Tag Archives: Economics

Culture

Economists need more sympathy

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The economic profession lost credibility after the financial crisis, seen by the public as overpromising the certainty and benefits of their models and not properly evaluating the risks involved. Even before Lehman Brothers collapsed, there existed a gap between how economists and how the general public sees the world.

Economic models’ overreliance on rational self-interest as the basis of human nature made their conclusions appear selfish and out of touch with reality. By not embracing a more nuanced view of human nature, economists lack a full understanding of how people behave and risk losing more credibility with the general public.

Economists: the textbook model

Mainstream academic economics is based on models that view individuals as rational utility-maximizers. People are seen as behaving in a way that benefits them to the highest degree given their available information.

 

Economic evolution

The Max U model is simple and beautiful. Homo Economicus, as it is sometimes called, is the rational economic human, guided only by its desire to maximize its well-being measured by a metric called utility – not exactly happiness, but somewhere close to it. A model is meant to be a representation of reality, so there will inevitably be shortcomings.

Anyone who has lived in a functioning society observes that we are not always guided by selfish reasons. We often try to design institutions that promote justice, we help others in need, and we act morally even when someone isn’t looking.

Looking to not have to re-invent the wheel (and keep the same model…), some economists have tried to explain this behavior by redefining what it means to “maximize utility.” Perhaps I cooperate with you because I know it is to my benefit in the long run. Maybe I help someone in need under the expectation of future reciprocity. Or I give to a charity not because it helps someone else but because it gives me a sort of warm glow. All of these seemingly selfless behaviors could arguably be seen through a lens of self-interest.

Towards more sympathy

Adam Smith, ironically considered the founder of modern economics, had a different view. Human behavior is founded upon our capacity for sympathetic fellow-feeling, not robotic prudent actions. In his book, Theory of Moral Sentiments, he gives instances of fellow-feeling that simply cannot be out of self-love.

When we see a stroke aimed and just ready to fall up on the leg or arm of another person, we naturally shrink back our own leg or our own arm.

Adam Smith

Or when we see a tightrope walker struggle for balance, we twist and writhe as if our own bodies were seeking steadiness. Consider the strong emotions we can have when watching a movie or reading a book. Crying for fictional characters undergoing fictional circumstances is difficult to explain using the homo economicus model. Our tears will not help the characters involved and we cannot expect these fictional people to reciprocate our sympathy for them.

By Smith’s account, there is something inherent and universal in human nature that makes us instantaneously put ourselves in the situation of others, regardless of any potential payoff.

Some economists have recently tried to incorporate this enriched understanding of human nature into their models. Vernon Smith, 2002 Nobel Laureate in economics, has used Smith’s writings to design experiments that show our interactions with each other being more than just transactional.

Behavioral economists like Richard Thaler—also a Nobel Laureate—have tried to incorporate ways people can be “predictably irrational” into models and policies that can “nudge” people in a better direction. The ideas that humans are irrational or sympathetic no longer on the margins, but economists have yet to successfully integrate them into models of the labor market, financial markets, or international trade. There has been progress away from the Max U foundation, but it still dominates economic theory.

Why the lack of change hurts economics

The foundational view of modern economic analysis does a disservice to the profession in two mutually reinforcing ways. First, by failing to acknowledge the sympathetic tendencies of people, economists lose predictive and explanatory power in their models. Additionally, the profession ends up with people who are more likely to see humans as behaving purely through rational self-interest.

Woman holding money
Source: Niels Steeman

In an experiment called The Dictator Game, people are given ten dollars and told they can give an anonymous peer as much of that ten dollars as they wish. In the Homo Economicus model, every person endowed with the ten dollars should keep all to themselves and give none to their peer. The game is anonymous and does not have repetition, so any altruistic behavior can’t be seen as expecting reciprocity or wanting to appear nice in the eyes of their peers. Yet people across all age groups and walks of life show relatively similar tendencies of charity, consistently giving more than zero to other people.

One major exception is economists, who give significantly lower to their peers in these experiments. The explanation is likely some combination of two things but both spell trouble: economists are naturally more selfish people, and studying economics convinces them that this is how we’re supposed to behave. Here on planet Earth, humans don’t always behave as their models suggest.

