I got an email from Steve Landsburg with the subject line "krugman, me and you." I can't decide whether that counts as the sort of threesome I've always dreamt about...
I get daily emails from The Chronicle of Higher Education newsletter. Today's headline: "Academe Today: Professor Says His University Cares Little About Teaching." I had to stop for a second and confirm that I wasn't in fact reading The Onion.
So a little while ago I wrote about the efficiency of free trade where I went through a situation in which a country would want to start importing a good from abroad. At the end, I noted that an export situation is basically the same but with a role reversal for producers and consumers. Nonetheless, there is an objection of “yeah, but you didn’t consider exports” in the comments section…I was mainly trying to not be repetitive, but in retrospect I think I inadvertently did what so many economists (especially economics instructors, sorry about that) do- we focus on the effects of imports and then gloss over the effects of exports. This isn’t great for students etc., and it’s particularly problematic because people more generally focus on the impact of foreign competition for production much more than the impact of foreign competition for consumption. So I apologize, and I’m here to make up for my earlier oversight.
I think this bias occurs at least partly because it’s easier to find motivating examples/case studies/etc. that have to do with imported goods. (This doesn’t mean that imports are a bigger deal, just that, like I said, we tend to focus on them more, so…chicken and egg, you know?) But here’s one on a topic near and dear to my heart…and stomach, and brain probably:
Meet the Man Bringing Coffee Back to Colombia
by Ethan Fixell
Despite the country’s reputation for fantastic coffee, it’s nearly impossible to get a good cup of joe in Colombia. The second largest coffee exporter on earth sent $2.6 billion worth of beans to other countries around the world last year, forcing locals in most Colombian cities to brew imported beans from far-off places like Vietnam.
Like before, I’m going to try to explain what’s going on here without using any graphs (even though I like them so much!). Say you’re a coffee grower in Colombia, and you live in a world where there is no trade among countries. Your only option, therefore, is to sell your coffee to people in Colombia, who might not have a lot of disposable income or might not like coffee that much or whatever. In this world, you sell your coffee (unroasted wholesale, to make the numbers make a little more realistic) for 25 cents per pound. (No, I don’t know why our Colombian transactions are denominated in USD, but let’s try to focus here.) The point is that Colombian roasters can buy your coffee pretty cheap, which is good since they can’t set too high a price for the finished product, what with Colombians not having a lot of cash and not liking coffee and whatnot.
Now let’s open up Colombia to some trade- you know, that thing that people have taken a sharp turn against for some reason:
If we’re honest with ourselves for a second, I think we can all agree that Americans have a (relatively) decent amount of disposable income and are pretty much welded (I was going to say wedded but I think the typo works better) to our coffee intake. This combination of factors leads to a higher willingness to pay for coffee, especially Colombian coffee, since we all bought into the coffee marketing of the 1980’s:
(No really, that ad is from 1983, and I have no idea why this marketing was so salient to my young self.)
As a result, let’s say that roasters in the US will pay $1 per pound for Colombian coffee. Also, let’s note that we drink a lot of coffee, so the US roasters are willing to buy as much as Colombia will sell us at that price. What are Colombian coffee growers going to do?
I feel like the article preview pretty much ruined the suspense here- if coffee growers can sell all they want to the US for $1, they aren’t going to sell to Colombia for less than $1, so the price to Colombian roasters goes from 25 cents to $1. Colombian roasters don’t buy as much Colombian coffee (demand curves do slope downward after all), and Colombian coffee drinkers get coffee imported from Vietnam rather than the stuff that it right around them. Weird, right? But is perfectly understandable from an economic standpoint.
In this scenario, Colombian coffee producers are better off because of trade and Colombian consumers are worse off. (Told you it was the reverse of the import situation.) Like with imports, trade is efficient since the producers win from trade more than consumers lose from trade. Why is this? Well, let’s think about this in a few consumer-group parts:
Those Colombian roasters who are still buying coffee at $1: They are 75 cents worse off, but the coffee producers are 75 cents better off, so there’s no net value change.
Those Colombian roasters who were willing to buy at 25 cents but not at $1: They are losing less than 75 cents in value (read, consumer surplus), since if this were not the case they would still be willing to buy at $1. (For example, if a roaster was willing to pay 60 cents, pricing him out of the market causes him to lose the 35 cents of value he had been getting at a price of 25 cents.) The coffee producers are better off by 75 cents since they are still able to sell the coffee at $1 to foreign consumers. This results in a net value increase.
Those foreign roasters who are willing to buy coffee at $1: Since the Colombian growers aren’t selling at a loss, this has to be a value increase.
This combination of no change, increase, increase has to result in an overall increase in value for Colombian society. (Like the basic import analysis, however, this doesn’t address distributional concerns regarding winners and losers.)
