Arnold Kling  

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Fixing the Health Care System... Sumner, Wilson, Harding, Keyne...

Don Boudreaux always gets to the heart of these issues.


Suppose, for example, that shirts can be made in one of two ways. The first is by hand. It costs a shirt maker using this method--regardless of how many shirts he produces--$250 to produce each shirt. Working full-time producing shirts by hand, the shirt-maker can produce 10 shirts each month. The second way to produce shirts is in a highly mechanized factory. If the factory runs at a peak capacity of a million shirts monthly, each shirt costs $5 to make. But because building and equipping the factory requires a huge initial investment, operating the factory at less-than-full capacity causes the cost of each shirt to rise. The reason for this increase is that producing fewer shirts denies the shirt-maker the opportunity to spread the investment cost over maximum output. The smaller the factory's output, the higher the cost of each shirt.

Which method of production would a shirt-maker use? The answer depends on the size of his market. If a shirt-maker expected to serve a market of millions of people, he would use the factory method. But if he expected to serve a market of only a few dozen potential customers, he would produce shirts by hand. If each shirt-maker had access only to small markets, the price of shirts would be higher than it would if shirt-makers had access to larger markets.

If you want your shirts to be manufactured using primitive technology so that they cost a lot, then buy local.


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CATEGORIES: International Trade



COMMENTS (22 to date)
rvman writes:

Sadly, that is my experience with the buy local folks. They WANT primitive technology, or none at all. That is, they worship at the feet of the 'skilled craftsman' (our $2500 shirtmaker). They love organic food (or food made by eschewing all of modern man's techniques for increasing yield and decreasing loss). Many want 'walkable neighborhoods' (so, like New York, it is a cast-iron pain to actually use your car when you need to buy your week's groceries). A not insignificant share of them are also into herbal and/or homeopathic medicine(eschewing modern chemistry in favor of the witch-doctor's packet). Raw foodists. (Eschew fire) Vegans (Eschew domesticated animals and hunting).

n writes:

"They WANT primitive technology, or none at all."

Sane, well-intentioned people are also jumping on the bandwagon.

libfree writes:

Yeah, I don't understand the herbal medicine thing. A person will tell you that you need to "believe the science" about global warming or stem cell research ect., but the same people eschew that same science when it comes to herbal medicines and other new age stuff. I don't actually bare a consistent line on this, but I have a consistent philosophy of doubt.

El Presidente writes:

Arnold,

If you want your shirts to be manufactured using primitive technology so that they cost a lot, then buy local.

OK, I get it. Scale matters and comparative advantage combines with scale so that we use the least amount of labor necessary to MAKE goods. That's great. But then there is the challenge of MOVING goods. While the price of foreign labor and the transportation combined might be less than the price of domestic labor, if you measure price instead by caloric expenditure (a more direct and tangible measure of expended effort) local can be cheaper, even with more rudimentary technology.

What's more, if you follow your theory to it's extreme, you end up with one producer for each good: a monopoly. This is the business form least likely to reduce prices and most likely to raise them (lower price-elasticity of supply) regardless of the reduced cost of production made possible by the increase in scale and improved technology. There needs to be a modicum of competition or regulation and consideration of other efficiencies and inefficiencies in order to arrive at an optimal solution. We also need to consider whether explicit costs alone are the best measure before we tell people what they should or should not want.

Joshua writes:

It may not matter for shirts, but do you think there's anything to the quality arguments... (ex. arguing that handcrafted furniture from a carpenter a century ago is more durable than today's mass-produced furniture?)

John writes:

The organic food craze is the one that I just don't understand. Eating organic is antithetical to the modern environmentalist/climate change political ideology: lower yields means you use more land and water per food item, which takes away water and space for forests that absorb C02. Moreover, "Science" is not in on whether organic foods are any healthier -- depending on the vegetable (probably more important for meat). So it's the ultimate selfish transaction -- they're saying: "I am willing to pay more for a high status good of questionable value that is detrimental to the general environment."

Robert Book writes:

Don is basically describing a downward-sloping supply curve ... right?

