Grand Pursuit: The Story of Economic Genius

• Introduction
• Remarks
• Questions and Answers

JOANNE MYERS: Good morning. I'm Joanne Myers, and on behalf of the Carnegie Council I'd like to thank you all for joining us.

Today it is our pleasure to welcome Sylvia Nasar to our Public Affairs Program.

As the author of the prize-winning book A Beautiful Mind, her name has become synonymous with the writing of elegant and engrossing prose. And now, with the publication of Grand Pursuit: The Story of Economic Genius, she illustrates that one of the best ways to explain how new economic ideas take root is by focusing on the formative experiences of some of this discipline's most famous geniuses.

The economy today is all about high levels of unemployment, bankruptcies, and a general lack of consumer confidence. It is a scenario that leads one to believe that these are the bleakest economic times in recent memory.

Yet, in reading Grand Pursuit, we soon learn that there have been other times in other places where economic conditions, whether in Victorian England or modern-day India, were considered extremely dire, so much so that in witnessing these conditions a new crop of economic theorists was born, whose experiences triggered new theories that came to shape economic and political battles for centuries.

In telling the story of the making of modern economics, Professor Nasar begins at a time when the specter of hunger was stalking the poor in Victorian England. She introduces us to Charles Dickens, who was as much a social reformer as a storyteller. She continues by looking at other difficult times in history, to find those who rescued mankind from endless poverty and a life of despair.

Among those economists whom Ms. Nasar has chosen to highlight are such well-known theorists as Karl Marx, Friedrich Engels, John Maynard Keynes, Paul Samuelson, Milton Friedman, and Amartya Sen. While these individuals are predictable, she has also chosen others who are equally important, such as Joan Robinson, a disciple of Keynes, and Beatrice Potter Webb, who was a well-known anti-poverty crusader and invented the idea of the welfare state.

In concluding what our guest has accomplished in writing this book is to bring to life the stories of the men and women whose economic ideas contributed to reshaping how we think about life's possibilities. After reading this wonderful book and being introduced to so many of the pivotal thinkers whose ideas transformed the world, you can't help but wonder who will be the next generation of economic theorists whose ideas will fuel the engines that will influence the changes we need in these very uncertain economic times.

Please join me in welcoming a very gifted and insightful storyteller, our guest today, Sylvia Nasar.

SYLVIA NASAR: Thank you. It's such an honor to be here. As Joanne and I were saying over breakfast, this is the end and also the high point of my book tour. So thank you very much.

I am going to start with A Christmas Carol and Charles Dickens. The early 1840s were the worst years in the 19th century in England, and Dickens had just come back from his book tour in the United States. As you probably know, he hated the United States because the United States was, in terms of copyright, the China of that time, and Dickens never got over it.

But what he was impressed by was the thousands of millions—he was really very good with numbers—the thousands of millions of acres of land as yet unsettled and our American custom of hastily swallowing large quantities of animal food three times a day. [Laughter]

These impressions were very much on his mind when he came back to England to find an industrial depression, massive unemployment, hunger, misery, early death, and class strife, even, according to some of the more alarmist conservatives of the day, a whiff of revolution.

Now, Dickens was a great admirer of the French Revolution, particularly of its democratic ideas, but not of violence, and he abhorred the notion that the interests of classes were diametrically opposed.

He did want to strike a blow for the poor. At first he was going to write a pamphlet. But, being the great journalist and novelist that he was, he made a better decision and he decided, in early 1843, to write a heart-warming story about a rich miser, a businessman's change of heart that he hoped would strike the public like a sledgehammer, with 20,000—he really liked big numbers—with 20,000 times the force of a political pamphlet.

A Christmas Carol was an attack. It wasn't just the wonderful image of a Christmas dinner with a flaming pudding that we all remember, but it was really Econ 1.01. It was an attack on the deeply pessimistic, and indeed dismal, economics of the day.

By the 1840s, whatever was optimistic in the vision of Adam Smith had been buried in the deeply pessimistic outlooks of Malthus, Ricardo, and Dickens's contemporary John Stuart Mill. They saw that the nation could get richer, as indeed England was becoming the richest and most powerful nation in the world, but that this would not mean that the bottom nine-tenths, the nine parts of all mankind who were born to drudge their way through life, that they could expect any improvement.

