Category Archives: Economic History

“Inventing Prizes: A Historical Perspective on Innovation Awards and Technology Policy,” B. Z. Khan (2015)

B. Zorina Khan is an excellent and underrated historian of innovation policy. In her new working paper, she questions the shift toward prizes as an innovation inducement mechanism. The basic problem economists have been grappling with is that patents are costly in terms of litigation, largely due to their uncertainty, that patents impose deadweight loss by granting inventors market power (as noted at least as far back as Nordhaus 1969), and that patent rights can lead to an anticommons which in some cases harms follow-on innovation (see Scotchmer and Green and Bessen and Maskin for the theory, and papers like Heidi Williams’ genome paper for empirics).

There are three main alternatives to patents, as I see them. First, you can give prizes, determined ex-ante or ex-post. Second, you can fund R&D directly with government, as the NIH does for huge portions of medical research. Third, you can rely on inventors accruing rents to cover the R&D without any government action, such as by keeping their invention secret, relying on first mover advantage, or having market power in complementary goods. We have quite a bit of evidence that the second, in biotech, and the third, in almost every other field, is the primary driver of innovative activity.

Prizes, however, are becoming more and more common. There are X-Prizes for space and AI breakthroughs, advanced market commitments for new drugs with major third world benefits, Kremer’s “patent buyout” plan, and many others. Setting the prize amount right is of course a challenging project (one that Kremer’s idea partially fixes), and in this sense prizes run “less automatically” than the patent system. What Khan notes is that prizes have been used frequently in the history of innovation, and were frankly common in the late 18th and 19th century. How useful were they?

Unfortunately, prizes seem to have suffered many problems. Khan has an entire book on The Democratization of Invention in the 19th century. Foreign observers, and not just Tocqueville, frequently noted how many American inventors came from humble backgrounds, and how many “ordinary people” were dreaming up new products and improvements. This frenzy was often, at the time, credited to the uniquely low-cost and comprehensive U.S. patent system. Patents were simple enough, and inexpensive enough, to submit that credit for and rights to inventions pretty regularly flowed to people who were not politically well connected, and for inventions that were not “popular”.

Prizes, as opposed to patents, often incentivized the wrong projects and rewarded the wrong people. First, prizes were too small to be economically meaningful; when the well-named Hippolyte Mège-Mouriès made his developments in margarine and garnered the prize offered by Napoleon III, the value of that prize was far less than the value of the product itself. In order to shift effort with prizes, the prize designer needs to know both enough about the social value of the proposed invention to set the prize amount high enough, and enough about the value of alternatives that the prize doesn’t distort effort away from other inventions that would be created while relying solely on trade secrecy and first mover advantage (I discuss this point in much greater depth in my Direction of Innovation paper with Jorge Lemus). Providing prizes to only some inventions may either generate no change in behavior at all because the prize is too small compared with the other benefits of inventing, or cause inefficient distortions in behavior. Even though, say, a malaria vaccine would be very useful, an enormous prize for a malaria vaccine will distort health researcher effort away from other projects in a way that is tough to calculate ex-ante without a huge amount of prize designer knowledge.

There is a more serious problem with prizes. Because the cutoff for a prize is less clear cut, there is more room for discretion and hence a role for wasteful lobbying and personal connection to trump “democratic invention”. Khan notes that even though the French buyout of Daguerre’s camera patent is cited as a classic example of a patent buyout in the famous Kremer QJE article, it turns out that Daguerre never actually held any French patent at all! What actually happened was that Daguerre lobbied the government for a sinecure in order to make his invention public, but then patented it abroad anyway! There are many other political examples, such as the failure of the uneducated clockmaker John Harrison to be granted a prize for his work on longitude due partially to the machinations of more upper class competitors who captured the ear of the prize committee. Examining a database of great inventors on both sides of the Atlantic, Khan found that prizes were often linked to factors like overcoming hardship, having an elite education, or regional ties. That is, the subjectivity of prizes may be stronger than the subjectivity of patents.

So then, we have three problems: prize designers don’t know enough about the relative import of various ideas to set price amounts optimally, prizes in practice are often too small to have much effect, and prizes lead to more lobbying and biased rewards than patents. We shouldn’t go too far here; prizes still may be an important part of the innovation policy toolkit. But the history Khan lays out certainly makes me more sanguine that they are a panacea.

One final point. I am unconvinced that patents really help the individual or small inventor very much either. I did a bit of hunting: as far as I can tell, there is not a single billionaire who got that way primarily by selling their invention. Many people developed their invention in a firm, but non-entrepreneurial invention, for which the fact that patents create a market for knowledge is supposedly paramount, doesn’t seem to be making anyone super rich. This is even though there are surely a huge number of inventions each worth billions. A good defense of patents as our main innovation policy should really grapple better with this fact.

July 2015 NBER Working Paper (RePEc IDEAS). I’m afraid the paper is gated if you don’t have an NBER subscription, and I was unable to find an ungated copy.

On the economics of the Neolithic Revolution

The Industrial and Neolithic Revolutions are surely the two fundamental transitions in the economic history of mankind. The Neolithic involved permanent settlement of previously nomadic, or at best partially foraging, small bands. At least seven independent times, bands somewhere in the world adopted settled agriculture. The new settlements tended to see an increase in inequality, the beginning of privately held property, a number of new customs and social structures, and, most importantly, an absolute decrease in welfare as measured in terms of average height and an absolute increase in the length and toil of working life. Of course, in the long run, settlement led to cities which led to the great inventions that eventually pushed mankind past the Malthusian bounds into our wealthy present, but surely no nomad of ten thousand years ago could have projected that outcome.

Now this must sound strange to any economist, as we can’t help but think in terms of rational choice. Why would any band choose to settle when, as far as we can tell, settling made them worse off? There are only three types of answers compatible with rational choice: either the environment changed such that the nomads who adopted settlement would have been even worse off had they remained nomadic, settlement was a Pareto-dominated equilibrium, or our assumption that the nomads were maximizing something correlated with height is wrong. All might be possible: early 20th century scholars ascribed the initial move to settlement to humans being forced onto oases in the drying post-Ice Age Middle East, evolutionary game theorists are well aware that fitness competitions can generate inefficient Prisoner’s Dilemmas, and humans surely care about reproductive success more than they care about food intake per se.

So how can we separate these potential explanations, or provide greater clarity as to the underlying Neolithic transition mechanism? Two relatively new papers, Andrea Matranga’s “Climate-Driven Technical Change“, and Kim Sterelny’s Optimizing Engines: Rational Choice in the Neolithic”, discuss intriguing theories about what may have happened in the Neolithic.

