Review: Good Economics for Hard Times

Review: Good Economics for Hard Times

Good Economics for Hard Times: Better Answers to Our Biggest Problems by Abhijit V. Banerjee

My rating: 4 of 5 stars

Economics is too important to be left to economists.


After listening to a series of lectures on introductory economics, I was struck by the degree to which the basic logic of supply and demand was used to make sweeping pronouncements about human behavior and economic policy. The lecturer, starting from the premise that supply and demand is inexorable, would rule out certain policies as working against the market, while promoting those he considered ‘market-friendly.’ But rarely did he stop to actually examine a case study to see how these theories played out, leaving me with the impression of a wholly a priori logic.

The central thrust of this book is that a priori logic cannot be trusted. The economy is complex and unpredictable, so the best way to understand it is through historical case studies and randomized control trials. The authors find that, when we examine the economy in such a way, many of our intuitions about how the it works or will respond to certain policies are wrong. Indeed, though this could hardly be called a revolutionary book—its tone is engaging but mostly academic—the two authors, Banerjee and Duflo, reach quite heterodox conclusions.

One basic economic argument used against permissive immigration policies is that the increased supply of cheap labor will inevitably drive down wages, thus hurting native workers. The logic is simple but it does not hold up under the evidence. In case study after case study, immigration is shown to be either economically neutral or beneficial to native workers. Indeed, ironically—and contrary to what Trump and his ilk may say—low-skill immigrants are better for native workers than highly skilled ones, because they often take jobs that native workers do not want—jobs requiring little communication and much labor. Native workers may even benefit by being promoted to managerial roles. A multilingual immigrant doctor actually competes more directly with native workers than a monolingual immigrant fruit picker.

Perhaps you can see that the above supply and demand argument against immigration is simplistic, since immigrants, apart from increasing the labor supply, also increase demand for goods. Indeed, most professional economists are decidedly in favor of migration. Workers have much to gain from moving to where their skills will be most highly rewarded; and businesses would gain from having good workers. But here the economists’ logic is shown to have its own flaw. Real workers are actually quite averse to migration. Banerjee and Duflo show that, even when a better job may just require move from the country to the city, most will simply not go. There is a large amount of inertia built into real people’s lives—the pull of family, friends, and familiarity—which works against even obviously beneficial moves.

This is not the only way that the real economy is (in economic parlance) ‘sticky.’ Though economists imagine a world of workers ready to move and re-train, of companies willing to fire and hire, banks that drop bad investments and jump on promising new ones, firms willing to relocate to new countries with cheaper labor, new businesses popping up and inefficient ones disappearing—in a word, a dynamic world governed by shifting supply and demand—the real world is consistently stickier than this logic suggests. This seems particularly true in the developing world—the authors’ main area of study—where they found that efficient and inefficient businesses coexisted, where bad-selling product lines were retained, where banks merely rubber stamped loan applications from existing clients, and where people do not migrate for work, or even take the work that is available locally.

Inhabitants of planet earth will likely not be surprised by all this. But the upshot, the authors argue, is that free trade does not deliver all that it promises. Now, the logic of free trade is simple and compelling, grounded in the law of Comparative Advantage put forward by David Ricardo. Simply put, this law states that we all will benefit from trade, since we can all specialize in what we are comparatively better at doing.

But the logic has not exactly played out as hoped. Though touted as a way of propelling developing nations out of poverty, in practice free trade policies have a mixed record. The authors use the example of India, which transitioned from a highly-regulated economy with high tariffs to a free market with low tariffs in the 1990s. The result of this transition was hardly the economic wonder that some economists could have predicted. In many places, wages actually went down rather than up, and in subsequent years much of the economic growth has simply gone to the country’s rich. This is not to say that the results of economic liberalization were all bad, only that it was hardly the panacea that free-market advocates promised.

The consequences for rich nations, like the United States, have also been mixed. While most economic transitions involve winners and losers, the shock of free trade has benefited those who were already ‘winning,’ and hurt those who were already ‘losing.’ In other words, while the big cities full of college-educated workers have grown richer, the arrival of cheap goods—mostly from China—has ravaged many blue-collar communities.

Admittedly, the theory of Comparative Advantage does predict that free trade will temporarily hurt some workers who are forced to compete with cheaper goods from abroad. But the belief in economic adaptability (not to mention the political will to help assuage the problem) was overly optimistic.

Even when jobs disappear, workers do not move. Many simply go on disability and leave the workforce entirely. In short, workers are sticky. Not only that, but the United States has been very bad at redistributing the gains of free trade in the form of worker retraining and extended unemployment. No wonder that many in the country are skeptical of the benefits. However, the authors are careful to note that the solution to this problem is not to impose new tariffs on China. This will only create further economic harm in other sectors (like agriculture) without remedying the harm already done. What is needed, the authors argue, are generous government programs to either re-train displaced workers, or to subsidize industries that are being driven out of business.

