Tag: noah smith

The Lawyer and The Secretary Travel To The Future

Well, maybe the present. It is difficult to tell these days, except in the realm of politics, which is clearly headed back to the past the whole world over.

What am I talking about when I talk about the lawyer and the secretary, you ask? Here’s my new favorite assistant, Claude 3 (Opus) with an explanation:

In his famous example, economist Paul Samuelson describes a skilled lawyer who is also an exceptionally fast typist. Even though the lawyer can type faster than their secretary, it still makes sense for the lawyer to focus on legal work and let the secretary handle the typing. This is because the lawyer’s time is much more valuably spent on legal tasks, while the secretary’s time is most effectively used for typing. By each focusing on what they do best relative to their other abilities, they can achieve more together than if they each split their time between both tasks.

https://claude.ai/

This is, of course, the idea of comparative advantage, an idea that econ students meet quite frequently in their studies. I explain it to my students by telling them about my love for eating and cooking good food. Why then, I ask my students, should we have a cook at home?

The answer is obvious to an economist:

The reason we have a cook at home is because paying the cook her salary is what makes us rich.

As I explain in the post I have linked to above, having a cook at home frees up my time to write about the fact that I have a cook at home. And while it is true that I love to cook, I get paid for using my skills as an economist, not for sautéing french beans (butter, salt and garlic, that’s it, and maybe parboil the beans first, if you like. Heavenly, I tell you).

Underpinning the idea of comparative advantage is the idea of opportunity cost. Every hour that I spend sautéing french beans is an hour that I am unable to spend on writing blogposts. The more beans I saute, the less blog posts I write.

So even though I am very good (even if I do say so myself) at sautéing beans, I am better at writing blog posts. Or at any rate, society is willing to pay me more for blog posts about comparative advantage than it is willing to pay me for sautéing beans.

So, comparative advantage and opportunity costs – topics we have covered in the past here at EFE, and repeatedly. Why do I talk about them today?

Because I beseech you to go and read Noah Smith’s excellent take on AI and employment. He’s written out the entire post by using these simple (but surprisingly deep!) ideas, and has done a masterful job:

So anyway, because of comparative advantage, it’s possible that many of the jobs that humans do today will continue to be done by humans indefinitely, no matter how much better AIs are at those jobs. And it’s possible that humans will continue to be well-compensated for doing those same jobs.

In fact, if AI massively increases the total wealth of humankind, it’s possible that humans will be paid more and more for those jobs as time goes on. After all, if AI really does grow the economy by 10% or 20% a year, that’s going to lead to a fabulously wealthy society in a very short amount of time. If real per capita GDP goes to $10 million (in 2024 dollars), rich people aren’t going to think twice about shelling out $300 for a haircut or $2,000 for a doctor’s appointment. So wherever humans’ comparative advantage does happen to lie, it’s likely that in a society made super-rich by AI, it’ll be pretty well-paid.

https://www.noahpinion.blog/p/plentiful-high-paying-jobs-in-the

There’s thoughtful analysis, simple (but not simplistic!) explainers and there’s even a section towards the end that would have raised Truman’s hackles. This section talks about real and pressing concerns regarding inequality and adjustment shocks (a la Autor), and other reasons why even the techno-optimists should pause to ponder.

Please do go and read the whole thing, and as always, if you happen to disagree with Noah’s take, please do let me know why.

Ross Douthat and Noah Smith on Asia (kinda)

The reason I say kinda is because Ross Douthat’s column is titled “Why We Should Fear More Than Middle Eastern War“. Noah Smith’s post, on the other hand, is titled “Asia Is Much More Important to US Interests Than The Middle East“.

But both are really talking about the same thing, if for slightly different reasons: the real fight for the USA is going to be with China, and therefore Asia is what President Biden (and whoever comes next) needs to focus on.

Here’s Ross Douthat:

“It makes sense to talk about China, Iran and Russia as a loose alliance trying to undermine American power, but it is not a trio of equals. Only China is an arguable peer of the United States, only China’s technological and industrial might can hope to match our own, and only China has the capacity to project power globally as well as regionally.”

And here’s Noah:

“The EU and the UK together have more than enough people, industrial capacity, and technology to defend against Russian aggression indefinitely with minimal American assistance, should they choose to do so. The only reason the U.S. remains key to Ukraine’s war effort is that Europe has been reluctant to step fully into that role. Over time, that will hopefully change. But in Asia, China is so strong that U.S. power is indispensable.

In sum, Asia wants and needs the U.S. to protect it. It needs U.S. military power and economic engagement, not to crush China, but to preserve the status quo that has worked so well. Developed Asian countries want to keep being rich and free, and developing Asian countries want to keep getting rich on their own, and to do this they need the U.S. to deter Xi Jinping from trying to upend the modern world’s greatest success story.”

Wish it away as much as you like, there is likely to be a showdown of sorts between America on the one side, and Russia, China and Iran on the other. Who else will be with America, and to what extent (and for what reasons) will only become clearer with time, and ditto for the other side. But it is coming – like I said, like it or not.

