It looks as though we are done:
Download: http://tinyurl.com/dl20080906
Bob Davis, John Lyons, and Andrew Batson write:
Globalization's Gains Come With a Price: Hermenegildo Flores was supposed to benefit from Mexico's decision to open its economy to foreign trade and investment in the 1990s. For a time, he did. As U.S. companies boosted purchases from Mexican factories, Mr. Flores's salary nearly doubled to $68 a week in 2001. Then foreign competition from places like India, Pakistan and El Salvador intensified.... Today, Mr. Flores is unemployed, having accepted a $900 buyout in April after the company switched to new machines.
A decade ago, the globalization of commerce promised to be a boon to low-wage workers in developing nations. As wealthy nations shed millions of jobs making apparel, electronics, and other goods, economists predicted that low-skilled workers in Latin America and Asia would benefit because there would be greater demand for their labor.... [G]lobalization delivered as promised. But there was an unexpected consequence... the gap between economic haves and have-nots has frequently widened... in wealthy countries... [and] in poorer ones like Mexico, Argentina, India and China as well.... [T]he biggest winners by far are those with the education and skills to take advantage of new opportunities....
"While globalization was expected to help the less skilled...in developing countries, there is overwhelming evidence that these are generally not better off, at least not relative to workers with higher skill or education levels," write economists Pinelopi Koujianou Goldberg of Yale University and Nina Pavcnik of Dartmouth in the spring issue of the Journal of Economic Literature.
And I want to call an intellectual foul here. There is compelling evidence that globalization--export-led and import-fueled industrialization in emerging market economies--has paid enormous dividends and made many poor people much better off. It has led to a much less unequal world. But it has led to more unequal countries. The poor are not better off relative to the rich in their own countries. The poor are better off relative to the rich in the world. And the poor are better off *relative to their own (and their parents' own) well-being i the past.
Goldberg and Pavcnik need to phrase what they say more carefully.
Davis, Lons, and Batson continue, and say this.
Globalization deserves credit for helping lift many millions out of poverty and for improving standards of living of low-wage families.... [G]lobalization... has created a vibrant middle class that has elevated the standards of living for hundreds of millions of people.... particularly... in China.... The poor in countries like Vietnam and elsewhere in Southeast Asia have also benefited greatly....
But... how much [within-country] inequality [can] countries... bear[?]... [C]ould [these gaps] ultimately produce a backlash that will undermine trade and investment liberalization around the world[?]... From 2000 to 2005, per-capita income of the bottom 10% of urban households in China rose 26% while those at the top saw gains of 133%.
While Mexico hasn't experienced the spectacular growth of China, wages of those at the bottom 10th percentile of urban full-time workers increased 12% between 1987, when the country first took steps toward opening its economy, and 2004. Since 2000, the percentage of Mexicans living in extreme poverty also has fallen below 20%.... In 2004, urban full-time workers at the top 10th percentile earned 4.7 times more than those at the bottom 10th, compared with four times as much in 1987, according to Columbia University economists Eric Verhoogen and Kensuke Teshima.... Growing inequality also feeds the populist argument that globalization is a sucker's game that benefits only the elites. In Latin America, that sense of alienation has powered populist presidential candidates who won in Ecuador, Bolivia, Nicaragua and Venezuela and came close to carrying Mexico last year. In China, the ruling Communist Party worries that support for liberalization could crumble. The government needs to "safeguard social fairness and justice and ensure that all of the people share in the fruits of reform and development," said Chinese Premier Wen Jiabao in March....
[I]nternational competition forces local firms to add skilled workers who can handle newer technology and shed workers who can't. Foreign firms bring new technology to developing nations and boost demand there for skilled workers.... Access to education also plays an important role.... The effects of globalization are vividly on display in Puebla... between... Veracruz and Mexico City.... During the 1970s, those [trade] barriers helped produce rapid economic growth, but the system collapsed in a debt crisis and deep recession that swept through Latin America in the 1980s.... Towel-maker Industrias Cobitel SA picked up two big new U.S. customers after Nafta and doubled the number of production workers to 250 by 2000. Exports accounted for 40% of the company's sales in 2000, about triple the percentage before Nafta. Business was so brisk that many employers didn't care whether new hires had much schooling. But foreign investment and competition also prompted a big demand for skilled labor. Local companies that had gotten by with outmoded machinery either upgraded or closed.
Volkswagen AG, the city's largest private employer, has had an especially large impact on the local economy.... VW ratcheted up the demands on its work force. The company started building the new Beetle in Puebla in 1998 and followed with other models aimed at hard-to-please U.S. buyers. New machinery was imported. Now welds are done by lasers. Robots paint the exteriors of cars for an even finish.... VW slashed its Puebla work force by about 15% since 2000 to 14,000... outsourced production of seats, steering wheels and wire harnesses to factories... outside... workers at those factories are paid about one-third the $225 a week VW line workers make....
For Poblanos, as Puebla natives are called, with the right education, globalization has also opened opportunities that were absent in Mexico just a decade ago. Victor Pasilla, the 30-year-old son of a hospital security guard, makes $600 a week designing oxygen sensors for a Puebla start-up, Biomedica Integral SA.... In the once-poor south of the city, housing developments of small, brightly colored homes, each topped with water tanks, have opened for young families who have become eligible for mortgage financing. There are also two new shopping malls with international clothing stores, including Zara and Massimo Dutti. Low-paid textile or auto-parts workers don't shop at Zara, although many now frequent the local Wal-Mart.... Low-wage workers live as they have for many years, in cramped urban tenements ringed with razor wire....
Mr. Flores, the unemployed tailor, has two brothers who have decamped for the U.S. but says he doesn't want to follow suit because he doesn't want to leave his wife and daughter. Instead, Mr. Flores is looking for work as a day laborer, building homes for Puebla's surging new middle class. "I have a fight in front of me trying to find work," he says.
Hoisted from Comments: Robert Waldmann asks, apropos of Daniel Gross's book Pop!: Why Bubbles Are Great for the Economy:
Grasping Reality with Both Hands: Brad DeLong's Semi-Daily Journal: A Review of Daniel Gross's Book "Pop": Yes, but do you know an academic economist who has formalized this argument [that bubbles are good for the economy by] writing a [formal] model in which irrationality is necessary for growth? It would not be hard. And have you asked yourself "If not me, who? If not now, when?" Posted by: Robert Waldmann | May 13, 2007 at 11:55 PM.
It was done two decades ago, Robert: a model in which the introduction of investors subject to irrational exuberance and panic can either raise or lower the economy's productive capital stock and hence enhance or diminish the economic welfare of others in the economy. The model doesn't have all the channels that Gross discusses, but it has some of them--and enough to make the point.
Unfortunately, the authors were chasing the case in which bubbles and panics were socially harmful--not the case when bubbles are beneficial to the rest of society. But that case is there in the model, if the parameter ρ∗ is big enough and the shock variance ratio (ση2)/(σε2) is small enough.
Here's an excerpt from the core of the argument:
Size and Incidence: There are two reasons why the capital stock [in the absence of bubbles and panics] is different.... If... misperceptions... are on average bullish [i.e., prone to bubbles, investors]... on average demand [more stock].... [I]f noise traders are on average bearish [i.e., prone to panics], the equilibrium capital stock is lower.... [I]nvestors’ demands [also] depend on the risk borne.... The θ2ση2 term in the denominator of [equation] (15) captures the reduction in the [economy's] capital stock that arises from aversion to noise trader-generated price risk.... The second term dominates, and the capital stock is lower in the presence of noise traders, if:
(17) ρ∗/(δ -r) < (θ/((1+r)2))((ση2)/(σε2))
For ρ∗≤0 [i.e., a market at least as prone to panics as bubbles], it is always the case that the presence of noise traders reduces the capital stock.
Even if ρ∗ is positive, only if both the noise trader wealth share θ is small and if noise traders’ opinions are not volatile relative to dividend risk (that is, ((ση2)/(σε2)) relatively small) is the ratio of productive capital to wealth increased because of noise traders.
A lower capital stock implies a lower average level of consumption. Since capital gains and losses on stockholdings simply redistribute wealth from one generation to another, the average level of consumption of a generation is simply:
(18) (1+r)W + K∗(δ-r)
which is an increasing function of the capital stock.
