Six Big Economic Ideas

About five years ago, The Economist published a series of essays, based around six big ideas in economics. Each essay is really well written, and I would strongly recommend that you read them. In no particular order, they’re about the Stolper Samuelson theorem from international trade theory, Minsky’s work on business cycles, Akerlof’s paper on information asymmetry, Keynes and the idea of the fiscal stimulus, Nash and early developments in game theory and finally the Mundell-Fleming model.

I got reminded of these essays when I wrote about Robert Mundell’s passing. And that, in turn, reminded me that I had wanted to see which ideas would make my list of six big ideas in economics. God knows if I’ll ever get around to writing these essays up – I know I would like to – but for what it’s worth, today is just about the list of ideas.

My criteria for selecting them is the following:

  1. The idea should be genuinely big. Other economists may disagree about whether it should make the cut or not, and that’s fine (in fact, that’s kind of the point. Maybe they’ll write their own lists!), but there should be no disagreement about the yuuugeness of the idea.
  2. It should be easy enough to explain in a single essay. Which in turn means it should be relatively simple, and not dependent on other big ideas for it to make sense. “Mr. Keynes and the Classics” is out, for example.
  3. It should be interesting, and applicable to the real world. Which, sadly, isn’t always a guarantee in academia.

For what it’s worth, here is my list of six big ideas in economics:

  1. Elinor Ostrom and her work on Common Pool Resources: there’s always a part of me that wonders if this is an idea that was underrated by economists and fairly rated by the rest of the world all along. Even the Wikipedia article notes that fieldwork played an important role in the development of her theories. Note that this isn’t (at all!) a criticism of Ostrom – but yes, it could be construed as a criticism of the rest of us economists. Maybe we just don’t look at the world often enough?
    Ostrom certainly did, and her conclusions have helped us economists understand how the world has been working so far, and how it might be made to work better in the future.
  2. Ronald Coase and The Theory of the Firm: Most people would be aware of the Coase theorem, and there is a case to be made for going with that paper rather than this one. But I remain fascinated with The Theory of the Firm, not least because of further developments in this field (Alchian and Demsetz, for one, and Hart and Holmstrom for another. There are many others, of course). In addition, how the theory has held up, and will hold up, because of the advent of modern communication, monitoring and signaling tools is a fascinating research question.
  3. Herbert Simon and Satisficing: “The Truth Lies Somewhere in the Middle” has become one of my favorite ways to simplify complex issues. Herbert Simon’s take on it was as follows: “decision makers can satisfice either by finding optimum solutions for a simplified world, or by finding satisfactory solutions for a more realistic world. Neither approach, in general, dominates the other, and both have continued to co-exist in the world of management science.” And the scissor analogy remains one of the most beautiful explanations I have ever come across, of anything.
  4. Dani Rodrik and premature deindustrialization: This idea is relatively speaking more recent, and in some ways needs to be updated already. But if you leave aside the specifics and think about the major point that is being made: poor countries in the 21st century will not take the same path of development as did the poor countries of the 20th century, it is certainly a very powerful and all-too-relevant field of study. Recommended pairing: How Asia Works, by Joe Studwell.
  5. Partha Dasgupta and the inclusion of nature in GDP: I’ve phrased the idea very poorly, I am sure, and I have not finished reading the report – barely started, if anything. Plus, perhaps I am suffering from recency bias, who is to say? But I remain convinced that we will see a better, more realistic way to measure our economic wealth this century – and if we do, Sir Partha Dasgupta and his work will have led the charge.
  6. Ed Glaeser and the importance of urbanization: Cities and urbanization will define our lives in this century, current pandemic notwithstanding. And while there is a long list of economists who have been working in this area for a very long time, my favorite book about what I think will be the most important topic of study in economics this century has been written by Ed Glaeser. It is a love letter to the idea of the city, and I think more people should read it to understand why urbanization, when done well, is a phenomenon to be celebrated, and not an idea to abjure.

