Author Archives: johnjhorton

The problem with “it’s just an app”

Middlemen seemingly exist just to get “cut out.” Online marketplaces like Airbnb and Uber are described as middlemen, and I frequently read about how they could be replaced, say, by worker cooperatives or open source apps. After all, “it’s just an app.” Replacement is an appealing idea—imagine Uber/Lyft, but with drivers making X% more money because they don’t have to kick up money to the platform. I’m deeply skeptical, as I think there is not enough appreciation of what these marketplaces do and what it would take to replace them. Setting aside network effects, I think even recreating the basic functionality of most popular marketplace-intermediating apps as they *currently* exist would be challenging.

Anyone who has built software will tell you that the complexity of the software grows much faster than the apparent complexity of what that software does. For example, the original Facebook was a couple thousand lines of code. Two plus years ago, the web codebase, excluding back-end services was over 62 million lines of code. Facebook doesn’t “seem” 1,000x more complex, but running an always-on, globally distributed system that can do all the things that modern Facebook does well is enormously complex. Part of this complexity is that it has to handle ever-more edge cases and be more robust to different failures. Another driver towards greater complexity is that with scale, the platform has an incentive to do small things marginally better. It makes sense to nail some user interface interaction if users will be subjected to it  billions of times.

For-profit platforms can get talented people to work very hard on boring problems. Right now, there is some Stanford CS PhD, some Harvard MBA and RISD-trained designer figuring out the right sequence of dialog boxes and push/in-app notifications to guide Lyft passengers to the arrivals level at an airport. And a PhD data scientist who is going to analyze GPS data, customer support tickets and server logs to try to figure out if whatever they come up with is working. It’s Einsteins designing refrigerators.

The idea of worker cooperatives or open source apps doing the above reminds me of the quip about the problem with socialism is that it wastes too many evenings. You’re not going to get volunteers to work through the kind of tedious problems that make an app seem smooth and intuitive. Most successful open source software  typically (1) solve a technical problem the creator had, (2) is inherently interesting to the creator, (3) or has a strong corporate sponsor/ecosystem ala Android. Where you don’t see open software succeeding is in solving some end-user boring, non-technical problems. And these are precisely the problems for-profit platforms focus on.

We already know what a marketplace looks like that ignores the boring stuff. Consider Craigslist, which although clearly a success, has seen nearly every one of its “verticals” attacked by for-profit platforms, some with great success. Those entrants realized that they can compete with “free” by solving problems that users had. 

It would be foolish to think that incumbents can never be brought down, but the “just an app” or “just a website” perspective doesn’t consider how much hard-to-duplicate work lead to that app in its current form, and how much of that work was tedious and unlikely to be done by any entity without a strong profit motive.

Why I think ride-sharing companies will win the self-driving future

There is growing interest in who will dominate the self-driving future: car companies,  ride-sharing companies or someone else?  My bet is on ride-sharing companies, and the reason is that I think that the self-driving car industry will require expertise that currently resides with ride-sharing companies. Furthermore, the kinds of things car companies have traditionally differentiated themselves on will not matter very much, pushing them into a commodity role.

**Important full disclosure: A close family member of mine works for a ride-sharing company.**

On the consumer side, I suspect that in the future people will think about the manufacturer of the self-driving vehicle they are in as much as they think about the manufacturer of the bus, train car or airplane they are in now, which is to say “very little.” They will not care about styling, aesthetics, mileage, maintenance, parts availability, re-sale value, and service costs, what it says about them as a person to own one, and so on. All things that would be car-buyers care about a great deal will matter very little. There’s a reason there’s no magazine called “Bus & Passenger.”

Some of these vehicle attributes will affect *costs* to platforms—and buyers of fleets of cars will presumably try to buy high quality at low cost, but they aren’t going to pay a premium for design or a brand. The self-driving world is going to be an ugly, commodified world focused on cost and reliability.

Customers *will* care about fleet reputations for cleanliness, timeliness, routing quality, customer service support, safety, and so on—the things they care about with airlines—but these are things that will be determined more by the *operational* excellent of whoever manages the fleet. Unfortunately for car makers, operations is not their forte, whereas the ride-sharing companies are extremely operations/customer-service focused.

