Rodrik and externalities

by Russ Roberts on April 13, 2011

in Podcast, Subsidies

In this week’s EconTalk, Dani Rodrik discusses how labor markets in some countries work better than others. It’s an interesting conversation about the next best alternative. When workers in America lost their jobs the next best alternative can be fairly close to the lost job and may pay nearly as well. And of course some workers who lose their jobs are fortunate to find a job that even pays more. But in poorer countries, if the agriculture sector is destroyed by cheaper imports, for example, the next best alternative may not even be there or if it is, it may pay very poorly. One way to think of this is that creative destruction may not be equally creative everywhere.

Along the way, Rodrik argued, to my surprise, that starting a new venture in a poor country has a positive externality that leads to market failure. He gave the example of a call center–suppose a country has a work force that would be good at working in call centers. An entrepreneur who starts a call center will thereby provide information to other entrepreneurs about the quality of the work force. The original entrepreneur can’t capture this gain so the government should correct this market failure by subsidizing it. Rodrik and I discussed the issue for a while and he raised what he considered other examples of market failure including the possibility that any rents generated from starting the call center might quickly be eroded by other entrants who start their own centers and bid up the price of your labor.

After the podcast was over, I realized I had neglected to raise an important objection to Rodrik’s claim. We ended up emailing back and forth and he kindly gave me permission to print our exchange. I offered him the last word but he didn’t respond. I’m sure he was had simply had enough or had other things to do. I mention it only because I don’t want you to think that I didn’t give him the chance or that he conceded my point. Again, I’m sure he has something more to say.

ROBERTS: If entrepreneurs are uncertain about whether a countries labor force is productive or not, how would a government policy maker assess that more accurately?

RODRIK: It’s actually very simple.  The first-best intervention here is an entry subsidy to any entrepreneur who invests in a product or technology that is new to the country.  And there is a host of second-best policies that could also do the trick.

You don’t need to assume the government knows more than the private sector, any more than in the case of externalities from R&D in the advanced economies.  Even though the government has no idea which research projects will produce genuine advances, there is an argument for subsidizing R&D across the board.

Or think of patents, which are aimed to achieve in a second-best fashion, the same kind of knowledge spillovers that new products and processes generate in rich countries.

In fact, when entrepreneurs in developing countries engage in cost discovery, they are the source of exactly the same kind of positive externalities that entrepreneurs in Silicon Valley produce.  Except that the latter get patent protection, while the first normally don’t get any subsidies at all (unless we implement the kind of policies I am advocating).

ROBERTS: Let’s say creating a cardboard box factory, a new venture for the country, has a negative rate of return so no one is willing to start one. The government offers a subsidy to all new products. Now, when the subsidy is included, the factory has a positive return so it gets built. How is that a good idea?

RODRIK: It’s a good idea in the same sense that financing a R&D project with a potential externality is a good idea EX ANTE, even if the project ends up failing.  Other R&D projects that are successful (and are similarly subsidized) will more than pay for the failures.

This is all worked out in the following paper: http://www.hks.harvard.edu/fs/drodrik/Research%20papers/selfdisc.pdf

But here is the gist.  If there is an externality in investing in new activities, there will be underinvestment by the private sector.  A (small enough) subsidy to investors is efficiency-enhancing, because it brings investment closer to the first-best level, even if not all of the new projects succeed.

ROBERTS: I guess I’m skeptical about subsidizing R& D as well. If the subsidy is set too high (and there will be a political incentive to so) the subsidy will make the nation poorer. The same seems true of a blanket subsidy to new ventures.

If you’re interested in the idea, check out his paper and the podcast. The only other point I would add is that political pressure will make it very hard to define “new” as in subsidies to “new” ventures.

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{ 71 comments }

WhiskeyJim April 13, 2011 at 3:21 pm

Most respectfully, this is a classic example of an idea that looks semi-attractive on paper, and defensible in theory.

In reality, it quickly becomes untenable economically, driving new venture ROI down significantly, crowding out better ideas, becomes a politically motivated football, and increases job churning. How do I know? Because private firms which already demand an eventual ROI on R&D already struggle to avoid those pitfalls. Everyone has a ‘great’ idea. Governments many times removed from the financing make it exponentially worse.

“financing a R&D project with a potential externality is a good idea EX ANTE”

It is beyond my comprehension how that statement can be true. The government is appropriating money. That banks can print it makes no difference. Mr. Roderick seems to be saying that a certain low level perpetual money loser on ‘new’ ideas is a good thing. On closer inspection, this is how governments end up over-extending themselves.

Methinks1776 April 13, 2011 at 6:34 pm

It’s beyond Rodrik’s comprehension as well – not that that will slow his roll.

