Endogenising economists

I’m afraid I was underwhelmed by The Power of Creative Destruction by Philippe Aghion & his co-authores Céline Antonin and Simon Bunel. The book falls between the two stools of textbook for econ courses and overview for the general reader. It is based on course notes and has that tone (and charts/tables/referencing of the literature), but all the technical apparatus students would need has been removed. Professor Aghion is of course a terrific economist who has published lots of excellent papers on growth and innovation. However, that too is a downside here, as the book is the Aghion view of the world rather than a broader survey of the economics of innovation and growth.

The oddest aspect of this is his contrast between the Solow neoclassical growth model and the ‘new paradigm’ of Aghion-style Schumpeterian growth. Set aside this claim to novelty, which might cause many other Schumpeterian economists to raise an eyebrow; there is nothing here about the competing workhorse approach of endogenous growth models. Paul Romer makes it to the footnotes, Paul Krugman’s increasing returns models not that far, Ken Arrow too isn’t mentioned. Joseph Stiglitz fares best out of the prominent thinkers about markets, growth and development in the context of increasing returns. The book is more or less an account of Prof Aghion’s own research, and his own papers (excellent as they are) are the most-often cited. So while accepting the importance of creative destruction and new ideas, the absence of much about information and ideas is pretty glaring. There is a chapter about R&D but little about the economic models endogenizing it.

I could quibble about other features too, such as relying on patents to measure innovation, but it’s this missing aspect of the dynamics – the scope for endogenous, self-fulfilling or -averting phenomena – that seems a particularly big gap. The discussion of intellectual property lacks any nuance: it is simply asserted that patent protection is essential. Of course it is, but that isn’t the point of the present policy debate, which is exactly about whether the right balance between patent-protected monopoly and broad access to new ideas has been struck.

41eUnCMDnVL._SX329_BO1,204,203,200_On the other hand, I also read Carlo Rovelli’s Helgoland and warmly recommend it. It sets out his view about quantum phenomena as manifestations of the fact that reality is relational: nothing is experienced, perceived, measured, or understood except in relation to everything else. “Every vision is partial. There is no way of seeing reality that is not dependent on a perspective. …. The actor of this process is not a subject distinct from phenomenal reality, outside it, nor any transcendent point of view; it is a portion of that reality itself.. …. Relations make up our ‘I’, as our society, our cultural, spiritual and political life.”

This appeals strongly to my intuition and echoes the argument of my forthcoming book, Cogs and Monsters, one of whose key threads is the point that economists can not stand outside the society they seek to analyse. Even the economists are endogenous.

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Growth, stagnation, and degrowth

There’s a new wave of interest in the degrowth idea, recently summed up in the New Yorker by John Cassidy. The degrowthers are mainly inspired by environmental concerns – how can consumption possibly continue to increase without limit without destroying the planet? – and the article also refers to Vaclav Smil’s recent book Growth, which adds to this seeming common sense the intellectual heft of energy physics and logistic curves.

I have no ideological commitment to the view that measured GDP growth will always revert to 1.5-2%, and found much food for thought in Smil. However, there is a misunderstanding in the degrowth movement about what growth implies for physical material and energy use, well explained by Noah Smith in his recent Bloomberg column. My colleague Dimitri Zenghelis also does an excellent job here of debunking degrowth, arguing it is not the best or only way to be green.

Smith refers to another recent book, Fully Grown: Why a Stagnant Economy is a Sign of Success by Dietrich Vollrath, to make the point that we can probably expect slower growth (Smil’s S-curve is flattening out) but this is very different from degrowth or zero growth.

The basic point is that the degrowth argument doesn’t either acknowledge intangible output growth or explain what somehow needs to be taken away from the economy when there is a new innovationto keep growth below zero. On the first point, think about oral rehydration therapy or mini-aspirin – new uses of existing materials which produce improved health outcomes that people are willing to pay for, whose value far exceeds the materials costs (sugar, salt and water; salicylic acid). On the second, if somebody invents a new item everybody wants to purchase – the way smartphones arrived in 2007, say – then what would we stop them buying to keep total growth at zero? And how?

Prof Vollrath’s book, which I read at the proof stage, is tremendous. He portrays the recent slowdown as an inevitability, the result of economic success. Past gains in health, and lower fertility rates due to reduced infant mortality and higher incomes, explain population ageing in the rich economies. Demography is reducing potential growth. We are on the whole also taking more leisure, with a trend decline in hours worked. Purchases of services are taking over from material goods as a share of expenditure, and productivity growth is slower in the service sector (for familiar, Baumol reasons). These two trends go a long way to explaining reduced growth.

