Although the details of the proposals are not made public, each finalist is likely offering some combination of tax breaks, subsidies, and other incentives in return for the company’s choice to locate in their city. The very bidding process necessitates a lot of time and effort by many parties. It will certainly seem “worth it” to the winning party, but the losers aren’t getting back the time and effort they spent.

This practice of offering incentives for businesses has been employed by states and localities for decades, with increased usage over time. Targeted economic development incentives can take the form of tax exemptions, abatements, regulatory relief, and taxpayer assistance. They are but one explicit cost paid by states and cities looking to secure business, and there is a growing literature that suggests these policies are more costly than meets the eye.

First, there’s the issue of economic freedom. Recent Mercatus research suggests that there may be a tradeoff to offering economic development incentives like the ones that Amazon is receiving. Economists John Dove and Daniel Sutter find that states that spend more on targeted development incentives as a percentage of gross state product also have less overall economic freedom. The theoretical reasoning behind this is not very clear, but Dove and Sutter propose that it could be because state governments that use more subsidies or tax breaks to attract businesses will also spend more or raise taxes for everyone else in their state, resulting in less equitable treatment of their citizens and reducing overall economic freedom.

The authors define an area as having more economic freedom if it has lower levels of government spending, taxation, and labor market restrictions. They use the Fraser Institute’s Economic Freedom of North America Index (EFNA) to measure this. Of the three areas within the EFNA index, labor market freedom is the most affected by targeted economic development incentives. This means that labor market regulation such as the minimum wage, government employment, and union density are all significantly related to the use of targeted incentives.

Economic freedom can be ambiguous, however, and it’s sometimes hard to really grasp its impact on our lives. It sounds nice in theory, but because of its vagueness, it may not seem as appealing as a tangible economic development incentive package and the corresponding business attached to it. Economic freedom is associated with a series of other, more tangible benefits, including higher levels of income and faster economic growth. There’s also evidence that greater economic freedom is associated with urban development.

Not only is the practice of offering targeted incentives associated with lower economic freedom, but it is also indicative of other issues. Economists Peter Calcagno and Frank Hefner have found that states with budget issues, high tax and regulatory burdens, and poorly trained labor forces are also more likely to offer targeted incentives as a way to offset costly economic conditions. Or, in other words, targeted development incentives can be – and often are – used to compensate for a less than ideal business climate. Rather than reform preexisting fiscal or regulatory issues within a state, the status quo and the use of targeted incentives is the more politically feasible option.

Perhaps the most concerning aspect of Amazon’s bidding process is the effect it has on our culture. Ideally, economic development policy should be determined by healthy economic competition between states. In practice, it has evolved into more of an unhealthy interaction between private interests and political favor. Economists Joshua Jansa and Virginia Gray refer to this as cultural capture. They find increases in business political contributions to be positively correlated with state subsidy spending. Additionally, they express concern over the types of firms that these subsidies attract. There is a selection bias for targeted incentives to systematically favor “flighty firms” or firms that will simply relocate if better subsidies are offered by another state, or potentially threaten to leave in an effort to extract more subsidies.

None of these concerns even address the question of whether targeted incentives actually achieve their intended goals.  The evidence does not look good. In a review of the literature by my colleague Matthew Mitchell, and me, we found that of the studies that evaluate the effect of targeted incentives on the broader economy, only one study found a positive effect, whereas four studies found unanimously negative effects. Thirteen studies (half of the sample) found no statistically significant effect, and the remaining papers found mixed results in which some companies or industries won, but at the expense of others.

In addition to these unseen costs on the economy, some critics are beginning to question whether being chosen by Amazon is even worth it. Amazon’s first headquarters has been considered a catalyst for the city’s tech industry, but local government and business leaders have raised concerns about other possibly related issues such as gentrification, rising housing prices, and persistent construction and traffic congestion. There is less research on this, but it is worth considering.

It is up to each city’s policymakers to decide whether these trade-offs are worth it. I would argue, however, that much of the evidence points to targeted incentives – like the ones that cities are using to attract Amazon’s business – as having more costs than benefits. Targeted economic development incentives may seem to offer a lot of tangible benefits, but their unseen costs should not be overlooked. From the perspective of how they benefit each state’s economy as a whole, targeted incentives are detrimental to economic freedom as well as our culture surrounding corporate handouts. Last but not least, they may often be an attempt to cover up other issues that are unattractive to businesses.

The post The unseen costs of Amazon’s HQ2 Site Selection appeared first on Neighborhood Effects.

In chapter 12 of a new Mercatus book on sin taxes, NYU professor Thad Calabrese examines the practice of locally-imposed selective taxes that are used to fund public pension liabilities and doesn’t find much evidence to support their continued usage.

Selective taxes are sales taxes that target specific goods and are also known as ‘sin taxes’ because of their popular usage in taxing less healthy goods such as cigarettes, junk food, or alcohol. In the examples that Calabrese examines, selective taxes are used to target insurance premiums as revenue sources for pensions.

Only a select few states have begun this practice – including Illinois, Pennsylvania, as well as municipalities in West Virginia and Missouri – but it may become more popular if courts begin to restrict the way in which current pension benefits can be modified. Once benefits are taken off the table as an avenue for reform, like in Illinois, policymakers will feel more pressure to find new revenue sources.

The proposal in Kentucky may seem appealing to policymakers, especially because of its potential to raise $600 million a year, but this estimate overlooks the unintended effects that such new taxes could facilitate. Thankfully, the proposal did not go through, but I think some time should be spent looking at what similar proposals have looked like at the local level, so that other states do not get tempted pick up where Kentucky left off.

Calabrese draws on the experiences in Pennsylvania and Illinois to examine how these taxes have operated, how the decoupling of setting and financing employee benefits tends to lead to these taxes, and how the use of these taxes is associated with significantly underfunded pension systems. Below I highlight Pennsylvania’s experience and caution against further usage of this mechanism for pension funding.

How it works (or doesn’t)

In 1895, Pennsylvania implemented a 2 percent tax on out-of-state fire and casualty insurance companies’ premiums on in-state property and then earmarked this for distribution to local governments to pay for pensions. Act 205 of 1984 replaced the original act in which the state of Pennsylvania allocated pension aid based on where the insured property was located and instead the new allocation was based on the number of public employees in a locality.

Calabrese explains how the funds were distributed:

“Each public employee was considered a ‘unit,’ and uniformed employees (such as police and fire) each represented two units. The pool of insurance tax revenue collected by the state was then divided by the sum of municipal units to arrive at a unit value. This distribution could subsidize local governments’ pension expenditures up to 100 percent of the annual cost. In 1985, this tax generated $62.3 million in revenues; as a result, each unit value was worth $1,146 – meaning that local governments received $1,146 for pension funding for each public employee and an additional $1,146 for pension funding for each uniformed public employee. Importantly, 75 percent of municipalities received enough funding from this revenue in 1985 to fully offset their pension costs.”

The new mechanism raised more funds, but it also unexpectedly raised costs. If a municipality had to contribute less than the $1,146 annually for a regular employee or $2,292 for a uniformed employee, for example, the municipality was essentially incentivized to increase benefits to public employees up to this limit, because local public employees would receive increased benefits at no direct budgetary cost to the municipality.

“…the tax likely increased insurance costs for residents and businesses (and then only a small fraction of the cost), but not directly for the government employer. Further, this system privileged benefits relative to other compensation, because these payments (borne at least statutorily by out-of-state companies) could only be used for financing pensions and not other forms of compensation.”

A tax originally implemented to fund pension costs statewide resulted in a system that encouraged more generous benefits.

Despite increased subsidies from the state, only 38 percent of municipalities received sufficient allocated funds from the pool to fully offset the costs of pensions. This was because annual pension contributions were growing at a faster rate than the rate at which the subsidy from the state insurance tax was growing.

To highlight a city with severely distressed pension plans, Philadelphia continued to struggle even following the implementation of the state insurance tax. The police pension plan, nonuniformed plan, and firefighter pension plan were all only 49, 47, and 45 percent funded, respectively. In 2009, the City Council passed a temporary 1 percentage point increase in their sales tax and when the temporary rate was renewed in 2014, any revenue in excess of $120 million was dedicated to the city’s pension plans. Additionally, the state permitted the city to pass a $2 per pack cigarette tax to fund a planned budget deficit for the school system; likely because its income tax capacity was largely exhausted.

Philadelphia’s new taxes technically generated new revenues, but they did little to improve the funding of the city’s pension plans.

The selective taxes implemented to fund pension liabilities in Pennsylvania were effectively a Band-Aid that was two small for the state’s pension funding problem, which in turn required the addition of more, insufficient pension Band-Aids. It merely created a public financing system that encouraged pension benefit growth which led to the passage of additional laws requiring certain pension funding levels. And when these funding levels were not met, even more laws were passed that provided temporary pension funding relief, which further grew liabilities for distressed municipalities.

Act 44 became law in 1993 and provided plan sponsors pension funding relief, but primarily by allowing sponsors to alter actuarial assumptions and thereby reduce required pension contributions. Another law delayed funding by manipulating how the required contribution was calculated, rather than providing any permanent fix.

Moving forward

Selective taxes for the purpose of funding pensions are still a relatively rare practice, but as pension liabilities grow and the landscape of reform options changes, it may become increasingly attractive to policymakers. As Calabrese has demonstrated in his book chapter, however, we should be wary of this avenue as it may only encourage the growth of pension liabilities without addressing the problem in any meaningful way. Reforming the structure of the pension plan or the level of benefits provided to current or future employees would provide the most long-term solution.

A solution with the long-term in mind and that doesn’t involve touching current beneficiaries includes moving future workers to defined contribution plans; plans that are better suited to keeping costs contained. The ballooning costs aren’t stemming solely from overly generous plan benefits, but more seriously are the result of their poor management and incentives for funding, only exacerbated by poor accounting practices. The problem is certainly complicated and moving towards the use of defined contribution plans wouldn’t eliminate all issues, but it would at least set governments on a more sustainable path.

At the very least, policymakers interested in long-term solutions should be cautioned against using selective taxes to fund pensions.

The post The use of locally-imposed selective taxes to fund public pension liabilities appeared first on Neighborhood Effects.

As part of each program students get access to funding, practical experience, and a wide network of passionate, dedicated scholars. Many graduates from each program go on to develop successful careers in academia and public policy. Ninety-two percent of MA Fellowship graduates, for example, receive a job within 9 months of graduation. Whether you’re pursuing a Master’s, PhD, or law degree, there may be something for you at Mercatus.

The four programs and their details are below.  If you’re interested in learning more and applying, check out our website. Deadlines are right around the corner, with the PhD Fellowship deadline approaching at the end of this week.

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Mercatus PhD Fellowship

The PhD Fellowship is a competitive, full-time fellowship program for students pursuing a doctoral degree in economics at George Mason University. PhD Fellows take courses in market process economics, public choice, and institutional analysis and work on projects that use these lenses to understand global prosperity and change.

Students receive an award up to $200,000 (over five years) for full tuition support and a monthly stipend, as well as experience as a research assistant working closely with Mercatus-affiliated Mason faculty. The application deadline is February 1, 2018.

