the dismal science

In general we’ve moved from an agricultural economy to manufacturing, then to a services industry.  What’s next?  Probably a frivolity economy.


I think this bothers some people.  A standard complaint about capitalism is that it devotes enormous energy to producing things we don’t need and shouldn’t want.  Many thinkers, left and right, seem to think we should just produce the bare necessities– or at least, avoid obvious excesses, like plastic surgery and bondage gear.

My contention is that what capitalism is good at is producing things people want, whether or not either anarchist professors or austerian central bankers approve of them– and that it should produce those things.  In fact, if it didn’t, the economy would collapse.  In the far future, I expect human activity to be little but frivolity.

Continued on Research Access

From Ha-Joon Chang:

If even the IMF doesn’t approve, why is the UK government persisting with a policy that is clearly not working? Or, for that matter, why is the same policy pushed through across Europe? A certain dead economist would have said it is because the government is “in reality instituted for the defence of the rich against the poor“. Dead right.

The dead economist is Adam Smith, and as Chang points out, there was no mystery about it in Smith’s day: only the wealthy could vote, and they ran the government for their own benefit.

When universal suffrage came, they were terrified of redistribution– or even a more equitable distribution of newly generated wealth.  They can’t directly attack democracy in the First World, so they attack “politics” instead.  When they can, they insulate wealth from politics entirely– not hard to do when ordinary voters don’t understand the stakes.  Thus we get reasonable-sounding independent central banks, balanced budget rules, IMF oversight, attacks on inflation that doesn’t exist, and ‘technocratic’ governments imposed on Italy and Greece– that is, governments that will do what the European wealthy think is best for Germany.

The irony at the moment is that there’s been a change of heart over at the IMF.  They’ve withdrawn support for austerity, and are suggesting to Britain that maybe sending the country back into recession isn’t that great an idea.  The Treasury promises to fight back.

Why do the Very Serious People love austerity?  After all, they’d themselves be richer if the economy was back on track.  I don’t think this a great mystery either.  Ideologically, it’s congenial to them– it sounds like the tough stuff leaders are supposed to say.  But best of all, the toughness is all faced by other people.  Austerity is an opportunity to beat back the claims of the middle class and the poor: cut social programs, fight attempts to reduce the dominance of  the 1%, and divert attention from how the financial industry caused the recession in the first place.

If you read Smith, it’s striking how the same preference existed two hundred years ago.  The conservatives preferred “cheap years”… i.e. recessions, when labor was pleasantly low-priced.  They’re going to do fine in bad times, and they sense that there will be less pressure on them if everyone else is feeling pinched.  As has long been noted, a system is in the most danger of revolution not when things are getting worse but when living standards are improving.

While I’m touting economics links, here’s an interesting essay from Brad DeLong on why corporations work at all.  As he points out, their structure is Soviet: they’re autocratic, huge-scale, centrally directed enterprises.  The USSR stagnated, so why don’t they?

He offers several possible reasons:

  • Soviet industries could be propped up indefinitely; unprofitable corporations do slowly decline, go bankrupt, or get taken over.  So there is a mechanism for replacement, however slow.
  • Huge enterprises may simply be the best organization for producing certain goods– planes, for instance: there’s a high cost if, say, you have the engine ready but not the wings.
  • Stockholders will discipline an incompetent CEO.  Pause for laughter.  OK, DeLong quickly admits that the theoretical oversight is mostly a failure, but he suggests that the punishment mechanism isn’t so much the stockholders as the stock market.  A crashing stock price talks very loudly, and creates a mechanism for a hostile takeover.
  • Finally, corporations are intensely useful to government, and thus are favored by taxation and economic policy.  Corporations do most of the work of tax collection (income and sales), and they’re encouraged to provide a good deal of health insurance.

(I’d also add that beating the Soviets is a pretty low bar.  They were more concerned with destroying opposition than in improving their methods.)