By the way, Noah Smith has advice for the United States about how to go about getting the answers to the questions I raised in the previous paragraph:

In Asia, meanwhile, the U.S. should be beefing up both our defensive power and our engagement with other countries. We need to accelerate the supply of defensive weapons to Taiwan, Japan, Vietnam, India, and the Philippines, and to keep building and strengthening and expanding multilateral organizations like the Quad. We need to re-engage economically by re-joining the modified TPP, and by creating a dense network of other economic agreements in Asia. And in general, we just need to pay a lot of attention to the region, making sure our allies and quasi-allies and potential allies know we’re there for the long haul, and won’t suddenly withdraw to go plunge into some foolish conflict in the Middle East.

https://www.noahpinion.blog/p/asia-is-much-more-important-to-us

In effect, both Ross and Noah are asking Biden a question I am fond of asking here (and they’re answering it for him too): what are you optimizing for?

And both of them are saying that America should be optimizing for going up against, and not being defeated by, China.

(The way I chose to frame that last sentence is striking to me, by the way, and I realized it as I was typing it out: not being defeated by China. Not, you understand, defeating China. Quite telling, no?)

Why does this matter for the USA?

China hawks tend to argue that losing a war over Taiwan would be much worse than our post-9/11 debacles, worse than letting Vladimir Putin hold the Donbas and Crimea permanently. You cannot definitively prove this, but I think they’re right: The establishment of Chinese military pre-eminence in East Asia would be a unique geopolitical shock, with dire effects on the viability of America’s alliance systems, on the likelihood of regional wars and arms races and on our ability to maintain the global trading system that undergirds our prosperity at home.

And it’s at home where I fear the effects of such a defeat the most. America has experience losing wars of empire — in Vietnam and Afghanistan, for example, where we were extending ourselves without putting our full might into the fray. But we have no experience being defeated in straightforward combat, not guerrilla war, by a great-power rival and ideological competitor.

Whatever anxieties you have about our current political divisions, whether you fear left-wing disillusionment with America or right-wing disillusionment with democracy or both, such a defeat seems more likely than anything to accelerate us toward a real internal crisis. Which is why, even with other foreign crises burning hot, a debacle in East Asia remains the scenario that the United States should be working most intensely to avert.

https://www.nytimes.com/2023/10/21/opinion/china-taiwan-war.html

And what about India? What is our position, and what should be our position?

The really big wild card here is India, which has a huge population and a reasonably hefty economy. The USSR was India’s protector during the Cold War, and much of India’s military equipment still comes from Russia (though this is starting to shift). So India can’t be expected to enter into any conflict against Russia. But China is a very different matter. China is India’s main military threat, and the two countries have come to blows recently over a disputed border. They are also rivals for influence in the Indo-Pacific region. This is why India has joined the Quad, forging a loose quasi-alliance with the U.S., Japan and Australia whose purpose is obviously to hedge against China.

https://www.noahpinion.blog/p/the-war-economy-sizing-up-the-new

We live in interesting times. On that score, there is no doubt.

One person worth following on Twitter on this topic is Elbridge Colby. This is his pinned tweet, if you’re asking why he is worth following on this issue:

Bottomline: buckle up. Life is about to get very interesting indeed.

Reflections on RE and China

The love-hate relationship goes on. For almost two years China’s leaders cracked down on borrowing to build and bet on property, plunging the market into a crisis. Now that the economy has been weakened by the failures of the “zero-covid” policy, the government is racing to rescue real estate. Ni Hong, China’s housing minister, has said his ambition this year is to restore confidence; a series of measures announced in the past few months seek to make it easier for developers to raise capital. These efforts are reviving the property market. Unfortunately, they leave it just as vulnerable to boom and bust as ever.

https://www.economist.com/leaders/2023/01/26/chinas-property-slump-is-easing-but-the-relief-will-be-short-lived

That’s The Economist, in January of this year. China’s RE problems are well known, of course. But the economics of how the Chinese government is “managing” this market is a fascinating story. As most economists (but not all!) will tell you, managing markets in general isn’t that easy. And “managing” the Chinese RE market is about as challenging a task as you can imagine.

As with diseases and doctors, so with problems in a market and its management. Getting the dose of the medicine right is tricky, and figuring out how long to keep the dose going is trickier still. As the same Economist article points out, “technocrats tend to respond to crises with lots of liquidity”. In other words, they apply too strong a dose, and keep it going for too long. This has happened in the past with many markets, but especially with the Chinese real estate market back in 2014. That led to a predictable boom, with predictable consequences.

The current crisis isn’t just bad for real estate buyers and sellers, however. It is also bad for government, because a slump in real estate markets takes away the chief source of revenue for local governments (land auctions). And so the real estate market needs to grow, but well, isn’t.

And that comes through not just in the case of the market for RE, but also in the labor market associated with RE:

In 2013, architecture was named the top career choice for Chinese graduates in education consulting firm MyCOS’s annual report. Architects not only enjoyed the highest employment rate and job conditions, they also reported the greatest career satisfaction scores. But by 2015 it had disappeared from the league table completely, and it has never featured in the list since.
When technology media outlet 36Kr asked over 1,200 Chinese graduates whether they regretted their choice of major this month, architecture students were among the most likely to say yes. “Architecture may have fallen from the throne faster than any other major,” the newspaper Southern Weekly commented in a recent report.

https://sixthtone.com/news/1013290

And there are two factors to keep in mind from a long term perspective. First, of course, is the fact that China’s population has almost certainly peaked, and that will of course have a knock-on effect on the RE market in the years to come. Second:

Another parameter also showed signs of peaking. The average urban residential area per capita in China was only 18.7 square meters in 1998, but reached 41.76 square meters by 2020. As a reference, the average residential area per capita in major developed European countries falls within the range of 35-45 square meters. Based on this information, the future space for growth under this metric is limited in China.

https://www.caixinglobal.com/2023-07-12/opinion-will-the-fourth-arrow-save-chinese-real-estate-102074879.html

You could fire three arrows, or throw in a fourth. The market is likely to be a challenge in 2023, and will continue to remain so for some time. What the Chinese would like, in effect, is a moderation of prices with not much impact on demand. A soft landing, in other words. Easier said than done, as Michael Pettis says:

And the reason this matters is because the real estate sector was a major source of employment, investment, tax revenue, and a way to save for millions of Chinese folks. That’s a dangerous mix!

