Why is housing so expensive?

Apr 30, JDN 2457874

It’s not your imagination: Housing is a lot more expensive than it used to be. Inflation adjusted into 2000 dollars, the median price of a house has risen from $30,600 in 1940 to $119,600 today. Adjusted to today’s dollars, that’s an increase from $44,000 to $173,000.

Things are particularly bad here in California, where the median price of a new home is $517,000—and especially in the Bay Area, where the median price is $838,000. Just two years ago, people were already freaking out that the median home price in the Bay Area had hit $661,000—and now it has risen 27% since then.

The rent is too damn high, but lately rent has actually not been rising as fast as housing prices. It may be that they’ve just gotten as high as they can get; in New York City rent is stable, and in San Francisco it’s actually declining—but in both cases it’s over $4,000 per month for a 2-bedroom apartment. The US still has the highest rent-to-price ratio in the world; at 11.2%, you should be able to buy a house on a 15-year mortgage for what we currently pay in rent near city centers.

But this is not a uniquely American problem.

It’s a problem in Canada: Housing in the Toronto area recently skyrocketed in price, with the mean price of a detached home now over $974,000 CAD, about $722,000 USD.

It’s a problem in the UK: The average price of a home in the UK is now over 214,000 pounds, or $274,000 (the pound is pretty weak after Brexit). In London in particular, the average home now costs nine years of the average wage.

It’s even a problem in China: An average 1000-square-foot apartment (that’s not very big!) in Shanghai now sells for 5 million yuan, which is about $725,000.

Worldwide, the US actually has a relatively low housing price to income ratio, because our incomes are so high. Venezuela’s economy is in such a terrible state that it is literally impossible for the average person to buy the average home, but in countries as diverse as France, Taiwan, and Peru, the average home still costs more than 10 years of the average household income.

Why is this happening? Why is housing so expensive, and getting worse all the time?

There are a lot of reasons that have been proposed.

The most obvious and fundamental reason is basic supply and demand. Demand for housing in major cities is rapidly rising, and supply of housing just isn’t keeping up.

Indeed, in California, the rate of new housing construction has fallen in recent years, even as we’ve had rapid population growth and skyrocketing housing prices. This is probably the number one reason why our housing here is so expensive.

But that raises its own questions: why aren’t more houses getting built? The market is supposed to correct for this sort of thing. Higher prices incentivize more construction, so prices get brought back down.

I think with housing in particular, we have a fundamental problem with that mechanism, and it is this: The people who make the policy don’t want the prices to come down.

No, I’m not talking about mayors and city councils, though they do like their property tax revenue. I’m talking about homeowners. People who go to homeowners’ association meetings and complain that someone else’s lopsided deck or un-weeded garden is “lowering property values”. People who join NIMBY political campaigns to stop new development, prevent the construction of taller buildings, or even stop the installation of new electrical substations. People who already got theirs and don’t care about anyone else.

Homeowners have an enormous influence in local politics, and it is by local politics that most of these decisions about zoning and development are made. They make all kinds of excuses about “preserving the community” and “the feel of the city”, but when you get right down to it, these people care more about preserving their own home equity than they do about making other people homeless.

In some cases, people may be so fundamentally confused that they think new development actually somehow causes higher housing prices, and so they try to fight development in a vain effort to stop rising housing prices and only end up making things worse. It’s also very common for people to support rent control policies in an effort to keep housing affordable—and economists of all political stripes are in almost total consensus that rent control only serves to restrict supply, increase inequality, and make housing prices even worse. As one might expect, the stricter the rent control, the worse this effect is. Some mild forms of rent control might be justifiable in particularly monopolistic markets, but in general it’s not a good long-term solution. Rent control forces rationing, and often the rationing is not in favor of who needs it the most but who is the most well-connected. The people who benefit most from rent control are usually of higher income than the average for the city.

On the other hand, removing rent control can cause a spike in prices, and make things worse in the short run, before there is time for new construction to increase the supply of housing. Also, many economists assume in their models that tenants who get forced out by the higher rents would get compensated for it, which is not at all how the real world works. It’s also unclear exactly how large the effect sizes are, because the empirical studies get quite mixed results. Still, rent control is a bad idea. Don’t take it from me, take it from Paul Krugman.

It’s also common to blame foreign investors—because humans are tribal, and blaming foreigners is always popular—even though that makes no economic sense. Investors are buying your houses because the prices keep rising. It’s possible that there could be some sort of speculative bubble, but that’s actually harder to sustain in housing than it is in most other assets, precisely because houses are immobile and expensive. Speculative bubbles in gold happen all the time (indeed, perhaps literally all the time, as the price of gold has never fallen to its real fundamental value in all of human history), but gold is a tradeable, transportable, fungible commodity that can be bought in arbitrarily small quantities. (Because it’s an element, you’re literally only limited to the atomic level!)

Moreover, it isn’t just supply and demand at work here. Fluctuations in economic growth have strong effects on housing prices—and vice-versa. There are monetary policy effects, particularly in a liquidity trap; lower interest rates combined with low inflation create a perfect storm for higher housing prices.

Overall economic inequality is a major contributor to steep housing prices, as well as the segregation of housing across racial and economic lines. And as the rate of return on productive capital continues to decrease while the rate of return on real estate does not, more and more of our wealth concentration is going to be in the form of higher housing prices—making the whole problem self-reinforcing.

People also seem really ambivalent about whether they want housing prices to be low or high. In one breath they’ll bemoan the lack of affordable housing, and in another they’ll talk about “protecting property values”. Even the IMF called the increase in housing prices after the Second Depression a “recovery”. Is it really so hard to understand that higher prices mean higher prices?

But we think of housing as two fundamentally different things. On the one hand, it’s a durable consumption good, like a car or a refrigerator—something you buy because it’s useful, and keep around to use for a long time. On the other hand, it’s a financial asset—a store of value for your savings and a potential source of income. When you’re thinking of it as a consumption good, you want it to be “affordable”; when you’re thinking of it as an asset, you want to “protect its value”. But it’s the same house with the same price. You can’t do both of those things at once, and clearly, as a society—perhaps as a civilization—we have been tilting way too far in the “asset” direction.

I get it: Financial assets that grow over time have the allure of easy money. The stock market, the derivatives market, even the lottery and Las Vegas, all have this tantalizing property that they seem to give you money for nothing. They are like the quest for the Philosopher’s Stone in days of yore.

But they are just as much a chimera as the Philosopher’s Stone itself. (Also, if anyone had found the Philosopher’s Stone, the glut of gold would have triggered massive inflation, not unlike what happened in Spain in the 16th century.) Any money you get from simply owning an asset or placing a bet is money that had to come from somewhere else. In the case of the stock market, that “somewhere else” is the profits of the corporations you bought, and if you did actually contribute to the investment of those corporations there’s nothing wrong with you getting a proportional share of those profits. But most people aren’t thinking in those terms when they buy stocks, and once you get all the way to sophisticated derivatives you’re basically in full gambling territory. Every option that’s in the money is another option that’s out of the money. Every interest rate swap that turns a profit is another one that bears a loss.

And when it comes to housing, if you magically gain equity from rising property values, where is that money coming from? It’s coming from people desperately struggling to afford to live in your city, people giving up 40%, 50%, even 60% of their disposable income just for the chance to leave in a tiny apartment because they want to be in your city that badly. It’s coming from people who started that way, lost their job, and ended up homeless because they couldn’t sustain the payments anymore. All that easy money is coming from hard-working young people trying to hold themselves out of poverty.

It’s different if your home gains value because you actually did something to make it better—renovations, additions, landscaping. Even then I think these things are sort of overrated; but they do constitute a real economic benefit to the people who live there. But if your home rises in value because zoning regulations and protesting homeowners stop the construction of new high-rises, that’s very much still on the backs of struggling young people.

We need to stop thinking houses as assets that are supposed to earn a return, and instead think of them as consumption goods that provide benefits to people. If you want a return, buy stocks and bonds. When you’re buying a house, you should be buying a house—not some dream of making money for nothing as housing prices rise forever. Because they can’t—sooner or later, the bubble will break—and even if they could, it would be terrible for everyone who didn’t get into the market soon enough.

Sometimes people have to lose their jobs. This isn’t a bad thing.

Oct 8, JDN 2457670

Eleizer Yudkowsky (founder of the excellent blog forum Less Wrong) has a term he likes to use to distinguish his economic policy views from either liberal, conservative, or even libertarian: “econoliterate”, meaning the sort of economic policy ideas one comes up with when one actually knows a good deal about economics.

