Economics by Lucky Charms: Government’s Role in Economic Prosperity
A 10 minute read/14 minute listen on rampaging cattle, NAFTA, and marshmallows shaped like blue moons.
It was my first macroeconomics class in college: 7 a.m. on a Monday. As a matter of routine, I usually had breakfast after class, and today I was glad. My professor's lecture on the importance of private property was making my stomach churn.
"When my brother and I were kids, every so often my mom would buy sugary cereal from the grocery store. She didn't do this often, and you'll soon see why," My macroeconomics professor was like a modern cookbook author. He didn’t start with a recipe, he started with a story. Pretty good strategy, it hooked me 7 a.m. each Monday. (See Note 1)
“The next morning, she'd place the cereal box on the table next to the healthy brand. My brother and I would lock eyes and go straight for the sweet stuff. It was on. We'd pile our bowls high and consume as much of that sugary cereal as we could, each trying to out-eat the other. The box was always gone in a single sitting, something that never happened with the healthy brand. A few times, one or both of us would end up sick. That's when she stopped buying the sugary kind altogether.”
My stomach gurgled. I remembered the one time my parents bought a box of Lucky Charms. Sugary cereals were a hard "no" in my house growing up. I don’t remember why my parents made this exception, but I remember there was only one box. Like my professor, I ate way too much, way too fast, and got sick. Just thinking about it made me queasy.
My professor went on to explain one solution for this cereal-based tragedy of the commons scenario: define property rights.
"If my mother had been an economist," he joked, "she would have split the cereal into two plastic bags, one for me and one for my brother. Each of us would own only what was in our bag. Then we could each eat as much or as little as we wanted. That simple change shifts the whole equation."
It was one of the few college lectures that really stuck with me. I reflected on my behavior as a consumer. At some point, I wasn’t eating because I enjoyed the Lucky Charms. I wanted to consume more of the sugary cereal than my siblings before the box ran out.
The story from my Macroeconomics professor helped me understand the theory of economist Ronald Coase.
Some Context: In Economics by Good Neighbors, we explored the top layer of Mancur Olson’s work on collective action problems by looking at rain and snow in the City of Chicago.
In general there are two approaches we can take when society agrees there's a problem that needs to be solved, but no one is taking action.
1. Make it the Government’s problem (collective taxation and systemic action)
or
2. Make it the individual’s problem (assignment and liability)
Today, we’re looking at the work of Ronald Coase (the pronunciation of his last name rhymes with “close”). Coase looked at the boundary between these two options. When should a problem be the purview of government? When should it be solved by individuals? Put another way:
How Much Government Does an Efficient Economy Really Need?
Coase would eventually receive the Nobel Prize in 1991, for his answers to this question and more. One illustration he used in his work takes us back to a time before strict zoning laws and neatly divided parcels. Picture a countryside in the early 20th century, maybe in rural England or the American frontier. The two protagonists in conflict are neighbors: one raises cattle, the other grows grain. No fences, no title insurance. Just people trying to make a living off the land.
Crucially, property rights are unclear. There is a dispute about who owns which part of the land and who has the right to use it for cattle grazing or growing grain. Like the box of Lucky Charms on the family table, everything is technically "shared."
You can probably see the problem coming a mile away: The cattle trample some of the grain farmer's crops. The grain farmer blames the cattle rancher. The rancher says the grain was planted on his grazing land.
Coase's insight: it's not the market's role to decide winners or losers in conflicts like this. The real problem isn't the cattle or where the grain is planted. The problem is that there is no clear property line. In Coase's view, this is the government's job: to define who owns what. Like dividing the box of cereal into bags, each clearly marked with a sibling's name. Once that happens, not only can each actor make better decisions, but conflicts can be negotiated quickly.
But there is an important assumption in this theory: the costs of negotiating must be low. Economists like Coase refer to these as “transaction costs”. Transaction costs refer to the time, effort, and expense involved in reaching an agreement. (See Note 2) If negotiation is too slow, costly, or complex, the system can break down. But if it’s relatively easy to identify who owns what and open a dialogue, transaction costs stay low and the system works well.
