That was when the Securities and Exchange Commission ended the New York Stock Exchange’s 180-year-old monopoly on corporate control, eliminating its authority to fix commissions in securities transactions. Although I barely understood it at the time, this accelerated the demise of the old WASP establishment that had presided over the country since its beginnings – The Last Days of the Club, as journalist Chris Welles put it in a perspicacious book – and opened the door to an era of restructuring, accomplished in the West mainly through mechanisms of finance, that would quickly spread all around the globe. Baseball’s Reserve Clause, which bound players to the clubs that owned their contracts “in the interests of the game,” fell in arbitration the same year.

After that, nothing surprised me, at least not for long – not Jimmy Carter’s election in 1976, or Ronald Reagan’s victory in 1980; not the capital gains tax cut in 1978 (and the subsequent explosion of venture capital investment in new enterprises) or the Bayh-Dole Act of 1980 (expanding private patent rights to government-sponsored research) or the income tax cuts of 1981; not the rise of Michael Milken or the breakup of AT&T; not the beginning of interstate banking or the collapse of the oil cartel; not Deng Xiaoping or Mikhail Gorbachev; not the fall of the Berlin Wall or the breakup of the Soviet Union; not even the transformative effect of the microprocessor, the software industry, the Internet and the browser.

There was a tide running, it was clear, one that favored outsiders over insiders, newcomers over incumbents, individuals over the group. The major exception to that rule in those years, it seems to me, when “the interests of the game” came first, was Paul Volcker’ appointment to the Federal Reserve Board in 1979 and subsequent career (then it was the Hunt brothers, busy attempting to corner the world market in silver, who were the first rugged individualists to be clobbered), though the Social Security compromise of 1982 and the tax reform act of 1986 should be mentioned as well.

These days I have something of the same feeling about the health care bill going forward in the US Congress, except that now, I suspect, the tide has finally turned and things have begun to flow the other way

Not that the House bill is by any means a decisive triumph. Instead, it signifies the opening of another door, this one leading to an era in which choices will routinely emphasize the social order instead of purely individual choice, not one big change, but lots of little ones

Like what? To get some sense of what such a shift in emphasis might mean going forward, think back on the changes in health care in the years when things went the other way.

Arnold Relman has described a process he calls the commercialization of the health system. A physician, Harvard Medical School professor, and for fifteen years editor of The New England Journal of Medicine, Relman long has been among the most nation’s most relentless critics of the growing influence of market capitalism on the practice of medicine. It had begun during World War II, when investor-owned health insurance companies were established in order to take advantage of employment-based insurance, he writes in A Second Opinion: Rescuing America’s Health Care System, his 2007 book, but rapid changes commenced only in the 1970s.

A key event, Relman explains, was the 1975 Supreme Court decision in Goldfarb v. Virginia State Bar which found that lawyers, and thus other professionals, including physicians, were engaged in interstate commerce, and therefore could be compelled to compete under the antitrust laws, from which they, like the owners of baseball teams and members of the New York Stock Exchange, previously had been exempt. (He reprised the argument here last summer.)

Before that decision, the American Medical Association had cultivated a professional ethos among its members, requiring them to limit their earnings to their patient practices, to refrain from advertising, and from going into business with pharmaceutical and device manufacturers. After suffering a series of courtroom defeats at the hands of physicians chafing at its control of fees and practices, the AMA acknowledged that medicine had become a business as well as a profession, and changed its ethical guidelines accordingly. The courts didn’t initiate the commercialization of medicine, Relman writes, but they accelerated it and gave it legal justification. Many other sources of authority, from Congress to venture capital firms, from investment bankers and institutional investors, sanctioned it and gave it force.

The result is a medical profession that has become far more entrepreneurial and profit-oriented than any other in the world. Relman says that investors own around 20 percent of nonpublic general hospitals, almost all specialty hospitals, and most freestanding facilities for walk-in patients, such as clinics, imaging and surgery centers. Non-profit hospitals are forced to compete by advertising their services to the public.

A certain amount of decentralization and competition is desirable in the health care sphere, obviously. But the risk of turning a service that by its very nature is not well delivered by the market into an industrial lobbying complex is substantial. Diminishing that risk is what reform of health care is about.

Is it possible to structure the system so as to bring more people into medicine because they want to practice a healing profession, secure in the knowledge that they will earn relatively high salaries and an appropriate measure of their communities’ respect? Probably. Cornell University economist and New York Times columnist Robert Frank today offers a good gloss on some of the details. The best overall guide to what to eventually expect is still Tom Daschle’s book Critical: What We can Do about the Health Care Crisis, in which he and co-authors Jeanne Lambrew and Scott Greenberger advocate the creation of a Federal Health Board designed to oversee medicine in much the same way that the Federal Reserve Board oversees the banking industry, through the agency of a dozen decentralized regional authorities. Daschle, who served for a time as Senate majority leader, was to have been Secretary of Health and Human Services in the Obama administration until his failure to report as income and pay taxes on a chauffeured car forced his nomination to be withdrawn. He retains much influence behind the scenes.

There will be plenty of opposition – threats of doctor shortages, of red tape, of health care rationing, of lagging national competitiveness. (Here’s an intelligent summary of the particulars that chafe so far. ) The Republican Party will continue to resist, perhaps to shake itself apart, until it can re-emerge once again as a broadly acceptable steward of institutions it shows no interest in helping build. The House bill as it stands is a step in the right direction, evidence of a flow that can be expected to continue for many years – towards a modest privileging of the rights of the community over a fortunate minority of its members. Its passage will be as significant in its way as was that May Day deregulation in New York long ago

So who is the most widely read woman in the profession? Susan Athey, of Harvard University, the first woman to win the Clark Medal? Christina Romer, of the University of California at Berkeley, chair of the President’s Council of Economic Advisers? Laura Tyson, also of the University of California at Bekeley, who held that job fifteen years before? Anne Krueger, of Stanford University, the second woman to serve as president of the American Economic Association? Alice Rivlin, of the Brookings Institution, the first?

The answer is probably Carmen Reinhart, of the University of Maryland, when measured by citation counts, the yardstick commonly used to gauge professional fame. (Google Scholar, which I consulted, makes this easy, but is in the nature of a leading indicator; the Web of Science database is more precise, but takes more time to search.) Reinhart is author, with Kenneth Rogoff, of Harvard University, This Time Is Different: Eight Centuries of Financial Follies, a book of tables, figures, flow charts and data appendices that has become one of the business best-sellers of 2009.

More to the point are the two electrifying papers that Reinhart and Rogoff brought to the yearly economic meetings in January 2008 and 2009. Both depended on a large historical data set the authors had compiled that in due course would be published as This Time Is Different. The first, “Is the 2007 US Sub-Prime Financial Crisis So Different? An International Historical Comparison,” persuaded a wide range of professional economists that the US economy was in for a terrific shaking – nine months before the banking crisis began.

The second, “The Aftermath of Financial Crises,” dispelled hopes that the recession would be an ordinary “v”-shaped variety, showing that financial crises, especially those involving asset bubbles, were almost always protracted affairs. Citations of the two papers are only now beginning to show up. Yet Reinhart and her co-authors have two papers with more than 2,000 citations and three more of around 1,000 each, dating back to 1993, analyzing previous crashes. Ordinarily, three or four papers of 300 citations or more are enough to make you a risen star: 575 for Christina Romer’s best-known paper, 265 for that of the more technical Athey.

So never mind, for the moment, “the second great contraction,” as Reinhart and Rogoff call it. Her story is interesting in its own right.

