Category: Economics
The puzzle of Pakistan’s poverty?
Until 2009, India was poorer than Pakistan on a per capita basis. India truly became richer than Pakistan after 2009 and since then it hasn’t looked back. If trends continue for a decade, India will be more than twice as rich as Pakistan soon…
So why has India pulled ahead in GDP per capita? The reason is simple. Pakistan’s high fertility has driven population growth faster than India’s. In 1952 Pakistan had about one-tenth of India’s population; by 2025 it had grown to nearly one-seventh.
In other words, many of the added Pakistanis have not started working yet, but they are on the books to lower the per capita esstimate. There is much in this Rohit Shinde essay I disagree with, but it is a useful corrective to those who simply wish to sing “policy, policy, policy.” Putting aside its per capita lag, Pakistan has done a better job keeping up with India than you might think at first.
In any case, I am not predicting that trend will continue in the future, I do not think so. So someday this essay might look especially “off,” nonetheless it is worth a moment of ponder.
O-Ring Automation
We study automation when tasks are quality complements rather than separable. Production requires numerous tasks whose qualities multiply as in an O-ring technology. A worker allocates a fixed endowment of time across the tasks performed; machines can replace tasks with given quality, and time is allocated across the remaining manual tasks. This “focus” mechanism generates three results. First, task-by-task substitution logic is incomplete because automating one task changes the return to automating others. Second, automation decisions are discrete and can require bundled adoption even when automation quality improves smoothly. Third, labour income can rise under partial automation because automation scales the value of remaining bottleneck tasks. These results imply that widely-used exposure indices, which aggregate task-level automation risk using linear formulas, will overstate displacement when tasks are complements. The relevant object is not average task exposure but the structure of bottlenecks and how automation reshapes worker time around them.
That is from a new paper by Joshua S. Gans and Avi Goldfarb. Once again people, the share of labor is unlikely to collapse…
The wisdom of Garett Jones
Two cases for capital share going to zero in a strong AGI world: 1. Capital and labor are more like perfect complements than perfect substitutes, always will be as long as the economy is for humans, and so astronomical increases in capital shrink the capital share to zero.
Why capital share goes to zero in a strong AGI world: 2. Capital & labor are more like perfect substitutes than complements because AGI de facto replicates free humans. Astronomical increases in capital make capital so abundant it’s unpriced like air, so capital share is zero.
The link has a bit more. Of course this is a thought experiment and a reductio, not a prediction. (It seems people in the rationalist community systematically misunderstand how economists communicate? Maybe that is partly the fault of the economists, but they should not so dogmatically believe that the economists are wrong.) And here are very good comments from Basil Halperin.
The bottom line is that it is premature, to say the least, to expect that the share of labor falls to zero or near-zero.
Why Some US Indian Reservations Prosper While Others Struggle
Our colleague Thomas Stratmann writes about the political economy of Indian reservations in his excellent Substack Rules and Results.
Across 123 tribal nations in the lower 48 states, median household income for Native American residents ranges from roughly $20,000 to over $130,000—a sixfold difference. Some reservations have household incomes comparable to middle-class America. Others face persistent poverty.
Why?
The common assumption: casino revenue. The data show otherwise. Gaming, natural resources, and location explain some variation. But they don’t explain most of it. What does? Institutional quality.
The Reservation Economic Freedom Index 2.0 measures how property rights, regulatory clarity, governance, and economic freedom vary across tribal nations. The correlation with prosperity is clear, consistent, and statistically significant. A 1-point improvement in REFI—on a 0-to-13 scale—correlates with approximately $1,800 higher median household income. A 10-point improvement? Nearly $18,000 more per household.
Many low-REFI features aren’t tribal choices—they’re federal impositions. Trust status prevents land from being used as collateral. Overlapping federal-state-tribal jurisdiction creates regulatory uncertainty. BIA approval requirements add months or years to routine transactions. Complex jurisdictional frameworks can deter investment when the rules governing business activity, dispute resolution, and enforcement remain unclear.
This is an important research program. In addition to potentially improving the lives of native Americans, the 123 tribal nations are a new and interesting dataset to study institutions.
See the post for more details amd discussion of causality. A longer paper is here.
AEA: Honoring Milton Friedman
Looks like a good AEA session on Sunday in Philly:
“Honoring Milton Friedman on his 50th Anniversary of Winning the Nobel Prize”
Mark Skousen: “My Friendly Fights with Milton Friedman”
Jeremy Siegel: “Milton Friedman’s contributions to financial markets and the influence of money on the business cycle.”
James K. Galbraith: “Milton Friedman’s Critique of Keynesian Economics and Fiscal Policy: A Response”
Michael Bordo: “The Future of Monetarism After Friedman: What Works, What Doesn’t.”
Judy Shelton: “Milton Friedman and Robert Mundell: Who Won the Nobel Money Duel?”
To be held Sunday Jan. 4, 8-10 am ET at the Philadelphia Marriott Hotel, Grand Ballroom Salon B.
