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Q&A with Matthew Turner on Road Congestion and Transportation Policy

It’s been another busy summer at PERC, with our summer fellowships bringing together an all-star cast of scholars to Montana to research topics relating to free market environmentalism. This week we continue our Q&A series with economist Matthew Turner, a leading expert on road congestion and transportation policy.

Matthew Turner is a 2012 PERC Julian Simon Fellow and professor of economics at the University of Toronto. His research focuses on the economics of land use and transportation. We thank Matthew for taking time to answer our questions. For more PERC Q&As, visit the series archive.

Q:  At your latest PERC workshop you presented new research, co-authored with Victor Couture and Gilles Duranton, entitled “Speed.” What aspect of speed are you looking at and why is it important?

A:  Bakeries in the Soviet Union used to hand out bread for free to the first in line while those at the back wait for the next batch. This was wasteful. It meant time was spent waiting that could otherwise be used for something else, and it gave bread to people with the most time on their hands rather than to the hungriest or the hardest working. We allocate highway space in much the same way. The commuter who arrives on the road at 7:00am gets to travel, but the one who arrives at 7:30am needs to waits in a traffic jam until road capacity becomes available. Just as for the old Soviet bakery, this leads to a lot of time wasted in traffic jams and assigns scarce rush-hour capacity to people willing to wait in traffic, who might not be the people who value rush hour travel most highly.

In our research we are try to understand the determinants of  driving speed in order to estimate the value of time lost to waiting in traffic. Since road travel, one way or another, accounts for about 18% of gdp, the value of this waste is a big number. We also want to develop a basis for making guesses about what a good road pricing system would look like.

Q You claim there are sizable welfare gains to be had from more sensible transportation policies? What sorts of policies are we talking about? Taxes on driving?

A:  Our research suggests that the failure to price access to roads leads Americans to waste tens of billions of dollars worth of time each year sitting in traffic. Yet roads are congested only part of the time and even our biggest and busiest cities have unused road capacity off peak. If we impose tolls on congested roads at congested times, we give people an incentive to shift their travel to an uncongested time when we have surplus road capacity. This saves people from waiting in traffic and will likely increase the capacity of our road network.

QAre there areas where congestion pricing has worked? Could it be implemented on a wide scale in the United States?

A:  Stockholm, London, and Singapore, and a handful of U.S. roads and bridges have congestion pricing programs. In these places we see big increases in travel speed in response to pretty small charges for peak hour road use. With that said, the devil is in the details. So far, these programs are expensive to administer and it is easy to imagine ways that they could create problems. Rather than aiming for wide scale application to the United States we ought to encourage pilot programs in congested cities like New York, Miami, Seattle, Boston and Portland. As we gain experience administering congestion pricing programs we can apply them more widely.

Q In earlier research you find that widening and building more roads actually creates more traffic. What is “The Fundamental Law of Road Congestion” and what are its implications for transportation policy?

A:  In this project we examine the relationship between the stock of highways and arterial roads in large U.S. cities and the total amount of road travel in these cities. More precisely, it examines the relationship between a city’s total lane kilometers of highway and arterial road and total miles driven within the city in a year. We find that a one percent increase in road lane kilometers causes almost exactly a one percent increase in driving. We also find that changes to the stock of buses in a city’s public transit network do not affect driving.

This means that we should not expect either road or transit expansions to alleviate traffic congestion in the long run. The only policy that we know to be effective at reducing traffic congestion is congestion pricing.

QWhen might investments in public transportation or road building be worthwhile?

A:  Even though road and transit expansions probably won’t reduce congestion on our roads and highways, they will allow more people to move around. We want to evaluate transportation infrastructure on the basis of the value of these extra trips. If a new subway line allows an extra 50,000 people to work downtown, we need to decide if the extra economic activity downtown justifies the cost of the train. The same is true of road expansions. We don’t have good answers to this question yet. Generally, it looks like expansions of highway and subway capacity are so expensive that it is going to be difficult to pass this test, especially in the countryside where rural state senators like to send federal highway funding. On the other hand, making investments that squeeze more capacity out of existing roads and tracks in big cities is going to be easier to justify.

For more from Matthew Turner on transportation policy, read his article in the Fall 2010 edition of PERC Reports.

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Q&A with Steven Medema on the Coase Theorem and Environmental Economics

There has been plenty of confusion surrounding the work of Ronald Coase since his article “The Problem of Social Cost” appeared in 1960 – so much, in fact, that two scholars wrote in 1992 that the so-called Coase theorem has “generated a negative externality for economists.” To clear up some of the confusion, we talked with Steven Medema for the next installment of PERC’s Q&A series.

Few know more about the legendary economist and his impact on economic thought than Steven Medema. He is the author of many books and scholarly articles on the history of twentieth-century economics, with an emphasis on the work of Ronald Coase. His latest book, The Hesitant Hand: Taming Self-Interest in the History of Economic Ideas, was awarded the 2010 Book Prize by the European Society for the History of Economic Thought.

Medema is a professor of economics at the University of Colorado Denver and a 2011 PERC Lone Mountain fellow. For more of PERC’s Q&As, see the series archive.