Mercatus MA Fellowship

The MA Fellowship is a tw0-year, competitive, full-time fellowship program for students pursuing a master’s degree in economics at George Mason University in preparation for a career in public policy. Fellows attend readings groups and career development workshops, spend at least 20 hours per week working with Mercatus scholars and staff, and complete a Mercatus Graduate Policy essay.

Students receive an award of up to $80,000 (over two years) for full tuition support and a monthly stipend, as well as practical experience conducting and disseminating research with Mercatus scholars and staff on pertinent policy issues. The application deadline is March 1, 2018.

Mercatus Adam Smith Fellowship

The Adam Smith Fellowship is a one-year, competitive fellowship program for PhD students at any university and in any discipline. The goal of this fellowship is to introduce students to a framework of ideas they may not otherwise encounter in their studies. Fellows meet a few times out of the year to engage in discussions on key foundational texts in the Austrian, Virginia, and Bloomington schools of political economy and learn how these texts may apply to their research interests.

Students receive a stipend up to $10,000 as well as travel, lodging, and all materials to attend workshops and seminars hosted by the Mercatus Center. The application deadline is March 15, 2018.

Mercatus Frédéric Bastiat Fellowship

The Frédéric Bastiat Fellowship is a one-year, competitive fellowship program for graduate students attending master’s, juris doctoral, and doctoral programs in a variety of disciplines. The goal of this fellowship is to introduce students to the Austrian, Virginia, and Bloomington school of political economy as academic foundations for pursuing contemporary policy analysis. Fellows meet a few times out of the year to engage in discussions on key foundational texts and interact with scholars that work on the cutting edge of policy analysis.

Students receive a stipend of up to $5,000 as well as travel, lodging, and all materials to attend workshops and seminars hosted by the Mercatus Center. The application deadline is March 15, 2018.

The post Graduate School Opportunities Available Through Mercatus appeared first on Neighborhood Effects.

A narrow tax base reliant on volatile revenue sources, restricted funds, and growing spending are all factors that made closing Alaska’s budget gap this year very difficult. It even contributed to pulling down Alaska from 1^st in our 2016 ranking of states by fiscal condition to 17^th in our 2017 edition. Given this deterioration, it will be helpful to look into how and why Alaska residents receive dividend payments each year. There is no public finance rule that says giving refunds to residents is fiscally irresponsible, but there definitely are better ways to do it, and Alaska certainly hasn’t proven to display best practices.

Another state that we can look at for comparison is Colorado, which has a similar “tax refund” for residents but is structured very differently. Colorado’s Taxpayer Bill of Rights (TABOR) requires that higher than expected tax revenues each year be refunded to taxpayers and acts as a restraint on government spending growth. In contrast, Alaska’s check comes from the state’s Permanent Fund’s earnings that are generated from oil severance taxes each year, and acts more like a dividend from oil investment earnings.

Are distributing these refunds to taxpayers fiscally responsible? I am going to take a deeper look at these mechanisms to find out.

First, Alaska’s refund.

The figure below displays Alaska’s Permanent Fund checks since 2002 overlaid with the state’s revenue and expenditure trends, all adjusted for inflation. The highest check (in 2015 dollars) was $2,279 in 2008 and the lowest was $906 in 2012, with the average over this time period being about $1,497 per person. Although the check amounts do vary, Alaska has kept on top of delivering them, even in times of steep budget gaps like in 2002, 2009, and 2015. The Permanent Fund dividend formula is based on net income from the current plus the previous four fiscal years, so it makes sense that the check sizes are also cyclical in nature, albeit in a slightly delayed fashion behind oil revenue fluctuations.

Alaska’s dividend payments often end up on the chopping block during yearly budget debates, and there is growing pressure to at least have them reduced. Despite this, Alaska’s dividends are very popular with residents (who can blame them?) and probably won’t be going away for a long time; bringing a new meaning to the Permanent Fund’s name.

The Alaska Permanent Fund was established in 1976 by constitutional amendment and was seen as an investment in future generations, who might no longer have access to oil as a resource. Although this may have been decent forward-thinking, which is rare in state budgets, it does illustrate an interesting public finance story.

Alaska is a great example of a somewhat backwards situation. They generate high amounts of cash each year, but because of the way many of their funds are restricted they are forced to hoard much of it, and give the rest to citizens in the form of dividends. If a different state were to consider a similar dividend before dealing with serious structural budget flaws would be akin to putting the cart before the horse.

Luckily for Alaskan dividend recipients, there are many other areas that the state could reform first in order to improve their budget situation while avoiding cutting payments. As my colleague Adam Millsap has recommended, a fruitful area is tax reform. Alaska doesn’t have an income or sales tax; two of the most common sources of revenue for state governments. These are two potentially more stable sources of income than what the state currently has.

How does Colorado’s “tax refund” compare?

Colorado’s Taxpayer Bill of Rights (TABOR) has a feature that requires any tax revenue growth beyond inflation and population growth be refunded to taxpayers. It was adopted by Colorado voters in 1992 and it essentially restricts revenues by prohibiting any tax or spending increases without voter approval.

A recent example of this playing out was in 2014 when the state realized higher than expected tax revenues as a result of marijuana legalization. At the point of legalization, the plan was to direct tax revenues generated from the sale of marijuana towards schools or substance abuse program funding. But because of the higher than expected revenues, TABOR was triggered and it would require voter approval to decide if the excess revenues would be sent back to taxpayers or directed to other state programs.

In November of 2015, Colorado voters approved a statewide ballot measure that gave state lawmakers permission to spend $66.1 million in taxes collected from the sale of marijuana. The first $40 million was sent to school construction, the next $12 million to youth and substance abuse programs, and the remainder $14.2 billion to discretionary spending programs. A great example that although TABOR does generally restrain spending, citizens still have power to decline refunds in the name of program spending they are passionate about.

The second figure here displays TABOR refunds compared with state revenues and expenditures over time. Adjusted for inflation, checks have varied from $18 in 2005 to $351 in 1999, much smaller than the Alaska dividend checks. TABOR checks have only tended to be distributed when revenues have exceeded expenses. The main reason why checks weren’t distributed between 2006 and 2009, despite a revenue surplus, was because of Referendum C which removed TABOR’s revenue limit for five years, allowing the state to keep collections exceeding the rule. The revenue limit has since been reinstated, but some question the effectiveness of TABOR given an earlier amendment in 2000 which exempts much of education spending from TABOR restrictions.

The main distinguishing factor between Colorado’s refund and Alaska’s Permanent Fund dividend is that the former also acts as a constraint on spending growth. By requiring the legislature to get voter approval before any tax increase or spending of new money, it implements automatic checks on these activities. Many states attempt to do this through what are called “Tax and Expenditure Limits” or TELs.

The worry is that left unchecked, state spending can grow to unsustainable levels.

Tax and Expenditure Limits

A review of the literature up to 2012 found that although the earliest studies were largely skeptical of the effectiveness of TELs, as time has passed more research points to the contrary. TELs can restrain spending, but only in certain circumstances.

My colleague Matt Mitchell found in 2010 that TELs are more effective when they (1) bind spending rather than revenue, (2) require a super-majority rather than a simple majority vote to be overridden, (3) immediately refund revenue collected in excess of the limit, and (4) prohibit unfunded mandates on local government.

Applying these criteria to Colorado’s TABOR we see that it does well in some areas and could improve in others. TABOR’s biggest strength is that it immediately refunds revenue collected in excess of the limit in its formula, pending voter approval to do otherwise. Automatically refunding surpluses makes it difficult for governments to use excess funds irresponsibly and also gives taxpayers an incentive to support TABOR.

Colorado’s TABOR does well to limit revenue growth according to a formula, rather than to a fixed number or no limitation at all. The formula partially meets Mitchell’s standards. It stands up well with the most stringent TELs by limiting government growth that exceeds inflation and population growth, but could actually be improved if it limited actual spending growth rather than focusing on tax revenue. When a TEL or similar law limits revenues, policymakers can respond by resorting to implementing more fees or borrowing. There’s some evidence of this occurring in Colorado, with fees becoming more popular as a way to raise revenue since TABOR’s passing. A spending-based TEL is more difficult to evade.

Despite its faults, Colorado’s TABOR structure appears to be doing better than attempts to constrain spending growth in other states. The National Conference of State Legislatures still considers it one of the strictest TELs in the nation. Other states, like Arkansas, could learn a lot from Colorado. A recent Mercatus study analyzes Arkansas’ Revenue Stabilization Law and suggests that it is missing a component similar to Colorado’s TABOR formula to refund excess revenues.

How much a state spends is ultimately up to its residents and legislature. Some states may have a preference for more spending than others, but given the tendency for government spending to grow towards an unsustainable direction, having a conversation about how to slow this is key. Implementing TEL-like checks allows for spending to be monitored and that tax dollars be spent more strategically.

Alaska’s Permanent Fund dividend is not structured as well as Colorado’s, but perhaps the state’s saving grace is that it has a relatively well structured TEL. Similarly to Colorado’s TABOR, Alaska’s TEL limits budget growth to the sum of inflation and population growth and is codified in the constitution. Alaska’s TEL doesn’t immediately refund revenue that is collected in excess of the limit to taxpayers as Colorado’s TABOR does, but it does target spending rather than revenues.

Colorado’s and Alaska’s TELs can compete when it comes to restraining spending, but Colorado’s is certainly more strict. Colorado’s expenditures have grown by about 55 percent over the last decade, while Alaska’s has grown approximately 120 percent.

The Lesson

Comparing Colorado and Alaska’s situations reveals two different ways of giving tax refunds to residents. Doing so doesn’t necessarily have to be fiscally irresponsible. Colorado has provided refunds to residents when state revenues have exceeded expenses and as a result this has acted as a restraint on over-spending higher than expected revenues. Although Colorado’s TABOR has been amended over time, its general structure illustrates the effectiveness of institutional restrains on spending. The unintended effects of TABOR, such as the increase in fees, could be well addressed by specifically targeting spending rather revenue, like in the case of Alaska’s TEL. Alaska may have had their future residents’ best intent in mind when they designed their Permanent Fund Dividend, but perhaps this goal of passing forward oil investment earnings should have been paired with preparing for the potential of cyclical budget woes.

The post State tax refunds and limiting spending growth appeared first on Neighborhood Effects.

The millennial generation has grown to be an integral part of the workforce, and private sector companies are increasing their efforts to understand what they value most a job. A Deloitte survey reveals that a good work/life balance, opportunities to progress/be leaders, flexibility, and a sense of meaning emerge as the most important factors when evaluating job opportunities. What’s more, millennials are not likely to stick around for a job that doesn’t meet this criteria. The same survey found that if given the choice during the next year, one in four millennials would quit his or her current employer to join a new organization or to do something different.

This flightiness appears to be a characteristic of many young people and to be happening in tandem with, if not contributing to, an increasingly transient job market. This phenomenon, corroborated by other surveys, demonstrates that more and more millennial workers are changing jobs at a higher rate than previous generations. It is not as common to stick with your first or second job until retirement, as it once was for Baby Boomers. The “loyalty challenge” facing companies, paired with changes in technology and culture, has in turn been transforming the landscape of retirement options.

