Economic Theory and Economic History
One reason to study economic history is so that you do not in the future make mistakes like that made by the economics profession in rejecting High Development Theory between 1970 and 1990.
Paul Krugman writes:
The Fall and Rise of Development Economics: [T]he [Albert] Hirschman I know is the author of The Strategy of Economic Development.... [W]hile I am a great admirer of The Strategy of Economic Development, I do not think that it was helpful to development economics. That may sound paradoxical, but I'll try to explain....
I regard the intellectual strategy that Hirschman adopted in writing that book as an understandable but wrong response to what had become a crisis in the field of economic development. Perversely, the very brilliance and persuasiveness of the book made it all the more destructive....
"[H]igh development theory"... was and is highly persuasive as at least a partial explanation of what development is about... for a stretch of about 15 years in the 1940s and 1950s it was deeply influential.... Yet in the late 1950s high development theory rapidly unravelled, to the point where by the time I studied economics in the 1970s it seemed not so much wrong as incomprehensible. Only in the 1980s and 1990s were economists able to look at high development theory with a fresh eye and see that it really does make a lot of sense....
[T]he crisis of high development theory in the late 1950s was neither empirical nor ideological: it was methodological. High development theorists were having a hard time expressing their ideas in the kind of tightly specified models that were increasingly becoming the unique language of discourse of economic analysis. They were faced with the choice of either adopting that increasingly dominant intellectual style, or finding themselves pushed into the intellectual periphery. They didn't make the transition, and as a result high development theory was largely purged....
Hirschman's Strategy appeared at a critical point.... It is a rich book, full of stimulating ideas. Its most important message at that time, however, was a rejection of the drive toward rigor.... Hirschman said that both the theorist and the practical policy-maker could and should ignore the pressures to produce buttoned-down, mathematically consistent analyses, and adopt instead a sort of muscular pragmatism.... Along with some others, notably [Gunnar] Myrdal, Hirschman didn't wait for intellectual exile: he proudly gathered up his followers and led them into the wilderness... they perished there.
The irony is that we can now see that high development theory made perfectly good sense.... But... to see that, we need to adopt exactly the intellectual attitude Hirschman rejected: a willingness to do violence to the richness and complexity of the real world in order to produce controlled, silly models that illustrate key concepts.
This paper, then, is a meditation on economic methodology, inspired by the history of development economics, in which Albert Hirschman appears as a major character... not a villain... a tragic hero....
[H]igh development theory... [is] the view that development is a virtuous circle driven by external economies... countries, according to this view, remain underdeveloped because they have failed to get this virtuous circle going, and thus remain stuck in a low level trap. Such a view implies a powerful case for government activism as a way of breaking out of this trap.... The distinctive features of high development theory came out of its explanation of the nature of the positive feedback that can lead to self-reinforcing growth or stagnation... the self-reinforcement came from an interaction between economies of scale at the level of the individual producer and the size of the market. Crucial to this interaction was some form of economic dualism, in which "traditional" production paid lower wages and/or participated in the market less than the modern sector... modern methods of production are potentially more productive... but their productivity edge is large enough to compensate for the necessity of paying higher wages only if the market is large enough. But the size of the market depends on the extent to which modern techniques are adopted, because workers in the modern sector earn higher wages and/or participate in the market economy more than traditional workers. So if modernization can be gotten started on a sufficiently large scale, it will be self-sustaining, but it is possible for an economy to get caught in a trap in which the process never gets going. The clearest and simplest version of this story is in the original paper by Rosenstein Rodan (1943) himself....
[M]ainstream economics was, by the late 1950s, becoming increasingly hostile to the kinds of ideas involved in high development theory... economics was going through an extended period in which increasing returns to scale, so central to that theory, tended to disappear from discourse.... Why did that present a problem? Because economies of scale were very difficult to introduce into the increasingly formal models of mainstream economic theory....
A friend of mine who combines a professional interest in Africa with a hobby of collecting antique maps has written a fascinating paper called "The evolution of European ignorance about Africa." The paper describes how European maps of the African continent evolved from the 15th to the 19th centuries.... The coastline of Africa was first explored, then plotted with growing accuracy, and by the 18th century that coastline was shown in a manner essentially indistinguishable from that of modern maps.... On the other hand, the interior emptied out. The weird mythical creatures were gone, but so were the real cities and rivers. In a way, Europeans had become more ignorant about Africa than they had been before... improvement in the art of mapmaking raised the standard for what was considered valid data. Second-hand reports of the form "six days south of the end of the desert you encounter a vast river flowing from east to west" were no longer something you would use to draw your map. Only features of the landscape that had been visited by reliable informants equipped with sextants and compasses now qualified....