Justin P April 13, 2011 at 7:24 pm

It’s all based on the assumption that politician will do what is in the public good over what is in their personal interests. 8 years of Clinton, 8 years of Bush and 3 years of Barry….I still can’t find any data that supports that assumption.

Daniel Kuehn April 13, 2011 at 3:22 pm

A very interesting idea.

This is an important point that he makes: “You don’t need to assume the government knows more than the private sector, any more than in the case of externalities from R&D in the advanced economies. Even though the government has no idea which research projects will produce genuine advances, there is an argument for subsidizing R&D across the board.

Often market failure corrections get billed as “central planning” and it gets pointed out that the state can’t do economic calculation. The response – as Rodrik provides – is “of course it can’t – nobody ever said it could”. Subsidization in response to externalities only makes sense if you agree that central planning does work. If you did think central planning worked – if you think that government could make specific investments – you wouldn’t bother with subsidies – you’d just nationalize the industry!

So this point is important… and its one that has to be made and re-made a lot when the “central planning” non-sequitor gets whipped out.

Daniel Kuehn April 13, 2011 at 3:33 pm

***Only makes sense if you agree that central planning DOESN’T work.

I desperately miss that edit button.

Daniel Kuehn April 13, 2011 at 3:25 pm

As for this: “If the subsidy is set too high (and there will be a political incentive to so) the subsidy will make the nation poorer.”, it’s true of course but it seems to me its highly unlikely that it would be poorer than the status quo. If you accept that there’s theoretical reason for a subsidy in the first place, you’re already accepting that the nation is poorer than it could be – so any initial application of a subsidy is moving in the right direction. True, you could overshoot. But the nature of a positive externality is that you have concentrated costs and dispersed benefits. Likewise, the very nature of a negative externality is that you have concentrated benefits and dispersed costs. Mancur Olson and public choice theory demonstrate for us that in these situations you’re actually wrong – there is a political incentive not to overshoot, not a political incentive to overshoot.

Daniel Kuehn April 13, 2011 at 3:38 pm

So on further consideration it’s not that you’re wrong so much as that you’re neglecting an important public choice argument that works in the other direction – forcing us to be ambivalent.

Correcting externalities is a political loser for the same reason that it’s a market loser: the benefits of correcting externalities are widely diffuse. But you’re right that as a budget priority it is a political winner: the costs of financing the subsidy are also diffuse.

Mancur Olson supports your argument and mine.

It doesn’t seem wise to pretend that it’s decisive either way – and history certainly provides a mixed record on whether externality correction is politically viable (which we’d expect with an ambiguous theoretical result).

Doc Merlin April 16, 2011 at 5:29 am

Any subsidy will make the nation poorer, because it diverts brilliant minds away from doing marketable tasks. The limiting scarce resource here isn’t money as your interviewee seems to think, but rather entrepreneurial initiative and intelligent minds. Paying them to do what the government wants them to do is a terrible idea.

Doc Merlin April 16, 2011 at 5:30 am

I should explain further. Your cost to society (what you get society to do for you) is roughly what you spend.

Daniel Kuehn April 13, 2011 at 3:28 pm

Finally – on your rate of return question, note that your first point (it has a negative rate of return) is implicitly a reference to a private rate of return. Investment decisions get made on the basis of private ROR.

In your last sentence (“how is that a good idea”) you’ve implicitly shifted gears to discussing a social rate of return (unless you have a different definition of “good” and “bad” from most economists).

If you think more explicitly about when you are refering to private returns and when you are refering to social returns, it’s clearer why situations with negative private returns may actually be good ideas.

That’s all I promise – sorry for all the comments but the subject interests me.

indianajim April 14, 2011 at 10:01 am

If you write enough in stream of conscious mode, no one can disagree with you; it becomes a tautological ramble. Apology accepted.

Daniel Kuehn April 14, 2011 at 11:21 am

You seem to have managed to accelerate to full-on ramble in only two lines of text!

indianajim April 14, 2011 at 11:54 am

My first auto was a Rambler (this is tit-for-tat, or rather non sequitur rebound).

:)

Colin Fraser April 13, 2011 at 3:51 pm

Russ, are you in favor of any government intervention in the case of a positive or negative externality ever? If so, what are the necessary conditions under which intervention would be appropriate? The answer to that could shed some light on your perspective on this argument.

jhodapp April 13, 2011 at 11:43 pm

I think that’s a good question and actually I am quite interested in Dr. Robert’s response.

Russ Roberts April 14, 2011 at 12:23 am

Good question. Maybe I’ll do a podcast on it.

