Free Markets Don’t Provide Enough Entrepreneurship

Dear Reader,
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Please consider the following argument in abbreviated form (original here).
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“Information is a public good because its consumption is nonrivalrous and it is very hard to exclude nonpayers from acquiring it once it has been generated. Thus in equilibrium the market will tend to provide too little information. When an initial entrepreneur discovers a new profitable product (the smart phone or the personal computer for example) he generates information on the profitability of this new product. If there is free entry, other potential entrepreneurs will use this information and will enter the market as producers of this new product. Because the information generated by the initial entrepreneur on the profitability of the new product is non rivalrous and it is very difficult to exclude others, the information generated by entrepreneurship will be under provided. In other words, in a free market, in equilibrium, entrepreneurship will be underprovided. Hence government must subsidize entrepreneurs.”
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What can be said in terms of Public Choice? What can be said in terms of pure theory? Please be social and answer in the comments!

Equilibrium, Disequilibrium, Non-equilibrium

Equilibrium and non-equilibrium systems have been a recurring theme at many panels in this year’s SEA conference leading me to muse on the differences between them. Please note that non-equilibrium is not the same things as disequilibrium. The difference being that disequilibrium is a property of some systems that have (stable or unstable) equilibria, usually used to characterize the dynamics of the system when outside of equilibrium. On the other hand non-equilibrium systems are systems that do not posses equilibria.
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One common, avoidable, and completely unnecessary confusion is that the way one can tell the difference between disequilibrium and non-equilibrium is through stability analysis, of the type that can only be carried out with mathematical models. We must not confuse physics envy for analytic sophistication. This view entails confusing non-equilibrium for systems with unstable equilibria (typically by analyzing the properties of fixed points in dynamic systems, Strogatz has posted all his lectures online, Yey!). But non-equilibrium is a category that applies to systems, not a property of those systems that have equilibra, a category mistake.
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Consider the definition of economic equilibrium: the vector of prices and the vector of quantities such that all possible gains from trade have been exploited. Two things that have been extensively pointed out by others are immediately apparent, equilibrium can never describe any real economic system unless all change is considered to be exogenous to the system. It then follows that if we assume that all change is exogenous, entrepreneurship is a disequilibrium path that characterizes the response of the system after it gets jolted out of equilibrium. In an equilibrium universe entrepreneurship is the name we give to disequilibrium, which is then by definition always equilibrating. This is as formal a definition of a closed ended economics I can give imagine. An open ended economics can then be defined simply as a non-equilibrium economics, and while it may seem difficult all it entails is to recognize that economic models are not representations of reality in the same sense that physics models are. Entrepreneurship is driving the dynamics (but what of coordination? more on that to come) of the non-equilibrium system, while in equilibrium/close-ended economics, entrepreneurship is merely the name we give to disequilibrium adjustment of the system.
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Cargo Cult Development: Signaling in the upper echelons of higher education

Ecuador, my home country, is hell-bent on increasing the production of individuals with advanced degrees. Through highly (ridiculously?) onerous regulatory requirements, generous scholarships, and billions of dollars invested in higher education infrastructure, the self proclaimed socialist of the XXI century government has led a big push for higher education. Although the claim is grounded on the positive externalities of education and the formation of human capital as necessary for development, I have always wondered whether the big push for education is more like cargo cult development rather than genuine development. What the pacific islanders did not understand when they built their airstrips and waited for goods to fall from the sky, is that airstrips and the accompanying capital structure that produces goods are consequences of development and not their cause. It is fair to ask whether governments undertaking massive investments in education like building billion-dollar research sites are they making the same mistake.
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Of course the immediate reply by most economists is that education is not like cargo cult development because we can identify the mechanism behind such development, specifically in endogenous growth models. The logic is that increasing human capital, especially in advanced degrees, increases the production of knowledge that due to its non-rivalrous and partly non-excludable nature spills over the productive sector and raises productivity and standard of living for all. Thus the positive externality of knowledge justifies public investment in R&D in this case by subsidizing the production of individuals with more advanced degrees. After all the mantra of economic growth for a little over 20 years has been that the generation of ideas is the “real” driver of growth. While these arguments certainly help advance our understanding of the determinants of growth in broad strokes, they also point to the limitations of an institutionally barren production-function-for-the-whole-economy approach to growth (more on this to come).
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The signaling model of education presents a more immediate challenge to the big push for education policies. While not completely denying the human capital-forming role of education, the signaling model challenges the relative importance of human capital in education. The signaling model implies that there are negative externalities to subsidizing education. By lowering the cost of acquiring a degree, the signal of worker quality is degraded because more low quality workers get through the selection mechanism (obtaining a degree). A new signal is needed to separate between worker qualities, leading to more expenditure of potentially productive resources in a sort of arms race of higher education degrees. If education does not lead to great improvements in human capital but is driven by primarily by signaling instead, even if there are positive spillovers from knowledge, subsidizing education may not be such a great bet, especially since the contribution of the signaling mechanism is negative in social terms.
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I am very sympathetic to the signaling argument (Bryan Caplan makes a very convincing case) and I think they are often/mostly/always ignored by those making big push for advanced degrees policies, and shouldn’t be. However when I do manage to engage advocates of big-push-for-advanced-degrees, two arguments always come up against the signaling model.

