Alberto Alesina: In Memoriam

Alberto Alesina passed away a couple of days ago, while on a hike with his wife. This is his Wikipedia page, while here is his Harvard faculty page.

He is famous for a variety of reasons, but macroeconomics students of a particular vintage might remember him for advocating austerity in the aftermath of the 2008 crisis (remember when that was the biggest problem our world had seen?). Here is one paper he co-authored during that time.

There are many reasons to be a fan of Alesina’s work, as Larry Summers points out in this fine essay written in his honour. I think it a bit of a stretch to say that he invented the academic field of political economy, or even revived it, but he certainly did more to bring in front and centre than most other economists. In fact, for the last two years, he was my pick for getting the Nobel Prize, and it would certainly have been a well deserved honour.

I haven’t read all books written by him, but did read (and enjoyed) The Size of Nations, particularly because it helped me think through related aspects of the problem (Geoffrey West and Bob Mundell and their works come to mind – but that is another topic altogether). Here is a short review of that book by David Friedman, if you are interested in learning more.

A Fine Theorem (a blog you should subscribe to anyway) has a post written in his honor (along with O.E. Williamson’s, who also passed away recently) that is worth reading.

I’ll be walking through some of his work with the BSc students at the Institute, in order to familiarize them with it, and will be repeating the exercise in honour of O.E. Williamson on Thursday. This post is to help me get my thoughts in order before the talk – but I figured some of you might also enjoy learning more about Alesina’s work.

My favorite paper written by him is “Distributive Politics and Economic Growth” written with Dani Rodrik. That’ll be the focal point of my talk today – but I will address what little I know of his body of work as well.

Links for 7th February, 2019

  1. “Using a series of network theory algorithms, Jen and Freire found that China’s influence on the world is now as sizable as the combined influence of the US and EU. The shift occurred following the financial crisis in 2008, which saw the US’s impact on average global GDP shrink from just over 40 per cent between 1989-98 to half that between 2009-18”
    FT Alphaville reports on analysis that shows just how big, and therefore important, China is in the global economy. Even more importantly, not all parts of the world will be equally affected by the Chinese slowdown/recession. Europe, it turns out, will likely be the worst hit.
  2. ““It would be kind of boring if everything was the same,” she said through a thicket of pink and green strobe lights at the bar, which sits in an upper-level parking lot. “That’s why this place is so valuable to people like us.””
    My apologies for the double-double quotes, but that excerpt encapsulates for me the dilemma underlying Singapore’s very existence. I loved the ten days or so I spent there, but maybe, just maybe, Singapore is too perfect? On the other hand, what a nice problem to have.
  3. “We became free of colonial rule in August 1947; and adopted a republican Constitution in January 1950. Seven decades later, we may be more democratic than when the British left these shores. But we are certainly less democratic than what the framers of our Constitution hoped us to be. Indeed, the faultlines I have identified here have persisted regardless of who is in power, at the Centre or in the states. They need to be addressed, and remedied, if we are to be more worthy of the ideals bequeathed us by the founders of our Republic.”
    Religious division, social inequality, environmental degradation and the degradation of public institutions are the faultlines that Ramchandra Guha speaks of – an article worth pondering upon.
  4. “All of this used to be obvious enough, but in the age of Alexandria Ocasio-Cortez it has to be explained all over again. Why does socialism never work? Because, as Margaret Thatcher explained, “eventually you run out of other people’s money.””
    Bret Stephens from the NYT lays out the reasons why socialism tends to not work – ever.
  5. “It seems clear that more people are receiving income and tax from activities that are outside traditional jobs. But other than ride-sharing jobs, just how to characterize these jobs remains murky, and the question of what rules and regulations might apply to such income-earning activities remains murky, too.”
    Care to guess which country we’re talking about before you click on this link?

