Grand Pursuit: The Story of Economic Genius

Release Date: 
September 12, 2011
Simon & Schuster
Reviewed by: 

“This is an incredibly well written history of several contributors to economic theory and a perfect follow-up to A Beautiful Mind. . . . What comes across most emphatically is the genius of Keynes as compared to economists before and after.”

This is an incredibly well written history of several contributors to economic theory and a perfect follow-up to A Beautiful Mind. Any author attempting such has to make tradeoffs, and in this Ms. Nasar emphasizes personalities over economic theory, an emphasis of England over America, and both countries over the rest of the world (with a little Austria and India tossed into the mix). The majority of the period covered is from just before the Victorian era up to just past WW II. What comes across most emphatically is the genius of Keynes as compared to economists before and after.

In 1789 Malthus projected the human population to be growing geometrically faster than the food supply. The imagined consequence of an increasing population would be higher food prices higher and lower wages, causing at best, the standard of living to fall and at worst, mass starvation. David Ricardo noted the “Iron Law of wages,” that real wages always tended to subsistence, the minimum necessary to sustain the life of the worker. In response to this, Thomas Carlyle called economics the “dismal science” in the belief that nothing was possible to improve the lot of the worker.

Political economists of that era were fatalists. If wealth were a zero-sum game social improvement and reform was impossible. If some workers had their wages increased then others would have to have theirs reduced, and charity would only increase suffering. In the London of 1834, life expectancy was a scant 32 years, and as poverty was a natural condition, English law restricted public relief to those who would became inmates of workhouses.

Capitalism continually cycles between boom and bust. Governments have the power to intervene in markets, to make them more fair, to redistribute wealth, but should they? Lack of intervention might lead to revolution, yet so might half-measures that only raised expectations. Intervention with faulty analysis could easily make matters worse. If taxes subsidized wages and as a result increased the number of people who sought work, that might cause greater competition for jobs and more unemployment. If government used taxation to support the poor, that burden could grow to consume the income of the entire nation. And as the leaders themselves were wealthy, and wealth was zero-sum, what could they do that wouldn’t also damage themselves?

To economists of the period, low wages had only two possible causes, the greed of the employer or the moral failing of the worker. Economic alternatives were also bipolar, laissez faire versus charity, and charity was the foot-in-the-door towards socialism, or worse. Marx moved to London in 1843 just in time to witness a cholera outbreak that claimed 14,500 lives. To Marx capitalism was a system that just couldn’t work, that private property and free competition simply led to more misery, that competition was a race to the bottom. Marx and Engels believed in the abolition of private property, the elimination of inheritance rights, and that nothing could get better unless the whole capitalistic system, governments and all, were torn down.

The English government did however made serious structural changes in response to social needs. These as noted by John Stuart Mill, included unions, universal suffrage, and women’s property rights. The first Reform Act in England 1832 turned England from a monarchy into a democracy by extending the franchise to male householders, which in one fell swoop both doubled the size of the electorate and brought the working classes into the political system. Government regulation limited abuse and wages rose through better management. The middle class grew. The revolution of the proletariat did not occur, at least not in England. A modern day economist, John Maynard Keynes would later go on to dismiss Marx’s Das Kapital as “an obsolete economic textbook which I know to not only be scientifically erroneous but without inherent application to the modern world.”

Still in 1867 no more than 1 in 14 households had incomes greater than 100 pounds per year. The paradox of modern society was (and still is) poverty amidst plenty. England’s second Reform Act in 1867 gave the right of workers to unionize and strike, and strike they did, leading to lockouts and bread riots. It was seen that there were limits to what problems economics could solve.

Alfred Marshall a Victorian economist of the time said, “Political economy is abused when any one claims for it that it is itself a guide in life.” He noted the limit of economics by pointing out that in regulating social behavior in terms of economics, the setting building fire codes for example, could not account for all human needs, such as the building of parks. Marshall saw increased education as one weapon in the struggle against social injustice left out of the economics equation. In the Victorian era the idea of free public education for children was novel, as was the concept of educating women at all. It took England’s married women property act of 1882 for women have a right to their own incomes.

One educated woman of the era, Beatrice Potter, later Mrs. Sidney Webb, played an important role on economics. She became a social issues journalist, a promoter of universal suffrage and free secular education. (Women wouldn’t have the right to vote in England until 1928, and only a bit earlier 1920 in the U.S.) Beatrice was at the center of a high-powered social circle that included economists and politicians including Winston Churchill. She helped bring to England the idea of a providing a minimum safety net and instead of dispensing welfare that government should go into the business of eliminating poverty’s causes.

