Undergraduate Economist

Perspectives of an economics student

60 Years after the 2nd Five-Year Plan: On Economic Theory, Planning & Policy

Posted by Alex M Thomas on June 18th, 2016

Picking up Ajit Dasgupta’s A History of Indian Economic Thought (1993) motivated me to revisit India’s 2nd Five Year plan (1956-61) and the Mahalanobis model in light of the structural changes in India’s economy and developments in economic theory, particularly of demand-led growth theory. Although 60 years have passed since the inception of the 2nd Five Year plan, the ‘Approach to the Second Five Year Plan’ contains ideas which are particularly important today, especially after the closure of the Planning Commission. In its place, we now have the NITI (National Institution for Transforming India) Aayog which assumes that Indian manufacturing and service sectors are currently operating ‘on a global scale’ and what is now needed is ‘an administration paradigm in which the government is an “enabler” rather than a “provider of first and last resort”’ (see Cabinet Secretariat resolution, 1 January 2015).

Why economics?

Economics is the study of commodities – its production, distribution and consumption. Economics provides us with the determinants of aggregate production (GDP), employment, and income distribution. This allows us to understand our economic surroundings better and consequently enables us to improve existing economic conditions. This may be carried out through general economic policies (for example, progressive taxation to reduce income and wealth inequalities and monetary policy to combat inflation) or through targeted economic policies (for example, fertilizer subsidies to improve agricultural productivity and tax concessions to foreign investors). Ultimately, economic interventions are made based on an assumption and several aims. The assumption is that economic theory tells us how economies function. The interventions are carried out to satisfy certain normative aims (for example, equity and freedom). This distinction is made in textbooks by distinguishing between positive and normative economics. For instance, if a particular society is not uncomfortable with unemployment its economic policies would not be aimed at reducing unemployment.

Objectives of the 2nd Five Year Plan

In this section, the economic objectives of the 2nd Five Year Plan are presented. All excerpts from the 2nd Five Year Plan are taken from here.

“The current levels of living in India are very low. Production is insufficient even for satisfying the minimum essential needs of the population….” Therefore, it was imperative to increase aggregate production. But, the economic architects of the plan did not visualize money as an end in itself.

“A rising standard of life, or material welfare as it is sometimes called, is of course not an end in itself. Essentially, it is a means to a better intellectual and cultural life. A society which has to devote the bulk of its working force or its working hours to the production of the bare wherewithals of life is to that extent limited in its pursuit of higher ends.”

Moreover, economic policy was aimed at an increase in activity levels and “also in greater equality in incomes and wealth.”

The Plan Document clearly favours social gain over private gain. In other words, private enterprise was regulated such that the economic yields benefitted all. To put it differently, a recognition of negative externalities was present.

“The private sector has to play its part within the framework of the comprehensive plan accepted by the community. … Private enterprise, free pricing, private management are all devices to further what are truly social ends; they can only be justified in terms of social results.”

More clearly,

“Economic objectives cannot be divorced from social objectives and means and objectives go together. It is only in the context of a plan which satisfies the legitimate urges of the people that a democratic society can put forward its best effort.”

The Plan Document also recognized the dual nature of urbanization – that economies of scale have both positive economic externalities and negative environmental externalities.

The 2nd Five Year Plan on economic inequality

The 2nd Five Year Plan clearly recognized that the gains from economic development are skewed and trickle down is not automatic. For the gains from economic development to be inclusive, two institutions have to be strong: trade unions and the democratic state.

“The gains of development accrue in the early stages to a small class of businessmen and manufacturers, whereas the immediate impact of the application of new techniques in agriculture and in traditional industry has often meant growing unemployment or under-employment among large numbers of people. In course of time this trend gets corrected partly through the development of countervailing power of trade unions and partly through state action undertaken in response to the growth of democratic ideas.”

There is a passage similar to Thomas Piketty’s view on wealth inequalities and the role of progressive taxation in reducing such inequalities in the document.

“The most important single factor responsible for inequalities of income and wealth is the ownership of property. Incomes from work are by no means equal, but in part at any rate, they have some justification in terms of productivity or relative scarcity. Some types of work are, however, remunerated more liberally than others for reasons which are not directly connected with productivity. Differential monetary rewards are often a matter of tradition an existing psychological or social rigidities. It has also to be borne in mind that capacity to work effectively at higher levels depends on a person’s education and training, and these are a matter of the accident of birth or circumstances. A large expansion of general and technical education for all classes of people irrespective of their paying capacity is over a period a potent equaliser. The point is that while inequalities in incomes from work have to be corrected, the case for taxation based specifically on wealth or property needs to be carefully examined.”

India needs to seriously consider a tax on wealth given the wide disparities of income and wealth. The connection between ‘productivity’ and ‘social rigidities’ is noteworthy and requires to be addressed through labour laws, education policy, food policy, employment policy and so on.

The core of the 2nd Five Year Plan: the Mahalanobis model

From the previous paragraphs, we can state the following as the normative economic aims of the 2nd Five Year Plan: (1) expansion of output and employment opportunities, (2) reduction of income inequalities, and (3) inclusive economic growth and development. The economic core of the 2nd Five Year Plan is constituted by the Mahalanobis model. As Ajit Dasgupta writes in A History of Indian Economic Thought, “The purpose of the model was to determine the optimal allocation of investment between different productive sectors so as to maximise long-run economic growth in India” (p. 164). In other words, the aim of this model is to increase the pace of aggregate economic activity in India.

The Mahalanobis model is a two-sector model with a capital goods and a consumption goods sector. The model tells us how the resources are to be distributed between these two sectors such that maximum economic growth is achieved. Note that the then production was insufficient to meet the basic needs of the Indian populace. There are inter-sectoral relations due to which one sector cannot exist (or grow) without the other. To produce consumption goods, capital goods are required. For the workers and capitalists in both sectors, consumption goods are needed. Employing the Mahalanobis model is to some extent vindicated because the model assumes “capital to be the effective constraint on output” and India lacked good physical infrastructure.

Note also that this model assumes that there are no demand constraints. As Dasgupta writes, “The higher the proportion of investment (i.e. of the current output of capital goods) that is allocated to the further production of capital goods, the higher the long-run growth rate of output” (p. 165). The dual character of investment is not clearly understood for investment creates productive capacity and is a component of aggregate demand. Logically, a solution can be found such that the addition to capacity is validated by the demand generated but it is a knife-edge equilibrium as in Harrod.

Dasgupta points out that the Mahalanobis model has been criticized “for being concerned exclusively with investment and for identifying investment with the production of capital goods” (p. 165). Yes, demand constraints and human capital investment are ignored. Another criticism of the model has been its neglect of foreign trade (p. 166). However, the model could be modified easily to account for foreign investment and consumption whereas the incorporation of demand constrains and human capital would not be easy.

Conclusion: the relevance of economic planning

Since the 2nd Five Year Plan, much time has passed and the Indian economy has undergone several changes. Developments have taken place in economic theory too, particularly in the areas of economic growth and development. While the Mahalanobis model has its limitations, the normative aims of the 2nd Five Year Plan are still valuable today. The expansion of employment opportunities needs to be at the forefront of any macroeconomic or growth strategy. As written in the 2nd Five Year Plan, “From the economic as well as from the larger social view point, expansion of employment opportunities is an objective which claims high priority”. However, NITI Aayog, the successor to the Planning Commission works within ‘an administration paradigm in which the government is an “enabler” rather than a “provider of first and last resort”’. The market cannot be expected to provide accessible and good quality education, health, housing and living environments to all. With existing economic and social inequalities, the need for economic planning is even more. Social costs require to be assessed and not ignored in the name of economic efficiency and economic growth.

An economic planner ought to know the implicit assumptions and scope of economic theories and be knowledgeable about legal and institutional constraints of policy implementation. The economic planner must therefore be an excellent economist and an experienced bureaucrat.

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A Review of Trautmann’s Arthashastra

Posted by Alex M Thomas on May 22nd, 2016

Kautilya’s Arthashastra is considered to be one of the earliest treatises on economics (roughly 2000 years old), more precisely, on economic administration. But note that it is ‘a compendium of earlier treatises’ (p. 9); there were several Arthashastras besides Kautilya’s but none of them survived (p. 16). Kautilya’s Arthashastra was thought to be lost until ‘an anonymous pandit brought a manuscript copy of it to R. Shamashastry, librarian of the Mysore Government Oriental Library, who published a translation in 1906-08 (p. 19).’ R. P. Kangle produced a critical edition in 1960. Kautilya ‘is a Brahmin gotra (clan) name’ (p. 21). ‘This Kautilya … is identified with Chanakya, minister to the first Mauryan king, Chandragupa’ (p. 21). However, the text ‘does not make a single reference to Chandragupta or to the Mauryan Empire or its capital city, Pataliputra’ (p. 23). But this does not suffice as proof that the text was not compiled by Chanakya because Arthashastra is about ‘a hypothetical king ruling a hypothetical kingdom’ (p. 24). The text is dated at about 150 CE.

Thomas Trautmann, being the author of Kautilya and Arthashastra (1971), was chosen to contribute to ‘The Story of Indian Business’ series which is edited by Gurcharan Das. The complete title of Trautmann’s book in this series is: Arthashastra: The Science of Wealth published in 2012. The book has 6 chapters including the introduction and conclusion. The 4 main chapters are titled ‘Kingdoms’, ‘Goods’, ‘Workplaces’ and ‘Markets’ which together come up to a little over 100 pages. This review does not focus on the ‘Kingdoms’ chapter which discusses the then two predominant models of political organization – kingdom (rajya) and republic (sangha).

Arthashastra comes from the Sanskrit word artha – material wellbeing (p. viii). Arthashastra, the ‘science of wealth’ (p. 1), is really the ‘science of kingship, the business of running a state’ (p. 2). Similar to political economy, but different from mainstream economics, ‘in the concept of artha, economics and politics were conjoined as a unit’ (p. 2). As Trautmann writes,

The source of the livelihood (vritti) of men is wealth (artha), in other words, the earth inhabited by human beings. The science which is the means of the acquisition and protection of the earth is Arthashastra. (p. 4)

The main forms of livelihood were farming, herding and trading (p. 99). The military formed the largest class after agriculturists (p. 46). Farming was considered the most productive and luractive (see p. 139).

The pre-eminence of the king arose from his ‘power to tax the productive people living in the territory he possesses’ (p. 4). The king’s share of the crop was one-sixth (p. 18, also see p. 88). Moreover, kingship ‘had the greatest capacity to form pools of capital to undertake large enterprises such as monumental architecture, empire-building through warfare, diplomacy and maintaining peace in the kingdom’ (p. 4). To put it in surplus terms, the agricultural surplus was appropriated by the king which was subsequently spent on empire-building – ‘for social order’ (p. 18). However, to characterize taxation as ‘the foremost enterprise in which the concept of sharing was applied’ is problematic because taxation is an enforcement of power (p. 121). The king was involved in direct production too; he was involved in (1) the care of cattle, horses, elephants; (2) mining; (3) manufacturing weapons for the army; (4) making cloth; and (5) the maintenance of law and order.

From the previous paragraph, it can be seen that the surplus approach to economics (that found in the classical economists and Marx) can provide a conceptual framework to understand economic processes in the Arthashastra. I mention this because the marginalist approach to economics (rational choice theory, marginal productivity theory of income distribution) appears to be an alien frame of reference – both then and now. As in classical economics, wages are at customary subsistence and not at biological subsistence: ‘provisioning depends not only on what we absolutely need to barely live, but what we desire, in order to live richly’ (p. 11). As Trautmann rightly writes: ‘while workers strike the best bargains they can get, there is a notion of customary rates of wages’ (p. 112). More importantly, these were dictated by social norms as the following passage attests.

As regards the quantity of rations to be issues to inmates in the king’s household: for upper-caste (Arya) males, the measure is one prastha of rice, one-fourth prastha curry (supa), salt one-sixteenth of the curry and butter or oil one-fourth of the curry. For lower castes, the measures are less. It is one sixth prastha of curry, and half the butter or oil. For women the measure is less by one quarter, and for children, it is less by one half. Thus ration units are proportionate to the status of the person and the body size. (pp. 57-58)

The social discrimination along the lines of caste and gender is visible from the above excerpt.

Chapter 3 deals with the management of goods to ensure that there are sufficient buffer stocks in terms of famine and to maintain stability of prices. Therefore,

Kingship requires detailed and expert knowledge of goods and the raw materials from which they are made, for provisioning the palace and the army as also for distributing food to people in times of famine. (p. 50)

Therefore, the duties of the director of store include building storehouses for ‘receiving, evaluating and dispensing goods’ (p. 51). Each granary has its own overseer. The stocks come from the king’s own farms and also ‘from produce in lieu of land tax’ (p. 53). The inventory had to be managed: ‘changes in volume have to be understood and tracked so that the total quantity of inventory items is known at all times’ (p. 56). Since Arthashastra is written from a ‘royal point of view’, it ‘reveals a lot about the economics of kingship’ (p. 84).

Chapter 4 discusses the nature of workplaces. The ‘kings arranged the land they inherited or acquired into different economic zones to provision the royal household and to defend the kingdom’ (p. 85). The most important economic zone was the farm, ‘the root of the king’s wealth’ (p. 87). According to Trautmann, the farmers, mostly Shudras, ‘have true private property rights in their lands, being able to sell, mortgage and bequeath’ (p. 91, p. 94). Here, the tendency to find ‘private property rights’ as in capitalist societies is unwarranted. Also, this needs to be qualified because there were social constraints on the way land was bought and sold (p. 125; see below). Akin to the director of stores, the overseer of royal farmland’s duty was ‘to coordinate, oversee and discipline a large and complex body of labourers’ (p. 91). Overseers were there for the mines, mints, salt, gold and textiles (pp. 100-101, pp. 106-107). As is to be expected, the priority was given to farmlands.

The settlement of farmland comes first. The next chapter is “Disposal of Non-agricultural Land”, the title of which tells us that all other economic zones are secondary to farmland. Pasture is the next of these zones. (p. 94)

…all other economic zones are designated only after land suitable for farming has been set aside. (p. 95)

A very similar conception is to be found in William Petty (1623-1687), the founder of the surplus approach to value and distribution. Although farming was mainly for subsistence, a surplus was required in order to pay taxes (p. 109). Who laboured on the farms? Arthashastra mentions the existence of ‘slavery, forms of debt servitude and the wage-labour or share-cropping by people who do not own farmland’ (p. 110). Landlessness was the prime reason for pushing people into ‘temporary servitude’ (p. 111).

The concern for sustainability/environment is visible in the administration of forests. A strict separation between pasture and forest land is seen in the following sentence: ‘While pasture land is for domestic animals (pashu), forests are for wild animals (mriga)’ (p. 103). Arthashastra also talks about ‘the active protection of elephants and harsh punishment of poachers, the keeping of an ongoing census of elephants in the forest, of different classifications and the use of forest people for the work’ (p. 105).

The next chapter on markets (chapter 5) discusses the idea of a proper price and the administrative ways of curbing extreme price volatility (also p. 140). As Trautmann notes earlier, ‘the text has an underlying idea of the fair or true price of things sold in markets’ (p. 99) as indicated by the following extract from Arthashastra.

In the case of commodities distant in place and time, the Overseer of Trade, expert in determining prices, shall fix the price after calculating the investment, the production of goods, duty, interest, rent and other expenses. (p. 130)

The concept of the true price is found in the classical economists in the form of ‘necessary price’, ‘intrinsic value’ and ‘natural price’. Similar to proper price, there was a notion of proper profits too.

The notion of fair profit is implied in the advice that the overseer of trade should fix a profit for traders of five per cent above the permitted purchase price of local goods, and ten per cent for foreign goods. (p. 129)

In terms of policy, ‘the king is supposed to act to contain the extremes in price to protect merchants and the people in general’ (p. 116).

The overseer of trade had to be knowledgeable about prices. In case of a fall in prices, ‘the overseer of trade is to concentrate goods in one place by establishing a single marketplace for it and raise the price, so as not to ruin the traders who are the sellers’ (p. 128). However, on examining the way in which land was sold, Trautmann observes that priority was given to ‘a kinsman, neighbor and creditor over the stranger’ (p. 123). In addition, the transactions were transparent (pp. 123-124). Moreover, ‘the King not only levies a tax on the transaction … but he also confiscates the excess amount if bidding among buyers pushes the price above the true value’ (p. 124). After describing the process of land sales, Trautmann concludes ‘that there is true private property in the hypothetical kingdom of the Arthashastra. But it is conditioned by the prior claims of kinship, neighbourhood, indebtedness and other conditions, and it is biased against strangers’ (p. 125). Yet again, there is a tendency to impose alien frameworks of analysis on Arthashastra. Rather than imposing alien concepts, what is required is an understanding of the extant nature of land ownership by examining surviving archival sources. And as Trautmann rightly notes, ‘ancient literary works are mainly written by and for elites and do not often give us a true picture of the lives of people in the lower echelons of society’ (p. 146).

To conclude, Trautmann’s introduction to the Arthashastra is accessible (in language and price) and informative to the interested reader. However, I think that this is not ‘a definitive introduction to the classic text, the Arthashastra’. A definitive introduction would require more than a simple analysis of the text. It warrants a critical engagement with the text by drawing on archival sources. Finally, the tendency to impose alien frameworks must be resisted.

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2015: A Round-Up

Posted by Alex M Thomas on January 18th, 2016

  1. An Economic Analysis of the ‘Make in India’ Program
  2. Summers, Secular Stagnation and Aggregate Demand Deficiency
  3. A Very Brief Introduction to Adam Smith’s Wealth of Nations
  4. A Foreword to Sraffa’s Production of Commodities by Means of Commodities
  5. A Review of Banik’s The Indian Economy: A Macroeconomic Perspective
  6. The Monopoly of Credit Rating Agencies
  7. A Review of Mian & Sufi’s House of Debt

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A Review of Mian & Sufi’s House of Debt

Posted by Alex M Thomas on October 31st, 2015

Lawrence Summers, a Professor of Economics at Harvard University and a Financial Times columnist, hailed Atif Mian & Amar Sufi’s book as ‘the most important economics book of the year’. The book was published in 2015 by the University of Chicago Press. This is a very readable book on issues of debt (particularly household debt in America), determination of activity levels, and on how to do good economics.

        Mian & Sufi begin by discussing the leverage ratio – ‘the ratio of total debt to total assets’ (p. 20). For the poorest homeowners, this ratio was near 80% and for the richest 20%, this ratio was only 7%. This is because the poor households borrow to purchase their assets (for example, a house). At the same time, the rich households deposit (credit) money with the banking sector to earn interest. The banking sector mediates the financial needs of the borrowers and the lenders. As Mian & Sufi write:

A poor man’s debt is a rich man’s asset. Since it is ultimately the rich who are lending to the poor through the financial system, as we move from poor home owners to rich home owners, debt declines and financial assets rise. (p. 20)

This observation immediately points to the need for looking at inequalities of income and wealth when studying debt or credit. Indeed, ‘[a] financial system that relies excessively on debt amplifies wealth inequality’ (p. 25). This is because when house prices fall, the decline in net worth for the indebted poor households will be more than proportional (p. 22-3).

       The authors rightly note that ‘the Great Recession was consumption-driven’ (p. 30) for ‘the decline in overall household spending in the third and fourth quarters of 2008 was unprecedented’ (p. 33). However, the dominant view in the US and across the world is what the authors term the ‘banking view’.

According to this view, the collapse of Lehman Brothers froze the credit system, preventing businesses from getting the loans they needed to continue operating. As a result, they were forced to cut investment and lay off workers. In this narrative, if we could have prevented Lehman Brothers from failing, our economy would have remained intact. (p. 31)

The dominant view locates the problem to be the lack of credit in the economy. And, they believe that if credit is made available at cheap rates (low rates of interest), the economy will revive. This view ignores the purpose of credit in an economy. Individual and firms demand money for consumption and investment (in a two-sector economy, aggregate demand is the sum of consumption and investment), and if aggregate demand falls so will the demand for credit. A fall in aggregate demand, as Keynes demonstrated in The General Theory, results in the reduction of activity and employment levels. This is precisely what happened during the Great Recession.

Job losses materialized because households stopped buying, not because businesses stopped investing. In fact, the evidence indicates that the decline in business investment was a reaction to the massive decline in household spending. If businesses saw no demand for their products, then of course they cut back on investment. (p. 34)

In other words, investment is not independent of consumption. This insight is of value in emerging economies like India where actual output is far below the potential output (large presence of disguised unemployment and underemployment), and political campaigns like ‘Make in India’ must be viewed with great caution. The dominant view is based on, what in growth theory is called, the supply-side growth theory. According to this theory, a growth in aggregate supply automatically generates an equivalent growth in aggregate demand. In House of Debt, the authors label this as the ‘fundamentals view’.

The basic idea behind the fundamentals view is that the total output, or GDP, of the economy is determined by its productive capacity: workers, capital, and the technology of firms. The economy is defined by what it can produce, not by what is demanded. Total production is limited only by natural barriers, like the rate at which our machines can convert various inputs into output, the number of working hours in a day per person, and the willingness of people to work versus relax. This is sometimes called the supply-side view because it emphasizes the productive capacity, or supply, of resources. (pp. 47-8)

That is, lower spending in the fundamentals view does not lead to contraction or job loss. Remember, output in the fundamentals view is determined by the productive capacity of the economy, not by demand. In response to a sharp decline in consumption, the economy in the fundamentals view has natural corrective forces that keep it operating at full capacity. These include lower interest rates and consumer prices … Obviously, however, these corrective forces weren’t able to keep the economy on track. (p. 49)

This view ignores the fundamental insight provided by Keynes in 1936. In a sense, the Say’s Law still lives on. And, in this theory, ‘[i]nvoluntary unemployment can only exist … if there are some “rigidities” that prevent wages from adjusting and workers from finding jobs’ (p. 56). These rigidities or frictions may be the following: presence of non-tradable jobs (that is, jobs which only cater to the local economy); wages do not fall; workers do not move; and the costs of reskilling if workers have to reallocate (p. 58, p. 63). For a critique and an alternative, see Thomas 2013.

       The marginal propensity to consume (MPC) varies across classes and therefore the assumption that everyone has the same MPC cannot be admitted. The MPC is high for poor households and low for rich households. ‘The larger the MPC, the more responsive the household is to the same change in wealth’ (p. 39; also p. 44). In fact, ‘the higher the leverage in the home, the more aggressively the household cuts back on spending when home values decline’ (p. 42). Therefore, debt matters. According to Mian & Sufi, ‘[t]he higher MPC out of housing wealth for highly levered households is one of the most important results from our research. It immediately implies that the distribution of wealth and debt matters’ (p. 42). Moreover, ‘[t]he MPC of households is also relevant for thinking about the effectiveness of government stimulus programs for boosting demand’ (p. 41).

       Very often, during recessions, the dominant policy response is the lowering of interest rates via monetary policy. But does the lowering of rates help? Is the problem a lack of availability of funds at cheap rates?

To help answer this, there is evidence from surveys by the National Federation of Independent Businesses (NFIB). Proponents of the bank- lending view are particularly concerned about credit to small businesses. Because small businesses rely heavily on banks for credit, they will be disproportionately affected. Large businesses, however, can rely on bonds or commercial paper markets for debt financing. The NFIB is informative because it surveys exactly the small businesses that should be most vulnerable to being cut off from bank lending. The survey asks small businesses to list their most important concern, where “poor sales,” “regulation and taxes,” and “financing and interest rates” are a few of the options. The fraction citing financing and interest rates as a main concern never rose above 5 percent throughout the financial crisis— in fact, the fraction actually went down from 2007 to 2009. It is difficult to reconcile this fact with the view that small businesses were desperate for bank financing. On the other hand, from 2007 to 2009, the fraction of small businesses citing poor sales as their top concern jumped from 10 percent to almost 35 percent. As indebted households cut back sharply on spending, businesses saw a sharp decline in sales. (p. 128)

As the survey indicated in the passage shows, the problem is a lack of aggregate demand, particularly consumption demand. ‘Companies laying off workers in these hard-hit counties were the largest businesses. This is more consistent with businesses responding to a lack of consumer demand rather than an inability to get a bank loan’ (p. 128). There is another issue here; this has to do with the effectiveness of the monetary policy mechanism. Hence, Mian & Sufi write: ‘[a]n increase in bank reserves leads to an increase in currency in circulation only if banks increase lending in response to the increase in reserves. If banks don’t lend more— or, equivalently, if borrowers don’t borrow more— an increase in bank reserves doesn’t affect money in circulation’ (p. 154) limiting the ‘effectiveness of monetary policy’ (p. 155). And there is no strict connection between interest rates and household spending; at the very least, a strong association cannot be assumed (see p. 161).

       This brings us to the end of this book review. It was noted in the introductory paragraph that this book is also about doing good economics. Mian & Sufi point to the need for have a good theory to make sense of the macroeconomic phenomena. This blog concludes with their view on the role of theory.

The ability to interpret data is especially important in macroeconomics. The aggregate U.S. economy is an unwieldy object – it contains millions of firms and households. … But unless an economist can put some structure on the data, he or she will drown in a deep ocean of numbers trying to answer these questions.

Which brings us to the importance of an economic model. Macroeconomists are defined in large part by the theoretical model they use to approach the data. A model provides the structure needed to see which data are most important, and to decide on the right course of action given the information that is available. (p. 47)

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Posted in Book reviews, Economics, Employment, Financial Economics, Government, Macroeconomics, Supply side economics, Unemployment | 1 Comment »