Thursday, July 20, 2017

The Cycles of Cities

Cities evolve. Sometimes they boom, with strong growth in center-city areas. Sometimes the center city seems to hollow out, but economic activity in the metro area as a whole, including suburbs, remains fairly robust. Sometimes older neighborhoods with low property values experience as wave of new investment in residential housing, often called "gentrification." Sometimes both a downtown area and its surrounding metro area decline. In addition, these patterns seem to affect a number of cities at the same time. Santiago Pinto and Tim Sablik discuss one aspect of these cycles in "Understanding Urban Decline," an essay that appears in the 2016 Annual Report of the Federal Reserve Bank of Richmond.

As a dramatic opening, here's a picture of a house in Detroit's Brush Park neighborhood as it appears in 1881, and then when a photo was taken from the same perspective in 2011. The house in the middle is the one from the earlier picture. The houses on either side are long gone. Detroit is obviously an extreme example, given that its economic base was so closely tied to the auto industry. But it's far from the only example of an urban area that suffered a severe downturn.

The underlying economic theory of cities points out that they offer advantages of agglomeration: that is, it's a lot easier to carry out certain activities of production, hiring, marketing, entertainment, provision of infrastructure, and transportation, when people are bunched more closely together. Thus, urban areas are engines of economic growth. There are also negative aspects of agglomeration, in that traffic congestion, crime, noise, and other negatives are also easier to carry out when people are bunched together. So cities are in a constant struggle to build on the advantages of agglomeration while mitigating the disadvantages.

The preferences of people interact with the economics of cities, and in particular, how people trade off different aspects of location. For example, people will place different values on their location relative  to  their job and the length of their commute, the cost of a place to live,high quality local-schools, a quiet and low-crime neighborhood, a bustling urban neighborhood, mass transit, shopping, parks and libraries, culture/entertainment/sports, and neighbors with certain types of income levels or ethnic mixes. As is true in so many life decisions, you can't always get all of what you want. As people with different income levels and jobs and preferences make these choices, urban patterns will emerge.

