Published by EH.Net (March 2014)

Richard S. Grossman, Wrong: Nine Economic Policy Disasters and What We Can Learn from Them. New York: Oxford University Press, 2013. xxi + 266 pp. $28 (hardcover), ISBN: 978-0-19-932219-0.

Reviewed for EH.Net by Hugh Rockoff, Department of Economics, Rutgers University.

Richard S. Grossman, professor of economics at Wesleyan University, has written a splendid book about the history of economic policy making. Grossman summarizes nine famous economic policy mistakes, anchoring his discussion in the literature that economic historians have developed, and draws some important generalizations for policy makers and for the professors, journalists, and ordinary citizens who hope to influence policy makers. In each case he explains why a policy was adopted, what it consisted of, and the short and long-term consequences. Grossman does not try to expand the scholarly frontier for any of these cases separately; He relies on his fellow economic historians to get the individual stories right. (Full disclosure: Richard is an old friend, and we are now doing some joint work.) The novelty is in the attempt to draw some broad generalizations. Inevitably, of course, scholars who are specialists on one of these cases will have some bones to pick. But unlike the efforts of some popular writers to draw lessons from economic history, Grossman has mastered the scholarly literature for the cases he chooses. The closest analog that I can think of is Michael J. Oliver and Derek H. Aldcroft’s Economic Disasters of the Twentieth Century, which enlisted nine outstanding economic historians to study nine major economic disasters.

All of Grossman’s examples will be familiar to economic historians. 1) The British decision to strengthen the Navigation Acts shortly before the Revolution; 2) the U.S. decisions to wind up the First and Second Banks of the United States; 3) The British decision to limit aid to Ireland during the potato famine; 4) the decision by the Allies to impose stiff reparations on Germany after World War I; 5) the British decision to return to the gold standard at the prewar parity after World War I; 6) the U.S. decision to raise rates in the Smoot-Hawley tariff; 7) the real estate boom and bust in Japan and the decision to allow Japanese banks to carry bad assets on their books for a prolonged period of time in the 1990s; 8) the decision to adopt the Euro; and 9) the U.S. subprime mortgage crisis.

Grossman’s main conclusion is that ideology played an important role in these policy mistakes, and that a greater willingness to base decisions on “cold, hard economic analysis” might have led policy makers to avoid them. In the case of the British decision to strengthen the Navigation Acts, Grossman sees the ideology of mercantilism at work. The Second Bank of the United States was done in by Andrew Jackson’s anti-bank ideology. Ireland’s great hunger resulted in part from British adherence to a laissez-faire economic ideology. In the case of Britain’s return to the gold standard, the ideology was simply a faith in the rightness of the nineteenth century gold standard. The subprime mortgage crisis, Grossman finds, was partly the result, again, of adherence to a free market ideology that undermined necessary regulation of the financial sector. Grossman, in other words, has provided abundant additional evidence to confirm Keynes’s famous comment (which Grossman uses as the epigraph for his book) that “the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood.” And his conclusion that we would be better served if policy makers would rely less on ideology and more on economic analysis is hard to dispute.

Grossman does not, I hasten to add, adopt a monocausal explanation of these mistakes. Often special interests must share the blame. This comes out clearly in the Smoot-Hawley tariff when each member or Congress fought for an increase in the tariff that would help producers in his or her district. Sometimes a lack of sympathy for people who were different in terms of culture, religion, or nationality played a role, as in the British failure to aid Ireland during the potato famine and the decision by the Allies to impose harsh penalties on Germany after World War I. Sometimes simple bad luck played a part. Perhaps, Grossman suggests, Keynes simply had an off-night when Churchill gave him a chance to make the case against returning to gold at the prewar parity. Nevertheless, Grossman’s point that adherence to mistaken ideologies played a major role in these mistakes comes through powerfully.

