Western civilization was being transformed by two great movements: the economic changes which we sum up as the rise of capitalism, and the changes in knowledge which we sum up as the scientific movement.
—GEORGE NORMAN CLARK, 1949
The band of commerce was designed
To associate all the branches of mankind;
And if a boundless plenty be the robe,
Trade is the golden girdle of the globe.
—WILLIAM COWPER, 1782
For an allegedly dismal science, economics generates lots of jokes. Economists, it is said, are frequently wrong (they “forecast twelve of the past three recessions”), tend to be noncommittal (“If you laid all the world’s economists end-to-end, they would not reach a conclusion”) and like to hedge their bets (“I asked an economist for her phone number and she gave me an estimate”). Harry Truman wanted a one-armed economics advisor who wouldn’t keep saying, “On the other hand.” Ronald Reagan speculated that if economists had invented Trivial Pursuit, the game would have a hundred questions and three thousand answers. As early as 1855, Walter Bagehot of the Economist was claiming that “no real English gentleman, in his secret soul, was ever sorry for the death of a political economist.”
Part of this is guilt by association. As a social science, economics tends to get lumped in with “soft” disciplines like cultural anthropology, much of which reads like fairy tales translated into Esperanto, and the psychoanalysis of Sigmund Freud, who discovered nothing and cured nobody. But the social sciences labor under two hobbling limitations—a constrained ability to conduct experiments (they cannot very well force human subjects to run mazes) and the lack of a dependable metric by which to quantify indistinct matters like human happiness, hope, anxiety, or fear. Economics suffers far less from these limitations. The financial world provides a ready-made metric—in the form of money, which generates a constant flood of hard, quantifiable data—and innumerable laboratories in the form of markets, which by their very nature involve constant experimentation. This has allowed economists to make important discoveries about profit and loss, prosperity and poverty, and the financial effects of governmental policies.
When the historian Thomas Carlyle characterized economics as “dismal,” he was responding to the admirably specific predictions of Thomas Malthus, who in his 1798 Essay on the Principle of Population argued that human population growth was unsustainable. Malthus’s thesis was that a well-nourished population would grow geometrically (1, 2, 4, 8, 16…) while the cultivation of crops to feed all those new mouths, limited as it was to available land, could only grow linearly (1, 2, 3, 4…). A “gigantic inevitable famine” thus stalked the human future, concluded Malthus, who conceded that his prediction had “a melancholy hue.”
Dismal though it may have been, the Malthusian hypothesis qualified as genuinely scientific: It was logical, quantitative—and it could be tested, by waiting to see what happened. As time passed, the number of mouths to feed did indeed increase. During the nineteenth century the population of England quadrupled, that of Europe more than doubled, and the world population climbed from about 900 million to 1.6 billion. Yet mass starvation did not result. Instead, farmers became much more productive than Malthus could have foreseen. Thanks to technological innovations and an increasing penchant for agronomic research and experimentation, English farmers by 1800 were feeding twice as many people as they had a century earlier, with half as much labor. Food production continued to soar thereafter while the number of agricultural laborers in England shrank from three-quarters of the workforce in 1690 to one-quarter by 1840. Progress in the United States was even more spectacular. From 1800 to 2000, the American agricultural workforce diminished from 70 percent to under 2 percent of the population, during which time American farms became thirty-five times more productive. Famine still occasionally raised its ugly head—its last European appearance being the Irish potato blight of 1845–1852, which resulted in a million deaths—but overall, Europe and the rest of the developed world managed to sustain ever larger populations with an ever smaller portion of its workforce. Malthus could still be proven right in the long run, of course, should the global population eventually outrun science and technology, but as the world becomes more urbanized and its population growth rate slows, it now appears that the human population will stabilize at something under twelve billion by about the middle of this century. So Malthus was probably wrong, and economics is not necessarily dismal.
Needless to say, our planet still faces many economic problems. Nearly 900 million people struggle to get by on less than a dollar a day, while Europe and the United States spend more on pet food than it would cost to feed them all. The world’s three hundred richest individuals have more money than the entire bottom half of humankind, while the per capita GDP of wealthy countries like Luxembourg, Switzerland, and the United States runs to fifty times that of poor countries like Sierra Leone, Tanzania, and Congo. But there have also been remarkable gains. In the past quarter century, the number of people in the developing world living on less than a dollar a day has been cut almost in half—down from nearly 1.5 billion to 900 million between 1981 and 2008, despite a simultaneous increase in world population—and the proportion of the world’s population living on under two dollars a day was halved between 1983 to 2003, although by 2009 a global slump had begun eating into some of those gains.
Confronted with this dynamic, it is important to understand not only what went wrong but what is going right. To continue to reduce hunger we need to identify its causes (they include civil war, bad government, and bad roads) rather than just feeling guilty about it or blaming the rich. (Soaking the rich to aid the poor wouldn’t work. If the entire wealth of all the world’s millionaires were confiscated and doled out to everybody else, the one-time giveaway would yield each person less than a year’s wages, while the global economy sank into depression for want of investment.) Until recently, science was of only marginal help in understanding such processes, involving as they do billions of people living in many different cultures. But the much-maligned science of economics has now begun to have a substantial impact. Indeed, economics has done so much to analyze problems and identify remedies that it may one day be ranked with the agricultural and medical sciences when it comes to saving lives and improving their quality.