By relying only on rational self-interest, the economics profession is often met with a reasonable amount of skepticism about its findings. The caricature of the selfish human is not only inaccurate but also deeply unsettling to anyone concerned about morality. It’s therefore easy for the general public to brush aside any findings economists have as unreasonable and not promoting a just or altruistic version of the world. Unfortunately, this means that instances of economics that go against people’s intuitions can be dismissed as heartless.

Rent control is an excellent example where economists believe a well-intentioned policy hurts the poor more than it helps. The laws of supply and demand predict that putting a price ceiling on rent will cause a shortage of available apartments and lead to poorly-maintained dwellings.

These predictions pan out noticeably in a highly-regulated housing market like Stockholm, where more than half a million people are on a waiting list for housing. By mandating rental prices lower than market rates, the government also incentivizes landowners to put their properties on the less-regulated sellers market, further decreasing the supply available for renters and making the shortage problem worse.

Of course, with a wait time of ten years or longer, those in Stockholm with friends or family that already have apartments are able to circumvent this dire situation. This means the few apartments that are available for rent are even more inaccessible to the less fortunate.

Rather than see economists’ views on rent control as a valuable insight into how well-intentioned policies actually work in the real world, the public dismisses their conclusions as being out of a heartless devotion to efficiency and wealth maximization.

Could it be good enough?

It could be that the Max U model is good enough. Newton’s F=ma equation doesn’t apply when considering Einstein’s Theory of Relativity or theories of quantum mechanics. While on planet Earth, however, we’re not going the speed of light and we just want to figure out how to build skyscrapers and bridges. F=ma has gotten physicists pretty far.

Similarly, one could argue that Max U has managed to make economics a powerful explanatory tool, albeit an imperfect one, but there still seems to be overreach with what economists feel they can explain, especially without better incorporating fellow-feeling into their models. A better way to look at it is that, as much as economists want to come up with a “theory of everything” to explain all human behavior, economics probably just doesn’t have all the answers we’re looking for.

Discomfort about the changing modern world that led voters to Brexit and Trump are more likely a sociological phenomenon rather than an economic one. Utility maximization can’t explain opioid addictions or homelessness. In order for economists to regain the trust of the public, they need to have more humility and recognize their current framework is an incomplete view of human nature. Otherwise, issues where they have much more certainty will continue to be met with skepticism from the general public.

Business, Politics

The euro is doomed

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The euro currency is inevitably doomed. The institutional arrangement is not set up to support a stable currency area and the cultural differences across the eurozone make it nearly impossible to move towards a regime that makes the currency integration beneficial. As countries experience more frustration and powerlessness from giving up significant political and economic autonomy, the arrangement will come apart and the currency will no longer exist in the same form as it does today.

Where’s the fiscal transfer mechanism?

Picture Arizona experiencing a bust in its housing market, a hurricane hitting Florida, or the mines going dry in West Virginia. In each case, the Federal government of the United States steps in to cushion the fall of these economies and their people. Banks might get bailed out, FEMA will dish out aid to rebuild destroyed communities, and medicaid will provide healthcare for those without incomes. The cost of such relief is often too hefty for one state to bear on its own. The Federal Government thus acts as an insurance mechanism so that different regions in the US can spread the risk from negative shocks. Political quibbles inevitably follow about the efficacy and bureaucratic process of these programs. But rarely will you hear accusations of Floridians displaced by a hurricane as “moochers” or recently unemployed rust-belters as “lazy.” Those left unaffected by such shocks living in Massachusetts or California see the people in these states as Americans and recognize that such Federal mechanisms are a part of the American system.

The Federal Government’s ability to take from a general fund of taxpayer dollars and redistribute across different states at different times is called a “fiscal transfer mechanism.” It not only serves as an insurance plan in the scenarios above, but can function to consistently redistribute income from richer states to poorer states. People in Connecticut and Maryland pay more into the Federal tax system than they take out, while states like West Virginia and Mississippi are net beneficiaries of the Federal government. Thus, independent of shocks like natural disasters or economic crises, some states get more from the Federal government and some get less. Political arguments over these transfers are constant, as politicians push for pork-barrel spending that disproportionately benefits their state. In equilibrium, however, this system exists.