Between the 1940s and the 1970s something similar happened to economics. A rise in the standards of rigor and logic led to a much improved level of understanding of some things, but also led for a time to an unwillingness to confront those areas the new technical rigor could not yet reach.... Economics has always been unique among the social sciences for its reliance on numerical examples and mathematical models. David Ricardo's theories of comparative advantage and land rent are as tightly specified as any modern economist could want. Nonetheless, in the early 20th century economic analysis was, by modern standards, marked by a good deal of fuzziness. In the case of Alfred Marshall, whose influence dominated economics until the 1930s, this fuzziness was deliberate....
From the point of view of a modern economist, the most striking feature of the works of high development theory is their adherence to a discursive, non-mathematical style.... [W]hy didn't high development theory get expressed in formal models? Almost certainly for one basic reason: high development theory rested critically on the assumption of economies of scale, but nobody knew how to put these scale economies into formal models. The essential problem is that of market structure. From Ricardo until about 1975, what economists knew how to model formally was a perfectly competitive economy... but there is no general theory of how... firms who have substantial market power... will set prices and output.... Since the mid 1970s economists have broken through this barrier in a number of fields: international trade, economic growth, and, finally, development. The way they have done this is essentially by making some peculiar assumptions that allow them to exploit the bag of tricks that industrial organization theorists developed for thinking about such issues in the 1970s.... In the 1950s, although the technical level of the leading development economists was actually quite high enough to have allowed them to do the same thing, the bag of tricks wasn't there. So development theorists were placed in an awkward bind, with basically sensible ideas that they could not quite express in fully worked-out models. And the drift of the economics profession made the situation worse. In the 1940s and even in the 1950s it was still possible for an economist to publish a paper that made persuasive points verbally.... It seems safe to say that such a paper would have been unpublishable any time after 1970, if not earlier.
Some development theorists responded by getting as close to a formal model as they could... others at least professed to see a less formal, less disciplined approach as a virtue rather than an awkward necessity. It is in this light that one needs to see [Albert] Hirschman and [Gunnar] Myrdal.... [T]heir books marked the end, not the beginning of high development theory.... What marked Myrdal and Hirschman was not so much the novelty of their ideas but their stylistic and methodological stance. Until their books, economists doing high development theory were trying to be good mainstream economists. They could not develop full formal models, but they got as close as they could.... Myrdal and Hirschman abandoned this effort, and eventually in effect took stands on principle against any effort to formalize their ideas.
One imagines that this was initially very liberating.... Yet in the end it was a vain stance. Economic theory is essentially a collection of models. Broad insights that are not expressed in model form may temporarily attract attention and even win converts, but they do not endure unless codified in a reproducible--and teachable--form. You may not like this tendency; certainly economists tend to be too quick to dismiss what has not been formalized (although I believe that the focus on models is basically right). Like it or not, however, the influence of ideas that have not been embalmed in models soon decays. And this was the fate of high development theory. Myrdal's effective presentation of the idea of circular and cumulative causation, or Hirschman's evocation of linkages, were stimulating and immensely influential in the 1950s and early 1960s. By the 1970s (when I was myself a student of economics), they had come to seem not so much wrong as meaningless. What were these guys talking about? Where were the models? And so high development theory was not so much rejected as simply bypassed....
The exception proves the rule. [W. Arthur] Lewis's surplus labor concept was the model that launched a thousand papers, even though surplus labor assumptions were already standard among development theorists, the empirical basis for assuming surplus labor was weak, and the idea of external economies/strategic complementarity is surely more interesting. The point was, of course, that precisely because he did not mix economies of scale into his framework, Lewis offered theorists something they could model using available tools...
