Category — Theory

The opening session today in the ongoing OECD Forum 2010 was on the future of capitalism, where economic historian Anatole Kaletsky argued that “we’re entering a new period of pragmatism, when ideology will give way to a more “common sense” approach.” Arguably, this is not such a radical notion; the financial crisis has shown in a dramatic way that there have been some serious cracks in what has commonly been accepted as “good” economic policy. It is easy to blame greed and carelessness in the financial sector, but that hardly goes to the heart of the problem. At the end of the day, even if the greed and carelessness of a few “evil bankers” really is to blame, policy has to change if the economic structures have been conducive to making it cause despair for millions of people.

Aside from highlighting dysfunctional economic structures and the need for reform, a very immediate consequence of the crisis is that Governments have been [Read more →]

The port of Shanghai from WikiCommons

Dani Rodrik recently had a commentary where he argued that industrial policy is returning to the main stage.  Within the Tallinn School (i.e. the economic research associated with the Technology Governance program in Tallinn) active government policies are seen as essential in order to create the ‘virtuous circles’ of high value-added economic activities. Rodrik (not associated with Tallinn), argues that industrial policy is  (i) “a state of mind rather than a list of specific policies” (ii) “relies on both carrots and sticks” and (iii) “industrial policy’s practitioners need to bear in mind that it aims to serve society at large” As Erik Reinert has shown, history abounds with  examples of how almost every successful economy has at some point employed some kind of industrial policy. Skeptics usually reply, yes, but what about all the failures?   By no means is industrial policy always effective and how well it works in a specific case depends on an inordinate amount of variables. Importantly, it is “a state of mind” and one must experiment to see what works. I would rather ask: what is the alternative, if industrial policy is the only way we know to have worked? Recently, the World Bank has come off as a bit more positive towards industrial policy, but their understanding is quite narrow:

“If industrial policy is nothing more than government agencies organizing conferences with private sector players, I’m all for it. If we include in the definition of industrial policy the supply of classic public goods like infrastructure and education in coordination with the needs of the private sector, I am still fully in support. However, I tend to part ways when the state gets involved to the point of picking winners, which must inevitably be the case when more heavy-handed interventions are put on the table. ” from the World Bank Private Sector Development Blog.

Industrial policy is more than supplying basic infrastructure, but still it is not about picking winners. One aims to develop specific sectors of the economy, calculating that the spillover effects will benefit the economy as a whole. The Asian economies, of India and China,  but also Brazil are recent examples of how industrial policy has been implemented successfully. But Chris Blattman points to an interesting example of how it has been carried out for shoe manufacturing in Ethiopia.

From my experience, how one looks at industrial policy depends a lot on one’s view of economics: In the first post here at Evolution-Revolution, we argued that “understanding the dynamics that propel the economy into the unknown should be at the core of economics, rather than optimizing a static economy that only exists in the abstract.” As such if one believes the most efficient allocation of today’s resources is essential one quite naturally comes to the conclusion that any form of intervention is inefficient. By incorporating the dimension of time however, one can more easily conclude that its worth sacrificing a little efficiency today for what might be a much more prosperous tomorrow.

Last week we endorsed an article on collapsing business models, but having read this must-read critique of it and the journalistic style it applies, one comes to wonder how accurate the analysis really is. When reading articles that tries to make sweeping generalizations just on the basis of a few cases or examples, we must really strive not to be swayed by what is most likely pure dramaturgy and seduction from the author.

A complex system that is very difficult to describe by a single phrase – Photo Credits

Thinking further about  this problem, business books that try to coin new phrases come to mind. Malcom Gladwell is a master of this art writing books such as “The Tipping Point” and “Outliers”.  Be careful when reading this, [Read more →]

I just came across a post at the North Korea Economy Watch blog linking to North Korean comic book translations made by Heinz Insu Fenkl, an associate professor in the department of English at the State University of New York, New Paltz . As such, I have spent the last couple of hours or so reading about the Great General Mighty Wing and the Kim Brothers in Blizzard in The Jungle. It is easy for those of us who grew up after the end of the cold war to think of authoritarian dictatorships and ultra-explicit propaganda as relics of the distant past. These North Korean comics sadly remind us that this is not the case. They are, however, [Read more →]

Picture by Josh Abene

In economics, the assumption that economic actors – i.e. people – are “rational” is a common one. By “rational” we mean that people, given a ranking of their preferences, will choose whatever options they prefer the most. Ironically, our definition of “rationality” means doing whatever you feel like.

More importantly, it means that if we propose to know how “rational” economic actors will behave, we are in fact proposing that we are intimately familiar with the emotional life of every economic actor relevant to our model.

It is of course easy to assume a preference ranking when working in the abstract. Also, we can argue that by putting a price or “pseudo-price” on anything and everything, we can just assume that everyone just wants a ton of money because this can be traded in for whatever else you might want. If you ask me, such a argument only proves right those who claim economists are amongst those who “know the price of everything, but the value of nothing.”

Me and the Sundance Kid have recently to an old Norwegian economist by the name of Torkel H. Aschehoug. Although he died a little more than a hundred years ago, his economics – and especially his approach to economics – remain highly relevant today. As opposed to presenting a single theory or logical system as proven and true, his work is characterized by broad inclusiveness. Firmly rooted in the history of economic thought, he consistently presents the work of several different schools of thought when dealing with economic questons, as if creating a “smorgasbord” of economics for the critical reader to pick and taste from. In the first edition of his 2400-page magnum opus, Socialøkonomik (Economics), written during the last years of his life, he cites almost 900 different economists, and more than a thousand in the second. He examines the work of different and disagreeing economists critically – often pointing out weak points in the various theories presented – but refrains from canonizing any one as indisputable and true. Rather, his epistemology is founded on the attitude that objectivity is achieved by viewing a particular question from as many different angles as possible. Above the age of 80, the old conservative eagerly read new and critical writings, constantly revising his manuscripts in order to include and reflect upon new and interesting directions taken in economics.

