by Robert Litan
But none of that happened. Indeed, even the two economists thought to be in the best position to predict future hard times and to recommend measures to avoid or at least minimize them—Federal Reserve Chairmen Alan Greenspan and Ben Bernanke—publicly indicated that the economy was doing pretty well up until the crisis. They didn’t even warn that when the housing market turned downward and borrowers began defaulting, the rot would slow the rest of the economy. Perhaps they each believed these things would happen but as public officials whose every word is sliced and diced by the media and the public, they couldn’t voice their misgivings out loud without triggering mass panic and thus the very crisis they wanted to avoid.
Nonetheless, to be fair to both of these distinguished economists, they were in good company: Many other highly credentialed economists didn’t issue such warnings either. Moreover, Alan Greenspan later apologized for not reining in the subprime mortgage lending boom earlier, while at least in my view (one that I know is not universally shared), Ben Bernanke’s extraordinarily innovative easy-money policy helped save the U.S. economy from a far worse recession than actually happened, one that was the worst since the Great Depression of the 1930s.
The failure of the economics profession—with a few notable exceptions like New York University’s Nouriel Roubini and Yale’s Robert Shiller—to see the crash coming has pretty much tarnished the reputations of all economists since. It has also promoted deep soul-searching among economic forecasters about how to improve their models so that they will be better able to warn the rest of us of future trouble with enough time to head it off, or at the very least to keep its impacts to a minimum.
I wish them luck because they have an uphill battle. Economic forecasters as a whole have never had a very good track record of predicting the turning points in the economy, either the beginning of recessions or recoveries. In his latest book, Greenspan argues, in my opinion persuasively, that forecasters have an especially difficult time calling financial crises and sudden downturns when economies, and especially banks, are highly leveraged—that is, when they operate with thin cushions of reserves or capital to absorb losses when economies hit bumps in the road or asset bubbles deflate.2 When that happens, financial panics can lead to sharp downturns that cannot easily be seen in advance.
Nonetheless, a major thesis of this book is that prediction is not what all economists do and the worth of economic ideas should not be measured by the success or failure of the few who attempt to make predictions. This proposition is important, I submit, not only for those who make policy—elected and appointed officials—and for the wider voting public, but also for those who run and create the businesses that produce the goods and services we want to buy and in the process generate the incomes with which to pay for them.
Indeed, through the years I have found many in business to be skeptical about economists who spend their time in the Ivory Tower and not in the trenches where business is actually done. How is it possible, people in business often ask, that economists can really understand what is going on in the real world if they are not actually working in business? Others in the business world are simply innocent about the economics profession. I can’t resist repeating this story that Hal Varian, Google’s chief economist whom you will meet in Chapter 3, told me about someone from the human relations department at Amazon, which now has a chief economist but was then looking for one, asking of Hal the same question my own mother asked me: “Now, could you tell me what it is that economists actually do?”3 Presumably, Amazon has figured that out by now.
The truth is that relatively few economists actually engage in economic soothsaying or prediction. Yes, let me repeat that, or phrase it in a slightly different way: The popular perception of what most economists do is wrong, and I intend to show that in the chapters that follow.
A third and even more important reason I have written this book is to tell readers, even economists, that some economic ideas have proven to be extremely important in launching or improving the performance of many businesses. In doing so, I will focus on U.S. businesses, because the United States is the country where I was born and live, and thus has the economy I know best. But readers from or interested in other countries should find the following material useful as well. Many businesses elsewhere around the world are modeled on successful businesses launched in the United States, so if economics is useful here, it can be useful anywhere. In Part II of the book, I show how policy ideas urged by economists, once they were adopted, actually led to the creation and growth of many businesses, a fact of which their founders, current executives, and employees may not even be aware.
Although I have not quantified the business impact of economic ideas with precision, I plan to show you that collectively the notions discussed in this book have created trillions of dollars of income and wealth for the United States and the rest of the world, hence the title of the book. Along the way, I hope to teach some economics through examples, ideally reawakening your interest in the subject if you took it long ago, but without the graphs, charts, and maybe lots of equations you were required to solve but whose relevance you did not immediately (or ever) grasp. Likewise, if you are running or thinking about creating a business, perhaps one or more of the stories in the chapters that follow may quiet your skepticism about the importance of economics in business, or maybe even inspire you to change the way you or your company operates. Finally, and I know this is a long shot, there may be a chapter or two in here that inspires some economists to change the way they teach the subject, by relating at least some economic ideas to their practical uses or consequences in business settings.
I focus primarily on the positive contributions of economists to business because they have been largely overlooked, in my opinion. The financial crisis and the Great Recession have provided many examples where economic ideas have been misused and taken too far—some derivative financial instruments that went bust and took a good portion of the U.S. economy with them last decade are perhaps the best known to this generation of readers—and I will briefly discuss those where it is relevant to do so. But I am deliberately going light on these instances for two reasons: They already have been discussed extensively by others, and where economic ideas have been misused, it was those who engaged in the misuse rather than economists or their ideas that were at fault.
