The Great Economists Read online

  And what about global forces at play that are outside government control? Piketty proposes a more radical solution: an internationally coordinated tax on wealth. But Angel Gurría, Secretary-General of the OECD, which is the think tank for advanced economies, disagrees. He says that national, not global, labour market and tax policies are needed to address inequality. Specifically, there should be a cut in taxes to encourage employment, offset by a rise in certain taxes, including green taxes.14

  There is a divide between those who argue for redistribution through the tax system and those who are against government intervention. Those who favour more government action would also support policies to raise wages, including setting a higher minimum wage and promoting the creation of well-paid, middle-skilled jobs. Others might prefer policies designed to give every person the same opportunities to earn a living and reduce inequality through market forces, rather than taxing and redistributing after the fact. Their concern is that redistributive policies create the wrong incentives by taxing the successful and subsidizing the less well-off, thus discouraging both the rich and the poor to work. As the political joke goes: ‘How can you tell the difference between a Republican and a Democrat? When a Republican sees someone drowning, he throws too short a rope and yells “the rest is up to you”. A Democrat throws too long a rope and lets go of his end.’

  Suffice it to say this is an unsettled debate. So, what would the father of neoclassical economics make of the rise in inequality, which has become such an issue that it has led some to question the validity of a capitalist system that permits it to happen?

  Alfred Marshall’s views on inequality

  Alfred Marshall argued that the role of the state in addressing inequality should include the following considerations:

  Taking it for granted that a more equal distribution of wealth is to be desired, how far would this justify changes in the institutions of property, or limitations of free enterprise even when they would be likely to diminish the aggregate of wealth? In other words, how far should an increase in the income of the poorer classes and a diminution of their work be aimed at, even if it involved some lessening of national material wealth? How far could this be done without injustice, and without slackening the energies of the leaders of progress? How ought the burdens of taxation to be distributed among the different classes of society?15

  That is the core of the debate. Marshall saw a trade-off between policies to more equally distribute income and the disincentives they create towards work. In his view:

  the chief dangers of socialism lie not in its tendency towards a more equal distribution of income for I can see no harm in that, but in its sterilizing influence on those mental activities which have gradually raised the world from barbarism.16

  Marshall drew a distinction between production and redistribution, as did John Stuart Mill. Mill had argued in his Principles of Political Economy that economic laws governing production were not easy to alter, while redistributive policies were crafted by governments and changeable.17 But Marshall initially did not support ‘fiscal’ redistribution through taxes. He viewed income taxes as inefficient because of their effects on work. But after the introduction of a graduated estate duty (higher rates on larger estates) in 1894, the forerunner to an inheritance tax, there was no disincentivizing effect on the willingness to work. That helped change Marshall’s mind, since what he had proposed before, encouraging philanthropy, was not enough to reduce inequality.

  So, during and after the First World War, Marshall came to believe in the benefits of progressive tax rates. He gradually accepted fiscal redistribution. What he did not support was equalizing income through extensive redistribution. It would at best achieve very limited results. Over the long run, such policies would hurt growth if people were disincentivized to work, and that would mean less money to redistribute. Redistributive programmes today do not go so far as to equalize incomes, in line with Marshall’s concerns.

  Progressive taxation is one of the standard tools used now to redistribute income. But the extent of redistribution differs across countries. For instance, there is less redistribution in America than in Europe, which has a larger welfare state. Bigger government, though, doesn’t sit well with Marshall.

  Marshall saw the government’s role more as that of regulator than as provider of goods and services. Ensuring that businesses acted lawfully, that products were of good quality and fairly priced were the sorts of tasks that governments should undertake. And there shouldn’t be a large number of bureaucrats: ‘The function of Government is to govern as little as possible; but not to do as little as possible.’18

  Marshall also favoured decentralization. He saw the benefits of experimentation and local competition. He strongly opposed local government as a delegated administrator of central government, though. In his view, education and town planning provided the greatest scope for local initiatives. However, larger tasks, such as the supply of water, electricity and gas, were to be undertaken by government only if they could not be undertaken efficiently by the private sector.

  Where Marshall believed that government could help to reduce poverty was by improving the skill set of the poor to make them more competitive in the market. As mentioned earlier, he advocated education to make unskilled labour scarcer and thus better rewarded. He also proposed controlling migration to limit competition.

  Like other Victorians, Marshall emphasized the impact on a person’s character of any policies that sought to reduce poverty and inequality. Concern about being reliant on charity led to an inevitable emphasis on self-help and mutual assistance, which was a Victorian perspective. But Marshall recognized that factors such as insecure employment, unemployment, illness and old age were common among many of the ‘deserving’ poor.

