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.

 

 

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!

Is there a pendulum of low-skilled workplace satisfaction?

One of the reasons given for why we see minimum wage increases leading to smaller drops in the quantity of labor demanded than we’d expect from a simple supply-and-demand graph is that employers don’t like to fire people. It’s easy to imagine that this argument has some merit. How would you feel breaking the news to somebody that he doesn’t have a job anymore, especially a low-skilled worker who was performing acceptably before the increase, especially knowing that you’ll be the one blamed for it? I think this effect is probably weak—the people who would be long-run managers would end up being the kinds of people who accept having to do their unpleasant duties—but it could have some non-negligible effects at the margin.
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A complementary argument is that employers adjust to MW increases by working employees harder to get more value out of them once they have to pay them more. (I also think this is an important puzzle piece.) Putting together the first and the second arguments, it seems like there’d be an important consequence of MW increases in low-skilled environments: more workplace tension. This is hard to measure, of course, but not impossible. Perhaps some workplaces already do this. If this idea holds water, periodic employee surveys, including managers, over a long enough timeline could show periods of increasing dissatisfaction and returns to stable levels of satisfaction. This would help fill in some of the details about labor force adjustments that many researchers are currently grasping at. Again, I don’t expect to see large changes, but they might be big enough to observe.
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Readers, I’m not wedded to this idea but I think it’s interesting to consider. What do you think?where to buy oakley sunglasses

What’s wrong with economics?

The recent economic crisis has brought about an entire chorus of complaints about economics. Student groups request changes of curricula, institutes for new economic thinking became more prominent, Eugene Fama got a Nobel Prize. Oh wait… I think most of these critiques have been misguided and, yeah, Fama is pretty awesome. These critics are a little bit like complaining that meteorologists don’t control the weather better or that geologists do such a poor job at predicting when exactly San Francisco is going to suffer the next big earthquake. But still, I think there are many things that are shaky with mainstream economics.
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Before I give you my draft list, here’s how not to complain about mainstream economics. Don’t just pick your pet theoretical peeve and whine that other people don’t find it as interesting or important as you do. That’s not “failure of economics”, it’s either your failure to explain your position or, blasphemy!, you’re wrong. A failure of economics can only be institutional, i.e. somehow you have to show that the organization of the economics profession is a priori biased against certain positions. You can have either an emergent order argument about this (the bias is part of no one’s intention or strategy, but it occurs in the aggregate for some reason) or a corruption story (the economics profession gets captured by certain interest groups). So, here’s a list of such likely institutional failures:

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  1. The sources for macroeconomic data are mostly governmental. Not only do they suck, e.g. according to the data the Earth as a whole has a $300-$700 billion trade surplus with outer space, but we also don’t know exactly just how much each piece of information sucks – amazingly, all the numbers in the, e.g., World Bank dataset come without margins of error. As you may imagine, governments have a vested interest to distort the data in particular directions.
  2. The intended use of data determines what kind of data one gathers. Most macroeconomic data is intended to serve the purpose of government controlling the economy. To control the economy one does need some understanding of how it works in terms of causes and effects, but, still, one is going to be biased towards a very aggregated perspective, because the possible levers of control are few. James Buchanan & Richard Wagner have a classic paper on this, “The political biases of Keynesian economics” and Peter Boettke has recently restated their argument.

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These two arguments are about emergent order biases. Here’s also two corruption stories:

  1. The editors of all major monetary economics journals have and have had personal connections with the Federal Reserve. Larry White is pretty convincing that this is indeed a problem as these journals act as a filter as to what counts as respectable opinion about monetary economics.
  2. Most economists writing about business rely on businesses for their empirical data and have personal connections with firms that make them biased in favor of business interests. Luigi Zingales has recently caused a bit of a splash making this argument, and also being careful to point out that being pro-business is quite different from being pro-market. (His discussion with Russ Roberts about this is pretty interesting too.)

What else?
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PS. Here’s my recently published paper on how a scientific community works and about which factors can bias science (and which are less likely to do so).