Jared writes:

El Presidente,

"What's more, if you follow your theory to its extreme, you end up with one producer for each good: a monopoly."

That is actually incorrect. For a particular good, it is both the extent of the market and the minimum of the long run cost curve for each individual firm that matters. If individual firms' minimum long run average cost is achieved at an output far below the quantity demanded at that cost, several suppliers will survive in long run equilibrium. If, however, that minimum point is equal to or exceeds the extent of the market at that cost, your claim--that a monopoly will obtain--is correct.

But so what? That monopoly is efficient; it would actually be *inefficient* to break up that firm, as multiple firms would operate with less cost effective combinations of inputs. Sometimes monopoly is the best you can do in the provision of an item; it is folly to assume that provision by multiple firms is the only efficient outcome.

Also, your claim about counting calories is incorrect. Often people think that the measurement of efficiency involves counting the quantity of inputs saved (in your case, calories). But inputs are not equal, and the relevant conversion is not their caloric content, but their subjective value in alternative uses. That subjective value is price; it is the appropriate method of determining efficiency, period.

Tom West writes:

Eating organic is antithetical to the modern environmentalist/climate change political ideology

Not if you believe that there are externalities that are not included in the calculation. If you believe that problems with pesticides. over fertilization, and monocrop culture are major environmental issues that aren't priced into environmental cost of conventional food production, then organic/buy local can be a logical response.

As well, a lot of the people I know who are big organic/buy local fans are also vegetarians or nearly so. This alone probably decreases their environmental/carbon footprint well below mine even if they're choosing less efficient means of food production.

Granite26 writes:

A Monopoly allows the Monopolist to charge rent based on the cost of setting up a second producer. This profit is a reward to the Monopolist for increased efficiency.

The danger comes when the Monopolist manipulates prices to keep competition out (operates at a loss to bankrupt competitors and then charges over-market rent to make up for it).

Economically, there's nothing wrong with a basic monopoly, but I still think that a variety of sources and pushing local (I.E. high variety) is a net social good.

aub writes:

Joshua: It may not matter for shirts, but do you think there's anything to the quality arguments... (ex. arguing that handcrafted furniture from a carpenter a century ago is more durable than today's mass-produced furniture?)

On one level, that's a fair argument, but I would buy it (and pay more) because it's higher quality, not solely because it is made locally.

But, your furniture example is a little flawed in that you're comparing hand-made furniture that has lasted a hundred years (you're not counting all the furniture that didn't last) to mass-produced furniture (designed for short-term use). A fairer example of local vs global is hand-crafted furniture made in the shop down the street to hand-crafted furniture made two states away or made outside the US.

What do you do if the craftsman down the street is not very good?

As a furniture importer, my experience has been that you will pay 3 to 4 times for furniture made locally without a huge difference in quality. The labor cost will be much higher. But you're going to pay a lot more for materials, as well. Imagine trying to sell a desk for $1,000 when a desk of similar quality is $250.

JH writes:

"Don is basically describing a downward-sloping supply curve ... right?"

No, he's describing shifts in both the supply and demand curve. A large shift in the demand curve (demand from more markets) would lead to an enormous shift in the supply curve (using machinery and a factory to mass produce goods).

El Presidente writes:

Jared,

That monopoly is efficient

Perhaps, but the price of the shirts is not likely to be less if the producer isn't forced by competition or regulation to lower prices. Arnold's point was about prices, wasn't it? Total surplus will be lower as output will be constrained and producer surplus maximized at the expense of consumer surplus.

Also, your claim about counting calories is incorrect. . . inputs are not equal, and the relevant conversion is not their caloric content, but their subjective value in alternative uses.

Relevant to whom, and for what purpose? You seem to be making an argument for a certain type of allocative efficiency; one based upon subjective utility. My point in using calories as a measure is to remove the subjectivity for a moment and impose objectivity on the question of efficiency. If mechanical efficiency is to be discarded in favor of utilitarian efficiency, then we are actually saying we prefer and will seek mechanical inefficiency. In other words, we prefer to waste stuff instead of using what we have more carefully simply because we get more money to do so. When you say I am incorrect, you are rejecting the standard I offered, but not refuting the accuracy of my statement. So, to be precise, my claim may be unpalatable, but not incorrect.