In general I think Yudkowsky overestimates this effect; I’ve known some very knowledgeable economists who disagree quite strongly over economic policy, and often following the conventional political lines of liberal versus conservative: Liberal economists want more progressive taxation and more Keynesian monetary and fiscal policy, while conservative economists want to reduce taxes on capital and remove regulations. Theoretically you can want all these things—as Miles Kimball does—but it’s rare. Conservative economists hate minimum wage, and lean on the theory that says it should be harmful to employment; liberal economists are ambivalent about minimum wage, and lean on the empirical data that shows it has almost no effect on employment. Which is more reliable? The empirical data, obviously—and until more economists start thinking that way, economics is never truly going to be a science as it should be.

But there are a few issues where Yudkowsky’s “econoliterate” concept really does seem to make sense, where there is one view held by most people, and another held by economists, regardless of who is liberal or conservative. One such example is free trade, which almost all economists believe in. A recent poll of prominent economists by the University of Chicago found literally zero who agreed with protectionist tariffs.

Another example is my topic for today: People losing their jobs.

Not unemployment, which both economists and almost everyone else agree is bad; but people losing their jobs. The general consensus among the public seems to be that people losing jobs is always bad, while economists generally consider it a sign of an economy that is run smoothly and efficiently.

To be clear, of course losing your job is bad for you; I don’t mean to imply that if you lose your job you shouldn’t be sad or frustrated or anxious about that, particularly not in our current system. Rather, I mean to say that policy which tries to keep people in their jobs is almost always a bad idea.

I think the problem is that most people don’t quite grasp that losing your job and not having a job are not the same thing. People not having jobs who want to have jobs—unemployment—is a bad thing. But losing your job doesn’t mean you have to stay unemployed; it could simply mean you get a new job. And indeed, that is what it should mean, if the economy is running properly.

Check out this graph, from FRED:

hires_separations

The red line shows hires—people getting jobs. The blue line shows separations—people losing jobs or leaving jobs. During a recession (the most recent two are shown on this graph), people don’t actually leave their jobs faster than usual; if anything, slightly less. Instead what happens is that hiring rates drop dramatically. When the economy is doing well (as it is right now, more or less), both hires and separations are at very high rates.

Why is this? Well, think about what a job is, really: It’s something that needs done, that no one wants to do for free, so someone pays someone else to do it. Once that thing gets done, what should happen? The job should end. It’s done. The purpose of the job was not to provide for your standard of living; it was to achieve the task at hand. Once it doesn’t need done, why keep doing it?

We tend to lose sight of this, for a couple of reasons. First, we don’t have a basic income, and our social welfare system is very minimal; so a job usually is the only way people have to provide for their standard of living, and they come to think of this as the purpose of the job. Second, many jobs don’t really “get done” in any clear sense; individual tasks are completed, but new ones always arise. After every email sent is another received; after every patient treated is another who falls ill.

But even that is really only true in the short run. In the long run, almost all jobs do actually get done, in the sense that no one has to do them anymore. The job of cleaning up after horses is done (with rare exceptions). The job of manufacturing vacuum tubes for computers is done. Indeed, the job of being a computer—that used to be a profession, young women toiling away with slide rules—is very much done. There are no court jesters anymore, no town criers, and very few artisans (and even then, they’re really more like hobbyists). There are more writers now than ever, and occasional stenographers, but there are no scribes—no one powerful but illiterate pays others just to write things down, because no one powerful is illiterate (and even few who are not powerful, and fewer all the time).

When a job “gets done” in this long-run sense, we usually say that it is obsolete, and again think of this as somehow a bad thing, like we are somehow losing the ability to do something. No, we are gaining the ability to do something better. Jobs don’t become obsolete because we can’t do them anymore; they become obsolete because we don’t need to do them anymore. Instead of computers being a profession that toils with slide rules, they are thinking machines that fit in our pockets; and there are plenty of jobs now for software engineers, web developers, network administrators, hardware designers, and so on as a result.

Soon, there will be no coal miners, and very few oil drillers—or at least I hope so, for the sake of our planet’s climate. There will be far fewer auto workers (robots have already done most of that already), but far more construction workers who install rail lines. There will be more nuclear engineers, more photovoltaic researchers, even more miners and roofers, because we need to mine uranium and install solar panels on rooftops.

Yet even by saying that I am falling into the trap: I am making it sound like the benefit of new technology is that it opens up more new jobs. Typically it does do that, but that isn’t what it’s for. The purpose of technology is to get things done.

Remember my parable of the dishwasher. The goal of our economy is not to make people work; it is to provide people with goods and services. If we could invent a machine today that would do the job of everyone in the world and thereby put us all out of work, most people think that would be terrible—but in fact it would be wonderful.

Or at least it could be, if we did it right. See, the problem right now is that while poor people think that the purpose of a job is to provide for their needs, rich people think that the purpose of poor people is to do jobs. If there are no jobs to be done, why bother with them? At that point, they’re just in the way! (Think I’m exaggerating? Why else would anyone put a work requirement on TANF and SNAP? To do that, you must literally think that poor people do not deserve to eat or have homes if they aren’t, right now, working for an employer. You can couch that in cold economic jargon as “maximizing work incentives”, but that’s what you’re doing—you’re threatening people with starvation if they can’t or won’t find jobs.)

What would happen if we tried to stop people from losing their jobs? Typically, inefficiency. When you aren’t allowed to lay people off when they are no longer doing useful work, we end up in a situation where a large segment of the population is being paid but isn’t doing useful work—and unlike the situation with a basic income, those people would lose their income, at least temporarily, if they quit and tried to do something more useful. There is still considerable uncertainty within the empirical literature on just how much “employment protection” (laws that make it hard to lay people off) actually creates inefficiency and reduces productivity and employment, so it could be that this effect is small—but even so, likewise it does not seem to have the desired effect of reducing unemployment either. It may be like minimum wage, where the effect just isn’t all that large. But it’s probably not saving people from being unemployed; it may simply be shifting the distribution of unemployment so that people with protected jobs are almost never unemployed and people without it are unemployed much more frequently. (This doesn’t have to be based in law, either; while it is made by custom rather than law, it’s quite clear that tenure for university professors makes tenured professors vastly more secure, but at the cost of making employment tenuous and underpaid for adjuncts.)

There are other policies we could make that are better than employment protection, active labor market policies like those in Denmark that would make it easier to find a good job. Yet even then, we’re assuming that everyone needs jobs–and increasingly, that just isn’t true.

So, when we invent a new technology that replaces workers, workers are laid off from their jobs—and that is as it should be. What happens next is what we do wrong, and it’s not even anybody in particular; this is something our whole society does wrong: All those displaced workers get nothing. The extra profit from the more efficient production goes entirely to the shareholders of the corporation—and those shareholders are almost entirely members of the top 0.01%. So the poor get poorer and the rich get richer.

The real problem here is not that people lose their jobs; it’s that capital ownership is distributed so unequally. And boy, is it ever! Here are some graphs I made of the distribution of net wealth in the US, using from the US Census.

Here are the quintiles of the population as a whole:

net_wealth_us

And here are the medians by race:

net_wealth_race

Medians by age:

net_wealth_age

Medians by education:

net_wealth_education

And, perhaps most instructively, here are the quintiles of people who own their homes versus renting (The rent is too damn high!)

net_wealth_rent

All that is just within the US, and already they are ranging from the mean net wealth of the lowest quintile of people under 35 (-$45,000, yes negative—student loans) to the mean net wealth of the highest quintile of people with graduate degrees ($3.8 million). All but the top quintile of renters are poorer than all but the bottom quintile of homeowners. And the median Black or Hispanic person has less than one-tenth the wealth of the median White or Asian person.

If we look worldwide, wealth inequality is even starker. Based on UN University figures, 40% of world wealth is owned by the top 1%; 70% by the top 5%; and 80% by the top 10%. There is less total wealth in the bottom 80% than in the 80-90% decile alone. According to Oxfam, the richest 85 individuals own as much net wealth as the poorest 3.7 billion. They are the 0.000,001%.

If we had an equal distribution of capital ownership, people would be happy when their jobs became obsolete, because it would free them up to do other things (either new jobs, or simply leisure time), while not decreasing their income—because they would be the shareholders receiving those extra profits from higher efficiency. People would be excited to hear about new technologies that might displace their work, especially if those technologies would displace the tedious and difficult parts and leave the creative and fun parts. Losing your job could be the best thing that ever happened to you.

The business cycle would still be a problem; we have good reason not to let recessions happen. But stopping the churn of hiring and firing wouldn’t actually make our society better off; it would keep people in jobs where they don’t belong and prevent us from using our time and labor for its best use.

Perhaps the reason most people don’t even think of this solution is precisely because of the extreme inequality of capital distribution—and the fact that it has more or less always been this way since the dawn of civilization. It doesn’t seem to even occur to most people that capital income is a thing that exists, because they are so far removed from actually having any amount of capital sufficient to generate meaningful income. Perhaps when a robot takes their job, on some level they imagine that the robot is getting paid, when of course it’s the shareholders of the corporations that made the robot and the corporations that are using the robot in place of workers. Or perhaps they imagine that those shareholders actually did so much hard work they deserve to get paid that money for all the hours they spent.