Reinhart (nee Castellanos) was ten when she left Cuba with her father and mother in 1966, each of them carrying what was permitted to those able to qualify for an exit visa: a suitcase containing three changes of clothes. An older brother had gone ahead of them. Her father, an accountant, found work as a carpenter in Pasadena, California. When the family moved to Miami, Reinhart started college at two-year Miami Dade College (where a professed Communist taught the economics course from Douglass Dowd’s The Twisted Dream: Capitalist Development in the United States Since 1776), then transferred to FloridaIinternational University, where, as luck would have it, Peter Montiel, a recent PhD from the Massachusetts Institute of Technology was teaching while he cared for his aging parents. (He teaches and does research at Williams College today.) It was Montiel who in 1978 recommended Reinhart to Columbia University.

Columbia in the late 1970s was enjoying something of a golden age. Philip Cagan and John Taylor taught monetary theory; Edmund Phelps, Guillermo Calvo and Maurice Obstfeld, macroeconomics; Ronald Findley and Jagdish Bhagwati, international trade. Reinhart married classmate Vincent Reinhart and, after the two passed their field examinations, quit to try her hand at Wall Street. She joined Bear Stearns as an economist in the spring of 1982, just as petrodollar recycling of the 1970s ended, and the Third World debt crisis of the 1980s began. It was, she says, an invaluable education in dealing with incomplete information. Three years later she was the firm’s chief economist. A year of that was enough. She returned to Columbia to write her thesis, under Robert Mundell, who by then was returning to economics after some years away.

The Reinharts moved to Washington. She worked as a research economist for the International Monetary Fund; he began a long climb to the top of the staff of the Federal Reserve Board, eventually serving as secretary of the Federal Open Market Committee under Alan Greenspan and, for a time, Ben Bernanke. (He’s at the American Enterprise Institute today.) Financial crises, colorful events in distant lands, came and went. A 1993 paper with Calvo created a ruckus within the Fund, suggesting that a rise in US interest rates might trigger a rapid outflow of funds elsewhere; it was especially disparaged in Mexico City. Six months later the “Tequila Crisis” began, and, as Calvo says, “The show was on.” Calvo brought her to the University of Maryland in 1996. A series of papers followed on the Asian financial crisis (and the threat of contagion it entailed), culminating in ‘The Twin Crises: the Causes of Banking and Balance-of-Payments Problems,” with Graciela Kaminsky, of George Washington University

It was in 2001 that Rogoff, by then teaching at Harvard, began a two-year term as chief economist at the IMF. Almost immediately he hired Reinhart to be his deputy. The two began collaborating at once, stitching together the patchwork history of post-war exchange rate regimes and financial crises. The record was far from complete. A substantial fraction of the policy literature on public debt was based on data collected since 1980, since it was in that period that they became easy to collect. The trouble was that financial crises unfolded in much longer cycles, and data that spanned 25 years had no better than a one-in-four chance of capturing the proverbial “hundred-year flood.” They expanded their horizons: one year, for Valentine’s Day, Reinhart gave his wife a complete set of the League of Nations’s annual economic reports from the 1920s. “It was like reading [the IMF’s] World Economic Outlook or the newspapers,” she says. Before long they were immersed in the details of sovereign default on external loans as far back as fourteenth century Europe. Says Rogoff, “I never worked harder in my life.”

The result was a growing sense that the first major crisis of the twenty-first century was really very little different from the five worst post-war episodes in industrial countries they had studied (Finland, Japan, Norway, Spain and Sweden). The run-up in equity and housing prices in countries experiencing large capital inflows was the same; so was the sharp peak in growth and so were the rationalizations, the stories about why “it’s different this time” (productivity growth, a savings glut). The fear was that the aftermath, too, might be little different: a dismal 5 percent from peak to trough, requiring more than three years to return to trend.

This is not the place to gauge the effectiveness of the stimulus enacted earlier this year in staving off a worse recession than the one that already has occurred. Reinhart and Rogoff are busy preparing a third paper for the January meetings, this one concerned with “de-leveraging,’ meaning the steps necessary to cause banks to write down overvalued assets and begin lending freely once again. Reinhart enumerates three worries about the present situation: the tendency to declare premature victory versus the tendency of spending to fall; delaying the re-liquefaction of banks, and general complacency about the rest of the world, particularly emerging markets. In China, for example, credit has been expanding at an annual rate of forty percent or even fifty percent; it’s hard to do that for any length of time without running into problems.. “It’s always a surprise when it happens,” says Reinhart “There’s always a plausible story about why it’s different this time.”

Now US-China relations are beginning to dominate the news: China powering out of its slump, China celebrating the sixtieth anniversary of its revolution with military displays, China investing in its cyber-spies, China low-balling its currency, China pinching jobs from poorer nations.

It’s a good time, therefore to consider Misadventures of the Most-Favored Nations: Clashing Egos, Inflated Ambitions, and the Great Shambles of the World Trade System, by Paul Blustein.

One of the best American economics journalists of his generation, Blustein took a buyout from The Washington Post in 2006 but stayed on the beat, thanks to the Brookings Institution and a series of foundation grants. The author of two well-regarded books about the International Monetary Fund – The Chastening, about the Asian financial crisis of 1997-98; and The Money Kept Rolling In (and Out), about the Argentine banking crisis of 2001 – Blustein is uniquely qualified to make a lively story out of the bureaucratic roundelay that began in Doha, the shimmering capital city of the desert kingdom of Qatar, in January 2001.

Misadventures is a beguiling story, 344 pages about the ins-and-outs of the global trading system and the personalities who preside over it, almost always in expensive settings. There are occasional field trips, too, to locations where things actually get made – a French vineyard, a Punjabi wheat farm, a Zambian dairy – but most of the action takes place in the elegant villa on the banks of Switzerland’s Lake Geneva that is WTO headquarters.

Blustein somehow makes it all readable (not that I read it all). He is the sort of fellow with whom you would be happy to sit down at lunch in order to explain your business – confident that you would be understood and fairly treated, expecting that both of you would see things more clearly afterwards as a result. In turn he gracefully illuminates the organizations that he covers: in this case, the 630 staffers of the WTO’s Secretariat, as opposed to the 2,600 persons who work for the IMF and the more than 10,000 who work for the World Bank.

He traces the WTO’s history, from its 1948 beginnings as the General Agreement on Tariffs and Trade, run for 45 years much like an English gentlemen’s club by a relative handful of powerful nations, to the far more complicated body that came into existence in January 1995, after eight years of negotiations, which apparently has become home to every form of blocking strategy known to humankind.

When negotiations finally break down in 2008, after nine intense days of dickering, Blustein concludes, “There has got to be a better way. That is one obvious lesson to be drawn from this book – from both its content and its length.” But how exactly might the WTO be saved from the Doha Round? He summarizes the various prescriptions that followed the breakdown:

Put the round out of its misery.

No, harvest the organs.

No, stay the course and just get it done.

No, try doing smaller deals with “coalitions of the willing.”

No, switch to negotiating bilateral pacts.

No, aim for a much bigger, more meaningful agreement on issues that really matter.

Naturally Blustein has some ideas of his own. After eight rounds of negotiations, he says, after fifty years, trade is today reasonably free. The important thing now is to keep it that way: to stick to a rules-based system, and prevent protectionism from becoming an ingrained feature of the global order. So he would, for instance, like to see a moratorium on the bilateral agreements that have become a familiar way of dividing up markets in recent years. He also boosts the expand-the-agenda ideas of a pair of economists whose article in Foreign Affairs last year, he says, “threw the Geneva trade community into a tizzy.”

In From Doha to the Next Bretton Woods, Aaditya Mattoo, of the World Bank, and Arvin Subramanian, of the Peterson Institute for International Economics, argued then that the Doha talks had become a distraction. Negotiators, they wrote, had “Nero-like, spent too much time dwelling on minor issues while ignoring the burning questions. These include food policy (big exporters like Argentina sometimes withhold production from world markets during periods of scarcity); climate (the Appellate Body of the WTO cannot be asked to make judgments on carbon tariffs in the absence of a major treaty, as it is sometimes asked to do); and above all, currency matters

Blustein writes, “The world needs an effective multilateral approach for dealing with countries that use their currencies to subsidize exports and penalize imports.” It doesn’t need a direct confrontation between Washington and Beijing, he says; that probably would end badly. But trade wars, or a cycle of beggar-thy-neighbor currency devaluations, are a distinct possibility if the Yuan doesn’t appreciate considerably.

