Soviet general equilibrium theory

When we think about a social planner that maximizes welfare by assigning optimal allocations without an explicit price system, we are really describing a Soviet economy. History has shown that this utopia does not quite work out for a variety of reasons. Yet, Soviet economies were following this doctrine and their governments must have acted on some principles that must have come from somewhere: what should one allocate where, how should allocations change according to changes in exogenous factors, etc. Russia actually has a rich history of economic theoreticians who have worked out models to guide the policy makers, who liked to think themselves as technocrats. These theoreticians were mostly mathematicians working on various optimization techniques.

Ivan Boldyrev and Olessia Kirtchik describe the life of Victor Polterovich, who expanded Walrasian theory to non-market economies in the 1970s and was the only active Soviet economist with visibility in the West during that period: he has an Econometrica in 1983 and another one in 1993, and a few articles in the Journal of Mathematical Economics in between (see his page on IDEAS) and is a fellow of the Econometric Society. While Polterovich started as many others his academic career of Marxist planning theories, his move to general equilibrium theory may seem puzzling. Indeed, the welfare theorems have often been touted as a victory for the market economy, and Polterovich would certainly have been ill-advised to promote a market economy.

The paper is largely based on interviews of Polterovich that reveal interesting anecdotes, such as the unique history of his first Econometrica and how some of his most important results never got translated. The other Soviet economists did not go through the trouble of integrating with the international research community, and I am sure their are still interesting results that are ignored by the wider general equilibrium theory community. Polterovich came to general equilibrium theory by realizing that one needs at least as many instruments as objectives to manage optimally an economy. That did not seem feasible to him, hence his interest in decentralization. In his early models, agents interact, possibly forming coalitions. Keep in mind that to Soviets, agents were not individuals but political entities or firms. Later, price constructs are introduced, and they are helpful in understanding coordination among agents.

Family wealth persistence over several centuries

Social mobility has been much studied to understand how the poor have a shot at becoming rich and how the rich manage to preserve their status. Such studies are usually limited to mobility during a lifetime for a single individual or for a family from one generation to the next. Going beyond this time frame is virtually impossible, because there is no panel dataset for wealth or income that spans over several generations. One can, however, discover some interesting proxies that allow to create such a dataset.

This is what Gregory Clark and Neil Cummins do in a pair of papers that exploit the fact that people with rare surnames are highly likely to be from the same family. Using national birth and death registries for England and Wales as well as probate registries that recorded wealth at death, they gather records for 21,618 people over about 150 years in the first paper. The second paper focuses on educational status instead of wealth over eight centuries and uses registries of students at Cambridge and Oxford universities as well as censuses for the rest of the population. In both cases, intergenerational correlations are estimated to be much higher than in studies with shorter samples. It can take 20 to 30 generations for an initial status to disappear. This may be indicative that social mobility has increased in recent generations in England and Wales (my interpretation, although Clark and Cummins argue that intergenerational persistence is stable over centuries despite stark changes in inheritance taxation) or that families have an underlying social status that changes much more slowly than characteristics that are easier to observe (the authors' interpretation).

PS: If you are looking at the papers, do not be surprised to see the same abstract on both. Very negligent LSE staff posted similar cover pages on both papers.

Why monogamy?

Isn't it interesting that most human societies, even when not in contact with each other, evolved to a model with long-term monogamous families? What made it crucial for evolution to avoid polygyny, communal families or repeated monogamy? Certain biological traits must have been necessary (and sufficient?) for this to happen.

Marco Francesconi, Christian Ghiglino and Motty Perry show that once you put this into the framework of a game theory model with overlapping generations, it all makes sense. You just need three features: children of different ages overlapping (i.e., women cannot bear "too many" children simultaneously), paternal investment (father need to help for children to succeed), fatherhood uncertainty (fathers may not be certain which children are theirs). This means that mothers need to secure the help of fathers by assuring that they are helping the right children thanks to monogamy. The first feature is necessary, but it is not clear to me why. I think it is because it gives more assurance to the father about paternity. Monogamy is then not only the most efficient family form in the sense that it maximizes the number of offspring, this is even amplified because it is the only form that creates altruistic ties between children.

