William Easterly

Romance Econometrics

Derrill Watson Culture, Economics , , , , , , ,

I had a mentor at BYU, Prof. James McDonald, who tried to convince us that

  • Econometrics is Fun.
  • Econometrics is Easy.
  • Econometrics is Your Friend.

One of his classes made a bronze plaque out of it for him. He also tried to convince us that Economics is Romantic because this one guy took a girl to his class on a date and she married him anyway. Because he was one of the economists I’ve tried to model my life after, I’ve always been on the lookout for ways to convince people that econometrics is, in fact, fun, friendly, easy, and romantic.

A while back, Bill Easterly blogged about how marriage search is like development, and in the process talking about how unromantic economists can be:

I recently helped one of my single male graduate students in his search for a spouse.

First, I suggested he conduct a randomized controlled trial of potential mates to identify the one with the best benefit/cost ratio. Unfortunately, all the women randomly selected for the study refused assignment to either the treatment or control groups, using language that does not usually enter academic discourse.

With the “gold standard” methods unavailable, I next recommended an econometric regression approach. He looked for data on a large sample of married women on various inputs (intelligence, beauty, education, family background, did they take a bath every day), as well as on output: marital happiness. Then he ran an econometric regression of output on inputs. Finally, he gathered data on available single women on all the characteristics in the econometric study. He made an out-of-sample prediction of predicted marital happiness. He visited the lucky woman who had the best predicted value in the entire singles sample, explained to her how he calculated her nuptial fitness, and suggested they get married. She called the police.

He goes on from there to describe how he eventually did find a mate and makes a comparison with development and over-reliance on econometric methods. As popular as it is in Libertarian circles to bash on econometrics, I’d like to defend empirics by pointing out that his regression advice was not sound:

1 – The suitor’s regressions ignored the self-selection bias. Regressions only tell us what the ‘average’ effects are, that is the effect for the ‘average’ person. Making the average guy happy is only relevant if he is the average guy. Economists being the strange lot we are, it is likely that it takes a special kind of person to marry one of us. He ought to have found a bunch of guys very similar to himself and examine the qualities that made a difference from among (and this is key) the population of women willing to marry guys like him – the women who self-select themselves into our group. If he then approached a women who was not in that group, no wonder he was rejected! I knew I had my work cut out for me since I was in junior high: a Latter-day Saint economist-in-embryo who read Shakespeare “in the original Klingon”, and who carried a briefcase to school? Small sample sizes indeed!

2 – He ignored endogeneity. Instead of trying to convince her that research showed she would make him happy, he needed to present research that demonstrated he would make her happy, and that’s the other half of the regression: male qualities on marital happiness. No wonder she rejected him: his regressions didn’t answer her question!

Personally, I took more of a Bayesian approach. Bayesians believe that a lot of things in life (like regression coefficients) are random and over time we get better and better signals about where the truth is, but we only ever approach it by degrees. First, by trying to become a friend, I identified if a woman was in the group of people who might marry someone like me. Each interaction gave me more information about the error term and the regression coefficients about fostering a happy, loving friendship that could endure. After any failed relationship, I had a new variable or two to add to my equations and I understood the ‘relationships’ between relationship variables better. That might be about finding out different things I needed (hunh, so her political affiliation isn’t as important as I thought and her willingness to smile at me is vital) or about learning more and better policies over time that I could enact to make her happier (tips for being a better listener or learn to identify her love languages and feed them to her regularly).

One of the most important regression-related romance tips I learned was to control the variables I could control, and leave the residual in God’s hands. I recall a graduate labor economics research seminar where the presenter claimed that the marriage market always cleared. I complained that I was willing to supply a great deal more marriage than had ever been demanded at prevailing prices. I was reassured that the marriage market clears in equilibrium, and I might not have found my equilibrium yet. The presenter’s prediction was, thankfully, prescient: I found a buyer a year later, and last week we celebrated 5250 days of married bliss.

Institutions, Machines, and Complex Orders (Part 4); Malthus and Darwin: population analysis and evolution

Federico Sosa Valle Culture, Law , , , , , , , ,

The institutional evolutionism has a history before Darwin, parallel to it and even later divergent. In parallel, Darwin for the elaboration of his concept of natural selection took from the political economy the notion of population analysis by Robert Malthus, the one that also comes from the analysis of the institutions as a framework of incentives. At the time Malthus sought to refute the anarchist philosopher William Godwin, who proposed abolishing marriage as a social institution. Mindful that the extra-marital children lacked at that time fewer rights than those born in marriage, Malthus replied that such a measure would lead to an exponential growth of the population and, therefore, marriage as an institution fulfilled the containment function of population growth. A similar analysis makes Malthus of the laws of poor: aid to the poor increases the cost of food, which generates more poor, assuming the dynamics of a vicious circle. The judgments of Malthus have an empirical character that makes them susceptible of refutation, it can be verified if Malthus was right or wrong. However, what has an abstract, methodological, propaedeutic character is its population analysis. That is what Darwin took to conceive natural selection processes and that today can be used in the analysis of institutional evolution.

When one speaks of a political, economic, or social institution displacing another, such movement becomes effective at the level of the populations. For example, literacy and accounting applied to business administration generates a leap in efficiency in the administration and auditing of businesses. It is not surprising that literate traders who carry inventory and accounting processes displace illiterate traders. This is how literacy and accounting can be extended without any central political decision, nor any disruptive phenomenon. (Of course, the modern state, in its process of rationalization, can impose the obligatory nature of certain principles of accounting or schooling, but not necessarily depend on it.)

To a large extent, the arrival of European immigration to South America in the second half of the 19th century consisted in the importation of habits, practices and techniques that immigrants already incorporated. It is widely known the arrival of new techniques of field work and breeding and care of livestock. Also many immigrants who arrived implemented inventory practices and cash management that were leaking into the rest of the population.

