Limitations of the Marshallian Toolkit

An (unfortunately still early) draft of my paper for the IFPRI/Cornell conference on threshold effects and nonlinearities in economic growth:

Adding to the Marshallian Toolkit: Big Push and Nonlinearity in History and Theory

J. Bradford DeLong
U.C. Berkeley and NBER
May 2005

ABSTRACT: Most of economics practiced, even today, uses the Marshallian toolkit. But there is an often-undervalued thread of economic theory--with traces in Smith, and visible in writers like Hirschman and Rosenstein-Rodan--that has focused on virtuous circles that, it is claimed, produce powerful non-linearities in growth and development. Looking back at economic history, one cannot be struck by how much of the economic past that is truly interesting is inaccessible to the neo-Marshallian toolkit. My hope, at least, is that a closer engagement with economic history will help economists build alternatives to the Marshallian toolkit, and help specify the situations under which "big pushes" are beneficial in that the whole is greater than the sum of the parts, and under which small changes in incentives may produce powerful changes for good or ill.

Introduction

This is the first time I have been asked to give a keynote, so I am unpracticed and somewhat unsure how one is supposed to proceed. I suspect that my greatest value-added will come in simply sketching out the importance of the problem that this conference is attempting to address. And the best way to do that, I think, is to point out how very little the smooth continuous-curve economics of Alfred Marshall--he who said that "nature does not make leaps"--can explain of the truly important aspects of economic life worldwide over the past two centuries. We live in a world of big pushes, thresholds, and nonlinearities. Yet we economists try to tackle it with a broadly neo-Marshallian toolkit of smooth changes and equilibrating responses, and so we do not do as well as we should.

There are, of course, theoretical alternatives and additions to the Marshallian toolkit: think of Rosenstein-Rodan (1943, 1961); Hirschman (1958); and Murphy, Shleifer, and Vishny (1989). Krugman (1996) regards Rosenstein-Rodan's (1943) "Big Push story as the essential high development model" in which:

development is a virtuous circle driven by external economies... an interaction between economies of scale at the level of the individual producer and the size of the market.... If modernization can be gotten started on a sufficiently large scale, it will be self-sustaining, but it is possible for an economy to get caught in a trap in which the process never gets going....

But as Krugman says, this "Big Push" branch of theory--even though it can trace itself back to Adam Smith (1776) and "the division of labor depends on the extent of the market--virtually vanished from the face of the earth in the 1960s and 1970s. Krugman attributes this to the fact that:

economies of scale were crucial to high development theory.... [And] economies of scale were very difficult to introduce into the increasingly formal models of mainstream economic theory.... A rise in the standards of rigor and logic [in economics] led to a much improved level of understanding of some things, but also led for a time to an unwillingness to confront those areas the new technical rigor could not yet reach.... After 1960... an attempt to publish a paper like Rosenstein Rodan's would have immediately gotten a grilling: "Why not build a smaller factory...? Oh, you're assuming economies of scale? But that means imperfect competition, and nobody knows how to model that, so this paper doesn't make any sense."... By the 1970s (when I was myself a student of economics)... [Big Push ideas] seem[ed] not so much wrong as meaningless.... Where were the models?...

But the increasing-returns model-building is not that hard. (Indeed, Krugman wonders about his own argument: "[was] the long slump in development theory... really necessary. The model [of Murphy, Shleifer, and Vishny (1989)] is so simple: three pages, two equations, and one diagram... could... have been written as easily in 1955 as in 1989. What would have happened to development economics, even to economics in general, if someone had legitimized the role of increasing returns and circular causation with a neat model 35 years ago? But... economists... were still absorbed in the possibilities of perfect competition and constant returns.... Good ideas were left to gather dust in the economics attic for more than a generation; great minds retreated to the intellectual periphery.) I suspect that the major problems lay elsewhere than in Krugman's diagnosis--which I think was a factor but not the factor. Two more important factors were, first, that investments in the standard neo-Marshallian toolkit promised high returns; and, second, that thresholds, increasing returns, and Big Pushes were scary. Small changes can have big effects, yes, but how then does one know which small changes to study?

As an economic historian, I cannot help with the second problem--although I will have a few words to say about it at the end of the essay. But I can help with the first: I am here to say that the payoffs to investments in the standard neo-Marshallian toolkit are in fact a lot smaller than most economists who do not worry about threshold effects and nonlinearities presume. Indeed, the most interesting parts of economic history are issues on which the neo-Marshallian toolkit has next to no purchase.

This essay documents that claim. In the next section, I briefly discuss how unlikely it is that the neo-Marshallian toolkit could give us much purchase on the biggest problems of development: neither the fact of modern economic growth nor the extraordinary divergence in relative prosperity over the next two centuries yields to the neo-Marshallian toolkit. Section 3 takes a slightly less Olympian view. It argues that three major problems in economic history--understanding the British Industrial Revolution itself, the East Asian Miracle, and western Europe's rapid post-World War II growth--all require serious thought about thresholds. We do not have all the answers, but it is plain that we cannot make progress without incorporating substantial nonlinearities into our models. At its end, section 3 considers a separate, non-historical problem: the macroeconomic collapse of neoliberal reform in Argentina at the start of this decade, and makes a similar argument that the neo-Marshallian toolkit is not of much help.

This paper thus serves a primarily negative purpose: it shows the extent of our ignorance, rather than putting forward strong positive models of how exactly, thresholds were passed and Big Pushes triggered. The concluding section 4 offers an apolog for this, and tries to provide a few insights into how economic inquiry might be able to use models in which thresholds and increasing returns are central in a productive way.

2. The Big Problem

Consider the biggest push of all. We live today in a world of extraordinary and unbelievable wealth. Within two generations human literacy will, if we avoid blowing ourselves up with thermonuclear weapons, be nearly universal. 2300 years ago Aristotle said that a society of even narrow literacy--let alone a society in which philosophy in its oldest sense of the love and pursuit of relatively abstract knowledge--was impossible in the absence of widespread slavery, or something like it, and that that would never change unless we went back to the Golden Age in which there were looms that could throw the shuttle by themselves and plows that could dig the furrows by themselves. We don't quite have those--although I did last year hear a presentation by a Caterpillar executive about prospects for teleoperated bulldozers that could be controlled from places of air-conditioned comfort. But we are close enough. What involuntary servitude exists in the world today is by and large an exercise of power over those who have none by those who have little, and not (as it was in the Classical Athens of Aristotle, the Imperial Rome of Hadrian, or the Federalist Virginia of Jefferson) a key distributive institution in the economy as a whole.

We have acquired this extraordinary per-capita wealth in the past three centuries. Before three centuries ago the overwhelming effect of technological progress--and there was a great deal of technological progress, from the mechanical clock and the watermill to the cannon and the caravel to the development of strains of rice that you can crop three times a year in Guangzhou and the breeding of merino sheep that can flourish in the hills of Spain--was to increase the numbers of humanity, not to raise median standards of living. Today, if we divided up what we produce worldwide equally, would it give us a standard of living ten times that of the bulk of our preindustrial ancestors? Twenty times? A hundred times? Does the question even have meaning? David Landes (1999) likes to tell the story of Nathan Meyer Rothschild, richest man in the world in the first half of the nineteenth century, dead in his fifties of an infected abscess. If you gave him the choice of the life he led as the finance-prince of Europe or a life today low-down in the income distribution, checking-in items as they arrive at the loading dock at the local Target, with thirty extra years of life to see his great-grandchildren, which would he choose?

We also live today in an extraordinarily unequal world. There are families today near Xian, in what was the heartland of the Tang Dynasty Empire, with two-acre dry wheat farms and a single goat. There are families today with four-bedroom two-story houses in Tacoma Park and civil-service jobs that could buy the two-acre wheat farm and the goat with one day's wages. Yet in terms of communication, transport, and shipment, the world today is far smaller than the world of three centuries ago when a passage from Britain to India could take half a year, and the London headquarters of the East India Company's directives to its agents on the spot were always at least a year out of date.

Marshall's economics--the equilibrium economics of comparative statics, of shifts in supply and demand curves, and of accomodating equilibrating responses--is of next to no help to us in accounting for any of this. Why, worldwide, did median standards of living stagnate for so long? Why did their rate of growth undergo an acceleration that is extraodinarily rapid in such a short period of time? Where is the economics of invention, innovation, adaptation, and diffusion anyway? Not in Marshall. And why is today's world so unequal--so unequal that it is hard to find any measures of global distribution that do not show divergence at least up until the 1980s (see DeLong (1986))?

It was Robert Solow (1957) and Moses Abramovitz (1956) who most strikingly pointed out that Marshall's economics is of little help in understanding modern economic growth. The action comes not from smooth supplies-and-demands and the allocation of scarce resources to alternative uses, but from the technological-and-organizational-change residual--and that is, after all, nothing but a measure of our ignorance. Mankiw, Romer, and Weil (1989) made a valiant attempt to shore-up the Solow growth theory version of Marshall, and attribute relative wealth and poverty in the world distribution of income to virtue (having a high investment rate and a low population growth rate) and vice (having a low investment rate and a high population growth rate) respectively. But Hsieh and Klenow (2002) undermine this by asking: are countries relatively poor because they have a low rate of investment (and thus little capital), or do they have a low rate of investment because they are poor (and so face a high real price of capital goods)? And that countries are still in the high-population-growth middle of the demographic transition is also both cause and conseuqence of relative poverty. The best that can be said is that the Mankiw, Romer, and Weil (1989) story is the top half of a vicious-virtuous circle--one assigned priority because the authors conduct their investigation under the maintained hypothesis that investment rates and population growth rates are determined exogenously.

