Tag Archives: institutions

Order and disorder

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I’ve been looking for the first time in some years at Douglass North’s short book [amazon_link id=”0691145954″ target=”_blank” ]Understanding the Process of Economic Change[/amazon_link]. North won his Nobel for the application of institutional economics to economic history, or in other words at the role played in the shaping of institutions and hence events by transactions costs and property rights.

This book is about how different societies arrive at their set of institutions. In particular, what enabled the historically rare success of the United States in the 20th century in establishing an orderly and thriving society, able to adapt even in the face of conflicts and technological change? And why has this kind of success been so rare in history, given that order seems clearly preferable to disorder?

[amazon_image id=”0691145954″ link=”true” target=”_blank” size=”medium” ]Understanding the Process of Economic Change (The Princeton Economic History of the Western World)[/amazon_image]

His answer lies in the beliefs members of a society hold, especially their beliefs in the legitimacy of their economic and political institutions. The book identifies four conditions for a society to produce order in the face of change. They are:

– citizens have rights that imply limits to the behaviour of officials and politicians;

– there is a constitutional framework that limits the decision-making power of the government;

– property and personal rights are well-defined and legally protected;

– the state credibly commits to upholding these rights, protecting citizens against expropriation by public officials.

This isn’t dissimilar to the conditions set out by Acemoglu and Robinson in [amazon_link id=”1846684307″ target=”_blank” ]Why Nations Fail[/amazon_link] for institutions to be ‘non-extractive’ – and indeed, their book cites North’s work quite extensively.

[amazon_image id=”1846684307″ link=”true” target=”_blank” size=”medium” ]Why Nations Fail: The Origins of Power, Prosperity and Poverty[/amazon_image]

Much of North’s focus here is on how to improve the institutional framework in developing economies, but his criteria are clearly more general. But he ends with a word about the United States: “All societies throughout history have eventually decayed and disappeared. … There is no guarantee that the [US’s] flexible, adaptively efficient institutional structure will persist in the ever more complex novel world we are creating.” I wouldn’t want to forecast anything, but it isn’t obvious at present that order has the upper hand over disorder.

Advice for madmen

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[amazon_link id=”0804780978″ target=”_blank” ]Madmen, Intellectuals and Academic Scribblers: The Economic Engine of Political Change[/amazon_link] by Wayne Leighton and Edward López has been out for a while but I’ve just read it. The Madmen are politicians or policy makers, the Scribblers are academics, scholars, generating new ideas, and the Intellectuals are those who translate ideas into politically digestible form, journalists, think-tankers, consultants. (I’d have found it more intuitive to reverse those last two labels, but there we are.)

[amazon_image id=”0804780978″ link=”true” target=”_blank” size=”medium” ]Madmen, Intellectuals, and Academic Scribblers: The Economic Engine of Political Change[/amazon_image]

The over-arching aim of the book is to explain why bad economic policies are implemented, why they last so long, and why they are sometimes overcome. The transmission mechanism runs from Scribblers’ ideas to decisions by Madmen, mediated by the competitive marketplace of ideas and entrepreneurs among the Intellectuals and junior Madmen.

This account, not particularly new (indeed, the title is drawn partly from the famous [amazon_link id=”1494854740″ target=”_blank” ]Keynes quotation[/amazon_link] about madmen in authority), is wrapped around some useful central chapters. These give a clear and concise history of thought that starts with the political philosophy of government (Plato, Aristotle, Cicero, through to Locke, Hume, Marx, and (as it’s an American book) the US Constitution and Pragmatism. This is followed by a chapter on the marginalism revolution in economics and the Pigouvian approach to social welfare as an allocation problem codified by Samuelson, which is contrasted with the Hayekian view of the economy as an organic entity concerned with exchange rather than allocation. It then sets out clearly Coase’s argument about the symmetry of ‘externalities’ and moves on to the start of the public choice revolution. (Including this sentence about James Buchanan: “He was determined to translate Wicksell’s [amazon_link id=”1855061570″ target=”_blank” ]forgotten book[/amazon_link] [from German] for the English-speaking world.” How marvellous to hear of such a well-rounded economist.)

The book comments: “For all its precision, the great vice of the new welfare economics [of externalities, second best theorem and so on] was to crowd out politics and philosophy. … Economists at mid-century were preoccupied with the pure theory of households and firms and busied themselves with proving equilibrium and devising optimal conditions for allocating scarce resources. Interestingly, the main problem was that many of those optimal conditions included very specific policy choices, like taxing polluters, subsidizing education and deficit spending during recessions. But the people making these policy choices – the madmen in authority – are not part of the economic model.”