To appreciate the dimensions of the change, consider how our predecessors thought about wealth and poverty before economics came along.
For nearly a thousand years after the fall of Rome, Europe was poor and stayed poor. It was a time, in the words of the historian William Manchester, of “incessant warfare, corruption, lawlessness, obsession with strange myths, and an almost impenetrable mindlessness,” a time when societies typically were “anarchic, formless, and appallingly unjust.” Per capita GDP long remained flat, at less than five hundred dollars per person per annum, and when it finally started to grow did so very slowly, by perhaps a tenth of 1 percent annually from around AD 1000 to 1600. (The American economist J. Bradford DeLong estimates that it took twelve thousand years for humanity worldwide to rise from the $90 annual “income” of the ancient hunter-gatherer to $180 by 1750. Thereafter it climbed to a global average of over $7,000 today.) Crop failures brought famine one year in four, and even in good years only the most prosperous farmers harvested enough grain to keep their families fed until much past Easter, whereupon many were reduced to foraging for herbs and roots. Malnutrition was so persistent that in the eighteenth century, when the Brothers Grimm set about collecting old fairy tales, they encountered hauntingly recurrent themes of people going hungry and happy endings in which the hero or heroine for once has enough to eat. The median life expectancy of Europeans overall was thirty years of age; that of females, who were apt to die in childbirth, only twenty-four. Ignorance was ubiquitous: Few could read, write, do sums, or recount the history of the hamlet in which they were born and were likely to die. Innovation was almost unheard of. Waterwheels, introduced in the 800s, and windmills, which appeared in the 1100s, were the only two medieval inventions of any consequence. As Manchester describes the prevailing mindset, “The Church was indivisible, the afterlife a certainty; all knowledge was already known. And nothing would ever change.” Europeans were not only unaware of any prospect of improvement, “They were convinced that such a phenomenon could not exist.”
Unsurprisingly, given Europe’s fiscal and intellectual paralysis, the economy was regarded as a zero-sum game: There was a fixed amount of wealth in the world, so for one person to do better, another—or many others—had to do worse. As it was with individuals, so it was thought to be for states. A nation’s prosperity was measured by the amount of wealth it possessed—gold, usually—and the object of foreign trade was to see that your nation wound up with more gold than the others, at their expense. (Even Francis Bacon, who strived to imagine the scientifically advanced world of the future, failed to envision a non-zero-sum economy: “The increase of any estate,” he wrote, “must be upon the foreigner.”) Should the citizens of another country produce better, cheaper goods than yours did, the remedy was to wall yourself off from the perceived threat by erecting protectionist trade barriers. To borrow money, a step without which only a fortunate few could build a business or launch a trade expedition, was frowned upon; to lend money at interest was a sin, punishable by excommunication. (A popular twelfth-century folk tale had it that a usurer, upon arriving at church to be married, was crushed by the toppling statue of another usurer—irrefutable evidence of God’s opposition to moneylending.) Amid rampant poverty, ignorance, and fear, the monarchs and bishops who held the pursestrings were quick to affirm that only their autocratic, top-down control of economic affairs prevented financial chaos.
This long economic ice age began to thaw—spottily, with the Italian Renaissance and the rise of the Dutch Republic, then more widely by the eighteenth century—thanks to four principal innovations: readier access to capital, once religious prohibitions against moneylending were relaxed; the growth of human rights and the rule of law; improved communications and transportation (beginning with the advent of reliable steamships in the early nineteenth century and competitive land transport a half century later); and the rise of science, which demonstrated how people could, as Descartes had dreamed, become “masters and possessors of nature.”
Encouraged by Bacon and other prophets of scientific progress, a few creative agrarians began experimenting. These “improving” farmers tried crop rotation, seed selection, and new tools that made farming less labor-intensive, freeing young men and women to try their hand at trades and factory work. Technological innovations and job specialization gradually amplified the productivity of the swelling industrial labor force until a growing class of merchants, capitalists, and tradesmen began to attain real wealth. The English “gentleman” whose cultivated manner, elegantly understated dress, and tasteful country house are still being imitated today belonged not to the aristocracy but to the gentry.
These changes, salutary in hindsight, were by no means universally welcomed at the time. Thousands died in riots protesting sixteenth-century English crop enclosures—the walling-off of farms to replace medieval commons with privately owned vegetable gardens and grazing pastures—although enclosure boosted production by giving farmers a proprietary stake in the land they worked. Oliver Goldsmith expressed the sentiments of many poets, for whom economics was seldom a strength, in his book-length poem “The Deserted Village”:
Ill fares the land, to hastening ills a prey,
Where wealth accumulates, and men decay.
When British weavers’ guilds protested to the king about competition from an innovative, mass-production wool factory, the factory was shuttered and its operating techniques outlawed. Sixteen thousand people were executed—many of them hanged, others broken on the wheel—in France in 1666 for unauthorized trading in imported calicoes. Clerics complained that a lust for gold was sullying their parishioners’ love of God. “This new unwanted society,” writes the historian Robert L. Heilbroner, was “at every step…misconceived, feared, and fought. The market system with its essential components of land, labor, and capital was thus born in agony—an agony that began in the thirteenth century and had not run its course until well into the nineteenth.”