The second half of the book explores other potential reasons for the growth slowdown, such as increased market power (see Thomas Phillippon), inequality (Piketty) or too much government tax and regulation – and sets out the data explaining why none has a big enough effect to explain a lot of the trend slowdown. “I see no obvious reason why the growth rate would accelerate in the near future,” Vollrath concludes.

I really enjoyed Fully Grown, which gave me much food for thought. It also is simply excellent on the data sources, growth accounting, and trends. But I don’t think it tells the whole story about innovation either. Vollrath accepts (as Robert Gordon does not) that there are significant technological advances under way; but he sees these as making production more efficient and thus accelerating the shift to services: an ever-smaller part of the economy is becoming super-efficient.

The catch, I think, is in using real GDP per capita as the sole indicator of growth. It is a conceptually flawed measure for an intangible/services economy. Consider a haircut, a service for which there is at least a volume measure (which many services do not have). If the price of haircuts goes up, real GDP as constructed goes down; but if the price is rising because people are substituting from cheap cuts at Big Jim’s Trims round the corner to expensive cuts in Covent Garden, it actually means that they are purchasing a haircut plus a bundle of quality attributes – lovely salon, free cup of tea, head massage, an hour’s talking therapy from a charming hairdresser….. In some four-fifths of the economy, the Price x Quantity = Revenue equation used to construct the growth statistics does not work. Either we should be quality-adjusting many more purchases (and this has its own problems) or there isn’t even a volume measure (what is a unit of management consultancy??)

Anyway, read Vollrath and Smil, devote energy to cherishing the environment. Read our Benett Institute report out in 10 days on how to take a more rounded view of economic progress, including environmental impact, by considering wealth. But ignore the fashionable lure of degrowth.

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Growth and civilisation

I’ve been slowly reading Growth: From Microorganisms to Megacities by Vaclav Smil. Slowly only because of the size of the book, which means reading it at home. It’s a somewhat eccentric but really rather compelling read. The subtitle indicates its ambition. We do literally go from the growth dynamics of archaea and bacteria all the way to empires, with the common thread being the argument that physics places fundamental limits meaning that almost everything follows the logistic S curve and thus reaches an asymptote – although predicting where the points of inflection will occur is a different matter. “Natural growth taking place on earth is always limited.”

In the final section on economies, Smil quite rightly points out that even if measures of economic activity – notably GDP – remain non-stationary series, such activity is rooted in energy use – echoes here of his tremendous Energy and Civilization. Much of economics has ignored this, regarding early work on energy use in the economy – such as Georgescu-Roegen – as a bit weird, although this is perhaps changing with the onward march of environmental economics. Smil is more sceptical than I am about whether the process of dematerialization of economic growth has shifted the asymptote of the growth curve up and out; I don’t think the concept of sustainable consumption is empty, whereas he does. (Although when it comes to regarding ‘the Singularity’ as nonsense, he and I are at one). He concludes that unless there are strict limits on material consumption, human civilization is doomed, and one gets the firm impression he’s putting his money on doom.

However, the joy of this book is less in the big picture than in the detail. And what a lot of it! The mind boggles at Smil’s extensive reading and absorption of information. We get the speed at which marathons are run – over the entire course of human history; the growth rates of piglets and weight of chicekns over time; sales of small non-industrial motors over time; the envelope for the maximum speed of travel; Kuznets cycles; Zipf’s law for city size….  The middle section of chapters offer a fantastic overview of technical progress over long periods in a wide range of technologies. I love all this detail.

Growth is therefore a tremendous work of synthesis, the biggest of pictures in pointilist form. If Bill Gates hadn’t named Vaclav Smil as his favourite author (“I wait for new Vaclav Smil books the way some people wait for the next Star Wars movie.“), one could imagine him (Smil) as a character in a Borges story. Best of all is the passing comment that nearly all the calculations for all his post-1984 books have been done on a TI-35-Galaxy Solar calculator. Talk about sustainable consumption.

41sJqD+KMbL._SX344_BO1,204,203,200_Before embarking on Smil, we had a week of holiday so I read some non-work books, standout among them The Kites by Romain Gary, whose oeuvre I’m now racing through.

 

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Going to extremes

Richard Davies obviously made the kind of road trip many of us only dream of to write Extreme Economies: from Akita in Japan to Santiago in Chile, from Glasgow to Kinshasa. The locations he chose illustrate one of three characteristics – survival (refugee camps in Jordan, post-tsunami Aceh, a US prison in Louisiana), failure (Panama’s Darien Gap, Kinshasa in DRC, and post-industrial Glasgow), and the future (ageing Japan, digital Estonia, unequal Chile. As the book sums it up: “The year 2030, for most people on earth, will be a cocktail of these three cities: an urban society that is old, technologically advanced, and economically unequal.”

