Thursday, 25 August 2016

What I've been reading (vol 8.): Economic history

As announced in the previous blog post the next two book reviews will cover four very interesting history books (well, history to some extent). The first one is actually all about geography and anthropology, and little bit about history - the Pulitzer winning book by Jared Diamond: Guns, Germs, and Steel. It has long been on my reading list and I am finally happy to have read it, and I have to say - it hasn't disappointed. Far from it actually. I can see why it was an instant success. The second is a more recent book, Harari's Sapiens. Another bestseller with an overreaching arc that extends from the biological knowledge about our ancestors all the way to the modern technological revolution that has the power to destroy our very species. In short, two brilliant books! Let's begin. 

Diamond, Jared (1997) Guns, Germs & Steel: The Fates of Human Societies. Norton, New York.

In this Pulitzer Prize-winning book, Jared Diamond, a noted polymath (made contributions in the fields of anthropology, biology, ornithology, ecology, history), delivers his unique and comprehensive theory of how societies evolved over the past 13,000 years, ever since the start of the agricultural revolution. He explains in amazing detail the multitude of factors that led to the dominance of the Eurasian civilization over all others. Most importantly he successfully discards the intellectual, moral, and genetic superiority arguments and instead proves how the initial geographical differences led to the huge technological gap between Eurasia (Old World) and the rest of the conquered (New) world. 

The essential question that he aims to answer is why history unfolded so differently on different continents. Why hasn’t it moved in the other direction, i.e. why haven’t indigenous Americans, Africans or Aboriginal Australians conquer the Europeans and Asians? Why are some parts of the globe so much better off than other parts? Why did civilization manifest itself differently in different places? Why did writing, technological progress, and organized governments originate in the Fertile Crescent (ancient Mesopotamia) first and not anywhere else? Why did the Spanish conquerors of South America had guns and swords, while the indigenous Aztecs and Incas only had wooden tools that were no match for the conquistadors? Even more interestingly, how did the Spaniards led by Pizzaro against the Incas, and Cortes against the Aztecs, managed to overcome these civilizations by only a handful of soldiers compared to the tens of thousands of Incas and Aztecs? 

The simple answer is embedded in the title of the book: the Eurasian conquers had the obvious advantage of guns, germs, and steel. Germs are the surprising addition to the usual advantages in military technology, as more indigenous peoples died from being exposed to diseases the Eurasian conquers were resistant against, than from their guns and swords. Additional factors that helped the Eurasians in their conquests were the technological innovations in maritime technology (enabling them to build large cross-ocean ships), their domestication of horses (a big advantage in warfare), the centralized political organization of their domestic states (that enabled the financing of explorations) and writing (for the quicker spread of information). These, however, are only proximate factors. They explain why the European conquers from Spain, England, Portugal, France, Netherlands, etc. managed to easily overcome the indigenous tribes and supposedly “primitive” civilizations, but they don’t tell us anything about how the Europeans got to these tools and advantages before the Americans, sub-Saharan Africans, and Aboriginal Australians. 

The ultimate causes of these inter-continental differences are what this book is about. It identifies several constellations of environmental factors that provide a large part of the answer to the initial question: why did history unfold differently in different places? 

All the factors are so diligently presented in the following diagram: 

The first major ultimate cause was the domestication of plants and animals, i.e. food production. This created food surpluses and consequently food storage. Having surplus food meant that there was no need for everyone to work in agriculture anymore, and that others within a society could specialize to do other things (like become bureaucrats, soldiers and rulers) and that these non-producers could be fed from the surpluses created for the whole society. This crucial factor of more food production enabled the growth of early population and further encouraged sedentary life-style as well as large and dense societies. This was the starting point for the origination of political and religious organizations, both of which were crucial in enabling cooperation between unrelated individuals in large societies. One of the underlying tasks of the political organization was to protect the food surpluses by organizing armies. Thus the first soldiers emerged, all loyal to the ruler who further strengthened his rule by assigning himself divine characteristics (which is where religion comes in as the first form of propaganda). Having surplus food, dense societies and political organization, writing was another factor crucial to sustain these relationships. Initially, writing developed as a way to note who owned stuff to whom. It was all about accounting. Only later did it evolve to support myths, religious stories, and propaganda. The origination of early political organizations also gradually developed into obtaining the technology for warfare (guns and swords), and a whole range of other activities. Finally, the very domestication of animals led to the development of new types of diseases carried to us from animals we lived close to. The bodies of Eurasians developed resistance towards such diseases over thousands of years, whereas the rest of the world never had any exposure to them before, primarily since they had no exposure to large mammals suitable for domestication. The Agricultural revolution, generating the ultimate causes, was thus arguably the most important condition behind explaining the proximate causes of societal differences and hence the development of Western civilization.

To understand this entire mechanism in more depth, I do recommend reading the detailed evidence so eloquently explained in the book. I could write pages and pages of comments on this, but I have to be concise in this review (which is, in this case at least, an impossible task).

How has the domestication of animal and plant species occurred in the first place? And why did it happen differently in Eurasia then the rest of the world? The answers to those questions are in my opinion the best part of the book, and the biggest contribution that Diamond’s theory has made. Here is where geography kicks in

The first reason Eurasians were able to domesticate wild species of animals and plants were the huge number of such species available for domestication in the first place. Food production developed in the early ages in only a few places around the globe, ecologically and geographically suitable for food production (at different times obviously): the Fertile Crescent (Mesopotamia), China, Mesoamerica, Eastern United States, the Andes, and possibly also West Africa, Ethiopia, New Guinea, and the Amazonia (it is inconclusive weather these areas developed food production on their own or was it influenced from other centers). What made these areas suitable for food production and why have the areas in the Fertile Crescent and China developed food production differently than elsewhere?