So the nation would get richer but the bottom nine-tenths would continue to live basically at subsistence, with a quality of life not really significantly higher than that of expensive livestock, just as they had for the previous 2,000 years.

This is the great fact, by the way, of economic history that divides the modern age, which we are very fortunate to be born into, and all of past human history, which is that for 2,000 years the average standard of living really didn't budge. The average person didn't benefit from any advance in civilization, science, technology, art, or moral philosophy. And, of course, the early economists were extremely cognizant of this.

Dickens here is calling for something that is really revolutionary, which is a hopeful science, a science that sees that the limits of growth might be pushed outward and that the bottom nine-tenths might have some hope—and not just utopian wishful thinking, but realistic hope of improvement. So Dickens was calling for an economics with a little human bloom, a little human warmth.

The idea that mankind was a creature of circumstance and that circumstances were not immutable, that mankind could take its material destiny into its own hands, was so new that even someone as evolved and articulate and thoughtful and liberal as Jane Austen—who was born only a brief generation before Dickens—never considered it. In her world, the world in which Dickens was born, the best that most of us in those bottom nine-tenths could hope for is that we could resign ourselves to the station in life to which we were born.

So this notion that our circumstances were malleable and that humanity was capable of taking its material fate into its own hands was one of the most radical ideas in human history. It was born in London among a group of people, of whom Dickens was the most imaginative, in an active imagination, and it spread outward like ripples in a pond until it transformed the lives of everyone on the planet. And it is still spreading.

Now, I want to just go to our current circumstances, because I've been asked over and over, "Well, if it's true, as you say, that economics was the tool, kind of the software, that helped humanity dig its way out of centuries of poverty, how come we're in such a mess now? Maybe that suggests that we really haven't learned too much in the 150 years since Dickens."

I'm just going to propose three things that we have learned and then tell you about a debate that I took part in a couple of weeks ago.

The three things are pretty basic:

• • The first is that the key to rising living standards, this revolution in living standards, is traced to productivity. In other words, the ability to make more material means for individuals to realize their aims was supplied by the ability to produce more per worker, the corollary of that being that the economic function of the corporation, business, is not to make its owners rich, but rather to raise our living standards, which I'm sure will come as news to some people downtown.
    
  • Secondly, that the key to long-run economic success, which essentially, especially since World War II, has meant the doubling of living standards every generation, is a stable economic environment that is business-friendly. That is, any country that can achieve that can achieve a modern standard of living for its citizens.

• Lastly, that the extremes of inflation and high unemployment can result, or do result, from monetary disturbances and can be cured by monetary means, that not only have we learned how to foster societies that produce higher standards of living, but we actually know how to cope with these short-term crises that are so politically destructive and cause so much suffering.
  

Now, recently, as you are probably aware, there has been a revival of the notion that was very popular, that was indeed the consensus, at the time of the Great Depression, a revival of the notion that the crisis we are in proves that we don't have any answers, that we are better off leaving things to nature, and that no intervention can really work.

That revival is associated with Friedrich Hayek, who at the beginning of the Great Depression came to England and was the advocate of non-intervention, the advocate of the notion that recessions are not monetary disturbances that lead to a collapse in effective demand that can be cured, but rather are the product of excesses in the previous boom—the bigger the boom, the bigger the bust—and, like a hangover, the best thing is to leave things be until there is a natural recovery.

The great thing about economic history, and one reason that what I try to do in this book is to show how events inspired individuals and ideas and framed the problems, is that it is a laboratory—Paul Krugman and I have often talked about this, because he's a big history buff—it's a laboratory where time and chance have performed experiments that can either confirm or challenge our ideas.

In this debate between Hayek, on the one hand, and Keynes, who we now know is the patron saint of activist government, and Irving Fisher, who is less often cited but who was very much the creator with Keynes of the theory of what determined in the short run the level of economic activity, there were very clear positions and there were three natural experiments that we can take a look at.

The first had to do with prediction. When Hayek came to England, he was a young upstart who admired Keynes very much and was making his career basically as his critic. He came to England as head of a forecasting institute. He was introduced in 1931 as the only one who had correctly predicted the U.S. crash, which was quite an introduction. It made him an instant star.