Links for 5th February, 2019

  1. “If there is one number that can make the edifice of budgetary arithmetic collapse and impair the growth prospects, it is the movement of crude oil prices. If for nothing else, but simply reduce the vulnerability of the fisc, this should be done. For, it is the “resource deficit” of the country which is the single biggest threat to sustained growth of 9%”
    How might a new age budget look like? Haseeb Drabu takes a look at the ways – five of them. You’ll be reading this by the time the budget has come out, of course, but it still makes sense to read this in order to think about how the budget needs to be structured.
  2. “The 0.9 per cent year-on-year (YoY) growth in the adjusted net profit of 385 companies, which have released their results for the third quarter (Q3) of the current financial year so far, does not inspire much confidence. If financials and energy companies are removed from the sample, net profit has grown 6.4 per cent in Q3 — the worst performance in five quarters.”
    I’d recommend that you read this article to either get a sense of how to judge the macroeconomic environment (partially!) on the basis of stock market performance, or even better, if you are new to finance, read this with an Investopedia tab open alongside.
  3. “Passenger vehicle sales in China fell for the first time last year since the early 1990s due to a cut to government tax breaks and wider economic sluggishness. Hyundai, which was once the third-largest automaker in China together with Kia, is now sorting out overcapacity as its sales in China have not picked up much since being hit by the anti-Korean consumer backlash in 2017.”
    The FT provides additional information on the slowdown in China – and the link on the anti-Korean backlash is also worth reading.
  4. “From the start of 2012 to the end of 2016, China produced nearly three times as much cement as the US did in the entire 20th century.Much of that investment has gone to waste. A recent study by China’s Southwestern University of Finance and Economics estimates that more than one in five Chinese homes in urban areas, or about 65m apartments, are empty. And if demography is destiny, China’s prospects are bleak. Between 1980 and 2012, China added about 380m people to its working-age population. But that number has been shrinking for the past five years and is expected to fall by a third, or about 220m people, in the next three decades.”
    More grist to the China recession mill, from the FT. The numbers are truly breathtaking – especially that quote about cement!
  5. “China’s fertility rate has officially fallen to 1.6 children per woman, but even that number is disputed. Yi Fuxian, a professor at the University of Wisconsin-Madison, has written that China’s government has obscured the actual fertility rate to disguise the disastrous ramifications of the “one child” policy. According to his calculations, the fertility rate averaged 1.18 between 2010 and 2018.”
    The NYT picks up from where the FT left off, and tells us about the impending population crisis in China – that there may soon be too few  people in China, not too many.

Choices, Not Prices: A Review of Where India Goes

There are four simple words that underpin the art of thinking like an economist: Costs, Incentives, Horizons and Choices. (They’re important enough to merit being capitalized, and are also important enough to deserve an acronym as well – CHIC).

It might surprise you that prices don’t make the list, but (realized) prices arise as an outcome of trade, and trade can’t happen unless you have some sort of framework in your head about your costs, incentives, horizons and choices.

Today, I’m going to post my thoughts (and notes) on a book that will help you understand why choices matter, and why prices are secondary.

Diane Coffey and Dean Spears have co-authored this book, titled “Where India Goes”. As the title suggests the book is about defecation, and as most of us are aware, India goes in the open.

Not all of us, of course – but a sizeable number do – this much has been in the news for quite a while now. But how many people, exactly? Or if not exactly, how many people, approximately, defecate in the open? Nobody knows, it turns out, for sure. And that’s because we are aiming to eliminate open defecation “without monitoring this simple statistic”.

All Indian governments, I should add, lest this turn into a politically charged debate, have been reluctant to collect this data, let alone share it, because the disquieting truth is that open defecation in India isn’t a matter of people not having access to latrines – people want to defecate in the open.

As Alex Tabarrok mentions in his review of the book, the problem isn’t one of lack of access per se:

Latrines are not expensive. Many people in countries poorer than India build their own latrines. If access is not the problem then building latrines may not be the solution. Indeed, India’s campaign(s) to build latrines have been far less successful than one might imagine based on the access theory. Quite often latrines are built and not used. Sometimes this is due to poor construction or location but often perfectly serviceable latrines are simply not used as latrines. In fact, surveys indicate that 40 per cent of households that have a working latrine also have at least one person who regularly defecates in the open (Coffey and Spears 2017).

