Wednesday 29 February 2012

Not good thinking

From Stuff comes the news that:
All Black great Chris Laidlaw believes the crisis in Otago rugby highlights the need for provincial rugby to return to its amateur roots.
Not good thinking. Either Otago (and other amateur teams) will lose all its good players to (semi-)professional teams or we will see all teams being amateur and we are back to the bad old days of under the table payments to these "amateur players", which was one of the reasons for going pro in the first place.

Or good players head to professional teams overseas. Or the good players play only in the professional leagues (Super Rugby and the ABs) and we never see them at the provincial level.

Or some combination of the above. All in all not a good outlook.

Tuesday 28 February 2012

Is China’s economic future a rosy one?

So asks Gary Becker. He writes,
Starting with the opening of agriculture to private incentives in the late 1970s, China has experienced faster and more prolonged economic growth than any other country. In a mere three decades China has moved from a very poor nation to a middle-income level country, a development that pulled hundreds of millions of Chinese out of poverty. China’s aggregate GDP is now second in the world only to that of the US. While its per capita income is still much smaller than that of America’s, many are predicting that even China’s per capita GDP will surpass that of the US in a few decades.
But as Becker points out, good economic growth today doesn't always mean good growth tomorrow. At different times the Soviet Union and Japan had faster growth than any country in the West but they didn't manage to become the world's economic superpower. We know what happened to the Soviet Union and Japan's rapid growth stopped abruptly during the early 1990s, and Japan has largely stagnated economically for the past two decades.

A major problem for China is its efforts to maintain growth may be political rather than economic. Economic growth will come at the price of political power. As people become wealthier, they have more to lose to the grabbing hand of government. People will want, and will demand, protection from the state and this means the Communist Party in China will lose power. Limits on the arbitrary power of the state are needed if growth is to continue at the rate it is now. The incentives are wrong for growth if people are not sure they will keep the rewards of their efforts. Even in the West we see an example of this problem in the effects of Regime Uncertainty. People don't invest when they fear the loss of any return to their investment.

A related problem is that the party will also have to give up its economic power. As an example of this problem look at the SOEs in China. As Becker notes
The China 2030 report argues that the SOEs must operate more like commercial companies, but that is not easy since officials from the Communist Party usually have high positions in these enterprises, and many of the larger SOEs are closely related to the Communist Party and the military. The ideal solution would be to privatize most SOEs, but that does not seem likely in the near future. This is partly because government officials would lose power if SOEs were privatized, and partly because the government fears that privatized companies would greatly cut employment and increase social unrest.Unfortunately for China, it would not be possible to close rapidly the per capita income gap with rich countries as long as a large fraction of manufacturing output in China is produced in over-manned and inefficient state enterprises.
So for growth to continue at anything near its current rate, at some point, the Communist Party in China will have to give up some, if not all, of its political and economic power. And its unlikely they will be too keen on that.

EconTalk this week

David Weinberger of MIT and author of Too Big to Know, talks with EconTalk host Russ Roberts about the ideas in the book--how knowledge and data and our understanding of the world around us are being changed by the internet. Weinberger discusses knowledge and how it is attained have changed over time, particularly with the advent of the internet. He argues the internet has dispersed the power of authority and expertise. And he discusses whether the internet is making us smarter or stupider, and the costs and benefits of being able to tailor information to one's own interests and biases.

Education and economic development: evidence from the industrial revolution

In this short audio from Sascha Becker of the University of Warwick talks to Romesh Vaitilingam about his research on the important role that formal education played in facilitating industrialisation in nineteenth century Prussia. They also discuss the relationship between education and fertility, and historical evidence in support of ‘unified growth theory’.

Boundedly rational dynamic programming

A new NBER Working paper on Boundedly Rational Dynamic Programming: Some Preliminary Results by Xavier Gabaix

The abstract reads
A key open question in economics is the practical, portable modeling of bounded rationality. In this short note, I report ongoing progress that is more fully developed elsewhere. I present some results from a new model in which the decision-maker builds a simplified representation of the world. The model allows to model boundedly rational dynamic programming in a parsimonious and quite tractable way. I illustrate the approach via a boundedly rational version of the consumption-saving life cycle problem. The consumer can pay attention to the variables such as the interest rate and his income, or replace them, in his mental model, by their average values. Endogenously, the consumer pays little attention to interest rate but pays keen attention to his income. One consequence of this is that Euler equations will be biased, and the intertemporal elasticity of substitution will be biased toward 0, in a manner that is quantitatively important.
Now who says economists don't do super-cool stuff!!