Is there no way out? Are there no bright spots? Well, consider Chengdu:

https://www.economist.com/finance-and-economics/2023/06/28/how-to-escape-chinas-property-crisis

What explains this success? Since 2016 officials in every Chinese city have been able to devise their own measures for cooling or heating local property markets. Most of the rules employed are restrictions on who can buy a flat, how many they may purchase and the size of the downpayment required. In most large cities, only people with local hukou, or residence permits, are allowed to buy homes. In Chengdu, high-level purchase controls remain in place. But officials have sought to attract families as a way of expanding the city and increasing demand for homes. Residents with two or more children are, for instance, allowed to buy additional homes, and local hukou-holders may buy up to three. Even those without a hukou may buy two. Since the start of the year, elderly parents who move to Chengdu to join their adult children may also purchase a flat.

https://www.economist.com/finance-and-economics/2023/06/28/how-to-escape-chinas-property-crisis

There are other factors at play too in Chengdu, but my biggest takeaway is that Chengdu is attempting to raise its population, and therefore the demand for RE. But that will only work by pulling people away from other parts of China – and so it’s a band-aid solution at best. As the Economist article itself points out “there simply aren’t enough people in China for another population boom”.

I’ve said it before, and I’ll say it again: the Solow model remains underrated!

Which begs the question: how should we use the Chinese experience today to think about the Indian RE market of, say, 2040?

That would need us to be familiar with the trajectory and current status of the Indian RE market – and if any of you have any information or stuff worth reading about this, please do share. Thank you!

Not Quite As Simple As One Would Like It To Be

Simple economic analysis can take you a very long way.

Not only do I hold this statement to be true, but it is one of the cornerstones of this blog. The idea that at its heart, economics is about a few important principles, and that the judicious application of these principles can take you a very long way – this idea has motivated nearly all of my writing on this blog.

But as with everything else in life, so also with this alluring, tempting idea. Every now and then, simple economic analysis can only take you so far, and you must wheel out the heavy artillery to make further progress.

In yesterday’s video, we heard John Cochrane talk about how if there is a problem, look first for the regulation that caused it. And there is more than an inconvenient iota of truth in that assertion. But between too much regulation and too little regulation lies that slippery little point of the optimum amount of regulation. Nobody knows exactly where that point lies, and it moves once you get close to it, but it is very much there. Finding it is all but impossible. Keeping it in sight once you find it is impossible.

But it’s there all right.

Consider housing.

The conventional wisdom has been that if restrictive zoning regulations are removed, ease of getting building and other permissions simplified, and taxes on construction lowered, it will increase the stock of housing of all kinds including affordable housing. This, in turn, will lead to lowering of house prices – “richer renters trade up into new luxe units, starting a chain of move-ins and move-outs that lower prices for modest homes”. This can be called the “trickle-down” theory of housing affordability. Instead, I’m inclined to believe that a meaningful dent in the housing affordability issue in the medium-term has to involve an increased supply of large volumes of public (or heavily subsidised) housing.

https://gulzar05.blogspot.com/2023/05/some-thoughts-on-affordable-housing.html

You’ll meet economists who tell you that housing can only be solved by removing as much regulation as possible. You’ll meet other economists who tell you that public housing is the only solution to the problem. And you’ll get bloggers like me, who will tell you that the truth lies somewhere in the middle. But by referring to Gulzar Natarajan’s (GN) excellent blogpost, let me explain to you why I think so:

  1. People in India think like much of the rest of the world, and are inclined to view housing as both a place to stay, but also as an investment asset. These are GN’s words, not mine, taken more or less directly from his blogpost, but they are worth repeating here. Yes the demand for housing is more than the supply, in many cities the world over, but that demand itself rather complicated to think about.
  2. For example, some people buy a house to stay in it. Others buy a house in order to sell it at a high price later, without ever having stayed in it. A Knight-Frank report form 2019 tells us, for example, that 25% of all residential houses in Gurugram are vacant. That number is almost 22% for Pune, 15% for Mumbai and about 10% or so for Ahmedabad, Bengaluru and Delhi.
  3. Who is likely to be able to afford to buy a house as an investment?
  4. Which types of houses will have higher margins?
  5. So the supply of what type of houses will go up?
  6. The answers most likely to be correct for the three questions above are “More affluent folks | luxury housing as opposed to affordable housing | Luxury housing”.
  7. By the way, Noah Smith has an excellent post (referenced by GN in his blogpost) that goes against the case I’m building here. It is, hopefully, free to read, and the link is here. Here’s an excerpt: “…you could probably get them to admit that if we built 10 market-rate (“luxury”) apartments for every resident of Austin, most of them wouldn’t get filled, and landlords would be forced to slash prices, and regular folks would have cheap apartments to live in”
  8. That is, Noah is saying that an increase in supply will get prices down eventually. And with reference to the excerpt, it’s not just “them” – I will also agree that prices will come down eventually. How long will the “eventually” take is one good question to ask in response. That is, how long before the price of those unoccupied apartments will come down? Will the rate of reduction be the same for all cities in all countries? Will class distinctions matter, for example? What about religion, what about caste and what about availability and affordability of public transport?
  9. Or as GN puts it: “We need to step back here a little bit. The starting conditions of the cities under consideration matter. For example, how segmented is the housing market, how do the prices in the different segments compare, what’s the likely profit differential between higher-end and marginal housing, what’s the marginal demand for higher end housing, how does it compare with the supply, how do the starting prices for each housing segment compare with the annual incomes of different population groups etc. Differences in each can generate entirely different outcomes.”
  10. There are many points to make over here, related to pricing, regulations, urbanization, public transport, urban sociology, and much else besides. But for the purposes of this blog post, I’ll leave you with just this one thought: economic models need to be rooted in the lived reality of whichever specific region you are modeling for. Noah isn’t wrong in his post, and neither is GN. But the “correctness” of their argument is very much dependent on whether they’re talking about Bombay or Austin.
  11. Context matters, in other words, and a good first pass answer as an economist always is “Well, that depends.”

Hedging, FDI, Poland and Malaysia

Noah Smith has a typically excellent explainer on the role of industrialization in Poland and Malaysia, itself only a single post in a long running series on the same theme. As one might expect if one is a fan of How Asia Works by Joe Studwell, the post begins by talking about industrial policy in South Korea. From that point of reference, he delves deeper into what made Malaysia and Poland grow so very vigorously over the past three decades or so. He also speaks about the limits of the strategies adopted by these two nations towards the end of this post, but more about that later on. For the moment, I would encourage you to read this post, and to subscribe to his Substack, as I have. Phull paisa vasool, guaranteed.

Also, because I simply cannot resist, a request to all of you to ponder this chart. How can one not want to learn macro after thinking about this chart?

But before we get back to Noah’s post, a brief segue into a post I wrote a while ago:

Here is how the placement process works in almost all colleges in India. If you sit for an interview, and you’re made an offer, you’re “out” of the placement process. There are variations to this rule, but in essence, the logic is that once you and the company have struck a deal, you can’t sit for any other firm that comes on campus later.
So here’s a conundrum for you: what if the company in October is a firm called HDFC, and it is offering you a package worth 8 lakh rupees (INR 800,000). The conundrum is that there is a very strong rumor (but it is, unfortunately, a rumor) that Google will be on campus next month, and they’ll be offering 20 lakh rupees (INR 2,000,000).
HDFC will pick up 20 students, but Google will pick up only 5.
Do you sit for the HDFC process or not?

https://atomic-temporary-112243906.wpcomstaging.com/2021/02/01/so-what-are-forward-markets-what-is-speculation/

What is your answer to this question? If you were that hypothetical student, would you sit for the HDFC process, or not? I’d argue it comes down to whether you are looking ot maximize your ‘profits’ or minimize your ‘risks’. If you’re the sort of person who would like to play it safe – if having a job, any job, is more important to you than having the high paying job of your dreams – then you’re likely to sit for the HDFC job process.

Note that there is no right or wrong answer here. It simply is a question of your preferences.

All right, now back to Noah’s post.

Poland and Malaysia may not be as rich as Germany or Korea, but they’ve definitely escaped poverty. Countries like Bangladesh or Vietnam or Ghana or even Mexico would kill to have a per capita GDP of $30,000. That’s about the GDP of the U.S. in the early 1980s. Is it really fair to call that level of development a “middle income trap”? If you’re a poor country, and you have a reliable, dependable way of getting as rich as the U.S. was in the early 1980s, dammit, you take it. You don’t worry about whether that strategy will eventually make it harder to get as rich as the U.S. of 2023.

https://noahpinion.substack.com/p/the-polandmalaysia-model

The issue that Noah is speaking about here is about whether option A is better or option B is better. Option A is the South Korean way, as he mentions in the next paragraph after the one I have excerpted here. This is done by ‘building a bunch of world-beating high-tech manufacturing companies from scratch’ and it is, as he says, incredibly hard. The good news is that if you get it right, you can get seriously rich as a country. The bad news is that very few countries have managed to get it right.

What is option B?

An FDI-centric strategy, on the other hand, is simple and straightforward, almost cookie-cutter — you give all your people a high school education, you build some roads and electric power lines and sewage lines, you designate some Special Economic Zones, and you give foreign companies big tax incentives and investment incentives and regulatory incentives to come in and hire your plentiful low-wage workers to make electronics and automotive goods and other complex products for export. Voila! No need to build the next Samsung or the next Hyundai; the existing Samsung and Hyundai will do nicely.

https://noahpinion.substack.com/p/the-polandmalaysia-model

The analogy that I am trying to develop here is a fairly obvious one. Option A is like Google coming to your campus. Only a few jobs on offer, and we don’t yet know for sure whether Google will actually come on campus or not. In other words, a high risk strategy. If it pays off, well, whoopee. But on the other hand, if it doens’t pay off, you’re in deep doo-doo.

