Learning the Wealth of Nations

This paper I had neglected, now it is time to remedy that.  The authors are Francisco J. Buera, Alexander Monge-Narajo, and Giorgio E. Primiceri, and it was published in Econometrica 2011:

We study the evolution of market-oriented policies over time and across countries. We consider a model in which own and neighbors’ past experiences influence policy choices through their effect on policymakers’ beliefs. We estimate the model using a large panel of countries and find that it fits a large fraction of the policy choices observed in the postwar data, including the slow adoption of liberal policies. Our model also predicts that there would be reversals to state intervention if nowadays the world was hit by a shock of the size of the Great Depression.

I don’t find that abstract so informative, this paper has a few main results:

1. Policymakers have priors about how good the market economy is, and they revise those views — and thus revise policy — as they observe their own growth results and those of their neighbors.  Success for market economies tends to breed greater reliance on markets.

2. A simple learning model predicts about 97% of the policy choices observed in the data.  Perhaps more importantly, the model accounts for more than 77% of the observed policy switches over a three-year time window.

3. Evolving beliefs — and not just the fixed demographic characteristics of countries — are critical for understanding policy decisions.

4. It was probably the growth collapse of the late 1970s for interventionist countries which led to a greater reliance on markets.

5. Adjustment toward better-performing policies is often quite slow.  In part this is because policymakers attribute the superior performance of other countries to heterogeneity rather than policy per se.

6. A global Great Depression would lead to a significant switch back to state interventionism.

7. If I understand the model correctly (and I am making a bit of a leap in interpretation here), it implies a Chinese growth slowdown will lead to greater state intervention in China, not greater liberalization.

The pointer to this paper is from Luis Garicano.

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