The reference?
J. Bradford DeLong, Andrei Shleifer, Lawrence H. Summers, and Robert J. Waldmann (1989), "The Size and Incidence of Losses from Noise Trading," Journal of Finance 44: 3 (July), pp. 681-696 http://www.j-bradford-delong.net/pdf_files/Noise_Traders_Incidence.pdf.
Note: Robert's comment--that the source of utility gains to the sophisticated in DSSW (1990) is different from the source in Gross (2007)--is completely correct. Gross argues that volatility of opinions is good. DSSW argue implicitly that irrational exuberance can be good when such exuberance is not very volatile.
Ezra Klein writes:
Ezra Klein: Health Insurance Works, Trusting Its Detractors Doesn't: Some of you asked me to take a look at The LA Times op-ed by Michael Cannon and Michael Tanner on why universal health care ain't all it's cracked up to be. I should preface this by saying that I like Michael Cannon.... [I]n trying to give him the benefit of the doubt here, I will say only that this article is violently, even surprisingly, misleading.... Cannon and Tanner write, "[y]ou may think it is self-evident that the uninsured may forgo preventive care or receive a lower quality of care. And yet, in reviewing all the academic literature on the subject, Helen Levy of the University of Michigan's Economic Research Initiative on the Uninsured, and David Meltzer of the University of Chicago, were unable to establish a 'causal relationship' between health insurance and better health. Believe it or not, there is 'no evidence', Levy and Meltzer wrote, that expanding insurance coverage is a cost-effective way to promote health."
Believe it or not, Cannon and Tanner are misrepresenting the study's conclusions.... [H]ere's what Levy and Meltzer actually conclude, in their own words:
The results of small quasi-experimental studies provide only mixed evidence that health insurance affects health, while larger quasi-experimental studies and the RAND Health Insurance Experiment provide consistent evidence that health insurance improves health. Only one large-scale quasi-experimental study (Perry and Rosen) fails to show a relationship between health insurance and health, and this study may not have adequate power to rule out the possibility that health insurance improves health. Taken as a whole, these high-quality studies of the health effects of health insurance strongly suggest that policies to expand insurance can also promote health.... We are left with the conclusion that health insurance can improve health but remain unable to say exactly which interventions related to insurance will do so most effectively...
Is there a way out? Or will Ezra have to add Michael Cannon to the list of people we read with great suspicion?
My CITRIS kickoff speech: Information Technology and the Future of Society (Hoisted from the Archives)
Information Technology and the Future of Society: For perhaps 9000 years after the beginnings of agriculture the overwhelming proportion of human work lives were spent making things: growing crops, shearing sheep, spinning yarn, weaving cloth, throwing pots, cutting down trees, copying books, and so on, and so forth. Technology did improve enormously over those 9000 years: contrast the clothes-making technology at the disposal of Henry VIII of England with that of Rameses II of Egypt three thousand years before; contrast the triple-crop paddy-irrigated rice- and water-control-based agriculture of the Yangtze Delta in eighteenth-century China with the scratch-the-soil-with-a-hoe agriculture of two thousand years before. But as Thomas Robert Malthus first wrote in the 1790s, rising populations had put enough pressure on scarce natural resources to offset the benefits of better technology and keep living standards nearly constant for the people if not for the elite: American President Thomas Jefferson in 1803 A.D. certainly enjoyed a higher standard of living than Roman Consul Marcus Tullius Cicero in 63 B.C. But did Jefferson's slaves enjoy a higher standard of living than Cicero's? A large amount of archeological evidence has not yet found significant differences.
For the past two hundred and fifty years, since the start of the Industrial Revolution, the productivity of those workers who make things has exploded. Hand-spinners in the eighteenth century took 50,000 hours--20 full work-years--to spin 100 lbs of cotton into thread (Freeman and Louca (2001), and spinning of one sort or another took up perhaps 5% of total labor-time. Today it takes 40 work hours to spin 100 lbs. of cotton: a more than thousand-fold amplification of productivity in this one task.
As our productivity at growing crops and making things has exploded, demand for the things we make has grown too, but not fast enough to keep the crop-growing, food-cooking, mineral-extracting, clothes-making, box-carrying, and other goods-producing share of our economy's labor force from falling. Today those who in any earlier age would be classified as "production workers"--and would have been the overwhelming majority of the labor force--are perhaps 20% of our economy, and the bulk of them are better characterized as machine-watchers and machine-fixers. According to Stanford's Robert Hall, as early as 1980 there were twice as many salesmen in Ford-selling auto dealerships as there were assembly-line workers employed by Ford Motor Company.
So what are the rest of us--the other 80%--doing? In a sense, we all--from U.C. professors to chief technical officers to xerox operators, Ford Salesmen, cashiers, and parking-lot attendants--are and have long been information workers: people whose jobs are, if we examine them closely, largely concerned with determining what exactly the goods-producing sectors should make, how it should be made, where it should go, and to whom it should be distributed--and that is leaving aside the large chunk of our economy that is symbolic communication as an end in itself.
Today we see--not yet sharply, not yet clearly, but no longer dimly--the prospect that the ongoing technological revolutions in data processing and data communications will do for the "information" sectors of the economy something like what the Industrial Revolution did for goods-producing sectors like cotton spinning. As Steve Cohen over in the City Planning department here likes to say, you are now building the equivalent of the industrial-age tools for shaping and handling matter, but you are building tools for thought (Cohen, DeLong, and Zysman (2001)). And if we can figure out how to make these tools for thought fulfill their promise, they should produce a quantum jump in our technological power, economic productivity, and--we hope--quality of life of as many energy levels as the jump of the Industrial Revolution itself.
But there are major problems of social engineering and organizational design that stand in our way. A century or so ago, at the height of the Industrial Revolution, the market economy turned out to have an extraordinarily good fit with the developing industrial technologies of goods-making. It provided a framework of social organization that was extraordinarily effective in providing people with incentives to carry on activities that generated rapid technological development, capital accumulation, and economic growth.
An effective form of social organization faces decision makers with incentives that mirror the impacts of their actions on society as a whole. Because the goods produced by industrial technologies were rival--that is, could only be of use to one person at one time--each person's use of such a good diminished the supply available to the rest of society. Thus it made sense from the viewpoint of efficient distribution to require that users pay a price--diminish their ability to acquire and use other resources--for commodities. And those prices paid then gave producing organizations the resources to carry on and expand their activities. Because the goods produced were excludable--that is, it was by-and-large straightforward to limit control over use to those authorized--it was easy and straightforward to push decision-making outward from the clueless bureaucratic center to the periphery where people on the ground might actually have a good sense of the situation, and of what should be done.
These three advantages--earmarking additional resources for successful and efficient production organizations, providing users with incentives for economically-efficient distribution, and decentralization of decision-making to where the knowledge was likely to be--were delivered by accident by the trade-and-market economic structure of Adam Smith.
But now as we try to realize the technological promise of information technologies, the old forms of economic organization no longer have a natural fit with the requirements of technological development and economic growth. Once an "information good" has been produced, sharing it with another person doesn't reduce the rest of society's resources and opportunities. So there is no efficient-distribution reason to charge a price for it. But where then does the flow of signals to assess which production organizations are efficient come from? In an earlier age we would be more inclined to rely on government funding, but these days we have a keen awareness of the advantages in applied development at least of semi-Darwinian competitive mechanisms, where investigators are responsible to investors seeking profits and not to committees seeking whatever committees seek.
Moreover, it is only with difficulty that information goods are excludable. But if their use can't be restricted to authorized users, then the entire market-as-a-social-calculating-and-signalling mechanism simply breaks down. Unfortunately, attempts to make information goods "excludable" by various forms of use protection waste valuable time and energy: I shudder at the memory of having spent two hours on hold during three phone calls, and having spent another two hours of my time rebooting and reading installation error messages the last time I tried to upgrade one of the Adobe programs--GoLive--on this laptop. I doubt I'll ever be able to face the prospect of buying another Adobe program again.
