The problem with Brazil (and it’s not socialism)

The problem with Brazil is not Luis Inacio Lula da Silva. It’s not the Worker’s Party. It’s not Socialism.

Certainly one of the most important politicians in Brazilian History was Getulio Vargas. Vargas came to power in a coup (that symptomatically most Brazilian historians call a revolution) in 1930. He ended up staying in power, without ever being elected by popular vote, until 1945. Then he peacefully resigned, not without electing his chosen successor, Eurico Gaspar Dutra. Vargas came back to power immediately after Dutra, and committed suicide while in office. Almost all Brazilian presidents from 1945 to 1964 were from Vargas’ close circle.

Brazilians to this day are still taught that Vargas was a hero, persecuted by an evil opposition. Initially, Vargas was some kind of Brazilian positivist. He was anti-liberal because liberalism is weak and slow. We need a strong technical government, able to identify problems and come with solutions fast. However, while in office, he became “the father of the poor,” a defensor of the lower classes. Nothing could be farther from the truth, of course, but that’s how Vargas is remembered by many.

One of my favorite interpretation of Brazil comes from Sergio Buarque de Holanda. According to Holanda, the problem with Brazil is that Brazilians are cordial. What he means by that is this: using Weber’s models of authority, he identified that Brazilians were never able to support a Legal-Rational authority. Vargas was seen as “a father.” not a president. The country is seen as a big family. Lula used a very similar vocabulary and tried to reenact Vargas’ populism.

As I mentioned, Holanda’s interpretation is Weberian. Weber’s most famous book is The Protestant Ethic and the Spirit of Capitalism. The problem with Brazil is that it never went through a protestant reformation. And because of that, it never developed the “spirit of capitalism” that Weber describes. Brazil is still, to a great degree, stuck with traditional and charismatic forms of authority.

To be sure, Brazil has many features of a modern liberal state. Since late 18th century Portugal tried to copy these from more advanced nations, especially England. Brazil followed suit. But you can’t have the accidents without the substance. Unless Brazil actually goes through a transformation in its soul, it will never become the modern liberal state many want it to be. Quoting Domingo Faustino Sarmiento, “An ignorant people will always choose Rosas.”

Revisiting Epstein’s Freedom and Growth


I was fortunate to be invited give the Epstein Lecture at LSE this March. The series is named after the great LSE economic historian Larry (Stephen) Epstein. Here I’ll summarize why it was such an honor to give the lectures. The content of the lecture will be another post.

Epstein was a historian whose origin field of expertise was medieval Italy. I encountered him through Freedom and Growth. Published in 2000, I first read it a couple of years later, perhaps in 2002 or 2003. At the time I was devoted to a story of economic growth shaped by Douglass North, particularly Structure and Change in Economic History (1981).

The focus of Structure and Change was on transaction costs. High transaction costs limited market exchange and kept societies poor for most of history. Sustained economic growth could only occur once transaction costs fell to a level that allowed markets to expand and the division of labor to develop. On this view, market expansion or Smithian growth was itself a stimulus to technological innovation. But what kept transaction costs high?

One answer North gave was the state. To paraphrase: the state had the ability to both keep a society mired in poverty through predatory behavior and to provide the preconditions for growth by securing property rights. The origins of sustained economic growth for North lay in institutional changes that occurred secured property rights and lowered transaction costs. The most important such institutional change was the Glorious Revolution of 1688.


North’s account received many challenges, but the issue that Epstein honed in on was the assumption that there was such a state, able to either revoke or secure property rights. It was assumed that “rulers rule”. Epstein contested this arguing that New Institutional Economists

“project backwards in time a form of centralised sovereignty and jurisdictional integration that was first achieved in Continental Europe during the nineteenth century; they therefore fundamentally misrepresent the character of pre-modern states.”

North, Wallis, and Weingast would address this in their 2009 Violence and Social Orders. But Epstein’s criticism was spot on in 2000. Epstein argued that alongside the problem of predatory states, a central problem was the lack of integrated markets. He attributed market disintegration to coordination and prisoners’ dilemma problems between political authorities. In so doing, Epstein set the agenda for the subsequent “state capacity” research agenda.

Epstein made several points which continued to be expanded upon by current research (see here). First, he documented that the lower interest rates that the British state paid after 1688 were characteristic of city republics from the middle ages onwards. He argued that the English monarchy in the 17th century was characterized by an anomalously backwards financial system. Lower interest rates after 1688 partly represent a convergence to the Republican norm achieved by Italian city-states centuries earlier.

Second, he challenged the argument that monarchies “overtaxed” cities. There was “no evidence that townspeople paid higher taxes under monarchies than republics”. Per capita taxes were likely higher in Republican city-states.