Industrial Revolution in Britain: it was thanks to human capital

Despite the fact that it happened about 200 years ago, we are still puzzling why the Industrial Revolution happened, why it started in Britain and it happened at that moment. A sample of previous work relevant to this has been discussed on this blog: 1, 2, 3, 4. While all this is old history, it is still kind of relevant, as we are also trying to understand how to get the least developed economies to get through a similar revolution. The circumstances are different, but lessons from two centuries ago may be useful.

Morgan Kelly, Cormac Ó Gráda and Joel Mokyr add another piece to the puzzle. British men were significantly better fed and taller than their continental counterparts. They likely had better cognitive skills, too, as we know today that they correlate positively with physical health. And, the distribution of these positive traits was such that a significant share of the population had the right characteristics to participate in the Industrial Revolution. That was not the case elsewhere. Thus, good human capital and a good distribution of it are necessary for the Industrial Revolution, but likely not sufficient.

Why Keynes dominates Hayek

I generally find debates about schools of economic thought annoying, especially when it is all about adoration of some dead economist while ignoring all the progress we have made since his contributions. Unfortunately, these dead economists keep coming up in the public debate, I think because these are the people non-economists are familiar with, from basic economics classes and popular readings.

Kristina Spanting studies the back-and-forth in popularity between Keynes and Hayek in light of the past 80 years or so of economic history. Keynes was all about shorter term solutions to crises, while Hayek had a longer term vision of things, and would not bulge from it no matter what the circumstances. Accordingly, their popularity in policy circles has oscillated depending on the need to react to a crisis. Keynes is an easy sell to politicians in such times. The electorate is asking them to do something, and Keynes provides the justification for that. And all the work economists have done since Keynes (and Hayek) is brushed aside just when you should draw the most on it. Sad.

The Economics of Christian Reformation

The social fabric of a country has a lot of inertia. It takes generations for norms to change, in large part because people rarely change during their lifetime, and if there is any change it is towards conservatism, that is, preserving the status quo. Yet sometimes change spreads quickly, like a revolution. In some sense we see this with the Arab Spring. All it needed was a small spark, and that spark may seem irrelevant at first. Another dramatic social change was the Christian Reformation that started with a simple priest in a completely irrelevant town of Saxony. Martin Luther was a spark that somehow set on fire an existing social norm, Catholicism, and set in motion a revolution that would keep Europe busy for centuries. How could this happen?

Philipp Robinson Rössner points out that central Germany suffered at the time from economic depression and deflation, at least partly as a consequence from a decline in silver supplies. This context deeply influenced Martin Luther's thinking, which found a receptive audience throughout the region. One thing that I take away from this is that the Reformation possibly happened because currency was tied to silver. Had the region had a modern central bank with fiat money, the money supply could have adapted to economic circumstances and the Reformation may have never happened. Europe would have suffered from much fewer wars, and the world's history (and economy) would have been quite different.

Seigniorage loss and the fall of the Roman Empire

Early in the 20th century, the United States took over from the United Kingdom the role of the preeminent economic and political power. Since the last turn of the century, some people are seeing hints that the United States may be losing that role (but it is not clear who would take it), often seeing parallels with the fall of the Roman Empire. We do not know, however, why the Roman Empire fell. There are several explanations, and several may be necessary for the fall. But there is no smoking gun that the United States should particularly look out for.

John Hartwig has an interesting suggestion: the Roman Empire fell because it lost the steady revenue from seigniorage. Of course, it is difficult to get detailed data from this period, thus Hartwig proceeds by formulating a four-sector (C, I, G, gold mining) model where the government gets a substantial fraction from minting gold and silver and issuing at a value substantially above cost. About 165AD, gold deposits were exhausted and Rome had to tax significantly more to sustain itself, thus switching from one type of tax to the other. Forced to mint low quality coins, inflation sets in but this does not bring sufficient revenue. In addition, the center of the Empire being used to import goods from the periphery suffers from a lack of productive capacity once there is no new gold to pay for imports. All in all, the Roman Empire lost the benefits of holding the keys to the world currency. This is something the US has definitely been benefiting from, through seigniorage and through low interest rates, and one motivation for the creation of the Euro has been to capture this rent. But it is so far hard to find evidence that the dollar is losing its status. The US thus seems safe on that front.

Risk management four centuries ago

I tend to think that financial management, and especially risk management, are modern creations that came about after the introduction of analytic accounting, information technology, and the rise of new financial instruments. In other words, you look one century back at firms and individual, they would have laughable financial setups by todays standards. How about some data?

