What Would the Great Economists Do?: How Twelve Brilliant Minds Would Solve Today’s Biggest Problems

314 Pages·2018·3.01 MB·English

by  Linda Yueh

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To my family
Introduction: Great Economists on Our Economic
Challenges
During times of fundamental change, economic expertise is in demand. Who
better to help shape our economic future than the Great Economists? Their
thinking transformed the modern economy into one characterized by
unprecedented prosperity, relatively speaking, in even the poorest countries.
Those ideas from the past can help guide us as we confront today’s economic
challenges.
Now is an ideal time to assess where the world economy is headed. Having
come through the global financial crisis of 2008 and the Great Recession that
followed it, the US, Britain, the European Union, Japan, China, and others are
experiencing significant challenges to growing their economies and generating
wealth. America, for long the leading economic engine of the world, faces the
prospect of slowing growth as slow wage growth weighs on its future. In Britain,
weak productivity growth and the historic referendum of June 2016 that resulted
in a vote to leave the European Union will affect the country’s economy for
years to come. The EU, meanwhile, faces difficult questions about how to
reform the euro area’s economy to generate growth while sharing a single
currency, the euro. Concerns over slow growth have long confronted Japan,
which is at the forefront of a number of innovative economic policies to energize
its sluggish economy, while China, too, faces structural challenges as it attempts
to join the ranks of the world’s rich countries. Emerging economies such as
those in Asia, Africa, Latin America, and eastern Europe are also in the
spotlight. After years of strong growth, they are slowing down, which raises the
question whether these nations will have enough economic momentum left to
eradicate poverty within their borders. Yet, we also live during a time of rapid
technological change, much like the previous Industrial Revolutions that raised
our living standards. We’ll also consider what drives innovation and how to
increase economic growth.
*
Who, then, were these Great Economists whose theories changed the world and
whose ideas can help us with our challenges today? It was a difficult choice to
make. Applying the criterion that their work must have direct implications for
our current economic problems helped a little, but there remain many not on my
list who might arguably have been included. Hyman Minsky, for example, who
is discussed in the Irving Fisher chapter because the pair’s combined thinking
helps us better to understand the nature of financial crises. And Paul
Samuelson’s ideas on the distributional impact of international trade builds on
the work of David Ricardo, so his thinking provides considerable insight into
how those who have lost out in the globalization process discussed in the
Epilogue might better manage their predicament.
This leads on to my second qualifier, which is that my selections also reflect
the issues that I have chosen to focus on. Choices had to be made, so I have
whittled a huge list down to one that is centred on economic growth – that is, the
rate and the quality of development. How economies grow will be affected by
the policy choices taken after the worst banking crash in a century and in the
context of a globalized world. The 2008 financial crisis and the rise of emerging
markets are among the fundamental factors in the past few decades that have
transformed and will continue to reshape the world economy. The crisis showed
that some of the old ways of growing an economy are unsustainable, while the
fast growth of a number of developing countries suggests that it’s time to
examine how they did that and what it means for big global challenges such as
eradicating poverty. Some countries have already confronted some of these
issues, and therefore hold potential lessons for other nations. For instance, what
can we learn from how the US and UK have been re-examining their growth
drivers after the 2008 crisis, or how China has emerged as a major economy so
rapidly? Other examples include how Europe is planning to increase investment
to boost economic growth, and Japan’s attempts to end decades of economic
stagnation through massive government intervention. So, the quality and nature
of economic growth will be central to this book.
You will note that I have largely chosen economists from an earlier vintage.
The Greats, unsurprisingly, tend to focus on big general questions, such as
growth, innovation and the nature of markets. Of course, there are eminent
economists who are currently working on key problems. Many of the recent
Nobel laureates are actively engaged in current policy debates, such as raising
economic growth rates and assessing the role of government spending, but their
research is rooted in the work of the originators of the general models that form
