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Journal of Economic LiteratureVol. XLIII (March 2005), pp. 135-196

Book Reviews

135

A General Economics and Teaching

Microeconomics: Behavior, Institutions, andEvolution. By Samuel Bowles. RoundtableSeries in Behavioral Economics. Princeton andOxford: Princeton University Press; New York:Russell Sage Foundation, 2004. Pp. xi, 584.$49.50. ISBN 0–691–09163–3.

JEL 2004–0833There’s a new microeconomics on the block,

and it’s not the microeconomics you were taughtin school. The new microeconomics takes seri-ously that many markets and contracts areincomplete, that agents are differentially

informed, that much that is pertinent to theirinteractions is not verifiable or admissible in acourt of law. While those first elements wouldshock no one trained in the past thirty years, thenew microeconomics goes much further, allowingthat people sometimes display social preferencessuch as concern over fairness, a desire to recipro-cate when treated well, and a desire to punishwhen taken advantage of. More radically, still,this new microeconomics takes institutions as notonly critical, but variable and scarce, and it treatstheir evolution and selection as a central problemof economics. Indeed, this new microeconomicssometimes takes preferences or institutions asthe variables to be explained, modeling selection

Editor’s Note: Guidelines for Selecting Books to Review

Occasionally, we receive questions regarding the selection of books reviewed in the Journal ofEconomic Literature. A statement of our guidelines for book selection might therefore be useful.

The general purpose of our book reviews is to help keep members of the American EconomicAssociation informed of significant English-language publications in economics research. We alsoreview significant books in related social sciences that might be of special interest to economists. Onoccasion, we review books that are written for the public at large if these books speak to issues thatare of interest to economists. Finally, we review some reports or publications that have significantpolicy impact. Annotations are published for all books received. However, we receive many morebooks than we are able to review so choices must be made in selecting books for review.

We try to identify for review scholarly, well-researched books that embody serious and originalresearch on a particular topic. We do not review textbooks. Other things being equal, we avoid vol-umes of collected papers such as festschriften and conference volumes. Often such volumes posedifficult problems for the reviewer who may find herself having to describe and evaluate many dif-ferent contributions. Among such volumes, we prefer those on a single, well-defined theme that atypical reviewer may develop in his review.

We avoid volumes that collect previously published papers unless there is some material valueadded from bringing the papers together. Also, we refrain from reviewing second or revised editionsunless the revisions of the original edition are really substantial.

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of agent types and institutional outcomes underrelevant evolutionary pressures.

In giving this microeconomics what is perhapsits first textbook-style and textbook-length treat-ment, Samuel Bowles makes only modest claimsfor the completeness of the new paradigm. In theintroduction, he cites J. S. Mill’s famous 1848howler: “Happily, there is nothing in the laws ofValue which remains . . . to clear up; the theory ofthe subject is complete.” Writes Bowles in con-trast: “This book conveys no such reassurance.Our understanding of microeconomics is funda-mentally in flux. Little is settled. Nothing is com-plete.” (p. 19). In the concluding chapter, wherehe summarizes key elements of the “evolutionarysocial science” he sees emerging, he readilyadmits that there “is no unified paradigm of thisname, but rather a disjointed set of approaches,many of which are rather rudimentary” (p. 478).Such modesty is becoming, and in some respectsapt, but should not give the wrong impression:there are already many promising tools inBowles’s paradigm-building kit.

The book is divided into three parts. Part 1,“Coordination and Conflict: Generic SocialInteractions,” introduces game theory, presentselements to be used in later chapters, and dis-cusses methodological issues. Chief among thelatter are the nature of preferences and the two-way relationship between preferences and insti-tutions, a subject of much discussion in part 3.Chapter 4, on coordination failures, discussescommon property, public goods, and other coor-dination problems, and considers how socialpreferences sometimes help to solve them.Chapter 5, “Dividing the Gains to Cooperation,”introduces Nash and other bargaining modelsand discusses the conflict between cooperationand competition that looms large throughoutthe book.

Part 2, “Competition and Cooperation: TheInstitutions of Capitalism,” treats the more tradi-tional topics of microeconomics in distinctive andsometimes novel ways. Chapter 6, “UtopianCapitalism: Decentralized Coordination,” laysout the Walrasian general equilibrium model andcarefully discusses its limitations. Exchangeunder more realistic conditions, such as incom-plete information about quality, is analyzed inchapter 7. Chapters 8 and 9, among my favoritesin the book, discuss labor and credit markets,elaborating the “contested exchange” framework

developed by Bowles and frequent collaboratorHerbert Gintis. Like its somewhat more staidcousins, the Shapiro–Stiglitz unemploymentmodel and the Stiglitz–Weiss credit marketmodel, the contested exchange approach depictsa world in which markets don’t clear and pricesdetermine effort or quality. For Bowles, theterms of the exchange, rather than being settledby a handshake, are worked out through timeunder the influence of “short side power.”Chapter 10 discusses why the institutions of acapitalist economy are as they are, e.g., why firmscontrolled by capital-providers hire workersrather than workers organizing firms and hiring(renting or borrowing) capital.

