This marks the 5th and final post in my series on game theory explanations for systemic problems in international development. I must warn you, this post is very different from the other posts. It is not so much about Liberia as it is about the type of work we are doing in Liberia. So if you are looking for a travel story please scroll down.
In this post I will be using the concept of a potluck dinner to discuss the value of voluntary exchange and using that framework to explain the problem of imported supply coupled with imported demand. I will also be introducing the concept of an Edgeworth box[1].
First up, you are probably wondering what a ‘Potluck Dinner Ninja’ is. The idea of a potluck dinner is that each person or family brings a dish to the dinner and then everyone shares. The two main benefits of a potluck dinner are (1) community bonding and (2) by cooking only one type of food you can try many other types of food. Usually a potluck dinner turns into a recipe swapping, neighbors talking, story sharing, joke telling - good old time. Now enters the Potluck Dinner Ninja. The Potluck Dinner Ninja brings a dish, but does not share the dish, nor does the Potluck Dinner Ninja sample anyone else’s food. The Potluck Dinner Ninja does not talk to anyone, but keeps to the shadows. The only evidence the Potluck Dinner Ninja even came to the dinner is a mysterious thank-you card left for the host.
The format of a potluck dinner is an economic masterpiece. Each person putting in some effort will receive in return much more gain than would be possible individually. By cooking your chicken, you can now try one neighbor’s tacos, someone’s homemade apple pie, someone else’s banana fried rice and if you feel adventurous maybe some squid. First, each person uses their individual skills (in this case recipes) and labor. Then, by sharing those goods in a voluntary exchange each person’s gain from that effort is multiplied. You yourself could not have cooked this many different types of food in ten hours, yet by the brilliant formatting of a potluck dinner you only spent two hours cooking. By the simple act of voluntary sharing you have created value.
Or, to use an Edgeworth box in three steps: [1]
**
Step 1 - Basic Graph
In a basic graph we measure from a starting point of zero in the bottom left corner. As the graph moves away from the starting point it means we have more stuff. Basic graphs can measure two items at the same time by placing those measurements on two different lines, usually marked as the X axis and the Y axis. The value of measuring two items at the same time is that we can now compare the two. The real value in a graph is the ability to compare two different measurements.
Step 2 - Graph with two Indifference Curves
An indifference curve is a line that compares two measurements at the point where you are equally happy. On line a we see two dots. Each dot represents an amount of chicken and an amount of tacos. One dot has more chicken than tacos and the other dot has more tacos than chicken. The point is that we like the two dots on line A equally. We actually like all of the spots on line a equally. We are just as happy with 8 chicken and 2 tacos as with 3 chicken and 5 tacos.
If we move from the curve with two dots to the curve with one dot we get more value. We prefer the indifference curve that is farther away from the bottom left corner. Any spot on line b is preferred to any spot on line a. We prefer 5 chicken and 5 tacos to all options on line a.
Line b is better than line a.
Step 3 - Edgeworth Box
In an Edgeworth box we have two sets of graphs with indifference curves put together. The bottom left corner is where you have no stuff, but your neighbor has all of the stuff. The top right corner is where you have all of the stuff and your neighbor has none of the stuff. Your goal is to move towards the top right corner and your neighbor’s goal is to move towards the bottom left corner.
We start at the dot in the bottom right corner. You have 10 pieces of chicken and your neighbor has 6 tacos. As you trade chicken for tacos both you and your neighbor both move to a higher indifference curve. As you trade you are both better off.
This is why we love trade. We get more value without creating more goods. You didn’t cook more tacos and I didn’t cook more chicken, but miraculously we are both better off from this voluntary exchange.
As we move towards the center of the Edgeworth box both You and your Neighbor gain value. Behold the economic miracle of voluntary exchange modeled as a potluck dinner.
**
Now that we see how fantastic a potluck dinner is, by contrast we can appreciate the irrational nature of the Potluck Dinner Ninja.