As workers become more transient, companies are forced to provide more portable retirement plan options. During the past two decades, the private sector has done just that by transitioning from offering primarily defined benefit retirement plans to offering more defined contribution plans. This change is to be expected in part because of the flexibility it provides for beneficiaries. Defined contribution plans allow for workers to take their benefits more easily with them from job to job.

The public sector has not quite caught up to this trend. Public sector plans have had much more difficulty staying solvent and much of this is because of the prevalence of defined benefit plans. Mercatus scholars, along with many economists, have long criticized the poor incentive structure of these plans. If these aren’t reason enough for policymakers to offer defined contribution plans in their place, then maybe their changing workforces will.

Much of the debate over growing pension liabilities has focused on whether public sector compensation costs are fair either in comparison to other states or to the private sector. But much less has been said about what is fair across generations.

Most pension reform efforts at the state level target changes in benefits for younger employees while preserving the benefits of older workers. Although this is largely the result of legal and political constraints, such changes have the potential to force younger generations of public-sector workers to shoulder a disproportionate share of the cost of reforms, as their retirement benefits become more uncertain, thus violating a crucial criterion of “intergenerational equity” for pension reform.

Pension experts Robert Novy-Marx and Joshua Rauh reveal in a 2008 study that the intergenerational transfer of pension debt could be quite large. They predict a 50 percent chance of underfunding across the states amounting to more than $750 billion, even before adjusting for risk. In other words, if left alone, the pension bills of today are going to be handed to the generations of tomorrow.

A new Mercatus paper uncovers how similar intergenerational equity issues have developed in the state of Oregon. The author, legal scholar Scott Shepard, writes:

“…the system radically favors (generally older) workers who started before 1996 and 2003, respectively – not just in expected ways, like seniority pay bumps, but in deeply structural ways; earlier-hired employees simply get a significantly better pay-and-benefit package for every minute of their climb up the seniority ladder.”

Oregon’s pension system, along with many other states’ plans, started out offering extremely generous benefits, but as this has grown increasingly unsustainable, the state is being forced to deal with reality and reign in benefits for newer workers.

The unfair retirement landscape that this creates is largely the result of many past poor policy decisions and although this difference in benefits between age groups is far from intentional, how Oregon – and other states in similar positions – responds can be. Changing demographic trends may lend reason for public pension officials to consider moving towards defined contribution plan structures, or at least providing the option.

Shepard strongly urges Oregon to make this shift. He describes a number of benefits; from the perspective of the state, taxpayers, and future generations:

“First, payments must be made when due, rather than being shifted off to future generations. This may seem painful to present taxpayers, but the long-term effect is to ensure a more honest government, in that politicians cannot make promises that their (unrepresented) descendants end up paying for generations later, long after the promisors have reaped the political benefits of making unfunded promises, only to have retired from the scene when payment comes due. This inability to promise now and pay later has a corollary benefit of thwarting the impulse to make extravagant pension promises, as the payments come due immediately, rather than being foisted off on future generations.”

Offering defined contribution plans for workers can provide a more sustainable option that would prevent this equity issue from worsening.

In addition to the accountability and savings that offering a defined contribution option provides, like we have seen demonstrated in Utah and Michigan, this also has the potential to lead to higher worker satisfaction.

With millennials looking to save money for retirement through more portable means, policymakers will want to offer benefits packages that match these preferences. Private sector workers and some public – including Federal and public university – workers lie at the forefront of those benefiting from the defined contribution trend. Most state public plans, however, still fall behind, which has continuing implications for public plan solvency and intergenerational equity.

The post A public sector retirement plan for Millennials appeared first on Neighborhood Effects.

Previous work examining entrepreneurship that categorizes all self-employed persons as entrepreneurs has often found that entrepreneurs earn less than similar salaried workers. But this contradicts the important role entrepreneurs are presumed to play in generating economic growth. As the authors of the new QJE paper remark:

“If the self-employed are a good proxy for risk-taking, growth-creating entrepreneurs, it is puzzling that their human capital traits are similar to those of salaried workers and that they earn less.”

So instead of looking at the self-employed as one group, the authors separate them into two groups: those who operate unincorporated businesses and those who operate incorporated businesses. They argue that incorporation is important for risk-taking entrepreneurs due to the limited liability and separate legal identity it provides, and they find that those who choose incorporation are more likely to engage in tasks that require creativity, analytical flexibility and complex interpersonal communications; all tasks that are closely identified with the concept of entrepreneurship.

People who operate unincorporated businesses, on the other hand, are more likely to engage in activities that require high levels of hand, eye and foot coordination, such as landscaping or truck driving.

Once the self-employed are separated into incorporated and unincorporated, the puzzling finding of entrepreneurs earning less than similar salaried workers disappears. The statistics in the table below taken from the paper show that on average incorporated business owners (last column) earn more, work more hours, have more years of schooling and are more likely to be a college graduate than both unincorporated business owners and salaried workers based on two different data sets (Current Population Survey (CPS) and National Longitudinal Survey of Youth (NLSY)).

(click table to enlarge)

The authors then examine the individual characteristics of incorporated and unincorporated business owners. They find that people with high self-esteem, a strong sense of controlling one’s future, high Armed Forces Qualifications Test scores (AFQT)—which is a measure of intelligence and trainability—and a greater propensity for engaging in illicit activity as a youth are more likely to be incorporated self-employed.

Moreover, it’s the combination of intelligence and risk-taking that turns a young person into a high-earning owner of an incorporated business. As the authors state, “The mixture of high learning aptitude and disruptive, “break-the-rules” behavior is tightly linked with entrepreneurship.”

These findings fit nicely with some notable recent examples of entrepreneurship—Uber and Airbnb. Both companies are regularly sued for violating state and local ordinances, but this hasn’t stopped them from becoming popular providers of transportation and short-term housing.

If the founders of Uber and Airbnb always obtained approval before operating the companies would be hindered by all sorts of special interests, including taxi commissions, hotel industry groups and nosy neighbors. Seeking everyone’s approval—including the government’s—before operating likely would have meant never getting off the ground and the companies know this. It’s interesting to see evidence that many other, less well-known entrepreneurs share a similar willingness to violate the rules if necessary in order to provide their goods and services to customers.

The post Smart rule-breakers make the best entrepreneurs appeared first on Neighborhood Effects.

Manufacturing has typically been a male-dominated industry, especially for males with less formal education, but increases in automation and productivity have resulted in fewer manufacturing jobs in the United States over time. As manufacturing jobs disappeared, the story goes, so did a lot of economic opportunities for working-age men. The result has been men leaving the labor force.

However, the same decline in manufacturing employment occurred in other countries as well, yet many of them experienced much smaller declines in their prime-age male LFP rates. The table below shows the percent of employment in manufacturing in 1990 and 2012 for 10 OECD countries, as well as their 25 to 54 male LFP rates in 1990 and 2012. The manufacturing data come from the FRED website and the LFP data are from the OECD data site. The ten countries included here were chosen based on data availability and I think they provide a sample that can be reasonably compared to the United States.

As shown in the table, all of the countries experienced a decline in manufacturing employment and labor force participation over this time period. Thus America was not unique in this regard.

But when changes in both variables are plotted on the same graph, the story that the decline in manufacturing employment caused the drop in male LFP rate doesn’t really hold up.

The percentage point change in manufacturing employment is across the top on the x-axis and the percentage point change in the prime-age male LFP rate is on the y-axis. As shown in the graph the relationship between the two is negative in this sample, and the change in manufacturing employment explains almost 36% of the variation in LFP rate declines (the coefficient on the decline in manufacturing employment is -0.322 and the p-value is 0.08).

In other words, the countries that experienced the biggest drops in manufacturing employment experienced the smallest drops in their LFP rate, which is the opposite of what we would expect if the decline in manufacturing employment played a big role in the decline of the LFP rate across countries.

Of course, correlation does not mean causation and I find it hard to believe that declines in manufacturing employment actually improved LFP rates, all else equal. But I also think the less manufacturing, less labor force participation story is too simple, and this data supports that view.

America and Italy experienced similar declines in their male LFP rates but neither experienced the largest declines in manufacturing employment over this time period. What else is going on in America that caused its LFP decline to more closely resemble Italy’s than that of Canada, Australia and the UK, which are more similar to America along many dimensions?

Whatever the exact reasons are, it appears that American working-age males responded differently to the decline in manufacturing employment over the last 20 + years than similar males in similar countries. This could be due to our higher incarceration rate, the way our social safety net is constructed, differences between education systems, the strength of the economy overall or a number of other factors. But attributing the bulk of the blame to the decline of manufacturing employment doesn’t seem appropriate.

The post Manufacturing employment and the prime-age male LFP rate: What’s the relationship? appeared first on Neighborhood Effects.

The 12.3% of prime-age males not in the labor force nationwide masks substantial variation at the state level. The figure below shows the percentage of prime-age males not in the labor force—neither working nor looking for a job—by state in 2016 according to data from the Current Population Survey.

The lowest percentage was in Wyoming, where only 6.3% of prime males were out of the labor force. On the other end of the spectrum, over 20% of prime males were out of the labor force in West Virginia and Mississippi, a shocking number. Remember, prime-age males are generally not of school age and too young to retire, so the fact that one out of every five is not working or even looking for a job in some states is hard to fathom.

Several researchers have investigated the absence of these men from the labor force and there is some agreement on the cause. First, demand side factors play a role. The decline of manufacturing, traditionally a male dominated industry, reduced the demand for their labor. In a state like West Virginia, the decline of coal mining—another male dominated industry—has contributed as well.

Some of the most recent decline is due to less educated men dropping out as the demand for their skills continues to fall. Geographic mobility has also declined, so even when an adjacent state has a stronger labor market according to the figure above—for example West Virginia and Maryland—people aren’t moving to take advantage of it.

Of course, people lose jobs all the time yet most find another one. Moreover, if someone isn’t working, how do they support themselves? The long-term increase in female labor force participation has allowed some men to rely on their spouse for income. Other family members and friends may also help. There is also evidence that men are increasingly relying on government aid, such as disability insurance, to support themselves.

These last two reasons, relying on a family member’s income or government aid, are supply-side reasons, since they affect a person’s willingness to accept a job rather than the demand for a person’s labor. A report by Obama’s Council of Economic Advisors argued that supply-side reasons were only a small part of the decline in the prime-age male labor force participation rate and that the lack of demand was the real culprit:

“Reductions in labor supply—in other words, prime-age men choosing not to work for a given set of labor market conditions—explain relatively little of the long-run trend…In contrast, reductions in the demand for labor, especially for lower-skilled men, appear to be an important component of the decline in prime-age male labor force participation.”

Other researchers, however, are less convinced. For example, AEI’s Nicholas Eberstadt thinks that supply-side factors play a larger role than the CEA acknowledges and he discusses these in his book Men Without Work. One piece of evidence he notes is the different not-in-labor-force (NILF) rates of native born and foreign born prime-age males: Since one would think that structural demand shocks would affect both native and foreign-born alike, the difference indicates that some other factor may be at work.

