Tag: the economist

The Times, They’re A-Changing Part II

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“The putting-out system is a means of subcontracting work. Historically, it was also known as the workshop system and the domestic system. In putting-out, work is contracted by a central agent to subcontractors who complete the project via remote work. It was used in the English and American textile industries, in shoemaking, lock-making trades, and making parts for small firearms from the Industrial Revolution until the mid-19th century. After the invention of the sewing machine in 1846, the system lingered on for the making of ready-made men’s clothing.
The domestic system was suited to pre-urban times because workers did not have to travel from home to work, which was quite infeasible due to the state of roads and footpaths, and members of the household spent many hours in farm or household tasks.”

So begins the Wikipedia article on the putting-out system, a system that is about sub-contracting work.

This system isn’t just suited to pre-urban times, of course, it is also especially suited to pandemic times. The question to ask, of course, is whether it is also suited to post-pandemic times. And an article in the Economist seems to suggest that this may well be the case:


The Industrial Revolution ended the “putting-out system”, in which companies obtained raw materials but outsourced manufacturing to self-employed craftsmen who worked at home and were paid by output. Factories strengthened the tie between workers, now employed directly and paid by the hour, and workplace. The telegraph, telephone and, in the last century, containerised shipping and better information technology (IT), have allowed multinational companies to subcontract ever more tasks to ever more places. China became the world’s factory; India became its back office. Nearly three years after the pandemic began, it is clear that technology is once again profoundly redrawing the boundaries of the firm.

https://www.economist.com/business/2023/01/08/how-technology-is-redrawing-the-boundaries-of-the-firm

If you are a person embarking upon a new career today, not only is it possible for you to earn a fairly comfortable living working out of your home, wherever it may be located in the world, it is actually desirable to do so. Not for all people of course, but the pandemic, and the acceleration of technologies associated with the consequences of the pandemic, has made it possible for you to easily do so.

Part of the reason is, as the Economist article puts it, because of the fact that ‘measuring workers’ performance based on their actual output rather than time spent producing it’ has become progressively easier. That’s not a light sentence to write, by the way, because it hides at least two Nobel Prizes’ worth of work, if not more. And because it has become easier to specify what you want, and how to measure whether it is being done or not, the ‘putting-out’ system seems to be making a comeback of sorts.

A survey of nearly 500 American firms by the Federal Reserve Bank of Atlanta last year found that 18% were using more independent contractors than in previous years; 2% said they used fewer. On top of that, 13% relied more on leased workers, compared with 1% who reduced this reliance.

https://www.economist.com/business/2023/01/08/how-technology-is-redrawing-the-boundaries-of-the-firm

Which, to my mind, means that we need to think about five big-picture questions as a consequence of this trend:

  1. How will this impact patterns of urbanization? This is not an easy question to think about!
  2. How will this impact education? Will there be the evolution of the putting out model in academia also? Why or why not, and what will the equilibrium look like? Also not an easy question to think about, and I now have a better appreciation for inertia.
  3. How will the certification of both learning and working evolve? Will freelancing now carry more weightage on a CV? Or less, as before? How should we think about what to look for on a fresher’s CV?
  4. How far away is ubiquitous VR? How will that impact the dynamics of working/learning from home?
  5. How will this impact work culture and college culture in the years to come, and how should we think about this from a normative perspective?

The Times, They’re A-Changing: The Firm Edition

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People ‘job-hop’ much more these days. Where it was very unusual for people to change jobs at one point of time, this slowly but surely changed over time. And today, we live in a world where not only is job hopping common, an increasingly large number of people are choosing to not work formally with a firm at all, but rather as free-lancers instead. Including yours truly!

What is the economic explanation for this? That is, if you look around and see that attrition is rampant, and that people up and quit their jobs, you might want to ask yourself this: what are the economic factors that explain this phenomena?

A first-pass answer is, of course, the pandemic. But the pandemic is the proximate cause, or in the language of the economist, an exogenous shock. The question that we need to ask is a narrower one: what changed in the economy that allowed people to respond to this exogenous shock by walking away from their jobs? Think of it this way – did the pandemic a century ago also result in increased attrition and folks deciding to be freelancers? While I’m not familiar with labor markets of a century ago, I feel reasonably safe in saying that the answer is almost definitely no.

So while the desire to quit (or freelance) may be because of the pandemic, the ability to do so must be because of other factors. What might these factors be?

To answer this question, we first need to understand what caused firms to exist in the first place.

