We are turning into a rentier society again

Wouldn't it be nice to live on old money? One does not really need to work, or at least on a regular basis, one is worry free, and one gets to enjoy life at its fullest. But this is only a dream that is reserved to a preciously small elite.

Thomas Piketty, Gilles Postel-Vinay and Jean-Laurent Rosenthal show that about a century ago in Paris close to 10% of the population were in fact rentiers, that is, people who consume more than their labor income during their lifetime. They thrived in an economy where the return of wealth was substantially higher than the growth rate. And by the looks of it, it appears that we are heading into a similar situation, as a small proportion of the population is generating substantial wealth from labor income, wealth that cannot be spent in a lifetime and will be inherited by happy an idle descendants. Perhaps more importantly, existing wealth is enjoying far better returns than average wages are growing at, laying the seeds of a new rentier society. History repeats itself.

The child quality/quantity trade-off in the Industrial Revolution

Non-economists cringe when they hear us talking about investment in children and the quantity/quality trade-off in this regard. Yet, this is a very real aspect of child rearing pointed out by Gary Becker that is at the core of many models, and has been found wild in nature. This trade-off is though to be an integral part of the demographic transition, where fertility suddenly drops massively in the course of development.

Marc Klemp and Jacob Weisdorf look at data from Anglican parish registers from the 18th century that contain all sort of demographic data to look at the child quality/quantity trade-off during the Industrial Revolution. Theory tells us that if the returns to education and/or the cost of time (wages) get larger, parents switch from having many children with no education to few of them with better education. Klemp and Weisdorf's data indicates clearly that this trade-off is present: each additional sibling reduces by 8% the probability of a child eventually becoming literate. That is a strong effect, in particular considering the larger number of children at the time, and its rather large standard deviation during this time of transition.

Could the Shadow Open Market Committee have outperfomed the Fed?

Decisions of the Open Market Committee of the US Federal Reserve bank have long been scrutinized, both by market for obvious reasons and by academics. Some of the latter have even formed a Shadow Open Market Committee in reaction to the decision by President Nixon to impose price and wage controls in 1971, with the support of the Fed president. This committee has evaluated Fed policy and criticize Fed actions when due. But would it have done a better job?

William Poole, Robert Rasche and David Wheelock, who are all Fed employees, study how the policies advocated by the SOMC during the period of high inflation in the 1970s would have performed. Those policies where at odds with what the Fed was doing and even with what many academics were proposing. The policy rule was rather simple: reduce the target money growth rate by one percent every year, down to 4%. To evaluate this rule, you need a model, so they take the New-Keynesian model of Clarida, Gali, and Gertler (1999) off the shelf and run various experiments: one with the SOMC rule, one with the historic data (the Fed's action: a one time drop in money growth). While both policies eventually achieve their goal of reducing inflation, the SOMC one does so with less cost in output.

Now things are not that easy. To be fair to the Fed, it had at the time had rather little credibility, and it is not clear it could have gained any more credibility by adopting the SOMC's policy, as it requires some long-term commitment. Also, the Fed had to fight against attempts by Congress to take over monetary policy, and thus its policy choices were limited. And had the SOMC known that it policy would have been actually implemented, I am not convinced it would have taken the same choice. Indeed, it was rather risky, as it was at odds with what most other people were advocating. And markets may have reacted with incredulity to such an odd move.

Fertility differences and agricultural techniques

There are times when you read a paper and you really wonder how the authors came up with the idea to check out a particular correlation in the data, because it seems to be so far-fetched. But thus a correlation can be beautiful if it also has a nice theory that comes with it.

The correlation that Alberto Alesina, Paola Giuliano and Nathan Nunn study is between current fertility and adoption of plough agriculture in history. OK, I did not think about that one. But now that they find a nice positive correlation, how could one explain it? They argue that this has to do that women and children are not particularly useful when ploughing, as strength is required. The traditional task of weeding, that fell on women and children, is not necessary with ploughing. Thus, there is a preference for fewer children that is ingrained in the culture of these regions to this day.

