Instituting a Development

During this summer, and perhaps later on, a few colleagues and I working on another blog to help expand our thoughts on the topics of institutions and development.

My first post deals with the rationality of individuals when faced with group wants.

You see, groups don’t make decisions, individuals do. In some sense, there is no such thing as collective action, but merely as an aggregate of the multitude of individual actions made by it members. Even then, there are multitudes of actions that happen outside the the control of said group, and these can also be taken into account as affecting the structure and perseverance of the group because of the transfer of information amongst individuals. Back to our point: Group actions must be individually rational. This is important, if the actions are not individually rational, many actions that are considered undesirable (from the group’s point of view) are more likely to occur.

The link can be found here.

Complex Adaptive Systems: Primer 1/N

Over the past year, I have dedicated a large portion of my research to the study of complex systems. This started out as me being bored in an econometrics course and reading random Wikipedia pages during class without any specific goal in mind.

Protip 1: If you’re finding yourself bored in class and are desperate for an escape, use class time to teach yourself about things that interest you; this is a classic case of using opportunity costs wisely.

Protip 2: Diversify your portfolio; sometimes the best ideas come from reading things unrelated to your research interests.

Since then, my knowledge and understanding of complex systems have come into fruition to something greater and will probably form the basis of my dissertation. Without further ado, let’s start our journey into complexity:

Systems are considered complex if they meet the following criteria:

  1.  The system is composed of interacting agents.
  2.  The system exhibits emergent properties.

The second criterion is of utmost importance. If you think of a system of gears (the gears being interacting agents), like a manual transmission, there is nothing unexpected that can happen. In my Toyota Matrix, I go through the same procedure every time I find myself stopped at a stop sign: 1) Disengage clutch, 2) Shift into first, 3) Let out clutch until I can feel the friction point, 4) Engage accelerator gently, 5) When car begins moving, remove my foot from the clutch. If I have done everything correctly, I will be on my way towards my destination. If I don’t, the engine will die and I will have to start again. This is a binary outcome. The transmission only allows for these two outcomes; even though, my transmission allows for eight different parameters: six gears, reverse, and neutral. No other outcome or pattern can emerge from this set of parameter and inputs (throttle and clutch engagement); the gears cannot create new combinations of movement, nor can they decide to go in any new direction. The transmission is closed system. It is not complex because of the inability for it to create new modes or patterns of interaction between the agents comprising the system.

This is a far cry from social systems which allow for pattern formation and new types of interactions. Patterns in our systems exist everywhere: The American system of government is pattern formed through over 200 hundred years of social interactions piled on top of the initial foray in 1776. This and all other forms of governance did not exist prior to the system, but are instead outcomes of the system. Importantly, forms of governance, from that of the family to corporations to governments to international organizations are the result of the interactions of individuals. Every so often, we create new modes of interacting: language, Morse code, Bell’s telephone, radio signals, television, cellphones, internet, email, texting, social media, Snap Chat, etc.

Talking about social systems allows us to introduce an additional criterion:

3. The agents can change based on prior and current conditions/parameters endogenous to the system; at this point the system can be classified as a complex adaptive system.

Think of how individuals and groups adapt to changing conditions in a social system. In the 1980s, laws were passed requiring that only certified electricians be allowed to work on electrical wiring in residential/commercial properties. This subsequently increased the cost of hiring an electrician; in response, homeowners were more likely to work on their own residential electrical systems. This was the first adaptation. The 1980s saw a rise in residential electrocutions as under-qualified individuals attempted to repair their homes. A second adaptation would have been one of homeowners realizing the dangers and then preferring to hire qualified electricians instead of risking injury. This is just one slice of adaptations; it doesn’t capture all the schools who expanded their electrician programs, those who lost work because they lacked the new qualifications, and etc.

Interactions breed consequences (not necessarily a negative term) and adaptations.

