How much freedom to choose?

Ed Glaeser argues that the "moral heart of economics" is "freedom" and in particular the "freedom to choose:"

Improvements in welfare occur when there are improvements in utility, and those occur only when an individual gets an option that wasn’t previously available. We typically prove that someone’s welfare has increased when the person has an increased set of choices.

When we make that assumption (which is hotly contested by some people, especially psychologists), we essentially assume that the fundamental objective of public policy is to increase freedom of choice.

I will leave it to others to dispute the notion that more choices are always better than fewer.  But I can't help but think that it is to easy for those of us who are tenured professors to extoll the virtue of free choice, for the simple reason that we get so many, well, choices.  We get to choose what we write, we to a large extent get to choose what we teach inside our classes, and we can piss our deans off and pay fairly little in the way of consequences.  We might not get a raise or we might have to teach a class that we would rather not, but this is all small beer.  We can make an awful lot of choices and still be economically secure.

Now consider the administrative assistant at a corporation who has a boorish boss and a sick kid.   The company she (he) works for has a good health insurance plan, but if she were to leave, she would find herself unable to get coverage at a reasonable price.  Does she really have choice?

Consider the West Virginia coal miner who goes into a dangerous mine every day, and whose life expectancy is shortened with each hour worked underground.  Now consider the fact that the miner grew up in a West Virginia town with a poor school in an environment where going to college was a rare phenomenon.  Does that miner have a choice?

I could go on, but I think the point is fairly clear.  There are times when government intervention could expand the choice set up a large number of people.

Ed does point out how government can improve choice sets, and for that he deserves credit.  But the more fundamental problem is that market economies produce large institutions that have limited markets inside of them, and therefore sometimes have hierarchies that can be as inhospitable to personal liberty as government bureaucracies.  Elinor Ostrom's Nobel win in 2009 shows that the economics profession is beginning to recognize this problem,  but I am not sure Ph.D. students are broadly encouraged to study it.    

Uh-oh

I met with a large developer here in India.  He told me that "rent models," (i.e., discounted cash flow models) don;t work in India--that everyone wants to own property in India, and so India is different.  I remember a Japanese real estate guy telling me the same thing about Japan in the late 1980s.

At least there isn't a lot of leverage here, so the systemic risk of a collapse in prices is lower.  But still....

Mark Thoma passes on terrible news about Maxine Udall, girl economist

To all Maxine Udall Girl Economist Readers

I didn't know who she was, but I felt like I knew her.  She was smart and wise.

Land use regulation and the cost of housing, Indian style

Mumbai is among the densest cities in the world: as a metropolitan area, it is roughly ten times denser than New York (h/t Alain Bertaud).  Yet residential zoning codes typically have FSIs (the equivalent of a floor-area ratio) of between 1 and 1.33.  This compares with typical central business district FSIs of between 5 and 15 in other cities around the world, and there are places in Hong Kong, which is a very attractive city, where it reaches 20.  

So what happens when the most crowded large city in the world forbids intense development?  Prices get very high.  The most expensive parts of Mumbai are more expensive than Manhattan; the least expensive are comparable to the American Midwest, but people's "middle-class" incomes are perhaps 1/8 as large in Mumbai.

A developer I spoke with last night told me that if FSIs were raised to 4 (still low by world standards), prices would fall by about 50 percent.  While this is not an econometrically determined elasticity, it does make a certain amount of sense.  It would be worth at least doing the policy experiment of raising FSI uniformly.

As for services, well, there are already plenty of people using services.  The average person in Mumbai consumes about 30 square meet of residential floor space, so allowing more vertical development might, if anything, alleviate crowding, both inside and out.  

The present value relationship still doesn't work in India

I had students here in Hyderabad gather data on rents, and then we put together a valuation pro forma.  We determined that the present discounted value of flats here is roughly 40 percent of their sale price.

I have been doing this sort of exercise since I first visited south Asia seven years ago, and I get about the same outcome every time.  It is not credit that is driving this market--many people buy property with cash.  People tell stories about "black money" financing property--this is untraceable, and therefore untaxed, money.    But our calculations imply an implicit tax rate of 60 percent--taxes in India are not that high (in fact, other than an eight percent transfer tax, they are fairly similar to the US).

So the story must be about expectations, and indeed, that is the story I hear.  But current yields are well under 3 percent, and if values rise faster than rents, those yields will get even lower.  Something has got to give.  I just have no idea when.

