A common argument against free trade is that when companies find it more profitable to move production overseas, they do, resulting in closed factories and unemployment at home. Economists have argued constantly, and accurately, that this is a good thing. More efficient production of goods means lower relative prices which means that everyone is a little bit richer in the long run. The unemployed can then go on to work in fields where they are more efficient producers.
This argument doesn't really ring true with the common laid off employee though. The sudden loss of income doesn't really led itself to the idea of "Congratulations! You're now richer and able to produce more efficiently!" What would be ideal is immediately after being laid off, the now unemployed worker would be either directed to a new job, or directed to new training for a different field while still being fiscally supported.
To a certain extent, this already happens. Many unemployed, especially in good times, quickly find new jobs, and unemployment insurance helps the rest get by while they're going through training or until they get reemployed.
However, in times like these, it's easy to notice that our system doesn't go far enough. Some individuals find their unemployment insurance lacking or even nonexistant, and many qualified indivuals don't bounce back as readily when unemployment is at 12% than they did when it was at 6%.
Having thought about this problem for roughly five seconds, I suggest that when a factory closes down and it's employees are laid off, a guidance counselor of sorts is sent with the resources to help the newly unemployed either find new jobs or direct them to the most beneficial training while simultaneously helping them make ends meet until they are reemployed.
The trouble that comes to mind is who will pay for it? If each company does it on a voluntary basis, then the practice will die out as soon as it begins, as the companies that do it find themselves at a disadvantage compared to the companies that don't.
Likewise, making it compulsory but still funded by the companies who are laying off the employees sounds tempting, but it perverts the incentives of the free market by making it more costly to move production overseas and therefore making US companies less competitive globally.
Asking the individual employees to take out loans to foot the bill seems unreasonable, but doable. Even assuming that banks would be willing to make reasonable loans to the unemployed, it ignores the psychological but real toll of going heavily into debt - something that most people would rather enjoy.
Asking local governments to foot the bill also seems counterproductive - the program would be expensive so local taxes would have to rise, scaring away more companies, adding to the cost, forcing taxes to rise even more, and the cycle continues.
Finally then, we are left with making the program part of federal policy. In theory, I'm not opposed. We can toss the cost on the deficit, and as long as it pays off at a higher rate than our debt (which overall, it will), than it will be worth it (see my previous post on deficits). The danger is in its becoming a bloated bureaucracy.
Perhaps the ideal compromise would be that unemployed individuals could take out the loans from the federal government at low rates (say, what the government's current interest rate is). That way, the individuals get reeducated and their ends are met, our economy improves, and the government doesn't lose any money (except for those who default on their loans).
Friday, September 30, 2011
Wednesday, September 7, 2011
Giffen Goods, Production, and the Great Depression
"They increased their output in an effort to make up for lower prices..." - John Garraty, The Great Depression, pg 60
Two of the fundamental laws of microeconomics are the law of demand and the law of supply. The law of demand simply states that ceter paribus (all things being equal), an increase in price leads to a decrease in the amount purchased and that a decrease in prices leads to an increase in the amount purchased. Similarly, the law of supply states that an increase in price leads to more of that good being produced and a decrease in price leads to less of that good being produced.
The concept of a Giffen Good, a good that violates the law of demand by having an increase in the price lead to an increase in the amount purchased, was first stated by Alfred Marshall in the 3rd edition (1895) of Principles of Economics: As Mr. Giffen has pointed out, a rise in the price of bread makes so large a drain on the resources of the poorer labouring families and raises so much the marginal utility of money to them, that they are forced to curtail their consumption of meat and the more expensive farinaceous foods: and, bread being still the cheapest food which they can get and will take, they consume more, and not less of it.
Despite the reference, we have no other evidence that Robert Giffen actually wrote or said that idea at any point. The funny thing about Giffen Goods is that even though they are mathematically possible and intuitively they make some sense, there's little evidence that they actually exist.
For a good to be a Giffen Good, it must meet the following conditions. First, it must be an inferior good. An inferior good is any good the consumption of which decreases as income increases. A good example is Ramen. Grad students eat it by the truckload when they're poor, but when they become tenured professors, they never touch the stuff again. Second, there must be no easy substitutes for that good, so, if we assume Ramen is a Giffen Good, there can't be, say, Easy Mac as another option. Third, expenditure must be a significant portion of income, but not so significant that normal goods aren't consumed. So, imagine this scenario. A grad student can only buy steaks or ramen to survive. He has $100 a month to spend on food. He needs a combined total of 10 steaks or ramen to eat. If Ramen is $5 and steaks are $15, then he can buy 5 of each. However, if Ramen goes up to $10, he ends up buying 10 Ramen, as he needs to eat. Despite the price increasing, he has spent more on Ramen.
