An “ecosystem” of relative prices

I just noticed an article on the industrial research limited site discussing how NZ needs to think.  Money quote is:

What I take from that is we need to think laterally, not literally. When we think about investing in particular sectors, we must realise we will need capabilities that aren’t necessarily obvious to us. We just won’t know what types of knowledge we are going to need to build particular parts of our economy.

The interesting thing is that many economists agree with some of what the author mentions in their piece, in terms of discussing scale and the inter-relationships of firms – but from this loose description there is no clear role for policy, or understanding.

In truth, we need to understand the idea behind inter-relationships in a way consistent with methodological individualism.  Then given that theory, we need to go back to data truly quantify what is going on – given the framework that this theory provides.  From there, we can try to decipher if policy can help of not.

And any such theory relies strong on relative prices – contrary to the inference the article appears to be making, we do not have a command and control economy, and the government is not trying to work out the allocation of resources.  Relative prices, both implicit and explicit, are the driving force of any description of what is going on in New Zealand – and our starting point, and final discussion in terms of policy needs to rely on these.

Think about it, we are told how these firms rely on each other, how they add value to each other, and in each others markets.  This doesn’t make an “externality” in the traditional sense, it just tells us that we have firms whose markets are interconnected – and as a result, there will be some implicit contracts between these firms (and implicit prices) that help to share the surplus of their trade.  In an extreme case, when the benefit is enough, and the outside contracting is weak enough, these firms would horizontally (or vertically depending on the relationship) integrate.

The fact that firms are inter-related doesn’t suddenly provide a role for government.  The fact that scale matters for output does not mean that FORCING an increase in the population distribution will increase welfare.

Update:  Bill discussed this here.  And Eric.  How did I miss it when I read both of those blogs daily … I blame my new Kindle for making me focus on Mill instead of my blog reading.

Sidenote:  I have to mention this statement:

Because New Zealand doesn’t have a truly large city by international standards, we must work harder at innovation to compensate for our economic geography and collaborate as if we were a city of four million people.

I have tried to be kind in the rest of the piece, but I have to admit that this statement is blatantly ridiculous.

Two things:

1. The benefits of population density in large cities come very much from population density – saying we are a city doesn’t do anything to change this.
2. More importantly, saying we need to “innovate more” because of our disadvantages doesn’t necessarily make sense – it depends on the marginal benefit of innovation relative to the cost.  If our distance from market reduces the marginal benefit from innovation, then this statement isn’t just wrong – its harmful if its followed through with.

I love to hear scientists describe the potentials for technology, and discuss the production possibilities they face.  But they really should get an economist to join the party when it comes to discussing issues of allocation – given that this is the economists area of expertise.