In the figure below, I subtract the foreign born not-in-labor-force rate from the native born rate by state. A positive number means that native prime-age males are less likely to be in the labor force than foreign-born prime age males. (Note: Foreign born only means a person was born in a country other than the U.S.: It does not mean that the person is not a citizen at the time the data was collected.)

As shown in the figure, natives are less likely to be in the labor force (positive bar) in 34 of the 51 areas (DC included). For example, in Texas the percent of native prime-age men not in the labor force is 12.9% and the percentage of foreign-born not in the labor force is 5.9%, a 7 percentage point gap, which is what’s displayed in the figure above.

The difference in the NILF rate between the two groups is also striking when broken down by education, as shown in the next figure.

In 2016, natives with less than a high school degree were four times more likely to be out of the labor force than foreign born, while natives with a high school degree were twice as likely to be out of the labor force. The NILF rates for some college or a bachelor’s or more are similar.

Mr. Eberstadt attributes some of this difference to the increase in incarceration rates since the 1970s. The U.S. imprisons a higher percentage of its population than almost any other country and it is very difficult to find a job with an arrest record or a conviction.

There aren’t much data combining employment and criminal history so it is hard to know exactly how much of a role crime plays in the difference between the NILF rates by education. Mr. Eberstadt provides some evidence in his book that shows that men with an arrest or conviction are much more likely to be out of the labor force than similar men without, but it is not perfectly comparable to the usual BLS data. That being said, it is reasonable to think that the mass incarceration of native prime-age males, primarily those with little formal education, has created a large group of unemployable, and thus unemployed, men.

Is incarceration a supply or demand side issue? On one hand, people with a criminal record are not really in demand, so in that sense it’s a demand issue. On the other hand, crime is a choice in many instances—people may choose a life of crime over other, non-criminal professions because it pays a higher wage than other available options or it somehow provides them with a more fulfilling life (e.g. Tony Soprano). In this sense crime and any subsequent incarceration is the result of a supply-side choice. Drug use that results in incarceration could also be thought of this way. I will let the reader decide which is more relevant to the NILF rates of prime-age males.

Criminal justice reform in the sense of fewer arrests and incarcerations would likely improve the prime-age male LFP rate, but the results would take years to show up in the data since such reforms don’t help the many men who have already served their time and want to work but are unable to find a job. Reforms that make it easier for convicted felons to find work would offer more immediate help, and there has been some efforts in this area. How successful they will be remains to be seen.

Other state reforms such as less occupational licensing would make it easier for people— including those with criminal convictions—to enter certain professions. There are also several ideas floating around that would make it easier for people to move to areas with better labor markets, such as making it easier to transfer unemployment benefits across state lines.

More economic growth would alleviate much of the demand side issues, and tax reform and reducing regulation would help on this front.

But has something fundamentally changed the way some men view work? Would some, especially the younger ones, rather just live with their parents and play video games, as economist Erik Hurst argues? For those wanting to learn more about this issue, Mr. Eberstadt’s book is a good place to start.

The post Many working-age males aren’t working: What should be done? appeared first on Neighborhood Effects.

Despite these issues, residents have not been complaining, at least not until recently. Every fall, some earnings from Alaska’s Permanent Fund get distributed out to citizens – averaging about $1,100 per year since 1982. Last summer, Governor Walker used a partial veto to reduce the next dividend from $2,052 to $1,022. Although politically unpopular, these checks may be subject to even more cuts as a result of the current budget crisis.

The careful reader might notice that Alaska topped the list of the most fiscally healthy states in a 2016 Mercatus report that ranks the states according to their fiscal condition (using fiscal year 2014 data). For a state experiencing so much budget trouble, how could it be ranked so highly?

The short answer is that Alaska’s budget is incredibly unique.

On the one hand, the state has large amounts of cash, but on the other, it has large amounts of debt. Alaska’s cash levels are what secured its position in our ranking last year. Although holding onto cash is generally a good thing for state governments, there appears to be diminishing returns to doing so, especially if there is some structural reason that makes funds hard to access for paying off debt or for improving public services. It is yet to be seen how these factors will affect Alaska’s ranking in the next edition of our report.

Another reason why Alaska appeared to be doing well in our 2016 report is that the state’s problems – primarily spending growth and unsustainable revenue sources – are still catching up to them. Alaska has relied primarily on oil tax revenues and has funneled much of this revenue into restricted permanent trusts that cannot be accessed for general spending. When the Alaska Permanent Fund was created in the 1980s, oil prices were high and production was booming, so legislators didn’t really expect for this problem to occur. The state is now starting to experience the backlash of this lack of foresight.

The first figure below shows Alaska’s revenue and expenditure trends, drawing from the state’s Comprehensive Annual Financial Reports (CAFRs). At first look, you’ll see that revenues have generally outpaced spending, but not consistently. The state broke even in 2003 and revenues steadily outpaced expenditures until peaking at $1,266 billion in 2007. Revenues fell to an all-time low of $241 billion following the recession of 2008 and then fluctuated up and down before falling drastically again in fiscal year 2015.

The ups and downs of Alaska’s revenues reflect the extremely volatile nature of tax revenues, rents, and royalties that are generated from oil production. Rents and royalties make up 21 percent of Alaska’s total revenues and oil taxes 6 percent – these two combined actually come closer to 90 percent of the actual discretionary budget. Alaska has no personal income tax or sales tax, so there isn’t much room for other sources to make up for struggling revenues when oil prices decline.

Another major revenue source for the state are federal grants, at 32 percent of total revenues. Federal transfers are not exactly “free lunches” for state governments. Not only do they get funded by taxpayers, but they come with other costs as well. There is research that finds that as a state becomes more reliant on federal revenues, they tend to become less efficient, spending more and taxing more for the same level of services. For Alaska, this is especially concerning as it receives more federal dollars than any other state in per capita terms.

Federal transfers as an income stream have been more steady for Alaska than its oil revenues, but not necessarily more accessible. Federal funds are usually restricted for use for federal programs and therefore their use for balancing the budget is limited.

A revenue structure made up of volatile income streams and hard-to-access funds is enough by itself to make balancing the budget difficult. But Alaska’s expenditures also present cause for concern as they have been growing steadily, about 10 percent on average each year since 2002, compared with private sector growth of 6 percent.

In fiscal year 2015, education was the biggest spending category, at 28% of total expenditures. This was followed by health and human services (21%), transportation (11%), general government (10%), the Alaska Permanent Fund Dividend (9%), public protection (6%), and universities (5%). Spending for natural resources, development, and law and justice were all less than 5 percent.

The next figure illustrates the state’s biggest drivers of spending growth since 2002. Education and general government spending have grown the most significantly over the past several years. Alaska Permanent Fund spending has been the most variable, reflecting the cyclical nature of underlying oil market trends. Both transportation and health and human services have increased steadily since 2002, with the latter growing more significantly the past several years as a result of Medicaid expansion.

Alaska’s spending is significantly higher than other states relative to its resource base. Spending as a proportion of state personal income was 31 percent in fiscal year 2015, much higher than the national average of 13 percent. A high level of spending, all else equal, isn’t necessarily a bad thing if you have the revenues to support it, but as we see from this year’s budget deficit, that isn’t the case for Alaska. The state is spending beyond the capacity of residents to pay for current service levels.

What should Alaska do?

This is a complicated situation so the answer isn’t simple or easy. The Alaska government website provides a Microsoft Excel model that allows you to try and provide your own set of solutions to balance the budget. After tinkering with the state provided numbers, it becomes clear that it is impossible to balance the deficit without some combination of spending cuts and changes to revenues or the Permanent Fund dividend.

On the revenue side, Alaska could improve by diversifying their income stream and/or broadening the tax base. Primarily taxing one group – in this case the oil industry – is inequitable and economically inefficient. Broadening the base would cause taxes to fall on all citizens more evenly and be less distortive to economic growth. Doing so would also smooth revenue production, making it more predictable and reliable for legislators.

When it comes to spending, it is understandably very difficult to decide what areas of the budget to cut, but a good place to start is to at least slow its growth. The best way to do this is by changing the institutional structure surrounding the political, legislative, and budgeting processes. One example would be improving Alaska’s tax and expenditure limit (TEL), as my colleague Matthew Mitchell recommends in his recent testimony. The state could also look into item-reduction vetoes and strict balanced-budget requirements, among other institutional reforms.

Ultimately, whatever steps Alaska’s legislators take to balance the budget this year will be painful. Hopefully the solution won’t involve ignoring the role that the institutional environment has played in getting them here. A narrow tax base reliant on volatile revenue sources, restricted funds, and growing spending are all factors that have led many to think that Alaska is and always will be “different.” But what constitutes sound public financial management is the same regardless of state. Although Alaska’s situation is unique, their susceptibility to fiscal stress absent any changes is not.

The post What’s going on with Alaska’s budget? appeared first on Neighborhood Effects.

Maybe. The real attraction might also be the $6 million of state handouts to Nestlé, along with an additional $6 million from Arlington County. Government handouts like these have become a way of life in the U.S. even though the results are often underwhelming.

Federal programs such as the New Markets Tax Credit Program have had at best small effects on economic development, and there is a good chance they just reallocate economic activity from one place to another rather than generate new economic activity. Local programs like Tax Increment Financing appear to largely reallocate economic activity as well. These programs might be good for the neighborhood or city that gets the handout, but it doesn’t help the residents of nearby places who are forced to contribute via their tax dollars.

In the Nestlé case, all of Virginia’s taxpayers are paying for Nestlé to locate in Arlington, which already has a relatively strong economy and is one of the wealthiest counties in Virginia. Why should taxpayers in struggling counties such as Buchanan or Dickenson County be forced to subsidize a company in Arlington? Government handouts to firms are often regressive since companies rarely want to locate in areas with a low-skill—and thus low-income—workforce. Everyone pays, but the most economically successful areas get the benefits.

Government officials often praise the jobs that these deals create and the Nestlé deal is no different: According to the performance agreement, Nestlé must create and maintain 748 new full-time jobs. And even if we ignore the fact that jobs are an economic cost, not a benefit, a closer look reveals that projections and reality usually diverge. For example, Buffalo awarded hundreds of millions of dollars to SolarCity, which promised to create 5,000 jobs. They have since revised that number down to 1,460. There are numerous other examples where the cost per job turned out to be higher than initially projected.

The grant performance agreement also estimates that Nestlé will provide $18.2 million in taxes to the county over the next 10 years, more than enough to offset the grant expenditure. But this doesn’t take into account what would have happened absent the handout. Perhaps some other company would have relocated here for free. Or a local company, or collection of companies, would have eventually rented out the space.

Government grants may also distort the real estate market: There’s a good chance no company had occupied 1812 North Moore because the rent was too high. If so, part of this grant is a handout to the owners of the building, Monday Properties, since now it does not have to lower its rent to attract a tenant. This may lead other property companies to lobby for and expect government handouts to help them find tenants.

