Reddit Economics Network

Here ye, here ye, the Joint Committee on Finance, Infrastructure, Academia, and Technology is now in session. In this session of the FIAT committee, all are welcome to come and discuss economics and related topics. No RIs are needed to post: the fiat thread is for both senators and regular ol’ house reps. The subreddit parliamentarians, however, will still be moderating the discussion to ensure nobody gets too out of order and retain the right to occasionally mark certain comment chains as being for senators only.

Here ye, here ye, the Joint Committee on Finance, Infrastructure, Academia, and Technology is now in session. In this session of the FIAT committee, all are welcome to come and discuss economics and related topics. No RIs are needed to post: the fiat thread is for both senators and regular ol’ house reps. The subreddit parliamentarians, however, will still be moderating the discussion to ensure nobody gets too out of order and retain the right to occasionally mark certain comment chains as being for senators only.

Repost from yesterday but adding R1, apologies!

R1: Harris spends a lot of time talking about lowering food prices. This is bad economics because (a) it avoids the root of the problem, which is overconsumption, (b) lower food prices can impact farmers who already operate with tight margins, (c) ignores the fact that with the introduction of Ozempic and related drugs consumption will start trending down anyway leading to a squeeze on the industry (lower prices + less consumption), and (d) the economic damage, not to mention societal, of obesity is largely overlooked by both parties opting instead of short term fixes instead of long term planning.

Hope that does it, and thanks!

"Dear Vice President Harris:

Hungry Americans expect you to lower food prices the minute you are in the White House. However, this directive may not be necessary as the hunger issue will soon resolve itself. Thanks to Ozempic, Mounjaro, and Wegovy, food consumption will plummet so significantly that supply will far outstrip demand. Instead of grappling with inflationary prices, we will confront deflationary food prices!

Walmart US operations CEO John Furner revealed to shareholders a noticeable shrinkage in the overall shopping basket size among consumers taking these miracle medications. Facebook Ozempic Support groups illustrate how consumption of food and beverages has reduced by perhaps 25%. These drugs are soon to be available in a pill form that is both cheaper and more effective.

The New York Times recently reported that restaurants have trimmed their portions (https://www.nytimes.com/2024/09/24/dining/restaurant-portions.html). However, the drop in alcohol consumption means they can't lower their prices. Restaurants thrive on liquor sales."

Read the full post here.

Here ye, here ye, the Joint Committee on Finance, Infrastructure, Academia, and Technology is now in session. In this session of the FIAT committee, all are welcome to come and discuss economics and related topics. No RIs are needed to post: the fiat thread is for both senators and regular ol’ house reps. The subreddit parliamentarians, however, will still be moderating the discussion to ensure nobody gets too out of order and retain the right to occasionally mark certain comment chains as being for senators only.

The attached article purports to say that Australia's Central Bank rigidly adheres to the Phillips Curve in deciding monetary policy.

Nowhere does he acknowledge that the RBA's concern is that inflation is too high, and nowhere does he recognise that economists have known for decades that the Phillips Curve is a short run phenomenon only.

I'm a bit hazy on how seriously economists take the concept of the NAIRU, but it's not part of a cynical plot to keep unemployed labour hanging around depressing wages. It just reflects the fact that structural and frictional unemployment always exists.

https://www.abc.net.au/news/2024-09-24/rba-relying-on-outdated-theory-about-inflation-and-employment/104384014?utm_source=abc_news_web&utm_medium=content_shared&utm_campaign=abc_news_web

When the Bureau of Labor Statistics released the June unemployment rate in July, the American Institute for Economic Research (AIER) asserted that the new data "triggers the Sahm Rule". Dr. Peter St. Onge of the Heritage Foundation tweeted about "unemployment ... triggering the Fed’s dreaded Sahm Rule that says we are already in recession".

The Sahm rule indicator was at 0.43 in June 2024, below the 0.5 threshold identified by Dr. Claudia Sahm as a recession warning. AIER and Dr. St. Onge made the mistake of using monthly data in their calculation, rather than the 3-month averages set out in the Sahm rule formula. Neither AIER nor Dr. St. Onge has corrected the record even though the St. Louis Fed publishes data for the Sahm rule indicator.

It is true that the Sahm rule did trigger the following month. But, that is no excuse for being one month early by not checking the formula.

https://economystupid.substack.com/p/sahm-rule-says-us-economy-not-in

Here ye, here ye, the Joint Committee on Finance, Infrastructure, Academia, and Technology is now in session. In this session of the FIAT committee, all are welcome to come and discuss economics and related topics. No RIs are needed to post: the fiat thread is for both senators and regular ol’ house reps. The subreddit parliamentarians, however, will still be moderating the discussion to ensure nobody gets too out of order and retain the right to occasionally mark certain comment chains as being for senators only.

A recent article in HBR purports to make the case against the YIMBY movement. It will be worth our time to read through this argument, as we shall see that we have apparently reached the end of history whereas housing policy is concerned: YIMBYism, it would seem, is the only legitimate position remaining that can sustain itself throughout the course of a housing policy discussion, and even its putative critics here fast reveal themselves to be crypto-YIMBYs.

Let us begin our walking tour of their piece. The authors start by offering this, in my opinion, quite fair characterization of the YIMBY / pro-market stance:

The housing market can be repaired with the simple fix of liberalizing zoning rules and other public regulations allegedly strangling the supply of new homes, which they say will lead to an explosion in housing construction. Once the government gets out of the way, private actors will fix the problem themselves.

Fair play deserves fair play, so I will offer you a condensed (but I hope fair) characterization of their stance:

There’s another view, however, in which one underappreciated cause of runaway housing costs is the market power of developers and landlords — and more recently, software that allows them to leverage this power in unfair ways. [...] These [anti-trust issues related to the RealPage app] show the limits of a “trust the market” approach to housing policy. Research from around the world shows that more permissive zoning rules do not, by themselves, lead to a major increase in housing supply, let alone more affordable housing. The truth is that the market itself needs to be fixed. Specifically, any plan to overhaul the housing market needs to, first, confront the power of landlords to raise rents. Second, it requires rethinking public governance of housing markets beyond simplistic prescriptions to just free the housing market from government regulation, assuming lower rents will follow. And third, to that end, we need more — not less — muscular government involvement in housing, through price regulation, more robust planning, and even direct public provision.

The antitrust element of this argument is, of course, of no real interest to me or, I imagine, any reader here. True, the authors dedicated quite a bit of space to it -- there are 7 paragraphs that I am going to skip over that talk about it and the RealPage app prosecution. But I judge it as being of little interest since, at best, the anti-trust question is more or less orthogonal to the YIMBY policy agenda. There's nothing incompatible between the view "unleash the market: legalize housing" and "unleash the DoJ antitrust division: make the market competitive". If anything, one might imagine that busting whatever landlord cartels and collusion apps exist would be quite complementary to a neoliberal YIMBY agenda. If I'm going to have the market fix the problem, I would want to invest in making sure the market is competitive!

I imagine the authors of the article wouldn't really disagree with the above point. You might think they would. But actually, they sort of acknowledge my point above at the end of their 7 paragraph stretch on antitrust policy, and more or less dismiss antitrust as a solution to the housing cost problem themselves. In particular, they characterize it as an insufficient 'Econ 101' solution to the problem of high housing costs:

[...] At a minimum, antitrust enforcement and a ban on algorithmic rent-setting is required. But enabling more competition along the lines of what’s described in Econ 101 textbooks isn’t enough, because there’s little evidence that private developers alone will — or can — provide enough housing to fix this crisis.

Ah, well. I suppose their view is that antitrust activities are a noble enough diversion, but at the end of the day, something of a waste of time, given that markets don't really work anyway. How disappointing for us! It's also a bit odd to bring it up, then, since (a) they reckon it doesn't really move the needle, and (b) they note that it isn't really a part of the YIMBY agenda as they see it. But I suppose when you work for Matt Stoller's old haunt, honor obliges you to at least make a pitch or two for an antitrust being the solution to whatever problem happens to be at hand.

