Our Age of Anxiety

David Brooks says Democrats don't understand that the Republican "extremism" that they perceive is, instead, a sense the liberal welfare state is on its last legs. It isn't, he argues, some kind of GOP "fever".

I guess I’d say Republicans don’t have an illness; they have a viewpoint. Let me describe it this way: In the 1950s, Dwight Eisenhower reconciled Republicans to the 20th-century welfare state. Between Ike and George W. Bush, Republican leaders basically accepted that model. Sure, they wanted to cut taxes and devolve power, but, in practice, they sustained the system, often funding it more lavishly than the Democrats.

But many Republicans have now come to the conclusion that the welfare-state model is in its death throes.

They just look at Europe, for one thing.

 

Brooks points to a "definitive" essay by Yuval Levin, who writes in the Weekly Standard:

To say that we are not, in fact, on the verge of the triumph of welfare-state liberalism is of course a gross understatement. We are, rather, on the cusp of the fiscal and institutional collapse of our welfare state, which threatens not only the future of government finances but also the future of American capitalism. But at the same time, American capitalism is not exactly ready to bloom once the shadow of Obama is lifted at last. While our welfare state has grown bloated and bankrupt, our economy has grown increasingly sclerotic—weighed down by a grossly inefficient public sector, the rise of crony capitalism, demographic changes transforming the workforce, and a general loss of focus on productivity and innovation. The American economy still has great stores of strength, but it is not well prepared to make the most of those strengths or to address its deficiencies as a global competitor

 

I think this is interesting, but he puts efficiency at the heart of his argument:

If we are to experience anything like the prosperity of the postwar era, our economy will need to be more productive than ever. Efficiency must be the watchword of our economic policy.

And one of the interesting things in the fascinating McCloskey book we have been looking at in the last week is that allocative efficiency does not really explain growth, at least historically. Innovation and efficiency are not the same. And institutional reform is not always just about introducing more market pricing.  

Levin is right, of course, that productivity is crucial to building wealth. And stagnation can ooze from ossified and outdated government structures. But this also rests on an assumption that productivity growth will flow through to the averge voter, as it did for most of American history. And that is not as safe an assumption any more.

The essay is right on diagnosis. We have stagnation and gridlock. Our current economic system is facing a much deeper problem.

But if you take the essay as a statement of the world view of more thoughtful Republican policy thinkers, it's still deficient in thinking through the fix. It's at most an evolution of the old twentieth century government v market debate I keep criticizing as stale and outdated. I may come back to the essay later.

However, if Europe really does hit the skids in the next six months (or six weeks) expect much more talk about the collapse of the liberal welfare state approach.


 

 

Gaming Greece outcomes

On the subject of Greece, Zerohedge has BoA's cheat sheet for the potential impact on asset classes.

Note they have a benign pro-EU government as the highest probability. But relief quickly fades as investors focus on Spain and Italy again.

And they don't count bank runs in their scenario. Greeks could vote yes with their ballots and be rushing to vote no with their semi-euros, pulling them out of the domestic system. I would. We'll see what the data evenually shows on that. It could be worse than people assume, leading to a need for even more short-term support.


And in the bear case BoA have 10-year Treasuries going to 1.3%. Wow.

 

 

The can can't be kicked much more in Europe

There is spreading apprehension over the potential impact of the Greek elections this weekend. This NYT piece is full of people making preparations for euro exit and disaster scenarios.

Because there has been time to prepare, some economists say, Greece’s departure from the euro will not be as much of a shock as the collapse of Lehman Brothers in 2008, which provoked a global financial crisis. Nor is it likely to be as abrupt. Even if a new Greek government eventually decided it could no longer stay in the euro union, no one expects an immediate, hasty exit.

Of course, the argument in 2008 was that Bear Stearns had been a warning for people to prepare for a bank failure. But the market had read that as the government bailing out banks and limiting the damage . No matter how much it was talked about, few thought the US government would actually let it happen.