Health cults in ancient Greece

Ancient Greece is a fascinating period as this is the start of the rational and scientific study of the world and many scientific principles were laid down. The Greek philosophers where in particular the first to think seriously about the role of institutions, markets and the functioning of government. In terms of health and medicine, we have all learned about the first attempts to explore and rationalize the human body, using a secular and scientific approach that was unparalleled until much later in history.

Carl Hampus Lyttkens points out that there was also a counter-movement where health care was leaning much more on religion. He also remarks that this is not unlike what we experience now with alternative medicine that has many followers and is even part of state sponsored health care in some countries. Calling these health cults, Hampus Lyttkens claims they arise because people are afraid of the uncertainties of life and cling to anything to reassure themselves. Just think about how many people believe in life after death while there is no scientific evidence for it. And healing cults are often, now and then, the realm of those who cannot afford the services of the scientific healers.

Fiat money, 1683

We tend to think that fiat money is an invention of the twentieth century and thus does not predate the Italian car industry. But there have been a few experiments before this and in particular a remarkably successful one in the Netherlands starting in 1683.

Stephen Quinn and William Roberds tell the story of the Bank of Amsterdam that in 1683 started limiting the ability of depositors to withdraw coin. At a time where this would have been interpreted as "taking the money and running," this was remarkably well accepted by the depositors, and the Bank of Amsterdam never abused the situation, maintaining stable prices over the next century and greatly facilitating trade in the kingdom. All this without government supervision, basically out of private initiative. Call that almost-private central banking (the bank was sponsored by the city of Amsterdam), even conducting open market operations. Of course, this all ended went the Bank of Amsterdam went bust in 1795: the rest of the world still relying on precious metal, the lack of access to fresh silver during the Fourth Anglo-Dutch War led to a strong depreciation of the guilder, and the experiment ended due to lack of fiat.

A neolithic prisonner's dilemma

Why did humans adopt agriculture in Neolithic times? Our intuition would say because it has better nutritional outcomes. But the evidence points to the contrary: the bones of early farmers consistently show poorer health than the preceding hunter-gatherers. So why would agriculture be adopted if it lead to a disadvantage?

Robert Rowthorn and Paul Seabright say it was individually rational to adopt agriculture, even though it was detrimental to society, much like in a prisoner's dilemma. The problem of a farmer is that he needs to defend his land and his cattle. That seems an additional disadvantage with respect to hunter-gatherers. But farmers can team up in villages, and fortify them. And voilà, now that they have a secure base, they can start raiding around them instead of only defending. This is where the prisoner's dilemma comes in: it is individually rational for every farmer to dedicate resources to defense, but this lowers everyone's welfare.

And thus started the grip of the defense industry on the economy.

An analysis of the oldest auction in history

Homo economicus is not a recent phenomenon. Not only that, he design market mechanisms early in history that appear to be very subtle. The oldest known auction was designed by Illyria in Babylonic times. This is a marriage markets in its true sense, as it is about auctioning off potential brides. All eligible girls are assembled, and an auctioneer offers them to the highest bidders, starting with the one expected to fetch the highest price. Proceeds are used to sell the least attractive brides to the poorest men assembled.

Michael Baye, Dan Kovenock and Casper de Vries analysis this auction in a two-player environment and claim that there is something paradoxical. Assume complete information, which means the auctioneer will always earn zero profit. Then is appears players can earn a much larger surplus by playing a mixed strategy than with a pure strategy. And there a continuum of these mixed strategies, and the expected payoff for both players is arbitrarily high, but finite. The problem is the solution procedure used to solve for symmetric mixed strategies breaks down here, because it selects strategies that are not part of Nash equilibria. We should learn from that to be very careful when applying standard theorems. A similar reasoning applies to incomplete information where the bidders do not know how much the other player values the potential brides.

There is no recent literature on this auction. However, it was mentioned on the back cover of the August 2006 issue of the Journal of Political Economy. I suspect this is what inspired the authors to work on this. They could have mentioned this and acknowledged the submitter, Costas Meghir.

On the consequences of slavery

I reported now long ago on the consequences of slavery in Africa, where it is shown that countries where more slaves were taken still have lower levels of development. It is quite amazing that this can have an impact on average income for so long. But what about the receiving end of the slave trade?