Part 3, “Change: The Co-evolution ofInstitutions and Preferences,” is the least tradi-tional part of the book. As its title suggests, theaim is to understand how preferences shape insti-tutions, how institutions shape preferences, andhow both could have emerged from human bio-logical and cultural beginnings. Economic histo-ry, growth, and development provide examplesfor discussion, and the text takes lengthy excur-sions into the preagricultural world of 100,000 to11,000 years ago. Why study the coevolution ofinstitutions and preferences? Because, arguesBowles, they’re of fundamental importance toreal world economic and social outcomes. Hebegins the book with the puzzle of why the lushBangladesh and wealthy Moghul India of thefourteenth and fifteenth centuries sank intopoverty while the relatively poor Europe of thatperiod grew, along with some of its colonial off-shoots, to be the economic leaders of today’sworld. The answer, he suggests, is the “emer-gence and diffusion of a novel set of institutionsthat came to be called capitalism [which] broughtabout a vast expansion in the productivity ofhuman labor in Europe and not in Bangladesh[or India].”

Capitalism is not, argues Bowles, simply thesubstitution of fully defined property rights andcontracts for custom, community, and state.Rather, it’s a dynamic mix of new, yet never con-tractually complete, arrangements, with long-present human motivations ranging from greedto reciprocity and vengeance, bolstered by effec-tive states, legal systems, and communities of theworkplace, neighborhood, and interest group.Understanding the system’s emergence and func-tioning requires not only the old invisible hand

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model and its protagonist, Homo economicus, butalso models of how trading partners establishtrust, why workers respond positively to jobrents, and why people participate in civic andpolitical organizations. And for this, one needs toknow how reciprocity, the tendency toward“altruistic punishment,” and other “social prefer-ences,” could be supported by a human genepool that from a simplistic evolutionary stand-point seems inconsistent with survival-of-the-fittest principles.

Although Bowles’s work helps to set out aresearch agenda that will take decades toexplore, the book offers many of the necessarytools, a number of interesting starts, and amplefood for thought served up with rich perspectiveon the histories of both the ideas and the sub-stantive questions at issue. It may not becomenext year’s core graduate micro text in most uni-versities. But whether as a companion to a moreconventional text, or as an entrée in its own right,it’s an intellectual meal to relish.

LOUIS PUTTERMAN

Brown University

Econometric Theory and Methods By RussellDavidson and James G. MacKinnon. New Yorkand Oxford: Oxford University Press, 2004. Pp.xviii, 750. ISBN 0–19–512372–7.

JEL 2004–0008The authors have previously written a graduate

level econometrics textbook entitled Estimationand Inference in Econometrics, which was pub-lished in 1993 by Oxford University Press. Thepresent book covers many new topics and is at aslightly less advanced level. Because of theadjustment in the level, the authors occasionallyrefer to their older book for more details or moreprecise derivations of results. Therefore onewonders whether both books will remain com-petitors in the market of graduate level econo-metrics textbooks. If the older book disappears, itmay also reduce the value of the present one.

The present book assumes a good bit of priorknowledge in statistics and econometrics.Although the prerequisites are often brieflyreviewed, this is done at a level which will not beeasily accessible to students without some back-ground knowledge. As the title suggests, the bookfocuses on the theory and methods and not onapplied econometrics. Given the lack of empiri-cal examples except in the exercises, it is clearly

helpful for a student to approach the book withsome background motivation.

The first ten chapters and thus almost twothirds of the book cover the foundations byfocusing on important methods of inference foreconometrics. After an introduction to the lin-ear regression model (chapters 1 and 2), estima-tion by ordinary least squares (chapter 3),hypothesis testing (chapter 4), confidence inter-vals (chapter 5), nonlinear least squares (chap-ter 6), generalized least squares (chapter 7),instrumental variables (IV) estimation (chapter8), the generalized method of moments (GMM)(chapter 9), and maximum likelihood (ML) esti-mation (chapter 10) are treated. Some of thematerial in these chapters is quite standard butthe presentation is often a bit nonstandard,which makes the text unique and interesting asa textbook. For example, there is a long discus-sion of the geometry of the linear regressionmodel. There may be students who prefer thatto a purely algebraic treatment. Also, confi-dence intervals are introduced via tests. Thisway some common misconceptions about confi-dence intervals may be avoided more easily thanwith a “classical” introduction. On the otherhand, understanding how to interpret and useconfidence intervals does not necessarilybecome easier.