Option B is like HDFC coming on campus. Relatively speaking, you’re much more likely to succeed in this endeavor. The downside? If you succeed, it won’t payoff as much as succeeding with Option A. But just as there will be students who will prefer Option B, Noah says that some countries also ought to choose the Malaysia-Poland route. Sure the success here isn’t quite as ‘sexy’, but it also does come with lower risk. And this ought to be, for some countries, therefore a very attractive proposition.

So if Poland and Malaysia haven’t found the secret to getting rich quick, perhaps they’ve found the secret to getting upper-middle-class quick. That wouldn’t be a full general solution to the problem of industrialization, but it would represent an amazing advance over what we know now. If I were a poor country, this is what I’d be looking at.

https://noahpinion.substack.com/p/the-polandmalaysia-model

Risk-rturn trade-offs, industrial policy, opportunity costs and an introduction to finance, all rolled into one smorgasbord of a blogpost. I enjoyed writing this one!

Principles of Economics and Nuclear Reactors

I read a great essay recently that does a fantastic job of explaining why we should be pushing to use much more nuclear energy than we do at present:

Nuclear energy has been quietly producing carbon-free energy for decades, but most don’t know that it accounts for 20% of the US’s electricity and over half of its carbon-free electricity. It’s been the underdog energy source—rarely celebrated, or worse, villainized, and deeply underinvested in.
The war in Ukraine and subsequent global energy crisis, alongside longstanding concern around climate change, has policymakers grappling with how to ensure energy is reliable, abundant, and carbon-free. Nuclear energy is the only energy source that solves for all three.
So why aren’t we building more?

https://juliadewahl.com/nuclear-energy-past-present-future

Oh, and by the way, do take a look at the artist who made the picture at the start of the essay!

I hope you read the whole thing, and I hope that you, like me, are also a fan of using much more nuclear energy in the years to come. If you aren’t, maybe this essay will convince you to at least read more about the issue.

But this essay is also a great way to brush up on your knowledge of the principles of economics!

  1. Take a look at how the author highlights the efficiency of nuclear energy in comparison to other sources. The technical term for the energy industry is “capacity factor”.
  2. How safe (or dangerous, if you prefer to be clear about framing effects) is nuclear fuel? Well, shouldn’t one always be asking relative to what? And if you do ask that question, take a look at this chart for an answer!
  3. Do incentives matter? You bet they do!
  4. Does government support matter? Yes, and yes.
  5. Don’t externalities matter? You bet they do.

Do read the whole thing, please. There’s lots of nice little nuggets in the essay that make it a very enjoyable read, including an xkcd cartoon, great resources that you can add to your bookmarks folder and lots of statistics and links to very interesting reads (Noah’s post on construction productivity is a personal favorite).

But most importantly, if you are a student of economics, get into the habit of reading stuff and deploying your knowledge of the principles of economics. It makes the read more interesting, more thought-provoking and best of all, more understandable.

What is finance for?

… is a question that is not asked often enough, not taught enough and not reflected upon enough.

Noah Smith reminds us that this question is very underrated:

We often forget this fact in the modern world of hedge funds and trading platforms, but finance is supposed to actually finance stuff. Ultimately, the purpose of finance is to channel capital to productive businesses so that the economy can grow. The “high finance” of fancy derivatives and ETFs and hedge funds and junk bonds and all that stuff is just a superstructure that’s built on the foundation of real productive assets. Sometimes the superstructure can outgrow the foundation and collapse, as we saw in 2008. But the foundation is still there.

https://noahpinion.substack.com/p/what-if-crypto-justdies

That’s it, that’s today’s post.

If you are a student of finance (and even better, financial economics) I urge you to bring this paragraph up for discussion in class. Please.

Imports, Exports and GDP

“The key is to understand that imports are also included in consumption, investment, and government spending. The real GDP breakdown looks like this:

  • GDP = Domestically produced consumption + Imported consumption + Domestically produced investment + Imported investment + Government spending on domestically produced stuff + Government spending on imported stuff + Exports – Imports

So you can see that while imports are subtracted from GDP at the end of this equation, they’re also added to the earlier parts of the equation. In other words, imports are first added to GDP and then subtracted out again. So the total contribution of imports on GDP is zero.”

That is an excerpt from a lovely little write-up by Noah Smith on his Substack, and one that I’ll be using whenever I teach macro. It’s lovely for many reasons, but most of all for the reason that the bullet point goes a very long way towards making the point that a lot of folks miss: you don’t get rich by importing less.

