Tenure!

Yay!

Sugar, obeseity and a possible regression discontinuity design

Here is a random research idea that may be crazy.  But maybe not.  Either way, I really haven't the time to investigate it seriously. Maybe someone else does have the time.

The idea is inspired by two recent things:  (1) Tuesday's seminar by David Just of Cornell University, who does research on the intersection of psychology and economics and is currently doing some interesting work on framing and package sizes; and (2) an intriguing article by Gary Taubes who investigates whether sugar is toxic.  Taubes is mainly following arguments made by Robert Lustig, a Professor of Pediactrics at UCSF who has an influential YouTube video "Sugar: The Bitter Truth" (nearly 900,000 views--yikes!).  That's a 90 minute tribe explaining Lustig's argument for why sugar is *the* culprit in the obesity crisis. 

Lustig is pretty strident. Shrill?  Regardless, I find his arguments compelling.  This is not a quack idea.

Anyway. The theory still needs smoking gun evidence and that is going to be difficult to construct.  And we all know there are extraordinary financial interests that will work hard to keep a tight lid on this if does turn out to be true.  Corn, ADM, all manner of food processors, etc.  It will be hard to obtain funding to do the experimental trials necessary to prove whether or not sugar is in fact toxic.

Are there any natural experiments worth exploiting?

Maybe.

By most accounts, the largest source of sugar is from sugary drinks, particularly soft drinks.  Consumption has steadily increased and, at least in the aggregate data, seems to roughly match the obesity crisis.  A lot of the growth in consumption must have come about from growth in the sizes of cup and bottle sizes.  Years ago a "Coke" came in an 8oz. glass bottle.  Later it was 10 oz.  And then a 12 oz. can.  Doesn't that seem quaint in this era of Double Big Gulp? Speaking of Big Gulps: the first super-sized soft drink at 7-11 convenience stores was in 1980, not long before obesity in the U.S. started its steep rise.  But all of this is just anecdotal evidence.... Lots of other things have changed since the 80s.

What might be interesting, if the data can be obtained, is to exploit discrete changes in drink sizes that have taken place over time, and see if these discrete changes are associated with unusually large increases in the incidence of weight gain and diabetes.  To do this well would require very large databases of weight, BMI, and/or incidence of diabetes, coupled with detailed data on drink package sizes over time.  It would be especially helpful new larger drink sizes were introduced in different places at different times, or if one could exploit demographic or other kinds of variations.  The nice thing about changes in drink sizes is that they are discrete and oftentimes large. This could be helpful because the largest possible confounding variable may be changes in consumption of meat or fat. I imagine changes in consumption of fat and meat were relatively smooth by comparison.  Unlike food, a few food chain and soft drink companies (e.g. Coke and Pepsi) dominate the market, and sizes and size changes seem relatively uniform, and sometimes large.

The biggest challenge would be to amass the data for such an exercise.  But if enough of the right data could be found, such an analysis might provide some powerful evidence, one way or the other.

What crop supply response looks like

The other day I asked where the new cropland was going to come from.

Today we have William Neuman reporting:

When prices for corn and soybeans surged last fall, Bill Hammitt, a farmer in the fertile hill country of western Iowa, began to see the bulldozers come out, clearing steep hillsides of trees and pastureland to make way for more acres of the state’s staple crops. Now, as spring planting begins, with the chance of drenching rains, Mr. Hammitt worries that such steep ground is at high risk for soil erosion — a farmland scourge that feels as distant to most Americans as tales of the Dust Bowl and Woody Guthrie ballads. ...

...Now, research by scientists at Iowa State University provides evidence that erosion in some parts of the state is occurring at levels far beyond government estimates. It is being exacerbated, they say, by severe storms, which have occurred more often in recent years, possibly because of broader climate shifts...

The article is a little short on quantitative facts.  But it's pretty clear that incentives are strong to clear land to try to take advantage of high prices.  And since marginal land tends to be more erodible, there will be more erosion.

But if farmers overuse the land today at the expense of future productivity, they may live to regret it.  Prices could be high next year too.  And the year after that.  A little extra care today could yield even greater profits tomorrow.

Shouldn't we be taxing gas more heavily?

I was lucky to be able to attend part of the NBER workshop on Environmental and Energy Economics at Stanford last week.

My favorite was a talk by Michael Anderson of UC Berkeley.  He spoke about a paper joint with Max Auffhammer, also of UC Berkeley:

"Vehicle Weight, Highway Safety, and Energy Policy"

Sorry, no link.  The  issue is one that's been talked about many times: an arms race in vehicle weight and safety.  The essential problem is that the heavier my vehicle, the safer it is for me and the more dangerous it is for you.  Now, if we could all commit to smaller lighter cars, we'd pay less for our cars, have better gas mileage, and be no little less safe [please excuse my exaggeration], since when it comes to car-on-car collisions, it's mainly relative size that matters.

This sets up a classic prisoner's dilemma in which it's smart for one and dumb for all to buy bigger, heavier vehicles.

