A Whirlwind Tour of the Dismal Science
Book Review:
Niall Kishtainy, "A Little History of Economics", Yale University Press, 2017/2018.
When I read Nigel Warburton's "A Little History of Philosophy" a few years back, I really enjoyed it for its clarity and brevity. So I was excited to pick up another book in the Little Histories series, and what better than one that tickles my fancy in economics? Hence A Little History of Economics, written by a UN policy adviser and LSE teacher by the name Niall Kishtainy. Reviewers have described this book as "highly readable", "accessible", "fast-paced", and "nontechnical".
I agree. The book is over 240 pages long, but is divided into 40 chapters, meaning that the average chapter is only 6 pages, so it feels like a breeze to read. The writing style is concise, with snappy sentences. Each chapter begins with a drawing related to the topic, which helps to liven things up. Besides these sketches, there are basically no graphs, tables, models or equations in this book. This is partly what people mean when they say it is a nontechnical introduction -- contrary to the stereotype of economists as math-freaks, Kishtainy's primer contains zero maths. Does it help make the book more accessible and readable for a wider audience? Yes, definitely. But given that economics as it is actually practiced is different from, say, philosophy or history, I'm not sure to what extent the deliberate avoidance of formalization is conducive to preparing people for things like econometrics.
In any case, I do think that forcing oneself to write a book about economics without using demand-and-supply functions or curves is an exercise in clarity and actually understanding the underlying concepts. (There is an oft-repeated quote that you only understand something if you can explain it to your grandmother.) This is exactly what Niall Kishtainy does here. Furthermore, the book isn't even meant to be a textbook, but rather a historical account of economics. As such, the fact that the author is able to explain basic economic concepts and theories while maintaining a narrative form is doubly impressive. Naturally, I won't be able to reproduce that effect by summarizing an already brief book here, but I believe that a summary is still worthwhile because it gives one an overview of the most important figures and findings in the field of economics. In other words: let this be a springboard for you if you are interested in learning more about economics.
A Little History of Economics begins and ends with a series of questions that economists ask (and try to answer). Why are some people poor and others rich? How do we decide what to spend our savings on? Perhaps most importantly: what makes people thrive and live well? According to Niall Kishtainy, economists need cool heads in order to approach these questions in a scientific (descriptive) way, but also warm hearts so that they can make wise (normative) judgments about what needs to change to let more people live well. In Chapter 1, Kishtainy defines "economics" in a number of ways:
- The study of how societies use their resources
- The study of scarcity, and how we use scarce resources to satisfy needs
- The study of humans' behavior in the economy
And yet, economics is still a matter of life and death. It is vital to humanity, as it affects people's quality of life for generations. The important thing to remember is that human societies are complex, with broader political and social aspects that aren't always captured by simple mathematical theories. Even though people criticize the way economics is taught in universities, when we look at history we actually see economic thinkers with a wide range of political beliefs and ideas -- including both supporters and opponents of capitalism. Kishtainy believes that we need to appreciate more those neglected thinkers who sought to answer the fundamental questions about how economies develop. By studying them, we might get inspired to come up with responses to the problems of our own times.
Chapters 2 to 39 explore the history of economic thought, from the ancient Greeks (who gave us the term oeconomicus) to contemporaries like Thomas Piketty. Unfortunately there is no timeline in A Little History of Economics and the chapters aren't grouped into parts, but at least they are mostly in chronological order. Therefore I shall try to summarize them in a way that groups chapters together by "period" or "theme". I'll also highlight the names of key thinkers in bold.
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History Before Capitalism
We begin with the ancient Greek philosophers. About 10,000 years ago the agricultural revolution paved the way for complex societies comprising farms and villages with workshops, factories and temples. The great Greek civilization produced poets and philosophers like Plato (428 - 347 BC) and Aristotle (384 - 322 BC). Plato thought than an ideal society would have a hierarchy of slaves, farmers, warriors, and "philosopher-king" rulers. Everyone in the polis (city-state) would have their place determined at birth. To ensure that the soldiers and kings ruled wisely and not corruptly, they would have to give up private property and live communally. Plato's student Aristotle took a less idealistic view -- he thought that there would be less infighting if people were allowed to own their goods. Aristotle also saw money (coins) as a useful means of exchanging goods, but he was suspicious of the commercial trading of things for the sake of profit.Aristotle's critique of moneylending (i.e. using money to make more money by charging interest on loans) was later continued by Christian monks like St Augustine of Hippo (354 - 430 AD), who argued that human laws had to be subordinate to God's laws. The "City of God" was governed not by profits but by Christ's earthly representatives like the pope foremost, and then the kings who gave land to their loyal warriors and lords, who in turn employed the peasants to work the land. (This system is called feudalism.) Later in the medieval period, St Thomas Aquinas (1224 - 1274) said that money ought to be used for buying and selling things, or for giving to the poor. In an imperfect world, owning property was fine as long as one did not love one's possessions or become greedy or envious. The problem with moneylending, or usury, was that it "stole" money from people by making them pay twice.