1) Even if the formation of human capital is small relative to signaling it is still there, and low-income countries have much more to gain from small increases in human capital (which then leads to knowledge creation that spills over and increases productivity).

2) While signaling may play a large part in lower end (undergraduate degrees) degrees, in advanced degrees (doctoral degrees) it is mostly human capital and not signaling, thus government spending in advanced degrees is an investment in human capital (which then leads to knowledge creation that spills over and increases productivity).
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My partial objection to 2) is that human capital and signaling are potential explanations for the investment (present expenditure aimed at greater future income) aspect of education. But there is also a consumption (present expenditure aimed personal satisfaction) aspect to education. The more advanced the degree, not only does the human capital component (presumably) increase, also the consumption aspect of education increases as well. Why pay for something individuals will probably pay for themselves in search of their own satisfaction (and benefit us with all the great ideas that spill over from their activity, maybe)?
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A further interesting possibility with respect to 2) is given in this post on The Economist’s Free Exchange blog (based on this JEP paper). If advanced degrees are aimed at improving human capital that increase the productivity of those generating knowledge, a good proxy for human capital formation and knowledge creation in advanced degrees is the research productivity of graduates. The low productivity of economics graduates as Free Exchange notes can be interpreted as a sign that signaling is very prominent for those pursuing the most advanced degree in Economics. It would be very interesting to see research productivity in other disciplines as a test of the significance of signaling in advanced degrees in general.
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The Victorious and the Resentful, Socialist calculation past and present

Twenty-five years ago today the Berlin Wall fell, that monument to the brutality that the domesticated ape is capable of when its operating software is infected by bad ideas. Twenty-five years is a dangerous amount of time because it is enough time for an entire generation to have grown up largely unaware of the significance of the event, and by extension of the horrors of socialism when put in practice. Around 42% of the current world population was born after the fall of the Berlin Wall. Yet considering that before a certain age (around 15?) politics and economics are largely alien interests, the percentage of us that are left largely to our own devices to learn about this history is much greater than 42%. This is dangerous if there is some reason to believe that those who do not know their history are condemned to repeat it.
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Another reason that twenty-five years is dangerous, is that it is just enough time for those who cried of sadness (and many in my home Latin America did) instead of joy when the wall fell to have distorted history enough to make socialism appealing once again. After all history, is not written by the victors, it is written by the resentful (regrettably these are often the same ones that write the textbooks). The advance of twenty first century socialism by Podemos in Spain, and its consolidation in Latin America, are proof positive that the failure of socialism in Eastern Europe has long been forgotten by those not directly affected by it, and that it has been revived and revised by the necromancers of bad ideas. In trying to understand how this is possible at least part of the problem is thinking that societies learn from their past. Societies do not learn from their past, individuals do. It is only when the learning of individuals is institutionalized that societies are capable of learning. But this analysis stops short as well because institutions are only self perpetuating on average terms and in the long run, the consolation of the economist is the misery of everyone else that lives in crests and troughs of history, and not on the trendline.
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The revived version of socialism slightly alters the means and goals of its former self. Unlike its Marxist-Leninism, it does not aim at producing more than capitalism, but rather at producing “buen vivir” or good living (as defined by the government’s sub-secretary of good living of course). The means have been revised as well, rather than the complete abolishment of private property, productive firms are to be directed by the state, with only certain sectors ripe for outright nationalization. Very reminiscent of Lenin’s New Economic Policy. Thus the only problem with socialism that this revised version concedes is the one that all practical implementations have conceded, the one pointed out by Mises, something really telling about the fundamental economic problem with socialism. The concession in the means employed by all the implementations of socialism is really a testament to Mises’ paradox of planning. The change in the goals of twenty first century socialism is telling as well. If you can’t accomplish what you originally set out to accomplish with the means you propose, alter your goal to that which your means can accomplish. If the means you propose are unable to deliver material prosperity but instead deliver poverty, redefine poverty as “good living”, and set up an official agency to preach about it.ray ban sunglasses Discount