Economic thought in the long-term

The pre-Columbian inhabitants left no documentary records, but their thinking on economic matters has been reconstructed by anthropologists and is summarised by Cicarelli (2012).

None of these writers had much influence in Europe, though Carey did attract criticism from John Stuart Mill. Along with the relatively obscure George Opdyke (1805—80), Carey and Bray were the only American economists cited by Karl Marx in the three volumes of his Theories of Surplus Value (1862—3; first published 1905—10), which was easily the most comprehensive history of economic ideas to have been written at the time. The first US economist to attract significant international attention was the journalist Henry George (1839—97), who won enormous popular support for his attack in Progress and Poverty (1879) on the ‘unearned increment' represented by the rent on unimproved land. George's adaptation of Ricardian rent theory (in a direction that its author never contemplated) struck a chord not only with Americans worried at the closing of the frontier but also with radicals in Britain, who had always been hostile to their country's hereditary landed aristocracy, and in Australia, where the ‘squattocracy' had a morally even more dubious claim to the land. Despite his call for ‘common ownership' of the land, which appealed to many socialists, George opposed nationalisation and argued instead for the replacement of all existing taxes by a ‘single tax' on rent to capture the unearned increment for the community (King, 1988, ch.5).

George was self-taught in economics, and it is notable that for much of the nineteenth century, Americans who wanted postgraduate education had to go overseas for it, most frequently to Germany; in 1880 there were only three professors of economics in US universities. This contributed to the considerable influence of the German Historical School in the US and probably slowed the diffusion of the new ‘marginalist' or ‘neoclassical' economic theory associated with William Stanley Jevons, Alfred Marshall, Carl Menger and Leon Walras.

The first American neoclassical theorist of any stature was John Bates Clark (1847—1938), who made a genuinely original contribution to marginalist theory. In The Distribution of Wealth (1899) he identified capital as a factor of production on a par with labour and land, whose contribution to production could in principle be measured. The marginal product of capital determined the return to its owners, he maintained, in the same way that the wage rate was set by the marginal product of labour, and rent was determined by the marginal product of land.

Again there was a political dimension to this analysis, since Clark had repudiated his earlier socialist sympathies and used the new theory to provide an explicit defence of the ethical legitimacy of the interest and profit income that was derived from the ownership of capital.

Hostility to socialism was a constant theme in US social thought, in both the ‘Gilded Age' (1865—95) and the ‘Progressive Era' (1895—1920). Indeed, it became stronger after 1865, when the evident existence of a large and rapidly growing class of permanent wage labourers turned the relations between capital and labour into the central social problem. This was ‘the crisis of American exceptionalism' (Ross, 1991, 172). These concerns intensified in the 1880s, with the emergence of radical trade unionism and a mass socialist movement. When the American Economic Association was established in 1885, its platform drew on the German Historical School in calling for urgent social reform and greatly increased state intervention in economic life. However, this platform was soon watered down, under pressure from pro-capitalist interests.

Repression of socialist ideas in the academy was a recurring phenomenon (Lee, 2009, ch.

By 1920 a distinct Institutionalist School of Economics had emerged, drawing on Veblen but also emphasising the priority of empirical research — above all, the collection of data — over abstract theoretical work. Its strongholds were Johns Hopkins, Wisconsin and Columbia Universities, with Harvard and Chicago dominated by neoclassical ideas (Morgan and Rutherford, 1998; Yonay, 1998).

Commons was the dominant force at Wisconsin, where he influenced the state's progressive social legislation and wrote the important text, Legal Foundations of Capitalism (1924), stressing the importance for economic theory of collective action by the state and also by a range of voluntary associations, including corporations and trade unions.

This emphasis on collective rather than individual behaviour served to distinguish the Institutionalists from the neoclassical economists. But the boundaries between the two schools were not at all clear-cut, either politically or methodologically. Thus Wesley Mitchell (1874—1948), author of a major book on Business Cycles (1913), expressed his support for capitalism in almost Panglossian terms, while John Maurice Clark (1884—1963), the son of John Bates Clark, attempted to reconcile the neoclassical and Institutional approaches. With the exception of Irving Fisher (1867—1947), who made important contributions to mathematical economics and to the theories of capital, value and money, the American neoclassical theorists were relatively undistinguished, in the 1920s and beyond.

