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Created: 2000-03-03
Last Modified: 2000-05-15
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Marking My Beliefs to Market

J. Bradford DeLong

March 2000

It is important to mark your beliefs to market occasionally. If you don't take a look at where you went right and where you went wrong, you might as well be dead. If you don't ponder why you went wrong, and what other beliefs of yours should probably be adjusted in light of what you have learned, then you are not using your brain.

As John Maynard Keynes reportedly said: "When I learn new things, I change my mind. What do you do, sir?"

So immediately below are ten predictions or beliefs that I have held--strongly--over the past decade. And further below are brief reflections of how I need to change my view of the world in light of what has surprised me over the past decade.

  • That deficit reduction in America would produce a high investment recovery, and an acceleration of productivity growth.
  • That accelerated productivity growth in America would produce rising incomes.
  • That the rapid growth of the Japanese economy would continue.
  • That the U.S. unemployment rate would not be able to drop below six percent without generating rising inflation.
  • That the Mexican and East Asian crises would prove to be capital panics--not the result of unsustainable policies or growth trajectories in the afflicted countries.
  • That IMF/ Treasury support packages for Mexico and East Asia would succeed in cutting short the crises and restoring growth.
  • That the rapid privatization of Russian industry would set up a favorable political dynamic that would lead to economic and political recovery in Russia.
  • That the closer a transition economy was to major western European cities (Vienna, Frankfurt, Stockholm) the better it will do.
  • That NAFTA would have no visible effect on the American economy, and would in the short and medium run have small positive effects on the Mexican economy.
  • That stock index prices would continue to exhibit large bull and bear market fluctuations that cannot be traced to changes in fundamentals, but appear due to fads and fashions among investors--"noise traders."

By my count, I was right on seven and wrong on three of these beliefs.

The seven on which I was right seem in retrospect obvious: the Lori Wallachs and the Pat Choates who saw the doom of the American economy in NAFTA never took their own rhetoric seriously, nor did those who thought that Mexico's best future lay in avoiding exporting to the United States. The power of the "cultural" factors that made east-central Europe more likely to transition to normality than Russia was always obvious. That the Mexican and East Asian crises were capital panics, and that lenders of last resort are useful in dealing with capital panics were both clear (to me at least) at the time. That productivity growth would not be completely without an impact on median wages--that the U.S. income distribution would not continue to widen rapidly forever--was perhaps less clear before the recent productivity speedup, but was still correct. And the prediction that deficit reduction would produce lower real interest rates, higher investment, and faster productivity growth was based only on the belief that capital was productive and on what the Federal Reserve said was its policy.

The three on which I was wrong are--to me at least--more interesting. They are:

That the U.S. unemployment rate would not be able to drop below six percent without generating rising inflation.

That the rapid growth of the Japanese economy would continue.

That the rapid privatization of Russian industry would set up a favorable political dynamic that would lead to economic and political recovery in Russia.


Let me run through them one by one:

That the rapid growth of the Japanese economy would continue.

After the crash of the Japanese stock and real estate markets at the end of the 1980s, I was still very optimistic about the medium-run growth prospects of the Japanese economy. I looked at the enormous gap between world best-practice and Japanese productivity outside of export industry. I looked at Japan's extraordinarily high level of domestic investment, and thought about how true it was that new capital goods embodied new and more productive technologies. I looked at the extent to which Japan was developing a comparative advantage in the most innovative and high technology components of manufacturing. And I thought that the end of Japan's "bubble economy" would produce a short and perhaps sharp recession, but would then be followed by a rapid recovery and a renewal of rapid Japanese productivity growth.

I was wrong.

The 1990s saw *no* motion toward eroding the extraordinary *internal* productivity gaps between export industry and the rest of the economy that characterize Japan's dual economy. Domestic investment remained high, but did not seem to generate visible improvements in technology and productivity. And those parst of high-tech in which Japan had a strong comparative advantage--memory chips, LCD screens, and so forth--turned out not to be the key capital goods of the information age but more like the rubber insulation you wrapped around your wires--a necessary but hardly high-value component.

The dominant view is still that Japan's key troubles are financial and structural: that a failure to liquidate and nationalize institutions that were underwater as of 1992 destroyed the financial system's ability to do its job, and that even strongly stimulative fiscal policy and real interest rates near zero could not bring about permanent recovery in the absence of complete financial markiet restructuring. I don't know enough about Japan to be able to judge this dominant view, however...

That the U.S. unemployment rate would not be able to drop below six percent without generating rising inflation.