Third, he disputed that Republican city-states like Florence brought economic freedom noting that “republican subjects faced several limitations to their economic and political freedoms that monarchical subjects did not”. All of this challenged generalizations made by historical sociologists like Charles Tilly and economic historians like North.


Epstein’s historical evidence came from medieval Italy. Late medieval Italy was highly urbanized and prosperous by pre-industrial standards. According to Broadberry’s estimates, per capita GDP in Italy in 1450 was not matched by England until 1750. Like growth elsewhere in the premodern world, it was Smithian growth, driven by trade, market integration, and the division of labor. But unlike in England, this Smithian growth did not continue and blossom into modern growth. Epstein’s explanation for why this did not take place was that late medieval Italy suffered an “integration crisis”.

He saw the late medieval period as characterized by new opportunities for growth and innovation. Urbanization increased. Capital markets expanded and deepened. Interregional trade developed. Proto-industrialization took place. But Epstein contended these opportunities were only seized in areas where political authority was centralization.

In reference to proto-industrialization, he observed that

“Crucially, the success of regional crafts was inversely proportional to the concentration of economic and institutional power in the hands of a dominant city.”

With respect to the establishment of permanent fairs, he noted that

In fifteenth-century Lombardy, new fairs proliferated only after the balance of power shifted decisively from the former city-states to the territorial prince with Francesco Sforza’s victory in 1447.

Market integration was complemented and perhaps driven by political integration. Integrated urban hierarchies were themselves the product of political centralization.

“Centralisation underlies all the major institutional changes to market structures previously described. It lowered domestic transport costs, made it easier to enforce contracts and to match demand and supply, intensified economic competition between towns and strengthened urban hierarchies, weakened urban monopolies over the countryside, and stimulated labour mobility and technological diffusion.”

The more centralized parts of Italy — notably Lombardy — were better able to benefit from these trends than was Tuscany. But in general, political fragmentation and regional diversity were “distinctive features of pre-modern Italy” in general and an impediment to its long-run growth prospects.

Unlike in his analysis of interest rates, Epstein brought little data to bear on these claims and I am unaware of subsequent research on late medieval Italy. As such, the thesis of a late medieval integration crisis laid out in Freedom and Growth remains speculative. Epstein would no doubt have fill in the details had he lived longer. Subsequent research has mostly focused on early modern rather than medieval Europe (see here).  But the larger message: the importance of the state for premodern economic development has been central to subsequent research, including my own work (e.g. here).

Nightcap

  1. The Left’s Double Standard on the Power of Media Madeline Grant, CapX
  2. What Happens Next for British Left? Zoe Williams, Times Literary Supplement
  3. Americans are richer and happier than Europeans Scott Sumner, EconLog
  4. South Africa decides Zimbabwe is an instruction manual Johnathan Pearce, Samizdata

What should universities do?

The new semester is here so it’s time for me to figure out what the hell I’m supposed to be doing in the weird world of modern American university life. Roughly speaking, the answer is going to be “do the stuff that professors do to help universities do what universities do.” So what do universities do? What are they supposed to do?

Universities occupy a few different niches in society. I’m usually tempted to think of universities like a business. And in that framework, I justify my salary by providing something of value to those students. At my school, something like 90% of the operating budget comes out of students’ pockets.

But that’s an overly narrow view. Students pay to go to school because they expect they’ll get value from it, but they also go to school because them’s the rules–if you want to enter adult society, university is the front gate. In this framework, I justify my salary by serving as a gatekeeper. Even though it’s students paying, the (nebulous) principal I’m obliged to is the collection of people already inside the walls.

But wait! There’s more! Universities are (in no particular order):

  • A repository of knowledge,
  • A generator of new knowledge,
  • A place people go to learn,
  • A place people go to prove themselves,
  • A place people make friends and have fun (in a way that may be hard to replicate),
  • A business (engaging in mutually beneficial exchange),
  • A special interest group,
  • An institution that holds a particular (privileged) position in a wider cultural landscape.

Any one of these functions is a can of worms in its own right. When we start to consider tradeoffs between each function (and the many less visible functions I’ve surely missed), it gets downright intractable. I’m going to focus on the student-focused aspects of university life.

The mainstream view:

University is a place students get educated. This education helps them get jobs because employers value it. Students might also learn things that help them be better citizens.

