Opportunity Costs and South Korea’s Nuclearization

South Korea’s launch of its Indo-Pacific strategy in December 2022 started the country’s ascent into “strategic clarity” for the US-led Indo-Pacific construct, winning favor with Washington for this policy shift. However, in January 2023, President Yoon Suk-yeol voiced the possibility of either building nuclear weapons indigenously or redeploying US tactical nuclear weapons in the face of an ever-growing nuclear threat from the Democratic People’s Republic of Korea (DPRK or North Korea). This reoriented the debate on South Korea’s own nuclear ambitions

https://www.38north.org/2023/10/south-korea-as-a-nuclear-state-trade-offs-and-choices/

Thus begins a piece authored by Jagannath Panda over at 38North. If you’re wondering about the name of the blog, click here.

So, should South Korea nuclearize or not?


Opportunity costs are everywhere, and this question is a way for us to understand how to apply principles of economics to a tragically important question:

  1. South Koreans are increasingly distrustful of the US commitment to South Korea’s security. The government in South Korea has reaffirmed Seoul’s commitment to the NPT, but about seventy percent of South Koreans approve of the country going nuclear. There is certainly a political incentive to keep the issue alive.
  2. Having North Korea (and then China) as neighbors is an excellent argument for going nuclear is what many South Koreans will tell you. You may or may not agree with them, but you do see where they’re coming from.
  3. It could make, proponents argue, North Koreans less militarily adventurous.
  4. Look at India, they might say. They have Pakistan and China as neighbors, and they went nuclear. Didn’t hurt them too much, now did it?
    • I mean sure, the US imposed sanctions, and cut off all assistance except humanitarian aid.
    • But especially after 9/11, they had no choice but to walk those back, right?
    • Russia and France didn’t say much back then, and got back to BFF status pretty quickly
  5. Well, maybe so. But I wouldn’t be so sure about the “didn’t hurt them too much” bit!
    • Some would say geopolitical uncertainty in the region went up, not down, after the nuclear tests
    • Pakistan went nuclear too – and they almost had to, in a way. Did that make things better, or worse?
    • The Kashmir issue gained prominence on the international stage, and India didn’t exactly want that, now did it?
  6. South Korea can launch a charm offensive in case they do go nuclear, and apart from its overt dependence on China when it comes to trade, things should be ok.
  7. Plus, of course South Korea will adopt a no-first-use doctrine.
  8. But think about this:
    • Is South Korea better off with the threat to go nuclear, or with actually going nuclear?
      • Will the USA be more or less incentivized to provide security to South Korea?
      • Will going nuclear stop or accelerate North Korea’s nuclear program?
      • Will going nuclear increase or decrease military activity at the border?
      • Will this increase or reduce the chances of an arms race in the region (and not just North or South Korea, but all countries in that region)?

The answer to the question, it turns out, is not a simple one. Your ability to answer this question depends on how you frame your analysis:

  1. Who are the impacted parties (directly and indirectly)?
  2. Who are the impacted parties (immediately and eventually)?
  3. What are the first order impacts on all of these parties?
  4. What are the second order impacts on all of these parties?
  5. Are you analyzing the short term, medium term or long term impacts?
  6. Which of these impacts are you giving greater weightage to? Why?

And bear in mind, of course, that this is a good list to keep in mind when you’re analyzing opportunity costs in general, not just in the case of opining about whether South Korea should go nuclear!

South Korea’s Demographics

The “picture” you see here is based off the picture in Ross Douthat’s column. I asked Dall-E to create this one, of course.

Without clicking on the link, can you guess what his column is about?

For some time now, South Korea has been a striking case study in the depopulation problem that hangs over the developed world. Almost all rich countries have seen their birthrates settle below replacement level, but usually that means somewhere in the neighborhood of 1.5 children per woman. For instance, in 2021 the United States stood at 1.7, France at 1.8, Italy at 1.3 and Canada at 1.4.