One morning, an economist went to buy a shirt. The one he chose was a marvel of global production. It was made in Malaysia using German machines. The cloth was woven from Indian cotton grown from seeds developed in America. The collar lining came from Brazil; the artificial fibre from Portugal. Millions of shirts of every size and colour are sold every day, writes Paul Seabright, the shirt-buying economist, in his 2004 book, “The Company of Strangers”. No authority is in charge. The firms that make up the many links in the chain that supplied his shirt had merely obeyed market prices.
Throwing light on the magic of market co-ordination was a mainstay of the “classical” economics of the late-18th and 19th centuries. Then, in 1937, a paper published by Ronald Coase, a British economist, pointed out a glaring omission. The standard model of economics did not fit with what goes on within companies. When an employee switches from one division to another, for instance, he does not do so in response to higher wages, but because he is ordered to. The question posed by Coase was profound, if awkward for economics: why are some activities directed by market forces and others by firms?

https://www.economist.com/schools-brief/2017/07/29/coases-theory-of-the-firm

So: why are some activities directed by market forces, and others by firms? Because being able to participate in market based activities is an expensive process in terms of money and time without having access to a firm. Consider my own example: I earn a living these days by teaching courses in economics and statistics, and do some consulting work on the side. But teaching courses in economics and statistics is something I do for the customers of firms called colleges.

Students – and this might come as a surprise to some people in academia – are the customers of firms called colleges. They are not aware of my existence before they enroll in these colleges (for the most part). And I am unaware of these students before I walk into my first class. It is the firm – the college – that does the job of getting ‘my’ customers to sit in class. Me? I rock up to the class and start yapping.

And while both the students and I would greatly prefer that we deal with each other directly, without the middleman’s meddling (attendance! examinations! certificates!), that realization only strikes us much later on in the semester. At the start of the college year, the costs involved in terms of the students getting together and figuring out who to hire to teach them economics are very high in terms of time, money and coordination efforts.

It is the same for the teacher too, of course. How do I know, without knowing of the student’s very existence, that this is the bunch of students I want to teach? It’s easier for both the students and the teacher in question to outsource this job to the firm – the college. An economist would say that we (the students and I) are reducing our transactions costs, or our search costs. Plus, the students might quite entirely reasonably point out that what the market values isn’t so much the fact that they’ve learnt economics, but the fact that the college has certified that the student has indeed learnt economics. And a certification to this effect from a college will always carry more weight than any certificate that an individual can issue. Colleges know this fact, by the way, and will of course do everything in their power to maintain this status quo.

So as far as I am concerned, and as far as students are concerned, it makes sense to enter into the kind of transaction we do, via the medium of a firm called the college.The college might prefer to hire me because it is much cheaper for the firm to pay me my hourly rate, and be done with me as soon as this transaction is over. There’s no need to pay me for the hours I sit in office, there is no need to make contributions into my Provident Fund, there is no need to pay out gratuity – outsourcing is cheaper. The higher the supply of people willing to work as visiting faculty, the more the temptation for the college to run a course by using visiting faculty only. It might make for a poorer on-campus experience, having more visiting faculty, but that’s a whole other story.

But are transaction costs going down over time? Did students realize that you could too learn at home during the pandemic? Did teachers realize that they could talk to their students using blogs, or YouTube videos, or podcasts or even Instagram reels? Did firms realize that the certificates issued by colleges – especially during the pandemic – are on the basis of examinations so horribly farcical that they effectively mean nothing? Might all these drive down transaction costs? If so, how? With what consequences for teachers, students and colleges?

Does all this make sense to you if you are (or recently have been) a student? And if yes, now ask yourself a broader question. How should you then think about all firms and all of their employees and all of their customers post the pandemic? Have transaction costs come down post the pandemic? If so, due to what reasons? With what consequences?

To understand this, you might wish to read this thread, which I will talk about in greater details in Monday’s blogpost:

On India’s Wu Liu

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Wu liu, in Chinese, is “the flow of things”, and is apparently the Chinese word for logistics:

Logistics covers transportation, warehousing and the management of goods. Its Chinese translation, wu liu, literally means “the flow of things”. But that flow within the country is costly and cumbersome. Much of the investment in infrastructure has gone to lubricate exports. Now, as China’s government shifts its focus to consumption at home it is finding that the domestic logistics industry is woefully inefficient.
Logistics spending is roughly equivalent to 18% of GDP, higher than in other developing countries (India and South Africa spend 13-14% of GDP) and double the level seen in the developed world. Li Keqiang, the prime minister, recently echoed industry’s complaints that sending goods from Shanghai to Beijing can cost more than sending them to America.

https://www.economist.com/china/2014/07/12/the-flow-of-things

This is an old report from The Economist – it came out in 2014. I’m not quite sure how much better China’s logistics sector has gotten since then, but back in 2014, India was also able to come up with similar statistics:

Indeed, the Financial Times reported in November 2014 that one French company finds that the cheapest and easiest way to send parts from Bangalore to Hyderabad, a few hundred kilometres apart, is to send them first from Bangalore to Europe, and then back from Europe to Hyderabad. It isn’t as if there isn’t a decent highway between the two cities; but the moment that a truck hit a state border, it has to stop and wait. According to the World Bank, Indian truck drivers spend a fourth of their time on the road waiting at the tax checkpoints that mark state borders. Factor in the time they spend in queues to pay highway tolls, and they spend less than 40 per cent of their time on the road actually driving. And that’s when the roads are good. Moving stuff around India costs this country’s manufacturers more than they spend paying their workers, the FT reports. Even India’s lower-than-low wages can’t make up for the dent logistics costs make in our competitiveness.

Sharma, Mihir. Restart . Random House Publishers India Pvt. Ltd.. Kindle Edition.

As I mentioned, I don’t know how the Chinese logistics sector has evolved since 2014, but India’s logistics sector needs to improve out of sight for us to become internationally competitive. And not just internationally competitive – even when it comes to domestic shipping of goods, there is a lot of scope for improvement:

“At the all-India level, the proportions of the produce that farmers are unable to sell in the market are 34 per cent, 44.6 per cent, and about 40 per cent for fruits, vegetables, and fruits and vegetables combined,” finds the committee on Doubling of Farmers’ Income. This means, every year, farmers lose around Rs 63,000 crore for not being able to sell their produces for which they have already made investments.
But, except for cold storage, the country is lagging in all other agri-logistics required to bring the produce from farm to markets. If plugged, the sector can create over 3 million jobs, a majority of which will be at the village level, says the State of India’s Environment in Figures 2018.
Although this seems to be a good show on the state of cold storage in the country, but it should be underlined that the existing cold storage capacity is confined mostly to certain crop types and not integrated with other requirements. In fact, close to only 16 per cent of the target set for creating integrated pack-houses, reefer trucks, cold storage and ripening units has been met. This means, there is an overall gap of about 84-99 per cent in achieving the target on improving the state of storage and transportation of the farm produce. Out of these, the country is far-far behind in meeting the requirement of integrated pack-houses, reefer trucks and ripening units.

https://www.downtoearth.org.in/news/agriculture/poor-post-harvest-storage-transportation-facilities-to-cost-farmers-dearly-61047

And that’s just agriculture. Taken as a whole, the logistics sector in India is rife with inefficiencies, and for many reasons:

A decade ago, the state of India transport and logistics was abysmal. The movement of goods within the country was an arduous and expensive affair. Serpentine queues at Interstate borders, random documentation checks, multiple regulatory checkpoints, tax compliance issues and poor infrastructure meant that India’s trucks had one of the slowest average speeds [20 to 40 kilometres per hour] and lowest distance covered in a day [250 to 400 kilometres] compared to developed countries [60 to 80 kilometres per hour and 702 800 kilometres per day respectively]. It also meant that Indian trucks spent about 60% of their time on the roads. Moreover the logistics sector was a complex beast with more than 20 government agencies, 40 partner government agencies, 37 export promotion councils and 500 certifications. All these factors combined made the cost of logistics in India much higher than most of her big trading partners.

https://twitter.com/anupammanur/status/1577483121183707136

Currently, we transport about 4.6 billion tonnes of goods worth 9.5 lakh crore rupees every year, and we do that through three different ways: coastal freight, road freight and rail freight. I got these statistics from a recent report on the Capitalmind website:

https://www.capitalmind.in/2022/11/how-india-transports-goods-is-changing/

And as the report goes on to say, this break-up is problematic because its much cheaper to transport stuff by rail or by water than road:

https://www.capitalmind.in/2022/11/how-india-transports-goods-is-changing/

Check the third graph in the Capital Mind article to see how the development of the Indian logistics sector defied economics – that is to say, over time, we’ve ended up transporting more by road than by rail! Except, of course, this isn’t in defiance of economics, it is because of it. Last mile connectivity is still poor in India, as most metro riders in this country will tell you. Plus, the fact that we’re transporting people and goods using the same infrastructure is a problem.

All of which is to say that we don’t transport stuff quickly, cheaply and seamlessly in our country. And that’s a amajor reason behind why we are not internationally competitive, and needlessly expensive in terms of domestic consumption. All of us, myself included, would do well to go over the broad countours of our National Logistics Policy. In addition, take a look at the associated e-book, and also read this interview of Vinayak Chetterjee on this issue. If India is to grow as rapidly as possible in the long run (and it must), getting our logistics right is an integral part of the puzzle.

