Economist's View: Krugman: Two Cheers for Formalism in Economics

Continuing the conversation on methodology in economics recently in Neoclassical Theory under Fire from the Sciences, followed up with David Altig Deflates Ball, a conversation in which many of you expressed doubt about the usefulness of formal economic models, here's Paul Krugman with rebuttal to your arguments:

Two Cheers for Formalism, by Paul Krugman: Attacks on the excessive formalism of economics - on its reliance on abstract models, on its use of too much mathematics - have been a constant for the past 150 years. Some of those attacks have come from knowledgeable insiders - from the likes of McCloskey (1997) or even Marshall. More often, however, the attacks have come from outsiders - from journalists, political crusaders, and so on.

In this essay I want to make three points. First, much of the criticism of formalism in economics is an attack on a straw man: the reality of what good economists do is a lot less formalistic than the popular image. Bad economists, of course, do bad economics; but one should not confuse a complaint about quality with a complaint about methodology. Second, when outsiders criticize formalism in economics, their real complaint is often not about method but about content - in particular, they dislike "formalistic" arguments not because they are formalistic, but because they refute their pet doctrines. Finally, as a practical matter formalism is crucial to progress in economic thought - even when it turns out that the ideas initially developed with the help of formal analysis can in the end, with some work, be expressed in plain English. Moreover, this is especially true precisely in the sorts of areas that economists are often accused of neglecting, such as those that involve imperfect competition, incomplete rationality, and so on.

1. What do economists do?

A few years ago a more or less typical article about the plight of economics (Parker 1993) criticized economists for "their deductive method, their formalism, their over-reliance on arcane algebra, their imperviousness to complex evidence", and repeatedly charged the field both with an excessive faith in free markets and with irrelevance. These accusations are standard. But are they really the way economics is? Do they really describe the way economists do economics?

Clearly each piece of this critique describes at least some economists. There are economists who rely on a "deductive method" - although if this is supposed to mean deriving everything from predetermined axioms rather than building models suggested by real-world observations, it actually describes only a handful of practitioners. "Formalism" could mean many things; so let's hold off on that one. "Over-reliance on arcane algebra" - well, there is certainly a lot of algebra in economics, and some of it is surely excessive. "Imperviousness to complex evidence" - actually, that is probably dead wrong. The real problem with the parts of economics that I personally believe have gone off the rails, such as much of business cycle theory, is imperviousness to simple evidence. But that, as we will see, is by no means a problem unique to mainstream economists.

But while some economists must fit each of this descriptions, do many leading economists fit all of them? And is irrelevance a major problem with contemporary economics?

Here is a simple reality check. The American Economic Association's John Bates Clark Medal is a highly coveted award; it is therefore an indicator of what the profession values. And because it must be given to an economist under 40, it reflects research undertaken fairly recently. So what do we learn about the values of the profession - the sorts of work that command the highest rewards - by looking at, say, the last ten Clark Medalists? Here is the list: 1979, A. Michael Spence; 1981, Joseph Stiglitz; 1983, James Heckman; 1985, Jerry Hausman; 1987, Sanford Grossman; 1989, David Kreps; 1991, yours truly; 1993, Lawrence Summers; 1995, David Card; 1997, Kevin Murphy. In short: two middlebrow theorists whose work on imperfect markets has had major impact both on policy and on corporate strategy; two econometricians whose techniques are widely used in practical applications; two theorists who specialized on issues of information and uncertainty; a trade theorist who focussed on increasing returns and imperfect competition; a macroeconomist with a strong empirical and policy bent; and two very empirically-oriented labor economists. Not one of these economists has worked mainly on perfectly competitive markets, or is a free-market ideologue. And as far as relevance goes, notice that in their subsequent careers some members of the group have found that businesses and governments are willing to pay large sums for work based on their earlier research; one became Chairman of the Council of Economic Advisers, while another is now a very powerful Deputy Treasury Secretary; and one has been known to write reasonably successfully for non-economists. So where in this group is the excessive formalism, the excessive reliance on the deductive method, of which economists are routinely accused?

You may answer that while the very best economists may be free of the sins for which the profession is criticized, things are different once one goes down the scale. But take any of the fields in which one of the lucky 10 works, and try listing 5 or 10 other successful economists in the same area. How many of them are engaged in arcane algebra that has no relationship to reality? (Some of them, like auction theorists or finance theorists, are indeed engaged in arcane algebra - but it turns out to be very relevant indeed). I have not done this exercise, but I would guess that if one took the 100 economists most cited in the Social Science Citation Index and summarized the nature of their work, it would turn out to be mostly focussed either on real-world problems, or on techniques that other economists have found very useful in addressing real-world problems. So where does the picture of economists as a tribe engaged in pointless, abstract mathematical games come from?

Perhaps the picture is based on the fact that most economists do not do first-rate research, and that there is a lot of irrelevant mathematical modeling out there. But in what academic field do most people do first-rate research? And if someone is doing work that will not be read or cited, does it matter whether it is boring literary work (as in many humanities), boring experimental work (as in many physical sciences), or boring mathematical modeling?

One can make a good case that the intellectual level of economics is not as high as it should be, given the importance of the subject. But that is a complaint about quality, not formalism. What, then, leads to such angry charges of excessive formalism?

2. Why outsiders dislike economic "formalism"

In 1997 the editor of Governing magazine published an op-ed attacking the economics profession for denying the obvious fact that globalization was having devastating effects on the economy (Ehrenhalt 1997). As an example of just how bad economists are, he quoted an unnamed "prominent economist" (the reference was actually to Krugman 1996), who had written that "there are ... important ideas in economics that are crystal clear if you can stand algebra, and very difficult to grasp if you can't". This, according to the op-ed writer, was an "insult", a "charge of illiteracy"; he went on to assert that algebra could not be essential to economic understanding, because if it were this would delegitimize the opinions of people who had not studied algebra when young and were now too old to retool.

It hardly gets clearer than this. Many, indeed probably most, of the non-economists who attack the field's formalism do so not because that formalism makes the field irrelevant, but on the contrary because economists insist that their equations actually do say something about the real world. And since the critic's view conflicts with what the equations say, this whole business of using mathematics to think about economics must be a bad thing.

What sort of equations are we talking about here? Well, how about the equation that says that the sum of a nation's capital account and current account is zero?

This is not meant to be a joke. While a number of issues motivate outsider critics of the economics profession, surely the most prominent and emotional involves concerns about the impact of globalization. Many people (like the op-ed writer cited above) who regard themselves as knowledgeable about economic affairs are convinced that growing international trade and investment are bad things for workers everywhere. The typical story - as found, for example, in the 1994 World Competitiveness Report (World Economic Forum 1994) or in Greider (1997a) - goes like this: Multinational corporations and other investors are massively relocating capital to low-wage countries, undermining traditional employment in the advanced countries. Meanwhile, hopes that these newly industrializing economies will provide export opportunities and thus alternative jobs for the displaced workers are a mirage: wages and hence purchasing power in these countries will remain low, both because of the sheer size of their labor forces and because they need to keep wages low to attract a continuing inflow of capital. Thus workers in the Third World will see no benefit from the process - their economies will achieve high productivity while continuing to pay low wages - while those in advanced countries will find their position undermined both by trade deficits and by capital outflows.

What is wrong with this story? Economists quickly notice that it violates the equation that says that current account plus capital account equals zero. It cannot be true that newly industrializing economies are or will be the recipients of large capital inflows and at the same time export much more than they are importing. And once one tries to fix this aspect of the story, the whole thing falls apart. In particular, suppose that one decides that newly industrializing economies will, in fact, attract large capital inflows. Then one must conclude that they will run current account and probably trade deficits rather than surpluses. But how can they run trade deficits when their productivity rises but their wages remain low? Doesn't this cost advantage ensure a trade surplus? Well, something must be wrong with the premise; perhaps wages will not remain low after all.

One can immediately see the reason why people hate economists. Here is a compelling, powerful story about the world economy, one that dovetails with the political agenda of those who tell it, and is a clear call to action. Yet economists insist that the story is literally nonsense - that it is, in the physicist Wolfgang Pauli's phrase, "not even wrong" - because of an abstract equation. Here, surely, is a prime example of how formalism makes economists impervious to the evidence.

The trouble is that the economists are right. The popular story is literally nonsense: that crucial equation is not some abstract theory, it is a simple accounting identity - and there is no way to save the story while getting the accounting right. Moreover, the facts fit the economist's story quite well. Most newly industrializing economies run trade and current account deficits, not surpluses: of the 25 "emerging market" economies listed at the back of The Economist, 17 were running trade deficits when this essay was written, 20 current account deficits. And wages in rapidly industrializing economies have not stayed low, they have risen sharply: the U.S. Labor Department's index of compensation in newly industrializing Asia rose from 8 percent of the US level in 1975 to 32 percent in 1995. (Incidentally, the response of opponents of globalization when these facts were pointed out helps put their charge that economists are "impervious to complex evidence" in perspective. Greider (1997b), offered an opportunity to rebut questions about his thesis, simply ignored the contrary evidence and repeated his original assertions without alteration. And other critics of conventional economic views about globalization, like the Economic Policy Institute, did not disavow Greider or express regret that he had failed to check his facts; they leapt to his defense, attempting to rationalize his claims).

This is not an incidental or unusual example. The refusal of economists to accept the popular indictment of globalization is, to repeat, the most important reason for attacks on the profession in recent years. Indeed, that op-ed was probably motivated specifically by the negative reviews Greider's book had received from economists. And thus this story helps reveal what the outsider critics really mean by their critique. By "formalism" they do not mean differential topology or fixed-point theorems: they mean annoying insistence on adding-up constraints, or such abstruse arguments as the assertion that partial equilibrium reasoning (increased productivity in a given industry may well lower employment in that same industry) does not always carry over to general equilibrium (increased productivity in the economy as a whole is much less likely to reduce employment in the economy as a whole).

A final point on the outsider critics: economists rarely listen seriously to what these critics are actually saying. The normal impulse is to assume that complaints from outsiders are simply a stronger version of the sorts of things economists criticize in each other. An economist like Rodrik (1997), whose argument that the adverse effects of globalization are larger than most of the rest of us believe has received enthusiastic approbation from critics of economics, seems himself to believe that someone like Greider is far out on the fringe of the debate, and not even worth arguing with. The truth, however, is that when critics attack formalism in economics what they really mean is the infuriating insistence of economists that they mind their arithmetic; and the reason they like Rodrik's work is precisely that they believe that it validates the ideas of people like Greider.

