September 30, 2002
Bob Solow's Views on Pretty Much Everything

John M. Irons links (ArgMax Blog: Solow on Globalization) to an interview given by Robert M. Solow on pretty much everything. It's very well worth reading: every topic is good. Let me pick a bone, however, with the interview's discussion of "globalization". Solow says some very smart things:

I think this is one of those cases in which focusing on growth is the wrong way to look at it. After all, what is the most you would expect international trade and international capital flows to do for a poor country? The most you could expect is that it might achieve the standard of living of a rich country. That would be terrific, that would be great. But it's a matter of getting from here to there. Now if you're going to get from here to there, then at least temporarily there must be faster growth, but growth is not the essence, growth is the byproduct. The essence here is a poor country learning and becoming able to do (it's more than just learning) what rich countries already do. There, I think the case is clear. The notion that the poor countries of the world can in any reasonable interval achieve rich-country incomes without trade and capital flows is utterly implausible. If the poor countries of the world have to depend upon themselves for the saving to finance the investment that they need, or have to develop by themselves the skills and technology they need to become rich by our standards, it's going to take forever...

And:

If you listen to the people in the streets of Seattle or Genoa or wherever, what they say is so dumb that it's hard to take them seriously. But if you say to yourself, OK, they're representing some very unhappy people; what could you say that made sense about the situation? You'd find plenty of things to say. In the United States and Europe, we've done very well in redistributing income. We're far from perfect, but we've done much better in making sure that nearly everybody profits from progress...

But he also says some dumb things:

Where I think the open-economy partisans run into problems - and it is a respect in which a lot of market-oriented economics and economists fail—is that they tend to look at overall progress and brush off the fact that a lot of people lose in this process. They brush it off as “That's just distributional. That's not my business. After all, any country that wants to can make transfers from the gainers to the losers.” I think that's a bad mistake, not only politically, but in a deep way. It's a socially bad mistake. A society in which a small number of people get very rich and a large number of people get very poor is not really progressing, even if when you add it up and average it, it appears to show rapid progress...

Solow appears to imagine that there were a bunch of countries in the 1990s in which GDP per capita rose, but in which most people became worse off--and that this is the source of the "anti-globalization movement." If you look at any set of estimates, however--say, those found in the United Nations Human Development Report you will find not that the poorer grew poorer and their lives grew more desperate in the 1990s, but rather that in the overwhelming majority of countries and for the overwhelming majority of people infant mortality fell, adult literacy rose, the fraction of children going to school rose, and, yes, market incomes rose for the poor as well as the rich (albeit in many and perhaps most cases not as fast as the rich). For the poor as well as the rich, life was better--as measured by the U.N.'s Human Development Index--in 2000 than in 1900 in Poland and Korea, in Indonesia and Nigeria, in Pakistan and Bangladesh, in China and India, in Brazil and Thailand, In Malaysia and Mexico, in Argentina and Turkey.

There are only two groups of countries in which the poor lost ground, and human development regressed. The first is in the southern half of Africa, where AIDS has brought two of the horsemen of the apocalypse: South Africa and Swaziland, Lesotho and Namibia, Botswana and Angola, Zambia and Zimbabwe, Mozambique and Tanzania, Kenya and Uganda. The second is in the former Soviet Union (but not in the former Soviet satellites save Bulgaria and Romania), where the poor truly have become poorer.

These two regions of tragedy are an indictment of our non-system of global economic management. The slow pace of progress in the rest of the world is a bitter disappointment. But Robert Solow is simply wrong when he implies that the past decade has seen--in Indonesia, or Malaysia, or Brazil, or India, or China, or Bangladesh, or Poland, or Korea--the "many" get poorer and worse off.

I'm all for paying more attention to distribution in crafting global economic development policy. But I don't think that paying attention to distribution would lead one to make it a crime for Mozambiquean cashew farmers to sell their produce to representatives of Indian processing plants, to forbid Bengali shrimp fisherman from setting to sea until they come up with the money to buy turtle excluder devices to attach to their nets, to require that Canada revoke all government programs that seek to put the thumb on the scales to encourage a distinctly "Canadian" culture, or to further restrict developing countries' exports of textiles to the United States--to name just four of the causes celebres of the demonstration in Seattle.

Robert Solow Interview

As a young professor in the 1950s, Robert Solow rejected prevailing theories about wobbly “knife-edge” economic growth paths governed rigidly by capital and labor. If they were accurate, he later wrote, all one could expect to find on earth was “the wreckage of a capitalism that had shaken itself to pieces long ago.” Instead, Solow created a robust model of “steady-state” growth in which economies progress on essentially stable paths. He then demonstrated that technological change—ignored by mainstream theory—accounts for a huge proportion of that growth.

Solow's model fundamentally changed economic analysis, providing “a framework within which modern macroeconomic theory can be structured,” according to the Royal Swedish Academy of Sciences, which selected Solow as the 1987 recipient of the Nobel prize in economics. His theory—born as Sputnik was launched—also altered history as national governments came to realize they must harness technology as an engine of growth. Solow's revolutionary model became the new orthodoxy.
The Keynesian interventionist policies that Solow advocated as senior economist to the Council of Economic Advisers during the Kennedy administration also became conventional wisdom for a time, but in recent decades Keynesians have been under stiff fire. Solow delights in the controversy, skillfully defending his position and disarming his opponents with humor. “The best thing you can say about Reaganomics is that it happened in a fit of inattention,” he once quipped. Dismissing a rival's theory, he said, “Intellectually soft as a grape.”

With The Region, Robert Solow discussed growth in growth theory, his tenure on the Boston Fed's board and the lessons economists can learn from sailors, among other things. Our conversation reflects the wit, intellect and commitment to human welfare of an economist who, often as not, makes progress by sailing against the prevailing winds.


Current growth theory

REGION: The field of growth theory blossomed after your contributions in the 1950s, but you observed that by 1970 it had reached a point of “intellectual diminishing returns.” Over the last 10 or 15 years, Paul Romer, Robert Lucas and others have brought about something of a renaissance. How far have we gotten with the “new growth theory”?

SOLOW: I'm probably in a minority here, but my perspective is that many more questions have been asked than answered. People are now willing to take a shot at issues that 40 or 50 years ago would have been thought to be a little too hard. But I don't have the impression that we have useful answers to the important issues that were pursued.