Undoubtedly there’s something to all of these ideas.  But I think DeLong misses some more Marxian possibilities:

  • Inertia.  We now think monarchy was a terrible system, but it persisted for a thousand years.  Even if the Next Big Thing was here, competition between entire systems can go on a long, long time.  (A Martian observer might have concluded from the history of the 18th century that UK was onto something, but it would take nearly two centuries before the majority of countries adopted democracy and capitalism.)
  • A better way of organizing production would be unlikely to benefit those currently in charge… who will therefore resist it tooth and claw.  Suppose the Next Big Thing is something as simple as Valve’s no-manager, vote-with-your-desk system.  Is EA going to adopt it?  Obviously not; the people who run EA would lose power and probably money, even if the employees of EA on the whole benefited.  And it’s the people who run EA who get to decide.  It’s the same problem Chang is pointing out: the entrenched interests are happy with things as they are.

Besides, what would happen if a new style of governance became available?  DeLong (the piece was written in 1995) reviews one such case:

Fifteen years ago it was fashionable to hold up the Japanese corporation as an example, to say that its managers regarded shareholders as only one stakeholder interest among many, and to say that the Japanese corporation was a superior organization and the wave of the future. Now it is fashionable to praise the American form of organization, with an active market for corporate control and with strong pressure on managers to do whatever they can to boost stock prices now.

In other words, a new system becomes a new fad, and a lot of people get rich writing bestsellers about it.  But the magic of Japan Inc. wore off abruptly when Japan plunged into recession in the early ’90s.

On the other hand, as I’ve mentioned before, the fad for highly paid CEOs was entirely successful.  In the 1960s it was accepted that American CEOs should get about 50 times the pay of their base workers.  Now it’s 500 times.  Corporations aren’t better run or more productive or more stable or more competitive; the effect has simply been to shift wealth from the 99% to the 1%.  Why did this fad succeed when the fad for Japanese-style management didn’t?  Pretty obviously, because it doesn’t require much convincing to tell executives that they should help themselves to ten times the salary.  It’s not that it was a good idea; it’s that it appealed to the people who make the decisions.

When change happens, it’s likely to come from either a new region or a new industry, and be very ignorable for years or decades or centuries.

I have a suspicion that top-down command works better for creating  vast new project– whether it’s an oil refinement industry or a spaceship or a computer or an online mega-bookstore– than it does for running an ongoing business.  Capitalism recognizes this to some extent, in that older businesses have more and more dilute ownership.  But this also means that there’s a kind of ongoing bias in favor of autarchy.  New firms, like the big web firms of the ’90s, are likely to be started by visionary hotshots, and that reinforces the elite’s notion that all corporations should be run by autarchs– even if, as happened recently at JC Penney, the hotshots come in and ruin the company.

So a more democratic corporate structure might have to wait for the next big thing that doesn’t happen to be a megaproject.  I can see it happen, for instance, if we move from the service economy to an art economy, for instance.  (Which I don’t see as unlikely: creative work is very hard to delegate to robots.)

My light reading for about a month has been An economic history of medieval Europe, by N.J.G. Pounds.  I recommend it half-heartedly.

What do we know about medieval economics?  Frustratingly little, it turns out.  Every few pages Pounds has to remind us that there just isn’t much data.  He goes over what we have, but it’s really impossible to build up the sort of overall statistics that we take for granted today.  It’s almost impossible to get estimates of production of goods, or even to definitively answer questions like when the moldboard plow was actually adopted, or whether the 1400s were a period of depression or a time of productive improvement.

The book is from 1974, so it’s possible that nearly 30 years have produced a slightly clearer picture.  E.g. I don’t quite buy his statements that medieval technology was stagnant, not after reading Jean Gimpel’s The Medieval Machine.  Pounds even mentions some of the same inventions, such as the blossoming of mill technology and the later focus on mining.

Perhaps the biggest surprise is in the first few chapters, on the late Roman Empire.  We have a picture of a flourishing, sophisticated, rich urban civilization, but in many ways this is an illusion.  Most of the Empire was at a barely subsistent level; the western half was “an uninhabited wilderness, broken by islands of cultivation”; trade was minimal; large-scale enterprises were undertaken only by the state; Rome itself basically produced nothing.  The East was of course richer and more urbanized.

The book also emphasizes that the lot of the peasant, from Roman times till well into the modern age, frankly sucked.  At the subsistence level, the peasant couldn’t afford much in the way of urban wares, so the cities remained small and trade was largely in luxury goods.  The empty spaces on the map filled in, and new towns appeared, but that just meant there were more and more peasants and on more marginal land.  The only real improvement in living conditions were a) in colonizing new lands, especially in Eastern Europe; and b) after the Black Death, when depopulation temporarily created a labor shortage.

