More Politics, Many Recipes

A good way to start thinking about Dani Rodrik’s genuinely excellent new book is to contrast its statement of objectives with a programmatic statement from another new book on international economics, Roberto Unger’s _Free Trade Reimagined_.

First of all, Rodrik:

First, this book is strictly grounded in neo-classical economic analysis. At the core of neoclassical economics lies the following methodological predisposition: social phenomena can best be understood by considering them to be an aggregation of purposeful behavior by individuals – in their roles as consumer, producer, investor, politician, and so on – interacting with each other and acting under the constraints that their environment imposes. This I find to be not just a powerful discipline for organizing our thoughts on economic affairs, but the only sensible way of thinking about them. If I often depart from the consensus that “mainstream” economists have reached in matters of development policy, this has less to do with different modes of analysis than with different readings of the evidence and with different evaluations of the “political economy” of developing nations. The economics that the graduate student picks up in the seminar room – abstract as it is and riddled with a wide variety of market failures – admits an almost unlimited range of policy recommendations, depending on the specific assumptions the analyst is prepared to make … the tendency of many economists to offer advice based on simple rules of thumb, regardless of context (privatize this, liberalize that), is a derogation rather than a proper application of neoclassical economic principals

Now Unger:

[rethinking the traditional debate over free trade] is an intellectual task for which the present methods of economics are inadequate. It would be tempting to adopt a strategy of caution, insisting that economics, purged of abusive applications and restored to analytic purity, provides help, and imposes no obstacles, to such a campaign. In this book I reject that claim: its modesty does not make up for its falsehood. The practice of economic analysis inaugurated in the late ninetheenth century by Walras, Jevons, and Menger, which came to be labeled “marginalism” and which guided the mainstream of subsequent economic theory and culminated in the theory of general equilibrium, is not only insufficient to the execution of the task. It is also, in certain decisive respects, incompatible with it. If economics continues to swing between purity of analysis, retreating from all controversial explanatory and prescriptive ideas, and abuse of application, unjustifiably equating abstract conceptions like the idea of a market economy with particular contingent sets of economic arrangements, it will not open the way. It will stand in the way. There are many past and present varieties of economic analysis, from the old institutional economics to the new behavioral economics, that suggest different methods and directions. However, they have not developed – and maybe they cannot develop – into ways of dealing with the problems that are central to the argument of this book. Their characteristic inability to imagine the possible forms of economic life cramps their insight into its actual forms.

These quotes seem to reflect positions that are starkly opposed to each other. Rodrik is proposing that we can and must develop new ways of understanding trade and growth from within conventional economic theory – it’s the only sensible way of laying out the issues. Unger claims that not only can conventional economic theory not help us to do this, but conventionally unconventional forms of economic theory such as behavioural economics can’t do this either. Nonetheless, I think that Rodrik is closer to Unger than he presents himself as being (similarly, Unger is much closer to Rodrik and conventional economic reasoning than _he_ says he is, but that’s the topic for another blogpost). Rodrik provides an account of economic institutions that in many places rests less on neo-classical analysis than on a non-conventional account of institutional experimentation in a world characterized by uncertainty. Indeed, both Rodrik and Unger give us visions of international economics that deviates from the conventional account in two ways. First, they both provide _pragmatic_ accounts – they are both much less interested in a Procrustean fitting of the world to an abstract theory than in figuring out what bits of theory help us to understand real life problems. Second, both explicitly acknowledge the _primacy of politics_ – the market shouldn’t be seen as a replacement for political decision making, but rather embedded in a political context where important collective choices are made through democratic means.

Enough about RodrikandUnger – what does _Many Economics, Many Recipes_ have to tell us?? First, even I don’t think that Rodrik delivers a systematically neo-classical book, he does very useful work, especially in the early sections, in clarifying the subtleties of the neo-classical approach, and in disentanglng it from the brutish simplifications of the so-called Washington Consensus. As Rodrik points out, there is _no necessary reason_ that the latter follows from the former. Not only are the Consensus’s prescriptions for institutional change – market liberalization, privatizating everything that moves, deregulation – not the only ways that we might think about reforming economies to improve economic growth, but they don’t seem to work very well. Our experience of economic reform suggests that many of the countries that have embraced the Consensus most enthusiastically (mostly in Latin America) have done, by and large, rather dismally, while countries that have adopted different sorts of reforms have done much better. This isn’t conclusive proof that the Washington Consensus is wrong – there are lots of confounding factors – but it is strongly suggestive. Nor, as Rodrik discusses at length, is the Washington Consensus the only – nor the most attractive – way to apply neo-classical principles to economic development.

Rodrik’s alternative approach is likely to annoy both adherents to the aforementioned Consensus and many of their critics. While Rodrik argues that the drafters of economic reform need to be sensitive to context, he wants them to be sensitive in quite specific ways. He would like them to use neo-classical tools of analysis, but to think first about (a) which problems need to be tackled when, and (b) to think carefully about the possible unanticipated repercussions of reform. First, he suggests, you need to analyze what are the most important constraints on growth in a particular economy. Second, you need to analyse the specific distortions that are causing these constraints. Third, you need to think about policy instruments that can target these problems narrowly rather than trying to change everything at once. Fourth(he doesn’t state this as part of his decision tree, but it’s an important part of his argument), you need to make sure that whatever reforms you advocate don’t have unanticipated repercussions elsewhere. The broader effects of reforms in a specific area (such as property rights or incentives to grow food) will vary between countries with different institutional settings, and second-best solutions that don’t badly disrupt other parts of the economy are likely to be vastly preferable to first-best solutions that do. Finally, he argues (foreshadowing the second and third parts of the book) that short term spurts in economic growth aren’t that uncommon, but they don’t necessarily mean all that much either. What you need if you want to create long term economic growth is to institutionalize economic success by (1) encouraging diversification of trading sectors through appropriate public sector strategies, and (2)ensuring that domestic institutions of conflict management are strengthened.

This is an unusual set of prescriptions for an economist to be giving, but it doesn’t deviate far from neo-classical orthodoxy if it deviates at all. It merely applies it in somewhat unorthodox ways. Where Rodrik begins, in my opinion, to really stray from the traditional account is in Chapter Four, the beginning of the section on institutions and industrial policy where he fleshes out what he means by appropriate public sector strategies and strengthening institutions of conflict management. After taking some entertaining swipes at the fainting spells that industrial policy produces in most economists (he points out in passing that many currently fashionable policy recommendations such as export zones are in fact industrial policy under a new label), he gets down to talking about why he thinks that states should be engaged in industrial policy, and how they should be doing it.

The why comes from standard economic reasoning – it’s an incentives problem. Discovering new activities or products that can profitably be produced in a given economy is costly, and only a small fraction of the benefits can be captured by the entrepreneur who succeeds in finding such an activity or product. Therefore, we may reasonably expect that what Rodrik and his colleague Ricardo Hausmann call ‘self-discovery’ – the discovery not of fundamentally new products, but of products that are suited well to production under local conditions – will be undersupplied. Thus, there is a case for the government to come in and subsidize investments in non-traditional industries.

Rodrik’s specific account of how this should be done, however, doesn’t really rely on standard economic reasoning. And this is for good reason – economics, despite some significant advances, still has fundamental difficulties in understanding innovation because it involves decision making under uncertainty rather than risk. Thus, Rodrik resorts instead to a thoroughgoing pragmatism, grounded in common sense rather than in economic theory, to make claims about how self-discovery can best be promoted. Rodrik is certainly still sensitive to incentive problems, such as the risk that any industrial development agency will be subject to regulatory capture. However, equally (and arguably more) important in his account is the need for a process of pragmatic deliberation in which businesspeople and bureaucrats engage with each other to figure out what errors government is making, and how it can engage in targeted financial and logistical support and coordination for new activities that these sets of deliberations identify as likely candidates.

In short, the core sections of One Economics set out the virtues of a kind of pragmatic deliberation that can better foster self-discovery. Where standard economic theory enters in, it is as a corrective to the risks of regulatory capture. Attention to incentives is important if we are to design institutions to minimize the likelihood of collusion among the bureaucrats and business people who are involved in deliberation. But as Rodrik notes, there is a balance to be struck – trying to make regulatory capture impossible would rule out the information flows and processes of experimentation and argument that allow the government to help address the underlying problem of self-discovery. Attention to static incentives can help us avoid certain pitfalls, but actual discovery involves complex processes of deliberation and conversation. Interestingly, Rodrik borrows some of his arguments about deliberation from Charles Sabel, who is vehemently opposed to standard economic theory (he is a strong constructivist who doesn’t believe that anything resembling stable interests or identities exist). While I don’t think that Rodrik’s argument requires him to buy into Sabel’s stronger claims (there are more rational-actor-friendly accounts of pragmatic deliberation than Sabel’s out there) his use of Sabel’s ideas suggests that he is less wedded to the neo-classical approach than his opening statement would suggest.