The problem isn’t prices – if you have a latrine already, the price is essentially free. The problem is choice.

open defecation is not an activity that most people are ‘forced’ into due to lack of latrines, but rather one that most household decision makers chose over using the kinds of affordable latrines that would need to be emptied manually.

And the reason this choice is made is twofold. One, it is actually perceived as being healthier: respondents to a survey conducted by the authors have said that going out to defecate is a way to get some clean air (in the process of walking to the location where you’ll actually defecate), the walk aids digestion, and for at least some women, it is a way to get out of the house for a bit.

And second, if it is a pit latrine (which is overwhelmingly likely in rural India), who’ll clean the pit?

But the vast majority of people we talked with said that they could not even conceive of emptying a latrine pit themselves. Priya, a woman living in peri-urban Sitapur who belonged to a lower, but not a Dalit, caste, explained why: We cannot empty [the latrine pit] ourselves. We call a Bhangi even if something gets clogged in the latrine … How can we empty it ourselves? It is disgusting, so a Bhangi must come to clean it … We are Hindus, so how can we clean it? [If we do], how will we worship afterwards? If money were an issue we would take a loan for it; we would have to find some way to get it emptied. This work can only be done by people who inherit this occupation. They are Bhangis, they have been created [by God] for this work.

Caste, it turns out, is an important reason behind people choosing to “go” in the open. People do not want to clean out their pit latrines because it is seen as being “ritually polluting”.

And which is why the latest scheme to reduce/eliminate open defecation is going to fail, like all of its predecessors. It’s not because we aren’t throwing enough money at the problem (we are), but we are throwing it at the wrong target. The problem isn’t the lack of infrastructure, it’s the lack of desire to use said infrastructure. This in spite of overwhelming evidence about the problems caused by open defecation, which Coffey and Spears explain admirably by a mixture of anecdotes and clear eyed data.

Children in India are shorter than children in Africa; children in West Bengal are shorter than equally poor children in Bangladesh; and babies born to Hindu households in India are more likely to die than babies born to Muslim households. Each of these inequalities can be hoped to eventually diminish as open defecation is eliminated everywhere; each reflects a difference in the pace of somebody’s switching to latrine use.

The 5th, 6th and 7th chapters do an admirable job of capturing the consequences of open defecation – but the true surprises (and therefore the worth) of the book are in the first section itself: open defecation is not because of a lack of access to latrines, it is because of a lack of desire to use them.

As Rose George puts it in her TED talk on much the same issue, open defecation is a software problem, rather than a hardware problem. But the attention being paid to this problem, ever since successive Indian governments have started tackling it, is scant:

Yet, existing health and community workers have little reason to take up the task of convincing people to use latrines when they will not be compensated for doing so. And despite the fact that sanitation experts agree that the government should put greater emphasis on behaviour change than latrine construction, the government has not allocated funds to hire a staff for this purpose. Behaviour change is nobody’s job. It is no wonder, then, that the programme guidelines never precisely specify who will do this work. The language carefully avoids sentences with human subjects: ‘emphasis is to be placed’; ‘behavior change communication should focus’; ‘delivery mechanisms would be adopted’.

Open defecation then, “Where India Goes” shows us, is a problem caused not by a deficit of funds, is a problem with extremely serious repercussions (in terms of health, income earning capacity, cognitive development and all-round economic well-being), and is a problem with a cure that nobody wants to be responsible for.

It will go away over time, but the longer it takes, the higher will be the percentage of deaths caused by it.

The last word is best left, perhaps, to the authors themselves:

The Millennium Development Goals of the first decade of the new millennium vowed to ‘make poverty history’. That fits better on a T-shirt than ‘possibly accelerate the existing slow decline of open defecation in rural India’, especially if we take the space on the back of the shirt to explain that rural Indians will probably eventually make open defecation history anyway, if everybody waits long enough. But it matters enormously how long the wait would be. It is not too late to substantially reduce the harm that open defecation will cause before it runs its course.


