Trading down and the business cycle

by on September 8, 2015 at 2:39 pm in Economics | Permalink

From the new NBER paper by Nir Jaimovich, Sergio Rebelo, and Arlene Wong:

We document two facts. First, during recessions consumers trade down in the quality of the goods and services they consume. Second, the production of low-quality goods is less labor intensive than that of high-quality goods. So, when households trade down, labor demand falls, increasing the severity of recessions. We find that the trading-down phenomenon accounts for a substantial fraction of the fall in U.S. employment in the recent recession. We study two business cycle models that embed quality choice and find that the presence of quality choice magnifies the response of these economies to real and monetary shocks.

In other words, we should subsidize relatively expensive goods as a downturn approaches…and tax thrift shops at a higher rate…?

1 albatross September 8, 2015 at 2:51 pm

Wouldn’t the same analysis apply to all inputs of production? I would expect that if an *adequate* (car, watch, phone, house, refrigerator) uses one level of all the useful inputs (raw materials, various types of skilled labor, capital, intellectual property), we’re probably in the realm of diminishing returns on all of them. So making a *superlative* one of those things probably takes better materials, higher quality labor or more of the normal kind, more capital (maybe just more time using up an expensive machine), etc.

Now, labor and materials are probably the two easiest of these inputs to vary quickly, so they’re probably where the impact is.

2 Al September 8, 2015 at 3:27 pm

Interesting.

I guess iPhone owners will choose a less expensive Android model next time they upgrade.

3 msgkings September 8, 2015 at 3:39 pm

Not until we’re in a recession according to that paper.

4 Hazel Meade September 8, 2015 at 3:51 pm

Are consumers really “trading down” or are they searching the space for more cost-effective (optimal) choices?
Just because something is lower-priced doesn’t *necessarily* mean that it’s lower quality. Often, there are lower-priced options that are just as good, but you don’t know about them.

It’s like exploitation vs. exploration in search algorithms. Maybe during a recession, consumers are more motivated to explore alternate options rather than exploit known ones.

5 Jody September 8, 2015 at 4:18 pm

While assuredly part of the story, there’s probably a bit of Pareto improvements and trade offs of quality for price. To get a grasp on the mix, I suggest looking at how purchasing patterns change on the rebound.

The stickier they are, the greater the fraction is due to Pareto improvements.

6 Hazel Meade September 8, 2015 at 5:23 pm

Which implies that the fall in labor demand is part of a pareto improving process that ought not to be interfered with. During recessions, consumers seek more Pareto improvements. Often the more Pareto optimal outcome is less labor intensive. Thus the recession is not so much a feedback of falling labor demand, as it is a spiral of Pareto improvements that cause shifts in labor demand as consumers and producers seek greater efficiency. At the end of the recession the economy should be at a higher optima.
Perhaps a “recession” is really just a transition from a worse local optima to a better one?

7 Brian Donohue September 8, 2015 at 6:33 pm

“Just”? Well, that’s a relief. Maybe we’ll have another such transition soon.

8 JWatts September 8, 2015 at 4:52 pm

“I guess iPhone owners will choose a less expensive Android model next time they upgrade.”

Those would definitely be the lower quality options.

9 TMC September 9, 2015 at 10:31 am

Until the 6 came out my Android was significantly better than any available iPhone.

My son then got the 6 and my wife an Android. Both very similar, I’d guess the droid only 90% the phone that the iPhone was. Price was $650 vs $150 though.

10 JW September 8, 2015 at 3:40 pm

They’re going to use tax policy to reduce the difference between normal and inferior goods? Good luck.

11 ad*m September 8, 2015 at 4:00 pm

The shocking thing is not that some liberal economists wrote that. To me, shocking is that Prof Cowen seems to be concluding that.

What is this change of mood, with the ‘refugees’ and now this. Does he see Sanders becoming POTUS and is he covering his bases?

12 JWatts September 8, 2015 at 4:54 pm

Dis you miss the question mark at the end of Prof Cowen’s sentence?

13 JWatts September 8, 2015 at 4:54 pm

Did

14 Howard Salter September 8, 2015 at 3:54 pm

The business cycle cannot be resolved with out first making the monetary supply equitable. The rich are already subsidized by the future earnings of taxpayers that haven’t even been born through a national debt that gives money to dictators who hate us via foreign aid and their corporate friends who build grain elevators from the US, those who build nations for multi-national corporations to utilize, and welfare programs for all who are not in the job market. Secondly, cartels whose subsidiaries straddle multinational boundaries bribe and lobby where ever they go to the exclusion of the every-man. Level the playing field with the powers of the state to protect the opportunity of the average Joe and Jane and you’ll see a real entrepreneurial boom–lazze faire 2.0– creation of wealth and jobs at a rate consistent with fairness of a market and not BFF Congressmen or their monetarists at the Fed. The statists who have currently partnered with these cartels would have more money in their coffers via fair taxation.