A full chapter on public choice theory, voting theorems, Olson’s interest group analysis and the economics of regulation follows. The final chapters set out in more detail the argument about how ideas get turned into policies, and a description of four US examples: radio spectrum, air traffic control, welfare reform and the housing bubble and sub-prime crisis. Of these, the first example generalises most easily to other countries.

The book is very clearly written and an accessible introduction to an important strand of the history of economic thought that is still highly relevant to policy debates today. The three core chapters and the examples make it an extremely useful introductory or background resource for students, and I’ll certainly add them to my reading list for next semester. The final chapter does also end with good advice for wannabee policy entrepreneurs: “Improving the human condition should start with recognising that people respond to incentives, and that incentives are part of institutions that neither rise nor fall overnight, and that the slow emergence of both good and bad ideas can change these institutions and thus have an enduring impact on the human condition. … Ideas indeed can have consequences.”

Taking information seriously in economic policy

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Earlier this month I wrote about Joe Stiglitz’s Jean-Jacques Laffont speech at the Tiger Forum, which was based on his new book with Bruce Greenwald, [amazon_link id=”0231152140″ target=”_blank” ]Creating A Learning Society: a new approach to growth, development and social progress[/amazon_link].

[amazon_image id=”0231152140″ link=”true” target=”_blank” size=”medium” ]Creating a Learning Society: A New Approach to Growth, Development, and Social Progress (Kenneth Arrow Lecture Series) (Kenneth J. Arrow Lecture Series)[/amazon_image]

Stiglitz won his Nobel Prize for his massively important work on asymmetric and missing information – how this shapes institutional structures, including markets. His Nobel Lecture is well worth the read.

This book builds on the information-based approach, and links it to other work on endogenous growth theory, which sees the process of growth as a cumulative process in which knowledge builds on earlier knowledge. This makes ideas (including those formalized as ‘intellectual property’) and people (to whom ideas are attached) the key to economic development. Stiglitz and Greenwald introduce industrial policy to endogenous growth models. They cover, among other areas, trade policy, intellectual property regimes, industrial strategy, and competition policy. It’s a somewhat technical book – there are quite a few equations and models at I would say advanced undergraduate level –  although one could skip those bits and still follow the argument.

I agree with the authors’ motivation for this book. They write: “Everyone today speaks of the innovation economy or the knowledge economy, and there have been important advances in the analysis of, say, patents and patent races, and network externalities, to take but two examples. But the full implications …. for the neoclassical model have still not been taken on board. And the implications for policy have been even less absorbed into mainstream thinking.” They go on to point out that it is 40 years since Stiglitz’s work on information questioned fundamentally standard economics results such as the existence of equilibrium, or the uniqueness of equlibrium, but little has changed in the standard approach. I doubt that any ‘mainstream’ economist would challenge the importance of the results on asymmetric information, non-linearities in growth and so on, so it is a puzzle that so few have taken the implications seriously. No doubt the answer lies in the sociology of the profession and academic incentive structures. My sense is that this is now changing.

This book takes the implications of information externalities forward into specific policy areas. It argues that not only can we not presume that a market economy is efficient, but also that industrial and trade policies can demonstrably increase social welfare. “Learning externalities are pervasive and it is a mistake not to take them into account.”

While not agreeing with every specific policy prescription they make, information, knowledge, learning – whatever you want to call it – definitely does change the prism for assessing structural economic policies. Maybe Prof Stiglitz will next write the popular book that makes this shift in perspective accessible to the policy world.

Prof Stiglitz and me at the TSE TIGER Forum

The social life of innovation

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I’m half way through and really enjoying [amazon_link id=”1594203288″ target=”_blank” ]The Idea Factory: Bell Labs and the Great Age of American Innovation [/amazon_link]by Jon Gertner. It was published in the US in 2012 and was a bestseller, but I’m not sure it was ever published here in the UK – it was a tweet from Tim Harford that alerted me to it. If that’s right, perhaps Penguin thought it was too American and nobody on this side of the Atlantic had ever heard of Bell Labs. Yet this is the organisation that employed Bill Shockley, John Tukey, Claude Shannon and many other brilliant scientists and mathematicians in the mid-20th century. When I studied at Harvard in the early 1980s one of my fellow-students, Kaye Husbands, had worked at Bell Labs, which is how I first came to learn about it.

