Tag: paul krugman

Bob and Ronald Come to India, Part II

The Story So Far

Today’s post is a continuation of yesterday’s. We learnt in yesterday’s post about the problems with the upcoming delimitation exercise, and how the Southern States feel that they contribute “too much” to Union government taxes, and get “too little” in return. The reason the phrases in the previous sentence are in quotation marks is because there are major differences of opinion about whether this is the case or not.

Asking a politician about this question is a useless endeavor, at least in public, because they’re optimizing for answering the question in a way that maximizes their current electoral benefits. If it is more important (for the moment) to win state elections, they will say that it is true that states doth give too much. If it is more important (for the moment) to win national elections, they will say it is true that the Union government doth take too little. This is not a criticism of politicians, please note. It is an application of one of the simplest principles in economics: incentives matter.

And by the way, for those of you thinking I’m throwing shade at a particular political party, perish the thought. All politicians in all countries have done this in the past, regardless of their ideology, they’re doing it now, and they’ll do it in the future. You and I would do it too, in their place, for those have become the rules of that game. So it goes.

Well, can us economists do a better job? How do economists think of the answer to the question of how much is the “correct” amount to be transferred from a given state to the Union government? How do economists think of the answer to the next obvious question – how to think through vertical and horizontal devolution?

In today’s blogpost, I am going to try and answer this question, but in terms of frameworks, not in terms of data. My job today is to help you develop a framework about thinking through this issue. Once you have a framework, the data tends to make much more sense – or so some economists hope. I’m one of them.

Let’s begin!

Trade is a non-zero sum game

You’ve heard me say this before, and you’ll hear me say it again. Today is a good day to reiterate this point – it is as important as the point “incentives matter”:

Trade is a non-zero sum game

People just don’t get this point. When two parties engage in trade voluntarily, both parties are better off. When I pay the chai-tapri owner ten rupees for a cutting chai, he’s grateful for the ten rupees I give him, and the lord knows I’m grateful for the chai I get in return. This is equally true for an overpriced cup of Americano at Starbucks. Sure it’s over-priced, over-roasted and over the top, but you know what you don’t see outside Starbucks? You don’t see Starbucks baristas kidnapping people and then forcing them to buy coffee (venti, naturally). It is voluntary trade, and the reason folks step in to a Starbucks is because they want to buy that coffee. The trade is worth it to them.

And that simple idea underpins modern economics. Why, you might say it defines who we are as a species!

So I would urge you to think of the “problem” of the Southern states as a trade between the states and the Union government. We’ve heard from the Southern states side of this debate – they think they give too much to the Union. Well, if this is a trade, it is worth asking the obvious question.

What do the Southern states get in return?

There are two questions at play here, not just one. And it is important to think through both of these questions:

  1. What do the Southern states get in return from the Union government?
  2. What do the Southern states get in return by being a part of a Union?

Think back to the young man who plaintively called up his uncle from yesterday’s post. Everybody in that young man’s house contributes half their salary to run the house, and our young friend feels hard done by, because he earns the most (and therefore contributes the most). Worse, once the money is pooled in, he doesn’t get a bigger say in how it is to be spent – that decision is purely democratic. So he feels he pays in too much, doesn’t get enough in return, and doesn’t have enough of a say in how the money is spent.

But as an economist, I would urge him to be more holistic in his thinking. Young man, I might harrumph in his direction, should you not be accounting for the pleasure of having your friends stay with you? The emotional benefits? The security you get by staying together? The ability to call on the help of near and dear ones when the time arises? You may still feel hard done by, and maybe you should, that’s not for me to say – but I would urge you to do a complete cost benefit analysis.

The Cost Benefit Analysis Framework

Weird tangent alert – you’re going to feel I’ve flown off the handle here for a bit, but I’ll circle the discussion back to the topic at hand, I promise. But for now, let’s talk migration. Say you are an unemployed youth in a rural part of our country, with not much education. Should you migrate to the city in search of a job?

Here’s a framework to help you think through the answer to this question:

Source: https://ucsbecon114help.wordpress.com/2013/06/10/todaro-migration-model/


It looks like a pretty complicated picture the first time you take a glance at it, but all that it is really saying is this:

  1. How much will you earn by living in the city?
  2. How much do you earn now?
  3. How much will it cost to be in the city?
  4. How much does it cost to stay where you are?
  5. Not just economic costs and benefits, mind you! Note the boxes that talk about psychic costs and psychic returns!

Net all of this out, and if you’re in the black, move to the city. If you’re in the red, stay where you are. Easy-peasy.

