Category Archives: Economic History

The Elastic Economy and the Great Moderation

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Alex Tabarrok writes,

Since the great recession ended, growth in real GDP has been much less volatile than in the 1950s to 1980s. Indeed, volatility has been lower even taking into account the great recession.

He goes on to point out problems with many theories that try to explain the continued Great Moderation.

I offered my explanation in 2003, in an essay called The Elastic Economy.

The United States economy has become more diverse and more robust. We are better able to withstand shocks, minimize concentration of economic power, and sustain growth without being hampered by resource constraints. This can be summarized by saying that the economy has become more elastic.

…There are several factors that have caused the economy to become more elastic. They include product diversity, globalization, the Internet, and increased innovation.

There are now more patterns of specialization and trade. That reduces the overall economic significance of any one product. That means that any particular shock causes less overall pain than it would have fifty years ago.

If this view is correct, then we should be less enthusiastic about claiming that policies in 2008-2009 prevented another Great Depression. Because we have a more elastic economy than we did in 1930, a repeat of the Great Depression was never going to happen.

The elastic-economy hypothesis fits in among theories of structural change to explain lower volatility in GDP growth. Alex points out that such theories, including the theory that sectors like health care are less volatile than manufacturing, want to predict further reductions in volatility in recent years, and this has not happened. Perhaps that is because asset markets have become a more important source of volatility than they were 30 years ago.

Should we miss the working class?

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Brink Lindsey writes,

people are not machines, and they don’t like being treated as such. By inducing millions of people to take up factory work and creating a social order in which those millions’ physical survival depended upon their doing such work for most of their waking hours, industrial capitalism created a state of affairs deeply inconsistent with the requirements of human flourishing—and, not unrelatedly, a highly unstable one at that.

…In pursuing the technical efficiency of mass production regardless of its human costs, the class system created by industrial capitalism divided people along very stark lines: those who work with their brains and those who work with their bodies; those who command and those who obey; those who are treated as full-fledged human beings and those who are treated as something less.

I spent two summers working in a plant that produced speakers for sound systems for buildings (think of the music piped in at shopping malls). A lot of the work was with materials that probably were dangerous to one’s lungs, including jute and fiberglass. Maybe my chronic cough comes from that. Otherwise, the work was not as rote as Lindsey depicts, and even when it was rote the time would pass reasonably well. On the plus side, there was no office politics, no ambitious co-workers stabbing you in the back or trying to steal credit for your ideas. But on net, I would tend to agree with Lindsey that we should be happy to see old-fashioned manufacturing production work phase out.

The last time I looked, which was a few years ago, the share of manufacturing production workers (as opposed to managers and supervisors) in the labor force was down to just over 5 percent. Fifty years ago, I believe it was more than 20 percent.

The erstwhile working class has moved in two directions. One direction is white-collar work. However, the other direction is non-employment. To address the latter, Lindsey offers this:

A more humane economy, and a more inclusive prosperity, is possible. For example, new technologies hold out the possibility of a radical reduction in the average size of economic enterprises, creating the possibility of work that is more creative and collaborative at a scale convivial to family, community, and polis. All that hold us back are inertia and a failure of imagination—and perhaps a fear of what we have not yet experienced. There is a land of milk and honey beyond this wilderness, if we have the vision and resolve to reach it.

To me, this sounds like the sort of utopian hope that we held for the Internet twenty years ago. As I pointed out in several posts a week ago, the reality has recently seemed to differ.

Land prices in San Francisco

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Robert L. Cutts writes,

Homes… now sell for 15 times the average salaried worker’s annual gross wage. Even small condominium units… sell for nearly 10 years’ pay. First-time buyers would have to contract 50- to 90-year mortgages to make the payments, even at … relatively low interest rates…It is clear that, once leases begin to expire, steady rent increases will have to ameliorate that impossible pressure. The result: inflation and a downward trend in home ownership for first-time buyers are being built into the … economy for decades to come.