And that brings us back to China.

There may have been no one better overall on the global crisis than Maurice Obstfeld, of the University of California at Berkeley, and Kenneth Rogoff, of Harvard University, co-authors of the leading textbook on international macroeconomics. Starting in 2001, they argued in a series of papers that growing global trade imbalance would eventually pose a serious threat to prosperity. They were not always right about the mechanisms, or precise course events would take, but they were always ahead of events – especially after January 2008, when Rogoff and his research partner Carmen Reinhart published a startling analysis of the likely consequences of the US subprime lending crisis – nine months before its panic phase began.

In a new paper, on Asian economic policy, prepared for a meeting of the Federal Reserve Bank of San Francisco earlier this month, Obstfeld and Rogoff look back on the decade of rapidly growing trade imbalances that they say were at the heart of the crisis – not the cause exactly of leverage and housing bubbles, they say, but an important co-determinant. A key factor in creating those continuing imbalances, they say, was Chinese exchange rate policy. Monetary policy in the US and euro zone was another, plus faulty regulatory frameworks in the US, Britain and some European countries, which permitted low interest rates to create explosive financial vulnerability.

“Until now, China has followed the model that Japan pioneered, orienting its economy towards exports in order to exploit scale economies, to learn by doing, and to move up the value chain.” Keeping its currency artificially low has worked very well indeed to this point. But now China, unlike other Asian nations, is in a position to reorient its economy towards internal growth, and to let its currency appreciate substantially, without losing its advantages in global markets. Coupled with some deficit reduction in the United States, such measures would go a long way in redressing the balance between surplus and deficit countries.

The trouble is, they write, with its position as the leading international lender, China has little incentive to undertake those reforms, even though they’d be good for its citizens and good for the world. Nor is it particularly vulnerable to pressure. The huge volume of foreign reserves it holds amounts to a form of self-insurance. And even threats of trade wars have evoked only small changes in its policies.

So what’s going to happen? More negotiation, that’s what, over the coming decades. And not just at the level of the IMF, which has the responsibility of assessing when a currency is undervalued, but at the WTO, where sanctions might be sought against countries found to be in violation of the rules. That’s the kind of world we live in now – and why reporting like that of Paul Blustein is important. Meanwhile, as Obstfeld and Rogoff conclude, it is a wise country, poor or rich, that increases regulatory oversight whenever the money starts rolling in.

Over a forty-year research career, Ostrom, 76, has studied everything from the harvest of fish in the sea and grazing rights in alpine meadows, to patterns of police law enforcement and the creation of private rights to public knowledge. She found that key institutions often had relatively little to do with either top-down regulation or top-down privatization, but rather “deep mechanisms that sustain cooperation” (in the words of the prize citation) that were evolved by human beings working together over many years.

The committee meanwhile held off on a corresponding prize to high theory in the economics of organizations. It opted instead to share the prize with Oliver Williamson, of the University of California at Berkeley, for the work he did long ago on the logic of hierarchical management in large firms.

The prize was described as recognizing Ostrom and Williamson’s contribution to the understanding of “economic governance.” A great deal of that governance, it turns out, occurs in a borderlands between the firm and the state.

Like many people, I had never looked at Ostrom’s 1990 book, Governing the Commons: The Evolution of Institutions for Collective Action, until Monday morning, when the news from Stockholm sent me scurrying for a copy. Smarter guys than me, indeed most of the economics profession, had never heard of Ostrom. (Steven Levitt, of the University of Chicago, describes in an edifying way how he looked her up on Google.) I knew at least that she and her husband, Vincent, also a political scientist, had a big following at George Mason University.

Once I had a chance to read quickly though the book, however, I understood pretty well the choice of Ostrom, despite the fact that she has published less frequently in economics journals than any other person to receive the prize. Her method is the polar opposite of the logical-deductive, law-enunciating style that had dominated modern economics in the two centuries since David Ricardo took the baton from Adam Smith.

Economic ethnography (the term is Nancy Folbre’s), or fieldwork (Alex Tabarrok), is not common in economics, but it happens. Some close observers of economic arrangements (besides Ostrom) include:

Ronald Coase, for example, in 1974, showed in “The Lighthouse in Economics,” that theorizing about the necessity of government provision of lighthouses as “public goods,” from John Stuart Mill to Paul Samuelson, overlooked the fact that traditionally they had been privately provided and financed by port fees, at least in the United Kingdom. A Nobel laureate himself in 1991, Coase wrote, “What we need is more empirical work.”

Truman Bewley, a distinguished mathematical economist, spent two years in the mid-1990s interviewing 300 business executives, labor leaders, consultants, and counselors of the unemployed asking them why market pay rates continued to rise during a business downturn despite rising unemployment. In Why Wages Don’t Fall During a Recession, he wrote, ““My findings support none of the existing economic theories of wage rigidity, except those emphasizing the impact of pay cuts on morale.”

Robert Ellickson, a Yale Law School professor, in his memorable Order Without Law: How Neigbors Settle Disputes, showed how cattle ranchers in California’s Shasta County governed themselves with informal rules and social norms with infrequent appeals to outside government.

Gordon Tullock, a maverick, trained as a lawyer, for many years a Foreign Service officer, made a long string of contributions to the investigation of what he called non-market decision-making – everything from licensing requirements to mosquito abatement projects to “log-rolling” voting behavior among politicians – sufficient to fill ten volumes of his collected papers. His name is thought to have been dropped at the last minute from the Nobel citation in 1986. The prize went solely to James Buchanan instead – a formally trained economist.

What qualifies Ostrom for the award is the breadth and duration of her reconnaissance. True, she’s the first woman to win the prize, first given in 1969; she’s the first resource economist as well. What really sets her apart, though, is the way she mapped her work into a discipline that tried its best to substantially ignore her.

Not only did Ostrom grapple with the best-known statement of the presumed problem of resource depletion – the famous “Tragedy of the Commons,” as formulated by biologist Garrett Hardin in an article in Science magazine in 1968. She tackled the two leading economic interpretations of the problem as well: the prisoner’s dilemma game, often employed to argue that rational creatures can’t possibly cooperate; and the free-rider argument, advanced by the late Mancur Olson in The Logic of Collective Action in 1964, to the effect that those who can ’t be excluded from the benefits of public spending will use too much of them and pay too little.

Her illustrations are designed to show that neither of the familiar arguments for depending on government to address such problems – government should assign property rights and get out of the way; or government should tightly regulate – are as likely to achieve success as are policies that seek to secure the active participation of users of the common pool. A typically telling finding, noted by the Nobel citation: total crop yield in Nepal is frequently higher around small primitive dams built from stone, mud and trees and managed locally, than near large concrete and steel dams where irrigation users have little incentive to concern themselves with necessary dam maintenance.

“I grew up in Los Angeles,” Ostrom told a press conference on the morning of her award. “The ocean is right there. And if you pull the groundwater down, surprise, surprise, the saltwater comes in. And if they had not found a way of reducing the quantity of water they pumped, and doing a variety of other things, they would have had to give up the groundwater basin to saltwater. I was very fortunate, I started that as a seminar paper, and I kept going and going.”

With the assertion that the sorts of commons she has studied are relics of an earlier time – Nova Scotia lobster beds, Sinhalese fisheries, Japanese forests, Spanish irrigation systems – Ostrom is impatient. The tasks of managing what she calls “common pool resources” (CPRs) are enlarging, not diminishing over time – and not just “natural” resources such as air and water, or relatively intimate collectives such as condominium associations and suburban school districts, but genuinely global commons, including the earth’s climate, its production and trading systems, and even the unfathomably complex body of know-how with which problems are addressed as they arise. Understanding Knowledge As a Commons is Ostrom’s most recent book; Working Together is to be her next.

