Tuesday, December 23, 2008

Education and Economic Heat Death

A number of economists in the last two centuries have contributed their part to the dismal science by describing new sets of conditions under which the expansion of wealth we've experienced since the industrial revolution must grind to a halt, often terminating in a kind of economic heat death that would persist indefinitely. For example, in The Tragedy of the Commons, Garret Hardin argued that in the end, common resources would necessarily be destroyed by rational actors optimizing individual wealth, using fisheries as an example; today we have already witnessed the collapse of some fisheries in North America as well as Europe. John Maynard Keynes did his part in this tradition when he elaborated the concept of the liquidity trap, which may or may not be the explanation for Japan's 1990s recession, depending on whether you listen to Paul Krugman or the Austrian+Chicago school. Most famously, Thomas Malthus argued that populations of humans - just like any other animal - would, in the absence of predation and disease, eventually out-reproduce their food supply and remain indefinitely in a state of starvation. Food supplies increase geometrically, and population increases exponentially. Here, finally, is a bright spot, at least for the Malthusian brand of economic heat-death: in one of the least-reported good news stories so far this century, the U.N. has projected that by 2030, modern agricultural methods will have spread far enough that calories produced per person will mean that on average, the Earth's population will be adequately fed.

Schumpeter, Growth, and Innovation

There are likely other plausible heat death scenarios for economies that haven't yet been elucidated, and I have been pondering one with particular reference to the writing of Joseph Schumpeter. Schumpeter was perhaps the most iconoclastic member of the Austrian school, best known today for his recognition of the entrepreneur's role in economic growth. Oddly for an Austrian school economist, Schumpeter wrote about what he thought was the inevitable transition from capitalism to socialism, though it must be said that it's unclear to what degree these passages were motivated by rhetorical salesmanship toward a socialist audience. Schumpeter based his economic models on the concept of circular flow. This idea echoes the all-too-common folk-conception of economies as systems of wealth moving through cycles, but not being created. That is, in a theory of folk economics that is regenerated with depressing frequency among otherwise bright people, money changes hands, but is not actually "made"; it just moves around. In point of fact, Schumpeter emphasized that without some method of wealth "injection" into this circular flow, this is exactly the situation that obtains. Not only is wealth not made, but wealth stagnates and class-stratifies. This is the Schumpeterian heat death scenario.

Now, wealth certainly seems to have been growing over the last five centuries, otherwise it's difficult to understand how we're at least as well-fed today as we were two centuries ago when there were only a billion of us. The simple-minded answer is that this too is just wealth moving around, and that the West plundered the rest of the world - when in fact The Wealth of Nations, that founding scripture of capitalism, was written partly as a refutation of mercantilism. Even if wealth production per person remains constant over time, it's hard to see how there could be the same wealth per person in the economies of the developed world than there was one or two centuries ago. Schumpeter's model shows that wealth creation and economic growth is permitted only by innovation. Without innovation - new technology introduced by entrepreneurs and R&D organizations - the same products would continue to compete and margins would race to the bottom; ultimately we end up with zero growth, stagnation, and concentrated wealth passing back and forth between the same players. Among hunter-gatherers this was in fact the normal state of affairs. In European history, this was true until after the end of the Crusades, when the reopened Middle Eastern trade routes gave rise to a merchant class who could generate wealth independent of the constraints of central political or theological power (which looks out not for the material gain of its subjects but for its own perpetuation). This virtuous cycle of innovation exploded during the industrial revolution, when new technology continued to create new wealth, and the process fed on itself. The Austrian economists would likely argue that economic heat death is caused by any process that blocks this process of continual innovation - a typical obstruction is an overbearing central government.

The race-to-zero-margins in a no-innovation environment is easiest to watch with price competition, which is notoriously tough on margins because price is the easiest thing for consumers to compare. I had my zero-innovation price-competition epiphany during a college road trip when I got off I-95 in northern Florida. The exit was in the middle of that kind of flat coastal pine forest in the American Southeast that seems to extend forever when you've been driving for seventeen hours, and the only buildings visible from the top of the ramp were four gas stations, all equidistant from the highway overpass. All of them had exactly the same prices posted for the same fuel grades. That's when it struck me that none of the stations had any incentive to drop the price by another cent. If one did, the rest would have to follow suit immediately or lose all the business; consequently, even the price-dropper would have the advantage only briefly. (Airlines behave the same way with fares.) Of course, from time to time one of the stations would drop their price to get a break, so the price would gradually inch down, but never up, until their fuel margins were very nearly zero.

Of course if there were some innovation in gasoline, the first to market with it would enjoy wider margins - Schumpeterian rents - until that innovation had diffused throughout the market, and everybody had it, and therefore it provided a special advantage to nobody. (At this point you also start to better understand the point of intellectual property protection in industries with long product development cycles - without them, Schumpeterian rents go away.)

It's worth mentioning that of course at one time refined gasoline was a new product, but continued innovation is the only source of non-zero margins. In point of fact, through advertising some of the service station chains would have you believe that such innovation has in fact occurred ("Ours cleans your engine!" "We're environmentally friendly!"). Making consumers think a meaningful innovation has occurred is one of the main strategies in mature industries, whether it not it's accomplished through advertising - I recently took my first Virgin America flight and people were impressed by the pop music and purple cabin lighting while we boarded, but I was underwhelmed - if that's the major industry innovation of the day, the industry is mature. And as in all such industries, gas is gas, and a combustion engine is a combustion engine. That's why service stations are better off trying to lure you in by having a popular fast food chain inside.

Innovation, Labor and Education

Growth industries (like biotechnology) are not mature industries (like petrochemicals) and they typically rely on highly educated workers. As economists beginning with Adam Smith have predicted, labor has become an increasingly important component in adding value to products. Today it's far and away the most important component, although as recently as the mid-eighteenth century mainstream economists were arguing that labor was negligible (to be fair, things have changed quickly; they were more right then than they would be today). Labor is what makes innovation possible at all. That is to say, technological advances are made possible through this highly valuable labor; that labor is expended by extensively trained professionals whose expertise is made possible by years of education. In that sense, education is an upfront investment for a future return. And here we have another possible path to Schumpeterian heat death, a barrier to innovation from the difficulty of educating the next generation of innovators. Although each generation's science rises one notch higher, resting as it does onto the shoulders of the giants that passed before, each generation is born knowing exactly the same amount of science and math and engineering that Adam Smith's and Hammurabi's children were; namely, none. Unfortunately, Lamarckianism doesn't work in the biological realm or in the intellectual one.

It's probably true that I began this speculation as a result of my own station in life. I will be returning to school at the age of 35, and will not be a practicing and fully licensed physician in a specialty until I am 43. Assume only for the sake of illustration (I hope) that I have created no value so far in my career prior to returning to school. Therefore, if I retire at 65, that means I have 22 years to a) make back the value of the resources I consumed throughout my life and b) return to society what was invested in me in scholarships and loans, just to "break even". Otherwise, I will have been a net drain on the economy.

Of course, I have had the luxury of 13 years between my undergraduate degree and my return to school; I could've been practicing by the time I was 30, had I made up my mind earlier. Imagine your great grandchildren in 2108, who want to become nanobiometallic neurodemolecularizationists. Maybe another century science will have generated so much knowledge and the subject matter will require mastery of so much material that they'll have to go to school straight through from age 5 until age 43, without a break, to finally become a licensed NBMNDist. This is only a profitable venture for society as a whole if NBMND generates wealth fast enough in 22 years of career to offset 43 years of consumption (38 of which was expensive NBMND-track education). And what about their great grandchildren, who have to go to school straight through until they're 60? Can they break even in 5 years after 55 years of education? One response to this problem is to state that knowledge has noticeably specialized already in our own time, decreasing the instruction that professionals need to pursue their field. This is true to some extent, and yet the average time spent in education is still increasing. A semiconductor engineer still needs the same physics education that a civil engineer did half a century ago, and then plenty more too. So to assume that this will never become a problem, we have to assume that the improvement in wealth created per year in careers of ever-decreasing length will outpace the wealth consumed during the ever-increasing educational periods required by the greater body of knowledge that has to be mastered. Contribution to economy enabled by education must stay ahead of cost of education. Education will keep getting longer and more expensive; time to recoup the investment will keep getting shorter.

Mathematically (without getting into summation notation)

I = wealth created per year
L = cost of living per year
R = retirement age
E = years required by education
P = years before education begins
T = cost of tuition per year

Therefore, for wealth creation to outstrip education and living costs:

(I - L)(R - E - P) > (T + L)E + LP

Working out the algebra then,

I >RL + ET
R - P - E

This is what the relation must be at any point in time. Over time, the answer for how fast wealth creation per year must change is expressed as the first derivative of this expression with respect to time.

The threat of stasis arises if the increase in wealth-creation per unit time cannot keep pace with the costs of education. By extension: your great-great-great granddaughter turns 65, gets her diploma, goes to work to write an awesome artificially intelligent computer program, the output of which just barely pays off her loans - and then she retires at the end of that one day of work. And her son is doomed, because he would consume more in education than he produces. At that point we are unable to profitably produce technical experts to create innovation, margins drop to zero, and money stagnates and class-stratifies. There is always the temptation here to hand-wave about AI and nanotechnology somehow stopping this trend, but for now we have to make realistic guesses based on the information we have today.