The prize example in my mind is not so much the Lucas case as the Romer case of endogenous technological progress. If you think about it, nobody in the world ever doubted that there was a large endogenous element in technological progress. All those people in Eastman Kodak or General Motors laboratories, drawing down salaries and doing work, were clearly not believed to be wasting their time.

On the other hand, I thought from the very beginning and still think now that there is an element of sheer chance in technological innovation that we've come nowhere near catching.

What little experience I have in observing industrial research says that R & D groups work on problems because those problems are interesting to their employers. But they may actually come up with something different from what was intended. They may fail where they thought they were going to succeed, and vice versa. Nor is it a pure probability thing. Every science has its own internal logic. There are questions you can answer and questions you can't, and that logic may have very little to do with the economic motive for trying to answer the questions. So I think there is a lot more of the exogenous in what actually comes out of serious technological research than the models allow. The models tend to be fairly simplistic. They have to be simplistic, of course: They're models. But not every simple model is a good one.

I thought from the very beginning that the so-called AK models [which assume that output is the product of capital, K, and a constant positive level of technology, A] were not only foolish but dangerous, in the sense that they would suggest to economists that they understood something that they didn't. I also thought they were intellectually threadbare. They came so close to assuming what they wanted to prove: that fiddling some easy-to-fiddle level could control a rate of growth. And in fact it has worked out that way. The AK models are gone. But what's left is almost always something very much like the AK assumptions, only more elaborate.

REGION: You've called them “arbitrary linearity assumptions.”

SOLOW: Exactly, and the reason is that if you want to talk about “the rate of growth” as an independent intellectual object, you need a linearity assumption; but talking about a rate of growth as an object may itself be an interference with intellectual progress.

If I show you a chart of a local red-tailed hawk gaining altitude through time as it flies, you'll see a graph with some wiggles but generally going up. If you ask, “What's the hawk's rate of altitude growth?” the right answer is that a hawk doesn't have a rate of growth. When the hawk has gone as high as it's going to go, you could say that on average it gained altitude at 20 feet per second, but you're telling me nothing about the hawk's path. In fact you're falsifying the hawk's path.

I think that economists—and I was partially responsible for this—have fallen into the trap of thinking that in order to talk about growth at all, you need a model in which the rate of growth is an independently defined object. Doing that may have been costly. It's why we have all these AK-type and other linearity assumptions, because growth theorists want to be able to say they have “determined” a
steady-state rate of growth. But nothing significant is lost if there is no steady-state rate of growth, if growth paths are not piecewise exponential.

I think it was really worthwhile opening up the question and saying that it can't be right to treat the level of technology—or the level of human capital, in Bob Lucas' version of this—as exogenous. We all know that to some extent ordinary economic incentives and motives play a role. So, we should study it as a piece of economics. But I think that the part of the profession that was interested in these subjects fell a little too easily into simple-minded but convenient theories. Maybe it was a necessary stage. But I don't have the impression that the next steps have yet been taken.

My own pet suggestion is that it would be a good idea for economists who are interested in endogenous technology and growth theory to do a little observational work on industrial research laboratories (or at least read what others have done). Part of the difficulty is that a lot of the improvement in technology has nothing to do with R & D, but emerges in a different way from the factory floor.

Even within R & D, it would be a good idea to pay closer attention to how, say, IBM allocates its research resources. How do they measure their output? If you were actually trying to describe the process of endogenous generation of new computer technology at IBM or Compaq or somewhere like that, how would you do it?

It might even be interesting to observe the difference between promises and results in industrial research. The reason not much of this has happened is that the kind of person who's good at observing things like this is not necessarily the kind of person who's good at making models.

The Solow paradox

REGION: The so-called Solow paradox, your 1987 observation that “computers are found everywhere but in the productivity data” has been quoted frequently over the past 15 years. At this point do you feel that the paradox has been resolved?

SOLOW: It was a paradoxical thing. It seemed the whole world was being revolutionized by the computer, and you would have expected that to have shown itself in improved productivity. But it didn't.

Now, what would it mean to resolve that paradox? It could mean that eventually productivity responded, that at last we do see computers in the productivity statistics. That is possible and, in fact, even likely. Why should all that technology not affect productivity? Even now, however, we don't have the complete story.

In retrospect, we know that the period from around 1970 until 1995—a whole quarter century—was a time of very slow productivity growth, and that is the period during which the computer was really penetrating our society.

We also know that from about 1995 until 2000 we had a period of much faster productivity growth. It is very tempting, it may even be plausible, but it's not a clear certainty, that some or all of that acceleration of productivity is the computer at last bearing fruit.

The third thing we know is that when the general economy slowed down toward the end of 2000, productivity slowed down again but not quite as much as it normally does in recessions. Unfortunately, as we're sitting here, we don't yet know what it's going to look like when the economy picks up again. The best guesses—but they are merely best guesses—are that in approximately the next five to 10 years, we'll experience productivity growth nowhere near what we did toward the end of 1990s but maybe a half a percent to a percent a year faster than in the 1970s. Still, even that probably won't be any faster than we experienced from about 1950 to 1970. And so there does not appear to be a miracle in productivity terms that we can attribute to the computer. Comparing the computer with electricity or the internal combustion engine just doesn't seem to me to be justified yet.

So, the question remains, what did happen in the 1970s? Where was the computer when it was everywhere but in the productivity statistics? And who knows what the answer is? It may have been a certain amount of social learning, of industry and commerce learning to make use of computers productively. It may be at the very beginning the power of computing was wasted. I always thought that the main difference the computer made in my office was that before the computer my secretary used to work for me, and afterward I worked for my secretary!

There could have been a certain amount of waste, especially in the service industries. On the other hand, there's also some respectable evidence that within the service sector, gains or acceleration in productivity are not much correlated with improved computer use.

So I think that the outcome is still unresolved. A certain amount of the paradox has gone away, partly because we got more productivity growth, partly because we began to understand more of the way computers are used. So, such as it was, the paradox has dissipated in part. I still don't think we fully understand the answer yet. But we're learning more all the time.

Trade and growth

REGION: Much controversy these days revolves around globalization and the contribution of trade liberalization to economic growth. Do you believe that developing countries need to open their economies in order to grow?