William Easterly characterizes this phenomenon as a leaking of knowledge. Following the example of the previous paragraph: those immigrants were more competitive because they brought with them new techniques of rationalization of time, they took inventories and accounted for income and expenditure of funds methodically. This advantage translated into prosperity and expansion of their businesses. However, in order to implement this type of “technology” they must necessarily share it with their collaborators. There is in these collaborators an incorporation of human capital through what Gary Becker called “on-the-job training”: a learning of how to work at a general level (to arrive at schedule, to concentrate on the task, to meet deadlines) and also at a particular level (particular techniques of sowing, raising livestock, managing a certain inventory system). Human capital is a set of habits and practices that “travels” incorporated in each “apprentice”. In this way, the entrepreneur can finance himself by paying part of the compensation to the dependent in kind: the training. On the other hand, there is the phenomenon characterized by Easterly as “leakage of knowledge”. This knowledge is transmitted, migrated, from person to person. To the extent that it reports a greater utility to its “bearer” it is expanding, extending, throughout the social fabric, often not as a deliberate education, but as an unintended consequence of the use of such knowledge, which, for can be put into practice, needs the help of more than one person.

It is in this sense that what evolve are the practices and habits, in this case of work and business. It is extended by its incorporation by individuals who adopt them, often involuntarily, either through the incorporation of guidelines from their place of work, or through imitation or emulation. Following the terminology of evolutionism, practices and habits are the unit of evolution and the people who incorporate their replicators. A practice or habit is more successful to the extent that it extends into the population. In turn, the populations carrying practices and habits more adapted to the environment will extend them to others.

[Editor’s note: You can find Part 3 of this essay here, and you find the full essay here.]

Institutions, Machines, and Complex Orders (Part 3): Evolutionary drift

Federico Sosa Valle Culture, Law , , , , , , , , ,

The affirmation that one should not judge the historical past with current values ​​forms a topic as widespread as the disobedience to it. However, a conscious exercise of the evaluative critique of the past allows us to identify continuities and disruptions in institutional patterns, i.e., in systems of incentives that are considered legitimate, whether by virtue of a question of social utility or principles.

Caste systems are obvious examples in which a differentiated attribution of rights, that is to say the legal protection of the interests of individuals assigned to a certain ethnic group, was interpreted as legitimate because it was a matter of principle.

While a caste is defined by an ethnic component, or at least with respect to its physiognomic marker, in the status system the ethnic differences lose preponderance, to transfer it to the different private orders or privileges that determine a function within the society. In both cases, both in the system of castes and status, it should be noted that they not only define privileges for its members but mainly establish obligations: war, worship or field work, for example. While the cult is reserved for a certain caste, in the status societies the cult is an institutionalized function, an order, whose members fulfilled certain procedures of admission and permanence.

In any case, beyond the similarities and differences in the systems of castes and status, what matters in this case is to emphasize that such attributions of rights and obligations, that is, of legal protection of interests, collective or particular, do not respond to a question of social utility but of principles. In the first place, because in such societies the power is fragmented and therefore there is no central power that can perform a critical judgment on the social utility of a given system of incentives; at the most, if there is a king, he assumes a role of primus inter pares, an arbitrator between castes or statuses or protector of order.

The emergence of central governments demanded the emergence of stable bureaucracies supported by a tax system to be systematized in a public accounting, that is, a calculation of utility. On the other hand, the incorporation of abstract procedures from private law to the administration of the government, displacing the systems of sages, mandarins, humanists, etc., allowed a better centralization and control and rational administrative decisions. However, what is important to note here is that such institutional innovations did not necessarily depend on a disruptive change, such as a revolution, but that many cases occurred through an evolutionary process, in which more efficient institutions displaced obsolete ones.

The emergence of central governments replaced fragmented political and social systems, because centralization allows a calculation of utility in decision making, which yields better results -not always but most of the time- than a decision system based mainly on honour. Most of the time but not always, since there is the possibility that, in a situation of extreme complexity, the calculation of utility has a wide margin of error and, in contrast, in such situations, a pattern of decisions based on emotions, traditions, or moral principles work as a kind of heuristic better adapted to the circumstances. After all, for the calculation of utility to be viable, it must have tools such as an accounting system, a literate bureaucracy, an abstract procedural system, among others. If you do not have such means, hardly a decision based on utilitarian issues is far from whimsical and arbitrary. Faced with such cases, traditional structures could be more efficient.

Another issue to consider is not to be confused between the rationalization of political power in a central administration – public budgets and control of their execution, a neutral and efficient tax system, administrative decisions of a particular nature adopted according to abstract and general procedures – with the rationalization of each subsystem of society and even of the individual in particular.

It is true that, as indicated by Max Weber, the bureaucratization of political power leads to the gradual bureaucratization of the rest of society: the generalization of the same accounting system for all companies, in order to verify compliance with tax obligations, the public instruction of the whole population, to name a few examples. These processes of rationalization are extremely beneficial and generate a jump in productivity. This is what William Easterly, in his work The Quest for Economic Growth, highlights as a phenomenon in which knowledge leaks and spreads throughout society. In this way the relations of complementarity generated by the knowledge shared with the rest of the individuals that make up a given community are much more important than the substitution effect could give an advantage to a single possessor of such knowledge. For example, having knowledge of accounting represents an advantage over the competition, but that all companies are organized according to reasonable and homogeneous accounting principles allows a jump in productivity throughout the system that yields even greater individual profits. Likewise, not only the leaking of knowledge is beneficial for all members of society, but reached a point is inevitable.

However, this does not mean that a rationalization of the society as a whole and of the individuals that compose it is necessarily possible or desirable; much less that such process is directed from a central political power. A process of compulsive and totalizing rationalization is not always modernizing. Both in biological and cultural terms, the evolution occurs in the margins, it is the mutations of small isolated populations that allow them to adapt to changes in the environment.

