Thursday, July 01, 2004

In Defense of the Wal-Mart Model

At Crooked Timber, Daniel Davies explains why Wal-Mart’s much-vaunted contributions to economic productivity might not be so great after all. I agree with Davies’s fundamental points, which I understand to be (a) that productivity is notoriously different to measure, and (b) that the productivity gains attributed to Wal-Mart have probably been exaggerated. But if the Wal-Mart boosters sometimes overstate their case in its favor, I think Davies overstates the case against. Even his own examples show how Wal-Mart has created value. Let’s take them one at a time:
1. Lower value added retailing = higher productivity! … The issue being that, if the boutiques on King’s Road were to get rid of the dolly assistants, free coffee and assorted perks and bijouterie, and move to a model where they piled the Prada high in fluorescent-lit barns, then they would presumably be able to shift more units at a lower price, at the expense of taking all the joy out of shopping for the Sex-in-the-City crowd. As Brad[1] pointed out in a critical comment on the Kay article, the national statistical agencies try their damndest to make sure that the productivity statistics don’t pick up a decrease in the value-added component of retailing as an increase in productivity, but it’s an intrinsically difficult task.
Granted, it’s a much less pleasant experience to shop at Wal-Mart than to shop in a boutique. If you want an accurate measure of the value added by switching to the warehouse model, you must remember to subtract out the value associated with the forgone ambience. That said, we should notice that lots of people still have the option of shopping at boutiques and choose to shop at Wal-Mart instead. That’s pretty strong evidence of value added for those people, since they could choose to patronize the boutiques if they didn’t perceive a net gain from shopping at Wal-Mart. Simply put, there are some people who are unwilling to pay for the additional amenities of the smaller stores; before Wal-Mart came along, they had to pay for them anyway.
2. Outsourcing distribution costs - to you! … I would contend that there is one particular, systematic mistake [identified by behavioral finance] that people make which is probably of macroeconomics. And it’s a hole in popular psychology which WalMart drives through in a coach-and-four.

That particular psychological quirk is the tendency of people in industrial societies to: a) put an irrationally low valuation on their leisure time, and b) believe that they have more spare time than they actually do. … In any case, as John pointed out a while ago, if you’re spending your “leisure” time driving to an out-of-town megastore, then it’s not leisure in any meaningful sense. If you end up doing more of this than you would, in a fully informed and reflective state, want to, then WalMart has successfully outsourced a proportion of its cost base to you, and the national income statistics and the McKinsey Global Institute will happily collaborate in helping you to fool yourself.
Again, there’s a large grain of truth here. There is a cost, in both time and inconvenience, involved in going to a big-box store on the outskirts of town. That cost ought to be taken into account in assessing Wal-Mart’s value added. But once again, the revealed preferences of actual consumers argue strongly in favor of the notion that, on net, lots of people still prefer the big-box store. Many of Wal-Mart’s customers have lower incomes, and that makes perfect sense: people who earn less per hour have a lower opportunity cost of their time, so they will naturally substitute time expenditures for money expenditures when they can.

Davies resists the revealed preference argument on grounds of behavioral psychology: people’s choices are sometimes afflicted by persistent biases that are inconsistent with pure rational choice. As a result, it is possible that their choices don’t reflect their true preferences. Now, it’s certainly true that people are subject to these biases in certain types of situation, but attributing such biases willy-nilly to any old situation, as Davies does here, is precisely the danger of people taking the behavioral results too seriously. What seems like a bias will sometimes turn out to be a (quasi) rational means of correcting other cognitive biases or dealing with a facet of the situation not apprehended by the observer.

So what countervailing biases might be involved here? One of the most common biases is placing too much value on the present relative to the future. A person with this bias might buy something at the expensive-but-local store, instead of sacrificing a little time now to save money for the future. I do this all the time, when I buy food at the corner market instead of driving an extra 5 minutes to the grocery store. Which bias is dominant in the Wal-Mart situation? Focusing on the undervaluation-of-leisure bias leads to Davies’s implied conclusion: people shop at Wal-Mart too much. Focusing exclusively on the overvaluation-of-the-present bias leads to the conclusion that people don’t shop at Wal-Mart enough. I, for one, would defer to the judgment of the people who have the greatest incentive to correct their biases and get the outcome right: the consumers. Choices may not reveal preferences perfectly, but they’re the best sign we’ve got.

Davies makes a third point, but this post is already way too long, so I’ll respond to that point in a later post.

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