8. The Physiocrats (18th Century)

The “économistes” or the Physiocrats

In the 18th century, the first real school of economic thought emerged in France. This school is now referred to as the Physiocratic school of thought, but the actual physiocrats called themselves Les économistes – the economists.

Physiocratic thought was largely indebted to the thoughts of one man, Francois Quesnay (1694-1774), who was actually a physician rather than an economist by trade. In 1758, Quesnay published his Tableau Economique, which modeled the entire economy in 26 maxims on a single sheet of paper. This was, in fact, one of the earliest instances of economic modeling.

In the Tableau Economique, Quesnay attributes the source of wealth in France to the agriculture sector. This contrasted sharply with mercantile thought. For Quesnay, the agriculture sector was the heart of the economy and its outputs spread to the rest of the country giving life to the non-agriculture sectors like blood. Quesnay was adamant that merchants were not the productive class of the nation. In fact, he called them the sterile class; farmers made up the ‘productive’ class.

In general, the physiocrats strongly opposed government regulations in the market. To return the blood analogy, the economy functioned best when the ‘blood’ or net products of agriculture were allowed to flow freely throughout the domestic economy.

Physiocratic thought gained a lot of traction over two short decades, but by the 1780’s Quesnay’s ideas had gone out of vogue. In the posts on Quesnay and his followers, I will try to understand why Physiocratic thought initially became so popular and why it’s popularity was so short lived. In future posts, we will also see how some of Quesnay’s ideas lived on through the work of Adam Smith.

7. Economics and Early Liberalism (17th Century)

Liberal Ideas in  17th Century and their effects on Economics…

Coupled with the early wave of quantitative analysis in economics, the 17th century witnessed the spread of liberal ideas and ideologies. As we saw in the mercantilist literature, businessmen, politicians, and academics had all become attuned to the fact that in economics and politics, private interests are not always aligned with the interests of the state. It is not surprising; therefore, that the rights and freedom of the individual were taken up as serious and important matters of debate.

                

(above left to right: John Lock, Sir Josiah Child, Sir Dudley North)

Prior to the work of 18th century economist, Adam Smith, men like Josiah Child, John Locke, and Dudley North advocated the idea that the protection of each man’s liberty and property was beneficial for the overall economy. “It would be for the advantage of the trade of England to leave all men at liberty to make what cloth and stuff they please,” writes Child (A New Discourse on Trade, 139). Locke adamantly opposed regulating interest rates, and was, perhaps, the strongest proponent of individual property rights. Dudley North wrote one of the earliest tracts describing the mechanism and importance of laissez faire. In the posts covering the lives and ideas of these liberal thinkers, we will see in more detail how ideas of freedom became linked to the ideas of a free economy.

AER Top 20: Friedrich Hayek

The Use of Knowledge in Society (1945)

A copy of the paper can be found here. Length: 11 page

 

What is the problem we wish to solve when we try to construct a rational economic order?

 

 

Summary & Relevance:

Of all of the papers on the AER’s Top 20 list, this paper tackles the most general problem. It questions whether or not the aims and purpose of economics have been misunderstood by economists.

“What is the problem we wish to solve when we try to construct a rational economic order?” Hayek asks. Certainly, if we lay out our models and assume we have all of the relevant information, then solving an economic problem boils down to working through the logic of some mathematical equations. This is certainly a useful exercise, Hayek argues, but inevitably, not the economic problem that societies face.

According to Hayek, there are two important types of knowledge in the world: expert knowledge and knowledge of circumstance. Expert knowledge is cultivated by experts and knowledge of circumstance exists in the minds of individuals in the economy. Economists, as academic experts, are in the business of collecting and building expert (or scientific) knowledge. They look at statistical aggregates and try to develop theories based off of these data. Individuals, on the other hand, have a monopoly on the specific information regarding individual circumstances and choice. They possess details that the expert can’t know, details that are specific to individual constraints, individual preferences, and the circumstances of some moment in time. The real problem that economics needs to address then “is not merely a problem of how to allocate ‘given’ resources – if ‘given is taken to mean given to a single mind which deliberately solves the problem set by these ‘data.’ It is rather a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know” (519-520).