Anyway, with the perhaps obligatory antitrust shout out out of the way, they proceed to the meat of their argument against YIMBY-ism. Here it is, in condensed form:

The most extreme version of “trust the market” housing policy is the common refrain — popularly associated with the “Yes in My Backyard” (or YIMBY) cause — that zoning rules are a primary, if not the primary, cause of the present housing crisis. [...] This cause is commonly captured in the slogan “legalize housing.” The idea is to get out of the market’s way and let the drive for profit solve the problem.

Profit considerations, however, mean that more liberal zoning rules are at most necessary, but not sufficient, to increase the supply of housing. Just because private developers can build housing does not mean they will. Liberalization of zoning regulations appears to increase the supply of housing, but the effect is rather modest. [...]

The problem, generally, is that building housing is just one way to profit from a piece of land, and zoning reform tends to increase land values. [...] In many places, expectations of inadequate profits — not zoning — appear to be the primary constraint on further housing construction by the private sector, as profit-motivated corporations are reluctant to build. Developers sometimes acquire and “bank” tracts of land for the future and develop them when expected profits are higher. Alternatively, they may build luxury units and focus their efforts on the affluent. [...]

Upzoning alone is also a contributor to displacement. [...] With the lure of higher land prices, property owners evicted current tenants and sold their plots to developers, pocketing a tidy windfall. In these cases, upzoning did not produce affordable housing or even a net addition of housing. Instead, it resulted in the replacement of older residential buildings and small businesses with higher-end apartments, condominiums, restaurants, and retail. Families and business proprietors who had lived and worked in one place for decades were forced to uproot and resettle, [...]

So, in brief, their view is that:

1. Zoning reform is likely to be anemic in its impact - housing supply just doesn't respond much to zoning.
2. Zoning reform is anemic because building housing just isn't that profitable. You can reform zoning, but at the end of the day, developers will mostly prefer to speculatively buy land and sit on it, rather than go to the trouble of actually building something on it -- some maybe rare cases where they can put up an ultra-luxe building aside.
3. The one thing zoning changes reliably achieve is gentrification: rezone an area and you should expect housing supply to stay the same or fall, while everything becomes more expensive.

I suppose I could take some time to really engage with this set of arguments. For example, (3) seems to be mistaking the partial equilibrium effect of upzoning for its general equilibrium effect (at best - the part about housing supply falling as the 5-over-1s invade strikes me as puzzling). And the business about housing just being too unprofitable to bother with also struck me as a bit odd, though I am sure if I wanted to hear a clearer and more detailed recitation of the argument, I'm sure it exists somewhere in the minutes of every city council meeting, probably in the part of the agenda reserved for subsidy-begging by developers.

Really, though, I am not sure much discussion of the above is warranted, as when we read the authors' preferred solutions to the housing problem, I think we will learn that the authors themselves are not much impressed by their own arguments.

So, let's look at their proposals. We begin with, oddly enough, with the return of antitrust schemes:

First, the federal government, states, and private plaintiffs’ bar must vigorously enforce the antitrust laws against real estate entities. [...]

I mean, I'm all for it - but I thought that competition wasn't enough? That in a competitive market, private developers wouldn't - or couldn't - provide enough housing to fix the crisis? I sure hope this isn't the entire story!

But collusion is hardly the entire story. Antitrust and other laws against unfair business conduct should be used to stop myriad restrictive practices in housing and land markets. [...] Private home and community developers have long imposed restrictive covenants, which bar purchasers and all future owners from certain uses. Millions of homes are subject to these restrictions, [...] including ones that prevent the construction of multifamily housing, establish minimum lot sizes, and even restrict non-traditional households from living in a neighborhood. Often enforced by private homeowners’ associations, these covenants function as a form of private zoning, but enacted without public input.

Huzzah, using antitrust to stop collusion wasn't the entire story! It seems that a more complete vision of what antitrust policy can do is that we can use it to repair housing markets by implementing the simple fix of liberalizing zoning rules restrictive covenants, which will lead to an explosion of housing construction. The logic being that once the government your HOA gets out of the way, private actors will fix the problem for themselves.

Interesting. Well, what else have you got for me?

State, regional, and local governments must engage in public planning. [...] Uncoordinated housing construction can lead to traffic congestion and overburdened bus, rail, and school systems and even inadequate water supply and sewerage capacity. Further, planning can mitigate the harmful effects of upzoning done in isolation. It can promote economically and racially diverse communities and prevent mass displacement following upzoning.

When upzoning land, some cities try to capture a portion of the increased value through public benefits agreements. For example, [...] in Brooklyn, [...] Developers got their rezoning, in exchange for a broad range of public benefits, including a new school and affordable housing.

[...] A necessary part of planning is zoning reforms that permit the construction of more housing, without also creating easy profit opportunities for speculators at the expense of established communities.

So, to take stock, we're arguing that the YIMBY psychos are set to unleash a tsunami of new housing upon our great nation's unsuspecting neighborhoods that will be so large in magnitude that -- without the government pumping the brakes on things -- the new residents in your town will literally clog the sewers and prevent you from taking a shit in your own home. The good news, though, is that government planners can slow things down and make sure things are wisely planned out in a way that keeps you from having to switch to septic. Moreover, since the YIMBY development plan will be insanely profitable for developers, planners can shake them down for concessions -- the government can name its price, and get all the schools and whatever else it wants built, gratis, just by modestly imposing on developers' immense profit margins.

Now, perhaps you forgot, but this piece began by arguing that zoning reform is a busted flush, unlikely to yield even modest increases in housing supply, and that this is due in part to the fact that housing development projects are pretty low return and not really worth engaging in for developers even when legal.

I'm not really sure how we got from point A to point B here. Did the antitrust cartel busting stuff increase developers' profit margins a whole bunch? Am I to believe that the net effect of the restrictive covenants is greater than that of zoning more broadly? In fairness, I elided over the fact that the authors had a stray paragraph in the antitrust section talking about how rent controls are great -- maybe the rent controls are what would make development projects suddenly very profitable to engage in? How did we get from zoning reform as paper tiger to zoning reform as potent force menacing our sewers?

I suppose at this point I should step back and note that, in fairness, they have a few not-very-NIMBY things in this article. As mentioned, there's that paragraph about rent control. And they tack on 3 paragraphs at the end of the article about how the government should directly build more housing (good luck without YIMBY reforms). But, come on, the heart of this piece isn't there. All the meat, all the energy -- it's all about the odd blend of why pro-market initiatives (a) won't really work, and (b) will work so well they will create even larger problems that the government must be prepared to address.

So, like I said, I'm puzzled. I thought I was going to read about how the YIMBYs are chumps that took Greg Mankiw's textbook a little too seriously, and instead got some proposals for antitrust policies that complement the YIMBY agenda and received a stern warning that the YIMBY plan will produce housing at a pace that is too-fast-too-furious for America to handle.

That being the case -- why did I have to read this? Why did they want to write this?

I suppose a person might be led to speculate that this article is strictly an expression of affective discontent that YIMBYs, who code as neoliberal, seem to have snatched the baton of history on this issue, when it might have been more pleasing if the baton carriers instead coded as 'progressive'. From this speculative lens, one might reckon that the authors don't particularly disagree with the direction the YIMBYs are carrying the baton, some anxiety about sewerage capacity aside. Instead, they just wish that the YIMBYs were cooler -- which is to say, more like the authors in language and outlook. Strip the YIMBYs of their black socks and cargo shorts, give them the right indie band t-shirt, and they might be acceptable!

Of course, I would not endorse such speculation, because it would suggest that the Harvard Business Review was fooled into publishing a somewhat frivolous article that struggles with internal coherence. And how could I suggest such a thing of an august outlet with a history of publishing genuine bangers?

P.S. - I have skipped over a fun section buried in their case for government planning. It wasn't too relevant to the overall point, but let's consider it here on the B-side of this RI:

Federal planning is important as well. A common YIMBY refrain is that the current economic geography of the United States, and resulting housing crisis on the coasts, is primarily the product of the economics of agglomeration, in which the productivity of any given firm is a function of the number of other businesses also operating in the same place. The coastal cities where housing costs have exploded, the argument goes, are simply the most productive cities, which naturally attract the lion’s share of labor and capital. In this view, the role of policy is helping people “move to opportunity,” by building more housing for them in wealthy cities.

