Do Americans work more because of status concerns? Maybe, but in all honesty, it's hard to tell

This case is more complicated than the status effects/savings case presented below. There's basically two reasons for this.

First, how much people want to work - labor supply - can be all kinds of weird, even without assuming any kind of "status effects". Labor supply curves can slope downwards (if the income effect dominates the substitution effect), they can bend backwards (same, except different at different wage levels), they can be discontinuous because of household specialization, and relatedly, there's two margins that people operate on when it comes to labor supply. Whether to play in the labor market in the first place (labor force participation) and then, if so, how much (hours worked). Add to that the various institutional structures which constrict the flexibility of labor supply and you can get pretty much anything.

The second reason why this is more complicated than the savings case is that now we have two "goods" (things which are desirable) which are subject to the "status effect" to a different degree. With saving and consumption the trade-off was between keeping up with the Joneses today, or keeping up with the Joneses tomorrow. In both periods there were status effects. However, the usual story with respect to work time is told differently:

Your annoying neighbor Jones works more and with his extra income goes out and purchases a Cadillac ("he means a Lexus but he don't know it") with a vanity license plate that says "YouAintGot1". At this point you start thinking "maybe I should have one" but the only way to afford it - given that you want to keep your level of savings constant so that we don't mix up our various "status effects" here - is to work more, slave like an ant and buy a Cadillac too. What ends up happening is that you end up working more than you'd like to just to keep up with the Joneses and you consume a (sub-optimal) amount of leisure.

The difference between this story and the one about consumption/saving one is that what is being implicitly assumed is that only one type of good - consumption of physical goods - is subject to "status effects". The other good - leisure - is not a "status good". Right at the start this is sketchy. Why couldn't leisure be a status good too? Obviously if I can show off to my neighbors that "I don't have to work hard for my income" by goofing off in conspicuous ways, why doesn't that involve status? Mr. Veblen, I'll see your Conspicuous Consumption and raise you some InYourFace Conspicuous Leisure! From what I understand (according to my reading of Victorian novels) that's how "status goods" used to play out. The merchant that was richer than an aristocrat was still looked down upon because, well, he still had to work for his money, whereas the aristocrat simply inherited it.

But never mind. From a theoretical point of view, the difference is that now not all goods are subject to the "status effect". Before, both "consumption today" and "consumption tomorrow" were both subject to status. In fact if both consumption of physical goods and leisure are status goods then we can just relabel:

consumption today = consumption of physical goods
consumption tomorrow = consumption of leisure

and then everything in the last post goes through - i.e. status effects essentially don't matter.

So let's consider the case where one good - consumption of physical goods - is a "status good", but the other - leisure - is not. If people for some goofy reasons are driven to compete in terms of their consumption of physical goods are they going to supply more or less labor? Will they work more or less?

Here it is actually plausible that the answer is "more", but not necessarily. Which is why a model which incorporates status effects on labor supply needs to be empirically tested. Them parameters need to be estimated. How do you know if some peoples care about status, rather than just having a lower disaffection for work (i.e. a lower marginal utility of leisure)?. The point here is that it's gonna be pretty much impossible to estimate this kind of thing.

Alright, so how do we go about analyzing this? Well, let's suppose that we've got a person whose welfare depends on their level of leisure, their consumption of some physical good ("trinkets") and also the consumption of trinkets by other people.
Specifically;



or



where c denotes consumption, l denotes leisure and c_J denotes the consumption of them annoyin' Joneses. Since our person has no power over how the Joneses choose their consumption level she regards c_J as a parameter and optimizes u over c and l.

Her consumption is equal to her income which is given by




where h is amount of hours worked and w is the wage. Normalizing the time endowment to 1, h=1-l, so





Graphing that sucker in consumption/leisure space you get your usual budget constraint:



The fact that both leisure and consumption are desirable, and assuming that there's diminishing marginal utility to both gives us a standard indifference curve. Since no one person has power over what average consumption is, c_J is just an argument in the utility function:



This means that one way to analyze what happens if people care about status in consumption is to see how the indifference curve changes when other people's consumption (here average consumption) changes. In other words, what happens to the slope of the indifference curve when, say, average consumption goes up. There's two possibilities. The indifference curve either gets flatter or steeper. If it gets flatter then the amount of leisure will fall and consumption will rise. If it gets steeper then the opposite will happen:



On the other hand it could be the case that your consumption gets "crowded" or "congested" by the status seeking of others. Every time you buy a damn Cadillac, Jones does too and you get no utility from it (this is another way of saying that other people's purchases mess with your marginal utility of consumption of physical goods). At some point you might decide to not bother and switch to the one good that is not affected by others' choices - leisure. In that case your indifference curve will become steeper rather than flatter and you will increase your leisure and decrease your consumption:



So which one is it? Well, to see what happens we can look at how the slope of the indifference curve changes when there's a rise in average (Jones') consumption. Of course if someone doesn't care about status at all then there won't be a change. Your econ 101 (or maybe 201 in some places) tells you that the slope of the indifference curve is given by the ratio of marginal utilities:




where the top is the marginal utility of leisure and the bottom the marginal utility of own consumption. To see the role of status effects we take a total derivative of (absolute value) that with respect to average consumption:





If that equation above is negative then we have the first case with the indifference curve gettin' flatter. If it's positive then we have the second case, with an increase in average consumption INCREASING leisure.

Of course
and


are just cross derivatives of leisure and consumption with other people's consumption:





Are these guys positive or negative? If Jones buys his Cadillac how does that affect your enjoyment of leisure? On the other hand it's somewhat plausible that your MARGINAL utility of consumption would go up if c_J increases - you not only get the extra benefit of consumption for its own sake but also you catch up with the Joneses. But it' not clear. Still, I'm willing to concede here that the relevant parameters work out so that the net effect of an increase in average consumption is to raise labor supply. But that's exactly why this is the sort of thing that you'd wanna estimate empirically. And that's gonna be messy.

To illustrate, take a simple specification of utility with own consumption, others' consumption and leisure:



where c is own consumption, c_J is others' consumption, h is own hours worked, w is own wage, h_J is others' hours worked and w_J is others' wage. Gamma measures the dis utility of work effort. Phi, like before, measures the extent of the "status effect".

