In his book, "The moral consequences of economic growth", Benjamin Friedman argues persuasively that economic growth has important spill-over benefits – movement towards more openness, tolerance, mobility, fairness and democracy. Arguably, these consequences are all consistent with development of institutions – rules of the game – that would encourage further economic growth. So why has economic growth been interrupted by periods of economic stagnation?
Friedman doesn’t address this question in his book. It might be unreasonable to expected him to do so - the book is highly ambitious as it stands. As I read the accounts of stagnation during the 1970s and 1980s, however, I could not help thinking that this stagnation was at least in part a consequence of the way governments had responded to the preceding period of economic growth during the 1950s and 1960s.
I found myself thinking that the book could have been better if the author had spent more time discussing the ideas of Joseph Schumpeter – in particular, Kondratieff cycles. Building on these ideas, and those of Mancur Olson, Wolfgang Kasper has suggested that contradictions and obstacles tend to build up in fast-growing economies after a generation of accelerated growth (“Building Prosperity”, The Centre for Independent Studies, 2000, pp 6-11). These obstacles can include bottlenecks in supply of raw materials and labour (a decrease in elasticity of supply) and increased use of market power to squeeze profits. If monetary policy is used to expand demand, the result is little real growth and much inflation. As growth stalls, the prevalent social mood shifts from can-do optimism to defence of existing positions. Politicians increasingly side with established interest groups against emerging competitors.
According to this Kondratieff – Schumpeter – Kasper cycle theory, downturns eventually become periods of rejuvenation in which past economic difficulties trigger economic reforms that make institutions more market-friendly. Periods of accelerated growth are triggered by low and stable real interest rates, secure supplies of raw materials at relatively low prices and a low degree of industrial relations conflict. This enables investors to plan ahead and anticipate strong profitability.
I think it is important to make the point that there is nothing inevitable about these long cycles. It is possible for a country to remain stuck in a downturn, or even to go into secular decline, while the rest of the world returns to prosperity. It is possible for a country to avoid the worst consequences of a period of stagnation in the world economy if it maintains a set of institutions that enable it to adjust quickly to the changed environment. It may also be possible for the world economy to grow indefinitely if leading economies can avoid the contradictions and obstacles that would otherwise lead to recession.
Finally, I think it is also important to note that in some countries the contradictions that lead to prolonged recession may have more to do with attitudes encouraged by governments and central banks than with specific government interventions (eg regulations or taxes). For example, the lax responses of central banks to inflationary pressures in the 1960s conditioned people to expect that increases in inflation (such as those resulting from oil price shocks) would tend to persist. Thus the economic stagnation experienced in the 1970s may be attributed, in part, to contradiction between the expectations of the public that increases in inflation would persist and the lower inflation outcomes that restrictive monetary policies were intended to produce. (See: Athanasios Orphanides and John Williams, ‘Imperfect knowledge, inflation expectations and monetary policy, 2002.)
During the 1960s it was commonly believed that governments could sustain economic growth at close to full employment – all that was required was political will and the judicious use of monetary and fiscal policies. These unrealistic expectations were shown to be unsustainable when it became necessary for economies to adjust to increases in energy prices in the early 1970s and early 1980s. Let us hope that faith in governments never again returns to the levels experienced in many countries during the 1960s.
Thursday, April 24, 2008
Were average incomes in Australia far behind those in Britain a century ago?
In his book, “The moral consequences of economic growth”, Benjamin Friedman claims:
“A century ago, Britain enjoyed the highest per capita income in the world, while southern European countries like Italy and Spain were far behind, as were distant parts of Britain’s own empire like Canada and Australia” (p300).
It is not clear where Friedman obtained his information about Australia, but it is almost certainly wrong. By most accounts, Australia had the highest per capita income in the world during the late 19th century. Research suggests that in the early years of the 20th century Australia’s per capita income was still at least on par with that in Britain, if not still slightly ahead. One set of estimates suggests that Australia’s per capita income was 2.8 percent higher than Britain’s in 1901 and 16.3 percent higher in 1911. Another set of estimates suggests that Australia’s per capita income was 11.2 percent higher than Britain’s in 1901 and 3.9 percent higher in 1911. (See: Stephen Broadberry and Douglas Irwin, ‘Lost exceptionalism? Comparative income and productivity in Australia and the UK, 1861-1948’, The Economic Record, September 2007.)