But South Korea is distinctive in that it slipped into below-replacement territory in the 1980s but lately has been falling even more — dropping below one child per woman in 2018 to 0.8 after the pandemic and now, in provisional data for the second and third quarters of 2023, to just 0.7 births per woman.

It’s worth unpacking what that means. A country that sustained a birthrate at that level would have, for every 200 people in one generation, 70 people in the next one, a depopulation exceeding what the Black Death delivered to Europe in the 14th century. Run the experiment through a second generational turnover, and your original 200-person population falls below 25. Run it again, and you’re nearing the kind of population crash caused by the fictional superflu in Stephen King’s “The Stand.”

https://www.nytimes.com/2023/12/02/opinion/south-korea-birth-dearth.html

Get used to worrying about not enough people, because that’s what the study of demographics will (has already?) come to mean in the 21st century. It’s not just South Korea, of course – Germany, Italy and Japan are also staring at the same problem, and that list is very far from being complete.

And what problem is that?

Not Enough People.

And as an Indian, sure you can ask how this can possibly be a problem. Here’s how:

There will be a choice between accepting steep economic decline as the age pyramid rapidly inverts and trying to welcome immigrants on a scale far beyond the numbers that are already destabilizing Western Europe. There will be inevitable abandonment of the elderly, vast ghost towns and ruined high rises and emigration by young people who see no future as custodians of a retirement community. And at some point there will quite possibly be an invasion from North Korea (current fertility rate: 1.8), if its southern neighbor struggles to keep a capable army in the field.

https://www.nytimes.com/2023/12/02/opinion/south-korea-birth-dearth.html

I’m actually slightly uncomfortable with the assertions in this paragraph (note the repeated use of the phrase “there will be”). Not because I disagree with them, but because we simply do not know how this will pan out. Maybe the immigration story will play out better than expected, and maybe (as Ross Douthat himself says elsewhere in the column, the tide will turn in pleasant and unexpected ways). Maybe, if you want to be all weirdly sci-fi about it, the South Korean government will produce babies in artificial wombs.

Too weird, and can’t possibly happen, you say? I present to you the last fourteen years or so.


But what really gave me pause was thinking about how Ross Douthat ends his column. What, he asks, are the underlying sociological causes of and responses to this rapid fall in birthrates?

  1. Traditional social mores in South Korea, including very low out of wedlock births
  2. A feminist revolt against conservative social expectations
  3. A consequential male anti-feminist reaction
  4. Sharp polarization between the sexes
  5. A sharp reshaping of the country’s politics, and a sharp decline in marriage rates

If you are a student of economics, but only faintly interested in demographics and sociology, you’re doing it wrong, I promise you.

We live in interesting times!

ChatGPT and Irwin Collier’s Latest Blog Post

The post is Abba Lerner’s final examination at Johns Hopkins University in 1958. The subject is welfare economics. I hope this doesn’t create legal problems of any sorts, but I’m reproducing below the full paper:

Answer four questions, in separate blue books, in ink.

  1. Discuss the meaning, the validity and the significance of the proposition that it is impossible to derive a social welfare function from individual preference functions.
  2. How far can one carry the analogy between a political voting procedure and the economic price mechanism, and between the rationale of voting between alternative policies and that of allocating dollars between alternative purchases?
  3. Discuss the rational elements in relation to other elements in the social objectives of optimum distribution of income, optimum population, and optimum rate of saving.
  4. What is sound, what is unsound, and what is useful in the doctrine of consumers’ surplus?
  5. Why is it socially desirable to have the prices of products equal to the value of the marginal factors used in their production? How is this objective affected by equity elements such as the need for subsidies?
  6. Under what conditions would a partial freeing of trade be harmful to society in the largest sense? In your answer explain the treatment of this problem in terms of “second best” and the use of the concept of “divergence”.
  7. Compare the arguments for the imposition of trade restrictions for the sake of affecting the international terms of trade with those undertaken for the sake of affecting the domestic distribution of income. Give special attention to the interdependence of efficiency and equity considerations.
https://www.irwincollier.com/johns-hopkins-exam-for-welfare-economics-lerner-1958/

