Edmund Phelps is an American economist and the recipient of the 2006 Nobel Memorial Prize in Economic Sciences. Early in his career, he became known for his research at Yale’s Cowles Foundation in the first half of the 1960s on the sources of economic growth. His demonstration of the golden rule savings rate, a concept related to work by John von Neumann, started a wave of research on how much a nation should spend on present consumption rather than save and invest for future generations.
His most seminal work inserted a microfoundation, one featuring imperfect information, incomplete knowledge and expectations about wages and prices, to support a macroeconomic theory of employment determination and price-wage dynamics. That led to his development of the natural rate of unemployment: its existence and the mechanism governing its size. In the early 2000s, he turned to the study of business innovation.
He is the founding director, since 2001, of Columbia’s Center on Capitalism and Society. He has been McVickar Professor of Political Economy at Columbia since 1982.
Driving Change (DC): Ned, great to be with you. You have seen a fair few economic crises over the years. I’d like to kick this off by asking you what lessons we can learn from this economic crisis, which is surely so much worse than many that we’ve been through before. What new challenges have been triggered by the pandemic that’s going on at the moment?
Edmund Phelps (EP): I think there have been a couple of problems which share some things in common with World War II. It’s a bit of a structural catastrophe rather than just a drop of demand. The Spanish flu is another example of a structural catastrophe.
This present downturn, which is very deep, is, I think, fundamentally not a demand recession. It’s a structural catastrophe. Workers cannot afford to supply their labor, for fear of losing their lives or their health to the virus. Of course, there was a knock-on effect of that. Many workers suffered a loss of incomes, which caused a secondary shock to demand.
DC: Do you think the policymakers have managed this structural catastrophe well? What have you seen that’s been working? What hasn’t?
EP: Well, I think it’s clear that the management has been very poor. It’s certainly poor compared to Germany and maybe Japan, [although] I’m not sure about that. I would say we didn’t respond quickly as Italy did.
We didn’t have sweeping subsidies to corporations to hang on to their employees, such as Germany did. We weren’t as good about outlawing gatherings, as Britain was. It just seems to me that we scored badly in just about all the dimensions that I can think of.
DC: America did do a very large stimulus.
DC: Do you think it was poorly designed or not big enough?
EP: Well, I wouldn’t say that. I thought it was designed as well as it could be, I dare say that there was plenty of room for improvement there. There have been lots of criticisms of the programs. So far as I know, it hasn’t been shown in any empirical way that the measures taken were effective.
DC: What do you see as the biggest challenges for economic policymakers as we try and manage the next phase of this crisis? What do you see as the biggest challenges for policymakers as we move into this next phase of the economic downturn and recovery?
EP: I would say that the biggest problem in the US at least, is that the government is weakened, or the government weakened itself where we needed to have quite a lot of strength and expertise. Disease control, the Science Foundation, all sorts of agencies that used to be strong and alert. I think they’ve been weakened and harmed in recent years. So the US government looks relatively ineffectual. [It’s] poorly structured, compared to the best responders out there.
Another thing is that the federal government has taken the attitude [of looking] to the states and cities. [They’ve] said: Here, you take it from here. We’ve spent some money to try to stabilize the situation and turn around a little bit. Now you deal with massive virus attacks. So we’ve found that the state governments are also pretty poor at it, some better than others.
The cities haven’t done themselves proud, either, I think. So maybe it’s true that what was a good balance between the central government and the decentralized bodies in decades or even centuries past doesn’t work very well when a cataclysmic event strikes. I think we’ve seen extremely poor communication and cooperation in the public sector.
DC: When you look at a country like Germany, which you feel has done a better job, what did they do right, that America didn’t?
EP: I think they had a better system for maintaining the viability of the working class. They had a well worked-out system of subsidies to the corporations [which allowed them to] hold on to their workforces. Almost right away, we saw high performance in that regard.
Germany got a tremendous jump. They acted right away, acted quickly. Of course, that didn’t happen in the United States.
DC: When you think about employment subsidies of this kind, I guess they get you through the initial shock without the whole economy collapsing. When you then have to restructure afterwards, the employment subsidy might become an obstacle to restructuring because of certain industries like cruises or airlines.
EP: Do you mean the Colombian bailing companies get subsidies to hang on to their work for well, newcomers.
DC: [What I mean is that] we’re probably going to see certain industries seem to be doing very well. Theme parks, airlines, or cruise liners, those industries will do quite badly, probably for years to come. Maybe office buildings, [because] people won’t want to go back to work. So subsidizing jobs in those industries will keep alive firms that probably should be shrinking. Whereas in America, I guess we’re going to move more quickly to the new industries and close down the failing industries like retail.
EP: I got your point. I would think that a lesson to draw from the point you’re making is that you want to phase out the employment subsidies. Not on day one of course, but after a while, and gradually. You don’t want subsidies to go on which would cause the existing firms to never make room for newcomers.
DC: We’ve seen in America this unemployment rate surge to a very high level. Do you feel that it’s going to remain at a high level for some time, or that we might see quite a quick rebound?
EP: I don’t think anybody can possibly put forward an answer without knowing what’s going to happen to the strength of COVID-19 virus. In a sense, we can have an idea of how, when, and how well we’re going to pull out of this thing.
DC: Is there anything that policymakers could be doing to accelerate job recovery now we have this unemployment problem?
