The Economics Book

CONTEMPORARY ECONOMICS 299 See also: Financial services 26–29 ■ Boom and bust 78–79 ■ Economic bubbles 98–99 ■ Economic equilibrium 118–23 ■ Financial engineering 262–65 ■ Bank runs 316–21 ■ Global savings imbalances 322–25 only firms that are part of this CDOs were made by pooling Money is a veil process. Governments finance different financial assets (loans) behind which the their national debts, and consumers together, some high-risk, others action of real, economic borrow large sums to buy cars and low-risk. These new assets were forces is concealed. houses. They too are part of the then cut up into smaller sections to Arthur Pigou complex financial market that be sold. Each section contained a funds transactions over time. mix of debts. In 1994, credit default According to Minsky, after World swaps were introduced to protect War II capitalist economies had Merchants of debt these assets by insuring them moved away from being dominated Minsky argued that there was a against the risk of default. Both of by either big government or big second big difference between these innovations encouraged the business. Rather, they were subject modern and pre-capitalist supply of loans into the financial to the influence of big money economies. He pointed out that the system, which increased the markets. The influence of the banking system does not merely supply of liquidity, or money, into financial markets on the behavior match lenders with borrowers. It the system. Minsky concluded that of people created a system that also strives to innovate in the way these innovations meant that it was held within it the seeds of its own it sells and borrows funds. Recent no longer possible for a government destruction. He argued that the examples of this include financial to control the amount of money in longer the period of stable instruments called collateralized its economy. If the demand for loans economic growth, the more people debt obligations (CDOs), which was there, the financial markets believed that the prosperity would were developed in the 1970s. could find a way to meet it. continue. As confidence rose, so did the desire to take risks. The longer an … the greater people’s Paradoxically, longer periods of economy remains confidence in the future, the stability resulted in an economy stable, the greater riskier their borrowing. that was more likely to become people’s confidence fatally unstable. in the future… Minsky explained the pathway from stability to instability by Eventually, asset Over time in a stable looking at three different types prices peak and then fall, economy, debt grows, of investment choices that people and borrowers start to default. asset prices rise, and can make. These can be simply Lending collapses, and risky borrowing comes illustrated by looking at the way the economy goes into houses are bought. The safest to dominate. decision is to borrow an amount recession. that allows the person’s income to repay the interest on the loan Stable economies contain the and also the original value of ❯❯ seeds of instability.

300 FINANCIAL CRISES During a period of stability, confidence With more time prices to meet the high level of returns in the future grows, which leads people to rise too much, then that were promised. Investors in make increasingly risky investments. This confidence disappears such schemes are likely to lose a causes an asset price bubble, which will large proportion of their money. eventually burst. Housing bubble In early years As time passes, The recent history of the US of stability asset prices rise housing market is an example of asset prices how an economy that has had a are reasonable long period of stability creates within itself the conditions for Low-risk Low-risk + Low-risk + high-risk + instability. In the 1970s and 80s investments the standard mortgage was sold high-risk investments reckless investments in a way that made sure that the interest and the capital could be the loan over a period of time. greatest amount of instability paid off, in what Minsky viewed Minsky called these hedge units, in the future. Minsky named as hedge units. However, by the and they create little risk for this third type of investor Ponzi end of the 1990s a sustained the lender or borrower. If people borrowers after Charles Ponzi, the period of growth had pushed felt more confident about the future, Italian immigrant to America who house prices up, persuading an they might buy a larger interest- was one of the first to be caught increasing number of people to only mortgage, where their income running the financial scam that use interest-only mortgages as could pay back the interest on the now bears his name. “Ponzi they speculated that prices would loan but not the loan itself. The schemes” attract funds by offering continue to rise. The financial hope would be that a stable period very high returns. Initially, the con system then began to supply a of positive economic growth would men use new investors’ money to whole array of “Ponzi”-style increase demand so that the value pay the dividends. In this way mortgage deals to borrowers who of the house would be greater at the they can maintain the illusion that had incomes so low that they could end of the period than at the start. investment is profitable and attract not afford to pay even the interest Minsky called these people new customers. However, soon the on the loan—these were the speculative borrowers. scheme collapses due to its failure “subprime” mortgages. The monthly shortfall was to be added As time passed, if stability and to their total debt. As long as house confidence continued to last, the prices continued to rise, the value desire to take greater risks would of the property would be worth encourage people to buy a house for more than the debt. As long as new which their income could not even people kept entering the market, pay the interest, so that the total prices kept rising. At the same time level of debt would increase, at the finance industry that sold the least in the short run. The mortgages bundled them up and expectation would be that house sold them on to other banks as prices would rise fast enough to assets that would deliver a stream cover the shortfall in the interest of income for 30 years. repayments. This third type of investment would create the The end of the game arrived in 2006. As the US economy stalled, An agent shows a couple around a home. In the US housing boom banks were lending on the expectation of rising prices. People who could not afford mortgages were encouraged to buy.

CONTEMPORARY ECONOMICS 301 The peculiar banks with enormous debts and, In 2009, financier Bernard Madoff was behavioral attributes since no one knew who had bought convicted of the largest Ponzi scheme of a capitalist economy the toxic mortgage debt, institutions fraud in history. He took more than $18 stopped lending to each other. billion from investors over the course of center around the As a result banks began to fail, 40 years before the scheme collapsed. impact of finance most famously Lehmann Brothers upon system behavior. in 2008. As Minsky had foretold, Minsky strongly believed that, in Hyman Minsky a near-catastrophic collapse of the the long run, this was necessary. financial system beckoned because However, the speed at which incomes fell, and the demand for a period of stability had generated innovation takes place in the new houses weakened. As house enormous levels of debt that money markets would make price increases began to slow, the created the conditions for increased regulation very difficult. first of an increasing number of enormous instability. defaults was triggered since For Minsky financial instability borrowers saw their debts grow The three possible actions taken is key to explaining modern rather than shrink. Rising numbers to halt the fatal instability, and the capitalism. Money is no longer of repossessed houses came onto problems associated with making a veil that hides the real workings the market, and prices tumbled. these corrections, had also been of the economy; it has become predicted by Minsky. the economy. His ideas are now In 2007, the US economy reached drawing increasing attention. ■ what has become known as the First, the central bank could act “Minsky moment.” This is the point as the lender of last resort, bailing at which the unsustainable out the failing banking system. speculation turns into crisis. The Minsky saw that this might further collapse of the housing market left increase instability in the system in the future because it would encourage banking firms to take greater risks, safe in the knowledge that they would be saved. Second, the government could increase its debt to stimulate demand in the economy. However, even governments have problems financing debts in times of crisis. Third, the financial markets could be subject to stricter regulation. Hyman Minsky After a period overseas with but since his death, and the US army during World particularly since the crash An economist of the political War II he returned home to spend of 2007–08 that he predicted, his Left, Hyman Minsky was born most of his working life ideas have become increasingly in Chicago to Russian-Jewish as a professor of economics at influential. Married with two immigrant parents who had met Washington University. children, he died of cancer at a rally to honor Karl Marx in 1996, aged 77. (p.105). He studied mathematics An original thinker and at Chicago University before natural communicator, Minsky Key works switching to economics. made friends easily. Academically, Minsky had a vision of a better he was more interested in the 1965 Labor and the War world and yet was equally idea than mathematical rigor. against Poverty fascinated by the practical The notion that pervades all his 1975 John Maynard Keynes world of commerce, and worked work is the flow of money. During 1986 Stabilizing an Unstable as an adviser and director of an his lifetime, partly by choice, he Economy American bank for 30 years. remained on the margins of mainstream economic thought,

302 BUSINESSES PAY MORE THAN THE MARKET WAGE INCENTIVES AND WAGES IN CONTEXT U S economists Carl Shapiro without cost (a problem that and Joseph Stiglitz contend economists call “moral hazard”). FOCUS that firms pay what must Because of this, Shapiro and Markets and firms be more than the market wage Stiglitz argue that efficiency wages because there is always a core cut “shirking.” If workers knew they KEY THINKERS of unemployed workers. They would be right back in a job as soon Joseph Stiglitz (1943– ) explain this with the idea of as they got fired, they might be Carl Shapiro (1955– ) “efficiency wages.” Employers tempted to slack on the job. The choose to pay over the market higher wages and the knowledge BEFORE wage because it is worth their that dismissal might lead to long- 1914 During a recession while—they get more from their term unemployment increases the US car manufacturer Henry employees this way. cost of losing a job and will make Ford announces that he is workers less likely to shirk. doubling the pay of his workers This situation arises because of to $5 a day. market “imperfections.” Employers Employers also cannot observe cannot observe their workers’ effort their workers’ ability without cost, 1920s British economist and efficiency wages might help Alfred Marshall suggests the Workers build the Model T motorcar to attract better applicants. Other idea of efficiency wages. on Henry Ford’s revolutionary assembly explanations include the employer’s line in 1913. One of Ford’s insights was desire to boost morale and 1938 The Fair Labor to realize that his own workers should minimize turnover (the higher Standards Act introduces a also be his best customers. the wage, the easier it is to hold minimum wage in the US. on to workers and avoid costly retraining). High wages may also AFTER keep workers healthy enough to 1984 Carl Shapiro and Joseph do a good job. This is particularly Stiglitz suggest that efficiency important in developing countries. wages discourage shirking. Efficiency wages can further explain why firms don’t cut wages 1986 US economists George if demand falls: if they did, their Akerlof and Janet Yellen best workers might quit. ■ suggest social reasons for paying efficiency wages, such See also: Supply and demand 108–13 ■ Depressions and unemployment as boosting morale. 154–61 ■ Market information and incentives 208–09

CONTEMPORARY ECONOMICS 303 REAL WAGES RISE DURING A RECESSION STICKY WAGES IN CONTEXT K eynesian economics costs”—the costs of making (pp.154–61) assumes that changes, such as printing new FOCUS wages in money terms price lists. Stickiness can also The macroeconomy tend not to fall: they are “sticky” be caused by labor contracts, in and respond only slowly to which wages are fixed for a time. KEY THINKER changing market conditions. When Individual behavior and rationality John Taylor (1946– ) a recession hits and prices fall, were absent from early Keynesian the real value of wages therefore models. The new Keynesian BEFORE increases. Firms then demand less economists placed their Keynesian 1936 John Maynard Keynes labor, and unemployment rises. conclusions on some firmer argues that government theoretical foundations. ■ intervention can pull The new Keynesian economists, economies out of recessions. such as US economist John Taylor, If you were going to turn attempt to explain this stickiness. to only one economist to 1976 Thomas Sargent and In the 1970s the introduction of understand the problems Neil Wallace argue that rational expectations (pp.244–47) facing the economy, there rational expectations make undermined Keynesian economics. Keynesian macroeconomic There could be no persistent is little doubt that the policies useless. unemployment because wages economist would be would fall and government policies John Maynard Keynes. AFTER to boost the economy wouldn’t 1985 Greg Mankiw suggests work. New Keynesian thinking Greg Mankiw that “menu costs”—the cost showed that even with rational to a firm of making price expectations, unemployment might changes—may cause linger and government policy could price stickiness. be effective. This was because wage stickiness could coexist 1990 US economist John with rational individuals. Taylor introduces the “Taylor rule,” showing that central Taylor and US economist Greg banks should run active Mankiw argue that prices may monetary policies to stabilize be sticky due to so-called “menu the economy. See also: Depressions and unemployment 154–61 ■ The Keynesian multiplier 164–65 ■ Rational expectations 244–47 ■ Incentives and wages 302

304 FINDING A JOB IS LIKE FINDING A PARTNER OR A HOUSE SEARCHING AND MATCHING IN CONTEXT I t is usually easy to decide Online dating agencies are markets where to buy bread or soap. where people are both buyers and FOCUS There are many supermarkets, sellers. Individuals cannot search Decision making and they are easy to find. But what indefinitely so they will work most about locating a particular make of effectively if they search within a range. KEY THINKER used car or an antique musical George Stigler (1911–91) instrument? According to the schedule matches, supply equals classical view of the market— demand and the market is in BEFORE where supply and demand always equilibrium. So how can it be that 1944 British politician William balance—buyers and sellers find at any one time there are many Beveridge argues that if the each other immediately, without workers looking for jobs and unemployment rate is high, the cost, and have perfect information employers looking for workers? number of job vacancies is low. about the prices of all goods and services. However, anyone who In the 1960s US economist George AFTER has tried to find a used car—or a Stigler argued that the “one wage” 1971 US economist Peter new house or partner—knows that market used by classical Diamond shows that costly it rarely works like this in reality. economists would only occur where search frictions prevent the there is no cost for information law of “one wage” from Search frictions about wages offered or sought. In working in practice. Markets are said to have “search any market where products (such frictions” when buyers and sellers as jobs) are all different, searching 1971 US economist Dale do not automatically find each other. Mortensen looks at how Economists have gradually unemployment can rise among developed “search theory” to skilled workers, even when investigate these frictions. One of there are jobs available. the theory’s main focuses has been on job searches and unemployment. 1994 British economist Christopher Pissarides The classical model of the labor provides empirical data and market assumes a labor supply models for search and schedule (the number of workers matching theory. willing to work at a given wage) and a labor demand schedule (the number of jobs offered at a given wage). When the wage for each

CONTEMPORARY ECONOMICS 305 See also: Free market economics 54–61 ■ Depressions and unemployment Global 154–61 ■ Rational expectations 244–47 ■ Sticky wages 303 unemployment Economists assume that … and that buyers have easy While many people now work buyers and sellers access to all the information in well-paid, satisfying jobs, they need from all the sellers unemployment is persistently can always find each other high in some parts of the immediately… within the market. world. Moreover, the market in jobs is shifting, and good jobs In the job market But in reality this is not the are vanishing even in richer individuals have to limit case, and the problem is made parts of the world. their search to the vacancies they can find within a certain worse if each search costs In March, 2012, nearly half time and money. of Spaniards and Greeks time and budget. under 25 were jobless, and unemployment in South Africa Finding a job is like finding was running at nearly 30 a partner or a house. percent. Even in the US, employment climbed above costs money. The greater the Diamond found that even a tiny 9.1 percent. This appears to search costs, the wider the range increase in the cost of searching counteract the argument that of wages for a similar job will be. leads to an increase in price of the there are always jobs for those People looking for work realize that goods. Buyers are reluctant to pay prepared to take lower wages. wages differ between employers for a second or third search, so if US economist Michael Phelps and have to decide how far and price rises are small in the place argues that globalization is a how long to search. Stigler’s they are searching, sellers know big factor in this because jobs research showed that to conduct that buyers will not notice because created in richer countries an optimal search, workers should they are not comparing them with tend to be in “non-tradable” reject any wage lower than their the results of other searches. sectors such as government “reservation wage” (the lowest they and healthcare, while tradable are willing to accept), but accept Searching and matching jobs (such as phone-making) any offer above it. This model—of theory has implications for the have moved to countries such drawing a line at an acceptable efficient design of unemployment as China and the Philippines, level—works for searching in any benefits. Benefits without where wages are generally market, even dating agencies. conditions might reduce low. Resolving problems like incentives for job seekers to these is one of the chief In 2010, economists Peter search and to accept job offers. concerns for economists today. Diamond, Dale Mortensen, and But those that are designed in a Christopher Pissarides were jointly way that encourages searching In 2011, thousands of Spaniards awarded the Nobel Prize for their might help to improve the calling themselves los indignados work on search and matching theory. efficiency of labor markets. ■ (the indignant), marched to Brussels to protest against an unemployment rate of 40 percent.