Maximizing that sucker wrt to h gives you a labor supply function:




If phi=0 - no status effects - then this would just collapse to




at which point you could just log that monkey and run some regressions in order to estimate alpha and gamma.

This is what it looks like for the average person (Jones):



and if you can find some variation in h and w then you could, at least in theory run a regression like this:




The problem with this is that both gamma - the disutility of work - and phi - the status effect - all wind up in the constant. In other words, there's no way to know - even if you can estimate this thing - whether people in a given economy work more because they care more about status, or because they just dislike working less. If you got some taxes, or labor market distortions running around that's gonna be in there too. And it could be very well the case that what looks like "Americans work more because they care about status" is really "the freakin' income taxes are lower". Or maybe Americans are just "more hardworking" for them, anthropological, sociological, psychological, and English Studies reasons. How would you know?

We can actually use the equation above for average/Jones' hours worked to plug into any ol' person's labor supply function. In that case we get a very nonlinear equation. We could still estimate it - to be honest I'm not up to my nonlinear econometrics - but I'm pretty sure you'd get the same problem. Work it through yourself. What you'll get is that with nonlinear methods you can estimate two parameters but you've got three variables you care about. In other words, one of your parameters will be a (nonlinear) combination of alpha and gamma, and the other a (nonlinear) combinations of alpha and phi. Which, again, means that even when you get all kinds of fancy statistically it's next to impossible to separate the "status effect" (phi) from just plain ol' "don't like to work effect" (gamma).

So how would you know? And anyway, isn't worry about "status" an Old World type of thing?

A final note here. You could get some estimates by considering some kind of variation in wages and labor supply levels. But this is going to get you thinking about exactly what kind of status people worry about. You could estimate the above equation across different countries. But that brings up the alpha/gamma problem mentioned above. You could assume that people care about status within their own status, zip code or county. Or maybe educational groups. At each point the same issue will arise. I could explain all this better, but god damn, I'm tired after writing all this.

Do Americans save so little because of status concerns? Nah.

Suppose you live next door to an annoying family named the Joneses. One day Mr. Jones goes out and buys a boat, which he then displays prominently in front of his house, washes it all the time, puts cute little ribbons around it and names it "NotYours". This rubs you the wrong way, you feel like your "status" has decreased and it gets you thinking that maybe you too should go out and buy yourself a boat. Maybe you should save less, consume more and keep up with the Joneses.

This is the usual story told of how "status effects" can lead to (sub-optimal) level of saving on the part of folks, why Americans don't save and how consumerism is going to be the death of us all.

But wait a minute. Suppose that, instead of buying that boat in order to keep up with the Joneses now you ... SAVE more money, get it back with interest in few years and buy... an even bigger boat! That'll show the Joneses! Maybe "status effects" lead to increased savings!?

The point missed by the usual story is that saving is just postponed consumption (I like the Buy-Nothing-Day. I like the Day-After-Buy-Nothing-Day where you spend all the money you didn't spend on BNT even more), so if you ARE trying to keep up with the Joneses you face a trade off: Keep up today, or keep up tomorrow. How you gonna play it? (hint: it might depend on your marginal rate of intertemporal substitution)

You also have to consider that the Joneses are playing the same game. They go through exactly the same logic. In fact, they might even anticipate that if they purchase a boat, you will purchase one too (or a bigger one) in order to keep up and any benefits of "status" will not materialize. Hence they will probably not buy the boat - unless of course they happen to enjoy going out on the lake in the summer and fishing, which is after all the primary, the overwhelming, if not the only reason people buy freakin' boats.

The end result might very well be that EVEN IF people care about status this has no effect whatsoever on their behavior.

Ok, here's the maths. I've got two cases - the first has a plausible "standard" representation of utility (people's preferences) which includes the fact that people care about status. But this case is boring. For a good reason. Nothing happens. It looks exactly like the case where people don't care about status. The second case has some more interesting dynamics, but, to be perfectly honest, from a purely theoretical point of view it's a bit sketchy (7 bonus points if you can tell me why).

The basis for all this is the Ramsey model of saving. In the standard model consumers have a utility function like this:



where c(t) is consumption at time t and theta measures the degree of intertemporal substitution mentioned above. The consumers discount future consumption at the rate and face the interest rate r.

The optimal path of consumption (hence, saving) is solved for by setting up the Hamiltonian, finding the first order order conditions, differentiating them wrt time and solving out. What you get at the end is the following differential equation for growth rate of consumption over time:

growth rate of consumption = g(c) =

Then in the long run the economy converges to a steady state such that the real interest rate is equal to subjective discount rate and consumption is constant, g(c)=0 (here we're assuming no technological growth ).

Alright. We modify the above utility function to include the possibility that consumers care not only about their own consumption but also about that of others. The simplest way to do this here is to include average consumption as an argument in their utility function.

Case 1.



where c_i(t) is person i's consumption at time t, c_a(t) is average consumption at time t, phi measures the strength of the "status effect" and it is less than 1 (more bonus points for telling me why).
The first order condition is then (omitting time arguments):



where
is the Hamiltonian multiplier for person i. Taking logs and differentiating wrt time we have:



The second first order condition (wrt to the state variable) tells us that:



Note the lack of i subscript on the real interest rate r. This means that we're assuming that all agents face the same interest rate. Since we want to examine the "pure" effect of status on consumption and saving rather than that of credit market imperfections this is a natural assumptions in this context. Of course if different consumers face different r's things get more complicated (and more ad hocy)

Setting the two FOC's equal we get:



Solving for g(c_i) we get:



which is POTENTIALLY different from the simple we had above. Note that if phi is zero than that equation becomes the standard equation in the model without "status effects". However, the second term on the RHS shows that how AVERAGE consumption changes has the potential effect of affecting how any one person's consumption changes. But is it up, down, or do the effects cancel out? Well, to solve it out, we could assume that all consumers are identical, blah blah blah, and then solve out for the "representative" consumer, but we don't have to. What we can do is to solve the above diff equation for the average consumer, then plug in that growth rate of consumption into the equation for any ol' person i. This means that we are NOT assuming that consumers are all identical. These malchiks can be as heterogenous as they wanna be. Replacing the i subscript by a above we get:



which means that the AVERAGE person's consumption follows the path which is the same as in the model without "status effects" - for the average person it washes out. This is not surprising if you think about it. Now that we have g(c_a) we can plug that into the equation for g(c_i) and get any person's consumption path. The algebra is straight forward and what you get at the end is:

for all i. In other words, same as the model without status effects.