This stuff matters, and if you are a student of economics in India, you absolutely must be familiar with our logistical challenges. They are many, they are inter-related, and solving them isn’t easy.

Elementary, My Dear Economist

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“There is an inverse relationship between interest rates and dishonesty,” says Carson Block, a short-seller.

https://www.economist.com/business/2022/11/07/a-sleuths-guide-to-the-coming-wave-of-corporate-fraud

You’d think we would learn, but it is hard to unlearn greed, alas. Whether it is tulips in the 16th century or collateralized debt obligations in the 2000’s – or whatever will be uncovered in the weeks (or months) to come – the underlying phenomenon is as old as humanity: greed.

People, institutions and organizations have been greedy these past few years, says The Economist in a lovely little article, and now that an era of high interest rates is upon us, some of these greed related shenanigans will be uncovered. This will not be a pretty process, and the repercussions will be tough for all of us. Job losses, reduced investments, slowing economies will all manifest themselves, and a familiar story will play itself out all over again.

But how will the tragedy start? What will be the straw that breaks the camel’s back? Which card in this particular house of cards will be the first to slip, bringing the whole edifice down? The Economist points to Environmental, Social and Governance (ESG) investing, or maybe various government schemes across the world to help business during the pandemic. Fintech is another obvious candidate. My own personal favorite pick is that the housing sector in China will be the epicenter, and a lot of things will begin to unravel from there on in. My personal worry is that this is such an obvious pick that I’m missing something else that will seem even more obvious with the benefit of hindsight.

But The Economist, in this article, teaches us how to begin to be an economist-y Sherlock. What facts should we cram our heads with, what story should we start to build, and how should we go about deducing how the collapse will start?

The article talks about a ‘triangle’ of factors: motives, circumstances and rationalization. If you are in charge of a business that seems to be doing well during the ‘good times’, there is pressure on you to keep making a good story better, and that spiral can be ascended with the help of some shady bookkeeping. That’s motive.

Circumstances effectively is shorthand for saying that fraud is likely to be higher in those economies where institutions are of lower quality: regulators not doing their jobs, politicians willing to look the other way. The article mentions China (and in a throwaway sentence, India), but I’d disagree. Institutions can be of poor quality the world over, and it has more to do with incentives and greed than it does with ’emerging economies’ alone. ‘In rich countries, opportunity beckons in the latitude of accounting practices’, says the article, but surely nobody today is under the illusion that rich countries have had institutions and regulators of great quality! If your memories are long enough to go back to Polly Peck, surely they can help one remember 2008 in the US and 2011-12 in Europe? And those, to me, aren’t examples of accounting malpractice, but rather of regulators asleep at the wheel, knowingly or otherwise.

And finally, rationalization. This is simply the “but everybody is doing it, so why shouldn’t I?” argument, and it is, unfortunately, all too common in all walks of life. To expect those involved in high-stakes finance to be immune from it is dangerously problematic.

Combine these three then: motives, circumstances and rationalization, and throw in slowing growth and high inflation, and ugly stories will start to emerge. They already have, of course, so long as you know where to look.

Two additional points: Goodhart’s Law remains underrated, and this article is yet another reason to learn it, and to learn how to apply it and above all, to learn to predict outcomes by using it:

That bosses feel pressure to deliver predictable profits is well documented. Almost all the 400 managers surveyed in the mid-2000s by John Graham, Campbell Harvey and Shiva Rajgopal, a trio of academics, confessed to a strong preference for smooth earnings. Most admitted they would delay big spending line items to meet a quarterly earnings target. More than a third said they would book revenues this quarter rather than the next, or incentivise customers to buy more earlier.

https://www.economist.com/business/2022/11/07/a-sleuths-guide-to-the-coming-wave-of-corporate-fraud

And two: get better at learning the basics of accounting. Among economists, this remains a very underrated skill. Myself included, I should mention!

Incentives Matter, the International Trade Edition

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A chart and a paragraph from The Economist to get us started today. First, the chart:

https://www.economist.com/finance-and-economics/2022/11/06/who-wins-from-the-unravelling-of-sino-american-trade

I’ve been a student of economics for a little more than two decades, and the one thing that is quite familiar to me in this chart is how large China’s share is in US imports (that’s what the “17” at the bottom right of the chart represents. Spend some time going over the rest of the numbers on the right of this chart, and come to the realization that China is about 50% more than all of the other nations on this chart combined.)