Here's what Pinto and Sablik have to say about the patterns that have emerged in US metropolitan areas (footnotes omitted):
"In most U.S. cities, wealthier households tend to live farther away from the city center, though there are a few notable exceptions (such as Chicago, Philadelphia, and Washington, D.C.). One explanation for this is that wealthier households prefer to occupy more land and therefore are willing to live in the suburbs despite higher commuting costs because the price of housing per square foot is lower. On the other hand, when a household’s income becomes sufficiently large, it may choose to move back to the city center to reduce time spent commuting. This type of trade-off could explain, for instance, why both very poor and very wealthy households are found living in some downtowns. Cities such as Boston, New Orleans, Atlanta, and Philadelphia are examples of this type of spatial pattern. Additionally, public transportation can help explain why poorer households live in the city center. Although the cost of housing per unit of land is higher in the city, public transportation allows poor households that don’t have access to cars to economize on transportation costs.
"Transportation may further explain the trend of households moving from city centers to the suburbs, often called suburbanization. Several studies suggest that the development of the highway system contributes to “urban sprawl.” One study estimated that just one highway passing through a central city reduces its population by 18 percent. Cities that experience such a decline in commuting costs do still tend to attract population, but that inflow typically causes the city to expand geographically more than it increases the number of people living in the city center.
"Certain amenities, such as schools, also may explain neighborhood sorting by income or race. For instance, as wealthier households move to the suburbs, the quality of schools and other public services provided there will tend to rise. As this process unfolds, lower-income households are left behind in the city center with limited access to high-quality local public services. This has been observed in the suburbanization that has taken place in many large U.S. cities starting around the mid-twentieth century. ... 
"Cities undergo long cycles of development and decay. When a city is new, buildings near the CBD [central business district]  are the most desirable and tend to be occupied by a mix of firms and wealthier households. But as those buildings age and deteriorate, those households may move to newer developments surrounding the city, leaving behind lower-income households. This process can repeat multiple times, pushing the city border outward as higher-income households retreat to the newest ring of development. Eventually, deteriorated buildings in the city center are redeveloped, once again attracting higher-income households back to the city and starting the cycle anew. This has taken place, for instance, in cities such as Chicago and Philadelphia. This process, however, has raised some controversies since transforming a neighborhood from low- to high-income may displace the low-income households who live there, a process called gentrification. ...
"Because buildings are durable goods, it can take a long time for a city to move through its lifecycle. When a city’s population is growing, it is profitable to construct new housing because demand and prices for housing are rising, and the city expands rapidly. But when the population declines, existing housing stock doesn’t simply disappear. It can take decades before it is profitable to refurbish or replace a building. The surplus of housing depresses  house prices below the cost of construction, and the city stops growing. Moreover, falling rents may draw lower-skilled and lower-income households into the city, intensifying urban  sorting by income."
The underlying message here, as I hear it, is that areas of cities or cities as a whole can become locked into negative patterns. Say that the positive economic effects of agglomeration are not operating well, and so that part of the city has a lot of low-priced real estate which offers housing for a disproportionate number of low-income people. We know that this dynamic can remain in place for decades. Can anything be done about it?  Pinto and Sablik write:
"If policymakers decide that some intervention is warranted, there are a number of different approaches they could consider. One option is to focus on helping households by giving them the tools to improve their situation. This could involve removing barriers that prevent households from relocating to thriving parts of the city, providing housing vouchers to help them move, or improving transportation networks to reduce commuting costs. An alternative approach is to focus on revitalizing the city itself. This includes revitalizing residential or commercial buildings that have declined or offering incentives to employers to locate in the city and hire local people. Economists have labeled these different approaches people-based and place-based policies, respectively."
However, as Pinto and Sablik discuss, the evidence on the effectiveness of either people-based or place-based approaches is fairly weak. For example, people-based policies include idea like  "moving-to-opportunity" programs that subsidize people in depressed urban areas to relocate to other parts or the urban area. Such programs seem to help young children, but the effects on other age groups are minimal or even negative. Improving the quality of local education is a worthwhile goal, but hard to accomplish. place-based approaches like "enterprise zones" or "urban renewal projects" sometimes show an effect in the specific area that is targeted for the policy, but even when the effects seem positive for that area, a common finding is that economic activity was just relocated. from other nearby areas.

Every city has areas where incomes are lower and social problems are higher, and the geographic location of those areas often seems to remain the same for decades at a time. This experience suggests rather strongly that we don't have any magic-bullet policy tools that will target these areas with strong local economic activity and addressing issues like crime. I worry that some cities have a tendency to focus to much on a magic-bullet solution--the single big project or law that will address problems in part of a city. Instead, cities might be better off if they would focus on providing a decent level of public services to all areas of a city: safe public areas and parks, cleaning up garbage, street repair, well-functioning schools, enforcing the housing code,  libraries and post offices, and the like. Moreover, a city can play a big role by whether it encourages or discourages people and firms who want to upgrade the base of real estate in a certain area of a city, whether it's for business or residential uses.

Finally, readers interested in the evolution of urban areas might also want to look back at "Economics of Gentrification" (December 6, 2016).

Tuesday, July 18, 2017

Global Value Chains and Productivity

Production processes have become more likely to cross international borders, thus creating what are called "global value chains" or "global supply chains." Chiara Criscuolo and Jonathan Timmis discuss "The Relationship Between Global Value Chains and Productivity" in the Spring 2017 issue of International Productivity Monitor  (vol. 32, pp. 61-83). I'll start here with a few facts, and then lay out the linkages they discuss. They write: 
"Economies can participate in GVCs [global value chains] by using imported inputs in their exports (the so-called backward linkages in GVC) or by supplying intermediates to third country exports (forward linkages). The overall participation in GVCs which is the total of backward and forward participation differs substantially across countries. Overall participation measure (measured as the sum of backward and forward linkages) reflects the importance of GVCs for an economy, with GVCs accounting for between one-third and two-thirds of gross exports (of goods and services) for OECD economies in 2011 ..."