Hayek believed economics was going astray, because it had overemphasized the importance of expert knowledge and forgotten all about the knowledge of circumstance. He hypothesizes that this might due to the discipline’s “growing preoccupation with statistical aggregates” (523). Experts are growing more and more interested in aggregating data with the goal of authoritatively ‘planning’  the economy, when really, economics ought to encourage the dissemination of information to individuals, so that they can collectively move the economy forward. This dissemination, Hayek argued, occurs through the price system. So long as prices are not manipulated, they will convey just enough information to individuals about events and situations occurring throughout the economy to make informed decisions.

Friedrich Hayek (1899-1992)  was an Austrian (later British) economist. He is popularly known for his book The Road to Serfdom and for his defense of liberalism. Hayek earned doctorate degrees from the University of Vienna in law and political science in the 1920s. His early influences were Carl Menger, Ludwig von Mises, and Fritz Machlup among others. In 1931, he joined the faculty at the London School of Economics where he began researching the price system alongside John Hicks and Abba Lerner. In the late forties, he founded the Mont Pelerin Society, an incredibly influential group of economists and public intellectuals that came together to advocate new liberalism. Starting in the 1950s, Hayek spent twelve years teaching at the University of Chicago after which he held a number of professorships at places like the University of Freibirg and UCLA. In 1974, Hayek was awarded the Nobel Prize in Economics.

Francis Bacon

Francis Bacon 1561-1626

What is there to say about the father of empiricism and economics? Well, quite a bit.

A few weeks back, I wrote briefly about the influence of Aristotle and the concept of Natural Law, which passed down to thinkers in the early modern era through the works of Thomas Aquinas and the medieval scholastics. Bacon represents the next chapter in this same narrative.

For the advocates of science in the 16th and 17th century, Aristotle – who reigned in the late medieval period as the philosopher – became associated with old-fashioned thinking and outdated methodology. Bacon was torn by Aristotle. He was at once drawn to Aristotle’s great works, but was also one of his fiercest critics. In 1620, Bacon published the New Organon, which was meant to replace Aristotle’s famous volumes on Logic. The New Organon was initially intended as part of a much larger project called the Great Instauration (Instauratio Magna), and it was Bacon’s goal to completely overhaul learning by reforming the methods and aims of science through this grand text. The Great Instauration was never completed, but the Novum Organum greatly influenced Bacon’s followers and centuries of thinkers to follow. It became a classic guide to modern science all on its own.

The Novum Organum begins with a critique of all intellectual thought that has come prior to Bacon’s own work. Bacon argues that, up until his time, thinkers have been misinterpreting the world either by falsely and loosely asserting truths about nature or by prematurely stating that nothing can be known about the world. He claims that there is a better balance to be struck “between the arrogance of dogmatism, and the despair of skepticism” (preface, 5). He also criticizes rationalism, empiricism, and theology for leading intellectual endeavors astray: “There are… three sources of error and three species of false philosophy: the sophistic, empiric, and superstitious” (Book I, LXII, p.35).

As a solution to all of these problems, Bacon prescribes two rules and a general methodology for his ‘new organum.’ The first rule of science is to leave all of your preconceived notions about the world to the side. The second rule is not to rush to any general theories about the world. For Bacon, a proper scientific method consists of working diligently from objective observations of specific instances of phenomena and working gradually towards general axioms (Book I.XIX, p.15): “Although there is a most intimate connection, and almost an identity between the ways of human power and human knowledge, yet, on account of the pernicious and inveterate habit of dwelling upon abstractions, it is by far the safest method to commence and build up the sciences from those foundations which bear a relation to the practical division, and to let them mark out and limit the theoretical” (Book II.IV, p. 111).