This is what I meant by the fact that this version is boring. After all that math you get back to exactly what you had if there were no "status" effect. Boring, but instructive, I guess.

(Note also that the way the whole thing works we could replace the average person with the median person - the most common growth of consumption - and it would still work. In fact, if everyone in this society compares themselves to Bob, where Bob's growth rate of consumption is given by g_bob, all this still works).


Case 2.

Here, instead we'll assume that the utility function which represents person i's preferences is given by:



where the notation is same as before and phi is still the "status effect" and is still less than one (the case where it's >1 is actually fun to work out from a mathematical point of view in the Ramsey model with Cobb-Douglas Production Function though it's empirically/economically implausible. Outward spirals and all. Which don't matter because of the transversality condition which I haven't even mentioned.)

Now the first order condition is:



Logs, time derivatives, second FOC same as before and all that gets you:



Again, note that if phi is zero, this is the same as the "standard" model. I'll save you the long story and just note that for roughly similar reason as above, the growth of any person's consumption, g(c_i), winds up being the same as the growth rate of the average person's consumption, g(c_a). Here however, this matters. Specifically, dropping the i and a subscripts and just denoting growth of consumption for anybody by g(c) we get:



which IS different from the standard model (). So, is the growth of consumption higher, lower, or the same? Obviously it depends on theta (you can also see in the above, if you play around a little why we need phi<1). Theoretically, theta, the reciprocal of the rate of intertemporal substitution, can be between 0 and infinity. If theta = 1 then utility is logarithmic and we get the standard model - "status effects" don't matter. If theta<1 then consumption will grow slower without the "status effect" than with it. If theta>1 then consumption will grow slower with the "status effect" than without it. In steady state, where rho=r, it doesn't matter.

Empirical estimates of theta are in fact all over the place. Roughly speaking it depends on whether you're looking at micro studies or macro studies. Saving behavior over time in most economies suggests a theta above 1 but somewhat less than 2 (Barro and Sala-i-Martin) which would mean that "Keeping Up with the Joneses" economies would have HIGHER saving rates than those where people don't care about status - flying in the face of the simple story I started this whole post with. On the other hand, micro studies - some of them actually looking at labor supply which is also related to theta (see next post, if I write it) tend to find much lower values of theta, so it could go the other way. Theta also measures the extent of risk aversion, and if you think that there's something to the equity premium puzzle other than pure weirdness than you'd also think theta is >1. At any rate, theta=1 is not implausible. So... again, status effects don't matter, even with this sketchy formulation

(answer to the bonus question about why this formulation is sketchy - "status effect" formulation of utility should mean that if you increase a person's consumption but keep their status constant by increasing average consumption as well then their utility should not decline. Case 1 has this property for all c_i and c_a, as long as phi<1. This case does not).

Final note: I don't really buy into the Duesenberry Hypothesis. Maybe at this point, I should note that I really like Robert Frank's article on the homo economicus with a conscience (jstor req), but I think he's wrong on this topic. I readily confess that I haven't read the original but only read the representations of DH that one can find around. The whole thing to me seems to ... dare I say it? ... lack microfoundations. I.e. It COULD be that status concerns increase present consumption. On the other hand it could go the other way and in fact probably shouldn't matter. And estimations of a Duesenberry style consumption functions are subject to the usual critiques of consumption function estimation and then some. Ok, if I feel like it next post is on "status effects" and labor supply.

Another final note: You can set this up in a two period model with "consumption today" and "consumption tomorrow", discrete time and all that but you still get the same results.

Non Tariff Barriers

(or how trade “protection” really works, or, the reason why the border is "wide")

Here’s a translation of a two recent news stories from the Polish press – Polish travelers carrying goods into Belarus are now required to bring condoms with them or else! And Belarus has its first declared millionaire.

---

Going into Belarus? Only if you bring … protection!
A Polish driver traveling to Belarus is required to bring with him a first aid kid. And now, also some condoms. Alexander Lukaszenko’s border guards will not lift the border barrier (szlagan?) until they see the required box of condoms.
Most of the Poles crossing the Poland-Belarus border regard the new regulations as ridiculous whose aim is only to make life more difficult. “What do I need condoms for?” – complains an irate Marcin Zlotnicki, a truck driver for a export firm from Lublin – “I’m not going there to have sex. I just want to deliver my load. It’s not enough that at every stop you have to pay bribes, now we’re supposed to find some place that’ll sell us condoms before the border”

The strange requirements of the border are not known to everyone yet. Many truck drivers think it’s a joke. But it’s not. One person who did not laugh was a local priest who wanted to cross the border in order to see of his parishioners on the other side of the arbitrary line, the Lublin cleric Piotr Mrozik: “Because of this new regulation all I had was trouble. Because, obviously, I didn’t have any condoms, they grabbed me, put me up against the wall and searched me. Then I had to go to the nearest gas station, and in my clerical garb ask the obviously embarrassed attendant for a pack of condoms just so I could cross the border. It was a ridiculous situation!”

Polish custom guards say they don’t know anything officially about the new requirements. “We’ve only heard about this from annoyed truck drivers. Initially we didn’t believe it ourselves” says Marcin Czajka from (some complicated name for a Polish Customs office) in (an even more complicated name of a Polish border town). “Supposedly the Belorussian border guards say that it’s for reasons of “safety and security”, so now all first aid kits which cross the border are required to include condoms. I guess it’s just in case or something”.

Aleksander Koncki, the Belorussian consul in Bialej Podlaskies, asked by our journalists about the subject is himself surprised. “No one told me anything. I don’t know if that regulation really exists. I think it’s just a rumor”.

The news about the new requirements of the customs guards has spread quickly among the border villages which engage in much trade with their Belorussian neighbors. Some villagers have been quick to realize upon the business opportunity. Aside the standard fruit and vegetable sellers one normally sees along the roads there have appeared mobile condom-sellers. At the gas stations near the border the supply of condoms has run out.

