Development reform and economic freedom

Chris Blattman has an interesting post on development reform and the paths to pursue. He considers what development reformers should focus on when rule of law is weak or absent. However, he misses an important point. Reformers can eliminate legal barriers to entry for businesses.
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To understand this point, let us differentiate between reforms which have the state act and reforms which have the state restrict its sphere of action. State action includes both new initiatives and reforming existing ones. Restricting a state’s sphere of action is the elimination of existing programs.
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In a state with corruption and weak rule of law, any state action will necessarily be effected by that corruption. The more corruption, the less effective any state action becomes. On the other hand, restricting state action is not effected by corruption. Because the state is not acting in a sphere, the effectiveness of a state’s capacity to act is not irrelevant to the outcome.
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Take for example two possibilities. A state could introduce a new unit in the police force or eliminate legal barriers to entry for private schools. If there is corruption in the old police force, the new unit is at a high risk for corruption, which would greatly reduce its effectiveness. On the other hand, eliminating barriers to entry for schools would not be effected by corruption. Some bureaucrats would be shuffled around or let go, but corruption or lack of rule of law would have little effect on implementation.
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What this analysis suggests is that on the margin, development reformers should focus on reducing the sphere of state action in states with less rule of law and more corruption.

Critiquing McCloskey

Adam Gurri has asked me for my opinion on a recent piece by Deirdre McCloskey. So, now seems a good a time as any to write about some of my misgivings of McCloskey.
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First, and this applies not only to McCloskey, attempts to explain important events should embrace uncertainty. When I read McCloskey and others, the industrial revolution was caused by institutions or ideas or X or Y. Every author has a fairly precise understanding of the factors of the industrial revolution. In reality, given that we are still arguing about it, I am skeptical of their certainty.
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Let’s imagine a future where we can simulate earth on the eve of the industrial revolution. With this advance we can make slight changes in institutions, ideas, and other factors to evaluate the impact on the timing, speed, and sustainability of the industrial revolution. Without these simulations, we could still have a betters market based on what those simulations would reveal. I doubt the odds any of the scholars place on their model are 100-1, and I imagine they would place different confidence on different parts of their models. As such, we should be honest about confidence levels in the current models, something that is rarely seen in such scholarship. As an aside, I imagine McCloskey would deny the applicability of the above thought experiment, but that is a discussion for another day.

Second, I greatly prefer McCloskey’s previous writing style. I found myself unable to understand several of her points, requiring a rereading. The essay also reads like a stream of consciousness, there is no single point, rather numerous smaller ones.

Third, I would like to give my understanding of the neo-institutionalist account of the industrial revolution. Glorious revolution was an institutional change that led to more commerce. Along with the increase in commerce technological innovation hit an inflection point of no return. The institutional change was a necessary, but not a sufficient factor to generate economic growth.

The role of technological change is also tricky to understand. We can imagine a set of undiscovered technologies. However, the set is heterogeneous. To have sustained technological improvement requires being in a part of the set where the undiscovered technologies are close enough together to allow for sustained advancement.
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For example, it is difficult to imagine sustained technological change coming after the discovery of fire. The following discoveries, how to cook meat, how to heat forge metal, etc, are all sufficiently complicated that we expect them to take generations to discover and perfect. For sustained economic growth of the kind experienced since the industrial revolution there must be a much faster advancement of technology.
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Now, perhaps undiscovered technology was sufficiently lumped together for sustained economic development in previous time periods, but political repression never allowed economic growth.

McCloskey critiques neo-institutionalism, arguing that a change in institutional equilibria cannot account for the 20-30 fold rise in living standards. However, this is an uncharitable view of the neo-institutionalists, as they would argue that the new institutional equilibria was necessary for technological advancement. Knowing government agents wouldn’t shut down your artisan shop for infringing on some government monopoly is crucial for economic growth.

Fourth, the critique McCloskey applies to the neo-institutionalists can also be applied to her. A change in ideas alone is unlikely to lead to 20-30 fold increase in living standards. Also, I believe she overstates the effect of a change in ideas. Many people in modern society have beliefs others find abhorrent. However, those people find groups which share their ideas, lowering the cost of holding them. There is little reason to believe merchants in England wouldn’t find associate amongst themselves lowering the cost of holding those ideas.

Fifth, McCloskey seems to conflate two things, the industrial revolution and economic development. The quick rise of East Asian tigers seems to suggest than an institutional change is enough to spur economic growth. Perhaps other conditions are necessary for the industrial revolution, but catch up growth seems to rely less directly on ideas.

