Customer Reviews

Knowledge and the Wealth of Nations: A Story of Economic Discovery

5 star:		(20)
4 star:		(12)
3 star:		(6)
2 star:		(3)
1 star:		(1)

 

 

David Warsh has written a lively history of economic thought from the time of Adam Smith to the present. His narrative begins in 1776 with the publication of "The Wealth of Nations" and the central contradiction that has puzzled economists for centuries: namely, the parable of the pin factory and the invisible hand.

According to Smith, the pin factory demonstrated how economies of scale produced increasing returns by lowering the costs of production. What Smith didn't follow up on was that increasing returns enabled a few players or a single player to drive smaller firms out of business and create oligopolies or monopolies. Smith's other theorem, which ran counter to the example of the pin factory was the theorem of the invisible hand. The invisible hand required that many players compete in the marketplace in order for the market to function properly so that no one firm or group of firms could become dominant.

Economists since then have favored the theorem of the invisible hand over the pin factory, not only because it was ideologically correct, but that it lent itself more readily to economic modelling. Yet things were happening economically that indicated that the invisible hand - which argued that rising costs and diminishing returns were inevitable - was no longer adequate in describing what was has been taking place over the last thirty years.

In 1990, a young economist named Paul Romer published a paper entitled "Endogenous Technological Change." Romer noticed that economic growth was accelerating in rich countries where the standard of living was diverging rapidly from poorer countries. This was contradicting the law of diminishing returns and, indeed, indicated increasing returns.

Romer's theory was that the accumulation and the deepening of knowledge in a society was the source of increasing returns. In classical economics, the fundamental factors of production were always labor, capital, and land (natural resources). Knowledge was always exogenous. Romer looked at the knowledge factor more carefully and deemed it an endogenous factor that economists had hitherto failed to take fully into account. Factoring in knowledge - creating new economic models of knowledge accumulation - has basically revolutionized the fields of industrial organization, international trade, urbanization, development and many other areas of social science. Although this development is still in its infancy it holds many exciting possiblilies for the future of economic growth. (And the growth of the economics profession.)

Warsh does an excellent job of portraying the key figures in economics and their rivalries as this drama unfolds. If you like intellectual history, you won't be disappointed with this book.

Most of the reviewers of this book apparently found it to be impressive. Sadly I did not.

Too little time is devoted to offering adequate clear explanations of the economic ideas and theories being addressed, too much time is devoted to irrelevant social asides. The non-economist reader seeking to understand the economics as opposed to learning a great amount of academic gossip and politics will probably be disappointed. I wanted to understand growth theory. I did not and do not care that the reason why Paul Romer left Chicago for the Bay Area was that his wife had a disagreement with her lab manager or that Paul Romer has developed software to teach economics. I found such digressions to be unnecessary and distracting.

To cite just two of the book's specific limitations:

(1) The book lacks referential footnotes and a bibliography. Readers not already familiar with the subject wishing to pursue a topic further will be at a loss.

(2) The book lacks a glossary. Throughout the book numerous technical terms are introduced and, at best, briefly described. It would have been nice to have all of these key terms explained in one place for easy reference.

Small efforts on the part of the author would have remedied both of these deficiencies.

Adam Smith's Wealth of Nations supposedly explains the effects of two opposing economic forces, one being the force of the famous "invisible hand" (the economy of diminishing returns) and the other behind the success of the "Pin factory" model (the economy of increasing returns, or, growth theory). The book is a history of economic thought from the time of Smith to the present from the vantage point of this growth theory. The economist Paul Romer is the hero of the story. Romer is the one who was finally able to explain growth by correctly incorporating knowledge into his economic/mathematical model, according to Warsh.

Technicalities aside, the book is a fascinating depiction of intellectual history. The author deftly manages to capture the entire economics "scene" in impressive details -- from economics' major academic journals and institutions, its division of schools and universities, the major players, their work and personalities, and even to the happenings at important conferences. Warsh's depiction is so lively as to give one the impression that he had been present through all the historical events, engaging personally with all the economists described.

Students in economics will benefit from this book for the perspective it provides. Readers interested in economics culture in general, or those who seek to catch up on the trends of economic thought leading up to the last decade also won't be disappointed. One would be hard pressed to find an account of recent intellectual history as rich as this for any academic discipline.

