Arnold Kling on Prosperity, Poverty, and Economics 2.0
Dec 14 2009

Arnold Kling of EconLog and the author (with Nick Schulz) of From Poverty to Prosperity: Intangible Assets, Hidden Liabilities and the Lasting Triumph over Scarcity talks about the book with EconTalk host Russ Roberts. Kling discusses how modern economists think about growth in both developed and undeveloped countries and contrasts those ideas with earlier views in economics. The focus of the modern understanding is on ideas and the ability of ideas to improve technology, leading to prosperity. Unlike physical capital, ideas can be enjoyed by many people at once, explaining why past models that ignored ideas and focused on physical capital failed to account for the observed magnitude of economic development. Kling also discusses the success of China and India.

Paul Romer on Growth, Cities, and the State of Economics
Nobel Laureate Paul Romer of New York University talks with EconTalk host Russ Roberts about the nature of growth, the role of cities in the economy, and the state of economics. Romer also reflects on his time at the World...
William Easterly on Growth, Poverty, and Aid
William Easterly of NYU talks about why some nations escape poverty while others do not, why aid almost always fails to create growth, and what can realistically be done to help the poorest people in the world.
Explore audio transcript, further reading that will help you delve deeper into this week’s episode, and vigorous conversations in the form of our comments section below.


Greg Ransom
Dec 14 2009 at 3:00pm

Let’s think again about the role of production goods in “growth” theory. Let’s thing about how Solow’s work has led economists to stop thinking about the economic problem of production goods — and the relation of production goods to trial and error and other learning processes withing the competitive world of changing relative prices and changing economic uses.

“Capital” as the “one good” _K_ does not exist, what we have are billions of interrelated production goods participating within millions of interrelated individual production processes.

Let’s look at what happens with “technological innovation”. I have a production good in my home called a camera. It produces pictures, among other things. What happens when technological innovation takes place. Say I buy a new technological superior camera. What happens to the old camera? What I do is I fit it into a slightly different production process using different labor — I give the old camera to my kids. The money value of the old camera objectively declines radically as new technology comes on the scene. It also declines in the “economy” of my own subject valuational considerations.

So the picture Kling where the role of “capital” in economic growth can be evaluated very simply in terms of “capital accumulation” really makes no sense. When I add a new technologically superior camera to my old camera my “capital” has not “accumulated” in any quantitatively measurable sense.

Why does this matter? Because as Roberts suggests, the old technology gives us the step stone to produce the new technology — and the consumption goods we consume while working on the next step.

Hayek points out the central economic problem posed by the creation of technologically changing production goods over time — the trial and error learning process of figuring out how to fit all of the old and new production goods of differing technological superiority together in the most economically superior fashion. This is THE central argument and point found in Hayek’s case against socialism and in Hayek’s magnum opus _The Pure Theory of Capital_, and it stands behind his popular essays “The Use of Knowledge in Society” and his “Economics as a Discovery Procedure”.

Hayek’s case against “mainstream” economics is that it fails to perceive and deal with what Hayek regards as the central problem of economic science.

My point is that Kling’s “trial and error” learning model should be thought of as the core the theory of capital within growth theory — and the Solow diversion should be retired to the dustbin of history as a false model that has given economist a deeply false template for perceiving the economic and the role of capital within the economy. (And this pathology extends to macroeconomics with the bogus reification of “the” long term growth trend.)

Ironically, as John Hicks points out, Hayek’s early work on intertemporal equilibrium and the the process of capital production coordination across time was the direct inspiration of the one good “growth theory” literature — and it was Harrod himself who stated this, in discussions of the issue with Hicks.

Michael G. Heller
Dec 14 2009 at 10:50pm


This is a great show, I always look forward to your podcasts (which I usually listen to while gardening), and I learn a great deal from them. But occasionally there is a really duff discussion. This was a duff one. I do read Kling on the financial crisis with interest. But, he clearly knows nothing about development and developing countries. It was embarrassing. I got the same red-face feeling listening to the podcast with Mike Munger on culture (again way outside his areas of expertise, where he is indeed priceless), and before that during Barry Weingast’s muddled ‘theory of everything’ podcast.