This “Smorgarbord Approach” to economics is radically different from what is the norm in mainstream economics today. In the latter, theory tend to be presented without reference to their origin or author – implying a timelessness and irrefutability far beyond what most of it deserves. And while some academic conflics are laid out, the vast majority of mainstream economics is not presented as the view of a particular school of thought – the Neoclassical one – in conflict with other schools, but rather as established truth. More importantly, its epistemological foundations suffer from an increased emphasis on the ability of new theory to be derived from particular mathematical methods and fit within the established axiomatic framework. Importantly, while there may be furious disagreements within the school, the theories of the various belligerents tend to be based on very similar methods and theoretical foundations. Still, empirical work within the mainstream has to some extent helped it stay more relevant and connected to reality. It has also tended to produce conclusions less consistent with established theory. However, econometric research also suffers from the fact that it largely emanates from a single school of thought, with biases and holy ghosts like any academic school of thought is bound to suffer from. There are always endless questions of what to control for and how to define variables, and as my econometrics professor at William & Mary tellingly taught his students: “If in doubt, we go with the theory.” – a rather dubious doctrine from a Popperian perspective.

I am not amongst those that think the methods, models, and theories of the Neoclassical school are devoid of value and relevance – far from it. I do, however, think that it is extremely damaging for Economics as well as the quality of work in the Neoclassical school that the latter is a de-facto “academic monopolist”. Neoclassical economists are right in their claim that structural monopolies tend to stifle both innovation and product quality – the same is true in academic research. Comparative advantage also applies – while Neoclassical economics may have a comparative advantage in dealing with some economic issues, other schools have a comparative advantage in areas that have been strongly dominated by the mainstream. Development economics is one field where this is particularly true, financial macroeconomics and (in)stability is another.

It is time for a return to a much more diverse Smorgasbord. As any nutritionist can tell you, a varied diet is key to good health. Even broccoli is unhealthy if you eat nothing but it.

While writing the last post I came over this by Paul Krugman:

“I should also mention that you don’t need to go back to Tobin 1975 to see serious academic analysis of the issue. Gautti Eggertson at the NY Fed has been doing yeoman work on all of this, for example here.”

Implying, to me at least, that there should be some intrinsic value to the freshness of the analysis. I concur that something new might well be more relevant, but then its the relevancy that makes it better and not the novelty. It is not at all given that the newest is the most relevant; it depends. 

I would much rather follow the somewhat impossible advise of Vicor Niederhoffer in his “The Education of a Speculator”, that you should only read books that are at least a hundred years old; it is first when they are still deemed valuable after so long that they have proven their real worth and quality.

The argument is simple;  in times of distress wage reductions will lead to a decrease of aggregate demand, reducing sales in turn decreasing demand for labor and wages.  One has a vicious circle of decreasing wealth and employment.

Some industries where wages / prices are very flexible are particularly vulnerable to this dynamic, agriculture being one. In the great depression farmers where hit particularly hard, prices collapsed and many defaulted on their mortgages. The goal of Franklin D. Roosevelt’s Farm Strategy And The Agricultural Adjustment Act of 1936 was precisely to stabilize agricultural prices and reestablish the purchasing power of the farmers. 

The common notion among economists, is exactly the opposite, that lower wages will increase employment. This sounds logical and is probably most often true, but its important to understand that the dynamics of economics are ever-changing and no universal laws can be made. By looking at – not only – the supply-side of the economy, but also at the demand-side, one realizes that if there is no one to buy your goods it doesn’t matter how cheap you produce them. This follows the reasoning of Henry Ford who argued that the role of a good industrialist was to set wages as high as possible and that all of his workers should afford a Ford Model – T. He reasoned that without demand, there is nothing to sell.

For more on this  see “On the Consequences of Nominal Wage Flexibility” at Economist’s View

The word economics stems from the Greek oikonomia, or simply put: household management. Historically, economists in the English tradition have dealt with how we can allocate the scarce resources we possess as efficiently as possible. The philosopher Adam Smith pointed out how increased division of labor, until an optimal point, will increase welfare. Later, David Ricardo, developed his theory of comparative advantage, explaining how trade can make both trading partners better off. 

What is striking, is that they were writing their works in Britain in the middle of the industrial revolution, not commenting on how innovation and technological development was forever changing the dynamics of growth, enabling an escape from the Malthusian trap (at least so far). In ancient Greece, where technological and economic development from generation to generation was minimal, it may have made perfect sense to mainly focus on efficient allocation of current resources. Luckily, we hardly live in ancient Greece.

Arguably the Soviet Union did not allocate its economic resources very effectively, but it was the lack of innovation that brought it down. Similarly, China is arguably wasting a large portion of its domestic product because of inefficient allocation, but this does not matter very much when yearly growth rates have been more than 10 percent the last decade as technology and innovation is absorbed from abroad. Efficient allocation is only truly important in an equilibrial steady state. We here at Evolution-Revolution have yet to find one off the blackboard, and strongly believe that understanding the dynamics that propel the economy into the unknown should be at the core of economics, rather than optimizing a static economy that only exists in the abstract.