The agglomeration view, however, neglects other factors that have concentrated wealth in a few cities, such as monopoly power concentrating wealth on the coasts where the largest firms are located, and the powerful role federal policy has played in creating and entrenching the regional economies of places like Silicon Valley in the first place. (In the case of Silicon Valley, defense contracts and publicly-funded university research have played a key role.)

Really? The theory of the case is that agglomeration is fake, it's largely just about where the monopolists are located? And I suppose we are to think that antitrust policy is going to, what, smooth out the distribution of population across the United States? I mean, come on.

Urban economics has churned up just piles and piles of evidence for agglomeration. Here's one of my favorites -- they even pin down on a map the bars and other places where the agglomeration externalities are getting generated in San Francisco. And then there's the matter of leisure agglomeration. I might find a small town here or there that can offer me the opportunity to regularly attend ballets, or to eat well-prepared Szechuan food, or to send my kids to a school with an actually diverse student population, or to go to an electronic music show at 1am, or to go to a Korean spa, or to have a tertiary hospital nearby, or to go to a nice history museum, or to have a specialized job in the same general vicinity of many of my friends. At the end of the day, however, you're only going to get 'all of the above' in a city - and that helps drive demand for them. Somehow, I don't think antitrust policy will move the needle on any of this.

Now, in fairness, the authors do also gesture to the fact that they don't actually disagree with the agglomeration explanation for the desirability of cities. For example, they complain that UC Berkeley and other universities helped build up San Francisco. Well, university knowledge spillovers are a very classic agglomeration type thing - I doubt they would strike Jane Jacobs as out of place, anyway. And they probably work against monopoly power, since new competitors can always spring up in the form of university students with startups. So the authors seem to think the agglomeration view is a mere YIMBY refrain, blindered to the fact that monopoly power is what drives urbanization. But then just as quickly they cite factors driving city formation that are really just about the agglomeration story again.

I suppose this B-side RI of mine is a bit unfair - after all, I am making a lot of hay out of what is really a pretty brief chunk of text in the authors' article. One has to imagine that if they had more time to discuss the issue, they would have offered a more elaborate version of their argument. Perhaps they would ultimately have persuaded us that agglomeration is tosh, that it's all about monopoly power being concentrated in coastal cities, and that if we unleashed antitrust policy to work its magic, it would enabled untold amounts of productive spillovers between small firms in cities that would create a policy crisis (requiring government management) in the form of the American heartland depopulating to move to coastal cities.

Oh, to be fair to them, I should probably show you the conclusion they offered to this little agglomeration discussion:

Seen in this light, reforming housing policy to cram 10 million more people into San Francisco and New York in blind obedience to the laws of agglomeration is the wrong tool for the job, when directing industrial policy to create jobs and generate opportunities where people currently live is also on the table.

Ha! Well, good luck, babe!

Here ye, here ye, the Joint Committee on Finance, Infrastructure, Academia, and Technology is now in session. In this session of the FIAT committee, all are welcome to come and discuss economics and related topics. No RIs are needed to post: the fiat thread is for both senators and regular ol’ house reps. The subreddit parliamentarians, however, will still be moderating the discussion to ensure nobody gets too out of order and retain the right to occasionally mark certain comment chains as being for senators only.

Every year or so, someone writes the same article on the determinants of home prices, trying to argue that prices are more demand driven than supply driven (this time from Aziz Sunderji on substack). The argument goes like this:

1. Plot home prices or rent on the Y-axis and incomes on the X-axis
2. Observe that prices and incomes are extremely positively correlated
3. Note that the handful of cities off the line of fit can mostly be explained by very obvious amenities (hawaii and los angeles have great weather; minnesota has bad weather; new york is new york)
4. Don't cite rosen-roback
5. Conclude that prices and changes in prices are mostly demand driven, not supply driven, and that we should focus more on incomes than on changing zoning regulations. (In this case, pretty explicitly by saying: "But loosening regulation to help unlock supply will only help on the margins. It constitutes rearranging the deck chairs while the Titanic is sinking." )

Because every person that writes this article can't do exactly the same thing as all the other people who do it, we usually also get one or two bonus points. In a Jacobin article that tried this same thing, the point was that an index of supply regulations correlated much more weakly with prices than incomes did. This time, the author also looked at changes and home prices and changes in incomes and found a similarly strong correlation.

Everyone, rosen, roback, and me included, agree that incomes (demand writ large) should be key determinants of prices, so what's the issue with plotting incomes against prices and using that to think about whether supply matters more or less than demand?

Let's take the author's changes in incomes and changes in prices, since this will make the example easier to think about. Now, go back to your econ 101 demand and supply curves. If there's an outward shift in demand, this should show up in two places, prices and quantities. If supply is perfectly elastic, the shock should show up entirely in changes in quantities, and if supply is perfectly inelastic it should show up entirely in prices.

With that in mind, let's go back to the changes in incomes and changes in prices. If there's a demand shock for a city and the city is more supply constrained, we should get a stronger correlation between prices and incomes.

The simple way to get prices and incomes to positively correlate is that if the demand shock is productivity related (e.g., a tech boom in San Francisco), then incomes go up and prices go up. In the classic Rosen-Roback model, if supply is perfectly inelastic and there's a productivity shock, nobody moves and the productivity gains are fully offset by increases in land prices. Note that in this extreme case, despite this result being *because* supply is perfectly inelastic, it looks like income changes are the only thing driving price changes. If supply is more elastic, and wages decrease with population growth (or, congestion externalities prevent corner solutions where everyone goes to a single city), a productivity shock shows up in prices, incomes and population changes, with the specific ratios being governed by partly by the elasticity of housing supply.

The slightly more nuanced version is that if there's a demand shock, and supply is constrained, prices increase, low income households are priced out, which forces median income upwards due to sorting, and induces a positive correlation between incomes and prices with the slope of the correlation being again moderated by the elasticity of supply. (San Francisco would have lower income households if it had built more housing, which would push down the correlation between demand and incomes).

From this, we can see that the steepness of the relationship between incomes and prices does not imply that prices are income (demand) determined, not supply determined. It's the classic alfred marshall problem of which blade of the scissors sliced the piece of paper.

So, do we see this play out in the data? First, let's replicate what the author did by plotting changes in income against changes in home values. They correlate very strongly. Next, let's plot changes in population against changes in home values.

Here we see my point: in places where supply is more elastic (like Houston and Phoenix) demand shocks show up in population growth less than price growth. Where supply is more inelastic (California counties plus New York), demand shocks show up in prices more than population growth. For places where supply is reasonably elastic and demand was strong, like Austin and Seattle, demand shows up in prices and quantities. Obviously, this isn't perfect as we have no conception of the magnitude of a demand shock, but the point should be clear: Don't reason from a price change in (spatial) general equilibrium.

Edit:

If I was going to be precise, it's less that you wouldn't see a steep correlation between income and prices absent binding supply constraints and more that you would see much less variation in income across space. A large part of the Bay Area's income "boom" was that there was an exodus of lower income households; with more housing supply there would have been lower rents, less migratory pressure, and lower incomes through sorting.

Here ye, here ye, the Joint Committee on Finance, Infrastructure, Academia, and Technology is now in session. In this session of the FIAT committee, all are welcome to come and discuss economics and related topics. No RIs are needed to post: the fiat thread is for both senators and regular ol’ house reps. The subreddit parliamentarians, however, will still be moderating the discussion to ensure nobody gets too out of order and retain the right to occasionally mark certain comment chains as being for senators only.

Here ye, here ye, the Joint Committee on Finance, Infrastructure, Academia, and Technology is now in session. In this session of the FIAT committee, all are welcome to come and discuss economics and related topics. No RIs are needed to post: the fiat thread is for both senators and regular ol’ house reps. The subreddit parliamentarians, however, will still be moderating the discussion to ensure nobody gets too out of order and retain the right to occasionally mark certain comment chains as being for senators only.