Latin Americans sometimes talk about the problem of ‘todologos’, meaning intellectuals who think that once they are recognized as knowing one area well they are qualified to speak authoritatively and influence public discourse in all sorts of other areas. Richard Posner wrote a book on this problem (Public Intellectuals). Don’t spoil the show even if you are desperate for a guest! I would rather listen to you ad libbing about past podcasts.

John Strong
Dec 14 2009 at 11:06pm

Some people still view capital as a magic bullet that will rescue poor nations from “poverty traps” (Paul Collier, for instance).

Can we draw an analogy between “poverty traps” and “idea traps”? In his book, The Power of Productivity William Lewis gives an example of what you might call an “informality trap.” He says that in the Brazilian construction industry, informality inhibits expansion of the division of labor, because skilled workers have greater bargaining power and invariably demand to be employed formally in order to enjoy government health subsidies. Consequently, the added tax burden to employers cancels any productivity gains from having a specialized work force and employers just prefer to continue using unskilled workers, so specialized trades languish.

In operating system terms this is what computer scientists would call a “deadlock”.

What would Hayek say about this?

Would he acknowledge that this kind of (undesirable) temporally static equilibrium might exist?

John Strong
Dec 14 2009 at 11:39pm

Michael J. Heller:

In the region of Mexico where I live the word “todologo” has no pejorative connotation. It is a compliment, kind of like “Renaissance man,” so I don’t see why Arnold Kling should object to be called a “todologo”.

Actually, most of the intellectual folk at George Mason strike me as being pretty eclectic, so perhaps they all deserve to be called “todologos”.

By chance, are you the author of Capitalism, Institutions and Economic Development? If so, I would love to hear Russ interview you!! The TOC of your book looks fascinating, but I retreated with a whimper after seeing the price tag ($125). That’s the capitalism I love. Alas.

jaron heard
Dec 15 2009 at 1:31am

I have been enjoying listening to EconTalk since I discovered it about a year ago. Monday is the best day of the week!

There was a comment that knowledge doesn’t depreciate the way capital depreciates. It seems to me that some knowledge depreciates, especially specific knowledge. For example, fact memorization depreciates as information becomes more easily accessible, knowledge of specific computer programs depreciates as programs change, and the knowledge of how to use a slide rule has depreciated to zero, but the general ability to learn new things, solve problems, and analyze situations probably do not. Anyways, just thought that was an interesting distinction that deserves more discussion.

arc of a diver
Dec 15 2009 at 6:49am

Kling can be interesting, but this podcast wasn’t that good. Many topics, but no new discussion.

Dec 15 2009 at 7:59pm

Yeah, that episode was a bit of a dud from lack of a narrow topic. Unlike Richard Posner or Tyler Cowen, Kling is not inherently compelling in a casual context.

Russ, when are you going to get Roger Garrison (Auburn University) on the show? It would be great to listen to a discussion about his book, “Time and Money” that seems quite relevant these days. Thanks.

John Thurow
Dec 16 2009 at 7:34am

One of my favorite “Farside” cartoons is a picture of two cavemen holding their meat over a fire with their bare hands, while they grimace with pain they look over and see one of their fellow cavemen using a stick. The caption has one of the two cavemen saying “see what zog do”.

Our country was designed for states to be competitive and try different innovations – those that worked, others states could adopt, those that didn’t – well they would be ignored by the other states. A fairly similar model to how the market works. It is unfortunate that the larger the Federal Government becomes and the more they mandate laws and regulations across all states the less innovative states can be. If for example, State A created a “Public Option” for health care and it failed, then all the other states could learn from State A’s experiment and not follow. The people in the other states would be spared from an idea that didn’t work. Overtime all the States would benefit from seeing what worked and didn’t work in other states. Alas, this idea has been trumped by national socialism -it is hard for states to compete with each other and innovate when they are all forced to adopt the same national laws and ideas as everyone else.

So now we are all forced to hold our meat over the fire but without anybody trying different ways not to get their hand burned. Why? Because Federal law says that is the best way.

paul vreymans
Dec 16 2009 at 7:47am

Thanks for another excellent podcast. Please keep up this unique initiative.