The evident pluralism of economics during the ‘Roaring Twenties' did not extend to toleration of Marxian political economy, which remained underdeveloped in the United States and was entirely absent from the academy. In fact the most prescient critics of unregulated capitalism were amateur economists: the professor of English William Trufant Foster (1879—1950) and the banker Waddill Catchings (1879-1967), who in their best-selling book Profits (1925) pointed to the danger of a crisis of underconsumption, since consumer expenditure tended to lag behind the growth of production. But Foster and Catchings failed to convince the academic economists, and right down to the Wall Street crash in 1929 all neoclassicals and many Institutionalists retained their faith in the market.

The Great Depression shattered this faith. It hit the US economy especially hard: between 1929 and 1933 output fell by 30 per cent, more than anywhere else in the developed world except Canada, and significantly more than in Germany, where the economic collapse brought Adolf Hitler to power. The percentage of Americans who were unemployed peaked in the high or low twenties, depending on whether the large numbers working on temporary government relief projects are counted as being in genuine employment.

Fisher redeemed himself, intellectually if not financially, by setting out a ‘debt-deflation' explanation of the Depression in his Booms and Depressions (1932). When the price level falls sharply, Fisher argued, as it did in the Great Depression, the real value of debt increases, forcing many debtors into bankruptcy and compelling many others to reduce expenditure in order to meet their financial commitments. There was a fundamental asymmetry between debtors and creditors: the former could be forced to reduce their spending, while the latter were under no compulsion to increase theirs. Thus a falling price level was a major part of the problem, not part of the solution to a cyclical downturn.

These lessons were learned for a while - they were repeated (without acknowledgement) in chapter 19 ofJohn Maynard Keynes's General Theory — only to be forgotten in the inflationary decades after 1945, when American economists began once more to maintain that debt was irrelevant and falling prices and money wages would be sufficient to eliminate unemployment of labour and capital. In the 1930s, however, Fisher's arguments had some influence on Franklin Delano Roosevelt's New Deal, which included provisions (later struck down as unconstitutional) legalising price-fixing agreements and encouraging the growth of trade unions and the determination of wages through collective bargaining.

Roosevelt's macroeconomic policies, however, were unstable and inconsistent, reflecting the confusion that prevailed among economists over the causes of the Depression and the potential remedies. The New Deal was, in fact, a series of improvisations, concocted by advisers who were sometimes sympathetic to Keynes, like Harry Dexter White and Marriner Eccles, and sometimes hostile. Among the latter was Henry Morgenthau, who was responsible for the disastrous attempt to restore ‘sound finance' in the austerity budget of 1937 that triggered a brief but extremely sharp fall in output and employment in 1937-8. The Second World War, however, served as ‘an incomparable laboratory demonstrating that deficits do cause prosperity' (Lekachman, 1969, 121). Keynes's own How to Pay for the War (1940) proved that the General Theory was not merely the economics of depression but was equally relevant to a situation of excess aggregate demand, when inflation had become the crucial policy issue.

By the early 1940s the influence of Keynes was beginning to grow, with the new ideas being accepted rapidly by a younger generation of American economists (Colander and Landreth, 1996). A particularly important older convert was Alvin Hansen (1887—1975), whose Fiscal­Policy and Business Cycles (1941) provided a teaching version of the General Theory with detailed statistical applications for the US economy. The statistical appendix was supplied by the young Paul Samuelson (1915—2009), who had already published a mathematical model of the business cycle in the same vein, synthesising the accelerator principle and the Keynesian multiplier and whose Foundations of Economic Analysis (1948) was a landmark in the development of math­ematical economics in the United States. After the war the new ideas found their way into the introductory textbooks, though not without resistance from conservative politicians and businessmen who regarded government demand management as dangerously close to socialism. Samuelson was again an important influence, his Economics (1948) making Keynes both accessible and respectable for first-year undergraduate readers; it is still in print, the eighteenth edition appearing in 2010.

