Argentina, Economic Science and this year's "Nobel"

Trump wanted the Peace one, Milei the one in Economics

A few random thoughts about some recent news. Today, Javier Milei met with Donald Trump at the White House. Trump reportedly warned that the United States “will not be kind” to Argentina if Milei does not win the upcoming elections. That statement seems to suggest that the much-discussed “rescue” of the Argentine peso may be tied to domestic electoral results — something that Treasury Secretary Bessent had already hinted at when he announced the possibility of a US Treasury rescue package for Argentina.

No surprise there. But the situation brings back memories of earlier crises — particularly the 2001–2002 collapse, when Argentina defaulted after a long neoliberal experiment of liberalization, deregulation and privatization under the Menem administration. The current crisis, which began with the 2018 IMF program, is in many ways a continuation of that same process.

Back in 2002, the crisis caught one economist in particular by surprise: Rudi Dornbusch. Writing in the Financial Times, Dornbusch argued that Argentina could not be trusted to govern itself and proposed that its fiscal and monetary policy should be overseen by a foreign board of central bankers — a shockingly neocolonial suggestion, even for that time ["I'm shocked, shocked I tell you"]. I wrote a short letter to the Financial Times in response, which you can find here, mocking this absurd idea.

Two decades later, we are still dealing with the same problems. The “cleanup” of the 2002 mess took place under the so-called populist governments of Néstor and Cristina Kirchner, through two major debt renegotiations in 2005 and 2010. During that period, Argentina’s debt-to-export ratio — a measure of repayment capacity — improved significantly [see my piece on Challenge on that and the Vulture Fund negotiations that Macri ended up finishing in a favorable way to the Vultures; you know on what side he is]. Yet the Macri administration (2015–2019) more than doubled the foreign debt once again, setting the stage for the current crisis [on the doubling of debt see this piece with Matias De Lucchi; whole issue, scroll down].

In short, the same set of economic elites have crashed the economy multiple times. Domingo Cavallo, Menem’s finance minister and architect of the 1990s convertibility plan, reappeared at the end of the De la Rúa government in 2001. Federico Sturzenegger, who was at the central bank during Macri’s failed experiment in 2018, is now serving as Milei’s Minister of Deregulation. This revolving door of orthodox technocrats has brought Argentina back to the IMF, and now possibly to a US Treasury rescue, for the third time in a generation.

What’s frustrating is how the narrative never changes. The mainstream explanation — repeated recently by a well-known economist from the Di Tella University — is that Argentina’s problems are caused by irresponsible “populists.” In his version, written in academic jargon about sunspots and expectations, the blame somehow always falls on Peronists, whether they are in power or not. If the economy collapses, it’s because investors fear a Peronist comeback; if it booms, it’s despite them. Don't worry, it won't.

This kind of argument says a lot about the state of the economics profession, perhaps more than about Argentina’s actual economy. Instead of looking at straightforward indicators — who increased the foreign debt, how exports performed, whether external repayment capacity was sustained — many economists hide behind highly subjective assumptions disconnected from reality.

This is part of a broader problem in Latin American economics: what my colleague Franklin Serrano calls “brain damage” — not “brain drain.” The issue isn’t that talented economists leave the country, but that many return from US PhD programs armed with orthodox models that have repeatedly failed our economies. They bring back the intellectual framework that justifies the very policies that keep generating crises.

This brings me to another bit of recent news: the so-called Nobel Prize in Economics (technically, the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel). This year’s award went to Philippe Aghion Peter Howitt, and Joel Mokyr for their contributions to what’s broadly called “Schumpeterian growth theory” — work that connects innovation and technological change to economic growth. Surprising and soul crushing news to Milei, who wanted the prize for stabilizing the economy (a miracle according to Niall Ferguson).

Aghion and Howitt's models attempt to explain long-term growth by endogenizing productivity — the famous Solow residual. They borrow Schumpeter’s language of innovation and creative destruction, though often in a far more formal framework. In that sense, the connection to Schumpeter is more symbolic than substantive. Still, compared to some recent laureates, this year’s selection is a relatively defensible choice. Their models are certainly more in line with Schumpeter that some of the heterodox neo-Schumpeterian models.

