Robert JensenOver 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 …
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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.
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)?
“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
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
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.
@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.
@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
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.