it picked up during the 1970s, and construction work began in 1972 in East Harlem. However, by 1975 the city was bankrupt and construction was halted.

Is it for real this time? Will we finally get a subway to serve one of the worst-connected parts of Manhattan?

Sort of.

It seems pretty clear that the first section of the line, running from the existing 63rd street Q station to 96th Street and Second Avenue, will get built. Unfortunately nearly a quarter of the funds needed are still unallocated. It seems like once construction gets going, it will be difficult to call it off, so I imagine that the city will manage to come up with the missing $800 million.

The second stage runs from 96th street to 125th Street. The troublesome thing is, no money has been set aside for it. On the other hand, something like 16 blocks along this route were already tunneled in the early 1970s. This stage is effectively very low hanging fruit, so I have some hope that it will be built.

Stages 3 and 4, which stretch south of 63rd street, seem quite unlikely. They will be expensive and less important than stages 1 and 2, and no money has been set aside for them.

The more interesting question to me is, why is it so difficult to build a new subway line these days? Before World War II, it seems like miles were added to the system every year. In a series of upcoming posts, I’m going to talk about what changed, and how it’s influencing the construction of the Second Avenue Subway today.

Roland Fryer strikes again, this time with Michael Greenstone. The paper entitled “The Causes and Consequences of Attending Historically Black Colleges and Universities” as the following abstract:

Until the 1960s, Historically Black Colleges and Universities (HBCUs) were practically the only institutions of higher learning open to Blacks in the US. Using nationally representative data files from 1970s and 1990s college attendees, we find that in the 1970s HBCU matriculation was associated with higher wages and an increased probability of graduation, relative to attending a Traditionally White Institution (TWI). By the 1990s, however, there is a wage penalty, resulting in a 20% decline in the relative wages of HBCU graduates between the two decades. We also analyze the College and Beyond’s 1976 and 1989 samples of matriculates which allows us to focus on two of the most elite HBCUs. Between the 1970s and 1990s, HBCU students report statistically significant declines in the proportion that would choose the same college again, preparation for getting along with other racial groups, and development of leadership skills, relative to black students in TWIs. On the positive side, HBCU attendees became relatively more likely to be engaged in social, political, and philanthropic activities. The data provide modest support for the possibility that HBCUs’ relative decline in wages is partially due to improvements in TWIs’ effectiveness at educating blacks. The data contradict a number of other intuitive explanations, including relative decline in pre-college credentials (e.g., SAT scores) of students attending HBCUs and expenditures per student at HBCUs.

A fun read.

Algebraic statistics: A short course by Seth Sullivant over at the Harvard Society of Fellows. Any potential in econometrics?

Can someone give me a slightly sane justification for making Voice over IP (VoIP) illegal? This story out of Bangladesh is very interesting:

VOIP has remained illegal in Bangladesh in an attempt by the government to protect the state-owned telephone company, the Bangladesh Telegraph and Telephone Board.

But it simply hasn’t worked. Earlier this year it was estimated that VOIP calls accounted for up to 80% of the total telephone traffic from abroad.

According to the BBC, “the country’s new military-backed government has been waging war on what it sees as the too-long tolerated illegality and corruption of the past.” How about instead of forcing everyone to use the state-owned telephone provider, Bangladesh just makes VoIP legal and forces providers to pay their share of taxes?

To most economists, the answer to the question posed in this post’s title is simple: no.

That’s because economists view jobs as a quantity that is set in the labor market. For a given job, the number of people doing that job will be determined by the supply of labor and the demand of labor. Labor supply is how much labor everyone in the economy is willing to do at all the different wages imaginable, and labor demand is how much work employers in the economy want done for them at all the different wages imaginable.

At some wage rate, the number of people willing to work equals the amount of work employers want to supply. That’s called equilibrium, and the number of people willing to work at this wage will determine the number of jobs in the market.

When someone says that immigrants are doing jobs that Americans just won’t do, they are claiming that American labor supply for a given job is always zero. No matter the wage, no American is willing to get off his behind and do the work. I find it hard to believe that this could be the case for any kind of work, even if the task is extremely dangerous.

A slightly more interesting question is “Are there jobs Americans won’t do at certain wages?” Well the answer to this question is probably yes! Not too many Americans would mine coal for $4 an hour. On the other hand, some immigrants may well be willing to do the job at wages lower than any American’s. At low wages, there are plenty of jobs that immigrants will do that Americans won’t.

Just something to keep in mind when someone trots out the argument that immigration allows us to get jobs done that no domestic resident would be willing to do. Certainly there may be other benefits to immigration, but this is not one of them.

(See also Andrew Samwick)

Of course not, I just wanted to get your attention. In a recent N.Y. Times article, Krugman argues that

Outsourcing of the government’s responsibilities - not to panels of supposed wise men, but to private companies with the right connections - has been one of the hallmarks of his administration. And privatization through outsourcing is one reason the administration has failed on so many fronts.

Krugman then proceeds to give a list of failed government outsourcing programs, most of which are related to defense.

Krugman suggests a reason for the failures of these privatization efforts

In fact, the private company will almost surely do a worse job if its political connections insulate it from accountability - which has, of course, consistently been the case under Mr. Bush.

Mr. Krugman, you are clearly at least partially correct. Yet clearly there are situations where government outsourcing is in fact effective. For instance, the Trump Ice Skating Rink in Central Park - New York City wasted millions of dollars attempting to construct the rink, over a total of six years. Donald Trump then took over the job, finishing it ahead of time, and for less than a million dollars.

So when outsource?

Although there are probably many relevant factors to consider, an important one is clearly specialization. In areas such as defense, where the government has long specialized, outsourcing may indeed be an unwise move. Yet in areas such as entertainment, clearly the government is outmatched by private industry.

Another important factor is (as the ever perceptive Krugman mentioned) accountability.

So I have a question: What about airline security? As things stand, it’s true that the government has more experience in many security related matters. But what about securing an airport filled with constant civilian activity?