I think all of you probably know what happened to Irving Fisher's reputation after he said "stocks are at a permanently high plateau" two weeks before October 29, 1929 [Black Tuesday]. Keynes lost the second of his fortunes in the crash of 1929, because he too, like Fisher, was an irrepressible optimist who didn't see the crash coming. But Hayek supposedly predicted it.

Fortunately, a friend of mine actually went back—very few of Hayek scholars seem to know German—and looked at his monthly newsletter. It's true that he said in April of 1929 that there might be some unpleasant consequences from the American boom. But what did he say in October? "There is no reason to expect a sudden breakdown of the New York Stock Exchange. A pronounced crisis need not be feared."

Okay. So our first experiment says that you can't judge any of these theories, any of these views, by the correctness of their predictions because none of them, including Hayek, saw it coming.

Now, in September of 1930, Keynes urged a large, long-lasting worldwide cut in interest rates. Keynes is now portrayed as a fiscalist—in other words, someone who took the position that monetary policy can't work, we need direct government spending or tax cuts.

But, in fact, from World War I until the middle of the Great Depression, Keynes and his American counterpart Irving Fisher were advocates of monetary expansion, which at that time meant getting off gold. You can think what that implies in the current situation in Europe. So this is Keynes.

Hayek took exactly the opposite position: the creation of artificial demand would only lead to inflation and another setback. Does this sound familiar?

What is less familiar is that there was a contemporaneous experiment—that is, all countries in the early 1930s eventually succumbed to the devil; i.e., they all let their currencies float, they all went off gold. But they didn't go off gold all at the same time. That is how we get our natural experiment.

The results were unambiguous and overwhelming. The United States, which stuck to gold—that is, which maintained a restrictive monetary policy—the longest, that is until FDR took office in 1933, had the deepest and longest depression. Industrial production in the United States fell in half over four years.

On the other hand, those countries that went off gold in 1930 never experienced a Great Depression at all. Japan, Sweden, those liberal Swedes, they had nasty recessions. The minute countries went off gold, they had strong rebounds. Britain, which kind of took a middling position, which followed the advice of people like Hayek, balanced its budget, stuck to gold, but was forced off in 1931, had a slump that was one-third of the depth of the United States.

So that, I think, is a pretty clear indication that the notion that there is nothing that you can do, that monetary expansion doesn't work, is pretty clearly wrong.

Hayek, who had attracted many of the brightest young economics students, was slowly abandoned by all of his disciples, who eventually, like good economists, let the facts influence their theories, which is a good thing to do.

The last experiment has to do with really the reason for Hayek's fatalism about short-term intervention, and that is its long-term consequences. This is obviously a serious issue.

Keynes took the position that the right remedy for slumps is not to be found in abolishing booms, and therefore keeping us permanently in a semi-slump, but in abolishing slumps, thus keeping us permanently in a quasi-boom. Very optimistic.

Hayek, on the other hand, admits: Well, if administered with extraordinary caution and superhuman ability—which means not in real life—the plan to have government counter slumps by pumping money into the economy could perhaps be made to prevent crises. But more likely in the long run this manipulation would only bring about grave disturbances and the disorganization of the economic system as a whole."

So the practice of fighting slumps, fighting unemployment, in the short run will lead to long-term stagnation.

Now, I wish I had a PowerPoint to show you this chart. I looked at the three periods—pre-World War I, the interwar period, and then 1950 to now—the prewar period being characterized by the gold standard and nonintervention and 1950 to now being characterized by an attempt to moderate recessions—and looked at the basic measure of economic performance, namely productivity growth and increase in living standards. And guess what? Guess which period did the best, which again I think tells us which of these views we should have confidence in.

I think I'll end on that note and invite your questions and rebuttals.

JOANNE MYERS: Thank you, Sylvia. I'm sure we have questions and somebody is going to ask, "How does it end, which is the best period?" But I'll wait and let somebody else do that.

SYLVIA NASAR: The best period is the last half-century, including the last 30 years, which were one of the most prosperous periods in U.S. history—not only in U.S. history but, now that this pattern of economic growth and success has spread all around the world, in world economic history.

QUESTION: Matthew Olson.