A big plus of the treatment in the present vol-ume is the introduction of simulation and boot-strapping methods at a very early stage. Theseimportant tools are presented here by expertswith admirable insights. I like especially the dis-cussion of bootstrap confidence intervals inchapter 5. A small problem in this chapter is per-haps the unfortunate example for the deltamethod on page 206, where the asymptoticproperties of an estimator of � = �2 are to beinferred from those of an estimator of �. Thedelta method can be used unless � = 0. This caseis also a very nice example for the bootstrapinterval given in (5.54) to be unsuitable becauseit will contain the true parameter value withprobability zero whenever the confidence level isless than one. Unfortunately these problems arenot discussed or pointed out by the authors andthe example is presented as one for rather thanagainst these methods. Generally, the expositionis quite insightful, however, and even advancedmethods like the method of simulated moments(chapter 9) become accessible.

Book Reviews 137


The statement of the central limit theorem interms of a probability limit rather than the morecommon convergence in distribution on page149 is nice because it makes some asymptoticarguments more intuitive and easy to explain. Onthe other hand, it might be helpful for somereaders to see a discussion of the relation to themore common definition of convergence in distribution.

Another special feature of the present text isthat the authors introduce method-of-momentsestimation early on and thereby make the discus-sion of IV estimation and GMM more natural orat least easier to motivate. In this context, a spe-cial feature of the book is also the discussion anduse of the theory of estimating functions.Moreover the authors emphasize the use of arti-ficial regressions. These features give the book itsspecial flavor which may well appeal to some stu-dents more than a standard approach to IV andGMM estimation, for example. In addition to thegeneral methods, a wide range of modern topicssuch as heteroskedasticity and autocorrelationconsistent (HAC) covariance matrix estimation isdiscussed.

Assumptions and mathematical or statisticaltools are usually introduced or reviewed wherethey are needed. This strategy of presentingthem has the advantage that they are easy tomotivate. Also the assumptions needed for thederivations are often just stated somewhere inthe text or are just referred to as regularity con-ditions which are not stated. The results are usu-ally not displayed as theorems or propositions.The drawback is that I sometimes had troublekeeping track of the conditions under which thederivations are done. Also it can be difficult tofind a particular result in the book. Therefore, Ican only agree with the authors’ self assessmentin the preface that “this book is intended more asa text than as a reference . . . ” (p. xi).

While generally the explanations and derivationsare quite well done, there are occasional excep-tions where I found the presentation unclear ormisleading. Take for instance the discussion of theasymptotic theory of the HAC covariance matrixestimator on page 363 which is clearly problemat-ic. Another problem occurs on page 161, wherethe authors infer from consistent estimation of anindividual error that the whole error vector of aregression model whose dimension depends onthe sample size is estimated consistently. Despite

these caveats, the first ten chapters provide a verygood foundation for departing to other economet-ric topics some of which are considered in the lastfive chapters.

Chapter 11 covers microeconometric toolssuch as logit, probit, tobit and duration models.Systems of equations including seemingly unre-lated regressions and nonlinear models are dis-cussed in chapter 12. Stationary time seriesmodels, including distributed lags, error correc-tion models, and a very brief introduction to vec-tor autoregressions, are considered in chapter13. Chapter 14 is then devoted to nonstationarytime series with unit root testing and cointegra-tion. Finally, chapter 15 discusses a wealth ofmodel checking tools in addition to those thatwere considered already in earlier chapters.These range from specification tests based onartificial regressions to tests of nonnestedhypotheses and nonparametric methods. Also abrief section on model selection criteria is includ-ed. Given the need for intense model checking inapplied work, the last chapter is clearly an assetfor an econometrics textbook.

In summary, the book is in my view a very goodchoice for a graduate level course in economet-ric theory for those who like the authors’ style. Ithas some particular strengths which make itattractive. One of them is the emphasis on mod-ern simulation methods throughout the text; oth-ers I have mentioned above. One advantage Ihave not mentioned previously is the rich set ofexercises. Some of them require challengingalgebraic derivations, some guide through simu-lation studies and others offer empirical illustra-tions. Solutions to selected exercises and othersupporting material for the book are available ata website.