Matranga writes a simple Malthusian model. The benefit of being nomadic is that you can move to places with better food supply. The benefit of being sedentary is that you use storage technology to insure yourself against lean times, even if that insurance comes at the cost of lower food intake overall. Nomadism, then, is better than settling when there are lots of nearby areas with uncorrelated food availability shocks (since otherwise why bother to move?) or when the potential shocks you might face across the whole area you travel are not that severe (in which case why bother to store food?). If fertility depends on constant access to food, then for Malthusian reasons the settled populations who store food will grow until everyone is just at subsistence, whereas the nomadic populations will eat a surplus during times when food is abundant.

It turns out that global “seasonality” – or the difference across the year in terms of temperature and rainfall – was extraordinarily high right around the time agriculture first popped up in the Fertile Crescent. Matranga uses some standard climatic datasets to show that six of the seven independent inventions of agriculture appear to have happened soon after increases in seasonality in their respective regions. This is driven by an increase in seasonality and not just an increase in rainfall or heat: agriculture appears in the cold Andes and in the hot Mideast and in the moderate Chinese heartland. Further, adoption of settlement once your neighbors are farming is most common when you live on relatively flat ground, with little opportunity to change elevation to pursue food sources as seasonality increases. Biological evidence (using something called “Harris lines” on your bones) appears to support to idea that nomads were both better fed yet more subject to seasonal shocks than settled peoples.

What’s nice is that Matranga’s hypothesis is consistent with agriculture appearing many times independently. Any thesis that relies on unique features of the immediate post-Ice Age – such as the decline in megafauna like the Woolly Mammoth due to increasing population, or the oasis theory – will have a tough time explaining the adoption of agriculture in regions like the Andes or China thousands of years after it appeared in the Fertile Crescent. Alain Testart and colleagues in the anthropology literature have made similar claims about the intersection of storage technology and seasonality being important for the gradual shift from nomadism to partial foraging to agriculture, but the Malthusian model and the empirical identification in Matranga will be much more comfortable for an economist reader.

Sterelny, writing in the journal Philosophy of Science, argues that rational choice is a useful framework to explain not only why backbreaking, calorie-reducing agriculture was adopted, but also why settled societies appeared willing to tolerate inequality which was much less common in nomadic bands, and why settled societies exerted so much effort building monuments like Gobekli Tepe, holding feasts, and participating in other seemingly wasteful activity.

Why might inequality have arisen? Settlements need to be defended from thieves, as they contain stored food. Hence settlement sizes may be larger than the size of nomadic bands. Standard repeated games with imperfect monitoring tell us that when repeated interactions become less common, cooperation norms become hard to sustain. Hence collective action can only be sustained through mechanisms other than dyadic future punishment; this is especially true if farmers have more private information about effort and productivity than a band of nomadic hunters. The rise of enforceable property rights, as Bowles and his coauthors have argued, is just such a mechanism.

What of wasteful monuments like Gobekli Tepe? Game theoretic deliberate choice provides two explanations for such seeming wastefulness. First, just as animals consume energy in ostentatious displays in order to signal their fitness (as the starving animal has no energy to generate such a display), societies may construct totems and temples in order to signal to potential thieves that they are strong and not worth trifling with. In the case of Gobekli Tepe, this doesn’t appear to be the case, as there isn’t much archaeological evidence of particular violence around the monument. A second game theoretic rationale, then, is commitment by members of a society. As Sterelny puts it, the reason a gang makes a member get a face tattoo is that, even if the member leaves the gang, the tattoo still puts that member at risk of being killed by the gang’s enemies. Hence the tattoo commits the member not to defect. Settlements around Gobekli Tepe may have contributed to its building in order to commit their members to a set of norms that the monument embodied, and hence permit trade and knowledge transfer within this in-group. I would much prefer to see a model of this hypothesis, but the general point doesn’t seem impossible. At least, Sterelny and Matranga together provide a reasonably complete possible explanation, based on rational behavior and nothing more, of the seemingly-strange transition away from nomadism that made our modern life possible.

Kim Sterelny, Optimizing Engines: Rational Choice in the Neolithic?, 2013 working paper. Final version published in the July 2015 issue of Philosophy of Science. Andrea Matranga, “Climate-driven Technical Change: Seasonality and the Invention of Agriculture”, February 2015 working paper, as yet unpublished. No RePEc IDEAS page is available for either paper.

“Editor’s Introduction to The New Economic History and the Industrial Revolution,” J. Mokyr (1998)

I taught a fun three hours on the Industrial Revolution in my innovation PhD course this week. The absolutely incredible change in the condition of mankind that began in a tiny corner of Europe in an otherwise unremarkable 70-or-so years is totally fascinating. Indeed, the Industrial Revolution and its aftermath are so important to human history that I find it strange that we give people PhDs in social science without requiring at least some study of what happened.

My post today draws heavily on Joel Mokyr’s lovely, if lengthy, summary of what we know about the period. You really should read the whole thing, but if you know nothing about the IR, there are really five facts of great importance which you should be aware of.

1) The world was absurdly poor from the dawn of mankind until the late 1800s, everywhere.
Somewhere like Chad or Nepal today fares better on essentially any indicator of development than England, the wealthiest place in the world, in the early 1800s. This is hard to believe, I know. Life expectancy was in the 30s in England, infant mortality was about 150 per 1000 live births, literacy was minimal, and median wages were perhaps 3 to 4 times subsistence. Chad today has a life expectancy of 50, infant mortality of 90 per 1000, a literacy of 35%, and urban median wages of roughly 3 to 4 times subsistence. Nepal fares even better on all counts. The air from the “dark, Satanic mills” of William Blake would have made Beijing blush, “night soil” was generally just thrown on to the street, children as young as six regularly worked in mines, and 60 to 80 hours a week was a standard industrial schedule.

The richest places in the world were never more than 5x subsistence before the mid 1800s

Despite all of this, there was incredible voluntary urbanization: those dark, Satanic mills were preferable to the countryside. My own ancestors were among the Irish that fled the Potato famine. Mokyr’s earlier work on the famine, which happened in the British Isles after the Industrial Revolution, suggest 1.1 to 1.5 million people died from a population of about 7 million. This is similar to the lower end of the range for percentage killed during the Cambodian genocide, and similar to the median estimates of the death percentage during the Rwandan genocide. That is, even in the British Isles, famines that would shock the world today were not unheard of. And even if you wanted to leave the countryside, it may have been difficult to do so. After Napoleon, serfdom remained widespread east of the Elbe river in Europe, passes like the “Wanderbucher” were required if one wanted to travel, and coercive labor institutions that tied workers to specific employers were common. This is all to say that the material state of mankind before and during the Industrial Revolution, essentially anywhere in the world, would be seen as outrageous deprivation to us today; palaces like Versailles are not representative, as should be obvious, of how most people lived. Remember also that we are talking about Europe in the early 1800s; estimates of wages in other “rich” societies of the past are even closer to subsistence.