Why does it matter whether or not average income in Australia was as high as that in Britain a century ago? If this was just about past glory it seems to me that it would just be a suitable topic for discussion at the local pub. It would matter no more than, say, the relative merits of warm and cold beer, or the relative merits of cricket pitches in England and Australia.
The reason why it should matter to Australians whether our per capital income was as high as Britain’s a century ago is because this is the base from which we assess the performance of the Australian economy during the 20th century. If Friedman was correct, then Australia’s relative economic performance during the 20th century would not look so bad. In reality, however, Australia’s economic performance throughout most of the 20th century was just about as pathetic as that of Britain. In my view the relatively poor economic performance of both countries, compared to the United States, can be attributed largely to economic policy failures.
“A century ago, Britain enjoyed the highest per capita income in the world, while southern European countries like Italy and Spain were far behind, as were distant parts of Britain’s own empire like Canada and Australia” (p300).
It is not clear where Friedman obtained his information about Australia, but it is almost certainly wrong. By most accounts, Australia had the highest per capita income in the world during the late 19th century. Research suggests that in the early years of the 20th century Australia’s per capita income was still at least on par with that in Britain, if not still slightly ahead. One set of estimates suggests that Australia’s per capita income was 2.8 percent higher than Britain’s in 1901 and 16.3 percent higher in 1911. Another set of estimates suggests that Australia’s per capita income was 11.2 percent higher than Britain’s in 1901 and 3.9 percent higher in 1911. (See: Stephen Broadberry and Douglas Irwin, ‘Lost exceptionalism? Comparative income and productivity in Australia and the UK, 1861-1948’, The Economic Record, September 2007.)
Why does it matter whether or not average income in Australia was as high as that in Britain a century ago? If this was just about past glory it seems to me that it would just be a suitable topic for discussion at the local pub. It would matter no more than, say, the relative merits of warm and cold beer, or the relative merits of cricket pitches in England and Australia.
The reason why it should matter to Australians whether our per capital income was as high as Britain’s a century ago is because this is the base from which we assess the performance of the Australian economy during the 20th century. If Friedman was correct, then Australia’s relative economic performance during the 20th century would not look so bad. In reality, however, Australia’s economic performance throughout most of the 20th century was just about as pathetic as that of Britain. In my view the relatively poor economic performance of both countries, compared to the United States, can be attributed largely to economic policy failures.
Does inner freedom link liberty with flourishing?
Dan Gilbert claims that “human beings come into the world with a passion for control, they go out of the world the same way, and research suggests that if they lose their ability to control things at any point between their entrance and their exit, they become unhappy, helpless, hopeless and depressed” (“Stumbling on happiness”, 2007, p 22).
As an economist I rarely feel entirely sure how much credence can be placed on strong claims made by psychologists. The problem is not with psychologists. Their knowledge of psychology might even make them less prone than, say, economists or climate scientists to let their enthusiasm run away with them when propounding their pet theories. It is just a problem of asymmetric information – scientists who are selling ideas related to their areas of expertise know a lot more about the strength and weakness of those ideas than do potential buyers of those ideas.
In this instance, however, I feel that a lot of credence can be placed on Dan Gilbert’s claim, not least because he backs it up with a reference to Martin Seligman’s path-breaking work on helplessness in the 1970s. This research has been tested extensively in the intervening years.
So, if humans have a passion for control of their own lives (or inner freedom) it seems to me that this raises a series of questions that are relevant to the purpose of this blog.
1. Is self-direction necessary for happiness? This question has already been addressed at two levels in this blog. First, at a philosophical level, it has been discussed in terms of Aristotelian views - ancient and modern - of about the nature of human flourishing as an inherently self-directed process (here). Second, at a more pragmatic level, it has been discussed in terms of the research undertaken by Edward Deci and Richard Ryan that indicates that human flourishing depends on the extent to which people satisfy a need for autonomy as well as a need to feel competent and connected to others (here).
