Rigorously Inaccurate Economic Models

I’ll have to begin this post with a disclaimer: Animal Spirits (by Akerloff & Shiller) is my jam.  I once thought I was headed toward a career in social science research, only to be frustrated and repelled by the frequent sacrifice of real-world application in favor of scientific rigor or academic prestige.  Therefore, when I read an author arguing that the human element needs a greater presence in our study of economics, I feel a certain “You had me at hello” sentiment coming on.

Additionally, I tend to fall strongly within the Keynesian school of thought with regard to public economics and financial policy.  As such, as I read the first few chapters I am both wholeheartedly enjoying the text and cognizant of some potent confirmation bias at work.  Now that you’re aware of the fine print on my take, here’s where I’ve seen evidence of the validity of Akerloff and Shiller’s argument with respect to sustainable development in Seattle:

1) We won’t achieve broadly “green” sustainable residential development until housing prices come down.  “Lindahl pricing” is an economic theory that, while certainly useful and groundbreaking, would benefit from a greater behavioral economics component.  Lindahl pricing argues that we assign values to the features of the things we buy.  For example, if most Seattlites are willing to pay $100/month more for an apartment for a dishwasher than one without, Lindahl argued that the value of having a dishwasher in Seattle is ~$100/year.  This gives landlords information they can use to more effectively price their rental units.   This can also apply to less tangible features (appearance of the exterior, proximity to a grocery store, etc.).  In a relatively environmentally-conscious city such as Seattle, the eco-credentials of an apartment could considerably have a considerable monetary value.  With high-and-rising housing prices, however, renters are so focused on simply finding a unit within their purchasing power that their capacity to consider high-efficiency appliances or double-paned windows is diminished.  Having a “green” apartment, at present, generally has a greater moral value (living according to one’s values) that it does monetary (energy savings).  As the pricing pressure goes up and the competition among renters to secure a place they can afford, the priority of such features falls relative to pure financial considerations *and* the fear of not locking down an apartment before the prior lease expires.  Lindahl’s pricing model is rather rigid, but individual financial and psychological circumstances will affect the capacity for Seattle to value green residential development going forward.

2) The economic effects of raising the minimum wage are highly moderated by psychological and sociological impacts.  For many years, economists have suggested that significant increases in the minimum wage would cause three negative effects: A) inflation, B) unemployment, and C) increased demand for government assistance. In short, businesses would have to cut employees and raise prices in order to pay low-wage employees more. Those laid-off would apply for unemployment and other financial assistance, causing a greater drain on tax revenues, causing taxes to rise to salvage public budgets, all leading to a downward economic spiral. The scenario is fear-inspiring, but so far we’ve seen evidence to the contrary. In cities, states, and jurisdiction where the minimum wage has been raised in the past twenty years, we’ve seen several examples of minimal effects on inflation, job growth, and decreased demand for public assistance. We also have seen increased migration into these cities (as opposed to residents fleeing an inflationary, jobless wasteland) as people are attracted to a city with higher paying jobs and less urban poverty. Seattle is about to race ahead of most cities in the U.S. with its landmark minimum wage policy. I argue that this helps improve the resiliency of our economy and creates a more sustainable economic model for our city to build on.

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