What you know about economic history is bunk

Back to Deirdre McCloskey's book, Bourgeois Dignity: Why Economics Can't Explain the Modern World. Her main question is what caused the extraordinary sixteen-fold leap in income of the industrial revolution?I discussed the causes of the industrial revolution before in connection with Joel Mokyr's book, the Gifts of Athena. I said:

It is of course perhaps the most significant question in economic history, but the precise sequencing and details is of more limited general interest.

But I find McCloskey's points are of much broader interest. She persuasively argues that many of the conventional ways we think about growth and development are wrong when it comes to explaining the biggest surge in growth of them all.

Competitiveness

For one thing, "competitiveness" appeals to many in journalism because it's like a horse race. And a horse race is a story. And stories sell newspapers. It is also a staple of politics and business schools. She takes issue with Michael Porter's book Competitive Advantage of Nations:

Howard Davies and Paul Ellis, though, put their finger on the central confusion underlying Porter's book-it confuses "`competitiveness' construed as productivity and 'competitiveness' construed as the market share held by a sub-set of industries." Being productive, producing a great deal with few inputs, is certainly a good idea. No one would dispute that. It is called Getting Rich By Being Smart. But getting a large market share has little to do with getting rich, or being smart.

And the cost of being less competitive are not so serious in a world where possibilities are going supernova. Take Britain's relative loss of competitiveness in the twentieth century, for example.

The prize for merely second place, or tenth place, was not poverty, or even loss of political hegemony. "Beaten' Britain is still the eighth-largest economy in the world, the second-largest source of direct foreign investment, and a permanent member of the United Nations Security Council; and London is the second-largest financial center in the world.

The familiar business world of differentiation and barriers to entry and first-mover advantage can help explain the distribution of the pie, but not the size of the pie.

Saving

Nor was the industrial revolution caused by thrift, saving, investment or accumulation. (Micawber exaggerated.) There had been high savings rates in many other times and places - extremely high, if you count peasants having to save a fourth of one low-yielding crop as seed for the next year.

Thrift or prudence did not increase in the childhood of modernity. Actual saving stood high before modern times, and did not change much at the time of modern innovation. It changed only after the innovation had given us new opportunities to invest.

The professionalization of history in the twentieth century has led to discovery that many previous arguments are simply wrong (and I take her at her word on this.)

The history of thrift was revolutionized around 1960, in other words, when economists and economic historians realized with a jolt that thriftiness and savings could not explain the Industrial Revolution. The economists such as Abramowitz, Kendrick, and Solow discovered that only a smallish fraction of recent economic growth can be explained by routine thrift and miserly accumulation (and even that fraction depended, I say again, largely upon innovations pushing out the productivity of capital accumulation).

Capital

And so it turns out that many nineteenth century thinkers, including Marx, were wrong about the facts. This is particularly interesting. I wasn't aware of the more recent historical change of mind.

For all Marx's brilliance-anyone who does not think he was the greatest social scientist of the nineteenth century has not read enough Marx, or is blinded by ideology or by the appalling effects of Marxian writings on the politics of the twentieth century-he got the history wrong... another of the discoveries of the 1960s by economic historians was that the savings demanded by England's heroic age of mechanization were quite modest, nothing like the eventually massive offspring of the "original accumulation of capital" that Marxist theory posits. Early cotton factories were not capital-intensive.

That is a little annoying if you have written a three-volume book called, er, Capital. There is a silver lining to this, however. If prosperity was not caused by capital accumulation, it means there is less potential damage from diminishing returns to capital.

During the 1930s and early 1940s the prospect of diminishing returns deeply alarmed economists such as the British economist John Maynard Keynes and the American follower of Keynes at Minnesota and Harvard, Alvin Hansen. They believed that the technology of electricity and the automobile were exhausted, and that sharply diminishing returns to capital were at hand, especially in view of declining birthrates. People would save more than could be profitably invested, the "stagnationists" believed, and the advanced economies would fall into chronic unemployment.Stagnationism proved false.' Instead, world income per head grew faster from 1950 to 1974 than at any time in history, and the liberal countries boomed. That is, innovation prevented the return to capital from declining.

This is of more than contemporary interest, given the "search for yield" in the years running up to the financial crisis. Not to mention the fact that US Treasuries have negative real yields along most of the curve, and, as we saw recently, the zero returns of most venture capital firms in the last ten years. The returns to capital are becoming increasingly mediocre. But that does not necessarily mean anything for the returns to innovation. You just can't count on being a rentier and living off risk-free government bonds. (And ask holders of Spanish bonds about that, too.)