SOLOW: I think this is one of those cases in which focusing on growth is the wrong way to look at it. After all, what is the most you would expect international trade and international capital flows to do for a poor country? The most you could expect is that it might achieve the standard of living of a rich country. That would be terrific, that would be great. But it's a matter of getting from here to there. Now if you're going to get from here to there, then at least temporarily there must be faster growth, but growth is not the essence, growth is the byproduct.

The essence here is a poor country learning and becoming able to do (it's more than just learning) what rich countries already do. There, I think the case is clear. The notion that the poor countries of the world can in any reasonable interval achieve rich-country incomes without trade and capital flows is utterly implausible. If the poor countries of the world have to depend upon themselves for the saving to finance the investment that they need, or have to develop by themselves the skills and technology they need to become rich by our standards, it's going to take forever. So from that point of view I'm entirely with the open-economy people.

Where I think the open-economy partisans run into problems—and it is a respect in which a lot of market-oriented economics and economists fail—is that they tend to look at overall progress and brush off the fact that a lot of people lose in this process. They brush it off as “That's just distributional. That's not my business. After all, any country that wants to can make transfers from the gainers to the losers.” I think that's a bad mistake, not only politically, but in a deep way. It's a socially bad mistake. A society in which a small number of people get very rich and a large number of people get very poor is not really progressing, even if when you add it up and average it, it appears to show rapid progress.

Economists who see the marvels of trade and markets wonder why these people complain so bitterly. They're complaining so bitterly because a lot of them aren't sharing. It's not enough to say—and everybody knows it's not enough—that “oh well, if these countries really wanted to redistribute income they could do that.” They can't do that. They can't do that because the people who are profiting from the open economy—and who usually have the political power—are not about to give any of it away to the people who aren't profiting. When a poor country gets attached to the world market and profits from it, the people who gain from this process immediately become politically conservative because they're the ones who have something to protect.

If you listen to the people in the streets of Seattle or Genoa or wherever, what they say is so dumb that it's hard to take them seriously. But if you say to yourself, OK, they're representing some very unhappy people; what could you say that made sense about the situation? You'd find plenty of things to say. In the United States and Europe, we've done very well in redistributing income. We're far from perfect, but we've done much better in making sure that nearly everybody profits from progress. But you could not say that about a lot of poor countries.

Still a Keynesian?

REGION: You feel, I believe, still comfortable with the label “Keynesian,” but as you know, some economists consider Keynesianism irrelevant, outmoded. What parts of Keynesian economics do remain relevant? Does fiscal intervention still work? Does the Phillips curve theory that you and Paul Samuelson brought to American shores in 1960 still live as an exploitable trade-off? Or do you have something broader in mind about what it means to be a Keynesian?

SOLOW: The broad way in which I would associate myself with Keynes is this. When you think about a modern capitalist economy, there are two polar perspectives you might take. It's possible to focus on the beautiful mechanics of the market and the way in which it decentralizes decision-making and therefore decentralizes information and yet manages to make all of those things cohere through this beautiful instrument of the price system.

Or you can focus on the deficiencies, on the way in which the beautiful mechanism of the market doesn't work. There are asymmetries of information. (By the way, nobody in the world today, after Enron and [Arthur] Andersen and all that, is ever going to be able to argue that information gets around. It doesn't.) There are substantial elements of monopoly in the modern world. Even international trade, though it certainly helps, doesn't necessarily clear that up. And there are inflexibilities, rigidities in the price and wage mechanism.

I think it's foolish to think that these are imperfections you could hope in time to get rid of. I think those rigidities in wages and prices correspond to needs that social institutions are trying to meet, and those social institutions don't function very well if every wage is open to nontrivial movement at every instant of time.

So there are these two perspectives. You could say the system works so well: Why doesn't it make sense just to suppose that the real world is like this beautiful textbook world. Maybe you can convince yourself that the things that follow in the textbook follow logically in the real world too. Markets clear all the time. Imperfections work themselves out. Competition eventually triumphs, especially if the state keeps its paws off of things.

The alternative view is to say the whole thing is hopelessly flawed. Capitalism cannot be made to work well, and therefore we might as well have the state or some other agency run everything. That's the other extreme.

I, of course, stand squarely in the common-sensical center. [laughs] My view is that we know no better way of running an economy than market capitalism. Nothing else seems to do. But there are many ways in which a market capitalist economy malfunctions. And one of the ways it malfunctions—and now I'm getting very close to Keynes—is it can have excess supply of goods in general and not be able to fix that by itself. Or at least not in a short enough interval of time so that it makes sense to say, let's just keep hands-off and let the system solve these problems the way it's supposed to.

I think there are periods of time when we have persistent excess supply or excess demand, and it is a function of government to repair the malfunction. There are times when there will be inflation and governments ought to try to control it. There are times when there will be prolonged unemployment and governments ought to try to fix that. I also think that there's every reason to believe that, in order to fix problems like that, fiscal policy, as well as monetary policy, is both necessary and effective.

Now it might sound as if I think that governments work just beautifully. Of course I don't believe that. For really short-run macroeconomic problems, monetary policy is the tool of choice precisely because we have learned to operate it in a way that doesn't get caught in political hang-ups.

By contrast, when you try to do economic stabilization through fiscal policy, you always (probably necessarily) end up with conflicting interests. You can't just say we need higher taxes or lower taxes. You have to have higher taxes in some particular way or lower taxes in some particular way and the people in society and their elected representatives are going to care quite a lot about who is favored by a tax reduction, who is damaged by a tax increase. The same is true on the expenditure side.

Because of this inevitable political process, it's hard to get fiscal policy done promptly, in a timely fashion. That's why I think that for short-run processes we do have to rely on monetary policy.

Now, getting back to the big-time macro theory dispute, we know that if a country has more than one economic objective, more than one goal it's trying to pursue, it has to have more than one instrument. Monetary policy is one instrument. You can measure it by what happens to the short-term interest rate or by some characteristic of the money supply or whatever, but it controls one thing and it can only have one objective at any moment of time.

If you listen to the enthusiasts (I'm thinking mainly of the old Bundesbank—this is more European than American generally, although in some ways it was true of American monetarism as well), you would think there was only one policy problem, namely, the control of inflation. And therefore you only needed one tool and monetary policy was the logical one. To say that there's only one policy problem—to control inflation—is to say that if only you control inflation, the rest of the system would work itself out very well.

