Tuesday, December 1, 2015

Cap and Trade: Lessons of Experience

A key question for a number of policy-makers, especially those contemplating the current negotiations in Paris about climate change issues, is whether a cap-and-trade approach might be a useful tool for reducing national emissions of carbon and other greenhouse gases in a cost-effective way. For example President Xi Jinping announced a couple of months ago that China will launch a national CO2 cap-and-tradsystem covering key industries in 2017. In the United States the American Clean Energy and Security Act of 2009 (more commonly known as the Waxman-Markey bill) was a cap-and-trade approach to reducing US carbon emissions. The bill passed the House, but was never brought up for discussion or a vote in the Senate.

For the uninitiated, a cap-and-trade approach to reducing pollution sets a total amount of pollution that can be emitted, and then divides up that quota among existing emitters of that pollution. The kicker is that a companies can trade--that is, buy and sell--portions of their pollution quota. As a result, every company that is emitting pollution has an incentive to seek out ways of emitting less for each unit of production, because it can then either expand production, or sell the extra pollution quota to a different firm that wants to expand production.

The potential advantage of this approach is that instead of requiring every pollution emitter to follow the same rule, those emitters who can reduce pollution most cheaply will have an incentive to do so. Moreover, the pollution quotas can also be gradually phased down over time, so that a permit which allows its holder to emit, say, one unit of pollution in a given year will only allow it to emit 95% of that amount in the next year, and lower amounts into the future. This challenge is that this approach to pollution reduction may sound unwieldy or unworkable.

Pragmatists who want to know when cap-and-trade has worked better or worse might begin with the essay by  Richard Schmalensee and Robert N. Stavins, "Lessons Learned from Three Decades of Experience with Cap-and-Trade," which is available as a November 2015 discussion paper from Resources for the Future (DP 15-51), and will appear in a future issue of the Review of Environmental Economics and Policy.  Schmalensee and Stavins offer an overview, with references to the underlying research, of real-world cap-and-trade programs addressing air pollution issues. I'll append their summary table of the seven main programs they discuss at the end of this post, although it may be a little hard to read in the blog format. But one takeaway is that the successes of cap-and-trade approaches to this point have involved lead, sulfur dioxide, and nitrogen oxides--but not the carbon emissions associated with an elevated risk of climate change.

Here's are three well-researched success stories of a cap-and-trade approach in non-carbon contexts:

1) Back in the 1970s, there was a decision to reduce lead emissions from gasoline by 90%. This was done with a cap-and-trade program between gasoline refineries that involving pollution permits for lead that were shrinking in size. The flexibility from using cap-and-trade meant that the desired reduction in lead emissions was achieved at 20% lower cost than in an inflexible "command-and-control" program that would have just ordered each individual refinery to reduce emissions.  The program then ended in 1987.

2) In the 1990s, there was a decision to reduce sulfur dioxide emissions from fossil-fuel electrical generating plants. This was done with a cap-and-trade program. As they report: "SO2 emissions from
electric power plants decreased 36 percent between 1990 and 2004, even though electricity generation from coal-fired power plants increased 25 percent over the same period." It's hard to estimate the cost savings in an exact way, because you have to do an estimate of what would have happened with a different set of regulations, but the range of estimates suggests that the pollution reduction happened with costs at least 15% lower, and maybe a lot more than 15% lower.

3) Emissions of nitrogen oxides are linked to ground-level ozone, otherwise known as smog. Starting in 1999, eleven northeastern states and the District of Columbia set up a regional cap-and-trade system to reduce nitrogen oxide emissions from about  1,000 electric generating and industrial units. Overall emissions fell by almost three-quarters, and one study found that the cost of the reduction was 40-47% lower with a cap-and-trade approach than it would have been with a less flexible set of regulations.

These examples offer what Schmalensee and Stavins at one point call "proof of concept," which in this case means that cap-and-trade can be a useful tool for cost-effective pollution reduction. However, the empirical evidence on whether it is a useful approach for reducing carbon emissions is not yet clear. Here are three examples of unclear or incomplete results.

1) For example, nine northeastern U.S. states have joined Regional Greenhouse Gas Initiative (RGGI), which seeks to reduce carbon dioxide emissions from power plants. But the "cap" in this particular cap-and-trade approach was set at a level which didn't take into account how the Great Recession would reduce demand for electricity, or how the availability of lower-cost natural gas would reduce carbon emissions. As a result, actual emissions have been below the level set by the cap with no need for trading at all.

2) California passed a bill in 2006 to reduce the state's greenhouse gas emissions using a cap-and-trade approach. However, the implementation of the law started in 2013, applying only to the electrical power and manufacturing sector, and only expanded to cover fuel in 2015. There isn't yet any evidence on its effects over time.

3) The world's biggest carbon trading system is the Emission Trading System in the European Union. It was adopted in 2003, and started operating in 2005. As Schmalensee and Stavins report, "the EU ETS covers about half of EU CO2 emissions in 31 countries. The 11,500 regulated emitters include electricity generators and large industrial sources. ... The program does not cover most sources in the transportation, commercial, or residential sectors ..." However, the price for emitting carbon in this system has been very low: indeed, it collapsed all the way to a price of zero in 2007, and in recent years has been in the range of €5 to €10, which isn't enough to drive the necessary reductions in carbon emissions. There are a lot of issues here in the design of the program, but basically, if you give out lots of permits for emitting carbon, and also have lots of ways of meeting the rules for emissions reductions (like letting carbon emitters pay for reducing carbon somewhere else in the world, rather than actually cutting their own emissions), then the system may not function well.