Graziella Bertocchi and Arcangelo Dimico look at county data for the US and find that current average incomes are not related to the inflow of slaves. However, income inequality is. Why would that be? It could be because slave could not own land, and this still has an impact today. Or it could be because of discrimination. Or it could be because of persistent differences in human capital.

Now using a panel data set, Bertocchi and Dimico find the last one is the most likely one. The education gap between blacks and whites has never recuperated, and segregation was certainly part of it. But this strongly persistent effect means that affirmative action still has a reason to be.

Was Malthus wrong about mortality?

One of the critical assumptions in the Malthusian model of growth that the mortality rate depends inversely on the standard of living. While this is not that obvious to replicate with data we have from Malthus' times, such a relationship ship is even more difficult to establish for previous centuries.

Morgan Kelly and Cormac Ó Gráda have dug up some inheritance records from England which allowed them to link wealth and age of death. What they find is quite interesting: all strata of society where affected by agricultural conditions. So if there were some poor crops, rich and poor were more likely to die. This fits right into the Malthusian model where the aggregate standard of living matters. The only subtlety is that the rich die a little later. Indeed, the authors do not attribute this mortality to hunger, but rather vagrancy following some poor crop that spreads epidemics. But such a relationship seems to have disappeared by the 17th century, which the authors justify by government intervention to help the poor. This makes it unclear why Malthus made it such a crucial component of his theory.

Pre-industrial revolution England did not grow, but was rich

Some people have an idealized image of the centuries before the Industrial Revolution, an image fed by pictures of elegant aristocracy and chivalrous knights. Others are more realist and see these times as a period of utter misery, filth and stagnation. Research on the standard of living in this period does not have conclusive answers because the evidence is sketchy and ranges from complete stagnation and misery à la Malthus to sustained growth. Gregory Clark has recently issued a pair of exciting papers that should set a few records straight, at least for England.

In the first, with Joseph Cummins and Brock Smith, he shows that England was surprisingly rich before the Industrial Revolution. This assertion is based on the fact the a small share of the population was engaged in farming. The primary sector accounted for 52% in 1817, and even 60% in 1560. These measurements are based on the occupations listed in men's wills and indicate that a substantial fraction of people living in rural areas were in fact not engaged in farming. Thus measuring the urban population share can be misleading in this respect.

In the second, Gregory Clark shows that there has been relatively little growth over these centuries, which means that way back in 1381, England was much richer than we thought. At that date, only 55% of the population was engaged in farming, based on records of the Poll Tax. This is very close to the number quoted above for 1817. Thus standards of living were not that different four and a half centuries apart.

Economic thinking in Bulgaria after the fall of the Berlin Wall

Economic thought, especially in macroeconomics, goes through episodic changes. These changes are very slow to occur, and historians of economic thought try to analyze what brought these changes and how they happened. The recent doctrinal changes in Eastern Europe offer in this respect a particularly interesting exercise, because everything happened very fast. In particular, you did not even have to wait for an old generation to retire or die for fundamental changes to happen.

Nikolay Nenovsky studies, from personal experience, what happened in Bulgaria. The evolution there was particularly dramatic there because the Russian Perestroyka was largely ignored by the political and intellectual class, and thus change had to happen much faster thereafter. Also, the economic transition happened in a theoretical vacuum, as only transition to communism was researched. Subsequently, economic research was largely event driven, reacting to price liberalization, restructuring of state ownership, foreign debt issues and the currency board.

Previous to reforms, economists were in two camps: those who studied socialism, and those who were to point out the ills of capitalism. The latter were much more ready to understand the transition and emerged as intellectual leaders. The first found refuge in Keynesianism and institutional economics. Bur all lacked empirical skills, and, ironically, sociologists took this over. But the big agents of change were the World Bank and the IMF, through their missions and advice, and imported western textbooks. Nowadays, western thinking has been adopted without much discussions about its fundamentals. Microeconomics is largely neo-classical, and macroeconomics mostly Keynesian. The latter is not surprising, given where Bulgaria is coming from.

The Great Depression: demand or supply shocks?