Lauren writes:

Granite26 writes:

A Monopoly allows the Monopolist to charge rent based on the cost of setting up a second producer. This profit is a reward to the Monopolist for increased efficiency.

Monopoly profits have nothing to do with rewarding monopolists based on the costs of setting up second producers, nor for providing increased efficiency.

Monopolists end up with profits because their competition has been artificially limited, either by government preclusions of their competitors or occasionally because of natural conditions that make them the only game in town. The size of the profits monopolists end up with depends on the elasticities of demand and supply conditions, but none of those conditions involve increased efficiency or the fixed costs of setting up other potentially-competitive firms.

In particular, the profit reaped by a monopolist is not a reward to increased efficiency. Monopoly profits and rewards shelter firms from ever bothering with efficiency. Efficiency is a concern primarily to competitive firms. A firm that is not competitive gets rewarded for reasons having nothing to do with efficiency. It may or may not be efficient in its production, relative to the uncompetitive standards it sets.

Let me recommend reading "Monopoly", by George Stigler, in the Concise Encyclopedia of Economics, as a starting point to understanding monopolies.


Dan Weber writes:
The organic food craze is the one that I just don't understand.
There are many different movements wrapped up in the phrase "organic." I think some are sensical, some not so (and others will have different opinions).

One of the biggest is "don't eat what poor people eat." As a marketing idea this is genius. People love being different from the poor, and until a year or two ago it was the big driver of the bottled water industry.

There are also some health issues, like the tendency to use whole grains and resist added sugars. This doesn't have to be part of organic farming, but until very recently the market was aligned that way.

Sustainable farming itself has very different subtopics that could probably fill a book.

The whole organic food thing is kind of like I feel about the Amish: more power to them. As long as they don't try to say I have to live like them, they're entirely in their freedom to live with a limited set of technologies. (And in that rare case that society goes through some doomsday scenario and we get sent back a few centuries, the rest of us will be glad to have their accumulated knowledge.)

Thomas DeMeo writes:

We will see higher levels of competitiveness from short run sources, and they will take a significant portion of the market shares held by mass manufacturers today.

As high wage earners continue to have their wages erode due to globalization, more talented people will move into local production, seeking to gain more control over their lives, and they will bring their management sensibilities with them. Everyone must differentiate to survive. Big is increasingly becoming unstable.

Technological advantages large firms have are beginning to flatten out, and that will accelerate.

The cost of freight will rise.

Retailers will become more concerned with differentiation, agility and redundancy.

Jared writes:

El Presidente,

On the monopoly: If the monopoly is the efficient producer (that is, if the extent of the market is such that the output of a single firm at its minimum long run average cost satisfies the entirety of the market-clearing quantity) there is *not* additional surplus that can be gained through adding firms. There just isn't. The best you can do is allow the monopolist to engage in price discrimination, which will capture all the surplus available were the competitive (i.e., multi-firm) market equilibrium tenable in the long run. As that surplus is captured only through its transfer to the monopolist, this has distributional consequences that, based on your previous statements, I'm not sure you'd be too keen on (indeed, I'm not sure I'm too keen on them, either).

You can go ahead and try to regulate the price, too, by estimating the competitive equilibrium (were two or more firms viable), but you'll end up using some sort of rule like "price at marginal cost", or "price at this level". If you do either, you've just encouraged the firm to pad its costs (they'll take their profits through costs--nicer offices, more perks, and so on).

You are correct that Prof Kling's point is about prices, but his argument is tied quite closely to the importance of the extent of the market relative to the productively efficient size of a firm. It seems you are arguing for some position which I have yet to understand. If a single firm, operating at its long run productively efficient output, produces the entire extent of the market, what regulation (or policy of any sort) are you considering that would make multiple firms doing the same job more efficient?

On caloric and mechanical efficiency:

I can save gasoline in any number of ways, including walking. Walking takes longer, but over many distances relative to my everyday life, will consume less calories overall than driving. Of course, walking takes time. How shall I convert my time into calories, to tell me if it is more efficient to walk than to drive?

