A thought provoking Twitter thread from Anup Malani

I usually keep interesting Twitter threads for Saturdays, but this one is deserving of additional commentary and additional reading links:

Unintended consequences, or externalities, or spillovers (some might say these aren’t really interchangeable terms) are a well studied phenomenon in economics, as Anup Malani himself says. Read the classic paper, and listen to many, many conversations over on EconTalk about the topic to get a better understanding.


Anup Malani says towards the end of that first tweet that he has seen economics give explanations for 1 (but not for 2, which we’ll get to later). So what are the explanations for 1? For us to understand the explanations, let us first take a look at the examples that Anup Malani cites in this thread:

And as he himself says in a subsequent tweet in this thread, these phenomena can be understood using simple price theory. Driving becomes safer as a consequence of the introduction of seat belt laws. What does one do with this increased safety? One can either benefit from it by maintaining the same driving speed as before, or one can “spend” the increased benefit by increasing the driving speed.

If, for example, you are the kind of person who thought you were a safe and competent driver before wearing seat belts, you might now think that wearing the seat belt makes you safer still. But you were ok with the level of safety you had before – you are now “extra” safe. But that’s “too” safe for you, so you up the speed at which you drive. Students who have studied basic micro before, kudos if you were reminded of this. If you haven’t formally studied micro before, please do watch that video.


So, price theory helps us “get” how to think about unintended consequences. Although this does raise the rather interesting question about whether one should have anticipated these effects in advance (us economists, we don’t like using simple words. We say ex-ante instead of in advance. It’s the same thing.)

And if we could have anticipated these effects in advance, then were they really unintended consequences in the first place? Something to think about, eh? Maybe that’s why these terms (externalities, unintended consequences and spillovers) aren’t really interchangeable?


But now we get to the second case. Part two of Anup Malani ‘s first tweet in this thread: that which does not kill you makes you stronger.

What are examples of this phrase? (Here’s the Wikipedia article about the phrase itself)

Vaccines, of course! They make you sick sometimes (you are, after all, injecting yourself with a dramatically weakened version of the virus), but they leave you stronger in the sense that you body “learns” how to cope with the virus if it actually does enter you body. Vaccines don’t kill you, and they make you stronger!

But that’s an example from the field of biology. What about economic systems?

Anup Malani gives excellent three excellent examples in his thread, I’ll just mention one over here. Please take a look at the other two as well.

Import of cloth from India, where wages were low, threatened the domestic British cloth-making industry. It didn’t kill this industry, but it did threaten it. And the British responded by increasing mechanization. And the rest is, well, literally history.


Now, this is where Anup Malani ‘s Twitter thread really takes off for me. Price theory, he says, helps us understand unintended consequences. What theory helps us understand “that which does not kill you makes you stronger”?

Anup Malani says we don’t really know.


Might Nassim Nicholas Taleb’s book, Anti-Fragile, have an answer?

Antifragility is a property of systems in which they increase in capability to thrive as a result of stressors, shocks, volatility, noise, mistakes, faults, attacks, or failures. The concept was developed by Nassim Nicholas Taleb in his book, Antifragile, and in technical papers.

https://en.wikipedia.org/wiki/Antifragility

I’m not sure, and I might be wrong about this, but I think the answer is yes, it does have an answer. Read, in the context of what we’re speaking about in this blog post, chapter 4 from this book very carefully. Here’s one excerpt from that chapter to help you get started:

Nietzsche’s famous expression “what does not kill me makes me stronger” can be easily misinterpreted as meaning Mithridatization or hormesis. It may be one of these two phenomena, very possible, but it could as well mean “what did not kill me did not make me stronger, but spared me because I am stronger than others; but it killed others and the average population is now stronger because the weak are gone.” In other words, I passed an exit exam. I’ve discussed the problem in earlier writings of the false illusion of causality, with a newspaper article saying that the new mafia members, former Soviet exiles, had been “hardened by a visit to the Gulag” (the Soviet concentration camps). Since the sojourn in the Gulag killed the weakest, one had the illusion of strengthening. Sometimes we see people having survived trials and imagine, given that the surviving population is sturdier than the original one, that these trials are good for them. In other words, the trial can just be a ruthless exam that kills those who fail. All we may be witnessing is that transfer of fragility (rather, antifragility) from the individual to the system that I discussed earlier. Let me present it in a different way. The surviving cohort, clearly, is stronger than the initial one—but not quite the individuals, since the weaker ones died. Someone paid a price for the system to improve.

