South Korea’s Demographics

The “picture” you see here is based off the picture in Ross Douthat’s column. I asked Dall-E to create this one, of course.

Without clicking on the link, can you guess what his column is about?

For some time now, South Korea has been a striking case study in the depopulation problem that hangs over the developed world. Almost all rich countries have seen their birthrates settle below replacement level, but usually that means somewhere in the neighborhood of 1.5 children per woman. For instance, in 2021 the United States stood at 1.7, France at 1.8, Italy at 1.3 and Canada at 1.4.

But South Korea is distinctive in that it slipped into below-replacement territory in the 1980s but lately has been falling even more — dropping below one child per woman in 2018 to 0.8 after the pandemic and now, in provisional data for the second and third quarters of 2023, to just 0.7 births per woman.

It’s worth unpacking what that means. A country that sustained a birthrate at that level would have, for every 200 people in one generation, 70 people in the next one, a depopulation exceeding what the Black Death delivered to Europe in the 14th century. Run the experiment through a second generational turnover, and your original 200-person population falls below 25. Run it again, and you’re nearing the kind of population crash caused by the fictional superflu in Stephen King’s “The Stand.”

Get used to worrying about not enough people, because that’s what the study of demographics will (has already?) come to mean in the 21st century. It’s not just South Korea, of course – Germany, Italy and Japan are also staring at the same problem, and that list is very far from being complete.

And what problem is that?

Not Enough People.

And as an Indian, sure you can ask how this can possibly be a problem. Here’s how:

There will be a choice between accepting steep economic decline as the age pyramid rapidly inverts and trying to welcome immigrants on a scale far beyond the numbers that are already destabilizing Western Europe. There will be inevitable abandonment of the elderly, vast ghost towns and ruined high rises and emigration by young people who see no future as custodians of a retirement community. And at some point there will quite possibly be an invasion from North Korea (current fertility rate: 1.8), if its southern neighbor struggles to keep a capable army in the field.

I’m actually slightly uncomfortable with the assertions in this paragraph (note the repeated use of the phrase “there will be”). Not because I disagree with them, but because we simply do not know how this will pan out. Maybe the immigration story will play out better than expected, and maybe (as Ross Douthat himself says elsewhere in the column, the tide will turn in pleasant and unexpected ways). Maybe, if you want to be all weirdly sci-fi about it, the South Korean government will produce babies in artificial wombs.

Too weird, and can’t possibly happen, you say? I present to you the last fourteen years or so.

But what really gave me pause was thinking about how Ross Douthat ends his column. What, he asks, are the underlying sociological causes of and responses to this rapid fall in birthrates?

  1. Traditional social mores in South Korea, including very low out of wedlock births
  2. A feminist revolt against conservative social expectations
  3. A consequential male anti-feminist reaction
  4. Sharp polarization between the sexes
  5. A sharp reshaping of the country’s politics, and a sharp decline in marriage rates

If you are a student of economics, but only faintly interested in demographics and sociology, you’re doing it wrong, I promise you.

We live in interesting times!

Max Roser on Data Pages

No Free Markets

About three weeks ago, Gulzar Natarajan wrote a blogpost titled “25 economic orthodoxies that should be discarded“. The list is fascinating and worth thinking about. Doubly so if you are learning or teaching economics, and each of his twenty-five picks is worthy of discussion.

So worthy, in fact, that a blogpost probably won’t be enough – but it will be a good enough start, perhaps? Let’s find out, beginning with his first point: there are no free markets in the world.

Have you heard of Gall’s Law? Here’s the quick definition:

A complex system that works is invariably found to have evolved from a simple system that worked. A complex system designed from scratch never works and cannot be patched up to make it work. You have to start over with a working simple system.

Economists look at the world, and try and make sense of it, by building the simplest possible system “that works”. To this system, they add increasing levels of complexity. At some point, they stop and say “Ah, this is now a working model of the world”. They then “run” this model, “see” what happens, and therefore predict what will happen in the real world. Sometimes the model “works”, in the sense that the model predicts, more or less, what actually took place in the real world. Sometimes the model fails, in the sense that the world goes and does something else altogether. The world is quite irritating that way.

In either case, we “update” the model, and we try again. And on and on we go.