Winston Churchill started in politics in 1903 an anti-union and anti-education platform but later changed is views in 1906 to pro-union and pro-minimum wage. He became president of England’s board of trade in 1908 following the recession of 1907, and also proposed unemployment insurance, disability insurance, compulsory education to age 17, along with public works jobs in lieu of public relief, and a nationalization of the railways. Note however that the German government under its first Chancellor, Otto von Bismarck was the first to support worker’s rights. Germany’s safety net included health insurance, accident insurance, disability insurance, and the creation of pensions.

America had little economic theory apart from laissez faire through its Gilded Age (which led to the Sherman Anti-Trust Act). In 1895 there was a bank collapse in America. Five hundred banks failed and 15,000 companies went bankrupt. Unemployment hit 15% and led to the 1896 presidential election being seen as a referendum on America’s economic direction. This was the era of William Jennings Bryan’s Cross of Gold speech. Gold was world money, the standard measure for imports and exports, basically a measure of a nation’s debt in terms of balance of payments. Each nation’s currency was valued in respect to gold. The gold standard kept nations honest, but having such a standard was inflexible during emergencies such as depression or war.

Irving Fisher was the first American economist who England took seriously. A social Darwinist (and eugenicist), he was a proponent of laissez faire and anti-big government but also condemned war as welfare, defended unions, the rights of women, and free trade. Fisher’s belief was that inflation, deflation, unemployment were the consequences of bad decision making in investment. The sum of many individual poor choices results in large economic swings, the cycles of boom and bust. Fisher believed, however, that there was little connection between the banking system and unemployment. He believed that the consequences of changes to investment, such as changing interest rates take a long time before having a jobs impact. Fisher’s ideas lead to new thinking not so much about price levels as much as their rate of change. Fisher was the first to tie changes in pay rates to inflation, called the COLA (Cost of Living Adjustment). His vision of COLA had one flaw: If inflation fell, so too should wages, which would cause resentment.

Joseph Schumpeter born in turn of the century Austria (later moving to America) who was another economist that studied boom and bust cycles. He believed that a nation’s growth was due to economic policy rather than its form of government. He also observed that living standards progressed in advanced nations at an accelerated pace as compared to less advanced nations—and that the mere fact of being advanced was a multiplier for further advancement. He believed that the difference was not in a nation’s resources so much as what it did with what it had. Ideas, entrepreneurs, machines and money could easily be transferred globally so economic growth was less a love of money than a drive to build and that with the right environment, property rights, free trade, stable currency, and cheap credit, any nation could thrive. He considered innovation to be creative destruction, inverting Bakunin’s “The urge to destroy is also a creative urge.”

Perhaps the greatest economist of all time was John Maynard Keynes. Keynes served on England’s treasury staff during World War I. No one, economists included, was able to predict WW I or the disaster that would follow. The English treasury’s goal of that time was according to Keynes, to generate the maximum slaughter for the minimum expense without ruining the pound or jeopardizing Britain’s position as the world’s banker. Keynes role in the war was to acquire U.S. loans for Britain at the best possible terms and then turn around and make loans to France at the worst possible terms. He also used English bonds to purchase French artwork, and considered it at the time the safest value for the money.

At its end WW I left 8.5 million dead, 8 million disabled, destroyed globalization, and bankrupted governments and businesses. The war left in its wake colossal debt, inflation, deflation, poverty, food shortages, hunger, disease, and violent revolutionary movements from Moscow to Munich. The Versailles Treaty made no provisions for the economic rehabilitation of Europe, nothing to make Europe good neighbors, nothing to resolve food shortages, and nothing about the future, apart from reparations.

Keynes initially proposed the amount of German war reparations should be based on their ability to pay, with a plan to extract greater tribute via a tax on trade when they were again able to export. That amount was less than what England and France owed America, and so it was a non-starter. The politicians believed that war should pay for itself and that Germany pay all debt immediately. Germany was punished beyond its ability to pay, in effect both humiliating and stripping Germany of public and private property, directly contributing to conditions that led to WW II.

Post WW I and pre-Versailles, the Austro-Hungarian, (and later American) economist Joseph Schumpeter became the financial minister of Austria-Hungary (later Austria). To pay back Austrian war bondholders he proposed an increase in sin taxes and increase on income taxes on the rich to pay back bondholders with their own money. This plan was overtaken by events. In 1919 with food shortages and risk of overthrow by Communists, Austria was close to civil war. Survival became more important than balancing the budget. The government was lucky at first to discover a cache of funds originally meant for revolution. This was spent on social welfare, but when that wasn’t enough, the government kept printing money and ruined the already failed economy. The Treaty of Versailles then dismembered the Austro-Hungarian Empire and destroyed any credibility Schumpeter had left. He was dismissed from government under public humiliation but later became a bank president and made a large personal fortune. He realized Austrian money was so weak that large profits could be made by exporting Austrian goods.

