South Africa in the 21st Century

My exchange semester at Auckland University of Technology is officially over! Now I am waiting on my exam results and I am also about to head back to Germany tomorrow for the summer break. This is why today’s post is not going to be a long one. Rather I would like to share one of my research essays that I completed in my Growth and Development Economics paper at AUT.

The task was to choose one of the BRICS economies and write a research essay on their growth and development performance in the last decade. In particular, we were supposed to analyse the extent to which institutional development supported or hindered the process of economic development. The essay should include four parts: an introduction to the country, a section on growth and development trends, a section on institutional development and lastly a summary including policy implications.

I chose to focus on South Africa and I have to say that it was a very interesting assignment and it helped me significantly in developing my research skills. Doing all this research on South Africa also changed my impressions on the current state of human and economic development in the country. It has been 22 years since the end of apartheid but South Africa continues to face significant obstacles as highlighted in the essay. Despite a range of headwinds identified in the essay there is however the possibility for South Africa to regain its strength and play up to the expectations of becoming one of the future drivers of world economic growth as part of the BRICS as argued in the last part of the essay.

I hope you enjoy reading my research! The abstract of the essay is included below and complete file is available from here.




South Africa joined the BRICS for their 3rd BRICS Summit in 2011 after being predicted to become one of the future drivers of world economic growth. However, both in the area of economic growth and development as well as governance South Africa continues to face substantial challenges. The aim of the essay is to assess the country’s performance in these areas over the past decade. After a brief overview on South Africa the essay analyses growth and development trends with the use of the Human Development Index (HDI), the inequality adjusted HDI and the Multidimensional Poverty Index. In the second part, the essay focuses on institutional development employing the World Governance and Doing Business Indicators, as well as the Index of Economic Freedom.

The main findings are that South Africa’s economic development is impeded by sluggish growth rates and a contracting economy as well as the rising burden in fiscal debt and its servicing costs. South Africa’s society still faces racial and gender inequality as well as multidimensional poverty. The country’s potential human development in all three areas of health, education and income remains dampened by inequality which persists after the transition to a more open society and economy under the post-Apartheid regime. The country has suffered from a deterioration of institutional quality over the last years, especially in corruption coupled with an on-going underperformance in political stability. Furthermore, the ease of doing business is impeded by constraints in getting electricity and a deterioration of conditions regarding the access to credit.  A major concern is that business freedom, labour freedom and investment freedom have seen a long-term deterioration in conditions.

The essay’s policy recommendations centre on a holistic reform of South Africa’s institutional system in order to reshape incentives to invest in physical and human capital and to establish incentives for innovation. The recommendations derive from the World Bank Growth Commission’s 5 common growth ingredients of market incentives, trade openness, future orientation, macroeconomic stability and good governance with a focus on inclusive growth.

Droege, J. (2016). South Africa in the 21st Century. Auckland University of Technology, Auckland. Retrieved from 

Alternative Thinking – What is Econophysics?

Recently I blogged about getting my hands on a copy of Debunking Economics by Steve Keen. At that point I did not really know what to expect but it seemed to be a good read for challenging my conventional economic training in university. My undergraduate classes – both Macroeconomics and Microeconomics – have so far been dominated by the Neoclassical and New Keynesian school of thought. An exception to this monopoly on the undergraduate economics curriculum is probably Behavioural Economics, especially Game Theory, which I really enjoyed last semester! However, it is normally the concepts of rational expectations, utility maximising firms and individuals (constrained optimisation) and equilibrium that dominate the lectures. I am certain that it is not just me, but most undergraduates are tortured with abstract supply and demand analyses and comparative statics.

As Richard Thaler (2015, p.6) in his book Misbehaving: The Making of Behavioural Economics points out, the core premise of economic theory can simplistically be summarised as follows:

Optimization + Equilibrium = Economics

These are the very basics of economic theory and almost never challenged in the undergraduate curriculum. I am honest about this, so far I have followed the standard Economics curriculum sheepishly because you are hardly encouraged to question the core premises. However, my main takeaway from Keen’s book is really to not take Equilibrium and Optimising Behaviour for granted. These should not be core premises of economic theory, because – in practice – they just do not hold. We cannot overlook this and work on the premise that our assumptions of optimisation and equilibrium do not matter as revealed by Milton Friedman’s “paradoxical statement that ‘the more significant the theory, the more unrealistic the assumptions’” (Keen, 2011, p.159). This is because most of the assumptions we make in Economics are not neglibility assumptions but either domain assumptions or heuristic assumptions. In short, assumptions do matter and therefore modeling economic systems based on the flawed premises of optimisation and equilibrium (and a range of other unreasonable assumptions) must also be flawed.

