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January 30, 2011
David Warsh, Proprietor


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A Mostly Happy Story

America’s first “Sputnik Moment” occurred 150 years ago, in April 1861, when Confederate cannons fired on Fort Sumter in Charleston Harbor. South Carolina had seceded a few months before. Sumter surrendered after a day and a half. The Civil War had begun.

The 37th Congress met that summer to deal with war finance. The next year its members passed not one but two far-reaching measures in response to the crisis:  the Homestead Act, giving federal land in the West free to those who settled it; and the Morrill Land-Grant College Act, appropriating millions (of land and/or dollars) to the states with which to establish mechanical and agricultural colleges. The measure had passed originally in 1857, only to be vetoed by President James Buchanan.  In the absence of the Southern states’ delegations, it sailed through.

Last week in Cambridge, Mass., one of the finest fruits of the Morrill Act kicked off a five-month-long celebration of its 150th anniversary.  As luck (or shrewd expectation) would have it, the Massachusetts Institute of Technology was chartered (but not much funded) two days before the attack on Fort Sumter. MIT split the state’s Morrill money with a newly-created agricultural college in Amherst, which in due course became the University of Massachusetts (Amherst College raked off some money for a time, too).

But “Plans for a Polytechnic School in Boston” that had been little more than talked-about since 1846 were finally galvanized by the prospect of federal money. MIT opened its doors in Boston’s Copley Square in 1865.  It moved across the Charles River to Cambridge in 1916, after the second of two failed attempts to merge it into Harvard University. By 1960, boosted by Cold War funding, it had become one of the world’s great universities, a genuine rival to its older neighbor down to river.

That the Morrill Act was an enormous success goes without saying. Its passage touched off a furious competition among existing institutions and many nascent ones. Cornell in New York, Yale in Connecticut, and the University of California were among those up-and-running schools that sought to turn the resources of the act to their own use, with varying degrees of success. But gradually one new university after another opened its doors and began to compete with the old Eastern centers of learning at Harvard, Yale, Princeton, Columbia and Pennsylvania.

These were not just new state universities, such as Michigan, Wisconsin, Illinois, Ohio and Minnesota. They included reinvigorated antebellum Southern universities in Virginia, Georgia, Tennessee, North and South Carolina too, as well as brand-new private institutions, including Johns Hopkins, the University of Chicago, Stanford, Duke, Vanderbilt and Washington universities.

The states may have created the universities, but in the nineteenth century the universities helped shape the states, according to Mark Nemec, in Ivory Towers and Nationalist Minds: Universities, Leadership and the Development of the American State. University presidents, in particular, behaved as entrepreneurs, developing experts who fostered new sinews of governance and regulation. By the twentieth century, research universities had begun to perform their roles as economic engines – contributions whose extent and consequences have only just begun to be seriously explored.

The MIT 150 website testifies to the institute’s myriad contributions to the development of the modern economy, via, among other things, a detailed timeline.  There, too, are filmed interviews with more than a hundred of the institute’s most celebrated figures, conducted by, among others, Karen Arenson, who covered higher education for many years for The New York Times, and John Hockenberry, of the public radio program The Takeaway.  Those interviewed include  Paul Samuelson, Robert Solow, Peter Diamond, Lester Thurow, James Poterba, William Pounds, Glen Urban, Jay Forrester, Howard Johnson, and MIT’s current chairman, John Reed, a Sloan School alumnus.

For those who want a proper narrative, is historian David Kaiser’s excellent Becoming MIT: Moments of Decision.  And a vivid insight into the unique culture of the place can be had from Mens et Mania: The MIT Nobody Knows, by Samuel Jay Keyser, for twenty years an MIT professor (of linguistics), administrator and residential housemaster.

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The sesquicentennial celebration kicked off with a symposium on economics and finance, the first of six (other topics include cancer research, the role of women, computation, brain science and, in its broadest sense, the environment). Stretching over two days, the economics program fell somewhere between a pep rally a sales pitch. (Video of all sessions is available here.) An audience of more than a thousand showed up. MIT President Susan Hockfield was in Davos.

The first day, devoted to economics, was organized along familiar linear lines:  from theory to practice to policy. A parade appeared of some of the theorists who made MIT famous as the home of small versatile models that permit the interrogation of of various aspects of the economy: George Akerlof,  Diamond,  Solow, Avinash Dixit, Paul Krugman (who appeared only digitally, thanks to a snowstorm).