It is in this sense that the Nobel Prize in economics, too, should be understood as part of a common resource pool of knowledge about our understanding of the world. Many different people are engaged in constructing the understanding of the prize, tugging it this way and that from year to year. The most recent suggestion arrived last month in the form of an open letter from ten distinguished scientists urging the Nobel Foundation to add two new prizes (environment and public health) to the current roster and to restructure the medicine prize. The British magazine The New Scientist put them up to the task. Studiously ignored was the existence of the economics award, the only one of the foundation’s prizes not established by Alfred Nobel’s original 1895 bequest. The adage, “The dogs bark, the caravan moves on,” doesn’t begin to describe this situation, whereas Ostrom’s Governing the Commons depicts it accurately. Who owns the prize in economics? In varying degrees, we all do.

As for markets and hierarchies, the other half of the prize, there is time enough for that when Oliver Williamson delivers his Nobel lecture in December.

xxxx

There was more to read about year’s economic Nobel than ever before, much of it from newspapers and magazines. Never mind Europe, where journalist Karen Horn made the shrewdest guess, as Ulrich Fritsche notes on his bilingual Macro blog. The New York Times’ Economix, TierneyLab, Conscience of a Liberal and Freakonomics blogs, and The Wall Street Journal’s Real Time Economics , with its fourteen reporters, had plenty. There were assessments by Time’s Justin Fox, Forbes’ Elisabeth Eaves, The New Republic’s Noam Scheiber as well

Then there was the blogosphere itself. Among the highlights: an open letter by Peter Boettke, of George Mason University (himself the author, with Paul Dragos Aligica, of a book on Ostrom, Challenging Institutional Analysis and Development: The Bloomington School); a careful profile of Ostrom written a few years ago by a National Academy of Sciences writer; two particularly good interviews with Vincent and Elinor Ostrom conducted when they were honored at George Mason’s Mercatus Center in 2003; as well as current commentary by Vernon Smith, Thomas Schelling, A. Michael Spence, Lynne Kiesling and Paul Romer.

Taken altogether, it adds up to more than most of us want to read. But it’s the process by which news becomes common knowledge — as Elinor Ostrom would have it, part of the CPR.

The science prizes created a master narrative for one of the great stories of the age. The prizes for literature and peace, while more controversial, carry considerable cultural and moral weight.

The problem with giving this year’s Nobel Peace Prize to President Barack Obama is obvious, at least when viewed from the perspective of American politics. So far he’s done little more than get elected.

It is last year’s solo prize in economics to Paul Krugman, of Princeton University and The New York Times, which poses the more interesting question. Are Scandinavians getting carried away with the US elections?

Not that Krugman didn’t deserve a Nobel soon for his work on the “new” economics of trade – or a half-portion of the prize, anyway.

For there were several other ways to make an award for the work on trade, most obviously jointly to Elhanan Helpman, of Harvard University, who teamed up with Krugman for a few crucial years in the early 1980s to overcome resistance to what were then regarded as thoroughly unorthodox ideas. Their 1985 monograph, Market Structure and Foreign Trade: Increasing Returns, Imperfect Competition and the International Economy, firmly established the new understanding of the strategic basis of much international trade, all but replacing a doctrine of natural “comparative advantage” that dated back 165 years to David Ricardo.

Lost in the shuffle, too, was Avinash Dixit, of Princeton University. It was Dixit, who, with co-author Joseph Stigliz (an earlier Nobel laureate, in 2001, for his work on winnowing information), developed the model of product diversity and monopolistic competition with which Krugman and Helpman quickly made their point – whereupon the Dixit-Stiglitz model became the workhorse by which several other major fields were similarly transformed. Wilfred Ethier, of the University of Pennsylvania, lost out on a plausible claim as well, as noted here last year. By giving the prize to Krugman alone, the Royal Swedish Academy of Sciences may have given a mistaken impression of his importance as a contributor to this tapestry, relative to the others.

Then, too, by stretching the prize citation to include Krugman’s widely-advertised but much less well-established contribution to economic geography, the Academy raised doubts about the extent of its ability to sell its judgment to the profession. Peter Neary, then of University College Dublin, reviewing The Spatial Economy: Cities, Regions, and International Trade, by Krugman, Masahisa Fujita and Anthony Venables, for the Journal of Economic Literature in 2001, noted the occasionally tenuous underpinnings of the volume and the tendency to hype that surrounded it. Neary wrote, “What next, the unconvinced reader may be tempted to ask. The tee shirt? The movie?” Almost no one would have guessed a piece of a Nobel Prize. (It was Neary, now at Oxford, who wrote up the award at the request of the Scandinavian Journal of Economics last summer. Nullum quod tetiget non ornavit, he quoth of Krugman – everything he has touched he has adorned – including, Neary noted, a brief early appearance in international macro and a highly visible second career as a public intellectual. But, he wrote, “putting the ‘New’ into ‘New Trade Theory’ remains his major professional achievement.”)

Most significantly, in giving the prize to Krugman in 2008, the Swedish Academy vaulted the work on international trade over developments in several others fields that, in any coherent account, was done earlier: in the economics of organizations, the organization of industries, measurement economics, public finance, auction theory, market design, environmental economics and the significance of entrepreneurs to economic growth, to mention only some of the areas that have seen significant gains in recent decades (never mind, for the moment, macroeconomics and finance!).There’s nothing that says the awards have to be chronological above all else, but the authority of the prize is diminished when its narrative aspect gets out of whack –as, for instance, with the long delay in recognizing MIT’s Robert Solow, in 1987, for his work on economic growth.

Until last week, the 2008 Swedish Central Bank Prize in Economic Sciences in Memory of Alfred Nobel (to give it its current official name), was merely an interesting anomaly. With the award to President Obama, the award to Krugman, at the height of last year’s financial panic, takes on additional interest. It was the timing, not the award itself, that arouses suspicion. Not since 1986, when James Buchanan, of George Mason University, received the economics prize by himself for his analysis of governmental failures – instead of sharing it with the late Richard Musgrave or Janos Kornai, both associated with Harvard – has a choice seemed so overtly political.

We’ll see tomorrow (October 12) what the prize awarders have in mind for economics in 2009. The Norwegian parliament, to whom Alfred Nobel assigned responsibility for the Peace Prize, has always demonstrated a bias towards hope. The Swedish Academy, whose 18 litterateurs enjoy lifetime tenure in their Stockholm salon, is as cosmopolitan and idiosyncratic in its taste as you might expect. The Karolinska Institute makes an award annually in either medicine or physiology, distinct subjects when Nobel laid down his pen which since have converged in the public mind to become biology.

But it is the the Royal Swedish Academy of Sciences, with some 600 members, 420 of them Swedes, custodian of the great prizes in physics and chemistry, which agreed to make the awards in economics, starting in 1969 – a decision that eventually will be seen as wise as it was bold. In the meantime, several more years will be required to demonstrate that the economics prize commands the respect of the Academy’s members, who are as worried about their jobs and personal savings as is everyone else. The authority of the prize depends, among other things, on not getting carried away by current events.

Dyson and I had worked down the hall from one another at Forbes in the mid-1970s. She was as fearless and indefatigable as any journalist I’ve ever known. Editor Jim Michaels blocked her path, so she quit the magazine and joined Wall Street securities analyst Ben Rosen. When he moved on to doing venture capital, she bought his electronics newsletter, renamed it Release 1.0, and began covering the emerging personal computer industry on a monthly basis. Delivered by postal mail in those days, Dyson’s letter looked a little like I.F. Stone’s weekly had in its heyday 25 years before. A subscription cost $400. Central to the business was an annual conference at which software magnates gathered to schmooze with one another.