Yet free-market capitalism survived and grew, as an acquired taste for profits, personal freedoms, and the material benefits of scientific and technological innovation spread from Europe to America and beyond. The capsizing of the old order called for new insights: “There is nothing,” wrote Samuel Johnson, “which requires more to be illustrated by philosophy than trade does.” Johnson had not expected such a work to be produced by Adam Smith—whose interests were primarily scientific, who had no personal experience in business, and whom Johnson thought “as dull a dog as he had ever met”—but it was Smith’s Wealth of Nations that began to make sense of it all.
The posthumous son of a Scottish customs officer, Smith grew up as a sickly child, closely watched over by an anxious mother whose anxieties redoubled when the boy, at age three, was briefly kidnapped by Gypsies. He studied mathematics and science at Oxford for six years, served for thirteen years as professor of logic and philosophy at the University of Glasgow—“by far the most useful, and therefore as by far the happiest and most honorable period of my life”—then traveled in France, where he was impressed by the vibrancy of experimental democratic states like Toulouse, which had its own parlement and institutes of art and science. Back in Scotland, Smith completed the Wealth of Nations and then moved to London, where he was feted by the likes of Gibbon and Burke—and by Benjamin Franklin, from whom he learned enough about the colonies to predict that America “seems very likely to become one of the greatest and most formidable [nations] that ever was in the world.” He died in 1790 at age 67, having enjoyed the uncommon experience of seeing his ideas put into political practice with beneficial effect.
Smith was a deeply preoccupied character, whose many peculiarities have tempted biographers to portray him as a figure of Newtonian eccentricity. Given to shy silence in social settings, he mumbled to himself in public; walked with a strange, rolling gait; and dictated drafts of Wealth while rubbing his head against a particular spot on the wall of his study, symptoms which suggest to doctors today that Smith suffered from Tourette's syndrome or Parkinson’s disease. He lectured without notes, in a tangled syntax that made him hard to follow, but his students adored him, James Boswell went out of his way to hear him speak, and his colleagues at Glasgow praised “his happy talent of throwing light upon the most abstract subjects [and] his assiduity in communicating useful knowledge,” calling him “a source of enjoyment as well as of sound instruction.” Nor did his oddities prevent his forming lasting friendships, notably with the philosopher David Hume—himself a critic of the prevailing economic philosophy who had pointed out that hoarding gold only inflated its price. The diffident Smith and the coolly acerbic Hume talked, corresponded, and critiqued each other’s manuscripts for more than thirty years. Upon reading the manuscript of Smith’s Wealth, Hume predicted that it would “fix the attention of public opinion.”
That it certainly did. Smith’s Wealth of Nations may be the one book between Newton’s Principia and Darwin’s Origin of Species that actually, substantially, and almost immediately started improving the quality of human life and thought. Despite its considerable length—380,000 words, more than twice that of the New Testament—Wealth was widely consulted, going through five editions in fifteen years. The prime minister, Lord North, took Smith’s ideas to heart when drafting the British budgets of 1777 and 1778. William Pitt, one of the most powerful figures in the government, is said to have told Smith, “We are all your scholars.”
Smith’s influence has continued to grow across the centuries, but precisely because the liberal-democratic, scientific nations of the twenty-first century evince so much of his program, detailed accounts of it tends to strike us as largely self-evident—as is the case for Newton and Darwin. Nevertheless it may be useful to briefly recount his major findings.
Smith’s approach to economics, if insufficiently quantitative to pass muster today, was scientific in at least three respects. First, Smith was more interested in understanding human affairs as they are than in urging how they ideally ought to be; he sought to establish what is before prescribing what should be. This set him apart from the moralizing and sentimental bent of many prior philosophers, among whom he counted even the rationalistic Descartes. (Smith remarked that the Cartesian philosophy “does not perhaps contain a word of truth,” dismissing it as “one of the most entertaining romances that have ever been wrote.”) He was equally critical of ancient philosophers like Cicero and Seneca, whom he assailed for treating the works of Greek mathematicians and astronomers with “supercilious and ignorant contempt.” This opinion was not unprecedented—Bernard Mandeville too attacked what he called the “sentimental moralists”—but it was sufficiently original that Smith to this day is criticized as amoral or even immoral for refusing to imagine that he could improve people by preaching to them in print. Second, Smith stressed quantitative analysis whenever possible—seeking, as William Petty had put it in his Political Arithmetic of 1690, to “express myself in terms of number, weight, or measure; to use only arguments of sense, and to consider only such causes as have visible foundations in nature” rather than resorting to “superlative words and intellectual arguments.” Third, Smith’s approach was empirical. Rather than reasoning from first principles, as Descartes did, or from pleasing fantasies à la Rousseau, he based his arguments on dispassionate observations of the real world. Wealth is crammed with examples of how bakers, spinners, weavers, rice planters, coal miners, shipbuilders, herring fishermen, masons, bricklayers, clockmakers, road builders, goldsmiths, and landlords actually conduct their affairs.
Out of this empirical, somewhat quantitative, and thoroughly unsentimental analysis, Smith produced a revolutionary account of the creation of wealth and the functioning of markets. The wealth of a nation, he asserted, is properly to be measured not by its stores of gold but by the quantity, quality, and variety of goods its citizens consume. For Smith, the consumer is king—a point that in later years was often lost sight of, when his name became associated with the laissez-faire economics that critics of capitalism blamed for the perceived excesses of “rapacious industrialists” and “robber barons.” The world’s gold supply is limited (even today, there’s not enough of it in circulation to fill the Washington Monument) but the production of consumer goods can be increased indefinitely if individuals are free to invest and to innovate.
The eighteenth century being a period of bustling inventiveness, Smith was able to find many examples of how innovations improve the quantity and quality of consumer goods. To make his case as simply as possible he opened Wealth with a very basic example, the division of labor in the manufacture of pins. Smith relates that he visited a small pin manufactory and found that it took “about eighteen distinct operations” to make a pin: “One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top,” etc. Thanks to this division of labor, ten workers could make almost five thousand pins a day; without it, “they certainly could not each of them have made twenty, perhaps not one pin in a day.” Another source of more efficient production was, of course, machinery—“beautiful machines,” Smith exclaims, “which facilitate and abridge labor, and enable one man to do the work of many”—none but the most rudimentary of which could be fashioned without divisions of labor. Writing, money, and financial ledgers were other examples of inventions that increase wealth. Inventions could arise almost anywhere, Smith noting that even children had invented useful devices. “It was probably a farmer who made the original plough,” he muses, and “some miserable slave…grinding corn between two stones, probably first found out the method of supporting the upper stone with a spindle. A millwright perhaps found out the way of turning the spindle with the hand; but he who contrived that the outer wheel should go by water was a philosopher”—that is, a scientist—“whose business it is to do nothing, but observe everything.” There was almost no limit to the potential economic growth of a nation whose people were free to exercise their creativity and to profit from it.
Smith’s analysis of markets has the excited air of a scientist making a great discovery—which in a sense it was, comparable to Newton’s dynamics or the discovery of binary computing. Free markets link prices to production. If prices get too high—Smith disparaged “exorbitant” prices, an appropriately Newtonian word meaning “out of their orbits”—suppliers will increase production and prices will soon come down again. If prices get too low, profit margins will shrink, supplies diminish, and prices rise accordingly. In this manner, Smith noted, again in Newtonian language, prices are “continually gravitating, if one may say so, towards the natural price.” Regulations and other legal restrictions are appropriate only insofar as they are required to keep the market fair and free. The beauty of a free market is that it benefits society as a whole without requiring its participants to act out of any loftier motive than the self-interested pursuit of personal gain: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.” In what has become the most famous passage of Wealth, Smith depicts the benevolent and self-regulating dynamics of marketplace as akin to the guidance of an “invisible hand.”
Every individual necessarily labors to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security [but] by pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.
As with domestic markets, so too with foreign trade:
If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them…. The general industry of the country…is certainly not employed to the greatest advantage when it is thus directed towards an object which it can buy cheaper than it can make.
If a nation erects trade barriers on, say, wool, to prevent cheap foreign wool from cutting into the domestic trade and costing jobs, the effect is to create a monopoly that obliges people to pay an inflated price for wool, leaving them with less to spend on other goods and so tying up domestic labor and capital. Interference with free trade reduces overall domestic productivity.
Smith was neither the first to propose that production is the engine of wealth (that came from François Quesnay, a French economist he met in Paris) nor the first to study markets. His contribution was to have combined these and other elements, along with his own experience and analysis, into a penetrating account of how the free market—what he called a “simple system of natural liberty [in which] every man, as long as he does not violate the laws of justice, is left perfectly free to pursue his own interest his own way”—facilitates both personal gain and social welfare. “Opulence and freedom,” he wrote, are “the two greatest blessings men can possess.”
He was at pains to show to how paltry an extent free trade was being permitted to function in the real world. Instead of encouraging individual initiative and the growth of industry, governments and guilds passed laws and rules constraining innovation and improvement. International trade was everywhere impeded by protectionist tariffs. Smith called the prevailing system mercantilism, meaning that it served only the shortsighted desires of merchants, about whom Smith harbored few delusions: “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.” The solution resides not in government intervention—“It is impossible indeed to prevent such meetings by any law which either could be executed, or would be consistent with liberty and justice”—but in permitting free markets to function on a level playing field.
Smith anticipated the importance of information to free markets, a connection much less evident in the eighteenth century than in today’s knowledge-based economies. He noted the superiority of an ordinary farmers’ market, where you can see much of what’s going on, to real estate transactions, which are conducted less openly and involve goods more difficult to compare with one another. Lack of information, he observed, hits unorganized working people the hardest:
Though the interest of the laborer is strictly connected with that of the society, he is incapable either of comprehending that interest or of understanding its connection with his own. His condition leaves him no time to receive the necessary information, and his education and habits are commonly such as to render him unfit to judge even though he was fully informed. In the public deliberations, therefore, his voice is little heard and less regarded, except upon some particular occasions, when his clamor is animated, set on and supported by his employers, not for his, but their own particular purposes.
Merchants are better informed, and hence better suited for doing business, than are gentry dabbling in trade: “Their superiority over the country gentleman is not so much in their knowledge of the public interest, as in their having a better knowledge of their own interest than he has of his.” Professional traders, being constantly updated on the state of trade, are superior to regulators in setting prices:
The inland corn dealer…is likely to sell all his corn for the highest price, and with the greatest profit; and his knowledge of the state of the crop, and of his daily, weekly, and monthly sales, enable him to judge, with more or less accuracy, how far they really are supplied in this manner. The interest of the corn merchant makes him study to do this as exactly as he can: and as no other person can have either the same interest, or the same knowledge, or the same abilities to do it so exactly as he, this most important operation of commerce ought to be trusted entirely to him; or, in other words, [so] the corn trade…ought to be left perfectly free.
Smith foresaw that free trade and a free flow of information could improve the lot of the poor and oppressed. The “dreadful misfortunes” that have befallen the inhabitants of the East and West Indies, he observed, resulted from their having encountered Europeans “at the particular time when…the superiority of force happened to be so great on the side of the Europeans that they were enabled to commit with impunity every sort of injustice in those remote countries.”
Hereafter, perhaps, the natives of those countries may grow stronger…and the inhabitants of all the different quarters of the world may arrive at that equality of courage and force which, by inspiring mutual fear, can alone overawe the injustice of independent nations into some sort of respect for the rights of one another. But nothing seems more likely to establish this equality of force than that mutual communication of knowledge and of all sorts of improvements which an extensive commerce from all countries to all countries naturally, or rather necessarily, carries along with it.
In other words, maximizing the free flow of information is not just admirable in itself, but can blaze a path to prosperity.
Smith had hoped that by applying what he called the “Newtonian method” to economics, it might be possible to identify natural laws of finance comparable to Newton’s laws of physics. Newton himself had expressed a similar expectation. “If natural philosophy in all its parts, by pursuing this method, shall at length be perfected,” he wrote of his own physics, “the bounds of moral philosophy will also be enlarged.” In terms of cross-pollination it is intriguing to note that Newton wrote a paper on economics and Smith a history of astronomy—which, Smith informed his literary executor, was in his opinion the only unpublished manuscript in his archives worth preserving. Smith sought to identify Newtonian action-and-reaction forces at work in commerce, leading to states of equilibrium comparable to the steady course of planets in their orbits. The extent to which he accomplished this task is not always appreciated. Although Smith’s invisible hand is sometimes compared to Newton’s gravitational force—inasmuch as both agencies cannot be perceived yet are constantly and consequentially at work—Smith’s resemblance to Newton goes deeper than that. Like Newton he discovered “an immense chain of the most important and sublime truths, all closely connected together.” The important thing about such a chain is not its invisibility (if perceptible, it would have been discovered long before) but its universality, its ability to predict a wide variety of activities in terms of a few basic precepts. No great scientific mind was required to discern that the sun makes crops grow, or that goods may be sold for profit in a market. But to quantify how gravitation holds the moon in its orbit, or to demonstrate how free markets establish fair prices and promote the efficient production of goods, required the insights of Newton and Smith.
It is often remarked that British economics after Smith proceeded in an almost unbroken chain down to the present day. Smith’s friend David Hume was close to Daniel Malthus, an eccentric botanizer and Rousseau devotee whose utopian reveries his son, Thomas Malthus, sought to deflate by arguing that social improvements were doomed to fail should a growing population breed famine. Thomas Malthus was himself a bridge: He obtained population data from Ben Franklin to support his thesis, which in turn kindled Charles Darwin’s first musings about evolution through natural selection. In a curious pairing, Malthus, an underpaid academician with a cleft palate, became best friends with David Ricardo, a glittering socialite and brilliant businessman who amassed a fortune by age forty. Both had intellectual tastes that ran counter to the interests of their respective social classes: Ricardo, whose accumulations of wealth demonstrated his command of practical finance, wrote mostly theory and opposed the interests of wealthy landlords, while the academic Malthus supported the landlords and evinced an almost journalistic fascination with real-world events. Ricardo always expressed his “admiration” for Malthus’s research, and Malthus said of Ricardo, who died suddenly at age fifty-one, “I never loved anybody out of my own family so much.”
Ricardo had been encouraged to get into economics by his friend James Mill, an opinionated historian who applied Locke’s blank-slate theory of the human mind to the education of his eldest son, John. The boy obediently studied Greek from age three and Latin from age eight. At thirteen he had mastered differential calculus, written three works of history, and learned just about everything there was to know about economics. These labors left no time for friendship, play, or leisure: “I was never a boy,” recalled John Stuart Mill. He suffered a breakdown, then recovered by delving into the Romantics, falling in love, and eventually getting married, a sentimental education that took none of the edge off his clearheaded philosophizing. Mill’s System of Logic stressed the fecundity of scientific induction and helped liberate logic from its preoccupation with syllogistic deduction, while his On Liberty—published in 1859, the same year as Darwin’s Origin of Species—reinforced the foundations of political liberalism. In his Principles of Political Economy, Mill argued that economic productivity is based on fixed, impersonal laws of nature, so that interference with free markets, “unless required by some great good, is a certain evil.” He regarded government involvement in economic matters with the same mixed feelings as economists do today. “There are some things with which government ought not to meddle, and other things with which they ought,” he wrote, while conceding that the question of which is which “does not…admit of any universal solution.” This rare ability to distinguish between questions he could answer and those better left for future generations, plus his comprehension that economics could become an objective science, made Mill’s work a bulwark of the liberal-scientific tradition. One of Mill’s closest readers was Alfred Marshall, who brought an unprecedented mathematical sophistication to money matters and helped create the “neoclassical synthesis” from which much of modern economics is derived. The intersecting lines of Marshall’s supply-and-demand graphs are as familiar to economists as Feynman diagrams of particle interactions are to physicists.