Joel Mokyr, a historian, has written extensively on the cultural roots of the Industrial Revolution. His work offers a deeply Eurocentric — also, and more importantly, culturalist and supply-side — interpretation of why growth took off in Europe. While I disagree with much of that perspective, it’s undeniable that the Industrial Revolution did begin in Europe, and any serious account must explain that historical specificity. The problem is less Eurocentrism per se than the exclusive focus on supply factors, ignoring the demand and institutional dimensions that Keynesian and structuralist economists once emphasized. In that sense, I welcome the recognition of a historian among the laureates. But I also lament the profession’s retreat from the richer, more historically grounded analyses of scholars like David Landes, whose The Unbound Prometheus offered a more balanced view of the Industrial Revolution — one attentive to the demand aspects of economic growth.

Perhaps the real lesson — both from Argentina’s crises and from this year’s “Nobel” — is that economics still struggles to learn from its own history.

More on the "Consumer Revolution"

I have noted before (and here and here) the neglect of the role of demand in more recent historical accounts of the Industrial Revolution. The typical view used to emphasize demand, like in Landes' Unbound Prometheus, but more recent accounts like Allen or Mokyr emphasize technological change and supply side forces.

Thankfully, there is a whole new literature that puts an emphasis on the so-called Consumer Revolution, in particular the work of Maxine Berg. T. H. Breen in The Marketplace of Revolution goes further and suggests that the economic reasons behind the American Revolution were also associated to the transformation in consumer culture. In his words:

"What gave the American Revolution distinctive shape was an earlier transformation of the Anglo-American consumer marketplace. This event, which some historians have called a 'consumer revolution,' commenced sometime during the middle of the eighteenth century, and as modestly wealthy families acquired ever larger quantities of British manufactures— for the most part everyday goods that made life warmer, more comfortable, more sanitary, or perhaps simply more enjoyable—the face of material culture changed dramatically. Suddenly, buyers voiced concerns about color and texture, about fashion and etiquette, and about making the right choices from among an expanding number of possibilities."

In this view, the demand for new goods (and not so new too), tea, coffee, tobacco, chocolate, china, calicos, silks, etc. was central for the technological revolution of the 18th century. What Breen seems to suggest is that the same Consumer Revolution that was taking place in England was taking place in America, and that the subordinated role in the colonial pact, and the trade restrictions imposed by the many Parliamentary Acts, are at the heart of the movement for independence. In other words, not only demand might be relevant to explain economic growth, but economic growth might be central for political developments.

Institutions, what institutions?

There are many explanations for why some nations are rich while others are poor. The dominant view, in mainstream (neoclassical) economic circles is that institutions are the central cause of the divide between developed (center) and underdeveloped (periphery). I discussed before (here and here) the role of institutions vis-à-vis geography and culture. I have also noted how the New Institutionalist argument concentrates on the institutions (fundamentally property rights) that act on the supply side of the economy. That is growth arises because property rights provide incentives for productive investment. I also noted (here) that the historical evidence for patents, copyright and other forms of property protection for explaining growth is limited at best. Note that mainstream authors and heterodox authors, at least the majority, tend to agree that institutions rather than geography or culture are central for development.

Also, the table above suggests that cultural and geographical explanations tend to put an emphasis on the supply side, but that is not necessarily the case, and it would be difficult to speculate about what Jared Diamond, for example, thinks about the relative role of supply and demand. Also, it’s worth noticing that while in his early work economic historian David Landes favored a demand-led view (which I tentatively put in the institutional box) he clearly moved to a cultural supply-side interpretation in his later work.

So if you believe most heterodox economists institutions are relevant, but not primarily those associated to the supply side; the ones linked to the demand side, in Keynesian fashion are more important than the mainstream admits. Poor countries that arrive late to the process of capitalist development cannot expand demand without limits since the imports of intermediary and capital goods cause recurrent balance of payments crises. The institutions that allow for the expansion of demand, including those that allow for higher wages to expand consumption and to avoid the external constraints, are and have been central to growth and development. The role of the State in creating and promoting the expansion of domestic markets, in the funding of research and development, and in reducing the barriers to balance of payments constraints, both by guarantying access to external markets (sometimes militarily, like in the Opium Wars) and reducing foreign access to domestic ones was crucial in the process of capitalist development.