Tufte had been the subject of one of the first Economic Principals columns I ever wrote for the Globe. His book, The Visual Display of Quantitative Information, had just appeared and begun attracting attention. For years afterwards I remembered the way he explained his decision to do the book himself, when no commercial publisher would consent to its extensive illustrations. “I’m a political scientist,” he said (his specialty was political business cycles). “Everything I write sells around 2,500 copies.” So he borrowed $100,000 against his house, priced the book to break even at $34.50, and is still dining out on the strength of its sales, now well over 100,000 copies. Three more books followed; the land around his house became a sculpture garden; once or twice a year he takes his one-day design lectures on the road. But Tufte’s greatest success was as consultant to the New York Times: the paper’s statistical graphics became the industry’s gold standard.

Stoll was a college sophomore when we met; it turned out we were both interested in “news.” He went into the business and became deputy to Seth Lipsky, a former Wall Street Journal editor who had started a weekly English-language version of the Yiddish-language Jewish Daily Forward. When in 2000, after a spat with the owners, the two men found themselves on the beach, Stoll started a website – today we might call it a blog. Smartertimes.com.was ostensibly a daily critique of The New York Times; instead, it turned out to be a way of trolling for potential subscribers to The New York Sun, a competitive daily newspaper in Manhattan that Lipsky and Stoll were quietly preparing to launch. The Sun shone brightly for six and a half years, from a few months after 9/11 until the September panic last year. Its biases were strong and sometimes repugnant to me, but it was a beautiful and lively paper that served its audience well.

Now Stoll is at it again, at FutureOfCapitalism.com. If you take a look at its How to Help page, you’ll get a sense of his plans for the future – grandiose, on their surface, until you remember that his last website grew into a newspaper with around a hundred employees.(As for Ira’s neoconservative tendencies, his news instincts are forever battling for the upper hand.) What’s encouraging is that an editor who in a short career has successfully managed three newspapers (if you count Stoll’s college daily) is beginning again with the Web, but this time perhaps intending mainly to remain there, with a plan reminiscent in many respects to that of editor Charles Sennott’s Global Post, which last month agreed to make its network of 70 correspondents in 50 countries available to CBS News.

It was Stoll who taught me about the possibilities of publishing on the Web. EP hired his designer, assembled a mailing list from those who wrote to express regret that the Globe had discontinued the column, fumbled with the mechanics of Dreamweaver development software, opened for business with no more of a business plan than that a well-established economics column was too valuable to waste. It took two years to hit on the model that now seems to work fairly well – reader-supported journalism, modeled on public broadcasting. A relative handful of subscribers pay $50 a year to receive, late Saturday, a bulldog edition of the weekly. Eighteen hours later, it goes online, where it is read by more than 30,000 readers interested in economics in 120 countries around the world – for free.

Having survived identification with the rise of a vast army of bloggers who have materialized in the years since its online incarnation began, EP thus finds itself a spear-carrier in the vanguard of online journalism. This is my day job now. I joined the Online Journalism Association. EP doesn’t aspire to a Washington bureau, doesn’t want to stage subscriber meetings in hotels, won’t offer bow ties as subscription premiums, and doesn’t accept advertising. But it does intend to keep doing what it’s been doing, to find more time to ask more questions and report more developments, to demonstrate that the Web is a viable platform for traditional journalism. The 300 or so subscribers who support this operation (renewal rates are always a little bit uncertain) should feel that they are part of a very interesting evolution in the news business.

To be sure, it’s not ProPublica, the glamorous not-for-profit news organization with its $14 million in foundation backing, its six-figure salaries for reporters, and its astonishing $570,000 salary for editor-in-chief Paul Steiger, former managing editor of The Wall Street Journal. But little start-ups – Dyson’s, Tufte’s, Lipsky’s, Stoll’s, Sennott’s, mine – may be more indicative of the possibilities for a new kind of journalism on the Web, perhaps even more durable in the end.

(Adapted from a recent quarterly Report to Subscribers.)

]]> http://www.economicprincipals.com/issues/2009.10.04/736.html/feed http://www.economicprincipals.com/issues/2009.10.04/736.html http://feedproxy.google.com/~r/EconomicPrincipals/~3/44FFhvTrTpo/724.html http://www.economicprincipals.com/issues/2009.09.27/724.html#comments Mon, 28 Sep 2009 00:07:24 +0000 admin http://www.economicprincipals.com/?p=724 Irving Kristol, who died earlier this month at 89, meant many different things to many different people. One way to remember him is as the editor who, with his friend and City College of New York classmate Daniel Bell, founded The Public Interest in 1965, at just the moment the phenomenon known as “the counterculture” was beginning to grip the popular imagination of the West.

The first issue featured Robert Solow on “Technology and Unemployment,” Daniel Patrick Moynihan on “The Professionalization of Reform,” Nathan Glazer on “The Paradoxes of Poverty,” Jacques Barzun on “Art – By Act-of-Congress,” Daniel Greenberg on “The Myth of the Scientific Elite,” Martin Diamond on “Conservatives, Liberals and the Constitution,” and Daniel Bell on “The Study of the Future.”

And for the next fifteen years, while the Americans lost their way in Vietnam, the Soviet economy stagnated, the Chinese people suffered Mao Tse Tung’s Cultural Revolution, The Public Interest was the quarterly that kept its head, serving as a focal point for meliorists of all kinds. Magazines such as People, Money and Rolling Stone built huge audiences in those years; The Public Interest rarely sold more than 12,000 copies. But the people who read it would in due course take over the nation’s politics.

An extraordinary galaxy wrote for Kristol in those days on nearly every social issue of the day (Bell, a professor of sociology at Harvard, cut back his participation after the two disagreed on the presidential election of 1972): Peter Drucker, Milton Friedman, Seymour Martin Lipset, James Coleman, Robert Nisbet, Henry Fairlie, Aaron Wildavsky, William Bennett, James Tobin, Richard Zeckhauser, Thomas Schelling, Herbert Stein, Gordon Crovitz, Anthony Downs, David Gordon, John Meyer, Jeffrey O’Connell, Paul Starr, Christopher Jencks, Charles Reich, Michael Novak, Charles Lindblom, Josiah Lee Auspitz. They were conservatives and liberals alike, but the quarterly’s content steadily trended over the years towards the stance that in time would become known as “neoconservative.” (A terrific full issue-by-issue archive can be found here.)

Kristol “was able to pick a side without losing his clarity,” wrote David Brooks in his New York Times column last week.

The side he picked in economics was an odd one. A 1975 issue featured a pair of articles: “The Social Pork Barrel” launched the career of a young Michigan Congressman, David Stockman, who would become budget director for Ronald Reagan; and “The Mundell-Laffer Hypothesis – a New View of the World Economy,” by Wall Street Journal editorial writer Jude Wanniski, introduced the world to economists Arthur Laffer and Robert Mundell, and their newly-invented brand of “supply side economics.”

The striking thing about Wanniski’s article was its anti-establishment tone, anti-Chicago as well as anti-Cambridge, Mass. The new hypothesis might be as transformative as the Copernican Revolution, he averred – or at least that of John Maynard Keynes. Mundell and Laffer’s enthusiasms for a gold standard, fixed exchange rates, large tax cuts and tight money were picked up and greatly amplified by the editorial page of The Wall Street Journal. The Republican Party was divided – insouciant economic populists in one wing, sober technocrats in another.

In the neo-conservative firmament, the stars of ordinarily first-magnitude conservatives Milton Friedman and Martin Feldstein dimmed, while Laffer and Wanniski brightened. The success of The Way the World Works, Wanniski’s 1979 book for editor Midge Decter, nearly ripped apart the boutique social science publisher Basic Books, where Kristol worked as an editor as well.