However, after the death of Aquinas, the European cities of Venice, Florence and Genoa started to become hubs of trade and commerce, and merchants and bankers increasingly came to dominate the economy. Even preachers believed that one could serve both God and money, as long as one charged reasonable interest rates that covered the opportunity cost of lending and didn't ruin the borrower. In the 16th and 17th centuries, the monarchies of Europe (especially Spain, England and the Netherlands) competed for the acquisition of gold, silver, pearls, precious stones, silk and spices. The alliance between rulers and merchants is called mercantilism. In essence, mercantile writers like Gerard de Malynes (active 1586 - 1641) and Thomas Mun (1571 - 1641) believed that a nation's wealth is determined by its stock of gold. Malynes argued that England needed to export more goods to foreigners and import less. Mun agreed. As governments taxed imports and conquered new lands, they helped the merchants get rich.
The Rise of Classical Economics
In the 18th century, mercantilism was transitioning into a new industrial age. Around this time, economic thinkers began to question whether what was good for the merchants was good for the nation. For example, when imports are restricted, businesses can make more money but ordinary workers pay more for things they need. In France, provocateurs like the Marquis de Mirabeau (1715 - 1789) and François Quesnay (1694 - 1774) argued that instead of taxing peasant farmers, France should tax the aristocrats. Quesnay led a school of thought known as the "physiocrats", which was the first circle of economists to try and find laws and models to describe the behavior of the economy. They believed that the source of a nation's wealth resided in nature: the surplus of crops and livestock produced by farmers, fishermen and shepherds. Everything else merely transforms what nature already created. So by heavily taxing farmers, Quesnay said, the government was shrinking the surplus and thus the economic lifeblood. Despite his critiques, Quesnay was still a supporter of monarchy. Not long after his death, though, the revolution of 1789 swept away the "old regime".The parallel economic revolution meant that manufacturers were able to invent new goods or make existing ones more efficiently, using technologies like waterwheels, looms, and steam engines. This led to an increasing specialization in labor, as observed by the Scottish philosopher Adam Smith (1723 - 1790), widely regarded as the father of modern economics. Smith argued in his influential book The Wealth of Nations that society functions best when people decide for themselves what and how much to produce based on their own self-interest. Social harmony arises not through the guiding hand of a manager, but through the "invisible hand" of free exchange. As Smith said:
"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."When markets deepen, so does the division of labor, since it becomes more profitable. In the new economy of Smith's time, wealth was neither gold nor what grows in the ground, but all the useful goods produced by a country's economy, as consumed by the people. Inspired by Adam Smith, the British stockbroker David Ricardo (1772 - 1823) looked at how the growing wealth was divided. He reasoned that as the population expanded and more food was needed, the price of grain would rise. But because farmers would compete for the most fertile land, this would ultimately end up benefiting not the farmers, workers or factories, but the landowners. According to Ricardo, one possible solution was to eliminate laws banning the import of cheap foreign grain. His analysis showed that if Britain specialized in producing goods in which they had a comparative advantage and then traded with other countries who did the same, both sides would gain. This became a cherished argument for free trade.
Utopia and Dystopia
The Industrial Revolution created great wealth, but many people still lived in abject poverty. The capitalist factories created harsh conditions and gave workers dull, simple and repetitive tasks. A group of Utopian thinkers sought to replace capitalism with a totally new society. One of them was the Frenchman Charles Fourier (1772 - 1837), who imagined life in a harmonious small community, the center of which was a "phalanstery" where people could follow their passions and get a share of the total profits. Another idea came from Welshman Robert Owen (1771 - 1858), who argued that poor people weren't poor because they deserved it, but because they were the product of a bad environment. He set up a couple of experimental model villages that were meant to promote good character, but with mixed success. A third "inventor" of socialism was Henri de Saint-Simon (1760 - 1825), who believed that society should be ruled not by princes and dukes but by talented scientists and industrialists who would create a humane and rich society where everyone is allowed to flourish.Meanwhile, a friend of Ricardo by the name of Thomas Malthus (1766 - 1834) was the first appointed professor of economics (and also a clergyman). Malthus soon became widely known for his views on population growth, which he believed would inevitably lead to more poverty. He disagreed that humanity was on a march of progress. Malthus's arguments were based on the premise that food production cannot double at the same rate as the population does; eventually there will be more deaths and fewer births due to starvation, disease, abortion and contraception. The implication was that society will always be stuck at subsistence-level wages (just enough to cover families' subsistence). Even worse, trying to help the poor through charity would only produce more misery by boosting the population! Thus Malthus was seen as the Scrooge of economics, and economics itself was labelled "the dismal science" by historian Thomas Carlyle. However, today we know that Malthus was wrong about wealth resulting in higher fertility rates -- people started having fewer children as their incomes rose and better medicine helped them live longer. Although the population today is much larger, we have plentiful food thanks to technology. Besides, not only do people use up resources, they help create new ones.