Moreover, the totalizing political systems, which not only seek to define from a central power each one of the functions of the social subsystems in function of a supposed calculation of utility, also seek to build a notion of “citizenship” that stifles the sphere of autonomy that defines each individual with civic obligations. Such conceptions are the first to see the processes of innovation and creative destruction and any individual initiative as dangerous. Thus, by cutting off all possible adaptation to changes in circumstances, by mutilating all possible discoveries, it is not uncommon for such political systems to experience stagnation and be displaced by other systems more open to innovation – or at least be invaded by results of said competition, discovery and innovation processes.

[Editor’s note: Here is Part 2; Here is the full essay.]

Institutions, Machines, and Complex Orders (Part 1): Introduction

Federico Sosa Valle Culture, Law , , , , , ,

Countries can change their course, they can turn from stagnation towards growth, as it is the case of South Korea in the last fifty years. They can also decline after a boom period. Together with other examples of successes and failures, these are indications that economic performance does not depend on geography, culture, or the education of ruling elites. Following the line expressed by other authors such as Douglass C. North (Institutions, Institutional Change and Economic Performance, 1990), William Easterly (The Elusive Quest for Growth, 2001) and Daron Acemoglu and James A. Robinson (Why Nations Fail, 2012), it is appropriate to maintain that the economic performance of nations, expressed in their growth, depends on the incentives provided to individuals by institutional frameworks. The incentive systems -that is, the institutions- evolve, and with them the fate of the countries. But to achieve such evolution, there must first be a change in the level of commonly accepted notions about what is right and what is wrong for governments to put into practice. That is, what are the principles that should inform the legislative policy that puts into effect such institutional frameworks to order the expectations of society.

[Editor’s note: This is the first part of a new series. You can find the full essay here.]

Three Lessons on Institutions and Incentives (Part 8): Conclusion

Federico Sosa Valle Economics, Law , , , , , , , , ,

Far from the custom of assigning to cultural factors, or educational, or geographic or relative to the particular constitution of the ruling elites, the three works reviewed – Institutions, Institutional Change and Economic Performance, by Douglass C. North; The Elusive Quest for Growth, by William Easterly and Why Nations Fail, by Daron Acemoglu & James A. Robinson, state an explanation of the progress and decline of nations articulated on abstract incentives, which serve as a structure in which frame the rational agent makes his choices. The four authors have a common reference to methodological individualism, but such an individual agent does not make decisions in a vacuum, but inserted within a framework of incentives.

That such incentives, to act as points of reference for individual action, should materialize historically, does not mean that such conditions for action come from a particular circumstance of time and place, but that they depend on an abstract structure that relates to different terms and that is present in every phenomenon of human interaction.

To finish, it is worth referring to the conclusions reached by North in his referenced work: the case of the two successive Spanish Americas, the Habsburg and the Bourbons. The first extended from the discovery and colonization of America to the early eighteenth century. The viceroyalties of America enjoyed great political autonomy – Spanish immigration had been little and a “Creole” elite had developed – and they were closed to trade, which was limited to the “export” of gold to Spain. With the arrival of the Bourbons at the beginning of the 18th century and the implementation of their Reforms – which from the economic point of view were a resounding success both in Spain and in America – the relationship was reversed: political power passed into the hands of the “Peninsular Spaniards” and an opening of a more fluid trade between the metropolis and its colonies was launched. North explains that the independence movements could be successful due to a transitory alliance between the sectors that wanted to return to the Habsburg system and those who wanted to deepen the modernizing and free-market impulse of the Bourbons. Once achieved independence, these two currents came into conflict, which, according to the author, would extend until today.

According to North’s thesis on Spanish America, there would be two political patterns in tension: on the one hand, an elitist politician who is open to the economy and on the other a “popular” current that is traditionally protectionist. In the second half of the 19th century, success belonged to the “Bourbon pattern” and, in the 20th Century, the “Habsburg pattern” prevailed. In terms of Acemoglu & Robinson, it would be the dispute between a combination of extractive political institutions with inclusive economic institutions and another combination of inclusive political institutions with extractive economic institutions. Of course, in practice, moments of extractive political and economic institutions were also known, as well as short-lived experiences of inclusive institutions, both politically and economically.

The notion of polarized societies used by Easterly can serve as a way to deepen this analysis. It is much clearer to find problems of countries with societies divided into distant and dissimilar regions, in which the policy is expressly articulated as a function of tribes or ethnic groups and which the dispute over public policies expressly favors or harms a another ethnic group. However, as it has been stated, it is not ethnicity or nationality that determines the low economic and institutional performance of a country, but the polarization structure itself, whatever the functions in which such polarization is expressed (language, religion, ethnicity, ideology, etc.). Understanding these latter is fundamental to be able to provide a common thread for a principle of solution.

Just as on the political level an express agreement can be reached on the way to choose who exercises public power and under what conditions, Easterly states a series of conditions related to economic institutions whose agreement would allow for economic growth, regardless of the region, culture, or education of the ruling class of each country. Throughout The Elusive Quest for Growth you can find mentioned to free trade as a main factor of progress, monetary stability and exchange freedom as examples of clear and equitable rules, a state that participates in large infrastructure works but that refrain from arbitrating in the distribution of economic rents among various groups, a low level of public indebtedness, stability in property rights and an independent justice that allows individuals to innovate and save, as well as support programs and incentives to members of society who are immersed in poverty traps.

As mentioned, many times the policy -especially when, in the terms of Acemoglu & Robinson, it is inclusive- consists of the composition of interests of various kinds for the purpose of articulating a government program. From the work of the authors commented here, it can be inferred that, just as there is an agreement on the political plane regarding the rules of the democratic game, which include periodic elections, limited re-elections and division of powers, among others, there should also be a consensus in a body of economic institutions that should be left out of political negotiation, so that economic policy is as neutral as possible against the conflicting interests of which a country with a polarized society is composed.

[Editor’s note: Here is Part 7, and here is the entire, Longform Essay.]