2) The average person did not become richer, nor was overall economic growth particularly spectacular, during the Industrial Revolution; indeed, wages may have fallen between 1760 and 1830.

The standard dating of the Industrial Revolution is 1760 to 1830. You might think: factories! The railroad! The steam engine! High Britannia! How on Earth could people have become poorer? And yet it is true. Brad DeLong has an old post showing Bob Allen’s wage reconstructions: Allen found British wages lower than their 1720 level in 1860! John Stuart Mill, in his 1870 textbook, still is unsure whether all of the great technological achievements of the Industrial Revolution would ever meaningfully improve the state of the mass of mankind. And Mill wasn’t the only one who noticed, there were a couple of German friends, who you may know, writing about the wretched state of the Working Class in Britain in the 1840s as well.

3) Major macro inventions, and growth, of the type seen in England in the late 1700s and early 1800s happened many times in human history.

The Iron Bridge in Shropshire, 1781, proving strength of British iron

The Industrial Revolution must surely be “industrial”, right? The dating of the IR’s beginning to 1760 is at least partially due to the three great inventions of that decade: the Watt engine, Arkwright’s water frame, and the spinning jenny. Two decades later came Cort’s famous puddling process for making strong iron. The industries affected by those inventions, cotton and iron, are the prototypical industries of England’s industrial height.

But if big macro-inventions, and a period of urbanization, are “all” that defines the Industrial Revolution, then there is nothing unique about the British experience. The Song Dynasty in China saw the gun, movable type, a primitive Bessemer process, a modern canal lock system, the steel curved moldboard plow, and a huge increase in arable land following public works projects. Netherlands in the late 16th and early 17th century grew faster, and eventually became richer, than Britain ever did during the Industrial Revolution. We have many other examples of short-lived periods of growth and urbanization: ancient Rome, Muslim Spain, the peak of the Caliphate following Harun ar-Rashid, etc.

We care about England’s growth and invention because of what followed 1830, not what happened between 1760 and 1830. England was able to take their inventions and set on a path to break the Malthusian bounds – I find Galor and Weil’s model the best for understanding what is necessary to move from a Malthusian world of limited long-run growth to a modern world of ever-increasing human capital and economic bounty. Mokyr puts it this way: “Examining British economic history in the period 1760-1830 is a bit like studying the history of Jewish dissenters between 50 B.C. and 50 A.D. At first provincial, localized, even bizarre, it was destined to change the life of every man and women…beyond recognition.”

4) It is hard for us today to understand how revolutionary ideas like “experimentation” or “probability” were.

In his two most famous books, The Gifts of Athena and The Lever of Riches, Mokyr has provided exhausting evidence about the importance of “tinkerers” in Britain. That is, there were probably something on the order of tens of thousands of folks in industry, many not terribly well educated, who avidly followed new scientific breakthroughs, who were aware of the scientific method, who believed in the existence of regularities which could be taken advantage of by man, and who used systematic processes of experimentation to learn what works and what doesn’t (the development of English porter is a great case study). It is impossible to overstate how unusual this was. In Germany and France, science was devoted mainly to the state, or to thought for thought’s sake, rather than to industry. The idea of everyday, uneducated people using scientific methods somewhere like ar-Rashid’s Baghdad is inconceivable. Indeed, as Ian Hacking has shown, it wasn’t just that fundamental concepts like “probabilistic regularities” were difficult to understand: the whole concept of discovering something based on probabilistic output would not have made sense to all but the very most clever person before the Enlightenment.

The existence of tinkerers with access to a scientific mentality was critical because it allowed big inventions or ideas to be refined until they proved useful. England did not just invent the Newcomen engine, put it to work in mines, and then give up. Rather, England developed that Newcomen engine, a boisterous monstrosity, until it could profitably be used to drive trains and ships. In Gifts of Athena, Mokyr writes that fortune may sometimes favor the unprepared mind with a great idea; however, it is the development of that idea which really matters, and to develop macroinventions you need a small but not tiny cohort of clever, mechanically gifted, curious citizens. Some have given credit to a political system, or to the patent system, for the widespread tinkering, but the qualitative historical evidence I am aware of appears to lean toward cultural explanations most strongly. One great piece of evidence is that contemporaries wrote often about the pattern where Frenchmen invented something of scientific importance, yet the idea diffused and was refined in Britain. Any explanation of British uniqueness must depend on Britain’s ability to refine inventions.

5) The best explanations for “why England? why in the late 1700s? why did growth continue?” do not involve colonialism, slavery, or famous inventions.

First, we should dispose of colonialism and slavery. Exports to India were not particularly important compared to exports to non-colonial regions, slavery was a tiny portion of British GDP and savings, and many other countries were equally well-disposed to profit from slavery and colonialism as of the mid-1700s, yet the IR was limited to England. Expanding beyond Europe, Dierdre McCloskey notes that “thrifty self-discipline and violent expropriation have been too common in human history to explain a revolution utterly unprecedented in scale and unique to Europe around 1800.” As for famous inventions, we have already noted how common bursts of cleverness were in the historic record, and there is nothing to suggest that England was particularly unique in its macroinventions.

To my mind, this leaves two big, competing explanations: Mokyr’s argument that tinkerers and a scientific mentality allowed Britain to adapt and diffuse its big inventions rapidly enough to push the country over the Malthusian hump and into a period of declining population growth after 1870, and Bob Allen’s argument that British wages were historically unique. Essentially, Allen argues that British wages were high compared to its capital costs from the Black Death forward. This means that labor-saving inventions were worthwhile to adopt in Britain even when they weren’t worthwhile in other countries (e.g., his computations on the spinning jenny). If it worthwhile to adopt certain inventions, then inventors will be able to sell something, hence it is worthwhile to invent certain inventions. Once adopted, Britain refined these inventions as they crawled down the learning curve, and eventually it became worthwhile for other countries to adopt the tools of the Industrial Revolution. There is a great deal of debate about who has the upper hand, or indeed whether the two views are even in conflict. I do, however, buy the argument, made by Mokyr and others, that it is not at all obvious that inventors in the 1700s were targeting their inventions toward labor saving tasks (although at the margin we know there was some directed technical change in the 1860s), nor it is even clear that invention overall during the IR was labor saving (total working hours increased, for instance).