The design of a cap-and-trade system clearly matters a lot, as does the type of environmental problem is it addressing, along with the economic and political context in which it is operating. Schmalensee and Stavins offer a useful overview of these very specific issues. My own sense is that when it comes to carbon emissions, these practical details make it hard to write legislation: indeed, the Waxman-Markey bill back in 2009 had eventually bloated to 1,200 pages of tall weeds in which the special interests could lurk.  Those who would prefer to think about a carbon tax as a way of reducing carbon emissions, rather than a cap-and-trade approach, might be interested in this post on "Carbon Tax: Practicalities of Cutting a Deal" (August 18, 2015).

Those who are interested in this subject might also want to check out the Winter 2013 symposium in the Journal of Economic Perspectives about "Trading Pollution Allowances." The four papers in that symposium were:
Finally, here's the Schmalensee-Stavins summary table of the seven cap-and-trade programs in the recent discussion paper:

Monday, November 30, 2015

Douglass North and Instititions

Douglass North, who shared the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 1993 with Robert W. Fogel "for having renewed research in economic history by applying economic theory and quantitative methods in order to explain economic and institutional change," died last week. Those looking for an accessible overview to his work might start with a couple of essays in the Journal of Economic Perspectives. North wrote an article called "Institutions" for the Winter 1991 issue. Claudia Goldin discussed the intellectual legacies of North and Fogel after they won the Nobel prize in "Cliometrics and the Nobel." in the Spring 1995 issue. 

As the one-word title of North's JEP article implies, he is perhaps best-known for his work in broadening the view of economics beyond the specifics of producing, and selling and buying, and emphasizing how a broader institutional context set the stage for economic interactions. In Goldin's essay, she traces this focus on the importance of institutions back to some of North's early work on transportation costs and economic growth. Goldin wrote (footnotes omitted): 

In the 1950s, a primarily theoretical literature emerged conjecturing that economic growth could be enhanced by decreased transport costs, at least under special circumstances. Even when productivity change is moving at a snail's pace in the goods-producing sectors, a decrease in the price of transportation can increase national income substantially. Developing economies were advised to increase certain capital expenditures if they wanted to grow, especially "infrastructure" and, most especially, transportation. How decreased transport costs affected the economic growth of the United States—the great success story—was a natural. ...
Douglass North's best-known research in transportation concerns ocean shipping from 1600 to 1860. The costs of ocean shipping decreased during much of the period, more so in the nineteenth century than before. A large part of the decrease, argued North (1968), came from an increase in total factor productivity. But the question was whether total factor productivity gains were rooted in technological advances or some other innovation. North found that from 1600 to 1784 productivity advanced at a slow rate, but that virtually all of the gains were due to decreased crew size and less time spent idle in ports. For the period from 1814 to 1860, productivity increased faster, at almost 10 times the annual rate in the previous two centuries. Virtually all the gain here was due to an increase in the size of ships and to their greater load factor. For most of the two and a half centuries considered, goods coming from the New World to the Old World were bulky raw materials, whereas those moving in the other direction were compact manufactured goods. In the 1840s and 1850s, however, there was a large increase in immigration, which meant that ships returned to the New World with cargo, not in ballast. The load factor thereby increased. 
The surprising finding is that for both periods, technological change was less responsible for the increase in productivity than were other innovations—a sharp reduction in piracy and organizational changes that increased round-trips per year by a factor of three. With less piracy, ships needed fewer crew members and could carry more goods and fewer armaments. With less need to arm ships, technologically superior vessels could be used. For example, the Dutch "flute," a sailing vessel with a rounded stern, had been used in the Baltic long before the modified flute made it to the ocean. But the reason these superior vessels were used in the Baltic was that piracy had been significantly reduced there, and the flute generally carried no armament. The important point for economic history and for North's intellectual development is that institutions interact with technology. One without the other does not produce economic growth. North learned the lesson well and shifted his attention for the next 25 years to a study of institutions.
North also pointed out how groups in power could use institutions to perpetuate their authority, and that such groups had an incentive to act in this way and hold on to power. even if the overall effects on growth were negative. For example, here's Goldin describing North's analysis of institutions in the US slave-holding South before the Civil War. 

