Author: conversableeconomist

social science which I could use my mathematics.\”  He went to the University of Chicago for a PhD in economics, and spent most of his professional career at Johns Hopkins University. A substantial number of students learned their introductory econometrics from Christ\’s textbook, Econometric Models and Methods, first published in 1966. Here\’s an obituary from Johns Hopkins, and here\’s one from the Baltimore Sun.

Back in Spring 1990, Christ wrote a nice biographical essay for The American Economist called \”A Philosophy of Life\” (pp. 33-39, available through JSTOR, and the source of the quotation above).  He gives a sense of academia as it used to be:

\”On the Lake Michigan beach in Michigan, where I spent summers as a child, and still do now, was an elderly gentleman in swim trunks, known to the children as Mr. Knight. I was quite surprised on entering graduate school at Chicago to find him, fully clothed, teaching economics. He had great skepticism of anyone who appeared to know all the answers. He told his classes, \”As soon as a person gets a theory, he\’s lost. …

\”I owe a great debt as well to Leonid Hurwicz, who was not even on my committee. I had presented my paper at the famous Cowles seminar (where only \”clarifying questions\” were allowed until the discussion period arrived, and where \”clarifying questions\” from Arrow, Hurwicz, and Modigliani began to fly as soon as the seminar began). I thought I was finished with my thesis, until Hurwicz invited me to come down to the University of Illinois (where he had just moved) because he had some suggestions for me. I stayed in his World War II prefab hut with him and his family for two days while he went over my thesis with a fine-tooth comb. When I left I was very depressed. But soon I realized that he had done me an enormous favor, and that my thesis was much improved as a result.\”

And here\’s a comment about what econometrics can teach and what economists can know:

\”I used to believe that it was possible to build and estimate an econometric model that would represent an invariant law of economic behavior, valid for many places and for long periods of time. I no longer believe this, because I have yet to see an econometric model that continues to describe new data with no change in its parameters. Instead, I believe that economic reality is so complex that the best we can expect of an econometric model is that it may approximately represent the relations among its variables for a limited place and time. Such an approximation may be very useful, and may permit us to make forecasts for short periods into the future. But until we have much more knowledge about human biology and its relation to economic, social, and political behavior I think we will not achieve econometric models that are invariant over wide reaches of space and time.

________________________

Symposium: Recent Ideas in Econometrics\”The State of Applied Econometrics: Causality and Policy Evaluation,\” by Susan Athey and Guido W. Imbens

Beggar-my-neighbor is a simple card game which according to reference in the Oxford English Dictionary dates back at least to the early 1700s. In 1776, Adam Smith applied the expression to trade policy. The often-quoted short passage from Book IV, Chapter III of the The Wealth of Nations reads.

\”[N]ations have been taught that their interest consisted in beggaring all their neighbours. Each nation has been made to look with an invidious eye upon the prosperity of all the nations with which it trades, and to consider their gain as its own loss. Commerce, which ought naturally to be, among nations, as among individuals, a bond of union and friendship, has become the most fertile source of discord and animosity.\”

Here\’s some of the broader argument surrounding Smith\’s particular comment. A key underlying theme for Smith is that attempts to limit trade are, pretty much by definition, attempts to limit competition. As a result, such attempts favor the producers (Smith calls them \”monopolists\”) who have less need to face competition, but impose costs on consumers of goods. Smith also discusses that the economic strength of a neighboring nation may be \”dangerous in war and politics,\” but beneficial economically because it offers more opportunity for trade. Finally, Smith points out that dire warnings of the dangers of international trade were prominent, then as now, but when you look across countries, the places more open to international trade typically tend to be better-off, not worse-off. Smith wrote:

\”Nothing, however, can be more absurd than this whole doctrine of the balance of trade, upon which, not only these restraints, but almost all the other regulations of commerce are founded. When two places trade with one another, this doctrine supposes that, if the balance be even, neither of them either loses or gains; but if it leans in any degree to one side, that one of them loses and the other gains in proportion to its declension from the exact equilibrium. Both suppositions are false. A trade which is forced by means of bounties and monopolies may be and commonly is disadvantageous to the country in whose favour it is meant to be established … But that trade which, without force or constraint, is naturally and regularly carried on between any two places is always advantageous, though not always equally so, to both.