Jared Diamond, the explorer in his 'natural habitat'
First of all, food production was not discovered or invented. Its origination was purely random. The choice between the hunter-gatherer lifestyle and the sedentary food production lifestyle was a gradual, unconscious occurrence. There are five contributing factors that made the gradual switch from hunter-gathering to food production. The first was a decline in the availability of wild food. Both plant and animal species (e.g. in the Fertile Crescent, the decline in the abundance of gazelles, a major food source for hunter-gatherers, encouraged animal domestication). The second factor was the increase in the domesticable wild plants that made domestication more rewarding (partially as a result of climate change). The third factor was the development of new technologies for collecting, processing and storing food. These included early blades for harvesting, baskets for carrying crops, underground storage pits, etc., all available in the Fertile Crescent by about 11,000 years B.C. The fourth factor was the positive feedback loop between a denser population and the rise in food production. All of these factors explain why did food production begin when it did (cca 8,500 years B.C. and not earlier). And fifth, more denser populations of farmers quickly displaced or killed the remaining hunter-gatherers. 

Why the Fertile Crescent and not anywhere else? Many areas around the globe had a similar Mediterranean climate, but it was Mesopotamia where food production started first, whilst in other areas with similar climates (like California, Chile, South Africa, or Southwest Australia) it never did (until the colonizers came). The Fertile Crescent possessed several advantages over all other areas for the successful development of food production. First, and most important, it was the largest such area, and it contained by far the largest amount of large-seed plant species (with suitable characteristics for easy domestication), as well as the largest diversity of animal species. Second, it provides a wide range of altitudes with a short distance corresponding to the variety of environments (mountains and lowland rivers, flood plains and deserts suitable for irrigation) and consequentially a wide diversity of plant and animal species. This also implied staggered harvest seasons as plants at higher elevation produced seeds later than plants at lower elevation. It meant that the hunter-gatherers did not need to be confined to a single area initially. Third, it experienced the greatest variation in climate from season to season which favoured the evolution of the largest amount of annual plants. For example, the Fertile Crescent contained in total 32 suitable large-seeded plant species, whereas North America contained only 4, Mesoamerica 5, South America 2, East Asia 6, and Sub-Saharan Africa 4. The particular regions with Mediterranean climate like California and South Africa had only 1 such species, and Australia not a single one. The exact same story is true with animal species. There were virtually no large mammal species suitable for domestication in other Mediterranean zones of the world, whereas Mesopotamia enjoyed the simultaneous existence of four big mammal species – goats, sheep, pigs, and cows. In fact there were only 14 animal species suitable for domestication, almost all of them (13) exclusively tied to the Eurasian continent, and only 1 in the Americas. This alone goes a long way in explaining why food production and plant domestication started in Mesopotamia. In addition to having the most species, Eurasia also had the most (almost all, in fact) plant and animal species suitable for domestication.

The final geographical advantage of Eurasia over all other continents was the ease of spread of such species across the Eurasian landmass, due to its east-west axis. The Eurasian landmass is oriented east-west, whereas the Americas and Africa are oriented north-south. Axis orientation is very important for the spread of species, particularly for plants. An east-west orientation offers the same latitude, the same day length, and the same seasonal variation. These all imply the origination of the same diseases, temperatures and rainfall, which give rise to the same type of species across the landmass. This was crucial for the rapid spread of crops from the Fertile Crescent on to Europe, as well as from China to the Indus Valley. Animals and plants enjoyed similar climate conditions and could have easily adapted to new environments across the Eurasian axis. In African and American north-south axes this was much harder due to geographical obstacles unsuitable for agriculture such as tropical rainforests or desserts, not to mention different climate conditions in the far south versus the far north. The benefits of Eurasia’s east-west orientation were not only confined to plants and animals. It later became even more obvious with the spread of inventions such as writing or the wheel. In contrast the wheel invented in prehistoric Mexico never spread south to the Andes (in fact, the civilizations in Mesoamerica were unaware of each other). The same is true for writing. Finally, the east-west orientation was extremely beneficial to the development of early trade – exchanges of crops, livestock and technologies were driving the Eurasian civilizations forward at a pace unimaginable in hunter-gatherer times.

Harari, Yuval Noah (2011) Sapiens. A Brief History of Mankind. Vintage Books. 

Harari’s Sapiens is a book about us – humans. How we evolved from the primitive animals to hunter gatherers and sedentary farmers, how we moved to top of the food chain to dominate all other species, how we learned to plough fields, how we invented an imagined social order and social conduct, how we unified behind our imagined constructs like money, empires, and religion, how we used science to grow even stronger, so strong that we are even capable of destroying our entire species and our planet. Sapiens is the ultimate story about us. 

Harari takes the reader through a fascinating historical journey. The book is divided into four parts, each corresponding to a historical era, but also to different stages of human progress. We begin with the Cognitive revolution and how the homo sapiens evolved from an early primate (i.e. our common ancestor), explaining how the life of hunter gatherers looked like and how our species began settling the vast open spaces of our planet. Then the story moves on to the Agricultural revolution (which the author dubs the biggest fraud in history) presenting a fascinating theory of our imagined order. It then furthers this argument even more by explaining in the third part (The Unification of Humankind) how money, empires, and religion tied us together and enabled us to cooperate as a species. Without these three great unifiers there would be no civilization as we know it (or any civilization at any point of history, from the early Middle Eastern empires, to China and India, to Rome, to Western Europe, and even to the Mayas, Aztecs and Incas). Finally, the story unfolds in the Scientific Revolution – the final step that made us the deadly creature that we are today, with a slightly worrying conclusion about the possible future of our species. 

The first part, the Cognitive Revolution, starts from the origin of our species and how it ascended to dominance over all other human species that existed on Earth. It summarizes well the standard evolutionary biology arguments on the importance of starting to walk upright, handle fire, and cook food, all of which contributed to the development of a larger brain. This development (walking upright) also affected the shortened pregnancies of women and consequentially the necessity of more than one person to raise a child, thus increasing social behavior and cooperation among early tribes of our species. Because of this fascinating evolutionary trail, humans developed much closer social networks amongst them. Single mothers couldn’t survive on their own, as they could not gather enough food for themselves and their child. They became dependent on their tribe (consistent of family and neighbors) for food and protection. “Evolution favoured those capable of forming stronger social ties.” Cooperation made the early humans survive.

