Sunday, January 25, 2015

Follow-up on "Why nations fail"

So, halfway done with the book "Why nations fail". 

The premise is simple: extractive institutions limit a nation's growth and benefits a few at the expense of many, while inclusive institutions cause the opposite: they foster competition and level the playing field, promoting a meritocracy that results in more a more prosperous nation.

Guns, germs and steel author Jared Diamond and other scientists/economists/academics argue that while authors Acemoglu and Robinson have a point, they're being overtly simplistic and are thus excluding other important factors (like geography, culture, etc).

David Levine, an American economist, and two of his colleagues wrote an interesting review of the book, questioning Acemoglu and Robinson's theories directly: their review presents Germany as a special case - a country that fared both well and badly under extractive (National Socialism during the 30's and 40's) and inclusive (the Weimar Republic) institutions. It turns out that Germany fared particularly well under the Nazi regime, having almost conquered most of Europe during the Third Reich, dominating their neighbors easily via their military force and industrial/economics prowess. 

At the time, it turns out, Germany was also neck-and-neck with other countries in terms of advances in technology, something that contradicts one of Acemoglu and Robinson's hypotheses: that extractive institutions ultimately fail because they don't advance technologically. And no one can deny that Hitler's government was anything but extractive. 

Veering towards an inclusive institution - before Nazi Germany, and after Imperial Germany came the Weimar Republic. Germany's transition to a more democratic state during the early 20th century turned out to be a disaster. Hard to believe, but Germany went through hyperinflation during that time. 

Inclusive institutions, thus, do not automatically provoke its agents to summarily choose or decide to take on the best economic and political policies. 

Meaning: inclusive institutions do not guarantee prosperity.

Extractive institutions, it seems, can advance in the realm of technology, and not necessarily meet an unavoidable dead end. 

Meaning: extractive institutions are not necessarily doomed to fail.

Both inclusive and extractive institutions can thus be good and bad for their nations.

To be fair regarding the Germany Case Study as profiled by Levine et co: the review authors might do well to study Russia and their extractive institutions during the Cold War years. Acemoglu and Robinson do mention how the Russians were advancing at an accelerated rate, during the Soviet era, but point out how that came to an end because of technology. And how even economist Paul Samuelson predicted that the USSR would (or could) overtake the US in economic terms. 

Amidst such contradictions, doubt now pervades in my mind. 

While simplicity, they say, is the seal of truth - in attempting to prove and answer whether inclusive institutions are all a country need to prosper, I'd go with the stereotypical consultant's response: it depends.

But, like so many other theories and hypotheses, it does not necessarily matter, if in the end, the research that led up to the original premise provides thought-provoking theory that effectuates change

Change could come from mere consciousness. 

I have found Acemoglu and Robinson's hypotheses about institutions to be a useful base to start from, particularly when thinking about my current perception about what goes (and has gone) on in Mexico. 

James Robinson wrote an apt account about Mexico, under the "Why nations fail" guise. True or not, having described in detail how Mexico's current and past political institutions have shaped the country, and how specific perverse incentives, have led to certain consequences, resonated with me.  

The wise adage holds that those who do not learn from history are bound to repeat it. At the very least, I think that somehow the authors are asking us to do the same (regardless of whether their theories hold water, or hold 100% of the water, as it were).

Sunday, January 18, 2015

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 1972

After a longer-than-expected break, Pseudoeconomics' Nobel Prize in Economics series is back.

Article preparation for this series has been a difficult task. The straightforward predetermined path that leads to a proper series post could invariably involve a mix of copy-pasting, sloppy appropriation and smart paraphrasing. I'll do my best to avoid this easier path. I am not beyond falling prey to regurgitating online information, there is no academic authority revising my work after all, but following that path would be somewhat wasteful. And boring. Not to mention painstakingly unoriginal.

The series' purpose is to promote research and a general background about how the nobel prizes in question came to be. Attempting to understand the nuts and bolts behind major breakthrough theories and advances in the realm of economics, albeit conceptually, is of tremendous value to an amateur economist.

And as such, posts like these belong in a website dedicated to an opinion-based take on economics and related subjects.

Having cleared that up, let us begin:

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 1972 was awarded jointly to John R. Hicks and Kenneth J. Arrow "for their pioneering contributions to general economic equilibrium theory and welfare theory"

To appreciate what John Hicks and Kenneth Arrow were celebrated for, it became fundamental to first brush up on the general economic equilibrium theory. A first glance at the theory quickly leads to Leon Walras, who first pioneered the concept. A pattern emerges amongst those who came to pioneer (Walras) and then revolutionize (Hicks and Arrow) the theory: they were all mathematicians first, economists second. 

Walras was influenced by his father, Auguste Walras, who pushed him to apply mathematics to economic theories. Leon Walras' subsequent findings, were a product of beauty, as complemented by Antoine Augustin Cournot, French mathematician and Auguste Walras' teacher (possibly mentor) who laid the early foundations for econometrics and published influential work on monopolies and duopolies

John Hicks touched on what the general equilibrium theory had not built on, mainly additional assumptions regarding consumers (demand) and producers (supply) behavior. More than complementing the theory, what Hicks did was to fortify it. He nurtured it by "spreading the word" via his book Value and Capital, with fellow contemporary economists, giving the theory a new audience, who, by then (1930's - 1940's) were developing alternate theories that would fit in nicely with his. Hicks also formalized comparative statics in the book, which has become second nature to any Economics student. Ceteris paribus notwithstanding, comparative statics is a nifty tool that helps understand how endogenous or exogenous factors affect an equilibrium. 