Grzegorz Gorczyca from the local Chelm Autoclub (like a local AAA) explains that even before this latest regulation, the requirements of crossing the border have always been arbitrary. “They always, for some reason, ask about condoms. And if you got condoms then they ask about something else. It’s just another pretext to extort another bribe. Now it seems the Belorussian border guards systematized it and made it official. I’m not especially surprised. If you’re going east, you expect these sorts of things.”

----

Depending on how you wanna look at it, here’s something on a more upbeat note:

A sensation among our neighbors! Belarus has it’s first millionaire!

This is the first time that the Belorussian economy has seen such a thing! Belarus has its first millionaire. A real millionaire, counting the income in dollars. So far no one has managed to accumulate a wealth of more than few hundred thousands. After all, Alexander Lukaszenko is a communist who, like Janosik, gives to the poor after taking way from the … somewhat less poor.

The information about the first ever Belorussian millionairehas been leaked out by the Belorussian Tax Office (Belorussian IRS). Apparently Belorussians tax official could not believe their eyes when they saw that some Belorussian had the courage to report an income of 20 billion rubles (9 million dollars). Obviously the Tax Office did not release the name of the magnate. But it did not hesitate to report the occurrence to the proper authorities (i.e. the “security police”,the KGB, i.e. the whatever version of Gestapo). Now the job of inspecting the person in question has been turned over to the agents, inspectors, controllers, bureaucrats and other person in government.

Most likely, if it turns out that the person in question is a (communist) party member and one of the friends of President Lukaszenko, who only got his millions “following orders” then the Belorussian Tax Office will leave him alone. On the other hand if it happens to be the case that some Belorussian had the nerve to have a decent business idea and got rich selling some product that Belorussians actually wanted, it would be better for him if he got his things together and left the country right now.

It’s not like Belarus is known for its friendly business atmosphere. Tax audits can last for many years, basically until the person investigated pays up what is demanded of him. If a “fault” is found then the punishment is severe. Someone who “misreported” their income pays, at the very least 150% of their income.

-----


Added (also corrected spelling):

Here's some rocking Belorussian tunes.

Daniel's post over at Crooked Timber

Here it is, no comment necessary but further repostings would probably be good:


-------
IMPORTANT: Time to do the right thing by our Iraqi friends
Posted by Daniel

I’ve written on this in the past (as has John, and Jim Henley, and it’s been in the New Republic), but the situation is now urgent as well as serious – there is a very grave danger that the UK is preparing to sell its local employees in Iraq down the river, and the time to do something about it is now.

Iraqi interpreters used by the British Army and CPA South have already been hunted down by death squads. The British forces in and around Basra are no longer really sufficient to protect themselves, let alone their employees, as Channel 4 news details.

There really is no way of keeping these people safe while they are in Iraq, and they need to be kept safe. Quite apart from what one would call a “debt of honour” (the phrase is somewhat pompous, but accurately describes the situation), it never makes sense to get a reputation for abandoning one’s friends. Therefore, the Iraqi staff used by the British in Iraq need to be given asylum in the UK, along with their families.

This is not the current policy of the UK. The Home Office has simply suggested that Iraqis put at risk by their work for the British “register with the appropriate UN refugee agency”, joining the mountain of 2 million-plus refugees and IDPs already caused by the war. This simply isn’t good enough; the safety of Iraqis who are marked out as traitors by the insurgency can’t be guaranteed in the refugee camps either.

Denmark has already done the right thing, giving asylum to all 200 Iraqis who worked alongside their forces. The vast majority of the people concerned are already fluent English speakers and number only a few thousand, so we are not talking about a huge burden on the UK’s asylum system here – certainly nothing like the scale of the Ugandan Asian asylum operation, which is itself generally recognised to have been a massive net positive for the British economy and society.

British readers of CT ought to write to their MPs to ask them what they plan to do about this problem. It is best if you can write an individual letter, perhaps based on the set of bullet points over the fold, but if not, then the form letter on Dan Hardie’s blog is better than nothing (Update: the entire form letter is now also below the fold, after a burst of realism about how many readers you lose per click). I’ve also emailed my small set of contacts in the media about this story – as the links above show, to a large extent the “MSM” is already working on it, but anything we can do to keep it on the front pages will help. American readers of CT, well I guess you probably need to be thinking about how to organise something similar when your politicians start doing the same thing.

(other CT authors – can we leave this one up at the top of the page during Monday UK daytime please?)

bullet points for a letter to an MP (Dan H wrote these):

* It is morally unacceptable that Britain should abandon people who are at risk because they worked for British soldiers and diplomats.

* This country will be shamed if any more Iraqis are murdered for the ‘crime’ of having supported UK forces.

* Iraqis who worked for British forces should not be told to leave Iraq and throw themselves on the mercy of United Nations relief agencies in Arab countries: these agencies are already being overwhelmed by the outflow of Iraqi refugees, and Iraqi refugees who have worked for British diplomats or troops may well be targeted by local jihadists.

* There is plentiful evidence that armed groups in Iraq kill the families of those they consider ‘enemies’: for this reason we must extend the right of asylum to the families of those who worked for us.

* It is entirely practical for this country’s troops in Iraq, and its embassies in neighbouring countries, to take in Iraqis who have worked for us and fly them to the UK. Indeed, there is already considerable anger among British servicemen that Iraqis are being abandoned in this way.

* This country is large enough and rich enough to accommodate several thousand Iraqi refugees. Denmark has already given asylum to all 200 Iraqis who worked for its smaller occupying force.

* It does not matter what your MP’s views (or what your views) are on the invasion and subsequent occupation of Iraq. People who risked their lives for this country’s soldiers are now being abandoned by the British Government. Their lives can and must be saved by their being granted the right of asylum in this country.

* This policy should be implemented regardless of whether British soldiers stay in Iraq or are soon withdrawn. But it must be introduced soon: applications for asylum cannot be processed in a lengthy fashion, as the security situation in Basra is deteriorating rapidly, and delay is likely to lead to further killings of Iraqis who worked for British troops.

and here’s the form letter, and a repeat of the Write To Them link.