 

And in a "crisis weekend", things can move too fast for arrangements to work out in an orderly way. Treasury had still hoped to sell Lehman to Barclays, but British regulators balked. And Paulson and Bernanke later claimed they faced serious legal restrictions on wht they could do in the Lehman case.

 

There are likely to be unforeseen problems. I'd put who holds CDS exposure to Spain and Italy at the top of the list.

 

The market is so priced for problems that anything which isn't a messy collapse, or any new kind of policy initiative could spark a short-term relief rally. But the underlying situation is getting critical. It's the banking system which is the heart of the issue, even more directly than sovereign debt (which it is tangled together with.)

 

If there is any doubt about government ability to prop up banks, whether for logistical, fiscal or political reasons, that could ignite a firestorm of counterparty risk fears and deposit withdrawals that runs ahead of regulators ability to cope. Bank runs on entire national banking systems are beyond the ability of most individual sovereigns to deal with, if there is any doubt they cannot suddenly absorb another 30% of GDP in debt. They can offer guarantees - but their government bond markets might implode. And that undermines the credibility of the guarantees.

 

Capital controls are also possibke - but would be a historic reverse to the post-Bretton Woods order. They might work temporarily to shore up the system, or at least make the problem happen in slow motion. But they would be seen as partial confiscation by frightened citizens, with immeasurable consequences for the legitimacy of the government.

 

The can has been kicked down the road so much that it is a torn and tangled scrap of aluminum, and it is now falling apart.

 

 

A Cambrian Explosion of Complexity

We've been discussing Bourgeois Dignity: Why Economics Can't Explain the Modern Worldthrough a series of recent posts on this blog, starting here.

By her own admission, McCloskey is eliminating other potential explanations why economic life was suddenly revolutionized in the industrial revolution. So the true explanation (if there is one) must lie in the residual.

For her that explanation is mostly a shift in ideas: an increase in respect and dignity for bourgeois strivers and tinkerers.

But she does not make much of a positive case for that argument in this book. That seems to be left for future books. From interviews and other writing on her site, it seems those will attempt to give more evidence that such a rhetorical shift did in fact take place, using a wider, qualitative range of evidence which economists usually ignore.

Still, despite her compelling and persuasive stress on the importance of encouraging innovation rather than just efficiency, she does not pay much attention to the work on how innovation happens (or does not happen) in other spheres. And not just innovation, but the evolution of complexity.

 

Evolution and Innovation

One consistent theme on this blog has been to see the economy as an evolutionary system. This originally stemmed from reading Eric Beinhocker's superb book, Origin of Wealth: Evolution, Complexity, and the Radical Remaking of Economics, which I mentioned in the first few days of the blog. But, as we shall see, it leads to a great deal of other work and thinking.


My own suspicion is that the shift in values that McCloskey describes was highly significant, because it facilitated a huge surge in the evolution of complexity of the economy. And that is more than just "talk, talk" acting alone.

There's various ways we can see this.

First, evolution is capable of sudden and stunning increases in complexity. Stuart Kauffman of the Santa Fe Institute develops this in his famous book At Home in the Universe: The Search for the Laws of Self-Organization and Complexity.

He works on simulated computational algorithms of evolution, and had been pondering how life first started. Chance alone was unlikely to generate those first steps in the lifetime of several universes, he argues. But fortunately there is some spontaneous order inherent in nature as well, which can produce sudden phase-shifts in complexity.

In the case of the beginning of lfe, he demonstrates how auto-catalysing sets could in effect suddenly spring into existence, in a S-curve of complexity, and start reproducing themselves. Once complexity hits a critical threshold it grows exponentially. A system goes "supracritical" in a short space of time once a network passes a key threshold.

So that is a first possibility here. There can be thresholds of complexity which, once crossed, can produce an enormous sudden expansion of possibilities.