Two things, however, are clear. First, caught between "government failures" in applied research and the ever-larger "market failures" that will be created as the characteristics of information-age goods clash with the requirements for market efficiency, intermediate forms of organization--like large publicly-funded research universities--need to play an even larger role in research and development in the future than they have in the past. Projects like CITRIS promise the benefits of government research--the wide distribution of knowledge and the acceleration of cumulative research--and the benefits of private entrepreneurship--the willingness to take risks and investigate large numbers of potential development projects rather than just those that have won the stamp of approval of a single central committee. It is the task of chancellors and deans, of course, to make sure that projects like CITRIS don't wind up producing the drawbacks of both forms of organization: the strangulation by bureaucratic red-tape and committee infighting of government, combined with the restrictions on the distribution of information and the use of products that make a large share of private-sector development work duplicative of what has already been done.
Second, realizing the promise of the Societal-Scale Information Systems that are the Holy Grails of this quest will turn out to be a problem of social engineering as well as computer science. I have long wondered just why it was that the first half of the 1980s were the era of the IBM PC rather than of the DEC VAX--when the hardware cost of a VAX was, as best as I can guess, no more than 1/5 that of the equivalent number of 8086 machines, and when thanks largely to Berkeley UNIX there was no comparison at all in software. The answer lies somewhere in social engineering--that somehow paying out five times as much for inferior software was worth not having to wrestle with established MIS bureaucracies. But what the answer is I am not sure.
So let me turn this into a sales pitch for the social scientists at Berkeley interested in information technology--from Manuel Castells in sociology to Pam Samuelson and Mark Lemley at the law school to John Zysman and Steve Weber in political science to Hal Varian and his simians to Suzanne Scotchmer at public policy to the industrial organization and antitrust barons of the business school and the economics department--Glenn Woroch, Rich Gilbert, Dan Rubinfeld, Mike Katz, Carl Shapiro--and a host of others. I do not know of a place with a more vibrant and smarter community of scholars interested in the social engineering aspects of information technology.
And I do not know of a better place than this to assemble the resources to build the Societal-Scale Information Systems that can make information technologies realize their promise.
Atrios is talking about the Kagan family--Yale historian father Donald and neoconservative hack children Fred and Robert. This reminds me that I wrote something about the (relatively) smart one--father Donald--several years ago, back when we were reading his one-volume Peloponnesian War:
History as Tragedy: The Peloponnesian War: Hoisted from the Archives: The Thirteen-Year-Old got Donald Kagan's (2003) Peloponnesian War (one volume) for Christmas.... [T]he New Yorker's Daniel Mendelsohn [certainly] doesn't think much of it:
Daniel Mendelsohn: Critic at Large: Kagan... informs us that... he wants his work to "meet the needs of readers in the 21st century"... "an uninterrupted account will better allow readers to draw their own conclusions." Uninterrupted, yes, but not unbiased... you tend to come away from his history with an entirely different view of the war than the one you take away from Thucydides....
The only way to do this, unfortunately, is [for Kagan] to flatten Thucydides's presentation of the Peloponnesian War, stripping away the many voices and points of view that [Thucydides] worked so hard to include.... Thucydides tends to be shy about overtly intruding.. not so Kagan. This is most apparent in [Kagan's] revisionist championing of Cleon and other Athenian hawks, whose policies he consistently presents as the only reasonable choice. "It is tempting to blame Cleon for the breaking off of the negotiations," goes a typical bit of rhetorical strong-arming. "But what, realistically, could have been achieved?" Anyone who hasn't read Thucydides will be inclined to agree. [Thucydides's own] explanation of the Athenians' distaste for peace was that "they were greedy for more."
The desire to rehabilitate Cleon inevitably results in a corresponding denigration of the [Athenian] peace party (with its "apparently limitless forbearance") and of the cautious policies recommended first by Pericles and then by Nicias, a figure for whom Kagan has particular disdain. Here Kagan's revisionism borders on being misleading. Nicias had tried to bluff the Athenian Assembly into abandoning the invasion of Sicily, declaring that it would require far greater expense than people realized; but they simply approved the additional ships and troops. This leads Kagan, bizarrely, to characterize the Sicilian Expedition as "the failed stratagem of Nicias." As for the Athenians' massacre of the Melians, Kagan dismisses it as "the outlet they needed for their energy and frustration."
Kagan's perspective on events and personalities at first suggests an admirable desire to see the war with fresh and unsentimental eyes. But after a while it becomes hard not to ascribe his revisionism to plain hawkishness, a distaste for compromise and negotiation when armed conflict is possible. His book represents the Ollie North take on the Peloponnesian War: "If we'd only gone in there with more triremes," he seems to be saying, "we would have won that sucker."
It is certainly the case that I have always found it very strange that Kagan is not much, much more hesitant than he is to dismiss and overturn Thucydides's analytical conclusions and moral judgments. Thucydides, after all, was there. We know next to nothing about the Peloponnesian War that he did not. He knew a great deal about the Peloponnesian War that did not make it into his book. His judgments are based on much more information than we have now, whether he lays out that information in a manner that is to Donald Kagan's liking or not.
Actually, we do know one important, big thing about the Classical Greek world that Thucydides did not know (and that, strangely, Kagan appears not to know). There is a deep, powerful sense in which time was on the side of Athens and its empire. Each decade that the war between Sparta and Athens remained cold rather than hot was a decade for metics and immigrants to the Geek world to think whether they wanted to live in Spartan-allied oligarchies dominated by a closed guild of landowners, or in Athenian-allied places where the (male, citizen) demos ruled and where there was much more growth, commerce, trade, and opportunity.
Each decade that the war between Sparta and Athens remained cold rather than hot was a decade for rich Spartiates to marry the daughters of other rich Spartiates, and for poor Spartiates to find that they could no longer afford the Spartan lifestyle and so drop out of the citizen body--and of the main line of battle. By 350 Sparta could--this is a guess--put only one-fifth as many professional hoplite soldiers into the line of battle as it could have two centuries before. Each decade that the war was postponed was a decade for Athens, its economy, its trade network, and its empire outside of Achaea and Aetolia to grow. A policy of postponing the showdown--even if one of "apparently limitless forbearance"--was a policy of greatly increasing the relative strength of the Athenian side.
But what is most disappointing to Mendelsohn (and most disappointing to me) is that he finds Kagan's Peloponnesian War to be a very different and much less interesting thing than Thucydides's Peloponnesian War (or, I would argue, than the Peloponnesian War wie es eigentlich gewesen). The lessons from Kagan's Peloponnesian War appear to be that war against Bad Guys calls for Harsh Measures and Total Mobilization.
By contrast, Mendelsohn writes, the lessons from Thucydides's Peloponnesian War:
...are no different from the ones that the tragic playwrights teach: that the arrogant self can become the abject Other; that failure to bend, to negotiate, inevitably results in terrible fracture; that, because we are only human, our knowledge is merely knowingness, our vision partial rather than whole, and we must tread carefully in the world...
But let's give Thucydides himself the last word:
[W]ar... proves a rough master that brings most men's characters to a level with their fortunes... the cunning of their enterprises and the atrocity of their reprisals. Words had to change their ordinary meaning.... Reckless audacity came to be considered the courage of a loyal ally; prudent hesitation, specious cowardice; moderation was held to be a cloak for unmanliness; ability to see all sides of a question, inaptness to act on any. Frantic violence became the attribute of manliness; cautious plotting, a justifiable means of self-defence.
The advocate of extreme measures was always trustworthy; his opponent a man to be suspected. To succeed in a plot was to have a shrewd head, to divine a plot a still shrewder; but to try to provide against having to do either was to break up your party and to be afraid of your adversaries.... The fair proposals of an adversary were met with jealous precautions... not with a generous confidence. Revenge also was held of more account than self-preservation. Oaths of reconciliation... only held good so long as no other weapon was at hand; but when opportunity offered, he who first ventured to seize it... thought this perfidious vengeance sweeter than an open one, since... success by treachery won him the palm of superior intelligence....
The leaders in the cities... on the one side with the cry of political equality... on the other of a moderate aristocracy... [recoiled] from no means in their struggles... in their acts of vengeance they went to even greater lengths, not stopping at what justice or the good of the state demanded, but making the party caprice of the moment their only standard.... Thus every form of iniquity took root...
JOHN Maynard Keynes's "Tract on Monetary Reform" may be his best book. It is certainly his best Monetarist book.
