When I took science in 9th grade, I remember being disturbed by a gap in the story. From one direction, we were told about atoms and subatomic particles and how they clustered into molecules. From the other, we were told about cells–single-celled animals and single human cells, then multicelled animals, then larger things such as jellyfish, etc., building up to people. We even talked about the parts of a cell–nucleus, axons, cilia, etc.
But we never were given the link between molecules and cells. And what really bothered me was that there was never even any recognition of the gap. This was really too bad, because long molecules are cool–there are proteins shaped like hooks that grab onto other molecules, etc. But it was either atoms or cells, nothing in between.
I was thinking about this recently after reading two blog entries by Steven Levitt. Here he writes that rich people aren’t really so much richer than poor people because rich people pay more for “fancy cars, expensive wine, etc.” This confuses me because I thought that, under the usual principles of economics, we should assume that fancy cars, etc., are worth their price–otherwise competitors would come into the market and sell them for less. Levitt’s related point is that the narrowing of the gap between rich and poor can be credited to Wal-Mart. I can see how this could be true, but once again I’m confused, because I thought standard economic theory said that if Wal-Mart didn’t exist, someone would invent it. I have an uncomfortable feeling here that economics is sometimes telling us that things are inevitable (the law of supply and demand) and other times is celebrating unique organizations such as Wal-Mart.
I’m not saying that economists are wrong on this–clearly, supply and demand are powerful forces, and it’s also clear that organizations such as Toyota or Bell Labs or, for that matter, City Harvest, can make a difference. Marketing is an art, and just as, if Picasso had never been born, there would still be abstract art but there would be no Picassos, I can well imagine that in a different world, there would be no Wal-Mart, and maybe Americans would all be paying fifteen cents more each for peanut butter, or whatever.
But . . . I’m still disturbed by the lack of connection that is made between the fundamental principles of economics (under which $5,000 worth of expensive wine has the same value as $5,000 worth of Cheetos) and the sort of technocratic reasoning (the kind of thing that makes me, as a statistician, happy) where you try to assign a cost to each thing.
Really this applies to economics, or “freakonomics,” in general: For example, you can do some data analysis to see if sumo wrestlers are cheating, or you can just say that sumo wrestling supplies an entertainment niche and leave it to the wrestlers to figure out how to optimally collude. Either sort of analysis is ok, but I rarely see them juxtaposed–it’s typically one or the other, and the conclusions seem to depend a lot on which mode of analysis is chosen.
I don’t think there are any easy answers here–to borrow a physics analogy, a stable economy is necessarily at a phase transition, entrepreneurs can’t repeal the law of supply and demand, and conversely “supply and demand” don’t mean squat if nobody’s there to take advantage of opportunities, etc. But I think there can be trouble if you can pull out a macro or a micro argument and not always see the connection between them.
P.S. This problem is not at all unique to economics. For example, some political scientists (such as myself) study public opinion and others study strategic bargaining among political actors. And we tend to work in parallel, even though of course these concepts interact. I study voters’ attitudes on issues and where they stand compared to the Democrats and Republicans, whereas Thomas Ferguson studies campaign contributions by major industries. It’s all part of the same big picture but it’s hard to put it all together in one place.
And I’m not saying this to criticize Levitt: he has interesting things to say both in the “big picture” sense and in detailed technical analyses. I just think there’s a big gap there that’s not often acknowledged.
P.P.S. The other example of Levitt’s I was thinking about was his tongue-in-cheek comment that people should be taxed 10 cents per hour on all recreational burning of calories. I realize he’s joking, but, setting that aside, wouldn’t it be more appropriate to have a carbon tax–if the concern is greenhouse gas emissions? (Or maybe you’re not worried about greenhouse gas emissions at all–that’s a separate issue. I’m just working from Levitt’s assumptions here, where he writes “According to Wikipedia, the social cost of a ton of carbon dioxide is $12. So the greenhouse gases released to make the food Americans ate in 2006 had a social cost of $16.8 billion.”) Again, I feel like I’m missing the point. If the goal is to reduce carbon dioxide emissions, taxing exercise would seem like a roundabout way of going about it. It’s also not clear why he wouldn’t tax non-recreational exercise, since under his assumptions this would lead to pollution as well.
