[Pen-l] The Mirage of Economic Efficiency

[Michael Perelman <michael@xxxxxxxxxxxxxxxxx>]

Almost 70 years ago, George Stigler introduced the 
concept of flexibility. A business might be highly 
efficient, but it may not have the flexibility to meet 
changing conditions. Stigler.s point is largely 
ignored. I would prefer that other parts of his work 
were ignored, but I do not have much say in such 
matters.

Stigler, George. 1939. .Production and Distribution in 
the Short Run.. Journal of Political Economy, 47 
(June): pp. 304-27.

Stigler. point is fairly simple. Nuclear power plants 
are often used to explain what he meant. Assume, for 
the sake of argument only, that a nuclear power plant 
can produce electricity much cheaper than other forms 
of generation (by the way, I do not believe this 
assumption is correct). The problem is that demand 
shifts. The capacity to produce for peak demand might 
not be needed 90% of the time, making it an 
economical.

A coal fueled plant might be far less efficient, but 
it can be brought online relatively quickly when it is 
needed. Even though the engineering efficiency of the 
coal-fired plant might be low, it might be appropriate 
for handling peak loads.

Uncertainty makes Stigler.s theory even more 
compelling. A biological example from my book, The 
Perverse Economy, might be appropriate:

.Biologists of all stripes acknowledge an amazing 
ability of various plants and animals to adapt to 
specialized niches. For example, scientists have 
recently discovered a new species, wholly unrelated to 
any previously known species, which survives on the 
lips of one particular type of lobster (Morris 1995). 
Although this form of evolution is remarkable, it also 
leaves the creatures vulnerable to even a slight 
change in the environment. The same specialization 
that made these creatures so dependent on the success 
of a relatively small group of lobsters makes them 
less adaptable to relatively small changes in the 
global environment. For example, this particular group 
of lobsters may decline or migrate to a less desirable 
location, threatening the existence of their tiny lip 
dwellers..

In the Perverse Economy, I used another example, 
regarding a glue shortage . not glue in general, but a 
particular kind of glue. A computer chip is a silicon 
wafer, which is useless without the capacity to send 
and receive signals from a circuit board. A plastic 
package allows the chip to make the connection between 
the chip and the board. The industry uses specialized 
epoxy glue for fabricating these packages.

During the 1990s, a single Sumitomo Corporation plant 
manufactured the majority of the world.s supply of the 
epoxy resin. About 60% of all memory modules depended 
on the product of this particular factory, when in 
July 1993 a fire destroyed this factory.

Ordinarily, an event like a fire in a glue factory not 
be of very much interest except for the people close 
to the event, but this fire ravaged the chip market. 
Dealers had been paying about $33 for a megabyte of 
memory before the fire. By the end of the month, the 
same memory commanded $95. The industry feared that 
prices would go even higher.

Bill Clinton.s trade policy with Haiti illustrates a 
similar danger. Clinton forced Haiti open up its 
agricultural markets. Heavily subsidized US rice 
destroyed Haiti.s capacity to produce rice. In terms 
of conventional economic theory, some economists might 
have seen Clinton.s policy as efficient, following the 
laws of conventional economics (subsidies are ignored 
in this logic, especially the heavy water subsidies 
given to California rice growers). Relatively 
unproductive rice farmers would give up that activity 
to participate in the modernization of Haiti, 
presumably in some sweatshop.

Unfortunately, when agricultural prices began to soar, 
Haiti was unable to quickly resuscitate its previous 
capacity to grow rice. Food riots soon followed.

The recent sawdust shock is relevant here. Here is 
what the Wall Street Journal reported about sawdust:

.The price of sawdust has soared since 2006, up from 
about $25 a ton to more than $100 in some markets. 
Blame the housing slump: Fewer new homes mean fewer 
trees cut for use in construction, which leads to less 
sawdust and other wood waste, driving up the price..

.Farms use sawdust and wood shavings as cozy and clean 
bedding for horses and chickens. Particle-board makers 
devour it by the boxcar to fashion a cheap building 
material. Auto-parts manufacturers blend a finely 
pulverized sawdust called .wood flour. with plastic 
polymers to make a lightweight material to cover 
steering wheels and dashboards..

.Wineries use oak sawdust as a flavoring agent for 
some wines. Perdue Farms, which raises broiler 
chickens, goes through seven million cubic feet of 
wood shavings a year. Oil-rig operators in Wyoming and 
Colorado pour sawdust into the caverns they find deep 
inside rock formations as they hunt for pools of 
petroleum. Sawdust gives drill bits something to grind 
through..

.The housing slump has devastated sawmill production 
across the country..

Millman, Joel. 2008. .Sawdust Shock: A Shortage Looms 
As Economy Slows.. Wall Street Journal (3 March): p. A 
1.http://online.wsj.com/article/SB120451039119406735.html
 
-- Michael Perelman 
Economics Department California State University
Chico, CA 95929

Tel. 530-898-5321
E-Mail michael at ecst.csuchico.edu
michaelperelman.wordpress.com
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