Comment on Stock and Watson: Hoisted from the Archives:
J. Bradford DeLong (2004) "Comment on James Stock and Mark Watson (2003), 'Has the Business Cycle Changed?' in Monetary Policy and Uncertainty: Adapting to a Changing Economy (Kansas City: Federal Reserve Bank of Kansas City):
James Stock and Mark Watson's paper challenges things that I thought I knew, and tells me that I am going to have to rethink a bunch of issues--going to have to mark my beliefs to market once again.
To the extent that there has been a conventional wisdom among economic historians, the extraordinary moderation of the business cycle--the reduction in the size of swings in the unemployment rate, and in the variance of annual output growth--has been due to very important learning about how to better conduct monetary policy. Christina Romer has been the most powerful advocate of this line of narrative. And this has been what I have taught my students over the past several years.
The founding of the Federal Reserve brought the possibility of an elastic currency, and of avoiding the great liquidity catastrophes that afflicted the U.S. in the late nineteenth century. The silver-agitation crises of the 1890s, the great crash of 1873 when British investors grew nervous about the "crony capitalism" of America (a crisis with remarkable similarities to the 1997-1998 East Asian crisis), the Panic of 1907 (mitigated by J.P. Morgan's getting the New York Clearing House to expand the effective money supply via printing Clearing House Loan Certificates, and then cramming them down the throats by telling banks that they would incur his permanent displeasure if they did not accept them as valid and liquid instruments).
But the Fed's performance in its first two decades was not impressive. The disaster of the Great Depression brought further institutional changes. The coming of deposit insurance to avoid the radical instability of the money multiplier that was such a powerful features of the Great Depression in America. Keen awareness of the dangers of, as Milton Friedman's teachers put it, "unbalanced deflation." The role of fiscal policy when short-term safe interest rates are near their zero nominal bound floor and yet risk, default, and term premiums remain high. Before World War II an economic disaster of the magnitude of the Great Depression was always a live possibility. With the institutional and organizational changes, since World War II a macroeconomic disaster of the magnitude of the Great Depression is--well, before the recent Japanese experience, I would have said impossible.
Nevertheless, when you compare the pre-Great Depression to the post-World War II period there is less of a reduction in the size of the business cycle than economists hoped or, in the case of Arthur Burns and many others, confidently expected. Improved credit markets allowed households to smooth their spending. Automatic stabilizers meant that incomes varied less than production. In his 1959 presidential address to the American Economic Association, Arthur Burns went as far as to say that deep recession--large spikes in the unemployment rate--were no longer a problem.
He was wrong. Look at 1975. Look at 1982-1983. In Christina Romer's interpretation, Arthur Burns was wrong because he did not recognize the developing stop-go nature of Federal Reserve policy. Most of the time the Fed worried about achieving maximum purchasing power. Some of the time the Fed worried about achieving price stability. While it was worried about achieving maximum purchasing power it successfully stabilized production, but at too high a level that allowed inflation to rise. As the late Rudi Dornbusch used to say, expansions in the U.S. before 1985 did not die of natural causes: they were killed by a Federal Reserve that had shifted to a mindset in which reducing inflation was job #1. Thus the first four post-World War II decades saw longer expansions, fewer recessions, but still substantial output variance driven by large inflation-control recessions. And the conventional wisdom has been that the remarkably good performance of the last two decades has been due to the Federal Reserve's greater success at maintaining its balance: at acting pre-emptively and maintaining an appropriate balance between price stability and maximum purchasing power, rather than careening from one objective to the other.
Now come James Stock and Mark Watson to challenge this belief. The reduction in output volatility is there, is real, is very large. (Although, as Larry Summers was saying in the shadow of Mt. Moran an hour ago, the fact that Stock and Watson's index of the size of the business cycle has fallen by 3/4 over a time period in which the average German unemployment rate rose from 2% to 8% makes one wonder whether the variance of output is what belongs on the left-hand side.)
But Mark Watson and Jim Stock look hard and find little sign that reduction in output volatility is due to changes in how the Federal Reserve reacts to economic circumstances. By process of elimination, they conclude that the reduction in the output business cycle is primarily due to luck and not to skill: primarily to smaller shocks hitting the American (and the other OECD economies) and only secondarily to better monetary policy.
This surprises me. This is a shock. I would have bet serious money that Stock and Watson's calculations would have come out the other way. I need to mark my beliefs about this to market. Clearly I have some serious rethinking to do before I give my "macroeconomic stability" lecture to my graduate students at the end of the semester.
But humans are, as cognitive psychology teaches us, really bad at changing their minds. We are really good at finding ways to explain away and ignore new information.
So let me now try to explain away and ignore Stock and Watson's results:
First, their idea of "policy" is limited to "systematic reactions by the Fed that change interest rates now and in the future in response to past changes in inflation and in economic growth rates." This is a very limited definition of "policy." For one thing, it leaves out much of what Christina Romer sees as harmful in pre-1984 policy: the fact that the Fed reacted in one way when it was worried about price stability, and reacted in another very different way to a similar economic situation when it was worried about maximum purchasing power. Stock and Watson's Taylor Rule framework can't see this at all. (Now it is true when Stock looks for evidence that such stop-go policy he fails to find it, but our econometric techniques are not very good at picking up such non-linearities.)
Second, it is not at all clear that the actual shocks to the economy have been smaller since 1984. Before 1984 we have the Vietnam War, the oil shocks of 1973 and 1979, et cetera. Since 1984 we have the stock market crash of 1987, the dot-com bubble and then the NASDAQ crash, the extraordinary near-panic of 1998 (which one low-ranking LTCM employee is supposed to have characterized as a nine-sigma shock: the universe will not last long enough for there to be an even chance of even one nine-sigma shock happening ever), 911, presidential warnings that all Americans are at risk of attack by Iraqi drone aircraft carrying weapons of mass destruction. These shocks are smaller than the earlier shocks in Stock and Watson's framework, but are they really smaller in reality?
Doesn't the swift reaction of the Fed to 1987, to 1998, to 2001--swift reactions that find no place in Stock and Watson's measures of "policy"--play a role in reducing the size of the business cycle? Doesn't the emergence of more private-sector willingness to speculate on stability as a result of confidence in the Fed reduce the magnitude of what Stock and Watson call "shocks"?
So my rationalization is that a lot of what Stock and Watson's framework calls "shock" is actually "policy". This is not a criticism, really: they have done a very good job. But it is a product of the limitations of our analytical tools.
Responses to Comments:
First, let me thank everyone--Alice Rivlin and Anne Krueger, Bill Poole and Allen Sinai, Marty Feldstein and Larry Summers, John Berry and Chairman Greenspan--who has tried in the discussion to stiffen my backbone and restore my full and unblemished confidence in the conventional wisdom. But it is worth remembering that ex ante I would have bet serious money that Stock and Watson's calculations would have come out the other way. And it is still a shock to me that it did not.
Second, let me underscore Antonio Fraga's point. Any interpretation of recent events that points to a smaller magnitude of shocks to the world economy has to explain why things have looked so different--look like the shocks are bigger--from a developing-country standpoint.
Looking back at my career, I see many local analytical low points. But my personal global analytical nadir came in early 1994, when I wrote a memo for my Treasury boss saying that yes, the Bank of Mexico's policy was inappropriate and overstimulative, but that the magnitude of the policy mistake was small and there was no reason to expect it to generate a serious problem. Now I still think the Bank of Mexico's sins against the Gods of Monetarism in 1994 were small, were venial, not mortal. But the punishment was swift and awful. And that is hard to reconcile with the view of a placid, low-shock world economy.
Morning Coffee Videocast: How Rich Is Fitzwilliam Darcy?: AT the end of Jane Austen's early-nineteenth century novel, "Pride and Prejudice," the hero Fitzwilliam Darcy proposes to the heroine Elizabeth Bennet, and Elizabeth's mother goes berserk...
Hoisted from the Archives. I wrote this back in 1995: Low Marx: A Review of Eric Hobsbawm's Age of Extremes:
Eric Hobsbawm (1994), The Age of Extremes (New York: Vintage: 0679730052) http://www.amazon.com/exec/obidos/asin/0679730052/braddelong00
Planet Hobsbawm
In the beginning was Karl Marx, with his vision of how the Industrial Revolution would transform everything and wash us up on the shores of Utopia. Marx saw the economy as the key to history: every forecast and historical interpretation must be based on the economy's logic of development. Sometimes--as in much of Eric Hobsbawm's previous work on the history of the nineteenth century--this functioned relatively well.