Truly exogenous variables to identify cross-country growth patterns are very hard to find. But it is hard to think about the determinants of population growth and relative price structures without concluding that there is potential for the circles of reciprocal causation to be very strong indeed, with infinitesimal changes in outside variables having large and measurable effects.

3. The Problems of Detail

Things get little better when we examine the past several centuries from a less Olympian height, and try to look at instances where it at least looks as though there has been a highly successful Big Push. Once again the things that we find of greatest interest are the places where the neo-Marshallian toolkit helps us the least. Consider, briefly, three positives and one negative: the British Industrial Revolution, Western Europe's extraordinary post-World War II growth spurt, the rise of East Asia, and--the negative one--the crash of Argentina's neoliberal reform program.

The Industrial Revolution

Consider, first, the Industrial Revolution itself. This great threshold nonlinearity is, in many ways, the greatest of them all. Economic historians like Ken Pomeranz (2000) point out truthfully that back before the Industrial Revolution differences in median standards of living across the high civilizations of Eurasia were relatively small. A peasant in the lower Yangtze Valley under Kangxi in the late seventeenth century had a different style of life than his or her contemporary peasant in the Thames Valley under Charles II Stuart, but not one that was clearly better or worse. Two centuries later that was no longer the case: by the end of the nineteenth century median standards of living in Britain and in other countries to which the Industrial Revolution had spread were, for the first time in recorded history, light-years above any neo-Malthusian benchmark of bio-sociological subsistence. Britain's early industrial-era economic accomplishment took place in spite of the drawing-off of a substantial proportion of national income to support a corrupt, decadent, and luxurious aristocracy (see Namier (1929)); in spite of a tripling of population that put extraordinary Malthusian pressure on the natural resource base underpinning the economy (see Wrigley and Schofield (1993)); and in spite of the mobilization of a prevously unheard-of proportion to national income for a near-century of intensive war against a power, France, with three times Britain's population (see Brewer (1989), Williamson (1984), Temin and Voth (2005)).

But the explanation of this extraordinary nonlinearity remains contested. Rostow's (1958) non-Communist manifesto boldly speculated that all that was needed was a market economy coupled with the doubling of society's investment share. North and Weingast speculated that all that was needed was a government strong enough to enforce private property rights and yet limited enough to respect them--and have been criticized by others pointing out that the eighteenth and nineteenth century British state's extraordinary powers of eminent domain and its eagerness to exercise them did play a key role and are definitely not part of the picture of the night-watchman state. Kremer (1991) argued from the principal that "two heads are better than one" that human brainpower was bound to someday attain its critical mass, boost the rate of productivity growth, and elevate standards of living enough to trigger the demographic transition and so cause a phase transition of the economy from neo-Malthusian medieval and early modern dynamics to the dynamics of modern economic growth. But at the key moments of the Industrial Revolution English was a language written and read fluently by at most a million people, and Chinese was written and read fluently by at least ten million. If two heads are that much better than one, shouldn't ten heads be even much, much better? Debate over even the quantitative shape continues. There are those in the ascendant (Crafts (1985), Harley (1982)) who see the Industrial Revolution as narrowly-focused on key transformative leading-sector industries: coal, cotton, machinery, and steam. Such an Industrial Revolution would be ripe for explanation in terms of the narrow logic of technological creativity in the context of the abundance of particular resources like coal, cotton, and iron ore. Others in eclipse--perhaps temporarily (see Temin (1997))--see the Industrial Revolution as an extremely broadly-based phenomenon, and so ripe for explanation as the result of political, social structural, or cultural factors.

We can build models of such a transition as the Industrial Revolution. But these models must have threshold effects. Nonlinearities. The rate of growth of British technological capabilities does not rise smoothly as world population (or even British population) increases. The level of productivity does not inch upward at each generation at a pace only a little bit faster than it had done before. Even the Crafts (1985) and Harley (1982) interpretations that see a "little" Industrial Revolution see it as made up of earth-shaking changes in the key leading sectors--they just see those key leading sectors as, initially, a relatively small part of the entire economy. And, of course, there is the most famous contemporary assessment of the power of the Industrial Revolution, even though it was written from the middle Rhine Valley, a place definitely on its fringes. In its authors' view, the Industrial Revolution:

has shown what man's activity can bring about. It has accomplished wonders far surpassing Egyptian pyramids, Roman aqueducts, and Gothic cathedrals.... The bourgeoisie, during its rule of scarce one hundred years, has created more massive and more colossal productive forces than have all preceding generations together....

Why? How? The neo-Marshallian toolkit is of little help here.

Post World-War II Europe in the Argentine Mirror

Consider, second, a more cheerful story: the story of Western Europe's post-World War II economic and political miracle. Before World War II, the countries of continental Western Europe appeared to be lagging further and further behind the United States. Brutally bitter labor relations, sharp social cleavages, intense distributional struggles that threatened and in many cases extinguished democracy--the interwar political economy of Western Europe as narrated by historians like Maier () sounds a lot like the post-World War II political economy of countries like Chile, and Argentina.

The aftermath of World War II threatened to make things much worse in Western Europe. Its export earnings were gone. Required repair and rebuilding needs were enormous. Inflows of private capital were nonexistent. In the absence of large-scale American aid--by some mechanism like the Marshall Plan--Western Europe faced a future in which hard-currency imports would be meted out by an eyedropper, reconstruction would be prolonged and slow, and distributional fights would once again destabilize its politics.

It is true that in a well-functioning market economy, it is hard to argue that resources for repair and rebuilding would remain critically scarce for long. The European economy had substitution possibilities, and market economies are very good at finding and using them where they exist.

Eichengreen and Delong (1991) take a back-of-the-envelope look at the most severe post-World War II Western European bottleneck: coal:

In 1938 Western Europe consumed 460 million tons.... It produced only 400 million tons in 1948.... [During the] Marshall Plan, Western Europe imported... seven percent of its coal consumption from the United States. Assuming... half of national product... produced in coal-burning sectors... [with] fixed [production] coefficients... elimination of coal imports would have reduced Western European total product over the duration of the Marshall Plan by no more than three per cent.

But would the market economy have been allowed to find the substitution possibilities? The memory of the Great Depression was still very fresh, and predisposed politicians toward intervention and regulation. Governments might well have severely constrained market mechanisms by continuing wartime controls (indeed, the British government tried to do so). The late 1940s and early 1950s might have seen the building-up of bureaucracies to allocate foreign exchange, and to impose price controls to protect the living standards of urban working classes. In short, post-World War II Western Europe might well have been a lot more like post-World War II Argentina.

Post-World War II Argentina did adopt demand stimulation and income redistribution coupled with a distrust of foreign trade and capital and a bias toward the use of controls as allocative mechanisms rather than prices. Diaz-Alejandro (1970) is still the classic analysis of Argentina's post-World War II long-run economic stagnation. As Eichengreen and DeLong summarize his interpretation:

[T]he collapse of world trade in the Great Depression [had been] a disaster of the first magnitude for an Argentina tightly integrated into the world division of labor.... Argentina continued to service its foreign debt... [but Britain and America] took unilateral steps to shut it out of [its traditional export] markets. The experience of the Depression justifiably undermined the nation's commitment to free trade. It was in this environment [that] Juan Perón gained mass political support. Taxes were increased, agricultural marketing boards created, unions supported, urban real wages boosted, international trade regulated. Perón sought to generate rapid growth and to twist terms of trade against rural agriculture and redistribute wealth to urban workers who did not receive their fair share....

This Perónist program was not prima facie unreasonable given the memory of the Great Depression, and it produced almost half a decade of very rapid growth. Then exports fell sharply... as the consequences of the enforced reduction in real prices of rural exportables made themselves felt. Agricultural production fell... low prices offered by government marketing agencies. Domestic consumption rose. The rural sector found itself short of fertilizer and tractors. Squeezed between declining production and rising domestic consumption...

Thus Juan Perón's government had only unattractive options: (i) devalue to bring imports and exports back into balance and meanwhile borrow from abroad (reducing the living standards of his domestic political base and abandoning a great deal of his appeal to national price); (ii) contract the economy, raising unemployment and reducing consumption, and expand incentives to produce for export by decontrolling agricultural prices (but this is even worse, and there is not yet a functioning IMF to blame for the policy turnarounds); (iii) control and ration imports to keep domestic demand growing. Not surprisingly, Perón and his advisors chose the third option, hoping that a dash for growth and a reduction in dependence on the world economy was good for Argentina. But the long-run consequences were dire indeed. As Díaz Alejandro writes:

First priority was given to raw materials and intermediate goods imports needed to maintain existing capacity in operation. Machinery and equipment for new capacity could neither be imported nor produced domestically. A sharp decrease in the rate of real capital formation in new machinery and equipment followed. Hostility toward foreign capital, which could have provided a way out of this difficulty, aggravated the crisis...

Subsequent governments could not fully reverse these policies, for even after his overthrow the political forces that Perón had mobilized still had to be appeased. The 1950s saw capital goods become hugely expensive in Argentina--and thus even a healthy savings effort produced little in the way of real investment. To quote Diaz-Alejandro again: "the capital... in electricity and communications increased by a larger percentage during the depression years 1929-39 than... 1945-55." Unable to invest on a sufficient scale, the Argentine economy stagnated.