Compare this to the eurozone, another consortium of polities with a supra-national power presiding over them. What happens if Italian banks fail or Greece overextends its fiscal accounts and is on the brink of default? Citizens of the countries that have sound banks and followed fiscal restraint don’t have the same instinctual support that Americans feel for their countrymen three time zones over. Germans think Greece’s fiscal insolvency is a self-inflicted problem that involves painful lessons to be learned. People in Ireland look at Portugal’s fiscal woes and wonder why the Portuguese can’t tighten their belts like the Irish did. The eurozone, by design in the Maastricht Treaty that brought them all together, forbids bailouts of national governments. In other words, the fiscal transfer mechanism cannot legally exist. As a result, more often than happens to states in the US, countries in the eurozone are forced to absorb the costs of these shocks entirely on their own, and these costs can be insurmountable.

How different currencies would cushion the blow

Yanis and Schauble
Wolfgang Schäuble, Germany’s Federal Minister of Finance, and Yanis Varoufakis, former Minister of Finance of Greece. Source

European countries survived on their own before they were in the eurozone, so what makes this arrangement different? The currency union itself is preventing smoother adjustment. When a country like Peru experiences a shock like a natural disaster, banking crisis, or garden variety recession, the weaker economy naturally weakens its Sol currency. This in turn causes Peruvian exports to become more competitive and the economy is on the road to recovery. Peru’s central bank can lower interest rates, too. This encourages more investment and gets the engines of the economy pumping again. However when Italy reaches high levels of unemployment, its currency doesn’t weaken in step with Italy’s economy. The exchange rate of the euro is tied to the eurozone as a whole, of which Italy is only about 10%, and Italy can’t lower interest rates to ramp up investment. The short-term interest rate is set by the European Central Bank which is set by bureaucrats all across the zone. So an Italian recession is accompanied by a stronger-than-should-be currency and interest rates that are higher than they would like.

Economic integration will help…in theory

Labor mobility is another way an economic area moves towards equilibrium when certain areas are hit harder than others. Here, the legal framework for the eurozone works in its favor. The Schengen Agreement allows for Schengen Zone citizens to work anywhere in the Zone, no matter their passport. This means that if Spain has a high number of unemployed workers, some of them can go over to Austria where the labor market is a little healthier. The shock is absorbed by Austria and things reach a happier equilibrium. When midwestern states in America experienced decline from fewer jobs in manufacturing, people headed to sun belt states like Arizona or Texas that have more opportunities. So why isn’t this happening in the eurozone?

Moving from Ohio to New Mexico is much easier than moving from Spain to Austria. Crucially, English is the dominant language in any American state. The cultures of different areas in America may be distinct, but they’re peanuts compared to the differences of countries in Europe with thousands of years of history that form their identities. What if a Greek with little formal education wants to move to Austria… What are the odds they’ll know German? The stigma against workers from lower-income countries like Poland or Bulgaria often make it difficult to find work in France or Belgium. Xenophobia within the eurozone discourages labor mobility that would other equilibrate labor markets more smoothly.

If labor mobility were perfect in the United States, people in West Virginia would be moving to places like Massachusetts, Texas, Silicon Valley, or North Dakota. Moving is tough. People set up roots, form communities, buy mortgages, and get used to local norms. It’s not as easy as packing up one day and leaving the next. Throw in cultural and linguistic barriers to this and the eurozone labor market is not nearly as integrated as it is in legal terms.

Europe is not the United States

The United States doesn’t have perfect harmony across the country, of course. Historically, national harmony was incredibly difficult. Since the founding of the country, there has been a constant push and pull between states’ rights and giving more power to the Federal government. The campaign towards states’ rights is founded on the idea that states have different beliefs and should be able to operate with a high level of autonomy. Heck, there was even a war fought over a critical disagreement that took the lives of over six hundred thousand Americans. And, in many ways, those two sides still remain divided via other ideologies one hundred fifty years later. Simply put, the United States got to be where it is today after more than two centuries of friction and it wasn’t easy. Even with all that, it benefitted from having tremendously more linguistic homogeneity than Europe has and it didn’t have millennia of regional identity baked in to individual identity. Furthermore, Project Euro has attempted to expedite this tough process of integration and identity in a mere 17 years. Having eurozone citizens suddenly consider themselves “European” before considering themselves “German” or even “Bavarian” isn’t going to happen anytime soon.

