Economic Ideas for the New Millennium

Nothing Is Sacred This page intentionally left blank Nothing Is Sacred Economic Ideas for the New Millennium Robert J. Barro The MIT Press Cambridge, Massachusetts London, England ©2002 Massachusetts Institute of Technology All rights reserved. No part of this book may be reproduced in any form by any electronic or mechanical means (including photocopying, recording, or information storage and retrieval) without permission in writing from the publisher. This book was set in Palatino by Achorn Graphic Services Inc. in QuarkXPress and was printed and bound in the United States of America. Library of Congress Cataloging-in-Publication Data Barro, Robert J. Nothing is sacred: economic ideas for the new millennium/Robert J. Barro. p. cm. Includes bibliographical references and index. ISBN 0-262-02526-4 (hc.: alk. paper) 1. Economics—History—20th century. 2. Economists—History— 20th century. 3. United States—Economic policy—1993–2001. 4. United States—Economic policy—2001– I. Title. HB87 .B293 2002 330—dc21 2002024435 For Rachel, to whom I owe the title of this book and many other things This page intentionally left blank Contents Introduction xi 1 Thoughts on Friends and Other Noteworthy Persons 1 Milton Friedman and His Memoirs 1 Adam Smith, Including Thoughts on Ken Galbraith and David Ricardo 6 George Stigler and the Chicago School of Economics 12 Gary Becker, the Great Economic Imperialist 17 Robert Mundell, the Father of International Macroeconomics 22 Bob Lucas and Rational Expectations 26 Larry Summers, the Economist as Treasury Secretary and Harvard President 32 Bono, the Rock Star as Amateur Economist 36 Domingo Cavallo—The Second Coming of the Argentine Savior? 44 Al Gore in the Balance 53 George W. Bush and Compassionate Conservatism 58 Joe DiMaggio 62 viii Contents 2 Economics of Social Issues 67 The Economics of Beauty 67 Abortion and Crime 73 Colombia and U.S. Drug Policy 77 SAT Scores and Meritocracy in Higher Education 81 Napster, Prozac, and Intellectual Property Rights 84 Microsoft and Antitrust Policy 88 Personal Accounts for Social Security: Not a Free Lunch 91 3 Economic Growth, Democracy, and Things International 95 Eastern Germany—A Lesson in Welfare Dependency 95 Inequality and Economic Growth 101 Democracy in the New Congo? 104 Chile’s Presidential Election 108 Mexico’s New Democracy 111 Dollarization in Russia? 114 Yankee Imperialism in Asia 118 Dollarization and the Grand Ecuadorean Experiment 122 My Brief Tenure at the World Economic Forum 126 What to Do with the International Monetary Fund? 129 4 Fiscal Policy, Monetary Policy, and the Macroeconomy 133 Budgets and Tax Cuts 133 September 11 and the War on Terror—What Does It Mean for the Economy? 137 Fiscal Profligacy at the American Economic Association 144 Contents ix It’s the Economy—Economic Evaluations of the U.S. Presidents 147 Serious and Nonserious Fiscal Reforms 150 Mr. Greenspan and U.S. Monetary Policy 154 And the Winner of the 2000 U.S. Presidential Election Was . 158 Oil—The Good Guys and the Bad Guys 161 Exuberance and Pessimism in the U.S. Stock Market 165 Index 171 This page intentionally left blank Introduction People often ask me why I became an economist. In col- lege and before that, I tended toward mathematics and science. As a physics major at Caltech in the early 1960s, I was lucky to take the two-year sequence taught to fresh- men and sophomores the one and only time by the great Richard Feynman. (To prove this, I have a signed and leather-bound copy of the notes from his course.) Feynman’s approach was to skip the standard topics in physics and deal instead with frontier material. That was partly why many of the faculty and graduate students attended the course. It also meant that I learned early on what it would mean to be an actual physicist, and I decided pretty quickly that I would not be a great one. In retrospect, it was fortunate that I learned this so soon, rather than having to wait until my senior year or, perhaps, even to graduate school. I had some exposure to economics from my brother, Steve, who was studying the subject in the 1960s in graduate school. This exposure motivated me to take my first xii Introduction course in economics as a junior at Caltech. Since Steve gets considerable teasing from his leftist friends about his right-wing brother, he may possibly regret this long-ago influence. I find it amazing now that my first economics class, taught by Alan Sweezy, used John Maynard Keynes’s General Theory of Income and Employment as the textbook. Although this book is one of the most influential works of the twentieth century, it makes a really lousy textbook. Moreover, since I now regard Keynes’s analysis as serious- ly flawed, it is surprising that I enjoyed the course so much. As