 

Finding the Max/Min: Modern Monetary Theory Part 1

Tonight, I finally decided to read an article explaining the details of Modern Monetary Theory. (It’s 4AM when I’m writing this and I’ve nothing better to do on a Friday morning.) The article’s summary purported MMT as a school of economic thought.

To be honest, it is not entirely a school of thought. It lacks the expansive nature of claiming that role. MMT is more of a classroom than a school; its proponents have taken a small slice of a very large pie and have tried to derive various insights from their perspectives. Let’s look at some of them:

  1. In a world of fiat money, there is no limit to the amount of money that can be printed.
  2. Because of the relative insignificance of inflation, fiat economies can print/borrow enough money to take on massive capital-intensive projects.
  3. In fiat economies, there exists a natural interest rate of zero (because money can be printed pay off any interest as it accumulates).
  4. Deficits don’t matter.
  5. Fiscal policy > greater than monetary policy; though, monetary policy can be used to great effect in ensuring the success of fiscal policies.
  6. The government should provide everyone with a job guarantee.
  7. The banks, the loaning of funds, and actions of a variety of other industries should be subject to central planning.

Though, it isn’t technically false, the error in the first proposition is obvious enough that it warrants very little consideration and it comes in the form of the equation of exchange: MV=Py. In other words, a change in the amount of nominal money M will also cause an equivalent change in the price level P. (This is an oversimplification, but Michael Darby’s text provides a great overview if you’re interested.)  In other words, the more money printed equals a proportionate rise in prices. A central bank with a fiat currency can print as many notes as there are resources to make them, but this comes at the not so insignificant cost of the decreasing value of those notes. This is called inflation, and unless you haven’t seen anything about Venezuela in the past year, you know it is very much a real phenomena. MMT doesn’t completely decry the validity of inflation, but they do some hand waving through a Keynesian full-employment argument and assume away any bad effects as long as this full-employment is maintained. 

The most egregious conflict of their ideology manifests itself in this statement: “MMTers believe that the natural rate of interest in a world of fiat money is zero and that pegging it higher is a giveaway to the investor class.” This poses a serious issue with their earlier premise that we should spend money now on programs we see fit without any regards to future generations.

Harking back to my first year of grad school macro, Bohm-Bawerk provided three reasons for the existence of a positive interest rate:

  1. Time preference — the perspective undervaluation of future wants
  2. Dated endowment mix — the anticipation of higher income in the future
  3. Intertemporal transformation opportunities — the technical superiority of present goods over future goods

MMT treats the creation of money as higher income; which is a workaround to Bohm-Bawerk’s second criterion. Is printing money the equivalent of income? Maybe for a short time, but eventually the creditors begin to notice the devaluation of the currency (relative to all other currencies) and will demand that the indebted country pay back in a given exchange rate. They may be somewhat correct in thinking deficits don’t matter in the moment, but they would definitely matter if all the creditors demand repayment at once (this would be worsened in the event of massive inflation.

By wanting to use the resources now without regards to any interest rate, MMTers effectively take from the future and remove significant transaction costs by doing so. I often worry about extraction economies, like those of the colonial era, in which countries extracted resources without regard to the livelihoods and needs of the contemporary generations. MMT allows for this, except the effected generations are those in the future. One might argue that they have good intentions by doing so, but good intentions aren’t enough. Furthermore, where would the wont of spending end? If you’re incentivized to spend future resources now with no recourse, why not spend all of it?

I’ll leave you with that to ponder until next time.

Not your father’s macroeconomics

The decision of the Fed not to raise interest rates raises some immediate doubts about the future of the economy; though, I question the validity of these doubts. Has the Fed been at the helm of the economy in a meaningful way over the past few years? I would argue that at most it has been a standard-bearer that the economy has looked up to since the Great Depression, but for a long time, there has been a disconnect between the actions of the economy and Fed policy. Just looking at the immediate trends: unemployment is low at less than 4% and interest rates are still near-zero when compared to historical averages. Is there an issue with this? Not really, unless you take stock in the Phillips Curve — the same curve taught today in many intermediate macro courses, but has been thoroughly debunked since the beginning of stagflation in the 1970s.