By advantage or gain, I understand not the increase of the quantity of gold and silver, but that of the exchangeable value of the annual produce of the land and labour of the country, or the increase of the annual revenue of its inhabitants. … 

It is a losing trade, it is said, which a workman carries on with the alehouse; and the trade which a manufacturing nation would naturally carry on with a wine country may be considered as a trade of the same nature. I answer, that the trade with the alehouse is not necessarily a losing trade. In its own nature it is just as advantageous as any other, though perhaps somewhat more liable to be abused. The employment of a brewer, and even that of a retailer of fermented liquors, are as necessary divisions of labour as any other. It will generally be more advantageous for a workman to buy of the brewer the quantity he has occasion for, than to brew it himself, and if he is a poor workman, it will generally be more advantageous for him to buy it, by little and little, of the retailer than a large quantity of the brewer. He may no doubt buy too much of either, as he may of any other dealers in his neighbourhood, of the butcher, if he is a glutton, or of the draper, if he affects to be a beau among his companions. It is advantageous to the great body of workmen, notwithstanding, that all these trades should be free, though this freedom may be abused in all of them, and is more likely to be so, perhaps, in some than in others. Though individuals, besides, may sometimes ruin their fortunes by an excessive consumption of fermented liquors, there seems to be no risk that a nation should do so.  …

By such maxims as these, however, nations have been taught that their interest consisted in beggaring all their neighbours. Each nation has been made to look with an invidious eye upon the prosperity of all the nations with which it trades, and to consider their gain as its own loss. Commerce, which ought naturally to be, among nations, as among individuals, a bond of union and friendship, has become the most fertile source of discord and animosity. … 

That it was the spirit of monopoly which originally both invented and propagated this doctrine cannot be doubted; and they who first taught it were by no means such fools as they who believed it. In every country it always is and must be the interest of the great body of the people to buy whatever they want of those who sell it cheapest. The proposition is so very manifest that it seems ridiculous to take any pains to prove it; nor could it ever have been called in question had not the interested sophistry of merchants and manufacturers confounded the common sense of mankind. Their interest is, in this respect, directly opposite to that of the great body of the people. As it is the interest of the freemen of a corporation to hinder the rest of the inhabitants from employing any workmen but themselves, so it is the interest of the merchants and manufacturers of every country to secure to themselves the monopoly of the home market. Hence in Great Britain, and in most other European countries, the extraordinary duties upon almost all goods imported by alien merchants. Hence the high duties and prohibitions upon all those foreign manufactures which can come into competition with our own. Hence, too, the extraordinary restraints upon the importation of almost all sorts of goods from those countries with which the balance of trade is supposed to be disadvantageous; that is, from those against whom national animosity happens to be most violently inflamed.

The wealth of a neighbouring nation, however, though dangerous in war and politics, is certainly advantageous in trade. In a state of hostility it may enable our enemies to maintain fleets and armies superior to our own; but in a state of peace and commerce it must likewise enable them to exchange with us to a greater value, and to afford a better market, either for the immediate produce of our own industry, or for whatever is purchased with that produce. As a rich man is likely to be a better customer to the industrious people in his neighbourhood than a poor, so is likewise a rich nation. A rich man, indeed, who is himself a manufacturer, is a very dangerous neighbour to all those who deal in the same way. All the rest of the neighbourhood, however, by far the greatest number, profit by the good market which his expence affords them. They even profit by his underselling the poorer workmen who deal in the same way with him. The manufacturers of a rich nation, in the same manner, may no doubt be very dangerous rivals to those of their neighbours. This very competition, however, is advantageous to the great body of the people, who profit greatly besides by the good market which the great expence of such a nation affords them in every other way. Private people who want to make a fortune never think of retiring to the remote and poor provinces of the country, but resort either to the capital, or to some of the great commercial towns. They know that where little wealth circulates there is little to be got, but that where a great deal is in motion, some share of it may fall to them. The same maxims which would in this manner direct the common sense of one, or ten, or twenty individuals, should regulate the judgment of one, or ten, or twenty millions, and should make a whole nation regard the riches of its neighbours as a probable cause and occasion for itself to acquire riches. A nation that would enrich itself by foreign trade is certainly most likely to do so when its neighbours are all rich, industrious, and commercial nations. 