An Economic Cambrian Explosion

 

In fact, that is precisely what seems to have happened in the later evolution of life on earth. Basic unicellular life evolved relatively early in Earth's history, not long after the surface of the earth cooled and meteroite bombardment tailed off, perhaps 3.9 billion years ago.


Then little happened for the next three billion years. Life was unicellular until a billion years ago, and evolutionary change was very slow.

That changed within the remarkably short timeframe of just 5-15 million years, the blink of an eye in historical perspective. Most of the current astonishing diversity of life suddenly appeared in that short interval around 530 million years ago, rather than gradual development of features over eons of time.

The Cambrian explosion completely transformed life. Before, there were three major phyla - main groups - of life on earth. After, there were the full thirty-eight or so that we still have today. The famous Burgess Shale in British Columbia is a snapshot of the transition, as celebrated by Stephen Jay Gould and others.

The reasons for the sudden change have been a major scientific mystery, with suggested explanations ranging from increasing oxygen in the atmosphere to the bottleneck effect of "Snowball Earth" freezing of the climate millions of years before.

The most recent work argues that there may have been slow internal changes in internal body form in the Ediacarian age which lay before it. Andrew Parker argues in In The Blink Of An Eye: How Vision Sparked The Big Bang Of Evolutionthat normal rates of mutation suggest that new phyla had in fact developed slowly before the Cambrian, but creatures still looked like similar worms on the outside. Then the development of eyesight triggered an enormous change in creatures' environment that led to a sudden huge radiation of the external forms of animals, as they now had to defend against predators or chase prey.

What has this to do with the industrial revolution? McClosely argues the central fact of modern economic life is the sixteen-fold increase in income, more than can be explained by efficient allocation or capital accummulation.

The number of basic divisions of living things increased more than tenfold in the Cambrian explosion.

Does this prove any similarity? No. But it does show that the evolution of complexity can follow a similar pattern. The more we look at evolution, the more intricate, finely balanced and sometimes fragile the process is.

The key point here is to think of evolution not as just the history of life on earth, and certainly not as the social darwinism (or even evolutionary psychology) that have provoked justified resistance in the twentieth century. This is not the old idea of nature red in tooth and claw.

Evolution as an Innovation Algorithm

Instead, think of evolution as a search algorithm for some kind of fitness relative to an environment, which, given enough time, generates dazzling complexity. It is an astonishingly effective generator of innovation. And in the right conditions there can be a sudden leap, a huge acceleration of evolution.

It is just the kind of small-scale, decentralized tinkering which McCloskey celebrates which can suddenly move that algorithm into high gear.

Evolution does not work in all circumstances. Some kinds of "fitness landscapes" , as Kaufmann explains, can be too random to be searched by evolution.

And you need some mechanism of variation, selection and adaptation. That is obviously a given in the natural world. You have genetic mutation, natural selection and the reproduction of selected individuals over time so that "fitter" genes spreaf through a population.

Similar processes may or may not exist in economic and political life. In fact, they likely do - but for thosuands of years they worked quite feebly. If you have a particular set of institutions and balance, the force of that algorithm creates evolutionary momentum.

But stasis is just as likely, especially as "fitness" is much more ambiguous in economic history. It is not just that variation was more difficult in traditional societies where change was perceived as a threat. But it was largely military or agressive success that was "selected" for, not wealth or innovation.

If you alter that, however, and tune the algorithm, you can suddenly get a surge of complexity with the full force of life itself.

In the next post we'll explore another one of Kaufmann's ideas, that evolution has a natural tendency to move a system to "the edge of chaos" which is where innovative and necessary change is most likely to happen.

No doubt McCloskey would see this as an attempt to reduce the independent significance of ideas, in favor of some other "as-if" process. But it's not. it is an explanation of why ideas can have such a startling effect. Not least because ideas evolve too, as Richard Dawkins' idea of the "meme" makes clear. And sometimes if you unleash the algorithm in a looser environment, a remarkable leap can result.