In 1929 Argentina had been richer than any large country in continental Europe. It was still as rich in 1950, when Western Europe had for the most part reattained pre-World War II levels of national product. Eichengreen and DeLong conclude that slow Argentinean growth thereafter came because Argentina's "mixed economy was poorly oriented: the government allocated goods, especially imports, among alternative uses; the controlled market redistributed income. Thus neither the private nor the public sector was used to its comparative advantage."

Why didn't Western Europe follow a similar post-World War II trajectory? Díaz Alejandro argued that four factors set the stage for Argentina's astonishing post-World War II relative decline:

1. a politically-active and militant urban industrial working class,
2. economic nationalism,
3. sharp divisions between traditional elites and poorer strata, and a government used to exercising control over goods allocation that viewed the price system as a tool for redistributing wealth rather than for determining the pattern of economic activity.

From the perspective of 1947, Western Europe looked as vulnerable as Argentina to economic stagnation induced by populist overregulation. The war had given Europe more experience than Argentina with economic planning and rationing. Militant urban working classes calling for wealth redistribution voted in such numbers as to make Communists plausibly part of a permanent ruling political coalition in France and Italy. Economic nationalism had been nurtured by a decade and a half of Depression, autarky and war. European political parties had been sharply divided along class lines for two generations.

Yet Europe avoided this trap because of small differences that mattered. Large-scale American aid to boost the pace of reconstruction and create, earlier, the impression that the liberalized mixed-economy was working? Fear of Stalin's T-34 tanks just east of the Fulda Gap and a belief by nearly all--conservative and social democrats alike--that this was not a good time to sharpen distributional conflicts? From the standpoint of 1945 it is not easy to see what would lead one then to forecast the wide gaps between Argentina and company on the one hand and France and Germany and company that we see today.

Once again, small differences that appear to matter a lot.

The East Asian Miracle

Last, consider East Asia. It is hard for us today to cast our minds back to the 1960s, and to realize how broadly unexpected the rapid economic rise of East Asia over the past generation and a half has been. From today's perspectives, studies like World Bank (1993) or Rodrik (1994) look back at East Asia and see a host of favorable initial post-World War II initial conditions, from favorable demography and low income inequality to high education levels and relative ethnolinguistic integration as playing a large role. Even Rodrik (1994), who wants to conclude that skillful government interventions (i.e., providing subsidies to producers that win the export tournament) can do significantly better than laissez-faire feels a need to caution his readers: South Korea and Taiwn shared a number os special initial conditions... high levels of educational attainment... equal distribution... that... other countries lack.... [T]he relevance of their experience with government intervention to other developing economies may well be limited. The World Bank's (1993) East Asian Miracle shades the story more toward the initial conditions side. And expressions of official orthodoxy like the Asian Development Bank's 1997 Emerging Asia: Changes and Challenges can flatly assert that East Asia is rich today because of "a fortunate combination of initial potential."

This would come as a surprise to those on the ground in the 1950s and 1960s examining that potential. Berkeley undergraduate thesis student Charlene Huang (2005) cites William Easterly (1995) reporting a World Bank mission's conclusion at the start of the 1960s that there is "no doubt that the development program [proposed by the government] far exceeds the potential of the Korean economy.... It is inconceivable that exports will rise as much as [forecast]..." And, of course, South Korean exports and GDP growth exceeded their targets.

Indeed, Huang (2005) claims that regressions suggesting a powerful role for initial conditions in East Asian development characterize it as:

having high initial levels of human capital (Rodrik 1994).... Primary school enrollment rates circa 1960 are...employed.... However, a country’s primary school enrollment rate circa 1960 is less of an "initial [post-WWII] condition" than an indicator of the competence and success of [governance]... a reflection of the... government's commitment to education and human capital development than as an indicator of initial levels of human capital.... Barro and Lee’s data on the percentage of the adults over 25 years of age in 1960 who completed primary school is... a [better] indicator.... The percentage of adults who completed primary school during the time of colonization is a better indicator of colonial legacy.... A comparison of primary enrollment ratios in 1960 and the Barro-Lee data on the stock of human capital in 1960 clearly illustrates the difference... Singapore and Korea both have about 100% primary enrollment in 1960, [but] the percentage of the adults over 25 years of age in 1960 who completed primary school was 26.2% for Korea, but only 5.6% for Singapore.... Singapore’s British colonizers were not as interested in educating the masses...

The East Asian tradition of heavy investment in human capital is, for many of the high-performing Asian economies, quite recent. That their governments' abilities to create and manage impressive educational systems has played a key role is not in dispute. But the ability to successfully make a Big Push for education from a near-standing start is a social capability that was, in many high-performing Asian economies, created after decolonization--rather than being a long-standing historical legacy.

Many other countries in the 1960s tried to build high-performing mass school systems, and failed. East Asia succeeded. What alternatives to the neo-Marshallian toolkit will help us understand how?

Modern Argentina in the European Mirror

Consider, last, the recent history of Argentina. Of all the disappointments of neoliberal reform in the 1990s, perhaps the most disappointing was the catastrophic 2001 financial crisis in Argentina. Coming after four years of slow recession, it pushed output per capita down to a full quarter below its late 1990s peak and inflicted extraordinary economic pain on a country that only a few years before had been the toast of card-carrying neoliberals like myself, and the example that we pointed to to show the benefits of neoliberal reform programs.

What the Argentinean government did wrong is well known (see Mussa (2002), Blustein (2005)). It failed to reform its tax collection system to reduce evasion. It failed to either put the provinces on their own bottoms as far as financing their expenditures was concerned, or to gain effective control over provincial-level spending. It failed to recognize that the hard external peg of the peso's value provided by the currency board required that confidence be maintained that the debt-to-GDP ratio would be stabilized. Without confidence in a stable debt-to-GDP ratio, a hard currency peg was an incredible and an unsustainable policy--and there is nothing worse than an attempt to make a credible commitment to an incredible and an unsustainable monetary policy.

In the end, when the immovable object of the currency board met the irresistible forces of a government unwilling to balance its budget and currency speculators--both domestic and foreign--sure that they had a sure-win one-way bet, it was the currency board that crumbled, and carried Argentina into a recession twice as deep relative to the size of the Argentinean economy as the Great Depression was in Argentina.

But what surprised me then and surprises me now is the speed of the collapse of the currency board. When it collapsed, Argentina's consolidated debt-to-GDP ratio was about 50%. That is not an unsustainable debt load. And the Argentinean government was managing to run a primary surplus. If there had been confidence in Argentina's fiscal future--confidence that no financial crisis was on the horizon--then interest rates would have been much lower, and the primary surplus would have generated only a moderate general deficit. With low interest rates, Argentina's prospects for growth would have been relatively good. With good growth prospects and a relatively moderate overall government budget deficit, there would be no reason to fear that fiscal policy is unsustainable. Only the fact that a crisis was expected pushed interest rates up to the level where investment was strangled, growth impossible, the overall budget deficit large, and a crisis inevitable.

Michael Mussa (2002) sharply criticizes the fiscal-policy dynamic analyses carried out by the IMF staff a year and more before the collapse:

What should be made of this analysis? The general principle in such matters is that if you are prepared to swallow the assumptions than you should also eat the conclusions. Or, as we used to say when I was growing up, "If, if, if... If my grandmother had wheels, she would be a bus...

This is, I think, too harsh. For the alternative, good equilibrium was out there somewhere: the equilibrium in which domestic and foreign speculators have confidence, interest rates stay low, policies appear successful, the government can leverage that apparent success into larger primary surpluses which further increase confidence, and has a decade or more to get the political-economy ducks in a row to ensure long-run fiscal balance and so medium-run rapid growth. We know that that good equilibrium was out there: Lula da Silva just to the north in Brazil, in a country with equally intractable long-run problems of macroeconomic management and much worse problems of income distribution and public management, appears (cross your fingers) to have found it. But the Argentineans could not.

Here, too, the neo-Marshallian toolkit is of little use.

4. Conclusion: What Is To Be Done?

Suppose that we accept the belief that Alfred Marshall and his toolkit no longer help us where we need help. Perhaps it never did. Perhaps it is just that the mother lode of problems accessible to this toolkit is now nearly mined out. In either case, what do we do now? This would be a far better paper if it could do more than point out that the truly important and interesting parts of economic history are filled with Big Pushes, thresholds, and nonlinearities. But unfortunately all I can do is offer scattered observations.

First, Harry Johnson (1971) observed in his not-quite-fair critique of Milton Friedman's monetarism that a successful intellectual revolution in economics had to do two things: (i) provide the young with a reason not to have to spend their time studying the work and doctrines of the old, and (ii) provide the young with something interesting and straightforward to do. In this, Johnson wrote, both Keynes and Friedman succeeeded admirably. The General Theory claimed that there was simply no point in reading pre-Keynesian business cycle theory. Friedman's monetarism claimed that the only relevant macroeconomic equation was the money-demand function (and perhaps some price adjustment process): all else was illusion and deception. Young Keynesians could go estimate consumption, investment, and export functions. Young monetarists could go estimate money demand functions and think about the division of nominal output into prices and quantities. Alternatives simply fell by the wayside. The endogenous business cycle tradition of Joseph Schumpeter and Wesley Mitchell required that the young spend too much time learning the doctrines of their elders, and so delayed the beginning of their own research. The American institutionalist tradition did not provide the young with something straightforward and productive to do: thus John Kenneth Galbraith is the last American institutionalist.