I do believe that much environmental regulation though distorted by special interests has probably been a net positive. The question here is whether these results could have been achieved more cheaply and effectively through the legal system or allowing emergent alternatives.

Similarly, the charity deduction has produced lots of good. But it seems wrong to force others to pay for the charities I like that the others may hate…

I’ll try to write something more systematic down the road.

vikingvista April 14, 2011 at 12:43 am

It would be interesting to find some reasonable trend line to show whether or not the creation of the EPA had any noticeable effect on declining pollution. I’m skeptical.

It seems odd to refer to an inaction–not confiscating funds used for a certain purpose such as charity–as a government intervention. I would say the intervention is the confiscation of the other funds. The proper comparison would be an income tax with deductions compared to no income tax at all. And there again, I’m highly skeptical that the income tax (excluding charitable spending) has had a positive effect on charity.

vikingvista April 13, 2011 at 4:59 pm

Thor save us from government efforts to perfect markets.

Can’t we be happy with positive externalities? Need we impose the grossly undervalued cost of government imposition to allow market actors to capture even more of the benefit that they’ve already voluntarily chosen to pursue?

And where does it end? Truly, positive and negative externalities can be seen in ANY action, including actions of government agents. Allowing governments the general authority to control externalities is like giving them a free license to do whatever the hell they want to the economy.

Daniel Kuehn April 13, 2011 at 5:25 pm

Coase takes away any mistake of assuming a “free license”.

vikingvista April 13, 2011 at 5:45 pm

Hardly. Government agents don’t carefully evaluate the presence of Coase’s conditions. They don’t accurately calculate costs and benefits. They instead put a magnifying glass to any externality, the mere existence of which will justify their actions, by ignoring everything else, such as secondary markets. Politicians select only what they need to justify their power. They have no interest in a balanced view.

Use Coase to instead help defuse some of this appetite for any government interference in externalities.

Daniel Kuehn April 13, 2011 at 7:13 pm

Well (1.) some policymakers absolutely do pay attention to Coase, but it’s true politicians don’t, and (2.) I suppose I was just curious why you’re even talking about a “general authority”.

re: “They have no interest in a balanced view”

I don’t know about this as a rule… one of the problems with correcting even major externalities – like carbon use – is that the benefits are so diffuse the public choice calculus works against passing anything. I think it varies case by case.

re: “Use Coase to instead help defuse some of this appetite for any government interference in externalities.”

This sounds like an abuse of Coase, not a use of Coase. We have had the externality logic somewhat longer than we have had Coase. It is good logic. We use Coase to even better understand externalities than we did previously. That seems like a better use than as a cudgel in a general “don’t fix externalities” agenda.

vikingvista April 13, 2011 at 7:21 pm

No, using Coase as a justification for government intervention is a misuse of Coase. Better understanding of externalities doesn’t mean government agents come anywhere near to a competent understanding of either the externalities or their proposed interventions.

Daniel Kuehn April 13, 2011 at 9:54 pm

I was thinking of citizens and voters getting a better understanding not “government agents”.

vikingvista April 13, 2011 at 11:30 pm

“I was thinking of citizens and voters”

Well, then no disagreement. But an understanding of government would make anyone hesitant to advocate its use as a tool to reduce externalities.

tkwelge April 14, 2011 at 3:34 am

Being that all value is essentially subjective in nature, and that the government planners are forced to view value objectively, the “objective” view is simply the subjective view of those in government, or the special interest that happens to control the strings at the moment. Vikingvista couldn’t be more correct. This subjectivity allows the government to declare any damn thing an “externality” and then demand resources to “correct” it.

Externalities must be dealt with through the courts, because only courts are capable of allowing two parties to come together to have a mediated discussion about the relevant SUBJECTIVE views. Any government edict is essentially an attempt to turn somebody’s subjective valuation into the government’s “objective” view. That view is then forced upon the public whether it is contrary to societies nature or not.

The idea that all externalities must be internalized for the market to work efficiently seems rather strange. After all, when I trade thirty apples for your thirty oranges and vice versa, it is not because thirty apples are equal in value to thirty oranges. It is because we both incur positive externalities, because we both view ourselves as receiving more than we have given up. WHy would you trade thirty apples for thirty oranges if they held the exact same value TO YOU? Clearly, you get MORE value from the thirty oranges than the thirty apples, thus a positive externality has occurred that isn’t being included in the sale price. Somebody call the police! In fact, it is because of non internalized externalities that market activity can occur at all.

