I'll keep this thread fully focused on Vicky 3 and try avoid comparisons to Vicky 2. Despite trying to write informally, I was also told that apparently I sounded too academic so I'll attach a ChatGPT rewritten version that sounds more normal. Please like this thread. I do want devs to see this. If you're a dev or a worker at Paradox please pin this. The original includes some jokes and far more detail. However, if you're unable or unwilling to get through the original the chatGPT summarised version isn't that bad. I also didn't proofread this (it's 7000 words long) so please excuse any grammatical mistakes.
Reading through the Dev Diary on Paradox's trade rework is endlessly ironic, because they seem to have identified the same issues as me, and have independently come to a similar solution to mine. However, there still exist the many other issues I have pointed out.
Throughout this thread, I will expand on two key theses: many problems with the game’s portrayal of economics is caused by fixed base prices, and the game’s portrayal of economic growth, particularly surrounding growth in labour productivity, creative destruction and geographic concentration makes the modelling of labour ahistorical and completely unrealistic. I will also, at the end, make some comments on the way the game models the fiscal and monetary system.
I think some people also misinterpret my intention when they see me write so much about economic theory. I do include a lot of economic theory, but this isn't just realism for realism's sake. I believe that the changes I push for will make the game more immersive and generally better. The changes I've listed are with computational load in mind. Most of the computational load in late game stems from having many different pop groups (grouped by building, religion, occupation, and culture) spread around the world each running separate calculations. Apart from the irrationality of consumers (which I didn't suggest a fix for as I couldn't think of one and it wasn't something I desperately needed changed), the additional computational load should be quite light.
Thesis 1: Base Prices
Supply and Demand, and Markets Clear are two truisms everyone learns and parrots back in introductory economics. Yet, the game misunderstands both points. The game views the balance of “supply and demand” as changing prices but never considers the price mechanism nor why they change prices. Markets clear, because fundamentally a shortage of goods causes a gradual rise in prices that keeps rising until demand contracts enough and supply expands enough such that both are at equilibrium again at that higher price. Vice versa for a surplus. The way the game treats good imbalances, however, means that any surplus does not clear but instead exists in the economy, pushing down prices by some fixed percentage. I’ll start with 3 minor gripes I have with the game before I move to the three big points that make clear that base prices severely limit the realism of the economic simulation of the game.
The Void and the Second Law of Thermodynamics
Honestly the subheading is a joke, and it would be funny if not for the fact that Victoria 3 conjures goods ex nihilo to fill shortages and sells unsold goods to the void for a profit and such a system underlies the “price mechanism” of the game. Factories can offload goods they’re ostensibly not supposed to be able to sell to an imaginary buyer such that all goods they produce generate revenue. This is inherently unrealistic, all sellers need a buyer, and it makes persistent surpluses of certain goods, and especially tools, a fact of late game Victoria 3 where every major nation and GP has a surplus of at least a couple thousand tools just lying around. The same can be said for goods conjured ex nihilo. Production penalties are an absolute joke. The production penalty is completely disproportionate to the actual scale of a goods shortage if there is one, on the side of being too lenient. Actual demand can never exceed supply, if there’s a shortage, production just should not be allowed to occur past consumption of all resources produced within the economy.
Utility and Prices
Victoria 3 treats prices and utility as synonymous, as the value any good provides for consumers is based entirely on its base price. From a game balancing point of view, this makes a lot of sense. You don’t want to create a “best” good, because then everyone would try only produce that to satisfy pop consumption needs. From an economic perspective however, this is absurd. While market prices do in effect signal the utility a good provides, as consumers should theoretically only buy a good if its price was lower than the opportunity cost of their money, market prices are best thought of as distributional signals which balance supply and demand for any particular good in an economy. By simply removing the concept of base prices and allowing the price to float freely, price is suddenly no longer tied to utility. However, another problem with utility and price is the consumers.
Irrational Consumers
Rational consumers is an expectation often made fun of by economists and non-economists alike. However, even if we consider consumers to not be completely rational, pops in Victoria 3 take this to a whole new level. They do not adjust consumption at all in response to changes in price, instead, at least from what I’ve heard, they base it on relative production levels of goods. The most egregious example on why this isn’t a good system is heating, where in the early game wood will be extremely expensive due to the presence of your construction sectors. However, pops consume this good which is more expensive in preference to coal which provides the exact same marginal utility.
In introductory microeconomics, students will learn Hicksian demand, demand equalised for the changes in real incomes due to changes in prices. Hicksian demand aims to capture the change in consumer consumption patterns due to a change in price. You’ll also learn convexity in utility functions, which means that consumers will tend to prefer a mix of goods rather than a large quantity of a single good, which is exemplified in the Cobb-Douglas function. The change in relative consumption will move towards where the convexity of utility matches the effect of cheaper prices. Obviously, it doesn’t work like this exactly in real life. However, such a phenomenon can work to explain why people will purchase more expensive goods that serve the same function as a cheaper good so long as they are not perfect substitutes. The main issue with the Victoria 3 system is that all goods ARE perfect substitutes. Thus, based on economic theory, consumers should switch their consumption of goods to substitutes until prices are equal for equal marginal utility. Victoria 3 does not simulate this at all.
Business Cycles
A very key flaw in the economic design of the current game is that there is no such thing as a business cycle. In the time of great financial panics, booms where war economies were being maintained to sustain railway construction, the great depression, and the long depression, there is no business cycle at all to simulate this. Some mods have tried to remedy this by adding a couple events and journal entries to simulate a business cycle, but all these methods are superficial, trying to paper over game design that fundamentally disallows a functional business cycle.
By creating truly floating prices, and with a small adjustment in the investment pool, a simple Keynesian business cycle within the game can be established. Capitalists love certainty and will seek profit. They will thus invest in industries where productivity is very high. This can be modelled in game by having the investment pool construct buildings with a heavy bias toward the buildings with green productivity. This is rational economic behaviour. When prices in the economy only change slowly (perhaps £0.1 a week with size dependent on the scale of the goods imbalance) though, the nominal rigidities in the price of goods will cause capitalists to overinvest in certain industries which leads to a decline in prices. There will be a period in which more goods are being produced even while in oversupply. The price falls slowly, then all at once. The factories have been caught with their pants down and all they can do is lay off staff, cut costs, and shut down. With many workers losing their jobs, the overall demand in the economy contracts too. Other factories uninvolved in the bubble will see their revenues fall as less product is consumed and because prices will begin to dip. Depending on the scale of the bubble, general prices will either decline by a bit before the economy quickly recovers, or in the alternate case prices decline by a lot, and most industries struggle to stay afloat. Due to nominal inelasticity in wages, economic activity contracts significantly. What can be expected is that the least efficient factories (i.e. those will the least throughput) will shut down first. After enough factory shutdowns such that demand again exceeds supply, prices will start climbing again, and the economy will recover from the depression. This system also integrates welfare into the economy as an automatic stabiliser. By giving welfare to the recently laid off, general contagion in the economy is avoided. Cutting government spending under this system will also produce the disastrous effects of austerity that we’ve seen in modern macroeconomies. All of this can be simulated through two simple changes in the Victoria 3 economic system, making it very apparent fixed base prices are terrible for economic realism.
For any real business cycle theory believers, the game with these two changes can also simulate your theory, but I won’t go into more detail as I think me explaining the dynamics of a Victoria 3 business cycle has already gone on for too long.
