Economics News Blog
In this blog I write about newspaper stories that relate to topics I teach in my economics courses. Sometimes, the articles are clearly about economic policy, but sometimes the articles are on subjects as strange as peanut butter. I decide to write about a news story and its applications of economics when I find that some economic theory can bring some more light to an issue. I might also choose a news story if it helps bring some economics to life. Many of these blog entries are mine, but on occasion some may be submitted by my economics students, or co-authored with them.
Disclaimer: I am a professor of economics but I make no claim that anything I write in this blog is correct. Do not cite without permission.
Monday, February 23, 2009
Countries Rush to Add Trade Barriers, but Economists Do Not Agree
This blog entry is about the following pair of articles:
The first is a commentary by New York University economics professor Dr. William Easterly pointing out that while economists are finally agreeing that the United States and much of the world is experiencing an economic recession, economists are also agreeing that putting up legal barriers to conduct commerce will make problems worse. Economists that are free market advocates are typically not hard to come by, but Dr. Easterly also cites a Harvard University economist, Dr. Dani Rodrik, an academic who describes his own views of economic development and globalization as unconventional. Dr. Rodrik has openly critiqued some proposed benefits of international trade, but in his December 31, 2008 blog he warned that the costs of raising barriers to international trade are especially large given the current state of the economy. Dr. Easterly also cites a group of economists that includes people with all sorts of political and academic ideologies that signed a formal statement warning world leaders of the negative consequences of undoing market deregulation laws that have allowed markets to operate more freely in the past couple decades. Some have suggested that these deregulation polices have made our economy more susceptible to volatile swings and market failure, but economists are suggesting these have allowed for more economic growth, and shutting down such policies will reduce production and consumption possibilities, worsening the recession.
The recent actions of world leaders, described in the Wall Street Journal (WSJ) article by John Miller, suggest that many economists' advice are falling on deaf ears. The economic stimulus package signed by President Obama includes "buy American" clauses. These clauses say in many instances, those receiving assistance from this new legislation must buy American made products, even when imported goods provide less expensive alternatives. The European Union (EU) has barred imports of Chinese screws and bolts, arguing that China is dumping them below cost to drive out European producers out of the market. The EU has also recently restricted imports on U.S. chicken and beef. In retaliation, he U.S. said it plans to increase tariffs on Italian water and French cheese. Russia has introduced 28 new measures to raise tariffs and increase subsidies on its own exports, arguing that the measures are necessary to allow Russian companies to survive the recession.
The WSJ article points out that, tempting as it may be, it is not yet time to be making comparisons with the great depression and the Smoot-Hawley tariff act, which raised tariffs to 60% on almost one third of U.S. imports, creating an average tariff of 20%. Many have argued that putting up this incredible barrier to trade caused the United States to sink deeper into the Great Depression. The WSJ article talked to Fredrik Erixon, director of ECIPE, a trade policy think tank in Brussels. Mr. Erixon said that world leaders will not go to these measures again. He said that policy makers now understand that such actions are "illegal and immoral".
I think many economists would actually disagree with Mr. Erixon. Protectionist trade policies may illegal, but laws can be free to change. Moreover, economists are not saying preventing free trade is immoral, they are saying such policies cause more harm than good to the countries that enact them. It is not a question of ethics, it is a question of intelligent economic policy. When the U.S. puts a tax on Italian water and French cheese, it not only hurts Italian water makers and French cheese makers, it hurts U.S. consumers who want to buy water and cheese. It even hurts U.S. consumers who are currently buying American-made cheese. The tax on French cheese reduces the supply of cheese in the U.S. Facing the same demand, this causes an increase in the price of cheese. This is the detrimental effect of trade barriers: when a country enacts these policies (presumably to help its struggling economy), it makes goods sold in the country more expensive, and causes the consumer's dollar to not go as far as it could. This is particularly painful when there is a recession with incomes down and unemployment up.
Moreover, even the threat of raising trade barriers reduces international trade and therefore increases the prices consumers pay for goods. The article mentions that Italian water companies have spent millions of dollars in the United States to get FDA and Kosher certification for their products. If tariffs are imposed on imported Italian water, then Italian water companies will not see the returns they expected on this investment. Now the general movement across the world to raise tariffs threatens all international trade, even among goods that are currently trading without legal barriers. The possibility that the U.S. government will impose future tariffs is preventing current investment by foreign companies in the United States. This reduction in supply again causes prices to increase, even for American made goods.
It is not hard to find pointing fingers in the news for the cause of the current economic downturn. Popular choices are financial institutions that took excessive risks providing mortgages, homeowners that took larger mortgages than they should have, low interest rates in 2003 that made this possible, new types of assets that made getting rid of these investments easier, lack of regulation that made these assets possible, imperfect information and economic uncertainty that caused credit markets to freeze among these problems, and the list goes on and on. While there is a lot of disagreement about what caused our troubles, what has never been seriously blamed is openness to international trade. Trade is instead like the bloodstream of a global economy, allowing for growth and a healthy movement of goods, services, and assets around the world. Cutting off the blood flow is no better a prescription for economic policy makers than it is for doctors.
