Economic Systems and Institutions

First, I know it's been a long time between posts - life isn't always what we want. I frequently come across items that should be brought to your attention. But due to other factors, I have to choose. It seems opportunity cost is an operative concept.

I don't know how many of you spend time discussing economic institutions and systems.  While many textbooks seem to bypass the subject or give it short shrift, I always try to spend at least one class period discussing them. And they are revisited throughout the semester. The rules that a society puts in place to influence or control decision-making are important if we are to understand the decisions.

Here is an excellent article from The Daily (HT to Arts & Letters Daily) that really brings the importance of institutions home. What I find particularly interesting is the aspect of traditional economies in a modern setting. One quickly understands how traditions can be an important mold for many choices. And attempts to change the rules, by issuing formal rules to replace informal rules, can have significant costs on many levels. I hope you take a moment to check the article out. And I hope you will share your thoughts.

The Mark of the Entrepreneur

Which of Schumpeter's five roles of the entrepreneur is/are illustrated here?

Productivity, Structural Unemployment & Creative Destruction

As we know, cyclical unemployment can become structural if prolonged. And as labor costs rise, there is an incentive for firms to increase the capital/labor ratio rather than hire workers. This can be part of the process of creative destruction. It's all explained rather well in this blog post at The Wall Street Journal.

What I like about the post is that it is short yet very clear. I would think you might want to use with your students as a discussion starter at the beginning of the period or to summarize a day's activity.

The Value of Cutting Costs

Recently, I took an online course that focused on economic development and poverty. One of the discussions we had questioned whether technological innovation benefited the rich, the poor or both.  One of the conclusions was that, because of the cost of innovation, initial benefits tended to gravitate to the rich because they could pay a price that would compensate the producer.  But over time, as the cost structure changed, the benefits were realized by those at lower income levels, as well. One of our classmates even noted that, because of the passage of time, the technology was actually better quality as well as cheaper by the time it became available at lower prices.

Yesterday, there was an opinion piece in The Wall Street Journal that dealt with that topic. It reinforces the point that the real value in innovation may not come in the initial stages - many innovations don't last very long.  But for new products and technology that does last, the real benefit comes as producers find ways to reduce the cost. And I will add, improve the quality and reliability in the process.

This relates to my post from one week ago which linked to a discussion of poverty and choice.  It also reminds me of a quote from Joseph Schumpeter who once said "The capitalist engine is first and last an engine of mass production which unavoidably also means production for the masses. . . . It is the cheap cloth, the cheap cotton and rayon fabric, boots, motorcars and so on that are the typical achievements of capitalist production, and not as a rule improvements that would mean much to the rich man. Queen Elizabeth owned silk stockings. The capitalist achievement does not typically consist in providing more silk stockings for queens but in bringing them within reach of factory girls."

I welcome your thoughts.

Human Capital and Growth

If you're looking for an example of the role of human capital on growth and the production function, look no farther than this article from today's edition of The Wall Street Journal. (Subscriber content at this writing but put the story title in your browser and you should be able to find an ungated version.) The story is about Portugal and the low level of education in that country. As you would expect, it has a significant impact on growth and standard of living.

The video below is from the story and explains some of the institutional aspects of the problem. And as we understand, you can change the law but changing culture and tradition can take a while.



I think this would make a great example for that production function discussion. Please share your thoughts.

Consumer Surplus and the Internet: Measuring the Unmeasurable?

For those of you dealing with productivity in micro or growth in macro I have something for you. And if you already passed either or both, file it for next time. Annie Lowrey has a very thought-provoking piece at Slate. (HT to Marginal Revolution.)

She asks why the internet hasn't turned out to be the great technological boost to growth and productivity that we thought it would be. She also puts it another way: if it is, why can't we measure the effect? How would you measure the computer surplus on most internet content. Can we adequately describe "willingness to pay" until there's actually a charge?  I suspect we will find out as more and more content becomes subscriber-access. But the point is there will still remain a good deal that's free.  And what is the value of that content - what is the consumer surplus for the user?

Lowrey points out that a lot of older technology had a much bigger measurable impact on GDP - things like planes, trains and automobiles.  And everyone thought computers were going to create a huge productivity boom and usher in an era of structural change.  (Oddly enough, they seem to have had the most impact in the manufacturing sector - helping us make more stuff at lower cost.) Why did those technological breakthroughs translate into workplace productivity enhancements - saving money and lowering prices?

I'm not sure what the answer is for her question.  Excuse me now…I have to get back to my game of minesweeper.

The Great Stagnation - A Review

Tyler Cowen of George Mason University has a new book out titled The Great Stagnation: How America Ate All the Low-Hanging Fruit of Modern History, Got Sick, and Will (Eventually) Feel Better.

As this review in The Wall Street Journal explains, this is not likely to be the definitive explanation of the current economic downturn, but it could be among the most significant.