Sixth, she argues that things like identity and morality cannot be captured by neo-classical economics, but gives little reason as to why. A simple explanation of identity and morality is they serve to signal in group status. People want to trade with people who have a shared set of expectations about what constitutes fair trade. More importantly, they want to live with people with a shared understanding of permissible violence. Because the most convincing person is one who believes what they are saying, identity and morality are a central part of humanity.
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Seventh, and this applies to McCloskey more broadly than just this paper, what basis does she have for abandoning central economic assumptions. For ideas to matter either preferences are not constant (what she seems to be arguing given her jabs at de gustibus) or rational expectations is false. You cannot have all constant preferences, rational expectations, and ideas mattering. Given the importance of constant preferences and rational expectations the burden of proof is on McCloskey to change methodological assumptions. This burden of proof is especially difficult to reach in complex problems, and she fails to meet it.
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Lastly, McCloskey is arguing that economics should embrace speech, stories, shame, and the Sacred. I agree. Economists should also take culture more seriously, take beliefs and morality more seriously, and rely less on complex mathematics. However, economists can do all that just fine within the existing framework.

Further typologies of property

My first typology of property is here. In it I differentiate between contract enforcement among family/friend, anonymous strangers, and government.  Adam Gurri responded, postingray ban sunglasses Best Price

You are definitely correct that the literature and experience has demonstrated that voluntary mechanisms are possible and widespread. Instead, it’s a matter of whether you can stop strangers from breaking into your house and stealing your stuff without government, which to my mind is a separate question from how behavior within the context of transactions is disciplined. I’m not sure the answer is as clear there; certainly *some* sort of threat of force is often required.

His point made me realize my typology was incorrect. We must not only consider the enforcement of contracts, but also immediate violence and theft. Therefore, the typology can be further broken up. Below is a table illustrating the possibilities.

Contracts Violence/theft
Family/friends 1 2
Anonymous strangers 3 4
Government 5 6

The first question is what protects against breaking contracts or violence and theft among family and friends, 1 and 2 in the table. The answer, repeated interaction.  It is a losing strategy to defect when the person is able to defect the next round.  This is a consensus among economists that state enforcement is unnecessary for small homogeneous groups.
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The second part is more interesting, how to enforce contracts among anonymous strangers, 3 in the table, and how to ensure there is no violence and theft against anonymous strangers 4. Most economists are unclear on the distinction between the two options, however it is an important one. There is much evidence, international trade being the primary one, that state enforcement is unnecessary to protect contracts among anonymous strangers.  However, as Gurri pointed out, the state is likely necessary to protect against violent expropriation from anonymous strangers.
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As such, the state exists less to protect private property per se, and more to protect against a specific type of encroachment on private property. In fact, given that many major American cities did not have police departments until the mid 19th century, it seems state exist primary to prevent large scale violence.
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The last section is less interesting.  Government has little incentive to violate contracts because it is usually easier to directly expropriate wealth.  The disagreement is how to ensure government does not expropriate wealth.

A typology of property

Property is not a relation between men and an object. Rather, it is a relation between men and other men about an object. It is a set of implicit and explicit norms governing a set of rights over objects, who can do what to what object. My ownership of the computer I am typing this on affords me a series of rights about a set of actions I am able to take with this computer that others are not able to take.
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With this in mind, I want to propose a typology of property. Because property is defined by the relation of men amongst men, property can be differentiated by the different types of relationships amongst men. There are two sets of players in property, the owner(s) and the non-owners. By differentiating the non-owners there are three main categories which can be differentiated.  First, property where the non-owners are family and close friends.  Second, property where the non-owners are anonymous strangers.  Third, property where the non-owners are government.
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It is important to clarify that all property has all three relationships.  However, because each group of non-owners will treat the property differently it  is useful differentiating them as an analytic tool.  Family and friends rarely need explicit contracts governing their relationships.  Instead, repeated interaction is sufficient to generate incentives to prevent abuse of property.  Anonymous strangers require explicit contracts in order to ensure they do not abuse property.  Explicit contracts are insufficient to protect property from governments.  Instead, the government must be constrained by a series of norms which constrain its action set.
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Take, for example, a house.  With a house usually family is allowed to use it to a wide set of ends.  Of course, there are certain implicit rules, do not burn down the house for example.  However, immediate is generally given permission to raid the fridge, cook, sleep on couches, watch tv, etc.  Friends are typically a little more constrained.  Close friends might be able to enter and exit as they please, but usually the owner requires his presence for them.  However, no explicit contract binds them.