Saturday 25 February 2012

A relationship between income and freedom

There is a new working paper by Derek Stimel out on The Short-Run Relationship between Income and Freedom: Evidence from 128 Countries. The abstract reads:
The relationship between income, economic freedom, and political freedom is often examined over the long-run but recently, there is increased interest in the short-run. From a review of the literature, I develop possible short-run relationships between a country’s income per capita, economic freedom, political rights, and civil liberties while taking into consideration broad institutional differences across countries. The empirical strategy is to estimate a structural panel vector autoregression where each equation is estimated using the dynamic panel general method of moments procedure of Arellano and Bover (1995). I then estimate impulse responses for the full sample of 128 countries between 1994-2009 as well as key sub-samples. From this relatively a theoretical approach, results indicate that improvements in economic freedom benefit more developed countries relative to less developed countries, as do improvements in income per capita. Improvements in political rights improve economic freedom in highly developed countries and low developed countries but improve income the most in countries with medium development. Improvements in civil liberties have somewhat the opposite effect as political rights. Implications of these results are discussed with an eye toward their practical relevance for business as well as policymakers.

Friday 24 February 2012

Daron Acemoglu and James Robinson now have a blog

This is good news. You can find the blog here. The blog is related to their forthcoming book Why Nations Fail.

(HT: Marginal Revolution)

Economics is what exactly?

Reading the Prologue to Roger Backhouse's book "The Ordinary Business of Life: A History of Economics from the Ancient World to the Twenty-First Century" (a very readable book even for non-economists) I found a number of definitions of economics.

Backhouse offers us
  • Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses. (From Lionel Robbins)
  • The study of mankind in the ordinary business of life. (From Alfred Marshall. Guess where the title of the book comes from!)
  • Economics deals with the production, distribution and consumption of wealth. (I guess that would capture much of classical economics.)
  • How production is organised to in order to satisfy human wants. (Surely economics is more than this. What of public choice for example?)
  • The logic of choice. (But what about production?)
  • The study of markets. (But what about all non-market institutions, like firms or clubs or farms or ....)
I'm not sure any of these really work for me.

Later Backhouse writes
Is is possible, for example, to have societies in which money does not exit [...], in which production is not undertaken by firms, or in which transactions are undertaken without markets.
I'm willing to accept this, apart from the no markets bit. I can't think of an example of a society without markets and I can't help thinking if there is such an example it would be a very poor, very small and very limited kind of society. As the division of labour is limited by the extent of the market, no markets means that the division of labour would be, basically, non-existent. This alone would make for a very poor society.

Tuesday 21 February 2012

Management practices

A quick Look at the paper "Recent Advances in the Empirics of Organizational Economics" by Nicholas Bloom, Raffaella Sadun and John Van Reenen, Annual Review of Economics (2010) 2: 105–37, shows up a few interesting results with regard to management practices and decentralisation of firms. In particular the paper suggest that (a) Competition seems to foster improved management and decentralisation; (b) larger firms, skill-intensive plants, and foreign multinationals appear better managed and are more decentralised; (c) firms that are both family owned and managed appear to have worse management and are more centralised; and (d) firms facing an environment of lighter labour market regulations and more human capital specialise relatively more in people management. Decentralisation here means the degree to which lower levels of the hierarchy have power relative to upper levels of the hierarchy (e.g., a higher degree of autonomy of junior managers from senior managers, a higher degree of autonomy of shopfloor workers from management)

The point about foreign firms being better managed is one that more than a few politicians, and others, in New Zealand would do well to take on board. Also the importance of competition to management practices needs to be kept in mind. This is just one advantage of increasing competition via a well implemented program of deregulation.

The paper also argues that there is evidence for complementarities between information and communication technology, decentralisation, and management, but the relationship is complex, and identification of the productivity effects of organisational practices remains to be fully investigated. But it does raise a possible reason for New Zealand's poor productivity performance. How well have we integrated ICTs into our businesses?