Two more Austrians economists who later came to America were Frederich Hayek and Ludwig von Mises. To them, the economy was like a computer, a machine for solving math problems. In terms of computational economics, central planning could never have enough data to compute valid solutions, that markets were smarter for consumer goods. One situation where central planning failed in Austria was in response to housing shortages. Rent controls were used to limit prices but instead lead to directly housing shortages. Owners stopped new construction when they realized that they could no longer get their money back quickly.

The end of WW I lead to the end of the gold standard in England. Churchill decided against Keynes on this issue. Keynes believed that a nation’s currency reflected the world’s confidence in its economic prospects, its solvency and ability to keep promises. Churchill wasn’t buying that argument. Having a gold standard would lead to a stronger pound, which in this case was too much of a good thing. England was an export nation and having a strong pound would cripple exports, leading to higher unemployment.

The argument for and against government intervention continued. Keynes’s thought instability was a greater threat to capitalism than inequality, that bubbles and arbitrary windfalls or losses led to greater discontent than the gap between rich and poor, that regulation was good compared to the evil of boom and bust cycles. The alternative view held by Schumpeter, von Mises and Hayek was that regulation is bad, and that depressions and recessions were healthy and self-correcting because they drive out inefficiencies. If markets were left to themselves they would stabilize in the long run. Keynes counter-argued that, “in the long run we are all dead.”

There were no early warnings of the U.S. stock market crash of 1929. Schumpeter thought the boom would last forever. Along with Schumpeter, von Mises, and Hayek, Fisher predicted a quick recovery, which appeared to be so. By April 1930 conditions were back to early 1929.

However with the more than 3000 bank failures between 1930 and 1931, unemployment hit 16% and U.S. output fell to 50% of what it was in 1929. By 1932 stocks were 20% of what they were in 1929, and unemployment hit 25%. Not only was Fisher was financially ruined but his reputation as well. President Hoover became the most hated man in America, and the Soviet experiment of Communism was beginning to look good in comparison. American economists during this period who came to the fore included John Kenneth Galbraith and Milton Friedman.

Depressions don’t respond to normal monetary policy and attempts to balance the budget only made the slump worse. FDR blamed the depression on overproduction and underconsumption. He took America off the gold standard. The U.S. government assumed more debt and created jobs.

The U.S. also began a massive defense expansion, which in turn caused inflation from issuing too many war bonds—the money raised was used to issue more bonds, leading to a doubling of prices. At one point FDR tried to restrain spending by increasing interest rates, which caused a recession within the depression. Monetary policy changes in 1941 included the first payroll tax, in which income taxes were collected by employers. This was the first broad based income tax in America, and what was learned was:

1. Manipulating taxes can be used to stabilize the economy

2. Large increases in tax collection can be made automatic.

England had a depression of its own and the English economists fell into two camps, Keynsian interventionists, who were called communists, and the non-interventionists, called liberals. England also escaped the depression by massive deficit spending on defense to catch up with Germany’s pre-war expansion. Keynes who first proposed deficit spending began to be worried about England’s debt and inflation, claiming that conditions had changed.

Keynes became head of England’s finances during WW II. His goal was to loosen America’s purse strings. FDR who had difficulty getting Congress to support England prior Japan’s bombing Pearl Harbor, proposed Lend-Lease, and England received $50B of aid in exchange for all of its gold. WWII was economically good for America. After four years of war the average American household consumed more than it did in 1939, and unemployment went down to 2%.

The U.S. economic concern at the end of the war was that rapid demobilization would overstrain industry’s ability to absorb it. The predictions of that time failed to see the combination of pent-up consumer demand and the quick exit of women from the industrial workplace.

The big difference between the end of WW I and WW II was that after WW II governments took an active role in planning for cooperation in economic matters. This included reviving world trade, stabilizing currency, and resolving war debt. Post war, Keynes wrote drafts of what would later become the International Monetary Fund (IMF) and the World Bank. Where Hayek thought that planning by governments was dangerous, that it would lead to totalitarian states, Keynes believed that “dangerous acts can be done safely in a community which thinks and feels rightly which would be the way to hell if they were executed by those who think and feel wrongly.”

For all its strengths, Grand Pursuit does have a few weaknesses. There is little explanation of banks or the banking system, the Federal Reserve, the World Bank, and the IMF’s role in economics. Its greatest weakness, however, is the relatively light coverage of American economics post WW II. There is no explanation of such touch-points such as Nixon’s wage and price freeze, the Laffer curve, the Bush era claim that “deficits don’t matter,” or the intent versus consequences of free trade. Of course if Grand Pursuit included all those, it would have been an even bigger book.