Download Econ 309 Lecture Jul13

Econ 309: Capitalism as
Complexity
July 13th
Capitalism as complexity
• The supply-and-demand model is a fairly
simple model of how markets work
• Macroeconomic models of the economy tend,
if anything, to simplify still more radically
• Yet Adam Smith’s ideas about the division of
labor link growth to complexity, suggesting
that theories which rely on simplification may
miss the point
Disclaimer: Austrian verbosity
Not all the eloquence and erudition of mid-20thcentury public intellectuals like Schumpeter
and Hayek is relevant today. There are
occasional insights and a lot of fog.
General equilibrium theory
• GE models are “static,” atemporal
• GE models tend to work better for
understanding allocation than production
• GE models tend to predict no trade in
equilibrium
• GE models that involve production typically
depend on an implicit assumption of constant
returns to scale
Adam Smith’s Big Ideas
1. Economic improvement is a result of the
division of labor.
2. Division of labor emerges not by design, but
through the self-interested independent
actions of millions of people (the “invisible
hand”).
3. The division of labor is limited by the extent
of the market.
Adam Smith: Self-interest
• We appeal to the self-interest of the butcher, baker,
etc. to supply our needs
– A person’s friends (“social capital,” as Robert Putnam calls
it) are too few in number to provide for large scale division
of labor
• The great irony: people are individually selfish, yet
their pursuit of selfish ends benefits the greater good!
• Compare: Schumpeter’s self-interested “bourgeoisie”
• How often do we rely on (a) markets, (b) social capital,
(c) government to supply our needs?
Friedrich Hayek: The failure of
planning
• Hayek emphasizes the importance of local
knowledge (as opposed to scientific
knowledge) in running an economy
• Decisions must be left to the people who have
the local knowledge
• Central planners can never assemble all the
needed information
Freidrich Hayek: GE theory and the
price system
“The economic calculus proper [i.e., formal mathematical
models of general equilibrium] helps us, at least by analogy,
to see how this problem [of allocating resources] can be
solved, and in fact is being solved, by the price system… It is
indeed the great contribution of the pure logic of choice
that it has demonstrated conclusively that even [a central
planner] could solve this kind of problem only by
constructing and constantly using rates of equivalence (or
“values,” or “marginal rates of substitution”), i.e., by
attaching to each kind of scarce resource a numerical index
which cannot be derived from any property possessed by
that particular thing, but which reflects, or in which is
condensed, its significance in view of the whole meansends structure.” (Hayek, 525)
Hayek vs. Coase
• Both Coase and Hayek generally want to leave
allocation decision to the market
• But Coase, who emphasizes incentives of private
actors, wants the state to allocate property rights
in order to maximize efficiency
• Whereas Hayek, who emphasizes information,
casts doubt on whether a central planner (e.g., a
judge) will have the knowledge to do this
• The public choice school (we’ll discuss them next
week) would question whether incentives of
public actors will give them reason to do it
Adam Smith: The division of labor is
limited by the extent of the market
• A simple principle: the more people, the more
division of labor!
• But what is “the extent of the market?”
– A large town is a larger market than a small town
– Access to the sea increases the size of the market
• A maritime theory of comparative development
– Water transport is far cheaper than land transport
– Industry and cash-crop cultivation progress first along
the coasts and navigable rivers
– Africa, with little access to the sea and few navigable
rivers, is underdeveloped
Wolf: History of globalization
• Long-run globalization: spread of religions,
languages, diseases, empires, technologies,
and crops has been going on for millennia
• One great age of globalization occurred in the
19th century, but collapsed in the time of the
world wars
• Since WWII, another era of globalization has
been underway
Wolf: Effects of globalization
• Enemies of globalization:
– Social security vs. immigration: When people’s
citizenship becomes their greatest asset, they
want to restrict access to it
– Protectionism leads to imperialism by creating a
need to secure markets
– Socialist economies tend to be closed because a
central planner needs to control the economy
Wolf: Dimensions of (economic)
globalization
• Trade
– Trade-to-GDP ratios are generally higher today
than during the first era of globalization
– WTO has brought tariffs down to low levels
– “Splitting up the value chain” is more
sophisticated today
Wolf: Dimensions of globalization
• Capital
– The world’s leading power today, the US, is a huge
importer of capital, whereas the UK c. 1900 was a
huge exporter
– Globalized capital markets tend to be among rich
countries, whereas c. 1900 they channeled capital
from rich to poor countries
– Possible explanation: imperialism facilitated richto-poor capital flows
Wolf: Dimensions of globalization
• Migration
– Large migrant flows occurred in the 19th century, e.g.
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Indians to Africa, Guyana
British to Canada, Australia, Africa, America
Europeans to USA, Chile, Argentina
Chinese to Southeast Asia
Japanese to US, Latin America
French to North Africa
European Russia to Siberia
– Migrant flows as a share of world population have not
regained their 19th- and early 10th-century peaks
Wolf and Smith
• Globalization and growth go together
• This confirms Smith’s principles that:
– Growth is driven by division of labor
– Division of labor is limited by the extent of the
market
• See tables on p. 107, p. 108
• Post-WWII, a strong correlation between
openness and growth in developing countries
Increasing returns
• Smith’s arguments (supported by Wolf’s
evidence) point to increasing returns at the
macro level
• But increasing returns at the macro level
probably require increasing returns at the
micro level…
• … and increasing returns at the micro level
create problems for competition theory (e.g.,
a prediction of generalized monopoly)
Monopoly and Competition: The
entry game
• If there are constant average costs, the
monopolist cannot deter entry (result: perfect
competition)
• If there are fixed costs (but not sunk) and
constant marginal costs, the monopolist can
deter entry (result: “contestable monopoly”)
• If there are sunk costs and constant marginal
costs, the monopolist can deter entry
Example of pro-social monopoly:
Patents
• Innovating firm faces:
– Substantial fixed development costs
– Sizeable profits if an initial monopoly position can be
retained, i.e., if entry can be prevented
– Losses if new entrants can produce and sell the goods
• Solution: Patents
• If an innovator has the prospect of patent protection,
temporary monopoly profits pay the costs of
innovation
The Concept of “Monopolistic
Competition”
• Most firms enjoy a certain degree of monopoly
power, e.g., due to location, loyal customers, unique
features
• (Exception: many agricultural markets fit the
description of “perfect competition”)
• Another way of putting it: most firms probably face
downward-sloping demand curves
• But they are face competitors with related products
that are partial substitutes
Schumpeter on the classical
economists
• Endorses their vision but finds their theory deficient
• Marshall and Wicksell preserve classical doctrines of
competition but “in the process of being more
correctly stated and proved, the [classic] proposition
[that in the case of perfect competition the profit
interest of the producer tends to maximize
production] lost much of its content– it does emerge
from the operation, to be sure, but it emerges
emaciated, barely alive.” (Schumpeter, 77)
Schumpeter: Creative destruction
• Perfect competition is the exception, not the rule
• Instead, competition in the real world is best
understood as “Creative Destruction”
• Effective competition comes from new goods,
processes, forms of business organization, etc.
• Capitalism is an evolutionary process (Hayek called
this “competition as a discovery process”)
Schumpeter: Monopolistic
practices
• Various practices identified as monopolistic
are ways of dealing with the uncertainties of
the “gale of Creative Destruction”
• They result in under-utilization of resources at
any given time but can increase the rate of
growth in the longer term (as brakes make
cars go faster)
• Many competitive situations are analogous to
the case of patents
Conclusions: Complexity and Policy
• What does complexity imply for policy?
– On the one hand, is a “simple” policy like laissezfaire inadequate to deal with a complex world?
– On the other hand, a powerful “law of unintended
consequences” applies to any state intervention.
Politics and Public Choice
• The traditional approach: greedy people, beneficent
states
– May result from economists’ role as presumptive policy
advisers
• The public choice approach: apply the rational agent
assumption to public-sector actors, e.g., voters,
elected officials, bureaucrats, special interests
• Are governments appropriate recipients of advice
that favors the public interest?