Economics has since spread across the intellectual landscape like a river delta. Some of its theories are so exotic as to have no evident connection with the real world, while others are practical enough to prove useful when asking for a raise or mortgaging a home; overall, their benefits may ultimately rank with those of electronics and the agricultural “green revolution.” Their success story has been overshadowed, however, by the spectacle of ongoing controversies, which are often cited as evidence that economists are indecisive and poor at making predictions. To glimpse the reality behind the myth, consider two of the best-known competing schools of economic theory, both of which are concerned with the role of government in financial affairs.
One school, associated with the work of Marshall’s student John Maynard Keynes, values free markets but favors active government intervention to dampen the shocks of economic cycles—such as raising interest rates to slow inflation, or spending public funds to kick-start a sagging economy. Keynes saw the alleged equilibrium of the free market portrayed by Marshall and other neoclassical economists—its ability to settle on pricing points as naturally as the pulsations of a variable star—as merely a “special case.” Markets, like stars, can flare up and explode, and it “is misleading and disastrous” to imagine that national leaders should ride out an economic downturn with folded arms, waiting for the market to right itself, if doing so means that millions cannot meanwhile provide for their families. Free-market forces may calm the tempest in the long run, but, as Keynes famously remarked, “In the long run we are all dead.” Keynes’ immediate influence was substantial—the 1944 British White Paper on Employment Policy and the U.S. Employment Act of 1946 both stated that it was government’s “responsibility” to assure high and lasting employment levels—and most liberal-democratic governments today routinely take Keynesian steps to fight unemployment, inflation, and recession. Even President Richard Nixon, a Republican, declared, “We are all Keynesians now.”
On the other hand (as economists allegedly like to say) there is the Chicago school. Associated with Milton Friedman and his colleagues at the University of Chicago, it stresses classical free-market values combined with the use of empirical tools to analyze how markets work. Its adherents start from the standpoint of individual liberty, regarding free markets as both an embodiment of liberty and a source of financial strength. As Friedman observed:
I know of no example in time or place of a society that has been marked by a large measure of political freedom, and that has not also used something comparable to a free market to organize the bulk of economic activity…. Underlying most arguments against the free market is a lack of belief in freedom itself.
Friedman declared himself “suspicious of assigning to government any functions that can be performed through the market, both because this substitutes coercion for voluntary cooperation in the area in question and because, by giving government an increased role, it threatens freedom in other areas.”
The Chicago school too has enjoyed great influence—notably on the international scale, where its championing of open markets and low taxes helped spur the free-trade revolution known rather unattractively as globalization. A striking instance of Chicago-style experimentation came in Poland in 1990, when Solidarity leaders who had recently thrown off the yoke of Soviet domination attempted to convert their nation to a market economy in a matter of months. The Polish finance minister, an economist named Leszek Balcerowicz, introduced free-market reforms and waited anxiously as food prices soared. Advised to monitor a single commodity, Balcerowicz each morning checked the price of eggs at a local market. Eggs got steeply more expensive for weeks—during which time Balcerowicz was pilloried by a populace that had known only the depressed food prices and the depressed wages of communist rule—but then farmers and merchants, attracted by the higher prices, began making their way in from the countryside to the markets. Prices leveled off by the end of the month and in some areas soon declined. Poland’s agonizing period of 17,000-percent hyperinflation ended, and a lasting transition from command-and-control to a market economy was under way.
In many ways the Keynesians and the Chicago school appear to be opposites. The Keynesians are seen as coming from the left and as blind to the dangers of big government, while the Chicagoans are depicted as rightists championing personal greed over social responsibility. Confusingly, members of both camps describe themselves as liberal. Even more confusingly, both are justified in doing so.
On one level, this is simply another instance of the distinction between concern with equality of opportunity (the Chicago school) and of outcome (the Keynesians). It is for instance clearly the case that excessive regulation can retard scientific and technological creativity. Friedrich Hayek of the Chicago school observed that prior to the Industrial Revolution
the beliefs of the great majority on what was right and proper were allowed to bar the way of the individual innovator. Only since industrial freedom opened the path to the free use of new knowledge, only since everything could be tried…has science made the great strides which in the last hundred and fifty years have changed the face of the world.
But corporate concentrations of power, too, can inhibit creativity and freedom, while illiberal practices such as discrimination against women and minorities in the workplace have historically been alleviated through social action and government intervention, with social safety nets such as the British Reform Acts, universal health care in Germany, and Social Security in the United States helping to protect free-market capitalism from the predations of Marxist and other socialistic illiberalisms.