If you are a masters level student, you will enjoy answering (or having ChatGPT answer) these questions, and I hope you try either one of these options. But on the other hand, if you are an undergraduate student, or an amateur fan of economics, here are some prompts you might want to use:

  1. You are a professor of the history of economic thought, with a keen interest in how the field of economics has developed, especially in the 20th century. You are well aware of the famous economists of this era, their main contributions, and the main schools of thought that have developed in this period. Explain to me what welfare economics is, why it mattered when it was first developed, and why it matters now. In light of your answer, choose three questions from this blogpost that are worth discussing, and give me your take on them. It will help if you contextualize your answers by assuming I am an Indian with a somewhat basic understanding of economic theory.
  2. What are social welfare functions, and why do they matter in economics? What was the basic problem that was being tackled when folks came up with the idea of social welfare functions? How are social welfare functions different from individual preference functions? In your answer, explain like you would to a curious fifteen year old.
  3. What does “socially desirable” even mean in the context of economics? Whatever your answer, how does equating the price of products to the value of the marginal factors used in their production help? When you answer this question, please use a simple example that I can follow.
  4. What are efficiency and equity considerations in economics? What is the link between international trade and welfare economics? Explain with the help of an example that makes sense to me in the year 2023.
  5. My professor has given me an assignment: I have to design one more question to add to this question paper, in addition to the seven that are already there. I have to explain why I added this question, and I have to answer it. Please do all of these things for me? Note that I am an Indian student, currently studying in the sixth semester of an Indian undergraduate course.

Two Exciting Announcements in the Field of Public Policy

One, I’d written a blogpost on a World Bank report on the progress of rural sanitation in rural India. These were, according to me, the key takeaways from that report:

Four key results emerge from this report:

Enormous expansion in toilet access, with near-universal coverage of rural sanitation infrastructure

Substantial increase in regular toilet use, especially for the poor and socially disadvantaged groups

Wide variation in progress of regular toilet use across and within states

The impressive gains in regular toilet use are slowing or reversing, sustainability is a key challenge

https://econforeverybody.com/2023/10/04/a-world-bank-report-on-the-progress-on-sanitation-in-rural-india/

But that report has now been withdrawn.


Two, next year there will be a festival in Pune. A festival of public policy. The theme is trade-offs.

Details of the festival are here.

Andrej Karpathy on an Intro to LLM’s

Max Roser on Data Pages

In Praise of GLS Shackle

You must have heard of the drunk who was searching for his keys under a streetlight. When asked why he is searching here, rather than the place where he had dropped the keys, the drunk replies that he can see well over here.

Haha and all that.

Here’s Kenneth Arrow writing about a person you likely have not heard of, GLS Shackle. Arrow is writing about why people aren’t interested in reading Shackle anymore:

The reason for the current lack of interest is probably not any denial that Shackle’s position is fundamentally correct; it is the absence of the analytic tools needed to make the exceptional approach capable of generating operationally meaningful conclusions.

https://www.journals.uchicago.edu/doi/abs/10.1086/257884

What was GLS Shackle’s position, and who was GLS Shackle?

GLS Shackle was an economist. Wikipedia tells us that he started work on a PhD under the supervision of Hayek, but that he later switched to “an interpretation of Keynes’s General Theory of Employment, Interest and Money”. Because we know that the truth lies somewhere in the middle, this is a most wonderful thing, of course. Note too that there is a correct way to handle a situation such as this, and Hayek was more than up to the task:

A student of Hayek’s at the London School of Economics in the 1930s, Shackle renounced his early Hayekian views and the doctoral dissertation on capital theory that he had already started writing under Hayek’s supervision, after hearing a lecture by Joan Robinson in 1935 about the new theory of income and employment that Keynes was then in the final stages of writing up to be published the following year as The General Theory of Employment, Interest and Money. When Shackle, with considerable embarrassment, had to face Hayek to inform him that he could not finish the dissertation that he had started, no longer believing in what he had written, and having been converted to Keynes’s new theory. After hearing that Shackle was planning to find a new advisor under whom to write a new dissertation on another topic, Hayek, in a gesture of extraordinary magnanimity, responded that of course Shackle was free to write on whatever topic he desired, and that he would be happy to continue to serve as Shackle’s advisor regardless of the topic Shackle chose.

