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

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."

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.

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

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.

The 'dismal or the dreary science' was as I remember made entertaining to generations of Freshman Economics students by Paul Samuelson's famous textbook, 'Economics'. Robert Heilbroner wrote an economic history in which he too made the theories come more to life by writing about the lives behind them. Now David Warsh has written a new history which gives the background to what he takes to be a turning point development in the history of Economics, revealed in a 1990 paperon 'Endogenous Growth' by Paul Romer. Paul Krugman who was one of the young economists involved in this revolution writes generations of economics had deliberately avoided the significant consequence of one aspect of Adam Smith teachings the concept of ' increasing returns'. Warsh's book 'describes how great economists chose to exclude increasing returns from their analyses, even though many of them understood quite well that they were leaving out an important part of the story. It also tells the tale of economists, most notably Joseph Schumpeter, who decided that if increasing returns couldn't be modeled rigorously, so much the worse for rigor -- and who found their literary, nonmathematical versions of economics simply ignored. (Schumpeter was a sad figure in his later years; his canonization as a patron saint of economic growth -- based largely on his famous phrase, "creative destruction" -- came long after his death.) The second half of the book describes how the underground river finally fountained to the surface.' Krugman praises Romer's paper but clearly believes that Warsh gives too much emphasis to it. The fact of 'increasing returns' was evident in other ways, especially in relation to the growth of value associated with the 'information revolution'. This book is instructive not only in showing the way a new set of ideas may come and transform the way a whole discipline is thought about. It is also instructive in showing how resistant entrenched established powers can be to new ideas when it comes to their own areas of expertise. Is it any wonder then that time and again in human history great new developments in a field have come from those who were as Thorstein Veblen saw it, 'inside and outside ' of it at once? In any case this work is a highly recommended read for both those who wish to gain a fair idea of the history of economics, and to understand a key late- term development in the field.