Sea level rise, coastal flooding, and house prices

In my ECONS102 class last week, one of the things we discussed was hedonic pricing - the idea that the price of some goods (such as houses or land) reflects the sum of the values of all of the characteristics of the good. In the case of property, if the property includes a dwelling, the price will reflect the quality and size of the dwelling, number of bedrooms, bathrooms, whether it has off-street parking, and so on. But the price also reflects the access of the property to local amenities, such as good schools, public transport, and so on (for example, see this post from 2017), as well as the property's risks of damage due to environmental disasters such as earthquakes or floods.

In the case of risk, properties that have a higher risk profile should have lower prices - a higher risk profile is a negative characteristic for a property. Two new research articles provide some relevant evidence.

First, this article by Allan Beltran, David Maddison, and Robert Elliott (all University of Birmingham) published in the Journal of Environmental Economics and Management (sorry I don't see an ungated version), looked at the impact of floods on property prices in the UK. They used data on over 12 million property transactions and nearly 5 million properties over the period from 1995 to 2014. Interestingly, their method looked at 'repeat sales'. That means that they essentially looked at property's prices before, and after, a flood event. Some properties were directly affected by flooding, while others weren't. They found that:

...in the immediate aftermath of inland flooding the average price of property in a postcode entirely inundated is 24.9% lower. For incidents of coastal flooding the corresponding figure is 21.1%. These results moreover emerge from a comparison of inundated and non-inundated properties all within the floodplain. Such discounts are however short-lived; property affected by inland flooding typically recovers after 5 years and in just 4 years for coastal properties. The time for price recovery differs markedly for properties in different price-quartiles. For properties affected by coastal flooding in the highest price-quartile, the property price discount disappears after only 1 year whereas for properties in the lowest price-quartile the discount remains statistically significant for up to 6-7 years.

So, floods reduced house prices, but the prices rebounded so that there was no net negative effect within several years. Interestingly, the effect was slightly lower for coastal flooding, and disappeared quicker. That is, people were quick to return to demanding coastal property soon after coastal flooding. That should be a bit of a worry to us, given that sea level rise is likely to be one of the enduring effects of future climate change.

Which brings me to the second article, by Asaf Bernstein (University of Colorado at Boulder), Matthew Gustafson (Pennsylvania State University), and Ryan Lewis (University of Colorado at Boulder), published in the Journal of Financial Economics (ungated earlier version here). This article provides more direct evidence on the effect of sea level rise on house prices, using data from over 460,000 property transactions of properties in the US that would "be inundated following a 1-6 foot increase in average global ocean level". Their analysis is not based on repeat sales, and neither is it based on actual sea level rise (it is projected future sea level rise). The latter point means that, if there are negative impacts on property prices, then buyers are factoring in future sea level rise in their decisions about buying. They find that:

...SLR exposed properties trade at a 6.6% discount relative to comparable unexposed properties. We further break this into exposure buckets, with properties that will be inundated after one foot of global average SLR trading at a 14.7% discount, properties inundated with 2-3 feet of SLR trading at a 13.8% discount, and properties inundated with 4-5 and six feet of SLR trading at 7.8% and 4.4% discounts, respectively.

Interestingly, it is non-owner-occupiers would are more likely to apply a discount to the property:

We find that the SLR exposure discount is concentrated in the non-owner occupied segment of the market. On average, exposed non-owner occupied properties trade at a 10% discount, relative to comparable non-exposed proper- ties, while exposed and unexposed owner occupied properties trade at similar prices.

In other words, owner-occupiers likely underestimate the negative impacts of sea level rise on their homes. They also found that owner-occupiers with stronger beliefs regarding climate change did apply a discount in buying coastal property.

These two papers, taken together at face value, should probably worry anyone who is concerned about the future impact of sea level rise and coastal flooding on people living near the coast. Coastal property is at risk in many (perhaps most) areas. Holding all other factors constant (such as the quality of housing, access to amenities and services, etc.), the value of these properties should be decreasing relative to less vulnerable property (or at least, not rising as quickly). It appears that is not the case, and in fact following flood events (which should make it abundantly clear to potential purchasers that these properties are vulnerable to coastal flooding and sea level rise), property prices are rebounding quickly to their previous levels. On top of that, it appears that it is owner-occupiers (and in particular climate-change-naive owner-occupiers) who will face the brunt of these future impacts.