Mr. Kling says that the fast acceleration in growth in the standard of living in the West during the last couple of centuries, whereas growth remained nearly flat during the centuries before cannot be explained by traditional economics.

At least part of the explanation may be that (just as saving provides exponential wealth growth for the individual), the accumulation of capital has an exponential growth effect on the macro level. The interacting effect of capital, knowledge, trade (and a competitive environment) may also have multiplicative rather than additive effects.

To my opinion the overwhelming importance of the exponential effect of capital growth (saving) for prosperity (Economics 1.0) might therefore be underestimated a bit in the final conclusion.

Thanks also for stressing the negative growth impact of institutions. Excessive public spending, excessive regulation (and corporatism) are very likely the major restraints for real growth during the last couple of decades (certainly so in Europe).

John R Palmer
Dec 17 2009 at 9:09pm

The mention of Atul Gawande made me think he would be a good guest of the show sometime. He gets so much attention in the health care debate, I would be interested to hear your conversation with him.

Dec 18 2009 at 12:34am

My question / comment relates to the discussion of India and China at the end of the podcast. I am somewhat disturbed to hear mentioned that some economists think China has the “right” set of institutions for its culture. I seem to remember hearing the same thing about Japan Inc. some 20 years ago.

My take on China’s economic growth is that it had a huge labor force that was heavily underutilized and even a little does of liberty led to a major growth in GDP. What China lacks, though, are incentives for innovation. As Kling notes, a great deal of the increased productivity in the agricultural sector is letting farmers do what they would naturally want to do — run private farms. In the industrial sector, which wasn’t discussed as much, there are incentives for some to keep some profits, but most the technology that they are using is imported or copied. There really are no incentives for the kind of entrepreneurial risk taking that fuels growth in the U.S. And this seems to fit Kling’s model, so I’m surprised he didn’t focus on it. Does anybody else share this viewa of China? (Interesting note on the high savings rate in China, by the way.)

As for future guests, may I suggest:

Terry Anderson (PERC) on cap ‘n trade (or cap ‘n crunch), or free market environmentalism generally. Anderson’s book on the Wild West was spectacular as well and would be a good substitute for Lin Ostrom if she is not available.

Dan Benjamin (Clemson) on myths of recycling

Thomas Sowell (Hoover) on his forthcoming book on intellectuals (he is the most astute writer about intellectuals)

Walter E. Williams (GMU) on anything. He is just such a joy to listen to. Perhaps the funniest and pithiest economist on the planet.

Arnold Harberger (UCLA) on international development.

Michael Chwe (UCLA – Pol Sci) on rational riddles.

I would like to hear a podcst specifically devoted to microfinancing, but I can’t think of who I would want to hear it from.

Either Winter or Lott on crime and gun laws. Actually, I would really like to hear Ted Nugent, but he doesn’t have a Ph.D. even though he knows more than most PhDs.

I think I might want to hear Steven Landsburg on his new book, but he seems to have veered off into “todoslogos-land” in some odd directions.

Please never have Posner on again. While he was great on law and economics in the ’70s, he just seems out-of-it now.

… and More Mike Munger. Lots more Munger.

Ken Ndirangu
Dec 20 2009 at 2:46pm

Russ I love your podcasts, your show bring the common man closer to the intellectual giants of today. Keep up the consistency and the quality..
Oliver Williamson just won the Bank of Sweden price in Economic Sciences, It would be great to listen to you discus with him his thoughts on Transaction costs in relation to the free market.
Nairobi, Kenya

Dec 20 2009 at 4:31pm

On the subject of possible future interviewees I have a couple of suggestions:

Joel Mokyr on the Enlightened Economy

Matthew Rabin on Behavioural Economics

Ernst Fehr on Experimental Economics

Dani Rodrik on trade and industrial policy

Oded Galor on Unified Growth Theory

Avner Greif on the medieval market institutions

Robert Allen on the Industrial Revolution

Keep up the good work!