Economic inequality does not equate to poor well-being or mental health
A meta-analysis of 168 studies covering more than 11 million people found no reliable link between economic inequality and well-being or mental health. In other words, living in a place that has large gaps between the rich and poor does not affect these outcomes, with implications for policy.
Here is the Nature link, this claim has been bad science all along.
One bad trend from 2025, diminution of the dollar’s safe haven status
It used to be that if you were worried about the future, you would move into dollars as the safe haven—in finance terms a countercyclical asset, which stays resilient when higher-risk assets fall. But if the United States’ own government and policies are unpredictable, and its economy is volatile, you will look for some other hedges instead. Chaos in the U.S., and particularly in the White House, is pushing investors to find alternatives to the dollar.
And so investment funds have been pouring into the precious metals, boosting their prices. While the current high price of silver reflects many factors, some of them technical and quite specific, the shift in risk attitudes has become pronounced over the last year.
The bottom line is that America is less of a safe haven than it used to be. When President Donald Trump announced his heavy tariff plan on “Liberation Day,” the dollar fell. That’s contrary to ordinary economic theory, which suggests that as Americans send fewer dollars abroad to buy imported goods, the dollar should rise. Traders, though, started to view the United States itself as a source of risk. It felt as if the right thing to do was to run away from the dollar. As a result, the dollar is down nearly 10 percent this year.
Here is more from me at The Free Press.
Taxation in a strong AI world
Here is Dwarkesh’s tweet, based on his recent paper with Trammell, raising the issue of whether wealth taxes will become desirable in the future. A few points:
1. I think quality homes in good locations will be extremely valuable. Those could be taxed more. You could call that a wealth tax, but arguably it is closer to a “housing services tax.”
2. You could put higher consumption taxes on items the wealthy purchase to a disproportionate degree. Paintings and yachts, and so on. Tom Holden argues: “In a world in which capital is essentially the only input to production, taxing capital reduces the growth rate of the economy. Whereas at present capital taxes have only level effects. So if anything, capital taxes will become less desirable as the labour share falls.”
3. I think the amount of money spent on health care will go up a lot. And people will live much longer, which will further boost the amount spent on health care. Taxing health care more is the natural way to address fiscal problems. Some people will fly abroad for their knee surgeries, but for a long time most health care will be consumed nearby, even in a strong AI world. If the way we keep the budget sane is to have people die at 95 instead of 97, there may be some positive social externalities from the shorter life spans. We also could use some of that money for birth subsidies.
4. As a more general point, capital will not be a perfect substitute for labor, or anything close to that, anytime soon.
5. Final incidence of the AI revolution is not just about the degree of substability of capital for labor. It is also about supply and demand elasticities in goods and services markets. For instance, to the extent AI makes various services much cheaper, real wages are rising not falling. That may or may not be the dominant effect, but do not assume too quickly that wages simply fall.
5b. It is not an equilibrium for capital to simply “have all the goodies.” Let’s say that Simon Legree, using advanced AI, can produce all the world’s output using a single watt of energy. And no one else with an AI company can produce anything to compete with that (this already sounds implausible, right?). If Simon simply hoards all that output, he has no profit, though I guess he can cure his own case of the common cold. The prices for that output have to fall so it can be purchased by someone else. The nature of the final equilibrium here is unclear, but again do not assume all or even most of the returns will stay with capital. That is almost certainly not the case.
Addendum: Here is some follow-up from Dwarkesh. I think he is talking about a world very different from our own, as there is talk of ownership of galaxies. That said, many other people wish to implement his ideas sooner than that.
Building more will boost labor’s share
This paper argues that the decline in the labor share is not driven by the overall quantity of capital, but by its changing composition. Constructing annual macro data for 16 advanced countries over two centuries, we show that, since 1980, the relative decline in buildings capital and the associated increase in real prices of buildings have reduced the labor share because buildings and labor are complements. The decline in the labor share has been reinforced by the increase in machinery capital and the associated decline of real prices of machinery capital because machinery capital and labor are substitutes. Together, these shifts in capital composition account for a substantial portion of the observed decline in the labor share of income.
Here is the full article by Jacob Kerspien, Jakob Madsen, and Holger Strulik, via tekl.
Existential Risk and Growth
By Philip Trammell and Leopold Aschenbrenner, a new paper:
Technological development raises consumption but may pose existential risk. A growing literature studies this tradeoff in static settings where stagnation is perfectly safe. But if any risky technology already exists, technological development can also lower risk indirectly in two ways: by speeding (1) technological solutions and/or (2) a “Kuznets curve” in which wealth increases a planner’s willingness to
pay for safety. The risk-minimizing technology growth rate, in light of these dynamics, is typically positive and may easily be high. Below this rate, technological development poses no tradeoff between consumption and cumulative risk.
Self-recommending…
“What we got wrong this year”
This is from The Free Press, and the instructions were to fess up to a mistake made in a piece for The Free Press (not elsewhere). Here is mine:
On October 26 I wrote about President Trump’s $20 billion support package for Argentinian president Javier Milei. At the time I, along with many other economists, thought the bailout was a costly mistake, but so far the decision has been vindicated.