For a scientist to be successful with the new method of science, she must also be well aware of the potential errors she might make. In Book I of the Organum, Bacon lays out his famous description of the idols of the mind. There are four idols (or common errors) that a scientist must avoid: idols of the tribe, idols of the cave, idols of the marketplace and idols of the theater. Idols of the tribe describe the tendency for humans to always look for reason and order in the universe. Bacon believes that humans are more likely to attribute false connections between phenomena than they are to embrace disorder. Idols of the cave (or den) describe ways in which humans are overly influenced by their environment and upbringing. While idols of the tribe affect all humans equally, idols of the den are unique to each person. Everybody is uniquely colored by their personality, their tastes, the books they have read, and the people they have met, but a proper scientist must ignore the effects of these influences and keep an open mind. Idols of the marketplace refers to errors that result from the imprecision of language. The only way people can communicate their ideas is through language, but every form of language (including math) is an abstraction and will result in some degree of imprecision. The goal here is to keep this imprecision to a minimum. Finally, idols of the theater – these are idols which have “crept into men’s minds from the various dogmas of peculiar systems of philosophy, and also from the perverted rules of demonstration” (Book I. XLIV). The idea here is to remain cognizant of the way prior and contemporary schools of thought have distorted your understanding of the world. It is interesting to think about Bacon’s idols of the mind in relation to modern economics. To what extent economics has been able to move past Bacon’s errors and to what extent the discipline is still afflicted by them is worth spending a moment to ponder.

Despite the fact that Bacon was cautious of rushing to generalizations; he was lured by the fact that all sciences were connected, and similarly, that the scientific/inductive method applied to all categories of science including the social sciences (Book I. CXXVII, p. 101). As we shall see, the idea of a universal science and the idea of the scientific method had a strong influence over men of the Scottish Enlightenment such as Hume and Smith.

Life

Bacon was born in London in January of 1561. He was the grandson of a well known humanist named Anthony Cooke, and he likely spent his early years being homeschooled due to poor health. When he was twelve years old, Bacon entered Trinity College. Three years later, he accompanied the English ambassador to Paris where he studied and from where he travelled around Europe on diplomatic assignments. In 1579, Bacon returned to London after the sudden death of his father and began residing in Gray’s Inn (one of the four ‘Inns of Court’ in London). Beginning in 1581, Bacon served as a Member of Parliament and continued to practice law and eventually became a master of the bench. He continued to make his way up the political ladder, and despite some conflicts during the reign Queen Elizabeth, he eventually became Lord Chancellor under James I. Despite his political successes, Bacon continuously struggled with his personal finances and spent much of his life in debt. He was thought to have been a pederast and married a fourteen year old girl when he was 45. His political career ended in 1621. He was charged with 23 counts of corruption, fell once again into debt, and was imprisoned for a few days in the Tower of London. Bacon was eventually forgiven by the king, but he was banned for the rest of his life from holding office.

Major Works

Essays I (1597)

The Advancement of Learning (1605)

Essays II (1612)

Novum Organum (1620)

AER Top 20: Robert Shiller

Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends? (1981)

A copy of the paper can be found here. Length: 15 page

We have seen that measures of stock price volatility over the past century appear to be far too high- five to thirteen times too high to be attributed to new information about future real dividends if uncertainty about future dividends is measured by the sample standard deviations of real dividends around their long-run exponential growth path (434)

Summary and Relevance: 

This paper questions aspects of the efficient market hypothesis and paved the road for behavioral analysis in financial economics.

According to the efficient market hypothesis, stock prices are perfectly informative and are determined by rational expectations about the future dividend streams of a given asset. According to this theory, every time a stock price moves up or down, the change reflects new information concerning the future dividends of the stock. In this paper, Shiller argues that stock prices are far too volatile to be based on this kind of rational expectations framework. “What accounts for movements in real stock prices,” he asks. “[A]nd can they be explained by new information about subsequent real dividends?” (424).