Taleb, Nassim Nicholas. Antifragile (p. 76). Penguin Books Ltd. Kindle Edition.

Mithridization? Here you go. Hormesis? Click here.

This blog post isn’t the place to get into the details of chapter four from Anti-Fragile. Please, do read the entire chapter (and the entire book!)

It is, of course, all too possible that I’m entirely wrong in saying that this is a good answer to Anup Malani’s question. And if you think so, I would love to learn how I’m wrong.

But for the moment, this is my first pass answer to a fascinating question at the end of a lovely thread.

The Positive Externalities of Writing a Blog Post

If I ever meet Zeynep Tufekci, a beverage of her choice is due to her from me.

Last week’s post about her take on metaepistomology bought forth two very pleasant consequences. Whether they were intended or not is a question I myself have been grappling with, but I shall deal with that question (and that story) later on this week.

About those consequences:

  1. A student from the BSc program at the Gokhale Institute wrote in asking if we could have a discussion about metaepistomology – and you’ll permit me a self-congratulatory pat on the back for getting folks interested in a word as daunting as that. This of course means that I will have to spend a fair chunk of my time today reading up about metaepistomology myself, but I know that can only be a good thing.

    (Or do I?)
  2. Another student from the same program asked why a course on philosophy wasn’t a part of the program in a formal sense. To which I had no good answer, beyond saying that the course constraints were such that it could not be fit in.

Which, let’s be upfront and honest, is no answer at all. So, the topic of today’s blogpost: if there were to be a summer school, or a workshop, or a weekend course – whatever – on philosophy at the undergrad level, what all should it contain?

I don’t have a formal training in philosophy, having never taken the subject in my own undergrad days. It wasn’t on offer, I am sad to report, when I was doing my Masters. But I have tried to read a little bit here, and a little bit there, and have jotted down the list below as a starting point. Note that I have tried to ask what should be included in a summer school for students of economics who are studying philosophy for the first time, rather than first time students of philosophy. Also not that I am a complete amateur: please, point out obvious omissions!

That, I’m guessing should be more than enough for a 30 hour introduction, and the reading list is already monstrous.

So when I ask of you, what am I missing, I’m really asking the following: who/what would you include (and why) and who/what would you remove (and why). If there is anybody reading this who could help, please do write in.

Thank you!

Reflections on The Entrepreneurial State, by Mariana Mazzucato

The full title of the book is “The Entrepreneurial State: Debunking Public vs. Private Sector Myths“, and the author is Mariana Mazzucato, Professor in the Economics of Innovation and Public Value at University College London (UCL), and Founder/Director of UCL’s Institute for Innovation and Public Purpose.

The key point made in the book is that entrepreneurship is not – and should not – the responsibility of the private sector. Indeed, it cannot be the responsibility of the private sector.

Early on in the book, she makes the strongest case there is to be made for her thesis, by arguing that the United States of America has known this, and practiced this, for years on end. The rest of the world, she says, would do well to emulate the USA:

If the rest of the world wants to emulate the US model they should do as the United States actually did, not as it says it did: more State not less.

LOCATION: 372 (Note that the location refers throughout to the Kindle version)

There are a lot of excellent reviews out there already. See this one in the New York Times, for example. It is a mostly favorable review. Or, if you want a slightly more critical one, see this one in The Guardian. Indeed, there are many others out there.

I want to focus on three key points in this essay: horizons, incentives and spillovers. Let’s tackle each in turn.