In the next figure, the blue bars showing the growth of global value chains across countries, while the red triangles show the growth rate of exports. The growth of global value chains is consistently faster than growth of exports, although you have to look closely at the figure to see this, because the blue bars are measured on the left-hand axis and the red triangles with the smaller numbers on tgghe right-hand axis. 
The bulk of these global value chains are regional: in particular, there is an east Asian cluster of value chains, a European cluster, and a North American cluster. There's some evidence that the growth of these global value chains may have slowed in the last few years, although this is a subject of ongoing research. One possible reason is that "there may also be changes in the structure of global production networks, such as China's domestic upgrading and the reorganization of East. Asian value chains, or the shortening of value chains to mitigate supply chain risks and rising labour costs in emerging economies."

How might global value chains affect productivity? Here's a taste of the details on these arguments (with citations omitted here for readability):
"Trade in goods, services and intangible inputs is at the heart of global value chains. The bulk of trade is comprised not of final goods or services, but of trade in intermediate parts and components and intermediate services. Among OECD economies , trade in intermediate inputs accounted for 56 per cent of total goods trade and 73 per cent of services trade over the period 1995-2005. ... GVCs present a new means to access international markets: economies need no longer build complete supply chains at home; instead, they can leverage foreign inputs in their production. The available variety and quality of foreign inputs (capital, labour and intermediates) can positively impact firm productivity. ... A large literature finds that productivity gains in firms that directly import these inputs. In addition, foreign competition in the domestic input market may also lead to price reductions or quality improvements for domestic suppliers, benefiting users of domestic inputs too.  ...
"GVCs are a well-established vehicle for productivity spillovers to local firms. A substantial part of GVC integration is mediated through FDI [foreign direct investment], and such multinational enterprises are typically at the global frontier of productivity, innovation and technology. Exposure to the global frontier can provide an opportunity for local firms to increase productivity through learning about advanced technologies or superior organizational and managerial practices. A large literature has investigated FDI spillovers and arrives at a broad consensus in favour of positive productivity spillovers to industries that supply multinationals through backward linkages, with little evidence through other linkages ... 
"Knowledge acquisition is an important motive for FDI, which may increase the scope for knowledge diffusion. Firms may relocate some activities, including innovation activities, to obtain access to so-called strategic assets - skilled workers, technological expertise, or the presence of competitors and suppliers - and learn from their experience . Firms locate in leading edge countries close to the technology frontier, in order to benefit from the diffusion of advanced technologies. In addition, MNE [multinational enterprise] acquisition of foreign firms can lead to a relocation of innovative activities to where they are most efficiently undertaken and increase knowledge diffusion to affiliates within the group. ...

"To participate directly in GVCs requires scale. For the largest, most productive firms that are able to export, access to new customers in foreign foreign markets can not only lead to increased learning and innovation but also incentivize complementary investments and the restructuring of internal processes to meet the additional demand. ... Upscaling may yield productivity gains. The cost of many productivity-enhancing investments, including those concerning GVC participation listed above, is largely fixed. Such investments are only viable for sufficiently large firms that can spread the fixed costs over high sales volumes. Firm upscaling may therefore contribute to productive investments."
One of the preeminent economic problems of our time is slow economic growth. Given that global value chains have expanded rapidly and seem to contribute to growth, would disrupt these production chains should face a high degree of skepticism.

Those who would like some additional  background on global value chains and productivity might want to look back at some earlier posts on the subject:

Monday, July 17, 2017

The Pricing Answer to Traffic Congestion

Traffic congestion present several tricky problems of analysis. One is that the amount of traffic on the road at a peak travel time is not fixed. As Anthony Downs in his mini-classic 1992 book, Stuck in Traffic. at least some of the travelers who are confronted by congestion will shift their patterns in one of three ways: they will shift the timing of their trip earlier or later, shift the route of their trip (say, from highways to surface roads), and shift the mode of their trip (say, from a single car to mass transit or a carpool). Conversely, when attempts are made to reduce traffic congestion by building more lanes of highway, one result will be that a certain number of those who had previously shifted their timing or route or mode of travel will now shift back to becoming drivers of single-passenger cars, and the gain in reducing congestion will be frustratingly smaller than might have been predicted.

