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Sunday, September 06, 2015

'The Thirty-Year Boom'

Part of an essay by David Warsh:

... For the old lions, Paul Samuelson and Milton Friedman, the ’80s meant a bittersweet departure from the center stage of economics after forty years of dominating the scene. The two had entered their sixties; neither was out of steam. But the leaders of the next generation had become apparent:  Lucas, in macroeconomics; Kenneth Arrow in nearly everything else.

The election of Ronald Reagan was a triumph for Friedman; they had known each other since Friedman spent a quarter at the University of California at Los Angeles, shortly after Reagan had been elected Governor of California.He was invited to lecture in China. And the international success of Free to Choose kept Friedman in the public eye.

But Paul Volcker took a different approach to monetary policy from the one Friedman advocated, and Friedman’s forecasts became markedly worse. The editorial page of The Wall Street Journal adopted as its champion Friedman’s long-time rival in currency matters, Robert Mundell, now teaching at Columbia University, and went all in for Mundell’s young associate, consultant Arthur Laffer. A research appointment at the Federal Reserve Bank of San Francisco was not the same platform as the University of Chicago.  Friedman still had his membership on the President’s Economic Policy Board, but after he  “savaged” Volcker to his face before the president in a meeting in 1983, both men lost influence. Pointing a finger at Volcker, Friedman said (according to Newsweek’s account), “because of the policies of the Fed under that man we have had an inflationary surge in the money supply that is going to have to be corrected.” Volcker was not reappointed. Edward Nelson, of the Federal Reserve Bank of St. Louis is writing a scientific biography of Friedman. It will make interesting reading when it is done.

In March 1981, Friedman wrote his Newsweek column in the form of a letter to Philip Handler, president of the National Academy of Sciences, advocating major cuts in the budget of the National Science Foundation, as a step towards the abolition of the NSF.  The Reagan administration had proposed sharp cuts in the economics program.  Friedman argued the government shouldn’t pay for any scientific research. True, the NSF had funded much good science; but it had paid for much bad science, too, including, he wrote, overmuch mathematical economics. The great scientists of the past had done without NSF funding. Einstein did his work in a government patent office; general relativity might never have made  it past a peer-review panel. “The innovative ideas that have stirred controversy in economics since NSF funding of economics began two decades ago owe little or nothing to NSF funding,” he wrote.

Thus did Friedman dismiss the agency that Paul Samuelson had brought to life in 1945.  Perhaps more important, by extension he dismissed the program of government fellowships, awarded by competitive exam,  that had sent Samuelson to graduate school in 1935, all expenses paid – and countless others  since, many of them as impecunious as Friedman had been in 1932.  The NSF ran similar programs in mathematics and many ciences, and the principle had been extended, by Sen. Jacob Javits (R-NY) to humanities.  NSF research grants funding had helped build the Massachusetts Institute of Technology into a powerhouse to rival Harvard, and played a similar role at many other public and private universities.

No Samuelson column followed Friedman’s. Samuelson never wrote again for Newsweek . He resigned the column he written for fifteen years. When, many years later, I asked him about his timing, he firmly denied that it had anything to do with Friedman’s column, and wrote me a letter for the file the next day repeating what he had said. I have always wondered if he sought to defuse the matter out of habit. That he and Friedman had remained on civil terms for seventy-five years was clearly a source of pride, though privately he  grew less tolerant of his rival after 1980.

Samuelson, too, was in mild recession in the ’80s. Keynesian economics hadn’t yet rebounded from the biting criticism of the New Classicals in the ’70s. Tensions were growing within the MIT department over appointments and the direction of future research.  Samuelson formally retired in 1985, at 70, to make room for others. He had plenty to engage his professional attention.  Commodities Corp., which had discovered such natural traders as Paul Tudor Jones and Bruce Kovner, was winding down, but Samuelson’s interest in Warren Buffet’s Berkshire Hathaway was gearing up. The Vanguard Group, whose godfather he had been ever since founder John Bogle introduced the first index fund, was thriving.  Samuelson’s friends and colleagues James Tobin, Franco Modigliani, and Robert Solow received Nobel Prizes.

Young Lions at Large   

To the young lions of Keynesian economics in the ’80s, rational- expectations macroeconomics and real business cycle theory posed a considerable bar. To work in the new traditions required a considerable investment in new tools and mathematical techniques, and, even fully teched-up, didn’t seem to speak very directly to policy. A strong corps of economists went to work to fashion a “new Keynesian” version of the latest general equilibrium economics. But gradually one rising star of saltwater economics after another left academia for a policy job.