3. Was Marshall right?

McCloskey (1997) has recently make an eloquent appeal for a return to a "Marshallian" style of economic discourse: a style based on verbal, intuitive exposition rather than formal modeling. Marshall (quoted in Sills and Merton 1991, p. 151) himself, of course, famously described his method:

(1) Use mathematics as a shorthand language, rather than as an engine of inquiry. (2) Keep to them till you have done. (3) Translate into English. (4) Then illustrate by examples that are important in real life. (5) Burn the mathematics. (6) If you can't succeed in 4, burn 3.

Was he right? Marshall's dictum can usefully be divided into two parts: how one should arrive at an economic idea, and how one should communicate it.

Should one use mathematics as an "engine of inquiry"? This is actually an ambiguous phrase. It might mean getting one's ideas entirely from mathematical logic; if so, that is a practice very few economists engage in. What is true, however, is that many economists use mathematics not merely as a way to check the internal consistency of their ideas, but as an "intuition pump"; they start with a vaguely formulated idea, try to build a model that conveys that idea, and allow the developing model in turn to alter their intuitions. One way to interpret what Marshall was saying, then, is that one should avoid this process - one should use mathematics only to check intuitions, never to help develop them.

What was Marshall thinking of when he said this (if that was what he meant to say)? Probably he had in mind his own youthful explorations of general-equilibrium trade theory, and in particular his development of the offer-curve technique for analyzing the determination of the terms of trade. (Irwin 1996, pp. 110-111 describes Marshall's ambivalence regarding his own creation). Offer-curve analysis, it turned out, forces one to a conclusion that the modeler might not have expected or wanted: a large country, with the ability to affect world prices, can always raise its real income by imposing a small tariff. Marshall's sense was that this conclusion, however much it might be a necessary consequence of the mathematical logic, was wrong or at least unimportant as a practical matter, and presumably this experience was what led him to conclude that one should only use math to check conclusions, not to arrive at them.

And yet general-equilibrium trade analysis is one of those areas in which models are a crucial aid to intuition. Consider once again the questions posed by the rise of newly industrializing economies. The common perception of most people who think about the issue at all is that the emergence of new competitors must surely reduce real incomes in the established economies - indeed, that this has already happened. On the other hand, some business enthusiasts are quite sure that the expansion of world markets will bring vast prosperity to everyone. Thanks to the models of Hicks (1953) and especially Johnson (1955) well-trained economists eventually learn why both intuitions are deeply wrong. Growth in other countries can either help or hurt us: it depends on the effect on our terms of trade, an effect that in turn depends on the bias of that growth. (And as a quantitative, empirical matter the overall effects are very small, both because North-South trade is a small share of Northern income and because there have not been large movements in the terms of trade). This position can eventually be made to seem intuitive, but it would have been very hard to arrive at without the aid of models - in particular, without the aid of Marshall's offer-curve construction.

This is not an isolated example. It is crucially important in itself, and it is also representative. Most of the topics on which economists hold views that are both different from "common sense" and unambiguously closer to the truth than popular beliefs involve some form of adding-up constraint, indirect chain of causation, feedback effect, etc.. Why can economists keep such things straight when even highly intelligent non-economists cannot? Because they have used mathematical models to help focus and form their intuition.

Of course, this gain in intuition sometimes comes at a cost: the modeler can become a prisoner of the assumptions embodied in his model. One often hears accusations, in particular, that model-based economics inevitably biases the field toward standard economic assumptions like constant returns, perfect competition, and perfect information. Yet this need not be true. In fact, economists like myself (and many of the others on that list of Clark winners) who have worked at length on imperfect markets have found modeling an essential discipline in the process of exploring new territory.

Trade theory is again a case in point. By the late 1970s there had been decades of discontent with conventional trade theory - discontent often manifested by complaints that conventional theory neglected increasing returns and imperfect competition. Many manifestos denouncing the conventional views had been published. Yet in all that literature of discontent it is hard to find any clear, let alone useful ideas. Only when the "new trade theory" began to emerge, driven by mathematical models that both embodied and shaped intuition, did compelling new ways of looking at international trade actually take shape.

Still, while it may be a good idea to use mathematical models to help develop one's ideas, shouldn't one then follow Marshall's precepts in communicating those ideas? The answer, surely, is that it depends on the audience. Marshall's advice is exactly appropriate when an economist is writing for an intelligent, literate audience of non-economists - such as, say, the readers of Foreign Affairs or Slate. To reach such an audience, to help them get a grasp of some important economic point (like the reasons why economic growth in Asia is not a disaster for the West), it is essential to find a way to express the crucial ideas without the formal apparatus. Nor is this a demeaning exercise: on the contrary, finding a way to convey good economic reasoning without the usual equations and jargon can be both a valuable discipline and an exhilarating experience. And even professional economists, especially those who specialize in different areas, can find non-technical expositions of economic concepts very useful.

But professional economists also have another task: to communicate with each other, and in so doing to help economics as a discipline progress. In this task it is important for your colleagues (and students) to understand how you arrived at your conclusions, partly so that they can look for weak points, partly so that they may find other uses for the technical tricks you used to think an issue through. I like to think that I can manage to explain international economic concepts pretty convincingly to a broader public without ever drawing an offer curve; I can give a pretty good account of the "home market effect" on trade patterns without ever mentioning Dixit-Stiglitz monopolistic competition and iceberg transport costs. However, I would be doing my graduate students a grave disservice if I never taught them offer curves and Dixit-Stiglitz-iceberg trade models: the point of their education is to learn methods, not answers. And publication in professional journals is or at least should be a form of education: it is how economists teach each other about their work. Tjalling Koopmans (1957) once complained about Marshall's "diplomatic style" - his emphasis on persuasion, his mingling of theory and evidence, his willingness to sweep awkward points under the rug. I am a great admirer of Marshall, yet Koopmans had a point. Marshall's style - the style some insider critics think we need to recapture - was entirely appropriate for a general audience, even a highly educated and intellectual one. But Marshall adopted the same style when writing for economists and their students. To do so is in effect to turn professional economics into the repetition of received truths rather than a continual process of exploration. Indeed, one can do no better on this than to quote Marshall again:

"Economic doctrine ... is not a body of concrete truth, but an engine for the discovery of concrete truth ..." (quoted in Sills and Merton, p. 150).

How are students and colleagues supposed to learn how to use this engine if you burn the evidence of the engine at work?

What, then, is left of the accusation of excessive formalism in economics? Perhaps the moral should be that there are not enough economists doing what Marshall did: writing economics in a way that makes it accessible and persuasive to a broader, though hardly mass, audience. I have spoken of the style appropriate for publications like Foreign Affairs; yet this is very nearly an abstract speculation. How many good economists actually do write carefully constructed, well-targeted articles, based on serious economic analysis, for a wider audience? I believe that the number in the United States can be counted on the fingers of one hand. This is absurdly low given both the size of the profession and the stakes involved: such articles, together with non-technical books aimed at a broader audience, can sometimes exert a startling influence on public discussion and even on policy. Yet for the most part good economists have simply abandoned this kind of writing, leaving the field wide open for the sort of person who hates economists because they insist that his arguments add up.

Here, then, is a revised version of Marshall's rules:

(1) Figure out what you think about an issue, working back and forth among verbal intuition, evidence, and as much math as you need. (2) Stay with it till you are done. (3) Publish the intuition, the math, and the evidence - all three - in an economics journal. (4) But also try to find a way of expressing the idea without the formal apparatus. (5) If you can, publish that where it can do the world some good.

In short, two cheers for formalism - but reserve the third for sophisticated informality.

REFERENCES

Ehrenhalt, A. (1997), "Keepers of the dismal faith", The New York Times, Feb. 23.

Greider, W. (1997a), One World, Ready or Not: The Manic Logic of Global Capitalism, New York: Simon and Schuster.

Greider, W. (1997b), "When optimism meets overcapacity", The New York Times, Oct. 13.

Hicks, J.R. (1953), "The long-run dollar problem", Oxford Economic Papers 2:117-135.

Irwin, D. (1996), Against theTide: An Intellectual History of Free Trade, Princeton University Press.

Johnson, H. (1955), "Economic expansion and international trade", Manchester School of Social and Economic Studies 23:95-112.

Koopmans, T. (1957), Three Essays on the State of Economic Science, New York:McGraw-Hill.

Krugman, P. (1996), "Economic culture wars", Slate, Oct. 24.

McCloskey, D. (1997), The Vices of Economics: The Virtues of the Bourgeoisie, Amsterdam University Press.

Parker, R. (1993), "Can economists save economics?", The American Prospect, 13.

Rodrik, D. (1997) Has Globalization Gone too Far?, Washington: Institute for International Economics.

Sills, D. and Merton, R. (1991), International Encyclopedia of the Social Sciences, vol. 19 (Social Science Quotations), New York: Macmillan.

World Economic Forum (1994), The World Competitiveness Report 1994.

Economist's View: Shiller: The Rising Wealth of Nations

Robert Shiller has an optimistic outlook for worldwide GDP growth in coming decades:

The rising wealth of nations, by Robert J. Shiller, Project Syndicate: The new Penn World Table, Version 6.2, comparing standards of living across countries, has just been released. The ... numbers are valuable because they are of exceptional quality and they correct systematically for relative price differences across countries, which sometimes leads to surprising results.

Among the 82 countries for which 2004 data are now available, there is good news: Real per capita gross domestic product rose by an average of 18.9 percent between 2000 and 2004, or 4.4 percent per year. ... At that rate, real per capita GDP will double every 16 years. ...

One surprise is that there was relatively little change in the ranking of countries by real per capita GDP after 2000. Despite all the talk about the Chinese economic miracle, China's ranking rose only slightly, from 61st (out of 82 countries in 2000) to 60th in 2004 -- even though per capita real GDP grew by ... 9.6 percent a year, the highest of the major countries.

The reason China did not rise higher is that other countries were growing too, and because the gaps between countries were enormous. ... The average real per capita GDP of the top 25 percent of countries is 15 times that of the bottom 25 percent. ...

China isn't the only success story. Other big winners in terms of real per capita GDP between 2000 and 2004 were Lithuania (up 48 percent), Romania (up 41 percent), Estonia (up 40 percent), Chile (up 33 percent), Hungary (up 32 percent), Greece (up 31 percent), New Zealand (up 28 percent), Australia (up 25 percent), South Korea (up 23 percent), Ireland (up 23 percent), South Africa (up 23 percent), and Nigeria (up 22 percent).

Some of the worst performers among the major countries were Israel (...with real per capita GDP up only 2 percent between 2000 and 2004) and Argentina (...up only 9 percent between 2000 and 2004).