The badeconomics is here.

The author criticizes the riciardian theory of comparative advantage:

A fallacy in a theory can arise either because the premise

is incorrect,or because the argument is incorrect. In the case of the

comparative advantage theory applied to Northern trade with warmer

lands, the premise itself is incorrect. The premise is that in the pre-

trade situation (assuming the standard two-country two-commodity

model) both countries can produce both goods. Given this premise,

then it can be shown that both the countries gain by specializing in

that good which it can produce at relatively lower cost compared to

the other country, and trading that good for the other good: for

comparedto the pre-trade situation, for a given level of consumption

of one good a higher level of consumptionof the other good results

in each country. This mutual benefit arising from comparative

advantage, is adduced as both the reason for and the actual outcome

of specialization and trade.

This is a passable explanation of the basic two countries-two goods model of comparative advantage, albeit specialization is not an inevitable outcome as it relies on the ability of both countries to produce enough the satisfy each other's demands (if this is not the case world prices will be equal to the autarky prices of the country that is able to supply more labor, which will produce both goods, see chapter 1 of Feenstra's Advaned International Trade: Theory and evidence).

Patnaik argues that the northern countries cannot produce some tropical crops at all and therefore the theory of comparative advantage does not apply:

If absolute cost is not definable, then ipso facto

relative cost is not definable. The premise of the theory does not

hold, namely that both countries can produceboth goods, hence the

conclusion does not hold, that specialization and trade is necessarily

mutually beneficial.

She gives a few examples. like that of England which cannot produce grapes.

Leaving aside wether these goods are actually impossible to produce or merely very difficult and costly, the conclusion is incorrect.

The fact that one country cannot produce one of the goods while other can means that the other has an absolute advantage in the production of said good.

Indeed it is the most obvious case of absolute advantage, as the cost of production of the good is in a sense infinite.

In this case, optimal specialization implies that England would produce the good that... they can actually produce and trade it for the good that it cannot produce domestically.

Edit: accidentally misgendered the author

A few recent papers have revived the idea of unequal exchange.

Two papers have caught my attention. They have a few different authors, however I have elected to single out Jason Hickel as the most prominent, whenever you read Hickel think the authors of the paper.

The main thesis of the two papers is that the imperialist/core/global north countries are able to consume more than they would under conditions of fair (non-exploitative) trade because they use their power to impose unfair terms on the colonies/periphery/global south.

Hickel is explicit that this northern plunder is not relative to autarky but to a condition of fair trade, thus he does not imply that southern countries would benefit from isolating themselves.

Hickel also presents this unequal exchange as an alternative explanation for international per-capita income differences.

These core countries exploit periphery countries by paying them less for their work than they would in the north.

From the 2021 paper

This net appropriation occurs because prices are systematically lower in the South than in theNorth. For instance, wages paid to workers in the South are on average one-fifth the level of Northernwages (Cope 2019, p. 80). This means that for every unit of embodied labour and resources the Southimports from the North, they have to export many more units to pay for it.

However this exploitation does not come from lower productivity in periphery countries but from imperial power, Hickel himself argues against productivity explanations (very badly as you shall soon see) because it’s seen as a competing explanation for lower wages in the periphery.

This exploitation is not therefore something that operates by sabotage of periphery countries productive capabilities.

It’s also not about some normative claim that equal effort ought to imply equal pay, since the same worker with different instruments can have a very different productivity (think digging with a shovel vs an excavator).

The problem with this thesis is that there is no explanation as to how this imperial power is exercised and why it manifests in such a way that it can be measured with the methods he proposes. As we will see, even accepting Hickel’s framing, it is impossible to take his calculations at face value.

This is most evident in the way countries are grouped across the Core/Periphery split, which does not seem to be explained by actual historical imperialism, since Switzerland has never been an imperialist country, and Russia definitely was.

It does not seem to be related to relative income per capita in the past, since South Korea is apparently a Core country, or previous/current poltical-economic alliances, since in the 2024 paper the Czech republic is classified as a global north country, while Poland is part of the global south.

When exactly did the Czech republic start exploiting its neighbors? Was it always doing so? Was 1960s South Korea part of the imperial core? To the extent that Hickel is making an argument about the monopoly power of rich countries, and depending on the answer, we must wonder why some countries were allowed to join the exploiters or why the leaders of such poor countries were in on it from the beginning.

This might seem like pedantry, but I don’t think Hickel should be allowed to make such strong claims about exploitation, essentialy arguing for some tacit or explicit conspiracy by northern countries, without even an attempt to explain how this system is implemented and sustained or why some countries are in on it while others aren’t.

The countries included in each group have an effect on the result and the lack of a theory that explains why some countries are part of the imperial core and which aren’t means that the results are completely unreliable and raise more questions than they answer.

Do political and business leaders of imperialist countries meet in smoke-filled rooms to conspire in order to keep prices low? Or are they somehow led to implement the same policies by some external force?

Hickel does attempt to give some examples of behaviors which keep southern worker wages low, but these seem to be either unrelated or actively work against his main point:

In the contemporary era, subsidised grain exports from the North, and land grabs by multinational companies, continue to undermine subsistenceconomies, placing downward pressure on wages

But subsidized grain export lower the prices of northern goods which is the exact opposite of the supposed mechanism behind the exploitation claim!!!.

Structural adjustment programs are also a boogeyman that Hickel is fond of, but it is unclear how they relate to his mechanism behind exploitation (Hickel seems to explicitly reject, at least in part, traditional arguments for protectionism in developing countries such as the Prebisch-Singer thesis).

Hickel does give a correct argument for international wage differences, but it does not lend credence to his conclusions about overconsumption in the north relying on southern exploitation:

Low wages are ultimately maintained through militarised borders,which preclude easy migration from South to North, and thus prevent international wage convergence.

It is true that limits to immigration stops southern workers from accessing labour markets which would reward them with a higher wage, under threat of force. In this sense they are exploited.

But the conclusion that with free immigration wages would equalize (or that the difference would diminish) is unwarranted, because the cause of low wages in southern countries isn’t an oversupply of workers but low productivity. It’s therefore perfectly possible for wages in southern countries to remain at the same level while newly arrived immigrants may very well be as productive as the native. The most obvious counter-argument to Hickel's conclusion is that significant wage difference persists even within areas that allow for free internal immigration like the US.

The most good faith interpretation of Hickel’s model of the world is one in which capital rich countries exploit their monopolistic power over capital intensive goods to artificially depress periphery countries terms of trade. This can be explained by the well-studied concept of optimal tariff theory. In international economics this theory explains that countries can exploit tariffs to change the terms of trade in their favor. Not every country can do this however, since generally they need some level of market power to pull this off.

The most obvious examples of such an exercise of market power would OPEC countries exploiting their monopolistic positions on the oil market or the EU exploiting its monopsonistic power in gas market against Russia.

I’m unaware of anything remotely similar concerning north-south trade. Most tariffs and quotas set in developed countries seem to be motivated more by income redistribution concerns than exploiting other countries, but I'm open to suggestions.

Onto the calculations in the first paper:

Köhler measures value transfer through unequal exchange by starting with the exchange rate

disparities between Northern countries and Southern countries. For instance, Köhler notes that

India’s GDP per capita in 1995 was US$1,400 in PPP terms (i.e. measured at the US price level),

but only US$340 in MER. Dividing PPP by MER yields what Köhler calls the ‘Exchange Rate Deviation

Index’, or ERDI. For India in 1995, ERDI was 4.12. Put differently, prices in the US were 4.12 times

higher than in India. For Northern countries, by contrast, ERDI is generally very close to 1. Köhler pro-

poses that we can use ERDI to measure value transfer. His formula is as follows:

T = d∗X –X

Where:

A couple recent papers have revived the idea of unequal exchange. These two papers have a few different authors, however I have elected to single out jason Hickel as the most prominent author, whenever you read Hickel think the authors of the paper.

T = value transferred through unequal exchange

X = exports from periphery to core

d = the ratio of the peripheral country’s ERDI to the core country’s ERDI

TL;DR Exploitation is when a country with low prices sells to a country with high prices. This is an unwarranted conclusion.

