Pursuit of Truthiness

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Archive for the ‘History of economic thought’ Category

Escape from Capital

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The composition of this book has been for the author a long struggle of escape, and so must the reading of it be for most readers if the authors assault upon them is to be successful,a struggle of escape from habitual modes of thought and expression. The ideas which are here expressed so laboriously are extremely simple and should be obvious. The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds. -John Maynard Keynes

The first economic model of growth came from David Ricardo. He thought that capital accumulation was they key to growth, capitalists were heroes, and landlords were villains who would eat into the profits capitalists needed to finance economic growth.

Marx made people think of capitalists as villains, but he was even more obsessed than other economists with the importance of capital for long-run economic growth; he just thought it was too important to be owned by capitalists alone. Capital was the name of his magnum opus and his constant focus.

In the 20th century, economists have discussed many other factors that determine economic growth: institutions, culture, entrepreneurship, human capital, technology. But the old obsession with physical capital has remained.

Joseph Schumpeter introduced the idea of creative destruction, the importance of innovation and entrepreneurs. But at the end of the day, he thought that communism would win out over capitalism because it would accumulate more capital and communist countries would out-grow capitalists. He loved the freedom of capitalism, but thought that communist countries forcing investment in physical capital would prosper more.

Robert Solow created a new model of economic growth, and his empirical tests of the model showed that the vast majority of differences in economic growth across countries could not be explained by differences in physical capital. Instead, we should focus on the Solow residual- the other things like technology that influence the productivity of labor. But Paul Samuelson, friend and colleague of Solow and arguably the greatest economist of the 20th century, still couldn’t shake the old focus on physical capital- his bestselling textbook kept predicting that forced capital accumulation would lead communist countries to surpass capitalist right up until the breakup of the Soviet Union.

New work continues to show the importance for growth of factors other than physical capital- Paul Romer on innovation, Acemoglu and Robinson and Douglas North on institutions, McCloskey on culture. Yet somehow, economists cannot escape from a focus on physical capital. Perhaps it is this, not modeling, that is the true Ricardian vice.

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Written by James Bailey

December 9, 2014 at 1:31 pm

So long and thanks for the $60 billion, Ronald Coase

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There have been a lot of great appreciations for Coase’s theorems after his recent death at age 102.

But one thing I haven’t seen emphasized is his work on spectrum allocation. Coase suggested auctioning off radio/tv/cellular spectrum instead of giving it to select companies through a licensing process.

This has improved life for consumers (speeding the adoption of cell phones, for instance) at the same time that it raised $60 billion for the government. As John Siegfried noted in Better Living Through Economics, this one suggestion brought in more money than the US government has spent on economic research in its entire 200+ year history.

It is worth keeping all of us around even if most are worthless, just in case one turns out to be the next Coase.

Written by James Bailey

September 4, 2013 at 6:03 pm

Institutionalism: Neoclassicism’s Big-Government Twin

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It was not inevitable that economics would end up in anything like its current form.

In fact, even well after much of the basics of economics were developed, Institutionalism remained as a viable alternative. In the 1920’s and 1930’s, two of the four major economics graduate programs in the US (Columbia and Wisconsin) were primarily Institutionalist. The Institutionalists thought of themselves as the wave of the future, creating a more scientific economics that would displace the old.

Nowadays, of course, if modern economists think of Old Institutionalists at all, they often say something like Ronald Coase did: “American institutionalists…. had nothing to pass on except a mass of descriptive material waiting for a theory or a fire”.

So what happened? What is Institutionalism? As you might expect, it focuses on institutions. These are notoriously tricky to define, but their definition is something like “rules both explicit (like laws) and implicit (like social norms)”. Their method was to try to be empirical (focus on the real world) and try to avoid unrealistic simplifying assumptions in theories.

The best-known example of Institutional empiricism is Wesley Mitchell’s founding the National Bureau for Economic Research (now a stronghold of orthodox neoclassical economics) to collect data about business cycles. In terms of goals, Institutionalists wanted to be scientific (which nowadays we might interpret as being impartial, doing positive rather than normative work), but also to achieve social control. According to Malcolm Rutherford, “the phrase ‘social control’ became almost a mantra for the Institutionalists of the time”. Institutionalist Helen Everett said that social control was “perhaps their central organizing principle”. By “social control”, the Instituionalists meant that they wanted society generally to control business, though I can’t help but hear the phrase as meaning that Institutionalists wanted themselves to control society and business. Certainly,  as the “social control” mantra suggests, they were almost always pushing for more government rather than less.

The best-known Institutionalist is Thorstein Veblen, the author of “Theory of the Leisure Class”, after whom Veblen goods are named. Reading his work I have thought he is funny and a master of criticism and satire, but it starts to grate that all his criticism is unconstructive. Apparently other Institutionalists agreed: Rexford Tugwell said Veblen “had discredited orthodox economics and had undermined the business culture” but that “all the constructive work remained to be done”, and Wesley Mitchell started trying in 1910 to push Veblen toward more scientific and constructive work.

Some criticism proved constructive, in that it spurred others to create new and useful tools. Institutionalist economists criticized neoclassicals for not being consistent with the findings of other fields, especially psychology. This should remind you of behavioral economics today, and it sounds quite reasonable to try to be consistent, but it also reveals a possible flaw in behavioral economics: sometimes, economics is actually right and psychology is actually wrong. At least, the early-1900’s psychology the Institutionalists wanted to incorporate was behaviorism (confusingly named since its ideas are unrelated to behavioral economics). Behavioralists wanted to refer only to observable things, not unobservable states of mind. This criticism helped spur the creation of indifference curves (so we don’t refer to cardinal utility, which was thought to be unobservable), and the general economist insistence on only using revealed preference. That’s right, two of the very things heterodox critics of economics like to complain about today were actually developed to answer a previous generation of heterodox critics.

The movement slowly faded away after World War II, after neoclassicals proved themselves more useful in the war planning, answered some critiques of institutionalists (through the Ordinal Revolution and the Keynesian Revolution), and Samuelson and Arrow pushed ahead with their mathematics.   The Institutionalists provide an important reminder that, for better or worse, economics does not have to be the way it is and may not remain this way forever. Institutionalism was the most recent movement to pose a credible threat to orthodox economics from the outside and fail to be co-opted (the way game theory is now at the core of neoclassical economics, and behavioral economics has been appended as an asterisk), but it may not be the last.

Written by James Bailey

April 12, 2013 at 12:29 pm