Useful Resources about the Solow Model

We’ve been updating the blog with a series of short, simple, easy to read essays about the Solow Model. If you’d like to read the entire series, just click here, and read in reverse chronological order.

We haven’t used a single chart, equation, graphic or video, to talk about the Solow mode, and each essay is no longer than around 500 words each. But reading all of them should give you a fairly good idea about the Solow model.

Think of these essays as appetizers, though. They are intended to whet the appetite, not fill you up. However, if your appetite has indeed been whetted, you might want to take a look at these resources to understand more about the Solow model.

Marginal Revolution University (MRU) is an excellent online resource for learning more about economics in general. Started by two professors from George Mason University, Tyler Cowen and Alex Tabarrok, it is a wealth of material, in the form of videos, for understanding both basic and advanced economics. Here is the link for their videos about the Solow Model.

We wouldn’t especially recommend the Wikipedia article about the Solow model, because it isn’t the most intuitive version going around. But if you are comfortable with some math, and know your way around the Solow model well, you could take a look at it.

Any introductory textbook on macroeconomics will also cover the Solow model, because it really is the workhorse model for thinking about the long run growth story for any nation. Dornbusch, Fisher and Startz have a good book out there, but really, take your pick – almost any book will do.

We hope you have enjoyed thinking about the intuition behind the Solow model, and we hope you find the resources put up above useful.

In the next post, we’ll move away from the Solow model, and talk about the most basic model in economics – the supply and demand framework.

Understanding depreciation

Depreciation is a simple word, and a difficult concept.

It simply means wear and tear. If the car you’re driving is about five years old, or maybe more, it isn’t going to be functioning as well as when you first bought it. Maybe the fender is a little bent, and maybe the engine is making noises it really shouldn’t be making. The specifics will be known only to you, the owner, but anybody will be able to predict that things aren’t as great as they were when she was first driven out of the showroom.

That is depreciation.

Now, the reason it is a difficult concept is because of what it implies for an economy, and how to go about accounting for it. Since we’ve been talking about masterclasses by Sachin, let’s continue to use the same example.

Who do you think knows more about the art of batsmanship – you or Sachin? That isn’t an entirely ridiculous question, because the reason behind asking it was this – who is more likely to forget stuff about the art of batsmanship – you or Sachin? Since the Little Master knows more than you ever will about batting, he is more likely to forget some things about it. That is why the very best batsman spend so much time in the nets – not necessarily to learn new things, but to polish stuff they are already very good at.

In other words, what they’re trying to do is reduce the depreciation of their skill sets.And the more you know, the more you have to protect.

It’s the same with countries! The more roads, dams, power plants and airports you have, the more money you have to spend on repairing them. And so, as you increase your capital stock, you have to spend an increasing amount of money every year in keeping that capital stock up and running. And what that means is, you therefore have lesser money to throw at building up new stock.

Put another way, here is what it means: the more you have grown, the more difficult it is for you to grow.

And so, we come to the crux of the Solow model.

Countries that have a low stock of capital, along with a mix of good institutions, are the countries that will grow the most rapidly. But, they can’t grow rapidly forever. As they accumulate more capital, the need to repair it will eat increasingly into the country’s ability to invest more, and growth will slow down. And eventually, all countries settle down into a rate of growth that is just about right for that country.

Economists call this the steady state growth rate – faster than this is unsustainable, and slower than this is not optimal.

Figuring out your long run steady state growth rate, figuring out the best set of institutions for your country, and figuring out how to get there – that’s what long run growth theory is all about.

Why do institutions matter?

Remember the Sachin masterclass example from the previous post?

Well, now imagine that he gives this masterclass to me, and to you. Also assume that I am a middle aged man, slightly portly, and not very good at sports (this would, in fact, be a very good assumption on your part). Furthermore, assume that you are young, lithe, and take to any sport naturally (for your sake, I’m hoping this is a very good assumption on my part!)

Who do you think will learn better in that masterclass? Portly, ungainly me, or lithe, athletic you?