According to Douglass North, the roots of southern stagnation are to be found in the geographic patterns of trade in the antebellum period. The South, using slave labor, grew cotton and exported it to the American North and to Britain. With the receipts from its northern shipments it purchased foodstuffs from the Midwest and industrial goods from the North. With its receipts from European shipments, it purchased luxury items and other industrial wares. Little was ploughed back into the South as internal improvements. Schooling was denied slaves and was poorly provided to southerners in general. Cities, those generators of agglomeration economies, were rare in the South. Innovation was thereby stifled. 
The North ran a very different ship. With far more equality of income and wealth, northerners purchased goods produced by local tradesmen and local firms. Its funds were ploughed back into local industry and internal improvements. Its people were the best educated in the world. The North established institutions that served an egalitarian society and that furthered an industrial and growing region. The South had norms that reinforced a caste and race-based society and that inhibited growth at the service of a master class. Such institutions have long lives. 
The message, repeated in many of Douglass North's later works, is that when institutions serve to enrich one group (masters, feudal lords) at the expense of another (slaves, serfs), it does not matter that these institutions also reduce the potential income of the elite. Pareto-improving trades are generally impossible between the two groups, and thus there is no assurance that more efficient institutions will drive out less efficient ones.
In North's JEP essay, North begins with a succinct summary of his view of the centrality of institutional development in understanding economic history and the performance of economies over time. North wrote: 
Institutions are the humanly devised constraints that structure political, economic and social interaction. They consist of both informal constraints (sanctions, taboos, customs, traditions, and codes of conduct), and formal rules (constitutions, laws, property rights). Throughout history, institutions have been devised by human beings to create order and reduce uncertainty in exchange. Together with the standard constraints of economics they define the choice set and therefore determine transaction and production costs and hence the profitability and feasibility of engaging in economic activity. They evolve incrementally, connecting the past with the present and the future; history in consequence is largely a story of institutional evolution in which the historical performance of economies can only be understood as a part of a sequential story. Institutions provide the incentive structure of an economy; as that structure evolves, it shapes the direction of economic change towards growth, stagnation, or decline.
 In some ways, North's emphasis on institutions has become so embedded in economic thinking that it runs the risk of sounding obvious. By now, everyone is familiar with the big idea that institutional traits like property rights and the rule of law play a central role in economic performance. But every big insight--like "institutions matter"--sounds obvious when it is raised to a high level of abstraction. The more lasting insights come from a double process: first digging down into the specifics of different times and places so that you can be specific about which institutions mattered at which times and for reasons, and then taking the next step of looking for commonalities and patterns across the landscape of these specific studies. North led the way in showing how to do these kinds of studies, and did far more than his fair share of them. But as North wrote at the end of his JEP essay in 1991:
The foregoing comparative sketch probably raises more questions than it answers about institutions and the role that they play in the performance of economies. Under what conditions does a path get reversed, like the revival of Spain in modern times? What is it about informal constraints that gives them such a pervasive influence upon the long-run character of economies? What is the relationship between formal and informal constraints? How does an economy develop the informal constraints that make individuals constrain their behavior so that they make political and judicial systems effective forces for third party enforcement? Clearly we have a long way to go for complete answers, but the modern study of institutions offers the promise of dramatic new understanding of economic performance and economic change. 
(Full disclosure: I've worked as Managing Editor of the JEP since the first issue in 1987. All JEP articles from the first issue to the present are freely available online courtesy of the journal's publisher, the American Economic Association.) 

Friday, November 27, 2015

Capitalism for Growth, Goverment for Fairness

When I hear discussions of how to encourage economic growth, along with equality and fairness, I sometimes feel as if the discussants are in the grip of a category confusion, like someone who rinses their vegetables in the shower and then tries to bathe in the kitchen sink. Here's the confusion as expressed in an October 1990 opinion column by Donald Kaul, who was a prominent opinion columnist, mainly with the Des Moines Register, from the 1970s through the 1990s. Kaul wrote: 
We have come to rely upon capitalism for justice and the government for economic stimulation, precisely the opposite of what reason would suggest. Capitalism does not produce justice, any more than knife fights do. It produces winners and energy and growth. It is the job of government to channel that energy and growth into socially useful avenues, without stifling what it seeks to channel. That's the basic problem of our form of government: how to achieve a balance between economic vitality and justice. It is a problem that we increasingly ignore.
In the modern version of this category confusion, a number of politicians and my fellow citizens seem to view it as the role of companies to provide justice and fairness. Their policy prescriptions seem to be all about how companies should be held responsible for providing higher wages, a more equal distribution of wages, health insurance, pensions and retirement accounts, parental leave and sick leave, job training, healthy foods, affordable housing, a sufficient number of parking spaces cleaning up the environment, paying more taxes, and so on. 

Meanwhile, when the discussion turns to encouraging growth in the US economy, the topics that seem to come up most often are how the government can encourage growth. Sometimes the focus in on how the Federal Reserve should be boosting growth through its monetary policies. Sometimes the focus is on how government should be boosting growth through tax cuts or spending boosts, either in general terms or by subsidizing  preferred sectors of the economy like noncarbon sources of energy and building more roads and bridges.  

Striking the balance between "economic vitality and justice" (in Kaul's phrase) can be an intertwined and delicate business.  But framing the discussion in a way that government is supposed to provide growth and companies are supposed to provide fairness is topsy-turvy, and blurs the lines of responsibility in a way that does not benefit either economic growth or concerns of fairness and justice. 

Thursday, November 26, 2015

Thankgiving Tidbits: George Washington, Sarah J. Hale, Abraham Lincoln

The first presidential proclamation of Thanksgiving as a national holiday was issued by George Washington on October 3, 1789. But it was a one-time event. Individual states (especially those in New England) continued to issue Thanksgiving proclamations on various days in the decades to come.  But it wasn't until 1863 when a magazine editor named Sarah Josepha Hale, after 15 years of letter-writing, prompted Abraham Lincoln to designate the last Thursday in  November as a national holiday--a pattern which then continued into the future.