Horizons

Moonshots is a word that has become increasingly popular over the last two decades, and it refers to projects or even ideas that have a relatively low chance of succeeding. The payoff, if these ideas succeed, is so large that that it may compensate for the relatively low probability of this actually happening. That, of course, is exactly what expectations are all about.

But for a firm, particularly one that may not have the luxury of time and money on its side, placing bets on projects that may not work out – and indeed most of them will not – is a rather risky thing to do. Money is an obvious constraint, but a less obvious one is time.

Firms just do not have the luxury of waiting while a project turns out to be successful… eventually. These kind of moonshots, then, are perhaps best handled, for this specific reason, by the state.

In fact, the point is even more nuanced, because a firm is much more likely to (if at all) invest in a moonshot project based on a specifically desired outcome. The word project itself is an indication of this fact – this is not “blue sky research” that we are talking about.

But blue sky research is important!

A core difference between the US and Europe is the degree to which public R&D spending is for ‘general advancement’ rather than mission-oriented. Market failure theories of R&D are more useful to understand general ‘advancement of knowledge’–type R&D than that which is ‘mission oriented’ (Mazzucato 2015). Mission-oriented R&D investment targets a government agency programme or goal that may be found, for example, in defence, space, agriculture, health, energy or industrial-technology programmes (Mazzucato and Penna 2015).

LOCATION: 1549

Governments need to focus, for the sake of their own economies, their domestic firms and their long term growth, on focusing on moonshot projects, precisely because firms are reluctant to do so. The state needs, in other words, to take risks that private firms will not.

Saying this is easy, but how to go about doing this?

That is, if governments need to tackle long-term low-probability-of-success and uncertain-outcome initiatives that are important, but unlikely to be taken up by the private sector, the question that then arises is: how?

Mazzucato offers two points in this regard that I found interesting:

Block (2008, 188) identifies the four key characteristics of the DARPA model:

1. A series of relatively small offices, often staffed with leading scientists and engineers, are given considerable budget autonomy to support promising ideas. These offices are proactive rather than reactive and work to set an agenda for researchers in the field. The goal is to create a scientific community with a presence in universities, the public sector and corporations that focuses on specific technological challenges that have to be overcome.

2. Funding is provided to a mix of university-based researchers, start-up firms, established firms and industry consortia.

3. There is no dividing line between ‘basic research’ and ‘applied research’, since the two are deeply intertwined. Moreover, the DARPA personnel are encouraged to cut off funding to groups that are not making progress and reallocate resources to other groups that have more promise.

4. Since the goal is to produce usable technological advances, the agency’s mandate extends to helping firms get products to the stage of commercial viability. The agency can provide firms with assistance that goes well beyond research funding. Part of the agency’s task is to use its oversight role to link ideas, resources and people in constructive ways across the different research and development sites.

LOCATION: 1808

In effect, she is suggesting that government alone cannot do this, it needs to be a “scientific community” that is decentralized, has autonomy, sets the agenda, and applies Darwinian principles (see point 3). Hmm, sounds familiar. Different context, but a similar lesson!

And elsewhere in the book, her example of how Japan did this in the 1970’s is instructive:

The general point can be illustrated by contrasting the experience of Japan in the 1970s and 1980s with that of the Soviet Union (Freeman 1995). The rise of Japan is explained as new knowledge flowing through a more horizontal economic structure consisting of the Ministry of International Trade and Industry (MITI), academia and business R&D. In the 1970s Japan was spending 2.5 percent of its GDP on R&D while the Soviet Union was spending more than 4 per cent. Yet Japan eventually grew much faster than the Soviet Union because R&D funding was spread across a wider variety of economic sectors, not just those focused on the military and space as was the case in the Soviet Union. In Japan, there was a strong integration between R&D, production and technology import activities at the enterprise level, whereas in the Soviet Union there was separation.

