Remarks by Chairman Alan Greenspan
At the Haas Annual Business Faculty Research Dialogue,
University of California, Berkeley, California
September 4, 1998
Question: Is There a New Economy?
The American economy, like all advanced capitalist economies, is
continually in the process of what Joseph Schumpeter, a number
of decades ago, called "creative destruction." Capital equipment,
production processes, financial and labor market infrastructure,
and the whole panoply of private institutions that make up a
market economy are always in a state of flux--in almost all cases
evolving into more efficient regimes.
The behavior of market economies across the globe in recent
years, especially in Asia and the United States, has underscored
how large a role expectations have come to play in real economic
development. Economists use the term "time preference" to
identify the broader tradeoff that individuals are willing to make,
even without concern for risk, between current consumption and
claims to future consumption. Measurable discount factors are
intended to capture in addition the various types of uncertainties
that inevitably cloud the future.
Dramatic changes in the latter underscore how human evaluation,
interacting with the more palpable changes in real output, can
have profound effects on an economy, as the experiences in Asia
have so amply demonstrated during the past year.
Vicious cycles have arisen across Southeast Asia with virtually no
notice. At one point, an economy would appear to be struggling,
but no more than had been the case many times in the past. The
next moment, market prices and the economy appeared in free
fall.
Our experiences with these vicious cycles in Asia emphasize the
key role in a market economy of a critical human attribute:
confidence or trust in the functioning of a market system.
Implicitly, we engage in a division of labor because we trust that
others will produce and be willing to trade the goods and services
we do not produce ourselves.
We take for granted that contracts will be fulfilled in the normal
course of business, relying on the rule of law, especially the law of
contracts. But if trust evaporated and every contract had to be
adjudicated, the division of labor would collapse. A key
characteristic, perhaps the fundamental cause of a vicious cycle,
is the loss of trust.
We did not foresee such a breakdown in Asia. I suspect that the
very nature of the process may make it virtually impossible to
anticipate. It is like water pressing against a dam. Everything
appears normal until a crack brings a deluge.
The immediate cause of the breakdown was an evident pulling
back from future commitments, arguably, the result of the
emergence among international lenders of widening doubt that
the dramatic growth evident among the Asian "tigers" could be
sustained. The emergence of excess worldwide capacity in
semiconductors, a valued export for the tigers, may have been
among the precipitating events. In any case, the initial rise in
market uncertainty led to a sharp rise in discounts on future
claims to income and, accordingly, falling prices of real estate and
equities. The process became self-feeding as disengagement from
future commitments led to still greater disruption and
uncertainty, rising risk premiums and discount factors, and a
sharp fall in production.
While the reverse phenomenon, a virtuous cycle, is not fully
symmetrical, some part is. Indeed, much of the current American
economic expansion is best understood in the context of favorable
expectations, interacting with production and finance to expand
rather than implode economic processes.
Full speech at: http://www.bog.frb.fed.us/boarddocs/speeches/1998/19980904.htm
While Greenspan did not actually say it, one can almost hear a global creative destruction being described. While Schumpeter was talking about US Steel as the creative destroyer in his days, Greenspan/Rubin is talking about US Steel being creatively destroyed by Japanese and Russian steel imports. They are also talking about Asian financial firms being creatively destroyed and taken over by American giants. The same is true in communication, IT, transportation, financial services. Schumpeter is Greenspan's idol, our modern creative destroyer.
Henry C.K. Liu
James Wilson wrote:
> Speaking of Schumpeter - happened to be browsing through some old
> Galbraith books at the library recently and found some interesting stuff
> about him and other high priests of the “Let them eat s__t” school of
> econonomics:
>
> When asked by President Herbert Hoover in 1932 for advice about the
> depression, leading economists Joseph Schumpeter of Harvard and Lionel
> Robbins of the London School of Economics answered that the government
> should do precisely nothing.
>
> Why?
>
> “Our analysis leads us to believe that recovery is sound only if it comes
> of itself.”
>
> In 1936, Schumpeter’s Harvard colleague Thomas Nixon Carver spoke publicly
> of the desirability of sterilizing all paupers in the U.S. so they could
> not breed and perpetuate their kind. He defined a pauper as anyone earning
> less than $1800 a year, a category that then embraced around half of all
> the families in the country.
>
> (See John Kenneth Galbraith’s “Economics in Perspective”, Houghton
> Mifflin, 1987 p. 196; the above passages are paraphrases and not exact
> quotes)
>
> James Wilson