The second half of my first question to Dr. Cowen is “should government be considered as an endogenous variable?” I must confess that I learned the word “endogenous” only recently after reading “Knowledge and the Wealth of Nations” by David Warsh, which I decided to buy after reading a somewhat positive review on Marginal Revolution.

The main thesis of the book is that “knowledge” should be considered as an endogenous variable in the current macroeconomic models, because doing so solves a conundrum that was already present in Adam Smith’s famous treatise. A simple differential equation might have a “nonhomogenous” term on the right hand side, e.g. the so-called harmonic oscillator equation $x^{\prime\prime}(t)+\omega^2 x(t)=0$ which gives rise to sines and cosines, can have a “forcing term” on the right hand-side: $x^{\prime\prime}(t)+\omega^2 x(t)=F(t)$. In this case the oscillator just responds to the forcing term which must be determined experimentally. Apparently “knowledge” had always been treated as a forcing term to be determined by other methods, but in the last twenty years or so economists have tried to change their equations so that “knowledge” is added as one more variable subject to a feed-back loop which governs its evolution inherently, within the system. The book is fun and informative, but I was disappointed that it didn’t go below the surface: it is highly non-technical and Warsh ends up repeating himself a lot.

Tyler’s answer is that “Yes!” government should be considered as an endogenous variable in equilibrium with other forces, hence it cannot be considered as a sort of puppet where we can just pull some strings and have it do want we want.

In fact, we can pull some strings (vote, yell, etc…) and it does do what we want (more or less), but this in turn affects what strings we pull, and on and on like this. One also wonders if “government” can be quantified with a single variable. What is the total cost of government? What is it’s total burden and it’s total benefit on the economy? How big is Big Government? I don’t know if economists have thought of adding “government” as a new endogenous variable, the way they have tried to add “knowledge”.