This leads us to the longest and most theoretical chapter in this book, that on growth. The argument is fairly dry but the conclusion the authors reach is striking: we do not know what makes economies grow. The greatest years of economic growth were between the end of WWII and the 1970s. This was also a time dominated by Keynesian economics, which led many to give Keynes the credit for this economic miracle. But the magic wore off with the coming of stagflation, which the Keynesian seemed powerless to stave off. This crisis brought the managed economy into discredit, and ushered in the neoliberal revolution, where deregulation, lower taxation, and free trade were seen as the best tools to rejuvenate the economy. Unfortunately, that did not work, either, and growth has never picked up to pre 1970s levels.

Instead, what has grown since the neoliberal turn has been inequality. Rather than stimulate the economy into mad activity, these policies have merely directed what modest economic growth there has been to the much-maligned top 1%. And their political influence has grown right along with their fortunes, which only reinforces the government’s tendency to embrace these sorts of ‘business-friendly’ policies.

As usual, the economic logic used to argue in favor of these policies—that lower taxes on the rich will spur greater activity—is supported by a priori logic rather than actual evidence. But the evidence does not bear it out. People work just as hard whether they are being taxed at 30% or 70%, or not at all, as demonstrated by a series of tax holidays in Switzerland. The notion that high salaries reflect employee value (which supply and demand would predict) is also not supported, as demonstrated by the remarkably high wages paid to those who manage stock portfolios, which consistently underperform against index funds—meaning that the wages are essentially a rent for holding onto money. (And since the high salaries in finance influence salary negotiations in other industries, this increases salaries across the board.)

A strange picture emerges from all this, a picture of an economic policy—at least in the United States—that is entirely divorced from reality. We wring our hands about immigration at a time when immigration is not going up, and even though immigrants pose no credible economic or cultural threat. We argue about tariffs but not about how to actually help those hurt by free trade policies. We cut taxes and deregulate businesses in the name of growth that never appears. Meanwhile, automation is likely to make many of these problems that much worse, and we persist in putting off any action related to the looming climate crisis.

The current pandemic—and concomitant economic crisis—has only put this magical thinking into high relief. Perhaps the best thing to call it is free-market fundamentalism: the belief that the economy, acting on its own, will sort out all of our problems—from poverty to pandemic—without any government aid. Strangely, it is a faith held most ardently by those who see the least evidence for it: people who have been hit by the economic dislocation of free trade. Indeed, at just the time when inequality is rising, we have embraced a kind of social Darwinism that treats the economic pecking order as a perfect reflection of personal merit. This mentality, resting upon the assumption of an imagined economic mobility (which is even lower in the US than in the European Union), justifies both extreme poverty and extreme wealth, since both are ‘deserved.’ To the extent that anyone is held responsible for the situations, it is either outsiders like immigrants or minorities, or the government—not the wealthy.

As Manny has suggested, the situation is rather reminiscent of the USSR in its final years. In both cases we have an economic philosophy based on a priori logic rather than evidence, and believed on the same grounds. As this philosophy fails to deliver, the country’s elites still do not publicly renounce it, but instead only increase their displays of fervor. Rather, entirely irrelevant factors—immigrants, minorities, nefarious citizens—are used to explain the lack of prosperity. Meanwhile, the rich line their already deep pockets while spouting the old egalitarian slogans. The result is a society gripped by nihilism, wherein the old ideals become barely-disguised lies by corrupt and incompetent leaders, and anger and hopelessness descend upon a country that senses it is going in the wrong direction but does not understand why.

This may seem rather hyperbolic. But when you consider how bad things have gotten in the United States in the short time since the publication of this book, when it was already quite bad, then perhaps you can see the justification.

If our economic logic is often misguided, and our policies either useless or worse, what do the authors suggest? Here is where I thought that the book was mostly lacking. Banerjee and Duflo are extremely heterodox when criticizing conventional economics, but are not nearly so bold in proposing solutions. Their general point, however, is that we ought to shift our focus away from trying to grow the economy—since we do not know how to do that anyway—and towards most justly distributing the resources we have now. High tax rates on the rich will help curb inequality without reducing effective incentives. Coordinated efforts between countries can help to reduce tax dodging, and enforcing anti-trust legislation will help curb corporate power.

The authors have a fairly nuanced view of basic income. They think that basic income schemes work well in developing countries, where the poorest are mostly working a variety of temporary or seasonal jobs. But they do not think UBI would work in developed countries, because people have come to rely on jobs not only for income but for structure and even meaning in their lives. In studies, people who stop working do not tend to increase time socializing, or volunteering, or on hobbies; instead, most people end up just watching a lot of television—which does not increase happiness or well-being. This is why the authors prefer significantly stronger unemployment support—helping workers to retrain and relocate.