The Bundesbank people used to say this almost with dead seriousness, but it strikes me as the most utter foolishness. The history of our economy since the Second World War, without going back to the Great Depression, tells us that even when inflation is under control, there are often other macroeconomic problems. If politics would allow fiscal policy to operate, then we could make good use of fiscal policy. Whether the United States can find a way to make timely fiscal policy, to master this fact that there are always conflicting interests and political bargaining, is uncertain. Maybe we can, though I am not optimistic.

My own particular view is that we have done something foolish regarding fiscal policy. We used to depend a lot—more than people other than economists knew—on what were called automatic stabilizers. Just as an example, if the economy began to boom, the first part of income to gain would be profits. Profits were very heavily taxed. So when the economy boomed, the federal budget moved in the direction of surplus.

On the other hand, if the economy began to turn down, transfer expenditures would rise rapidly, profits would turn into losses, and corporate tax revenues would fall. So you'd get the kind of shift in federal budgets that any good Keynesian type would have wanted, but you got it without legislation.

Over the years we have weakened those stabilizers. We've weakened them by, for good or evil, diminishing welfare and other transfer expenditures. It might have been right or wrong to do that, but it was not done in order to weaken automatic stabilization. That was a side effect. We also tax corporate profits relatively much less. We depend much more on personal income taxes now than we used to.

The beauty of these automatic stabilizers was that they didn't depend on the stupid Congress getting its act together. It just happened. It wasn't exactly a policy rule but it operated almost as if it were. And so one of the things I think we could do right now is to go back and try to find ways of strengthening those automatic stabilizers again.

Inflation-targeting

REGION: Rules vs. discretion has been a major monetary policy debate, of course, but over the past decade or so, inflation targeting has become a key topic in many central bank discussions. What is your view?

SOLOW: This is a good example of the one-objective, one-instrument business. I'm not terribly happy with the idea of counting off the instruments and associating each one with a target. I think the better thing to do is to list the instruments and then to decide in any instance how they can interact to meet as many of the targets as possible.

If I were prepared to say that inflation targeting is the right way to go for monetary policy, the next question I have to answer for myself is, well, is that all? Are there no targets other than control of inflation? If there are targets other than control of inflation, how are we supposed to deal with those?

The answer that you found among European central bankers a few years ago, as I've mentioned, is that there really is only one problem, so there only needs to be one tool. In the United States, we avoid that kind of senselessness but it seems to me we approach another kind of senselessness. Whatever the target is, we assign it to the Federal Reserve. The “magical” Mr. Greenspan can do anything. If there's unemployment, he'll fix that. If there's inflation, he'll fix that. If there's both unemployment and inflation, he'll find some way of fixing that, too. And all of that comes, I think, from not being willing to consider other instruments and consider them simultaneously. So I really think the inflation targeting debate is a false debate. It comes from formulating the macro policy problem in an inappropriate way.

The Phillips curve

A related issue that you raised earlier, and I wanted to get to, is the Phillips curve. And that, I think, is a long and complicated story, both in reality and in terms of the intellectual history. If you read the article that Paul Samuelson and I wrote in 1960 about the Phillips curve, I think you'll find in it tucked away somewhere every necessary qualification.

REGION: Even expectations.

SOLOW: Yes, we even thought about expectations. From some points of view, then, I feel we could pat ourselves on the back and say we got it right. On the other hand, the article was clearly more optimistic about policy use of Phillips curve trade-offs than I, or Paul Samuelson, would now be. We did think of all those qualifications but we almost certainly didn't focus on them enough.

I want to go further and be more provocative. What replaced the initial Phillips curve idea was the Friedman-Phelps natural rate of unemployment long-run vertical Phillips curve. And I have never, from the very first day, thought that that was other than a flimsy theory supported by flimsy empirical analysis.

The theory that leads to the expectations-augmented Phillips curve is very weak. It's full of ad hoc assumptions that turn out just right, and it depends crucially on the natural rate of unemployment—the unemployment rate at which the long-run Phillips curve is vertical—being a number with some structural stability. And I have never been able to convince myself that there was a number with that kind of structural stability.

There was a period of time in the United States when the augmented curve did work very well, a decade or so. But of course it broke down terribly in the 1990s. And I don't think there's any way of repairing that. There will be many excuses: “Oh well, the economy managed to live for three years with falling inflation and an unemployment rate well below 6 percent, but that was just this accident or that lucky break.” They ain't never gonna put that egg together again. No, I just don't think that can be done.

Without confidence about the natural rate of unemployment, then, the expectations-augmented Phillips curve is not a useful tool for policy. It seems to me that what the profession does—in a very sophisticated way, so that it's not clear just what it's doing—is that it says, well, we know what the natural rate of unemployment is. If the rate of inflation is increasing, then the current unemployment rate must be less than the natural rate of unemployment. If the current rate of inflation is decreasing, then the current unemployment rate must be above the natural unemployment rate. But that, of course, is a way of saying exactly nothing.

Once, out of sheer mischief, I estimated a crude model in which the natural rate of unemployment was the average of the last five years of unemployment, whatever they may have been. You can make a model like that. It's perfectly logically consistent. It is in many ways just like a natural unemployment rate model. The only difference is the natural rate of unemployment can be anything. If you can just hold the unemployment rate constant at any level for five years you make it into the natural unemployment rate.

I found that a model like that fit just about as well as the standard model. If I'd tweaked it I know I could have made it fit better. That was a joke, of course. An economist ought to be a skeptic all of the time, and the way that we fall for that sort of simple thing is from a general lack of skepticism.

Real business cycles

REGION: You've been very critical over the years of “real business cycle” theory. Could you explain why? You've already referred to it indirectly, of course.

SOLOW: Yes, I already have touched on it, but there are some further things I want to say. By the way, when I say all this I want you to understand that I am not expressing ill will. I don't know Finn Kydland, but I know Ed Prescott. I like him personally; I admire him professionally. I think he's very smart. I don't mean to be hypercritical and don't think that in print I have been hypercritical.

But I start by being critical of real business cycle theory because of the implausibility of the assumptions that lead up to the basic model—I'm thinking, to begin with, of the pristine, initial Kydland-Prescott model. It is so fundamentally implausible that a modern industrial economy could be carrying out the infinite horizon utility maximization of a single coherent consumer and could be translating that representative consumer's wishes into reality. The assumptions that you need to make that work strike me as far-fetched, to put it mildly.

So then you have to ask yourself, does the theory actually work? If in fact highly implausible assumptions somehow give you the right answer, you have to wonder if maybe you're wrong about the plausibility of the assumptions.