Conclusion: I have great admiration for this book. Grossman addresses an important question and his judgments are uniformly well reasoned and balanced. He is also an outstanding teacher of economics. To explain Keynes’s critique of the Britain’s decision to return to gold at the prewar parity after World War I Grossman constructs a simple, easily understood, numeric example to get to the heart of Keynes’s analysis. And in describing why the Smoot-Hawley Tariff was a bad idea, Grossman goes back to the theory of comparative advantage and explains it in a way that non-economists could actually understand – no easy task. For this reason, the book would also make a good text for an undergraduate course. Each week or so a new problem could be considered, and students could choose the event that most interested them for their papers. Students would learn a great deal of economics without realizing that they were being taught. Few economic historians can write as well as Grossman. But more of those who can write well should follow his example and write for policy makers and for the general public. If not economic historians, then who?

Comment: While I find Grossman’s central argument convincing, his discussion raises some additional questions for me; a sign of a challenging book. One is whether it is always possible to distinguish ideology from “cold, hard economic analysis” ex ante. His analysis of the problems of the Eurozone is a case in point. In hindsight, perhaps, it is obvious that the Eurozone was not an optimum currency area, and that even if it managed to survive, the Eurozone was likely to suffer many needless troubles. Some economists recognized this at the time the Eurozone was established. But one of the key supporters of the Euro was Robert Mundell, the brilliant Nobel Prize economist who invented the idea of optimum currency areas. Indeed, Mundell can also be considered the father of the Euro. (If you don’t believe me, try typing “Who is the father of the Euro?” into Google. At least this worked on February 12. 2014.) Mundell believed that adopting the Euro would set the Eurozone on the path to becoming an optimum currency area. When I was in graduate student at the University of Chicago I had the good fortune to take courses from both Mundell and Milton Friedman, who would become a staunch critic of the Euro. I can attest that they were both possessed dazzling intellects, and that both could construct economic arguments that would be hard for mere mortals to demolish.

That brings me to my second question: why do policy makers, and those who hope to advise them, rely so much on ideology when so often ideology leads them astray? I think the reason is that ideology also plays a positive role in economic policy making. It helps policy makers reach decisions when economic science simply does not provide clear guidance. An analogy with medicine will help make my point. When medical science provides a clear answer most practitioners will give the same advice. Someone who is diagnosed with malaria will be given one of a number of drugs that have been shown to be effective. But there are cases where medical science does not provide such clarity: for example, an elderly man diagnosed with a slowly growing prostate cancer. The medical researcher is free to say “I don’t know what the best treatment is; more research is needed.” But the practicing physician may feel obligated to advise the patient. Here ideology, or in the case of medicine let’s say philosophy, plays a useful role. There are conservative physicians who are impressed by the natural tendency of the body to heal itself and of the danger of unintended side effects from medical interventions, who will advise a wait-and-see approach.  But there are also “liberals” who believe that the body is an imperfect machine and that an aggressive interventionist policy is more likely to prove effective.  Of course, when advising a patient a physician will take more into account than just medical science and medical philosophy. The patient’s willingness to gamble on a risky intervention must be considered. And, of course, interest groups influence medical policies just as they influence economic policies. In the prostate cancer example we have the recommendation based on data analysis by the United States Preventive Services Task Force that routine screening PSA tests not be done. But this recommendation has been widely challenged in part, it has been alleged, because it would negatively impact the interests of certain groups of physicians and hospitals. Nevertheless, even the best intentioned physician must often fall back on his or her medical philosophy simply because medical science has not reached a clear consensus.

In the same way, economic policy makers who must make decisions about raising and lowering taxes, raising or lowering the minimum wage, increasing or decreasing Federal Reserve asset purchases, confirming or not confirming free trade agreements, and so on, cannot wait until economic science has reached a clear answer on the right policy. Instead, policy makers must inevitably rely on their economic ideologies to guide them.

Hugh Rockoff is the author of America’s Economic Way of War: War and the U.S. Economy from the Spanish-American War to the Persian Gulf War (Cambridge University Press, 2012).

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