In this view, for example, what China did not have that England did, was not lack of secure property rights and the rule of law, but a rising bourgeoisie (capitalists) that had to compete to provide for a growing domestic market that had acquired a new taste (and hence explained expanding demand) for a set of new goods, like cotton goods from India, or china (porcelain) from… well China, as emphasized by economic historian Maxine Berg among others (for the role of consumption in the Industrial Revolution go here). Or simply put, China did not have a capitalist mode of production (for the concept of mode of production and capitalism go here). Again, I argued that Robert Allen’s view according to which high wages and cheap energy forced British producers to innovate to save labor, leading to technological innovation and growth, and the absence of those conditions in China led to stagnation is limited since it presupposes that firms adopt more productive technologies even without growing demand.

The same is true of Latin American economies, which several authors like Engerman Sokoloff suggest fell behind as a result of absence of secure property rights. Latin American economies entered the world economy to produce silver (mining-economy/Amerindian population), sugar (plantation-economy/African-American population) and other commodities, for external markets. They were exploitation colonies, less reliant on the development of domestic markets, typical of settlement colonies in the Northeast United States or of the central countries in Western Europe.

The economies that depend on the production of commodities for world markets and import everything else are more vulnerable to the fluctuations of the price of commodities. Booms in commodity prices lead to growth, albeit very concentrated in the hands of the owners of capital, but they leave very little in terms of infrastructure for future growth. Further, since the economy must import everything to satisfy domestic demand, the economy is dependent on external sources of production, and when the export of commodities does not allow for enough imports, then either demand must be curtailed or the economy must become indebted to be able to continue to consume. A thriving domestic market is central for economic development, and the ability to diversify production to provide for the market is the key to catching up.

Finally, since the economy was based on the mono-production of commodities (and the size of the domestic markets is relatively limited) there were little if any incentives for technological innovation and higher productivity. Note also, that once a country falls behind, and almost all countries were essentially at the same level of income per capita around 1800 (or at least differences were considerably smaller than now), it is very hard to catch up, since the distance to the technological frontier is increasingly steep. It is not the same to copy a textile mill that uses a steam engine than to emulate the development of the Silicon Valley. In this sense, the institutions associated to the colonization period are central, rather than property rights, to explain underdevelopment in Latin America. Capitalism and its institutions both caused growth in the center, and stagnation in the periphery.*

* I discussed here how the industrialization of Britain meant the deindustrialization of India and China.

Ben Franklin, Consumption and the Industrial Revolution

The idea that demand expansion was central for the Industrial Revolution, in Keynesian fashion, was at some point dominant among economic historians. It was, for example, explicit in both Phyllis Deane and David Landes famous books about it, both published in 1969 (The First Industrial Revolution and The Unbound Prometheus, respectively).

It is also well-known that Adam Smith recognized that productivity growth (the division of labor) was limited by the extent of the market (demand), so that growth and the wealth of nations, which depended on productivity growth, and not on the accumulation of foreign reserves (gold) or trade surpluses as defended by Mercantilists, was in a sense demand-led.

Ben Franklin is not often cited in relation to his economic writings, but he was knowledgeable in the main developments of his time.  He was both a defender of the labor theory of value, and of paper currency in his famous A Modest Enquiry into the Nature and Necessity of a Paper-Currency, and the consensus is that his ideas came essentially from William Petty, the father of the surplus approach according to Marx.

As it turns out Franklin had also something to say about the role of demand in the process of industrialization in Britain. He said in Observations Concerning the Increase of Mankind, Peopling of Countries, etc. (here) that:

"But in Proportion to the Increase of the Colonies, a vast Demand is growing for British Manufactures, a glorious Market wholly in the Power of Britain, in which Foreigners cannot interfere, which will increase in a short Time even beyond her Power of supplying, tho' her whole Trade should be to her Colonies."

In other words, he suggests that the role of higher demand by the colonies was essential in the process of industrialization. I should note that there is no consensus among those that defend the demand side story of the industrial revolution between domestic demand or foreign demand, but increasingly the literature associated to the changes in the patterns of consumption in Britain suggests that it was domestic markets (e.g. Maxine Berg and her discussion of the consumer revolution).