The paper consists of five sections. In the first section, Shiller mathematically describes the efficient markets framework. In sections 2-4, he considers how information is revealed to the market, whether the model should be based on earnings expectations rather than dividends, and thinks about the assumptions made about real interest rates. Finally in section V, Shiller compares the model to six decades worth of historical data on stock prices (taken from the S&P index and the Dow Jones). The paper concludes that stock prices are in fact too volatile to be explained by rational expectations. Shiller’s conclusions along with the stock market crash in the late eighties brought greater attention to the behavioral and psychological aspects of financial markets, and has shifted the consensus away from the assumption that asset prices are always rationally calculated and fully capture all of the available information in the market.

Rober Shiller (1946 – ) is an American economist and professor at Yale University. He is also a co-founder of the investment management firm MacroMarkets LLC. In 2013, Shiller was awarded the Nobel Prize in economics alongside two other financial economists. Shiller was born in Michigan and studied at Kalamazoo College and the University of Michigan. He received his Ph.D. in economics from MIT in 1972. In 2000, he put out a book called Irrational Exuberance.

AER Top 20: Paul Krugman

Scale Economies, Product Differentiation, and the Pattern of Trade (1980)

A copy of the paper can be found here. Length: 9 pages

For some time now there has been considerable skepticism about the ability of comparative cost theory to explain the actual pattern of international trade. Neither the extensive trade among the industrial countries, nor the prevalence in this trade of two-way exchanges of differentiated products, make much sense in terms of standard theory… a new framework for analyzing trade is needed (950)

Summary & Relevance:

Forget everything you know about comparative advantage and trade for a second. There’s a new way of thinking about international trade.

In this paper, Paul Krugman presents a new framework for considering some of the discrepancies between traditional trade theory and actual patterns in international trade. He creates a very basic model and with it hypothesizes why certain countries with similar factor endowments will still be compelled to trade with each other and why a strong domestic market for a good tends to make a country a net exporter of that good.

In section I of the paper, Krugman presents his model. Krugman uses terms like alpha, beta, and tilda to describe his model, but to keep things simple, I’m going to describe his models in terms of coffee and tea. The first thing to note about Krugman’s setup is the fact that he is using a Chamberlinian monopolistic competition framework. Edward Hasting Chamberlin (1899-1967) was an American Economist at Harvard who in 1933 laid out the theory of monopolistic competition in a book called The Theory of Monopolistic Competition. The Chamberlin setup used in Krugman’s paper is important because it describes markets for goods as consisting of a number of ‘differentiated’ products. Each producer has a monopoly on the good that they produce, but since each good is a close substitute for all other goods in the industry, each producer is a price taker.

Now, imagine you live in a country, town, or small village where the only industry is coffee. Every coffee producer produces their own unique type of coffee – some dark, some light, some smokier, varieties using exotic beans etc. There are a large number of coffee producers and hence a large variety of coffees in your country. Assume further (though these assumptions are quite strong) that labor is the only factor in the production of coffee, the cost function for all types of coffee are the same, there’s just enough coffee to meet consumer demand, there’s no unemployment, and each coffee producing firm tries to maximize profits (but since there is free entry and exit into the coffee industry equilibrium profits will be zero). These are the basic assumptions of Krugman’s model.

The next step is to consider consumer and producer behavior and the equilibrium number of firms in this coffee producing country. If we assume that the country is a closed economy and that consumers in the country derive all of their utility from consumption of the various types of coffee produced, we can find first order conditions and an aggregate demand equation (which Krugman does). From there, Krugman comes up with an equation for equilibrium output.

Now assume there is a second country. This country is identical to the first country and even has the same factor endowments. We’ll start out by assuming that these two coffee producing countries can trade with each other at no cost. In this set up, there seem to be no motivating factors for the two country to trade with each other… they’re identical; neither country has a comparative advantage over the other. Still, Krugman points out that there will still be incentives and benefits to the two countries from trade. This is because each coffee producer is assumed to have increasing returns to scale in their production and also because we assumed that each producer of coffee has a complete monopoly on their specific variety of coffee. The fact that each variety of coffee is only made by one producer implies that each variety of coffee is only produced in one country. The two countries will benefit from trade because consumers in each country will have a greater variety of coffees to consume as a result of trade.