But what really made us unique as Homo Sapiens was our ability to develop a unique language. We developed language possibly as a consequence of our increasingly social behaviour. Language developed as a form of communication, but not necessarily for warnings against other animals – language evolved thanks to gossip! People living closely together loved to share stories about each other (as we still do). Social cooperation was crucial for early humans in cases of both survival and reproduction. Knowing who sleeps with whom, who is lying, who is not, who is a hard worker and who is a freeloader, who we hate, who will love – is a very important initial character trail of early humans which provided the evolutionary demand for developing a means of communication. By being able to communicate more effectively than all other animals, the Sapiens species was able to develop even more sophisticated types of cooperation. Even more so the development of language during the Cognitive Revolution enabled the humans to spread legends, myths, gods and religion among themselves. The rise of language gave rise to fiction, and fiction gave rise to almost everything else. Religious fiction was extremely important in further strengthening the social ties and cooperation motives between early humans. Later, religion and the nation state (both products of our imagination) will enable humans to cooperate even with complete strangers. Our fiction, our ability to imagine order, has enabled us to move beyond the small tribe and, over thousands of years, become the cosmopolitan creature we are today. 

What does the 'imagined order', the key factor of Harari's theory, exactly mean? Given the development of language and the broadening of early tribes, the largest size of a tribe that can be held together by gossip (and intimate knowledge about one another) is around 150 members. The only way this threshold was to be surpassed into building even larger tribes of humans is by fiction. Only if a large number of people collectively believe in the same fictional authorities (either religious or that of a state), can they successfully cooperate. This is why the early development of religion and beliefs in common myths and legends proved to be pivotal in further evolution of cooperation among early humans, which later fostered their expansion and growth. 

Harari goes on to defend his imagined order hypothesis in great length. Everything we have developed as a social construct is by definition an imagined order. As opposed to a river, a forest, a mountain, the sun, the food we eat and the clothes and shelter we have; the state, the monetary system, corporations (as legal entities), the legal system, human rights - all of these are fiction; figments of our imaginations. They are important to maintain our social conduct, but they were all invented by us. In other words they do not originate from a natural order, but an imagined one. Their existence depends on us telling stories and convincing others to believe in them as well. We hear stories about gods when we are young and choose to believe in them and worship them. We hear stories about our nation and choose to believe in it, love it, and, if necessary, defend it against enemies.  Later when we grow up we hear stories about our money, our currencies and what makes them stable, and banks, buildings that we trust to keep our money on hold for us. We also learn about the legal system through stories. We feel protected by it as we hear stories about how it protected others. We believe a company is good and that it produces good products also through stories they tell us. They convince us that their product/service is necessary and better than other similar products/services. We hear stories from other people buying the product and liking it and we believe them and buy it. Storytelling, developed in the earliest phases of the cognitive revolution, is what makes us humans. It enabled our cooperation and our imagination. It enabled our society to operate as it does today, under a dual reality – the real and imagined objects around us.

In the second part of the book, the Agricultural Revolution, Harari tells an interesting story of how evolution played an important role in switching the Homo Sapiens from forgers to farmers. “The currency of evolution is neither hunger nor pain, but rather copies of DNA”. So the higher the number of humans, the more successful the species. Our basic reproductive instincts changed since we settled down. Farmers living a sedentary lifestyle could give birth to more babies and in a shorter time span than nomadic hunter gatherers. This implied growth of population and considerably higher tribes of settled farmers than nomadic forgers. Furthermore, sedentary lifestyle brought innovation in terms of tools, and with the origination of food surpluses, stronger incentives for protection (and the rise of the first organized armies). Furthermore, sedentary lifestyle contributed to humans becoming even more territorial and protective of their fragile food supplies. This change brought to one very important difference in human behaviour – thinking about the future! They had to learn how to plan ahead, how to manage to grow enough food to keep everyone fed through the winter, and most importantly how to adapt to nature’s uncertainty regarding agriculture. This encouraged innovation and increasing adaptive behaviour, but it also made the people feel more protective of their food supply. Hence the demand for the first types of proto-governments (as already described above). 

From here the books goes on in discussing the importance of writing to sustain the imagined order around us as well as to spread myths and create a hierarchical social order that is responsible for a multitude of class, racial and gender struggles our civilization faced. In the third part the author discusses the great unifiers of mankind: money, empire, and religion. All are imagined, but were crucial in the development of our society. For traders, the world is a single market, for conquerors the world is a single empire, for prophets, there is one truth and all the people are potential believers in it. The final part of the book is about the last piece of the puzzle in the pattern of human history, the one that made us so powerful that we are now able to eliminate our entire species and our entire planet by one single blow: the Scientific Revolution. 

Harari here takes a slightly different approach to standard economic history analyses, and attributes the scientific revolution instead of the industrial revolution to the huge increase in human living standards. He cites 1500 as the approximate year when things started to change and evolve into the political and economic order we have today, by comparing the relative variables of living standards then and now. I disagree with this approach, as living standards were marginally better throughout the next 300 years, until the 1800s. Yes, great discoveries were made, new inventions too, Europeans were conquering and colonizing the New World, the enlightenment was responsible for huge advancements in many scientific fields, but the very pinnacle of human development, the very best of inventions that we today take for granted (like electricity, the engine and its subsequent vehicles, machines and telephones, computers and the Internet, etc.) were all invented as a consequence of the Industrial Revolution. 

In fact, the Industrial Revolution set the stage for humans to abandon the subsistence-based Malthusian economic model (more on that next time), and evolve into the dynamic capitalist system we know today (the author describes this mechanism very well actually). This evolution was not without its faults, as the early industrial societies were extremely unequal and, due to them being based on an imagined hierarchy, discriminative. From the early industrialization evolved the differences between the rich and the poor, similar to the ones classifying the ruling nobility and the peasants during feudalism. The era of new discoveries after 1500s uttered the rise of mercantilism, an economic order still bounded by the shackles of the Malthusian trap, which failed to offer many benefits to the majority of the population, but only to the elites and ascending merchants. Industrialization (as a consequence of the rising power of merchants) continued in the same fashion, but with the simultaneous rise of power of the population the old elites were forced to give concessions (first to the selected few as in England, which slowly evolved into introducing democracy to the rest of the population), or were being replaced and killed (as in France and Russia). So it was from the trails of the Industrial Revolution, not mercantilism (which tied together scientific explorations and imperial visions of dominance), that democratization was later attainable. Without the significant increase in living standards it would have been hard to imagine for some underprivileged groups in society to get hold of economic and political power and hence challenge the old elites.