The mainstream view doesn’t seem far off from what I’ve got in mind until you get your hands dirty and start disentangling what that view says. Here are three big problems inherent in that mainstream view:

  1. The education-for-job myth.
  2. The definition problem.
  3. The one-size-fits-all problem.

The Job-training myth

We’re told that students go to school to learn valuable skills. I think that’s true, but not in the usual way. Any specific skills students learn in school are a) incredibly general, or b) out of date. My students might learn some interesting ways of looking at the world (general knowledge), but a lot of what I teach is completely useless in the workforce (“Johnson, draw me a demand curve, stat!”). But students do learn valuable skills incidentally. They learn to manage their time (ideally), how to be conscientious, and in general they’re socialized so that they can fit in with adult society.

Lately I’ve been thinking of college as a form of upfront consulting. Instead of going to school when you’ve got a specific problem to solve, go when you’re young and have nothing better to do. Since you’re getting the consulting before you know what sort of problems you’ll face in the future, we couldn’t possibly give you exactly the right bundle of knowledge.

College exposes students to lots of different ideas that might combine in unexpected ways. Your class in underwater basket weaving might seem like a waste of time until some day 30 years later you are trying to solve some problem that turns out to make a lot more sense if you think of it like wet wicker (I’m looking at you civil engineers!).

Some of what I (and my colleagues) do helps prepare students for their careers, but mostly I’m trying to help them be better–better thinkers, better able to understand and appreciate, better able to enjoy life.

The definition problem

The word “Education” means a lot of things to a lot of people. More often than not, people use the word without being clear about what they mean. Often it means “job training.” Sometimes it means “enlightening.” Other times it means “making you agree with me.” In practice, it means surviving enough classes that you get a piece of paper indicating as much.

It should be recognized as a vague and nebulous word instead of being pigeonholed. It isn’t a binary state (I was ignorant, now I’m educated). It’s helpful to think of people as being more or less educated, but the state of your education isn’t something we can really objectively compare to my state of education.

There are lots of important but nebulous things in our lives: health, happiness, moral worth. Their vagueness makes them difficult, but it isn’t going away.

It isn’t hard to convince people that education is nebulous, but it is hard to get people to behave as though they really understand that.

Homogenization and commodification

Once people start thinking of education as some objective thing we can pull off a shelf and give to someone, we run into the real problems. This unexamined view leads to bureaucracies that attempt to standardize and commodify education.

Don’t get me wrong, I get why people would try to do this. We want everyone to get education (and moral training, and good health, and…). And as long as we’re worried about that, we’re going to worry about making sure everyone gets the best education possible. But “the best” gives the false impression that there’s one right answer.

A top-down approach isn’t the right way to achieve the goal of widespread education. Attempting to systematically scale up education provision kills the goose that lays the golden eggs. We should fight against attempts to commodify university (which currently happens via accreditation-as-gateway-to-subsidy and the general expansion of bureaucracy through administration).

So what should universities do?

There are different margins on which we can justify our existence, but it’s not obvious how to balance our tasks: teaching, researching, advocating, etc.. Given the high degree of uncertainty, I’d argue for pluralism… different schools (and professors) should be trying different things. As universities adapt to the future, it’s important that they don’t all try to adapt in the same way at the same time.

I think a big part of the problem is that we’ve been too successful at rent seeking. All money/privilege/goodies comes with strings attached, and more money comes with more strings. We’re always going to get a little tangled up in those strings, but in the last couple generations we’ve hamstrung ourselves. Accreditation and assessment have become the most important things a modern university does, which distracts from our more fundamental goals.

A bottom up approach doesn’t mean less education, just different education. A more modest education system would change the mix of costs and benefits faced by stakeholders. Employers might rely less on degree signalling, which means hiring managers and potential employees exercising more judgement in sending and evaluating quality signals. I don’t know exactly what would happen, but flexibility is valuable for the nebulous goals universities are supposed to be pursuing.

But at the moment we seem to be in an equilibrium. Students are expected to go to school, schools are expected to deliver on promises they can’t really fulfill, and we go through the motions of keeping schools accountable in a way that basically misses the point.

So what will I do this semester? I’m going to keep talking about interesting stuff to students. I’m going to keep working towards getting tenure. But I’m also going to quietly subvert attempts to commodify university.

 

On Monopsony and Legal Surroundings

A few days ago, in reply to this December NBER study, David Henderson at EconLog questioned the idea that labor market monopsonies matter to explain sluggish wage growth and rising wage inequality. Like David, I am skeptical of this argument. However, I am skeptical for different reasons.

First, let’s point out that the reasoning behind this story is well established (see notably the work of Alan Manning). Firms with market power over a more or less homogeneous labor force which must assume a disproportionate amount of search costs have every incentive to depress wages. This can lead to reductions in growth as, notably, it discourages human capital formation (see these two papers here and here as examples). As such, I am not as skeptical of “monopsony” as an argument.