I hope, in all sincerity, that you strongly disagree with my list, and come up with your own!

The Long, Slow, But Inevitable Death of the Classroom

If you read enough about Robert Solow, this quote coming up is but a matter of time:

You can see the computer age everywhere but in the productivity statistics

http://www.standupeconomist.com/pdf/misc/solow-computer-productivity.pdf

Much the same could be said about internet based learning technologies if you tried to measure it in colleges and universities before March 2020. We had lip service being paid to MOOC’s and all that, but if we’re being honest, that’s all it was: lip service.

Things have changed around a bit since then, I think.

We’ll get to that later on this post, but let’s go back to the seeing computers everywhere but in the productivity statistics bit for the moment. Paul David, an American economist, wrote a wonderful essay called “The Dynamo and the Computer: An Historical Perspective on the Modern Productivity Paradox“, back in 1990.

I think of this essay as an attempt to respond to the question Robert Solow had posed – why isn’t the data reflecting the ubiquitousness of the computer in the modern workplace? Read the essay: it’s a very short, very easy read.

Paul David draws an analogy between the move away from steam as a source of power, back at the end of the 19th century.

In 1900, contemporary observers well might have remarked that the electric dynamos were to be seen “everywhere but in the productivity statistics!”

David, P. A. (1990). The dynamo and the computer: an historical perspective on the modern productivity paradox. The American Economic Review80(2), 355-361.

Adjusting to a new technology, it turns out, takes time.

Steam-powered manufacturing had linked an entire production line to a single huge steam engine. As a result, factories were stacked on many floors around the central engine, with drive belts all running at the same speed. The flow of work around the factory was governed by the need to put certain machines close to the steam engine, rather than the logic of moving the product from one machine to the next. When electric dynamos were first introduced, the steam engine would be ripped out and the dynamo would replace it. Productivity barely improved.
Eventually, businesses figured out that factories could be completely redesigned on a single floor. Production lines were arranged to enable the smooth flow of materials around the factory. Most importantly, each worker could have his or her own little electric motor, starting it or stopping it at will. The improvements weren’t just architectural but social: Once the technology allowed workers to make more decisions, they needed more training and different contracts to encourage them to take responsibility.

https://slate.com/culture/2007/06/what-the-history-of-the-electric-dynamo-teaches-about-the-future-of-the-computer.html

Again, please read the whole thing, and also read this other article by Tim Harford from the BBC, “Why didn’t electricity immediately change manufacturing?” The article, by the way, is an offshoot of a wonderful podcast called “50 Things That Made The Modern Economy“. Please listen to it!

But here’s the part that stood out for me from that piece I excerpted from above:

“Eventually, businesses figured out that factories could be completely redesigned on a single floor. Production lines were arranged to enable the smooth flow of materials around the factory. Most importantly, each worker could have his or her own little electric motor, starting it or stopping it at will.”

https://slate.com/culture/2007/06/what-the-history-of-the-electric-dynamo-teaches-about-the-future-of-the-computer.html

Colleges and universities are today designed around the basic organizational unit of a classroom, with each classroom being “powered” by a professor.

Of the many, many things that the pandemic has done to the world, what it has done to learning is this:

each worker learner could have his or her own little electric motor personal classroom, starting it or stopping it at will.

In fact, I had a student tell me recently that she prefers to listen to classroom recordings later, at 2x, because she prefers listening at a faster pace. So it’s not just starting or stopping at will, it is also slowing down or speeding up at will.

Today, because of the pandemic, we are at an extreme end of the spectrum which describes how learning is delivered. Everybody sits at home, and listens to a lecture being delivered (at least in Indian universities, mostly synchronously).

When the pandemic ends, whenever that may be, do we swing back to the other end of the spectrum? Does everybody sit in a classroom once again, and listens to a lecture being delivered in person (and therefore synchronously)?

