Afghan Entrepreneurship

Via a link from Virginia Postrel, i learn about Sarah Chayes’ trials and tribulations of setting up a soap business in Afghanistan.

A warning is in order — its a scandalous indictment of poor management of USAID in Afghanistan. One of the juicier paragraphs:

I was under the impression that our proposal had been complete for weeks. …Now I would probably have to start the application procedure all over again, at the whim of yet another incoming ALP/S manager.

The letter I received from him a few days later confirmed my premonition. It requested a ream of further documentation, such as a breakdown of the raw-materials cost of a bar of soap and our financial accounts from previous years. “Maybe even more importantly,” the letter went on,

we need to show the real raison d’etre for all of this. It’s because there’s real demand for your products. Demand is not your problem, Sarah, satisfying it is. You’ve already established a vibe in the market. You’re selling in Manhattan and sundry other swanky places. You’ve had plenty of free publicity in media with the appropriate reach to capture the attention of the chattering class whose hands you’re washing. The wind is now behind you and you’ve an opportunity to make a significant contribution to establishing Afghanistan as something other than a squalid state exporting only smack and terror. This is what USAID wants to hear.

But its also an inspiring story about how a simple idea is potentially frustrating to implement in practice; about how lots of people who have the capability to help need only a way to do so; about how local people rise to the occasion when given a substitute to the illegal drug trade.

Focus

In writing this paper, i need to focus on a question. The literature is wide, interesting, yet frustatingly rambling. Thats understandable. It is the task of the writer to take all of these elements and tell a cohesive story.

There is one a central fact vital in the history of economic growth:From the beginning of recorded history until the 18th century, output per person in countries in the world [specifically england, but this can be generalized] is negatively related to population. Specifically, this rapid growth appears to start around 1760, but explodes around 1860.

Higher incomes in this period is also associated with the rise of manufacturing and the decline of agriculture in the economy (share of output). This is why this has been called the Industrial Revolution.

Modern Growth theory says that Investment in the stock of production knowledge is the key to ever increasing incomes. The big question is: why did such investment not happen before; or if it did, why did it fail to create increasing incomes we have witnessed for almost 200 years.

This question is one of the most important questions in economics. Tantalizingly, it remains a mystery.

The phrase ‘production knowledge’ is key here — how have societies been able to marshall labor power in ever more productive ways?

This is not the same question that many other people pursue. Other people have asked about the question of incentives: since incentives matter, it is imperative to know how this knowledge generation is incentivized. And if it is knowledge that cannot be completely appropriated, then there must be some sort of externality — what is the nature of this externality?

Out of the first concern come the arguments for intellectual property and innovation, out of the second derive some of the literature on endogenous growth. Needless to say, elements from both concerns might also be operating simultaneously.

My next concern is the nature of one of the major characters in the drama of modern growth: firms. Old treatment of the theory of the firm talk about a black box of despotism in a sea of the free market. [note: whose quote is this? ] A firm is a Cost Function with an assumed shape. A firm is a faceless technology, whose only purpose is to maximize profit. Let this firm interact with other firms, under different conditions – and you get results on prices and outputs in an economy. Larger questions of what the definitions of market and industry are largely ignored. Within an industry, firm dynamics are simple: entry occurs until profits are driven to zero.

One of the major problems of this old literature is that ‘between industry’ dynamics are also ignored. Industries exist by assumption. Industries are different from each other in certain, parameterized ways: i.e. some industries have higher fixed costs than others, some are more regulated, etc. New industries are assumed to be born; they don’t rise endogenously. Much of this stems from the lack of a good definition for industry/market. The absence of a definition implies an inability to model it.

Newer versions of the theory talk about the definition of a firm. This is again a large and voluminous literature, that showcases the firm as a contractual arrangement, from Williamson. this highlights the dangers of opportunism in long-run relationships, and that long-run contracts — firms — are written to circumvent them. A related view of the firm says that a firm is an incomplete contract. The incompleteness of it gives one party the power to influence how resources are allocated and effort incentivized.

There is a less popular approach to defining a firm that neoclassical theory has neglected — the entrepreneur. Again, problems of definitions plague the literature, and the absence of a groundbreaking theoretical technique has stymied its popular use. [note to self: this is kinda similar to one of my conclusions!]

Moving forward, the critical questions to be asked are: what is an entrepreneur? (i.e. definitions by Schumpeter, Kirzner, Baumol, et al.) and how does this agent bring about sustained growth in productive knowledge? In addition, the entrepreneur concept must highlight the dynamics and transitions that characterize economies everywhere. Specifically, a theory of entrepreneurship must be consistent with the stylized fact on growth mentioned at the start.

Another way of stating things is: how do capitalist societies come to be? What are the forces that underlie such dramatic changes in an economies structure? What role do entrepreneurs/firms play in the propagation and the creation of these forces?

Entrepreneurship, Post I

I’m writing on entrepreneurship, and its my first, so this will be incredibly confusing and disjointed. To jog my brain, i’ll start with Baumol’s ideas.

In his JPE paper, Baumol assumes that the supply of entrepreneurship varies across societies but it is the allocation of entrepreneurial talent is a key driver of differences in growth rates. Talent can be allocated in either productive enterprises or rent-seeking or organized crime. The allocation in any society depends on the relative pay-offs of either activity.
When the government can affect the pay-offs between either activity, then it can also influence growth. Furthermore, it is assumed that government can affect relative returns, but not the supply of entrepreneurship.

He has three different propositions on entrepreneurship over time. The first is that pay-offs to entrepreneurship changes dramatically from one time to another. The second is that these changes correspond to the ‘rules of the game’. And last, the alllocation of entrepreneurial talent has effects on the innovativeness of the economy and the dissemination of that innovation. He elaborates on these propositions by discussing several germane historical episodes.