The fallacy that all externalities must be internalized comes from the fact that academic economists work with models that assume that the economy should be perfectly competitive and that resources should be perfectly allocated at all times or else a “market failure” has occurred. In a perfectly competitive market with perfect knowledge and perfect allocation of resources, their would be no profits and no change. This “perfect” state would be the end of all economic activity! It is the friction of the market and creative destruction combined with the profit motive that drives all economic evolution. Profit is created by the inherent scarcity of resources and the lack of satisfaction that inevitably exists at any given time for an infinite number of reasons. It is because man DOESN’T live in a state of perfection that he/she acts.

Daniel Kuehn April 14, 2011 at 6:42 am

re: “The idea that all externalities must be internalized for the market to work efficiently seems rather strange. After all, when I trade thirty apples for your thirty oranges and vice versa, it is not because thirty apples are equal in value to thirty oranges. It is because we both incur positive externalities, because we both view ourselves as receiving more than we have given up.”

But if “you incur”, as you say, it’s not a positive externaltiy. It’s precisley your internalized benefit above the market price – your surplus – that drives trade. You are highlighting precisely why internalization of benefits and costs is necessary for maximizing consumer surplus – or welfare in general.

You say: “thus a positive externality has occurred that isn’t being included in the sale price”, but you’re misunderstanding the term. An externality occurs when a cost or a benefit isn’t considered by the parties to the transaction, not when it isn’t reflected in a sales price.

Could you explain what a perfect market has to do with externalities? I don’t quite understand.

tkwelge April 14, 2011 at 7:22 am

“An externality occurs when a cost or a benefit isn’t considered by the parties to the transaction, not when it isn’t reflected in a sales price.”

In the context of the discussion of positive externalites benefiting customers above and beyond what they pay for a product (think of the argument that the decrease in profit that would occur for certain companies if there were no patent protections represents a version of the “free rider” problem), the pro internalization argument is that producers somehow have a right to earn revenue dollar for dollar for every external benefit that they provide in order for the market to operate efficiently. That is essentially the nitty gritty of the argument that Rodrik is making.

An externality doesn’t necessarily have to involve a third party. It is also considered an externality when a benefit or disbenefit effects one of the two parties to a transaction without being reflected in the cost or benefit that the other party receives. That is the essence of the free rider problem and the entire argument for patents and copyrights.

Daniel Kuehn April 14, 2011 at 11:18 am

tkwelge -
No, you are describing consumer surplus, not an externality.

Pick up any intro text book. Prices do not reflect all costs and all benefits. Prices reflect marginal cost and marginal benefit. When prices reflect marginal cost and marginal benefit all internalized costs and all internalized benefits are maximized but that does NOT mean they are equal to the price.

The entirety of the marginal revolution and welfare economics seems to have passed you by.

yet another Dave April 14, 2011 at 2:13 pm

…one of the problems with correcting even major externalities – like carbon use – is that the benefits are so diffuse…

You are correct that the benefits of carbon use are diffused widely, but why on earth would you want to “correct” the enormously positive externalities of carbon use???

tkwelge April 14, 2011 at 4:04 pm

@ Daniel Kuehn

“But here is the gist. If there is an externality in investing in new activities, there will be underinvestment by the private sector. A (small enough) subsidy to investors is efficiency-enhancing, because it brings investment closer to the first-best level, even if not all of the new projects succeed.”

This is what I’m referring to.

“Pick up any intro text book. Prices do not reflect all costs and all benefits. Prices reflect marginal cost and marginal benefit. When prices reflect marginal cost and marginal benefit all internalized costs and all internalized benefits are maximized but that does NOT mean they are equal to the price.”

Yes, this is the argument that I’m making. Rodrik is the one confusing consumer surplus with an externality. In fact, the entire argument for patents is an argument that consumer surplus is a positive externality, which is why it is false.

Stop being such an arrogant jack ass. Rodrik is the one making the argument that consumer surplus is an externality. Rodrik was arguing that government intervention, patent protections, is necessary to internalize demand for innovation. That is what I’m responding to.

tkwelge April 14, 2011 at 4:12 pm

“In fact, when entrepreneurs in developing countries engage in cost discovery, they are the source of exactly the same kind of positive externalities that entrepreneurs in Silicon Valley produce. Except that the latter get patent protection, while the first normally don’t get any subsidies at all (unless we implement the kind of policies I am advocating).”

Replace the first quote in my last comment with this one. Whoops.

Daniel Kuehn April 15, 2011 at 10:03 am

tkwelge -
Screw you – don’t call me an arrogant jackass because I point out that you’re wrong.

You write: “when I trade thirty apples for your thirty oranges and vice versa, it is not because thirty apples are equal in value to thirty oranges. It is because we both incur positive externalities”

How is that NOT confusing consumer surplus with positive externalities?

