Thursday, 22 January 2009

The endowment effect, willingness to trade and the scale of the US economy

Driving through the US it is slightly hard to believe that a place with such a vast and humming industrial economy could have a recession. But it's all relative, and it is entirely possible that the $60-70,000/head GDP of this region could decline by $2,000/head in a year or so.

I was provoked to wonder about how the US economy can sustain what appears to be a much higher level of consumption and infrastructure than the UK. On the surface there are no great insights or mysteries here - the US has more natural resources and space, therefore needs to spend fewer resources on working around those shortages; it spends proportionally less on public goods, and (arguably) its infrastructure is of lower quality - built quicker but also decaying faster. People work more hours and therefore create more resources (which are included in GDP), but spend less time on leisure (which isn't).

But I wonder to what extent this is not to do with explicitly differing preference, but with multiple equilibria - with the US economy simply in a higher-activity equilibrium than the UK. For example, if people are working more hours and eating out more often, rather than making their own food, it's probably a more efficient way of preparing food. Workers who make $40/hour are probably willing to spend $25 on dinner if it saves them half an hour of shopping and half an hour of preparation, but it certainly doesn't cost $25 for the restaurant to make it.

The consumer surplus that's generated is shared between restaurant owner and hungry labourer. This is a decision that is economically efficient in both the US and UK, but it seems to happen much more in the US (UK spend on eating out is around £12bn according to Keynote - note that the linked page has an erroneous statistic for the number of meals per person; in the US, more like $600bn, or about seven times the spending per person).

In this sense the US may just be at a more advanced level of specialisation than the UK. It seems plausible that this is technologically available to the UK, but we are stuck in a less efficient equilibrium. But it raises the question of how we could switch from one to the other. Workers can only afford to spend $25 on dinner if their employer will pay them for an extra hour - therefore the economy needs to already be at a sufficient level of activity in order to make this a stable situation. Hence the multiple equilibrium argument.

I would posit that moving from the UK to a US-style equilibrium requires a kind of cultural mindset which we might call "willingness to trade". Arguably people in the US are more willing to pay others to carry out services for them which in the UK the consumer provides for themselves. Americans are, if this model is correct, more willing to sell their time for the highest achievable value and spend money instead of time on personal services. This willingness may take time to build up, as the minds of individual workers and consumers are subject to inertia. One could perhaps model the time and effort taken to overcome this inertia as a type of investment good, which may give us a way to estimate its value and see what kind of return the US gets for having made that investment.

I would imagine that this figure would be correlated with measurements of the endowment effect - which is also based on people's willingness to trade something they already possess for something that (in a rational model) may have more value to them. If there are any experiments comparing the endowment effect among citizens of different countries, it would be very interesting to measure its correlation with the size of various personal-services sectors - foodservice, childcare, taxis, home decoration. Anyone know if that research is out there?

3 comments:

Anonymous said...

Wouldn't be surprised if people tend to eat out more in the U.S. because food in shops is relatively more expensive than in the U.K.

BTW, have just wandered over here from Peston's blog, and am very much enjoying your articles.

DevonNative

Leigh Caldwell said...

Thanks for your kind comment.

I wasn't aware that shop-bought food is more expensive in the US, but if that's the case then it certainly would contribute to this effect.

Though it would immediately provoke me to want to know why it's more expensive! Perhaps distribution is more expensive, but other factors should be cheaper. Always on the hunt for the underlying cause.

Anonymous said...

I lived in the Midwest for a while, and a standard 2-lb loaf of white bread was about $2.50! I did wonder why it was so expensive at the time - perhaps U.S. farmers are more effective at collective bargaining with supermarkets, or maybe their subsidies aren't as high.

DevonNative