On that same line, it comes as no surprise that most of Hicks' work opened up the possibility for others to take what had previously been put forth (by, for example, school-of-thought defining economists like Keynes) and tinker with the different formulas, provoking thought and new questions. Application became primordial. It was as if a non-digestible ultra-nutritional food was suddenly synthesized to an easy to eat meal. Not only that, as time went by, good taste would become part of the deal too.

The general economic equilibrium theory can get complex, in terms of the dynamism it takes on when taking into account how a supply-and-demand equilibrium can be affected by price (most notably), time, consumer choices, the production function, facing simultaneously the complications that arise from marginalism, and other factors. Hick's nobel prize lecture sheds light on what he had been thinking when he approached the general equilibrium theory, and the factors that distort it. The production function, he says, is affected by invention. Of course! Isn't that obvious? 

Not in the least. But, going back to the most primary part of the general equilibrium theory - it is widely understood that good's prices, above all, affect other good's prices, and so forth, until an equilibrium, via normal economic activity, is produced. 

Part of what has not been mentioned regarding Hicks' and Arrow's prize is the advancement in welfare theory, which itself was shapen by a Walras and Cournot colleague, Vilifredo Pareto. Much like his peers, Pareto was passionate about veering towards economics as a more scientific discipline, gently leaning away from the more moral philosophical side of things. Still, every Economist mentioned in this post was a philosopher, except for Hicks and Arrow. 

That fact is understandable: as Economics progressed, so did the interests of those that advanced it. Mathematical and scientific inquiry was now a must - and if anything, other disciplines would now have to be such that these would comfortably take on issues like behavior. Psychology in economic theory has now become important, and behavioral economics has been given equal footing as well. 

Continuing the report on what Hicks prepared for others - If we throw in wages, savings, investment, (Hicks was also responsible for the IS-LM model) growth, and business cycles in the mix, the concocted potion becomes more potent. Hicks references John Stuart Mill and also shakes Adam Smith's invisible hand all throughout his research. It's great to see how giants rest on the shoulders of other giants. Continually.

While Hicks did much for general equilibrium theory, it was Arrow, through the Arrow-Debreu model who rigorously developed a model that proved the existence of general equilibria in any given economy. Per his additional work, Arrow's endogenous growth theory caused an interesting conversation to get going, given that not long before Arrow's time, it was generally believed that mostly exogenous factors caused technological change (and thus advancement). Still, what Arrow did, in my opinion, was not only to theorize, but to focus on the positive aspects a first world country, that invests in research and development, education and forward-thinking social programs might produce in terms of growth. In a similar way, Arrow sets forth an interesting take on political theory through his impossibility theorem. 

Technological change, much like politics are practically impossible to observe closely and measure, but are aspects of Economics that merit academia's attention nonetheless. Other economist's growth & social models and theories have benefited and followed suit.

Both Economists were visionaries in their own right - Arrow still is. He is the youngest Economics Nobel Prize Winner to date, which makes it no surprise that he is still amongst the living.

To conclude, something Arrow wrote, that encapsulates the past and future of the general equilibrium theory. Very well put:

'“From the time of Adam Smith’s Wealth of Nations in 1776, one recurrent theme of economic analysis has been the remarkable degree of coherence among the vast numbers of individual and seemingly separate decisions about the buying and selling of commodities. In everyday, normal experience, there is something of a balance between the amounts of goods and services that some individuals want to supply and the amounts that other, different individuals want to sell. Would-be buyers ordinarily count correctly on being able to carry out their intentions, and would-be sellers do not ordinarily find themselves producing great amounts of goods that they cannot sell. This experience of balance indeed so widespread that it raises no intellectual disquiet among laymen; they take it so much for granted that they are not supposed to understand the mechanism by which it occurs.”'

For an excellent and technical take on the general equilibrium theory, read Stanford Economist's Jonathan Levin's 2006 paper "General equilibrium"

What good are Economists?

As redirected by Greg Mankiw - via his blog.

Robert shiller explains

An interesting excerpt:
We do not blame physicians for failing to predict all of our illnesses. Our maladies are largely random, and even if our doctors cannot tell us which ones we will have in the next year, or eliminate all of our suffering when we have them, we are happy for the help that they can provide. Likewise, most economists devote their efforts to issues far removed from establishing a consensus outlook for the stock market or the unemployment rate. And we should be grateful that they do. 
In his new book Trillion Dollar Economists, Robert Litan of the Brookings Institution argues that the economics profession has “created trillions of dollars of income and wealth for the United States and the rest of the world.” That sounds like a nice contribution for a relatively small profession, especially if we do some simple arithmetic. There are, for example, only 20,000 members of the American Economic Association (of which I am President-Elect); if they have created, say, $2 trillion of income and wealth, that is about $100 million per economist. 
A cynic might ask, “If economists are so smart, why aren’t they the richest people around?” The answer is simple: Most economic ideas are public goods that cannot be patented or otherwise owned by their inventors. Just because most economists are not rich does not mean that they have not made many people richer.
Social science problems.