The winner's curse and why cities should prefer not to have Amazon's new HQ

As many readers will know, Amazon has been searching for a location for its second headquarters in the U.S. The Washington Post reported earlier this week (gated, but there is an ungated version on the New Zealand Herald website):

Amazon's search for a site for its second headquarters is now mostly playing out behind closed doors, as officials from 20 finalist locations provide the company with additional materials...

The Amazon search is a serious matter. The chosen city could reap 50,000 jobs and $4 billion in investments from the company. Taxpayers may be asked to foot billions of dollars of subsidies to win the deal. Housing markets and traffic patterns may be dramatically affected by the company's decision. A group backed by the Koch Brothers published a video opposing subsidies for the project. On the other hand, former Virginia governor Terry McAuliffe suggested recently, in an interview, that "whoever wins this thing is going to run for president."

The mayor of the winning city may feel like running for president. But eventually, whichever city wins the affections of Amazon and gets the second headquarters will almost certainly wish they hadn't. Why would I say that? Because of the winner's curse.

Consider a group of cities vying to be the location for the second Amazon headquarters (you can see the shortlist here). Rational city planners (or the city council or mayor or whoever is making the decision to try to woo Amazon) with the same preferences would all have the same valuations (or very similar valuations) for how much economic benefit Amazon will generate for their city (based on jobs growth, for instance). However, not all city planners have the same preferences, and the city planners may make random errors in determining how much value Amazon will provide the local economy, so all of the city planners will have different willingness-to-pay to attract Amazon. In this case, their willingness-to-pay reflects how much in incentives (local tax rebates, subsidies, etc.) they are willing to offer to Amazon in exchange for Amazon locating the second headquarters in their city. For city planners with similar preferences, these differences in willingness-to-pay arise randomly - some will overestimate how much they should be willing to offer to Amazon, and some will underestimate.

Now consider Amazon's decision. They will try to maximise their "economic rent", by choosing the city that will offer them the greatest advantage, which includes the amount of tax incentives and subsidies that are on offer. Cities where the planners have underestimated the value that Amazon will provide will offer Amazon relatively small incentives to locate there, and Amazon won't choose them as a result. The 'winning' city will likely be the city that offers the greatest incentives (the most tax incentives, or largest subsidies, etc.), which will be the city that over-estimates the value that Amazon will provide to the local economy by the most.

So sure, the 'winning' city will get the Amazon headquarters. But they will also win a lot of obligations for tax incentives and subsidies offered to Amazon. Overall, the gain in terms of jobs and tax revenues will likely be less than the subsidies paid to attract Amazon, adding up to a net loss for the city. Sometimes it's best not to win.

Uber and Lyft increase traffic congestion in cities

Many people claim that ridesharing services like Uber will reduce traffic congestion. However, what happens if people start to favour those services over public transport, or over walking or cycling? The New Zealand Herald reported today:

One promise of ride-hailing companies, such as Uber and Lyft, was fewer cars clogging city streets. But studies suggest the opposite: that ride-hailing companies are pulling riders off buses, subways, bicycles and their own feet and putting them in cars instead.

And in what could be a new wrinkle, a service by Uber called Express Pool now is seen as directly competing with mass transit...

One study included surveys of 944 ride-hailing users over four weeks in late 2017 in the Boston area. Nearly six in 10 said they would have used public transportation, walked, biked or skipped the trip if the ride-hailing apps weren't available.

The report also found many riders aren't using hailed rides to connect to a subway or bus line, but instead as a separate mode of transit, said Alison Felix, one of the report's authors.

"Ridesharing is pulling from and not complementing public transportation," she said.

One of the things we are discussing in the first week of my new ECONS101 class this week is economic decision-making. And one of the key aspects of the decision between alternatives is the relative price - the cost of one alternative compared with the cost of another. Public transport may be cheap, but it isn't always convenient. Once you factor in convenience (being able to be picked up from in front of your home, rather than having to walk in the rain to the nearest bus stop or subway station), it shouldn't be surprising that many commuters are choosing Uber or Lyft instead, because in relative terms the cost of Uber or Lyft may be lower than public transport (or walking, or cycling, especially in the rain). The new Uber Express Pool service looks set to make things even worse:

Uber's new Express Pool links riders who want to travel to similar destinations. Riders walk a short distance to be picked up at a common location and are dropped off near their final destinations — essentially, how a bus or subway line functions.

The service was tested in November in San Francisco and Boston and has found enough ridership to support it 24 hours a day. Round-the-clock service was also rolled out last week in Los Angeles, Philadelphia, Washington, Miami, San Diego and Denver, with more cities to follow.

"This could be good for congestion if it causes vehicle occupancy rates to go up, but on the other hand, the Uber Pool rides and I guess these Express rides are really, really cheap, just a couple of dollars, so they're almost certainly going to be pulling people away from public transport options," [Christo Wilson, a professor of computer science at Boston's Northeastern University] said. "Why get on a bus with 50 people when you can get into a car and maybe if you're lucky, you'll be the only person in it?"

Overall, Uber might be a substitute for ambulances, but that isn't going to do you much good if your Uber ambulance is stuck in a traffic jam, mostly made up of other Ubers.

[Update: The irony of this op-ed by Richard Menzies, NZ general manager of Uber, should be obvious]

Paying landowners to change land use

Economists recognise that people respond to incentives. If you increase the cost of doing something, on average people will do less of it. On the other hand, if you increase the benefits of doing something, people will do more of it. So, economists are less surprised than 'normal people' about things like this, as reported in the New York Times at the end of last year:

In environments as different as North America and Africa, new programs are preserving land through short- and-long-term deals that pay people to protect nature on their own land. The innovation makes it possible to transform a binary approach to land use — either devoting it to private development or turning it into a nature reserve — into something in between.