But it all begins by building the simplest possible system.

How does this work, exactly?

Let’s say I want to stop writing this post, and I want to go have a cup of chai. Let’s model this simple statement.

I want to have chai.

But I’m a hopelessly lazy person, I don’t want to make chai. I simply want to go outside to a tapri, ask for a cup of chai, and sip on it.

We now have demand. There is a “rational agent”, who desires a particular commodity called chai. Do we have supply?

Sure we have supply! In fact, there is a lot of it – why, there are at least ten chai tapris a short stroll away from my house. Each of them will happily sell me a cup of chai for ten rupees. And, if I so desire, a packet of biscuits, or a cigarette to go with it. I desire neither, but that will not matter to the seller – they will happily sell me just the chai.

So now we have supply. And we have, therefore, a market for chai.

Gall’s Law, y’see. A simple, working model of a market. It’s easy, this economics-y stuff.

Just as there are no frictionless surfaces, there are no free markets in this world, ones that have perfect competition. Nor can there ever be any such markets. All markets, embedded as they are in the real world with people having widely varying and idiosyncratic preferences, suffer from imperfections and failures. The markets cannot self-correct these. Policy interventions are essential in those markets where failures impose significant social costs.

Is the market for a cup of chai close to where I stay perfectly competitive? That is, is the market that I just described “without friction”?

  1. Am I indifferent to where I will have my chai? Will any one of the ten tapris do, or do I have a favorite? Of course I have a favorite, which self-respecting Indian doesn’t?! In the language of economics, the good in question (a glass of cutting chai) ain’t homogenous. I have preferences.
  2. It’s weird, and it is a story worth the telling – I actually am indifferent to the chai in all of the ten tapris, but my favorite tapri sells vada pav as well, and ooh, there’s this one tapri has fantastic vada pavs. And I’ve made friends with the lady who runs that tapri, and whenever possible, she fries up a fresh batch of vadas whenever I turn up. And so I end up having chai there.
    Why do I bring this up? Because friction, because imperfection, because idiosyncrasy. This is already not a perfectly competitive market.
  3. Are all ten chai tapris run equally efficiently? Are all run by folks equally proficient in running a chai tapri? What does being equally proficient mean, exactly?
    • Equally good at making a cup of chai? Maybe one of them puts green cardamom in their chai, maybe one of them puts ginger, and maybe a third puts a bit of both?
    • Equally good at dealing with the local politician or local cops? Maybe one of them speaks Marathi but another does not? Maybe one of them is from a particular religion, but the other is not? Maybe one of them speaks a particular language, but the other does not? Maybe one of them is from a particular gender, but the other is not? Maybe one of them is from a particular caste, but the other is not? Don’t these things matter? Of course they do.
    • One of these chai tapris is located next to a sports facility. Another is located right next to a building that has a lot of offices and shops. Another also sells vada pav. A fourth is closest to a mandir. Do preferences build differently over time within the same locality as a consequence? Of course they do.
    • Do all of them have access to the same quality and quantity of water, tea leaves, vessels and cups?
  4. And so, for all of these reasons and so, so many more, the market for chai tapris right outside where I stay isn’t competitive.

I do not bring all of this up to show you that India in particular is imperfect, or that economic theory is hopeless. All societies the world over will have different preferences and constraints. And so both demand and supply, in any market, will have frictions and imperfections. And this is just the market for chai! What about the market for nuclear reactors? Covid-19 vaccines? Helicopters for the military? Software engineers? Milk? Votes? Kidneys?

These frictions and imperfections will mean that markets will not work as efficiently as they would have otherwise. And because they are not able to work as efficiently as they could have, the good in question is either not produced as much as it could have been, or is sold at a slightly higher price than it could have been, or both. And so either producers suffer, or consumers do, or both.

And all this before we talk about externalities, but that’s a whole other story.

Gulzar Natarajan’s first point in his list of things that don’t work in economics theory is that markets are not self-correcting. They don’t work perfectly.

And so, he says, “policy interventions are essential in those markets where failures impose significant social costs.”