Criticising conventional economic theory is one side of the coin, putting forward promising alternatives is the flipside. This is why Keen devotes his very last chapter of the 2011 Edition to the main alternative schools of thought. In particular, he gives a brief overview on Austrian economics, Post-Keynesian economics, Marxian economics, Sraffian economics, Complexity theory and Econophysics, and Evolutionary economics. However, it should be pointed out that all of them have their own weaknesses and I very much appreciate that Keen discusses both their strengths and weaknesses in the chapter.

According to Keen, one of the promising alternatives is Econophysics – the merger of Economics and Physics – due to its contribution to complexity in economics. The Econophysics approach is empirical, dynamic rather than static, and devoid of equilibrium conditions. This motivated me to devote today’s blog post to Econophysics, giving a short introduction to what Econophysics is about. I am also going to highlight the main areas of application at the moment as well as some interesting articles and books to get started with this multidisciplinary approach.

First, let’s look at what Physics and Economics have in common: They both make use of dense mathematics. Physicists even more so than Economists, because naturally their background is far more mathematical. And this is also where they depart and where Physics can greatly enhance the current state of the Economics profession. Physicists have the tools to investigate complex systems. Econophysics recognises that statistical physics concepts, such as stochastic dynamics, short- and long-range correlations, self-similarity and scaling, can be applied to to understand the global behaviour of economic systems (Mantegna and Stanley, 2000). For Economists this means that they can turn to empirical analysis methods without imposing a priori assumptions. Adopting theoretical tools of Physics allows Economists to model systems with interacting subsystems and this is exactly what we need in order to model the Macro-economy. Rather than building Macroeconomics from Microeconomics this merger of Economics and Physics allows Macroeconomists to model the Macro-economy as something that is more than the sum of its parts. It allows Macroeconomists to abandon representative agent models of the economy which in the past have failed to accurately describe the real economy anyway.

There are two approaches in Physics that Economics can greatly benefit from: complexity theory and chaos theory. While the former is the study of non-deterministic systems the latter are deterministic systems, which might seem a bit counterintuitive.

Chaotic systems are non-linear and dynamic. For example, when we take two variables which are influenced by each other they give constant feedback. Chaotic systems are sensitive to initial conditions, meaning that even a small change in the initial conditions leads to a completely different outcome in the long run and the so-called Butterfly effect (Jacobs, 2006). Therefore, in chaotic systems uncertainty arises because we cannot determine the chaotic system’s initial conditions (Fisher, 2012).

In comparison, complex systems are characterised by emergent behaviour. They are made of agents that interact with and adapt to another. Complex systems can be robust to small shocks at one point in time but fragile at another. Because complex systems are non-deterministic the outcome of the interaction of its agents is unpredictable. This gives rise to uncertainty, because even if we knew the initial conditions of the complex system we could not predict the future (Fisher, 2012).

What are the main areas of application? In the past Econophysics was centred on financial markets due to the availability of high frequency data thanks to electronic trading and financial markets being active 24 hours around the world. Financial markets create a vast amount of data which is needed for modeling. One of the most striking application is risk management which greatly benefits from Econophysics as a multidisciplinary approach making use of financial mathematics, probability theory, physics and economics (Mantegna and Stanley, 2000). However, the discipline is now moving on to explain more general economic phenomena. Starting out as what Keen calls ‘Finaphysics’ the discipline is now becoming more of ‘Econophysics’. One example is the Economic Complexity Index developed by Hidalgo and Hausman which shows “that countries tend to converge to the level of income dictated by the complexity of their productive structures” and which sees the emergence of complexity as a main factor for generating sustained growth and prosperity (Hidalgo and Hausmann, 2009, p. 10570). The Economic Complexity Index has proven to be more accurate in predicting income growth relative to the World Bank’s traditional governance measures. In particular, in the Atlas of Economic Complexity Hausman, Hidalgo et al. conclude that “the Economic Complexity Index captures significantly more growth-relevant information than the 6 World Governance Indicators” (2011, p.33).