HELMUT LÜTKEPOHL

European University Institute

Feminist Economics Today: Beyond EconomicMan. Edited by Marianne A. Ferber and JulieA. Nelson. Chicago and London: University ofChicago Press; 2003. Pp. ix, 209. $38.00, cloth;$16.00, paper. ISBN 0–226–24206–4, cloth;0–226–24207–2, pbk.This book is sequel to the 1993 volume, Beyond

Economic Man: Feminist Theory and Economics(eds. Marianne A. Ferber and Julie A. Nelson,Chicago and London: University of ChicagoPress). These two books, if digested along with



two other essay collections, Out of the Margin:Feminist Perspectives on Economics (eds. EdithKuiper and Jolande Sap, 1995, London and NewYork: Routledge) and the encyclopedic ElgarCompanion to Feminist Economics (eds. JanicePeterson and Margaret Lewis 1999, Cheltenham,UK: Edward Elgar), would provide one with athorough overview of the major issues and topicstreated by the still-nascent area of feminist eco-nomics, both as originally conceptualized in thelate 1980s and as developed over the ensuingdecade and a half.

Marianne A. Ferber and Julie A. Nelson’s intro-duction summarizes the development to date offeminist economics institutions. This progress issubstantial and includes formation of a healthyflagship organization, IAFFE (InternationalAssociation for Feminist Economics), IAFFE’sjournal, Feminist Economics, and a growing list ofpublications that can be recognized as explicitlyfeminist economics. Ferber and Nelson alsoassess how much of an impact feminist econom-ics has made upon the economics mainstream(some—but awareness lags).

Sociologist/honorary economist Paula Englandfollows with an essay that expands upon herpiece on “the separative self” in the earlier vol-ume, addressing the dichotomy between separa-tive and soluble self as well as the use ofdichotomous thinking in economics. After cri-tiquing the lack of allowance for altruism, tasteformation, and empathy in mainstream econom-ic models, she cites increased interest in themodeling of bargaining within marriage,endogenous tastes, and the study of care work as promising countertrends within economics.

England and Nancy Folbre then combine toconsider contracting for care, a topic that Folbrein particular is noted for developing. They sug-gest the usefulness of theory regarding variouscontracting problems, including missing andincomplete markets and monitoring and enforce-ment problems, in considering why the level ofcare provided in societies may be suboptimal.They also critique the “traditional masculineemphasis on individual choice, rational choice,and measurable results” (p. 75) for deflectingeconomists’ attention away from the issues ofhow and how much care service is provided.

Julie A. Nelson continues the separative vs. sol-uble discussion from the England paper and fromher own earlier work, using this framework to

address the modeling of the firm by economists.Nelson draws on a range of insights from bothmainstream economists and economic sociolo-gists in critiquing the way in which the firm istreated in much of economic modeling. This dis-cussion is not overtly gender-related, butnonetheless continues her critique of economicthought regarding the blindness that stems fromoveruse of gender-linked dichotomies.

Lisa Saunders and William Darity Jr. considerthe symmetries and asymmetries in treatment ofgender and race in economics. They argue forgreater explicit recognition of the relationshipbetween feminism and antiracism, while at thesame time arguing that exclusionary mechanismsneed not operate similarly on the bases of genderand race.

Lourdes Benería contributes an essay on“Economic Rationality and Globalization.” Thiscontribution, incorporating as it does broad dis-cussions of current globalization patterns,Polanyi’s work in analyzing earlier market forma-tion trends, Davos man, and gender norm cre-ation, is overly ambitious given the spaceconstraint and wavers in focus.

Myra Strober discusses how mainstream eco-nomics constructs have been used in the educa-tion literature and how this has been in many waysproblematic, for instance in narrowing the view ofthe role of education down to an emphasis onearnings-related skills and in focusing on increas-ing efficiency and choice rather than on increas-ing funding to schools. Strober thus identifies thecolonization of a multifaceted field by neoclassicaleconomics as problematic when no offsetting het-erodox economic perspective serves as balance(much as when Beckerian analysis was used toanalyze marriage and family-related topics).

Rebecca M. Blank and Cordelia W. Reimers, incontrast to the rest of the authors, explicitly iden-tify as “economists who are feminists” rather thanas “feminist economists.” As such, they ponderthe way in which feminism affects their topicselections and emphases within their empiricalpublic policy-oriented research agendas, andadvocate a marginalist approach to incorporatingfeminist-motivated theoretical innovations intoeconomic modeling.

S. Charusheela and Eiman Zein-Elabdin con-sider the relationships between feminism, post-colonial thought, and economics. This essayserves as a useful primer for economists who

Book Reviews 139


want to begin to understand the terminology andconcerns of their university colleagues who aresteeped in postcolonial (often by way of post-modern) thought. The literature that explicitlyties economics to postcolonial thought is small,but likely to grow substantially, in intersectionwith development studies and thereby withdevelopment economists, in the near future.