That basic tension is pretty well known, I think. What Anderson and Auffhammer did was measure, with apparent extraordinary accuracy, the size of the external cost of extra vehicle weight.  That is, they estimated how much more likely someone is to die in a car accident if the opposing vehicle weighs a little more.  I'm going from memory here, but I recall the number was something like a 50% increase in the odds of fatality for a 1000 lb. increase in vehicle weight.  They estimated this using a huge database of actual vehicle-on-vehicle collisions and the estimate seemed amazingly robust.  (Still, I need to read the paper...)


Using EPAs measure for the value of a statistical life (something like $5.8 million/life) and information on vehicle mileage, there were able to convert that weight externality into a near-equivalent gasoline tax.  That tax didn't exactly match an appropriate tax on weight, but it turned out to be extremely close.


The take home number:  $1/gallon.  


That's a huge number. Before this study the conventional wisdom among transportation economists was that the largest driving-related externality was congestion, at something like $0.55/gallon.  Pollution externalities, including CO2, come in at about $0.33/gallon. These are rough numbers from my recollection.


Can we start taxing gas more heavily already?  It's not as if we don't need the revenue.

What if subprime and CDOs never happened?

I was watching the Inside Job for the other sleepless night (great movie by the way, both substantively and artistically), and I had a thought about the whole bubble and financial crisis that had not really occurred to me before. It's also a point that I think has been generally overlooked in commentary thus far.

First, some context:

Inside Job does a fine job spelling out the history of deregulation, development of CDOs and growth of the AAA bond market. They also do a really nice job explaining how CDOs worked and ultimately failed and the blatant corruption of the bond rating agencies. These features account for how financial markets were able to innovate new securities in an effort satisfy a nearly unquenchable thirst for low risk assets.

The movie basically blames Greenspan for low interest rates. But if Greenspan was at fault, it was only in that he didn't use the Fed's portfolio to help quench the world's thirst for safe assets.  Consider, however, the size of AAA bond market and how much it grew between 2000 and 2008.  I don't have the specific numbers in front of me, but it was in the tens of trillions of dollars.  The Fed's balance sheet at the time was only about 800 billion.  Yeah, maybe the Fed should have tried to increase rates a bit by selling some of its portfolio.  But even the Fed was small relative to the demand forces at play.

It's that demand side that gets too little billing in the movie Inside Job.  That demand side is the focus of an excellent radio story from This American Life that was broadcast on NPR.  (You can listen here--note this was first broadcast before Lehman Brothers collapse and the ensuing crisis).  The giant pool of money derived mainly from booming China and oil producing countries, aided partly by China's currency manipulation, which continues to this day.

Okay, that's the background.  Now here's my thought of the moment: 

What if there wasn't any funny business on the part of the banks and wall street?  What if CDOs were regulated all along and we never had a boom in subprime lending and liar-loan mortgages with unverified income?   Well, the basic economics tells us that the supply of AAA bonds would have been a lot less than it was.  Which, in turn, means that the price of the AAA bonds would have been bid up even more than they were.  Which, in turn, means that higher-risk bonds would also have been bid up to a higher price.  Which means that interest rates would have fallen to a lower level--probably a significant lower level--than they had already fallen.  And with interest rates falling even lower people with suitable credit would have wanted to buy even bigger houses.  And people with suitable credit would have been even more tempted to take out even larger home equity lines of credit.  And home prices would have kept going up.  And so "the bubble," such as it was, almost certainly would have happened anyway.

The best example of this is Canada, where banking didn't get out of control but home prices still boomed.  But unlike the US and much of the rest of the world, prices there haven't fallen much either.  To the extent that they have fallen, it's probably due to the near collapse of the world economy, not Canadian problems.

Anyway.  While all the shenanigans exposed in Inside Job boils my blood as much as the next guy or gal, I think the economic forces at play were even larger than the movie suggests.

Update: I changed the title to something more appropriate.

Where's the land?

Corn, wheat and cotton plantings are anticipated to go up, and soybeans down just a smidgen.  That's not too surprising given how high prices are.

But where's the land coming from?  According to USDA, the net increase for these (the four largest cash crops besides hay) will be about 10 million acres.  That's nearly one third the size of North Carolina.  Notice in the graph that increases for one crop are typically offset by losses in another.  Most hay land isn't going to be suitable for these crops.

Two wild guesses:

1) Prospective plantings are a little too optimistic
2) The Conservation Reserve Program is going to have a hard time enrolling much land in its signups this year.

But I don't think these two things can account for 10 million acres.

Cotton prices are going to fall

Cotton is the third most valuable crop in the US, after corn and soybeans.

Cotton prices have roughly doubled over the last year, perhaps a bit more than other staple agricultural commodities.  The big difference with cotton is that it uses a much smaller share of the land base than corn, soybeans and wheat do.  That makes it a lot easier to proportionately expand production when prices rise.  And since it's a higher-value crop than corn, soybeans and wheat, that land expansion is going to happen, as described here in the New York Times today

... In the United States, the economics of growing cotton vary according to many factors, including regional differences and whether or not the land is irrigated. Farmers in several southern states said that at a cotton price of about $1 a pound, their profit could be roughly $200 to $500 more per acre than they could earn growing corn or wheat. For 1,000 acres planted in cotton, that means an additional $200,000 to $500,000 profit.