Mechanical efficiency offers no meaningful answer to this question, nor a whole host of other questions. It takes many tons of concrete and steel to build a wastewater treatment plant, or to improve it to make drinking water cleaner. Cleaner drinking water prevents illnesses and deaths. Mechanical efficiency cannot tell me whether the tons are worth the illnesses, because there is *no common metric of mechanical efficiency*. Indeed, it is not the quantities of stuff preserved, but rather their usefulness to humans and human activities that matters.

And how do we judge that usefulness? With the metric in which things are valued: prices. Your claim is not unpalatable; conserving energy is a good thing. So is conserving steel. And aluminum. And glass. And clean air. And fish stocks. And lives. And the conversion rate among these things is what they are worth to us, and that rate is the relative price.

Your claim is not unpalatable. Mechanical efficiency is nice. But we can make all processes more mechanically efficient by using more of some other resource. So mechanical efficiency cannot answer the question of which activities to make more mechanically efficient, because it does not tell us what calories (or tons, or ounces, or... you get the picture) are worth in terms of well being. Mechanical efficiency isn't an unpalatable method of assessing efficiency in human affairs; it's really just an incorrect one.

El Presidente writes:

Jared,

On the monopoly: If the monopoly is the efficient producer (that is, if the extent of the market is such that the output of a single firm at its minimum long run average cost satisfies the entirety of the market-clearing quantity) there is *not* additional surplus that can be gained through adding firms.

You are restating and yet missing the obvious. Monopolies are frequently not the most efficient (surplus-maximizing) producers. They usually appear and persist because they are the most profitable, but that is often different. Furthermore, any monopoly earning economic profits may invite competition for those limited but exceptional profits, even if they currently supply the whole of demand at current prices. So your observation, while correct, has narrow application.

It seems you are arguing for some position which I have yet to understand.

Accuracy.

If a single firm, operating at its long run productively efficient output, produces the entire extent of the market, what regulation (or policy of any sort) are you considering that would make multiple firms doing the same job more efficient?

If long-run economic profits are zero, none. How often does that occur with unregulated monopolies? You've indicated your skepticism of their benevolence and/or impotence by saying:

If you [regulate price with pricing rules], you've just encouraged the firm to pad its costs (they'll take their profits through costs--nicer offices, more perks, and so on).

How shall I convert my time into calories, to tell me if it is more efficient to walk than to drive? . . . Mechanical efficiency offers no meaningful answer to this question, nor a whole host of other questions.

Thus, it is unpalatable because you feel these are the important questions, right? We cannot make intelligible statements about optimal means except with respect to specific ends. You seem to be adopting the respected course of pursuing 'utility' which anoints the individual sovereign, taking their desires as the origin of all things economic. I think sometimes we want things we shouldn't want and sometimes we want to have our cake and eat it too. That usually leads to us having our cake and eating someone else's. Perhaps you disagree. I would like to see us make greater use of those near us instead of going half-way around the world to find labor so cheap that we can pay for the shipping and make an even larger profit. I'm not against global trade, so please don't misunderstand me. But, trade opens up avenues of exploitation and doesn't always deliver lower prices, even when it delivers lower costs. We get all the cost and only some of the benefit. It's not an unqualified good. Buying locally can have non-price advantages.

Does Nike make shoes in Asia because Chinese, Thai, Vietnamese, and Malaysian workers are naturally gifted cobblers with proprietary methods? They don't locate there to take advantage of superior shoe-manufacturing technology and Asia is not their primary consumer market. There may be many good reasons to buy these shoes, but low price as a result of comparative advantage based on geographically-bound technology is not one of them. The exact same shoes could be made right here, but they would cost more in wages and regulatory compliance to produce. I'm not saying they should be made here, but this illustrates the flaw with the argument that buying globally causes use of the most efficient technology and THEREFORE cheapest prices.