Similarly impressive was testimony of an array of veteran regulators:  Olivier Blanchard (the International Monetary Fund), Dennis Carlton (antitrust), Paul Joskow (energy), Mark McClellan (health care), Richard Schmalensee (the environment). In a panel on fiscal policy, Robert Gordon (PhD 1967), of Northwestern University, made the case that the macroeconomics policies fashioned in the MIT style in the l970s had served to guide policy ever since.

Conspicuous by its absence was a panel on monetary policy. That was, of course, the debate with Chicago that MIT lost. Ben Bernanke, surely one of MIT’s most successful students, led the efforts two and a half years ago that successfully staved off a global depression, relying on doctrine developed mainly by Milton Friedman and Anna Schwartz in their analysis of the failure of Federal Reserve policy in the Great Depression.

At another point, Poterba, who organized the seminar, reminded the audience that MIT had denied young Kenneth Arrow a graduate fellowship. “You can’t win them all,” he said.  Thirty years later Arrow came to Harvard and in the late 1960s and 1970s trained a series of students there (and at Stanford) whose work in due course eclipsed MIT for many years. A strong school necessarily excludes much by virtue of honing its comparative advantage.

The late 1960s were, of course, the very years in which the field of modern finance was undergoing a revolution, mainly at MIT’s Sloan School of Business.  Sure enough, the seminar’s second day was devoted to the many triumphs that emanated from the fourth floor of the former soap company headquarters that, until recently, housed the Sloan School. (A gleaming new building opened next door last fall.)  Probably there had been nothing like it since chemical engineering was invented at MIT in the second decade of the twentieth century.

There were, however, abundant clues to the gulf that still exists between the new finance and the wider and deeper tradition that is economics. No longer is the relationship that of osteopathy to medicine, as one adviser described it to Stephen Ross in the early1970s (meaning teched-up folk wisdom as opposed to science), neither has it been integrated, intellectually or socially into the larger field. The least subtle evidence of the gap that still exists were the different furniture arrangements on the Kresge Theater stage. On day one the economists sat cheek-by-jowl on chairs, forearms resting on a folding table.  On day two, finance professors John Cox, Robert Merton, Stewart Myers, Ross and Myron Scholes relaxed in armchairs arrayed around a coffee table.

In the wake of the crisis of 2007-08, several MIT professors, Bengt Holmstrom chief among them, are among the many working overtime around the world to bridge that gap, seeking a better understanding of how the financial sector interacts with all the rest in the world economy.

But the star of the show last week was Bennett Golub, one among five MIT-trained practitioners who discussed “finance in action.”  Among the founders of BlackRock Inc. (which, with more than $3 trillion in assets under its care, is the biggest money- management firm in the world), Golub described how that company originated in the late 1980s as a result of the dawning recognition that participants in the market for mortgage-backed securities and their derivatives had begun to deliberately obfuscate the nature of their offerings.

One area which I think gets neglected, with all the focus on the models and their value added, is how do you help practitioners be able to peer through the anonymity implied by these models to understand the effect on real people. If we are honest, there was quite a bit of abuse of models and techniques.  Some of that abuse may have been people who just didn’t understand models, but I think there was also a fair amount of avarice in the marketplace and models used as techniques to basically fool people about the reality.

So we can talk about finance in use, sort of [as] scientific methodology. But if we don’t also make sure people understand there are real consequences to what happens, that real people are affected, then all the work and the modeling and the financial science can create fairly amoral individuals who go out and do terrible things that really hurt real people in their lives.

The history of economics and finance at MIT is a mostly happy story.  But on the day that the Financial Crisis Inquiry Commission issued its final report, it was downright shocking, at least to me, that Golub’s was the only clear voice questioning the haste and carelessness with which the new ideas about finance had been put into practice.  I would have thought the quality of introspection would have been higher.

During an earlier arms race, the musical satirist and mathematician Tom Lehrer put the problem of technological exhilaration this way: “Once the rockets are up, who cares where they come down/ That’s not my department, says Wernher von Braun.”  Yes, it’s certainly necessary to train many more financial rocket scientists and send them out into the world – that is the Sloan School’s stated goal. Going forward, though, it is important to be much more thoughtful about what they are going to do when they get there.

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