Economic performance in several Latin American countries was relatively weak in this period... But the overall picture was amazingly good. If such growth rates continue, we will see relatively poor countries like India, Indonesia, the Philippines or Nicaragua reach the average levels currently enjoyed by advanced countries in 50 years. But, of course, they will not have caught up with these countries, for those countries will have moved ahead too.

It is hard to imagine now what that world will be like with a doubling or quadrupling of just about every country's GDP. What will all these countries do with all that money? ...

Real per capita GDP in the United States is now three times higher than it was in 1958. What have people been spending all that extra money on? Is it all dictated by advertisers and salesmen who are inventing needs?

According to my calculations comparing 1958 and 2005 data from the U.S. Department of Commerce, Americans spent 27 percent of the huge increase in income between 1958 and 2005 on medical care, 23 percent on their homes, 12 percent on transportation, 10 percent on recreation, and 9 percent on personal business activities.

The kinds of things that advertisers and salesmen typically promote were relatively unimportant. Food got only 8 percent of the extra money, clothing only 3 percent, and personal care 1 percent.

Unfortunately, idealistic activities also received little of the extra money: 3 percent for welfare and religious activities, and a similar share for education. Thus most of the extra money was spent on health, a nice home, travel and relaxation, and doing a little business.

Maybe that is the way it will be around the world. As long as we can keep worldwide growth going at its current rate, billions of people can look forward to the same kind of improvement. And that should be truly inspirational.

Brad DeLong's Semi-Daily Journal: Columbia Journalism School 701: Highly Advanced Journamalism

It turns out that Bree Nordenson's true beef with Paul Krugman is that Paul "fails to reveal [in his column] that during... [2000-2005] incomes dropped for [the median] household."

The idea that somebody could accuse Paul Krugman of being "partisan" for failing to reveal to his readers that median household incomes have fallen during the Bush administration... well, words really do fail me. That really doesn't pass the laugh test.

Funniest thing I have heard all month.

Here's what Bree Nordenson has to say, on the record. Not believing that she really wanted to call Krugman "partisan" and "slippery" for "fail[ing] to reveal" that median household incomes have fallen during the Bush dministration, I gave her a chance to amend it. She declined:

Dear Mr. DeLong:

Here is my response to be posted in its entirety (or not at all) on your blog (not simply the comments section):

Leaving aside the question of whether "typical" households can be characterized as "median" (rather than, say, "average" or "neighbors of Paul Krugman"), we stand by our conclusion that Mr. Krugman's statistic was cherry-picked and utterly unsupportive of his argument.

We wonder whether Professor DeLong's economics students would be permitted to look at the median personal income of college graduates in two separate years, chosen at random, and then present a paper suggesting that this data alone sheds light on the question of education's effect on income inequality. Mr. Krugman notes that the (median) real income of college graduates was lower in 2005, compared to 2000, and offers this as evidence that education does not improve income disparities. But he fails to reveal that during the same time frame, incomes dropped for all households, regardless of their level of education (see http://www.census.gov/prod/2006pubs/p60-231.pdf, p. 31). To determine whether a gap between the incomes of two groups has narrowed, one must know the incomes of both groups.

And unless the objective is merely to win the argument, rather than identify the truth, it is also necessary to test one's hypothesis against a range of years and other information. Krugman compares college graduates' incomes in 2000 and 2005, because that suits his ends. An entirely different picture emerges, however, if we compare the median incomes of college graduate in, say, 2004 to those in 2005. During that time frame, the number increases (after adjusting for inflation, of course).

Ideology passed off as science is the essence of demagoguery. An economist of Professor DeLong's stature should know this.

Sincerely,

Bree Nordenson
Assistant Editor, Columbia Journalism Review

Her boss Mark Mitchell, assistant managing editor of the Columbia Journalism Review, backs her up at the price of damage to his own reputation, and says that Paul Krugman is indeed culpable for suppressing knowledge that median incomes have fallen during the Bush administration (I think this is a fair summary quote from our conversation):

If you are talking about income inequality, you cannot just take the statistic of one group's income dropping over a period of time and not compare it to the other group's income. I am surprised that the Berkeley economics department cannot figure this out...

And--of course--never any attempt by Bree Nordenson (or anybody else) to talk to Paul Krugman or any labor economist about where the numbers were coming from, and whether they were reasonable.

Can there be any reaction other than "Wow. Look at the circular firing squad of flying journamalistic attack monkeys?"

Economist's View: The Debate over Inequality: "The Debate over Inequality

Well, me versus Samwick, Mankiw, and DeLong seems like a difficult match to win, but I am going to persist anyway. Stay the course so to speak (see also the Paul Krugman column that is at issue, an earlier post by Andrew Samwick, my response to Andrew, and a follow-up at Angry Bear). Each is objecting to Paul Krugman's claim that government policies may be able to change income inequality and that changes in political ideology may explain, in part, variations in income inequality over time.

I hope to have more to say later, but for now let me offer a bit of evidence from Australia through Andrew Leigh, and add a bit more on the US as well. First, here's Andrew Leigh:

Top Floor, Going Up, by Andrew Leigh: An updated version of my research with Tony Atkinson on top incomes is written up by John Garnaut in the SMH today. There’s not much there to surprise regular readers of tbis blog. But since it’s not every day that I crack the front page of the SMH, I thought I’d indulge in some shameless self-promotion.

Here's the abstract from the article. It's also written up in the Sydney Morning Herald as noted by Andrew:

ABSTRACT Using taxation statistics, we estimate the income share held by top income groups in Australia over the period 1921-2002. We find that the income share of the richest fell from the 1920s until the mid-1940s, rose briefly in the post-war decade, and then declined until the early-1980s. During the 1980s and 1990s, top income shares rose rapidly. At the start of the twenty-first century, the income share of the richest was higher than it had been at any point in the previous fifty years. Among top income groups, recent decades have also seen a rise in the share of top income accruing to the super-rich. Trends in top income shares are similar to those observed among other elite groups, such as judges, politicians, top bureaucrats and CEOs. We speculate that changes in top income shares may have been affected by top marginal tax rates, skill-biased technological change, social norms about inequality, and the internationalisation of the market for English-speaking CEOs.

Factors like top marginal income tax rates and social norms are connected to the political environment, but of course, this is in no way conclusive. A lot of the change is driven, according to their results, by the incomes of CEOs. But I think it's at least suggestive that the political environment drove some of the change.

For the US, as passed along to me in an email, factors such as the New Deal's very large tax increases on the wealthy, both directly on income and indirectly on corporate profits are an important factor connected to the political environment at the time. It's an open question how much of the change in inequality that might explain by itself.

Unions are also worth taking seriously with union membership nearly tripling to about a third of the workforce from the mid 1930s to the mid 1940s. This would affect all wages, not just those in sectors where unions are prevalent. The decline of unionization after the 70s is also a factor to consider, and there's a strong case to be made that this was made possible by a political environment that allowed union busting to occur. In any case, I don't think this is a settled question and I hope to follow up with more later.

Update: Please see Brad DeLong's excellent summary and follow-up on this debate.

"

Economist's View: Paul Krugman: Tax Farmers, Mercenaries and Viceroys: "Paul Krugman: Tax Farmers, Mercenaries and Viceroys

Back to a bad old future:

Tax Farmers, Mercenaries and Viceroys, by Paul Krugman, A Monarchy Commentary, NY Times: Yesterday The New York Times reported that the Internal Revenue Service would outsource collection of unpaid back taxes to private debt collectors, who would receive a share of the proceeds.

I

It’s an awful idea. Privatizing tax collection will cost far more than hiring additional I.R.S. agents, raise less revenue and pose obvious risks of abuse. But what’s really amazing is the extent to which this plan is a retreat from modern principles of government. I used to say that conservatives want to take us back to the 1920’s, but the Bush administration seemingly wants to go back to the 16th century.

And privatized tax collection is only part of the great march backward. In the bad old days, ...[t]here was no bureaucracy to collect taxes, so the king subcontracted the job to private “tax farmers,” who often engaged in extortion. There was no regular army, so the king hired mercenaries, who tended to wander off and pillage the nearest village. There was no regular system of administration, so the king assigned the task to favored courtiers, who tended to be corrupt, incompetent or both.

Modern governments solved these problems by creating a professional revenue department to collect taxes, a professional officer corps to enforce military discipline, and a professional civil service. But President Bush apparently doesn’t like these innovations, preferring to govern as if he were King Louis XII.

So the tax farmers are coming back, and the mercenaries already have. There are about 20,000 armed “security contractors” in Iraq, and they have been assigned critical tasks, from guarding top officials to training the Iraqi Army.

Like the mercenaries of old, today’s corporate mercenaries have discipline problems. “They shoot people, and someone else has to deal with the aftermath,” declared a U.S. officer... And armed men operating outside the military chain of command have caused at least one catastrophe. ...

To whom are such contractors accountable? Last week a judge threw out a jury’s $10 million verdict against Custer Battles, ... a symbol of the mix of cronyism, corruption and sheer amateurishness that doomed the Iraq adventure — and the judge didn’t challenge the jury’s finding that the company engaged in blatant fraud.

But he ruled that the civil fraud suit ... lacked a legal basis, because ... the Coalition Provisional Authority ... wasn’t “an instrumentality of the U.S. government.” It wasn’t created by an act of Congress; it wasn’t a branch of ... any ... established agency.

So what was it? Any premodern monarch would have recognized the arrangement: in effect, the authority was a personal fief run by a viceroy answering only to the ruler. And since the fief operated outside all the usual rules of government, the viceroy was free to hire a staff of political loyalists lacking any relevant qualifications for their jobs, and to hand out duffel bags filled with $100 bills to contractors with the right connections.

Tax farmers, mercenaries and viceroys: why does the Bush administration want to run a modern superpower as if it were a 16th-century monarchy? Maybe people who’ve spent their political careers denouncing government as the root of all evil can’t grasp the idea of governing well. Or maybe it’s cynical politics: privatization provides both an opportunity to evade accountability and a vast source of patronage.

But the price is enormous. This administration has thrown away centuries of lessons about how to make government work. No wonder it has failed at everything except fearmongering.

Deal Maker Details the Art of Greasing the Palm - New York Times

Deal Maker Details the Art of Greasing the Palm

By DAVID JOHNSTON and DAVID D. KIRKPATRICK

WASHINGTON — In 1992, Brent R. Wilkes rented a suite at the Hyatt Hotel a few blocks from the Capitol. In his briefcase was a stack of envelopes for a half-dozen congressmen, each packet containing up to $10,000 in checks.

