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Drive into the Whole Foods parking lot, and you’ll see the latest BMWs, Mercedes, Audis, Porsches and Volvos. More relevant than what the 1% are paying is the widening gap between the 1% and the rest of their countrymen who are struggling to pay the food bills at Walmart.
So writes Elliot Schiff of Wilmette, Ill in the letters section of the Wall Street Journal (December 5, 2024; December 6 print edition.) As you can tell, I’m catching up on this month’s Wall Street Journals.
What is Schiff’s implicit assumption? That people who are driving the latest BMWs, Mercedes, Audis, Porsches, and Volvos are wealthy. The odds are that many of them are wealthy; the odds are also that many of them are not. You don’t generally build wealth by buying assets that depreciate quickly. New luxury cars tend to depreciate quickly. Schiff would do well to read The Millionaire Next Door. I posted about it here. In response to a question from commenter TMC on that post, I got the book from the library and enjoyed rereading some of the stories and facts.
Here’s one that directly relates to Schiff’s point. It’s from Table 4.1 of the book. 46.3% of millionaires had cars that were current year’s or last year’s model. But 37.6% had cars that were 3 years old or older. And 18.9% had cars that were 5 years old or older. Of course, you would want to know what % of the luxury cars Schiff names are owned by millionaires and the book’s data don’t tell us that. Remember also that $1 million when the authors were writing in 1996 would be just over $2 million today. Using the personal consumption expenditures index, which is a more accurate measure of inflation, the $1 million in 1996 translates to $1.77 million today.
So a reasonable question is: What percent of the luxury cars in the lot that Schiff observed are owned by people with a net worth of at least $1.77 million. I would give even odds that it’s fewer than 60%, and a 40% probability that it’s fewer than 50%.
(3 COMMENTS)Every year, millions of parents propagate the myth of “Santa Claus”: an omniscient, magical man bringing near-infinite toys to children across the globe. Santa Claus employs elves and flying reindeer, lives in an inhospitable environment, and necessarily travels 0.5% the speed of light. Despite the obvious dubiousness of these claims, parents invest in the story regardless, taking children to see Santa, write letters to Santa, leave cookies at night, and—perhaps most costly—enforcing these beliefs collectively. Why?
An alternative expression of the question comes from Gary Becker’s model of the altruistic family, wherein members maximize each other’s utility. Said model descriptively approximates relationships between adults, where a husband may purchase shoes for his wife if (a) she is not also at the store, (b) she would have purchased the shoes had she been there, and (c) the husband has this knowledge. But children are an odd exception to Becker’s model: their utility is not maximized as other family members’ are. We know this because a child with a parent’s income would own every toy or candy; that this isn’t happening is proof their utility functions aren’t being wholly considered in intra-family income distributions.
To this point, parents claim children don’t know what’s best for themselves. Translated to economics, children don’t internalize the cost of their actions. In this sense, children are akin to drug addicts: their utility functions are so near-sighted that they ignore the costs on others and their future selves. So phrased, the question of maximizing children’s utility becomes one we’re more familiar with: how do we allocate to drug addicts, knowing their requests don’t internalize the costs on us and their near-future selves?
Becker comes close to addressing this issue with his “Rotten Kid Theorem,” which argues bad actors are still incented to internalize the costs of their actions because hindering your income supply, in turn, hinders your future income. In other words, rational actors don’t bite the hand that feeds them. But the Rotten Kid Theorem doesn’t account for actors with unusually high time preferences, such as actual children and drug addicts. Assuming parents want to maximize their children’s present utility function, how can they allocate resources such that these little drug addicts functionally internalize costs?
For drug addicts, you (the income distributor) transfer income in an amount negatively relating to monitoring costs. This achieves a sub-par outcome for the income distributor, where they wish to spend more, but cannot for fear of the addict spending (or trading) for drugs. The case for drug addicts seems bleak, but what about children? What difference could exist between drug addicts and children that lead to, for instance, a superstitious fiction for gift-giving in the latter case but not the former?
Two explanations persist: one preference-based (“it’s cute!”), the other what I call “behavior-check” theory: Santa Claus lets parents punish children, while removing themselves as the punisher. Dismissing preference-based explanations, the behavior-check theory relies on the “naughty list” Santa supposedly updates constantly; but behavior-check is unconvincing because Santa’s threat is never credible. One could argue that children don’t understand the lack of credibility, but once children’s mental capacity is considered, behavior-check makes even less sense: why would children, with incredibly short time horizons, care about a punishment they receive months later?
I argue, alternatively, that parents utilize children’s gullibility to allocate what I call “seasonal” goods: stuff that can’t be distributed in frequent intervals, like expensive electronics or other items that can’t be consumed frequently (i.e., candy). Since children’s incomes are dependent on parents’, we should expect rent-seeking behavior. For example, constant requests for toys, candy, etc. A rational parent faces two choices: give in and purchase every item a child asks for, or allocate provisions below what children would buy with unlimited access to the family’s income.
