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!

What is development economics?

That was a question sent in by a student recently, and today’s essay is an attempt to answer the question.

Have you heard of the tsetse fly? Unless you are a student of biology, or from Africa, it is unlikely that you have. And there’s no reason for you to have heard of it, of course. On the other hand, if you were to be from Africa, and from a long time ago, you likely would not only have heard of the tsetse fly, but you would have dreaded it.

Why would you have dreaded it? Because the tsetse fly feeds on the blood of vertebrate animals, and in doing so, also manages to transmit diseases between species. And this fly was so very efficient at transmitting diseases that it actually prevented the emergence of animal husbandry in those parts of Africa where it was both present and dominant.

Worse: research has established that the existence of the tsetse fly in certain parts of Africa has at least partially contributed to those parts of Africa remaining relatively underdeveloped today.

Ethnic groups inhabiting TseTse-suitable areas were less likely to use domesticated animals and the plow, less likely to be politically centralized, and had a lower population density. These correlations are not found in the tropics outside of Africa, where the fly does not exist. The evidence suggests current economic performance is affected by the TseTse through the channel of precolonial political centralization.

That’s what development economists do: they try and figure out which parts of the world are not doing well. Then they try and figure out why (imagine being able to identify a fly as a potential cause of underdevelopment!). And finally, they try to recommend policies that might make the situation better.

Three Big Questions

When I teach courses in development economics, I often introduce the subject by speaking about three “big picture” questions:

  1. What does the world look like?
  2. Why does it look the way it does?
  3. What can we do to make it better?

And honestly, that is really all you need to think about when you want to understand what development economists do. Let’s tackle each of these questions in turn.

What does the world look like?

Good development economists don’t begin with recommendations and policy measures. That’s a long way down the road. They begin by trying to paint for themselves a picture of the world.

My favorite way to paint for myself a picture of the world is by using a freely available online tool called Gapminder.

Click here to open Gapminder in your browser

What are we looking at? Hans Rosling, the Genius (I don’t use the word lightly, and the capitalized G is intentional) who came up with this tool, used to call this chart the “Health and Wealth” chart.

Inflation adjusted, purchasing power parity adjusted per capita income for each country is plotted against the life expectancy for the citizens of that country. The color coding shows you which part of the world that country is from, and the size of the bubble indicates the population in that country.

Well, ok – but what does it tell us?

Well, here’s what it tells me – see if you agree with my understanding. It tells me that the reason economists harp on so about increasing income (GDP) for all nations is not because getting rich is an end in and of itself. It is the means to an end – that end in this case being better health.

Two caveats: higher life expectancy doesn’t necessarily mean better health. But in this case, I think it is an acceptable proxy. Second, correlation is not necessarily causation! Higher wealth may not necessarily be causing better health. Maybe better health is causing higher wealth? Maybe some other variable is causing both of these things? Maybe it is all of these and more?

But all those caveats aside, at first glance, a basic fact emerges:

There is no country that is at the top left of this chart, and there is no country at the bottom right of this chart.

Poor countries tend to not do well in terms of life expectancy, and rich countries tend to do well in terms of life expectancy. If I want the members of my family to live longer, I would want my country to be towards the top right of this chart.

But back to the central question: what does the world look like? This is a generalization, of course, but most of the African nations tend to lie towards the bottom left. Most of the European nations tend to lie towards the top right. And Asian nations (and some South American nations) tend to lie somewhere in the middle.

That’s one answer to the question we were trying to answer in this section: what does the world look like?

But there are other answer possible! Here are just two to get you started:

  1. Read the excellent introductory chapter in Partha Dasgupta’s “A Very Short Introduction to Economics”
  2. Play around with the World Bank Atlas, a most excellent data repository.

Why does the world look the way it does?

The Magic That Happens When You Hit Play in Gapminder

I have been using Gapminder for over 12 years now, but I am yet to get tired of watching that video. In fact, as I often tell my students, you could do a lot worse than spending time with Gapminder open in one tab, and Wikipedia in the other.