 

 

Facebook data could lead to new insights on human behavior?

I'm not sure whether this is creepy or exciting. Probably creepy, given it's Facebook.

Private conversations, family photos, and records of road trips, births, marriages, and deaths all stream into the company's servers and lodge there. Facebook has collected the most extensive data set ever assembled on human social behavior. Some of your personal information is probably part of it.

And yet, even as Facebook has embedded itself into modern life, it hasn't actually done that much with what it knows about us. Now that the company has gone public, the pressure to develop new sources of profit (see "The Facebook Fallacy") is likely to force it to do more with its hoard of information. That stash of data looms like an oversize shadow over what today is a modest online advertising business, worrying privacy-conscious Web users (see "Few Privacy Regulations Inhibit Facebook") and rivals such as Google. Everyone has a feeling that this unprecedented resource will yield something big, but nobody knows quite what.

So they have a 12-strong social science team trying to figure out just that.

Not all the possibilities are bad. For example, this is quite amazing if true:

In April, influenced in part by conversations over dinner with his med-student girlfriend (now his wife), Zuckerberg decided that he should use social influence within Facebook to increase organ donor registrations. Users were given an opportunity to click a box on their Timeline pages to signal that they were registered donors, which triggered a notification to their friends. The new feature started a cascade of social pressure, and organ donor enrollment increased by a factor of 23 across 44 states.

But I'm also a little skeptical that "big data" will live up to the hype surrounding it. I doubt it will generate genuinely new or useful insights into people's behavior in general, or allow social influence which is durably different to the real world. At most, it will give more information on weak ties and how they impact us.

It might predict given enough data when people are going to buy a car or announce an engagement, or the birth of a child, however. Although the more it targets people accurately in commercial terms, the less it may be trusted.

It reminds me of this fascinating NYT piece a few months ago :

 

As the marketers explained to Pole — and as Pole later explained to me, back when we were still speaking and before Target told him to stop — new parents are a retailer’s holy grail. Most shoppers don’t buy everything they need at one store. Instead, they buy groceries at the grocery store and toys at the toy store, and they visit Target only when they need certain items they associate with Target — cleaning supplies, say, or new socks or a six-month supply of toilet paper. But Target sells everything from milk to stuffed animals to lawn furniture to electronics, so one of the company’s primary goals is convincing customers that the only store they need is Target. But it’s a tough message to get across, even with the most ingenious ad campaigns, because once consumers’ shopping habits are ingrained, it’s incredibly difficult to change them.

 

There are, however, some brief periods in a person’s life when old routines fall apart and buying habits are suddenly in flux. One of those moments — the moment, really — is right around the birth of a child, when parents are exhausted and overwhelmed and their shopping patterns and brand loyalties are up for grabs. But as Target’s marketers explained to Pole, timing is everything. Because birth records are usually public, the moment a couple have a new baby, they are almost instantaneously barraged with offers and incentives and advertisements from all sorts of companies. Which means that the key is to reach them earlier, before any other retailers know a baby is on the way. Specifically, the marketers said they wanted to send specially designed ads to women in their second trimester, which is when most expectant mothers begin buying all sorts of new things, like prenatal vitamins and maternity clothing. “Can you give us a list?” the marketers asked.

So this kind of short-run prediction can still be valuable in dollar terms, even if it does not produce a revolution in understanding human nature that eluded Shakespeare or Dostoyevsky.

 

Science didn't cause the revolution (at least not directly)

One final point on the book before concluding with a discussion of innovation. Was the industrial revolution simply a matter of science and technology? It seems such an obvious possibility.

But in fact it does not work out in chronological terms, according to McCloskey. It was more a matter of tinkering than eureka.