The unstable equilibrium

Globe with europe highlighted
Source

The only solution to the eurozone’s problems is More Europe. That means a more-powerful European government that can provide a fiscal transfer mechanism and a move away from national identity and towards a European one. The first part can be done politically, the second is left up to the people. If the eurozone moves in a direction of nationalism and isolation, its problems will persist and only get worse. Right now, the zone is a house of cards ready to collapse into Less Europe unless it can search deep down for the political capital to give it the strength it needs to stay together.

The result of the Brexit referendum in June, while not technically involving the eurozone, reflects the tension of the struggling European identity. Brits felt they were giving too much to the European Project and decided to go down a path that emphasizes national identity more than integration. The unfulfilled promises of a more-integrated Europe were disappointing enough to have Britons call it quits. As Germans and Greeks increasingly resent each other’s norms, convincing either side that the solution to their problems is more integration is near impossible.

The reforms needed to keep the eurozone intact are dramatic and especially difficult to pass in a stagnant economy that’s dealing with millions of refugees knocking at the door. While the eurozone may make the necessary changes, time is running out. The political climate is shifting strongly towards Less Europe, and once the direction gains momentum, it will be difficult to ever turn back.

Culture

Ignore Brexit and Trump, we’re better off than we used to be

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The strong current of populism in high-income countries in the last year has taken many by surprise. An unexpected victory for the Brexit campaign and a shocking level of support for Donald Trump’s Presidential run are among the recent political events that show a drastic turn away from cosmopolitanism and towards nationalism.

Everyone is trying to make sense of these phenomena, blaming whatever aspect of international policy trends that will prove their previously held ideology. The racial aspect and a resistance to multiculturalism could be viewed in hindsight as a significant catalyst for this sentiment. Perhaps the most popular explanation right now is the economic one: so-called neoliberalism has made a few rich at the expense of the working-class and this surge in populism is a revolt after being ignored for so long.

Whatever legitimate economic anxiety Brexiteers and Trumpkins have from the last few decades of increasing globalization, it is dwarfed by the historic rise in living standards nearly everywhere else in the world.

Elephant graph
Source: Bloomberg

Take a look at the graph above. A quick check on the internet will reveal slightly different permutations of it: maybe a different time period, an emphasis on certain countries, etc. All of them have the same message: the last few decades have seen incomes rise for the vast majority of people across the world.

The Good News

The quick way to interpret this graph is that the poorest 77 percent of the world—the first three quarters of people starting from the left-hand side—have, on average, seen their incomes drastically increase between 1988 and 2008.

Everyone above the 85th percentile has also seen their incomes rise. Consider that, during this time period, more people escaped poverty than the rest of human history combined. The oft-vilified globalization, characterized in popular discourse by sweatshops, environmental destruction, and greedy multinational corporations, has coincided with bringing 320 hundred million people out of poverty.

The time period and its policies or corporate behavior are not without flaws – climate change being an obvious and urgent downside. But if one is to only look at the economic outcomes, this time period did more to lift the standard of living of the bottom 75 percent of the world than any other period in history. Was it because of globalization or in spite of it? Of the 320 million that escaped poverty during this time, 270 million were in China. China’s general trend post-Mao has been a gradual embrace of markets and opening itself up to trade. China is experimenting with its own flavor of capitalism, there’s no doubt that its embrace of international trade and markets is the underlying cause of their tremendous growth during this time period. In other words, aspects of what anyone would include in their definition of globalization are at the root of the country growing the way it has.

The Bad News

Notably, there is still five percent of the global population—the poorest five percent—that have not seen their incomes rise during this time. These people should not be ignored in global policy arguments, but how to lift the material well-being of that income group is a separate conversation. For now, focus on the eight percent of the world population who consider themselves between the 77th and 85th percentiles, whose incomes have seen a slight dip. This group of people can be considered the working-class in America, Britain, and other high-income countries. Assembly line jobs that used to be able to support entire families are now being competed away by a combination of cheaper labor overseas and more efficient machinery. So far, the gains of globalization and technology have increased the affordability of every good and service this group can buy, but not the wages many need to purchase them.

In a sense, we can think of the “Western working-class” being pushed aside by an “Emerging Market working-class.” Emerging market economies like China, India, Brazil, and Indonesia are building their own middle classes, simultaneously lifting hundreds of millions out of poverty and displacing the Westerners that used to do that work.