An original and thus hard-to-read version of George Washington's Thanksgiving proclamation can be viewed through the Library of Congress website. The economist in me was intrigued to notice that some of the causes for giving of thanks included "the means we have of acquiring and diffusing useful knowledge ... the encrease of science among them and us—and generally to grant unto all Mankind such a degree of temporal prosperity as he alone knows to be best."

Also, the original Thankgiving proclamation was not without some controversy and dissent in the House of Representatives, as reported by the Papers of George Washington website at the University of Virginia.

The House was not unanimous in its determination to give thanks. Aedanus Burke of South Carolina objected that he “did not like this mimicking of European customs, where they made a mere mockery of thanksgivings.” Thomas Tudor Tucker “thought the House had no business to interfere in a matter which did not concern them. Why should the President direct the people to do what, perhaps, they have no mind to do? They may not be inclined to return thanks for a Constitution until they have experienced that it promotes their safety and happiness. We do not yet know but they may have reason to be dissatisfied with the effects it has already produced; but whether this be so or not, it is a business with which Congress have nothing to do; it is a religious matter, and, as such, is proscribed to us. If a day of thanksgiving must take place, let it be done by the authority of the several States.”

Here's the transcript of George Washington's Thanksgiving proclamation from the National Archives.
Thanksgiving Proclamation
By the President of the United States of America. a Proclamation.
Whereas it is the duty of all Nations to acknowledge the providence of Almighty God, to obey his will, to be grateful for his benefits, and humbly to implore his protection and favor—and whereas both Houses of Congress have by their joint Committee requested me “to recommend to the People of the United States a day of public thanksgiving and prayer to be observed by acknowledging with grateful hearts the many signal favors of Almighty God especially by affording them an opportunity peaceably to establish a form of government for their safety and happiness.”
Now therefore I do recommend and assign Thursday the 26th day of November next to be devoted by the People of these States to the service of that great and glorious Being, who is the beneficent Author of all the good that was, that is, or that will be—That we may then all unite in rendering unto him our sincere and humble thanks—for his kind care and protection of the People of this Country previous to their becoming a Nation—for the signal and manifold mercies, and the favorable interpositions of his Providence which we experienced in the course and conclusion of the late war—for the great degree of tranquillity, union, and plenty, which we have since enjoyed—for the peaceable and rational manner, in which we have been enabled to establish constitutions of government for our safety and happiness, and particularly the national One now lately instituted—for the civil and religious liberty with which we are blessed; and the means we have of acquiring and diffusing useful knowledge; and in general for all the great and various favors which he hath been pleased to confer upon us.
and also that we may then unite in most humbly offering our prayers and supplications to the great Lord and Ruler of Nations and beseech him to pardon our national and other transgressions—to enable us all, whether in public or private stations, to perform our several and relative duties properly and punctually—to render our national government a blessing to all the people, by constantly being a Government of wise, just, and constitutional laws, discreetly and faithfully executed and obeyed—to protect and guide all Sovereigns and Nations (especially such as have shewn kindness unto us) and to bless them with good government, peace, and concord—To promote the knowledge and practice of true religion and virtue, and the encrease of science among them and us—and generally to grant unto all Mankind such a degree of temporal prosperity as he alone knows to be best.
Given under my hand at the City of New-York the third day of October in the year of our Lord 1789.

Go: Washington

Sarah Josepha Hale was editor of a magazine first called Ladies' Magazine and later called Ladies' Book from 1828 to 1877. It was among the most widely-known and influential magazines for women of its time. Hale wrote to Abraham Lincoln on September 28, 1863, suggesting that he set a national date for a Thankgiving holiday. From the Library of Congress, here's a PDF file of the Hale's actual letter to Lincoln, along with a typed transcript for 21st-century eyes. Here are a few sentences from Hale's letter to Lincoln:
You may have observed that, for some years past, there has been an increasing interest felt in our land to have the Thanksgiving held on the same day, in all the States; it now needs National recognition and authoritive fixation, only, to become permanently, an American custom and institution. ...  For the last fifteen years I have set forth this idea in the "Lady's Book", and placed the papers before the Governors of all the States and Territories -- also I have sent these to our Ministers abroad, and our Missionaries to the heathen -- and commanders in the Navy. From the recipients I have received, uniformly the most kind approval. ... But I find there are obstacles not possible to be overcome without legislative aid -- that each State should, by statute, make it obligatory on the Governor to appoint the last Thursday of November, annually, as Thanksgiving Day; -- or, as this way would require years to be realized, it has ocurred to me that a proclamation from the President of the United States would be the best, surest and most fitting method of National appointment. I have written to my friend, Hon. Wm. H. Seward, and requested him to confer with President Lincoln on this subject ... 