EconTalk this week

Adam Davidson of NPR's Planet Money talks with EconTalk host Russ Roberts about manufacturing. Based on an article Davidson wrote for The Atlantic, the conversation looks at the past, present, and future of manufacturing. Davidson visited an after-market auto parts factory in Greenville, South Carolina and talked with employees there as well as with executives at corporate headquarters. What is the future of factory work in America? Why are some manufacturing jobs in America while others are in China or elsewhere? The conversation looks at these questions as well as how well or poorly the U.S. education system prepares students for the world of work.

Monday 20 February 2012

Just for fun: theory of the firm 12

A recent, but still relatively unknown, contribution to the theory of the firm which can be seen as outside, if related to, the mainstream of the economic approach to the theory of the firm is Daniel F. Spulber, "The Theory of the Firm: Microeconomics with Endogenous Entrepreneurs, Firms, Markets, and Organizations", Cambridge: Cambridge University Press, 2009. If we think of the mainstream theory of the firm as being concerned with three basic issues to do with the existence, boundaries and internal organisation of the firm then Spulber's book is somewhat outside of the mainstream but the issues it deals with are related closely enough to those of the mainstream to justify a brief overview. (For criticisms of the Spulber approach to the firm from inside the mainstream see Hart (2011).) In addition Spulber offers insights into a number of important issues missing from the mainstream and thus lays the groundwork for future research in both the theory of the firm and industrial organisation more generally. Spulber "[ ... ] seeks to explain (1) why firms exist, (2) how firms are established, and (3) what firms contribute to the economy" (Spulber 2009: ix). These issues are clearly related to those of the mainstream but they are not the same. In particular the mainstream does not have a theory of the entrepreneur or market creation. Spulber's book in an attempt to create a general approach to microeconomics in which entrepreneurs, firms, markets, and organizations are all endogenous.

To start Spulber defines a firm "[ ... ] to be a transaction institution whose objectives differ from those of its owners. This separation is the key difference between the firm and direct exchange between consumers". (Spulber 2009: 63). Note that under this definition organizations such as clubs, basic partnerships, many family firms, worker cooperatives, non-for-profit organisations and public enterprises are not firms. The basic reason being that the objectives of these types of organizations cannot be separated from those of their owners. The separation of objectives between owners and firms also justifies the profit maximisation objective. Consumers who are the owners of the firm, obtain income via the firm's profits and thus want profit maximisation so they can maximise their consumption (utility).

Spulber has three additional players in his story: consumers, organisations and markets. Consumers are individuals who consume the goods and services generated within the economy. Organisations are transaction institutions whose objectives cannot be separated from those of their owners. Markets are transaction mechanisms that bring buyers and sellers together.

For Spulber the entrepreneur is important because it is their efforts that leads to the creation of firms. A combination of market opportunities interacting with the individual's preferences, endowments and other such characteristics leads the consumer to take on the role of entrepreneur. The individual is an entrepreneur for the time it takes to establish the firm. Assuming that the firm is successfully established, the entrepreneur's role changes to that of an owner of the firm. Ownership is valuable insofar as it provides returns to the (former) entrepreneur. This change from entrepreneur to owner is in Spulber's terms, `the fundamental shift'. (Spulber 2009: 152). The point is that before the change from entrepreneur to owner, the objectives of the organisation cannot be separated from those of the (then) entrepreneur. After the fundamental shift has occurred, the entrepreneur is now the owner and the firm's objectives are separate from those of the owner, which means a firm has been established.

Other organisations can be formed that allow consumers to take advantage of joint production. Such advantages include economies of scale, public goods, common property resources and externalities. Unlike the firm, the objectives of the organisation reflect the consumption objectives of the members of the organisation. A problem with an organisation is that it can experience inefficiencies due to free riding. Firms overcome such problems by separating the objectives of the organisation from the consumption objectives of its owners and thus inducing profit maximisation. Profit maximisation may not achieve full efficiency due to problems such as allocative inefficiencies that result from market power. Thus the comparison between a firm and an organisation depends on the trade-off between profit maximisation and free riding. When the number of consumers is small, free riding problems tend to be small and thus an organisation may be more efficient than the firm.