For example, tool factories in general have a productivity of £50, so capitalists start building tens more tools factories. The factories are built and productivity declines to £40 because the same profit is being split among more workers and because the price has slowly declined. However, this productivity is still green, and so capitalists start building even more tool factories. This reaches a point until the least productive tool factories start losing money, and soon the most productive do too. Let us presume that in this case only the tools were a part of a bubble. The tooling industries start losing money, and they start laying off workers. The number of unemployed workers is not enough to significantly change the demand of goods in the wider economy, and after some factory closures the tooling industries quickly begin to recover and the unemployed workers quickly find work. Let us presume though, that now it wasn’t just the tooling industries that were in a bubble but 8 different industries at once which employ 20-30% of your work force. Once they start laying off workers, your demand for consumer goods starts quickly evaporating, and your least productive consumer industries start becoming unprofitable. Without any automatic stabilisers, contagion spreads throughout the economy, and soon the entire economy starts collapsing. Such a circumstance is viable in the game if only base prices were not a thing.
Sidenote: Historical precedent for this kind of system of overinvesting and overproduction within the Victoria 3 timeframe is abundant. During the 1920s, something like 40% of new cars remained unsold, yet production for cars was still increasing in the US. The influence of private credit and the collapse of global trade (which significantly decreased demand for American made products) also contributed to the later depression. Although this system can represent the disastrous implications of a trade war as demand for exports decreases, it cannot simulate retaliatory tariffs applied in a trade war. It also cannot simulate the tremendous influence private debt plays on our economies which I will discuss later in my final section.
Trade
Trade is integral to any economy. Under the theory of comparative advantage, countries should specialise in producing certain goods which they then export to earn the necessary foreign exchange to buy imports from other countries who have specialised in producing other goods. This optimises the efficiency of good production. I have it on good account that the game devs want to simulate the importance of global trade from them saying as such in their dev diary introducing companies. Why is trade never important in the game though? It’s because every single country has the exact same baseline price for any good. You would thus only ever export or import goods in the case of a shortage or surplus of a good. Companies in the game provide throughput efficiency. However, as of right now, due to the problem of base prices, throughput efficiency’s benefit is solely to increase the productivity of a factory and thus directly or indirectly boost the incomes and SoL of your nation. In real life, when nations are more efficient at producing a good, they can sell the product at a lower price and most often do. When a good is produced very cheaply in another country, it is imported into the country at that lower price point, undercutting most if not all domestic competition and providing great economic benefit to consumers and downstream industries utilising that product. When prices are homogenous, this cannot occur.
In a system without base prices, high throughput factories will produce lower price goods due to the simple fact that they have higher labour productivity and smaller unit labour costs. Companies serve to reinforce a country’s comparative advantage in boosting a certain sector’s throughput. Countries can import input goods, and export completed goods based on what their companies and industries are specialised in. This heavily incentivises players and AI to import everything that they don’t produce well and export everything they do produce well. All of this is accomplished through eliminating the system of base prices.
Furthermore, such a system will demonstrate some of the dynamics of globalisation we’ve seen in the late 20th century, and some of the drawbacks of free trade. To paraphrase from Professor Ha-Joon Chang, once you open the doors to free trade, your industrial development effectively stops. For the industries unable to compete against global competitors, they have no prospects, and their development stops before either shutting down, or being on perpetual government life support. Free trade gives all your country’s consumers an immediate surge in SoL as real incomes increase by getting access to cheaply made products around the world, but it will also destroy all industry in non-competitive sectors. It also allows for outsourcing of factories into countries with up to date technology and lower labour costs. In this manner, the incentive to protect certain darling industries which may be strategically important like military production or budding industries which are not yet fully developed can be demonstrated in the game. This increases the economic dynamism of the game through merely allowing prices to float rather than having base prices.
Of course, there is also New Trade Theory as described by Krugman and other economists, but as it relates heavily to my criticism of the way the game models production, I’ll discuss it as a part of my second thesis.
Money Itself Represents Real Economic Wealth
Money, as encapsulated by modern mainstream economic theory is merely a lubricant to exchange of goods and services. It is a medium of exchange and not an actual resource. This is even taken by neoclassical economists to the point whereby money is described as a “veil over barter”. The main problem with Victoria 3 in this sense is that money is an actual resource. When you get or spawn in money, you automatically spawn in an infinite quantity of resources. Thanks to being able to spawn goods ex nihilo out of the void, and because prices can only rise 75% above the base price, in many cases you’re just better off eating the 175% price for goods. Production penalties due to goods shortages makes this slightly unfair, as you’re not truly getting unlimited amounts of goods. However, have you considered giving this money to the people instead? There exists no such thing as a shortage for consumer goods. Pops will simply pay the 75% premium and potentially enjoy thousands of goods ostensibly not being produced yet contributing to their SoL.
Money is a fake resource and a medium of exchange, yet in the game when money is generated, real economic wealth is also generated. It should be that the real economic wealth in an economy backs up the value of money, which is why hyperinflation can occur, but in this game the value of money creates real economic wealth in a country. This is best exemplified by my go to early game strategy whereby I maximise taxes, cut spending, and run 10 more construction sectors than I can afford. I go into a massive iron shortage, cut everyone’s disposable income, and wreck the economy. In 3 short years my economy’s better than ever before. In real life, this level of deficit spending would not only cause inflation, but it would also not increase real economic wealth. The iron shortage indicates that the economy did not have the capacity to absorb the construction surge I saddled my economy with on game start. However, thanks to money itself being a real economic resource in the game, my strategy is reasonably optimal from a gameplay point of view.
There’s also the issue whereby free trade can generate free SoL by virtue of trade triangle doom loops. Country A will export a good to country B, which exports it to country C, which in turn exports it to country A. Because each trade route is “profitable”, each trade route generates real economic wealth despite nothing being produced, because they generate money. Trade should not be some weird rent extraction machine that somehow provides free SoL through questionable means but a means of maximising the efficiency of production through specialisation. Such a system whereby countries can export things in a doom loop is also because of base prices, but I will also discuss a system whereby this phenomenon is avoided altogether.
Thesis 2: Misunderstandings in Economic Growth and Development Economics
The model of growth in Victoria 3 seems almost like a carbon copy of the Soviet style of development, before it was adjusted by an anarcho-capitalist. You build factories and force workers to move to factory jobs to increase productivity. Afterwards, changing PMs becomes one of your three viable sources of productivity growth. The second source of productivity growth, economies of scale, incentivises building massive conglomerates that have monopolistic control over your market. The third source of productivity growth, companies, suddenly means you should grant your state owned monopoly to a private monopoly to administer instead. The only detriment to this style of development is MAPI, which discourages geographic concentration as local prices crater in your production megacity and soar everywhere else. Techs increase MAPI which make building these kinds of production megacities more and more viable late game, but this fundamentally misunderstands the reasons for, and growth of geographic concentration. Geographic concentration is also very different to the concept of economies of scale, and the game heavily misunderstands this. I will use these three points as the pillars for my argument.
Growth in Labour Productivity
For an economist utilising the Solow growth model, two things increase the size of the economy: growth in stock of knowledge, and growth in labour. Thus, economists will often multiply the two to derive “aggregate labour”. Why does growth in capital not grow the economy? It does, but in a neoclassical growth model, for any level of saving, growth in stock of knowledge, and growth in labour, capital will reach a steady state, the balanced growth path, whereby capital per unit of effective labour will be stagnant unless the savings rate changes. Using an endogenous growth model, in which spending on R&D can boost the growth rate of stock of knowledge in the economy, the above fact that economic growth is driven by growth in aggregate labour is still not changed. Economic growth year over year is driven by the incremental gains in labour productivity over time, and growth in working age population.
In the game however, the growth in knowledge stock is fully abstracted away solely into production methods which form the backbone of what makes your workers more productive. This is not accurate to real world economic development in the 19th and 20th centuries nor to economic. Carnegie steel, despite still using the Bessemer process, was producing more and more steel each year per worker for all its history. The same can be said for the entire US steel industry which produced more and more steel per worker each year across the entire 19th century. Very often it’s the incremental improvements in stock of knowledge and production processes that form a competitive advantage and serve to heavily boost worker productivity over time.