All the contributors think that economicsshould be more open to critiques from within andwithout economics and more open to subjectmatter that may be currently more of a preoccu-pation within other disciplines. But they vary inwillingness to depart substantially from main-stream modeling, in high correlation to thedegree to which their own training was neoclassi-cal vs. heterodox. For good or bad, although thisbook goes a long way in helping the readerunderstand what feminist economics is (and isnot), the definition of feminist economics, andthe answer to whether or not the critiques ofmainstream practice that it entails are uniqueamong the heterodox economic traditions andrelated social sciences, is still not cast in stone.

JOYCE P. JACOBSEN

Wesleyan University

African Economic Development. Edited byEmmanuel Nnadozie. San Diego and London:Elsevier Science, Academic Press, 2003. Pp.xliv, 662. £68.95. ISBN 0–12–519992–9.

JEL 2004–0016This book is a twenty-three chapter-long spear

that aims to kill the woolly mammoths that arecourses on African economic development.Unfortunately, the book’s aim is not true. Thechapters are repetitive, disconnected, the editingshockingly bad, and there are significantabsences (little on gender or debt, for example).

Chop the book up, and the teacher will havesome darts—not suitable for woolly mammoths,but capable of bringing down smaller prey.Among these are several fine contributions thatwould be useful in undergraduate courses.Chapter 5, for example, is an excellent survey ofgrowth theories and their application to Africa byMarcel Fafchamps. His argument is that bothneoclassical and endogenous growth theoriesmiss the point: the pecuniary externalities ofagglomeration are the real game in town. Thisseems sensible. Unfortunately, this shift in per-spective yields no silver bullet for policy; Blaise

Compaoré of Burkina Faso and the three dozenother strongmen on the continent will receive noanswer to the question central to Fafchamps’sarticle: How long to wait until agglomerationexternalities are played out in China and what todo in the meantime?

Paul Collier in chapter 8 reprints a stimulatingsummary of the relation between ethnic diversityin Africa and economic and political outcomes.He reiterates a controversial finding: ethnicdiversity only matters when decoupled fromdemocracy. Multiethnic societies that are demo-cratic perform fine. The chapter also includes afine review of theories of ethnicity in politicalaction. This literature is hobbled by a lack ofattention to the problem of scale and to the tech-nology of identity. Kin, clan, and tribe are impor-tant identities everywhere in the world. Collier isat pains to note that they are effective identitiesfor structuring economic transactions in an envi-ronment of limited information and repeatedinteraction. Being tall or liking salty food wouldnot be useful identities for solving the socialproblem of who to trust. Effective identities arerelatively immutable, geographically encompass-ing, and easily verified. Being tall misses the sec-ond property, while liking salt misses the third.But the identity that matters for the nationalstage, referred to as “ethnicity” in most Africancontexts, which generates the ethnic markers thatcorral voters into blocs, is plainly neitherimmutable nor verifiable. A vast literature showsprecisely how mutable national-level ethnicity is.So does it make sense to treat the two kinds ofidentity—local tribe and national ethnicity—asthe same thing? Local identities can coexist,rather, with national-level ethnicities. The ques-tion of the production of national-level ethnici-ty—its endogeneity—is left undiscussed. This isunfortunate, because it may well be that democ-racy and dictatorships produce different kinds ofnational ethnicities. One thinks of the colonialperiod, when ethnicities were produced quitedeliberately by authorities for reasons of bothadministrative convenience and Machiavellianpreservation of illegitimate regimes.

Some of the other chapters in the book arequite adequate. Chapter 3, by Nnadozie, is adecent introduction to concepts and measure-ment of growth. Chapter 7 by N. Vink and N.Tregurtha on poverty is a reasonable quantita-tive assessment of the quality of life of South



African farm workers. Mario Azevedo offers agood survey of health issues on the continent inchapter 9, and Azevedo and Nnadozie in chapter10 present a nice introduction to educationissues. Surveys on financial development, byLéonce Ndikumana, and globalization anddevelopment, by Richard Mshomba, will be use-ful to students in introductory courses. FemiBabrinde’s introduction to regionalism in chap-ter 19 is silent on empirical estimates of the costof trade diversion in the African context, anabsence that considerably reduces the value ofan otherwise decent essay.