Because pay is for work, isn’t it? The reason you get money is because you’ve earned it by your hard work?

No. This is a lie, told to you by the rich and powerful in order to control you. They know full well that income doesn’t just come from wages—most of their income doesn’t come from wages! Yet this is even built into our language; we say “net worth” and “earnings” rather than “net wealth” and “income”. (Parade magazine has a regular segment called “What People Earn”; it should be called “What People Receive”.) Money is not your just reward for your hard work—at least, not always.

The reason you get money is that this is a useful means of allocating resources in our society. (Remember, money was created by governments for the purpose of facilitating economic transactions. It is not something that occurs in nature.) Wages are one way to do that, but they are far from the only way; they are not even the only way currently in use. As technology advances, we should expect a larger proportion of our income to go to capital—but what we’ve been doing wrong is setting it up so that only a handful of people actually own any capital.

Fix that, and maybe people will finally be able to see that losing your job isn’t such a bad thing; it could even be satisfying, the fulfillment of finally getting something done.

What you need to know about tax incidence

JDN 2457152 EDT 14:54.

I said in my previous post that I consider tax incidence to be one of the top ten things you should know about economics. If I actually try to make a top ten list, I think it goes something like this:

  1. Supply and demand
  2. Monopoly and oligopoly
  3. Externalities
  4. Tax incidence
  5. Utility, especially marginal utility of wealth
  6. Pareto-efficiency
  7. Risk and loss aversion
  8. Biases and heuristics, including sunk-cost fallacy, scope neglect, herd behavior, anchoring and representative heuristic
  9. Asymmetric information
  10. Winner-takes-all effect

So really tax incidence is in my top five things you should know about economics, and yet I still haven’t talked about it very much. Well, today I will. The basic principles of supply and demand I’m basically assuming you know, but I really should spend some more time on monopoly and externalities at some point.

Why is tax incidence so important? Because of one central fact: The person who pays the tax is not the person who writes the check.

It doesn’t matter whether a tax is paid by the buyer or the seller; it matters what the buyer and seller can do to avoid the tax. If you can change your behavior in order to avoid paying the tax—buy less stuff, or buy somewhere else, or deduct something—you will not bear the tax as much as someone else who can’t do anything to avoid the tax, even if you are the one who writes the check. If you can avoid it and they can’t, other parties in the transaction will adjust their prices in order to eat the tax on your behalf.

Thus, if you have a good that you absolutely must buy no matter what—like, say, table saltand then we make everyone who sells that good pay an extra $5 per kilogram, I can guarantee you that you will pay an extra $5 per kilogram, and the suppliers will make just as much money as they did before. (A salt tax would be an excellent way to redistribute wealth from ordinary people to corporations, if you’re into that sort of thing. Not that we have any trouble doing that in America.)

On the other hand, if you have a good that you’ll only buy at a very specific price—like, say, fast food—then we can make you write the check for a tax of an extra $5 per kilogram you use, and in real terms you’ll pay hardly any tax at all, because the sellers will either eat the cost themselves by lowering the prices or stop selling the product entirely. (A fast food tax might actually be a good idea as a public health measure, because it would reduce production and consumption of fast food—remember, heart disease is one of the leading causes of death in the United States, making cheeseburgers a good deal more dangerous than terrorists—but it’s a bad idea as a revenue measure, because rather than pay it, people are just going to buy and sell less.)

In the limit in which supply and demand are both completely fixed (perfectly inelastic), you can tax however you want and it’s just free redistribution of wealth however you like. In the limit in which supply and demand are both locked into a single price (perfectly elastic), you literally cannot tax that good—you’ll just eliminate production entirely. There aren’t a lot of perfectly elastic goods in the real world, but the closest I can think of is cash. If you instituted a 2% tax on all cash withdrawn, most people would stop using cash basically overnight. If you want a simple way to make all transactions digital, find a way to enforce a cash tax. When you have a perfect substitute available, taxation eliminates production entirely.

To really make sense out of tax incidence, I’m going to need a lot of a neoclassical economists’ favorite thing: Supply and demand curves. These things pop up everywhere in economics; and they’re quite useful. I’m not so sure about their application to things like aggregate demand and the business cycle, for example, but today I’m going to use them for the sort of microeconomic small-market stuff that they were originally designed for; and what I say here is going to be basically completely orthodox, right out of what you’d find in an ECON 301 textbook.

Let’s assume that things are linear, just to make the math easier. You’d get basically the same answers with nonlinear demand and supply functions, but it would be a lot more work. Likewise, I’m going to assume a unit tax on goods—like $2890 per hectare—as opposed to a proportional tax on sales—like 6% property tax—again, for mathematical simplicity.

The next concept I’m going to have to talk about is elasticitywhich is the proportional amount that quantity sold changes relative to price. If price increases 2% and you buy 4% less, you have a demand elasticity of -2. If price increases 2% and you buy 1% less, you have a demand elasticity of -1/2. If price increases 3% and you sell 6% more, you have a supply elasticity of 2. If price decreases 5% and you sell 1% less, you have a supply elasticity of 1/5.

Elasticity doesn’t have any units of measurement, it’s just a number—which is part of why we like to use it. It also has some very nice mathematical properties involving logarithms, but we won’t be needing those today.

The price that renters are willing and able to pay, the demand price PD will start at their maximum price, the reserve price PR, and then it will decrease linearly according to the quantity of land rented Q, according to a linear function (simply because we assumed that) which will vary according to a parameter e that represents the elasticity of demand (it isn’t strictly equal to it, but it’s sort of a linearization).

We’re interested in what is called the consumer surplus; it is equal to the total amount of value that buyers get from their purchases, converted into dollars, minus the amount they had to pay for those purchases. This we add to the producer surplus, which is the amount paid for those purchases minus the cost of producing themwhich is basically just the same thing as profit. Togerther the consumer surplus and producer surplus make the total economic surplus, which economists generally try to maximize. Because different people have different marginal utility of wealth, this is actually a really terrible idea for deep and fundamental reasons—taking a house from Mitt Romney and giving it to a homeless person would most definitely reduce economic surplus, even though it would obviously make the world a better place. Indeed, I think that many of the problems in the world, particularly those related to inequality, can be traced to the fact that markets maximize economic surplus rather than actual utility. But for now I’m going to ignore all that, and pretend that maximizing economic surplus is what we want to do.

You can read off the economic surplus straight from the supply and demand curves; it’s the area between the lines. (Mathematically, it’s an integral; but that’s equivalent to the area under a curve, and with straight lines they’re just triangles.) I’m going to call the consumer surplus just “surplus”, and producer surplus I’ll call “profit”.

Below the demand curve and above the price is the surplus, and below the price and above the supply curve is the profit:

elastic_supply_competitive_labeled

I’m going to be bold here and actually use equations! Hopefully this won’t turn off too many readers. I will give each equation in both a simple text format and in proper LaTeX. Remember, you can render LaTeX here.

PD = PR – 1/e * Q

P_D = P_R – \frac{1}{e} Q \\

The marginal cost that landlords have to pay, the supply price PS, is a bit weirder, as I’ll talk about more in a moment. For now let’s say that it is a linear function, starting at zero cost for some quantity Q0 and then increases linearly according to a parameter n that similarly represents the elasticity of supply.

PS = 1/n * (Q – Q0)

P_S = \frac{1}{n} \left( Q – Q_0 \right) \\

Now, if you introduce a tax, there will be a difference between the price that renters pay and the price that landlords receive—namely, the tax, which we’ll call T. I’m going to assume that, on paper, the landlord pays the whole tax. As I said above, this literally does not matter. I could assume that on paper the renter pays the whole tax, and the real effect on the distribution of wealth would be identical. All we’d have to do is set PD = P and PS = P – T; the consumer and producer surplus would end up exactly the same. Or we could do something in between, with P’D = P + rT and P’S = P – (1 – r) T.

Then, if the market is competitive, we just set the prices equal, taking the tax into account:

P = PD – T = PR – 1/e * Q – T = PS = 1/n * (Q – Q0)

P= P_D – T = P_R – \frac{1}{e} Q – T= P_S = \frac{1}{n} \left(Q – Q_0 \right) \\

P_R – 1/e * Q – T = 1/n * (Q – Q0)

P_R – \frac{1}{e} Q – T = \frac{1}{n} \left(Q – Q_0 \right) \\

Notice the equivalency here; if we set P’D = P + rT and P’S = P – (1 – r) T, so that the consumer now pays a fraction of the tax r.