It never is that easy, of course, and cost-benefit lists aren’t always the answer. But us economists will always give poor ol’ Ross a sympathetic pat on the shoulder. He was wrong, of course, but still. Brownie points for using a framework (and god help you).

What framework can we use?

So, OK, here is where we are now:

  1. Think of the delimitation and devolution exercise as a trade between the states and the Union government.
  2. The Southern states are quite clear about the fact that they think they’re contributing too much.
  3. But they should also think about what they’re getting in return from the Union government, and by being a part of the Union.
  4. A cost-benefit analysis will help, as will a cost-benefit framework.

So let’s go find a framework!

And what framework am I going to use? I’m going to call upon the ideas of the great Canadian economist, Robert Mundell (and those of Peter Kenen). A very accessible discussion of these ideas is to be found in a lovely little essay by Paul Krugman, called Revenge of the Optimum Currency Area. The title is a play on important work done by Robert Mundell in the late 1950’s on the topic of Optimum Currency Areas (OCA’s).

What are OCA’s? Have you ever wondered why, say, all SAARC nations don’t have the same currency? If you are going to break out in spots and rashes at the thought of having anything at all to do with Pakistan, calm down, and think of why all the ASEAN nations don’t have a single currency. And then think of how and why all of the states in the United States of America chose to have a common currency.

What are the conditions, Robert Mundell was asking, under which having a common currency across different political jurisdictions is optimal. And (very) long story short, Paul Krugman’s take on the issue, courtesy Mundell and Kenen’s ideas, is this:

It makes sense to have the same currency (a monetary union) across political jurisdictions if:

  1. These jurisdictions have labor mobility
  2. These jurisdictions have capital mobility
  3. These jurisdictions have a fiscal union

What if we “flip” this around? For those of you familiar with linear programming, think of the “dual”. It is not an exact analogy, I’ll be the first to admit, but try this on for size:

It makes sense to bear the costs of being in a fiscal union across political jurisdictions if:

  1. These jurisdictions have labor mobility that proves to be beneficial
  2. These jurisdictions have capital mobility that proves to be beneficial
  3. These jurisdictions have a monetary union that proves to be beneficial

That is, so long as the net benefits that accrue from having labor mobility, capital mobility and being in a monetary union are more than the net costs of being in a fiscal union, it is more than worth it.

(This is worth emphasizing again: net benefits and costs. Sure there are costs to being in a fiscal union, but there are benefits too!)

Labor mobility means being able to count upon (freely!) accessing surplus labor from other parts of the country. Capital mobility means ditto, but for capital, not labor. And a monetary union is, of course, having the same currency across all states. What is the net benefit from all of these? So long as this is more than whatever the (actual and perceived) costs of being in a fiscal union are, well, all izz well.

But kahaani abhi baaki hai mere dost!

Heresy for an economist, but counting is problematic

My head hurts just thinking of the number of academic papers that can be churned out in terms of trying to quantify the previous section. We can keep the paper mills churning for years on end, and LinkedIn will drown in a deluge of “Delighted to share that our paper on…” messages.

But I would say that such exercises will ultimately be futile. Why, you ask? Here’s Paul Krugman’s take on this:

Now, what we need to say right away is that this “weighing” takes place only in a qualitative sense: at this point nobody says that the benefits of joining the euro are x percent of GDP, the costs y, and x > y, so the euro it is. Instead, it is more along the lines of arguing that Florida is a better candidate for membership in the dollar zone than Spain is a candidate for membership in the euro zone. This does not necessarily say that Spain made a mistake by joining the euro—nor does it necessarily refute the argument that Florida would be better off with its own currency! But the theory does at least give us some insight into the trade-offs.

https://www.journals.uchicago.edu/doi/full/10.1086/669188#

And my own take is this: remember psychic costs and benefits from our migration example? Drill this into your head – just because these cannot meaningfully be measured doesn’t mean they don’t exist!

What are the psychic benefits of being in a monetary and a fiscal union? In English, if you prefer (and you should, because economics is a most unpoetic* language):

What are the psychic benefits of being part of a nation?

Equally, because being analytical requires being evenhanded, what are the psychic costs of being part of a nation? Factoring in the answers to these questions is impossible very, very difficult. So very impossible difficult, in fact, that I would be of the opinion that it cannot and should not be done.

So how to think of a solution?

Ronald, the OG, will tell us all about it on the morrow.

*It’s a word, and I will not be taking any questions.

It’s Baaaack, But In China This Time

China’s Japanification, by Robin Wigglesworth in FT

What does Japanification mean? From the same article that came up with my favorite chart from 2023 (shown above):

“It can be described simply as a protracted period of deflation, economic sluggishness, property market declines and financial stress as households/companies/governments unsuccessfully try to deleverage after a debt binge.”

