Lunch with the FT

June 13, 2014 1:16 pm

Edmund Phelps, economist

Over pumpkin soup, the Nobel Prize-winning economist talks to the FT’s Martin Wolf about creativity and innovation
Illustration by James Ferguson of Edmund Phelps©James Ferguson

I have arranged to meet Edmund (Ned) Phelps, director of the Center on Capitalism and Society at Columbia University, at the Kongress Hotel in Davos during the World Economic Forum. It is old-fashioned and very Swiss.

I sit at our reserved table in a still-empty restaurant slightly before Phelps arrives. At 80, he is grey-haired but slim and active, physically and intellectually. I have long admired his originality, disarming modesty and courtesy.

Phelps won the 2006 Nobel Memorial Prize in economics for path-breaking work of the 1960s, particularly on the “natural rate of unemployment” – the idea that monetary policy cannot alter the long-run rate of unemployment.

Born in 1933, Phelps grew up in Hastings-on-Hudson, New York, and has been at Columbia since 1971. He is, in my view, a true Yankee, promoting the dynamism that made the north of the US the most dynamic, and enterprising region of the planet from the middle of the 19th century into the 20th century. In his latest book, Mass Flourishing (2013), Phelps calls the desire of individuals to shape their lives “modern values”.

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We settle on pumpkin soup as remedy for a cold Alpine day, followed by tagliatelle for me and veal carpaccio (a second starter) for him. We stick with mineral water and focus on debating his ideas.

Phelps starts by telling me that at a dinner for Nobel laureates at Davos he had argued that “the state of Europe is not described simply by the financial crisis but is also due to a loss of innovation that happened a long time ago. For a while this was not visible because Europe transferred technology from the US. But the growth of productivity in the US also fell from the early 1970s. Then Europe was living on borrowed time.”

What, I ask, led to writing Mass Flourishing? He tells me he started thinking about capitalism and socialism in the 1990s. But “it was only around 2002 that I began to think about creativity. I realised that the economics profession was mired in the idea that advance is ultimately the result of scientific discovery.

“Joseph Schumpeter [an Austrian economist of the first half of the 20th century] said that it requires entrepreneurs to do the work of building commercial applications. Yet he also argued one hardly ever sees creativity in entrepreneurs.

“I was appalled by this. So I started to think about what drives innovation and what its social significance might be. The next step was to think: innovators are taking a leap into the unknown. That led me to the thought that it is also a source of fun and employee engagement.”

We are eating our soup with relish. Phelps goes on to tell me that me he felt this idea was sufficiently novel and questionable “that I’d better see whether I could find some supporting evidence and I did. In societies where one sees a higher prevalence of ‘modern values’ – individualism, vitalism and self-expression – there’s also higher reported job satisfaction.

“I went on to argue that it’s hard to see much innovation in Britain after the second world war and Germany never got back to the dynamism it showed from the era of Bismarck [the chancellor who united the country in the 19th century] to the 1930s. France, which came late to the innovation game, hung on a bit longer.

“Finally we see a sharp reduction in the rate of innovation even in the US. You could begin to see it in the late 1960s.” Phelps believes this decline in innovation is a tragedy “compared to the great times that most people had in the 19th century. I think the 19th century is an extraordinary period with a welling up of creativity and all kinds of experimentation and exploration going on at least until 1940.

“I thought I’d love to have some [contemporary] diaries or autobiographical scripts I could dig into, to see whether I could detect this joy of being involved in new stuff. But I thought that I couldn’t take the year or two off to do that. So I took a short-cut. I argued that we could see this experimentation and exploration in music and fiction.

“I suggest there was a new feeling of self-respect, mastery, engagement and creativity in the 19th century. Emma Griffin, author of Liberty’s Dawn [a 2013 history of the English industrial revolution that uses the first-hand testimony of hundreds of workers], finds evidence of people beginning to take control of their lives. She started with the 18th and early 19th centuries. Now she’s getting to the mid-19th century and has sent me an email about a teenager who went to work in the mines. Did he feel imprisoned? Far from it. He writes that he felt liberated and suddenly he had problems to solve and much to learn about how to operate in the mine, how to do it safely, and so forth. It changed his whole life.”

I note that this is hardly what Karl Marx saw. “He didn’t want to see it,” is Phelps’s response. I agree that the 19th century was economically creative. But how far did that lead to “mass flourishing”? Is this view not unduly romantic? As the waiter brings the second courses, Phelps says I’m the first person to suggest he is a “romantic”.

He continues to talk about 19th-century flourishing, in, for example, “owner-operated firms, blacksmith shops, which are constantly tinkering because it’s fun, but also because they hope they can get a better profit if they find a better way of producing. The rise of factories and cities was also a tremendous boon to job satisfaction and intellectual development. Moreover, real wages took off more or less pari passu with productivity.”

Many argue that, from the late-19th century onwards, innovation came increasingly from the research and development branches of large corporations. So even if he is right about the mid-19th century, surely most people ceased to be engaged in innovation during the 20th century?

“I’m sceptical about the thesis that innovation was bureaucratised to a large extent during this period,” Phelps counters. “The 1920s and 1930s were a period of sensational productivity growth, new products were springing up all over the place and most of those new products and new methods were developed by people who started their own companies.

“So it must have been a very exciting time, which is paradoxical, since the Great Depression intruded.”

Is he not, I ask, underestimating the impact of fundamental breakthroughs, such as electricity, the internal combustion engine, chemistry and the computer? Were such innovations not the real drivers? And isn’t the problem that we are no longer making breakthroughs on a big enough scale?