Production methods in the game should not form the foundation of productivity improvements. They should instead represent disruptions to prior modes of production itself. Factories and the investment pool should be able to invest in existing factories to improve the stock of knowledge and to boost their production. Simulating investment into R&D as captured by various endogenous growth models, investments into existing factories should increase the throughput efficiency of the factory. There should be a cap on the maximum throughput efficiency gain you can obtain based on these investments, representing the point where you’ve squeezed out all the potential for a production method. To increase production, you need to find a new method of production. The cap on throughput increase should be higher for more advanced PMs since they have more potential. These productivity improvements can be wiped upon the introduction of a new production method. In this way, the game can also simulate the declines in production that may occur when transitioning over to a radically new production process as new procedures and productivity improvements have yet to be figured out. This system also heavily alleviates the mid game issue of running out of population to industrialise which wasn’t an issue in real life. The reason for this was that economic growth was primarily driven by these incremental boosts in productivity, which the game would now capture.
For example, let us presume that there exists a textile mill of size 30. It has a base throughput of +30%. Now, let’s say it’s on dye workshops as a PM. This PM affords the 30 levels of building each a £3 million cap for throughput investment. Each million pounds provides a +5% throughput efficiency gain. Thus, by investing £50 million, you can get a 250% throughput gain, essentially tripling the production of the exact same textile mills through investments in productivity improvements on the same PM. Reading the details of this system, you might think it’s unfair that massive productivity improvements should be prioritised to the big factories. However, it is the fairest and most realistic. A key insight captured by Romer’s endogenous growth model is that the growth rate of knowledge is influenced by investor time preference, substitutability of inputs, R&D productivity, and the size of the population. The last one is what matters in this case. Following the details of the model, it should be the largest factories and the largest countries that capture the greatest boons from R&D. This plays out in real life too. Who do you think benefits the most from industrial agriculture or improvements in production lines? And who do you think comes up with innovations on them? Smaller farms and factories obviously have less of an ability to implement and discover these improvements. Furthermore, it also means that smaller countries should specialise in a far smaller range of industries than big countries, which also mirrors historical economic development. More on this will be discussed in the section about geographic concentration and New Trade Theory.
Another complaint I have about the way PMs are represented is the complete lack of structural unemployment and how when jobs are cut, they’re also added back as jobs which require higher qualifications. This isn’t very major and can mostly be ignored. To fix the issue of no structural unemployment, I believe that there should be slightly less higher qualification jobs than existed before as labourer jobs. They shouldn’t cut as many jobs as a labour saving PMs, but they should slightly reduce the number of workers to reflect the diminishing need for labour in technologically more advanced production as each labourer becomes far more efficient. They will struggle finding jobs, leaving them open for migration and working in the budding new industries you unlock later in the game, which should also help the AI open these industries. There should also be a slightly higher barrier for labourers to transition into higher qualification jobs. Unemployment then won’t entirely be frictional as it is in the current game.
Sidenote: The investment pool should have a heavier weight in investing in new resources that have been generated. This simulates the optimism and speculative mania that often surrounds new technologies (think dot com bubble and current AI hype), as well as making it so that AI will organically switch to new PMs instead of being stuck on the old ones. This process can also simulate the speculative bubbles of the Victorian age like the railway mania.
Geographic Concentration and New Trade Theory
Paradox heavily misunderstands and mismodels why geographic concentration occurs. I’ll admit that I do not know very much about this topic as I have neither taken classes on it nor wrote research on it, and I can’t be bothered to read a 50 page paper on the Geographic Concentration of Enterprise in Developing Countries. You can find it yourself by googling The Geographic Concentration of Enterprise in Developing Countries, Felkner and Townsend MIT UChicago. Although I don’t know much about the topic, I still know enough to contest Paradox’s implementation of concepts like MAPI. Let’s first discuss the problem with the concept of a “market price” prevalent throughout the entire market. What defines this market price? Would it be something like the spot price on an exchange like the LME? Or would it be the average price of a good across all local markets? Paradox says neither. Though considering how the stock exchange tech gives you +10% MAPI, I feel it prioritises the former definition. The market price is the price determined by the supply and demand of goods throughout the entire market. Local markets have prices based on this market price and then partially through local supply and demand. Instead of a bottom up system of price discovery, this is purely top down. It also fails to capture the market dynamics shaping local prices. Any town or city cannot produce all the products it consumes, thus a large proportion of the goods consumed are imported. Does this mean you pay the going market rate and more or less depending on if your place of residence produces a good or not? Not at all. Why not is pretty apparent. The local producers of a good are often far less efficient in production than big multinational chains who benefit from massive economies of scale. They don’t shape your local costs at all. What determines the price you pay is the cost of production, the transportation cost, and the markups applied in each step of the trade. MAPI thus runs counter to reality.
From a gameplay point of view, I can understand wanting to encourage vertical monopolies to simulate geographic concentration which I will discuss shortly. I can also understand wanting players to spread production across different states, at least in the early game, so players don’t build 5 megacities that supply the entire rest of the country. Instead of keeping MAPI though, which fails to model the dynamics shaping local prices, a shipping feature can be added. This serves to emphasise the importance of railways and better port infrastructure which was critical to the development of the economy during the Victorian age. States with local supply surpassing local demand will attempt to offload the excess production onto other states. States where local demand is greater than local supply will attempt to import the shortage from the closest state in the same market, or a different market with an active import route. However, for each unit of goods being shipped, there is a necessary consumption of the transportation good (let’s say 0.25 transportation per good being shipped) for each state that the good passes through. This makes building transcontinental railways vital for the United States’ and Russia’s development just as it was in our own timeline. This also means that better rail infrastructure which means cheaper and more abundant transportation will mean cheaper goods which allow you to build megacities late game. It also means however, that the megacities of production cannot be concentrated all in one place, as then the state on the other side of your country will be stuck paying sky high prices for goods due to excessive transportation costs. Without rail infrastructure and the transportation good, the costs for moving goods across states is very expensive, and so states are only able to ship goods across one state at tremendous cost. This means that in early game Victoria 3 without railways, your economy is extremely fragmented between states which effectively operate their own local economy. This is akin to pre-industrialisation England where different communities developed functionally independent languages and different economies due to lack of widespread intracountry trade. This is merely the process for landlocked states.
For states with a port a slightly different system is in place. Ports instead of being government owned and run and purely loss making will be run like railways. There will be a market price for the price of a convoy. For each sea tile a good needs to be transported, the more convoys are needed to be consumed for each good. For example, let’s suppose that a good needs to be transported from London to New York and there are four sea tiles between them. Each convoy can transport 10 goods, and an extra convoy is consumed for each sea tile the trade route passes through. This simulates how shipping goods by sea also incurred costs and avoids the doom loops that occur on free trade when shipping is free. As port infrastructure naturally improves with greater techs, convoys become cheaper and cheaper and global trade will thus naturally increase. This system also makes the canals potentially profitable, as money can be charged for each convoy passing through the canal as a sea tile which does not consume a convoy. In this way the convoy savings from using the canals enriches both the canal holder as well as the buyers and sellers of goods as shipping costs decrease. In terms of mixing land and sea transportation, in the case of a landlocked state whose closest import state is a landlocked state across a sea, it will simply use the above processes as described based on the route the goods must take.
Another benefit of this system is that it simulates the economic theory of trade gravity. Trade gravity is a model formed around the econometric observation that countries tend to trade more with countries that are nearby rather than countries that are further away. One possible explanation is due to transportation costs being lower, while another is based on a theory of trade frictions, and another is based on a theory of geographical and cultural/historic ties to countries closer to you. There is no unified explanation for why it occurs, but a very strong tendency for it has been shown. The game, however, can demonstrate it so long as it follows the above system of trade.
Let me now move on to another problem with the way the game models geographic concentration. Geographic concentration primarily occurs because industry seeks to position itself near 3 things: qualified workers, intermediate goods, and transportation infrastructure. There is also a fourth benefit which is spillovers in knowledge and innovation. Positive feedback loops reinforce this cycle, which cements certain places as hubs of manufacturing. Let me demonstrate these points with a couple of examples.