The article appears in the May-June 1990 issue of the Harvard Business Review. It is about Japan at that time. Any resemblance to land prices in major American cities today is strictly coincidental. After all, the ratio of median house prices to median income in San Francisco is only 14.7

Broadberry and Wallis: A Suggested Interpretation

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The Economist reports,

Stephen Broadberry of Oxford University and John Wallis of the University of Maryland have taken data for 18 countries in Europe and the New World, some from as far back as the 13th century. To their surprise, they found that growth during years of economic expansion has fallen in the recent era—from 3.88% between 1820 and 1870 to 3.06% since 1950—even though average growth across all years in those two periods increased from 1.4% to 2.55%.

Instead, shorter and shallower slumps led to rising long-term growth. Output fell in a third of years between 1820 and 1870 but in only 12% of those since 1950. The rate of decline per recession year has fallen too, from 3% to 1.2%.

Tyler Cowen inspired me to find the article.

Set up two random-number generators, each producing a normal distribution. Give generator M a mean of 2.55 and a standard deviation of 1.5, and give generator H a mean of 1.4 with a standard deviation of 3. Take about 100 draws from those two random-number generators, and then separate the results into positive and negative numbers.

Presumably, the negative numbers from generator H will be more numerous and have a more negative average than those from M. The positive numbers from H, although fewer, could turn out to be larger on average than those from M. That is, by truncating the results from H at zero, the larger standard deviation might lead to a higher average for H than for M. If it does not, then tweak the difference in standard deviations between the two generators a bit more.

In other words, you can replicate the Broadberry-Wallis results without the nature of booms or recessions having any causal role. If modern economic growth, M, is higher with a lower annual standard deviation than historical economic growth, H, then you would observe these sorts of results if you arbitrarily select 0 as your dividing point between booms and slumps.

[UPDATE: a reader writes,

1. With the parameters you suggested, the conditional expectation for H is 2.99, whereas the conditional expectation for M is 2.7.

2. To reproduce their results with the Gaussian model, we’d need to have a standard deviation of about 4.16 for (H), and a standard deviation of about 2.2 for situation (M).

I would add that as you go back in history, much of output is agricultural, and subject to annual variation in weather. So variance might well have been higher for that reason.]

Supply, Demand, and Immigration

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Don Boudreaux writes,

An increase in the supply of labor lowers wages only if nothing else changes. But when immigrants enter the workforce two very important other things change. First, immigrant workers spend or invest their earnings, both of which activities increase the demand for labor – thus putting upward pressure on wages. By focusing only on immigrants’ effect on the supply of labor, Mr. Burwell overlooks immigrants’ effect on the demand for labor.

A second change is one that was emphasized by Adam Smith: larger supplies of workers, as well as more consumers of the economy’s output, lead to greater specialization. Jobs change. As Smith explained, this greater specialization makes workers more productive. This increased productivity, in turn, causes wages to rise.

Peter Turchin would disagree. In Ages of Discord, he finds a strong historical correlation between periods of high rates of immigration and stagnant wages for ordinary workers. I have read through Turchin’s book once, and I mean to write a review. But I keep procrastinating. I am tempted to say that the book, while it appeared to be very interesting on a first pass, is un-rereadable. The data that lands in Turchin’s charts takes a very circuitous route to get there, and it hard for me to stay on top of the relationship between the underlying data and what Turchin says that they represent.

Peter Turchin’s Latest Book

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It is called Ages of Discord: A Structural-Demographic Analysis of American History, and I received a review copy. I am not very far into it. An alternative title might be “Average is over. . .and maybe so is everything else.” From the back cover:

Historical analysis shows that long spells of equitable prosperity and internal peace are succeeded by protracted periods of inequity, increasing misery, and political instability. These crisis periods–“Ages of Discord”–have recurred in societies throughout history. Modern Americans may be disconcerted to learn that the US right now has much in common with the Antebellum 1850s and, more surprisingly, with ancien regime France on the eve of the French revolution.

I will have some problems with his approach to history, if what he says on p.6-7 is any indication.