https://uneasymoney.com/2014/01/22/g-l-s-shackle-and-the-indeterminacy-of-economics/

And what was his position? This is not an easy question to answer, and I will admit that I am not entirely sure of the correct answer. But given that disclaimer, here is the best I can do:

You can either reject rationality or time


What does this mean, and why does it matter?

A rational-expectations model allows for stochastic variables (e.g., will it be rainy or sunny two weeks from tomorrow), but those variables are assumed to be drawn from distributions known by the agents, who can also correctly anticipate the future prices conditional on any realization (at a precisely known future moment in time) of a random variable. Thus, all outcomes correspond to expectations conditional on all future realizations of random variables; there are no surprises and no regrets. For a model to be correct and determinate in this sense, it must have accounted fully for all the non-random factors that could affect outcomes. If any important variable(s) were left out, the predictions of the model could not be correct. In other words, unless the model is properly specified, all causal factors having been identified and accounted for, the model will not generate correct predictions for all future states and all possible realizations of random variables. And unless the agents in the model can predict prices as accurately as the fully determined model can predict them, the model will not unfold through time on an equilibrium time path. This capability of forecasting future prices contingent on the realization of all random variables affecting the actual course of the model through time, is called rational expectations, which differs from perfect foresight only in being unable to predict in advance the realizations of the random variables. But all prices conditional on those realizations are correctly expected

https://uneasymoney.com/2014/01/22/g-l-s-shackle-and-the-indeterminacy-of-economics/

I wouldn’t blame you if your eyes glazed over while reading this. But bear with me, and let’s go over this slowly:

  1. Imagine that you are a farmer, and you are going to harvest strawberries two weeks from now.
  2. If it rains at or around the time of the harvest, your harvest is going to be destroyed. If it doesn’t rain, you will have strawberries to sell. Should you assume that you will have a harvest ready to sell, or not?
  3. Imagine that your best friend has a shop that sells smartphones, and you’ve told him that you will buy a smartphone from his shop, once you’ve sold your strawberries. Should he assume the sale of a smartphone to you, or not?
  4. The strawberries from your farm are usually purchased by a jam manufacturing company. This company has, for the first time ever, won a contract to sell its famous strawberry jam to Walmart. They got this contract because of the quality of your strawberries. No harvest on your farm, no sale of their jam to Walmart.
  5. This firm has promised temporary employment to locals to make this jam, who in turn have promised their families a trip to their hometown once the jam manufacturing company pays them.
  6. Toy manufacturers in that hometown are anticipating a rise in sales when these families come visiting.
  7. We don’t know if it will rain in two weeks or not. Nobody does. But should we assume that we can forecast rain with x% probability?
  8. And should we therefore assume that we know today the prices of smartphones, the wage-rate for hiring workers to make jam, the price of a ticket to a village nearby, and the prices of toys in that village – all of these two weeks from now?
  9. Now read the last two sentences in that excerpt above:
    “This capability of forecasting future prices contingent on the realization of all random variables affecting the actual course of the model through time, is called rational expectations, which differs from perfect foresight only in being unable to predict in advance the realizations of the random variables. But all prices conditional on those realizations are correctly expected”

GLS Shackle was saying that there is no such thing as rational expectations, because, well, time. That is, if you accept rational expectations as a feature of your model, you must reject time. And if you accept time, you must reject rational expectations.

So, dear reader, do you accept the existence of time, or not?


But what does the “existence of time” mean, in the context of economics?