Silicon Valley is the hub of computing and technology in the world because it has a large pool of qualified tech workers that live there. This was because Stanford students lived in the area where the university established an industrial park. These students went on to create tech firms which attracted qualified tech workers around the country to Silicon Valley. This large concentration of tech workers in Silicon Valley encouraged all the big tech firms to headquarter themselves there, attracting even more tech workers.
Pittsburgh was once called the steel city. The reason for this was because Pennsylvania had a large coal and iron industry which led to Carnegie Steel headquartering itself there. This meant that steel workers moved to Pittsburgh to obtain a job, meanwhile the production of steel drove up the demand for iron and coal, which meant that even more intermediate goods for steel were being produced.
Detroit and Michigan’s access to the Great Lakes in the age of the steam ship meant that industrial production could be cheaply shipped across the country and world. Cheap shipping meant industry could concentrate within the one city. Infrastructure was built to facilitate the Detroit car industry including a dedicated rubber and steel supply chain. This meant that car manufacturing was most easily and cheaply done in Detroit, which only strengthened the established supply lines, meaning there was even more benefit to car manufacturing in Detroit.
All three cases also benefitted from knowledge spillovers and transfers, in which nearby situated competitors can learn from each other increasing efficiency and surpassing the efficiency of those locked out of the ecosystem built up around a particular industry. (This only further demonstrates why throughput efficiency bonus from investment should be capped based on factory size).
The game fails to capture this. Increasing the requirements to transition to a new job and introducing new job types should address the first issue (though there are lag concerns with the latter). The proposed system of shipping should fix the second issue, but giving intermediate goods buildings small throughput bonuses to their final good’s factories should strengthen this effect (such as iron mines giving steel mills a 0.1% throughput bonus per level or engines giving power plants a 0.1% throughput bonus per level). The last issue can be resolved by giving established trade routes a ticking discount on cost based on how long it has lasted as well as giving more states the natural harbour terrain modifier. These harbours will produce cheaper convoys, allowing for cheaper exports from certain states’ factories. (Also, you really have to let the Great Lakes have harbours).
Let me first explain what New Trade Theory is. In the Cobb-Douglas function, which underlies a relatively large portion of macroeconomic analysis, production is presumed to have constant returns to scale. Essentially, if you double the labour and capital inputs, assuming the same stock of knowledge, your outputs should double. New Trade Theory states that investments in certain industries bring increasing returns to scale. This means that even countries with identical levels of comparative advantage still benefit from trade. This is because of economies of scale. Thus, the cap for investment in industry should be massive, encouraging countries to really specialise in just a handful of niches which they export. Even big countries should not be able to specialise in every industry. Smaller countries can afford to specialise in even less industries as they have less labour and capital. If they want to maximise their economies of scale, they can only focus on a couple of specific niches. For instance, I often make fun of Korea for playing themselves, making themselves into a modern day cyberpunk dystopia due to its economic development style of utilising national champions. Based on the economics of New Trade Theory, South Korea’s focus on a few national champions produced a market dominance which meant they could achieve massive economies of scale and specialisation. While they were still protected from outside competition, they rapidly developed a market dominance that meant they could compete with foreign companies which also had economies of scale. Once the South Koreans embraced free trade, these companies were competitive in the global market. Economies of scale is also represented poorly in the game, which I will discuss in my final section about competition, monopolies and economies of scale.
Sidenote: GDP calculation is based on market prices and not state prices, so increasing MAPI, which has the real effect of decreasing prices for many people and boosting real GDP has no effect on GDP. Granted, this complaint is superfluous.
Competition, Monopolies, and Economies of Scale
The game does not model market competition at all, nor does try to. I don’t fault the game for that. Creating an implicitly tiered system of factories by factory throughput where some are more productive than others and some fold in a recession essentially simulates how unproductive businesses die. The way the game rewards you for creating companies that have a monopoly over your entire industry though, is a very large issue. Monopolies have various deleterious effects on a national economy. Foremost is that a monopoly has no incentive to innovate. Their sole purpose is to extract rents from the economy to enrich their owners. They also have market power, meaning prices are not placed at an optimal level, but instead at a level which maximises profits for the monopoly. The substitution effect is often used to describe how consumers will switch to using substitutes if the price changes. What’s often not considered is how inputs are also subject to the substitution effect. When goods are priced too high, some uses for a product which may bring massive societal benefit are made unavailable. This is the case with long distance communication. The advent of the internet was in large part driven by the massive reductions in cost of telecommunications brought about by the destruction of AT&T. None of this is simulated in Victoria 3. Instead, if someone were to attempt to learn economics from Victoria 3, they would walk away thinking monopolies were good. To fix this, companies in Victoria 3 should switch between two modes: rent-seeking, and competitive. Under a rent-seeking mode, which they will automatically switch to if they control over 50% of the supply of a good, they will increase prices and cut production to maximise profit. They won’t reinvest any profits into increasing productive efficiency and they give massive payouts to the workers of the company headquarters. If the company is competitive, they should reinvest most of their profits into increasing throughput efficiency, with a smaller proportion going to the investment pool and paying their workers. There should also be a new economic law on monopoly regulation which prevents rent-seeking behaviour from emerging at all if passed.
Paradox’s current economies of scale system is extremely bad. Also, why does government control necessarily lower the economies of scale of a business? If anything, government run companies in the Soviet style have the biggest economies of scale because they were functional monopolies. The reason they were inefficient and why government run firms are inefficient in general is because when firms are monopolies without competition, or when they’re shielded from competition, there is little reason to innovate or invest in firm operations. The reason Soviet growth slowed in the 60s and 70s isn’t because everything was owned by the government, but because they weren’t making the iterative improvements that contribute to economic growth. After everyone was moved from a farm to a factory, the factories’ productivity almost did not grow at all. This was because they were functional monopolies, and with government support, there was very little need to innovate. If there were a way for governments to create market competition, select the best ideas, implement these ideas, and allow for the firms which implement the best ideas to grow while the bad firms are destroyed, then government control is identical to private control. Of course, there is no way to know ahead of time which idea is the best idea. This can be represented in game by disallowing or severely reducing the efficiency of direct government investment into buildings. As for any economy of scale bonuses, the bonus for a building perhaps can match the highest ownership level for a building. So, for instance, a level 50 building with 30 levels owned by a single company will produce a 30% economy of scale bonus. This is because economies of scale are for single businesses which can centralise fixed costs and spread them out across the massive quantity of goods they produce. However, I also think there is decent enough reason to fully abolish economies of scale as they exist now. The bonuses and systems I have listed above already benefit high building levels enough.
Fiscal Policy and Monetary Policy
Fiscal Policy and Government Debt
The problem with fiscal policy as represented in the game is the complete lack of any depiction of crowding out. Buying government debt is not represented as the investment that it is. When people save money for a rainy day fund, they don’t buy government bonds with that money. They save it as cash. Government debt is an investment, and so government deficits should be financed via the investment pool and not the cash reserves of buildings which I think are ludicrously high. Generally, businesses don’t like having massive piles of cash just sitting around in their vaults doing nothing. They will either attempt to invest that money or hand it out to investors in the form of dividends. This has only changed in recent years because of pro-business policies that encourage supply and not demand and the GFC. It’s because of a lack of demand which means companies cannot expand operations that they are sitting on a massive pile of cash and liquid investments: $100 billion in the case of Apple. The primary effect of this change means that as the investment pool is what contributes to growth in productivity, the government deficit constrains private investments. This simulates the crowding out effect.
