On Property Rights and Economic Development

India is ranked 46th alongside Costa Rica, Kuwait and Slovenia. Finland has secured the first rank and Bangaldesh is given the last rank in the IPRI 2009 report.

Property rights is an issue that all scientists, social scientists and others have had to think about directly or indirectly in their lives. It is property rights that we are talking about when a new product is introduced, a new book is released, two siblings fight over their father’s property, people are displaced from land which they had considered to be their own, prime agricultural land is handed over to giant companies, etc. This post questions the notion that property rights ’causes’ economic development by focusing attention on the International Property Rights Index (IPRI) 2009 report.

The 2009 IPRI shows that economic growth is intimately related to ownership. Such a statement is derived from a positive correlation that is seen to exist between a country’s protection of both physical and intellectual property rights and its economic well-being. In order to analyse this claim, the post looks at concepts such as economic growth, ownership and correlation.

Ownership
Property rights is considered to be fundamental to all human rights. Of course, lack of property rights makes governance difficult and also makes business cumbersome. But, one needs to understand the history of ‘property rights’ or ‘ownership’. This is where Karl Marx can aid us. It is the forced separation of the labourer from his means of production that led to the emergence of ‘private property’. In Das Kapital Volume I, Marx talks of the brutal and coercive policies that were carried out so as to divorce workers from their land. This is a section which all students who are concerned about property rights must read.

Economic Growth
There is an increasing tendency to equate economic growth with economic well being. Though, very often rates of economic growth surge without any ‘real’ improvement in the livelihood of the populace. Economic growth is to be understood as the rate of growth of GDP in a country over a period of time. At times, per capita GDP is used in the calculation. Which ever definition is used, one must always keep in mind that they are only statistical indicators, which are arrived at on the basis of a lot of assumptions. This is not to say that such indicators are useless or meaningless, but rather to emphasise their power in framing policies. Hence, the need to use them with utmost caution.

Correlation
It is alarming when correlation analysis provides ’scientific support’ to causation. Such instances are in plenty within the discipline of Economics. Economics as a discipline tries to identify cause and effects so that appropriate policies can be framed. But, causation is a philosophically challenging concept. Philosophers still grapple with it and will continue to do so. However, economists seem happy to be talking about causes and effects by making use of just correlation!

Positive correlation between IPRI and GDP per capita
Source: IPRI 2009 Report

How can one conclusively establish that it is property rights which leads to high GDP per capita? Couldn’t it be possible that it is the high per capita GDP that is resulting in stronger property rights? Is it is on the basis of statistical correlation that property rights are considered to be a significant factor for economic growth?

Inflation: Theory vs Reality

The shift of focus from employment generation to inflation targeting seem to have taken place during the period India was being liberalised. Inflation, however, is a concern to the populace of any nation where wages are not indexed to inflation. In India, inflation poses problems as a rise in prices reduces the real wages and hence their purchasing power. Life, itself, can become difficult.

This post briefly tries to clarify how inflation is conceptualised in economics (neoclassical). Initially, it needs to be pointed out that neoclassical economics analyses equilibrium positions and differences between them – commonly termed as comparative statics. Another significant issue is that, in neoclassical demand and supply, the analysis is entirely carried out in logical time. Now, let us take a look at how prices are formed in equilibrium. In equilibrium, it is required that total demand of a commodity equals its total supply. And, if demand is more than the supply, prices are caused to rise, in order to restore equilibrium. Surprisingly, it is this insight that forms the basis of the current theory of inflation, which is mentioned in the media and talked about by economists.

Thinking through this ‘insight’, a few points come to my mind. First, an economy is never in a state of equilibrium. And neoclassical theory does not have the necessary tools to understand disequilibrium. Though, neoclassical theory can point out the characteristics of disequilibrium positions vis-a-vis equilibrium position. I doubt whether this is adequate. Secondly, prices in an economy does not rise, just because demand increases. Such a behaviour is commonly seen in markets for vegetables, fruits, meat, etc. It seems absurd to posit that prices of manufactured commodities will move according to changes in demand.

This much said, let us examine the impact of money supply on prices in an economy. Is there a relation between money supply and prices? The first question which needs to be answered is how are prices formed. According to neoclassical economics, when demand rises, it implies that money supply in the economy has risen compared to the equilibrium state of affairs. The quantity theory of money seems to corroborate the hypothesis that money supply and prices are directly related. But what if they are not? Wouldn’t the policies fail?