And is that where China finds itself today? Well, it is difficult to say, because data is hard to come by:

The statistics bureau stopped publishing a consumer-confidence index after April numbers fell to levels last seen during the depths of the pandemic. With youth unemployment climbing remorselessly, the same bureau stopped reporting that statistic this week, saying it is reviewing how to count jobless young.

https://www.economist.com/china/2023/08/17/chinas-slowing-economy-seen-from-ground-level

Data has, of course, been hard to come by for a while:

Bu you can suppress bad news for only so long, and to even the most casual of China watchers, it has been clear for a while that China is slowing down. And China slowing down is, in a sense, both inevitable and predictable. If you know anything about China’s demographics, it’s emphasis on capital-led growth and the Great Decoupling, China had to slow down.

But ah, the debt. That is where the problems become truly worrisome:

According to the BIS, China’s total non-financial credit/GDP ratio approached 297% of GDP by end-2022, similar to Japan in the 1990’s. Also similarly, debt is mainly domestic, and the domestic saving rate is high in both countries.

China’s Japanification, by Robin Wigglesworth in FT

Plus:

  1. China is ageing more rapidly than Japan was in the 1990’s
  2. China’s debt, when properly accounted for, is even more than Japan’s was.
  3. China has less wriggle room when it comes to monetary policy.
  4. China also seems to be less willing to use monetary policy as a tool.

And above all, culture. I wish I knew more about China, and I wish I could travel to China. Lots of reasons for me to say this (food included, and it is one of the top three reasons) – but in this blog post, I say I wish I could travel to China to make sense of this from The Economist.

It is difficult to excerpt from it, but here are the concluding paragraphs:

Does Mr Xi understand this? His thoughts on how to achieve national greatness have evolved, along with his message to young people. A few months after coming to power in 2012 he met a group of young entrepreneurs, volunteers and students, telling them to “dare to dream, to bravely chase their dreams and to strive to fulfil them”. Their ambitions will make China great, he said. One beaming participant, who had recently climbed Mount Everest, said it was a good time to be young.
Now, though, Mr Xi says the “Chinese Dream” of national rejuvenation is to be achieved by focusing on collective goals, rather than by encouraging individual aspirations. He admonishes the young to obey the party and toughen up—to “engrave the blood of their youth on the monuments of history, just as our fathers did.” That is a message that relatively few young people are taking to heart. Told to eat bitterness, they prefer to let it rot.

https://www.economist.com/briefing/2023/08/17/chinas-defeated-youth

Keep a close eye on China in the coming months, it is a story that is likely to be interesting and of immense relevance to everybody who lives on this planet.

By the way, did you get why today’s blogpost is titled the way it is? If you are a student of macro, you should have. You might think there’s a typo on my part, but hey, China deserves an extra “a”.

At least.

Demography and Democracy

Yesterday’s post was about fiscal policy in China, and how difficult it is to get it just right.

Which is true enough, but Paul Krugman points out how even if China gets that bit right (and it is a big if!), it still will eventually come up against a much more intractable problem: demographics.

There’s some truth to aspects of this story, but it misses the most important factor in Japan’s relative decline: demography. Thanks to low fertility and unwillingness to accept immigrants, Japan’s working-age population has been declining quite rapidly since the mid-1990s. The only way Japan could have avoided a relative decline in the size of its economy would have been to achieve much faster growth in output per worker than other major economies, which it didn’t.

https://www.nytimes.com/2023/07/25/opinion/japan-china-economy.html

Krugman gos on to point out an underappreciated point. Relative to the troubles that Japan has gone through, it actually has not done all that badly. Far from it, in fact – it is doing rather well, relative to expectations:

By the way, if you’re unfamiliar with FRED St Louis, this would be a fun assignment to get you going. Try and recreate this chart by yourself.

So what worked with Japan? Paul Krugman hypothesizes that this may be due to Japanese society being dynamic and culturally creative. I haven’t been to Japan so far, but I cannot wait to go. Next year, fingers crossed.