Mokyr’s Editor’s Introduction to “The New Economic History and the Industrial Revolution” (no RePEc IDEAS page). He has a followup in the Journal of Economic History, 2005, examining further the role of an Enlightenment mentality in allowing for the rapid refinement and adoption of inventions in 18th century Britain, and hence the eventual exit from the Malthusian trap.

“Entrepreneurship: Productive, Unproductive and Destructive,” W. Baumol (1990)

William Baumol, who strikes me as one of the leading contenders for a Nobel in the near future, has written a surprising amount of interesting economic history. Many economic historians see innovation – the expansion of ideas and the diffusion of products containing those ideas, generally driven by entrepreneurs – as critical for growth. But we find it very difficult to see any reason why the “spirit of innovation” or the net amount of cleverness in society is varying over time. Indeed, great inventions, as undeveloped ideas, occur almost everywhere at almost all times. The steam engine of Heron of Alexandria, which was used for parlor tricks like opening temple doors and little else, is surely the most famous example of a great idea, undeveloped.

Why, then, do entrepreneurs develop ideas and cause products to diffuse widely at some times in history and not at others? Schumpeter gave five roles for an entrepreneur: introducing new products, new production methods, new markets, new supply sources or new firm and industry organizations. All of these are productive forms of entrepreneurship. Baumol points out that clever folks can also spend their time innovating new war implements, or new methods of rent seeking, or new methods of advancing in government. If incentives are such that those activities are where the very clever are able to prosper, both financially and socially, then it should be no surprise that “entrepreneurship” in this broad sense is unproductive or, worse, destructive.

History offers a great deal of support here. Despite quite a bit of productive entrepreneurship in the Middle East before the rise of Athens and Rome, the Greeks and Romans, especially the latter, are well-known for their lack of widespread diffusion of new productive innovations. Beyond the steam engine, the Romans also knew of the water wheel yet used it very little. There are countless other examples. Why? Let’s turn to Cicero: “Of all the sources of wealth, farming is the best, the most able, the most profitable, the most noble.” Earning a governorship and stripping assets was also seen as noble. What we now call productive work? Not so much. Even the freed slaves who worked as merchants had the goal of, after acquiring enough money, retiring to “domum pulchram, multum serit, multum fenerat”: a fine house, land under cultivation and short-term loans for voyages.

Baumol goes on to discuss China, where passing the imperial exam and moving into government was the easiest way to wealth, and the early middle ages of Europe, where seizing assets from neighboring towns was more profitable than expanding trade. The historical content of Baumol’s essay was greatly expanded in a book he edited alongside Joel Mokyr and David Landes called The Invention of Enterprise, which discusses the relative return to productive entrepreneurship versus other forms of entrepreneurship from Babylon up to post-war Japan.

The relative incentives for different types of “clever work” are relevant today as well. Consider Luigi Zingales’ new lecture, Does Finance Benefit Society? I can’t imagine anyone would consider Zingales hostile to the financial sector, but he nonetheless discusses in exhaustive detail the ways in which incentives push some workers in that sector toward rent-seeking and fraud rather than innovation which helps the consumer.

Final JPE copy (RePEc IDEAS). Murphy, Schleifer and Vishny have a paper, also from the JPE in 1990, on the topic of how clever people in many countries are incentivized toward rent-seeking; their work is more theoretical and empirical than historical. If you are interested in innovation and entrepreneurship, I uploaded the reading list for my PhD course on the topic here.

“Forced Coexistence and Economic Development: Evidence from Native American Reservations,” C. Dippel (2014)

I promised one more paper from Christian Dippel, and it is another quite interesting one. There is lots of evidence, folk and otherwise, that combining different ethnic or linguistic groups artificially, as in much of the ex-colonial world, leads to bad economic and governance outcomes. But that’s weird, right? After all, ethnic boundaries are themselves artificial, and there are tons of examples – Italy and France being the most famous – of linguistic diversity quickly fading away once a state is developed. Economic theory (e.g., a couple recent papers by Joyee Deb) suggests an alternative explanation: groups that have traditionally not worked with each other need time to coordinate on all of the Pareto-improving norms you want in a society. That is, it’s not some kind of intractable ethnic hate, but merely a lack of trust that is the problem.

Dippel uses the history of American Indian reservations to examine the issue. It turns out that reservations occasionally included different subtribal bands even though they almost always were made up of members of a single tribe with a shared language and ethnic identity. For example, “the notion of tribe in Apachean cultures is very weakly developed. Essentially it was only a recognition
that one owed a modicum of hospitality to those of the same speech, dress, and customs.” Ethnographers have conveniently constructed measures of how integrated governance was in each tribe prior to the era of reservations; some tribes had very centralized governance, whereas others were like the Apache. In a straight OLS regression with the natural covariates, incomes are substantially lower on reservations made up of multiple bands that had no pre-reservation history of centralized governance.

Why? First, let’s deal with identification (more on what that means in a second). You might naturally think that, hey, tribes with centralized governance in the 1800s were probably quite socioeconomically advanced already: think Cherokee. So are we just picking up that high SES in the 1800s leads to high incomes today? Well, in regions with lots of mining potential, bands tended to be grouped onto one reservation more frequently, which suggests that resource prevalence on ancestral homelands outside of the modern reservation boundaries can instrument for the propensity for bands to be placed together. Instrumented estimates of the effect of “forced coexistence” is just as strong as the OLS estimate. Further, including tribe fixed effects for cases where single tribes have a number of reservations, a surprisingly common outcome, also generates similar estimates of the effect of forced coexistence.

I am very impressed with how clear Dippel is about what exactly is being identified with each of these techniques. A lot of modern applied econometrics is about “identification”, and generally only identifies a local average treatment effect, or LATE. But we need to be clear about LATE – much more important than “what is your identification strategy” is an answer to “what are you identifying anyway?” Since LATE identifies causal effects that are local conditional on covariates, and the proper interpretation of that term tends to be really non-obvious to the reader, it should go without saying that authors using IVs and similar techniques ought be very precise in what exactly they are claiming to identify. Lots of quasi-random variation generates that variation along a local margin that is of little economic importance!

Even better than the estimates is an investigation of the mechanism. If you look by decade, you only really see the effect of forced coexistence begin in the 1990s. But why? After all, the “forced coexistence” is longstanding, right? Think of Nunn’s famous long-run effect of slavery paper, though: the negative effects of slavery are mediated during the colonial era, but are very important once local government has real power and historically-based factionalism has some way to bind on outcomes. It turns out that until the 1980s, Indian reservations had very little local power and were largely run as government offices. Legal changes mean that local power over the economy, including the courts in commercial disputes, is now quite strong, and anecdotal evidence suggests lots of factionalism which is often based on longstanding intertribal divisions. Dippel also shows that newspaper mentions of conflict and corruption at the reservation level are correlated with forced coexistence.