“It’s going to be cotton stalks everywhere,” said Travis Patterson, 44, a farmer near Spearman, who was irrigating one of his fields on a recent afternoon with help from his son Zane, 12, in preparation for planting cotton. “The landscape’s going to change,” he said, describing a countryside blanketed with the white of cotton rather than the more familiar green and gold of corn.

It's going to be harder to expand production of corn, soybeans and wheat.  Competition with cotton is just a small part of it.  For these much larger crops there simply isn't much land available on which to expand production.  So, I expect prices for cotton to fall quite a bit over the next year.  I'm less sanguine about corn, soybeans and wheat.

AMS Briefing on Capitol Hill

This morning's slides.  I believe slides with audio of the presentation will eventually be posted here.

Open publication - Free publishing - More agriculture

Using quotas in procurement auctions

I have a new working paper with Daniel Hellerstein and Nathaniel Higgins (both with USDA) on the use of quotas in procurement auctions.

This is a new area for us.  Our motivation came from thinking about the Conservation Reserve Program and a rapidly emerging literature on "payments for ecosystem services." Basically, the government or environmental interests or the carbon market or whatever wants to buy a lot of something--say carbon sequestration services, water quality benefits, wildlife habitat, etc.--from a large and extremely heterogeneous pool of sellers.

One issue surrounding the heterogeneity of sellers is that we need to put the environmental services provided across varied landscapes, locations, and situations on an equal footing, which requires some method of valuing the environmental benefits.  That's a hard thing to do, but it's not new.  And I think people are already doing about as good a job as could be expected.  Or at least I don't think I've got anything to contribute in this area.

Aside from valuation, it seems to me the biggest challenges everyone has been worrying about essentially come down to price discrimination:  The buyers of environmental services want to pay different prices to different sellers according to their opportunity costs for providing those services.  I can see a lot of practical reasons for wanting to do this, even if doing so involves a little bit of inefficiency.  I wrote about this a bit here.

So, how can one go about price discriminating if the buyer knows costs differ across sellers but they don't know how much they differ, or perhaps even who has high costs and who has low costs?  Well, a simple thing to do is to just have a procurement auction and put a modest quota or limit on the share of offers accepted by any observationally similar group of sellers.  This causes sellers within low-cost groups to compete with each other much more aggressively.  And it causes all sellers to generally compete more aggressively because they realize sellers within low-cost groups are competing more aggressively. 

It turns out that solving these kinds of auction theoretically is quite a bit of work.  But if costs do in fact vary a lot across groups, quotas can save the buyer a lot of money.  If groups are actually quite similar, quotas have no real benefit, but no real cost either.

We also ran some experiments and found somewhat greater savings from quota in the laboratory than in theory, and less of an efficiency loss verses standard pay-as-offered auctions.

I think there are many potential applications besides CRP or PES programs, so the paper is pitched more generally.  I also figured out a simple but powerful new technique for solving Bayesian Nash equilibria in asymmetric auctions, but that would only be of interest to a more limited audience.

How much might this kind of auction save the Federal government if they used it for CRP?  I don't think that question is strictly answerable given the available data.  But I think it's highly plausible that it could eventually save hundreds of millions of dollars per year while simultaneously improving environmental outcomes.  Part of this is because the way they currently go about price discriminating looks hugely inefficient (see here). It would be a lot simpler to implement than the current program, too. 

Will they do it?  I'm not going to hold my breath.  But I'm going to shamelessly sell the idea, because I think it would implement exactly what they seem to be trying to achieve in a way that's simpler, would possibly be perceived as fairer, and is almost surely more efficient.  If I could get them to do this, and it actually worked, I'd have concrete evidence that I earned my Wheaties.  Other applications would just be icing on the cake.

Commodity Prices and the Fed

I think Mark Thoma nails this.  What he describes is exactly the way I think about the issue but have been unable to articulate.

To answer the question in the title of this post, it's useful to think of an island with only two goods. One of the goods is non-renewable, but highly desirable. The other good is less preferred, but it is renewable (thinking of renewable and non-renewable energy resources, for example). The key is to distinguish between changes in prices that reflect changes in the relative scarcity of the two goods, and changes driven by increases in the money supply.

Over time, as the stock of the more desired good falls due to consumption, the price of this good will rise relative to the renewable good. Consumers will be hit by increases in the cost of living -- the same basket of the two goods purchased last year now costs more.

But is this the kind of increase in prices the Fed should respond to? No, the price increase -- and the increase in the cost of living -- reflects increasing scarcity of the desired good. The price of the two goods are changing to balance the relative supplies of the two goods. Unless the price of the non-renewable resource does not properly take account of the preferences of future generations -- and it may not -- or there is some other market failure, there is no reason for government to intervene to change the prices. If the prices are correct, they will allocate the resources optimally.

