Umair Haque / Bubblegeneration

Friday, April 08, 2005

How to Not Analyse Econ, pt 19294

Gene Epstein, the econ editor of Barron's, responds to this piece about Wal-Mart's hidden costs at NYbooks. Not to pick on him, but his response is a great example of how to misuse econ.

"...Finally, Head's analysis leaves a great hole. A few back-of-the-envelope calculations reveal how Wal-Mart lifts the living standards of ordinary people by offering them goods at bargain prices.

In 2004, the company's domestic sales ran $210 billion. How much more would these items have cost if Wal-Mart were not selling them? According to a recent study (not mentioned by Head) from the National Bureau of Economic Research about the company's influence on food prices, Wal-Mart offers "identical food items" at prices that run "15%�25% lower than traditional supermarkets."

Assume the midpoint of that range (20 percent less) for all items sold by Wal-Mart; if the $210 billion were 80 percent of what consumers otherwise would have paid, their annual savings comes to more than $50 billion. For some perspective on that figure, after-tax income of the poorest three fifths of households runs about $1,400 billion. So $50 billion boosts their nominal income by more than 3 percent."

Let me point out just two quick flaws in this thinking.

1) The implicit assumption underlying Epstein's response is that people always buy the same amount of food regardless of price - that demand for food is inelastic. Is this a fair assumption? Obviously not - as food prices fall, people buy more food, and get fatter. The demand for food is elastic.

This is actually a point that could work in Epstein's favor. Except that, as we all know, buying cheap mass-produced food has huge hidden costs. And except for point 2...

2) Let's assume, as Epstein does, that there are no demand elasticity effects. In that case, his response is a perfect example of Bastiat's Broken Window Fallacy.

American consumers realize savings from Wal-Mart. But this does nothing to defeat the original argument that Wal-Mart's efficiency is based largely on arbitraging poor Chinese labor standards. In this case, the analysis above ignores completely the fact that each dollar American consumers save is a dollar lost by Chinese workers. Standards of living don't rise - they merely get distorted and redistributed.

This leads to a hidden cost which is, as previously argued, borne by Chinese workers, whose incentives are distorted by Wal-Mart's market power and China's currency dilution and lack of labor standards.

Because of these distorted incentives, workers' largest short-term payoff comes from working in sweatshops, rather than investing in education, technical skills, or other things which ultimately boost capital stock, productivity and total welfare across China and the US. So everyone is worse off than they would be without Wal-Mart.

Now, I go to the trouble of pointing all this out because I think the argument against Wal-Mart is intuitive, and it should be listened to. And because I think just because you've quantified your analysis, doesn't mean it's rigorous.

-- umair // 4:11 PM // 1 comments

Comments:

Two additional factors in the analysis:

1) Cheapest food tends to be the most fattening -- while Protein is the most expensive food you can buy (beef, chicken, fish, legumes), versus the cheaper, more-filling products like pasta, rice, potatoes.

Perhaps Wal-Mart is dramtically shifting people's purchase preferences -- maybe their customers are buying some more proteins and fresh vegetables than they would have otherwise.

In that case, they would actually be improving people's health -- but somehow, I doubt this is happening. A more likely scenario is consumers are spending the savings on purchasing other goods. (IMHO).

The bigger issue -- the Macro-economics one -- WMT has rapidly accellerated the global labor arbitrage betwen the US and the 3rd world.

I suspect it would have happened eventually, but thewy ripped the bad aid off quickly. Makes it tough to adjust to.

I'm curious is fast and painful is better than slow and agonizing . . .

# //

Ritholtz // 12:42 PM