The Political Reality

As demand has shifted more to labor in these emerging markets, the Western working-class of yesterday has seen their wages go down. As the graph illustrates, the high-income earners in the world have seen their material well-being go up over the same time. This has indeed increased inequality on a national scale in high-income countries. However what is less appreciated is the decrease in global inequality. The massive increase in the purchasing power of the average worker in the bottom 77 percent has made the difference between the gold-yacht billionaires—or even your typical middle-class American suburbanite—and the median Indonesian significantly smaller.

If we could increase the standard of living for everyone without any rough adjustment period, we would and it would be our best option. The alternative, the era of increased globalization, offered a regime that increased the well-being of maybe 90 percent of the global population. Remember that the 77–85ers are still in the richest quarter of the global population. I imagine a global vote on the 1988-2008 international order would be mostly favorable.

In reality, the current marriage of national sovereignty and electoral democracy means that only citizens of a given country will vote for its leaders and policies, even if every country’s political landscape increasingly spills over into the rest of the world.

This means that the 77-85ers, generally being citizens of Western democracies, are, in a sense, overrepresented in the voting electorate. They represent a significant share of voters in high-income countries that, for the time being, play a powerful role in geopolitics and international economic affairs. With decisions like Brexit and the success of Trump so far, they are shifting international politics in a direction that reflects their economic conditions more than global economic conditions.

The last few decades of increased globalization, technology, and trade have not been perfect. The system is sub-optimal in some ways through things like corporatism, unfair intellectual property enforcement, and environmental degradation. Yet, through all of this, hundreds of millions of people have escaped poverty. Those in the global 77–85 percentile feel they have been left behind. Some of this may be racial resentment or general fear of change. From an economic point of view their struggles, while legitimate, need to be placed in the greater global context during the last few decades. Rather than dismantling the current system and replacing it with protectionism, nationalism and xenophobia, a preferred remedy would be to assist the 77-85ers within the existing system.

What’s the solution…more emphasis on education and skill-training? More progressive taxation? It’s not obvious what the most effective or cost-efficient policy would be. But before we upend an economic order with unparalleled ability to lift people out of poverty, let’s appreciate the phenomenal gains of the last thirty years.

Culture

The Economics of Festivus

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In a season 9 episode of Seinfeld, George’s father Frank resurrects a holiday from George’s childhood called Festivus. Among other things, Festivus rejects the gift-giving aspect of many holidays. Frank Costanza may have been onto something.

Around Christmas time, the media will report excitedly that a certain amount of money has been pumped into the economy because of higher consumer spending. While this dollar estimate may seem like only good news, looking behind the numbers reveals a less rosy picture. The gift-giving surrounding Christmas and other holidays can be viewed as a loss in value to society from an economist’s point of view.

Festivus Pole from Seinfeld

Consumer Choice

Anytime you go online, go to a store, or browse through a shopping magazine, you decide to buy something only if you value the item(s) at equal or more to the price you’d pay. If you think you could spend the $20 for a widget on better things, you wouldn’t buy the widget. Yes—you can buy impulsively, be under the influence of an illicit substance, or act in an otherwise irrational manner. But generally speaking you’re only going to buy that $20 widget if it’s worth $20 or more to you. This seems self-evident. Less obvious is that how much you value the widget isn’t widely known public information.

When someone goes to buy a gift for you, they’re taking an educated guess at how much you value an item. They have imperfect information about how much you value something. They could be buying a $20 item that you actually only value at $10. That $10 difference is what economists call deadweight loss.

Evidence

Joel Waldfogel at the University of Pennsylvania surveyed different populations to find out the difference between the cost of gifts people received and how much they valued those gifts. Waldfogel found that in general 10–33% of value is lost in gift-giving transactions. Because of this massive amount of destroyed value, Waldfogel has referred to Christmas as an “orgy of wealth destruction.”

How much that difference is correlates highly to the magnitude of imperfect information. The people who know you the best have the best sense of how much you value things. On one end of the spectrum, you have someone’s spouse or significant other. This person is most likely to know the gift recipient’s interests, needs, and daily routines. There is likely the least amount of imperfect information in this case and the lowest amount of wealth destruction. A step down from this is close friends and family; they know the recipient fairly well but there’s still more room for over-valuing a gift. On the other the end of the spectrum—where value goes to die—lies the office Secret Santa exchange. In this scenario people are compelled to buy gifts for people they barely know. The overall lesson, from an economist’s point of view, should be to minimize the level of gift-giving on this end of the spectrum.

