Vincent van Gogh painted twenty-eight portraits of himself in just two years! I have avoided such introspection and have managed to keep both ears attached to my head. I had not read New Ideas from Dead Economists since early 1989, when I delivered a manuscript to the offices of E. P. Dutton for its hardcover debut. I suppose some authors reread their works often, reminiscing about a skillful turn of phrase or prescient thought. Rather than reread my work, I continually watched the world economy over the subsequent years to see how the book’s ideas and the great economists’ ideas held up. This newly revised edition benefits from a careful study of economic trends and crises from my perch as a White House economist, Wall Street adviser, investment fund manager—and father. I was none of those when I drafted the first edition.
The world has changed in staggering ways. Mostly for the good. New medicines, new technologies, more jobs, less inflation, and less crime have blessed the United States. In 1989, we had no Internet, no anti-baldness drugs, few automobile airbags, and no hope that the jobless rate could plunge below 5 percent or that U.S. stock prices would more than triple during the 1990s and then jump by another 75 percent in the early 2000s (with some cliff-hanging moments along the way). The pandemic in 2020 did not bring massive bank failures and soup kitchens like the Great Depression of the 1930s did, but instead a Great Cessation as people were forced to stay in their homes and away from shops and friends.
In the years since the first edition, we have also witnessed a phenomenon I call the “scissors economy.” Technology has permitted Americans to cut out the middleman from many purchases. Who needs a stockbroker or an insurance agent when the Internet allows people to comparison shop? You can buy a sockeye salmon direct from Alaska within seconds or an airplane ticket to Timbuktu. Consumers have more control than ever before and can customize purchases with an ease that only a prince or a potentate could have afforded in past epochs. Even bespoke dog food can be ordered online, tailored for a hound’s age, weight, fur type, and preference for poultry, bison, or vegan protein.
In a tech-driven economy, consumers spend more of their income on digital products like video games and streaming entertainment. Digital products often have “zero marginal cost,” meaning the seller does not pay much to make an extra copy. In past eras, vinyl records, cassette tapes, and CDs were made up of advanced plastics, pressed and assembled by machines, and then shipped to stores. Every time a music studio churned out another record, it spent money on raw materials, processing, and shipping. Today, when artists invite you to download a tune, your extra download costs them virtually nothing. Of course, plenty of resources may go into the initial creation of an item. I co-founded an educational software company that makes math games for children based on the Math Arrow matrix. Designing the game, writing software code, and hiring cartoonists to draw Kyle the Kangaroo cost a great deal. But when a parent or child downloads the game to play, it costs the company very little. This model is vastly different from what Adam Smith, our first great economist, encountered in 1776. He observed a pin factory, not bytes zooming through a digital stream.
Across the United States, old monopolistic utilities have broken down as cable, satellites, fiber-optic, and wireless technologies compete for your television, smartphone, and streaming business. Every time your eye catches the glint of a rooftop solar panel on a home, a centralized power company sheds a tear. A striking advertisement once appeared in the Washington, D.C., area, touting a new telecommunications company. Posters displayed a statue of Lenin with a rope around his neck and the headline “No Empire Lasts Forever—Especially One That Keeps You Waiting 5 Hours for a Repairman.”
The scissors economy has not snipped out every middle person, of course. In a modern economy, most of us cannot avoid toiling in the middle. Very few of us spend the morning picking strawberries by hand or hammering steel on an anvil. But the scissors economy has placed a new burden on middle people: they must prove their value. Traditional retailers may lament the “Amazonization” of sales, but Amazon has carved itself a prosperous place directly in the middle of transactions, as have PayPal, Venmo, and others. Amazon’s success comes from stunning innovations: same-day delivery, rapid refunds, easily read customer ratings, and algorithms that may display sensible recommendations. Sears, a once mighty competitor that built the world’s tallest skyscraper in 1973 and was the nation’s largest retailer throughout the 1980s, trumpeted the slogan “Where America Shops.” By 2018, Sears had not innovated much and found itself booted from its tall building and instead in bankruptcy court. Will Amazon hold on to its lead, or will nimbler new competitors emerge to humble it?
Sweeping changes in European and Asian political economy command our attention. Europe has been stitching itself together and then breaking itself apart again. The Berlin Wall came tumbling down in 1989, freeing hundreds of millions of Eastern Europeans from Soviet drudgery and pushing them into competitive markets, where many have thrived and others have struggled. Within a few years of the Berlin Wall’s crumbling, Czech and Bulgarian versions of New Ideas from Dead Economists appeared, as newly freed minds searched to understand a market economy. In 2000, Western European nations gave up sovereign currencies like the German deutsche mark, Italian lira, and French franc in order to embrace the euro currency. In 2020, the United Kingdom, which clung to the pound sterling, waved good-bye to the European Union, frustrated by its political and legal demands. In Asia, the Japanese economy transformed itself from a threatening giant in the late 1980s into a humbled midget in the 1990s. The key Tokyo stock market, which climbed to 39,000 in 1989, collapsed and stood at just 19,000 in 2020. What happened to all those stories of superior Japanese management techniques? Meanwhile, China emerged as a powerhouse in world trade, its factories churning out more goods than any other country’s. This from a nation whose GDP barely showed up on a chart in the 1970s.
As the Soviet Union and the United States waged the Cold War, each had intercontinental ballistic missiles poised and aimed at the other, ready to destroy humanity. Most geopolitical strategists believed that a standoff—that is, a “stable Cold War”—was a good outcome that could, hopefully, be extended well into the twenty-first century. Not even Ronald Reagan, surely the most optimistic Cold Warrior, thought that the Soviet empire would crumble as swiftly and peacefully as it did after 1989. Many of his advisers and almost all his opponents urged caution. When Reagan implored then Soviet leader Mikhail Gorbachev to “tear down this wall,” State Department “experts” objected to the forceful yet fanciful dare. Why rile the Soviet bear and ask for an impossible task? It turned out that the bear was not so strong and the task not so farfetched. Only a few years later, East Berliners and West Berliners took picks and hammers to the wall in all-night celebrations while their radios blared the youthful, uplifting tunes of American rock and roll. Similar rejoicing took place in Warsaw, Prague, and Budapest.
Under German chancellor Helmut Kohl’s bold leadership, West Germany adopted East Germany, funneling generous financial gifts and resources to its poorer brethren. A fascinating study showed that East Germany would have been even further behind in 1989 had its communist government not engaged in spying and stealing secrets from West German technology companies!1 Today, residents of eastern Germany still earn less money than their countryman cousins, but they have surely adapted to Western capitalist ways. The Polish, Czech, and Hungarian economies have also strived to transform themselves. Despite economic turbulence, democratic elections have largely reinforced a pro-market approach and buried Soviet ideology. Even when former communist officials win parliamentary seats, they generally support market reforms. During a recent visit to Gdańsk—home of the Solidarity movement that brought down communism in Poland—I was impressed by the entrepreneurial energy of young Poles who had opened up shops throughout the medieval Baltic port city. Prague and Budapest and Tallinn, Estonia, also bustle in living color, rather than in the drab grays of the communist era.
In Russia, the path has been bumpy. In 1998, Russia looked economically defunct, as the ruble lost most of its value and panicked sellers hammered the Russian stock market into rubble. Foreign investors who held Russian bonds could use them for wallpaper. Why did Russia’s capitalist experiment fail? A not-so-funny thing happened on the way to the free market: the country took a dangerous detour into “crony” capitalism, in which former communist bosses exploited their connections, twisting former state monopolies into private monopolies that they continued to control. Managers of mines made fortunes by smuggling precious metals out of the country by rail, by truck, and even tucked in the pockets of trench coats. The iron hand of the Soviet police lost its grip, and the new democratic Russia had only a flimsy legal system to deal with crime and settle business disputes. Moscow, with its fancy clubs populated by newly rich racketeers, more closely resembled Chicago under Al Capone than a developed country. Billionaire barons set up their own private security forces. Moreover, President Boris Yeltsin’s government could not figure out how to force these barons to pay taxes. Thus, the Russian government ran up a huge budget deficit, forcing it to borrow money from foreigners by selling them bonds. After a frenzied bubble of stock market gains in 1996 and 1997, the country looked corrupt, bankrupt, and ready to erupt. So Russians and foreigners snuck their money out of the country, erasing the modest wealth built up by a new middle class.
Is there a lesson here, or just a depressing tale? Russia’s 1998 debacle teaches us that a market economy must rest on a dependable legal system. A free market does not mean utter chaos; it requires ground rules. Without courts to enforce contracts, police to punish mafiosi, and agencies to collect taxes, Russia detoured into crony capitalism, a voyage of the doomed. In the West, they say that justice is blind. Russia’s problem was that she was blind to justice. Of course, Russia has failed before. The entire twentieth century was an economic failure. Visiting regal old cities like Saint Petersburg and Odessa (in Ukraine) and witnessing breathtaking nineteenth-century architecture and stunning opera houses teaches one that the problem with communism was not that it couldn’t keep up with capitalism; the problem was that it couldn’t even keep up with the standards of the czars in 1917. Let’s hope for a new Russian revolution in this still-young twenty-first century, a revolution that finds a place for both economic liberty and the rule of law. Over the past twenty years, President Vladimir Putin has presided over periods of strong growth, but he has yet to shatter the iron shackle on Russia’s economy: its reliance on selling heavy metals and slick sludge to others. Rich in oil, natural gas, and gold, Russia booms when world commodity prices soar but stumbles when they crash. The rebirth of the U.S. energy industry, which now pumps out more oil than any other country, threatens Russia’s future profits. Until it further diversifies, Russia cannot boast of a nimble economy but can only brag that it is the world’s best-stocked pantry.
When I wrote the first edition of New Ideas from Dead Economists, scholars and journalists were crowning Japan as the king of the world economy. Books with titles such as Yen! Japan’s New Financial Empire and Its Threat to America and Trading Places: How We Are Giving Our Future to Japan painted a picture in which Japan would take over the world, and Americans would be reduced to flipping hamburgers to make ends meet. Japanese speculators collected Van Goghs, Monets, and golf course memberships as if they were souvenir tokens. They bought up downtown Los Angeles and the best properties in Hawaii. Their banks dominated the financial industry, and analysts calculated that the land beneath the Imperial Palace in Tokyo was worth more than all the land in California. A prominent Japanese politician wrote a bestselling book condemning U.S. hegemony, called The Japan That Can Say No. How the mighty have fallen! Japanese investors turned out to have a reverse Midas touch, turning precious assets into worthless trinkets. Along with a devastating slide in the Tokyo stock market, the price of Impressionist paintings sank along with that of Hawaiian real estate. Their investments in movie studios left them with staggering losses, as slick Hollywood producers ripped them off. Back in Japan, arrogance turned to humility and fear, as property prices and incomes dropped. In 1998, interest rates fell to zero, meaning that you could borrow money from the government for free. The only thing that rose was the jobless rate.
What happened? The quick answer is that in 1989 the Japanese central bank jacked up interest rates to deliberately pop a bubble in the stock market. But that does not explain a nearly ten-year plunge. Two culprits come to mind. First, the Japanese government encouraged its premier corporations to dominate the manufacturing sector, while the United States was shifting toward service industries like finance and health care. Though Japanese banks dominated the world in size, they lagged way behind in profitability and sophistication. Most of the new financial products, from stock index funds to complex derivatives, were made in the United States or the U.K. Why didn’t Japanese companies develop these ideas? They faced little competitive pressure at home. The Ministry of Finance protected the insurance companies from the savings banks and the savings banks from the corporate banks. Whereas in the United States these industries faced ferocious competition from each other, the Japanese government created fiefdoms that were safe behind bureaucratic walls. The ministry basically forced households to pour their money into pitifully low-yielding bank accounts, giving firms a captive audience. Adam Smith would have seen it coming. By keeping their home turf sedate, they imperiled their ability to fight in the real world.
Japan looked feeble in information technologies, too. When a Japanese friend of mine first encountered the Internet and noticed that almost all the websites were in English, he shook his head and said, “We’re toast.” Although Japanese businesses successfully won market share in manufactured goods like electronics, they found their prices undercut by South Korean and Malaysian factories. Soon they gave up the fight and closed down Japanese factories and opened up cheaper ones in China. The concept of “lifetime employment” died, deflating the confidence of working men and women. Japanese commentators called the phenomenon the “doughnut” economy, as the economy turned hollow.
These structural flaws came along with incompetent fiscal and monetary policy. Essentially, the Bank of Japan waited too long before cutting interest rates, and the Ministry of Finance actually pushed up tax rates in the middle of a recession. John Maynard Keynes (see chapter 9) taught the world that during the Great Depression, you shouldn’t punish consumers when the economy is rushing down the drain. The message apparently did not make it into Japanese until recently, though New Ideas from Dead Economists has been available there since 1991! Under Prime Minister Shinzō Abe’s “Abenomics,” Japan finally made some forward progress. Abe urged the central bank to disregard inflation fears and to instead flood the economy with yen to encourage consumers. Abe’s biggest problem is more structural. The population is aging as fast as sushi left out in the sun: by 2050, senior citizens will make up 40 percent of the population; and by 2100, Japan’s population will be one-third smaller than in 2000. Abe has tried to get around the demographic stumbling block by encouraging more women to enter the workforce. He declared that “Abenomics is Womenomics,” and now a higher proportion of women hold jobs in Japan than in the United States or Europe. But of course those female employees are aging and will eventually retire. To avoid becoming the land of the setting sun, Japan may have to become the land of the rising robots.