The Good News

We have already seen demographic indications of increasing average education, and I don't think anyone is surprised. Without running numbers my guess is that we will not encounter this problem for generations. To avoid Schumpeter-Caton stasis,* we have three options: put kids in school even earlier (I doubt we have much leeway there) raise the retirement age (that will help some, as lifespans get a little longer), and focus on developing the technology of instruction. I predict that the economically successful societies of the late twenty-first century will focus on this third option.

As a final note, this article is far from an argument against public funding for education. It's exactly the opposite. In any nation in 2008, it should be considered nothing short of a suicidal assault on economic health when political leaders question the value or necessity of a strong educational and research university system. These are the engines of innovation whose role in driving economic growth will only become more prominent.

*If you can come up with a catchier name, by all means leave a comment.

Thursday, December 4, 2008

Coding Economic Mores as Religious Taboo

One of the reasons Japanese food is good for you is that it uses little red meat. I had always assumed that this resulted from the scarcity of good grazing land in Japan over many centuries, given that it's an island country with a high population density and the land is mostly rugged and thickly-forested. In fact this is even more true than I realized, in a way that I didn't expect. Until 1871, it was actually illegal to eat meat from livestock (especially beef) in Japan. This law, repealed by the occidentophile Meiji emperor, dated to the Heian (Kyoto) period (eighth through twelfth centuries), but other prohibitions on beef-eating were in place even well before then; cows eat a lot and divert resources from other activities which feed people more efficiently. In an island nation subject to famines, it's easy to see the appeal of such restrictions to the controllers of Japan's medieval centrally-planned economy.

Any discussion of prohibitions on eating cow meat immediately invites comparisons to India. It's thought that the Hindu prohibition on eating beef also originated as a way to keep people from destroying their capital (i.e., their early iron age plowing and milk machines), which you might be tempted to do by eating them when times got tough. The question is this. Why did the prohibition become part of a religion in India, but not in Japan? Why in Japan did it remain merely an edict of the emperor (or the samurai junta)? Would it only have been a matter of time before the Japanese prohibition became incorporated into religion? That is to say, would a Japan unpolluted by contact with the outside world have, by the year 3000, evolved a Shinto ban on eating beef, parallel to the Hindu one? Conversely, would an Indian king entertaining a Roman ambassador have been able to repeal a ban on beef-eating, because back then the ban was still recognized as a man-made law as opposed to a god-given one?

It's intriguing to think that there's another reason, that the respective bans were part of cultural-economic complexes that affected how this taboo developed over time. If so, we should expect other differences. And to that end, another difference in the taboo system between Japan and India is that in Japan, an actual caste (the eta, or burakumin - less derogatory today) developed for the handling of beef- and cattle-related products. This caste is only now achieving re-integration with the rest of Japanese society, and reading about Japanese Buddhism's treatment of this subculture will go a long way to disabusing you of any notion that the Eastern religions are any kinder than their Middle Eastern and Western counterparts. Just like orthodox Jews made an end-run around the Torah by hiring goy children to run errands involving fire and whatnot on the Sabbath, in Japan a (disrespected) caste evolved that handled butchery and leatherworking. Orthodox Jews still had to cook food on the Sabbath and Japanese still needed leather.

But some Hindus like beef and leather just as much as anyone else (and so do foreign tourists in Hindu countries). From indirect observation I know that in the world's only remaining officially Hindu nation Nepal, cattle are killed in rural areas by such clever workarounds as "I didn't kill it; the fall off the cliff (that I pushed it off) killed it." And yet there has evolved no separate class of cattle-killers. These inane theological loop-holes produce not only cultural but technological artifacts, my favorite of which is Tibetan prayer spinners (spinning the holy maraca makes the scroll inside it go around; on the scroll is written a prayer, so apparently the Buddha is indifferent to whether your meditation is supplemented by angular momentum). At first glance, it's an admirably ingenious spiritual machine. At second and succeeding glances it becomes more and more ridiculous, but at least it's much less sinister than workarounds involving living things, as I mentioned above. But as to the question, why a religious rule in India, and not Japan; why a caste in Japan, and not in otherwise caste-heavy India - I confess I'm as fascinated as I am without an answer.

On a personal note, about ten years ago I was put to use by a Hindu scientist friend who needed mouse erythrocytes for an experiment, except his religion forbade him from killing the mice himself. He asked me to come up to his lab to turn on the gas and dispatch the mice for him. I did him the favor, but needless to say, after the fact I badly tortured him with questions about how, exactly, he could avoid karmic penalty yardage for this, considering that he was the one who recruited me for the task, and he even closed the lid of the jar. If I were Japanese I guess that would make me a nezumi-no eta.

Gini Matters, Because So Does Income Mobility

Originally I was going to post an article arguing that the U.S.'s large Gini coefficient for income distribution is less significant than it appears because of increased income mobility. That is to say, it matters less to you if incomes are less widely distributed as long as there's a chance for you to move up, and overtake the rich families if they're resting on their laurels. Milton Friedman and Josef Schumpeter expressed this idea eloquently (quoted here). My expectation was that while Gini might be greater in the U.S. than in Europe, income mobility would also be greater, leading to lower income inequality. My expectation was wrong.

I encountered this NY Times piece about two minutes into my research, which stopped me from writing the rest of the article. The piece shows with a slick Flash animation that U.S. income mobility is less than that of France, Canada, and Denmark.

Of course the U.S. has long been noted as a conspicuous Gini outlier (click on the image to view it legibly):

I'm not the first person to think about this question: other economists and social scientists who had a similar expectation to mine have written similar articles, coming to the opposite conclusion: that the U.S.'s rising income inequality is not offset by income mobility.

My justification would have begun here, arguing that humans are better off under such a system as long as income mobility is better than in lower-Gini states. This echoes Nozick's counterargument to Rawls's Theory of Justice. Rawls argued that if a group of peole were voluntarily setting up a new state and allocating power (and wealth) within it, the only truly moral manner of doing so would be for them to conceal their assignments from themselves until they had pressed "go". That is to say, it must have been great living in ancient Rome if you were a patrician and not a slave, and no sane person would agree to step into such a system if s/he couldn't know his/her assignment until they were in it. As a result, the only moral and rational choice is to create a society with a totally or nearly egalitarian distribution of power. Nozick rebutted thusly (imaginatively paraphrasing): imagine it's the first Friday night in Egalitaria (population 1 million), where everyone popped into existence the previous Tuesday as a result of a Rawlsian state set-up process, and each person has $50,000 in their pockets. It has been made known that the Egalitarians have in their company a fantastic violinist. She offers a performance, at the cost of $1 a head. The entire population of Egalitaria orders pay-per-view (voluntarily) and watches the performance.

There are now almost a million people with $49,999 and one with $1,050,000. Egalitaria now has to change its name to Sortaegalitaria. Gini has increased. But where was the immoral act? Nozick's conclusion: if point A (Egalitaria) is moral, and a society can get to point B as a result of moral choices made by its members, than point B is also moral. To dispute this you would have to find moral fault with the Egalitarians' desire to exchange goods and services based on their own judgment. If income mobility is greater (in a regime of overall economic stability or growth), it's likely that this results from these voluntary choices being made. Unfortunately (I say as a patriot and a libertarian), income mobility in the U.S. is not greater than in the so-called welfare states of Western Europe, as already seen, even in an analysis that researchers had thought would support the Austrian circle and its descendants (as with Ken Lakeworthy's).

The U.S.'s larger Gini has been justified by saying that we're a bigger country with a far more diverse landscape, both demographically and physically, and that it's unfair to compare the U.S. to Denmark. It's also been argued that a higher Gini has been at least partly responsible for the U.S.'s on-average-one-percentage-point higher economic growth than Western Europe - and by extension, that any redistributive taxation that would lower U.S. Gini would damage economic growth over the long run. This theory must assume a "sweet spot", otherwise Mexico would be an unstoppable powerhouse. Complicating the picture are several factors that have conspired in favor of the US. Western Europe was flattened twice in the first half of the twentieth century; much of Western Europe's business and civil infrastructure is early twentieth century (hence the exceptional development of Ireland for the last 15 years, and why developing Asian metro areas have a better business and transportation infrastructure than the US, stuck in the 1960s and 70s); and that the U.S. is a larger, younger and more self-sufficient country.

Ultimately the question is what is the best way to encourage economic growth, and to remain focused on increasing happiness and reducing suffering, which is the point of the whole thing. I ennumerate these confounding factors as much for myself as for readers because I am a market libertarian but I'm also a rationalist. Consequently, when I see new data, I change my mind; and consequently my objections to certain parts of the traditional (U.S.) liberal program are weakening.

Regardless of the reason for growth, any nation will benefit from transparent institutions that allow growth, transparent property and business law, openness to outside trade, and a strong educational system (also open and available to all) that allow ever-more-important value-adding labor to take place.