A successful economics of thresholds and nonlinearities will have to meet these challenges, especially that of providing the young with clearly productive things to do. On the theoretical side, there needs to be a grammar, or perhaps a hierarchy, of threshold models worth investigating. On the empirical side, there need to be consensus views about which potential ways of modelling are in fact likely to be fruitful.

Second, the stakes are quite large--and always were very large. The neo-Marshallian toolkit really is not sufficient. The chances of long-run success are greatly raised by keeping economists' minds focused on all the truly important problems where the neo-Marshallian toolkit makes little progress.

Third, success is not guaranteed: just because economics needs models of virtuous and vicious circles to help it understand the world doesn't mean that journal editors will publish articles using them, or that graduate students will become excited by them. The new toolkit must be shown to be of great use even before it is built, which is hard to do.

Bibiography

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T.S. Ashton (1968), The Industrial Revolution 1760-1830 (Oxford: Oxford University Press).

Paul Blustein (2005), And the Money Kept Rolling in--and Out: Wall Street, the IMF, and the Bankrupting of Argentina (New York: Public Affairs).

John Brewer (1989), The Sinews of Power: War, Money, and the English State, 1688-1783 (New York: Knopf).

Gregory Clark (2001), "Debt, Deficits, and Crowding Out: England 1727-1840," European Review of Economic History

N.F.R. Crafts (1985), British Economic Growth during the Industrial Revolution (Oxford: Oxford University Press).

J. Bradford DeLong (1986), "Productivity Growth, Convergence, and Welfare: Comment," American Economic Review

Carlos Diaz-Alejandro (1970) Essays in the Economic History of the Argentine Republic (New Haven: Yale University Press).

Barry J. Eichengreen and J. Bradford DeLong (1991), "The Marshall Plan: History's Greatest Structural Adjustment Program"

C. Knick Harley (1982), "British Economic Growth Before 1841: Evidence of Slower Growth," Journal of Economic History 42:2, pp. 267-89.

Albert Hirschman (1958), The Strategy of Economic Development (New Haven: Yale University Press).

Albert Hirschman (1967), Development Projects Observed (Washington: Brookings Institution).

Albert Hirschman (1970), Exit, Voice, and Loyalty (Cambridge: Harvard University Press).

Chang-Tai Hsieh and Pete Klenow (2002), "Relative Prices and Relative Prosperity"

Charlene Huang (2005), "Can Favorable Initial Conditions Explain Rapid Growth in East Asia?" (Berkeley: B.A. Thesis Draft).

Harry Johnson (1971), "The Keynesian Revolution and the Monetarist Counter-Revolution," American Economic Review

Michael Kremer (1991), "Population Growth and Technical Change: One Million BC to 1990," Quarterly Journal of Economics.

Paul Krugman (1996), "The Fall and Rise of Development Economics" http://web.mit.edu/krugman/www/dishpan.html

David Landes (1999), The Wealth and Poverty of Nations

Charles Maier (1988), In Search of Stability (Cambridge: Cambridge University Press).

N. Gregory Mankiw, David Romer, and David Weil (1989), "A Contribution to the Empirics of Economic Growth," Quarterly Journal of Economics.

Alfred Marshall (), Principles of Economics

Karl Marx and Friedrich Engels (1848), Manifesto of the Communist Party.

Kevin Murphy, Andrei Shleifer, and Robert Vishny (1989), "Industrialization and the Big Push," Journal of Political Economy 97: pp. 1003-1026.

Michael Mussa (2002), Argentina and the Fund: From Triumph to Tragedy (Washington: IIE).

Louis Namier (1929), The Structure of Politics at the Accession of George III.

Ken Pomeranz (2000), The Great Divergence (Princeton: Princeton University Press).

Dani Rodrik (1994), "Getting Interventions Right: How South Korea and Taiwan Grew Rich" (Cambridge: NBER).

Paul N. Rosenstein-Rodan (1943), "Problems of Industrialization of Eastern and South-Eastern Europe," Economic Journal.

Paul N. Rosenstein-Rodan (1961), "Notes on the Theory of the Big Push," in Economic Development for Latin America (London: Macmillan).

Walt Whitman Rostow (1958), The Stages of Economic Growth (Cambridge: Cambridge University Press).

Adam Smith (1776), An Inquiry into the Nature and Causes of the Wealth of Nations (London: Millar).

Robert Solow (1957), "Technical Change and the Aggregate Production Function," Review of Economics and Statistics 39: pp. 312--320.

Peter Temin (1997), "Two Views of the Industrial Revolution," Journal of Economic History

Peter Temin and Hans-Joachim Voth (2005), "Credit Rationing and Crowding Out during the Industrial Revolution: Evidence from Hoare's Bank, 1702-1862" (Cambridge: MIT).

Abbott Payson Usher (1929), A History of Mechanical Inventions (Cambridge: Harvard University Press).

Jeffrey Williamson (1984), "Why was British Growth so Slow During the Industrial Revolution?" Journal of Economic History 44 (1984), 687-712.

World Bank (1994), The East Asian Miracle (Washington: World Bank)(.

Wrigley and Schofield (1993), The Population History of England ().

Comments

[P O'Neill]

You may know that there's been a bit of a push-back against the Big Push idea from the World Bank not least since it got embraced by Sachs. Aart Kraay presents a quick review of the case against in the paper linked below, beginning around page 15.

http://www.imf.org/external/np/seminars/eng/2005/famm/pdf/kraay.pdf

[P O'Neill]

sorry that link got clipped, go to
www.imf.org/famm & scroll down for the paper.

[Matt]

Not to mention the mother (or, perhaps, the daughter) of all non-linearities, the internet.

[Jess Olson]

"...one cannot be struck by how much of the economic past that is truly interesting is inaccessible to the neo-Marshallian toolkit."

one cannot be struck

Am I reading this wrong or is this written wrong?

[Winslow R.]

Brad wrote:

"attribute relative wealth and poverty in the world distribution of income to virtue (having a high investment rate and a low population growth rate) and vice (having a low investment rate and a high population growth rate)"

Ah, so no wonder "offshore manufacturing" has included baby production! The U.S. and Europe have imported labor for many years, now even Japan is considering shifting baby production offshore.

Leads to the question, will someday all "manufacturing" be considered a vice?

[Bill Sundstrom]

It's a little harsh to hang this on Marshall. It's true that he wrote "Natura non facit saltum," but he also contributed significantly to our thinking about external scale economies, no?

Bill

[spencer]

I find it fasinating that you start off talking about imperfect competition. When I first was exposed to the imperfect competition model I thought, this is it, this is what describes the real world so much better then the perfectly competitive world. I could not understand why main stream economics ignored imperfect competition and focused exclusively on the perfect competition model. Of course, as you said, the reason was that imperfect competition did not lend itself to ecometric modeling and math. So the profession went off on a tangent that massively distorted the field.

[kharris]

Jess,

You're reading it right, and it's wrong. "One cannot help but be struck" must be somnething like what the perfesser intended.

[Russil Wvong]

Fascinating historical perspective for a general reader, Brad.

One of the most interesting discussions of economic development that I've seen is from a 1964 collection of essays, "Foreign and Other Affairs," by John Paton Davies Jr. (a colleague of George Kennan's, worked with Kennan on the Policy Planning Staff, went into exile in Lima after being purged by the McCarthyites). Davies emphasizes sacrificing current consumption, which sounds similar to the Mankiw/Romer/Weil story. I think I'll have to get a copy of the Hsieh/Klenow paper, to see what the counter-argument is.

Davies:

"The cost has been high for those societies that have done it on their own. Britain, Japan, and the Soviet Union are three disparate cases. About the only thing that they had in common was that they were in the same general latitude. Yet their patterns of growth had certain things in common.

"A small minority decided instinctively or by plan to industrialize and expand the economy. They kept control of the process in their own hands. They siphoned off a small fraction of the increase for their personal benefit. The bulk of it was reinvested. None was distributed to improve the lives of the workers. To the contrary, generations of workers and peasants were sacrificed to the national growth process. But it worked."

Davies also highlights the political factors of leadership and bureaucracy:

"The nature of most civilian leaders, liberal and conservative, is that they want to be popular. Their inclination is toward going along with the wishes of the people which, in underdeveloped countries, are often conflicting and usually ignorant, extravagant, and unattainable. So like surfboard riders, the leaders try to balance themselves atop a breaking comber, more or less cleverly adjusting themselves to the agitation below while praying that they may last out the ride. The performance can be, as was President Goulart's in Brazil and Sukarno's in Indonesia, breathtaking for the spectator. But is it government?

"The combination of exaggerated public expectations and the leaders' desire for popularity tends to make politicians into demagogues. And demagogues must have devils to exorcize from the body politic. The conventional devils are the 'reactionary' rich and foreigners. But in attacking these two, the masses and their demagogues drive out what they need for economic growth -- domestic and foreign private investment."

And:

"Even had there been a basic social harmony of purpose, there remained the problem of the competence and vigor, not to mention integrity, of the system of public administration. Many of the leading figures in the governments of backward countries are themselves intelligent, well-educated, vigorous, and honest. In general, the same cannot be said of their subordinates, through whom they must operate and upon whom they are dependent. And without a reasonably competent public administration, foreign assistance is at best wasteful and at worst futile."

The context of the discussion is Davies' skepticism towards the Kennedy Administration's Alliance for Progress.

[W. Raymond Mills]

Toolkits apply in some conditions and not others. The cultural assumptions determine which tools work. This makes life difficult, for people like DeLong, because "culture" is such a messy and unlimited concept.

