Economics 101: The Babysitting Co-Op model

My apologies for not blogging more frequently, but, having been busy with graduating, finding a career among other things, I simply haven’t had the time to sit down and jot down all my thoughts here. One thing I have managed to do in the time since my last post, however, was attend the annual meeting of The American Economic Association at the Hyatt-Regency in Chicago. My attendance, albeit unexpected, game me unprecedented insight into some of theories of modern economists. Some notable attendees of the event included Rahm Emanuel, Paul Krugman, Larry Summers, Austan Goolsbee and Gregory Mankiw, and I was fortunate enough to make the acquaintance of several other world-renowned economists and Nobel laureates. As those who know me best may know, I took an interest in economics rather recently, at the beginning of my college career and since then my interest has continue to grow. Needless to say I found my experience at the AEA meeting to be incredibly informative, and I even managed to pick up a few books from some of my favorite economists. This blog post, however, relates to a particular analogy – an economic model – used by economist Paul Krugman to describe some of the basic elements of a recession and how it can be dealt with.

The story goes as follows:

The co-op in the 2000s. Photo credit: Susan Hormuth.

The story takes place on Capitol Hill in Washington D.C. In the late 1950’s a babysitting co-op was started by several members of Capitol Hill. The idea was simple, couples take turns babysitting each other’s children and share the burden. As the group grew from about 20 families in the 1960’s to nearly 200 families in the 1970’s, the task of making sure that each couple babysat their fair share became somewhat troublesome and a new system was implemented. The idea is that each couple is issued 20 “scrip, essentially an I.O.U. for 30 minutes of babysitting, upon joining the co-op and then must pay it back if and when they choose to leave it. In addition, couples may babysit other couples’ children to earn more scrip or go out for a night and pay scrip to other couples to babysit their children. As managing the co-op was no small task, officers and other administrators were paid through annual dues which amounted to 28 scrip per year.

Sounds simple enough right? But here’s where it gets a bit more complicated…

As was to be expected, many couples found that it was desirable to save up scrip, in case they decided to go out several nights in a row. This was especially true with younger couples who seemed reluctant at first to go out and leave their children to be babysat. As a result, the demand for scrip grew and the demand for babysitting fell. People wanted to save their scrip and were eager to babysit whenever the opportunity arose. Because, however, everyone else was also trying to save their scrip at the same time, babysitting opportunities became scarce, further encouraging the couples to save the scrip they had.

The situation just described is precisely what happens in a recession. As spending declines, so does demand for goods and services. As a result, fewer workers are needed to produce the reduced demand of goods and services. With fewer people receiving money, spending declines even further and the cycle continues. To make matters worse, those that have money to spend, begin to save it in fear that they may not be able to earn more money in the future as easily as they had in the past. The result of this is a large number of people looking for work (high unemployment rate) and very low demand for goods and services.

Still following?
Good, because it gets slightly more complicated.

In response to the “recession”, the officers of the co-op decided to increase the money….I mean “scrip” supply by giving new members 30 scrip instead of 20, but still requiring that they only pay back 20 upon leaving. Within a few years, a new problem arose. As more new members joined, more scrip was added to the system until couples simply had too much and were unable to spend it because no one else wanted to babysit their children. In addition, the administration also began taking in more than it spent.

Now let’s examine a hypothetical issue with the co-op.

Let’s assume that there is an element of seasonality in babysitting. It makes sense that couples would be more likely to go out in the summer when the weather is nice and the days are long, as opposed to winter. If seasonality is weak, relatively little is changed. Some couples may spend more scrip in the summer, but they are able to earn it back by babysitting more in the winter and the system remains table. Consider for a moment, however, if the seasonality is strong. All of a sudden couples are desperate to babysit during the winter in order to save up the much needed scrip to pay for babysitters during the summer months or in case of emergency. The result is a surplus of babysitting supply during the winter and a surplus of babysitting demand during the summer. In order to compensate for the seasonality, the administration begins to administer “loans” to couples which can be repaid in the future with interest. This would allow couples to borrow scrip from the administration in emergencies and pay it back with interest later. Due to the seasonality of demand, interest rates would be higher when there is a large demand for babysitting and lower when demand is small. The result is that the administration is analogous to a central bank.

The same is true on a macroeconomic scale, in theory. During good times when money and jobs are plentiful, interest rates increase, and the cost of borrowing money is generally higher. During times of economic downturn, interest rates decrease in order to encourage lending to stimulate consumption.