Monetary Policy
I’ll be honest, I have 0 clue how the monetary system works in Victoria 3 and so I won’t speak too much on it. However, I think there should be consideration for a private debt system. Banks create money upon issuing private debt. This is simultaneously a good and a bad thing. It’s private debt which can cause an extended depression because it’s too high. There is also debt deflation as described by Fisher. However, good loans can finance investments and consumption that drives productive growth in the economy. An implementation of a private debt system should be considered.
Reading through the Dev Diary on Paradox's trade rework is endlessly ironic, because they seem to have identified the same issues as me, and have independently come to a similar solution to mine. However, there still exist the many other issues I have pointed out.
Throughout this thread, I will expand on two key theses: many problems with the game’s portrayal of economics is caused by fixed base prices, and the game’s portrayal of economic growth, particularly surrounding growth in labour productivity, creative destruction and geographic concentration makes the modelling of labour ahistorical and completely unrealistic. I will also, at the end, make some comments on the way the game models the fiscal and monetary system.
I think some people also misinterpret my intention when they see me write so much about economic theory. I do include a lot of economic theory, but this isn't just realism for realism's sake. I believe that the changes I push for will make the game more immersive and generally better. The changes I've listed are with computational load in mind. Most of the computational load in late game stems from having many different pop groups (grouped by building, religion, occupation, and culture) spread around the world each running separate calculations. Apart from the irrationality of consumers (which I didn't suggest a fix for as I couldn't think of one and it wasn't something I desperately needed changed), the additional computational load should be quite light.
Thesis 1: Base Prices
Supply and Demand, and Markets Clear are two truisms everyone learns and parrots back in introductory economics. Yet, the game misunderstands both points. The game views the balance of “supply and demand” as changing prices but never considers the price mechanism nor why they change prices. Markets clear, because fundamentally a shortage of goods causes a gradual rise in prices that keeps rising until demand contracts enough and supply expands enough such that both are at equilibrium again at that higher price. Vice versa for a surplus. The way the game treats good imbalances, however, means that any surplus does not clear but instead exists in the economy, pushing down prices by some fixed percentage. I’ll start with 3 minor gripes I have with the game before I move to the three big points that make clear that base prices severely limit the realism of the economic simulation of the game.
The Void and the Second Law of Thermodynamics
Honestly the subheading is a joke, and it would be funny if not for the fact that Victoria 3 conjures goods ex nihilo to fill shortages and sells unsold goods to the void for a profit and such a system underlies the “price mechanism” of the game. Factories can offload goods they’re ostensibly not supposed to be able to sell to an imaginary buyer such that all goods they produce generate revenue. This is inherently unrealistic, all sellers need a buyer, and it makes persistent surpluses of certain goods, and especially tools, a fact of late game Victoria 3 where every major nation and GP has a surplus of at least a couple thousand tools just lying around. The same can be said for goods conjured ex nihilo. Production penalties are an absolute joke. The production penalty is completely disproportionate to the actual scale of a goods shortage if there is one, on the side of being too lenient. Actual demand can never exceed supply, if there’s a shortage, production just should not be allowed to occur past consumption of all resources produced within the economy.
Utility and Prices
Victoria 3 treats prices and utility as synonymous, as the value any good provides for consumers is based entirely on its base price. From a game balancing point of view, this makes a lot of sense. You don’t want to create a “best” good, because then everyone would try only produce that to satisfy pop consumption needs. From an economic perspective however, this is absurd. While market prices do in effect signal the utility a good provides, as consumers should theoretically only buy a good if its price was lower than the opportunity cost of their money, market prices are best thought of as distributional signals which balance supply and demand for any particular good in an economy. By simply removing the concept of base prices and allowing the price to float freely, price is suddenly no longer tied to utility. However, another problem with utility and price is the consumers.
Irrational Consumers
Rational consumers is an expectation often made fun of by economists and non-economists alike. However, even if we consider consumers to not be completely rational, pops in Victoria 3 take this to a whole new level. They do not adjust consumption at all in response to changes in price, instead, at least from what I’ve heard, they base it on relative production levels of goods. The most egregious example on why this isn’t a good system is heating, where in the early game wood will be extremely expensive due to the presence of your construction sectors. However, pops consume this good which is more expensive in preference to coal which provides the exact same marginal utility.
In introductory microeconomics, students will learn Hicksian demand, demand equalised for the changes in real incomes due to changes in prices. Hicksian demand aims to capture the change in consumer consumption patterns due to a change in price. You’ll also learn convexity in utility functions, which means that consumers will tend to prefer a mix of goods rather than a large quantity of a single good, which is exemplified in the Cobb-Douglas function. The change in relative consumption will move towards where the convexity of utility matches the effect of cheaper prices. Obviously, it doesn’t work like this exactly in real life. However, such a phenomenon can work to explain why people will purchase more expensive goods that serve the same function as a cheaper good so long as they are not perfect substitutes. The main issue with the Victoria 3 system is that all goods ARE perfect substitutes. Thus, based on economic theory, consumers should switch their consumption of goods to substitutes until prices are equal for equal marginal utility. Victoria 3 does not simulate this at all.
Business Cycles
A very key flaw in the economic design of the current game is that there is no such thing as a business cycle. In the time of great financial panics, booms where war economies were being maintained to sustain railway construction, the great depression, and the long depression, there is no business cycle at all to simulate this. Some mods have tried to remedy this by adding a couple events and journal entries to simulate a business cycle, but all these methods are superficial, trying to paper over game design that fundamentally disallows a functional business cycle.
By creating truly floating prices, and with a small adjustment in the investment pool, a simple Keynesian business cycle within the game can be established. Capitalists love certainty and will seek profit. They will thus invest in industries where productivity is very high. This can be modelled in game by having the investment pool construct buildings with a heavy bias toward the buildings with green productivity. This is rational economic behaviour. When prices in the economy only change slowly (perhaps £0.1 a week with size dependent on the scale of the goods imbalance) though, the nominal rigidities in the price of goods will cause capitalists to overinvest in certain industries which leads to a decline in prices. There will be a period in which more goods are being produced even while in oversupply. The price falls slowly, then all at once. The factories have been caught with their pants down and all they can do is lay off staff, cut costs, and shut down. With many workers losing their jobs, the overall demand in the economy contracts too. Other factories uninvolved in the bubble will see their revenues fall as less product is consumed and because prices will begin to dip. Depending on the scale of the bubble, general prices will either decline by a bit before the economy quickly recovers, or in the alternate case prices decline by a lot, and most industries struggle to stay afloat. Due to nominal inelasticity in wages, economic activity contracts significantly. What can be expected is that the least efficient factories (i.e. those will the least throughput) will shut down first. After enough factory shutdowns such that demand again exceeds supply, prices will start climbing again, and the economy will recover from the depression. This system also integrates welfare into the economy as an automatic stabiliser. By giving welfare to the recently laid off, general contagion in the economy is avoided. Cutting government spending under this system will also produce the disastrous effects of austerity that we’ve seen in modern macroeconomies. All of this can be simulated through two simple changes in the Victoria 3 economic system, making it very apparent fixed base prices are terrible for economic realism.
For any real business cycle theory believers, the game with these two changes can also simulate your theory, but I won’t go into more detail as I think me explaining the dynamics of a Victoria 3 business cycle has already gone on for too long.
For example, tool factories in general have a productivity of £50, so capitalists start building tens more tools factories. The factories are built and productivity declines to £40 because the same profit is being split among more workers and because the price has slowly declined. However, this productivity is still green, and so capitalists start building even more tool factories. This reaches a point until the least productive tool factories start losing money, and soon the most productive do too. Let us presume that in this case only the tools were a part of a bubble. The tooling industries start losing money, and they start laying off workers. The number of unemployed workers is not enough to significantly change the demand of goods in the wider economy, and after some factory closures the tooling industries quickly begin to recover and the unemployed workers quickly find work. Let us presume though, that now it wasn’t just the tooling industries that were in a bubble but 8 different industries at once which employ 20-30% of your work force. Once they start laying off workers, your demand for consumer goods starts quickly evaporating, and your least productive consumer industries start becoming unprofitable. Without any automatic stabilisers, contagion spreads throughout the economy, and soon the entire economy starts collapsing. Such a circumstance is viable in the game if only base prices were not a thing.