Being a student of economics in these past two decades makes it inevitable that some notions of how the world works and functions will get deeply ingrained. And the idea that China will be much larger in everything compared to, often, the addition of all other countries performances has become a useful rule of thumb. Note that I am not advocating forming such a rule for the future – I’m simply saying this has been the case for the past two decades.

But as the Nobel Laureate said, the times, they’re a-changin’:

Yet Mr Trump’s tariffs seem to have played an important role. According to recent analysis of industry data by Chad Bown of the Peterson Institute for International Economics, a think-tank, China’s share of America’s imports rose from 36% to 39% this year in goods not covered by tariffs. For goods subject to a 7.5% tariff, however, China’s share sank from 24% to 18%. And for those hit by a whopping 25% tariff, which covers lots of it equipment, China’s share of imports fell from 16% to 10%. Overall America is now much less dependent on Chinese goods, from furniture to semiconductors.

https://www.economist.com/finance-and-economics/2022/11/06/who-wins-from-the-unravelling-of-sino-american-trade (Emphasis added)

This post isn’t about whether Trump should have imposed those tariffs or not, nor is it about whether those tariffs have been worth it. That is an important topic, but we’re going to skip over it in today’s post. Today is just a reaffirmation of a principle of economics:

When something becomes more expensive, there will be lesser demand for it.

That, of course, is just another way to state the law of demand. You can draw a curve, if you like, or you can phrase it the way I did, or you can write out a paragraph that gives an application of the law, like The Economist did. But the next time you read people opining about whether Policy X will work or not, ask yourself how the incentives have been realigned as a consequence of the new policy.

By how much will demand go down (elasticity), should this policy be implemented or not (geopolitics), and what might be the impact of this policy on China and America and other nations (international trade) are all excellent questions, and they will keep all manner of professionals busy for decades to come.

But again, that’s for another day. Today’s post is about helping you realize that the law of demand is one way to understand incentives, and (don’t stop me even if you have heard this before) it is about chanting a mantra that all economics students would do well to internalize:

Incentives Matter

Chart of the Day: Incentives Matter

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https://www.economist.com/graphic-detail/2022/09/29/a-study-of-lights-at-night-suggests-dictators-lie-about-economic-growth

Incentives matter:

The explanation is probably simple: opportunity and motive. Part of what makes dictatorships dictatorships is that questioning the official line is dangerous. At the same time, autocratic regimes have a strong incentive to report healthy growth: its absence may be taken as a sign of incompetence or weakness, which dictators can ill afford.
Autocrats’ subordinates face similar incentives. In a related study Jeremy Wallace, a researcher, found misreporting by Chinese provinces, too. As he notes, a leaked American diplomatic cable from 2007 revealed the view of Li Keqiang, the prime minister, then a provincial party secretary. He had said, with a smile, that gdp figures were “for reference only”: he relied instead on proxies, such as electricity use.

https://www.economist.com/graphic-detail/2022/09/29/a-study-of-lights-at-night-suggests-dictators-lie-about-economic-growth

Incentives matter is the very first slide in my presentation on Principles of Economics (as it should be). But there’s always more to learn and think about where this deceptively simple idea is concerned, and this chart and the accompanying article from the Economist are a great example about the deceptive bit.

Once you understand the incentives associated with a particular entity in a particular context, you should then learn the art of being appropriately sceptical about their statements. One shouldn’t assume that they’re lying, nor should one assume that they’re telling the truth – one should understand what the incentives are of the person reporting a particular claim, and adjust one’s expectations accordingly.

Incentives matter, and understanding a person’s incentives matters at least as much, if not more.

Like their leaders, citizens in dictatorships often assume they are being lied to. Outsiders should be similarly sceptical.

https://www.economist.com/graphic-detail/2022/09/29/a-study-of-lights-at-night-suggests-dictators-lie-about-economic-growth

I’d go one step further, and recommend that while reading, listening or viewing anything, one should keep the incentive of the creator in mind. It makes for a more interesting experience while consuming said content, and you are, at the margin, less likely to be taken for a ride.

The Economist on What To Read To Understand How Economists Think

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Here’s the article, and I hope you’re able to access it.

Just in case it is behind a paywall for you, here is a quick summary:

  1. The Economist says that thinking like an economist is primarily about two things:
    1. There is no such thing as a free lunch, which is another way of saying you can never avoid opportunity costs
    2. When possible, try to put numbers on things
  2. The article then lists out five books that help you think along these lines:
    1. Capitalism and Freedom, by Milton Friedman
    2. The Worldly Philosophers, by Robert Heilbroner
    3. Africa: Why Economists Get it Wrong, by Morten Jerven
    4. Capitalism Alone, by Branko Milanovic
    5. Freakonomics: A Rogue Economist Explores the Hidden Side of Everything

I’m about to share my own list, but before I do that, a couple of points.

