Economic growth

25 November, 2015 at 17:55 | Posted in Economics | 10 Comments

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I came to think about this dictum when reading Thomas Piketty’s Capital in the Twenty-First Century. 

Piketty refuses to use the term ‘human capital’ in his inequality analysis.

I think there are many good reasons not to include ‘human capital’ in economic analyses. Let me just give one — perhaps analytically the most important one — reason and elaborate a little on that.

In modern endogenous growth theory knowledge (ideas) is presented as the locomotive of growth. But as Allyn Young, Piero Sraffa and others had shown already in the 1920s, knowledge is also something that has to do with increasing returns to scale and therefore not really compatible with neoclassical economics with its emphasis on constant returns to scale.

Increasing returns generated by non-rivalry between ideas is simply not compatible with pure competition and the simplistic invisible hand dogma. That is probably also the reason why neoclassical economists have been so reluctant to embrace the theory wholeheartedly.

Neoclassical economics has tried to save itself by blurring the distinction between ‘human capital’ and knowledge/ideas. But knowledge or ideas should not be confused with ‘human capital.’ Chad Jones & Paul Romer gives a succinct and accessible account of the difference:

Of the three statevariables that we endogenize, ideas have been the hardest to bring into the applied general equilibrium structure. The difficulty arises because of the defining characteristic of an idea, that it is a pure nonrival good. A given idea is not scarce in the same way that land or capital or other objects are scarce; instead, an idea can be used by any number of people simultaneously without congestion or depletion.

new-way-oct14Because they are nonrival goods, ideas force two distinct changes in our thinking about growth, changes that are sometimes conflated but are logically distinct. Ideas introduce scale effects. They also change the feasible and optimal economic institutions. The institutional implications have attracted more attention but the scale effects are more important for understanding the big sweep of human history.

The distinction between rival and nonrival goods is easy to blur at the aggregate level but inescapable in any microeconomic setting. Picture, for example, a house that is under construction. The land on which it sits, capital in the form of a measuring tape, and the human capital of the carpenter are all rival goods. They can be used to build this house but not simultaneously any other. Contrast this with the Pythagorean Theorem, which the carpenter uses implicitly by constructing a triangle with sides in the proportions of 3, 4 and 5. This idea is nonrival. Every carpenter in the world can use it at the same time to create a right angle …

Ideas and human capital are fundamentally distinct. At the micro level, human capital in our triangle example literally consists of new connections between neurons in a carpenter’s head, a rival good. The 3-4-5 triangle is the nonrival idea. At the macro level, one cannot state the assertion that skill-biased technical change is increasing the demand for education without distinguishing between ideas and human capital.

In one way one might say that increasing returns is the darkness of the mainstream economics heart. And this is something most mainstream economists don’t really want to talk about. They prefer to look the other way and pretend that increasing returns are possible to seamlessly incorporate into the received paradigm — and talking about ‘human capital’ rather than knowledge/ideas makes this more easily digested.

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  1. They don’t want to think about it because once you do you realise that enclosing ideas and inventions in long running patents and copyright is a really, really silly idea – since it prevents increasing scale effects from occurring.

  2. I agree that non-rival goods are incredibly important to keep in mind when discussing growth. But Chad Jones is a neoclassical economists who follows the footsteps of Paul Romer — another neoclassical economist. Add to this the work on increasing returns to scale in trade, and I find it hard to digest the idea that neoclassical economists ignore non-rival goods or increasing returns.

    As for Neil, I’m not sure what conspiracy theory you have in mind – there are so many by now – but you are indeed correct that most neoclassical economists so support, to a varying degree, the concept of intellectual property rights. Someone needs to develop those non rival ideas to behind with, and they might need incentives to do so.