Primitive Accummulation

Marx and his followers since have also been wrong in believing that there had to be some kind of original sin in capital accumulation.

The original accumulation was necessary (Marx averred) because masses of savings were necessary, and "conquest, enslavement, robbery, murder, briefly, force, play the greater part." He instanced enclosure in England during the sixteenth century (which has been overturned by historical findings that such enclosure was economically minor) and in the eighteenth (which has been overturned by findings that the labor driven off the land by enclosure was a tiny source of the industrial proletariat) and enclosure happened then mainly in the south and east where in fact little of the new sort of industrialization was going on, and where agricultural employment in newly enclosed villages in fact increased).'

Not only does Marx not explain what happened in England. The theory does not explain why the frequent murder, conquest and slavery through the rest of recorded history did not produce an industrial revolution. The West is not rich because the developing countries are poor, either.

Modern economic growth has not depended on saving, and therefore has not depended on stealing to get the saving, or any other form of original accumulation.

Education and human capital

Nor was the industrial revolution a consequence of education or knowledge in isolation. After all Chinese mandarins had been superbly educated for millennia. It mattered what kind of knowledge and eduction and attitudes people had. In fact, the wrong kind of education could kill off innovation.

Yet education without the new bourgeois rhetoric is merely a desirable human ornament, not the way to human riches. It makes for a clerisy that may in fact be hostile to bourgeois values, and very willing to be of professional service to the antieconomic projects.Without a liberalized attitude toward innovation, however, such sophisticates would have worked at keeping their country impoverished. The educated Chinese elite did. The educated Spanish elite did.

She keeps coming back to her core argument: Innovation is the key. And innovation requires living with the consequences of change. And that requires respect for bourgeois dignity rather than aristocratic or traditional status. Of course, it's possible that the causes of the industrial revolution two centuries ago may have little to tell us about the prospects or dilemmas which confront us now. But all of these argument have substantial relevance to contemporary policy debate. For example, I'll have to think a bit harder about the rationale for lower capital gains taxes (much as I like their effect on my portfolio.) And the arguments about primitive accumulation have huge implications for many left-wing projects. There was no original guilt. She says near the end:

The Marxist and the reactionary views of economic history-in many ways they are the same view-have poisoned our political lives for a century and a half. If we're going to have a future, it is desirable that we know what really happened, and listen to the lessons derived from the really-happened, and not go on and on getting inspiration for our politics from historical fairy tales of left or right.

I'll be interested to see if other economic historians dispute some of her historic points. But the logic seems sound to me, at least as presented here. And that is a matter of some importance. And there's quite a bit of ground left to cover in coming posts, too.

 

The Mythic Golden Age of Bookstores?

 

Very few people had access to bookstores. Alex Madrigal writes of the state of the book business in 1931 in the Atlantic, based on a study by historian Kenneth C. Davis: 

"In the entire country, there were only some four thousand places where a book could be purchased, and most of these were gift shops and stationary stores that carried only a few popular novels," Davis writes. "In reality, there were but five hundred or so legitimate bookstores that warranted regular visits from publishers' salesmen (and in 1931 they were all men). Of these five hundred, most were refined, old-fashioned 'carriage trade' stores catering to an elite clientele in the nation's twelve largest cities."

 

You've Got Mail and Amazon.com may still look messy .. but not so bad.

 

We skid over the concepts underling economics

I want to briefly divert and develop one point in the last post, about how the 'givens' in economics and resistance to examining ideas,.

It isn't just in the areas McCloskey talks about in her book, of course. Many other of the central concepts in economics need a lot more fresh and rigorous thought.

Capacity and potential output is at the top of the list for me. Some measure of an output gap is at the hear of nearly every major forecasting macro mode, of course, and plays a central role in most central bank decision-making.

But what does capacity mean now? Marginal costs of accommodating extra demand for computing capacity, for example, is virtually zero. You call up Amazon internet services if you need to add to your website transaction capacity. What does capacity mean in the US if you can get the folks in Bangalore to catch up with work overnight? What is the capacity of the "US economy" in that circumstance?