This seemed somewhat timid to me. But perhaps it is misguided to seek bold, sweeping solutions from authors who insist on hewing to trial, experiment, and evidence. Hard-headed economists, the authors do not promise miracles. Yet if you are looking for a probing and insightful look at many of our current economic woes—now only exacerbated by the coronavirus recession—then this book is quite an excellent place to start. The most pressing point is that our economical problems have political solutions. As usual, the only thing we need is the political will to start acting.



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Letters from Spain #15: The Darker Side of Spain

Letters from Spain #15: The Darker Side of Spain

Here is the next episode of my podcast. This one is about some of the social and economic problems besetting Spain.

To listen on Apple Podcasts, click here:

https://podcasts.apple.com/us/podcast/letters-from-spain-15-the-darker-side-of-spain/id1469809686?i=1000466239844

See the transcript below:


Hello.

I realize that I’ve spent the last few podcasts comparing Spain and the United States, usually to show how my own country is lagging behind. But I am afraid that I am painting an overly sunny picture of Spain. It’s not a paradise by any means. But I admit that it is a bit harder for me to talk about Spain’s shortcomings. Like most people, Spaniards are not overly keen on foreigners criticizing their country. And there is a long tradition of foreigners criticizing Spain. Spaniards sometimes refer to the leyenda negra (the “black legend”)—which is a tendency among historians to treat Spain as backward, cruel, conservative, and uncivilized.

As an example of this, many people know that the Jews were expelled from Spain. (This happened in 1492, under the reign of the Catholic monarchs. They were officially given a choice between conversion or exile, or death I suppose.) This is sometimes used as the basis for portraying Spain as particularly intolerant. But you may not know that, in the course of history, the Jews were expelled from nearly every European country, and sometimes multiple times. Of course, a multitude of wrongs doesn’t make a right. Intolerance is always bad. The point, however, is that Spain was not exceptional in its intolerance.

Well, I’m not here to talk about the black legend. Rather, I want to talk about some of the shortcomings of Spain’s economy now. Along with Portugal, Ireland, and Greece, Spain was among the EU countries that took a big hit during the 2008 financial crash. Recovery was long, painful, and slow. But Spain did turn itself around, and now has an economy well ahead of Greece’s, or Italy’s, or Portugal’s. Still, there is cause for concern. I can report some anecdotal evidence. During my time as a teacher, I’ve come across doctors, lawyers, and engineers who couldn’t find work, or at least couldn’t find good work. That’s concerning enough as it is—highly-skilled workers who can’t find a job?! And even now, over ten years later, unemployment is still alarmingly high. While it is now well below 5% in the United States, it is around 14% here. That’s huge. And unemployment among young people (below 25) is about double that. Obviously this is a huge problem for an economy.

I have a pretty distorted picture of Spain’s economy myself, since I work as an English teacher. In general, native English teachers are in high demand in the country, so for me finding a job could hardly be easier. You’re basically hired on the spot. So from my point of view Spain’s economy is just great. But of course, the reason why a lot people want to learn English in the first place is so they can work in international business. In other words, it’s a sign that the best business opportunities are not to be found within Spain itself. But why is this?

The main explanation I’ve heard for Spain’s economic sluggishness—and admittedly it’s an explanation from a particular ideological camp—is that the EU’s economic policies are to blame. For one, because it shares the euro with so many countries, Spain cannot control its own currency, which means it can’t exert the kind of control that the Federal Reserve uses to adjust the American economy. Another commonly-blamed culprit is the economic philosophy of the German-dominated European Union, which insisted on imposing austerity in response to the crisis, and it’s generally preoccupied with keeping the deficit smaller than some pre-ordained limits. Now, please don’t ask me to explain any of this in detail. For this, you can read Joseph Stiglitz’s book The Euro for more. (Or just read my review.) And also, please don’t think that I’m anti-European Union. I love my euros. All I’m saying is that there’s a reason so many young professionals go to Germany and that so many people are out of work. Something isn’t working right.

This very high youth unemployment rate, by the way, is a major reason why so many young Spaniards live with their parents for such a long time. It’s not just because Spanish men are mama’s boys—although that’s true, too—but often from economic necessity that people live with their parents until adulthood. I should also mention that Spain is suffering from the same economic maladies that we often complain about in the United States. Inequality is only growing, while social mobility is not high. According to an OECD report, it would take a low-income family four generations to reach the country’s average income. (What does that mean?) Like most places, if you’re born poor you’re likely to remain poor, and the same goes for people born rich. This is not the society most people want to create.

