The Economics Book

CONTEMPORARY ECONOMICS 299

See also: Financial services 26–29 ■ Boom and bust 78–79 ■ Economic bubbles 98–99 ■ Economic equilibrium 118–23 ■
Financial engineering 262–65 ■ Bank runs 316–21 ■ Global savings imbalances 322–25

only firms that are part of this CDOs were made by pooling Money is a veil
process. Governments finance different financial assets (loans) behind which the
their national debts, and consumers together, some high-risk, others action of real, economic
borrow large sums to buy cars and low-risk. These new assets were forces is concealed.
houses. They too are part of the then cut up into smaller sections to Arthur Pigou
complex financial market that be sold. Each section contained a
funds transactions over time. mix of debts. In 1994, credit default According to Minsky, after World
swaps were introduced to protect War II capitalist economies had
Merchants of debt these assets by insuring them moved away from being dominated
Minsky argued that there was a against the risk of default. Both of by either big government or big
second big difference between these innovations encouraged the business. Rather, they were subject
modern and pre-capitalist supply of loans into the financial to the influence of big money
economies. He pointed out that the system, which increased the markets. The influence of the
banking system does not merely supply of liquidity, or money, into financial markets on the behavior
match lenders with borrowers. It the system. Minsky concluded that of people created a system that
also strives to innovate in the way these innovations meant that it was held within it the seeds of its own
it sells and borrows funds. Recent no longer possible for a government destruction. He argued that the
examples of this include financial to control the amount of money in longer the period of stable
instruments called collateralized its economy. If the demand for loans economic growth, the more people
debt obligations (CDOs), which was there, the financial markets believed that the prosperity would
were developed in the 1970s. could find a way to meet it. continue. As confidence rose,
so did the desire to take risks.
The longer an … the greater people’s Paradoxically, longer periods of
economy remains confidence in the future, the stability resulted in an economy
stable, the greater riskier their borrowing. that was more likely to become
people’s confidence fatally unstable.

in the future… Minsky explained the pathway
from stability to instability by
Eventually, asset Over time in a stable looking at three different types
prices peak and then fall, economy, debt grows, of investment choices that people
and borrowers start to default. asset prices rise, and can make. These can be simply
Lending collapses, and risky borrowing comes illustrated by looking at the way
the economy goes into houses are bought. The safest
to dominate. decision is to borrow an amount
recession. that allows the person’s income
to repay the interest on the loan
Stable economies contain the and also the original value of ❯❯
seeds of instability.

300 FINANCIAL CRISES

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

An agent shows a couple around a
home. In the US housing boom banks
were lending on the expectation of rising
prices. People who could not afford
mortgages were encouraged to buy.

CONTEMPORARY ECONOMICS 301

The peculiar banks with enormous debts and, In 2009, financier Bernard Madoff was
behavioral attributes since no one knew who had bought convicted of the largest Ponzi scheme
of a capitalist economy the toxic mortgage debt, institutions fraud in history. He took more than $18
stopped lending to each other. billion from investors over the course of
center around the As a result banks began to fail, 40 years before the scheme collapsed.
impact of finance most famously Lehmann Brothers
upon system behavior. in 2008. As Minsky had foretold, Minsky strongly believed that, in
Hyman Minsky a near-catastrophic collapse of the the long run, this was necessary.
financial system beckoned because However, the speed at which
incomes fell, and the demand for a period of stability had generated innovation takes place in the
new houses weakened. As house enormous levels of debt that money markets would make
price increases began to slow, the created the conditions for increased regulation very difficult.
first of an increasing number of enormous instability.
defaults was triggered since For Minsky financial instability
borrowers saw their debts grow The three possible actions taken is key to explaining modern
rather than shrink. Rising numbers to halt the fatal instability, and the capitalism. Money is no longer
of repossessed houses came onto problems associated with making a veil that hides the real workings
the market, and prices tumbled. these corrections, had also been of the economy; it has become
predicted by Minsky. the economy. His ideas are now
In 2007, the US economy reached drawing increasing attention. ■
what has become known as the First, the central bank could act
“Minsky moment.” This is the point as the lender of last resort, bailing
at which the unsustainable out the failing banking system.
speculation turns into crisis. The Minsky saw that this might further
collapse of the housing market left increase instability in the system
in the future because it would
encourage banking firms to take
greater risks, safe in the knowledge
that they would be saved.

Second, the government could
increase its debt to stimulate
demand in the economy. However,
even governments have problems
financing debts in times of crisis.
Third, the financial markets could
be subject to stricter regulation.

Hyman Minsky After a period overseas with but since his death, and
the US army during World particularly since the crash
An economist of the political War II he returned home to spend of 2007–08 that he predicted, his
Left, Hyman Minsky was born most of his working life ideas have become increasingly
in Chicago to Russian-Jewish as a professor of economics at influential. Married with two
immigrant parents who had met Washington University. children, he died of cancer
at a rally to honor Karl Marx in 1996, aged 77.
(p.105). He studied mathematics An original thinker and
at Chicago University before natural communicator, Minsky Key works
switching to economics. made friends easily. Academically,
Minsky had a vision of a better he was more interested in the 1965 Labor and the War
world and yet was equally idea than mathematical rigor. against Poverty
fascinated by the practical The notion that pervades all his 1975 John Maynard Keynes
world of commerce, and worked work is the flow of money. During 1986 Stabilizing an Unstable
as an adviser and director of an his lifetime, partly by choice, he Economy
American bank for 30 years. remained on the margins of
mainstream economic thought,

302

BUSINESSES PAY
MORE THAN THE
MARKET WAGE

INCENTIVES AND WAGES

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

CONTEMPORARY ECONOMICS 303

REAL WAGES
RISE DURING
A RECESSION

STICKY WAGES

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

304

FINDING A JOB
IS LIKE FINDING A
PARTNER OR A HOUSE

SEARCHING AND MATCHING

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

CONTEMPORARY ECONOMICS 305

See also: Free market economics 54–61 ■ Depressions and unemployment Global
154–61 ■ Rational expectations 244–47 ■ Sticky wages 303 unemployment

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

306 IN CONTEXT

THE BIGGEST FOCUS
CHALLENGE FOR Economic policy
COLLECTIVE
ACTION IS KEY THINKERS
CLIMATE CHANGE William Nordhaus (1941– )
Nicholas Stern (1946– )
ECONOMICS AND THE ENVIRONMENT
BEFORE
1920 British economist Arthur
Pigou proposes levying taxes
on pollution.