William Seward was Lincoln's Secretary of State. In a remarkable example of rapid government decision-making, Lincoln responded to Hale's September 28 letter by issuing a proclamation on October 3. It seems likely that Seward actually wrote the proclamation, and then Lincoln signed off. Here's the text of Lincoln's Thanksgiving proclamation, which characteristically mixed themes of thankfulness, mercy, and penitence:

Washington, D.C.
October 3, 1863
By the President of the United States of America.
A Proclamation.
The year that is drawing towards its close, has been filled with the blessings of fruitful fields and healthful skies. To these bounties, which are so constantly enjoyed that we are prone to forget the source from which they come, others have been added, which are of so extraordinary a nature, that they cannot fail to penetrate and soften even the heart which is habitually insensible to the ever watchful providence of Almighty God. In the midst of a civil war of unequaled magnitude and severity, which has sometimes seemed to foreign States to invite and to provoke their aggression, peace has been preserved with all nations, order has been maintained, the laws have been respected and obeyed, and harmony has prevailed everywhere except in the theatre of military conflict; while that theatre has been greatly contracted by the advancing armies and navies of the Union. Needful diversions of wealth and of strength from the fields of peaceful industry to the national defence, have not arrested the plough, the shuttle or the ship; the axe has enlarged the borders of our settlements, and the mines, as well of iron and coal as of the precious metals, have yielded even more abundantly than heretofore. Population has steadily increased, notwithstanding the waste that has been made in the camp, the siege and the battle-field; and the country, rejoicing in the consiousness of augmented strength and vigor, is permitted to expect continuance of years with large increase of freedom. No human counsel hath devised nor hath any mortal hand worked out these great things. They are the gracious gifts of the Most High God, who, while dealing with us in anger for our sins, hath nevertheless remembered mercy. It has seemed to me fit and proper that they should be solemnly, reverently and gratefully acknowledged as with one heart and one voice by the whole American People. I do therefore invite my fellow citizens in every part of the United States, and also those who are at sea and those who are sojourning in foreign lands, to set apart and observe the last Thursday of November next, as a day of Thanksgiving and Praise to our beneficent Father who dwelleth in the Heavens. And I recommend to them that while offering up the ascriptions justly due to Him for such singular deliverances and blessings, they do also, with humble penitence for our national perverseness and disobedience, commend to His tender care all those who have become widows, orphans, mourners or sufferers in the lamentable civil strife in which we are unavoidably engaged, and fervently implore the interposition of the Almighty Hand to heal the wounds of the nation and to restore it as soon as may be consistent with the Divine purposes to the full enjoyment of peace, harmony, tranquillity and Union.
In testimony whereof, I have hereunto set my hand and caused the Seal of the United States to be affixed.
Done at the City of Washington, this Third day of October, in the year of our Lord one thousand eight hundred and sixty-three, and of the Independence of the United States the Eighty-eighth.
By the President: Abraham Lincoln
William H. Seward,
Secretary of State

Wednesday, November 25, 2015

An Economist Chews Over Thanksgiving

As Thanksgiving preparations arrive, I naturally find my thoughts veering to the evolution of demand for turkey, technological change in turkey production, market concentration in the turkey industry, and price indexes for a classic Thanksgiving dinner. Not that there's anything wrong with that. [Note: This is an updated and amended version of a post that was first published on Thanksgiving Day 2011.]

The last time the U.S. Department of Agriculture did a detailed "Overview of the U.S. Turkey Industry" appears to be back in 2007, although an update was published in April 2014 . Some themes about the turkey market waddle out from those reports on both the demand and supply sides.

On the demand side, the quantity of turkey per person consumed rose dramatically from the mid-1970s up to about 1990, but since then has declined somewhat. The figure below is from the Eatturkey.com website run by the National Turkey Federation. Apparently, the Classic Thanksgiving Dinner is becoming slightly less widespread.

On the production side, the National Turkey Federation explains: "Turkey companies are vertically integrated, meaning they control or contract for all phases of production and processing - from breeding through delivery to retail." However, production of turkeys has shifted substantially, away from a model in which turkeys were hatched and raised all in one place, and toward a model in which the steps of turkey production have become separated and specialized--with some of these steps happening at much larger scale. The result has been an efficiency gain in the production of turkeys. Here is some commentary from the 2007 USDA report, with references to charts omitted for readability:

"In 1975, there were 180 turkey hatcheries in the United States compared with 55 operations in 2007, or 31 percent of the 1975 hatcheries. Incubator capacity in 1975 was 41.9 million eggs, compared with 38.7 million eggs in 2007. Hatchery intensity increased from an average 33 thousand egg capacity per hatchery in 1975 to 704 thousand egg capacity per hatchery in 2007.
Some decades ago, turkeys were historically hatched and raised on the same operation and either slaughtered on or close to where they were raised. Historically, operations owned the parent stock of the turkeys they raised while supplying their own eggs. The increase in technology and mastery of turkey breeding has led to highly specialized operations. Each production process of the turkey industry is now mainly represented by various specialized operations.
Eggs are produced at laying facilities, some of which have had the same genetic turkey breed for more than a century. Eggs are immediately shipped to hatcheries and set in incubators. Once the poults are hatched, they are then typically shipped to a brooder barn. As poults mature, they are moved to growout facilities until they reach slaughter weight. Some operations use the same building for the entire growout process of turkeys. Once the turkeys reach slaughter weight, they are shipped to slaughter facilities and processed for meat products or sold as whole birds.
Turkeys have been carefully bred to become the efficient meat producers they are today. In 1986, a turkey weighed an average of 20.0 pounds. This average has increased to 28.2 pounds per bird in 2006. The increase in bird weight reflects an efficiency gain for growers of about 41 percent."
The 2014 report points out that the capacity of eggs per hatchery has continued to rise (again, references to charts omitted):
For several decades, the number of turkey hatcheries has declined steadily. During the last six years, however, this decrease began to slow down. As of 2013, there are 54 turkey hatcheries in the United States, down from 58 in 2008, but up from the historical low of 49 reached in 2012. The total capacity of these facilities remained steady during this period at approximately 39.4 million eggs. The average capacity per hatchery reached a record high in 2012. During 2013, average capacity per hatchery was 730 thousand (data records are available from 1965 to present).