And, of course, the most astonishing thing about the rejection of High Development Theory is that it is the oldest of all proper economic theories:
The greatest improvements in the productive powers of labour... seem to have been the effects of the division of labour.... To take an example... from a very trifling manufacture... in which the division of labour has been very often taken notice of, the trade of a pin-maker: a workman not educated to this business (which the division of labour has rendered a distinct trade), nor acquainted with the use of the machinery employed in it (to the invention of which the same division of labour has probably given occasion), could scarce, perhaps, with his utmost industry, make one pin in a day, and certainly could not make twenty. But in the way in which this business is now carried on, not only the whole work is a peculiar trade, but it is divided into a number of branches, of which the greater part are likewise peculiar trades. One man draws out the wire; another straights it; a third cuts it; a fourth points it; a fifth grinds it at the top for receiving the head; to make the head requires two or three distinct operations; to put it on is a peculiar business; to whiten the pins is another; it is even a trade by itself to put them into the paper; and the important business of making a pin is, in this manner, divided into about eighteen distinct operations, which, in some manufactories, are all performed by distinct hands, though in others the same man will sometimes perform two or three of them. I have seen a small manufactory of this kind, where ten men only were employed, and where some of them consequently performed two or three distinct operations. But though they were very poor, and therefore but indifferently accommodated with the necessary machinery, they could, when they exerted themselves, make among them about twelve pounds of pins in a day. There are in a pound upwards of four thousand pins of a middling size. Those ten persons, therefore, could make among them upwards of forty-eight thousand pins in a day. Each person, therefore, making a tenth part of forty-eight thousand pins, might be considered as making four thousand eight hundred pins in a day. But if they had all wrought separately and independently, and without any of them having been educated to this peculiar business, they certainly could not each of them have made twenty, perhaps not one pin in a day; that is, certainly, not the two hundred and fortieth, perhaps not the four thousand eight hundredth, part of what they are at present capable of performing, in consequence of a proper division and combination of their different operations.
In every other art and manufacture, the effects of the division of labour are similar.... The division of labour, however, so far as it can be introduced, occasions, in every art, a proportionable increase of the productive powers of labour. The separation of different trades and employments from one another, seems to have taken place in consequence of this advantage. This separation, too, is generally carried furthest in those countries which enjoy the highest degree of industry and improvement; what is the work of one man, in a rude state of society, being generally that of several in an improved one. In every improved society, the farmer is generally nothing but a farmer; the manufacturer, nothing but a manufacturer. The labour, too, which is necessary to produce any one complete manufacture, is almost always divided among a great number of hands. How many different trades are employed in each branch of the linen and woollen manufactures, from the growers of the flax and the wool, to the bleachers and smoothers of the linen, or to the dyers and dressers of the cloth!...
This great increase in the quantity of work, which, in consequence of the division of labour, the same number of people are capable of performing, is owing to three different circumstances; first, to the increase of dexterity in every particular workman; secondly, to the saving of the time which is commonly lost in passing from one species of work to another; and, lastly, to the invention of a great number of machines which facilitate and abridge labour, and enable one man to do the work of many.
As it is the power of exchanging that gives occasion to the division of labour, so the extent of this division must always be limited... by the extent of the market. When the market is very small, no person can have any encouragement to dedicate himself entirely to one employment, for want of the power to exchange all that surplus part of the produce of his own labour, which is over and above his own consumption, for such parts of the produce of other men's labour as he has occasion for.
There are some sorts of industry, even of the lowest kind, which can be carried on nowhere but in a great town. A porter, for example, can find employment and subsistence in no other place. A village is by much too narrow a sphere for him; even an ordinary market-town is scarce large enough to afford him constant occupation. In the lone houses and very small villages which are scattered about in so desert a country as the highlands of Scotland, every farmer must be butcher, baker, and brewer, for his own family. In such situations we can scarce expect to find even a smith, a carpenter, or a mason, within less than twenty miles of another of the same trade. The scattered families that live at eight or ten miles distance from the nearest of them, must learn to perform themselves a great number of little pieces of work, for which, in more populous countries, they would call in the assistance of those workmen. Country workmen are almost everywhere obliged to apply themselves to all the different branches of industry that have so much affinity to one another as to be employed about the same sort of materials. A country carpenter deals in every sort of work that is made of wood; a country smith in every sort of work that is made of iron. The former is not only a carpenter, but a joiner, a cabinet-maker, and even a carver in wood, as well as a wheel-wright, a plough-wright, a cart and waggon-maker. The employments of the latter are still more various. It is impossible there should be such a trade as even that of a nailer in the remote and inland parts of the highlands of Scotland. Such a workman at the rate of a thousand nails a-day, and three hundred working days in the year, will make three hundred thousand nails in the year. But in such a situation it would be impossible to dispose of one thousand, that is, of one day's work in the year....
When the division of labour has been once thoroughly established, it is but a very small part of a man's wants which the produce of his own labour can supply. He supplies the far greater part of them by exchanging that surplus part of the produce of his own labour, which is over and above his own consumption, for such parts of the produce of other men's labour as he has occasion for. Every man thus lives by exchanging, or becomes, in some measure, a merchant, and the society itself grows to be what is properly a commercial society.
A free copy of The End of Influence to the first commenter who identifies where this passage comes from...