LOCATION: 1142

And…

Equally important were the lessons learned by Japanese people that went abroad to study Western technologies for their companies, and relationships between those companies and US firms. These companies benefited from the lessons of the US (hidden) ‘Developmental State’, and then transferred that knowledge to Japanese companies which developed internal routines that could produce Western technologies and eventually surpass them.

LOCATION: 1156

So, bottom-line: the state has to get in this business, but it can’t “go” it alone. There needs to be a community of academicians, researchers, firms, scholars – and as the example of Japan shows, this community needs fostering, and horizontal collaboration.

Or, if you prefer to put it simply, this is going to be hard.

Incentives

Academia suffers from the same problem that government bureaucracy does in India: the incentives are all wrong. Both are about risk minimization.

A professor in a college has no incentive to try and do something new, something risky, something innovative. Why, if you think about it, should she? Your best case scenario is that it works, but you get no upside for it: remember, wages aren’t a function of what you do, they are a function of how long you have been in the system. Your worst case scenario is that what you tried to do blows up in your face. So why take the risk?

And it is the same, of course, with a government bureaucrat. And that makes the conclusion of the previous section even more problematic, for where, exactly, are you going to unearth government bureaucrats willing and able to make this happen?

I’m all for the state being more entrepreneurial. I buy into the idea. But I worry, especially in a country like India, about the feasibility of it, for hey, incentives matter!

In a blogpost I had written earlier this year about the budget, I had touched upon this point:

Here is Ninan’s solution:

“Is there a solution? Yes, railway engineers of old like the metro builder E Sreedharan, builders of government companies like D V Kapur and V Krishnamurthy, and agricultural scientists like M S Swaminathan have shown how they made a difference when given a free hand. Vineet Nayyar as head of Gas Authority of India was able to build a massive gas pipeline within cost and deadline in the 1980s. The officers who are in charge of Swachh Bharat and Ayushman Bharat, and the one who has cleaned up Indore, are others who, while they may not match China’s speed, can deliver. Perhaps all we have to do is to spot more like them and give them a free hand.”

But as any experienced HR professional will tell you, spotting them is very difficult, even in the corporate world. And as any corporate CEO will tell you, giving these talented folks a free hand is even more difficult. And as any student of government bureaucracy will tell you, achieving the intersection set of these two things in a governmental setup is all but impossible.

And so what we need to study and copy from China is not so much anything else, but lessons in achieving, and sustaining, excellence in government bureaucracy. Or, if you prefer, how to improve state capacity.

In short, quality of government, not size of government, is what matters for freedom and prosperity.

https://econforeverybody.com/2020/02/17/how-to-think-about-the-budget/

That point resonates even more in this context: fostering an ecosystem led by the government is dead in the water without either the proper incentives, or at least bureaucrats who are able to work through poorly designed incentives. It is a hard problem, state led entrepreneurship, and made harder by the problem of incentives.

Spillovers

Or externalities, if you prefer. It doesn’t matter how hard the problem is, the payoffs are worth it!

Ruttan (2006) argues that large-scale and long-term government investment has been the engine behind almost every GPT (general purpose technology) in the last century. He analysed the development of six different technology complexes (the US ‘mass production’ system, aviation technologies, space technologies, information technology, Internet technologies and nuclear power) and concluded that government investments have been important in bringing these new technologies into being.

LOCATION: 1570

(Note: emphasis added)

If those GPT’s are the outcome of general, as opposed to specific, R&D, sign me up. They are magnificent positive externalities. Indeed, elsewhere in the book, Mazzucato points to how almost everything produced by Apple today simply could not have been produced without an entrepreneurial state:

LOCATION: 2326

The final point that I’ll make relates to how Mazzucato proposes “capturing” some of these externalities:

Where an applied technological breakthrough is directly financed by the government , the government should in return be able to extract a royalty from its application . Returns from the royalties , earned across sectors and technologies , should be paid into a national ‘ innovation fund ’ which the government can use to fund future innovations . Granting a return to the State should not prohibit the dissemination of new technology throughout the economy , or disincentivize innovators from taking on their share of the risk . Instead it makes the policy of spending taxpayers ’ money to catalyse radical innovations more sustainable , by enabling part of the financial gains from so doing to be recycled directly back into the programme over time .