I’ve read the first, second and fifth book, and they’re all great books to read. I look forward to reading the other two, and the description of the fourth in particular sounds particularly exciting to my ears:

This is the book to read if you want to understand why capitalism—and economists’ way of thinking—has triumphed the world over. By the beginning of the 1990s, it was clear that the capitalist system had defeated the communist one. Today, however, many people yearn to move to a new system, such as “millennial socialism”. A left-leaning scholar, Mr Milanovic sympathises with these feelings. But ultimately he finds many radical prescriptions unconvincing. A country which tried to de-marketise on the scale envisaged by socialists would, he says, be unstable and dissatisfied in other ways. Shifting towards a much shorter working week, for instance, would leave it poorer than its neighbours. For how long would people put up with that? Capitalism is far from perfect, his book shows, yet it is hard to shake the notion that it is the only system that broadly works.

https://www.economist.com/the-economist-reads/2022/08/09/what-to-read-to-understand-how-economists-think

In a way, this reminds me of Churchill’s quote about democracy being the worst form of government, except for all the others that have been tried. And it rings true – there’s many things that we all wish could be “better” when it comes to capitalism, but one of my favorite econ questions is very apposite here: relative to what? That is, if you say capitalism is not good/not perfect, you need to answer the question “relative to what”?

Second, please don’t interpret this blogpost as a critique of the list put out by the Economist. This blogpost is very much in the spirit of “Yes, and” rather than “No, but”. But that being said, my own opinion of the main features of thinking like an economist are slightly different. I couldn’t agree more with the first feature (opportunity costs), but I do disagree with the second one. I would argue that it is entirely possible to get the most out of life without having to put a number on it. In fact, as Russ Roberts recently pointed out in a podcast, it simply isn’t possible or desirable to put numbers on some things. I haven’t read the book yet, but the podcast was instructive in many different ways. Here’s one apposite quote (Russ is answering a question by Tim about how to decide whom to marry):

Alain de Botton has a wonderful YouTube video I recommend on that; I think the title is “You’re going to marry the wrong person.” Fantastic short video. Don’t show it to my wife because she thinks she married the right person, I don’t want her to see it and depress her. But seriously, there’s no best. And part of the theme of my book is that most of life is a matrix. And by that, I don’t mean the movie, the red or blue pill. What I mean is that it’s a set of complicated attributes that are pluses and minuses for all kinds of things.
So the person you’re with, that you’re seeing now, whoever’s listening out there, there are certain levels of attractiveness, there’s a certain level of kindness, there’s a certain level of intelligence, or a certain level — many, many, many attributes. And then there’s chemistry and sexual attraction. We’ve got all those things working. And so, which is the best one? Oh, well I need a formula to add up all those measurements so I can get a single number, and then I’ll just pick the one that gets the best score. And I’d argue that’s the wrong way to think about life. It’s the wrong way to think about how to pick your friends. It’s the wrong way to think about how to find the best job. It’s the wrong way to think about most things.

https://tim.blog/2022/08/07/russ-roberts-transcript/

As I mentioned, I haven’t read the book yet – sometimes I think I should get a T-Shirt with this line printed on it. But I very much belong to the school of thought that would argue that not everything in life need be quantified.

So if I disagree with “if possible, put numbers on everything”, what according to me are the main features of thinking like an economist? If I had to pick just two, here they are (and I’m going to cheat, so there):

  1. Opportunity costs are everywhere
  2. Incentives matter
  3. Life is a non-zero sum game

Getting incentives right, and worrying about what happens if incentives go wrong ought to be part and parcel of your toolkit an an economist. And if you asked me to recommend a book about this topic, my pick would be Discover Your Inner Economist, by Tyler Cowen.

Bonus: check out the podcast between Russ Roberts and Tyler Cowen on this book.

Bonus Bonanza: reflect on the very first comment at the top of the page!

More Bonus Bonanza: Learn about callbacks.

