Monday, August 17, 2009

Let's digress... Economics and modeling

Lee over at RovingBandit had some discussion of the value of economists making assumptions that people are rational and self-interested (as opposed to ordinary humans who are far more complex). I wrote a longish comment. Today I just happened to be reading an abstract of a new paper (see below) and the thought occurred to me: regardless of whether you think their results are simply an interesting math problem or some serious deep insight, the simple likelihood is that only the rational and self-interested assumption lets you do this kind of modeling. Anything else is simply too complex at this time! And the math results that come from this modeling form the stepping stones for more complex modeling that will happen when some math-oriented breakthrough economist comes up with clever algorithms or theorems (there's one in economics that was revolutionary, called the "revelation principle") so that we can model people who are bounded in their rationality, emotional, and often weird.

So both camps can be right at the same time- most models of rational self-interested actors are just sometimes fun sometimes boring math problems, but solving thousands of those math problems generates tools that will be useful down the road, and is the only way to generate the tools, and they are probably better in the meantime than just repeating "in my opinion based on what I had for lunch today" stories back and forth.
Foreign Influence and Welfare
Pol AntrĂ s
Harvard University and NBER
Gerard PadrĂ³ i Miquel
London School of Economics and NBER
February 4, 2009
How do foreign interests influence the policy determination process? How is trade policy affected? What are the welfare implications of such foreign influence? In this paper we develop a model of foreign influence and apply it to the study of optimal tariffs. We develop a two-country voting model of electoral competition, where we allow the incumbent party in each country to take costly actions that probabilistically affect the electoral outcome in the other country. We show that policies end up maximizing a weighted sum of domestic and foreign welfare, and we study the determinants of this weight. We show that foreign influence may be welfare-enhancing from the point of view of aggregate world welfare because it helps alleviate externalities arising from crossborder effects of policies. Foreign influence can however prove harmful in the presence of large imbalances in influence power across countries. We apply our model of foreign influence to the study of optimal trade policy. We derive a modified formula for the optimal import tariff and show that a country’s import tariff is more distorted whenever the influenced country is small relative to the influencing country and whenever natural trade barriers between the two countries are small. We also show that the viability of free trade agreements can be hampered by large imbalances in power across countries.

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