Now consider a different case. Suppose the central bank in charge of money -- sea shells of a particular type identified with the central bank's special mark -- and the money supply is being increased at a rapid rate. This will drive the prices of both goods up, but so long as the price of each good rises in proportion to the change in the money supply so that the relative price of the two goods is undisturbed, no problem. The price level will adjust to the number of sea shells in circulation, but since relative values remain intact, nothing will change.

However, suppose one of the two prices is sticky. It does not change very fast when the number of sea shells in circulation increases. In this case relative prices will be distorted as the number of sea shells increases, one price will rise faster than the other, and resources will be misallocated. In this case the Fed would want to do something about the inflation since it is having negative effects on the efficient allocation of the two resources. This is, essentially, the Fed's justification for activist policy.

A couple of notes. First, it's interesting to think about how technological change that improves the quality or lowers the price of the renewable good plays into this. Such a change could offset the increase in the cost of living that households face. Thus improving technology, not Fed policy, is the key to helping people on the island struggling with high prices. 

Second, this is about the long-run and growth in demand. The central bank may still want to try to offset temporary price spikes, for example when sticky prices can cause problems that persist beyond the spike in the price of one of the two goods (e.g. a spike in the price of oil that leads to long-lived price distortions). But long-run growth that causes the price of one of the goods to rise by more than the other, i.e. relative price changes, is not something the Fed should try to neutralize.

To me right now, commodity prices look to be driven mainly by fundamentals.  The clearest thinker I know when it comes to oil is Jim Hamilton, and he seems to think so too.  Thus, inflation coming from commodity price increases is reflecting something real--an increase in relative scarcity.  The kind of inflation the Fed needs to worry about is of a purely nominal nature.

It's always nice to have your research cited in testimony before Congress

In email this morning I learned that my work with Wolfram Schlenker was cited extensively by Christopher B. Field in his testimony before congress (PDF).

In today's New York Times our findings were obliquely referenced via Field.  Apparently his testimony "piqued the interest of members on both sides of the aisle."  The specific statistics cited in the New York Times come from our research results.  While the NYT is citing Field, you can see from Field's testimony that it comes from our work.

One little quibble with Field's testimony.  He testified as if these are going to be adverse effects to the U.S.  Actually, US crop production getting hammered by climate change may be good for us.  That's because we export a good share of our crops and demand is extremely inelastic.  It's is quite likely that price increases will help farmers far more than the lower quantities hurt them.  The gain in domestic producer surplus could be so large that there could be a net gain for the United States.

But this should inspire the opposite of complacency.  It's the rest of the world, particularly the world's poorest, that would suffer.

Update: Maybe I'm being too oblique here.  I'm NOT sanguine about these potential impacts.  What I'm trying to do by pointing out the big price effects is to show that the economic impacts from climate change will often happen to people and places far different from the physical impact.  When the Midwest takes a hit on corn yields, North Carolina hog and chicken farmers suffer while most Midwestern farmers gain, since prices more than compensate.  With climate change, this kind of economic displacement of physical impacts will probably be common.

Covariances reveal differences between supply shocks and demand shocks

This is for all the inflation mongers out there who think that today's oil price spikes are a prelude to hyperinflation.

Up until a few weeks ago, demand factors were driving oil and other commodity prices.  When oil prices went up, so did the stock market and interest rates.  Aggregate demand shocks, the earlier drivers, were mainly good news about growth, and this drove up interest rates and the stock market.  They also signaled higher prospective inflation, which I saw as good news.  We could use a bit more inflation, given we remain well below target and there is lots of labor to sop up before wage increases (the main part of inflation) kick in.

Over the last couple weeks, prices have spiked more sharply, but for very different reasons, mainly the quickly unfolding events in the Middle East.  Markets are speculating about a possible, if unlikely, major disruption in supply.  While oil prices have spiked, other commodity prices have generally softened, and the stock market and long-term interest rates have declined.  Anticipated downward shifts in supply are clearly bad news for the economy and growth.

And the decline in interest rates shows how little we should be concerned about hyperinflation.

Short-run inflation and perhaps even stagflation are real possibilities in this fragile economy.  This is just a textbook shift in aggregate supply.  Whether or not you're a Keynesian, the textbook says a supply shock to a fundamental resource will cause the price level to increase and output to decline.  But it's not a monetary phenomenon.  It's not the kind of thing that could kickstart a vicious inflationary spiral.  Not with unemployment at 9%.  This is bad news, not too much good news about an overheated economy.  Markets realize this and that's why stocks and interest rates are down.

Hyperinflation remains a truly remote prognostication. The only risk here may be if we shutdown the government indefinitely and default on our debt.  But that has nothing to do with oil prices either.

Update : I'm not the only one who thinks these kinds of changing covariances are interesting.

Ethanol and food prices, again

Last week I served on a panel for the RTEC and gave my usual spiel about ethanol and food prices.

In a nutshell:

1) Both supply and demand of staple grains are highly inelasitic. This means it doesn't take much of a shift in supply or demand to cause a big change in price.