Q: Ronald Coase’s 1960 article on “The Problem of Social Cost” had a tremendous impact on economics, including PERC’s work on free market environmentalism. What is the “Coase theorem” and how has it evolved in economic thought?

A: The Coase theorem tells us that if property rights over the relevant resources are well-defined and the costs of transacting are zero, parties who disagree over the use of those resources will negotiate to an efficient solution, regardless of to whom the property rights are assigned. The upshot of the theorem is that private negotiations or other market-like processes can efficiently resolve social cost (“externality”) problems such as those associated with air and water pollution. Of course, transaction costs are never zero, and much of the discussion of the theorem over the years has attempted to work out the possibilities and limitations of negotiated solutions when transaction costs are positive. Though much of the early reaction to the theorem was negative, the discussion has evolved into one that focuses somewhat less on the theorem per se (that is, with its highly restrictive assumptions) and somewhat more on departures from these conditions and how Coase-theorem-like processes may be operative under more realistic conditions.

Q: Over the years, people have come to refer to a hypothetical world of zero transaction costs as a “Coasian world.” Is this view accurate?

A: Those who refer to such a world haven’t read Coase very closely. The world of zero transaction costs is a fiction—but a sometimes useful fiction, not unlike a vacuum in physics. It was also a bedrock assumption of mainstream economics for ages, including of the economics against which Coase was reacting in “The Problem of Social Cost.” What Coase showed was that, in the world of neoclassical economics, government regulation was unnecessary for an efficient resolution of social cost problems. If property rights are assigned over the resources in question and there are no costs of transacting, the parties will efficiently resolve the problem through negotiation. So, Pigovian remedies are unnecessary in a Pigovian (costless transacting) world. But Coase’s emphasis was on the fact that the costs of transacting are not zero, and nor are the costs associated with government action to deal with social cost problems. The evaluation of how society should deal with such problems thus involves a comparison of the benefits and costs of alternative courses of action—including the possibility of allowing the problem to persist if the costs of “curing” it are worse than the disease itself.

Q: We hear a lot about the Coase theorem in environmental economics. How has the Coase theorem impacted discussions of environmental economics and environmental policy?

A: I think that its central impact has been in the way of making scholars—and later policy makers—aware of the possibility of using the exchange process to deal with social cost issues. Of course, the Coase theorem is an idealized construct that does not reflect the world in which we live. But by showing how property-rights-based solutions can generate private, efficiency-enhancing moves, the theorem opened the door to the subsequent analysis of exchange solutions in the real world, and thus to both theories and policies that employ such a framework.

Q: You suggest that the Coase theorem is widely recognized among environmental economists and taught in most textbooks, yet its relevance is often viewed as extremely limited. Why is this so? Why then are so many environmental economists interested in Coase?

A:  My sense is that most environmental economists see Coase as important because he emphasized that social cost problems are ultimately problems related to incomplete property rights. This makes Coase’s analysis the natural starting point for the analysis of social cost issues. The rub comes in where one goes from there. Some continue to hew to what we might call a “Pigovian” line—emphasizing that regulatory mechanisms or taxes are necessary to correct the problem—while others are more interested in exploring whether markets or market-like mechanisms can be utilized to resolve the problem. But there is broad general agreement that social cost problems have their roots on the property rights side, and this viewpoint owes to Coase.

Q: Discussions of environmental economics often center around externalities. Coase avoids this term. How has Coase’s work influenced the way we think about external costs?

A: My sense is that, at a minimum, he impressed upon some that social cost problems, or externalities, are reciprocal in nature. One can view this in two ways. First, it takes two to tango. That is, if A is generating smoke that harms B, B may be said to be as much the “cause” of the harm as A, since B could mitigate damages by, e.g., moving away. Second, A may be imposing harm on B, but to restrain A’s activity in favor of B is to impose harm on A. Some see this as a “right-wing” sort of point, but it is not. It actually has a long history in jurisprudence and was held by none other than J.R. Commons, a prominent Institutionalist economist and Progressive in who worked during the first half of the twentieth century. But value judgments often get in the way of sound reasoning when it comes to things like externalities, so not everyone has gotten on board with Coase’s notion of reciprocity.

Q: Critics of Coase often contend that transaction costs in markets are too high for Coasian-type bargaining to occur: negotiations can be costly, multiple parties can be affected, and information is diffuse. This is no doubt often the case, yet transaction costs are also present in the political process. How do these costs affect the way we understand Coase’s relevancy to environmental policy?

A: If one adopts an efficiency-based perspective on these things, the point to be taken is that there is no such thing as a determinate optimal solution to social cost problems. One can only come to grips with these things on a case-by-case basis, weighing the benefits and costs associated with alternative courses of action and recognizing that both markets/exchange and government activity have associated with them certain costs—often substantial. Coase is not about the Coase theorem; he was a strong advocate of comparative institutional analysis and that, at a minimum, economic benefits and costs have an important role to play in evaluating policy options. With this came a great concern about the costs associated with government action—costs that he (rightly) believed had been underplayed or ignored in the theory and practice of social cost policy.

