Weekend Long Read: Paul Samuelson Saw China’s Inequality Problem Coming
The highly respected economist, late Paul Samuelson (1915-2009) anticipated the big challenge China would encounter, an interview in his MIT office with me in 1998.
The process of the interview had clear marks of its time.
About a half month before I visited his office, a thoroughly worked-out list of questions was faxed to Samuelson’s secretary, which was somehow got lost. The interview began anyway with Samuelson’s self-introduction, and with my follow up questions. The one-hour conversation was recorded on a Sony tape recorder. The quality of content stored in that 60-min tape after ten years could be deteriorating quickly, and this did happen, even sooner, causing much trouble. A careful reader would find some words missing or mis-spelled in this article.
What is more interesting to me, in addition to this conversation, is the photo I found recently that Samuelson sit in front of his blackboard posed for the camera.
Before sitting into his chair, he wrote on the blackboard two lines of mathematical formulae. As I could recognize now, that is the calculus of variations of an optimal consumption along a given time period, or the first-order condition of a dynamic optimization based on Ramsey’s equation, which is part of the so-called “fundamental efficiency conditions”. For more details, I recommend his 1965 paper (with an “errata”): “a catenary turnpike theorem involving consumption and the Golden Rule”, The American Economic Review, Vol. 55, Issue 3, pp. 486-496, and issue 4, pp. 864-866.
It seems to me that the great Samuelson in this portrait wanted his Chinese readers to remember this formula as his central contribution to economics.
A “warm heart” needed
— Samuelson worried that the study of economics was becoming too “narrow-minded” and out of touch with real-world policymaking.
Paul Samuelson: I used to say that I was the last generalist in the field of economics, because the field became so big and so technical, that the most people concentrate on one small part. I used to try to keep up with all of the different kinds. Maybe (around) the time that I was 60 years of age, I could mostly keep familiar with most parts, but the subject continues to proliferate so that I would not pretend that now in my ninth decade, I am a master of all the different parts.
I don’t think that everybody should try to do that. Great advantages come from the division of labor, but it is very good to have a few people try to combine understanding of the most complex, mathematical, technical, analysis of econometrics, statistics and economic theory with a good judgment (and) feel for what’s important in the real world. I think the late Arthur Okun, like Walter Heller, had a good sense of what is practical and what is possible. And he had a concern for what I’m interested in, which is the ethics of economic systems.
When we’re talking about ethics, we’re not (doing so) in the positivistic, factual realm, alone. … For 15 years, I wrote a Newsweek column at the same time with Milton Friedman and Henry Wallich at Federal Reserve. I have put them together. I called this economics with a warm heart.
Now I don’t think that in order to have a warm heart, you have to have a good brain. You can’t prove that one ethical position is better than another ethical position in a way that you can prove that three angles of the Euclidean triangle must add up 180 degree or two plus two equals four.
This becomes a problem in education for a developing society. If the society is developing, and the emerging society is surrounded by the advanced industrial society. There’s a tendency for some of the best students to become preoccupied with a highly technical part of economics.
And that’s true in a terrible degree of Japanese economy. They have gone through Oxford or to Harvard or MIT to study. They are interested in the fixed-point theorem and do that very well. But back home in Tokyo and the government, nobody pays any attention to that. They are not useful in writing newspaper criticism, for example, of Japan’s governmental policy macro policy in the 1990s. I regard Japan as one of the most self-mismanaged governments in the world, because unlike Italy or South Korea, which are countries without very much elbow room to make a mistake or to do the right thing. Japan has very plentiful reserves, (and) was free to choose which macroeconomic policies to follow.
Wang Dingding: Philippines? I mean, it is bad. You want to talk about their high-quality bureaucracy?
No, I want to talk about the fact that they (bureaucrats) are the fourth estate. You have the voters, you have the legislators, you have the cabinet, but you also have the bureaucracy.
Well, in Victorian England, the bureaucrats had an influence. But they were under the command of elected officials. And similarly, in the United States, the people who are chairman of the Council of Economic Advisers, or the Secretary of the Treasury: they are not the king, and they have to be responsive to the will of the electorate. And we don’t see that in a country like Japan.