1896 Swedish scientist Svante
Arrhenius predicts a doubling
of atmospheric carbon dioxide
will produce a 9–11°F rise in
global surface temperature.

1992 The United Nations
Framework Convention on
Climate Change is signed.

1997 The Kyoto Protocol is
ratified; by 2011 more than
190 countries sign up to it.

AFTER
2011 Canada retracts from
the Kyoto Protocol.

E conomic development
and prosperity since the
Industrial Revolution have
come about through technology,
largely driven by fuels such as coal,
oil, and gas. It is increasingly clear,
however, that this prosperity comes
at a cost—not only are we fast
depleting these natural resources,
but burning fossil fuels pollutes
the atmosphere. A growing body
of evidence points to emissions of
greenhouse gases, in particular
carbon dioxide (CO ), as a cause of

2

global warming, and the consensus
now among scientists worldwide is
that we risk devastating climate
change unless emissions are cut
quickly and drastically.

CONTEMPORARY ECONOMICS 307

See also: Provision of public goods and services 46–47 ■ Demographics and economics 68–69 ■ External costs 137 ■
Development economics 188–93 ■ The economics of happiness 216–19

Energy use driven by economic
growth is causing pollution,

accelerating climate change.

The Industrial Revolution that Pollution in one Firms and countries
began about 150 years ago has led country affects produce too much
to countries burning large amounts of other countries… pollution because they
fossil fuels. These emissions create a don’t face the full costs of
“greenhouse effect” in the atmosphere.
their actions.

The implications are as much To be effective, The biggest
economic as environmental, but measures to curb carbon challenge for
both economists and governments emissions must be adopted collective action
are divided on the measures that worldwide, even by those is climate change.
should be taken. Until recently,
many have argued that the costs who do not want to around 1 percent of GDP to tackle
of combating climate change are adopt them. the problem if action was taken
more damaging to economic promptly. In 2009, Nordhaus
prosperity than the potential the uncertainties involved, the estimated that without intervention,
benefits. Some continue to dispute international scope of the problem, economic damages from climate
the evidence that climate change and the uneven distribution of change would be around 2.5
is human-made, while others argue benefits and costs across the globe. percent of world output per year by
that global warming could even be 2099. The highest damages would
beneficial. A growing number now In 2006, the UK government be sustained by low-income
accept that the issue is one that commissioned a report by British tropical regions, such as tropical
must be addressed, and economic economist Nicholas Stern on Africa and India.
solutions have to be found. the economics of climate change.
The Stern Review was unequivocal The question was no longer
The economic facts in its findings; it presented sound whether we could afford to cut
In 1982, US economist William economic arguments in favor emissions, but whether we could
Nordhaus published How Fast of immediate action to reduce afford not to, and how this could
Should We Graze the Global greenhouse gas emissions. Stern best be achieved. There are
Commons?, looking in detail at estimated that the eventual cost strong arguments for government
the economic impact of climate of climate change could be as much intervention: the atmosphere can ❯❯
change and possible solutions. He as 20 percent of GDP (gross
pointed out that certain features of domestic product, or total national
the climate problem make it unique income), compared with a cost of
in terms of finding economic
solutions: the long time scale,

308 ECONOMICS AND THE ENVIRONMENT

Ggraeseenshtoraupseheaant dfraoEbmmsoinsrasptitouionrnes Carbon in atmosphere Emissions emissions of greenhouse gases.
from industry Many governments have developed
environmental policies and
Emissions from strategies for implementing those
consumption policies. Regulation in the form of
punishments, such as fines for
Damage or excessive production of pollutants,
to nature INDUSTRY is one solution, but it is difficult to
NATURAL Lab set emissions quotas that are fair to
Temperature RESOURCES mption all businesses concerned. The fines
rises are also difficult to enforce.

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

CONTEMPORARY ECONOMICS 309

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

Most economists now agree
that climate change is a complex
problem with the potential to cause
serious long-term damage. The
solution is far from obvious, but
in 2007, Nordhaus said that he
believed the secret to success lies
not in large, ambitious projects,
such as Kyoto, but in “universal,
predictable, and boring” ideas,
such as carbon taxes. ■

310

GDP IGNORES
WOMEN

GENDER AND ECONOMICS

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

CONTEMPORARY ECONOMICS 311

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

312

COMPARATIVE
ADVANTAGE IS
AN ACCIDENT

TRADE AND GEOGRAPHY

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

CONTEMPORARY ECONOMICS 313

LIKE STEAM,
COMPUTERS HAVE
REVOLUTIONIZED
ECONOMIES

TECHNOLOGICAL LEAPS

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

2005 Richard Lipsey argues See also: The emergence of modern economies 178–79 ■ Institutions in
that technological revolutions economics 206–07 ■ Economic growth theories 224–25
led to the rise of the West.

314

WE CAN KICK-START
POOR ECONOMIES BY
WRITING OFF DEBT

INTERNATIONAL DEBT RELIEF

IN CONTEXT Debt in poor countries has Many of the loans were
grown so large that they made by rich countries
FOCUS cannot afford to service the to corrupt governments.
Growth and development debt and invest in growth.