Given parents want to maximize their children’s utility, but only such that costs appear internalized, they face the issue of opportunistic and rent-seeking behavior, where children know their parents could presently purchase items that would otherwise be rationed seasonally, but don’t have the appropriate time horizon to wait. You could say there is a contractual issue: parents would like to “contract” with their children such that some gifts are received seasonally (expensive items that can’t be provided often), but children are prone to “breach,” where they demand items sooner than later.
For drug addicts, this contract seems impossible to enforce, and thus the solution is often to reduce distribution (null the contract entirely). Children’s gullibility allows for a more optimal outcome: a parent (income distributor) may remove themselves as the object of rent-seeking behavior and appoint somebody else. Perhaps, say, a jolly reindeer-riding saint. This yields some testable predictions, proving Santa Claus to be quite an effective reducer of deadweight loss.
Removing oneself as the income-distributor may stop the negative effects of rent-seeking on oneself specifically, but it doesn’t reduce deadweight loss. If a parent appoints an uncle, the children will simply rent seek from the uncle, but via Coasean bargaining between family, the parent is still at a loss. Thus we should predict the appointed income distributor to be a stranger. But appointing an actual stranger still gives the child an incentive to rent-seek; their utility function, if maximized, will see resources then leave the family towards the stranger. Thus the deadweight loss is still affecting the family.
Another prediction, then: the family will appoint a stranger that is difficult to rent seek from. But also, the parent can capture the deadweight loss from children’s rent-seeking into a boon if, for whatever, reason, the stranger’s utility is maximized by the child acting “good.” In reality, no stranger has these incentives (unless they’re paid to; mall Santa, anybody?). Thus, we should expect that this stranger is fictional, so parents can capture benefit from children’s rent-seeking behavior. Finally, we should also predict this stranger to be only appointed when families actually have a disposable income for gift-giving; with no seasonal gifts, we shouldn’t expect said fictional stranger.
Santa Claus, the ever-unreachable stranger commanding children to be “nice,” fits all these predictions. Santa allows parents to remove themselves as the object of rent-seeking behavior, and his location forbids children from engaging in direct rent-seeking. Instead, parents capture the value of children’s rent-seeking by maintaining that Santa is sueded only by the relative nicety of the children he distributes income to. Santa Claus also arose as a prevalent gift-giver after the industrial revolution and early in the 20th century, when families actually had a disposable income for children to rent-seek, and “seasonal” goods were allocated at all.
This counters the behavior-check theory by arguing that acting “nice” is merely a way of capturing the value expended in rent-seeking, not the impetus for Santa Claus itself (which is explained, as I argue, by the necessity to remove parents from the role of income distributor). Moreover, none of my arguments suggest parents’ rationale for Santa lies outside their love for children. On the contrary, their love for children is precisely the reason they hope to maximize their utility in the first place, via Santa Claus.
Sam Branthoover is an economics PhD student at Ole Miss.
(1 COMMENTS)
In several recent posts, Tyler Cowen has stressed the need for better models of inflation. In one case, he expressed exasperation at my claim that (price) inflation is an almost meaningless concept:
4b. More seriously, Scott seems to dismiss the price level concept altogether. For instance he once wrote: “In the past, I’ve frequently argued that inflation is an almost meaningless and useless concept. I’m not even aware of any coherent definitions of the concept.” I don’t think this is a defensible point of view, and you have to compare Scott’s criticisms of the o1 model to his own approach, which is fairly nihilistic. And I think wrong. If inflation were higher and someone offered Scott an inflation-indexed contract to sign, would he be unable to evaluate such a transaction? Obviously not.
Yes, there’s some hyperbole in the phrase “almost meaningless”. But I suspect there’s much less exaggeration than most economists would assume. I’ll present my case with an example and then discuss Keynes’s view on the subject, which I believe is more accurate than either my previously expressed view or Tyler’s view. Then I’ll discuss China’s economy, an area where I seem to view the price level as important, but most other economists “dismiss the price level concept altogether”. No one will come out looking very good (except Keynes.)
What led me to such an overheated claim about inflation being almost meaningless? It would help to look inside the “sausage factory” and see what’s going on when the government estimates inflation. The more I look at official government estimates of TV inflation, for instance, the more skeptical I become about the entire process:
According to the U.S. Bureau of Labor Statistics, prices for televisions are 99.15% lower in 2024 versus 1960 (a $495.77 difference in value).
Between 1960 and 2024: Televisions experienced an average inflation rate of -7.18% per year. This rate of change indicates significant deflation. In other words, televisions costing $500 in the year 1960 would cost $4.23 in 2024 for an equivalent purchase. Compared to the overall inflation rate of 3.76% during this same period, inflation for televisions was significantly lower.
To me, that estimate doesn’t just seem wrong, it seems borderline insane. And that’s despite the fact that I’m probably in the top 1% of snobs who really care about picture quality. A few years back, I paid thousands of dollars extra to get a 77-inch OLED TV. Yes, in a technical sense modern sets are much better. But more that 100 times better? Please define the term ‘better’.