Given we have firms, firms can create markets. Firms can act as intermediaries and in doing so they increase the gains from trade and reduce transactions costs when consumers are separated by time, distance and uncertainty. Firms create markets by providing centralised mechanisms for matching consumers, in their roles as buyer and sellers, in a more efficient manner than decentralised exchange can achieve. Market making firms are required to buy and sell at any moment meaning that buyers and sellers avoid the costs involved with trading delays and the risk of being unable to find a trading partner. In the world of financial markets, market-making firms provide liquidity by being ready to buy and sell financial assets. Addition transaction efficiencies are bought about by market-making firms being able to consolidate trades which allows traders to reduce the costs involved with having to find multiple trading partners or with having mismatched trades. Firm can also avoid the problems inherent with complex bartering arrangements by simplifying the trading process vis the use of posted prices. Supply and demand can be equated in a market by firms adjust their buying and selling behaviour thereby reducing potential losses due to market imbalances. Thus market creation is endogenous.

Spulber offers insights into a number of issues that the mainstream theory of the firm does not deal with well, if at all. The discussion of issues such as the role of the entrepreneur and the creation of markets are important issues that lie outside of the mainstream of the theory of the firms, at least as far as the mainstream is conceived of here. Such issues do however raise questions for the future of the theory of the firm and industrial organisation.
  • Hart, Oliver D. (2011). `Thinking about the Firm: A Review of Daniel Spulber's The Theory of the Firm', "Journal of Economic Literature", 49(1) March: 101-13.

Thursday 16 February 2012

To GE or not GE

That is the question. While looking on the web for material for a paper I'm working on, "The Past and Present of the Theory of the Firm", I came across a number of discussions on the evils or the non-evils of general equilibrium theory. Some people argue McKenzie, Arrow and Debreu et al are the great satans who are out to destroy economics - if not the world. Others believe GE theory is the greatest achievement in the history of economics. This interested me because I end my paper with the following observation (a couple of footnotes have been removed)
A final point about the models of the firm discussed in this essay is that they highlight a general issue to do with post-1970 microeconomics, that is, the movement away from the use of general equilibrium (GE) models. All the models considered above are partial equilibrium models, but in this regard the theory of the firm is no different from most of the microeconomic theory developed since the 1970s. Microeconomics such as incentive theory, incomplete contract theory, game theory, industrial organisation etc, has largely turned its back, presumably temporarily, on GE theory and has worked almost exclusively within a partial equilibrium framework. This illustrates the point made at the beginning of the paper that there is a close relationship between the economic mainstream and the theory of the firm; when the mainstream forgoes general equilibrium, so does the theory of the firm.

For the case of contract theory, a field closely related to that of the theory of the firm, Salanie (2005: 2) has argued,
``[t]he theory of contracts has evolved from the failures of general equilibrium theory. In the 1970s several economists settled on a new way to study economic relationships. The idea was to turn away temporarily from general equilibrium models, whose description of the economy is consistent but not realistic enough, and to focus on necessarily partial models that take into account the full complexity of strategic interactions between privately informed agents in well-defined institutional settings".
As was noted in Section 4.1 the post-1970s literature on the firm can be classified into two general groups based on which of two of the standard assumptions of GE theory, namely symmetric information and complete contracts, is violated when modelling the firm. This requirement to violate basic assumptions of GE theory so that we can model the firm, suggests that as it stands GE can not deal easily with firms, or other important economic institutions. As Bernard Salanie notes,
``[ ... ] the organization of the many institutions that govern economic relationships is entirely absent from these [GE] models. This is particularly striking in the case of firms, which are modeled as a production set. This makes the very existence of firms difficult to justify in the context of general equilibrium models, since all interactions are expected to take place through the price system in these models". (Salanie 2005: 1).
This would suggest that creating GE models that can account for information asymmetries, contractual incompleteness, strategic interaction and the existence of institutions is needed if GE theory is to be able to deal with the issues - including those related to the firm - that microeconomists wish to tackle.
Now what I'm wondering is, Is the problem with GE a problem with the idea of general equilibrium as such or a problem with the Arrow-Debreu approach to GE? I can't help thinking that the world is GE and thus to handle the "real world" we need general equilibrium models. But the way we model GE leaves much to be desired. The current generation of GE models don't deal well with things like information asymmetries, contractual incompleteness, strategic interaction and economic institutions. Thus do we need at new GE which doesn't just try to model the extreme decentralisation of the perfectly competitive framework? Not that it is obvious what such a form of GE would look like. How much, if any, of the current approach to GE can be saved? Or is the Arrow-Debreu framework the right way to go? Or should we just stay with partial equilibrium models and not worry about interactions between markets?