the foundation of economics. This book reveals who those Great Economists
were, where their ideas came from and how their insights have shaped economic
thinking.
Unsurprisingly, my first subject is Adam Smith. It is almost a truism that all
economists first turn to Smith when confronted with an economic question. I
was reminded of it recently when I presented a BBC radio programme. I asked
an academic why we tend to overlook the dominant services sector and instead
focus on manufacturing, which comprises only around one-tenth of the British
and American economies. He referred immediately to Adam Smith, who thought
that the services sector was unproductive. Smith believed that the sector was
comprised of ‘buffoons, musicians, opera-singers’,1 whose output could not be
traded and therefore did not add to national output in the same way as
manufacturing. Smith was, naturally, a product of his times, which witnessed the
advent of industrialization that led to an unprecedented increase in incomes and
living standards. His 1776 The Wealth of Nations is the seminal work on the
subject. Smith’s legacy is evident in nearly every aspect of economics. We still
view the economy through the lens he fashioned.
So, Adam Smith is the first Great Economist in the book. His idea of the
‘invisible hand’ of market forces – meaning the innate effects of supply and
demand, rather than direct intervention by governments or other institutions – is
the foundation of economic theory. As I explored in that Radio 4 programme,
the British government is trying to rebalance the economy towards making
things once again, after the 2008 crisis revealed the downsides of relying too
much on financial services. So far they haven’t succeeded. A decade later, the
services sector has recovered to pre-recession levels, while manufacturing has
not. And it’s not just Britain. America, China and other major economies are
also seeking to rebalance their economies so that they can grow in a more
sustainable fashion. What would Adam Smith say about these attempts? How
would he reconcile his affinity for manufacturing with an aversion to
governments intervening in the workings of the ‘invisible hand’?
An economist inspired by Adam Smith later became the father of
international trade. In 1817 David Ricardo formalized the theory of comparative
advantage that shows how every country benefits from free trade. This is true
even if that country is worse than every other country in the world at producing
everything. It should still focus on making what it was relatively less bad at, and
specializing and trading would benefit it as well as the rest of the world. But,
what if the result of trading on the basis of comparative advantage is that
countries like America and Britain run persistent trade deficits, meaning that the
value of the goods they import outstrips the value of their exports? What would
Ricardo advise governments to do?
Karl Marx viewed the Industrial Revolution rather differently from Adam
Smith. Although he too experienced the dramatic transformation of Western
economies in the nineteenth century, Marx rejected market-driven outcomes and
instead favoured collectivization over capitalism. He viewed the market
economy as exploitative and unsustainable, and his views led the former Soviet
Union and China, among others, to adopt a communist rather than capitalist
system.
The collapse of the Soviet Union is generally viewed as an indictment of
central planning. By adopting market-oriented reforms, China has emerged as
the world’s second largest economy. Still, China is undergoing perhaps the most
challenging part of its marketization process. How would Marx judge the trail
that the Chinese economy is blazing?
On the opposite side of the planning – market spectrum from Karl Marx was
his near contemporary Alfred Marshall. Instead of the government running the
economy, Marshall formalized how Smith’s ‘invisible hand’ achieves an
equilibrium for the economy through market forces. He showed how supply and
demand determine the price and quantity of a good. Marshall’s belief in a self-
correcting market that moves towards an equilibrium means that we only need a
laissez-faire state. There is no imperative for the government to intervene a great
deal in the workings of the market economy, for instance, in the ups and downs
of a business cycle. But, how about redistributing income in the face of rising
inequality? How would Marshall have viewed inequalities that have burgeoned
as the benefits of a growing economy disproportionately accrue to the top 1 per
cent?
There’s no doubt that inequality is high on the policy agenda, a reminder that
we must consider the quality and not just the speed of economic growth. A best-
selling book on the topic of inequality is by the French economist Thomas
Piketty. Its popularity reflects a widespread concern that inequality is as high
now in America as the Gilded Age of the late nineteenth century. A recent