24_economics_rules.md

Economics Rules

• Rodrik's worldview:
  • Science advances by increasing repertoire of models, not refining a model
  • Key skill = which model is applicable. Do adhoc analysis of data to get to that. e.g., Diagnostics Before Prescription. Fun phrase = "we tried to develop informal empirical tests" Very close to how PMs work in the industry. See also Hausmann, Klinger and Wagner--- Doing Growth Diagnostics

Models

1. GS --- Thaler's "Econs" may be from "The Swedish-born economist Axel Leijonhufvud published in 1973 a little article called “Life among the Econ."

2. Model As Fable: As the distinguished economic theorist Ariel Rubinstein puts it, “The word ‘model’ sounds more scientific than ‘fable’ or ‘fairy tale’ [yet] I do not see much difference between them.”

   • Fable: story around a few principal characters, generic place (village, forest), makes little effort to be realistic or to draw a complete picture of the characters, sacrifices realism and ambiguity for clarity of story line. And each fable as a transparent lesson.
   • Nancy Cartwright thinks economic models are more like parables. Unlike fables, where the moral is clear, economic models require lots of care in interpretation.
   • Fables with contradictory messages everywhere so you need judgment there too.
   • Key argument (which is flawed): key thing we need is judgment about which fable applies the best to the circumstance.

3. Comparison to experiment --- modeler practices a similar method of insulation, isolation, and identification. Creating policy from experiments generally requires some additional evidence, reasoning, etc. (Uskali Maki -- JEM)

4. Unrealistic Assumptions May Not Matter if they are not 'critical'

5. Realism can be worthless: Jorge Luis Borges describes a mythical empire in the distant past in which cartographers took their craft very seriously and ...

Value of Math

1. Math makes clear the assumptions and prevents sloppy reasoning and allows you to work to what can be counterintuitive results. No endless debates about what Keynes, Marx meant.

2. But Math is instrumental --- not needed for models. Schelling was mostly math free.

How to select b/w models

1. Verify critical assumptions
2. Verify mechanisms postulated are indeed operating
3. Verify direct implications
4. Verify incidental implications
   • the relative prices of the associated resources should be comparatively high. Shortage of physical capital (that is, plant and equipment) should show up in high real interest rates; shortage of skills should result in a high skill premium in the labor market; infrastructure constraints should produce power shortages and road congestion; and so on. Second, changes in the availability of resources in short supply should produce a particularly large response in economic activity. Third, serious constraints should lead firms and households to make investments that would enable them to bypass that constraint. If electricity is in short supply, we should see lots of demand for private generators. If regulations on large firms are excessive, we should see firms taking steps to remain small. If monetary instability is a big deal, we should see a shift to foreign currencies in everyday and financial transactions (“dollarization”).

Slightly Counterintuitive Results

• Paul Samuelson was challenged by Stanislaw Ulam, the Polish-American mathematician, to state one proposition in the social sciences that is both true and nontrivial. Samuelson’s answer was David Ricardo’s Principle of Comparative Advantage. “Using four numbers, as if by magic, it shows that there is indeed a free lunch—a free lunch

  • Suppose, Ricardo wrote, it takes the labor of 80 workers to produce a given amount of wine in Portugal, and the labor of 90 workers to produce a given amount of cloth. In England, it takes 120 and 100 workers, respectively, to produce the same quantities of the two goods. Note that Portugal is more efficient than England in both cloth and wine. Nevertheless, Ricardo showed that Portugal would benefit by exporting wine to England and importing cloth in exchange.

• Impact of immigration:

  • But what if local workers responded to the increased competition by moving out of state, to jobs in other parts of the country? What if the availability of a larger employee pool resulted in greater physical investment in the state, as firms moved in to build new factories and businesses? What if more workers at the low end of the skill distribution slowed down the introduction of new technologies? What if the migrant workers stimulated demand for the types of goods that are produced by migrant labor specifically?

• Theory of Second Best

  • Meade, Lipsey, Lancaster

  • freeing up some markets, or opening a market that did not exist before, is not always beneficial when other, related markets remain restricted.

    • beef is supplied by the United States to Germany at a price of $100. Assume that Germany imposes a tariff of 20 percent, raising the consumer price of US beef in the German market to $120. France, meanwhile, can supply beef of equivalent quality only at a price of $119. Prior to the preferential agreement between France and Germany, French suppliers, facing the same tariff rate as US producers, were outcompeted. Now consider what happens when Germany eliminates its tariffs on imports from France but keeps in place those on the United States. French-supplied beef suddenly becomes cheaper in Germany ($119 versus $120), and imports from the United States collapse. German consumers are better off by $1, but the German government forfeits $20 of tariff revenues collected on US beef
    • dutch disease:
      • resource boom -> currency appreciates -> hurts manufacturing. manufacturing apparently a source of 'technological dynamism' so hit to it causes hit to broader econ.
      • Governments in resource-rich countries in sub-Saharan Africa face this challenge on a daily basis, as wage pressures emanating from lucrative mining activities erode their competitiveness in manufacturing.
      • if declining industry -> dirty, it can be good news

  • Israeli Day Care --- Gneezy/Rustichini --- post the institution of fine, more people come late to pick up kids

  • Possible: If you know the gov. is going to pump the economy, you may choose to not spend money that you were planning to spend, waiting for the handout

Classicists Vs. Marginalists

• Classical:

  • Price of goods -> Labor theory of value
  • Labor: They presumed wages would hover around the subsistence level, the level required to feed, clothe, and shelter a family. If wages rose too much above this level, the result would be an increase in population—because more children could survive—and in the labor force. As a consequence, wages would drop back down to their “natural” level.
    • Unemployment would eventually be eliminated as the shortage of jobs brought wages down. ... if wages increase -> people will have more kids

• Marginalist:

  • Price: cost/value of last unit of oil
  • People paid at marginal value
    • across country: 80 and 80% diff. in wage levels -> variation in productivity
    • within US: b/w 2000 and 2011, wages rise from $32/hr to $35/hr but prod. grows by 1.9%/yr so prod > 2x wage growth. 25% explained by prices of goods workers like to consume rising more rapidly than prices of goods they produce but 75% unknown.

(In)Efficient Markets

• Assume that two competing firms must decide whether to have a big advertising budget. Advertising would allow one firm to steal some of the other’s customers. But when they both advertise, the effects on customer demand cancel out. The firms end up having spent money needlessly.

• Ship Builder needs low cost steel. The latter needs first. 'Good' and 'bad' equilibria can happen.

Mild Ribbing

1. The maverick economist Kenneth Boulding is supposed to have said, “Mathematics brought rigor to economics; unfortunately it also brought mortis.”

2. The Cambridge University economist Ha-Joon Chang says, “95 percent of economics is common sense—made to look difficult, with the use of jargons and mathematics."

3. Debreu, on getting Nobel Prize was accosted by journalists who wanted to know where the economy was headed. He is supposed to have said: imagine an economy with n goods and m consumers.

4. Writing in early 2003, Lucas had said, “[The] central problem of depression prevention has been solved, for all practical purposes.”

5. God created economic forecasters to make astrologers look good, quipped John Kenneth Galbraith.

Impact of Commerce

• Israeli day care
• 17th and 18th century thinkers thought commerce allowed you to overcome baser instincts:
  • Montesquieu famously said, “Wherever manners are gentle there is commerce; and wherever there is commerce, manners are gentle.”
  • commerce, pointed out Samuel Ricard, David Ricardo’s grandfather, man seeks virtues such as deliberation, honesty, and prudence. He stays away from vice lest he lose his credit and become an object of scandal. in this this way, interests could mollify the passions.