Things you ponder on a Thursday afternoon.

Tuesday 14 February 2012

Its ok to hate Valentine's Day

Let me repeat my posting from a few years back, it still applies.

The Times has a list, "20 reasons it's okay to hate Valentine's Day". Number 14 is
It's such a rip-off. With flowers, dinner and cabs, you’re looking at a hundred quid minimum. Wouldn’t she just prefer the cash instead?
This has to be true, as any economist will tell you. Just giving her the cash must be Pareto improving. With the cash she can either go out and buy what you would have bought, so she and you are no worse off, or she can buy what she really wants, and you would not have bought, so you will both be better off.

So next year, just give her the money guys.

EconTalk this week

David Owen of the New Yorker and author of The Conundrum talks with EconTalk host Russ Roberts about the ideas in his book. Owen argues that innovation and energy innovation have increased energy use rather than reduced it and similarly, other seemingly green changes do little to help the reduce humanity's carbon footprint or are actually counter-productive. Only large reductions in consumption are likely to matter and that prescription is unappealing to most people. Owen points out that New York City, ironically perhaps, is one of the greenest places to live because of the efficiencies of density. The conversation concludes with a discussion of how to best approach global warming given these seeming realities.

Friday 10 February 2012

The past and present of the theory of the firm

There is a new paper available at SSRN that looks at The Past and Present of the Theory of the Firm.

The abstract reads,
In this survey we give a short overview of the way in which the theory of the firm has been formulated within the 'mainstream' of economics, both past and present. As to a break point between the periods, 1970 is a convenient, if not entirely accurate, dividing line. The major difference between the theories of the past and the present, as they are conceived of here, is that the focus, in terms of the questions asked in the theory, of the post-1970 literature is markedly different from that of the earlier (neoclassical) mainstream theory. The questions the theory seeks to answer have changed from being about how the firm acts in the market, how it prices its outputs or how it combines its inputs, to questions about the firm's existence, boundaries and internal organization. That is, there has been a movement away from the theory of the firm being seen as developing a component of price theory, namely issues to do with firm behavior, to the theory being concerned with the firm as a subject in its own right.

Tuesday 7 February 2012

More MED mercantilism?

From Groping towards Bethlehem we learn that
[...] MED in its Briefing to the Incoming Minister pointed out that the high exchange rate means we are all a little bit richer? Don’t be silly. ‘Cause, see, it’s all about the exports. The opening sentence:
The Government’s aim of building a stronger economy will require a substantial increase in the share of exports in the economy.
The question I would ask of MED is, But why does building a stronger economy require an increase in the share of exports? In simple terms, doesn't building a stronger economy just mean producing more - and thus increasing our real wealth - and who we sell our output to doesn't matter?

I mean if we produce a widget here in Canterbury, does MED really mean that selling that widget to someone in Auckland doesn't help our economy, since it wouldn't increase the share of exports, but selling it to someone in Sydney does, since it does increase the share of exports in the economy?!!

EconTalk this week

William Black of the University of Missouri-Kansas City and author of The Best Way to Rob a Bank Is to Own One, talks with EconTalk host Russ Roberts about financial fraud, starting with the Savings and Loan debacle up through the current financial crisis. Black explains how bank executives can use fraudulent loans to inflate the size of their bank in order to justify large compensation packages. He argues that "liar loans" were a major part of the crisis and that policy changes made it easy to generate such loans without criminal repercussions.

