John G Bell


Winter '04 - Bohmer, Hahn & Vavrus

Economics Workshop - Take-Home Exam I

1. Explain briefly the following concepts and their relevance

a. The Marx problem

This critique of capitalism is focused on the inequity of power between workers and owners. There is a significant danger for workers that cannot be sure of basic survival when entering into negotiations with owners. This structural disadvantage is amplified when there are significant levels of un- and under-employment. This disadvantage is that there is a ready supply of distressed workers, the reserve army, willing to undercut those workers attempting to negotiate with owners. Also, merely the impression that there might be potentially workers willing to undercut negotiated wage levels contributes to the uncertainty of current workers. The conclusion is that the market forces themselves are insufficient to address this inequity of power.

b. The Keynes problem

This critique of capitalism is focused on a catch-22. If the primary driving force of a capitalist economy is business investment this has to be understood in contrast to the essential uncertainty of future gains. This is points out that business is an essentially speculative. The result of speculation is a recurring boom-bust cycle when speculation accelerates toward riskier and riskier ventures that eventually fail. These failures of speculation can take the entire economy down which makes intervention and bailouts necessary. Unfortunately, when bailout occurs this merely rescues speculation from failure, thus incentivising further excess of high-risk speculation. Thus, proactive intervention in systems of speculation is necessary to avoid recurrence.

c. The relationship between changes in wages and changes in (labor) productivity (in mainstream economics theory and over the last 30 years in the U.S. economy).

There are two important trends in labor wages over the last 30 years that alone are damaging, but in combination are devastating. The first is that average wage for non-supervisory workers, average wage for the lowest tenth of the labor force have gone steadily down while the ratio between the lowest and highest decile wages has increased. This indicates a widening gap in wages. The second feature is the comparison of real wages to productivity level over the last 30 years. The relationship is one where productivity has been steadily increasing with the ration to real wages slightly increasing slightly toward intersection leading up the to '80s. However, from the mid-70's forward real wages decreased and the gap between wages and productivity reaching alarming levels until a slight upturn nearing the period when the Internet stock bubble burst in 2000. This means that after the early '70s, wages reflected a declining approximation of the economies developing wealth.

2. Using Table, 2.3, pp. 35 of Pollin, assess the economic performance of the U.S. economy from 1961-2000. What are Pollin's major claims about the performance of the U.S. economy under Clinton? Does the data in Table 2.3 support Pollin's argument? Explain.

During the period represented by the data in table 2.3, GDP real growth fluctuated, but did not exceed the levels in '61-'68. The non-farm productivity slammed to almost zero in '77-'80 to climb quickly to a 20 year plateau at approximately 50% of the '61-'68 level. Unemployment steadily increased by close to 1% each period until a significant drop of almost 2% in '93-'00. The inflation rate approximates a bell curve during from '61-'00. These numbers do not suggest a spectacular economy during the Clinton administration when compared to the full historical record, but there does appear to be a increase in productivity and GDP matched with lower unemployment and inflation, especially over the last half of the period presented.

Pollin strongly counters the claim that the economic policies of Clinton resulted in economic growth. In fact, he argues that Clinton's policies harmed workers more than anything else, that the apparent economic success during the Clinton administration was due to a stock market boom fueled by spectacular levels of speculation and that what benefits did occur accumulated for the wealthy.

The claim of success for the Clinton administration economic policy does not appear to be supported by the data, thus Pollin's counter argument seems solid. The data does not demonstrate a significant spike in productivity in the final 5 years of the Clinton presidency, which is used by some as further evidence of success for Clinton policy. However, Pollin further counters this by pointing out that this period is significantly impacted by the commercialization of the Internet in '94, which started being reflected a year later. The period of growth appears to have been isolated primarily to the computer industry, specifically the manufacture of computer hardware, and those gains not specific to computer hardware appears to have been due to the rampant speculation in the stock market which demonstrably failed to sustain.

3. According to Janet Yellen and Alan Blinder in their book, The Fabulous Decade, (see Pollin, p.51), two of the most impressive aspects of the U.S. economic performance in the 1990's were the simultaneous decline of inflation and unemployment, and the changes from a federal government in deficit to one in surplus. What is Pollin's explanation of these changes? Explain carefully what happened, and then assess Pollin's analysis and conclusions of the changes. Did the standard of living improve substantially for most people in this period?

The particularly important feature of this period of time was that the lower unemployment levels and lower inflation coincided. This contradicts the prevailing notion of how an inflation-safe unemployment level works. However, the fact that productivity levels increased while real wages fell significantly point to the resolution to this conflict. The assumption in the Non-Accelerating Inflation Rate of Unemployment (NAIRU) is that real wages would track or gradually increase in ratio toward the level of productivity. However, when real wages fall, it is possible for low inflation and low levels of unemployment to coincide.