Martin Feldstein, of Harvard University, was the first. As something of an acolyte of Milton Friedman, Feldstein was never very high in salinity, but he demonstrated plenty of professional backbone as Chairman of the Council of Economic Advisers under Ronald Reagan for two years in the early days of the controversies over deficits before returning in 1984 to Harvard and his position as  president of the National Bureau of Economic Research. Stanley Fischer, of MIT, was next, wrapping up a highly successful research career in order to serve as chief economist of the World Bank (a path that led to leadership positions in the International Monetary Fund, governor of the Bank of Israel and, currently, vice chairman of the Fed).   Lawrence Summers, Feldstein’s student, served as campaign economist to Democratic candidate Michael Dukakis in the 1988 presidential campaign and succeeded Fischer at the World Bank before joining the Clinton administration, where he advanced to Secretary of the Treasury.

Soon the flood was on:  Jeffrey Sachs, Joseph Stiglitz, Olivier Blanchard, Kenneth Rogoff, Gregory Mankiw, Glen Hubbard, and Christina Romer were among those MIT- or Harvard-trained economists who served in  government jobs or NGO positions.  Paul Krugman retooled as a journalist. Lists of MIT and Harvard graduates in high positions in European, South American, and Asian governments were even longer.  Did this differ in kind, and not degree, from the trajectory of academic economists dating back to to the New Frontier, if not the New Deal?  I think so.

In 2006, Harvard’s Mankiw, in an article for the Journal of Economic Perspectives argued, as I did in a book, that the differences in interests among economists were best understood as being similar to those between scientists and engineers. The early macroeconomists, led by Samuelson and Friedman, had resembled engineers seeking to solve practical problems, Mankiw wrote;  macroeconomists of the past several decades, led by Tjalling Koopmans, Jacob Marschak, Kenneth Arrow, and others had been more interested in developing analytic tools and establishing theoretical principles. Their students the ’80s had joined teams along similar lines. “Recently Paul Romer, of New York University, introduced a different distinction to elucidate some of the controversies in present-day macro – between bench science and clinical medicine. Both analogies will get plenty of elaboration in future years, for this is what changed in kind in the ’80s: economics developed a clinical/engineering wing.

A Fabulous Decade?

In 2001, Alan Blinder and Janet Yellen published The Fabulous Decade: Macroeconomic Lessons from the 1990s. They had in mind mainly the policies of the Clinton administration, a combination of modest tax increases and monetary easing that led to rapid income growth and low inflation in the second half of the decade and to a US budget surplus by its end. Soon economists had begun calling it “the Great Moderation”   But the ’90s were fabulous in other ways as well.

After China’s entry into the world market system had become clear, the hold of the Soviet Union on its European satellites had become shaky.  Poland was the first, followed by Czechoslovakia, Hungary, and, in 1989, East Germany. The Tiananmen Square protests of 1989 checked the spread of democracy in China, but by 1991 the Soviet Union was on the verge of collapse.  It dissolved at the end of the year. Rapid global growth ensued, punctuated by financial crises in Scandinavia, Mexico, Asia, and Russia.  There was often desperate trouble in the Balkans throughout.

The ’90s saw the rise of the Internet. What had been a military network with around 60 nodes, or points of connection, in 1977, was turned over to the National Science Foundation in the ‘80s and to private businesses in the ‘90s. Once the World Wide Web was established, in 1991, and the first browsers installed on personal computers, after 1993, the Web became a highway of commerce, so quickly populated that the second half of the decade saw a boom, a mania, and a crash.

Finance, too, raced ahead. After the scare of 1987, when the Dow Jones Industrial Average dropped by near 25 percent in a single day, a whole new roster of firms appeared to take the other side of increasingly complex deals.  A savings and loan crisis in the United States stimulated a new wave of interest among economists in banking. Deregulation accelerated; Albert Wojnilower, a Wall Street economist, compared the “decompartmentalization” of the US financial industry to letting the animals of a well-ordered zoo out of their cages. By the end of the decade, the  Glass-Steagall and McFadden Acts had been superseded by the Financial Services Modernization Act of 1999.

You know the rest:  there was a mild recession, a housing boom, a saving glut, an invasion of Afghanistan and Iraq, and, in 2004, a Nobel Prize for real business cycles to Edward Prescott and Finn Kydland. ...

    Posted by on Sunday, September 6, 2015 at 09:01 AM in Economics, History of Thought | Permalink  Comments (64)


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