Wednesday, December 1, 2010

Understanding the economy from the bottom up

Anthropologists have developed a framework that I think would be instructive to economists. The Livelihoods Framework, as it is known, was developed by scholars of development to compare the development status of two unrelated groups. But I think it offers general insights on how economies work.

For the Livelihoods Framework, the fundamental unit of analysis is the household. Households are socially defined, and include just the nuclear family or a large network of relatives, blood-related or otherwise, depending on the culture.

Households control assets. These are the bundles of goods/abilities/talents/resources that households use in order to survive, and meet their livelihood goals. Because these resources used for the purpose of gaining access to other resources, they are known as varying forms of capital.

Anthropologists have identified around six main forms of capital:
  • Natural capital: Resources/access that come from geography. This includes the land that a household owns, or access to river or forests.
  • Physical capital: The structures and equipment that a household may own. This includes a house, machinery, and wells, for example.
  • Human capital: The skills and abilities of the people in the household. This may be simply having access to labor, from the kids, or also the levels of education, street-smarts, or health that the members of the household may have.
  • Social capital: The ability to mobilize social connections to procure resources. For example, a family in tough times may be able to lean on their relatives, or their friends.
  • Economic capital: Financial resources. It refers to both the households' income stream, as well as the material assets it can sell in order to raise money.
  • Political capital: The ability to procure resources through the political structure. Political capital takes the form of well-connectedness, or access to political institutions.
Households operate within a specific geographical, historical, political, economic and cultural context. This context determines the kinds and levels of assets available to households.

Livelihood strategies are the way in which households mix and match assets to meet their needs and goals. The household's set of available strategies is constrained by the processes and structures which govern the society. These are the rules, norms, and institutions that direct households to act in a certain way.

As a result of employing strategies, households face outcomes. These outcomes refer to the goals that households seek—health, education, financial stability, security, a sense of place. These are the true measures of a household's success.

The following is a standard graphic summarizing the Livelihoods Framework:

What can economists learn from this model?

1. Economists should think of replacing the individual with the household as the fundamental unit of analysis.

Society is not just a collection of individuals trading and bargaining with each other. Rather, we are parceled into small, socialist blocs, called families, which govern and constrain our actions. Hayek also recognized the divide that exists between family life and social life:
...we must constantly adjust our lives, our thoughts and our emotions, in order to live simultaneously within different kinds of orders according to different rules. If we were to apply the unmodified, uncurbed rules (of caring intervention to do visible ‘good’) of the…small band or troop, or...our families…to the (extended order of cooperation through markets), as our instincts and sentimental yearnings often make us wish to do, we would destroy it. Yet if we were to always apply the (noncooperative) rules of the extended order to our more intimate groupings, we would crush them. (The Fatal Conceit, p 18; qtd. Vernon Smith's Nobel Lecture).
Thus the market isn't reducible down to the individual (nor, as Hayek argues, should it), as classic economic models assume. To be honest, I'm not sure whether this really makes a differences, since we can think of individuals in the market as representing the interests of the whole household, but I think it might, and it's worth exploring. Also, it's useful for us economists to ask ourselves why we are naturally averse to using market principles within families.

2. The assets that households hold are diverse.

I think we often think of money as the only way households can procure resources, but this model makes it clear that there are a number of other ways too. Economists should see the wealth of households in a more holistic light, and see beyond income flows. If, for example, a certain program increases household income, but decrease its natural capital, or its social capital, then we need to be able to recognize a potential net loss in wealth.

3. The importance of consumption is overstated.

This is an old refrain, but the model offers an alternative. Consumption is for the sake of fulfilling outcomes, and these outcomes should be the metrics we use to judge economic success. These other metrics aren't separate from the economy, but an integral part of it.

4. An economy is not only a distribution of resources, but also a distribution of livelihoods.

Economy is the way we live our lives. It's how we decide what careers we pursue, the places we live, the industries we establish, and the way we spend our leisure time. It's what we think our job is, not only in the market, but in life. These concepts are so fundamental to our being that we have a hard time adjusting to change. This is why economic changes are so difficult and, at times, heart-wrenching.

In The End of Poverty, Jeffrey Sachs talks about his role in advising the Russian government during the transformation from communist planning to markets. His description of the challenges that Russia faced really illustrate this point.
The transformation would be the hardest in modern history because the gap between where Russia was and where it needed to be—for domestic peace, stability and economic development--was as vast as imaginable...People were literally in the wrong places. They were in Siberia, living in large secret cities that had been created for military purposes. They were working in heavy industries utterly dependent on the massive use of oil and gas reserves, as if there was no limit to those resources....No economic policy could be massive enough to relocate people, factories, and assets in a matter of days or weeks or even a few years. (pgs. 134-135)
That's why when we craft economic policy, we need to be very careful and judicious. We're pulling the strings of peoples' livelihoods.

1 comment:

  1. I really had no idea what people who majored in economics actually studied and talked about, but you make it very interesting.