Again, both intuitively and mathematically, this works. Finding real world examples, however, is much more difficult. Largely, this is because most real world data deals with aggregates, and aggregates tend to average out income inbalances, whereas Giffen Goods largely describe specific situations of poor individuals. The important point to hammer home is that we have a way to violate the law of demand, even if it only works in very specific situations.
Switching gears a bit, nearly every account of agriculture during the Great Depression includes a line similar to the quote at the top of the page. Whether it be rubber farmers in Indonesia or wheat famers in the Great Plains, almost all accounts agree farmers, when faced with lower prices for their crops, increased output. Again, intuitively, this makes sense. A farmer has bills, he pays his bills by selling crops, if his crops sell for less, he needs to grow more.
Economically though, this makes no sense at all. In economics, it is assumed that someone continues producing until the marginal cost equals the marginal benefit. If the costs remain the same, and the benefit is decreased, then the worker will produce fewer goods until marginal cost equals marginal benefit again.
So, if farmers really did produce more during the Great Depression as prices fell, either farms became vastly more efficient during the depression and costs fell dramatically, or the laws of economics quietly snuck out the back door and shot themselves.
Two of the fundamental laws of microeconomics are the law of demand and the law of supply. The law of demand simply states that ceter paribus (all things being equal), an increase in price leads to a decrease in the amount purchased and that a decrease in prices leads to an increase in the amount purchased. Similarly, the law of supply states that an increase in price leads to more of that good being produced and a decrease in price leads to less of that good being produced.
The concept of a Giffen Good, a good that violates the law of demand by having an increase in the price lead to an increase in the amount purchased, was first stated by Alfred Marshall in the 3rd edition (1895) of Principles of Economics: As Mr. Giffen has pointed out, a rise in the price of bread makes so large a drain on the resources of the poorer labouring families and raises so much the marginal utility of money to them, that they are forced to curtail their consumption of meat and the more expensive farinaceous foods: and, bread being still the cheapest food which they can get and will take, they consume more, and not less of it.
Despite the reference, we have no other evidence that Robert Giffen actually wrote or said that idea at any point. The funny thing about Giffen Goods is that even though they are mathematically possible and intuitively they make some sense, there's little evidence that they actually exist.
For a good to be a Giffen Good, it must meet the following conditions. First, it must be an inferior good. An inferior good is any good the consumption of which decreases as income increases. A good example is Ramen. Grad students eat it by the truckload when they're poor, but when they become tenured professors, they never touch the stuff again. Second, there must be no easy substitutes for that good, so, if we assume Ramen is a Giffen Good, there can't be, say, Easy Mac as another option. Third, expenditure must be a significant portion of income, but not so significant that normal goods aren't consumed. So, imagine this scenario. A grad student can only buy steaks or ramen to survive. He has $100 a month to spend on food. He needs a combined total of 10 steaks or ramen to eat. If Ramen is $5 and steaks are $15, then he can buy 5 of each. However, if Ramen goes up to $10, he ends up buying 10 Ramen, as he needs to eat. Despite the price increasing, he has spent more on Ramen.
Again, both intuitively and mathematically, this works. Finding real world examples, however, is much more difficult. Largely, this is because most real world data deals with aggregates, and aggregates tend to average out income inbalances, whereas Giffen Goods largely describe specific situations of poor individuals. The important point to hammer home is that we have a way to violate the law of demand, even if it only works in very specific situations.
Switching gears a bit, nearly every account of agriculture during the Great Depression includes a line similar to the quote at the top of the page. Whether it be rubber farmers in Indonesia or wheat famers in the Great Plains, almost all accounts agree farmers, when faced with lower prices for their crops, increased output. Again, intuitively, this makes sense. A farmer has bills, he pays his bills by selling crops, if his crops sell for less, he needs to grow more.
Economically though, this makes no sense at all. In economics, it is assumed that someone continues producing until the marginal cost equals the marginal benefit. If the costs remain the same, and the benefit is decreased, then the worker will produce fewer goods until marginal cost equals marginal benefit again.
So, if farmers really did produce more during the Great Depression as prices fell, either farms became vastly more efficient during the depression and costs fell dramatically, or the laws of economics quietly snuck out the back door and shot themselves.
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