The fact that we are in a big recession has renewed interest in the Great Depression, and this has revived the questions about its origin. In particular, the eternal question on whether demand or supply shocks have driven it is back.

This time it is asked by Mark Weder, who runs a horse race between tow versions of a real business cycle model: one with only shocks to total factor productivity (supply shocks) as measured by Solow residuals, one with only preference shocks (demand shocks), measured as residuals of an Euler equation. The latter, though, are not associated with monetary or fiscal variables. Both types of shocks are the evaluated in their ability to forecast what happened to GDP, and none is a clear winner.

But is this really the best one could do? Clearly the models are way to simple to 1) forecast anything, 2) to capture the changing policy environment during this period, as highlighted by Milton Friedman, Anna Schwartz, Harold Cole, Lee Ohanian and many others. Also, the relative importance of the two shocks may have shifted over time, something that would have been worthing looking at.

The crisis and the loss of Bourgeois values

What triggered the Industrial Revolution has been the subject of debates for decades. While currently the emphasis is on the Unified Growth Theory, other interesting explanations exist. One of them is by Deirdre McCloskey, who claims that the wide adoption of Bourgeois values was critical. By that, she means that once innovators and capitalists were looked up to or were considered gentlemen, an economic transformation towards industrialization could happen.

Are there some lessons to be learned for the current economic situation? Gustavo Morles thinks that we are currently witnessing a loss of Bourgeois values, particularly in Europe where welfare states are strong and demographic shrinkage attracts people with different values. The United States are not immune, as shown by the election of Barack Obama. The consequences would be a prolonged economic crisis due, presumably, to disappearing entrepreneurship.

While there is indeed worldwide more anti-business and pro-regulation rhetoric than for a long time, I think it is too early to call this a permanent change in attitudes. And in an era so dominated by fads fed by the media, this may change as fast as it arose.

The debt that would not disappear

There are sometimes papers you just cannot put down only because they are so well crafted, even though your are not really interested in their topic. I just read one of those, by François Velde.

The French government is still honoring an annuity dating back from 1738, yielding annually €1.20 to be distributed to 58 people. That seems to be a very inconsequential amount, but this particular debt, which survived several kings and political regimes, just does not die. I do not want to reveal too much about the story here, as Velde does a remarkable job at trying to understand where this annuity comes from, how it survived various challenges and how its current amount was established. Along the way, we learn a lot about politics and economics through almost three centuries of French history. A true page turner.

Isolation and development

Geographic isolation is generally thought to be an impediment to growth. While I do not give too much credit to cross-country regressions, they have consistently shown that being landlocked or not have direct access to navigable waters is bad for national income. The reason is that being cut off from trade routes, you do not benefit from technological advances as early as others.

Quamrul Ashraf, Oded Galor and Omer Ozak argue that this logic does not hold for development in prehistoric times. They compute an isolation index by measuring the average time it takes to travel from a capital to any other location in the known world (excluding the Americas and Sub-Saharan Africa). It ranges from 5.5 weeks in Georgia to 12.1 weeks in Malaysia. In the premise that Malthusian economies strive to increase population, not per capita income, they then look at the impact of this isolation index on population density in the years 1, 1000 and 1500. They find that the effect is there, and in fact it is still present when using these antique isolation measures on modern day income per capita.

The big question is now to understand why in old periods isolation was beneficial, for example for China. Is it because isolation made one less susceptible to war and envy? Is it because isolation prevents slavery? Or is it because of a fluke in the data? Note that population density is used as a measure of development, which make for example that Egypt scores particularly low. But population is extremely dense around the Nile... In any case, this paper raises more questions than it answers, which is good.

Did railroads induce or follow economic growth?

It is, at least in the general public and in the teaching of history in schools, a well accepted idea that the development of railways brought economic development to the West in the nineteenth century in the United States. But thinking about it, it is also entirely possible that the railways went were business was already established, after all the railways companies were seeking profit.