We pause briefly to order double espressos. Phelps goes on: “That spikes in innovation occur is neither here nor there. I can’t imagine a world in which it is impossible to conceive new things. So the question is rather why have we had fewer of these spikes recently? I think it has to do with the return of traditional values [values opposed to individual self-expression].”

Is he not, I suggest, ignoring the fact that in the early 19th century people could make innovations in their backyards – but one cannot make computer chips like that.

However crucial science is to some industries, you’ve got to have a willingness and room to innovate

“I accept that what I’ll call ‘big innovation’ is now more technical. It’s less ‘grass-rootsy’. But there’s a huge amount of innovation that has nothing to do with science or engineering.

“What about the creative industries? In the arts, movies, publishing, fiction, we’ve had huge innovations in what we buy and what we consume that has no salient connection with science. Suppose science had never advanced at all since 1820. Would that mean that we couldn’t create anything new? We couldn’t create a new genre of movies, or a new genre of books, or a new kind of clothes?”

I counter that humanity has always developed such innovations: the novel was one. But if there had been no scientific advances, we would not have had the productivity improvements of the past two centuries.

Phelps says: “I’m not particularly interested in the growth of productivity, except as a measure of the rate of innovation. My fundamental interest lies rather in what’s happening to the experience of work and opportunities to exercise creativity.

“I’m saying that the innovative life which opened up in the 19th century made possible a satisfaction that had never existed before. With no advance in fundamental science, innovation would have yielded less growth than otherwise but there would not necessarily have been a reduction in innovative activity. Moreover, the rewards of the innovative life to the individual would have been undiminished.

“My argument is that now there is a decreased desire and capacity to innovate and this permeates the creative industries, as well. Who would disagree that the golden age of film was in the Berlin studios and later in Hollywood in the 1920s and 1930s?

“I think this whole science thing is just a red herring and it gets us away from the point that, however crucial science is to some industries, you’ve got to have a willingness and room to innovate.”

. . .

The waiter brings the bill as we turn to an area where there has been a lot of scientific innovation: information technology. Phelps points out that Steve Jobs would never have called himself a scientist, and I agree.

But, I argue, the silicon chip, the microprocessor and the internet created opportunities for innovators. Jobs was one. So where the possibility of deep innovation existed, it was exploited. It was limited to this area because that happened to be where there were opportunities.

He says: “A wave of scientific breakthroughs is said to explain innovation in America, Britain, Germany and France between the 1880s and 1940. But that leaves unexplained the paucity of innovation in Holland, Italy and Spain. So why should there be a presumption that the loss of innovation in America since the early 1970s is the result of a dearth of scientific breakthroughs rather than resurgence of traditional values? A values theory of history gives a better explanation of economic innovation than a science theory does.

“The resurgence of traditional values has brought forth a new materialism, which isn’t good for innovation, because innovation is a cerebral, intellectual thing. There’s also my point that the financial sector is short-termist. That now affects the way business is done in the heartland of America and I think these large, established corporations are hardly innovative at all. But that’s something new. There was a time when they were innovative.”

Also, he adds, “in the US every piece of legislation is now a thousand pages long, with all sorts of carve-outs and special tax breaks and special treatments . . . and the possibility of obtaining these special breaks, of course, excites lobbying, which then encourages more of it.

“This distracts chief executives from innovation, because there’s an easier way to improve the bottom line. Not only that, but vested interests have made it harder for newcomers to break in. And so established corporations don’t have to innovate any more.”

If a president really believed in the Phelps doctrine, what would his programme look like? “Well, it’s necessary to start with a national conversation on the importance of creativity and discovery but particularly business innovation. We need the people and government to ‘get with the programme’. I’m not against a big government. I’d love to have colossal employment subsidies, to revolutionise the terms on which low-wage workers are employed, and, if there are some exciting initiatives that the government could take to open the way for more innovation, that would be great. But we’ve got to stop all this social protection. We’ve got to use that tax money for things like low-wage employment subsidies – subsidising work, subsidising innovation maybe, subsidising investment maybe.”

. . .

What about unemployment benefit? Medicare? “I’m not against social insurance. In my ideal world, wage rates would be so pulled up at the bottom by employment subsidies that everybody would be able to afford good levels of medical and retirement insurance in private markets. But we don’t live in that world. So, I would be loath to crusade against social insurance.”

I suggest that it is difficult to draw the line between the “social insurance” he favours and the “social protection” he condemns “Yes. We have got to protect the indigent. But social protection is out of control now.”

Wouldn’t he also accept that government can provide unemployment insurance and health insurance better than the private sector can?

“Yes, I understand there are flaws in private insurance markets. But the balance of advantage might have been in favour of private insurance if we had distributed the fruits of work more justly.”

I turn finally to whether he thinks the decision to rescue the financial sector in 2008-09 was a terrible mistake?

Phelps admits banks are a problem: “If you can get to be the largest, then you’re going to have a good bottom line. So all the banks were trying to get larger and larger during the housing boom. Part of my vision is that the big banks should be broken up. I would like to see the American economy go back to small banks rooted in communities where the bankers know something about the local start-ups.”

With that, we leave. Phelps believes passionately that creativity allows individuals to live fuller lives and remake the world. He is a true American, in a good way.

Martin Wolf is the FT’s chief economics commentator

Illustration by James Ferguson

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Kongress Hotel

Promenade 94 Davos 7270, Switzerland

Pumpkin soup x2 SFr22.00

Veal carpaccio SFr26.00

Tagliatelle SFr34.00

Mineral water SFr9.50

Double espresso x2 SFr12.40

Total (incl service) SFr103.90

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Letter in response to this article:

Intensity of innovation has never been sustained / From Mr Nick Goulder

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