So what does this mean? Justin Wolfers sums it up nicely:

Fine tuning the economy is over… Controlling for u and r in face on inflation fails muster; the rudders connected to this helm aren’t as large or as sensitive as previous thought.

The discipline of economics is changing for the better. Two years ago, David Wilson Sloane claimed that economics as we know it is dead The stories economics uses to explain the world are extremely useful, but in all their explanatory power, they are merely fictions that simplify the world into understandable pieces. (I don’t mean to understate their importance, only to state that economics can go further. For all it’s simplifying, economics during the past century has had truly brilliant insights.) Macroeconomics is currently at sort of crossroads, one that will help define the discipline for generations to come. The useful fictions can be maintained, but their explanatory power can be made to be more robust through the integration of economic thought with the processes and knowledge of other sciences towards a common goal of creating a more humane science. Beinhocker et al. sum it all up in a recent response to their neoclassical counterparts, “We believe that in order for economics to progress it needs to fully embrace a transdisciplinary approach and modernize a number of its key concepts.” The authors of that essay come from a wide variety of backgrounds and believe that their combined insights allow for more perfect version of the truth. Given the exponential nature of combinatorial interactions, I am sympathetic to this claim.

They posit that economics can do three things to increase its explanatory power:

  1. Most of us admit to the downfall of homo economicus, we should bring in insights from the fields of neuroscience, psychology, etc. to advance the understanding of homo sapien.
  2. Heterogeneity goes mostly unexplored in neoclassical because most things are generalized to help simplify things. Complexity thrives in a heterogenous space; people are not homogenous.
  3. We need to look at the economy from the systems level. (I’m most in tune with with this action.)

In an aside to all of this by Dani Rodrick, he claims that we must take up FDR’s credo of nothing less than “bold, persistent experimentation” in order to advance the field. I couldn’t agree more.

You might find yourself asking, “Where will macroeconomics take us next?” That’s not the question we should be asking. The better question is: Where will we take macroeconomics?

One final thought, Noah Smith is right, the Fed is our scapegoat no matter what happens.

 

More thoughts on “The Economy of Cities”

Jacobs’ main thesis is that cities experience growth through import replacement: the economies of the cities begin producing the products that they are currently importing from other economies. One of her examples was that Tokyo started manufacturing bicycles once they became technologically able (the costs became sufficiently low) to produce them in the city rather than importing the bicycles from abroad. What this entails is the internalizing of economic activity– a city may seek to be self-sustaining, and this seeking causes economic growth. But this comes at a significant cost: the city, and its contents, must always be in constant adaptation and change. In fact, Jacobs remarks, “The primary economic conflict, I think, is between people whose interests are with already well-established economic activities, and those whose interests are with the emergence of new economic activities.”

I do not think that this is merely an anti-rent seeking argument. Surely, there is some of that implicit in the statement; people who want to maintain the status quo may want to stifle further innovation and may do so by seeking legal and political tools to prevent others from infringing upon their profit opportunities. These interests may attempt to exert control over who may enter the markets via certain qualifying measures, certifications, and fee structures; some may go as far as attempting to set up a government-licensed monopoly. Jacobs’ argument speaks to something far more devastating to economic evolution: not in my backyard.

It’s not only the resistance of change from those who own the methods of production but the resistance from those who would benefit from future economic evolution.  She states, “Conformity and monotony, even when they are embellished with a froth of novelty, are not attributes of developing and economically vigorous cities. They are attributes of stagnant settlements.” Economic evolution must advance the interests and benefit the lives of the average person– an argument I heard earlier this week said the same thing of climate change regulation. Import replacement, as Jacobs describes it, is a process of entrepreneurial discovery and division of labor within a city. These processes are part of a larger Schumpeterian system of creative destruction: new economic activities evolve to replace older activities. These stand to increase the wealth of both the city and its inhabitants.

