Dani Rodrik's weblog

Why Dani Rodrik should do more political economy

by Jeffry Frieden

(DR note:  Some time ago, I posted an entry called Why I don't do political economy any more where I said that I had lost interest in political economy because it presumes we know what the efficient policies are and because it leaves too little room for human agency. This is Jeff Frieden's attempt to dissuade me.)

It is certainly true that there is a fatalistic side to political economy. After all, a political economy analysis that correctly identifies the sources of existing policy also presumably shows how the policy is politically stable and hence unlikely to change unless exogenous conditions change. In other words, if all actors are optimizing, no amount of advice or encouragement from well-meaning scholars and advisers can improve the outcome.

In broad outlines, this is a convincing story. Indeed, it is one reason why I, personally, am ambivalent about getting involved in policymaking in any capacity (other than voting as a citizen). Politicians are, in my view, very good at figuring out the realm of the possible; if they haven’t struggled their way to a Pareto improvement, there may not be one available that is politically feasible. I confess to the personal view that the principal policy relevance of my job as a scholar has to do with helping inform the public about issues and options available to them, not with advising policymakers who already know most of what I would tell them. But that is just my own personal preference, not a principled belief – such as the one you express – that political economy implies powerlessness.

There are a number of reasons why the view you profess to hold is not the whole story, and why you should return to the political economy fold. Here are a few.

1. The irrelevance of unattainable alternatives. This one is easy, and you know it well. Simply put, if a first-best policy is not politically feasible, it is not first-best. The actual first-best policy is the best policy that is also politically feasible. Economics can help clarify the welfare ranking of policies (maybe); only political economy can clarify their political feasibility.

2. Multiple equilibria. Ever since Arrow, we have known that no political equilibrium can be stable; that is, any existing political coalition can be defeated by an alternative. Much of modern Political Science (and political economy) is devoted to figuring out how actual political systems stabilize political choices, typically by means of political institutions (what Ken Shepsle has called structure-induced equilibrium). The broader point is that in most instances, there is scope for a new political coalition to defeat the existing one, allowing society to move from one equilibrium to another (perhaps welfare-enhancing) one.

In American politics, for example, scholars and politicians alike are constantly on the lookout for “wedge issues,” policy issues that can break apart existing coalitions and create new ones. The Democrats focus on gun control, or Iraq, or Social Security, to try to win over Republicans who agree with them. The Republicans focus on prayer in the schools, or terrorism, or tax cuts, to win over Democrats who agree with them. This helps explain why politicians in developing countries long polarized – between Right and Left, or nationalists and internationalists, or on regional grounds – often try to bring new issues to the fore, such as corruption. Or, more nefariously, why politicians may latch on to ethnic differences that were previously politically unimportant to create a new set of feasible coalitions.

This means that political entrepreneurs are often open to the possibility of new feasible coalitions, especially if they are in opposition or if they are in countries in trouble. And political economy analyses can help clarify who the potential coalition partners may be, what issues can help unify them, and how their preferences can be met by new (one hopes, superior) policy packages.

In other words, political economy can provide valuable – and not otherwise available – ideas about the range of politically feasible options available to political entrepreneurs. Pure economics can only provide ideas about the range of economic options available, and perhaps try to rank them on some welfare grounds. For politicians, I submit, the former is highly relevant; the latter almost totally irrelevant.

3. Crucial parameters. While politicians may have a good handle on the feasibility of policy alternatives, and economists may be able to identify alternatives (and Pareto-rank them), this leaves a gap. Political economists focus, in many instances, on the sources of stasis or volatility in political agreements. One common observation, for example, is that politically attractive agreements are not reached because the actors’ commitments are not credible. Proposals to reform agriculture or labor markets may be rejected by farmers or workers because they do not believe that politicians, or alliance partners, will follow through on agreements to compensate those harmed by the reforms.

In fact, there is an old paper by Raquel Fernandez and some other guy, AER 1991, that argues that welfare-improving stabilizations may be delayed due to uncertainties about the distributional implications of the policies in question. Like commitment problems, incomplete information can make otherwise politically feasible policy outcomes hard to attain.

In these instances and more, serious political economy analyses can help clarify precisely where the obstacles to new policy initiatives may lie, and what the pitfalls of trying to pursue them may be. Policymakers may, in many circumstances, understand that they face opposition; scholars of political economy can help elucidate the underlying reasons for the opposition, and suggest whether and how those reasons might be addressed.

