Ideas not Institutions, part 1

Prof. Clark gave an interview the other day at the Intrepid Liberal Journal blog. Here’s Clark discussing what national and international governments should (and shouldn’t) do to help those places stuck in Malthusian Traps today:

ILJ: Fair enough. Professor Clark you’ve been very generous with your time. A final question if I may sir. Assuming all your conclusions about the importance of culture in facilitating the industrial revolution are correct, what lessons can we draw from history as we try to influence economic growth in the underdeveloped world in the 21st century?

Clark: Well, the lesson is unfortunately a little pessimistic. But I think one thing that is important is that for fifty years institutions like the World Bank have been applying the same kind of medicine. And it’s like pre-industrial doctors, you try bloodletting, and when it doesn’t work, you conclude let’s do more bloodletting.

ILJ: (Laughs)

Clark: And there is this emphasis now, it seems, a very strong emphasis, on achieving good government in a bunch of African societies which really have a hard time maintaining Western style governments. But yet when you look you see someone like China growing very rapidly with a very corrupt government, terrible social institutions, and the rule of law really evaded on a massive scale (laughs).

ILJ: (Laughs)

Clark: And so when you see this you think maybe to focus all your energies on institutions is not the way to go. What the very clear problem, say, within these African societies, is that even inside production enterprises it’s very hard to get people to cooperate in production in a way that makes workers have high value. And the shocking thing that’s occurred recently is that in Zambia and Malawi, where Chinese entrepreneurs have moved into these very poor African countries, wages are much lower now then they are in most of China. But they’ve actually been importing Chinese workers in factories in sub-Saharan Africa.

ILJ: That’s ironic.

Clark: And encountering a lot of local opposition. The puzzle then is it seems just very hard to get people to cooperate effectively in production in these societies. I think that says this is an area where we really must examine what is going on here. One interesting idea is that the nature of modern technology is very demanding in terms of how careful workers have to be, how exactly they have to follow rules. So one thing to think of is there any way to develop other technologies more forgiving of the cultural histories of these societies? Another thing to look at is if we expose workers more to the kind of Western high income economic life and send them back would that actually help in changing workers attitudes and changing the economic life of those societies? But I don’t have any simple recipe for economic growth, and anyone who does is someone you should avoid.

ILJ: (Laughs)

Clark: I do think that we’re looking in the wrong place, and have been systematically. And it’s the ideology of economics that pushes us there but it’s very clear that it is the wrong place. So it’s at least worth considering, given the true constraints, what can we do? How can we operate? What are the processes we can set in place? And if we are going to solve the problem of poverty in sub-Saharan Africa, the solution is going to come in a very different form then the followers of Adam Smith are going to accept.

Funniest sentence I’ve read today

This first sentence is just here for all the bloggers who want to read the first sentence of the post and then go write an angry rebuttal of my claim that poor Americans should have to torture puppies in order to be eligible for Bandaids.

Megan McArdle

And, no, I didn’t read the rest of the post… even though I’m sure its quite good.

UPDATE: It is good:

If you do believe that there is no right to a decent standard of living, then I won’t argue with you. That doesn’t mean I think you’re right; I disagree rather vehemently. But I’m pretty sure I’m not going to persuade you that you have moral obligations you don’t feel, and you’re not going to persuade me that the American taxpayer should let babies die because they made the mistake of having the wrong parents. How about wandering over to the music thread and making some suggestions? Some of my favourite bands have come via anarchocapitalists.

But what decent minimum standard of living? Liberals, it is safe to say, believe that this should be much more generous than do libertarians; I lean closer to the P.J. O’Rourke axiom that “the biblical injunction is to clothe the poor, not style them”.

and this makes me want to vote for her for President next time around:

The second is that I prefer a system which interferes as little in the lives of the poor as possible. I don’t think the government should be providing vouchers for food and housing; I think the government should be giving poor people money, and letting them decide what they want to spend it on. I support the elimination of almost all government benefit programs, except those targeted at children and the disabled, and a more comprehensive version of the earned income tax credit. In fact, I’d like to see a tax system which has positive and negative rates in a continuously increasing function, zeroing out somewhere around $28,000 a year.

