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The Economist's Pantheon

Friday, March 30, 2012

Sylvia Nasar. Grand Pursuit: The Story of Economic Genius. Simon and Schuster. 558 Pages. $35.00.

Sylvia nasar’s account of the Great Depression has a disturbing resonance with the Great Recession of 2007 to 2009 and our anemic recovery from it. In Grand Pursuit, she recounts an array of public policy interventions by the economists and economic commentariat of the time (including John Maynard Keynes, Irving Fisher, Felix Frankfurter, and occasionally Friedrich Hayek and Joseph Schumpeter). The wide range of their often conflicting views was not that different from the contemporary commentariat (including Paul Krugman and Larry Summers, on one side, and Gregory Mankiw, Robert Barro, and Michael Boskin on the other).

Keynes, in an open letter to President Franklin Roosevelt published in the New York Times in May 1933, explicitly urged the president to pursue deficit spending of eight percent of gdp as a federal stimulus program (about 50 percent larger as a share of gdp than the Obama stimulus spending of 2009–10). His recommendation included a confident forecast that this stimulus would “increase national income by at least three or four times this amount because [of the] . . . Multiplier — the cumulative effect of increased individual income [which] . . . improves the incomes of a further set of recipients and so on.”

Keynes’s optimistic forecast brings to mind similar forecasts by contemporary Keynesians. It also brings to mind the directly contradictory empirical work of Barro and Boskin showing negative or nugatory stimulus effects from deficit financing of expanded government spending. It also suggests a theoretical flaw in the Keynesian model that is not addressed by Nasar. I’ll have more to say about this flaw later in this review.

The resonance between then and now gives fresh meaning to the familiar aphorism plus ça change, plus c’est la même chose — or, in the same vein, the Yogi Berra version: “It’s déjà vu, all over again!”

Sylvia Nasar, a former economics correspondent for the New York Times and current professor at Columbia’s Graduate School of Journalism, also wrote A Beautiful Mind, the biography of one-time mathematician, turned game theorist, turned economist, and Nobel Prize recipient, John Nash. Grand Pursuit is more expansive and more ambitious, as well as more cursory, than the sharply-focused Nash biography.

The narrative of Grand Pursuit traverses nearly two centuries of economic thought and economic history. Its successive chapters describe the work of Marx, Engels, Marshall, the Webbs (Beatrice and Sidney), Fisher, Schumpeter, Keynes, and Hayek, as well as several lesser luminaries including Engels, von Mises, Friedman, Samuelson, Robinson, and Amartya Sen. Nasar’s account focuses especially on the social and political environment in which these economists developed their thinking, rather than the more strictly economic content of their work. Consequently, Grand Pursuit may be of particular interest to political scientists, sociologists, historians, and other social scientists rather than economists. Schumpeter’s own little book, Ten Great Economists (1951), and more recently Nicholas Wapshott’s Keynes Hayek: The Clash That Defined Modern Economics (2011), contain more of the nitty-gritty of economics in their overviews of economic history and economic thought.

Reflective of Nasar’s interest in the political and social context of the times, several themes emerge from the book’s broad sweep.

Another theme that recurs in the book's account of economists' thinking is their accompanying concern about inequality, along with their occasional recognition of the more subtle distinction between inequality and inequity.

One is the change that economics embraced and helped to energize from the Dickensian and Malthusian world in which poverty and misery were assumed to be permanent and predominant. Nasar suggests economists from the mid-19th century sought explanations of why substantial improvements in human well-being had actually occurred, and whether and how the trend might be sustained. Marx lodged the explanation in exploitation and imperialism and erroneously predicted violent collapse of the capitalist system. Alfred Marshall, though, suggested that the explanation for the improvements that had occurred was the dramatic increase in labor productivity. He thereby envisioned a major direction for the further development of modern economics.

Another theme that recurs in the book’s account of economists’ thinking is their accompanying concern about inequality, along with their occasional recognition of the more subtle distinction between inequality and inequity — a distinction often overlooked in much of our current discussion of the subject. The Webbs, Harold Laski, and other Fabian socialists at the London School of Economics saw the prevalence of inequality as a symptom of “class war.” To relieve the egregious evidence of inequality in England, they advocated development of what Beatrice Webb called “the Housekeeping State,” the precursor of what became the modern welfare state. In Nasar’s account of economists’ thinking about inequality, Keynes subsequently and unequivocally “rejected the politics of class war.” His rejection focused especially on the Labor Party, with which the Webbs were associated. Keynes condemned what he described as that Party’s opposition “to anyone who is more successful, more skillful, and more industrious, more thrifty than the average.” Keynes, somewhat imperiously, criticized it as “a class Party,” adding that “the Party is not my Party. I can be influenced . . . by . . . justice and good sense, but the class war will find me on the side of the educated bourgeoisie.”