In practice, the liberal democracies have elected to experiment with aspects of both schools, turning the dial between equalities of opportunity and of outcome as they see fit. England and the United States both moved far toward socialism in the 1950s—when Britain nationalized major industries and the American income tax stretched all the way up to a confiscatory 90 percent—but then backed off considerably. The liberal-democratic world today is a patchwork of experimentation. An economically liberalized England boasts Europe’s largest economy, yet Ireland, where the government bet heavily on a combination of free markets and government-sponsored, information-age education, outperformed England on a per capita basis and became Europe’s fastest-growing economy. A relatively socialistic France suffered from high unemployment (government regulations make it hard for employers to fire anybody, which in turn makes them reluctant to hire anybody) but the even more socialistic Danes and Finns to the north ranked among the ten most economically competitive nations in the world.
It appears, as Adam Smith anticipated, that there is no one right solution for all peoples when it comes to the proper economic role of governments. Nor are the data terribly conclusive, even within a given nation. In the United States, the Republican party cut taxes and preached the Chicago line, yet the American economy over the past half century has performed better under Democratic than Republican administrations. In the years 1948–2007, per capita GDP grew 2.8 percent under the Democrats and 1.6 percent under the Republicans, while family income growth from 1948 to 2005 was substantially higher at all levels, from 2.6 versus 0.4 percent for the bottom 20 percent to 2.1 versus 1.9 percent for households in the top 5 percent. The situation is similar when viewed from an investment perspective: Ten thousand dollars, invested in stock market index securities solely during the forty years that Democrats occupied the White House from 1929–2008, would have yielded over three hundred thousand dollars; the same money, invested solely during Republican administrations, would have returned only fifty-one thousand dollars. This might seem to score points against the Chicago school, except that the Republican presidents Ronald Reagan and George W. Bush swelled the size of government and ran up the national debt, while Bill Clinton, a Democrat, shrank the government slightly, curbed welfare spending, and balanced the budget. All economic models are imperfect, and ideologies, because they are the least empirical, are the least perfect systems of all. George W. Bush’s administration spent eight years fostering the minimally regulated economic strategies their ideology favored, yet in 2008 presided over a virtual nationalization of investment banks and insurance firms whose assets exceeded a trillion dollars. The best way to reduce the incidence of such surprises is by increasing the quality of economic theory and the quantity of sound empirical data.
In a deeper sense all economics is liberal anyway, inasmuch as economics is a science. Economists are liberal, notwithstanding their political differences, to the extent that their work promotes fact-finding over ideology. An image that comes to mind is that of Hayek and Keynes during World War II. The two disagreed with and distrusted each other—Hayek was an aristocratic Viennese war veteran, Keynes a Bloomsbury bisexual—but when Hayek fled London during the Blitz, Keynes put him up in his rooms at Cambridge and the two stood rooftop air-raid watches together, scanning the night skies for German warplanes while debating the relative merits of government intervention versus unfettered free markets. What makes such scientific collegiality possible is not just a shared interest in a particular discipline but a common commitment to enlarging the circle of scientific knowledge. So it should come as no surprise that economists of all stripes have campaigned for improving the lot of the poor. Adam Smith’s case for free markets is full of admonitions about reducing poverty—the existence of which he never blamed, as his conservative contemporaries were apt to do, on the poor themselves. Malthus felt that science exposed the basic equality of all human beings. “The constancy of the laws of nature,” he observed
is the foundation of the industry and foresight of the husbandman; the indefatigable ingenuity of the artificer; the skilful researches of the physician, and anatomist; and the watchful observation, and patient investigation, of the natural philosopher. To this constancy we owe all the greatest, and noblest efforts of intellect. To this constancy we owe the immortal mind of a Newton.
Mill advocated women’s rights, the abolition of slavery, and free public education for the working poor. Marshall, a bank teller’s son whose mathematical brilliance was discovered while he was studying at Cambridge, used to spend his vacations visiting “the poorest quarters of several cities [and] looking at the faces of the poorest people.” He majored in economics rather than physics because he thought it the best way a mathematician like himself might help reduce poverty.
The tradition of economists using their knowledge of wealth production to combat poverty continues today. Jeffrey D. Sachs, an economist who has devoted his career to alleviating global poverty, credits Keynesian economics and scientific innovation with virtually eliminating extreme poverty in the developed world and thus providing a model for how the same feat can be accomplished elsewhere. The economist Paul Collier seeks to improve the lot of “the bottom billion” by drawing on sciences ranging from sociology (the poorest nations suffer from “brain drain” as the educated emigrate) to geography (they tend to be landlocked nations with “bad neighbors” whose problems with war and infrastructure prevent their participating in meaningful levels of trade). Collier is particularly illuminating on the privations that discovery of a single profitable resource can have on a poor nation. He notes for instance that the rebel leader Laurent Kabila, “marching across Zaire with his troops to seize the state, told a journalist that in Zaire, rebellion was easy: All you needed was $10,000 and a satellite phone.” The $10,000 would hire an army; the cell phone was for making deals with the oil companies; Kabila reportedly negotiated oil contracts worth $500 million on his way to seizing Kinshasa. In the midst of such privations, Collier advises, the suffering population may “see the society as intrinsically flawed” and fall victim to “the quack remedy…of populism.” Ideologues blame globalization for the world’s ills, but economists like Collier know better: “We need stronger and fairer globalization,” he argues, “not less of it.”