What we need is theory in the broadest sense, which includes general principles that explain the functioning and dynamics of societies and models that are built on these principles, usually formulated as mathematical equations or computer algorithms. Theory also needs empirical content that deals with discovering general empirical patterns, determining the empirical adequacy of key assumptions made by the models, and testing model predictions with the data from actual historical societies.

This sounds like it borrows some of the more dubious methodological doctrines of economics. I have been arguing that mental processes are important in explaining social outcomes. I fear that the emphasis on mathematical equations and data leads instead to a focus on physical processes, to the neglect of mental processes. I do not think that Turchin will turn out to be such a physical determinist. But we will see.

Somewhat related: Yascha Mounk on indicators of fragility in democracy.

The first factor was public support: How important do citizens think it is for their country to remain democratic? The second was public openness to nondemocratic forms of government, such as military rule. And the third factor was whether “antisystem parties and movements” — political parties and other major players whose core message is that the current system is illegitimate — were gaining support.

Pointer from Tyler Cowen.

Turchin also uses indicators, but his set is different.

President Nixon’s Wage and Price Controls

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Burton A. Abrams and James L. Butkiewicz write,

We uncover and report in this paper evidence that Nixon manipulated his New Economic Policy to help secure his reelection victory in 1972. He became convinced that wage and price controls were necessary to grab the headlines away from the defeatist abandonment of the Bretton Woods Agreement and the closing of the U.S. gold window. Nixon understood the impact of his wage and price controls, but chose to trade off longer-term economic costs to the economy for his own short-term political gain.

Pointer from Tyler Cowen. The paper is based on President Nixon’s secret tapes.

I think that Nixon’s New Economic Policy is under-studied by economists. At the time, many people though that the central policy was getting rid of the gold peg and that wage and price controls were a “cover.” The cover worked, both in the short term and the long term, as people focused on the wage and price controls then and now.

The conventional story of the inflation of the 1970s is that Fed Chairman Arthur Burns printed a lot of money. But as you know, I need to fined a different explanation. My alternative is that abandoning fixed exchange rates set off an inflationary wave, starting with traded goods but spreading elsewhere.

It was less than two years later that OPEC was able to quadruple the dollar price of oil. After that, inflationary psychology took over. Even though we retained price controls on refined petroleum products, such as gasoline, this regime probably raised costs (such as gasoline shortages) more than if prices had been allowed to rise.

What alternative did the Nixon Administration have? The U.S. had been losing reserves of gold and foreign currency at an unsustainable pace. Higher domestic interest rates would have stemmed the outflow, but this would have been unpopular. A lower government budget deficit would have raised net domestic saving (T-G + S-I) and reduced the outflow from the trade deficit, but Mr. Nixon did not go for that, either.

PSST and 1946

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Commenter Handle asks,

As a first guess, would a PSST theory also predict significant disruption and delay in establishing a healthy ‘new normal’ from such a substantial and rapid transformation in the overall economy as accompanied the huge changes from the post-war demobilization? Would we expect the same thing to happen today?

I think that the rapid adaptation of the economy to peacetime in 1946 and 1947 is surprising from the perspective of patterns of sustainable specialization and trade. I have a couple ideas, both speculative.

1. Workers were much more mobile after the war. Having been overseas, a move to another city did not seem daunting. Also, men had met men from other parts of the country. A guy could say, “My buddy Joe, who lives in California, says that there are jobs near where he lives, and he can help me get settled there.”

2. Economic activity was much less geographically concentrated than it is today. My guess is that the percentage of counties where net business formation was positive was much higher than it is now.

Book Discussions

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If any readers are willing/able to organize a group interested in Specialization and Trade, I am willing/able to travel to talk with such a group. I think about 10-20 people would be a good size. I am particularly interested in speaking to autodidacts in their 20s and 30s.

There are several topics in the book which, in hindsight, could have been developed further. One of them that I have been thinking a lot about recently is the long shadow cast by World War II on economic thinking and policy. In the book, I do mention that all of the major nations fighting the war used central planning to a considerable extent. But other points are worth noting, including:

1. In Great Britain, major industries were nationalized from the post-war period all the way up to the late 1970s, when Margaret Thatcher took over as Prime Minister.