Mr. Wilkes had set up separate meetings with the lawmakers hoping to win a government contract, and he planned to punctuate each pitch with a campaign donation. But his hometown congressman, Representative Bill Lowery of San Diego, a Republican, told him that presenting the checks during the sessions was not how things were done, Mr. Wilkes recalled.

Instead, Mr. Wilkes said, Mr. Lowery taught him the right way to do it: hand over the envelope in the hallway outside the suite, at least a few feet away.

That was the beginning of a career built on what Mr. Wilkes calls “transactional lobbying,” which made him a rich man but also landed him in the middle of a criminal investigation.

Last November, Mr. Wilkes was described as “co-conspirator No. 1” in a plea agreement signed by Representative Randy Cunningham, a California Republican on the House Appropriations Committee. In the plea deal, Mr. Cunningham admitted accepting more than $2.4 million in cash and gifts from Mr. Wilkes and other contractors. Another defense contractor, Mitchell J. Wade, pleaded guilty to paying some of the bribes.

Mr. Wilkes could also figure in a related federal investigation into the House Appropriations Committee. The inquiry has focused on ties between Mr. Lowery, who left Congress and became a lobbyist, and Representative Jerry Lewis, a California Republican who is the chairman of the committee and the former chairman of its Defense Subcommittee.

Speaking publicly for the first time since Mr. Cunningham’s plea agreement, Mr. Wilkes said in recent interviews that he had done nothing wrong and did not believe that Mr. Lewis and Mr. Lowery had broken the law. Mr. Wilkes, who has not been charged in the Cunningham case, has refused prosecutors’ appeals to plead guilty.

But Mr. Wilkes acknowledged that he was a willing participant in what he characterized as a “cutthroat” system in which campaign contributions were a prerequisite for federal contracts. “I attempted to get help and advice from people who could show me the way to do it right,” Mr. Wilkes said. “I played by their rules, and I played to win.”

Mr. Wilkes said he was speaking now to rebut false assertions about him by prosecutors and the news media. While it is unknown whether his account is complete and it is impossible to verify his recollections of certain conversations, many aspects of his story were confirmed by federal records, other documents and interviews with people involved in the events he described.

The Cunningham scandal set off alarms about the proliferation of Congressional earmarks — money for pet projects inserted anonymously in spending bills — which critics say pervert public policy, encourage cronyism and waste federal money. The 12,000 earmarks in this year’s spending bills amount to $64 billion.

Offering a rare insider’s view, Mr. Wilkes described the appropriations process as little more than a shakedown. He said that lobbyists close to the committee members unceasingly demanded campaign contributions from entrepreneurs like him. Mr. Wilkes and his associates have given more than $706,000 to federal campaigns since 1997, according to public records, and he said he had brought in more as a fund-raiser. Since 2000, Mr. Wilkes’s principal company has received about $100 million in federal contracts.

Mr. Wilkes described the system bluntly: “Lowery would always say, ‘It is a two-part deal,’ ” he recalled. “ ‘Jerry will make the request. Jerry will carry the vote. Jerry will have plenty of time for this. If you don’t want to make the contributions, chair the fund-raising event, you will get left behind.’ ”

Lanny A. Breuer, a lawyer for Mr. Lowery, acknowledged that his client had been a lobbyist for Mr. Wilkes. But he said Mr. Wilkes’s portrait of their dealings was “an absolute fabrication.”

“Bill Lowery never demanded lobbying fees in return for any kind of a guarantee of an earmark,” Mr. Breuer said. “He never demanded contributions to Jerry Lewis. There was absolutely no quid pro quo.”

Barbara Comstock, a spokeswoman for Mr. Lewis, said the congressman was unaware of any conversations like those Mr. Wilkes described having with Mr. Lowery.

Contractors who do business with the federal government routinely contribute to the campaigns of Congressional appropriators, and politicians frequently assist constituents in their efforts to win government contracts. But legal experts say that explicitly linking official acts to campaign contributions could constitute a criminal offense, including bribery or extortion. They caution that proving criminal intent is difficult.

The culture of the House Appropriations Defense Subcommittee is one of great power and little scrutiny. Mr. Wilkes said every member appeared to have a personal allowance of millions of dollars to disburse without public disclosure. Lawmakers, though, sometimes boast about money being spent in their districts.

In the spending bill for this fiscal year, each member took credit for an average $27 million in earmarks, with the chairman, Representative C. W. Bill Young, Republican of Florida, claiming about $125 million, according to Taxpayers for Common Sense, a nonpartisan group that tracks earmarks.

‘Feast or Famine’

When Mr. Lowery became a lobbyist, he set himself up as a gatekeeper to his old friend, Mr. Lewis, the appropriations chairman, Mr. Wilkes said. At times, Mr. Lowery hinted ominously that Mr. Lewis might block future earmarks if Mr. Wilkes stopped making campaign donations and paying Mr. Lowery’s fees, Mr. Wilkes said.

In recent months, Mr. Lewis has said that he barely knew Mr. Wilkes and that he did not remember seeing him in nearly a decade. But Mr. Wilkes says their relationship was closer than that.

Ever since they went on a scuba-diving trip together in 1993, he said, Mr. Lewis had referred to him as his “diving buddy.” They occasionally dined together or met at political functions, Mr. Wilkes said. At a Las Vegas fund-raiser in April 2005, Mr. Wilkes said, Mr. Lewis greeted him as “Brento” and hugged him as Mr. Wilkes surprised the lawmaker with $25,000 in campaign contributions.

At his peak, Mr. Wilkes controlled a dozen companies whose work included digital document storage. The federal government was his chief customer, and he spent up to 30 weeks a year in Washington courting congressmen and agency procurement officials.

Mr. Wilkes capitalized on the system. The license plate on his black Hummer still reads “MIPR ME,” a reference to a “military interdepartmental purchase request” — bureaucratic jargon for payments for a defense contract.

Mr. Wilkes built a headquarters of smoked glass and stainless steel outside San Diego with a 450-seat banquet hall, where Cirque du Soleil performed at a birthday party for his wife, Regina. He crossed the country in private jets and raised hundreds of thousands of dollars for the Bush-Cheney ticket in 2004, making him a Republican “Pioneer.”

Nancy Luque, his lawyer, said the image of Mr. Wilkes as a swaggering deal maker was a caricature. “He had his life in Washington and then his real life,” Ms. Luque said. “His real life was his family, his friends and his business.”

His success, though, depended on government contracts. “It’s a feast or famine deal,” Mr. Wilkes said. “If we didn’t get our earmark, we were finished.”

Washington Connections

A former accountant in Washington and San Diego, Mr. Wilkes had known Mr. Lowery casually for years in California Republican circles. Because of those ties, a San Diego businessman hired Mr. Wilkes as a consultant in 1992 to help persuade Congress to earmark contracts for his company, Audre, which was seeking to convert military documents into digital form.

Mr. Lowery, in his final months in Congress, was looking for new opportunities as well. He had decided to resign after a 1992 inquiry into the misuse of an internal House bank found that he had written more than 300 bad checks.

Mr. Wilkes said Mr. Lowery set up meetings for him with a handful of House Defense Subcommittee members, including Representative John P. Murtha, a Pennsylvania Democrat who was the chairman at the time, and Mr. Lewis. Mr. Lowery instructed Mr. Wilkes to go to the sessions prepared.

“Lowery says, ‘We should raise money; you get the checks,’ ” Mr. Wilkes recalled, describing the meetings at the Hyatt. “I was a rookie. I didn’t want to separate the checks from the briefing,” he said, explaining that he did not understand the need to avoid appearing to link the money to his pitch.

Although they welcomed the checks, Mr. Wilkes said, the lawmakers seemed bored by a lengthy presentation. “I became the king of the 10-minute meeting,” he said.

Later that year, Mr. Wilkes and Mr. Lowery took a diving trip to Belize, where they visited the United States ambassador. Eugene Scassa, then the envoy, said in an interview that Mr. Lowery had quizzed him about his out-of-pocket expenses and then suggested, “You need a chuck wagon.”

Mr. Scassa said Mr. Lowery pointed to Mr. Wilkes and explained: “He is a chuck wagon. If you have expenses, they pay. If you go out to lunch, they pay. If you need a pair of boots, you go out to the chuck wagon to get them.” (The next year, Mr. Lowery and Mr. Wilkes returned for a diving trip with Mr. Lewis.)

When Mr. Lowery left Congress in January 1993, Mr. Wilkes hired him to lobby for Audre. Mr. Wilkes was impressed by Mr. Lowery’s knowledge of the Defense Subcommittee and his confidence in being able to help deliver an earmark.

Mr. Lowery and Mr. Lewis seemed “like brothers,” Mr. Wilkes said. “These guys ate dinner together a hundred times a year.”

Mr. Wilkes and Audre executives gave members of the Appropriations Committee about $54,000 in campaign donations from 1992 to 1994. The Defense Subcommittee earmarked $14 million for Audre in 1993 and $20 million in 1994.

Mr. Wilkes said that at his suggestion, several recipients of his campaign contributions — Mr. Lewis; Mr. Cunningham; Representative Charlie Wilson, Democrat of Texas; and Representative Duncan Hunter, Republican of California — wrote a letter to top defense officials supporting the expenditures. Mr. Lewis wrote a second letter to an admiral.

In December 1994, Mr. Wilkes set up his own company, ADCS, and continued to use Mr. Lowery’s services. Later, the lobbyist got Mr. Wilkes invited to a party at Mr. Lewis’s town house. The purpose was to help pay the legal bills of former Representative Joseph M. McDade, a Pennsylvania Republican charged with bribery in awarding earmarks. (He was acquitted in 1996.) Many members of the Appropriations Committee and many prominent lobbyists, Democrat and Republican, were there.

“The set of rules that Lowery was teaching me was obviously the right set of rules,” Mr. Wilkes recalled thinking. “If I wasn’t playing the game the way they wanted me to, I never would have been there.”

During his Washington visits, Mr. Wilkes held poker games at the Watergate Hotel, in a suite stocked with beer, Scotch and cigars. He invited several congressmen, colleagues and intelligence officials. Among the occasional guests was Kyle Foggo, the chief administrative officer of the Central Intelligence Agency and a childhood friend of Mr. Wilkes.

Federal prosecutors in San Diego are investigating whether Mr. Foggo, who resigned in May after coming under scrutiny, accepted vacation travel expenses from Mr. Wilkes in exchange for a classified agency supply contract, lawyers involved in the case said.

Ms. Luque, Mr. Wilkes’s lawyer, said, “My client did not give his best friend of over 40 years anything because of any position he may have held.” Mr. Foggo’s lawyer, Mark J. MacDougall, said his client had done nothing unlawful.