And re: life being a non-zero sum game, I would recommend In The Company of Strangers, by Paul Seabright. If you do end up reading the book, you might end up coming away with the “complaint” that it is about much more than just life being a non-zero sum game, but in my world, that’s a feature, not a bug. But for the moment, here’s a relevant excerpt from the book:

Once bands were willing to make tentative peaceful contact with other bands, they could exchange with them, thereby enormously expanding the kinds of foods, tools, and resources to which they had access. We have evidence of exchange between hunter-gatherers from many thousands of years before the foundation of agriculture, although their lifestyle must have made such contacts sporadic and limited by comparison with the opportunities available to sedentary farmers in later millennia. Some of the oldest known symbolic artifacts, carved beads dating back over forty thousand years, may have played a role in facilitating such exchanges.7 In more recent times, the Yir Yoront aboriginals of Northern Australia had stone axes even though they lived many hundreds of kilometers from the nearest stone quarries (they exchanged stingray-tipped spears for them with neighboring tribes) and even steel ones, well before their first contact with European traders at the end of the nineteenth century. Trade allowed access not only to their neighbors’ skills but to those of their neighbors’ neighbors, and so on.

Seabright, Paul. The Company of Strangers (pp. 46-47). Princeton University Press. Kindle Edition.

And a final recommendation: please also do read The Undercover Economist and The Undercover Economist Strikes Back, both by Tim Harford.

What is a Doom Loop?

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Is a global recession imminent?

Probably. Macroeconomic forecasting is the stupidest of sports, but it is looking quite likely, yes.

How will recession start, how will it play out, and how long will it last? I don’t have the faintest idea, and trust me, nobody knows for sure.

But certain channels of both cause and effect (and sometimes both at the same time, because macro is hard) can be readily identified. And one such channel in today’s day and age is that of a ‘doom loop’.

A country is at risk of a doom loop when a shock to one part of its economic system is amplified by its effect on another. In rich countries, central banks should have the power to halt such a vicious cycle by standing behind government debt, stabilising financial markets or cutting interest rates to support the economy. But in the euro zone, the ECB can only do this to a degree for individual countries.

https://www.economist.com/the-economist-explains/2022/06/22/what-is-the-doom-loop-in-the-euro-zone

I haven’t taught international macro for a while now, but when I used to, I would explain this to my students by calling it the Mamata Banerjee/Narendra Modi/Raj Thackeray problem. I hope your curiosity is piqued!

For an economic union of political entities to work, there are (very broadly speaking) four things that must be present:

  1. A monetary union (which the EU has)
  2. A fiscal union (this is the Mamata Banerjee angle, explained below)
  3. Capital mobility (Narendra Modi)
  4. Labor mobility (Raj Thackeray)

Now, bear in mind that my examples are from a while back. I am referring to Mamata Banerjee’s first stint as Chief Minister, and the version of Narendra Modi I have in mind is the Chief Minister of Gujarat.

But back when Mamata Banerjee became Chief Minister of Bengal for the first time, one of the first things she did was to ask the Centre for help given West Bengal’s precarious finances. The point is not about whether it was given or not (as far as this blogpost is concerned), the point is that states routinely ask for, and sometimes get, aid from the centre. This may be because of natural disasters, or man made ones, financial ones or otherwise. The point is that the central government has the ability to ‘help’ out states if necessary. It is, of course, more complicated than that, and a fiscal union also implies the ability to raise and share taxes, but the central point is the fact there is help available, if needed.

But the ability of the European Union to do so is severely constrained, because you will need a lot of good luck to convince, for example, German voters that their taxes might be used to help the Spanish economy in its time of need. And for somewhat similar reasons, you can make more or less the same argument for the inability of the European Central Bank to chip in when necessary.

Or consider Narendra Modi’s invitation to Ratan Tata, to have his Tata Nano factory be relocated from West Bengal to Sanand in Gujarat. That’s an example of capital mobility, and again, this is much easier to achieve within a country.

And finally, Raj Thackeray, and his opposition to workers from outside Maharashtra ‘taking’ jobs within the state – that is a great way to understand what (lack of) labor mobility means.

The point is that an economic union must necessarily have these four things in place for it to be a meaningful, stable and well-functioning European Union. The idea isn’t new, of course – Robert Mundell‘s idea has been around since the late 1950’s, and there have been others who have worked on related ideas. Also read Paul Krugman on the topic.

But the point is that if a crisis strikes the EU, they have a limited range of weaponry that they can deploy.

Please read the rest of the article to get a sense of how linkages between European governments and its banks, the banks and the broader economy, and the broader economy and the European governments can both cause and exacerbate a crisis.

And as usual, the concluding paragraph for your perusal:

The euro zone is at less risk from doom loops than it was ten years ago, thanks to reforms to the banking system, the ECB’s commitment to preserve the euro and some embryonic fiscal integration. But the danger has not disappeared. And reforms to the euro zone’s architecture that would further reduce the risk have stalled⁠—in part because in 2012 the ECB boldly stepped in, easing the pressure on governments to make difficult decisions. As the ECB once again intervenes, the prospects for deep euro-zone reform look increasingly remote.

https://www.economist.com/the-economist-explains/2022/06/22/what-is-the-doom-loop-in-the-euro-zone

Interesting Times Indeed

AshishLeave a comment
https://horizons.tatatrusts.org/2018/november/indian-agronomist-swaminathan.html

Shown here are two people who, in my opinion, have perhaps done more for India than anybody else. That’s the kind of remark that can keep Twitter going for days, but I would honestly be surprised if these two didn’t make at least the top ten for most people.