This is in no sense whatsoever a bad thing (when you’re looking to give practical advice to policy makers, you shouldn’t let abstract theory get in your way when it’s unhelpful or irrelevant) – but I’d like to see more in the way of micro-level grounding. If neo-classical economics doesn’t provide us with a good grip on how self-discovery is likely to occur, there are other theories out there that at least provide some initial ideas of how best to think about innovation. “Arnold Kling”:http://econlog.econlib.org/archives/2007/10/losing_to_dani_1.html has already claimed Rodrik as a neo-Austrian. Economic sociologists also have some interesting things to say about these issues. Finally (and my personal preference) the more mathematically grounded variants of complexity theory (people working on the consequences of network topology for innovation, and agent based modelling as a means of capturing the importance of heuristics) have interesting things to say that might help flesh out Rodrik’s practical advice, and give it more analytic bite.

Finally, it’s useful to highlight a more subtle way in which Rodrik deviates from the usual economic account – his discussion of the relationship between institutions and democracy. Here, even if the difference is one of normative position rather than explanatory focus, it’s still quite important. The new institutional economics is strongly biased towards functionalist explanations (in which institutions come into being to fulfil certain broadly valuable functions), and towards explanations that fill inconvenient holes in conventional economic theory without challenging the fundamental emphasis on the primacy of markets as a means of social choice. This approach is the result of attempts from Coase through Williamson to(rather uneasily) North to explain how institutions can support certain kinds of functions that the market needs to work, without at the same time undermining basic claims about the virtues of freely functioning markets. This approach regularly slides from examining how political institutions may support market exchange to the tacit or explicit normative claim that political institutions are primarily valuable and good _insofar_ as they support market exchange. It thus pushes for a quite narrow vision of politics (in which the state limits itself to protecting property rights, supporting impersonal exchange and so on), and in which democracy is seen as being rather ambiguous (it is good insofar as it limits the predatory aspirations of the state, but bad insofar as it allows for either interest groups or populist politics to interfere with market processes). Markets always come first.

While Rodrik favors some of the same institutions as do standard new institutional economists (e.g. effective property rights), it seems to me that his overall emphasis is quite different. This comes out most clearly in his discussion of trade, where he stresses that it is a means to an end rather than an end in itself. Democracies may legitimately choose to value other things than trade expansion, such as environmental and labour standards, and they should be allowed to do so. In Rodrik’s words:

Trade serves at best as an instrument for achieving the goals that societies seek: prosperity, stability, freedom, and quality of life. Nothing enrages WTO bashers more than the suspicion that, when push comes to shove, the WTO allows trade to trump the environment or human rights. And developing countries are right to resist a system that evaluates their needs from the perspective of expanding world trade instead of alleviating poverty

It may be that there is a greater trade-off than Rodrik acknowledges between democracy and economic growth (Adam Przeworski suggests that Rodrik’s empirical claims about this relationship are hard to substantiate given the virtual impossibility of establishing the direction of causation from available empirical evidence). But even if this were true, Rodrik’s fundamental claim for the primacy of democracy rests less on its economic benefits than its normative attractiveness. Over the very long run, people should support a kind of global federalism (which Rodrik distinguishes sharply from world government), because it would allow them to exert democratic control over choices that are currently denied to them under existing multilateral institutions. Over the shorter term, trade rules should be changed so that they accommodate diversity better.

Reversing our priorities would have a simple but powerful implication. Instead of asking what kind of multilateral trading system maximizes foreign trade and investment opportunities, we would ask what kind of multilateral system best enables nations around the world to pursue their own values and developmental objectives

Furthermore, these different choices and values are worthy of respect precisely insofar as they reflect democratic processes of choice. Rodrik emphasizes that national standards should receive presumptive respect only if they are made by democracies, and thus reflect some reasonably fair process of choice and deliberation.

I hope Rodrik won’t be offended if I say that this is the kind of claim one expects to hear from a political theorist, not an economist. It suggests quite emphatically that politics (more precisely democratic politics) should have primacy over markets. It points to the need for a set of international institutions that are not only better geared to support economic development, but that are democratically accountable either through national governments, or (perhaps in the future) through a combination of national governments and supranational democratic bodies. Reading through my own particular set of cognitive biases, it seems to me that a more accurate title for the book would be “One Economics (plus some extra-economic reasoning, Many Politics, Many Recipes.” Or perhaps instead, Rodrik should write another book or long article that draws together the threads of his claims about deliberation and democratic choice – while there seems to me to be an underlying consonance between his prescriptions for industrial policy and his arguments about how best to reform the multilateral trade system, much of it is buried in footnotes and asides. Either way, this is a provocative and important book that should be read not only by economists, but by political scientists, political theorists, economic sociologists and anyone with an interest about how global economic processes do and should work. Most of these ideas have already been published elsewhere – but when brought together they pack a normative and analytic punch that they didn’t as individual pieces. Good stuff.