U.S. agriculture is full of examples of remarkable increases in yields over a few decades, but they always drop my jaw. I tend to think of a "turkey" as a product that doesn't have a lot of opportunity for technological development, but clearly I'm wrong. Here's a graph showing the rise in size of turkeys over time from the 2007 report.

The production of turkey remains an industry that is not very concentrated, with three relatively large producers and then more than a dozen mid-sized producers. Here's a list of top turkey producers in 2014 from the National Turkey Federation:

In the last couple of years, the US turkey industry has been affected by an outbreak of HPAI
 (Highly Pathogenic Avian Influenza). In the November 17, 2015 issue of the "Livestock, Dairy, andPoultry Outlook" from the US Department of Agriculture, Kenneth Mathews and Mildred Haley offer some details.
U.S. turkey meat production in third-quarter 2015 was 1.35 billion pounds, down 9 percent from a year earlier. This continued the downward path for turkey production in 2015 ... The third-quarter decline was due to both a lower number of turkeys slaughtered and a drop in their average live weight at slaughter. The slaughter number fell to 57.5 million, 6 percent lower than a year earlier, while the average live weight at slaughter declined to 29.3 pounds, a drop of 3 percent from the previous year. Since April the average live weight at slaughter has been lower than the previous year, for a period of 6 consecutive months—reflecting the impact of the HPAI outbreak, which caused processors to slaughter birds somewhat earlier than they normally would in order to maintain supply levels. ... Lower turkey meat production during third-quarter 2015 helped to lower overall turkey stocks, which, in turn, put upward pressure on whole bird prices. ... Turkey meat production in 2016 is forecast at 6 billion pounds, which would be an increase of 8 percent from the HPAI-reduced production of the previous year; much of the increase will come in the second half of the year. ... Prices for whole frozen hen turkeys at the wholesale level averaged $1.36 per pound in October, up from $1.16 per pound the previous year (17 percent). ... The quarterly price for frozen whole hens in 2016 is forecast higher through the first half of the year, but then to average below year-earlier levels in the second half, as higher production mitigates traditional seasonal price increases.

For some reason, this entire post is reminding me of the old line that if you want to have free-flowing and cordial conversation at dinner party, never seat two economists beside each other. Did I mention that I make an excellent chestnut stuffing?

Anyway, the starting point for measuring inflation is to define a relevant "basket" or group of goods, and then to track how the price of this basket of goods changes over time. When the Bureau of Labor Statistics measures the Consumer Price Index, the basket of goods is defined as what a typical U.S. household buys. But one can also define a more specific basket of goods if desired, and since 1986, the American Farm Bureau Federation has been using more than 100 shoppers in states across the country to estimate the cost of purchasing a Thanksgiving dinner. The basket of goods for their Classic Thanksgiving Dinner Price Index looks like this:

The cost of buying the Classic Thanksgiving Dinner rose by a  bit less than 1% in 2015, compared with 2014. The top line of the graph that follows shows the nominal price of purchasing the basket of goods for the Classic Thanksgiving Dinner. The lower line on the graph shows the price of the Classic Thanksgiving Dinner adjusted for the overall inflation rate in the economy. The line is relatively flat, especially since 1990 or so, which means that inflation in the Classic Thanksgiving Dinner has actually been a pretty good measure of the overall inflation rate.

Thanksgiving is a distinctively American holiday, and it's my favorite. Good food, good company, no presents--and all these good topics for conversation. What's not to like?

Will Convergence Occur?

Economic theory suggests that low-income countries have the possibilities for growing rapidly in a way that would allow them to converge toward the per capita income levels of high-income countries. After all, the low wages and lack of capital of low-income countries should make them an attractive place for international firms and investors. Moreover, today's low-income countries don't have to invent all the technologies developed in the last century all over again; instead, they can draw on knowledge and technology already available. A prominent essay by an economist named Alexander Gerschenkron back in 1962 (available at various places on the web like here ) referred in the spirit of these arguments to "the advantages of backwardness."

So how is that process of convergence actually coming along Maria A. Arias and Yi Wen offer some fact and analysis in "Trapped: Few Developing Countries Can Climb the Economic Ladder or Stay There," which appears in the October 2015 issue of the Regional Economist, published by the Federal Reserve Bank of St. Louis (pp. 4-9). Consider a couple of figures showing where some convergence has happened in the last 60 years--and where it has not.

First, consider countries that were "middle income" by global standards in 1950--that is, their per capita incomes at that time were between roughly 10% and 40% of the US level. On the figure, the US level of per capita GDP is used as the baseline, represented by 1, and the per capita GDP of other countries is expressed relative to that baseline. The rising lines show some examples of convergence: Hong Kong, Ireland, Spain, and Taiwan. Other examples would include some countries of east Asia like South Korea. But the other four countries, all from Latin America--Mexico, Brazil, Ecuador, and Guatamala--have seen at best a very modest force of convergence over the last 60 years.