What does depreciation of the capital stock mean? Software doesn't depreciate in the same way as a physical structure or automobile. Does it depreciate more slowly, because it does not wear out and can continue its function. Or does it depreciate faster because it becomes obsolete and replaced by newer and better methods so quickly that there is no choice but to replace it much faster than old depreciation schedules imply?

What is the capital stock if more of it than ever before is locked up in human brains rather than on shop floors? How do you measure the capital value of new organizational techniques or better management processes?

We've seen before how intangible goods and services are likely hugely mismeasured. And the bulk of the economy is now intangible.

We have a system of economic statistics which is very good at measuring manufacturing and very poor at measuring service output. If you want to know all about cold rolled steel production, you're in luck. If you want to know how many Kindles Amazon has sold - we have no idea.

And how many people really deeply think about this at a conceptual level in economics departments? Very few, as a rule. They just want to run regressions.

 

Getting past a prejudice against ideas

We're talking about Dierdre McCloskey's book The Bourgeois Virtues: Ethics for an Age of Commerce, starting [here].She has several leading intellectual enemies in the book. One is the majority of her colleagues in economics departments, on methodological grounds. She spent the first part of her career as a hard-core Chicago-school economist, and still remembers the sense of rigor and certainty.

.. few of my social-scientific and even many of my humanistic colleagues will be strongly inclined to disagree, and not merely about my praise for the bourgeoisie. They have the idea, held with passionate idealism, that ideas about ideas are unscientific. For about a century, 1890 to 1980, the ideas of positivism and behaviorism and economism ran the social-scientific show, and many of the older showpeople still adhere to the script we learned together so idealistically as graduate students.'

This is a consistent theme on this blog. It is not just economics. Psychology turned positivistic for half a century, and helped obscure the real problems we faced. But it is very hard to persuade people that they are wrong when their joe or self-respect depend on it. As McCloskey says,

.. opponents of ideas as causal are what the modern Marxists call with a sneer "vulgar" Marxists-wanting passionately to be seen as tough-minded behaviorists, positivists, materialists, quantitative, "evidence based," every single time, regardless of the common sense or the historical evidence. Their methodology, they are quite sure, yields the only scientific truth. It is their identity, which is why they become upset and abusive when some unScientific fool claims that something was caused by ideas.

In fact - and this is a lovely quote -

The great economist Simon Kuznets, notes his student Richard Easterlin, believed that "the `givens' of economics- technology, tastes, and institutions- are the key actors in historical change, and hence most economic theory has, at best, only limited relevance to understanding long-term change." Mokyr and Goldstone and Jacob and Tunzelmann and I and some others would go one step further, to ideas.

How can I disagree when the very name of this blog is Big Sky Ideas? I've always found the history of ideas particularly important. Unexamined ideas can be profoundly damaging. A preference for theorems and lemmas is mostly just an esthetic preference for a particular style of argument. Claims of greater "precision" or "consistency" are usually overdone.

 

Bourgeois Dignity and the Causes of the Modern World

We talked extensively a few months ago about Deirdre McCloskey's book The Bourgeois Virtues: Ethics for an Age of Commerce, which I thought was magnificent. She argues that economics and other social sciences went wrong in promoting prudence - maximizing utility - over the other older virtues.McCloskey is a Chicago-school trained economic historian who now believes that more attention to rhetoric and ideas is essential. And she is dazzlingly well-read and original, flitting from philosophy and literary trends to the math of modern endogenous growth theory. I've read the next book in her planned six book series, Bourgeois Dignity: Why Economics Can't Explain the Modern World.The main subject of this latest book is the cause the industrial revolution. Once more, she says, you cannot properly understand it without looking at ideas and the balance of different virtues.

People believe, for example, that imperialism explains European riches. Or they believe that markets and greed arrived recently. Or they believe that "capitalism" required a new class or a new self-consciousness about one's class (as against a new rhetoric about what an old class did). Or they believe that economic events must be explained "ultimately," and every single time, by material interests. Or they believe that it was trade unions and government protections that have elevated the working class. None of these is correct, as I hope to persuade you. The correct explanation is ideas.

A Sixteen-fold leap

At the center of her argument is a dazzling fact that we too often forget. The industrial revolution was not an incremental improvement in the $3 a day or so living standards that most people had been condemned to since the beginning of recorded history. Living standards improved at least sixteen times over. Growth in income had been flat more or less forever, and then in a few short decades turned up almost vertically like a hockey stick. Other proposed explanations have to account for the sheer scale of the increase, and explain why it happened at that time in northwest Europe, as well.