Similarly, a spanking new airport in Mumbai, and a spanking new airport in Bangui (the capital city of the Central Africa Republic) won’t have the same impact on both cities. I’ve never been to Bangui, and I certainly mean no disrespect, but it would be a safe bet to assume that law and order, level of corruption, ease of transactions are all better in Mumbai than they are in Bangui. Not perfect, not by a long shot, but better.

Institutions, in this context, is the framework in which economics happens. Markets don’t – cannot – exist in a vacuum. They must be protected by courts, who help in mediating disputes. They must be protected by the police, who help in guaranteeing property rights. There must be a state that creates laws for citizens to abide by. When these things function the way they ideally should, markets thrive, capital is rapidly created, and the economy grows fast.

When these things are broken – when corruption, theft and lawlessness are the norm, markets crumble, capital flees and the economy turns moribund.

The key point is, it isn’t enough for Sachin to give you a masterclass. You must have the body conditioning to learn.

Similarly, it isn’t enough for you to have a low stock of capital – your country must also have the right mix of institutions.

But as with most things in life, that is easier said than done. In some ways, it is the classic chicken and egg problem. A country will have quality institutions only once it gets rich, and we’ve just argued that you can’t get rich without having quality institutions. But that is part of what makes thinking about development so tough.

It is fair to say that both institutions and the accumulation of capital proceed hand in hand – when one grows, so does the other, and vice versa.

Are India’s courts, police force, and laws better today than in the 1950’s? Yes. Have we a higher stock of capital today than in the 1950’s? Yes. Does one cause the other, or is it a self-reinforcing process? Probably the latter – but this much is certain: one can’t happen without the other.

So, to sum up our story so far: growth is important, and growth can’t happen without capital. Accumulating capital is hard, but the good news is that if you have hardly any to begin with, you can grow it quite fast. The bad news, institutions really matter.

Next up: depreciation.

Small economies, big economies

Here’s a fun thought experiment.

What if Sachin Tendulkar agreed to give you a one-on-one batting masterclass for an hour? One hour with the Little Master, who will carefully observe your technique, our shots and your overall batting, and then proceed to tell you how he thinks you can become better. It’d be fairly safe to assume that you’ll be a much better batsman at the end of that session, right?

Now, what if Sachin also did a one-one-one masterclass with Virat Kohli? Here’s a batsman who’s at the peak of his game, and who is, in his own right, a very accomplished batsman indeed. Here’s the question: will it be equally safe to assume that Kohli will be a much better batsman at the end of that session?

Hopefully, all of you agree that Kohli was already a very good batsman That masterclass won’t hurt him, but the rate of improvement won’t be all that much, because he was so very good already.

But you? Your rate of improvement will be stratospheric, because you are a novice in batting compared to Kohli.

Similarly, what will be the impact of a spanking new expressway connecting two cities in America? Marginal, because they already have a pretty good network of highways. What will be the impact of a spanking new expressway connecting two cities in India? Much larger, because in all likelihood, this will be the first such road between these cities.

The flow of commerce between these cities will be higher than earlier, the measurement of which will show up as an increase in GDP. This is a central prediction of the Solow model.

Countries with a low level of capital will, other things kept aside, grow faster than countries with a high level of capital. America will not grow at anything in excess of 3% per year, while India will consider it a tragedy if we grow at less than 5% a year.

That doesn’t mean America is somehow worse than India when it comes to economic performance. Of course America will grow slower, because she has seen so much growth already. We, on the other hand, are just about beginning our growth story. Villages in India will see electricity for the first time, and many Indians will travel in a car, on a national highway, for the first time in their lives. These indicators of progress will all be registered in our GDP measurements as growth, and so India will (or at least ought to) grow faster than America in the years to come.

So countries with a low capital stock tend to grow faster. Tend to, unfortunately, isn’t a guarantee of growth. In other words, not all countries with a low capital stock grow rapidly – some don’t.

What holds countries back is institutions – and that’s what we will be looking at next.

Thinking about capital

You’re reading this post, right here and right now, using capital. You’re using some sort of electronic machine – maybe a computer, maybe a phone, maybe a tablet – in order to read these words. I used a laptop to write them.