It is in consequence of these maxims that the commerce between France and England has in both countries been subjected to so many discouragements and restraints. If those two countries, however, were to consider their real interest, without either mercantile jealousy or national animosity, the commerce of France might be more advantageous to Great Britain than that of any other country, and for the same reason that of Great Britain to France. France is the nearest neighbour to Great Britain. In the trade between the southern coast of England and the northern and north-western coasts of France, the returns might be expected, in the same manner as in the inland trade, four, five, or six times in the year. The capital, therefore, employed in this trade could in each of the two countries keep in motion four, five, or six times the quantity of industry, and afford employment and subsistence to four, five, or six times the number of people, which an equal capital could do in the greater part of the other branches of foreign trade. …
But the very same circumstances which would have rendered an open and free commerce between the two countries so advantageous to both, have occasioned the principal obstructions to that commerce. Being neighbours, they are necessarily enemies, and the wealth and power of each becomes, upon that account, more formidable to the other; and what would increase the advantage of national friendship serves only to inflame the violence of national animosity. They are both rich and industrious nations; and the merchants and manufacturers of each dread the competition of the skill and activity of those of the other. Mercantile jealousy is excited, and both inflames, and is itself inflamed, by the violence of national animosity: And the traders of both countries have announced, with all the passionate confidence of interested falsehood, the certain ruin of each, in consequence of that unfavourable balance of trade, which, they pretend, would be the infallible effect of an unrestrained commerce with the other.

There is no commercial country in Europe of which the approaching ruin has not frequently been foretold by the pretended doctors of this system from an unfavourable balance of trade. After all the anxiety, however, which they have excited about this, after all the vain attempts of almost all trading nations to turn that balance in their own favour and against their neighbours, it does not appear that any one nation in Europe has been in any respect impoverished by this cause. Every town and country, on the contrary, in proportion as they have opened their ports to all nations, instead of being ruined by this free trade, as the principles of the commercial system would lead us to expect, have been enriched by it. …

Some years back I was giving some talks in South Africa, and found myself in a back-and-forth with a group of sharp and thoughtful students about whether the US was better off if other countries of the world, like South Africa, were poor or rich. The sense of many of the students was that the US wanted other countries to remain poor, so that the US could import goods produced by low-cost labor. I argued that for all the back-and-forth of US policy over time, the main thrust of policies like leading the way in the GATT and the WTO was an underlying belief that the US economy benefited when other countries were better off. Channeling Adam Smith, I found myself asking the group: \”If you want to be economically successful, would you prefer to live in a rich neighborhood or a poor one?\” I doubt that I changed anyone\’s mind, but at least the question led to a pause in the conversation, in which I could almost hear ideas being recalibrated and reframed.

Jason Furman was an economic policy insider through all eight years of the Obama administration, with \”oughly the first half of them as Deputy Director of the National Economic Council and the second half of them as Chairman of the Council of Economic Advisers.\” In the Arnold C. Harberger Distinguished Lecture on Economic Development at the UCLA Burkle Center for International Relations, Furman reflects on \”The Role of Economists in Economic Policymaking\” (April 27, 2017).

Furman has a pleasantly wry and discursive tone, with lots of anecdotes that mix together stories of success and failure. At least for readers like me, it\’s a tone that carries far more appeal and persuasive power than feverish oratory set to the sound of trumpets. For example, here are some of Furman\’s thoughts on the four things that economists have to offer when the answer to a policy question is not known.