And as Eastern Europe filled up, the feudal lords exerted more and more control and turned most of the peasants into serfs.  In Western Europe the tendency was for the king to rein in the nobles, which was a little better for the peasants.

There’s a discussion of the guilds; Pounds seems to think that they never amounted to much.  They always tried for monopoly power, which in theory could restrain the economy; but in most places it was the merchants, not the craftsmen, who really ran the economy.  (Often they supplied the raw materials and even the tools.)  In any case, when the urban cloth workers grew too expensive, the merchants simply outsourced the work to the rural areas.

One surprising assertion is that the cities had trouble feeding themselves– the northern Italian cities had to import grain from as far as Sicily.  This seems a bit odd when none of them exceeded 50,000 residents.  But perhaps the surplus of the European farmer really was that low– or perhaps the situation illustrates the price differential of wagons vs. ships.

There’s quite a bit about how the early fairs developed into permanent commercial markets, and how the early traders operated.  Currency was scarce, so things were arranged such that little money had to actually change hands.  You’d bring your alum to Bruges, take home a shipment of woolens, and payments were mostly handled by moving numbers within the bankers’ ledgers.  (The last few days of a fair were devoted to the settling of accounts.)  At first the big merchants actually traveled across the continent; later on they simply employed local agents.

Kings and other lords were constantly interfering in the market.  Landowners, including the king, were generally able stewards of their own estates.  Their powers of enforcement over the rest of society were limited, which led to interesting compromises.  Close control was impossible, but on the other hand focusses of wealth could be seized.  Thus cities were given a large measure of autonomy, but were also easily taxed.   In many countries the king had the right to all mineral resources– but as he could hardly mine everywhere, what this came down to was that anyone could mine, but owed a tax to the king.  Most states were highly in debt to the banks, but didn’t scruple at confiscating a local bank or defaulting to a foreign one.

Another lesson is just how miscellaneous Europe was.  Generalizations at the national level are almost useless; you have to look at each region and even each town.  The Elder Scrolls continent of Tamriel, with its ragged multiplicity of races and regions, is actually not a bad model, certainly much better than the usual fantasy expedient of one uniform country with perhaps one exotic neighbor.

I recently got into a conversation with a work colleague regarding piracy. Specifically, the basic assumption that I came to is that internet piracy of media is that we do not value the artist’s effort in production, nor do we comprehend the inherent monetary value of art (I positioned it as a symptom of post-modernism, that art is for art’s sake, and art-for-monetary’s sake is blasphemous.) He stated that the cost of media is just too high, and he also opposes (much like a lot of things) certain studios so refuses to give them his money, but still wants to enjoy the media produced under their umbrella. My question is, knowing that you have written on this before: What are your initial thoughts on the MegaUpload extradition? And what are your thoughts pertaining to the idea of media piracy— why do we do it? Ultimately, I’m not trying to understand why the government is wrong in trying to push SOPA and PIPA through, nor am I trying to figure out which one of us was right, if any, just your opinions on the subject.


As a content creator myself, I think people should pay for their art.  (Except sometimes; see below.)

But in general, I think ‘piracy’ is a sign of market failure, and disappears when providers make it easy to get content in whatever form is desired.  My best argument for this is the enormous success of Steam.  Steam is at root a DRM system, but it’s so packed with features for the gamer that it’s actually a pleasure to use, and I don’t buy games any other way now.  You can buy your games there, see what games your friends are playing, chat with them, use games on multiple computers and platforms.  There are frequent sales, so those $60 games will soon be available for half that— or wait a year and get them for under $10.  You can review games or get links to other reviews before you buy.  You automatically get updates and patches.  I recall an interview with Gabe Newell where he said people thought Steam was crazy to get into Russia, which is notorious for piracy, but they’ve done very well there.

The music industry earned a lot of hatred for attempting to continue its lucrative old model— selling physical CDs for $20 a pop— well into the electronic age.  Their business model had very little to do with helping artists; they wanted the profits of the manufacturer / distributor… precisely those costs that go away with electronic distribution.  I don’t know the figures, but I’d guess that most people are pretty happy buying single songs from iTunes for a buck.

