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Theory, General Equilibrium, and Political Economy in Development Economics

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Theory, General Equilibrium, and Political Economy in Development Economics Journal of Economic Perspectives—Volume 24, Number 3—Summer 2010—Pages 17–32 Theory, General Equilibrium, and Political Economy in Development Economics Daron Acemoglu eevelopmentvelopment eeconomicsconomics iinvestigatesnvestigates tthehe ccausesauses ooff ppovertyoverty aandnd llowow iincomesncomes aaroundround tthehe wworldorld aandnd sseekseeks ttoo mmakeake pprogressrogress iinn ddesigningesigning ppoliciesolicies tthathat D ccouldould hhelpelp iindividuals,ndividuals, rregions,egions, andand countriescountries toto achieveachieve greatergreater economiceconomic pprosperity.rosperity. EEconomicconomic ttheoryheory playsplays a ccrucialrucial rroleole iinn tthishis eendeavor,ndeavor, nnotot oonlynly bbecauseecause iitt hhelpselps usus ffocusocus oonn tthehe mmostost iimportantmportant eeconomicconomic mmechanisms,echanisms, bbutut aalsolso bbecauseecause iitt pprovidesrovides gguidanceuidance oonn tthehe external validity ooff eeconometricconometric eestimates,stimates, mmeaningeaning tthathat iitt cclarifilarifi eess howhow wwee ccanan llearnearn ffromrom sspecifipecifi c eempiricalmpirical eexercisesxercises aaboutbout tthehe eeffectsffects ofof ssimilarimilar shocksshocks aandnd ppoliciesolicies inin differentdifferent circumstancescircumstances aandnd wwhenhen implementedimplemented oonn ddifferentifferent sscales.cales. GGeneraleneral eequilibriumquilibrium andand politicalpolitical economyeconomy issuesissues oftenoften createcreate challengeschallenges fforor tthishis ttypeype ooff eexternalxternal vvalidity.alidity. GGeneraleneral eequilibriumquilibrium rrefersefers ttoo ffactorsactors thatthat bbecomeecome iimpor-mpor- ttantant wwhenhen wewe considerconsider ccounterfactualsounterfactuals iinn wwhichhich largelarge changeschanges areare contemplated.contemplated. TThehe ddiffiiffi ccultyulty lliesies iinn tthehe ffactact thatthat suchsuch counterfactualscounterfactuals wwillill induceinduce changeschanges iinn ffactoractor ppricesrices aandnd ttechnology,echnology, wwhichhich wwee hholdold fi xxeded iinn ppartialartial eequilibriumquilibrium aanalysis,nalysis, aandnd ccreatereate ddifferentifferent ccompositionomposition eeffectsffects thanthan inin partialpartial equilibrium.equilibrium. PoliticalPolitical eeconomyconomy rrefersefers ttoo tthehe ffactact thatthat tthehe feasiblefeasible setset ooff iinterventionsnterventions iiss ooftenften ddeterminedetermined bbyy ppoliticalolitical ffactorsactors aandnd thatthat llargearge counterfactualscounterfactuals wwillill induceinduce ppoliticalolitical responsesresponses fromfrom vvariousarious aactorsctors aandnd iinterestnterest ggroups.roups. GGeneraleneral eequilibriumquilibrium andand politicalpolitical economyeconomy considerationsconsiderations aarere iimportantmportant bbecauseecause partialpartial eequilibriumquilibrium estimatesestimates thatthat ignoreignore responsesresponses fromfrom bbothoth ssourcesources wwillill nnotot givegive thethe appropriateappropriate answeranswer toto counterfactualcounterfactual exercises.exercises. IInn tthishis eessay,ssay, I fi rrstst explainexplain wwhyhy iitt iiss iimportantmportant ttoo tthinkhink ooff eexternalxternal validityvalidity iinn ppolicyolicy analysis,analysis, particularlyparticularly inin developmentdevelopment economics,economics, andand I describedescribe thethe rolerole ooff eeconomicconomic theorytheory inin thisthis exercise.exercise. I thenthen illustrateillustrate thethe importanceimportance ofof generalgeneral ■ Daron Acemoglu is Charles P. Kindleberger Professor of Applied Economics, Massachusetts Institute of Technology, Cambridge, Massachusetts. His e-mail address is 〈[email protected]〉. doi=10.1257/jep.24.3.17 18 Journal of Economic Perspectives eequilibriumquilibrium reasoningreasoning inin severalseveral majormajor problemsproblems inin developmentdevelopment economics.economics. FFinally,inally, I aarguergue thatthat politicalpolitical economyeconomy considerationsconsiderations hhaveave ttoo bbee ccentralentral ttoo aanyny iinvestigationnvestigation ooff ddevelopmentevelopment pproblemsroblems aandnd tthathat iinferencesnferences tthathat iignoregnore politicalpolitical eeconomyconomy ccanan ggoo wwrong.rong. Why Development Economics Needs Theory TTherehere isis nono generalgeneral aagreementgreement onon howhow muchmuch wewe shouldshould relyrely onon economiceconomic ttheoryheory inin motivatingmotivating empiricalempirical wworkork aandnd wwhetherhether wewe shouldshould ttryry ttoo fformulateormulate aandnd eestimatestimate ““structuralstructural pparameters.”arameters.” I aarguergue tthathat tthehe aanswernswer iiss llargelyargely ““yes”yes” bbecauseecause ootherwisetherwise