Extraordinary Observations

Policymakers have been trying to come up with solutions to the problem of suburban sprawl for years; and yet, the solution is so easy and so obvious and is finally now coming to fruition. So how do you stop rich people from fleeing cities for mansions way out in increasingly distant suburbs? Make it too expensive and too inconvenient to commute significant distances on a daily basis. Duh.

NPR ran a great story about home prices in Washington DC. As you can probably guess, the biggest drops in prices occurred in suburbs way outside of the beltway. Some of these suburbs are so far away and so inconvenient that it can take 90+ minutes each way to commute to Downtown Washington. In those places, home prices are double-digit percentage slides, supply is overwhelming the market, fire sale auctions are failing to liquidate the properties, and construction has come to a grinding halt. And interestingly enough, properties in the city of Washington have increased by a median value of 3.2%, and some homes near Washington’s famous Metrorail stations are up close to 10%.

Of course, the casual observer could argue that Washington DC is a unique story, as few cities in this country can rival the convenience and usefulness of Metrorail (although New York City, Chicago and the San Francisco Bay cities probably come close). Nevertheless, even in cities with mediocre public transportation systems and weak economies, the same phenomenon is occurring. In my hometown, Cleveland Ohio, I’ve contended for some time now and still believe that downtown real estate is the only worthwhile property investment in town. While the Greater Cleveland area has been the poster child for the housing meltdown and foreclosures, downtown has been relatively unscathed, and is arguable the only part of the city where you can still find construction and development taking place. With the long-awaited Euclid Corridor project finally coming to life, once the housing market bottoms and the tides start to turn, the urban downtown, midtown, and University Circle neighborhoods are the first places where I expect to see development into the future – not the suburbs 15, 20, and 30 miles away from the city, which seemed to become wildly popular in the 90s.

A final takeaway from the NPR story is a quote from an economist who works on the Case-Schiller Home Price Index, as he says, buyers are finally asking questions like, "What is the cost of gasoline? What is the cost of my time?" These questions become easier to understand when viewed over a longer time frame. For instance, someone who lives in a suburb 30 miles from a major city, commutes one hour each way to and from work, and spends 2 hours per day in the car will spend 10 hours per week, and about 500 hours per year driving; that means every year this person spends over 20 full days doing nothing but driving a car; if you make the same calculation using 16 hour days (assuming the average person is asleep 8 hours per day), the number jumps to over 30 days per year. The value of that time has to be worth something, and finally, we’re beginning to figure that out.

John McCain’s proposal for creating a “tax free gasoline holiday” is laughably atrocious. I realize that my opening sentence just offended 99 out of 100 average Americans, but allow me to present my argument and take a few moments to think about it before automatically concluding that I’m totally off my rocker.

The economics of gasoline production are painfully complicated and I admit, I possess far from a complete understanding of it. That said, I feel that my knowledge of the subject is strong enough to draw a few basic conclusions. Many Americans don’t know that gasoline and crude oil are distinct commodities. Crude oil is pulled up out of the ground and by itself, is relatively useless. Crude needs to be converted into usable products before we consume it for energy. Oil giants like Valero, Chevron, and BP operate refineries that take crude oil and refine it into gasoline, diesel, kerosene, asphalt, and other useful products.

As demand for products like gasoline grows, refineries take more crude oil and crank out more refined products. The problem is that there is a finite capacity at which these refineries can produce, and we’ve just about reached it. That means that as demand for gasoline increases supply is unable to keep up the pace – creating a supply shortage and driving up prices. Think about it, the reason why gasoline prices are historically higher in the summer than in the winter is because Americans consume more gasoline in the summer; refiners, unable to keep up with the demand, simply raise their prices to compensate for the shortage. In the winter, refiners start operating below capacity again and traditionally supply/demand equilibrium can be reached.

So what happens when you eliminate the federal gasoline tax between Memorial Day and Labor Day as McCain proposes? Well… since demand is high and drivers are willing to pay the (arguably) absurdly high gasoline prices, and since refiners are maxing out capacity, when the gasoline tax is eliminated, refiners will simply raise their prices to fill in the gap. Effectively, revenue that was previously going to the federal government will simply shift to the bottom lines of these corporations. If McCain’s goal is to pad the profits of oil refiners, then his policy is great; if his goal is to help ailing consumers, then his policy is terrible. Ironically enough, politicians in this country love to bash oil companies for windfall profits and make empty promises to supply Americans with gasoline at below market prices, and their policies tend to do exactly the opposite.

Of course, there are other negative consequences. America’s bridge and road infrastructure is decaying at an alarming rate. Where does a substantial portion of the money for bridge and road repair come from? You guessed it, the federal gasoline tax. And don’t forget the fact that burning carbon is incredibly bad for the environment; but that is a topic worthy of its own discussion, and not necessary to prove my point that McCain’s policy is a disaster.

Why not just build more refineries in the United States, you might ask? The answer is the classic “not in my backyard” problem. Oil refineries are big, dirty, polluting machines. Nobody wants to live near an oil refinery, and as far as politics and economics goes, the well being of a few frequently outweighs the well being of many. Why? Because 5000 residents in small-town Texas, who will have to live near the refinery and whose lives might ultimately be destroyed because of it, care significantly more about keeping the refinery out than the millions of Americans who will save pennies on their next fill-up. These small town Texans will do everything in their power to lobby congress and local government to keep the refinery away from their homes; the consumers who would benefit from the refinery will lobby very little (if at all).

