Category Archives: Specialization and Trade Economics Intro

Some great FITs links

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I recommend checking this out. Concerning the last link in the essay, I write

Many of my readers know that in Specialization and Trade I pointed out that the political process for industrial policy is to subsidize demand and restrict supply, which is never what orthodox economics recommends for dealing with market failures. Subsidizing demand while restricting supply has ambiguous effects on output (in the case of housing, for example, the net effect is probably negative) while certainly raising prices.

This refers to Noah Smith’s link to a paper by Steven M. Teles, Samuel Hammond, and Daniel Takash.Their paper is called Cost Disease Socialism, which I think of as synonymous with “subsidize demand and restrict supply.”

I differ from Noam and from the authors in that I don’t believe that “cost disease socialism” is some sort of mistake or aberration. Instead, it is the inevitable path for industrial policy, given the way political incentives work. See Specialization and Trade.

The industrial revolution: how did workers eat?

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Davis Kedrofsky writes,

There was an Industrial Revolution, and it was slow.

The debate’s been over for two decades. The gradualists, armed with new growth accounting techniques, have won, exorcising forever the Ashtonian vision of an eighteenth-century leap into exponential growth. Where historians once thought the spinning jenny, steam engine, and factory system the immediate preconditions of England’s dramatic transformation, they now accept that these advances emerged in a trickle in a few tiny sectors.

Pointer from Tyler Cowen.

I believe that that the gradualists may have it wrong. Here is a clue, from later in Kedrofsky’s essay.

And a growing share of the population moved out of agriculture and into that increasingly-recognizable branch of manufacturing—from 33.9 percent in 1759 to 45.6 percent in 1851.

How did these manufacturing workers eat? There had to be a significant increase in agricultural productivity. But I am guessing that a lot of the increase did not take place on farms. Here is Wikipedia.

The British Agricultural Revolution, or Second Agricultural Revolution, was an unprecedented increase in agricultural production in Britain arising from increases in labour and land productivity between the mid-17th and late 19th centuries. Agricultural output grew faster than the population over the century to 1770, and thereafter productivity remained among the highest in the world. This increase in the food supply contributed to the rapid growth of population in England and Wales, from 5.5 million in 1700 to over 9 million by 1801, though domestic production gave way increasingly to food imports in the nineteenth century as the population more than tripled to over 35 million

I want to focus on the last point, about food imports. Borrowing a trope from David Friedman, I would say that British manufacturing workers were very productive at growing foodstuffs. They produced manufactured goods, put them on ships, and the ships came back with foodstuffs.

Suppose that productivity did not change in either agriculture or manufacturing between 1800 and 1850. A worker could produce a bushel of grain per day either year, and a worker could produce a bolt of cloth per day either year. But if you can trade a bolt of cloth for two bushels of grain, and you move some workers out of agriculture and into manufacturing, that worker now produces twice as much grain.

Adam Smith and David Ricardo knew more about how living standards improve than do modern productivity historians. And my guess is that the transformation that people who were alive around 1800 were seeing with their own eyes was real, today’s gradualists notwithstanding.

UPDATE: A commenter points to Anton Howes.

The push thesis implies agricultural productivity was an original cause of England’s structural transformation; the pull thesis that it was a result. The evidence, I think, is in favour of a pull — specifically one caused by the dramatic growth of London’s trade.

On the larger question, Howes is a gradualist.

Anti-fragile Arnold hates this bailout

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As reported by the WSJ,

The $100 billion Term Asset-Backed Loan Facility is a reprise of a program launched in 2009 that enabled investors to buy bonds linked to consumer and business debt using money borrowed from the Federal Reserve. The central bank and other supporters say the program, known as TALF, helped unfreeze credit markets vital to the workings of the economy.

If it works as intended, TALF will jolt the market into reviving the issuance of new bonds, which spreads risk to investors and allows lenders to continue making loans. On the other hand, the Fed could face criticism for helping to super-charge returns for some of the biggest investors at a time when millions of Americans are losing their jobs as a result of the coronavirus pandemic.

In short, at a time when ordinary individuals and small businesses are getting only partial relief, these Wall Street activities will get a complete bailout. Moreover, this rewards the kind of behavior that Anti-fragile Arnold hates: financial engineering that results in privatized profits and socialized risks. Continue reading →

A non-virtue of nationalism

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Alberto Mingardi writes (in an email to followers of the Bruno Leoni Institute that he heads),

Nationalism, as political rhetoric, is quite incompatible with a concept which is key to classical liberal. That of the sovereignty of the consumer, as it has been called perhaps with an infelicitous term. It is difficult to ‘nationalize’ consumers, very easy to ‘nationalize’ producers.

In Specialization and Trade, I pointed out that we are much more concerned with conditions in the one market in which we produce than with conditions in any one of many markets in which we consume. If we are going to use our political voice in a market, it is going to be as a producer rather than as a consumer. Economic nationalism, by strengthening political voice rather than markets, is bound to favor producers rather than consumers. In short, Mingardi has a point.

A review of Specialization and Trade

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Dirk Niepelt writes,

Kling’s criticism of contemporaneous macroeconomics reads like a criticism of the kind of macroeconomics still taught at the undergraduate level. But modern macroeconomics has moved on—it is general equilibrium microeconomics. Its primary objective is not to produce the one and only model for economist-engineers or “experts” to use, but rather to help us understand mechanisms. A good expert knows many models, is informed about institutions, and has the courage to judge which of the models (or mechanisms they identify) are the most relevant in a specific context. We don’t need a new macroeconomics. But maybe we need better “experts.”