More recent research by Alan Waterman and others suggests that requiring the performance of an activity previously associated with the feeling of eudemonia – developing one’s unique individual potentials and furthering one’s purposes in living – “may have the effect of moving it from the category for which both hedonic enjoyment and eudaimonia are present to the category for which neither is present” (‘The implications of two conceptions of happiness ...’, Journal of Happiness Studies, 2008).
However, it seems to me to be consistent with self-direction that people voluntary submit to various requirements because they feel that some short-term sacrifice is worthwhile in order to achieve greater happiness later. For example, people submit to examinations in the process of skill development - knowing that this will take some of the joy out of learning. From an economic perspective such sacrifices are what investment is about.
2. Is liberty necessary for human flourishing? Some people view human flourishing as a communal effort that does not leave individuals much if any room for self-direction. I think that view is mistaken, but I am prepared to live and let live provided the people who hold that view are willing to reciprocate. I agree with Douglass Rasmussen and Douglas Den Uyl that if people are to be allowed to flourish to the maximum extent possible without infringing on the flourishing of others, then we need a political/ legal order that will not favour some varieties of human flourishing above others (see here).
3. Is freedom a sufficient condition for happiness? Some people may not flourish under freedom simply because they lack the minimal resources that are necessary. This opens up questions about how such people might be helped (see here).
Learned helplessness can also be a problem. In Seligman’s original experiments some dogs were subjected to conditions under which they were unable to escape electric shocks no matter what they did. Some of these poor animals "learned" to be helpless because after changes were made so that they could easily escape shocks by jumping over a low partition, they didn’t even try. Even though they were free to escape the shocks, they just lay down passively and whined. (The experiment is described here.)
I propose to consider the following additional questions at some stage in the future:
- How closely is inner freedom correlated with life satisfaction?
- Is inner freedom correlated with external freedom as measured in indexes of economic freedom?
- Is inner freedom correlated with income and other economic variables?
Wednesday, April 23, 2008
How much do ideas matter?
In recent posts I have been discussing whether there is a tendency for people to be more tolerant in periods of economic growth than during periods of stagnation. In his book, The moral consequences of economic growth, Benjamin Friedman argues that when the economic pie is growing, people are happy that they are getting more than in the past and are less concerned about whether the slice they are getting is larger or smaller than that of other people.
Another way of thinking about this is in terms of perceptions about the nature of the economic game. The economic game can usually be thought of as a game of mutually beneficial exchanges in which everyone is a winner. However if individuals think that they can only win by taking from other people then they think they are playing a zero sum game (total gains minus losses equal zero). If large numbers of people think that way, the economic game actually becomes negative sum because there are costs involved in the redistribution process (including costs in lobbying governments to redistribute wealth or to defend the existing distribution).
In a growing economy people are more likely to perceive that they are involved in a positive sum game – gains clearly exceed losses and everyone has a better chance of being a winner. The opposite is true in a declining economy.
However, I think that ideas (or ideologies) often matter more than economic circumstances in determining perceptions about the nature of the economic game. I will give three examples.
First, it would be hard to think of anything more like a zero sum game than a gold rush. There is a limited amount of gold to be found. If one person is lucky enough to find some, that means that there is less gold available for others. As a result, mining camps could be expected to be unruly places with a great deal of dispute over mining claims (property rights). In fact, however, observers of the mining camps at the time of the Australian gold rushes of the 1850s were surprised at the order maintained and the capacity for spontaneous organisation shown by the miners, who came from many different countries. In many camps order seems to have been maintained through the miners’ own efforts to ensure compliance to informal codes of conduct rather than through a permanent police presence. (See Edward Shann, “An economic history of Australia”, 1930, p 171.)
Second, export booms in Australia have in the past often been characterised by increased conflict over distribution of national income, even though they offered the prospect of widely-shared benefits through stronger economic growth. The prevailing ideology, from early in the 20th century until the mid-1980s, was that the wage fixing system – combining a centralised system for setting minimum wages and a system of pattern bargaining where wage increases in one industry quickly spread to others – should be used to distribute the benefits of prosperity being experienced in export industries. This led to a great deal of industrial conflict, higher inflationary expectations and higher unemployment.