But the obvious question, of course is whether China in the near future can manage what Japan did over the last thirty years. Paul Krugman thinks not:

Yet if China is headed for an economic slowdown, the interesting question is whether it can replicate Japan’s social cohesion — its ability to manage slower growth without mass suffering or social instability. I am very definitely not a China expert, but is there any indication that China, especially under an erratic authoritarian regime, is capable of pulling this off? Note that China already has much higher youth unemployment than Japan ever did. So, no, China isn’t likely to be the next Japan, economically speaking. It’s probably going to be worse.

https://www.nytimes.com/2023/07/25/opinion/japan-china-economy.html

Yesterday’s post was about problems in the near term for China. Today’s post is about long term problems in the case of Japan, and how they’ve dealt with it. Both perspectives are important, and if you are a student of economics, both really and truly matter:

I often begin introductory classes in macroeconomics by saying that there’s two reasons you might want to take your child to a doctor. I should know, I have a five year old daughter.
The first reason is because the child has a cold say, or a fever. A temporary problem, that can hopefully be fixed in the “short run”. The other reason that you might want to take your child to a doctor is to figure out if your child is doing well on parameters such as height, weight etc. Any parent who has agonized over what percentile their child is on that accursed chart which shows “normal” height and weight knows what I’m talking about. These are “long run” parameters.
The economy is the same! We worry about short run problems, such as the deficit, or the annual budget, and well we should. But we should also be thinking long and hard about the long term growth prospects of our children economy.

https://atomic-temporary-112243906.wpcomstaging.com/2018/10/09/links-for-9th-october-2018-aka-the-nobel-special/

Note to readers: if you’re wondering why “democracy” in the title, ponder this phrase from Paul Krugman’s post: “especially under an erratic authoritarian regime”. Democracy may give you slow growth, but it is underrated, especially in today’s day and age.

Note to self: that five year old daughter will be ten years old next month! Where did time go?!

Everywhere But In The Statistics

That is, of course, part of a very famous quote by Robert Solow:

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

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

And in a recent newsletter, Paul Krugman agrees:

…have the past few decades generally vindicated visionaries who asserted that information technology would change everything? Or have they vindicated techno-skeptics like the economist Robert Gordon, who argued in a 2016 book that the innovations of the late 20th and early 21st century were far less fundamental than those between 1870 and 1940?
Well, by the numbers, the skeptics have won the argument, hands down.

https://www.nytimes.com/2023/04/04/opinion/internet-economy.html

Paul Krugman goes on to show this chart:

https://www.nytimes.com/2023/04/04/opinion/internet-economy.html

I’ll tell you how to read this chart, but back up for a moment and learn about total factor productivity first:

Total Factor Productivity (TFP) is a measure of how much output an economy can produce using the same amount of inputs, like labor and capital.
In simpler terms, TFP is like a measure of how smartly an economy is using its resources to make things. It tells us how efficiently a country is using its workers, machines, and materials to create products and services.
TFP is important because it can help explain why some countries are richer than others. When a country can produce more with the same amount of inputs, it can grow faster and become richer over time.
Measuring TFP is tricky because it’s hard to tell how much of a country’s output is due to factors like capital and labor, and how much is due to other things like technology and innovation. To measure TFP, economists use complex models that take into account all the different factors that could be affecting a country’s productivity.
In the context of development economics and growth theory, TFP matters because it can help explain why some countries are able to grow faster and become richer than others. Countries that are able to improve their TFP can create more goods and services with the same amount of resources, which can lead to faster economic growth and higher living standards for their citizens.
To improve TFP, countries can invest in education and research, create better infrastructure, and implement policies that encourage innovation and entrepreneurship. By doing so, they can create a more productive and efficient economy that can grow and thrive over time.

chat.openai.com

So here’s the question to ask: did the advent of the internet allow us, as an economy, to get smarter at using our resources to make things? Paul Krugman’s chart answer this question by showing how TFP growth changed over the next twenty five years from each given date on the x-axis. So if in 1948, TFP growth was just below 2, what that means is that TFP growth over the period 1948-1973 was just below 2. So did TFP growth go up in a twenty-five year period following 1996? The chart clearly says no, it didn’t, and Paul Krugman says “Ha!“:

See the great productivity boom that followed the rise of the internet? Neither do I.

https://www.nytimes.com/2023/04/04/opinion/internet-economy.html

Here’s the paragraph that really stuck out for me, though, from Paul Krugman’s column:

For the fact is that while moving information around is important, we’re still living in a material world: Most of what we consume is physical stuff or in-person services, which haven’t been drastically affected by the internet.

https://www.nytimes.com/2023/04/04/opinion/internet-economy.html

Huh. Let’s try to think this through:

  1. Use your own example, as I am about to do below.
  2. Do you use online services, even when it comes to consuming physical stuff or in-person services? In my case, Amazon is where I buy most of my physical stuff from, or from Amazon’s competitors. But they all have an online presence, and that is my preferred mode of shopping.
  3. I much prefer to have my food delivered home via Zomato or its competitors. My consumption of music is via online streaming services, my consumption of video is via YouTube or via OTT, I don’t even have a cable connection at home. My consumption (and creation) of the written word is almost entirely online (blogs, Kindle, Twitter, newsletters in my inbox). A fair few chunk of my classes at various colleges are online every now and then.
  4. Calling a plumber home, or an electrician, is via Urban Company, or one of its competitors. Booking flight/train tickets, booking movie tickets, paying my daughter’s school fees, transacting with my bank – I can go on, but it’s mostly online.
  5. Software has eaten, I would say, most of my world.
  6. But I should ask if I am falling prey to confirmation bias. What is decidedly offline, for me, as a consumer?
  7. I should also be asking if I am truly representative of the average Punekar, let alone the average Maharashtrian, let alone the average Indian, and still lesser an average citizen of the world.