Collier’s chapter on ethnicity is best read aftera straightforward chapter 11, by John Quinn, thatreviews the evidence on democracy and develop-ment. Quinn’s chapter is pitched at the rightlevel for this volume, and students will then beready for the more challenging chapter byCollier. The opposite is true for the dynamicpanel GMM estimates of Kwabena Gyimah-Brempong’s chapter 12 on political instabilityand for the muddled summary by E. WayneNafziger of a project exploring inequality andconflict in Africa. Nafziger’s outcome variable,humanitarian emergencies, is not well-defined inthe chapter, so it is difficult to read without goingto other papers by the author. The chapter seemsto be simply a direct “lifting” of a discussion ofregression coefficients, but without any of theregression results presented, leaving the readerwith an impression of arbitrary pronouncementthat this or that factor matters or does not mat-ter. The sketches of real conflicts scatteredthrough the text add to the impression of a hastycut-and-paste document.

These last two are not the only bad chapters inthe volume. Oddly, the introductory chapter bythe editor is among the least useful. Nnadozieattempts to motivate the study of Africaneconomies, but in very confused and hesitantway. A section on “principal messages” beginswith a brief discussion of the W. A. Lewis model,continues with a summary of recent cross-coun-try growth regressions, and then arrives at theprincipal message that there is no principal mes-sage because studies of African economic devel-opment are in flux, are complex, and areconfused. Surely the goal of an introductionshould have been to resolve, simplify, and clarify.

Following the vein of bad chapters, chapter 6on population growth is marred by an inability

to clearly specify the difference between causa-tion and correlation between growth in popula-tion and growth in income per person. An awfulchapter on land tenure and agricultural devel-opment includes a bizarre section laudingZimbabwe’s growth in maize production, withnary a nod to the daunting land tenure issuesthat have helped turn Zimbabwe into a basketcase. A chapter on trade and developmentreprints seven pages of tables giving per year,per country, data on trade flows, in micro-fontsizes. These and others suffer from poor writ-ing, disorganization, inappropriate discussionsof technicalities, and lack of focus. A closingchapter by a Cambridge, MA “brain trust” ofJames Deusenberry, Arthur Goldsmith, andMalcolm McPherson fails to deliver originality.Instead, the authors survey all of the policy fail-ures on the continent, and conclude that if thepolicy failures are reversed, growth will follow.How pat is that?

The book is intended for students, but theinstructor should be very wary of assigning thisbook. One editorial mistake was to have eachchapter begin with a list of “key terms.” The first“key term” of the book is an infelicitous term:African dummy. What kind of a book oriented tostudents who do not know regression analysisstarts out by highlighting a negative coefficienton a dummy variable? Many of the key words formany other chapters are nonsensical. In somechapters the writing is quite bad. Should a stu-dent be exposed to such poor writing?

If I seem caustic, it is because the publisher,Academic Press, an imprint of Elsevier Science,seems here to be in the business of duping a well-meaning public. Around the world, courses onAfrican economic development will be taughtwith greater frequency. Should Elsevier cash inon this trend by selling an amoebic product? Yes,one of the editorial lapses is letting an authorrefer not to anemic economic growth but toamoebic growth . . .

MICHAEL KEVANE

Santa Clara University

Reconstructing Macroeconomics: StructuralistProposals and Critiques of the Mainstream. ByLance Taylor. Cambridge and London:Harvard University Press, 2004. Pp. ix, 442.$59.95. ISBN 0–674–01073–6.

JEL 2004–0853

Book Reviews 141


Lance Taylor’s new book, ReconstructingMacroeconomics, offers an impressive structural-ist critique of modern macroeconomics andbuilds the case for restoring an encompassingstructuralist perspective on contemporary macro-economic issues. This critique rejects two coretenets of mainstream economics, the role ofmethodological individualism, as articulated inthe representative agent, and the reliance on asupply-side determination of output, in favor ofan approach which emphasises social relationsbetween broad groups (often “workers” and “cap-italists”), views macroeconomics as being drivenby the dynamic evolution of these social tensions,and sees output determined on the demand side(the Keynes–Kalecki principle of effectivedemand). This book is concerned with challeng-ing the former and promoting the latter.

The book’s origins lie in Professor Taylor’s lec-ture course in advanced macroeconomics at theNew School in New York. In style and structureit reads as such, which is both a strength and aweakness. However, it is much more than a text-book: it is a highly individual essay on the historyof economic thought, but also the best introduc-tion to the canon of structuralist economics Ihave read. And, as the cover reviewers stress, it iswritten in Taylor’s distinctively witty, provocative,and deeply intelligent style.

