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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.

Wednesday
Nov202013

Is Endogenous Technology Conservative?

In our previous post, we reviewed the basics of the debate between Paul Ehrlich and Julian Simon over whether economic growth would lead to widespread resource scarcities and demographic catastrophes.

In The Bet: Paul Ehrlich, Julian Simon and Our Gamble over Earth’s Future, Paul Sabin puts this debate, and their famous wager, in context and provides useful and interesting historical details.

Sabin also follows one interpretation of this debate in which Paul Ehrlich is the liberal, voicing left-wing concerns about economic growth, and Julian Simon the conservative, subscribing to a techno-optimistic view.

Though it is true that Paul Ehrlich considered himself to be from the left, and Julian Simon’s views came to be adopted by the right (and Simon himself embraced some American conservatives’ climate-skeptic views), it is wrong to see this debate as pitting liberal vs. conservative views of technology and economic growth.

At the center of the debate are some basic economic questions: is technology endogenous, and can it change enough to overcome scarcities?

There is nothing inherently right or left in the answer to these questions.

To an economist, it is natural to presume that technology is endogenous, and many economists view technological change as a powerful factor capable of overcoming all sorts of scarcities.

John Hicks anticipated this in his Theory of Wages, writing

A change in the relative prices of the factors of production is itself a spur to invention, and to invention of a particular kind—-directed to economizing the use of a factor which has become relatively expensive…

The most famous version of this idea is embedded in the endogenous technological change models every economist encounters in graduate school (and nowadays, many even see in their undergraduate studies).

In the basic neoclassical growth model, as formulated by Robert Solow, long-run economic growth necessitates exogenous technological change (except in some degenerate cases). Without such technological change raining down as mana from heaven, capital accumulation can drive growth for a while, but must ultimately come to an end. One way of understanding the reason for this is that as capital accumulates, the capital-labor ratio increases and this makes labor “more scarce” (relative to capital). This increases wages and reduces the return to capital, discouraging further capital accumulation.

Looked at it from this perspective, what endogenous technological change models do is that they create incentives for technology to also advance. As a result, even though labor does become more expensive (thus more scarce), this does not choke off economic growth. Scarcities are overcome by technological ingenuity.

Nice in theory, but does this have anything to do with reality?

Actually yes. Considerable empirical evidence shows that technology does indeed respond to incentives, including scarcity.

An interesting example comes from David Nye’s  Electrifying America: Social Meanings of a New Technology, 1880-1940, where he argues

Cities grew larger, better transportation was needed, so the [electric] trolley was invented, called into being by the crowded late nineteenth century cities….By the 1870s large cities had ceased to be accessible by foot, or built to the scale of pedestrians, and traffic congestion was terrible.

But crucially, the difficulties that over-congestion created also induced the development and adoption of new technologies in the form of the electric trolley, which ultimately solved the major conundrum that cities were facing at the end of the 19th century.

The famous Habakkuk hypothesis in economic history also amounts to the same thing (with different historical examples to back it up).   

In American and British Technology in the Nineteenth Century Habakkuk argued that technological progress was more rapid in 19th-century United States than in Britain because American labor scarcity induced faster technological progress and mechanization.

Habakkuk, for example, quoted from a contemporary observer of technology, Pelling, who wrote:

… it was scarcity of labor `which laid the foundation for the future continuous progress of American industry, by obliging manufacturers to take every opportunity of installing new types of labor-saving machinery.’

Or in Habakkuk’s own words:

It seems obvious—- it certainly seemed so to contemporaries—- that the dearness and inelasticity of American, compared with British, labour gave the American entrepreneur … a greater inducement than his British counterpart to replace labour by machines.

More recently, economic historian Robert Allen suggested in The British Industrial Revolution in Global Perspective the same mechanism as the reason why Industrial Revolution took place in Britain rather than in continental Europe or elsewhere.

A more contemporary example comes from the work of economists Richard Newell, Adam Jaffee and Robert Stavins. They show with historical data from Sears catalogs that, when energy was abundant and cheap, innovation in air conditioners tended to reduce prices and leave energy efficiency largely unchanged. After the oil price hikes, when energy became more expensive and “scarcer”, the direction of technological progress changed and air conditioners started becoming more energy efficient over time (but not much cheaper).

So the idea that technology is endogenous and responds to prices and scarcities isn’t an ideological belief, but an economic idea with fairly solid empirical backing.

This of course doesn’t mean that technological change is always powerful enough to overcome all scarcities. That’s another empirical question, and one we will discuss more in the next post.

But here, to put it into context, it is perhaps also useful to note that belief in the power of technology to overcome scarcity and create abundance is not under the monopoly of the right.

Many of the early socialist thinkers, including Robert Owen, Henri de Saint-Simon, Charles Fourier and Edward Bellamy, believed in the power of technology to create their utopian societies. Even Karl Marx was fairly optimistic about what technology and scientific knowledge could achieve (even though he was fiercely critical of what technology did under capitalist control, arguing, for example that “all progress in increasing the fertility of the soil for a given time isn’t progress towards winning the more long-lasting sources of that fertility… Capitalist production, therefore, develops technology, and the combining together of various processes into a social whole, only by sapping the original sources of all wealth…”).

Neither is there anything inherently progressive or left-wing in arguing, as Paul Ehrlich did, that the world is overpopulated and population must be controlled at all costs.

Matthew Connelly’s entertaining and troubling Fatal Misconception shows how the obsession to control population (which in practice means international organizations controlling or attempting to control population in poor countries) could acquire an almost fascistic zeal.

In light of all this, it would seem that the debate between Ehrlich and Simon shouldn’t be viewed as the struggle of left and right-wing ideologies, but an economic and empirical debate.

On the economics of it Simon’s position seems right: technology is endogenous and does respond to scarcities and prices.

On the empirics of it, that is, on the question of whether this response of technology is powerful enough to overcome all scarcities and avoid serious negative environmental consequences, the answer is a little more nuanced as we will see next week.

Tuesday
Nov192013

Ehrlich, Simon and Technology

A new book by Paul Sabin, The Bet: Paul Ehrlich, Julian Simon and Our Gamble over Earth’s Future, revisits the famous wager between Ehrlich and Simon.

Many scholars and commentators over the years have publicly, and sometimes very loudly, worried that we will outgrow our planet’s ability to support us. One of the most colorful was the environmentalist Paul Ehrlich, who repeatedly predicted over the 1960s and 70s widespread resource scarcities and consequent demographic catastrophes. He became more than a public intellectual, almost a household name as a result.

But Ehrlich was challenged by economist Julian Simon, who believed that technological ingenuity would overcome any scarcities before these would have much of an impact on human welfare.

Simon challenged Ehrlich to a bet about the prices of a bundle of commodities that Ehrlich would choose.

Ehrlich picked chromium, copper, nickel, tin, and tungsten as five commodities that would experience increases in their inflation-adjusted prices between 1980 and 1990. The wager ended with a victory for Simon when the prices of all five commodities fell.

But as Sabin recounts, the story would have been different if the bet was extended two more decades.

The next figure shows that indeed Simon’s victory may have been premature.

 

Before the Great Recession prices had reached and surpassed their 1980 level.

That of course neither proves nor disproves Simon’s broader point: technology will respond to scarcities.

That being said, revisiting this bet and the preceding and ensuing debate is interesting for several reasons as we will discuss in the next several posts.

To give a preview, in the next post, we will suggest that the oft-drawn interpretation of the wager between Ehrlich and Simon, repeated by Sabin, as the facing off of liberal and conservative views about growth and technology misses the point.

We will then review some of the economics literature on how technology responds to scarcities and the implications of this for climate change.

We will conclude with a final post on the role of politics in technological change. 

Thursday
Nov142013

Labor Coercion in the British Industrial Revolution! Surely not?

Can’t be true? Didn’t Britain have inclusive institutions? Yes on balance it did, but of course reality is full of grey areas.

One such grey area is labor coercion. There was probably less labor coercion in Britain by the 19th century than most other places at the time — certainly less than the extensive labor coercion in the US South, coexisting with the broadly inclusive set of institutions of the US North.

Less than elsewhere, but still there.

For instance, the Combination Acts banned trade unions until 1824/25, and even then groups of nascent unionists like the Tolpuddle Martyrs were shipped to the penal colony of Australia in 1834. (This was done by invoking obscure laws that made it illegal to, of all things, ‘swear oaths’ …).

In our blog post on why Barbados and Jamaica are different we pointed out how the Masters and Servants Acts have been used to repress labor in Jamaica. In fact Britain had such laws until 1875, and they made employee contract breach a criminal offense. These laws and their implementation were of course a far cry from the punitive measures implemented in the British Caribbean, but coercive they still were.

Why the timing of their abolition?

We think this is not unrelated to the political developments. The Second Reform Act of 1867 enfranchised working class English people for the first time, and they were able to use their new political power to break down some last residual elements of extractive institutions.

Path-breaking research by Suresh Naidu of Columbia University and Noah Yuchtman of Berkeley has investigated the impact of the repeal of the Masters and Servants Laws on the British Labor Market.

Naidu and Yuchtman find that the repeal of these laws had large effects on wages, which rose disproportionately in places that had previously seen a lot of prosecutions under the law. Interestingly, wages also became more responsive everywhere to changes in supply and demand conditions.

Naidu and Yuchtman also find something else that is very interesting – the industries that were the hallmark of the British Industrial Revolution were heavily involved in prosecuting people under the Masters and Servants Acts. Though the origins of these laws in England go all the way back to the fight against wages rising after the Black Death in the 1340s, they were not some anachronistic cultural left-over waiting to be modernized.

They were being involved by the modern parts of the economy. Institutions in practice are full of gray areas.

Tuesday
Nov122013

Millennials and Why Nations Fail

An interesting article in The New York Times by Tom Agan argues that millennials, those born between 1980 and 2000, are likely to revolutionize companies and innovation, with the company insiders and elites being the only thing standing on their way.

Agan draws a parallel between the theory we lay out in Why Nations Fail on how the political resistance of elites holds back innovation and growth at the country level and the resistance of the company elites that prevents innovation and growth at the company level.

This accords well with new research by Daron joint with Ufuk Akcigit and Murat Alp Celik (both from the University of Pennsylvania), arguing and empirically documenting that openness to disruptive innovations at the country and the company level is a very major determinant of creative innovations. In fact, a key dimension of that openness is how the young are allowed, or not, to contribute to the creation of innovation and wealth. Companies (and countries) that allow the young to rise up within the corporate hierarchy are much more innovative and generate higher quality and more radical innovations. We will report in more detail on this research soon.

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