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Entrepreneurs and the informal economy

Here is a very interesting new paper on the informal economy by Andrei Shleifer and Rafeal la Porta. It is great to see two prominent economists write on the subject. The abstract gives an overview of the first half of the paper:

We establish five facts about the informal economy in developing countries. First, it is huge, reaching about half of the total in the poorest countries. Second, it has extremely low productivity compared to the formal economy: informal firms are typically small, inefficient,  and run by poorly educated entrepreneurs. Third, although avoidance of taxes and regulations is an important reason for informality, the productivity of informal firms is too low for them to thrive in the formal sector. Lowering registration costs neither brings many informal firms into the formal sector, nor unleashes economic growth. Fourth, the informal economy is largely disconnected from the formal economy. Informal firms rarely transition to formality, and continue their existence, often for years or even decades, without much growth or improvement. Fifth, as countries grow and develop, the informal economy eventually shrinks, and the formal economy comes to dominate economic life.

I found the second half more interesting. They critique Hernando de Soto, who argues informal economies are an untapped reservoir of potential constrained by regulations. Because of the need for business permits and government recognition of property they are unable to enter the formal economy. Shleifer and la Porta find that most informal businesses are constrained by finance, not regulation, and fail to enter the formal economy. This suggests the problem is not regulation. Instead, they conclude:

The evidence suggests that an important bottleneck to economic growth is not the supply of  better educated workers; indeed, at least on many observable characteristics the workers are rather  similar in informal and formal firms. Rather, the bottleneck is the supply of educated entrepreneurs –  people who can run productive businesses. These entrepreneurs create and expand modern businesses  with which informal firms, despite all their benefits of avoiding taxes and regulations, simply cannot compete.

This is largely consistent with my experience during the last week in Honduras. I was interviewing with a firm run by an Italian. In his words, the firm imports business models from middle income countries, Mexico and Argentina, to low income countries, Honduras, Guatemala, and Nicaragua. His success, without substantial changes in economic freedom, suggests the problem is not institutional, but entrepreneurial. I very much look forward to more research along these lines.

On child labor

I have been in Honduras since Monday and am spending the next week in El Salvador. One thing I notice when traveling in the third world is child labor. There are always children, some as young as 7 years old, trying to sell you something, usually gum, other candy, or cigarettes. These kids are not in school and their futures are bleak. However, despite the obvious poverty of their situation one feels compelled to buy from them. Buying from them increases their income, making them better off. There is an implicit recognition that the alternative is not school, but hunger.

There are two reactions to child labor, one which comes from thinking about it, and the other which comes from seeing it. No one likes the idea of child labor to the extent that even considering it can get you ostracized from polite society. However, actually seeing child labor elicits a different reaction. The feeling is not to ban the child labor itself, but to help the kids in another way. The visualization of child labor forces one to understand the poverty of the choices they face.

The question is how to get people to understand opportunity cost as an abstract concept. Common arguments that children are working because it is the best option available to them fall on deaf ears. Even pointing out the outcomes that follow from restricting child labor is not enough. Paul Krugman notes that when Bangladesh banned child labor many kids turned to prostitution or starved. Even this is sometimes not enough. People have ideological predilections so strong they ignore problems of scarcity, ignoring the fact that the literal alternative to child labor is occasionally starvation.

When we think about child labor sometimes it is better to forget the statistics. Remember the kid trying to sell you gum. Would you take away his livelihood? How would he live? How would he eat?

Kill enough people and become a governor

I found a new favorite blog. It is dedicated to popularizing North, Wallis, and Weingast’s (hereafter NWW) framework of violence and social orders. The argument is that the natural type of government is vicious and predatory. It is what we see in the third world today. Modern liberal governments only really emerged in the 18th century and are still largely restricted to Europe.

A main contribution of NWW is changing the frame of reference for government action. Good governance is not the norm, but the exception. In much of the world, local tyrants are rewarded with power, rather than punished. This post details David Yau Yau, who, having lost an election, decided the best way to keep his rents was to start low-scale warfare:

On again off again since 2010, he’s led one of the most vicious, mindlessly murderous little tribal guerrilla wars you’ve never heard of for control of his home region in Jonglei State’s Pibor County, just near Ethiopia.

For his troubles, he was appointed governor of the area he terrorized. While this offends basic notions of justice, it is probably better than the alternative. Theft by governments is far less socially damaging than raiding villages and murdering their inhabitants.

Leaks and the rule of law

Conor Friedersdorf has a new piece critiquing the liberal moderate critics of Greenwald and Snowden, most recently George Packer in the Prospect. Below is an excerpt, but I recommend you read the whole thing, it is excellent:

Stepping back, notice that in the same passage, Packer contrasts the wrongs of Greenwald with the Obama Administration – the people who’ve persecuted whistleblowers, presided over domestic spying on Muslims and launched drone strikes that kill Americans without due process – yet it is Greenwald who, according to Packer, doesn’t understand that “the rule of law has to protect people regardless of politics.”

I think Friedersdorf doesn’t go far enough in his critique of how writers equivocate regarding Greenwald versus the NSA’s respect for the the rule of law. A simple interpretation of the rule of law is that the laws that apply to people also apply to government officials. The important part of the equation is government officials. No one doubts laws apply to the average citizen, it is how they constrain government officials that matters. Arguing that the actions of private individuals violates the rule of law fundamentally misconstrues the rule of law itself, as a constraint on government action.