John Strong
Dec 21 2009 at 10:43am

As long as people are recommending guests 🙂

I suggest:

Robert Aumann on the nature of scientific discovery

Russ would have to get up *early* in the morning and do the interview by satellite link.

Dec 21 2009 at 11:46am

“Yeah, that episode was a bit of a dud from lack of a narrow topic. Unlike Richard Posner or Tyler Cowen, Kling is not inherently compelling in a casual context.”

Oops, that would be “Richard Epstein”.

Justin Palmer
Dec 23 2009 at 5:00am


Love the show. I love discussion on growth. In the current crisis, growth seems to be treated more as an opportunity cost than anything else.

I’ve suggested people in the past…but I have a different suggestion this time. Why not put up a poll from polldaddy or something and let your listeners vote for guests?

Personally Walter Williams, Sowell and Garrison are my top 3 but I say let the market decide.

Jan 3 2010 at 7:52am

There was no mention of the parabolic increase in energy use during the period in question,and the parallel rise in population. These were the critical underlying forces with the ideas providing some guidance. Technology was an epiphenomenon, trimtabs on a powerful motor.

Jan 16 2010 at 4:44am

At about the 34 minute mark they talk about the
article in the New Yorker of December 14, 2009
by Atul Gawande:

Kling: What Gawande said is that the key to
a better health care system is more trial
and error on the part of government. And
I just cringed when I saw that because I
think government is the most ineffective
trial and error mechanism out there.
… my jaw dropped when I read that.

Roberts: Yea, mine did too. He’s an
interesting guy but I thought it an
unusual claim.

What is funny (or sad, depending on how one looks
at it), is that a big part of Gawande’s article
was about how GOVERNMENT run agriculture programs
in the early 1900’s successfully USED trial and
error to greatly improve agriculture in this
country when the free markets could not. And the
gist of the article was that government could do
that again with health care.

It always amazes me how one’s beliefs can so
distort what one see and reads. You can see
for yourself at:

[Reposted to correct podcast entry–Econlib Ed.]

Comments are closed.


About this week's guest:

About ideas and people mentioned in this podcast:Articles:

      • "How China Won and Russia Lost," by Paul R. Gregory and Kate Zhou. Policy Review, No. 158, December 2009 and January 2010.
      • "Human Capital", by Gary Becker. Concise Encyclopedia of Economics.
      • "Industrial Revolution and the Standard of Living", by Clark Nardinelli. Concise Encyclopedia of Economics.
      • "Intellectual Property", by Stan Liebowitz. Definition of nonrivalrous. Concise Encyclopedia of Economics.
      • "Entrepreneurship", by Russell S. Sobel. Definition of nonrivalrous. Concise Encyclopedia of Economics.
      • "Comparative Advantage", by Donald J. Boudreaux. Definition of nonrivalrous. Concise Encyclopedia of Economics.
      • "Lionel Robbins". Biography. Scarcity in economics. Note that Robbins's famous definition of economics is not stated as given endowments to be allocated amongst alternative ends, but about given ends (i.e., tastes, goals) and scarce means to achieve them. Those means could include using scarce resources--including time and energy--to invest in the future in order to achieve the desired ends. Concise Encyclopedia of Economics.
      • "Robert Solow". Biography. Concise Encyclopedia of Economics.
      • "David Ricardo". Biography. Concise Encyclopedia of Economics.

Podcasts and Blogs:



Podcast Episode Highlights
0:36Intro. [Recording date: December 9, 2009.] Economics 2.0--what do you mean by that? Economics you don't hear about in the mainstream media or in undergraduate economics curriculum. Traditional economics is all about allocating a given amount of resources. Textbooks: people have unlimited wants, limited resources, and the economic problem is to allocate scarce resources among competing ends. Guns versus butter. Not in mainstream--makes it sound like this is a weird, rogue view; but of the ten economists interviewed in book, four won Nobel Prizes and the others highly prestigious. Prestigious view but not widely disseminated. Flip side of scarcity is abundance. In terms of measuring the standard of living and how it's changed over time, and in some sense it's changed very suddenly. Can argue that from the time when people first formed civilizations until around 1800 the standard of living changed relatively little. Dramatic improvements since then. If people lived on the equivalent of $150 a year until around 1500 or 1600; then from 1800 till now, people go from a couple hundred dollars a year to $8000 a year--on a worldwide average. In the United States it's more like $40,000 a year. Tremendous acceleration in growth in the standard of living, just as a fact. Where did that come from? Traditional economics says you've got these scarce resources; the only place that could come from is people forgoing consumption today to get consumption tomorrow by accumulating capital. Yet clearly we've been able to go way beyond what we could get just by accumulating capital. Intangible factors: ideas, innovations.
4:32Some of that is produced by capital. Average undergraduate economics major has some idea that technology has something to do with our standard of living. But we don't teach our students much about the texture of that or where it comes from. Ideas--just someone's thinking, gets added to the pile of ideas. But it's more than that. Massive focused effort for some ideas, research and development, private sector and some from public sector as well. Economics 2.0 phrase: Trial and error. Think of the way pharmaceutical companies operate. They will just try a bunch of different molecules and see how they affect different symptoms in different tissues. If they find some they think are promising they might try them on animals; if they work and are safe, go on to human trials. True with entrepreneurship in general: dot com experience, all sorts of new companies formed to try many things. Some failures, like which was going to deliver pet food to your door. Couple of spectacular successes, like amazon. Hard to predict which would succeed because none were making money. Ex ante, trial and error process. Trial and error underrated and also difficult to model. Interview with Joel Mokyr in book; talks about because this is stuff that cannot be predicted, you cannot model it, cannot forecast the way economic growth will take place. Things happen that are not anticipated.
8:05Early days of show, talked about growth and how it is talked about in economics. MIT, Robert Solow. How did economists think about growth in the 1960s and 1970s, and how has that changed? Even true now: daughter in college, had to grind through Solow models; capital accumulation, sacrifice consumption today. Solow himself found the most important problem which is that empirically, capital accumulation doesn't account for very much in the increase in the standard of living over time--maybe a quarter or less. Or the differences across countries. Report under the World Bank--growth accounting analysis of the standard of living in different countries and converted it into wealth terms. Instead of just saying what's the income of a country, they asked what's the wealth. In that measure the average citizen in a well-developed country has over $400,000 of wealth--lifetime income. Most is intangible. Not gold coins, not accounted for by the resources or the capital of the country. All intangible. Things like human capital--education--and odd phenomenon that for some countries, negative intangible wealth. How can you have negative intangible wealth? Their institutions are so harmful--e.g., North Korea--that the institutions cause so much harm that they actually produce less than what you'd think they'd be able to produce just based on their labor and capital. Institutions subtract output and wealth from the country.
11:27Let's talk about capital, phrase that economists bandy about loosely. Standard view of a country's resources would be labor--people; raw materials--iron ore, gold, physical assets; and capital--produced goods that can be used to produce other goods, like factories, machine tools, office buildings, computers, equipment and plant used to produce other goods. In the Economics 2.0 approach, capital also includes knowledge, which can also be used to produce other goods. Embodied in human beings and in physical equipment. Knowledge drives a large amount of our productivity--includes know-how, not just facts. Knowledge: how to prevent dysentery, Paul Romer podcast. Sugar in water, prevent dysentery. Walmart knowing how to increase its logistic system has increased GDP--know-how. Companies constantly trying to learn, improve. Knowledge can be anything from scientific, abstract knowledge to workers figuring out how to do their jobs better. Strange that it has taken economics 200 years to figure out intangible assets; granted that it wasn't as important 200 years ago. Listener would say, "Well, duh!" For podcasts, physical capital like microphone, recording device, server; know-how--how to upload