Atanu Dey On India's Development

LOSADS!

Law of Supply and Demand

Not to put too fine a point on it, but the law of supply and demand is a bitch. Stripped of all details it basically states that the price of something is determined by the interaction of the quantities supplied and demanded. Therefore (1) an increase of the quantity demanded, holding the supply constant, will increase the price; (2) an increase in the quantity supplied, holding the demand constant, will decrease the price; (3) a decrease in the quantity demanded, holding the supply constant, will decrease the price; and (4) a decrease in the quantity supplied, holding the demand constant, will increase the price.

Sing pretty songs, if you please, or dance nimbly invoking the gods, or pass sincere legislation to suspend the effects of that law. You would have as much success doing that as you would have in suspending the law of gravity and legislate against it effects. The law of supply and demand is not quantum mechanics and can be taught to the average 6 year-old with ease. Ignorance of the law should be a matter of shame, and willful disregard of the law by policymakers should be punished through public floggings.

Public Floggings

So why, you may ask, don’t we regularly enjoy the spectacle of public floggings of policymakers given that they frequently willfully disregard the law of supply and demand and legislate prices? Two reasons. First, the general public is shamefully ignorant of that law. They don’t know that the law is inviolable as it is not a man-made law. Second, the idea of public flogging makes them queasy. I am very much in favor of public flogging as punishment because it is equitable and wealth invariant.

Suppose you impose a monetary fine which is the same for everyone irrespective of the wealth of those being punished. The rich will be much less affected than the poor. But if you flog publicly, the rich and therefore the more powerful (and thus those who should be expected to be more responsible) would pay more in terms of loss of dignity and greater shame for their crimes, and it would have a greater deterrent effect. Imprisonment for most non-violent crimes is not a good idea because it is costly for society to maintain prisons and besides it robs society of any productive services that the criminal could otherwise provide.

I am rambling. But of course I am rambling. It’s my blog and if I want to build a solid foundation upon which to rest my argument, I have that privilege.

Poverty

I have arrived at the conclusion that poverty is a fact of life and will remain so for a while because the poor will be around for a bit longer. I should explicitly define what I mean by “poverty” and “the poor.” Poverty is a relative term and its definition varies across time and space. By US standards, most of the world is poor. Also by today’s US standards, most of the US of a hundred years ago was poor. Conversely, by the US standards of 1900, most of today’s India’s population is not poor.

That said, one could define something called absolute poverty. I would define it to be a degree of material deprivation which does not allow a person to obtain the most basic of food, shelter and clothing. From what I have seen first hand and know second hand from various published sources, by my standards (therefore naturally not objective), about 40 percent of India’s population – about 400 million — is poor.

LOSADS! Supply

Now let’s ask a very stupid question: Why does India have so many poor people? It’s the law of supply and demand, stupid! LOSADS.

So here’s what we will do now. We will let the simple model of supply and demand inform our investigation in the questions of why there are so many poor, how long will poverty (absolute or relative) persist in our world, what are the factors which tend to increase or decrease the number of the poor, and many other such matters. The subject, in this application of supply and demand, is people.

Wages correspond to “the price” which is jointly determined by the supply of and the demand for people. Let’s focus for now on low-skilled manual labor. Their wage is low in India because the supply is high and the demand is relatively low. So their price, or wages, though low is positive. That low positive price is sufficient for the continued supply of low-skilled people. In certain states of India and within a certain socioeconomic class, families produce half a dozen children or more. Without going into the details of the factors that lead to this fecundity, let’s just note that the supply is plentiful. Now let’s see the demand side.

LOSADS! Demand

On the demand side, there is sufficient demand for low-skilled manual labor to maintain a positive price which happens to be close to subsistence level. But the demand is not so little so as to drive the price to zero and therefore the wages below the subsistence level. In that case, the supply would contract. Also, the demand is not sufficiently high that it would raise the price such that the wages climb way above the subsistence level. Indeed, if the wages go too much above the subsistence level, the supply is sufficiently wage elastic that the higher wages would induce an increase in the supply so that the price is once again driven down to the subsistence level.

Derived Demand – Manufacturing

Demand for low-skilled manual labor derives from the usual domestic sources. For example, there is a great deal of construction going on around India. Labor and capital are to some degree substitutes in construction. You can use huge earthmovers (capital) or you can use an army of laborers armed with shovels. Firms will figure out their profit maximizing mix of capital and labor. As the supply of manual labor is plentiful, firms in India use labor preferentially over capital where it is feasible, such as in road-building or digging canals. But in high-tech manufacturing such as in semiconductor chip fabrication, substitution of labor for capital is not possible. Note that the amount of high-tech manufacturing going on in India is not very large. So relative to the supply to high-skilled labor, the demand is low and therefore the wages for high-skilled labor is low relative to, say, in Taiwan where the demand is high and the wages are high.