There is certainly a role for a range of technical fixes to traffic problems: more highways, mass transit, coordinating traffic lights, signs warning of congestion, and maybe someday autonomous vehicles platooning in coordinated groups. But ultimately, putting a price on travel during peak-level congested times needs to be part of the answer, too. Brian D. Taylor (no relation) offers a short essay on the subject in "Traffic Congestion Is Counter-Intuitive, and Fixable," ACCESS Magazine, Spring 2017. He writes:
"There are five major views on how to best manage traffic congestion. One view focuses on adding road capacity: wider streets, new traffic lanes, left- and right-turn lanes, more parking, and even new freeways — all of which cost a lot of money. A second view favors putting roads on “diets” and adding capacity elsewhere: improved bus service, more bike lanes, increased building densities to encourage walking, and new rail transit lines — the last of which also costs a lot of money. A third and more cost-conscious view focuses on better management of our existing transportation systems: coordinated signal timing for cars, signal pre-emption for buses, remote coordination of bus and train operations, and freeway service patrols all aim to make our transportation systems operate more effectively. A fourth view is that technology will save the day: traffic-sensitive navigation systems, increasing use of services like Lyft and Uber, and, eventually, fully autonomous vehicles that reduce the need for parking and use road capacity more efficiently. The fifth view is perhaps most favored by transportation experts, but is also generally reviled by the traveling public and the officials they elect: using prices to balance the supply of and demand for travel. ...
[W]hen traffic is crawling along at rush hour, fewer vehicles are getting through than at other times, not more. A typical freeway lane can handle up to 2,000 vehicles per lane per hour, but in really bad traffic that throughput can be cut in half; just when we need the most out of our road system, it performs at its worst. So heavy traffic is not only irritating, it’s also really inefficient. ...
"Road pricing is expanding around the globe. In the US, Los Angeles, Orange County, San Diego, Houston, Minneapolis, and a growing list of other cities have high-occupancy toll (HOT) lanes. The prices on these lanes vary based on congestion levels in the parallel “free” lanes in order to keep traffic flowing smoothly in the toll lanes. The Orange County 91 Express Lanes celebrated their 20th anniversary in 2016, and over 600,000 travelers in Los Angeles have accounts to use the I-110 and I-10 ExpressLanes. The revenues generated have helped to pay for improved public transit service in the ExpressLanes corridors. ...
"Outside the US, London, Milan, Singapore, Stockholm, and several other cities now charge drivers who enter their congested central areas. Chronic bumper-to-bumper traffic disappeared virtually overnight after the charges were introduced in each of these places. Buses now travel much faster and more reliably, the streets are more pleasant for walking and biking, and those who want to pay to drive can do so with few delays. In Stockholm, public support for the central area (or cordon) pricing increased after people saw how well it worked."
The economics of traffic congestion is clear-cut. Those stuck in traffic naturally prefer to think of congestion as caused by everyone else, but everyone in the jam is part of the problem.When you are in a traffic jam, those in front of you in line are imposing costs of time delay on you, and in turn, you are imposing costs of time delay on all of those behind you in line. Those costs are a form of pollution, a "negative externality" as economists call it.   If drivers were required by road pricing to pay these peak-load costs that they impose on others when the roads are congested, many of them would find a way to shift the time or route or mode of their commute, or to telecommute at certain times.

Friday, July 14, 2017

Apprenticeships for Early Childhood Education?