Three Lessons on Institutions and Incentives (Part 7): Breaking the mold

Federico Sosa Valle Economics , , , , , , , , , , ,

This role of entrepreneurs also depends on an abstract characteristic of technological knowledge: it works in a manner contrary to that of most goods, since it is more productive to the extent that it is more widespread in the population. This characteristic of the abstract nature of technological knowledge is related to the phenomenon of the combination of skills (matching of skills): the negative side of creative destruction lies in substitution phenomena (a computer program of inventory management increases the productivity of work saving the salaries of the army of employees who used to carry them with pencil and paper), but the positive side comes from the phenomena of complementarity.

As William Easterly exemplifies, the cardiac surgeon will be more productive in a first world hospital, where he will have specialized nurses, other qualified doctors like him, a sophisticated system of hospital administration, and so on, being the only cardiac surgeon in a hospital. city ​​of the third world, where it does not have professionalized nurses, nor the help of other medical colleagues, working in a hospital in which he himself has to deal with administrative issues. If there were only substitution relations, it would be convenient for a doctor to practice his profession in the most remote place possible. However, as relations of complementarity of knowledge exponentially increase the productivity of the professionals involved, the doctor will find it more convenient to practice in a health center that has the largest number of doctors and paramedics possible.

The latter does lead to the phenomenon of “traps”: any rational agent, who maximizes the utility of their choices will be discouraged to deepen their studies if they perceive that they can not give any use to their education. There are the cases in which a person discovers that in his country there is no technology or the necessary number of professionals to develop a specific activity, or that, existing, you will find prohibited the exercise of their profession based on restrictions regarding their race, caste, social class, sex, etc. Since, rationally, a person who is included in a particular group under which he will be found forbidden or will be hindered the exercise of his profession, he will find as the most rational of their alternatives to abandon their studies, so that their chances of progress will no longer be limited only by legal or social barriers, but because of their lack of suitability for high-paying functions. Such are the so-called “poverty traps.”

There are also wealth traps. There are those cases in which the individual knows that he is within a favored group or in which he knows a large number of professionals and, therefore, invests time and money in his education because he knows that he has high chances of success, which will then be confirmed. Obviously, such phenomena of divergence generates another problem, addressed both by Easterly and by Daron Acemoglu & James Robinson, which is that of polarized societies.

Easterly affirms that it is the exchange of goods and services, through the mutual benefits that they report to the parties that participate in it, the main source of wealth generation. Where individuals are allowed to exchange, in a stable institutional framework with a stable currency, is where prosperity flourishes. However, Easterly recognizes that bad luck can devastate nations, as are the cases of geological and climatic phenomena such as earthquakes, tsunamis or mudslides, as well as recognizing that the situations of individuals involved in a poverty trap can only be resolved through an active public policy that not only provides education, but also establishes the conditions so that the recipients of that educational system can count on certain expectations that they will be able to apply that knowledge acquired through education and that, consequently, it is reasonable to study.

Just as the bad star can affect the economic performance of the countries, so can a favorable conjuncture, such as the case of a transitory improvement in terms of exchange of a given country. But this favorable circumstance can become a counter-march. Easterly explains that, for a simple statistical matter, it is very difficult for both a nation and an individual to always remain on the crest of the wave, over the years everything tends to return to the average. The problem occurs when a country -or a person, too- got used to a certain level of spending in the boom years and intends to maintain it through debt or emisionism. We come to the cases in which, according to Easterly, the government can “kill the growth.” Public debt and inflation generate capital consumption and, consequently, poverty.

Another way that governments have to discourage growth is through corruption. Not only because it means a transfer of resources from productive activities to unproductive activities, but because it also means a bad signal for citizens. However, in cases of corruption, as noted above, wealth at least changes hands. There is another case, even more pernicious, in which the government’s actions, whether motivated by corruption or inspired by good intentions, destroy wealth, without even redistributing it: this is the case of inconsistent public policies derived from highly polarized societies.

Public policies that aim to favor a given industry, but at the same time need to agree on measures with other sectors of the economy, whose purpose is to compensate for the losses generated by those policies, can lead to a tangle of inconsistent regulations that, instead of transfer riches from one sector to another, directly destroy them. For example: exchange controls harm the export sector, since they generate black markets. The exporters will have costs that will be partly quoted according to the black market prices (which are higher) and they will have to liquidate the value of their exports at the official exchange rate, which will be lower. Regulations of this kind may not involve acts of corruption, but they do destroy wealth, which there is no way to recover.

Easterly lists numerous examples of everything that needs to be done to destroy growth. However, there is something that deserves to be especially highlighted: the progress or stagnation of nations does not depend on educational, cultural or geographic factors, but rather on the incentive framework that predominates. This incentive framework will always be abstract, that is, it can be applied at any time and place.

[Editor’s note: Here is Part 6, and here is the entire, Longform Essay.]

Three Lessons on Institutions and Incentives (Part 6): Breaking the mold

Federico Sosa Valle Economics, Law , , , , , , , , , ,

Daron Acemoglu & James Robinson acknowledge that the weakest point of their theory consists of recommendations to “break the mold.” How to change the historical matrix that leaves the nations stagnant in extractive political and economic institutions, or that move them back from having inclusive economic institutions with extractive political institutions to being trapped in exclusively extractive institutions with the risk of falling into a failed state. This brings us to Douglass C. North and his theory of institutional change.

Although he published works before and after Institutions, Institutional Change and Economic Performance, this book can be taken as the archetypal expression of neo-institutionalism. In the United States, institutionalism, whose main speaker was the Swedish immigrant Thorstein Veblen, was the local expression of what in Europe was known as “historicism”: a romantic current, inspired by Hegelian idealism, which denied the universal validity of institutional rules and claimed the particularism of the historical experience of each nation. American historicism was called institutionalism, because it concentrated the sciences of the spirit in the empirical study of the institutions given in the United States.

On the contrary, North’s school is called “neo-institutionalist” because it does exactly the opposite: it studies the phenomenon of institutions from a behavioral point of view and, therefore, universal. As already noted here, for North institutions are limiting the choice of the rational agent in his context of political, economic and social interaction. These limitations are abstract; that is, they are not physical, like the law of gravity, nor do they depend on a specific and specific order of authority. Examples of these abstract limitations can be found in social customs and uses, in moral rules, in legal norms insofar as they are enunciated in general and abstract terms.