Unsurprisingly, the influence of Marxist ideas also increased substantially in the wake of the Depression, and the first genuinely original and distinctively American work on Marxian political economy was produced by Paul Sweezy (1910—2004), whose Theory of Capitalist Development (1942) contains one of the best summaries of Marx's economic thought ever written, together with a comprehensive account of developments in European Marxism in the sixty years since Marx's death. In the final part of the book Sweezy set out his own ideas, which were often described (though not by him) as ‘Left Keynesian'. In the monopoly stage of US capitalism, and above all in the Roaring Twenties, corporate profit margins had widened, real wages had lagged behind productivity, and there was a chronic tendency for consumption to grow too slowly relative to output. This explained the severity of the Great Depression, and it made any sustained recovery unlikely. In essence Sweezy (like Hansen, but for very different reasons) was a stagnationist.

The Great Depression and the New Deal were only two of the forces that transformed American economics after 1933. Equally important were the flood of refugees from Hitler's Germany, the huge expansion of the military in the Second World War, and the rapidly increasing use of mathematical models and advanced statistical techniques. These developments were closely related. First, there were the European immigrants. Two of the most notable figures arrived before the establishment of the Nazi regime. Joseph Schumpeter (1883—1950), author of Business Cycles (1939, two volumes) and the posthumously published History of Economic Analysis (1954), spent the last two decades of his life at Harvard. The Hungarian-born polymath John von Neumann (1902—57), who was based at Princeton but worked extensively for the US government, made important contributions to mathematics and computing as well as to economics. Von Neumann's Theory of Games and Economic Behaviour (1944), co-authored with another emigre, Oskar Morgenstern (1902—77), was not fully appreciated for some years but eventually established game theory at the very heart of microeconomic analysis.

Between 1933 and 1941 a steady stream of Europeans arrived in the US. The authoritative two-volume study edited by Harald Hagemann and Claus-Dieter Krohn (sadly not translated into English) has entries on over 300 German-speaking refugee economists, many of whom ended up in the United States. Many of them left a mark on the development of American economics, including the development economists Albert Hirschman (1915—2007), Bert Hoselitz (1913—95) and Paul Rosenstein-Rodan (1902—85); the public finance theorists Gerhard Colm (1897-1968) and Richard Musgrave (1910-2007); the trade theorists Gottfried Haberler (1900-95) and Wolfgang Stolper (1912-2002); and the economic historian Alexander Gerschenkron (1904-78). Outside the mainstream, there were the Austrian subjectivists Fritz Machlup (1902-83) and Ludwig von Mises (1881-1973) and a number of Marxists, including Paul Baran (1910-64) and Adolph Lowe (1893-1995).

Probably the most important of all the Europeans, however, were the mathematical theorists and econometricians Jacob Marschak (1898—1977), Gerhard Tintner (1907—83), Tjalling Koopmans (1910—85) and Abraham Wald (1902—50). As Director of the Cowles Commission, which was based first at Chicago and then at Yale, Marschak was especially important in developing the foundations of econometrics and in encouraging the formalisation of economic theory. His team at Cowles included the future Nobel laureates Kenneth Arrow (b. 1921), Tryge Haavelmo (1911—99) and Lawrence Klein (1920—2013). These radical changes in the nature of American economics were profoundly affected by the Second World War and the Cold War that soon followed it. The new techniques of linear programming, activity analysis and decision theory were extremely useful to the US military, and the work of the economists who developed them was often financed by the federal government and its agencies (Mirowski, 2002).

All this foreshadowed the future of American economics. The reality at the end of the war was still very different, as can be seen from the contents of a typical issue of the American Economic Review (AER), then (as now) the country's leading academic journal. The September 1944 AER was a relatively slim volume. Just over 100 of its 250 pages were taken up by six main papers. The lead article was devoted to a pressing policy issue, the disposal of surplus war property. Then there was an analysis of the national output at full employment in 1950, which involved the use of descriptive statistics and informal projections, and an empirical and descriptive article on the future economic prospects of Palestine. The remaining two papers were contributed by Leon Trotsky's former secretary, the Russian emigree Raya Dunayevskaya (1910—87). One was her translation of a 30-page article on the teaching of economics in the Soviet Union, from the Russian-language journal Under the Banner of Marxism, and the other was her own analysis of this ‘new revision of Marxian economics'. The editors promised further discussion of the Soviet article in the December issue.