EP: One thing that could be done, [although] I’m not sure it’s the most cost effective thing to do (and I confess I have a personal stake in) is that it’s a good time to institute subsidies to firms for their employment of low-wage labor. We have a lot of [people who work in] low-wage labor who have become unemployed by the pandemic and will not be pulled back into employment at all or quickly.
We could stimulate employment of these unemployed workers by paying subsidies to employers. Subsidize old employers and also new employers according to the number of people they put on their books. Something like that exists in the country with the AITC, the earned income tax credit. That was to some extent scuttled by turning it into a program for mothers with young children, not that there’s something wrong with that. But that came with the total exclusion of subsidies for men.
So [then we] had the terrible problem of drawing men from the disadvantaged segments of the population into work. Besides ruining their lives, it also drove them into illegal activities, drug dealing, and so forth. Anything to earn money to live on. I think that was another disappointing failure by the government. Was it some pigheadedness, about employment subsidies?
DC: Are there any big new economic ideas that are coming out of this crisis?
EP: Well it’s not the first time I’ll say I’m about to say. I’ve probably said it 100 times, or maybe 500 times. But I think it bears listening to. [If we listened,] we wouldn’t be in such a social mess. I don’t think the economy would have been as vulnerable as it is now. Have we done everything possible to keep up the rate of growth of productivity in the economy?
As you know, I don’t doubt somewhere in the late 60s, and then in a more pronounced way, in the early part of the 70s, there was a tremendous drop-off in the rate of growth of productivity. I’ve just spent about 15 or 16 years of my life thinking about that, and writing a couple of books about it. Trying to figure out what underlies that, and giving some thought to what we can do about it. I continue to believe that to some considerable extent, the tragedy we’re witnessing would not have been so pronounced, had we had low wage employment subsidies and every effort by the government to keep growth going and keep it [going]. Which would mean of course, keeping up innovation.
We had a second wave, after the great wave of innovation from the mid-19th centuries, right up to about 1970. We had a little wave between 1990 and 1992, and in 2002. There was the electronic revolution of course, but that was short-lived — at most 10 years.
We’re right back in the dumps after that. I just feel it’s especially unhealthy for a society such as ours that prizes achievement and likes a bit of adventure and exploration. It’s created a lot of problems, not having that anymore.
DC: All the talk prior to this pandemic was that the economy had finally recovered from the crisis of 2008, 2009 and was now on a strong growth trajectory. You don’t buy that.
EP: No, I think there are two prongs to the argument. One is that by having slow growth, we were more vulnerable to the catastrophe that struck us. And second, even if we hadn’t been more vulnerable, it would have been great if we were growing lickety-split all the time.
Then, [it’s like,] who cares if we have a deep recession for a few months? We’ll wait, the way we’re going. We’ll quickly grow our way out of that.
DC: What’s the one thing you would do now to stimulate that kind of productivity growth?
EP: Well, that has to be a long-term program. I think the remedy that will take the longest time to be effective, is to return the educational system back to something more like it was before when students were steeped in great books and tales of adventure, even heroism. We don’t do that anymore.
Then I suppose it wouldn’t hurt to beef up the National Science Foundation a little bit, particularly if you could steer them in a different direction, which would stimulate commercial innovation. I don’t have a whole recipe book of things to do, but I, I feel sure that the two things I just mentioned are quite important.
I feel that they’re not sufficient by themselves. But I do think they’re necessary. We won’t do well, with respect to economic growth, unless we change attitudes. There’s such poor attitudes these days, so many people [who] are ready to cut corners in order to make a buck. That’s really been discouraging to see. There’s almost an epidemic of cutting corners.
Then, of course, on the government side, we’re tending more and more toward a government of corporatism. When Trump won the election it was around that time that the American Economic Association met in Chicago. I was scheduled to be a speaker there commenting on the direction we’ve been going and reflecting on the election that brought Trump to the presidency.
I said that in many ways, Trump’s rhetoric, to me, is very reminiscent of Mussolini. Mussolini really felt that he should be in control, guiding the economy, like the puppeteer that guides the puppets. I think that that was an observation that was ahead of its time, but I think there’s considerable truth in it.
DC: Do you think that’s how the pandemic stimulus has been handled?
EP: There’s a tremendous amount of favoritism.
DC: Do you think this will go down as the worst economic recession since the Great Depression, or certainly since the Second World War? Do you think this will be the most significant economic crisis of our lifetime?
EP: I have thought about that. If we count World War II as an economic crisis, then then that would be a contender. If you count this crisis as an economic crisis, then it’s a contender.
Alternatively, though, you could think of World War II as a military crisis, and the present phenomenon as a health crisis.
DC: But in both cases, economic policy had things to say that were relevant and useful. What is the number-one lesson that the economic profession has for this crisis?
EP: I was just reading a little bit about somebody whose path might have crossed [a similar situation to this one]. Willard Thorp came out of Princeton and worked in statistics for Wall Street. Then he came into one position after another under Roosevelt, during World War II, and then under Truman. In reading about that, I was struck by the number of brilliant people who dedicated their entire careers to responding to a public crisis, first the depression and then the war, and then the years after the war.
I don’t think we have that now.
DC: That worries you.
DC: Well on that note, [laughs] it’s been great speaking with you and thank you for talking with Driving Change. I look forward to speaking with you again soon.
EP: I hope I didn’t depress you too much. Thank you.