Another problem is that the inspiriting discoveries of a Newtonian clockwork universe, and the great mathematization in Europe of earthly and celestial mechanics in the eighteenth century, had practically no direct industrial applications until the late nineteenth century at the very earliest. The historian of technology Nathan Rosenberg noted that "before the twentieth century there was no very close correspondence between scientific leadership and industrial leadership," instancing the United States, which had negligible scientific achievement by 1890 and yet industrial might, and Japan, ditto, by 1970.

 

China had been ahead of Europe technologically for a thousand years before the Renaissance, but that did not produce an industrial revolution. Nor did the scientific and mathematical advances of the ancient Greeks. It was the rainy provincial parts of England where it happened, not dazzling cosmopolitan Alexandria at the time of Eratosthenes, or Baghdad or Cordoba or Jingdezhen.

And the advance of science was pan-European. But the industrial revolution started in Britain.

Scientific advance from Copernicus to Carnot was pan-European, and in the late nineteenth century became strikingly German. Yet the Industrial Revolution of the eighteenth and early nineteenth centuries was strikingly British. And despite the mistaken rhetoric of late Victorian "failure," the British continued into the late nineteenth and indeed into the twentieth century to be great innovators: the military tank, penicillin, jet planes, radar. It is conventional to observe that unlike the French or Germans the British were not significant theorists (with rare if glorious exceptions like Newton, Darwin, Maxwell, Kelvin, Hawking), but that they were nonetheless very significant tinkerers and muddlers through. Technologists. Bourgeois.

So it is the kind of science and technology, and why it gets pursued, and used, and protected from resistance that matters.

There have been many periods of scientific leaps - which are then smothered or wither. There is nothing inevitable or mechanical about societies continuing to pursue science and technology. Quite the opposite.

 

A Swipe at Douglass North and Institutional Economics

We're still on Bourgeois Dignity: Why Economics Can't Explain the Modern World. Here's one point where I think McCloskey goes too far, even if you can understand her reasons. She is bitterly critical of Douglass North, who I have talked about with some admiration on this blog. She believes North is still far too trapped within the Samnuelsonian rational-actor methodological cage.

The economists want the big change to be a matter of Northian "institutions" because they want incentive to be the main story of the Industrial Revolution and the modern world. But suppose incentive (Prudence Only) is not the main story, and cannot be the main story without paradox: if it was Prudence Only, then the Industrial Revolution would have happened earlier, or elsewhere. Suppose that other virtues and vices matter a lot-not only prudence, beloved of the Samuelsonians; but temperance, courage, justice, faith, hope, and love, which changed radically in their disposition during the seventeenth and eighteenth centuries.

So North does not take religion seriously, for example. And the approach has led to the excesses of agency theory in finance and corporate compensation. CEOs have to be incentivized and aligned - and paid as such - but the results have often been disastrous. Prudential incentives do not make up for the lack of other virtues. Instead,

A good deal of life and politics and exchange takes place in the damning of incentives and the assertion of meaning-the mother's love or the politician's integrity or the teacher's enthusiasm, what Keynes (and after him George Akerlof and Robert Shiller) called "animal spirits" and what Sen calls "commitment" and what I call "virtues and corresponding vices other than Prudence Only.

She insists that ideas and beliefs still matter.

I believe on the contrary, with Alexis de Tocqueville in 1853, that "institutions" such as laws are not fundamental: "I accord institutions," wrote Tocqueville in 1853, "only a secondary influence on the destiny of men.... Political societies are not what the laws make them, but what sentiments, beliefs, ideas, habits of the heart [in his famous phrase from Democracy in America], and the spirit of the men who form them prepare them in advance to be.... The sentiments, the ideas, the mores [moeurs] ... alone can lead to public prosperity and liberty."

