RIP: Sajogyo

Rest in peace, Prof. Sajogyo, the quiet man behind the poverty line measurement. You are deeply missed.

Widjojo (1)

Widjojo (1)

He was loved and he was hated. Now he’s gone. No doubt, we in The Café are in the group who loves him dearly. We are aware that Kwik Kian Gie, Rizal Ramli, and the likes hate him. We don’t care. For us, Pak Widjojo is eternal. He lives in our way of thinking, way of seeing things. It’s not only economics. It’s about how one should deliver an idea. How to argue civilized way. How to respect even the unknown. We are way his juniors. Our experience is a tiny fraction of his. But if there is a model we would like to follow, that’s him.

But what really is this concept called Widjojo? Unlike that of prolific economic writers such as Chatib Basri, Sadli and Emil Salim, Widjojo’s writings were dry, almost boring. But the messages were strong and important at the same time. Read his 1963 professorial inauguration speech 1963. That was dry and dismal. But it was incisive and contemporary. At the time, Robert Solow’s 1956 seminal paper on neo-classical growth model was a big thing. One of the model’s predictions is growth convergence between rich and poor countries that share the same steady state (current textbook example: Germany and Japan in the aftermath of World War II). This is theoretically neat. But empirics do not always confirm: some poor countries remain poor, rich keeps progressing. It took some time before the profession agreed that the convergence that goes with the empirics is conditional convergence. That is, a country will converge to its own steady state. Or, if any, countries with similar starting points will meet. But what if this similar starting point is nowhere to find? What if savings rate or technological rate of a less developing country never catches up with that of the developed? Almost two decades after Solow’s paper, Krugman came along with an inconvenient truth: it is possible that a rich country keeps leaving the poor behind due to increasing returns and economies of scale. And of course, from more micro-perspective we are now familiar with poverty-trap, et cetera. Today, ground researches by members of the younger bastion like Banerjee and Duflo attest this. But Widjojo, among a few, had warned us in 1963. He wrote that a big gap in initial levels of income might not be neutralized simply by equal rate of growth in income. In order to overcome this situation, he added, less advantageous countries need a rational planning with economic analysis – and implement it vigorously and consistently. Then he explained in greater details what he meant by planning – in that inaugural speech. Two years ago, Widjojo admitted in his book, that that speech went against the tide: people were unconvinced that economic issues were important. Worse yet, people were skeptical to economics as a “text-book thinking” approach.

Now, this same person, the text-book-thinking Widjojo was no blind supporter of heavy state planning. He was actually more pragmatic. In 1955 – he was 28 years old – he debated Wilopo, the former influential prime minister. The event was the fifth anniversary of Department of Economics, University of Indonesia. Wilopo, the key-note speaker, presented an argument against economic liberalism. In particular, Wilopo disapproved private initiatives and individual property rights. Widjojo called this contradiction – that Wilopo treated private initiatives as necessary evil in development. Instead, according to Widjojo, private enterprises should be given a role in economic development. He also warned that by “private” we should not just mean big enterprises (to name a view, he mentioned a Dutch-owned oil company BPM and an American Stanvac), but also the small ones. As he put it, “the little farmers with a piece of land of no more than 0.1 hectare are also private”.  (Note that Widjojo’s stand with regards to private role in economic development had shaped even before he went to UC Berkeley in 1957).

(this might be continued).

A Tribute to Widjojo by Pram Oktavinanda

Dear cafe patrons, our friend Pram Oktavinanda shares his tribute to Pak Widjojo. This is cross-posted at his blog too. Being a lawyer and legal scholar, Pram highlights Widjojo's contribution to the economic analysis of law in Indonesia. Enjoy. - Kate.

An Introduction to Economic Analysis of Law - A Tribute to Prof. Widjojo Nitisastro

by Pramudya A. Oktavinanda

It was a sad day indeed for Indonesia as one of its greatest economists, Prof. Widjojo Nitisatro, passed away yesterday. What a great loss! Although I have never met him in person, I know him through his splendid articles and books about him, especially the Kesan dan Pesan Sahabat-Sahabat Widjojo Nitisastro. Two of my favorite articles of him deal with the economic analysis for national development and the economic analysis of Article 33 of the 1945 Constitution (which discuss the correct economic structure for Indonesia). I consider those articles as the classical example of economic analysis of law in Indonesia and they have significant impact on inducing me to pursue the art of Law and Economics.

