What use economic history?

By Felix Salmon
May 28, 2009

In the blogosphere, 2=trend, and recently two high-profile financial journalists — Alan Beattie of the FT and Justin Fox of Time — have come out with heavyweight new books of economic history. Beattie’s False Economy looks at global development, while Fox’s The Myth of the Rational Market looks at the history of the efficient markets hypothesis. What I didn’t know until today was that Beattie and Fox are both distant relatives of misguided liquidationists — something which came out when I asked them both about economic history.

How relevant is economic history at times like this, I asked. Can studying history prevent us from repeating past mistakes, or does it just end up forcing us into committing new ones? And how much of a good thing is it that an economic historian is chairman of the board of governors of the Federal Reserve?

Beattie replied first:

- yes, I think it definitely helps when looking at such once-in-a-century events to have a discipline which focuses on specific similar episodes in the past, not least because the sample size is so small. And that does seem to be having some effect on the policy response now. Despite the best efforts of some, I don’t think the Montagu Norman/Andrew Mellon liquidationist instinct or the 1930s “Treasury view” on deficit spending are getting much serious traction in the US or UK, for example. (Irrelevant trivia: I am very distantly related by marriage to Andrew Mellon – something like a third cousin three times removed. She divorced him in a spectacular case involving all sorts of legal shenanigans and managed to walk off with a sizeable chunk of the Mellon loot, though not a nickel has trickled down to me.)

- but of course you need to learn the *right* lessons and pick the right comparator. the current German reluctance to increase fiscal stimulus, for example, seems to be assuming that this is a 1920s/1970s inflationary situation, not a 1930s deflationary one.

- it is good that an economist *who is also an economic historian* is Fed chairman. Not sure you’d want someone who was reading entirely out of the previous playbooks without also being able to recognise that the monetary transmission mechanism has changed out of all recognition. The General Theory is a bit light on what to do about credit default swaps, for example.

Then Justin weighed in:

My book is basically the story of a bunch of guys who decided to ignore financial market history (the dodgy parts, at least) in order to create more elegant models of financial markets’ future. That didn’t work out so well, so yeah, knowing economic history would seem to be useful. But Alan’s right that there are lots of different lessons that can be drawn from the past, and sometimes people draw the wrong ones. I too am related to a liquidationist, by the way—George Washington Norris, the hard-line president of the Philly Fed in the early 1930s, was my great great uncle.

On Bernanke, I’d certainly rather have somebody with his background in that job than an ahistorical rational expectations type who believes bubbles and panics don’t happen. He’s not really a historian, though. He’s a macroeconomist who’s done some research on the financial system breakdown of the early 1930s. He’s worked really hard to avert such a breakdown over the past two years, and on balance that’s a good thing. But he hasn’t really been a student of what causes financial crises in the first place. Still, he’s an open-minded guy who reads a lot, so maybe he’ll figure it out.

I’d be interested in what Brad DeLong — one of the foremost economic historians of our own time — thinks about whether the “Treasury view” is getting much serious traction — I suspect he might have killed it before it had a chance to spread widely, and it certainly doesn’t seem to have been mentioned much since January 20. And in general I think that economic historians are having something of a day in the sun right now, with lots of people looking back to previous economic crises around the world, and fewer people finding modern theory-based economics particularly helpful from a policymaking perspective. Maybe economic history is a classic countercyclical asset.
Update: Brad DeLong comments:

The “Treasury View” that fiscal policy will be ineffective–well, in the past two months I have seen it advocated by Pete Klenow, Luigi Zingales, Michele Boldrin, Niall Ferguson, and Nobel Prize winners Gary Becker, Edward Prescott, and Robert Lucas. Of these, only Pete Klenow had even a half-coherent argument.