I take the point, but not everything about rational-actor economics is wholly wrong. I've tended to take North as an example of thinking about people, rather than simply automatic equilibrium on the model of 19th century physics. It is not the whole story, of course. But it is a useful chapter. I agree with her general point that ideas matter. But I think we have to take motivation very seriously. Perhaps North has too narrow a view of motivation. But his work is still a step forward, which is more than you can say for much standard economics. It is about influencing human behavior, not simply laissez faire. He is asking the right questions, even if he is still restricted in methodology. And even then, his work is discursive rather than simply math. It isn't just "as-if" models. Still, perhaps I need to think a bit harder about the limits to North's approach. I might come back to this in due course.

Property rights don't explain the Great Leap

McCloskey is on stronger ground when she criticizes the specifics of the institutional explanation of the industrial revolution. It was not caused by better property rights, she says. Property rights had been relatively secure in England for centuries.

lack of defined property perhaps characterizes some parts of Europe during the ninth century (though consider the ordered realms of Charlemagne or Alfred the Great) but certainly not England in the seventeenth century, as North to the contrary claims….No quantitative case can be made, in short, that it was after 1689 that England moved from predation to security of property.

After all, if anything our existing property rights today are not necessarily stronger.

An American government armed with the doctrine of eminent domain and the power to tax incomes at combined federal and state proportions of 35 percent, and with administrative agencies having broad powers over labor relations and air pollution, not to speak of unusual definitions of torture and the ability to tap telephones, and a passionate desire to limit people's consumption of recreational drugs, seems in this respect to be more, not less, like the Muscovy of old than did, say, France in 1576.

Nor was there obviously better treatment of intellectual property rights or incentives to innovate:

A recent calculation by the ever-useful economist William Nordhaus reveals that nowadays an inventor gets a mere 2.2 percent of the economic gain from an invention: "Only a miniscule fraction of the social returns from technological advances over the 1948-2001 period was captured by producers, indicating that most of the benefits of technological change are passed on to consumers rather than captured by producers.

Innovation is not purely a matter of incentives. But that leads to the question: what does facilitate innovation? So far she says it is bourgeois dignity and liberty. But she has not explained why that should make such a huge difference.

 

Jargon Watch: "Heilmeier's Questions"

I noticed an ad from the Intelligence Advanced Research Projects Agency, IARPA on the blog, which I thought was curious. It's a high-level US government research outfit, who are looking for people to predict economic and political events. It's interesting.

Here's a term I hadn't heard before, which must be a fixture in government and defense research: "Heilmeier's questions", for anyone launching a project or developing a product:

(via wikipedia)

 

• What are you trying to do? Articulate your objectives using absolutely no jargon.
• How is it done today, and what are the limits of current practice?
• What's new in your approach and why do you think it will be successful?
• Who cares?If you're successful, what difference will it make?
• What are the risks and the payoffs?
• How much will it cost?
• How long will it take?
• What are the midterm and final "exams" to check for success?

 

It's an interesting alternative to the startup/ entrepreneur/ busines discussion of new projects.

 

Cutting the Cord

On a different subject completely, we're going back to the future in tv. We set up the antenna on our tv and it works dazzlingly well. It's going to be sayonara, cable tv in our household.

The story is: We had cut back on our Time Warner Cable package about two months ago. We ditched the extra tiers of digital channels and went down to just the basic service.

We increasingly found we weren't watching the cable channels enough to justify the cost. We'd flick through the hundreds of channels looking for something to watch, and end up on Netflix streaming anyway. So why pay $50 a month for something that we used less and less, especially when G could watch episodes of Mad Men (the holy grail of television) on iTunes whenever she liked.

That left us with just roadrunner internet and the basic channels. It was working for us. We liked it.

Then G said why pay $40 a month for the basic channels if we can maybe get that free over the air anyway? That was a very good point (and it pays to listen to your other half). So I looked into it and eventually ordered an antenna, Mohu Leaf Indoor HDTV Antenna , from Amazon.

It's small and flat, and fits invisibly behind my tv. I connected it to the antenna and the tv auto-tuned the channels.

Reception is perfect. I had been worried we're so relatively close to the antenna at the Empire State Building that we would have problems, but it locked in without a flaw.