Fourier, Owen and Saint-Simon were believers in progress. They also believed that we could reach a perfect world through peaceful change; through appealing to people's reason and goodwill. But other opponents of capitalism called them naive dreamers -- the most famous was Karl Marx (1818 - 1883). Marx was concerned about how to get to a new world, and concluded that capitalism would have to collapse in great upheaval. According to Marx, history is about the conflict between rich bosses and poor workers. Ironically, capitalism contains the seed of a new economic system within itself, because capitalists will keep exploiting their workers more and more until the workers rise up and seize the "means of production" (the fields, factories and capital needed to make goods). This exploitation occurs because capitalists hire workers at subsistence wages, and then take the surplus value produced by the workers as profit. And because workers only own their own labor, and compete against other workers, they have little choice but to work hard, long hours at low wages. Even if workers did get higher wages, Marx believed that capitalism would still "alienate" workers because they would come to view themselves and others as mere cogs in a giant machine of production, rather than as human beings with a real connection to the goods they make. Marx, together with his collaborator Friedrich Engels (1820 - 1895) published The Communist Manifesto in 1848, in which the authors famously wrote that "the spectre of communism" is haunting Europe. Indeed, the Marxist worldview inspired numerous political movements in the 20th century, in places like Russia, Hungary, Poland, and China. Meanwhile, there were other countries (e.g. France, Germany, Denmark and Britain) which banned child labor, provided mass education, extended the right to vote, and implemented payments to the unemployed. These measures made capitalism kinder and raised workers' living standards.
Battle of the Methods
Karl Marx, just like Adam Smith and David Ricardo, believed in the labor theory of value, which holds that the value of a good is equal to the amount of labor input. However, later economists tore apart this theory. For example, William Jevons (1835 - 1882) asked why people would buy a bottle of champagne for £300 when it didn't cost nearly as much to make. His answer was that consumers get a lot of satisfaction from it, or utility. He went further: suppose you ate ten toffees... surely the tenth toffee wouldn't be just as pleasurable as the first; each extra toffee gives you less marginal utility. Using this principle as a model, economists explain how people make choices under scarcity by balancing the marginal utilities of their options. The British economist Alfred Marshall (1842 - 1924) developed the "laws" of demand and supply: due to diminishing marginal utility, there is an inverse relationship between the demand for a good and its price, whereas a higher price would allow firms to produce (supply) more. On a graph that links price with quantity, the "demand curve" (line) would slope downwards while the "supply curve" would slope upwards. At the point where demand equals supply, the market is said to be in equilibrium. The work of Jevons and Marshall led to neoclassical economics, which focuses on the economic calculations of rational individuals. In this way of thinking, there is no exploitation of workers by ruthless capitalists, because the value of something is simply its price as determined by demand and supply, and workers decide how much to work based on marginal utility.Neoclassical economists relied on the idea of "perfect competition", which assumes that no single buyer or seller has the power to alter the market price. They also agreed with Smith and Ricardo on the importance of free trade. Other economists disagreed -- in particular, the German Friedrich List (1789 - 1846) argued that trade between countries was different than trade between individuals because different countries are at different stages of industrialization. Countries like the newly-independent United States needed their "infant industries" to be nurtured and shielded from foreign competition. List criticized the British economists for thinking that what was good for the British economy was also good for other countries' economies. He also argued that economics should begin by looking at the facts and history, not from abstract logical reasoning. Today, economists try to do both -- they invent theories to sort through a mass of facts, and test those theories against historical experience. But they still tend to lean more toward the world of general mathematical concepts, for which they still get criticized.
World Wars
The Russian revolutionary Vladimir Ilyich Lenin (1870 - 1924) was inspired by Marx and took the criticism of the "bourgeoisie" further by saying that capitalism causes conflicts between nations which lead to war. The rise of large banks and large corporations together with European imperialism meant, for Lenin, that imperialism was simply about making money. One unorthodox British economist, John Hobson (1858 - 1940), even wrote that an excess of savings by rich people was the motivation for invading foreign countries to find new investments and sell goods to the colonized people. Hobson argued that a better alternative to military invasion was to redistribute income. But Lenin, after witnessing the First World War break out in 1914, was so furious that he wanted the imperialist war to be converted into a civil war between the united working classes and the ruling classes. After his exile in Poland, Lenin returned to Russia to lead the revolution that would result in the establishment of the first communist state, the Soviet Union.Jumping ahead to the Second World War, a student of Alfred Marshall by the name Arthur Cecil Pigou (1877 - 1959) was busy developing the field of "welfare economics" in Cambridge while German bombs were falling. He argued that markets don't always make the best use of an economy's resources. In particular, he talked about externalities (the unintended side-effects of private choices on society, e.g. the costs of pollution or the benefits of research) and public goods (things like armies and street lighting that would benefit people even if they didn't pay for them). These are cases of "market failure", in which the market would provide too much or too little of a good from society's point of view -- unless the government steps in to provide public goods, subsidize positive externalities, and tax negative externalities. Society can also be hurt by monopolies with too much market power; the solution is to make markets more competitive via "antitrust" policies.