But sometimes it led to very bad results indeed. And when Marx and Engels's writings became sacred texts for a world religion called Communism, things passed beyond the absurd: the belief that the logic of development of the economy was the most important thing about society became entangled in the belief that Joe Stalin was our benevolent master and ever-wise guide.
Now it is over. The red stars of the Soviet Union no longer shine from the tops of the Kremlin towers at night. Radicals still seek Utopia, but they no longer think the road leads through the economy. Instead, they study culture--as if to change the world just by understanding it. It is difficult to see a future in which authors with the intelligence, industriousness, and audience of Eric Hobsbawm are disciples of Karl Marx in anything like the sense that Eric Hobsbawm is a disciple of Marx.
Now Eric Hobsbawm has written a history of the twentieth century, The Age of Extremes. It has by and large received good reviews: Stanley Hoffman in the New York Times Book Review; Eugene Genovese in the New Republic; Edward Said in the London Review of Books. But my reaction to The Age of Extremes was different. It struck me as history gone awry: a sketch of the twentieth century not as it has been lived here on earth but as it might have been lived somewhere else, on some "planet Hobsbawm" that might be found in one of those parallel universes often visited in Star Trek episodes, where what looks familiar at first glance turns out on close examination to be alien indeed.
Let me give an example: the last word of the book is darkness: it ends "one thing is plain. If humanity is to have a recognizable future, it cannot be by prolonging the past or the present. If we try to build the third millennium on that basis, we shall fail. And the price of failure, that is to say, the alternative to a changed society, is darkness." But a decade ago, when Hobsbawm finished an earlier book, Hobsbawm was optimistic: looking forward to a twenty-first century much better than the twentieth if nuclear war were successfully avoided.
What has happened in the past decade that has so darkened his vision of our human future?
The past decade has seen good news along a number of important dimensions: The environment is in better shape: the clean-up of the first world continues; the clean-up of the ex-Communist world has begun; and the third world is more aware of environmental degradation. Progress has been made in creating the international climate to guard against ozone depletion and global warming. Nuclear war is much less likely. China and India, more than one-third the human race, had their best economic growth decades in the 1980s.
In addition, many of the Communist régimes that ruled more than half the human race have fallen. Awful tyrannies have passed into history. Hundreds of millions have a chance for a more normal life--not spending six hours a day waiting in some commodity distribution line, not being spied on by one out of every ten of their eighbors, not seeing one out of every fifteen neighbors killed by the state's bullet, labor camp, or political famine.
Good news on the environment, on the danger of nuclear war, on Asian and Latin American (albeit not African) development, on the spread of democracy, and on the end of tyrannies have been the major developments of the past decade. If you were optimistic about the human future before the mid-1980s, you should be ecstatic today.
Yet Eric Hobsbawm is much gloomier than he was a decade ago.
There is no doubt that his gloominess is due to the end of European Communism. This is not to say that Hobsbawm still worships the post-1917 pre-1991 Soviet Union. The days are gone when he saw directives from Moscow as the logos of History speaking through the Party. He no longer judges "heroic" communists' obedience to Stalin's instructions to undermine Britain's World War II effort against Hitler (before June 22, 1941, that is), or claims "my International right or wrong."
Yet traces remain of the Eric Hobsbawm who was once a fanatic acolyte of the despotically-governed world religion of Communism. Judgments made then remain unexamined, or unsuccessfully reexamined, parts of the structure of his thought. It is as if a star--belief in the world religion of Communism--died, but light emitted before its death continues to reflect off planets and moons. The remains of Hobsbawm's commitment to the religion of World Communism get in the way of his judgment, and twist his vision.
On planet Hobsbawm, for example, the fall of the Soviet Union was a disaster, and the Revolutions of 1989 a defeat for humanity. On planet Hobsbawm, Stalin planned multi-party democracies and mixed economies for Eastern Europe after World War II, and reconsidered only after the United States launched the Cold War. On planet Hobsbawm, Hungarian--collectivized--agriculture is more productive than modern French agriculture.
Perhaps worst of all, on planet Hobsbawm modern democracy is not a good thing: elections are "contests in fiscal perjury" among voters with "no qualifications to express an opinion," that create governments that work only when they "did not have to do much governing." If there is a good word about really existing democracy--as a check upon official paranoia, as way of ensuring that people can lead a quiet life, or as a way of ascertaining the public interest--I missed it.
Cold-War Polemics
Let me briefly note one more belief that is false, but that was once part of the worldview of Stalin's acolytes:
The book has one single substantive sentence about the Korean War: "Shaken by the communist victory in China, the U.S. and its allies (disguised as the United Nations) intervened in Korea in 1950 to prevent the communist régime in the North of that divided country from spreading to the South." (p. 237). Now this simply will not do. It is not fair to tuck Kim Il Sung's army and Stalin's tanks into that little word, "spreading." The only other mention of Kim Il Sung's rule--264 pages later, in a discussion of the arts--calls it a "megalomaniac tyranny."
I find it odd that Hobsbawm chooses to describe North Korea's government by the colorless word "régime" in the context of the Korean War: If Kim Il Sung is a megalomaniac tyrant when talking about the arts, he should also be a megalomaniac tyrant when talking about the Korean War.
And it matters: a war undertaken to stop military conquest by a megalomaniac tyranny is a different thing from a war undertaken to oppose the "spread of a régime."
Hobsbawm's Cold-War polemics would not, by themselves, necessarily greatly harm the book: Readers could speculate whether the change in description of Kim Il Sung's government is Hobsbawm's delieberate and conscious avoidance of any hint that the Cold War might have been a struggle between bad guys and less-bad guys. They would argue over whether the change of Kim Il Sung's government from a "megalomaniac tyranny" to a "régime" as it enters the context of the Cold War is the result of unbreakable habits of doublethink created by decades of Communist Party membership.
But Hobsbawm's past as a Communist acolyte does much more additional damage to his book. It warps its themes. Hobsbawm's history has one major theme that takes up nearly forty percent of available space: Communism as the Tragic Hero of the twentieth century. Too many other aspects of the century are crammed into the corners left over, with the positive aspects of the terrible and glorious twentieth century--the rise of political democracy, the technologically-driven explosion of material wealth, and the creation of social democracy with its mixed economies and welfare states--allowed less than one-tenth of available space.
And this is the wrong focus for anyone's history. The proportions should be reversed.
The fundamental source of the distortion is that, for Eric Hobsbawm, World Communism was the Tragic Hero of the twentieth century. It was born in unfavorable circumstances in a backward agricultural country. Lagging behind historians' judgments, Hobsbawm believes that it by and large succeeded in its historical task of industrialization. And before its death, according to Hobsbawm Communism saved the west and what little there is of good in the twentieth century twice:
The victory of the Soviet Union over Hitler was the achievement of the regime... [of] the October Revolution.... Without [Communism] the Western world today would probably consist (outside the USA) of a set of variations on authoritarian and fascist themes.... It is one of the ironies of this strange century that the most lasting result of the October Revolution... was to save its antagonist, both in war and in peace--that is to say, by providing it with the incentive, fear, to reform itself after the Second World War.
There is some here that is true, but much here that is false. There is an enormous and eternal debt for the defeats of Hitler's armies at Stalingrad (1942), Kursk (1943), 2nd Kiev (1944), the Beresina (1944), the Vistula (1945), and Berlin (1945) that collectively broke the back of the Nazi war machine. But this debt owed to Stalin and Stalin's régime? No. It is owed to the people of the Soviet Union.
Before Hitler attacked the Soviet Union, Stalin decimated his army through purges, attacked Finland and adding it to Hitler's allies, and fed the Nazi war machine with raw materials it could not get through the British naval blockade. Had Stalin joined the allies in September 1939, he would have had three allied armies--Polish, French, and British--fighting on the continent of Europe, and a neutral Italy. Add in the role played by the Comintern in gleefully helping to destroy the democratic center that lay between Hitler and Weimar Communists in Germany, add in what Hobsbawm calls "Stalin's... extraordinarily inept interventions into military strategy," and conclude that Stalin made the Soviet people's task in 1941-1945 more difficult.