And the huge upside surprise is the quality of the main broadcast channels - CBS, NBC etc - is actually visibly higher than on cable. The cable companies apparently compress their feed, while the over-the-air broadcast is uncompressed.

So it is as if my 1080p set has suddenly had a quantum leap in performance. It's quite entrancing.

Our plan is to rely on the antenna for broadcast channels, and a combination of Neflix streaming/DVD, iTunes and web feeds for everything else over roadrunner. We'lll watch what Apple does later today with their Apple TV service with interest. We'll miss the ability to skip commercials on dvr for now, but we may figure something out.

And in the meantime, we're going to save around $90 a month from our original package. That pays for a lot of ad-hoc iTunes downloads. And it is so nice to take revenge for all those hours spent on hold to Time Warner Cable in the past, and the endless "press 1 for English, press 3 for support.." If you mistreat your customers and keep hiking rates, they're going to remember.

 

Spanish and Italian yields soar

So far, the Spanish deal is not impressing the markets. Zerohedge has a Bloomberg chart showing that Spanish and Italian yields have actually exploded higher today.

 

We'll see how long the latest Euro rescue lasts

Europe is still trying to buy time with this latest Spanish bailout. Niall Ferguson writes

It’s binary. Either German Chancellor Angela Merkel has to bow to the logic of her predecessor but one, Helmut Kohl, who always saw monetary union as a route to federalism, or it’s over—and the process of European disintegration is about to spiral out of control. Put another way: if Europe’s leaders try kicking the can one more time, it will turn out to be packed with explosives.

 

Division of labor is not in fact the source of wealth

 

I find I have a lot to say still about Deirdre McCloskey's book Bourgeois Dignity: Why Economics Can't Explain the Modern World, which I think is proportionate to the insightfulnesss and intellectual range of her book. In fact there's still four main topics i want to cover: Allocative efficiency, Institutions, Science and Technology, as well as my puzzlement over why she does not relate her thesis about innovation to studies about evolution and algorithmic efficiency. Take allocative efficiency first, because it is so ingrained in any of us who have studied economics.

Nor was Adam Smith correct that the wealth of the nation depended on the division of labor. True, the economy did specialize. Ann Kussmaul's pioneering work on rural specialization showed it happening in England from the sixteenth century onward.

So it was too early to explain the revolution by itself. And increases in efficiency don't add up, either. Perhaps I'd forgotten, or didn't come across at college, Harberger's growth accounting. If you multiply increases in efficiency in key sectors by their actual size in the economy, you get quite small numbers. Take enclosure for example.

Harberger's Law asserts itself again: (1/3) (1/2) (io percent) = 1.7 percent of national income to be gained from the enclosure of open fields.

Allocative efficiency does not take you very far in itself. Changes in the allocation of labor to rising or falling industries does not make a great deal of difference.

Expanding the woolen industry and shrinking the growing of wheat might achieve for the nation, if the reshufflers were lucky or skilled, a national gain of 10 percent. But not 1,500 percent. To put the findings another way, we have learned since 1970 many nots: that industrialization in Britain was not a matter of internal reallocation of the labor force, nor of transport innovation, nor of investment in factories, nor even of foreign trade-all of which are matters of reshuffling the employment of labor, land, and capital. The making of the modern world was not a matter of a merely reshuffling prudence and temperance.

This of course has implications for how important you think capital markets or private equity are to the economy. It isn't a welcome argument for Bain Capital and co. (Sorry, Mitt.)

Trade and Empire

Nor, she says, was the great leap a matter of international trade and empire.

Empires were not necessary. Thus Belgium, without an empire on its formation in 1830, industrialized smartly, as at the same time did the Rhineland, which was a part of a non-nautical and nonimperial (overseas) Prussia. Both of them saw the price of tobacco, sugar, spices, bananas, cotton, and other tropical and subtropical products fall greatly as imperialist and nonimperialist Europeans traded with the world. Overseas trade was not about Britain but about Europe. Britain's overseas trade, in short, can't explain Britain's peculiarity.