The next battleground is movies.  Why haven’t the studios come up with a Steam-like service where all movies are available on all platforms, at reasonable prices?  Instead of tracking down pirates and alienating customers, they should be figuring out a feature-packed, cheap distribution system of their own.

During the SOPA fight many people pointed out the absurdity of the jobs claims made by the industry, which were based on the idea that any pirated viewing represents a full theater admission lost.  Of course it doesn’t.  If someone wasn’t able to pirate the movie, he would probably have skipped it, or waited till it was free on TV or at the library.  Or maybe he’d pay $1 for a used DVD, or $2.50 for an iPad version.

Many businesses have discovered the joys of variable pricing— Tim Harford’s The Undercover Economist goes into detail on this.  Econ 101 tells you that there’s a single price— let’s say $17.95— where the supply curve and demand curve intersect, and which maximizes sales and profits.  Econ 101 is wrong!  All those consumers who’d happily pay $10, or $5, or $1, don’t get what they want, so their sales are lost.  And those consumers who’d pay $50 or $100 aren’t being milked for enough simoleons!

It’s not easy to work up a pricing scheme where everyone pays the maximum they’re willing to… but plenty of markets do their damnedest to try.  Airlines are very good at this— it’s almost the case that no two flyers get the same price.  Books are a good example: you can get a hardcover for $25, a trade paperback for $15, a mass market paperback for $9, a Kindle for $5, a used book for $3, a library book for free.  Steam approximates this for video games, the chief variables being willingness to wait, and assiduousness in checking sales.  (Game companies have even figured out how to get the really motivated customers to spend more, largely with premium editions and DLC.)

And note, there’s a role in this model for free.  I don’t mind if you lend your copy of the LCK to a friend, or donate it to the local library!  A certain amount of free distribution builds recognition and good will, and in the long run increases sales.  (Neil Gaiman has experimented with giving books away for a limited time; it always increases actual sales as well.)

Plus, art needs art as a source of ideas and inspirations— it would be a bad thing if the heirs of Shakespeare controlled performance of his plays.  It’s right there in the Constitution: copyright is a balance between the interest of creators and consumers.  The sign that the balance has gone too far toward the consumers would be that artists are starving and not producing any art— and they’re not!  We’re awash in art!

If I read anti-industry people too much, I start to sympathize with the conglomerates.  People make all sorts of rationalization for what sounds like entitlement and miserliness.  But really such things are a reaction to the obvious greed and stupidity of the distributors (who aren’t even the creators).  If your friend doesn’t want to pay $17.95, that doesn’t justify him in paying $0, but if they were smart the distributors would find a way to get him to pay $5, or whatever.

I also think we’re going through a slow transition from a system dominated by middlemen, to one where artists handle their own production and distribution, and of course the middlemen are squawking.  But it’s their own fault for not adapting.  Books and music, and even indie movies, could easily be produced by their creators.  Maybe not blockbuster movies, but somehow I don’t think we’ll ever have too few of those.



In 1989 the Peruvian economist Hernando de Soto published a remarkable book, The Other Path, a detailed exploration of the extralegal economy, mostly based on his research in Peru.  He pointed out that the informales controlled 60% of the Peruvian economy, and his group painstakingly documented the barriers to full legality.  To open a tiny garment factory, for instance, took nearly a year as well as fees totalling five times the monthly minimum wage.  (And none of this red tape had any actual social utility: not a single bureaucrat actually asked to see the factory.)

In 2000 he published a follow-up, The Mystery of Capital, which presents research in more countries (Egypt, Haiti, the Philippines, and Mexico) and makes a bolder thesis: that extralegality is itself an oppressive situation that results in the underdevelopment of the Third World.  In the Philippines, for instance, he estimates that extralegal property alone is worth $132 billion– four times the value of all the firms on the country’s stock market.

As he documents, the informals have their own property arrangements among themselves for recognizing ownership.  So why is legalization important?  Mostly because titles allow mortgages.  He points out that 70% of new businesses in the US raise capital by mortgaging property.   There are other benefits as well, from the use of the court system to access to insurance to better relations with law enforcement.  Informal companies can do a lot but they can’t expand into major companies or take advantage of economies of scale.

Just recording titles isn’t enough, and he criticizes governments who think high-tech computer mapping is all they need.  People will only use systems that seem fair to them, and that means recognizing and regularizing the informal systems they’ve developed themselves.  To make it all work requires work by politicians, lawyers, banks, and the residents themselves.