  His student and successor as Professor of Political Economy at Cambridge as well as literary executor, Arthur Cecil Pigou, believed that Marshall would have welcomed the government’s efforts in promoting greater income equality after the Second World War. Marshall had become less concerned about the disincentive effects on work, except for a high tax on savings. So, he was more willing to accept socialist-type policies so long as they were not economically harmful. Still, Marshall worried about the negative effect on productivity ‘from the deadening influence of bureaucratic methods’.19 For instance, Marshall opposed nationalization on principle, except for natural monopolies, which are industries such as utilities where it is efficient to have one firm, and only accepted government involvement if it meant the task could be carried out more efficiently. This was in line with his opinion that economic prosperity depended on the forces of competition. So, he would not support socialist experiments in production, but came to accept fiscal policies designed to alleviate poverty. In this respect, a role for the state in the redistribution of income would be acceptable.

  So, we might surmise that Marshall would weigh any tax purporting to reduce inequality carefully against the disincentivizing effects. The OECD recommendations of cutting taxes to encourage employment would be in line with Marshall’s beliefs. Given his preference for evidence, he would be swayed by the studies of fiscal redistribution policies adopted since the creation of the welfare state after the Second World War. The International Monetary Fund (IMF) has looked at moderatively redistributive taxes and policies and concluded that they do no harm and might help to reduce income inequality.20

  Marshall would recognize that the decision as to what level of inequality is acceptable would ultimately be a political one where economics merely provides the analytical tools to determine those benefits and costs to be considered. The US is less redistributive than Europe, which has a larger welfare state and some of the most egalitarian societies in the world, notably the Nordic countries. Americans have chosen to focus on promoting equality in opportunity, giving rise to the notion of an American Dream where everyone who works hard can have a house and a good job. China seems to be headed down the American path, with the phrase of the Chine
se Dream used to promote similar ideas. But the dramatic rise in inequality in the United States over the past few decades suggests that the American approach is under challenge. Europe has a different problem in that its expensive welfare state, only some of which has to do with redistributive policies, is unaffordable, for example pension payments are increasing due to ageing societies. Thus, re-examining how to address inequality in capitalist economies has become a pressing issue for many countries.

  Marshall’s legacy

  In May 1908, just before his sixty-sixth birthday, Marshall retired as a university professor in order to work on the second volume of his Principles of Economics, which he had announced nearly two decades earlier but was yet to complete. (He had wanted to retire earlier, in 1901, but could not afford to do so.) After retirement, though, he abandoned the second volume. In 1910 ‘Volume I’ was removed from the sixth edition of Principles. Instead, he wrote three companions between 1919 and 1924.

  One reason was, like many renowned economists, Marshall found himself very busy in retirement. In addition to revising Principles, he contributed to parliamentary commissions, engaged in correspondence and undertook other activities that took up his time. Mary Paley wrote that her husband said: ‘I don’t care for living except to work. He said that he was glad to have done all he could to help the world on.’21 And he did just that. Marshall was active for nearly two decades after retirement. He died at home in 1924, a fortnight before his eighty-second birthday, due to cardiac failure.

  The most important economist Marshall taught in his final decade at Cambridge was John Maynard Keynes, who, along with Pigou, became the major link in creating the Cambridge School who followed Marshallian thought. It is well known that Keynes had no formal qualifications in economics, like many Cambridge students at the time. They would formally study mathematics and pick up what they were really interested in along the way. Keynes’s economics training consisted of attending Marshall’s and Pigou’s lectures and supervisions for a term or so, as well as reading Marshall’s work. He probably got the best economics education on offer in England. The more specialist London School of Economics and Political Science was only founded in 1895. Thus, there are Marshallian foundations in Keynesian macroeconomics, particularly in terms of the need for economics to provide policy solutions.

  This prompted Marshall and some of his contemporaries to alter the name of their subject from political economy to economics. He advocated for the change to avoid associating the subject with political considerations rather than with national objectives. It was not intended to narrow its scope.

  As mentioned earlier, he had also considered calling it social economics. Marshall’s economic theory was rooted firmly within the social sciences, where human responses to policies must be considered. So, fiscal measures to address inequality, within the context of rising social discontent that made such actions urgent, would have been consistent with his economic beliefs. A capitalist system that produced another Gilded Age, even more unequal than the original during his lifetime, is unlikely to have sat well with Marshall. And he would certainly have made his views known. His nephew, Claude Guillebaud, recalled the fear associated with an invitation to lunch for Marshall’s students. They could never be certain when Marshall’s intellect would crush them if they expressed an analysis or opinion that wasn’t wholly rigorous.