Thinking about experiments that have happened over time, I started my adult life as a bond trader in the 1970s, when monetary expansion was the rule for the decade, and was followed by Paul Volcker stepping on monetary expansion, famously on Columbus Day weekend of 1979. While he was in the process of stepping on monetary expansion, Reagan came in and gave us a huge Keynesian boost in cutting taxes. That coincidence seems to run counter to what I took to be one of your principal arguments this morning.

SYLVIA NASAR: My principal argument is that the notion that you can't fight recessions with monetary or fiscal policy doesn't seem to be borne out. The Reagan example is very good, that when you couldn't use monetary policy because you had double-digit inflation, fiscal policy did work. I was making the contrast between intervention to fight slumps, on the grounds that slumps were nasty accidents, not wonderful cures, and intervention.

Secondarily, saying that the position right now, which is if for some reason you can't resort to fiscal policy, the notion that monetary policy won't work seems unnecessarily pessimistic and counter to everything that we've learned.

QUESTION: Thank you very much, first of all. It was great.

One of the words you have not invoked is "regulation" or "deregulation." Much of the debate over the last year or two years, at least, has been about whether economic growth is advanced or retarded by government regulation. Of course Alan Greenspan, inter alia, was a great guru of deregulation. At least one analysis of what has brought us to our peril is the excessive deregulation. I'm wondering if you could relate the regulation/deregulation debate to the themes you have outlined here.

SYLVIA NASAR: I am always struck by the fact that the two most successful, best-performing stock markets over time in the world are the United States—and guess which the other one is? Sweden.

The more I think about that, the more I think: Gee, they have so many differences, particularly in the size of the welfare state, that maybe what's important about long-term economic success is not whether you have a bigger welfare state or a smaller one or more regulation or less, but what you have in common: that is, a very vibrant, super-competitive private sector.

It doesn't seem to be the case that it's the level of regulation, but maybe it's the consistency and efficiency of regulation that is at issue, because, again, the most successful period of economic growth, both in the rich countries and in the poor countries, has been since World War II, a period where there has certainly been more regulation but also more growth. In other words, it doesn't seem to be about the level of regulation so much as the quality of regulation and the efficiency of regulation.

QUESTION: Susan Gitelson.

Thank you for helping to expand our minds. You have a much larger laboratory in the period since World War II if you include the whole world—India, which went from socialism to capitalism; Singapore, and so forth. So please have fun with some of the other examples and what strengthens your argument and what perhaps detracts from the argument.

SYLVIA NASAR: The other example that interests me a lot is that, as you know, there have been financial crises of a type that we thought were ancient history. There have been lots and lots of them since the early 1990s. So it seems to be clear that it does have something to do with the financial regulatory scheme and the way it has interacted with financial innovation and integration.

But one of the most interesting episodes has to do with the Asian crisis and the differing responses of Korea versus Thailand and Malaysia. That is that, in 1998, Korea, which was not initially implicated, nonetheless was engulfed. Not only did its currency collapse, but its banking system went into a death spiral; the economy plummeted.

I'm sure you remember that the IMF [International Monetary Fund] came along and said: "The problem here is crony capitalism, and especially the relationship between banks and corporations." That was the diagnosis du jour.

Well, Malaysia and Thailand took the IMF package and it took them X years to recover. Korea said "No thanks," and they did nothing on banking reform. They recovered in a year. It's extraordinary. You almost can't believe the numbers. A year after the collapse, South Korean GDP was back at the level of before the crisis.

It would seem to suggest that, first of all, something that worked for 30 years to produce spectacular growth maybe was a better indication than the "one size fits all and you should make your banking sector look like ours." Maybe what works locally may differ.

The fact that the Swedes have a very efficient government, both in a regulatory and in a welfare sense—I don't know if we could have that. Maybe we can.

So this idea that one size fits all is really not the case.

And again, the one common thread that all these countries that have now started to deliver a modern standard of living to their populations have in common, however different they are, is a vibrant, competitive private sector where managers can focus on doing a little more every year with the resources at their command, which is what productivity is about. It's doing more with what you have. It's not about what you have; it's about what you do with what you have.