By then The Public Interest was losing its force. As James Q. Wilson wrote the other day in The Wall Street Journal, “It began to speak more in one voice and the number of liberals who wrote for it declined.” Daniel Bell quietly resigned, in 1980. It didn’t matter. The Republicans were in power; and Kristol was ready for a second act. He would become widely known as “the Godfather” of neo-conservatism, dispensing favors and advice as a political activist operating out of the American Enterprise Institute in Washington.

In its obituary last week, The Economist summed up this second act of Kristol’s career: “American conservatism, before he began to shake it up, was dour, backward-looking, anti-intellectual and isolationist, especially when viewed from the east coast. By the time Mr. Kristol … had finished with it, it was modern and outward looking, plumped up with business-funded fellowships and think tanks and taking the lead in all policy debates.”

Success profoundly changed the game. The Cold War ended. The discipline and sense of fair play seemed to go out of civic life. There hasn’t been anything like The Public Interest since. But for fifteen crucial years in the late ’60s and ’70s, Kristol’s editing was the straw that stirred the drink.

xxxxx

There’s more to say about economics’ renewed macro wars, but not this week.

But it is not easy to find agreement on these matters.

This much is clear: the Keynesian Revolution was real. When the first glimpses of what soon came to be called “macroeconomics” were described in the 1930s, by Keynes and others, the discovery invigorated young economists who were struggling to understand a world then mired in persistent depression. It was as if the entire generation “were taken by a spell,” recalled James Meade. The contagion of enthusiasm among economists under the age of 35 had “the unexpected virulence of a disease,” wrote Paul Samuelson. No wonder, then, that when Lawrence Klein laid out the standard interpretation (at book length) as The Keynesian Revolution in 1949, not even dissenters such as Milton Friedman demurred publicly. Instead they mastered the consensus view.

Nor can there be much doubt that the reception of the new economic ideas was affected by the mood of the times, particularly by a pair of developments that had occurred in physics during the early years of the twentieth century – Einstein’s theories of special and general relativity, and the piecing-together by Niels Bohr and many others of quantum mechanics to describe the peculiar behavior of sub-atomic matter. Just as the new physics was understood to have altered profoundly the understanding of very large and very small phenomena, and to have left substantially unchanged the common-sense Newtonian understanding of the world between, so Keynes invited comparisons of himself to Einstein when he called his book The General Theory of Employment, Interest and Money, and labeled what he called “classical” economics “a special case.”

He explained (in the preface to the French edition) what made his theory general. “I mean by this I am chiefly concerned with the behavior of the system as a whole, with aggregate income, aggregate profits, aggregate output, aggregate employment, aggregate investment and aggregate savings, rather than with the incomes, profits, output, employment investment and saving of particular industries firm or individuals.” Thus did macro take over what had been studied previously under the heading of money and the business cycle; all the rest was microeconomics.

But 75 years later, despite the efforts of a luminous string of interpreters (John Hicks, Franco Modigliani, Don Patinkin), counter-interpreters (Joan Robinson, Axel Leijonhufvud, Nicholas Kaldor, Luigi Pasinetti), biographers (Roy Harrod, Robert Skidelsky, D.E. Moggridge), historians (Peter Clarke, David Laidler) and various re-interpreters (Lorenzo Pecchi and Gustavo Piga’s conference volume, Revisiting Keynes: Economic Possibilities for Our Grandchildren, is especially interesting, and Keynes is a major figure in Liaquat Ahamed’s best-selling Lords of Finance: The Bankers who Broke the World as well), it’s hard to say what it all means.

The standard story is easy to grasp: theoretical breakthrough, professional recognition, World War II, political influence, and, thanks to the adroit management of aggregate demand, a 25-year post-war boom in the industrial democracies (Time magazine put Keynes on its cover in December 1965, nearly twenty years after his death, at 63, in 1946). Then came a second act, not so triumphant: inflation and unemployment, the end of the gold standard and system of fixed exchange rates that Keynes had engineered at Bretton Woods, the counterattack by the Chicago school aimed mainly at various naïve psychological underpinnings of Keynesian dogma; and, after 1982, a second 25-year boom, this one said to rest on successful monetary policy.

The trouble is, as co-editor Bradley W. Bateman writes in the Cambridge Companion to Keynes, virtually every strut of both arguments of this stylized drama has been challenged by serious scholarship.

Certainly the historical figure of Keynes is as fabulous as ever: philosopher, economist, statistician, author, speculator, patron, collector, journalist, politician, friend, sexual adventurer, husband. He dominates the British financial scene in a glamorous time as completely as ever. With Keynes: The Return of the Master and Keynes: The Rise, Fall and Return of the 20th Century’s Most Influential Economist, biographer Skidelsky and historian Clarke have published reprises of their work with a view to demonstrating the relevance of the subject to the crisis of the present day. If it’s an introduction to Keynes himself you want, though, better to pony up the outrageous $45 for the paperback edition of Keynes and His Battles, by Gilles Dostaler, a charming book positioned neatly between the Skidelsky and Moggridge biographies.)

I have been following this controversy, on and off, for more that thirty years as a journalist, and for the last fifteen of those, the book that has seemed to me to situate Keynes in the context of the history of economics better than any other has been A History of Economic Theory: Classic Contributions, 1720-1980. After a long career as a monetary theorist, most of it spent at the Johns Hopkins University in Baltimore, Jürg Niehans returned to his native Switzerland and the University of Bern to write a history of thought.

He created what he described as a pantheon, a temple full of niches depicting the for greater and lesser deities, chapters on the life and work of the twenty authors of the last three hundred years he deemed to have been most significant, with another fifteen chapters on various topics and schools required to stitch together their stories to produce coherent narrative. Pitched at the level of an advanced undergraduate, the book appeared in 1990. Though 1980 (the book’s endpoint) was a long time ago, A History of Economic Theory is still the best history of thought I know.

Niehans, as noted, was a professional theorist. With Keynes, his irritation is plain. His argument, the one you often hear from those who make war on ambiguity, is that Keynes wrote better than he thought. Indeed, he sometimes borders on snide. One of Keynes’s grandfathers had been a brushmaker and florist, he observes, the other a clergyman; his father a university administrator who never made professor, despite his widely-known book on the methods of political economy. Nevertheless, “Maynard’s genealogical researches later showed that the Keyneses had belonged to the aristocracy and that one of his forebears was a Norman knight who had fought at Hastings. Maynard Keynes always managed to end up at the top.”

Niehans argues that Keynes rode roughshod over the rest of the economics profession in order to make his point; that, contrary to the doctrines of orthodox economics, the economy could regularly become trapped in a series of high unemployment equilibria. It was a point never nailed down to other economists’ satisfaction, says Niehans. Instead the outsider created various straw men to knock over in order to become a Great Economist.

True, he grudgingly admits, Keynes was an effective critic of the optimistic dogma of the 1920s, which held that monetary policy might eliminate the business cycle through the use of open-market operations. There were two reasons monetary policy might fail to work in a panic, Keynes said: either because the money supply, caught in a liquidity trap, would have little influence on the interest rate, or because the interest rate, undermined by a swift decline in the marginal efficiency of capital, would have little effect on investment demand.

Keynes’s most durable contribution, according to Niehans, was to place the failure of wages to fall in a recession at the center of the debate – in a model. Keynes was by no means the first economist rely on a mathematical model to bolster his argument, and he certainly wasn’t the best, but he was undoubtedly the most personally influential. And after John Hicks summarized the key ideas of the General Theory in a handful of simultaneous equations, with a simple diagram to depict the relationship of investment, saving, liquidity and money, the tight chains of formal reasoning, whose properties could be measured and tested against the real world, became the standard form of economic argument.