I don't know that this leads to a strong case for regulation of coastal property in some way, but at least it suggests that coastal property owners (and potential buyers of coastal property) must become better informed about the risks. The specific vulnerability of coastal property to inundation and flood events probably needs to be communicated to potential buyers for every coastal property transaction.

Book review: The Everything Store

At the end of 2017, I read and really enjoyed Brad Stone's book The Upstarts (which I reviewed here). So I looked for other books by the same author. It turns out, I already had one on my shelf that I hadn't read - The Everything Store. The book tells the story of Jeff Bezos, and in particular of the rise of Amazon, initially as an online bookstore, and later as an online purveyor of almost everything (hence the title).

As he did for Uber and AirBnB in The Upstarts, in this book Stone does an excellent job of chronicling the history of Amazon. The key players (and there are many) are all included and their contributions to Amazon are noted in some detail. Stone includes lots of anecdotes that help you to really feel the relentless pace of development of the company over the years including, surprisingly, that they briefly toyed with the idea of calling the company Relentless (indeed, the web address relentless.com still takes you to the Amazon homepage today!).

Many of the details in the book, I had already read elsewhere over the years. However, there were still many stories that were new. I hadn't quite appreciated Bezos's total dedication to low pricing, but this quote in relation to Amazon Web Services (AWS) captures it well:

Bill Miller, the chief investment officer at Legg Mason Capital Management and a major Amazon shareholder, asked Bezos at the time about the profitability prospects for AWS. Bezos predicted they would be good over the long term but said he didn't want to repeat "Steve Jobs's mistake" of pricing the iPhone in a way that was so fantastically profitable that the smartphone market became a magnet for competition.

The comment reflected his distinctive business philosophy. Bezos believed that high margins justified rivals' investments in research and development and attracted more competition, while low margins attracted customers and were more defensible.

In its determination to capture customers through low prices, Amazon has driven hard bargains with its suppliers, and the book contains lots of stories to that effect. It has also driven hard bargains with its employees, and if the book is missing one thing, it is the lack of stories from the front line. I guess that many readers would not have appreciated it in a business book, but I wanted more than a few isolated anecdotes about "top-grading of employees" (where managers grade employees along a curve, and "dismiss the least effective performers"). Even those few anecdotes only appeared towards the very end of the book. However, despite their absence, there is no doubt from reading the book of the challenges that working for Jeff Bezos presents. He appears to be a hard taskmaster.

The book doesn't lack humour though, such as the story of the missing pallet of Jigglypuff Pokemon toys in one fulfilment centre:

The group was looking for a single box inside an eight-hundred-thousand-square-foot facility. "It was very much like that scene at the end of Raiders of the Lost Ark," Rachmeler says. She dashed out to a nearby Walmart to buy a few pairs of binoculars and then passed them out among her group so they could scan the upper levels of the metal shelving....

After three days of exhaustive searching, at two o'clock in the morning, Rachmeler was sitting, spent and dejected, in a private office. Suddenly, the door flew open. A colleague danced in, and Rachmeler briefly wondered if she was dreaming. Then she noticed that the woman was leading a conga line of other workers and that they were jubilantly holding above their heads the missing box of Jigglypuffs.

I guess it wasn't all bad news for the employees of Amazon. It has made a large number of them (not least Bezos himself) fabulously wealthy. For a company that was originally "conceived in 1994 on the fortieth floor of a midtown New York City skyscraper", Amazon has certainly come far. And this book does a great job of showing you just how far it has come.

You can pay a subsidy with a tax, but it won't eliminate the deadweight loss

The government's new plan for incentivising a switch to electric vehicles (EVs) is interesting, as reported in the New Zealand Herald last week:

The Government is signalling its intention to slash the price of imported electric and hybrid vehicles by up to $8000 in a bid to make greener cars cheaper for Kiwis.

But it is also planning to slap a new fee of up to $3000 on the import of vehicles with the highest greenhouse gas emissions.