Note that I am going to keep things as simple as possible, both for your sake and mine. And the simplest possible answer to this question is this:

Acknowledging the existence of time necessarily implies that the future is always, and by definition, unknowable

You have two choices: to continue reading from here on in, or to stop reading at this point. You have created your future by choosing one of these two courses of action. And until you make that choice, your future is unknown.

If, after you stopped reading, you walked into a store and purchased a jar of strawberry jam, you changed the future of the store owner, the strawberry jam manufacturer, the part time employee of the strawberry jam manufacturer, the kid of the part time employee and the toy manufacturer. If you didn’t stop reading, and therefore ran out of time to buy that jar, you changed their future too! And of course, if it rains (rained?) in the next two weeks, there might not be any strawberry jam to buy in the first place! Oh, and of course you could sprain your ankle while stepping into that store. Or <insert random event of your choice here>.

We just don’t know what our future holds, and our future is being shaped and fashioned by the choices made by million of other people – in much the same way that their futures are being shaped and fashioned by the choices made by you.

Bottomline?

Acknowledging the existence of time necessarily implies that the future is always, and by definition, unknowable

Again, GLS Shackle was saying that there is no such thing as rational expectations, because, well, time. That is, because the future is inherently and by definition unknowable – not predictable, not modelable – there can be no such thing as rational expectations.


Is there any point, then, to building a rational expectations model?

If you say no, you are a newly minted member of Team Shackle. If, on the other hand, you say yes – well, I hope you find those keys of yours under this streetlight.

Good luck!

Sunk Cost Fallacy, Except It Need Not Always Be A Fallacy

About a decade or so ago, my wife and I went out on a date. Because our daughter was a toddler back then, this didn’t happen all that often. But that day was a rare ol’ oasis: a meal (lunch) followed by a movie. What a treat!

And so lunch was had, and off we went to watch the movie. It is at this point, dear reader, that our little tale of love turns into one of horror.

For the movie that we had chosen to see on that fateful afternoon was a movie called Happy New Year.

There are no words in any known language that can describe how bad the movie was. Vogon poetry makes more sense than did the plot of that movie, and I wouldn’t blame the Vogons if they destroyed the planet all over again because of what I said.

But here, I tell my students when I narrate this horrible tale of horror in class, is where this turns into a teachable moment.

Within five minutes, I tell them, I and my wife knew that this movie was going to be crap. Actually, I’m lying, I tell ’em, because the other four minutes and fifty five seconds weren’t needed. I and my wife, I remind them – both of us with PhD degrees in economics. And even though we knew how bad the movie was, and even though we knew that sitting through it would be a complete, utter waste of our time – even then, dear friends, we sat and watched the whole damn thing.

I could have helped out at the popcorn stand outside, and that would have been a better use of my time. I could have stood on one leg in the men’s washroom for three hours, I say, and that would have been a better use of my time. I could have slapped myself for three hours – and I should have too, for having chosen this movie – and that would have been a better use of my time.

But because we had gotten the chance to go out after so long, I tell ’em, we stayed here and saw the whole damn thing.

And that, my friends, is the sunk cost fallacy. I’ve told this story before in these parts, but why let that get in the way or a good story, no?


But is it possible to use the sunk cost fallacy to one’s advantage?

Perhaps, and Aaron Nicholas tells us how in a blogpost:

A second, less obvious benefit is actively using the fallacy to your advantage. For example, many gym memberships require upfront payments regardless of how much you use the facilities. If you find it hard to ignore sunk costs, choosing gym memberships that have large upfront fees and minimal pay-per-usage fees may be a way to commit yourself to a regular gym habit.

This can also apply to other activities that involve short-term pain for long-term gain – for example, paying for an online course will make you more likely to stick with it than if you found a free course.

But be warned, this doesn’t work for everything: it seems that spending wildly on a wedding ceremony or engagement ring doesn’t have a “sunk cost” effect – it fails to increase the likelihood of staying married.

https://theconversation.com/what-is-the-sunk-cost-fallacy-is-it-ever-a-good-thing-217798

Oh and by the way, while it is true that spending wildly on a wedding ceremony or an engagement ring doesn’t (always) have a sunk cost effect, skimping on these things ain’t a good idea either.

It’s hard is what it is, this econ business!

Markets Are Complicated: Foxconn in Tamil Nadu edition

I wrote this just yesterday, that what “worked in the 1970’s for a village in India will work very differently for a city in China in the 2020’s”.

And as if to do me a favor, RestofWorld.com came out with a lovely story about Foxconn’s struggle to make iPhones in India. As always, please read the whole thing, but if you’re looking for great examples of why getting markets to work across time and space is difficult, this is a great example.

Lots of great takeaways, beginning with this chart:

https://restofworld.org/2023/foxconn-india-iphone-factory/

But data and charts aside, this article is worth reading for fascinating little snippets on the intersection of culture and labor markets:

  1. “In India, Apple’s suppliers have to contend with local policymakers, landowners, and labor groups. The country lacks China’s vast network of material and equipment makers, who compete for Apple orders by cutting their own margins. “Apple has been spoiled in China,” a senior manager at an Apple supplier, who was recently deployed from China to India, told Rest of World. “Here, except labor, everything else is expensive.””
  2. Foxconn has hired women in Tamil Nadu for the most part, and this, it turns out, is how they started off in China as well. Women have, in China, moved now to “less arduous service sector jobs”.
  3. “Hiring a young, female workforce in India comes with its own requirements — which include reassuring doting parents about the safety of their daughters. The company offers workers free food, lodging, and buses to ensure a safe commute at all hours of the day. On days off, women who live in Foxconn hostels have a 6 p.m. curfew; permission is required to spend the night elsewhere. “[If] they go out and not return by a specific time, their parents would be informed,” a former Foxconn HR manager told Rest of World. “[That’s how] they offer trust to their parents.””
  4. “Foxconn also had to find a workaround for employing married women. The company typically requires workers to pass through metal detectors when entering and exiting its factories in order to prevent leaks about upcoming products, according to reports. But in India, married women wear a mangalsutra, a metal pendant; and a metti, a metal toe ring. These workers are searched manually and have their jewelry logged in a notebook.”
  5. “They recounted how a Chinese Foxconn worker became frustrated with a junior Indian technician who repeatedly failed to solve a technical glitch. The Chinese worker fixed it himself and walked away. “He did not teach me,” the translator recalled the Indian worker saying timidly. “How many times should I teach?” the Chinese worker replied.”
  6. The well documented opposition to the move to twelve hour shifts finds mention here, of course, but what I found particularly interesting was the fact that China has only eight hour shifts. Foxconn relies, the article says, on lax enforcement of the country’s labor law to get around this requirement.
  7. Indian workers are getting acquainted with the neijuan culture, and the Chinese workers aren’t sure if this is, all things considered, a good thing.
  8. I’ve met my share of Indians who don’t like to eat food from abroad while traveling, because it is too smelly/exotic/<insert adjective of choice here>. So when I read about Li, a Chinese worker in India being unable to stand the smell of Indian food, and it being “all yellow and mushy stuff”, I couldn’t help but chuckle.
  9. This is probably my favorite bit from the entire article:
    “Both groups have picked up phrases from the other’s language. Sometimes an Indian colleague will greet Li with the common Chinese greeting, “Have you eaten yet?” To which Li will reply in Tamil, “I already ate.””
  10. The article speaks about workers being able to convince their families to delay their marriages, because these workers are now the main bread-winners for their families… but on the other hand, the workers also mention in the same article their fears about being too old for the company to retain them. The age of the worker in question? 26.
  11. And finally this anecdote:

    “During the first week of October, the national holiday celebrating Mahatma Gandhi’s birthday fell on a Monday and created a rare two-day weekend for Foxconn employees. Li planned to visit the Taj Mahal. He would spend a good deal of the weekend in buses and airplanes, but figured it would be worth it — he wanted to have seen it before his time in India was up. But a few days before he was due to leave, Li had to cancel. Management had announced that the factory needed to stay open to meet targets. Sunday would be a workday.”

    reminded me of this one from Studwell’s How Asia Works:
    “After the first steel was poured on 9 June 1973, Park Chung Hee declared an annual National Steel Day to go with the annual National Export Day he had inaugurated in 1964. This being Korea, these were working holidays.”

H/T Mihir Mahajan

No Free Markets

About three weeks ago, Gulzar Natarajan wrote a blogpost titled “25 economic orthodoxies that should be discarded“. The list is fascinating and worth thinking about. Doubly so if you are learning or teaching economics, and each of his twenty-five picks is worthy of discussion.

So worthy, in fact, that a blogpost probably won’t be enough – but it will be a good enough start, perhaps? Let’s find out, beginning with his first point: there are no free markets in the world.


Have you heard of Gall’s Law? Here’s the quick definition:

A complex system that works is invariably found to have evolved from a simple system that worked. A complex system designed from scratch never works and cannot be patched up to make it work. You have to start over with a working simple system.

Economists look at the world, and try and make sense of it, by building the simplest possible system “that works”. To this system, they add increasing levels of complexity. At some point, they stop and say “Ah, this is now a working model of the world”. They then “run” this model, “see” what happens, and therefore predict what will happen in the real world. Sometimes the model “works”, in the sense that the model predicts, more or less, what actually took place in the real world. Sometimes the model fails, in the sense that the world goes and does something else altogether. The world is quite irritating that way.

In either case, we “update” the model, and we try again. And on and on we go.

But it all begins by building the simplest possible system.

How does this work, exactly?

Let’s say I want to stop writing this post, and I want to go have a cup of chai. Let’s model this simple statement.


I want to have chai.

But I’m a hopelessly lazy person, I don’t want to make chai. I simply want to go outside to a tapri, ask for a cup of chai, and sip on it.

We now have demand. There is a “rational agent”, who desires a particular commodity called chai. Do we have supply?

Sure we have supply! In fact, there is a lot of it – why, there are at least ten chai tapris a short stroll away from my house. Each of them will happily sell me a cup of chai for ten rupees. And, if I so desire, a packet of biscuits, or a cigarette to go with it. I desire neither, but that will not matter to the seller – they will happily sell me just the chai.

So now we have supply. And we have, therefore, a market for chai.

Gall’s Law, y’see. A simple, working model of a market. It’s easy, this economics-y stuff.


Just as there are no frictionless surfaces, there are no free markets in this world, ones that have perfect competition. Nor can there ever be any such markets. All markets, embedded as they are in the real world with people having widely varying and idiosyncratic preferences, suffer from imperfections and failures. The markets cannot self-correct these. Policy interventions are essential in those markets where failures impose significant social costs.

https://gulzar05.blogspot.com/2023/11/25-economic-orthodoxies-that-should-be.html

Is the market for a cup of chai close to where I stay perfectly competitive? That is, is the market that I just described “without friction”?

  1. Am I indifferent to where I will have my chai? Will any one of the ten tapris do, or do I have a favorite? Of course I have a favorite, which self-respecting Indian doesn’t?! In the language of economics, the good in question (a glass of cutting chai) ain’t homogenous. I have preferences.
  2. It’s weird, and it is a story worth the telling – I actually am indifferent to the chai in all of the ten tapris, but my favorite tapri sells vada pav as well, and ooh, there’s this one tapri has fantastic vada pavs. And I’ve made friends with the lady who runs that tapri, and whenever possible, she fries up a fresh batch of vadas whenever I turn up. And so I end up having chai there.
    Why do I bring this up? Because friction, because imperfection, because idiosyncrasy. This is already not a perfectly competitive market.
  3. Are all ten chai tapris run equally efficiently? Are all run by folks equally proficient in running a chai tapri? What does being equally proficient mean, exactly?
    • Equally good at making a cup of chai? Maybe one of them puts green cardamom in their chai, maybe one of them puts ginger, and maybe a third puts a bit of both?
    • Equally good at dealing with the local politician or local cops? Maybe one of them speaks Marathi but another does not? Maybe one of them is from a particular religion, but the other is not? Maybe one of them speaks a particular language, but the other does not? Maybe one of them is from a particular gender, but the other is not? Maybe one of them is from a particular caste, but the other is not? Don’t these things matter? Of course they do.
    • One of these chai tapris is located next to a sports facility. Another is located right next to a building that has a lot of offices and shops. Another also sells vada pav. A fourth is closest to a mandir. Do preferences build differently over time within the same locality as a consequence? Of course they do.
    • Do all of them have access to the same quality and quantity of water, tea leaves, vessels and cups?
  4. And so, for all of these reasons and so, so many more, the market for chai tapris right outside where I stay isn’t competitive.

I do not bring all of this up to show you that India in particular is imperfect, or that economic theory is hopeless. All societies the world over will have different preferences and constraints. And so both demand and supply, in any market, will have frictions and imperfections. And this is just the market for chai! What about the market for nuclear reactors? Covid-19 vaccines? Helicopters for the military? Software engineers? Milk? Votes? Kidneys?

These frictions and imperfections will mean that markets will not work as efficiently as they would have otherwise. And because they are not able to work as efficiently as they could have, the good in question is either not produced as much as it could have been, or is sold at a slightly higher price than it could have been, or both. And so either producers suffer, or consumers do, or both.

And all this before we talk about externalities, but that’s a whole other story.


Gulzar Natarajan’s first point in his list of things that don’t work in economics theory is that markets are not self-correcting. They don’t work perfectly.

And so, he says, “policy interventions are essential in those markets where failures impose significant social costs.”

Now, here’s where things get interesting, tricky and contentious, so make sure you follow along carefully:

  1. Almost every economist I know will agree that markets are not entirely self-correcting. We can and do quibble about the extent and ability of self-correction in different markets, but that’s a debate about degrees. It is not a debate about the existence of perfectly competitive markets.
  2. Almost every economist I know will agree that market failure, in some cases and for some markets, will impose significant social costs. That just is a fact. Again, the debate is about degrees, not about the fact that these social costs exist.
  3. But those four simple words… “policy interventions are essential”… that is where the debate rages. If economic theory is Jupiter, this is our Great Red Spot.
    • Folks who support policy interventions will say “There is market failure! There are significant social costs!”
    • Folks who don’t support policy interventions will say “Nah, it’s not as bad as you think it is! See this study, and that one, and that one, and this RCT, and that one, and this RDD and that one!”
      • And folks who support policy interventions will publish 547 well-researched, impeccably cited and co-authored papers refuting the 389 well-researched, impeccably cited and co-authored papers saying it wasn’t as bad as you thought, and well, this never stops. Avoid getting sucked into these battles, unless you like doing this sort of thing, or need to publish in order to get a degree or a promotion.
  4. Bu even if both the pro-interventionists and the anti-interventionists agree about the presence of significant social costs, the story is very far from over. Because all that we have managed to do is agree upon the diagnosis. Not the cure!
  5. “Market failure leads to social costs leads to policy intervention and so QED”, say the pro-interventionists.
    “Not so fast!”, say the anti-interventionists. “Who, exactly, is going to guarantee that the intervention will not make things worse? You and what army?”
  6. “So which is it?”, you may well ask. “Do interventions make things worse, or better?”
  7. I’m positively delighted to inform you that the answer to this question is dependent on time, place and scale. So a policy intervention that worked in the 1970’s for a village in India will work very differently for a city in China in the 2020’s. So we just don’t know for sure.

Bottomline: yes, of course there is market failure. Measuring the extent of it, and its impacts, is tricky. Yes, thinking about interventions is necessary. Coming up with the best possible design and the best possible implementation for these interventions is tricky. Measuring (let alone predicting) their first and second order effects is impossible.

Bottom-er line: Folks who say markets always work are wrong. Folks who say interventions always make things better are wrong.

The truth, you see