There's an enjoyable review of Thomas Sowell's Intellectuals and Society in the American Spectator. The book was quite widely reviewed when first published almost a year ago. Reviewer Jeremy Rabkin is sceptical about Sowell's argument but nevertheless seems to have liked reading the book. He writes:

“As Sowell was trained as an economist, the chapter on
intellectuals and the economy is, naturally, among the most
illuminating. So, for example, commentators have repeatedly told us
in recent years that the gap between rich and poor has been
widening. It is true, if you compare the income of those in the top
fifth of earners with the income of those in the bottom fifth, that
the spread between them increased between 1996 and 2005. But, as
Sowell points out, this frequently cited figure is not counting the
same people. If you look at individual taxpayers, Sowell notes,
those who happened to be in the bottom fifth in 1996 saw their
incomes nearly double over the decade, while those who happened to
be in the top fifth in 1995 saw gains of only 10 percent on average
and those in the top 5 percent actually experienced decline in
their incomes.”

This certainly doesn't at a stroke undermine all the arguments being made about the political and social effects of widening inequality, as these are social and not individual phenomena. It does, though, offer a useful caveat about being too swift to draw conclusions about welfare. So much discussion about social welfare makes the mistake of forgetting that welfare attaches to individuals, and nowhere is this more true than in discussions of inequality. (Francois Bourguignon and I once wrote a paper making this point in the context of global inequality.) Anyway, I'm always pleased when writers (whatever their politics) argue for the more careful use of statistics. Nor do I dispute with the argument that many people who engage in public debate – call them intellectuals – are statistically illiterate.

Rabkin's conclusion is that we need, not fewer intellectuals, but better ones. He might be right but I can tell him from down in the trenches of economics that the argument, 'No, we need lots of economists, we just need better ones,' doesn't have much traction at the moment. His review rather made me want to read the book. Other reviews are far more discouraging – The New Republic, for example, was perhaps unsurprisingly very negative about it. Still, as I'm part way through Will Hutton's marvellous rant about inequality, perhaps I should look at Sowell's counter-rant as a corrective.

On my recent travels to the lovely north west of England, I picked up (in the book town of Sedbergh) The New Economics: Keynes' Influence on Theory and Public Policy, edited by Seymour Harris. It's a 1947 collection of essays in memory of the recently deceased Keynes. The contributors include Roy Harrod, Wassily Leontief, Joan Robinson, Paul Samuelson, James Tobin, James Meade – and more – a star-studded list. The one that caught my eye first, however, was the contribution by Joseph Schumpeter.

In his introductory essay Seymour Harris explains that most of the economists whose essays he selected are supporters of Keynes, but he spiced the mix with a few friendly critics. Schumpeter is one of these, clearly holding Keynes in warm personal regard. (As indeed all of the contributors do – Keynes seems to have been a thoroughly engaging person as well as a genius.) The essay assesses the earlier works such as the Treatise on Money but culminates in an assessment of The General Theory. And I think Schumpeter's central criticism is completely relevant to the current debate about fiscal policy.

The point is this. Schumpeter notes that Keynes's model of the economy ignores the long term. (Famously, Keynes said “In the long run we are all dead.”) But 'long term' in reality translates into relatively short term dynamics. In this essay, he writes: “It does not seem to be realised sufficiently how very strictly short-run his model is and how important this fact is for the whole structure and all the results of The General Theory.” This excludes from consideration all “the phenomena that dominate the capitalist process.” The examples he gives are investment in new equipment, changing the labour-capital mix in production, changes in the composition of total output, changes in competitive intensity in a particular industry, and so on. Needless to say, Schumpeter thought such issues too important to exclude, and argued that the failing made Keynesian economics good only for thinking about the next year or two.He concludes, though: “It is possible to admire Keynes, even though one may consider his social vision to be wrong and every one of his propositions to be misleading.”

Turning to the current debate about how far and how fast government deficits should be cut, it's clear to me that (a) macroeconomists don't know, or they wouldn't be shouting at each other so much; and (b) the disagreement turns on the trade-off between the potential short term contractionary impact and longer term dynamics. I haven't seen either side of the debate address this directly – the swingers of big axes should be explaining the transmission mechanism for improved growth after the very short term, in the context of ultra-low long term real interest rates; the loud Keynesians need to explain how we can get beyond a series of short terms in which fiscal contraction would be too damaging to ensure the economy doesn't fall into a debt trap. I do keep an eye on the macro debates on VoxEU and Economist's View but might have missed a magisterial overview of this issue – do let me know if anyone else has spotted it.

A new book by Will Hutton is always to be welcomed, and this morning's Observer carries a long extract from his new one, Them and Us. This is all I've read so far and I'm struck, as ever, by the passion of his writing.