To me, this sounds as though Niepelt is happier than I am with what he calls general equilibrium microeconomics and what Paul Krugman (rightly) calls Dark Age Macro. Of course, Krugman wants to go back to old-time Keynesian religion, which I reject. I would refer Niepelt to my macro memoir essay.

Nathan Smith

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On Facebook, he writes,

The most overrated economist in the world is Daron Acemoglu; the most underrated may be Arnold Kling. For years, I’ve been getting more and more disillusioned with economics, as the noise of pointless rent-seeking “publications” (the term is a falsehood because articles are more public on SSRN than in a subscription journal) marginalizes fresh insight, and excessive respect (to the point of sycophancy) for legacy ideas and a few academic stars prevents newer and truer ideas from capturing the heart of the discipline. I’ve been wanting to write a book that builds economics from the ground up in a new way, rethinking the basics, selecting a truer set of ideas and integrating them into a new curriculum that would do more to help people understand capitalism… but what publisher would take me seriously? And then I found that Arnold Kling has written it! This is a well written book with good explanations, but more importantly, he picks the right ideas, the ones that aren’t just gimmicks or too unrealistic fort the gap with reality to be bridged, the ones that really matter and have limitless applications and are worth understanding and reflecting on. And then he sequences them well so that they build on each other. I’d like to see this book adapted to become the standard textbook for college freshmen studying economics. If you want to understand capitalism, this is the book I’d recommend.

He is plugging Specialization and Trade. So I’ll plug his (semi-dormant) blog, called Reinventing Economics.

Debating Daniel Jelski

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He criticized my moonshot essay in which I attacked neoclassical economics. I appreciate that he took the time to read it and consider it seriously. But I want to reply to two of his points.

1. He writes,

My old professor in general chemistry (Norman Nachtrieb–now deceased) told us that “science is the art of successful approximation.” Ideal gas law is valid as long as intermolecular forces are assumed to be negligible. A step in an engine cycle is adiabatic as long as no appreciable heat escapes into the environment. The words “negligible” and “appreciable” are purposely left vague, and depend on how precise an answer one actually needs in the result.

I do not believe that the neoclassical model of two factors of production is a decent approximation for any purpose. In the essay, I explain why the concept of aggregate labor productivity is not a useful approximation.

The main claim of the neoclassical model is that factors of production are compensated according to their marginal productivity. We do not observe this in practice. The neoclassical model says that all “labor” is compensated identically at the rate w, and all “capital” is compensated identically at the rate r. Instead, we observe heterogenous wage rates and heterogeneous returns on various forms of investment.

The neoclassical model says that the main cause for variation in wage rates should be the amount of capital per worker. To explain the difference in wages between a construction worker in the U.S. and a construction worker in Mexico, you should be able to point to much higher capital per worker in construction in the U.S. But it turns out that very little of this “capital differential” is tangible. A lot of it reflects cultural differences in management and social norms.

Suppose that you wanted to explain why software engineers are paid more at Google than at some other firm. According to neoclassical theory, that must be because their marginal product is higher at Google. But you cannot even begin to measure “marginal product.” They are working on teams that create a joint product. So the neoclassical claim is vacuous in this case–you can neither confirm nor refute it.

2. Jelski writes,

Contrary to Mr. Kling, I think culture changes are on a generational timescale–roughly 30 years.

If this is true, it does not refute my point that cultural change is accelerating. When did cultural change start occurring at a generational timescale? Probably not before the 20th century. Go back several hundred years, and hardly any cultural change took place over the span of a generation.

Suppose we were to look at measures of economic change. I think the economy is becoming more specialized at a faster rate than before.

How many companies broke into the top 100 between 2000 and 2010, and how does that compare with the number that broke in between 1980 and 1990?

How many new occupations were created between 2000 and 2010, and how does that compare with the number created between 1980 and 1990? (note: the BLS may not have been able to track this accurately)

Take the top five occupations in 1980, and calculate the change in the percentage of the labor force engaged in those occupations in 1990. Then take the top five occupations in 2000, and calculate the percentage of the labor force engaged in those occupations in 2010. If change is accelerating, then we should see a much bigger drop in the recent period.

A moonshot to overthrow neoclassical economics

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Tyler Cowen gave me an idea. He described his personal moonshot. He wrote,

My goal is to be the economist who has most successfully used the internet as a platform to foment broad enlightenment.

He elaborates on this, creating a concise statement of his mission as a public intellectual.

So I did something similar. Please read Overthrow Neoclassical Economics: my personal moonshot. It begins,

My personal moonshot is that I wish to be a leader in overthrowing neoclassical economics.

…As I see it, neoclassical economics is characterized by two essential propositions.

1. Production is a process that employs two primary factors — labor and capital.
2. The distribution of returns to labor and capital reflects their respective contributions to the production process.
There are many economists, particularly on the left, who reject (2) in favor of theories of distribution that stress the role of political power. This criticism may have merit. But my criticism is more fundamental than that. I reject (1) as a useful description of the contemporary economy.

In neoclassical economics, individual productivity is inherent in the technology and the amount of capital per worker. In reality, it is way more complicated than that. Indeed, there are power relationships, but it is way more complicated than that. Technology and relative power are not sufficient to determine individual productivity and compensation. Everything depends on who you are teamed up with, how you are organized, the overall culture in which you are embedded, and other factors, including ongoing dynamics and expected future changes.