I do however agree with his glorification of the Scientific Revolution that enabled us to make an evolutionary leap no other being was ever capable of in the 4 billion years of the Earth’s existence – no other animal ever managed to leave the earth’s atmosphere and land on another planet. No other animal is capable of leaving the Earth at some distant point in the future by colonizing other solar systems. And finally, no other animal ever developed the power to destroy the Earth and end history. Only the Homo Sapiens did. 

Friday, 19 August 2016

Physics meets Economics: "Why Information Grows?" (or What I've been reading, vol. 7)

I haven't posted any book reviews for a while now. It's not that I haven't been reading the books, it's just that I failed to find the time to write the reviews. So now, in the next three, four blog posts, I will be writing a series of reviews about 8 or so books (with more to come in the following months). I will start with Cesar Hidalgo's Why Information Grows for today's single book review (it's a big one, since this is an exciting new theory), and then I move on to 4 economic history books (in two separate posts), and close with three inequality/cronyism books. After all of that, in September I will continue with my standard ramblings about economic stagnation, the role of technology and the third industrial revolution, inequality and social mobility, the endless austerity vs stimulus debates, etc. Enjoy! 

Hidalgo, Cesar (2015) Why Information Grows. The Evolution of Order, from Atoms to Economies. Basic Books

Cesar Hidalgo, a physicist from MIT, in one of the most lucid books I have read so far, presents a new fascinating theory of economic growth. One of the most fundamental issues in the field of economics – why some nations tend to be rich while others stay poor – has been given a huge amount of attention in the field over the past 60 years. A number of theories have arisen and have been tested to account for and explain economic growth and development. From Sollow to Romer and Mankiw, from Kuznets to Leontief, from Porter to Acemoglu and Robinson, many have given their unique contributions, each having its own merits and being probably true to some extent. Hidalgo joins this group by producing a synthesis of social and natural sciences in the study of networks and information. He moves beyond the simple factors like land, labor, and capital, and replaces them with matter, energy, and information. It may sound puzzling at first, but once you dwell into the argument, it’s actually very simple and quite intuitive. Basically, in order to understand how economies grow, we need to first understand how information grows. Hidalgo’s theory is where physics meets economics.


Before I descend into the detailed flow of his argument, here is a brief summary of the basic idea relating networks, energy and information to economic growth. His theory relies on the novel concept of economic complexity. Economic complexity, in simple terms, is the diversity, the number, and the ubiquity of products a country exports.  It is not surprising to notice a positive relationship between economic complexity and economic growth, but what’s even more important is that this measure of economic complexity allows us to predict long-run economic growth. So based on the structure of our economy, and which kinds of products we are specialized in today, we can quantify economic growth ten to fifteen years from now. This makes sense, as the total production structure of an economy determines its long-run equilibrium path – i.e. potential output. Countries which are evolving in their complexity are able to catch up with the countries which have already reached the same equilibrium path. This explains faster growth of developing nations, and slower growth of developed nations – or in other words, convergence theory. E.g. consider China and India - they are evolving the complexity of their economies which is why they are more likely to keep high levels of economic growth in the future.

The theory is still in its infancy, as the research on economic complexity has just started (here's the link to the Observatory of Economic Complexity). However, the ingenuity behind some of the concepts makes it a worthwhile effort and may bring us closer to understanding cross-country inequality. The only thing that the book fails to uncover in greater detail is the initial difference in trade specialization patterns. Yes, the current export and production patterns may be good predictors of future growth, and good explanations over why the US is more complex and hence richer than Brazil, and why is Brazil more complex and richer than Chad. But, there is no systematic answer to how and why some products and industries originated in one place, and not the other. This is beyond the scope of the book, intentionally so. Even though it isn’t big in volume it does attempt to do a difficult task of explaining the interconnection between matter, energy, information, and economic growth. So let's dive in. 

Information vol. 1 (the physics behind the idea)

The first part of the book, the one explaining the origin of order from atoms is pure physics. Fascinating, a bit complex, but given the intuitive explanations the ideas tend to stick as you read more and more.

When an average layman hears the word information he or she thinks of it in standard terms; it is digital, immaterial, weightless, easily transferable, a message of some sort – essentially, a man-made phenomenon. However, Hidalgo emphasizes that information is physical. It is not a thing per se, but rather an arrangement of several physical things. Basically, information implies order. The concept of information therefore needs to be detached from its colloquial meaning in order to understand its usage in the book. The capacity to process information and sustain order which involves computation (in addition to a few other conditions) is what he defines as the accumulation of knowledge and knowhow. In this sense information (knowledge and knowhow) is embodied in the products we produce: how complex they are, how widespread they are, and who knows how to produce them. It is this difference in the accumulation of knowledge and knowhow across countries that gives rise to global inequality between nations. In other words, our patterns of production and exports will determine our different levels of development and economic growth.

To understand how information represents physical order, the author gives an interesting example. Consider smashing a $2.5m Bugatti against a wall. It will still be a sum of all its parts, except now the atoms that made the car will be arranged differently. This different arrangement of the same atoms makes the car lose its value. And significantly so. Furthermore, destroying a Bugatti means increasing the multiplicity of its states (increasing entropy), which implies less information about what these parts were. Creating a Bugatti from scratch implies combining iron, aluminum, plastic, and rubber (with of course some engineering and designer knowledge and knowhow), where all of them individually convey less information that their collective final usage. Therefore, destroying a product means destroying information, whereas the creation of a product implies creating information. So regardless of all the inputs we have at our disposal as a nation, our ability to use our knowledge and knowhow to turn these inputs into tangible and valuable outputs (products – pockets of information) is what will define our success as a nation.