Anonymous strangers have a different set of rules for a house.  With the success of airBnB, we can see how renting a house to strangers differs from letting family members crash there.  There is an explicit contract detailing what the strangers may and may not do.  There is typically a defined way to resolve such disputes if they do arise.  Third party enforcement works for the anonymous strangers.
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Third party enforcement does not, on the other hand, work for government.  Because government has a territorial monopoly of force, they can choose to violate contracts if they wish.  Instead, government is constrained by two things; a set of norms which define acceptable actions for government and power relations among groups in the ruling coalition.
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Such a distinction is useful for analyzing economic growth.  Virtually all economists agree that contracts are stable in small homogeneous groups, essentially family and friends.  While there is disagreement over whether government is needed to enforce contracts among anonymous strangers, most evidence suggests markets can come up with mechanisms to enforce contracts among anonymous strangers.  However, ensuring a government does not plunder a populace is far more difficult.  Markets alone are unable to do so.
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While this typology is present in the works of many economists, Hayek differentiates between family and friends and strangers, Acemoglu and Johnson differentiate between strangers and government, it has never, to the best of my knowledge, been explicitly presented.  I imagine most of the dispute among economists is whether markets can enforce contracts among anonymous strangers without government.  However, as I believe a close reading of the evidence, the existence of international trade, and the sharing economy demonstrate, the real problem lies in constraining government.

 

 

Proprietary cities and institutional change

Alex Tabarrok has an interesting post on proprietary cities in India.  He writes,

In Lessons from Gurgaon, India’s private city (working paper) found in a new book Cities and Private Planning  Shruti Rajagopolan and I explore this question. Gurgaon, which I have written about before, shows both the successes and failures of private development. On the surface, Gurgaon is a gleaming, modern city built nearly overnight on wasteland. Gurgaon was built, however, without benefit of planning and its failures–most notably poor and inefficient provision of  water, sewage, and electricity–are a warning. The failures all stem from high transaction costs, Gurgaon’s private developers have simply not managed to Coasean bargain and internalize externalities. It’s clear from Gurgaon that cities need advance planning–a reservation of rights of way for water, sewage and electricity at the very minimum–but does the planning have to be provided by government which is often incapable of such foresight?
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The lessons of Jamshedpur, India, suggest another approach. Jamshedpur is a private township, planned from the beginning by visionary businessman Jamshetji Nusserwanji Tata, who, after travelling to the United States to see Pittsburgh, returned to India to found Tata Iron and Steel. Jamshedpur has been run by a single, integrated entity for over 100 years and as it is integrated it has internalized externalities. As a result, Jamshedpur, India’s other private city, has some of the best urban infrastructure in all of India.

While supplying good infrastructure is important, it pales in comparison to the importance of institutions.  If these developers are going to spend hundreds of millions or billions of dollars why not lobby the state to opt out of onerous laws.  Florida created a special district for Disney to create an amusement park.  Surely the benefits to India would be far greater.
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SEZ growth

 
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The Growth of SEZs suggest governments are increasingly willing to grant local legal autonomy.  Proprietary cities could start by opting out of licensing laws and other trade restricting legal burdens.  Such a process would have to be carefully managed, but eventually (or sooner) allowing a proprietary city to hire a common law judge to adjudicate disputes seems to have little downside.  Why not give it a try?
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Edit: Thanks Tom Bell for the graph.  Be sure to watch out for his new book Your Next Government?

Culture and space colonization

Consider the following thought experiment.  Earth is dying, unable to further sustain human life.  Mankind has thrown their last resources into creating a space ship that can reach a habitable planet.  However, the space ship can only carry 10,000 people and little is known about the planet beyond gravity and oxygen levels.  With the literal fate of humanity lying before us, who do we send and why?
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Traditionally, attempts to answer this question have focused on individuals.  We would pick the most outstanding specimens of humanity, our greatest scientists and athletes.  However, there is a more important dimension to consider, what cultural group should we send?  To further refine the question and focus the mind, if we could bet on the outcome, which cultural group would have the highest probability of success?
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For all the praise of multiculturalism, no one would seriously bet a diverse group of cultures would give the greatest chance for success.  Even if we ignore the obvious language barrier, consider how children are raised.  What is standard practice for one culture might be considered child abuse in another.  The differences in raising children are merely indicative of numerous other problems which arise among different cultural groups.  Ethnic fractionalization is associated with numerous bad outcomes in the economics literature.
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Picking a cultural group to colonize a new planet and save humanity forces the mind to focus on positive and negative attributes of the cultural group.  Positive aspects include trust as well as a tradition of liberal democracy.  Without trust impersonal exchange becomes nearly impossible.  Further, a people who have only known tyranny are likely to recreate such tyranny in their new homes.  A last consideration is the malleability of their formal institutions.  A new planet will likely present new challenges which require new solutions.  As such, a people with a history of adapting would be better than a people without.
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My personal choice would be to send the Swiss.  Their informal institutions are comparable to other first world countries.  Their form of government, Cantons, which is likely to be recreated in part in the new planet, is what gives them their decisive advantage.  By decentralizing the provision of public goods they will be able to respond more rapidly and effectively to the new challenges that await them while giving a new life for humanity.