Some interesting articles are listed on the website of the Economics: The Open-Access, Open-Assessment E-Journal. For example, in one of the papers Paul Ormerod applied random matrix theory to the analysis of macro-economic time series data. He examined “the evolution of the convergence of the business cycle between capitalist economies from the late 19th century to 2006” (Omerod, 2008, p.1). With the help of random matrix theory Ormerod distinguished true information from noise and showed that there is now a strong level of synchronisation of business cycles which makes it possible to speak of an international business cycle. In another paper Chen, Chang and Wen (2014) examined the effect of social networks on macroeconomic stability. They made use of an agent-based network-based DSGE and showed that both the non-linear and combined effects of network characteristics and the shape of the degree distribution are significant in determining the effect on economic stability. In another paper Challet, Solomon and Yaari deployed a three-parameter equation to model how GDP evolved during recessions and recoveries and argued that their equation is “the response function of the economy to isolated shocks” (2009, p.1) which therefore can help detecting shocks and has predictive power. The last interesting paper I want to point out was only published recently by Solferino and Solferino (2016). They applied the geometrical model of the Möbius strip to a Corporate Social Responsibility context to allow for complex interactions that characterise social and economic relationships today. As discussed before in the paragraph on complex and chaotic systems, this paper makes deliberate use of complexity and nonlinearity and acknowledges that feedback loops make systems interdependent and interacting with their environment and which, according to Solferino and Solferino, is also at the core of the models of Corporate Social Responsibility. For people interested in a comprehensive introduction to the field beyond the Econophysics papers published in journals, Mantegna and Stanley published the book An Introduction to Econophysics: Correlations and Complexity in Finance which might be worthwhile to read!

I hope you enjoyed today’s post. Thanks for reading!




Challet, D., Solomon, S., and Yaari, G. (2009). The Universal Shape of Economic Recession and Recovery after a Shock. Economics: The Open-Access, Open-Assessment E-Journal, 3(2009-36), 1-24.

Chen, S.H., Chang, C.L., and Wen, M.C. (2014). Social Networks and Macroeconomic Stability. Economics: The Open-Access, Open-Assessment E-Journal, 8(2014-16), 1-40.

Fisher, G. (2012, July 14). Chaos Versus Complexity. Retrieved from

Hausmann, R., Hidalgo, C.A., Bustos, S., Coscia, M., Chung, S., Jimenez, J., Simoes, A., and Yildirim, M.A. (2011). The Atlas of Economic Complexity: Mapping Paths to Prosperity. Retrieved from

Hidalgo, C.A., and Hausmann, R. (2009). The building blocks of economic complexity. PNAS, 106(26), 10570-10575.

Jacobs, J. (2006, May 7). Chaos theory, game theory and complexity theory. Retrieved from

Keen, S. (2011). Debunking Economics: The Naked Emperor dethroned? London: Zed Books.

Omerod, P. (2008). Random Matrix Theory and Macro-Economic Time-Series: An Illustration Using the Evolution of Business Cycle Synchronisation, 1886–2006. Economics: The Open-Access, Open-Assessment E-Journal, 2(2008-26), 1-10.

Mantegna, R.N., and Stanley, H.E. (2000). An Introduction to Econophysics: Correlations and Complexity in Finance. Cambridge, UK: Cambridge University Press.

Solferino, N., and Solferino, V. (2016). The Corporate Social Responsibility Is just a Twist in a Möbius Strip. Economics Discussion Papers, No 2016-12, Kiel Institute for the World Economy.

Thaler, R. (2015). Misbehaving: The Making of Behavioural Economis. London, UK: Penguin Books.


Michael Sandel on the Moral Limits of Markets

Recently I widened my weekly podcast subscription to Intelligence Squared. It describes itself as a forum for debate and intelligent discussion. What makes the organisation great is that they make their forums available as podcasts. I actually regret not having discovered them earlier, you really learn a lot by listening to the discussions on the go!

In May they re-broadcasted a special Intelligence Squared event from 2013 at which the American political philospoher Michael Sandel discussed his book What Money Can’t Buy: The Moral Limits of Markets. The event was a hybrid between a lecture and discussion and was actually even published by Intelligence Squared on Youtube.