KEY THINKER Canceling the loans The loans should not
Jeffrey Sachs (1954– ) will enable poor countries have been made in

BEFORE to invest in growth. the first place.
1956 The Paris Club,
a grouping of creditor We can kick-start poor economies
nations, was established to by writing off debt.
facilitate debt relief between
individual countries. I n the last few decades of the suffering, let alone make the
20th century the world’s investments needed to climb out
AFTER poorest countries piled up a of the vicious cycle of economic
1996 The IMF and World Bank staggering amount of debt, which decline. Campaigns for debt
launch the Heavily Indebted grew from $25 billion in 1970 to cancellation intensified.
Poor Countries (HIPC) $523 billion in 2002.
initiative to give debt relief Many campaigners took a moral
and initiate policy reform in By the 1990s it was clear stance, criticizing the negligent or
poor countries. that there was a debt crisis. No self-interested role of the rich
heavily indebted African nation countries and institutions such as
2002 Seema Jayachandran had ever prospered. Indeed, most the World Bank and International
and Michael Kremer argue were in such dire economic straits Monetary Fund (IMF), which
that countries may not be that they could not even service had made many of the loans.
legally liable for “odious” debts their debts without terrible Campaigners argued that since
incurred by corrupt regimes.

2005 G8 countries agree
to write off $40 billion of debt
under the Multilateral Debt
Relief Initiative (MDRI) as part
of the Gleneagles summit.

CONTEMPORARY ECONOMICS 315

See also: International trade and Bretton Woods 186–87 ■ Development economics 188–93 ■ Dependency theory 242–43 ■
Asian Tiger economies 282–87 ■ Speculation and currency devaluation 288–93

Shall we let the children debts were incurred by corrupt reform programs that are made
of Africa and Asia die regimes to feather their own nests, a condition for relief, which may
of curable disease, prevent they could be considered “odious.” damage the economic prospects of
them from going to school, This would mean that countries the countries receiving the relief.
and limit their opportunities have no legal obligation to repay
for meaningful work—all them. The World Bank, for instance, Interestingly, the debt crisis has
to pay off unjust and continued to lend to former dictator now shifted from the less developed
illegitimate loans made Mobutu Sese Seko in Zaire (now world to the once-flourishing
the Democratic Republic of Congo), countries of Europe. Here, similar
to their forefathers? even after an IMF representative free market austerity measures
Desmond Tutu pointed out that he was stealing are being pushed through—but,
the money. Many of South Africa’s crucially, without the debts
South African archbishop (1931– ) debts were borrowed by the being canceled. ■
apartheid regime, considered
rich countries had made these by many not to have been a In South Africa, high debts were
loans either to buy support in the legitimate government. incurred by the apartheid regime.
Cold War or to secure contracts Many argue that the debts from the
for their own companies, they had Others, such as Jeffrey Sachs, apartheid era should be canceled since
an obligation to lift the debt. US gave an economic argument. the government was not legitimate.
economist Michael Kremer took a Sachs argued that canceling debt
legal line. He said that since many and increasing aid could kick-start
growth in poor countries. Such was
the appeal of these arguments that
the G8 countries (the eight largest
economies in the world) agreed to
write off over $40 billion in 2005.
Another American, William
Easterly, argues that debt relief
rewards poor policies and
corruption by recipient countries.
Many criticize the free market

Jeffrey Sachs One of the world’s most known as a global economic
controversial economists, Jeffrey troubleshooter. He was on hand
Sachs was born in Detroit, in 1990 to shift Poland out of
Michigan, in 1954. He first came communism with breakneck
into the public eye in 1985 with a privatization and did the same
plan to help Bolivia deal with in Russia in the early 1990s. In
hyperinflation. The plan came to the 2000s Sachs turned his
be called “shock therapy” and attention to global development
centered on making the country issues, arguing that, with the
easily accessible to foreign right interventions—including
business. This meant opening aid and microloans—extreme
up the Bolivian market, ending poverty could be eradicated
government subsidies, eliminating in 20 years.
import quotas, and linking the
Bolivian currency to the US dollar. Key work
Inflation was indeed brought
under control, and Sachs became 2005 The End of Poverty

PESSIMISM CAN

DESTROY

HEALTHY BANKS

BANK RUNS



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

2007–09 Thirteen countries Each person starts off with
across the world experience a certain amount of the good.
systemic banking crises. On Monday people can do two

A bank makes If customers become … they will want to
long-term investments fearful about withdraw ahead of
but keeps some cash on the future… others, leading to a run
deposit for depositors who
on the bank.
wish to withdraw.

Pessimism … and so will To honor their
can destroy default on its last withdrawals, the bank
healthy banks. remaining depositors.
must sell investments
at a loss…

CONTEMPORARY ECONOMICS 319

See also: Financial services 26–29 ■ Institutions in economics 206–07 ■ Market information and incentives 208–09 ■
Speculation and currency devaluation 288–93 ■ Financial crises 296–301

Banks only keep a relatively small percentage of their
deposits in cash reserves. If all a bank’s depositors turn
up to demand their money back on the same day, only
those at the front of the line will receive their money.

Total depositors

Bank Total amount on deposit

Amount held in cash deposit

less than they invested. These reflect these proportions. But because with large numbers, the
investments, which are made for whatever people choose, it will bank can do this in a way that
a set period, are what is known never be the most efficient outcome the individual cannot.
as “illiquid” investments. This overall because impatient people
means that they cannot easily be should never invest, and patient On Tuesday the bank has
transformed into ready cash, as people should not store anything. illiquid assets—the patient people’s
liquid assets can. A bank can solve this problem. We investment that will reap a return
can think of a bank in this model on Wednesday. At the same time
Patient and impatient as a place where people all agree it has to pay the impatient people
Diamond and Dybvig assume to pool their goods and share risks. their deposits right away. Its
there are two types of people: The bank gives people a deposit ability to do this is the reason
patient people, who want to wait contract and then itself invests for its existence. ❯❯
until Wednesday, when they can and stores the goods in bulk.
consume more, and impatient A bank run in our
people, who want to consume on The deposit contract offers a model is caused by a
Tuesday. However, people do not higher return than storage and shift in expectations,
discover which type of person they a lower return than investment, which could depend
are until Tuesday. The decision and allows people to withdraw on almost anything.
that people face on Monday is how their goods from the bank on either Douglas Diamond
much to store and how much to Tuesday or Wednesday with no
invest. The only uncertainty in penalty. Having pooled people’s Philip Dybvig
the model is whether these people goods, the bank, knowing the share
are patient or impatient. Banks of patient and impatient people,
might have a good idea about can then store enough of the good
probabilities: in general, 30 percent to cover the needs of impatient
of people might prove to be people and invest enough to cover
impatient and 70 percent patient. the wants of patient people. In the
So it is possible that people will Diamond–Dybvig model this is
store and invest amounts that a more efficient solution than
people could reach independently

320 BANK RUNS

A panicking crowd is held back
by police outside a German bank
in 1914. The declaration of war had
caused pessimism among savers,
leading to a number of bank runs.

