Atanu Dey On India's Development

The AN-WWTSD-MFGTT

Why is the US so Cheap? – Part 2

This is a response to the comments on the last post “Why is the US so Cheap?” I had argued that the US is more efficient in producing stuff compared to India. The people in the US are more productive because they don’t face as many hurdles – they have bigger and better machines, they use more energy, they have more economic freedom, and so on.

Economic freedom is a matter of policy. Policy is made by people who are entrusted to do so. Determining who the policymakers are in an economy is part of the political process. The political system evolved as a historical process from a set of initial conditions which are to a large extent a random draw. Smart people figured out the set of rules that the economy would play under. It is my belief that differences in the performances of economies arise from the differing set of rules that economies adopt. One set of rules may allow greater economic freedom to the people relative to the government; another set may allow the government control over most of what an individual is allowed to do. I believe that the US is successful (to the extent that it is) primarily because it got the rules worked out better (not perfectly, though) than the others.

Now on to the comments. Amit’s comments are interesting. He writes:

I’m no fan of socialism and agree with the ills you pointed out, but I’m puzzled as to why economists like you prefer to tout the “free market” while blithely ignoring its negatives and costs to the public. US is, at best a mixed economy (and not a pure free market economy – and thanks for that), though there’s much more entrepreneurial freedom than other countries.

Basic courtesy aside, it is prudent to read what is actually written in a post rather than reading things into it based on one’s prejudices and biases. It is not very productive to construct a straw man and then proceed to knock it down with gusto.

I did not claim that the US is a “free market.” If one goes around with a chip on one’s shoulder about those horrid free-marketeers, one may be seeing things that are not actually there.

Saying that the US is a mixed economy is accurate, of course, because every economy is. Every economy – even the most determinedly socialist – has to have markets at some level. After all, economies have people. And trade and barter is intrinsic to humans. Therefore markets. What is important is how far along the continuum, from total control to totally free markets, is an economy actually situated. It is important to ask in what activities does the market dominate, and what other activities non-market allocation is mandated. Only the simple-minded imagine that it is a dichotomous choice.

Markets Work — Often

Even the most basic of economic reasoning is sufficient to persuade one that (1) markets are extraordinarily good at allocating resources most efficiently; (2) there are well-recognized conditions under which markets don’t grind out the socially optimal solutions; (3) there are well-known mechanisms for correcting for market failures.

So you look at any decently functioning economy, you are guaranteed to find that it is market oriented for most tasks, but in some tasks the markets are lightly regulated, in some heavily regulated, and in some others markets are disallowed. Economists are neither ignorant of market failures, nor are they ignorant of the causes and circumstances under which markets fail, and certainly not ignorant of what needs to be done to correct for market failures.

What are markets, why do they work and when, whey do they fail, and how failures are corrected for is not arcane esoteric voodoo insider secrets. Anyone with a bit of patience and basic reasoning skills can sit down with an introductory economics textbook and understand what is what. It is a failure of our educational system that economic literacy is so abysmal that the average college graduate cannot reason economically (in all senses of the term.)

Subsidies

To take an example from the comments, consider the question of subsidies that the US provides to agriculture. That issue was raised in the comment for some reason that I could not fathom. My post was about the high productivity (and high production) of the US, and the claim I made was that economic freedom was somehow to account for this. The fact that the US provides agricultural subsidies is true but cannot be cited as a point against the argument that the US is extremely productive. Indeed, that the US can provide such enormous subsidies to agriculture is because it produces so much stuff.

The point is that you have to tax Peter to be able to subsidize Paul. Therefore the fact that the US can subsidize this that or the other to the tune of hundreds of billions of dollars just means that the US economy is productive enough.

(OK, there is the matter of the US having a huge trade deficit and that the Chinese are bankrolling the current US consumption, and that the US is the biggest borrow in the known universe. But the general thrust of the argument does not change.)

Here’s the low down on subsidies in a nutshell. Consider an economy with only two activities: agriculture and manufacturing. Early in its development sequence, most of the economy is agricultural. For some reason, they want to promote manufacturing. So they tax agriculture (that is take a part of the production of agriculture) and give it to the manufacturing sector. Manufacturing is thus subsidized. Later on in the story, it so happens that manufacturing becomes fabulously productive and produces lots of stuff. Now, what you do is take some of the production of manufacturing and give it to agriculture. Of course, you don’t literally take cars and computers and give it to farmers. What you do is from the general revenues of the government, you give money to the farming sector. The general revenues of the government is a function of what the economy produces. Great deal of production, great deal of general revenues.

While I am at it, I should mention that this is a basic lesson in development economics. At the early stages, since agriculture is the primary sector of an economy, it is also the only source of surplus. Initially, you can – and indeed you have to – take from agriculture to give a boost to other sectors. If there is no agricultural surplus, you cannot develop other bits of the economy (barring of course manna from heaven, massive amounts of foreign aid, etc.) Later, if manufacturing becomes very productive, you can take part of that surplus to help agriculture.

Promote Manufacturing to Help Agriculture

The farmers are in dire straits in India partly because Indian manufacturing is not the most productive and does not produce sufficient surplus. In other words, if economic policies help the manufacturing sector in India, it would produce the surplus you need to help the farmers. The simple way of stating it is this: when manufacturing becomes very efficient, it produces a lot of stuff at low cost. Low cost manufactures translates into low prices for manufactures. The terms of trade between agriculture and manufacturing improves. That is, farmers can buy more stuff in exchange for the food they produce. That is, consumers of agricultural stuff will be able to pay more to the producers of agricultural stuff.

It is sort of counter-intuitive to say that by removing hurdles from the manufacturing sector, you will help the agricultural sector. But I have a heuristic device, a simple rule of thumb to decide if something is likely to be true. I just ask myself, “What would the socialists do?” (WWTSD). I then just negate the answer to that question and I have a fairly good shot at making a policy recommendation that is correct. Try it out yourself sometimes. I call it the Amazing Negated WWTSD Mechanism for Guessing the Truth. AN-WWTSD-MFGTT.

Moving on, there is a very telling comment by bawaraa. He says that the US is not cheap in everything relative to India. He says drivers and masseurs, for instance, are cheaper in India. Thanks much. That is so juicy a topic that I will have to leave it for the next post.

But remember that you heard about the AN-WWTSD-MFGTT here first. Tell your friends about it.

  • Vaidehi

    Atanu ,
    You write with such clarity which of course presupposes clarity of thought. Thank God, I discovered your blog !

  • Krishnan

    Part of the efficiency at producing stuff arises from the willingness to relocate parts of the manufacturing process to wherever it is most efficient (China for engineering goods, India for software) . This is one of the most impressive aspects of the US economy, production efficiency and producing cheaper goods for the consumer overrides all other interests.

    One can be inefficient in areas where there is no competition. The US has done well here too. A lot of things they make themselves (planes, software, even arms) cannot be produced by other countries because they do not have the technology.

    Much of our lack of progress can be traced to being inefficient when there WAS competition. India just kept out the competition by other means. The process of liberalization that has started from 1991 is really a process of competitioni-zation.But there are large swaths of the economy still reeling from the lack of competition and this is why our economic progress is not as fast as it could be

  • http://www.cfdvs.iitb.ac.in/~amv BytePro

    I suppose the responses to the parent post reaffirm the truth of what John McCarthy, and many others say: ignore arithmetic at your own peril! Maybe, we just need to worry much more about basic education in our country – the three Rs :) .

    Amen!