Kwak starts by discussing a paper that asked questions about various actions to see if people thought it was fair or unfair, reaching a broad conclusion that “The cardinal rule of fairness is surely that one person should not achieve a gain by simply imposing an equivalent loss on another.” I wholeheartedly agree; that seems like a great, succinct summary of the concept of fairness as it relates to economic transactions. This is why actions like fraud and torture are illegal; they are simply one person's gain at the expense of someone else's loss. This is why at the heart of capitalism lies the concept of consent of the individual.
However, Kwak then relates this broad concept to his current class.
"Today in class, the professor posed the first question from the paper:
A hardware store has been selling snow shovels for $15. The morning after a large snowstorm, the store raises the price to $20.”
In 1986, 82 percent of respondents thought this was unfair. In class, it was about 50-50.
As the professor said, this is probably because there are a lot of business school students in this class. Business school students are classic Econ 101 robots. They know enough to know that if there is a demand shift, not only is it OK to raise prices, but you should raise prices in order to clear the market. In this case, supply is fixed in the short term, so raising the price won’t increase supply; the Econ 101 argument is that raising the price allocates the shovels to people who will derive more utility from them (because they will pay more), thereby increasing social welfare.
This writing is rich in irony and confused reasoning. As business school students may be classic Econ 101 robots, so too are law school students classic law professor stenographers. If the professor said it, it must be true!
More substantively, we're talking about snow shovels here. That cost $20. Simply buying a replacement blade for the Snow Wovel costs $19.85, and that's based upon shipping to an area that is not encumbered by a snow storm. Moreover, the fact that someone would even need a snow shovel implies two very important things. First, they own property that needs care (a house with a sidewalk, a driveway for a car, etc). How many renters are expected to shovel snow? How many poor people have cars? Second, they don't currently have a snow shovel; in other words, they're being negligent in maintaining their property and free-riding off of others to bail them out when they want help. That's like complaining that the gas company shuts off your gas after not paying your bills for six months.
In addition, there's a lot of 'shoulds' in here. Notice, the question doesn't ask what students would do if they were the business owner. Rather, the question is if it's unfair for the business to raise prices. Finally, one point worth mentioning here is that this is all based upon insufficient information. It's speculation; one cannot conclude what people are thinking, or why, from the given information.
Kwak continues
But this rests on a huge assumption: that willingness to pay is the same as utility. Unfortunately, however, this assumption fails in the real world; poor people simply can’t pay as much for snow shovels as rich people, and as a result a price increase will allocate shovels to rich people, not to those who need them the most.* But people who believe Econ 101 only remember the demand and supply curves they saw on the first day of class, so they think firms should raise prices.
Note the bait and switch here, how Kwak almost subconsciously transitions from concerns about people who have to pay the higher price for the shovel to concerns about people who won't get a shovel. The people paying $20 for the shovel after a snowstorm are deriving greater utility from it, otherwise they wouldn't pay the extra $5. Now, for those who can't afford the $20, the question remains, why didn't they buy a shovel at $15? Are they too poor to afford even a $15 shovel? At that rate, we're talking about people too poor to worry about things like driveways and sidewalks. That kind of property is owned by rich people. Kwak would need to demonstrate some data that suggests that the marginal increase in the price of the shovel impacts the distribution of shovel consumption with respect to income. This is not academic, by the way. For example, one substitute good for buying a shovel is hiring somebody else to shovel your driveway. Guess who is more likely to do that? Richer folks! Another substitute good is calling in to work to take a day off. Guess who has more paid leave time? Richer folks! Another substitute good is bringing in shovels from someplace else. Guess what's going to attract other sellers to brave the snow and distance? Higher prices! Another substitute good is borrowing/renting a shovel from a neighbor. Guess who's more likely to live in an area where there are other property owners who would have shovels to share/loan? Richer folks! The point of all this is that higher prices might lead to more shovels being bought by poorer folks, not less; we would need actual data to determine that. The conceptual framework alone offers no guidance. That price increase can just as easily signal to richer folks that they should choose some other method at their disposal of clearing their property of snow as it can signal to poorer folks that they can't get a shovel because they can't afford the extra $5.
