Economics in a Changing World

This is a time and place of great moment. I do not come here pretending to know as much about the Russian economic reforms as many others in this room. Nor am I certain that what I am about to suggest is the right course for Russia, nor for any other nation. Nonetheless, there is something about this time and place that lures the mind into big-think. So I will succumb to temptation and indulge in some speculations about where the formerly socialist economies of Europe should be going — and why.

In recent years, economists have displayed growing interest in what goes on inside firms. Once they regarded firms as undifferentiated atoms without any internal structure worthy of study. Now, however, they have begun to develop a microeconomic analysis of firms’ internal organization — the particles that make them up, the forces that hold their components together, and the way their internal composition affects their relationship to other atoms. This development is of great potential importance to historians of business, who in recent years have also come to treat the firm in increasingly sophisticated ways. Gains from trade between the two disciplines are now really possible, and our aim in this chapter is to encourage scholars to exchange ideas. We begin by summarizing briefly developments in each field and then devote the bulk of our essay to examples that illustrate how economic theory can illuminate problems in business history and vice versa.

Growth theory flourished in the 1950s and 1960s, died, and has now been resurrected. Romer (1986) led the way, but it needed Lucas’ (1988) uncanny knack of creating followers to beget the now large and growing literature. The aim of the new growth theories is to have an account of an economy’s growth rate which is not exogenous to the theory. In what follows I make an attempt at a somewhat general formulation of the problem which appears to be needed. For at the moment there is a bewildering variety of models, all relying on special functional forms and special assumptions. Most of these models are ‘closed’ in the sense that they have enough relations to determine an equilibrium growth rate. In one, everything hinges on the production of human capital, in another this is ignored and we focus on R&D, while in yet another it is the process by which the variety of goods is increased which makes the world go round. There are common features but they are not easy to discern. Moreover for each process singled out as central, for instance the production of human capital, one can think of a large number of others which, plausibly, could also claim centrality.

Economics is now experiencing the second post-war wave of neo-classical growth theory. This wave has brought relief to those tired of the sterile debates that have plagued macroeconomic theory for so long. Unlike Keynesianism, monetarism, new classicism and real business cycle theory, the endogenous growth movement has not divided the discipline of macroeconomics into two opposing camps. Instead, there has been an almost total absence of controversy, and a coming together of previously incompatible schools of macroeconomists, all of whom are now addressing the same topic with the same class of models. Instead of greeting endogenous growth theory with dogmatic resistance, the macroeconomics profession embraced it almost as soon as Romer’s (1986) seminal contribution appeared in print.

I am not going to present a theoretical or empirical contribution, but rather to express some views on our understanding of the interplay between investment and economic evolution. This understanding leaves much to be desired, notwithstanding the efforts of past research on the subject. I should like to be able to find clues on how to make quick progress, but I shall fail to do so here. My reason for speaking rather comes from this very special occasion: Russia has now to rebuild economic teaching and research. As a teacher and research worker I feel a duty to provide some message that could be useful.

Much has been written in recent years concerning the problem of reconciling observed patterns of real wages with competitive equilibrium theory. The failure of real product wages to rise in economic downturns suggests that firms are off their supply curves;¹ and the failure of real consumer wages to fall substantially suggests that workers are off their labour supply curves.

Until recent years, most finance economists believed that expected stock returns were constant through time. This belief implied that unexpected stock returns were driven by news about future dividends. Since finance theory has little to say about the economic forces behind dividend expectations, finance economists were generally content to treat unexpected stock returns as exogenous, and to work instead on the determination of mean returns given risk aversion and exogenous variances and covariances of returns. Fama (1970) is a particularly clear survey of this traditional approach to finance.

Between 1973 and 1987, the rate of saving of households, businesses and governments declined in virtually all 24 OECD countries. For the United States, France, Japan, and the United Kingdom, the drop in national saving amounted to about 5 per cent of GDP. Since 1987, savings rates have recovered somewhat, but as of 1994 remain substantially below their levels in the early 1970s (see Table 9.1 and Figures 9.1 and 9.2).

After lying dormant for about fifteen years (1975–89), the theory of optimum currency areas (OCAs) has awakened and is being exercised by international economists and national politicians. There are three main current applications of OCA theory. The first, and most obvious, is Economic and Monetary Union (EMU) in Western Europe, an area with an eastern boundary that is moving east. The second application is analysis of the emerging tri-polar currency world of the dollar, the yen, and the European Currency Unit (ECU). These are the ‘large’ areas of my title. The third application is the analysis and perhaps design of the evolution of currency and exchange rate arrangements in Central Europe (by this term I mean the formerly centrally planned economies that were called Eastern Europe) and the former Soviet Union, which I will refer to as the Baltics and (optimistically) the Commonwealth of Independent States (CIS). These are the ‘small’ areas of my title. Since EMU has been extensively studied, I will concentrate here on the other two applications of OCA theory.

This chapter assesses some of the recent literature on ‘contract inefficiency’ in employment. Two main sources of potential inefficiency in labour markets have been widely discussed in the literature: (i) the process by which employee meets employer to start negotiations is inefficient; and (ii) the wage/employment/effort outcomes agreed once employer and employee (or their representatives) have started negotiating are inefficient. It is the latter to which I apply the term ‘contract inefficiency’. The former gives rise to the inefficiencies discussed in the search and matching literature. These are well surveyed in Mortensen (1986) and, although that survey is now somewhat dated, I do not attempt to update it here.

Since some is not one and could well be two, I will devote this chapter to two issues: (a) to voice a concern about the prevailing choice of the dependent variable(s) in research on migration and development, and (b) to draw attention to a new sphere of analysis, if I may call it that, which I consider fruitful and promising in accounting for migration.