The Government has today opened a six-week consultation period before it introduces new legislation in Parliament later this year...

The Government is proposing discounts of up to $8000 for zero-emission new imported vehicles, such as electric vehicles (EVs).

That number would be $6800 for plug-in hybrid electric vehicle (PHEVs) and $4800 for hybrids.

The level of the discount depends on the total net emissions of the vehicle...

A used Mazda Axela, which is one of New Zealand's most popular imported vehicles, would cost $7200 after an $800 discount.

But a new Land Rover Sports V8 would be slapped with a $3000 high-emissions fee.

A $22,000 Toyota Hiace would cost an extra $1400 after the fee was applied.

Genter said the policy would be cost neutral – meaning the money gained through the fees from higher emitting vehicles would offset the subsidies provided to the lower emission cars.

A specific excise tax on the sale of a good, such as high-emission vehicles, will raise revenue for the government, but it also creates a deadweight loss - there is some economic welfare from the market for those vehicles that is lost, because fewer of them are being traded. This is illustrated in the diagram below. If the market were left alone, it would operate with a price of P0, and Q0 high-emission vehicles would be traded. When the excise tax is imposed, we represent that with the new curve S+tax. The price the consumer pays for a high-emissions vehicle increases to PC, but the effective price for the seller decreases to PP (which is the consumer's price PC, minus the amount of the tax paid to the government). The quantity of high-emissions vehicles decreases to QT.

However, now think about economic welfare. Consumer surplus is the difference between the amount that consumers are willing to pay (shown by the demand curve), and the amount they actually pay (the price). In the diagram, at the equilibrium price and quantity, consumer surplus is the triangle AEP0. Producer surplus is the difference between the amount the sellers receive (the price), and their costs (shown by the supply curve). In the diagram, at the equilibrium price and quantity, consumer surplus is the triangle P0ED.  Total welfare is the sum of the two areas (consumer surplus and producer surplus), and is equal to the triangle AED.

Once the tax is imposed, the consumer surplus decreases to ABPC, while the producer surplus decreases to the area PPCD. The government gains the area of tax revenue, which is the rectangle PCBCPP (this rectangle is the per-unit amount of the tax, multiplied by the quantity of taxed vehicles). Total welfare is the sum of all three areas (consumer surplus, producer surplus, and government revenue), or ABCD. Notice that total welfare with the tax is lower than it is without the tax, by the area BEC. That is the deadweight loss of the tax - lost economic welfare as a result of the tax reducing the quantity of high-emissions vehicles traded.

So, we lose economic welfare in the market that is taxed. Does that mean that we gain welfare in the market that is subsidised? Actually, it doesn't. The diagram below shows the effect of a subsidy on the market for EVs. If the market were left alone, it would operate with a price of PA, and QA EVs would be traded. When the subsidy is introduced (and assuming it is paid to the importers of EVs), we represent that with the new curve S-subsidy. The price the consumer pays for a high-emissions vehicle decreases to PE, but the effective price for the seller increases to PF (which is the consumer's price PG, plus the amount of the subsidy paid to the seller by the government). The quantity of EVs increases to QS.

Now consider the areas of economic welfare. Without the subsidy, consumer surplus is the area FGPA, and producer surplus is the area PAGH. So, total welfare without the subsidy is the area FGH. With the subsidy, the consumer surplus increases to the area FJPG, while the producer surplus increases to the area PFKH. The government subsidy is the rectangle PFKJPG (this rectangle is the per-unit amount of the subsidy, multiplied by the quantity of subsidised vehicles). The subsidy is negative welfare - it reduces total welfare, because the government could instead use that subsidy money to pay for schools, roads, etc. So, it has an opportunity cost (it is not free money). Total welfare with the subsidy is the sum of consumer and producer surplus, minus the area of the subsidy. This is tricky because all the areas overlap, but if you work it out you'll find that total welfare is now FGH-GKJ. So, total welfare with the subsidy is lower than without the subsidy, by the area GKJ - the subsidy also creates a deadweight loss.