The positive externalities that Rodrik is highlighting are the benefits that other people get when I engage in “cost discovery”, or any other kind of innovation or research for that matter. That’s not “consumer surplus” because the other parties that benefit aren’t a party to the transaction that I’m engaging in. It’s precisely because what he’s talking about is not included in consumer surplus (but does provide welfare) that it’s an externality.

indianajim April 14, 2011 at 10:04 am

Great comment.

Gareth April 13, 2011 at 5:37 pm

“Other R&D projects that are successful (and are similarly subsidized) will more than pay for the failures.”

What makes this more than wishful thinking? Isn’t it possible that all the subsidies would fail and the country would be worse off.

Andrew_M_Garland April 13, 2011 at 5:50 pm

What a line: “Even though the government has no idea which research projects will produce genuine advances, there is an argument for subsidizing R&D across the board.”

The phrase “there is an argument for” is the gaping hole in discussions. What is that argument? Further, where is the example of public investment by politicians being generally profitable? What does “across the board” mean? Is it any idea presented by some cronies who see money being handed out by politicians?

Rodrik seems to support the Ignorant Politician hypothesis. The Politician knows almost nothing, but makes up for this ignorance by investing in everything. Surely, something will be successful and pay for all the losers.

This is another form of Cargo Cult economics. The Ignorant Politician observes smart people in the private sector investing in a range of projects, each with an expectation of success. Still, some projects lose money.

The politician doesn’t invest in those funds. The politician instead copies the actions of those funds (as he sees it from his ignorant perspective). He mimicks what he sees, confident that his random investments will be successful overall, just like the funds run by the smart guys. Motto: “They aren’t so smart. I can do that too.”

Worse is the theory that Spending Money Can’t be Bad. Even if the projects fail to “produce genuine advances”, at least a lot of activity has been created (at a loss) and the supposed Multiplier Effect will produce “externalities” somewhere (where?) even if all the projects fail. Motto: “When you spend a lot of money, there is a great benefit somewhere”.

People spend money in a prosperous economy, so let the US government give them money to spend. Prosperity is sure to follow. Where is the official government approved analysis which supports that policy? It would be a laugh to read and analyze it.

What is the similarity between our government and some superstitious Pacific islanders during World War II?
–> Cargo Cult Economics

Justin P April 13, 2011 at 7:29 pm

I agree. The problem with Rodrik’s statement is that when a private firm blows up, only private capital is destroyed. When a government funded project blows up, then they have to make up for it through taxation.

Paul Andrews April 14, 2011 at 8:50 am

…not only that, a private firm that fails, stops. A public project that fails is likely to keep going regardless.

Captain Profit April 13, 2011 at 8:54 pm

Andrew_M_Garland wrote:
>> What does “across the board” mean?

There’s the rub. At best, the state will always be biased toward the familiar. At worst, toward the politically connected. Hayek suggested that if the state really wanted to foster innovation through subsidy, they should periodically give a random individual a sum of wealth sufficient to allow him to pursue any aim he chooses.

Chucklehead April 13, 2011 at 5:58 pm

So existing basket weavers get to pay taxes to subsidize R&D for the new box maker who will creatively destroy them? Sign me up.
The only subsidy for R&D should be the expensing of the R&D cost against other profits.

Dr. T April 13, 2011 at 8:57 pm

I think Rodrik is wrong. We’ve had numerous recent examples of government subsidies of “new” ventures or R & D: the “green energy” projects in many nations, including the USA. I have yet to hear of a government-subsidized green energy industry that was successful once the subsidies were removed. I have yet to hear of a government-subsidized green energy R & D project that led to competitively-priced energy that does less harm to the environment than extracting, distributing, and burning petroleum products.

Rodrik apparently believes that venture capital markets are inadequate, and that governments need to fund new ventures. The only places where that would be true are in nations that are so politically unstable that the most adventurous venture capitalists won’t invest there. The unstable governments of such nations aren’t likely to have the skills to choose which enterprises should get subsidies, and they aren’t likely to have funds for subsidies.

WhiskeyJim April 14, 2011 at 2:21 am

I see where you are trying to go in the developing nation argument. I believe that is where government should absolutely NOT intervene. It has scarce resources. To argue that the government should spend money, you must at least partly believe that government injection of funds has a positive multiplier effect even if it fails. I believe this is one of Roderik’s (false) assumptions.

Better for poorer country governments to concentrate on clearing away corruption, establishing the rule of law to provide safe harbor for investment. Corruption is the killer in all poor countries. Is it the number one reason they are poor? Our foreign aid delivery system makes it worse.