Ann Carlos, Erin Fletcher and Larry Neal look at the financial marketplace four centuries ago in London. They look at firms that were discussed in the financial press at that time and reverse-engineer their ownership structure. Quite remarkably, they find that investors in those old times were not very financially literate. While there is no doubt they were among a very small elite of the population and should have known better, they were very poorly diversified. About 80% of them were investing in a single company, while there were ample opportunities to diversify. The authors think this may also have to do with shareholder voting rules, which required a minimum number of shares to be allowed to vote. But I think such rules could only emerge if shareholders were not aware of the benefits of diversification, which must have been quite large.

Cannibalism in Ireland

Cannibalism within most animal species arises only in extreme circumstances. It is not clear to me why this is less prevalent than intra-species killing, as the latter has a clear negative impact on the survival of the species, whereas eating already dead fellows has no impact. In any case, there is a huge taboo on cannibalism, and humans are no different. But it happens in extreme situations, and famine may be one.

Cormac Ó Gráda studies the incidence of cannibalism during famines and focuses on Ireland. Unlike for other great famines elsewhere or before, conclusive evidence for cannibalism and especially murder-cannibalism seems difficult to find for 19th century Ireland. The famine was certainly severe enough for some hearsay about it to emerge, perhaps figuratively. Does the lack of a record imply that the Irish are more humane and principled? Or that the taboo is so strong that cannibalism is unmentionable? While the paper provides an interesting analysis of the historical record, answers to these questions would also be interesting.

How Japan financed WWII

71 years today, Japan attacked Pearl Harbor and opened a new front in its global war. Why would a relatively small country take on a much larger adversary when it is already stretched with other wars and occupations? In particular, how do you find the resources to wage such wars, and by resources I mean not just the financing but also the physical resources?

Gregg Huff and Shinobu Majima offer part of the answer by looking at the financing of the Japanese occupation of Southeast Asia. Japan had a strategy that invading troops needed to be self-sufficient. This means that they had to either confiscate (tax) or acquire goods through money creation. To a large extend, the latter was performed through the issuance of military scrip, which is unbacked military notes, along with bilateral clearing arrangements with the occupied countries. This allowed not only to finance local occupation but also transfer substantial resources to Japan, in the case of Indochina up to a third of its GDP.

You would think that money creation on such a massive scale would create hyperinflation or at least high inflation. That does not seem to be the case, at least in the sense that the price levels increased as much as the money supply. One could have expected that given the circumstances inflation would have been significantly higher than money growth if market participants were forward-looking and money velocity would increase (think of hyperinflation à la Cagan). Huff and Majima trace this missing hyperinflation to the fact that money was needed to act as a medium of exchange and store of value, despite very substantial seigniorage taxes. There was not viable alternative, in part because of Japanese coercion. I think this would not have worked in more modern economies where more assets are available.

Longevity increased much before the Industrial Revolution

There is no doubt that average human lifetimes have considerably lengthened since Antiquity (except, maybe, Biblical times...). Improvements in living standards through better nutrition, salubrity and medicine likely were the major factors in this dramatic evolution. When this improvements started kicking in is a subject of debate, which is not helped by the fact that good data about lifetimes is difficult to come by. Written genealogical records go only so far back, and their quality and comprehensiveness declines considerably with age. And working from cemeteries is also quite unreliable, especially for longer horizons.

David de la Croix and Omar Licandro provide a very significant step towards a better understand of longevity in human history by compiling a database of 300,000 famous people spanning 25 centuries. The data includes information about location, religion, occupation, and nationality, which should take care of the major selection biases. They find that longevity was mostly flat throughout human history until it started increasing with the cohort born in the 1640s. This is before Malthus, whose assumption of stagnation is thus wrong. And this is much before the Industrial Revolution and has happened across the world and across occupations, thus the two events seem unrelated.

The impact of irrigation on democratization

There is a large variety of institutions and cultures around the world, and I find it fascinating to understand how they originated. The literature has shown that some of them have origins that go back very far, possibly all the way to the introduction of agriculture (Example 1 and example 2)

Jeanet Sinding Bentzen, Nicolai Kaarsen and Asger Moll Wingender discuss how irrigation has influenced the arrival of democracy, and in fact prevented it. They point out that this is not a story about irrigated versus rain-fed agriculture, but rather of areas where there was potential for irrigation versus the others. The story is as follows. Irrigation requires large investments and control of water sources, and allows the extraction of substantial rents. This is a perfect environment for a despot. This theory was advanced by Wittfogel in Oriental Despotism and was soundly criticized. But Sinding Bentzen, Kaarsen and Moll Wingender confirm that the theory holds water empirically. The fact that irrigation potential is crucial allows to avoid the reverse causality issue, as geographic factors are presumably exogenous to institutions, at least until man started having an impact on climate. What is fascinating is that this still has an impact today on the prevalence of democracy.