306 IN CONTEXT THE BIGGEST FOCUS CHALLENGE FOR Economic policy COLLECTIVE ACTION IS KEY THINKERS CLIMATE CHANGE William Nordhaus (1941– ) Nicholas Stern (1946– ) ECONOMICS AND THE ENVIRONMENT BEFORE 1920 British economist Arthur Pigou proposes levying taxes on pollution. 1896 Swedish scientist Svante Arrhenius predicts a doubling of atmospheric carbon dioxide will produce a 9–11°F rise in global surface temperature. 1992 The United Nations Framework Convention on Climate Change is signed. 1997 The Kyoto Protocol is ratified; by 2011 more than 190 countries sign up to it. AFTER 2011 Canada retracts from the Kyoto Protocol. E conomic development and prosperity since the Industrial Revolution have come about through technology, largely driven by fuels such as coal, oil, and gas. It is increasingly clear, however, that this prosperity comes at a cost—not only are we fast depleting these natural resources, but burning fossil fuels pollutes the atmosphere. A growing body of evidence points to emissions of greenhouse gases, in particular carbon dioxide (CO ), as a cause of 2 global warming, and the consensus now among scientists worldwide is that we risk devastating climate change unless emissions are cut quickly and drastically.

CONTEMPORARY ECONOMICS 307 See also: Provision of public goods and services 46–47 ■ Demographics and economics 68–69 ■ External costs 137 ■ Development economics 188–93 ■ The economics of happiness 216–19 Energy use driven by economic growth is causing pollution, accelerating climate change. The Industrial Revolution that Pollution in one Firms and countries began about 150 years ago has led country affects produce too much to countries burning large amounts of other countries… pollution because they fossil fuels. These emissions create a don’t face the full costs of “greenhouse effect” in the atmosphere. their actions. The implications are as much To be effective, The biggest economic as environmental, but measures to curb carbon challenge for both economists and governments emissions must be adopted collective action are divided on the measures that worldwide, even by those is climate change. should be taken. Until recently, many have argued that the costs who do not want to around 1 percent of GDP to tackle of combating climate change are adopt them. the problem if action was taken more damaging to economic promptly. In 2009, Nordhaus prosperity than the potential the uncertainties involved, the estimated that without intervention, benefits. Some continue to dispute international scope of the problem, economic damages from climate the evidence that climate change and the uneven distribution of change would be around 2.5 is human-made, while others argue benefits and costs across the globe. percent of world output per year by that global warming could even be 2099. The highest damages would beneficial. A growing number now In 2006, the UK government be sustained by low-income accept that the issue is one that commissioned a report by British tropical regions, such as tropical must be addressed, and economic economist Nicholas Stern on Africa and India. solutions have to be found. the economics of climate change. The Stern Review was unequivocal The question was no longer The economic facts in its findings; it presented sound whether we could afford to cut In 1982, US economist William economic arguments in favor emissions, but whether we could Nordhaus published How Fast of immediate action to reduce afford not to, and how this could Should We Graze the Global greenhouse gas emissions. Stern best be achieved. There are Commons?, looking in detail at estimated that the eventual cost strong arguments for government the economic impact of climate of climate change could be as much intervention: the atmosphere can ❯❯ change and possible solutions. He as 20 percent of GDP (gross pointed out that certain features of domestic product, or total national the climate problem make it unique income), compared with a cost of in terms of finding economic solutions: the long time scale,

308 ECONOMICS AND THE ENVIRONMENT Ggraeseenshtoraupseheaant dfraoEbmmsoinsrasptitouionrnes Carbon in atmosphere Emissions emissions of greenhouse gases. from industry Many governments have developed environmental policies and Emissions from strategies for implementing those consumption policies. Regulation in the form of punishments, such as fines for Damage or excessive production of pollutants, to nature INDUSTRY is one solution, but it is difficult to NATURAL Lab set emissions quotas that are fair to Temperature RESOURCES mption all businesses concerned. The fines rises are also difficult to enforce. Consumption Consu Another option, which was first suggested by British economist PEOPLE Arthur Pigou in 1920, is the imposition of taxes on pollution William Nordhaus devised a computer program called DICE to show (p.137). Levying taxes on firms that how the elements of climate change interact, and where the ecological and emit greenhouse gases, and on financial costs lie. This financial modeling system allows governments to energy suppliers and producers for factor in their current consumption, resources, and needs, and weigh up the amount of carbon they release the costs and benefits—to them and the Earth—of the choices available. into the atmosphere, would act as a disincentive to pollute. be considered in economic terms economies, which are mainly in Taxes on fossil fuels would as a public good (pp.46–47), which temperate areas, are not likely to discourage their excessive tends to be undersupplied by suffer the worst consequences of consumption. Pigou’s idea is to markets; pollution can be seen as a rise in global temperatures. The make individuals face the full an externality (p.137), where the likely changes in climate will hit social costs of their actions, to social costs of an action are not poorer countries much harder. This “internalize” the externality. reflected in prices and so are not means that, in many cases, the fully borne by the person taking it. countries with the greatest Carbon-trading schemes For these reasons Stern described incentive to mitigate the effects of Pollution can be viewed as a market climate change as the greatest climate change are those that are failure because normally there is no market failure ever experienced. producing the least pollution. market for it. Economists suggest that if there was, the socially optimal Unequal nations The worst polluters, such as The first hurdle for economists the US, Europe, and Australia, Price-type approaches such as Nordhaus and Stern was to have been reluctant to accept like harmonized taxes convince governments to introduce that governments should impose on carbon are powerful measures that would be harmful to expensive policies. Even if they tools for coordinating their economies in the short run did, the pollution is not restricted policies and slowing but would mitigate more damaging to their land masses. The problem consequences in the long run. The is global and demands collective global warming. second was to find the most efficient action on a global scale. William Nordhaus way of enforcing an emissions policy. Not all governments were easily The need for collective action persuaded. The more developed was first noted at a U.N. “Earth Summit” in 1992, which called for all its members to curb their

CONTEMPORARY ECONOMICS 309 Hurricane Katrina destroyed much be tackled globally to avert the India’s growing needs of New Orleans in 2005. The cost of the risk of climate change. However, damage, estimated at $81 billion, international agreements such as India’s growth rate for 2012 focused worldwide attention on the the Kyoto Protocol have failed to was predicted to be 7–8 economic effects of climate change. achieve universal ratification. In percent for the year. The 1997, 141 countries took part in country’s business leaders amount of pollution would be emitted discussions, but by 2012 only 37 are aware that if this rate of because polluters would face the full countries had agreed to implement growth continues, there will costs of their actions. Therefore, its targets for greenhouse gas be a huge energy shortage. another proposed solution to the emissions. The US has consistently The fear is that the shortfall climate problem is to create a market rejected the terms of the agreement, will be met by the use of for pollution through emissions and Canada pulled out in 2011. low-cost “dirty” coal and trading. This involves a government Even those countries that pledged diesel fuel, so efforts are being (or, in some cases, a number of to curb their emissions have often made to increase efficiency governments working together) failed to meet their reduction targets. while also encouraging the determining an acceptable level of, Developed countries such as the US use of renewable energy for example, CO emissions, and and Australia argue that it would be products, using solar, wind, too harmful to their economies; and geothermal technologies. 2 developing economies such as China, India, and Brazil argue that Economists hope that then auctioning permits to firms they should not have to pay for the renewable energy forms, whose business involves the pollution caused by the West (even together with nuclear energy discharge of carbon dioxide. The though they themselves are fast (judged to be a “clean” energy permits are tradable, so if a firm becoming major polluters). On the provider) can combine to meet needs to increase its emissions, it other hand more eco-advanced all of India’s growing needs. can buy permits from another that nations, such as Germany and However, so far the renewable has not used its quota. This kind of Denmark, agreed to reduction energy forms, such as solar, plan has the advantage of rewarding targets of more than 20 percent. are not commercially viable the firms who cut their emissions industries on a large scale. and can then sell their surplus Economic modeling This means that they will permits. It can discourage firms Economists have devised various need a short-term boost from from exceeding their quotas and models for studying the economic state subsidies to expand. having to buy extra permits. impact of climate change, such as This is provided for in India’s However, the total amount of Nordhaus’s Dynamic Integrated ambitious National Action emissions remains the same and model of Climate and the Economy Plan on Climate Change, is controlled by a central authority. (DICE), first presented in 1992 introduced in June, 2008. (see opposite). This links together The Kyoto Protocol CO emissions, the carbon cycles, Solar panels capture sunlight in While emissions trading programs the Himalayas in northern India. are certainly a step in the right 2 Solar power may be an efficient direction, the problem needs to source of renewable energy in climate change, climatic damages, India, where sunshine is intense. and factors affecting growth. Most economists now agree that climate change is a complex problem with the potential to cause serious long-term damage. The solution is far from obvious, but in 2007, Nordhaus said that he believed the secret to success lies not in large, ambitious projects, such as Kyoto, but in “universal, predictable, and boring” ideas, such as carbon taxes. ■

310 GDP IGNORES WOMEN GENDER AND ECONOMICS IN CONTEXT G ross domestic product GDP relies on the collection (GDP) is the most of data relating to economic FOCUS commonly cited economic transactions. The principle behind Society and the economy statistic. It provides a summary it is that everything bought and measure of the economic activity sold in a year should be registered KEY THINKER taking place within a country over by GDP. Government statisticians Marilyn Waring (1952– ) a whole year—and appears to relate conduct in-depth surveys to directly to important factors such measure this figure. However, BEFORE as household incomes or the rate everything bought and sold in a 1932 Russian-American of employment. However, for nation is not exactly equivalent economist Simon Kuznets all its prominence in economic to all the economic activity that produces the first accounts debates, GDP is subject to takes place. Nor does the eventual of the whole US economy. considerable problems. figure necessarily capture much of what people might value about 1987 US economist Marianne The problems and limits of a country. For example, an Ferber publishes Women and GDP center on how it is calculated environmentalist would say that Work: Paid and Unpaid, a and what it includes. Measuring bibliography of prior research on women and economics. GDP aims to record the This is supposed to value of transactions in an represent all meaningful AFTER 1990 First release of UN economy over a year. economic activity. Development Index, which attempts to account for These activities are But it excludes non-market a broader concept of often largely performed activity, such as housework development than is available and child care, even though in national income figures. by women. they have value. 1996 US economists Barnet Wagman and GDP ignores women. Nancy Folbre analyze the contribution of housework to US national income.

CONTEMPORARY ECONOMICS 311 See also: Measuring wealth 36–37 ■ Economics and tradition 166–67 ■ Marilyn Waring The economics of happiness 216–19 ■ Social capital 280 One of New Zealand’s first reproduction of the labor force, female members of for example. But in the vast Parliament, Marilyn Waring majority of cases it is not paid, was born in 1952. She was and so does not enter into the promoted by the National calculation of GDP. Party Prime Minister Robert Muldoon to become chair of Many kinds of work are performed Excluding women the Public Expenditure mostly by women, including child care. The accounting differences Committee in 1978. She later They are vital to the economy but do involved in calculating economic fell out with the government, not count toward GDP because they output can be highly arbitrary, threatening to vote in favor of are not recorded in the paid economy. treating essentially equivalent an opposition motion banning work very differently. Cooking is nuclear weapons and nuclear GDP does not allow for the “economically active” when food power from New Zealand in depletion of natural resources. is sold, but “economically inactive” 1984. Muldoon called a Deforestation generally adds to when it is not. The only distinction general election in response, GDP, assuming the lumber is sold. here is the presence or absence of a which the National Party lost. But a potentially irreplaceable market transaction, but the activity natural resource is being is identical. One will act to exclude After Parliament Waring consumed, and GDP gives no women, while the other will not. pursued her interests in indication of this. Similarly, if an farming and economics. In economic activity produces There is, then, a huge implicit 2006, she became Professor of pollution, GDP would count only gender bias in national accounts, Public Policy at the Auckland the products sold and ignore the and the true economic value of University of Technology, undesirable side effects, such as work performed by women is where she has continued loss of biodiversity or worsened systematically underestimated to research the measurement public health. in our conventional accounting of areas excluded by systems. Waring went further conventional economics. Women’s work to argue that the standard There are other difficulties with international system for calculating Key work the figure arrived at in calculating national income, the United GDP. In her influential 1988 book Nations System of National 1988 If Women Counted: If Women Counted, Marilyn Waring, Accounts (UNSNA), is an example A New Feminist Economics a one-time New Zealand politician, of “applied patriarchy:” in other argued that GDP systematically words an attempt by the male We women are visible underreports the work performed economy to exclude women in a and valuable to each by women. Women account for a way that acts to reinforce gender other, and we must, now great bulk of the work performed divisions globally. in our billions, proclaim in households across the world, as well as most child care and Waring’s criticisms, and those that visibility and care for the elderly. This work is of other feminist economists, have that worth. clearly economically necessary, helped to shape arguments over because it helps to ensure the the future of national income Marilyn Waring accounting. Current debates on how to account for well-being and the development of broader social measures of economic progress indicate a growing desire to move beyond the constraints and limitations of GDP as a measure of worth. ■