Third, the difference in response to the 1930s depression in Germany and other industrialised countries seems to be largely attributable to differences in prevailing ideas or ideologies. The discontents of the1930s provided fertile grounds for radical ideas (including Keynesian ideas which weakened resistance to budget deficits and monetary expansion) in all industrialised countries, but in Germany the idea that the world was a dog eat dog kind of place had gained considerable academic respectability prior to the depression and the rise of national socialism. These ideas were evident, for example, in Werner Sombart’s identification of Jews with the elements of capitalism that he most despised – the calculative search for advantage that led to dissolution of the traditional way of life of the Volk. (See: Jerry Muller, The mind and the market, 2002, pp 253-255.) Another influential example was Hans Freyer’s view that individuals acquire a sense of meaning and purpose only from the particular culture of the Volk of which they were a part and that the state exists to assert the interests of the Volk through struggle against external threats (Muller, pp 276-287). Even though Hitler declared himself to be anti-intellectual, national socialism was widely supported within German universities.
The social consequences that follow from economic events depend to a huge extent on prevailing ideas about what those events mean.
Another way of thinking about this is in terms of perceptions about the nature of the economic game. The economic game can usually be thought of as a game of mutually beneficial exchanges in which everyone is a winner. However if individuals think that they can only win by taking from other people then they think they are playing a zero sum game (total gains minus losses equal zero). If large numbers of people think that way, the economic game actually becomes negative sum because there are costs involved in the redistribution process (including costs in lobbying governments to redistribute wealth or to defend the existing distribution).
In a growing economy people are more likely to perceive that they are involved in a positive sum game – gains clearly exceed losses and everyone has a better chance of being a winner. The opposite is true in a declining economy.
However, I think that ideas (or ideologies) often matter more than economic circumstances in determining perceptions about the nature of the economic game. I will give three examples.
First, it would be hard to think of anything more like a zero sum game than a gold rush. There is a limited amount of gold to be found. If one person is lucky enough to find some, that means that there is less gold available for others. As a result, mining camps could be expected to be unruly places with a great deal of dispute over mining claims (property rights). In fact, however, observers of the mining camps at the time of the Australian gold rushes of the 1850s were surprised at the order maintained and the capacity for spontaneous organisation shown by the miners, who came from many different countries. In many camps order seems to have been maintained through the miners’ own efforts to ensure compliance to informal codes of conduct rather than through a permanent police presence. (See Edward Shann, “An economic history of Australia”, 1930, p 171.)
Second, export booms in Australia have in the past often been characterised by increased conflict over distribution of national income, even though they offered the prospect of widely-shared benefits through stronger economic growth. The prevailing ideology, from early in the 20th century until the mid-1980s, was that the wage fixing system – combining a centralised system for setting minimum wages and a system of pattern bargaining where wage increases in one industry quickly spread to others – should be used to distribute the benefits of prosperity being experienced in export industries. This led to a great deal of industrial conflict, higher inflationary expectations and higher unemployment.
Third, the difference in response to the 1930s depression in Germany and other industrialised countries seems to be largely attributable to differences in prevailing ideas or ideologies. The discontents of the1930s provided fertile grounds for radical ideas (including Keynesian ideas which weakened resistance to budget deficits and monetary expansion) in all industrialised countries, but in Germany the idea that the world was a dog eat dog kind of place had gained considerable academic respectability prior to the depression and the rise of national socialism. These ideas were evident, for example, in Werner Sombart’s identification of Jews with the elements of capitalism that he most despised – the calculative search for advantage that led to dissolution of the traditional way of life of the Volk. (See: Jerry Muller, The mind and the market, 2002, pp 253-255.) Another influential example was Hans Freyer’s view that individuals acquire a sense of meaning and purpose only from the particular culture of the Volk of which they were a part and that the state exists to assert the interests of the Volk through struggle against external threats (Muller, pp 276-287). Even though Hitler declared himself to be anti-intellectual, national socialism was widely supported within German universities.
The social consequences that follow from economic events depend to a huge extent on prevailing ideas about what those events mean.
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