Nikes are not sold cheaply, and they're not made cheaply on account of technology so much as cheap labor. We can argue that they never would have pursued their best technology unless cheap labor had made it profitable, but that is a different argument. We seem instead to place the cart before the horse and argue that spontaneous explosion of Asian shoe-manufacturing technology led to the unrivaled quality and affordability of Nikes. That isn't even slightly true. The fact that they split production between at least a half-dozen Asian countries suggests that their efficient scale requires more than one facility to meet market demand. Splitting those factories among different owners may be just as effective a mode of production (exactly the same technology) and would almost certainly reduce prices and increase innovation.

The reason Nike seems to be non-conforming is that they are engaged in monopolistic competition. For most purposes, their products have many close substitutes, but they persuade consumers that there are no close substitutes. You want to wear what Kobe and LeBron wear (BTW: their shoes are actually custom-fitted, not off-the-shelf), not just some ordinary shoe that costs half as much and works twice as well. Monopolistic competition prevails with many consumer goods.

Jared writes:

El Presidente,

"Monopolies are frequently not the most efficient (surplus-maximizing) producers. They usually appear and persist because they are the most profitable, but that is often different."

If they are not the most efficient, then others can enter, produce at a lower cost, and sweep the market. Period. If somebody can outcompete you, they will. What model of monopoly are you imagining where the possession of profits (which encourage competitors to enter) is sufficient to keep out competitors (who want to enter!)?

[This, of course, is different from Lauren's point--that most monopolies exist because of some artificial barrier, not because of the natural scale of the enterprise. When that's the case, then your point obtains: the monopolist does not have to be the efficient producer... but that's *only* because somebody else (i.e., a political entity) restricts entry and awards the monopoly to a firm that isn't the most productively efficient.]

"Furthermore, any monopoly earning economic profits may invite competition for those limited but exceptional profits, even if they currently supply the whole of demand at current prices. So your observation, while correct, has narrow application."

The monopoly does not invite competition, the profits do (but I think we mean the same there). It is the quest for those profits that leads others to attempt to enter the market. Of course, in long run, every firm whose average cost is less than or equal to average revenue will survive. Everyone will rejigger their capital allotment until they get to their most productively efficient point; some will go out of business along the way. Sometimes that means just one firm. The end.

"'It seems you are arguing for some position which I have yet to understand.'

Accuracy.

'If a single firm, operating at its long run productively efficient output, produces the entire extent of the market, what regulation (or policy of any sort) are you considering that would make multiple firms doing the same job more efficient?'

If long-run economic profits are zero, none. How often does that occur with unregulated monopolies? You've indicated your skepticism of their benevolence and/or impotence by saying:"

You are correct when you say "none", but incorrect with "long-run economic profits are zero." It can be the case that a single producer is efficient *and earns economic profit*, but adding an additional producer would mean *neither* can operate efficiently. And you have completely failed to understand the point of mentioning the futility of regulating a monopoly's profits: it has nothing to do with their benevolence and everything to do with incentives. If you regulate away my profits, I'll take them in my costs if I can. That's not evil, it's just a rational response to a constraint.

In light of the fact that he's a pioneer of modern trade theory, I'm going to outsource my response to your discussion of shoe making in Asia to Paul Krugman ("In Praise of Cheap Labor: Bad Jobs at Bad Wages Are Better than No Jobs at All", in The Accidental Theorist). Also, you may want to look at the result of all the terrible exploitation: a dramatic increase in the wages in those countries.

But I do want to hone in on this:

"I think sometimes we want things we shouldn't want and sometimes we want to have our cake and eat it too. That usually leads to us having our cake and eating someone else's."

If you are concerned that people are "eating someone else's cake", I recommend you support greater enforcement of (and a larger scope for) property rights, rather than less trade. It is through trade--not regulating monopolies--that the well-being of so many of the citizens of the countries you mentioned has been improved.

El Presidente writes:

Jared,

I recommend you support greater enforcement of (and a larger scope for) property rights, rather than less trade.

I was very clear that I do not advocate less trade, per se. Acknowledging that would demonstrate your integrity. You may wish to read my previous remarks again. As for property rights, that's a long discussion that I've had several times on this blog, recently here. In short, leverage can induce voluntary exchange to the progressive detriment of one party, even in positive sum interactions, because it can further increase leverage in subsequent iterations. Property rights do not necessarily prevent exploitation. In some cases, they facilitate it until one defends themselves through what is sometimes called 'protectionism' (i.e. refusing to trade with particular entities on the terms they offer).