Former colleagues say Mr. Wilkes was frank about his view of the appropriations process in Washington. “He was just on a power trip,” said Steve Caira, the former chief executive of a company that sometimes collaborated with Mr. Wilkes. “You would be at a party, and he would come out and say he paid this guy so-and-so, if you throw enough money at him you will get your share back,” Mr. Caira recalled. Mr. Wilkes denied making those comments.

In Mr. Cunningham’s guilty plea, prosecutors portrayed the lawmaker as eager to help Mr. Wilkes. In court documents, they say Mr. Wilkes made cash payments of more than $500,000 to Mr. Cunningham, who intervened to help him earn earmarks and pressed a Defense Department official for faster payment of an inflated invoice. Mr. Cunningham was sentenced to eight years and four months in prison.

Mr. Wilkes said that in recent years, he preferred to work with other Appropriations Committee members. In 1998, records show, he turned to Mr. Lewis for help with the Veterans Affairs administration. Mr. Wilkes was then a subcontractor on a project paid through the Department of Veterans Affairs, and he wanted to take over as the primary contractor. In February 1999, he met with Jeffrey Shockey, a Lewis aide, to ask the congressman’s office to intervene, according to a follow-up letter by Mr. Wilkes that was obtained by The New York Times.

When a Veterans Affairs accounting officer complained about questions from a congressman on ADCS’s behalf, a Wilkes aide, Mike Williams, wrote back that Mr. Lewis was “a close personal friend of Brent’s.” The letter offered to “have the congressman’s office contact the V.A. to put this issue to rest.”

Sometimes, Mr. Wilkes said, lobbyists offered him an earmark if he could come up with a project. In 2004, he said, Edwin A. Buckham, another lobbyist for Mr. Wilkes, reported that the House Appropriations Committee wanted to make a “going-away gift” in the form of an earmark to Representative George Nethercutt, Republican of Washington, who was leaving his seat on the panel to run for the Senate.

Mr. Wilkes suggested a shipboard communications project in Washington State and got $1 million for it. Mr. Nethercutt said he thought the technology was promising.

As he grew more confident, Mr. Wilkes said, he often considered dropping Mr. Lowery, whose fees had escalated to $25,000 a month by 2005, from $2,500. But Mr. Wilkes said Mr. Lowery threatened to block future projects if their relationship ended. Mr. Wilkes said Mr. Lowery had warned several times that doing so could prompt Mr. Lewis to cut off earmarks, saying, “You don’t want me telling those guys on the committee that you are moving on without me.” That meant, Mr. Wilkes said, “I’d be out of business.”

Mr. Breuer, Mr. Lowery’s lawyer, said Mr. Lowery did not make any such threats and called the account “pure fantasy.” He pointed out that in the late 1990’s the two men severed their relationship for a few years, but that Mr. Wilkes retained Mr. Lowery again in 2002.

Business in Jeopardy

In the end, it was the Cunningham investigation that jeopardized Mr. Wilkes’s business with the government. In August 2005, a team of F.B.I. agents swept through Mr. Wilkes’s headquarters. The flow of earmarks, his companies’ lifeblood, dried up. He laid off 200 employees.

Ms. Luque said her client’s legal problems were a battle that he “will fight and win.”

She said federal prosecutors told her in January that they were not interested in Mr. Wilkes’s dealings with Mr. Lowery and Mr. Lewis. “Cunningham couldn’t have followed through on what he did without the cooperation of other people on the committee,” Ms. Luque said. Prosecutors should be looking at the entire committee, she said.

Sitting in his office recently, the shelves lined with photographs of himself with President Bush, Vice President Dick Cheney and the presidential adviser Karl Rove, Mr. Wilkes reflected on his plight.

“I’m a dead man. I wouldn’t be able to get a meeting. I wouldn’t be able to get a phone call returned,” he said. “There’s no way I could get a deal.”

Sabrina I. Pacifici contributed reporting from Washington for this article, and Aron Pilhofer from New York.

Economist's View: Baumol: Errors in Economics and Their Consequences

New Economist notes William Baumol's essay on the consequences of errors in economics:

    Errors in economics a reason for modesty: Baumol: NYU's William Baumol thinks economics "is particularly vulnerable to mistaken ideas contributed from the outside." His article, Errors in economics and their consequences, appeared in a special issue of Social Research on errors (hat tip: Political Theory Daily Review). His concluding remarks...

Here's the section of the article just before the conclusion highlighted by New Economist, along with the conclusion itself. Those of you who have been critical of economists will want to read this, and there's plenty for everyone else too:

    Must Outsourcing to Other Nations Always Benefit Both Affected Countries?

    I come to my last illustration, this time as a misunderstanding widely current among economists, and one on which the unspecialized general public seems to have arrived at a more defensible conclusion than many of the professionals. Not without reason, economists are usually strongly predisposed to favor free trade, globalization, and market-driven apportionment of industries among nations. But this orientation has led many of them to conclude that when a portion of an economic activity or even an entire industry moves from a high-wage to a low-wage country as a result of an increase of productivity in the latter, both the gainer and the loser of the industry can be expected to benefit. In particular, while some individuals in the country from which the activity has emigrated will evidently be harmed, on this view the country as a whole will normally benefit ... sufficiently to compensate for the damages and more.

    Here, a colleague and I have been driven to disagree with many other economists and have shown that, in what we believe to be a large range of cases, the country that loses the activity can be expected as a result to suffer a decrease, possibly substantial, in its overall per-capita income, that is, in its standard of living, and this damage need not just be a transitory loss (see Gomory and Baumol, 2000 and forthcoming).

    Those who believe that macroeconomic policy can effectively limit involuntary unemployment have reason to conclude that loss in the total number of jobs is not an inevitable consequence of globalization... But though we may reject the popular view that globalization is a major threat to employment and an instrument of extensive job loss, we cannot deny that there is reason to be concerned with at least the short-term effects on wages in both developing and developed lands. International competition can influence relative input prices and thereby determine whether machinery will be substituted for labor, for example, or whether skilled labor will be substituted for unskilled. There are, also, more direct implications for wages. Surely, the increased use of computer programmers in India can be expected to reduce the demand for such skills in the United States below what it might otherwise have been.

    For the developing countries, economic history suggests that an industrial revolution initially tends to depress real wages and real living standards, thus supporting the concerns of those who fear the consequences of globalization for the world's less prosperous nations. Though the British industrial revolution is usually considered to have taken off about 1760, it was probably not until approximately 1840 that wages began to rise. Data on life expectancy and average height also indicate that the spread of innovation was accompanied by worsening of the economic status of wage earners, perhaps in part as a result of the move from the countryside to crowded, unsanitary slums; the evidence indicates that the US labor force underwent a parallel trajectory. One may surmise that part of the explanation was a rise in the power of employers and an inability of the workers, in the absence of labor organizations, to resist.

    The opponents of globalization draw attention to a similar phenomenon in twenty-first-century globalization, with multinational employers subjecting their employees to disturbingly low wages and shocking working conditions, particularly on the criteria widely accepted in the affluent economies (though by no means always adhered to even there). Thus, even if globalization is a very promising influence for the more distant future prospects of the developing countries, there is good reason to fear that in the short run the workers in those lands may gain little and may even lose out in the initial stages of globalization.

    It can be argued that all this is transitory and that in the long run the lower-income groups in the developing countries will be better off, as has indeed been true in the developed economies. But the process can easily take decades. We cannot just ignore decades of very substandard earnings that amount to preservation of grinding poverty in a developing country or the permanent structural unemployment in a developed economy that can beset older workers whose skills are made redundant by innovation, and for whom the acquisition of new skills is not a practical option. These are hardships that constitute an extremely painful economic pathology for the affected individuals. At the very least, one can argue that those who stand to benefit from the process should be expected to agree to provide systematic and substantial assistance to the victims, presumably through government channels, and supported liberally by the wealthier communities. If that is not acceptable politically, there is surely little that can be said convincingly in support of a contention that the suffering of the victims will be justified by the promised future benefits to their descendants.

    Possible Longer-Run Damages from Globalization

    Though it can be hoped that, in the longer run, globalization will help to reduce (and even eliminate) poverty in the developing countries, as I have stated earlier (and contrary to widely held views), globalization can also permanently damage economic well-being in some of the affected countries, notably those countries that are now in the economic vanguard. This possibility may seem surprising, and even paradoxical. The simple explanation is that competition and mobility of products tend to equalize wages, raising those that are low, but also reducing those that are especially high. ... [T]his scenario shows the possible dangers to wealthier nations that arise from globalization. It does not mean that globalization is inherently undesirable, or that wealthier nations should never make sacrifices to help impoverished societies. But it does mean that we should not proceed under the illusion that we will assuredly profit from the process.

    What Have We Learned and What we Need to Learn

    The approach taken here is quite different from most current discussions of globalization. ... The approach ... has been used to investigate that overall effect, and has told us that the net consequence for a country of improved productivity abroad is neither always beneficial nor always deleterious but can be either, depending on the circumstances characterized above. To this result there is also something contributed by the more popular discussions that characteristically focus on the possibility that displaced workers will not find new jobs or will only obtain jobs that provide a lower wage than before, because these workers can no longer use the accumulated skills and know-how of a lifetime.

    Of course, that is not the end of the story, at least in the long run. For there is a powerful countervailing force that works to produce long-run benefits to all countries affected by globalization. The power of international competition has arguably contributed much of the unparalleled, sustained economic growth and the unrivalled explosion of innovation that the free-market economies have experienced in the past two centuries. In the countries that have participated in this process, the economic benefits are so spectacular that they could hardly have been imagined by our ancestors. Globalization can extend this process to other nations and can strengthen such developments substantially even in the world's leading economies. Although difficult to quantify, this may well be the greatest economic promise of globalization.

    Anyone Can Err

    If the arguments of this paper are not themselves in error, what I have shown is that the economics profession can, indeed, sometimes show the layperson the error of his or her more common-sense thoughts. But not always. Sometimes the errors and the route toward correction go the other way. This observation is not meant in any way to denigrate the work of my colleagues. After all, it is only through careful analysis that one can discover where it is the specialist who has been wrong and where the often exceedingly fallible common sense of those with no formal training in the field has turned out to be closer to the underlying reality.

    We have also seen that misunderstanding in the field of economics can have consequences beyond pushing researchers and teachers in misguided directions. Perhaps as much as any discipline, erroneous economic analysis and conclusions can elicit policies severely damaging to the public interest. And, in this, I believe that we economists do have something to answer for. We are all too prone to put more faith in the implications derived from our quite appropriately simplified models, and to draw from those implications policies that really only apply universally in the artificial world of the constructed model.