Here's the dilemma: On one side, it seems important that those who do early childhood education are well-qualified for the job. After all, one justification for such programs is to help children who would otherwise have already been lagging behind in kindergarten and first grade to be school-ready. A National Academy of Science report in 2015 recommended that all lead teachers working with children from birth through age 8 should have at least a four-year bachelor's degree. On the other side, these jobs don't have high pay, and aren't likely to have high pay in the future. Thus, the dilemma is that it doesn't make economic sense to require someone to go through a lengthy and potentially costly training program to qualify for a job that doesn't have especially high pay.

Mary Alice McCarthy tackles this question in "Rethinking Credential Requirements in Early Education: Equity-based Strategies for Professionalizinga Vulnerable Workforce," written for the New America think tank (June 2017). Her proposal is that an expansion of paid apprenticeships may be a more functional way of getting high-quality teachers in place for early childhood education. She describes the underlying dilemma this way:
Few people question degree requirements for teachers in elementary schools, including in kindergarten and first grade. Advocates for degree requirements for early educators ask why we would expect anything less for the teachers of our youngest children. If a bachelor’s degree is required to teach a five-year-old, why not a four-year-old? Or a three-year-old? Teachers are teachers, according to this view, and all of them need professional training before they are ready for the classroom. ...
However, the argument that teachers in early childhood centers are the same as teachers in elementary schools and should be held to similar qualification requirements is deeply problematic. Both might be groups of teachers, but they do not represent a single workforce. Just as high school teachers and college faculty both educate, they do so in such different settings and under such distinct expectations that we do not generally think of them as a single workforce. Teachers in early childhood centers operate in a vastly different segment of the labor market than their elementary school peers. The majority work in private settings marked by rules, funding sources, and employer relationships distinct from those of public school teachers. Most importantly, they generally earn significantly lower wages and enjoy far fewer benefits than their counterparts in elementary schools. These two groups of workers are not even represented by the same unions. ...

Degree requirements might change who qualifies for a job as a lead teacher for young children, but they can’t change the underlying realities of the labor market—and that is the real problem with degree requirements in early childhood education and other low-wage occupations. The way the early education market is structured, the costs of any degree requirement will be borne almost entirely by workers who will see little, if any, increase in wages.  And college isn’t getting any cheaper. An average associate degree at a two-year public college costs around $9,500 a year. A bachelor’s degree from a
four-year public institution costs about $18,600 a year. That is a steep entry price for a profession where hourly wages average less than $10 an hour.
McCarthy suggests a structured and organized two-year apprenticeship program instead, which would lead to outside evaluations and a certificate of completion, and points to a pilot study in Philadelphia for evidence of workability. She makes a very strong case.

Requiring a college degree for early childhood education workers is not likely to raise wages for those workers. 
"The working conditions of early educators, meanwhile, are also unlikely to be affected by a degree requirement. The system of funding in the early education field—not the perception of its teachers—is what drives its fragmentation and decentralization. A degree requirement will not make state and local school systems expand the size and scope of their early childhood education centers, where working conditions and pay tend to be better. Nor will it change how federal and state programs channel their funding for early education through a decentralized system of public and private early education centers. Unless those funding sources, particularly the public programs, move toward more school-based provision of early education, there is little reason to expect a degree requirement will spark a recalibration of the early education market."
A college degree is an inefficient way to learn the specific jobs skills needed for a job working with very young children.
"A bachelor’s degree is a very time-consuming credential to earn. It is also a remarkably inefficient way to equip early educators with the knowledge, skills, and competencies outlined in the National Academies report and identified by key stakeholders like the Council for the Accreditation of Educator Preparation (CAEP) and NAEYC [the National Association for the Education of Young Children] ..."
Requiring a college degree for early childhood education would have the effect that those working in these positions are younger, whiter, and tend to come from families with higher income levels.
"In other words, we can expect that the workforce will become more stratified along race, income, and age. Early childhood educators holding degrees are more likely to be young and white, and educators without degrees more likely to be older and from communities of color. That is the case for our elementary teaching workforce, which is more than 80 percent white. A bachelor’s degree requirement has the potential to reduce the likelihood that children from low-income and racially diverse backgrounds will have teachers from their communities."
I agree with the broad direction of McCarthy's proposal, but the application of this insight extends well beyond workers in early childhood education. A substantial number of those who graduate from high school have no reason to view additional academic classwork with anticipation or enjoyment. Throughout their K-12 school careers, they have mostly been in the bottom half, or bottom quarter, of the academic distribution. If a job requires additional years of classroom study, it will appear to them as a heavy burden and a strong discouragement. For many of these students, a well-structured rigorous learning-on-the-job program will be a more attractive option. Our economy needs more alternative career pathways that don't require piling up academic degrees as a starting point.