  3. Increasing returns and the art of self-trapping
    Comment on ‘Economic growth’
    .
    As Krugman put it on his blog “most of what I and many others do is sorta-kinda neoclassical because it takes the maximization-and-equilibrium world as a starting point …”.
    .
    Here, one has the fatal methodological blunder in a nutshell. By taking these green-cheese assumptions as hard core premises (Weintraub, 1985, p. 147) neoclassicals simply cannot handle increasing returns — which are the very characteristic of industrialization since Adam Smith’s pin factory.
    .
    “A competitive equilibrium is not possible at a point of increasing returns to scale because no one wants to be the firm (negative profits). A competitive equilibrium is not possible at a point of decreasing returns to scale because everyone wants to be the firm (positive profits). General equilibrium theory for a competitive capitalist economy only works in the special case of constant returns to scale where (by assumption) no one cares who acts as the firm (zero profits).” (Ellerman, 1986, p. 70)
    .
    In order to get out of this home-made analytical trap the sorta-kinda maximization-and-equilibrium premises have to be dropped and replaced (2011). Neoclassicals cannot do this because it amounts to self-annihilation.
    .
    References
    Ellerman, D. P. (1986). Property Appropriation and Economic Theory. In P. Mirowski (Ed.), The Reconstruction of Economic Theory, pages 41–92. Boston,
    MA, Dordrecht, Lancaster: Kluwer-Nijhoff.
    Kakarot-Handtke, E. (2011). Increasing Returns and Stability. SSRN Working Paper
    Series, 1921267: 1–19. URL http://ssrn.com/abstract=1921267
    Weintraub, E. R. (1985). Joan Robinson’s Critique of Equilibrium: An Appraisal.
    American Economic Review, Papers and Proceedings, 75(2): 146–149. URL
    http://www.jstor.org/stable/1805586.

  4. The key to that quote is competitive equilibrium (and even then it’s only half true). Most models with increasing returns to scale uses monopolistic competition as the benchmark. I don’t find that particularly problematic, and it certainly doesn’t amount to self-annihilation, nor does it necessitate neither equilibrium nor maximisation to be “dropped and replaced”. Some of you post-keynesians really need to up your game.

    • ICYMI (pontus Nov 26)
      .
      You say “I don’t find [increasing returns] particularly problematic”. This, perhaps, is due to a lack of deeper understanding.
      .
      “So, Brian, what are you working on these days?” Arthur had given him the the two-word answer just to get started: “Increasing returns.” And the economics department chairman, …, had stared at him with a kind of deadpan look. “But — we know increasing returns don’t exist.” “Besides,” jumped in Rothenberg with a grin, “if they did, we’d have to outlaw them!” And then they’d laughed. (Waldrop, 1993, p. 18)
      .
      “The whole [invisible hand] theory is at risk if there are increasing returns which are ‘large relative to the size of the economy’. … It arises from the fact that, even if firms continued to act as price takers, there may exist no equilibrium prices.” (Hahn, 1984, p. 116)
      .
      Neoclassical economics, i.e. sorta-kinda maximization-and-equilibrium, is dead and buried. The same holds for Post Keynesianism (2011). What is needed is a paradigm shift. Because this is clearly beyond the capabilities of Neoclassicals and Post Keynesians (2013) they are asked to retire without further self-debunking.
      .
      References
      Hahn, F. H. (1984). Equilibrium and Macroeconomics. Cambridge, MA: MIT Press.
      Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL http://ssrn.com/abstract=1966438.
      Kakarot-Handtke, E. (2013). Confused Confusers: How to Stop Thinking Like an Economist and Start Thinking Like a Scientist. SSRN Working Paper Series, 2207598: 1–16. URL http://ssrn.com/abstract=2207598.
      Waldrop, M. M. (1993). Complexity. London: Viking.

      • Hi,

        No, I don’t find *monopolistic competition* particularly problematic. I believe both Krugman and Arthur showed some possibilities that were not immediately obvious, and thereby made real (non-rival) contributions. But that was early 80s, the lesson was learned and the literature adapted accordingly. You have to start criticising modern economics, not eighties economics.

        Repeating that something is dead doesn’t make it dead.

  5. I didn’t read the OP as suggesting that neoclassical economists “ignore” non-rival goods and increasing returns altogether. The suggestion is that neoclassical economics uses conceptual compartmentalization, exemplified by the false concept of “human capital”, to preserve the general equilibrium framework of Solow-Swan growth theory, with its accumulating capital stock, against the logical implications of non-rival goods and increasing returns. The accumulation of “human capital” becomes a ready and stylized explanation for the stylized facts that neoclassical growth theory, in its insulation from critical thought, so loves to propound.
    .
    Piketty did something profoundly clever with capital, by not directly challenging the production function framework for analyzing income distribution among factors, with its easy talk of substitution between factors, but nevertheless defining capital income as deriving from legal claims or assets, rather than a stock of heterogeneous factors of production directly responsible for producing output. It forces a critical distinction, and one grounded in actual facts. We will see how far it goes toward subverting the whole rotten structure of neoclassical growth theory.

