Journal Issue
From the Editor: What to Do about Growth

Book Reviews

International Monetary Fund. External Relations Dept.
Published Date:
March 2017
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Judging Greenspan

Sebastian Mallaby

The Man Who Knew

The Life and Times of Alan Greenspan

Penguin Press, 2016, 800 pp., $40.00 (hardcover)

Too much success can be a dangerous thing. That is perhaps the key takeaway from Sebastian Mallaby’s epic new biography of former US Federal Reserve chair Alan Greenspan, The Man Who Knew. The central and (to this reviewer at least) somewhat shocking revelation of the book is that far from being a blind follower of “markets know best” efficiency theory, Greenspan was well aware that easy monetary policy and stock prices could create bubbles in the market—terribly damaging ones (he did a seminal paper on the topic in 1959). And yet he allowed them to inflate anyway, believing this preferable to more dramatic government interference in the market. The great irony is that thanks in large part to Greenspan, central bankers themselves have become the major player in global markets—something that has introduced huge, unknown risks into our economy. Clearly, the man who knew didn’t know everything.

Despite this, many lessons in Greenspan’s legacy are relevant to today’s economic problems. For one, economics should move toward the empirical. Greenspan had what was arguably his biggest insight when he was deep in the weeds, tallying numbers rather than relying on ivory tower models. In the summer of 1996, there was a debate at the Fed about whether interest rates should be hiked to ward off overheating in the economy. Wages were rising, and the stock market was up 45 percent over the course of a year. Yet productivity figures seemed oddly weak, given the efficiency gains that businesses were seeing from globalization and new technologies. Solving the conundrum was crucial—if productivity was actually rising, then there was no reason to hike interest rates, since workers making more widgets could also be paid more without triggering inflation. Nearly every economic guru at the time—from Larry Summers to Janet Yellen—worried about inflation. But Greenspan insisted that Fed researchers go back and re-tally the numbers across 155 industries and four decades. The result? The maestro was right; low productivity in services was artificially lowering the overall rate.

The times that Greenspan—and as a result, the economy—faltered were usually when there was too little data and too much ego in the room. The praise and political power that came with his many lucky hunches—and some well-deserved policy home runs—made him less willing to rock the boat and raise interest rates, even when it was clear that this really was what was needed to derail a potential crash and recession. Once a staunch opponent of government bailouts he later supported bailouts of emerging markets like Mexico (whose debt was held by big US banks—a crucial fact that the book underplays). He dismissed warnings by US Commodity Futures Trading Commission chair Brooksley Born on derivatives, believing incorrectly that they weren’t as potentially damaging as she thought they might be, but also that it would be too politically tricky to push through regulation. He made sideways references to “irrational exuberance” by the late 1990s, but backed off on curbing it when the markets stabilized. Like most finance-friendly regulators, Greenspan didn’t want the music to stop. When it did, to his great credit, he issued a mea culpa, admitting there had been a “flaw” in his thinking. Mallaby—who wrote this book over five years with Greenspan’s cooperation while working as a senior fellow at the Council on Foreign Relations—believes it was mistake for him to do so, since ideologically, he had never bought totally into “rational” markets.

The man who knew didn’t know everything.

I disagree. Actions matter, and Greenspan took responsibility for his. While his “flaw” was less an intellectual one than a moral one, the fact that he admitted to making a mistake of any kind is one of the things that redeems him. Many others who played a part in the events leading up to the 2008 crisis and Great Recession failed to do so. What’s more, Greenspan’s admission marked an important departure from the fiction of the omniscient central banker (one that he helped craft). The world has come to depend far too much on central bankers being those “who know.” It’s time to demand more from the politicians we elect to run the real economy itself.

Rana Foroohar

Assistant Managing Editor

Time magazine

Reinventing the Past

Peter Temin

The Vanishing Middle Class

Prejudice and Power in a Dual Economy

MIT Press, Cambridge, Massachusetts, 2017, 208 pp., $26.95 (hardcover)

Americans tend to assume that history marches forward and that their children will do better than they did. This is a fundamental tenet of the American Dream and a core deliverable of the economy over most of the course of the 20th century.

Sometimes, though, there are detours.

Even though over the past 40 years, the United States grew ever richer, the gains from this growth have not been shared. The US economy produced $18 trillion worth of goods and services in 2016, more than any other country that year—or any year on record. Data show that between 1980 and 2014 pretax income grew, on average, by 61 percent, yet most of these gains went to those at the very top. For the bottom 50 percent of the US population incomes grew only 1 percent; those in the top 1 percent snagged 205 percent income growth.

This is not the way the American Dream was expected to play out.

Explaining rising inequality in the United States is the aim of Peter Temin’s new book, The Vanishing Middle Class. Temin argues that the distribution of gains from economic growth today make the United States look like a developing economy. He builds on the dual sector model developed in the 1950s by W. Arthur Lewis. Looking at developing economies, Lewis proposed that economic growth and development did not conform to national boundaries. Within countries, he saw that “economic progress was not uniform, but spotty.” His model explains how development and lack of development progress side by side. One sector, which Lewis calls “capitalist,” is the home of modern production, where development is limited only by the amount of capital. The other sector, which he calls “subsistence,” is composed of poor farmers who supply a vast surplus of labor. In these two sectors’ symbiotic relationship the capitalist sector seeks to keep wages down to maintain an ongoing source of cheap labor.