Now, here’s where things get interesting, tricky and contentious, so make sure you follow along carefully:

  1. Almost every economist I know will agree that markets are not entirely self-correcting. We can and do quibble about the extent and ability of self-correction in different markets, but that’s a debate about degrees. It is not a debate about the existence of perfectly competitive markets.
  2. Almost every economist I know will agree that market failure, in some cases and for some markets, will impose significant social costs. That just is a fact. Again, the debate is about degrees, not about the fact that these social costs exist.
  3. But those four simple words… “policy interventions are essential”… that is where the debate rages. If economic theory is Jupiter, this is our Great Red Spot.
    • Folks who support policy interventions will say “There is market failure! There are significant social costs!”
    • Folks who don’t support policy interventions will say “Nah, it’s not as bad as you think it is! See this study, and that one, and that one, and this RCT, and that one, and this RDD and that one!”
      • And folks who support policy interventions will publish 547 well-researched, impeccably cited and co-authored papers refuting the 389 well-researched, impeccably cited and co-authored papers saying it wasn’t as bad as you thought, and well, this never stops. Avoid getting sucked into these battles, unless you like doing this sort of thing, or need to publish in order to get a degree or a promotion.
  4. Bu even if both the pro-interventionists and the anti-interventionists agree about the presence of significant social costs, the story is very far from over. Because all that we have managed to do is agree upon the diagnosis. Not the cure!
  5. “Market failure leads to social costs leads to policy intervention and so QED”, say the pro-interventionists.
    “Not so fast!”, say the anti-interventionists. “Who, exactly, is going to guarantee that the intervention will not make things worse? You and what army?”
  6. “So which is it?”, you may well ask. “Do interventions make things worse, or better?”
  7. I’m positively delighted to inform you that the answer to this question is dependent on time, place and scale. So a policy intervention that worked in the 1970’s for a village in India will work very differently for a city in China in the 2020’s. So we just don’t know for sure.

Bottomline: yes, of course there is market failure. Measuring the extent of it, and its impacts, is tricky. Yes, thinking about interventions is necessary. Coming up with the best possible design and the best possible implementation for these interventions is tricky. Measuring (let alone predicting) their first and second order effects is impossible.

Bottom-er line: Folks who say markets always work are wrong. Folks who say interventions always make things better are wrong.

The truth, you see

Supply, Demand, Productivity (and, of course, 70 hours!)

Via Navin Kabra

Ashok Gulati on How We Tame Food Inflation in India

Sisyphus was lucky to be given the task of pushing that boulder. If they really wanted to be cruel, they could have asked Sisyphus to write about India’s agricultural policies.

Given that a number of state elections are coming up, one can understand the central government’s overdrive to tame food inflation. Obviously, it does not want inflation to be an issue in election campaigns. But how we tame food inflation, and at whose cost, is important to analyse for rational policy making.

Thus begins Ashok Gulati’s recent column on taming food inflation in India – and it becomes angrier from there on in. And with good reason.

  1. We now have a minimum export price on basmati rice, of $,1200 per tonne. The typical export price for this commodity for the last five years or so has been not more than $1,000 per tonne, so let’s call this what it really is: a ban on exporting basmati rice.
  2. So if there is supply, and the government artificially curtails demand, what do you think will happen to the price? Who will get this lower price?
  3. Plus, demand has been curtailed not in India, but abroad (say, for example, in Dubai). Who will help meet this demand in Dubai? Farmers in Pakistan – so it would seem the Indian government has put in place policies to help Pakistani farmers. Go figure.
    Here’s how Ashok Gulati puts it:
    “Externally, it must be remembered that it takes years to develop export markets, and by putting such a high MEP, India is basically handing over our export markets to Pakistan, who is the only other main competitor of basmati rice. Is this a conscious policy decision?”
  4. There’s this rather depressing statistic in the piece:
    “It may be noted that in 2013-14, the last year of the UPA government, India’s agri-exports touched $43.27 billion, up from $8.67 billion in 2004-05 when it took over power at the centre. This is almost a five-fold growth in 10 years. If the same momentum had been maintained during the 10 years of NDA rule, agri-exports should have touched $200 billion. But in reality, they may not touch even $50 billion this year (2023-24).”
  5. Finally, Ashok Gulati also points out that our R&D expenditure on agriculture is 0.5% of our agri-GDP. And that, as he says, is simply too small a number, and needs immediate doubling, if not tripling.

