Tuesday, September 8, 2009

Teaching Economists Economics

Paul Krugman is a former economist, and he sets out to describe the state of economic inquiry in the context of the current recession. He correctly notes that there's a sharp division among economists in terms of how to respond to the financial crisis and ensuing recession. But it's his too-clever-by-half attempt to discredit the "freshwater" side of the debate that gets the laughs. He begins with an amusing anecdote:
Consider the travails of the Capitol Hill Baby-Sitting Co-op.

This co-op, whose problems were recounted in a 1977 article in The Journal of Money, Credit and Banking, was an association of about 150 young couples who agreed to help one another by baby-sitting for one another’s children when parents wanted a night out. To ensure that every couple did its fair share of baby-sitting, the co-op introduced a form of scrip: coupons made out of heavy pieces of paper, each entitling the bearer to one half-hour of sitting time. Initially, members received 20 coupons on joining and were required to return the same amount on departing the group.

Unfortunately, it turned out that the co-op’s members, on average, wanted to hold a reserve of more than 20 coupons, perhaps, in case they should want to go out several times in a row. As a result, relatively few people wanted to spend their scrip and go out, while many wanted to baby-sit so they could add to their hoard. But since baby-sitting opportunities arise only when someone goes out for the night, this meant that baby-sitting jobs were hard to find, which made members of the co-op even more reluctant to go out, making baby-sitting jobs even scarcer. . . .
And then returns to the world of economists:
Freshwater economists are, essentially, neoclassical purists. They believe that all worthwhile economic analysis starts from the premise that people are rational and markets work, a premise violated by the story of the baby-sitting co-op. As they see it, a general lack of sufficient demand isn’t possible, because prices always move to match supply with demand. If people want more baby-sitting coupons, the value of those coupons will rise, so that they’re worth, say, 40 minutes of baby-sitting rather than half an hour — or, equivalently, the cost of an hours’ baby-sitting would fall from 2 coupons to 1.5. And that would solve the problem: the purchasing power of the coupons in circulation would have risen, so that people would feel no need to hoard more, and there would be no recession.
Why was the freshwater efficiency ideal "violated by the story of the co-op"? Because the prices didn't adjust. Why didn't prices adjust? Because the co-op fixed them! Krugman even describes how price change would have looked in that case, but it was precisely the rigidity of the system that prevented efficient prices and caused a 'babysitting recession'.

Krugman, of course, is a proponent of government regulation and price-setting.


Tim Vail said...

One other thing Krugman missed is that when you leave the group, you have to return all 20 coupons. It doesn't matter if you are talking about 20 coupons or 40 coupons -- whatever the number is that people have to return, everyone would want more than that on hand at all times. This is especially true if those coupons cannot be bought. What's more is those coupons couldn't be translated via monetary value. The whole thing is a faux economy proposition. In a true economic system -- you would be able to exchange ANY goods or services (not just money, or coupons) for ANY goods or services. I don't know what restrictions were placed on the coupons other than amount of babysitting time. I'd imagine that because folks might have felt they couldn't exchange it for anything else, they wind up feeling that they cannot even use the coupons.

Chops said...

I agree.

Anonymous said...

Salim, please send me your email & phone number. I have a question for you.

Dan Noronha