Great Transformations: Economic Ideas and Institutional Change in the Twentieth Century

Published by EH.NET (August 2003)

Mark Blyth, Great Transformations: Economic Ideas and Institutional Change in the Twentieth Century. Cambridge: Cambridge University Press, 2002. xii + 284 pp. $60 (cloth), ISBN: 0-521-81176-7; $22 (paperback), ISBN: 0-521-01052-7.

Reviewed for EH.NET by Janet T. Knoedler, Department of Economics, Bucknell University.

Mark Blyth begins his important new book, Great Transformations: Economic Ideas and Institutional Change in the Twentieth Century, with his working class father’s complaint about the British Labour party. “Once they get elected,” his father said, “Labour will spend all this money on creating jobs, which is fair enough, but it never works. It just means prices go up. … This means we all have to pay more on loans and such things, so people will have less money to spend. The less people spend, the more the economy slows down, and so there are fewer people in work. If the Tories get in again, they’ll cut taxes, people will spend more, and there will be more jobs” (p. vii). His father’s concise summary of the basic Keynesian-Monetarist-Supply Side debate of the late twentieth century and his obvious rejection of activist government resonated deeply with Blyth, who began in graduate school to reflect on the great power of these economic ideas and to develop the argument that appears in this book.

For most of the twentieth century, thanks of course to Keynes and the Keynesians and, less famously, to Karl Polanyi’s The Great Transformation, it was for the most part not disputed that governments had an important role in softening the rough edges of capitalism. Polanyi argued that a self-regulating market mechanism could not govern the fates of labor, land, and capital (Polanyi, p. 73), without inviting great social disruption and upheaval. Governments had to provide protection for their workers, the natural environment, and aggregate purchasing power, from the often wrenching vicissitudes of economic and technological change. Change could not be prevented, argued Polanyi, but governments could and should take action to manage the rate and direction of change so as to protect those most vulnerable to the ravages of capitalism. Moreover, because protective social institutions and legislation had appeared almost immediately after the rise of the self-regulating market and had been strengthened since that time, Polanyi believed that the very notion of a self-regulating capitalism had been effectively repudiated.

Or had it? In Great Transformations, Blyth questions whether Polanyi was correct in positing activist government and the social safety net as a permanent feature of modern capitalism. If the first great transformation led to workers demanding protection from self-regulating market processes, it is reasonable to expect “in turn another reaction against those embedding institutions by those most affected, namely capitalists” (p. 4). And, according to Blyth, we have indeed seen just such a counter double movement over the past two decades, as many governments have come to diagnose their economic problems as being rooted in their own activist policies and have begun to take apart many of their important institutions and instruments of social protection. Blyth identifies two important factors in this reversal of the double movement: the political use of economic ideas and concerted political action by the business sector. In addition to his careful delineation of the historic role of the business sector in combating the double movement, Blyth also contributes a theoretical analysis of how economic ideas “are vitally important components of institutional construction and change” (p. 6).

The role of economic ideas is the essential piece of the puzzle for Blyth. Ideas may or may not reflect the real world, but they are nonetheless constructs that provide “agents with both a ‘scientific’ and a ‘normative’ account of the existing economy and polity, and a vision that specifies how these elements should be constructed” (p. 11). Moreover, given that economic change most often produces “Knightian uncertainty,” that is, an economic crisis with uncertain causes, economic ideas become even more important because they serve as simplifying blueprints that “tell agents what to do and what future to expect” (p. 11). Building upon these basic premises, Blyth sets forth five specific hypotheses about how economic ideas lead to the kind of institutional change that we have witnessed with the counter double movement: 1) economic ideas reduce uncertainty; 2) economic ideas allow for coalitions of various interest groups to be built around them; 3) economic ideas can be used as weapons by the major actors in a given society to challenge existing institutions, these major actors being the state, the business sector, and labor; 4) economic ideas are used in the construction of new institutions to supplant the old; and finally, 5) economic ideas help to coordinate the expectations of the various actors, helping to produce institutional stability.

Blyth then uses this basic framework to investigate the construction, and later dismantling, of activist states in the U.S. and Sweden, and makes use of a massive literature from both economics and political science. His five chapters detailing the double movements and the counter double movements in the U.S. and Sweden are real strengths of this book. A brief consideration of these two movements in the U.S. will demonstrate his theory in action.