A third theme is the instability of prices and employment, inflation and deflation, the business cycle, the recurrence of “booms and busts” — and what to do about them. Irving Fisher claimed that expanded credit was the main cause of booms, and the crunch of debt repayment the main precipitant of busts. Milton Friedman (and his co-author and wife Anna Schwarz) found instead that the peaks and troughs in America’s instability were preceded by contractions of the money supply or its rate of growth (along with considerable uncertainty as to what was cause and what was effect).

To this broad theme of economic instability Schumpeter brought a vision of both causes of the booms and remedies (or at least palliatives) for the busts. The ingredients of Schumpeter’s The Theory of Economic Development are innovation, entrepreneurship, and credit. Schumpeter advanced the classic Marshallian emphasis on increased productivity by emphasizing as the distinctive feature of capitalism “incessant innovation” and “the perennial gale of creative destruction.” In Nasar’s account, “Schumpeter focused on the human element” finding that “economic development depended primarily on entrepreneurship” and “sharing the obsession of late 19th century German culture with leadership.” The entrepreneur’s essential function was, in Schumpeter’s words, “to revolutionize the pattern of production,” and to use “an untried technological possibility . . . to destroy old patterns of thought and action.” Exceptional abilities and exceptional people were required for these tasks. As set forth in Schumpeter’s Theory, “Carrying out a new plan and acting according to a customary one are things as different as making a road and walking along it.”

Nasar writes that in Schumpeter’s view “entrepreneurs did more to eliminate poverty than any government or charity.” For entrepreneurship to thrive required a propitious environment including, as Schumpeter saw it: property rights, free trade, stable currencies, and especially cheap and abundant credit provided by “bankers and other financial middlemen who mobilize savings, evaluate projects, manage risk, monitor managers, acquire facilities and otherwise redirect resources from old to new channels.” Nasar further describes Schumpeter’s thinking: “The entrepreneur’s dependence on the financial sector, and that sector’s peculiar dependence on confidence and trust made it vulnerable to panics and crashes . . . What distinguished successful economies,” according to Schumpeter, “was not the absence of crises and slumps,” but that these economies “more than made up lost ground during investment booms.”

Nasar’s perceptive conclusion to this exposition of Schumpeter’s thinking is worth quotation because of its relevance to the current predicament of the post-recession U.S. economy:

By emphasizing the local business environment . . . Schumpeter’s theory suggested that nations made their own destinies. Governments that wished to see their citizens prosper should . . . focus on fostering a favorable business climate — strong property rights, stable prices, free trade, moderate, and consistent regulation — for entrepreneurs. . . . His was an equal opportunity, optimistic and not coincidentally unwarlike formula for economic success.

One more theme that leaps from the pages of Grand Pursuit is the frequency and ease with which the principal members of Nasar’s cast of characters crossed the borders between their sequestered academic purlieus and the open, free-for-all fields of politics and the media. Keynes through the New Statesman journal, but also through innumerable other news outlets as well, was an indefatigable source in the public media. So, too, were Beatrice and Sidney Webb, Fisher, Friedman, Samuelson, Sen, and, to a lesser extent, Hayek and Schumpeter. Whether their main motivation for these border crossings was to increase the policy impact of their scholarly work, or to spring free of scholarly constraints, or to realize some personal ego gratification, or perhaps a combination of all of these, the reality is they all tended toward public advocacy apart from their scholarly endeavors.

Most of the economists who populate Nasar’s book were energetic publicists, pamphleteers, and public letter-writers, as well as economic scholars. It’s also worth noting that, when some stalwart economists shifted their attention to public commentary, the link between their scholarly work and their policy stances often vanished. For example, Robert Solow’s principal scholarly contribution suggested that 90 percent of the increase in U.S. labor productivity in the first half of the 20th century was due to technological progress, innovation, and (inferentially at least) entrepreneurship. Logically, this important empirical finding should have placed Solow’s policy stance squarely in the Schumpeterian camp. Yet, in his public commentary, Solow has been an unrelenting Keynesian, echoing calls for expanded deficit financing of government stimulus programs, while (in Nasar’s understated words) “dismiss[ing] Schumpeter, rather unfairly.” The grasp of their ideological commitment is sometimes no less relenting among scholars than it is among those with weaker intellectual credentials. Whatever the outlandish one-track emanations from Krugman in his biweekly diatribes (which, like the Solow example, actually have no connection with his own scholarly work), he can claim that his fulsome recourse to the media follows a path traversed by many eminent predecessors.

