25 March 2019

The Great Economists

How their ideas can help us today

Linda Yueh
2018, Penguin Random House, 368 pages,
ISBN 9780241234976

Reviewer: Christine Shields

The introduction to this ambitious book is excellent, bringing current relevance to what could have been a dry, historical study. A useful summary, too, of why she chose the ‘greats’ she did – explaining who missed the cut and why. Interestingly, she avoided upsetting peers by choosing only one living economist – Robert Solow - of her twelve greats.

And the individual analysis also transposes the theories into a present day context. So Adam Smith would now, perhaps, perceive services as more productive than he did when writing, because technical change now allows services to be traded – in the past concerts were a one-off performance, now they can be recorded into perpetuity. Likewise, Smith’s ‘laissez- faire’ still stands as a valid tenet, but regulation and policy could now be used to shape the economy to raise efficiency.

On David Ricardo, who builds on Smith’s notion of specialisation raising efficiency via trade, not just the productive process, Yueh touches on the disadvantages of protectionism (Trump, please note). Rather trade, by boosting efficiency, raises the real wage of labour, so profits increase with the resultant higher demand. She draws on many current examples.

For instance, UK manufacturing may be a small proportion of the total economy, but a larger share of exports – and of value added. So even as services rise, the WTO is still relevant, but increasingly struggling as protectionist forces mount.

The chapter on Karl Marx brings China into the story. Here Yueh is authoritative. After much on Marx’s background, which allows her to track Marx’s shifting influence, from Europe to Russia by the late nineteenth century, she reaches China’s version of Marxism. On Deng’s reforms, factor reallocation is key – labour migrations, state planned investment, and eventually the shift from state to private sector led development. So Ricardo’s openness to trade and Smith’s productive efficiency combine with factor reallocation to allow China to rapidly catch up with more advanced economies via the adoption of new technology. Yet China is far from fully open – restrictions continue on capital flows, on inward investment and on foreign ownership. And its legal system leaves much to be desired, which impedes its financial sophistication. But Marx’s worst legacy is the lack of incentive to be efficient – viz. Russia’s and China’s poor performance when closely following his principles. He would probably not approve of either now.
Alfred Marshall was fascinating. His wife was forced to resign as a fellow of Cambridge on her marriage (just like the UK as recently as the 1970s), yet she became one of the first female economics lecturers. Yueh cleverly bridges current western inequality (10% of those in the US have half total income and the richest 1% have 20%, while Europe is far less unequal) with emerging market experience – e.g.  beggars exist in Shanghai yet China has more billionaires than the US. Why? She posits that (i) globalisation constrained wages especially for the lower skilled; (ii) technical change multiplies the advantages to skilled labour. Marshall was sensitive to incentives and not keen on centralisation – hence emphasising education to raise skills. He was a forerunner to Keynes, building on strong mathematical rigour.

Next Irving Fisher, another mathematical economist, though with poor personal financial fortune, having fared badly in the Great Depression, partly through his own mis-management. It’s ironic then that he developed the Quantity Theory of Money. Yet the lessons he provided are still valuable, as Ben Bernanke would attest in 2008.

Now JM Keynes. I loved the quotes. ‘A speculator is one who runs risks of which he is aware, and investor runs risks of which he is unaware’. Keynes himself speculated – and lost. Yet he learnt from the Great Depression – and crucially looked from the long-term to the short-term because ‘in the long-run we are all dead’. Hence the origins of demand management. The New Deal in 1933 US was not enough and the UK measures in 1933 were even less effective. Keynes also differentiated between deficits for capital or current spending, the former being justifiable, the latter less so. But the IMF intervention in the UK in 1976 spelt the end for Keynesian demand management. Friedman’s monetarism was by then on the rise, Reagan was elected in 1980 and supply-side economics took precedence. Only after the global financial crisis was there much renewed interest in demand management.  It remains an open question whether low interest rates now should be an excuse for new public investment to boost demand.

Joseph Schumpeter – to whom an economy is in constant flux due to technological innovation – is highly relevant as technical change, especially artificial intelligence, gains sway. Himself an entrepreneur who had suffered bankruptcy, he had a life of reinvention – as a lawyer, a banker, and economist and a one-time Austrian Finance Minister, then back to academia. To him entrepreneurship and innovation were the key drivers of economic growth – and that requires boom and bust. Nokia and Blackberry are topical examples. Kodak too. Will Apple be next? And will China become the world’s leading innovator?

Another Austrian, Friedrich Hayek, saw central planning as the consequence of socialism. He was loud in his criticism of Keynes. If Keynes saw deficient demand as the cause of cycles, Hayek saw poor monetary policy, specifically too-low interest rates, as the cause. He may see the same cause for the global financial crisis. How then would he see QE?
Joan Robinson – the only female ‘great’ – focused on wage growth – very topical now. Key for her was imperfect competition. In this, she reconciled the mathematical and the empirical sides of economic theory. Robinson’s views have resonance now given the backdrop of weak real wage growth. This could be due to globalisation or shocks such as German reunification. She contrasts the gig economy and temporary workers to the convention of lifetime employment and permanent contracts in Japan – and in Korea the impact of temporary workers on skills. And what do robotics imply for trade unionism?

Milton Friedman is Yueh’s next great. Here QE is the inevitable focus. How would he see the scale of government intervention post global financial crisis, given that he favoured small government? Ben Bernanke may have learnt the lessons of the 1930s, but Friedman may have disapproved of how his views were interpreted into 2008 policy with the rescue of JP Morgan while Lehmans was allowed to fail.

I particularly liked the chapter on Douglass North. As country risk practice dictates, he saw history and institutional structure as key to why some economies are richer than others. He also brought in social policy, behavior and politics, the latter being fundamental to country risk differences. Yueh examines progress in narrowing the income gap between countries using Millennium Development Goals and compares Vietnam, Myanmar and South Africa to identify why they arise. Institutions are key, but so is the rule of law.

Finally Robert Solow, whose work is even more pertinent in our current ‘new normal’ of slow trend growth. Highly influential because of his growth models and the implications of technical progress, productivity growth is to him the key to economic progress. So true in Brexit-dominated UK, though also valid in Japan where performance has been sluggish for decades. The latter is a story of policy failure – both fiscal and monetary – but also of inadequate structural reform.   
In the epilogue, Yueh draws together all these greats. Brexit, Trump and the rise of populism reflect the economic disruption from globalisation. Bilateralism is a consequence.

Inequality adds to the sense of wide exclusion. The solutions of the “greats” might be: Smith and Ricardo – more free trade; Marx and Robinson – blame capitalism; Marshall – redistribute moderately; Fisher – open up economies more; Keynes – more intervention to boost demand to help losers; Hayek and Friedman – free up markets; Schumpeter – look global; North – reform; Solow – boost investment.

The bottom line? Learn from the past and avoid the same mistakes. How true.

Overall, a highly readable book that is very informative and sets important historical theories in a current context to better inform future policy choices.