Derived Demand – Services

Another source of domestic demand for low-skilled labor is the services sector. Household servants in the cities and towns, for example. There is an apparently unending supply from the rural areas. The wages are really low but still they come to cities like Mumbai. Of course, they somehow have to subsist and therefore you have those mega slums. If demand for low-skilled manual labor were to magically disappear tomorrow, the slums will disappear just as magically without the need for bulldozing them.

Derived Demand – Foreign

In the world of the past, domestic supply and demand were all that mattered. Today’s more integrated global economy allows foreign demand to play in the domestic market. Once again, where possible, the profit maximizing decisions of transnational corporations take into account the substitution of domestic production with off-shore production, and also substitution of capital with low-skilled labor.

Thus Gap, the giant clothing manufacturer and retailer, could produce stuff in the US but the supply of low-skilled labor there is sufficiently low that the wages would be high, and since the job cannot be sufficiently automated, the possibility of substituting capital for labor is limited. Therefore they send the work off-shore and locate their sweatshops in poor countries where the supply of low-skilled labor is so abundant that the price (wage) is really low.

As long as there are things that people in the advanced industrialized countries need which cannot be made using only capital and high-skilled labor, there will be a derived demand for low-skilled labor in the world. And that demand for low-skilled labor together will continue to perpetuate the supply but at a subsistence wage level.

If the demand for low-skilled labor derived from foreign sources (such as Gap and Nike) were to magically disappear overnight, the immediate effect will be a drop in the price of labor. That will contract the supply till the wages once again hover around the subsistence level. At the new equilibrium price, the supply will contract appropriately.

LOSADS! Conclusions

Hence I reach the following conclusions. First, as long as the demand for low-skilled workers continues in this globalized economy, the supply of low-skilled workers in the third world will persist. In other words, the poor will continue to go forth and multiply. Poverty will be a fact of life and cannot be wished away. Children of the poor will be exploited in sweatshops and the monkeys will continue to wring their hands in feigned anguish while simultaneously saving fish from drowning (quite a feat, you must admit.)

It is easy to do the arithmetic to figure out that if the will existed, the poor and the attendant poverty could be a thing of the past. The world produces enough wealth, and the production of wealth continues to grow, that if only a relatively small percentage of it were distributed to the poor, it would be sufficient to eradicate extreme and absolute poverty. The reason it is not done is because with the eradication of poverty, the elastic supply of low-skilled labor would disappear. Why? Because only those who hover around the subsistence wage level display a degree of fecundity that is unmatched by those who are comfortably off. By eliminating poverty, those who are currently comfortably off would be worse off. Shoes currently produced in third world sweatshops would cost a lot more and so will all sorts of low-skilled labor intensive goods.

Second, the supply of low-skilled workers in the advanced industrialized economies will shrink further. I refer you to the “factor price equalization” theorem. Low-skilled labor wages would equalize around the world due to globalization. This low price (another word for wages in our context) would be sufficient to induce continued supply in the poor economies but be insufficient to induce supply in the advanced industrialized economies.

Third, it is rational for the rich to ignore the problem of overpopulation. Overpopulation is a good thing for them because it lowers the cost of low-skilled labor. As long as they need low-skilled labor, and the poor obligingly supply the fruit of their loins to be exploited in sweatshops, everything is hunky-dory. Of course, it makes good copy and sells newspapers whenever someone discovers that children from Bihar and Bengal as young as 9 years old have been sold into bondage and slavery to sweatshops in Delhi.

It gives everyone a great opportunity to feel morally superior and express their shocked outrage and righteous indignation. Celebrated journalists on the left write movingly about the horrible capitalist system; other celebrated journalists on the right write movingly about how overpopulation is just a figment of the fevered imagination of neo-Malthusian morons. The bullshit factories go into overdrive and the world sinks a little deeper into the ocean of stupidity that we have floundered into by not understanding the simple demand supply model.

It is all karma, neh?

Notes:

1. An excellent brief introduction to supply and demand is at ThinkEconomics. Do click the “Next” button on the interactive graph. You will find a little more detail here but you can skip it for now.

2. If you are easily disturbed by reports of very small children suffering inhuman treatment, I recommend that you don’t click on these links. But if you care to know how terrible the situation is, check out these: “Children Tricked into Industrial Slavery”, “Child Sweatshop Threatens Gap’s Ethical Image”, and “Indian Slave Children”.

My (almost) dispassionate analysis above is an attempt by me to maintain my sanity in face of the horrors that I can well imagine when I read those reports. Humanity has little claim to being human as long as injustice, poverty, and needless suffering is tolerated by us all.

  • PJ

    It sounds to me like the solution to your problem here is robots that can do all our manual work for us.

