Using Economics to Solve Puzzles
Have you ever wondered how economics can make a difference in the world? That was the theme of the Women in Economics Symposium held earlier this year.
During her keynote presentation at the symposium, Lisa D. Cook talked about how economists like to solve puzzles. “Many of us are particularly motivated by puzzles that, if resolved, could improve people’s lives,” she said.
Cook, a professor of economics and international relations at Michigan State University and director of the American Economic Association Summer Program, gave several examples of such puzzles. This blog post highlights three:
- Why doesn’t higher health care spending mean better health outcomes in the U.S.?
- Can a market-based banking system arise where there is little rule of law and poor information?
- Why might innovation be missing even when laws protect intellectual property?
Why doesn’t higher health care spending mean better health outcomes in the U.S.?
Cook started off with an example related to health care expenditures that she uses in her classes.
The economist pointed out that the U.S. spends more on health care than all other countries in the Organization for Economic Cooperation and Development, or OECD, which is made up of the world’s richest countries. In 2019, the U.S. spent 17% of its GDP on health care, compared with the OECD average of 8.8%, she said.
But despite spending a higher share of GDP on health care, the U.S. has some of the worst health outcomes among these countries, she said. For instance, she cited a higher infant mortality rate in the U.S. and a higher obesity share (percentage of the total population) in the U.S. than the OECD averages.
Cook said this is a puzzle in that we don’t see what we would believe to be reasonable: that more health care spending would lead to better health outcomes.
She discussed some interventions that could potentially improve health outcomes for all Americans. Policies that have been proposed over time include increasing the number of people who are insured, disentangling health insurance from a particular job, and investing in preventive care, she said.
Can a market-based banking system arise where there is little rule of law and poor information?
Another example that Cook described has to do with Russia in the 1990s. Russia was making the shift from being a socialist economy to being a market-based economy, and this transition was occurring with every sector of the economy, she noted. The particular puzzle that she focused on was related to the banking system.
“Market economies rely on banks and financial institutions to capture information in the economy and to allocate capital to its most productive uses,” she explained. For example, a bank’s role in a market economy is to lend money to borrowers who have the best plans—that would be the most productive use of that financial capital.
Cook examined the question: Could a market-based banking system arise in an environment where both the rule of law and information were lacking? A place, for example, where contract enforcement was poor and where there were no credit histories on individuals or firms?
To work out this puzzle, she moved to Moscow in 1995. She conducted surveys and interviewed bankers and entrepreneurs to understand how the market for credit in Russia was evolving among banks as well as among potential borrowers.
Cook found that bank lending did happen on a market basis—credit was being allocated as if Russians were living in a market economy, she said. However, she noted that there wasn’t much bank lending.
She also found that more trade credit was being extended to bridge the gap between firms and banks. For example, a computer copier firm could extend trade credit in the form of a photocopier to an entrepreneur with a small print shop. The entrepreneur would make payments every month, but the firm could confiscate the copier if payments weren’t made.
The increase in trade credit showed that property rights and contract enforcement were important in this environment, she said. Cook noted that information was also important, and trade credit was performing a useful role as banks were being introduced to firms. If entrepreneurs had trade credit, banks used that as a signal of the entrepreneurs’ creditworthiness.
Why might innovation be missing even when laws protect intellectual property?
Through her discussions with bankers and entrepreneurs in Russia, Cook came across another puzzle—one related to innovation, which is fundamental to economic growth, she noted.
The conventional wisdom in economics at the time was that if intellectual property rights were protected, that should provide enough of an incentive to get invention and innovation going, Cook explained. However, she observed little invention and innovation in Russia and wondered why.
To gain some insights, she looked to a historical example in the U.S.—the experience of Black inventors from 1870 to 1940.
“There is a period of time when African American inventors and white inventors were doing the same thing, but then African American inventors became subject to some circumstances that white inventors were not subject to,” Cook said.
Analyzing data on patents, she found similar patterns for Black inventors and white inventors before 1900 (although the number of patents per million were much lower for the former group). But at 1900, there was a dramatic decline in patents for Black inventors; the number of their patents per million didn’t recover back to the 1899 peak for the rest of the period examined, which Cook found surprising—and a puzzle.
She decided to investigate the impact of violence on invention and innovation. So, in her analysis she also included variables that convey information about violence: lynchings, major riots and segregation laws.
She found that violence is bad for innovation, which is subsequently bad for the economy. She estimated that the lost patents were roughly equivalent to those of a medium-sized country in Europe at that time. Another conclusion, she said, is to stop violence before it starts because the greatest impact comes from the first act of violence.
She also found that the rule of law is as important as intellectual property law, she said. Things like contract enforcement and protection of personal security are needed for innovation to work, she explained.
Finally, she noted that her findings transcend space and time—that the historical experiment is relevant for developing countries and emerging markets.
More to Explore
The examples that Cook described illustrate one way that using economics can make a difference in the world—by resolving puzzles that could improve people’s lives.
You can also check out these related Open Vault blog posts:
This blog explains everyday economics, consumer topics and the Fed. It also spotlights the people and programs that make the St. Louis Fed central to America’s economy. Views expressed are not necessarily those of the St. Louis Fed or Federal Reserve System.