Consider how Airbnb works. Think of Minneapolis during the coming Super Bowl, when hotel rooms are scarce and residents will be enticed to rent their homes to football fans. Something like that happens in the environmental realm, too: There is a surge in demand for protected land when migratory birds are passing through an area or a threatened species is breeding.

In the United States, the nonprofit Nature Conservancy has been a pioneer in bringing the “sharing economy” business model to conservation. It has been temporarily expanding wetlands for migratory birds in California’s Sacramento Valley since 2014. In early fall, when birds head south for the winter, and again in early spring on their return journey, birds need larger protected areas than the current mix of parks and nature preserves allows, as the website Howstuffworks reported in August.

The big insight was realizing “we could use a rent rather than buy model,” said Mark Reynolds, an ecologist with the Nature Conservancy, which pays rice farmers to flood their fields for the few crucial weeks each fall and spring. Rice growers routinely flood their fields for irrigation and to decompose crop residue after harvest; through the conservation program, named BirdReturns, they do so during periods when the fields would have been dry.

So often, activists and environmental campaigners settle on a 'command and control' model as their preferred policy to ensure positive environmental outcomes ('command and control' policies are policies that say you 'must do' some things, or 'must not do' other things). As the New York Times article makes clear, a market-based approach can be just as effective, if not more effective, in some circumstances. A market-based approach doesn't rely on compelling people to obey, it relies on changing the incentives.

In this case, if you offer landowners a payment for changing their land use for part of the year (e.g. flooding their fields to make wetlands), then landowners can choose whether they want to do so. Landowners who face a low cost of changing their land use (maybe because their land is not highly productive so they won't be giving up much production) will be more likely to do so (because the payment will exceed the costs of land use change). Economists refer to the value of the foregone production for these landowners as an opportunity cost - it is the cost (to those landowners) of choosing to change land use. In contrast, landowners who face a higher cost of changing their land use (maybe their land is more productive, so they would be giving up more production) will be less likely to do so. For these landowners, there is an opportunity cost of not changing their land use - they are giving up the payment they would have received from the environmental group.

How do you work out how much to pay the farmers to get the right number of them to change land use? The article explains:

A team of ecologists and economists figured out how much to compensate the farmers for this change. They ran “reverse auctions” in which landowners specified the lowest payment that would entice them to flood their fields for a given four- to eight-week period.

This auction system adjusts payments to farmers’ costs. For example, flooding during the end of the spring migration season is trickier to fit into an annual rice-growing schedule, so bids — and payments — are higher then. The auction model is also flexible when the weather fluctuates. The early years of the program occurred during California’s prolonged drought, but abundant rainfall in 2017 meant that BirdReturns could dial back the amount of pop-up wetland it procured this year.

Note that the reverse auction is a good way for the environmental group to ensure that they can achieve their desired change in land use at the lowest cost, provided the landowners are genuine in specifying their opportunity cost for changing land use as the lowest payment they would accept. The italicised bit in the last sentence is important. You don't want landowners to simply hold out for higher payments. One way to avoid that problem is to ensure that you invite more landowners (with more land) than would be necessary to achieve your desired amount of land use change.

Finally, it is worth noting that this type of market-based system can't make farmers worse off. Since farmers are not compelled to participate, they will only do so if the benefits to them outweigh the costs. Markets aren't a perfect solution for every problem, but sometimes they can solve problems in a surprisingly simple way.

Book Review: The Secret Life of Money

Sometimes books over-promise and under-deliver. I think I'm pretty good at spotting those and avoiding reading them, but occasionally one slips through. And that was the case with The Secret Life of Money, by Daniel Davies and Tess Read. The promise is big and on pages 2-3 of the book:

The problem is that the kind of economics they teach in universities is all too abstract... What you need to know is the smallest possible set of general principles, but much more about the way in which the various bits fit together...

That's what we're trying to do in this book.

The problem is that Davies and Read have created a sort of straw man argument. The kind of economics I (and many others) teach in universities is very applied (at least, I think so). So, in the very next chapter when they cover lifts (elevators for those in some countries), what they were essentially discussing was customer lock-in, which we cover in ECONS101. In the third chapter, they talk about the economics of trade shows, which are a platform market (also covered in ECONS101). Not exactly an auspicious start, if you're claiming to explain things that aren't taught in university economics. And made worse when, a few chapters later, they discuss the economics of credit cards but completely miss the fact that credit cards are also a type of platform market.

Many of the chapters are exceedingly shallow, such as a chapter on money laundering that could be best summarised as "don't do it". I'm not sure why we needed four pages to tell us that. On top of which, a surprising amount of the book is actually accounting, not economics. We can quibble over where the disciplinary boundary lies between accounting and economics, but most of us would agree that depreciation belongs in the former.

There are some highlights. Despite picking on those first two chapters above, I think they included the most interesting material and examples (perhaps that's why they were at the start of the book), and the chapter on blood diamonds ends with the key observation that there are no 'blood emeralds' (because emeralds are genuinely scarce, but diamonds are not, so emerald miners do not need to create artificial scarcity by shutting out some of the competition). There are also a few examples of epic cynicism, like:

If you want to value a brand, you have to make a discounted cash flow (DCF) model (see your favourite business school textbook - if you don't have one, then mentally substitute 'a magic spreadsheet that gives you a usually rather spurious but toothsomely precise number for the financial value of a company or project').

However, those rare highlights are not enough to redeem the book, which will tell you less about the secret life of money than about the secret life of business consultants with a book deal and too much time on their hands. Give this one a miss.