Despite its name, this book will not tell you very much about the wealth of nations. It is a history of economic thought rather than an economic history; specifically, the story of how English language theoretical economics came to develop mathematically tractable models of increasing returns to scale, as exemplified by Paul [edit: not David!] Romer and his 1990 paper "Endogenous Technological Change".

Within these narrower limits, the story is told well. Romer's intellectual journey is explored thoroughly, and attention is paid to his antecedents, both those who approached the topic intuitively (eg the "big push" theorists of the 50s) and those neoclassical economists who started down the same path as early as 1965 but were deterred by their elders (Uzawa, Shell, Akerlof, Stiglitz and Nordhaus, some of whom still bear grudges to this day). There are some fascinating asides on Nordhaus' work on the historical cost of lighting, and the fact that Bill Gates took a microeconomics course (focusing on patent races) under Michael Spence before dropping out of Harvard. (One wonders if this should count as a negative on the scorecard of economics education!)

Warsh is less successful at explaining why the general reader should care. "So there is a new economics of knowledge. What has changed as a result? . . . not much, at least not yet." Yet he is still willing to proclaim that this new economics is an "indispensable guide to the modern world", and even get up on a soapbox himself: while "by all means" we should fix intellectual property, "first rebuild the education system . . . in ways that emphasise the new reality of international competition".

This is meaningless drivel. What exactly are these "ways" and why does this system need "rebuilding" in the first place? Obviously if high school graduates are functionally illiterate this is a problem, but it is hard to see what the new growth theory adds to the subject. And what does "international competition" have to do with anything? Even if there was a one world government, or if the United States was transplanted to another planet, the importance of education would be the same. Indeed, it would be greater since there would no longer be any hope of free riding off other countries' innovations or stealing their educated labour.

The big question remains, though: Should anyone who can't understand the original paper care? Warsh borrows Krugman's analogy with the map of Africa in the 18th and 19th centuries - getting emptier as vague rumors and hearsay were expunged, before it was filled up again with more accurate data. This does not seem valid. The newer maps illustrated with greater precision things that were actually there. The new growth models are simply mental constructs, better than unaided intuition at checking logical consistency, but in the end only useful if they illuminate aspects of reality previously hidden. It is hard to see education and intellectual property as previously hidden. And the "precision" of theoretical parameters estimated by fancy econometric techniques has yet to translate into reliable control of economies, to put it mildly.

If this book was just called "The Genealogy of Romer 1990" or something similar, I would have given it three or even four stars. But "The Wealth of Nations" is not a title to be claimed lightly.

Since Adam Smith first published the Wealth of Nations more than 200 years ago, there has been an episodic tension in the dismal science between the concepts of deceasing returns to scale embodied in the image of the invisible hand and increasing returns to scale due to specialization and the division of labor in the pin factory. Generally, most of us are more steeped in the views of competition, supply and demand and creative destruction arising from a view of the traditional factors of production of capital, labor and land. Only in fits and starts has the economics profession turned its attention to the importance of knowledge and readily observed increases in wealth.

David Warsh attempts to bring Adam Smith's story back into balance. Using Paul Romer's seminal paper, "Endogenous Technological Change," published in the Journal of Political Economy in 1990 as the centerpiece, Warsh first weaves a story of economic growth theories since Smith. Warsh argues that the early dominance of the decreasing returns of the invisible hand is partially due to the general sense of scarcity as embodied in early thinkers like Malthus and because its analysis and maths are more tractable. It thus required the mathematical maturation of the profession for the question of the pin factory and increasing returns (and declining costs) to find a resolution. Yet even as the theories and the profession itself become more mathematical in the 20th century, Warsh sticks to a literal and easy-to-read narrative. His story covers virtually every major economist from Smith and Ricardo in the early years to the Nobel laureates Arrow to Solow prior to Romer. He traces the eras of neglect with the slow discoveries as to the factors leading to growth.

The story really begins in earnest after World War II when the hidden X factor of technological change -- in what came to be expressed as total factor productivity -- came to the fore to complete the economic growth equation. Like the missing "dark matter" still being sought to explain why the universe doesn't fly apart, this TFP "X factor" remained elusive for many years and was generally viewed as something external - or exogenous -- to the standard understanding of growth in output. What Romer was able to argue in what came to be called New Growth Theory, was that this mysterious "dark matter" was itself knowledge and that it was an internal product -- that is, endogenous -- to the economic system.