How should we interpret these results? Since moving to Canada, I’ve quickly learned that Canadians generally do not subscribe to the melting pot theory; largely because of the “forced coexistence” of francophone and anglophone populations – including two completely separate legal traditions! – more recent immigrants are given great latitude to maintain their pre-immigration culture. This heterogeneous culture means that there are a lot of actively implemented norms and policies to help reduce cultural division on issues that matter to the success of the country. You might think of the problems on reservations and in Nunn’s post-slavery states as a problem of too little effort to deal with factionalism rather than the existence of the factionalism itself.

Final working paper, forthcoming in Econometrica. No RePEc IDEAS version. Related to post-colonial divisions, I also very much enjoyed Mobilizing the Masses for Genocide by Thorsten Rogall, a job market candidate from IIES. When civilians slaughter other civilians, is it merely a “reflection of ancient ethnic hatred” or is it actively guided by authority? In Rwanda, Rogall finds that almost all of the killing is caused directly or indirectly by the 50,000-strong centralized armed groups who fanned out across villages. In villages that were easier to reach (because the roads were not terribly washed out that year), more armed militiamen were able to arrive, and the more of them that arrived, the more deaths resulted. This in-person provoking appears much more important than the radio propaganda which Yanigazawa-Drott discusses in his recent QJE; one implication is that post-WW2 restrictions on free speech in Europe related to Nazism may be completely misdiagnosing the problem. Three things I especially liked about Rogall’s paper: the choice of identification strategy is guided by a precise policy question which can be answered along the local margin identified (could a foreign force stopping these centralized actors a la Romeo Dallaire have prevented the genocide?), a theoretical model allows much more in-depth interpretation of certain coefficients (for instance, he can show that most villages do not appear to have been made up of active resistors), and he discusses external cases like the Lithuanian killings of Jews during World War II, where a similar mechanism appears to be at play. I’ll have many more posts on cool job market papers coming shortly!

“The Rents from Sugar and Coercive Institutions: Removing the Sugar Coating,” C. Dippel, A. Greif & D. Trefler (2014)

Today, I’ve got two posts about some new work by Christian Dippel, an economic historian at UCLA Anderson who is doing some very interesting theoretically-informed history; no surprise to see Greif and Trefler as coauthors on this paper, as they are both prominent proponents of this analytical style.

The authors consider the following puzzle: sugar prices absolutely collapse during the mid and late 1800s, largely because of the rise of beet sugar. And yet, wages in the sugar-dominant British colonies do not appear to have fallen. This is odd, since all of our main theories of trade suggest that when an export price falls, the price of factors used to produce that export also fall (this is less obvious than just marginal product falling, but still true).

The economics seem straightforward enough, so what explains the empirical result? Well, the period in question is right after the end of slavery in the British Empire. There were lots of ways in which the politically powerful could use legal or extralegal means to keep wages from rising to marginal product. Suresh Naidu, a favorite of this blog, has a number of papers on labor coercion everywhere from the UK in the era of Master and Servant Law, to the US South post-reconstruction, to the Middle East today; actually, I understand he is writing a book on the subject which, if there is any justice, has a good shot at being the next Pikettyesque mainstream hit. Dippel et al quote a British writer in the 1850s on the Caribbean colonies: “we have had a mass of colonial legislation, all dictated by the most short-sighted but intense and disgraceful selfishness, endeavouring to restrict free labour by interfering with wages, by unjust taxation, by unjust restrictions, by oppressive and unequal laws respecting contracts, by the denial of security of [land] tenure, and by impeding the sale of land.” In particular, wages rose rapidly right after slavery ended in 1838, but those gains were clawed back by the end of 1840s due to “tenancy-at-will laws” (which let employers seize some types of property if workers left), trespass and land use laws to restrict freeholding on abandoned estates and Crown land, and emigration restrictions.

What does labor coercion have to do with wages staying high as sugar prices collapse? The authors write a nice general equilibrium model. Englishmen choose whether to move to the colonies (in which case they get some decent land) or to stay in England at the outside wage. Workers in the Caribbean can either take a wage working sugar which depends on bargaining power, or they can go work marginal freehold land. Labor coercion rules limit the ability of those workers to work some land, so the outside option of leaving the sugar plantation is worse the more coercive institutions are. Governments maximize a weighted combination of Englishmen and local wages, choosing the coerciveness of institutions. The weight on Englishmen wages is higher the more important sugar exports and their enormous rents are to the local economy. In partial equilibrium, then, if the price of sugar falls exogenously, the wages of workers on sugar plantations falls (as their MP goes down), the number of locals willing to work sugar falls, hence the number of Englishman willing to stay falls (as their profit goes down). With few plantations, sugar rents become less important, labor coercion falls, opening up more marginal land for freeholders, which causes even more workers to leave sugar plantations and improves wages for those workers. However, if sugar is very important, the government places a lot of weight on planter income in the social welfare function, hence responds to a fall in sugar prices by increasing labor coercion, lowering the outside option of workers, keeping them on the sugar plantations, where they earn lower wages than before for the usual economic reasons. That is, if sugar is really important, coercive institutions will be retained, the economic structure will be largely unchanged in response to a fall in world sugar prices, and hence wages will fall, but if sugar is only of marginal importance, a fall in sugar prices leads the politically powerful to leave, lowering the political strength of the planter class, thus causing coercive labor institutions to decline, allowing workers to reallocate such that wages approach marginal product; since the MP of options other than sugar may be higher than the wage paid to sugar workers, this reallocation caused by the decline of sugar prices can cause wages in the colony to increase.

The British, being British, kept very detailed records of things like incarceration rates, wages, crop exports, and the like, and the authors find a good deal of empirical evidence for the mechanism just described. To assuage worries about the endogeneity of planter power, they even get a subject expert to construct a measure of geographic suitability for sugar in each of 14 British Caribbean colonies, and proxies for planter power with the suitability of marginal land for sugar production. Interesting work all around.

What should we take from this? That legal and extralegal means can be used to keep factor rents from approaching their perfect competition outcome: well, that is something essentially every classical economist from Smith to Marx has described. The interesting work here is the endogeneity of factor coercion. There is still some debate about much we actually know about whether these endogenous institutions (or, even more so, the persistence of institutions) have first-order economic effects; see a recent series of posts by Dietz Vollrath for a skeptical view. I find this paper by Dippel et al, as well as recent work by Naidu and Hornbeck, are the cleanest examples of how exogenous shocks affect institutions, and how those institutions then affect economic outcomes of great importance.