15 Nathan W September 8, 2015 at 9:46 pm

There have been times where these were all legitimate concerns, but there are mere GRAINS of truth and you make mountains of them, and meanwhile there are fewer FORMAL barriers to entrepreneurial effort than ever.

If you are concerned about leveling the playing field, I would direct your attention to school funding formulas in the USA, where poor neighbourhoods receive less funding that wealthy ones. The

16 TMC September 9, 2015 at 10:35 am

Not likely. Poor neighborhoods typically have higher budgets than everyone save the the most wealthy.

17 Nathan W September 9, 2015 at 9:15 pm

I thought school funding in the USA was based on property taxes. Is this untrue?

18 Mike September 8, 2015 at 4:24 pm

Why not tax capital and subsidize labor during recession instead of subsidizing high-priced goods?

19 JWatts September 8, 2015 at 4:55 pm

Wouldn’t taxing capital just drive up the cost of the low end goods? And would you implement import taxes on all imported goods?

20 Mark Thorson September 8, 2015 at 4:39 pm

Whoa, there! That’s Commie talk!

21 JWatts September 8, 2015 at 4:57 pm

Not quite. It doesn’t go full Commie until you start shooting the upper class and sending the middle class off to reeducation camps.

22 Nathan W September 8, 2015 at 9:49 pm

Hardly. It would be the first “communist” argument I ever heard in favour of subsidizing luxury goods.

23 8 September 8, 2015 at 4:53 pm

Economists are always thinking of new ways to serve their Statist masters.

24 John Hawkins September 8, 2015 at 5:02 pm

“Having proven this to be so by stating it to be true, I’d like to move right onto polciy implications” – Zach Weiner

25 Brian Donohue September 8, 2015 at 5:04 pm

Interesting. If true, does this suggest that monetary policy should be driven more by labor market conditions than GDP if the two diverge?

26 dearieme September 8, 2015 at 5:54 pm

Everyone should buy GM and Chrysler cars so that the repair industry thrives.

27 rayward September 8, 2015 at 6:05 pm

This is as ridiculous as Krugman’s dictum that aggregate demand is aggregate demand, whether for mansions in the Hamptons or household goods at Walmart.

28 Turkey Vulture September 8, 2015 at 6:06 pm

Tax high-quality goods at some rate that automatically adjusts inversely to the unemployment rate. 0-20%, hitting 0 around say 8.5%+ unemployment and 20% at 4.5% and below.

29 Turkey Vulture September 8, 2015 at 6:11 pm

Would a tax based on “high-quality” status produce less distortion than one based on “low-quality” status since the detriment of the tax would be partly offset by the quality signal? A “low-quality” tax would give a double whammy of reasons to try to avoid that designation (through lobbying or manipulating product attributes to game the system).

30 Donald Pretari September 8, 2015 at 6:23 pm

In the same spirit, since unemployment insurance leads to less employment, we should also tax charity.

31 Bob September 8, 2015 at 6:49 pm

The paper didn’t measure quality. “… as in most of our analysis, we use prices as a proxy for quality. Our assumption is that, if consumers are willing to pay more for an item, they perceive it to be of higher quality.” So they found that during a recession people substitute lower priced goods for higher priced goods. Plenty of people pay more for the status of paying more, not because the quality is any better..

32 acscott September 8, 2015 at 7:44 pm

What is the %: “We find that the trading-down phenomenon accounts for a substantial fraction of the fall in U.S. employment in the recent recession”

If we could subsidize high-quality goods during the next recession and see the effect on employment, the experiment would be more valuable than the subsidy I think. On the other hand, if producers know the subsidy is coming their behavior will change and ruin the experiment.

There exists goods and services in markets where there are no alternatives (electricity for example). Would taxing them more during recessions and using those taxes as subsidies on more expensive goods accelerate the effect of reduced employment?

Ok, ultimately using carrots and sticks can be refined down to the individual level the more policy makers can know about individuals or cohorts. But it has to be done without transparency. If you agree with that then, you agree that if the policy makers can make non-transparent decisions, they will bias the policies towards themselves. Ultimately, this technique will deteriorate as agents devolve to their self-interests, paths of least least resistance and all.

Also, employment is not the be-all end-all of human existence. It has to be quality employment I think (normative). (Gosh I wish I had the original article!).

33 Nathan W September 8, 2015 at 9:51 pm

Why not do nothing, and sit back and watch while firms innovate to capture market share by attracting penny pinchers and value seekers?

34 Los Ranchos September 8, 2015 at 10:39 pm

When the economy stinks people don’t buy as much expensive shit? Really? Keep ’em coming.

35 CD September 9, 2015 at 1:43 am

Surprised nobody has really picked up on the labor-intensive point, which is the less-obvious part of this.

36 Lord September 9, 2015 at 11:39 am

The largest change though is the shift from buying to doing and making, the shift from markets to home production, more labor intensive but unpaid. Good luck taxing that.

37 Miko September 11, 2015 at 2:07 am

I earned a bunch of money comfortably in my own home by trading. It’s the best thing that ever happened in my life, and if you are interested to learn how to trade just Google Superior Trading System.

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