Sidenote: Historical precedent for this kind of system of overinvesting and overproduction within the Victoria 3 timeframe is abundant. During the 1920s, something like 40% of new cars remained unsold, yet production for cars was still increasing in the US. The influence of private credit and the collapse of global trade (which significantly decreased demand for American made products) also contributed to the later depression. Although this system can represent the disastrous implications of a trade war as demand for exports decreases, it cannot simulate retaliatory tariffs applied in a trade war. It also cannot simulate the tremendous influence private debt plays on our economies which I will discuss later in my final section.
Trade
Trade is integral to any economy. Under the theory of comparative advantage, countries should specialise in producing certain goods which they then export to earn the necessary foreign exchange to buy imports from other countries who have specialised in producing other goods. This optimises the efficiency of good production. I have it on good account that the game devs want to simulate the importance of global trade from them saying as such in their dev diary introducing companies. Why is trade never important in the game though? It’s because every single country has the exact same baseline price for any good. You would thus only ever export or import goods in the case of a shortage or surplus of a good. Companies in the game provide throughput efficiency. However, as of right now, due to the problem of base prices, throughput efficiency’s benefit is solely to increase the productivity of a factory and thus directly or indirectly boost the incomes and SoL of your nation. In real life, when nations are more efficient at producing a good, they can sell the product at a lower price and most often do. When a good is produced very cheaply in another country, it is imported into the country at that lower price point, undercutting most if not all domestic competition and providing great economic benefit to consumers and downstream industries utilising that product. When prices are homogenous, this cannot occur.
In a system without base prices, high throughput factories will produce lower price goods due to the simple fact that they have higher labour productivity and smaller unit labour costs. Companies serve to reinforce a country’s comparative advantage in boosting a certain sector’s throughput. Countries can import input goods, and export completed goods based on what their companies and industries are specialised in. This heavily incentivises players and AI to import everything that they don’t produce well and export everything they do produce well. All of this is accomplished through eliminating the system of base prices.
Furthermore, such a system will demonstrate some of the dynamics of globalisation we’ve seen in the late 20th century, and some of the drawbacks of free trade. To paraphrase from Professor Ha-Joon Chang, once you open the doors to free trade, your industrial development effectively stops. For the industries unable to compete against global competitors, they have no prospects, and their development stops before either shutting down, or being on perpetual government life support. Free trade gives all your country’s consumers an immediate surge in SoL as real incomes increase by getting access to cheaply made products around the world, but it will also destroy all industry in non-competitive sectors. It also allows for outsourcing of factories into countries with up to date technology and lower labour costs. In this manner, the incentive to protect certain darling industries which may be strategically important like military production or budding industries which are not yet fully developed can be demonstrated in the game. This increases the economic dynamism of the game through merely allowing prices to float rather than having base prices.
Of course, there is also New Trade Theory as described by Krugman and other economists, but as it relates heavily to my criticism of the way the game models production, I’ll discuss it as a part of my second thesis.
Money Itself Represents Real Economic Wealth
Money, as encapsulated by modern mainstream economic theory is merely a lubricant to exchange of goods and services. It is a medium of exchange and not an actual resource. This is even taken by neoclassical economists to the point whereby money is described as a “veil over barter”. The main problem with Victoria 3 in this sense is that money is an actual resource. When you get or spawn in money, you automatically spawn in an infinite quantity of resources. Thanks to being able to spawn goods ex nihilo out of the void, and because prices can only rise 75% above the base price, in many cases you’re just better off eating the 175% price for goods. Production penalties due to goods shortages makes this slightly unfair, as you’re not truly getting unlimited amounts of goods. However, have you considered giving this money to the people instead? There exists no such thing as a shortage for consumer goods. Pops will simply pay the 75% premium and potentially enjoy thousands of goods ostensibly not being produced yet contributing to their SoL.
Money is a fake resource and a medium of exchange, yet in the game when money is generated, real economic wealth is also generated. It should be that the real economic wealth in an economy backs up the value of money, which is why hyperinflation can occur, but in this game the value of money creates real economic wealth in a country. This is best exemplified by my go to early game strategy whereby I maximise taxes, cut spending, and run 10 more construction sectors than I can afford. I go into a massive iron shortage, cut everyone’s disposable income, and wreck the economy. In 3 short years my economy’s better than ever before. In real life, this level of deficit spending would not only cause inflation, but it would also not increase real economic wealth. The iron shortage indicates that the economy did not have the capacity to absorb the construction surge I saddled my economy with on game start. However, thanks to money itself being a real economic resource in the game, my strategy is reasonably optimal from a gameplay point of view.
There’s also the issue whereby free trade can generate free SoL by virtue of trade triangle doom loops. Country A will export a good to country B, which exports it to country C, which in turn exports it to country A. Because each trade route is “profitable”, each trade route generates real economic wealth despite nothing being produced, because they generate money. Trade should not be some weird rent extraction machine that somehow provides free SoL through questionable means but a means of maximising the efficiency of production through specialisation. Such a system whereby countries can export things in a doom loop is also because of base prices, but I will also discuss a system whereby this phenomenon is avoided altogether.
Thesis 2: Misunderstandings in Economic Growth and Development Economics
The model of growth in Victoria 3 seems almost like a carbon copy of the Soviet style of development, before it was adjusted by an anarcho-capitalist. You build factories and force workers to move to factory jobs to increase productivity. Afterwards, changing PMs becomes one of your three viable sources of productivity growth. The second source of productivity growth, economies of scale, incentivises building massive conglomerates that have monopolistic control over your market. The third source of productivity growth, companies, suddenly means you should grant your state owned monopoly to a private monopoly to administer instead. The only detriment to this style of development is MAPI, which discourages geographic concentration as local prices crater in your production megacity and soar everywhere else. Techs increase MAPI which make building these kinds of production megacities more and more viable late game, but this fundamentally misunderstands the reasons for, and growth of geographic concentration. Geographic concentration is also very different to the concept of economies of scale, and the game heavily misunderstands this. I will use these three points as the pillars for my argument.
Growth in Labour Productivity
For an economist utilising the Solow growth model, two things increase the size of the economy: growth in stock of knowledge, and growth in labour. Thus, economists will often multiply the two to derive “aggregate labour”. Why does growth in capital not grow the economy? It does, but in a neoclassical growth model, for any level of saving, growth in stock of knowledge, and growth in labour, capital will reach a steady state, the balanced growth path, whereby capital per unit of effective labour will be stagnant unless the savings rate changes. Using an endogenous growth model, in which spending on R&D can boost the growth rate of stock of knowledge in the economy, the above fact that economic growth is driven by growth in aggregate labour is still not changed. Economic growth year over year is driven by the incremental gains in labour productivity over time, and growth in working age population.
In the game however, the growth in knowledge stock is fully abstracted away solely into production methods which form the backbone of what makes your workers more productive. This is not accurate to real world economic development in the 19th and 20th centuries nor to economic. Carnegie steel, despite still using the Bessemer process, was producing more and more steel each year per worker for all its history. The same can be said for the entire US steel industry which produced more and more steel per worker each year across the entire 19th century. Very often it’s the incremental improvements in stock of knowledge and production processes that form a competitive advantage and serve to heavily boost worker productivity over time.