After Pigou and WWII, most economists agreed that capitalism plus some government action was the best economic system. However, between the wars, in the 1920s and 30s, there was a huge debate between capitalism and communism. One Cambridge economist who was sympathetic to the communist countries was Joan Robinson (1903 - 1983). She wrote that markets in practice are neither perfectly competitive nor monopolistic, but that there are "monopolistically competitive" firms that compete against each other by marketing a "brand image". This idea that advertising is used to distinguish products was also put forth by American Edward Chamberlin (1899 - 1967). Robinson and Chamberlin inspired later economists to study "oligopolies", which are markets dominated by a handful of huge firms that sometimes collude or engage in price wars. Robinson also came up with the theory of monopsony, which is basically like a reverse monopoly where one buyer can control the price it pays. For example, if there is only one employer in an area, it can push down wages -- Robinson used this idea to argue for labor unions and minimum wages. She became critical of the conventional economics of Marshall.
Meanwhile in the 1930s, the Soviet Union was carrying out a big economic experiment. It was government officials, not factory directors, that made decisions about what and how much to make. Rather than market supply and demand, it was the state that set prices. The Soviet government also determined people's incomes. This system is known as "central planning", and in practice many details were decided by the ruthless dictator Joseph Stalin, who frequently imprisoned or executed those who disobeyed. The communists promised abundance, but in reality, millions starved. The reason why was explained by Ludwig von Mises (1881 - 1973), who argued that central planning would always have problems with "economic calculation" (i.e. figuring out who gets what). A communist society has to work out the daily economic decisions of millions of people, a dizzying amount of information. Moreover, the government has no yardstick for deciding prices -- it has to make them up by irrationally groping in the dark. By contrast, in capitalism the market prices are signals for what goods people want most, so by seeking profits, firms automatically allocate resources to their best uses. But the Soviet Union was not a failure in every way; it did manage to rapidly industrialize. Some economists, including Oskar Lange (1904 - 1965) and Abba Lerner (1903 - 1982) thought that socialist economies could be managed rationally if planners were able to solve a set of equations, known as the Walras equations.
Critique of American society also came from Thorstein Veblen (1857 - 1929), who grew up in a small community of Norwegian farmers who settled in Wisconsin during America's "Gilded Age". Veblen said that people don't make choices through rational calculation, as the conventional economic theory held. Instead, they follow instincts and habits learned from their history and the culture they grew up in. This is why we buy things in order to gain approval from others. The new rich in America bought gaudy mansions and fur coats and went on leisure trips to the French Riviera not just because it gave them utility, but because it signaled to others that they didn't have to work, thereby gaining social recognition (similar to tribal chiefs in earlier societies). This is called conspicuous consumption. Veblen argued that conspicuous consumption is a waste and results in a treadmill of dissatisfaction as lower classes seek to imitate the rich. Unlike Marx, however, Veblen did not call for a revolution, but said that society had to replace the instinct of predation with the instinct of workmanship -- doing productive work to serve real human needs.
One of the momentous events of the interwar years was the Great Depression of the 1930s. Between one quarter and one half of American workers were unemployed in 1933. The long and deep recession spread to Europe as well, and some believed it would be the end for capitalism. The British economist John Maynard Keynes (1883 - 1946) saw that the real problem was not scarcity, but that resources which were already there weren't being used -- after all, there were many unemployed people willing to work. According to Keynes, the recession happened because the level of savings exceeded the level of investments, possibly due to high interest rates. In any case, an important factor was certainly that people were injecting less spending into the economy as they felt gloomy about the future. The solution would require the government to help the economy get back on track.