Commitments

People that have large commitments of expenditures (like mortgage payments) are more risk averse on small gambles than big ones (gated pdf). According to Chety and Szeidl, this might explain why people play the lottery:

Intuitively, an agent who earns an extra dollar can spend it only on food; but buying a lottery ticket gives him an opportunity to buy a better house or car, which can have higher expected utility than another dollar of food.

Agents only pursue gambles which have payoffs that would make it optimal to drop prior commitments. To see why such gambles can be attractive, consider an individual who is deciding whether to buy a candy bar that costs $1 or a fair lottery ticket for $1 that will pay $1 million if he wins. A one-good (no commitments) model assumes that the agent will buy one million candy bars if he wins the lottery (or one million units of the composite commodity). In this case, buying the lottery ticket is not optimal because the marginal utility of candy is diminishing, and the agent would be better off getting one candy bar with certainty. However, with commitments, the agent will buy more than just candy if he wins the lottery. While the $1 in hand cannot be spent to buy a better house or car, the $1 million can. Consequently, the expected utility of the skewed lottery may exceed the utility of the candy bar.

BTW, their theory also predicts people with higher percentages of their income tied up in commitments are more likely to play the lottery. Does this seem right? Do poorer people, who play the lottery more often, have more of their incomes tied up in commitments?

Anyway, there model also gives an explanation for the seemingly contradictory facts that in the long run families tend not to adjust their labor supply much to changes in wages (or taxes on wages), but they respond a lot, by adding spouses or teens to the work force, to short term changes in income.

To understand the intuition for this result, suppose the primary earner is temporarily unemployed. If the household has commitments that it wishes to maintain, there is a strong incentive for spouses to enter the labor force to help pay the mortgage and other bills, especially in the presence of liquidity constraints. In contrast, a household that experiences a large, permanent change in wealth will reoptimize on all margins of consumption in the long run, reducing the pressure to make large adjustments on [the number of family members in the labor force].

Studies of behavioral responses to taxation generally find small [effects of the tax on the number hours worked] in households with incomes below $100,000 [e.g., Saez 2004]. The inability to fully re-optimize consumption in the short run may dampen responses to tax reforms because of temporarily amplified income effects. In the short run, households may be reluctant to cut labor supply in response to a tax increase if they have made prior commitments. However, taxes may still have significant effects on labor supply in the long run, when short-run income needs due to commitments are diminished. Hence, empirical studies that focus on short-run changes in behavior could understate the distortionary effects of taxation.

Megan’s model

Megan from up the street in Sacto (that’s Sacramento for you out of town folks) thinks people don’t think enough about risk, they know too little about the various options available in the market and they don’t like to comparison shop and would rather some else would do it for them. She says,

You know what makes good sense for that model of the individual? Government based health care that does a decent job by me. You know what doesn’t make sense? For profit insurance agencies who do not have my best interests at heart.

My model of individuals is very similar to Megan’s. I think they have, what economists call, behavior anomalies. But where Megan and I part ways is in her suggestion that government has my best interests at heart. My model of government is that its filled with people that happen to have the same behavior anomalies as the rest of us. Why should I believe those people, with those flaws, will do better by me than I would?

(h/t MR)

UPDATE: VC has some better thoughts.

SUPER UPDATE: Megan (the one down the street in Washington D.C.) has even better thoughts.

Net neutrality (remember that?)

I didn’t hear about this story when it happened:

AT&T delivered less than [Pearl Jam]’s full performance during its Lollapalooza webcast. The powerhouse telco turned off the audio during the song “Daughter” while singer Eddie Vedder was railing against President George Bush.

Now, I swear I wrote a post a while back opposing Net Neutrality on free market principles. I can’t seem to find that post, now. But the basic idea was that if the industry thinks it needs to provide different services for different customers, I didn’t see why Congress should get in its way. Obviously, more services, meant more choice, more innovation and happier web users. Right!?

Well, the Peal Jam incident or, as Lessig puts it, The Jamming the Pearl incident makes me think twice. If the telco market was competitive at the local level, if consumers got to choose between services and vote with their feet when they saw something better or needed to leave a particularly bad service, Net Neutrality would be a no-go. But we don’t live in that world and maybe this additional regulation would improve efficiency.