P = P’D – rT = P_r – 1/e*Q = P’S + (1 – r) T + 1/n * (Q – Q0) + (1 – r) T

P^\prime_D – r T = P = P_R – \frac{1}{e} Q = P^\prime_S = \frac{1}{n} \left(Q – Q_0 \right) + (1 – r) T\\

The result is exactly the same:

P_R – 1/e * Q – T = 1/n * (Q – Q0)

P_R – \frac{1}{e} Q – T = \frac{1}{n} \left(Q – Q_0 \right) \\

I’ll spare you the algebra, but this comes out to:

Q = (PR – T)/(1/n + 1/e) + (Q0)/(1 + n/e)

Q = \frac{P_R – T}{\frac{1}{n} + \frac{1}{e}} + \frac{Q_0}{1 + \frac{n}{e}}

P = (PR – T)/(1+ n/e) – (Q0)/(e + n)

P = \frac{P_R – T}}{1 + \frac{n}{e}} – \frac{Q_0}{e+n} \\

That’s if the market is competitive.

If the market is a monopoly, instead of setting the prices equal, we set the price the landlord receives equal to the marginal revenue—which takes into account the fact that increasing the amount they sell forces them to reduce the price they charge everyone else. Thus, the marginal revenue drops faster than the price as the quantity sold increases.

After a bunch of algebra (and just a dash of calculus), that comes out to these very similar, but not quite identical, equations:

Q = (PR – T)/(1/n + 2/e) + (Q0)/(1+ 2n/e)

Q = \frac{P_R – T}{\frac{1}{n} + \frac{2}{e}} + \frac{Q_0}{1 + \frac{2n}{e}} \\

P = (PR – T)*((1/n + 1/e)/(1/n + 2/e) – (Q0)/(e + 2n)

P = \left( P_R – T\right)\frac{\frac{1}{n} + \frac{1}{e}}{\frac{1}{n} + \frac{2}{e}} – \frac{Q_0}{e+2n} \\

Yes, it changes some 1s into 2s. That by itself accounts for the full effect of monopoly. That’s why I think it’s worthwhile to use the equations; they are deeply elegant and express in a compact form all of the different cases. They look really intimidating right now, but for most of the cases we’ll consider these general equations simplify quite dramatically.

There are several cases to consider.

Land has an extremely high cost to create—for practical purposes, we can consider its supply fixed, that is, perfectly inelastic. If the market is competitive, so that landlords have no market power, then they will simply rent out all the land they have at whatever price the market will bear:

Inelastic_supply_competitive_labeled

This is like setting n = 0 and T = 0 in the above equations, the competitive ones.

Q = Q0

Q = Q_0 \\

P = PR – Q0/e

P = P_R – \frac{Q_0}{e} \\

If we now introduce a tax, it will fall completely on the landlords, because they have little choice but to rent out all the land they have, and they can only rent it at a price—including tax—that the market will bear.

inelastic_supply_competitive_tax_labeled

Now we still have n = 0 but not T = 0.

Q = Q0

Q = Q_0 \\

P = PR – T – Q0/e

P = P_R – T – \frac{Q_0}{e} \\

The consumer surplus will be:

½ (Q)(PR – P – T) = 1/(2e)* Q02

\frac{1}{2}Q(P_R – P – T) = \frac{1}{2e}Q_0^2 \\

Notice how T isn’t in the result. The consumer surplus is unaffected by the tax.

The producer surplus, on the other hand, will be reduced by the tax:

(Q)(P) = (PR – T – Q0/e) Q0 = PR Q0 – 1/e Q02 – TQ0

(Q)(P) = (P_R – T – \frac{Q_0}{e})Q_0 = P_R Q_0 – \frac{1}{e} Q_0^2 – T Q_0 \\

T appears linearly as TQ0, which is the same as the tax revenue. All the money goes directly from the landlord to the government, as we want if our goal is to redistribute wealth without raising rent.

But now suppose that the market is not competitive, and by tacit collusion or regulatory capture the landlords can exert some market power; this is quite likely the case in reality. Actually in reality we’re probably somewhere in between monopoly and competition, either oligopoly or monopolistic competitionwhich I will talk about a good deal more in a later post, I promise.

It could be that demand is still sufficiently high that even with their market power, landlords have an incentive to rent out all their available land, in which case the result will be the same as in the competitive market.

inelastic_supply_monopolistic_labeled

A tax will then fall completely on the landlords as before:

inelastic_supply_monopolistic_tax_labeled

Indeed, in this case it doesn’t really matter that the market is monopolistic; everything is the same as it would be under a competitive market. Notice how if you set n = 0, the monopolistic equations and the competitive equations come out exactly the same. The good news is, this is quite likely our actual situation! So even in the presence of significant market power the land tax can redistribute wealth in just the way we want.

But there are a few other possibilities. One is that demand is not sufficiently high, so that the landlords’ market power causes them to actually hold back some land in order to raise the price:

zerobound_supply_monopolistic_labeled

This will create some of what we call deadweight loss, in which some economic value is wasted. By restricting the land they rent out, the landlords make more profit, but the harm they cause to tenant is created than the profit they gain, so there is value wasted.

Now instead of setting n = 0, we actually set n = infinity. Why? Because the reason that the landlords restrict the land they sell is that their marginal revenue is actually negative beyond that point—they would actually get less money in total if they sold more land. Instead of being bounded by their cost of production (because they have none, the land is there whether they sell it or not), they are bounded by zero. (Once again we’ve hit upon a fundamental concept in economics, particularly macroeconomics, that I don’t have time to talk about today: the zero lower bound.) Thus, they can change quantity all they want (within a certain range) without changing the price, which is equivalent to a supply elasticity of infinity.

Introducing a tax will then exacerbate this deadweight loss (adding DWL2 to the original DWL1), because it provides even more incentive for the landlords to restrict the supply of land:

zerobound_supply_monopolistic_tax_labeled

Q = e/2*(PR – T)

Q = \frac{e}{2} \left(P_R – T\right)\\

P = 1/2*(PR – T)

P = \frac{1}{2} \left(P_R – T\right) \\

The quantity Q0 completely drops out, because it doesn’t matter how much land is available (as long as it’s enough); it only matters how much land it is profitable to rent out.

We can then find the consumer and producer surplus, and see that they are both reduced by the tax. The consumer surplus is as follows:

½ (Q)(PR – 1/2(PR – T)) = e/4*(PR2 – T2)

\frac{1}{2}Q \left( P_R – \frac{1}{2}left( P – T \right) \right) = \frac{e}{4}\left( P_R^2 – T^2 \right) \\

This time, the tax does have an effect on reducing the consumer surplus.

The producer surplus, on the other hand, will be:

(Q)(P) = 1/2*(PR – T)*e/2*(PR – T) = e/4*(PR – T)2

(Q)(P) = \frac{1}{2}\left(P_R – T \right) \frac{e}{2} \left(P_R – T\right) = \frac{e}{4} \left(P_R – T)^2 \\

Notice how it is also reduced by the tax—and no longer in a simple linear way.

The tax revenue is now a function of the demand:

TQ = e/2*T(PR – T)

T Q = \frac{e}{2} T (P_R – T) \\

If you add all these up, you’ll find that the sum is this:

e/2 * (PR^2 – T^2)

\frac{e}{2} \left(P_R^2 – T^2 \right) \\

The sum is actually reduced by an amount equal to e/2*T^2, which is the deadweight loss.

Finally there is an even worse scenario, in which the tax is so large that it actually creates an incentive to restrict land where none previously existed:

zerobound_supply_monopolistic_hugetax_labeled

Notice, however, that because the supply of land is inelastic the deadweight loss is still relatively small compared to the huge amount of tax revenue.

But actually this isn’t the whole story, because a land tax provides an incentive to get rid of land that you’re not profiting from. If this incentive is strong enough, the monopolistic power of landlords will disappear, as the unused land gets sold to more landholders or to the government. This is a way of avoiding the tax, but it’s one that actually benefits society, so we don’t mind incentivizing it.

Now, let’s compare this to our current system of property taxes, which include the value of buildings. Buildings are expensive to create, but we build them all the time; the supply of buildings is strongly dependent upon the price at which those buildings will sell. This makes for a supply curve that is somewhat elastic.

If the market were competitive and we had no taxes, it would be optimally efficient:

elastic_supply_competitive_labeled

Property taxes create an incentive to produce fewer buildings, and this creates deadweight loss. Notice that this happens even if the market is perfectly competitive:

elastic_supply_competitive_tax_labeled

Since both n and e are finite and nonzero, we’d need to use the whole equations: Since the algebra is such a mess, I don’t see any reason to subject you to it; but suffice it to say, the T does not drop out. Tenants do see their consumer surplus reduced, and the larger the tax the more this is so.