Of course, it's not difficult to be outraged and passionate at present. The first paragraph of the extract sums it up neatly:

The British are a lost tribe – disoriented, brooding and suspicious.
They have lived through the biggest bank bail-out in history and the
deepest recession since the 1930s, and they are now being warned that
they face a decade of unparalleled public and private austerity. Yet
only a few years earlier their political and business leaders were
congratulating themselves on creating a new economic alchemy of unbroken
growth based on financial services, open markets and a seemingly
unending credit and property boom. As we know now, that was a false
prospectus. All that had been created was a bubble economy and society.
Yet while the country is now exhorted to tighten its belt and pay off
its debts, those who created the crisis — the country's CEOs and
bankers, still living on Planet Extravagance, not to mention mainstream
politicians — all want to get back to “business as usual”: the world of
1997 to 2007.

Indeed.

I was also struck, over my porridge this morning (it is now autumn, after all), by how depressingly little the issues have changed since Will's bestseller, The State We're In, was published in 1995. It starts: “The British are accustomed to success. This is theworld's oldest democracy. Britain built an empire, launched the Industrial Revolution and was on the winning side in the 20th century's two world wars. … Yet in the last decade of the 20th century the record of success is tarnished. … Even its unique economic asset, the City of London, is sullied by malpractice and a reputation for commercial misjudgement.”

The ills diagnosed then – short termism, the social scars of entrenched inequality and privilege, and a political system not up to the challenges  – are still with us, but worse than ever. I think Them and Us will repay reading in tandem with The State We're In. Will was right in 1995, and I suspect he's still right in 2010.

This past week I had a lot of meetings and on the occasions (few and far between, naturally) when the meetings themselves failed to hold my full attention, I pondered the sorry state of macroeconomics. Of course, I'm not the only person to have been doing so lately, post-crisis. The attacks on macroeconomics (actually, usually on economics full stop, but that's for another post) have not as yet stimulated much more than defensiveness in response. But surely, surely, macroeconomists are debating amongst themselves how they can restore intellectual credibility as well as rigour to their branch of the discipline?

It seems not. Yesterday Ben Bernanke gave a speech at Princeton which was mainly about microeconomics, which in my view (as a microeconomist) is relatively easy to defend. In the paragraph late in his speech in which he turns to macro, he concluded:

“Standard macroeconomic models, such as the workhorse new-Keynesian
model, did not predict the crisis, nor did they incorporate very easily
the effects of financial instability. Do these failures of standard
macroeconomic models mean that they are irrelevant or at least
significantly flawed?  I think the answer is a qualified no. Economic
models are useful only in the context for which they are designed. Most
of the time, including during recessions, serious financial instability
is not an issue.”

So that's ok then – the models work when they work. Hmmm. In fact, the Fed chairman then went on to add a few comments about the need to incorporate credit and financial mechanisms into macro models. But it's a pretty unsatisfactory response from one of the world's leading macroeconomists.

Back to my reflections instead, then. I remembered from my undergraduate days a book by the French economist Edmond Malinvaud, The Theory of Unemployment Reconsidered. It's a terrific book – although unfortunately out of print – which injects the work of earlier Keynesians such as Axel Leijonhufvud on disequilibrium dynamics into a classical general equilibrium framework. Depending on the initial conditions and shocks hitting the economy, the aggregate outcome then falls into one of three disequilibrium regimes: classical unemployment, Keynesian unemployment and repressed inflation. The policy response required for a return to equilibrium depends on which regime the economy is in.

This seems a useful framework for assessing exactly the kind of debate we're having now. If governments try to cut their budget deficits quickly will that be good for the economy, keeping it out of a debt trap, or bad for the economy, due to the contractionary impact of spending cuts? It's clear that macroeconomists, divided into two camps shouting at each other, don't know. It's decades since I've done any macro, but I'm going to read my yellowing copy of Malinvaud's book carefully, and let you all know the answer.

Ian Bright from ING has just sent me a review of Raghuram Rajan's Fault Lines which I commissioned for the next issue of The Business Economist. I'll post a link to the journal when it's available, but Ian's summary is:

“

This is a book that is intriguing, depressing and annoying
simultaneously.
“

He also pointed me to a highly critical review of the book by Paul Krugman and Robin Wells, in the New York Review of Books. Their main complaint about Fault Lines is:

“The idea that the government did it—that government-sponsored loans,
government mandates, and explicit or implicit government guarantees led
to irresponsible home purchases—is an article of faith on the political
right. It’s also a central theme, though not the only one, of Raghuram
Rajan’s Fault Lines.”

They disagree, and are not mollified by Rajan's emphasis on the malign role of massive income inequality in the US.

I reviewed it on this blog, and heartily recommend it. I have no problem with the suggestion that government policies distorted lending in the US, and found the book thought-provoking, putting together separate strands of argument in a way that sheds fresh light on the Great Financial Crisis.