Back to the story…

Now let’s suppose that the seasonality is unusually high, that couples do not want to go out at all, but rather prefer to stay in to acquire more scrip for the summer. Suppose that the seasonality is so strong that, even when the administration sets interest rates to zero, parents still refuse to go out, even when they can borrow money for free. In this what is known as a liquidity trap.

Liquidity trap visualized in a IS-LM diagram. A monetary expansion (the shift from LM to LM') has no effect on equilibrium interest rates or output. However, fiscal expansion (the shift from IS to IS") leads to a higher level of output with no change in interest rates: Since interest rates are unchanged, there is no crowding out.

A liquidity trap is defined as a situation in which injections of cash into an economy by a central bank fail to lower interest rates and hence to stimulate economic growth. Put simply, a liquidity trap is a situation in which an increase in the supply of money has no effect on the equilibrium interest rates or output.

In a liquidity trap, couples have no incentive to borrow money, even for free, because they know that the value of their scrip in the winter will be worth exactly the same value the following summer.  This is, of course, assuming that there is no inflation.  Though many people talk of inflation as though it is something to be avoided, an undesirable consequence of economic policy, the fact of the matter is that inflation is a tool and can be a useful one, assuming that it can be controlled.

Assume now that the co-op system has an inflation rate, and that, as a result, 5 scrip in the winter will be worth 4 scrip the following summer.  Now the situation begins to change.  Because there is now a penalty associated with saving scrip for the summer, couples become more willing to spend their scrip during the winter in order to get their full value.  The result is that saving becomes less desirable and the consequences of a liquidity trap can be avoided.  If the inflation rate is too low, however, the co-op can fall back into the same liquidity trap it found itself in before.  Contrariwise, if the inflation rate is set too high, couples begin spending all of their scrip, they become desperate to babysit, and the system falls back into a recession as previously discussed.

In several of his books, Krugman notes that, if ever the system is to reach a point where the couples of the co-op are reluctant to spend their scrip no matter the circumstance, then it is the job of the administration to begin spending scrip in order to stimulate demand, effectively creating an economic stimulus.  Krugman states that, if the private sector isn’t spending and economic growth is slow, the administration – the government – must step in and provide temporary stimulus in order to promote growth and increase demand.  Even a temporary increase in demand can have a ripple effect and lead to a further increase in demand and economic growth.

I suppose that, in conclusion, macroeconomics is a bit more complicated that most are led to believe.  The important thing to note here is that, like most things, the ideal situation involves a balance , an equilibrium if you will.  I think that the babysitting co-op model is an excellent example of some of the basic principles of economics and it provides a look at how recession-era economics work.  As I continue my research, I’m sure I will be posting further updates, but for now I think this provides a fairly basic foundation to build upon.

Further reading:

Economics 101: Understanding the Effects of Exchange Rates

Having followed the crisis in the Eurozone fairly closely for the past couple years, I think it has become an incredible learning experience for me, as there are many lessons that can be learned with regard to managing a nations economy, austerity measures and bailouts.  The other thing I’ve noticed, however, is that many people lack a fundamental understanding of how an exchange rate affects a nation (or bloc of nations’) economy.  Many people often assume that the appreciation of the dollar is a good thing for Americans, and I’ve heard several people even welcome the collapse of the Eurozone because “that makes it cheaper to travel there right?”.  While on the outside, this may appear to be the case, the effects of an exchange rate fluctuation are far deeper than what we often realize.  To better understand how this works, I think it’s best to start out with a hypothetical example:

Let’s say we have two countries, Country A and Country B.  Now let’s assume that Country A has vast natural coal deposits and iron ore, while Country B has rich deposits of precious metals, the kinds often used to make things like phones and computers.  For the sake of keeping things simple, we’ll assume that Country A has a developed, high-tech manufacturing economy and needs the precious metals mined by Country B in order to produce it’s high-tech products, which are generally exported.  Likewise, Country B has a large manufacturing economy and needs the coal and iron of Country A to produce steel, one of it’s chief exports.