The Cold War
While Thorstein Veblen called wealthy industrialists like Cornelius Vanderbilt and Andrew Carnegie cutthroat "robber barons", the Austrian economist Joseph Schumpeter (1883 - 1950) celebrated them as heroic entrepreneurs who created wealth for society by producing a vast array of goods using new technologies. These entrepreneurs were motivated not just by money but also a drive to conquer. They take risks, and when they succeed they get rich. But old technologies and companies are regularly killed off by new ones -- a process Schumpeter called "creative destruction". This was the driving force behind the boom-and-bust cycles of the capitalist economy. Unlike conventional economists, Schumpeter didn't think monopolies were usually bad (the big rewards encourage risky innovation). At the same time, Schumpeter saw a dark side in capitalism: the dynamism of creative destruction would eventually get replaced by boring, automated and predictable procedures in giant corporations. People in gray suits will grow frustrated by all the dreary meetings and become anti-capitalist "intellectuals" who argue for socialism.To study the behavior of oligopolies as they battle for market domination, economists developed the field of game theory. But game theory can also be applied to individuals or to countries; in the case of the Cold War (which followed the Second World War) there was an "arms race" between the United States and the Soviet Union, with both sides stockpiling nuclear missiles aimed at the enemy. Game theory uses mathematics to model "strategic interactions", where the decisions of one side are based on the decisions of the other. The RAND Corporation, funded by the US military, employed mathematicians like John von Neumann (1903 - 1957) to develop methods for finding the outcomes of games. Another mathematician, John Nash (1928 - 2015), arrived at the insight that the equilibrium (or Nash equilibrium as it is known today) of a game is the outcome in which each player does best for themselves in light of what the other player does. The equilibrium shows that, in the famous "prisoners' dilemma", when each player makes their best response (i.e. acts "rationally") they end up in a position that is not the best for both. For example, if a country buys weapons to gain an advantage, the rival country does the same -- but it would have been better and cheaper if neither bought any weapons in the first place. Prisoners' dilemmas are abundant in economics.
After WWII, the British economy was really a "mixed economy", a middle way between capitalism and socialism. One economist who didn't like this compromise, and strongly disagreed with Keynes, was the Austrian-born Friedrich Hayek (1899 - 1992). Hayek was afraid that the same thing that happened in Nazi Germany (the government having total control) would happen in Britain and America. Inspired by Ludwig von Mises, Hayek believed that economic progress was generated by free markets, but moreover, that political freedom depended on economic freedom. He said:
"The last resort of a competitive economy is the bailiff... the ultimate sanction of a planned economy is the hangman."Hayek annoyed a lot of people, and even today most economies are still a mix of private business and government action. Most economists agree that some government spending, if done sparingly, does not mean less freedom. Depending on what you mean by "freedom", governments can actually increase it by providing public goods, guaranteeing a basic living to the unemployed, and funding education for every child.
Growth in the Era of Decolonization
In the 1960s, dozens of colonies gained their independence. Many of these nations, such as Ghana, were poor and looked forward to making their people wealthier, healthier and freer. The economic adviser of Ghana's first president Kwame Nkrumah was Arthur Lewis (1915 - 1991), who helped start the field of development economics. Lewis noted that most of the economy consisted of traditional family farms, with contrasting patches of modern capitalist industry. He believed that to make progress, the modern sector would have to grow. Another development economist, Paul Rosenstein-Rodan (1902 - 1985) argued that markets wouldn't automatically create profitable factories, because many different industries depend on each other and therefore need to be built together, in one "big push". He said the government can help make this massive leap. This idea worked in South Korea, but in many countries in Africa, Asia and Latin America it didn't, because the new industries became inefficient due to corruption.After the 1950s, the field of economics also expanded to cover almost everything. This was thanks in part to the Chicago economist Gary Becker (1930 - 2014), who thought that economic life was intertwined with "social" life -- things like family, culture, and crime. Becker believed that economic calculation of costs and benefits could be applied to these areas too. For example, a major factor in crime, according to Becker, was simply that it was profitable. He even said that racism was a preference that was costly to racist employers because it meant that they were paying extra for the same quality staff. When it comes to marriage and raising children, Becker said that the "time intensity" of cooking and looking after kids presented an opportunity cost that was higher for people who earn higher incomes -- which is why women started having fewer children as they entered the workforce. Many of Becker's ideas, like "human capital", were once controversial but today quite standard.
The heart of economics is still the question of economic growth: how do societies get richer and better at providing what people need? Two economists, the American Robert Solow (born 1924) and the Australian Trevor Swan (1918 - 1989), used mathematics and statistics to explain how economies grow in normal times (i.e. not in recessions). In their theory, rich countries have a lot of capital and output per worker, thanks to knowledge and technological improvements. But because poorer countries have higher "returns to extra capital", they can grow faster and eventually catch up to the rich countries. Indeed, after WWII, Europe and Japan caught up to America. However, most of Africa still lagged behind. According to Paul Romer (born 1955), this may be because some countries don't invest enough in the research and development of technology (a type of market failure). Without government intervention, these poor countries will not automatically catch up.
In the 1950s, economists were also putting a new twist on Adam's Smith's idea that harmony and coordination in the economy can arise by millions of people just doing their own thing. Kenneth Arrow (1921 - 2017) and Gérard Debreu (1921 - 2004) showed how supply and demand in a single market can have ripple effects on other markets. They followed in the tradition of Léon Walras (1834 - 1910), who postulated a set of equations that describe the "general equilibrium" (when all markets are in equilibrium). Arrow and Debreu solved Walras's mathematical problem by assuming that people have consistent preferences; they then demonstrated that the general equilibrium is "efficient" in the sense that one person cannot be made better off without making someone else worse off (this is called pareto efficient after Italian economist Vilfredo Pareto (1848 - 1923)). This result came to be cherished as the "First Welfare Theorem". It implies that a market economy in equilibrium does not waste resources. However, efficiency is not the same as fairness. Furthermore, Arrow and Debreu assumed perfect competition and no externalities, conditions that are unlikely to hold in reality.