In the 1930s U.S., a number of competing theories were offered to explain the economic crisis. The dominant economic idea then prevailing, that this (and any) depression, Great or otherwise, was temporary and would therefore self-correct, was quickly rejected by Hoover. However, his attempts to use alternative theories met with little success. Throughout Franklin Roosevelt’s first administration, other economic theories, such as the administered prices thesis and “sound finance” (or as we call it today, balancing the federal budget), were tested. Business rejection of the National Recovery Administration and failure of sound finance in the crisis of 1937 led the Roosevelt administration to seize upon a fourth theory, the theory of underconsumption, to diagnose the continuing economic crisis as one of insufficient aggregate demand. Both labor and business came to support this approach, labor because of the earlier Wagner and Social Security Acts, and business due to its involvement in wartime production and in many wartime institutions. Significantly, after the war, the business sector formed the Committee on Economic Development to develop the theory of growthmanship — a peacetime variation of FDR’s Keynesian approach that supported sustained high employment and high production and an activist state, in part to quash socialist-stagnationist theories but in part to signal its formal support for activist government. Several major institutions emerged during the 1930s and 1940s to become instruments of embedded liberalism and expanded in the 1950s and 1960s. The resulting institutional stability benefited labor with growing real wages and business with rising profits for three decades.

But, as has been documented by many economists and economic historians, the mid-to-late 1970s ushered in a turning point, or in Blyth’s phrasing, the second great transformation. A major contribution of this book is Blyth’s analysis of the role of ideas and the complicity of the business sector in bringing about this second transformation. This time, the Great Inflation of the 1960s and 1970s, accompanied by periods of high unemployment and stagflation, created an environment of great uncertainty for business, labor and government. Once again, an economic crisis called for new theories, or more precisely, the repackaging of several old neoliberal theories that were taken “off the shelf” (p. 267). Both Milton Friedman’s theory of monetarism and the rational expectations school of macroeconomics challenged the effectiveness of activist monetary policy. Supply-siders resuscitated Say’s Law. Public choice theorists attacked government spending as the self-interested behavior of political actors. All four of these theories challenged important foundations of activist government, and posited that inflation and the current economic crisis, rather than being something that government should try to solve, was in fact the very product of that activist government.

As Blyth hypothesizes, such new (or “rediscovered”) economic ideas must garner support from coalitions of various interest groups if they are to be heard and then used as weapons to challenge existing institutions. And a key interest group — the business sector — played an essential role in dismantling the institutions of activist government in the U.S. by becoming, as Blyth puts it, “directly involved in the production and dissemination of alternative ideas” (p. 154). The rise of corporate PACs beginning in the 1970s was one important step. A second step was business funding of conservative think tanks: the American Enterprise Institute, the Hoover Institute, and the Heritage Foundation were three key institutions that received major infusions of funds in the 1970s to carry out research in the vein of conservative economics. A third step occurred when publications as diverse as the Wall Street Journal, The Public Interest, and Reader’s Digest began to popularize supply-side theories. Finally, the financial markets and the Fed together embraced monetarism, making “the state’s role in economic management obsolete almost at a stroke” (p. 171).

A “new again” theoretical foundation was thus arrayed against activist government through the active sponsorship of the business sector. All that was left was the actual dismantling. Reagan used the refrain, “government is the problem,” to win the 1980 presidential campaign and proceeded to roll back activist government on many fronts throughout the 1980s. A decade later, Clinton continued this reversal of the double movement by embracing deficit reduction (the sound finance rejected decades earlier by FDR), substantially reducing the welfare entitlement, and proclaiming that “the era of big government is over.”

The result of this second great transformation in the U.S, according to Blyth, is a greater concentration in both income and wealth (it is noteworthy that this data does not include the tax cuts of the last three years) and a substantial weakening of the institutions of embedded liberalism. Falling real wages have been exacerbated by higher interest rates (until recently) due to the burgeoning federal deficit of the Reagan and first Bush eras. Citing William Berman, Blyth states that an average of $140 billion annually has been transferred to the wealthiest 5% in the United States. All of this suggests, even without the privatization of Social Security that is the next likely target of the forces arrayed against activist government, that this second great transformation has been at least as “great” as the first.

Why has labor been so quiescent in voting for political leaders that have worked hand in hand with the business sector to dismantle the safety net? Part of the answer lies in an irony noted by Blyth: “While the Democrats defeated the ideas of business in order to build embedded liberalism, business was able to dismantle embedded liberalism only once the Democrats had lost sight of what they were defending” (p. 201). And another part of the answer is found in Blyth’s very careful and sober discussion of the corporate takeover of democracy through PACs and think tanks. But these are only pieces of a more complex story still to be told.

Blyth also recognizes another key unanswered question when he asks: “Why were the ideas used to attack and dismantle embedded liberal institutions … essentially the same ideas discredited a generation before?” Blyth speculates that the “mythology of competition, individualism, and markets” (p. 267) may hold residual power over enough of the core constituencies to maintain belief in these powerful theories. Answering this question satisfactorily, of course, would take at least one more book, but it is indeed the important question.

In summary, this is a good book that raises more questions than it answers, but uses Karl Polanyi’s analysis to raise them well.

Reference: Polanyi, Karl. The Great Transformation. Boston: Beacon Press, 1957 (orig. 1944).

Janet T. Knoedler is Associate Professor of Economics at Bucknell University. She has published numerous articles on institutional economics and history of economic thought, and is presently at work co-editing a book on institutionalist approaches to labor economics, to be published by M.E. Sharpe.