Who carries the costs of these import replacements? There are immediate costs of undergoing change; this is where the NIMBYs can strike with the most damage. By refusing to change or limit the amount of growth, those with interest in older economic activities can prevent the evolution of new ones before they even get started. There is a cost in saying yes to development, but remember, there is no cause of poverty — that is the base condition — there is a cause to prosperity, which a key to which is the change of economic activity. There may be short-run costs to those exporters of goods from the which the city previously consumed, but these will be made back in the long-run by more and better technologies being produced in the city. These technologies then get imported to other cities and rural areas. The long walk of progress determines that growth is not simply for some, but all can prosper in the long-run. Recent trends in poverty reduction are proof to this. The reason that so much food can be grow with so little labor involved originates in work and innovation done in urban areas, not with the farms themselves. As I noted in an earlier post, urban and rural economies must work in a cycle for both to survive. (This will probably be true until someone figures out to grow enough food in urban  areas; vertical farms aren’t enough to feed an entire city. A lot of this is due to the limited selection of foods that can be grown in a vertical farm.)

Jacobs has a wonderful bit on discrimination in cities and how it is inefficient for unequal governance to be operation. Prior to gender/race equality, an economy is losing out on a large portion of labor, creativity, and human capital. Engaging in such discriminatory behavior only allows for more stagnation, sooner.

Side note for future thought: If contracts are unable to be performed, then there will be inefficiencies. Think apple trees and bees– Where is the Coasean bargain?

“Five myths about socialism,” response

On March 1, 2019, Sheri Berman of Barnard College published a column entitled “Five Myths about Socialism” at the Washington Post. This is my response:

Socialism is making a comeback in recent thought. There is a multiplicity of causes for this; some of which being the seeming rise in relative wealth inequality, the forgotten knowledge of previous generations, and a way to overcompensate for strong voices originating in the political far right.

The five myths purported by Berman are as follows: 1) Socialism is a single coherent ideology. 2) Socialism and democracy are incompatible. 3) All socialists want to abolish markets and private property. 4) When socialism is tried, it collapses. 5) Socialism offers a ready-made solution to numerous current problems. None of these myths are technically false, but technicalities do not always pass muster.

The first myth is an attempt to differentiate various strains of socialism so that if one has failed in the past, is currently failing, or may fail in the future, the author and all other socialists can stand on a platform as they decry the fallen economic system, claiming that it was never true socialism. Given their ardent cognitive dissonance, they have nothing to fear from the failures of others claiming to be socialists. This further aides them in future potential failures: “If the system fails, it was because we didn’t get X correct; therefore, this couldn’t have been a true test of socialism. The ideal form of socialism still prevails and we will succeed next time.”

Often times, supporters of socialism engage in the “No true Scotsman” fallacy as way to continue their ideology without coming into direct contact with any of the logical flaws that might persist underneath. It still stands to reason that the purest form of socialism ever attempted by an economic system, War Communism. The top goals of this regime were as follows:

  1. Nationalization and centralization of all industries
  2. State control of foreign trade
  3. Control over labor
  4. Forced labor of citizens
  5. Prodrazvyorstka
  6. Rationing of goods, complete with centralized distribution centers.
  7. The abolition of free markets and enterprise
  8. State control of intranational transportation

In many of these goals, the Soviet Socialist government succeeded, but at what cost? according to multiple sources, the Russian Civil War (1917-1922), including the time of War Communism (1918-1921), resulted in between 9 and 20 million casualties. Only a relatively small percentage of these were due to combat; the overwhelming majority were due to famine and disease. Berman’s critique that the division of Democratic-leaning socialism and Bolshevik-style communism shows that socialism stays true to a democratic form of governance is another example of her allowing room to decry these experiments as being untrue forms of socialism.