2) The U.S. is hugely important in world grain markets.  With the largest share of world production and a much larger share of world exports, we drive international prices for staple grains.

3) Ethanol uses about 1/3 of the U.S. corn crop, or about 5 percent of the calories produced, worldwide, of corn soybeans, wheat and rice--the key grains that feed the world.  That's even with a bigger corn crop (and smaller soybean crop) that has been brought about by ethanol subsidies and mandates.

4) When prices go up, we in rich countries don't eat much less, since commodities are a trivial share of our food expenditures.  Those consuming less are most plausibly the world's poorest.  If not, who do you think is eating less due to the huge diversion from ethanol?

5) Yes, there are other and possibly larger factors affecting food prices: growth in China and other parts of the world, particularly growth in demand for meat, and bad weather.  These factors accentuate the effects of ethanol; they don't diminish it.  A big problem with all this stuff coming online at the same time is that it has drawn down inventories, making markets far more susceptible to other shocks.

I was challenged by the usual armchair reasoning that doesn't hold up under inspection.  Yes, some of the grain used in ethanol production goes back to farmers in the form of distillers grains. But it cannot be used for all animals.  It's 1/3 the calories, maybe less.  The wet stuff is economical but very expensive to transport.

In the real world there are tradeoffs.  You can't have your cake and eat it too.

One anecdote I wish I mentioned but didn't:  In October, the USDA revised its crop forecast for corn downward by about 5% from the September forecast.  This is a nice thing to look at because it provides something of a natural experiment--a large, clear, measurable unexpected shock to the market.  This supply shock caused prices to go up nearly 10% on the same day.

Consider how large this small adjustment on quantity had on price.  Now consider that this production shock was likely due to late season weather, a temporary phenomenon.  Now consider that ethanol is a permanent shock that is about six times the size on an annual basis.

If you say you don't think ethanol is affecting prices for staple grains and soybeans, you are a fool or a knave looking to mislead.

New, small farms with young hip operators

At least anecdotally, the local and small farm movement seems to be taking hold.

In New Food Culture, a Young Generation of Farmers Emerges

...Mr. Jones, 30, and his wife, Alicia, 27, are among an emerging group of people in their 20s and 30s who have chosen farming as a career. Many shun industrial, mechanized farming and list punk rock, Karl Marx and the food journalist Michael Pollan as their influences. The Joneses say they and their peers are succeeding because of Oregon’s farmer-foodie culture, which demands grass-fed and pasture-raised meats.

 ...The Grange master, Hank Keogh, is a 26-year-old who, with his multiple piercings and severe sideburns, looks more indie rock star than seed farmer. Mr. Keogh took over the Grange two years ago. 

He increased membership by signing up dozens of young farmers and others in the region. He had the floorboards refinished, introduced weekly yoga classes and reduced the average age of Grange members to 35 from 65. 

The young farmers crowded around a table brimming with food they had produced — delicata squash, beet salad, potato leek soup and sparkling mead. On a separate table were two pony kegs of India pale ale.... 

...“Literally, four years ago, this was not happening,” Ms. Jones said, gesturing to the 30 farmers who congregated at the hall. “Now, everywhere you turn, someone’s a farmer.” 

I think we may have a better idea whether this is real or not when the 2013 census comes out. The numbers from the 2007 census convinced me of nothing.

It's hard for me to imagine how these young farmers will make it.  Some people are willing to pay more for more healthful food that is locally grown.  But my guess is that share of the market is pretty thin.  Even if the movement grows, they will find it ever more difficult to compete with large-scale agriculture donning an organic label.  This doesn't seem like the thing that's going to support very many local farms.

I hope they make it. I really do.  But I'm doubtful.

Public and Private Storage of Oil

I've been thinking and studying a lot about storage and commodity markets, mostly with regard to food commodities.  A grad student, Nam Tran, is neck deep solving stochastic dynamic programing models.  I'm pretty optimistic something good will come out of his dissertation--he's focusing on rice markets and the price spike in 2008.

Anyway, the theory for oil isn't all that different.  In the news we're seeing a lot about the US strategic oil reserve.  Obama is thinking about selling some of our reserves.  Would this be a good idea?

The thing to recognize is that the recent price spike is coming from private markets building up their own reserves.  Reserves have gone up about 4% since early January, perhaps a bit more depending on what the next report says. Markets are speculating that there may be an actual disruption of supply in the future.  If that happens, prices will spike, and so it makes sense to store a little more in anticipation of that possibility.  If that speculation is rational, markets are responding in a reasonable and efficient manner to a potential supply shock.  If the speculation is irrational--if too much is being held off the market given the potential threat to supply--a release of pubic inventories may make sense.

It does look to me like Lybia's share of the oil market is too small to pose much of threat to supply.  Other countries could easily make up a lot of the difference, and likely will in order to capitalize on higher prices while anticipating that disrupted supplies will come back online.  But then problems in the Middle East could spread much further.  This doesn't seem like the kind of uncertainty one pin down very precisely in an objective manner.  Moreover, prices haven't gone up that much.  Yet.