Diamond and Dybvig showed that customers become eager to be at other people think in the same way
this property also makes the bank the front of the line. that I have. This itself can cause
vulnerable to a run. A run occurs a run on the bank, even if the bank
when, on Tuesday, patient people Pessimism can arise out of would otherwise be able to meet its
become pessimistic about what concerns about investments, other obligations today and tomorrow.
they will receive from the bank on people’s withdrawals, or the bank’s This is an example of what
Wednesday, and so withdraw their survival. Crucially, this allows for economists call “multiple
deposits on Tuesday. Their actions the possibility of a self-fulfilling equilibrims”—more than one
mean that the bank must sell bank run even if the bank is sound. outcome. Here there are two
investments at a loss; it will not For instance, suppose that on outcomes: a “good” one in which the
have the resources to pay all of its Tuesday I believe that other people bank survives and a “bad” one in
patient and impatient customers, are going to withdraw their which it is sunk by a run. Where we
and those later in the line will not deposits—I then decide to do so as end up may depend on the people’s
receive anything. Knowing this, well because I fear that the bank beliefs and expectations rather than
may fail. Then suppose that many the true health of the bank.

Preventing bank runs
Diamond and Dybvig showed how
governments could alleviate the
problem of bank runs. Their model
was partly a defense of the US’s
system of federal deposit insurance,
under which the state guarantees
the value of all bank deposits up
to a specified amount. Introduced
in 1933, this system reduced bank
failures. In March, 1933, President
Franklin D. Roosevelt also declared

A modern bank run run began. At 8:30 p.m. on depositors. However, this
Thursday, September 13, BBC reassurance did not happen,
In September, 2007, the first Television News reported that and a run on personal deposits
serious British bank run the UK central bank, the Bank began over the internet that
since 1866 took place. Northern of England, would announce evening. Under Britain’s deposit
Rock, Britain’s eighth-largest emergency liquidity support insurance program, deposits
bank, was a fast-growing the next day. above $3,300 (£2,000) were not
mortgage lender. To expand fully insured, and the next day,
its business, it had become It emerged later that Mervyn long lines formed outside
over-reliant on “wholesale” King, the Governor of the Bank Northern Rock branches. The
funding—funding provided of England, had opposed a run ended the following
by other institutions—rather rescue offer by Lloyds, another Monday evening after the
than personal deposits. When British bank. King had government announced a
wholesale financial markets suggested that central bank guarantee for all deposits.
froze on August 9, 2007, a support might reassure
gradual, unseen wholesale

CONTEMPORARY ECONOMICS 321

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

322 IN CONTEXT

SAVINGS GLUTS FOCUS
ABROAD FUEL Global economy
SPECULATION
AT HOME KEY THINKER
Ben Bernanke (1953– )
GLOBAL SAVINGS IMBALANCES
BEFORE
2000 US economists Maurice
Obstfeld and Kenneth Rogoff
raise concerns about the large
US trade deficit.

2008 British historian Niall
Ferguson describes a world of
crisis because of overuse
of credit.

AFTER
2009 US economist John B.
Taylor argues against the
existence of a savings glut.

2011 Economists Claudio
Borio of Italy and Piti Disyatat
of Thailand argue that it is
wrong to think that global
imbalances in savings
triggered the financial crisis.

I n February, 2012, 111 million
Americans watched the
Superbowl on television.
At halftime an advertisement
for Chrysler cars was shown. It
was to become a national talking
point. “It’s halftime in America,
too,” said the ad. “People are out
of work and they’re hurting…
Detroit’s showing us it can be
done. This country can’t be
knocked down with one punch.”

The unashamedly patriotic
implication of the ad—to buy
Chrysler because it would save
American jobs—was in tune with
the feeling among many Americans
that the US had let economic power
slip into foreign, especially

CONTEMPORARY ECONOMICS 323

See also: Financial services 26–29 ■ Economic bubbles 98–99 ■ Market integration 226–31 ■
Financial engineering 262–65 ■ Financial crises 296–301 ■ Housing and the economic cycle 330–31

If one country is importing
more than it is exporting
(in trade deficit), another
country must be exporting
more than it is importing
(in surplus).

The country in deficit must
fund its imbalance, while the
country in surplus can build

up a savings glut.

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

324 GLOBAL SAVINGS IMBALANCES

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

CONTEMPORARY ECONOMICS 325

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

326

MORE EQUAL
SOCIETIES
GROW FASTER

INEQUALITY AND GROWTH

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

CONTEMPORARY ECONOMICS 327

See also: The tax burden 64–65 ■ The emergence of modern economies 178–79 ■ Social choice theory 214–15 ■
Economic growth theories 224–25 ■ Taxation and economic incentives 270–71

The greater the if the distribution of capital and worldwide—which can help to
inequality of wealth accumulated wealth is shared lessen inequality—is due mainly
and income, the higher the equally through society, the median to economic growth. On the other
rate of taxation, and voter will be relatively rich in hand slower-developing countries,
the lower growth. capital and will therefore demand such as many in Africa, have
Alberto Alesina a modest tax rate, which will not suffered from decades of little or
impede growth. If, however, there no growth. This has hurt living
Dani Rodrik are large inequalities in wealth, standards and impeded poverty
with much of the accumulated reduction; the poorest lag behind,
capital being concentrated in a and inequality persists. ■
small elite, the majority will be poor
and will demand a higher tax rate,
which would stifle growth. Alesina
and Rodrik argue that the more
economic equality there is in any
society, the higher the growth rate
of its economy will be.

