Posts Tagged ‘growth’

thoughts on economic models

Sunday, July 10th, 2016

A typical, very simple economic model is a demand curve, Dx = f(Px). It states that, other things equal, an increase in the price of x will result in a decrease in demand for x. I other things are not equal, the assumptions of the model do not hold. Suppose, writes blogger Arnold Kling, that x stands for tuition charged by a school, and we observe that demand went up rather than down when tuition increased. What may have happened is that scholarships became more generous, so the full tuition – net of student aid – fell. Other things did not remain equal.

Most economic models contain more variables. Consider the aggregate production function X = f(K,L). The quantity of output is a function of the quantity of physical capital plus the quantity of labour.

[This model] is used to predict that differences in output per worker will be proportionate to differences in capital per worker. When this fails, there are many possible reasons: workers may differ in their human capital; physical capital may not be measured or aggregated correctly; output may not be measured or aggregated correctly; institutional differences may matter. etc.

In fact, the primary use of the aggregate production function model is to examine its failure, which is called “the residual.” Economists place an interpretation on this residual, calling it “total factor productivity.” They interpret the rate of change in this residual over time as “productivity growth.” They interpret the change in the rate of change in this residual as “change in the trend rate of productivity growth.”

Arnold Kling, “Thoughts on the use of Models in Economics“, askblog, 9 July 2016.

Arnold’s explanation of how economists use models is useful, but I think he is too easy on model-building. It is very difficult – probably impossible – to measure output, labour and capital without using prices. This is necessary, because if prices are used, the model becomes close to a tautology. The value of the quantity demanded, for example, is always equal to the value of the quantity supplied (plus or minus abnormal profits or losses). Similarly, the value of output is equal to the cost of the rental of machines plus the wages of labour (adjusted for any abnormal profit or loss).

Think how difficult it is to measure (without prices!) the heterogeneous output of a factory, or the hours of equivalently productive workers. Physical capital is even more difficult to measure. Without prices or interest rates, what is the unit of measure. Kilos of capital? Number of shovels, hammers or machines?

Economic models are helpful, but only as toy models, useful for understanding, but not predicting, how a real economy functions.

See here for past posts on production functions.

imperialism and growth

Saturday, July 9th, 2016

I am continuing to read Deirdre McCloskey’s delightful book. Each page contains material to think about. Professor McCloskey is not kind to anyone she feels has misinterpreted economic history. Here is a brief example.

True, people thought that mercantilist aggression was good for them. …. It is the rhetoric of business-school deans and big-thinking journalists. But it is not sound, then or now, whatever people believe.

An instructive example of the unsound connection of aggression to economic success is the military historian Correlli Barnett’ brilliant old book of 1972, The Collapse of British Power, an influence for example on the Thatcher administration in Britain. …. [Barnett] mixes rank in the league table of power with economic success, and assumes … that what people thought at the time was an important connection among trade, empire, military might, and domestic prosperity was in fact the case. Thus Barnett:

in the eighteenth century the English ruling classes … saw foreign policy in terms of concrete interest: markets, national resources, colonial real estate, naval bases, profits. …. They saw national power as the essential foundation of national independence; commercial wealth as a means to power; and war as among the means to all three. They accepted it as natural and inevitable that nations should be engaged in a ceaseless struggle for survival, prosperity and predominance.

That’s right. That’s what they thought. But they were wrong–even in the dismal year for the British economy of 1972–to lament British economic “decline.” He attributed the “decline” to softness of mind and softness of will, arising especially from a new evangelical Christianity:

The abolition of the slave trade in 1807 as a result of a campaign led by William Wilberforce and of slavery itself in the British Empire in 1833 were the earliest of the great social achievements of British evangelicalism. …. As a consequence of this spiritual revolution English policy ceased to be founded solely on the expedient and opportunistic pursuit of English interests. ….

Barnett’s analysis sounds quite plausible, and it sounded even more so in the realpolitik days of 1972. Certainly British politics, at home and abroad, became in the nineteenth century more ethically driven, right down to coming to the aid of the French in 1914, against expediency, and then making a welfare state …. /but Britain, despite its lamentable descent into namby-pamby soft-heartedness, to be cured in the glorious war of conquest against the Argentinians, has remained one of the richest economies on earth, and has shared in the modern engine of innovation, which it started.


Britain’s overseas trade [and colonies], in short, can’t explain Britain’s peculiarity. Lining up national conquest with national trade is an old claim, though Adam Smith and many economists since him have wisely contradicted it (without persuading many politicians or journalists.) National conquest, though, doesn’t explain early British industrialization, and certainly not the continuation on the way to the [growth] factor of sixteen.

Deirdre N. McCloskey, Bourgeois Dignity: Why Economics Can’t Explain the Modern World (University of Chicago Press, 2010), pp. 215-216, 225.

More snippets from McCloskey will follow. I have added a “McCloskey” tag so that you can easily find them.

China’s economic growth prospects

Thursday, September 3rd, 2015

FT columnist Martin Wolf is very optimistic regarding China’s long-run prospects.

The important economic fact about China is its past achievements. Gross domestic product (at purchasing power parity) has risen from 3 per cent of US levels to some 25 per cent. GDP is an imperfect measure of the standard of living. But this transformation is no statistical artefact. It is visible on the ground.

The only “large”(bigger than city state) economies, without valuable natural resources, to achieve something like this since the second world war are Japan, Taiwan, South Korea and Vietnam. Yet, relative to US levels, China’s GDP per head is where South Korea’s was in the mid-1980s. South Korea’s real GDP per head has since nearly quadrupled in real terms, to reach almost 70 per cent of US levels. If China became as rich as Korea, its economy would be bigger than those of the US and Europe combined.

Martin Wolf, “China risks an economic discontinuity“, Financial Times, 2 September 2015 (metered paywall).

Short-run prospects are less rosy, since China’s fast growth rates will probably revert to the global mean. Chinese policymakers, writes Martin, “need to re-engineer a slowing economy without crashing”.

Moreover, the challenge is not only, or even mainly, technical. A big question is whether a market-driven economy is compatible with the growing concentration of political power.

development goals and development strategies

Tuesday, September 1st, 2015

Following the Millennium Summit of the United Nations in 2000, all UN member states and many international organizations pledged to contribute to achievement of eight Millennium Development Goals (MDGs) within 15 years. Much remains to be done, so activists, lobbyists and government officials believe that a new set of goals is needed.

This month, UN member states are expected to adopt Sustainable Development Goals (SDGs), to guide global development from 2015 to 2030. The number of goals has expanded from 8 MDGs to 17 SDGs, and the SDGs are more complex, with 169 targets and 304 indicators.

But, are global, quantitative goals necessary to plan economic development? Two economists from the The New School for Social Research argue that they are not at all helpful, because development is a national process in which strategies are usually more important than specific targets.

Ban Ki-Moon, the United Nations’ Secretary General, recently claimed that the “… MDGs [Millennium Development Goals] helped to lift more than one billion people out of extreme poverty”.

Unfortunately, there is little justification for this statement. ….

If there must be development goals — which is far from obvious — then global quantitative targets should be de-emphasized or in some cases done away with altogether. Specific targets such as the reduction or elimination of diseases or of poverty may retain their attractiveness but others will not.

Global goals should be advanced through national plans that might not involve quantitative targets but that would specify strategies. …. Such an approach would open more room for experimentation with innovative development strategies, and create a richer global public conversation on what development is, whom it should serve, how and why.

Sanjay G. Reddy and Ingrid Kvangraven, “Does the world really need development goals?“, Beyond Brics, Financial Times blog, 28 August 2015 (unmetered access with free registration).

Sanjay G. Reddy is associate professor and Ingrid Kvangraven is a PhD student in the economics department of The New School for Social Research, New York City.

population ageing and economic growth

Friday, August 28th, 2015

Pundits frequently warn us to avoid population ageing, because of its negative effect on economic growth. FT reader Simon Ross, in contrast, sees population ageing as an opportunity to be seized.

An ageing population should encourage us to use the skills and experience that workers have developed during their careers into their later lives. A falling workforce can prompt us to improve both workforce participation among the marginalised, and levels of automation and efficiency.

…. Populations cannot grow forever. A falling population is an opportunity to reduce the cost of living as competition for housing and other resources falls, to reduce emissions and resource depletion, to move to sustainable energy production and to improve biodiversity from today’s low levels. For the individual, what matters is not the overall size of the economy but average per capita income, and how that income is distributed. [Emphasis added.]

Simon Ross, “Use the experience older workers have developed“, letter to the editor, Financial Times, 27 August 2015 (metered paywall).

Mr Ross is CEO of Population Matters, a UK-based advocacy group.

efficient financial markets?

Sunday, August 23rd, 2015

Economists cannot agree on whether asset markets are efficient or not. This has very important policy implications. Freelance writer Anna Louie Sussman interviews New York University economist Paul Romer for a WSJ blog.

Sussman: Are there any areas where research or refinements in methodology have brought us closer to understanding the economy?

Romer: There was an interesting [2013] Nobel prize in [economics], where they gave the prize to people who generally came to very different conclusions about how financial markets work. Gene Fama at University of Chicago got it for the efficient markets hypothesis. Robert Shiller from Yale got it for this view that these markets are not efficient and subject to too much noise. ….

It was striking because usually when you give a prize, it’s because in the sciences, you’ve converged to a consensus. And it was kind of a prize to economics saying, “You know, you can’t really agree what’s going on in asset markets, but we’ll give a prize anyway.”

Anna Louie Sussman, “Q&A: Paul Romer on ‘Mathiness’ and the State of Economics“, Real Time Economics, Wall Street Journal blog, 17 August 2015.

Most of the interview is about the rise of “mathiness” in economic growth theory. In my opinion, this interview of Paul Romer (born 1955) is of general interest, and should be published in the Wall Street Journal.

HT Mark Thoma.

mathiness in economic growth theory

Monday, June 8th, 2015

Truthiness” was coined a decade ago by television satirist Stephen Colbert. A Wikipedia article (retrieved 7 June 2015) defines it as

a quality characterizing a “truth” that a person making an argument or assertion claims to know intuitively “from the gut” or because it “feels right” without regard to evidence, logic, intellectual examination, or facts.

NYU economist Paul Romer recently coined a related term, “mathiness”:

The style that I am calling mathiness lets academic politics masquerade as science. Like mathematical theory, mathiness uses a mixture of words and symbols, but instead of making tight links, it leaves ample room for slippage between statements in natural versus formal language and between statements with theoretical as opposed to empirical content.

Paul M. Romer, “Mathiness in the Theory of Economic Growth“, American Economic Review 105:5 (May 2015), pp. 89-93.

Professor Romer thinks that “mathiness” explains the lack of progress toward a consensus in growth theory over the past two decades. His article is brief (5 pages) and ungated. I recommend that you read the entire essay, but here are two key extracts from the beginning (p. 89) and another from the end (p. 93) of the article:

Politics does not lead to a broadly shared consensus. It has to yield a decision, whether or not a consensus prevails. As a result, political institutions create incentives for participants to exaggerate disagreements between factions. Words that are evocative and ambiguous better serve factional interests than words that are analytical and precise.

Science is a process that does lead to a broadly shared consensus. It is arguably the only social process that does. Consensus forms around theoretical and empirical statements that are true. Tight links between words from natural language and symbols from the formal language of mathematicsencourage the use of words that are analytical and precise.


[With mathiness] empirical work is science; theory is entertainment. Presenting a model is like doing a card trick. Everybody knows that there will be some sleight of hand. There is no intent to deceive because no one takes it seriously. Perhaps our norms will soon be like those in professional magic; it will be impolite, perhaps even an ethical breach, to reveal how someone’s trick works.

Paul Romer (born 1955) is a well-known proponent of endogenous growth theory, the view that investment in human capital, innovation, and knowledge play a key role in economic growth.

Edmund Phelps on the economic crisis in Europe

Tuesday, March 3rd, 2015

Nobel laureate Edmund Phelps (born 1933) writes that the economic crisis that much of Europe faces is due not so much to a reduced supply of labour (the view of classical economists) or insufficient aggregate demand (the Keynesian view), but rather to slower technological change. With more automation, with more robots, all would be well!

European economists speak of a loss of competitiveness in southern Europe. They suggest that output and employment are down, relative to the past trend, because wages leapt ahead of productivity, making labour too expensive and forcing employers to cut back. ….

Economists of a classical bent lay a large part of the decline of employment, and thus lagging output, to a contraction of labour supply. And they lay that contraction largely to outbreaks of fiscal profligacy — as happened in Europe from the mid-1990s to the mid-2000s. ….

Disciples of Keynes, who focus on aggregate demand, view any increase in household wealth as raising employment because they say it adds to consumer demand. They say Europe needs a lot more fiscal “profligacy” if it is to bring unemployment down. Some evidence favours the classics.

Yet both sides of this debate miss the critical force at work. The main cause of Europe’s deep fall — the losses of inclusion, job satisfaction and wage growth — is the devastating slowdown of productivity that began in the late 1990s and struck large swaths of the continent. It holds down the growth of wages rates and it depresses employment.

Edmund Phelps, “Europe is a continent that has run out of ideas“, Financial Times, 3 March 2015 (metered paywall).

Profess Phelps may be right, but I am not convinced. If slow technological change is the cause of unemployment and slow (or negative) GDP growth, why are economies of northern Europe (such as Germany and Austria) doing rather well, while those of southern Europe (including Italy, Greece and Spain) suffer stagnation and high unemployment. The technology (machines) used in the north, after all, can also be used in the south. Reduced technological change should affect the entire European Union, not just its southern fringe. Exchange rates – which are fixed for countries in the eurozone – in my opinion are an important reason for diverging economic competitiveness.

In 2006, Phelps was awarded the Nobel Prize in Economics for “his analysis of inter-temporal tradeoffs in macroeconomic policy”. His best-known paper, “The Golden Rule of Accumulation: a Fable for Growthmen” was published in The American Economic Review 51:4 (1961). In 1997 he published a book for the general public, Rewarding Work: How to Restore Participation and Self-Support to Free Enterprise (Harvard University Press).

Professor Phelps is a brilliant economist. TdJ has often highlighted his work, for example here, here and here.

does human (and physical) capital exist?

Wednesday, February 25th, 2015

In the heated bloggers’ debate over human capital, I was surprised by the absence of discussion of how to measure human capital, a point that was crucial in the earlier “Cambridge controversy” over physical capital. Typically, human capital is measured as years of schooling. All this is added up (sometimes with adjustment for levels of schooling – counting a year in High School or University as more than a year in primary school). The sum total is then taken to be a nation’s stock of ‘human capital’, which becomes an input into an aggregate production function for the economy. This seems wrong, to me. Some schools are terrible, whereas others are excellent. How can we take account in differences in the quality of schooling?

Nick Rowe has a clever solution to the problem. “Capital” – whether physical or human – is not really a thing, so it is not necessary (impossible?) to measure it.

We invest in increasing our skills, our strength, our knowledge, etc. It just easier to use the words “human capital” to describe the things we have invested in in the past. And we can talk about how our human capital depreciates too, as we forget stuff, or technology changes so our skills become obsolete.

Now the word “capital” is deeply problematic, because time has many future periods, and so trying to convert a vector into a single scalar number is….tricky. That is true for both human and non-human capital. I prefer to say that “capital” isn’t really a thing; it’s just a name we give to a production process where time matters, because inputs and outputs come at different times. And once you start to think of “capital” as just the time-structure of production, then brain surgeons are just as much capital as blast furnaces. Costs come first, and benefits come later.

Nick Rowe, commenting on Max Speak, “For Noah and Nick”, 24 February 2015.

I find it difficult to understand Nick’s argument. If capital is not a ‘thing’, how can it be an input producing output “in a production process where time matters”? If it is an input, it is certainly not a measurable output.

The implication is that we should do away with the aggregate production function, and much of econometrics. I am sympathetic to this idea, and will give it more thought.

For much, much more, see

Nick Rowe, “Does capital income exist?“, WCI, 24 February 2015, and

Nick Rowe, “Ours the task eternal — investing in human capital“, WCI, 24 February 2015.

the human capital controversy

Sunday, February 22nd, 2015

Back in the 1960s there was a famous debate between economists (led by Joan Robinson and Piero Sraffa) of the University of Cambridge in England and economists (led by Paul Samuelson and Robert Solow) of MIT in Cambridge, Massachusetts. The debate, known as “the Cambridge capital controversy“, was over measurement and aggregation of physical capital. The Cambridge (England) economists argued that aggregate physical capital could not be measured without reference to the rate of return on capital. Cambridge (Massachusetts) generally agreed that the Cambridge (England) side won, though many professors of economics continue to teach aggregate production functions and economic growth theory as though the debate never took place.

A similar debate is now taking place, over human rather than physical capital. Noah Smith (HT Mark Thoma) provides a nice overview for those are interested.

Is “human capital” really capital? This is the topic of the latest econ blog debate. Here is Branko Milanovic, who says no, it isn’t. Here is Nick Rowe, who says yes, it is. Here is Paul Krugman, who says no, it isn’t. Here is Tim Worstall, who says yes, it is. Here is Elizabeth Bruenig, who says that people who say it is are bad.

Noah Smith, “Is human capital really capital?“, Noapinion, 21 February 2015.

Noah Smith offers an alternative view: human capital requires owners to work (give up leisure time) to obtain a return from it, so the more leisure is valued relative to other things, the less valuable human capital is. This will be different for each person. In consequence, you are “entitled to your own modeling conventions and definition of terms. So whether human capital is capital is up to you.”

This is an interesting, complex debate. I am still thinking about it but, as TdJ readers might predict, I am most persuaded by the arguments of Carleton University economist Nick Rowe. Before turning to Branko Milanovic and Nick Rowe, however, I would like to emphasize two points that are not always appreciated by participants in this debate. First, financial capital is not capital in an economic sense. Nick makes this point clearly, but others confuse financial capital with physical capital. Financial capital – stocks, bonds and the like – are just pieces of paper, IOUs. They are claims of lenders, and the loans may even have been made for the purpose of consumption rather than investment.

Second, even if human capital is a useful category of income-producing assets (and I think it is), it is as difficult to measure as physical capital is. In fact, it is probably even more difficult to measure. This does not really matter though, as it is impossible to measure aggregate assets of either asset apart from (only in theory!) the present value of the future income the assets produce. The problems of measurement of human capital are  very similar to the problems of measurement of physical capital. For example, if I purchase an automobile which I use for pleasure, and also – as an Uber driver – to generate income, part of the purchase represents investment (addition to physical capital) and part is consumption. Similarly, part of the expense of schooling represents investment (for the purpose of earning more income than I would without skills) and part is consumption (the satisfaction of obtaining knowledge and the ability to better understand the world in which I live).

There is much, much more at the links above. Bloggers will no doubt continue to debate this issue for weeks and months (years?) to come. Here, to get you started, are brief quotes from Branko Milanovic (on the ”No’ side of the debate, and from Nick Rowe (on the ‘Yes’ side, the one that I support):

If “human capital” and “real” capital are the same thing, how can there be a conflict between labor and capital?  If profits and wages are the same thing, why should we fight about distribution? You have your form of capital (which just happens to look like labor), and I have mine, which just happens to look like T-bills and stocks.

Branko Milanovic, “On ‘human capital’ one more time“, Global Inequality, 19 February 2015.


What we call “labour” is as much capital as labour. The wages on “labour” are as much a return to capital as they are a return to raw labour.

Some labour needs very little investment to make it productive; other labour requires a lot. Some labour gives a high return on investment; other labour gives a low return. It’s all different.

“Human capital” is not a synonym for “labour”. It tells us something important about the investment needed to make labour productive.

Nick Rowe, “Human Capital” and “Land Capital“, Worthwhile Canadian Initiative, 14 February 2015.

Once again, I encourage you to click on the links above, to get a feel for the full debate.