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Michael Strong's avatar

The role of institutions is largely invisible to models. One can interpret "institutions" as "technology" in Solowian growth, but insofar as access to better institutions is in part an ideological decision rather than a capital investment in innovation, then "better technology" is not merely a matter of investment. Advocates of prosperity must push back against anti-capitalist ideologies and advocate explicitly for property rights, rule of law, and economic freedom. Insofar as the Chinese SEZs were modeled on Hong Kong and Singapore, their models had been available for replication much earlier, but it took a decision by Chinese leaders to pilot the SEZs. Lee Kuan Yew to the rescue!

Of course, the SEZs then led to China's massive growth. What model would or could have predicted that growth (unless institutional changes such as SEZs were assumed in the models as exogenous factors, distinct from the mechanics of the model)?

Similarly, insofar as experiments with new jurisdictions and zones is an active field globally, growth models will be blind to the potential impact of such new jurisdictions.

Insofar moving from global poverty to prosperity necessarily involves institutional innovation, and insofar as mathematical models completely miss institutional innovation (at least at present, and please point me to any models that do incorporate institutional innovation), then mainstream economics based on mathematical modeling is missing the most important moral and practical issue pertaining to economics that matters for humanity.

Romer, of course, deserves considerably credit for advocating for charter cities. He basically saw this. It is a pity that his example has not been more widely followed among economists. Here is a piece he wrote which is much better than his well-known TED talk,

https://www.cgdev.org/publication/technologies-rules-and-progress-case-charter-cities

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Doctor Hammer's avatar

"Using math can help you avoid making claims that are internally inconsistent. For example, you cannot claim that a perfectly competitive firm in long-run equilibrium is producing at a point where marginal cost is greater than the minimum of average cost. For a perfectly competitive firm, price equals marginal cost, and in the long run price equals average cost. A little calculus shows that marginal cost only equals average cost at the minimum of average cost."

I feel like you missed an opportunity here to point out how internal consistency is almost entirely besides the point, at best necessary for a good model, but nowhere near sufficient. One could start with how "a perfectly competitive firm" is something that does not exist, nor can exist, in the real world, and is in fact a construct to make the math easy. One could then step into how demonstrating that the model is correct, actually checking to see if all these firms that can't exist are charging the same price that also equals their lowest average cost, is also impossible as defining cost in the real world is terribly difficult. (Ask an accountant about activity based costing sometime.)

So we have a mathematical model about the behavior of firms that can't exist and how they price goods that we can't test. Yes, the model is internally consistent, but only because we have defined

'perfectly competitive firms' such that they behave the way the model suggests they should. In other words, the model is a mathematical tautology, telling us 2 +2 = 4 because 4 = 2 + 2.

What have we gained? A false sense of insight, and a false sense that we should be able to look at the world and say "aha! These firms are acting contrary to the model! We should do something!"

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