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July 6, 2014
David Warsh, Proprietor


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The Contest between Macro and Growth

It was about a year ago that Paul Krugman asked, “[W]hatever happened to New Growth Theory?”  The headline of the item on the blog with which the Nobel laureate supplements his twice-weekly columns for The New York Times telegraphed his answer: The New Growth Fizzle.  He wrote:

For a while, in the late 1980s and early 1990s, theories of growth with endogenous technological change were widely heralded as the Next Big Thing in economics. Textbooks were restructured to put long-run growth up front, with business cycles (who cared about those anymore?) crammed into a chapter or two at the end. David Warsh wrote a book touting NGT as the most fundamental development since Adam Smith, casting Paul Romer as a heroic figure leading economics into a brave new world.

And here we are, a couple of decades on, and the whole thing seems to have fizzled out. Romer has had a very interesting and productive life, but not at all the kind of role Warsh imagined. The reasons some countries grow more successfully than others remain fairly mysterious, with most discussions ending, as Robert Solow remarked long ago, in a “blaze of amateur sociology”. And whaddya know, business cycles turn out still to be important.

Krugman’s post raised eyebrows in my circles because many insiders expected that a Nobel Prize for growth theory would be announced within a few weeks. A widely-noticed Nobel symposium had been held in Stockholm in the summer of 2012, the usual (though not inevitable) prelude to a prize.  Its proceedings had been broadcast on Swedish educational television.  Romer, of New York University, had been the leadoff speaker; Peter Howitt, of Brown University, had been his discussant; Philippe Aghion, of Harvard University and the Institute for International Studies, the moderator of the symposium.

Knowing this, I let Krugman’s gibe pass unchallenged, even though it seemed flat-out wrong. These things were best left to the Swedes in private, I reasoned; let the elaborate theater of the prize remain intact.

Then came October, and a surprise of a slightly different sort.  Rather than rousing one or more of the growth theorists, the early morning phone calls went to three economists to recognize their work on trend-spotting among asset prices and the difficulty thereof – Eugene Fama, Robert Shiller and Lars Hansen.  Fama’s work had been done fifty years before; Shiller’s, thirty-five. Two big new financial industries, index funds and hedge funds, had grown up to demonstrate that the claims of both were broadly right, in differing degrees. Hansen had illuminated their differences. So old and safe and well-prepared was the award that its merit couldn’t possibly be questioned.

What happened?  It’s well known that, in addition to preparing each year’s prize,  prize committees work ahead on a nomination or two or even three, assembling slates of nominees for future years in order to mull them over. Scraps of evidence have emerged since last fall that a campaign was mounted last summer within the Economic Sciences Section of the Royal Swedish Academy of Sciences, sufficient to stall the growth award and bring forward the asset-pricing prize – resistance to which Krugman may have been a party.

These things happen.  The fantasy aspects of the Nobel Prize – the early-morning phone call out of the blue – have been successfully enough managed over the years as to distract from the “hastily-arranged” press conferences that inevitably follow, the champagne chilled and ready-to-hand. Laureates, in general, are only too happy to play along.  Sometimes innocence may even be real. Simon Kuznets, on his way to visit Wassily Leontief in New York in 1971, told friends that he overheard heard only that “some guy with a Russian name” had won, before stepping into the high-rise elevator that would carry him to his friend’s apartment. It was, he said, the longest ride of his life.

As described on the Nobel website, the committee meets in February to choose preliminary candidates, consults experts in the matter during March and April, settles on a nomination in May, writes up an extensive report over the summer, and sends it in September to the Social Science class of the Academy – around seventy professors, most of them Scandinavians – where it is widely discussed. Thus by summer, the intent of the committee is known, if very closely held, by a fairly large fraternity of scientists. The 600-member Academy then votes in October.

There is nothing obvious about the path the economics prize award should take; even within the Academy there are at least a couple (and probably more) different versions of what the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, established in 1969, is all about. Wide-ranging and free-wheeling discussion among the well-informed is therefore crucial to its success; so is dependable confidentiality. Nominations and surrounding documentation are sealed for fifty years, so none of this has been revealed yet since the economics prize was established less than fifty years ago.