Now, combining the two markets, it is clear that the government could use the revenue that it raises from the tax on the high-emissions vehicle market, to pay for the subsidy on the EV market. However, that only pays the subsidy - it does nothing about the deadweight loss in either market. [*] So, while the policy may be cost neutral from a government fiscal standpoint, it clearly isn't cost neutral for society as a whole.

*****

[*] Now, you could argue (rightly) that the high-emissions vehicle market has a negative externality, and so too many high-emissions vehicles are traded relative to the welfare-maximising quantity. So, a tax on that market would actually increase total welfare (once you factor in the externality). However, that still leaves the deadweight loss in the EV market.

You could also argue that the EV market has a positive externality, since EV use reduces the number of high-emissions vehicles, and so too few EVs are traded relative to the welfare-maximising quantity. So, a subsidy on that market would actually increase total welfare (once you factor in the externality).

However, you couldn't argue that both of those things are true, since you would be double-counting the externality. Either there is a negative externality of high-emissions vehicles, or a positive externality of EVs, but there can't simultaneously be welfare increases for both of those things.

Mark Kleiman, 1951-2019

Normally on this blog I only mark the passing of famous economists, but I'll make an exception for Mark Kleiman, who was a professor of public policy at NYU, and was most famous for his work on drug policy. In fact, I referenced a blog post by Kleiman in a post last year on the economics of fentanyl.

Gabriel Rossman at National Review has an excellent article that captures some of Kleiman's key contributions:

Market failure and high transaction costs are policy successes when the commodity is poison, and so good policy means encouraging bad market design. For instance, Kleiman favored a noncommercial approach to marijuana decriminalization precisely because he expected nonprofit or state-operated dispensaries to be less efficient than for-profit firms, and in particular less likely to grow the user base through advertising and make intense use more convenient. The billboards advertising dispensaries, and even marijuana delivery, that saturate Los Angeles are exactly what Kleiman thought sensible decriminalization should avoid.

But just as good market design has to be careful, so does deliberately bad market design. A major argument in Against Excess is that if you make selling drugs risky by locking up drug dealers (or encouraging them to shoot each other over territory), you build in a risk premium to the price, which draws in suppliers who don’t mind risk. The better approach is to create a deadweight loss so you don’t encourage more supply. For illegal drugs, make it a time-consuming hassle to score. For legal drugs like tobacco and alcohol, impose stiff excise taxes. In both cases the consumer faces costs that do not benefit, and therefore encourage, sellers. These costs might not discourage addicts in the short run, but long-run demand is relatively “elastic”: Increased costs from hassle or taxes can discourage potential users from starting and encourage existing addicts to quit.

Those are insights that I have used in my ECONS101 and ECONS102 classes. Rossman also highlighted some additional contributions that I probably should make more use of:

Jointly tackling mass incarceration and crime was the aim of his most famous book, When Brute Force Fails. At a theoretical level, the book is an argument that Gary Becker’s economic theory of crime must be radically reconceptualized in light of behavioral economics. Becker argued that deterrence was the expected value of punishment, defined as the probability of punishment times its severity, which has the practical upshot that we can achieve deterrence by punishing infrequently but severely. However, behavioral economics suggests that people aren’t good at reckoning unlikely-but-severe outcomes — and if ever there were a group of people who live for the moment and ignore the future, it would be those who are either intoxicated or addicts looking to score. (Contrary to popular myth, relatively few prisoners are incarcerated for non-violent drug offenses, but many violent and property offenses are committed while intoxicated or to acquire money for drugs.) This implies that a ten-year prison sentence won’t have much more of a deterrent effect than a five-year sentence would. In practice, extremely long sentences serve not to deter crime, but to induce plea bargains and incapacitate criminals throughout their prime-offending young years — and beyond.

When Brute Force Fails is an important book not just for contributing to a theoretical dispute, but also for its empirical evidence and practical solution: mild but extremely consistent punishments, the opposite of Becker’s approach.

Given that I make a lot of use of Becker, and of behavioural economics, the juxtaposition of the two seems like something that would work well in future.

You can read more about Kleiman in this article by German Lopez on Vox, and here is the New York Times obituary.

[HT: Marginal Revolution]