Dear (MP’s name)

As your constituent, I am writing to discover your views on the treatment of Iraqi citizens who are working, or have worked, for the British Army, t he Coalition Provisional Authority, and contractors working for both organisations in the South of Iraq. In particular, I would like to know if you support the right of these people to indefinite asylum in the United Kingdom. I strongly suggest that they do indeed have this right. They have, by definition, put their lives at risk by the support they have given to British soldiers who were sent to war by a vote of the House of Commons.

Whether you- or I- supported or opposed the invasion and occupation of Iraq is immaterial. The risk run by Iraqis working for British troops is even greater than that run by the soldiers themselves. British soldiers are now suffering very high casualties in Iraq, and are continuing to serve bravely- but the ir local staff are obliged to live among neighbours who will, in many cases, be sympathetic to or even belong to the armed groups fighting the British army. We owe these people a clear moral debt. We cannot allow them to be murdered for the ‘crime’ of helping our service men and women.

The most effective way of helping these brave Iraqis is to offer them indefinite right to remain in the United Kingdom. There is plentiful evidence that armed groups in Iraq make a practice of murdering not only their ‘enemies’ but their families too: and for this reason we must extend the right of asylum to the families of those who have worked with us. This policy should be enacted immediately whether our forces stay in Iraq or are soon withdrawn. Applications for asylum cannot be ‘processed’ in a lengthy fashion: the situation in Basra is deteriorating, the ability of British soldiers to protect those that work for them is seriously compromised and any delay is likely to lead to the murder of Iraqis who have worked for the British military.

I would appreciate your views on this matter.

Yours sincerely
NAME

MINDME

Mark Thoma takes the Free Exchange blog to task for mis attributing views to him. In his response the following sentence jumped out at me:

Mark Thoma:
Please quit implying my ideology drives my economics, it doesn't.

Can I get that on a T-shirt or a bumper sticker? Or maybe it should be made into one of those internet age acronyms like IMHO, ROTFL, AFFAIK, etc. so that it doesn't have to be typed out every time it's relevant.

MIDNDME?

MINDME is more aesthetic but it's grammatically incorrect.

(and anyway, even if it did, it wouldn't be the end of the world, or the debate for that matter. As Shumpeter said, just because it's ideology, doesn't mean it's wrong)

Doxy Wars II

Max Sawicky - who last time around pretty much stated that the only good kind of Economics is a left wing Economics (when he was warning fellow heterodoxists against trusting too much in Behavioral Economics because it too could be "reactionary") - has a pretty little smear job over at TPM Cafe. I guess I could use a nicer phrase to describe his article, but since in the fairly recent past Max has not found it in his heart to give others a charitable reading, I don't see why I should extend him that courtesy. And this is part of a theme. Last time this whole heterodox vs. orthodox economics thing went around the Internets I walked away with a distinct feeling that many of the mainstream economists (Brad DeLong, Mark Thoma, Tyler Cowen, if he can be called mainstream) where bending over backwards to find something nice to say about the heterodoxists (I believe the only one who called them whiners and said mean things (though probably true) about them was Henry Gintis, a fellow heterodoxist), while most of the heterodox behaved like assholes or spoiled little brats with a sense of entitlement (I'll leave it alone at that). Let me note the exceptions that pop in my head immediately- Barkley Rosser was as always calm, reasonable and with many interesting things to say. Robert was esoteric, cryptic and, uh, less than clear as always but polite. There were probably a few others but anyways... no more Mr. Nice Mainstream Economist.

Let's go through Max's list. (Also read the comments on Max's site. It's true. I insulted what he said (which I think is fair game in these kinds of debates). He on the other hand goes straight for the personal. "Toady". "Comedian". I'm surprised that it hasn't been suggested that I take money from Evil Corporations. Did I mention the word "asshole"?)

1. Supply and demand, 1. This celebrated and most basic economic model while in principle multidimensional in practice obscures anything interesting that affects market conditions. It bespeaks militant, ideologically-based reductionism. A good illustration is the minimum wage debate. In the usual supply and demand model, a minimum wage can only reduce employment. Nothing else is logically possible.

Bunkum. In the "usual" supply and demand model the consequences of a minimum wage can be:
1. Unemployment if the min wage is set high.
2. No effect if the min wage is set low.
3. Higher wages with no effect on employment if the labor demand curve is inelastic.

Now, the 3rd one is pretty "unusual" in that it probably doesn't happen very much. But Max's speaking of logical possibilities. What is a weasel word like "usual" doing in an enumeration of logical consequences? It's there so he can BS his way out if called on it.


2. S&D, 2. The outcome in an supply and demand model in principle has no inherently attractive qualities, in and of itself, since it depends on the distribution of ability to pay. If Oliver Twist has no money to buy a crust of bread, his zero allotment is "efficient." The lack of any normative foundation is typically glossed over.

Well first, you need a positive model before you can start making normative judgments. And the equilibrium of the "usual" S&D model does have one attractive feature - no waste, no money left on the table. Okay, lemme explain slowly the concept of Pareto Efficiency here because folks is confused.

Suppose there's a total of 100$ in the economy and two people, Meriadoc and Pippin. If all of that 100 bucks is in some way fully divided between the two, then regardless of who gets what, the outcome is said to be Pareto Efficient. Not fair. Not just. Just efficient. But suppose that only 80$ gets divided between Meriadoc and Pippin with, say, Mary getting 79$ and Pip getting 1$. The other 20$ just lies there on the sidewalk rotting. Then we have inefficiency. We could pick up the 20$ and give it to Pip, or give it to Mary or split it up between them two. Even if we give it all to Mary, so that now he's got 99$ and Pip only 1$, assuming Pip and Mary don't care about relative status, only more money, then we can all agree that (Mary=99, Pip=1) is "better" or, more precisely, "more efficient", then (Mary=79, Pip=1). (If they do care about status or whatever, you can reformulate the problem in equivalent terms)

Of course we may care about income distribution, inequality and all those other things. But that comes later. The PO criteria just says, if there's 20$ laying on the side, for goodness sake, pick it up and give it to someone, anyone. And that's the attractive property that a "usual" S&D equilibrium has - no 20$ left lying around rotting.