While Warsh has too great a tendency to lionize Romer, this story is indeed a fascinating yarn and very informative for the non-economist. The theories that have emerged from Romer and other new growth theorists have special relevance in today's Internet and information economy where increasing returns to scale and network effects so manifestly surround us.

So, if you can put up with a bit of journalistic license and economists-worship, do check out this fast, 400-pp read. It's a rousing good tale and educational to boot. Not all economists can have beautiful minds, but a few fortunate ones can formulate beautiful equations.

As someone with only a basic background in Micro- and Macro- Economics (towards which I had a rather cavalier attitude) during b-school, I found this history extremely illuminating. The author tracks the central ideas in economics through Adam Smith to 2006 - telling the history of how Economics has historically treated the puzzle of growth (increasing returns) through technological change. Along the way, you get to meet a whole host of brilliant economists and come to appreciate the nuances of what gets them excited.
I also began to appreciate that the common refrain against serious economic discussion "...but it is just common sense" not only indicates our deep ignorance about the topic, but that it is only by understanding (and then learning to measure) the economic changes that one can begin hope to benefit from them. For example, it is intuitively well understood that technological innovation makes for good economics - but it seems a terribly difficult question to answer how and how much! If governments and businesses knew 'how and how much' about more economic concepts, we'd be rid of a lot of random policies based on seemingly sound common sense, great politics, but really bad economics.
The reasons this doesn't get 5 stars are:
(a) typos abound in the book - surprising from someone who has written 3 books and perhaps many columns (the author doesn't furnish his educational background though!)
(b) Hilarious 'Americanisms' through the book. Sample: "visit with" (which seems to be the preserve of public speakers in the US) and "Many various things..." (!!!). I wish a serious book hoping to go down as a definitive history on growth economics used better language - this is like elegant suits with cheap lining which don't last.
(c) In an effort to simplify and entertain, the thread of actual economics keeps being lost or muddled while you read about the various characters and digressions. The style is ok to give you a good feel of what it means to do Economics, but the actual content needs deeper treatment. For example, the chapter about Romer's paper actually talks more about other people and topics than the key topic this book is about! I understand this is a fine line to tread as an author, but I'd learn from Simon Singh (Fermat's last theorem, Code book), Gary Zukav (Dancing Wu-Li Masters), or Richard Rhodes (Making of the atomic bomb) and make the assumption that someone who buys a book about economic theory would be looking for a more serious treatment of the content. This book won't be read by your typical business travellers or Oprah's book club, so the trap of mass appeal is just not worth it.
Having said this, this book is still a great exposition of economic history - had I read it before my b-school courses, perhaps I'd have had the sense to learn (and get better grades too) and appreciate that Economics is closer to our lives than we think. For those with no background in economics and just a passing interest (but not enough to learn the concepts), this is an interesting and very contemporary introduction.

This is an excellent book written by one of the best economics journalists. David Warsh is not an economist. But, he is bright enough to have studied a good deal of it on his own. He has also followed the field closely for decades and is up on all the cutting edge trends of the dismal science. He is the perfect translator of forbidding math equations and obtuse economics concepts into everyday accessible English.

The book is essentially divided in two parts. Part I gives you a foundation in the history of economics working its way from Adam Smith, Ricardo, Keynes, Marshall, and Schumpeter to all the subsequent giants of the field. It also opens the black box of how economists work and essentially produce economic theories. They do so by publishing working papers within the most notorious peer-reviewed economics journals. This is an example of the scientific method at its best. There is no funding by compromising corporate interest or any other conflict of interest. The direct motivator is not money but prestige. Successful working papers eventually modify the content of economics textbooks and can lead to the receiving of Nobel Prize in economics for their authors. The economics field works out like Evolution (including natural selection) for the brain. It constantly changes, adapts, learns, and evolves one working paper at a time.

Part II focuses on the most influential contemporary economists and their studies of economic growth ("New Growth Theory"). These include: Robert Solow, Kenneth Arrow, Robert Lucas, and Paul Romer. Warsh focuses on Paul Romer's working paper "Endogenous Technological Change" published in 1990. According to Warsh, this was a paradigm shifting paper for economics. This was because Romer changed the basic economic input framework first established by Adam Smith (land, labor, and capital) to a new set of inputs: people, ideas, and things. Also, Romer's paper uncovered the mathematics of "increasing return" underlying the concepts of economic growth, rising productivity, economies of scale, network externalities, and knowledge spillovers. Prior economists failed to uncover the formidable mathematics associated with "increasing returns" and had instead developed the more explicit mathematics of "diminishing returns" supporting the concept of market competition. They knew they were missing out. Romer filled the missing gap. Romer's framework better explains the economics of our information age knowledge based society.