Perhaps the abolition of markets and private property is not explicit in all forms of socialism, but underlying the expanse of socialist ideology is the implicit knowledge that such forms of market governance and institutions will be overturned in the name of the “greater good.” She points to redistribution as a virtue in that it does not abolish the market; though, she fails to posit that redistribution by definition entails the destruction of property rights for some and the creation of new rights for others. Intuitively, this changes the market mechanisms and causes the potential destruction for some markets.

Berman points to the Scandinavian countries as lights upon a hill for socialism; however, a quick look at their histories show that many of these nations are more capitalist than socialist. Furthermore, they built up their capital and institutions far before “socially-democratic” words were being slung at them. It is not hard to find perspectives that mesh with one’s priors in the information age. Yet, we haven’t seen the long term outcomes for many of these systems; nor do we know what additional issues other countries not being as homogenous would have to resolve. Furthermore, one cannot merely transplant the institutions from one country to that of another. There exists no anti-immune pills for economic systems.

Her final myth is the truest of all. Though it might be purported by its proponents, socialism fails to offer a panacea for all the world’s problems. Given its history, socialism might offer short-term solutions that remedy a few economic ailments, but the final cost of these solutions might outweigh the losses from the initial problems.

 

 

The Efficacy of Groups, Group Selection, and an Ecology of Plans

Richard Wagner posits that the macroeconomy is made up of an ecology of plans; I am sympathetic to his views because this allows for a framework of the economy to be seen as more than just the sum of its parts. This is because macroeconomic action is not just an aggregate of microeconomic action. The exception to this is at the very first encounters where the macro level interactions have yet to be formed (there are no institutions, formal or informal, that dictate behavior). After these are established, the micro transactions rely on the macro economy to enable them while the macro economy can only be perpetuated by the continuance of micro-level human action. One cannot exist without the other once the cycle has been initiated. Though, it is very possible that either one of these may wane in presence of the other.

The mediator between micro and macro action is that of the meso-level. Agents form themselves into groups; in fact, many agents will self-select or be selected into several groups. Families are one such type of these groups, while political parties, friendships, civic organizations, and religious congregations are all examples of groups in which any one agent can simultaneously take part. In both the public and private sphere, what causes these groups to survive throughout more than just one generation? What about an even smaller time scale, like more than a few meetings? What about Black Swan groups like the Bolsheviks? What are the behavioral mechanisms that ensure their continued survival? How does this compare to those who do not propagate for more than one life cycle?

I do believe that in the case of many of these sets, there exists a form of group selection similar to that in the evo-bio literature. Groups evolve a specific set of geno/phenotypic traits that occur at the group level instead of at the individual level. There is some argument in the evo-bio literature, but given that social systems can exhibit increasing returns to scale because of institutions or technology, I intend to sidestep their disagreements until another time. This means that a social system (a collection of groups into a very large group) is able to evolve certain traits that are different from those of another social system. I’ve argued in short essays that these traits may be readily copied by another group because knowledge is non-excludable and nonrival in nature. It has been pointed out to me that this means very little because it depends not on transference of knowledge but on the use of knowledge. I can’t agree more given that most people today have access to the entirety of human knowledge via a device in their pockets, but instead of using it for the advancement of our species, many play video games or feed a dopamine addiction. (This is pot calling the kettle black; I guilty of both of these.)

What I propose is an extension of Dr. Wagner’s hypothesis: the ecology of plans matters at the meso-level as well. Groups have plans. They are a way to lower the transaction costs of many people into a singular goal. Some of these groups seek domination of an entire economic system, others simply want to enjoy the fellowship of their members. I think I’ve mentioned Ostrom’s rules on common pool resources; these extend to efficacy of groups. In future posts, I hope to work out some agent based modelling of this.

Sidebar for myself: Demand will eventually create a supply through a variety of mechanisms and processes that necessitate the actions of entrepreneurial agents, but the converse is not true.