Government grants often distort the economy by treating out-of-state companies differently than in-state companies. They encourage relocation by subsidizing it, which discourages expansion. A better strategy is to create a simple, non-intrusive business environment that treats all businesses equally.

Government grants are a characteristic of what my colleague Chris Koopman calls Mutant Capitalism and are antithetical to real capitalism and free enterprise. Capitalism involves businesses competing for consumers on an even playing field—there is no room for government favors that tilt the playing field towards one business or another.

The post Mutant Capitalism rears its ugly head in Arlington appeared first on Neighborhood Effects.

Money spent by state and local governments is collected from taxpayers who earn money in the labor market and through investments. The money earned by taxpayers is the result of producing goods and services that people want and the total is essentially captured in a state’s Gross Domestic Product (GSP).

State GSP is a good measure of the amount of money available for a state to tax, and if state and local government spending is growing faster than GSP, state and local governments will be controlling a larger and larger portion of their state’s output over time. This is unsustainable in the long run, and in the short run more state and local government spending can reduce the dynamism of a state’s economy as resources are taken from risk-taking entrepreneurs in the private sector and given to government bureaucrats.

The charts below use data from the BEA to depict the growth of state and local government spending and private industry GSP in Nebraska (click on charts to enlarge). The first shows the annual growth rates in private industry GSP and state and local government GSP from 1997 to 2014. The data is adjusted for inflation (2009 dollars) and the year depicted is the ending year (e.g. 1998 is growth from 1997 – 1998).

In Nebraska, real private industry GSP growth has been positive every year except for 2012. There is some volatility consistent with the business cycles over this time period, but Nebraska’s economy has regularly grown over this period.

On the other hand, state and local GSP growth was negative 10 of the 17 years depicted. It grew rapidly during recession periods (2000 – 2002 and 2009 – 2010), but it appears that state and local officials were somewhat successful in reducing spending once economic conditions improved.

The next chart shows how much private industry and state and local GSP grew over the entire period for both Nebraska and the U.S. as a whole. The 1997 value of each category is used as the base year and the yearly ratio is plotted in the figure. The data is adjusted for inflation (2009 dollars).

In 2014, Nebraska’s private industry GSP (red line) was nearly 1.6 times larger than its value in 1997. On the other hand, state and local spending (light red line) was only about 1.1 times larger. Nebraska’s private industry GSP grew more than the country’s as a whole over this period (57% vs 46%) while its state and local government spending grew less (11% vs. 15%).

State and local government spending in Nebraska spiked from 2009 to 2010 but has come down slightly since then. Meanwhile, the state’s private sector has experienced relatively strong growth since 2009 compared to the country as a whole, though it was lagging the country prior to the recession.

Compared to the country overall, Nebraska’s private sector economy has been doing well since 2008 and state and local spending, while growing, appears to be largely under control. If you would like to learn more about Nebraska’s economy and the policies responsible for the information presented here, I encourage you to read Governing Nebraska’s Fiscal Commons: Addressing the Budgetary Squeeze, by Creighton University Professor Michael Thomas.

The post Government Spending and Economic Growth in Nebraska since 1997 appeared first on Neighborhood Effects.

Virginia’s economy has steadily grown over time in spite of expenditures outpacing revenues each year since 2007. However, economic growth within the state is not evenly distributed geographically.

We examine Virginia’s revenue and expenditure trends, highlighting the sources of Virginia’s revenue and where it spends money. Then we discuss trends in state economic growth and compare that to recent personal income data by county.

Government Overview: Expenditures and Revenue

Figure 1 shows Virginia’s general spending and revenue trends over the past ten years. According to the Virginia Comprehensive Annual Financial Report (CAFR), after adjusting for inflation, government expenditures have outpaced revenue every single year as seen in Figure 1 below (with the exception of 2006). The red column represents yearly expenditures while the stacked column represents revenues (the lighter shade of blue at the top represents revenue from “Federal Grants and Contracts” and the bottom darker shade of blue represents “Self-Funded Revenue”).

During the recession in 2009, expenditures climbed to $40 billion. Expenditures hovered around this amount until 2015 when they reached $41 billion. Then in 2016 expenditures dropped to just under $37 billion, a level last seen in 2006.

On the revenue side, the majority of Virginia’s government revenue is self-funded i.e. raised by the state. Self-funded revenue hovered between $24 and $29 billion over the ten year period.

However, revenue from federal contracts and grants steadily increased over time. There were two sharp increases in federal contracts and grants: 2008-2009 jumping from $8 to $10 billion and then 2009-2010 jumping from $10 to $13 billion. While there was a drop in federal contracts and grants from 2015-2016, the amount of revenue received from federal contracts and grants has not returned to its pre-2009 levels.

What is the state of Virginia spending its revenue on? According to the Virginia CAFR, state spending is separated into six major categories: General Government, Education, Transportation, Resources & Economic Development, Individual & Family Services, and Administration of Justice. The spending amounts from 2006-2016 (adjusted for inflation) are depicted in Figure 2.

As shown, the majority of spending over the ten year period was on Individual and Family Services. Prior to 2008, spending on Education closely tracked spending on Individual and Family services, but from 2008 to 2010 spending on the latter increased rapidly while spending on education declined. From 2010 through 2015 spending on Individual & Family Services was just over $15 billion per year. It dropped from 2015 to 2016, but so did spending on education, which maintained the gap between the two categories.

During the ten year period, Education spending hovered between $10 and $12 billion until it dropped to $9 billion in 2016. With the exception of Transportation (steadily climbing from 2010-2016), spending on each of the other categories remained below $5 billion per year and was fairly constant over this period.

Virginia Economic Growth & County Personal Income

After examining Virginia’s revenue and expenditures in Part 1, we now look at changes in Virginia’s economic growth and personal income at the county level. Data from the Bureau of Economic Analysis (BEA) shows that Virginia’s GDP hovered between $4 and $4.5 billion dollars (after adjusting for inflation), as shown in Figure 3 below. The blue columns depict real GDP (measured on the left vertical axis in billions of chained 2009 dollars) and the red line depicts percent changes in real GDP (measured on the right vertical axis).

While Virginia’s GDP increased from 2006-2015, we’ve condensed the scale of the left vertical axis to only cover $3.9-4.35 billion dollars in order to highlight the percent changes in Virginia’s economy. The red line shows that the percent change in real GDP over this period was often quite small—between 0% and 1% in all but two years.

Virginia’s GDP rose from 2006-2007 and then immediately fell from 2007-2008 due to the financial crisis. However, the economy experienced larger growth from 2009-2010, growing from roughly $4.07-$4.17 billion, a 2.3% jump.

Virginia’s economy held steady at $4.17 billion from 2010 to 2011 and then increased each year up through 2014. Then from 2014-2015, Virginia’s economy experienced another larger spike in growth from $4.24-$4.32 billion, a 2% increase.

Virginia’s economy is diverse so it’s not surprising that the robust economic growth that occurred from 2014 to 2015 was not spread evenly across the state. While the BEA is still compiling data on county GDP, we utilized their data on personal income by county to show the intra-state differences.

Personal Income is not the equivalent of county-level GDP, the typical measure of economic output, but it can serve as a proxy for the economic conditions of a county.[1] Figure 4 below shows which counties saw the largest and smallest changes in personal income from 2014 to 2015. The red counties are the 10 counties with the smallest changes while the blue counties are the 10 counties with the largest changes.

As depicted in Figure 4 above, the counties with the strongest personal income growth are concentrated in the north, the east and areas surrounding Richmond. Loudon County in the north experienced the most personal income growth at 7%. The counties surrounding Richmond experienced at least 5.5% growth. Total personal income in Albemarle County grew by 5.7% while the rest of the counties—Hanover, Charles City, Greene, Louisa, and New Kent—experienced growth between 6.2% and 6.7%.

With the exception of Northumberland, the counties in which personal income grew the least were along the western border and in the southern parts of the state. Four of these counties and an independent city were concentrated in the relatively rural Southwest corner of the state—Buchanan, Tazewell, Dickenson, Washington and the independent city of Bristol. In fact, Buchanan County’s personal income contracted by 1.14%.

Cross-county differences in personal income growth in Virginia from 2014 to 2015 are consistent with national data as shown below.

This map from the BEA shows personal income growth by county (darker colors mean more growth). Nationwide, personal income growth was lower on average in relatively rural counties. Residents of rural counties also have lower incomes and less educational attainment on average. This is not surprising given the strong positive relationship between human capital and economic growth.

And during the most recent economic recovery, new business growth was especially weak in counties with less than 100,000 people. In fact, from 2010 to 2014 these counties actually lost businesses on net.

Conclusion:

Government spending on Individual and Family Services increased during the recession and has yet to return to pre-recession levels. Meanwhile, spending on education declined while spending on transportation slightly increased. This is consistent with other research that has found that state spending on health services, e.g. Medicaid, is crowding out spending in other areas.

Economic growth in Virginia was relatively strong from 2014 to 2015 but was not evenly distributed across the state. The counties with the smallest percentage changes in personal income are relatively rural while the counties with the largest gains are more urban. This is consistent with national patterns and other economic data revealing an urban-rural economic gap in and around Virginia.

[1] Personal Income is defined by the BEA as “the income received by, or on behalf of, all persons from all sources: from participation as laborers in production, from owning a home or business, from the ownership of financial assets, and from government and business in the form of transfers. It includes income from domestic sources as well as the rest of world. It does not include realized or unrealized capital gains or losses.” For more information about personal income see https://www.bea.gov/newsreleases/regional/lapi/lapi_newsrelease.htm

The post An Overview of the Virginia State Budget and Economy appeared first on Neighborhood Effects.

The effect of innovation on economic growth has been heavily analyzed using data from the post-WWII period, but there is considerably less work that examines the relationship between innovation and economic growth during earlier time periods. An interesting new working paper by Ufuk Akcigit, John Grigsby and Tom Nicholas that examines innovation across America during the late 19^th and early 20^th century helps fill in this gap.

The authors examine innovation and inventors in the U.S. during this period using U.S. patent data and census data from 1880 to 1940. The figure below shows the geographic distribution of inventiveness in 1940. Darker colors mean higher rates of inventive activity.

Most of the inventive activity in 1940 was in the industrial Midwest and Northeast, with California being the most notable western exception.

The next figure depicts the relationship between the log of the total number of patents granted to inventors in each state from 1900 to 2000 (x-axis) and annualized GDP growth (y-axis) over the same period for the 48 contiguous states.

As shown there is a strong positive relationship between this measure of innovation and economic growth. The authors also conduct multi-variable regression analyses, including an instrumental variable analysis, and find the same positive relationship.

The better understand why certain states had more inventive activity than others in the early 20^th century, the authors analyze several factors: 1) urbanization, 2) access to capital, 3) geographic connectedness and 4) openness to new ideas.

The figures below show the more urbanization was associated with more innovation from 1940 to 1960. The left figure plots the percent of people in each state living in an urban area in 1940 on the x-axis while the right has the percent living on a farm on the x-axis. Both figures tell the same story—rural states were less innovative.