In the end, then, Niehans writes, “Keynes added a solid and useful brick to the building of economic theory. A brilliant writer, he offered this brick packed in glittering gift-wrap, sparking with hints, allusions, suggestions and quotable obiter dicta. Half a century later, The General Theory still glitters, but economic science has learned to distinguish the wrapping from the brick.” Unlike the scientific contributions and policies of that other genius of persuasion, Adam Smith, Niehans asserted that the insights of Keynes had tended to fade away. But what about the continuing debate about “what Keynes really meant?” — imperfect competition, transactions costs, multiple budget constraints? Niehans: “For a competent scientist, endowed with Keynes’s command over words, fifty years should have been long enough to make himself understood.”

A harsh judgment, but consistent with the rest of what I observed to be going on in the rest of mainstream economics – theorists building a more secure foundation, block by block, on the lot next door to the increasingly quaint but unapproachable edifice that was the General Theory. From a distance of fifty years, Keynes seemed to have been a charismatic figure, a literary master, the author of a series of suggestive metaphors, but with no more durable claim to have advanced that part of economics considered by its adepts to be “scientific” than was possessed by his rough contemporary Sigmund Freud as a psychologist. They were a couple of great writers. Wasn’t that enough?

Has that appraisal changed as the result of the experiences of the last year? It is, I think, too early to say. It is possible that, even as his name looms large again in newspaper columns and bookstalls, the great man recedes further into the distant past. But recently I have been spending more time reading the work of professional historians of economic thought, and at one point, I came across an assessment of Keynes that struck me as being more deeply knowledgeable and on the mark than that of Niehans. It belonged, interestingly enough, to Robert Lucas, of the University of Chicago, the man who, after Milton Friedman, did more to undermine the underpinnings of the Keynesian analysis than any other (and, among economists, more than Friedman himself). His comments came in the course of an address to a conference organized a few years ago at Duke University by the editors of the journal History of Political Economy, designed to sift a portion of the legacy of Keynesian thought. Lucas’s talk described some of the circumstances in which he and a handful of colleagues fell away from Keynesian ideas and created the rival New Classical or freshwater tradition. Its title: “My Keynesian Education.” (It appears in The IS-LM Model: Its Rise, Fall, and Strange Persistence, a supplement to the journal, for those readers with access to a good library).

The Einstein business, said Lucas, the revolutionary interpretation of Keynes’s contribution to the tapestry of economic thought, “that’s just so much hot air.” In writing the General Theory, he said, the larger role Keynes had assigned himself was as a spokesman for “a discredited profession.”

He’s writing in a situation where people are ready to throw in the towel on capitalism and liberal democracy and go with fascism, or corporatism, protectionism, socialist planning. Keynes’s first objective is to say “Look, there’s got to be a way to respond to depressions that’s consistent with capitalist democracy.” What he hits on is that the government should take on some new responsibilities, but the responsibilities are for stabilizing overall spending flows. You don’t have to plan the economy in detail in order to meet this objective. And in that sense, I think everybody in the post-war period – I’m talking about Keynesians and monetarists both — that’s the agreed-on view: We should stabilize spending flows, and the question is really one of the details about how best to do it. Friedman’s approach involved slightly less government involvement than a Keynesian approach, but I say slightly.

So I think that was a great political achievement. It gave us a lasting image of what we need economists for. I’ve been talking about the internal mainstream of economics, that’s what we researchers live on, but as a group we have to earn our living by helping people diagnose situations that arise and helping them understand what is going on and what we can do about it. That was Keynes’s whole life. He was a political activist from beginning to end. What he was concerned about when he wrote the General Theory was convincing people that there was a way of dealing with the Depression that was forceful and effective but didn’t involve scrapping the capitalist system. Maybe we could have done it without him, but I’m glad we didn’t have to try.

A generous estimate, I thought – an understanding of Keynes that seems likely to stand the test of time.

“How Did Economists Get It So Wrong?” asked Paul Krugman last week in The New York Times Magazine. “The Financial Crisis and the Systemic Failure of the Economics Profession, “ wrote David Colander, Alan Kirman and several others in Critical Review.

“The Other-Worldly Philosophers,” offered the headline of thoughtful examination in The Economist two months ago. On its cover, a textbook – “Modern Economic Theory” – melted into a puddle. The editorial began, “Of all the bubbles that have been pricked, few have burst more spectacularly than the reputation of economics itself.”

Is that really true? Or is the hubbub another case of what Sigmund Freud, in Civilization and Its Discontents, termed “the narcissism of small differences” – the tendency to exaggerate the dissimilarities of those who resemble us in an effort to buttress our own self-regard?

Since the controversy is mainly a renewal of hostilities among the New Classical and New Keynesian schools that flared fiercely in the 1970s and ’80s, supplanting the antagonisms among Monetarists and Old Keynesians before settling down to an uneasy backseat truce the ’90s and ’00s (dubbed, if you can believe it, “the new neoclassical synthesis”), there is some reason to suspect that psychopathology is the real problem

The fireworks, as usual, have been provided by Krugman, New York Times columnist, Princeton professor and winner of last year’s economics Nobel Prize.

Forty years ago, he wrote, economics had divided into two great factions, purists and pragmatists, meaning New Classicals and New Keynesians (or freshwater and saltwater economists, in Robert Hall’s memorable phrase, which characterized the neighborhoods of the universities in which the various parties tended to work).

The purists, led by Robert Lucas, Thomas Sargent and Edward Prescott, favored ingeniously-constructed mathematical models, disparaged Keynes, doubted that business cycles can be cured by policy (other than steady monetary growth and credible policy actions to control inflation).

The pragmatists, including Olivier Blanchard, David Romer and N. Gregory Mankiw, inherited from Keynes the belief that market failure is at the center of the business cycle, and built their own style of mathematical models to relate that failure to individual behavior in setting wages and prices. They remained convinced that policy could combat recessions.

Lulled by the success of central bankers Paul Volcker and Alan Greenspan – the quarter-century of steady growth and low inflation over which they presided has been dubbed “the Great Moderation” — the pragmatists gradually abandoned the Old Keynesian faith in activist fiscal policy (although they continued to argue among themselves over whether the smooth sailing stemmed from good monetary policy or from a series of positive developments in the economy itself).

Gradually, even the pragmatists traded their customary wariness for triumphal confidence that monetary policy alone was adequate to tame the business cycle – until last year, when the housing bubble and its counterpart sub-prime crisis gave way to panic when a large investment bank, Lehman Brothers, was allowed to fail. That development, a year ago, took almost all macroeconomists completely by surprise, purists and pragmatists alike.

“Neither side was prepared to cope with an economy that had gone off the rails despite the Federal Reserve Board’s best efforts,” wrote Krugman, though he acknowledged, far down in his article, that policy makers seem to have muddled through. (“Cross your fingers,” he wrote.) For economics itself, he concluded, there was nothing for it now except to admit that, “after several revolutions and counter revolutions, Keynesian economics remains the best framework we have for making sense of recessions and depressions.” The article was accompanied by a series of even more forceful cartoons.

A more temperate version of the same story was offered by Robert J. Gordon, of Northwestern University, earlier this summer at the International Colloquium on History of Thought in Sao Paulo, Brazil. For those interested in the history of the freshwater-saltwater controversy, his account makes fascinating reading.

Gordon offers to relinquish the “Keynesian” adjective to describe the present-day pragmatist (or saltwater tradition) in recognition that this nomenclature was tainted in the ’70s, in large part due to the success of New Classical purists to link it to the failed Phillips Curve, with its one-way tradeoff between unemployment and inflation. Instead, he proposes to substitute “1978-era macro” to describe the pragmatist point of view. A new generation of models, developed to describe supply-side responses to the OPEC shocks as well as traditional demand-side effects, was introduced in two path-breaking intermediate texts that appeared that year, one by Rudiger Dornbush and Stanley Fischer, both of the Massachusetts Institute of Technology, the other by Gordon himself. They contain virtually all the tools necessary to understand the crisis of 2008, he says.