312 COMPARATIVE ADVANTAGE IS AN ACCIDENT TRADE AND GEOGRAPHY IN CONTEXT E conomists used to believe Regions that for historical that nations traded with reason have a head start as FOCUS each other because they centers of production will Global economy were different: tropical countries attract even more producers. sold sugar to temperate countries, KEY THINKER temperate ones exported wool. Paul Krugman Paul Krugman (1953– ) Some countries were better at producing certain things—they industry arising from a chance BEFORE had a “comparative advantage” event in Georgia. He observed that 1817 David Ricardo says because of their weather or soil. a lot of trade goes on between that countries have similar economies. Production has comparative advantages However, there is good reason economies of scale: the initial outlay due to physical factors. to believe that this is not the whole for a car plant means that costs are story. In 1895, Catherine Evans lower the more cars are made. Either 1920s and 1930s Eli from Dalton, Georgia, was visiting country could make cars, but once Heckscher and Bertil Ohlin a friend and noticed a homemade one starts, it builds up a cost argue that capital-abundant bedspread. Inspired, she made a advantage that is hard for the other countries export capital- similar one and began to teach to erode. So a region may end up intensive goods. others. Soon, textile firms sprung dominating trade in a good due up, creating a carpet industry that purely to quirks of history. ■ 1953 Wassily Leontief finds came to dominate the market. This an empirical paradox: the US, contradicted the usual explanation a capital-abundant country, of international trade, since has relatively labor-intensive Georgia has no comparative exports, in violation of existing advantage for making carpet. trade theories. Quirk of history AFTER In 1979, US economist Paul 1994 Gene Grossman and Krugman proposed a new theory Elhanan Helpman analyze that allowed for the influence of the politics of trade policy, accidents of history, such as an examining the effect of lobbying on the level of See also: Protectionism and trade 34–35 ■ Comparative advantage 80–85 ■ protection given to firms. Economies of scale 132 ■ Market integration 226–31

CONTEMPORARY ECONOMICS 313 LIKE STEAM, COMPUTERS HAVE REVOLUTIONIZED ECONOMIES TECHNOLOGICAL LEAPS IN CONTEXT E conomic growth is types of machines. Recently, powered by innovation and economists have started to think FOCUS invention. Some innovations about these leaps. US economists Growth and development are incremental, while others are Timothy Bresnahan and Manuel revolutionary. A better drill may be Trajtenberg call electricity a KEY THINKER one of many small innovations by “general purpose technology.” Robert Solow (1924– ) which economies gradually become A better drill helps builders; more productive. The discovery electricity makes all firms more BEFORE of electricity, however, was truly productive. However, the positive 1934 Joseph Schumpeter revolutionary, and over the last effects of such revolutionary stresses the vital role of two centuries it has transformed advances can take time to be felt. technological change in economies, enabling the use of new economic growth. Exploiting new technology By the 1980s computers had In the late 1980s US economist 1956 Robert Solow devises revolutionized the way that many of us Robert Solow (p.225) thought the neoclassical growth work. However, it can take years for that he had found a paradox: the model in which technological such fundamental changes to be proliferation of information and change plays a role but is reflected in increased productivity. communication technology (ICT) not explained. didn’t seem to have had an obvious impact on productivity. During the 1966 Jacob Schmookler Industrial Revolution the spread of argues that technological steam power was surprisingly slow: development responds to it took time for it to become cost- economic incentives. effective and for firms to reorganize in order to use it. ICT has taken AFTER hold more quickly, but it has still 2004 Nicholas Crafts taken time to spread. Solow’s shows that general purpose paradox is resolved by the fact that technologies take time to the full benefits of general purpose diffuse through economies. technologies take time to arrive. ■ 2005 Richard Lipsey argues See also: The emergence of modern economies 178–79 ■ Institutions in that technological revolutions economics 206–07 ■ Economic growth theories 224–25 led to the rise of the West.

314 WE CAN KICK-START POOR ECONOMIES BY WRITING OFF DEBT INTERNATIONAL DEBT RELIEF IN CONTEXT Debt in poor countries has Many of the loans were grown so large that they made by rich countries FOCUS cannot afford to service the to corrupt governments. Growth and development debt and invest in growth. KEY THINKER Canceling the loans The loans should not Jeffrey Sachs (1954– ) will enable poor countries have been made in BEFORE to invest in growth. the first place. 1956 The Paris Club, a grouping of creditor We can kick-start poor economies nations, was established to by writing off debt. facilitate debt relief between individual countries. I n the last few decades of the suffering, let alone make the 20th century the world’s investments needed to climb out AFTER poorest countries piled up a of the vicious cycle of economic 1996 The IMF and World Bank staggering amount of debt, which decline. Campaigns for debt launch the Heavily Indebted grew from $25 billion in 1970 to cancellation intensified. Poor Countries (HIPC) $523 billion in 2002. initiative to give debt relief Many campaigners took a moral and initiate policy reform in By the 1990s it was clear stance, criticizing the negligent or poor countries. that there was a debt crisis. No self-interested role of the rich heavily indebted African nation countries and institutions such as 2002 Seema Jayachandran had ever prospered. Indeed, most the World Bank and International and Michael Kremer argue were in such dire economic straits Monetary Fund (IMF), which that countries may not be that they could not even service had made many of the loans. legally liable for “odious” debts their debts without terrible Campaigners argued that since incurred by corrupt regimes. 2005 G8 countries agree to write off $40 billion of debt under the Multilateral Debt Relief Initiative (MDRI) as part of the Gleneagles summit.

CONTEMPORARY ECONOMICS 315 See also: International trade and Bretton Woods 186–87 ■ Development economics 188–93 ■ Dependency theory 242–43 ■ Asian Tiger economies 282–87 ■ Speculation and currency devaluation 288–93 Shall we let the children debts were incurred by corrupt reform programs that are made of Africa and Asia die regimes to feather their own nests, a condition for relief, which may of curable disease, prevent they could be considered “odious.” damage the economic prospects of them from going to school, This would mean that countries the countries receiving the relief. and limit their opportunities have no legal obligation to repay for meaningful work—all them. The World Bank, for instance, Interestingly, the debt crisis has to pay off unjust and continued to lend to former dictator now shifted from the less developed illegitimate loans made Mobutu Sese Seko in Zaire (now world to the once-flourishing the Democratic Republic of Congo), countries of Europe. Here, similar to their forefathers? even after an IMF representative free market austerity measures Desmond Tutu pointed out that he was stealing are being pushed through—but, the money. Many of South Africa’s crucially, without the debts South African archbishop (1931– ) debts were borrowed by the being canceled. ■ apartheid regime, considered rich countries had made these by many not to have been a In South Africa, high debts were loans either to buy support in the legitimate government. incurred by the apartheid regime. Cold War or to secure contracts Many argue that the debts from the for their own companies, they had Others, such as Jeffrey Sachs, apartheid era should be canceled since an obligation to lift the debt. US gave an economic argument. the government was not legitimate. economist Michael Kremer took a Sachs argued that canceling debt legal line. He said that since many and increasing aid could kick-start growth in poor countries. Such was the appeal of these arguments that the G8 countries (the eight largest economies in the world) agreed to write off over $40 billion in 2005. Another American, William Easterly, argues that debt relief rewards poor policies and corruption by recipient countries. Many criticize the free market Jeffrey Sachs One of the world’s most known as a global economic controversial economists, Jeffrey troubleshooter. He was on hand Sachs was born in Detroit, in 1990 to shift Poland out of Michigan, in 1954. He first came communism with breakneck into the public eye in 1985 with a privatization and did the same plan to help Bolivia deal with in Russia in the early 1990s. In hyperinflation. The plan came to the 2000s Sachs turned his be called “shock therapy” and attention to global development centered on making the country issues, arguing that, with the easily accessible to foreign right interventions—including business. This meant opening aid and microloans—extreme up the Bolivian market, ending poverty could be eradicated government subsidies, eliminating in 20 years. import quotas, and linking the Bolivian currency to the US dollar. Key work Inflation was indeed brought under control, and Sachs became 2005 The End of Poverty

PESSIMISM CAN DESTROY HEALTHY BANKS BANK RUNS



318 BANK RUNS During the Great Depression If any bank fails, a general of the early 1930s some run upon the neighbouring IN CONTEXT 9,000 US banks failed—a third of the total. However, it was banks is apt to take FOCUS not until the 1980s that economic place, which if not Banking and finance theory came to grips with basic checked in the beginning questions such as why banks exist, by a pouring into the KEY THINKERS and what causes a bank run— circulation of a very large Douglas Diamond (1953– ) where depositors panic and rush to quantity of gold, leads to Philip Dybvig (1955– ) withdraw their money from banks extensive mischief. they think are at risk of failing. The Henry Thornton BEFORE article that started the debate was 1930–33 One third of all Bank Runs, Deposit Insurance, and UK economist (1760–1815) US banks fail, leading to the Liquidity, written in 1983 by US creation of the Federal Deposit economists Douglas Diamond and Insurance Corporation (FDIC) Philip Dybvig. They showed that to insure depositors’ money. even healthy banks can suffer from a bank run and go bust. 1978 US economic historian Charles Kindleberger publishes Liquid investments things with their good: they can a landmark study of bank runs, Diamond and Dybvig made a store it, in which case they get Manias, Panics, and Crashes: mathematical model of an economy back the same amount on Tuesday A History of Financial Crises. to demonstrate how bank runs to consume; or they can invest it. occur. Their model has three points If they choose to invest the good, AFTER in time—such as Monday, Tuesday, which is only possible on Monday, 1987–89 At the peak of the and Wednesday—and assumes they will receive much more of it decade-long US savings and that there is only one good or back on Wednesday. However, loan crisis, US bank failures product available to people, which if they cash in the investment rise to a level of 200 per year. they can consume or invest. early on Tuesday, they will receive 2007–09 Thirteen countries Each person starts off with across the world experience a certain amount of the good. systemic banking crises. On Monday people can do two A bank makes If customers become … they will want to long-term investments fearful about withdraw ahead of but keeps some cash on the future… others, leading to a run deposit for depositors who on the bank. wish to withdraw. Pessimism … and so will To honor their can destroy default on its last withdrawals, the bank healthy banks. remaining depositors. must sell investments at a loss…

CONTEMPORARY ECONOMICS 319 See also: Financial services 26–29 ■ Institutions in economics 206–07 ■ Market information and incentives 208–09 ■ Speculation and currency devaluation 288–93 ■ Financial crises 296–301 Banks only keep a relatively small percentage of their deposits in cash reserves. If all a bank’s depositors turn up to demand their money back on the same day, only those at the front of the line will receive their money. Total depositors Bank Total amount on deposit Amount held in cash deposit less than they invested. These reflect these proportions. But because with large numbers, the investments, which are made for whatever people choose, it will bank can do this in a way that a set period, are what is known never be the most efficient outcome the individual cannot. as “illiquid” investments. This overall because impatient people means that they cannot easily be should never invest, and patient On Tuesday the bank has transformed into ready cash, as people should not store anything. illiquid assets—the patient people’s liquid assets can. A bank can solve this problem. We investment that will reap a return can think of a bank in this model on Wednesday. At the same time Patient and impatient as a place where people all agree it has to pay the impatient people Diamond and Dybvig assume to pool their goods and share risks. their deposits right away. Its there are two types of people: The bank gives people a deposit ability to do this is the reason patient people, who want to wait contract and then itself invests for its existence. ❯❯ until Wednesday, when they can and stores the goods in bulk. consume more, and impatient A bank run in our people, who want to consume on The deposit contract offers a model is caused by a Tuesday. However, people do not higher return than storage and shift in expectations, discover which type of person they a lower return than investment, which could depend are until Tuesday. The decision and allows people to withdraw on almost anything. that people face on Monday is how their goods from the bank on either Douglas Diamond much to store and how much to Tuesday or Wednesday with no invest. The only uncertainty in penalty. Having pooled people’s Philip Dybvig the model is whether these people goods, the bank, knowing the share are patient or impatient. Banks of patient and impatient people, might have a good idea about can then store enough of the good probabilities: in general, 30 percent to cover the needs of impatient of people might prove to be people and invest enough to cover impatient and 70 percent patient. the wants of patient people. In the So it is possible that people will Diamond–Dybvig model this is store and invest amounts that a more efficient solution than people could reach independently

320 BANK RUNS A panicking crowd is held back by police outside a German bank in 1914. The declaration of war had caused pessimism among savers, leading to a number of bank runs. Diamond and Dybvig showed that customers become eager to be at other people think in the same way this property also makes the bank the front of the line. that I have. This itself can cause vulnerable to a run. A run occurs a run on the bank, even if the bank when, on Tuesday, patient people Pessimism can arise out of would otherwise be able to meet its become pessimistic about what concerns about investments, other obligations today and tomorrow. they will receive from the bank on people’s withdrawals, or the bank’s This is an example of what Wednesday, and so withdraw their survival. Crucially, this allows for economists call “multiple deposits on Tuesday. Their actions the possibility of a self-fulfilling equilibrims”—more than one mean that the bank must sell bank run even if the bank is sound. outcome. Here there are two investments at a loss; it will not For instance, suppose that on outcomes: a “good” one in which the have the resources to pay all of its Tuesday I believe that other people bank survives and a “bad” one in patient and impatient customers, are going to withdraw their which it is sunk by a run. Where we and those later in the line will not deposits—I then decide to do so as end up may depend on the people’s receive anything. Knowing this, well because I fear that the bank beliefs and expectations rather than may fail. Then suppose that many the true health of the bank. Preventing bank runs Diamond and Dybvig showed how governments could alleviate the problem of bank runs. Their model was partly a defense of the US’s system of federal deposit insurance, under which the state guarantees the value of all bank deposits up to a specified amount. Introduced in 1933, this system reduced bank failures. In March, 1933, President Franklin D. Roosevelt also declared A modern bank run run began. At 8:30 p.m. on depositors. However, this Thursday, September 13, BBC reassurance did not happen, In September, 2007, the first Television News reported that and a run on personal deposits serious British bank run the UK central bank, the Bank began over the internet that since 1866 took place. Northern of England, would announce evening. Under Britain’s deposit Rock, Britain’s eighth-largest emergency liquidity support insurance program, deposits bank, was a fast-growing the next day. above $3,300 (£2,000) were not mortgage lender. To expand fully insured, and the next day, its business, it had become It emerged later that Mervyn long lines formed outside over-reliant on “wholesale” King, the Governor of the Bank Northern Rock branches. The funding—funding provided of England, had opposed a run ended the following by other institutions—rather rescue offer by Lloyds, another Monday evening after the than personal deposits. When British bank. King had government announced a wholesale financial markets suggested that central bank guarantee for all deposits. froze on August 9, 2007, a support might reassure gradual, unseen wholesale

CONTEMPORARY ECONOMICS 321 By the afternoon of In 1933, President Roosevelt Recent bank crises have usually March 3, scarcely a bank signed an act that guaranteed bank begun with investment losses. deposits. Bank runs were reduced, Banks are forced to sell assets to in the country was but some believe that such deposit reduce their borrowing. This leads open to do business. guarantees increase risk taking. to further falls in asset prices and Franklin D. Roosevelt further losses. A run on deposits threat of a run also provides an follows, which can spread to other a national bank holiday to prevent incentive to the bank to make safe banks to become a panic. If the people from withdrawing their investments. This is one side of whole banking system is affected, savings. Alternatively, the central so-called “moral hazard” (pp.208– it is called a systemic banking bank can act as the “lender of last 09). The other side is that managers crisis. In the 2007–08 crisis, runs resort” to banks. However, there is will take riskier decisions than they occurred despite the system of often uncertainty about what the would if there were no deposit deposit insurance. A large part central bank will do. Deposit insurance. The problem of moral of the recent crisis took place insurance is ideal, because it hazard became apparent in the institutions that are not regulated ensures that patient people will 1980s US savings and loan crisis, as banks, such as hedge funds, but not participate in a bank run. when mortgage lenders were were doing much the same as a allowed to make riskier loans and bank: borrowing for short terms Alternative views deposit insurance was enhanced. and lending for long terms. There are alternative explanations US bank failures rose. for the existence of banks. Some Many countries strengthened focus on banks’ investment role. their deposit insurance policies The bank can gather and keep during the financial crisis that private information about began in 2007–08. This is investments, choosing between understandable, since bank failures good and bad investments, and can have a devastating effect on reflect this private information the real economy, breaking the efficiently through the returns it connection between people with offers to savers. It can offer a savings and people who need to return to depositors that is only invest. The moral hazard argument possible if it carries out its is like fire prevention, in that it is monitoring role well. concerned with protecting the economy from a future crisis. In 1991, US economists Charles However, the midst of a crisis may Calomiris and Charles Kahn not be the time to be talking about published an article that took issue preventative actions. ■ with the Diamond–Dybvig view. They argued that bank runs are Recent crises In the history of modern good for banks. In the absence of It is hard to prove which of these capitalism, crises are the deposit insurance, depositors have two views about bank runs is norm, not the exception. an incentive to keep a close eye on correct, since in practice neither how well their bank performs. The explanation can be isolated. There Nouriel Roubini are many forms of moral hazard in a Stephen Mihm bank. A shareholder may encourage risk taking because all he can lose is his investment. A bank employee, offered bonus incentives, may take risks because all that is at stake is a job. One commonly proposed solution to moral hazard is tougher regulation.