So how can China — as newly developing from a one-party controlled political system and a collectivist bureaucratic plan system — how can you develop simultaneously good technical economists but broad thinkers? And I think the problem in there is that there are (far) too few top Japanese economists who are worth listening to.
I find the paradox. The very best of our economic advisers over the years have also been among very best of the theoretical and historical scholarly economists. My idea is to have a combination of both … From experience, I have become more and more eclectic for over the years. My result is that you have to be as eclectic as the fact of current experience and history call for, but not be more eclectic, just having an open mind for anything is possible, then you have nothing to contribute to.
I also see no clash between economic history and economic theory. In the last analysis, it is real experience which is decisive. The theorists must be the handmaiden of the empirical situation. No, we are limited in our ability in social sciences, to gather data because we can’t do controlled experiments. We must use historical observation, cross sectional, and time series of observations to give us … plausible patterns. But a very elegant theory that doesn’t fit the actual facts is worse than useless. It is counter-productive.
I don’t believe in the great man theory in science. I think we’re all workers who in different degrees contribute. We’re getting checked up on by other scholars. We’re checking up on by ourselves. Why give the fun to the other person to find the effects in your theory? You should do, you should do that then as a matter of self-protection. So I think we’ve learned a lot, but I don’t think we’re anywhere near converting forward certain things.
Moreover, this is effective experience. Generally speaking, when economics is on our own track, later going to get corrected, it doesn’t happen by a new outside school. It comes in and it’s not familiar with the intricacies of economics. It’s going to correct itself, if it is to be corrected, mostly from the inside.
I’ve learned so that I always study the views of people who don’t agree with me. And it’s very good to have a questioning, critical stance. I think it leads to correction. So I’m always studying past views to see whether they don’t need to be adapted to a new situation.
Pursuing “freedom” is not an excuse
— Samuelson believes the rigid laissez-faire doctrine by some schools is selfish and misguided, because it does not help solve the inequality problem.
Actually your discussion just brings new questions in my mind. But I only ask you, maybe one question following that, it seems to me, do you think that modern economics needs some corrections? It might be already heading down the wrong path led by, say, the rational expectation theory of the 1980s.
I believe that the Nobel Prize of Robert Lucas was well-deserved, and not just for rational expectation. His critique of how we identify econometric patterns is worthwhile for its own sake.
Japan spent a lot of deficit financing to get its growth rate up. It cannot by conventional open market operations. The Bank of Japan, must stimulate the economy, because the interest rate is already down below half a percent. It is a liquidity trap like the American one in the middle and late 1930s. I think if, it did that, it would have a measure of success. The rational expectations, who claim that the only effect of systematic policy intervention will be on the price level. I think that most of economic history accounts against that view. Wars have led to a very feverish activity. And so rational expectations would say it’s just because people are surprised, and the effect will not last.
I think that it’s not consistent with either good theory, or with the actual economic history. But I think there’s much truth that these days people learn faster.
And there’s an old Native American saying, you fool me once, shame on you; you fool me twice, shame on me. But the rational expectation of a thing, it’s only when somebody gets fooled. Now, I think when the gold comes in from the new world, after Columbus’ voyages, and raises the price level of (gold in) Europe and causes a half century of extraordinary expansion. I don’t think people are being fooled the whole time.
It’s just easier to ride a wave of mild inflation, then to deflate the economy and engineer a full employment by that particular method. Nobody is being fooled along the way, really. I go back to 1933 to 1939 in the American New Deal. It wasn’t as if you told people what was going to happen, they wouldn’t have done what they did do.
I find it very interesting that one country in Asia, up to now, people have not been worried about it. It’s China. You worry about Hong Kong dollar, about whether China can support it, but do not worry about China, which has capital controls. Capital controls are bad from a micro standpoint, and from a longer term standpoint. But compared to the massive swings one way … and in other way in rational expectations, it can be temporarily effective.
And on the other hand, whether it’s compatible with a degree of margin primacy. That’s a micro level. You have capital control, and in particular, this new expression, crony capitalism. So the banks were borrowing and making loans, which if somebody’s started a business contact book of how there will be a return on the investment which were liquidated and pay it off. Nobody thought about that. It was the new Asian pattern of the long-view corporate governance by unanimity, as if a large group of men can’t run a ship by universal vote.
That answers the question in your own words …
Let me tell you what a big problem with China will be.
