Growth, happiness and misbehaving

I’m enjoying reading Richard Thaler’s Misbehaving: The Making of Behavioural Economics. At about the half way stage, there hasn’t been anything startlingly new in terms of the economic content, as the book is addressing general readers rather than economists who have already read widely on the subject. It is very well written and also interesting to hear from Thaler what it felt like to be one of the pioneers in this field.

There are also some very interesting new (to me) insights. For instance, I’d never really thought before about the importance of changes from the reference point in prospect theory. Thaler writes: “Kahneman and Tversky recognized that we had to change our focus from levels of wealth to changes in wealth. This may sound like a subtle tweak, but switching the focus to changes as opposed to levels is a radical move….. Changes are the way humans experience life.”

This is the consequence – obvious when you think about it – of the hedonic treadmill, of acclimatising to a situation. Over in the well-being literature, this is often taken as helping explain the Easterlin paradox, the implication being that “we”/policy should help push people off the hedonic treadmill above high-enough income levels, by demoting or even somehow halting growth. But it seems to me to imply the contrary, that it makes growth very important for well-being. Just as some of the empirical work indicates.

I’ll review the book when I’ve finished – which will be at the weekend as I need something smaller to pack in my bag for the train tomorrow.

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Cities, infrastructure and growth

By way of a follow up to yesterday’s post on the new book Urban Economics and Urban Policy, I read recently a very interesting paper by David Starkie (Investment and Growth: The Impact of Britain’s Post-War Trunk Roads Programme, In Economic Affairs, Feb 2015) in which he argues that the construction of the British motorways in the 1960s and 70s had no discernible effect on productivity and growth. One reason was that pre-existing commercial traffic was intra-regional whereas the motorways radiated out from London. Contrast yesterday’s map of how the motorways were planned:

Motorway planning

Motorway planning

with this map from the article showing road freight patterns in the 1950s, before the construction of the motorways.

1950s road freight

1950s road freight

A second reason was that the productivity advantage from time saving was eaten by higher real wages and lower labour productivity. Although it is always hard to discern the effect of specific investments or technologies in GDP growth figures (as the cliometrics literature dating back to Vogel has found over and over – see Nick Crafts on why one should not read too much into the small numbers), I wholly agree with David’s conclusions:

“First, economic relationships are complex and changes can lead to unexpected consequences….Second, the time taken for institutions and commercial structures to
adapt to change can extend over decades, which suggests that the impact on output and growth will be long-term… [Third], as the structure of the economy adapts to transport improvements, there is not necessarily a (sizable) net gain but a partial shift in activity into new economic sectors and geographical areas.”

I’ve argued on the FT’s blog The Exchange that standard cost-benefit analysis does not do a good job when it comes to big infrastructure projects (like a motorway or HS2) because it is a tool for assessing marginal changes, not ones which might involve large non-linearities – behaviour changes or network effects.There is some work being done on non-marginal CBA (eg Cameron Hepburn’s paper for example) but it is not (yet?) standard practice.

Like many/most economists, I think we need much more infrastructure investment now – see for example the report of the LSE Growth Commission, Investing for Prosperity. My reading of the trunk roads article is that David Starkie would be more sceptical than I am but we certainly share the point about complex, long and uncertain responses; it isn’t about saving 20 minutes on your journey time to increase the amount of time you can spend in a meeting at the other end.

Conventional wisdom on cities. Not.

The subtitle of Urban Economics and Urban Policy, by Paul Cheshire, Max Nathan and Henry Overman, is “Challenging conventional policy wisdom.” This surprised me: these are eminent economists and Henry Overman runs the newish government-funded What Works Centre for Local Economic Growth, with a specific policy advice remit. In what way are these authors ‘challengers’?

Luckily, the final chapter of this excellent book answers that question. The conventional wisdom consists of the kind of “place-based” policies so much loved by local governments over the decades. The book: “Argues that focusing public expenditure on ‘turning around’ the economies of declining places has had little success; and specifically, many policy interventions have had little economic effect.” It argues that the evaluation of disparities between places should anyway take account of cost differences as well as nominal wages, and should consider too non-wage and non-monetary amenities. But in any case, disparities between people are more important than geographic ones – people, not places – although people do sort themselves with similar people into specific locations. Thus the skills of individuals matter – places don’t have skills – so the challenge is attracting and retaining the individuals. Or, conversely, enabling people to move away from declining places.

A separate, powerful strand of argument concerns housing supply and land use in general. The book argues that land-use is an under-appreciated factor in differences in urban performance. This is tied in to the argument that decline must be made possible: “We would argue for a greater focus on encouraging labour market activity and removing barriers to mobility. In practice, this will require a better understanding of the three-way interaction between the benefit system and the housing and labour markets, and the expansion of housing supply and reduction of costs of living in relatively successful places.”

The book does have a brief chapter on the city devolution process under way now in the UK, but it’s fair to say that the authors are unimpressed by the standard range of urban policies – ‘cluster’ policies, infrastructure investment, area-based initiatives and so on. While sharing their sentiment about some of the guff produced about localism (and there’s a lot of it), I think they are too sceptical about the potential. Consider for example the argument made in Chapter 8 that infrastructure investment does not deliver on regional ‘rebalancing’ and could be counterproductive; and look at the map below showing the way the UK’s motorways were planned (discovered courtesy of Tom Cheshire, @chesh):

All motorways lead to London

The railways post-Beeching cuts have the same radial pattern around London, as do the big internet pipes. Is it really any surprise at all that the UK is such an unusually capital city-centric economy?