Over the years, however, scraps of information have leaked out about struggles that have taken place behind the scenes, in areas where sharp philosophical disagreements existed. For example, Gordon Tullock, of George Mason University, a lawyer and career diplomat with no formal training in economics,  told me years ago that  he woke in 1986 expecting to share the prize for public choice with James Buchanan.  He didn’t.  In her biography of game theorist John Nash, A Beautiful Mind, Sylvia Nasar reported that Ingemar Ståhl had sought to delay an award to Nash by moving up the prize prepared for Robert Lucas.  He didn’t succeed, and Lucas was honored, as had been planned, the following year. (Harold Kuhn, the Princeton mathematician who tirelessly insured that Nash’s story would be told, died last week, at 88.)

Something of the sort may actually have happened in 2003: preparations were made in Minneapolis for a press conference for Edward Prescott, then of the University of Minnesota; the prize went instead to a pair of low-key econometricians, Clive Granger, of the University of California at San Diego, and Robert Engle, of New York University. Prescott and Finn Kydland, of the University of California at Santa Barbara, were cited the following year, “for their contributions to dynamic macroeconomics: the time consistency of economic policy and the driving forces behind business cycles.”  The latter award remains even more controversial today than it was then.

Indeed, Krugman’s own prize may have been moved up, amidst concern in Stockholm for the bourgeoning financial crisis of 2008.  As late as that October it was believed, at least in Cambridge, Mass., that the committee recommended that a prize be given for measurement economics, citing Dale Jorgenson, of Harvard University; Erwin Diewert, of the University of British Columbia; and Robert Hall, of Stanford University. It would have been the first prize for empirical economics since the award to Richard Stone, in 1984, and only the third since Kuznets was recognized, in 1971.  Instead the prize was to Krugman, by then working mainly as a columnist for the Times, “for his analysis of trade patterns and location of economic activity.”

No one seriously disputes that Krugman should have been recognized at some point for the consensus-changing work he did, beginning in the late 1970s, on monopolistic competition among giant corporations engaged in international trade, though a common view in the profession is that two others, Elhanan Helpman, of Harvard University, and Gene Grossman, of Princeton University, should have shared in the award. Committees over the years have been very conscious of the emphasis conferred by a solo award – only 22 of 45 economics prizes have been “singletons.”

The deferral of the measurement prize, if that is what happened, suggests there must have been considerable tumult behind the scenes. The gravity of the global financial crisis was very clear in Stockholm in September 2008. What happened in those few months won’t be known with any certainty for another forty-four years. But the effect of the award in October 2008 was to empower Krugman as a spokesman for the tradition of Keynesian macroeconomic analysis.  He responded with alacrity and has employed his bully pulpit since.

So much, then for what is known and, mostly, not quite known, about the recent politics of the prize.  What about the contest between macroeconomics and growth?

Macro is the dominant culture of economics – the center ring ever since Keynes published The General Theory of Employment, Interest and Employment, in 1936. It is a way of looking at the world, “an interpretation of events, an intellectual framework, and a clear argument for government intervention,” especially in the management of the business cycle, according to Olivier Blanchard, author of an authoritative text, Macroeconomics. There are many other fields in economics, but macro is the one that seeks to give an overall narrative and analytic account of expansion and recession, of capacity and utilization, of inflation and unemployment.  Macro has had its ups and downs in the years since 1936. Today anyone who studies fluctuations is a macroeconomist; but not all macroeconomists acknowledge the centrality of Keynes.

In the 1950s and ’60s, a “neoclassical synthesis” merged Keynesian contributions with all that had gone before. New standards for formal models, plus national income and product accounts and measures of the flow of funds,  produced various rules of thumb for managing modern industrial economies: Okun’s Law (output related to unemployment) and the Phillips Curve (inflation to unemployment); and so on. By the end of the 1960s, many economists thought of their field as mature.

