Category Archives: Methodology

Economic history in two (and a bit) charts

My MSc was in economic history. That probably sounds more straightforward than it actually is. Let me explain.

Adam Smith deployed episodes from history to illustrate the laws of economics he claimed to be outlining in The Wealth of Nations. These laws, like those Newton had just laid down for physics when Smith wrote, were held to be good at all times in all places. Just as Newton’s law of gravity dictated that the apple would always fall from the tree wherever it was in the universe, so did Smithian economists believe that the law of demand would hold anywhere at any time.

In the nineteenth century a group of economists in Germany challenged this. To them, economic theory was not something apart from the varied experiences of economic life. Instead, it grew from them. To these economists, it was ludicrous to argue that the lives of African tribesmen were dictated by the same economic laws as those of the industrial proletariat then emerging in European and North American cities. These economists thought, then, that economics should not be the study of a priori theories, but of the particular historical circumstances of economic life which varied from time to time and place to place. They set out to collect data on economic life, earning the nickname the Historicists and pretty much founding the field of economic history.

In recent decades theory has pushed back. The tools of econometrics were applied to historical data to create the field of cliometrics. Econometrics, essentially, is the application of statistical analysis to data to test economic theories. This appealed to economic historians as it gave their discipline the extra veneer of credibility that pages of impenetrable mathematical equations always bestows. But they needed theories to test. Thus were economics and economic history reunited. That is largely where the discipline stands today, at least at the LSE.

That is a brief history of economic history, what of economic history itself? The two big subjects can be laid out in the two and a bit graphs below.

First, the graph below shows GDP per capita from the year 0 to 2000. Two things are striking and worthy of study. First, why is the line so flat for so long? Second, why did the line take off like a rocket around 1800?

Image result for gdp per capita history

This chart doesn’t quite show everything though, so take a look at the ‘and a bit’ chart below.* This zeros in on the inflexion point of the line in the graph above. What we see is that the rocket didn’t take off for everyone around 1900. Some countries, with levels of GDP per capita previously comparable to the fast growers of the nineteenth century like Britain and France, stayed stuck on the launch pad, namely India and China.

This, then, gives rise to some further questions. Why did Britain’s economic growth take off? Why did China’s stagnate? Why did Japan’s catch up, both in the late nineteenth century and again after the Second World War? To carry on from above, the third question is in essence why did that GDP per capita line in the first chart diverge from country to country?

But even for those countries whose GDP per capita line did take off it did not proceed smoothly. At times the line has gone upwards very fast, at other times not so fast, and at still others it has even gone down. This is known, erroneously I think, as the business cycle and is illustrated by the chart below.

We see a steadily rising trend for GDP per capita but we also see fluctuations around that trend. We see, for example, the Roaring Twenties and the Great Depression which followed them. We see the sharp contractions in the US and UK in the late 1970s and early 1980s and the prolonged expansions which came afterwards.

If the first set of questions relates to why economies grow – or don’t, as it was for most of human history – the second set relate to why that growth fluctuates. Why do economies sometimes stop growing? What, if anything, can be done to get them growing again? These questions are the stuff of macroeconomics.

But that is another topic, macroeconomics, funnily enough. The rest, in a nutshell, is economic history as it is practiced today.

* These graphs are sometimes merged and that would have helped here. However, I couldn’t find such a graph at present and my graph drawing skills are such that I thought it best not to try.

Wages, immigration (again), and economic methodology

econ

A while ago I wrote about a Bank of England paper investigating the effect of immigration on wages in Britain which found that “the immigrant to native ratio has a small negative impact on average British wages”. Then, some time after, I came across a paper by Julie L. Hotchkiss in the Southern Economic Journal which finds that “illegal immigrants actually raise wages for documented/native workers”. How to explain this contradiction in the economic evidence?

The first thing to note is that the Bank’s researchers, Stephen Nickell and Jumana Saleheen, are looking at slightly different question to Hotchkiss. Nickell and Saleheen are looking at immigration in general, Hotchkiss only at that part of it which is illegal.