Or does society begin to ask if we could retain some parts of virtual classrooms? Should the semester than be, say, 60% asynchronous, with the remainder being doubt solving sessions in classroom? Or some other ratio that may work itself out over time? Should the basic organizational unit of the educational institute still be a classroom? Does an educational institute still require the same number of in person professors, still delivering the same number of lectures?

In other words, in the post-pandemic world…

How long before online learning starts to show up in the learning statistics?

Additional, related reading, for those interested:

  1. Timothy Taylor on why “some of the shift to telecommuting will stick
  2. An essay from the late, great Herbert Simon that I hadn’t read before called “The Steam Engine and the Computer
  3. The role of computer technology in restructuring schools” by Alan Collins, written in 1990(!)

Ec101: Choices matter!

We’ve, in our Thursday posts this year, learnt about incentives and costs. But, and this is a really, really big “but” – they become operational only when we live in a world where we’re able to choose.

Tyler Cowen and Alex Tabbarok – two people who have probably done more for educating people in economics than anybody else over the last thirty years or so – have written two of the best textbooks on economics available anywhere – one on micro and the other on macro.

In the book on microeconomics, they summarize ten different “big ideas” in economics: incentives, the invisible hand is the best kind of magic*, trade-offs matter, thinking on the margin matters, trade matters, wealth matters, institutions matter, business cycles are unavoidable, printing more money will lead to inflation and central baking is hard.

*I’ve paraphrased practically all of the big ideas, but this in particular is my phrasing, not theirs.

Two other asides before we proceed: in retrospect, it is interesting (at least to me) that at least one of their PhD’s (Tyler Cowen’s) and quite a few of their books are based literally on nothing more complicated than an exposition of these big ideas. There’s a lesson in there somewhere.

Also, they say that the biggest idea of them all is that economics is fun. I’d paraphrase that too: learning about the world is fun, and economics is a great tool to use towards that end.

Now, that allows for a neat segue to the topic du jour. At the very start of the book, even before the table of contents, they provide their definition of economics, one that I agree with wholeheartedly: economics is the study of how to get the most out of life.

Here’s the two word version: choices matter!

Unless we live in a society that is free to choose, at an individual level or otherwise, none of the other big ideas even come into play. So, to me, economics is first and foremost about being free to choose – and then about the benefits and costs of the choices that you make.

Which, I’d argue, means that learning about choices is plenty important. Ergo, this post.

  1. First things first. What is choice?
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    I chose (see what happened there?) this Quora post not because it is the “best”, but simply because it is so typical. Here’s what I think choice is: it is an admission of the fact that you can’t have everything. A particularly relevant example for me: what to eat from a buffet at a five star restaurant? With every passing year, “everything!” becomes an increasingly unrealistic answer. So choose those dishes that are likely to taste the best (maximizing happiness), or those dishes that are likely to cause the least harm (minimizing unhappiness) along some dimensions such as spiciness, oiliness or what have you.
    Or hey, do both at the same time! Choose the dish that is likely to taste the best and the dish that is likely to do the least harm. That’s half your micro paper right there – the rest is just math and diagrams. (I am kidding, of course, but only a little bit.)
    Choice is an admission of the fact that you can’t have everything, but that’s a good thing! It forces you to go with the best. Which paintings should you look at when you’re at the Louvre? “Every single one!” is unrealistic. Force yourself to choose, therefore, the very best of the lot. Constraints help you understand your own tastes better: aesthetics is, among other things, a matter of acknowledging the existence of constraints.
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  2. So having too many choices is a bad thing? It would seem so:
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    “It all began with jam. In 2000, psychologists Sheena Iyengar and Mark Lepper published a remarkable study. On one day, shoppers at an upscale food market saw a display table with 24 varieties of gourmet jam. Those who sampled the spreads received a coupon for $1 off any jam. On another day, shoppers saw a similar table, except that only six varieties of the jam were on display. The large display attracted more interest than the small one. But when the time came to purchase, people who saw the large display were one-tenth as likely to buy as people who saw the small display.”
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  3. But hang on. Of what use is an economics theory that doesn’t have a on-the-other hand angle? Tim Harford, as is so often the case, to the rescue.
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    “But a curious thing happened almost immediately. They began by trying to replicate some classic experiments – such as the jam study, and a similar one with luxury chocolates. They couldn’t find any sign of the “choice is bad” effect. Neither the original Lepper-Iyengar experiments nor the new study appears to be at fault: the results are just different and we don’t know why.”
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  4. And on a related note, have you heard of Herbert Simon and satisficing? This excerpt is from a Wikipedia article on Barry Schwartz’s book, The Paradox of Choice, but it is actually about Herbert Simon.
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    “A maximizer is like a perfectionist, someone who needs to be assured that their every purchase or decision was the best that could be made. The way a maximizer knows for certain is to consider all the alternatives they can imagine. This creates a psychologically daunting task, which can become even more daunting as the number of options increases. The alternative to maximizing is to be a satisficer. A satisficer has criteria and standards, but a satisficer is not worried about the possibility that there might be something better. Ultimately, Schwartz agrees with Simon’s conclusion, that satisficing is, in fact, the maximizing strategy.”
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  5. And the final word goes to Tyler Cowen. Or is it Herbert Simon all over again? Choices, choices.
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    “What if you asked people the following: do you wish to choose your own means of limiting your (subsequent) choices, or do you wish to let someone else, perhaps the government, do the work? I suspect the answers would overwhelmingly favor the former option, namely voluntary choice at the meta-level. And if you reexamine the experiments mentioned above, they are all about ways in which people voluntarily limit their own choices. Maybe you don’t wish to run your own cancer treatments, but you wish to choose the doctor who will.”