On the other hand, I have a hard time seeing the general point of our strategic oil reserve.  I don't know that it serves much if any social good.  This is because it's hard for me to see the market failure in private speculation and storage.  While speculative bubbles seem to have occured in other places, I haven't seen any good evidence to support their existence in commodity markets (except maybe precious metals--a very different thing).  Actually, commodity prices appear to behave in near textbook economic fashion.  So, if the US is going to dump its public reserve and get out of the oil speculation business, now seems about as good a time as any.

One good thing about recent news: the more information they provide about what they will do and the circumstances in which they will do it will help private markets store more efficiently.

Matthew Kahn has a more optimisitic view

I guess Wolfram Schlenker and I have become the modern day Malthusians and doomsayers when it comes to potential impacts of climate change on agriculture.  I often try to emphasize that we are not in fact doomsayers; we are simply laying out the range of possibilities, and show strong evidence that the downside is indeed bad.   But we also maintain that there is room for adaptation in ways we cannot yet model or cannot yet anticipate.  We're a long ways from Malthusians--he had a different kind of doom in mind and was much more certain about it that we are. Uncertainty is large.   But, as Brad Delong often points out (and with whom I agree on this point), uncertainty is not our friend when it comes to climate change.

Matthew Kahn, esteemed professor at UCLA, leading specialist in environmental economics, and author of the new book Climatopolis, recently wrote about our work and offers a more optimistic view.  He argues that our work provides a clear incentive for innovation.  It shows us that we need more heat tolerant crops and that those who invent such crops will profit from inventing them. Thus, pointing out such potential problems lets us "escape" from the impending catastrophe.

Maybe Kahn is right.  I believe similar credible arguments have been made about past doomsayers: they showed the then-current paths to be unsustainable and thereby allowed our society to avoid the doom they had once prognosticated.  Maybe Rachel Carson made our water cleaner.   Maybe worries about resource shortages in the 50s and 60s pushed Norman Borlaug to foment the Green Revolution.

But what if it's not possible.  What if growing enough grain at low enough cost to feed a world with as much income inequality as we will surely have is not physically possible.  What if it's as difficult to grow crops in 33+ C temperatures as it is to currently grow crops in Siberia?

Human innovation and technological change has been stupendous.  But also quite varied.  In some ways productivity grows at seemingly interminable exponential rates, as Ray Kurzweil likes to emphasize.  But somethimes innovation looks like innovation in battery technology--stubbornly slow and halting.  Erk.

It is also important to note that some of the human response to social problems like pollution comes from policy. Libertarians often point out how much cleaner our air and water in the US are today compared to 30 or 40 years ago, which is true.  But at least some of that improvement surely came about from the Clean Air and Clean Water Acts.

So.  Maybe Kahn is right and we shouldn't worry about climate change. The problems will take care of themselves.

The question you may want to ask yourself is: Do you feel lucky?

Coping with High and Volatile Food Prices

So high and volatile food prices may be with us for awhile.  What should we do about it?

At the end of my Room for Debate column I wrote:

The best immediate response to these problems would be to reduce barriers to international agricultural trade, and to develop mechanisms to protect the world’s most vulnerable from inevitable price spikes. Such protections, if credible, might convince markets that crude market interferences like export bans were less likely, which would reduce speculative inventories and prices today.

Economists almost always favor free trade.  I'm not quite as ideological about this as the headline "Open Up Trade" may have suggested (NYT chose the titles).  But in this case I think free trade is the right answer, but with an important caveat:  I think the international community (UN, FAO, rich nations, etc.) need to develop a clear, credible, anticipatory mechanism for delivering aid, perhaps in the form of food subsidies, for the poorest people in the most vulnerable places in the event prices do spike.

What I'm suggesting here is a form of market intervention.  Call it a conditional cash transfer that depends on food price levels.  Such commitments from the international community might be offered in exchange for commitments not to interfere with trade in other ways, like tariffs, export quotas, taxes or bans.  I think these kinds of conditional transfers would be a more efficient way of dealing with the problem than other policies being suggested, like public storage projects.  And they would likely have fewer unintended consequences.

For example, I worry that public storage projects would be managed in erratic and unpredictable ways, and thus attract private speculators and storage in addition to public storage, no matter the size of public storage projects.  The more we store, the more eventually spoils, which ultimately means higher average prices.   And in the process of building up public inventories we would effectively be increasing demand even more.  This would be an easy thing to screw up and make the food price problem worse than it is already.

Furthermore, I don't perceive any evidence that commodity markets are storing in insufficient quantities.  Indeed, commodity markets look remarkably efficient to my eyes.

Now, by guaranteeing low food prices for the poor we would, in effect, cause demand to be artificially  more inelastic than it is already.  Thus, guarantees could, indirectly, cause larger price spikes.  I believe private markets would quickly recognize this and respond by developing larger inventories on their own--a speculative bet that would pay off when price spikes do happen (and they *will* happen).  Guarantees for the poor would mean that prices would have to rise to the point where the relatively more wealthy would have to reduce quantity demanded.  But the relatively wealthy can afford it.  We can find other things to eat besides grain fed beef and chicken.