One of the major themes of twentieth century history must be barbarism and mass murder. This is a century in which perhaps 160 million civilians have been killed by governments--through execution, overwork in prison camps, terror-bombing with no proportional military effect, and mass famine induced as an aim of policy. Perhaps three quarters of these civilians have been killed by their own governments. Thomas Hobbes wrote that people pledged allegiance to governments to protect them from the fear of violent death. In the context of the twentieth century Hobbes was a utopian optimist: governments--Communist governments above all--have been the principal source of violent death.
Hobsbawm's book contains some eloquent passages describing the tyrannies of Stalin and Mao. But they are oddly disconnected from the narrative of the "Age of Catastrophe" that was the first half of this century. For Hobsbawm, this disconnectedness serves a purpose: it allows him to write as if Stalin's Soviet Union was part of the solution in the struggle against tyranny in the twentieth century, rather than a large part of the problem.
As odd--and indefensible--is Hobsbawm's attempt to find roots of what he calls the post-World War II "Golden Age" in the October Revolution. It is even harder to see post-war success--prosperity, democracy, the welfare state, and greater economic equality--as due to World Communism. Hobsbawm wants the October Revolution to have provided "[Capitalism] with the incentive, fear, to reform itself after the Second World War." But "capitalism" is not a live, breathing, intelligent creature that feels fear and thus undertakes to reform itself. Concepts like "capitalism" do not make history. Humans make history--even if not just as they please, but under circumstances dictated by the past.
The post-World War II order in the industrial west was made by the voters who chose the Trumans, the Adenauers, and the Attlees, and who set the parameters of the politically possible within which politicians seeking to maintain public support and provide for the general welfare could operate. A secondary role in making the post-World War II order belongs to the politicians themseles, who drafted, negotiated, and enforced the laws that created the mixed economies, welfare states, and social democracies of the post-World War II industrial and democratic west.
They did a good job.
In the United States, they would have done a better job had Communism not existed; Stalin's presence brooding offstage was not helpful. In western Europe as well, the subservience of national Communists to Stalin meant that social democracy could only assemble majorities by taking several steps to the right, and thus limiting the coverage and scope of the welfare state. In the developing world, countries that adopted the Soviet model did so at an enormous price.
Hobsbawm half-recognizes that he has misused his space. He muses on "the changes in human life... brought about [by economic growth in the twentieth century] all over the globe" and calls them "as profound as they were irreversible." He notes that the twentieth "century marked the end of the seven or eight millennia of human history that began with the invention of agriculture." He concludes that "[c]ompared to this, the history of the confrontation between 'capitalism' and 'socialism'"--the major theme of his book--"will probably seem of more limited historical interest."
Yet he has only eleven pages--257 to 268--for the century's economic revolution, and only two chapters--10 and 11--for the consequences of the end of the ten thousand year era in which most humans worked growing or making things with their bare hands.
Hobsbawm would have served himself and his readers infinitely better if he had cut by three-quarters the space devoted to Communism and its struggles, and devoted it to the central theme of twentieth century history. Call it the "elevator to modernity," the explosion in productivity seen in the economies of the industrial core. A first corollary is the "escalator to modernity": the third world today is far from levels of prosperity found in the industrial core, but for more than three billion people this century has seen the beginnings of the industrial, urban, educational, and communications revolutions. And a second corollary is the triumph of social democracy: the combination of political democracy, the mixed economy, and the welfare state.
The Elevator to Modernity
This year--1995--the U.S. Commerce Department will report that the gross value produced in the United States by the average employed worker is about $56,970. A century ago--1895--historical statistics tell us that the gross value produced, divided by the number of workers, is some $14,150 measured at 1995 prices (and $408 when measured at 1895 prices). The average American worker produces some four times as much as a century ago according to this set of numbers, which roughly answer the question: "What would 1895's production be worth if we had it to sell today?"
But we are most interested in a different question: roughly, how much better is today's economy than that of a century ago in making what humans need and want? And simply valuing last century's goods at today's prices leaves out the important fact that we, today, produce a much wider range and quality of goods than a century ago. Anyone taken back in time to 1895 would feel cramped and harassed by the absence of so many of the goods and services we take for granted: no airplanes, limited telephones, no communications media or compact-disk players, limited prepared foods, no automobiles and no asphalt or concrete roads, no electrically-powered consumer durables.
How much does the expanded range of choice made possible by the inventions--new goods and new categories of goods--of the past century matter? If you try to duplicate in the past the capabilities we have today in the past, you fail. The capability of your compact-disk player--that of listening to, say, Don Giovanni in the evening in your home at whim--could not have been provided two centuries ago at any price.
Let me use Alan Greenspan's guess that the invention of new goods, new kinds of goods, and new features for old goods boosts our true standard of living by one-half to one and one-half percent per year: combining the fourfold multiplication in measured output per worker with the one-fifth decline in hours and the increase in the scope and range of goods and products, America as a society today is at least eight and perhaps as much as twenty-three times as wealthy as America a century ago. The average American today has a "real standard of living" higher than 999 out of every thousand Americans alive in 1895.
Perhaps the nineteenth century saw a doubling of real standards of living in the industrial core. Perhaps there was some progress not just in technology but in standards of living in the previous eighteen centuries of the Christian era--although I would not place high odds that the median Frenchman in the age of Louis XIV had a higher standard of living than the median Athenian at the birth of Christ.
Nevertheless, the difference between economic growth in any previous century and economic growth in the twentieth century is a large enough quantitative to invoke not just one, but several qualitative transformations. It is like the difference between climbing a ramp, and riding up the World Trade Center in an elevator.
Why has the twentieth century been so different from all previous centuries? Market economies have the standard advantages of giving manufacturers and traders every incentive to use resources most efficiently, and which have the additional advantage of providing that "sunset" for relatively inefficient organizations. Enterprises that are relatively inefficient cannot pay their bills, and vanish. This automatic weeding-out of inefficient organizations that fail the test of the market is so lacking where state enterprises draw on the general taxation or money-printing power of the state.
But markets alone do not generate the tenfold multiplication of human productive potential that the twentieth century has seen. Previous mercantile capitalisms, like Classical Athens, Sung dynasty China, Mediterranean Islam circa 1000, northern Italy in the late middle ages, or Augustan Britain have been relatively bright spots in human history. But they are only pale shadows of what we have seen this century.
If I had to lay odds on the necessary additional factors, I would bet on two: first, democracy; second, technological density.
Before our century, a productive mercantile economy was a goose that laid golden eggs--but there was always the temptation to squeeze the goose a little tighter to pay for a slightly greater degree of courtly splendor or a slightly higher military effort on whatever was the current active conquest frontier. History is littered with the corpses of golden geese. The loss of control by a mercantile aristocracy to a military one, or to a despot, meant that the best days of the local mercantile economy were past.
Successful democracy changes the calculus. Courtly splendor and an overmighty military become of less interest and less urgency than keeping real wages, employment, and profits rising--for political parties that are either unlucky to catch an unfavorable wave of the business cycle or unskillful enough to disrupt economic growth vanish rapidly. Economic growth and market institutions certainly coexist with political despotism for a while, but there is good reason to doubt their long-term compatibility.
But we need "technological density" as well: research and development has to become an industry in itself, rather than an avocation of a few learned gentlemen reading papers before a Royal Society, to maintain the pace of invention and innovation that we now take for granted. Only the confluence of all three, market institutions, political democracy, and high technological density, could generate the economic revolutions of the twentieth century.
This is the proper central theme of twentieth century history: the pace of economic transformation--its causes, its implications for productivity, for the structure of employment, for the use of education, for the value of capital, for society and social order, for cultural events, for politics. This is where a truly Marxist analysis could have been extremely powerful. For if there was ever an age in which changes in the material conditions by which humans produce and reproduce the necessities and conveniences of their life dominate every other sphere of human activity, it is the twentieth century.
The upward jump of productivity and wealth is not confined to the core of the world economy. In 1987, 97 percent of households in Greece, not usually considered one of the world's industrial leaders, owned a television set. In Mexico there was one automobile for every sixteen people, one television for every eight, one telephone for every ten.