Not gonna lie- it’s pretty perplexing to me that this dynamic doesn’t seem to call for export restrictions nearly as much as the reverse situation results in calls for import restrictions. If I had to guess, I would hypothesize that people are more inclined to think about their welfare in terms of money coming in (i.e. the producer side) rather than in money going out (i.e. the consumer side). On the other hand, people complain way too much about inflation for this explanation to be entirely satisfying, so who knows. Maybe it has to do with the fact that producers tend to be more concentrated than consumers, and more protest happens when losers are more concentrated? In any case, it *is* sort of unfair to talk about the effects of imports without considering the effects of exports, or vice versa, if for no other reason it’s difficult to include a “we want to sell you stuff without restriction but we’re going to tax the stuff you try to send to us” clause in trade agreements nowadays.
You know you’re an econ/math nerd if you read this and think “haha, it’s like the matching pennies game”:
But hear me out…here’s the matching pennies game, and, like the joke, the crux of the game is that there is no Nash equilibrium without randomization. To further the analogy: The matching pennies game works as it does because player 1, let’s say, “gets off” when the pennies match whereas player 2 gets off when the pennies don’t match. (This wording hopefully shows the intuition of why there is no pure-strategy Nash equilibrium, since the goals of the players are clearly mutually exclusive.) The…uh, matching fetishes game works in a similar fashion, since the guy gets off when he and his partner are in agreement, but the woman gets off when there is discord.
With some minor labeling changes, you could even make a payoff matrix for the matching fetishes game, the conclusion of which is…hm, can one randomize being turned on or not?
In my class, I try to introduce a topic and then give my students a discussion question to work through so I can make sure that everyone is catching on. This discussion question relates back to the disposition effect, or the bias towards selling winning stocks and away from losing stocks.
If you need a refresher, you can see the entire behavioral economics playlist here.
Steve Levitt, in addition to gaining fame (at least at an economist level, not a Justin Bieber level) for writing Freakonomics, has made a career teasing cause and effect out of (largely) observational data. (By “observational data,” I mean that he doesn’t explicitly run controlled experiments in a lot of cases and just looks at the world as it transpired naturally instead.) Observational data presents an interesting challenge because people usually make choices in life rather than being guided by randomness. As a result, we often end up with selection bias that makes causal interpretations difficult- for example, we can look at people with and without pets and observe that the people who have pets are happier. (This is hypothetical, but it is in keeping with everything I would like to believe about the world.) This doesn’t mean that pets make people happier, since it could just be the case that people who are already happier also tend to adopt pets. It would be better from a data analysis standpoint if people were just randomly endowed with pets (like when a cat showed up on my doorstep when I was little I suppose), but unfortunately for science purposes we live in a society where people choose whether or not to have pets, and this choice aspect kind of messes things up.
To try to overcome this issue, economists tend to look really hard for sources of randomization- technically known as instrumental variables. In the pet example, whether a stray animal showed up on the doorstep might make a good instrumental variable, at least if the showing up was fairly random and people tended to keep the animals once they showed up. Using some statistical fanciness, we could compare the group of people who had animals show up versus those that didn’t and get a reasonable estimate of the causal effect of pets on happiness.
I know what you’re thinking- this is all nice in theory, but it’s not like we keep good records on stray animal on doorstep prevalence. This is true, and wouldn’t it be nice if we could actively create an instrumental variable- perhaps let a bunch of stray cats loose in a neighborhood and record what happens? (I was going to add a disclaimer to not try this, but it could actually be pretty interesting for research purposes.) How about if we could introduce a source of randomness in the easiest way possible, by flipping a coin?
Little is known about whether people make good choices when facing important decisions. This paper reports on a large-scale randomized field experiment in which research subjects having difficulty making a decision flipped a coin to help determine their choice. For important decisions (e.g. quitting a job or ending a relationship), those who make a change (regardless of the outcome of the coin toss) report being substantially happier two months and six months later. This correlation, however, need not reflect a causal impact. To assess causality, I use the outcome of a coin toss. Individuals who are told by the coin toss to make a change are much more likely to make a change and are happier six months later than those who were told by the coin to maintain the status quo. The results of this paper suggest that people may be excessively cautious when facing life-changing choices.
(Note that you should be able to access the article with most university email addresses, and even some alumni email addresses. Worth trying, at least.)
So let’s think this through…the outcome of a coin flip is random, so people were essentially randomized into “change” and “don’t change” groups. This randomization implies that the two groups are (at least approximately) comparable along other dimensions, leaving the change directive as the only systematic difference between the groups (and therefore the only plausible cause of any observed differences in outcomes). If everyone who was told by the coin to make a change actually did so (and vice versa), Levitt wouldn’t have even had to do anything statistically fancy and could have just compared the average levels of happiness of the two groups. Because not everyone listened to the coin (which I guess is sort of a good thing for the world more generally), he had to do the more fancy version of the math but is still able to find a statistically significant causal effect of change on happiness. Cool, huh? Now go make a change- apparently it’s good for you.
In case you’ve forgotten, the disposition effect is the bias toward selling winning stocks (or other investments I guess) and away from selling losing stocks. In the video below, I start covering one of the seminal empirical papers on the disposition effect and can’t resist fangirling out for a second in the process.
You can see the full behavioral economics playlist here.