You can be a well cultured despot you know

Noah and Scott‘s argument about China’s culture is going nowhere. They’ve got bogged down talking about whether culture affects economic potential or not. Long story short, of course it does! Consider these two examples:

Chinese expats around south-east Asia seem more entrepreneurial and they sure as hell are richer than the locals in places like the Malay Peninsula and Thailand. Less fortunately, Black Africans are less trusting than other people and this is just one reason economic growth is more difficult there. Without being able to trust that someone will take your money, disappear into another room and come back with what you want there can be no Argos. And where would you be without Argos? A lot poorer. [1]

The reasons for these cultural traits are complex. I don’t know the Chinese, but Africa’s level of trust appears to still be badly effected by the long defunct institution of slavery; kidnapping was very common for 200 years or so in a way which the rest of the world hasn’t had to deal with. You can be culturally more entrepreneurial. Likewise, you can culturally more or less prone to trust strangers. Both of these have real effects for lots of things, including economics. There, cleared that one up for you.

But whether culture affects wealth given a certain set of economic institutions is irrelevant. What is important is whether culture can influence China’s institutions. China is still deep in the throws of catch up growth, entrepreneurship is of course very important, but not nearly as important as having institutions which allow for the full execution of whatever entrepreneurship occurs. As I said earlier:

No amount of “pragmatism” will make a self-interested elite step aside, the pragmatic thing to do is to expropriate assets and imprison your enemies: to shut down economic activity you’re not involved and to erect barricade between the population and your clients…

Until now, Chinese elites have not been threatened by creative destruction they have been able to harness it to embellish their own power, wealth and status. The true test of Chinese growth will come when China’s central planning runs out of steam and urban elites and rural poor separate from the CCP begin to erode its power, then we will see whether elites will be forced to do what is right.

The only way China’s culture will significantly influence its long run – at least until it reaches say half of rich world income per capita) – growth prospects is by influencing its institutions. An entrepreneurial culture, or pragmatic culture, is completely unrelated to whether China adopts a growth friendly political framework over the next five to ten years. What matters is whether the politically powerful can be convinced/forced to become economic losers. Look at those guys at the top. Do you think they’re culturally inclined to agree to that?


[1] Not sure if that translates to my non-British readers. Argos is a shop with a tiny shop front full of catalogues and a big warehouse full of stuff. You order at the front and stuff appears a few minutes later from the back. The flippancy of my reference is of course a little ruined by this extensive footnote.


Microfoundations: a beautiful theory was killed by an ugly fact

Modern economics looks like macroeconomics. Not much is important when lots of people are out of employment apart from getting those people into employment. Getting macroeconomics right is therefore very important and this is why recently the Lucas Critique has been receiving extra attention.

Lucas argued in the 1970s that macroeconomics could offer little useful advice were it built on looking at specific experiences, during specific periods, under specific policy regimes exactly because such models would only be useful in those specific episodes. Macroeconomics in the 1970s, he argued, wasn’t able to teach us anything useful about the future, which is what matters.

Disciples of Lucas had a very big win in the 1970s when they predicted successfully that the long run payoff between inflation and employment would break down. That we were heading for previously unseen combination of high inflation and high unemployment. They won that fight, and I think have kinda coasted since. So, even conceding this success, I would like to put forward three critiques of the Lucas critique.

Firstly, and most obviously, it doesn’t seem very useful, it hasn’t helped anyone in the developed world recover quickly from the little depression. In fact, it seems to have actively caused inaction in some economists who have thrown up their hands when asked for policy advice and said “its all very complicated!” The sort of people who really wound up Keynes in the 1930s.

The most useful policy advice I’ve come across macroeconomically speaking is from Scott Sumner. The advice is very simple and is, essentially, for central banks to keep very sticky prices moving along a predictable trajectory. This means keeping nominal gross domestic product growing at a steady rate along a predictable level. Employment is subdued in countries which have not seen NGDP recoveries like the UK and US and employment is catastrophically low in countries which have seen NGDP plummet like Greece and Spain.

Not a lot of “deep parameters” were necessary to arrive at a useful policy. Imagine, policy changes in a way that might affect the usefulness of Scott’s advice, for example, allowing the widespread proliferation of competing currencies as favoured by the free banking crowd, would this mean Scott’s theory is not “policy invariant” and therefore useless? Possibly, possibly not, it doesn’t matter though because right now what he proposes would be useful. That is how theories should be evaluated.

Subsidiary to this, is my confusion as to what would qualify as policy invariant, “deep parameters.” All aspects of the modern economy are unnatural to an extent; the whole edifice is upheld by the state. I’m not sure what a theory which ignored everything apart from “deep parameters” would like like, but I suspect Hobbes got closest and that wasn’t very close; I remain suspicious of what this approach has to teach us about day to day macroeconomics.

Lastly, Noah and Nick‘s posts defending Lucas’s insistence on microfounding models were very, very fact light. In fact, neither cited anything that suggested the Lucas critique had been empirically verified. This led me to find out whether there was any evidence to support the Lucas critique. It turns out In 1995 “an extensive search of the literature reveals virtually no evidence demonstrating the empirical applicability of the Lucas Critique.” [pdf] A cursory search of more recent literature hasn’t thrown up anything which says “look, proof!” to me. I’d say the last four or five years reveal a similar dearth of useful policy advice.

In summary, the most major problem of microfounding macro models is that it doesn’t seem to have helped us produce anything useful for macroeconomics. Modernmacro has cost me a lot of money in forgone earnings. It has produced some nifty statistical techniques and I’m a big fan of nifty statistical techniques, but they aren’t very useful at putting my friends and I to work.