Ride-sharing companies have expertise in customer service, marketing, analytics, developing maps, developing routing algorithms, creating software interfaces, and fighting regulatory/legal battles. All of these things are still likely to matter a great deal in the self-driving future. The customer service aspect in an area where these companies are actually quite different form the Silicon Valley mold—they deal with paying customers constantly in a high-touch way, unlike say Google or Facebook.

Ride-sharing companies don’t have expertise in managing fleets of cars (fueling, cleaning, repair and so on), but neither do car companies. But even then, this part of the business doesn’t seem that hard relative to the others, and there are lots of companies and people with this expertise (UPS, FedEx, Hertz, Avis etc.). Car manufacturers have almost no experience with operations. And they have almost no experience dealing with customers.

On the actual self-driving technology side, to extent that improvements will be driven mainly by more and better data rather than hardware, the ride-sharing companies are also the ones well-poised to collect the most data about driving under actual and varied conditions in the long run up to a fully-automated future.

Perhaps the biggest advantage held by ride-sharing companies is that they have a very natural way to transition to the future—start slipping self-driving vehicles into the mix, pacing the introduction as the technology develops. In contrast, the car companies (or Google/Waymo) essentially need to clone Uber or Lyft functionality, but do it with an unproven technology from day one. This will be very hard. Instead, car companies will largely choose to partner with ride-sharing companies, but the ride-sharing companies will have lots of manufacturer options to choose from, and are not going to give away the company to do so, or recklessly form exclusive partnerships.

One might argue that you can’t have a fleet without a car maker willing to sell to you, but there are many, many car markers out there. Just because the car is an essential component of the productive process doesn’t mean that the maker of that input will control everything—McDonalds isn’t a subsidiary of a stove company.

Anyway, for course this is all highly speculative and maybe I’ll wistfully read this naive blog post from my Ford-brand self-driving vehicle in a few years, but I think it’s more likely it will be an Uber/Lyft/Didi/Ola/Gett and some nameless, white-label vehicle made by Honda.

AI, Labor, and the Parable of the Horse

Today I attended the 5th year anniversary celebration for MSR NYC. There was a great group of speakers and panelists—I’m super impressed by what MSR has accomplished. One topic that came up at several points during the day was the labor market effects of technological developments—particularly that powerful AI might displace many workers.

Economists have traditionally been sanguine about the effects of technological change on the labor market, viewing widespread technological unemployment as unlikely. This perspective is based on the historical experience of substantial technological change not having persistent disemployment effects. However, it has been pointed out that we have one vivid example where this optimism has not been warranted—what I call the parable of the horse.

The story is that the internal combustion engine came along and horses saw their marginal product decline below the cost of their feed and so horses disappeared, at least in the “labor” market. This is undoubtedly true—the figure below shows the number of horses (and mules) in the US (from The Demographics of the U.S. Equine Population). The implication is that today’s “horses”—low skilled labor or maybe even labor in general—will disappear as AI can do more and more tasks.

I find the horse parable interesting, but unpersuasive—at least with respect to how it is likely to affect relatively low-skilled workers—because I think the analogy misses the reason why horses fared so poorly. The problem was not that they were “low skilled”  but rather their extreme specialization. Horses did one job and one job only—exerting physical force, which could be used to pull or push things. That they could be almost entirely displaced by a superior pushing/pulling technology is, in some sense, not surprising. But what I think is important in the human labor market is that being able to do one thing—and one thing only—is typically a characteristic of high skilled labor, not low skilled labor.

Most low-skilled labor is no longer like horse labor, in that the low-skilled jobs that exist now are those that require some mix of physical, intellectual and even “emotional” skills. This mix makes full automation challenging. But even when some specific job does “fall” to automation, there is a still a very large pool of remaining jobs that could still need to be done and require relatively little skill or new training, by definition of being low-skilled. In short, one advantage of the low skilled labor market is that there are lots of jobs you qualify for. The downside, of course, is that precisely because lots of people can qualify for those jobs and so wages are low. The workers that are vulnerable to technical change—in the sense that they are likely to experience large declines in income—are those workers with highly specialized skills.