Using our example: if property rights are clear, then we know if the farmer or the rancher is owed compensation.
If the grain farmer owns the land the cattle trampled, she can demand compensation for the market cost of the destroyed grain.
If the cattle rancher owns the land, he might ask the farmer to build a fence around what is hers to protect her crops.
There are many possible solutions. Here is where Coase draws a boundary on government intervention. According to Coase, the government should stop at defining property rights, ensuring they are clear and enforceable to keep transaction costs low. Government shouldn't prescribe specific solutions.
Circling back to our question: How much government does a functioning economy need? Coase would say one crucial role the government plays is establishing clarity of ownership, or property rights. Without clear property rights, good economic players act badly, planting where they shouldn't, letting their cattle roam free, or eating Lucky Charms until unpleasant things happen. Conflicts become long, expensive, legal battles. Interesting side note: Coase was a law professor, but he didn’t believe it was a profession that added much to economic efficiency.
Coase’s work has aged well in economics classrooms. Let’s see if we can apply it in the real world.
Trade and Workers: The North American Free Trade Agreement
Bill Clinton signing NAFTA (from Politico)
Let’s use NAFTA, the North American Free Trade Agreement, as a case study. NAFTA lowered trade barriers between the U.S., Mexico, and Canada, promising mutual prosperity. And for some, it delivered: lower prices, increased efficiency, higher profits.
Let’s start where everyone agrees: NAFTA is credited with modest economic growth. In other words: a bigger box of Lucky Charms for everyone to share. Estimates are between $10 to $127 billion each year between Mid-1990’s to Mid 2010’s in increased GDP. Large number, but modest compared to the US Economy which was between $8-17 trillion (with a T) during the same time period. (See Note 3)
One critique of NAFTA is that, in exchange for that modest GDP growth, NAFTA hit workers hard. The trade agreement brought layoffs, plant closures, and lower wage growth.
From a Coasean perspective, this was predictable.
The US legal framework tells us why: in the United States bargaining power generally comes from ownership or formal recognition. The vast majority of American workers
Do not own the factory they work in
Do not own the capital they create that moves overseas
Do not own a legal right to keep their job or a share in the profits that result from its elimination
Most do not belong to a union that could negotiate on their behalf
NAFTA created a slightly bigger box of Lucky Charms to split. Every sibling is excited. Even better, our metaphorical parent is an economist that clearly defined who gets what: the bigger box of sugary cereal has been divided up and labeled.
One bag of Lucky Charms for my sister.
One bag of Lucky Charms for my brother.
One . . . wait, there’s no bag with my name on it?
Here’s where a second viewpoint comes into play. For folks that support NAFTA as originally written, including workers would have raised transaction costs. According to Coase, transaction costs matter. This doesn’t mean trade deals are bad, but it reminds us that who benefits depends on who can bargain. And transaction costs help decide who has legal standing to negotiate.
Adding seats to the negotiating table makes the negotiation more complex. In fact, it borders on overreach: using international trade policy to tell domestic companies how to run their business. Agreements with provisions to include workers, in this view, would lessen the positive economic impact.
Dani Rodrik notes this tension in his book The Globalization Paradox: Democracy and the Future of the World Economy
"The deeper the trade agreement, the more it impinges on domestic institutions, and the greater the transaction costs of reaching consensus."
Conclusion
NAFTA is a reminder that economic policy is rarely black and white. On one hand, the North American Free Trade agreement did what many hoped it would. It helped the U.S. economy grow. On the other, it brought real disruption to workers and communities who weren’t part of the conversation.
That’s where Ronald Coase helps us see a bigger picture. His work shows that economic outcomes aren’t just about good ideas. Economic outcomes are shaped by who has bargaining power, what rights are recognized, and how costly it is to bring more voices to the negotiating table.
Outside of NAFTA, Coase’s work helps us understand why real-world negotiations often leave someone out. And once we see who’s missing, we can start to ask better questions about what kind of growth we want, and who we want it to serve.