Now, I could argue that in the best possible world, telcos would be unregulated, unleashing competition and all its virtues. Instead of instituting yet another regulation, we could do away with them all.

But I realize, given the vested interests, this perfect world is politically unfeasible. So, bowing to political realities, I’m forced to support more regulation instead of none, right?

If so, am I a “second best” economist? Or should I, in my capacity of an economist, inform people about the most efficient outcome (i.e. no regulation, more competition)*, in which case, be a “first best” economist and, in my capacity as a pragmatist, lobby my Congress people to support Net Neutrality, in which case, be a “second best” voter?

Are economists pragmatists when giving policy advice or idealists? If its the former, do we have any special ability or training to analyze and give advice about political realities?

*Assuming the IO folks are with me on this one.

The Economist needs to have more faith in markets

Because the comments section at the Economist has an excruciating registration process — I’ve attempted and failed to sign up at least three times now — I’ll ask this question here. Maybe the internet gods will get this back to the Economist blogger’s ear…

Why is “the purchasing of carbon credits” analogous “with medieval Catholic absolution”?

The Church was absolving sins in the name of God. It was obviously a racket; as if the negative of the sin could be somehow removed by a blessing and so many Hail Marys (and the lining of a pocket or two).

In the case of carbon credits, we can actually erase the sin of carbon emissions. Yes, the Vatican planting trees in Romania makes it hard for Romanians to plant trees (and offset carbon emissions). Trees aren’t the only way to offset carbon though. There’s lots of talk of artificial carbon sequestration. These techniques will become more and more profitable as a) demand for them increases and b) natural sequestration becomes more expensive.

You’re The Economist for criminy sakes. Have more faith in markets!

In which two smart economists talk past each other

This back and forth between Brad Delong and Dani Rodrik makes me think economists are ill equipped to talk about the second best world in which we live.

Dani says that bad constitutions prevent the necessary flows of factors (labor and capital) to make free trade policy effective in getting us to the first best world (where market outcomes are efficient and we dance naked in the streets singing songs of praise to Milton Friedman):

The two situations are alike only in the limiting (and counterfactual) case where government-imposed tariffs are the only transaction costs blocking economic exchange across international borders. In reality, national borders demarcate political and legal jurisdictions, which means that there remain plenty of transaction costs which block economic convergence. Capital flows are hindered by sovereign risk and the absence of international regulation and lender-of-last resort functions, which create the kind of syndromes that I often discuss in this blog. Labor mobility is severely restricted. And differences in regulatory regimes impose severe transaction costs (estimated by Jim Anderson and Eric van Wincoop to be of the order of 40% in tariff equivalents) on international trade. In the presence of these transaction costs, free trade in goods (in the sense of zero import tariffs) is in general incapable of achieving rapid economic growth and economic convergence in poorer nations of the world. If you do not believe this, just ask the Mexicans.

Within this U.S., economic convergence is achieved because there is a common constitution, a federal judiciary, nation-wide financial regulation, and free flow of labor.

Rodrik concludes we’re stuck in a second best world where it makes sense to have restrictions on trade, via “industrial policy” (read: government control of the markets) in the developing countries.

Delong responds by quoting Lant Pritchett “there is nothing as catastrophic as state-led development led by an anti-developmental state” and adds:

Any argument to commit a government to an active protectionist industrial policy must be accompanied by arguments about why the government will be capable and effective in this role when it has not been capable and effective in its primary roles of establishing property rights, providing tolerable administration of justice, building infrastructure, and providing education.

Rodrik counters:

Brad DeLong does not express my views accurately… In the absence of these [free flow of factors], trade liberalization does not get you there. You are in a second-best world and you need to think appropriately. The idea that developing countries cannot employ industrial policy in such a world to good effect is downright silly…. Here is a thought experiment: does anyone really believe that China would have grown as fast as it did if it had removed all its tariffs and trade restrictions in 1978, instead of liberalizing strategically and sequentially–first in agriculture, than in industry, then on the export side, and only later in the 1990s on the import liberalization side? There are many reasons why the Chinese strategy worked, but one of them is that it protected employment while industrial capabilities were being built up.

Finally, Delong responds with a nice, long post about the immediate post-Mao economic policy of China. He describes the second best policies China put into place to jump start its amazing, so far, track record of economic growth.