On our low estimate of the pace of growth in the twentieth century, some 44 countries today--from South Africa and Estonia to Botswana and Brazil, from Slovenia and South Korea to Japan and Switzerland--are as rich as or richer than the United States was a century ago. And the United States a century ago was a society with a level of wealth previously unseen in world history. On our high estimate of growth, not 44 but 76 countries are wealthier today than the U.S. was at the turn of the cneuty.
The world's distribution of wealth, today, is probably more unequal than at any time in the past: the explosion of wealth in the industrial core carried them far above the four-plus billion below. But when future historians look back at the third world in the second half of the twentieth century, they will say that this was a period in which three billion humans climbed onto the escalator to modernity.
Social Democracy
A second theme of any history of the twentieth century should be the triumph of democracy over a large chunk of the globe, and the consequent arrival of the developed welfare state with its web of support services and social insurance programs.
A look back at human history can be read to suggest that, unless the extraordinary wealth generated by the twentieth century has had some subtle impact on political dynamics, that our current democracies may not survive for even half a millenium. Those writing history four or five centuries from now might live under imperial régimes: emperors whose dynastic titles are based on keeping relative peace, ruling through aristocracies that negotiate semi-consent with the ruled. Imperial aristocracy may be in the future, as it has been in the past, the canonical form of human government.
Nevertheless, just as the Classical experience with semi-democractic and republican forms of government has always been of great interest to Europe's historians and politicians, so our experience with democracy in the industrial west--even if it ultimately ends--will be of as great interest to historians and politicians in the future. As Thucydides, Plutarch, Livy, and Sallust spoke to Niccolo Machiavelli as he tried to preserve the Florentine and to James Madison as he tried to establish the American Republic, so we should try to speak to our possible successors perhaps a millennium hence.
The rise of stable democratic governments has transformed not only how governments work but what they do. The industrial, democratic west has for the past half century been the realm of the social insurance state. Whether called "mixed economy," "social democracy," or "social market economy," the major business of government has become social insurance: progressive tax systems, income support, and benefit provision programs to partially counterbalance the extremes of economic inequality produced by the market distribution of income, and to create countries that are more middle-class societies.
Thus the past fifty years in the industrial, democratic west marks one of the few eras in history in which the distribution of wealth and economic power is to a degree the result of political choice, instead of the distribution of economic power largely determining political organization. Opposing pressures have balanced: populist calls for taking "unearned increment" from the rich balanced by an admiration for entrepreneurs and savers, and a realization that economic life is a positive sum game; compassion toward the poor balanced by resentment of those seen as trying to get something for nothing--even if the something is pitifully small by middle-class standards.
But the political and economic balancing act of social democracy appears possible only if economic growth continues. And the record of the twentieth century is that modern mixed economies are not stable, and require the most delicate management to avoid economic chaos.
Go to Wall Street. Look around. Wall Street is, in a very real sense, the investment planning department of the human race. Power to purchase commodities that owners of property have earmarked for savings flow into Wall Street and, in a complicated social and economic dance, are distributed to enterprisers and bureaucracies seeking permission to invest, develop new enterprises, or expand old ones.
The future becomes visible only slowly: one day at a time. Our technological capabilities, individuals' preferences for spending and saving, and natural resources change very slowly. Thus Wall Street should be a quiet place. Financial prices are the shorthand that Wall Street-considered-as-investment-planning-department uses to assess the desirability of investment projects. They should move glacially, as an extra day's information causes forecasters to revise so very slightly their image of the economy's bottlenecks twenty years down the road.
But this is not how Wall Street works. Today Mexico is fifty percent off--the valuation of all things Mexican, whether the cost of employing a worker, the value of a house, the worth of Mexico's currency, or the long-term profits to be gained from investment in a Mexican enterprise, is today fifty percent less than what it was in the late summer of 1994. If you had wanted to buy insurance against a fall in the peso in the late summer of 1994, you could have done so extremely cheaply. Few saw a peso collapse of the magnitude seen in the winter of 1994-1995 as possible; no one saw it as likely.
What has caused such a change? In part, financiers now believe that they were overoptimistic about the economic future of. In large part, however, financiers concluded that other financiers' downgrading of Mexico meant that Mexico would be starved of capital and short of international means of payment, and that as a result of this shift in mood the Mexican economy would perform more poorly.
This is an old story: a régime that bet a large chunk of its chips on rapid industrial development financed by capital inflow from world financial markets finds itself suddenly subject to a panic. In the United States, 1873 saw British investors lose confidence that American railroads and infrastructure were that day's equivalent of investments in the Pacific Rim. The largest investment house in the United States--that of Jay Cooke, politically well-connected industrial visionary who financed Abraham Lincoln's armies, and whose picture the Treasury Department's antique custodians will not release for me to hang in my office--went bankrupt.
Then there was no International Monetary Fund, no Bank for International Settlements, no Exchange Stabilization Fund, no one willing to guarantee the liquidity of the financial system that had funneled capital to America from Europe. As a result of the collapse of Jay Cooke and Company the City of London sneezed. The U.S. economy caught pneumonia. The share of America's non-agricultural labor force building railroads fell from perhaps one in ten in 1872 to perhaps one in forty by 1877--a seven percentage point boost to non-agricultural sector unemployment from this source alone.
Now we have a keen awareness of what is lost when a crisis of confidence is allowed to lead to the unraveling of a financial network. We have governments and institutions willing to take action. Unlike the United States in the 1870s, Mexico in the 1990s will not undergo anything near to a great depression.
Nevertheless, for at least three centuries capitalist financial markets have been working their erratic will. No one has a preferable alternative to allowing financial markets to do our collective investment planning: Wall Street's vision of where investment capital should be directed is infinitely better than the vision any group of planners. All would agree that financial markets require the most delicate political regulation and management. But it is rare that you find any two agreeing on exactly what form that political regulation and management should take.
There are a number of rules-of-thumb for economic management: Run a government surplus to keep the government's hunger for resources from draining the pool of resources for society's non-governmental investments. Use "automatic stabilizers"--decreases in tax collections and increases in social welfare spending in recessions--to cushion declines in employment and increases in poverty that occur when financial market shifts trigger depressions. Guarantee the safety and soundness of the credit system as a whole in emergencies, even though it rescues many who made overrash bets and provides some encouragement for future overrash. Guarantee not just the domestic but the international credit system.
Governments balance conflicting goals: high investment to boost productivity growth, stable prices so that private economic planning decisions focus on productivity rather than on exploiting quirks in the price-adjustment process, and high employment. The terms of the tradeoff are lousy. Election cycles tend to emphasize short-term as opposed to long-term performance.
And even good macroeconomic management is no guarantee that the average over the business cycle will produce the levels of employment or of income distribution that you want. Structural policies to level out the income distribution and maintain a high average level of employment face their own tradeoffs. Structural labor market policies are expensive; if you try to do them on the cheap you wind up with an unfavorable distribution of income, or a high level of employment; if you commit the appropriate level of resources to education and training, to job search assistance and employment subsidies, you will surely hear complaints--sometimes justified--that taxes are too high to sustain growth and investment.
Moreover, the entire system can lose forward motion completely. It is possible to mismanage a capitalist economy so badly as to bring a halt to essentially all economic growth. Consider Argentina, on a par with France and ahead of Italy in GDP per worker, agricultural productivity, and some areas of industry in 1950. Yet Argentina today may have no higher a standard of living than it had in the aftermath of World War II.
Given the importance of the issue, for the world economic system is more fragile than anyone would wish and has gone completely off its rails once in this century, government management of the business cycle and the economy would seem worth an extended and thoughtful treatment. It should, say, receive more space than a discussion of the policy dilemmas facing Soviet planners trying to build authoritarian socialism-in-one-country in the 1920s and 1930s.
But Hobsbawm is not equipped to provide such a treatment, and shows no sign of wishing to equip himself. Perhaps I feel the flatness and ineptness of his narrative more because of my own particular training. But I would have expected at least a little curiosity about, say, why the Great Depression was so much larger than any previous or subsequent depression. It was more than three times as deep and more than twice as long as any other. Yet all Hobsbawm has to say to account for the Greatness of the Depression is to chant words--speculation, over-production, credit boom--that have equal force applied to earlier and later recessions and depressions, of one-tenth the size of the Great Depression.