3. Gross Domestic Product (GDP). Add up all the quantities in the supply and demand models over the year ("final goods and services") and you get GDP. Solemn assurances that GDP is not synonymous with economic welfare fall easily by the wayside. More GDP (and less leisure time, less environmental quality, a less sustainable economic future) is always better. If terrorists knock down the Empire State Building, GDP could go up. More! Better! Comrade Stalin would approve.

This one's dumb in several ways. In fact it's so dumb it's embarassing - Max doesn't seem to even know what GDP measures. First, measurement or the definition of GDP HAS NOTHING TO DO WITH FREAKIN' SUPPLY AND DEMAND! It is simply adding up everything that has been produced by an economy in a given year. True, there are practical issues in what weights to use when constructing this measure - the prices - and a lot of sweat has been poured out over tackling that issue but for one if all you care about how GDP changes over time, a lot of those problems go away. And that's not what Max is talking about anyway. Second, the part about "assurances..fall easily by the wayside" is just pulled out of thin air. And um, for a given amount of leisure, and a level of environmental quality, more GDP is better. If you want something that measures other things then look at another measure.

Third, and perhaps most tellingly, the statement about GDP going up if terrorists destroy the Empire State building is a classic example of the Broken Window Fallacy, and anyone minimally trained in economics should know better. Presumably Max thinks that GDP would go up because you'd have to use firemen, policemen to deal with it, and construction workers to rebuild it. Of course the firemen, policemen and construction workers employed to deal with the terrorist strike are firemen, policemen and construction workers who would otherwise be employed in some other endeavor and so GDP WOULD NOT go up.

But suppose that through some weird, complex, effects, GDP could go up because of a terrorist strike. So freakin' what? DO YOU REALLY SERIOUSLY THINK THAT THE US GDP, OR THE EUROPEAN GDP, OR THE GDP FOR ANY FREAKIN' COUNTRY IN THE WORLD HAS INCREASED OVER TIME BECAUSE OF AN INCREASE IN TERRORIST ATTACKS? Or because of car accidents (Nader used that line once when I saw him speak)??? NO! It has increased over time because of investment and technological growth. This is misleading shyster-ness at its worst.

4. Commerce versus The Market. Forgetting about boring concerns of economic justice, the idea of a competitive, functioning market is actually very rigorous. So much so, there are hardly any good examples of such things. (The example often used is grain, undoubtedly by people who have never seen the back end of a cow.) When the Federal government tries to organize markets with the buzzword of "competitive sourcing," the results are even more comical. There is plenty of commerce, but there are very few markets, even though economists pretend they solve most of our problems.

I'm not gonna say much about this one because it's too ambiguous to really know what he's talking about. Let me just 1) suggest that Max looks through the, I dunno, last five years, of top economic journals and see what small percentage of articles actually assumes perfectly competitive markets, and 2) note that if you have a badly designed government auction then you get bad outcomes and if you have a well designed government auction you have good outcomes. How do you get a well designed auction? Yo hire some mainstream economists trained in game theory friend.

And having spend a lot of time on the farm as a kid let me just note that I've seen plenty cows but never this much bullsh... never mind.


5. In Search Of: The profit motive. Professors tell their gullible students that business firms maximize profits. This induces efficient use of resources and fortuitous allocation of capital. But if you study the economics of firms, even under orthodox auspices, you find out they don't maximize profits.

Because I'm getting lazy I'm gonna skip this one too. But what is it that firms do anyway? Maximize the number of ponies per capita? All the stuff on the principal agent problem, role of managers, market shares, has been part of mainstream, even in undergrad teaching for years.

6. The deficit's gonna getcha. Years of braying about the evils of budget deficits have failed to be borne out by the purported consequence -- high interest rates. The entire traditional macro apparatus fails to allow for the interventions of large foreign lenders who aren't dumb enough to believe what the textbooks say.

So apparently Max is with Dick Cheney on this one. Hey, cut'em taxes George, deficits are nothing to worry about. (I'll go out on a limb here and guess that Max thinks deficits are not a problem if they're produced by high spending by left wing presidents, but are a problem if produced by low taxes under right wing presidents) More substantially, you might not see higher interest rates as a consequence of budget deficits if the Fed doesn't want to see'em, since that's ultimately where interest rates get set. But since Max has put my mind at rest here, I've learned to stop worrying and learned to love the deficit.


7. Capital fundamentalism. As with reductionism of the S&D model, growth modeling zeroes in on private capital accumulation, even though a) other factors are demonstrably important and beg for attention; and b) private capital accumulation may be a consequence of other factors, rather than a cause and appropriate object for policy. Out of an obsession with this premise, the International Monetary Fund has screwed up a lot of countries too weak to ignore its advice.

This is another one that's particularly dumb. The story of Growth Theory in the past ... 25 years ... has been all about looking at "other factors that are demonstrably important". In fact, if it wasn't for that past 25 years of mainstream theory we might still be putting too much emphasis on capital accumulation today (and worrying too much about stuff like the CCC). Either Max hasn't read a Growth paper in the past 25 years or he's making stuff up for an audience that may not know any better. As far as b) goes, why the heck do you think all them Growth Regressions (to take an example, other approaches do the same thing) go to all these lengths to control for "endogeneity of investment". Same for human capital (ever heard of Bils and Klenow?). What you get at the end of the day is that once the growth-as-a-cause-of-investment (rather than vice versa) is controlled for, there's still some room for investment playing a role. But see answer to a) on that.


8. Every import is sacred. Regulation of markets is allowed, unless the market includes parties from different countries. Then it is strictly verboten.

Huh? Oh yeah, I remember a while back EPI was estimating "job loss due to trade" by counting every unit of imports as displacing exactly one unit of domestic production. Even Paul Krugman made fun of them for it.

9. The unnatural rate of unemployment. Economists used to say it was 6.0, maybe 5.5 percent. Lower would give rise to ruinous inflation. The huge social benefits of another couple of percentage points less unemployment were -- are -- implicitly discounted. Current rate is 4.5. 'Nuff said.

This particular one may have some truth to it. But it's a "smart after the fact" kind of thing. If the Fed was trying to get unemployment down to 4.5 in say 1978, not only would it had not been able too, but inflation would've been very high. Oh wait. It actually was very high.