I would say this much: I’m fairly confident that the Internet has enabled more consumption of goods and services than was the case twenty-five years ago. As a sixteen year old in 1998, I can guarantee you that reading what Paul Krugman wrote a couple of days ago would have been a very hard thing to do! And I feel fairly safe in saying that at varying margins, this is true for a lot of people in Pune, in Maharashtra, in India, and indeed in the whole world. Those margins will likely be influenced by per capita income in each country, by whether you stay in a more (or less) urbanized part of the world, and by a whole host of other factors. But as a species, a lot of our consumption of even physical goods or in-person services has been impacted by the advent of the internet.

I’m very curious to hear from you, especially if you disagree. Please tell me what I’m missing out on!

But that makes Paul Krugman’s chart even more puzzling! I’m tempted to disagree with him based on what I’ve written above, but I’m not sure how to disagree with the chart.
What about you?

Measuring GDP is hard.

Paul Krugman’s post ends with a few cool references, and since it’s behind a paywall, I’m listing them over here:

First, a nice YouTube video on washing machines and the internet:

Second, a simple explainer on TFP.

Third, a lovely book by Robert Gordon which you absolutely must read.

Final point: how to get better at measuring GDP is (and will likely continue to be for a very long time) a fascinating problem, and I will definitely write more about it in future posts. But in the meantime, if you have any recommendations about what to read/listen/view, please do share!

Team So What Exactly is Going on Then, Huh?

Paul Krugman responds (and also visit his Twitter profile to take a look at other threads by him on the issue).

But above all: if you think macro is tough, the good news is that you’re in excellent company!

Can Micro be Weird?

Donald Bodreaux has an excellent, truly thought-provoking write-up on the imposition of price floors.

…governments also sometimes attempt to push prices upward. When the intervention is designed to increase prices by outlawing the charging of monetary prices below some minimum, the intervention is called a price floor.

https://www.aier.org/article/on-the-negative-consequences-of-price-floors/

I usually explain price floors to my students by speaking about attendance requirements in colleges and universities. Think of it, I urge them (only somewhat in jest), as a price that you guys have to pay me. Even if you happen to not like my classes, and think me to be the most boring guy ever – and therefore don’t wish to pay me by spending your time – no can do. You must pay me with your time.

That’s a price floor.

So what might be the unseen consequences of a price floor?

Here’s where Donald Bodreaux’s ((quick question for grammar Nazi’s – should it be Bodreaux’s or Bodreaux’)) column gets truly interesting (apologies for the lengthy extract):

Suppose that the government imposes a true price floor in the market for pickles. The government declares illegal all purchases and sales of pickles at prices below, say, $10 per pound (which price, let’s assume, is above the market price that would prevail absent the price floor).
The first and most obvious effect of this price floor is that the quantity of pickles that consumers are willing to buy will fall; the quantity that consumers demand will be driven lower than it would be without the price floor. If pickle producers are economically naïve, this price floor will create a physical surplus of pickles as producers, attracted by the higher price, increase their production of pickles. But even the most naïve pickle producers will soon learn that consumers are willing to buy at the high price-floor not only fewer pickles than producers are willing to produce and sell at that high floored price, but even fewer than consumers were willing to buy at prices lower than the floored price.
Discovering themselves unable to sell all of the output they are willing to sell at the price floor, pickle producers reduce their production. They produce no greater amount of pickles than consumers are willing to buy at the high price floor. So while price ceilings always create shortages, price floors don’t always create physical surpluses.
Nevertheless, because price floors do always reduce the quantities that buyers wish to buy while increasing sellers’ willingness to produce and sell, price floors create a second negative consequence – namely, the need for some means to determine which sellers will be among the lucky ones to sell at the higher price and which sellers will not be able to take advantage of the higher price by actually selling units of output at that price.
This determination might be done by luck or random chance. Perhaps only those sellers who encounter consumers early will be able to sell, while sellers who get to market too late find no more buyers.
But luck or random chance is unlikely to operate for long. Eager to sell at the high price floor, sellers will compete for buyers in ways other than cutting prices. A third negative consequence of a price floor is, thus, that the quality of the price-floored good rises. Pickle producers might attach to each jar they sell “free” coupons for discounts on crackers or deli meats or beer. These producers might work harder to make their pickles even tastier. Such non-price competition for consumer patronage is an inevitable result of price floors.
Unlike with the quality reductions caused by price ceilings, the impetus to quality improvements caused by price floors perhaps seems to be a positive consequence rather than, as I’ve described it, a negative one. But negative it is when compared to what the situation would be absent the price floor.
It’s true that, given that consumers aren’t allowed to buy pickles at any price below $10 per pound, they like their pickles being even tastier or sold with discount coupons. But what consumers would like even more is to pay a lower price for a lower-quality product. Were there no price floor in place, consumers would reveal through their spending that the higher quality isn’t worth the higher price. Yet because lower prices are unlawful – that is, because consumers must pay the higher price if they want pickles – consumers settle for the second-best outcome of paying this higher price for a higher-quality product.
Price floors, in short, compel consumers to buy too few units but too much quality.