A country's prices are influenced by many different factors like transportation costs, climate, tax policy...

There is zero basis to assume that such price differences are entirely due to exploitation.

It also has goofy implications, such as Barbados and Iceland exploiting the United states, which seems incompatible with any explanation abount monopoly power in international trade. Link here

Hickel could respond to the above by arguing that only ERDIs between Imperialist and periphery countries matter, but then he would have to admit that ERDIs are not just caused by imperial power and therefore his calculations, which assume the opposite, cannot be trusted.

The alternative explanation for rich countries relative price level being higher is the Balassa-Samuelson effect, which is explained surprisingly well in this wikipedia article.

And this effect has actual evidence behind its existence, as well as following from a few basic assumptions about the relationship between wages in the tradeable and non-tradebale sectors. Both things that Hickel’s imperial exploitation model lacks.

The Balassa-Samuelson effect is by no means the only determinant of price levels, but it is an important one.

One might argue that the higher wages of workers in the North reflect their greater pro-ductivity. Yet this assumption is belied by a 1971 study of export processing zones in Mexico, which found that Mexican metal workers, electronics workers and seamstresses produced 10%-40% more output in an hour than their US counterparts (Baerresen 1971, p. 33).

Besides the obviously cherrypicked study, the conclusion that wage differences are unexpected in the absence of exploitation is incorrect. That the same industry in different countries pays different wages is unsurprising, because wages aren't set based on industry, but on the wider labor market.

Hickel seems to believe that if the same factory is operated by clones in two different countries any wage difference must be exploitation because we would expect their wages to be equal.

This is wrong, wages are set in the labor market and a single sector of the economy has relatively little influence on labor demand.

It's possible that the sector is the only high productivity industry in the poor country and thus there is no expectation for wages in the same sector in different countries to be equal. This could be the case if the poor country was still relying on low-productivity agriculture, which is the case for many countries in Africa.

His new 2024 paper makes the same mistake from a different perspective.

This study demonstrates that large North-South wage inequalities and unequal exchangeoccur even when accounting for sectors and skill levelsThe argument is that the net export of embodied labor from global south countries is a net loss of labor hours, this time Hickel attempts to control for different skill-levels and sectors.

I'm not going to comment on sectors, but his attempt to control for human capital is woefully inadequate. Hickel separates the skill levels into three buckets and that’s it, which doesn’t include important measures of human capital such as health

But there is a much more fundamental problem, which Hickel himself admits.

None of his calculations consider the effects of physical capital:

Physical capital per worker may better help us understand produc;vity differences, butthis data is only available at the country level (i.e. for total producton), when what mattersfor our purposes is the specific sectors and industries involved in producing goods that aretraded between North and South

This is a pretty glaring problem because it's not surprising that digging a ditch would require more labour hours if done by hand than with an excavator.

It is not legitimate to ignore such an obvious factor, but Hickel does and then repeats the misunderstanding above i.e. some industries are as productive and therefore the wages in the different countries ought to be equal.

He has a couple new arguments against the productivity objection in the supplemental material, none of which are good.

In the main text we noted that in cases where physical productvity differences do

exist, this is often because it is more profitable for capital to use cheaper, more labour-

intensive methods than to invest in modern equipment – especially in cases where state

investment in technological development has been curtailed by structural adjustment

programmes, or where patents prevent affordable access to necessary technologies –

precisely because Southern wages are maintained at artificially low levels.

But this doesn't make sense because using more productive methods would surely be more convenient for the imperialist countries? They would extract more value as the difference between the fair price, based on productivity, and the price that imperialist countries supposedly impose on them. Why aren't imperialist companies producing with the most productive method available? Is it perhaps that some factors, like extractive governements, prevents them from making the necessary investments?

Hickel also argues that physical capital differences cannot be the whole story because:

Even if it was, insights regarding comparable products and processes would not be generalizable to the totality of North-South trade,because – as described in the main text (and as Amin, Emmanuel and others have pointed out) – many of the South’s exports have no counterpart in Northern production.

Hickel in general does not like using metrics that rely on prices, such as value-added, to measure productivity differences. But even without using prices, his conclusion that productivity cannot be used to explain income differences because north and south produce different goods is flawed.

It is true that Global south countries are specialized in different sectors than their richer counterparts, but Hickel is wrong in implying that this means that the differences in wages cannot be attributed to productivity. Even disregarding prices as a measure of value, comparative advantage implies that countries who are less productive relative another would specialize in producing different goods.

Global south countries may very well have absolute advantages and Hickel’s repulsion to using prices may invalidate any comparison, but many industries in the global south are based on comparative advantage, and in that case it is possible to rank workers based on productivity, since workers in the poor country would be less productive in both southern and northern industries.

Indeed Hickel doesn’t explain why capitalists are not re-creating these northern industries in the poor countries in order to take advantage of the wage difference, he seems to take the fact that countries are specialized in different industries as a given.

Apparently there is a paper in the pipeline that deals with the question of productivity: Sullivan, D. ‘Unequal Exchange and the question of productivity’

I await its publication with trepidation.

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I want to know if there are alternative foundations for microeconomic theory that are:

1. Not, based on the ideas of Austrian Economics , or any libertarian bent, or are just minimal extensions or modifications of such

2. Mathematical and rigorous

3. That can predict market failures like monopolies even in the absence of government regulation

4. That try to serve as a foundation for macroeconomic theories?

5. That do not incorporate the idea of "revealed preferences" and hence predict the inelasticity of goods like health care?

6. That are empirical(ie try to develop a foundational theory that gets adjusted by empirical data)

And if there are, how well-developed are they?

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Steve Keen has a few, but very revealing words on expected utility theory in his book Debunking economics.

Hilarity ensues.

The development of Behavioral Finance was motivated

by the results of experiments in which people were presented with gambles

where their decisions consistently violated the accepted definition of rational

behavior under conditions of risk, which is known as ‘expected utility theory.’

Alright, that's not exactly correct (behavioral economics did arguably start with observation on Prospect theory, but not behavioral finance) but it's close enough to the truth !!!

Pretty impressive. Unfortunately it's all downhill from here.

Under this theory, a rational person is expected to choose an option that

maximizes their expected return – and expected return is simply the sum

of the returns for each outcome, multiplied by the odds of that outcome

actually happening.

For example, say you were asked whether you’d be willing to take the

following ‘heads or tails’ bet:

Heads: You win $150

Tails: You lose $100

Most people say ‘no thanks!’ to that gamble – and according to expected

utility theory, they’re being irrational. Why? Because the ‘expected value’ of

that gamble is greater than zero: a 50 percent chance of $150 is worth $75,

while a 50 percent chance of minus $100 is worth minus $50. The sum is

plus $25, so that a person who turns the gamble down is walking away from

a positive expected value.

No, that's not what expected utility theory predicts. What Keen is describing here is expected value, the average payout of the lottery weighed by the probabilities of the possible payouts.

Expected utility theory predicts that the choice would be influenced by the risk aversion of the gambler, and thus can easily explain the above choice, contra Keen.

Keen continues with this comment:

Do you think it’s irrational to turn that gamble down? I hope not! There’s

at least one good reason to quite sensibly decline it.

This is that, if you take it, you don’t get the ‘expected value’: you get either

$150 or minus $100.

Such insightful commentary.

Whether the coin will come down heads or tails in any given throw is an

uncertain event, not a risky one. The measurement of risk is meaningful only

when the gamble is repeated multiple times.

What an absurd statement, there is nothing preventing you from thinking about the risk of a single coin toss. The fact that repeated independent trials results in a lower variance of the lottery is a trivial observation, and of course the fact that lower variance makes a lottery more attractive to a risk averse agent is another obvious observation.

This is easily illustrated by modifying the bet above so that if you chose

it, you have to play it 100 times. Think carefully now: would you still turn

it down?

I hope not, because the odds are extremely good that out of 100 coin

tosses, you’ll get more than 40 heads, and 40 is the breakeven point.

(...)

In other words, you get the expected value if, and only if, you repeat the

gamble numerous times. But the expected value is irrelevant to the outcome

of any individual coin toss.