If you pressed an economist, they’d probably say “better” means more utility. Fine, but what utility measuring device determined that viewers derive 100 times more utility from a modern TV? In 1960, I was five years old. I don’t recall picture quality having much effect on how hard I laughed while watching I Love Lucy. In what meaningful sense is a modern TV 100 times better?
Economists obsess over whether the CPI or the PCE is closer to the “true rate of inflation”. But how can there be a true rate of inflation if economists cannot even precisely define what they mean by “better”?
If TVs were the only good, I’d stand by my claim that government inflation estimates are “almost meaningless”. But they are not the only good. And I would have to concede that inflation estimates for a gallon of gasoline or a dozen eggs are far from meaningless. The overall CPI is a hodgepodge composite of meaningless and meaningful data points, all mixed together.
Here’s Keynes in the General Theory, discussing the question of whether inflation data is meaningful:
But the proper place for such things as net real output and the general level of prices lies within the field of historical and statistical description, and their purpose should be to satisfy historical or social curiosity, a purpose for which perfect precision — such as our causal analysis requires, whether or not our knowledge of the actual values of the relevant quantities is complete or exact — is neither usual nor necessary. To say that net output to-day is greater, but the price-level lower, than ten years ago or one year ago, is a proposition of a similar character to the statement that Queen Victoria was a better queen but not a happier woman than Queen Elizabeth — a proposition not without meaning and not without interest, but unsuitable as material for the differential calculus. Our precision will be a mock precision if we try to use such partly vague and non-quantitative concepts as the basis of a quantitative analysis. . . .
In dealing with the theory of employment I propose, therefore, to make use of only two fundamental units of quantity, namely, quantities of money-value and quantities of employment. . . . We shall call the unit in which the quantity of employment is measured the labour-unit; and the money-wage of the labour-unit we shall call the wage-unit. . . .
It is my belief that much unnecessary perplexity can be avoided if we limit ourselves strictly to the two units, money and labour, when we are dealing with the behaviour of the economic system as a whole; reserving the use of units of particular outputs and equipments to the occasions when we are analysing the output of individual firms or industries in isolation; and the use of vague concepts, such as the quantity of output as a whole, the quantity of capital equipment as a whole and the general level of prices, to the occasions when we are attempting some historical comparison which is within certain (perhaps fairly wide) limits avowedly unprecise and approximate.
In general, I find the General Theory to be wildly overrated. Of course it’s got some good stuff, as Keynes was brilliant. But overall it is a far less useful guide to macroeconomics than is the earlier Tract on Monetary Reform.
The preceding quotation, however, is a very insightful observation. Keynes was right; fuzzy concepts like the price level can be useful for some purposes, but are inadequate for more rigorous scientific investigations. And whereas price inflation is not very useful, wage inflation should be a central concept in any macroeconomic model.
On the other hand, while inflation is a fuzzy concept, it is obviously not a meaningless observation to say that Venezuela’s nominal GDP growth overstates its real GDP growth due to a fast rising price level. We do have some rough but reasonable estimates of price inflation that can help to illuminate comparisons between time periods, or between countries.
Consider my frequent claims that China has the world’s largest economy. That statement only makes sense if you compare the US and Chinese economies in real terms. In nominal terms, the US has the largest economy. So in that sense, I’m a bit of a hypocrite.
When Tyler says that I “dismiss the price level concept altogether”, a reader might be forgiven for assuming that I hold some fringe views outside the mainstream. So I decided to google “world’s second largest economy”, to see what I got. At the top of the list was AI overview:
There followed a long list of links that mentioned China, not the US (which is the actual second largest economy.) And yet the claim that China is second only makes sense if one “dismisses the price level concept altogether.” There is simply no plausible estimate of US and Chinese price levels that would have China in any position other than world’s largest economy.
So let’s compare the views of Keynes with the views of mainstream economists:
1. Both Keynes and I believe that wage inflation and employment are the two key macroeconomic variables. While price inflation is not completely useless, its marginal value is almost zero, once you have accounted for wage inflation.
2. Recessions occur when aggregate demand falls relative to nominal wage rates.
3. The price level may be of interest to people making very general comparisons about the relative size of economies, or when estimating the change in living standards over very long periods of time, but should not be treated as if they were precise scientific concepts.
4. The original Phillips Curve utilized wage inflation. I am almost certain that Keynes would have shared my view that the later shift to price inflation was a mistake.
To summarize, economists tend to use price inflation in places where it is not appropriate–where wage inflation would be far more useful. Even worse, they often “dismiss the price level concept altogether” when considering exactly the sort of broad generalizations where price level adjustments would be highly appropriate, such as the question of whether the US or China has the world’s largest economy.
And don’t try to argue that when discussing “the economy”, the AI Overview assumed we meant “nominal economy”. I am quite confident that if you asked any AI a question about recent US economic growth, they would cite data for real GDP, not nominal GDP. That’s also true of the media. “The economy” seems to mean real GDP when discussing the business cycle, but it suddenly means nominal GDP when people wish to show the supremacy of the US economy.