The Potluck Dinner Ninja does not join in conversation, does not experience the value multiplying effect of sharing food. The Potluck Dinner Ninja does not move to a higher indifference curve, does not build social capital by talking with neighbors. What would be the point of even coming to the potluck if you don’t share food or talk to people?
Or to put it into a decision matrix:
The rational choice is to Share in the potluck. Now behold the irrational nature of the Potluck Dinner Ninja.
-
What does the Potluck Dinner Ninja have to do with imported goods in developing countries? Well…
A developing nation can sometimes experience large gains in import consumption. It only makes sense. If your nation can no longer make sugar, or salt or bread or anything, you will need to import those items. The supply of those items is imported, not made locally. Developing nations will necessarily go through a process of needing imported goods, and I am not arguing against imported goods. The problem I want to address is bubble-markets from imported demand coupled with imported supply.
Imported demand is essentially all of the market place activity created by ex-pats. These people are temporary and their demand for the goods they purchase is also temporary. When these people leave, their imported demand will leave with them. Imported demand doesn’t have to be bad. When new people enter a system they will purchase goods, and if they purchase local goods local merchants will prosper. Hopefully the local merchants will in turn purchase more local goods with that money. The local economy would then grow and when the imported demand leaves, the system remains relatively stable.
But, if the imported demand is entirely met by imported supply, like importing Swedish fish for the Swedish Ambassador, when the Swedish Ambassador leaves then the market for Swedish fish collapses. No one locally buys Swedish fish; no one locally makes Swedish fish. The good will simply disappear. When goods disappear the economy contracts. The bubble bursts.
IF the market demand for foreign goods is met entirely with a foreign supply, economic collapse will happen to those goods when the foreigners leave. The bubble-market bursts. We can now see markets for goods demanded solely by foreigners supplied solely by imports as Potluck Dinner Ninjas. They bring their own food, eat their own food, and then leave.
This is a serious problem because every small contraction in the economy is magnified in a developing country. A robust economy actually needs products to fail from time to time, but for less stable economies this system of predictable failure is not good.
-
How can we avoid this situation? How can we get local people to start producing these imported goods? How can we get foreigners to start purchasing local goods? Why hasn’t the free market corrected this aberrant behavior on its own?
Because I am studying at a policy school I am apt to make a policy suggestion. We need to either stimulate import-replacing production [2] (get local people to start making these imported goods) or stimulate expatriate consumption of local goods (get the foreigners to buy local stuff). We can’t, however, just mandate a change in behavior because that may lead to even worse market conditions. We don’t want to use tariffs or subsidies except as options of last resort. What is a policy analyst to do?
The market will probably not correct itself in this situation because the best and brightest local business minds will be concerned with earning profits. The best profits will be in supplying foreigners with imported goods. The business talent will be siphoned away from establishing local markets, almost like an internal brain drain. Local people do not have to leave the country to effectively leave the local economy. The market will not be able to correct itself when its best minds are off earning money in foreign currencies.
My suggestion is to target the tax code to treat import-replacement start-up businesses as time-deferred non-profit organizations. I know that’s an awkward mouthful, give me a chance to explain. Essentially, for any new business that seeks to supplant an imported good we create a separate tax code. This special tax code would treat the business like a non-profit for the first 5 years (or some other number of years). Unlike a non-profit, however, the money owed on taxes does not go away, it is time-deferred. After 5 years the new business owes those back taxes and if it can’t turn a profit it will go bankrupt, as it should. This policy is close in concept to the current idea of Special Economic Zones [3] except that in this situation the special tax breaks are temporary and targeted to import-replacing business start-ups, rather than to geographical regions.
-
Citations
[1] Gaus, Gerald F.(2008) On Philosophy, Politics, and Economics. Thomson Wadsworth, 2008. pp. 75-78.
[2] Jacobs, Jane (1984) Cities and the Wealth of Nations: Principles of Economic Life. New York, Random House 1985.
[3] wordiq.com
No comments:
Post a Comment