Max Weber claimed that a religious uprising, Protestantism, was a necessary precondition for the industrial revolution.

Pitrim A. Sorokin looked back through history to find reoccurent cycles: ideational cultures (religious mostly), replaced by idealistic (reformation), replaced by senseate (satisfying the senses), replaced by ideational, etc.

Possibily no economic tool kit will lead to understanding of transformations because transformations are largely cultural rather than economic. Perhaps all that can be hoped for is to provide tools that work within a given set of assumptions shared in one culture.

[Barkley Rosser]

"Natura non facit saltum" was originally coined by Leibniz and quoted by Darwin, from whom Marshall got it. Thresholds and nonlinearities have become very fashionable (see Malcolm Gladwell's _The Tipping Point_), and remain controversial in growth theory and history, as some of this discussion shows. Older, but more recent, (if that makes any sense) references include Tom Schelling's _Micromotives and Macrobehavior_ (1978) and my _From Catastrophe to Chaos: A General Theory of Economic Discontinuities_, 1991, Kluwer (vol. I of 2nd edition, 2000).

[Robert J. Chassell]

My memory of Aristotle does not include the
plowing. I did remember the shuttle, but
thought he had spoken of a shuttle that could
"weave by itself".

However, according to Benjamin Jowett's 1985
translation of Aristotle's Politics. Section
1.4, Aristotle said,

http://www.mdx.ac.uk/www/study/xari.htm#1253b23

> ... if every instrument could accomplish its
> own work, obeying or anticipating the will of
> others, like the statues of Daedalus, or the
> tripods of Hephaestus, which, says the poet,

>> "of their own accord entered the assembly of
>> the Gods"

> if, in like manner, the shuttle would weave
> and the plectrum touch the lyre without a hand
> to guide them, chief workmen would not want
> servants, nor masters slaves.

Two millennia after Aristotle, inventors created
automated textile machines; these machines could
do the work that women, slaves, and other people
had done before.

[marku]

Stephen Keen's "Debunking Economics" and Mandlebrot's "Misbehavior of Markets" would be excellent companions to BdL's lecture. Equilibrium is a fallacy. Ignoring economies of scale is ludicrous. The important effects are non-linear and non-continuous.

[Auros]

Two thoughts:

One: The successes of Lula may be undermined by US hostility to his ideology. (During the cold war, we frequently pushed people who might've been our friends into the arms of the Soviets, because they were insufficiently ideologically pure.)

Two: Trying to model population growth seems almost futile... Many of the factors involved -- stuff like religious rejection to contraception -- is nearly impossible to make sense of. How do you model the effectiveness of a religion's system for indoctrinating the next generation? Both Brazilian and American Catholics ignore the teachings on condoms, but for the Brazilians this seems to be a cause of their current economic circumstances, and for the Americans, an effect.

[liberal]

Brad wrote, "Looking back at economic history, one cannot be struck by how much of the economic past that is truly interesting is inaccessible to the neo-Marshallian toolkit."

There's an interesting twist on that. Marshall was apparently one of the neoclassical economists who actually understood that land isn't capital and that the supply of land is fixed.

Much of the economy (not just the "past") would be more accessible if economists had the same understanding (viz, the correct one) of the role of land in the economy that Marshall (and of course his classical predecessors) did.

[liberal]

P. O'Neill wrote, "sorry that link got clipped..."

Actually, no. The entire link is there, but the end is hidden and might not get copied correctly by other users. I'm sure this happens in these comment sections (seen it many times now) because of the way the HTML and stylesheet are working.

[meno]

The comments on Argentina are very interesting. Especially how long it took the govt's poor economic
plans to come home to roost - for a decade things were okay. Yet they did strike, and one of the wealthiest nations in the world turned into modern Argentina.

One wonder's if there's a moral for the current US fiscal problems...

There are a huge number of books on economic 'miracles' and success stories, but very little on nations that have been economic failures or that have stopped being successful. Yet avoiding screwing up your economy really should be a major consideration.

(anyone wanting to post a ref to a good book on economic non-success stories, please feel free)

[SkipWalkDC]

not a macro study of economic success stories but interesting nonetheless (admittedly, its still on my too read stack after 'Manias Panics and Crashes' and 'Invisible Bankers')
Born Losers: A History of Failure in America
Scott A. Sandage

Jonathan Yardley - The Washington Post
By examining the lives and careers of a number of businessmen who failed during the 19th century, [Sandage] portrays what we reflexively think of as the dark side of the American dream but what is, in reality, an only slightly exaggerated mirror of the reality with which ordinary people -- i.e., thee and me -- are fated to contend. He explores what he rather nicely calls "the hidden history of pessimism in a culture of optimism" by recording the "voices and experiences of men who failed (and of their wives and families)" as expressed in their "private letters, diaries, business records, bankruptcy cases, suicide notes, political mail, credit agency reports, charity requests and memoirs." In so doing he examines the ways in which our attitudes toward failure and our ways of measuring it have changed; if at moments Sandage lapses into the clotted patois of contemporary academia (he teaches history at Carnegie Mellon University in Pittsburgh), for the most part Born Losers is readable, interesting and thoroughly researched.

[Michael Martin]

Seems to me that your initial comment about a whole that is greater than the sum of its parts and the recognition that nonlinear effects are involved already points toward a General Systems Theory approach to economics. A similar application in paleontology led to "punctuated equilibrium" as an explanation of the kind of sudden shifts in steady states.

General Systems Theory involves a recognition that there are interdependent feedback mechanisms that tend to counteract external attempts to change them. The significance is that relationships such as Keynesian and Moneterist explanations are both separate interdependent forces within a single economic dynamic system.

It seems to me that DeSoto's popular book about how government creates capital is the fundamental relationship missing from your explanation. Wealth creation is fundamentally related to the extent that government creates and enforces property rights, including intellectual property. High taxation and over-regulation diminishes the value of property, but low taxation and consequent inefficient government guarantees of property rights and regulatory protections equally diminishes the value of property. Thus we must consider optimality rather than maximization when discussing dynamic relationships.

Finally, there needs to be a greater recognition of the human capital relationship to economic development. The value of labor is fundamentally linked to the ability to produce enough workers with the skills to create, maintain, and employ the capital goods that produce value added. There needs to be a recognition that individuals have "comparative advantage" just like countries that must be nurtured in the same way countries nurture industries that exploit their comparative advantage. Thus education optimizes its output when it matches skills to the innate talents of its workers, which is best accommodated by a liberal education program, rather than maximizing some predetermined skill level in some predetermined career focus.

The key being that simply measuring values without recognizing the optimality involved in dynamic systems will not produce any useful models.

[radek]

"Stephen Keen's "Debunking Economics" and Mandlebrot's "Misbehavior of Markets" would be excellent companions to BdL's lecture."

Don't know about Mandlebrot but Stephen Keen's book is 90% idiotic nonsense disguised with a faux style of (pretty shallow) mathematical knowledge.

[radek]

"(anyone wanting to post a ref to a good book on economic non-success stories, please feel free)"

The big non-success stories, aside from countries that went communist, would be Sub Saharan Africa and, as you note, Argentina:

"A New Economic History of Argentina" by G.d. Paolera and A.M. Taylor

[radek]

"There's an interesting twist on that. Marshall was apparently one of the neoclassical economists who actually understood that land isn't capital and that the supply of land is fixed."

It sounds like you're actually talking about DECREASING returns to scale. Land is the standard way to set up a model with DRS. The way to set up a model with IRS is either through some kind of a (continuos) externality to (possibly human) capital, like in the AK model or its modern variants, or through some kind of fixed costs - more or less the threshold effects that Brad is talking about.
(I'm not trying to pick on you liberal, I promise. And if I am misunderstanding your point then I apologize in advance)

[derrida derider]

For those who haven't read it the Krugman essay is just about his finest. His NYT pieces are too short - his muse seems to take the first 1k words to get past platitudes and rhetoric. And the muse seems to get tired about 10k words in - I didn't much like his books. But an essay this length is just right.

Do click on the hyperlink in the Bibliography - it's worth your time.

[Les Brunswick]

You mentioned that economists tend to neglect technological innovation. My guess is this is because technological invention is unpredictable, and economists want to have a perfect, determinate science. With all their equations, they seem to be modeling themselves after physics.

As a former physics major, let me say that this is simply impossible, as the systems under consideration are many orders of magnitude too complex. I wish economists would just admit that economics is a social science, with all that implies, and get on with it.

[kharris]

This is an early draft? Are the pompous among us allowed to offer editorial suggestions?

[Roger Bigod]

"Marshallian toolkit" is ugly and obscure, and on repetition becomes exceedingly rebarbative. Why not "neoclassical model", or "equilibrium analysis" or "assumption of continuity"?

[Chip Poirot]

When I read these sorts of papers by mainstream economists I can never quite decide whether I schould a)just be happy that the mainstream is starting to accept that non-linearities are important or b) bang my head on my keyboard for the incredible, vast ignorance of the history of thought exhibited here.

If anyone wants to know what has gone on, and what was going on in development economics I would suggest Cypher and Dietz's excellent text. It serves as a useful history of development thought, a useful history of development itself, and a useful exposition of many modern mainstream (endogenous growth theory) and non-mainstream (structuralist, radical and institutionalist) development thinking. All this and they even manage to talk about real world institutions like the state.

