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February 4, 2007
David Warsh, Proprietor


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On Being Invisible

The United State filed a complaint last week against China with the World Trade Organization. Hidden subsidies, including special tax rebates and tariffs, not to mention a monetary policy aimed at keeping China’s currency, the yuan, artificially low, were conferring unfair advantages on its exporters, the US claimed. The charges were an expression of exasperation, an escalation of rhetoric in a longstanding conversation previously dominated by strategic bilateral bargaining.

It was not the first time a nation had been accused of taking advantage of a wide array of policies to secure advantage in the global marketplace. Suspicions of a similar sort were harbored against the US in many quarters in the years after World War II.

Indeed, after Edmund (Ned) Phelps, in his Nobel lecture, in December, suggested that the lack of dynamism in the European economy today stemmed from, among other deficits, a scarcity of home-grown university-educated entrepreneurs, Lance Taylor, of the New School University, took to the letters page of the Financial Times to reply, when columnist Martin Wolf  celebrated Phelps.

It was true the European economies had not played a leading role in the development of information technology, Taylor allowed, but European “corporatism” was not the problem. Instead, American industrial policy, operating mainly through its Defense Department, had supplied the key advantage.

“Coming out of the Second World War,” Taylor wrote, “the UK and the US were on an equal footing with regard to IT (Turing vs. von Neumann, Colossus v. Eniac). Knowledge of valves vs. tubes was the same on both sides of the pond. Then macroeconomics and policy weighed in. The British did not have the resources to keep up, and the Continent at that stage was out of the game.

“Largely through public (read defense) support of leading corporations, the US took three big steps: development of programming and computer systems for national security purposes (concentrated on IBM); transistors (Bell Labs); and the creation of the Internet (initially for the military in the Pentagon’s Advanced Research Project’s Agency Network, Arpanet).”

Taylor might have added a fourth big US step, the personal computer revolution, led by Bill Gates, but then those developments had little or nothing to do with national security. He might have noted, too, that the sheer size of the American home market has been an enormous advantage. Broadly speaking, though, he’s right, despite having left out  the names of any number of important business entrepreneurs. US corporatism during the Cold War, properly understood, put the European variety in the shade.

But then, the lack of attention to the interaction between policy and entrepreneurial activity had been among Ned Phelps’ most important points when he spoke in Stockholm. European economic policy since 1945 had taken over-many of its cues from neoclassical economics, said Phelps, (instead of the modern economics in whose creation he had participated) with the consequence that the role of independent entrepreneurs had been seriously neglected. Neoclassical growth theory, in particular, “was conspicuous in having no people in it.”

“It explained the accumulation and investment of physical capital yet the driving force in that story — increases in knowledge, called ‘technology’ — rains down exogenously, like manna from heaven, and the selection among new technologies is instantaneous, costless and error-free.  Though in fact crucial for growth, a human role over a vast range of activities involving management, judgment, insight, intuition and creativity is absent.”

I thought of this exchange last week while reading Barry Eichengreen’s new book, The European Economy since 1945: Coordinated Capitalism and Beyond. Eichengreen, 55, is professor of economics and political science at the University of California at Berkeley. He is an expert on international finance in the interwar years (author of Golden Fetters: the Gold Standard and the Great Depression 1919-1939 and Elusive Stability: Essays in the History of International Finance 1919-1939), he worked his way up through the 1970s (Global Imbalances and the Lessons of Bretton Woods) to the present day. The new book takes on some of the most interesting questions in the world today.

For thirty years after 1945, Western Europe grew like a mushroom; then, after 1973, it slowed down. How? Why? Why, too, after the collapse of central planning in the 1980s, and the integration of Eastern Europe into the European Economic Community in the 1990s, has this huge single market failed to re-attain anything like the rate of growth of those early golden years? What are the prospects for the future?

Eichengreen ascribes much of the growth to an extended period of catch-up. The ’30s and ’40s, depression and war, were especially hard on Europe. There was no chance to emulate the American example. But after the war, there was on hand “an extraordinary backlog of technological knowledge ready for Europe’s use.”  European firms licensed technology, copied American methods of mass production, and adopted personnel management practices, and rapidly closed the gap — a situation captured nicely by historian Alexander Gerschenkron in a famous essay on “the advantages of backwardness,” who argued that that Banks and States could plant where, elsewhere, Entrepreneurs had plowed.

This European catch-up didn’t just happen, Eichengreen asserts; it could just as easily have gone off the rails. It required a wide array of what economists like to call institutions, not just well-established property rights and a tradition of respect for “the rule of law,” but also “solidaristic trade unions, cohesive employers associations and growth-minded governments working together to mobilize savings, finance investment and stabilize wages at levels consistent with full employment.

Thus in Western Europe, planning boards, state holding companies and industrial conglomerates were required to coordinate “big push” investments in several interdependent industries at the same time in order to take advantage of falling costs (coal, steel, machine tools, consumer durables, for example).  In Eastern Europe, wholesale nationalization and central planning would suffice. On both sides of the Iron Curtain, though, the results were more or less the same. Europeans who, at the beginning of the period, had heated their homes with coal, cooled their food with ice, and who, in many cases, lacked indoor plumbing, saw their standard of living skyrocket. Incomes soared, hours worked fell by a third, life expectancy grew dramatically. As Harold MacMillan famously told Britons in the general election of 1959, “You never had it so good.”