Very few things in life are as frustrating as analyzing India’s agricultural policies in general. And within this set of policies, our muddled thinking about agricultural exports takes the cake.

Economics as an Inductive Science

…the development of science is driven, in normal periods of science, by adherence to what Kuhn called a ‘paradigm’. The functions of a paradigm are to supply puzzles for scientists to solve and to provide the tools for their solution. A crisis in science arises when confidence is lost in the ability of the paradigm to solve particularly worrying puzzles called ‘anomalies’.

(Trivia question for econ nerds: what long running series in an academic journal are you reminded of when you read this? I’ll answer the question in tomorrow’s post.)

I was one half of a very nice conversation we recorded over the weekend for a podcast. The podcast will be out in a couple of weeks or so, and I will write more about it then. But for today, we’re going to talk about a lovely little essay that I read after many, many years. I re-read this essay because it came up in conversation during the podcast.

The title of the essay is “Economics as an Inductive Science“, and it is the Presidential Address that was delivered at the sixty-third annual meeting of the Southern Economic Association, in 1993. It was delivered by Robert Clower. If you’ve read enough macroeconomics in your life, Clower is a name that is bound to come up sooner or later. But this particular essay isn’t necessarily (or exclusively) about Keynesian economics. It is, instead, a rant about where economics seems to be headed. And it is a rant that is worth reading.

Apart from some kickass quotations (“Logic is the art of going wrong with confidence” is the first quote, and it only gets better from there on in), it is an essay that makes you think about how we go about “doing” economics.

Economics (and especially macroeconomics), Clower says, is riddled with Kuhnian anomalies. What are Kuhnian anomalies? That’s why we began with that quote at the top of the blogpost.

But let’s back up for minute. What do we do as economists? We learn principles, theories and models (and some of us even develop some of these principles, theories and models). We then go look at the world. Based on what we see in the world, and based on what we think we know of how the world works, we make certain predictions.

Note that the word prediction doesn’t necessarily mean forecasting the future. “If we see x going up, y should be going down” is a prediction, but not a forecast.

Now, if these predictions turn out to be repeatedly and wildly wrong, we are left with three hypotheses. Either, we should reason, the data we have collected is wrong. Or our theory is wrong. Or both! And then, as “scientists”, we go and take a look at our data collection methodologies. Once we ascertain that we haven’t erred there, we look at the theory. And if the data looks right but the theory ain’t working out… well, then, we have an anomaly.

Collect enough of these anomalies, and you get to challenge theory. And every now and then, we get to update the theory. And so science chugs along, inch after excruciating inch.

If you are looking for a concrete example of how this works in practice, I have a story to tell you. This story consists of a lot of things, including static on your television set, a Nobel prize in physics… and pigeon poop. Yes, really.

“I had a lot of experience fixing practical problems in radio telescopes,” Robert Wilson now says. He and his wife Betsy Wilson still live in Holmdel, New Jersey, not far from hilltop where the tests were run. “We looked for anything in the instrument or in the environment that might be causing the excess antenna noise. Among things, we searched for radiation from the walls of the antenna, especially the throat, which is the small end of the horn. We constructed a whole new throat section and then tested the instrument with it.”
At one point, new suspects emerged. Two pigeons had set up housekeeping inside the guts of the antenna. Maybe their droppings were causing the noise? Wilson and Penzias had the birds trapped and then cleaned the equipment, but the signals continued.
After a year of experiments, the scientists concluded that they’d detected the cosmic background radiation, an echo of the universe at a very early moment after its birth.
“We started out seeking a halo around the Milky Way and we found something else,” notes Dr. Wilson. “When an experiment goes wrong, it’s usually the best thing. The thing we did see was much more important than what we were looking for. This was really the start of modern cosmology.” In fact, Wilson and Penzias were awarded the Nobel Prize in Physics in 1978 for determining that the hiss they were hearing wasn’t pigeon poop at all, but the faint whisper of the Big Bang, or the after glow that astronomers call the cosmic microwave background.

You set up an experiment, and you expect to see x. “Expect” to see x? That’s the current theory!