The concept of expected value is thus not a good arbiter for rational

behavior in the way it is normally presented in Behavioral Economics and

Finance experiments – why, then, is it used?

As mentioned, expected value is not used, expected utility theory explicitly rejects expected value maximization as a general choice criterion.

Keen posits that the reason expected value is till used by economists is because the profession misunderstood Von-Neumann and Morgernstern te theory of games and economic behavior, in whih modern expected utility theory was first derived. Needless to say, the opposite is the truth.

Keen begins by writing about how von Neumann proved that you can have cardinal utility functions, in contrast to economists which only believe in ordinal utility. This procedure is based on presenting a certain agent with various lotteries, this allows for the creation of a cardinal scalee, but only when one good is normalized to be one 'util' worth.

Contrary to what Keen seems to believe, this procedure is well known to economists and VnM weren't even the first to come up with a similar concept, Fisher actually wrote his Phd thesis on the observation that it is possible to construct a cardinal utility scale when the utility functions are additively separable (of which the VnM utility function is only an example)

Von Neumann was emphatic about this: to make sense, his procedure had to be applied to repeatable experiments only:

Probability has often been visualized as a subjective concept more or less in the nature of an estimation. Since we propose to use it in constructingan individual, numerical estimation of utility, the above view of probabilitywould not serve our purpose. The simplest procedure is, therefore, toinsist upon the alternative, perfectly well founded interpretation of probability asfrequency in long runs. (Ibid: 19; emphasis added)

Unfortunately, both neoclassical and behavioral economists ignored this caveat, and applied the axioms that von Neumann and Morgenstern developed to situations of one off gambles, in which the objective risk that would apply in a repeated experiment was replaced by the subjective uncertainty of a single outcome.

As far as I can tell, Keen seems to be making a distinction between an uncertain event, which is generally taken to be a gamble in which the gambler does not know the probabilities, and a risky one, in which the probabilities are known.

This distinction can be better understood in terms of objective probabilities (like the probability that a fair die will come up with a six) compared to subjective probabilities (like the probability that Donald Trump will win the next election).

The key distinction between these two types of probability harkens back to the frequentist and subjectivist/bayesian split. for our pourposes, it suffieces to say that according to frequentists only repeated events can be analyzed with the tools of probability theory, while subjectivists allow for the use of probability as it relates to one-off events which cannot be repeated, as probability is taken to be a degree of belief in a certain outcome, rather than the long run frequency resulting from repeated experiments.

Here's the best interpretation of the above that I can come up with: he thinks that the single trial with the coin means that the probability of the single toss and the probability of the repeated tosses are fundamentally different, but this is an error, both of these lotteries as presented deal with objective probabilities, they are both risky choices, not uncertain ones. One of the lotteries has a much lower variance, which obviously can influence the choices between lotteries, but they are both the same kind of lottery, where probabilities are known.

Moreover this absurd 'large number of trials' interpretation that Keen is pushing renders the theory of risk aversion developed by VnM completely superfluous, as the variance is minimized by construction, making for a very poor theory of risky decision making, and that was clearly not the intention of the the two economists.

Apparently Dan Thornton wrote an article that John Cochrane quoted at https://johnhcochrane.blogspot.com/2017/07/thornton-on-interest-rate-humility.html?m=1

Key quote:

“So why do policymakers believe that monetary policy works through the interest rate channel and that monetary policy is powerful?” Well, there was one important event that brought economists and policymakers to this conclusion. Specifically, the Fed under Chairman Paul Volcker brought an end to the Great Inflation of the 1970s and early 1980s.

Yep, that's it. The one important event. Nothing else. Economists have learnt absolutely zero from any other country or any other time period.

Swiss experiences with exchange rate pegs in the 1970s? Nah, too many foreign languages there, shame there's not some international organisation that could collect important economic statistics from countries with good statistical systems and publish them on a common basis, of which Switzerland was a founding member. That would be useful to have.

Australian and NZ experiences with inflation targeting in the 1980s and 90s?. Why would economists learn anything useful from Crocodile Dundee and Middle Earth?

The UK government cutting inflation in the early 1980s? Nope - can't really expect economists to understand anything written in English but with extra 'u's.

If only there had been some developments in monetary policy theory since the early 1980s. You know once in a dusty corner of the Internet I came across an interesting sounding rule proposed by a guy calling himself "John B. Taylor" - shame that guy hasn't had any influence on academic research or policy-making.

Tell you what, if there's some American economist who wants to sue Thornton for libel and has set up a Go Fund Me, I'll kick in ten bucks.

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Here ye, here ye, the Joint Committee on Finance, Infrastructure, Academia, and Technology is now in session. In this session of the FIAT committee, all are welcome to come and discuss economics and related topics. No RIs are needed to post: the fiat thread is for both senators and regular ol’ house reps. The subreddit parliamentarians, however, will still be moderating the discussion to ensure nobody gets too out of order and retain the right to occasionally mark certain comment chains as being for senators only.

Joe Stiglitz recently had an interview with Tyler Cowen to promote his new book. One of the topics of conversation was YIMBYism, specifically whether we should deregulate housing to allow more of it to be built. Somewhat surprisingly, Joe Stiglitz came out in favor of regulation, or at minimum, not for YIMBYism. Specifically:

COWEN: Do you favor the deregulations of the current YIMBY movement to allow a lot more building?

STIGLITZ: No. That goes actually to one of the themes of my book. One of the themes in my book is, one person’s freedom is another person’s unfreedom. That means that what I can do . . . I talk about freedom as what somebody could do, his opportunity set, his choices that he could make. And when one person exerts an externality on another by exerting his freedom, he’s constraining the freedom of others.

If you have unfettered building, for instance-- you don’t have any zoning-- you can have a building as high as you want. The problem is that your high building deprives another building of light. There may be noise. You don’t want your children exposed to, say, a brothel that is created next door. In the book, I actually talk about one example. Houston is a city with relatively little zoning, and I have some quotes from people living there, describing some of the challenges that that results in.

Getting the elephant in the room out of the way immediately: brothels are illegal; no, high rise brothels are not coming to a city near you, regardless of what happens with the YIMBY movement.

But let's take Stiglitz seriously here, for a second. Specifically, the idea that new construction imposes externalities on existing residents, and as such we should limit where apartments can be built. Let's ignore the fact that most zoning isn't prohibiting high rise apartments; it's prohibiting small homes and midrise apartments -- nobody would seriously build a ten-story apartment in suburban Charlotte, but they might build a 1500 square foot home and a midrise apartment.

Most economists will read Stiglitz's quote and say "sure, shadows are bad, but more housing also has these very large positive externalities". And this is true! Urban agglomeration effects are impaired by housing constraints and housing supply constraints are one of the main drivers of the decline in regional income convergence; US economic dynamism and US regional inequality are impaired and exacerbated, respectively, by constraints on housing supply.

On the macro, negative externality side, zoning (housing supply constraints writ large) also drive up prices and are partially responsible for very environmentally harmful sprawl; when Coastal California refuses to build housing, new housing gets built instead in Central California, Phoenix, and Nevada; when cities ban apartments, they push housing demand out to suburbs; when suburbs ban apartments, they push housing demand out to the far-flung exurbs.

Sitglitz acknowledges that housing is being and has been built in the wrong places, but doesn't make the connection between that and housing regulation:

COWEN: Well, we built a lot of homes, right? It’s turned out we’ve needed them. The home prices that looked crazy in 2006 now seem somewhat reasonable.

STIGLITZ: A lot of them were built in the wrong place and were shoddy. I used to joke that there were a huge number of homes built in the Nevada desert, and the only good thing about them is they were built so shoddily that they won’t last that long.

But put all of those aside for a second. Put aside all the positive economic benefits of more housing supply, and put aside the macro environmental effects of encouraging sprawl. Let's talk about the kind of local externalities imposed by new construction that Stiglitz is referring to.

First, we should be very clear on what the original intent of many zoning and building code ordinances were: the "harmful externalities" were poor and non-White people, and they were to be kept away from the rich, segregated into less desirable parts of the city. One of the first building code ordinances, the 1871 Cubic Air Ordinance, which mandated more than 500 cubic feet of living space per person, was explicitly targeted at removing Chinese San Franciscans from the city and resulted in hundreds of arrests of Chinese immigrants. In 1921, San Francisco passed one of the first zoning and building code ordinances in the country and was also explicitly segregationist in its intents.

Richard Rothstein's The Color of Law goes further into depth into how, again very explicitly, prohibiting the "externalities" of poor and non-White people living in certain neighborhoods was written into zoning codes. These zoning codes largely continue through today; in California, in over 80% of residentially zoned land you cannot build anything more than a (large) singe family home. Austin's 1928 minimum lot size requirements, which continued until this year, were explicitly written to keep poor and Black residents out of certain neighborhoods. 81% of residentially zoned land in Connecticut requires a minimum of around one acre (over 43,000 square feet) per home.

Looking closer at today, and when you do, as Stiglitz suggests, restrict where large apartments can be built two things happen: one, as I mentioned before, you push housing demand out to sprawling suburbs, but two, you force the large apartments that do get built to be built on high-traffic, high-pollution, noisy arterials. Look at the zoning code for any city; to the extent that apartments are allowed they will be put on the busiest streets. This "makes sense" to most people as density is supposed to go with amenities. Put the dense apartments downtown and alongside highways and high traffic roads and keep the single family homes in the quiet neighborhoods with safe streets. The result is that poor people, who disproportionately live in these apartments, are subject to higher levels of noise pollution, enviornmental toxins, and traffic deaths.

There's a way to do zoning and building ordinances correctly; everyone agrees on this. Congestion and other externalities are real and sizable, and cities should plan accordingly. But what often happens in these conversations is that the nominally-progressive person says "yes, I understand the discriminatory origins of all the existing housing ordinances", but then when it comes time to repeal them, you get the song and dance of externalities and concerns about shadows, or parking, or noise -- the kind of which Stiglitz has voiced here.

The cousin of NIMBYism is "these ordinances should be changed in general, but never in any specific cases." To the extent that Stiglitz would like to make housing supply regulations a conversation about externalities, he should make clear that the status quo disproportionately harms poor renters. And given how bad the status quo is, Stiglitz, and really everyone, should not have perfect be the enemy of good in fixing our cities.

Steve Keen has a chapter about demand in his book ‘Debunking economics: The Naked Emperor Dethroned?’.

It’s very bad. Worse than you are thinking.

Adam Smith’s famous metaphor that a self-motivated individual is led by an ‘invisible hand’ to promote society’s welfare asserts that self-centered behavior by individuals necessarily leads to the highest possible level of welfare for society as a whole. Modern economic theory has attempted, unsuccessfully, to prove this assertion.

Economists aren’t trying to prove anything of the sort. Indeed there is no agreement on what social welfare even is exactly. The most common approach used by economists to analyze issues of redistribution is the social welfare function (SWF), which in general are not automatically maximized by an economy, even a pareto efficient one. Alternative approaches like sen’s capabilities do not suggest anything of the sort either.

To avoid any confusion, Keen is NOT writing about the first welfare theorem (which makes no claim about social welfare besides efficiency), at least not the version which belongs to reality. Indeed, he seems to argue that economists want to prove that a market economy necessarily maximizes some kind of utilitarian SWF:

However, economists encountered fundamental difficulties in moving from the analysis of a solitary individual to the analysis of society, because they had to ‘add up’ the pleasure which consuming commodities gave to different individuals. Personal satisfaction is clearly a subjective thing, and there is no objective means by which one person’s satisfaction can be added to another’s.

Indeed, that is the argument against interpersonal comparisons of utility.

But note that these have nothing to do with Pareto optimality, and neither does ‘adding up pleasures’.

So how are economists attempting to prove… whatever Keen thinks they are?

Economists were therefore unable to prove their assertion, unless they could somehow show that altering the distribution of income did not alter social welfare. They worked out that two conditions were necessary for this to be true: (a) that all people have to have the same tastes; (b) that each person’s tastes remain the same as his income changes, so that every additional dollar of income was spent exactly the same way as all previous dollars – for example, 20 cents per dollar on pizza, 10 cents per dollar on bananas, 40 cents per dollar on housing, etc

When conditions (a) and (b) are violated, as they must be in the real world, then several important concepts which are important to economists collapse. The key casualty here is the vision of demand for any product falling as its price rises

The above is wrong on every level, but even more interesting is how he believes this fake result to have been discovered.

First of all, Keen argues that the above conditions are found in Gorman(1953), this is technically true, but misleading.

What Keen is describing is only a special case of the preferences that have an indirect utility function of the Gorman polar form (which are the subject of Gorman’s paper).

Another example, explained in Gorman’s paper, is that of quasi-linear preferences, which do not need to be identical, and form the basis of partial equilibrium analysis (because they are approximated by small expenditures relative to consumer’s income) which Keen attacks later for neglecting to mention his “conditions”.

Keen seems to think that parallel engel curves impliy that they must be the same engel curves (and therefore preferences must be identical across consumers, because...well:

Even saying that the Engel curves of different consumers are parallel to each other is an obfuscation – it implies that two consumers could have parallel but different Engel curves, just as two lines that are parallel to each other but separated by an inch are clearly different lines. However, as anyone who has studied geometry at school knows, parallel lines that pass through the same point are the same line. Since a consumer with zero income consumes zero goods in neoclassical theory(11), all Engel curves pass through the point ‘zero bananas, zero biscuits’ when income is zero

The error is obvious: Engel curves need not cross the origin, because the the quantity purchased of some good could, for instance, be zero at low incomes and then increase linearly with income.

Clearly, Keen is confused about Engel curves. Another part of the chapter solidifies that conclusion:

The shapes show how demand for a given commodity changes as a function of income, and four broad classes of commodities result: necessities or ‘inferior goods,’ which take up a diminishing share of spending as income grows; ‘Giffen goods,’ whose actual consumption declines as income rises; luxuries or ‘superior goods,’whose consumption takes up an increasing share of income as it increases;and ‘neutral’ or ‘homothetic’ goods, where their consumption remains a constant proportion of income as income rises.

The above classification makes no sense, as it mixes budget share engel curves and income-consumption engel curves.

Budget share engel curves describe the share of the budget expended on a good as income increases, while standard engel curves describe the actual quantity consumed of a good as income increases.

Superior (aka normal) goods are not necessarily luxuries nor are necessities necessarily inferior (food is a normal necessity, its consumption increases but its share of expenditure dimishes as income increases) and Giffen goods are just inferior goods (aka … goods whose consumption declines as income increases) when classified according to the sign of the income effect.

Second, these two “conditions” are by no means necessary to prove that quantity demanded is decreasing in price, nor is the assumption that all consumers have an indirect utility function of the Gorman form.

Much weaker conditions suffice for a downward sloping market demand curve.

So why does Keen believe something so wrong? Well, somehow, in a truly impressive feat of logic, Keen has convinced himself that the result from Gorman’s paper is the same as the Sonnenschein-Mantel-Debreu theorem.

Indeed Keen writes:

Gorman’s original result, though published in a leading journal, was not noticed by economists in general – possibly because he was a precursor of the extremely mathematical economist who became commonplace after the 1970s but was a rarity in the 1950s. Only a handful of economists would have been capable of reading his paper back then. Consequently the result was later rediscovered by a number of economists – hence its convoluted name as the ‘Sonnenschein-Mantel-Debreu conditions.

That’s right, Keen’s explanation is that economists in the 1950s, which by the way included Debreu himself, just couldn’t understand Gorman’s paper.

The actual reality is, of course, completely different: the Gorman result concerns the extent to which the techniques used to analyze the individual consumer problem can be applied to an entire community. The SMD theorem characterizes the behavior of excess demand functions in general equilibrium economies.

These two results are about different subjects and are therefore, well, different.

Keen also writes this nugget about Gorman’s paper:

He proved the result in the context of working out whether there was an economy-wide equivalent to an individual’s indifference curves:

‘we will show that there is just one community indifference locus through each point if, and only if, the Engel curves for different individuals at the same prices are parallel straight lines’ (Gorman 1953: 63; emphasis added).