While I have been writing about law and economics for many times in my blog, I have never formally written about an introductory article on economic analysis of law itself. I guess this is the right time to do so as a tribute to the late Prof. Widjojo Nitisastro. You will surely be missed and may you rest in peace. God bless you.

Economic analysis of law or law and economics is a school of thought primarily developed in the United States that uses the powerful tool of economics to analyze various legal issues. It discusses three primary questions: (i) What is law? (ii) Why law exists in the society and can have binding power? (iii) What can be considered as a good law? Two prominent scholars can be considered as the early developers of law and economics, Gary Becker, a prominent economist who won Nobel prize in 1992, and Richard Posner, a prolific legal academician who is also considered as one of the best judges in the United States. Both teach at the University of Chicago and contribute significantly to the development of law and economics.

Why economics can be a useful tool in analyzing the law? The primary notion used in this school of though is that men act rationally. Not in the sense that they can always make perfect calculation at all times but in the sense that they respond to incentives and pay attention to the costs and benefits of their actions, even when they are subject to various limitations in doing so. This is the basis of positive law and economics which deals with descriptive analysis on the law and how it will affect human behavior.

The second notion in law and economics is the pursuit of efficiency and welfare maximization of society. This is used by normative law and economics which believes that law should be designed to maximize the welfare of the society, whereas to reach that goal, law must be designed as efficient as possible. The more efficient the better, since it means that we can save costs while produce the biggest benefits to the society.

Interestingly, despite the fact that law and economics has reached a very strong position in the United States, dominating the legal thought there, it is relatively unknown in Indonesia which sadly, still focuses its law teaching with classical legal thought. I guess this should be changed if we really want to improve our Indonesian legal system.

Why law and economics is helpful for developing our legal system? I have three main reasons. First, by paying attention to how the law can shape the incentives of the people, we can shape our law to effectively affect the behavior of the people. As an example, I once argued on limiting the use of prison as a sanction for corruptors and instead using the sanction of assets confiscation. Assets and money are the bloodline of corruptors, the ones that significantly induce them to do the crime in the first place. If we only send them to prison but fail to secure the assets back, that will allow the criminal defendant to use the money to buy his way through the legal system (remember the case of luxury prison).

Second, by paying attention to the notion of efficiency, we will also pay attention to the costs and benefits of having regulation. Only regulate if the costs of doing so are lower than the benefits. Do not try to regulate everything because we cannot have an effective regulation without effective enforcement. And enforcement can be costly, the bigger the scope of the enforcement, the bigger the costs. Classical legal thoughts believe that law should be obeyed because it is promulgated by the relevant authorities. This is completely wrong. It is obeyed either because we find a mechanism to enforce it or the general society believe unanimously that such law is useful. Hence, the need of enforcement.

One good example of this would be laws that deal primarily with regulating private behaviors that do not produce clear harms such as how to dress publicly. On the one hand, regulating those kind of things will be costly, imagine the price for enforcement and the potential social unrest that it will create since it will give legitimation to people to violate other people on the basis of dress. On the other hand, there is no clear benefit of regulating such behavior in the first place other than to serve the idea of several people about morality. We've seen a lot of these absurd laws, such as laws that try to regulate how to name your child. I wonder how these laws could even exist if not only for the purpose of political maneuver.

Finally, by putting the goal that laws should always aim to maximize the welfare of the society, we will have a good guide in developing laws that will be useful for the society. And there are a lot of things that we can discuss here. Some good examples that I have once discussed: how to efficiently regulate liability of people in tort cases (such as whether we need to establish good samaritan liability), whether we should maintain death penalty (do the benefits justify the costs?), how to prevent rape crimes effectively, the extent to which we can limit foreign investment in Indonesia, how to share the legal risks of infrastructure development in order to induce more investors to come to Indonesia, how to reduce courts burden by cutting unnecessary costs for judging petty crimes (the latest Supreme Court regulation is a nice example of this), and many more.

I believe that it is important for law makers and legal enforcers to always strive for welfare maximization in rendering and interpreting the law. You do not enforce the law for the sake of the law itself. Law is not holy, it is not untouchable, it is not derived from the sky, rather it is made to serve men and should be made in view of men needs. Prof. Widjojo Nitisastro has started the idea of using economic analysis in shaping our national development and making sound economic policy long time ago. It was a great contribution, something that we, youngsters, must also strive to achieve. The least thing that I could do is to introduce law and economics to Indonesia and contribute in offering good public policy for our nation.