When I say “you”, I mean the country in question – and this equation, written out this way, helps us understand why. If you’re a student of macro, and are under the impression that India will get richer if only we imported lesser, think about the definition of GDP:

Gross domestic product (GDP) is the total monetary or market value of all the finished goods and services produced within a country’s borders in a specific time period.

https://www.investopedia.com/terms/g/gdp.asp

If you think about it, how can imports possibly qualify as being produced within a country’s borders? As Noah says, the equation can also be written like this:

GDP = Domestically produced consumption + Domestically produced investment + Government spending on domestically produced stuff + Exports

https://noahpinion.substack.com/p/imports-do-not-subtract-from-gdp?s=r

Read the rest of Noah’s post, especially if you are a student of macroeconomics. It should help clear up a lot of basic, but important and often misunderstood ideas about GDP calculations.

https://www.economist.com/finance-and-economics/2022/05/13/russia-is-on-track-for-a-record-trade-surplus

Russia has stopped publishing detailed monthly trade statistics. But figures from its trading partners can be used to work out what is going on. They suggest that, as imports slide and exports hold up, Russia is running a record trade surplus.
On May 9th China reported that its goods exports to Russia fell by over a quarter in April, compared with a year earlier, while its imports from Russia rose by more than 56%. Germany reported a 62% monthly drop in exports to Russia in March, and its imports fell by 3%. Adding up such flows across eight of Russia’s biggest trading partners, we estimate that Russian imports have fallen by about 44% since the invasion of Ukraine, while its exports have risen by roughly 8%.

https://www.economist.com/finance-and-economics/2022/05/13/russia-is-on-track-for-a-record-trade-surplus

Think about the previous section, and try and answer this question: is Russia poorer or richer or unchanged because Russia isn’t importing as much, as measured by GDP and changes in GDP?

Well, Russia may be worse off, and Russians may be worse off. It’s leader?

As a result, analysts expect Russia’s trade surplus to hit record highs in the coming months. The iif reckons that in 2022 the current-account surplus, which includes trade and some financial flows, could come in at $250bn (15% of last year’s gdp), more than double the $120bn recorded in 2021. That sanctions have boosted Russia’s trade surplus, and thus helped finance the war, is disappointing, says Mr Vistesen. Ms Ribakova reckons that the efficacy of financial sanctions may have reached its limits. A decision to tighten trade sanctions must come next.
But such measures could take time to take effect. Even if the eu enacts its proposal to ban Russian oil, the embargo would be phased in so slowly that the bloc’s oil imports from Russia would fall by just 19% this year, says Liam Peach of Capital Economics, a consultancy. The full impact of these sanctions would be felt only at the start of 2023—by which point Mr Putin will have amassed billions to fund his war.

https://www.economist.com/finance-and-economics/2022/05/13/russia-is-on-track-for-a-record-trade-surplus (Emphasis added)

Macro is hard! But it also matters, especially at times such as these.

The Solow Model and China

If you don’t know what the Solow model is, here is a great place to get started:

There are 11 videos in that series, and if you can spare the time, please watch all of them. Just two a day (they’re not more than 5 minutes each), and you’ll be done come the weekend.

But in effect, here is what the Solow model says:

  1. Output for a nation is a function of three (actually four) things:
    1. Capital (K): Buidings, ports, dams… infrastructure, basically.
    2. Education Augmented Labor (eL): The amount of hours that a person is able to put in to their work, but with the built in assumption that an educated person is likely to be more productive than a person without education.
    3. Ideas: Read the paragraph below to get a sense of what this means in practice.

Think about this blogpost that you are reading. I wrote it using my laptop, which is my capital. I will spend about an hour (that’s my plan, I’ll update you towards the end of this post about how well it worked out) writing it, and that’s the labor that I’ll be putting into this post. The fact that I have been “educated” in economics should mean that this post will be easier to write for me than, say, a gardener. The gardener could have written this post as well, of course, but it’s safe to assume that she would first have had to learn about the Solow model, and that, presumably, would have taken longer.

So that’s K and eL where the output (this blogpost) is concerned. But now think about it this way: what if another person, with a similar level of economics education as mine were to write this blogpost instead of me? Would that person have chosen this video, and these paragraphs to explain the Solow model? Maybe they would have recommended some other video, or some other podcast, or chosen to share details of an online textbook in which the Solow model is explained. That’s one way to think about ideas.

And so when you combine the capital (the laptop), the labor (the time I spend on this blogpost, given my education levels) and the ideas (what I choose to put into this blog post, and how), you get the output you’re reading right now.

What if I double the capital? Will the blogpost be done in half the time? Say I have an external monitor attached to my laptop – will two screens mean finishing the blogpost in half the time? It will save some time, but not by a factor of two, surely. Trust me, I have tried.

What if I double the labor? Hire an assistant to write this blogpost with me? The way I work, trust me, it will probably take longer! What if I go get a post-doc, to augment my education? Will that save me time? The hysterical laughter you hear in the background is the response of any PhD/post-doc student anywhere in the world, and that sound means a loud and resounding no.

In a sense, the Solow model asks these and related questions, and answers them using some graphs and equations. Except, of course, the Solow model does it for not one guy writing one blog, but for an entire nation at a time. There is no sense in me explaining the whole model over here, for it would be a case of me reinventing what is already a very good wheel. Please watch the videos.

But the Solow model is a remarkably useful way to get a handle on the long run growth prospects of a country. Is India likely to grow in the future? Well, is it going to add to its capital stock? Yes. Is it going to augment it’s stock of education augmented labor? Yes. Is it likely to produce more ideas than it is right now? Yes. And so the growth prospects for India look reasonably good.

Of course, there is more to the Solow model. All of this holds true given a strong and stable political system, well established rules of law, and strong and capable institutions. But so long as you believe that these are likely to continue to be so in the Indian case, you should be bullish on India.

