Germany’s Great Depression and Sticky Wages

Reading Peter J. Evans on the Great Depression in Germany made me wonder whether the causes of the catastrophe without which, as Evans convincingly shows, Hitler would never have come to power were the same as in the US.

This paper suggests that indeed they largely were. If there is widespread deflation it means that the revenue of many firms falls. Firms need to slash costs, including wages. But if wages are not allowed to fall (enough), firms will have (regardless of any Keynesian demagoguery) to lay people off. Thus, you get the mass unemployment disaster in the US and Germany. In Germany it was due not to the then government’s activism but due to trade unions and probably the general atmosphere of violence at the time, especially the violence by unemployed communists.

Ironically, in contrast to Hoover in the US who did everything to make businesses keep wages from falling, German chancellor Heinrich Brüning tried to achieve the opposite result when the scope of the catastrophe became apparent. For this he was savaged and is still savaged by folks like Krugman.

The final interesting question is to what extent the unemployment created through wage fixing causes falling output. There are two such ways which can’t be captured by Keynesian-style aggregate reasoning. One is that it is generally not possible to immediately replace the laid-off workers by capital.

But there is another, a bit less obvious, reason. In the case of mass unemployment caused by preventing wages from falling in the face of deflation, people who retain their jobs with the same (or too high) wages are actually nominally better off than before the crisis because their purchasing power is higher. But the problem is that they can’t just replace the laid-off people’s consumption. One won’t necessarily increase the consumption of bread just because it’s price has fallen. Thus, to meet their additional needs, there should have been a substantial reshuffling of the production structure. Which of course takes time.

Obituary. Kakha Bendukidze

Yesterday came very sad news. The author of unprecedented liberal reforms in Georgia, entrepreneur, philantropist, teacher, visionary, and one of the most extraordinary human beings, Kakha Bendukidze passed away in the age of 58. I had the honour to know Kakha personally, although not very closely, so I thought I should share some of my thoughts.

The most memorable thing about Kakha was his frankness. He always said what he thought and as he thought it, bluntly and often very aphoristically. Perhaps, the most amazing words that he said were, “Everything is for sale, except conscience”. By this he meant that as the driver of the Georgian liberal reforms he would try to privatize as many government functions as possible but not for his or some politicians’ gain. Among other delightful turns of phrase I immediately recall were, “The only thing that should be owned by government is the Great Seal of the Realm” and “importing the institutions of civil society is like importing maturity”.

I called the reforms that Kakha managed to push through in Georgia unprecedented for a reason. I am not aware of another example of such an extensive, deep and fast economic liberalization. Among the most impressive measures were essential abolition of antitrust and labour law (both formally stayed on the books but just formally) but lots of other things have been achieved. He even tried to abolish the central bank but did not have time for it.

What was very unusual, though, was that, despite having been first a big businessman in Perestroika-era Russia and then a high-level statesman in Georgia, Kakha was never corrupted where almost anyone would have been. He always remained above all a teacher who was most excited when he could show people the truth, especially the truth of something which most people failed to see. Perhaps, his favourite project was the Free University of Tbilisi which he founded and in which he often lectured. And his students truly loved him.

His dedication to seeking and promoting the truth meant that he was a passionate enemy of stupidity. The thing you were most terrified of in his presence was to say something stupid. I remember how scared I was of exactly this when I first met him in a restaurant in Tbilisi in May 2010. But after getting to know him you realized that even when he was very angry with people, it was because he wanted them to reach their true potential.

When people like Kakha die I sincerely wish I could believe in the afterlife. But in tribute to his devotion to truth I cannot.

The economic and moral case against patents

One of the most conventional of conventional wisdoms today is the idea that the development of new ideas will at least be highly jeopardized in the absence of intellectual property, especially of patents which this essay is dealing with for the sake of brevity.

There are two apparently sound basic arguments for it, one moral and one economic. The moral argument is based on the notion of desert. By analogy with the Lockean idea that an individual has a right to the physical objects which are products of her labor, it is claimed that the results of intellectual labor must also belong to their creators.

The economic case for patents rests on the belief that certain ideas can be very difficult (costly) to come up with but easy to understand and utilize once they are made public in order to achieve material gains. The latter may lead to the inability of the would-be developers of certain ideas to receive adequate compensation of their costs, thus leading to low incentives for discovery and innovation.

However, despite the apparent strength of those arguments, there are both empirical and theoretical reasons for doubting that patents are necessary for scientific and technological progress. Of course, it is far beyond the scope of this essay to even list all those arguments, but it is possible to sketch the most important ones.

Now let us turn to the economic counter-arguments. On the fundamental level, there is something odd about the notion that there can be certain ideas that:

1) require a lot of effort, and (or) resources, and (or) thinking to arrive at;

2) can be immediately understood and put into application once made public;

3) can bring its user substantial profit.

It is tempting to believe that it is at least very unlikely that an idea may satisfy all those conditions simultaneously. For instance, there are a lot of ideas that satisfy (1) and (3). A good example of such ideas is the TEA laser technology. As Michael Polanyi rightly noted in his classic book Personal Knowledge,

So in 1971, when Harry Collins studied the spread of a technology called the TEA laser, he discovered that the only scientists who succeeded in copying it were those who had visited laboratories where TEA lasers were already up and running: “no-one to whom I have spoken has succeeded in building a TEA laser using written sources (including blueprints and written reports) as the sole source of information.[1]

Many ideas also meet criteria (2) and (3). They usually fall into the category of entrepreneurial discoveries, the term coined by I. Kirzner (1973). It often only takes a substantial degree of alertness and chance for an entrepreneur to notice an opportunity to receive profit. At the same time, no significant effort, amount of thinking or allocation of resources may be required.