PS. Off topic: Happy birthday to my stepfather Maxwell Freeman, who turned 100 today. Max earned two Purple Hearts fighting in places like Leyte and Okinawa during WWII. He is still going strong.
(20 COMMENTS)
Am I subsidizing Safeway? Why would I ask? Here’s why. My wife and I spend at least $400 a month at Safeway. Safeway doesn’t buy anything from us. So, our monthly trade deficit with Safeway is at least $400. And, in Trump’s view of the world, a trade deficit equals a subsidy. By Trump’s reasoning, yes, I am subsidizing Safeway.
This sounds ridiculous. It is. But it’s no more ridiculous than Trump’s claim that Americans are subsidizing Canadians. When you spend more on someone’s goods than that someone spends on your goods, there’s no subsidy involved. The fact that the spending occurs across borders doesn’t change that fact.
And that fact makes Trump’s proposed tariffs on Canadian goods and services all the more tragic.
This is from David R. Henderson, “Tariffs Will Hurt Canadians and Americans Alike,” Defining Ideas, December 19, 2024.
Read the whole thing. It is unusually long–about 2,500 words.
Shout out to Don Boudreaux, who looked at an earlier draft and gave good comments.
(3 COMMENTS)Many years ago, shortly after joining the Marines, I signed up for a bone marrow donor registry. I largely forgot having done so as the years passed until one day in June 2020, when I got a call from my father. He had gotten a call from the registry. (When I had first registered, I didn’t have a cell phone of my own so I just put down my old home phone number as my contact information.) It turned out that I was an ideal match for someone suffering from leukemia and in need of a bone marrow transplant. My father passed the information he collected on to me, and I contacted the registry.
My only conception of how bone marrow transplantation worked came from what I recalled from medical shows – usually involving a gargantuan needle driven into the bone to extract marrow. It turned out this called for a different method. A nurse would come out to my house daily for several days leading up to the donation, to administer filgrastim injections. This, in turn, would cause my body to overproduce bone marrow stem cells that would flood into my bloodstream. I was also advised that common side effects of filgrastim injections were significant muscle, joint, and bone pain, along with headaches, weakness, and nausea. After a week of these injections, I would spend several hours hooked up to what was essentially a dialysis machine that would filter these cells out of my bloodstream and make them available to the person in need.
That all sounded like a lot to go through. Adding to the complications was that this was June of 2020 – still in the early days of the Covid-19 pandemic. I was already cautious about the disease because I was concerned that my past as a heavy smoker might have made me more vulnerable to a respiratory illness. Taking additional risks seemed, well, risky. An even further complication was that my wife and I had just welcomed our firstborn into the world in mid-May of 2020, only a couple of weeks earlier. As any parent can attest, we hadn’t slept more than a couple of hours in a stretch since then. Spending a week experiencing the side effects of these injections, while also keeping up with my job and attending to a newborn, seemed very daunting.
In the end, I decided I’d go ahead and do it. I was already feeling pretty ragged and I’d end up having a rough time leading up to the donation, plus the unpleasantness entailed by the donation process. But I wasn’t dying – and someone else was, and I could help save them. I’m glad I did. But at the time, I was right on the line with my decision. If I had been a little more cautious about Covid and possible complications, a little more exhausted from the newborn phase, a little more worried about the painful side effects of the injections – I could very well have ended up on the other side of the line.
This stage of being right at the line, right at the tipping point of moving from one option to an alternative, is what economists have in mind when we talk about “the margin.” When making that decision, I was the marginal donor – the person who was just over the cusp of being willing to go through with it. The costs were all the complications described above, the benefits were the fulfillment of a general desire to help someone in need. For me, at that time, the benefits just narrowly outweighed the costs. But suppose it hadn’t. Suppose my general desire to help people was a bit lower, or I had weighted any or all of those costs a bit more heavily at the time. In that case, I would have just barely been on the other side of the line. Almost willing to donate, but not quite. In that kind of case, you know what would have made a difference and tipped the balance toward donation? The prospect of being paid.
If my willingness to donate had only just barely fallen short, then only a small payment offered would have been enough to push me over the line towards donation. If my reservations were stronger, it would have taken a bigger payment. And so on.
In the United States, being paid to donate an organ is against the law. Everyone else involved in the procedure – the hospital and medical staff, for example – can be paid for their part in, say, a kidney transplant, but if the person actually losing a kidney receives any compensation for their part in the process, then a crime has been committed. As a result, kidneys can only be given by donors willing to do it for free. The number of such people is not zero – Scott Alexander is one such person – but the number is demonstrably much, much lower than the number of kidneys needed by sick people. This is why there is a huge backlog of people waiting for a donor kidney, with thousands of them dying each year before a donor can be found.
The number of people out there with Scott-Alexander-levels of altruism isn’t enough. But what about people who are right at the edge of the line? People who are almost, but not quite, altruistic enough to donate a kidney for free. For these people, only a small payment offered would be needed to move them over the line, from not quite willing to donate to willing to donate. And as those people cross the line, there will be a new batch of people who are just barely on the side of this new line. People whose altruism combined with a small payment is almost but not quite enough to make them willing to donate. If after a small payment is offered there are still more people needing kidneys than there are willing donors, the price can go up and bring this next group of people just over the line. This process could keep going until the price is high enough that the last needed person crosses the line of “not quite willing” to “just barely willing” – that is to say, the final price for donor kidneys will ultimately be set at the margin.