However, I am skeptical of “monopsony” as an argument. Well, what I mean is that I am skeptical of considering monopsony without any qualifications regarding institutions. The key condition to an effective monopsony is the existence of barriers (natural and/or legal to mobility). As soon as it is relatively easy to leave a small city for another city, then even a city with a single-employer will have little ability to exert his “market power” (Note: I really hate that word). If you think about it simply through these lenses, then all that matters is the ability to move. All you need to care about are the barriers (legal and/or natural) to mobility (i.e. the chance to defect).

And here’s the thing. I don’t think that natural barriers are a big deal. For example, Price Fishback found that the “company towns” im the 19th century were hardly monopsonies (see here, here, here and here). If natural barriers were not a big deal, they are certainly not a big deal today. As such, I think the action is largely legal. My favorite example is the set of laws adopted following the Emancipation of slaves in the United States which limited the mobility (by limiting the chances of Northerners hiring agents to come who would act as headhunters in the South). That is a legal barrier (see here and here). I am also making that argument regarding the institution of seigneurial tenure in Canada in a working paper that I am reorganizing (see here).

What about today? The best example are housing restrictions? Well, housing construction and zoning regulations basically make the supply of housing quite inelastic. The areas where these regulations are the most severe are also, incidentally, high productivity areas. This has two effects on mobility. The first is that low-productivity workers in low-productivity areas cannot easily afford to move to the high-productivity area. As such, you are reducing their options of defection and increasing the likelihood that they will not look. You are also reducing the pool of places to apply which means that, in order to find a more remunerative job, they must search longer and harder (i.e. you are increasing their search costs). The second effect is that you are also tying workers to the areas they are in. True, they gain because the productivity becomes capitalized in the potential rent from selling any property they own. However, they are in essence tied to the place. As such, they can be more easily mistreated by employers.

These are only examples. I am sure I could extend the list to reach the size of the fiscal code (well, maybe not that much). The point is that “monopsony” (to the extent that it exists) is merely a symptom of other policies that either increase search costs for workers or reduce the number of options for defections. And I do not care much for analyzing symptoms.

In the Search for an Optimal Level of Inequality

Recently, the blog ThinkMarkets published a post by Gunther Schnabl about how Friedrich Hayek’s works helped to understand the link between Quantitative Easing and political unrest. The piece of writing summarized with praiseworthy precision three different stages of Friedrich Hayek’s economic and political ideas and, among the many topics it addressed, it was mentioned the increasing level of income and wealth inequality that a policy of low rates of interest might bring about.

It is well-known that Friedrich Hayek owes the Swedish School as much as he does the Austrian School on his ideas about money and capital. In fact, he borrows the distinction between natural and market interest rates from Knut Wicksell. The early writings of F.A. Hayek state that disequilibrium and crisis are caused by a market interest rate that is below the natural interest rate. There is no necessity of a Central Bank to arrive at such a situation: the credit creation of the banking system or a sudden change of the expectancies of the public could set the market interest rate well below the natural interest rate and, thus, lead to what Hayek and Nicholas Kaldor called “the Concertina Effect.”

At this point we must formulate a disclaimer: Friedrich Hayek’s theory of money and capital was so controversial and subject to so many regrets by his early supporters – like said Kaldor, Ronald Coase, or Lionel Robbins – that we can hardly carry on without reaching a previous theoretical settlement over the apportations of his works. Until then, the readings on Hayek’s economics will have mostly a heuristic and inspirational value. They will be an starting point from where to spring new insights, but hardly a single conclusive statement. Hayekian economics is a whole realm to be conquered, but precisely, the most of this quest still remains undone.

For example, if we assume – as it does the said post – that ultra-loose monetary policy enlarges inequality and engenders political instability, then we are bound to find a monetary policy that delivers, or at least does not avoid, an optimal level of inequality. As it is explained in the linked lecture, the definition of such a concept might differ whether it depends on an economic or a political or a moral perspective.

Here is where I think the works of F.A. Hayek have still so much to give to our inquiries: the matter is not where to place an optimal level of inequality, but to discover the conditions under which a certain level of inequality appears to us as legitimate, or at least tolerable. This is not a subject about quantities, but about qualities. Our mission is to discover the mechanism by which the notions of fairness, justice, or even order are formed in our beliefs.

Perhaps that is the deep meaning of the order or equilibrium that it is reach when, to use the terminology of Wicksell and Hayek’s early writings, both natural and market interest rates are the same: a state of affairs in which the most of the expectancies of the agents could prove correct. The solution does not depend upon a particular public policy, but on providing an abstract institutional structure in which each individual decision could profit the most from the spontaneous order of human interaction.