Would it have been possible for me to write these words without any machine whatsoever? No computer, no paper, no pen, no nothing. In theory, yes. I could have used my foot to etch some words in the sand. But not only would that have been tedious and impractical, it would also have required you to be there in order to read it. But with my laptop, and its internet connection, I could put this post up on the internet, and anybody could read it, including you. So I could produce something of value (and you could consume it) much more easily because of the presence of capital.

And in general, that holds true for almost everything. Most goods and services are far easier to produce, and turn out to be of far better quality, when produced with the aid of machines. This is true of something as simple as haircuts (scissors), or classes (computers and projectors), and something as complicated as a rocket launch. Machines (that is, capital) help us grow faster.

So a growth in the amount of capital we possess (what economists refer to as capital stock) is almost a prerequisite for economic growth. Now, if this is true, we can make a series of predictions. I have outlined them below.

One, countries that have a low level of capital stock will be poor, and countries that have a high level of capital stock will be rich. Also, countries that are in the process of adding to their capital stock will be growing more rapidly than others.

Are these claims true? Nothing is ever completely true in economics. It is, after all, a social science, and you’ll always have a bit of error. But most economists would agree with the claims made above.

And without getting into the data and the charts, it is possible to see that the claim makes sense. Which country, do you think, has more roads, airports, seaports and power plants – India or the United States of America (USA)? Which country is richer?

Has China added, in the last three decades, an enormous number of airports, seaports and power plants (besides much else)? Has China grown rapidly?

Long story short, if we want India to grow rapidly, we have to add to India’s capital stock. We have to, in the years to come, build more roads, more dams, more solar farms – more everything, really. This will raise, to use a bit of jargon, our productivity. That is to say, it will raise our ability to produce more goods and services in the future – and that is what we mean by growth.

And this is the first intuition behind a model that we will be fleshing out now. The model is called the Solow model, and the intuition is painfully obvious in hindsight: adding to the capital stock helps a nation grow.

Thinking About Long Term Growth

We now know what GDP is, and why it is important to measure growth using GDP. We know what statistical adjustments are made over time so that growth is made truly comparable. We also know the difference between long term and short term growth.

Armed with the answers to all of these questions, we now ask the million dollar question:

What makes a nation grow over time?

That is, if we are to transform India into a developed nation by increasing her growth rate in a sustained, sustainable fashion, then what, specifically, needs to happen? Well, lots of things, is the easy answer. And a true answer, too.

Here’s a better question. What are the things without which this growth story absolutely can not happen?  What are the indispensable factors?

Answering this question takes us into the realm of growth, or development economics. Nomenclature aside, it is the area that lies at the heart of all economic policy-making. What we are looking for is the framework, the core, around which everything else can be built, added and embellished. Just as a truly great dish looks good and tastes better with more accompaniments, but can’t really work without the core ingredients – similarly, our growth story needs some core ingredients, around which we’ll add more stuff later.

And our core ingredients are labor, and capital. Turns out, India’s growth story cannot happen, without first possessing (and growing) capital and labor.

What is capital, and what is labor?

Capital is machinery. You’re almost certainly reading this post on an electronic device, and that device is your capital. The ladle with which a dosa-wala flips a dosa is capital. The pushcart that a chaiwala uses as his makeshift shop is capital. An assembly line in a Tesla factory is capital.

And the effort that I put in to type out this article is labor. The hands that use the ladle to flip the dosa is labor, as is the chaiwala himself and the worker on the factory floor of that Tesla factory. That is all labor.

And any production, anywhere in the world, of any good at all, can only be done with some combination of labor and capital. In order to produce something – anything – you need capital and labor.

The more you produce, the more you grow. The faster you produce, the faster you grow. And so in order to grow more, and grow fast, you need more capital, and you need more labor. So any story about the long term growth prospects of a nation need to start from capital, and labor.

Economists call these the factors of production, and without them, our story can’t start. But with them, we encounter another question: how do you get capital and labor to grow?