Q: Why are concerns about equity so prominent in environmental discussions of Coase?

A: Probably because Coase focused so heavily on efficiency. But there was good reason for this—it was the language in which the welfare economics of social cost issues had been discussed for a half-century. And as we all know, there are plenty of occasions when the dictates of efficiency collide with some people’s sense of what is “right.” The very possibility that the “victims” of pollution should bribe the factory owners to reduce their pollution levels is anathema to many. Interestingly, though, Coase talks about larger concerns (“aesthetics and morals”) toward the end of “The Problem of Social Cost.” But since most readers failed to pay attention to his arguments beyond the Coase theorem material (the first 15 pages of a 44-page article), they didn’t seem to notice this.

Q: What can we take away from Coase’s work and apply to the area of free market environmentalism?

A: I believe that there are two key insights. The first is that markets/exchange can work to resolve certain social cost issues. The question is which ones, and this can only emerge from careful and patient study. The second is that neither markets nor government are panaceas. Both generate imperfect solutions, and the question is that of which of these imperfect solutions is best for dealing with the problem at hand. This, too, can only be determined from careful and patient study. Unfortunately, too many economists and policy makers do not want to hear such things. But “create markets” or “we need government to solve the problem” takes us nowhere. These are difficult problems, and we seldom find that difficult problems have easy solutions.

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The costs and benefits of the word ‘externality’: what I learned at PERC

by Andrew Balthrop, a PhD student in economics at Georgia State University and 2011 PERC Graduate Fellow.

Until this summer, the way I thought about externalities was pretty abstract: an externality was where one agent affected another agent’s utility without compensation. The solution was to get a social planner to tell each agent what to do, and society would be better off for it. I had never thought too deeply about why the two agents could not settle the problem themselves, or about the institutions that might help address the problem. It was merely an optimization problem with two possible solutions.

For most of the summer, I didn’t get why everyone at PERC hated the term. Often times a point was made that went something like, “If this is really a problem, why haven’t people dealt with it?”  I took that point as an assumption that the economy must always and everywhere be in equilibrium; I thought the senior researchers were ignoring the most amazing thing about the economy: its dynamism. People do get rich with new discoveries, the landscape is ever shifting, and if you don’t adapt, you get left behind.  But I will come back to this point.

What changed my view–what put me in my place as a graduate student–was listening to the senior fellows at PERC talk about Ronald Coase. I must sheepishly admit that what I had taken from Coase was only the first three pages of “The Problem of Social Cost.” I was exactly what the fellows railed against. My take away was that externalities were reciprocal, and that if “transactions costs” were low, and property rights clear, agents would achieve the efficient outcome. But I assumed the point of the paper was that  transactions costs were not low, and that property rights were not clear, and that is why you have to study Baumol and Oates. I didn’t understand that the court cases were a way to make property rights clear and transactions costs low–that the courts were a solution. I left that seminar with my mind blown, and a little embarrassed.

How I should have been interpreting the comment of “If this is a real problem, why haven’t people dealt with it?” is actually, “You are talking in abstractions here. The real world is not a blackboard problem, and people are not hapless. If this is a problem, there must be specific institutional friction(s) preventing agents from solving it. Tell me specifically what that is, or you have not understood the situation.” This is why PERC researchers don’t say externality. Or spillover.

My own research focuses on the extent to which neighboring oil producers interfere with each other’s production. While at PERC I learned that merely quantifying this production interference was not sufficient to demonstrate a true externality. In order to do good research on the subject of oil and natural gas production, I would have to know the institutional environment inside and out. Inter-well communication isn’t enough to assure an externality; it is only a physics problem and people solve those all the time. For there to be an externality, something else has to be going wrong. For me to use the term, I need to identify specifically what that something else is, whether it is a peculiarity to oil production or oil law that makes contracting difficult, a regulation that incentivizes perverse behavior, or something else. And once I identify this problem specifically, there isn’t much reason to use the term “externality.”

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The Fiscal Effect of Stimulus: Evidence from “Cash for Clunkers”

by Pete Geddes

If I ever get a tatoo, it will read: “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.” (F.A. Hayek)

From a new paper by Atif Mian and Amir Sufi:

We examine the ability of the government to increase consumption by evaluating the impact of the 2009 “Cash for Clunkers” program on short and medium run auto purchases. Our empirical strategy exploits variation across U.S. cities in ex-ante exposure to the program as measured by the number of “clunkers” in the city as of the summer of 2008. We find that the program induced the purchase of an additional 360,000 cars in July and August of 2009. However, almost all of the additional purchases under the program were pulled forward from the very near future; the effect of the program on auto purchases is almost completely reversed by as early as March 2010 – only seven months after the program ended. The effect of the program on auto purchases was significantly more short-lived than previously suggested. We also find no evidence of an effect on employment, house prices, or household default rates in cities with higher exposure to the program.

It appears PERC senior fellow Bruce Yandle was right last year when he wrote that “Cash for Clunkers Was a Loser.”