The book is a great read – I tore through it. An economist who can write so well while at the same time explaining the economic principles so clearly is always a joy. I will admit to being rather envious of the opportunity he had to visit all these places. Getting out and visiting should be required for all economists, whether they are writing about development and progress as Davies is, or about industrial organisation or education. You always learn something not only relevant but also important. One of the things I did love about this book was the painless administering of some substantial chunks of economic research – it’s an ideal read for eager 6th form students or undergraduates. It might encourage them to appreciate that economics is not only important but also exciting.

The book also includes some important threads. One is the environment as an economic as well as intrinsically valuable asset. Darien’s economy depends on extraction from the jungle, living now on its future potential: “The puzzle is why, in a region where everyone knows the environment is being degraded, the people of Darien can’t manage the economy in a way that stops it happening.” This segues into a discussion of the ‘tragedy of the commons’. Later, though, it’s Glasgow’s social capital, another overlooked asset, that’s pinpointed as one source of failure: “When an economic force is shared, unseen and hard to measure, you will do too little to protect it.” I couldn’t agree more. Social capital features in all the examples here, either as a source of resilience or a cause of failure. It isn’t a sufficient explanation of economic outcomes – for example, in the chapter on refugee camps in Jordan, one thrives and the other fails because of external forces shaping the structure of the camps and their economic potential – but it is a necessary element.

Davies picks this up in the conclusion: “The biggest gap in economics is the way it completely ignores social capital.” This is why our Bennett Institute Wealth Economy team is exploring the measurement of social capital. Economics doesn’t entirely ignore it – it gets lables such as ‘institutions’ or ‘goodwill’ – but is treated as a black box at best. So I agree with the book that economics will have more to offer the world if we measure and understand better the “subtler and more human aspects of income and wealth.”

Meanwhile, I recommend enjoying the tour through the rebuilt Aceh, refugee camps in Jordan, the market in Kinshasa, Lousiana’s Angola prison and all the other economies featured here. And I hope some TV producer will pick up the book and take its author round the world all over again to film it.

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Making economic miracles

I’ve always really liked Michael Best’s 2001 book The New Competitive Advantage, and his latest, How Growth Really Happens: The Making of economic miracles through production, governance, and skills is a worthy successor. Best, who has vast experience of visiting businesses and learning in detail how they produce their goods and services, centres his account on the idea of a ‘capability triad’. Growth requires success in three linked domains: skills, a production system and a business model. Note how largely intangible these capabilities are – this is not a matter of investing in capital equipment or even inventing molecules or gadgets. Policies should aim at ensuring businesses can access or develop these capabilities, broadly understood, rather than taxes and subsidies.

The book has a number of examples, historical and more recent, illustrating the concepts, ranging from the wartime transformation of the US economy to modern Greater Boston’s reinvention to the present loss of production capabilities and skills in the US; from the UK’s postwar relative decline to Japan and China’s more recent experience.

There is also a chapter looking at the tradition of thinking about production systems and capabilities in the history of economic thought. Smith is there but also some names too often overlooked in modern economics: Charles Babbage; work on increasing returns models by Thomas Schelling and Paul Krugman, following in the footsteps of Alfred Marshall and Allyn Young (author of a 1928 article ‘Increasing Returns and Economic Progress’; and above all Edith Penrose. I knew too little about her work until a fine biography by Angela Penrose, No Ordinary Woman, sent me to it earlier this year. Given the obvious prevalence of increasing returns in modern economies, it’s high time to revisit this tradition.

The book ends with some reflections about the links between the productivity slowdown of the past 10 years and diminishing capabilities in the affected economies it mainly looks at the US here. Like a growing number of others (see for instance this article by Gregory Tassey), Best argues that the worst long-term consequence of offshoring has been the loss of know-how embedded in production systems and skills. The way to address this? A policy framework aimed at strategic economic development, something that has been lost from the vocabulary of policy for a generation, although tacitly recognised perhaps in the UK’s debates about an industrial strategy.

There’s a mass of interesting detail in the book – perhaps too much compared to the more reflective sections, but then the ideas do pick up on Best’s earlier work where there is much more on the conceptual framework. How Growth Really Happens is well worth a read, along with the earlier book – so much so it’s on the Enlightened Economist Prize 2018 longlist.

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