The tax rate is set by governments, Growth and equality Nordic countries such as Sweden
which react to popular concerns. Alesina and Rodrik’s explanation seem to contradict Alesina and
Even a dictatorship cannot ignore is not the whole story. Some people Rodrik’s conclusions. They combine
the popular will, due to the fear of think that the two economists high tax with high living standards
being overthrown. For this reason have misidentified cause and and the world’s smallest equality gap.
the tax rate is set with the aim effect. Spanish economist Xavier
of pleasing as many people as Sala-i-Martin (1962– ), for instance,
possible—that is, the rate preferred claims that economic growth has
by the median voter (the person at fueled a diminishing rate of
the exact middle of the spectrum income inequality across the
of voters’ views). According globe. The World Bank has argued
to Alesina and Rodrik’s logic, that the reduction of poverty

Alberto Alesina Alberto Alesina was born in 1957, political systems of the US
in the northern Italian town of and Europe. He has achieved
Broni. He studied economics and wide recognition for drawing
society at Boccini University in attention to the influence of
Milan, graduating with distinction politics over economic matters.
in 1981. He went on to complete
his M.A. and PhD in the Key works
economics department at Harvard.
After completing his studies in 1994 Distributive Politics and
1986, he became a full professor Economic Growth (with Dani
at Harvard in 1993 and was Rodrik)
chairman of the economics 2003 The Size of Nations (with
department from 2003 to 2006. Enrico Spolaore)
2004 Fighting Poverty in the US
Alesina has published five and Europe: A World of
books. His work straddles politics Difference (with Edward
and economics and focuses Glaeser)
especially on the economic and

328

EVEN BENEFICIAL
ECONOMIC REFORMS
CAN FAIL

RESISTING ECONOMIC CHANGE

IN CONTEXT R eform is designed to kick- growth, it is necessary to remove
start an economy and the inefficiencies within the
FOCUS benefit a whole population economic system. This can be
Economic policy through the transformation of difficult if the country is run by an
institutions. One might think that unaccountable political class for its
KEY THINKERS reforms that benefit the economy own benefit, as is often the case in
Dani Rodrik (1957– ) would be welcomed and carried the developing world.
Daron Acemog˘ lu (1967– ) through. However, sometimes there
is substantial resistance to reform, Reform and influence
BEFORE even from those who might Turkish economists Dani Rodrik
1989 British economist eventually benefit. In order to and Daron Acemog˘ lu have pointed
John Williamson uses the “fix” an economy and return it to out that when powerful groups
term “Washington Consensus”
for the first time (see Reforms are proposed that would
box, opposite). benefit the economy.

2000 South African economist … because they wish Powerful elites may resist
Nicolas van de Walle to preserve their these changes…
documents the failure of
IMF-backed “structural control of resources.
adjustment” reforms in Africa.
They distort the reforms, Even beneficial
AFTER which become ineffective or economic reforms
2009 US economists Douglass
North, John Wallis, and Barry achieve the opposite of can fail.
Weingast propose a new their intended aims.
approach to reform based on
societies’ responses to the
problem of violence.

2011 Reform packages
in Europe following the
2008 financial crisis run
into opposition.

CONTEMPORARY ECONOMICS 329

See also: Free market economics 54–61 ■ Institutions in economics 206–07 ■ The theory of the second best 220–21 ■
Economic growth theories 224–25 ■ Independent central banks 276–77 ■ Asian Tiger economies 282–87

Policies that work do become in these cases because they tend
popular, but the time lag not to address these deeper
can be long enough for the political constraints. However, in
relationship not to be countries with highly accountable
exploitable by… reformers. leaders, the benefits of reforms
Dani Rodrik may already have been reaped.
For these reasons reforms are most
effective in “intermediate countries,”
where reforms are likely to have
significant and positive results,
and at the same time the political
elites are not dominant enough
to derail them.

expect to see their privilege Winners and losers Sani Abacha seized power in Nigeria
disappear as a result of economic However, there are also problems in 1994. His corrupt dictatorship was
reform, they may use their influence when introducing reform into above the jurisdiction of the courts,
to introduce economic policies that intermediate societies. When which allowed his family to appropriate
redistribute income or power to economic reform is proposed, it more than $2.2 billion from state funds.
themselves. Alternatively, they may is often not clear who the winners
distort policies so that measures and losers of the reform will be. proposed but shelved due to lack
are not implemented effectively. This discourages people from of popular support, politicians and
Acemog˘ lu has argued that this accepting the measures, even economists may later propose it
often happens when political elites where there would ultimately be again in the belief that it will
are highly unaccountable, so there more winners than losers. There benefit the economy and society.
are limited checks and balances on may be a bias toward maintaining However, without new, supportive
their actions. Reforms typically fail the status quo; individuals like to information a society may well
protect what they already have reject the measure again. On the
and minimize the risk of losing out. other hand if beneficial reform is
If a beneficial economic reform is implemented despite a lack of
popular support and goes on to
The Washington Consensus create more winners than losers,
it often goes on to gain popular
The term Washington liberalization of domestic support and is not repealed.
Consensus was first coined and international trade, the
in 1989 by British economist introduction of competitive Most attempts at reform focus
John Williamson to refer to exchange rates, and balanced on measures designed to change
the package of free market fiscal (tax) policies. “formal” institutions such as
economic reforms prescribed courts and voting systems.
to developing countries in The Washington Consensus Their success depends on whether
crisis during the 1980s. was discredited in the 1990s. underlying “informal” institutions
Reforms were said to have been and surrounding politics support
These policies aimed to implemented with little them. Without this, reforms of
move the state-run economies sensitivity to the differing laws and constitutions are
of Latin America and post- political constraints evident unlikely to change much. ■
socialist Eastern Europe in such a diverse group of
toward the privatized free countries. In Africa, in
market. They focused on particular, dynamic markets
privatization of state enterprises, raise the poorest out of poverty.

