Innovation, industrial policy and controlling the fate of nations

 

How Progress Ends: Technology, Innovation, and the Fate of Nations, by Carl Benedikt Frey, is one of the most important economic and policy books of the last year. It is especially relevant given the discussion following the Draghi Report that has influenced European thinking about the need for change and innovation. Frey makes an important argument that economic progress is a combination of innovation, which often occurs in a decentralized environment, and the implementation of scale through bureaucracy. He develops this argument through close observation of 1,000 years of history across different economic systems around the globe. Technological progress and economic growth are inevitable. There needs to be a special combination between technology and bureaucracy.

Frey draws a distinction between technological innovation that often occurs in a decentralized environment, where experimentation and exploration of new ideas take place. The technology then has to be put to use, which requires a bureaucracy or centralization to effectively employ it. Some countries did not get the technology right because bureaucracy stifled innovation. In contrast, other countries lacked technological advances but were able to grow by harnessing their bureaucracy to build on others’ innovations. 

The EU needs new technology, but that is not enough. There also needs to be a bureaucracy that not only gets out of the way but also uses its power to allow for economies of scale. 

The complexity of trade - not always simple

 

Those imports are taking away good jobs. We have to impose tariffs to stop the invasion of foreign goods to our shores. These comments all sound good, but the reality is more complex. It is usually always that way. One chart that caught my attention showed that many good imports are intermediate goods rather than final products. We take in components and assemble the final product. As an intermediary good, a tariff will increase the price of the final good. The answer could be to produce these intermediate goods in the US, but they are often specialized and may be hard to produce at low cost. Some industries are very dependent on these imports, and they do not fit the usual trade story being used to justify tariffs. Think about complexities and realize most problems are not easy yes or no answers. 

The relative US - EM inflation story

If I asked the simple question, "Is EM inflation higher than US inflation?", most would say that EM inflation is higher. It has been, and always will be, yet the reality is different. US inflation has been higher than EM for almost 5 years. That is right. The Fed manages an inflation regime that is worse than that of the combined EM economies, and the gap is widening. Do you have to wonder why the dollar is falling? 

What driver performance of machine learning

 

A recent paper, "What drives the performnce of mchine learing factor strategies?" seeks to disentangle two key ingredients in modeling: expanding the dataset and allowing for flexible functional forms. Now, as expected, as you move closer to a realistic setting, you find that the value of both deteriorates. However, this research finds that the value of an expanded dataset is more persistent than the functional form employed. While many may think that machine learning is a form of holy grail for investing, the reality is that real-world constraints and transaction costs are key drivers of performance. Reality indicates that adding nonlinear complexity does not add value, whereas being non-sparse is beneficial.