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.

Clark shoots another one down

If you think “the switch from a self-sustaining organic economy to a mineral resource depleting inorganic economy was central to the British Industrial Revolution” then you’re wrong. The Industrial Revolution resulted in an increased demand for energy; it wasn’t caused by the availability of energy via some great technological advances in coal extraction.

So Prof. Clark argues, coal is not the reason Britain industrialized first. (That’s the fire-walled-even-though-the-research-was-supported-by-public-funds link and here’s the unlocked version. Also, check out Clark’s fancy new website.):

Productivity growth in English coal mining in the Industrial Revolution era was extremely modest even under upper bound assumptions on productivity gains. The enormous expansion of coal output owes to factors external to the industry: increased demands for coal from greater populations and higher incomes, increased demands following on improvements in iron smelting technology, reduced taxation of coal used for domestic purposes in cities like London, and declining real transport costs… English coal reserves, known and exploited since medieval times, simply found a much larger market in Industrial Revolution England.

I wonder if this historical lesson has any relevance today? Where today do we see demand driving changes in the supply of energy? Hmmm…

UC Davis Econ in the News

(… of the blog coverage variety …)

Will Wilkinson writes about Prof. Clark‘s good book:

This a profoundly insightful work sure to raise ire and inspire further progress. Key claim: labor quality is the difference between rich and poor. Depressing claim: Sub-Saharan Africa has largely Malthusian conditions, so success in increasing health and life-spans has decreased the average material standard of living below hunter-gatherer levels. Biggest disappointment: seems evasive on the question of the cause of variations in labor quality. Why not culture?

I should be careful critiquing Prof. Clark’s work, he’s grading my Growth Field exam next week, but I have similar questions about his work.

The professor does a great job of carving out the negative space of whatever topic he’s writing about. In his papers, he tells his readers what can’t explain the phenomenon. He leaves us hanging, though, on what can explain it.

For example, take cotton mills in the 19th century. Many of the countries to develop early, did so via the textile industry. So the mills are important for understanding why some countries are rich today and some aren’t. Why was productivity in Indian cotton mills so much lower than in England in the 19th century (jstor link)? Clark demonstrates it wasn’t because of differences in schooling or the skill of managers or differences in technology or anything else you can think of. What caused the productivity differences then?

Dunno and Clark doesn’t provide the answer either. He does defend himself, though:

These lessons from the mills will undoubtedly seem to some as merely destructive of conventional wisdom on underdevelopment without suggesting any replacement. Nevertheless, identifying the effects of the local environment or culture on the labor force as the source of the poor performance of textile mills in low-wage countries is a significant advance in understanding development. For if we can isolate one factor as supremely important, no matter how poorly we comprehend that factor at present, we are in a much better position to direct future research on economic growth.

UC Davis Econ in the News

(The link from prominent blog type…)

Brad DeLong puts these words in Prof. Peri’s mouth:

If I had Giovanni Peri here at hand, I think that he would say that increased immigration is very good for new migrants, good for savers worldwide, good for native-born workers, good for previous immigrants who have substantially assimilated–social knowledge, English proficiency, et cetera–and probably bad for previous immigrants who have no assimilated. And he would also say that the model goes haywire and is untrustworthy when the number of non-assimilated immigrants is small, and that that going haywire is where the very large income losses for previous migrants is coming from.

And, of course, the thing to object to in the turn this entire debate has taken has been the failure to focus evenly on the consequences for all stakeholders in global migration–look at what happens to everyone, not just one particular group that is convenient for your current political position.

But I will ask him.

From what I can tell, Peri paper shows that because native born workers and immigrant workers are compliments (i.e. working together they produce more than the sum of their individual production), immigrants can help or at least not harm native workers. He hasn’t said anything about “savers worldwide” or “immigrants who have substantially assimilated.” His innovation was to think of workers as compliments not substitutes and he says nothing about the welfare effects of “all stakeholders in global migration.” I’m not sure were Brad is getting all this, but its not Peri’s paper.