How to wreak havoc in sovereign debt seniority

With the European sovereign debt crisis continuing to linger with the frustrating hesitation waltz of the politicians, it may be a good idea to look back at somewhat similar situations in the past to learn what worked and what did not. There is actually a particularly striking example of how not do to things, the German debt between World War I and the rise of Nazism.

Albrecht Ritschl takes a fresh look at this, with the current crisis in mind. The Great Depression in Germany was particularly severe and has been blamed on the reparation payments that were imposed on the country after the war. Ritschl argues the true reason is more subtle than that. Until 1929, commercial credit to Germany had seniority of reparation payments. This meant that lending to Germany was relatively safe, and Germany took advantage of that with an unprecedented borrowing spree. Then came the Young Plan in 1929, which was supposed to reschedule the reparation payments that were absolutely crushing (after all, reparations amounted to over half the gold ever mined on earth). While the reorganization of the debt included a lower principal, it also gave reparation payments seniority over commercial debt. Suddenly, lending to Germany was much more risky. Of course, the balance of payments and private investment collapsed, and Germany slid into a deep depression.

Lesson: be very careful with changing debt seniority. But it can still make sense to use wisely this instrument, as discussed before.

Family wars

Family feuds can be terrible, and divorce is the worst. That may be because people who trusted each other find themselves victims of treason, and react violently. Does this scale up to relationships between nations?

Enrico Spolaore and Romain Wacziarg find that populations that are genetically closer tend to be more frequently at war, after obviously controlling for geographic distance. They favor the explanation that sharing genes means also sharing preferences over scarce goods. I prefer the family trust story. Seeing how vicious civil wars are does not discredit either theory as well.

Two millenia of growth in a couple of equations

Many scientists dream of finding a unified theory of something, a theory that would encompass others and explain, with a few equations, a large number of observations. Physicists in particular have been looking for fundamental equations. In economics, there is currently a drive among growth theorists to find a unified growth theory, although here the focus is not on a single equation, but rather a model. Indeed, one has to realize that explaining several thousand years of economic growth involves some complexity.

And now the physicists get interested in the topic. Andrey Korotayev and Artemy Malkov actually go beyond a simple one equation model and use some theory, linking surplus output to population growth à la Malthus. Up to 1970, population is hyperbolic, while GDP is quadratic-hyperbolic (in both cases levels, and not growth as the authors assert). They conclude from this that technological progress is expanding because of the larger number of inventors as population grows. That seems a bit simplistic, as one should also bear in mind that there are decreasing returns to inventing, as documented by rather constant long-run growth rates for total factor productivity in modern history despite an increasing share of a growing population dedicated to research and development. But one can get misled when one looks only at few indicators.

Compared to other physicists, Korotayev and Malkov are careful to use real numbers for output and draw on growth theory a little bit. However, they tout a bit too much high correlation coefficients between data and their forecast. Indeed, when both have a trend, the R2 will always be very high (not counting the fact that for some data points, the uncertainty about their measurement is considerable). And using a logarithmic scale for the graphs would also give a fairer visual assessment of the fit.

PS: I am rather surprised to see that physicists have such difficulties formatting correctly their equations.

The origin of de-unionization in the United States

For better or worse, union are particularly weak in the United States. This was not always so. Why unions declined is not limited to Reaganism which merely accelerated a trend already present in the data. The difficulty is to explain this trend which is for example only present in some other countries and nowhere as pronounced.

Emin Dinlersoz and Jeremy Greenwood explore whether this has to do with the distribution of income, at least in the US. Indeed, over the past century and a half, union membership rates followed an inverted U-shape, while the income share of the top 10% did the opposite. Greenwood and Dinlersoz think that both can be explained by the evolution of skill-biased technical change: basically, while the assembly-line was the main means of production, unskilled labor garnered a higher higher income share and unions were strong, but both decline since as information technology became important. Nice story, but I wonder whether it can apply to more observations (i.e., countries). Also, I wonder whether the timing of events works out. Indeed, the ratio of of unskilled to skilled workers went into a tailspin starting in 1945, while union membership started decreasing only in 1955 and the income distribution started getting more skewed in the 1980's.