10. "Power? You want the political science dept." Power looms over economic transactions, except in economic theory. Workers do not hire capitalists. Consumers do not choose merchants. Shareholders do not choose managers. Voters do not choose elected officials.

Maybe workers do not hire capitalists. But they do choose what employers they work for. Hey, I worked 12 years in the food industry, about half at minimum wage and I quit my job plenty of times. And seriously, "Consumers do not choose merchants"????? Is that actually said with a straight face? Is this heterodox wisdom that we've been missing? It happens to be summer and so I'm spending some time with the family. Always, always, my folks insist on telling me about where they shop, which stores have the best deals for the best items, and how they...um...choose the merchants they patronize. Again, I can't believe this is said in any kind of seriousness. Same freakin' thing for the voters - though I'm guessing here Max has the political lobby's and so on in mind. Maybe he's right. Maybe he knows better. After all he works for one.






Here's some folks who are nicer about it. Me? I just don't have it in me to put up with personal insults and arguments-in-bad-faith without hitting back a bit.

Thank you Alex Tabarrok

This is a very good piece of commentary on the stupidity of this article.

And I'm really starting to wonder what the hell is David Card talking about. I'm thinking of the previous "I lost some friends over the minimum wage research" quote too - maybe he did. But seriously, Card is a top-notch, widely respected, as celebrated-within-the-profession as they come economist, so where's all the whinnying coming from? Card, Krueger, Blinder, Stiglitz, Akerloff, Krugman - not to mention the old liberal guard of Arrow, Samuelson, Solow, Tobin, Modigiliani and Icouldgoon, - are some of the most successful and respected economists out there, and at the same time not folks one would really call "pro free market".

I think this all has to do with perspective or framing. Every other freakin' department on campus, that isn't science or enginneering, is out on the loony left. So when the economics department has the nerve to be left-center or moderate or balanced, or "leftist-but-sometimes-markets-do-work-you-know" the economists seem like wild eyed libertarian radicals to the rest of the intelligentsia (actually, you know what, you other folks can keep that label, with all the pretensions and phony sophism that goes with it).

And that NY Times article is proof that the barbarians are real.

Graphical explanation for empirical studies of immigrant's impact on wages (with some unavoidable maths)

Note to the heterodox readers, if any: This post is unabashedly neoclassical.

Note to everyone else; this post is a bit of a mess. I could go through and clean up notation, label all the graphs, add in relevant links and edit it for readability and um, make it more inflammatory, but after drawing all the graphs and typing in all the formulas in LaTex I'm just feeling too lazy right now.

Here's some relevant links:
George Borjas
Brad DeLong
Mark Thoma

Ok.


Solow Model:



On the x-axis is capital per worker, K/L. The bright blue line represents the addition to capital stock per worker, the saving rate times per capita output, s*Y/L. The dark blue line is output per worker as a function of capital per worker. The red line represents the subtraction from capital per worker due to capital depreciation and maybe (native) population growth, (n+d)*K/L. Where subtraction from capital per worker equals addition to capital per worker, capital per worker is constant (for simplicity I'm assuming there's no technological growth which would drive additional capital accumulation). This is the long run steady state of this economy. On the y-axis we can read of the level of output per capita (as well as things like total savings and consumption per capita).

Now we want to relate wages to per capita output. If we take the commonly used Cobb Douglas aggregate production function to represent the relationship between capital, labor and output;


so that per capita output is

where K is capital, L is labor (later on, an index of labor input) and Y is aggregate output.

and assume labor gets paid its marginal product then we'll have an equation for wages


Inverting that (so we can line up our graphs nicely) we have


This is shown below:



The reason why the slope of the green line is greater than 1 is because some of the per capita output goes to capital owners rather than workers. Parameter a generally measures the extent of diminishing returns to capital but here it also turns out to represent the share of total output going to capital owners. The higher the share a, the steeper the green line, the lower the wages. Additionally we can find the return on capital, r, by looking at the purple line tangent to the production function (dark blue curve - in the graph I tangented the wrong curve and I don't feel like redrawing it). Since all the debate has been about immigration's impact on wages, I'm not gonna worry too much about r for the rest of the post.

So how does immigration come in? Well, the simplest way to introduce it is to assume it represents and increase in the number of workers. As the number of workers increases due to immigration capital per worker (K/L) falls and so does output per worker (Y/L). We find the new Y/L (in graphs denoted by lower case y, just like K/L is k) by moving down the dark blue production function, come over to the graph on the left and find the new, lower wage level.

This is essentially what some really old, "naive", studies of the effects of immigration on wages did. But it isn't the end of the story. Because now K/L is below it's steady state value, return to capital is higher and as a result addition to capital per worker is greater than subtraction per worker. So the process of capital accumulation starts again and K/L returns over time to its old level, as does Y/L and as do wages.

(note for the mathematically savvy; you can actually linearize the system of differential equations around the steady state and compute the rate of convergence from which one could estimate how fast wages recover to their pre-immigration levels)

This is equivalent to estimating the elasticity of labor demand. But here I can just tell you what it is. It's alpha, or if you believe that capital's share in output is 1/3, it's 1/3. So this simple analysis would say that for every 10% increase in the number of workers due to immigration, wages would fall, on impact by 3.3% and then slowly go back to where they were. The whole process is illustrated below. This is where you're gonna hafta start clicking on the images to enlarge'em.




But like I said, this is a fairly naive approach. That's because it implicitly assumes that all workers, foreign and domestic, skilled and unskilled are perfect substitutes for each other. This doesn't mean that workers are of the same quality, it's just that quality is related linearly. One engineer equals three doctors equals five lawyers equals a hundred construction workers equals six hundred and sixty six economists. For the purposes of production, if you're a firm, it doesn't matter whether you hire the five lawyers or the six hundred sixty six economists.

Obviously that's not very good. So let's start differentiating workers. First let's just differentiate them by skill level. Suppose that now L is not the number of workers but an index of a labor input, composed of skilled and unskilled workers. Specifically let's assume that the labor input index is constant elasticity of substitution and is given by:



where U is number of unskilled workers, S is number of skilled workers and rho measures the elasticity of substitution in production between'em.