a student, I appreciated the simple way that the Keynesian model explained the workings and failings of the overall economy. Especially appealing were the clever policy remedies, such as increased government spending and tax cuts, that Keynes recommended to combat unem- ployment. Too bad that I discovered later that the model was theoretically and empirically deficient! Bolstered by the Keynesian inspiration from my junior year course, I decided to make economics my career (although Caltech’s rules at the time did not permit a major in economics). This switch in fields turned out to be one of the best decisions I have ever made. I also remember my time as an undergraduate at Caltech as the most academically challenging of my life. This descrip- tion accords with Caltech’s recognition as one of the nation’s top undergraduate colleges. However, I have been greatly disappointed that Caltech never followed Introduction xiii MIT’s lead by seeking to become as first rate in economics as it is in the “hard sciences.” I was attracted initially to economics because of its application of analytical methods to macroeconomic issues and policies. In fact, the emphasis on mathematics in economic research made it easy for me to make the transition from my undergraduate training in physics. My later periods as an economics Ph.D. student at Harvard and as a faculty member at various universities have been easy in comparison to my undergraduate experience. Perhaps I just had a greater aptitude for economics than for physics, because I do not believe that economics is intrinsically an easier subject. I learned later that economic reasoning was not just mathematics and could be applied to a wide variety of social problems. Now, I think that no forms of social interaction—including religion, love, crime, and fertility choice—are immune from the power of economic reasoning. Hence, even widely held beliefs—for example, that beauty is an illegitimate credential of a worker or that democracy is important for economic growth—are not sacred truths and are subject to analysis. That is why the title of this book is Nothing Is Sacred. Intellectual pur- suit in a free society such as ours is about reasoning and not about reaching forgone conclusions—at least not if one wants to obtain new economic ideas for the new millennium. Early on in my career—at least through graduate school in economics at Harvard and into my stint as an xiv Introduction assistant professor at Brown in the early 1970s—I was a standard twentieth-century liberal. Thus, my main approach to economic problems was to design clever government policies that could help to fix things. Later, particularly influenced by my first experience at the University of Chicago from 1972 to 1975, I became more impressed by the efficiency of private markets and less enamored with the curative role of government. I would describe my underlying philosophy since that time as libertarian or classical liberal rather than conser- vative or Republican. As I said in the introduction to my book Getting It Right, “My views are more akin to the nineteenth-century liberal philosophy espoused by Milton Friedman, especially in his Capitalism and Freedom. In that work, he proposed many policies that are harmo- nious with free markets and are receiving serious atten- tion in the United States and other countries. This list includes school choice, the flat-rate income tax, rules for monetary stability, privatized social security, and the elimination of affirmative-action programs.”1 I also said in Getting It Right, “My view is not anarchic; I believe that government has some key functions, notably to define and protect property rights. This head- ing encompasses national and domestic security and the enactment and enforcement of a system of laws and con- tracts. My belief in the appropriateness of this limited 1. Robert Barro, Getting It Right (Cambridge, Mass.: MIT Press, 1996), p. xiv. Introduction xv range of public functions is consistent with the view that most governments have gone much too far in their expenditures, taxation, and regulations.” Larry Summers, my colleague at Harvard until 1991 (and later U.S. Treasury secretary and now president of Harvard and sort of my boss), had a view on my philosophy. He told me: “If I had your views on economics, I would find another profession.” The point is, for Larry still (and for me when I was a student and junior professor), the main attraction of economics is its scope for designing policies that can improve private choices. If I was right that private markets usually function better without the government’s intervention, then Larry thought that economics would be a pretty dull field. Thus, he would find something else to do.

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