Sep 14, 2016

Reading Frank H. Knight's "Risk, Uncertainty, and Profit"

The true uncertainty in organized life is the uncertainty in an estimate of human capacity, which is always a capacity to meet uncertainty.
Frank Knight

It is the first time I read RUP. There are a few points I would like to make: 

  1. This is an incredibly good book to understand the origins of entrepreneurial profits. Profits are the reward for an entrepreneur's good judgement when she faces uncertainty. And uncertainty is a kind of risk that can not be measured. 
  2. The book starts with a methodological discussion and Knight indicates the importance of clarity for scientific endeavors. In particular Knight emphasizes that scientists should be transparent about explaining the assumptions of their models. By the way, for Knight there are no economic laws, only tendencies. 
  3. The exploration of assumptions is key for what Knight does in RUP. In particular he describes the perfectly competitive model and explains its assumptions. By doing that he concludes that in this model profits do not exist. However, in reality, profits do exist. And the reason is that in the real world information is not perfect and there are barriers to entry, among other factors -- there is uncertainty! By dissecting the assumptions of a theory (perfect competition) Knight creates a new theory (a theory of profits). 
  4. Once the assumption of perfect information (and others) is relaxed we see the emergence of uncertainty. Uncertainty as explained by Knight has different origins. One is the changing nature of the world, which is partially explained by unpredictable human behavior.
  5. On the one hand, perfect competition is situated in a static world where there are no barriers to entry. Imperfect competition, on the other hand, is situated in a dynamic world. Profits do exist and are taken by entrepreneurs that exercise their good judgment when facing uncertainty. For Knight entrepreneurial good judgement cannot be precisely distinguished from good luck. An interesting topic to discuss is what exactly "good judgment" is, and to what extent good judgment can be taught. 
  6. Once one accepts the importance of good judgement it is easy to understand the implicit theory of the firm in RUP. For Knight entrepreneurs are specialized in maximizing good judgement and they create companies to do so. Entrepreneurs are also specialized in wealth creation. A related point here is that stockholders are the entrepreneurs in modern corporations. 
  7. Who is the entrepreneur? She has "skin in the game," and she is residual claimant of income after the prices of the factors of production (land, capital, and labor) have been imputed. 
  8. It is possible to reduce uncertainty, by grouping different events. Another way (although extreme) to do so is to stop progress. 
  9. Knight argues that human beings maximize wealth, not consumption. He also indicates that human beings are constantly looking to have "interesting" lives. 
  10. Knight was a pioneer of what we call now behavioral economics. He mentions that human beings do not necessary know what they want. Psychology is important and that opens the door for manipulation through marketing. He even mentions what would be known as the "winner's curse." For Knight preferences are not constant, and human beings are often trying to acquire better preferences. 
There is much more in the RUP, and if you have not read it and are interested in entrepreneurship, market process, microeconomics, and risk RUP is a must. Besides, Frank Knight had a fascinating approach to social sciences. He was critical, skeptical, and a heretic in many ways.

Additional readings

These additional readings helped me understand the RUP better and to contextualize Frank Knight and his thinking - they are in no particular order: 

Knight, Frank H. "Abstract Economics as Absolute Ethics." Ethics 76, no. 3 (1966): 163-77.

Knight, Frank H. "Anthropology and Economics." Journal of Political Economy 49, no. 2 (1941): 247-68.

Patinkin, Don. "Frank Knight as Teacher." The American Economic Review 63, no. 5 (1973): 787-810.

Leigh, Arthur H. "Frank H. Knight as Economic Theorist." Journal of Political Economy 82, no. 3 (1974): 578-86.

Economics Is Not All of Life

Kern, William S. "The Lemon Principle, Democratic Politics, and Frank Knight's First Law of Talk." Public Choice 59, no. 1 (1988): 83-87.

Frank H. Knight on the “Entrepreneur Function” in Modern Enterprise

Knight, Frank H. "Imperfect Competition." Journal of Marketing 3, no. 4 (1939): 360-66.

Frank H. Knight and the Chicago School

Langlois, R. N. and Cosgel, M. M. (1993), Frank Knight on Risk, Uncertainty, and the Firm: A New Interpretation. Economic Inquiry, 31: 456–465.