My impression is that real business cycle theory doesn't work. It thinks it works, but only because the hurdles it sets itself are very low hurdles. Low hurdles in this sense: The standard procedure is that you start with your model, you calibrate the key parameters, and then you ask it to reproduce some relative variances and covariances. This quantity should have a high variance relative to that quantity; this quantity should have a high covariance with that quantity relative to the covariance of this with that.

But how many other models could do the same job? Are there alternative models of the economy that will produce those same simple truths about the world? I think there's every reason to believe there are dozens of such models. Suppose 10 different models are equally good at getting to the same conclusions. It seems to me to make much more sense to choose among those models by choosing the one that's based on the most plausible assumptions and meets intuitive criteria. It's much more likely to be getting at the true mechanism.

Now of course, if you have 10 different models they must have some different implications, because otherwise they wouldn't be different models. So what you should do in principle is to pursue further and further until you can distinguish between them by saying that this model will actually do that correctly, and these other nine models will not. The real business cycle theorists have never done that.

No one has done it. It's not easy to do, of course. But without that, I don't think there is any good reason to think that real business cycle theory is getting anywhere. In other words, the low-hurdle tests have very low power against plausible alternatives.

All is not lost, however. It does seem to me that some real business cycle modelers have gone at it in a different way. They've said, well, since the world does seem to have imperfections, whether market imperfections or information imperfections that are not in the simple model, why don't we try to keep as much as we can of the real business cycle theory but allow for the imperfections? Some people have done that, Marty Eichenbaum at Northwestern and [Susanto] Basu and [John] Fernald, [Craig] Burnside and [Sergio] Rebelo, and others. I think that they're going in the right direction.

As I say, I'm not a doctrinaire Keynesian. I'm not trying to defend J.M. Keynes, whom I undoubtedly would have disliked intensely if I'd ever met him. And I'm not against dynamic stochastic general equilibrium models. But what I want them to do is to explain not only the good things, but also the important pathologies of market economies. So to the extent that you introduce imperfections and you explain pathologies, that's great, that's the way it ought to go.

It seems to me that the original model was OK for a start, but there was a tendency to claim too much. I have an intellectual aversion to models that start with a representative consumer optimizing over infinite time. It just seems to me to be asking too much. Real business cycle theorists start there and then say let's whittle away elsewhere in this model to try to make it look more like the world. It's one way to go, but I don't think it's necessarily the best way.

The Boston Fed

REGION: The Boston Fed was fortunate enough to have you on its board during the mid to late '70s.

SOLOW: I was on the board for, it was supposed to be six years, but I was actually on it for eight. I guess they couldn't find Class C directors. Who would want to be a Class C director? And I was the chairman for three years or so, and vice chairman before that.

REGION: What insights could you share about how district bank boards work, and also about the relationship between district bank boards and the Board of Governors?

SOLOW: I found that what made the Boston bank work was the then-president, Frank Morris, who was himself (a) a very good economist and (b) a very undoctrinaire economist. He had both university experience and he had worked in the financial services industry. The useful role that someone like me could play was doing two things. First of all, just talking with Frank. He liked to talk and collect ideas. And secondly, to act as an intermediary between Frank Morris, the president, and the rest of the board that didn't always have much of a grasp of the logic of monetary policy or the nature of the current macro problem. Having someone on the board who could translate, so to speak, those things from the staff—and Frank was very good about using his staff—to the board, that was a really useful function to perform.

That it was part of my education is unimportant, but I learned a lot about the banking system and a lot about the way the Federal Reserve System worked. And I loved going down to Washington and extracting out of the Board of Governors a really high salary for Frank Morris. I thought he deserved every bit of it and more.

It was then, I suppose, that I got a serious feeling for the way in which part of the problem of doing monetary policy is the necessity of juggling multiple objectives with a single tool. When do you focus on this, when do you focus on that? I don't know whether that has changed internally, but as I've been saying right along here, I think that is still a besetting problem for makers of monetary policy.

It is very important to remember that during that time Paul Volcker was the chairman. And he, like Alan Greenspan, was someone you could talk to, a person of real economic sophistication. It was a lot of fun.

I don't know that the experience I had way back then has very much to say to current boards. But I do think that the things that I learned about running a Federal Reserve bank, I learned from Frank Morris. And they included such things as getting and keeping the staff involved. And using the staff to brief the board on current events, current policy issues. Not so much on analytical issues. There I think that what every Federal Reserve bank board needs is one or two academic economists who can intermediate between the staff, including the president, and the rest of the board.

But keeping the staff involved and exposing the board to the staff so that they realize that there's a lot of hard work going on, to brief the president for his functions on the Open Market Committee, that's really very important.

Economic literacy

REGION: You once wrote a provocative essay with a wonderful title, “Why Economic Ideas Turn to Mush,” explaining how difficult it is to convey economic ideas clearly. It sounds as if you played that role between the staff and board of the Boston Fed, and you demonstrate it in the pieces you write, for example, for the New York Review of Books. What have you learned about how to maintain the integrity of an economic idea, yet still convey it clearly?

SOLOW: It's the hardest thing in the world. It really is very, very difficult. What have I learned apart from the fact that it's really difficult to do? Well, first of all, focus. Try to formulate an economic problem in a very clear, focused way. Try to answer one question at a time, and insist on that. And above all—this is really what's difficult—at least I know that I tend to forget it: Don't omit qualifications. Never claim more than you actually believe or can justify.

What makes that hard is that what people want—especially if they're being fed it in sound bites on a television program or in a two-sentence quotation in The Wall Street Journal—what they want is something very definite. They don't ever want those qualifications. And you must never let them off that hook. The interesting thing is that I think it's useful. An economist trying to talk to the general public gains respect by insisting on the qualifications, by not appearing as a pundit, as someone who knows all the answers.

All my academic life I have tried to be a good teacher. I've spent a lot of time at it. And communicating economic ideas to the general public bears a lot of relation to communicating economic ideas to freshmen or sophomores. If you're worth your pay you ask yourself before every class, what is the best way to get this stuff across to these kids? You have to ask yourself, what is the best way to get this across to the reader of The Region, or the Minneapolis StarTribune? Think of it as teaching. At least, think of it as teaching if you're a decent teacher. [Laughs]

Welfare reform

REGION: You've written extensively about welfare reform and led research on the issue as chair of the Manpower Demonstration Research Corp. What have we learned from the past five years of welfare reform?