Next Time: Garret Hardin and the Tragedy of the Commons
A few of you economics nerds might have seen my head nod to Garrett Hardin’s “Tragedy of the Commons”.
We’ll take an old-school look Hardin’s proposal that it’s human nature to overconsume common resource. (That’s right - more cattle and pastures.) But we’ll also check out more modern examples like fishing and forestry. For those of you Hankering for more math - we’ve got a lovely graph of how Scotland approaches regulation when it turns out there are not “plenty of fish in the sea”.
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Extra Credit
If you’d like to read more on free trade and its impact to workers, here’s some follow up material.
News Article: Warren Bill Would Mandate Sweeping Corporate Governance, Political Spending Reforms
Elizabeth Warren, Senator from Massachusetts, proposed a bill inspired in part from the German legal framework that includes workers in corporate decision making. Her proposed legislation would require large U.S. corporations (with over $1 billion in annual revenue) to obtain a federal charter obligating directors to consider all stakeholders, not just shareholders. It mandates that 40% of corporate board members be elected by employees.
Book: Has Globalization Gone Too Far? Rodrik, D. (1997) Cambridge, MA: Institute for International Economics.
Rodrik outlines the growing tension between global economic integration and domestic social cohesion. He argues that while free trade enhances efficiency, it can also exacerbate inequality, erode labor protections, and weaken workers’ bargaining power, especially in countries lacking strong domestic institutions to cushion the shocks.
Academic Article: “The China Syndrome: Local Labor Market Effects of Import Competition in the United States.” Autor, D.H., Dorn, D., & Hanson, G.H. (2013). American Economic Review, 103(6), 2121–2168.
This influential paper is commonly referred to as the “China Shock” study. It examines the impact of rising import competition from China on U.S. labor markets. The authors find that areas more exposed to Chinese imports experienced greater job losses, lower wages, and increased reliance on disability and other safety-net programs. Their findings highlight how trade liberalization can disproportionately harm less-skilled workers in specific geographic regions.
Notes
A funny story about the 7AM Mon/Wed/Fri schedule. This macro professor cited signal theory as the reason why he taught at 7AM. Essentially, he believed the schedule was a gatekeeping mechanism. “I don’t begrudge those who came to college to party, but I’ve found it’s more fun to teach students who are willing to show up at 7AM Monday.” More on signal theory in a future post. It doesn’t look like I’ll be able to fit it into that post, but this was one of my favorite examples of using signal theory effectively.
One important item Coase cites as a transaction cost is essentially safety. I glaze over it here and in Economics by Bluey when I mention markets need to be “reasonably safe”, but markets need to be reasonably safe to operate. If the famer cannot negotiate with the cattle rancher because the cattle rancher is part of a crime syndicate, then government needs to be involved
The general concensus of economists is that modest US economic GDP gains can be directly attributed to NAFTA. Here are some sources you can look at
Peterson Institute (PIIE): A 2014 PIIE report found that NAFTA boosted U.S. GDP by about $127 billion per year, roughly $400 per person annually. Most of this came from expanded exports, productivity improvements, and lower consumer prices
University of Michigan & Chicago Fed via USINFO: Short‑run estimates suggest NAFTA added about $13 billion to GDP by 1996; long‑run projections included an additional $3–6 billion annually in real income
Econometric Welfare Studies (JSTOR / NBER): One NBER‑style estimate finds that U.S. welfare increased by 0.08% overall (plus 41% intra‑bloc trade growth). These welfare gains represent actual expansion in real income.
Not to lose the forest for the trees. One of the biggest shift economic thinking post NAFTA and other major trade deals is the importance of safety nets for affected workers. Previously it was expected that economic gains from trade deals would be distributed equally. One example is this report from the OECD (2012). In it the Organization for Economic Co-operation and Development highlights how economic displacement from NAFTA led governments to adopt active labor-market policies and safety nets to cushion workers shifting the conversation from expecting equal gains to the fair management of uneven losses .