Truck driving as a low-skilled example

To give a more concrete example, consider the job of truck driver, which might be on the automation chopping block. First, many people with the job “truck driver” are actually some combination of sales representative, inventory-taker, first line mechanic, warehouse worker, forklift operator and so on. As such, it is far from obvious that even if substantial amounts of driving end up being done through automation that labor demand for “truck driver” would fall.

Second, even if the truck driver occupation sees a large negative demand shock, what other jobs could a truck driver do that pay about the same? Well, let’s look at the BLS  occupational data. The table below shows the most recent BLS occupational data, w/ US employment totals and average hourly wages, sorted by average hourly wage. I restricted the list to occupations with more than 500K employees. We can see that being a light truck driver (i.e., not a heavy truck transporting freight or heavy equipment) pays about $16.50/hour, which is below the median wage in the US but still substantially higher than the minimum wage. 

Retail Salespersons 4,612,510 12.67
Nursing Assistants 1,420,570 12.89
Landscaping and Groundskeeping Workers 895,600 13.20
Laborers and Freight, Stock, and Material Movers, Hand 2,487,680 13.39
Receptionists and Information Clerks 975,890 13.67
Security Guards 1,097,660 13.68
Substitute Teachers 626,750 14.25
Bus Drivers, School or Special Client 505,560 14.70
Team Assemblers 1,115,510 15.17
Office Clerks, General 2,944,420 15.33
Medical Assistants 601,240 15.34
Shipping, Receiving, and Traffic Clerks 674,820 15.55
First-Line Supervisors of Food Preparation and Serving Workers 884,090 16.02
Light Truck or Delivery Services Drivers 826,510 16.38
Industrial Truck and Tractor Operators 539,810 16.39
Medical Secretaries 530,360 16.50
Customer Service Representatives 2,595,990 16.62
Secretaries and Administrative Assistants, Except Legal, Medical, and Executive 2,281,120 16.92
Construction Laborers 887,580 17.57
Maintenance and Repair Workers, General 1,314,560 18.73
Bookkeeping, Accounting, and Auditing Clerks 1,580,220 18.74
Inspectors, Testers, Sorters, Samplers, and Weighers 508,590 18.95
Automotive Service Technicians and Mechanics 638,080 19.58
Heavy and Tractor-Trailer Truck Drivers 1,678,280 20.43

We can see that both above and below, there are a number of jobs that are plausible substitute occupations for a displaced truck driver. For example, of those below, most require no formal education or certification, perhaps except for substitute teachers or medical assistants. If we go higher, we start to see jobs that require more skills or that are more physically taxing or dangerous (e.g., construction laborer), but are still reasonable substitutes. For example, many truck drivers are also decent mechanics and perhaps with some more training, could find work as “Maintenance and Repair Workers, General.”

Not only do displaced truck drivers have lots of “nearby” occupations that pay about the same with little additional human capital requirements, the displaced drivers are not likely to drive down wages very much in their new occupations. There are, of course, lots of truck drivers, but if they split into a reasonably large chunk of other occupations, the new entrants would not be much of a supply shock.

A specialized occupation example

Now we’ll look at a more specialized occupation. Let’s consider accountants and auditors (even this one still seems far away from being even remotely automatable). It pays quite nicely and requires substantial specialized skill. If we look at nearby jobs, very few would be open to a displaced accountant without substantial re-training.

Lawyers 609,930 65.51
Financial Managers 531,120 64.58
General and Operations Managers 2,145,140 57.44
Software Developers, Applications 747,730 49.12
Management Analysts 614,110 44.12
Computer Systems Analysts 556,660 43.36
Accountants and Auditors 1,226,910 36.19
Business Operations Specialists, All Other 926,610 35.33
Registered Nurses 2,745,910 34.14
Market Research Analysts and Marketing Specialists 506,420 33.67
First-Line Supervisors of Construction Trades and Extraction Workers 517,560 32.13
Sales Representatives, Wholesale and Manufacturing, Except Technical and Scientific Products 1,409,550 32.11
Sales Representatives, Services, All Other 886,580 29.98
Police and Sheriff’s Patrol Officers 653,740 29.45
Secondary School Teachers, Except Special and Career/Technical Education 962,820 *

Accountants are the “horses” here—the ones that are vulnerable to large drop offs in earnings because of their specialization. Fortunately, if we care about inequality, this is the “right” group to be affected. Because of their existing financial wealth and their general human capital, they are likely better able to deal with the disequilibria created by technological change.