Temin applies this framework to the United States today. He argues that “the vanishing middle class has left behind a dual economy.” His dual sectors are finance, technology, and electronics, or FTE—akin to Lewis’s capitalist sector—and low-skill work, akin to the subsistence sector, whose workers bear the brunt of the vagaries of globalization. The book lays out how members of the FTE sector seek to keep their own taxes low and suppress the wages they pay so as to maximize their profits. Mass incarceration, housing segregation, and disenfranchisement all serve—among other things—to keep the low-skill sector in a subservient labor market position. These developments play out along racial lines set by the nation’s history of slavery.

The bridge between these two sides of the economy is education. There are paths for children of low-wage families to get into the richer FTE capitalist group, but Temin argues that there are many more obstacles, especially for children from African-American families. This is why Temin’s top policy recommendation is universal access to high-quality preschool and greater financial support for public universities.

His second recommendation is to reverse policies that repress poor folk of any race. He advises an end to mass incarceration and housing discrimination so that families can escape the low-skill trap and more coherently integrate into the broader economy and society.

This is not the way the American Dream was expected to play out.

Alas, neither of these recommendations is potent enough to overcome the fundamental problems Temin identifies. The US path of natural progression toward greater equality has been detoured for decades now. The idea that the US economy is on a trend more like that of a developing economy than of a rich, developed nation may seem jarring, but that is exactly the nature of the distributional structure of the world’s richest economy.

The steps that brought the United States more equality in the middle of the 20th century certainly included attention to education—the United States was among the first to provide universal access to primary education nationwide, and the GI bill after World War II opened college doors to generations of students—but that was not the only policy. Among other things, the middle decades of that century also boasted high taxation on estates and top incomes—money that could be invested in broader economic growth—yet both have been seriously eroded over the past four decades. If we want to revive our vanishing middle class, which Temin so eloquently describes, we’ll need to do more to undermine the dual economy structures he so accurately details.

Heather Boushey

Executive Director and Chief Economist, Washington Center for Equitable Growth

Culture at the Roots of Growth

Joel Mokyr

A Culture of Growth

The Origins of the Modern Economy

Princeton University Press, Princeton, New Jersey, 2017, 400 pp., $35 (hardcover)

Joel Mokyr’s A Culture of Growth: The Origins of the Modern Economy gives culture center stage in the rapid economic growth and industrialization brought about by the first Industrial Revolution and ongoing and self-reinforcing in Western Europe ever since. It is a certain type of culture that is the reason growth-inducing change occurred in Europe and not, say, in China, the author insists. What this culture means, and what made it different in Europe, is the topic of this provocative analysis.

Mokyr proposes that the Enlightenment and the Industrial Revolution were not exogenous developments, but were a consequence of a change in attitudes (which he sums up as “culture”) in Western Europe. This occurred over roughly two centuries, between 1500 and 1700, a period that brought about a change in beliefs about people’s ability to use science to control their destiny and, especially, the natural world.

The Enlightenment, taking off in the late 17th century and lasting through the 18th, encouraged a quest for “useful knowledge”—that is, science and technology—that resulted in permanent and sustained command over the forces of nature.

Nudging this process were two prominent figures, Francis Bacon and Isaac Newton, who changed thinking in Western Europe and then the world. “The true and legitimate goal of the sciences is to endow human life with new discoveries and resources,” wrote Bacon. His and his followers’ impact on the Enlightenment was instrumental in bringing about the conviction that “natural inquiry” through experimentation is essential for economic growth and human well-being. Newton’s contribution was to demonstrate that the “rules”—the mathematical regularities—of nature could be identified, thereby unlocking the mysteries of the natural world. Both Bacon and Newton altered thinking in their time because competition in the marketplace of ideas allowed their ideas “to be distributed and shared, and hence challenged, corrected and supplemented,” says Mokyr.

But how did these cultural changes come about and spread in the period of fundamental change in Europe? How did the Enlightenment turn into the Industrial Revolution, which in turn was the starting point of sustained growth? Mokyr paints a backdrop of improved navigation and shipbuilding that opened Europe to new products and new ideas (early globalization), and the printing press, which lowered the cost of communication and increased the benefits of literacy. These developments opened minds to new ideas and new ways of thinking elsewhere and reduced attachment to old ideas. These changes were also helped by the absence of a single central authority in Europe, individual freedom, the enforcement of property rights, and competition in the marketplace for both material goods and ideas. Among other things, the new ideas led to advances in science and technology that we now call the Industrial Revolution. And all of that led to sustained economic growth.

Mokyr then shows that although looking at why something happened is useful, so is analyzing why it did not. He uses the example of China as a counterpoint to Europe’s rapid development of a culture of growth. Although China had previously been at least as technologically advanced as Europe, if not more so—and certainly more literate—it had produced nothing like the Industrial Revolution. Mokyr attributes slow progress in China to factors such as veneration of classical Chinese literature, a centralized government that discouraged competition among regions, the selection of administrators for plum government positions based on knowledge of Chinese literature rather than of science and technol-ogy, and the relative unimportance of competition compared with Europe. These provided incentives that fostered success in other areas of Chinese culture but did not stimulate the ideas and actions associated with an industrial revolution. Mokyr concludes, “It seems wrong to dub the Chinese experience a ‘failure.’ What is exceptional, indeed unique, is what happened in eighteenth-century Europe.”

These developments reduced attachment to old ideas.

This book is the latest example of Mokyr’s ability to explicate complex issues, illustrating his big-picture thesis with a myriad of fascinating details. He writes with clarity— enjoyable for the general reader as well as for the specialist in economic history. A Culture of Growth is a must-read for anyone interested in how Western society got where it is today and what this implies for the spread of technology in the global economy of the future.

Barry R. Chiswick

Professor of Economics and International Affairs, The George Washington University

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