322 IN CONTEXT SAVINGS GLUTS FOCUS ABROAD FUEL Global economy SPECULATION AT HOME KEY THINKER Ben Bernanke (1953– ) GLOBAL SAVINGS IMBALANCES BEFORE 2000 US economists Maurice Obstfeld and Kenneth Rogoff raise concerns about the large US trade deficit. 2008 British historian Niall Ferguson describes a world of crisis because of overuse of credit. AFTER 2009 US economist John B. Taylor argues against the existence of a savings glut. 2011 Economists Claudio Borio of Italy and Piti Disyatat of Thailand argue that it is wrong to think that global imbalances in savings triggered the financial crisis. I n February, 2012, 111 million Americans watched the Superbowl on television. At halftime an advertisement for Chrysler cars was shown. It was to become a national talking point. “It’s halftime in America, too,” said the ad. “People are out of work and they’re hurting… Detroit’s showing us it can be done. This country can’t be knocked down with one punch.” The unashamedly patriotic implication of the ad—to buy Chrysler because it would save American jobs—was in tune with the feeling among many Americans that the US had let economic power slip into foreign, especially

CONTEMPORARY ECONOMICS 323 See also: Financial services 26–29 ■ Economic bubbles 98–99 ■ Market integration 226–31 ■ Financial engineering 262–65 ■ Financial crises 296–301 ■ Housing and the economic cycle 330–31 If one country is importing more than it is exporting (in trade deficit), another country must be exporting more than it is importing (in surplus). The country in deficit must fund its imbalance, while the country in surplus can build up a savings glut. Since the closure of plants such example, by funds from foreign The savings in the as this Chrysler factory in Detroit, the investments or by running country in surplus are US has been running trade deficits, down central bank reserves. borrowed in the country meaning that it has been importing Bernanke pointed out that the in deficit, and this can fuel more than it has been exporting. US deficit rose sharply in the late financial speculation. 1990s, reaching $640 billion, or 5.5 Chinese, hands. It was this type of percent of GDP, in 2004. Domestic Savings gluts feeling that made the explanations investment remained fairly steady abroad fuel of the 2008 global financial crisis at this time, but domestic saving offered by US Federal Reserve dropped from 16.5 percent of GDP speculation at home. chairman Ben Bernanke so widely to 14 percent between 1996 and appealing. He had developed his 2004. If domestic savings fell nor buying things; they were simply argument from 2005 onward, yet investment remained steady, squirreling it away in savings and before the crisis really hit, and his the deficit can only have been currency reserves. Bernanke thesis focused on global imbalances financed using foreign money. highlights a number of reasons in savings and spending. for the global savings glut besides The savings glut Chinese frugality,including the Central to Bernanke’s idea is Bernanke argued that the deficit rising oil prices and the building America’s balance of payments was being funded by a “global up of “war-chests” to guard against (BOP). A country’s BOP is the savings glut”—an accumulation future financial shocks. ❯❯ account of all money transactions of savings in countries other than between that country and the rest the US. For instance the Chinese, of the world. If a country imports who have a huge positive trade more than it exports, its trade surplus with the US, were neither balance is in deficit, but the books putting all their American export must still balance. The shortfall is earnings into investment at home made up in some other way—for

324 GLOBAL SAVINGS IMBALANCES Saving seems, at first sight, a In the 1990s a new financial instrument called a collateralized debt prudent thing to do, a safeguarding obligation (CDO) was invented. High-risk mortgages were combined of the future. However, savings in with low-risk bonds to create the illusion of low-risk debt. These debt the global capitalist world is a obligations were central to the failure of the credit system in 2007–08. mixed blessing. Any money that goes into savings is money lost High-risk loan Low-risk Rating to direct investment or consumer loan granted as spending, but it doesn’t just vanish. if combined Bernanke’s argument is that money debt was from the savings glut overseas low-risk ended up flooding the financial markets of the US. Mortgage High-ranking debt AAA Credit rating An abundance of money All this money damped down those on lower incomes were able parasitic) link between China and interest rates and reduced the to find a foot on the property ladder. the US. The notion appealed to incentive for Americans and Some of the mortgages granted many in American financial circles Europeans to save. With loan to fund this boom—the so-called since it seemed to imply that it was markets apparently awash with “subprime” mortgages in the the frugal Chinese who were to easy money, lenders bent over US—were given to people who blame for the financial crisis. backward to offer deals. To meet could not pay them back. the demand for outlets for the Bernanke is adamant that it foreign cash, America’s financial The crisis was Chinese cash that stoked engineers came up with products In 2008, a cluster of subprime American fires, though he argues such as collateralized debt mortgage failures exposed how that only a small portion went into obligations (CDOs), which packaged massively many financial high-risk assets. In 2011, he said, high-risk mortgages with lower-risk institutions had invested many “China’s current account surpluses debts to make bonds that were times more than the value of their were used almost wholly to given AAA credit ratings, meaning capital. The Lehman Brothers acquire assets in the United that they were rated very low-risk. investment bank collapsed in States, more than 80 percent of Meanwhile, house prices boomed 2008, and many other financial which consisted of very safe in two dozen countries, as even institutions seemed in such great Treasuries and Agencies.” danger of going into meltdown In the longer term the that they had to be rescued by The vanishing glut industrial countries as a government bailout packages in Many economists have challenged group should be running most of the world’s rich countries. Bernanke’s theory. In the financial current account surpluses blog “Naked Capitalism,” Yves The simple thrust of Bernanke’s Smith has suggested that the and lending… to the message seemed to be that the global savings glut is a myth, developing world, not financial crisis all came down to noting that global savings have the other way around. Chinese saving and American stayed almost rock steady since overspending. This was also the the mid-1980s. US economist Ben Bernanke message in Niall Ferguson’s John B. Taylor argues that although Ascent of Money (2008), in which there was increased saving outside he analyzed the credit crunch and the US, the decline in saving focused on the fated “Chimerica” within the US meant that there —the symbiotic (or, as some saw it, was no global gap between

CONTEMPORARY ECONOMICS 325 I don’t think hedge funds, money markets, Ben Bernanke that Chinese ownership and structured investment vehicles. European and American Ben Shalom Bernanke was of US assets is so shadow banks were eager to born and raised in South large as to put our find these securities and found Carolina. In the early 1970s them in Ireland and Spain as well Bernanke went to Harvard country at risk as the US. University and then to the economically. Massachusetts Institute Ben Bernanke The markets played in by these of Technology, where he shadow banks are dominated by received a PhD in economics saving and investment—so derivatives. These are “financial under the supervision of the idea of a world awash with instruments”—bets upon bets Stanley Fischer, future cheap cash is false. as to which way markets will governor of the Bank go, underpinned by ingenious of Israel. Other economists point out that mathematical formulas. The the current account deficits in the charge here is that derivatives Bernanke joined the US US and other countries amounted trading can encourage excessive Federal Reserve in 2002. In to much less than 2 percent of the risk-taking. It also creates a 2004, he proposed the idea money flow, so surely would have market in which financial of the Great Moderation, only a marginal affect. The savings institutions can make massive which suggested that modern glut theory also becomes harder to profits by betting on failures, monetary policies had virtually sustain when applied to Europe. including the failure of eliminated the volatility of the Germany, for instance, in the years mortgage-backed securities. business cycle. In 2006, leading up to the 2008 crisis, was Bernanke was made chairman savings-rich. The savings glut The extra reserves of a savings of the Federal Reserve. His theory would imply that German glut might be irrelevant in this tenure as chairman of the savers took up speculative financial virtual casino. Indeed, the problem Reserve has not been smooth, arrangements in Ireland and Spain seems to have been that the banks and he has been criticized for rather than put their money in were trading without sufficient failing to foresee the financial institutions at home in Germany, cash backup. Bernanke points out crisis and for bailing out Wall which seems highly unlikely. that while Chinese and Middle Street financial institutions. Eastern buyers bought into A “banking glut”? American securities with funds Key works Princeton University economics from trade surpluses and oil professor Hyun Song Shin exports, the European banks had 2002 Deflation: Making Sure has argued that the floods of to borrow money to buy in, leaving It Doesn’t Happen Here speculative money chasing after them exposed when the crisis hit. 2005 The Global Saving mortgage securities came not Glut and the US Current from a savings glut but the Economists differ in their Account Deficit “shadow” banking system— views about the trade imbalances 2007 Global Imbalances the complex variety of financial that underlie the savings glut. entities that fall outside the Some have argued that the US normal banking system, including trade deficit can be sustained, and that it would always be funded easily by foreign savings. Others worry about a hard landing for the US economy if capital flows were to dry up. Much of this has become a political issue between the US and China since US politicians have charged China with keeping its currency unfairly low in order to support its trade surplus. ■

326 MORE EQUAL SOCIETIES GROW FASTER INEQUALITY AND GROWTH IN CONTEXT Wealth is divided For much of the 20th inequitably through society. century economists asked FOCUS themselves how economic Growth and development Those without growth affects people’s incomes. accumulated capital Does growth increase or decrease KEY THINKERS become dissatisfied… income inequality? In 1994, Italian Alberto Alesina (1957– ) economist Alberto Alesina and Dani Rodrik (1957– ) … and call for more Turkish economist Dani Rodrik redistributive policies turned the question on its head. They BEFORE wondered how income distribution 1955 US economist from the government. affects economic growth. Simon Kuznets publishes Economic Growth and Income But redistribution is paid Alesina and Rodrik examined Inequality, which concludes for through higher taxes on two factors in their model: labor that inequality is a side effect and capital (accumulated wealth). of growth. accumulated capital… They argued that economic growth is fueled by growth in total capital, 1989 US economists Kevin … and higher taxes slow but government services are funded Murphy, Andrei Shleifer, and economic growth. by a tax on capital. This means the Robert Vishny claim income higher the taxes on accumulated distribution affects demand. More equal societies wealth, the less incentive there will grow faster. be to accumulate capital, and the AFTER lower the growth rate of the 1996 Italian economist economy will be. Roberto Perrotti claims that there is no link between lower Those whose income derives taxes and higher growth. mostly from accumulated capital prefer a lower tax rate. On the 2007 Spanish economist other hand an individual who Xavier Sala-i-Martin argues has no accumulated wealth, and that growing economies have whose income derives entirely from reduced inequality. his labor, tends to prefer a higher tax rate. This will provide him with public services and allows for a better redistribution of accumulated wealth.

CONTEMPORARY ECONOMICS 327 See also: The tax burden 64–65 ■ The emergence of modern economies 178–79 ■ Social choice theory 214–15 ■ Economic growth theories 224–25 ■ Taxation and economic incentives 270–71 The greater the if the distribution of capital and worldwide—which can help to inequality of wealth accumulated wealth is shared lessen inequality—is due mainly and income, the higher the equally through society, the median to economic growth. On the other rate of taxation, and voter will be relatively rich in hand slower-developing countries, the lower growth. capital and will therefore demand such as many in Africa, have Alberto Alesina a modest tax rate, which will not suffered from decades of little or impede growth. If, however, there no growth. This has hurt living Dani Rodrik are large inequalities in wealth, standards and impeded poverty with much of the accumulated reduction; the poorest lag behind, capital being concentrated in a and inequality persists. ■ small elite, the majority will be poor and will demand a higher tax rate, which would stifle growth. Alesina and Rodrik argue that the more economic equality there is in any society, the higher the growth rate of its economy will be. The tax rate is set by governments, Growth and equality Nordic countries such as Sweden which react to popular concerns. Alesina and Rodrik’s explanation seem to contradict Alesina and Even a dictatorship cannot ignore is not the whole story. Some people Rodrik’s conclusions. They combine the popular will, due to the fear of think that the two economists high tax with high living standards being overthrown. For this reason have misidentified cause and and the world’s smallest equality gap. the tax rate is set with the aim effect. Spanish economist Xavier of pleasing as many people as Sala-i-Martin (1962– ), for instance, possible—that is, the rate preferred claims that economic growth has by the median voter (the person at fueled a diminishing rate of the exact middle of the spectrum income inequality across the of voters’ views). According globe. The World Bank has argued to Alesina and Rodrik’s logic, that the reduction of poverty Alberto Alesina Alberto Alesina was born in 1957, political systems of the US in the northern Italian town of and Europe. He has achieved Broni. He studied economics and wide recognition for drawing society at Boccini University in attention to the influence of Milan, graduating with distinction politics over economic matters. in 1981. He went on to complete his M.A. and PhD in the Key works economics department at Harvard. After completing his studies in 1994 Distributive Politics and 1986, he became a full professor Economic Growth (with Dani at Harvard in 1993 and was Rodrik) chairman of the economics 2003 The Size of Nations (with department from 2003 to 2006. Enrico Spolaore) 2004 Fighting Poverty in the US Alesina has published five and Europe: A World of books. His work straddles politics Difference (with Edward and economics and focuses Glaeser) especially on the economic and

328 EVEN BENEFICIAL ECONOMIC REFORMS CAN FAIL RESISTING ECONOMIC CHANGE IN CONTEXT R eform is designed to kick- growth, it is necessary to remove start an economy and the inefficiencies within the FOCUS benefit a whole population economic system. This can be Economic policy through the transformation of difficult if the country is run by an institutions. One might think that unaccountable political class for its KEY THINKERS reforms that benefit the economy own benefit, as is often the case in Dani Rodrik (1957– ) would be welcomed and carried the developing world. Daron Acemog˘ lu (1967– ) through. However, sometimes there is substantial resistance to reform, Reform and influence BEFORE even from those who might Turkish economists Dani Rodrik 1989 British economist eventually benefit. In order to and Daron Acemog˘ lu have pointed John Williamson uses the “fix” an economy and return it to out that when powerful groups term “Washington Consensus” for the first time (see Reforms are proposed that would box, opposite). benefit the economy. 2000 South African economist … because they wish Powerful elites may resist Nicolas van de Walle to preserve their these changes… documents the failure of IMF-backed “structural control of resources. adjustment” reforms in Africa. They distort the reforms, Even beneficial AFTER which become ineffective or economic reforms 2009 US economists Douglass North, John Wallis, and Barry achieve the opposite of can fail. Weingast propose a new their intended aims. approach to reform based on societies’ responses to the problem of violence. 2011 Reform packages in Europe following the 2008 financial crisis run into opposition.