According to this website, as of September 2024 there were about ninety thousand people waiting for a kidney transplant in the United States. About a dozen of them will die waiting any given day. The previous year had seen a total of about 27,000 kidney transplants occur. That’s a shortfall of over 60,000 kidneys. The question is, how high would the price have to be to move 60,000 people from being just barely unwilling to donate, to being willing? It might be lower than you suspect. Even if most people wouldn’t consider donating a kidney for less than a million dollars, prices aren’t set by what most people want. Prices are set at the margin. Because of this, the payment would only need to be high enough to motivate the 60,000 people already most inclined to donate, starting with the people who are only just barely unwilling to donate for free. It wouldn’t surprise me if the payment needed to fill the gap turned out to be fairly small.
Many people dislike the idea of paid organ donation. Debra Satz raises a number of objections to the idea in her book Why Some Things Should Not Be For Sale: The Moral Limits of Markets. It’s a perfectly fine book. But none of its arguments have anywhere near enough force to overcome the simple fact that today, a dozen people will die waiting for a kidney. Another dozen tomorrow, and the day after that, and on Christmas, and every other day until we get more kidneys. Against that, all of Satz’s worries about “repugnant transactions” are but a tempest in a teacup.
(6 COMMENTS)Economic theory predicts that, except in certain edge cases, tariffs will raise the domestic price of imported goods and services in a country. The way economists present the effects of tariffs to students is generally through a simple supply and demand model (for example, see this discussion of tariffs that is fairly representative of the textbook presentation). In this model, we posit the direct exchange of goods between buyers and producers (foreign and domestic).
One of the logical results of this model is that the tariff burden will be shared between buyers and producers, with their respective shares determined by how sensitive each party is to a change in price. Consequently, if the consumer does not pay all of the tariff, some portion of it will be borne by foreign producers, resulting in a possible net welfare gain if the producer surplus gain plus the government tariff revenue gain from foreign producers is greater than the welfare loss of consumers.
There are a lot of practical problems with this so-called “optimal tariff” model, and consequently many economists reject its usefulness for policy purposes. I won’t rehash those arguments (interested readers may find a useful summary here). Rather, what I wish to highlight is that the textbook supply-and-demand model, while exceedingly useful, is limited in crucial respects when discussing the practical effects of some policies. Not understanding those limitations can lead to incorrect conclusions.
The main shortcoming of the model for the discussion here is that it flattens down the process of trade too much. The simple supply and demand model posits direct exchange between the consumer (end-user) and the producer. As a literal translation of the model, that implies each consumer goes to the factory/farm/etc., where the goods are being produced, buys directly from the producer, and transports the goods back themselves. Reality is not so simple. Transaction costs arise during the exchange process and various middlemen exist to reduce those costs. For example, rather than buy my coffee right from the coffee company, I buy it from my grocer, who bought it from a wholesaler, who bought it from an importer, who bought it from the roaster. Rather than a single exchange between me and the producer, there are four exchanges. Each producer is a consumer at different stages of the process.
These middlemen make the conversation about tariffs (indeed most taxes) a bit more complicated. We need to examine how much prices change at each stage of the exchange (called “pass-through”). If some actors in the exchange are more sensitive to a change in price, then they will be less likely to see their prices increase. Those who are more insensitive to a change in price will see their prices rise. Consequently, we do not want to look at just one set of prices (eg. Consumer Price Index, Producer Price Index, etc.), but the whole schedule of prices in the exchange.
Looking at just one price can lead to faulty conclusions. For example, let’s say that a 10% tariff is placed on imported widgets. Widgets are a common item with many substitutes. Widget end-users have many options and thus are very sensitive to changes in price. Widget retailers, on the other hand, are very insensitive to price. Let’s further assume, for the sake of argument, that widget importers are insensitive to price. In this scenario, the burden of the tariff would be borne by the retailers and importers. Their margins would shrink. The consumer would see very little price increase. If one were to only look at the consumer prices, one would erroneously conclude that the tariffs had no effect on price. Indeed, one could even conclude that the tariff was being paid by the foreigners! What they would not see is that the tariff is being paid for by other domestic members of the exchange.
A recent Wall Street Journal article demonstrates this problem (“American Compares Are Stocking Up t o Get Ahead of Trump’s China Tariffs,” 20 November 2024). Two American business owners discuss the problem of raising prices to their consumers and how it affects their business:
In addition to duties on Chinese goods, Trump proposed tariffs of 10% to 20% on imports from all countries. That would be the worst-case scenario for Leah Dark-Fleury, co-founder of Stone Fleury, a natural-stone and porcelain wholesaler in San Francisco. She has been buying natural stone from the same supplier in China for two decades and imports most of her other materials from Europe. When Trump imposed a tariff on Chinese natural stone during his first term, Dark-Fleury continued buying from China as usual. The company raised prices to compensate, but tried to not charge the full increase to stay competitive.