the file into the server; most of what we are producing in this podcast can only be measured in trivial ways such as how many hours spent preparing for the podcast. Input into the production function of this experience. People really will think about the economy differently once they concentrate and focus on this. George Mason economist Garrett Jones: Most workers today don't make widgets; they build organizational capital. Add to the capacity of the company to do something new or control risks; not actually assembling things by hand or making new output. Macroeconomics assumes everyone is homogeneous labor, L; and all capital is homogeneous K. Encourages you to think about differently the sources of economic prosperity. Political debate: We can't get rich doing each other's laundry. Idea was that we used to make stuff, but now we have a service economy and services are ultimately going to impoverish us. What is the answer via Economics 2.0? At consumer end, you are going to get better and better goods and services at lower and lower cost through innovation. Laundry: Economics 1.0 story--isn't it great that you can send your shirt out to be ironed by somebody else so you can use your comparative advantage to work on something else? Economics 2.0 answer--that's great that you can send your shirt out, but haven't you heard of permanent press, eliminates ironing shirts altogether. Creates abundance from consumer point of view. What kind of work are people going to do if you put them out of business by doing permanent press? Answer: they will learn to do these building-organizational-capital skills, new ideas, helping new products reach the market. Use their brains more. Risk of implying we will all end up being consultants. New version of permanent press--no iron, 100% cotton shirt. Permanent press was synthetic.
19:03Home in on a little piece of this: The traditional worry about innovation is that people get replaced by machines; but people get replaced by ideas. Travel from D.C. to Boston; pay tolls; people are paid. They've been replaced by device you put on your window, Easy Pass. Misleading to say that Easy Pass transmitter put the person out of work. Really the extraordinary set of software behind that little gadget that is doing the work. Somebody had to come up with the concept that people could get through tollbooths faster; wouldn't it be great if we could use the same transponder here as in New York? Paul Romer's work: nonrivalrous aspect. We are producing EconTalk; eventually pressure on bandwidth but currently it can't be used up. Transponder, efficient. Hardware vs. software. Two people can't type on the same keyboard at the same time; but there is no reason why two people can't use spreadsheets software at the same time. Economics 2.0: stuff that operates like software, nonrivalrous, can be replicated cheaply. Better idea for running fast food restaurant--arranged food certain way, better contracts. Business process patent--Amazon wanted to patent the idea of being able to order with one click. Why should they be able to do that and no one else? Tension. Want them to have an incentive to think of it. Discussion in book about intellectual property. If you are thinking about intangible ideas more, you are going to be confronted with value that is not embedded just in hardware or physical stuff, but value embedded in ideas. No conclusive, one-size-fits-all answer for that. Some situations where clearly a lot of work goes into developing an idea, yet the idea can easily be copied. Pharmaceuticals: years of trial and error, come up with this molecule that works and you are ready to market it; somebody else can copy the work without doing the work. Something like one-click ordering--didn't take years and years of trial and error; probably something you could come up with in a couple of days, or an afternoon or five-minute brainstorming. Wouldn't want to give that years of copyright protection.
25:01Hardware/software distinction--nonrivalrous part, issues of growth and poverty; bugs in the software; metaphor. Two parts: why is the standard of living so much higher than it was 200 years ago? Software part of that story is ideas. If ideas are easily copied, easily replicated, then that's our story--growth just takes off because ideas start building on each other, lots of growth without using up resources. But then other issue: it makes the differences in the standard of living across countries even more puzzling. Why is it that North Korea doesn't use the same ideas we use? Another aspect of software, analogous to the operating system: communism a different operating system than capitalism, Mugabe's dictatorship different from a more democratic society. Certain operating systems mess up the ability of the economy to operate--extremely buggy. Some of the bugs: things like poorly enforced property rights, government confiscating wealth so that there is very little incentive to create it, government dictating all aspects of the economy. Property rights in the United States have changed quite a bit in the last 50 years. Uncertainty with how regulations are going to go. Countries in the developed world do lots of redistribution and have high taxes, but seem to thrive. Why in Scandinavia or much of Europe even with big government--they produce lots of ideas, maybe not as much as in the United States. Transition over time in developed world, rich nations, could argue that the rule of law is diminished, less certainty about what you get to keep. How come we're doing so well? Several economists in the book point out that we don't know what the optimal institutional structure is. We for