Attentive to such diversity, Douglass C. North groups institutions in formal and informal. Within the formal institutions we find, unquestionably, the positive law, in which its rules of formation and transformation of the statements that articulate them can be identified very clearly. In a modern democracy, laws are sanctioned by the legislative body of the State. Meanwhile, the rules of formation and transformation of statements concerning morality are more diffuse – previously, Carlos Alchourrón and Eugenio Buligyn, in Normative Systems, had used this distinction to support the application of deontic logic to law, since deontic statements of law are much more easily identifiable than those of morality.

On the other hand, North distinguishes two types of institutional change: the disruptive and the incremental. An example of disruptive institutional change can be a revolution, but it can also be a legislative reform. The sanction of a new Civil Code, entirely new, can mean a disruptive change, while partial reforms, which incorporate judicial interpretative criteria or praetorian creations, can be examples of incremental changes.

Institutional changes do not necessarily have to come from their source of creation or validity. Scientific discoveries, advances in transport and telecommunications, information technologies, are some of the innovations that can make certain institutions obsolete or generate a new role or interpretation for it, depending on the open texture of the language.

Therefore, following the tradition of Bernard Mandeville and Adam Ferguson, neo-institutionalism admits that there are unintended consequences in the field of institutional change. Not only the incremental change of institutions, be they formal or informal, depends largely on changes in the cultural and physical environment in which institutions are deployed. Also the disruptive and deliberate change of a formal institution can generate unforeseen consequences, since it is articulated on a background of more abstract informal institutions.

Both Acemoglu & Robinson and North acknowledge that there is no universal law of history that determines institutional change -i.e., they deny historicism, as Karl R. Popper had defined it at the time-; what we have, on the other hand, is an “evolutionary drift,” a blind transformation of institutions. In this transformation, political will and environmental conditions interact. The latter not only limit the range of options for the exercise of “institutional engineering,” but also introduce an element of uncertainty in the outcome of such institutional policies, the aforementioned unintended consequences.

Much more complex is to identify which components are included in that black box that is called “environment” (environment). In principle, there could reappear the creatures that both William Easterly and Acemoglu & Robinson had banished from their explanations: the geography, culture and education of the ruling elites; more sophisticated elements such as the one referred to in the previous paragraph could also be incorporated: technological change. However, the discoveries of science would have no impact if the institutional framework pursued “creative destruction”, seeking to protect already installed activities from competition, or a lifestyle threatened by technological innovation.

We arrive here at a seemingly paradoxical situation: the institutions’ environment is the institutions. Using the Douglass North classifications system, one could try as a solution to this paradox the assertion that formal institutions operate on the background of informal institutions, which escape political will, and that disruptive institutional changes occur in a context of other institutions that are transformed in an incremental way. From this solution to reintroduce culture as a factor of ultimate explanation of institutional change, only one step remains.

At the other extreme, following the typologies used by Acemoglu & Robinson, the institutions can be political or economic and these in turn can be extractive or inclusive, jointly or alternatively. Inclusive economic institutions within a framework of extractive political institutions can result in a limitation of creative destruction and, consequently, produce a regression to extractive economic institutions. In the institutional dynamics of Acemoglu & Robinson, history can both progress and regress: from economic institutions and extractive policies it can be involuted even to situations of failed state and civil war. To reach the end of history, with inclusive institutions, seems to depend on the conjugation of a series of favorable variables, among which is the political will; while to fall back into chaos and civil war it is enough to let go. Without looking for it, the conceptual background of Why Nations Fail rehabilitates the thesis of Carl Schmitt insofar as it presupposes that in the background of human interaction there is no cooperation but conflict.

For his part, William Easterly in The Elusive Quest for Growth does not ask these questions, but simply works under a hypothesis that already has it answered: whenever there is human interaction, there will be a framework of incentives and such a framework of incentives will have certain universal characteristics. Douglass C. North’s central concern in Institutions, Institutional Change, and Economic Performance, as well as that of Acemoglu & Robinson in Why Nations Fail, was to establish patterns of events and conditions that made some nations be prosperous while others could not emerge from stagnation. That is, they are works that must necessarily be about the differences between one country and another and, therefore, emphasize the different conditions. Notwithstanding that both North and Acemoglu & Robinson expressly shun culturalist explanations, but instead postulate abstract models and typologies of institutions and institutional change to be applied universally, when the moment of exemplification arrives, they must necessarily resort to the differences between countries and regions. While it is true that both books resort to the description of the problems of the southern United States when illustrating how certain institutions generate results similar to those of third world countries, the culturalist explanation is always available.

In contrast, William Easterly in his The Elusive Quest for Growth: Economists’ Adventures and Misadventures in the Tropics focuses almost exclusively on countries with low economic performance and only tangentially refers to cases of high performance. Therefore, in his work, the empirical analytical tools used to dissect it are well separated. To do this, Easterly will not only use a utility-maximizing rational agent model, but will also enunciate abstract models of universally valid human interaction.

In the first part of the work, Easterly describes the failed panaceas of growth: direct aid, investment, education, population control, loans to make adjustments and subsequent debt forgiveness. Affirms that such policies invariably failed because they did not take into account the basic principle of the economy that indicates that people respond to incentives (people respond to incentives, a statement that is repeated as a mantra throughout the book). While acknowledging that in some cases of extreme poverty and bad luck it is necessary for governments to take direct action to help people escape from poverty traps, the author proposes as the main means for people to take a path of prosperity: work to establish the right incentives. It clarifies, however, that this should not be a new panacea but a principle to be implemented little by little, displacing the layers of vested interests impregnated with the wrong incentives and allowing the entrance of the right incentives.