Toni Norton, owner of Fine Fit Sisters in Charlotte, N.C., sources body oil from China that is popular with customers in the summertime. She normally wouldn’t be stocking up until the new year, but is trying to order about 20,000 units before the end of the year.
If tariffs on Chinese products indeed reach 60%, Norton said she might have to stop selling body oil and focus more on her fitness-coaching services. She said she doesn’t think she has much room to raise prices on the body oil, which she mostly advertises on TikTok and sells for about $13, because ‘people like cheap things.’
The Trump/Biden tariffs have been characterized by such pass-through effects. A 2021 paper by Cavallo et al finds that the tariffs are being borne almost entirely by US firms. Looking at (inflation-adjusted) retail prices is insufficient to tell us whether or not tariffs are being harmful. We must look at the whole exchange process.
PS: This just-released paper looks at the longer run effects of the Chinese tariffs. The authors find “There is no consistent evidence of reshoring but evidence of nearshoring to border nations. Despite the significant reshaping, China remained the top supplier of directly imported goods to the US in 2022.”
Jon Murphy is an assistant professor of economics at Nicholls State University.
(4 COMMENTS)
During the period from 2021 to 2023, inflation was far higher than the Federal Reserve would have wished, and also far higher than forecast by the markets. Does that mean we can excuse the Fed for allowing inflation to overshoot its target by a large amount? The answer is no. I’ll try to explain why using an example of how things would look under both inflation targeting and price level targeting. We will assume that the Fed’s inflation target is 2%.
Let’s assume that the price level is 100 in March 2021. The Fed would like prices to rise by 2% per year, or 0.5% per quarter (three months.) Here’s how they would like to see the price level rise each quarter over two years (for simplicity, I am ignoring compounding effects):
Case A: 100, 100.5, 101, 101.5, 102, 102.5, 103, 103.5, 104
Now assume that for 8 consecutive quarters, the Fed underestimated quarterly inflation by 1%. They expected 0.5%, and got 1.5%. Also assume that the Fed was doing inflation targeting, letting “bygones be bygones”:
Case B: 100, 101.5, 103, 104.5, 106, 107.5, 109, 110.5, 112
Over two years (8 quarters) the price level rose by a total of 12%, much more than the 4% rise desired by the Fed. Annual inflation was 6%, much higher than the target of 2%.
Now suppose that for 8 consecutive quarters, the Fed underestimated inflation by 1% per quarter. But now assume that the Fed was doing price level targeting, rather than inflation targeting. That means that at each and every point in time, the Fed was trying to achieve the price level path shown above in Case A:
Case C: 100, 101.5, 102, 102.5, 103, 103.5, 104, 104.5, 105
Notice that even though the Fed made exactly the same size errors in cases B and C, during every single quarter, the price level path in Case C is far closer to the ideal path shown in Case A. Under price level targeting, you have an extra 1% inflation in the first period, but after that time the inflation rate is 0.5% per quarter, or 2%/year. As a result, in Case C the inflation rate averages 2.5%/year between March 2021 and March 2023, not 6% as in Case B.
In real life, there was roughly an extra 8% worth of inflation in the two years after March 2021. This occurred even though under “average inflation targeting” the price level path should have been much closer to Case C than Case B. In other words, the Fed did not adopt the policy regime that it advertised to the public; it had no intention of targeting the average inflation rate.
Were the Covid supply problems and the Ukraine War a valid excuse? Not at all. NGDP growth overshoot the 4% growth path by even more than inflation overshot the 2% trend line. Policy was far too expansionary under any reasonable criterion. Nor can you blame the mistake on the fact that even the markets missed the size of the inflation surge. Under either level targeting, or a true “average inflation targeting” regime, those missed market forecasts would have only caused a small overshoot, the sort we see in Case C.
PS. I started the clock at March 2021, as by this time the price level had recovered from the initial drop during the early stages of Covid, and was back on trend.
Some years ago, a crisis emerged in Flint, Michigan. The public water supply was found to have dangerously high levels of lead and this was having a significant negative public health impact. Among the first to raise the alarm was a professor at Virginia Tech named Marc Edwards. He brought a great deal of attention to the issue, and as a result of his efforts, significant steps were taken to improve the situation. As these steps were taken, Edwards continued to monitor the situation. Eventually, the water quality reached safe levels again, and Edwards reported on this success. Thankful for his work, his fellow activists expressed their appreciation for what he had done and gratitude that the situation had improved.
Hahahahaha, I’m only kidding. Of course that’s not what happened. When Edwards reported that testing had shown the improved safety of the water supply in Flint, his fellow activists responded with insults, verbal abuse, and generally attempted to destroy his personal life and professional reputation. Kevin Drum of Mother Jones magazine wrote about this bizarre affair:
Marc Edwards, the Virginia Tech professor who first exposed toxic levels of lead in the water supply of Flint, Michigan, was initially a hero to the Flint community. Thanks to him, Flint became the target of nationwide outrage, and steps were finally taken to reconnect Flint to the (safe) Detroit water supply. In less than a year, lead levels in Flint water had dropped to safe levels.