Now, suppose that the market for buildings is monopolistic, as it most likely is. This would create deadweight loss even in the absence of a tax:

elastic_supply_monopolistic_labeled

But a tax will add even more deadweight loss:

elastic_supply_monopolistic_tax_labeled

Once again, we’d need the full equations, and once again it’s a mess; but the result is, as before, that the tax gets passed on to the tenants in the form of more restricted sales and therefore higher rents.

Because of the finite supply elasticity, there’s no way that the tax can avoid raising the rent. As long as landlords have to pay more taxes when they build more or better buildings, they are going to raise the rent in those buildings accordingly—whether the market is competitive or not.

If the market is indeed monopolistic, there may be ways to bring the rent down: suppose we know what the competitive market price of rent should be, and we can establish rent control to that effect. If we are truly correct about the price to set, this rent control can not only reduce rent, it can actually reduce the deadweight loss:

effective_rent_control_tax_labeled

But if we set the rent control too low, or don’t properly account for the varying cost of different buildings, we can instead introduce a new kind of deadweight loss, by making it too expensive to make new buildings.

ineffective_rent_control_tax_labeled

In fact, what actually seems to happen is more complicated than that—because otherwise the number of buildings is obviously far too small, rent control is usually set to affect some buildings and not others. So what seems to happen is that the rent market fragments into two markets: One, which is too small, but very good for those few who get the chance to use it; and the other, which is unaffected by the rent control but is more monopolistic and therefore raises prices even further. This is why almost all economists are opposed to rent control (PDF); it doesn’t solve the problem of high rent and simply causes a whole new set of problems.

A land tax with a basic income, on the other hand, would help poor people at least as much as rent control presently does—probably a good deal more—without discouraging the production and maintenance of new apartment buildings.

But now we come to a key point: The land tax must be uniform per hectare.

If it is instead based on the value of the land, then this acts like a finite elasticity of supply; it provides an incentive to reduce the value of your own land in order to avoid the tax. As I showed above, this is particularly pernicious if the market is monopolistic, but even if it is competitive the effect is still there.

One exception I can see is if there are different tiers based on broad classes of land that it’s difficult to switch between, such as “land in Manhattan” versus “land in Brooklyn” or “desert land” versus “forest land”. But even this policy would have to be done very carefully, because any opportunity to substitute can create an opportunity to pass on the tax to someone else—for instance if land taxes are lower in Brooklyn developers are going to move to Brooklyn. Maybe we want that, in which case that is a good policy; but we should be aware of these sorts of additional consequences. The simplest way to avoid all these problems is to simply make the land tax uniform. And given the quantities we’re talking about—less than $3000 per hectare per year—it should be affordable for anyone except the very large landholders we’re trying to distribute wealth from in the first place.

The good news is, most economists would probably be on board with this proposal. After all, the neoclassical models themselves say it would be more efficient than our current system of rent control and property taxes—and the idea is at least as old as Adam Smith. Perhaps we can finally change the fact that the rent is too damn high.

In honor of Pi Day, I for one welcome our new robot overlords

JDN 2457096 EDT 16:08

Despite my preference to use the Julian Date Number system, it has not escaped my attention that this weekend was Pi Day of the Century, 3/14/15. Yesterday morning we had the Moment of Pi: 3/14/15 9:26:53.58979… We arguably got an encore that evening if we allow 9:00 PM instead of 21:00.

Though perhaps it is a stereotype and/or cheesy segue, pi and associated mathematical concepts are often associated with computers and robots. Robots are an increasing part of our lives, from the industrial robots that manufacture our cars to the precision-timed satellites that provide our GPS navigation. When you want to know how to get somewhere, you pull out your pocket thinking machine and ask it to commune with the space robots who will guide you to your destination.

There are obvious upsides to these robots—they are enormously productive, and allow us to produce great quantities of useful goods at astonishingly low prices, including computers themselves, creating a positive feedback loop that has literally lowered the price of a given amount of computing power by a factor of one trillion in the latter half of the 20th century. We now very much live in the early parts of a cyberpunk future, and it is due almost entirely to the power of computer automation.

But if you know your SF you may also remember another major part of cyberpunk futures aside from their amazing technology; they also tend to be dystopias, largely because of their enormous inequality. In the cyberpunk future corporations own everything, governments are virtually irrelevant, and most individuals can barely scrape by—and that sounds all too familiar, doesn’t it? This isn’t just something SF authors made up; there really are a number of ways that computer technology can exacerbate inequality and give more power to corporations.

Why? The reason that seems to get the most attention among economists is skill-biased technological change; that’s weird because it’s almost certainly the least important. The idea is that computers can automate many routine tasks (no one disputes that part) and that routine tasks tend to be the sort of thing that uneducated workers generally do more often than educated ones (already this is looking fishy; think about accountants versus artists). But educated workers are better at using computers and the computers need people to operate them (clearly true). Hence while uneducated workers are substitutes for computers—you can use the computers instead—educated workers are complements for computers—you need programmers and engineers to make the computers work. As computers get cheaper, their substitutes also get cheaper—and thus wages for uneducated workers go down. But their complements get more valuable—and so wages for educated workers go up. Thus, we get more inequality, as high wages get higher and low wages get lower.

Or, to put it more succinctly, robots are taking our jobs. Not all our jobs—actually they’re creating jobs at the top for software programmers and electrical engineers—but a lot of our jobs, like welders and metallurgists and even nurses. As the technology improves more and more jobs will be replaced by automation.

The theory seems plausible enough—and in some form is almost certainly true—but as David Card has pointed out, this fails to explain most of the actual variation in inequality in the US and other countries. Card is one of my favorite economists; he is also famous for completely revolutionizing the economics of minimum wage, showing that prevailing theory that minimum wages must hurt employment simply doesn’t match the empirical data.

If it were just that college education is getting more valuable, we’d see a rise in income for roughly the top 40%, since over 40% of American adults have at least an associate’s degree. But we don’t actually see that; in fact contrary to popular belief we don’t even really see it in the top 1%. The really huge increases in income for the last 40 years have been at the top 0.01%—the top 1% of 1%.

Many of the jobs that are now automated also haven’t seen a fall in income; despite the fact that high-frequency trading algorithms do what stockbrokers do a thousand times better (“better” at making markets more unstable and siphoning wealth from the rest of the economy that is), stockbrokers have seen no such loss in income. Indeed, they simply appropriate the additional income from those computer algorithms—which raises the question why welders couldn’t do the same thing. And indeed, I’ll get to in a moment why that is exactly what we must do, that the robot revolution must also come with a revolution in property rights and income distribution.

No, the real reasons why technology exacerbates inequality are twofold: Patent rents and the winner-takes-all effect.

In an earlier post I already talked about the winner-takes-all effect, so I’ll just briefly summarize it this time around. Under certain competitive conditions, a small fraction of individuals can reap a disproportionate share of the rewards despite being only slightly more productive than those beneath them. This often happens when we have network externalities, in which a product becomes more valuable when more people use it, thus creating a positive feedback loop that makes the products which are already successful wildly so and the products that aren’t successful resigned to obscurity.

Computer technology—more specifically, the Internet—is particularly good at creating such situations. Facebook, Google, and Amazon are all examples of companies that (1) could not exist without Internet technology and (2) depend almost entirely upon network externalities for their business model. They are the winners who take all; thousands of other software companies that were just as good or nearly so are now long forgotten. The winners are not always the same, because the system is unstable; for instance MySpace used to be much more important—and much more profitable—until Facebook came along.

But the fact that a different handful of upper-middle-class individuals can find themselves suddenly and inexplicably thrust into fame and fortune while the rest of us toil in obscurity really isn’t much comfort, now is it? While technically the rise and fall of MySpace can be called “income mobility”, it’s clearly not what we actually mean when we say we want a society with a high level of income mobility. We don’t want a society where the top 10% can by little more than chance find themselves becoming the top 0.01%; we want a society where you don’t have to be in the top 10% to live well in the first place.

Even without network externalities the Internet still nurtures winner-takes-all markets, because digital information can be copied infinitely. When it comes to sandwiches or even cars, each new one is costly to make and costly to transport; it can be more cost-effective to choose the ones that are made near you even if they are of slightly lower quality. But with books (especially e-books), video games, songs, or movies, each individual copy costs nothing to create, so why would you settle for anything but the best? This may well increase the overall quality of the content consumers get—but it also ensures that the creators of that content are in fierce winner-takes-all competition. Hence J.K. Rowling and James Cameron on the one hand, and millions of authors and independent filmmakers barely scraping by on the other. Compare a field like engineering; you probably don’t know a lot of rich and famous engineers (unless you count engineers who became CEOs like Bill Gates and Thomas Edison), but nor is there a large segment of “starving engineers” barely getting by. Though the richest engineers (CEOs excepted) are not nearly as rich as the richest authors, the typical engineer is much better off than the typical author, because engineering is not nearly as winner-takes-all.