Thursday, July 13, 2017

The Ingredients for a US Productivity Revival

It's easy to find gloomy predictions for continued slow growth of the US economy. Thus, Lee Branstetter and Daniel Sichel caught my eye with their essay, "The Case for an American Productivity Revival,"  written as a "Policy Brief" for the Peterson Institute of International Economics (June 2017, PB17-26). Here how they start:

Labor productivity performance in the United States has been dismal for more than a decade. But productivity slowdowns—even lengthy ones—are nothing new in US economic history. This Policy Brief makes the case that the current slowdown will come to an end as a new productivity revival takes hold.  
Why the optimism? Official price indexes indicate that innovation in the technology sector has slowed to a crawl, but better data indicate rapid progress. Standard measures, focused on physical capital, suggest that business investment is weak, but broader measures of investment that incorporate intellectual and organizational capital report much more robust investment. New technological opportunities in healthcare, robotics, education, and the technology of invention itself provide additional reasons for optimism. This Policy Brief gauges the potential productivity impact of these developments. The evidence points to a likely revival of US labor productivity growth from the 0.5 percent average rate registered since 2010 to a pace of 2 percent or more. A productivity revival of this magnitude would provide a solid foundation for steady increases in wages ... 

The essay spells out details behind these claims.  Here are a few of the comments that caught my eye.

Past methods for adjusting for the improved quality of microprocessors may not be working well at capturing changes in the last decade or so. 

Before the mid-
2000s, the posted prices of MPUs tended to fall as newer
models were introduced. This price trajectory allowed a
standard methodology used for semiconductors in the
producer price index (matched-model indexes) to capture
quality change through the rapid price declines of older
models. Since the mid-2000s, posted prices of Intel MPUs
have tended to remain stable, even after the introduction
of newer, more powerful models. Reflecting these relatively
flat price profiles, a matched-model index will indicate little
change in quality-adjusted prices even if the quality of each
newly introduced model is much greater than its predecessor.
The new price measure Byrne, Oliner, and Sichel
developed (an hedonic index) more fully captures ongoing
quality change and reveals rapid price declines after this
quality change is taken into account.
This evidence on faster price declines indicates that
innovation and multifactor productivity growth in semiconductors—
the general-purpose technology behind much
of the digital revolution—has been far more rapid than official
indexes suggest.

Although conventional tangible business investment is down as a share of GDP, intangible investment is on the rise.

In this figure, the light blue line shows tangible business investment, and the well-known pattern of overall decline (as a share of GDP) since the 1970s. The dark blue line shows the official US government statistical measure of "intangible investment," which includes "software, scientific R&D, mineral exploration, and the development of entertainment products." The dashed red line shows a broader version of intangible investment that includes both the official measures and also "nonscientific product development, brand equity, training, and organizational capital." As the authors write (footnotes and citations omitted):
In fact, the overall investment share of both tangible and all intangible capital has been relatively stable since the late 1970s. This conclusion is not surprising in an economy in which the newest technical capabilities and products rely at least as much on intangible capital as on tangible capital. This feature surely characterizes leading companies such as Google, Amazon, Facebook, and Microsoft. Even industrial companies like GE are increasingly investing in big data, predictive analytics, and machine learning.