Sam Grove April 13, 2011 at 11:03 pm

Corruption is merely incidental to the exercise of political power and need not be taken into account when conceiving of political actions.
/sarcasm

Designer Wholesale Handbags April 13, 2011 at 11:53 pm

conceiving of political actions

Steve_0 April 14, 2011 at 12:01 am

Where does the subsidy come from? Who can claim to know the empirical effect of the spending that can’t happen because it’s been collected to subsidize some venture that private capital merchants can’t be convinced has value.

This is just more attempts of bootstrapping the same concept over and over again. Somehow; never explained- the government shuffling money around must produce a better output than you idiots can manage for yourselves. That’s what these people are always saying.

WhiskeyJim April 14, 2011 at 2:25 am

Exactly. The injection of money on useless projects produces a positive churning effect. Pure unadulterated Keynes.

Pure unadulterated crap.

Think of the billions spent on green energy in the last 50 years. It is enough to keep you awake at night.

Ronald Coase Himself (For real) April 14, 2011 at 12:50 am

Let me try to clarify matters, young ‘uns.

Rodrik is right. Duh. People creating positive externalities? Subsidize them. The problem is that his model might not be relevant to reality–but it might be. 

In my brilliant 1947 paper, I show that Hotelling’s argument about marginal cost pricing, which is perfectly correct given his model, fails terribly when applied to a more complicated model. Hotelling wasn’t exactly wrong, but his argument was irrelevant to policy.

Similarly, it’s one thing to talk about Rodrik’s argument on its own merits (he’s probably right) and another thing to apply his results to policy (he’s probably wrong, though perhaps for reasons irrelevant to his argument, just as my refutation of Hotelling was irrelevant to his argument).

Economists have the worst of both worlds. They are simultaneously theorists and engineers. A theoretical physicist struggles to describe and explain reality. However, what he does describe and explain is probably totally true, on his terms. Engineers, on the other hand, struggle less to come up with answers because they are worried less about whether the plane is theoretically rigorous than whether the damn thing flies. However, engineers must offer useful results. They can’t be interesting for interesting’s sake.

Economists have a hard time explaining The Thing And The Whole Of The Thing because it’s damn complicated. However, they can’t afford to be right on their own terms and their own terms only (I know I’m overgeneralizing here–as I demonstrate now– but I believe there’s truth here as well) because the public and the politicians demand results and the damn plane had better damn well fly. The balance is hard to find because economists make terrible engineers, but the theory is too hard to compensate for that.

So Rodrik is obviously right and obviously wrong. It would be a miracle if he really captured everything relevant to policy in his model, but as theory it’s right. So the argument should either be purely theoretical–what does this add to the paradigm and how can we use it to further develop and hopefully break the paradigm–or else practical–are any of the zillion and one things his policy advice ignores relevant?

About the latter, here’s an analogy. Take McCloskey’s argument about how certain rhetoric promotes development (what crazy things you kids think up). An analogy to Rodrik’s argument is that pro-market rhetoric should be subsidized. As theory? Awesome. As policy? Crazy. But maybe it’s not a perfect analogy.

Economists are terrible engineers. We lack quality feedback, and when we fail (whether too much or too little government), a lot of people get hurt. However, it’s still necessary as a second-best consideration. If economists don’t tell governments what to do, someone else will (unless I’ve left something critical out of my model). But economists, when doing policy, should be as much like Coase and as little like Hotelling as possible. Also, wisdom matters. Start with Socrates, I suppose. It helps not to get emotional or dogmatic. Being systematic and cautious and self-conscious is good, although they have costs. 

However, it strikes me that Roberts vs. Rodrik is more theory than policy anyway. Who’s listening to either? Hotelling is therefore OK. Just make sure you’re on the same page about what conversation you’re having.

Kids these days.

Ronald Coase Himself (For real) April 14, 2011 at 12:57 am

You need to think about how to have productive dialogue, is my point.

Daniel Kuehn April 14, 2011 at 6:44 am

Sir, I have a tremendous amount of respect for you but it seems a little self-serving to call your own paper “brilliant”, don’t you think?

jjoxman April 14, 2011 at 8:14 am

Are you shitting me? Dude. I think Prof. Coase has a good sense of humor but don’t call out a living legend. Sheesh – kids these days.

Ronald Coase Himself (For real) April 14, 2011 at 7:46 pm

Back in my day, we didn’t even have kids. Just snow. Had to walk three miles through it just to get to the bank. I remember wishing the transaction costs were lower….

Dan April 18, 2011 at 11:41 pm

I think the ghost of Friedman is channeling thru me……….

Eric Hammer April 14, 2011 at 10:22 am

It can probably be shown that no one has ever referred to their own product as “brilliant” and served themselves in the process, except in demonstrating their ability to poke a little fun at themselves.