To cite one, he begins with the Roman period. He describes this period as one of intense innovative activity, but its entrepreneurs were sidelined with non-productive goals. They were interested in wealth and prosperity, but were not interested in commerce or industry. The rich had three acceptable sources of wealth: land holdings, usury, and political payments. Industry was looked down on, as the province for freedmen (former slaves). There was also a wide gulf between science and technology.

He gets into trouble when he tries to link policy to entrepreneurial allocation. He doesn’t really have proof that policy can affect relative pay-offs. He realizes that alot might depend on preferences or culture, so in the final section of his paper, he assumes that every entrepreneur in history has the same goals to save the proposition that policy might matter to redirect entrepreneurial attention.

The restriction on the royal grant of monopolies (in 1624) was cited as the main policy change in england to ignite the industrial revolution in the 18th century. Yet, he continues that maybe it is the attitudes of the english towards commerce that was changing. Commerce was becoming more acceptable as more sons of english lords had to resort to commerce and industry because of primogeniture — the land goes only to the eldest son. So, more and more rich people had to be business people, so it became acceptable, even respectable.

I also have been reading “Booty Capitalism” by Paul Hutchcroft. He has the same theme as Baumol. Focusing on the development of the filipino banking sector, he says that filipino oligarchs were pre-occupied with rent-seeking instead of opening new markets and innovation.

I am sympathetic to these claims. But i have a problem with the growth story. If we say that productive entrepreneurship and growth go hand in glove, then aren’t we being truistic? Isn’t it saying that industrialization is heralded by industrialists? This isn’t a theory of the history of growth or development. It is unclear how or why entrepreneurs are engaged in productive or unproductive activity, not the least is it clear how or why government can affect it.

Baumol leaves me with one last thing to think about — the pursuit of power and standing in society. This preference is unlikely to change over time and its manifestation over time changes, depending on relative conditions. Further, the pursuit of power itself can generate changes in the rules of the game, which influences how people pursue power, which influences institutions, which changes relative returns, etc… It seems very general equilibrium. Can the pursuit of power explain the waves of entrepreneurship and its allocation over activities?

Lhuillier on Project Runway

I was watching Project Runway’s new season on Bravo, when i noticed the name of the guest judge – Monique Lhuillier. Yup, that Lhuillier. From her website, she’s very accomplished bridal clothing designer. Her credits include Brittney Spear’s wedding dress (in her wedding with KFed). My question is, does she identify herself as a ‘filipino’ designer? I hope so.

Virtues of Bad Times

A very interesting paper “Virtues of Bad Times Revisited” was presented by its author, Min Ouyang, this week in our Macro-Intl seminar.

Its about recessions and whether they are good or bad in terms of productivity. An old idea, credited to Schumpeter, says that recessions are good because they free resources to more productive uses. This is a ‘cleansing’ effect of recessions, sort of how you get more productive when all the old crap laying around your room gets ushered to the nearest recycling bin.

The problem is that the cleansing story doesn’t really agree with the data. First, she cites that those firms that ‘die’ during a downturn aren’t necesarily the least productive firms. Second, assume that firms learn to be more productive as time goes by. If so, then the following fact would mean that the dynamic effects of recessions are hurtful to productivity — the firms that die during recessions are young firms. These firms don’t have a chance to learn what their true productivity. This is what she calls a ’scarring’ effect.

The paper continues to model the above phenomenon, and the exact details are interesting.

But i have a problem with this paper. Firm productivity, and the learning of one’s intrinsic ability, comes from somewhere. In her paper, she briefly mentions three sources of uncertainty regarding intrinsic productivity: unobserved managerial skill, unknown demand for product, unpredictable profitability of certain locations. But in a recession, while firms may die, these sources of productivity do not.

So when the recession ends, these same factors are still in play, so scarring need not happen. To be specific, lets say its managerial talent that is important. Then, when a recession hits, its still possible for this talent to bloom elsewhere (another industry), and so there is no loss — its merely re-allocated.

To retain scarring, you have to assume idiosyncratic productivity that is industry and time dependent. So, lets say I am a manager for a software firm gets laid off because my firm ‘dies’ in the recession of ‘07. I get another job, in another industry, or — gasp! — get into Economics Grad School. I earn some human capital in my new industry, but my inate talents in software engineering never get used again because my built abilities aren’t transferable to software engineering. Depending on your viewpoint on human capital, these are either natural assumptions or onerous.

History Paper on Entrepreneurship

Tomorrow, i’ll seek out Greg Clark during his office hour to discuss my Econ 210a paper. He is busy (rightfully) promoting his new best-seller “A Farewell to Alms“.The class is basically economic history, with a focus on economic growth. One of the biggest puzzles in economic history and growth is the origin and source of technological advance.In the class, we have to write a ‘paper’ and i have chosen to focus on entrepreneurship and her [i've decided to call an enterpreneur 'her'] role in economic growth and change. Recently, there has been a burgeoning literature on entrepreneurship, and currently i’m focused on the work of Will Baumol.I settled on this, because my dissertation discussion partner suggested that i focus on research that is related to my current interests. At this point, i’m an IO/Trade person who is interested in multi-product firms and industry dynamics. Current models that i’ve been exposed to implicitly integrate entrepreneurship. Active entry and exit of firms, and entry and exit into product markets are tell-tale evidence of entrepreneurial activity, together with the introduction of new (presumably, but not necessarily) higher quality goods.So, in writing this paper, i hope to shoot two birds with one stone and put them together in a dissertation. In subsequent posts, i hope to write my paper in parts.On an unrelated note, I might as well add here that i hope that Prof. Peri will successfully launch his International Migration Seminar in the Winter Quarter. This is another International Economics/Labor/Macroeconomics topic i’m interested in.