None of these six main articles was concerned with neoclassical economics, and none contained a single equation or diagram. The same was true of three of the four brief ‘communications', which dealt with the official British White Paper on full employment and the work of the US Labor Board. Ironically, the only theoretical piece in the entire issue was contributed by Kenneth Boulding (1910—93), whose later career revealed that his sympathies lay with evolutionary and Institutional rather than neoclassical economics. Boulding's brief note on the incidence of profits taxation did include two elaborate diagrams, but there were no equations. It was followed by no less than 80 pages of book reviews, and the issue concluded with 48 pages of lists, covering new books, the contents of new periodicals, and recent doctoral dissertations in economics. This final list demonstrates just how different the US PhD programme was in 1944; extended, book-length dissertations had yet to succumb to the twenty-first-century formula of compulsory coursework plus three (possibly unrelated) short articles.

This is, of course, not the only contrast. The December 2013 issue of the AER was the latest available to me as I completed the first draft of this chapter. It ran to a massive 470 pages, but there were no book reviews or lists of journal articles, which had long been relegated to the Journal of Economic Literature, established by the AEA in 1969 to release space in the Review for more articles. Books were in any case much less important than they had been in 1944, and were often ignored altogether by the increasingly influential citation indices. The entire issue of the AER consisted of 12 main articles, averaging more than 30 pages in length, and five shorter pieces. All were entirely mainstream in content and presentation, all included formal modelling, usually with many equations, and the empirical articles all used elaborate econometric techniques.

In 1944 the use of the term ‘mainstream' would have been premature and anachronistic. Twenty years later, however, it would have been an entirely accurate description of the economics that was taught in all the major US universities and formed the basis of publications in all the leading journals. By the early 1960s, the core of mainstream microeconomics in the United States was provided by the Arrow-Debreu formalisation of Walrasian general equilibrium theory, set out in a series of journal articles and in Debreu’s Theory of Value: An Axiomatic Analysis of Economic Equilibrium (1959). Gerard Debreu (1921—2000) was born and educated in Paris, where he was strongly influenced by the Bourbakist movement, a group of French mathemati­cians who attempted to reformulate mathematics on strictly axiomatic foundations (Weintraub, 2002). He came to the United States on a Rockefeller Scholarship in 1948 and made a perma­nent move in 1950, working first at Cowles and then at Berkeley; Arrow was nearby, at Stanford.

This was high theory, produced on the American seaboard, in California and also on the East Coast, at Harvard and MIT; it was sometimes described as ‘saltwater economics’. The ‘freshwater economics’ taught at the University of Chicago was less abstract and more overtly political. Here Milton Friedman (1912-2006), George Stigler (1911-91) and their colleagues made the case for corporate capitalism, arguing that even the most concentrated product markets behaved in practice as if they were perfectly competitive, and denying the need for govern­ment regulation. Their free market liberalism was reinforced by the British-born Ronald Coase (1910-2013), who demonstrated that, on certain (somewhat implausible) assumptions, external costs and benefits could be internalised in voluntary contracts between the affected parties, eliminating the need for either regulation, or Pigovian taxes and subsidies. The Coase Theorem subsequently became a key element in neo-liberal economics.

Friedrich Hayek (1899-1992), who arrived at the University of Chicago in 1950, played a significant role in establishing the Mont Pelerin Society, which was based in Switzerland and, beginning in 1947, brought together American and European neo-liberals to promote the cause of the free market (Van Horn and Mirowski, 2009). Hayek’s own interests were already moving away from economics to political philosophy and psychology, and he was never really a core member of the Chicago school. By 1970, however, there was a distinct Austrian school of economics in the United States, in which Israel Kirzner (b. 1930) and Murray Rothbard (1937-96) were prominent. These American Austrians were firmly subjectivist in orientation, stressing the role of entrepreneurship, the importance of competitive market processes, the irrelevance of equilibrium outcomes and the futility of macroeconomic modelling. Although they were strong supporters of unregulated markets, their hostility to mathematical formalism and econometric research rendered them very uncertain allies of the neoclassical mainstream in microeconomics.

