Economics at work / Economic ideas, Litan claims, "have directly made money for firms" (emphasis in original). For instance, the idea of price discrimination (charging a lower price to the most price-sensitive consumers) comes from economists. The book gives many other convincing examples.
Consider the proliferation of auction practices in today's business activities. In the 1960s, Julian Simon conceived the idea of auctioning overbooked seats on planes—specifically, using a reverse auction, which would pay the minimum price necessary for passengers to happily switch to another flight. Today, this idea is only imperfectly applied, as airlines typically offer vouchers to passengers who volunteer to be "bumped." Another example is Google's auctioning of online ad space, which company executives initiated without apparently realizing that they were using a sort of auction previously designed by Nobel prizewinning economist William Vickrey. Google later hired Hal Varian to improve its auctions and data processing. Although Litan does not put it in these terms, economists naturally think in terms of auctions because they understand that free-market prices are, in fact, the result of continuous silent auctions.
Another example of the usefulness of economists is the recent explosion of "data mining" or "Big Data," which has been made possible technologically by the growth of computing power and the proliferation of data available on the Internet. Statistical techniques are essential for processing these data (on prices, choices, consumers, other businesses), but economists are useful to interpret the statistical results—and to know what to look for in the first place.
Perhaps the best example of Big Data is the increasing use of statistical analyses in hiring players and devising strategies in sports. Michael Lewis's book Moneyball, about the statistical work used by Billy Beane and the Oakland A's front office, was turned into a (good) movie with Brad Pitt. Big Data is especially prominent in advertising and marketing: "Do customers respond better to solicitations in blue or white envelopes?" Similarly, Litan tells us that "there is no single Google website"; instead, visitors are presented a number of different Google homepages so that their reactions can be measured in order to optimize the site.
Another field where economists have helped business is matchmaking between suppliers and demanders where prices do not provide a sufficient signal. Examples of this include sectors where pricing is forbidden, like in organ transplants, or the good is subject to information asymmetries (the seller knows more than the buyer), like in online dating. Cupid.com hired two economists to solve a vexing problem: women were receiving too many requests and men, therefore, were getting too few replies to their approaches. The economists' solution was to increase the cost of men-to-women communications by limiting their number. Another dating site, Whatsyourprice.com, openly put a money price on communications and dates.
Economists have contributed much to the financial industry. They have shown that, for any given level of risk, a diversified portfolio brings higher returns. This discovery led to the 1970s creation of index funds, mutual funds made of diversified stocks or other financial instruments. Index funds have consistently generated higher returns than actively managed funds. The Efficient Market Hypothesis, which claims that no stock-picker can consistently outperform the market because all available information is incorporated in the prices of financial instruments, formalized this idea. Eugene Fama won the 2013 Nobel Prize in economics for his work in this area.
Although options (tradable contracts to buy or sell commodities or, now, other financial instruments) have existed for centuries, three financial economists—Fisher Black, Myron Scholes, and Robert Merton—contributed to the growth of this market by developing a famous options pricing formula to determine what an option should be worth.
Public policy implications / Economists have also contributed much to public policy. Litan emphasizes the importance of entrepreneurship and blames economists for "failing to recognize how increasing bureaucracy and regulation are stifling American entrepreneurship." But economists have also been instrumental in the deregulation experiments that began in the 1970s.
At the time, transportation was heavily regulated. Litan reminds us that "airlines could not transport air cargo by truck beyond 20 miles of an airport." Like airlines, truckers were subject to rate fixing and route controls. He notes, "Economists from across the political spectrum were well ahead of the politicians and regulators in advocating deregulation." Without deregulation, much of the online commerce revolution and just-in-time delivery systems we know today could not have happened. And airline fares would probably be double what they are now.
Starting with Jimmy Carter's administration, oil prices were also deregulated thanks to the advice of economists. This was "yet another example," writes Litan, "where a Democratic president and a Democratic-controlled Congress did what free market Republicans had long been associated with—letting the market, rather than the government, set prices." This deregulation paved the way for the ongoing shale oil revolution.
What is surprising about all these regulations is that they were imposed in what was supposed to be the country of free enterprise.
The same paradox was apparent in telecommunications. The deregulation movement in telecom, with economists at the forefront, also started in the 1970s. First, AT&T was broken up into regional entities by the Antitrust Division of the U.S. Justice Department. Litan properly criticizes AT&T's longtime monopoly and the ongoing power that the regional "Bells" have over the "local loop," but he does not emphasize enough the paradox that these monopolies were creatures of government itself. Also in the telecom section, he discusses the partial deregulation of the electromagnetic spectrum that got underway in the 1990s with the auctioning of frequencies by the Federal Communications Commission. The idea for those auctions had been advanced by Ronald Coase three decades earlier in work that would help earn him the Nobel Economics Prize.
The attentive reader of Trillion Dollar Economists will notice that the economists credited for innovations were often not holders of economics Ph.D.s, but instead were statisticians, mathematicians, engineers, and others who "[think] like economists." Yet economics remains essential. The advance of Big Data has made empirical work easier, but theory has become even more necessary because aimlessly fishing for data easily leads to misleading correlations.
Regulation / Litan is careful not to blame the Great Recession on economics or finance. He recognizes that "politicians promoted home ownership" and thus they deserve much of the blame for the real estate bubble and subsequent collapse. But he is still too soft on the federal government. He thinks that financial regulators did not regulate enough prior to the recession; they "got too cute, or too complicated." He believes that government can and should manage the macroeconomy. He is persuaded that "Bernanke's extraordinarily innovative easy-money policy helped save the U.S. economy from a far worse recession than actually happened."