You have a remarkable ability to miss points like that. In all seriousness, it actually is a little worrisome, in the sense that you seem unable to imagine the other person’s frame of reference when evaluating their statements. There’s a term for that, and it doesn’t denote a happy situation, though I don’t recall the exact issue.

Daniel Kuehn April 15, 2011 at 10:34 am

Are you just thinking of projection bias?

I’m not sure that applies to blog replies to facetious pseudonymous blog comments…

Daniel Kuehn April 15, 2011 at 10:36 am

Or perhaps Ronald Coase really does hang around in blogs and call people whippersnappers… in which case I have egg on my face, but can at least rest assured I’ll never meet the man.

Ronald Coase Himself (For real) April 14, 2011 at 7:43 pm

Oh, I’m sorry. I’m just a Nobel Prize-winning economist. Do excuse my lack of decorum. When you’re busy contributing revolutionary new paradigms to the body of economics before you’re 30, you tend to miss those little details. Thanks for the heads-up. Maybe I’ll go write a paper that finally settles the controversy over what caused and ended the Great Depression and you can fix the typos in it for me. Whippersnapper.

brotio April 15, 2011 at 5:30 pm

Lesvic? Is that you?

Eric Hammer April 14, 2011 at 10:29 am

I love this point. I have been struggling lately with economics professors who show a model which pretty obviously has issues with implementation in the real world, and when asked how it actually applies respond with “Well, somehow or another you estimate x and y, then use this to get the exact right answer to your question.” I think you draw out the root cause of the issue, that they make the assumption that their theory and model with all of its precision translates directly to practice, without thinking about what sort of mechanisms and knowledge one would have to have to make that work. Thus they begin to consider the model and reality interchangeable, in the process becoming more divorced from reality, without a good feedback-hand to bring them back into line.

It don’t often consider saving a post for later consideration, but yours is definitely worth a second look! Thanks for posting.

carlsoane April 15, 2011 at 9:32 am

In his appendix to the Space Shuttle Challenger accident report, Feynman showed that a great theoretical physicist could do great engineering: http://www.ralentz.com/old/space/feynman-report.html. Perhaps there’s a lesson for economists in how Feynman studied the problem from the bottom up to convey the systemic risks. In economics, I guess the incentives of the individual actors would be the equivalent of the physical properties of the tiniest components of the space shuttle.

dsylexic April 14, 2011 at 1:41 am

” If economists don’t tell governments what to do, someone else will “.
big effing deal! thin line separating well intentioned idiots from evil idiots.
rodrik’s example of the call center is not rooted in reality (ofcourse,who cares eh?),
the indian call center entrepreneurs made their millions precisely because the govt was slow witted and didnt know what to make of it.it didnt try to regulate .they did benefit from taxbreaks given to all new exporters,though.which is not terribly innovative policy.
economists should be only teachers and explainers -since when did they think that “policy making” should be their metier.

Chucklehead April 14, 2011 at 1:34 pm

“financing a R&D project with a potential externality is a good idea EX ANTE, even if the project ends up failing. Other R&D projects that are successful (and are similarly subsidized) will more than pay for the failures.”
If is such a good idea, then why does the force of government have to be used to get people to invest. Government invests for a political return not a economic one. Reality is, the company & industries chosen will be those of the politically connected, said the engineer.

Martin Brock April 14, 2011 at 2:20 pm

I thought you answered Rodrik well in the podcast. Negative externalities are possible in theory, but this fact does not imply a political solution. Political solutions can be negative externalities themselves. Patents in the more developed world are not evidence that political solutions are effective, unless one simply assumes that patents do more good than harm. Do they? I doubt it.

Even if patents have done more good than harm in the past, this fact is not evidence that patents of ever expanding scope will do more good in the future, and intellectual property does expand in scope inexorably as an empirical matter. The first copyright in the U.S. lasted 14 years. Software patents didn’t exist at all when I graduated from with college with a Computer Science degree in 1984. International patents didn’t then either. Political solutions almost always expand this way.

You didn’t challenge Rodrik on empirical grounds. Call centers are big business in India for example. Did India subsidize these businesses? If not, where is the evidence that entrepreneurs can’t capture enough profit regardless of the theoretical externality that Rodrik proposes? So what if Rodrik imagines this market failure. He can imagine anything he wants to rationalize any political imposition he likes.

vikingvista April 14, 2011 at 3:11 pm

“Negative externalities are possible in theory, but this fact does not imply a political solution. Political solutions can be negative externalities themselves.”

Worth shouting from the rooftops.