Then, again assuming that each kind of worker gets paid her marginal product we get wages:





and inverting again we have







where the last part follows after some simple algebra. This means we have two green lines - one that relates skilled workers' wages to per capita ... we actually got to be careful now, it's no longer per capita output, it's output per unit of labor input, but the two are related in a straight forward manner so I might slip in what follows. Likewise now it's capital per unit of labor input rather than capital per worker ... anyway, two green lines, one for the unskilled and one for the skilled workers.

So what happens now when there's immigration, which here I'll take to be an increase in the number of unskilled workers? Well, as before, each worker (or unit of labor input) has less capita to work with so Y/L goes down as before. But note that now the slopes of the green lines depend on the the number of workers, skilled and unskilled. I'll let you take the derivatives (it's simple for the skilled since there only L changes, but for the unskilled both L and U change). Anyway if you do that, you'll get that how the lines shift depends on rho - which measures the elasticity of substitution between skilled and unskilled workers.

Well, most estimates of rho suggest that skilled and unskilled workers are complements. To build a house you need some relatively unskilled construction workers, but you also need skilled architects, surveyors, etc. You can't build the house if you don't have one group or the other. This means that rho is negative (and it's a pain to always worry about a negative parameter, but there you go). If you took your derivatives correctly you'll see that this means that the slope of the green line for the skilled workers shifts downward, while the green line for the unskilled workers shifts upward. This means that the effect on unskilled workers' wages is acerbated but skilled workers gain from immigration. If you were to do an empirical study based on the simple model based above, rather than this one, then the gains to skilled workers would instead show up, incorrectly, as gains to capital (if it wasn't just a complete mess).

Here's the graph, and to avoid clutter I'm omitting labels - think of it as one of those puzzles where you have to fill in the missing parts.



Of course, once the shock occurs, the process of capital accumulation starts up again, which the graph illustrates. Now the green lines are permanently shifted, but output per ... indexed labor, starts going back to its old level. This means that now both wages of unskilled and skilled start rising. So the wages of the unskilled recover somewhat (math can tell you that it's not all the way) while the wages of the skilled keep on rising. The purple arrows in the upper graphs indicate how wages move, while the red lines in the lower graphs show the time path of wages for the two worker groups.

Here's the same thing with good old supply and demand, but it's less pretty and you don't see everything that's going on:



The increase in the number of unskilled workers is a shift in labor supply in the upper graph represented by a shift in the blue line. This lowers the wage rate for unskilled workers. But through complementarity effects it also increases the demand for skilled labor, increasing their wages as seen in the lower graph. Then capital accumulates and the demands for both kinds of labor shift up. (Again, I omitted all the labels out of laziness. Wages are on the y-axis, amount of each type of labor is on the x-axis).

Of course all this begs the question; who are the skilled workers? Well, if you look at Ottaviano and Peri, then for the US, the answer seems to be "anyone's who graduated from high school", which means most workers see some gains in the short run and even larger gains in the long run. But it's true, the very bottom would be hurt. Or would it?

Well, this kind of study is still fairly basic. I guess you could call these kinds of studies "second generation" - they estimate the effects separately for various skill levels of workers and allow for capital accumulation that might result. But they still differentiate workers only very coarsely.

The above mentioned Ottaviano and Peri goes much further and differentiates workers by skill level, occupation and whether they're immigrants or not. It's not implausible that foreign born and native born workers, even when they have the same education and are employed in the same industry would not be perfectly substitutable for each other. It'd be too much work here to go through all the differentiations possible. Let's just differentiate between three types of workers here: skilled-native, unskilled-native, and unskilled-immigrant. So we're assuming a labor index like this:





Where now S is number of skilled native workers, U_n is number of unskilled native workers and I is number of immigrants. Now rho measures elasticity of substitution between skilled and unskilled workers and epsilon measures elasticity of substitution between foreign and native workers.

Let's define the unskilled labor index as:



Since we've got three groups now, we'll have three green lines. The equations for the wages are now:




And if we invert these we'll get the three green lines.


Now we increase the number of immigrants. The effect on native-skilled workers is pretty straight forward because it is essentially the same as the effect on skilled workers in the model right above. The green line shifts down and skilled workers gain today and even more in the future. The effect on PREVIOUS immigrants is also pretty straightforward - above we were increasing the number of unskilled workers, here we're increasing the number of immigrants, so the effect on previous immigrant's wages when the new ones come is to decrease their wages on impact, which then gradually recover somewhat over time.

The difference is in what happens to native unskilled workers. Again, if you do the math, you'll see that it depends on elasticities of substitution (now rho and epsilon) and which one is bigger. So theoretically, now, the answer is "it depends". The green line for native-unskilled workers could shift up or it could shift down. It could even shift down enough so that even unskilled workers gain, today and in the future. For this to be true however, there would have to be a lot of complementarity between native and foreign unskilled workers (epsilon would have to be negative and large in absolute value). Here again is a stripped down graph:





So like I said, for the native unskilled workers it could go either way. They could loose some and then recover or they could gain and then gain some more. What it depends on is the relative magnitudes of elasticity of substitution between native-unskilled and foreign-unskilled and the elasticity between the unskilled as a group and skilled as a group. As it turns out most estimates suggest that the complementarity between skill groups is larger than between foreign and native (note that actually you don't need complementarity. You need enough less-than-perfect substitutability) which means that the loose-then-recover-some scenario is more plausible for the unskilled (again here roughly meaning "high school drop outs"). But it's not that much larger. In fact what the estimates suggest is that the green line for unskilled workers shift down though not quite enough to offset the fall in wages due to decreased capital per worker. What this means is that the likely effect on unskilled workers' wages is "small loss in short run, slight gain in the long run", or, more or less 0.

0.



And in fact, that's roughly speaking (in terms of orders of magnitude) what Ottaviano and Peri find although that study being more detailed is not directly comparable to all them graphs above. As often is the case The World doesn't really feel like providing unambiguous, strong, one sided evidence that would make taking an ideological stance easy (until you think about the gains to the migrants themselves).


In a way the bottom line here, if you've read this far, is that the main people that immigrants are hurting through their effect on wages are those most like them. In other words, previous immigrants.

HAPPY FOURTH OF JULY!