So, while I am happy that Brad has discovered virtuous circles, I wish to point out that Gunnar Myrdal had discovered them a while back, and even shared a Nobel Prize with Hayek for the contribution. And it wasn't like Solow was unaware of Myrdal. And it also wasn't like Solow has ever been unaware of the possibility of disequilibrium analysis. Mainstream economists like Solow made a deliberate, theoretical choice to model capital and growth in a particular way. At last, he finally conceded the point to the dark underground of economic thought led by Joan Robinson that trying to aggregate capital and trying to prove that capital was just a set of brick a bats to be assembled and dissassembled at will was not sustainable. But that did not stop the mainstream from continuing on.

There is a lot more I could say, but I doubt it would have an impact.

Anyway, Brad should know that the Original Institutional Economics did not end with Galbraith. There really is such a journal called the Journal of Economic Issues and it really does publish material by Original (and sometimes even new) Institutional economists. This journal has been around for quite some time.

Sometimes the arrogance of the mainstream can be astonishing.

Anyway, I am glad that Brad has discovered the existence of virtuous and vicious circles. Welcome to the club. Perhaps next he will discover "conspicuous consumption" or perhaps "spread and backwash effects".

It's too much to hope that he will discover the tendency of long run commodity prices to fall. Of course, that discovery would require blaming Argentina's woes on someone other than Peron. Too much to expect from the mainstream-I know. But there is hope.

[rjw]

Interesting essay, but I would be careful about limiting Marshall to supply and demand curves. Marshall was not a narrow economist in that sense. He was well aware, for example, of the role of external economies between firms in creating industrial districts. The idea that modern textbook microeconomics with its nice production functions is a straight representation of Marshall is not quite right.

[jonathan Goldberg]

For anyone interested in the paper cited by P. O'neil, above, this link:

www.imf.org/external/np/ seminars/eng/2005/famm/pdf/kraay.pdf

worked as of 8:25 CDT 5/12/05

[kharris]

""Marshallian toolkit" is ugly and obscure, and on repetition becomes exceedingly rebarbative. Why not "neoclassical model", or "equilibrium analysis" or "assumption of continuity"?"

Without waiting for a response to my earlier pompous question, let me just say - Roger is right. Tack on "neo-" every time, and it's even worse.

This essay is, in its substance, a very nice thing. Make the language equally nice, and it can be added to "Noise Trader" and the few other essays you point to with pride on your front page. It can be popularized and put in front of the general public many, many times to improve understanding of how far economics has come. As it is now stands, the language is a bushel underwhich the substance hides.

[liberal]

radek wrote, "It sounds like you're actually talking about DECREASING returns to scale. Land is the standard way to set up a model with DRS. The way to set up a model with IRS is either through some kind of a (continuos) externality to (possibly human) capital, like in the AK model or its modern variants, or through some kind of fixed costs - more or less the threshold effects that Brad is talking about."

Huh? I'm talking about the fact that classical economists, and apparently Marshall also, knew that there are three factors of production: labor, capital, and land.

Neoclassical economists conflate land and capital, which is an error.

[liberal]

radek wrote, "Don't know about Mandlebrot but Stephen Keen's book is 90% idiotic nonsense disguised with a faux style of (pretty shallow) mathematical knowledge."

You could say that about a lot of modern orthodox economics.

[liberal]

Les Brunswick wrote, "My guess is this is because technological invention is unpredictable, and economists want to have a perfect, determinate science. With all their equations, they seem to be modeling themselves after physics."

It's often claimed that economists have "physics envy."

However, physicists have pointed out that economists, with their emphasis on models and frequently unrealistic assumptions, really envy mathematicians, not physicists.

From
http://archives.econ.utah.edu/­archives/pkt/1998m11-d/msg0001­9.htm

----------begin quote--------------
This is in response to the widely quoted wisecrack about "physics envy" that I think was originated by Phil Mirowski, if I am not mistaken. Actually, as a number of observers have recently pointed out, including Deirdre McCloskey and Brian Arthur, it should really be labeled "mathematics envy." The tale is told about what happened at the first Santa Fe conference on economics back in 1987 where a bunch of mainly neoclassical economists got together with a bunch of physicists. The physicists were shocked at the propensity of the economists to prove theorems that had nothing to do with the real world. This is not the way physicists proceed who are much more empirical and when they are theoretical, much more "ad hoc" as economists would say. The emphasis on proving theorems is actually an imitation of what the mathematicians do, not what the physicists do. And the physicists think that we are suffering from a ridiculous version of rigorous mortis when we do so.
--------------end quote---------------------

[Chris R]

As a budding young macroeconomist, I have my $0.02 about this sort of stuff.

We've known about IRTS and DRTS for a pretty long time. I actually kind of wonder where the myth that economists don't understand increasing returns comes from. Nowadays we understand the concepts pretty well and have had them in the back of our heads for a very long time. However, we run into problems trying to take nonstationary models to the data for one major reason: The time-series issues get pretty hairy.

If you look at Kremer's 1993 paper on population and technological progress, he discusses the theory that the more minds working on problems, the faster that technological progress occurs, and vice versa. It's a parsimonious model that fits with intuition. But he uses OLS on levels for extremely nonstationary, nonergodic, trended data. Here, OLS offers no insight about how well the model works and doesn't work. We're reduced to eyeballing graphs and drawing curves by hand. We just don't have the technology yet to do good time-series work in these environments. We're doing better than we did 40 years ago; we understand random walks and time trends pretty well. We don't understand explosive series that well.

(As a side note, in the short to medium run, most macroeconomic series seem pretty nonexplosive. In the long run, that's much more open to debate.)

There are also few different sources of IRTS that have very different theoretical (but not necessarily empirical) implications:

1. Imperfect competition. We know how to model this now. We've known how to model monopolies for a long time, and if we let income effects go to zero we get monopolistic competition. To me this seems like a bit of a crutch, since entry and exit don't seem like much of a problem. We can't measure elasticities in a CES aggregator particularly well, for instance. But, there are situations where this class of models is appropriate--in a world of retail, advertising, and large shopping costs, a carefully done model of imperfect competition is probably the way to go.

2. Externalities. There are a million and one different kinds of externalities--some negative (congestion, pollution), some positive (specialization, sharing costs of infrastructure, human capital augmentation, certain institutional changes, etc). This sort of thing is difficult to model because we can't observe the magnitudes of these different effects firsthand. We know that they're there; we just can't measure them too well. They do seem nonconvex though.

3. DRTS and land: When we're talking about nonagricultural economies, we can effectively ignore land. How much land do you need in order to program a computer or make steel? Even in agriculture, if you're doing time series, it's a constant. It matters in cross-sectional work.

The lesson of the past forty years is that sometimes the Marshallian toolkit works well and sometimes it doesn't. If we're talking about whether to put price floors on the supply of milk, a first pass at the problem using introductory micro will usually give the right answer (Don't do it.). If we're talking about the permanent effects of the Thirty Years' War on German corporate culture, or whether the increase in income inequality since 1970 is a bad thing, we have to turn to history and philosophy and our own priors. Hammers are great tools for pounding nails. But if you want to drive a screw, get a screwdriver.

In other words, don't expect a model of everything anytimes soon. As economists we're not searching for the One True Catholic and Apostolic Model. (That's a common misconception held by nonpracticioners). We're looking for little insights here and there. The model has to fit the problem at hand. I do think that this means that we should be more open to insights from historians, biologists, psychologists, and (gasp) sociologists; and that we should idolize the math department a little less. But I also think that noneconomists should recognize that economics is a useful tool for understanding the world. We never claimed to have a complete model of everything. That's impossible. But the idea that people respond to incentives has a wide array of rich implications that people often choose to ignore.

[Auros]

Liberal said: The entire link is there, but the end is hidden and might not get copied correctly by other users. I'm sure this happens in these comment sections (seen it many times now) because of the way the HTML and stylesheet are working.

Yeah, that's what's going on exactly. I have never understood why anybody would choose a page format that fixes the width of the text column. Resizing my browser window should allow me to squeeze more or less text on a line. Disabling that functionality is extremely irritating.

[radek]

"Huh? I'm talking about the fact that classical economists, and apparently Marshall also, knew that there are three factors of production: labor, capital, and land."

Which is true, but the context was Brad's essay on increasing returns. Land usually implies decreasing returns. Actually they're sort of fake decreasing returns - you can't double land, but if you could you'd get at least constant returns.

Once again, the very excellent and informative New School website on History of Economic Thought has a very nice explanation of the issue:

http://cepa.newschool.edu/het/essays/product/returns.htm

(and all you 'mainstream economics is for da foolz' folks should appreciate it since they're not mainstream economists over there. They do know what they're talking about though, even when talking about neoclassical economics. That can't be said for most critics of the mainstream.)

[radek]

"There are also few different sources of IRTS that have very different theoretical (but not necessarily empirical) implications:

1. Imperfect competition"

I've always understood it to be the other way around. Imperfect competition is a result, not a source of IRTS which generally are just a function of the technical aspects of production. So its IRTS => IC, not IC => IRTS

"2. Externalities"

Even from a purely theoretical view not all externalities are created equal as far as modeling goes. If the externalities are external to the firm (so that each firm takes them as given when doin' their maximizin' ) then we're okay. If they're internal then we get a big mess. Krugman has some nice discussions of this all over the place. Both in popular writings (forget which) and in academic - it's talked about in Helpman and Krugman "Market Structure and Foreign Trade"

And as far as everything else goes I think you hit the nail on the head.