RIP: Widjojo (2)

Here's some hallmarks in Pak Widjojo's life:

Born 1927
Head of LPEM-FEUI 1955-1957
Professor of Economics, FEUI 1962
Dean of FEUI 1964-1968
Director of LIPI 1964-1971
Head of Bappenas 1967-1971
State Minister of Bappenas 1971-1973
Coordinating Minister for Economic Affairs 1973-1983

RIP: Widjojo Nitisastro

Taken from The Indonesia Today

The Cafe is mourning. Pak Widjojo passed away yesterday. We'll post and link to some articles related to Pak Widjojo. For now, Ape's 3-piece article in JakartaBeat is of relevance: Part 1, Part 2, Part 3.

The Tale of Two Countries (in Three Pictures)

The demise of the North Korean dictator Kim Jong Il, in addition to generating endless internet memes and jokes, has prompted some to remind us about the devastation that his regime (and his father's) brought to the North Korean population. Among those reminders, the following three pictures can illustrate the grim legacy the best.

GDP
The first is the following GDP figure of North and South Korea between 1997 and 2003 that shows how massively different the neighboring countries performed in the period. Because yes, GDP is still one of the best summaries of a country's economic performance. (Source is here)



Night lights and economic vitality
The second one, my favorite, is this satellite image of the Korean peninsula at night time. South Korea is brimming with lights, evidence of vibrant economy, while North Korea is almost completely dark. (Source is here).  Why this is important? An economic study by Henderson, Storeygard, and Weil (2010) shows that satellite images of night lights provide a good proxy for measuring economic growth (here's the WSJ version)





The biology
The third figure, while may not look as dramatic as any satellite image actually provides an even starker evidence of the failure of the centrally-planned economy. It is a graph also of a stagnated growth, not of the economy, but of the human population. (Source is here).



The above graph is from a  2004 study by Sunyoun Pak who looks at data on height of adults and children of the neighboring countries. Pioneered by Nobel prize winner Robert Fogel, in the last 3 decades, economists have looked at the relationship between income and health. Among a number of biomarkers, height has proven to be one of the best and most useful indicator of long-term health and well being.

It goes without saying that one could not conduct a typical household survey in North Korea, so the author uses data from North Koreans who escaped to the south between 1999 and 2003. Anthropometric measures were taken of the escapees and compared to those of South Korean population (the author noted that the escapees may be from lower socio-economic background relative of the North Korea society).

The graph clearly shows the difference in heights between the two groups and the difference is larger the younger the cohort. On average, South Korean young adults are 6 cm taller than their Northern counterparts. The author goes as far as to conclude: “In contrast to population of South Korea, as well as to that most of the rest of the world, North Koreans did not experience an increase in physical stature during the second half of the 20th century.”

There you have it.  Two countries sharing similar geography, climate, ethnicity, but different political and economic system, and massively different outcomes.

Suggested readings
1. Demick, Barbara (2009)  "Nothing to Envy: Ordinary Lives in North Korea". Here is the book official website.
2. Pak, Sunyoun (2004), "The Biological Standard of Living in the Two Koreas", Economics and Human Biology 2 (2004) 511-521.
3. Henderson, JV, A. Storeygard, D.N. Weil (2009), "Measuring Growth from Outer Space", NBER Working Paper 15199.

... and a bonus for my fellow Atlantic Monthly reader(s):
The Atlantic's photo essay from earlier this year, "Inside North Korea". Which one is your favorite?

Updates (2/25/2014):
This image and the commentary  from NASA Earth Observatory website have been making rounds. The satellite image taken on Jan 30, 2014 shows an even starker contrast than the one we had in this blog post. Most notably the city lights around Shenyang show how much the Chinese's northeast of commerce and transportation hub has grown in recent years.

The NASA commentary also offers a mindboggling fact behind the image: the per capita power consumption in South Korea is 10,162 kilowatt hours, compared to 739 kilowatt hours in North Korea.

More On Buying Frenzies

Two things I learned coming home from Thanksgiving dinner this year: i) turkey goes well with gado-gado sauce, especially if you don’t have discerning taste buds for boring white meat, ii) there’s a buying frenzy and then there’s a buying frenzy.