How would we know if “The Bay Area Should Levy a 5% Equity Tax on Startups”

In a recent Information article, Sam Lessin proposed a Bay Area 5% equity tax on startups. It’s an interesting idea; I don’t know whether it’s “good” idea. This blog post will not answer the “good” question, but I’d like to use this proposal to explore some ideas in public policy and economics and talk about some of my work that bears on the question.

If a 5% equity tax were imposed, what would happen? Ideally, we’d have a true experiment to settle the question: say we had 300 more or less equivalent Silicon Valleys, half of which got the tax, half of which didn’t, and then we’d check in on them in 5 or 10 years. Yeah, so that’s not going to work.

The problem is clear—we don’t have that many Silicon Valleys, we don’t have that much time, and we certainly don’t have the political power to impose such a tax randomly. Further, it is not clear what we should even look at to assess “good”—we could see how much revenue that tax generated, but what we care about is the revenue generated at what cost to society. If the shadow of a 5% tax causes a huge reduction in the number of startups, then whatever is raised could be very costly indeed. Though even saying something strong here would require some notion of the “quality” of the startups the tax displaced or prevented and whether some other startup would have just filled its place (e.g., kill Uber, get Lyft). We’d also care about who ultimately paid the tax, as the incidence is unclear—is it entrepreneurs? VCs? Workers in the tech sector? Landlords? Consumers of what Silicon Valley makes?

To assess the proposal, we’re going to need to be less empirical and more theoretical. I am highly empirical. I’m a card-carrying member of the credibility revolution. Most of my papers are not just empirical but experimental. That being said, there are important policy questions we care about that we need to answer quickly that existing empirical work just does not speak to. That leaves economic theory or guessing.

Screenshot 2017-04-24 11.18.28

My working paper, “A Model of Entrepreneurial Clusters, with an Application to the Efficiency of Entrepreneurship” is theory paper designed to answer this kind of question (among others). The model is not complex, but it has a few too many moving pieces for a blog post, but I can sketch out the relevant parts and show how to apply it.

In a nutshell, the paper describes a model with three important markets: the market for venture capital, the market for “engineers” and the product market for what successful startups sell. In the paper, would-be entrepreneurs weigh the expected returns to doing a startup to the “safe” returns to being an engineer/employee. A key feature of the model is the notion that lots of would-be entrepreneurs can pursue the same “idea” but that there is a single winner on each idea. This has some implications for the entrepreneurial system. One less startup does mean one less shot at commercializing some innovation, but if lots of startups were pursuing more of less the same idea, the welfare consequences of “losing” that startup to employment is not so bad. Furthermore, it doesn’t have much of a labor market consequences either—there is no “missing” successful startup that is no longer demanding labor.

Anyway, getting back to the tax question. We can think of the tax as increasing the cost of doing a startup. The effects of such a shock are worked out in Section 3.8 in the paper. This increase in cost shifts some would-be entrepreneurs back into the labor market, which lowers wages. This, to some extent, offsets the effect of the tax from the entrepreneurs perspective, as it lowers startup labor costs, making startups ex ante more attractive (imagine Google, but getting to pay 3% lower wages—starting Google is more attractive). So some of the tax gets borne by workers. How much? Well, in the model, the effect of a small change in startup costs on wages is

Screenshot 2017-04-24 11.37.58

which, uh, may still leave you with some questions. The “g” is the fraction of the labor force that is entrepreneurs. This part just says that when a large fraction of the labor force is entrepreneurs, a tax on that has a big spill-over effect on wages, and vice versa when it is small.