In the ’70s came the “expectations revolution,” a series of high-tech developments (most of them anticipated by low-tech Milton Friedman), in which economists sought to build accounts of forward-looking people and firms into the macro scheme of things. The effectiveness of monetary policy was debated, until the Federal Reserve Board, under Paul Volcker, gave a powerful demonstration of its effectiveness.   Reputation and credibility became issues; targets and new rules emerged.

Growth theory, on the other hand, has a less clear-cut provenance.  There is no doubt that it began with Adam Smith, who, in the very first sentence of The Wealth of Nations, pronounced that the greatest improvement in the productive powers of humankind stemmed from the division of labor. Smith expounded for three chapters on the sources and limits of specialization, using a mass-production pin factory as his example, before dropping the topic in order to elucidate what  economists today call “the price system.” Interest in the kind of technological change that the pin factory represented faded into the background.

Karl Marx was a growth theorist (remember “Asiatic,” “ancient,” “feudal,” “bourgeois” modes of production and all that?), but he came late to economics and never found his way into the official canon. So was Joseph Schumpeter, who came closer to giving a persuasive account in economic terms but still failed to leave much of a mark. In the ’50s, MIT’s Robert Solow, a leading macroeconomist, ingeniously showed that most of the forces generating gains in wealth (gross domestic product/per capita) were exogenous, that is, outside the standard macro model, unexplained by it as the tradition stood. Macro debates continued to flourish. By end of the ’70s, interest in growth once had again faded away in technical economics.

In the ’80s, excitement over growth was suddenly rekindled in economics by three key papers, of which Romer wrote two and Robert Lucas wrote one. Romer’s primary interest was in “endogenizing” technology; that is, showing why governments, universities, corporations and entrepreneurs engaged in research. Lucas was intrigued by stories from international trade:  Asian trading nations such as Japan, Hong Kong, Taiwan, Korea and Singapore grew rich quickly while communist nations stagnated.  Where did the growth “miracles” come from?

As usual, the arguments of both men were intricately related to other on-going debates in technical economics. Lucas, a University of Chicago professor, was at pains to preserve, for convenience’s sake, the assumption of perfect competition.  Romer, educated at both Chicago and MIT and by then teaching at the University of Rochester, was intent on writing intellectual property into the act, employing the sixty-year-old convention of monopolistic competition.  Pure competition “spillovers,” meaning, roughly, the gains you reap from watching your neighbors, animated the first models that Romer and Lucas produced.  Romer’s second – and final – model depended on income streams that arose from new processes and new goods. The University of Chicago hired Romer; after a year, he moved to California where his wife had obtained a better job.

It seems clear that Romer won the debate. Aghion, then at MIT, and Howitt, then at the University of Western Ontario, quickly buttressed the case for viewing growth through the lens of monopolistic competition, but without producing the same clean convention as Romer’s “non-rival goods,” that is, know-how that can be possessed by more than one person at the same time. Helpman and Grossman obtained the same result.

Once it was established formally that privately appropriable knowledge was somehow involved in the process of growth – that ideas were economically important, as well as people and things – interest shifted quickly to the institutions and norms by which knowledge and the power to protect it were diffused.  A shower of interesting new work ensued. The effects on growth of patterns of suffrage, political governance, education, tax policy, land and immigration policy, laws, banking, religion and geography came under economists’ lenses.

The Nobel symposium in 2012 made it clear just how sprawling the “new” literature of growth and development has become. Presenters included a galaxy of stars, nearly every one of them players in the Nobel nomination league. They ranged from experts on technology, schooling, health, credit, geography and political and legal institutions; to empirical economists; and policy evaluation specialists.  So is it true, then, as Krugman asserted last summer, that “The reasons some countries grow more successfully than others remain fairly mysterious?” Only if you take the view from macro, and an extremely narrow view at that.