As the Cold War lumbered on, revolutionaries like Fidel Castro and Ernesto "Che" Guevara in Cuba continued to assert that American companies were exploiting the poor countries of Latin America. This idea was supported by economist Andre Gunder Frank (1929 - 2005), who wrote that big foreign companies take the profits from banana and coffee exports and take it back home -- essentially looting the land in the same way that European explorers in the 15th century sucked gold out of South America. Frank's "dependency theory" implied that the gap between rich countries and "peripheral" countries would get bigger over time. A less radical economist was the Argentinian Raúl Prebisch (1901 - 1986). Prebisch still contradicted conventional economics by arguing that free trade would harm poor countries, because the prices of primary products (e.g. bananas, coffee and sugar) tend to rise more slowly than the prices of manufactured products (e.g. television sets, cars and jewelry). This would create a vicious cycle whereby poor countries get trapped into exporting cheap sugar and coffee, not enough to import cars from rich countries. The solution would be to close the borders and diversify their economies. Many countries did this in the 50s and 60s, but by the 1970s there was a turn back toward capitalism, thanks to the free-market Chicago school. (And also thanks to the United States government supporting violent coups against socialist governments.)
The Great Macroeconomic Schools
Whereas microeconomics studies the behavior of individual consumers and firms, macroeconomics studies the economy as a whole, for example the level of unemployment and inflation. The latter was heavily influenced by Keynes and his followers, such as Paul Samuelson (1915 - 2009), Alvin Hansen (1887 - 1975), John Hicks (1904 - 1989) and Bill Phillips (1914 - 1975). The Keynesians maintained that the government should help the economy grow and create enough jobs. Their policies were called "fiscal policy", and included tax cuts and government spending (on roads, hospitals, schools, tanks, or pretty much anything). There was also "monetary policy", which included printing money and buying bonds in order to influence the amount of money in circulation or the interest rate. The Keynesians often preferred fiscal policy because even when interest rates are low, businesses might still be pessimistic about investment (as was the case during the Great Depression). Even though the decades following WWII saw good economic performance and rising living standards, some economists grew wary of Keynesian policies and the rising inflation they caused.As the American government went on a spending spree in the 1960s, the Keynesian economists and the government bureaucrats who implemented their policies came under fire from a new breed of economist known as public choice theorists. A leading figure in the field was James Buchanan (1919 - 2013), who asserted that politicians do not work for the good of society, but are more like clowns who act in their own interests. His argument was based on the work of Swedish economist Knut Wicksell (1851 - 1926). Buchanan developed it by showing how politicians stay in office by paying "rents" (giving special privileges) to their supporters, for example by protecting domestic businesses from overseas competition. In turn, this encourages businesses to be rent-seeking, which wastes resources and hurts consumers. The cause of the problem, according to Buchanan, was that the government was too powerful.
Another attack on Keynesian economics came in the 1970s when high inflation combined with high unemployment resulted in so-called "stagflation" (which was not predicted by the Phillips curve, which said that higher inflation went with lower unemployment). A new giant of economic policy emerged -- his name was Milton Friedman (1912 - 2006) and he came from the Chicago school of economics. Friedman was a staunch defender of capitalism, and unlike the Keynesians he favored monetary policy over fiscal policy; hence why his school of thought is known as "monetarism". Friedman argued that the rate at which a dollar bill changes hands (i.e. the "velocity of circulation") remains relatively stable, which implies that an increase in the quantity of money can lead to a real increase in production and income. But this only happens in the short run; as prices rise, people eventually realize that their "real" wages are not any higher, and the level of employment falls again while prices remain high. This is the effect of money illusion. To Friedman, this meant that it was pointless to try and boost the level of employment above a certain "natural" rate. The best governments could do was to commit to a fixed rate of growth in the money supply each year. It could also engage in "supply-side economics" by making it easier for businesses to produce more, for instance by loosening regulations.