Next, the authors look at the financial health of each state using deposits per capita as their measure. A stable, well-funded banking system makes it easier for inventors to get the capital they need to innovate. The figure below shows the positive relationship between deposits per capita in 1920 and patent production from 1920 to 1930.

The size of the market should also matter to inventors, since greater access to consumers means more sales and profits from successful inventions. The figures below show the relationship between a state’s transport cost advantage (x-axis) and innovation. The left figure depicts all of the states while the right omits the less populated, more geographically isolated Western states.

States with a greater transport cost advantage in 1920—i.e. less economically isolated—were more innovative from 1920 to 1940, and this relationship is stronger when states in the far West are removed.

The last relationship the authors examine is that between innovation and openness to new, potentially disruptive ideas. One of their proxies for openness is the percent of families who owned slaves in a state, with more slave ownership being a sign of less openness to change and innovation.

The figures show that more slave ownership in 1860 was associated with less innovation at the state-level from 1880 to 1940. This negative relationship holds when all states are included (left figure) and when states with no slave ownership in 1860—which includes many Northern states—are omitted (right figure).

The authors also analyze individual-level data and find that inventors of the early 20^th century were more likely to migrate across state lines than the rest of the population. Additionally, they find that conditional on moving, inventors tended to migrate to states that were more urbanized, had higher bank deposits per capita and had lower rates of historical slave ownership.

Next, the relationship between innovation and inequality is examined. Inequality has been a hot topic the last several years, with many people citing research by economists Thomas Piketty and Emmanuel Saez that argues that inequality has increased in the U.S. since the 1970s. The methods and data used to construct some of the most notable evidence of increasing inequality has been criticized, but this has not made the topic any less popular.

In theory, innovation has an ambiguous effect on inequality. If there is a lot of regulation and high barriers to entry, the profits from innovation may primarily accrue to large established companies, which would tend to increase inequality.

On the other hand, new firms that create innovative new products can erode the market share and profits of larger, richer firms, and this would tend to decrease inequality. This idea of innovation aligns with economist Joseph Schumpeter’s “creative destruction”.

So what was going on in the early 20^th century? The figure below shows the relationship between innovation and two measures of state-level inequality: the ratio of the 90^th percentile wage over the 10^th percentile wage in 1940 and the wage income Gini coefficient in 1940. For each measure, a smaller value means less inequality.

As shown in the figures above, a higher patent rate is correlated with less inequality. However, only the result using 90-10 ratio remains statistically significant when each state’s occupation mix is controlled for in a multi-variable regression.

The authors also find that when the share of income controlled by the top 1% of earners is used as the measure of inequality, the relationship between innovation and inequality makes a U shape. That is, innovation decreases inequality up to a point, but after that point it’s associated with more inequality.

Thus when using the broader measures of inequality (90-10 ratio, Gini coeffecieint) innovation is negatively correlated with inequality, but when using a measure of top-end inequality (income controlled by top 1%) the relationship is less clear. This shows that inequality results are sensitive to the measurement of inequality used.

Social mobility is an important measure of economic opportunity within a society and the figure below shows that innovation is positively correlated with greater social mobility.

The measure of social mobility used is the percentage of people who have a high-skill occupation in 1940 given that they had a low-skill father (y-axis). States with more innovation from 1920 to 1940 had more social mobility according to this measure.

In the early 20^th century it appears that innovation improved social mobility and decreased inequality, though the latter result is sensitive to the measurement of inequality. However, the two concepts are not equally important: Economic and social mobility are worthy societal ideals that require opportunity to be available to all, while static income or wealth inequality is largely a red herring that distracts us from more important issues. And once you take into account the consumer-benefits of innovation during this period—electricity, the automobile, refrigeration etc.—it is clear that innovation does far more good than harm.

This paper is interesting and useful for several reasons. First, it shows that innovation is important for economic growth over a long time period for one country. It also shows that more innovation occurred in denser, urbanized states that provided better access to capital, were more interconnected and were more open to new, disruptive ideas. These results are consistent with what economists have found using more recent data, but this research provides evidence that these relationships have existed over a much longer time period.

The positive relationships between innovation and income equality/social mobility in the early 20^th century should also help alleviate the fears some people have about the negative effects of creative destruction. Innovation inevitably creates adjustment costs that harm some people, but during this period it doesn’t appear that it caused widespread harm to workers.

If we reduce regulation today in order to encourage more innovation and competition we will likely experience similar results, along with more economic growth and all of the consumer benefits.

The post Innovation and economic growth in the early 20th century and lessons for today appeared first on Neighborhood Effects.

Perhaps the most popular theory of regulation is that it exists to advance the public interest. According to this view, well-intended regulators intervene in the marketplace due to “market failures”, which are situations where the market fails to allocate resources optimally. Some common examples of market failures include externalities (cases where third parties are impacted by the transactions involving others), asymmetric information (cases where buyers and sellers possess different levels of information about products being sold), public goods problems (whereby certain items are under-provided or not provided at all by the market), and concentration of industry in the form of monopoly power. When market failure occurs, the idea is that regulators intervene in order to make imperfect markets behave more like theoretically perfect markets.

Other theories of regulation are less optimistic about the motivations of the different participants in the rulemaking process. One popular theory suggests regulators work primarily to help powerful special interest groups, a phenomenon known as regulatory capture. Under this view—commonly associated with the writings of University of Chicago economist George Stigler—regulators fix prices and limit entry into an industry because it benefits the industry being regulated. An example would be how regulators, up until the late 1970s, fixed airline prices above what they would have been in a competitive market.

The interest groups that “capture” regulatory agencies are most often thought to be businesses, but it’s important to remember that agencies can also be captured by other groups. The revolving door between the government and the private sector doesn’t end with large banks. It also extends to nonprofit groups, labor unions, and activist groups of various kinds that also wield significant resources and power.

The “public choice theory” of regulation posits that public officials are primarily self-interested, rather than being focused on advancing the public interest. Under this view, regulators may be most concerned with increasing their own salaries or budgets. Or, they may be focused primarily on concentrating their own power.

It’s also possible that regulators are not nearly so calculating and rational as this. The behavioral public choice theory of regulation suggests regulators behave irrationally in many cases, due to the cognitive limitations inherent in all human beings. A case in point is how regulatory agencies routinely overestimate risks, or try to regulate already very low risks down to zero. There is significant evidence that people, including regulators, tend to overestimate small probability risks, leading to responses that are disproportionate to the expected harm. For example, the Environmental Protection Agency’s evaluations of sites related to the Superfund clean-up project routinely overestimated risks by orders of magnitude. Such overreactions might also be a response to public perceptions, for example in response to high-profile media events, such as following acts of terrorism. If the public’s reactions carry over into the voting booth, then legislation and regulation may be enacted soon after.

One of the more interesting and novel theories as to why we see regulation relates to public trust in institutions. A 2010 paper in the Quarterly Journal of Economics noted that there is a strong correlation between trust in various social institutions and some measures of regulation. The figure below is an example of this relationship, found in the paper.

Trust can relate to public institutions, such as the government, but it also extends to trust in corporations and in our fellow citizens. Interestingly, the authors of the QJE article argue that an environment of low trust and high regulation can be a self-fulfilling prophecy. Low levels of trust, ironically, can lead to more demand for regulation, even when there is little trust in the government. One reason for this might be that people think that giving an untrustworthy government control over private affairs is still superior to allowing unscrupulous businesses to have free rein.

The flip-side of this situation is that in high-trust countries, such as Sweden, the public demands lower levels of regulation and this can breed more trust. So an environment of free-market policies combined with trustworthy businesses can produce good market outcomes, more trust, and this too can be a self-fulfilling, allowing some countries to maintain a “good” equilibrium.

This is concerning for the United States because trust has been on the decline in a whole host of areas. A Gallop survey has been asking questions related to trust in public institutions for several decades. There is a long-term secular decline in Gallup’s broad measure of trust, as evidenced by the figure below, although periodically there are upswings in the measure.

Pew has a similar survey that looks at public trust in the government. Here the decline is even more evident.

Given that regulation has been on the rise for decades, a decline in trust in the government, in corporations, and in each other, may be a key reason this is occurring. Of course, it’s possible that these groups are simply dishonest and do not merit public trust. Nonetheless, the US might find itself stuck in a self-fulfilling situation, whereby distrust breeds more government intervention in the economy, worse market outcomes, and even more distrust in the future. Getting out of that kind of situation is not easy. One way might be through education about the institutions that lead to free and prosperous societies, as well as to create a culture whereby corruption and unscrupulous behavior are discouraged.

There are a number of theories that seek to explain why regulation comes about. No theory is perfect, and some theories explain certain situations better than others. Nonetheless, the theories presented here go a long way towards laying out the forces that lead to regulation, even if no one theory can explain all regulation at all times.

The post Why Do We Get So Much Regulation? appeared first on Neighborhood Effects.

The argument for building high-speed rail lines usually entails promises of faster trips, better connections between major cities, and economic growth as a result. It almost seems like a no-brainer – why would any city not want to pursue something like this? The answer, like with most public policy questions, depends on the costs, and whether the benefits actually realize.

In a forthcoming paper for the Mercatus Center, transportation scholar Kenneth Button explores these questions by studying the high-speed rail experiences of Spain, Japan, and China; the countries with the three largest systems (measured by network length). Although there are benefits to these rail systems, Button cautions against focusing too narrowly on them as models, primarily because what works in one area can’t necessarily be easily replicated in another.

Most major systems in other countries have been the result of large public investment and built with each area’s unique geography and political environment kept in mind. Taking their approaches and trying to apply them to American cities not only ignores how these factors can differ, but also how much costs can differ. For example, the average infrastructure unit price of high-speed rail in Europe is between $17 and $24 million per mile and the estimated cost for proposals in California is conservatively estimated at $35 million per mile.

The cost side of the equation is often overlooked, and more attention is given to the benefit side. Button explains that the main potential benefit – generating economic growth – doesn’t always live up to expectations. The realized growth effects are usually minimal, and sometimes even negative. Despite this, proponents of high-speed rail oversell them. The process of thinking through high-speed rail as a sound public investment is often short-lived.

The goal is to generate new economic activity, not merely replace or divert it from elsewhere. In Japan, for example, only six percent of the traffic on the Sanyo Shinkansen line was newly generated, while 55 percent came from other rail lines, 23 percent from air, and 16 percent from inter-city bus. In China, after the Nanguang and Guiguang lines began operating in 2014, a World Bank survey found that many of the passengers would have made the journey along these commutes through some other form of transportation if the high-speed rail option wasn’t there. The passengers who chose this new transport method surely benefited from shorter travel times, but this should not be confused with net growth across the economy.

Even if diverted away from other transport modes, the amount of high-speed rail traffic Japan and China have generated is commendable. Spain’s system, however, has not been as successful. Its network has only generated about 5 percent of Japan’s passenger volume. A line between Perpignan, France and Figueres, Spain that began services in 2009 severely fell short of projected traffic. Originally, it was expected to run 19,000 trains per year, but has only reached 800 trains by 2015.

There is also evidence that high speed rail systems poorly re-distribute activity geographically. This is especially concerning given the fact that projects are often sold on a promise of promoting regional equity and reducing congestion in over-heating areas. You can plan a track between well-developed and less-developed regions, but this does not guarantee that growth for both will follow. The Shinkansen system delivers much of Japan’s workforce to Tokyo, for example, but does not spread much employment away from the capital. In fact, faster growth happened where it was already expected, even before the high-speed rail was planned or built. Additionally, the Tokyo-Osaka Shinkansan line in particular has strengthened the relative economic position of Tokyo and Osaka while weakening those of cities not served.

Passenger volume and line access are not – and should not be – the only metrics of success. Academics have exhibited a fair amount of skepticism regarding high-speed rail’s ability to meet other objectives. When it comes to investment value, many cases have resulted in much lower returns than expected. A recent, extreme example of this is California’s bullet train that is 50 percent over its planned budget; not to mention being seven years behind in its building schedule.

The project in California has been deemed a lost cause by many, but other projects have gained more momentum in the past year. North American High Speed Rail Group has proposed a rail line between Rochester and the Twin Cities, and if it gets approval from city officials, it plans to finance entirely with private money. The main drawback of the project is that it would require the use of eminent domain to take the property of existing businesses that are in the way of the planned line path. Private companies trying to use eminent domain to get past a roadblock like this often do so claiming that it is for the “public benefit.” Given that many residents have resisted the North American High Speed Rail Group’s plans, trying to force the use of eminent domain would likely only destroy value; reallocating property from a higher-value to a lower-value use.

Past Mercatus research has found that using eminent domain powers for redevelopment purposes – i.e. by taking from one private company and giving to another – can cause the tax base to shrink as a result of decreases in private investment. Or in other words, when entrepreneurs see that the projects that they invest in could easily be taken if another business owner makes the case to city officials, it would in turn discourage future investors from moving into the same area. This ironically discourages development and the government’s revenues suffer as a result.

Florida’s Brightline might have found a way around this. Instead of trying to take the property of other businesses and homes in its way, the company has raised money to re-purpose existing tracks already between Miami and West Palm Beach. If implemented successfully, this will be the first privately run and operated rail service launched in the U.S. in over 100 years. And it doesn’t require using eminent domain or the use of taxpayer dollars to jump-start that, like any investment, has risk of being a failure; factors that reduce the cost side of the equation from the public’s perspective.

Which brings us back to the Houston-to-Dallas line that Trump appears to be getting behind. How does that plan stack up to these other projects? For one, it would require eminent domain to take from rural landowners in order to build a line that would primarily benefit city residents. Federal intervention would require picking a winner and loser at the offset. Additionally, there is no guarantee that building of the line would bring about the economic development that many proponents promise. Button’s new paper suggests that it’s fair to be skeptical.

I’m not making the argument that high-speed rail in America should be abandoned altogether. Progress in Florida demonstrates that maybe in the right conditions and with the right timing, it could be cost-effective. The authors of a 2013 study echo this by writing:

“In the end, HSR’s effect on economic and urban development can be characterized as analogous to a fertilizer’s effect on crop growth: it is one ingredient that could stimulate economic growth, but other ingredients must be present.”

For cities that can’t seem to mix up the right ingredients, they can look to other options for reaching the same goals. In fact, a review of the economic literature finds that investing in road infrastructure is a much better investment than other transportation methods like airports, railways, or ports. Or like I’ve discussed previously, being more welcoming to new technologies like driver-less cars has the potential to both reduce congestion and generate significant economic gains.

The post High-speed rail: is this year different? appeared first on Neighborhood Effects.

The authors graph the correlation between city population and city productivity for five different countries. There is a positive relationship between population and productivity in all of the countries, which is consistent with other studies that find a similar relationship. This relationship is largely due to agglomeration economies and the greater degree of specialization within large cities.

One of the figures from the study—for the U.S.—is shown below. City productivity is measured on the y-axis and the natural log of city population is on the x-axis. (Technical note for those interested: city productivity is measured as the coefficient on a city dummy variable in an individual-level log hourly wage/earnings regression that also controls for gender, age, age squared, education and occupation. This strips away observable characteristics of the population that may affect city productivity.)

Source: Ahrend, Rudiger, et al. “What makes cities more productive? Evidence from five OECD countries on the role of urban governance.” Journal of Regional Science 2017

As shown in the graph there is a relatively tight, positive relationship between size and productivity. The two noticeable outlies are El Paso and McAllen, TX, both of which are on the border with Mexico.

The next figure depicts the same information but for cities in Germany.

What’s interesting about this figure is that there is a cluster of outliers in the bottom left, which weakens the overall relationship. The cities in this cluster are less productive than one would expect based on their population. These cities also have another thing in common: They are located in or near what was East Germany. The authors comment on this:

“In Germany, the most noteworthy feature is probably the strong east-west divide, with city productivity premiums in eastern German cities being, on the whole, significantly below the levels found in western German cities of comparable size. In line with this finding, the city productivity premium in Berlin lies in between the trends in eastern and western Germany.”

The data used to construct these figures are from 2007, 17 years after the unification of Germany. After WWII and until 1990, East Germany was under communist control and had a centrally planned economy, complete with price controls and production quotas, while West Germany had a democratic government and market economy.

Since 1990, both areas have operated under the same country-level rules and institutions, but as shown above the productivity difference between the two regions persisted. This is evidence that it can take a considerable amount of time for an area to overcome damaging economic policies.

The post Economic policies and institutions matter appeared first on Neighborhood Effects.

The first, shown below, has log income per capita by state on the x-axis for two different years, 1940 (left) and 1990 (right). On the vertical axis of each graph is the annual population growth rate by state for two periods, 1940 – 1960 (left) and 1990 – 2010 (right).

In the 1940 – 1960 period, the graph depicts a strong positive relationship: States with higher per capita incomes in 1940 experienced more population growth over the next 20 years than states with lower per capita incomes. This relationship disappears and actually reverses in the 1990 – 2010 period: States with higher per capita incomes actually grew slower on average. So in general people became less likely to move to states with higher incomes between the middle and end of the 20^th century. Other researchers have also found that people are not moving to areas with better economies.

This had an effect on income convergence, as shown in the next set of figures. In the 1940 – 1960 period (left), states with higher per capita incomes experienced less income growth than states with lower per capita incomes, as shown by the negative relationship. This negative relationship existed in the 1990 – 2010 period as well, but it was much weaker.

We would expect income convergence when workers leave low income states for high income states, since that increases the labor supply in high-income states and pushes down wages. Meanwhile, the labor supply decreases in low-income states which increases wages. Overall, this leads to per capita incomes converging across states.

Why labor mobility matters

As law professor David Schleicher points out in a recent paper, the current lack of labor mobility can reduce the ability of the federal government to manage the U.S. economy. In the U.S. we have a common currency—every state uses the U.S. dollar. This means that if a state is hit by an economic shock, e.g. low energy prices harm Texas, Alaska and North Dakota but help other states, that state’s currency cannot adjust to cushion the blow.

For example, if the UK goes into a recession, the Bank of England can print more money so that the pound will depreciate relative to other currencies, making goods produced in the UK relatively cheap. This will decrease the UK’s imports and increase economic activity and exports, which will help it emerge from the recession. If the U.S. as a whole suffered a negative economic shock, a similar process would take place.

However, within a country this adjustment mechanism is unavailable: Texas can’t devalue its dollar relative to Ohio’s dollar. There is no within-country monetary policy that can help particular states or regions. Instead, the movement of capital and labor from weak areas to strong areas is the primary mechanism available for restoring full employment within the U.S. If capital and labor mobility are low it will take longer for the U.S. to recover from area-specific negative economic shocks.

State or area-specific economic shocks are more likely in large countries like the U.S. that have very diverse local economies. This makes labor and capital mobility more important in the U.S. than in smaller, less economically diverse countries such as Denmark or Switzerland, since those countries are less susceptible to area-specific economic shocks.

Why labor mobility is low

There is some consensus about policies that can increase labor mobility. Many people, including former President Barack Obama, my colleagues at the Mercatus Center and others, have pointed out that state occupational licensing makes it harder for workers in licensed professions to move across state borders. There is similar agreement that land-use regulations increase housing prices which makes it harder for people to move to areas with the strongest economies.

Reducing occupational licensing and land-use regulations would increase labor mobility, but actually doing these things is not easy. Occupational licensing and land-use regulations are controlled at the state and local level, so currently there is little that the federal government can do.

Moreover, as Mr. Schleicher points out in his paper, state and local governments created these regulations for a reason and it’s not clear that they have any incentive to change them. Like all politicians, state and local ones care about being re-elected and that means, at least to some extent, listening to their constituents. These residents usually value stability, so politicians who advocate too strongly for growth may find themselves out of office. Mr. Schleicher also notes that incumbent politicians often prefer a stable, immobile electorate because it means that the voters who elected them in the first place will be there next election cycle.

Occupational licensing and land-use regulations make it harder for people to enter thriving local economies, but other policies make it harder to leave areas with poor economies. Nearly 13% of Americans work for state and local governments and 92% of them have a defined-benefit pension plan. Defined-benefit plans have long vesting periods and benefits can be significantly smaller if employees split their career between multiple employers rather than remain at one employer. Thus over 10% of the workforce has a strong retirement-based incentive to stay where they are.

Eligibility standards for public benefits and their amounts also vary by state, and this discourages people who receive benefits such as Temporary Assistance for Needy Families (TANF) from moving to states that may have a stronger economy but less benefits. Even when eligibility standards and benefits are similar, the paperwork and time burden of enrolling in a new state can discourage mobility.

The federal government subsidizes home ownership as well, and homeownership is correlated with less labor mobility over time. Place-based subsidies to declining cities also artificially support areas that should have less people. As long as state and federal governments subsidize government services in cities like Atlantic City and Detroit people will be less inclined to leave them. People-based subsidies that incentivize people to move to thriving areas are an alternative that is likely better for the taxpayer, the recipient and the country in the long run.

How to increase labor mobility

Since state and local governments are unlikely to directly address the impediments to labor mobility that they have created, Mr. Schleicher argues for more federal involvement. Some of his suggestions don’t interfere with local control, such as a federal clearinghouse for coordinated occupational-licensing rules across states. This is not a bad idea but I am not sure how effective it would be.

Other suggestions are more intrusive and range from complete federal preemption of state and local rules to federal grants that encourage more housing construction or suspension of the mortgage-interest deduction in places that restrict housing construction.

Local control is important due to the presence of local knowledge and the beneficial effects that arise from interjurisdictional competition, so I don’t support complete federal preemption of local rules. Economist William Fischel also thinks the mortgage interest deduction is largely responsible for excessive local land-use regulation, so eliminating it altogether or suspending it in places that don’t allow enough new housing seems like a good idea.

I also support more people-based subsidies that incentivize moving to areas with better economies and less place-based subsidies. These subsidies could target people living in specific places and the amounts could be based on the economic characteristics of the destination, with larger amounts given to people who are willing to move to areas with the most employment opportunities and/or highest wages.