It is through trade--not regulating monopolies--that the well-being of so many of the citizens of the countries you mentioned has been improved.

And this is the heart of the matter. We could have just given them the money if their prosperity was our primary aim. It wasn't. We didn't. Let's not be confused or simple. I don't argue with Krugman on this. He is correct. We do leave gold dust in our wake. Lower wages are their comparative advantage. If their wages continue to improve faster than others', they may work themselves out of their jobs. This has already happened as jobs outsourced from the United States were subsequently outsourced from their new host countries to a third, all to chase lower wages and higher profits, not better technology or lower prices. What will we do when there is nowhere else to go, give up on profit, localize to reduce shipping costs, stop making these products? It seems that relative poverty is necessary to sustain this business model. So, eliminating poverty would undermine business, or at least reduce profits . . . unless rents are secured and expanded. Do we wish to be dependent upon poverty to increase our wealth? Is that the end for which we select our means?

Jared writes:

El Presidente,

One of these things is not like the other:

"I would like to see us make greater use of those near us instead of going half-way around the world to find labor so cheap that we can pay for the shipping and make an even larger profit."

"I'm not against global trade, so please don't misunderstand me."

"But, trade opens up avenues of exploitation and doesn't always deliver lower prices, even when it delivers lower costs. We get all the cost and only some of the benefit."

"It's not an unqualified good. Buying locally can have non-price advantages."

I pulled all of this from the same paragraph. One of these is "I'm not against global trade", but the rest of it all advocates *less* trade.

Make greater use of those near us *instead of* trade... trade opens up avenues of exploitation... buying locally can have non-price advantages. Read your own paragraph before you every make remarks about my integrity again.

And I've read your... writings... about property rights. Go ahead and read Henry George if you like, whose central argument leading to the land tax Robert Heilbroner calls, simply, naive. And for that matter, go ahead and believe that "We could have just given them the money if their prosperity was our primary aim. It wasn't. We didn't." despite the nearly universal body of evidence that direct transfers of aid do not produce lasting prosperity of any sort.

You go ahead and believe all those things, if you like. But I am through discussing them with you; you have repeatedly demonstrated that you do not have an underlying model of economic activity, but rather your moral feeling that something is wrong. That is not a model; it does not explain. And I have no wish to discuss it. Good day.

El Presidente writes:

Jared,

You did not seem to understand what I wrote. If that is my fault, I apologize. I'm not trying to be inscrutable, just accurate. It is true that there are costs to global trade as we know it. If we can't agree on that, we can't agree on much. The question is whether the benefits outweigh the costs, and next whether the ratio of benefits to costs can be improved. I think the benefits do outweigh the costs presently (my normative assessment of aggregate outcomes) and that the ratio can be improved, but I think it requires a little unconventional thinking. Dismissing the costs does not advance that cause, so I refuse to do so. To be blunt, if we are going to trade (and I hope we will), we shouldn't be trading in poverty. That's not a sustainable way to do business.

I seem to have disappointed you inadvertently. I never purported to offer a model, nor did anyone ask me to produce one, as far as I know. I would also like a model to work with. Models help in evaluating and understanding complex phenomena. I like models. As the bumper stick says, "Economists do it with models." I find the ones we've been relying on to be rather imperfect, and I think it's a good thing to say so when we recognize it and to try to improve upon them. This is why ends matter in defining the efficiency of means. If we are chasing different ends we will be talking past one another. I have other questions, in addition to the ones you described as relevant, that I find to be important. So, I work for something that suits my concerns. Maybe I'm the only one, but I doubt it. That's how I understood academic inquiry was supposed to function. Perhaps I was misled in that regard.

If you'd like to discuss the difficulties of implementing a single land tax (which I don't advocate) or the conditions under which direct aid is more or less likely to produce sustained benefits, those are worthwhile conversations I would be happy to have. I hope you do have a good day, and many more to follow.

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