Now let’s assume that, one day, the exchange rate of Country A appreciates by 10% compared to the value of the currency of Country B.  Once this happens, a few different things take place:

  1. Exports of Country A decline – While goods and services within Country A remain the same price, exports are now 10% more expensive for customers in Country B.  In this case, a company could also reduce their prices to stay competitive, but that reduce their profit margin, forcing them to make cuts elsewhere.
  2. Slower real GDP growth – As the exchange rate of Country A appreciates relative to the currency of Country B, it causes a slower rate of growth of the real GDP in Country A.  Because a reduction in exports also means a reduction in demand and output, business may seek to control costs by laying off employees.
  3. Outsourcing to Country A slows – Because goods and services are now 10% more expensive in Country A for the rest of the world, companies may do one of two things: reduce compensation to their employees in country A, or reduce the number of employees in country A, in favor of outsourcing them to another country.  As a result, unemployment rises further.
  4. Raw materials become cheaper – Since their currency has appreciated by 10%, it means that raw materials from Country B are now 10% less expensive to import, leading to greater profit margins for manufacturers in Country A.
  5. Imports from Country B become cheaper – A consumer in Country A can now buy 10% more than they could yesterday since their currency has appreciated relative to Country B.  In turn, this may lead to increased imports from Country B, pushing the trade deficit towards the negative.
As you can see, a fluctuation in the exchange rate of Country A has both positive and negative effects on it’s economy.  The key is to keep the exchange rate at a certain balance to ensure that it doesn’t go to the extremes.  On the one hand, if a country’s currency appreciates too high (as we see in more developed countries like Switzerland), exports fall with drastic consequences to employment.  This is one of the reasons why Switzerland recently decided to set a minimum exchange rate of 1 Swiss Franc to 1.20 Euros, in order to keep the currency from appreciating too high.  On the other hand, other countries like China may attempt to keep their currency artificially low in order to attract business looking to outsource labor, and increase their exports to other countries.
This is why economics is so complicated.  A slight appreciation or depreciation of a country’s currency isn’t necessarily bad or good, it all depends on the country’s situation.  If you look at a country like Germany, for example, you’ll see that they rely heavily on manufacturing and exports in order to maintain their economic strength.  Since many of the major importers of German goods lie within the Eurozone (France, Netherlands, Italy, Austria), it makes sense why Germany would choose to join a currency union that, ideally, would provide a level of security, ensuring that the cost of exporting goods to each country would remain the same, even with small fluctuations in the exchange rate of the Euro.  If Germany were to, say, go back to the D-Mark and let their currency float freely, it would quickly appreciate as it did shortly before the adoption of the Euro, leading to decreased exports, increased unemployment and catastrophic consequences for the German economy.
This is why the idea of a currency union, or even pegging a currency to another, makes economical sense. The problem with currency unions is that they are at risk of becoming overextended.  As we are seeing with countries like Greece, Ireland, Portal, Spain and Italy, overextending a currency union to many countries, without closely examining their economic structure, can lead to a decline of the union as a whole.
So what is the solution then? With the Euro declining even further against major world currencies every day, what can be done to protect the Eurozone?  The short answer: no one really knows.  Because of the interconnected-ness of the global economy, it’s extremely difficult to say exactly what would happen should Greece leave the Eurozone.  One thing is for sure though, whatever happens over these next few weeks, months, and years, it will prove to be a lesson for all currency unions in the future.
*Side note – I know I’m missing a few things in my list, and I know it’s been dumbed-down a bit, but I’ll continue to add to it as things come to mind.*

The effect of good professors

After having criticized some of the bad professors I’ve had in my past, I think it’s time for me to share a bit about the ones who have been truly awesome in my last 4.5 years of school.

I came to Illinois State University in the Fall of 2007 a very different man than I am at present.  At the time, I really had no desire to travel internationally, having only visited Canada once as a child.  I had a mild interest in learning foreign languages, though my years of Spanish in high school yielded very little, and I was a little less than optimistic about taking an entry level foreign language yet again. I was also a Chemistry major, having planned to intern at the National Renewable Energy Laboratories to research hydrogen fuel technology.

As my semester progressed, my interest in Chemistry began to dwindle as I slowly started to realize that everything I had learned about Chemistry in high school was really an oversimplified, watered-down version of the actual science.  Upon realizing that the life of a Chemistry major didn’t simply consist of blowing things up, lighting fires and mixing chemicals (you know, all the cool stuff Bill Nye used to do), I started focusing my effort on other classes.

This same semester I was also enrolled in an entry level German course with a certain Dr. Van der Laan.  To me, Dr. Van der Laan seemed a bit unconventional in that he often put students in the spotlight, asking them questions in a rapid-fire manner and pushing them in a way that I had never seen before.  German 111 was by far my most difficult class that semester, and, unlike in high school, I couldn’t simply “float” my way through his class by putting in minimal effort just to get a B.  After a few class periods, I began to spend much of my time immediately after class in Dr. Van der Laan’s office, asking him questions, learning from his experiences, and occasionally asking for help with the material in class.  The result of this was a professor-student bond that allowed me to become much more comfortable in asking questions in class.  He also often held me accountable for my failures in the class, constantly pushing me harder, encouraging better study habits that helped me succeed in future courses.