Cowen points out that the amazing success of the United States over the past 300 years (that includes a considerable period before we were the United States - I know) has been due to a unique mix of circumstances that he calls "low-hanging fruit". These were aspects that provided easy and quick return for the most part. They were easy to "pluck" and benefit from.  But Cowen points out that the easy stuff may be gone, and the sooner we realize that the sooner we can begin to benefit from the harder stuff by finding ways to get at it. That is what will bring renewed economic growth.

There are numerous reviews of this book elsewhere. Many of them echo the evaluation of the

Journal, this can be an important and a good read.  I'm adding it to my reading list and my carousel at left. I hope you'll be moved to purchase it. From what I can tell, it is currently only available in a Kindle edition.

"Marginal" Thoughts

Today's issue of The Wall Street Journal has a keeper (subscriber content at this writing, but put the headline in your browser and you might find an ungated version). it contains a very good article that can be used when discussing marginal productivity of labor and marginal revenue product. It really is worth the effort to try and find it. The slideshow is "okay" but doesn't have the potential of the article.

The is about how the venerable fast-food chain is adding things to its menu to appeal to changing customer tastes. The problem is some of the investments are hefty and the additional revenue generate may not pay for the investment. In the article, one franchiser talks about how a certain piece of equipment wasn't paying for itself. Another franchiser discusses how an attempt to stay open 24 hours at a certain location didn't cover the labor costs.

At the same time, the article discusses how new ideas can drive productivity - a key aspect for profitability in the fast food business. The most obvious example is the addition of a second drive-thru lane at some restaurants.

As I said, you might want to spend some time trying to find this article. It has real potential to help when discussing those "exciting" cost curves in your micro classes. As always, I look forward to your comments.

Productivity and Growth

Harvard professor Kenneth Rogoff has an informative piece on the Project Syndicate web site (HT to Planet Money).

He addresses the concern that Europe and the U.S. may be heading for a period of stagnation similar to that faced by Japan in the 1990s, a "lost decade". And while there are some similarities, he points out there are also important differences, the main one being productivity.

As we know, long-run economic growth is determined by productivity. Japan had some significant productivity problems, according to Rogoff. The U.S. doesn't have the same issue. But as he points out that in the latter part of the article; that could change depending on the policies put in place. Policies that improve productivity have the ability to improve long-run growth.

I would add that those policies also presage continued structural change with the need for more skilled workers. The supply of skilled workers may come from better preparation (call for education) or retraining (call for different types of policies for the unemployed).

I would like to hear your thoughts.

Comparative Advantage and Tradeoffs

When discussing comparative advantage, students will often ask if it's possible for a nation to gain a comparative advantage where there originally is none. The answer of course lurks in that basic concept opportunity cost. Don Boudreaux at Cafe Hayek gives a good explanation while discussing the idea of energy independence.

I would suggest you could even use a production function to help with the explanation. What do you think?

Productivity

This video (HT to Carpe Diem) is about a new, robotic warehousing system. I could see all kinds of lessons arising from this video.



Show the video and ask students to identify which tasks disappear when a system like this is introduced? Using a productivity or growth equation (Y = aF[L,K,N] or some variation), what is happening when a system like this is introduced? What tasks is the system taking over? What skill-level would workers doing that job have to have to do those tasks? How would those jobs be classified (skilled, semi-skilled, unskilled)? How might this system offer an improvement over workers performing those tasks? How would marginal cost/benefit be a part of the decision to introduce such a system?

What would be the implications to a program of unemployment support for displaced workers if systems like this were wide-spread? Would this be an example of cyclical or structural unemployment? How does this relate to Schumpeter's idea of creative destruction?

Education, Skill Sets and Recovery

The Federal Reserve Bank of Cleveland has an interesting article in the recent issue of Economic Trends (see page 14). The author asks whether a mismatch between worker skills and job skills may be a factor in the slow job creation growth.

On the surface, this is a logical question. Recessions are often seen as a time for factors of production to be reallocated. This applies to labor. Certainly, as companies retrench they will look to increase productivity among existing workers before bringing on new ones. Indeed, one lesson we teach is that rising prices increase supply, partially because higher prices allow less productive resources to come into the process. Workers with weaker skill sets may, indeed, face a period where their skills don't match demand.

But I'm not sure I agree with one aspect of the article's conclusion. The author talks about lower productivity and higher unemployment. I would think that the retrenchment would lead to higher productivity. To that point I would point at the long-term trend, as illustrated here by Mark Perry on Carpe Diem. Mark's data is longer-term. And granted, the past does not guarantee the future, but I think it would be logical to expect increased productivity from the existing workforce, at least in the near-term. If there is a skills mismatch, growth will have to come from higher productivity. And that increase in productivity may change the larger economic landscape, establishing a higher premium for certain skills, while those with lesser skills could face an uncertain job market. Recent productivity data would be helpful in this respect.

This brings me to a post by Greg Mankiw. Greg asks whether the current average duration of unemployment may indicate the Non-Accelerating Inflation Rate of Unemployment (referred to as NAIRU or "the natural rate of unemployment" by some) may be increasing. If the economic structure has fundamentally changed, say by requiring more skilled and more productive workers, one could see how this would be possible. However, as has been pointed out here and in other places, the duration of unemployment could be a result, in part, of extended unemployment benefits providing a skewed incentive. I'm not sure I totally buy that explanation, but I do understand it. I think Greg is right in saying we may not have the answer to the question for some time.