https://www.aier.org/article/on-the-negative-consequences-of-price-floors/ (Emphasis added)

And that’s why the title of this blogpost is what it is: can micro be weird?

Demand will go down with a higher price, sure, and suppliers will eventually reduce their supply given low demand. So far, so standard.

But remember that suppliers compete with each other, not with folks on the demand side – and so if you and I and five of our friends are pickle manufacturers facing high prices and low demand, we have to “do battle” with each other to sell our produce.

Facing low sales, will a producer’s natural response be an upping of quality? Discounts, freebies, and maybe the attempt to convince buyers that my product is of higher quality (marketing, branding) – but an actual increase in quality? But hey, that’s why studying micro can be fun – because it is weird!

This is covered in Paul Krugman’s textbook on micro too, where he cites the example of airlines upping the quality of service when faced with price floors set by international treaties. And, the textbook goes on to say, when prices were allowed to come down, so did quality.

So, long story short, yes, micro can be weird – but that’s what makes studying economics fun!

So You Think You Know Economics

I hope you do, and I think I do – know economics, that is.

But I’ve always thought about economics (how to get the most out of life), here on earth. I haven’t thought about what economics might be like on other planets, on space stations, or on whatever else lies ahead of us in terms of both space and time (pun kind of intended).

Paul Krugman had a fun paper about this written more than forty(!) years ago. The paper is freely available, and you can download it over here, but there is also a Wikipedia article about it, if you would prefer to begin there.

As the Wikipedia article says, the summary of the paper was this:

How should interest rates on goods in transit be computed when the goods travel at close to the speed of light? This is a problem because the time taken in transit will appear less to an observer traveling with the goods than to a stationary observer.

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

The next line in the Wikipedia article is genuinely funny, and that in typical Krugman style:

This paper, then, is a serious analysis of a ridiculous subject, which is of course the opposite of what is usual in economics.

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

But a much more recent post by Robin Hanson invites us to do a serious analysis of a no-longer-ridiculous subject: how should one think about social analysis of a future that is much more about space travel.

We understand space tech pretty well, and people have been speculating about it for quite a long time. So I’m disappointed to not yet see better social analysis of space futures.
In this post I will therefore try to outline the kind of work that I think should be done, and that seems quite feasible.

https://www.overcomingbias.com/2022/07/space-econ-howto.html

I teach Principles of Economics for a living, but have only very rarely (well ok, almost never) thought about Principles of Economics as it relates to space travel. As Tyler Cowen might say, most of the basic principles will remain the same, and demand curves will slope downwards, but what will actually change?

This is surprisingly hard to think about, because I tend to just assume that economics is always earth bound. And it takes me time to wrap my head around the fact that I’m thinking about economics in a very different context. Robin Hanson helps us overcome this initial hurdle:

Here is the basic approach:
1. Describe how a space society differs from others using economics-adjacent concepts. E.g., “Space econ is more X-like”.
2. For each X, describe in general how X-like economies differ from others, using both historical patterns and basic econ theory.
3. Merge the implications of X-analysis from the different X into a single composite picture of space.

https://www.overcomingbias.com/2022/07/space-econ-howto.html

His first example about X is that of lower density. Or, in plainer English, space is just going to be really far away from everything else. I mean, really far away. What does that mean for an economy, when it is just ridiculously far away from everything else?

Let’s think through this a bit. Can, say, thinking about Neom be similar to thinking about this problem? Or Naypyidaw? Or are we talking about a completely different problem, because of the vast difference in terms of distance? And if you say it is a completely different problem, why do you say so?