In terms of structure, the book inverts the“structuralist proposals and critiques of the main-stream” of the subtitle. Chapter 1 sets the stagewith an introduction to the social accountingmatrix (SAM) framework used throughout thebook, using it to place class-based conflicts at theheart of the national accounting system (eventhough SAM methods are widely used outside thestructuralist camp). The next five chapters repre-sent the “critiques of the mainstream.” These areall excellent chapters covering: price determina-tion (chapter 2); money, interest rates, and infla-tion (chapter 3); and the characterization (anddetermination) of aggregate demand, consump-tion and investment (chapter 4). It is here thatTaylor throws down the gauntlet, arguing that;

“the essentials of the principle of effectivedemand thus appears to have survived sixtyyears of intense scrutiny. Moreover, strongattacks to a greater or lesser extent havemisfired . . . Say’s Law is not true . . . andeffective demand is the valid approach tomacroeconomics” (p. 172).

The development of this theme starts with adiscussion of alternative macroeconomic clo-sure rules and how they shape perspectives ongrowth (chapter 5); building up eventually to afull-frontal assault on monetarism and new clas-sical economics in chapter 6. Typically, thesechapters start from the SAM laid out in chapter1 and then introduce a few simple finger exer-cises based on alternative closure rules so as tohighlight basic insights which form the link intothe broader critique to follow. Taylor’s masteryof mainstream macroeconomics, and his abilityto place ideas within a compelling historicalnarrative, make these chapters highly readableand thought-provoking, and contribute to acompelling critique. For example, the first tenpages of chapter 3 on money is one of the bestshort histories of monetary thought one willfind anywhere.

The second half of the book turns to the “struc-turalist proposals” of the title, developing, in par-ticular, the ideas foreshadowed in chapter 4. Themain elements of Taylor’s structuralist synthesisare contained in chapter 7 (on effective demandand the idea of the “Distribution Curve”), chap-ter 8 (on structuralist finance and money), andchapter 9 (on cycles). All three chapters are, how-ever, very hard work, especially for the reader(especially the graduate student) schooled inmainstream economics. Part of the problem isthe book’s format: by following the lecture courseeach chapter is constrained to be roughly thesame size. As a result, density is the endogenousvariable. Having worked through these densechapters, though, the reader will greatly enjoythe book’s final excellent chapter on growth anddevelopment—figure 11.1 on “filiations andoppositions in growth and development theory”could occupy an entire graduate seminar by itself.Briskly paced and highly entertaining, this chap-ter ends with Taylor taking a tilt at many bignames and shibboleths in the neoclassical canon.It is easy to imagine the graduate students whohave stuck with him through the rigours of earli-er chapters applauding Professor Taylor on as hecompletes the course with this virtuoso flourish!

I close with two, minor, reservations about thebook. The first is that, as with any partisan review,Taylor tends to build straw men. Mainstream the-ory is often caricatured, giving the reader thesense that deep issues have remained underex-plored from within the mainstream. This tendency



is apparent to various degrees in all chapters, but perhaps the most notable instance is thealmost complete failure to recognize the wealth ofmodern (mainstream) political economy.

A second, deeper, frustration is that despite itsgreat length and broad sweep, and an acknowl-edgement in chapter 1 of the principle of falsifi-cationism, the book never really engages with theempirical evidence that would support (or refute)Taylor’s thesis. True, some considerable space isdevoted to a structuralist explanation of recentdevelopments in the U.S. economy, but what isrequired is not that we can construct a coherentstructuralist interpretation that is consistent withthe data, but rather that mainstream economics isfalsified at the same time. This evidence is neveradduced. Perhaps more surprisingly, the book isremarkably silent on the evidence and experienceof developing countries, especially those in LatinAmerica where, arguably, structuralist ideas weremost readily accepted in policy circles.

These are minor reservations, though. Feweconomists will fail to appreciate the scholarshipand historical sweep of this book. It will annoyand amuse in equal measure, but ultimately it isunlikely to change any minds. It is also unlikely,sadly, to make it to the top of the “recommend-ed reading list” for many graduate courses—astatement which says more about the challengeswe face in teaching graduate economics thanabout the quality of the book. It should, howev-er, certainly be prominent in any good “extendedreading list.”

CHRISTOPHER ADAM

University of Oxford

Income, Wealth, and the Maximum Principle. ByMartin L. Weitzman. Cambridge and London:Harvard University Press, 2003. Pp. viii, 341.$55.00. ISBN 0–674–01044–2.

JEL 2003–1284Martin Weitzman has written an innovative and

important new book on dynamic optimization—inparticular, the Maximum Principle of optimalcontrol theory—and its application to economics.It is an excellent textbook on optimal control the-ory, but it is much more than that. It explains howmuch of capital theory can be formulated in termsof a “prototype” optimal control problem, and itshows how, in the context of a multisector growthmodel, the Maximum Principle can be used toobtain a comprehensive measure of national

income. Thus, this book will appeal to several dif-ferent audiences: graduate students in economics,practicing economists with an interest in capitaltheory, and environmental economists.