This book is written in the spirit of Better Living Through Economics, edited by Vanderbilt economist John Siegfried, who also was a long-time secretary of the profession’s main professional organization, the American Economic Association.4 This useful book contains essays by some leading economists on how various economic ideas have changed society through the adoption of public policies urged by economists. There is a bit of overlap between Siegfried’s book and this one—especially in my later discussion of some policy-related topics—but most of what readers will find here is new, even my gloss on public policies in the second section of this book. It is the business perspective in this book that I believe is unique and one that I know that business readers will appreciate, and hopefully others will too.
Organization of the Book
This book takes key insights from various economists—some, but not all, rewarded for ideas with one of the two leading prizes for economists—the Nobel Prize or the Clark Medal, both described in detail in Appendix A—and show how these concepts, knowingly or unknowingly, have been applied in real businesses to make real money, and also in the process to benefit consumers in the United States and elsewhere around the world.
Let me clarify, by the way, whom I mean by economists—mostly, but not exclusively, individuals with PhDs in the subject. I take a broader view because the main purpose here is to focus on economic ideas, so along the way you will not only meet some famous economists but also some statisticians, specialists in finance, psychologists (one, Daniel Kahneman, has even won the Nobel Prize in Economics), or business executives or entrepreneurs who have commercialized an economic idea. For me, since it’s the ideas
that count, I will give the originators credit for being economists if the content of their ideas is related in some fashion to how the economy or some portion of it really works.
I have been privileged to know, and occasionally work with, many of the economists (so broadly defined) whose work is featured in this book. I feel a bit like Forrest Gump since I have had the good fortune to meet and know so many outstanding members of the profession during some very exciting times. My personal connections to the entrepreneurs and business executives are fewer. Where relevant, I will tell you a few personal stories about the individuals I know, in sidebars throughout. I do this not out of vanity—I have just been lucky enough to know these people—but instead because I believe this will help humanize both the individuals and the subject of economics, which I have learned over the years, can be intimidating (or boring) to many.
Each chapter of the book is devoted to one or several related economic ideas and to one or more economists who developed them. You will learn something about why some of the economists went into the field and, in particular, what led them to their ideas. The chapters contain similar information about a number of entrepreneurs and business leaders, and their companies that commercialized these ideas. Along the way, I’ll mention or introduce you to some very interesting and (believe it or not) readable books by certain economists, so if nothing else, consider this book a reader’s guide to some of the best popular economics writing by those who really know their stuff. At the same time, I apologize to the many worthy economists whose great ideas have not made it into this book because of space limits and my judgment that their research does not bear directly on the business-related themes of this particular book.
The chapters in the book are structured in three broad groups. The first part includes chapters that center on ideas that have directly found their way into certain businesses. In some cases, there is a straight line from the ideas to the businesses. In other cases, the line is not so clear, or the lines are parallel: that is, economists came up with a given idea that businesses thought of independently and found a way to make money off it. In a few cases, the economists learned from the businesses. Whichever way the causation runs, I simply want to demonstrate the importance of the ideas themselves as a way of illustrating the usefulness of economic insights, regardless of who thought of them first.
The second part focuses on economic ideas that have influenced public policies that created opportunities for a surprisingly wide range of companies to emerge and grow and, in the process, have changed much of the way business is done in this country. Many economists (including me) make it their career because they believe it will help them influence policy in some way for the better, not so much out of a desire to run for office (although many politicians have studied the subject in college and a few even have had graduate degrees), but through their writing and, for some, as advisers to elected officials or government agencies. Each of the chapters in the second part of the book discusses economic ideas that have powerfully changed governmental policy, specifically facilitating the deregulation of industries where conditions never or no longer warranted it, and in turn unleashed major, positive forces for existing and new businesses in the U.S. economy.
The concluding part of the book peers into the future by identifying a few economic ideas already in circulation that are waiting for potentially large business applications or policy changes that will create platforms for many businesses in the future, many that almost certainly cannot now be imagined. The last chapter in this part of the book concludes with some thoughts about the future of economics as a separate academic discipline, and the implications this might have for business in the future.
At the end of each chapter I summarize some of the main takeaways or “bottom lines.” I haven’t said enough in this introduction to warrant a bottom line for this chapter, but to whet your appetite for what’s in the rest of the book and to justify the “trillion dollar” claim in the title of the book, here are a few things you will find as you read further:
Economists have been instrumental in implementing and designing auctions in a variety of companies that collectively have market values in the hundreds of billions of dollars, or more.
Economists have built the mathematical backbone for minimizing costs in much of the transportation industry.
Statistical techniques developed and refined by economists are increasingly being used in the sports industry (and not just in baseball!).
