The Indiana Jones of Economics, Part III

JensenRobert Jensen

Over the last two days, Robert Jensen has described his hunt for the ever-elusive Giffen good. Like all action adventure stories, this one has a happy ending. Jensen then goes on to explain the important implications of his findings for food policy in the developing world.

Raiders of the Lost Arc Elasticity, Part III
By Robert Jensen

What had gone wrong? A simple, human flaw called stupidity (mine).

I had coded our price change variable in the wrong direction (a price reduction was coded as a price increase — a negative price decline). So the data was in fact telling us the exact opposite of what we thought — we had indeed found a positive arc price elasticity of demand. The Giffen good.

In fact, we sort of found two Giffen goods. The evidence that rice was a Giffen good in Hunan was very strong; the evidence for wheat in Gansu was a bit weaker. But it turns out that our experimental design in Gansu had a flaw (we subsidized wheat flour, whereas many people purchased prepared wheat foods like noodles, so our subsidy didn’t affect them). And many of our Gansu households didn’t fit the Giffen conditions well; when we focused on households that did, the evidence of Giffen behavior was stronger.

In the end, it’s funny that people have looked in crazy places for Giffen behavior (fermented whale bile, anyone?), and it turns out it could be found in the most widely consumed food in the most populous nation in the history of humanity — rice in China. But, it turned up exactly where theory predicted it would. And the Giffen conditions (poor households with simple diets) are widespread in developing countries.

We’re sure more cases could be found, now that it’s clearer where and how to look for them.

The Giffen effect is an important part of economic thought, history, and pedagogy. And along the way, we had produced some new theoretical predictions about consumption behavior that the data supported — so that was good for the economics side of things.

But it turns out the Giffen story also has some important, real-world implications for public policy that matter much more.

Many low-income countries use consumer price subsidies or price controls to improve or protect the nutrition of the poor. For example, both India and Egypt spend about 1 percent of their G.D.P. subsidizing basic foods such as rice and wheat, making them among the largest forms of social assistance for the poor in both countries.

But critics often attack such policies on several fronts. The biggest concern is that they distort market signals, i.e., how price reflects scarcity. For example, high oil prices tell us that demand is high relative to supply. If we subsidize the price of oil, we’re getting rid of the market signal that tells us to conserve or discover new ways to use less oil, as well as the incentives to use or develop new alternative fuel sources or technologies.

Price subsidies are also criticized because they often lead to shortages, smuggling, and black market activity — or in practice, disproportionately benefit the poor the least.

But subsidies enjoy significant political and popular support because it is believed they at least protect the nutrition of the poor. This is especially the case when comparing subsidies to other forms of welfare, like cash payments, since people worry that the poor may spend the cash on things other than food, or at least may not use the money in a way that improves their nutrition.

But when we subsidized the price of rice and wheat, people consumed less of them, not more.

And in a follow-up paper, we show that when you take together all the consumption substitutions people make, our large subsidies did not improve nutrition at all.

In fact, in Hunan nutrition actually declined in response to the subsidy. In Gansu, the effect on nutrition was essentially zero. And our sample included only the very poorest households, malnourished by international standards and earning much less than a dollar per person per day — i.e. the exact group whose nutrition subsidies are intended to improve.

Of course, households that got the subsidies were still better off, because we increased their purchasing power. But at the end of the day, you can’t dictate what people eat, and they can act in ways that make them happier but may reduce or even reverse the intended consequences of government policy like subsidies (or price controls, or rations, or in fact anything else designed to improve nutrition).

Now, we’re absolutely, definitely not saying that we should therefore do nothing to help the poor. Quite the opposite. And that’s especially the case in light of recent, dramatic increases in world food prices — which have been much larger than the price changes we analyzed and which have affected a wide range of foods, not just a single food like we studied.

In fact, it would be immoral to do nothing to alleviate the suffering of the poor.

But while there may be some reasons to prefer subsidies as a form of welfare, it’s time to abandon the long-standing presumption that they are the best policy because they improve nutrition.

So, hidden inside this old economics mystery, the real prize was an observation relevant to real world policy issues. We just hope it doesn’t end up in a crate, hidden away in some warehouse like the Lost Ark …


Joe

Justin James:

A short explanation: what they mean when they say "A Giffen good is one where an increase in price causes an increase in consumption" has nothing to do with a time component, as in turning a cucumber into a pickle. What it has to do with is the slope of the demand curve. Usually, the slope of a demand curve is negative: as Price increases, Quantity decreases. The line goes down. If you go backwards on that line (which you can do, since it's just a line on a graph), the reverse is obviously true (as P decreases, Q increases). With Giffen goods, the line has positive slope (at least for part of it): as P increases, Q increases. Again, the reverse is true.

Maybe it would be easier for you if you ignored the time component and instead considered the two different groups: one with high rice prices, one with low. If the families were put into the two groups randomly (as they were in this study), and then you see that the group with higher prices consumed more rice, then you've found a Giffen good. That's what they found.