If you depend more and more on the market economy, you are going to in all probabilities, (have) more and more have a tendency towards inequality. That’s the nature of a market economy. Some people work harder than others, some people are luckier than others. Some people are more educated than others, some are endowed naturally. Now Simon Kuznets thought that when you went from feudalism to capitalism, at first there would be inequality. Most of any shrinking just took place prior to the related welfare state. However, there’s been a big political revolution in the West towards selfishness.
You call it selfishness?
That’s what it is. My prosperous neighbors in the suburbs, are almost all Republican, because they know which party is likely to give them a flat tax or reduce the degree of progression of their taxes. There’s a limited amount of altruism, or more reasons to create a more efficient government, and responsiveness to real human needs, as against the good slogan that’s power to the people or by the people. So you have to work within that particular constraint.
Now, the question becomes acute. When 40%, 50%, 60% of the gross national product just going through the hands of government. The examples would be the Swedish welfare, which is now trying to move on the other direction. The miracle in Sweden wasn’t that for decade after decade, productivity manufacturing grew at 10% a year 8% a year 7% a year. But it did so within a regiment of rather considerable equality and also a regiment of civil liberties. However, since about 1970s the egalitarianism has remained, but the productivity progressiveness eroded away.
Let me come to a very important question. You mention several examples to me showing that MIT economists are not as narrow as modern economists that we perceive. In order to do the economic research, you think, while come back to the first question that you responded, you think that’s a good economist should also be good at sociology and psychology, and political science.
There is a limitation to what you can do. I think that the real clue to the history of economics, particularly, not the first Chicago School, but the second school, e.g. Friedman, Stigler, Becker, is libertarian. I have known Friedman for 60 years. I was an undergraduate when he was a graduate in the University of Chicago. And I think I’ve read everything you’ve ever read with admiration and criticism. But what’s really important to them is not that there will be more rapid material progress in the United States. It’s the octopus of power in Washington (that needs) to be reduced. He was being the most unhappy man in the world.. If you read “Capitalism and Freedom,” you will find it very hard to see a genuine good word for any governmental program.
It’s the same argument of why I’m for private property in land. If everybody can run over the land, everybody will be trampling everybody else’s. And so we need property rights. It is better to have more freedom. On the other hand, the freedom to by-election does not work consistently within life in the field of a democratic process. One of the books is “The Tyranny of the Majority.” Because they have 51 %, which would indeed be regarded by someone like myself as the tyranny. But there’s no ideal model in possibility of this, there’s no ideal voting system, which can give or just an axiom, holding simultaneously of non-dictatorship and the rest.
So I’m always looking for the golden mean. The advantage of this, the advantage of that, the trade-off where we started to balance our costs.
Yeah, that’s what I have been trying to talk my colleagues about, healthy markets. Otherwise, you have no time to talk about your economics based on the society and social morality … So that creates an optimality…
That is a necessary condition in an already just society. But we won’t have an already just society it unless there is some intervening, interfering with laissez-faire to create the conditions for a successful society. Now, some nations are maybe luckier, for example, as the Swedish, it’s very homogeneous, it’s more possible to get a good education. There’s also an underground class system. But it’s still much easier than a very diverse country with free immigration like the United States to expect the market economy to work with any spontaneous semblance of ideal effort.
So, I’m going to say something in loss of efficiency and even progress. In order to rectify the worst extreme of inequality.
I need to ask about your opinions on the new institutional economy which is relevant in this context.
The protection of property rights, I think, and I approve of that. But I think it’s overdone in that it assumes that somehow there will be a trade-off, or greater optimal collusion, but how the benefits of that will be divided they have no theory at all, I think there is no theory of how the benefits are divided. And you have a faulty theory whether that collusion will spontaneously take place.
Because this school is developed out of the free market will take care of everything related to private property rights?
And also somebody like you even believes that the law itself will go down so as to create the Pareto optimal situation and I think that there’s over-optimism connected with that.
By agreement, you may be able to reduce the notion. It takes a very special kind of law of returns and non-externality to make the pricing system the right way of organizing a society. But I don’t really recognize that there is a big impulse with new institutionalism.
Wang Dingding is a Caixin columnist and academic advisor. He was a professor of economics at Peking University and Zhejiang University.
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