In macroeconomics, a neoclassical-Keynesian synthesis came to dominate teaching, research and eventually (in the Kennedy-Johnson administrations of the 1960s) US government policy. It had three components. The first was the IS-LM model that established the equilibrium levels of real income and the rate of interest, with output potentially constrained by effective demand rather than by supply conditions, requiring active fiscal and/or monetary policy to guarantee full employment. This, however, applied only to the short period. The second component of what came to be known as the Old Neoclassical Synthesis was the neoclassical growth model published in 1956 by Robert Solow (b. 1924), which assumed full employment of both labour and capital. Finally, the inflation rate was determined in the labour market by reference to the Phillips Curve, which related the rate of money wage inflation to the unemployment rate. Like IS-LM, first devised by the English theorists J.R. Hicks and James Meade, this was another analytical import from the United Kingdom (the New Zealander A.W. Phillips was based at the London School of Economics).

In this theoretical framework, changes in the stock of money affected the rate of interest but not (directly) the inflation rate. This drew strong criticism from ‘monetarists’ like Milton Friedman, who insisted on the continuing relevance of the Quantity Theory, as formalised by Irving Fisher; on the importance of inflationary expectations; and on the need for the Federal Reserve to apply a strict zero-inflation rule limiting the rate of growth of the money stock to the expected rate of growth of real output. In A Monetary History of the United States, 1867—1960 (1963), Friedman and Anna J. Schwartz explained the severity of the Great Depression in monetarist (and clearly anti-Keynesian) terms, as the result of the Fed's inaction in the face of the bank failures of the early 1930s, which had led to a sharp and damaging contraction in the money supply. Until the acceleration of inflation in the late 1960s, however, monetarism remained a minority position, and as late as 1971 the Republican President Richard Nixon declared himself to be a Keynesian.

Very different objections to the Old Neoclassical Synthesis came from Sidney Weintraub (1914-83), his former student Paul Davidson (b. 1930) and Hyman Minsky (1919-96), who complained that the new orthodoxy was inadequate in its treatment of money and finance and also neglected the cost-push (and especially the wage-push) dimension of inflation. From Money and the Real World (1972) through to his Post Keynesian Macroeconomic Theory, Second Edition (2011), Davidson consistently stressed the role of fundamental uncertainty in Keynes's own thought, and the need to reject the three fundamental axioms that the neoclassical Keynesians took for granted: the neutrality of money, its gross substitutability for all other commodities, and the ergodic (that is, predictable) nature of economic phenomena. Minsky's John Maynard Keynes (1975) set out a rather different, original and idiosyncratic version of Keynesian macro­economics, focussing on the financial fragility created by the relaxation of lending standards in the upswing phase of the business cycle and the need for vigilant regulation of the financial system to prevent a repetition of the Great Depression. By the late 1970s these ideas formed the theoretical core of a new ‘Post Keynesian' school.

There was also some life elsewhere outside the mainstream. The emergence of an American school of Austrian economics has already been mentioned. One or two of the surviving Institutionalists were also prominent. Clarence Ayres (1891-1972) taught at the University of Texas for almost forty years. Drawing heavily on Veblen, Ayres distinguished ‘techno­logical' and ‘ceremonial' forms of behaviour and stressed the interplay of institutions and technology, which he contrasted with the neoclassical emphasis on individual wants and scarcity. At least one Institutionalist exercised real influence over public policy in the postwar era. This was Arthur F. Burns (1904-87), who was President of the AEA in 1959 and served both the Eisenhower and Nixon administrations, first as Chair of the Council of Economic Advisers (1953-6) and then as Chair of the Board of the Federal Reserve (1970-8). Burns is a salutary reminder that the Institutionalist/neoclassical divide was not also unambiguously a division between left and right, for he was a Republican and an associate of the strongly pro-market American Enterprise Institute. Compare his political persuasions with those of the neoclassical stalwart Paul Samuelson, who was a liberal Democrat and served the Kennedy and Johnson administrations.

