Russ Roberts

Hidalgo Follow-up

EconTalk Extra
by Russ Roberts
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There was an interesting moment in this week's episode when Cesar Hidalgo said the following when I was asking why he ignored the role of prices:

like Hayek said it, and basically it gets regurgitated even nowadays in every common section of every newspaper more or less when people are discussing the economy--since the role of prices in revealing information about supply and demand has been said, I tried to focus on aspects of information in the economy that had not been so much discussed in the literature.
Hidalgo's take on prices reminded me of this EconTalk episode with William Byers. Byers makes the point that there are some concepts such as "randomness" that can be defined. But you can spend a lifetime thinking about them and still not understand them completely. You can always go deeper.

For me the role of prices in steering information and allocating resources is one of those ideas. It's a very deep idea. But a lot of people (and Hidalgo seems to be in this group) treat it as been-there done-that idea. Let's move on to the more interesting stuff. Like when they don't work. Or they're good for explaining buying and selling so let's talk about trust and cooperation among networks of people, which is what Hidalgo finds more interesting.

But the role of prices in supply and demand is just the beginning. Of course it doesn't work perfectly except in textbooks. But what do we know about when it works better and when it works less well? And prices do a lot more than just take care of supply and demand--they create the division of labor and decide what receives attention from innovators and entrepreneurs. Prices coordinate undesigned cooperation across firms and across space ad across time. Prices encourage collaborators to work on some things and not others. Freely adjusting prices don't solve all problems. They aren't perfect. But their effects are not fully understood or appreciated. See Venezuela for one example.

And finally, not all prices are monetary. Commercial transactions are not the only results from a well-functioning price system. Again, see Venezuela. I have a feeling there isn't a lot of trust in a system where the price system isn't allowed to function.

I understand Hidalgo's interest in going beyond (or maybe it's beside) the role of prices. But I wonder if he's thought enough about them. I haven't and I think about them a lot. I do concede that they are often my hammer looking for a nail. (After all, I wrote a book about how prices create order and prosperity and flourishing.) I'm just encouraging Hidalgo to take a closer look at the hammer. It might be more interesting than it appears at first glance.

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COMMENTS (8 to date)
jw writes:

I also disagreed with Hildago on pricing. The fact that shoe making is quickly moving to Vietnam and garment making is being ramped up in Madagascar proves that China had little comparative advantage in those markets other than plentiful and cheap labor (and some infrastructure, hence India still lags).

As to your comment above: "I have a feeling there isn't a lot of trust in a system where the price system isn't allowed to function.", I totally agree. Hence my complete distrust (along with many other capital investors) when the price of MONEY isn't allowed to function due to Fed diktat.

Price controls ALWAYS lead to misallocations and unintended consequences. Some PhD's never learn...

Cesar Hidalgo writes:

Hi Russel,

Thanks for your comments. It was great being part of your podcast.

After reading your post-mortem, I felt the need to explain myself better.

First, my position is not that prices are irrelevant, or that they do not matter, or that we should not think about them. Rather, my position is that when it comes to our understanding of the role of information in economics prices have dominated the debate, when there are other aspects of information that one can also spend a life thinking about and that are rarely considered.

Examples of other aspects of information that are conspicuously absent (or largely absent) in our discussion of economic systems are the second law of thermodynamics (present mostly in sustainability discussions), the relationship between energy dissipation and the creation of order (Prigogine's work), the energy cost of computation (Landauer's Principle), the finite capacity of systems to compute (see Seth Lloyd's papers in the computational capacity of the universe from early last decade), the role of social networks in the distribution of computation, etc.

These are all topics that are important to understand for anyone trying to understand any organized system, including those embodied in economies. These are also topics that one can spend a life thinking about.

As a writer I need to prioritize, and when I do that I need to choose between describing prices, in a world where many people are probably more prepared than I am to do that, or to bring into the surface fundamental aspect of systems of organized complexity that are often excluded from the conversation. I believe that I contribute more doing the latter, even if it makes me somehow unpopular among the mainstream.

So I agree with you that prices are interesting to think about, and I'll continue thinking about them. But since I am a unit with fundamental constraints in my computational ability (and time), I will also agree with you on the importance of the division of knowledge (which is not the same as that of labor). To improve our ability to understand economic systems better it is important that we create an inclusive environment where different people can focus on different "hammers." Of course, we need a common language to be able to communicate, but we should not fall in the trap of judging people based on what they do not say. In your case, I can be crucified by not focusing on prices in lieu of thermodynamics and computation. In the case of others, I could be crucified by not focusing on the organizational role of religions, the constraints to social organization emerging from evolutionary psychology, or the historical processes that give rise to formal institutions. To write a focused story about a few "hammers," there are other hammers I need to leave out. Hopefully, this will not be my last book. :-)

As always, it has been a pleasure to interact with you.