But how does information grow? How does it differ across nations?

Essentially, the author defines three conditions necessary for information to grow, necessary for it to ascend from disorder into order (to oppose the second law of thermodynamics of closed physical systems). The first condition is a non-equilibrium system in a steady-state (I’ll explain), the second is the existence of solids in order to store information in them, and the third is the ability of matter to compute.

The simplest example of a steady-state of a non-equilibrium system (used in the book) is the whirlpool that forms when you empty a bath tub. It is easily created (just remove the stopper and the water starts flowing), and easily stopped (do the opposite). So it’s dynamic, and it requires energy to persist (out of equilibrium). The point of such a state is that once in it, the production of entropy is minimized. Think of this as a bowl where if you put a marble it will eventually end up at the minimum of its potential energy (this is also known as a thermodynamic potential – I actually co-authored a paper explaining high and low corrupt systems through double-well thermodynamic potentials). So in an out-of-equilibrium steady state, order will spontaneously emerge and by doing so it will minimize the destruction of information.

Once we have the system flowing from disorder into order, to preserve the newly formed information, it has to be stored in packages. In other words, it has to be stored in solids. Why? Because solids, unlike gases and fluids, are much better at crystallizing information. Information lasts much longer in solids. Finally, in order to have information grow, matter (and its evolution into life forms) needs to be able to process information, it needs to be able to compute. Compute doesn’t necessarily mean making calculations. It can be limited to the very simple perception of animals and even plants, all of which adapt and adjust to the environment around them. Basically, life itself and where we are today is due to our ability to compute (adapt/evolve). So the combination/existence of these three factors is the key determinant of information growth.

(Gosh, I hope I explained this correctly and intuitively enough. If you find it too cumbersome, read the book)

Information vol. 2 (the economics behind the idea)

Ok, so now that we know the physics behind it, let’s see how this information paradigm fits into the economic life.

First and foremost, our capacity to compute isn’t limitless. If it were, there would be no differences between countries. In addition to our intrinsic individual limitations, there are also societal limitations, such as institutions and the availability of technology. These can prove to be essential in limiting the networking capacity necessary for knowledge and knowhow to expand. The economy itself is an amplification engine of knowledge and knowhow. It is within the complex socio-economic network through which we learn how to produce products and in essence – make information grow. We stand on the shoulders of giants – not only in ideas, but primarily in products. Writing this would not have been possible without the internet or the personal computer. Old products embody information to create new products out of them.

One way of showing the difference in knowledge and knowhow, or in other words the difference in accumulating and processing information, is a country’s export structure. As Hidalgo says, the export structure of a country “is a fingerprint that tells us about the ability of people in that country to create tangible instantiations of imaginary objects such as automobiles, espresso machines, subway cars… In fact the composition of a country’s exports informs us about the knowledge and knowhow that are embodied in that country’s population”.

This is the point – the product structure of a country is defined by the population’s capacity to imagine and produce a wide range of products. The greater the available knowledge and knowhow in a country (economists would call this human capital), the better and more complex the range of products, and hence the more advanced a country will be. The export structure also tells you something else. Countries that are well off but only export raw materials which they have due to their access to abundant natural resources are not economically complex. They are actually quite fragile in their structure, as the first sign of a resource price shock, their economies end up in shambles (there is no better contemporary example for this than Venezuela in the past two years; Taleb’s favorite example of this fragility based on natural resources is Saudi Arabia – if the world switches from oil to renewable energies, Saudi Arabia is destined to follow in Venezuela’s footsteps).

Hidalgo shows that the resource curse is due to a lack of imagination (knowledge) to use the resources at their disposal in better fashion. Resource curse leads to a rent-seeking society, which works well as long as the people can all be well-off from the money flowing from the resource abundance. Smarter countries (e.g. Qatar, UAE, Norway) will use the opportunity to invest the money from the natural resources into something else, that will ensure their high living standards even after they drain their resource. This way they improve their knowledge and knowhow, they build their imagination to design more complex products and thus more advanced economies.
                                                                 
However information growth will be prevented if people lack the opportunity to document knowledge and knowhow. If you have a brilliant, life-altering idea, it really matters where you will have the chance to develop it. This is where institutions come in. In many countries having the proper opportunity to even gain knowledge not to mention to use it, is unfortunately unimaginable. Poor institutions and poor governance of such countries makes it hard for people within them to improve them. It is a reinforcing negative cycle. Breaking it up from within is immensely difficult, and breaking them up from the outside is often unfeasible. Going back to thermodynamics, low-income countries are stuck at the bottom of a thermodynamic potential, and unfortunately the only way to break this up is purely random. And the chances of the right combination of factors to occur for a country to break out of a low-income equilibrium are decreasing with the size of the corrupt network within a country. This leads to a very pessimistic conclusion that some countries are doomed (this is the pessimistic conclusion of my paper).

But I digress. Hidalgo also discusses all the possible limitations of expanding knowledge and knowhow. These include intrinsic individual capabilities which then translate to geographically-biased accumulation of knowledge (as individuals spread their knowledge within their own social groups, narrow and broad). This is important to comprehend since complex products (like a car, machine, airplane, or computer), in order to be created, require much more knowledge than one person can have. Hidalgo defines the individual capacity of a single human as a personbyte. Complex products involve a lot of personbytes. In addition to personbytes he also defines a firmbyte – how knowledge and knowhow are distributed across a network of firms. Modern manufacturing is a global process – it involves the coexistence of many networks through which exchange takes place and a product is created (in the modern supply chain economy there is not a single complex product that is being produced in one country, not to mention one place, alone).

Firms, like humans, also have their limitations. Many fail to adapt and go bust. Others succeed if they uncover cheap links to expand their networks in order to accumulate more knowledge and knowhow. For example governments can be both helpful and burdensome in maintaining the costs of such links. They can introduce helpful standards and the proper infrastructure, but they can also impose unnecessary bureaucratic procedures and overreaching regulations that will make links and networks more expensive. This undermines the capacity of economies to accumulate knowledge and put it to good use in producing complex products.