Also on the left was John Kenneth Galbraith (1908-2006), who combined Institutionalist and Keynesian themes in a series of influential books, including American Capitalism: the Concept of Countervailing Power (1952), the best-selling The Affluent Society (1958) and The New Industrial State (1967). He argued that the highly unionised, big-government, corporate capitalism of the post-1945 period was fundamentally different from the nineteenth-century owner-managed, competitive, liberal capitalist market system on which neoclassical economic theory was based, and therefore required a very different type of economic analysis. Galbraith drew on the ideas of many earlier thinkers, including Veblen, the technocrats of the 1920s and Adolph Berle's and Gardiner Means's Institutionalist classic, The Modern Corporation and Private Property (1932).

He may also have been influenced by the ex-Trotskyist James Burnham's The Managerial Revolution (1941), which maintained that Nazi Germany, Stalin's Russia and corporate America were con­verging to a post-capitalist managerial dystopia. In his Capitalism, Socialism and Democracy (1943), Galbraith's Harvard colleague Joseph Schumpeter had taken a rather similar line. Although Galbraith was a brilliant writer and was respected sufficiently by the profession to be elected President of the AEA in 1970, his ideas were by this time a very long way outside the mainstream of US economics.

There was also a small (and declining) Marxist residue, which was subject to severe repres­sion in the heyday of McCarthyism (Lee 2009). In the 1950s Paul Baran was the only tenured Marxist professor of economics in the United States (King, 1988, ch. 8). In 1958 Baran pub­lished The Political Economy of Growth, a powerful attack on US imperialism that attributed the continuing poverty and slow growth of the underdeveloped global South to exploitation by the rich capitalist countries of the North. The poor countries did produce an economic surplus, Baran argued, but much of it was extracted in the form of super-profits and most of the rest was squandered on luxury consumption by parasitical ruling classes subservient to overseas capital. He was already working with Paul Sweezy on Monopoly Capital (1964), which applied the concept of the economic surplus to the United States, in an ambitious application of Marx's analysis of productive and unproductive labour. Baran and Sweezy set out a ‘law of the rising surplus', according to which a steadily increasing proportion of economic activity was wasteful, or surplus-absorbing. This included expenditure on advertising and product differentiation, much civilian government spending, and the ever-increasing military budget.

None of these heterodox groupings had any significant influence on teaching or research in Ivy League universities or on the activities of the major research foundations. But this began to change in the late 1960s, with the re-emergence of political radicalism, especially among students (where a crucial role was played by opposition to the Vietnam War), industrial workers (with a wave of strikes, and an increasingly serious problem of ‘wage-push' inflation), and women (with the emergence of a ‘second wave' of feminism). There was a rediscovery of Marx, again with a distinctively American flavour; the beginnings of a consciously feminist economics; the revival of Institutionalist ideas; and the emergence of a self-proclaimed Post Keynesian macro­economics that rejected the neoclassical synthesis. New organisations were established: the Association for Evolutionary Economics in 1965 and the Union for Radical Political Economics in 1968. New journals began to appear: the Journal of Economic Issues in 1967, the Review of Radical Political Economics in 1969, the Journal of Post Keynesian Economics in 1977 and (surprisingly delayed) Feminist Economics in 1995.

Neoclassical economics was now being criticised for its excessive abstraction and formalism, for its neglect of the social, psychological, political and gender dimensions of economic behaviour, and (not least) for its political apologetics. Serious logical defects in the Clarkian theory of capital had been identified by the Cambridge (UK) economists Piero Sraffa and Joan Robinson, which undermined both the marginal productivity theory of distribution and the neoclassical growth model. Samuelson, Solow and other theorists based in Cambridge (MA) attempted unsuccessfully to rescue neoclassical analysis, before Samuelson conceded defeat in 1966 (Harcourt, 1972). When John Kenneth Galbraith was elected president of the American Economic Association for 1971, and invited Robinson to give the keynote Richard T. Ely lecture at the AEA's annual meeting at the end of that year, opponents of the mainstream had some reason to believe that they were in with a chance of supplanting it, or at least of bringing about substantial change.