There were those back in the early 1990s who argued that the U.S. unemployment rate could drop far below six percent without generating inflation. Some such--James Galbraith for example--can be dismissed because they made the same argument in the 1980s, and when at the end of the 1980s unemployment fell below six percent inflation did accelerate, and did accelerate quickly. A stopped clock sometimes tells you the correct time. But it is of no use nevertheless.

James Medoff, however, had a much more powerful argument in the early 1990s that things had shifted. He collected vacancy data from help-wanted ads, compared them to unemployment data, and showed that the relationship between vacancies as reported in help-wanted ads and unemployment had shifted. Since wage inflation is presumably generated not by low unemployment but high vacancies, the fact that a given level of unemployment was associated with lower vacancies in the 1990s suggested that the natural rate of unemployment--the rate below which unemployment could not drop without inflation accelerating--had fallen.

One response was that perhaps what had changed was not the number of vacancies but the fraction of vacancies that showed up in the newspaper. Without proof that the change in measured vacancies was a change in real vacancies, I was extremely skeptical--to put it mildly--of Medoff's argument.

I was wrong; Medoff was right.

But it is still not clear to me that Medoff's forecast was right for the right reasons. Some argue that the key factor lowering the natural rate of unemployment was the anti-union offensive conducted by the Reagan administration (but the timing is wrong). Others argue--and I am very attracted to this argument--that workers' desires for real wage increases are higher when the unemployment rate is low. Since real wages can in the long run increase no faster than productivity, whenever productivity growth is low the natural rate of unemployment will be high, because inflation accelerates whenever workers' real wages aspirations outrun productivity. This real-wage-aspirations theory makes sense of the mid-1990s fall in the natural rate of unemployment (as productivity growth accelerated) and also of the mid-1970s rise in the natural rate of unemployment (as productivity growth slowed).

I'm pretty confident that Reagan's breaking of PATCO had little affect on the natural rate of unemployment. But otherwise I am still at sea...

That the rapid privatization of Russian industry would set up a favorable political dynamic that would lead to economic and political recovery in Russia.

Back at the start of the 1990s I was one of those who believed (a) that Russia needed to privatize and stabilize its economy as fast as possible, and (b) that the U.S. needed to embark upon a Marshall Plan-scale--$60 billion a year of grants--aid program to support Russian reform.

Thanks to the Reagan deficits and Bush's "read my lips: no new taxes" Republican convention speech, we blew the opportunity to make a $240 billion or so short-term investment that would have been likely to make the world a better place, and that would have removed the chance that we will have to spend $100 billion a year permanently--$2 trillion in present value--to guard against whatever follows the current Weimar Russia.

But even in the absence of large-scale western aid, and even with the lack of the political consensus--found in east and northeast central Europe--that copying the institutions of western Europe as rapidly as possible was job 1, Russia's reformers pushed ahead with (rapid) large-scale voucher-based privatization, (delayed) macroeconomic stabilization, and in the process struck a bunch of political details that concentrated industrial wealth in the hands of a new group of "robber barons."

Now to have concentrated ownership of industrial wealth is not fatal to an economy. The U.S. prospered in the late nineteenth century when its robber barons directed industrial development. And the corrupt interpenetration of economy and politics is not fatal either--Leland Stanford could run the Central Pacific Railroad and be Governor of California, Nelson Aldrich could be the Senator from Standard Oil, and the Pennsylvania state legislature could be a wholly-owned subsidiary of the Pennsylvania Railroad. In the long run, as long as politics remains or becomes democratic, pressure for social democracy will redistribute wealth. And as long as the robber barons are good not just at extracting privileges from legislatures but also at running enterprises they will leave much of value behind them, and people who benefit in subsequent generations can imagine that they were industrial statesmen.

So I continue to be optimistic about Russia: politics is slowly becoming more democratic--with a successful transfer of power via election--and wealth is now in the hands of people who have a very strong interest in successful economic development. Now if only Russia's nascent politically-powerful property-owning class recognizes its interest in successful development instead of (or alongside of) its interest in suckling at the teat of the state.

But others before have tried to create a powerful, self-confident, entrepreneurial class in Russia interested in economic growth and development: Pyotr Stolypin, Peter the Great, Ivan Kalusha. And Russia today is in much worse a state than I had thought a decade ago that it would be by now...

Suggestions for what it would mean--what I would have to think and believe--in order to have successfully marked my beliefs to market?