What about, say, Japan? It has a capital stock that is more in need of replacement than new construction ( a feature of the Solow model that we have not discussed here, called depreciation), so it is unlikely that it will grow its capital stock too much. Here’s an example of what I mean. What about it’s stock of education augmented labor? Well, the news ain’t very good. Ideas? Trending upwards, but not by much. So if I had to bet on which country would grow more over the next twenty years, I would bet on India, not Japan.

Bear in mind that this is a model, and like all models, it is an imprecise abstraction of reality. So it is possible that at the end of the twenty year period, we find out that I am completely wrong. But if you think the Solow Model is a reasonably good model, you ought to bet the way I did.

So what about China?

Well, now, that’s a whole different story, and one that Noah Smith talks about in a recent blog post. Long story short, he doesn’t think China’s growth prospects are that great.

But the story is a little more complicated than that. The Solow model is a good model, sure, but it’s not as if the Chinese authorities/experts aren’t aware of the problem. And in his blog post, Noah looks at arguments put forth by two people who know a thing or two about China, and analyzes them critically.

The first argument is that sure, China’s demographics are on a downward trend, but what if we raised the retirement age for Chinese workers? Would that not solve the problem? Noah says no, probably not, because firms made of exclusively old folks isn’t necessarily a good idea. I wholeheartedly agree.

What about adding to China’s urbanization, and therefore its infrastructure? After all, China’s urbanization rate is “only” 64%. The inverted quotes around only in the previous sentence is because we, in India, are officially at 31%, but as in the case of China, it very much is a function of how you define urbanization. But similarly, in China, the urbanization rate is actually way more than 64%, and the Lewis turning point has already taken place in China, or will do so any moment.

And about ideas, well, China is an even more complicated story. Noah makes the point that China’s industrial policy is essentially a one-man army that is trying something that has never been tried before, and Noah is betting on it not quite working out. And given the events of the last year and a half or so, it is hard to disagree.

And so the Solow Model would probably tell you that China is unlikely to grow as fast in the near future as it did in the recent past, and even if you take into account potential adjustments, it likely will still be the case that China’s growth rate will start to plateau.

Please, read the entire post by Noah. But if you are a student of economics who has not yet met the Solow Model, begin there, and then get on to Noah’s post – your mileage will increase considerably.

More Than An Inconvenient Iota of Truth

Regular people everywhere are being deprived of purchasing power — and tricked by chauvinists and opportunists into believing that their interests are fundamentally at odds. A global conflict between economic classes within countries is being misinterpreted as a series of conflicts between countries with competing interests.

https://noahpinion.substack.com/p/book-review-trade-wars-are-class?s=r

An extract twice removed, as it were, for Noah Smith extracted this bit in his excellent review of a book called Trade Wars are Class Wars, by Michael Pettis and Matthew C. Klein. I have not read it yet, but it has shot to the top of my reading list.

Any student who has attended a class in which I have taught aspects of international trade will tell you that I bore them to death with one particular theme: that the textbook study of international trade doesn’t adequately cover (in my opinion) the study of inequality.

Now that might sound weird if you are a student new to the study of international trade. What on earth, you might think, does inequality have to do with international trade?

Well, here’s the thesis put forward in the book, via Noah:

Trade Wars are Class Wars offers a provocative thesis — that what looks like economic competition between nations is actually just a manifestation of economic competition between classes within those nations.

https://noahpinion.substack.com/p/book-review-trade-wars-are-class?s=r

Again, I haven’t read the book, but this is slightly confusing to me. I have always thought of the causality running the other way around: increased competition between nations has exacerbated economic competition (and therefore inequality) within nations. It would seem that the authors think of it differently. Excellent, more things to ponder upon!

Why do I think that international trade is one causal factor where inequality is concerned? Let’s begin with an excellent article published by The Economist a few years ago:

In rich countries, skilled workers are abundant by international standards and unskilled workers are scarce. As globalisation has advanced, college-educated workers have enjoyed faster wage gains than their less educated countrymen, many of whom have suffered stagnant real earnings. On the face of it, this wage pattern is consistent with the Stolper-Samuelson theorem. Globalisation has hurt the scarce “factor” (unskilled labour) and helped the abundant one.

https://www.economist.com/schools-brief/2016/08/06/an-inconvenient-iota-of-truth

Please, pretty please with a cherry on top, read the whole thing, especially if you have studied the Stolper Samuelson theorem. This article remains the best explainer that I have come across.

But what is being said here should be at least somewhat surprising to a student just beginning to study international trade. Trade, it would seem, may well be welfare enhancing, but it does not affect everybody a) equally and b) not necessarily positively! But, you might think as an Indian student, this might imply that unskilled labor in India might benefit from international trade.

Remember, one thing a good student of economics always bears in mind is a specific question: relative to what? That is, unskilled labor in India might well benefit from international trade, but relative to what? And the answer turns out to be, well, an unexpected one:

But look closer and puzzles remain. The theorem is unable to explain why skilled workers have prospered even in developing countries, where they are not abundant.

https://www.economist.com/schools-brief/2016/08/06/an-inconvenient-iota-of-truth

What might explain this?