The first is just describing the data. Describing the data does not tell you what caused what. It does not tell you what is the right policy or what is the wrong policy. But it can help you at least figure out what questions you should be asking, what areas you should be looking at to solve those questions, and what you can do about them. The data can be complicated. The government released two different measures of economic growth in the fourth quarter of 2016, one was 1.0 percent and one as 2.1 percent. The government also released two different measures of job growth in March 2017, 98,000 jobs and 472,000 jobs. Moreover, for the first quarter of this year the data tells a divergent story—with strong employment growth and strong “soft data”, like surveys of confidence, but much weaker GDP growth and weaker “hard data”, like actual sales numbers. I have spent a lot of time on these issues and developed a number of rules of thumb, almost all of which can be summarized by saying that you should look at a wide range of data, ideally smoothed over a longer period of time—without placing too much weight on any given indicator … Data description can be more sophisticated than just looking at single numbers or even trends. Sometimes it helps to decompose a number into its components to identify what is driving it, at least in an arithmetic sense. 

The second set of techniques we use is economic theory. Economic theory can sometimes give you a very helpful answer to a question. One of the biggest insights in economics is that some items are more valuable to one person than to another person, and if those two people trade things, they can both be better off. These are the basic motivations for a market economy and the basis of the argument for expanding international trade. … Let me give you one: the example of the allocation of electromagnetic spectrum …  Spectrum is a scarce resource and in many cases the rights to use it were allocated decades ago. Today, much of the best spectrum is reserved for the exclusive use of television broadcasters while users of smartphones and tablets often face frustrating and economically costly delays in accessing data because of crammed airwaves. In the Los Angeles area, for example, there were more than 25 broadcast stations, some of them with only a handful of viewers, most of whom could watch the shows on cable, online or through other means. A station with only a few thousand viewers might be worth $5 million, but at the same time may own a license for spectrum that a mobile broadband provider would be willing to buy for $50 million. We proposed to deal with this by setting up an incentive auction. Anyone who is a television broadcaster who wants to sell their spectrum can do so, and anyone who is a mobile broadband provider or anything else and wants to buy that spectrum can do so. The auction is entirely voluntary—a station will only sell if it is better off with cash than with spectrum, a mobile broadband provider will only buy if it (and presumably its consumers) benefit more from the spectrum than the cash they pay, and taxpayers get a cut of the difference in the bids to reflect the government’s role in organizing the process, including repackaging the spectrum into contiguous blocks to make it more valuable. Economic theory was enough to motivate and support this proposal—which ultimately resulted in $5 billion for taxpayers as well as profits for television broadcasters, mobile broadband providers, and benefits for their consumers. … In the last two decades, one of the fastest growing areas of economics has been “behavioral economics,” which relaxes the standard assumption that people are fully rational, and instead pays close attention to the ways people can be myopic, make decisions that depend on framing, and have limited attention spans or ability to incorporate information. One of the big successes of labor economics has been getting policy to focus less on the rate of return to savings and more on making it easier and more automatic to save. 

The third set of techniques we use is empirical work, trying to understand the causes and effects of different economic phenomena. I want to give you an example of a mistake I was involved in because I did not think hard about causation. At the end of 2008, I was working with Congress on legislation to raise the tax on tobacco products in order to pay for an expansion of the Children’s Health Insurance Program (CHIP). The main proposal was to raise the tax on a pack of cigarettes from $0.39 per pack to $1.01 per pack. But we also needed to set tax rates on a wide range of other tobacco products including roll-your-own tobacco, pipe tobacco, small cigars, large cigars, and more. Amidst everything that was going on at the end of 2008 with the Great Recession I did not pay enough attention to this issue, even though I once sat through what felt like an endless meeting on the topic. What came out of that meeting was a proposal to raise the tax rate on roll-your-own tobacco by more than $20 a pound while leaving the tax rate on pipe tobacco largely unchanged. What followed was a huge decline in the sale of roll-your-own tobacco and a huge increase in the sale of pipe tobacco … It turns out that roll-your-own tobacco and pipe tobacco are highly substitutable—not because people have shifted to smoking pipes, but because you can still put pipe tobacco in a piece of paper, roll it up, and smoke it. This is not just a minor, technical observation. It turns out to be highly consequential for public health. I have estimated that the 2009 tobacco tax increase will reduce the number of premature deaths due to smoking by between 15,000 and 70,000 for each cohort. But it would have reduced them even more if we had harmonized the tax rate on different tobacco products, as we did in a subsequent proposal. In fact, economists in the Treasury Department estimated that the reduction in tobacco consumption under a harmonization proposal would be nearly two and a half times the size it would be under an increase in the cigarette tax alone that raises comparable revenue. 