So what did Edwards do? Well, he’s a scientist, and just as he had honestly exposed Flint’s problems in the first place, he also continued to honestly report the results of the intervention. When the water was once again safe, he said so—and that turned him from a hero into a pariah.
But why? Why was it so horrible of him to report that a situation people ostensibly wanted to improve had, in fact, improved? Drum suggests the activists were too bitter to accept good news:
Here in the progressive community, we like to criticize conservatives for being too anti-science; too tribal; and too subservient to their most extreme wing. But look at what happened here. The science, as you’d expect, told us that Flint’s water got better after mitigation measures were taken—but the activists on the ground were too angry and bitter to accept that. Instead, they turned tribal on the guy reporting the results, and at that point you were either with them or against them…
So here we [progressives] are: anti-science, tribal, and subservient to our most extreme wing. Oh, and a guy named Marc Edwards, who exposed this disaster and got it fixed, is now practically an exile. It’s a sad microcosm of our modern political arena.
Of course, “activists” are not a monolith – they are a collection of individuals who are all motivated by a number of different factors – with multiple different factors influencing each individual. Could bitterness be part of the explanation? I’m sure it had a role to play. But coming across this story, I was also reminded of another framework I wrote about that I think can also explain part of what’s going on.
A while back, I suggested that there were two ways we could think about political activism. One form was what I called activism as a form of production, the other was activism as a form of consumption.
When activism is viewed as a form of production, the point and purpose of engaging in activism is to improve or solve some social problem – in other words, to produce a particular result. When activism is viewed as a form of consumption, the point and purpose of activism is to gain personal benefit – a feeling of community, social status, a sense of purpose and meaning, and so on. These two different activities have very different implications.
When activism is meant to be a form of production, there is a clearly defined goal to be achieve, and once achieved the need for activism ceases.
When activism is used as a form of consumption (such as people who see “being involved” as a great source of meaning and purpose in life), there is no clearly defined goal and the goalposts often shift, because to actually achieve a goal deprives one of their impetus to activism.
As a problem genuinely improves, those who use activism as a form of production will declare “mission accomplished” and get on with their lives. But those who engage in activism as a form of consumption, and especially those who see activism as an important part of their social identity, the idea that a problem has been solved can be threatening. This gives them an incentive to deny the improvements, or shift the goalpost, or both. As time goes on, and especially as the world gets better, any given movement will become more and more dominated by those using activism as consumption rather than for production – a form of Gresham’s Law in action.
This seems to capture some measure of what happened in this case. Edwards got involved with the Flint water supply as a production-activist. Therefore, when the water supply safety issues improved, the obvious next step for him was to acknowledge the progress that had been made. But for consumer-activists, people who find meaning and purpose in “fighting the good fight,” being told that the fight had been won threats to deprive them of that meaning and purpose. Thus, those who claim the situation has improved become a new enemy to attack. And that’s why we end up witnessing the bizarre spectacle Drum laments. The phrase “don’t shoot the messenger” has historically applied when the messenger in question was the bearer of bad news. But for consumer-activists, the urge to shoot the messenger instead arises when the messenger is the bearer of good news. Marc Edwards was the unfortunate bearer of good news, but his case is hardly unique.
(2 COMMENTS)Brother, can you paradigm, or spare a signature?
In a recent post, blogger Janet Bufton writes:
The second way toward lasting change is to do the persuasive work that would have brought them [the changes] about—or the best approximation that the people can bear—through democratic politics. This method does not save anyone from the problems in politics that public choice so usefully identifies. But unlike a solution that prevents politics from breaking out, democratic persuasion keeps power dispersed and treats people as equals, with principles of motion of their own.
What I got from her post is that one can be so trapped in the public choice paradigm that one doesn’t even consider the idea of working through the system to effect good change or stop bad change. I’ll be posting in the near future about a few experiences I had through the political system, mainly in preventing bad changes.
But for now, I’ll tell one story about my trying to effect good change. It’s also about someone who was so imbued with the public choice view that he wouldn’t take even one second to support a change that he agreed with. Janet’s post caused me to remember this.
In the summer of 1973, I was a summer intern with President Nixon’s Council of Economic Advisers. I was from Canada and was on an F-1 student visa. (I mention that because it’s conceivable to me, in retrospect, that I unknowingly broke a law, if there was one, against political activism by a non-permanent resident.)
I thought it would be a good idea to write a succinct statement calling for ending the U.S. postal monopoly and send it to someone in Congress. So I wrote one up and sent it to Milton Friedman for his signature. A few days later, I got Milton’s signed copy in the mail. He recommended a few other economists to send it to and so I did. I also had my own list of people whose work I respected, people I thought would certainly agree with the idea.