Second, they are also looking at different data. Nickell and Saleheen are looking at data from Britain, Hotchkiss from the US state of Georgia.

But should this matter? Should not an economic theory which predicts that, ceteris paribus, an increase in immigration will raise/lower wages in Britain also predict the same for Georgia? In his excellent History of Economic Thought, Lewis H. Haney called the belief that the answer to this question is Yes ‘cosmopolitanism’ and the belief that the answer will be Yes at any point in time ‘perpetualism’.

That seems to depend on which theory you mean. As I wrote of Nickell and Saleheen’s paper, “In the short run at least, this is what economic theory would lead you to expect. If you increase the supply of anything relative to the demand for it, ceteris paribus, the price of that thing, whether it is shoes or labour, will fall.” But Hotchkiss applies a different bit of economic theory, that of comparative advantage, and finds the opposite. So which theory to apply?

The theory of comparative advantage is one of the old workhorses of economics. It states that Country A should specialise in the production of the good or service A that it produces most efficiently, even if it also produces good or service B more efficiently than Country B. This will lead to more efficient production and, via trade, make both countries better off. The more countries there are, the more they can specialise, the more productive they become, and the better off everyone is, so the theory goes.

Hotchkiss applies this to illegal immigration. Illegal immigrants “with limited English skills” (I’m quoting Art Carden’s write up here) coming into Georgia and finding jobs   “frees up low-skill American workers who can then specialize in tasks that require better English”.

That makes theoretical sense, but it isn’t happening in Britain, according to Nickell and Saleheen. Perhaps this is because the premium on speaking English particularly well isn’t all that high lower down the value chain in the UK. Consider Mike Ashley’s Sports Direct warehouse where the signs are posted in English and Polish. There would seem to be little advantage accruing to a native English speaking employee over his or her Polish immigrant colleague from their greater language skills.

It is interesting to speculate on the microeconomic differences between the British and Georgian labour market that allow for so much more specialisation in linguistic ability lower down the value chain in Georgia than there would seem to be in Britain. After all, these differences would seem to determine whether we apply standard supply and demand analysis to the question of immigration’s impact on wages, or the theory of comparative advantage.

But how much of this is fitting theory to the facts? When I read Nickell and Saleheen’s paper I thought “Well, that’s what standard supply and demand analysis would predict”. Did Hotchkiss, I wonder, see her results and think “Well, that’s what the theory of comparative advantage would predict”? Imagine if the British results had also shown a positive impact on wages from immigration. Would I then have thought to myself “Well, that’s what the theory of comparative advantage would predict”? If so, whither economic theory?

Prior to conducting the analysis on British and Georgian data, we would not have known which theory to apply and, hence, could have made no predictions. If, for example, you assumed that comparative advantage applied to the British labour market you would have predicted that immigration would cause wages to rise, as in Georgia. When confronted with the result, that immigration actually causes wages to fall in Britain, you would conclude that your prediction was wrong and that your theory had been falsified. But if you had gone through the same process in Georgia, your prediction would have been borne out and your theory would stand.

These are fundamental questions of economic methodology. Economists generate theories which make predictions such as ‘if X then Y‘.Governments spend large sums of money according to these predictions based on these theories. Is it the case, however, that the appropriate economic theory is entirely contingent on the particular circumstance in which it is applied?

I generally consider myself a cosmopolitan perpetualist in economic methodology. This can lead to situations where, when data contradicts theory, I assume that the data is faulty, that it must be failing to take some relevant factor or magnitude into account. But if there is even a question over which theory to apply in the first place, whither economic methodology?

Money, Blood and Revolution: How Darwin and the doctor of King Charles I could turn economics into a science

In this quarter’s Economic Affairs I have a review of Money, Blood and Revolution: How Darwin and the doctor of King Charles I could turn economics into a science by George Cooper. If you have access, you can find it here.