Yes, I know, I know, Levitt’s just making a joke here, he’s not serious about this tax. But I think there’s a serious point here–not a substantive point, but a methodological point. Economists such as Levitt have two basic quantitative tools, each of which are extremely useful:
1. The idea that markets can allocate resources efficiently: if externalities are priced appropriately, you can rely on individual agents to work out the details. An example would be setting a carbon tax to raise the money for cleaning the environment (again, given Levitt’s assumptions above; I don’t want to get into an argument here about the appropriate price for this).
2. Specific cost-benefit calculations, of the sort that Levitt does, saying how much each person should pay for the costs incurred from their recreational exercise.
I think the phrase "we should assume that fancy cars, etc., are worth their price–otherwise competitors would come into the market and sell them for less" is wrong, at least in standard economic theory, and leading you to incorrect conclusions about Levitt's claim. In basic economic theory, the price equates the marginal cost of production to the marginal value that it provides to society, ie how much the last person is willing to pay for it. That doesn't mean that goods are "worth" their price, in fact they are worth far more than their price to most consumers and (and less to producers), the difference of which is called economic surplus. So, if I value a Lexus at $75,000 but only have to pay $50,000, then I have an extra $25,000 of consumer surplus from purchasing a Lexus.
Further, Levitt is making a point about changes in supply and demand, in particular a shift in the supply curve because of technological developments such as big-box retailers. These supply shifts affect the total amount of consumer surplus, and Levitt's (and the paper he cites) basic claim is that these supply shifts have been heavily weighted towards lower income groups. In other words, the consumer surplus of low income people has boomed relative to the consumer surplus of high income people, a claim that would be missed in the standard inequality literature which tends to focus on wages and aggregate price levels.
There's some other issues you touch on that economicists don't really understand, such as where technological innovations really come from, ie if we didn't have Walmart would we really invent it? What are the supply and demand forces that operate on these margins of innovation? We don't have good answers to these questions.
I'm really not sure I'm following you, and I have a penchant for misunderstanding you, so forgive me if I'm way off. You're right to be thrown by the inequality argument, because I think it's mistaken. The mistake appears to be here: "How rich you are depends on two things: how much money you have, and how much the stuff you want to buy costs." By that definition, an average-income hunter who suddenly decides he wants a Holland & Holland shotgun has become hopelessly poor. That makes no sense.
You're also right to wonder about the connection between macro- and microeconomics. I've noted before that micro is axiomatic, built up from consumer preferences to general equilibrium. I don't know if I've ever really studied any models explicitly connecting all the micro activity to the macro models. In my experience, macro models tend to be ad hoc, though quite openly so. Lucas Islands Model being one example. (It's on Wikipedia.)
And you're right that non-recreational exercise would be taxed; however, since it's food production that's the problem, food, not exercise, should be taxed for it's global-warming effects.
One perspective that might help would be to point out that riding a bicycle for an hour would consume perhaps 10% of the calories running a motorcycle for the same length of time would. Your rendition of his comment was that recreational uses would be taxed, not specifically exercise. Price would push people to doing absolutely nothing or chosing a low cost alternative, generally not using energy intensive forms of recreation many of which would involve some exercise, even if only the elbow bending variety.
So obviously Andy is over my head, but to restate the issue in terms of simple economic theory (which is fair because you constructed the problem in simple economic theory) consider the long term price of goods given no barriers to entry. Classical economics says the price of goods is the cost of production ~not~ the value of the good. It might be that you as a consumer are willing to pay much more who knows. But as long as there is a long term, no barriers to entry, no environment for collusion or gaming, and interchangable goods and services someone is going to offer you the good at economic cost.
And that is consistant with the blog post you objected too. That walmart can get us goods that carry most of the value of the fine stuff for fractions of the cost.
Its really kind of commonsense when you think about it. Poor americans live better than wealthy counterparts in other times and other places.