These incentives, right or wrong, do not depend on the culture, nor on the education of the elites, nor on geography. On the contrary, they consist of abstract models of human interaction, which can materialize at any time or latitude. Since the main interest of The Elusive Quest for Growth is, precisely, growth, such models concern this matter, but nothing prevents future research from identifying other abstract patterns of behavior that allow us to infer incentives to address other issues, such as crime, equity, violence, etc.

Some incentive structures that Easterly describes in relation to the problem of growth are the following: conditions for increasing returns – instead of decreasing ones – that come from technological innovation, which in turn depend on phenomena identified as “leakage of technological knowledge” (leaks of technological knowledge), “combination of skills” (matches of skills) and traps (traps) of poverty -although there are also wealth traps.

Technological knowledge has the capacity to filter into a population because it is mainly abstract. It can be exemplified in an accounting system, the practice of carrying inventories, literacy, techniques and procedures for the production, distribution and sale of products, etc. If the technological knowledge consisted exclusively of physical machinery, then yes it would be to a point where yields would become decreasing. On the contrary, understanding technological knowledge as consisting of “abstract machines”, it acquires the characteristics of a public good: it is not consumed with its use nor can it be exclusive. This is how technological knowledge can be extended in a society, multiplying the productivity of its members without entering into diminishing returns.

Also, following the ideas of the recent Nobel Prize in Economics Paul Romer, Easterly highlights that technological change can generate increasing returns thanks to the work of an endogenous agent of the economy, the entrepreneur. Being the labor force a fixed factor of production with respect to machinery, it is expected that, at a certain point, capital will generate diminishing returns, thus conditioning the growth rate of an economy (the main concern of The Elusive Quest for Growth). For its part, the entrepreneur is not only that agent of the economy who discovers new business, he also discovers new uses for existing capital goods. Easterly does not mention it, but this is also the main conclusion reached by Ludwig Lachmann in his work Capital and Its Structure. This work of the entrepreneurs, to find a new utility for a set of capital goods that had come to generate diminishing returns, making them continue to generate increasing returns is what frees the rate of growth of the economy from the limits of technological change and, in turn, makes it depend on the endogenous factor of the economy: the incentives for entrepreneurs to develop their activity -which some call creative destruction.

[Editor’s note: Here is Part 5 and here is the entire, Longform Essay.]

Three Lessons on Institutions and Incentives (Part 4): Institutions and the Rule of Law

Federico Sosa Valle Economics, Law , , , , , , , , , ,

Daron Acemoglu & James Robinson call the set of regulations that obstruct innovation “extractive institutions.” Of course, here again, extractive institutions are less harmful than the total absence of institutions. Not every change in the status quo can be interpreted as “creative destruction” or “entrepreneurship.” As Friedrich Hayek pointed out in Law, Legislation and Freedom, so that the most mutually compatible plans can be carried out, it is necessary that a well-defined set of expectations be systematically frustrated: the usurpations, the frauds, collusions, the paramilitary bands, etc., etc. The main thing is to have institutions that guarantee a minimum of order. Now, many times the institutions manage to be put into effect as a result of having the consensus of a certain number of interests that see in the law an opportunity to extract benefits. It is the distinction between Acemoglu & Robinson between the already mentioned “extractive institutions” and “inclusive institutions.” The latter are constituted by that set of rules that formally are equal for all and that materially protect private property, the value of money, competition understood as freedom of entry to markets, among other values ​​of modern capitalism.

The distinction between extractive and inclusive institutions can find its parallelism in the expressions of “Rule by Law” and “Rule of Law.” The first consists on the accommodation of general and abstract normative statements with a second intention: to benefit a group at the expense of society as a whole. It is common to hear the criticism that the law has a false neutrality and that therefore any defense of the “Rule of Law” must be ideological (in the Marxist sense of the term). However, what distinguishes the concept of “Rule of Law” from “Rule by Law” is that, for the first of the terms, the consequences are unlikely to be predicted in terms of their particular and even more individual, while the second has an intentionality, declared or hidden.

To give an example, the procedural due process has such a degree of abstraction that it can hardly be predicted who will benefit from those proceedings. However, a law that prohibits the importation of a product of domestic manufacture clearly aims to redistribute resources from consumers to the local producers (although this type of regulation usually also generates consequences that are very difficult to foresee and often contrary to its original intentional).

Critics of the Rule of Law state that it is not neutral, because it protects exclusively the interests of the proprietors. However, such criticism loses sight of the fact that in the Modernity, any inhabitant, even those who are not citizens, can have access to the right to property, regardless of whether or not they belong to a certain caste, class, or social class. This, unlike the legal and political systems of the so-called Ancien Régime, which limited access to private property in perpetuity and irrevocably to a certain group of people, or even more, to a certain clan or group of families. It does not matter if, in Modernity, a person does not own any particular good, as long as he can count on the expectation of being able to become one at some time. In this sense, private property understood in the modern sense as that right that any inhabitant can enjoy from having stability in their possessions to the point of only being stripped of it by their own consent or by following the procedural due process.

This unlike laws protecting infant industries, professions or trades, or promotion of certain activities that are deemed as socially necessary or valuable, which establish a regime of transfers of resources from one sector of society to another. As the School of Public Choice indicates, such laws encourage “lobbying” and reduce the efficiency in the allocation of resources. In such institutional arrangements, individuals and businesses do not prosper through the discipline of serving the consumer, but through political agreements. Economic agents continue to maximize, but at the expense of regulations that deliberately establish certain winners (the owners of protected activities) and certain losers (consumers and potential producers who are denied access to protected activities). Under these circumstances, the citizenry begins to perceive an arbitrary sense in the norms and have no moral issues with challenging them (any contraband, without commercial purposes, is a clear example of this). Obviously, when non-compliance with standards becomes so extensive, regulations become ineffective. Moreover, as James M. Buchanan put it in his brief essay “A policy in the interests of producers,” the stagnation generated by protectionism means that the winners of such a system – the protected producers – turn out to be less rich than they would be in an open and competitive institutional framework.