Jeremy Atack, Fred Bateman, Michael Haines and Robert Margo look at this chicken and egg question under a new light with new a new technology, GIS data. Using geographic data on population density, as a measure of economic development, as well as the fraction of urban households and the development of the railroad system. Using difference in difference estimation they find indeed that development preceded the railway. There certainly is anecdotal evidence for that, as the most advanced western state at the time, Ohio, did not rely on railways, but canals. And Michigan was the first to adopt railways. But this does not mean that railways did not transform the economic landscape, as they caused urbanization.

Measuring centuries of numerical literacy

Measuring the evolution of human capital in previous centuries is tricky business. The most common measure, years of schooling, is fraught with major mismeasurement even in modern times, as it does not take into account the quality of education. A better measurement is to look at various cognitive tests, but those are not available for more than a few decades. Some measure of literacy are available for the 19th century, based on the ability for individuals to sign their names.

Brian A'Hearn, Jörg Baten and Dorothee Crayen use a very subtle idea to get a better grip on the evolution of numerical literacy. Accuracy in age awareness is thought to be a reflection of people that are "calculating" and using numbers in everyday life. Inaccuracies translate into age heaping, for example reporting age in multiples of five. For recent data, it is known that age heaping is inversely correlated with human capital, so why not use it as a measure of human capital for older periods, as demographic data is not that bad.

This is what A'hearn, Baten and Crayen do, and they use it to compare different regions. They find that numerical literacy started to increase in Europe in the sixteenth century after a millennium of stagnation, and Russia waited two centuries to start improving.

Genetic diversity and development

What can explain the persistent differences in development acorss the world? While the dispersion of income has increase with the Industrial Revolution, it was already very high before that. Some have claimed that the timing of the transition for hunting and gathering to agriculture during the Neolithic Revolution is crucial, in other words the luck of geography is determinant. But maybe genes are more important.

This is what Oded Galor and Quamrul Ashraf claim. Specifically, they say that genetic diversity within a population can have important effects on the development of an economy. On the one hand, genetic diversity leads to lower social cohesion, and therefore mistrust and coordination failures, which leads to a depressed economy. On the other hand, genetic diversity allows to exploit complementarities and thus increase (faster) total factor productivity. Thus the impact of geeneti diversity is ambiguous.

The empirical analysis reveals that diversity is beneficial at low levels of diversity, and detrimental at high levels. This analysis was performed using expected heterozygosity at the ethnicity level: what is the likelihood that two random people form the same ethnicity would share genes. In this, distance from East Africa, following the migration patterns of early humans, proves particularly useful.

Looking at data for AD 1 to 1500, where economic development can be somewhat reliably be measured by population density (this was a Malthusian world after all), the authors claims that between 15% and 42% of economic development dispersion across the world can be explained by genetic diversity. Surely not negligible. And intriguing.

Patents and copyrights are an abomination

Over the past few days, I finally came around reading Michele Boldrin and David Levine's Against Intellectual Monopoly. I had read bits and pieces from the on-line version (still available) and followed their blog (see my blogroll in the sidebar), but reading it from cover to cover makes their case more convincing.

Essentially, the book challenges the conventional view that temporary monopolies like patents and copyrights are necessary for innovation. This is the mantra you hear everywhere: if there weren't patents on drugs, the pharmaceutical companies would never be able to recoup their investment in research, their stratospheric returns on investment notwithstanding. Or that without copyright, artists cannot make a living.

Boldrin and Levine show plenty of examples that demonstrate that it is possible to make an absolutely decent living without monopoly protection. For example, the early US book industry did not have copyright protection, yet publishers and authors were make more profits than in Britain, where protection pushed prices up and print runs down. US printers, however, flooded the market with cheap books and thus contributed to the increase in literacy.

This brings me to the fact that monopoly is rarely good for social welfare. The book goes through numerous instances where patents actually inhibit progress by preventing innovations based on a current patent. Also, they have been many example where an industry expanded greatly while it was free from patents, but once some big players started feeling threatened by new innovators, they pushed Congress to extend the coverage of patent laws, and innovation and expansion comes to a standstill.

This is a great book. I bought a copy, but you did not need to, as it is not copyrighted and available for free download. But I guess I contributed to demonstrate that you can make a buck without copyright, and the authors deserve to be rewarded.