    Then we can all live in a delightful utopia where everyone gets their guaranteed income in the mail and sits on their butt all day.

  • t

    Excellent post.

  • abhilash.shastry

    Atanu said:

    “I am very much in favor of public flogging as punishment because it is equitable and wealth invariant.”

    I am not surprised. Talibans of every flavor think alike!

    “Indeed, if the wages go too much above the subsistence level, the supply is sufficiently wage elastic that the higher wages would induce an increase in the supply so that the price is once again driven down to the subsistence level.”

    Now I am really surprised! Did your study of economics never teach you using your brains beyond coming up with cookie-cutter explanations? Where did you get the idea that supply of labor is “sufficiently wage elastic”?

    Let us revisit your arguments:

    When price increases, supply of goods also takes the upward trend to maximize profit. Fine. Now, goods in this case is labor. So, per your profound analysis, if price of labor increases, people will start having more children so that supply of labor will increase. Really? Open your eyes, dude. Price of labor is high in developed countries. Do you see people producing army of babies in developed countries?

    It is the price of labor that adjusts to supply, not the vice versa. Supply of labor i.e. population depends on lot of factors most important being education, not the price of labor.

    Law of gravity is inviolable. That does not mean you can use it solve some problem of anthropology. It has its jurisdiction. When you use supply and demand to explain overpopulation, you will keep deriving such stupid conclusions.

  • Sameer

    LOSADS: Law of Supply and Demand S?

    What is the last “S” for? Is it like “It’s the economy, stupid!” slogan?

  • Amit

    So why, you may ask, don’t we regularly enjoy the spectacle of public floggings of policymakers given that they frequently willfully disregard the law of supply and demand and legislate prices?

    Didn’t know you hob-nobbed with sharia-lovers. This is the most ridiculous thing I’ve ever read on your blog. Next you’ll be advocating for death-penalty like it is in China.

  • http://chaitanya1.wordpress.com chaitanya

    The price of a good-or-service certainly does act in the way described by Atanu in his four principles of supply-demand in the first paragraph. However, there is a fifth principle which he din’t mention: When the price is altered by the external forces such a government legislation to suit a parcticular public policy goal, the demand & supply of that good-or-service will change in the market place.

    Atanu’s BELIEF or OPINION is that prices should never be mucked with. This is clear from his argument against politicians who try to “legislate prices”. Fair enough. That’s his opinion. But, it does NOT mean supply-demand is a LAW of nature like gravity. It is a policy TOOL. Now, whether or not legislating prices results in good or bad, depends on case by case basis. We may call it a “law” in so far that, when supply and demand alter, the prices will adjust. But, there is certainly no law-of-nature that prices of something should NEVER be legislated.

    I’ve brought up the point because its a favorite ploy by free-market enthusiasts to project supply-demand as a law-of-nature, to justify their policy positions.

    Lets take a simple example. Suppose governments wanted to cut the usage of paper for environmental reasons. They could heavily tax paper, and that would alter the supply & demand of paper in the marketplace. We can argue whether legislation of this kind results in desired goals or if it has any side effects, but there is no god-given-law that price of paper should never be altered for policy goals.

    Now, coming to the issue on hand, which is poverty, and whether governments should legislate wages, i don’t have any comment. Obviously, the issue is discussed so much in policy circles and always much more complex that it appears.

  • http://jihadwatch.org/ Notsure

    I am going to address the 2 ramblings separately.
    Regarding Public Flogging
    I am not for public flogging for taste reason as well as practical reason. If I enjoyed that kind of stuff
    I would have circumcised my self and begged to be accepted as a quraishi and would beg for saudi citizenship.

    The non taste practical position is based on recent observation.
    If you do recall there have been more than one incident recently of police being caught on camera nearly flogging people what do you attribute that to?
    There is a social contract most indians have agreed to wrt the gand pe danda when it comes from the mamas and the taus.

    What i see happening is another outspoken kid
    being whipped and flogged for questioning if Indira gandhi was great rather than a movie actor being showed with a chinkaras horn.

  • http://jihadwatch.org/ Notsure

    Regarding Demand for Cheap Labor?
    there is a demand but at the same time those doing the job dont necessarily pop out babies left and right.
    My parents were poor. But they only had one kid. Being upper caste and a desire to upward mobile may have something to do with it.
    South Korea and Taiwan were both producing low cost items for a while.
    Sneakers were from korea till early 90;s in US and Tshirts were from tiawan till early 80′s
    Japan was known for labor intensive low cost an d low quality goods till mid 60′s
    One of the reason Sony was able to capitalize on early transistors being flaky was cheap labor(nearly all women) sitting and testing them.
    and all these countries didnt pop babies out.
    and all of them transitioned within 15-20 years into something more stable.
    I dont buy that arguement.