This is a terrific book that summarises the state of economic knowledge about urban economies but – as it also acknowledges – there is much we don’t understand. Why do some declining places in fact achieve a turnaround? Why do people not leave poor locations even when they apparently can? Why do policy makers insist on trying over and over again things that don’t work? Answers will surely involve neighbouring social sciences as well as economics. The momentum toward city devolution in the UK, limited as it is, mean that these are pressing questions, and a lot of people will be piling in to offer answers. Although I don’t share the policy scepticism to the degree it is expressed here, Urban Economics and Urban Policy provides an invaluable foundation for the debate ahead.

Read more (e-)books!

There were some new figures from the Association of American Publishers that seemed to indicate e-book sales growth picked up in 2014 after a dip but the trend has slowed; and that paperback sales growth was strong while sales at retail stores increased modestly after some years of decline. Total sales revenues were up about 4.5% and unit sales 3.5%.

I’ve often written about how innovative publishers have been in their response to digital, compared to the music industry – okay, not a high hurdle, but still. It has certainly been a tough environment for the business but how encouraging it is to see more words (and pictures) being read in more formats than ever.

Another of my perennial themes is that people assume new technologies or formats are pure substitutes for pre-existing ones. Often with communications technologies (although not always – bye-bye fax machines and telegrams) they are complements, or start out as substitutes but the older technology then finds a stable and complementary niche.

Of course there is a binding constraint that ensures some substitutions have to occur, and that is time to spend on the various leisure pursuits. Looking on the bright side, if the robots do all the work, we’ll all have more time for reading.

The information economy

I very much enjoyed reading Cesar Hidalgo’s Why Information Grows: The evolution of order, from atoms to economies. It’s a very original perspective on the process of secular economic growth, bringing together not only several strands of the economics literature – growth theory, institutional economics, social capital etc – but also physics, biology and information theory. So it’s certainly ambitious, and I found it largely persuasive.

Hidalgo’s first point is that we are misled by thinking of the information economy as ‘weightless’ (a term I think I coined, or at least popularised, in my 1996 book The Weightless World) into forgetting that information is nevertheless physical. “Information is not a thing; rather, it is the arrangement of physical things. It is physical order.” He links the order of the economy to the order of the universe that can exist in pockets despite entropy. Economic order comes about through information embodied in things (‘crystallised imagination’) and in the way people organise themselves to apply knowledge and know-how. The first section is rather poetic. Hidalgo describes a tree as a computer powered by sunlight. “A tree processes the information that is available in its environment.” He describes a colleague at MIT who lost both his legs to frostbite while mountaineering, and built his own prosthetics: “He is walking on solidified pieces of his own imagination.”

The book goes on to consider products imported and exported by countries in terms of ‘crystallised imagination’, which requires “an enormous amount of knowledge and know-how.” Knowledge is the set of instructions – a book describing how to play a guitar – and know-how is the practical experience enabling application – the process of learning and practising playing to produce lovely music. Hidalgo introduces the concept of a ‘personbyte’ – the limit to the knowledge and know-how that can be embodied in one individual. For an economy to go beyond that requires collective organisation. He argues against the normal economic argument that economic development is the process of acquiring the ability to consumer more goods and services. “Economic development is based not on the ability of a pocket of the economy to consumer but on the ability of people to turn their dreams into reality.” (This part doesn’t wholly convince me – it’s an appealing case but surely consumption matters too.)

The book then turns to the idea of the economy as a social and technological system for amplifying knowledge and know-how, and looks at institutional economics and the role of social capital in growth in this context. Conveying know-how is difficult, and becoming more so as time goes by and the economy becomes more diverse and complex. The “computational capacity” of the economy needs to grow, but it is constrained by the ability for knowledge and know-how to be embodied in networks of people – hence the value of trust, as it makes that easier.

Hidalgo’s work on the Atlas of Economic Complexity enters here: there is a strong positive correlation between a complexity index and long term growth (over 10 years). The falling cost of communications and the emergence of standards have increased the number of long-distance market links (instead of transactions within single firms), and this know-how transfer is made far easier by high trust, which enables larger networks. Low trust economies are often characterised by more family firms and rely more on the state to spread knowledge and know-how through its support for industries.

There is a very nice analogy of the economy as a jigsaw. “Moving a complex industry is like trying to move a jigsaw puzzle from one table to another. The more pieces in the puzzle, the harder it will be to move it, as the puzzle falls apart when we fail to move all the pieces at the same time.” It is easier to move just a few pieces to another table that already has part of the puzzle in place. Thus economies mostly grow out from their earlier set of products, which embody the know-how they already have – they already have some of the pieces. The description of this process would very much appeal to evolutionary economists.

A final point that very much intrigues me is measuring growth. Hidalgo makes the same point as the final chapter of my GDP book, that in adding things up in terms of their monetary value we are not capturing the value of diversity: three spoons are not as valuable as a knife, fork and spoon. He says that using market price denomination to aggregate implicitly assumes there is friction-free trading; but this is often not possible, especially with stock variables. He advocates looking at the disaggregated economy via input-output tables.  “The mix of products exported by a region’s industries represents a fingerprint of its productive capacities that does not suppress the identity of the economic elements involved.”

So a highly recommended read for anyone interested in economic growth and development. The insistence on the embodied-ness of knowledge and know-how is surely correct, and also a useful corrective to overly-abstract accounts of economic development, including quite a lot of the newer institutional literature (as Morten Jerven argues, this often amounts to the advice to poorer countries to “be more like Denmark”, ignoring the trajectory from here to there). It’s also a pleasure to read such a well-written economics book; from now on I’ll be envisioning the economy in terms of crystals of imagination.