Economists have contributed to a growing “matchmaking” industry, of human organs and whole people (in the “marriage market”).
Economists and their insights helped spawn the growth of index investing and financial options contracts (collectively involving several trillion dollars).
Without the deregulation of the transportation industry and the breakup of AT&T, events in which economists played prominent roles, Internet retailing would not exist on nearly the scale that it does today, if at all.
Economists also played prominent roles in encouraging the deregulation of the prices of oil and natural gas without which energy firms would not have had the financial incentives to make the technological breakthroughs that have dramatically increased U.S. oil and gas production, reversing the “energy pessimism” that has overshadowed the country and world since the early 1970s.
Not bad for a relatively small profession, if you ask my opinion.
My Personal Interest (and Bias)
I find economics to be a fascinating and exciting subject. While I had some interest in it before attending college, I really got turned on to it by the best teacher I have ever had, a then young, dashing, and brilliant economist from India, Jamshed Ghandi, at the Wharton School of Finance at the University of Pennsylvania (the nation’s first undergraduate school of business, which later added a famed master’s program and a limited PhD program). As my choice of schools implies, I went to Wharton to learn about business, and specifically corporate finance, a subject I then only vaguely understood. Although my enthusiasm for choosing economics as a major waned a bit after taking the standard introductory level course in my freshman year—an experience I’ll bet many readers and countless other former college students have had—that attitude changed completely the following year when I had the great fortune and privilege to take Ghandi’s seminar in finance, which was really about macroeconomics. Ghandi had a reputation for being a very tough but fair grader, and an outstanding teacher, a reputation he maintained long after I took his course and graduated.
You will find as you read through the book that other economists were attracted to the subject in the same way that I was, through the gifts of one special teacher, admittedly a not unusual way in which many people choose their professions. In my case, what appealed to me most about economics is that it was a practical way to apply mathematics, which I was good at, but not good enough to be a mathematician, or even to be a physicist (a trait shared by other famous economists, too, although the field has become more mathematical over time, and the very best economists tend to be those who are both mathematically gifted and can express themselves well in writing). That is because, as MIT Professor Robert Solow reportedly once quipped, “Little boys don’t grow up wanting to be economists, they have to learn about it later in life.” (He made this remark at a time when it was rare to find women economists, a situation that has changed significantly, as it has for other professions).
For students who are thinking about taking an economics course, I hope this book will help you get through the graphs and equations and understand, at least at some level, that they actually have been or can be useful. For those who have suffered through an economics course and want an easy way to go back and remember some of what you learned, or perhaps learn a few new things with business relevance, then hopefully this book is for you.
I realize that those running a business or working in one are perhaps my toughest audience. Many of these readers are probably skeptical that economists have very little und
erstanding of the real world, or their particular business. One of the noted economists featured in a later chapter, Franklin Fisher of MIT, told me a great story that encapsulates this attitude.
The building at MIT that houses both the business school and the economics department is called the Sloan building, named after one of America’s leading industrialists, Alfred P. Sloan, who built General Motors (in the good old days, long ago). When the MIT president at the time told Sloan about the plans to name the building after him, he reportedly replied something to the effect, “That’s all very nice and I’m grateful, but only if you move all the economists out of the building.” They weren’t moved, but Sloan’s attitude is not at all unusual in business, in my experience, and I fully understand it.
Sloan’s skepticism about the usefulness of economists uttered many decades ago persists elsewhere. Even a famous historian, Harvard’s Niall Ferguson, has climbed on the anti-economist bandwagon. Worrying about how America has lost its way (in his book by that name),5 Ferguson singles out the profession for failing to recognize how increasing bureaucracy and regulation are stifling American entrepreneurship, a position with which I am sympathetic. I personally applaud Ferguson for turning his attention to the importance of entrepreneurs in advancing innovation, a theme I have stressed in my own past writings and discuss later in this book, and even agree with his assertion that “[n]ot many economists talk about [institutional impediments to entrepreneurship],” a situation I spent nine years as research director at the Kauffman Foundation trying to rectify (even recommending the funding of historians like Ferguson himself to study the subject, which he clearly has). It’s his diagnosis of the reason why economists ignore these impediments, echoed by many in business—“because not many economists run businesses”—that I want to counter.6
By the end of this book (maybe even before), I hope all readers will come away with a different impression of at least some economists, and more importantly, with a more positive view about the importance of economic ideas or the way economists tend to think. I may not be able to tell you everything about economics you might benefit from knowing, but ideally it will be enough for you to realize that Keynes was right when he famously uttered that practical men (he wasn’t thinking of women) have little idea of the extent to which their beliefs and actions have been heavily influenced by the writings of some defunct economist. Most of the economists you will meet vicariously in this book are not yet defunct, but alive and well and still contributing to the ongoing process of understanding how economies work, and still coming up with ideas that real people in real businesses are using to improve their lives and those of their customers, suppliers, and employees.