 

Fourth, we sometimes combine empirical description, theory, and causation to build models that allow us to simulate the impact of different policies. For example, such simulations can tell you how a tax cut will be distributed or affect the economy, how much a particular health plan will cost per person covered, or how much carbon emissions will change as a result of different policy approaches. While any model is limited and imperfect, models can be especially useful in quantifying plausible tradeoffs in designing a policy and communicating the impact of policies to policymakers.

It\’s interesting to me that of these four approaches, Furman lists basic description of data and basic theoretical insights first, ahead of the more complex modelling approaches. Here are a few more words from Furman:

In the Obama Administration I worked on everything from helping to prevent a second Great Depression to restructuring the post office—although I confess that we were only successful on one of these. Many of the topics I worked on are standard fare for economics, like the minimum wage, international trade, or environmental regulation. Others might be topics you do not associate with economists, like criminal justice reform, immigration, and sanctions. And on none of these did economists fully get their way which, ceteris paribus, is a good thing …

After the election many people expressed frustration that facts and analysis did not matter anymore. Paul Krugman cited the statistic that the three major networks spent a cumulative total of 32 minutes covering policy issues in the 2016 election. … I certainly share the sentiment that facts and analysis play too small a role not just in campaigns but in governing. And I think there is a role for many types of communication and persuasion. For myself, I am not someone who could give a rousing speech at a rally so I will stick to my comparative advantage. And I do believe that the right response to the lack of sufficient weight for facts and analysis is to embrace more facts and analysis.

For those who are interested in the Council of Economic Advisers and the role of academic economists in policy-making, here are a few more links: 

Here\’s a figure showing seven waves of corporate mergers in the US since the 1851, according to the Institute for Mergers, Acquisitions & Alliances (a not-for-profit think tank that does research and workshops, and runs an educational certificate program, with main offices in New York, Vienna, Zurich, and Ho Chi Minh City). As the figure shows, the first three waves of merges have substantial periods of time between them. The most recent four waves are all since 1985.

Looking more closely at recent years, here is some additional information on these patterns. In this figure, the blue bars (and the left-hand axis) show the number of announced deals in each year, while the red line (and right axis) show the total value of the deals. For example, the number of deals rose from 2011 to 2014, but not all that sharply, while the value of the deals jumped considerably. I

In both this figure, and the one above, the \”wave\” of mergers in the 1980s doesn\’t look to me so much like a separate wave, but rather just a time of transition to the higher levels of mergers that would follow. In addition, from a longer historical perspective, it looks more as if the US economy has entered  period since the 1990s when mergers are generally at high levels–although sometimes higher than others.

For another perspectives, here is the number and value of mergers and acquisitions on a worldwide basis since 1985, which again shows either three \”waves\” or just a generally higher level of mergers since the late 1990s, depending on how you interpret it.

Of course, patterns like these don\’t prove anything by themselves, and I try not to be someone who over-extrapolates. But I\’ll just say that these merger and acquisition patterns are certainly consistent with a vision of the US and the global economy in which large companies seem relatively more focused on spending their funds and their managerial time on financial maneuvers that allow them to reduce their exposure to market pressures (either by combining with direct competitors or combining with firms along the supply chain), and thus relatively less focused on seeking to improve their competitive position by internal investments in capital, skills, and innovation.

As final exams draw near at many colleges and universities (at least for those on a semester schedule), it seems appropriate to pass along this old story as told by Nicholas Murray Butler, President of Columbia University, at the 143rd Annual banquet of the Chamber of Commerce of the State of New York., 1911 (pp. 43-55), and available through the magic of the HathiTrust Digital Library

\”I cannot help recalling an admirable story which is told of ROBERT SOUTHEY, once Poet Laureate of England. SOUTHEY was boasting to a Quaker friend of how exceedingly well be occupied his time, how he organized it, how he permitted no moment to escape; how every instant was used; how he studied Portuguese while he shaved, and higher mathematics in his bath.