    The recommendation to ourselves that seems appropriate here is advocacy of somewhat enhanced modesty when we do offer advice, and more ready willingness to remind our listeners that, though we are offering the best advice we are in a position to provide, they must recognize that the recommended course may yet prove dangerous to the public health.

‘The Bourgeois Virtues,’ by Deirdre N. McCloskey- The New York Times Book Review - New York Times

Bobos in Paradise
Review by JIM HOLT

The heft, the air and the title of this book all promise a big thesis. But what the devil could that thesis be? At no point during my reading of the 500-plus pages — an experience by turns piquant, maddening, edifying and wearying — was I altogether sure. Sometimes the author appeared to be arguing that capitalism makes us virtuous. Sometimes she seemed to be saying that virtue is the most important ethical idea we have. And sometimes she more or less announced that Love Is Bigger Than Economics. Each of these is a potentially interesting claim. But where, amid the luxurious orgy of quotations, epigrams, pop-cultural and poetic allusions, charts, lists, etymologies, asseverations, innuendoes, zingers and brickbats, was the meticulous reasoning that might establish their truth?

Perhaps, though, such a complaint misses the point. Deirdre McCloskey is a maverick, and in more ways than one. A classically trained economist — Harvard Ph.D., junior appointment to the star-studded University of Chicago economics department, r?sum? packed with rigorous quantitative research — McCloskey broke ranks in 1985 with “The Rhetoric of Economics,” which mocked the pretensions of economists to scientific objectivity. What the profession needed was less highfalutin mathematics and more emphasis on persuasion, stories, rhetoric: so she argued. Or he, I should say. For, at the time, Deirdre was still a man named Donald. In 1995 McCloskey broke ranks again by choosing to undergo a sex-change operation, the central event in her memoir, “Crossing” (1999). Currently a distinguished professor of economics, history, English and communication at the University of Illinois, Chicago, McCloskey is that rarest of things, a transexual, new-Christian, postmodern, minimal-government conservative. She is also, by her own avowal, “a tough urban girl who can take it as well as dish it out.”

And dish it out she does. Foremost among the many, many recipients of McCloskey’s abuse are those who (she thinks) misunderstand the nature of morality. How do we determine what is right and wrong? Modern moral philosophers have offered two sorts of answer. One focuses on consequences: according to the utilitarianism of Jeremy Bentham, for instance, the right action is the one that results in the greatest happiness for the greatest number. The other focuses on the acts themselves: for Immanuel Kant, the right action is the one that conforms to a certain idea of duty, regardless of consequences. (Thus, by Kant’s lights, it is always wrong to kill an innocent person on purpose, even to save the world.) McCloskey will have neither of these; each, she thinks, wants to reduce ethics to “a quick little formula, the pocket-sized card.”

In the last few decades, however, an alternative to utilitarian and Kantian ethics has emerged, one that harks back to the ancient philosophers. It centers neither on acts nor on their consequences, but on character. According to “virtue ethics,” morality cannot be captured in a universal code; the right thing to do in a particular situation is what a virtuous person would do. And how do we identify a virtuous person? Aristotle defined virtue as a quality of character that makes for a life well lived. Then he characterized the good life as a life lived in accordance with virtue. Circular? Today’s virtue ethicists obviously don’t think so, but they have nevertheless struggled to come up with an account of human nature that would give some definite content to the idea of virtue.

McCloskey likes virtue ethics for two reasons. First, it elevates stories over abstract rules. The guide to action becomes “What would X do?” where X is to be filled in by one’s moral exemplar of choice, who might be drawn from the Bible, say, or from a Jane Austen novel. Second, virtue ethics lends a womanly touch to moral theory, which has long been a “guy thing,” with masculine notions like justice and autonomy shutting out feminine notions like caring and love. Many of the movers behind virtue ethics, she notes with satisfaction, have been women, like Elizabeth Anscombe, Iris Murdoch and Martha Nussbaum. (On the other hand, some pretty important male philosophers — Alasdair MacIntyre, Bernard Williams, John McDowell — have also played a role. One man that McCloskey decidedly does not want on her team is William J. Bennett, who, she observes with some severity, pumped his royalties from “The Book of Virtues” into slot machines.)

In taking the question “What sort of person ought I to be?” as fundamental, virtue ethics entails a richer moral psychology than its rivals. Yet it is not very useful in resolving ethical dilemmas. Should I betray my friend or my country? Utilitarianism at least yields an answer (friend). Virtue ethics tells me to do what a virtuous person would do in the circumstances — scant guidance for anyone who lacks the virtuous person’s built-in ethical know-how. And the egoistic emphasis on cultivating one’s virtue can easily lead to a preening moral vanity, not to say self-infatuation. How much more likable the Kantian ideal of doing the irksome thing simply because it’s your duty, damn it.

McCloskey does not trouble to rebut such criticisms. Instead, she submerges them in a flood-tide of contrary quotations from other thinkers. (She has read the library, and won’t let you forget it.) Her real interest is in applying virtue ethics to capitalism, and to capitalism’s distinctive product, the bourgeoisie. In “The Rhetoric of Economics,” McCloskey mocked bourgeois man as a ludicrous character, “at once master and servant, inclined therefore to hypocrisy and doubletalk, ’umble and yet pompous.” But she appears to have had a change of heart. McCloskey now sees the bourgeoisie as a noble class, the chief repository of the virtues instilled by commercial life.

And what are these “bourgeois virtues”? Thrift? Punctuality? Respectability? Cleanliness? McCloskey has nothing so dismal in mind. Rather, she is talking about the four classical pagan virtues — courage, justice, temperance and prudence — plus the three Christian virtues of faith, hope and love. Especially love. Here is something her fellow economists are incapable of capturing in their arid quotations. “Modern capitalist life is love-saturated,” she declares, as “markets and even the much maligned corporations encourage friendships wider and deeper than the atomism of a full-blown socialist regime or the claustrophobic, murderous atmosphere of a ‘traditional’ village.” We already knew that markets make us rich. But McCloskey wants to convince us that markets are also good for the soul.

Here is where things ought to get interesting. Even fans of capitalism concede that it can have a corrosive effect on morals and community ties. Critics have argued that it fosters consumerism, greed, narcissism, Gesellschaft over Gemeinschaft, anomie, Enron. . . . The bourgeois is a beastly little creature — so say the German Romantics, D. H. Lawrence and, in a rather drier way, Francis Fukuyama. How might these people be proved wrong? The pro-bourgeois case would start with the historical observation that liberal values like tolerance and freedom have been a product of commercial life. It would proceed with the careful marshaling of evidence that capitalism can be ethically beneficient — that, for example, markets generate trust. And who better to construct such a case than a polymath econometric virtuosa like McCloskey?

But instead we get rhetoric. There is polemical hand-waving (“Who says?”; “I think not”; and, most logically decisive, “Point, schmoit”). There is sophomoric sarcasm: Stephen Weinberg, a Nobel laureate in physics, is mocked for his reasoned stand against religion, and the French philosopher Andr? Comte-Sponville is dismissed with stale jokes about Gauloises and Jerry Lewis. Anecdotes masquerade as data: the evidence against the Marxist thesis that work is alienating under capitalism is the author’s perception that Chicago garbagemen seem to enjoy emptying trash bins. McCloskey is contemptuous of scientists like Steven Pinker for trying to explain the origins of virtue along Darwinian lines; yet her dogmatic counterclaim — “Every human is born in sin, and must seek redemption” — doesn’t greatly advance the argument.

And how strong, really, is the correlation between bourgeois virtue and laissez-faire capitalism? Like her friend Milton Friedman, McCloskey would like to see the role of the state much reduced. She says she dreams of “literally one-third to one-fifth of the government we now have.” Yet a social democracy like Sweden, where the state plays a far greater role in society, would seem to be the very soul of bourgeois virtue by many objective standards, with less violence and more solidarity and trust than the United States.

McCloskey probably won’t sway many readers who do not already share her convictions, but for all the book’s flaws one can’t help being impressed by her verve, erudition and fitful brilliance. When she argues that Vincent van Gogh was actually a good bourgeois, or that Jesus, notwithstanding the Sermon on the Mount, was pro-commerce, the rhetorical moves are as deft as the claims are surprising. And who would have imagined that the film “Groundhog Day,” in which the annoyingly smug Bill Murray character comes to see the point of humility and love, epitomizes the process by which virtue is inculcated? But it is a little dispiriting to hear McCloskey announce that this book is merely the first of four (!) projected volumes by her on the subject of virtue and capitalism. Somewhere within this loose, baggy monster there has to be a slim, cogently argued treatise struggling to get out.

Jim Holt, a regular contributor to The New Yorker and The New York Times Magazine, is working on a book about the puzzle of existence.

Economist's View: "Comparative Advantage, Comparative Advantage, Wherefore Art Thou, Oh Comparative Advantage?"

An email suggested looking at this paper by Richard Freeman on globalization and trends in U.S. and worldwide labor markets. It was a good suggestion. This is longer than usual even though I cut quite a bit, but well worth the time it takes to read it:

    Labor Market Imbalances: Shortages, or Surpluses, or Fish Stories?, by Richard B. Freeman, Boston Federal Reserve Economic Conference: There are two competing narratives about the how the labor market in the US will develop over the next decade or two.

    The Impending Shortage narrative, which has attracted attention from business and policy groups, is that the retirement of baby boomers will create a great labor shortage. Slower growth of new entrants from colleges and universities, an increased proportion of young workers from minority groups, and inadequate training in science and math will produce a shortage of the skills the country needs to maintain itself as the leading economy in the world. The message to policy makers is to forget about the sluggish real wage growth of the past three decades, the deterioration in pensions and employer provided health care, and fears of job loss from off shoring or low wage imports. Instead policy should focus on helping business find workers in the coming shortage.

    Shortage claims have focused on science and engineering. Many leaders of the scientific establishment and high tech firms have complained that the US faces a shortfall of scientists and engineers and have asked for governmental policies to address this problem. ... The heads of Intel, Microsoft, and other high tech firms have spoken out on this issue as well. ...

    But the shortage claim goes beyond science and engineering. Demographic projections of the US labor supply that show a sharp reduction in the growth of the work force through 2050 (see table 1) have aroused concern in the business and policy community. Reporting the consensus from the Aspen Institute’s Domestic Strategy Group, David Ellwood stated that: "CEOs, labor leaders, community leaders, all came to the unanimous conclusion that we will have a worker gap that is a very serious one.“ ... A 2003 Fortune Magazine headline declared “Believe It or Not, a Labor Shortage Is Coming” for virtually all workers (Fisher, 2003).