It has by now become clear that economics has helped bring about the greatest increases in wealth and reductions in poverty in all history. It has done this both by creating theories the implementation of which has improved the economic performance of nations, and by building a body of empirical information through which the theories continue to evolve.
One such finding is that freedom works. Free markets, provided that they are kept aboveboard, are more efficient, and grow economies faster, than do markets that are excessively regulated, controlled, or shielded from competition. “Market capitalism is the best economic system ever invented for the creation of wealth,” writes the financier Felix Rohatyn, “but it must be fair, it must be regulated, and it must be ethical.” Centralized, government-controlled economies are less efficient, because it is both theoretically and practically impossible for any central body to manage a large, complex economy with anything approaching the efficiency attained by leaving it in the hands of the many. Socialism is dead, if socialism means state command of the majority of a nation’s resources, but right-wing conservatism is dead too, insofar as it favors protectionism, opposes immigration, and would have us attempt to deal with modern economic challenges by applying only the precepts of the past. What remains is liberalism. Cant and quackery still raise their heads in the making of economic policy, but the ongoing ascendance of science and liberalism make it increasingly unlikely that the world will be plunged into another Great Depression, or that billions will again fall victim to the illiberal and unscientific siren songs of communism, fascism, populism, and other creeds that have been tested and found wanting. Freedom means human rights and not just free markets, of course, but there are no other human rights without the right to possess property—not just land and money, but intellectual property. You cannot participate in a free market unless you own the things and ideas you wish to trade, and you cannot speak and write freely if the authorities own your phone, your computer, and your Web site. On the other hand, your ownership of your ideas—or, say, Walt Disney’s ownership of Mickey Mouse’s silhouette—cannot be extended forever without hampering the free flow of information, ideas, and images throughout society. Thomas Jefferson understood this inherent conflict of interests quite well, which is why he ranked his service as the first head of the U.S. Patent Office as comparable with his having written the Declaration of Independence and been twice elected president.
Economics need not be divorced from morality. Preachers may call money the source of all evil, but the data of economic inquiry suggest otherwise. The virtuous circle of science increasing productivity—which generates wealth, which in turn provides the capital required to underwrite further scientific and technological progress—may well extend to actual virtue. Slavery was abolished, human rights expanded, and education and health care provided to millions by liberal-democratic, scientifically proficient nations, while the opposite has been the case in most of those nations which remain illiberal, undemocratic, and unscientific. As the economist Benjamin M. Friedman puts it, “Economic growth makes a society more open, tolerant, and democratic, [and] such societies are in turn better able to encourage enterprise and creativity and hence to achieve ever greater economic prosperity.”
Links between wealth, liberty, and virtue had been glimpsed before. Montesquieu, writing before Adam Smith, argued that commerce nourishes such virtues as “economy, moderation, work, wisdom, tranquility, order, and rule.” His contemporary Auguste Comte maintained that “all human progress, political, moral, or intellectual, is inseparable from material progression.” Alfred Marshall, having long studied the poor, saw poverty being reduced by economic growth during his lifetime, just as he had wished would be the case. “The hope that poverty and ignorance may gradually be extinguished,” he wrote
derives much support from the steady progress of the working classes during the nineteenth century. The steam-engine has relieved them of much exhausting and degrading toil; wages have risen; education has improved and become more general…while the growing demand for intelligent work has caused the artisan classes to increase so rapidly that they now outnumber those whose labor is entirely unskilled…. A great part of the artisans have ceased to belong to the “lower classes” in the sense in which the term was originally used; and some of them already lead a more refined and noble life than did the majority of the upper classes even a century ago.
William Cowper, lines from whose poem “Charity” appear at the top of this chapter, championed both free trade and human rights. His abolitionist poem of 1788, “The Negro’s Complaint,” ends with a slave’s stinging riposte to the claim that human bondage could be justified on grounds of the superiority of European to African societies:
Deem our nation brutes no longer,
Till some reason ye shall find
Worthier of regard and stronger
Than the color of our kind.
Slaves of gold, whose sordid dealings
Tarnish all your boasted powers,
Prove that you have human feelings,
Ere you proudly question ours!
Good intentions count for little unless the scientific tools are sound, and economics models remain crude in many respects. To cite one notorious example, economics traditionally has treated consumers and investors as perfectly rational entities: Homo economicus, as this creature was called, always acted to maximize his economic position. However, Homo economicus is but a mathematical fiction. He is assumed to know all the relevant information, but even skilled investors can miss important clues. He is totally selfish, but nearly half of all Americans do unpaid volunteer work and nearly three-quarters donate to charity. Homo economicus changes jobs to maximize his income, but we’ve all encountered people who pursue careers for reasons other than financial gain. Nor do people always act rationally in the jobs they do have. Cab drivers, rather than working long hours on rainy days when they have more fares, tend instead to quit early and hence limit their earnings. New “behavioral” models are now beginning to emerge, based on laboratory research that more accurately predicts how real people think and act. Social scientists find, for instance, that most people overestimate their prospects of success in a given enterprise (the majority of students taking a college course predict that their final grade will be above average) and to inflate price estimates based on first impressions (retailers have long appreciated that people are more apt to pay $19.99 for a dicer if they’ve been told that it lists at $29.95). As real human behavior intrudes increasingly into the equations, economics may become not only less dismal but better at making forecasts.