Peri has shown complementarities existed. He didn’t identify the source of that complementarity. Maybe the industries immigrants moved into during the period of Peri’s study (1990-2004), like construction, were especially amenable to this happy division of labor. There was a housing boom, if I recall. Maybe the conditions that produced Peri’s counterintuitive result no longer hold. We keep hearing the housing bust is just around the corner.

Or maybe all the complementarities are “used up.” Industries have found all the ways, given the current stock of native born, to split jobs between natives and immigrants to exploit the division of labor.

I’m not trying to take away from the Professor’s paper and politically his results support my position on immigration. Its just not clear to me how Brad DeLong is reading so much into Peri’s paper.

DeLong’s post really makes me angry (its not the first time and by now I should be used to it, but still). Its fine for journalists or lay folk to misrepresent empirical results, everybody knows science reporting sucks. This is different. DeLong is an economist at a prestigious institution. Why is he treating Peri’s results like they’re simply arguments in a political discourse? Would he want me to claim his paper on despots and growth is an argument for the Iraq War? I doubt it.

Are we doing science here or are we just giving ammunition to political causes?

UC Davis Econ in the News

(We need a new phrase that means the same thing as “in the news” but refers to links from high-profile blogs…)

Prof. Peri’s work is critiqued by his evil arch-nemesis George Borjas. (Hey, we have to make this fun some how…)

Borjas has doubts about Peri’s assumption that low-skill natives and low-skill immigrants are compliments. He goes on to say that employers must be big winners in the immigration game because they spend lots of money lobbying Congress to get pro-immigration legislation passed.

Commentator Sami B has this observation, “the mere fact that foreigners at the same skill levels are willing to work for lower wages suggests to me that the “native” labor at time t was merely accruing rents in the form of income beyond the marginal productivity of their labor.” The point: who’s exploiting who? If immigrants can come into the country and do the same jobs for less, then the natives who currently have the jobs are getting paid more than they’re worth.

Actually, this supports Peri’s “hey they’re compliments” theory. Before the immigrant comes, natives are doing two jobs in one. One requires skills (language or other technical skill) and is high paying. The other is manual labor and low paying. When the immigrants come, they take the manual labor job (at low pay) and the natives specialize in the high paid, high skill job.

Division of labor is loverly.

Cargo Cults

The easiest way to explain this idea is to contrast it, for example, with advertising. Last night I heard that Wesson oil doesn’t soak through food. Well, that’s true. It’s not dishonest;
but the thing I’m talking about is not just a matter of not being dishonest, it’s a matter of scientific integrity, which is another level. The fact that should be added to that advertising statement
is that no oils soak through food, if operated at a certain temperature. If operated at another temperature, they all will– including Wesson oil. So it’s the implication which has been conveyed, not the fact, which is true, and the difference is what we have to deal with.

…this type of integrity, this kind of care not to fool yourself, that is missing to a large extent in much of the research in cargo cult science…

The first principle is that you must not fool yourself–and you are the easiest person to fool. So you have to be very careful about that. After you’ve not fooled yourself, it’s easy not to fool other
scientists. You just have to be honest in a conventional way after that…

One example of the principle is this: If you’ve made up your mind to test a theory, or you want to explain some idea, you should always decide to publish it whichever way it comes out. If we only
publish results of a certain kind, we can make the argument look good. We must publish both kinds of results.

Richard Feynman (h/t swong… get a blog dude!)

Deidre McCloskey famously charged that Economics was a Cargo Cult science (pdf). Here’s Davis Prof Kevin Hoover debunking some of her claims (pdf).

Texting the Fed

I think this is cool.

Prof. Cogley warned us against textual analysis a la Romer and Romer today in lecture. Figuring this is a plot to steer us away from interesting research topics (he wants to keep them for himself, of course), I dove right into the Fed meeting notes and did some textual analysis. Below are some results (using this tool):
fed_freq.JPG

More talk about velocity under Volker, but less talk about inflation and unemployment.