 

EC101: Links for 20th June, 2019

  1. “One needs to be cautious in these type of businesses trading at higher multiples as slip in any one of the parameters – decline in sales and profit growth, build up of debt, deterioration in working capital, capital misallocation – wrong acquisitions and expansions will lead to derating of the stock quickly. The company has shown no signs of these as of now and investors need to keep a close look at these.”
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    A vastly under-rated skill among economics students. The theory of (and in this case also the application of) reading a balance sheet. Read this article to get a sense of how to read one – and in an ideal world, try to write a similar article about a firm of your choice.
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  2. “In other words, to quote Simon, “so long as the rate of interest remains constant, an advance in technology can only produce a rising level of real wages. The only route through which technological advance could lower real wages would be by increasing the capital coefficient (the added cost being compensated by a larger decline in the labor coefficient), thereby creating a scarcity of capital and pushing interest rates sharply upward.” In other words, the price of capital would have to rise by more than the price of consumption.”
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    Under what circumstances will advances in technology cause the real wage rate to go down? The vastly under-rated Herbert Simon provided an answer to this question way back when – read this article to find out its rediscovery.
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  3. “Now that the crisis is in the rearview mirror and the current expansion is nearing the longest on record, is it possible to go back to having a balance sheet as small as in 2007? The answer is no. The amount of currency in circulation has grown so much that it is not possible to shrink the balance sheet to its earlier size. This is good news because it reflects a growing economy. The larger balance sheet also reflects banks wanting to hold more reserves at the Fed. Banks partly hold these highly liquid and essentially risk-free assets to meet new liquidity regulations designed to improve the resilience of the overall financial system.”
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    A short, but useful essay about the huge expansion to the Federal Reserve’s balance sheet, and why it is unlikely to shrink anytime soon. A useful read for students of monetary economics.
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  4. “The correlation phrase has become so common and so irritating that a minor backlash has now ensued against the rhetoric if not the concept. No, correlation does not imply causation, but it sure as hell provides a hint. Does email make a man depressed? Does sadness make a man send email? Or is something else again to blame for both? A correlation can’t tell one from the other; in that sense it’s inadequate. Still, if it can frame the question, then our observation sets us down the path toward thinking through the workings of reality, so we might learn new ways to tweak them. It helps us go from seeing things to changing them.”
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    The phrase is burned onto my brain, as it is for everybody else who ever attended a statistics class. “Correlation is not causation” Sure, it isn’t – but this article warns us against the over-use of this phrase, and how it might have ended up making us not think deeper.
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  5. “The Baumol effect reminds us that all prices are relative prices. An implication is that over time prices have very little connection to affordability. If the price of the same can of soup is higher at Wegmans than at Walmart we understand that soup is more affordable at Walmart. But if the price of the same can of soup is higher today than in the past it doesn’t imply that soup was more affordable in the past, even if we have done all the right corrections for inflation.”
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    A short, but very readable interpretation of the Baumol effect – and as this excerpt makes clear, also a great reminder of the fact that all prices, everywhere and always, are relative.