Another important category that affects the accumulation of knowledge is a social network. In particular, culture and trust. In fact the level of trust in asociety will influence the organizational structure of its economy. Hidalgo draws this from Fukuyama who emphasizes the differences in low-trusting “familial” societies (you can only trust your family, not strangers) which tend to be dominated by many small family businesses and a few dominant family conglomerates, and high-trusting societies where professionally-run businesses give rise to large networks of firms and consequentially more complex industries and their products (pharmaceuticals, aircraft, high-tech, etc.).

Therefore, producing complex products implies a lot of personbytes and a lot of firmbytes who get assembled into large networks (which is to a large extent determined by a country’s social, or informal institutions), which consequentially implies a huge accumulation of knowledge at one place. The more complex products you tend to produce, the more knowledge you will accumulate, and vice versa. This is the example of a positive feedback loop. Not to mention that accumulating a lot of knowledge and knowhow at one single place constitutes a comparative advantage of a given country. It is now becoming clearer how this theory explains the development conundrum.

As knowledge and knowhow get geographically clustered there should be a way to visualize this. And here is where Hidalgo does his best. Along with several colleagues, including the famous Ricardo Hausmann from Harvard, they use trade data to show how large networks of accumulated knowledge grow by mapping them into something called a product space (pictured below) (all the visuals are really good, play with them here).


The product space is a network connecting similar products. The closer the products the more similar they are, and the more likely that they will be co-produced and co-exported from one country. For example, a country exporting knit t-shirts is also likely to export other garments and undergarments. Or if you export beef you’re also likely to export cheese. Car engines and motor engines. And so on.

The product space shows that while some industries, and hence products (like clothes) are present everywhere, others are limited to only a few places (like cars, airplanes, or computers). Obviously, the greater the distribution of such industries the less complex they are and the less knowledge they require. The opposite goes for the highly clustered (nested) industries which tend to produce the most complex products. It is therefore easy to see how developed, richer countries, with much larger networks, are able to attract and accumulate the necessary knowledge and knowhow to produce the most complex products. This further ensures their dominance in the global trade and specialization patterns and preserves their position of wealth (e.g. Germany, Japan, US, etc). As Hidalgo says, moving large networks from one country to another is almost inconceivable. Poor countries on the other hand are thus limited to producing only a small subset of products which don’t require a lot of information nor a large network to be produced. This basically means that economic growth is path-dependent. A country cannot just jump from growing crops to producing heavy machinery. It takes time to develop complexity, as countries can only move to products close to the initial ones on its product space.

The problem (and the only criticism I have) however is that the theory doesn’t provide a historical account as to why knowledge accumulated in one place, and not the other. We know why countries differ, this part the theory explains quite well, but we cannot explain its initial divergence – the initial critical point that led some countries to become rich, knowledge-accumulating large networks capable of producing the most complex products, and descended others to a low-equilibrium self-reinforcing negative cycle with a lack of imagination and the capacity to accumulate knowledge at all. On the other hand, I don’t think the author had this ambitious task in mind. Not quite yet I believe.

The answer here probably lies in the development of institutional patterns from the Industrial Revolution onward, and perhaps some historical antecedents we carried from as long as we were able to plow fields. But more on that in the next few books. 

Friday, 5 August 2016

The new political distinction is not left-right, but open-closed

It's holiday season, and the Olympic games have just started, I know, but I read this great piece in last week's the Economist and I just had to share it with my readers. It is possibly one of their best briefing articles to date, as it tackles a very important contemporary phenomenon of a newly arising political divide across the developed world (that was the cover of the entire issue, pictured below). The left vs right is passé, so 20th century. The new distinction is open vs closed. Or in other words, liberal vs national-socialist (OK, maybe not that far away from early 20th century). 

One group is against immigrants, in favor of closing the borders, advocates protectionism, and fears competition (a typical merger between left and right collectivism), while the other group is for open borders, in favor of free trade, in favor of competition and against protectionism. One group advocates and feeds from fear - fear of immigrants and foreign competition taking away domestic jobs, fear from globalization, and fear from terrorism (carried out by, obviously, immigrants). The other group welcomes immigrants, advocates globalization and stresses its benefits and long-term gains. The second group is supported by experts and the current establishment elites. The first group are losers from globalization, the low-skilled workers who lost their jobs and their good health, as well as the middle classes fed up with rising inequality and declining social mobility. They lost their belief in a just meritocratic world and have turned towards the extremes. So far these extremes are in most European countries still on opposite sides of the old left-right political spectrum (e.g. Syriza and Golden Dawn in Greece, AfD and Linke in Germany, National Front and the communists in France, etc.). But in some countries they are merging together. Poland is a good example. Its Law and Justice party served as an inspiration for the opening of the article:
"IS POLAND’S government right-wing or left-wing? Its leaders revere the Catholic church, vow to protect Poles from terrorism by not accepting any Muslim refugees and fulminate against “gender ideology” (by which they mean the notion that men can become women or marry other men). Yet the ruling Law and Justice party also rails against banks and foreign-owned businesses, and wants to cut the retirement age despite a rapidly ageing population. It offers budget-busting handouts to parents who have more than one child. These will partly be paid for with a tax on big supermarkets, which it insists will somehow not raise the price of groceries."
France's Marine Le Pen is hardly any different from this. As is Victor Orban in Hungary. Or Donald Trump, an anti-establishment billionaire (talk about political paradoxes!) with a stringent anti-globalization view, and an elementary misunderstanding of foreign policy, who became a nominee of a party that always supported free trade and a strong US global presence. The list goes on, with the one thing in common is that they all represent a strange mixture of traditionally leftist economic policies wrapped around in right-wing nationalism. One can also argue that Brexit aligned both the far-right voters opposing immigration as well as the far-left voters opposing the "neoliberal" EU (there were other types of Brexit voters as well, but more on that another time). In fact, "neoliberal", whatever it means, became the swear word for both extremes on the left-right axis. Just like in the post-Great Depression era of the 1930s, liberal economic ideas are again facing dangerous populist opposition. 