Are we talking about travel costs being significantly different? What about the cost of communication (both within that base, and back to Earth)? Which resources become more valuable because this base is s far away, and which resources are valuables “just” because they are scarce on that base? Will, as Robin Hanson points out, lower density mean lower product variety, and what will that imply for this economy? How should one think about Dixit-Stiglitz in this context?

Read the whole thing, of course, but Robin Hanson points out a variety of ways in which space economics is going to be different. I’ll highlight just a few below:

  1. It’s going to be very far way, as we just discussed
  2. It’s going to be much harsher (read science fiction!)
  3. It’s going to be wildly different in terms of resource economics
  4. What about population growth?

As I said, I struggle to think about this just because my mental framework thinks about economics in a very Earthian (yes, this is now a word) context. And that precisely why I enjoyed reading this blogpost so much, because it gives me a very pleasant headache about stuff I thought I knew.

And I hope you’ll spend some time with this very pleasant headache too! 🙂

Update: Shubhneet Arora sends along this recent Krugman column/newsletter, very relevant to this blogpost. Thanks Shubhneet!

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

On Noahlism

About the title of today’s blogpost: I couldn’t resist, I’m sorry. The post is about something Noah Smith calls the “The Two Paper Rule”, about which much more below – but the title is courtesy Paul Krugman. About which, also, more below.

Noah wrote this post a while ago, in May 2017. His original post is about a Very Simple Idea that hopefully solves a Very Real Problem. Here’s the Very Real Problem:

I don’t know why academic literatures are so often referred to as “vast” (the phrase goes back well over a century), but it seems like no matter what topic you talk about, someone is always popping up to inform you that there is a “vast literature” on the topic already. This often serves to shut down debate, because it amounts to a demand that before you talk about something, you need to go read voluminous amounts of what others have already written about it. Since vast literatures take many, many hours to read, this represents a significant demand of time and effort. If the vast literature comprises 40 papers, each of which takes an hour to read, that’s one week of full-time work equivalent that people are demanding as a cost of entry just to participate in a debate! So the question is: Is it worth it?

https://noahpinion.substack.com/p/the-two-paper-rule?s=r

Anybody who has suffered through a PhD knows the problem all too well. These days, anybody who has been asked to do a literature review for any paper knows the problem all too well. There is just too much to read.

And folks who want to make sure that uppity folks don’t get, well, too uppity always have a fail-safe defense at the ready: “Have you read all the relevant literature?”. There’s so much stuff that is being published about everything imaginable, that you’re never going to be able to get through even a fraction of it. Why, there’s even a law about it! And there’s a law about the law, which only goes to prove the point further, I suppose.

And here’s Noah’s Very Simple Idea to solve this Very Real Problem:

My solution to this problem is what I call the Two Paper Rule. If you want me to read the vast literature, cite me two papers that are exemplars and paragons of that literature. Foundational papers, key recent innovations – whatever you like (but no review papers or summaries). Just two. I will read them.
If these two papers are full of mistakes and bad reasoning, I will feel free to skip the rest of the vast literature. Because if that’s the best you can do, I’ve seen enough.
If these two papers contain little or no original work, and merely link to other papers, I will also feel free to skip the rest of the vast literature. Because you could have just referred me to the papers cited, instead of making me go through an extra layer, I will assume your vast literature is likely to be a mud moat.
And if you can’t cite two papers that serve as paragons or exemplars of the vast literature, it means that the knowledge contained in that vast literature must be very diffuse and sparse. Which means it has a high likelihood of being a mud moat.

https://noahpinion.substack.com/p/the-two-paper-rule?s=r

I love this idea, and for the following reasons. One, I have an immediate repartee whenever I’m attacked with the “But have you read the literature?” question. And it’s not just a repartee, but a genuine request that serves two purposes. The person asking the question had better be able to come up with at least two papers on the spot. There is otherwise not much point in they having asked the question! Second, assuming the person does come up with two papers I haven’t read, there’s more to read and more to learn.

But second, as a student, what a wonderful way to start building up a repository of papers about a series of subjects! Always ask your profs, no matter the subject, about the two papers worth reading about today’s topic, and keep a running list. (Hint: this is a great way to spend a summer!)

Third, and I’m personally very curious about the results in this case, what about asking young profs and old profs this very question about the same subject? If the answers differ, this is a field worth examining rather more deeply, for it obviously has evolved fairly rapidly. I did my PhD in business cycles, and trust me, the answers would never have been the same – by age, adherence to a particular school of macroeconomics thought, or even by nationality.

