Commentary Magazine

Dangerous Currents: The State of Economics, by Lester C. Thurow

Of Men and Markets

Dangerous Currents: The State of Economics.
by Lester C. Thurow.
Random House. 247 pp. $16.95.

Lester C. Thurow first became visible in 1972 as chief economic adviser to George McGovern. Since the publication of his book The Zero Sum Society several years ago, he has made a strong bid to succeed John Kenneth Galbraith as the Left’s favorite economist. In his latest book, Dangerous Currents: The State of Economics, Thurow searches for solutions to our recent economic malaise and issues a fundamental challenge—criticizing the economics profession for pretending to know more than it does, and attacking the very basis of modern economics. His challenge has attracted a great deal of attention, and is especially interesting because of the favorable notices it has received from two leading conservatives, William F. Buckley, Jr. and Irving Kristol.

Most economists, surveying the persistence of our broad problems (low growth, unemployment, inflation), and trying to understand wherein the failures lie, would focus not on the workings of separate, individual markets—the province of microeconomics—but on macroeconomics, the way the tens of thousands of separate markets aggregate into the whole, how they add up. Thurow disagrees. He argues that the failures in recent policy result from flaws not in macro-economic theory, but in the underlying theory of individual markets.

Thurow takes the heart of micro-economic theory to be what he calls the equilibrium price-auction model. In this model, he writes,

every market is a price-auction market that clears based on competitive bidding within a framework of supply and demand. Accordingly, any market is always in equilibrium, having no unsatisfied bidders, and every individual is a maximizer in his decisions to consume and produce. . . . In equilibrium price-auction markets, it is impossible to find over-or under-employed resources.

As prices equalize supply (which reflects incremental costs) and demand (which reflects incremental value to consumers), resources are allocated to their most valuable uses. Most important, according to Thurow, these market adjustments are believed by most economists to occur in a fairly fluid way, unobstructed by rigidities.

Thurow argues that the principal attraction of the price-auction model is its deterministic certainty—a certainty that can be codified and quantified in higher mathematics (which is the business of econometrics). But this is also its fatal flaw; economics cannot achieve such scientific certainty, both because it lacks constants (such as the speed of light in physics) and because its subjects, human beings, are always free to change their behavior. In basing their observations and calculations on the extremely rationalist and individualist homo economicus, Thurow writes, economists fail to understand homo sapiens, who is strongly influenced by the interrelationships and interdependencies that become evident in group behavior.

Thurow’s critique of the price-auction model is the major theme running through this book. At various points he does acknowledge that no one really believes in the model in the extreme form in which he describes it, but such acknowledgments are rare. Using the extreme model as his point of reference, he proceeds to analyze monetarism, Keynesianism, supply-side economics, “rational-expectations” theory, and traditional labor economics, as well as the shattered remains of attempts to build large econometric forecasting models.



Thurow begins by reviewing the sorry economic record of the past decade, with its unhappy combination of stagnation, rising unemployment, and rising inflation, as well as the OPEC boycott and rapidly rising energy prices. According to Thurow, price-auction economists had no solutions to any of these problems, especially inflation, which, he writes,

does not matter in the standard model of behavior. Only relative prices—the price of one kind of goods in terms of another—matter. Accordingly, because a general increase in the price level does not affect relative prices in the equilibrium price-auction model, there is no theoretical reason for eschewing inflation. Yet the same price-auction economists are often the foremost proponents of the position that society should take drastic action to stop inflation.

Thurow devotes a chapter to exploring issues related to the use of stringent monetary and fiscal policies in order to control inflation. He criticizes the monetarists for placing excessive faith in the ability to control nominal GNP by controlling the money supply. He also explores the factors that prevent rapid market adjustments, including what he calls “supply-side inflation,” whereby multi-year contracts, indexed wages, and the like sustain upward pressure on prices and thus delay the market’s ability to moderate inflation without large increases in unemployment. These rigidities explain the attractions of “incomes policies” which would control wages in an attempt to moderate the unemployment otherwise associated with reducing inflation. Unfortunately, the economy is too complex for anyone to implement an incomes policy without causing the shortages associated with other forms of price controls.

In Thurow’s view, Reagan-style supply-side economics “represents the triumph of literal and unqualified equilibrium price-auction economics,” especially in the claim that the increased output resulting from a tax cut would yield new tax revenues exceeding the revenue lost from the tax cut. No evidence was adduced for this claim, and hindsight reveals it to have been dramatically wrong.

If the supply-siders are overly optimistic about opportunities to improve the economy’s performance, the so-called rational-expectations theorists exhibit the opposite failing. They argue that the government’s ability either to harm the economy or to improve it is extremely limited since private individuals anticipate the future impact of government decisions, change their behavior accordingly, and thus cancel the effect. If the federal deficit rises, a rational-expectations economist would reason, people will save more to anticipate increased future taxes, in this way canceling any stimulative effect relating to the increased deficit as well as any net effect on lendable funds available to the private sector. This analysis, according to Thurow, is supported by little empirical evidence.