In short, Branstetter and Sichel believe that the official statistics are understating both current productivity gains as well as the investments that firms are making for the future.  They then note: "Four developments have the potential to contribute to faster productivity growth in the United States: improvements in the healthcare system, increasing use of robots, a revolution in e-learning, and globalization of invention." They further argue that these changes can be supported by some mostly well-known policies: for example,
  • "robust federal investment in basic science"
  • "immigrant scientists and entrepreneurs play a disproportionate role in driving the technological advances that power productivity growth in the United States"
  • "globalization of invention presupposes the continuation of an open global trading and investment system supported by the United States"
  • "a public agency or public-private partnership that could certify the efficacy of new educational technologies in the same way the Food and Drug Administration (FDA) certifies the safety and efficacy of new drugs, by supervising rigorous, randomized control trials. Modest policy effort
  • in this direction could yield rich dividends in the form of much faster, more cost-effective human capital formation."
I would add that economic growth is by its nature a disruptive process, and part of embracing this disruption is to find ways for both its benefits and costs to be widely shared. The authors conclude: "A standard productivity growth accounting framework captures these factors to highlight how a significant revival of productivity growth could emerge, especially in the medium to long run. A pace of 2¼ percent a year is eminently plausible—and there are solid reasons to hope for
even more rapid productivity growth."

Wednesday, July 12, 2017

Tally Sticks and the Fundamentals of Money

Do you know the true story of how a careless clerk, while burning up some outdated money, caused the Great Fire of 1834 which destroyed both Houses of the British Parliament, along with large portions of the Palace of Westminster? Tim Harford tells the tale in "What tally sticks tell us about how money works" (BBC News, July 10, 2017).

In this case, the outdated money takes the form of "tally sticks." As Harford explains:
The artefacts in question were humble sticks of willow, about eight inches (20cm) long, called Exchequer tallies. The willow was harvested along the banks of the Thames, not far from the Palace of Westminster in central London. ... Tallies were a way of recording debts with a system that was sublimely simple and effective. The stick would contain a record of the debt, for example: "£9 4s 4d from Fulk Basset for the farm of Wycombe". Fulk Basset was a Bishop of London in the 13th Century. He owed his debt to King Henry III.
Now comes the elegant part. The stick would be split in half, down its length from one end to the other. The debtor would retain half, called the "foil". The creditor would retain the other half, called the "stock" - even today, British bankers use the word "stocks" to refer to debts of the British government. Because willow has a natural and distinctive grain, the two halves would match only each other.
Of course, the Treasury could simply have kept a record of these transactions in a ledger somewhere. But the tally stick system enabled something radical to occur. If you had a tally stock showing that Bishop Basset owed you £5, then unless you worried that he wasn't good for the money, the tally stock itself was worth close to £5 in its own right.
If you wanted to buy something, you might well find that the seller would be pleased to accept the tally stock as a safe and convenient form of payment. So the tally sticks themselves became a kind of money, a particular sort of debt that could be traded freely, circulating from person to person until it utterly separated from Bishop Basset and a farm in Wycombe.

Here are a few pictures of tally sticks: the first is from Harford's article, which shows accounts accounts of the bailiff of Ralph de Manton of Ufford Church in Northampton, circa 1299.The second is from a short article by Frank J. Swetz and Victor J. Katz, "Mathematical Treasures - English tally sticks," Convergence (January 2011). The inscription on that tally stick shows the name of William de Costello, who was Sheriff of London in 1296.

Medieval tally sticks. circa 1299

Largestick with name engraved

Of course, making marks on a stick or bone to keep a record of days or lunar cycles or livestock dates back millennia. The specific idea of tally sticks to keep track of debt dates back hundreds of years; in one telling, they were invented by King Henry the First, son of William the Conqueror, when he became King in 1100 AD.  Moreover, when a tally stick was split, it was divided into two different lengths, with the debtor literally receiving the short end of the stick.

Tally sticks were a highly successful monetary innovation, in the sense that they were used for centuries. They offer a demonstration of the idea that money, at its root, is something that can be stored and then accepted for purchases: as the textbooks say, money is a medium of exchange, a store of value, and a unit of account. They also demonstrate that money can be created by private actors, although textbooks typically emphasize the role of banks in creating money in the modern economy.