So today I want to provide you with some of the highlights discussed to nudge you to watch the complete forum. The frame of the event was the question whether we want a society in which wealth conquers all aspects of life. In particular, Sandel argues that our market economy has transformed into a market society. While the former is an effective tool to organise productive activity, the latter is a society in which market values become a way of life. In a market society one can find market values in almost every domain of life. For example, Sandel points out that cash incentives are now increasingly used as policy instruments and highlights the case of “health bribes” which are cash incentives to nudge people into a healthy lifestyle. Is it ethical to pay people to lose weight?

Another area in which cash incentives are now increasingly used as policy instruments is education. He asks whether it is right to pay children to motivate them to study or to read. One of the objections put forward is that these cash incentives would undermine the children’s intrinsic motivation. One of the commentators for example suggests that you would put a contract on the gift of reading and incentivise passion. In her opinion this would not work because you essentially cannot put a price on passion and gifts. However, another commentators argues that we are often paid to learn a skill and that education belongs into this category. He argues that the interchange between teacher and student has to offer the student some recognition and one method to allow for this recognition is a cash incentive.

In the last part of the debate Sandel talks about whether money incentives are counterproductive. From the point of view of standard economic models and the well-known concept of homo economicus, it must be that offering people money to do something will increase their willingness to do this. However, in practice putting a price on something reduced people’s willingness to undertake it. Sandel puts forward empirical evidence from Switzerland which had to decide where to locate a nuclear waste site. After narrowing down the choice to a potential town they surveyed its residents and asked the following question:

“If the parliament chooses your town will you accept the nuclear waste site?” 

Thereafter they asked a follow-up question which seemed to make the deal more attractive:

“Suppose the parliament chooses your town and votes to allocate a financial compensation to each resident of the town yearly of up to $8,000, then would you approve?” 

If people were to behave like homo economicus, then the approval rate of the nuclear waste site would have increased because the monetary incentive would have increased the residents’ willingness to tolerate a nuclear waste site in their town. However, this was not what actually happened. The willingness to accept the nuclear waste site fell substantially in the follow-up question. Sandel points out that the residents did not want to be bribed. In the first question approval was motivated by a sense of public responsibility but when offered the $8,000 financial compensation the civic duty diminished into a financial transaction which people were not willing to approve of. Sandel argues that this monetary incentive crowded out the sense of public responsibility and corrupted civic duty.

A similar result was found in Israeli daycare centres. When introducing a fine for picking up children late the rate of late arrivals went up and not down. This was because the introduction of a cash incentive crowded out parents’ sense of feeling guilty. It transformed the issue into a financial transaction and parents did not have to feel guilty anymore but paid an appropriate amount for the “baby sitters”. But what is more, when reversing the fine due to its adverse impact the increased rate of late arrivals to pick up the children did not reduce back to the initial level. Once the parents’ sense of obligation to pick up their children on time was eroded, it could not be re-established that quickly.

Sandel final take-away from the discussion is important for the Economics profession. He points out that in order to make the decision where markets serve the public good and where they don’t, we have to go beyond economic efficiency and establishing incentives in order to nudge people into good behaviour (what is ‘good by the way?). Economists – like everybody else – have to ask about…

… whether introducing money into a certain practice will dissolve or displace or crowd out goods, attitudes, norms, values worth caring about (Sandel, 2013).

Sandel points out that we have been missing out on the debate where markets belong. Markets and market mechanisms like cash incentives have been established in many aspects of life without discussing the implications of transforming into a market society. A new moral public discourse is needed to create this debate: Where do markets belong and where do they not belong? Where do we benefit from introducing market mechanisms? In which areas will society be better off with the use of cash incentives?

Thanks for reading and I hope that you will enjoy the videos!


Sandel, M. (2013). Michael Sandel on the Moral Limits of Markets [Youtube video]. Retrieved from 

The Peculiar Relationship of the Interest rate and the Rate of Inflation

Today’s post is going to be about the impact of the interest rate on the rate of inflation. This is because I stumbled across this twice today. In one of my Economics classes my professor claimed that higher interest rates lead to higher rates of inflation while in my Macroeconomics class which teaches the Liquidity Preference Model and the AD/AS Model it would be that higher interest rates lead to lower rates of inflation in the short run. So let’s shed light on their relationship.