The low-income countries of the world back in 1950, those starting at well below 10% of the US level of per capita income, show a mixed pattern as well. In the figure below, the recent rise of China and India are put in perspective. In terms of per capita GDP, they have now reached the lower part of "middle-income" by global terms. But a number of other low-income countries around the world haven't shown much convergence. The examples given here, which can be thought of as representing other low-income swaths of south Asia, sub-Saharan Africa, and Latin America, are Bangladesh, El Salvador, Mozambique, and Nepal. 

More systematic evidence shows that countries often remain in the low-income and middle-income positions for a long time. By their calculation based on all the countries for which estimates are available  (references to tables omitted): 
The probability of remaining trapped in the low-income range is 94 percent after 10 years 90 percent after 20 years and 80 percent in the entire observational period, 30 to 61 years.  ... [T]he probability of escaping the middle-income trap is 11 percent after a 10-year period, 21 percent after a 20-year period and 36 percent after 30 to 61 years. Also interesting to note is that countries almost never degrade to low- or middle-income status once they have reached the high-income status: The probability of remaining at a high-income status is at least 97 percent.
One of the central questions of development economics is: "What is holding back convergence?" It's easy to come up with theories. For example, low-income countries might have economic or political institutions that aren't conducive to growth. For example, perhaps they don't offer support for the rule of law or private property in a way that helps economic growth. Or perhaps political elites in a low-income country would rather control and sometimes close off interactions with the rest of the world, rather than open up to the world and risk that alternative centers of power and wealth might form. But as the authors point out, many of these explanations are at best partial, and it's not hard to think of exceptions to whatever rule you have formulated. 

All of which leaves me with a few thoughts: 

1) It doesn't seem quite right to argue that countries are "trapped" in their current level of income. Aart Kraay and David McKenzie make a persuasive case for skepticism about this view in their essay "Do Poverty Traps Exist? Assessing the Evidence," in the Summer 2014 issue of the Journal of Economic Perspectives. They point out that while there has been a lack of convergence, the world's poorest economies circa 1960 actually have growth at about the same rate as the world's higher-income economies since then. Moreover, whatever kind of "trap" exists apparently applies not just to the poorest countries, but also to middle-income countries and high-income countries--which rarely switch their positions, either.  

2) The take-off of China and India from low-income toward middle-income status is a phenomenal change. These countries each have populations over 1.2 billion, and together they represent something like one-third of the world population. Their growth in recent decades suggest that we need to rethink our beliefs from a few decades ago about countries being stuck. I find myself wonder if something about the huge size of these countries has perhaps helped their growth. Maybe once a large-population country gets its economy rolling, it has more sustained momentum than would a small-population country that took similar steps. 

3) As a way of thinking concretely if anecdotally abou this issue, Arias and Wen compare two middle income countries: Ireland, which has experienced convergence in recent decades, and Mexico, which has not. Both countries are near high-income countries. They give Ireland credit for its willingness to be open to foriegn direct investment, which helped link it to the global economy, as well as for its investments in education and its ability (most of the time) to avoid high government budget deficits or inflation. In contrast, Mexico for many decades focused mainly on exporting oil, while its government did not invest heavily in education and instead ran up large debts and periods of high inflation. These kinds of differences surely aren't a full description of why one country converges and another doesn't, but it's a start. 

4) My own sense, for what it's worth, is that convergence is in some substantial way a broad national commitment to welcome extensive and continual change. Sustained economic growth will shake up the lives of people in low-income and middle-income countries: not just what they can buy, but what jobs they do, what their living spaces look like, how their children will be educated, ties with family, what firms prosper or go under, and an ongoing transformation of villages, towns and cities. CNo nation can have a genuine commitment to sustained and powerful economic growth if it doesn't also have a broad-based willingness to to experience extensive change. But change is disruption, and disruption involves losses as well as gains. 

Tuesday, November 24, 2015

The Economics of the Retail Sector

Lots of economic analysis focuses on production, or on consumption. But there is less focus on the economic characteristics of what happens in between production and consumption--which is called the retail sector. In the Fall 2015 issue of the Journal of Economic Perspectives, Ali Hortaçsu and Chad Syverson look at "The Ongoing Evolution of US Retail: A Format Tug-of-War," while Bart J. Bronnenberg and Paul B. Ellickson take an international view in "Adolescence and the Path to Maturity in Global Retail." (Full disclosure: I've been Managing Editor of JEP since the first issue in 1987.)

Broadly understood,  the retail sector includes all of the activities between the producer and the consumer, which can include purchases by a wholesaler, transportation costs of shipping to warehouses, and the costs of holding that inventory for a time along with transportation costs of shipping to the retailer and the costs of retailing itself, including physical facilities and inventory costs. The evolution of retailing means that these costs are reshuffled among different players. For example, if I order a giant bulk-pack of paper towels from an e-retailer, and then store it in the basement and use it for several, I am bearing some of the storage and inventory costs that would otherwise be carried by a brick-and-mortar retailer.  However, the transportation costs of delivering that bulk-pack of paper towels from the e-retailer involves a relatively small shipment in a delivery van from a warehouse to my house, while the transportation costs of delivering to a warehouse store involves both a large truck shipment to the store, my own time and energy to pick up the bulk-pack and take it through check-out, followed by use of my own car to complete the delivery to my home. In various ways, the economic of retail involves issues of coordination, inventory-holding, economies of scale, as well as questions of how much variety is provided.