Saturday, February 21, 2009
"Wal-mart Forecasts Gains as Rivals Stumble," by Karen Talley and Ann Zimmerman, Wall Street Journal, February 18, 2009.
Wal-mart appears to being doing well despite economic recession hurting businesses nationwide, including some of Wal-mart's competitors like Target and Costco. Wal-mart reported a 1.7% increase in quarterly sales, and its chief financial officer predicts its earnings per share will rise by 6% during 2009.
The United States currently has high and growing unemployment as the country continues to suffer with an economic recession. According to the Bureau of Labor Statistics, in January unemployment grew from 7.2% to 7.6%. This number alone does not reveal the extent of economic hardship. Businesses across the country are handing out smaller and fewer raises, and many businesses, especially those in the service sector, can cut down on labor costs by cutting hours, causing lower incomes for hourly employees.
As a consequence of lower incomes, demand for many types of consumer goods have decreased, but not so much for many of Wal-mart's goods. Economists refer to these types of goods as inferior goods. The term may be unjustly cruel, but it simply refers to goods whose demand increases when a consumer's income decreases. As a result of lower incomes, people have made their dollars go farther by foregoing some of their usual purchases and shopping at Wal-mart instead. For example, instead of eating out so much in restaurants, people are buying more of their food from Wal-mart. Instead of buying as much fashionable brand-name clothing, more people are buying the less expensive clothes at Wal-mart. Even goods that economists do not consider to be inferior goods may be selling well at Wal-mart. For example, the article mentioned that Wal-mart is bringing in more brand-name electronics to attract "affluent consumers" who nonetheless are worried about declining incomes. When people think of inferior goods, they often think of goods like used clothing and Ramen noodles, not flat panel giant screen televisions. Indeed, I did not purchase my first big flat panel TV until my income increased with first well paid steady job. However, for those consumers who are seeing high incomes becoming somewhat smaller, it may now be more attractive to buy a fancy TV from Wal-mart, instead of a very fancy TV at places like Best Buy or Sharper Image.
Of course, not all of Wal-mart's goods are inferior goods. If the recession deepens, Wal-mart's success with its inferior goods may not offset a decline in its other sales. Moreover, when the United States pulls out of this recession and incomes start rising again, I would expect Wal-mart will be enjoying growth in its sales along with its competitors.
Tuesday, February 17, 2009
"Makeshift Cuisinart Makes a Lot Possible in Impoverished Mali" by Roger Thurow. Wall Street Journal, July 26, 2002.
This article is about a new invention that is beginning to be used in impoverished African countries such as Mali. The invention is a grain and nut grinder and blender, specifically designed to be used by rural African women, that can turn 15 pounds of recently harvested peanuts into peanut butter in about 10 minutes. Before this machine came to the village of Sanankoroni, Mali, women made their living by manually grinding peanuts, corn, and grains for days before being able to sell the product at the market. This new technology makes the process extremely more efficient, freeing up an incredible amount of time for the women in the village.
What has resulted is not only more peanut butter for the village, but more of everything. Since the introduction of the machine, girls that used to stay at home helping with the grinding are now attending school, mothers and grandmothers are taking literacy courses, and more women are spending their time expanding farming plots. Using the proceeds from the invention the town has for the first time invested in lights across the village. With the village and buildings now equipped with light, businesses can stay open longer, and a midwife reports healthier babies are being born as delivery complications are more likely to occur when working in the dark.
This article is a classic demonstration of a movement in the production possibilities frontier (PPF). The production possibilities frontier shows what combinations of production of goods are possible when all resources are used efficiently. Figure 1 shows a hypothetical PPF for Sanankoroni with Peanut Butter (and other products made by grinding nuts, grain, and corn) on the horizontal axis and all other goods on the vertical axis. Points on the PPF are possible when the village uses all its resources most efficiently. Points inside the PPF are possible, but not efficient. Points outside the PPF are impossible with existing technology.
What happened in Sanankoroni was a drastic improvement in technology for peanut butter. The ability to produce much more peanut butter and similar goods shifts the horizontal intercept of the PPF to the right. Point A on Figure 2 indicates how much peanut butter the village can produce if it decided to allocate all its time and resources to peanut better. With the improved technology, this point shifts outward. There is no initial shift in point B. This point represents how much of all other goods can be produced if the village made absolutely no peanut butter (and similar goods that use the new invention). If these goods are not being produced, the invention is not being utilized, therefore the village is no better off.
With simply an increase in the technology for peanut better, the village can produce more of everything. It can move from a point near point A on the original PPF to point C on the new PPF which results in not much more peanut butter, but more of all other goods. This improvement in lifestyle was in fact the motivation behind the invention.
Finally, the future may show that the introduction of this invention will shift the PPF outwards at both intercepts. The article mentions some of the new things the village is enjoying include education, literacy classes, and lighting, which leads to improved productivity for other goods. These investments will likely lead to greater production possibilities of all other goods, which will shift the PPF outwards and lead to a higher standard of living for villages like Sanankoroni.