December 2014 working paper (no RePEc IDEAS version)

Labor Unions and the Rust Belt

I’ve got two nice papers for you today, both exploring a really vexing question: why is it that union-heavy regions of the US have fared so disastrously over the past few decades? In principle, it shouldn’t matter: absent any frictions, a rational union and a profit-maximizing employer ought both desire to take whatever actions generate the most total surplus for the firm, with union power simply affecting how those rents are shared between management, labor and owners. Nonetheless, we notice empirically a couple of particularly odd facts. First, especially in the US, union-dominated firms tend to limit adoption of new, productivity-enhancing technology; the late adoption of the radial tire among U.S. firms is a nice example. Second, unions often negotiate not only about wages but about “work rules”, insisting upon conditions like inflexible employee roles. A great example here is a California longshoremen contract which insisted upon a crew whose sole job was to stand and watch while another crew did the job. Note that preference for leisure can’t explain this, since surely taking that leisure at home rather than standing around the worksite would be preferable for the employees!

What, then, might drive unions to push so hard for seemingly “irrational” contract terms, and how might union bargaining power under various informational frictions or limited commitment affect the dynamic productivity of firms? “Competition, Work Rules and Productivity” by the BEA’s Benjamin Bridgman discusses the first issue, and a new NBER working paper, “Competitive Pressure and the Decline of the Rust Belt: A Macroeconomic Analysis” by Alder, Lagakos and Ohanian covers the second; let’s examine these in turn.

First, work rules. Let a union care first about keeping all members employed, and about keeping wage as high as possible given full employment. Assume that the union cannot negotiate the price at which products are sold. Abstractly, work rules are most like a fixed cost that is a complete waste: no matter how much we produce, we have to incur some bureaucratic cost of guys standing around and the like. Firms will set marginal revenue equal to marginal cost when deciding how much to produce, and at what price that production should be sold. Why would the union like these wasteful costs?

Let firm output given n workers just be n-F, where n is the number of employees, and F is how many of them are essentially doing nothing because of work rules. The firm chooses price p and the number of employees n given demand D(p) and wage w to maximize p*D(p)-w*n, subject to total production being feasible D(p)=n-F. Note that, as long as total firm profits under optimal pricing exceed F, the firm stays in business and its pricing decision, letting marginal revenue equal marginal cost, is unaffected by F. That is, the optimal production quantity does not depend on F. However, the total amount of employment does depend on F, since to produce quantity D(p) you need to employ n-F workers. Hence there is a tradeoff if the union only negotiates wages: to employ more people, you need a lower wage, but using wasteful work rules, employment can be kept high even when wages are raised. Note also that F is limited by the total rents earned by the firm, since if work rules are particularly onerous, firms that are barely breaking even without work rules will simply shut down. Hence in more competitive industries (formally, when demand is less elastic), work rules are less likely to imposed by unions. Bridgman also notes that if firms can choose technology (output is An-F, where A is the level of technology), then unions will resist new technology unless they can impose more onerous work rules, since more productive technology lowers the number of employees needed to produce a given amount of output.

This is a nice result. Note that the work rule requirements have nothing to do with employees not wanting to work hard, since work rules in the above model are a pure waste and generate no additional leisure time for workers. Of course, this result really hinges on limiting what unions can bargain over: if they can select the level of output, or can impose the level of employment directly, or can permit lump-sum transfers from management to labor, then unionized firms will produce at the same productivity at non-unionized firms. Information frictions, among other worries, might be a reason why we don’t see these types of contracts at some unionized firms. With this caveat in mind, let’s turn to the experience of the Rust Belt.

The U.S. Rust Belt, roughly made up of states surrounding the Great Lakes, saw a precipitous decline from the 1950s to today. Alder et al present the following stylized facts: the share of manufacturing employment in the U.S. located in the Rust Belt fell from the 1950s to the mid-1980s, there was a large wage gap between Rust Belt and other U.S. manufacturing workers during this period, Rust Belt firms were less likely to adopt new innovations, and labor productivity growth in Rust Belt states was lower than the U.S. average. After the mid-1980s, Rust Belt manufacturing firms begin to look a lot more like manufacturing firms in the rest of the U.S.: the wage gap is essentially gone, the employment share stabilizes, strikes become much less common, and productivity growth is similar. What happened?

In a nice little model, the authors point out that output competition (do I have lots of market power?) and labor market bargaining power (are my workers powerful enough to extract a lot of my rents?) interact in an interesting way when firms invest in productivity-increasing technology and when unions cannot commit to avoid a hold-up problem by striking for a better deal after the technology investment cost is sunk. Without commitment, stronger unions will optimally bargain away some of the additional rents created by adopting an innovation, hence unions function as a type of tax on innovation. With sustained market power, firms have an ambiguous incentive to adopt new technology – on the one hand, they already have a lot of market power and hence better technology will not accrue too many more sales, but on the other hand, having market power in the future makes investments today more valuable. Calibrating the model with reasonable parameters for market power, union strength, and various elasticities, the authors find that roughly 2/3 of the decline in the Rust Belt’s manufacturing share can be explained by strong unions and little output market competition decreasing the incentive to invest in upgrading technology. After the 1980s, declining union power and more foreign competition limited both disincentives and the Rust Belt saw little further decline.

Note again that unions and firms rationally took actions that lowered the total surplus generated in their industry, and that if the union could have committed not to hold up the firm after an innovation was adopted, optimal technology adoption would have been restored. Alder et al cite some interesting quotes from union heads suggesting that the confrontational nature of U.S. management-union relations led to a belief that management figures out profits, and unions figure out to secure part of that profit for their members. Both papers discussed here show that this type of division, by limiting the nature of bargains which can be struck, can have calamitous effects for both workers and firms.

Bridgman’s latest working paper version is here (RePEc IDEAS page); the latest version of Adler, Lagakos and Ohanian is here (RePEc IDEAS). David Lagakos in particular has a very nice set of recent papers about why services and agriculture tend to have such low productivity, particularly in the developing world; despite his macro background, I think he might be a closet microeconomist!

“International Trade and Institutional Change: Medieval Venice’s Response to Globalization,” D. Puga & D. Trefler

(Before discussing the paper today, I should forward a couple great remembrances of Stanley Reiter, who passed away this summer, by Michael Chwe (whose interests at the intersection of theory and history are close to my heart) and Rakesh Vohra. After leaving Stanford – Chwe mentions this was partly due to a nasty letter written by Reiter’s advisor Milton Friedman! – Reiter established an incredible theory group at Purdue which included Afriat, Vernon Smith and PhD students like Sonnenschein and Ledyard. He then moved to Northwestern where he helped build up the great group in MEDS which is too long to list, but which includes one Nobel winner already in Myerson and, by my reckoning, two more which are favorites to win the prize next Monday.