330

THE HOUSING
MARKET MIRRORS
BOOM AND BUST

HOUSING AND THE ECONOMIC CYCLE

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

CONTEMPORARY ECONOMICS 331

See also: Boom and bust 78–79 ■ Economic bubbles 98–99 ■ Supply and Irresponsible lending
demand 108–13 ■ Testing economic theories 170 ■ Financial crises 296–301 in the housing market

As the economy grows, more people feel The economic crash of 2008
confident enough to purchase a house. owed much to the liberalization
of the mortgage market and
This increased demand leads to a rise in house prices. irresponsible lending by
House builders invest in further building. banks. At first, lenders
enforced strict requirements
Prices reach an unsustainable level on borrowers, lending only to
and demand stagnates. those who could cover both
the interest and repayments
Residential investment is halted, and jobs in associated industries on the base amount that had
are lost. House prices stagnate, and the wider economy falters. been lent. However, as the
economy improved, mortgages
The housing market mirrors boom and bust. were offered to those who
could afford to pay only the
interest payments. These
people were relying on an
increase in their income or in
the price of their home to pay
off the balance of their loan.

In the US lenders then
began to offer mortgages
to people who did not earn
enough even to cover the
interest payments—these
loans could only be serviced
with strong growth in house
prices and income. When
the economy faltered and
borrowers began to fail to
pay back their loans, the
whole economy collapsed.

that the value of their houses will and Boris Hofmann showed that During the wave of bank
rise. This confidence rises in step there is a correlation between foreclosures that followed the 2008
with an improving economy. As economic performance and housing financial crisis, boarded up homes
residential sales begin to return to prices. They claim that by following such as this one in New Jersey
a normal level, residential investment appropriate policies in the future, became a common sight.
increases, providing jobs and further it should be possible to strongly
fueling a return to economic growth. mitigate, or even avoid, the worst
effects of a recession.
Economists have analyzed the
relationship between the housing Unfortunately, this was not the
market and the overall economy case with the housing “bubble”
and believe that by studying the that burst in the US in 2008. Here,
levels of investment in housing, it rapid financial innovations created
is possible to accurately forecast instability in mortgage financing
recessions and recoveries. In their that led to unwarranted consumer
2006 book Housing Prices and confidence and an unsustainable
the Macroeconomy, British boom. The housing market was the
economists Charles Goodheart cause of the eventual bust. ■

DIRECTO

RY

334

DIRECTORY

T his book examines some of the most important ideas in economic
thought, from its earliest beginnings to the evolution of political
economy and the wide-ranging subject as we know it today. In
doing so it inevitably looks at the ideas and achievements of major
economists such as Adam Smith, John Maynard Keynes, and Friedrich
Hayek. However, there are, of course, many other economists who have
made important contributions, often in more than one area of study, and
who deserve more than a passing mention. The thinkers discussed in the
following pages have all played a part in establishing economics as a vital
subject in modern industrial society, making sense of complexity, and
expanding our understanding of economic activity in the world today.

JEAN-BAPTISTE COLBERT opposed the tax system introduced HENRI DE SAINT-SIMON
by Jean-Baptiste Colbert. He
1619–1683 believed that production and trade 1760–1825
generated wealth, and proposed
Although born into a family of a reform of taxes to encourage Claude Henri de Rouvroy was born
merchants in Rheims, France, Jean- freer trade. into a noble family in Paris, France,
Baptiste Colbert chose a career in See also: The tax burden 64–65 but rejected his rightful title of
politics rather than commerce. He comte because he advocated a form
rose to become Finance Minister to YAMAGATA BANTO of socialism. His views were
Louis XIV in 1665, and brought in influenced by seeing the new
measures to end political corruption. 1748–1821 society created in the US after the
He also reformed the tax system, American Revolution. He argued that
introduced policies to boost French One of the most respected scholars poverty could be eliminated through
industry and encourage overseas of the city of Osaka, Japan, Yamagata cooperation and technological
trade, and instituted improvements Banto was also a money-exchange innovation, and that education
to the French infrastructure. merchant. Along with others in would remove the greed that drove
See also: The tax burden 64–65 the Kaitokudo School of Osaka, people to seek social privilege and
he introduced Western ideas of exploit others. His work influenced
PIERRE DE BOISGUILBERT rationalism to Japanese institutions, socialist thinkers of the 19th
helping to end Japan’s feudal century, notably Karl Marx (p.105).
1646–1714 society, which had until then been See also: Marxist economics
built on Confucian ideas. Banto’s 100–05
A French aristocrat, Pierre Le multi-volume Yume no shiro
Pesant, sieur de Boisguilbert, (“Instead of Dreams”) was critical FRIEDRICH LIST
pursued a career in law. He was a of the old system, which he saw as
magistrate, then judge, and in 1690 dominated by the “age of gods,” 1789–1846
became the bailie—the King’s and proposed a rational, scientific
representative in charge of approach to the social, political, and Friedrich List started his career
administration and justice for the economic structure of modern Japan, as a civil servant in his hometown
city of Rouen, a post he held until founded on industry and trade. of Reutlingen, Germany, and rose
his death in 1714. Seeing the effect See also: Comparative advantage quickly to high office. However,
of tax on the local economy, he 80–85 in 1822 he was imprisoned for his

DIRECTORY 335

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

336 DIRECTORY

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

DIRECTORY 337

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

338 DIRECTORY

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

DIRECTORY 339

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

340

GLOSSARY

Absolute advantage The ability Bond An interest-bearing form of Cartel A group of firms that agree
of a country to produce a product loan used to raise capital. Bonds to cooperate in such a way that
more efficiently than another. are issued as certificates by the the output of a particular good is
bond issuer (such as a government restricted, and prices are driven up.
Aggregate The total amount; or firm) in return for a sum of money;
for instance, aggregate demand the bond issuer agrees to repay the Central bank An institution that
is the total demand for goods and borrowed sum plus interest at a manages a country’s currency,
services in an economy. fixed date in the future. alters money supply, and sets
interest rates. It may also act as
Asymmetric information An Bretton Woods system A system a lender of last resort to banks.
imbalance of information; for of exchange rates agreed upon
instance, buyers and sellers may between the world’s major industrial Central planning A system
have more or less information nations in 1945. It tied the value of of centralized government
about the product than each other. the US dollar to gold, and the value control of an economy, where
of other currencies to the US dollar. decisions regarding production
Austrian School A school of and allocation of goods are made
economics founded by Carl Menger Budget A financial plan that lists by government committees.
in the late 19th century. It attributes all planned expenses and incomes.
all economic activity to the actions Chaos theory A branch of
and free choice of individuals and Budget constraint The limit mathematics that shows how small
opposes all forms of government on the goods and services that changes in initial conditions can
intervention in an economy. a person can afford. cause larger effects later on.