Most importantly, however, such a policy might do a lot to stave off the most destructive policies, like export bans.

Right now, this is the best idea I have.

Debating Food Prices at the New York Times

We're live at the Room for Debate:

Bad weather is clearly influencing food commodity prices. So is demand growth, most notably from rapidly emerging economies like China, where people like grain-fed meat and dairy products as much as we do, and many now have incomes to afford them. Then there is the increased demand from subsidized and mandated ethanol production.

Price spikes like the current one can and will happen regardless of whether the climate has changed or will change. It is just the nature of these kinds of markets: bad weather shocks draw down inventories, which make prices higher and more volatile. A few good weather years could replenish inventories and bring prices back down.

Thankfully, rice prices haven’t spiked -- yet. Historically, market forces have caused spikes in rice prices to follow those of corn, soybeans and wheat. These four crops provide the caloric basis for most food worldwide.

Here in the U.S., we won’t notice high commodity prices in the price of food we buy at stores and restaurants. The price of our food is comprised mainly of the labor involved in processing, transporting and marketing. Indeed, this fact helps explain why commodity prices can increase so much so fast -- we’ll buy little less even if commodity prices double or triple from current levels.

High commodity prices matter mainly for the two billion or so living on $2 a day or less and spend the bulk of their income on food. Some of these people will buy less food as prices rise, because they simply won’t be able to afford as much. I wouldn't be surprised to see more civil conflict as more people go hungry.

Productivity growth will need to accelerate from historical trends to keep up with F.A.O.’s predictions for population and income growth. If it doesn’t, prices will trend higher, perhaps a lot higher.

Markets must be worried that the weather shocks we have recently experienced are not transitory, but rather tidings of more permanent and significant changes. Climate models predict that extreme weather events, like the ones recently experienced in Australia, Russia, the United States and China, and potentially much worse, will begin happening with greater frequency, and possibly much sooner than many people expect. Looking ahead, we need to start dealing more realistically with the risks posed by climate change.

The greatest hopes against truly catastrophic declines in crop production are a possible boost from CO2 fertilization and improved productivity through breeding or genetically modified crops. But there is increasing skepticism that these factors can compensate for the negative effects of a warmer climate and growing demand.

Trade restrictions remain pervasive and help to keep commodity prices high. Recent research by Jeffrey Reimer and Man Li indicates prices could fall by 57 percent if all countries were as open to trade as the United States. Particularly acute examples, like the recent ban of wheat exports by Russia, India’s rice export ban in 2008 and subsequent Philippine hoarding, can greatly exaggerate the effects of weather shocks on world prices. Such policies likely come about from efforts to keep food affordable for a country’s most disadvantaged. Their ultimate effect, however, is to keep food prices higher worldwide, and make more people hungry. To make matters worse, market speculators likely hold greater inventories in anticipation of possible future export bans or hoarding.

The best immediate response to these problems would be to reduce barriers to international agricultural trade, and to develop mechanisms to protect the world’s most vulnerable from inevitable price spikes. Such protections, if credible, might convince markets that crude market interferences like export bans were less likely, which would reduce speculative inventories and prices today

My piece was a lot longer than they requested, and they still kept nearly all of it with only minor and helpful edits.  The one key piece that was cut in editing was my dig at those tying to tie commodity price increases to monetary policy and fears of broader inflation.  One of the links makes that point, so I guess that's okay.

The first debater, Raj Patel, makes no sense to me whatsoever.  Knorr seems thin.  But I see little to disagree with from anyone else.

Update:   To the tireless inflation mongers out there:  Today is different than the 70s.  There's more than I have time to get into at the moment, but the two big differences are:

1) Commodity prices make up a much smaller share of our economy today than they did back in the 70s.  The one place to look at to see this is energy consumption expenditures as a share of the economy.  That's the big one, and it's still much smaller today.  Food commodities were trivial back then and are much smaller now.

2) Unemployment.  It's higher today than when prices spiked in the 70s while the natural rate is probably lower.  If you think wages are going up any time soon in this country you are smoking some really strange grass.  Without a wage-price spiral, we're not going to have inflation.

If you don't believe me, then by all means, go short on traditional treasuries and long on inflation-indexed treasuries, and if you're right and I'm wrong, wake up next year a very rich man or woman.

I think the market has this about right: historically low inflation for the next 5 years or so.  Which is too bad. I think a bump up in inflation to 3, 4 or 5 percent would do our economy a heck of a lot of good.

It's not about us.  Really.  It's about poorest 1-2 billion in the world, and those folks don't live in this country.

The price of cotton in your shirt

Yesterday the near month futures price of cotton closed at $1.83/lb.  That's pretty high, more than double the price of just a year ago.  Before this year, I'm not sure cotton prices ever exceeded $1.20.  But that's in nominal dollars. Adjusted for inflation cotton prices were a good clip higher back in the early 80s.