Cheers!

C

jw writes:

Prof. Hildago,

I would never characterize Russ as "crucifying" anyone, I hope that word was used as a satirical exaggeration.

In any case, thanks again for a great podcast, I look forward to reading your book when I get home to my Kindle.

So on to information destruction, entropy and conservation. If not in your book, can you help me understand the relationship between information destruction in your mind and the conservation of quantum information that Susskind/Hawking once debated (and although they now agree, I understand that some physicists still don't agree with them)?

How is quantum information related to what we perceive as information? Our information is also based on those same quantum spins and entanglements, so our information can be lost while still preserving quantum information (ie, when we die, all of the uncommunicated information that is in our brains simply ceases to exist - leaving out theology for now, so how does that impact quantum information that we created/changed when we retained the original information)?

I have many more questions, but I don't want to monopolize the forum.

jw writes:

I reread my original post and just want to make it perfectly clear that I was referring to Bernanke and Yellen (and several other Fed governors) with my "Some PhD's will never learn" comment.

JP writes:

Another important thing to note about firms where teamwork is prevalent is that the price system still guides this off-price behavior. The reason that firms elect to bypass the price system is a direct result of the costs of using the price system and the benefits of off-price connection--this is still a result of prices. The only place where the price system can be disconnected from behavior is in the use of force--even Robinson Crusoe faces relative prices though we can't quantify them in a numeraire.

Russ Roberts writes:

Cesar,

A lovely response. I am a big fan of specialization, so I totally get it. I guess I was reacting as much to the tone as to the content, as if the role of prices is well-known. I think the textbook version is well-known--prices equilibrate the quantity supplied with the quantity demanded. That's nice but it's misleading (equilibrium is a construct not a reality) and there's so much more to the role prices play in creating order. I look forward to that next book.

jw writes:

I read “Why Information Grows” yesterday and it had several good insights. Besides the “time machine birth canal”, I was impressed by Pep’s game planning quote, THAT is a book for someone to write (I will attempt to review the book without too many spoilers). Also, like Boltzmann’s frustration with atoms, if someone actually derives the invisible mechanism behind Smith’s invisible hand, that will be an interesting day.

The personbyte did not make sense to me. Defining something as finite may increase its usefulness, but does not seem to aid much in making predictions based upon it. Humans may have a maximum and finite ability, but to use IQ as a proxy, the distribution has a zero bound, but no upper bound. We may not yet understand where the limits of human abilities are. If you are only concerned with the mean or median, that already exists. It also reminded me a bit of “The Mythical Man Month”.

There is a lot of “I, Pencil” in the middle of the book, but from a slightly different perspective. Still, I didn’t see much differentiation. Yes, markets self-develop, but their communication mechanism remains prices. Interfering in any way with the free flow of that communication reduces total information.

If, as we learned in Thermodynamics, energy is required to locally buck entropy, then the rapid increase in worldwide human wealth that has occurred in the last 200 years that has been attributed to using more energy (primarily fossil fuels) to increase industrial production (information stored in solid form) may be more generally thought of as a leap in increasing Shannon information. I can certainly accept that. (Conversely, non-price driven, centrally planned and state mandated limits to using energy are reducing the growth of information.)

Overall, the book is very well written, the epilogue on his experience in writing the book was excellent, and I scanned the notes and think that most should have been included, there is a lot of value there. (Note: the linked D3 Plus graphs crashes Kindles). I also urge the professor to defer betting any money on his econometric model until at least a few decades of out of sample data come in.

Lastly, on the concept of isolation and losing information, someday in the future when humans become fully globalized, will we not then be isolated on a global scale? What information will we lose then?

Morgan Dubiel writes:

Price itself is a trust building tool. In construction when I get a price that is too high or too low, I am naturally suspicious and do more investigating. When I get an expected price, given the history of pricing for that item or service, I buy. I do always like a lower price, but it often reflects a factor that has been lowered.

For instance, if a subcontractor underbids the job, no matter how awesome that price is, there's a cost to be borne by lower quality, delayed or lost time, and perhaps even a lawsuit. Price really contains a ton of information and is not the only signal, but the clearest. If something sounds too good to be true...

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