We live in ‘Brazil,’ not 1984

It has become cliché to make comparisons of the modern world to Orwell’s 1984. Government collection of metadata means we are always being watched. Homeland Security illustrates the penetration of doublespeak in our lives. That we are engaged in a never-ending war against terrorism is analogous to having “always been at war with Eastasia.”

However, despite many important parallels, I find the primary theme of 1984 to be an inaccurate portrayal of modern life.  1984 imagines the evil of unified power. It is personified through Big Brother. The primary theme, “If you want a picture of the future, imagine a boot stamping on a human face — forever,” is simply not apt.

Most people do not feel the boot on their face. Obama, despite the fact he occasionally drones children, is not Big Brother. Homeland Security is not the Ministry of Love, it is the DMV with police powers. Rather than the horrors of totalitarian dictatorship, we have the horrors of rampant, dysfunctional bureaucracy.

“Brazil,” directed by Terry Gilliam and loved by those who have seen it, captures these themes expertly. It follows Sam Lowry, a low-level bureaucrat with fantasies about saving a woman from his dreams.

A clerical error leads to the imprisonment, looking very much like a modern SWAT raid, of a Mr. Archibald Buttle, instead of terrorist Archibald Tuttle. This is reminiscent of putting Rahinah Ibrahim on the no-fly list because of a clerical error. It took 8 years for the government to admit its error.

Later, Archibald Tuttle, an air conditioning repairman gone rogue because of his dislike of paperwork, helps Sam fix his air conditioning. I can’t help but think of licensing laws and how they keep people impoverished.

Overall, the picture is painted is not one of evil, but incompetence. The bureaucracy is impossible to navigate, but no one is responsible. It is the result of human action but not human design. Our world today is the same.

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Was Mises a fascist?

Anyone who has bothered to read Ludwig von Mises immediately knows that the answer is no. However, because of a few out of context quotations from his book, Liberalism, every few years he is attacked as one. The most recent offender is Michael Lind, making such ridiculous arguments I wonder if Poe’s law applies to Salon.

He quotes Mises:

It cannot be denied that Fascism and similar movements aimed at the establishment of dictatorships are full of the best intentions and that their intervention has for the moment saved European civilization. The merit that Fascism has thereby won for itself will live on eternally in history.

Now this quotation looks bad. Mises literally writes that fascism has saved European civilization. However, it is important to consider the context within which Mises was writing. The Soviet Union was about a decade old and had already starved 3-10 million people under war communism. The output of heavy industry had fallen to 20 percent of 1913. Communist parties were all over Europe and close to power.

Mises, out of all people, stood to be most horrified by this. He wrote the most penetrating critique of communism, warning of the impossibility of rationally allocating resources without prices. Prices were only meaningful with private property and market transactions. Fascism, on the other hand, was a new phenomenon. Hitler hadn’t taken power in Europe. Fascists had not started any wars. They had not yet committed genocide.

Hindsight is 20-20. Perhaps it is too much to expect Mises to be knowledgeable about the future evils of fascism — wait, no it isn’t. Mises was a genius. Let’s quote the entire passage rather than the two sentences Michael Lind does.

So much for the domestic policy of Fascism. That its foreign policy, based as it is on the avowed principle of force in international relations, cannot fail to give rise to an endless series of wars that must destroy all of modern civilization requires no further discussion. To maintain and further raise our present level of economic development, peace among nations must be assured. But they cannot live together in peace if the basic tenet of the ideology by which they are governed is the belief that one’s own nation can secure its place in the community of nations by force alone.

It cannot be denied that Fascism and similar movements aiming at the establishment of dictatorships are full of the best intentions and that their intervention has, for the moment, saved European civilization. The merit that Fascism has thereby won for itself will live on eternally in history. But though its policy has brought salvation for the moment, it is not of the kind which could promise continued success. Fascism was an emergency makeshift. To view it as something more would be a fatal error.

So, not only does Mises dislike fascism in 1927, he also fully realizes the threat to European peace that it is. He takes the likelihood of what fascism will lead to as so obvious it “requires no further discussion.” Viewing fascism as anything more than an “emergency makeshift” would be a “fatal error.”

Reading the full passage it is clear that Mises had a nuanced and amazingly prescient understanding of fascism. Forced to choose between two of the greatest evils of the 20th century, he chose the fascists, fully recognizing where they would lead if they retained power and warning against it.

Now, unlike Michael Lind I try to be reasonable. I read passages in full, and do not selectively quote to obscure meaning. That being said, based on my reading of Liberalism I am forced to conclude Mises was a time traveler. It is the only possible explanation of such brilliance.

As a bonus, if you’re interested in what Mises wrote about the domestic policy of fascism:

Many people approve of the methods of Fascism, even though its economic program is altogether antiliberal and its policy completely interventionist, because it is far from practicing the senseless and unrestrained destructionism that has stamped the Communists as the archenemies of civilization. Still others, in full knowledge of the evil that Fascist economic policy brings with it, view Fascism, in comparison with Bolshevism and Sovietism, as at least the lesser evil.