To summarize this post, I don't know whether we are undergoing a major structural reorganization of the economy. A skill mismatch would certainly contribute to that, and changing productivity would certainly be expected in such a circumstance. If these issues are tied together, it would indicate a need for a different approach to economic policy than what is being tried. But I find all three links interesting and worth your time. I certainly welcome comments.

Hypothetically, What Would It Cost?

Visualeconomics has an engaging visual on some of the costs we might associate with celebrating Independence Day in the U.S. Included is information on where various parts of the traditional mid-summer cookout come from. As I looked at the chart, I thought "what would our celebration cost if we imposed trade barriers between the states - depending totally on locally grown or produced items? Alternatively, how would we celebrate differently if it weren't for ideas like comparative advantage, productivity and specialization?"

It's just a thought as we pass the "mid-point" of summer and start thinking ahead (the local stores have their "back-to-school" displays up).

Put a Cork (or Plastic Stopper) in It

This article from The Wall Street Journal (still free at this writing) has been in my inbox for a couple months. But it's a good one. It's about how the corks in wine bottles have increasingly been replaced by plastic stoppers. It's a good example of how firms mature and evolve, how substitution drives competition, and potentially about efficiency and creative destruction. It also has an interesting slide show.

Relative Labor Costs

This graphic (HT to Chartporn) is telling in a couple of ways. On the surface, it would seem to reinforce the idea that firms move to other countries to save on wages. (But as is sometimes said "if wage was the whole story, Bangladesh and Ethiopia would be the industrial capitals of the world.")

But the true value of the graphic is in the follow-up questions. If so many countries have a wage advantage, why does organized labor often support a higher minimum wage? And why do many firms stay in the U.S.?

The answers may lie in the concept of productivity and/or self-interest. I'd be interested in your thoughts.

I'm Not Sure This Is the Answer to the Resource Curse

A couple of days ago, I wrote about "the resource curse", referencing an article in the Planet Money web site. As a follow up, here's another story on NPR's Planet Money about a proposal by some economists to distribute the proceeds and break the resource curse.

I don't think it would solve the problem of the curse. It removes the incentive for the people to develop anything new. They have a steady stream of income (at a level that may well be above what they have now), and it comes in without any real effort on their part. It may remove the government as the funnel for the funds, but it doesn't create any incentive to diversify.

Afghanistan and the Resource Curse

When discussing economic development, the folks at National Public Radio have an interesting story to use with students in a discussion of "the resource curse." Most often we use that concept to refer to economies that are blessed with abundant natural resources but fail to diversify. Those economies frequently see the natural resources as a way to improve the lives of the people, but it only works if other resources are developed, as well.

You can also use this in discussions about the production function. One can put the equation (Y = A f (L, K, H, N)) on the board and begin by asking what the story means for Afghanistan. You can then extend by asking about the other factors and how they can be provided. And wrap up by asking about what happens if the only resource that is developed is N?

Standard of Living

One of my favorite exercises is explaining real income and improving per capita gdp. The Federal Reserve Bank of Dallas had some great tables in their annual reports in the 1990s. They showed how the real cost of many common items fell as a result of improving productivity and how standard of living related to labor costs.

Now, there's another resource you can use. Check out this post by David Henderson on EconLib. It links to Radio Shack catalogs from 1939 to 2005. It's a little more up-to-date. And while it is limited to electronic gadgets, it still makes the point.

I'd be interested in your thoughts.

People Respond to Incentives....

...but which incentives?

In economics class, we teach that people respond to incentives. Then we frequently add that sometimes incentives don't work. The truth is when an incentive (negative or positive) doesn't work it usually means it was the "wrong" incentive to motivate a particular individual. Sometimes it's not about money. It can be other "non-economic" - or more correctly "non-monetary" - factors that provide incentive. I often use the term "psychic income" to explain some of these factors. But I have been looking for something that could provide a better explanation.

Barry Ritholz at The Big Picture posted this very interesting video animation on this topic, which can help. The video has taken a presentation by Dan Pink, the author of Drive, (which I have added to my carousel, at left) and edited and illustrated it. It's short. It's interesting. And while not complete, it provides a good platform. (If you're interested in a longer version of the talk - 41 minutes - without the animation, you can find it here.)

On Barry's blog, many of the comments were insightful and/or useful. (That's where I found the link to the longer version.) The animated version doesn't address negative incentives. Nor does it include other positive incentives such as recognition and status - both of which can be powerful positive incentives.

I recommend both the short version (for possible classroom use) and the long version (for self-edification). I would be interested in your thoughts, as well.

Making of Florida One

There are so many concepts you can pull out of this video (HT to Cafe Hayek): exchange, specialization, division of labor, interdependence, economies of scale (imagine the cost if you were building only one), productivity, economic institutions, etc.

Please share other ideas.