Not all economists agree with Waldfogel’s idea of Scroogenomics. People give gifts for reasons other than purely utilitarian ones and these shouldn’t be dismissed. Sentimentality—“it’s the thought that counts”—is of course a significant value in many exchanges. But this sentimentality is partially captured in Waldfogel’s surveys. Additionally, there’s a positive correlation between the level of sentimentality and the accuracy of the gift-giver’s valuation; a gift from a spouse will mean more to the recipient than a gift from the randomly assigned office co-worker.

Gift-giving is also a method of ‘signalling’ a giver uses to show the recipient how much he/she cares and well he/she knows the recipient. The diamond ring shows the level of love the giver has (apparently?) for the recipient but more importantly the choice of ring is a signalling device to the recipient as to how well the giver knows him/her. Signalling then could be a value of gift-giving Waldfogel fails to quantify in his results. Or, an argument could be made that it’s an explanation for why we give gifts the way we do today, even if there are much better ways to signal to others how much we care for them.

Larger Implications

Money is the closest gauge we have to putting a number on how much we value something. But spending $20 on digging holes just to fill them back in again doesn’t mean we are $20 richer in our well-being—even if it means our GDP went up $20. This fact should be considered whenever we see government spending has increased our output by a reported amount. Arguably, there are reasons to think government spending makes up for a loss of aggregate demand in the macroeconomy. However, this spending always involves a certain amount of imperfect information on how much individuals actually value things. If the government spends money on a Bridge to Nowhere or bails out companies that we don’t want, there is value destruction. Gift-giving around Christmas time increases the dollar amount of consumer spending but the level of value added to the economy is much less than this spending.

Many economic transactions involve the same sort of imperfect information found in gift-giving. An argument can be made that others will know better than the recipient for how he/she should value something. However most of the time, money is most efficiently spent when the recipient is the one doing the spending. This logic has been the inspiration for recent charitable projects like Give Directly. (Giving cash instead of specific items also works to lower overhead and give as much money to the recipients as possible.) How individuals spend their money reveals their preferences rather than assuming we as givers know what they need the most. The effectiveness of these charities for individuals in developing countries is currently inconclusive but early evidence suggests promising results.

What Could We Do Instead?

Waldfogel has a few suggestions on how we can improve on the level of deadweight loss associated with gift-giving. The first is to just give cash. Cash has this amazing power of giving people the power to exchange it for pretty much anything they see fit. It might not be romantic and it might not look good underneath the Christmas tree, but there certainly is no orgy of wealth destruction. Another option is gift cards. Gift cards could have a small amount of imperfect information; I remember getting a Best Buy gift card as a young child when I was nowhere close to being in the market for electronics or even to buy a CD. But gift cards give enough flexibility that the destruction of value in gift-giving can be significantly minimized.

This takes away the excitement of gift-giving but it could be just because we’re used to the status quo of gift-giving. There are many gift exchanges in modern society that follow purely practical guidelines. Wedding and baby registries, for example, tell gift-givers exactly what the recipient needs. The next time a birthday, holiday, or office exchange comes around, think twice before you buy a gift. Put some money in an envelope and know you are doing your part to minimize the orgy of wealth destruction that is running rampant in modern society. Or give money to The Human Fund.

To hear the ideas of this article in podcast form, check out episode 9 of Upset Patterns (Podbean | iTunes).

Business

Aparkalypse Now: The Economics of Parking

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Imagine your town decides to mandate that all ice cream is free or very cheap. Soon, lines are out the door for people wanting to get cheap ice cream. Sure, people can get similar desserts, but they’d have to pay full price. In order to take care of these long lines, the town decides to mandate that every store must provide free or very cheap ice cream. This might sound silly but it’s exactly how cities deal with parking. Cities price street parking, or “curb parking,” very cheaply and then deal with the excess demand by requiring businesses and residences to have off-street parking. The costs of this distortion of land use may not be immediately obvious but they are significant financially, environmentally, and with regards to time.