Monday 6 February 2012

Shleifer on the transition from communism

At Andrei Shleifer tells us about the Seven things I learned about transition from communism. These seven things being:
First, in all countries in Eastern Europe and the former Soviet Union, economic activity shrunk at the beginning of transition, in some very sharply. In many countries, economic decline started earlier, but still continued. In Russia, the steepness and the length of the decline (almost a decade) was a big surprise. Countries with the biggest trade shocks (such as Poland and Czechoslovakia) experienced the mildest declines. To be sure, the true declines were considerably milder than what was officially recorded – unofficial economies expanded, communist countries exaggerated their GDPs, defence cuts, and so on – but this does not take away from the basic fact that declines occurred and were surprising. These declines contradicted at least the simple economic theory that a move to free prices should immediately improve resource allocation. The main lesson of this experience is for reformers not to count on an immediate return to growth. Economic transformation takes time.

Second, the decline was not permanent. Following these declines, recovery and rapid growth occurred nearly everywhere. Over 20 years, living standards in most transition countries have increased substantially for most people, although the official GDP numbers show much milder improvements and are inconsistent with just about any direct measure of the quality of life (again raising questions about communist GDP calculations). As predicted, capitalism worked and living standards improved enormously. One must say, however, that for a time things looked glum. So lesson learned: have faith – capitalism really does work.

Third, the declines in output nowhere led to populist revolts – as many economists had feared. Surely reform governments were thrown out in some countries, but not by populists. Instead of populism, politics in many countries came to be dominated by new economic elites, the so-called oligarchs, who combined wealth with substantial political influence. From the perspective of 1992, this came as a huge surprise. Ironically, in some countries in Eastern Europe populism appeared 20 years after transition started, after huge improvements in living standards were absolutely obvious. Indeed, people in all transition countries were unhappy with transition: they were unhappy even in countries with rapidly improving quality of life (and this itself is another surprise and major puzzle – something for future reformers to keep in mind). But the lesson is clear: a reformer should fear not populism but capture of politics by the new elites.

Fourth, economists and reformers overstated both their ability to sequence reforms, and the importance of particular tactical choices, eg, in privatisation. In retrospect, many of the theories that animated the discussion of reform – whether institutions should be built first, whether companies should be prepared for privatisation by the government, whether voucher privatisation or mutual fund privatisation is better, whether case by case privatisations might work – look quaint. Reformers nearly everywhere, including in Russia, had a vastly overstated sense of control. Politics and competence frequently intervened and dictated to a large extent most of the tactical choices. Still, most countries, despite different choices, ended up with largely similar outcomes (notable and sad exceptions are Belarus, Uzbekistan, and Turkmenistan). In various forms, all had privatisation and macroeconomic stabilisation as well as legal and institutional reform to support a market economy. Lesson learned: do not over-plan the move to markets, but, more importantly, do not delay in the hope of having a tidier reform later.

Fifth, economists have greatly exaggerated the benefits of incentives by themselves, without changes in people. Economic theory of socialism has put way too much weight on incentives, and way too little on human capital. Winners in the communist system turned out not to be so good in a market economy. Transition to markets is accomplished by new people, not by old people with better incentives. I realised this and wrote about it in the mid-1990s, but the lesson both in firms and in politics in profound: you cannot teach an old dog new tricks, even with incentives.

Sixth, it is important not to overestimate the long-run consequences of macroeconomic crises and even debt defaults. Russia experienced a major crisis in 1997–98, which some extremely knowledgeable observers said would set it back by 20 years, yet it began growing rapidly in 1999–2000. Similar stories apply elsewhere, from East Asia to Argentina. Debt restructurings do not necessarily make permanent scars. This experience bears a profound lesson for reformers, who are always intimidated by the international financial community: do not panic about crises; they blow over fast.

Seventh, it is much easier to forecast economic than political evolution. Although nearly all transition countries have eventually converged to some form of capitalism, there has been a broader range of political experiences, from full democracies, to primitive dictatorships, to just about everything in between. There appears a strong geographic pattern in this, with countries further West, especially those involved with the European Union, becoming clearly democratic, and countries further East remaining generally more authoritarian. For countries in the middle, including Russia and Ukraine, the political paths over the 20 years have wiggled around. Lesson learned: middle-income countries eventually slouch toward democracy, but not nearly in as direct or consistent a way as they move toward capitalism.