It is dangerous to build flimsy theories; for, policies draw arguments from these theories. For instance, the central bank tries to reduce money supply during inflationary conditions by raising the interest rates (indirectly) or through open market operations. How far are they effective? Or, is inflation just a temporary phenomenon? It needs to be mentioned that cases of hyperinflation is significantly different as they are strongly correlated with the breakdown of institutions.

This post ends by asking whether an increased rate of interest leads to decreased money supply? Or whether an increased rate of interest causes prices to rise because the cost of borrowing increases? Also, high interest rates attract capital from abroad. Very often, causes of inflation are not properly identified, which makes policy construction very difficult.

On Prices

This is a part of a series which aim at elucidating the notion of ‘prices’ in various periods in history and according to various economists (mainly heterodox). What do prices convey? How are prices formed? Is there any mechanism underlying the formation of prices or is it random in nature? Is there a possibility of finding ‘natural laws’ which determine prices?

In reality, we often come across various kinds of prices – wholesale price, retail price, administered price, maximum retail price (mrp), etc. In economics, neoclassical theories posit that prices are determined owing to the interaction or intersection of supply and demand. What prices are they talking about? These are prices which are abstract in nature. Theorising is done for practical purposes; therefore, theoretical entities are constructed in order to understand the ‘real’ world. Does the demand-supply theory enlighten us? Does it provide an approximation of price formation in reality? Or does it only tell us about a special set of commodities? In the secondary market which carries trading in shares, prices are formed according to the demand and supply. But, would it be right to say that prices of automobiles, mobile phones, eatables, etc are fixed by the same mechanism? Wouldn’t it be the producer who fixes theprice taking into account the cost of producing and transporting it, over which she/he charges a percentage as profit?

Keeping these questions in mind, let us move on to the issues pertaining to ‘prices’ in period between 12th and 16th centuries. The period is roughly before the period known as the mercantile period. The establishing of a ‘just price’ was a significant issue then. Actually, this debate goes back even to the time of Aristotle. Prices then has more to do with ethics and morality than with objective mechanisms of equilibrium or competitive conditions. Now, it is clearly seen how ‘economic theory’ rationalities a lot of price hikes by providing the reason that ‘demand is more than supply’. I ask the question which prevailed in early centuries: is such a price rise just? How does one say that it is rational for prices to increase when there in excess demand? Where does the rationale come from? Economic theory! Who constructs these theories? And what are the implications? Who does it benefit?

In the earlier centuries, trading or exchange was carried out only by a few people. People exchanged after their needs were met. According to Thomas Aquinas, just price was the price that prevailed in the markets in the absence of fraud or monopolistic practices. This conception is reminiscent of the underlying power structure which prevailed at time. ‘Just’ did not necessarily mean just. And, this period was characterised by a lot of political interventions (especially, in Italy). Some other writers considered as ‘just’ that price which allowed producers to maintain a standard of living befitting their position in society. That is, the cost structure was determined by social stratification.

In the debates on ‘price’, references to utility and rarity was abundant. Another price – the legitimate price also prevailed. It referred to the price which was fixed in any transaction agreed on by the participants freely. Again, the ‘freedom’ here is questionable. For, liberal authors argue that the transaction carried out by a CEO and a wage labourer is ‘just’ because both of them are freely participating. Surprisingly, the origin of property rights is seldom mentioned.

To conclude, this is a post inspired by the sub-disciplines of economic history and history of economic thought, which is rapidly vanishing from the departments of economics.

Reference

1) Roncaglia, A (2005), The Wealth of Ideas: A History of Economic Thought, CUP.

Foucault and Economics

This post is more of a suggestion than an explanation. There has been hardly any scholarly work done with respect to applying Michel Foucault’s ideas and approaches to political economy or economics. On searching the internet, all I could find was a conference conducted in 2005 titled ‘Rethinking Foucault, Rethinking Political Economy’ at University of Leicester, UK and a PhD thesis submitted by Iara Vigo de Lima at the University of Stirling in 2006. This post is a result of my reading of certain sections of Dr. Lima’s thesis and the sadness associated with the knowledge that economists have not studied/read/understood Foucault.