Land: A Limited Resource

The fundamental problem of economics is finding out how to use the scarce resources we have on Earth in the best way possible. In the case of parking, land is a limited resource with many alternative uses. A typical parking space is around 330 square feet, not including aisles in parking garages and parking lots. 330 square feet is no insignificant amount of space, especially in dense cities. With other resources, we can think of prices as a “signal wrapped in an incentive” that coordinate resources in an economy. A free parking spot in New York City is giving away some of the most valuable land on Earth and completely ignoring the price system as a means for allocation. Most cities, due to history and the political inertia of voters being used to free parking, charge too little for curb side parking. When the price of a resource is lower than what the market would otherwise dictate, there is a shortage. If ice cream were close to free, people would want to consume more of it than was available. The land used for parking is no exception. To get rid of this shortage, public policy has been set mandating more off-street parking.

In the United States, the number of spots required for off-street parking is largely arbitrary. Consider the following graph showing how San Jose mandates parking space depending on the type of establishment. When pressed to come up with a reason for where they get the numbers, public officials usually claim ignorance or just say it’s how it’s always been.

Parking requirements, San Jose, CA

Some other examples of requirements:

  • 1 space per 10 nuns for a nunnery
  • 1.5 spaces per fuel nozzle for a gas station
  • 1 space per 2,500 gallons of water for a swimming pool
  • 1 space per tennis player for a tennis court
  • 3 spaces per beautician for beauty shop

It should be noted that these numbers are created from little data-driven research on efficient land use. One study surveyed 49 cities in the San Francisco Bay Area and found parking required for hospitals ranged between 29 and 1,682 spaces. The differences were uncorrelated to the corresponding cities’ population levels or densities. Why should we allocate land like this when we’d never allocate any other resource with such arbitrary mandates?

Parking requirements compared to building requirements

The Cost of Cheap Parking

Measuring the costs of this distortion can be hard to wrap one’s head around. The only obvious price in the case of free/cheap parking is the price of the parking spot to the driver. Because of this, the costs to sub-optimally priced parking are hidden and diffused across the entire population. Mark Delucchi at University of California – Davis estimates drivers pay between 1-4% of the actual costs of off-street parking. He estimates the annual capital and operating costs of off-street parking in the US to be between $79B and $226B in 2002. Remember that the cost of parking is not only the land used but also the maintenance for the spaces. As a comparison, the US spent $231 billion on medicare the same year. Because drivers pay so little of this, it is essentially a pure subsidy. A gas tax between $1.27 and $3.74 per gallon in 1991 dollars would have to be enacted to offset the subsidy for off-street parking.

But how do the costs of this subsidy manifest themselves? One evident symptom is the sprawl it creates. Any land used for parking is land that cannot be used for residential or business purposes. So if a city block could fit 5 shops in a world with no parking, but a city requires half the block to effectively be used for parking spaces, two blocks are now needed to fit those same 5 shops. Multiply this effect over every different kind of establishment and you can picture how much it spreads everything out.

When one considers the cost of driving a car to a destination versus other forms of transport, many costs add up to create the total cost – fuel, automobile insurance, the car purchase itself, parking etc. By reducing a drivers’ cost of vehicle travel, we are distorting an individual’s travel choices towards cars over other forms of transportation. We are ok to drive more because it’s cheaper than the actual cost of the journey. Off-street parking requirements have existed since the middle of the twentieth century so our habits have adopted accordingly. This sprawl has a spiraling effect and the car dependence is a self-fulfilling prophecy – parking requirements increase mobility by car, but the sprawl decreases mobility by bike, foot, or public transit.

Off-street parking requirements also have the unfortunate effect of reducing the amount of affordable housing. Most municipalities require a certain number of parking spaces based on how many residents will be in the building. This number does not change depending on the demographics of the residents. So if your residents are all poor and don’t have enough money to buy cars, you still need to devote part of your property to parking spaces. This means parking spots for people that don’t own cars and less space devoted to actual residences. A lower supply of housing means higher prices.

These requirements also have a second effect of distorting incentives to build affordable housing in the first place. If the city requires you to include x number of spots per resident, wouldn’t you be more inclined to build bigger tenancies that fit fewer tenants so you have to devote less land to parking? Bigger tenancies with fewer tenants means residencies that are more expensive and out of reach to low-income individuals. Oakland had no parking requirements until 1961. Afterwards, housing density went down 30% (sprawl) and construction costs went up 18% (decreased housing affordability).