Conclusion
Eric Hobsbawm might complain that I have been unfair: that my real gripe is that I wish that he had written another, different book. He might say that I want a Book Written for the Ages, that reflects what historians in future centuries will find of greatest interest. And he is right, I do. By contrast, he might say, his book is "written by a twentieth-century writer for late-twentieth-century readers," to whom "the history of the confrontation between capitalism' andsocialism'...[s]ocial revolutions, the Cold War, the nature, limits, and fatal flaws of `really existing socialism' and its breakdown" are worth discussing at length. He is writing for readers who take the central theme of twentieth century history to be the tragical-heroic course of World Communism.
But the tragical-heroic course of World Communism is simply not the central theme of twentieth century history. For what audience is Hobsbawm writing his book? To what "late twentieth century readers" can we recommend The Age of Extremes as covering the pieces of twentieth century history they want and need to learn?
For new students seeking a genuine overview, the flaws, euphemisms, and silences arising from Hobsbawm's past political commitments are too mischievous. Hobsbawm's past political commitments lead him to believe both that (a) Kim Il Sung was a megalomaniac tyrant, and that (b) U.S. intervention to stop his extending his empire by conquest was a backward step for humanity. You cannot understand the twentieth century without finding an answer to the question of how as keen-eyed an analyst as Eric Hobsbawm can have held both these beliefs--without apparent strain--for more than forty years.
Yet Hobsbawm's book is constructed as if he wants to make it as hard as possible for a new student to figure out that this is an important question to ask.
For informed and experienced students seeking an overview of how the twentieth century changed the world, its focus is awry. Forty percent of space on the world religion of Communism and ten percent on the triple successes of social democracy--material prosperity, political democracy, and successful creation of middle-class societies--is the wrong balance. Ten percent on the world religion of Communism and forty percent on social democracy would be infinitely preferable
For students of Communism who believe that on balance it--a social movement that has, after all, contributed two of the twentieth century's three members of the I-killed-thirty-million club (Hitler, Mao, and Stalin), and at least four members of the I-killed-one-million club (Kim Il Sung, Pol Pot, Vladimir Lenin, Mengistu)--was not one of the brighter lights on humanity's tree of good ideas, the book will be profitable. But it will be profitable as an index of the impact decades of doublethink can leave on a good mind, as well as as an interpretation of history.
How many potential readers are left?
Morning Coffee Videocast: Forecasting Recessions Is a Fool's Game: ECONOMISTS should never forecast changes in long-term interest rates, the next move in the stock market, or whether there is about to be a recession. We have very good theories to explain why all three are more-or-less completely unforecastable.
I wrote this eleven years ago. I still like it:
John Maynard Keynes, A Tract on Monetary Reform (London: Macmillan, 1924)
This may well be Keynes's best book. It is certainly the best monetarist economics book ever written.
What do I mean by monetarist? Consider the book's preface, where Keynes writes:
[The economy] cannot work properly if the money... assume[d] as a stable measuring rod, is undependable. Unemployment, the precarious life of the worker, the disappointment of expectation, the sudden loss of savings, the excessive windfalls to individuals, the speculator, the profiteer--all proceed, in large measure, from the instability of the standard of value.
It is often supposed that the costs of production are threefold... labor, enterprise, and accumulation. But there is a fourth cost, namely, risk; and the reward of risk-bearing is one of the heaviest, and perhaps the most avoidable, burden on production....[T]he adoption by this country and the world at large of sound monetary principles, would diminish the wastes of Risk, which consume at present too much of our estate.
The belief that monetary instability--inflation and deflation--is the principal, or at least a principal, cause of other economic evils; the hope that sound monetary principles can be identified and, when identified, would greatly diminish uncertainty and risk; the focus on the job of the public sector being to provide the private economy with a stable measuring-rod and a stable environment--all these are core ideas of whatever we choose to call monetarism. Keynes believed these ideas very, very strongly in the mid-1920s. And his Tract on Monetary Reform is a review of economic theory and a look at the economic problems of post-WWI Europe through this set of monetarist spectacles.
The first chapter--"The Consequences to Society of Changes in the Value of Money"--may still be the best summary of the many and varied effects of deflation and inflation--on the distribution of income, on economic activity, on attitudes toward risk and reward--ever written. From our present-day standpoint, it could use a little more focus on the differing effects of "anticipated" and "unanticipated" inflation and deflation. But a great deal is packed into a short space.
The second chapter--"Public Finance and Changes in the Value of Money"--may also be the best of its class. It provides an extremely lucid introduction to the idea of the "inflation tax"--that inflation is most importantly seen as a way for governments to levy a hidden tax on holdings of real money balances, and that governments almost inevitably find themselves resorting to this tax, whether by accident or by design.
The third chapter--"The Theory of Money and the Foreign Exchanges" is in its firsts part a rapid introduction to the so-called "Quantity Theory of Money". It contains what must be Keynes's most famous line--in the long run we are all dead--which is embedded in the following discussion:
It would follow... that an arbitrary doubling of [the money stock], since this in itself is assumed not to affect [the velocity of money or the real volume of transactions] ... must have the effect of raising [the price level] to double what it would have been otherwise. The Quantity Theory is often stated in this, or a similar, form.
Now "in the long run" this is probably true. If, after the American Civil War, the American dollar had been stabilized... ten per cent below its present value ... [the money stock] and [the price level] would now be just ten per cent greater than they actually are.... But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the strom is long past the ocean is flat again.
In actual experience, a change in [the money stock] is liable to have a reaction both on [the velocity of money] and on [the real volume of transactions]...
The second part of the chapter is a rapid introduction to exchange-rate determination--the purchasing-power-parity theory of exchange rate movements, and why there might be substantial and persistent deviations from what purchasing-power-parity would suggest.
Chapter four--"Alternative Aims in Monetary Policy"--sees Keynes shift from analyst to advocate: he comes down, in the context of Western Europe in the 1920s, on the side of devaluation to bring official currency values in line with relative national price levels rather than of deflation to force national price levels into consistency with pre-WWI exchange rate parities. He argues that when you are forced to choose between maintaining a stable exchange rate and maintaining a stable internal price level, choose the second. For avoiding fluctuations in your internal price level avoids a host of evils:
We see, therefore, that rising prices and falling prices each have their characteristic disadvantage.... Inflation is unjust and Deflation is inexpedient.... [I]t is not necessary that we should weigh one evil against the other. It is easier to agree that both are evisl to be shunned. The Individualistic Capitalism of today, precisely because it entrusts saving to the individual investor and production to the individual employer, presumes a stable measuring-rod of value, and cannot be efficient--perhaps cannot survive--without one...
He argues against return to the gold standard, on the grounds that modern central banks run by clever people like him can do a better job of maintaining price stability if they are not tied to gold. Keynes's arguments in chapter four look very good: current opinion among economic historians, exemplified by Barry Eichengreen's Golden Fetters: The Gold Standard and the Great Depression, is that attachment to gold did a large part of the work in preventing central banks from stemming the Great Depression of the 1930s.
The last chapter contains Keynes's "Positive Suggestions for the Future Regulation of Money". Keynes's suggested policies are the same as Irving Fisher, or indeed as Milton Friedman: spend money to construct a good price index, and then tune monetary policy so as to stabilize internal prices. As Keynes wrote in his preface:
We leave Saving to the private investor.... We leave the responsibility for setting Production in motion to the business man.... [T]hese arrangements, being in accord with human nature, have great advantages. But they cannot work properly if the [value of] money, which the assume as a stable measuring-rod, is undependable...
The implicit point of view is that if the value of money is dependable then leaving saving to the private investors and investment to business will work well. The magnitude of the Great Depression of the 1930s would destroy Keynes's faith in the proposition that stable internal prices implied a well-functioning macroeconomy and small business cycles. But from our perspective today--in which the Great Depression is seen as a unique disaster brought on by an unprecedented collapse in financial intermediation and in world trade, rather than as the largest species of the genus of business cycles--it is far from clear that Keynes of 1936 is to be preferred to Keynes of 1924.
Besides, Keynes of 1924 writes better: his prose is clearer, less academic, less formal; his argument is more straightforward, linear, easier to follow; his style is as witty.