He then concluded, believe it or not, that these conditions were ‘intuitively reasonable’:

‘The necessary and sufficient condition quoted above is intuitively  reasonable. It says, in effect, that an extra unit of purchasing power should be spent in the same way no matter to whom it is given’ (ibid.: 64).

‘Intuitively reasonable’? As I frequently say to my own students, I couldn’t make this stuff up!

Keen seems to believe that ‘intuitively reasonable’ was meant as an observation on the assumption itself (specifically how stringent it is), while Gorman was clearly referring to the fact that the result had eluded economists for decades despite the ease of its derivation.

Indeed, immediately after the passage quoted by Keen:

Nevertheless, it does not seem to have been discovered before.

Moreover, just a couple of lines before that passage:

These conditions are rather restrictive.

He then writes about the textbook Microeconomic theory (Mwg), pointing out that it does talk about the SMD theorem (after complaining that “neoclassicals” were trying to drown the result) and has this to say:

Earlier, when considering whether a market demand curve can be derived, Mas-Colell begins with the question:

‘When can we compute meaningful measures of aggregate welfare using […] the welfare measurement techniques […] for individual consumers?

The quoted text is not asking ‘wether a demand curve can be derived’. This can be readily understood by reading it.

It is about the conditions under which it’s possible to analyze aggregate welfare in the same way as individual welfare was in the preceding chapter, which are not the same as the conditions under which a positive representative agent exists, nor those that ensure a downward sloping demand function, nor those that were discovered by Gorman (altough the latter are an important special case).

To ensure that the actual distribution of wealth and income matches the social welfare function, Mas-Colell assumes the existence of a benevolent dictator who redistributes wealth and income prior to commerce taking place:

‘Let us now hypothesize that there is a process, a benevolent central authority perhaps, that, for any given prices p and aggregate wealth function w, redistributes wealth in order to maximize social welfare’ (ibid.: 117; emphases added).

So free market capitalism will maximize social welfare if, and only if, there is a benevolent dictator who redistributes wealth prior to trade??? Why don’t students in courses on advanced microeconomics simply walk out at this point?

Well, that passage is not about the benefits of free market capitalism, but a theoretical analysis about welfare measures. It’s far from surprising that redistribution would be required to maximize a social welfare function, so those students probably aren’t particularly shocked.

He then concludes the chapter by arguing that the the shift from cardinal to ordinal preferences was done so that economists could argue against the redistribution of income, which is not true, but also writes this about the transition from cardinal to ordinal utility:

It is ironic that this ancient defense of inequality ultimately backfires on economics, by making it impossible to construct a market demand curve which is independent of the distribution of income.

The cardinality of utility functions is irrelevant for a positive theory of consumer behavior, thus there is no reason to assume that they exist, utility functions are just one way to analyze preferences.

The fact that it’s difficult to construct a market demand curve without reference to the distribution of income is thus independent of any hypothesis of cardinality or interpersonal comparability.

Mas-Colell, A., M. D. Whinston et al. (1995) Microeconomic Theory, New York: Oxford University Press.

Gorman, W. M. (1953) ‘Community preference fields,’ Econometrica, 21(1): 63–80.

Keen, Steve (2011). Debunking Economics: The Naked Emperor Dethroned?, Zed Books.

Because prices adjust

RI of this common sentiment To be affordable housing must be a bad investment

This paper shows total housing returns are consistent across markets and approximately equal to stock returns

The thing they do, is to consider both cash flows and asset appreciation.

One could still end up with a great investment but only on accident, or with great market beating insight.

Functionally, markets where strong rent appreciation (and thus price appreciation) is expected price that in. If you buy (and owner occupy) the rent you are avoiding will be significantly below your cost of ownership and you will have a functionally negative cash flowing position just like a land lord for the next few years that counteracts the appreciation that increasing rents will cause.

Markets without expectation of excess rent growth have price-rent ratios such that the rent you are forgoing when you buy provides a positive cash flow but there is no price appreciation without increasing rent.

Capital flows and prices adjust such that there are no excess returns today even as prices rapidly increase. Capital would flow and prices would adjust if we removed the price support for housing such that housing would continue to provide normal economic returns.

Here ye, here ye, the Joint Committee on Finance, Infrastructure, Academia, and Technology is now in session. In this session of the FIAT committee, all are welcome to come and discuss economics and related topics. No RIs are needed to post: the fiat thread is for both senators and regular ol’ house reps. The subreddit parliamentarians, however, will still be moderating the discussion to ensure nobody gets too out of order and retain the right to occasionally mark certain comment chains as being for senators only.

I have been asked to post this here.

Many economists teach that in competitive markets, wages and employment are determined by the supply and demand for labor. Demand is a downward-sloping curve in the employment-real wage space. As an example, I cite Figure 3-11 in the sixth edition of Borjas' textbook. But doubtless you can find many more examples.

Economists have known such a curve is without foundation for over half a century. The long-run theory of the firm from the 1970s is one body of literature that can be used to show this lack of foundation. In the theory, zero net (economic) profits can be made by the firm in equilibrium. Thus, one must consider variation of other price variables in analyzing the decisions of firms in reacting to a variation in a real wage.

I draw on another literature that looks at the theory of production, some sort of partial equilibrium analysis, and the condition that no pure economic profits are available to firms in long run equilibrium. And I posted a numeric example:

https://np.reddit.com/r/CapitalismVSocialism/comments/1dfvobq/wages_employment_not_determined_by_supply_and/

The example has some assumptions not necessary for the conclusion that competitive firms may want to hire more labor at a higher wage. Some of these are for analytical convenience; others are because I think they are realistic. But my conclusion can be illustrated with many examples without, say, Leontief production functions.

Since we're doing short R1s now...

Thing: https://www.tiktok.com/@theeconomist/video/7371487005114371361

Comments:

Wait did this guy just try an gaslight me into thinking that because I can't afford to buy jam, its not that my pay is less its just that my tastes have changed ? Eejit

The video says that the PCE index adjusts for substitution. It doesn't ignore changes in the overall price level. If the price of jam goes up, even with the PCE's consideration of substitution, the index is going to go up (just not as much as it would in the case of the price of, say, gasoline going up, since your mouth takes jam or marmalade and your fuel inlet takes gas only).

Bro just added ceo pay to the average lol

This does, in fact, occur in the video. Nothing explicitly wrong with what the commenter is saying here, but a lot of people seem to have only seen "CEO pay was added to the average! This distorts the picture!" and deleted the apples-to-apples part of the video from their memory. Comparing overall productivity to the compensation of the bottom 80% of earners tells us nothing about whether pay has kept pace with productivity for the bottom 80%. Adding CEO pay to the average isn't the problem.

Isnt this just saying that the executives and managerial class are siphoning off of wages at a higher rate than ever??

No, it doesn't show that. Nothing in the video ever made reference to rates of exploitation, even in a very formal, academic sense of "What's the difference between the wage and the competitive wage as a consequence of market power?" The only thing seen in the video is income statistics. You can infer exploitation only if you ignore the possibility that sometimes people make more money than others for reasons other than exploitation, which would be very nice to assume, but we can't.

Really, the lesson here is don't ever look at TikTok comments. I just wanted to rewatch a video from the Economist and the first source Google gave me was this one.

I'd prefer if the Economist had included a direct pay-productivity comparison for the bottom 80%, but I'm not sure if data like that even exists. It also would have been better to say it's not clear if inequality is rising, which is true by their own admission.

I think imma keep sending the chart

):

(As a final note, The Chart has been covered here before.)

Here ye, here ye, the Joint Committee on Finance, Infrastructure, Academia, and Technology is now in session. In this session of the FIAT committee, all are welcome to come and discuss economics and related topics. No RIs are needed to post: the fiat thread is for both senators and regular ol’ house reps. The subreddit parliamentarians, however, will still be moderating the discussion to ensure nobody gets too out of order and retain the right to occasionally mark certain comment chains as being for senators only.