And forget, as we saw with Marx's notion of primitive accumulation, your dependencia or anti-colonial prejudices.

The modern corollary of the historical argument is that the prosperity of the West depends not at all, or at the worst very little, on exploiting the third world. Imperialism was bad. Badness, however, does not invariably bring profit to the bad man. British imperialism was about protecting the sea routes to India. Yet India itself, one can show, yielded no economic benefit to the average person in Britain. Imperialism had therefore no national economic point.

Again, her point is that innovation matters far more than anything else. Pushing out the production possibility frontier matters far more than efficient allocation within it. After all, even the greedy, exploitative rich in the past were not, in fact, all that rich.

What comes out of the economics, in other words, is that on the whole, and time and again, the attempt to live off poor people has not been very profitable. Even the rich in former times, who for millennia did in fact live off poor people, remained poor by the standard of ordinary people after modern economic growth.

Louis XIV did not have a reliable hot shower or color tv, even if he was way ahead in gold trinkets and horses. In the end, efficiency and accumulation do not explain the great leap.

None of the static arguments, and few of the dynamic, have any chance of explaining what happened in modern economic growth. No merely static improvement of conventional economic factors in 1780 or 1700 can come remotely close to the curve of Now. That's why this greatest of secular historical events cannot be explained by static reallocation. And if it is to be explained by "dynamic" accumulation one has to explain, too, why earlier accumulation did not get the same explosive result.

 

 

Classical economists did not notice the leap while it was happening

We're still discussing Bourgeois Dignity: Why Economics Can't Explain the Modern World. One brief point about humility. We saw in the last post that nineteenth century thinkers were often wrong about the history. In fact, many classical economists failed to notice the biggest change in economic history was happening at all at the time.

The economists, in other words, did not notice that something entirely new was happening from 1760 or 1780 to 1860. As the demographer Anthony Wrigley put it a while ago, "The classical economists were not merely unconscious of changes going on about them that many now term an industrial revolution: they were in effect committed to a view of the nature of economic development that ruled it out as a possibility."'

Compare our worry about the present recession and crisis-strewn world.

In the late 1940s Joseph Schumpeter was already scornful of the classical economists for their failure to see what was happening. T. R. Malthus (1766-1834) and David Ricardo (1772-1823) "lived at the threshold of the most spectacular economic development ever witnessed.... [yet] saw nothing but cramped economies, struggling with ever-decreasing success for their daily bread."' Their student Mill (18o6-1873) even in 1871 "had no idea of what the capitalist engine was going to achieve."

Current environmentalists are just as wrong as Malthus, McCloskey argues.

The radical environmentalists do not realize that gradually after 1800 natural resources became no longer the main scarcity. Nowadays (it is wisely said) there are no natural resources, only human resourcefulness. Yet Malthus told a great truth about earlier history. In medieval England, for example, during the two centuries before 1348 a rising population had become poorer, and in Elizabethan England the impoverishment happened again

What changed?

Land fell dramatically in its power to constrain humans. The fact was contrary to every prediction of the classical economists, and fits poorly with the analysis of many of their successors down to the present.

So what should we take from this for this blog? Well, economic experts are not always attuned to changes in the economy, for one thing (although we knew that.) But it's also an illustration that if some of the underlying constraints are falling away, then relying on past economic experience is not a reliable guide.Material production of stuff in general is increasingly not a constraint. And we have to think through what that means for the economy. Hence this blog (with suitable humility.) There's also a deeper point. Expert judgement very often fails. I think making the right policy call is more usually a matter of correct perception than correct parsimonious theory. Internally consistent theory is the easy bit. What you see is the mark of the true expert - as we saw in the discussion of Gary Klein v Daniel Kahmenan.