4. Dynamics. An observation that a particular policy is stable at a point in time is not necessarily an argument for it being stable under all circumstances. Indeed, the identification of sources of policy stability may point toward factors that could make it flexible. And this might suggest to policymakers a path forward. For example, to take a case that I am sure is uppermost in your mind, the Corn Laws would not have been repealed in Britain in the 1840s without the prior passage of the Reform Acts. Perhaps somewhat less arcanely, there is strong evidence that the probability of such policies as land reform and increased access to basic health care and primary education increases as the franchise is expanded. So a reform-minded politician might first aim at the expansion of the franchise – which people not otherwise inclined to the policy might support for other reasons – and then at the policy change.

In this context, political economists can provide some ideas about the interrelationships among political and policy realities. Political systems are complicated; relatively minor changes to legislative structure, bureaucratic delegation, electoral institutions, party alignments, and the like can have a significant impact. Few politicians think about these things – they focus on doing the best they can in the circumstances they face – but political economists do, in particular because most of their analyses involve variation among countries or over time.

5. Comparisons. As just mentioned, politicians typically only have their own societies in mind as they think about the realm of the possible. Scholars of political economy typically think cross-nationally, or about change over time. In this somewhat trivial sense, political economy analyses can suggest pathways that have worked in one country to policymakers in another. The general interest in Progresa or micro-finance are potential examples; at some level, new policies are a bit like new technologies, and it can take time for them to become known outside their country or region of origin.

In short, political economy is rarely so deterministic as you purport to think. Our professional incentives as scholars are to insist that there is only one feasible equilibrium, and that we have identified it. But what this really means is that we believe we have accurately identified the constraints on policy, and the direction in which they point, and the range of options to which they restrict policymakers. Just as I don’t know of any economists who believe that economic models are capable of completely and deterministically predicting all economic outcomes, I don’t know of any political economists who believe that our models can completely and deterministically predict all policy outcomes.

Political economy is a powerful tool for understanding policy. It is based on trying to clarify the constraints that political actors face as they interact in the political (and economic) arena. In fact, I think that it is only with the tools of political economy that we can understand why the world is as it is. And, as you know, the first step in trying to change the world is to understand it.

So, Dani, come home! We need you, and people like you.

WTO strikes against China

The WTO has made a ruling that Chinese import surcharges on car parts violate WTO rules. This is the first time that the WTO has ruled against China since the country joined in 2001. China's intention with the policy was clearly to discourage imports of car parts and thereby encourage upstream production of inputs for its auto assembly industries.

So a clear victory for sound economics and the world trade regime? Well, read first the following from the distinguished economist John Sutton (hardly a rabid protectionist):

In the decade prior to WTO entry, both China and India used domestic content restrictions to stimulate development of the component industry, with a view to widening and deepening the benefits accruing from attracting international car-makers. The requirements were stringent, requiring about 70% domestic content within about 3 years, and this led to adverse comment from some of the car-makers who cast doubt on whether this target was feasible or sensible.
Policies of this kind are not always appropriate, or successful; but in the present cases the ‘infant industry’ has been successfully nurtured, and international car-makers show no inclination to turn away from local suppliers following WTO entry.

In other words, policies encouraging domestic content were successful--at least in these two important cases (Sutton speculates that they would have been less successful in smaller economies).

Perhaps such policies have outlived their usefulness and the WTO decision makes economic sense. Perhaps. But what is clear is that there is no room within the WTO procedures for the relevant economic arguments to have played a role. Domestic content preferences are illegal period, regardless of whether they help a country industrialize and grow. 

A new paradigm in development economics?

Until very recently, if you spent anytime thinking about development policy, the chances are that you fell into one of three groups.  One group believes the problem with developing countries is lack of resources. So the solution is a vast increase in foreign aid.  A second group believes the real problem if lack of incentives. So the solution is more and better markets. The third group thinks the problem is lousy governments, so the answer lies with improved governance. I leave it to the reader to identify these positions with their most distinguished (or at least most vocal) representatives...

But there is something new afoot. Increasingly, some people are saying the right way to approach development policy is to start with the view that we actually don't know where the problems lie, to acknowledge that the key problems may differ from setting to setting, and to adopt an explicitly experimental attitude to policy selection and formulation so that you can learn about the environment in which you operate. In this approach, monitoring and evaluation are key, as you want to pull back from mistakes and improve policies over time. Indeed, you build the monitoring into the policy process itself so that learning becomes part and parcel of it--rather than something you leave to your researchers or economists.  This way of thinking about development policy is radically different from the three schools I summarized above, as it admits much greater diversity and heterodoxy. It is humble about the extent of our knowledge but optimistic about our ability to learn. 

This of course is the way I have been thinking about development policy for a while (having been influenced by the work of Roberto Unger and Chuck Sabel). It was striking to hear Esther Duflo articulate this afternoon a virtually identical perspective with respect to social policy. Esther was giving the Wellington-Burnham lecture at Tufts and I was her discussant. As I said in my comments following her presentation, this is nothing less than a paradigm change in development. It is extremely encouraging that people who are approaching development from rather different ends are converging on an identical perspective on how you think about development policy.

Now, Esther and I differ on what we mean by "evaluation": I think randomized field experiments have serious limitations and problems of generalizability ("external validity" to use the jargon) and that we can actually learn from a variety of other types of evidence. Sometimes it seems as if Esther thinks anything other than randomized evaluations is just "stories." But this is a discussion for another time.  For the moment, I rejoice that "macro" types like me and "micro" types like her are articulating a very similar line...

One economics, again

Tom Palley wrote last week a review of my One Economics, Many Recipes, and some people have asked me to comment on it.  On the whole, I have very little to complain about: Tom's review is gracious and probably gives me more credit than I deserve.  But he does take me to task for pushing the "One Economics" line instead of defending a plurality of methods of inquiry.

Part of the reason I have procrastinated writing this response is that in some ways Tom makes my case better than I did.  Consider his main point:

But, while the many recipes thesis has strong appeal and empirical support, and suggests a spirit of theoretical pluralism, the claim of “one economics” is misguided, for it implies that mainstream neoclassical economics is the only true economics.

This is immediately followed by

Part of the difficulty of exposing this narrowness is that there is a family split among neo-classical economists between those who believe that real-world market economies approximate perfect competition and those who don’t. Believers are identified with the “Chicago School,” whose leading exponents include Milton Friedman and George Stigler. Non-believers are identified with the “MIT School” associated with Paul Samuelson. Rodrik is of the MIT School, as are such household names as Paul Krugman, Joseph Stiglitz, and Larry Summers. This split obscures the underlying uniformity of thought.

In other words, the neoclassical family can house such diverse views on economic policy as those espoused by Milton Friedman, on the one hand, and Joe Stiglitz on the other. What "uniformity of thought" is Tom talking about?

Similarly, Tom says:

This reality [of an increasingly narrow and exclusionary view of the discipline] is difficult to convey. One reason is that liberal neo-classical economists like Stiglitz and Krugman share values with heterodox economists, and shared values are easily conflated with shared analysis. Another reason is that heterodox and MIT School economists also often agree on policy, even if their reasoning is different. Finally, most people are incredulous that economists could be so audacious as to enforce one view of economics.

Well, maybe it is difficult to convey this reality because it does not have much bite, for all the reasons that Tom explains.

Tom is right that "heterodox economists like Thorsten Veblen and Joseph Schumpeter long ago raised many of today’s cutting-edge issues in neoclassical economics, including the role of social norms and the relationship between technological innovation and business cycles."  But neoclassical economics is fairly good--in my view--in absorbing insights from outside perspectives and developing them in ways that their originators could not do. For my part, I have to say that I understand Schumpeter's key insights on technological innovation a whole lot better once I see it expressed in neoclassical garb (i.e., here is a bunch of firms, here are their choice variables, here is the market structure under which they operate, here is what they maximize, and here is what the equilibrium will look like...)

This is in part because I am not as smart as Schumpeter was. But then again, most of the students we teach aren't either.   

What use is sources-of-growth accounting?

I am teaching this stuff this week, and while I enjoy doing it and think it is important for students to know--no World Bank country economic memorandum is apparently complete without a sources-of-growth exercise--I wonder what purpose it really serves.

These accounting exercises come in two flavors.  A levels-exercise which decomposes differences in GDP per worker across countries into factor endowments and efficiency (or TFP). For the state of the art on this, see this paper by Francesco Caselli. The more traditional kind decomposes growth within a country into components having to do with physical and human capital deepening and a residual (TFP growth).  A comprehensive source on the latter is the 2003 paper by Barry Bosworth and Susan Collins.

Aside from all kind of measurement problems, these accounting exercises say nothing about causality, and so are very hard to interpret.  Say you found it's 50% efficiency and 50% factor endowments.  What conclusion do you draw from it?  You could imagine a story where the underlying cause of growth is factor accumulation, with technological upgrading or enhanced allocative efficiency as the by-product.  Or you could imagine a story whereby technological change is the driver behind increased accumulation.  Both are compatible with the result from accounting decomposition. Indeed, I have yet to see a sources-of-growth decomposition which answers a useful and relevant economic or policy question.

Caselli says that these accounting exercises are just a diagnostic tool--but he does not say how they help us diagnose anything in particular.  Sure, they tell us that accumulation alone cannot be the whole story, but is that a surprise to anyone?  

Perhaps the best known paper on sources of growth was the Alwyn Young exercise on East Asia, which showed that most of growth was "accounted" for by accumulation rather than productivity growth. In other words, the East Asian miracle was mostly perspiration, and not much inspiration.  Yet surely it was a miracle for these countries to have engineered jumps in their investment rates of the order of 20 or more percentage points, and even if the Young decomposition is right (it has been challenged by Chang-Tai Hsieh among others), I am not sure the result teaches us anything of importance. Do you suddenly think less of East Asians because the residual is lower than what you may have anticipated?

So here is a contest for economist (or wannabe economist) readers of this blog: can you come up with an interesting question to which a sources-of-growth decomposition is the answer?

Jan Svejnar for President

I am embarrassed to learn this late, just today, that the Michigan economist and all-around decent person Jan Svejnar has been combating the Thatcherite Vaclav Klaus for the presidency of the Czech Republic.  In the last round of parliamentary vote held today Klaus received 139 and Svejnar 113 votes, neither managing to get the majority needed to get elected. The next vote is scheduled for February 15th.

In the words of one Czech political analyst

[Svejnar] has contributed a great deal to the atmosphere of Czech political culture. His approach has been novel. He decided to run what is referred to here in the Czech Republic as an 'American' campaign. So even though the president is elected by parliament, he traveled around the country, he spoke to people and presented his views. And in a country where the president is elected through behind-the-scenes deals, this was a very refreshing approach. He basically said to the current political establishment: Look, let's do it openly, let's find the best person and not just let someone in who promises the most, behind-the-scenes.

The Czech public and the media were quite skeptical at the beginning but Svejnar really managed to excite the people. The latest opinion polls show that he is gaining on Mr. Klaus or even leading, which means that more people would prefer to see him as president than Mr. Klaus. Given that his campaign has lasted only about two months, this is an amazing achievement. He deserves full credit for being a very good candidate.

Wow. One day he is submitting articles to journals, the next he is running for president...

Comrade Jeffrey Frankel

Never appear on a TV interview without checking up on your host. (Actually in my case, never appear on a TV show, period.) My colleague Jeffrey Frankel explains in his inaugural blog entry. Read and weep.

Slow down the world, I want to get off

There is no shortage of polls on how people around the world feel about globalization, but here is one that asks a somewhat different question: what do you think about the pace at which economic globalization has been advancing?

It turns out that in a majority of countries, most people feel economic globalization is growing too rapidly.  Here are the results country by country:

 

Look at China: more people there think that the pace is too rapid than in the U.S. Aren't the Chinese the main beneficiary of what we have now?  Well, maybe no longer all the Chinese.

Interestingly, Turkey bucks the trend: a clear majority there feels that the pace of globalization has been too slow!  A comment on the tortuous process of membership in the EU perhaps? Or a reassuring sign that headscarf or not, Turks are obstinate modernizers?

The American economist's vice

Mark Thoma points us to an excellent review by Angus Deaton of the controversy surrounding the Stern climate report. Much of the discussion on the report has revolved around Stern's use of a very small discount rate, on the ethical assumption that we have no reason to value the wellbeing of a future generation less than we value our own.  American critics have objected on the ground that people do not really behave like this, and that the discount rates implicit in market outcomes suggest a much higher discount rate.

Deaton frames this as a conflict between British and American economists, with the former more at ease with making ethical assumptions and the latter preferring to defer to markets.  Deaton leaves no doubt which he thinks preferable--he is definitely not on the side of the country he lives in.

Whatever it is that is generating market behaviour, it is not the outcome of an infinitely lived and infinitely far-sighted representative agent whose market and moral behaviours are perfectly aligned, and who we can use as some sort of infallible guide to our own decisions and policies. The optimal savings and growth models that used to be taught in development courses as tools of central planning, along with careful explanations of why their solutions cannot not be decentralized by the market —remember the transversality conditions? — are now routinely taught in macroeconomics courses as descriptively accurate accounts of the economy. According to some stories, the government does better, correcting our collective missteps, but is it really possible to seriously imagine that an administration that dismissed global warming without economic analysis is nevertheless making optimal provision for future generations? Zero pure time preference, if it is a vice, is surely a minor one. Relying on markets to teach us ethics is very much worse.

I like especially the bit about old-style development economics. Can there be a bigger insult to modern macroeconomics than to say that it is falling into the same kind of trap that traditional development economics found itself in?

The backlash against happiness

... is here.  (Hat tip to Murat Iyigun.) The good news for economists is that their training allows them just as easily to minimize happiness as it does to maximize it.

And no, I don't think that's what we have been doing all along.