In section II, Krugman considers what will happen to his model if he assumes that trade is costly. He describes this cost in a very particular way. If countries send their product abroad, some portion, g, of their product will get damaged or lost along the way; therefore, a company will only be able to sell 1-g percent of the product they export. Krugman finds that the only way this assumption affects the outcome of the model is that wages in the larger country will end up being higher than wages in the smaller country. Krugman provides some basic intuition for this result. Given that the countries are identical and given that there is a cost associated with trade, it will always make sense for producers to produce in the country with a larger base of consumers. The higher wage in the large country offsets this imbalance.

In section III, things start to get interesting. Now, Krugman considers what he calls ‘home market effects.’ Let’s get back to coffee and our initial single country, closed economy model. Let’s assume that this country now has two industries instead of one. The country produces coffee and tea and within each of these industries there are a large varieties of coffees and teas being produced. The consumers in the country are now also split in two. There are consumers in the market who derive all of their utility from drinking coffee and the rest of the country derives all of their utility from consuming tea. Equilibrium analysis of this scenario shows that demand in each industry will depend on the portion of coffee (or tea) drinkers in the country.

If we introduce trade into the coffee & tea (2-industry) version of the model, we find that the country with the bigger portion of coffee drinkers will be a net-exporter for coffee (and likewise for tea). In laying out this version of the model, Krugman assumes, once again, that the two trading partners are identical. The only thing that differs between the two countries is their portion of coffee and tea drinkers. The second country has the same portion of coffee drinkers as there are tea drinkers in the first country. So long as there isn’t a 50/50 split in each country between coffee drinkers and tea drinkers, Krugman’s result holds. The result is also affected by transportation costs. Although, the country with a larger domestic market for coffee will end up being a net-exporter of coffee, higher transportation costs will lower the degree of specialization towards a given industry in either country.

And that’s pretty much it. That’s Krugman’s paper – a basic and somewhat intuitive explanation for why similar countries might benefit from trading with one another, along with an explanation, for why a country with a relatively large domestic market for a given good might end up being a net-exporter of that good. Krugman admits that he is making some strong, stylistic assumptions in his models, but assures us that the model and its results can be generalized to a useful degree (for example, he argues, that even if the two countries aren’t assumed to be so similar the basic results of the model don’t change). It is precisely the combination of simplicity and ingenuity in this paper that has made it so popular and influential.

Paul Krugman (1953 – ) is an American economist who until recently taught at the School of Public and International Affairs at Princeton University. He has just recently joined the faculty at the City University’s Graduate Center in New York. Krugman is also a well-known public intellectual and writes a popular op-ed column for The New York Times. Krugman won the Nobel Prize in 2008. 

AER Top 20: Sanford Grossman and Joseph Stiglitz

On the Impossibility of Informationally Efficient Markets (1980)

A copy of the paper can be found here. Length: 15 pages

If competitive equilibrium is defined as a situation in which prices are such that all arbitrage profits are eliminated, is it possible that a competitive economy always be in equilibrium?…The assumptions that all markets, including that for information, are always in equilibrium and always perfectly arbitraged are inconsistent when arbitrage is costly (393)

Summary & Relevance:

This paper challenges the efficient market hypothesis by modeling situations where asset prices do not perfectly convey all of the information in the market. In these situations, there is what Stiglitz and Grossman describe as “an equilibrium degree of disequilibrium” (393).

The paper presents a model where individuals in the market can hold two types of assets: a safe asset and a risky asset. The risky asset has a return u=θ + Ɛ, where θ is a random observable variable which can be observed at cost ‘c,’ and Ɛ is random variable that is unobservable. Individuals in the market are all the same, but can choose to purchase information, θ. The portion of individuals who choose to purchase θ is represented by λ, and the price at any given λ, is a function of θ and the supply of the risky asset denoted by x.