    • I don’t want to sidetrack the discussion of whether neo-classical theory can handle increasing returns, but I have another problem with it which I think is even more fundamental.

      Does it tell us what we need to know?

      We know that certain countries have gone through a process of growth. We know that others have been largely left behind. The first group have been concentrated in Europe, North American and (particularly North) East Asia. The second group are in the Middle East, Africa, and South America. (Brazil is growing, but we will see how sustainable that is.)

      Is the above a coincidence? Romer says you can explain why certain countries enter the catch up phase without historical and social context – eg the role of political, social and institutional factors.

      But take that to a Japanologist, Sinologist, or a Middle East or Africa area specialist. They will tell you it is all about those things. For example to understand the industrialisation of Japan you have to go back to the period of isolation, how an import substitution structure and a firm basis for growth was created which meant once the country entered into globalisation it did not find itself in the position that Africa and South America did. And unlike the latter case, there is undeniable evidence that import substitution policies in Japan during the Meiji Era actually worked.

      These issues are crucial. They even extend to security issues. Really if we really tried to understand these issues properly and we could get the Middle East on to a stable growth curve and end the marginalisation, we have dealt with Islamic State.

      To do that though, you have to engage with the history and the societies. You have to trawl through the archives and go out on the field.

      • Indeed.

        Alternatively, another context to appreciate the full horror of growth theory on display, you need only look to the projective analyses of the economics of climate change mitigation gathered by the IPCC for its most recent set of reports.

  6. Still behind the curve
    Comment on pontus on ‘Economic growth’
    .
    In the 1980s the neoclassical avant-garde arrived at the insight that the research program had run into the sand.
    .
    “I have always regarded Competitive General Equilibrium analysis as akin to the mock-up an aircraft engineer might build. My amazement in recent years has accordingly been very great to find that many economists are passing the mock-up off as an airworthy plane, and that politicians, bankers, and commentators are scrambling to get seats. This at a time when theorists all over the world have become aware that anything based on this mock-up is unlikely to fly, since it neglects some crucial aspects of the world, the recognition of which will force some drastic re-designing.” (Hahn, 1981, p. 1036)
    .
    It was obvious to some that cosmetic corrections and the habitual quick fixes would no longer suffice.
    .
    “There is another alternative: to formulate a completely new research program and conceptual approach. As we have seen, this is often spoken of, but there is still no indication of what it might mean.” (Ingrao et al., 1990, p. 362)
    .
    To attempt a paradigm shift in earnest is what genuine scientists would have done. But there is a longstanding tradition in economics to violate scientific standards.
    .
    “In economics we should strive to proceed, wherever we can, exactly according to the standards of the other, more advanced, sciences, where it is not possible, once an issue has been decided, to continue to write about it as if nothing had happened.” (Morgenstern, 1941, pp. 369-370)
    .
    All this got lost on the representative economist and this is why he makes a fool of himself as sorta-kinda maximization-and-equilibrium guy ‘as if nothing had happened’.
    .
    You give me this good advice: “You have to start criticising modern economics, not eighties economics.”
    .
    There is no need for anybody to criticize modern neoclassical economics because nothing that has been produced since the eighties can be taken seriously (Quiggin, 2010). The premises of maximization-and-equilibrium have been false then and are false now.* The iron methodological rule holds: garbage in, garbage out.
    .
    The representative economist has failed to catch up with Joan Robinson of 1980: “Scrap the lot and start again.”
    .
    Throw away all papers, books, and posts that apply sorta-kinda maximization-and-equilibrium and only what then remains is worthy of further discussion.
    .
    Egmont Kakarot-Handtke
    .
    References
    Hahn, F. H. (1981). Review: A Neoclassical Analysis of Macroeconomic Policy.
    Economic Journal, 91(364): 1036–1039. URL http://www.jstor.org/stable/
    2232512.
    Ingrao, B., and Israel, G. (1990). The Invisible Hand. Economic Equilibrium in the
    History of Science. Cambridge, MA, London: MIT Press.
    Morgenstern, O. (1941). Professor Hicks on Value and Capital. Journal of Political
    Economy, 49(3): 361–393. URL http://www.jstor.org/stable/1824735.
    Quiggin, J. (2010). Zombie Economics. How Dead Ideas Still Walk Among Us.
    Princeton, NJ, Oxford: Princeton University Press.
    .
    * See also the post ‘Heterodoxy as superior alternative’
    http://axecorg.blogspot.de/2015/11/heterodoxy-as-superior-alternative.html


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