Among the stars in Nasar’s firmament, none shines as brightly as Keynes. Five of the eighteen chapters in Grand Pursuit are devoted principally if not wholly to Keynes, while three chapters principally focus on Schumpeter, and two on Hayek.

Early in his career, Keynes concentrated on the role of money and its effect on prices, exchange rates, and trade. His later concerns shifted to employment and particularly to the high and sustained unemployment generated by the Great Depression. The link between his prior work on money and his later concern with unemployment led him to invent the concept of “aggregate demand” and, in particular, the insufficiency of aggregate demand (that is, consumer demand plus investors’ demand) to generate full employment when recessions strike. The Keynesian remedy was a large expansion of deficit-financed government spending to boost aggregate demand. Furthermore, the effectiveness of this remedy was said to be hugely enhanced by the elixir of the so-called “multiplier” — hopefully calculated as the sum of a geometric progression whose first term is the proportion of incremental government spending spent by the initial recipients of that spending, and whose second, third, and subsequent terms comprise the same proportion spent by these latter and continuing recipients, ad infinitum.

Elixir indeed! As I mentioned earlier in this review, empirical work has been done by thoroughly competent economists (Barro and Boskin, neither of whom is mentioned in Grand Pursuit) showing that the effects of deficit-financed government spending on aggregate demand and on employment have either been negligible or negative in prior recessions as well as in the recent recession of 2007–08. The absence of empirical support for the Keynesian remedy and its multiplier elixir suggests that there may well be flaws in the underlying theory.

For many economists, flawed theory would be of greater concern — at least more hurtful to professional pride — than nugatory results from stimulus programs based on a valid theory. Moreover, indications of a flawed theory signify that no amount of improvements in program design would be likely to help. Although not addressed by Nasar, a brief summary of flaws in the Keynesian theory follows.1

Central to the Keynesian theory of deficit-financed government spending, and the multiplier concept associated with it, is the assumption that the admittedly insufficient level of consumer and investment demand experienced during a recession would not be further depressed as a consequence of the added government borrowing. In a theory that purported to be “general” (i.e., Keynes’s major work is The General Theory of Employment, Interest, and Money) rather than a singular, “special” case, this is a strong and vulnerable assumption. In theory, as well as in fact, the levels of spending by consumers and investors that prevail prior to and during a recession might actually be further reduced as a response to the debt-financed additional dose of government spending. There are three plausible reasons for this response:

  1. “Ricardian equivalence,” a conjecture advanced by David Ricardo suggesting that consumers and investors might reduce their spending to prepare for the tax increases they would face in the future in order to pay for the added government spending financed by borrowing in the present. Ricardo’s idea was formulated a century before Keynes’s general theory and thus was something Keynes should have been aware of.
  2. Friedman’s “permanent income” hypothesis suggested that spending by consumers depended on their expected permanent income, and would be unaffected by any windfall increases in income they regarded as temporary, or at most that any increases in consumption that might result would be slight.
  3. Investors’ spending might shrink as a result of increased government spending because of anticipated increases in future taxes, or because of increased regulatory restrictions attached to the government spending, or simply because investment alternatives abroad might appear to be less onerous and more profitable.


Grand Pursuit has an ambitiously wide reach that sometimes exceeds its grasp. Yet, it is a good read — a quality that reflects its author’s credentials as a journalist (rarely do economists write as well as Nasar). That said, I have reservations about her choice of a subtitle, “The Story of Economic Genius.” I’m familiar with the work of all the economists whom she discusses, and I’ve been personally acquainted with several of them, either as my graduate school professors or as colleagues. All were very smart; none qualifies for admission to the genius category. Perhaps the single economist who would qualify is one who receives only passing acknowledgement by Nasar, but who inhabited an earlier period than her book is concerned with: Adam Smith.

1. A more extended treatment of the topic is contained in my article “Where Keynes Went Wrong,” which appeared in the Weekly Standard’s November 7, 2011, issue.