Knight, Frank H. "Laissez Faire: Pro and Con." Journal of Political Economy 75, no. 6 (1967): 782-95.

Wick, Warner. "Frank Knight, Philosopher at Large." Journal of Political Economy 81, no. 3 (1973): 513-15.

Raines, J. Patrick, and Jung Clarence R. "Knight on Religion and Ethics as Agents of Social Change: An Essay to Commemorate the Centennial of Frank H. Knight's Birth." The American Journal of Economics and Sociology 45, no. 4 (1986): 429-39.

Mitchell, Wesley C. The American Economic Review 12, no. 2 (1922): 274-75.

Knight, Frank H. "Profit and Entrepreneurial Functions." The Journal of Economic History 2 (1942): 126-32.

Stigler, George J. "Frank Knight as Teacher." Journal of Political Economy 81, no. 3 (1973): 518-20.

Schultz, T. W. "Frank Knight as Colleague." Journal of Political Economy 81, no. 3 (1973): 516-17.

Watkins, G. P. "Knight's Risk, Uncertainty and Profit." The Quarterly Journal of Economics 36, no. 4 (1922): 682-90.

Raines, J.P. and Jung, C.R. (2009) ‘Monopolies as “Mechanical Defects”: Frank H. Knight on Market Power’, History of Economics Society Bulletin, 10(2), pp. 135–143.

Aug 12, 2016

El Capitalismo del Centavo

Este extraordinary libro es un clásico y fue publicado en español en 1964. Es un estudio detallado de la economía de Panajachel, Sololá, Guatemala. Está basado en el trabajo de campo que el prestigioso antropólogo Sol Tax hizo en la comunidad en los años 30s. En ese tiempo la población de Panajachel no superaba los 2,000 habitantes. 

El autor afirma que la economía de los indígenas de Panajachel puede caracterizarse como “una economía monetaria organizada con las casas individuales como unidades de producción y de consumo, con un mercado fuertemente desarrollado, el cual tiende a ser perfectamente competitivo” p. 51

Sol Tax atribuye la pobreza del pueblo a la falta de tecnología. Es muy posible que las condiciones de vida en los alrededores de Panajachel no hayan cambiado mucho en el tiempo transcurrido desde la investigación de Tax. Creo que este libro es de los más importantes en el área económica que se escribió sobre Guatemala en el siglo 20. De mucho interés para economistas, historiadores, y antropólogos.

Oct 6, 2015

What is language? / Qué es el lenguaje?

…is not a protocol legislated by an authority but rather a wiki that pools the contributions of millions of writers and speakers, who ceaselessly bend the language to their needs and who inexorably age, die, and get replaced by their children, who adapt the language in their turn. (p. 3) 
That is from the excellent book: The Sense of Style by Steven Pinker.

…no es un protocolo legislado por una autoridad sino un wiki que incorpora las contribuciones de millones de escritores y hablantes, quienes sin parar moldean el lenguaje a sus necesidades y quienes inexorablemente embejecen, mueren, y son sustituidos por sus hijos, quienes también adaptan el lenguaje. (p. 3)
 Del excelente libro: The Sense of Style por Steven Pinker.

Oct 3, 2015

Tyler's conversation with Dani Rodrik

This is the video of Tyler's conversation with Dani Rodrik:

A few points:

  1. Tyler's conversations are excellent.
  2. I was not convinced by the "fundamental" difference between agriculture and manufacturing as Rodrik put it.
  3. Even though Tyler pushed the issue of culture, Rodrik does not see it as an important explanation for economic development generally, and for adoption of manufacturing in particular. (Sachs is not persuaded about culture either, but Zingales is).
  4. About Vietnam: Rodrik: "I think you see the same about why is it that Vietnam has developed in the way that it has after it opened up its economy. I think if Vietnam was located in Latin America or Central America, I don’t think it would have been half the miracle that it was." Hard to make something with this statement. If Vietnam were in Central America it would not be Vietnam any more. In any case, does it imply that if Guatemala were in South East Asia, it would be an economic miracle given an opening of its economy? 
  5. What should change in graduate school education in economics? Both, Rodrik and Sachs shared deep concerns about the use of math for its own sake in the profession. Sachs recommended a new approach in the method of development economics, as I understood it, something akin to what anthropologists do. Rodrik indicated that spending a year in a developing country would help a lot to think abut a relevant research agenda. I agree with both . . . I would add more years to the economic development experience. The basic message is to get closer to real world problems. 