How do we explain this sudden outburst (or gradual ascent, see graph below) of closed-border, anti-immigrant, anti-globalization, protectionist national-socialists? The Economist summarizes: 
"Mr Trump’s charisma aside, the success of drawbridge-up parties in so many countries is driven by several underlying forces. The two main ones are economic dislocation and demographic change.
Economics first. Some 65-70% of households in rich countries saw their real incomes from wages and capital decline or stagnate between 2005 and 2014, compared with less than 2% in 1993-2005, says the McKinsey Global Institute, a think-tank. If the effects of lower taxes and government transfers are included, the picture is less grim: only 20-25% of households saw their disposable income fall or stay flat. In America nearly all households saw their disposable income rise, even if their headline wages stagnated. Such figures also fail to take full account of improvements in technology that make life easier and more entertaining. Nonetheless, it is clear that many mid- and less-skilled workers in rich countries feel hard-pressed. Among voters who backed Brexit, the share who think life is worse now than 30 years ago was 16 percentage points greater that the share who think it is better; Remainers disagreed by a margin of 46 points. A whopping 69% of Americans think their country is on the wrong track, according to RealClearPolitics; only 23% think it is on the right one. 
Many blame globalisation for their economic plight. Some are right. Although trade has made most countries and people better off, its rewards have been unevenly spread. For many blue-collar workers in rich countries, the benefits of cheaper, better goods have been outweighed by job losses in uncompetitive industries. For some formerly thriving industrial towns, the impact has been devastating (see article). Economic insecurity makes other fears loom larger. Where good jobs are plentiful, few people blame immigrants or trade for their absence. Hence the divide between college-educated folk, who feel confident about their ability to cope with change, and the less-schooled, who do not. 
... 
The second force pulling drawbridges up is demographic change. Rich countries today are the least fertile societies ever to have existed. In 33 of the 35 OECD nations, too few babies are born to maintain a stable population. As the native-born age, and their numbers shrink, immigrants from poorer places move in to pick strawberries, write software and empty bedpans. Large-scale immigration has brought cultural change that some natives welcome—ethnic food, vibrant city centres—but which others find unsettling. They are especially likely to object if the character of their community changes very rapidly. 
This does not make them racist. As Jonathan Haidt points out in the American Interest, a quarterly review, patriots “think their country and its culture are unique and worth preserving”. Some think their country is superior to all others, but most love it for the same reason that people love their spouse: “because she or he is yours”. He argues that immigration tends not to provoke social discord if it is modest in scale, or if immigrants assimilate quickly. When immigrants seem eager to embrace the language, values and customs of their new land, it affirms nationalists’ sense of pride that their nation is good, valuable and attractive to foreigners. But whenever a country has historically high levels of immigration from countries with very different moralities, and without a strong and successful assimilationist programme, it is virtually certain that there will be an authoritarian counter-reaction."
The Economist is right. There is a new political divide out there, and it doesn't look pretty. The traditional liberal-conservative debates (big vs small government, cutting taxes vs increasing spending, austerity vs fiscal stimulus) are still out there, but they are being replaced by the more dominant immigration and globalization debates. The far left and the far right are joining forces against the liberals, which are very much in retreat. This is all to familiar in Europe, and should not be taken lightly. The conclusion of the article is positive. It emphasizes that younger generations carry a much more open mindset and are thus much less prone to be on the losing side of globalization, meaning that in 10 years time, as more young voters mature and fully exploit their global opportunities, radicalism will once again be defeated and pushed aside. But in the mean time they will do their damage, that's for sure.

Monday, 25 July 2016

Having more money helps the poor? Go figure!

The link between income and happiness has been one of the most hotly contested relationships among social scientists. Many researchers from various branches of social sciences have repeatedly denied the existence of a causal relationship between income and happiness (despite overwhelming evidence on how the great rise in living standards was led by the significant increase of post-Industrial Revolution incomes per capita), with the obvious normative conclusion being that having more money is not that important to us after all. 

Well it just happens that it is important.

In an article published last month in the New Yorker entitled "The Case for Free Money", the author James Surowiecki (the Wisdom of Crowds guy) makes a compelling case in favor of universal basic income - a policy proposal (rejected in a referendum in Switzerland earlier this year) where every adult citizen of a country would each year receive a guaranteed basic income. In the US this would be equivalent to $10,000. While there are many potential benefits to this idea (as well as some major obstacles - such as it being too expensive), I do not intend to contemplate on the basic income proposal in this post. I will leave that for another time. What caught my attention was the opening paragraph where Surowiecki calls upon a research paper from a Canadian economist Evelyn Forget who examined the effect of a field experiment being done in Canada in the 1970s. Here's the excerpt:
"In the mid-nineteen-seventies, the Canadian province of Manitoba ran an unusual experiment: it started just handing out money to some of its citizens. The town of Dauphin, for instance, sent checks to thousands of residents every month, in order to guarantee that all of them received a basic income. The goal of the project, called Mincome, was to see what happened. Did people stop working? Did poor people spend foolishly and stay in poverty? But, after a Conservative government ended the project, in 1979, Mincome was buried. Decades later, Evelyn Forget, an economist at the University of Manitoba, dug up the numbers. And what she found was that life in Dauphin improved markedly. Hospitalization rates fell. More teen-agers stayed in school. And researchers who looked at Mincome’s impact on work rates discovered that they had barely dropped at all. The program had worked about as well as anyone could have hoped."
I went through the paper and it was indeed a proper field experiment (lasting a total of 4 years): they had random selection of participants, paired control group from the same community, isolated families, etc. In other words, it was legit, making the conclusions of the paper correct. Having more studies and field experiments just like this one would make the case for the universal basic income even stronger (although, the main problem was the lack of money to carry out the experiment further than 4 years).

However, you can't tell any of this from the paragraph above as the author makes an inference mistake. He should have said that hospitalization and schooling outcomes improved compared to the relevant control group. This way a reader might suspect that the research was not done properly if it only looked at the pre- and post-basic income outcomes in that city alone (these alone would not tell you much about the causal relation). I, for example, had immediate doubts about the validity of the research, which is why I had to read the paper myself. But as I said, the paper is legit. 