The deep causes of the Great Divergence: or why China fell behind

In the last post, I suggested that Kenneth Chase's explanation of why China invented, but did not pursue the development of gunpowder and guns to its ultimate consequences, could be seen as the very deep cause of the so-called Big Divergence, i.e. of the rise to dominance by Western Europe. Chase explains the lack of interest in the development of firearms in China as the result of geographical conditions and how they affected warfare. He argues that two types of warfare developed after the invention of firearms.

"Where there were technologically advanced agrarianate societies that were not threatened by steppe or desert nomads, we find the combination of firearms and pikemen, with an emphasis upon infantry (western Europe, Japan). Where there were technologically advanced agrarianate societies that were threatened by steppe or desert nomads, we find the combination of firearms and wagons, with an emphasis upon cavalry (eastern Europe, the Middle East, India, north China)."

From a geographical point of view Chase divides Eurasia in three regions. The Arid Zone, which includes those areas that supported pastoral nomads, the Inner Zone including the areas that were directly threatened by pastoral nomads, principally eastern Europe, the Middle East, India, and China, and the Outer Zone that was not directly threatened by pastoral nomads, principally Western Europe and Japan, as shown in his map below.

In a sense, this is a more sophisticated geographical argument than the one put forward by Jared Diamond in Guns, Germs and Steel, since it is capable of explaining why Western Europe and not China (or India, or the Ottomans) dominated the world, while Diamond (in a book that uses old political economy arguments, in particular the notion of surplus, something typical of many historians as argued here before) can only explain why Europeans conquered the people outside Eurasia (that had less luck in the choice of animals and plants to domesticate, and less chance to spread them in an East-West axis with similar climate) really. Note that Cipolla long ago had noted that the main advantage of Westerners when they arrived in the East (Vasco da Gama in 1498) was basically military.

The only thing missing in most of these non-economists discussions of the causes of Western European dominance is the role of demand expansion in technological progress and economic growth in general. But many historians do have an implicit demand-led growth or Keynesian story too, I should add. By the way, on the Keynesian view of many historians it might be worthwhile reading the last section of Garegnani and Palumbo's entry on the Elgar Companion to Classical Economics available here.

PS: This also suggests that on some level, particularly military and naval technology, the West was already ahead of the Oriental Empires considerably before Pomeranz and the revisionists time frame (i.e. around 1800).  However, the argument does not hinge on Eurocentric views about the superiority of culture, as in many neo-Weberian arguments (e.g. David Landes).

Ronald Coase (1910-2013) and Friedman's legacy

There will be several obituaries and posts in the next few days about Coase's contributions (see here or here, for example), to the theory of the firm (his 1937 paper here; subscription required), which used the notion of transaction costs, later used by Douglas North and other economic historians, but also central for certain discussions in Industrial Organization, and his famous Theorem (or so-called as McCloskey calls it). He won the Sveriges Riksbank Prize (aka Nobel) "for his discovery and clarification of the significance of transaction costs and property rights for the institutional structure and functioning of the economy."

An interesting story is the famous dinner in which the main Chicago economists (including Friedman and Stigler) met for dinner [David Warsh calls it the most famous dinner party in the history of modern economics] with Coase at Aaron Director's home (Friedman's brother in law) and decided that the Theorem was correct. The paper (subscription required) was then published in the relatively new (at that time, 1960) Journal of Law & Economics. I always thought that it was very revealing of the way publications, even peer reviewed ones, take place. Coase had to convince the audience, basically the Chicago School, that his arguments were valid.

Don't get me wrong convincing editors and reviewers is always part of the process. What the dinner party makes explicit is that, something that is increasingly true, is that Coase had to convince a group of people that is like minded. There was nobody with an alternative [and I don't mean heterodox or radical] perspective at the dinner party. Maybe I'm wrong, but it seems that Chicago was ahead of its time in excluding alternative views on the basis of ideological purity than other places. That's Milton Friedman's real legacy.

PS: I was traveling, and didn't post anything about David Landes death. Brad DeLong had a nice post here. I should say that I liked way more the Landes of Unbound Prometheus, than the one of The Wealth and Poverty of Nations.