Finally, there is a probably much smaller set of discoveries that satisfy (1) and (2). Those are some discoveries made by fundamental science. Their key feature is that they do not have an immediate commercial application.

In addition to this line of reasoning, even if there is a very small set of ideas that satisfy all the three conditions in question, it is still impossible to predict the future discoveries, otherwise we would have already made them. The mostly abysmal performance of futurologists of all kinds is a testament to that.

Therefore, someone who would wish to derive profit from appropriating the discoveries made by others would have to maintain a heterogeneous set of resources in order to be able to cling to the opportunity of copying as soon as it arises. This means that such an entrepreneur will have to bid away resources most of which will stay idle for considerable periods of time.

The empirical evidence generally seems to confirm the idea that patents are not exactly very useful for innovation. First, Hall et al. (2013) document that only 4% of UK innovating firms actually obtain patents for their products. Balasubramanian and Sivadasan (2011) find a similar figure (about 5.5%) for US manufacturing companies.

At the same time there is an obvious direction of influence of patents which is troubling for economic progress. Patents are one of the pure cases of monopoly. Their existence stifles competition and limits the dissemination and sharing of knowledge. Thus, it would seem from the viewpoint of economic theory that patents do not contribute to and probably impede the achievement of their goal.

However, perhaps there are certain special cases where the use of patents is warranted. Let us now return to the issue of pharmaceutical drugs which was mentioned in the beginning of this essay. The pharmaceutical industry is considered to be a prime example of a field where patents are essential for innovation. The popular explanation for this is that huge up-front investment needs to be made into developing, testing and obtaining the regulatory approval of new drugs whereas it is very easy to copy them once they are made public.

In reality, original drugs are not exactly copied. Instead, they are reverse-engineered into generics. Reverse engineering requires sophisticated technological processes and usually takes around six months. But this is not the end of the process. The producer of a generic drug must make sure that it is bioequivalent to the original drug. Finally, the generic drug must be approved for entry into the market by the regulator, although the requirements for obtaining such approval are less stringent than for original drugs. According to Appelt (2010, 12), generic drug producers in the EU usually start the preparation for market entry of the new generic drug three years before such entry. In countries with more lax regulatory frameworks, like India (Rai 2003), this process may take less time but is still a matter of years.

Thus, it would seem that the economic rationale for patents fails even when applied to the apparently most promising case, in addition to being dubious from the theoretical standpoint. But perhaps patents are ethically justified even if they are an economic non-starter?

As was mentioned in the beginning the main ethical argument for patents is grounded in the notion of desert. According to this logic, someone who originated an idea must be able to get an adequate reward for it, just as the creator of a valuable material object is. Perhaps, rewarding the desert is an integral part of prosperity in the broad sense of societies being virtuous.

There are at least three issues that cast serious doubt on this idea. First, it is unclear whether the notion of desert has any determinate meaning. Who and on the basis of what criteria should decide what remuneration the originator of an idea is entitled to? There does not seem to be a plausible answer to those questions. This arbitrariness is perhaps best reflected in the question of the duration of the term of patent protection. Should it be 20 years, 50, 70? The question seems to be rhetorical.

Another problem arises from the fact that, as was shown above, it is implausible that the originator of an idea may not derive certain remuneration for it in the market. The originator of a new basic scientific discovery may, if she so wishes, switch from doing basic science to creating marketable products on the basis of her discovery. The commercial success the discoverer of the properties of the DNA James Watson is a good example of this. And if an idea has an immediate commercial application, its creator will, as a rule, have a certain advantage before her potential competitors in exploiting it commercially, even, as it turns out, in the pharmaceutical sector.

Finally, perhaps the most important ethical objection to patents (and intellectual property in general) is that the idea of intellectual property is in a certain sense an oxymoron. The main rationale behind property rights is that they bolster personal autonomy of individuals by allowing them to predictably use in their projects certain material objects or parts of certain objects. But property rights are only necessary because the relevant objects are scarce in one way or another, or, in other words, because they cannot be simultaneously used without certain limitation. But there is no such scarcity with respect to ideas. No objective features of ideas are changed by their use, no matter how many people use them.

As a consequence, what intellectual property rights do is create artificial scarcity where there is none which leads to actually restricting by force legitimate property rights and liberties. Quite a problematic way to promote virtue.

Bibliography

Appelt, S. 2010. “Entry and Competition in the Pharmaceutical Market following Patent Expiry: Evidence from Macro and Micro Data.” Inaugural-Dissertation zur Erlangung des Grades Doctor oeconomiae publicae (Dr. oec. publ.) an der Ludwig-Maximilians-Universitat Munchen.

Balasubramanian, N. and Sivadasan, J. 2011. “What happens when firms patent? New evidence from US economic census data.” Review of Economics and Statistics 93: 26-46.

Hall, B., Helmersy, C., Rogers, M. and V. Sena. 2013. “The importance (or not) of patents to UK firms.” Oxford Economic Papers 65 (3): 603-29.

Kealey, T. 2013. “The Case against Public Science.” CATO Unbound. August 5.

Kirzner, I. 1973. Competition and Entrepreneurship. The University of Chicago Press.

Rai, S. 2003. “INTERNATIONAL BUSINESS; Generic Drugs From India Prompting Turf Battles.” The New York Times. December 26. http://www.nytimes.com/2003/12/26/business/international-business-generic-drugs-from-india-prompting-turf-battles.html.

[1]Quoted in Kealey (2013).