CONTEMPORARY ECONOMICS 329 See also: Free market economics 54–61 ■ Institutions in economics 206–07 ■ The theory of the second best 220–21 ■ Economic growth theories 224–25 ■ Independent central banks 276–77 ■ Asian Tiger economies 282–87 Policies that work do become in these cases because they tend popular, but the time lag not to address these deeper can be long enough for the political constraints. However, in relationship not to be countries with highly accountable exploitable by… reformers. leaders, the benefits of reforms Dani Rodrik may already have been reaped. For these reasons reforms are most effective in “intermediate countries,” where reforms are likely to have significant and positive results, and at the same time the political elites are not dominant enough to derail them. expect to see their privilege Winners and losers Sani Abacha seized power in Nigeria disappear as a result of economic However, there are also problems in 1994. His corrupt dictatorship was reform, they may use their influence when introducing reform into above the jurisdiction of the courts, to introduce economic policies that intermediate societies. When which allowed his family to appropriate redistribute income or power to economic reform is proposed, it more than $2.2 billion from state funds. themselves. Alternatively, they may is often not clear who the winners distort policies so that measures and losers of the reform will be. proposed but shelved due to lack are not implemented effectively. This discourages people from of popular support, politicians and Acemog˘ lu has argued that this accepting the measures, even economists may later propose it often happens when political elites where there would ultimately be again in the belief that it will are highly unaccountable, so there more winners than losers. There benefit the economy and society. are limited checks and balances on may be a bias toward maintaining However, without new, supportive their actions. Reforms typically fail the status quo; individuals like to information a society may well protect what they already have reject the measure again. On the and minimize the risk of losing out. other hand if beneficial reform is If a beneficial economic reform is implemented despite a lack of popular support and goes on to The Washington Consensus create more winners than losers, it often goes on to gain popular The term Washington liberalization of domestic support and is not repealed. Consensus was first coined and international trade, the in 1989 by British economist introduction of competitive Most attempts at reform focus John Williamson to refer to exchange rates, and balanced on measures designed to change the package of free market fiscal (tax) policies. “formal” institutions such as economic reforms prescribed courts and voting systems. to developing countries in The Washington Consensus Their success depends on whether crisis during the 1980s. was discredited in the 1990s. underlying “informal” institutions Reforms were said to have been and surrounding politics support These policies aimed to implemented with little them. Without this, reforms of move the state-run economies sensitivity to the differing laws and constitutions are of Latin America and post- political constraints evident unlikely to change much. ■ socialist Eastern Europe in such a diverse group of toward the privatized free countries. In Africa, in market. They focused on particular, dynamic markets privatization of state enterprises, raise the poorest out of poverty.

330 THE HOUSING MARKET MIRRORS BOOM AND BUST HOUSING AND THE ECONOMIC CYCLE IN CONTEXT M ovements in the housing A new housing development market are a reflection of expands across farmland in the state of FOCUS “boom and bust” cycles Washington during the boom period of The macroeconomy in the wider economy. These are the early 2000s. Building was fueled by the periods where an economy’s lax mortgage-lending standards. KEY THINKER real output reaches its highest and Charles Goodheart (1936– ) lowest levels during the business and rather than prices adjusting cycle, which moves through periods downward, they can remain stable BEFORE of contraction and expansion, even when the volume of sales falls. 1965 US economist Sherman usually over periods of between Maisel is the first to explore three and seven years. Signs of a recession the effects of residential Although house prices are usually investment on the economy. There are many reasons why resilient, they have been known residential investment is high in to stagnate; the accompanying 2003 US economists Morris periods of economic growth. There decline in residential investment Davis and Jonathan Heathcote are more jobs available, and a is often the first indicator that a conclude that housing prices booming economy leads a greater recession is about to occur. In more are related to the overall state number of people to think about developed countries the housing of the economy. buying their own home. At the market has begun to decline before same time mortgage lenders begin each major recession of the last 50 AFTER to relax their lending requirements, years. The housing market recovers 2007 US economist Edward making buying easier, so more only when consumers are confident Leamer argues that housing houses are sold. As this happens, construction trends are an the rising demand means that early warning of recession. house prices rise. Those who sell are able to pay off large mortgages 2010 US mortgage-lenders in full. House builders continue Fannie Mae and Freddie Mac to invest in further housing stock to are delisted on the New York profit from the higher prices. Stock Exchange after lowering underwriting standards House prices are often relatively during the subprime crisis resilient, meaning that they do (offering mortgages to those not change quickly in response to unable to repay). factors that could influence them. This is one of the reasons housing is seen as such a good investment,

CONTEMPORARY ECONOMICS 331 See also: Boom and bust 78–79 ■ Economic bubbles 98–99 ■ Supply and Irresponsible lending demand 108–13 ■ Testing economic theories 170 ■ Financial crises 296–301 in the housing market As the economy grows, more people feel The economic crash of 2008 confident enough to purchase a house. owed much to the liberalization of the mortgage market and This increased demand leads to a rise in house prices. irresponsible lending by House builders invest in further building. banks. At first, lenders enforced strict requirements Prices reach an unsustainable level on borrowers, lending only to and demand stagnates. those who could cover both the interest and repayments Residential investment is halted, and jobs in associated industries on the base amount that had are lost. House prices stagnate, and the wider economy falters. been lent. However, as the economy improved, mortgages The housing market mirrors boom and bust. were offered to those who could afford to pay only the interest payments. These people were relying on an increase in their income or in the price of their home to pay off the balance of their loan. In the US lenders then began to offer mortgages to people who did not earn enough even to cover the interest payments—these loans could only be serviced with strong growth in house prices and income. When the economy faltered and borrowers began to fail to pay back their loans, the whole economy collapsed. that the value of their houses will and Boris Hofmann showed that During the wave of bank rise. This confidence rises in step there is a correlation between foreclosures that followed the 2008 with an improving economy. As economic performance and housing financial crisis, boarded up homes residential sales begin to return to prices. They claim that by following such as this one in New Jersey a normal level, residential investment appropriate policies in the future, became a common sight. increases, providing jobs and further it should be possible to strongly fueling a return to economic growth. mitigate, or even avoid, the worst effects of a recession. Economists have analyzed the relationship between the housing Unfortunately, this was not the market and the overall economy case with the housing “bubble” and believe that by studying the that burst in the US in 2008. Here, levels of investment in housing, it rapid financial innovations created is possible to accurately forecast instability in mortgage financing recessions and recoveries. In their that led to unwarranted consumer 2006 book Housing Prices and confidence and an unsustainable the Macroeconomy, British boom. The housing market was the economists Charles Goodheart cause of the eventual bust. ■

DIRECTO

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334 DIRECTORY T his book examines some of the most important ideas in economic thought, from its earliest beginnings to the evolution of political economy and the wide-ranging subject as we know it today. In doing so it inevitably looks at the ideas and achievements of major economists such as Adam Smith, John Maynard Keynes, and Friedrich Hayek. However, there are, of course, many other economists who have made important contributions, often in more than one area of study, and who deserve more than a passing mention. The thinkers discussed in the following pages have all played a part in establishing economics as a vital subject in modern industrial society, making sense of complexity, and expanding our understanding of economic activity in the world today. JEAN-BAPTISTE COLBERT opposed the tax system introduced HENRI DE SAINT-SIMON by Jean-Baptiste Colbert. He 1619–1683 believed that production and trade 1760–1825 generated wealth, and proposed Although born into a family of a reform of taxes to encourage Claude Henri de Rouvroy was born merchants in Rheims, France, Jean- freer trade. into a noble family in Paris, France, Baptiste Colbert chose a career in See also: The tax burden 64–65 but rejected his rightful title of politics rather than commerce. He comte because he advocated a form rose to become Finance Minister to YAMAGATA BANTO of socialism. His views were Louis XIV in 1665, and brought in influenced by seeing the new measures to end political corruption. 1748–1821 society created in the US after the He also reformed the tax system, American Revolution. He argued that introduced policies to boost French One of the most respected scholars poverty could be eliminated through industry and encourage overseas of the city of Osaka, Japan, Yamagata cooperation and technological trade, and instituted improvements Banto was also a money-exchange innovation, and that education to the French infrastructure. merchant. Along with others in would remove the greed that drove See also: The tax burden 64–65 the Kaitokudo School of Osaka, people to seek social privilege and he introduced Western ideas of exploit others. His work influenced PIERRE DE BOISGUILBERT rationalism to Japanese institutions, socialist thinkers of the 19th helping to end Japan’s feudal century, notably Karl Marx (p.105). 1646–1714 society, which had until then been See also: Marxist economics built on Confucian ideas. Banto’s 100–05 A French aristocrat, Pierre Le multi-volume Yume no shiro Pesant, sieur de Boisguilbert, (“Instead of Dreams”) was critical FRIEDRICH LIST pursued a career in law. He was a of the old system, which he saw as magistrate, then judge, and in 1690 dominated by the “age of gods,” 1789–1846 became the bailie—the King’s and proposed a rational, scientific representative in charge of approach to the social, political, and Friedrich List started his career administration and justice for the economic structure of modern Japan, as a civil servant in his hometown city of Rouen, a post he held until founded on industry and trade. of Reutlingen, Germany, and rose his death in 1714. Seeing the effect See also: Comparative advantage quickly to high office. However, of tax on the local economy, he 80–85 in 1822 he was imprisoned for his

DIRECTORY 335 views on reform, and escaped to final split from the German FRIEDRICH VON France and then England. He Historical School, which was based WIESER   emigrated to the US, becoming on 19th-century romantic ideals. the US consul in Hamburg and See also: Economic liberalism 1851–1926 then Leipzig. In 1843, he founded 172–77 a newspaper to air his views on a Friedrich von Wieser was born in “National System,” whose expanded LUJO BRENTANO Vienna. Like his brother-in-law customs union could unite all of Eugen von Böhm-Bawerk, he Germany. Ill health and financial 1844–1931 originally studied law but switched problems dogged his final years, to economics after reading Carl and he committed suicide in 1846. Born in Bavaria, Germany, Lujo Menger’s work. After working for See also: Comparative advantage Brentano earned doctorates in both some years as a civil servant, in 80–85 law and economics. In 1868, he 1903 he succeeded Menger as made a trip to Britain with the professor in Vienna. His first major JOSEPH BERTRAND statistician Ernst Engel (p.125) to contribution was in value theory, in study trade unionism, and his ideas which he was influenced by Léon 1822–1900 were influenced by the experience. Walras (p.120) and Vilfredo Pareto A member of the German Historical (p.131), and he is credited with The son of a French writer of School, Brentano nonetheless coining the term “marginal utility” popular science, Joseph Bertrand challenged many of its theories, (the satisfaction gained from each showed a precocious aptitude for arguing for social reform, human additional unit). He then turned his mathematics from an early age. rights, and state responsibility for attention to applying economic In 1856, he became a professor at public welfare. His influence was theory to sociology, devising the the École Polytechnique in Paris. particularly evident in the formation important theory of social economy He made his name in the fields of of the social market economies. and its idea of opportunity cost. number theory and probability, See also: The social market See also: Opportunity cost 133 and opposed the theory of oligopoly economy 222–23 described by his compatriot THORSTEIN VEBLEN Antoine Augustin Cournot (p.91), EUGEN VON BÖHM-BAWERK proposing instead an alternative 1857–1929 model of price competition. 1851–1914 See also: Effects of limited Famous as a maverick among US competition 90–91 A founder of the Austrian School of economists, Thorstein Veblen was economics, Eugen von Böhm- the son of Norwegian immigrants CARL MENGER Bawerk was born in Brünn, Austria who lived on a farm in Minnesota. (now in the Czech Republic). He His unconventional background 1840–1921 studied law at the University gave him an outsider’s view of US of Vienna and had a successful society, which led him to reject the One of the founders of the Austrian academic and political career, conventional wisdom of his teachers. School of economics, Carl Menger twice serving as Minister of He developed a new institutionalist was born in Galicia, now in Poland. Finance in the 1890s, during which approach that combined sociology His Principles of Economics (1871) he was able to put his frugal and economics. In 1899, he published outlined his theory of marginality budget-balancing ideas into The Theory of the Leisure Class, (goods derive their value from the practice. His critiques of Marxist which introduced the idea of worth of each additional unit), which economics and theories of interest “conspicuous consumption” became key to the Austrian School’s and capital were highly influential, and criticized the inefficiency and thinking. While professor of especially on his students Joseph corruption of the capitalist system economics at the University of Schumpeter (p.149) and Ludwig and its “parasitic” business class. Vienna, he wrote the Method of the von Mises (p.147). See also: Conspicuous Social Sciences, which marked the See also: Central planning 142–47 consumption 136