First, let’s revisit the standard Macroeconomics Liquidity Preference and AD/AS Model. Taken together they provide the conventional answer how changes in the money supply affect the economy in the short run as well as in the long run. It is also called the money transmission mechanism. Consider what happens if the Central Bank decides to increase the interest rate. In order to do so it can either engage in open market operations or set the official cash rate directly. However, both tools are equivalent in the Liquidity Preference Model with the outcome that interest rates rise and in response the demand for money (MD) falls. In the AD/AS Model the increase in the interest rate alters aggregate demand, because at least investment is negatively related to the interest rate. In particular, a rise in the interest rate decreases investment and shifts the AD curve to the left. As a result (1) output falls and (2) the price level falls. Hence an increase in the interest rate is expected to be deflationary in the short run. In the long-run, however, the demand for liquidity in the Liquidity Preference Model will adjust. Because the aggregate price level is lower people will demand less currency which shifts the MD curve downward and which causes the interest rate to return to its long-run steady state. Simultaneously, in the AD/AS Model the SRAS curve will shift as nominal wages adjust. As a result (1) output rises back to its initial level and (2) the price level falls further. Hence, in the long run inflation and interest rates fall in tandem.

In sum, an increase in the interest rate is predicted to lead to lower inflation in the short run. In the long run, however, the relationship is less clear if there is a relationship at all. This depends on what is happening in the AS/AD model, i.e. whether the economy shifted away from potential GDP or whether it shifted towards potential GDP because of the change in the interest rate and whether there is deliberate government intervention. While the interest rate will return to its long run steady state the price level might remain unchanged, increase again or decrease further.

Let’s contrast this with the Neo-Fisherian View and what it predicts what will happen to inflation when interest rates rise. After some research I found a great video by George Waters of Illinois State University on The Fisher relation and monetary policy from which I have taken the graph included below. The starting point is the so-called Fisher relation. It states that the real interest rate is equal to the nominal interest rate adjusted for (expected) inflation. Assuming that the real interest rate is stable in the short run one can rearrange the relation so that the nominal interest rate (i) equals the fixed real interest rate, which is practically a constant, plus inflation (π). Waters points out that the assumption of a fixed real interest rate is valid as long as savings behaviour and the returns to capital are stable in the short run. Because the real interest rate is held constant, one can draw the Fisher relation as an upward sloping line with the intercept being at the fixed real interest rate and a slope of 1, as shown in the diagram below.

Fisher relation
(Source: Waters, 2015)

So the diagram depicts essentially a positive relationship between the nominal interest rate and the rate of inflation. Hence in the Neo-Fisherian point of view an increase in the interest rate actually increases inflation. If this were to hold a Central Bank could raise inflation by raising the nominal interest rate rather than lowering it. This result stands in contrast with the predictions of the standard textbook Liquidity Preference and AD/AS Model which I presented before.

But which theory is right? Is it the classical Keynesians or the Neo-Fisherians? As Scott Sumner (2015) points out, probably “both sides are right, and both sides are wrong”. An argument for the Neo-Fisherians is that the nominal interest rate does indeed seem to match changes in trend inflation over any extended time period. An argument for the Keynesian view is that the money transmission mechanism acts as a signalling device, meaning that interest rate cuts signal an expansionary monetary policy and interest rate increases signal a contractionary monetary policy to the public (Sumner, 2015).

So where does this leave us with? There seems to be no clear-cut answer to the relationship of interest rates and the rates of inflation at the moment and with contradicting economic theories and empirical evidence leaning towards a positive relationship there will need to be more research in the future. As nominal interest rates currently hit the zero lower bound this will be an interesting debate to follow. Some researchers have taken it as a ‘natural experiment’ to explore essentially the impact of an interest rate peg at zero. There is an ongoing debate about the Neo-Fisherian idea in the blogosphere and there are new working papers coming out which now even include concepts like Behavioural Macroeconomics (Smith, 2015). For example, a more recent working paper by John Cochrane (2016) titled “Do Higher Interest Rates Raise or Lower Inflation?” makes the case for a positive relationship with only weak evidence for lower inflation…