The term inside the parentheses has an economic interpretation, in that it captures how large a flow of engineers must leave entrepreneurship to re-establish an equilibrium, with larger flows leading to greater reductions in wages. Suppose that the startup success probability was completely inelastic, meaning that a reduction in the number of startups doesn’t “help” the startups that remain succeed. The increase in startup costs drives engineers from entrepreneurship, but because the startup success probability does not change, there is no compensating increase in success probability that would occur if the success probability was elastic. As such, a larger flow out of entrepreneurship is needed to re-establish the equilibrium, which means that employees see a larger fall off in wages. With a highly elastic success probability, a smaller number of exiting entrepreneurs is needed to establish a new equilibrium, and so there is less downward wage pressure and so less pass through of startup costs.

The model says that the overall surplus of the system is proportional to engineer wages in equilibrium. As such, what we would hope, as a social planner, is that the tax does not lower wages much in equilibrium. This happens when the startup success probability is highly elastic. A key feature of the model is that a highly elastic startup success probability is the sign in the model of too much entrepreneurship, in the sense that there are lots of entrepreneurs pursuing more of less the same ideas. In the model, ideas differ in their perceived “quality” and obviously good ideas get lots of entrants pursuing them, while only the marginal ideas get the efficient number of entrepreneurs (perhaps the ideas-that-seem-bad-but-are-actually-good). The figure below is the key figure from the paper:

Screenshot 2017-04-24 11.54.03

Conclusion

To wrap it up, the model says that if you think there is lots of duplicative entrepreneurship right now—too many entrepreneurs pursuing more or less the same idea—the model says that Sam’s tax is very likely to be a good idea, as it will mostly reduce, on the margin, startups pursuing ideas that were already being pursued, and hence the social welfare consequences will be minimal (interestingly, I think this elasticity question probably can be pursued empirically, using booms and busts in startup funding and/or technological shocks). Is my model the right way to model things? I have no idea, but it’s *a* model and we have to make choices. Of course, there are lots of considerations this analysis doesn’t consider, but I think it’s a  starting point for thinking about the issue, and also potentially the impetus for newer, better models.

 

2SLS in Mathematica

2SLS data setup. Note that there is RV u that appears in both x and in the error term. There is also an IV, z, that affects x but not u.

n = 10000;
z = Table[Random[NormalDistribution[0, 1]], {n}];
B0 = 1;
B1 = 2;
gamma0 = -2;
gamma1 = 4;
u = Table[Random[NormalDistribution[0, 1]], {n}];
x = u + gamma0 + gamma1 * z +
Table[Random[NormalDistribution[0, 1]], {n}];
e = 5*u + Table[Random[NormalDistribution[0, 1]], {n}];
y = B0 + B1*x + e;

Screen Shot 2017-04-23 at 9.53.52 AM

Note that the real coefficient on x is 2, but the estimated coefficient biased upwards. Now we can do the first stage:

First stage


iota = Table[1, {n}];
Z = Transpose[{iota, z}];
Gammahat = Inverse[Transpose[Z].Z].Transpose[Z].x;
xhat = Z.Gammahat;
Xhat = Transpose[{iota, xhat}];
Bhat = Inverse[Transpose[Xhat].Xhat].Transpose[Xhat].y

and now the coefficient estimates are close to the true values:

Screen Shot 2017-04-23 at 9.55.10 AM

Panel data in Mathematica

This code constructs the design matrix for a panel with both time and individual fixed effects and then estimates the model.


\[Beta] = 3;
NumIndividuals = 323;
NumPeriods = 4;
NumObs = NumIndividuals * NumPeriods;
x = Table[Random[NormalDistribution[0, 1]], {NumObs}];
y = \[Beta]*x + Table[Random[NormalDistribution[0, 1]], {NumObs}];
XindivFull =
KroneckerProduct[IdentityMatrix[NumPeriods],
Table[1, {NumIndividuals}]] // Transpose;
XtimeFull =
KroneckerProduct[Table[1, {NumIndividuals}],
IdentityMatrix[NumPeriods]];
Xcombo = Join[XindivFull[[All, {2, NumPeriods}]],
XtimeFull[[All, {2, NumPeriods}]], 2];
\[Iota] = Table[1, {NumObs}];
XwIntercept = MapThread[Append, {Xcombo, \[Iota]}];
Xfull = MapThread[Append, {XwIntercept, x}];
\[Beta]hat = Inverse[(Transpose[Xfull].Xfull)].Transpose[Xfull].y

OLS in Mathematica

These are some notes for myself on econometrics in Mathematica.