But hey, you don’t see x, you see y instead. Well, maybe we’re seeing y because there’s some problem with our data gathering apparatus. That is, we’re sticking to our guns when it comes to our theory, and we’re going to see if our data collection strategy is off. But if you eliminate every single source of data contamination (including pigeon poop!), then it is finally time to challenge established theory and update it – and win a Nobel Prize to boot.

Cool, huh?

Well it is, except for the fact that Clower is really telling us that this doesn’t happen enough in economics. Consider this quote from Einstein, cited in the speech we are talking about today:

“Science is the attempt to make the chaotic diversity of our sense-experience correspond to a logically uniform system of thought. [ … ] The sense experiences are the given subject matter, but the theory that shall interpret them is man-made. It is the result of an extremely laborious process of adaptation: hypothetical, never completely final, always subject to question and doubt”

Clower is making the point that our theories have become completely final, and are not subject to question and doubt. Read in particular Clower’s descriptions of his set of stylized facts (pp5), and the facts as assumed by our paradigmatic model (pp6).

As economists, we have two choices:

We can keep searching for the pigeon poop, even though it may not exist. Or we can ask if our theory needs to be updated. And maybe, Clower suggests, we should work on updating our theories a bit.

And while doing so, he suggests keeping three things in mind.

While doing inductive science, he says, one’s motto ought to be that “If it isn’t common sense, it’s probably wrong.”

Second, a direct quotation from the speech: “If we are ever to be taken seriously as scientists we would be well advised to proceed with this task as most practitioners of other inductive sciences have proceeded – by taking a hard look at the world around us in a serious effort to lend intellectual order to the “chaos” that strikes our eyes at first sight”

And finally, an admonition of sorts. We should remember, he says, that inductive sciences deal with plausible inference, not with demonstrative reasoning.

Tyler Cowen Writes A(I) Book

Tyler writing a book has happened quite often, and will happen again. But this is a book written for and in AI. But not, it should be noted, with AI.

Do you yearn for something more than a book? And yet still love books? How about a book you can query, and it will answer away to your heart’s content? How about a book that will create its own content, on demand, or allow you to rewrite it? A book that will tell you why it is (sometimes) wrong?
That is what I have tried to build with my latest work. It’s called GOAT: Who is the Greatest Economist of all Time and Why Does it Matter?

I have not finished reading the book, but plan to do so in the next couple of days. I’ve finished reading the chapters on Friedman, Keynes and Hayek, along with the introductory chapter – but in a manner of speaking, I haven’t even started.

Not because I’m less than halfway through the book (though there’s that too) – but because I haven’t yet read the book in ChatGPT. And that, I suspect, is where the book will really and truly come alive. But even without that mouth-watering prospect being taken into consideration, the book is already well worth my time (and I know one is supposed to say your mileage will vary, but it will be worth yours as well).

Because how many books about the history of economic thought will talk about basketball, peering in through Gottfried Haberler’s window and Edgeworth looking like a Schnauzer Terrier? And all that in just the first chapter!

The first chapter explains, in typically Tylerian fashion what is being supplied by Tyler, and there are four broad things that are being supplied:

  1. The teaching of economics (duh)
  2. Economics as a vehicle for carrying ideas about the world (about which there is a paragraph below)
  3. Economists and how to think about their talents
  4. Tyler’s adjudication for who is the GOAT in economics

I find it interesting that the title of the book is actually his fourth reason for writing the book. Come for the shortlisting and the prize giving ceremony, Tyler seems to be saying, but stay to learn economics (1), learn more about economists (3), and (maybe, and best of all), learn how to carry ideas about the world in your creations (2).

And again, in typically Tylerian fashion, we learn that the inspiration for writing this books comes not from what you and I would have considered the usual suspects – but from some book about basketball. When I say “some book about basketball”, I do not mean to be disparaging about the sport. I mean to convey how little I know about the sport, and about books written about the sport. But the point is well taken – this is a book written by a fan of the subject. I take that to mean that this book is to be taken the way Tyler’s podcast is to be taken – this is Tyler’s conversation with himself about his favorite subject, not the conversation you wish to have with Tyler about his favorite subject.