Who are they? M.S. Swaminathan on the left, and Norman Borlaug on the right. And what, you might ask, are they famous for? Almost every student in India is likely to say “The Green Revolution!” by way of response, and they wouldn’t be incorrect.

Read the entire Wikipedia article, because it is quite the story. And if, after reading the article, you still wish to learn more, consider reading a book called The Wizard and the Prophet:

In November 1963, Swaminathan received the next shipment of Borlaug’s wheat: 220 pounds each of four commercially released varieties and samples of another 600 breeding lines that were promising but not yet commercially available. IARI researchers divided the wheat among five-acre plots in four different experimental stations. The results were remarkable. Indian farmers typically reaped less than half a ton per acre. The four Mexican varieties yielded a per-acre average of about a ton and a half, and some plots came in at almost two tons.

Mann, Charles C.. The Wizard and the Prophet: Two Groundbreaking Scientists and Their Conflicting Visions of the Future of Our Planet (Kindle Locations 6706-6710). Pan Macmillan. Kindle Edition. (Emphasis added)

How and why India (and other nations) fell short in terms of food production, Borlaug’s research in Mexico, and the fascinating story of how both Borlaug and his wheat made it to Asia is told incredibly well in the book (there is much more in the book besides, and I mean that as a compliment), and I would strongly recommend you read it.

Their work has gone a very long way towards making sure that the so called Malthusian Trap hasn’t really been a problem for most countries.

But well, we live in interesting times.

Russia and Ukraine supply 28% of globally traded wheat, 29% of the barley, 15% of the maize and 75% of the sunflower oil. Russia and Ukraine contribute about half the cereals imported by Lebanon and Tunisia; for Libya and Egypt the figure is two-thirds. Ukraine’s food exports provide the calories to feed 400m people. The war is disrupting these supplies because Ukraine has mined its waters to deter an assault, and Russia is blockading the port of Odessa.
Even before the invasion the World Food Programme had warned that 2022 would be a terrible year. China, the largest wheat producer, has said that, after rains delayed planting last year, this crop may be its worst-ever. Now, in addition to the extreme temperatures in India, the world’s second-largest producer, a lack of rain threatens to sap yields in other breadbaskets, from America’s wheat belt to the Beauce region of France. The Horn of Africa is being ravaged by its worst drought in four decades. Welcome to the era of climate change.
All this will have a grievous effect on the poor. Households in emerging economies spend 25% of their budgets on food—and in sub-Saharan Africa as much as 40%. In Egypt bread provides 30% of all calories. In many importing countries, governments cannot afford subsidies to increase the help to the poor, especially if they also import energy—another market in turmoil.

https://www.economist.com/leaders/2022/05/19/the-coming-food-catastrophe

The effects are already being felt the world over, and as the article points out, this is likely to get much worse before it gets better, and for a variety of reasons. These are worth listing out:

  1. The war in Ukraine has resulted in supply chain disruptions
  2. Unexpected changes in weather patterns the world over. You may wish to debate the word “unexpected”, and I would be in agreement with you!
  3. Raging inflationary pressures due to loose monetary policies (how loose for how long with what effects is a topic that will turn into a miniature cottage industry in academia)
  4. A steep rise in oil prices, which impacts and is in turn impacted by 1., 2. and 3.

And the worst of it is that none of these factors look likely to subside anytime soon. And once you bake in the inevitable political response in most countries, you have found a way to make a bad problem worse:

Since the war started, 23 countries from Kazakhstan to Kuwait have declared severe restrictions on food exports that cover 10% of globally traded calories. More than one-fifth of all fertiliser exports are restricted. If trade stops, famine will ensue.

https://www.economist.com/leaders/2022/05/19/the-coming-food-catastrophe

This is a story worth keeping track of, and you can be assured that all governments will be doing just that. Working through the myriad implications of multiple scenarios in a geopolitical situation as volatile as the one we’re going through right now is a migraine inducing thought, but it needs to be done.

Make no mistake, these are very interesting times indeed.

But on the plus side, imagine where we might have found ourselves today had the Green Revolution not taken place.

Read The Wizard and the Prophet, please.

Imports, Exports and GDP

Ashish2 Comments

“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.