Balance of trade The difference Bull market A period when Chicago School An avidly free
in value of a country’s imports and the value of shares or other market group of economists—linked
exports over a given time period. commodities increase. to the University of Chicago—whose
ideals of market liberalization and
Bankruptcy A legal declaration Business cycle An economy- deregulation became mainstream
that an individual or a firm cannot wide fluctuation in growth that in the 1980s.
repay their debts. is characterized by periods of
expansion (boom) and periods Classical economics An early
Barter system A system of of contraction (bust). approach to economics developed
exchange in which goods or services by Adam Smith and David Ricardo,
are exchanged for one another Capital The money and physical focusing on the growth of nations
directly without the use of a medium assets (such as machines and and free markets.
of exchange, such as money. infrastructure) used to produce
an income. A key ingredient of Collusion An agreement between
Bear market A period of economic activity, along with land, two or more firms not to compete
decline in the value of shares labor, and enterprise. so they can fix prices.
or other commodities.
Capitalism An economic system in Command economy An economy
Behavioral economics A branch which the means of production are in which all aspects of economic
of economics that studies the effects privately owned, firms compete to activity are controlled by a central
of psychological and social factors sell goods for a profit, and workers authority, such as the state. Also
on decision making. exchange their labor for a wage. called a planned economy.

GLOSSARY 341

Commodity A general term for Deflation is associated with periods to another (such as price). Prices of
any product or service that can of economic stagnation. products may be elastic or inelastic.
be traded. Often used in economics
to refer to raw materials that are Demand The amount of goods and Entrepreneur A person who
always of approximately the same services that a person or group of undertakes commercial risk in
quality and can be bought in bulk. people are willing and able to buy. the hope of making a profit.

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

342 GLOSSARY

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

GLOSSARY 343

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

344

INDEX

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

153, 174–77
Axelrod, Robert 273, 338

INDEX 345

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

D E fairness 64, 65, 131, 215
Fama, Eugene 168, 185, 272, 337
Darwin, Charles 273 East Asia 187, 230, 282–87 famine 256–57
Davis, Morris 330 East India Company 18, 35, 38, 168 Ferber, Marianne 310
Debreu, Gérard 211, 232 Easterlin, Richard 216, 217–18 Ferguson, Niall 322, 324
Easterly, William 315 Field, John 280
equilibrium model 120, 123, 212 Eastern Europe 185, 193, 232, 329 financial crises 51, 79, 104, 296–301
on free markets 56, 60, 130, 220 econometrics 152, 153, 170
on market efficiency 210–13 2007–08 28, 136, 177, 213, 261, 262,
272, 320, 321, 322–24, 331

currency crises 255, 288–93
East Asian (1997) 187, 230, 292–93

346 INDEX

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

INDEX 347

innovation 58, 60, 148–49, 313 on supply and demand 110 Lorenz, Edward 278, 279
institutions 206–07, 230–31, 285 on unemployment 74, 75, 156–61, Lucas, Robert 77, 161, 202, 224, 276,
insurance 209, 275
International Bank for Reconstruction 202 337
Keynesianism 60, 184, 245, 260, Lucas critique 246–47
and Development (IBRD) 184, 186,
187 262, 276 on rational expectations 198, 201,
International Monetary Fund (IMF) Kindleberger, Charles 290, 318 246–47
King, Gregory 18, 36, 37, 170
184, 187, 228, 231, 314 King, Mervyn 208 M
intervention 51, 146, 152, 153, 185, Kirman, Alan 278
Knight, Frank 126, 129, 163, 208, Mackay, Charles 88, 98
284–87, 303 macroeconomics 19, 42, 77, 152,
investment 190, 192 248, 249
Kondratiev, Nikolai Dmitriyevich 336 153, 201, 202, 203
risk 262–65 Kornai, János 184, 232–33 Maisel, Sherman 330
irrationality 194–95, 266–69, 290 Kraay, Aart 85 Malestroit, Jean de 30
ISLM model 153, 160, 165 Kremer, Michael 314, 315 Malinowski, Bronislaw 166
Italy: banking 26–27, 28 Krugman, Paul 192, 284, 290, 312, Malthus, Thomas 51, 57, 68–69, 74,

J 339 141, 256
Kublai Khan 24 management 152, 168–69
Jayachandran, Seema 314 Kuznets, Simon 153, 179 Mandelbrot, Benoit 265, 278,
Jensen, Michael 168
Jensen, Robert 116, 117 on inequality and growth 326 279
Jevons, William 88, 89, 114–15, 121, on modern economy 178–79 Mandeville, Bernard 56, 66
national income accounting 36, 42, Mankiw, Gregory 244, 303
130, 232 Mao Zedong 102, 105, 185
job searches and unemployment 216, 310 marginal utility 63, 88, 89, 116, 110
Kydland, Finn 260, 276–77
304–05 diminishing 114–15, 124
joint-stock companies 38, 168 L market 51, 88