Paul Krugman loved the idea (Noah links to Krugman’s blog towards the end of Noah’s blog post, but the link seems to be down. The excerpt below is from Google’s cache):

What about trade? Autor/Dorn/Hanson on the China shock may not be the last word, but surely a revelatory approach. In a strange way, I’d put Subramanian and Kessler in the same category: realizing that this globalization is different from anything that came before is a big deal.
I guess that in a way I’m pushing back against Noah’s nihilism (noahlism?) even while endorsing his method. I think there has been a lot of good economics done, even if there are also vast literatures not worth your time.

Click here to access the link, too long to post in its entirety

… and you now know, of course, where the title of today’s post comes from! What I think Krugman is getting at when he refers to his pushing back against Noah’s idea is that perhaps just two papers is too restrictive. And if that be the case, Tyler Cowen agrees:

The difference between total value and marginal value may be relevant. You might conclude a field literature has low total value, but the marginal value of learning more about that area still could be quite high. That is in part because muddy fields and results don’t spread so readily, and so dipping into the muck can yield some revelations. That is another reason why I would not offer the “two paper standard” as practical advice.

https://marginalrevolution.com/marginalrevolution/2017/05/vast-empirical-literature.html

I have quoted only one of Tyler’s points (he’s got nine others), but in general, I don’t think we should be taking the two part of the two paper rule as being sacrosanct. In some cases you may need to read five, in some rarer cases ten. So long as the number is reasonable (and the standard will change), we can still live with the spirit of the two paper rule.

But if you are a student in college, the two paper rule is a good way to build up a repository of about fifty odd papers that you Really Should Have Read. Twenty five courses (roughly speaking), two papers each.

Well, get started! 🙂

In Memoriam: Robert Mundell

Robert Mundell passed away earlier this week. Most macroeconomics students will know of the Mundell-Fleming model, of course, while a lesser number may have heard of his work on optimum currency areas.

Here is a relatively old article about him from the New York Times:

”In the very short run, I’m a Keynesian,” he said. ”In the intermediate run, I’m a supply-sider, and in the long run I’m a monetarist.”

https://www.nytimes.com/1986/01/12/business/eccentric-economist-robert-a-mundell-supply-side-s-intellectual-guru.html

And here is a summary by The Economist on the impossible trilemma:

HILLEL THE ELDER, a first-century religious leader, was asked to summarise the Torah while standing on one leg. “That which is hateful to you, do not do to your fellow. That is the whole Torah; the rest is commentary,” he replied. Michael Klein, of Tufts University, has written that the insights of [[international macroeconomics]] (the study of trade, the balance-of-payments, exchange rates and so on) might be similarly distilled: “Governments face the policy trilemma; the rest is commentary.”

https://www.economist.com/schools-brief/2016/08/27/two-out-of-three-aint-bad)

Here is Paul Krugman, first rhapsodizing about the Optimum Currency Area((This essay, along with the tables, used to be freely available on the NBER website. No longer, and I don’t know why. My apologies)):

First up, Mundell, whose classic 1961 paper argued that a single currency was more likely to be workable if the regions sharing that currency were characterized by high mutual labor mobility. (He actually said factor mobility, but labor is almost surely the one that matters). How so?

https://krugman.blogs.nytimes.com/2012/06/24/revenge-of-the-optimum-currency-area/

.. and then rhapsodizing about Robert Mundell and his early theoretical work:

Those of us who work on international monetary theory have been wondering for a decade when Robert Mundell would get his richly deserved Nobel Memorial Prize in Economic Sciences. Mundell’s work is so central to that field, so “seminal”–an overused term that really applies here–that on many disputed issues his ideas are the basis for both sides of the debate. But a layperson might be confused about exactly what Mundell and his prize are really about.

https://slate.com/business/1999/10/o-canada.html

This is the NYT obituary:

In his 2006 interview, he said that winning the Nobel “was particularly pleasing to me as my work has been quite controversial and no doubt stepped on a lot of intellectual toes.”
He added: “Even more than that, when I say something, people listen. Maybe they shouldn’t, but they do.”

https://www.nytimes.com/2021/04/05/business/economy/robert-mundell-dead.html

And finally, the Washington Post’s obit:

Dr. Mundell gave one of the more unusual — and crowd-pleasing — acceptance speeches in the history of the Nobel Prize. He ended his remarks by singing a few bars of the hit Frank Sinatra song “My Way,” an allusion to the independent-minded approach that he brought to his life and work.

https://www.washingtonpost.com/local/obituaries/robert-mundell-dead/2021/04/06/36793d92-96d4-11eb-b28d-bfa7bb5cb2a5_story.html

RIP.