[Barkley Rosser]

I will go along with whoever it was that said that Marshall was not so simple-minded, even though he repeated "natura non facit saltum" and is usually credited (with some accuracy) for giving us standard textbook micro. It is not just that he was aware of external economies, which are a main source of nonlinearities and broader scale economies, he was also aware that broader economic reality was more complicated than he posed in his models. Some of this was seen in his invocation of biology, although that may have been consistent with his Darwinian continuism.
However, the following is a quote from p. 346 of the 8th edn of Marshall's Principles, a quote that appeared in a paper by me that Brad approved of about price dynamics.

"But in real life such oscillations are seldom as rhythmical as those of a stone hanging from a string; the comparison would be more exact if the string were supposed to hang in the troubled waters of a mill-race, whose stream was allowed at one time to flow freely, and at another partially cut off. Nor are these complexities sufficient to illustrate all the disturbances with which the economist and the merchant alike are forced to concern themselves.
If the person holding the string swings his hand with movements partly rhythmical and partly arbitrary, the illustration will not outrun the difficulties of some very real and practical problems of value."

[liberal]

Chris R. wrote, "3. DRTS and land: When we're talking about nonagricultural economies, we can effectively ignore land. How much land do you need in order to program a computer or make steel?"

LOL!

Perfect example of the ignorance of modern economists.

Ask programmers in the San Francisco Bay area, who have to pay rent or make mortgage payments, whether land can be ignored.

Or ask a small businessman renting space for his store whether land can be ignored.

The claim that land rents play little role in a modern, nonagricultural economy is bizarre.

[liberal]

radek wrote, "Which is true, but the context was Brad's essay on increasing returns."

But the context of my initial post is that, while Brad is suggesting Marshall's toolkit is limited, Marshall on the other hand would consider the modern neoclassical toolkit limited because modern economists don't understand that land is not capital.

[radek]

"You could say that about a lot of modern orthodox economics."

No. A lot of modern orthodox economics MIGHT be nonsense, but it is not IDIOTIC nonsense. Economic models are true in the sense that they are consistent given their assumptions. One can of course quibble with the assumptions or question the relevance of these models. Stephen Keen, on the other hand basically has no idea what the fuck he's talking about.

His 'criticisms' are just plain wrong, are amazingly stupid ('infintesmals are not zero', well, no, they're infintesimal), fail to even understand the concept they are supposed to address (from average and marginal cost curves to monopoly pricing to price taking) or are just confused as hell. If you gonna criticize something you have to understand it first. For good, legitimate arguments against 'modern economic orthodoxy' read Joan Robinson, or the New School web page I mentioned earlier or even day present day Marxian economists like John Romer. Don't bother with hacks like Stephen Keen who either has no clue, or pretends that he doesn't so that he can sell books to people who want a quick confirmation of their world view and preformed opinion that 'mainstream economics is junk'. It's like trying to understand controversies in evolutionary theory by reading Chick pamphlets.

[radek]

Alright, if you'd like it in stronger words here it is:

One can of course question, dismerit, parody or even disprove many assumptions made by 'mainstream economic models'. And? The whole point is that an explanation of any phenomenon has to be based on SOME assumptions. If you got better ones that work, then please, let me know or publish them somewhere. Not understanding what is one criticizing while shooting off cretinous opinions surely deserves a disapprobation, does it not? At least mainstream economic models (some particular ones)make logical sense, even if they might not have much relavance. You can't say that for SK who fails on BOTH counts. Exactly what is it that you're critizing? Be specific, be brave. Quit the snarky comment shit and say something intelligent. Or substantial at least.

[Mark]

"Perfect example of the ignorance of modern economists.

Ask programmers in the San Francisco Bay area, who have to pay rent or make mortgage payments, whether land can be ignored."

The point is that land can be safely ignored sometimes, to simply analysis, and other times of course it can be a critical component, as in analyzing agriculture or real estate. In terms of modern industrial economies, rent (including imputed rent) is not a significant share of GDP. Additionally, as noted elsewhere, land is not a significant element of production. Agriculture is a small part of industrialized economies and doubling the amount of land that, say, Intel uses does not increase its value added to the economy very much.

To make a broader point, it is only superficially true that land is fixed. If you've ever been to Manhattan, you know the amount of real estate in square feet has very little to do with land area (in the Bay Area building restrictions and zoning laws prevent building up, unlike in Manhattan). In agriculture, land can be farmed more intensively and better technology can increase crop yields. American agriculture is significantly more productive than agriculture in Bangladesh or China, for instance. Viewing land as fixed ignores the fact that land can be used more intensively and previously unused land can be brought into production.

[Robert]

Keen sometimes simplifies things too much for my taste. But his basic point is correct: the advanced literature has shown that much of neoclassical economics is logical nonsense. If you click on the link on my name and look at the "Publications for fun" section of my page, you can find some demonstrations of logical possibilities of mainstream assumptions. The student of mainstream economics often gets implicitly taught that these possibilities are impossibilities. This is not a matter of relevance or realism of assumptions, but simply incorrect reasoning.

A paper in which Keen makes this point is available somewhere or other:

Frederick S. Lee and Steve Keen, "The Incoherent Emperor: A Heterodox Critique of Neoclassical Microeconomic Theory", October 2003.

[liberal]

radek wrote, "The whole point is that an explanation of any phenomenon has to be based on SOME assumptions. If you got better ones that work, then please, let me know or publish them somewhere."

Of course one must make simplifying assumptions.

But there's lots of evidence that much of modern economics is a bad joke.

Example 1: Martin Feldstein predicted the 1993 Clinton tax hike would harm the economy. In a truly positive science, what actually happened would have resulted in Feldstein becoming a laughingstock. What did happen to Feldstein? He's head of NBER.

Example 2: Prescott argues that the Great Depression occured because US workers decided to take a long, extended vacation.

[liberal]

Mark wrote, "In terms of modern industrial economies, rent (including imputed rent) is not a significant share of GDP."

Simply false. More examples of economic illiteracy and ignorance.

Economists like to *pretend* that land rent is a relatively tiny fraction of GDP. That doesn't mean it is so, however. More reasonable estimates put it at 10--20%.

"...doubling the amount of land that, say, Intel uses does not increase its value added to the economy very much."

But land rent jacks up labor costs, because the workers have to live somewhere. I reckon land is pretty cheap in the middle of the dessert in Wyoming, say, but I don't see Intel relocating there.

"If you've ever been to Manhattan, you know the amount of real estate in square feet has very little to do with land area (in the Bay Area building restrictions and zoning laws prevent building up, unlike in Manhattan)."

But that, of course, is the point. Land is a necessary factor of production; you need to situate yourself in terrestrial space to do anything. Zoning and real estate tax schemes have conspired to lead to an egregious inefficient of this particular factor of production.

[anon]

someone here said "how much land do you need to program a computer" etc, hence supposedly provinf land is not important in a nonagricultural economy.

look at manhattan or singapore and see what a nonagricultural economy does to the price of land, and the share of production paid as land rent.

[radek]

Robert, I've looked around the Publications for Fun portion of your website but I don't see anything that would change my mind about Stephen Keen or that demonstrates the nonsense of mainstream economomics.

I do see a bunch of stuff about LTV and the CCC. I'll leave the first for a different discussion and as far as CCC goes I'll just say that I am tend to agree with Robinson, though I think that aggregate production functions can be a useful tool on occasion - though one should always keep in mind the aggregation problems behind them.

If I had a more bit of time, and the willingness to play in the mud, I'd comb through Stephen's web site a bit and specifically point out some of his more egregerious nonsense. Might do it anyway even though I'm busy as hell.

[radek]

"Example 2: Prescott argues that the Great Depression occured because US workers decided to take a long, extended vacation."

I don't this is true - I don't know where you're getting it but you should check your sources. I'm no big fan of RBC but Prescott has repeatedly said that the kind of macro model he has in mind 'applies to post WW2 economy only'. Hell, I saw him speak a few weeks ago and even though his topic was not really relevant to business cycles he made the same disclaimer several times 'the business cycle model does not explain the Great Depression', almost out of the blue.

What I think has happened is that someone used the above statement as a joke/caricature of RBC models, then the meme got started that Prescott himself believed it then folks like you take it up as an exhibit in the 'case against mainstream economics'. But it's a fabricated one as far as I know - and I've heard it from the horse's mouth.
(It's also a possibility that he did actually say this on some occasion - since Ed Prescott has a tendency to occasionally say crazy stuff - and is now busy taking it back)

[Barkley Rosser]

One more defense of Marshall as being somewhat heterodox, or at least more so than most are aware of. Although he clearly viewed it as an odd case to be kept in appendices, he was the first in the English language tradition to recognize the possibility of multiple equilibria in 1879, unless one counts Thornton's observation of how English and Dutch auctions for the same thing can result in differently priced outcomes.
Marshall's model was of offer curves in a trade model. Without question, foreign exchange markets are among the most likely contenders for ubiquitous multiple equilibria and accompanying discontinuous dynamics.

[Roy L]

Radek's comments on land are totally false, and indeed the diametric opposite of the truth. Land rent in an advanced industrial economy is often a _larger_ share of GDP than in an agricultural economy. Any estimate using a scientifically credible methodology will find that it is about 20% of GDP, an immense amount of money that neoclassical economists just studiously ignore -- when they are not flat-out trying to falsify it.