K labor: division of 51, 66–67 bull and bear 79
market 113, 304–05 distortions 220–21
Kahn, Charles 321 value of 19, 36, 37, 89, 106–07, 110 efficiency 185, 210–13, 272–73
Kahn, Richard 164, 165, 181, 336 failure 61, 65, 147, 185, 213, 308
Kahneman, Daniel 162, 194, 260, Laffer, Arthur 260, 270, 271 gluts 74–75
laissez-faire 57, 60, 61, 147 imperfections 302
266–69 Lancaster, Kelvin 185, 220–21 information 208–09
Kalecki, Michal 164 land 19, 39, 106, 124 integration 226–31
Kant, Immanuel 21 Lange, Oskar 120, 146, 175–76, 210 perfect 65
Kaplan, Sarah 148 Latin America 193, 286, 290, 291, socialism 146
Kates, Steven 74 uncertainty 274–75
Keynes, John Maynard 78, 79, 161, 329 see also free market
Lausanne School 147 market price 22–23, 57–58, 145
177, 184, 208, 249 Layard, Richard 216 Markowitz, Harry 262
on consumption 204 Leamer, Edward 330 Marshall, Alfred 89, 110, 114, 117, 136,
on depressions 298 Lehman Brothers 213, 265, 301,
on general equilibrium 123 147, 232
international currency union 186 324 definition of economics 171
on money 30, 33, 75, 198 Leontief, Wassily 225, 312 on economies of scale 132
multiplier 44, 45, 164–65 le Prestre, Sébastien 37 on elasticity of demand 124
on state intervention 152, 153, Lerner, Abba 146 on limited competition 126–29
liberal economics 88, 153 on monopolies 94, 96
303 Liefman, Robert 97 on supply and demand 22, 88, 116,
Lipsey, Richard 185, 220–21, 313
List, Friedrich 190, 242, 284, 334 110–13, 133
Locke, John 19, 20, 21, 50, 63, 106, Marshallian Cross 110, 111
Marshall Plan 190, 192
110, 113

348 INDEX

Marx, Karl 21, 45, 57, 66, 67, 68, 89, Moore, Henry 170 ordoliberalism 222
100–05, 261 moral hazard 208, 209, 321 Oswald, Andrew 216, 219
morality, and markets 22–23 overproduction 74–75, 78, 79,
Capital 42, 88, 102, 106, 144 Morgenstern, Oskar 114, 194, 237,
Communist Manifesto 20, 46, 88, 104
274 Owen, Robert 78
102, 104, 222 Mortensen, Dale 304, 305
creative destruction 148, 149 mortgages 298, 299–300, 330–31 PQ
labor theory of value 89, 106
on socialist economy 144 subprime 265, 300–01, 324, 330, Pantaleoni, Maffeo 131
Marxism 147 331 paper money 24, 25
Maskin, Eric 273 Pareto, Vilfredo 60, 88, 120, 122, 131,
mathematics 89, 110, 120–23, 152, Müller-Armack, Alfred 222–23
Mun, Thomas 18, 35, 228 144
153, 210, 279 Mundell, Robert 185, 252–54, 270, Pareto efficiency 89, 130–31, 212–13
Mauss, Marcel 166 patents 46, 47
McCulley, Paul 298 271 Patinkin, Don 165
McKenzie, Lionel W 123 Murphy, Kevin 326 Perrotti, Roberto 326
McKinnon, Ronald 252 Muth, John 244–47, 276 Pettit, Nathan 136
Meade, James 137 Myerson, Roger 294 Petty, William 18, 36–37, 39, 42, 106
Means, Gardiner 152, 168–69 Phelps, Michael 305
measurement, economic 19, N Phillips, Bill 202–03, 221

36–37 Nash, John 90, 91, 184, 236–40, Phillips Curve 185, 200, 201
Medici Bank 18, 27 294 physiocrats 19, 39, 42–45, 51, 61, 62,
Menger, Carl 62, 88, 114, 116, 124,
national income accounting 36, 42, 65
147, 335 44–45, 216–17, 310–11 Pigou, Arthur 157, 220, 299, 336
mercantilism 18, 19, 34–35, 42, 58,
Navarrus (Martín de Azpilcueta) 31 on pollution tax 89, 137, 306, 308
68, 82, 102, 228 neoliberalism 177, 187 on price discrimination 180, 181
merchant banks 27–28 New Deal 153, 184 Pissarides, Christopher 304, 305,
Merton, Robert C. 264 Nixon, Richard 186, 187, 199, 260,
Mesopotamia 26 339
microeconomics 152, 153 262 planned economy 102, 105, 153,
Milgrom, Paul 294 Nordhaus, William 306–09
Mill, John Stuart 88, 95, 126, 132, 136 Nordic model 223 174–75, 176, 184, 232–33
North, Douglass 166, 206–07, Plato 18, 20, 66, 67
on economic man 52–53 Poincaré, Henri 278
on happiness 216 328 Polanyi, Karl 136, 153, 166–67
on monopolies 94–95, 97 North, Dudley 34 pollution 89, 137, 306, 308, 309
on poverty 140, 141 Northern Rock 320 Polo, Marco 24
Miller, Nolan 116, 117 Nurske, Ragnar 190, 191, 336 Ponzi schemes 298, 300, 301
Minsky, Hyman 26, 260, 261, poor countries 185, 308
O
298–301 debt relief 314–15
Mises, Ludwig von 74, 75, 147, 170, 185 Obstfeld, Maurice 292, 322 dependency theory 242–43
Offer, Avner 166, 167 economic growth 224–25
on central planning 144–47 Ohlin, Bertil 82, 84, 312 population 36, 51, 68–69, 190, 256
on labor division 66 oil industry 193, 260 poverty 140–41, 152, 156, 157, 261,
on prices 133 oligopoly 70
on socialism 22, 89, 175 Olson, Mancur 82, 85 327
Mishkin, Frederick 204 OPEC 71–72, 73, 185, 260 Prebisch, Raúl 124, 242, 243
Modigliani, Franco 204–05, 247 opportunity cost 89, 133 Prescott, Edward 260, 276–77
monetarism 184, 196–201, 222, 260 option pricing model 264–65 price 88–89
money 24–25, 75
circulation of 40–45 and competition 90, 126–29
markets 113, 301 discrimination 180–81
quantity theory 30–33, 198, 200 and economic bubbles 98–99
supply 18, 147, 152, 184, 196–201 elasticity 64, 124
monopoly 70, 92–97, 129, 132, inflation 30–32

147, 221
price discrimination 180, 181
Smith on 58, 88