    Believers in the impending shortage story generally favor increased immigration, particularly of highly skilled workers through H1B and other visas? increased spending on education and technological innovation? and guest worker programs to keep a sizable flow of less skilled but legal immigrants coming to the country. They regard many of these immigrants as complements rather than substitutes for US workers. They also advocate greater education and training of US citizens, particularly of disadvantaged minorities.

    The Globalization Surplus narrative, which has attracted attention as part of discussions of the current mode of globalization, takes the opposite tack. It holds that the spread of global capitalism around the world, particularly to China and India, has generated a labor surplus that threatens wages in advanced and higher wage developing countries. Trade, off-shoring, global sourcing of jobs, and flows of capital to the low wage giants combine to reduce the demand for workers in manufacturing and tradable services in advanced countries and in moderate income developing countries.

    At first, the advent of huge numbers of workers from India and China into the global capitalist system seemed to offer a boon to most workers in advanced countries. The labor force is less skilled in the global giants than in the advanced economies. According to the Heckscher-Ohlin model, skilled workers in the advanced countries would benefit from the new trading opportunities while only the relatively small number of unskilled workers would lose. If all workers in the North were sufficiently educated, they would avoid competing with low paid labor overseas and benefit from the low priced products produced there. Competition from low wage workers in China and India might create problems for apparel workers in Central and Latin America or for South Africa, but not for ... the advanced North. Similarly, the “North-South” trade model that analyzes how technology affects trade between advanced and developing countries implied that trade would benefit workers in the North, who had exclusive access to the most modern technology. More low wage workers in the developing world would lead to greater production of the goods in which the South specialized, driving down their prices.

    Tell it to Lou Dobbs! The off shoring of computer jobs, the US’s trade deficits even in high technology sectors, and the global sourcing strategies of major firms have challenged this sanguine view. The advent of China, India, and the ex-Soviet Union shifted the global capital-labor ratio massively against workers. Expansion of higher education in developing countries has increased the supply of highly educated workers and allowed the emerging giants to compete with the advanced countries even in the leading edge sectors that the North-South model assigned to the North as its birthright.

    Which narrative better fits the labor market? ... In this paper I assess the two competing visions and the demographic and economic projections on which they are based. I reject the notion that the retirement of baby boomers and slow growth of the US work force will create a future labor shortage in favor of the argument that the increased supplies of skilled labor in low-wage countries will squeeze highly skilled as well as less skilled US workers. I examine the problem of attracting native US talent in science and engineering in the face of increasing supplies of highly qualified students and workers from lower wage countries. Going beyond the US, I argue that the expansion of global capitalism to China, India, and the former Soviet bloc has initiated a critical transition period for workers around the world. Pressures of low wage competition from the new giants will battle with the growth of world productivity and the lower prices from those countries to determine the well being of workers in higher income economies as the low-income countries catch up with the advanced countries. While US wages will not be “set in Beijing” how workers fare in China and India and other rapidly developing low wage countries will become critical to the position of labor worldwide.

     

    1. A Great Labor Shortage – An Angler’s Tale

    The most alarmist claims that the US labor market faces a great labor shortage in the foreseeable future begin with the notion that total gross domestic product (GDP) should increase in the future at a rate comparable to the growth rate in the recent past. From 1980 to 2005, US real GDP grew by 3.1 % annually, with 1.4% due to the growth of labor supply and 1.7% due to the growth of labor productivity. The growth of the labor force is projected to drop in half – to 0.7% per year, which makes the 3.1% growth of GDP unsustainable absent increases in labor productivity above historical levels. To maintain past growth of GDP with 1.7% growth of labor productivity from 2005 to 2030, the US would need 30 million workers more than the labor supply that the Bureau of Labor Statistics has projected for that year. The result: the cry of impending shortages.

    Despite the attention given to calculations of this kind, they make little sense in terms of social welfare. Making a given growth rate of GDP the touchstone of economic policy is a cart before the horse policy from the perspective of standard welfare analysis. As a wealthy country, the US can increase GDP whenever it wants by admitting more immigrants. A massively larger labor supply would increase GDP but would reduce GDP per capita and real wages. The standard metrics for assessing how well an economy performs, GDP per capita, or productivity per hour worked, are more appropriate indicators of economic success than the volume of GDP irrespective of population or work force...

    There are two problems with basing projections of labor market imbalances on demographic developments. First, demographic changes have not been consistently associated with changes in labor market conditions in the past, even for the young workers whose position is most sensitive to changing market realities. As a case in point, labor supply grew slowly in Europe in the 1980s-1990s without creating a labor shortage nor reducing high levels of youth unemployment. In the US, the wages of young persons fell relative to older workers when the baby boomers hit the job market in the 1970s (Freeman, 1979, Welch, 1979) but the wages of the young workers did not increase relative to older workers when smaller youth cohorts entered the market in the 1990s.

    The employment and earnings of young workers depends more on macroeconomic conditions, wage-setting institutions, and technological developments than on demography. Second, the US is not a closed economy dependent only on domestic labor to produce goods and services. In the global economy, demographic and labor conditions in other countries affect the US labor market. Globalization gives US firms access to labor overseas through foreign direct investment, off shoring, or subcontracting... The claims of a coming labor shortage must be assessed in a global context...

    For the world as whole, the UN projects that the number of persons aged 15-59 will increase massively, so that if enough of these persons gain appropriate labor skills, it would take a massive increase in demand for labor to generate labor shortages.

    

    2. Doubling the global workforce: a real whale

    Demographic trends aside, the global labor market changed greatly in the 1990s due to the advent of China, India, and the ex-Soviet bloc to the world economic system. During the Cold War era, these countries had trade barriers, self-contained capital markets, and little immigration to the advanced countries – all of which isolated their labor markets from those in the US and the rest of the capitalist global world.

    The collapse of Soviet communism, China’s decision to “marketize” its economy, and India’s rejection of autarky, greatly increased the supply of labor available to the global capitalist system. I estimate that if China, India, and the ex-Soviet bloc had remained outside of the global economy, there would be about 1.46 billion workers in the global economy in 2000 (figure 1). Because those countries joined the rest of the world, there were 2.93 billion workers in the global economy in 2000. Since twice 1.46 billion is 2.92 billion, I have called this “The Great Doubling”...

    The effect of this huge increase in the work force changed the balance between labor and capital in the global economy. ... I estimate that as result of the doubling of the global work force the ratio of capital to labor in the world economy in 2000 fell to 61 percent of what it would have been in 2000 before China, India, and the ex-Soviet bloc joined the world economy. ...

    By giving firms a new supply of low wage labor, the doubling of the global work force has weakened the bargaining position of workers in the advanced countries and in many developing countries as well. Firms threaten to move facilities to lower wage settings or to import products made by low wage workers if their current work force does not accept lower wages or working conditions, to which there is no strong labor response. The result is a very different globalization than the IMF, World Bank, and other international trade and financial organizations envisaged two decades or so ago when they developed their policy recommendations for the world economy.

    What about skills and technology?

    The difference between the skills of workers in the US and those in low wage countries was in the forefront of the debate over the impact of the NAFTA treaty with Mexico on US workers. Proponents of the treaty argued that the US would gain high skilled jobs from increased trade with Mexico while exporting low-wage less-skilled jobs. All US workers had to do to benefit from globalization was to invest more in human capital. The proponents also promised that the ensuing boom in Mexico would reduce the flow of illegal immigrants to the US and thus lessen labor competition at the bottom of the US job market. The argument that the US/other advanced countries should gain skilled jobs while losing less skilled jobs would seem to apply even more strongly to China and India than it did to Mexico. The average worker in China and India has lower skills than the average Mexican worker because so many are peasants with limited education and relatively few have university training. Perhaps the right way to consider these workers is as complements rather than substitutes for American workers, who will increase US demand for educated labor relative to less-educated labor, and thus create a greater potential shortage of skills in the US.

    The current global labor market has not developed according to this scenario. Countries around the world, including the new giants, have invested heavily in higher education, so that the number of college and university students and graduates outside the US has grown rapidly relative to the number in the US. ...

    But highly populous low wage countries have also invested heavily in higher education. Indonesia, Brazil, China, India – name the country – have more than doubled university student enrolments in the 1980s and 1990s (Freeman, 2006). China has made a particularly large investment in science and engineering, so that by 2010 it will graduate more PhDs in science and engineering than the US. While the quality of graduate training is higher in the US than in China, China will surely improve quality over time. India has produced many computer programmers and engineers. ...

    In sum, the notion that US skilled workers need not worry about competition from equally skilled workers in low income countries because developing countries have fewer graduates per capita does not fit with reality. With an increased supply of highly educated persons from low wage developing countries, multinational firms can offshore high-skilled work and hire graduates from universities world wide? while large numbers of highly educated immigrants can come to the US to work.

    

    3. Scientists and Engineers as a special case?

    As noted, the scientific and technological establishment proclaimed that the US has a shortfall of science and engineering workers in the early to mid 2000s. Past experience with shortages of scientists and engineers suggests that we view such claims skeptically. The first time the US troubled over shortfalls in the science and engineering work force was in the late 1950s-1960s, prompted by the surprise launch of Sputnik by the Soviet Union in 1957. Congress responded by enacting the National Defense Education Act of 1958 and by increasing federal R and D and development of missiles.

    The immediate result of the R&D increase was a rapid rise in the earnings of scientists and engineers, so the labor market confirmed the shortage claim. Given the time required for the new fellowships and higher wages to increase supply, the supply/demand balance had indeed shifted in favor of workers.

    The next two claims of shortages failed, however, to reflect reality. In the early 1980s, NSF announced a scientists and engineers’ shortage that turned out to be unjustified. The shortage was based on policymakers’ erroneous use of data, which produced angry articles and editorials in Science and Nature, among other places. As best one can tell, the claimed shortage came from a desire to reduce the cost of scientists and engineers to large firms (Weinstein).

    In the early 1990s, leaders of the scientific community again proclaimed an incipient shortage of scientists and engineers.... But throughout the decade, indicators of the state of the S&E labor market (salaries? unemployment rates? the number of graduates and post docs relative to tenure track job in academic institutions, etc) showed no evidence of a shortage. From 1990 to 2000 earnings rose more slowly in science and engineering than in law, medicine, and related professions. While the booming 1990s did produce a shortfall of computer programmers and related specialist, this disappeared in ensuing years as firms off-shored work to the lower wage countries, notably India. ... From the perspective of young persons choosing a career, prospects in science and engineering seemed highly uncertain and less lucrative than prospects in business, finance, law, or medicine.