Enter Professors Maskin and Kremer:

Nineteenth-century economist David Ricardo’s theory of comparative advantage predicts that China’s poorest workers should benefit most from the growth in trade. Before globalization, that country had a huge supply of unskilled workers and relatively few high-skill workers, who were thus in high demand; the situation was just the opposite in the United States. When two such countries begin to trade, the theory states, the less-developed nation has the advantage in producing relatively low-tech products—so demand and income for under-educated workers should shoot up, while their high-skill countrymen suffer. Thus, the theory predicts, globalization should lower inequality in the developing world.
Instead, as Gates professor of developing societies Michael Kremer explains, in much of the developing world, “The empirical evidence is not really consistent with the idea that trade is reducing inequality.” He and Adams University Professor Eric Maskin, a 2007 Nobel laureate in economics, have therefore proposed a new model to help explain the discrepancy between traditional theory and current reality. The key, they say, lies in a more nuanced understanding of how global production cycles sort workers into different jobs.

https://www.harvardmagazine.com/2015/03/how-globalization-begets-inequality

Here’s one way to understand their model. Note, before you proceed to read, that this is my explanation of their model, and I have simplified it a bit. I’ll add more nuance in as we go along:

Think of two countries, and two types of workers in both countries. Let’s say country 1 has Type A and Type B workers, and Country 2 has Type A1 and Type B2 workers. A and A1 are skilled workers, and B and B2 are unskilled workers. Maskin and Kremer make the point that international trade and the advent of modern globalization has resulted in skilled workers across countries “matching” with each other. As a result, their incomes go up, relative to unskilled workers in their own countries. So while the Stolper Samuelson theorem may be unable to explain why skilled workers have prospered even in developing countries, we now have a plausible answer to the question.

As an illustrative example, consider the fact that I joined a multinational firm called Genpact straight out of college.

And of course, one can think of many countries, not just two, and one can imagine a spectrum of skill sets across workers, rather than a binary framing. The point still holds!

And to complicate the matter further still, there may well be explicit/implicit choices made by policymakers in their own countries.

Back in the good old days, FT Alphaville used to be a free blog. And about seven years ago or so, it carried an excellent, excellent post written by Isabella Kaminska. The title of the (two-part) post was “What Are Chinese Capital Controls, Really?”. The post is a must-read for any student of international trade, but this excerpt is especially relevant for us today:

What those who accused China of using its exchange rate to gain advantage probably misunderstood was that it wasn’t the currency which was being undervalued, it was the people.
…
…
There are several other reasons why China should leave its currency unchanged. Contrary to widespread perception, China does not compete on the basis of an undervalued currency. It competes mainly in terms of labour costs, technology, quality control, infrastructure and an unwavering commitment to reform.

https://www.ft.com/content/d11a4c5e-d5fb-32f4-a606-e64d1483cea1 (Emphasis Added)

“It competes mainly in terms of labor costs” is a dry, academic way to put it. Elsewhere in this post, Isabella puts it much more plainly, when she says that it sucked to be a Chinese worker. And it did! Not just because of low labor costs, but because of a whole host of other reasons that should excite students of macroeconomics. Read the whole thing to get a richer understanding of how China has gone about doing what it has. As I always say to folks in my classes who wish we “grew like China”: be careful what you wish for!

You might also want to take a look at David Autor’s work on The China Shock. A good place to begin would be Russ Roberts’ podcast with David Autor, and for those who are interested, there’s a follow-up symposium about this episode as well. The point I’m making is that where trade between China and the USA is concerned, it would seem that inequality has gone up in both countries, but for different reasons.

This applies to international trade in general, of course – I’ve used China and US as examples because we are more familiar with them.

So, to return to the original question: are trade wars class wars? And more importantly, are class wars causing trade wars, or is it the other way around?

And so here we get to the book’s primary thesis. The authors only return to it in the conclusion, having reached it by a circuitous route that took them through history, data, theory, and more history.
The conclusion they ultimately draw is more nuanced than the one initially promised (and that’s a good thing, since nuance is good). In Klein and Pettis’ telling, global imbalances feed inequality in the U.S., but the fundamental cause isn’t inequality.

https://noahpinion.substack.com/p/book-review-trade-wars-are-class?s=r

Yup, that I completely agree with, and “get”. But it doesn’t solve the original problem of course, it only helps us understand that it exists: trade does seem to exacerbate inequality.

How we should think of this problem, how we might resolve it, and with what consequences, is likely to be fertile ground for economic research in the years to come. If you are a student wondering about how to go about picking a topic to work on, well, please do consider this one! And a good place to begin would be Noah’s post, (and the book itself sounds like a must read too).

Bonus material alert: I simply had to share this extract from Noah’s blog, written by Paul Krugman. If you have recently studied macro, you can thank me later for bringing this to your attention:

[E]conomic explanations…have to [describe] how the actions of individuals…add up to interesting behavior at the aggregate level.
And the key point is that individuals in general neither know nor care about aggregate accounting identities…. [I]f you want to claim that a rise in savings translates directly into a fall in the trade deficit, without any depreciation of the currency, you have to tell me how that rise in savings induces domestic consumers to buy fewer foreign goods, or foreign consumers to buy more domestic goods. Don’t tell me about how the identity must hold, tell me about the mechanism that induces the individual decisions that make it hold…. [O]nce you do that, you realize that something else has to be happening — a slump in the economy, a depreciation of the real exchange rate, it depends on the circumstances, but it can’t be immaculate, with nothing moving to enforce the identity….
Accounting identities… inform your stories about how people behave, [they do] not act as a substitute for behavioral analysis.

https://krugman.blogs.nytimes.com/2012/01/16/mistaken-identities-wonkish/?pagewanted=all