Production methods in the game should not form the foundation of productivity improvements. They should instead represent disruptions to prior modes of production itself. Factories and the investment pool should be able to invest in existing factories to improve the stock of knowledge and to boost their production. Simulating investment into R&D as captured by various endogenous growth models, investments into existing factories should increase the throughput efficiency of the factory. There should be a cap on the maximum throughput efficiency gain you can obtain based on these investments, representing the point where you’ve squeezed out all the potential for a production method. To increase production, you need to find a new method of production. The cap on throughput increase should be higher for more advanced PMs since they have more potential. These productivity improvements can be wiped upon the introduction of a new production method. In this way, the game can also simulate the declines in production that may occur when transitioning over to a radically new production process as new procedures and productivity improvements have yet to be figured out. This system also heavily alleviates the mid game issue of running out of population to industrialise which wasn’t an issue in real life. The reason for this was that economic growth was primarily driven by these incremental boosts in productivity, which the game would now capture.
For example, let us presume that there exists a textile mill of size 30. It has a base throughput of +30%. Now, let’s say it’s on dye workshops as a PM. This PM affords the 30 levels of building each a £3 million cap for throughput investment. Each million pounds provides a +5% throughput efficiency gain. Thus, by investing £50 million, you can get a 250% throughput gain, essentially tripling the production of the exact same textile mills through investments in productivity improvements on the same PM. Reading the details of this system, you might think it’s unfair that massive productivity improvements should be prioritised to the big factories. However, it is the fairest and most realistic. A key insight captured by Romer’s endogenous growth model is that the growth rate of knowledge is influenced by investor time preference, substitutability of inputs, R&D productivity, and the size of the population. The last one is what matters in this case. Following the details of the model, it should be the largest factories and the largest countries that capture the greatest boons from R&D. This plays out in real life too. Who do you think benefits the most from industrial agriculture or improvements in production lines? And who do you think comes up with innovations on them? Smaller farms and factories obviously have less of an ability to implement and discover these improvements. Furthermore, it also means that smaller countries should specialise in a far smaller range of industries than big countries, which also mirrors historical economic development. More on this will be discussed in the section about geographic concentration and New Trade Theory.
Another complaint I have about the way PMs are represented is the complete lack of structural unemployment and how when jobs are cut, they’re also added back as jobs which require higher qualifications. This isn’t very major and can mostly be ignored. To fix the issue of no structural unemployment, I believe that there should be slightly less higher qualification jobs than existed before as labourer jobs. They shouldn’t cut as many jobs as a labour saving PMs, but they should slightly reduce the number of workers to reflect the diminishing need for labour in technologically more advanced production as each labourer becomes far more efficient. They will struggle finding jobs, leaving them open for migration and working in the budding new industries you unlock later in the game, which should also help the AI open these industries. There should also be a slightly higher barrier for labourers to transition into higher qualification jobs. Unemployment then won’t entirely be frictional as it is in the current game.
Sidenote: The investment pool should have a heavier weight in investing in new resources that have been generated. This simulates the optimism and speculative mania that often surrounds new technologies (think dot com bubble and current AI hype), as well as making it so that AI will organically switch to new PMs instead of being stuck on the old ones. This process can also simulate the speculative bubbles of the Victorian age like the railway mania.
Geographic Concentration and New Trade Theory
Paradox heavily misunderstands and mismodels why geographic concentration occurs. I’ll admit that I do not know very much about this topic as I have neither taken classes on it nor wrote research on it, and I can’t be bothered to read a 50 page paper on the Geographic Concentration of Enterprise in Developing Countries. You can find it yourself by googling The Geographic Concentration of Enterprise in Developing Countries, Felkner and Townsend MIT UChicago. Although I don’t know much about the topic, I still know enough to contest Paradox’s implementation of concepts like MAPI. Let’s first discuss the problem with the concept of a “market price” prevalent throughout the entire market. What defines this market price? Would it be something like the spot price on an exchange like the LME? Or would it be the average price of a good across all local markets? Paradox says neither. Though considering how the stock exchange tech gives you +10% MAPI, I feel it prioritises the former definition. The market price is the price determined by the supply and demand of goods throughout the entire market. Local markets have prices based on this market price and then partially through local supply and demand. Instead of a bottom up system of price discovery, this is purely top down. It also fails to capture the market dynamics shaping local prices. Any town or city cannot produce all the products it consumes, thus a large proportion of the goods consumed are imported. Does this mean you pay the going market rate and more or less depending on if your place of residence produces a good or not? Not at all. Why not is pretty apparent. The local producers of a good are often far less efficient in production than big multinational chains who benefit from massive economies of scale. They don’t shape your local costs at all. What determines the price you pay is the cost of production, the transportation cost, and the markups applied in each step of the trade. MAPI thus runs counter to reality.
From a gameplay point of view, I can understand wanting to encourage vertical monopolies to simulate geographic concentration which I will discuss shortly. I can also understand wanting players to spread production across different states, at least in the early game, so players don’t build 5 megacities that supply the entire rest of the country. Instead of keeping MAPI though, which fails to model the dynamics shaping local prices, a shipping feature can be added. This serves to emphasise the importance of railways and better port infrastructure which was critical to the development of the economy during the Victorian age. States with local supply surpassing local demand will attempt to offload the excess production onto other states. States where local demand is greater than local supply will attempt to import the shortage from the closest state in the same market, or a different market with an active import route. However, for each unit of goods being shipped, there is a necessary consumption of the transportation good (let’s say 0.25 transportation per good being shipped) for each state that the good passes through. This makes building transcontinental railways vital for the United States’ and Russia’s development just as it was in our own timeline. This also means that better rail infrastructure which means cheaper and more abundant transportation will mean cheaper goods which allow you to build megacities late game. It also means however, that the megacities of production cannot be concentrated all in one place, as then the state on the other side of your country will be stuck paying sky high prices for goods due to excessive transportation costs. Without rail infrastructure and the transportation good, the costs for moving goods across states is very expensive, and so states are only able to ship goods across one state at tremendous cost. This means that in early game Victoria 3 without railways, your economy is extremely fragmented between states which effectively operate their own local economy. This is akin to pre-industrialisation England where different communities developed functionally independent languages and different economies due to lack of widespread intracountry trade. This is merely the process for landlocked states.
For states with a port a slightly different system is in place. Ports instead of being government owned and run and purely loss making will be run like railways. There will be a market price for the price of a convoy. For each sea tile a good needs to be transported, the more convoys are needed to be consumed for each good. For example, let’s suppose that a good needs to be transported from London to New York and there are four sea tiles between them. Each convoy can transport 10 goods, and an extra convoy is consumed for each sea tile the trade route passes through. This simulates how shipping goods by sea also incurred costs and avoids the doom loops that occur on free trade when shipping is free. As port infrastructure naturally improves with greater techs, convoys become cheaper and cheaper and global trade will thus naturally increase. This system also makes the canals potentially profitable, as money can be charged for each convoy passing through the canal as a sea tile which does not consume a convoy. In this way the convoy savings from using the canals enriches both the canal holder as well as the buyers and sellers of goods as shipping costs decrease. In terms of mixing land and sea transportation, in the case of a landlocked state whose closest import state is a landlocked state across a sea, it will simply use the above processes as described based on the route the goods must take.
Another benefit of this system is that it simulates the economic theory of trade gravity. Trade gravity is a model formed around the econometric observation that countries tend to trade more with countries that are nearby rather than countries that are further away. One possible explanation is due to transportation costs being lower, while another is based on a theory of trade frictions, and another is based on a theory of geographical and cultural/historic ties to countries closer to you. There is no unified explanation for why it occurs, but a very strong tendency for it has been shown. The game, however, can demonstrate it so long as it follows the above system of trade.
Let me now move on to another problem with the way the game models geographic concentration. Geographic concentration primarily occurs because industry seeks to position itself near 3 things: qualified workers, intermediate goods, and transportation infrastructure. There is also a fourth benefit which is spillovers in knowledge and innovation. Positive feedback loops reinforce this cycle, which cements certain places as hubs of manufacturing. Let me demonstrate these points with a couple of examples.