For a long time I’ve harped on this blog that gasoline prices are too low and we should raise gasoline taxes, not slash them. I stand by that contention. It certainly isn’t a popular position, but it is necessarily for the long term stability of our country, which due to half-baked policies like McCain’s, is growing increasingly unstable. The reason that gasoline taxes work is that it increases the cost of driving at the margin. Each time you get on the road you have to ask yourself whether or not that extra mile is worth it, increasingly the answer is “no” – and that is exactly the point. It doesn’t matter how much you love your big bad truck, the world is changing in a way that makes driving that guzzler unsustainable.

If you believe in markets, you should be in favor gasoline taxes. Some might say such a statement contradicts itself; after all, free market capitalists hate taxes. However, this is only true in a world free of externalities. Realistically, given the external costs of consuming gasoline, the real cost of a gallon of gasoline is significantly higher than what we pay at the pump. To many, this concept goes in one ear and out the other, but for Harvard economist Greg Mankiw and dozens of academic economists who support gasoline consumption taxes, it makes perfect sense. Gasoline taxes bring the price we pay closer to the fair market price (factoring in external costs). If you believe in markets then you already know that over time we will come up with solutions to rising energy costs; the question is whether the transition will gradual or painfully abrupt. Slashing gasoline taxes and encouraging dangerous behaviors like McCain proposes will make the ultimate transition much harder and more painful than anything we’ve experience thus far.

Central Ohio’s economy recently lost one of its favorite new companies as maverick airline Skybus recently announced that it was throwing in the towel, less than a year after taking to the sky. In reality though, the day of reckoning should have been painfully obvious to the casual observer. In fact, a mere 10 months ago, I blogged about the coming demise of this silly maverick airline.

That isn’t to say that Skybus was a complete disaster; in the last month in operation, it edged out Southwest as the busiest carrier at Port Columbus Airport. Of course, its collapse ultimately comes as a big blow not just to Skybus employees, who found themselves abruptly out of work, but also for Columbus travelers, who now find themselves with significantly fewer options for travel out of Port Columbus. Earlier this year, JetBlue decided to ditch the Columbus market entirely, as other carriers reduced service. It isn’t clear if those carriers will pick up Skybus’s slack, but even if they do, the short term damage has already been done.

So as Skybus joins the graveyard of failed airlines, I’m sure that back in New York, a group of Wall Street cowboys are cooking up plans for the next eccentric airline to hit the skies. In an attempt to learn from the mistakes of the past, I’ve put together a short list of lessons that I hope these guys can take to heart.

Lesson One: An airline can only make money if it controls its fuel costs. I’ve been harping about this issue on this blog for years. The cost of fuel is in an uptrend and will continue to rise until the world comes up with some reasonable alternative. Fortunately for individuals, we can adjust our lives to compensate for these challenges. Moving closer to work and reducing travel is the best way to offset rising energy costs; changing the type of vehicle we drive is another method. Airlines, unfortunately, do not have this luxury. Commercial jets are gas guzzlers and there isn’t exactly a Honda Civic style aircraft that these guys can switch to in the next upgrade cycle (sans the Boeing 787 Dreamliner, which won’t be available for years in the future). Additionally, for logistical reasons, airlines fly whether their planes are completely full or nearly empty. Running an airline and hoping fuel prices will stay in an affordable range is as good of a business strategy as taking the company’s money to Vegas and sticking quarters in slot machines – you might have a few good hours of play, but over time you will lose everything.

Lesson Two: Alternative airports don’t always make sense. Proponents of smaller, regional airports often point to Southwest Airlines and their embrace of the smaller airport. A closer look at Southwest’s strategy reveals that it only makes sense in some instances. In Dallas, Houston and Chicago, for example, Southwest flies into Love Field, Hobby and Midway, respectively. The key is that these are not just smaller alternative airports, but they are also closer to the city than the larger, international airports, Dallas/Fort Worth, Intercontinental, and O’Hare. In the northeast, Southwest services Manchester, Providence, and Long Island; but its market performance in places like Boston and Manhattan is considerably weaker than the competition. The point is that some alternative airports have the added benefit of also being more conveniently located – others don’t. Skybus attempted to use alternative airports that were located in the boondocks of major cities with inconvenient access to the major city. Even if Skybus could offer the best fare to a city like Gary, Indiana, for example, the price I’d pay in cash and time to get myself into Chicago certainly doesn’t make it worth it. Some consumers were willing to pay it – but obviously not the ones that were willing to pay for the convenience of traveling into the city they need to visit. Most airlines have figured this out, which leads me to…

Lesson Three: Know your customers. The truth is that Skybus tried to market its product to an audience that was gullible enough to fall for the “10 fares for 10 dollars” hype. These are people that are so cheap that they will do anything and everything in their power to save a buck. I don’t quite understand how Skybus, then, expected to generate substantial revenue by peddling all kinds of random crap on the aircraft. Honestly, I do not know exactly how good or bad merchandise sales were on Skybus flights, but certainly they weren’t good enough. As most airlines have learned by this point – the real revenue is made on business travelers, who are willing to pay up for amenities, exactly those which Skybus attempted to strip out to keep its fare prices so low.

On a final note – I do find it ironic that the founder or Skybus retired just weeks before the company went bankrupt in order to “pursue his novel writing career”. I think he might have confused fiction with reality when he started Skybus, as it really does seem surprising that this airline actually existed for any period of time.