Set up the data


n = 100;
B0 = 1;
B1 = 2;
x = Table[Random[NormalDistribution[0, 1]], {n}];
\[Epsilon] = Table[Random[NormalDistribution[0, 1]], {n}];
y = B0 + B1*x + \[Epsilon];
ListPlot[Transpose[{x, y}]]

Screen Shot 2017-04-23 at 8.52.46 AM

Create the model matrix


iota = Table[1, {n}];
X = Transpose[{iota, x}];
k = Dimensions[X][[2]];

Estimate coefficients


Bhat = Inverse[Transpose[X].X].Transpose[X].y

Make predictions


yhat = X.Bhat;
ListPlot[{Transpose[{x, y}], Transpose[{x, yhat}]}]

Screen Shot 2017-04-23 at 8.55.34 AM

Compute the variance/covariance matrix


error = y - yhat;
sigma = Sqrt[Variance[error]]
sigma^2* Inverse[Transpose[X].X] // MatrixForm

Screen Shot 2017-04-23 at 8.57.34 AM

Regression statistics

R squared


rsq = Variance[yhat]/Variance[y]

A Way to Potentially Harm Many People for Little Benefit

Noah Smith has an article proposing some kind quasi-mandatory national service. The end-goal is not, say, winning WWII, but rather the social cohesion side-effect gained from making young people from different backgrounds work together. For many reasons, I think this is a bad idea, but perhaps the most important is that for it to “work”—to really forge some kind of deep band-of-brothers connection, you’d have to impose terrible costs on the participants.

The reason military service is described as “service” or a “sacrifice” is that is, even in peace time. You risk death and terrible injuries, both mental and physical. You lose a great deal of personal freedom and gain a great deal of worry and anxiety. You risk seeing your friends and people you are responsible for killed and maimed. You spend months and even years away from loved ones. I spent 5 years in the Army as a tank platoon leader & company executive officer, after 4 years at West Point. Of my active duty time, 15 months were spent in Iraq (Baghdad and Karbala). It was, without a doubt, the worst experience of my life—nothing else even comes close, and I got off easy.

One might say, well, this is just the “war” version of military service. Not really. Outside of combat, back in Germany: one soldier in my battalion (slowly) drowned when his tank got stuck in deep mud during a training exercise and the driver’s compartment filled with water; another in my brigade was electrocuted when loading tanks onto rail cars; another young soldier from my brigade was, two weeks after arriving in Germany, promptly robbed & beaten to death by two other privates from his battalion. With our deployment looming, one lieutenant in our brigade went AWOL and later killed himself. And I’m not considering the numerous injuries. This was never summer camp.

When you peel back the superficially appealing aspects of military service—focus on teamwork, training, college benefits, supposed egalitarian design etc., you’re confronted with the fact that militaries are impersonal bureaucracies that (1)  treat soldiers as a means to an end, and (2) are designed to efficiency kill people and destroy things. Both features are necessary , but that does not make them less evil. Participating in those two functions, no matter how just the cause, is mental damaging for many, and deeply unpleasant for almost everyone.

So that’s all cost. Does military service “work” to build cohesion? I would give a qualified “yes,” but I don’t think it’s a generalized social cohesion Smith is after anyway—I don’t feel some deep attachment to the white working class, though I am more familiar with that culture than I otherwise would be. I’m sure I know more Trump supporters than the average (any?) NYU professor, but I don’t think I’m any more sympathetic. I have a bond to soldiers from my *platoon* and a deep friendship with some of my fellow officers, but here’s the rub—it’s based on the shared sacrifice. If we had just spent our time together fixing up trails or building playgrounds, those fellow soldiers would be something I already have lots of—former work colleagues.

To wrap it up, society doesn’t get the cohesion without the costly sacrifice, and creating that sacrifice artificially would be deeply wrong. And if the goal of mandatory service is just to get people to meet people from other backgrounds—say the kind of band-of-brothers level cohesion isn’t needed—surely there are cheaper, less coercive ways to do it.