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The “Treasury View” that fiscal policy will be ineffective–well, in the past two months I have seen it advocated by Pete Klenow, Luigi Zingales, Michele Boldrin, Niall Ferguson, and Nobel Prize winners Gary Becker, Edward Prescott, and Robert Lucas. Of these, only Peye Klenow had even a half-coherent argument…

Posted by Brad DeLong | Report as abusive

Considering how much has changed over the years, I believe that history is a poor predictor of future economic conditions. Besides the obvious inability of past market performance to accurately predict future market performance, when one looks at large state economies, there are too many variables to accurately predict future economic progress on historical, quantitative or fiscal analyses alone.

For example, economists still do not place enough weight on political influences on economies. Whether it is a political party’s deference to different constituencies; such as the Democratic Party’s protection of the UAW, Upper Midwest state’s, and industry’s interests; clashes of economic ideologies, or wars, famines, plagues and natural disasters, etc.. These factors all weigh very heavily on economic development. One unpredictable event can wreck a state’s economic performance for years.

These geopolitical concerns must be considered more carefully, as opposed to relying primarily on pure rational analysis. The psychology of market actors must also be evaluated more closely, whether it is of government actors, institutional players, or other outside organizations and forces.

When these elements are more closely incorporated into fiscal and economic policy making, only then will we be able to better determine the future path of a state’s economy.

Posted by Greg | Report as abusive

Maybe whether fiscal policy will work depends on contingent features of the world beyond the control of such policy?

If fiscal policy spends 1 Billion dollars and develops a clean, cheap, limitless, technologically feasible energy source (such as solar or fusion), then surely America’s problems are solved. On the other hand, if fiscal policy spends 2 trillion dollars digging holes and filling them up again, then surely what we can expect is catastrophe.

Posted by a | Report as abusive

It’s amazing how many people miss the point about the value of history. As an agnostic, Greg’s view is fairly typical, considering it as a “poor predictor”.

Its value is in its evidential base. It is the single biggest source of available knowledge, all too often perceived as irrelevant because circumstances change. But the fact that conditions are always changing is exactly why it becomes useful. Decision making is not a reflex skill, and the lessons derived from prior experience are, for a better description, an abstract dress rehearsal for real decisions to come.

The point is that history has to be APPLIED to be useful. Without it, decision-makers have to start from scratch every time they have to make a determination. It is instructive to appreciate how people and organizations mainly learn. They do so organically. Thus, history, which can otherwise be called prior experience, is more beneficial than its ignorance. Another way of describing it is that history provides experience cheaply. And we all know that people with more experience are generally more useful than people without.

The trick is in the ability to experientially learn, a discipline that few educational institutions bother to teach. If they did, we wouldn’t be repeating so many mistakes and re-inventing so many wheels. History’s awareness and the application of formal experiential learning methodology can help to confirm managers’ oft-repeated admission after the fact that hindsight is a wonderful thing.

See my e-book “Knowledge Management: Begging for a Bigger Role”, Business Expert Press, 2008, at http://www.businessexpertpress.com/node/ 70

Arnold Kransdorff.

History has only one certain lesson to teach: The near past resembles the present more than the far past. That is the only probability approaching 100%. (And this is the best argument for taking history into account.)

The folks here may try reading David H. Fischer’s “The Great Wave: Price Revolutions and the Rhythm of History” for a broader perspective. He kind of takes a Ferdnand Braudel level of approach.

Posted by Jon Goodfellow | Report as abusive

For the harm done to the people, I confidently blame most the mainstream news media self-servers. You the news media massively deceive by omission: asset price bubbles are well-shown by real inflation-adjusted price histories, e.g.
“Real Dow & Real Homes & Personal Saving & Debt Burden” at
http://homepage.mac.com/ttsmyf/RD_RJShom es_PSav.html
Well-shown dictates well-deterred — that’s clear to me.
But these histories are kept little-apparent — because more money is made from bubbles by those who provide information flow to the people.

You the news media do know how to show these real histories, but do so nearly never. Here are two (one-time only) precedents:
DOW: from WSJ 3/30/99 (page C14)
HOMES: NYT 8/27/06 (section 4, page 1)
http://www.nytimes.com/imagepages/2006/0 8/26/weekinreview/27leon_graph2.html

Dear Michael…………..

Some more thoughts on that book you mentioned “The Myth of the Rational Market’ by Justin Cox. I hope you were able to find his Blog site following the link I sent you. It’s a curious title he has given his book. He is obviously NOT a great believer in the market delivering quality outcomes, well not for ALL.

Where did this myth begin you may ask. I am proud to say a Scot wrote in 1776 (the same year as the American War of Independence) a famous book called the “Wealth of Nations” (short title!). Adam Smith wrote in his wonderful manuscript arguing passionately that the wealth of a nation is essentially driven by two most important ideas or concepts…..by the ‘invisible hand’ (his language for the market) and by self interest. He argued passionately that that economic growth and prosperity was assured if we built an economic society around these two things. The Market Economy was born and capitalism built around the relatively new factory system was set to flourish. We had reached utopia or paradise so we thought.

In that phrase ‘self interest’ is the root of rational behaviour. Of course Man will always operate by self interest rather than the common good or the greater good as the Jesuits would call it (the ‘Magis’). Economists always say ‘let us assume’ and all their assumptions are assuming (Ha) that Man is rational in his behaviour. For example with reference to the market, consumers will always demand less at high prices and sellers will always supply more at high prices (profit motive) thus creating an inherent conflict in the market. He believed the conflict best resolved by the freely operating market (the invisible hand) which would under a perfect market establish an equilibrium price and quantity (and so on).

I should say that I was introduced to a wonderful concept early in my study of economics, the famous ‘Fallacy of Composition”. This simply states that what is true for the individual will also be true for the whole!!! I always thought this to be a fallacy and was deeply suspicious of self interest as one of the driving forces of a market economy. How can everyone operating in their own interest be good for the nation as a whole? Every man for himself never works and generates chaos I have always thought. Smith said it would assure the ‘Wealth of A Nation’ but from my point of view only wealth for some! It did not take long for critics to emerge and the ultimate critic was obviously Karl Marx (much under appreciated I feel) who clearly thought that the market would only deliver wealth for some and poverty for the many. His solution of socialism was bold but too extreme perhaps and failed as we know in the 20th century probably because it was introduced in a Communist political State. To this day “Das Kapital” remains a mystery to many but Marx clearly had the right idea about market capitalism but maybe the wrong solution.

Adam Smith of course wrote in his book many things about the “Wealth of A Nation (the concept of specialisation for example being pivotal for productivity and growth). To be fair to Smith he wrote in the late 18th century when markets were small and competition fierce. In those days he could not for see the growth of the New Industrial State and the post market economy of John Kenneth Galbraith who clearly had it right in realising that in reality eventually market power would determine outcomes and wealth (for a few)! There is no such thing as a perfect market (a magical invisible hand) and mans behaviour is often far from rational. Look at the superficial frenzy in ‘bear and bull’ financial markets for example.

On a greater scale the power eventually shifted to big firms first domestically and now globally. Consumer power and labour market power have been swamped by the power of large firms who manipulate the market to suit there ends. This has led to post market ideas and to a realisation that there are great social and economic costs associated with market liberalism. Are not greenhouse gas emissions and climate change one such example? The social cost is great. Man simply must be more vigilant and markets which are set free to operate like an invisible hand are a recipe for potential disaster such as the GFC now filtering down to reach the real economy, economic growth and the loss of jobs. We must learn from this that in modern times the world of Smith and Co cannot simply operate the way Smith so eloquently explained.

It will be interesting to see what a brave new world might look like. Have we learnt from these mistakes? I doubt it but we must be vigilant with markets or we risk prosperity in a brave new world

In all this you may discern the economic philosophy of an old mate who has proud Scottish roots. I love Adam Smith (ha) and still despite my comments regard him as the founding father of modern economics.

cya Steve

We must learn from history.

Posted by Stephen Corbett | Report as abusive