"Land is not a significant element of production"? Ask anyone who operates a business on a major city street how important his location is, and how much of his gross revenue he pays for it. Ask anyone who produces accommodation -- i.e., builds housing -- what fraction of the final price of the units is the value of the bare land they are built on. And then reflect that from the moment those housing units are completed, the improvements will be depreciating roughly exponentially, while the land rent is _increasing_ roughly exponentially.

Radek's claim that land is "only superficially" fixed in quantity is likewise false and ridiculous. Improvements are not land. Using land more intensively tends to increase land rents, it doesn't create more land. Natural resources by definition cannot be produced by labor. Duh.

I would suggest people should make at least a minimal effort to inform themselves of the facts before embarrassing themselves with such absurd and misinformative comments. Google sci.econ and start reading the threads with "land" in the subject line. In a few hours, if you are willing to know the inescapable implications of the facts that you already know, you will understand land economics better than about 99% of economics PhDs.

[liberal]

radek wrote, "And yeah Feldstein's crime is that he didn't forsee the productivity growth of the mid 90's that swamped whatever effects the tax hike maybe had - not to surprising actually since he's more of a tax specialist than a productivity/growth specialist."

But there's no reason to think that the tax hike *would* harm economic growth.

Again, if economics as actually practiced were a positive science, he'd be laughed out.

[Chris R]

Folks, if you look at the data, economic growth in 1993 after the tax hike was in fact pretty crummy. The productivity growth and recovery from the 1990 recession that happened around that time swamped the effects of this tax hike, so growth didn't go negative for very long. The real pickup in growth seems to have taken place from 1994 onward. So, yes, all else equal, raising taxes a little bit did seem to reduce output a little bit. A small tax increase slowed the recovery a by a small amount--we see this effect again and again in other situations too. What's so hard to understand? Tax something and there's less of it, _all else equal_.

I'll eat my hat if I run a VAR and the estimated effect of certain tax rates on GDP doesn't turn out to be slightly negative. (Watch out for endogeneity in your normalization.) Has anyone here done this recently? At any rate, there seem to be bigger things to worry about, like intergenerational Ponzi schemes, encouraging R&D, and schools which refuse to teach.

Roy (and to some extent Liberal), I really don't understand your issue with land rents. If we're talking about something land-intensive like agriculture or maybe mining, then it makes sense to think of land as a factor of production. This is what Ricardo did. But the bagel shop over on the corner doesn't really use much land. It uses location. Location isn't land. You're confusing location and buildings (which are indeed part of the capital stock) with land (which isn't).

Land offers a classic example of decreasing returns to scale, as everybody else has pointed out. First you farm the good land, then the rocky stuff, then the sides of hills. Location offers a classic example of increasing returns; the entire field of urban economics is built around that principle. Am I paying rent so that I can have use of an unimproved piece of land 50 miles east of here, inhabited by rattlesnakes and ornery mountain folk? No, I pay rent in order to live in a home (a piece of capital) in a decent location (near good transportation infrastructure--lots of capital--and my work, in a school teeming with capital) and in a decent neighborhood (reasonably safe, clean, where other people maintain their pieces of capital reasonably well). Nope, no capital here.

Natural resources can't be produced (or augmented) by labor? Haven't you ever heard of oil exploration? Mining? Timber farming? Iron ore and oil aren't resources until someone discovers, mines, and refines them. Otherwise it's just a bunch of muck. Surely you know this.

Rather than calling other people names, I suggest that you actually study some economics. You might actually enjoy it. You seem to have a passion about these issues, which can be very good if you directed it appropriately.

[radek]

Roy:

"Radek's claim that land is "only superficially" fixed in quantity is likewise false and ridiculous.
...
I would suggest people should make at least a minimal effort to inform themselves of the facts before embarrassing themselves with such absurd and misinformative comments"

I would suggest that people actually read what someone writes before getting their panties all in the twist. And specifically, they should read who wrote what. I didn't say anything about land - except that usually land is used to model decreasing returns to scale. I didn't say anything about it's importance in modern day economies. I didn't say anything about land and neo classical economics. Your fervent desire to criticize and spew at me and that amorphous whipping boy, 'neoclassical economics', has led you to attribute something to me that I didn't say. So who looks like a fool now, fool?

[radek]

"But there's no reason to think that the tax hike *would* harm economic growth.

Again, if economics as actually practiced were a positive science, he'd be laughed out."

I said this was a red herring didn't I? So why don't you respond to the point I actually made instead of attacking some imagined boogey man?

Anyway, for the record I will state that I agree with both Mark and Chris for the most part. Land in developed economies IS NOT that important - there's no way you can slice the data that gets you more than 5% or so of GDP. Silicon valley programmers and Manhattan real estate seem like big issues because people forget how much bigger the whole (total GDP) is. Missing the forest for the trees. Also, Feldstein's claim is not neccesarily wrong. Maybe not right either. At any rate it's an empirical question and the fact that the tax increase was followed by rapid growth does not prove anything. Correlation does not imply causation (personally I think he was mistaken - but the magnitudes involved were small). And this 'he'd be laughed out' ... you read that line somewhere, thought it'd to be pretty good and now you're parroting it somehow believing it to be a piece of evidence.

If we're gonna argue over whether economics is a science or not, that's fine, but it is a different discussion than the one we were having until liberal decided to change topics (which originally was the stupidity of Stephen Keen or the relevance of land to decreasing returns to scale) and it is also one where the criteria of what it means to be scientific need to be defined more clearly. As I said, the problem is lack of controlled experiments, a lot like evolutionary biology where you're forced to make inferences from the data that the world, in its random generosity, throws at you. So one shouldn't be too surpirised that economists get stuff wrong more often than physicists or chemists who can blow up stuff in their little test tubes until they understand the forces involved.

[radek]

Also for the record, so far from what I've read, Robert's web site seems pretty damn good. Alright, so far I've only been reading the stuff related to the Cambridge Capital Controversy, which IS a very weak point in Neoclassical Growth Theory (as an aside I think this is the only area where the term 'Neoclassical' actually makes sense) so it's the easy avenue to easy criticism. Nonetheless, I've gotta say that the example on ReSwitching and the discussion that follows is very well done.

Now, how this somehow justifies Stephen Keen I still don't know (couldn't find the paper cited above). I think I'm gonna have to throw Robert into the set of "otherwise intelligent people who get taken in by Keen's hackery only because it alligns nicely with their distate for 'mainstram' economics".

[Randolph Fritz]

Your resident gadfly saith:

Let me offer the suggestion that the basis of the achievements of the industrial revolution was to harness energy without relying on biological systems. The industrial revolution could only have happenned in a relatively thinly populated place, a place where there were both intellectuals and openness to new ideas, and a place where there was a desire for new systems. It could not have happenned in China or India; there was neither space nor resources. The trans-temporal cultural contact with ancient Greek and Roman sources sparked much creativity, and there was more the story than that (and I don't know it). There really weren't other places for it, and the right opportunities may just not have existed beforehand.

And is no-one looking at Mandelbrot's work on market microeconomics? Likely enough it is relevant to large-scale non-linearities.

(So far as I am concerned one gets much more mileage out of analyzing the physical systems and geography of an economy and the ideas of the participants than out of looking at money. Money tells you what people did, but not why, nor yet what else they might have done.)

[liberal]

Chris R wrote, "So, yes, all else equal, raising taxes a little bit did seem to reduce output a little bit. A small tax increase slowed the recovery a by a small amount--we see this effect again and again in other situations too. What's so hard to understand? Tax something and there's less of it, _all else equal_."

Not necessarily. If the tax falls on rents, for example, it has no negative impact.

Furthermore, with your logic in the context of the current argument, we could reduce income taxes to zero, and there would be only positive effects on the economy.

As regards 1993, Feldstein made a very simple prediction. His prediction was wrong. Moreover, the empirical, scientific (positive) evidence in Feldstein's favor was extremely weak.

[liberal]

Chris R wrote, "But the bagel shop over on the corner doesn't really use much land. It uses location. Location isn't land. You're confusing location and buildings (which are indeed part of the capital stock) with land (which isn't)."

Incorrect. "Location" is subsumed in the rubric of land. (You are correct that buildings and other improvements are capital.)

[liberal]

Chris R wrote, "At any rate, there seem to be bigger things to worry about, like intergenerational Ponzi schemes, encouraging R&D, and schools which refuse to teach."

Right...I suppose a general fund deficit that is projected to be much larger than the Social Security deficit over the long run somehow didn't make it to that list because...?

Chris R wrote, "Location offers a classic example of increasing returns; the entire field of urban economics is built around that principle. Am I paying rent so that I can have use of an unimproved piece of land 50 miles east of here, inhabited by rattlesnakes and ornery mountain folk? No, I pay rent in order to live in a home (a piece of capital) in a decent location (near good transportation infrastructure--lots of capital--and my work, in a school teeming with capital) and in a decent neighborhood (reasonably safe, clean, where other people maintain their pieces of capital reasonably well). Nope, no capital here."

As I pointed out above, infrastructure is indeed capital. Location, *per se*, is not.

"Natural resources can't be produced (or augmented) by labor? Haven't you ever heard of oil exploration? Mining? Timber farming? Iron ore and oil aren't resources until someone discovers, mines, and refines them. Otherwise it's just a bunch of muck. Surely you know this."

Yes, but the natural resources themselves are not produced by anyone. Certainly it takes labor and capital to exploit the natural resources; no one is disagreeing with that.

You might want to crack open an economics text and learn about land and Ricardian rent.

"Rather than calling other people names, I suggest that you actually study some economics. You might actually enjoy it."

LOL! You mean,