Also, this sentiment languishes in the same insufficient information purgatory. Since Kwak does not claim to speak for people who 'believe' Econ 101, he would need to present some actual evidence about what those people believe. He would also need evidence that law students at Yale are representative of the general population in the ways material to the original paper. Perhaps the problem isn't business at all; maybe it's our elite universities that create concepts of fairness alien to average Americans.
While the above academic fun is fun, the real meat lies ahead:
I suspect that belief in Econ 101 is not only stronger among business school students (and the businessmen they become) than among ordinary people, but is also stronger today than it was in 1986. The free market ideology teaches not only that businesses can maximize profits by any legal means, but that they have a moral imperative to maximize profits by any legal means, including generating profits by imposing equivalent losses on their counterparties. (Essentially all proprietary trading fulfills this condition.) And three decades of this ideology have probably changed people’s responses to these types of questions.
More fundamentally, the 1986 paper shows that Econ 101 is diametrically opposed to human beings’ intuitive sense of fairness. Yet public policy largely follows the dictates of Econ 101. Is that a good thing?
Notice the leap from 'Econ 101' to 'free market ideology'? That claim calls for a modicum of warrants, shall we say. And then we're back to this business of generating profits by imposing losses on counterparties. That may be what the laissez-faire 'free market ideology' types think, and perhaps Kwak shows his subtle cultural biases by assuming that's what everybody thinks. And maybe I just had great professors. I mean, I'd take Wash U over Yale any day (which is why you should recognize both of our biases in the odd event we played a basketball game or something). While I have great disdain for certain parts of the business community and great appreciation for certain parts of the legal community, I think overall there are probably too many lawyers and too few people who really understand business in our society. In fact, you could go so far as to argue that Kwak has the cause and effect reversed. Maybe the problem isn't that business education creates market fundamentalism, but rather, that those inclined toward the free market ideology are about the only folks who think business education is valuable? Maybe if we had more architects and painters and philosophers and social service agency staffers and gay rights activists and whoever-whatsie else's studying the basic concepts of business, both the economy and society would benefit?
Regardless of where you align on that particular mode of thought, consider the core inaccuracy of Kwak's assertion. The store selling the shovel for $20 isn't imposing a loss on the buyer. That's a stupid argument; I don't know how to put it more kindly. If the shovel wasn't worth $20, the buyer wouldn't buy it. In fact, refusing patronage to a store is precisely how one demonstrates that the legal actions of the store's proprietors are unfair.
I would also point out the misguided nature of his last statement. Our public policy isn't dominated by Econ 101. It largely ignores it. That's why we're in such the crapper at the moment, so to speak. Remember my comment about things like fraud and torture? Imagine if we actually prosecuted stuff like that which has been undermining both our economy and our democracy.
Kwak's footnote sums it up
* I’m not saying that there is a perfect way to allocate the shovels, just that using price isn’t perfect, and does have inequality effects
In other words, there is no perfect way to allocate scarce resources. Everything has inequality and inefficiency effects. The pricing mechanism in capitalism is just the best system we've got until we come up with something better. I highly encourage everyone to investigate Econ 101 and see what you think for yourself. I enjoyed my own professors, like Jackson Nickerson, who taught my Management 100 class, William Emmons, who taught my Microeconomics class, Dottie Petersen, who taught my global macroeconomics class, Russ Roberts, who taught my class on business and public policy, and Robert Pollak, who taught my course on business and the environment. These are only a handful of professors, of course, but I highlight them because they were teaching the fundamentals, the 'Econ 101' stuff that Kwak apparently thinks is destroying our culture. My beef isn't with the economic textbook written by Gregory Mankiw, George Bush's economic advisor; it was a great textbook. My beef is with the public policies our government enacts that ignore basic economics. I'm not worried about changes in public attitudes toward 'free markets'; my concern is when our public policies ignore the broad will of the people.
I can't wait until Kwak posts a piece about how personal finance education and financial literacy caused the DJIA/NASDAQ and housing bubbles!
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