Fast forwarding a few years, I also had the pleasure of taking courses with both Dr. Weeks and Dr. Segelcke, both of whom continued to push me to succeed in the same way that Dr. Van der Laan had.  The result was that I began to improve in my classes across the board, and I took a more active role on campus, both with the German club, as well as other organizations relating to my major.  Being involved with the German department also meant making connections with German students studying abroad at ISU.  One student in particular, my friend Matthias, would later go on to help me find an internship working for his employer in Paderborn, Germany.  My professors also worked with me tirelessly to help me improve my resume, write cover letters, and gave me numerous tips to help ensure my success.

Do you see what they’ve done? These professors have completely changed my life.  They’ve made it their number one priority to focus on the education of their students, both in and outside of the classroom.  They legitimately care about the success of their students during and after their college studies. They’ve helped me travel to nearly 25 countries around the world, and over 100 cities in Germany alone.  They’ve helped me plan my studies abroad, showing me how to get the most out of my experience and providing me with tips every step of the way.  They’ve helped me get internships and jobs, and have provided me with opportunities to lead and be responsible, opportunities I probably would not have had were it not for them.  My German has improved greatly since my freshman year, and I speak it quite comfortably while in Germany, especially with those who know little to no English.  Now, as president of the ISU German Club, I can honestly say that the lessons and skills these professors have taught me have been far more valuable to me in my experience than anything I’ve learned in any of my classes, and I’m extremely grateful for that.

We need more professors like this.  We need professors who care, professors who form bonds and personal relationships with their students.  Professors like these can change the world, one student at a time.

How not to be a professor

This post will be the first of two posts regarding my take on the professors I’ve had during my time at the university.  I will start by saying that this post does not by any means apply to all of my professors, but rather a select few that I’ve had over my last 4.5 years of higher education. I’ve had many, many wonderful professors, some that have been truly life-changing (I’ll get to that in the next post), but I’ve also had some that were…well…somewhat disappointing.

As most senior college students can tell you, what you learn in a class and the grade that you get can vary greatly depending on who your professor is.  Though I’m not too fond of this reality, I recognize that it’s difficult to assure a standard level of teaching given the varied backgrounds and experiences of each individual professor.  As a freshman, I viewed my professors as my bosses, taking note of everything they said, accepting their words as fact, never questioning them and always assuming that their experiences were reflective of how things were in the real world.  This went on for the first few years, until I had a few remarkable professors who really opened my eyes and showed me just how big of an impact a professor can have on your life.  I also took courses with professors who clearly showed no interest or passion for the material they were teaching, professors who, as it appeared to me, cared more about paychecks and have their students read every chapter of the book, rather than focus on the education of their students.

As a result of this, I’ve come to view my professors more as employees than bosses.  Students pay large sums of money each semester for tuition for a quality university education, and professors are the means to receiving that education.  In my opinion, if a professor is not doing their job to share valuable experience and insightful information with their students, it’s no different than an employee in a factory falling asleep on the assembly line.  To give you an idea of exactly what I’m talking about, allow me to give you an example:

A few years ago, I took a marketing course with a professor who, at this time, will not be named.  The professor would come to class every morning, book in hand, load up the Powerpoints (made by the textbook publisher) and begin lecturing.  Lecturing essentially consisted of reading these Powerpoint slides for about an hour, before telling the class that their assignment is to read the next chapter before the next class period.  Occasionally the professor would give us quizzes (also made by the textbook publisher) and a few times a semester we would take exams (again, made by the textbook publisher).  These exams and quizzes would be done with the use of Scantron sheets, which would then be taken by the TA to be graded.

Many students would see this as normal.  I, however, see this as a cop out.  The professor I had in this class was no doubt extremely intelligent, having studied at some very prestigious universities.  I also knew that this professor had extensive experience in their field, having spoken with them after class several times.  The issue I have with the professor, however, is that they neglected to relate any of the key classroom concepts to their real-world experience.  I can pay any student on campus to come into a classroom, read a Powerpoint presentation, hand out a quiz or exam and then have a TA grade it.  The added value of having an experienced professional is that they are, or were at one point, involved with the material that they are teaching.  The word professor derives from Latin, and refers to a “person who professes”.  If a professor does nothing but read off slides to the class, then there is no added value, and that professor, at least in my opinion, has failed to do their job of teaching their students.  It’s no wonder we pay so much for textbooks, they’re teaching the classes for the professors!