a long time have had heavy government involvement in many sectors--housing, agriculture, education, health. Imagine you were a startup country; look at United States as a potential model--which of those regulations should you copy? Same agricultural policy? Same housing policy? Same financial regulation policy? Could argue all of them. Could argue none of them. All we can conclude is that we know that communistic organization and allocation of resources doesn't work. So many examples: Brad Delong book exhibit: Cuba vs. Mexico, North Korea vs. South Korea, East to West Germany. Communism doesn't work for the average person. Other regulations, room for controversy. Some economists would argue that government-provided education is a great thing, a necessary thing; other economists would say at this point it might be holding the United States back. How you feel might vary over time. Casual bit of economic history: we don't have a decisive answer: From 1880-1980, when America goes through industrialization, starts leaving the agricultural sector behind, productivity, improvement in standard of living interrupted by the Great Depression and then restarted afterwards with big success. Some would argue: If it weren't for all those regulations, a lot of that wouldn't have happened. Others would argue that without those regulations, growth would have been even greater. No way to evaluate those two claims. Germany, Korea natural experiments; otherwise, use intuition. Argument for more trial and error in terms of government. Since trial and error seems to be the way we learn and grow in the economy, why wouldn't that be a way for government. Trial and mostly-error would be the concern. Edsel doesn't last very long; Corfam shoe fiber dropped out of the market place. Government trickier. Markets are very efficient trial and error vehicles. In government we don't have that equivalent. Atul Gawande, writes for New Yorker--N.B. we take no position on legislation here on EconTalk--more trial and error on the part of government, vs. government being much less efficient in trial and error than markets.
35:01Role of savings. In the old days, Economics 1.0 story was to grow you have to put aside money today. Have to save; without savings without growth. Still true: the nature of what the money gets devoted to solely. We used to talk about you don't consume the apple; you save it so that the seeds can grow larger tomorrow. Don't chop down the tree to make a table, let it grow so you can make a house. With intangible ideas, tendency to say we can just make ideas and they don't use up current consumption as much. But you still have to make sacrifices today to get stuff tomorrow? Two types of saving that are important. One is developing your own human capital. Big component of this intangible is people's own knowledge. Are people setting aside money for college going to get a good return out of it? To start a business still costs some money. Some of these businesses are going to fail; and those failures are part of the saving, part of the sacrifice you make in order to get progress. Still scarcity at a point in time, dynamic equally or more important. At a point of time there is trade-off. Ideas have expanded our wealth and our standard of living.
38:18Talk to people in book about growth, poverty. What have we learned as economists over the last 50 years and what do we still need to learn? Intangibles, knowing how to do things. Knowledge doesn't depreciate the way capital depreciates; get positive returns, increasing returns. Learned at a rough level to believe that institutional differences help explain differences in standard of living across countries. Haven't learned in a detailed level which institutions can work. Latent controversy: will the same institutions work in different cultures? North vs. South Korea: different institutions. South Korea has a standard of living 20 times that of North Korea, so clearly institutional differences. But project of going to Iraq and installing our idea of the right institutions will work there--probably no, too many cultural problems in order to do that. Basic level: we don't know the relative role of culture and institutions or how long an institution has to be in place to change culture. Don't know which institutions, optimal, suboptimal. Where does that leave us for helping countries that want to help themselves to get out of poverty? Less hubris, more humility; argument for doing nothing. Better than sending thugs money as a first approximation. If we want to do a little better, any guidelines? Interview Bill Easterly, go-to person on that issue. Very much in trial and error camp, distinction between searchers an planners. Planners try from the top down to design systems that are supposedly going to increase development. Searchers start out with what's on the ground and look for small improvements. Strong believer in the searcher approach. Easterly supports entrepreneurialism in foreign aid. Person who tries an idea and may not be successful may not have a lot of influence, but cumulative effect of a lot of entrepreneurs is that a few will be spectacularly successful, some will be successful, and those that fail will just disappear and not cause great harm. Top-down plan that fails is a spectacular nationwide failure. Hayek: The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design. Optimistic or positive story here: they have to figure it out themselves, help themselves. Institutional design has to evolve in a way that is congruent with culture and existing institutions. Can't be imposed by outside. Freedom to try, fail, succeed. Takes a while; impatience. Impatience and sense that you didn't accomplish it. Development assistance designed to make the donors feel good, and donors don't feel as good with trial and error processes as with big-name processes.