This is the sort of swirl that the Nobel program in economic sciences exists to rise above. It is true that Romer, 58, hasn’t made it easy for the Swedes. He stopped writing economics in the ’90s, started an online learning company, sold it, then quit economics altogether, leaving Stanford University’s Graduate School of Business and started a movement (which he announced in a TED talk) to create “charter cities” in less-developed countries around the world.

Charter cities?  By analogy to charter schools, these city-scale enterprise zones would spring up on greenfield sites, their police and legal systems guaranteed by volunteer foreign governments: perhaps Norway, for example, or Canada. “Opt-in colonialism,” say the critics.  After a couple of last-minute failures, in Madagascar and Honduras, Romer seems to be trying again, this time from the Urbanization Project  at New York University’s Stern School of Business.

Second careers have become more common in recent years among economists whose early work has put them into the nomination for a Nobel Prize. Some intellects become bored by the chase.  A. Michael Spence became a business school dean; Krugman took up journalism.  Romer has become a reformer. But before he quit, he carefully dotted his i’s and crossed his t’s.  He added growth to economics’ agenda, once and for all. Its integration into macroeconomics has barely begun.

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4 Comments

  1. Andy wrote:

    Thanks for the post, but, can you say more, or point in the right direction to learn more, about the content of the theories? You’ve definitely got my interest; I’ve been following the economics blogs pretty closely the last few years, this type of economics doesn’t show up much (for clear reasons of course) but given some of the recent discussion (Gordon’s productivity projections, Summers secular stagnation) this type of work is crucial. Implications abound…

    Monday, July 7, 2014 at 12:53 pm | Permalink

  2. Dale wrote:

    You write, “Once it was established formally that privately appropriable knowledge was somehow involved in the process of growth – that ideas were economically important, as well as people and things – interest shifted quickly to the institutions and norms by which knowledge and the power to protect it were diffused. A shower of interesting new work ensued. The effects on growth of patterns of suffrage, political governance, education, tax policy, land and immigration policy, laws, banking, religion and geography came under economists’ lenses. [...] So is it true, then, as Krugman asserted last summer, that “The reasons some countries grow more successfully than others remain fairly mysterious?” Only if you take the view from macro, and an extremely narrow view at that.”

    But after hinting that it isn’t really mysterious why some countries do better than others, you don’t explain what is known about the subject — which is what really matters to us voters.

    Monday, July 7, 2014 at 2:42 pm | Permalink

  3. Art Vandelay wrote:

    There is nothing controversial over the prize going to Kydland-Prescott. You seem bitter about being wrong.

    Tuesday, July 8, 2014 at 6:49 pm | Permalink

  4. John Seater wrote:

    The discussion of growth theory stops too soon. The 1st-generation” growth models developed by Romer, Aghion and Howitt, and Grossman and Helpman have been rejected by the data. They have been replaced by “2nd-generation” models that fix the problem underlying the rejection of the 1st-gen models and in the process open unexpected doors to new analysis and new results that for the first time offer true micro-foundations of macroeconomics.

    The best known rejection of the 1st-gen model is the predicted scale effect, that the growth rate depends on the size of the population. No such effect can be found in the data. However, the scale effect derives from a more fundamental defect of the 1st gen models, which is that crucial aspects of the economy’s industrial structure are taken as exogenous when in fact they are endogenous. The 2nd-gen models fix that defect. By doing that, they eliminate the scale effect by eliminating its underlying cause. In the process, they also open whole new lines of research that the 1st-gen models cannot address. The result is a true marriage of genuine micro-foundations and general equilibrium analysis. The relevant references are the early papers of Pietro Peretto (IER 1996, JEG Mar & Dec 1998, JME 1999) and the slightly later papers of Elias Dinopoulos & Peter Thompson (JEG 1998, JEvolutionaryEcon 1999, JIE 2000) and Peter Howitt (JPE 1999). A minor contribution is Young’s paper (JPE 1998) that presents a very mechanical model that eliminates the scale effect but that does not have a useful micro foundation and so has not been used as the basis for subsequent work.

    Thursday, July 10, 2014 at 3:58 pm | Permalink

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