More on Substitutes and Complements

In a previous post, I discussed substitute goods (things you buy instead of each other) and complementary goods (things you buy as well as each other)*.

This way of thinking is useful in working out how price changes affect different goods. For an example of substitute goods, imagine beef becomes more expensive. People may stop eating McDonald’s hamburgers and substitute KFCs instead. For complementary goods, this price rise might mean less hamburger buns get sold.

I wanted to apply this way of thinking to some bigger issues:

Taxes: Imagine the government raised taxes. Suddenly, an hour of work isn’t worth as much to you. You might decide to cut back on overtime to spend more time with the family or on the golf course. That is, you would substitute more leisure for work. We think of leisure being something you do instead of work. This effect would be the substitution effect of higher taxes.

However, you might decide to work harder to maintain your standard of living, now you earn less per hour. This is the income effect of higher taxes. Whether the substitution or income effect is larger than the other determines whether higher taxes reduce people’s incentives to work or not.

Automation: One of the longest trends in economic history has been using machines to do more and more things that people once did. We can think of this as machines being a substitute for people in the workplace.

Undoubtedly this has been a good thing overall – someone transported from the Middle Ages would be astounded by the huge numbers of different things we can buy after a few centuries of industrialization, and how much healthier, varied and fulfilling our lives are because of economic and scientific progress. But it can be painful for the people who lose their jobs due to technological change. Think of the Luddites in the early 1800s who broke into early factories to smash machines. Think today of the taxi drivers who protested against the Uber app.

If you want to protect yourself against future technological change, try not to be a substitute for a machine, but a complement. Don’t pick a career that a robot or computer may be able to do in a decade’s time. Better, be the person who creates and uses technology to make themselves more productive.

Immigration: People often worry about immigration because immigrants ‘take our jobs’**. The degree to which immigrants take our jobs depends on whether they are substitutes or complements to British workers.

If they are a good substitute for your job, then employers will ‘buy’ their labour rather than a native’s. A Polish factory worker or a Pakistani taxi-driver might be a good substitute for a native worker, then they are more likely either to take a British job or bid down wages.

But they can also be complements – that is when an employer employs the immigrant, they have to employ more Brits. The Romanian builder might allow more homes to be built, giving work to British electricians and plasterers. The Indian programmer may allow for more software companies to be created, giving work to British accountants and managers.

This raises a difficulty, though. People are more comfortable with immigrants ‘like us’, who speak the same language and mix with us. But these people, being more like British people, are more likely to substitute for British jobs. The immigrants people dislike more will be those, who being more different, will take jobs Brits don’t tend to do.

Who’s more likely to take a native’s job: the Australian barmaid or the Bangladeshi curry chef? But which one is more likely to integrate? Yet another of those pesky trade-off we bump into all the time in life.

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*I forgot to mention independent goods, which are unrelated.

**People may be committing the lump of labour fallacy – wrongly thinking there is a fixed amount of jobs out there, so if an extra person gets a job, there’s one less to go round.

If that was the case, every time a new child is born would mean there’s less work to go round. Yet, the population has grown significantly for a long time, and the number of jobs has managed to keep pace with it.

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