The punchline to the story of the tally sticks happens in 1834. Tally sticks had fallen out of use, and apparently there were no historians or museum curators nearby, so a decision was made to burn several large cartloads of remaining tally sticks. Thanks to a "senile Housekeeper and careless Clerk of Works," the fire got loose and roared through the Palace of Westminster, destroying the House of Commons and the House of Lords. It was the largest fire in London between the Great Fire of 1666 and the devastation of the Blitz during War II.

Tuesday, July 11, 2017

Arm's-Length International Trade

"Global value chains often involve numerous cross-border operations, conducted either `intra-firm,' that is, between firms related through ownership or control, or between unaffiliated firms at `arm’s-length.'" The World Bank explains this difference in "Arm’s-Length Trade: A Source of Post-Crisis Trade Weakness," which appears as a "Special Focus" chapter in Global Economic Prospects: A Fragile Recovery (June 2017). The chapter begins:
"Trade growth has slowed sharply since the global financial crisis. Based on U.S. trade data, arm’s-length trade—trade between unaffiliated firms—accounts disproportionately for the overall post-crisis trade slowdown. This is partly because arm’s-length trade depends more heavily than intra-firm trade on sectors with rapid pre-crisis growth that boosted arm’s length trade pre-crisis but that have languished post-crisis, and on emerging market and developing economies (EMDEs), where output growth has slowed sharply from elevated pre-crisis rates. Unaffiliated firms may also have been hindered more than multinational firms by constrained access to finance during the crisis, a greater sensitivity to adverse income and exchange rate movements, heightened policy uncertainty, and their typical firm-level characteristics."
Here's are the growth rates of US imports and exports for arm's-length and intra-firm trade in recent years. Detailed international data with a similar breakdown isn't available, although a similar pattern seems to hold in the research that has been done.

An extraordinarily high share of US trade happens through a relatively small number of firms. For example, Andrew B. Bernard, J. Bradford Jensen, Stephen J. Redding, and Peter K. Schott explained this point  10 years ago in "Firms in International Trade," in the Summer 2007 issue of the Journal of Economic Perspectives: "Yet engaging in international trade is an exceedingly rare activity: of the 5.5 million firms operating in the United States in 2000, just 4 percent were exporters. Among these exporting firms, the top 10 percent accounted for 96 percent of total U.S. exports."

These big players in international trade face a choice: import and export from affiliated firms, which often own pieces of each other, or import and export from unaffiliated firms on an arm's-length basis. The obvious advantage of the first approach is that when operating across national borders, there are likely to be conflicts and issues about  pricing, costs, timeliness, quality, transfers of technology and resources, and more. Addressing such issues on an ongoing basis with an affiliated firm may be more streamlined and easier than, say, trying to sue some other firm in the courts of its home country. The World Bank report notes (citations omitted):
"In practice, multinationals employ intra-firm and arm’s-length transactions to varying degrees. In 2015, intra-firm transactions are estimated to have accounted for about one-third of global exports. Vertically integrated multinational companies, such as Samsung Electronics, Nokia, and Intel, trade primarily intrafirm. Samsung, the world’s biggest communications equipment multinational, has 158 subsidiaries across the world, including 43 subsidiaries in Europe, 32 in China and 30 in North and South America. Other multinationals, such as Apple, Motorola, and Nike, rely mainly on outsourcing, and hence on arm’s-length trade with non-affiliated suppliers."
In a time when international trade faces a relatively high degree of suspicion, it's useful to be clear on just what is involved. When it comes to trading raw materials like energy or metals, or basic manufactured goods like textiles, or exporting to emerging markets, then arm's length trade is common. But a lot of the prominent, productive, and dynamic firms in the US and around the world are tied into international networks of intra-firm trade and global supply chains. If US policymakers put US firms at a disadvantage in accessing and using those global supply chains, those US firms will be at a disadvantage against their global competitors.