336 DIRECTORY ARTHUR PIGOU mathematics and statistics in laid the foundations for the new economics. He coined the terms field of econometrics. He worked 1877–1959 econometrics, microeconomics, and as an adviser to the League of macroeconomics. He initially Nations and the Dutch Central Born in Ryde, Isle of Wight, Arthur trained as a goldsmith, intending to Bureau of Statistics, where, Pigou studied history at Cambridge join the family firm, but then studied in 1936, he developed a new University, UK, where he developed economics and mathematics in national macroeconomic model. an interest in economics and met France and England. In 1932, he It was later adopted by Alfred Marshall (p.110). After founded the Oslo Institute of other governments. graduating, Pigou lectured at Economics, and in 1969 he became See also: Testing economic Cambridge until the outbreak of the first recipient of the Nobel Prize theories 170 World War I, taking over Marshall’s in Economic Sciences with his professorship in political economy colleague Jan Tinbergen. RICHARD KAHN in 1908. He is best known for the See also: Testing economic “Pigouvian taxes” he devised to theories 170 1905–1989 offset externalities (costs or benefits that “spill over” onto third parties). PAUL ROSENSTEIN-RODAN Richard Ferdinand Kahn was born See also: External costs 137 in London to German parents and 1902–85 gained a degree in physics at NIKOLAI DMITRIYEVICH Cambridge University, UK, before KONDRATIEV   Born into a Polish-Jewish family in switching to economics, obtaining Austrian-ruled Kraków, Rosenstein- an honors degree in one year under 1892–1938 Rodan began as a member of the the supervision of John Maynard Austrian School of economists. In Keynes (p.161). At the age of 25 Brought up in a peasant family 1930, he fled anti-Semitism in his he made his name with an article near Kostroma, Russia, Nikolai homeland for London, where he describing the multiplier, Kondratiev studied economics at lectured at the London School of a building block of Keynesian the University of St. Petersburg, Economics. In the 1940s his economics. A practical economist, then worked for the government. interest moved to development he advised the British government When Tsar Nicholas II was ousted economics, and he proposed what during World War II before returning in 1917, Kondratiev was a member came to be known as the “Big to Cambridge University, where he of the Revolutionary Socialist Party Push” theory. After World War II he taught until his retirement in 1972. and was made Minister of Supply. moved to the US, working for the See also: The Keynesian A month later, the provisional World Bank and as an adviser to Multiplier 164–65 government was overthrown and the governments of India, Italy, Kondratiev returned to academic Chile, and Venezuela. RAGNAR NURKSE life. He developed a theory of 50- See also: Development economics to 60-year cycles in capitalist 188–93 1907–1959 economies, now known as Kondratiev waves. In 1930, his ideas JAN TINBERGEN Born in Käru, Estonia (then part of fell out of favor. He was arrested, the Russian Empire), Ragnar Nurkse and executed eight years later. 1903–1994 studied law and economics at the See also: Boom and bust 78–79 University of Tartu. He continued Joint winner of the first Nobel Prize his studies in Scotland and then RAGNAR FRISCH in Economic Sciences with Ragnar Vienna. In 1934, Nurkse began Frisch in 1969, Dutch theorist Jan working as a financial analyst for the 1895–1973 Tinbergen initially studied League of Nations, which influenced mathematics and physics, then his interest in international and Born in Christiana, Norway, Ragnar began to apply scientific principles development economics. After Frisch was a pioneer in the use of to economic theory and, in so doing, World War II he moved to the US,

DIRECTORY 337 teaching at Columbia and Princeton the field of information economics. Hand, won the Pulitzer Prize. universities. With Paul Rosenstein- In 1982, he won the Nobel Prize. The book described the rise of Rodan (p.336) he established the See also: Searching and matching large-scale corporations as a modern field of development 304–05 “second industrial revolution.” economics, and was an advocate See also: Economies of scale 132 of the “Big Push” theory. JAMES TOBIN See also: Development economics ROBERT LUCAS 188–93 1918–2002 1937– JOHN KENNETH James Tobin was born in Illinois and GALBRAITH   is popularly known today for the One of the most influential so-called “Tobin tax” that he economists of the Chicago School 1908–2006 devised to discourage speculation of economics, Robert Lucas is also in currency transactions. Tobin is one of the founders of new classical Born in Ontario, Canada, John better known to economists as an macroeconomics. He studied at Kenneth Galbraith studied economics advocate of Keynesian economics Chicago University and has been in Canada and the US. He later and for his academic work on a professor there since 1974. taught at Cambridge University, UK, investment and fiscal (tax) policy. He overturned Keynesian ideas, where he was greatly influenced by Tobin went to Harvard University and his research into rational John Maynard Keynes (p.161). in 1935, where he met John expectations (the idea that because During World War II he was deputy Maynard Keynes. In 1950, he people make well-informed, rational head of the US government Office took up a teaching post at Yale, decisions, their actions can alter of Price Administration, but his remaining there for the rest of his the intended course of government advocacy of permanent price life. As a consultant to the Kennedy policy) influenced monetary policy controls led to his resignation in administration he helped to shape during the 1980s. 1943. He worked as a journalist, US economic policy throughout the See also: Rational expectations academic, and economic adviser 1960s, and in 1981 he won the 244–47 to President John F. Kennedy and Nobel Prize. gained a popular readership in 1958 See also: Depressions and EUGENE FAMA with his book The Affluent Society. unemployment 154–61 ■ The See also: Conspicuous Keynesian multiplier 164–65 1939– consumption 136 ALFRED CHANDLER A third-generation Italian-American, GEORGE STIGLER Eugene Fama was the first in his 1918–2007 family to go to college. He initially 1911–91 studied French but became Born in Delaware, Alfred Chandler fascinated by economics. He was Greatly influenced by Frank Knight graduated from Harvard University awarded a scholarship to study for (p.163), his PhD supervisor at in 1940. After serving in the US a PhD at the University of Chicago, Chicago University, George Stigler Navy in World War II he wrote where he has taught ever since. went on to become a leading his PhD thesis on management He is best known as the originator member of the Chicago School of structures, based on documents of the efficient market hypothesis, economists, working with his left to him by his great-grandfather, which says that in any market friend and contemporary Milton the financial analyst Henry with many, well-informed traders, Friedman (p.199). Known for his Varnum Poor. From the 1960s on the price reflects all the available research into the history of he focused his attention on information. He is also known economic thought, he also worked managerial strategy and the for demonstrating the correlation in the field of public choice theory organization of large corporations. between market efficiency (analysis of government behavior), He wrote a large number of books, and equilibrium. and was one of the first to explore and his 1977 work, The Visible See also: Efficient markets 272

338 DIRECTORY KENNETH BINMORE theory of migration in developing (how information affects an countries and set out what became economy) and the idea of “signaling” 1940– known as the Todaro paradox. information indirectly (such as He worked for the Rockefeller when a job hunter “signals” his or British academic Kenneth Binmore Foundation in Africa and the her ability for a certain job through is a mathematician, economist, Population Council in New York academic qualifications). In 2001 and game theorist. His work has before taking up a permanent he won the Nobel Prize with pioneered the integration of professorship at New York University. George Akerlof (p.275) and Joseph traditional economics with new See also: Development economics Stiglitz for his work on asymmetric mathematical techniques and 188–93 (unbalanced) information in markets. the use of experiments. He has See also: Market uncertainty developed theories of bargaining ROBERT AXELROD 274–75 behavior and theories in the field of evolutionary game theory. 1943– JOSEPH STIGLITZ See also: Competition and cooperation 273 US economist and political scientist 1943– Robert Axelrod has taught for most PETER DIAMOND of his career at the University of One of the most influential (often Michigan, which he joined in 1974. controversial) economists of his 1940– He is best known for his contribution generation, Joseph Stiglitz was born to the theories of cooperation and in Indiana to a family that he says US economist Peter Diamond complexity. His exploration of the “liked to debate political issues.” graduated in mathematics from “Prisoner’s dilemma” in his book He has held professorships at Yale University, then studied The Evolution of Cooperation (1984) several prestigious universities in economics at the Massachusetts showed that a “tit for tat” strategy the US and the UK, served as an Institute of Technology (MIT), could generate cooperative behavior adviser to Presidents Clinton and where he has taught for most of in hostile and friendly situations. Obama, and was Chief Economist his career. He is best known for his Axelrod has advised the United for the World Bank. He made his research into social insurance and Nations, World Bank, and the US name in the 1970s for his work on has acted as a government adviser Department of Defense on promoting the economics of information (how on Social Security policy. His later cooperation between countries. information affects an economy), for work on search and matching See also: Competition and which he was a joint winner of the theory in the labor market led to cooperation 273 2001 Nobel Prize. In the 1990s he him sharing the 2010 Nobel Prize was a critic of the Washington with Dale Mortensen and MICHAEL SPENCE Consensus (p.329), especially as Christopher Pissarides (p.339). applied to developing countries. See also: Searching and matching 1943– See also: Incentives and wages 302 304–05 Michael Spence’s father was based ALICE AMSDEN MICHAEL TODARO in Ottawa during World War II, and although actually born in New 1943–2012 1942– Jersey, Spence was brought up in Canada. He studied philosophy at Described as a “fearless” economist, US economist Michael Todaro Princeton University, but then Alice Amsden focused on the graduated from Haverford College switched to economics for his PhD development and industrialization in Pennsylvania, then spent a year at Harvard University. He has spent of emerging economies. A graduate in Africa with his mentor, Professor most of his career teaching at the of Cornell University, she studied Philip Bell, which inspired a passion universities of Harvard and for her PhD at the London School for development economics. His 1967 Stanford. His work has focused of Economics, and then worked PhD thesis formed the basis of a mainly on information economics at the World Bank and the

DIRECTORY 339 Organization for Economic 1990s he developed a model of job HA-JOON CHANG Cooperation and Development creation and destruction with Dale (OECD), while also holding high- Mortensen. He and Mortensen, 1963– level academic posts. In 2009, she along with Peter Diamond, were was appointed to a three-year seat awarded the 2010 Nobel Prize for Born in South Korea, Ha-Joon on the United Nations. She is their analysis of markets. Chang is a leading critic of especially remembered for her See also: Searching and matching mainstream economics. He challenges to conventional ideas 304–05 graduated from the National of globalization, through books such University in Seoul before moving as The Rise of “The Rest” (2001). PAUL KRUGMAN to the UK to gain a PhD from the See also: Asian Tiger economies University of Cambridge, where he 282–87 1953– continues his research. Chang has acted as a consultant to several ROBERT BARRO Winner of the Nobel Prize in 2008 United Nations agencies, the for his analysis of trade patterns, World Bank, the Asian Development 1944– US economist Paul Krugman is Bank, and a number of national known for his pioneering work in government agencies and NGOs. US economist Robert Barro originally international trade and finance, and He criticizes conventional studied physics, but then switched for his analysis of currency crises development policies as espoused to economics at the PhD level. He and fiscal (tax) policy. He has held by the World Bank, and his book, has taught at many universities in many university teaching posts 23 Things They Don’t Tell You the US and is honorary dean of the and worked as an economic adviser About Capitalism (2010) helped China Economics Academy at to the Reagan administration to popularize aspects of the Central University of Beijing. during the 1980s but is considered alternative economics. Barro was a leading figure in the Left-leaning, politically. In the 1990s See also: Asian Tiger economies formation of the new classical he developed an approach to the 282–87 macroeconomics and first drew analysis of international trade that attention in 1974 with his theories is now known as new trade theory. RENAUD GAUCHER on the effect of present borrowing See also: Trade and geography 312 and future taxation. His later work 1976– has focused on the influence of DANI RODRIK culture on political economy. A graduate in psychology, See also: Borrowing and debt 1957– history, and geography as well as 76–77 economics, French thinker Renaud Born in Istanbul, Turkey, Dani Gaucher has sought to integrate CHRISTOPHER PISSARIDES Rodrik moved to the US for his elements of the social sciences into university studies. Now Professor economic thinking and take a more 1948– of International Political Economy holistic approach. He has examined at Harvard University, his main fields the psychology of money and Born in the Greek-Cypriot village of interest are international and behavioral economics from of Agros, Christopher Pissarides development economics. He has the point of view of positive studied for a degree in economics worked as a consultant for many psychology, with an emphasis at the University of Essex, UK. He international organizations, on the “economics of happiness,” then earned a PhD at the London including the Centre for Economic following the research of School of Economics in 1973, where Policy Research, the Center for economists such as Richard he has been on the staff since 1976. Global Development, and the Easterlin, and considering its place His most significant contribution Institute for International Economics. in policies for development and has been in the field of searching See also: Market integration climate change. and matching theory in the labor 226–31 ■ Resisting economic See also: The economics of market, and unemployment. In the change 328–29 happiness 216–19

340 GLOSSARY Absolute advantage The ability Bond An interest-bearing form of Cartel A group of firms that agree of a country to produce a product loan used to raise capital. Bonds to cooperate in such a way that more efficiently than another. are issued as certificates by the the output of a particular good is bond issuer (such as a government restricted, and prices are driven up. Aggregate The total amount; or firm) in return for a sum of money; for instance, aggregate demand the bond issuer agrees to repay the Central bank An institution that is the total demand for goods and borrowed sum plus interest at a manages a country’s currency, services in an economy. fixed date in the future. alters money supply, and sets interest rates. It may also act as Asymmetric information An Bretton Woods system A system a lender of last resort to banks. imbalance of information; for of exchange rates agreed upon instance, buyers and sellers may between the world’s major industrial Central planning A system have more or less information nations in 1945. It tied the value of of centralized government about the product than each other. the US dollar to gold, and the value control of an economy, where of other currencies to the US dollar. decisions regarding production Austrian School A school of and allocation of goods are made economics founded by Carl Menger Budget A financial plan that lists by government committees. in the late 19th century. It attributes all planned expenses and incomes. all economic activity to the actions Chaos theory A branch of and free choice of individuals and Budget constraint The limit mathematics that shows how small opposes all forms of government on the goods and services that changes in initial conditions can intervention in an economy. a person can afford. cause larger effects later on. Balance of trade The difference Bull market A period when Chicago School An avidly free in value of a country’s imports and the value of shares or other market group of economists—linked exports over a given time period. commodities increase. to the University of Chicago—whose ideals of market liberalization and Bankruptcy A legal declaration Business cycle An economy- deregulation became mainstream that an individual or a firm cannot wide fluctuation in growth that in the 1980s. repay their debts. is characterized by periods of expansion (boom) and periods Classical economics An early Barter system A system of of contraction (bust). approach to economics developed exchange in which goods or services by Adam Smith and David Ricardo, are exchanged for one another Capital The money and physical focusing on the growth of nations directly without the use of a medium assets (such as machines and and free markets. of exchange, such as money. infrastructure) used to produce an income. A key ingredient of Collusion An agreement between Bear market A period of economic activity, along with land, two or more firms not to compete decline in the value of shares labor, and enterprise. so they can fix prices. or other commodities. Capitalism An economic system in Command economy An economy Behavioral economics A branch which the means of production are in which all aspects of economic of economics that studies the effects privately owned, firms compete to activity are controlled by a central of psychological and social factors sell goods for a profit, and workers authority, such as the state. Also on decision making. exchange their labor for a wage. called a planned economy.