(On a tangential note, take a look at what happened to the world between 1918 and 1921. That’s the Spanish flu at work.)

Why did I include this video in this blogpost?

Because it helps us begin to think about the answer to the second question: why does the world look the way it does?

The world looks the way it does today because some countries were able to steal a march on others about two hundred years ago. The United Kingdom, the United States of America, Japan, Germany and some other nations started moving towards the right top of the chart before other countries could. You could, in fact, make an argument these countries were able to move to the right top by making sure that the other countries stayed at the bottom left!

And when you make that argument, you begin to try and answer the second question – this argument is the anti-imperialist stance. The Asian and African colonies of the European powers of the 19th century lag behind as much as they do today because they were colonies: that’s one candidate for explaining why the world looks the way it does.

The tse-tse fly (remember?) is another candidate for a more localized answer to the second question. Politics, race, religion, geography, caste, gender, openness to innovation – there are so, so many candidate answers! People can (and do!) spend entire careers making their way through just one of these candidates.

By the way, if you would like to read books about this topic – why does the world look like the way it does – here are two absolute must-reads:

  1. Guns, Germs and Steel, by Jared Diamond
  2. Why Nations Fail, by Acemoglu and Robinson

What can we do to make it better?

Can chickens cure poverty in Africa?

I’m not joking! That was a genuine proposal, made by this guy who you may have heard of. Started a software firm, dabbled in philanthropy, and is now engaged in trying to literally save the world. Yes: Bill Gates. His master plan to save Africa involved giving everybody a chicken.

Our foundation is betting on chickens. Alongside partners throughout sub-Saharan Africa, we are working to create sustainable market systems for poultry. It’s especially important for these systems to make sure farmers can buy birds that have been properly vaccinated and are well suited to the local growing conditions. Our goal: to eventually help 30 percent of the rural families in sub-Saharan Africa raise improved breeds of vaccinated chickens, up from just 5 percent now.
When I was growing up, chickens weren’t something you studied, they were something you made silly jokes about. It has been eye-opening for me to learn what a difference they can make in the fight against poverty. It sounds funny, but I mean it when I say that I am excited about chickens.

Well, I exaggerate, of course. Not literally giving everybody in Africa a chicken – but something along those lines.

Development economists were less than impressed:

But first, let’s talk about poultry. I think we can agree that we can only give away so many chickens. You’ve said that a family that receives five hens could eventually earn $1,000 annually, assuming a per-bird price of $5. But would that still be true when a third of your neighbors are in the same business? As supply goes up, I’d expect the price and profits to come down. And moving to an economy in which 30 percent of rural Africans sell chickens is a humongous increase in supply.

And to make matters worse, other development economists were less than impressed with the development economists who were less than impressed with Bill Gates’ chickens:

I have friends/alumni/colleagues working around the world in many facets of the challenge of development. I have friends working for the Prime Minister of India. I have friends working for the President of Indonesia. I have friends working on the conflict in Yemen. I have friends working as civil society activists in Egypt. I have had policy discussions with policy makers all over the world. I worked for 15 years in the World Bank. I have taught development at Harvard for 15 years. In all of those conversations with friends, colleagues, policy makers, and students all kinds of difficult and pressing development questions have arisen that research could address. Never, ever, ever has “chickens versus cash” arisen as an issue at all, much less as the remotely possible “best investment” in research.

By the way, that blog post that I quoted above? It has possibly my all time favorite title ever: Getting Kinky with Chickens.

Why am I telling you all this? Because allow me to let you in on a dirty little secret: there is zero consensus on what is the correct answer to the third question.

Well, OK, zero consensus is an exaggeration. But it ain’t a settled issue, no sir.

That is, nobody has come up with a definitive, one-size-fits-all answer to the question, “What can we do to make the world better?”