Performative economics, or how my paper is used in wage negotiations

One sociological critique of economics is that unlike the physical sciences, economic research can affect the thing it studies. I might not be using the jargon the correct way, but the basic idea is that economics is “performative“—it’s not just a magnifying glass—it’s a magnifying glass that sometimes focuses the light and burns what you’re looking at. I have an example of this from my own work that bugs me more than a little bit, but is ultimately, my own fault. Let me explain.

So back in graduate school, Lydia Chilton and I wrote a paper called “The Labor Economics of Paid Crowdsourcing” (data & code here). In a nutshell, we introduced the labor economics way of thinking about labor supply to the crowdsourcing/computer science crowd. We also did some experiments where we varied earnings to see how workers reacted on MTurk. We thought the really cool “so what” of the paper was that we presented strong evidence for target earning—that workers had a preference for earning amounts of money evenly divisible by 5 (here’s the key figure–note that taller black histogram bars):

Screenshot 2017-04-20 11.01.44

Almost as an afterthought, we estimated the distribution of worker reservation wages for our (*very* unusual) task. We came up with a median value of $1.38/hour, using some strong assumptions about functional form. We put this in the abstract & we even discussed how it could be used to predict how many people would accept a task, because every paper has to make some claim to how it is useful.

Screenshot 2017-04-20 11.03.27

Anyway, every once in a while, I see something on twitter like this (7 *years* later):

Screenshot 2017-04-20 11.07.13

Hmmm, I wonder where that $1.38/hour figure came from. Anyway, mea culpa. If you’re a MTurk worker, my apologies. Feel free to cite this blog post as the authority that $1.38/hour is a silly number that shouldn’t anchor wages.

Causes of the Silicon Valley real estate crunch (and some potential solutions)

I unexpectedly got into two Twitter discussions recently about Silicon Valley (SV) and its effects on the local real estate market. I felt constrained by the 140 character limit, so I thought I’d write a blog post explaining my thinking (and add supply & demand diagrams!).

To understand what is happening in SV, we need to think about three markets:
(1) the product market for what SV tech companies sell
(2) the SV tech labor market and
(3) the SV housing market.

First, what’s obvious: there’s been a huge increase in demand for what Silicon Valley sells: the world is using way more IT than it used to. Someone has to build & program this stuff, and so there’s been a large increase in demand for certain kinds of high-skilled labor—namely software engineers, designers, product managers and so on. Let’s call them “tech people.”

First thing google shows for

Most tech people are transplants, coming to SV specifically to work in tech. They need a place to live. As such, a demand shock for tech labor is also a demand shock for housing in SV.

How the labor demand shock plays out

In the figure below, the top diagram is the labor market and the bottom diagram is the housing market. The y-axes are wages and real estate prices, respectively. The x-axes are tech people hired and units of housing consumed, respectively. The connection between these two markets is so tight that I assume that changes in tech people employed must be met one for one with changes in housing units consumed. This is why the two diagrams are stacked on top of each other.

Pre-boom equilibrium:

Here comes the iPhone: Tech Boom!

Let’s consider how a product market demand shock leads to a new equilibrium. First, the demand curve for labor shifts out (in red, top panel). If we ignored the housing market, we would just see higher wages and more tech people hired. However, these new tech hires want a place to live, so they shift out the demand curve in the housing market (in bottom panel, also in red).

But the tech people labor supply curve depends on housing costs

At this new higher price for housing, fewer tech people are willing to work at each wage (i.e., “I’ll stay in Seattle and work for Jeff Bezos, spending more on tissues and psychological counseling, but spending less on rent”). The higher housing prices shifts in the tech people labor supply curve. This shift takes some pressure off the housing demand, pushing down housing prices a little. This tatonment goes back and forth until a new equilibrium is reached with:

(1) more tech employees (but not as many as would be in absence of housing effects)
(2) higher wages and
(3) higher real estate prices

Where we are now:

The importance of the housing supply elasticity

As you might expect, how this process works out depends a great deal upon how these curves are shaped and how big these shocks are. One critical piece is the slope of that one curve that didn’t move around—the housing supply curve. From the perspective of of tech and non-tech workers and tech firms, we can say “elastic”  = “good” and “inelastic” = “bad” (existing, homeowners are another story).

