Economics


How the Industrial Revolution happened remains a major question. Robert Fogel’s End of Hunger and Greg Clark’s Farewell to Alms try to explain the dramatic change.

Beginning around 1700-1750, there were a series of major economic changes. A “Consumer Revolution” in Britain and the American Colonies happened as the Middle Class grew. At the same time, the Second Agricultural Revolution began, which massively expanded food production. A health care revolution, beginning with Germ Theory rapidly improved medical care. The Industrial Revolution began at the start of the 19th century with the invention of the coal-powered steam engine.

The population skyrocketed, as did the pace of technological inventions. There was a cultural revolution too, as 10,000 years of agricultural lifestyles and traditions were replaced.
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After World War II, the US slashed its average tariffs from 40% to 4% and created the GATT world trade system. Most industrial countries followed the American lead. International Trade boomed.

How much did trade benefit the US economy? About $1.3 trillion more per year. Household incomes rose $10,000 larger per year. This does not unilaterally benefit the US either. Mexico has greatly benefited from NAFTA, particularly Northern Mexico.

I could wax prosaic about the productivity benefits of comparative advantage and faster technological growth. This is possibly an underestimate. The US economy as a whole is built around foreign trade.
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Microfinance is a way of bringing small-scale banking to the poor. The poor, especially in the third world, normally lack access to capital and usually have no formal property rights. This structural problem limits their options in life. Microfinance gives the promise of finance to those without sufficient collateral or income to participate in normal banking or market activities.

In the third world, many earn less than $2 a day. Microbanks offers them loans of less than $100, which can help them start small businesses. And it offers microsavings for others.
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Tyler Cowen reviews Charles Karelis’ Persistence of Poverty which describes why economic ideas from wealthier individuals and societies do not help the poor. The problem is not the amount of money or lack of effort.

The poor, due to their position, have different marginal preferences than the rest of us.
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China is running out of skilled workers and wages are rising, which means the prices of manufactured goods will rise too. This is starting to happen in India as well. China and India are undergoing the same process Japan did in the past.

Marginalism is one of the more important concepts in economics. It answers the question: why do people pay more for diamonds than water, when the total value of water is higher?

Pure rationalism fails to describe economic behavior. Consumerism is determined by subjective incremental preferences. The marginal value per unit of water decreases once our basic needs are met. Marginalism describes how consumers decide how much of something they will buy.
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I believe the problem with healthcare spending is that healthcare has a Pareto Distribution. 1% of the population uses 30% of healthcare spending, 10% uses 72% of healthcare. The bottom 50% of the population only costs 3% of total healthcare. Those percentages are from an this study.

The maximum costs increase exponentially over time even though most people are not using health care. The average cost per individual does not increase much. The problem is at the extreme – it’s a powerlaw curve without an upper limit. Epidemics spread according to a power-law distribution, as do hospital stay lengths and medical costs. The most anyone can do is try to slow the inflation rate of maximum costs.
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It looks like insurance inflated the healthcare costs more than technology. I’ve been reading Amy Finklestein’s work, like this paper that finds that Medicare increased hospital spending 37% in just 5 years after it was introduced. Spending increased more after 5 years.

Insurance may account for almost half the increase in costs. When the burden of cost is shifted onto third parties, there’s no limit on spending increases. No individual consumer has knowledge of the costs but they know about the benefits. That’s happening across the OECD, so it’s not like US private insurance companies are to blame specifically, anymore than Medicare or the UK’s NHS.
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The RAND Health Insurance Experiment is the best long-term study of the effects of insurance on spending and quality of care. Between 1974 to 1982, RAND studied 7,700 in six cities. The experimental group received free health-care and the control group shared costs with an HMO. They compared the spending on treatments.

So how much more did the free-care group spend and how much did their health improve?
The main finding was a lack of correlation between increased spending and increased health.
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The Blue Ocean Strategy is a business theory about discovering brand new markets without having to face the competition in a Red Ocean.

In the Red Ocean, you have to be bloodthirsty and defeat the competition. In Blue Oceans, you have to be a pioneer.
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Economist reports on Africa’s continuing lack of electricity.

Without electric, economic development stagnates. There was an attempt at building electrical infrastructure in the 1970s and 80s, but corruption, autocracy, and abuses took their toll and returned Africa to darkness.
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The increase in absolute trade under the trade shows how well the the GATT/WTO trade regime worked.

The increase in trade allowed greater specialization, comparative advantage, and cheaper consumer goods which reduced the costs of living. Globalization provided the fuel for many of the technological revolutions of our generation.
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“Altruism” Reseach has produced a number of very counterintuitive results. Cooperation and concepts of fairness and justice are provoked by irrational elements like spite and revenge. People cooperate because other people are mean.

The Nobel winning Economist Vernon Smith ran a number of psychological experiments to test economic decision making. Reason describes one test that produces irrational behavior.

The subjects like to believe they are acting altruistically, when they are really pointlessly cruel.
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Here’s another neuroscience study, this time trying to explain the odd results of the Ultimatum Game.

The ultimatum game is a one turn game. Player 1 is given $100 and told to divide it with Player 2. If Player 2 rejects the offer, then neither player gets anything. After that turn, the players never interact again. Player 2 cannot hold out for a bigger offer.

According to pure logic in game theory, Player 1 will take $99 and give Player 2 $1. Since $1 is greater than $0, player 2 will accept. In real life, people are spiteful. A 56-44 split is more common.
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One way to stop defections in a Prisoner’s Dilemma game is to change the mechanism to punish defections. Punishments enforce cooperation.

Our brains may be wired to punish cheaters. Men and women lose empathy for cheaters who are punished. Men, in particular, enjoy physically punishing someone who cheated. This may be our foundation of justice.
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The Formal Economy is protected by law, property rights, and contracts. This is what Westerners are used to. When you go into a shop, you engage in an economic contract with the businessman. You trade money for merchandise. This exchange is recorded by government and there is recourse within the legal system if the contract is violated.

The Informal Economy is unregulated, untaxed and unmonitored by the government. This is sometimes called the gray market – the goods are legal, but it is not under the protection of the law. The Informal Economy makes up the majority of economic activity in the poorer states of the world. It’s one of the major structural restrictions on development.
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William Nordhaus released a new study (huge pdf) measuing the costs and benefits of environmental economic policies to stop global warming. It’s too long for me to read through right now, much less dissect. Reason magazine summarized his findings though.
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It’s election time again, so we’re about to hear a lot of economic feel-good nonsense. One of the most important economic theories is that of comparative advantage. It’s a counterintuitive theory that describes the benefits of free trade.

Absolute Advantage is an easier concept. One country can be absolutely better at producing something, but that does not mean it can produce everything. Workers are not an infinite resource. This is key to understanding free trade.

One of the better essays I’ve read on this topic is Paul Krugman’s Ricardo’s Difficult Idea:
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Gregory Clark offers a provocative thesis in Farewell to Alms that human nature changed to escape from a malthusian cycle. Prior to industrialism, any improvement in productivity was nullified by an increase in population. This kept humanity trapped at the same level of wealth throughout the Middle Ages and doomed men to face frequent bouts of famine.

Around 1750s to the 1850s, there was a series of major behavioral changes that allowed Industrialism to take place. Clark argues that this is due to a mixture of cultural and biological evolution.
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Jeffrey D. Sachs calls attention to Neglected Tropical Diseases – or NTDs. This diseases afflict Africans especially.

Currently, developmental aid focuses too much on vague economic structural reform or big-name diseases like HIV. Yet it’s the little things like dysentery and parasitic worms that wreck societies. Many of these ailments can be cured with very cheap medicine and treatment
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