Intriguingly, he shows that the same problems hit the US, Europe, and Japan.  In the US, for instance, in theory the government managed the westward expansion, selling land to settlers.  In practice much of the settlement was started by squatters.  There were big fights in the 1800s over this, and a slow turn from fighting the squatters to recognizing them as valuable agents who were creating national wealth.

De Soto has been highly praised on the right, though I have a sense his friends haven’t read him very carefully.  He’s taken as praising capitalism, supporting property rights, and lauding small businessmen… stuff the right thinks it’s doing.  But he’s actually a severe critic of capitalism, and warns that globalization and capitalism are largely failures in the Third World, because nothing has been done to address the systems that exclude the poor.  “Capitalism” in the Third World all too often is limited to little bubbles in the capital where First World rules apply, and the elites aren’t even aware of the obstacles that prevent the bubbles from expanding to serve the whole nation.

On the left I think he’s largely ignored, or else assumed to be an apologist for the elites or for globalizing capitalism, which he certainly is not.  His main point is that the poor have enormous energy and want to be part of the system, and the system should make reforms to let them in.  Third World legal systems largely assume that the legal sector is a tiny, urban phenomenon; it did not anticipate and can’t handle the flood of millions of people who prefer the opportunities of urban life.

If you’ve never read him, I recommend either book– I really don’t think development in the Third World can be understood without confronting his ideas.  They’re not a program for utopia– we have property rights here and that doesn’t prevent us from being pretty messed up.  But much of the world would love to advance to our organizational level.  It’s just absurd to maintain the levels of corruption and red tape that he describes; they are certainly real obstacles to people building prosperous economies and should be fixed pronto.

On the whole, I think the first book was stronger.  The second adds more cases, plus some salutary lessons from US history, but it’s often repetitive and relies a little too much on exhortation and cutesy metaphors.  He’s been involved with actual legalization programs, and I wish there were more details on how those have gone and what lessons have been learned.

(The last ten years have maybe not been kind to the idea of building wealth through mortgaging.  So his estimations of the value of informal property may be exaggerated.  But again, his basic point about the informals being excluded from the financial and legal sector is hard to refute.)

Wow.  Sometimes for the most stinging critiques of capitalism, you need to look in a business magazine.  Such as Steve Denning’s article in Forbes on the catastrophe that is managing companies to maximize stockholder value.  (The article in turn is a review of Roger Martin’s Fixing the Game).

The culprit turns out to be Jensen & Meckling’s infamous 1976 paper which argued that CEOs should be incentivized to share the concerns of shareholders, which was to be done by giving them massive amounts of company stock.  The CEOs didn’t object, of course, since this meant obscene amounts of money. 

What this led to was an epidemic of short-term thinking, a shorter business cycle, corruption and business scandals, and an orientation toward gaming the system (e.g. looting the pension fund, or outsourcing, in order to meet quarterly targets).  And as a kicker, the system fails at its own intended purpose: stockholder value has grown slower than back when companies were managed to maximize real-world benefits for customers.  

These things can be fixed, though it will require legal changes.  E.g. MArtin favors repealigng the “safe harbor” provision and FASB 142, both of which require executives to make predictions about stock performance and penalize them for not making targets. 

In short, companies that focus on delighting the customer not only do better for those customers, and for their employees, but they make more money and thus keep the stockholders happier too.  The whole trend of overpaying the CEO isn’t merely a great injustice; it’s also bad business.



Since Yesterday is Frederick Lewis Allen’s sequel to Only Yesterday, and deals with the ’30s in the same way. 

It’s a better and a worse book, due to its subject matter.  The first book had a lightness of tone (even when dealing with scandals and gangsters) that had to be abandoned facing the enormity of the Depression.  A quarter to a third of the population out of work, the farms of the Great Plains blown away as dust, heads of corporations bewildered as to what to do next, fascism marching in Europe– it wasn’t a cheery time.  The events give the book greater depth than its predecessor; but then they refuse to provide a nice coda.  He concludes with Britain’s declaration of war; the problem is that his story is only half told. 