But the main topic for today is actually patent rents. These are a greatly underappreciated segment of our economy, and they grow more important all the time. A patent rent is more or less what it sounds like; it’s the extra money you get from owning a patent on something. You can get that money either by literally renting it—charging license fees for other companies to use it—or simply by being the only company who is allowed to manufacture something, letting you sell it at monopoly prices. It’s surprisingly difficult to assess the real value of patent rents—there’s a whole literature on different econometric methods of trying to tackle this—but one thing is clear: Some of the largest, wealthiest corporations in the world are built almost entirely upon patent rents. Drug companies, R&D companies, software companies—even many manufacturing companies like Boeing and GM obtain a substantial portion of their income from patents.

What is a patent? It’s a rule that says you “own” an idea, and anyone else who wants to use it has to pay you for the privilege. The very concept of owning an idea should trouble you—ideas aren’t limited in number, you can easily share them with others. But now think about the fact that most of these patents are owned by corporationsnot by inventors themselves—and you’ll realize that our system of property rights is built around the notion that an abstract entity can own an idea—that one idea can own another.

The rationale behind patents is that they are supposed to provide incentives for innovation—in exchange for investing the time and effort to invent something, you receive a certain amount of time where you get to monopolize that product so you can profit from it. But how long should we give you? And is this really the best way to incentivize innovation?

I contend it is not; when you look at the really important world-changing innovations, very few of them were done for patent rents, and virtually none of them were done by corporations. Jonas Salk was indignant at the suggestion he should patent the polio vaccine; it might have made him a billionaire, but only by letting thousands of children die. (To be fair, here’s a scholar arguing that he probably couldn’t have gotten the patent even if he wanted to—but going on to admit that even then the patent incentive had basically nothing to do with why penicillin and the polio vaccine were invented.)

Who landed on the moon? Hint: It wasn’t Microsoft. Who built the Hubble Space Telescope? Not Sony. The Internet that made Google and Facebook possible was originally invented by DARPA. Even when corporations seem to do useful innovation, it’s usually by profiting from the work of individuals: Edison’s corporation stole most of its good ideas from Nikola Tesla, and by the time the Wright Brothers founded a company their most important work was already done (though at least then you could argue that they did it in order to later become rich, which they ultimately did). Universities and nonprofits brought you the laser, light-emitting diodes, fiber optics, penicillin and the polio vaccine. Governments brought you liquid-fuel rockets, the Internet, GPS, and the microchip. Corporations brought you, uh… Viagra, the Snuggie, and Furbies. Indeed, even Google’s vaunted search algorithms were originally developed by the NSF. I can think of literally zero examples of a world-changing technology that was actually invented by a corporation in order to secure a patent. I’m hesitant to say that none exist, but clearly the vast majority of seminal inventions have been created by governments and universities.

This has always been true throughout history. Rome’s fire departments were notorious for shoddy service—and wholly privately-owned—but their great aqueducts that still stand today were built as government projects. When China invented paper, turned it into money, and defended it with the Great Wall, it was all done on government funding.

The whole idea that patents are necessary for innovation is simply a lie; and even the idea that patents lead to more innovation is quite hard to defend. Imagine if instead of letting Google and Facebook patent their technology all the money they receive in patent rents were instead turned into tax-funded research—frankly is there even any doubt that the results would be better for the future of humanity? Instead of better ad-targeting algorithms we could have had better cancer treatments, or better macroeconomic models, or better spacecraft engines.

When they feel their “intellectual property” (stop and think about that phrase for awhile, and it will begin to seem nonsensical) has been violated, corporations become indignant about “free-riding”; but who is really free-riding here? The people who copy music albums for free—because they cost nothing to copy, or the corporations who make hundreds of billions of dollars selling zero-marginal-cost products using government-invented technology over government-funded infrastructure? (Many of these companies also continue receive tens or hundreds of millions of dollars in subsidies every year.) In the immortal words of Barack Obama, “you didn’t build that!”

Strangely, most economists seem to be supportive of patents, despite the fact that their own neoclassical models point strongly in the opposite direction. There’s no logical connection between the fixed cost of inventing a technology and the monopoly rents that can be extracted from its patent. There is some connection—albeit a very weak one—between the benefits of the technology and its monopoly profits, since people are likely to be willing to pay more for more beneficial products. But most of the really great benefits are either in the form of public goods that are unenforceable even with patents (go ahead, try enforcing on that satellite telescope on everyone who benefits from its astronomical discoveries!) or else apply to people who are so needy they can’t possibly pay you (like anti-malaria drugs in Africa), so that willingness-to-pay link really doesn’t get you very far.

I guess a lot of neoclassical economists still seem to believe that willingness-to-pay is actually a good measure of utility, so maybe that’s what’s going on here; if it were, we could at least say that patents are a second-best solution to incentivizing the most important research.

But even then, why use second-best when you have best? Why not devote more of our society’s resources to governments and universities that have centuries of superior track record in innovation? When this is proposed the deadweight loss of taxation is always brought up, but somehow the deadweight loss of monopoly rents never seems to bother anyone. At least taxes can be designed to minimize deadweight loss—and democratic governments actually have incentives to do that; corporations have no interest whatsoever in minimizing the deadweight loss they create so long as their profit is maximized.

I’m not saying we shouldn’t have corporations at all—they are very good at one thing and one thing only, and that is manufacturing physical goods. Cars and computers should continue to be made by corporations—but their technologies are best invented by government. Will this dramatically reduce the profits of corporations? Of course—but I have difficulty seeing that as anything but a good thing.

Why am I talking so much about patents, when I said the topic was robots? Well, it’s typically because of the way these patents are assigned that robots taking people’s jobs becomes a bad thing. The patent is owned by the company, which is owned by the shareholders; so when the company makes more money by using robots instead of workers, the workers lose.

If when a robot takes your job, you simply received the income produced by the robot as capital income, you’d probably be better off—you get paid more and you also don’t have to work. (Of course, if you define yourself by your career or can’t stand the idea of getting “handouts”, you might still be unhappy losing your job even though you still get paid for it.)

There’s a subtler problem here though; robots could have a comparative advantage without having an absolute advantage—that is, they could produce less than the workers did before, but at a much lower cost. Where it cost $5 million in wages to produce $10 million in products, it might cost only $3 million in robot maintenance to produce $9 million in products. Hence you can’t just say that we should give the extra profits to the workers; in some cases those extra profits only exist because we are no longer paying the workers.

As a society, we still want those transactions to happen, because producing less at lower cost can still make our economy more efficient and more productive than it was before. Those displaced workers can—in theory at least—go on to other jobs where they are needed more.

The problem is that this often doesn’t happen, or it takes such a long time that workers suffer in the meantime. Hence the Luddites; they don’t want to be made obsolete even if it does ultimately make the economy more productive.

But this is where patents become important. The robots were probably invented at a university, but then a corporation took them and patented them, and is now selling them to other corporations at a monopoly price. The manufacturing company that buys the robots now has to spend more in order to use the robots, which drives their profits down unless they stop paying their workers.

If instead those robots were cheap because there were no patents and we were only paying for the manufacturing costs, the workers could be shareholders in the company and the increased efficiency would allow both the employers and the workers to make more money than before.

What if we don’t want to make the workers into shareholders who can keep their shares after they leave the company? There is a real downside here, which is that once you get your shares, why stay at the company? We call that a “golden parachute” when CEOs do it, which they do all the time; but most economists are in favor of stock-based compensation for CEOs, and once again I’m having trouble seeing why it’s okay when rich people do it but not when middle-class people do.

Another alternative would be my favorite policy, the basic income: If everyone knows they can depend on a basic income, losing your job to a robot isn’t such a terrible outcome. If the basic income is designed to grow with the economy, then the increased efficiency also raises everyone’s standard of living, as economic growth is supposed to do—instead of simply increasing the income of the top 0.01% and leaving everyone else where they were. (There is a good reason not to make the basic income track economic growth too closely, namely the business cycle; you don’t want the basic income payments to fall in a recession, because that would make the recession worse. Instead they should be smoothed out over multiple years or designed to follow a nominal GDP target, so that they continue to rise even in a recession.)

We could also combine this with expanded unemployment insurance (explain to me again why you can’t collect unemployment if you weren’t working full-time before being laid off, even if you wanted to be or you’re a full-time student?) and active labor market policies that help people re-train and find new and better jobs. These policies also help people who are displaced for reasons other than robots making their jobs obsolete—obviously there are all sorts of market conditions that can lead to people losing their jobs, and many of these we actually want to happen, because they involve reallocating the resources of our society to more efficient ends.

Why aren’t these sorts of policies on the table? I think it’s largely because we don’t think of it in terms of distributing goods—we think of it in terms of paying for labor. Since the worker is no longer laboring, why pay them?