How much do these high prices matter for the prices we pay for clothes?

Not so much.  Consider that there is about 0.6 lbs. of cotton in a typical man's shirt.  So that $1/lb increase in cotton prices over the past year means it costs an extra 60 cents to make the Brooks Brothers shirt for which I paid $40.  On sale.

Would it be so hard for the news media to put this kind of perspective on things?

Aw shucks, Hoss... It's so much more fun stoking inflation fear and general hysteria.

Take the New York Times, for example, one of our last and best shining stars of high-quality media.
Stephanie Clifford, Mokoto Rich and William Neuman:

A package of Oscar Mayer cold cuts. A pair of Nine West boots. A Whirlpool washing machine.

By the fall, people will most likely be paying more for each of them, as rising prices hit most consumer goods, say retailers, food companies and manufacturers of consumer products.

Cotton prices are near their highest level in more than a decade, after adjusting for inflation, and leather and polyester costs are jumping as well. Copper recently hit its highest level in about 40 years, and iron ore, used for steel, is fetching extremely high prices. Prices for corn, sugar, wheat, beef, pork and coffee are soaring. Labor overseas is becoming more expensive, meanwhile, and so are the utility bills to keep a factory running.

“There are cost pressures from virtually everywhere,” said Wesley R. Card, the chief executive of the Jones Group, whose brands include Nine West and Anne Klein. After trying to keep retail prices flat or even lower during the recession, Jones says prices for its brands will climb 15 to 20 percent by autumn.

When commodity prices started to rise last summer, many manufacturers and retailers absorbed the costs, worried that shoppers would not pay higher prices during the competitive holiday season or while the economy was still fragile.

Many big companies, including Kraft, Polo Ralph Lauren and Hanes, say they cannot hold off any longer and must raise prices to protect some profits..... 

I don't think so.  Especially not for name brands like these.  They have a lot of market power and the profit maximizing thing for them to do is to absorb much of this (quite modest) cost increase.  The price of my Brooks Brothers shirt will probably go up less than 60 cent cost increase from higher cotton prices.

Their nod to reality-based journalism comes at the bottom of page one.

The cost of raw materials accounts for a small portion of the cost of most consumer goods, as labor, processing and packaging tend to make up a larger share of the price at the cash register. Foods like coffee, meat and milk, which are closer to raw materials, will probably show some of the biggest price jumps.

But no facts to put this in perspective.  Too little, too late.

There is, in fact, another and far more plausible reason why firms will raise prices this year: increasing demand.  Especially for brand-name companies like the ones mentioned in this article, prices will be more sensitive to demand than they are to cost.  They've probably been holding down prices due to the recession.  Now that we're recovering (albeit slowly), demand is somewhat higher and they can raise prices a bit.

Update: A lot more on commodity prices here.

Climate Change and Elasticity

 Elasticity---the responsiveness of production and consumption to price---is important to keep in mind when thinking about potential climate change impacts on agriculture.  Sadly, much of the profession doing empirical work on potential climate impacts seems to ignore this part of the equation.  I'm thinking particularly of this paper and this paper, both of which have other issues (see here and here).

On a global scale, supply and demand of staple commodities are highly inelastic.  Demand is inelastic mainly because commodity expenditures comprise a small share of the price of most consumption goods. Supply is inelastic because there's only so many places where it makes sense to grow certain crops. As a result, commodity prices can be very sensitive to shifts in supply or demand.  If climate change causes a big inward shift in supply, it could cause a huge loss in consumer surplus.  But if climate change were to cause a big outward shift in supply, the welfare change would be modest.

This is a key reason why uncertainty with climate change matters: the potential downside is so much bigger than the potential upside.

Sadly, what we often see from economists are references to the tiny share of agriculture in world GDP Thomas Schelling is a famous example (he makes good points about the bargaining problem). But GDP is no welfare measure.  And the difference between GDP and welfare is going to be large, mainly because it doesn't count a huge consumer surplus.

Elasticity and Climate Change
Now, it is true that a lot of the loss in consumer surplus will be offset by gains to producer surplus.  The U.S., with its large land base, excellent soils and climate, produces and exports more than anyone else in the world.  A doomsday scenario for food production doesn't look so bad for us--we'd be the ones gaining a lot of that producer surplus.

But in other places, particularly in certain developing countries with large urban populations, demand is not quite as inelastic. This is because the urban poor spend a large share of their income on staple food commodities, and when prices change a lot, it changes their real incomes a lot, and they spend less. So a lot of the loss in consumer surplus is likely to land on the people who most value that surplus---a dollar of surplus to a typical person in India is worth a lot more than it is to us.

A contemporary case in point: As I recall, Egypt imports about half its wheat and about half the people live on $2/day or less.  Today's high wheat prices must be doing a lot of damage to their real incomes.  And they are letting the world know about it.

Update:  I'm not the only one thinking about commodity elasticities.  I think I posted mine first. But the other guy always puts things much better than I do...

Update 2:  Krugman made this issue a headline column.  He's basically outlined my current research agenda.