Sometimes protectionism seeks its foundation in a mistaken theory of “original accumulation.” (Joseph Schumpeter ruled out the validity of such proposals by pointing out that, although those could have had some basis until the 19th century, the development of capital markets made this theory completely obsolete.)

However, neither Douglass North, nor William Easterly, nor Acemoglu & Robinson, deal with the problem of original accumulation. They prefer to encompass such phenomena within the set of erroneous theories that serve to justify policies arising from political agreements in polarized societies. This means that a certain institutional arrangement, an economic growth policy, a stabilization program, a constitutional reform, foreign policy and so on, in a polarized society is not inspired by abstract and formal principles but in concrete goals that benefit certain sectors of society above others.

The examples of polarized societies, to which Easterly and Acemoglu & Robinson turn, come mostly from African countries since these are mostly created in the process of decolonization and comprise different ethnic groups and languages ​​within themselves, so polarization is much more evident: certain policies benefit a certain ethnic group over another. Easterly specifically cites the case of an African nation in which an ethnic group that represents 10% of the population lives in the region where a certain commodity is produced and whose export generates large revenues and, in the meantime, the government is elected, with some exceptions, by 90% of the remaining population, which imposes export rights on the said commodity, whose collection is destined to industrialization plans that systematically fail.

It is often tempting to explain the failure of such industrialization plans for the corruption evidenced in their execution. In fact, corruption cases are verified, but public policy would also fail even if those involved were incorruptible. Many times bad policies destroy much more wealth than political corruption. Corruption implies a transfer of resources and, therefore, an inefficient allocation of resources, while bad public policies result in the destruction of wealth.

However, examples of polarized societies in African countries can generate confusion around the main message of The Elusive Quest for Growth and Why Nations Fail. The economic performance of nations has nothing to do with geography, culture, or lack of preparation of the ruling elites to draw the plans of government. Easterly holds the main responsibility for the rise and fall of nations in incentives, while Acemoglu & Robinson point to the institutions that establish such incentive schemes. Regarding the opinion of Douglass C. North, although his line of research can lend itself to a “culturalist” interpretation, he himself recognizes the disruptive change of formal institutions as a determining factor of economic performance.

In summary, the three works discussed here have as a common denominator the role of incentives as a determinant of the economic performance of countries, above culture (which North would call “informal institutions”), geography, or the level of education of its elites. However, the case of polarized societies is presented as a critical point of such approaches.

José Luis de Imaz in Los que mandan (The ones who command) had defined politics as the activity consisting of articulating diverse interests according to a coherent plan of government. The definition of Imaz deserves to be put back into use, since it addresses the problem of polarization and also because its double edge allows to tie the loose ends left by the visions that we can group, with greater or lesser precision, under the “neo- institutionalist” (clearly the case of North, although it would be pending to discuss the label for Easterly and Acemoglu & Robinson).

Notwithstanding, that polarization is manifest in tribal or caste societies does not mean that it is not present in other societal forms. In the United States, the north and south; in Europe, the separatist movements; in Argentina, the interior and Buenos Aires. With greater or lesser intensity, manifestly or latently, politics is always structured on a space of tension of interests in competition for resources. Those who frequent the work of Carl Schmitt often claim that trade and law are “civilized” means for the exchange and dispute of such resources, politics and war are on the other side of the same question in terms of intensity of the conflict.

However, the term institutions – which define incentives – does not refer only to deliberate political agreements in pursuit of a specific purpose, such as a given public policy. The concept of institution also concerns a series of abstract and general principles whose final result at a particular level no one can foresee, because their level of abstraction imposes an insurmountable limit for the knowledge of its concrete consequences.

[Editor’s note: Here is Part 3; Here is the entire, Longform Essay]

Three Lessons on Institutions and Incentives (Part 1): Introduction

Federico Sosa Valle Books, History , , , , , , ,

There are books that are aimed at a spectrum of readers that are counted within the “well-informed public.” They are not books confined to academic circles, they are not for mass consumption, but they do concern problems that involve entire countries and are written in a register that involves certain intellectual training. In this genre, there are three works that have much to say about the relationship between institutions and incentives. The first of them dates from 1990 and was published by a Nobel Prize winner in Economics, Douglass C. North: Institutions, Institutional Change and Economic Performance, which elaborates the distinction between formal and informal institutions and incremental and disruptive institutional change, ending with a historical analysis that seeks to explain the differences in economic performance between the United States and Latin America. It is an academic book that can be approached by the said well-informed public.

Eleven years later, in 2001, William Easterly published The Elusive Quest for Growth: Economists’ Adventures and Misadventures in the Tropics. It is proposed as a political essay in which an economist interprets his own professional experience as a member of international teams for the development of Third World countries. To do this, drawing on the theoretical notions of other leading economists, such as Paul Romer (who later, in 2018, received the Nobel Prize in Economics), he makes an assessment on the development plans for the Third World that were implemented since the end of World War II. The central thesis of Easterly stresses that, in order to have an empirical relevance, every theory of development -or of the absence of it- must carry the following behavioral postulate: “people respond to incentives.” If this reality is not taken into account, there is no public policy that can be successful. The main lessons that can be drawn come from the theoretical instruments deployed to explain the political dynamics of most of these countries, particularly in regard to the phenomenon of polarized societies.

The third book to consider is also the more recent publication. Why Nations Fail, by Daron Acemoglu & James A. Robinson, was published in 2012 and reached the global debate on the realm of the well-informed public. The proportions achieved by the population of academics and professionals, in addition to the extension of the internet, allowed the aforementioned book to generate varied opinions along both traditional and digital media throughout the world. Acemoglu & Robinson dedicate their pages to those countries that were successful, as well as those that were not, but also here, in the case of this book, the most juicy lessons truly comes from the conceptual structure that articulates the whole book. Among such notions, we find those of inclusive and extractive institutions, which in turn are divided into political and economic institutions. The worst of the institutions are preferable to the total lack of institutions. Thus, a country organized around a closed political and economic system will be preferable to a failed state. However, once a certain degree of centralization and institutionality has been achieved, it is preferable to move towards a pluralist democracy and a competitive economy. The challenge is how to accomplish such transitions.