Doc Merlin April 16, 2011 at 5:24 am

AGREED!

n2k April 15, 2011 at 10:33 am

So we will change entrepreneurs into Wisconsin dairy farmers. See “Think before you regulate: choose a better model” http://www.sfomag.com/article.aspx?ID=1338&issueID=c
For a description of the GAAMA model, a capital market thermostat that provides three-dimensional governance.

The model’s feedback mechanism drives market efficiencies that mitigates unintended consequences resulting from ambiguous, confusing, conflicting, and/or disproportionate commands. Notwithstanding bureaucratic attempts to gerrymander a one-size-fits-all regulatory regime, market realities determine compliance boundaries by their informational domain. This requires a regulatory regime’s domain of material information correspond/correlate to governance commands in a continuous function that preserve the domain’s limits.

John Galt April 15, 2011 at 4:47 pm

Most of your minds are nothing but externalities. Today is the anniversary of Operation El Dorado Canyon. It might as well have been a hurricane that “killed Gaddafi’s daughter [sic]” for all your conceptual prowess.
I’m not knocking mindlessness and thoughtless per se. I’m knocking it because it goes hand in hand with you being only a few days away from impoverished starvation and overdependent on a division of labor easily thwarted by the powers that be.

The saddest part of Blair’s 1984 is that he lets slip that liquor was freely provided by employers during the golden age of America. You’ll need a glass if you read further.

In a wired world with only controlled trinkets of freedom, it will be a majority coerced fact that there are jinn.
These jinn are above your rational self and are the rightful masters of your body and mind. These rightful rulers will soon return to the throne. These rulers are mystics of spirit beyond your power to conceive. Your consciousness is not valid, your concepts of existence are null. A good man is always obedient to these jinn.
Serving this worldwide ruler, is the chosen or popularly elected earthly embodiment. This tangible mystic of muscle will display for your benefit what is good. He will tell you society itself is an organism without physical form. Society is a super-being who is no one in particular and everyone in general – except yourself. A good man, along with his fellows, is subordinate to the will of this super organism.
Man’s mind, say the mystics of spirit, must be subordinated to the will of Jinn. Man’s mind, say the mystics of muscle, must be subordinated to the will of Society. Man’s standard of value, say the mystics of spirit, is the
pleasure of jinn, whose standards are beyond man’s power of comprehension and must be accepted on faith. Man’s standard of value, say the mystics of muscle, is the pleasure of Society, whose standards are beyond man’s right of judgment and must be obeyed as a primary absolute.

The purpose of man’s life, say both, is to become an abject zombie who serves a purpose he does not know, for reasons he is not to question. His reward, say the mystics of spirit, will be given to him beyond the grave. His reward, say the mystics of muscle, will be given on earth—to his great-grandchildren.

Doc Merlin April 16, 2011 at 5:23 am

NO NO NO NO NO!
Brilliant minds are a scarce resource, government misallocation of that resource is terrible.

Doc Merlin April 16, 2011 at 5:38 am

Where does this end? Do we start subsidizing plastic surgery because of the large positive externality associated with looking at attractive people? Do we tax ugly people who refuse plastic surgery more, because they are causing a negative externality?

This just seems like it would lead to all sorts of horrible places once taken to its logical (and inevitable) conclusions.

andy April 16, 2011 at 7:37 am

Thought about this a little.. there are enterprenual possibilities that don’t let you capture full rent. There are enterprenual possibilities that do let you capture full rent, sometimes even handsome monopoly profit. How are we going to distinguish between these two options when subsidizing new? We are not. You get some benefit of more experimentation and some loss of overproduction of certain things.

The other thing is where does the money come from; so you have more of experimenting, more of new subsidized R&D…and less of all the things that don’t get subsidized (the money must come from somewhere). Add to it that we have not only imperfect market, but even more imperfect government and I don’t think this gets you anywhere….

Jim Ancona April 16, 2011 at 9:29 am

Getting back to Rodrik’s original proposal, can someone explain why a patent-like system (if I open a call center, I get an N year monopoly on call centers) is a “second-best solution”? I would think that approach more directly addresses the supposed externality, and has the advantage that it would be less prone to political rent-seeking than direct subsidies. What am I missing?

Doc Merlin April 17, 2011 at 3:12 am

Actually, I think that system would in fact be a lot better than subsidies, so long as the monopoly could be guaranteed to stay short. As that is impossible, I don’t think subsidies OR monopolies are a good idea.

Remember, copyrights used to be less than 20 years and are now over 100.

S_M_V April 18, 2011 at 4:47 pm

All succesful businesses provide positive externalities. The first policy that should be adopted is to not tax business.

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