Let’s parse through the question. That might help us understand why it is such a controversial one.

What can we do to make the world better?

  1. Who, exactly, is “we”? That is, who is in charge of decision making when it comes to making things better? Do democracies work better? Or do autocracies? Or something in between?
    Remember, we are not asking which political system is the best from a moral, or political, perspective. We are asking which system is likely to give us the most rapid growth. Was Singapore under Lee Kuan Yew a true, participatory democracy, or was it a democracy with Asian characteristics? What about South Korea under General Park? And while we’re on the subject, an autocracy is not by itself a guarantee of rapid growth! Pakistan, Cambodia are two examples from our own neighborhood.
    Also remember: just because a system may give us more rapid economic growth doesn’t mean it is the best system to use. China is the obvious country to think about in this regard!
  2. Do we really need to “do” stuff, or is it more about just getting out of the way, and letting the economy work it’s magic?

3. Are we agreed on what “better” means? Lesser pollution comes at the cost of lesser industrialization, for example. Are we so sure that all seven billion of us can identify the exact point on the spectrum that works best? And if not, then we’re back to the first point: who is “we”?

And hey, even if you could imagine a world in which we somehow, magically get everybody to agree on “What can we do to make the world a better place?”, we’d begin a new round of battles, centered around a new question.

“How?” – and on this point, last year’s Nobel Prize winners have won accolades and received brickbats in equal measure.

Still, there is some good news. The unsettled nature of the debate means that this is extremely fertile ground to work upon, and you can count on development economics as a field remaining a fundamentally interesting one to work in for years, if not decades, to come.

And that, my friend(s), is what development economics is all about!

Book Review: Economics, A Very Short Introduction

I came across this book, as I mentioned, by regularly reading Brad DeLong’s blog (which is very rewarding in and of itself). He has mentioned this book frequently and always admiringly on his blog, and with good reason. It is one of the very best introductory books you could ever hope to read.

But, and this is an important but, it is not the most accessible book you will read about economics. Even after multiple readings, I find the going slow, and not just because of the technical concepts in the book but because of how much thought and (if you’ll forgive a particularly poor way to phrase this) thought-provoking thought is packed into only one hundred and fifty odd pages.

In fact, in the post in which I alluded to this book for the first time, I mentioned that the entire book should not be read at one seating, or at one go. Brad DeLong, based on his blogs, would probably criticize me for saying so, but I stand by that recommendation. The prologue is magnificent reading, and the rest of the book even more so – but the prologue is a nice meandering walk up a gentle hill. The rest of the book is a trek in the upper reaches of the Himalayas. To be clear, that is a good thing! You should trek up the upper reaches of the Himalayas, but a little training might be in order first.

The rest of this post is in praise of the prologue, which, as I have mentioned is worth many times the price of admission. Partha Dasgupta talks about Becky and Desta, two little girls who are of the same age (more or less) but are separated by a) geography and b) economic circumstances.

The author describes the lives of the two little girls and how very different they are: what they do during a day, what their parents’ lives are like, where they live, how they are being educated, and ultimately, what kind of lives they are likely to lead in the future. And then, Partha Dasgupta asks two very simple, but urgent questions.

Why? Why are their lives so different? Is it because of the geography they find themselves in? Is it because of historical factors? Might past and present governments have a role to play in how different their lives are? Might the choices made by their parents be a factor?All of these at the same time, perhaps? Who can say?

Second: given that their circumstances are different, can we do anything to make sure that Desta gets a leg up in life? How can her circumstances be made better, while leaving Becky’s either the same or better (but certainly not worse)? In other words, what needs to change in terms of markets, policies, institutions and indeed beliefs, for meaningful, long-lasting and sustainable change to visit Desta’s life?

I shall be deliberately provocative: if pondering these questions does not excite you about learning more about economics, then nothing ever will. Strong words, but I stand by them.

Read the whole book (eventually), but read the prologue right now.