Until 1973, that is. Then, growth slowed down, in the United States, too, but especially in Europe.  In Eastern Europe, it precipitated the collapse of central planning and, with it, authoritarian regimes, as well. Growth based on capital formation had been rapid; now it  gave way to innovation-based growth that was slow. The opportunities for catch-up had been exhausted.  The Continent found itself having to search for bold new ways of sustaining growth. This was hard enough to do in Western Europe. In Eastern Europe, it was impossible. And so communism collapsed.

The body of the book is a superb chronicle of the evolution of these institutions of “coordinated capitalism:” the political economy of the Marshall Plan; the creation of the European Coal and Steel Community of 1948; the 1949 devaluations and the European Payment System; the European Free Trade Association of 1960 and the first inklings of monetary union; the incorporation of the European periphery in the early 1960s (Spain, Portugal and Greece) and the discontent in Eastern Europe over a longer period of time (Yugoslavia, Hungary, Czechoslovakia, Poland); the overemotional ’60s; the various payments crises of the early 1970s and the end of  pegged exchange rates and the Bretton Woods system; the European Monetary System, the Delors Report, the Maastrict Treaty and, finally, amid giddy excitement, the twenty-first century transition to a single currency and a European Central Bank.

The problem, Eichengreen notes, is that the very institutions that were created to facilitate catch-up — big banks, strong unions, indicative planning by government boards — no longer worked well in an era of rapid technological change. The studied tripartism and devotion to the principles of worker entitlement was ill-adapted to a world in which one after another Asian nation successfully entered global markets, and the United States honed its traditional advantages. Despite the much-heralded Lisbon Agenda of 2000, intended to make the European economy the most competitive in the world by 2010, the Continent resisted reform and endured years of recession. Nor did it meet innovation with open arms. After private equity funds emerged as major engine of corporate restructuring in the U.S., German Social Democratic Party chairman Franz Müntefering condemned them as “swarms of locusts that fall on companies, stripping them bare before moving on.”:

As is fitting in a book about the macroeconomic management of national economies, Eichengreen’s emphasis at every point is on the human role “over a vast range of activities involving management, judgment, insight, intuition and creativity” — but only in government. Almost completely missing, however, are businessmen and entrepreneurs. Business historian Alfred Chandler doesn’t even make the bibliography. As if  to prove Ned Phelps’ point, the human beings who actually created European growth in the years after 1945 — the men (and, occasionally, women) who opened the factories, met the payrolls, searched for new markets and created them — are conspicuous by their absence from his account. His economy has no industries to speak of, much less particular cynosure companies. His entrepreneurs operate in the public sector.

This is not Eichengreen’s fault, I think. He goes about as far as the theory he inherited permits; the book suffers from its shortcomings, not his. As a Yale PhD of 1979, Eichengreen went to school and then entered professional life in the last days of the era of which Ned Phelps complained (and against which Yale professors Richard Nelson and Sidney Winters, among others, valiantly battled) — the era of exogenous technological change, when the growth of knowledge was simply “in the air,” something that government might have paid for, but that otherwise was freely available to those who would use it for manufacturing purposes, “instantaneously, costlessly and error-free.” There was, in other words, no economics of knowledge. No wonder, then, that his index doesn’t mention “universities” or “higher education.”

As a history of coordination, then, The European Economy since 1945, is unmatched. As a history of European capitalism, West and East, inevitably, it leaves much to be desired.  It will be compared to Jeffrey Frieden’s Global Capitalism: Its Fall and Rise in the Twentieth Century and Tony Judt’s Postwar: A History of Europe Since 1945.  Eichengreen’s is the one for those of us who take transnational institutions seriously.

Meanwhile, a glimpse of what lies ahead was to be found last month in a pair of articles by Michael Spence, which appeared on op-ed page of The Wall Street Journal. Spence, a Nobel laureate, is professor emeritus at the Graduate School of Business at Stanford University, and chairman of the Independent Commission on Growth in Developing Countries, a blue-ribbon panel of 21 practitioners sponsored by the governments of Sweden, the Netherlands, the United Kingdom, the William and Flora Hewlett Foundation and the World Bank.

There have been only eleven cases of sustained high growth since World War II, Spence wrote — “high” meaning more than 7 percent, “sustained” meaning for 25 years or more.  Never mind Europe; eight of them have been in Asia. They include China, Hong Kong, Indonesia, Korea, Malaysia, Singapore, Taiwan and Thailand.  (The others are Botswana, Malta and Oman.) What can be said with certainty about the factors that drive these extraordinary episodes? A fair amount, said Spence, some of it gleaned from the European experience, some of it from Japan.

“The prospects for developing countries are, in fact, probably more favorable now than they have been since World War II.  International trade is growing faster than global GDP. The benefits of decades of learning with respect to operating global supply chains are accessible. Information and technology continue to lower transaction costs and to be a powerful integrating force.

“But perhaps even more important, the key players in all this — the leaders in emerging economies who have the responsibility for building policies that support private sector entrepreneurship and that lead to sustained inclusive growth — have a wealth of experience to rely on. No one is in the dark.”

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A memorial service for Richard Musgrave will be held on May 18 at 3 P.M. in the Harvard Memorial Church, with a reception afterwards.

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