Economics, though, can't explain the rise in the whole world's (absolute) advantage from $3 to $3o a day, not to speak of $137 a day. That is the main scientific point of the book. Economics can't explain the blade of the hockey stick. It can't explain the onset or the continuation, in the magnitude as against the details of the pattern, of the uniquely modern-the widespread coming of automobiles, elections, computers, tolerance, antibiotics, frozen pizza, central heating …

Indeed, an increase of sixteen in income may substantially underestimate the actual improvement in tangible living standards. People spend much less on basic needs, as calculated by Nobel winner Robert Fogel:

Fogel calculates that in 1875 in the United States the average family spent 74 percent of its income on food, clothing, and shelter. In 1995 it spent 13 percent

And if you calculate the improvement in the quality of many things we spend money on, the improvement is larger still. For example, she says, William Nordhaus calculated the cost of light from earliest firelight through candles to electric light. He estimated the cost fell over eleven millennia by a factor of 417,000. So,

Nordhaus concludes that from 1800 to 1992 in the American economy the real wage-the money wage divided by the prices of things, but properly corrected for their improving thingness-grew not by that conventionally and crudely measured factor of thirteen, but anywhere from a low estimate of a factor of forty to a high of a factor of 190. One hundred and ninety.

And despite claims of increasing income disparity, the system is still working:

Most economists reckon that on account of quality improvements the inflation rate conventionally measured was overstated in the period by about 1 percent a year (and continues to be overstated by about the same extent)." When allowing for the better quality of goods and services, therefore, the period of nominal stagnation in real wages witnessed (at 1 percent per year and no other improvement) a rise of about a third in the properly corrected real wage, which is what matters."

Eliminating other explanations

Why? Or, to put it more emphatically, WHY?She systematically examines the usual explanations put forward for the huge leap. If none of the other explanations work, she says, the answer must be in what is left over - and that is a change in ideas about bourgeois dignity and liberty in tne late eighteenth century. The leap forward cannot be explained in purely material or prudential terms, she says. It must involve other virtues as well, especially courage and hope.

Toward 1800 many northwestern Europeans, and toward 1900 other Europeans, and then toward 2000 many ordinary people elsewhere, came to accept the outcome of the market with more or less good grace.But ideas, not mere trade or investment or exploitation, did the creating and the releasing. The leading ideas were two: that the liberty to hope was a good idea and that a faithful economic life should give dignity and even honor to ordinary people, to My Sovereign Lord Cheeseman as much as to Your Grace the Duke of Leicester.

One thing she does not do, as we shall discuss, is explain why a change in bourgeois dignity could make such a vast difference to outcomes. That is presumably left until future books, or perhaps she does not have a full explanation yet. In fact, I think there is a neat dovetailing between what she says and some of the results of recent evolutionary theory, as we shall see.As usual, we'll split the discussion into several posts to make it more tractable. When done, I'll put links to the other posts [here]. I'll use direct quotes a bit more than a print review would do, to be fair to the author and let her speak in her own words. It's worth reading the whole book, of course.

 

The Last Days of MF Global

The firm spirals to disaster grim detail by grim detail in this Fortune report. It's a bit like watching a car wreck in a Hollywood movie.

It beats me how anyone could have been that positive on European sovereign debt. There must be other sovereign debt losses lurking around the US financial system, too.

 

Tudor Psychological Chills

 

I read Hilary Mantel's new novel, Bring Up the Bodies: A Novel last week as well, about Thomas Cromwell and the fall of Anne Boleyn in sixteenth century England. The successor to her Booker-Prize -winning Wolf Hall: A Novel, it is a chilling evocation of politics and court psychology around Henry the Eighth in the mid-1530s.

I greatly enjoyed it, even if I had to take breaks from confronting the conniving fractiousness and cruelty of humanity in the book. It is absorbing and evocative, although not quite as rewarding as Wolf Hall. Cromwell is established and powerful. It is less intrinsically interesting and dramatic than the story of this rise to the top.

 

Nor is Anne Boleyn a particularly interesting or attractive character. Instead, the chief angle is the dreadful spectacle of how someone like Anne can fall so quickly and terribly. Just three years after her triumphant marriage, she is beheaded in 1536 by a French swordsman on a platform in the Tower of London.

 

The history is familiar. But Mantel brings it alive with vividness and insight.