Since there are still four years left until the year 2023 – following the periodicity of the selected works – we are still in time to make a brief synthesis of the ideas that can be applied to the analysis of the impact of the institutions on economic and political incentives.

[Editor’s note: this is the first part of a rich series on institutions and incentives. You can find the full, Longform Essay here.]

A non-argument against immigration

Vincent Geloso Culture, Current Events , , , , ,

I often encounter the argument that immigrants, especially Muslims, are so different from the populations of their host countries that they threaten the institutional foundations of these societies. As a result, the logic goes, we must restrict immigration.

I do not accept that argument as valid nor do I accept it as sufficient (in the case I am wrong) to make the case in favor of further restrictions on immigration.

First of all, the “social distance” between immigrants and the hosts society is very subjective. The caricature below offers a glimpse into how “unsuited” were Catholic immigrants to the US in the eyes of 19th century American natives. Back then, Catholics were the papist hordes invading America and threatening the very foundations of US civilization. Somehow, that threat did not materialize (if it ever existed).  This means that many misconceptions will tend to circulate which are very far from the truth. One good example of these misconceptions is illustrated by William Easterly and Sanford Ikeda on the odds of a terrorist being a muslim and the odds of a muslim being a terrorist. Similar tales (especially given the propensity of Italian immigrants to be radical anarchists) were told about Catholics back then. So let’s just minimize the value of this argument regarding going to hell in a hand basket.

nast1

But let us ignore the point made above – just for the sake of argument. Is this a sufficient argument against more immigration? Not really. If the claim is that they hinder “our” institutions, then let them come but don’t let them participate in our institutions. For example, the right to vote could be restricted to individuals who are born in the host country or who have been in the country for more than X-number of years. In fact, restrictions on citizenship are frequent. In Switzerland, there are such restrictions related to “blood” or “length of stay”. I am not a fan of this compromise measure (elsewhere I have advocated the Gary Becker self-selection mechanism through pricing immigration as a compromise position).*

The point is that if you make the argument that immigrants are different than their host societies, you have not made the case against immigration, you have made the case for restrictions against civic participation.

* Another “solution” on this front is to impose user fees on the use of public services. For example, in my native country of Canada, provincial governments could modify the public healthcare insurance card to indicate that the person is an immigrant and must pay a X $ user fee for visiting the hospital. Same thing would apply for vehicle licencing or other policies. Now, I am not a fan of such measures as I believe that restrictions on citizenship (but offering legal status as residents) and curtailements of the welfare state are sufficient to deal with 99% of the “problem”. 

Another unintentional argument for Hayek’s spontaneous order

Brandon Christensen History , , , ,

The institutionalization of the Standestaat did not proceed smoothly. It was the result of almost continuous internal and interstate conflicts. Its ultimate beneficial results in strengthening the independence of towns and in providing a legal-constitutional basis for state power were neither anticipated nor necessarily desired by many of the participants in the conflicts, who would have preferred to gain absolute power. But benefits there were: Arbitrary government power was reduced; separation of powers between church and state were formalized; disruptive local feudal lords were controlled; highly specialized legal codes to regulate economic and fiscal exchanges were developed; and finally there began to emerge a loyalty to state structures which went beyond faithfulness to any particular king or ruling house. (186)

This is from sociologist Daniel Chirot’s 1985 article (pdf) “The Rise of the West” in the American Sociological Review. Hayek is not cited in the bibliography. I am reminded of this old tweet by economist Bill Easterly…

Optimism and Despair in a World of Injustice

Brandon Christensen Current Events, History , , , , , , , , , , , ,

The infamous development economist William Easterly recently tweeted that writing about spontaneous order without citing Friedrich Hayek is now “mainstream cool,” while writing about spontaneous order and citing Hayek makes one an ideological extremist. This biting critique of intellectual discourse, a mere 140 characters long, does more than just expose the drastic ideological shortcomings of the modern Left. It highlights the endlessly interesting obstinate ignorance that collectivists of all stripes have historically displayed toward the basic theoretical and moral insights advanced by libertarians.

In a recent Freeman essay by anthropologist Mike Reid, a pattern similar to the one noticed by Easterly emerges in the actions of central planners aiming to preserve the cultural heritage of a number of ethnic groups that have been deprived of their property rights by the very governments now looking to preserve their cultures for them. Reid takes examples from India and Canada and finds that the logic of preserving a specific culture does not hold up to scrutiny.

On the policies of the government of India, Reid writes: Continue reading →

Mali: Let It Collapse, Duh! Part 2

Brandon Christensen Current Events, Liberty, Links, Politics , , , , , , , , , , , , , , ,

I just came across an article in the New York Times via Bill Easterly, and it is very discouraging. The article is, of course, about the aspirations of Azawad, the breakaway region of Mali that just declared its independence. The article outlines the slim-to-none chances Azawad has of breaking free from the shackles of colonial legacy and African despotism:

“[…] there is little likelihood that anyone will defeat the Tuaregs on the battlefield anytime soon.

Still, they face slim odds of establishing a nation. Just ask Ahmed Abdi Habsade, a government minister in Africa’s other unrecognized state, Somaliland. ‘We have many problems,’ Mr. Habsade said in a telephone interview from Somaliland’s capital, Hargeysa. ‘The country cannot get donations from the U.N. or other governments. We are not having a budget to develop our country.’

Somaliland, which sits in the northwestern corner of Somalia, has been a de-facto independent nation for the better part of two decades, and an oasis of calm in the chaos that has swept up Somalia. Its claims to independence date from the colonial era, when it was a British protectorate while Somalia was controlled by Italy. The two states merged after independence, but the Somalilanders had almost immediate regrets, and have been trying to break free ever since.

Somaliland has had successes, including holding peaceful elections, yet it has struggled without an international stamp of Continue reading →