If you want to further study the New Growth Theory, I recommend also Elhanan Helpman's "The Mystery of Economics Growth" and Charles I. Jones' "Introduction to Economic Growth."

Warsh has authored a well written book with a compelling tale of the foundations of theory of economic growth. More than anything else, it is a story of Paul Romer and his groundbreaking ideas. Romer is a remarkably creative thinker on a search for an economic theory (aka model) to explain growth. The author starts us on Romer's odyssey first with a brief history back to Adam Smith. It is clear Romer stood on the shoulders of giants (Smith, Marshall, Arrow, et al) in formulating theories (models) for growth, recognizing the value of knowledge and technology.

The kernel of the story becomes a bit muddled at times as Warsh becomes more fascinated with the great economists than he is about great economic ideas. The book is not written with a clear exposition of the evolution of economic thinking. It is written toward explaining the history of events of how the evolution of the thinking occurred. As such, it can be a tough slog as we are introduced to one economist after another without sufficient explanation of each person's contribution of ideas and how it fits into the mosaic of 'the real economy' (my emphasis). Romer comes and goes throughout the chapters but he is the central subject.

Toward the end (chapter 25), the history of Microsoft is introduced as an example of the ultimate 'pin factory' (Adam Smith). At this point in the story, reading about MS feels artificial and disconnected. I would have left it out completely.

One interesting observation was leading economists make 'discoveries' through models, explaining through sophisticated mathematics what the average businessman already knows from observation and experience. I felt this throughout the book so was not surprised when the author recounted a story of Krugman testing a new learning from a model on a non-economist friend. The friend's response was the discovery was "obvious". This says something about the theoretical economist's need to connect with the real world as opposed to spending all their time with models. To be fair economists must work with models which are mathematically well behaved, similar to physicists and engineers working with linear equations which are tractable for solution. These models often require assumptions or simplification which leaves out important factors. (I do worry at the unreal assumptions in the models described since many of these same economists find their way to be Presidential advisors or Fed Governors.)

I am glad I read the book and learned about how the profession develops its thinking. I also wonder if the time was well spent.

Short version: you'll enjoy this book if you already are an economist. Otherwise, you'll get little out of it.

Potential reader beware: at the end of the day this is more about economists-as-rock stars than it is about economics itself. I really wanted to like this book and learn something. And I somewhat did. However, two points stand against it to my mind:

1) The fawning tone. Warsh idolizes economists and the practice of economics itself. I found myself regularly asking, when confronted with yet another series of passages about who is teaching whom, and who is friends with whom, "So what?" Does it really make a difference who taught whom, and where? Does it matter if so-and-so is on the edge of their seat because some other so-and-so is giving a lecture he disagrees with?

I suppose it CAN make a difference, if you're trying to trace the intellectual lineage of theory, but Warsh prevents the reader from doing this with ease. Which brings me to my next point...

2) Lack of transparent "meat and potatoes." Because Warsh spends so much time talking about economists and how they pursue economics, it gets in the way of discussing the actual arguments and theories themselves in an intelligible manner. Further, Warsh swings wildly between focused and clear explanations that advance the intellectual narrative and bland, excessively technical explanations; he also inadequately explains some of the new twists in thinking as they develop. Such an approach is probably not helpful for the lay reader; I had a hard time following on occasion, and I still couldn't tell you what the big deal was other than "Romer figured out how to quantify knowledge and technological change."

Because of this, I felt like I learned little that I didn't know already. Warsh doesn't really bring the reader along. I don't see how this will be helpful for others like me who are not technically trained already. Ultimately, this isn't about new growth theory so much as how ideas become conventional economic wisdom (in academia, not the real world).

As an student of Economics, I purchased this to provide an overview of what I had learned in college. The beginning of the book is very dry and at times too technical for a reader not well versed in economics. However, towards the end, Warsh builds some steam and the book has several chapters offering Freakonomics-like stories with more detailed economics explanations.

Overall, the beginning really is necessary to appreciate the end however it may be too technical for some readers to (want) to understand. For economists, a great review of where the science is. I agree on another's comment that there is no more discussion of where the study is now going, but this is a small quible to a solid and entertaining book.