The OECD says imputed rent should be taxed

When homeowners own their property with equity, they get a tax benefit as important as the mortgage interest deduction: the imputed rent they pay to themselves goes untaxed.  To think about how this works, consider two nieghbors who own their houses free and clear.  Suppose the houses are identical, and that the nieghbors swap houses, paying rent to each other.  They now have a tax liability that they would not have had they remained in their houses.  Avoiding this liability is tantamount to a tax expenditure--a benefit to those who own their houses without debt.  The OECD is correct that countries rarely tax imputed rent, and argues that this lack of taxation has tilted investment toward housing to the detriment of more productive uses.  It also argues that the benefits to homeownership are overstated.  I am not sure that this is true (see here and here), but I will leave that for another time.

The question is how does one go about taxing imputed rent?  It is not easy.  One could start by imposing an ad valorem tax on property values (such as a local property tax), but that doesn't tax imputed rent per se, because it does not take into account expected inflation (if one person expects her house to go up in value, and another does not, the rent the first person pays is lower than the second).  Alternatively, one could find comparables in the rental market and attribute rents found there to the owner market.  But owner and rental markets are so segmented that this would be difficult to do.

This has implications for fairness; if we don't know what we are taxing, it is hard to know how much to tax it. 

Amy Chua and the Reflection Problem

I saw Amy Chua speak some years ago (at the World Bank, I think) about her book, World on Fire. She was an excellent, witty and provocative speaker, so much so that I read the book as a result. And while the book was indeed thought-provoking, it was not convincing. Her basic point was that democracies can produce instability: minorities in democracies can amass economic wealth, which in turn leads to resentment, which in turn leads to political scapegoating and instability and all other kinds of bad things. The problem is she never presented to me a convincing counterfactual; she never showed me how a world devoid of democracy would also be devoid of resentment and instability.

As a result of reading World on Fire, I will not read Battle Hymn beyond the excerpt in the Wall Street Journal (although I understand that the excerpt is not representative of the book). If the book is only a memoir, then it is almost certainly fine, but this is not how it is being represented. Instead, it is being characterized as a comparison between "Chinese parenting" and its results and "Western parenting" and its results. Again, this may be unfair to Ms. Chua, but the book has spurred myriad commentary about the virtues and deficiencies of various parenting styles.

What is lost in all of this is how difficult it is to actually draw inferences about the effects of parenting styles on outcomes. Charles Manski calls this "the reflection problem." Here is Manski:

Here is an identification problem from everyday life: Suppose that you observe the almost simultaneous movements of a person and of his image in a mirror. Does the mirror image cause the person's movements, does the image reflect the person's movements, or do the person and image move together in response to a common external stimulus? Empirical observations alone cannot answer this question. Even if you were able to observe innumerable instances in which persons and their mirror images move together, you would not be able to logically deduce the process at work. To reach a conclusion requires that you understand something of optics and of human behavior.

A like inferential problem, which I have called the reflection problem (Manski 1993a), arises if you try to interpret the common observation that individuals belonging to the same group tend to behave similarly. Two hypotheses often advanced to explain this phenomenon are endogenous effects, wherein the propensity of an individual to behave in some way varies with the prevalence of that behavior in the group; and correlated effects, wherein individuals in the same group tend to behave similarly because they face similar environments and have similar individual characteristics.

Similar behavior within groups could stem from endogenous effects (e.g., group members could experience pressure to conform to group norms) or group similarities might reflect correlated effects (e.g., persons with similar characteristics might choose to associate with one another). Empirical observations of the behavior of individuals in groups, even innumerable such observations, cannot per se distinguish between these hypotheses. To draw conclusions requires that empirical evidence be combined with sufficiently strong maintained assumptions about the nature of individual behavior and social interactions.

Why might you care whether observed patterns of behavior are generated by endogenous effects, by correlated effects, or in some other way? A good practical reason is that different processes have differing implications for public policy. For example, understanding how students interact in classrooms is critical to the evaluation of many aspects of educational policy, from ability tracking to class size standards to racial integration programs.

Suppose that, unable to interpret observed patterns of behavior, you seek the expert advice of two social scientists. One, perhaps a sociologist, asserts that pressure to conform to group norms makes the individuals in a group tend to behave similarly. The other, perhaps an economist, asserts that persons with similar characteristics choose to associate with one another. Both assertions are consistent with the empirical evidence. The data alone cannot reveal whether one assertion or the other is correct. Perhaps both are. This is an identification problem.

Whatever one thinks about Ms. Chua's parenting, we have no firm evidence whether her kids' outcomes are a function of Chinese parenting, Chua-specific parenting, or just her kids' endemic talents. It is a serious problem when we forget that.