This is clearer on a chart.  Here’s US industrial production from the height of the stock boom (September 1929) to the end of the war (August 1945):

Allen ends at the red line.  No wonder things still looked bleak!  Though the overall trend was up, immediate memory was dominated by the 1937 recession, which had gobbled up 2/3 of the gain since the New Deal.  Production was barely at the 1929 level again; it was hard to imagine that in a few years it would double that number.  (And keep rising; the current value of the index is over 1200.)

As a history of the New Deal, I prefer Wiliam Leuchtenberg’s Franklin D. Roosevelt and the New Deal, which goes into more detail and with more historical perspective.  Still, it’s an amazing period and there’s always something new to learn about it.  I hadn’t realized, for instance, that on the day Roosevelt took office, the banking system had ceased to function.  To prevent bank runs, governors were declaring bank holidays, and that day the rot reached the biggest banks, in Illinois and New York.

On the other hand, perhaps the lack of hindsight isn’t a vice, as Allen can convey the full frustration felt at the time.  Allen thinks the economy had a structural problem: industrialization was reducing the need for workers on farms and in factories even as unemployment soared; at the same time, the concentration of industries into megacorporations made it hard to start up new enterprises.  (He points out that the banks were sitting on plenty of credit; there just didn’t seem to be much to lend to.  The megacorporations could fund their own research and expansion.)  There’s some truth to the idea of restructuring– e.g. the share of the population engaged in agriculture went from 21.5% to 16% from 1930-1945.  But the structure hypothesis doesn’t explain why the preceding and following periods were prosperous.  It looks much more like a demand crunch.  (Moral: don’t listen to businessmen about how to end a recession.  They have no idea, and their vague notions about “confidence” and “deficits” are plumb wrong.)

Again, one of the lessons of Allen’s books is how little has changed in America’s political structure.  Hoover was not as inactive as one might think– he had some small-scale stimulus going– but the business class had about the same program as today: prop up the banks, then just wait for things to get better, forever if necessary.  There was a good deal of horror over Roosevelt going off the gold standard, establishing relief programs, dividing commercial and investment banking, supporting unions, raising taxes on the rich, and above all regulating business.  On the other hand, when Roosevelt moved toward them in 1937– scaling back the New Deal and trying to balance the budget– he was rewarded with a resounding recession.  As Allen points out, of all the things Roosevelt tried, the only things that arguably worked were stimulus spending and devaluation. 

The most striking difference in our times is the near-absence of a radical left.  Roosevelt had to deal with substantial movements (Huey Long, the Townsendites, the unions, the socialists) who thought he was moving way too slowly and actually coddling business.  Not that this prevented his critics from calling him a dictator or a communist.  In general the middle and upper classes disliked him– but the country as a whole was all for the New Deal; he won re-election in the midst of of the Depression by a 61% landslide (with broad coattails: Congress was 3/4 Democratic). 

Also striking is the regional difference: the South was then a Democratic stronghold, and Republicans were strongest in the Northeast.  (It’s also worth noting that this was well before the Civil Rights era.  Though there were some victories for blacks, they’re all symbolic– e.g. Marian Anderson singing at FDR’s inauguration, Jesse Owens winning medals in Berlin.)

Everyone knows that the war ended the Depression; people often seem to think this was some kind of fluke with no contemporary application.  But economically, what the war did was make it politically acceptable to greatly multiply the size of government stimulus.  Roosevelt’s ’30s-era stimulus was too small, and had the same effect as Obama’s: improvement but no end to the economic doldrums. 

Allen once refers to Roosevelt as a “cripple”; I had thought his handicap wasn’t general knowledge.  But some Googling tells me I was wrong; it was well known that Roosevelt had polio and used a wheelchair, but the extent of it was downplayed.

Allen does his best to indicate the temper of the times, and makes a case that the ’30s in general were more sober (though not in the literal sense: we finally got rid of Prohibition) and that the mere rebelliousness and hedonism of the ’20s was largely gone– though there was no return to Puritanism.  (He quotes a survey that found that something like 70% of couples had sex before marriage.)  The intellectuals of the day did their best to focus attention on social problems– even as Hollywood pretended that there were none.  In wider histories of art, this makes the ’30s look like a strange blip: modernism was called off for a decade!

A sobering thought for bloggers: many of the cultural figures Allen names are still known… except for the opinion columns.  You can have a whole nation hanging on your analysis of politics, but no one will want to re-read them in fifty years.

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