For me the most interesting finding this experiment suggests is that by handing out more money to people, the policy entailed positive effects on their quality of life. The basic income improved peoples' health and social outcomes. In other words, it made them happier. So without any unnecessary quibbles about the existence or non-existence of the correlation between money and happiness, by using basic income experiments we can finally empirically establish a positive relationship between money and happiness. Not directly, as few people enjoy money just for the sake of money, but indirectly, as money helps us attain a better living standard. 

My point is, if you advocate universal basic income, don't contradict yourself by saying that money doesn't make people happy. I certainly does. If not directly, than indirectly (just look at the leftist propaganda meme below). For one thing having money means less worries about it. That fact alone improves happiness.  

Tuesday, 12 July 2016

Why is the US white middle class going rouge? ... and voting for Trump

A recent paper published in PNAS by Princeton professors Anne Case and Angus Deaton (last year's Nobel prize winner) reported a stunning finding: there has been a significant increase in mortality and morbidity among middle-aged non-Hispanic white men and women in the US over the past 15 years. The causes have been attributed to suicide, and drug and alcohol abuse. The graphs below summarize the findings:
Mortality in selected countries, 1990-2013.
USW stands for US white. USH stands for US hispanics.
Source: Case & Deaton (2015) "Rising morbidity and mortality in
midlife among white non-Hispanic Americans in the 21st century."
Proceedings of the National Academy of Sciences Vol. 112(49)
December 8th 2015.
Mortality by cause, US white non-Hispanics, 49-54. Source: Case & Deaton
(2015) "Rising morbidity and mortality in midlife among white non-Hispanic
Americans in the 21st century." Proceedings of the National
Academy of Sciences
112(49) December 8th 2015.
Every comparable developed country has experienced a steady decrease in midlife mortality over the past two decades, while the trend for whites in the US has suddenly switched upwards in 1999 and has been steadily increasing ever since. The second graph illustrates why this is so. Deaths from poisonings have gone way up (over 300%) over a time span of only 15 years. Liver diseases and suicides have also gone up. Furthermore, the turnaround in mortality has been driven primarily by whites with a high school degree or less. Those with college education or less remained the same, while those with BA or higher have had death rates decrease. All this suggests that mid-life low-skilled workers, after experiencing job losses, have descended into personal depression and are trying to cure this with drug and alcohol abuse. And if you think that drugs are too expensive for an average unemployed person in the US, think again. The popular TV series Breaking Bad has showed that getting your hands on things like crystal meth is becoming widespread across the low and middle classes in the US (I know it's a fictional TV show, but it does draw implications from the real world). 

Why are these people descending to such states? Why are they killing themselves with alcohol and drugs? A simple explanation is economic, although not necessarily tied to the financial crisis since the trend started during favorable economic times. However the productivity slowdown and the outsourcing trend (a trend that accelerated in the 1990s and particularly in the 2000s), have made their own dents among the low-skilled population. These are not just job losses we are talking about. It's also the prospects of finding a new job for the low-skilled workers (which is perceived to be difficult given immigrants which are prepared to work for much less), as well as their lagging incomes, widening inequality, and disturbed social mobility. However most developed countries have experienced the same problems in recent decades, but these problems haven't manifested themselves into higher death rates for the mid-life low-skilled workers. 

So what gives? Perhaps the fault lies within the US health care system that is out of reach for the poor and middle classes (particularly if unemployed), making them more likely to die from the conditions they've imposed on themselves. In other words, perhaps European low-skilled workers are reacting the same way to globalization-induced job losses (via drugs and alcohol) but are simply more likely to be cured by their free-of-charge public health care systems. That still, however, doesn't explain the increase in suicide rates in the US. Perhaps the inequality and social mobility problems are even worse than we think which is forcing people over the edge. Financial insecurity could also be the issue, as pensions are traditionally tied to stock market earnings. But it's always been this way, and it wasn't a problem before. On the other hand, there has never been such a prolonged period of stagnating low and middle class incomes, so once a low-skilled worker losses his/her job, not having any significant savings accumulated (recall that the savings rate in the US is in steady decline since the 1980s), and possibly overburdened with a home loan, there isn't really much else he or she might hope for. Finally, perhaps the US cultural values emphasizing individual success are taking a psychological toll on its population for the first time in history (or since the Great Depression) as they are unprepared to deal with failure. I'm tapping in the dark here, but one thing is certain - something has definitely gone wrong in the US. 

It is therefore perfectly understandable why the white mid-aged US low and middle classes are switching to populism and are grouping behind Donald Trump. This has been long time coming. Populist messages blaming immigrants on job losses and a wrecked benefits system is exactly what the low-skilled workers have been craving for. Looking at these graphs it is easy to understand why Trump's support has been so high despite all of his political incorrectness and even his billionaire stature. Trump is delivering loud and clear messages that resonate with a part of the electorate that seems to be fighting with various forms of psychological depression and which represent clear losers of globalization (note: globalization certainly has a lot of benefits, but it also has its inevitable losers - for developed countries these are the holders of the scarce resource - the low-skilled workers). Furthermore, the political establishment has failed to hear these voices over the past decades (not only in the US). In such a state, where you lose your job and blame immigrants for it, where you have no savings and no long-term prospects, when you're faced with foreclosure on your home loan, when you realize your children will probably be facing the same bleak future, and finally when the politicians you never really liked anyway are not even hearing your messages, you very easily descend into populism and accept the first loud enough rhetoric that's expressing everything you're concerned about. It is no wonder these people "want to make America great again". For them, America has failed. Their intrinsic voter motivation is in this case actually quite rational. 

Europe is faced with the exact same problem of rising populism resonating to low-skilled losers of globalization, despite its lower mid-life death toll. The most dangerous way of fixing these problems facing low-skilled workers is descending into populism. Let's hope the establishment will realize this and offer realistic solutions before it's too late.