Links for 13th March, 2019

  1. “For most projects I’ll never look at anything in ARCHIVES again. But of course it’s easy to do so if I want to. And the fact that it’s easy is important, because it means I don’t have nagging concerns about saying “this is finished with; let’s put it in ARCHIVES”, even if I think there’s some chance it might become active again.As it happens, this approach is somewhat inspired by something I saw done with physical documents. When I was consulting at Bell Labs in the early 1980s I saw that a friend of mine had two garbage cans in his office. When I asked him why, he explained that one was for genuine garbage and the other was a buffer into which he would throw documents that he thought he’d probably never want again. He’d let the buffer garbage can fill up, and once it was full, he’d throw away the lower documents in it, since from the fact that he hadn’t fished them out, he figured he’d probably never miss them if they were thrown away permanently.”
    It is exhausting just reading it, but a very long article from Stephen Wolfram o how he organizes his life. You don’t have to go quite as all out – but you might learn a trick or two about organizing your life better by reading this article. God knows I need all the help I can get.
  2. “Nonetheless, this work suggests a potentially serious problem. Many situations in economics are complicated and competitive. This raises the possibility that many important theories in economics may be wrong: If the key behavioral assumption of equilibrium is wrong, then the predictions of the model are likely wrong too. In this case new approaches are required that explicitly simulate the behavior of the players and take into account the fact that real people are not good at solving complicated problems.”
    If I was to be (excessively?) cynical, I’d say this would mean that economists know nothing. But that isn’t necessarily true – Herbert Simon’s work on bounded rationality come to mind here. But the article is interesting about how to think about excessively complicated stuff – such as life.
  3. “In a low-saving, low-investment economy like the US, it’s a little hard to conceive that its possible for savings and investment rates to be too high for a country’s economic health. But that’s where China has been, and shifting away from established patterns is rarely simple.”
    To range across domains, there is this line from dietary studies that goes something like this: “It is the dose that makes the poison”. But if the USA suffers from too low a savings rate (maybe), China has the opposite problem. And this article does a great job of explaining the how and the why.
  4. “Historically, interim budgets in India have consistently overestimated revenue growth and underestimated expenditure growth. An analysis of the projected, revised, and actual budget figures since 1991 by Deepa Vaidya and K. Kangasabapathy of the EPW Research Foundation showed that deviations from budget estimates tend to be extraordinarily high for budget estimates presented in interim budgets ”
    This should surprise nobody, but budgets shouldn’t be trusted. Households budgets tend to have the same biases and errors that government budgets do, and for mostly the same reason – they’re drawn up by humans, who will be tempted to gloss over inconveniences. This article is full of interesting infographics that help you understand this point better – and also makes the point that an independent fiscal council is both necessary and overdue. I wouldn’t hold my breath.
  5. “But as the global giants arrive, they have been driving up salaries, rents, and reputations. Now some fear that the multinationals that once nurtured this fledgling technology powerhouse are unwittingly damaging the potent but fragile mix of entrepreneurship, military training, and chutzpah that drew them to it in the first place. That, they worry, could prevent it from developing into a mature digital economy.”
    Can you guess, before you click on the link, which country we’re talking about? Reading this article should make you want to read more about industrial organization, low interest rate environments, and urbanization – three of the biggest issues in economics today.