Why we need small countries: they experiment with policies

Small countries are often considered a nuisance. They are sometimes tax havens that annoy larger countries because it increases tax competition. They have more weight than their size in international organizations (UN, European Commission, ECB) or sports organizations (FIFA), which at least in the latter case encourages corruption. And they increase sample sizes in cross-country regressions without truly adding information, sometimes leading to erroneous results. But small countries are also great because it allows to experiment with policies.

That is the argument of Jeffrey Frankel. He gives plenty of examples of innovative policies adopted in small countries that turned out to be good choices. In many cases, it looks like larger countries would also benefit from adopting them, that is, smallness is not a necessary condition for success. A good read with a boatload of interesting anecdotes to bring up in conversation.

Looking at the transition from Malthus to industrialization in Germany using real wages

A standard model with a production function concave in labor will tell you that the marginal productivity of labor, and hence the real wage, decreases as labor increases. This the core relationship in the Malthusian model and has been the reason brought forward why some have observed that England enjoyed relative prosperity after the many deaths due to the Great Plague (and why some think the same will happen to Africa due to the AIDS epidemic). Of course, empirical evidence is somewhat thin for such old times.

Ulrich Pfister, Jana Riedel and Martin Uebele add an new data point to this by construction measured of real wages in Germany for the years 1500 to 1850, which they compare to population size. And they confirm the above. The Thirty Year War, which lead to significant population loss, was a period of significantly higher welfare for the survivors than before. This kind of relationship weakened over time though, probably reflecting that new factors became important in production. And it appears this change happened before the typical date we set for the Industrial Revolution in Germany.

Universities as catalysts of the commercial revolution in the Middle Ages

Universities can have a profound impact on the economy of a region, Silicon Valley being a prime recent example. But this is usually difficult to see as they are spread pretty much everywhere now. Hence the interest in looking at older data, where universities were less common and economic activity differed a lot more across regions.

Davide Cantoni and Noam Yuchtman go way back, up to the 14th century in Germany. They compare the establishment of new market places to the founding of universities and find a surprisingly strong correlation when looking at the distance from the nearest university. Of course, you may think this is all endogenous. If a city or region develops, new market places emerge and there is critical mass or wealth for an institution of higher learning. But the authors argue there is causation from universities to markets. Indeed, the Papal Schism of 1386 was an exogenous shock that allowed the creation of universities, and they exploit the trend shift in the granting of markets around this date. The intuition of the causation is that universities provided training in law, which facilitated the creation of legal institutions and ultimately the enforcement of contracts. So, once more, institutions matters, but this is also an interesting counterexample to the intuition that lawyers create demand for there services with no economic or social benefit.

How societies can collapse

Some say that the western economies are doomed and that China is taking over as the main economic power. I do not think we are quite there yet, after all China is still not the largest economy, and by far, despite its huge population. And China may itself be at risk of a financial crisis due to its very inefficient banking system. At least it could diffuse an impeding real estate bubble, but this is not the topic of this post. The worst case scenario, however unlikely it may be, is the western society would collapse. It has happened before, so it would be interesting to learn how this could happen.

Rodrigo Pacheco, Newton Paulo Bueno, Ednando Vieira and Raissa Bragança study the collapse of the Mayan civilization, which was well organized, covered a lot of territory and had a long history. Yet it appeared to collapse within a few years in the 9th century. How could this unravel to quickly?

Their point of departure is that societies are inherently resilient. They can be subject to shocks, even large shocks, and they bounce back. Yet, sometimes they do not. What makes this happen? The main point is that dynamics are important. It is believed that a severe drought was the trigger. But this civilization had such drought before and survived. The last one was different because it brought about systemic changes. There precise nature is difficult to determine, after all we do not know that much about Mayan history. One hypothesis is that the drought brought some unrest which made it worse. For example, agriculture used terraces, which are costly to maintain and rely on the good shape of the ones uphill. Under a severe drought, maintenance may have been lacking, and after some time the terracing system fell apart, and with it probably the structure of society. In short, there needs to be the dynamics of a death spiral for a collapse to happen, but it will still take some time.