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Re: Former Soviet Union. I lived in Kiev, Ukraine for two years. I was besides myself trying to figure out what the Ukrainians just didn't get about political and economic development. After all the steps to be taken were simple, and before them them was laid out a rational system of carrots and stickes to reach that end. Upon returning to New York, I stumbled across Edward Said's Orientailism in a vain attempt to make sense of it all. His writing about the West has traditionally manufactured knowledge about other cultures, especially colonized peoples, and for whom they produce this knowledge (the West itself) is right on the mark We use Western concepts to undertand non-Western cultures. We were in effect talking to ourselves. Said wrote that in its pure form Orientalism is laughable; e.g., Islam is sort of like Christianity without Jesus. It ain't so. Well, Russia and the whole of the former Soviet Union are sort of like the West, too! No amount of policy prescription based on the experience of the advanced liberal democratic industrial West would have made sense in the FSU. I was part of the group that just didn't get it. It was their way of life that should have influenced the policy choices, not mine.

Contributed by Ted Schrader ( on May 22, 2000.

Nope. I would not have expected that, and I did not.

I have seen Morgan Stanley Vice Presidents set across a table from Cisco Vice Presidents and say that Cisco is far too big for *any* principles of valuation to justify anything near its current equity value. And the people from Cisco smile... It's scary...

Contributed by Brad DeLong ( on May 22, 2000.

Interesting piece. However, did you really believe that the "noise traders" would be as powerful as they have turned out to be?

Contributed by Chris DeLong ( on May 22, 2000.

The way the exchange went was: Alvin Hansen: "But Maynard, you yourself said (such and such)."

Keynes: "But Alvin, surely I have learned something since that time." The context was pre-war to post-war.

Hansen never did learn anything after the General Theory that any of us could spot, and we weren't too sure how much of that he had learned.

Contributed by Paul Cook ( on May 22, 2000.

On Russia: With deference to Douglas North, one might suggest that the missing link in the Russia success story had to do with who wrote the rules. Your idea of a democracy is that the voters write the rules, and this will eventually fix things. Perhaps in Russia (and parts of Africa and historically in S. America), the culture votes for the richest or most powerful men as leaders, with the vague idea that they are most capable of trickling down wealth and protection. The idea that gate-keeping destroys wealth is not in the voters minds. Nor is the idea that voters can shop for a bigger trickle. At some point, elections become uncontested. If this description fits, the question becomes do the rulers find themselves better off taking what they can from a poor populace, or encouraging wealth so they can take more. The latter approach (called stock options in this culture, and crony capitalizm in SE Asia these days) does not seem to have been the historically dominant behavior of rulers. Nor have wealth increases been the historically dominant result. All of which trys to say that Russians don't get richer until who writes the rules changes. The assumption that democracy does it soon may not be compelling.

Contributed by bill swan ( on June 19, 2000.

Hi, Brad. Nice piece.

This is the kind of essay where I wish I had automated hyperlinks to use to find out more.... I'd like to be able to click on Nelson Aldrich or Pyotr Stolypin or Ivan Kalusha to find out who they were... :-)

OK, back to work on my JEP piece... I probably won't take the time to try to look up these names for myself on the Web...

Contributed by David Lucking-Reiley ( on June 19, 2000.

Brad DeLong states here (and a bit snippishly, I thought) that my views in opposition to the NAIRU can be dismissed because I stated similar views back in the 1980s.

I am, first, curious as to DeLong's source for this claim. While I have frequently written in recent years that I never fell prey to the Nairu dogma, I doubt he can cite a writing of mine from the 1980s that deals in depth with the issue.

Certainly I did not take the view then,which I have actually come to hold in the 1990s, that anti-inflation policy could be prudently placed on the back burner -- at least for the time being.

Quite to the contrary. My writings on inflation in the 1980s were not complacent. Rather, they stressed the importance of incomes policy and other measures to deal with the inflation threats that still existed at that time. My 1989 book, Balancing Acts, is largely devoted to this question. I may in fact have over-stated the extent to which inflation threats still existed by the time that book appeared.

What I never accepted was that full employment, as such, was a cause of inflation, and therefore something to avoid. I have consistently argued that inflation threats, when they exist, are largely separable from the unemployment rate, and should be dealt with by means that do not require sacrificing employment.

The notion of a rigid inflation/employment tradeoff was a bit of silliness perpetrated on the profession over thirty years ago, in the face of very thin evidence. DeLong's perplexity seems to me mainly to reflect his unwillingness to give up on a very cherished, deeply held, but very little supported belief.

Contributed by James K. Galbraith ( on July 11, 2000.

Hernando De Soto's book The Mystery of Capital offers some ideas on former communist countries. His thesis is that the poor actually have considerable assets, but with out legal ownership; therefore they cannot use them as collateral for bank loans, and cannot extend side-walk shops into real businesses. They are what we would call squatters, with an actvie informal economy, but unable to expand scale as they do not have formal title to their holdings and therefore cannot participate in the larger financial structure.

Contributed by David Cohen ( on December 21, 2000.

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