Hortaçsu and Syverson point out that the US retail sector accounts for about 11% of all jobs, and about 6% of the economy, as measured by the economic value-added by the sector. If one measures productivity by value-added per employee, then productivity is relatively low in the retail sector, which helps to explain why the average job in retail relatively low-paid. 

The story in US retail over the last few decades is the appearance of two new sets of players, each with a powerful gravitational pull that has greatly disrupted traditional retailes. One new set of players are the big box retailers, sometimes known as "warehouse clubs" and "supercenters," led by Walmart but also including Costco, Target, and others. The other new set of players are the e-commerce retailers, led by Amazon, eBay, and including many others.  In different ways, these new players in retail are both driven by changes in information technology. For the big-box retailers, information technology is how they manage their huge set of suppliers and  their inventories, allowing them to take advantage of economies of scale and scope. For the e-commerce retailers, information technology creates their virtual stores, ties them to their customers, and coordinates their shipping and billing. Hortaçsu and Syverson summarize the situation in US retail in this way:

"One can imagine the future of the retail sector as being pulled in one direction by the growth of e-commerce, which involves smaller employment firms, less market concentration, more geographical dispersion, and higher productivity. At the same time, the sector is being pulled in another direction by the warehouse clubs and supercenters, with higher employment firms, very high market concentration, location near population centers, and lower productivity relative to online channels. While warehouse clubs/supercenters have had more influence on the sector to this point, e-commerce has had its own effects and may be growing in relative importance. Perhaps this concurrent expansion and strength of e-commerce and a physical format portends a retail future not dominated by either, but rather with a substantial role for a “bricks-and-clicks” hybrid. The formats may end up being as much complements as substitutes, with online technologies specializing in product search and discovery, and physical locations facilitating consumers’ testing, purchase, and returns of products ...."
The international view of retail in the article by Bronnenberg and Ellickson shows a related transformation of retail happening at different speeds and in different ways around the word. They emphasize a broad view of retailing that includes potential roles for customers and government, as well as for retail firms themselves. For example, if customers have cars for transporting goods, spacious living accommodations for storage, and sufficient income, they will be more likely to buy bulk-packs of goods from warehouse retailers. The time consumers need to spend affects retail: for example, by encouraging e-commerce purchases that will be delivered.

A number of government policies affect retailing, including the road infrastructure, but also "the ease of obtaining building permits, the regulation of corruption, the availability of autos (through policies allowing the imports of used cars), and the minimum wage structure. ... In many emerging markets, another way in which government affects the retail sector lies in its ability to set policies regarding foreign direct investment."

Of course, large firms also play a role in what they call "modern retailing." They write:
"Firms are clearly the foremost strategic players driving the adoption of modern retailing technology. A modern chain of vertically integrated, large-format stores relies on an upstream distribution system of local producers, third-party logistics firms, and either third-party or integrated wholesalers who must all modernize together. Transactions that were often historically informal must be formalized through contracts with local suppliers and intermediaries. In a case study of Chile, Berdegué (2001) found that small farming cooperatives had to incur significant costs to deliver products of homogeneous quality, to coordinate harvest cycles, and to grade, sort, and package in a manner that met the downstream chain’s requirements. Also, adopting formal accounting processes makes previously informal transactions subject to taxes. ... Among the toughest coordination problems is the joint adoption of commonly used technology."
"In developed markets, the transition to modern retailing is nearly complete. In contrast, many low-income and emerging markets continue to rely on traditional retail formats, that is, a collection of independent stores and open air markets supplied by small-scale wholesalers, although modern retail has begun to spread to these markets as well. ... E-commerce is a notable exception: the penetration of e-commerce in China and several developing nations in Asia has already surpassed that of high-income countries for some types of consumer goods."
 This graph shows the takeoff in e-commerce in China, as measured by retail in the two sectors of "Apparel/Footware" and "Electronics/Appliances."

Bronnenberg and Ellickson agree that while e-commerce is going to be a big player in the future, it's not going to take over retail in general. Warehouses and supercenters will still play a large role, quite likely the dominant role, for some time to come. Other kinds of niche retailers--for example, those who specialize in a certain product, or those located in urban areas where huge store-spaces and parking places aren't available--will also play a role. In thinking about the tradeoffs of the various kinds of retail, they write: 
"Online purchases have benefits and costs that vary by product category. For example, online purchase of physical goods introduces a delay between purchase and delivery, but also gives consumers a greater opportunity to comparison-shop by lowering search costs and travel time and provides a seamless method of gathering information on the experience of previous customers (through online reviews). On the other hand, online retail offers less ability to inspect goods before purchase (and adds the risk of not having a product delivered at all), which renders the reputation of the firm all the more important. Whether a purchase is made online or in-store clearly depends on the frequency of purchase, the homogeneity of the product, and the number of products typically purchased in a given occasion, amongst other factors. Books fall at one end of this spectrum, and thus, in modern retailing systems, are primarily bought online, while groceries fall at the other end, and are typically bought in-store."