I wonder if we may be at the end of an era for topic-diverse theory departments. Business schools are all a bit worried about “Peak MBA”, and theorists are surely the first ones out the door when enrollment falls. Economic departments, journals and funders seem to have shifted, in the large, toward more empirical work, for better or worse. Our knowledge both of how economic and social interactions operate in their most platonic form, and our ability to interpret empirical results when considering novel or counterfactual policies, have greatly benefited by the theoretical developments following Samuelson and Hicks’ mathematization of primitives in the 1930s and 40s, and the development of modern game theory and mechanism design in the 1970s and 80s. Would that a new Cowles and a 21st century Reiter appear to help create a critical mass of theorists again!)

On to today’s paper, a really interesting theory-driven piece of economic history. Venice was one of the most important centers of Europe’s “commercial revolution” between the 10th and 15th century; anyone who read Marco Polo as a schoolkid knows of Venice’s prowess in long-distance trade. Among historians, Venice is also well-known for the inclusive political institutions that developed in the 12th century, and the rise of oligarchy following the “Serrata” at the end of the 13th century. The Serrata was followed by a gradual decrease in Venice’s power in long-distance trade and a shift toward manufacturing, including the Murano glass it is still famous for today. This is a fairly worrying history from our vantage point today: as the middle class grew wealthier, democratic forms of government and free markets did not follow. Indeed, quite the opposite: the oligarchs seized political power, and within a few decades of the serrata restricted access to the types of trade that previously drove wealth mobility. Explaining what happened here is both a challenge due to limited data, and of great importance given the public prominence of worries about the intersection of growing inequality and corruption of the levers of democracy.

Dan Trefler, an economic historian here at U. Toronto, and Diego Puga, an economist at CEMFI who has done some great work in economic geography, provide a great explanation of this history. Here’s the model. Venice begins with lots of low-wealth individuals, a small middle and upper class, and political power granted to anyone in the upper class. Parents in each dynasty can choose to follow a risky project – becoming a merchant in a long-distance trading mission a la Niccolo and Maffeo Polo – or work locally in a job with lower expected pay. Some of these low and middle class families will succeed on their trade mission and become middle and upper class in the next generation. Those with wealth can sponsor ships via the colleganza, a type of early joint-stock company with limited liability, and potentially join the upper class. Since long-distance trade is high variance, there is a lot of churn across classes. Those with political power also gather rents from their political office. As the number of wealthy rise in the 11th and 12th century, the returns to sponsoring ships falls due to competition across sponsors in the labor and export markets. At any point, the upper class can vote to restrict future entry into the political class by making political power hereditary. They need to include sufficiently many powerful people in this hereditary class or there will be a revolt. As the number of wealthy increase, eventually the wealthy find it worthwhile to restrict political power so they can keep political rents within their dynasty forever. Though political power is restricted, the economy is still free, and the number of wealthy without power continue to grow, lowering the return to wealth for those with political power due to competition in factor and product markets. At some point, the return is so low that it is worth risking revolt from the lower classes by restricting entry of non-nobles into lucrative industries. To prevent revolt, a portion of the middle classes are brought in to the hereditary political regime, such that the regime is powerful enough to halt a revolt. Under these new restrictions, lower classes stop engaging in long-distance trade and instead work in local industry. These outcomes can all be generated with a reasonable looking model of dynastic occupation choice.

What historical data would be consistent with this theoretical mechanism? We should expect lots of turnover in political power and wealth in the 10th through 13th centuries. We should find examples in the literature of families beginning as long-distance traders and rising to voyage sponsors and political agents. We should see a period of political autocracy develop, followed later by the expansion of hereditary political power and restrictions on lucrative industry entry to those with such power. Economic success based on being able to activate large amounts of capital from within the nobility class will make the importance of inter-family connections more important in the 14th and 15th centuries than before. Political power and participation in lucrative economic ventures will be limited to a smaller number of families after this political and economic closure than before. Those left out of the hereditary regime will shift to local agriculture and small-scale manufacturing.

Indeed, we see all of these outcomes in Venetian history. Trefler and Puga use some nice techniques to get around limited data availability. Since we don’t have data on family incomes, they use the correlation in eigenvector centrality within family marriage networks as a measure of the stability of the upper classes. They code colleganza records – a non-trivial task involving searching thousands of scanned documents for particular Latin phrases – to investigate how often new families appear in these records, and how concentration in the funding of long-distance trade changes over time. They show that all of the families with high eigenvector centrality in the noble marriage market after political closure – a measure of economic importance, remember – were families that were in the top quartile of seat-share in the pre-closure Venetian legislature, and that those families which had lots of political power pre-closure but little commercial success thereafter tended to be unsuccessful in marrying into lucrative alliances.

There is a lot more historical detail in the paper, but as a matter of theory useful to the present day, the Venetian experience ought throw cold water on the idea that political inclusiveness and economic development always form a virtuous circle. Institutions are endogenous, and changes in the nature of inequality within a society following economic development alter the potential for political and economic crackdowns to survive popular revolt.

Final published version in QJE 2014 (RePEc IDEAS). A big thumbs up to Diego for having the single best research website I have come across in five years of discussing papers in this blog. Every paper has an abstract, well-organized replication data, and a link to a locally-hosted version of the final published paper. You may know his paper with Nathan Nunn on how rugged terrain in Africa is associated with good economic outcomes today because slave traders like the infamous Tippu Tip couldn’t easily exploit mountainous areas, but it’s also worth checking out his really clever theoretical disambiguation of why firms in cities are more productive, as well as his crazy yet canonical satellite-based investigation of the causes of sprawl. There is a really cool graphic on the growth of U.S. sprawl at that last link!

“Organizing Venture Capital: The Rise and Demise of American Research and Development Corporation, 1946-1973,” D. Hsu & M. Kenney (2005)

Venture capital financing of innovative firms feels like a new phenomenon, and is clearly of great importance to high tech companies as well as cities that hope to attract these companies. The basic principle involves relatively small numbers of wealthy individuals providing long-term financing to a group of managers who seek out early-stage, unprofitable firms, make an investment (generally equity), and occasionally help actively manage the company.