Businesses also have distorted incentives in how they build. For a new building, a business can decide its use and then fulfill parking requirements accordingly. For an old building, a business needs to use the parking available as a limitation on its possible uses. If the number of spots wouldn’t satisfy the requirements for your nunnery, swimming pool, or beauty parlor, you need to build elsewhere. This means lots of vacant buildings remain unfilled because of the limited flexibility. It also incentivizes demolition and new development rather than using existing buildings.

Perhaps the most apparent cost is one we’re all accustomed to when trying to find a parking spot – “cruising.” Cruising refers to that tedious amount of time you spend circling the block around your destination hoping someone will leave their spot and you can swoop in. Since the cheap cost of curbside parking has created a shortage of spots, it’s only natural to cruise around until you find one that’s available. Some drivers will pay for lot parking, but why would you if a free spot is just around the corner? As George Costanza said, “It’s like going to a prostitute. Why should I pay for something when, if I apply myself, I can get it for free?” Cruising causes congestion that creates pollution and wastes time and energy. Research estimates that around 30% of cars in congested traffic are cars cruising and up to 45% in Brooklyn. If the line is too long at that free ice cream place, you’re gonna keep scoping out nearby places until you find one that’s available.

The Solution

In order to use land most efficiently, it only makes sense to make parking as expensive as it actually costs. This means having parking be priced according to forces relating to its supply and demand and not arbitrary regulations. Cheap parking enforces inefficient land use in urban sprawl, causes residential and business rents to increase, decreases the amount of affordable housing, and increasing pollution through cruising and the increased transportation time from increased sprawl. This doesn’t mean getting rid of parking altogether. It just means that the price of a car journey should more closely reflect its true cost.

The “right price” for curbside parking has been defined by economist Donald Shoup at the University of California – San Diego as the lowest price that ensures a 15% vacancy rate for a given area. Technology is available that can change this price based on fluctuating demand. Certain neighborhoods in cities like San Francisco and San Diego have effectively utilized this technology. A 15% vacancy rate means just enough cars can park without having an unnecessary amount of cruising.

Businesses naturally will be afraid this increase in price will scare away customers. But remember that the status quo of underpriced parking scares away customers too. Higher prices could incentivize carpooling, since the higher price of parking can be diffused across a handful of passengers. Businesses can also be convinced to embrace this increased price by having the parking revenue be re-invested in the respective business districts. Old Pasadena, a formerly skeezy neighborhood in LA, embraced right price parking and started using the money for district improvement efforts and eventually became a popular entertainment/shopping district. Austin does something similar, investing in trees and sidewalk upkeep with the revenue it gets near the University of Texas campus. In both instances the businesses, though perhaps initially skeptical, have embraced right price parking.

Water flows in the path of the least resistance, and it could be that parkers go from the spots of right price to residential neighborhoods with cheaper parking. So what’s the best way to counter-act this problem? Resident-only parking permits tend to over-compensate for this problem by creating an artificial scarcity – many of the spots go unused throughout the day as residents go to work or run errands. Instead, Shoup recommends a scheme where residents and guests park for free in their neighborhood but can charge parkers that want to use their designated spot. Remember all those unused parking spots in the housing for low-income individuals? Why not allow them to rent out their spots to people from other neighborhoods? Otherwise, the land goes completely unused. Cities like Boulder, Aspen, and Santa Cruz have successfully enacted schemes like Shoup’s to efficiently allocate residential parking spaces.

The Endgame

It can be hard to imagine paying more for parking in our given city landscapes. Remember that our cities have developed based on distorted incentives that increase sprawl and devote unnecessary land use to parking. Once parking is priced correctly and parking requirements are removed, land previously used for parking can be devoted to more valuable uses. Cities will slowly become denser and the higher price for parking won’t be as unavoidable as one may think.

The status quo of a car-dependent urban lifestyle does have its perks – cars allow one to carry large items, avoid adverse weather than encountered by biking or waiting at a bus stop, and often gets a traveler quickly from one point to another. But the price of a car journey needs to closer reflect the true cost. An ice cream-dependent urban lifestyle also has its perks – but we can spend all that milk, sugar, labor, and land on better resources.

To hear the ideas of this article presented in podcast form, check out episode 10 of Upset Patterns (iTunes | PodBean). This article draws heavily from Donald Shoup’s 2011 book “The High Cost of Free Parking.“