2. In the U.S., price controls were used during the war to fight inflation, and the belief in price controls died hard. If I recall correctly, many in the Truman Administration wanted to continue controls after the war, and they were disappointed when Congress abolished them. As late as the early 1970s, the Nixon Administration attempted to go the price-control route, with disastrous results.

3. Another challenge during the war and the post-war period was the potential for labor unions in key industries, such as steel and coal, to bring the economy to its knees. In the decades following the war, Presidents had to resolve major strikes by cajoling (or even forcing) industry and labor leaders to accept settlements. Finally in the 1980s, both Thatcher (coal miners) and President Reagan (air traffic controllers) won important confrontations with striking workers. Many on the left are still bitter about this. They long for the days when unions were more of a force.

4. Because the wartime economies were centrally planned, a lot of economic research involved developing tools for such planning. Prior to the war, the idea of representing an entire economy using mathematical symbols and equations to represent inputs and outputs was adapted from the Soviet Union by Wassily Leontief, who was awarded the Nobel Prize in 1973. After the war, MIT economists, notably Robert Solow (who had studied with Leontief at Harvard), thought that Leontief’s model of production was both too detailed and too rigid. They worked on solutions to the problem of optimizing output that involved linear programming, resulting in an important textbook on programming techniques by Joseph Dorfman (Harvard), Paul Samuelson, and Solow.

5. Also, the MIT economists developed and elaborated on the concept of an aggregate production function. This eliminates the detail by aggregating “capital” and “labor” inputs and treating the economy as a GDP factory. This generated an extensive, but now largely forgotten, literature, including the so-called Cambridge Capital Controversy.

6. The advantage of the aggregate production function is that there are mathematically tractable ways to represent substitution between capital and labor. The Constant Elasticity of Substitution production function, which includes Cobb-Douglas as a special case, was another topic that filled the journals of the early 1960s with now-forgotten articles. I recall that in the early 1970s one of my undergraduate professors, Bernie Saffran, pointed out to us that econometricians trying to estimate the CES production function were trying to tease second and third derivatives out of data where you could be lucky merely to find that the first derivative had the correct sign.

Modernity is a Package

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I have just started reading Leviathan 2.0, by Charles S. Maier. I could not find a Kindle edition when I was ordering the book. Here is a quote from p.5-6:

The winners were the well-organized representatives of Europeans and their American or African or Asian descendants organized into the most efficient engine of expansion and governance that the world had seen for centuries: the modern nation-state. This was a large-scale unit organized to permeate and master territory, to pursue sedentary agriculture and industrial technology, possessing complex legal systems that allowed the preservation and transmission of family and individual property, the salaried employment of large-scale private and public workforces, the rapid communication of commercial and policy decisions by electrical telegraph, the ministerial archives and records that ensured institutional memory, and ideologies of rivalry and group purpose that generated intense loyalties.

Reading this passage, I came up with a catch-phrase “Modernity is a package.” Libertarians see the evils of the state–wars, inefficient and harmful policies, rent-seeking–and they imagine a utopia with a minimal state or no state at all. Progressives see the evils of capitalism, and they imagine a utopia with minimal or no use of markets.

But both capitalism and the state are deeply embedded in modernity. To eliminate either is to pull the rug out from under the system that supports prosperity an innovation.

To take a less politically fraught example, consider urbanization. We know that in small villages people feel a stronger sense of community. They know one another’s names. When they meet on the street, they take time to have a conversation, whereas in a large city people hurriedly rush past one another–friends might say “Oh, hi! We should have lunch, strangers might mutter “good morning.” People look out for one another.

And yet, the overwhelming majority of people who migrate from one to the other move from small villages to large cities, not the other way around. The city offers better employment opportunities, more variety of consumption options, and more overall effervescence.

The city represents the package of modernity, both good and bad. You cannot enjoy both the pre-modern charm of the small village and the modern wonders of the city in the same place.