44:55Microfinance: recipe touted and still tout. Imperfect property rights in poor countries, collateral; Hernando de Soto. Microfinance: small loans, person by person. What about China and India? They seem to have gotten something right; a lot of top-down stuff allegedly going on in China; India maybe less so. Why are they doing so well and how does that fit in with the story of the book? India mentioned as a negative example by William Lewis, one of the people interviewed in the book, who points out things like the fact that maybe 90% of India's land doesn't have proper title, so there is huge inflation in the value of the land where you can get proper title. A lot of electricity gets stolen, which creates really bad incentives in the electricity market. Still the license raj--it's hard to start a business, get through all the regulations. India has a lot of bugs in their operating system. Fixing a few has allowed them to make progress. China: both sides of that. Sheer amount of power invested in leaders of Communist Party doesn't seem congruent with decentralization. Others look at it and say they really are allowing a bottom-up reform. Hoover Policy Review: Russia tried to impose economic reform from the top down and China's reforms really were the government adapting to what peasants were doing--private farming and government's saying we'll allow that--creating productivity increase in agriculture which allowed people to move to the industrial sector; economic zones something like capitalism. China has a bottom-up reform, working better because it's reflecting the people's desires and trial and error, whereas in Russia people really were not ready for a capitalist system, so what emerged was a mafia-type system which doesn't protect property rights, and general resistance to the social safety net people had under socialism. Any idea how much capitalism there really is in China? Do they use prices? How free are people to compete? Any measures? Hard to get data? Heard that they are not really free to accumulate capital; capital gets accumulated a government level. Goes against what we think of as capital markets needing to allocate capital to its best uses. Interesting one to watch. High savings rate. Is it confiscated? High personal savings rate. One-child policy: what used to be the safety net for people growing old was having many children. They've eliminated that, yet no government social security system. So strong incentive to save for old age. People are myopic.
50:52Trade. What creates prosperity: many economists would point to David Ricardo's comparative advantage. What role in Economics 2.0 for traditional topics such as comparative advantage and specialization? Just call that Economics 1.0. Trade is a way of getting a free lunch, something for nothing; that hasn't gone away as a way of getting more resources. Economics 2.0 focus is on technology. Sometimes try to explain trade and advantage of it by using a technology analogy. David Friedman talks about how we can grow cars in the wheat fields by growing wheat, shipping it overseas, and having the ships come back with cars. More efficient way to produce cars than manufacture them. Treating trade as if it's technology. Economics 2.0 is about how technology plays the role that trade traditionally played in economics, allowing people to consume more with the resources they have. Additional aspect, left out of standard textbook stories, talk about trade, England swapping wool for wine with Portugal. What happens in the modern world is that a multinational corporation builds a factory in Indonesia and brings all those recipes and ideas at no investment cost to the people of Indonesia, takes advantage of their low labor cost but in doing so helps increase their standard of living. Big advantage of free trade in Economics 2.0 is that trade helps spread ideas around. When Wal-mart comes up with a better logistics system, that puts pressure on every retailer. Trade has the advantage of putting competitive pressure to adopt new ideas. Entrepreneurs' role is to force this new adoption. People resist change; big companies resist change. Wide open free entry. End of the Great Moderation. During the Great Moderation when the business cycle was thought to be tamed, a lot of economists started focusing on growth. Now we are in a different world. Physics: light as a wave or a particle analogy. Business cycle versus growth. Paradox of thrift argument saying savings is bad. Can't seem to think about them both at the same time. Looking at business cycles in some sense takes your eye off the ball. Lucas: once you start thinking about these large differences in the standard of living over time it's hard to think about anything else. Measure the changes in consumption during a recession really turn out to be very small; but people get frightened or maybe government sees the crisis as an opportunity to expand. This too shall pass. A lot of things going on are probably increasing growth--probably getting an acceleration in movement out of declining industries. People will have to be more creative about how to start businesses or how they are creating human capital. Typical college student right now has to be thinking a lot more about what is going to be useful for a career than a few years ago when they thought they could just come out with a nice job. Which businesses expand and how to develop own career. Positive for growth longer term.