When it comes to labor economics, Thurow turns to the rigidities that maintain persistently high rates of unemployment despite the predictions of the price-auction model that wages will fall and thus guarantee full employment. Labor unions are one factor here, but their members constitute only 20 percent of the work force. Other factors include those “group effects”—including consideration for the general morale of the work force—that discourage employers from setting wages at the lowest point necessary to attract workers. Setting wages above the “market-clearing level” (defined as the point where the number of workers seeking jobs exactly equals the number of jobs) means less than full employment in individual firms—contrary to the model.

In his conclusion, Thurow stresses the need for economists to be humble about what they know and do not know. In particular he calls for a fundamental rethinking of the equilibrium price-auction model, and for the incorporation into economics of insights about human needs from other disciplines such as sociology, anthropology, and political science.



This book is lively, well-written, and provocative, but several fundamental flaws render it unlikely to have any real impact on the economics profession.

The major problem with Thu-row’s thesis, already alluded to, is that no competent economist believes in the perfectly fluid price-auction model that he describes. This creates difficulties all along the line. Take the following statement about monetarism: “According to monetarist theory, a cut in the money supply reduces real economic activity in the short run, but since prices are assumed to be flexible, real economic activity quickly returns to its natural (full-employment) level.” If monetarists truly believed that real output returned “quickly” to its natural level, they would have no reason to oppose abrupt changes in monetary policy. Yet this is the very heart of the current monetarist critique of the policy of the Federal Reserve Board over the past several years—a wildly fluctuating policy that monetarists argue has produced the greatest instability in both interest rates and economic activity of any comparable time in the postwar period.

In his chapter on supply-side economics, Thurow similarly oversimplifies by focusing on extreme positions while avoiding mention of more moderate alternatives. Although his criticisms of supply-siders like Arthur Laffer and Jude Wanniski are well taken, he gives no serious attention to mainstream economists like Martin Feldstein and Michael Boskin, who are also concerned with providing incentives to work, save, and invest. In fact, this concern is so widely shared that it formed the basis of several unanimous reports of the Joint Economic Committee of Congress under the chairmanship of Senator Lloyd Bentsen (D., Texas) before Ronald Reagan was elected President. To limit oneself to the ideas of some who have boasted about never receiving any formal economic training seems irresponsible if not tendentious.

Thurow also oversimplifies when he fails to separate the economic dimensions of policy from the political. This is particularly evident in his discussion of the Reagan economic program, where he completely ignores the complicated political forces influencing the program’s ultimate shape, which was very different from what the President initially proposed to Congress. The whole program is described as the creation of economists, as if conceived in an institutional and political vacuum. Moreover, by neglecting to distinguish between, for example, Milton Friedman’s support for the Kemp-Roth tax-cut bill and Arthur Laffer’s, he gives the reader no basis on which to understand the complex considerations that underlay different experts’ evaluation of the program.

Frequently, Thurow advances arguments in a tone that suggests he is the first person to have thought of them, yet in some cases they represent ideas very widely held. His failure to credit other people is especially striking in the light of his complaint that economists are “too certain about what they think they . . . know.” In the specific case of Keynesian “fine-tuning,” for instance, this is precisely what monetarists have been saying over the past three decades. Compare Milton Friedman, writing in 1969:

Is fiscal policy being oversold? Is monetary policy being oversold? I want to stress that my answer is yes to both of those questions. I believe monetary policy is being oversold; I believe fiscal policy is being oversold. What I believe is that fine tuning has been oversold.



In the past it has often been the Right that has stressed the limits of economic knowledge and the consequent need to reduce the discretionary power of government policymakers. In this book, Thurow seems to align himself with the skeptics. Yet it is difficult to square this skepticism with his repeated intimations of sympathy for central economic planning—as when he blames economists for their failure to solve essentially political problems (such as those concerning energy and the environment), when he emphasizes the importance of group values that are unreflected in market outcomes, and when he opposes the monetary and fiscal stringency necessary to curb inflation. I call these “intimations” because in this book Thurow curiously avoids any explicit endorsement of economic planning. Indeed, considering the importance the Left has attached to central planning, this avoidance is perhaps the book’s most significant ideological statement. But Thurow’s failure to endorse what is everywhere between the lines contaminates the discussion with an odor of disingenuousness.

Both liberals and conservatives are rightly disturbed by the commitment of professional economists to something called “rational individual utility maximization,” an idea that seems to imply indifference to the content and substance of the good life (what has come to be known as the “quality of life”). In reality, however, “utility maximization” is only a fancy, if creepily depersonalized, way of saying individual free choice. It is all well and good to criticize economists for their apparent lack of concern for what constitutes the good life, but much too easy to forget that its pursuit is made possible only through the preservation of free choice.

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