Elastic supply = good. Imagine a better world in which the housing supply is completely elastic. The housing supply curve is flat. This means that no matter how large the positive demand shock in the housing market, house prices stay the same. Here, the demand shock in the tech labor market has no effect on non-tech workers through the housing channel (because housing prices do not rise). Also note that there is no pulling in of the tech worker supply curve—the workers get the “full” benefit in higher wages.

Inelastic supply = bad. Now, let us imagine a world where housing is completely inelastic, making housing a vertical line. In this inelastic case, housing is fixed. We already “know” that tech companies aren’t going to be able to hire more. Tech wages are going to rise, but the main beneficiaries will existing owners of housing because of the price increase. They get enormous rents—literally. Of course, the curve is not completely inelastic because of one very controversial “source” of elasticity is displacement. The tech people move in, the non-tech person moves out. This is why people throw yogurt (at best) at tech buses.

How do non-tech people fare?

A more complete analysis might consider the effect of the tech boom on non-tech wages. Presumably they get some benefit from increase demand on their services from tech people. And to some extent, non-tech sectors have to increase wages to get people to still live and work in SV. It seems unlikely to me that this is fully off-setting.

The main adjustment is probably housing displacement, meaning longer commutes. It makes more economic sense for them to move farther away (i.e., travel an hour a day and save $20/day on rent). That being said, they are almost certainly worse off with these horrendously long commutes than they were pre-boom.

What are the solutions?

  1. Do nothing. One “solution” is do nothing, under the belief that things will run their course and the tech boom will fizzle. To the extent that the boom does not subside, other places in the world will become relatively more appealing for tech as the high cost of labor in SV persists (because of housing). However, to date, SV seems to be becoming more important and tech becoming more centralized in SV, not less, so this might be a slow-acting solution. Further, it seems bad for SV as a region: If I were king of SV, I wouldn’t be sanguine about the “Detroit solution” to too much product market demand for what my region specializes in.
  2. Build more housing. Another solution (of course) is to increase the housing stock. This should push prices down. A better solution might be to enact structural changes to make the supply of housing more elastic. Given how much housing prices have risen, it seems that the supply is very inelastic (more on this later).
  3. Let people work remotely.  Another solution is radically different, which is to try to sever or at least attenuate the connection between the housing and labor markets. This is the “Upwork” solution in a nutshell, which their CEO outlined in a recent Medium postIf a tech company is open to remote hiring, then those remote hires never enter the local rental market and do not drive up prices. It does not even have to be either/or, as letting your employees work remotely some of the time helps: if I only have to be in San Francisco three days a week, living in Half Moon Bay rather than Cole Valley becomes much more attractive (Uber also helps here and autonomous vehicles would help a lot).

I’m particularly optimistic about, (3), the tech-focused solution, as it seems more likely “work” right away and it requires little political change. Also, somewhat ironically, the increasing maturation of technology for remote collaboration means that this approach should become more attractive over time.

Incidentally, why is the supply of housing in SV so inelastic?
Some of it is surely geography, about which little can be done. The peninsula is just not that wide and there aren’t large, nearby tracts of undeveloped land. I imagine that the, uh, interesting geological properties of the area matter for construction. However, the main cause seems not to be so much the quantity of land, but rather the intensity with which the land is used.

Take a Google streetview of walk of Palo Alto or Melo Park. When you consider how large the demand for housing is and then look at the built environment of those cities, there is a wild disconnect. These cities should be Manhattan-dense or at least Cambridge, MA-dense but they are not—it is mostly single family homes, some on quite large lots. They could be nice suburbs more or less anywhere. These are *very* nice place to live, of course, and I can understand the instinct to preserve them as they are. But the unchanging neighborhood character of Palo Alto is part of the reason why tech is having a huge negative externality on non-tech people, through the channel of higher housing costs.

Relevant disclosures: I used to work at Upwork’s predecessor company, oDesk. I still consult with them and I conducted academic research with their data. I also visited Uber as a visiting economist last summer and my wife works for them still. When I worked for Upwork, I lived in Redwood City until my landlord decided to not renew our lease so he could sell the place. We rented somewhere else that was a little cheaper, but my commute got longer. I might go back to SF to work for a bit this summer, if I can find a cheap enough place on Airbnb.