There are many other ways firms can fund themselves: issuance of equity, investment from friends or family, investment from an existing firm in a spinoff, investment from the saved funds of an individual, or debt loans from a bank, among others. Two questions, then, are immediate: why does anyone fund with VC in the first place, and how did this institutional form come about? VC is strange at first glance: in a stage in which entrepreneur effort is particularly important, why would I write a financing contract which takes away some of the upside of working hard on the part of the entrepreneur by diluting her ownership share? Two things are worth noting. VC rather than debt finance is particularly common when returns are highly skewed – a bank loan can only be repaid with interest, hence will have trouble capturing that upside. Second, early-stage equity finance and active managerial assistance appear to come bundled, hence some finance folks have argued that the moral hazard problem lies both with the entrepreneur, who must be incentivized to work hard, and with the VC firm and their employees, who need the same incentive.

Let’s set aside the question of entrepreneurial finance, and look into history. Though something like venture capital appeared to be important in the Second Industrial Revolution (see, e.g., Lamoreaux et al (2006) on that hub of high-tech, Cleveland!), and it may have existed in a proto-form as early as the 1700s with the English country banks (though I am not totally convinced of that equivalence), the earliest modern VC firm was Boston’s American Research and Development Corporation. The decline of textiles hit New England hard in the 1920s and 1930s. A group of prominent blue bloods, including the President of MIT and the future founder of INSEAD, had discussed the social need for an organization that would fund firms which could potentially lead to new industries, and they believed that despite this social goal, the organization ought be a profit-making concern if it were to be successful in the long run.

After a few false starts, the ARD formed in 1946, a time of widespread belief in the power of R&D following World War II and Vannevar Bush’s famous “Science: the Endless Frontier”. ARD was organized as a closed-end investment trust, which permitted institutional investors to contribute. Investments tended to be solicited, were very likely to be made to New England firms, and were, especially in the first few years, concentrated in R&D intensive companies; local, solicited, R&D heavy investment is even today the most common type of VC. Management was often active, and there are reports of entire management teams being replaced by ARD if they felt the firm was not growing quickly enough.

So why have you never of ARD, then? Two reasons: returns, and organizational structure. ARD’s returns over the 50s and 60s were barely higher, even before fees, than the S&P 500 as a whole. And this overstates things: an investment in Digital Equipment, the pioneering minicomputer company, was responsible for the vast majority of profits. No surprise, then, that even early VCs had highly skewed returns. More problematic was competition. A 1958 law permitted Small Business Investment Corporations (SBICs) to make VC-style investments at favorable tax rates, and the organizational form of limited partnership VC was less constrained by the SEC than a closed-end investment fund. In particular, the partnerships “2 and 20” structure meant that top investment managers could earn much more money at that type of firm than at ARD. One investment manager at ARD put a huge amount of effort into developing a company called Optical Scanning, whose IPO made the founder $10 million. The ARD employee, partially because of SEC regulations, earned a $2000 bonus. By 1973, ARD had been absorbed into another company, and was for all practical purposes defunct.

It’s particularly interesting, though, that the Boston Brahmins were right: VC has been critical in two straight resurgences in the New England economy, the minicomputer cluster of the 1960s, and the more recent Route 128 biotech cluster, both of which were the world’s largest. New England, despite the collapse of textiles, has not gone the way of the rust belt – were it a country, it would be wealthier per capita than all but a couple of microstates. And yet, ARD as a profitmaking enterprise went kaput rather quickly. Yet more evidence of the danger of being a market leader – not only can other firms avoid your mistakes, but they can also take advantage of more advantageous organizational forms and laws that are permitted or created in response to your early success!

Final published version, in Industrial and Corporate Change 2005 (RePEc IDEAS).

“The Rise and Fall of General Laws of Capitalism,” D. Acemoglu & J. Robinson (2014)

If there is one general economic law, it is that every economist worth their salt is obligated to put out twenty pages responding to Piketty’s Capital. An essay by Acemoglu and Robinson on this topic, though, is certainly worth reading. They present three particularly compelling arguments. First, in a series of appendices, they follow Debraj Ray, Krusell and Smith and others in trying to clarify exactly what Piketty is trying to say, theoretically. Second, they show that it is basically impossible to find any effect of the famed r-g on top inequality in statistical data. Third, they claim that institutional features are much more relevant to the impact of economic changes on societal outcomes, using South Africa and Sweden as examples. Let’s tackle these in turn.

First, the theory. It has been noted before that Piketty is, despite beginning his career as a very capable economist theorist (hired at MIT at age 22!), very disdainful of the prominence of theory. He, quite correctly, points out that we don’t even have any descriptive data on a huge number of topics of economic interest, inequality being principal among these. And indeed he is correct! But, shades of the Methodenstreit, he then goes on to ignore theory where it is most useful, in helping to understand, and extrapolate from, his wonderful data. It turns out that even in simple growth models, not only is it untrue that r>g necessarily holds, but the endogeneity of r and our standard estimates of the elasticity of substitution between labor and capital do not at all imply that capital-to-income ratios will continue to grow (see Matt Rognlie on this point). Further, Acemoglu and Robinson show that even relatively minor movement between classes is sufficient to keep the capital share from skyrocketing. Do not skip the appendices to A and R’s paper – these are what should have been included in the original Piketty book!

Second, the data. Acemoglu and Robinson point out, and it really is odd, that despite the claims of “fundamental laws of capitalism”, there is no formal statistical investigation of these laws in Piketty’s book. A and R look at data on growth rates, top inequality and the rate of return (either on government bonds, or on a computed economy-wide marginal return on capital), and find that, if anything, as r-g grows, top inequality shrinks. All of the data is post WW2, so there is no Great Depression or World War confounding things. How could this be?

The answer lies in the feedback between inequality and the economy. As inequality grows, political pressures change, the endogenous development and diffusion of technology changes, the relative use of capital and labor change, and so on. These effects, in the long run, dominate any “fundamental law” like r>g, even if such a law were theoretically supported. For instance, Sweden and South Africa have very similar patterns of top 1% inequality over the twentieth century: very high at the start, then falling in mid-century, and rising again recently. But the causes are totally different: in Sweden’s case, labor unrest led to a new political equilibrium with a high-growth welfare state. In South Africa’s case, the “poor white” supporters of Apartheid led to compressed wages at the top despite growing black-white inequality until 1994. So where are we left? The traditional explanations for inequality changes: technology and politics. And even without r>g, these issues are complex and interesting enough – what could be a more interesting economic problem for an American economist than diagnosing the stagnant incomes of Americans over the past 40 years?

August 2014 working paper (No IDEAS version yet). Incidentally, I have a little tracker on my web browser that lets me know when certain pages are updated. Having such a tracker follow Acemoglu’s working papers pages is, frankly, depressing – how does he write so many papers in such a short amount of time?


Get every new post delivered to your Inbox.

Join 270 other followers

%d bloggers like this: