Wednesday, August 16, 2006

On Economic Collapse

Early in the recent conflict between Israel and Lebanon, Kai Ryssdal, the anchor on the public radio program
"Marketplace," conducted two interviews: one with an Israeli civilian living in Haifa and another with a journalist living in Beirut. He didn't ask for their feelings and opinions about the war. Instead, he talked to them about the details of their everyday economic lives.

The parallels were striking. Each talked primarily about the supermarkets, or more particularly, what wasn't in the supermarkets. In Israel, there was no bread or milk, because the delivery drivers didn't want to risk being on the roads; in Lebanon, there were long lines for the little that remained. (Remember, too, that these interviews were early in the conflict--as the weeks went on, what little had stocked the shelves was long gone.)

Both interviewees talked about the dangers of travel on the roads. The Israeli military viewed Lebanese roads as strategic targets, and being on the open road in Israel left one vulnerable to rocket attacks.

When we learn about comparative advantage in economics, the theory is rosy. The market, after all, coordinates the efforts of complete strangers from many different countries to produce a product as seemingly simple as a pencil. Missing from most of these discussions are the assumptions underlying the free flow of international trade, including, most importantly, the assurance that the cargo and its transporter will arrive safely at their destination.

In other words, gains from trade can only be realized when the infrastructure is there to support it. It only takes a few days of shelling in the Middle East--or a few days without clean water and electricity in New Orleans--to remind us that the economic web we depend on can be quite fragile.

1. One of the arguments against free trade is that it is unreasonable to depend on foreign suppliers of essential goods like food and energy. Yet free trade also yields incredible benefits. How does an economist balance these two arguments? How would you go about finding the optimal level of domestic and foreign production? Why might the optimal choice for Israel be different than the optimal choice for, say, Singapore or the United States?

2. Economies of scale exist when a few large firms can produce a good or service at a much lower cost than many small firms. For example, massive farms have become the norm in the United States, where a century ago small farms dominated (but had much higher costs). How much of the food you eat comes from farms within 10 or 20 miles of your home? In the case of a major emergency, how long would it take for food shortages to become a major problem? Would the United States be better off if everyone still owned a farm--or are the gains from trade we've realized from specialization large enough to offset that change? How can you tell?

3. The interviewees talk about how expensive it is for Lebanese to evacuate Beirut, and how difficult it is to get cash from ATMs in Israel. Think about the implications of sustained political upheaval on economic growth. In some ways, war acts like a tax, making everything more expensive. Try drawing some supply and demand diagrams for various goods, and guess as to what happens to those markets in times of turmoil. What could the governments of Israel and Lebanon do, if anything, to help alleviate the economic suffering of their people?

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