The problem was not with their explanation but with your lack of understanding. Go read any introductory economics textbook and maybe that'll help. Or just read the freaking wikipedia entry for supply and demand.

Read more...

Joel

Justin,
You rightly pointed out in your previous post that they simply "changed the opportunity cost"...but that's really the only thing that matters in Economics anyway, so it is effectively EQUIVALENT to changing the explicit market price.

In other words, a $5 bag costs me the same as an $8 bag of rice when someone gives me a $3 voucher. In MY market for rice, therefore, the two are equivalent.

The voucher recipients, therefore, were dealing in a rice market where the price of rice was the market price minus the voucher value. Once the voucher was removed, they were dealing in a market where the price had risen to the normal market price.

When the price rose for them (it doesn't matter if it rose or fell for anyone else) they consumed more.

Giffen good. End of story.

Justin James

@16 (Joe)

Joe -

Please point out to me where I am mistaken. All you can say is, "you're wrong, stick to something you know" (to paraphrase), and comment that I spelled it wrong (I forgot to double check that).

And yes, the direction of a price change is extraordinarily important. It falls under the same principle of, "I can make a cucumber into a pickle, but I can't make a pickle into a cucumber". In this case, demonstrating the opposite of something does not prove something. I may not be a economist, but I understand formal logic, scientific method, and mathematics fairly well.

So either one of two things has happened here. Either they have not properly explained a "Giffen Good" (to the point that it is clear enough that it can go both ways, and that showing an opposite [lowered cost resulting in reduced demand] is indentical), or they have a bogus study.

So now, please show me where I am mistaken. I am glad to be open minded about this, but telling that I am wrong without any reasoning behind it, other than sniping at the periphery, is really not going to help me learn here, nor support your case or the researchers.

J.Ja

Read more...

1-2

I am sure it would be a far more difficult study--as what i am about to propose is not a fungible good--but has anyone done a study on the price/demand relationship in higher education??

Justin James

"By subsidising rice you were increasing the incomes of these individuals in China, as they can now use the subsidies to purchase the rice and transfer the cash they save from the subsidies to purchase other food stuffs."

Precisely my thoughts as well. This study is hardly conclusive. Did the participants use the money they saved to buy meat (a major status symbol in China)? Did they use it to pay down debt, or maybe save up for something else? Just because we know that they are malnourished does not mean that they would necessarily buy more rice if they could. I've spent literally years of my life subsiding on coffee, water, and 2 hot dogs per day, even when I had money. Do it long enough and you get used to it, and it does not occur to you to buy more food when you have the money to do so.

J.Ja

Joe

Wow, Justin James. Wow. You really don't know what you're talking about.

You say that a "non-economist" such as yourself shouldn't be able to find obviously flaws in the study in less than a minute worth of thought. Well, sorry to break it to you, but you haven't. Maybe you should consider the fact that you're a non-economist, and that you've given it less than a minute worth of thought, before you start criticizing it, because you obviously don't understand the concepts. (I won't even go in to your obvious lack of understanding of opportunity cost, or the fact that you misspelled "Giffen" even though you spelled it correctly earlier in your post).

I'm not saying this study is perfect; I'm sure there is further research to be done. But the direction of the price change for the experiment really isn't important. If a price decrease causes less usage, that's essentially the same as the reverse. It doesn't really matter which one came first in time; they're just trying to figure out the shape of the demand curve. And if a group with a lower price level than a control group consumes less, then that's a Giffen good.

Maybe you should take an economics class and/or think about things for longer than a minute before you speak up.

Read more...

Matthew R.

The most obvious questions can be the most troublesome. I pose this one: Do we want people to be poor?

If we don't want people to be poor, then why do we subsidize poverty (e.g., food stamps)? If we don't want them to be poor, shouldn't we rather subsidize venues that get people out of poverty (e.g., job creation, education)?

Justin James

@13 (Travis) - From what they have desacribed to be a "Giffen Good", they have NOT found it. specifically, rice consumption did NOT go up when the price was raised. Rice consumption simply went down when the price was lowered. In fact, the price wasn't even lowered, the *opportunity cost* for rice was lowered. So no, they have not found a "Giffin Good", they have simply produced a different effect which *appear* to be the opposite of a "Giffin Good"; but the "Giffin Good" is not described as a two-way phenomenon, just a one-way item. In fact, any rise in rice consumption after the removal of ther vouchers is not a "Giffin Good" either, unless the rice consumptions rises to be above its pre-voucher level; unless that happens, it is just returning to its normal state.

Shame on Jensen for passing this off as quality research, and shame on Freakonomics for not giving this proper scrutiny, and shame on the people who funded this study without proper scrutiny. This is happening all too often. A non-economist such as myself should not be able to find the obvious flaws in multiple-year studies in less than a minute worth of thought.

J.Ja

Read more...

bill

It's interesting what happens with food stamps. In general, people do use them for food. But the effect is often that that frees up their other cash sources to buy non-food items. So, it may not improve their nutrition, but they do effectively get more money to spend.