Back to the Microfoundations
For many economic activities, firms and workers have to predict the future. If you don't predict using all the information available, though, you could lose out. The American economist John Muth (1930 - 2005) introduced the revolutionary theory of rational expectations, which simply says that people do make good predictions on average, and when they're wrong it's mostly due to random factors. Eugene Fama (born 1939) worked out the implications of the theory: if investors believed that the price of a share would go up next week, then according to rational expectations they would buy it today; but in doing so they would push up the price until the profit opportunity disappeared. Therefore, according to Fama's "efficient market hypothesis", it is impossible to consistently beat the market. And according to Robert Lucas (born 1937) the idea of rational expectations also means that workers aren't "fooled" when the government tries to boost the economy, because they know that higher inflation will negate any rise in wages. This was another attack on Keynesian economics, and it led to a school of thought known as "new classical economics".In the 1970s, speculation by banks and hedge funds became much more intense. Financiers such as George Soros traded in currencies for profit, including by attacking pegged currencies (i.e. currencies whose exchange rates are fixed at a specified value of another currency). According to the economist Paul Krugman (born 1953), currency speculators look for governments who print a lot of money because they anticipate that the government will eventually run out of the foreign currency reserves needed to maintain a peg. The speculators then buy up the remaining reserves so that the peg breaks, causing the weaker currency to experience a crisis as it depreciates. But even if money is not being printed, a currency crisis can still happen if speculators believe that the government will abandon the peg -- this is what Maurice Obstfeld (born 1952) said happened to Britain in 1992. Some people blame speculators for crashing economies. Jeffrey Sachs (born 1954) argues that an unnecessary panic among speculators can trigger a crisis even when governments are not pursuing bad policies.
Sometimes, fluctuations in markets (triggered by disruptive floods or droughts) can cause famines, as happened in Bangladesh in 1974. When agricultural workers lose their jobs and food prices skyrocket, many poor people simply starve. One economist and philosopher who cares a lot about the issue is Amartya Sen (born 1933). Sen believes that poverty is not just about money or food -- it is also about freedom and democracy. A government scrutinized by free journalists is more accountable and has a greater incentive to do something about the hardships of the poor. People who are healthy and can read will live more fulfilled lives. According to Sen, what matters here is not purely material, economic development, but a capability-based conception of human development. He therefore helped the United Nations to create the "Human Development Index", which includes literacy rates and life expectancy alongside the traditional measure of gross domestic product.
In 1970, a famous article by George Akerlof (born 1940) helped create the new field of information economics. Akerlof explained another way in which markets can fail to work well -- that is, when sellers know more than buyers or vice versa. For example, a second-hand car dealer might know that a certain car is a "lemon" (dud) but won't tell you. If you therefore suspect that any car for sale might be a lemon, you'll be unwilling to pay a high price; but this means that owners of good cars will be less willing to sell their cars (as they prefer a higher price), leading to a market where mostly bad cars are sold. The lack of "perfect information" also applies to the market for health insurance (you know your health better than the insurance company) and other kinds of insurance (you might be more careless with your mobile phone after you've insured it). One way to get around this is to "signal" your abilities through qualifications, an idea developed by Michael Spence (born 1943). Information economics has also been applied to questions of development by Joseph Stiglitz (born 1943), who argued that free-market financial policies led to bad loans in East Asia, since lenders didn't have accurate information about borrowers. The work of Akerlof and Stiglitz challenges Adam Smith's idea of the "invisible hand".
Alongside information problems there are also problems of time inconsistency. People often change their minds and don't follow through on threats, because "what's best today is no longer what's best tomorrow" (p. 201). The economists Finn Kydland (born 1943) and Edward Prescott (born 1940) found that rational expectations lead to time inconsistency. If people anticipate that the government will break its promise to keep inflation low, for example, then the economy becomes more volatile and turbulent. The government might try to suddenly boost the economy before an upcoming election. But according to Kydland and Prescott, when the government has discretion to decide policy at any point in time, it leads to self-defeating actions. A better approach would be to stick to a rule decided in advance -- and in order for people to believe the promise, economists have argued for governments to make their central banks independent. This could have been a contributing factor to the low inflation of the 1980s and 1990s, but there where other factors too, such as fewer oil shocks.
Economics in the Modern Age
Even though women live longer than men, some countries (like China, Bangladesh and Pakistan) have more men than women, possibly because women in those countries are more likely to die from malnutrition or lack of medicine. A group of feminist economists in the 1990s, inspired by Amartya Sen, argued that societies were biased against women and didn't give women their fair share of resources. Diana Strassmann (born 1955) says that the economic stories we tell tend to reflect a male point of view, for example by assuming that men are the heads of households and kindly provide their dependent wives and children what they need. This overlooks the ways in which resources can be distributed unfairly inside the family. Another economist, Nancy Folbre (born 1952) wrote that women's work in raising children is wrongfully excluded in calculations of national productivity. Julie Nelson (born 1956) argues that economists shouldn't judge economic positions merely on the criteria of free choice and Pareto efficiency (because those favor already-powerful groups), but in terms of "provisioning": providing people with the things they need to live well, including food, medicine, education, and the care of children and the elderly.Conventional economists have assumed that people are rational, but psychologists like Amos Tversky (1937 - 1996) and Daniel Kahneman (born 1934) have discovered that people have various illogical quirks in decision-making. This has helped create the field of behavioral economics, which has found that people weigh up gains and losses differently (they have "loss aversion") and that people's choices are influenced by how something is "framed" in comparison to a reference point. Kahneman and Richard Thaler (born 1945) found that people put a higher price on something if they already have it than when they don't. People also make mistakes in judging probabilities, for instance in thinking that a narrow event is more likely than a broad event because it sounds more representative of a description. Economist Robert Shiller (born 1946) argues that prices in financial markets are more unstable than they would be if those markets worked efficiently, implying that people follow emotions or economic fashions rather than rationality. He predicted the 2000 stock market crash.