The most obvious evidence of Spanish poverty are the shanty-towns. For three years, on the bus ride to work, I could see what was unmistakably a shanty-town out my window. It was just like you see in pictures from the great depression: improvised shelters made of bits of metal and wood, all huddled together. This was a settlement on one of the old shepherding trails given a royal license back in the middle ages, called cañadas reales. According to El País, almost 8,000 people were living on this illegally developed land, although admittedly not all of them in a shanty-town. In fact, some of the houses belong to middle-class families; and this wouldn’t be the first time in Madrid’s history that an illegally developed land became a thriving neighborhood. But obviously many of the people living there are abjectly poor, without access to basic services or infrastructure. 

For many years, you could also see a shanty town in a bit of undeveloped land behind Madrid’s railroad museum. The authorities were pretty slow in dealing with the situation. From what I’ve read, they came in, performed a census, and then tried to arrange public housing for the residents who qualified. Then, they came in and bulldozed the shelters. This happened in the cañadas reales, too, I believe. Even now, you can see bits of rubbish and blacked concrete left near the railroad museum.

Now, many of the people who were living in these shanty towns were ethnically Romani (they are often called “gypsy,” but that term is now considered offensive). The Romani area substantial ethnic minority in Spain, ultimately originating from India (though they left a long time ago). The word “gypsy,” by the way, comes from the word “Egyptian,” since this is where people thought they were from. Even though the Romani culture has had a great influence on the culture of Spain in general—particularly in the southern province, Andalusia—there is quite a bit of prejudice against the Romani people. They are imprisoned in huge numbers, and the vast majority are living below the poverty line. Many Spaniards are openly hostile to Romani people.

Admittedly the situation is quite complex, since the Romani are traditionally itinerant and thus tend to live outside of the norms of sedentary society. But as usually happens, it is difficult to say what is a cause and what is an effect. Are Romani pushed to the margins by choice, or is it a reaction against the prejudice of society? I suppose you’d have to ask an anthropologist. But I think it’s fair to say that the poor living conditions of so many Romani—and there are over one million in the country—is one of Spain’s most obvious social problems.

Another sort of person often pushed to the margins are migrant workers. Just last week, Philip Alston, an ambassador from the United Nations, visited a migrant workers’ camp in Huelva, in the south of Spain. What he found was yet another shanty town, with people living in what he describes as some of the worst conditions he’d ever seen in Europe. Here’s a little quote from an article in El País: “people cook by the light of their cell phones, fetch water from a tap two kilometers away and store it in plastic bottles that were once used for weedkiller. They shower outdoors with water heated on a stove, and go to the bathroom in the field.” Now keep in mind that some of these people have been living like this for a decade. They are agricultural temp workers, some of them without work permits, who make about six euros a day.

Not too far away from Huelva, in the province of Almeria, there is a huge conglomeration of green houses—so many that you can easily see it from space. (Just try it using Google’s satellite view.) This used to be totally arid land, but the greenhouses have made it incredibly productive. In fact, this relatively small space provides a big chunk of Europe’s fresh produce. But conditions inside the greenhouses are so brutal that the labor is mostly done by migrant laborers from Africa or Eastern Europe; and just like in Huelva, many of these workers live in slums and shanty towns, making much less than the minimum wage. Thirty percent of the workers are undocumented. Now, you can talk about illegal immigrants taking jobs all you want, but the fact is that Spaniards don’t want these jobs. And Europeans are happy to have cheap fruits and vegetables. But someone is paying for those cheap prices. It’s these migrants who are being exploited, and who live and work in unsafe conditions.

To round out this picture of the economic and social woes of Spain, I also have to mention the depopulation of the interior. Many villages in Spain are emptying out. In the least densely populated area in Spain—in the mountains between Cuenca, Guadalajara, and Teruel—the population density is less than it is in Lapland, the northernmost region of Finland. For years, the whole province of Extremadura has been struggling. Almost half of the people in Extremadura are living on less than 700 euros a month. It’s no surprise, then, that young people are trying their best to move into the cities. Meanwhile, in the cities, decent housing is getting harder and harder to find. Rents perpetually rise. Partially this is because so many houses are purchased at a high price and then mostly left empty by wealthy people. According to El País, there are almost three and a half million properties left empty. That’s pretty crazy to think about, when you keep in mind the people living in shanty towns on the edges of the city. In fact, the current socialist government is trying to create legislation to solve this problem.

Well, so there you go. That’s the best I can do in talking about the shortcomings of Spanish society. A sluggish economy, lots of people out of work, inequality and a lack of social mobility, and lots of people living on the margins of society. But I do want to end this podcast on a less gloomy note. As even the UN ambassador noted, Spain’s public healthcare system is working quite well, achieving universal coverage. An immigrant named Eva Costizo recently shared a “symbolic” invoice of what her medical bill would have been had there not been public healthcare. To an American that’s hard to fathom, someone publicly celebrating not paying a medical bill. Meanwhile, I just saw an article in the NYTimes about a person who received a “surprise” medical bill for $145,000. So I don’t think we have much to be gloating about.

Thank you.