[amazon_image id=”1594203288″ link=”true” target=”_blank” size=”medium” ]The Idea Factory: Bell Labs and the Great Age of American Innovation[/amazon_image]

I’ll review the book at length later in the week. The question it immediately raises, though, is about the structure of innovation, a costly business. AT&T funded Bell Labs from its monopoly profit but its executives were well aware that its privileged position of a regulated monopoly meant Bell Labs had to serve public purposes as well as private profit, and to do so in a public way. This meant that, for example, the transistor technology was publicised and quickly licensed on reasonable terms to competitors – AT&T knew there would be an outcry if the company tried to keep that innovation to itself. An interesting history lesson for large technology organisations. Indeed, as John Kay often points out, sustained success for any business depends on its moral purpose as a social institution delivering benefits to everybody, not on maximising short term profit; and the very purpose of a tech business is innovation.

Of course, the AT&T monopoly was eventually broken up by the US authorities, but I’m not yet that far through Gertner’s account.

Working class heroes

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Sometimes life brings unexpected gifts. On Thursday evening I attended the launch of this year’s BBC Proms season, and had the pleasure of meeting the baritone Roderick Williams, who is singing on the Last Night, and is one of the most life-affirming and delightful people I’ve met. Do listen.

Yesterday the treat was visiting the UK HQ of Vice News. My reaction on walking in: I want to work here. My second: I’m way too old to do so! Just around the corner is the London HQ of the Workers’ Educational Association. Founded in 1903, my mother took some of its courses in the 1990s after she retired: wine appreciation and watercolour painting. It is a sign of progress that working people now have options like those.

The WEA is one of the many organisations featuring in Jonathan Rose’s brilliant book [amazon_link id=”0300153651″ target=”_blank” ]The Intellectual Life of the British Working Classes[/amazon_link]. All of them, and the many autodidacts among working class people, formed part of the social and political innovation that was a response to the profound structural dislocation caused by the industrial revolution. It isn’t yet clear at all what the modern response will be to automation and inequality, although we can be sure there will be one; I found Thomas Piketty disturbingly deterministic about these trends. (Incidentally, there have now been gazillions of reviews of [amazon_link id=”067443000X” target=”_blank” ]Capital in the 21st Century[/amazon_link] including my own, but I found this one by Joshua Gans one of the best, and this by Gillian Tett interesting on the social psychology of Piketty-mania.)

[amazon_image id=”0300153651″ link=”true” target=”_blank” size=”medium” ]The Intellectual Life of the British Working Classes[/amazon_image]

The reason for this ramble is the publication of [amazon_link id=”0747591849″ target=”_blank” ]The Valley: A Hundred Years in the Life of a Family[/amazon_link] by Richard Benson, which has had wonderful reviews – today in the FT, previously in The Guardian and elsewhere. The FT covers several other books – [amazon_link id=”1848548818″ target=”_blank” ]The People: The rise and fall of the working class 1910-2010[/amazon_link] by Selina Todd, [amazon_link id=”1846142784″ target=”_blank” ]Dreams of the Good Life: Flora Thompson and the Creation of Lark Rise to Candleford[/amazon_link] by Richard Mabey, and [amazon_link id=”030018784X” target=”_blank” ]The Gardens of The British Working Class[/amazon_link] by Margaret Wiles.

[amazon_image id=”0747591849″ link=”true” target=”_blank” size=”medium” ]The Valley: A Hundred Years in the Life of a Family[/amazon_image]

It’s interesting to see this batch of books on the subject of the working class. There is an issue here. Lynsey Hanley’s [amazon_link id=”1847087027″ target=”_blank” ]Estates[/amazon_link], Owen Jones’s [amazon_link id=”1844678644″ target=”_blank” ]Chavs[/amazon_link] and [amazon_link id=”1907994165″ target=”_blank” ]Why FIght Poverty?[/amazon_link] by Julia Unwin all address from different perspectives the theme of the fear and loathing among the elites for people with low incomes. The weakening in the public sphere of a once-vibrant working class culture and the rise in inequality are two facets of a significant phenomenon.

[amazon_image id=”1907994165″ link=”true” target=”_blank” size=”medium” ]Why Fight Poverty? (Perspectives)[/amazon_image]