Economics needs to be aware of its own biases. At the same time, it should get credit for making a difference to people's lives, because not only do economists describe how the economy works, they also use theory to create new, real parts of the economy. An example of this is market design, a field pioneered by Alvin Roth (born 1951), who designed a database of kidney patients and kidney donors that uses algorithms to find matching kidneys, enabling many more exchanges and organ transplants to take place. There is also auction theory, which was used by economists in the 1990s and 2000s to help governments sell radio spectrum licenses to mobile phone network companies. British economist Paul Klemperer (born 1956) started off as an engineer before turning to economics. He designed an ascending auction in which bidders could only bid on one license -- this way, bidders couldn't play crafty tricks and had to bid their true valuation. In other contexts such as eBay auctions, the winner pays only the second-highest bid, a principle promoted by Canadian William Vickrey (1914 - 1996) since it reduces the incentive to "shade" one's bid.
After Lehman Brothers went bankrupt in 2008, the global financial system went into recession and many people lost their jobs and homes. Violent protests erupted in Greece in 2010. Many economists were shocked by the crisis. However, one Hyman Minsky (1919 - 1996) was ahead of his time in the 1980s when he formulated theories that could explain why capitalism runs into crises. Minsky followed Keynes in saying that people invest because they feel optimistic and not because they've calculated the probability of future profit. To open a business or buy a house, you might take out a loan from a bank, and the bank will be cautious about your ability to repay. Thus, according to Minsky, banks power the economy by creating money. But as more people want to borrow, banks are tempted by profit and become more daring: they lend "speculatively" by loosening their terms. Capitalism then develops into "reckless capitalism", whereby banks will lend even to people who don't have much ability to repay (known as subprime loans). They can profit from this for a while thanks to securitization: the innovation of new, complex financial instruments. However, this creates a bubble, which eventually bursts when lenders ask for their money back. A recession is triggered when people's homes are foreclosed or banks go bust. Unfortunately, the 2009 situation in Greece was exacerbated when the government embarked on "austerity" policy (cutting spending) too soon.
The distribution of income today looks rather different than it did in the 1970s. Since then, the share of the nation's income of the top 1% of US earners has risen from 10% to 20%. The "one percent" comprises pop stars, sportsmen, and executives at large companies. But mostly they are people who own businesses and land. The French economist Thomas Piketty (born 1971) has found that the rate of return on wealth (i.e. profits from shares, rents from land) tends to grow faster than the output of the economy. He summarized this in his famous equation: r > g. In order for society to reach a more equal distribution, the government must redistribute resources from the rich to the poor; but it must do so without upsetting efficiency, otherwise growth will slow. Anthony Atkinson (1944 - 2017) argued that higher wages can encourage staff to work hard, so a generous minimum wage could reduce inequality while improving efficiency. Atkinson and Piketty have also proposed a global wealth tax, and the encouragement of technologies that promote equality.
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So there you have it: A Little History of Economics. After reading Bill Bryson's book "A Short History of Nearly Everything" (my summary here), which deals primarily with natural sciences, you may find it apropos to read something similar about the social sciences. Of course, Niall Kishtainy's book is limited to economics, and so it cannot capture the richness of all of social and behavioral science. Yet there is something to be said for the breadth of economics -- it touches on issues relevant to sociology (e.g. Gary Becker's analysis of the family and crime), psychology (e.g. the behavioral economists), feminism, political science (e.g. James Buchanan's public choice theory), public policy, environmentalism, war (e.g. Lenin's critique of imperialism), competitive strategy, human geography (e.g. Thomas Malthus on population growth), religion (e.g. the taboo of usury), and of course philosophy (e.g. questions of equality, fairness, and the moral limits of markets). The way all these threads are tied together in this book makes it worth reading -- not as a textbook but as a kind of "anti-textbook", which challenges the mainstream econ 101 treatment by laying bare the value judgments that economic thinkers have sparred over for centuries.
In that sense, Kishtainy's A Little History performs a great service. Yet because it doesn't dive into the nitty-gritty of the theories for the sake of being as compact as possible, the book sometimes feels a bit underwhelming. Other reviewers on Goodreads have said that the book was "a bit choppy" and its brevity "worked against their enjoyment", while others have pointed out the lack of notes or references. But the vast majority of readers gave it an excellent rating, and I would concur by giving it 4.5 out of 5 stars.
P.S.: The MIT Media Lab has a project called Pantheon, which has a ranking of people according to historical popularity. Check it out if you want to read up on some influential economists who were not included in Kishtainy's book.
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