    During the 1990s boom the US increased the employment of scientists and engineers greatly. It did this despite fairly constant numbers of graduates in science and engineering among citizens or permanent residents. Much of the increased S&E employment took the form of “importing” large numbers of foreign-born students and workers in these disciplines. ...

    The lesson from the 1990s increased employment of S&E workers is clear: if the US economy demands more highly skilled workers in the period of projected slow labor force growth, it can increase supplies by admitting more immigrants in areas with rising labor demand, as it did in the 1990s...

    This does not mean that the US does not have a potential problem in the supply of citizens into science and engineering work. It is possible that the country relies excessively on foreign-born talent in this area. This could risk a sudden decline in supply due to political problems, visa restrictions (as occurred for international graduate students post 9/11), or other factors outside the job market. To the extent, moreover, that the native born are more attuned to American economic and social realities, reduced numbers of US born scientists and engineers could weaken the connection between S&E and business that has made the country a paragon in turning scientific knowledge into technological and business innovation.

    I would recast concern about shortages of S&E workers in the US from supposed shortages of overall supply, which find no support in labor market data, to the balance between native and foreign-born scientists and engineers in the work force. If the problem is this balance, there are clear policies that could make S&E careers more lucrative and attractive to Americans. More spending on research and development would raise demand and wages relative to opportunities in other occupations. Provision of more and higher valued scholarships and fellowships would increase the supply of Americans (Freeman, Chiang, Chang, 2005).

    Allocation of a larger share of research grants to young researchers as opposed to senior researchers would make the fields more attractive to young Americans. But as in the 1950s, this would require government spending as opposed to moral suasion.

    

    4. The Challenge of Human Resource Leapfrogging

    Comparative advantage, comparative advantage, wherefore art thou, oh comparative advantage?

    In the North-South model that trade economists use to analyze how technology affects trade between the advanced North and the developing South, the advanced countries monopolize cutting edge innovative sectors while developing countries end up producing traditional products. The greater the rate of technological advance and the slower the spread of the newest technology to low wage countries, the higher paid are workers in the North relative to workers in the South. The comparative advantage of advanced countries in high tech sectors is rooted in those countries having more scientists and engineers and other highly educated workers relative to the overall work force than developing countries.

    In these sorts of analyses, the spread of higher education and modern technology to low wage countries can reduce advanced countries’ comparative advantage in high-tech sectors and adversely affect workers in the advanced countries as a result. Any country with a comparative advantage in a given sector can lose when another country can compete successfully in that sector. ... If a foreign competitor gains comparative advantage in industries that have particularly desirable attributes– that employ large numbers of highly educated workers and offer great opportunities for rapid technological advance – the country with the initial advantage has to shift resources to less desirable sectors – those with lower chance for productivity growth, with fewer good jobs, and so on. The usual assumption regarding high tech sectors is that only advanced countries have the educated work force necessary for competing in them. In the 1980s, Americans got worked up when Japan seemed to be producing better high tech products than the US.

    In the 1990s the US worried about the competition between Airbus and Boeing in the manufacturing of aircraft. No one entertained the notion that China or India would become major players in high technology leading edge industries. ...

    The advance of China and India into high tech has obsolesced these analyses. China has moved rapidly up the technological ladder? has greatly increased its high tech exports, and has achieved a significant position in research in what is purported to be the next big industrial technology – nanotechnology. Over 750 multinational firms have set up R&D facilities in China. China’s share of scientific research papers has risen greatly. While India has not invested as much in science and engineering as China, it has achieved a strong international position in information technology, also attracting major R&D investments, particularly in Bangalore. How can low income countries with few scientists and engineers relative to their work forces compete in high tech?

    These countries have moved to the technological frontier because success in high tech depends on the absolute number of scientists and engineers rather than on the relative number of S&E workers to the work force. It isn’t how many engineers per person that produces a technological breakthrough as much as the total number of engineers working on the problem. ... I have called the process of moving up the technological ladder by educating large numbers as “human resource leapfrogging” since it uses human resources to leapfrog comparative advantage from low tech to high tech sectors, contrary to the assumption of the North-South model. The low wages in these large populous countries, moreover, makes them formidable competitors for an advanced country because it gives them a potentially large cost advantage in attracting R&D.

    The bottom line is that the spread of modern technology and education to China and India will undo some of the advanced countries’ monopoly in high tech innovation and production. The North no longer has a lock on high tech that lies at the heart of the North-South model.

    

    5. Transition to the New Global Labor Market

    The triumph of global capitalism has brought modern technology and business practices to most of humanity. Barring disaster, the world is on an historic transition to a truly global economy and labor market that should produce rough income parity among nations and “make poverty history”. The way the transition proceeds will have immense consequences for workers throughout the world. Workers in the new entrants to the global economy should do better since capital will flow to them, raising wages and modern sector employment. Developing countries where wages exceed those in China and India face a big problem as these countries will have find their place in the global economy without engaging in head on competition with the giants in low wage industries. Workers in the US and other advanced countries will benefit from the low prices of goods from China and India but will suffer from enhanced labor market competition.

    Joining the global capitalist system has improved the economic position of workers in China and India. The two countries have been leaders in economic growth and in the reduction of poverty. ... Estimated rates of change in real earnings vary across surveys and groups, but invariably show increases in real wages for virtually all groups of workers...

    But the 1990s growth in China has done little to advance the economic position of peasants. The rising inequality and lack of political freedom and of legitimate channels of protest presents a challenge to China and to the transition process. ... Inequality, which has been moderately high in India, did not grow during the 1990s and 2000s. Wages appear to have risen overall, also at a rapid pace. ... The structure of wages has also shifted in India in favor of more skilled and educated labor.

    Workers in many of the developing countries in Latin America, Africa, and Asia have not done well in the 1990s-early 2000s. Employment in Latin America, South Africa and in parts of Asia has shifted from the formal sectors historically associated with economic advancement to informal sectors, where work is precarious, wages and productivity low, and occupational risks and hazards great. The backlash against the current model of globalization in Latin America reflects this failure. ...

    Research has not begun to explore in depth the causes of the growing informalization of labor in developing countries. I suspect that China and India’s entry to the world economy has contributed to the informalization and failure of the Washington Consensus style policies in many countries. Their entry has transformed many developing countries from low wage competitors with advanced countries to high wage competitors with China and India. Wages in Peru or El Salvador are three times those in China or India. Mexico is more expensive site for production of blue jeans than China. ...

    How workers in the advanced countries will fare in the transition depends upon a race between the improvements in global productivity and reductions in prices that the new giants will bring to the world economy vs the labor market pressure for wage concessions to compete with them. Ideally, the increased number of scientists and engineers and spread of high tech worldwide will accelerate the rate of technological advance enough to raise living standards in all countries? the US and other advanced countries will retain comparative advantage in enough leading sectors to remain hubs in the global development of technology? and the world savings rate will rise so that the global capital labor ratio increases rapidly. In the US, increased social services and social infrastructure – national health insurance, for instance – may be needed to improve living standards if workers cannot gain real wage increases. As GDP will continue to grow, a key policy issue should be to find ways to distribute that growth beyond the super-wealthy who have benefited most from the past two or so decades of growth.

    

    6. Conclusion

    I conclude that the forces of globalization associated with the doubling of the global work force will trump demographic developments associated with slower population growth in determining supply/demand balances in the labor market. Because the transition to a global labor market will be lengthy, the economic and labor market policies that countries, the international community, unions, and firms can help determine whether it proceeds smoothly, or bumpily, or – invisible hand forbid – aborts.

    How long might it take the global economy “absorb” the huge work forces of China, India, and potentially other developing countries The recovery of Western Europe and Japan after World War II and Korea after the Korean War provide some historical guideposts. The US sent capital to Europe under the Marshall Plan that helped those countries reconstruct their economies rapidly. Recovery of Europe in turn created markets for American products while rapid increases in European wages kept US workers from facing low wage competition. Similarly, the US helped Japan develop into a market democracy with the capability of challenging the US in many technically advanced sectors. The progress of Korea from one of the poorest economies in the world to an advanced economy in about fifty years is even more remarkable since that country had never before been among the leading global economies. If China maintains its successful development and wages double every decade, as they did in the 1990s, Chinese wages would approach levels in the advanced countries today in about 30 years. India would take longer. My assessment is thus that the transition will take 40 to 50 years.

    There are examples of unsuccessful transitions as well, of which the reunification of East Germany with West Germany is the most recent. The German government acted as if low income East Germany would meld seamlessly with the wealthier capitalist West despite the legacy of nearly half a century of communism. It offered extensive welfare programs to keep workers in the East, but did not raise taxes to fund a massive Marshall plan style program to rebuild the East’s economy. German unions sought wage parity between East and West rather than allowing wage differences to reflect productivity differences. The healthiest economy in Europe was transformed into one of the sickest, with high unemployment and sluggish growth. Reconstruction of the US South after the Civil War was an even greater failure. It took over a century for the South to achieve something akin to economic parity with the rest of the country. The southern whites spent the better part of the 20th century oppressing the blacks, limiting their schooling and economic opportunities rather than joining with them to try to move the southern states’ economies forward.

    If I am right, the overriding goal of labor market policy around the world in the next decade or so should be to assure that the absorption of China, India, and the ex-Soviet bloc into world capitalism goes as smoothly as possible. The bent of policy in the US and elsewhere should be in the direction of favoring labor rather than capital, which ought to be able to take care of itself in a global economy with twice as many workers, many available at low wages. There should be sustained international pressure on developing countries to raise their labor standards and to distribute the benefits of growth to workers. And there should be efforts to maintain or improve living standards if not wages of all workers in the advanced countries so that even the less skilled gain some from the movement to a global labor market.

    I am not sure what policies would enable the developing countries that cannot compete with China and India in low wage goods to improve the conditions for their workers. Some may expand through sale of natural resources but mining and other resource industries employ few people. Some may be able to expand their domestic markets. I suspect that there is no simple answer about what to do in the face of the doubling of the global workforce and that each country will have to craft a strategy dependent on its own unique circumstances.

    Finally, if I am wrong and there is to be a great labor shortage in the foreseeable future, I believe that it will come not from demography but from events that the shortage soothsayers ignore – a global pandemic that kills millions of people? climate change that destroys parts of economies? political insanity that produces barriers to trade, migration, and capital flows around the world. With reasonable policies and a bit of luck, however, none of these events will upend the movement toward a single and more egalitarian world economy.

Update: For more, see New Economist who has a nice presentation of this topic. He also links to an older post of mine on the same topic (commenting on a WSJ article about Freeman's paper) that I overlooked when I put this together.