The resolution of this conflict is an indicator of some important social trends. Labor was unable to either recognize the falling real wage, unable to negotiate for better wages, or both. This is in sharp distinction to the militancy of labor at the beginning of the century and relative strength of labor through the mid-century. Clearly, this means that the standard of living for most people did not increase even during a period of relatively high production. This indicates that the upper percentiles of economic castes significantly accumulated the benefit of the productive economy.

4. Based on your reading of Irwin, explain as clearly as possible what he means by free trade. Present as clearly as possible the case Irwin makes for free trade, beginning with the theory of comparative advantage. In your answer, critique the theory and evidence that Doug Irwin presents in Free Trade Under Fire. Put forward limitations to the theory of free trade and any alternatives that you consider desirable.

What is Free Trade?

Free trade policy as described by Irwin is a domestic and international trade system with only those minimal tariffs or restrictions that can be significantly justified, eschewing government intervention or regulation.

What is the case for Free Trade?

Irwin makes extensive claims about the advantage of free trade.

One of the ways in which trade, of any kind, produces benefits is by allowing individuals or firms to focus their efforts toward specific tasks. This allows skills to achieve maximum utility. Further, continued use of specialized skills increases the value of marginal labor by improving the skill or productive capability itself. By trading with others, firms and individuals are able to reciprocally exchange the product of maximally utilized skills. This division of labor allows for aggregate increases in production, the value of the product itself, and the future maximal utility of labor. Irwin claims that the apparent advantageous division of labor between nations results in higher real income between nations and then further claims that the benefit is greater for nations that engage in free trade when compared to those that do not. Further, this is then used to support the idea that restrictions on trade should be avoided without justification.

Irwin, using an argument from Adam Smith, [Irwin 22, et al.] holds that desirable public good will be requested through market demand. Further, this demand would create an incentive for productive capacity to meet that need. Thus, the claim is made that market forces result in socially beneficial activities in preference to socially unproductive activities. The claim is also made that free trade would result in increased competition both domestically and internationally. This competition is, in Irwin's view, good because it decreases the ability for firms to unilaterally determine prices to consumers and decreases a firms ability to exploit labor when competitive firms are bidding for that same labor. Irwin and Smith both claim that the division of labor from specialization is essential to the question of wealth and productivity. [Irwin 23] This argument is extended by the claim [Irwin 23-24] that productivity "the basis for rising standards of living." This standard of living is an increase in "consumptions beyond that which would be possible" [Irwin 22] otherwise. Another advantage given to free trade is that it increases market reach and allows for greater specialization, thus accelerating the previous claims.

One potential possible critique of the idea that trade is mutually beneficial could be if one country or firm was able to efficiently produce everything. However, the idea of comparative advantage indicates that efficiently producing everything is not comparatively more advantageous to specializing in efficiently producing good that have the higher margin of productive advantage. It is more advantageous to specialize in producing goods against which there is less competition and higher margins than to be self-sufficient. It is the opportunity costs of production that are essential to the calculation of productive advantage, and decisions of what to produce must take into account not only one's own productive efficiency but also the productive efficiency of competition firms. There is one additional important insight to the function of comparative advantage is that competition is not just vertically within a firm's own industry, but also horizontally between the firms in other productive industries. If the comparative advantage of productive firms in other industries is relatively greater then those other firms will likely be more successful at exporting goods. In this equation, free trade is the unfettered ability to specialize in producing goods with the highest marginal advantage and unfettered ability to leverage the broader market reach previously mentioned.

Tariffs and other trade restrictions interfere with the advantages of free trade by restricting freedom of firms to specialize in the most advantageous production, limit the size of a firm's market and advantages of specialization and reduces the variety and availability of goods in local markets. Tariffs protect inefficient firms by inhibiting the incentives to greater production caused by competition and by inhibiting the transfer of technology and technologically advanced capital.


There is circular logic employed in the argument that no limits should be made to trade without justification and this is a justification for no limits to trade. [Irwin 22] Unfortunately, Irwin does not adequately explore what he means by possible justification except by omission to claim there is no such justification.

Voicing an argument from Adam Smith, [Irwin 22] Irwin makes an explicit connection between the freedoms to pursue one's own interests and that "the private interests of individuals could be turned toward productive activities" that concludes does that free pursuit of "self-interest could be channeled toward socially beneficial activities." This does not follow. There is significant anecdotal evidence that socially unproductive activities are exactly the goal and purpose of elite self-interest. If the primary purpose of power is to protect that power, then the efforts of elite self-interest are to protect that self-interest. If the primary privilege of privilege is not having to talk about privilege, then it is the specific self-interest of social and economic elites to avoid addressing socially beneficial efforts that would address social or economic injustice. It is not in the interest of the economic elite to address the market demands expressed b the public except to the extent explicitly required by dissent and resistance and only until the structural memory of that struggle and success fades. Examples of this are clearly present in the way in which the specific social gains (8 hour work day, 40 hour work week, overtime pay, protections for union organizing, etc...) from the militant labor movement have been continuously eroded.