\”And then the Quaker said to him softly: `But when, friend, dost thee think? 

\”My impression is that we need now some time to think, in order that reflection and study of principle, and grasp upon realities, may take the place of perpetual discussion and exposition, partly of what is, partly of what never was, partly of what never can be.\”

For those feeling the need for a bracing dose of optimism about the prospects for US productivity growth, I recommend \”The Coming Productivity Boom: Transforming the Physical Economy with Information,\” written by Michael Mandel and Bret Swanson (March 2017), and published by the Technology CEO Council (which is more-or-less what it sounds like, a \”public policy advocacy organization comprising Chief Executive Officers from America’s leading information technology companies, including Akamai, Dell, IBM, Intel, Micron, Oracle, Qualcomm and Xerox.\”)

Mandel and Swanson split the US economy into two big chunk, which they call the \”digital economy\” and the \”physical economy.\” In the digital economy, which accounts for about 30% of US GDP, they argue that investment in information technology and productivity growth are doing fairly well. But in the physical economy, investment in information technology and productivity growth have been low. Thus, they argue that there is potential for rapid productivity growth in more than two-thirds of the US economy.

What are the industries in these two economic groupings? The digital economy is: \”Computer and electronics production; publishing; movies, music, television, and other entertainment; telecom; Internet search and social media; professional and technical services (legal, accounting, computer programming, scientific research, management consulting, design, advertising); finance and insurance; management of companies and enterprises; administrative and support services.\” The physical economy is: \”All other industries, including agriculture; mining; construction; manufacturing (except computers and electronics); transportation and warehousing; wholesale and

Most people who teach economics are on a continual lookout for current examples of supply and demand. Otherwise, you end up falling back on  hypothetical goods like \”widgets\” and \”leets\” (which is \”steel\” spelled backward), at which point you can almost see the life and brightness fade out of the eyes of students.  nice lively example of shifts in demand comes from the demand for sand used in hydraulic fracking operations. As the Wall Street Journal recently reported, \”Latest Threat to U.S. Oil Drillers: The Rocketing Price of Sand: The market for a key ingredient in fracking is again surging,\”
(by Christopher M. Matthews and Erin Ailworth, March 23, 2017).

A couple of years ago, the USGS published \”Frac Sand in the United States—A Geological and Industry Overview,\” by Mary Ellen Benson and Anna B. Wilson, with a section on \”Frac Sand Consumption History\” contributed by Donald I. Bleiwas (Open File Report 2015-1107, posted July 30, 2015). The report includes this useful figure, in which the bars show the metric tons of sand used for fracking (measured on the left axis); the numbers above the bars show the number of horizontal drilling rigs in operation in the US during any given week of the year; and the line shows the value of the sand (right axis).

For an update through 2016 on production levels and price, the USGS publishes an annual fact sheet on various minerals. Fracking sand falls into the category of \”Industrial Sand and Gravel,\” of which more than 70% is used for fracking. Here\’s the relevant table from the 2017 factsheet. Thus, back in 2012 there was about 50 million tons of total sand production, with about 70% of it going to fracking. By 2014, output of sand had doubled–mostly due to increased demand from fracking. The price per ton rose from $52 in 2010 to $106 per ton in 2014. Then output and price sagged in 2015 and 2016.

The Wall Street Journal story reports rising prices for sand this year. It also notes: \”In Louisiana, Chesapeake Energy Corp. recently pumped a record 50.2 million pounds of sand into a horizontal well roughly 1.8 miles long, piquing the interest of some rivals who are now weighing whether they can do the same.\” And here\’s a figure showing quantities of sand being used in different fields.

No world-changing lessons here. The higher prices for sand don\’t seem likely to make much difference in the quantity of fracking, least for now, because sand is a fairly small slice of the overall cost. Environmental concerns are being already being raised in some US locations about the extent of sand-mining, and those concerns are likely to become more acute as the demand for fracking sand rises. But my guess is that if it becomes difficult to increase the supply of fracking sand, then those doing the fracking will either find ways to economize on sand or will figure out some alternative substances that would fill a similar purpose.

