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Friday
Dec132013

Nelson Mandela, Leadership and Ideas

Nelson Mandela, who passed away on December 5, 2013, was not just a great politician and an inspirational leader, but also constitutes  a challenge to our models of political economy. 

Models of political economy attempt to systematically study the distribution of political power in society and the resulting equilibrium policies and institutions. This typically proceeds by means of a game theoretic model in which different groups (which are implicitly or explicitly assumed to have solved their internal collective action problems) compete, negotiate or fight in order to get their way. Or individuals, who are assumed to have well-defined beliefs about policy preferences, vote or by other means support different parties, policies or institutions. In some models, which individuals and groups enter into a coalition with others is studied, while other approaches focus on political and economic conflict under incomplete information. 

But two things are generally missing in these models: leadership and ideas.

Leaders play little role in these models, and there is only a limited role for ideas (except through some Bayesian modeling of beliefs and perhaps experimentation).

But it is hard to understand Nelson Mandela’s huge impact on South African politics — and beyond — without incorporating leadership and ideas into our political economy paradigm.

Mandela showed great leadership in steering the anti-apartheid struggle, in negotiating the transition from apartheid to democracy, and then later in bringing about some partial reconciliation between black and white South Africans. 

Mandela was also so transformative for South African politics because he changed people’s ideas about what should be done and what could be done. He did this first in his fight against the apartheid regime, and then with his efforts to define South Africa as the “Rainbow Nation”. His “idea creation” perhaps gained its apogee when, as South Africa’s first black president, he presented the 1995 Rugby World Cup trophy to the South African national team, the Springboks, long identified with the apartheid regime, wearing their jersey, opening a new chapter in reconciliation between whites and blacks.

So let’s think of incorporating leadership and ideas into political economy as Nelson Mandela’s challenge. 

Can political economy rise up to this challenge?

In the next few posts, we will argue that the answer is yes, but with some work. 

For now, it is useful to note that these issues are not entirely absent in the political economy literature.

Mancur Olson in his seminal Logic of Collective Action already put leadership at the center of political economy, particularly with his discussion of “political entrepreneurs” as agents solving collective action problems.

Dani Rodrik has recently emphasized the importance of ideas and made a call for their systematic incorporation into political economy. 

But the devil is in the details. What is it exactly that leaders do? And what are ideas and in what way are they endogenous and manipulable by individuals, groups and institutions? 

These are the questions we have to ponder in order to come to grips with Nelson Mandela’s challenge.

Wednesday
Dec112013

David Cameron's Favorite Book

Thursday
Dec052013

Value of Connections of the United States

It is well-known that who you know and who you are connected to matters greatly for your business success in many countries. This is nicely documented in several papers that show how connections to powerful politicians have a huge value in countries with weak institutions.

For example, in a famous paper Ray Fisman used an event study methodology exploiting rumors about the health of the Indonesian dictator President Suharto to show how close connections to Suharto were greatly valuable: these adverse news reduce the stock market value of the firms connected to him.

Similar results were found, among other places, in Malaysia by Simon Johnson and Todd Mitton and in Pakistan by Asim Khwaja and Atif Mian.

But the consensus view has been that such connections don’t matter in countries with strong institutions such as the United States.

In fact, Larry Summers used this as the basis for his argument for why the response to financial crises should be different in the United States in his Ely Lecture to the American Economic Association: strong US institutions imply that policies that should not be tried in Indonesia or Malaysia because of concerns about cronyism and corruption could be adopted with little worry in the United States.

This view was supported by work that applied similar methodology to the United States. For example, other work by Ray Fisman, together with co-authors, found that the value of connections to Dick Cheney were small or nonexistent.

So US institutions do seem to work as they are supposed to.

Recent work by Daron, Simon Johnson, Amir Kermani, James Kwak and Todd Mitton finds something quite different, however.

Focusing on the announcement of Timothy Geithner as President-elect Obama’s nominee for Treasury Secretary in November 2008, they report robust and large returns to financial firms with connections to Geithner. Connections here are defined either from Timothy Geithner’s meetings with financial firm executives during the previous two years when he was the President of the Federal Reserve Bank of New York, or from his overlap on non-profit boards with these executives. What’s going on?

One possibility is that this just reflects the fact that firms that had such connections are also those that would have actually benefited from the safe pair of hands that Timothy Geithner would bring to the job of Treasury Secretary. Though plausible, this explanation does not receive any support from the data:  controls for characteristics that could capture such benefits do not change the results, and in fact the results hold when comparing firms of very similar size, profitability and leverage, and similar risk and stock market return profiles.

Another possibility is that the same sort of shady dealings that went on in Indonesia, Malaysia or Pakistan are also present in the United States — or at the very least were thought to be present by stock market participants. But this seems very unlikely, and there is no evidence to support this. Timothy Geithner appears to be an honest technocrat, with no interest in doing favors in order to get campaign contributions or financial gain.

Instead, the paper suggests a different hypothesis: “social connections meets the crisis”.

Namely, the excess returns of connected firms may be a reflection of the perception of the market (and likely a correct perception) that during turbulent times there will be both heightened policy discretion and even more of the natural tendency of government officials and politicians to rely on the advice of a small network of confidants. For Timothy Geithner this meant relying on, and appointing to powerful positions, financial executives from the firms he was connected to and felt comfortable with. But then, there is no guarantee that these people would not give advice favoring their firms, knowingly or perhaps subconsciously (for example, they may be under the grips of a worldview that increases the perceived importance of their firm’s survival for the health of the US economy).

So Larry Summers is probably right that strong US institutions preclude the sort of dealings that went on in Indonesia under Suharto or in Malaysia under Mahathir Mohamad. But this does not mean that connections don’t matter or that we should not worry and be vigilant about them, particularly during turbulent times when important decisions have to be made quickly and the usual mechanisms for scrutinizing important policy decisions are weakened or suspended.

Tuesday
Dec032013

Politics and Technology

In our last post, we discussed how government policy can change the direction of technological change and deal with some of the environmental consequences of laissez-faire economic growth.

But of course the fact that the government could do this is no guarantee that it will do it. Whether or not it will comes down to politics.

This is a special case of the more general interaction between politics and technology, a topic that is unfortunately much ignored.

When social scientists think about technology, institutions and politics, regardless of their ideological leanings, their first instinct is to take their cue from Marx who viewed technology as an exogenous driver of history, and institutions and politics as merely parts of “superstructure” adapting to the needs and peculiarities of technology. As we noted in our post about a year ago, Marx famously summarized this perspective by stating:

The hand-mill gives you society with the feudal lord; the steam-mill, society with the industrial capitalist.

We also noted there that this view is seriously at odds with the facts, for example as recounted by historian Marc Bloch in Land and Work in Medieval Europe.

On the contrary, the development of these technologies, as with other technologies, has been endogenous and strongly responded to incentives in part shaped by politics.

History is in fact full of telling examples how technology responds to politics. Roman technology did not stagnate and then disappear in much of Europe after the collapse of the Roman Empire because it had reached some natural technological barrier, but because politics first within the Roman Empire and then among the fragmented European structure of polities that emerged after its collapse created no incentives for technological progress or even the use of existing technologies.

Nor can the phenomenal advances in sailing and ship-building technology starting in the 15th century documented for example by Carlo Cipolla in Guns, Sails and Empires be understood as the exogenous march of technology. Rather, they were a consequence of incentives created by inter-state competition for the capture of overseas trade routes and colonies.

Likewise, government policy and conflict over it is probably a first-order factor in understanding the direction of technological change today. For example, can we understand the types of technologies developed and enthusiastically used in the US health care system, which then rapidly spread to the rest of the advanced world, without considering the distorted incentives that the US health care system creates?

Though this point was made by Burton Weisbrod as early as the 1991 in a very interesting paper in the Journal of Economic Literature, there is curiously very little work on how politics affect endogenous technology, which seems a clearly under-researched area.

Returning to the issue of climate change, though the impact of government policy on the direction of technology may be potent, the politics here is unfortunately particularly challenging.

First, there is the issue of domestic politics. Government policy can be fruitfully used to redirect technological change from fossil fuel-based technologies to cleaner ones, but this will involve a significant redistribution of profits away from some of the most powerful companies in the United States. Not surprisingly, existing oil companies and energy producers relying on coal aren’t the biggest fans of a transition to clean technology.

This domestic dimension of the politics of energy technology is further complicated by the war over the science of climate change. It’s hard to know for sure, but one would imagine that without the involvement of the energy sector, there wouldn’t be so much confusion on what climate science does or does not say about man-made climate change.

Second, there is the issue of international politics. Any country that unilaterally adopts policies to redirect technological change towards cleaner technologies is likely to end up bearing the cost but not benefiting much unless others follow.

In this light, perhaps the defining political struggle over climate change is the one between the United States and China, the two biggest polluters today. Not surprisingly, this looks like a classic game of chicken or war of attrition, each side waiting for the other to make a concession while we get closer to the abyss.

If you thought that politics of technology was something you could ignore, perhaps you should think again.

Tuesday
Nov262013

Directed Technological Change and Resources

In our previous post, we discussed some of the evidence suggesting that technology is indeed endogenous and does respond to scarcities and prices.

Many economists have worked on modeling this type of endogeneity of technology and how it responds to prices. Remember the great economist John Hicks’s assertion, which we quoted in our previous post, about how higher price of a factor will tend to induce technological changes directed at economizing on that factor.

Hicks was not the only major figure to think about these issues. Charles Kennedy, Paul Samuelson, and Drandakis and Edmund Phelps all weighed in in the 1960s with various theoretical models. But in the age before micro-founded models of endogenous technology based on monopolistic competition, they faced a major challenge: how to model technological progress.

(The technical, but also conceptual, problem was this: If the production function of firms exhibited constant returns to scale in capital and labor, then they would have increasing returns to scale with technology being chosen by firms also, and this would make price-taking behavior impossible).

Work by Daron as well as Michael Kiley developed simple models of directed technological change building on the theories of endogenous technological change.

These models turned out to be not just tractable but also quite surprising in some aspects. In particular, as this paper shows, the implications are quite robust but also different from those that Hicks and others conjectured. But this is a topic for another time.

For our focus here, what is more important is the application of these ideas to the issues of resource scarcities and other environmental implications, which were studied in work by Daron, Philippe Aghion, Leonardo Bursztyn and David Hemous. This work does shed quite a different light on the debate between Ehrlich and Simon.

Recall Simon’s most important point: technology will endogenously respond to scarcities.

One of the results in this research provides a clear support for this line of reasoning: if oil gets scarcer over time, then technology will endogenously switch to cleaner sources of energy, reducing our dependence on oil.

So far so good.

But things are not really as rosy as Simon’s view would suggest.

The real problem isn’t the world running out of oil, but the world frying itself with all sorts of fossil fuels — not just oil but also coal. And coal doesn’t look like it will run out anytime soon.

More specifically, as production using fossil-fuel-based energy creates climate change, economic growth can indeed bring the downfall of the world as we know it (though the exact extent of this does depend on how the world will adjust to significant increases in average temperatures and the variability of climate, on which there is some debate).

In the process some sources of energy may become scarcer, but provided that there are other sources of “dirty” energy, such as coal, this won’t change the trajectory of fossil fuel consumption and climate change.

This research and a complementary paper by Daron, Ufuk Akcigit, Doug Hanley and Bill Kerr suggests that directed technological change may actually make things worse. To start with, dirty technologies are more advanced than clean technologies based on wind, solar power or geothermal (and even, more controversially, nuclear power). Given this state, directed technological change implies that private incentives will encourage firms and researchers to invest more in using and improving these dirty technologies  — clean technologies are just too far behind and won’t be competitive, so it wouldn’t make private sense for people to invest much in them.

But in fact, the most important lesson of this work might be a perspective that brings Ehrlich and Simon together. Though the market without intervention fails and fails badly (think environmental disaster), government intervention can be hugely powerful because it leverages the endogeneity of technology and, as Simon posited, the power of the market to generate new technologies.

If the government intervenes and subsidizes clean research, then this can powerfully stave off an environmental disaster. That intervention is necessary comes from the fact that the market, by itself, will not internalize the negative impact it’s creating on the environment (and on future generations).

This is much more powerful than one might have imagined because of an interesting reasoning. Once the government intervenes by subsidizing clean research, this starts making clean technologies better and better over time. As they become sufficiently better and thus competitive with dirty technologies, the tables turn. Now private incentives that previously directed everybody to invest in and do research for dirty technologies start encouraging the advancement of clean technologies.

Perhaps surprisingly, the government does not even need to intervene forever. Temporary (though not short-term) interventions are sufficient to redirect technological change towards clean technologies and slow down adverse climate change.

What about carbon taxes? Carbon taxes would do the same also, but interestingly they are not by themselves sufficient. Unless one is willing to have prohibitively high carbon taxes — enough not just to reduce carbon consumption today but to also change the future path of technological change — subsidies to clean research have an important role. And typically it would be very costly to have such high levels of carbon taxes anyway.

So bringing Ehrlich’s concern about the adverse implications of economic growth together with Simon’s insight that endogenous technology is a powerful force leads to new and somewhat hopeful insights.

But here’s the catch. Will governments actually do it? Will they choose the right levels of subsidies to clean research and carbon taxes to slow down and even stop climate change? Or will they just stick to business-as-usual until it’s too late? That brings us to our next topic: the politics of technology.

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