Its important to point out that Delong isn’t conceding the point. He’s merely pointing out China is the exception that proves the rule. “Any argument to commit a government to an active protectionist industrial policy must be accompanied by arguments about why the government will be capable and effective in this role.” Delong has Deng Xiaoping as the hero that saved China from disastrous Mao era policy and made the Chinese government a credible force for development thus justifying its second best policies.

I think my Professor Woo would disagree (pdf). 72% of the work force was employed in unsubsidized agriculture when Deng instituted market reforms. These reforms, creating a non-state non-agricultural sector, unleashed normal economic development as peasants streamed into these new and profitable industries. Any pain from those reforms was masked by great increases in productivity.

Woo argues that growth occurred in China despite gradual reforms. Gradualism wasn’t a series of second-best policies, but it was a result of the political reality in China. Gradual reform was the compromise between old statists and the people that recognized communism wasn’t working. Perhaps growth, and the structural transition inherit in it, would have come faster with faster reforms.

Plus, with only 19% of the population in subsidized industries, there was no credible threat of “riots and revolution as the now-unemployed urban manufacturing workers overthrew the government.” The only credible political force was the millions of peasants (and their pitchforks). The Soviet Union, with 93% of its population in subsidized heavy industry, was a different story.

Deng may be a hero, but its not because he orchestrated some great path of reform. Rather, he had the “courage” to take the pebble out of the dam holding China’s economy back; holding the peasants in the countryside*.

China isn’t an example of a credible pro-development government being entrusted with an “industrial policy” filled with second best policies. It, like Japan’s recovery after world war 2, is an example of the power of millions of people freed to do their business as they see fit in an economy running much below its potential.

*Ok, with TVEs peasants didn’t really leave the countryside. But if you can’t bring the peasant to the city, bring the industry to the peasant, I always say.

Health Care, again, but this time real people talking…

… in a real comment thread. Only authenticity from this blog…

Check out this Crooked Timber thread. The post itself is so-so, but the comments starting here are pretty good.

Slocum writes:

The idea that only flinty-eyed capitalists try to deny or delay treatment and that this never happen with government funded health systems is ridiculous.

and abb1, a regular commentator at CT, replies:

In the for-profit case only financial considerations apply. In the government case financial aspect is one among many.

My take is that “financial considerations apply” (in the first order, which I think is what the abbster is talking about) only when corporations are myopic. Pissing off customers isn’t a great business strategy, especially if the corporation wants to keep its customers. In fact,

[p]eople in the U.S. are probably much more satisfied with our health care system than Moore’s overly pessimistic portray of overwhelming dissatisfaction. For example, 88% of Americans say their own health care coverage is excellent or good, and 89% are satisfied with the quality of care they receive (see chart above). If about American 250 million people are insured, that means that there are about 225 million people in the U.S. who are satisfied with their coverage and medical care – and this overwhelming majority of satisfied American never made it into the movie.

It’s true that Americans express lower levels of satisfaction when asked about “health care in the country as a whole,” and 80% are dissatisfied with health care costs and 54% are dissatisfied with the “quality of health care.” In other words, according to Reason, “Insured Americans are overwhelmingly (89%) satisfied with their own care, while broadly concerned about rising costs of prescription drugs and critical of the care others receive.”

Here’s that Reason article and if you read the Carpe Diem post you’ll find he has an interesting prescription for curing American health care. I won’t ruin the surprise but it has to do with the artelCay of octorDays.

Best MR comment this year

… is this comment by John Thacker on this post:

Neoclassical economists argue that however people behave, they are expressing their true preferences. However people behave, they are right, according to the neoclassical economists. Any behavior that differs from stated assumptions of what is right is really showing some sort of revealed preference, demonstrating that the person herself has some different standard of what is best for herself than the supposed experts.

It is the paternalists and the behavioral economists who argue that people are “wrong” in their choices. It is the paternalist and the behavioral economists and the busybodies who “wish to depose of their people and choose a new one,” deciding for them because they are “irrational” and make the “wrong” choices. It is the paternalists and the behavioral economists and others who believe that people are irrational who think that people must be protected from their wrong decisions, who should have others decide.