SOLOW: I was very critical of the welfare reform act of 1996, but not because I was against welfare reform and specifically not because I was against trying to convert welfare into work. I gave two lectures at Princeton on this, later published as a small book, and there I made it very clear that I thought converting welfare into work was (a) a good idea and (b) it was what welfare recipients themselves would want.

I think that there is some evidence from these last five or six years that does suggest that it was a good idea, that it has moved some people, or at least initially moved some people, into the labor market to their advantage.

What remains problematic, however, is the fact that by great good fortune, welfare reform was launched in the midst of that incredible boom. We do not really yet have a good idea as to what will happen when the economy either stagnates as it did very briefly last year, or starts growing at some moderate sustainable pace, unlike the years between 1995 and 2000.

Will we continue to have unemployment rates as low as we had in that period? What happens when the economy is growing at a slower but sustainable rate? What will that mean for the welfare population?
There is some evidence that we are left with the former welfare recipients with the greatest number of market disabilities, the smallest stock of skills that will enable them to survive in the labor market. The data appear to indicate, as seems natural, that the first group of welfare recipients to have worked their way into the labor market are the ones who are best equipped with labor skills.

And we know that even the lucky ones are, on the average, worse off than they were on welfare. So we Americans have the satisfaction of knowing that we're not supporting low-lifers and that we're making them work. But we don't have the satisfaction, if it's a satisfaction we're seeking, that we're relieving poverty. We have not done a lot of poverty relief. And if we continue to force more and more people into the labor market, off the welfare rolls, and we get down to the dregs, almost certainly we will be increasing the amount of poverty rather than decreasing it. Now that doesn't strike me as a very good situation.

The political debate on welfare reform has not yet faced one critical aspect of the issue and I really think it should. The political debate so far operates on the assumption that you're either on welfare or you're in the labor market. We have to ask ourselves: Would it be a better situation, a better steady-state situation, if some number of people were both in the labor market and on welfare, if they were piecing together—either serially or simultaneously—welfare transfer income and earned income? I think that would be a really important thing to work for.

The idea of time limits on welfare strikes me as a really bad idea. Is there anything fundamentally un-American about earning part of your income in the labor market and getting supplemented from welfare? Now we could build the Earned Income Tax Credit (EITC) into an alternative way of doing that. It is after all a wage subsidy. We could say that we're going to convert welfare into the EITC.

But we have to consider how someone who simply does not have marketable skills could still earn an income and reach a standard of living that other citizens would find tolerable. One way to do that is to have work and welfare. And another is to have a greatly beefed-up EITC. Which is the better way is a technical question, and I have not looked into it enough to know how well you can manage either route. But we have so far avoided that debate, and I think we should have it.

Global warming

REGION: In the 1970s, you criticized the Club of Rome's “limits to growth” scenarios as too simplistic. Environmentalists these days are concerned about the problem of climate change. Does climate change constitute a limit to growth? More broadly, is there a horse race, in a sense, between technological growth and environmental dangers?

SOLOW: I would look at it a little differently. First of all, if you go back to what I wrote about the Club of Rome and “The Limits to Growth,” that reveals where I really live. The one thing that really annoys me is amateurs making absurd statements about economics, and I thought that the Club of Rome was nonsense. Not because natural resources or environmental necessities might not at some time pose a limit, not on growth, but on the level of economic activity—I didn't think that was a nonsensical idea—but because the Club of Rome was doing amateur dynamics without a license, without a proper qualification. And they were doing it badly, so I got steamed up about that.

The major practical problem in connection with global warming is how do we deal with the poorer parts of the world? How do we intelligently and equitably deal with the part of the world that is now preindustrial or primitive industrial and is “uppity” enough to think it has every right to live as well as Americans or Europeans? How are we going to tell them we developed economically by burning fossil fuels at a tremendous rate, by partially depleting reserves and by polluting the atmosphere, but then tell them not to?

The obvious case is China, which sits on a vast pile of coal. If they burn it and get to be an economy of a billion people living at a modern standard of living, then we really are in for a problem.

What do we do instead? Technology has to be the main part of the solution. To the extent that we talk in terms of any moral obligation, it's our obligation as rich countries to find ways for the rest of the world to develop economically with a proper respect for the environment and the dangers that could be associated with global warming.

I think the intellectual foundations for talking about that are still very weak. We have no clear idea about what the regional economic consequences of global warming are likely to be. It's clear that some places will gain; some places will lose. But we're really utterly unprepared to talk about the economic consequences because those are different for different places. We need a lot more work on that.

Apart from that, I think we need to be a little more serious about the supply of energy and the possibilities of developing economically while using less of it. So we should try to reduce the greenhouse gas intensity of our own technology and then be able to offer that technology to other people. Whether that can be done in time to make a big difference I don't know, but I see no reason to think it can't.

We can't be that far from renewable, less polluting sources of energy. We're talking on a 10-year, 15-year or more time scale and that's plenty of time. But at the moment, there's very little incentive going in that direction; whether carbon taxation or something like that would provide the right incentive I don't know because I haven't read the literature well enough.

Lessons from the sea

REGION: The economic world seems infused with aquatic metaphors, from liquidity trap to cash flow to exchange rate float. Even “leaning against the wind”—a favorite Fed slogan—sounds vaguely nautical. You're an avid sailor and have been for years. I believe you even used some of your Nobel prize money to buy a jib for your boat here on Martha's Vineyard.

SOLOW: That's right, I did.

REGION: Do you ever relate these two worlds? Is there anything you've learned from sailing the Atlantic that has taught you about economics, or vice versa?

SOLOW: Let me remind you, I'm an inshore sailor. I never even talk about sailing a transatlantic sail. If it ever comes up in the family, the next sentence is, “Well, you can do that with your next wife.” But I have no wish to do that. I'm an inshore sailor. I just like sailing a boat. Apart from the activity itself, the main thing I like about sailing is that it teaches you that the water and the wind out there don't give a damn about you. They're doing whatever the laws of physics tell them to do and your problem is to adjust as best you can.

And learning to adjust, to adapt, is not a bad thing for economists to learn either: Adapt to changes in the world. If things that used to be in inelastic demand suddenly acquire a lot of substitutes and demand for them becomes elastic, there's no point in wishing it would go back to the old situation which was so simple. You've got to fit your model to the world, not the world to your model. (We're back to real business cycle theory again.)

I don't build a lot of my life around sailing a 28-foot boat; it's just one thing I take some pleasure in. But I do think as a metaphor for other things sailing teaches you that there's the water and there's the wind and if you'd like to get from here to there, well, figure it out, but don't expect any help. And don't try to impose your will on the world because it's going to go the other way.

REGION: Thank you, Mr. Solow.


—Douglas Clement

More About Robert Solow

  • Currently, Institute Professor Emeritus, the Massachusetts Institute of Technology, where he has been a professor of
    economics since 1949

  • Foundation Scholar at the Russell Sage Foundation, where
    he is participating in an extensive study of the sustainability of high employment

  • Bank of Sweden Nobel Memorial Prize for Economic Sciences,
    1987, for his theory of growth

  • National Medal of Science, 2000

  • Member of the National Academy of Sciences

  • Fellow of the British Academy

  • Past president of the American Economic Association
    and the Econometric Society

  • Former member of the National Science Board

  • Served as member and chairman of the Board of Directors
    of the Federal Reserve Bank of Boston

  • Author or co-author of the following notable books: Capital Theory and the Rate of Return; Growth Theory: an Exposition;
    Made in America: Regaining the Productive Edge; The Labor
    Market as a Social Institution
    ; and A Critical Essay on
    Modern Macroeconomic Theory


  • Honorary degrees from two dozen schools, including the
    University of Chicago, University of Paris, Warwick University,
    Yale University, University of Helsinki, Harvard University,
    University of Buenos Aires and New York University

  • John Bates Clark Medal, American Economic Association, 1961

  • Doctorate (David A. Wells Prize), master's and bachelor's
    degrees in economics from Harvard University
Posted by DeLong at September 30, 2002 01:44 PM | Trackback

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Comments

Where in the interview does Solow say that '... paying attention to distribution would lead one to make it a crime for Mozambiquean cashew farmers to sell their produce to representatives of Indian processing plants..' etc etc?

All he says is that economists tend to look at aggregates and not the distribution. This seems fair enough to me, especially if you consider policy with respect to developing countries.

Posted by: Robert Ponter on October 1, 2002 07:19 AM

Assume that absolute levels of income arose across the board in the 1990s. So what? Since (average income)/(highest income) went down in the 1990s, then people can still be rightfully unhappy. That is, while one's absolute level of income may be important for some things, it is not important everywhere. Take the political process for one, where money tends to rule: just because you're better off does not mean your voice is more important or even stays even. You tend to lose out to all the new millionaires above you who can donate and get their voice heard.

Posted by: Andrew Boucher on October 1, 2002 09:18 AM

"Where I think the open-economy partisans run into problems - and it is a respect in which a lot of market-oriented economics and economists fail—is that they tend to look at overall progress and brush off the fact that a lot of people lose in this process."

This is a fine statement and if attended to will allow for increased success for globalization. Solow is not arguing with DeLong about the merits of open-economies, merely arguing that distribution of wealth must be attended to for development to support democracy.

Posted by: on October 1, 2002 10:04 AM

i thought prof. delong's reaction was a little extreme for what i thought was an innocuous comment -- that distribution is important in thinking about the political economy of trade and that there are a lot of people (though by no means the majority) who are hurt by trade. i don't think he was at all arguing that the average citizen had actually become poorer, but merely making the analytical point that it is possible for this to happen.

but maybe i didn't understand what was said. :)

Posted by: on October 1, 2002 10:08 AM

>>But I don't think that paying attention to distribution would lead one to make it a crime for Mozambiquean cashew farmers to sell their produce to representatives of Indian processing plants, to forbid Bengali shrimp fisherman from setting to sea until they come up with the money to buy turtle excluder devices to attach to their nets, to require that Canada revoke all government programs that seek to put the thumb on the scales to encourage a distinctly "Canadian" culture, or to further restrict developing countries' exports of textiles to the United States--to name just four of the causes celebres of the demonstration in Seattle. <<

Nor would it be inconsistent with making it a crime for France to subsidise the production of French television programs, to forbid Portugal from making regulations on the transparency of ownership of its financial structure or to shut down plants producing generic AIDS drugs in South Africa and Brazil -- to name just four of the causes celebres of the *meetings* in Seattle.

What the heck's either of these things got to do with the price of fish?

Posted by: Daniel Davies on October 1, 2002 10:48 AM

"I'm all for paying more attention to distribution in crafting global economic development policy."

Terrific. Then let us figure out how to use trade and aid to foster faster growth and better distribution through southern Africa. The well-being of some 580 million people is at dire risk.

Posted by: on October 1, 2002 11:39 AM

"Oxfam, which analyzed the effect of American cotton subsidies on African producers, estimated that American cotton subsidies eliminated 1 percent of the total economic output in three impoverished African nations — Burkina Faso, Mali and Benin.

"Mali lost about $43 million as a result of plunging cotton prices, which was significantly more than the $37 million in foreign aid it received from the United States. Over all, according to Oxfam, the American government spends three times as much on cotton subsidies as it does on foreign aid for all of Africa."

NYTimes - September 29.

Posted by: on October 1, 2002 11:41 AM

Brad

I dearly wish globalization to succeed, but you have to pay attention when America and Europe subsidize farmers, for example, at the expense of families through southern Africa. Africa is in the midst of possibly the greatest health crisis in recorded history and "globalization" is doing far too little for them for we are playing fast and loose with the rules. Fine to help our farmers, but we must help African farmers in turn. This a real globalization issue, if we really do wish for open-economies.

Posted by: on October 1, 2002 11:47 AM

'Nor would it be inconsistent with making it a crime for France to subsidise the production of French television programs'

You know, now that I think about it, why is this illegal? Technically, shouldn't the French subsidizing domestic television screw the French and benefit everyone else? If they were exporting stereoes or something, you'd certainly expect it to be that way.

Posted by: Jason McCullough on October 1, 2002 12:15 PM

Prof DeLong,

Once again I think your analysis is quite shallow. Globalization in a cultural context is a very positive thing, but in an economical perspective, is it always so? I'm extremely pussled by the fact that so many professional economists tend to believe that the world wide economic liberalization of the economies has been something good, increased growth and so on. In the developed world, not a single country has avereged a higher growth between the liberal era (1980-2000) than was the case in the more regulated era (1960-1980).

You also bring up infant mortality, yes, very interesting. It has decreased the last 20 years, but not any way near in the speed it did the 20 years before that.

Economic globalization could be done better of course too. The western world (EU and USA) are very anxious to remove trade barries for industrial and technological products, but keep increasing farm subsidies and barriers.

The Washington-consensus run by the authistic IMF has created misery in several countries. It is definitely scary to see how many economists tend to believe in the "one-size-fits"-all ideology. Partly I guess this is because the education the economists recieve today is so narrow and blind to bigger issues outside the world of economics.

Posted by: on October 1, 2002 02:31 PM

Prof DeLong,

Once again I think your analysis is quite shallow. Globalization in a cultural context is a very positive thing, but in an economical perspective, is it always so? I'm extremely pussled by the fact that so many professional economists tend to believe that the world wide economic liberalization of the economies has been something good, increased growth and so on. In the developed world, not a single country has avereged a higher growth between the liberal era (1980-2000) than was the case in the more regulated era (1960-1980).

You also bring up infant mortality, yes, very interesting. It has decreased the last 20 years, but not any way near in the speed it did the 20 years before that.

Economic globalization could be done better of course too. The western world (EU and USA) are very anxious to remove trade barries for industrial and technological products, but keep increasing farm subsidies and barriers.

The Washington-consensus run by the authistic IMF has created misery in several countries. It is definitely scary to see how many economists tend to believe in the "one-size-fits"-all ideology. Partly I guess this is because the education the economists recieve today is so narrow and blind to bigger issues outside the world of economics.

Mikael, Milano

Posted by: on October 1, 2002 02:31 PM

Sorry for the double post. For more one the subjects above see Mark Weisbrot, at CEPR, http://www.cepr.net/relative_impact_of_trade_liberal.htm

Mikael, Milano

Posted by: on October 1, 2002 02:32 PM

Personally, I have much less problems with the French trying to salvage their culture (and its media and artistic expressions) than with their continued lobbying of the EU bodies for keeping the antiquated PAC around.

Cultural protectionnism may or may not be a smart thing to do but it seems to me like a defendable policy, unless we're in the business of cultural imperialism. Once one's culture is lost, it's very difficult to bring it back to life. I know of only one country that has succesfully done this, Israel. If you have more examples, I'd be happy to learn about them.

The culture of my region of origin, Wallonia, has been completely overtaken by French culture, and by now barely a few near-retirees can speak our original language, Wallonian, even as a second language. Yes, French is more useful and prestigious, but I can't learn about my history by reading otherwise great French authors...

I betcha that if it was American cultural that was at stake the tone of this thread would be quite different...

Okay, now shoot me! ;-)

Posted by: Jean-Philippe Stijns on October 1, 2002 02:48 PM

What did you make of Solow's views on computers and productivity? He says that the "best guess" is that productivity growth is going to slide backwards--don't you disagree with that?

I was not as upset about his comments about income distribution, which I think you misread as if he were saying that growth causes poverty. I think what he is saying is that growth requires change, change generates losers, and so we should not be surprised that people fight change. He is saying that better income redistribution might make growth easier to sell politically, by reducing the effect on the losers. I don't think this is a terribly powerful point, but I think it's better than the point that you attribute to him.

Posted by: Arnold Kling on October 1, 2002 03:06 PM

I recall a historian - I'm afraid I can't remember which, just that he was pretty conservative overall - remarking that revolutions tend not to follow sharp drops in standards of living but sharp rises. People who are poor and get poorer tend to fight harder for what little they have. People who have been poor and powerless who suddenly get a little breathing space are more likely to organise and to ask themselves why they have to still be poorer and more powerless than whoever it is that they blame for their condition.

This strikes me as a pretty good insight. The French revolution was preceded by a significant increase in French standards of living. The two decades before the Russian revolution were a period when things mostly improved, with the exception of the war years. Not every revolution fits this pattern, but a surprising number do.

Thus, I could make a case that the soi-disant anti-globalisation movement is the product of the very increase in standards of living that globalisers claim responsibility for. I'm hesitant to make the case though. For one thing, I'm not quite sure to which part of this rather amorphous movement it applies. Not to middle class college kids from the US - they haven't really been big winners over the last decade, they just haven't been big losers either. (Not that middle class Americans can't believe in a cause in full sincerity, or that they are nuts for doing so.)

I can't judge the sentiments of the developing world from here, so I can't tell how widely held these ideas are held in the places most affected by them. I have not seen any evidence that people in the developing world are demanding free trade and free movement of capital. People aren't taking to the streets to demand the establishment of stock markets or the deregulation of their banking sectors. I have seen some evidence that anti-globalisationist sentiment does have some currency - there are protests against abusive workplaces and damaging industries and sometimes against specific international interests - but it's hard for me to project that into the kinds of protests that take place in the west. Such actions tend to be local, like the Ogoni's (and Acehnese' and U'we's) beef against Shell, and involve specific grievances.

The people I do know from the less wealthy parts of the world may not be very representative, but I don't know any who unconditionally support the kind of globalisation that seems to have currency in America. I do know a few who are opposed. I know quite a few with specific resentments - usually something along the lines of "the {colonialists|Zionists|World Bank|IMF|American bankers|American backed dictatorship|Western industrialists|British|French|UN} have done nothing but {ruin|oppress|bankrupt} my {country|region|ethnic group|national trade position|people's lives} and they need to be stopped!" Sometimes they have what seem to me to be well founded reasons for those beliefs, sometimes not. But I can well imagine a little improvement in conditions actually making people with such resentments even more active in expressing them.

Posted by: on October 1, 2002 03:44 PM

Perhaps he's just saying that the debate should be about solving income inequality directly as opposed to dealing with it indirectly (and very poorly) through international trade policy. Everything from productivity increases in some sectors and not others to the evolution of utility functions can increase or decrease inequality. International trade is just another one of those things. But if we were to halt everything and examine it to make sure that it does not increase inequality there would be no economic progress. It's not so simple, but the idea is to have the greatest aggregate welfare which will result in shocks to inequality, but to try our best to redistribute it appropriately afterwards. If anti-globalizers care about inequality, we should debate the issue directly and debate policies to deal with inequality directly like the EITC, instead of trade which is only an indirect and very poor mechanism for improving inequality.

Posted by: Bobby on October 3, 2002 01:04 PM
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