Ricardo and comparative advantage 2

Thanks to an email from Jorge Morales Meoqui I have been alerted to his recent paper in the journal History of Political Economy on "Comparative Advantage and the Labor Theory of Value". The abstract reads,
With the famous numerical example of chapter 7 of the Principles (1817) David Ricardo intended to illustrate first and foremost the new proposition that his labor theory of value does not regulate the price of international transactions when the factors of production are immobile between countries. Unfortunately, later scholars have often omitted this proposition when referring to Ricardo's numerical example. Instead, they have highlighted only the comparative-advantage proposition, although Ricardo considered it as a corollary of the omitted proposition and therefore inextricably linked to it. This inexplicable omission has led to an incomplete understanding of the logical construction of Ricardo's numerical example, as well as to the misinterpretation of the four numbers as unitary labor costs. With an accurate understanding of Ricardo's numerical example and the logical relationship between the two propositions it meant to prove, it is relatively easy to refute the main objections that have been raised against the very same numerical example in the past. Moreover, it reaffirms the sustained relevance of Ricardo's two propositions as important insights for understanding the current process of economic globalization.
Jorge also has a working paper "On the distribution of authorship-merits for the comparative-advantage proposition". The abstract reads,
Due to a better understanding of the logical interrelationships between the comparative- advantage proposition, the classical rule of specialization and the proposition regarding the non- appliance of the labor theory of value in international exchanges in Ricardo’s famous numerical example in the Principles, it is now possible to arrive to a definite conclusion regarding the longstanding academic debate about the true author of the comparative-advantage proposition. Torrens is not entitled to the same amount of merit as David Ricardo with regard to the comparative-advantage proposition since he fell short of formulating a full prove of it prior to the publication of Ricardo’s Principles. In the 1815 example of English cloth being traded for Polish corn, Torrens missed to apply the classical rule of specialization for Poland. For the featured international exchange to take place, though, there has to be gains from trade for both trading partners. More importantly, Torrens also failed to recognize the crucial role of Ricardo’s insight regarding the non-appliance of the law of value in international exchanges in proving the comparative-advantage proposition. Therefore, the bulk of the authorship-merit for this proposition rightly belongs to Ricardo.

Saturday 4 February 2012

Ricardo and comparative advantage

David Ricardo is probably most famous because of his introduction of the idea of comparative advantage into economics. Today comparative advantage is the standard reason given as to why countries gain from trade. But is Ricardo the author of the famous pages in his "Principles of Political Economy"?

In a footnote on page 132 of the fifth edition of his "Economic Theory in Retrospect" Mark Blaug writes
Ironically enough, it is now been shown that the famous pages on comparative advantage in the chapter on foreign trade were almost certainly written by James Mill. Moreover, Ricardo's own conception of foreign trade never effectively went beyond the idea of absolute advantage; in short, he does not deserve the credit he has been given for the theory of comparative advantage.
The basis for Blaug's claim is the paper, by William O. Thweatt, "James Mill and the Early Development of Comparative Advantage", History of Political Economy 8 (Summer 1976) 207-34.

A quick look at Douglas Irwin's book "Against the Trade: An Intellectual History of Free Trade" gives rise to another footnote, from page 91, which reads,
Thweatt's case is plausible because Mill worked closely with Ricardo on the Principles and commented extensively on drafts. Inconclusive evidence against his interpretation comes in a letter from Mill to Ricardo in which he states: "... that it may be good for a country to import commodities from a country where the production of those same commodities cost more, than it would cost at home: that a change in manufacturing sill in one country, produces a new distribution of the precious metals, are new propositions of the highest importance, and which you fully prove." See David Ricardo (1952, 7: 99). Futher, in his article on colonies Mill also credits Ricardo with the theory.
I had known that Mill explained the idea of comparative advantage better in his "Elements of Political Economy", published after Ricardo's "Principles", but not that he could have been the author of Ricardo's original discussion.

Friday 3 February 2012

EconTalk this week

Eugene Fama of the University of Chicago talks with EconTalk host Russ Roberts about the evolution of finance, the efficient market hypothesis, the current crisis, the economics of stimulus, and the role of empirical work in finance and economics.