Hay tres puntos fundamentales, me parece, en esta entrevista que Tyler Cowen le hace a Dani Rodrik:
  1. La economia de países como Turquia no se han modernizado porque enfrentan dos limitantes principales, una de estructura y otra de agencia. Esto significa que existen condiciones iniciales (las interpreto como históricas, geográficas, etc). La otra es agencia, es decir el liderazgo que puede promover reformas exitosas y otras fallidas. 
  2. La educación económica, principalmente a nivel de postgrado debe redefinirse en el sentido que es deseable una aproximación del estudiante a problemas reales. La matematización de la economía per-se puede distraer el cometido principal del economista, que es resolver, o contribuir a resolver problemas sociales urgentes. 
  3. Rodrik parece poner mas peso a restricciones políticas y estructurales de la economía, y no tanto al factor cultura. 
La transcripción de la entrevista, en ingles, esta aquí.

Sep 30, 2015

Venezuela: Without Liberals, There Is No Liberalism

The Venezuelan economy evolved from a growth miracle (1920–1957) to a growth disaster (1960 to the present). This paper describes the institutional collapse behind this reversal of fortunes. To cast light on Venezuela’s U-turn we provide a brief historical account, and we discuss the role played by educational organizations, the media and culture, and political and entrepreneurial elites in the destruction of liberal institutions. We also describe the most prominent liberal reactions to the pervasive institutional decay endured by the country. Finally, a major lesson emerges from this case study: illiberal mindsets coupled with the absence of leadership bring dire consequences for the people’s standard of living.
That is the abstract of a new article by Hugo J. Faria and Leonor Filardo in the new number of Econ Journal Watch. 

There is also this article on classical liberalism in Guatemala. 

Sep 3, 2015

Legalizing cocaine: Uno de los elementos que puede conducir a reducir el conflicto en Colombia.

La guerra puede terminar con una victoria, pero los conflictos sociales, culturales y de clases acaban realmente cuando la gente está cansada. Y ojalá que Colombia esté en ese punto. Ahora, hay elementos de ese conflicto que no son de Colombia, que no son su culpa. Si la cocaína, por ejemplo, fuese legal, este conflicto no habría existido. El combustible de la guerra es el uso de la cocaína afuera. Y cuando se tiene ese ‘petróleo’, es muy difícil. Si las Farc tienen plata, si pueden comprar armas, si se pueden esconder en las montañas, es muy duro. Para mí, lo que se tiene que hacer es matar el negocio de la cocaína. Después, bueno, no puedo hablar por Colombia, pero me parece que una nueva generación tiene que llevar a cabo un cambio social para que todos los colombianos puedan tener esperanza en el futuro, que puede ser brillante.
Otras preguntas están en esta entrevista hecha al antropólogo y botánico.

Aug 29, 2015

Los altos costos de la corrupción

Los guatemaltecos conocen bien las consecuencias de la corrupción, ya que las viven día a día. No hace falta recordarlas. Lo nuevo es que en las últimas semanas se han dado manifestaciones históricamente trascendentales contra la corrupción. 

Podemos sin embargo listar algunas consecuencias de la corrupción que sobresalen de una muy breve evaluación de literatura económica sobre este tema: 
  • Gobiernos corruptos gastan menos en educación ya que destinan fondos a actividades donde es mas fácil extraer rentas. 
  • Un incremento en el nivel de corrupción baja el crecimiento de los ingresos de los mas pobres.
  • La corrupción reduce el crecimiento económico a través de una reducción en la inversión.
  • La corrupción aumenta la desigualdad económica.
  • La corrupción afecta el crecimiento económico al aumentar la inestabilidad política. 
  • La corrupción se alimenta del proteccionismo, y tiende a perpetuarlo. 
  • La corrupción aumenta los déficits fiscales, distorsiona incentivos, reduce la protección de derechos de propiedad, y reduce la legitimidad de la economía de mercado y la democracia. 
  • La corrupción reduce el nivel de confianza y capital social. 
  • Etc.

La corrupción se alimenta de si misma.