As long as that's what business owners and managers are focusing on, as opposed to politicking or whatever, that seems to be the essential ingredient—discovered, by the way, by Alfred Marshall, who came to the United States in the 1870s and realized that there was this ingenious mechanism at the heart of this new society that would generate rising living standards.

QUESTION: Ron Berenbeim.

I was really struck by your choice of 1843 and A Christmas Carol to open your talk, because it struck me that the similarity between Britain in 1843 and the world today could not be more apt—very significant increases in productivity; people moving from rural areas into cities; enlargement of the franchise for voting (in 1832 in Britain); interdependence of world trade, trade with China, trade with India, bringing cloth in and sending it back out.

So what got Britain out of this funk? It seems to me that it was the development of effective political institutions and systems of governance. They also developed a rule of law, about which Dickens did not have very many nice things to say.

But setting that aside, how do we do this on a global scale, because isn't the development of political institutions and the institutional wisdom that goes along with it essential to whatever economic theory you use?

SYLVIA NASAR: Yes. But it seems that there is a wide variety of institutions that work locally.

Look, what is striking to me about Britain in the 1840s is that of course everyone was asking, "Where is this going to end?" and, clearly, a lot of people agreed with Marx that it couldn't work, that the existence of all this class conflict, all this misery, these constant crises, was proof of that. Ironically, that is exactly when, those years, the early 1840s—after 100 years of the standard-of-living debate—we now know that that's exactly the period when real wages started rising.

How did that happen? Because the same competition that was driving business owners and managers to constantly do more with the same resources was also spreading out the gains from increased productivity to the bottom nine-tenths. That's really the big discovery, because if there wasn't such a mechanism, then the system couldn't deliver.

But there was, in fact. I think that that really led in the 1920s to Fisher and Keynes making a very sharp distinction between the long term and the short term—not saying that the short term didn't matter, but that it was a different problem. I think that distinction between what are the deep issues that affect the ability of business to deliver higher productivity and the ability of labor markets to spread those gains around—those problems which we see in Venezuela right now—and the problems of short-term slumps—we are constantly conflating them.

So in 1931 Keynes says: It wasn't a dream, the 1920s booms was not a dream. This is a nightmare. We're stuck at the side of the road, we have engine trouble, but it doesn't mean that we're going back to the horse and buggy—making this distinction between short-term problems and these long-term structural issues.

We are constantly conflating the two, which is why in this situation, people are saying the American dream is dead, our children are not going to live our living standard—no. They are two separate things and they have two different solutions.

QUESTION: Howard Lentner.

When you have exported your jobs and revenues and your research and development and you assign services overseas and you don't have the jobs here, won't expanding the money supply cause stagflation? And what's the future of this country, where they don't have enough jobs for the masses who have the skills to take them?

SYLVIA NASAR: Well, look, every rich, successful country has had a shrinking share of employment in manufacturing. Most Americans—and this has been true for a long time—work. The biggest employers are education and health care, and if you add construction—it's not trade that drives the level of employment at any given time.

QUESTIONER [off-microphone]: If people don't have the jobs, how will they pay [inaudible]?

SYLVIA NASAR: Our jobs problem is not a long-term problem. In other words, there's no long-term trend toward joblessness in the United States. Most of the job destruction has not come from trade or exporting jobs. It has come from innovation and productivity improvements.

QUESTIONER [off-microphone]: [Inaudible]

SYLVIA NASAR: The short-term problem is that we had a recession, we had a fantastic monetary shock, and maybe we haven't taken enough short-term measures to solve that. But that's a very different problem than the problem you are talking about. You are talking about declining competitiveness, which is fact the United States does not suffer from.

QUESTION: Mike Koenig, Long Island University.

I, too, like Ron, am struck by the fact that you started with 1843. My question is: Is there an analogy between our current economic situation and the takeoff of the cell phone about 15 years ago to the invention of the railroad in 1830 and conditions in 1843?

SYLVIA NASAR: In what sense? Why do you think that?

QUESTIONER [off-microphone]: [Inaudible] innovation for the creation of productivity worldwide.

SYLVIA NASAR: In other words, was this recession caused by a real productivity shock?

QUESTIONER [off-microphone]: No. Will the cell phone pull us out of this recession in the way that the railroad did out of the recession of 1843?

