I have written a concept album with a band called The Benevolent Dictators all about Adam Smith, and the first song was just released.

screen-shot-2017-01-11-at-1-50-06-pm

My motivations for writing the album and general vibe will be left for another time, but I feel inclined to discuss more about this particular song’s thematic significance. The song is inspired by text from The Wealth of Nations, Book 3, Chapters 2-4. The summary: commerce liberated the masses from the feudal system.

[Adam Smith was an 18th century Scotsman. His first book, Theory of Moral Sentiments, is about morality and human nature. His second book, Wealth of Nations, is considered the starting point for modern economic thought.]

The story begins just after the Roman Empire’s demise. Everything is in chaos and eventually order is restored via different sovereign monarchs throughout the former Empire. The monarchs don’t have the capability to enforce laws and protect everyone in their respective polities, so they enlist the help of others in exchange for big chunks of land. These estates produce enough food for the feudal landlords to survive. But, Smith observes, our desire for food is limited to the extent our bellies can make space. To utilize the surplus food, the feudal lords give their additional food to individuals in exchange for their servitude in the feudal estate. At the time, the feudal lords had no other outlets for their surplus food. Thus, their best option was to increase their power by making commoners dependent on them for food.

Meanwhile, a bunch of city dwellers (called “Burghers”) were given a special exemption by the king to start making stuff. These are the artisans and merchants. Soon, the Burghers had shiny baubles and trinkets that they were looking to sell. The feudal landlords might have limits for their desire to fill their bellies, but they have no boundaries on their childish vanity. The feudal lords wanted to show off how great they were and get their hands on these diamond trinkets. As a result, they started to trade their surplus food not for the servitude of commoners, but for the luxury goods the merchants were selling.

What they used to exchange for the servitude of hundreds, sometimes thousands of men, was now going to service their childish vanity. As the demand for these trinkets went up, so did the supply, so the previously dependent commoners now could join in on the market. Before, when the commoners were given subsistence-level resources in exchange for their work, there was of course no incentive to innovate or increase efficiency. They did the bare minimum that allowed them to survive, because any extra work would go unrewarded. Now, they began to cultivate different areas, knowing the fruits of their labor would mean more money for themselves. Prosperity follows.

In addition to the cultivation, this new market brought about interdependence where dependence used to be. In a sense, all of the parties involved were just as reliant on each other as before. The commoners of course needed the landlords as consumers of their goods, and the landlords needed an outlet for their surplus food. The difference now was that the power was completely decentralized. Rather than a commoner being subjected to the whims of one feudal lord, the market gave him the ability to appeal to the childish vanity of all the landlords to which he could ship his goods.

What is more exciting than reading about how peaceful commercial exchange liberated the masses from the tyranny of the feudal system? Smith emphasizes how this ‘silent revolution’ came about not because a top-down authority dictated it, and not because anyone was consciously trying to bring about positive change for the masses.

A revolution of the greatest importance to the public happiness was in this manner brought about by two different orders of people who had not the least intention to serve the public. To gratify the most childish vanity was the sole motive of the great proprietors. The merchants and artificers, much less ridiculous, acted merely from a view to their own interest, and in pursuit of their own pedlar principle of turning a penny wherever a penny was to be got. Neither of them had either knowledge or foresight of that great revolution which the folly of the one, and the industry of the other, was gradually bringing about.

There are free PDFs all around the internet if you’d like to read the passages in their entirety. Here is one.

I leave you with the lyrics of Silent Revolution:

They say beauty is in order
What’s left over in so few hands
But the landlords spell their doom
Wanting the jewelry the merchants have

The price they paid could buy them
A thousand different men
And though they get the diamond
Power leaves them
And commerce wins instead

Here comes the silent revolution
Moving slowly, no certainty
Interdependence, cultivation
From no design comes prosperity

Without any intention
Without beneficence
The feudal system’s dying
Lords made obsolete from
Their childish vanity

Without any intention
Without beneficence
The feudal system’s dying
Lords made obsolete from
Their childish vanity

For those of you not aware, I did a podcast series with the Development Research Institute at NYU earlier this year. It was nine episodes focusing on development that happens on a level other than the nation-state. Each episode featured me discussing a paper with its author and is worth checking out. My favorite one is probably the fourth episode, focusing on the centuries-long history of one New York City block. Here’s the summary:

Between Houston and Prince Streets on Greene Street in lower Manhattan, one city block has undergone dramatic changes over the course of four centuries. Today this Greene Street block is home to luxury retail and expensive residences, but not too long ago it was filled with art galleries, brothels, and garment manufacturing. The shifts in the block’s physical character and value were often sudden and totally unanticipated. Looking only at the nation-state level can obscure meaningful growth that occurs on much smaller levels, but how much can we learn from looking at just a city block? William Easterly of New York University tells us about this exciting and surprising history of one New York City block and what it can teach us about development.

Here’s a link to the iTunes page.

I’ve got a new post over at Novel Stance about putting the “economic anxiety” of the Western working class in the greater context of global income trends. A couple excerpts:

Whatever legitimate economic anxiety Brexiteers and Trumpkins have from the last few decades of increasing globalization, it is dwarfed by the historic rise in living standards nearly everywhere else in the world.

In a sense, we can think of the “Western working-class” being pushed aside by an “Emerging Market working-class.” Emerging market economies like China, India, Brazil, and Indonesia are building their own middle classes, simultaneously lifting hundreds of millions out of poverty and displacing the Westerners that used to do that work.

I’ve got a post over at Novel Stance about Brazil’s economic woes and the misguided blame Dilma Rousseff gets for it. Here’s a teaser:

But look closer at the causes of Brazil’s economic performance during the two’s rule: Lula held office at a time when commodity prices were soaring. Nearly half of Brazil’s exports are commodities. The world economy was stronger in the 00s than it is now, meaning other countries had more money to buy the stuff Brazil was digging out of the ground. Rousseff survived one term with decent commodity prices but was in power when the price of iron ore and oil fell 67%, corn lost a quarter of its value and soybeans cheapened by nearly half. These underlying conditions had nothing to do with either Rousseff or Lula.

 

Based on a referendum from last Thursday, voters in the United Kingdom have chosen to leave the European Union. The referendum campaign got the portmanteau of “Brexit” as a combination of the words “Britain” and “Exit.” Now that we have got those basic facts out of the way, let’s move on to the sexier details like what is going to happen and why I think it’s a bad idea.

What Brexit means

No one really knows at this point. The referendum asked “Should the United Kingdom remain a member of the European Union or leave the European Union?” and the “Leave” vote won. This does not mean Brits will not be able to travel or work in the European Union – America and Canada are not in the EU but their citizens are able to – it just means it’s much more likely they’ll face difficulty. The UK will still be more integrated into the happenings of Europe than a country like Australia or Indonesia by virtue of its history and geographical proximity. But it will now make separate laws regarding regulation, trade, immigration, and other hot-button issues. The European divorce could be gradual, and it’s not clear what politicians on both the UK side and European side will negotiate in the future. The end result could be a very isolated Britain or it could be a very still-integrated Britain. People on both sides have made promises about what each result will entail, but the fact is that there is still a lot of uncertainty. In a larger symbolic sense, this vote reverses a consistent post-WW2 momentum of more European integration. The fact that there was even a referendum goes against a main ethos of the EU: This was meant to be a permanent thing!

Why did it happen

Just like any polity that has to live with a supranational power, a chunk of British people felt membership in the European Union was not working out so well. Popular reasons ranged from its immigration policies, its arguably undemocratic nature, or expensive costs that don’t seem to produce many benefits. In the last national election, Conservative Prime Minister David Cameron feared that his party was losing too many voters to the UK Independence Party. In an effort to woo UKIP voters to vote Conservative, he promised more autonomy and an eventual referendum on EU membership. The Conservatives won their first outright parliamentary majority since 1992, but Cameron had to follow through on his promise.

Why Brexit will be bad economically

When barriers to trade and migration are removed, efficiency goes up and economies grow. Creating a common market in Europe to remove frictions and allow flexibility in the overall labor market was one of the great successes of Project Europe. The integration of these countries provided substantial economic benefits overall, though gains and losses were experienced heterogeneously across the population. More on this later. Removing itself from this common market, at least formally, will have some costs to the UK, though it remains to be seen what the magnitude will be.

There are two major costs to Brexit economically, and both could cause a deep deep recession in the near future. The first is a loss of trade of goods and people. Half of British exports are to the European Union. If barriers go up and trade is made more difficult for these exporters, they will have less of a demand to buy their goods and Brits will be poorer. Like most European countries, the UK has a social welfare system built at a time where workers vastly outnumbered retirees/dependents. As birth rates went down and people got older, these pension systems found it difficult to finance themselves. But immigrants come in with money to spend and wanting to work (despite xenophobic conventional wisdom). In many ways, low-wage immigrants from elsewhere in the EU have been a lifeline to Britain’s public fiscus that are inevitably under-appreciated. With less European integration, labor mobility in the UK will decrease and these benefits from migration will shrink. The corollaries aren’t perfect, but look at a country like Japan where a rapidly aging population combined with a hard-line stance on immigration has caused their economy to stall for nearly three decades.

The second is a massive shock of financial outflows. Britain’s current account is a huge deficit. What this means is that they are consuming a lot more than they are producing. By virtue of an accounting identity, this means money from outside the country is coming in to make up for that shortfall. London has become a major financial hub for a variety of reasons, but it has almost certainty retained this position under the assumption that investors – from inside and outside the EU – can move this money seamlessly around Europe. If Continental Europe has different rules and shifting financial assets from the UK to Europe involves burdensome regulation, London is no longer an attractive place to invest. For many years, the UK was being supported by investors in commodity-producing countries. When commodity prices crashed in the middle of 2014, a lot of this money dried up, hurting Brits. With Brexit, even more money will move out of London…and quickly. Major banks have already announced future shifts of main headquarters to Amsterdam, Frankfurt, and Paris. If London can no longer get the financial resources to make up for Britain’s current account deficit, it will come at the expense of consuming less. In everyday people’s terms, this means that Britons will have much less disposable income, also known as a recession.

current-account-1980-600x449

Why Brexit will be bad geopolitically

After thousands of years of fighting wars and hating each other, Europe in the last century has been moving generally in a more integrated and peaceful direction. Project Europe as it stood before Brexit was already in a very delicate equilibrium. Countries that weren’t really friends suddenly had to share laws and sometimes the same currency, and allow people to freely cross borders. It took the United States 240 years to get where we are in terms of integration – and we fought a Civil War, have a common language, and our cultural differences are not nearly as vast as those between European countries. Whatever progress America has made to make all areas more “American” took a long time. In many ways, Europe has tried to do this process in half a century.

In this delicate equilibrium, there are only two steady states. One was more Europe – countries would have to sacrifice national sovereignty to make the union stronger. The other is less Europe – more power goes to individual countries at the expense of integration.  Brexit is a step in the direction of Less Europe. Brits have effectively voted to “take care of their own” rather than try to work through difficulties of multiculturalism and foreign economic competition.

To me, this is the greatest fear. A wave of populism has swept the higher-income world and people are turning inward. The world was becoming more peaceful, more integrated, and more multicultural. This new world order had its imperfections, so understandably there was pushback and the time has come for opposing forces to become more powerful. People are blaming outsiders of all dimensions (immigrants, the Chinese, The Rich, bankers, etc) and this is a recipe for decreased prosperity, increased nationalism, and less peace.

People are speaking of Brexit as a signal of what is to come in the Western world. Other countries are calling referenda, xenophobia is running rampant, and Do I Really Need to Mention the Republican Nominee? It’s hard to tell if these warnings are overstated. But I don’t want the world to have to take the risk.

Why Brexit will be bad for Brits’ autonomy

Economics isn’t everything and the liberal global order is not everyone’s cup of tea. A lot of the slacktivism being expressed by non-Britons since the referendum never seems to consider Britons’ desire to rule themselves and determine their own future. The European Union is in many ways a clunky bureaucracy with disproportionate power given to certain countries. Its inherent undemocratic nature also bothers some people (ummm, are they also complaining about the House of Lords?). If you felt a supranational institution was unfairly dictating rules for you, wouldn’t you be pissed off? Nonetheless, the belief that Britain leaving the European Union will lead to more autonomy for Brits is incorrect.

Although it remains to be seen what direction new leadership will take Britain in the context of Europe, many Brexit politicians and activists have suggested they’ll move to be integrated into Europe’s common market without formally being in the European Union. Switzerland and Norway do it, why can’t we? This is getting the goodies with no strings attached, in theory. This is unrealistic not only because I find it overly optimistic about how Continental Europeans will treat Britain in negotiations after this messy divorce. If Britain were to commit to political and economic arrangements made by the EU, they’d be doing so without a democratic voice in the process. This reminds me of Scottish independence supporters paradoxically thinking that they could be simultaneously more independent economically and use the pound as their currency (thus be subjected to a monetary policy over which they have no control as an independent country).

Rather than being a powerful voice in the first/second/third largest economy – the EU, depending on how you measure it – Britain will on its own be barely a top 10 economy. This means that it will have even less of a voice in international negotiations and thus likely less self-rule. I admit there’s a degree of uncertainty here: Leave activists argued that Britain can now make unilateral agreements with other countries and this isn’t impossible. But my best prediction is that overall Britain will now have less of a voice in world affairs than it did before. The most powerful countries that are still in the EU are not going to treat the UK nice to try to lessen the harm to Brexit…they are more likely to punish them to give a message to other countries that they shouldn’t even consider it.

Final Thoughts

There’s a lot to say on this topic – and I know native Brits have a lot more to say from a lifetime of experience compared to my ivory tower reading into it and four short years of living in a Scottish bubble. But I truly hope this isn’t the beginning of a global populist wave. And I weep for my British friends who woke up to see their country no longer a part of Europe.

 

 

Alex Tabarrok posts this speech Nobel Laureate Thomas Sargent gave at Berkeley’s 2007 graduation:

I remember how happy I felt when I graduated from Berkeley many years ago. But I thought the graduation speeches were long. I will economize on words.

Economics is organized common sense. Here is a short list of valuable lessons that our beautiful subject teaches.

1. Many things that are desirable are not feasible.

2. Individuals and communities face trade-offs.

3. Other people have more information about their abilities, their efforts, and their preferences than you do.

4. Everyone responds to incentives, including people you want to help. That is why social safety nets don’t always end up working as intended.

5. There are tradeoffs between equality and efficiency.

6. In an equilibrium of a game or an economy, people are satisfied with their choices. That is why it is difficult for well meaning outsiders to change things for better or worse.

7. In the future, you too will respond to incentives. That is why there are some promises that you’d like to make but can’t. No one will believe those promises because they know that later it will not be in your interest to deliver. The lesson here is this: before you make a promise, think about whether you will want to keep it if and when your circumstances change. This is how you earn a reputation.

8. Governments and voters respond to incentives too. That is why governments sometimes default on loans and other promises that they have made.

9. It is feasible for one generation to shift costs to subsequent ones. That is what national government debts and the U.S. social security system do (but not the social security system of Singapore).

10. When a government spends, its citizens eventually pay, either today or tomorrow, either through explicit taxes or implicit ones like inflation.

11. Most people want other people to pay for public goods and government transfers (especially transfers to themselves).

12. Because market prices aggregate traders’ information, it is difficult to forecast stock prices and interest rates and exchange rates

If you’re one of the few people that reads this blog, listens to our podcast, and was not aware that we released an episode on the Economics of Parking…here it is!