Cochrane, J.H. (2016). Do Higher Interest Rates Raise or Lower Inflation? [Pdf] Retrieved from

Smith, N. (2015, July, 12). Woodford vs. the Neo-Fisherians. Retrieved from

Sumner, S. (2015, May 19). Neo-Fisherism, missing markets, and the identification problem. Retrieved from

Waters, G. (2015, July 31). The Fisher relation and monetary policy [YouTube Video]. Retrieved from

Daily Reading: Life Among The Econ

Having finished Thaler’s and Sunstein’s bestseller Nudge recently, I somehow ended up with the second edition of Debunking Economics by Steve Keen (2011). It is more or less an in insiders’ tip for its reckoning with economic theory, going through its flaws both at micro- and macroeconomic level. To be honest, I had not heard about Keen until recently. But then my Macroeconomics lecturer turned to a discourse of the Global Financial Crisis in 2008. Focusing on Fisher’s Debt Deflation Theory and Minsky’s Financial Instability Hypothesis, Steve Keen’s work came into play and I actually ended up catching up on that week’s lecture material with some of Steve Keen’s numerous Youtube videos.

Being quite impressed by Keen’s online lectures I decided to broaden my reading list with his post-Keynesian book Debunking Economics. First of all it is heavy (literally) with more than 450 pages of pure Economics. Second, this is clearly not an easy-going book. I admire his style of writing but it makes the book also less accessible. Being an Economics undergraduate I can, for example, mostly follow his argumentation in chapter 3 ‘The Calculus of Hedonism’ but I am certain it would be hard to sell to a ‘foreigner’ and I am sure I will be mentally challenged over the course of the book.

While still ploughing through the first part, the very opening of Keen’s fourth chapter “Size Does Matter” caught my interest. It refers to Leijonhufvud’s 1973 rather sarcastic paper Life Among The Econs. Keen refers to this paper because it touches upon Economists’ obsession for (strictly downward-sloping) demand and (strictly upward-sloping) supply analyses to find the one and only equilibrium in an economy or a market. However, the overarching idea of observing academic Economists through the lens of an anthropologist initially sounded absurd to me. But what followed hit the nail right on the head and so I decided to have a go at Leijonhufvud’s paper.

First of all, Leijonhufvud’s ‘Life Among The Econs’ (1973) is sarcastic through an through. There is the hypothetical Econ tribe which social structure has the two dimensions of caste and status. While caste is the basic division, status follows at the next level with a network of status relationships of every Econ. What is more, Econs call their castes ‘fields’. Several fields are mentioned by Leijonhufvud (1973). Besides the Micro and the Macro, there is also the Math-Econ and the Develops but there is no clearly set hierarchy despite the general observation that the Math-Econs are being the priests above all. The Econs work in distinct social units, i.e. the villages or ‘depts’, and almost all castes come together and interact in these depts. Thereby the status of the Econ derives from his ability to make ‘modls’ of his field while the trouble that they overall do not seem to have practical use is widely ignored. In particular, the most basic modl of both the Micro and the Macro are called the Totems of the two castes. While the Totem of the Micro is the S-D Model, the Macro’s Totem is the IS-LM Model. Leijonhufvud (1973) points out that both castes adore their Totems to such an extent that intermarriages seem impossible. At the same time they collectively are firm believers in their Totems while there is a decreasing amount of implementarists who question both castes’ modls. Overall, the future of the Econ is bleak to put it into Leijonhufvud’s words. The Econ tribe suffers from poverty, high population growth and there is no reason to hope that the disintegration of Econ culture is about to reverse. The political organisation of the Econ is weakening while rural-urban migration is increasing and Econ turnover from dept to dept is on the rise, even for the seniors among the Econs. What is more, Leijonhufvud (1973) predicts “alienation, disorientation, and a general loss of spiritual values” (p. 336) which could mark the end for the tribe in the future.

That is a really brief overview on Leijonhufvud’s paper but there is much more to it and I recommend anyone with a good taste of humour and sarcasm to have a go at it! It really made my day!


Keen, S. (2011). Debunking Economics: The Naked Emperor Dethroned? New York, NY: Zed Books.

Leijonhufvud, A. (1973). Life Among The Econ. Western Economic Journal, 11(3), 327-337. Retrieved from