The backstory is that Milei was trying to peg the Argentinian peso artificially high. Such policies usually do not work, even with strong backing from the International Monetary Fund, or in this case the U.S. It felt like the U.S. would lose a lot of money supporting a doomed economic policy. After all, Milton Friedman taught us long ago that floating exchange rates, set by market forces, usually are best.
But Milei stuck to his guns with the peg, an unusual move for a libertarian-oriented reformer, and Trump decided to back him. What happened in the “market test of strength” is that Milei and Trump won. The peg held, and the U.S. government seems not to have suffered any losses from this policy. By December, Argentina announced that it would be softening its currency peg and moving closer to a floating-rate system, as most economists recommend.
Why were the economists—including me—wrong? Maybe we were right ex ante, and Milei and Trump got lucky ex post. An alternative view is that the political symbolism of holding the peg was more important than the economics of the decision, and Milei had insight the economists did not.
When you are not sure why you were wrong, or how wrong you were, that is all the more reason to stay humble.
There are many other answers at the link.
Conor Sen claims
Resale housing inventory has climbed toward or above pre-pandemic levels in most of the South and West. Even in the supply-constrained Northeast and Midwest, there are signs of inventory growth. By 2027 — the year in which the oldest members of Gen Z start turning 30 — the US will probably have more existing homes for sale than it’s had in a decade.
This normalization is putting gradual but persistent pressure on prices. At a metro level, price growth is either decelerating or prices are outright falling just about everywhere. A surge in delistings heading into year-end indicates that market dynamics are weaker than advertised home prices suggest. The S&P Cotality Case-Shiller US National Home Price Index rose just 1.3% in September from a year ago, well below the 3.7% growth in the average hourly earnings of American workers.
Here is more from Bloomberg. Conor has further analysis and suggests the 2030s will be quite a good house-buying time for Generation Z.
Top Posts of 2025
Here are the top MR posts of 2025 as measured by page views. Number one post goes to Tyler:
An excellent post that pairs well with another Tyler post, also in the top ten, A median voter theory of right-wing populism which has the punchline:
The right-wing populists are gaining ground in so many countries because the cultural liberals in various parliaments and congresses are extremely reluctant to meet the preferences of their median voters.
Number two was also a Tyler post. Why I think AI take-off is relatively slow, an excellent accounting of AI economic and institutional bottlenecks. This pairs well with another top-ten post in which Tyler announces that AGI is already here. Both posts are correct. An interesting conundrum.
Third and fourth are two of my posts:
3. UCSD Faculty Sound Alarm on Declining Student Skills
4. One-Third of US Families Earn Over $150,000
Next is Tyler’s rundown of non-fiction books. Well worth re-reading.
5. Best non-fiction books of 2025 with one late addition.
Next I was pleased to see my post in which I explain some standard economics but in a deeper, more fundamental way than is usually done: One of my favorite posts of the year:
Why Do Domestic Prices Rise With Tariffs?
Zephyr Teachout’s op-ed wasn’t fun to read but I admit I did have some fun writing a response
Here’s another issue which makes me mad. The destruction of boarding houses, a perfectly reasonable housing form that reduces homelessness. Or to put it more simply, why is sharing a house illegal? Outrageous.
The War on Roommates: Why Is Sharing a House Illegal?
I am all for American greatness but the approach of the Trump administration is often backwards. I pointed out the big differences between the Sputnik moment and what I called the DeepSeek Moment in two posts.
The Sputnik vs. DeepSeek Moment: Why the Difference? and The Sputnik vs. Deep Seek Moment: The Answers.
I was pleased that David Brooks picked up on my framing in the NYTimes.
Finally my post The Library Burned Slowly sparked a brief spat with Chris Rufo. Rufo’s ability to turn the tools of the left on them is impressive but I haven’t changed my mind that “Bludgeoning your enemies is fun while it lasts but you can’t bludgeon your way to a civilization.”
What were your favorite posts of the year, either at MR or elsewhere?
J. M. W. Turner, financial arbitrageur
Abstract. J. M. W. Turner is famous for his achievements in graphic arts. What is not known is that he engaged in some pioneering market arbitrage, a profitable and risk-free swapping of British government securities. His activities lead to interesting insights into British markets of the 19th century. Financial innovation frequently created profitable arbitrage opportunities. However, among regular investors it seems that it was mostly mavericks like Turner who took advantage of them. Apparently there were strong cultural factors that inhibited most people from imitating him, which allowed obvious pricing anomalies to persist for extended periods.
That is from a recent paper by Andrew Odlyzko. Via Colin.
The Inflation Attention Threshold
From Oliver Pfäuti:
The recent inflation surge brought inflation back on people’s minds. I quantify when and how much attention to inflation changes and derive the macroeconomic implications of these attention changes. I estimate an attention threshold at an inflation rate of 4%, that attention doubles when inflation exceeds this threshold, and that supply shocks have stronger and more persistent effects on inflation in times of high attention. Developing a model featuring the attention threshold, I show that the observed attention changes offer a joint explanation for the recent inflation surge, its interplay with inflation expectations, and the long last mile of disinflation.
Here is the paper.