This being a supposedly an economics-minded café, I’ll dwell more on the second. Watching the coverage on the door-busting sale at a neighborhood Best Buy store on the local news, and reading the tweeter feed on the chaotic Blackberry launch in Pacific Place, one looks for explanations. Aco’s post goes a long way in doing so. The people clearly were there for the deep discounts but their decisions to stand in line reflect not only their valuation of the products they’re waiting in line for but also how much they value their own time. Some of them may actually were there because they enjoy experience.

There’s a slightly different kind of buying frenzies, though, the like of which we see every time Apple launches a new product. The people standing in line in front of an iBox store are there for a different reason than those standing in front of Macy’s or Best Buy on Black Friday. Most likely, these are the people who like to be first in having everything Apple-related. No deep discounts are necessary for them. In fact they may even be willing to pay a higher price to be first. We know the type. Almost all Apple fanboys fall into this group. A lot of movie fanboys fall in to this, from the Jedi wannabes, the Trekkies, and those standing in line for hours to see Breaking Dawn (yes, you, you, and you).

There’s actually a rather classic paper by deGraba (1995)* discussing this second type of buying frenzy. The idea is that there’s a monopolist who wants to launch a new product of unknown quality. The monopolist has the option to supply enough units for the market to clear, or to deliberately ration the market and create excess demand. Often they do the latter for the following reason.

When a new product is launch, often the quality is not fully known to the potential buyers. For a brand with a fan base, limiting the number of units of the new product on the market will create a buying frenzy where potential buyers will clamor to get their hands on the "new big thing". Any fan worth his salt will try to get his hands on one. The hype is on. Anyone who wants to wait until they have more information about the product will face the threat of not getting any unit available to them. In this case, the monopolist can even set a price higher than a market clearing price. Later when the true quality of the products becomes known to the rest of the market, there’s less room for the monopolist to influence the frenzy.

So which category do people who fight over the Blackberry in Pacific Place fall into? It seems like they’re a combination of both: they put relatively lower value on their time, and they’re also the type who’s willing to take some risks in getting new products of relatively unknown quality. Some of them were probably there for the experience (well, probably not for the stampede).

How about the people standing in long line for those Cr*cs sandals years ago? Well, they clearly fall into the first category since nothing about those sandals are unknown by that time. Everybody knows they’re damn comfortable. And everybody knows they’re ugly.

Next we could discuss why people should go to restaurants with long lines in front of them.

* Patrick deGraba (1995) "Buying Frenzies and seller-induced excess demand", Rand Journal of Economics 26:2.

Economics of queuing, again

I'm in a seminar and I'm bored. So I just checked Twitter and saw some people tweeting about a long queue in some mall in Jakarta. Apparently they are standing in line for the newest Blackberry product or something. Why queue? Wait, let's step back: what is queue? Or more precisely, what does a queue imply? From an economist's point of view, queue is a signal that the good being sold is under-priced (of course, why else do people want to queue?). You see motorists are queuing on a gas station? That's because the price is too low. You see people form a long snake to buy Crocs? Must be because it is being sold in a heavily discounted price.

In other words, queue reflects price distortion - in that case, the price does not tell you correctly the number of goods being sold (i.e. the supply). When the price is lowered, people/consumers will naturally think that the quantity sold is a lot. That's the law of supply: (for normal goods) supply increase will lead to price decrease. When this holds, you don't see queuing. But, because the law is violated - supply does not change (or even: reduced), while the price is cut, then you *should* see some queuing. Those who stand in the queue either think that the goods are many, or are full well that the supply is limited but is driven by a mere .. hype (think about Apple iPad's launching - that's hype*).

So: what do we expect when a good is priced too low contrary to the level it should be (i.e. the one driven by the market)? A queue. Put it another way, what is a queue telling you? That the price of some good is not normal (or that some people are hyped). 

But now let's push it further. Are people so shallow so as not to understand this? Well, actually no: they know it. They are just willing to trade some of their time and energy for the discounted price. If one can factor these in, he or she will actually find that the price is not as cheap as the store declares. What are other hidden costs of distorted price that leads to queuing? Impatience, stampede, quarrel - and even death (remember the story from China in 2007 when somebody died after a brawl over queue-jumping in a gas station?)

Now, why are some people not willing to join the queue? Can be because many things: they value their time more than those standing in the queue do, they know that queue means price distortion and hence an artificial sign that has hidden costs, or simply because they are not affected by some crazy hype. 

