Most academic economics rely on concepts laid down at the beginning of the twentieth century by the British economist Alfred Marshall, who said that “nature does not make leaps.” Yet we economists find ourselves increasingly disturbed by the apparent inadequacy of the neo-Marshallian toolkit that we have built to explain our world.
The central bias of this toolkit is that we should trust the market to solve the problems we set it, and that we should not expect small (or even large) changes to have huge effects. A technological leap that raises the wages of the skilled and educated will induce others to become skilled and educated, restoring balance so that inequality does not grow too much.
So a country where labor productivity is low will become an attractive location for foreign direct investment, and the resulting increase in the capital-labor ratio will raise productivity. Wherever one looks, using Marshall’s toolkit, one sees economic equilibrium pulling things back to normal, compensating for and attenuating the effects of shocks and disturbances.
Marshall’s economics has had a marvelous run, and has helped economists make sense of the world. Yet there is a sense that progress and understanding will require something new – an economics of virtuous circles, thresholds, and butterfly effects, in which small changes have very large effects.
Perhaps this has always been so. By the standards of centuries ago, we live in a world of unbelievable wealth. Within two generations human literacy will be nearly universal.
Yet three centuries ago there was also technological progress, from the mechanical clock and the watermill to the cannon and the caravel, and on to strains of rice that can be cropped three times a year in Guangzhou and the breeding of merino sheep that can flourish in the hills of Spain. But these innovations served only to increase the human population, not raise median standards of living.
Today, if we divided up equally what we produce worldwide, would it give us a standard of living ten times that of our pre-industrial ancestors? Twenty times? A hundred times? Does the question even have meaning?
David Landes likes to tell the story of Nathan Meyer Rothschild, the richest man in the world in the first half of the nineteenth century, dead in his fifties of an infected abscess. If you gave him the choice of the life he led as the finance-prince of Europe or a life today low-down in the income distribution but with thirty extra years to see his great-grandchildren, which would he choose?
No doubt, we live today in an extraordinarily unequal world. There are families today near Xian, in what was the heartland of the Tang Dynasty Empire, with two-acre dry wheat farms and a single goat. There are other families throughout the world that could buy that wheat farm with one day’s wages.
Marshall’s economics – the equilibrium economics of comparative statics, of shifts in supply and demand curves, and of accommodating responses – is of almost no help in accounting for this. Why, worldwide, did median standards of living stagnate for so long? Why has the rate of growth undergone an acceleration that is extraordinarily rapid over so short a period? Where is the economics of invention, innovation, adaptation, and diffusion? Not in Marshall. And why is today’s world so unequal that it is hard to find any measures of global distribution that do not show divergence at least up until the 1980’s?
It has been generations since economists Robert Solow and Moses Abramovitz pointed out that Marshall’s toolkit is a poor aid for understanding modern economic growth. The real sources of growth are not to be found in supplies and demands and the allocation of scarce resources to alternative uses, but in technological and organizational change – about which economists have too little to say.
Economic historians like Ken Pomeranz rightly point out that before the Industrial Revolution, differences in median standards of living across the high civilizations of Eurasia were relatively small. A peasant in the Yangtze Valley in the late seventeenth century had a different style of life than his or her contemporary peasant in the Thames Valley, but not one that was clearly better or worse.
Two centuries later that was no longer the case: by the end of the nineteenth century, median living standards in Britain and other countries to which the Industrial Revolution had spread were, for the first time in recorded history, light-years above any neo-Malthusian benchmark of subsistence. The early industrial-era economic accomplishments occurred despite the loss of a substantial proportion of national income to support a corrupt, decadent, and profligate aristocracy. They occurred despite a tripling of the population, which put extraordinary Malthusian pressure on the economy underlying natural resource base, and despite the mobilization of an unprecedented proportion of national income for nearly a century of intensive war against France, a power with three times Britain’s population.
How, exactly, did these accomplishments occur? What were the small differences that turned out to matter so much?
Economists are now awakening to the realization that the most interesting questions they face were always beyond the reach of Marshall’s toolkit. Clearly, economics – if it is to succeed and progress – must be very different in a generation from what it is today.