On the dark side, food stamps also create a gray market. People will trade food stamps for a smaller amount of cash. Both parties profit in the sense that the food stamp seller gets cash to spend anywhere, while the food stamp buyer gets food at a discount. But that also means the food stamp recipient has less money to spend on food. A counter-intuitive, but logical effect.

Travis

@11 and all who think this isn't conclusive.

While this may not be exactly conclusive, it stands that they did find a giffen good. When the price of rice was more expensive, more rice was purchased and when it was cheaper less rice was purchased.

The argument that food subsidies are bad because they do not improve nutrition is definitely arguable, because it relies on value judgments. Namely, how important is nutrition of the poor when compared to other things they could spend their money on.

@1 This doesn't conflict with the gas tax for 2 reasons. Gas isn't a giffen good, and gas is currently subsidized to keep the cost low for people. Simply removing the gas subsidies would be interesting as it would give people a realistic view of the price of gas, and it would really really encourage innovation. And ultimately removing a subsidy is very similar to adding a tax.

Simon

By subsidising rice you were increasing the incomes of these individuals in China, as they can now use the subsidies to purchase the rice and transfer the cash they save from the subsidies to purchase other food stuffs.

Just because you found that by subsidising rice (ie reducing the price of rice) the demand for rice fell, this does not mean that a price increase in rice will induce increased demand.

Is this not more of a case of rice being an inferior good, with incomes rising and relative prices of rice falling they found themseleves able to purchase new goods that were substitutes for rice?

cg

I'm a bit confused by the conclusions. The way this concept of a giffen good had been presented was to say that when the price of rice increased, that people bought more rice and less of other, still more expensive foods.

In saying that nutrition stayed the same or declined in response to a subsidy, the author seems to conclude that then subsidies are a bad idea. It seems possible that these poor households, when suddenly faced with the prospect of greater buying power, rebudgeted their funds - and used their money on something other than food, something also important to them.

It seems that giving poor people the ability to spend less money on food would allow them to improve their lives in some way. I'm not convinced that it matters that they don't use the funds for food.

Could the people in the study have looked at the money that they saved when buying subsidized rice as found money and used it to splurge on something? It seems that there might be a psychological component to the response of suddenly perceiving a savings on something, as opposed to entering an unfamiliar market, and finding that the relative prices of things were different.

Just a few thoughts.

Read more...

Alexandre

I'd like to see the research data. I am still wondering if rice prices were really affected with these vouchers, that is, did they really work as subsidies?

Because these vouchers might have been traded, say, at a discount rate, in exchange for other goods or money (a "vouchers market").

So, what we might have observed was an increase in the purchase power of those who received the vouchers for free. Since it's an inferior good, rice consumption declined with the rise in income for those households.

Bill Harshaw

Not an economist and Giffen goods are counter-intuitive and very confusing, but I am interested in agricultural programs. So--what do these results say about food stamps in the U.S.? Are they causing poor nutrition?

Simon Mc G

By subsidising rice you are as mentioned increasing the individuals incomes. This means that you are now not considering a negative relationship between the price of rice and the demand for rice (price elasticity of demand) but a negative relationship between income and the demand for rice (income elasticity of demand). Which does not imply a giffen good.

Consider the following:
"I am poor and live only off hamburgers, if I become rich and my income increases a lot I will substitute my consumption of hamburgers for steak or some other meat that is a more luxurious substitute for hamburgers"

This is exactly what the Chinese are doing, substituting an inferior good (rice) for a normal good.

I don't believe Robert Jensen will "be immortalized by a paragraph in every introductory economics textbook" just yet.

Good work though

jonathan

BTW, the end of this post stands in stark contrast to the arguments offered elsewhere by this blog about the gas tax. This poster speaks of morality though the effect is small and the other poster speaks of objective price changes.

Given the role of rice in the culture of Hunan, did you control for consumption being related to status? In other words, the Hermes bag issue. Did the ability to consume rice as prices rose confer status? A sense of social belonging? Was rice consumption viewed in those areas as a requirement of being part of that society in that place? I emphasize place because people in Shanghai, more connected to global culture, might be less rooted in cultural traditions.

jooboy

so the price of rice increases, and nothing else does? i would think that prices of other foodstuffs would increase if rice prices increase.

Doug (again)

Good work. Still, I refuse to give up my giffen nominee - college tuition.

http://www.nytimes.com/2006/12/12/education/12tuition.html

Doug

Congratulations. You will now be immortalized by a paragraph in every introductory economics textbook.

Tam Chee Hong

But wouldn't there be a maximum price before the people switch to cheaper alternatives to get their nutrition?

During WW2, when rice is scarce and expensive, the Chinese and neighboring countries ate substitutes like sweet potatoes and tapioca.

Does rice still qualifies as giffen goods when, after a certain price (Assuming the price is when the poor spend all their money on rice, no meat, and still would not get the required nutrients), it will start to resemble normal price and demand curve?