China’s emergence since 1990 looks awesome and a little frightening, as it galloped along at a pace of 10 percent GDP growth each year between 1990 and 2012. When I traveled to Shanghai in 1993, the city’s beautiful old art deco buildings along the Bund dominated the skyline. The Peace Hotel, which my father had visited as a seventeen-year-old sailor at the end of World War II, still captured the imagination. By 2005, an entire new city with dozens of futuristic skyscrapers had emerged across the river in Pudong, casting literal and metaphoric shadows over the colonial past. Between 1990 and 2005, about half a billion people had been lifted from poverty.2 This is likely the greatest victory in the war on poverty in the history of the world.
If you read the financial press, you will hear that nearly every hiccup in the world economy may be blamed on China. High oil prices? China must be hoarding. Low interest rates? China must be snapping up too many U.S. Treasury notes. Fewer manufacturing jobs? China must be stealing them. A lethal pandemic? Someone must be noshing on an undercooked bat in a Wuhan “wet market.” True, China is a mammoth force in the global economy today, especially considering that the country was an economic invalid just thirty years ago. In chapter 6, on Karl Marx, we will see how Deng Xiaoping dismissed Maoism and sent his people scurrying not for copies of Mao’s Little Red Book of communist quotations, but for copies of Harvard’s crimson MBA manual. Despite China’s current triumphs in world trade, the next ten years will pose extreme challenges. Like Japan, China will hit a demographic wall when it has to support more senior citizens with fewer young workers. Its quick-rising middle class will spend more abroad on tourism, health care, and luxury goods. When countries move from poverty to middle-class status, they desire three things: cars, protein (meat and grains), and health care. This provides enormous opportunities for foreigners to sell goods there, if the Chinese government permits more imports. The switch to cars has already taken off, and you can see Beijing choked with automobiles that spew fumes and trample over traditional bicycles. China’s future will be rocky, fascinating, and, hopefully, a force for global prosperity.
Most people, including many professional economists, think about a country’s economy like a potential home buyer thinks about a model home. It’s awfully hot in Costa Rica! How lucky that Venezuela has oil! Too bad Australia is so far away from the action! The cliché “location, location, location” might work well for buying a three-bedroom colonial in Peoria, but it’s hardly worth a hill of beans when analyzing a country. Take Mexico, please. Mexico has enjoyed a great location, right on the U.S. border. It hasn’t moved. Yet America’s wealth and technology have not rubbed off much. Now look at prosperous Australia—a twelve-hour flight even after you change planes at LAX! And settled by criminals who sailed on leaky boats!
Economic textbooks spend a lot of time focusing on “factor endowments,” telling us that a country blessed with lots of minerals and natural resources has a big advantage. Really? Hong Kong is a pile of rocks. The Netherlands was a sinking Venice, but without the charming bridges or the spumoni, and yet in the seventeenth century it leapfrogged its better-endowed neighbors. And then there’s Israel today. It may be settled by God’s chosen people, but He chose not to give them a drop of oil, while gushers spout across Arabia. Read Mark Twain’s description of the arid and empty land. Israel’s terrain doesn’t naturally grow enough green for a sprig of parsley on your dinner plate, and yet there she blooms. In the race for economic development, would you rather bet on a country with a million tons of endowed zinc or one with a couple of extra IQ points and a free flow of ideas?
A big endowment of riches may even be a curse. The earth under many parts of Africa bulges with metals. And yet some of the most promising economies are retarded, as oligarchs like Robert Mugabe in Zimbabwe hung on to power for four decades, preventing capital from diffusing through society. Think back to the schoolbook atlases that displayed the natural resources of each country. As a kid, I always thought it unfair that the evil Soviet Union seemed to have all the great stuff, even bauxite, which sounded like a mysterious, earthly version of kryptonite, a bad thing in an enemy’s arsenal. But the Soviet system had a reverse Midas touch, too. It turned precious metals and rich soil into famine and poverty. Way back in 1500, when Yuan dynasty vases were being baked, the Chinese had all the technology they needed to beat England to the Industrial Revolution. But the mandarins of the time stomped on trade and financial flows. Because leftists refused to believe that “attitude beats latitude,” they felt sorry for and made excuses for the Soviet Union’s seventy years of bad weather. As Ronald Reagan put it, there are just four things wrong with communist farming: “spring, summer, winter and fall.”
What counts most, then? Attitude, not latitude. And the best indication of a country’s attitude may be the wisdom it gleans from the great economists.
The history of economic thought teaches us that success often goes to the hungry, the humble, and the limber. And that is what you will learn in the pages ahead.
The 1990s and early 2000s gave us plenty of opportunities to test the wisdom and assess the musings of the great economists. And now as we head toward the middle of this century, we will face fresh and sometimes baffling challenges—and the ideas of the dead economists will be there to help.
San Diego, California
January 2020