This sounds reasonable at first, but consider this: Why give that money to the shareholder? What did they do to earn it? All they do is own a piece of the company. They may not have contributed to the goods at all. Honestly, on a pay-for-work basis, we should be paying the robot!

If it bothers you that the worker collects dividends even when he’s not working—why doesn’t it bother you that shareholders do exactly the same thing? By definition, a shareholder is paid according to what they own, not what they do. All this reform would do is make workers into owners.

If you justify the shareholder’s wealth by his past labor, again you can do exactly the same to justify worker shares. (And as I said above, if you’re worried about the moral hazard of workers collecting shares and leaving, you should worry just as much about golden parachutes.)

You can even justify a basic income this way: You paid taxes so that you could live in a society that would protect you from losing your livelihood—and if you’re just starting out, your parents paid those taxes and you will soon enough. Theoretically there could be “welfare queens” who live their whole lives on the basic income, but empirical data shows that very few people actually want to do this, and when given opportunities most people try to find work. Indeed, even those who don’t, rarely seem to be motivated by greed (even though, capitalists tell us, “greed is good”); instead they seem to be de-motivated by learned helplessness after trying and failing for so long. They don’t actually want to sit on the couch all day and collect welfare payments; they simply don’t see how they can compete in the modern economy well enough to actually make a living from work.

One thing is certain: We need to detach income from labor. As a society we need to get over the idea that a human being’s worth is decided by the amount of work they do for corporations. We need to get over the idea that our purpose in life is a job, a career, in which our lives are defined by the work we do that can be neatly monetized. (I admit, I suffer from the same cultural blindness at times, feeling like a failure because I can’t secure the high-paying and prestigious employment I want. I feel this clear sense that my society does not value me because I am not making money, and it damages my ability to value myself.)

As robots do more and more of our work, we will need to redefine the way we live by something else, like play, or creativity, or love, or compassion. We will need to learn to see ourselves as valuable even if nothing we do ever sells for a penny to anyone else.

A basic income can help us do that; it can redefine our sense of what it means to earn money. Instead of the default being that you receive nothing because you are worthless unless you work, the default is that you receive enough to live on because you are a human being of dignity and a citizen. This is already the experience of people who have substantial amounts of capital income; they can fall back on their dividends if they ever can’t or don’t want to find employment. A basic income would turn us all into capital owners, shareholders in the centuries of established capital that has been built by our forebears in the form of roads, schools, factories, research labs, cars, airplanes, satellites, and yes—robots.

The Rent is Too Damn High

Housing prices are on the rise again, but they’re still well below what they were at the peak of the 2008 bubble. It may be that we have not learned from our mistakes and another bubble is coming, but I don’t think it has hit us just yet. Meanwhile, rent prices have barely budged, and the portion of our population who pay more than 35% of their income on rent has risen to 44%.

Economists typically assess the “fair market value” of a house based upon its rental rate for so-called “housing services”—the actual benefits of living in a house. But to use the rental rate is to do what Larry Summers called “ketchup economics”; 40-ounce bottles of ketchup sell for exactly twice what 20-ounce bottles do, therefore the ketchup market is fair and efficient. (In fact even this is not true, since ketchup is sold under bulk pricing. This reminds me of a rather amusing situation I recently encountered at the grocery store: The price of individual 12-packs of Coke was $3, but you could buy sets of five for $10 each. This meant that buying five was cheaper in total—not just per unit—than buying four. The only way to draw that budget constraint is with a periodic discontinuity; it makes a sawtooth across your graph. We never talk about that sort of budget constraint in neoclassical economics, yet there it was in front of me.)

When we value houses by their rental rate, we’re doing ketchup economics. We’re ignoring the fact that the rent is too damn highpeople should not have to pay as much as they do in order to get housing in this country, particularly housing in or near major cities. When 44% of Americans are forced to spend over a third of their income just fulfilling the basic need of shelter, something is wrong. Only 60% of the price of a house is the actual cost to build it; another 20% is just the land. If that sounds reasonable to you, you’ve just become inured to our absurd land prices. The US has over 3 hectares per person of land; that’s 7.7 acres. A family of 3 should be able to claim—on average—9 hectares, or 23 acres. The price of a typical 0.5-acre lot for a family home should be negligible; it’s only 2% of your portion of America’s land.

And as for the argument that land near major cities should be more expensive? No, it shouldn’t; it’s land. What should be more expensive near major cities are buildings, and only then because they’re bigger buildings—even per unit it probably is about equal or even an economy of scale. There’s a classic argument that you’re paying to have infrastructure and be near places of work: The former is ignoring the fact that we pay taxes and utilities for that infrastructure; and the latter is implicitly assuming that it’s normal for our land ownership to be so monopolistic. In a competitive market, the price is driven by the cost, not by the value; the extra value you get from living near a city is supposed to go into your consumer surplus (the personal equivalent of profit—but in utility, not in dollars), not into the owner’s profit. And actually that marginal benefit is supposed to be driven to zero by the effect of overcrowding—though Krugman’s Nobel-winning work was about why that doesn’t necessarily happen and therefore we get Shanghai.

There’s also a more technical argument to be had here about the elasticity of land supply and demand; since both are so inelastic, we actually end up in the very disturbing scenario in which even a small shift in either one can throw prices all over the place, even if we are at market-clearing equilibrium. Markets just don’t work very well for inelastic goods; and if right now you’re thinking “Doesn’t that mean markets won’t work well for things like water, food, and medicine?” you’re exactly right and have learned well, Grasshopper.

So, the rent is too damn high. This naturally raises three questions:

  1. Why is the rent so high?
  2. What happens to our economy as a result?
  3. What can we do about it?

Let’s start with 1. Naturally, conservatives are going to blame regulation; here’s Business Insider doing exactly that in San Francisco and New York City respectively. Actually, they have a point here. Zoning laws are supposed to keep industrial pollution away from our homes, not keep people from building bigger buildings to fit more residents. All these arguments about the “feel” of the city or “visual appeal” should be immediately compared to the fact that they are making people homeless. So 200 people should live on the street so you can have the skyline look the way you always remember it? I won’t say what I’d really like to; I’m trying to keep this blog rated PG.

Similarly, rent-control is a terrible way to solve the homelessness problem; you’re created a segregated market with a price ceiling, and that’s going to create a shortage and raise prices in the other part of the market. The result is good for anyone who can get the rent-control and bad for everyone else. (The Cato study Business Insider cites does make one rather aggravating error; the distribution in a non-rent-controlled market isn’t normal, it’s lognormal. You can see that at a glance by the presence of those extremely high rents on the right side of the graph.)

Most people respond by saying, “Okay, but what do we do for people who can’t afford the regular rent? Do we just make them homeless!?” I wouldn’t be surprised if the Cato Institute or Business Insider were okay with that—but I’m definitely not. So what would I do? Give them money. The solution to poverty has been staring us in the face for centuries, but we refuse to accept it. Poor people don’t have enough money, so give them money. Skeptical? Here are some direct experimental studies showing that unconditional cash transfers are one of the most effective anti-poverty measures. The only kind of anti-poverty program I’ve seen that has a better track record is medical aid. People are sick? Give them medicine. People are poor? Give them money. Yes, it’s that simple. People just don’t want to believe it; they might have to pay a bit more in taxes.

So yes, regulations are actually part of the problem. But they are clearly not the whole problem, and in my opinion not even the most important part. The most important part is monopolization. There’s a map that Occupy Wall Street likes to send around saying “What if our land were as unequal as our money?” But here’s the thing: IT IS. Indeed, the correlation between land ownership and wealth is astonishingly high; to a first approximation, your wealth is a constant factor times the land you own.

Remember how I said that the average American holds 7.7 acres or 3 hectares? (Especially in economics, averages can be quite deceiving. Bill Gates and I are on average billionaires. In fact, I guarantee that Bill Gates and you are on average billionaires; it doesn’t even matter how much wealth you have, it’ll still be true.)

Well, here are some decidedly above-average landowners:

  1. John Malone, 2.2 million acres or 9,000 km^2
  2. Ted Turner, 2 million acres or 8,100 km^2
  3. The Emmerson Family, 1.9 million acres or 7,700 km^2
  4. Brad Kelley, 1.5 million acres or 6,100 km^2
  1. The Pingree Family, 800,000 acres or 3,200 km^2
  1. The Ford Family, 600,000 acres or 2,400 km^2
  1. The Briscoe Family, 560,000 acres or 2,270 km^2
  2. W.T. Wagonner Estate, 535,000 acres or 2,170 km^2

I think you get the idea. Here are two more of particular note:

  1. Jeff Bezos, 290,000 acres or 1,170 km^2
  1. Koch Family, 239,000 acres or 970 km^2

Yes, that is the Jeff Bezos of Amazon.com and the Koch Family who are trying to purchase control of our political system.