I realize to people versed in economic theory this is all a really simply notion of things, but the original blog post was constructed with really simple notions suggesting their was a classical contradiction when there was not =0~
Andy pretty much said what I was going to throw in. Standard Economic Theory does not maintain that all markets are perfectly competitive, and higher prices for funtionless product differentation are exactly what you would expect to see in monopolistically competitive markets.
With the Wal-Mart example, I think this is a confusion between Standard Economic Theory and a well known joke about Standard Economic Theory. Obviously SET admits the possibility of innovation, from both a managerial and technological standpoint. But because most of SET is about behaviors responding to prices and vice versa, it (often) treats innovation as exogenous to it's models. Declaring something exogenous is not the same as declaring it can't exist.
Finally there's the matter of Lewitt's joke, which I think is more a light-hearted jab at his own discipline for a tendency to propose a tax for every externality under the sun.
Andrew,
I highly recommend the book "The Origin of Wealth" it touches a lot on what economist know and don't know in some of the "gaps". Overall I think the author beats on traditional econ a bit too much and oversells the promise of complexity econ, but its a great treatment of some of the things you are mentioning.
Jeremiah (and Andy),
I wasn't objecting to Levitt's blog entry or saying it's wrong; I was just pointing out that he (and other economists) seem to have two distinct modes of reasoning:
1. Efficient markets, fundamentals, etc.: the sort of reasoning that says that things are as they should be and that everything is self-correcting. Under this reasoning, you wouldn't really distinguish between "fancy cars, expensive wine, etc." and other purchases; the idea is that people purchase what they want with their dollars.
2. Technocratic analysis specific to the problem at hand, for example an analysis saying that rich people aren't really so rich because they're spending their money on silly things like expensive wine.
Both these methods of reasoning can be correct; I just don't see much of an attempt to connect the two. It's just one or the other, which reminds me of how science was presented to us in 9th grade. I have no doubt that economists are working on this; it just doesn't seem to come out in popular presentations.
Anonymous:
Yes, I agree. Once you step on the slippery slope of wanting to tax "recreational" consumption, the priority would be taxing all those holidays to the Caribbean rather than targeting joggers.
Economics is a bit like evolutionary psychology with mathematics. There's a heavy bias toward explaining what IS by explaining that "well, it is supposed to be that way."
But back to Wal-mart. The Wal-mart niche has always existed — people always want stuff cheaper. So, the need to "invent" Wal-mart has always been there. What's changed is the ability to "invent" Wal-mart. Wal-mart's fundamentally a logistics company. That led them 15 years or so to heavily outsource, particularly to China. Wal-mart is demonstrably better at that than other people (notably, K-Mart). So, what's different with Wal-mart is that they have been able to execute technology to fill a perennial market niche better than anyone else out there…at the moment.
In terms of Levitt's point, let's switch examples and suppose in country X the poor people get 80% of their calories from rice, the rich people 10%. Then anything that changes the price of rice (ceteris paribus) changes the well-being of the poor. The rich certainly CAN eat rice, but even given relatively large swings in the price of rice will still prefer fancier stuff. So, if the price if rice goes down, the poor disproportionately benefit [and vice-versa].
Obviously this stuff changes over time. Commodity prices change. Chinese laborers may demand more wages. Remember that special U.S. laws (Robinson-Patman) were passed to prevent A&P from gaining too much power over the supermarket industry? Yes, the same A&P.
You are correct about the divide between the economic theory and practical calculations. There is however a new field or rather style of economics (re)emerging, of which levitt is uninformed, namely, structural econometric modelling. You may want to read about it in the transcript of michael keane speech "structural vs atheoretic approaches to econometrics". Or even google for "when walmart comes to town" for a representative article relevant to your example. Needless to say, practitioners of this approach are quite critical of the kind of fame levitt brings to the discipline.
Is structural econometric modeling the same as structural equation modeling?
The approach indeed has its roots in the work of haavelmo and others who estimated systems of equations in order to establish causality direction. However it goes much further with the data and processing power that has recently became available. It also considers microeconomic relations rather than pioneers of the middle of the last century who studied macroeconomics.
I'll get a copy of the recommended Origin of Wealth