Or they might be participating in a seminar, albeit bored. 

Thanksgiving Random Notes

Gee, it's been for awhile that I don't serve anything here. I am a lousy barista, indeed.

So where are we? Well, apparently we, the baristas, here don't seem to believe that a revolution in economics would happen real soon -- which doesn't mean that the field has gone nowhere since the last time you open the textbook. Come to academic seminars, open NBER web or AEA web, and you'll know what I mean.

Psychology/behavioral approach is moving to the mainstream now, to take one direction of progress in micro, and many are talking about (funny shape of) aggregate demand in near zero short term nominal interest rate in macro.

But we're now near Thanksgiving break, so all those seemingly important serving shall wait.

Well, maybe holiday mood and good behavioral economics shall not be contradicted, thanks to Daniel Kahneman.

His latest book, "Thinking, Fast and Slow", is delightful and well-written -- so well that actually you can read it while waiting for your train, cooking the Turkey, or attending the royal wedding (well, maybe not). For such a heavy academic content, it's not an easy to write in popular lingo yet retain the depth of knowledge. Kahneman did it. You don't need to know psychology or economics (god forbid) to digest Kahneman's thought in this book.

In short: you should buy it.

The other thing that you can do during holiday is probably going to your typical movie theater and watch The Muppets and not-so typical theater for Being Elmo.

Happy Thanksgiving, folks

You said you want a revolution?

This week, we had email exchanges with some colleagues about Harvard undergraduate students walked out of Mankiw's introductory economics class. The discussion was not so much about the walk-out (and much less, or nothing, about the reactions, as in here, here and here). The colleagues were talking about limitations of economic theory in explaining many phenomena, the need to give more room for multidisciplinary analytic framework, and to call for a revision for, even revolution in, economic curriculum and to another revolution in economic thinking.

Here's the summary of my response. First, no one would disagree that economic theory is limited. It provides a framework of analysis, not the framework. All economic models are based on certain assumptions. Not that we believe that the assumptions would (should) hold. But it serves as a benchmark condition to argue what would happen if the assumptions hold.

Second, no doubt that multidisciplinary analysis is good. Economists, and economists, would benefit from talking to, or collaborating with, scholars from other disciplines. But multidisciplinary requires each scholar have solid background on his/her own discipline. Imagine two people, an Indonesian an American, discussing their cultures. If the Indonesian doesn't have a solid understanding about Indonesian culture, the dialogue would be a lecture on American culture, not a cross-cultural one.

Third, while the curriculum and teaching methods should always be revisited to reflect current developments, we need to ask how much information we can (should) feed the students. Besides, the purpose of education and teaching is not to provide answers. The purpose is to make students asking the right questions (and find the answers) by providing analytic framework.

I am not sure about how much revisions we could have in microeconomics. It basically tells us that resources are scarce, so we need to make choices, which imply opportunity costs and give us trade-offs. Then there is demand and supply analysis, which, under a certain assumptions of how the market works, will define the prices. But we don't assume that market works all the time, so there is a substantial discussion of market failure in externality, public goods, uncertainty and game theory chapters. That's usually what we covers in 2 semester of microeconomics. There are more applications, such the agricultural household model, different game theoretical analysis and many more, which we usually teach in more advanced classes.

On the other hand, macroeconomics is a very dynamic subject. To be honest, I am not really catching up with the subject. But to catch up with the current state-of-the-art, including to criticize some mainstream theories, still you need to have the solid fundamentals. You can not, for example, argue for divergence in growth without starting from the basic Solow model which implies convergence. To criticize efficient market hypothesis you need to start from the AD-AS, Keynesian-cross and IS-LM models. No short-cut to do that.

Yes, Keynesian was a revolution in economics. Prior to Keynes, economists did not think of national income, and the relationships between money, interest and employment. In short, people never thought economics as a macro system, hence the term macroeconomics. But since then, (macro)economics have evolved, leaving us few rooms for revolutionary thoughts. Even Keynesian was at one time in a crisis, when excessive government's intervention in the economy led to high inflation without growth in production.

Honestly, the room for another revolution is getting much and much smaller now. Most big ideas have been delivered. The frontiers have been pretty much explored. Of course, there are still many unexplored spots in the forest. That is the real call: to fill the missing puzzles through new theoretical and empirical researches.