  Although Marshall is viewed as the economist who increased the rigour of economics, he taught his students to see economics as offering a set of tools and an analytical way of thinking but not to believe that the textbook reflected the real world. He described his approach as follows:

  a good mathematical theorem dealing with economic hypotheses was very unlikely to be good economics; and I went more and more on the rules –

  1. Use mathematics as a shorthand language, rather than as an engine of inquiry.

  2. Keep to them till you have done.

  3. Translate into English.

  4. Then illustrate by examples that are important in real life.

  5. Burn the mathematics.

  6. If you can’t succeed in 4, burn 3. This last I did often.22

  CHAPTER 5

  Irving Fisher: Are We at Risk of Repeating the 1930s?

  In October 1929, shortly before the Great Crash, the American economist Irving Fisher infamously declared that stocks had reached a ‘permanently high plateau’.1 But just days later, on 24 October, commonly known as Black Thursday, the market dropped. This was just a precursor to a larger fall. The following week, on 29 October, what became known as Black Tuesday, the stock market crashed. Over those few days, the stock market lost a quarter of its value.

  Fisher told the shell-shocked audience of the National Association of Credit Men that he believed nothing fundamental had happened, and they should ride out the temporary storm in the markets. He said: ‘The trough was close and the ensuing rally will see the markets quickly return to previous highs.’2 But, as we know, Fisher was wrong. The Great Crash became the Great Depression and the resulting plunge in the markets wiped out his own $10 million fortune. Ever the optimist, or just out of sheer desperation, he continued to predict a recovery in stock markets and the US economy. However, neither would happen until the end of the 1930s.

  Fisher’s loss was not just financial. His reputation suffered irreparable damage and he found himself marginalized by businessmen and politicians. Few were willing to take seriously somebody who had been so publicly and spectacularly proven wrong, and lost almost everything as a result. Fisher had marked himself out as a loser.

  History, though, has been much kinder, and recognized Fisher’s huge contribution to economics. The influential Austrian economist Joseph Schumpeter described him as potentially the greatest economist that America has produced.3 Indeed, a great deal of modern day economics can be traced back to Fisher’s work.

  He was the first American economist of any standing. In the late nineteenth century, the US had comparatively few economic thinkers. This was largely because the US government intervened little in the economy, so economics had a limited role in policy. Fisher’s work marked a turning point where the HQ of academic economics moved from Europe to the US and in doing so firmly aligned economics with mathematics and statistics. In 1930, he was the co-founder and first President of the Econometric Society, which developed the quantitative aspects of economics. Nearly every Nobel laureate in Economic Sciences has been a member.

  Fisher viewed economics in the following way:

  The effort of the economist is to see, to picture the interplay of economic elements. The more clearly cut these elements appear in his vision, the better; the more elements he can grasp and hold in his mind at once, the better. The economic world is a misty region. The first explorers used unaided vision. Mathematics is the lantern by which what before was dimly visible now looms up in firm, bold outlines. The old phantasmagoria disappear. We see better. We also see further.4

  It is remarkable just how much of modern economics, taught in university programmes today, was established by Irving Fisher. Yet he is seldom included in books such as this one, or considered by those studying the history of economic thought. This might have been because he never combined his ideas into a unified theory of economics, in comparison to, say, John Maynard Keynes’s General Theory, which rather stole his limelight. He also had few disciples, working predominantly on his own and rarely supervising graduate students.

  The Theory of Interest, published in 1930, is probably the nearest he came to a General Theory type of work. In many ways, it drew together previous research, and Fisher came close to anticipating much of the work of macroeconomic theorists of the late 1930s through to the 1950s. But he didn’t carry it through. He was not interested in formulating a theory explaining the level of national income and its changes, as Keynes was to do a few years later.5 By contrast, Fisher never really pushed his work, thinking of it as an academic project rather than of practical value.

  His near death fro
m tuberculosis early in his career led him to emphasize intellectual endeavours that he could accomplish in a short time, as he feared he might never complete long-term tasks.6 Although he failed to meet his target of writing a book a year, he did manage to turn one out for every two years of his working life, along with scores of professional papers as well as hundreds of popular articles.

  He was prolific despite being far from a full-time scholar. His academic work was often put to one side while he promoted his many crusades. He was a reasonably well-known public figure, but most non-economists would associate him with his views on public health, his advocacy for the League of Nations and his stance in favour of Prohibition. On top of this, he was also a businessman and director of companies, accumulating a large fortune before being wiped out by the Great Crash.

  By almost all accounts, Fisher was a proud man and hated to be proved wrong. The events of the Great Depression were a chastening experience for him, and he sought to understand how and why his wealth had been lost and the economy and stock market failed to break out of the grip of depression. Between 1932 and 1937 he became an unpaid adviser to the US President, first Herbert Hoover and then Franklin D. Roosevelt. He was clearly motivated by a desire to fix the American economy and with it restore his own finances. It spurred his work on ‘debt-deflation’, the idea that economies can get trapped in a persistent deflationary spiral where prices fall as the economy stalls since people are not consuming and firms are not investing while they repay debt.