I find it difficult to believe that nobody has tried to think/rethink the methodology and historiography of Economics by applying Foucauldian themes. To do justice to this area of research, it is necessary that I quote certain sentences from Dr. Lima’s thesis, as my knowledge of Foucault is limited.

“Foucault followed Nietzsche’s genealogical approach aiming not ‘simply to gain access to the unfamiliar past’, but mainly ‘to articulate and illuminate the familiar present’, and ‘the past, then, becomes a means to access the present’.” [p. 16]

“For Foucault, concepts, notions, theoretical frameworks, methods, etc., are bounded by time and culture.” [p. 21]

“Michel Foucault’s particular insight, especially his way of thinking about history – which he preferred to call ‘history of systems of thought’ – does offer elements that let us think about this question, and specifically in economics (given that he applied it to the history of economic thought). According to him, every age has its way of producing ‘the truth’, which can be uncovered as we think about history.” [p. 24]

“… one of his objectives in OT: to find out how political economy established itself as a discipline (discourse) at the end of the 18th century.” [p. 29]

Very often economics is taught (in India) as if the present day economics is what has evolved out of the previous economic theories. Therefore, the multiple paradigms that prevail in economics are seldom expressed clearly. It is not uncommon to learn the theories of Adam Smith, David Ricardo, Thomas Malthus, etc under Classical theories. Then, they are forgotten. They are mentioned as the initial thinkers. No more are they mentioned nor their relevance. For, neo-Smithians, neo-Rocardians, neo-Malthusians, etc are very much present. And, they do come out with better theories than the neoclassical economists.

This post suggests that one ought to know that there are ‘other’ truths (heterodox economic theories) apart from the truth that we are taught – neoclassical economics. And in this aspect, a reading of Foucault will prove to be immensely insightful.

On the (US) Financial Crisis of 2008-200?

I initially thought of writing a post which explains the possible causes of the present financial crisis in the United States. But, to my dismay, I found that it has been/are being discussed by the BBC, IMF, New Left Review, EPW and Wikipedia. (The list is not exhaustive.) However, I was delighted about the fact that I did not have blog about the details; I can directly plunge into my reflections regarding the crisis. Therefore, the present post is concerned with a few issues that have risen in my mind owing to the crisis.

1) Should financial institutions be completely unregulated? In other words, does a ‘free market’ set up result in a favourable outcome, where the resources are allocated efficiently? By ‘free market’, I mainly refer to a situation where market forces like “demand” and “supply” are not tinkered by any external body.

2) Is it financially prudent for financial institutions to invest much more than their savings? Investment and savings need to be understood as financial capital. Money was advanced on the premise that the future conditions will be favourable; there was no actual collateral. This is what happened in the sub-prime lending market. To add to that, the drive to make faster and higher profits induced the banks to lend that money to (unregulated) financial intermediaries. Money (funds) was not advanced for production purposes (industrial capital). Financial capital is a way to make huge profits in comparison with industrial capital, which produce commodities by means of commodities. With the progress of Capitalism as a mode of production, the wealth of the nation (understood as GDP by orthodox economists) has changed from industry to financial services – derivatives especially. In textbooks, progress is shown by a movement from agriculture to manufacturing and finally to services. In my opinion, it is the institutionalization of financial capital which is the source of present crisis.

3) The system thrived of the belief that the ‘alarms’ created by the quantitative analysts (Quants) would sound. [For more on Quants, read this.] They rely on mathematical models to estimate risks. Remember Black-Scholes, Markowitz and Robert Merton, Nobel Prize winners in Economics! One of the things that we learn from reading Keynes’s General Theory is that expectations cannot be quantified. To build elegant models, expectations can be quantified to some extent with the aid of probability. But, it shouldn’t be used in policy making lest the expectations of the individuals change drastically. But, New Keynesian Macroeconomics has to its (de)merit ‘Rational Expectations’; I wonder about the extent of the interpretations of Keynes’s works.

Another interpretation to the crisis would be that, the market does identify ‘problem makers’ within it. Think of the various asset bubble bursts that have taken place. But, with the complex and tight interdependencies of various economies in the world, a financial crisis can have repercussions on other countries as well, mainly through international trade. Thus, it is important that every country devotes resources for (trying to) understanding these interdependencies for solving the problems of today.

Update

Read this essay at Risk Latte. I am happy to find such views on a financial company website.