Irwin, [Irwin 23] and by genesis Adam Smith, makes the claim that the market will check the ability for firms to exploit consumers and labor. However, this assumes full access to information and individual mobility. This condition is essentially exploding in significance when the system of consumption and labor are extended beyond borders, physical and political. When workers and consumers do not have access to accurate information they cannot make well considered choices. When workers and consumers have limited mobility, they cannot make effective changes in employment or consumption. The effect of marketing and branding are examples of firms accelerating this trend of dysfunctional relationships with consumers. The effect of inequitable or selectively enforced labor relations law is an example of firms accelerating this trend of dysfunctional relationships with labor.

The equation stating that wealth and productivity depend on division of labor begs the question of whether Irwin’s definitions of wealth and productivity are desirable. The notions of wealth and productivity are claims that the engine of progress is a beneficial process, but these are indistinct and aggregate terms. These terms to not address inequity in the distribution of wealth or the labor required for production. Significantly the elite share more wealth and less labor when compared to the economically, socially or politically disadvantaged. The penchant for Social Darwinism among the elite points out that convenient illusion is more important than actually addressing inequity.

A rise in living standards from increased productivity is an increase in the capacity to consume. This is not, and cannot without question, be linked to a notion of increased quality of life. However, the ability to consume more that is produced with increasingly productive labor can be linked to a loss of quality of life. The loss of family and community connections between individuals has been linked significantly to higher individual stress and dissatisfaction.

Competition is not good. Competition forces less competitive businesses to shutter their doors. This is a loss of both actual capital investment and a loss of personal effort by the owners and employees. Competition results in consolidation because the opportunity to trade "allows more efficient firms to grow." This means that less efficient firms are driven out of business. The inefficiency of a firm is a failure of productivity, however this inefficiency is determined by a myopic notion of the value of productive work. If a firm spends more time with a customer, then this is inefficient unless the customer is able to pay for the labor through higher costs. Unfortunately, this assumes that the customer is always able to afford to subsidize high-touch labor in the fact of aggregate demands on the customer's own labor and money by an otherwise accelerated and high-stress productive economy. There is an inflationary effect to costs when the elite, at the expense of the disadvantaged, accumulates wealth and advantage. Inefficiency is the kind of family, community and personal connection between people that is seriously diminished in the current culture of pervasive capitalism and in this way inefficiency becomes an extra-market value that is sorely missed with the passing of "mom & pop" storefronts ill-equipped to compete against national or transnational competitive forces. Competition between firms destroys community.

Productive efficiency is not good. Market inefficiencies become unaddressed externalities that have to be addressed by government or social oversight. Demand to meet externalities is not sufficient to incentivise producers to include such needs within the market. If it is cheaper for a firm to ignore externalities by either choosing to pay fines or by the minor expense of public relations to address the perception of those externalities, then the comparative advantage for the producer is to not address the externalities. Since these externalities are so difficult to quantify, it's likely that the full impact of the refusal to act inefficiently cannot be measured properly within the market or regulation after the fact. Therefore, proactive restrictions on firms and individuals must be used to avoid, as much as possible, even the first quanta of damage.

Free trade is not good. The benefits touted by Irwin are not necessarily related to free trade and they may also be possible from other systems of trade. For example, the advantage of expanding knowledge of biodiversity techniques in farming of rice [Irwin 36] is not necessarily tied to free market capitalism since that advantageous technology could be shared outside the intense pressure of the profit motive in a way that does not extract value from the exchange from one or the other participant. So much of the evidence presented by Irwin is based on admittedly weak links or difficult to determine relationships. This ambiguity is a double-edged sword that could ultimately be counter indicative of Irwin's conclusions.

The profit motive encourages exploitive pricing, usurious labor relations and speculative investing. The effect of exploitive pricing, usurious labor relations and speculation is accumulation of wealth and consolidation. The effect of competition is consolidation. The outcome of extended consolidation is monopoly and inequitable distribution of wealth. The first advantage of monopoly and inequitable distribution of wealth is being able to weather the boom-bust cycle. The second advantage is the ability to purchase the capital of failing firms at discounted prices. Free trade is not possible when there is inequitable distribution of wealth, power and influence because elite firms can weather or ameliorate the effects of market forces that destroy middling and plebeian firms. Free trade in truth helps elite firms to acquire or destroy competition and control the market.