GLOSSARY 341 Commodity A general term for Deflation is associated with periods to another (such as price). Prices of any product or service that can of economic stagnation. products may be elastic or inelastic. be traded. Often used in economics to refer to raw materials that are Demand The amount of goods and Entrepreneur A person who always of approximately the same services that a person or group of undertakes commercial risk in quality and can be bought in bulk. people are willing and able to buy. the hope of making a profit. Communism A Marxist economic Demand curve A graph showing Equilibrium A state of balance system in which property and the amount of a product or service within a system. In economics, the means of production are that will be bought at different prices. markets are in equilibrium when collectively owned. supply equals demand. Dependency theory The idea that Comparative advantage The resources and wealth flow from poor Eurozone Countries within the ability of a country to produce a countries to rich countries in such European Union that have formed product relatively more efficiently a way that the poor countries are a monetary union. They all use than another country, even if the unable to develop. the same currency, the euro, and other country is more efficient overall. monetary policy is controlled by Depreciation A decrease in the the European Central Bank. Competition Competition arises value of an asset over time, caused when two or more producers by wear and tear or obsolescence. Exchange rate The ratio at attempt to win the business of a which one currency can be buyer by offering the best terms. Depression A severe, long-term exchanged for another. An exchange decline in economic activity in rate is the price of a currency in Consumption The value of goods which output slumps, unemployment terms of other currencies. or services purchased. Individual rises, and credit is scarce. buying acts are aggregated by Externality A cost or benefit from governments to calculate a figure Diminishing marginal returns any economic activity that is felt by for national consumption. A situation in which each extra unit a person not directly involved in that of something produces successively activity and is not reflected in price. Credit crunch A sudden reduction smaller benefits. in the availability of credit in a Factors of production The inputs banking system. A credit crunch Duopoly A situation in which used to make products or services: often occurs after a period in which two firms have control over a market. land, labor, capital, and enterprise. credit is widely available. Economic liberalism An ideology Fiat money A form of money Debt A promise made by one party claiming that the greatest good is that is not backed by a physical (the debtor) to another (the creditor) achieved when people are given commodity such as gold, but gains to pay back a loan. the maximum personal freedom to its value from the confidence people make choices over consumption. have in it. The world’s main Default The failure to repay a loan Economic liberalism advocates a currencies are fiat money. under the terms agreed. free market economy. Fiscal policy A government’s Deficit An imbalance. A trade Economy The total system of plans for taxes and spending. deficit is an excess of imports economic activity in a particular over exports; a government budget country or area, comprising all the Free market economy An deficit is an excess of spending over production, labor, trade, and economy in which decisions about tax revenues. consumption that take place. production are made by private individuals and companies on the Deflation A fall in the price of Elasticity The sensitivity of one basis of supply and demand, and goods and services over time. economic variable (such as demand) prices are determined by the market.

342 GLOSSARY Free trade The import and export Hyperinflation A very high rate to describe markets free from of goods and services without tariffs of inflation. government intervention. or quotas being imposed. Inflation A situation in which the Liquidity The ease with which an Game theory The study of strategic prices of goods and services in an asset can be used to buy something decision making by interacting economy are rising. without this causing a reduction individuals or firms. in the asset’s value. Cash is the Interest rate The price of most liquid asset since it can be GDP See gross domestic product. borrowing money. The interest rate used immediately to buy goods or on a loan is generally stated as a services, with no effect on its value. Globalization The free flow of percentage of the amount per year money, goods, or people across that must be repaid in addition to Macroeconomics The study of international borders; increased the sum borrowed. the economy as a whole, looking economic interdependence between at economy-wide factors such as countries through the integration of International Monetary Fund interest rates, inflation, growth, goods, labor, and capital markets. (IMF) An international organization and unemployment. set up in 1944 to supervise the GNP See gross national product. post-war exchange rate system, Marginal cost The increase in later moving into the provision of total costs caused by producing Gold standard A monetary system finance to poor countries. one more unit of output. in which a currency is backed by a reserve of gold and can theoretically Inverse relationship A situation Marginal utility The change in be exchanged on demand for a in which one variable decreases as total utility, or satisfaction, that quantity of gold. No country another increases. results from the consumption of one currently uses the gold standard. more unit of a product or service. Investment An injection of Good Something that satisfies the capital aimed at increasing future Market failure Where a market desire or requirement of a consumer; production, such as a new machine fails to deliver socially optimal normally used to refer to a product or training for the workforce. outcomes. Market failure may be or raw material. due to lack of competition (such as Invisible hand Adam Smith’s idea a monopoly), incomplete information, Great Depression A period of that as individuals pursue their own unaccounted costs and benefits worldwide economic recession from interests in the market, it leads (externalities), or lack of potential 1929 to the mid-1930s. It started in inevitably to the collective benefit private profit (as with public goods). the US with the Wall Street Crash. of society, as if there were some guiding “invisible hand.” Mercantilism A doctrine that Gross domestic product (GDP) dominated Western European A measure of national income Keynesian Multiplier The theory economics during the 16th and over the course of a year. GDP is that an increase in government 18th centuries. It stressed the calculated by adding up a country’s spending in an economy produces importance of government control entire annual output, and it is often an even greater increase in income. over foreign trade to maintain a used to measure a country’s positive balance of trade. economic activity and wealth. Keynesianism A school of economic thought based on the Microeconomics The study of Gross national product (GNP) ideas of John Maynard Keynes, the economic behavior of The total value of all goods and advocating government spending individuals and firms. services produced in one year by to pull economies out of recession. domestic-owned businesses, Mixed economy An economy whether those businesses operate Laissez-faire A French term in which part of the means of within the country or abroad. meaning “let it do,” which is used production is owned by the state

GLOSSARY 343 and part of it is owned privately, danger that firms may form cartels Shares Units of ownership in a combining aspects of planned to fix prices. company; also known as equities. economies and market economies. Strictly speaking, nearly all Pareto efficiency A situation in Social market The economic economies are mixed economies, which no change can be made model developed in West Germany but the balance can vary widely. in the allocation of goods to make following World War II, characterized someone better off without making by a mixed economy in which Monetarism A school of economic somebody else worse off. Named private enterprise is encouraged, thought that believes that the after Vilfredo Pareto. but government intervenes in the primary role of government is to economy to ensure social justice. control the money supply. It is Perfect competition An idealized associated with US economist situation in which buyers and sellers Stagflation A period of high Milton Friedman and conservative have complete information and there inflation, high unemployment, governments of the 1970s and 80s. are so many different firms producing and low growth. the same product that no individual Monetary policy Government seller can influence the price. Sticky wages Wages that are policies aimed at changing the slow to change in response to money supply or interest rates in Phillips curve A mathematical market conditions. order to stimulate or slow down graph illustrating the supposed the economy. inverse relationship between Supply The amount of a product inflation and unemployment. that is available to buy. Monopoly A market in which there is only one firm. Monopoly firms Planned economy Supply curve A graph showing generally produce a low output, See Command economy. the amount of a product or which they then sell at a high price. service that sellers will produce Price The quantity of payment, at different prices. Neoclassical economics The in money or goods, given by a dominant approach to economics buyer to a seller in return for a Surplus An imbalance. A trade today. It is based around supply good or service. surplus is an excess of exports over and demand and rational imports; a government budget individuals, and is often couched Protectionism An economic policy surplus is an excess of tax revenues in mathematical terms. aimed at restricting international over spending. trade, in which a country imposes New classical macroeconomics tariffs or quotas on imports. Tariff A tax imposed on imports, A school of thought within often to protect domestic producers macroeconomics that uses forms Public good Goods or services, from foreign competition. of analyses that are based entirely such as street lighting, that will not on a neoclassical framework. be provided by private firms. Tax A charge imposed on firms and individuals by governments. Its Nominal value The cash value Quantitative easing The injection payment is enforced by law. of something, expressed in the of new money into an economy by a money of the day. Nominal prices central bank. Utilitarianism A philosophy that or wages change due to inflation, claims that choices should be made so cannot be usefully compared Real value The value of something so happiness will increase for the across different time periods (a wage measured in terms of the amount of greatest number of people. of $50 would not buy the same goods or services they can buy. amount of goods in 1980 and 2000). Utility A unit used to measure Recession A period during the satisfaction, or happiness, Oligopoly An industry with only a which an economy’s total gained from consuming a product few firms. In an oligopoly there is a output decreases. or service.

344 INDEX Numbers in bold refer B BRIC nations 261 to a person's main entry. Brickman, Phillip 218 Bachelier, Louis 262 Britain 51, 105, 179, 184, 186, 202, A Bagehot, Walter 26 balance of payments 19, 252–53, 262, 323 223, 285, 320 Acemog˘ lu, Daron 206, 207, Banik, Dan 256 British School 147 328–29 banks 26–29, 152, 299, 331 bubbles 18, 38, 88, 98–99, 272, 300 bull and bear markets 79 Adenauer, Konrad 184, 222 banking crises 28, 174, 177, 209, Burke, Edmund 51 Africa 314, 328, 329 233, 293, 300–01 Bush, George W. 270 Aghion, Philippe 232 business cycles 51, 78, 153, 298 agriculture 39, 60, 128, 152, central banks 33, 260, 276–77, 320 butterfly effect 278 runs on 316–21 178 Banto, Yamagata 334 C derivatives 263–64 Barone, Enrico 144, 174 physiocrats on 19, 42–44, 62, 65 Barro, Robert 76, 77, 164, 276, 339 Cagan, Philip 244 Akerlof, George 156, 275, 302 barter 18, 24, 25, 75, 166 Cairnes, John Elliott 126, 128 information economics 61, 208, 260 Bauer, Peter 190 Calomiris, Charles 321 Baumol, William 94, 96 Campbell, Donald 218 275–75, 281 Becher, Johann 90 Cantillon, Richard 42, 56 Alesina, Alberto 261, 326–27 Becker, Gary 52, 53, 171 Cantoni, Davide 138 Al-Ghazali 67 behavioral economics 53, 194, 195, capital 59–60, 230 Allais, Maurice 120, 195 Capital Asset Pricing Model 248, 260, 261, 272 (CAPM) 262 on decision making 184, 185, irrationality 61, 266–69 capitalism 20, 51, 88, 89 195 Bentham, Jeremy 51, 214 Berle, Adolf 152, 168–69 Marx and 102–05, 107, 261 and utility theory 114, 162, 266 Bernanke, Ben 322–25 cartels 70–73, 88 Amsden, Alice 261, 284, 285, Bernoulli, Daniel 63, 162 central banks 33, 260, 276–77, 320 Bertrand, Joseph 91, 335 Chamberlin, Edward 180 338 Beveridge, William 304 Chandler, Alfred 132, 337 antitrust laws 70, 73, 97 bills of exchange 18, 28 Chang, Ha-Joon 339 Aquinas, Thomas 18, 20, 23 Binmore, Kenneth 283, 338 chaos theory 261, 278, 279 Ariely, Dan 266 Black, Fischer 262, 264 Chenery, Hollis 178 Aristotle 18, 21, 22, 62, 94, 114 Bodin, Jean 30–32 Cheung, James 137 Arkwright, Richard 50 Böhm, Franz 222 Chicago School 185, 260 Arrhenius, Svante 306 Böhm-Bawerk, Eugen von 63, 106, Child, Josiah 19, 38 Arrow, Kenneth 185, 209, 232 Chile 201, 260 147, 335 China 85, 105, 184, 185, 223, 243, on equilibrium 120, 123, 212–13 Boisguilbert, Pierre de 37, 42, 57, 334 on free markets 56, 60, 130, Bolton, Patrick 232 287, 323–25 boom and bust 78–79, 330–31 Christensen, Clayton M. 148, 149 220 Booth, Charles 140 Clark, Colin 36, 178 general possibility 184, 214–15 Borda, Jean-Charles de 214 classical economics 50–51, 88 on market information 208–09, Borio, Claudio 322 climate change 261, 306–09 borrowing and debt 76–77 Coase, Ronald 137 281 Brentano, Lujo 335 coins 18, 24, 25 Arthur, Brian 278 Bresnahan, Timothy 313 Colbert, Jean-Baptiste 334 Asian Tigers 85, 243, 261, 282–87 Bretton Woods 153, 184, 187, 231, Atkinson, Anthony 64 auction theory 294–95 252, 262, 290 Austrian School 60, 88, 89, 97, 146–47 153, 174–77 Axelrod, Robert 273, 338

INDEX 345 Cold War 185, 236, 238, 239 debt 76–77, 298–301 economic cooperation 186–87 Coleman, James 280 relief 261, 314–15 economic liberalism 172–77 collateralized debt obligations economic reform 328–29 (CDOs) 265, 299, 324 decision making 185, 273 economics, definition of 152, 171 collective bargaining 134–35, 160 game theory 234–41 economies of scale 27, 132, 213 collusion 70–73 irrationality 194–95, 266–69 Edgeworth, Francis 116, 117, 120 Commons, John 206 paradoxes 184, 248–49 communication technology 185, 313 Edgeworth box 212 communism 46, 75, 88, 152, 185, 223 DeLong, Brad 224 education 281 De Malynes, Gerard 34, 35 efficiency 56, 59, 144, 232 collapse of 57–58 demand 74–75 Marxism 102–05 market 185, 210–13, 272–73 planning 102, 105, 153, 174–75, elasticity of 124–25 Pareto 89, 130–31, 212–13 law of 112 tax 64, 65 176, 184, 232–33 supply and 51, 88, 89, 108–13, 121–22 wage models 160, 161, 302 companies, see firms democracy 176, 231 elasticity 64, 124–25 comparative advantage 80–85, 312 demographics 68–69 Ellsberg, Daniel 162, 249 competition 70, 79, 104, 126–29 Deng Xiaoping 222, 223 employment 202–03, 276 Denison, Edward 178 Engel, Ernst 124–25 and cooperation 273 depression 152, 154–61, 164, 298 entitlement theory 256–57 free market 58 see also Great Depression entrepreneurs 89, 149 limited 90, 91 deregulation 260, 264, 293 equilibrium 56, 58, 88, 144, 278, 294 and monopoly 94–97 derivatives trading 263–64, 325 general 60, 88, 113, 118–23, 210, perfect 88, 90, 126–29 devaluation 292–93 complexity theory 261, 278–79 developing countries 85, 141, 185, 212–13 computers 123, 313 Nash 237, 239, 240, 241 Condorcet, Nicolas de 68, 215 219, 230, 261, 293, 309 partial 111, 112–13, 123 consumption 42, 58, 198–200, 204–05 development economics 153, 185, Eucken, Walter 222 conspicuous 89, 117, 136 Europe 76, 85, 135, 185, 223, 260, convergence 224–25 188–93, 261 cooperation 237, 241, 273 dependency theory 185, 242–43 315, 325 Cootner, Paul 272 UN Development Index 310 euro 209, 254–55, 290 Corn Laws 82–83 developmental state 284–87 European Monetary System (EMS) 292 corporate governance 168–69 Devereux, Stephen 256 Evans, Peter 287 Cournot, Antoine Augustin 70, 88, Diamond, Douglas 318–21 exchange rates 185, 250–55, 262 Diamond, Peter 304, 305, 338 currency crises 290–93 90–91, 94, 238 DiLorenzo, Thomas 97 derivatives 263–64 Crafts, Nicholas 313 diminishing returns 62, 68, 224 expectations: adaptive 244–45, 246 creative destruction 148–49 Disyatat, Piti 322 rational 60, 198, 201, 244–47, 276, 303 credit default swaps 299 Dollar, David 85, 228 expected utility 194–95, 248, 266 culture 153, 166–67 Domar, Evsey 224 externalities 137, 213, 308 currencies 250–55 dot.com bubble 79, 99, 272 Dresher, Melvin 238–39 F crises 261, 288–93 Dunoyer, Charles 78 debasement 30, 290 Duns Scotus 110 devaluation 292–93 Dupuit, Jules 126, 180, 181 unions 252–55 Dybvig, Philip 318–21 D E fairness 64, 65, 131, 215 Fama, Eugene 168, 185, 272, 337 Darwin, Charles 273 East Asia 187, 230, 282–87 famine 256–57 Davis, Morris 330 East India Company 18, 35, 38, 168 Ferber, Marianne 310 Debreu, Gérard 211, 232 Easterlin, Richard 216, 217–18 Ferguson, Niall 322, 324 Easterly, William 315 Field, John 280 equilibrium model 120, 123, 212 Eastern Europe 185, 193, 232, 329 financial crises 51, 79, 104, 296–301 on free markets 56, 60, 130, 220 econometrics 152, 153, 170 on market efficiency 210–13 2007–08 28, 136, 177, 213, 261, 262, 272, 320, 321, 322–24, 331 currency crises 255, 288–93 East Asian (1997) 187, 230, 292–93

346 INDEX financial engineering 260, 262–65 GATT 184, 187, 231 happiness 107, 130, 216–19 financial instability 26, 260, 261, Gaucher, Renaud 339 Hardin, Garrett 68 gender 261, 310–11 Harrod, Roy 224 296–301 George, Henry 39, 140 Harsanyi, John 236, 240 financial markets 260, 262–65, 300–01 German Historical School 147 Hayek, Friedrich 56, 57, 126, 129, 177, Fine, Ben 280 Germany 152, 184, 199, 222, 223, firms 88, 184 260 319, 325 on complexity 278 and competition 94, 126–29 Giffen goods 89, 116–17 on markets 60, 153, 174–77, 185 corporate governance 168–69 gift giving 166, 167 on socialism 144, 146 economies of scale 132 globalization 67, 135, 185, 226–31, on state interference 152 executive pay 168, 169 Heathcote, Jonathan 330 managers 152, 168–69 305 Heckscher, Eli 82, 84, 312 Fisher, Irving 30, 32, 198, 298 Godwin, William 68 hedge funds 169, 321 Fitoussi, Jean-Paul 219 gold standard 24, 25, 152, 186, 260 hedging 263, 264 Fleming, Marcus 185 Goodheart, Charles 330–31 Hegel, Georg 102, 104 Flood, Merrill 237, 238–39 Gordon, David 276 Helpman, Elhanan 312 Flood, Robert 261 government 60–61, 176, 177, 202, Hicks, John 130, 156, 165, 244 Folbre, Nancy 310 on elasticity 124 Ford, Henry 302 203, 221 general equilibrium theory 120 Foster, Richard 148 borrowing v. taxation 76–77 ISLM model 153, 160, 165, 202 Frank, Andre Gunder 185, 242, and climate change 308 Hirschman, Albert 191 in developing world 192, 193 Hobbes, Thomas 37, 57 243 intervention 51, 146, 152, 153, Hofmann, Boris 331 Frankel, Jeffrey 252, 255,293 Holmes, Thomas 180 free market 50, 51, 54–61, 105, 174–75, 284–87, 303 Homo Economicus 52–53 non-interference 57 Hoover, Herbert 152 131, 220 spending 19, 46, 47, 51, 140, 152–53, housing market 299–301, 324, development policy 193 economic liberalism 174–77 164–65, 198–200 330–31 equilibrium 118–23 Grandmont, Jean-Michel 278 Hume, David 19, 30, 47, 50, 57, 61 failings 152, 261 Granger, Clive 170 Hungary 232–33 free trade 19, 34, 35, 82 Great Depression 29, 152, 158, 186, Hurwicz, Leonid 240 French Revolution 50, 51, 65, 75, 102 Friedman, Milton 199, 260 198, 229–30, 290, 298, 318 I definition of economics 171 Greece 18, 46, 77, 82, 106, 290, 292 on exchange rates 252 Greif, Avner 206 Ibn Taymiyyah 110 on free market 34, 60, 177 Gresham, Sir Thomas 274, 275 India 85, 309 monetarism 184, 186–201, 222, 223 gross domestic product (GDP) 37, Industrial Revolution 50, 51, 95, 132, permanent income hypothesis 205 on Phillips Curve 202, 203, 221 216–19, 284, 310–11 168, 179, 307 quantity theory of money 30, 33 Grossman, Gene 312 industrialization 50, 88, 178–79, on unionization 135 gross national product (GNP) 36 Friedman, Thomas 231 growth 45, 104, 224–25 191–93 Fries, Steven 232 industry 102, 191, 285–87 Frisch, Ragnar 152, 153, 170, 336 Asian Tigers 284 inequality and growth 261, Fudenberg, Drew 273 endogenous growth theory 224, Fukuyama, Francis 174, 280 326–27 225 inflation 30–33, 262, 276, 277 G and inequality 261, 326–27 modern 178–79 hyperinflation 152, 199, 290 Galbraith, John Kenneth 140, 184, 337 Smithian 59 monetarism 198, 260 game theory 184, 206, 234–41, 273, stagflation 201, 203, 271 H and unemployment 185, 200–03, 294, 295 Garber, Peter 98, 99, 261 Hales, John 82 246 Hall, Robert 204, 247 information 52, 61, 176, 208–09, Hamilton, Alexander 34 Hanifan, Lyda J. 280 260, 272, 281 Hansen, Alvin 204

INDEX 347 innovation 58, 60, 148–49, 313 on supply and demand 110 Lorenz, Edward 278, 279 institutions 206–07, 230–31, 285 on unemployment 74, 75, 156–61, Lucas, Robert 77, 161, 202, 224, 276, insurance 209, 275 International Bank for Reconstruction 202 337 Keynesianism 60, 184, 245, 260, Lucas critique 246–47 and Development (IBRD) 184, 186, 187 262, 276 on rational expectations 198, 201, International Monetary Fund (IMF) Kindleberger, Charles 290, 318 246–47 King, Gregory 18, 36, 37, 170 184, 187, 228, 231, 314 King, Mervyn 208 M intervention 51, 146, 152, 153, 185, Kirman, Alan 278 Knight, Frank 126, 129, 163, 208, Mackay, Charles 88, 98 284–87, 303 macroeconomics 19, 42, 77, 152, investment 190, 192 248, 249 Kondratiev, Nikolai Dmitriyevich 336 153, 201, 202, 203 risk 262–65 Kornai, János 184, 232–33 Maisel, Sherman 330 irrationality 194–95, 266–69, 290 Kraay, Aart 85 Malestroit, Jean de 30 ISLM model 153, 160, 165 Kremer, Michael 314, 315 Malinowski, Bronislaw 166 Italy: banking 26–27, 28 Krugman, Paul 192, 284, 290, 312, Malthus, Thomas 51, 57, 68–69, 74, J 339 141, 256 Kublai Khan 24 management 152, 168–69 Jayachandran, Seema 314 Kuznets, Simon 153, 179 Mandelbrot, Benoit 265, 278, Jensen, Michael 168 Jensen, Robert 116, 117 on inequality and growth 326 279 Jevons, William 88, 89, 114–15, 121, on modern economy 178–79 Mandeville, Bernard 56, 66 national income accounting 36, 42, Mankiw, Gregory 244, 303 130, 232 Mao Zedong 102, 105, 185 job searches and unemployment 216, 310 marginal utility 63, 88, 89, 116, 110 Kydland, Finn 260, 276–77 304–05 diminishing 114–15, 124 joint-stock companies 38, 168 L market 51, 88 K labor: division of 51, 66–67 bull and bear 79 market 113, 304–05 distortions 220–21 Kahn, Charles 321 value of 19, 36, 37, 89, 106–07, 110 efficiency 185, 210–13, 272–73 Kahn, Richard 164, 165, 181, 336 failure 61, 65, 147, 185, 213, 308 Kahneman, Daniel 162, 194, 260, Laffer, Arthur 260, 270, 271 gluts 74–75 laissez-faire 57, 60, 61, 147 imperfections 302 266–69 Lancaster, Kelvin 185, 220–21 information 208–09 Kalecki, Michal 164 land 19, 39, 106, 124 integration 226–31 Kant, Immanuel 21 Lange, Oskar 120, 146, 175–76, 210 perfect 65 Kaplan, Sarah 148 Latin America 193, 286, 290, 291, socialism 146 Kates, Steven 74 uncertainty 274–75 Keynes, John Maynard 78, 79, 161, 329 see also free market Lausanne School 147 market price 22–23, 57–58, 145 177, 184, 208, 249 Layard, Richard 216 Markowitz, Harry 262 on consumption 204 Leamer, Edward 330 Marshall, Alfred 89, 110, 114, 117, 136, on depressions 298 Lehman Brothers 213, 265, 301, on general equilibrium 123 147, 232 international currency union 186 324 definition of economics 171 on money 30, 33, 75, 198 Leontief, Wassily 225, 312 on economies of scale 132 multiplier 44, 45, 164–65 le Prestre, Sébastien 37 on elasticity of demand 124 on state intervention 152, 153, Lerner, Abba 146 on limited competition 126–29 liberal economics 88, 153 on monopolies 94, 96 303 Liefman, Robert 97 on supply and demand 22, 88, 116, Lipsey, Richard 185, 220–21, 313 List, Friedrich 190, 242, 284, 334 110–13, 133 Locke, John 19, 20, 21, 50, 63, 106, Marshallian Cross 110, 111 Marshall Plan 190, 192 110, 113

348 INDEX Marx, Karl 21, 45, 57, 66, 67, 68, 89, Moore, Henry 170 ordoliberalism 222 100–05, 261 moral hazard 208, 209, 321 Oswald, Andrew 216, 219 morality, and markets 22–23 overproduction 74–75, 78, 79, Capital 42, 88, 102, 106, 144 Morgenstern, Oskar 114, 194, 237, Communist Manifesto 20, 46, 88, 104 274 Owen, Robert 78 102, 104, 222 Mortensen, Dale 304, 305 creative destruction 148, 149 mortgages 298, 299–300, 330–31 PQ labor theory of value 89, 106 on socialist economy 144 subprime 265, 300–01, 324, 330, Pantaleoni, Maffeo 131 Marxism 147 331 paper money 24, 25 Maskin, Eric 273 Pareto, Vilfredo 60, 88, 120, 122, 131, mathematics 89, 110, 120–23, 152, Müller-Armack, Alfred 222–23 Mun, Thomas 18, 35, 228 144 153, 210, 279 Mundell, Robert 185, 252–54, 270, Pareto efficiency 89, 130–31, 212–13 Mauss, Marcel 166 patents 46, 47 McCulley, Paul 298 271 Patinkin, Don 165 McKenzie, Lionel W 123 Murphy, Kevin 326 Perrotti, Roberto 326 McKinnon, Ronald 252 Muth, John 244–47, 276 Pettit, Nathan 136 Meade, James 137 Myerson, Roger 294 Petty, William 18, 36–37, 39, 42, 106 Means, Gardiner 152, 168–69 Phelps, Michael 305 measurement, economic 19, N Phillips, Bill 202–03, 221 36–37 Nash, John 90, 91, 184, 236–40, Phillips Curve 185, 200, 201 Medici Bank 18, 27 294 physiocrats 19, 39, 42–45, 51, 61, 62, Menger, Carl 62, 88, 114, 116, 124, national income accounting 36, 42, 65 147, 335 44–45, 216–17, 310–11 Pigou, Arthur 157, 220, 299, 336 mercantilism 18, 19, 34–35, 42, 58, Navarrus (Martín de Azpilcueta) 31 on pollution tax 89, 137, 306, 308 68, 82, 102, 228 neoliberalism 177, 187 on price discrimination 180, 181 merchant banks 27–28 New Deal 153, 184 Pissarides, Christopher 304, 305, Merton, Robert C. 264 Nixon, Richard 186, 187, 199, 260, Mesopotamia 26 339 microeconomics 152, 153 262 planned economy 102, 105, 153, Milgrom, Paul 294 Nordhaus, William 306–09 Mill, John Stuart 88, 95, 126, 132, 136 Nordic model 223 174–75, 176, 184, 232–33 North, Douglass 166, 206–07, Plato 18, 20, 66, 67 on economic man 52–53 Poincaré, Henri 278 on happiness 216 328 Polanyi, Karl 136, 153, 166–67 on monopolies 94–95, 97 North, Dudley 34 pollution 89, 137, 306, 308, 309 on poverty 140, 141 Northern Rock 320 Polo, Marco 24 Miller, Nolan 116, 117 Nurske, Ragnar 190, 191, 336 Ponzi schemes 298, 300, 301 Minsky, Hyman 26, 260, 261, poor countries 185, 308 O 298–301 debt relief 314–15 Mises, Ludwig von 74, 75, 147, 170, 185 Obstfeld, Maurice 292, 322 dependency theory 242–43 Offer, Avner 166, 167 economic growth 224–25 on central planning 144–47 Ohlin, Bertil 82, 84, 312 population 36, 51, 68–69, 190, 256 on labor division 66 oil industry 193, 260 poverty 140–41, 152, 156, 157, 261, on prices 133 oligopoly 70 on socialism 22, 89, 175 Olson, Mancur 82, 85 327 Mishkin, Frederick 204 OPEC 71–72, 73, 185, 260 Prebisch, Raúl 124, 242, 243 Modigliani, Franco 204–05, 247 opportunity cost 89, 133 Prescott, Edward 260, 276–77 monetarism 184, 196–201, 222, 260 option pricing model 264–65 price 88–89 money 24–25, 75 circulation of 40–45 and competition 90, 126–29 markets 113, 301 discrimination 180–81 quantity theory 30–33, 198, 200 and economic bubbles 98–99 supply 18, 147, 152, 184, 196–201 elasticity 64, 124 monopoly 70, 92–97, 129, 132, inflation 30–32 147, 221 price discrimination 180, 181 Smith on 58, 88