The equilibrium for this framework is where the expected utility for the informed individuals is equal to the expected utility of the uninformed. As c, λ, θ, and Ɛ all change, the equilibrium clearly shifts. The paper puts forward a number of conjectures regarding these changes and demonstrates them by working through the model. The price of the asset is imperfectly informative, but becomes more informative as λ increases. The higher the cost of the information, the lower λ* will be; and the greater Ɛ is, the higher λ* will be.

The model in the paper makes a number of strong assumptions, but makes a strong enough case to demonstrate the tension that exists between market efficiency and the incentives for individuals in the market to acquire information, particularly when acquiring information is costly.

Sanford Grossman (1953 -)  is an American financial economist who has taught at Stanford, the University of Chicago, Princeton, and UPENN. He is also a hedge fund manager and has previously served on the Federal Reserve board and on the Chicago Board of Trade. In 1994, he was President of the American Finance Association.

Joseph Stiglitz (1943- ) was born in Gary, Indiana and is a heavily cited and influential economist. Stiglitz worked as a research assistant at the University of Chicago before attending MIT where he received his PhD in economics. He currently is a professor at Columbia University, but has taught at a number of different institutions including Yale, Oxford, and Stanford. He was the chair of the Council of Economic Advisors under President Clinton and also served as the chief economist at the World Bank.

AER Top 20: Angus Deaton and John Muellbauer

An Almost Ideal Demand System (1980)

A copy of the paper can be found here. Length: 14 pages

In this paper we have introduced a new system of demand equations, the AIDS, in which the budget shares of the
various commodities are linearly related to the logarithm of real total expenditure and the logarithms of relative prices. The model is shown to possess most of the properties usually thought desirable in conventional demand analysis, and to do so in a way not matched by any single competing system (322)

Summary:

In this paper, Deaton and Muellbauer present a useful consumer demand model, which they call the Almost Ideal Demand System (AIDS). The model consists of a system of demand equations and is used to analyze consumer behavior. The model is useful in that it provides arbitrary first-order approximations for any demand system. Other advantages of the model are described as follows: “it satisfies the axioms of choice exactly; it aggregates perfectly over consumers without invoking parallel linear Engel curves; it has a functional form which is consistent with known household-budget data; it is simple to estimate, largely avoid- ing the need for non-linear estimation; and it can be used to test the restrictions of homogeneity and symmetry through linear restrictions on fixed parameters. Although many of these desirable properties are possessed by one or other of the Rotterdam or translog models, neither possesses all of them simultaneously” (312). This paper consists of two parts. In part I, the authors describe the specifications of their model, and in part two, they estimate the model using postwar British data that includes information on consumer expenditure on basic goods such as food, housing, fuel, transportation, etc.

Angus Deaton (1945- ) is a Scottish and American economist currently teaching at Princeton University. Deaton received his bachelors, masters, and doctorate degree from Cambridge University. He is one of the leading microeconomists, and more recently, has produced scholarship in development and health economics. He was the president of the American Economics Association in 2009. 

John Muellbauer is a macroeconomist teaching at Oxford. He studied at Cambridge University and received his PhD in economics from UC Berkeley.  He currently studies the relationship between the financial sector with the rest of the economy, paying specific attention to the effects of financial liberalization on consumer debt. 

AER Top 20: Avinash Dixit and Joseph Stiglitz

Monopolistic Competition and Optimum Product Diversity (1977)

A copy of the paper can be found here. Length: 11 pages

Summary & Relevance: 

The Dixit-Stiglitz model of monopolistic competition is one of the foundational models in trade theory and imperfect competition. In this paper, Dixit and Stiglit actually present three models, but it is their CES (constant elasticity of substitution) utility model, which is heavily referenced and used today. You can find a beginner’s guide/description of their model here. The Dixit-Stiglitz model demonstrates how optimal product diversity can be derived in situations where there is monopolistic competition and increasing returns to scale for each good.