Silicon Valley is the hub of computing and technology in the world because it has a large pool of qualified tech workers that live there. This was because Stanford students lived in the area where the university established an industrial park. These students went on to create tech firms which attracted qualified tech workers around the country to Silicon Valley. This large concentration of tech workers in Silicon Valley encouraged all the big tech firms to headquarter themselves there, attracting even more tech workers.
Pittsburgh was once called the steel city. The reason for this was because Pennsylvania had a large coal and iron industry which led to Carnegie Steel headquartering itself there. This meant that steel workers moved to Pittsburgh to obtain a job, meanwhile the production of steel drove up the demand for iron and coal, which meant that even more intermediate goods for steel were being produced.
Detroit and Michigan’s access to the Great Lakes in the age of the steam ship meant that industrial production could be cheaply shipped across the country and world. Cheap shipping meant industry could concentrate within the one city. Infrastructure was built to facilitate the Detroit car industry including a dedicated rubber and steel supply chain. This meant that car manufacturing was most easily and cheaply done in Detroit, which only strengthened the established supply lines, meaning there was even more benefit to car manufacturing in Detroit.
All three cases also benefitted from knowledge spillovers and transfers, in which nearby situated competitors can learn from each other increasing efficiency and surpassing the efficiency of those locked out of the ecosystem built up around a particular industry. (This only further demonstrates why throughput efficiency bonus from investment should be capped based on factory size).
The game fails to capture this. Increasing the requirements to transition to a new job and introducing new job types should address the first issue (though there are lag concerns with the latter). The proposed system of shipping should fix the second issue, but giving intermediate goods buildings small throughput bonuses to their final good’s factories should strengthen this effect (such as iron mines giving steel mills a 0.1% throughput bonus per level or engines giving power plants a 0.1% throughput bonus per level). The last issue can be resolved by giving established trade routes a ticking discount on cost based on how long it has lasted as well as giving more states the natural harbour terrain modifier. These harbours will produce cheaper convoys, allowing for cheaper exports from certain states’ factories. (Also, you really have to let the Great Lakes have harbours).
Let me first explain what New Trade Theory is. In the Cobb-Douglas function, which underlies a relatively large portion of macroeconomic analysis, production is presumed to have constant returns to scale. Essentially, if you double the labour and capital inputs, assuming the same stock of knowledge, your outputs should double. New Trade Theory states that investments in certain industries bring increasing returns to scale. This means that even countries with identical levels of comparative advantage still benefit from trade. This is because of economies of scale. Thus, the cap for investment in industry should be massive, encouraging countries to really specialise in just a handful of niches which they export. Even big countries should not be able to specialise in every industry. Smaller countries can afford to specialise in even less industries as they have less labour and capital. If they want to maximise their economies of scale, they can only focus on a couple of specific niches. For instance, I often make fun of Korea for playing themselves, making themselves into a modern day cyberpunk dystopia due to its economic development style of utilising national champions. Based on the economics of New Trade Theory, South Korea’s focus on a few national champions produced a market dominance which meant they could achieve massive economies of scale and specialisation. While they were still protected from outside competition, they rapidly developed a market dominance that meant they could compete with foreign companies which also had economies of scale. Once the South Koreans embraced free trade, these companies were competitive in the global market. Economies of scale is also represented poorly in the game, which I will discuss in my final section about competition, monopolies and economies of scale.
Sidenote: GDP calculation is based on market prices and not state prices, so increasing MAPI, which has the real effect of decreasing prices for many people and boosting real GDP has no effect on GDP. Granted, this complaint is superfluous.
Competition, Monopolies, and Economies of Scale
The game does not model market competition at all, nor does try to. I don’t fault the game for that. Creating an implicitly tiered system of factories by factory throughput where some are more productive than others and some fold in a recession essentially simulates how unproductive businesses die. The way the game rewards you for creating companies that have a monopoly over your entire industry though, is a very large issue. Monopolies have various deleterious effects on a national economy. Foremost is that a monopoly has no incentive to innovate. Their sole purpose is to extract rents from the economy to enrich their owners. They also have market power, meaning prices are not placed at an optimal level, but instead at a level which maximises profits for the monopoly. The substitution effect is often used to describe how consumers will switch to using substitutes if the price changes. What’s often not considered is how inputs are also subject to the substitution effect. When goods are priced too high, some uses for a product which may bring massive societal benefit are made unavailable. This is the case with long distance communication. The advent of the internet was in large part driven by the massive reductions in cost of telecommunications brought about by the destruction of AT&T. None of this is simulated in Victoria 3. Instead, if someone were to attempt to learn economics from Victoria 3, they would walk away thinking monopolies were good. To fix this, companies in Victoria 3 should switch between two modes: rent-seeking, and competitive. Under a rent-seeking mode, which they will automatically switch to if they control over 50% of the supply of a good, they will increase prices and cut production to maximise profit. They won’t reinvest any profits into increasing productive efficiency and they give massive payouts to the workers of the company headquarters. If the company is competitive, they should reinvest most of their profits into increasing throughput efficiency, with a smaller proportion going to the investment pool and paying their workers. There should also be a new economic law on monopoly regulation which prevents rent-seeking behaviour from emerging at all if passed.
Paradox’s current economies of scale system is extremely bad. Also, why does government control necessarily lower the economies of scale of a business? If anything, government run companies in the Soviet style have the biggest economies of scale because they were functional monopolies. The reason they were inefficient and why government run firms are inefficient in general is because when firms are monopolies without competition, or when they’re shielded from competition, there is little reason to innovate or invest in firm operations. The reason Soviet growth slowed in the 60s and 70s isn’t because everything was owned by the government, but because they weren’t making the iterative improvements that contribute to economic growth. After everyone was moved from a farm to a factory, the factories’ productivity almost did not grow at all. This was because they were functional monopolies, and with government support, there was very little need to innovate. If there were a way for governments to create market competition, select the best ideas, implement these ideas, and allow for the firms which implement the best ideas to grow while the bad firms are destroyed, then government control is identical to private control. Of course, there is no way to know ahead of time which idea is the best idea. This can be represented in game by disallowing or severely reducing the efficiency of direct government investment into buildings. As for any economy of scale bonuses, the bonus for a building perhaps can match the highest ownership level for a building. So, for instance, a level 50 building with 30 levels owned by a single company will produce a 30% economy of scale bonus. This is because economies of scale are for single businesses which can centralise fixed costs and spread them out across the massive quantity of goods they produce. However, I also think there is decent enough reason to fully abolish economies of scale as they exist now. The bonuses and systems I have listed above already benefit high building levels enough.
Fiscal Policy and Monetary Policy
Fiscal Policy and Government Debt
The problem with fiscal policy as represented in the game is the complete lack of any depiction of crowding out. Buying government debt is not represented as the investment that it is. When people save money for a rainy day fund, they don’t buy government bonds with that money. They save it as cash. Government debt is an investment, and so government deficits should be financed via the investment pool and not the cash reserves of buildings which I think are ludicrously high. Generally, businesses don’t like having massive piles of cash just sitting around in their vaults doing nothing. They will either attempt to invest that money or hand it out to investors in the form of dividends. This has only changed in recent years because of pro-business policies that encourage supply and not demand and the GFC. It’s because of a lack of demand which means companies cannot expand operations that they are sitting on a massive pile of cash and liquid investments: $100 billion in the case of Apple. The primary effect of this change means that as the investment pool is what contributes to growth in productivity, the government deficit constrains private investments. This simulates the crowding out effect.
Monetary Policy
I’ll be honest, I have 0 clue how the monetary system works in Victoria 3 and so I won’t speak too much on it. However, I think there should be consideration for a private debt system. Banks create money upon issuing private debt. This is simultaneously a good and a bad thing. It’s private debt which can cause an extended depression because it’s too high. There is also debt deflation as described by Fisher. However, good loans can finance investments and consumption that drives productive growth in the economy. An implementation of a private debt system should be considered.
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