Wednesday, 2 May 2012

Persistent fallacies

Note: This post was also published at the Adam Smith Institute blog, on 12th June. For all my Adam Smith Institute texts, click here

Whilst reading Acemoglu and Robinson's insightful and exhilarating book, I ran across a stunning fact. In the Chapter 5 of the book, entitled "I've Seen the Future and It Works" they talk about why economic growth cannot be sustainable under a set of extractive political institutions. They mention the case of Soviet Russia and emphasize how their rapid growth during the 50-ies and the 60-ies was unsustainable since it wasn't supported by economic dynamism or innovation, i.e. there were no forces of creative destruction. They managed to achieve growth simply by reallocating a huge number of people from under-productive agriculture into industry. It was only natural that rapid growth would follow since productive resources (labour and capital) could now be used in a much more efficient way, and close to full capacity. However, when this reallocation ran out of steam (70-ies and 80-ies), a collapse was imminent. 

What was surprising was that a large group of academics, policymakers and intellectuals in the West were mesmerized by this astonishing growth. In fact, many people believed in the 60-ies that it was a matter of time before Russia would overcome the USA in its economic and global power. In fact, the argument was that not only do the Soviets grow faster, they manage to do that under full employment and a society based on altruism instead of individualism (and apparently better ethical values). 

Sound familiar? 

Now I've been aware of all of that, but this I didn't know:
"...the most widely used university textbook in economics, written by Nobel-prize winner Paul Samuelson, repeatedly predicted the coming economic dominance of the Soviet Union. In the 1961 edition, Samuelson predicted that the Soviet national income would overtake that of the United States possibly by 1984, but probably by 1997. In the 1980 edition there was little change in the analysis, though the two dates were delayed to 2002 and 2012." 
Acemoglu, Robinson (2012) "Why Nations Fail", pp. 128. 
Needless to say, during the years Samuelson predicted the Soviet Union would overtake the US, Russia was bankrupt twice (!), and has returned to a system of extractive political institutions which were again able to produce some growth and better living standards based on rising oil and gas prices during the 2000s. But as the West again slowly begins to realize, this is unsustainable as soon as Russia starts experiencing a twin deficit and when its growth stops being driven by swings in energy prices. 

However, many pundits now share the same thoughts on China and its "miracle". But as the authors of the book clearly emphasize in their final chapter, China's growth now is as unsustainable as Russia's then. They are both based on extractive political systems which can only achieve temporary growth via reallocation of resources, not technological advancements or creative destruction. I just wonder how long will it take some leftist Western pundits to realize this? 


  1. I have been thinking of getting Acemoglu's previous book on the reasons for economic growth. But it seems to be a big, and perhaps Daunting book for a person who is not a trained economist. I was just wondering if anyone here would recommend it before I decided to invest a lot of time in it.

    1. Oh but he is a trained economist. He got his PhD from LSE on micro-foundations in macroeconomics: contracts and economic performance. Needless to say, contract theory is one of the most difficult and mathematically abstract areas in economics - especially at LSE.

      Now which book did you have in mind of his? Introduction to modern economic growth is a brilliant textbook: it's very challenging and you need to know a lot of maths before engaging in it (in fact, it has a 100 page mathematical appendix - I'm not kidding). So if you're a maths guy, go for it! Even if you're not I think it's worth it, well, depending on what you want to get from it, of course. But as a textbook on economic growth theories - it's the best one out there. It's perfect for a whole academic year of study. Take a look inside the book on Amazon and see if you think you'd like it.

      As for his other book - Economic Origins of Dictatorship and Democracy, also with Robinson, it's a sort of a prelude to Why Nations Fail. A great book indeed which I really recommend as well. It's technical as they summarize all their theories from their great papers on enfranchisement and consolidation of democracies. It's a game-theoretic, micro political economy framework (if that makes any sense).

    2. the introduction to economic growth is good, but it's too analytical. It's more about theories and models of growth, then about the essence of growth or how to achieve it.
      I prefer Weil's's clear and precise and it puts the subject of growth, not models or theories, in the main picture.

    3. Yes I meant introduction to modern economic growth, and the person I was speaking about who lacked the training was ME! (I only have a bachelors in Econ.) I was wondering If it was too technical for me to dive into it.

    4. oh, haha, sorry about that
      yeah, it is a bit technical but can be done..again, try and look inside the book to see if you think it would be too much.

      btw, I agree with Charlie, Weil's textbook is very good. It's the one I used when studying growth theory

  2. Also, just a comment on your post. China's remarkable growth is much of the same, although sustainable because it is market oriented. Still, the huge growth numbers we have seen will slow down inevitably because you can only get that sort of growth by the initial wave of industrialization when millions are pulled away from their farms ad into the big city.

    It is a fallacy to think that this sort of growth is dependent on any sort of special expertise or political system. India is undergoing the same type of growth right now with a completely different system.

    1. I don't think it's a question of expertise the Chinese government is applying. It's more due to a massive allocation of labour and capital from agriculture into export-oriented industry, as you've pointed out. However, with no creative destruction nothing will sustain this growth and nothing will arise as a substitute to falling industries.

      They point out to a case of this guy who founded a low-cost steel company that was a competition to the state owned steel companies. He was arrested and sentenced to 5 years in prison. So what kind of signal is this to anyone who wants to start a business of his own? Can you imagine a multi-billion dollar (or renminbi) business in China founded by a college drop-out from his garage?

      As for India, despite their democratic system they still have extractive elites that will permit personal freedoms and will form extractive institutions - especially at a local level. Even if they do try and offer the proper incentives to many businesses by removing red tape and lowering taxes, it still has a lot to do to tackle the problems of corruption and mass poverty.

  3. btw, nice quote and a good point. When will the people start to learn?
    I think there's an obsession among the leftists with anything remotely similar to an "equal" society. So they tend to praise it so much they can't see the forest for the trees.

    I remember the same thing people saying about Putin's Russia. It doesn't matter that he's an autocrat, at least he's steering the country the right direction and people are living better. Well, not many share this view anymore...

    1. and as for the equality argument, any socialist society is much more unequal than any Western capitalist democracy. This is a fact!