Avinash Dixit (1944 – ) is an Indian and American economist who is a professor at Princeton University. Dixit studied math and physic at Cambridge University and received his Ph.D in economics from MIT in 1968. He has been president of both the Econometric Society and the American Economic Association.

Joseph Stiglitz (1943- ) was born in Gary, Indiana and is heavily cited and influential economist. Stiglitz worked as a research assistant at the University of Chicago before attending MIT where he received his PhD in economics. He currently is a professor at Columbia University, but has taught at a number of different institutions including Yale, Oxford, and Stanford. He was the chair of the Council of Economic Advisors under President Clinton and also served as the chief economist at the World Bank. 

AER Top 20: Anne Krueger

The Political Economy of the Rent-Seeking Society (1974)

A copy of the paper can be found here. Length: 12 pages

In many market-oriented economies, government restrictions upon economic activity are pervasive facts of life. These restrictions give rise to rents of a variety of forms, and people often compete for the rents. Sometimes, such competition is perfectly legal. In other instances, rent seeking takes other forms, such as bribery, corruption, smuggling, and black markets. It is the purpose of this paper to show some of the ways in which rent seeking is competitive, and to develop a simple model of competitive rent seeking for the important case when rents originate from quantitative restrictions upon international trade (292)

Summary & Relevance:

Anne Krueger coined the term rent-seeking in this 1974 paper (the idea had initially been presented seven years earlier by Gordon Tullock in his paper The Welfare Costs of Tarrifs, Monopolies, and Theft). 

Rent-seeking occurs whenever there are restrictions placed on the free market. Wherever these restrictions occur, opportunities arise for some group of market participants to benefit from the restriction. These opportunities are referred to as rents and those who attempt to acquire them are ‘rent-seekers.’

In this paper, Krueger considers the effect of rent-seeking behavior when rent-seeking is competitive and results from quotas placed on imports. She finds empirical evidence that in some developing countries these types of rents can be substantial. In Turkey and India, she finds that there are high levels of competition for import licenses. In Turkey, in 1968, these rents amounted to roughly 15% of GNP. Around the same time, in India, important licenses amounted to roughly 7% of national income.

Next, Krueger considers the impact of such rent-seeking behavior on the general welfare of a national economy. She finds that welfare costs are higher when trade is restricted through quotas rather than tariffs, and she attributes this higher cost to the rent-seeking that ensues when import licenses are up for grabs. According to Krueger, the welfare costs of quotas are equal to the deadweight loss that would result from a tariff plus the value of all of the rents offered. So long as there is competition for rents, her results suggest that trade restrictions in the form of tariffs do less damage to an economy than restrictions that are put in place in the form of quotas.

In the paper’s concluding remarks, Krueger makes some provocative statements about rent-seeking and our general perception about free-markets. If we believe in the power and prevalence of free-market mechanisms then we tend to be more accepting of income inequalities and the varying degrees of success that individual members in the economy experience. If, on the contrary,we find that rent-seeking is far more prevalent in economies then previously assumed, our perspective about economic outcomes might change. She uses the United States as an example:

In the United States, rightly or wrongly, societal consensus has been that high incomes reflect at least to some degree high social product. As such, the high American per capita income is seen as a result of a relatively free market mechanism and an unequal distribution is tolerated as a by-product. If, instead, it is believed that few businesses would survive without exerting “influence,” even if only to bribe government officials to do what they ought in any event to do, it is difficult to associate pecuniary rewards with social product (302)

Mary O. Krueger (1934- ) is the only female economist to make the list. She was born in New York state, received her bachelors degree from Oberlin College and her Ph.D. from the University of Wisconsin-Madison. Krueger has served as the chief economist of the World Bank (1982-1986) and as the deputy managing director at the IMF (2001-2006). She is also a former president of the American Economics Association. She is now a professor at Johns Hopkins teaching international economics.