Of course, it’s easy to criticize someone without having a solution, so here are a list of things that I think these select few professors could improve upon.

  • The textbook should be an aid, not a crutch.  This one may be the most irritating. If you lack the fundamental knowledge of the subject you are teaching and cannot teach the basics without the use of a textbook, then you should not be teaching that subject. I don’t pay you to read me a book (that’s what preschool was for), I pay you to tell me why the material in the book matters in the real world.  We are adults. This is not a game of consumption and regurgitation.  Students want to learn why the course materials apply to the real world, not what the AMA’s official definition of marketing is over and over again.
  • Teach your own class! I’ve had several professors that have assigned each student a part of the book to read and present upon, essentially removing all professor involvement in return for getting a grade.  I realize students need to learn how to present, but if half of the semester is being taught by the students and not the professor, you’re doing something wrong.
  • Share your experiences with the class! If I can gain the same amount of knowledge just by reading the textbook on my own, then why come to class in the first place? Real world experiences matter far more than textbook definitions, and it’s important that student learn from your successes and failures.
  • Get involved with your students.  Never being available in your office to network and socialize with your students creates a disconnect and a disinterest in the course.  If you can form a personal connection with your students, they’ll be much more eager to learn the material.  This may not be feasible for big lecture halls, but if you’re teaching a class of 10 students, you should at least know their names by the end of the semester.
  • Get feedback from your students! Encourage your students to come to you with suggestions on how the class could be improved.  Never asking your students questions or encouraging them to ask you questions is a great way to ensure that your students never learn anything.

While I think that this list applies mostly to the few bad professors I’ve had in the college of business, I also believe some aspects of this apply to professors across the board.  The moral of the story is this: education should be student-oriented and the education of those students should be your number one priority.  If students in your class are consistently scoring low grades on exams (I had a professor once whose average grade was a D- for the last 5 semesters), then perhaps it’s not the students but YOU that need to spend some more time studying.

Got that? Good.

Learning from others: Kurzarbeit in Germany

Anyone who has seen the news anytime in the past few months knows that the USA isn’t the only place in the world with severe economic troubles right now.  The Eurozone has been struggling with the near-collapse of many major economies within the EU, the most prominent ones being Greece, Ireland, Portugal, Spain and Italy (seems like having a nice coastline causes economic crisis).  For years, there has been a push in America to be more “European” in our financial and social policies, however, with the recent economic crisis going on in Europe, that push seems to have died down a bit.  Now anyone that suggests that America be more like Europe is met with criticism from those suggesting that the economies of the struggling European nations aren’t exactly the best model for our country.

This is, of course, rather selective.  One needs to look no further than Germany to understand how America’s economic policies could have been better adapted to protect against the major financial crisis that we’re in.

The peak of Germany’s unemployment rate during this financial crisis came in August of 2009 and reached a rate of (hold on to your seats ladies and gents) 7.8%.  In fact, the unemployment rate as of today is 6.1% and still declining.  Germany’s unemployment rate at the moment is even better than it was BEFORE the crisis even began!

So what’s the secret to maintaining relatively low unemployment?  As many people are well aware, Germany’s economy is heavily dependent on exports, especially in the area of manufacturing.  This is where the idea of “Kurzarbeit” (German for ‘short-work’) comes in.  During a recession, rather than laying off employees to cut costs during periods of reduced demand, companies enter into an agreement with the government where working hours are reduced for most or all employees.  The government then pays these employees to make up for some of their lost income.  This results in lower hiring and severance costs to the employer, reduced unemployment costs to the government, and sustained demand for goods and services.

Another issue lies within the manufacturing of the industries themselves.  In order to stay competitive on a global scale, companies like BMW, Audi and Mercedes realize that they cannot compete on cost, especially given the low cost of labor in developing nations.  They instead form their competitive advantages based on quality an customer satisfaction.  Even with the strength of labor unions, high costs and standards of living, benefits and pay in Germany, companies still remain competitive because the products they produce are high quality and innovative.

In my personal opinion, I think that this is something the USA needs to focus more on.  In this country we have some great engineers and some very innovative talent, but if we focus on all of our attention on competing with cheap labor in China, we’ll drive ourselves out of business.  The USA should be competing with Germany on quality an innovation, not with China on price.  As we transition from a manufacturing to a services economy, it becomes even more vital that American companies seek a way to diversify themselves and provide additional value to their customers all over the world.