By the way, in an interesting coincidence, just yesterday I was talking to a friend about a post I’d written on the blog a while ago, about who, in my opinion, was the worst economist of the 20th century. Two people (who will both remain anonymous) told me in conversations that Milton Friedman is their pick for the worst economist of the 20th century. One of them meant it as a joke, and one of them was quite serious. I disagree, of course. Milton Friedman was undoubtedly one of the best economists of the 20th century, and certainly among the top 10 all time, in my book.

But who would be my pick for the GOAT?

So far, Adam Smith.

But I hope to be able to update you by the end of the week, if not sooner, if my answer changes.

Geopolitical Conflicts and Their Impacts on Equity Markets

Seemed like a good time to write about this, since this topic looks like it will be of interest for a while. What happens when war breaks out? Death, disaster and destruction. But outside of the obvious and the tragic…

One likely immediate question that emerges is what it means for investors, and what action (if any) is called for. This short note is our attempt to answer this question.

It’s a nice and short post, the on we’re talking about today, and can be read fairly quickly. The first chart itself is quite instructive:

It’s instructive for a lot of reasons, but not all of them are obvious:

  1. War seems to have an immediate (and negative) impact on equity markets.
  2. But we actually cannot say so for sure, and for two reasons. One, the relatively small sample size. And two, there are likely hajjar other things that are also going on in the world, and the dip may well be because of these other factors. In fact, the war itself may have been caused by some (or all) of these other factors. Econometricians will chomp at the bit upon reading this, but it suffices for us to know that establishing causality can be tricky.
  3. The severity of each event, in terms of their impact on American equity markets is difficult to measure. It would seem safe to say that 9/11 had a bigger impact on equity markets than did the US operation in Cambodia, for example. But the Iranian hostage crisis – did it have the same impact as the US invasion of Panama? For the same reasons or other reasons? What has changed in the intervening ten years in the global economy, in the USA, and in specific markets within the USA?

The rest of the post is definitely worth a read, and the research seems to indicate the following:

  1. It takes somewhere between one to three months for markets to mean-revert after a particular event. This event could be positive or negative.
  2. For negative events, markets end up being about 2% below pre-event level a month or so after adverse events.
  3. Risk aversion seems to go up on part of investors
  4. Markets seem to react more to negative news than positive news (who woulda thunk it?!)
  5. Emerging markets have higher sensitivity to such events than developed markets.
  6. Markets are quick to price in perceived threats, and the actual event itself therefore does not see that much of a reaction.

As regards that last point, see this from Taleb:

If you asked any intelligent “analyst” or journalist at the time, he would have predicted a rise in the price of oil in the event of war. But that causal link was precisely what Tony could not take for granted. So he bet against it: they are all prepared for a rise in oil from war, so the price must have adjusted to it. War could cause a rise in oil prices, but not scheduled war—since prices adjust to expectations. It has to be “in the price,” as he said. Indeed, on the news of war, oil collapsed from around $39 a barrel to almost half that value, and Tony turned his investment of three hundred thousand into eighteen million dollars.

Taleb, Nassim. Antifragile: Things that Gain from Disorder (p. 210). Penguin Books Ltd. Kindle Edition.

Tricky thing, predicting markets!

If you would like to read a more detailed review of the literature on this topic, I would suggest the section titled “How Sensitive Are Markets to Armed Conflict” from this paper (pp 625)

Kurzgesagt on Why South Korea is Dying Out

I struggle to explain how important this point is for the 21st century in class, in part because we had the exact opposite problem in the 20th century.

The study of demographics is ridiculously underrated!

On Industrial Policy

One of my favorite book to have read (and to recommend to others to read) is How Asia Works, by Joe Studwell. I liked the book for many reasons, but here are the three main ones:

  1. It taught me that international trade textbooks are overrated
  2. It taught me that the practice of international trade is very different from the theory of international trade
  3. It helped me realize that when done properly, industrial policy is underrated

The trick, of course, is to understand fully what the phrase “when done properly” means. There are lots of excerpts from the book worth quoting in this regard, but I will restrict myself to just two:

“The state’s role is to keep money targeted at a development strategy that produces the fastest possible technological learning, and hence the promise of high future profits, rather than on short-term returns and individual consumption. This tends to pit the state against many businessmen, and also against consumers, who have shorter strategic horizons.”