eeconometricconometric eestimatesstimates wwouldould llackack eexternalxternal vvalidity,alidity, iinn wwhichhich ccasease ttheyhey ccanan nneithereither iinformnform uuss aaboutbout wwhetherhether a pparticulararticular mmodelodel oorr ttheoryheory iiss a uusefulseful aapproximationpproximation toto reality,reality, nornor wouldwould theythey bebe usefuluseful inin providingproviding usus guidanceguidance onon wwhathat thethe effectseffects ofof similarsimilar shocksshocks andand policiespolicies wouldwould bebe inin differentdifferent circumstancescircumstances oorr iiff iimplementedmplemented iinn ddifferentifferent sscales.cales. I tthereforeherefore ddefiefi nnee ““structuralstructural pparameters”arameters” aass tthosehose thatthat provideprovide eexternalxternal validityvalidity andand wouldwould thusthus bebe usefuluseful inin testingtesting theoriestheories oror iinn ppolicyolicy aanalysisnalysis bbeyondeyond tthehe sspecifipecifi c eenvironmentnvironment aandnd ssampleample ffromrom wwhichhich ttheyhey aarere dderived.erived.1 EExternalxternal vvalidityalidity bbecomesecomes a particularlyparticularly challengingchallenging tasktask iinn tthehe ppresenceresence ooff ggeneraleneral eequilibriumquilibrium andand politicalpolitical economyeconomy considerations,considerations, aandnd a mmajorajor rroleole ooff eeconomicconomic ttheoryheory iiss iinn hhelpingelping uuss oovercomevercome tthesehese pproblemsroblems oorr aatt tthehe vveryery lleasteast aalertinglerting uuss ttoo ttheirheir iimportance.mportance. TToo iillustratellustrate thesethese points,points, considerconsider tthehe rrelationshipelationship bbetweenetween tthehe costcost ooff sschoolingchooling aandnd sschoolingchooling decisions.decisions. WeWe cancan describedescribe thisthis relationshiprelationship ppurelyurely aass a ddescriptiveescriptive oone,ne, ffocusingocusing oonn a ssampleample aandnd llookingooking aatt tthehe ccorrelationorrelation oorr tthehe oordi-rdi- nnaryary lleasteast squaressquares relationshiprelationship bbetweenetween thesethese twotwo variables.variables. ForFor example,example, wewe couldcould sspecifypecify thethe followingfollowing reduced-formreduced-form relationship:relationship: log (si ) = X ′i β – α log (ci ) + εi , where i denotes an individual in the sample, si is years of schooling, ci denotes the cost of schooling to the individual resulting, for example, from foregone earn- ings and actual costs of attending schools, Xi is a vector of characteristics of this individual for which we may wish to control, and β iiss a vvectorector ofof pparameters.arameters. TThehe pparameterarameter ooff iinterestnterest iiss α. WWee ccanan tthenhen uusese oordinaryrdinary lleasteast ssquaresquares ttoo eestimatestimate β aandnd α. 1 See Shadish, Cook, and Campbell (2002) on internal and external validity. The notion of external validity, in particular the emphasis on counterfactual exercises, as the defi ning characteristic of a structural parameter is closely related to Marschak’s (1953) defi nition, which distinguishes between structural parameters that provide “useful knowledge” for understanding the effects of policy within a given sample and/or in new environments. It also clearly presupposes that the empirical strategy has been successful in estimating “causal” effects (for example, as defi ned in Angrist, Imbens, and Rubin, 1996). Daron Acemoglu 19 AAlternatively,lternatively, wwee ccouldould sstarttart wwithith aann eeconomicconomic mmodel.odel. IInn ffact,act, ssomeome ssimpleimple ttheoriesheories willwill leadlead toto exactlyexactly tthishis eequation.quation. Suppose,Suppose, forfor example,example, thatthat tthehe hhumanuman ccapitalapital ooff aann iindividualndividual iiss a ffunctionunction ooff tthehe llevelevel ooff sschoolingchooling fforor tthathat iindividual.ndividual. IInn 1– σ pparticular,articular, ssupposeuppose thatthat thethe humanhuman capitalcapital ooff iindividualndividual i iiss ggiveniven bbyy hi = s i fforor ssomeome pparameterarameter σ bbetweenetween 0 andand 1 aandnd si ddenotesenotes tthehe pperson’serson’s llevelevel ooff sschooling.chooling. TThehe iindividualndividual ccanan tthenhen eearnarn iincomencome eequalqual ttoo yi = whi , wwherehere w iiss tthehe mmarketarket wwageage pperer unitunit ofof humanhuman capital.capital. IInn aaddition,ddition, iindividualndividual i hhasas a costcost ooff sschoolingchooling ggiveniven bbyy ζi c i s i , wwherehere ζi iiss aann uunobservednobserved nonmonetarynonmonetary costcost componentcomponent (for(for exampleexample duedue ttoo ddifferentialifferential ddiscountingiscounting oorr bborrowingorrowing cconstraints),onstraints), aandnd ci iiss tthehe monetarymonetary costcost ooff sschoolingchooling fforor tthishis iindividual.ndividual. SSupposeuppose thatthat iindividualsndividuals mmaximizeaximize nnetet iincome,ncome, ssoo tthathat
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