Postscript: Some readers might want to revisit my post on  \”Demand for Sand\” (April 16, 2014), which has some additional background on international demand for sand (mostly for concrete and construction purposes) and some environmental effects of sand-mining.

\”The large global banks were at the heart of the global financial crisis. In response to the crisis, the international Financial Stability Forum was upgraded to the Financial Stability Board (FSB) in 2009, with the full participation of finance ministers and even heads of government. The newly established FSB then published an integrated set of policy measures, such as capital surcharges and resolution plans, to address the systemic and moral hazard risks associated with global systemically important banks (G-SIBs). Eight years later, it is time to take stock of the impact of these measures. We answer three questions on what happened to the G-SIBs. First, have they shrunk in size? Second, are they better capitalised? Third, and in reference to the reported end of global banking, have they reduced their global reach?\”

For a few years now, Joseph Gyourko has been doing research and writing essays with a focus on housing supply, and in particular, how a collision between local restrictions that hinder home-building combined with growing demand in those localities lead to differences in prices. In an interview with Hites Amir, Gyourko lays out these views in the April 2017 issue of the Global Housing Watch Newsletter. (The newsletter is produced by Amir, who works fo the International Monetary Fund, but it is not an official IMF document).

\”In forthcoming work, Ed Glaeser and I conclude that most housing markets in the interior of the country function so that the price of housing is no more than the sum of its true production costs (the free market price of land plus the cost of putting up the structure) plus a normal entrepreneurial profit for the homebuilder. That is what we teach should happen in our introductory microeconomics courses—namely, that price paid by consumers in the market should equal the real resource cost of producing the good (housing in this case). These well-functioning housing markets exist in a broad swath of the country outside of the Amtrak Corridor in the Northeast (Washington, D.C. to Boston) and the major West Coast markets from Seattle all the way down to San Diego. The bulk of the population lives in these well-functioning markets, by the way. They just are not focused on by the media. …

\”Restrictions began to be imposed in many west coast markets in the 1970s, with east coast markets in the northeast following the next decade. Thus, it is the people who owned in those markets at those times who enjoyed the most appreciation in their homes. Those people tend to be senior citizens today, and even if they do not earn relatively high incomes, they are wealthy because of the real capital gains on their homes. …  

\”If they limit supply sufficiently relative to demand, then the existing housing units will be rationed by price. Richer households will be able to bid more to live in their preferred markets, so we get the sorting of the rich into the higher priced coastal markets. … The divergence in home prices between low cost, elastically supplied markets and high cost, inelastically supplied markets has been growing over time—since 1950, at least. …  This can generate a spiral up in prices, and it can last a long time. In 1950 for example, housing in the most expensive metropolitan areas was about twice as costly as in the average market. At the turn of the century in 2000, the most expensive metros were at least four times more costly than the average market. I expect that gap to widen over the coming decade. …

\”In a well-functioning market with elastic supply, prices should be equal to fundamental production costs. In most American markets, that is no more than $200,000-$250,000.\”

 Here\’s a figure, which is a version of a diagram that appears in \”Superstar Cities,\” by Joseph Gyourko, Christopher Mayer, and  Todd Sinai in the American Economic Journal: Economic Policy, November 2013 (5:4, pp. 167-99). The figure shows what the distribution of the average house value across US metropolitan statistical areas (MSAs) in 1950 and 2000. Average prices are higher in 2000 than in 1950, which isn\’t surprising, since the average house is bigger, too. But the key insight here is that the distribution of average housing prices across cities in 1950 is more bunched together, while the distribution across cities in 2000 is much wider, with a long right-hand-tail.

This wider distribution of housing prices across cities has broader trade-offs. It becomes harder for those living in cities with lower housing prices to relocate to cities with higher housing prices. It creates a greater level of economic segregation, because those with higher incomes are more likely to end up living in a smaller number of cities where they can afford the high housing prices, while those with middle-level or lower-level incomes struggle to find alternatives.  It adds a dose of bitterness to local arguments over zoning, because current owners of high-priced houses (whether they have owned a house for decades or bought more recently) live in fear that an increase in the supply of housing–or even building more moderately-sized and -price housing–might in some way limit whether their own home will keep rising in price. Gyourko says: