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Modeling Ideas

So how can we model ideas and their impact on political economy?

One obvious way is to approach it as a Bayesian learning problem. Perhaps we can think of new ideas as states of nature which had very low probabilities before being proposed or developed by some agents (“idea entrepreneurs”, and once those proposed, people may come to believe that they are more likely through Bayesian updating. If this happens, behavior will change.

This sort of modeling would tap into a long tradition in economics and political economyThough the Bayesian approach is both useful and standard in general and may also be a promising research direction in the context of ideas, it does not feature idea innovations in the sense that from the beginning, even if some states of nature have low probability, all agents are aware of all states of nature, so there are no surprises and no eureka moments. 

An alternative would be to partially depart from the Bayesian framework and assume that agents start with a limited state space (a limited set of possible states of nature) and are unaware of the full set of states of nature. This type of unawareness has been modeled in economics by, among others, HalpernModica and Rustichini, Li, and Heifetz, Meier and Schipper.

These approaches make individuals unaware of states of nature. An alternative might be to make individuals unaware of potential political states. For example, people in the Middle Ages may not have been able to conceive of democracy because they were unaware of the political system in which political power is not monopolized by the king or the aristocracy. 

The implications for political dynamics of this type of approach could be quite interesting. If at some point a political entrepreneur uses the argument that a monarch’s power is not divinely granted but based on his ability to dominate society, then this can make people aware of a new political state (or in fact a whole new set of political states without such monarchical monopoly of power). Interestingly, when such possibilities are taken into account by potential clinical entrepreneurs and organizations, there will be other game theoretic interactions. For example, if the political entrepreneur who wants to empower the middle class is afraid of power shifting to poorer segments of society after they become aware of organized social groups to be able to increase their political power in the world no longer divinely dominated by the monarch, then he may not want to start using arguments and strategies that will change their awareness, even if these arguments and strategies would, in the short run, enable him to shift power to the middle class. This of course has a nice parallel to what Daron, Georgy Egorov and Konstantin Soninhave have called the “slippery slope” in the context of dynamic political economy (though in a model without this sort of unawareness issues and the possibility to make sense of the importance of ideas).

A complementary approach might be to relax the Bayesian approach to allow for manipulation of ideas. This could be, for example, through indoctrination and inculcation (and a few papers in economics have investigated this, for example, this and thisor through the ability of inflation allegiance or thought leaders to convince others of certain ideas (for example as in this work).

Yet another possibility is to relate ideas to arguments. It might well be that people are more likely to understand (less likely to misunderstand) arguments that they have encountered before. This would imply that political and thought leaders might have to use and combine arguments that have already been used a lot in order to avoid misunderstanding and be more effective. But then this may then restrict what they can communicate. At some point, this restriction may become too burdensome, inducing them to experiment with new arguments even if this will lead to some temporary misunderstanding. 

The bottom line is that there seem to be lots of interesting ways to approach ideas within political economy, and many of them use already existing tools and sometimes even insights in political economy even if their details and of course implications will be quite different once they come to the worked out systematically.


How Ideas Matter

In the last several posts (here, here, here and here), we have discussed the role of leadership in political economy and organizations. What about ideas?

For example, Dani Rodrik has recently argued that ideas are much more important than the political economy literature admits.

Is this true? If so, how could this role of ideas be incorporated into political economy and more broadly economics?

There are two senses in which ideas could be important in political economy. The first is that important political dynamics can be explained mainly by certain ideologies or ignorance. This is a view we have argued against in Why Nations Fail, for example in our discussion of the “ignorance hypothesis”.

We also pointed out on this blog that even the best case for this view, the emergence and persistence of communist regimes, isn’t so clear-cut. In fact, these regimes cannot be understood as a result of people slavishly following an ideology. Nor is the state control over resources, production and distribution something that was invented out of thin air by the followers of Karl Marx. Rather, it was “invented” in history many times over because it has an attractive political logic for those dominating political power.

The second sense in which ideas matter is more plausible. Ideas interact with institutions and interests.

There are several ways in which this may happen.

First take once more the case of communism. As we have argued, communism would not have emerged and lasted if it was simply a (mistaken) worldview in which well-meaning, selfless leaders and their followers came to believe in. Rather, it became a powerful system because of the interplay of the interests of the party leaders and the ideological framework it provided for them and their followers. In particular, communism became a powerful “ruling ideology” because it successfully centralized political power in the hands of the party leaders; because it provided them with economic tools to extract resources from society (e.g., collectivization and state control of much of production); and because it also created a language and a set of beliefs that, combined with the right type of repression, kept a sufficient part of the population silent or even willing to collaborate. North Korea’s dystopic dictatorship powerfully highlights all of these points, even though Soviet Russia and China also illustrate the same ideas.

Second, consider our discussion in Why Nations Fail of state centralization among the Bushong. We put a lot of emphasis there on King Shyaam’s being able to centralize power, which was beneficial for him and for the Bushong elite. But how did he do that? Ideas probably played two important roles. First, the idea that a stable order with the Bushong elite centralizing power in their hands could be forged may not at first have been obvious. Somebody had to come up with this idea and make it operational. So there was an aspect of “idea innovation”. Second, this process of state centralization likely went hand-in-hand with its own brand of indoctrination — or manipulation of beliefs. For example, King Shyaam was presented as a powerful religious leader in addition to being a political leader.

Third, consider the march of democracy in 19th-century Britain, which was also discussed at length in Why Nations Fail. Though this was mostly a classic political economy problem, as we argued in our first book, Economic Origins of Dictatorship and Democracy, ideas and beliefs played an important role also. Organizations vying for greater political inclusivity often used arguments and imagery from earlier periods to legitimize their claims. For example, Chartists named themselves after the “Charter,” the Magna Carta, with the argument that their demands for the broader franchise were simply a continuation of the process that the Magna Carta started.

In all of these examples, ideas play an important role, but this is not despite of interests or institutions. They do so by strengthening, organizing or enabling underlying interests, and they became powerful in the context of a given set of institutions and political conflicts.

In view of this, we agree with Rodrik that ideas need to be more systematically integrated into economics models, but not with the conclusion that “ideas trump interests”. Rather, ideas become powerful in conjunction with interests and institutions.

And what about modeling them more systematically? Well that’s easier said than done, but as we will argue in our next post, there are also some promising directions here within the economics literature.


Limits of Leadership

We dubbed the challenge of incorporating leadership into the study of political economy Nelson Mandela’s challenge because Mandela powerfully illustrates the role of a visionary, talented and shrewd leader who can critically impact the course of affairs.

But Mandela’s legacy also points to a dilemma of leadership.

Leaders can form and hold together new coalitions and change beliefs in a way that expands the set of political feasible options. But if all of this is embedded in the skills, trustworthiness and networks of the leader, most of their achievements can be reversed or at the very least will slowly wither away when they disappear from the stage.

At some level, his huge leadership success in manufacturing reconciliation and a peaceful transition to democracy in South Africa notwithstanding, Mandela has perhaps not been as successful in building institutions.

This is reflected in part in the troubles of the African National Congress (ANC), which despite its huge mandate from South Africans, has not been able to form an effective government. It has not been able to deal with the huge inequality — and inequality of opportunity — challenge that is central to South Africa’s economy today. And South Africa has failed to play a constructive role in helping peaceful transitions to democratic institutions in neighboring countries, most notably in Zimbabwe, whose kleptocratic autocrat, Robert Mugabe, still receives implicit or explicit support from many ANC leaders.

Rather, the ANC has concentrated power in the hands of a small group of leaders that have mightily benefited from their newfound status. It has been mired in corruption scandals which it has not shown any ability to control or properly investigate. What’s more, it may be in danger of splitting between an “anti-reconciliation” wing, epitomized by Julius Malema, the former head of its Youth League, and a “business-as-usual” wing, entrenched in and benefiting from power.

This all raises the question of whether there are two kinds of leadership to be distinguished and separately modeled. The first is leadership that at some level transcends institutional realities and as such is truly inspiring, but does not entirely transform the institutional dynamics already set in motion. We argued, for example, in a previous post about Venezuela that Hugo Chavez’s leadership was (fortunately!) of this sort, though without making this conceptual distinction.

The second is institutions-building leadership, perhaps more in the mold of George Washington’s leadership in the United States or Seretse Khama’s role in building Botswana’s inclusive institutions which we discussed at length in Why Nations Fail.

So it seems there are many more questions to ponder about leadership.


Modeling Leadership

So leadership does seem to matter. But then, how do we incorporate into our political economy models?

The answer is not clear, mostly constituting an area for future research, though there are a few attempts.

One approach to this has been pioneered in organizational economics, for example by Benjamin Hermalin’s work, focuses on how leaders, such as top managers, can take actions to “lead by example” and to motivate other workers in the organization (e.g., work visibly hard on a project to signal the value of putting more effort for a specific project).

Roger Myerson’s work has pursued a different line, modeling leadership as a form of reputational equilibria (the leader builds a reputation for sticking to his word, for example).

Perhaps more important in political economy is the role of leaders in solving collective action problems and coordinating beliefs and behavior. There is much less on this.

One approach is developed by Daron and Matt Jackson. Leaders are those individuals whose actions are “prominent” meaning that they are seen by more agents and more precisely. In a dynamic coordination game, this creates an advantage. If an individual who is not prominent wishes to switch from the Pareto dominated equilibrium of the coordination game to the Pareto dominant one, she will rightly worry that others will not see her action or its signal or that the signal will not be sufficiently informative. The prominence of leaders enables them to circumvent this problem, enabling them to change the equilibrium if they want to.

There are several directions for extending this. First, rather than taking prominence as exogenous, one can try to endogenize prominence by the past actions of an individual. For example, Nelson Mandela became prominent because of his key role in the African National Congress’ struggle, his organizational efforts and then unwillingness to make a deal with the Apartheid regime.

Second, one can introduce similar ideas in the context of a game of collective action (rather than simply a game of coordination between two players). Then the role of leaders would become closer to that of “solving the collective action problem,” a hallmark of political leadership.

This work takes a first, and specific, step in thinking about the role of leadership as coordinating beliefs, but there are other possibilities. For example, leaders solve the collective action problem not because of their prominence, but by introducing new ideas (something we will discuss in later posts) or by more effectively communicating their actions or information (for example, by forming or exploiting their social networks). But these ideas have not yet been, at least to the best of our knowledge, systematically investigated.

Another important role of leaders, which has been investigated even less, is to form new coalitions. They may be able to solve again affecting beliefs or by exploiting their network of friends, followers and associates.


Does Leadership Matter?

In our last post, we introduced Nelson Mandela’s challenge to political economy: incorporate the role of leadership and ideas into our theoretical and empirical investigations.

This is a bit like world peace. Pretty much everybody is in favor of it — or at least says they are in favor of it. But few know how to achieve it.

Of course it’s easy to criticize existing approaches because they don’t have leadership and a role for ideas independent of interest. But that’s also a little cheap.

Though some would disagree, we believe firmly that economics — and more generally social science — makes progress by being much more specific about how certain social phenomena can be modeled formally; by deriving new insights and perspectives that would not have been obvious without doing this modeling work; by devising new ways of measurement corresponding to these new concepts; and by testing hypotheses and new ideas systematically using state-of-the-art econometric and statistical methods.

So the devil is in the details.

Be that as it may, there is actually work in political economy and economics in general on these topics.

First, two related strands of work show that leaders do indeed matter.

The first is exemplified by a creative paper by Benjamin Jones and Benjamin Olken, “Do Leaders Matter?”. Focusing on changes in national leadership resulting from random leader death (where leader here means the person with executive power which could be president, prime minister or dictator), Jones and Olken find evidence that leaders do matter.

In particular, they test for the hypothesis that the growth rate of GDP is the same before and after the random leader death, and comfortably reject this hypothesis, suggesting that there is a change in growth as leaders die and are replaced by new ones.

Two things are particularly interesting about this paper.

First, they are testing whether a change in leadership is associated with any change in growth — a hypothesis much weaker than a change in leadership from somebody with certain characteristics (say low education) to other characteristics (say high education) increasing economic growth. This is for good reason. There doesn’t seem to be as strong patterns when it comes to leader characteristics (but see this paper and this paper).

Second and more interestingly, Jones and Olken show that this result is driven by changes in leadership in countries with weak and non-democratic political institutions. This says that the change from George W. Bush to Barack Obama, important though it was for many things, should not have changed the US growth rate, which is plausible.

This makes a lot of sense at some level. Good — what we would call inclusive — political institutions will allow less discretion for politicians to pursue policies that would be disastrous, and hence gyrations of economic growth should also be more limited.

It also implies that if you believe — as we firmly do of course — that institutions are central for understanding economic performance, there is no conflict with this view and one that shows that leaders do matter: leaders function in a framework created by institutions and their impact very much depends on and is modulated by these institutions (though of course they may in turn also shape the evolution of institutions as we will discuss later).

The second is a related line of work investigating the impact of Chief Executive Officers (CEOs) on company performance. An important paper that is the precursor to Jones and Olken’s work is Marianne Bertrand and Antoinette Schoar’s paper on “Managing with Style” which uses a related but in some ways richer empirical design exploiting the fact that, differently from national leaders, CEOs manage several major companies during their careers (or work as other top managers in such companies, which Bertrand and Schoar also incorporate into their sample). Thus one can estimate an econometric specification in which company performance can be decomposed, among other things, into “CEO effects” and “firm effects” (formally, this means the estimation of a panel data regression in which there are both CEO and firm fixed effects).

Bertrand and Schoar also find that these CEO effects are statistically important — which is the equivalent of Jones and Olken’s finding that the hypothesis that growth before and after random leader death being equal can be rejected.

In addition, using the data available for practices under the reign of different CEOs, they can have a first attempt at investigating why different CEOs matter. In particular, they show that dividend policy, investment policy, cost-cutting strategies, financial policies and merger and acquisition decisions are particularly sensitive to who holds the reins of the company.

This conclusion is corroborated by more recent work by Nick Bloom and John Van Reenen which shows huge differences in management practices across and within countries, and provides evidence suggesting that these are likely to be quite important for firm performance.

These studies make considerable progress in showing that leadership at the company or the country level matters, and also putting some new ideas on the table related to in what ways leadership may matter.

Of course, there are many open questions. For example, at the national level, the death of a leader may matter not because of his character or vision, but because there are different “rent seeking coalitions” associated with different leaders (think of the rent seeking coalition in Egypt before and after Mubarak).

When one leader dies, this leads to the dissolution of one rent seeking coalition and the formation of another. This will naturally have an impact on economic performance even if the two rent seeking coalitions have exactly the same preferences over economic growth and investment in different sectors of the economy. Add to this the possibility that different rent seeking coalitions are supported by and will favor different businesses in sectors of the economy, it becomes quite possible that leadership transitions can be associated with very significant changes in economic growth without any of the notions about “leadership” we normally think about — particularly when being inspired by Nelson Mandela — being important.

At the company level, the same problem can occur, though this is easy to put to rest with the evidence that many important company practices do change significantly with leadership changes.

More important at the company level is the fact that leadership changes may be endogenous, partly occurring when the company already wants to change course in terms of some of these policies (this wasn’t as much of an issue at the country level because of Jones and Olken’s focus on random leader deaths).

Though there is probably some of this going on, it seems unlikely that the presence of this sort of endogenous CEO change by itself can explain all of Bertrand and Schoar’s results. Also, even if it could bias their point estimates, the qualitative results shouldn’t be affected, since the only reason why there would be a systematic change from one type of CEO to another when the company wants to change course is that some CEOs are better with or more likely to adopt some types of practices or will implement them more effectively, thus providing another type of support to importance of leadership.

This is of course just scratching the surface. Much more is needed to advance our understanding of how leadership matters at the national or the company level. We also need to study when there are leader transitions and also perhaps whether, when and how existing leaders change their strategies and approaches because of changing circumstances.

So there is much to be done here.

The same is true when it comes to the modeling of leadership, which we will discuss in our next post.

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