One of them was a young economics professor at the University of Missouri, St. Louis. His name was Thomas Ireland. Here’s his CV. He was generous enough with his time to write me a letter explaining why he wouldn’t sign. It wasn’t because he disagreed with the goal. He agreed. But, Ireland explained, workers in the U.S. Post office were a concentrated interest group and we consumers were a dispersed interest and so there was no point in pushing for such a change. I’m guessing he assumed that I didn’t know this argument. But in the year I took off to study economics on my own (1970-71), which I’ve written about in The Joy of Freedom: An Economist’s Odyssey, I had come across public choice and had read not only Buchanan and Tullock, but also Anthony Downs. It was Downs who made the argument that Ireland made.
Here’s what I found strange. It had to have taken Ireland at least 3 minutes to write the few paragraphs in which he explained the Downs concentrated benefit/dispersed cost paradigm. That’s 180 seconds. It would have taken him about 1 second to sign the statement. He didn’t. That’s how tightly he held on to the public choice paradigm.
(9 COMMENTS)It may seem obvious that Taylor Swift “juiced the economy” during her two-year Eras world tour (Hannah Miao, “Billions in Cocktails and Friendship Bracelets: How Taylor Swift Juiced the Economy,” Wall Street Journal, December 8, 2024). But it is not. For example, the claim cannot be evaluated by simply counting how much money her fans paid in tickets, travel, outfits, etc., to attend her concerts.
Start with the question that Ms. Miao raises close to the end of her report but does not follow through:
There is debate among economists and analysts about how to measure Swift’s economic impact. Do her concerts just divert money that her fans would have spent elsewhere, or does she generate new activity?
Indeed, what her fans paid, they would have spent on something else—other shows or kinds of entertainment, vacations, household appliances or furniture, etc. (In the US, a ticket for an Eras concert reached more than $2,000 and sometimes much more.) The money could also have been saved, with means it would have served to finance investment somewhere in the economy. The objection that expenses related to Swift’s concerts produce “ripple effects” is voodoo economics: spending elsewhere would also produce “ripple effects,” if this expression has any meaning.
A more methodologically defendable estimate of Taylor Swift’s contribution to the economy would be their contribution to GDP. GDP is, by definition, the total production of the final goods at market prices, which is equal to total value added or, alternatively, the sum of all incomes. Only final goods to consumers are included in order to avoid double-counting—say, of the value of the wheat and the flour in the bread they serve to make. What’s important to understand is that the resources used to produce Swift’s concerts (the use of concert venues, the equipment, performers, sound engineers, other personnel, and so on, plus of course the singer’s time) would have otherwise been used to produce something else in the economy.
But to evaluate Taylor Swift’s (and her coproducers’) contribution to “the economy,” even a measure in terms of GDP is very imperfect. Her real contribution is the net benefits gained by the consumers. “Consumer surplus” is the technical term for this concept. It measures in dollars what the consumers gained from something they purchased over and above what they paid for it. The consumers who attended an Eras concert must have considered that it produced the highest consumer surplus that they could obtain with their money.
Besides the forbidding statistical problems of such measurements, there is a more basic problem: any dollar value of either GDP or consumer surplus is not sufficient to measure the “utility” of consumers. By utility, modern economic theory refers to a measure of how a consumer ranks different configurations of goods and situations in terms of his (or her, of course) own preferences. More money to purchase more goods and services will, ceteris paribus, increase one’s utility (and mutatis mutandis for less money), but money is not the only factor in satisfaction or happiness. Moreover, one dollar can give more utility to some individuals than to some other individuals.
One way to directly introduce utility in economic analysis is a model showing how individuals reach their “contract curves” by exchanging with each other. (Students of economics will see a general-equilibrium Edgeworth-Bowley box diagram pop up in their minds.) Most gains in utility come through exchange and trade: you work to, say, produce cars or write articles in order to buy a seat at a Taylor Swift concert; it’s like if you exchanged your piece of car or your articles with Ms. Swift and her organizers for their services.
Preferences and utility are subjective. They reside in the mind of each individual. As much as we can deduce that each party to an exchange gains utility from it (otherwise he would have declined the exchange), it is impossible, even conceptually, to aggregate utility across individuals to measure its net total increase or decrease. Economists speak of the impossibility of interpersonal utility comparisons. “The economy” is a set of individuals who interact to maximize their respective utility, not a bundle of physical objects. We cannot hope to calculate whether the resources employed for the Eras concerts would have produced more or less utility in some other allocation. We cannot hope to calculate a “net utility” figure that would tell us to which extent Taylor Swift brought a net contribution to the economy compared to the alternatives.
The impossibility of producing a precise number doesn’t matter because the same analytical tradition that leads to that conclusion also demonstrates a more general and useful proposition: an economic regime of free markets provides each individual (an individual randomly chosen, says Hayek) with the most opportunities to maximize each his utility through his acts of free exchange. Since some consumers do choose to attend Taylor Swift’s concerts instead of doing or buying something else, and bid up the price of tickets to make sure they get them (as opposed to those who chose to scalp their tickets), we can be sure that, to the extent the economy is free, the result is economically efficient.
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