SYLVIA NASAR: I don't think that the railroad pulled us out of the recession of 1843.

I think that what is pulling us out of this recession, albeit perhaps not as quickly as it could, is actually the Federal Reserve. The fiscal stimulus really didn't work because it wasn't very stimulating. It wasn't anything like the Reagan or the Kennedy tax cut. But what is pulling us out is pumping money into the economy.

Look, the technology is going to affect the composition of jobs. It doesn't affect the level at any one given time.

QUESTION: John Richardson.

As I look for models of economic order that seem to work or don't work, the Second World War was one, where the United States went from depression to wealth.

Also, democracy—government ran everything. High taxes, everybody who wanted a job had a job. Terrific. Some political forces now would like to have 50 states with 50 separate railway gauges and 50 separate time zones. So you can work that out. The states will work it out.

But what about Europe, where you don't have a federal system? That doesn't work. What's going to happen? Are the Germans going to have to pay for everything? Is that a solution, that they simply buy the Parthenon and they buy the Arc de Triomphe?

SYLVIA NASAR: That's their choice.

It is quite analogous to the gold standard in the 1920s, in the sense that the gold standard operated a little bit like a single currency. So you only had two choices: either the Germans paid for everything; or some of the peripheral countries drop out. That was the choice.

That's when the Swedes and the Japanese and the Argentines went off gold. That was the same choice. I don't know what they are going to do. But economically those are the choices.

And yes, politically it's harder, although some of the biggest—our political history is full of—I'm talking about the United States—clashes between regions over monetary policy—like the election of 1896, Williams Jennings Bryan, because the farmers were being killed by the gold standard and wanted to inflate, and the east, the manufacturers, didn't really want to go with that.

I think the point here is that it's not the lack of economic insight. It's these choices are really difficult politically. Those political choices haven't gotten any easier, even though we know more and we are better diagnosers of our economic ills and we do have remedies. But they are not easier choices.

QUESTION: Arlette Laurent.

What can you tell us about the fact that certain individuals or corporations can sell short on currencies and create total havoc by themselves on the political economic system on which they did sell short?

SYLVIA NASAR: I have to think about that. What are you referring to exactly?

QUESTIONER: Well, let's say Soros selling short on the pound sterling, him selling short on the Thai baht, one large banking institution in the United States selling short on the euro. What do you think can be done about that? These individual acts have had enormous impact on the economic and political situation there.

SYLVIA NASAR: I have to think about that. It's certainly true that, if you look at the early 1990s, from the early 1990s we've had lots of crises like the current one, and that was certainly new because they hadn't happened. It obviously has something to do with the growing integration of capital markets and deregulation.

But, since all these things are tradeoffs, what the right solution is is probably not in these general realms. It's probably very specific and out of my—you know, there's probably not one regime, broad answer, that we could come up with.

We know that there's a problem. But how best to solve it—and I don't think that's really going to come out right in the middle of a crisis, before we really have had a chance to learn all the facts.

QUESTION: Richard Valcourt.

What do you see as the impact of increased public-sector employment as opposed to private-sector employment, and the resulting necessity right now, in times of economic stress, of the public sector downsizing and the impact on that? Similarly, the impact of public-sector unions, as opposed to private-sector unions, particularly at times like these?

SYLVIA NASAR: I think about the U.S. national debt a little bit differently, because I looked at the data. If the United States were a typical American family with an income of $50,000 a year, its debt would be about $35,000.

Now, it's true that the federal debt is growing quickly. The major reason is that we've been in a recession and we have not recovered yet.

The debt crisis is the same old one that we had before the recession, and that has to do with the fact that in the future, because of the aging of the American population, the old formula that balanced revenues and expenditures is no longer going to work, so the gap is going to be five percentage points of GDP bigger. That has nothing to do with the current slump. That's the crisis.

Now, it's not exactly an asteroid hurtling toward Earth, and the kind of apocalyptic descriptions of the problem are really not warranted.

You know, timing is everything. Obviously, it's far preferable to grow your way out of debt and to solve these structural problems longer term and not to take radical action in the middle of what is a continuing weak economy.

So I don't think the imperatives are there that you imply.

JOANNE MYERS: Thank you very much, Sylvia, for sharing your ideas this morning. Thank you for taking the time.