An “ecosystem” of relative prices

I just noticed an article on the industrial research limited site discussing how NZ needs to think.  Money quote is:

What I take from that is we need to think laterally, not literally. When we think about investing in particular sectors, we must realise we will need capabilities that aren’t necessarily obvious to us. We just won’t know what types of knowledge we are going to need to build particular parts of our economy.

The interesting thing is that many economists agree with some of what the author mentions in their piece, in terms of discussing scale and the inter-relationships of firms – but from this loose description there is no clear role for policy, or understanding.

In truth, we need to understand the idea behind inter-relationships in a way consistent with methodological individualism.  Then given that theory, we need to go back to data truly quantify what is going on – given the framework that this theory provides.  From there, we can try to decipher if policy can help of not.

And any such theory relies strong on relative prices – contrary to the inference the article appears to be making, we do not have a command and control economy, and the government is not trying to work out the allocation of resources.  Relative prices, both implicit and explicit, are the driving force of any description of what is going on in New Zealand – and our starting point, and final discussion in terms of policy needs to rely on these.

Think about it, we are told how these firms rely on each other, how they add value to each other, and in each others markets.  This doesn’t make an “externality” in the traditional sense, it just tells us that we have firms whose markets are interconnected – and as a result, there will be some implicit contracts between these firms (and implicit prices) that help to share the surplus of their trade.  In an extreme case, when the benefit is enough, and the outside contracting is weak enough, these firms would horizontally (or vertically depending on the relationship) integrate.

The fact that firms are inter-related doesn’t suddenly provide a role for government.  The fact that scale matters for output does not mean that FORCING an increase in the population distribution will increase welfare.

Update Bill discussed this hereAnd Eric.  How did I miss it when I read both of those blogs daily … I blame my new Kindle for making me focus on Mill instead of my blog reading.

Sidenote:  I have to mention this statement:

Because New Zealand doesn’t have a truly large city by international standards, we must work harder at innovation to compensate for our economic geography and collaborate as if we were a city of four million people.

I have tried to be kind in the rest of the piece, but I have to admit that this statement is blatantly ridiculous.

Two things:

  1. The benefits of population density in large cities come very much from population density – saying we are a city doesn’t do anything to change this.
  2. More importantly, saying we need to “innovate more” because of our disadvantages doesn’t necessarily make sense – it depends on the marginal benefit of innovation relative to the cost.  If our distance from market reduces the marginal benefit from innovation, then this statement isn’t just wrong – its harmful if its followed through with.

I love to hear scientists describe the potentials for technology, and discuss the production possibilities they face.  But they really should get an economist to join the party when it comes to discussing issues of allocation – given that this is the economists area of expertise.

Size matters

The Economist thinks that the prevalence of small firms in Greece is a problem.

A bias to small firms is costly. The productivity of European firms with fewer than 20 workers is on average little more than half that of firms with 250 or more workers (see right-hand chart). …If the best small firms were able to grow bigger, Greece and the rest might solve their competitiveness problems…

This is pertinent to New Zealand since we also have a small number of very large firms, although we may not have the prevalence of very small firms that Greece does. Beyond the arguments over data issues, it’s interesting to ask whether we might agree with The Economist that this poses a problem for growth. Certainly, New Zealand’s growth might be higher if firms grew, but then why haven’t they already? Not because the owners don’t want to reap the rewards of growth, surely.

Of course, what we need to ask is why the proportion of small firms/large firms is the way it is. The Economist points to tax and labour laws in Greece that punish large firms. In New Zealand it is hard to point to similar legal barriers to growth in firm size, as far as I know. It may be that New Zealand firm owners prefer smaller firms, or that it is difficult for firms to find local, skilled labour (random speculation, not to be taken too seriously). What this highlights is the importance of understanding the differences in countries, as well as their similarities, before rushing to emulate them. Are we the next Ireland/Singapore/Finland? Well, no, we’re a bit different from all those countries and we can’t replicate their successes without understanding those differences.

Wealth distribution and demographics

A very good point from Stephen Gordon at Worthwhile Canadian Initiative that the growing concentration of wealth may, in part, be to do with changing demographics.

Although I doubt this is the sole factor behind the growing concentration of wealth, it is a factor I’ve been thinking about – and that I’m keen to see someone else quantify.

One thing we have to keep in mind is that standard economic theory does predict a growing concentration of wealth as

  • the idea of  “rational expectations” when some agents are not rational implies that rational agents will tend to suck up wealth from irrational agents – it is a common misconception that “rational expectations” requires any agents to be “rational” in the strictest sense …  however, it does imply that agents that are “more rational” do receive transfers through time from their “irrational” buddies.
  • the fact that individuals have different discount factors suggests that more patient individuals who are more patient will tend to accumulate more wealth.

Now this isn’t necessarily even an issue, after all if people built up wealth due to their own choices they deserve it.  However, trying to understand how much of the recent change is due to the full functioning of financial markets in recent decades, how much is due to demographics, and how much is due to other policy change is important to understand before we really know anything.

Are nations just large labour unions?

We generally allow capital and goods to flow freely between nations nowadays – which is a good thing. However, that leaves us in the situation where the whole purpose of a nation appears to be working for the benefit of labour in that country.

Now it may well seem like the best thing to do – if we didn’t do it we would undoubtedly have lower incomes. However, this would be because the people in abject poverty overseas now have more options and will be able to manage a higher living standard.

Often people blame globalisation for the abject poverty we see overseas. But it isn’t globalisation that is the problem – it is the lack of globalisation. Closed labour markets, which are effectively massive labour unions, are a large part of the reason why poor countries can’t pull themselves out of poverty.

Now we may value the welfare of local citizens more than we do foreign people – some people have said so here. But even in the case where loosening migration would lead to worse outcomes for locals (which is not always the case), we would have to discount “non-local” people quite substantially not to let them in. Remember that the human cost isn’t all on one side – when we close off migration we are implicitly falling the lives of people overseas as well.

How is this like a labour union? Well labour unions do all they can to increase workers wages, often at the cost of the unemployed (who are the competition of the employed). Unions thrive by hurting the unemployed through artificial barriers – and they inherently value employed people more than unemployed people. Change unemployed to “non-local” and employed to “local” and we have the same thing for nation states.

Kiva: Individual microlending

When looking at Questionable Content (it is a webcomic – I’m addicted to watching the guy develop his drawing style!) I saw a link for a site named Kiva. To explain what this is I will leave it up to the Kiva about page.

Kiva is the world’s first person-to-person micro-lending website, empowering individuals to lend directly to unique entrepreneurs in the developing world.

It is so incredibly cool – it lets you loan money to individual entreprenuers in developing countries. Instead of giving money to a charity as a black hole you are giving money directly to someone who you believe will make good use of it – furthermore, you are pretty likely to get you money back!

This is a great way to incentivise capital transfers and charity – seriously cool.

Is anyone keen to join a TVHE Kiva group – I’m sure I can rope at least the other authors into it 😉

Technology as king?

Over the holidays I had a little peek at “the Universe in a nutshell” by Stephen Hawking.  Early on in the book he states that it is technology, not political systems or economic dogma, that has led to the vast improvement in living standards in modern times.

Now to a large degree, economists agree with this idea (here, and here).  Technological progress increases the usability and availability of resources, expanding choice and satiating desires.

However, the creation of technology also relies on the political and economic system of the day.  An environment that rewards and promotes progress is likely to experience more “technological advancement” than one that doesn’t.  As a result, there is a trade-off between technology and types of social structures – and issue that does involve political science and “economic dogma”.  Just because technology is a closer link in the chain towards higher living standards does not mean that other elements are inconsequential.

Furthermore, the social structure of a group does influence living standards – in so far as it influences happiness.  The belief that better technology will increase happiness is just that – a belief.