The reasoning is more delicate than Krugman’s article; the survey of the relevant work more even-handed and generous. And he traces some important similarities between the bubbles of 1927-29 and 2003-06. But in the end, Gordon makes the same point as Krugman: to understand what happened in the US during the 2007-09 worldwide crisis, “we are best served by applying 1978-era macro and forgetting most of the modern macro that has developed since.” He concludes, “Empirical success and common sense have triumphed over the endless search for deep microfoundations in a world in which macroeconomic interactions triumph over individual choice.” He means that wage earners don’t choose to leave their jobs and firms to shut their plants in a recession, in order to enjoy more free time (the caricature implied by purists’ models); instead they are the victims of the coordination failures that occur when financial crashes spill over to the demand for products, and from there to layoffs and unemployment.

That is almost certainly true. But neither is it the whole story. The search for microfoundations may not have turned up much to brag about in the investigation of recessions and unemployment, but it has paid off handsomely in other fields, such as monetary theory and the economics of growth. It may yet tell us something worth knowing about public finance, and even produce a good strong model of the relationship of banking and finance to the real economy. (Almost everyone agrees that’s what’s needed now.) There is no reason to think that the purists should abandon their quest.

But then there is no reason to turn to them for policy advice. For once, there is strong evidence that, with the pragmatists, we’re in good hands. Consider, for example, the performance of the Israeli economy, where arch-pragmatist Stanley Fischer is head of the central bank. A veteran of the Asian and Russian financial crises – during which he was deputy managing director of the International Monetary Fund – Fischer was quick to act when the global economy abruptly stalled last year. He slashed interest rates and conducted a modest competitive devaluation. Now Israel’s export-driven economy is expected to grow by 3.3 percent next year. A single country, yes, but significant as was the performance of the Swedish economy (on similar grounds) in the early 1930s.

More to the point is the current situation in the United States, where another arch- pragmatist, Ben Bernanke, has assumed control, and where the economy apparently is beginning to grow again. Unemployment is still rising; job growth next year is expected to be painfully slow: the recession will go into the record books as the worst since World War II. The seven major economies of Europe are growing again, according to the Organization for Economic Cooperation and Development, as are those of China, India and Russia. On the evidence so far, it is Robert Lucas, not Paul Krugman, who has been more nearly correct: the central problem of depression-prevention apparently has been solved.

By no means is it time to sound the All Clear. But broadly speaking, economics has served us well in understanding and managing the crisis — microeconomics in understanding the myriad mismatched incentives that produced it; battle-tested pagmatic macroeconomics in managing it, so far. Taking the saltwater/freshwater battle back to the public won’t help. Freud wrote Civilization and its Discontents in part to explain the persistence of ethnic strife. Never mind the narcissism of small differences. The last thing we needs is a civil war in economics’ equivalent of the Balkan states, the fractious province of Macro.

How’s he doing? Everybody knows he’s had a rough summer. The 2010 elections are barely a year away. The polls suggest the Democrats’ majority in Congress may erode somewhat,

Still, if Obama can regain the confidence of the majority this autumn (and keep it), he has seven years in which to work. “Valor consists in the power of self-recovery,” wrote Emerson (in “Circles”), “so that a man cannot have his flank turned, cannot be out-generalled, but put him where you will, he stands.”

In those terms, then, sequence is all. Herewith a very quick look ahead – well ahead – as Washington goes back to work.

Whatever accommodation with the bitterly-divided Congress Obama adopts next week, it should be enough to make a start on a new level of government involvement in health insurance markets. Counselor David Axelrod told Politico last week, “It’s fairly obvious we are not in the second inning. We’re not in the fourth inning. We’re in the eighth or ninth inning here, and so there’s not a lot of time to waste.” This particular contest will have been decided by December; a pause; and then another season.

Plans for financial regulatory reform are picking up speed. They can be expected to eclipse expensive cap-and-trade legislation on the administration’s agenda, perhaps well into next year. The Treasury Department last week proposed new rules for stronger capital and liquidity standards designed to re-shape the banking industry, favoring smaller and more stable firms over larger ones. The decision to reappoint Ben Bernanke to a second term as chairman of the Federal Reserve Board means that the administration’s economic team has finally settled down, retaining Lawrence Summers as chief strategist.

The extent of the recovery (and the size of the deficit, which depends on it), though closely watched, will remain a mystery well into next year. Economic concerns, therefore, will dominate next year’s Congressional elections, but they will be short-term issues – jobs, unemployment, stimulus – and not the more serious matter of the broad tax increases that will be necessary in the next few years to pursue fiscal balance and price stability. That’s an issue for the second term.

The biggest problem, therefore, is the war in Afghanistan. If I am any judge, American opinion in the last few months has turned decisively against it, evidenced, for example, by testimony from opinion-makers George Will, Clive Crook and Garry Trudeau, and by this expert chronicle by a reporter and photographer for the Associated Press of The Death of One Marine. “We can still win a counterinsurgency, but not on the cheap,” exhorts the editorial page of The Wall Street Journal, one of the few remaining centers of enthusiasm for the war. Nor quickly, the editor might have added.

Alas, the problem of Pakistan must be solved some way other than by occupying its neighbor. The best Obama can do now is to opt for a short-lived “surge,” modeled on Iraq, designed to firmly signal US forces’ intent to leave the theater. But Afghanistan is not a relatively coherent political culture like Iraq, and the exit it permits may not be as graceful. The war there, as the British used to say, is a very sticky wicket. The Russians no doubt had a phrase of their own.

In short, the self-recovery that Obama must achieve will not be an easy matter. Emerson warned that a man can only accomplish it “by preferring truth to his past apprehension of truth,” by “alert acceptance” of the news from whatever quarter it may arrive, and by “the intrepid conviction that his laws, his relations to society, his christianity, his world, may at any time be superseded and decease.”

Things change, in other words, and leaders must change with them.

                                          xxx

Paul Krugman has a very interesting 6,700 word article in the Sunday New York Times Magazine, How Did Economists Get It So Wrong? It is an elaboration of the added chapter (“The Central Problem Has Been Solved”) that he wrote at lightning speed last autumn for The Return of Depression Economics and the Crisis of 2008.

Krugman reviews the rough convergence that emerged in macroeconomics over the past thirty years between the views of “New Classicals” (or “freshwater” economists, associated with universities in places like Chicago, Minnesota and Rochester) and “New Keynesians” (or “saltwater” economists, identified with universities such as the Massachusetts Institute of Technology, Harvard and Princeton). He examines some of the compromises that each side made. And he contrasts the professional consensus among macroeconomists with the more robust approach he ascribes to behavioral finance.

He doesn’t much credit the motives of those with whom he disagrees:

…[A]s memories of the Depression faded, economists fell back in love with the old, idealized vision of an economy in which rational individuals interact in perfect markets, this time gussied up with fancy equations. The renewed romance with the idealized market was, to be sure, partly a response to shifting political winds, partly a response to financial incentives. But while sabbaticals at the Hoover Institution and job opportunities on Wall Street are nothing to sneeze at, the central cause of the profession’s failure was the desire for an all-encompassing, intellectually elegant approach that also gave economists a chance to show off their mathematical prowess.

Nor does he note that Princeton University, where he teaches in the Woodrow Wilson School, has been adding freshwater economists to the portfolio of its economics department for years, including two very senior figures, Christopher Sims and José Scheinkman. Indeed, Princeton just hired Patrick Kehoe, from the Federal Reserve Bank of Minneapolis, one of the better young freshwater economists around, and missed out on two other prominent freshwater economists to whom it had made offers, Martin Eichenbaum and Lawrence Christiano, both of Northwestern University.

Whatever his tendency to stack the deck of his arguments, painting the other side in a consistently unfavorable light, Krugman infuses the story of the search for the root causes of recessions and depressions with his customary clarity and verve. He is, to put it mildly, a very useful citizen.

But then so is Robert Lucas, of the University of Chicago, whose gloss on the the significance of crisis, In Defence of the Dismal Science, appeared in The Economist last month. More on these topics next week.