Interpolating the ones I couldn’t easily find data on, I estimate that these 102 landowners (there were ties in the top 100) hold a total of 30 million acres, of the 940 million acres in the United States. This means that 3% of the land is owned by—wait for it—0.000,03% of the population. To put it another way, if we confiscated the land of 102 people and split it all up into 0.5-acre family home lots, we could house 60 million households—roughly half the number of households in the nation. To be fair, some of it isn’t suitable for housing; but a good portion of it is. Figure even 1% is usable; that’s still enough for 600,000 households—which is to say every homeless person in America.

One thing you may also have noticed is how often the word “family” comes up. Using Openoffice Calc (it’s like Excel, but free!) I went through the whole top 100 list and counted the number of times “family” comes up; it’s 49 out of 100. Include “heirs” and “estate” and the number goes up to 66. That doesn’t mean they share with their immediate family; it says “family” when it’s been handed down for at least one generation. This means that almost two-thirds of these super-wealthy landowners inherited their holdings. This isn’t the American Dream of self-made millionaires; this is a landed gentry. We claim to be a capitalist society; but if you look at who owns our land and how it’s passed down, it doesn’t look like capitalism. It looks like feudalism.

Indeed, the very concept of rent is basically feudalist. Instead of owning the land we live on, we have to constantly pay someone else—usually someone quite rich—for the right to live there. Stop paying, and they can call the government to have us forced out. We are serfs by another name. In a truly efficient capitalist market with the kind of frictionless credit system neoclassicists imagine, you wouldn’t pay rent, you’d always pay a mortgage. The only time you’d be paying for housing without building equity would be when you stay at a hotel. If you’re going to live there more than a month, you should be building equity. And if you do want to move before your mortgage ends? No problem; sell it to the next tenant, paying off your mortgage and giving you that equity back—instead of all that rent, which is now in someone else’s pocket.

Because of this extreme inequality in land distribution, the top landholders can charge the rest of us monopolistic prices—thus making even more profits and buying even more land—and we have little choice but to pay what they demand. Because shelter is such a fundamental need, we are willing to pay just about whatever we have in order to secure it; so that’s what they charge us.

On to question 2. What happens to our economy as a result of this high rent?

In a word: 2009. Because our real estate market is so completely out of whack with any notion of efficient and fair pricing, it has become a free-for-all of speculation by so-called “investors”. (I hate that term; real investment is roads paved, factories built, children taught. What “investors” do is actually arbitrage. We are the investors, not them.)

A big part of this was also the deregulation of derivatives, particularly the baffling and insane “Commodity Futures Modernization Act of 2000” that basically banned regulation of derivatives—it was a law against making laws. Because of this bankers—or should I say banksters—were able to create ludicrously huge amounts of derivatives, as well as structure and repackage them in ways that would deceive their buyers into underestimating the risks. As a result there are now over a quadrillion dollars—yes, with a Q, sounds like a made-up number, $2e15—in nominal value of outstanding derivatives.

Because this is of course about 20 times as much as there is actual money in the entire world, sustaining this nominal value requires enormous amounts of what’s called leverage—which is to say, debt. When you “leverage” a stock purchase, for example, what you’re doing is buying the stock on a loan (a generally rather low-interest loan called “margin”), then when you sell the stock you pay back the loan. The “leverage” is the ratio between the size of the loan and the amount of actual capital you have to spend. This can theoretically give you quite large returns; for instance if you have $2000 in your stock account and you leverage 10 to 1, you can buy $20,000 worth of stock. If that stock then rises to $21,000—that’s only 5%, so it’s pretty likely this will happen—then you sell it and pay back the loan. For this example I’ll assume you pay 1% interest on your margin. In that case you would start with $2000 and end up with $2800; that’s a 40% return. A typical return from buying stock in cash is more like 7%, so even with interest you’re making almost 6 times as much. It sounds like such a deal!

But there is a catch: If that stock goes down and you have to sell it before it goes back up, you need to come up with the money to pay back your loan. Say it went down 5% instead of up; you now have $19,000 from selling it, but you owe $20,200 in debt with interest. Your $2000 is already gone, so you now have to come up with an additional $1,200 just to pay back your margin. Your return on $2000 is now negative—and huge: -160%. If you had bought the stock in cash, your return would only have been -5% and you’d still have $1900.

My example is for a 10 to 1 leverage, which is considered conservative. More typical leverages are 15 or 20; and some have gotten as high as 50 or even 70. This can lead to huge returns—or huge losses.

But okay, suppose we rein in the derivatives market and leverage gets back down to more reasonable levels. What damage is done by high real estate prices per se?

Well, basically it means that too much of our economy’s effort is going toward real estate. There is what we call deadweight loss, the loss of value that results from an inefficiency in the market. Money that people should be spending on other things—like cars, or clothes, or TVs—is instead being spent on real estate. Those products aren’t getting sold. People who would have had jobs making those products aren’t getting hired. Even when it’s not triggering global financial crises, a market distortion as large as our real estate system is a drain on the economy.

The distorted real estate market in particular also has another effect: It keeps the middle class from building wealth. We have to spend so much on our homes that we don’t have any left for stocks or bonds; as a result we earn a very low return on investment—inflation-adjusted it’s only about 0.2%. So meanwhile the rich are getting 4% on bonds, or 7% on stocks, or even 50% or 100% on highly-leveraged derivatives. In fact, it’s worse than that, because we’re also paying those rich people 20% on our credit cards. (Or even worse, 400% on payday loans. Four hundred percent. You typically pay a similar rate on overdraft fees—that $17.5 billion has to come from somewhere—but fortunately it’s usually not for long.)

Most people aren’t numerate enough to really appreciate how compound interest works—and banks are counting on that. 7%, 20%, what’s the difference really? 3 times as much? And if you had 50%, that would be about 7 times as much? Not exactly, no. Say you start with $1000 in each of these accounts. After 20 years, how much do you have in the 7% account? $3,869.68. Not too shabby, but what about that 20% account? $38,337.60—almost ten times as much. And if you managed to maintain a 50% return, how much would you have? $3,325,256.73—over $3.3 million, almost one thousand times as much.

The problem, I think, is people tend to think linearly; it’s hard to think exponentially. But there’s a really nice heuristic you can use, which is actually quite accurate: Divide the percentage into 69, and that is the time it will take to double. So 3% would take 69/3 = 23 years to double. 7% would take 69/7 = 10 years to double. 35% would take 69/35 = 2 years to double. And 400% would take 69/400 = 0.17 years (about 1/6, so 2 months) to double. These doublings are cumulative: If you double twice you’ve gone up 4 times; if you double 10 times you’ve gone up 1000 times. (For those who are a bit more numerate, this heuristic comes from the fact that 69 ~ 100*ln(2).)

Since returns are so much higher on other forms of wealth (not gold, by the way; don’t be fooled) than on homes, and those returns get compounded over time, this differential translates into ever-increasing inequality of wealth. This is what Piketty is talking about when he says r > g; r is the return on capital, and g is the growth rate of the economy. Stocks are at r, but homes are near g (actually less). By forcing you to spend your wealth on a house, they are also preventing you from increasing that wealth.

Finally, time for question 3. What should we do to fix this? Again, it’s simple: Take the land from the rich. (See how I love simple solutions?) Institute a 99% property tax on all land holdings over, say, 1000 acres. No real family farmer of the pastoral sort (as opposed to heir of an international agribusiness) would be affected.

I’m sure a lot of people will think this sounds unfair: “How dare you just… just… take people’s stuff! You… socialist!” But I ask you: On what basis was it theirs to begin with? Remember, we’re talking about land. We’re not talking about a product like a car, something they actually made (or rather administrated the manufacturing of). We’re not even talking about ideas or services, which raise their own quite complicated issues. These are chunks of the Earth; they were there a billion years before you and they will probably still be there a billion years hence.

That land was probably bought with money that they obtained through monopolistic pricing. Even worse, whom was it bought from? Ultimately it had to be bought from the people who stole it—literally stole, at the point of a gun—from the indigenous population. On what basis was it theirs to sell? And even the indigenous population may not have obtained it fairly; they weren’t the noble savages many imagine them to be, but had complex societies with equally complex political alliances and histories of intertribal warfare. A good portion of the land that any given tribe claims as their own was likely stolen from some other tribe long ago.

It’s honestly pretty bizarre that we buy and sell land; I think it would be valuable to think about how else we might distribute land that didn’t involve the absurdity of owning chunks of the planet. I can’t think of a good alternative system right now, so okay, maybe as a pragmatic matter the economy just works most efficiently if people can buy and sell land. But since it is a pragmatic justification—and not some kind of “fundamental natural right” ala Robert Nozick—then we are free as a society—particularly a democratic society—to make ad hoc adjustments in that pragmatic system as is necessary to make people’s lives better. So let’s take all the land, because the rent is too damn high.