Making it easier for people to retain any state-based government benefits across state lines would also help improve labor mobility. I support reforms that reduce the paperwork and time requirements for transferring benefits or for simply understanding what steps need to be taken to do so.

Several policy changes will need to occur before we can expect to see significant changes in labor mobility. There is broad agreement around some of them, such as occupational licensing and land-use regulation reform, but bringing them to fruition will take time. As for the less popular ideas, it will be interesting to see which, if any, are tried.

The post Why the lack of labor mobility in the U.S. is a problem and how we can fix it appeared first on Neighborhood Effects.

Last month, after California officials told Uber to stop its pilot self-driving car program because it lacked the necessary state permits for autonomous driving, Uber decided to relocate the program from San Francisco to Phoenix, Arizona. In an attempt to alleviate safety concerns, these self-driving cars are not yet driverless, but they do have the potential to reduce the number of cars on the road. Other companies like Google, Tesla, and Ford have expressed plans to develop similar technologies, and some experts predict that completely driverless cars will be on the road by 2021.

Until then, however, cities like San Francisco will continue to suffer from the most severe congestion in the country. Commuters in these cities experience serious delays, higher gasoline usage, and lost time behind the wheel. If you live in any of these areas, you are probably very familiar with the mind-numbing effect of sitting through sluggish traffic.

It shouldn’t be surprising then that these costs could culminate into a larger problem for economic growth. New Mercatus research finds that traffic congestion can significantly harm economic growth and concludes with optimistic predictions for how autonomous vehicle usage could help.

Brookings Senior Fellow Clifford Winston and Yale JD candidate Quentin Karpilow find significant negative effects of traffic congestion on the growth rates of California counties’ gross domestic product (GDP), employment, wages, and commodity freight flows. They find that a 10% reduction in congestion in a California urban area increases both job and GDP growth by roughly 0.25% and wage growth to increase by approximately 0.18%.

This is the first comprehensive model built to understand how traffic harms the economy, and it builds on past research that has found that highway congestion leads to slower job growth. Similarly, congestion in West Coast ports, which occurs while dockworkers and marine terminal employers negotiate contracts, has caused perishable commodities to go bad, resulting in a 0.2 percentage point reduction in GDP during the first quarter of 2015.

There are two main ways to solve the congestion problem; either by reducing the number of cars on the road or by increasing road capacity. Economists have found that the “build more roads” method in application has actually been quite wasteful and usually only induces additional highway traffic that quickly fills the new road capacity.

A common proposal for the alternative method of reducing the number of cars on the road is to implement congestion pricing, or highway tolls that change based on the number of drivers using the road. Increasing the cost of travel during peak travel times incentivizes drivers to think more strategically about when they plan their trips; usually shifting less essential trips to a different time or by carpooling. Another Mercatus study finds that different forms of congestion pricing have been effective at reducing traffic congestion internationally in London and Stockholm as well as for cities in Southern California.

The main drawback of this proposal, however, is the political difficulty of implementation, especially with interstate highways that involve more than one jurisdiction to approve it. Even though surveys show that drivers generally change their mind towards supporting congestion pricing after they experience the lower congestion that results from tolling, getting them on board in the first place can be difficult.

Those skeptical of congestion pricing, or merely looking for a less challenging policy to implement, should look forward to the new growing technology of driverless cars. The authors of the recent Mercatus study, Winston and Karpilow, find that the adoption of autonomous vehicles could have large macroeconomic stimulative effects.

For California specifically, even if just half of vehicles became driverless, this would create nearly 350,000 additional jobs, increase the state’s GDP by $35 billion, and raise workers’ earnings nearly $15 billion. Extrapolating this to the whole country, this could add at least 3 million jobs, raise the nation’s annual growth rate 1.8 percentage points, and raise annual labor earnings more than $100 billion.

What would this mean for the most congested cities? Using Winston and Karpilow’s estimates, I calculated how reduced congestion from increased autonomous car usage could affect Metropolitan Statistical Areas (MSAs) that include New York City, Los Angeles, Boston, San Francisco, and the DC area. The first chart shows the number of jobs that would have been added in 2011 if 50% of motor vehicles had been driverless. The second chart shows how this would affect real GDP per capita, revealing that the San Francisco MSA would have the most to gain, but with the others following close behind.

As with any new technology, there is uncertainty with how exactly autonomous cars will be fully developed and integrated into cities. But with pilot programs already being implemented by Uber in Pittsburgh and nuTonomy in Singapore, it is becoming clear that the technology’s efficacy is growing.

With approximately $1,332 GDP per capita and 45,318 potential jobs on the table for the San Francisco Metropolitan Statistical Area, it is a shame that San Francisco just missed a chance to realize some of these gains and to be at the forefront of driving progress in autonomous vehicle implementation.

The post Decreasing congestion with driverless cars appeared first on Neighborhood Effects.

The author also finds that high-ability workers experience additional wage growth in large cities but not in small cities or rural areas. This leads to high-ability workers sorting themselves into large cities and contributes an additional 3.2% to the urban wage-growth premium.

These findings are consistent with several other papers that have analyzed the urban wage premium. Potential causes of the wage premium are faster human capital accumulation in denser, more populated places due to knowledge spillovers and more efficient labor markets that better match employers and employees.

The high cost of housing in San Francisco, D.C., New York and dozens of other cities is preventing many young people from earning more money and improving their lives. City officials and residents need to strike a better balance between maintaining the “charm” of their neighborhoods and affordability. This means less regulation and more building.

City vs. rural is only one of the many dichotomies pundits have been discussing since the 2016 election. Some of the other versions of “two Americas” are educated vs. non-educated, white collar vs. blue collar, and rich vs. poor. We can debate how much these differences matter, but to the extent that they are an issue for the country our public policies have reinforced the barriers that allow them to persist.

Occupational licensing makes it more difficult for blue-collar manufacturing workers to transition to middle-class service sector jobs. Federal loan subsidies have made four-year colleges artificially cheap to the detriment of people with only a high school education. Restrictive zoning has made it too expensive for many people to move to places with the best labor markets. And once you’re in a city, unless you’re in one of the best neighborhoods your fellow citizens often keep employers and providers of much needed consumer staples like Wal-Mart out, while using eminent domain to build their next playground.

Over time people have sorted themselves into different groups and then erected barriers to keep others out. Communities do it with land-use regulations, occupations do it with licensing and established firms do it with regulatory capture. If we want a more prosperous America that de-emphasizes our differences and provides people of all backgrounds with opportunity we need more “live and let live” and less “my way or the highway”.

The post Today’s public policies exacerbate our differences appeared first on Neighborhood Effects.

Professor Robert Inman of the University of Pennsylvania presented a helpful categorization of the different avenues to address the public pension crisis. He explained that as a reformer, you can either put stock in (1) courts, (2) markets, or (3) politics to solve the public policy problem. The next question is, which avenue is most effective at making pensions solvent while also keeping promises to beneficiaries?

First, take the courts. In municipal bankruptcy cases like that of Central Falls, Rhode Island; Stockton, California; and Detroit, Michigan, courts have ruled that reductions in benefits of current public workers and retirees are legally allowed. Until these rulings, however, it was thought to be almost impossible do such a thing. These cities employed reforms ranging from cutting payments to reducing current benefit formulas. By contrast, the state supreme court of Illinois has ruled similar cuts unconstitutional. It will be interesting to see how these conflicting legal precedents will affect future cases and what it will mean for the benefits of public workers.

However this legal discussion unfolds, it will certainly affect the courts as an avenue for solving the pension crisis. Strict rulings prevent states from cutting pension benefits of current workers, but they also require states to keep their promises, especially when it is politically hardest – during times of fiscal stress.

Times of fiscal stress are often prompted by a combination of factors. Growing unfunded liabilities, not enough cash in reserves, and poorly structured tax systems can all come together to really put policymakers in a tough spot and often leaves a large bill for taxpayers. A struggling economy on top of all of this can really exacerbate the situation. The main difference between the first three things and a struggling economy is that the latter is largely out of a policymaker’s control.

Despite this, many policymakers rely on the market to get them out of tough times. From the policymaker’s perspective “relying on the market” to solve the pension crisis usually means something different than what it means for an economist. This phrase for the policymaker usually entails reaping the benefits of more taxes generated from an economic boom or relying on high investment returns to improve the performance of pension funds.

Not only are the timing of economic booms fairly unpredictable, but they also don’t guarantee to solve all of your problems when they do occur. The growing city of Austin, Texas, for example, is facing budgetary pressures and only has enough money to pay for about two-thirds of the benefits workers have already earned, demonstrating that even good economic times don’t exempt you from pension problems.

The good news is that what we learn from market interactions can be transferred to the political sphere in order to increase our understanding. One lesson we learn from markets is that individuals respond to incentives and that the institutional structure in which they act influences how this occurs. The importance of incentives and rules doesn’t change when going from markets to politics, but the way they manifest does.

At the Law and Economics conference, Anthony Randazzo of the Reason Foundation explained how there is a tangled web of factors causing inappropriate pension funding behavior. These factors create misaligned incentives between fiduciaries and taxpayers. One way this has manifested is that the pension funding policy process has been captured by elected officials who are more concerned with near-term budget allocation than long-term solvency.

My colleague Eileen Norcross and her co-author Sheila Weinberg expanded more on the type of behavior that Randazzo spoke of. In their paper titled “A Judge in their Own Cause: GASB 67/68 and the continued mis-measurement of public sector liabilities” they review how policymakers are incentivized by state and local accounting guidelines to underreport the true value of their pension liabilities. Two new accounting rules were implemented in fiscal year 2015 in an attempt to improve this, but as Norcross and Weinberg’s findings suggest, they have not had their intended effects.

For example, there is evidence that one of the rules, GASB 67, is creating incentives for pension actuaries to project robust funding levels far into the future in order to avoid calculating and reporting large unfunded liabilities in the present.

They sum up the effects of both rules in their conclusion:

“Though these measures are justified in providing flexibility and practicality for governments, they only contribute to an artificial picture of state’s true fiscal results and thus affect important decisions on how states use resources.”

Their analysis demonstrates just how important it is to study the incentives present in both the measurement of and the governance of public pension funds. Luckily, there is also work being done that attempts to understand exactly what type of rules can improve incentives facing policymakers.

Another paper, presented by Professor Odd Stalebrink of Penn State, touched upon this by examining how governance structures affect the investment performance of public pension funds. He found that pension systems are more likely to meet their performance targets if they are governed by an institutional structure that (1) extends plan autonomy, (2) places emphasis on transparency, and (3) limits inefficient investment practices. In states that exhibit more corruption, however, Stalebrink noted that plans might actually be better off with less autonomy, while still focusing on transparency and improving efficiency.

The discussion of these papers along with many others at the conference underscored that pension problem in the states multifaceted one. The question of what avenue to employ reform efforts through does not have a simple answer. Growing unfunded pension liabilities are a result of many factors across market, political, and legal spheres. It only makes sense that effective solutions will revolve around an understanding of all three areas.

Proceedings of the conference will be published in a special symposium issue of Scalia Law School’s Journal of Law, Economics & Policy.

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