“It investigates how Japan, Korea, Taiwan and China perfected ways to marry subsidies and protection for manufacturers – so as to nurture their development – with competition and ‘export discipline’, which forced them to sell their products internationally and thereby become globally competitive”

Defined in this fashion, industrial policy is not about raising employment, reducing inequality, reducing risk or mitigating the effects of climate change. It is, instead, about “producing the fastest possible technological learning”. And it is about nurturing the development of manufacturers with competition and export discipline.

(Note that India has tended to nurture the development of manufacturers by taking away competition and export discipline, and this remains mostly true even today)

As it turns out, industrial policy and how successful it is depends a lot on how one defines it, and what one wants from it.

The Economist has a Special Report in its latest edition, called “Homeland Economics”, which is its way of describing industrial policy. The six articles (and a video) that form this special report doesn’t define industrial policy in so many words, but the first article does define “homeland economics”:

Now, though, a radical alternative really is taking shape. Some call it “global resilience” or “economic statecraft”. We call it “homeland economics”. The crucial idea is to reduce risks to a country’s economy—those presented by the vagaries of markets, an unpredictable shock such as a pandemic, or the actions of a geopolitical opponent. Supporters say this will produce a world that is safer, fairer and greener. This special report will argue that it will, in large part, create the opposite.

Homeland economics, it goes on to say, is a response to four big shocks:

  1. The economic crises of 2008 and 2020
  2. Geopolitical shocks (America and China going hammer and tongs at each other, plus Vladimir)
  3. Energy shocks (partly related to the second point, of course)
  4. Generative AI

And as the article goes on to say, homeland economics is about “protecting the world from similar shocks in the future”. It then describes what moves are afoot in the USA, in Europe, in India and elsewhere, and goes on to predict that these will mostly fail.

Why will it fail? Well, because the benefits will be lesser than the cost, simple:

The benefits of the new approach are at best uncertain. Meanwhile, attempts to break free economically from China are likely to be partial, at best. The benefits of green subsidies for the fight against climate change are also less clear than their proponents admit.The costs, by contrast, are clear. Research by the imf considers a hypothetical world which has split into America- and China-led blocs (with some countries remaining unaligned). In the short run, global output is 1% lower, and in the long run 2% lower. Other estimates put the global gdp impact at over 5%. It is as if the entire world decided to Brexit. The historical experience of industrial policy is not encouraging. Governments are going to waste a lot of money—not a good plan, given the demands from health care and pensions, and already-large deficits.

The special report then goes on to make this point in more detail, and each of these articles are worth reading:

  1. Demand for Supplies (about supply chains and their resilience)
  2. State v Market (about how poverty will likely increase as a consequence of homeland economics)
  3. Missing the Point (about how inequality will increase)
  4. Second Best (about how green protectionism is unlikely to work out well)
  5. In Search of a Problem (about how economic stability will be lower)

So who is “wrong”? Is the book “How Asia Works” wrong, or is the special report by The Economist wrong?

Neither, if you ask me, and that is not me ducking out of having to give an answer. The reason both are not wrong is because both are answering the question “what are you optimizing for?” very differently. The Economist argues for economic efficiency being sacrificed at the altar of geo-strategy, economic security, self-reliance, the building of national champions in “strategic” industries, to encourage production at home, to limit the harmful impacts of climate change and to reduce inequality. How Asia Works optimizes for the fastest possible technological learning. If this increases inequality, results in molly-coddled domestic firms being shut down, or financial repression for households, well, so be it.

I do not know if the industrial policies being followed by many nations (including India) will “work” or not. I do not know if they are morally, ethically desirable. Nor do I know if they are the “best” set of policies. These are complicated questions, and like the rest of the planet, I have some ideas and opinions. But a lot of the confusion and debate, I suspect, will melt away by asking (and answering) a very simple question.

When it comes to industrial policy, what are you optimizing for?

Most countries today are not optimizing for economic efficiency. We can (and should) debate about whether this is a good idea or not. But if you tell them that they will fail from an economic efficiency viewpoint, they might well reply that this was the point!

To be fair to The Economist, they make a compelling case for why this is going to be a major problem (failing at economic efficiency). But most countries are likely to say that this is a price they think is worth paying in today’s day and age!

In all seriousness, I would love to read a Special Report from The Economist on whether economic efficiency is underrated or overrated.