Perhaps blinded by the limited experience of deregulation of the last decades of the 20th century, Litan seems to overlook the generally growing trend of regulation. Since the end of World War II, the Code of Federal Regulations (which annually consolidates all existing federal regulation) has grown from less than 20,000 pages to more than 130,000; state and local regulations have also mushroomed. Even with the late-20th century deregulation era, overall government regulation has continued to grow. (See my "A Slow-Motion Collapse," Winter 2014–2015.)
Consider finance. It is true, as Litan argues, that some deregulation occurred—brokerage commissions were decontrolled, for example. But the whole industry is quite certainly more regulated today than at any time in American history. Even before the Great Recession, the regulatory burden was heavy; for example, the New York Fed had hundreds of regulating bureaucrats working on the very premises of large banks. Regulation has become so omnipresent that we do not see it anymore.
Nor, seemingly, does Litan. He is sympathetic to cryptocurrencies but he does not seem to realize that they are being crushed by regulations (many emanating from the war on drugs). He explains well the efficiency of prediction markets (they predicted the 2004 presidential election better than opinion polls) but is soft on the government's attempts to regulate them out of existence, including with the Dodd-Frank financial legislation. He seems to buy wholesale the necessity of antitrust laws.
Litan is an intelligent and well-informed economist. He knows his classics, from "the great Austrian economist Friedrich Hayek," to Milton Friedman, not to forget Joseph Schumpeter and Israel Kirzner. He is familiar with public choice theory. He generally believes in the efficiency of markets: "the alternative to allocation by price is allocation by queue." He is well aware of the disagreements among economists, including on redistribution, even if he himself favors it for equity reasons and as "a form of social glue." And he understands that in a free economy, what matters is the satisfaction of consumer demand, not the success of producers.
Values and analysis / I find in Trillion Dollar Economists the same disquieting contrast I contemplate every week in reading The Economist. (Interestingly, the review of Litan's book in The Economist blames him for being too obsessed with economic efficiency.) On the one hand, one sees a generally good understanding of markets and their efficiency. On the other hand, one is struck by a constant deference toward those who run the government and interfere in markets. How can they miss that inconsistency? Or is it just me?
The problem is, no doubt, partly attributable to differences in values. Contrary to my view, Litan, like The Economist, is willing to call on government coercion to skew in favor of different people the distribution that would otherwise result from the working of free markets. In their perspective, there exists some public goal or purpose to which individual ends must be subordinated, but they realize that this subordination is done at a lower cost if the market is put at the service of public policy instead of being crushed. This approach is very different from the classical liberal—or, at any rate, the libertarian—approach where only individual preferences, goals, and happiness matter.
But, contrary to what Hayek argued, libertarians and socialists probably also have analytical differences besides differences in values. One such analytical disagreement lies in the social democrats' belief in the omnipresence of market failures. The fact that Litan was at one time "principal deputy assistant attorney general" in the Antitrust Division reveals something not only about how embedded he was in the monstrous federal bureaucracy, but also about his belief that economic freedom is impossible without constant government threats and meddling. In this perspective, the mildest conditional prejudice in favor of some economic freedom looks like free-market ideology. How else could we understand his claims that the George W. Bush administration was "a Republican administration committed to free markets"?
Another sort of analytical disagreement is probably traceable to the influence of John Maynard Keynes. It is true that Litan shows some skepticism toward macroeconomic management. But he seems to agree that a free-market economy is inherently unstable, as if any other economic system were better. In a more general way, I suspect that Litan would agree with Keynes that, in a society that "thinks and feels rightly"—a society where, probably, the government regularly consults him—politicians and bureaucrats can be trusted to take risks with other people's liberty.
Trusting government / The author of Trillion Dollar Economists does not distrust government. He talks fondly of "government service" and "public service." He does not appreciate that political solutions are generally more risky than the market failures they are (officially) meant to correct. Information asymmetries are potentially more damaging in the political market, where bureaucrats use the information they control to manipulate politicians while the latter use their own privileged information to defraud citizens. Litan argues that a carbon tax or a cap-and-trade system "is really a matter of prudence," but he forgets that protecting citizens against Leviathan is a much more serious matter of prudence.
Another sort of reason why our trust in government should be very limited lies in the fuzziness of the very notion of public interest. Society is the locus of private interests resulting from individual preferences that cannot be aggregated into nondictatorial "social preferences." Government action nearly always overrules some individuals' preferences in favor of other individuals'. On the contrary, Litan believes that "the best interest of society as a whole" requires constant attention and meddling with cost-benefit analysis. Perhaps, like many economists, he has just not thought through issues of social choice and welfare economics, but he should have.
The reader of Trillion Dollar Economists will appreciate that Litan has worked with many of the most important economists of our time, but the name-dropping gets a bit tiresome. Everybody seems to be his "good friend." Is there any liberal economist with whom Litan has not rubbed elbows? Perhaps he is just a sociable guy who has problems finding faults with his fellow citizens. But he may also be much too close to the establishment.
As any author knows in his bones, nothing is perfect. If a good book is a book in which one learns something, Trillion Dollar Economists is a good one for me, both for what it contains and for what it underplays.