Location 3735

Mazzucato does present alternative schemes to the one shown above, but this is the one that strikes me as being the one with the most promise, if administered well, with appropriate risk-mitigation built in. But again, saying that is much easier than actually getting it done.

But all the being said, one simple fact is inescapable: India needs to be thinking about how to get something like this off the ground, and ASAP.

For that reason alone, more of us should be reading this book.

Links for 21st March, 2019

  1. “In a 2011 paper, trade-policy researchers Anwarul Hoda and Shravani Prakash analyzed the impact of “the proclivity of the U.S. administration to leverage the GSP program to achieve its economic and political objectives.” They found that with major developing-country trading partners “the reciprocity requirement has proved to be ineffectual.” In 1992, the U.S. stopped India’s preferential access for chemicals and pharmaceuticals in an effort to improve intellectual-property protection. New Delhi shrugged off the pain, and waited for a World Trade Organization agreement before amending its patent law, the researchers noted.”
    Andy Mukherjee doesn’t think the removal of the GSP support by the USA will have any meaningful impact on India’s exports to that country. He also cites an interesting paper (which I haven’t read yet), which seems to say essentially the same thing.
  2. “The opportunity is simple to describe but requires real effort to achieve: the community must enforce systems that build the external costs into the way that the industrialist does business. Faced with an incentive to decrease bycatch, waste or illness, the industrialist will do what industrialists always seek to do–make it work a little better, a little faster, a little more profitably.Industrialism can’t solve every problem, but it can go a very long way in solving the problems that it created in the first place.”
    Seth Godin (whose blog is a remarkable thing, by the way) gives his take on externalities, and makes the case that economists take a far too restrictive, anti-septic view of the problem. I’m putting words into his mouth, but that’s how I interpret it – and I’d agree. Certain problems can be identified best by economists, but perhaps the solutions lie outside the textbook. A useful article to read for starting discussions around externalities, the Coase theorem, Elinor Ostrom’s work, the role of culture in economics.
  3. “When it comes to the institutional framework, there are obviously massive differences between India and China. Any leader in India must contend with parliament, the courts and state governments. Also known as democracy. That limits how quickly stuff can get done. It can also save politicians from serious mistakes. China has competing interests and constituencies as well, but it’s not the same sport, let alone ballpark.”
    The article is about India’s less than stellar economic growth in the previous quarter, but that paragraph above was important to me. India is a functioning democracy, China anything but. That has it’s advantages, and its disadvantages – to both. A point worth remembering in many ways – one of which part of the focus of this article.
  4. “In the process, Netflix has discovered something startling: Despite a supposed surge in nationalism across the globe, many people like to watch movies and TV shows from other countries. “What we’re learning is that people have very diverse and eclectic tastes, and if you provide them with the world’s stories, they will be really adventurous, and they will find something unexpected,” Cindy Holland, Netflix’s vice president for original content, told me.”
    Farhad Majoo in the NYT about why Netflix is such a good thing. It’s a useful article to understand the impact Netflix is having the world over – but also a good article to learn about pricing, the implications of pricing, content discovery on Netflix.
  5. “For several years, India’s banks have been in the spotlight over their problematic lending to prominent industrialists. Now the mutual funds and non-bank lenders — who have taken increasingly important roles in the credit system amid the banks’ woes — are coming under similar scrutiny. That is good for the development of the Indian financial sector. But it is yet another headache for some hard-pressed members of the promoter class.”
    Simon Mundy in the FT on how the IBC has provided teeth to creditors in India – which is genuinely good news. But the transition is unlikely to be smooth, and there may well be some unexpected skeletons waiting to tumble out of the closet. A good read for finance, bankruptcy and non-bank lending in India.