To begin with, the book provides a clear andcomprehensive exposition of optimal control the-ory as a mathematical tool and, using a variety ofexamples, illustrates its application to problemsin economics. Of course, there are other booksthat explain optimal control theory and show itsuse in economics; an example is the 1970 volumeby Kenneth Arrow and Mordecai Kurz, PublicInvestment, the Rate of Return, and OptimalFiscal Policy, Johns Hopkins Press, thatWeitzman, I, and many others benefited fromduring and shortly after graduate school.However, there is no other book (at least that Iam aware of) that provides such clarity, particu-larly with respect to the economic relevance ofoptimal control. Given the importance of themethodology and the breadth of economic appli-cations, this is a textbook that should be assignedreading for most graduate students in economics.

This book introduces optimal control theory notin its most general (and rigorous) form, but ratherin terms of a simple “prototype” economic controlproblem with wide applicability. In the one-dimensional version, the problem is to maximizethe present discounted value of a “payoff” flow(e.g., cash flow, profit, utility), which is a functionof a state variable (e.g., the capital stock, K) and acontrol variable (e.g., investment, I), subject to adifferential equation linking the state variable tothe control variable (e.g., dK/dt�I�δK) and oneor more non-negativity constraints. Because thisprototype problem has an infinite horizon, theapplication of the Maximum Principle is relative-ly simple, but it also has broad applicability.Weitzman shows how ten basic problems in capi-tal theory fit this prototype framework—forexample, the investment decision of a value-max-imizing firm, the optimal extraction of anexhaustible resource, optimal tree harvesting, andthe neoclassical optimal growth problem.

The most innovative aspect of the book is itstreatment of national income accounting.Weitzman shows (in chapter 5) how a fairly gen-eral optimal multisector growth model can bestructured and solved using the MaximumPrinciple. This is interesting in its own rightbecause Weitzman introduces and explains themultidimensional version of the Maximum

Book Reviews 143


Principle and shows how it can be applied toproblems in growth theory. But the main payoffis the application to a comprehensive theory ofnational income accounting. Weitzman showsthat the Hamiltonian of the optimal controlproblem can be interpreted as the income or“net national product” of the unit doing the opti-mizing. This is more than a theoretical curiosity.By incorporating, for example, resource deple-tion in a multisector growth model, one canderive a comprehensive (I will avoid the adjec-tive “green”) measure of national income. Thus,this book addresses a fundamental problem inmodern environmental economics.

Is anything missing? I would have liked to see achapter devoted to explaining the relationshipbetween optimal control theory, dynamic pro-gramming, and the calculus of variations. Thetypical approach in dynamic programming is toeliminate the control variable from the Bellmanequation (by substituting in the first order condi-tion) and then solving the Bellman equation forthe value function. Depending on the problem,the Maximum Principle can be easier to applybecause it is not necessary to actually solve for thevalue function. On the other hand, in some casesthe value function itself can be very informative.(For a detailed discussion of dynamic program-ming, see Dixit and Pindyck, Investment UnderUncertainty, Princeton University Press, 1994). Itis also worth noting that by differentiating theBellman equation with respect to the state vari-able, one can then use the first order condition tosubstitute out the value function, which yields theEuler equation of the calculus of variations.

Weitzman introduces the Euler equation anddiscusses it briefly, but it actually deserves moreattention. Why? Because that is the estimatingequation used in most econometric models ofdynamic optimization with rational expectations.In models of factor demands, dynamic consump-tion behavior, asset allocation, etc., it is usually notpossible to solve the underlying stochastic dynam-ic optimization problem, but it is almost alwayspossible to derive the Euler equation and thenestimate it to obtain the parameters of interest.

But these are quibbles. It is easy to ask formore when someone else has to do the writing.Weitzman deserves considerable applause forthis clear and elegant book.

ROBERT S. PINDYCK

Massachusetts Institute of Technology

B Schools of Economic Thought and Methodology

Toward a Feminist Philosophy of Economics.Edited by Drucilla K. Barker and EdithKuiper. Economics as Social Theory series.London and New York: Routledge, 2003. Pp.xvi, 349. $39.95, paper. ISBN 0–415–28387–6,cloth; 0–415–28388–4, pbk. JEL 2003–1292Feminist economics emerged as a self-defined

field in the mid-1990s, with the publication of theclassic collection Beyond Economic Man(Marianne Ferber and Julie Nelson, eds.,University of Chicago, 1993) and the inception ofthe journal, Feminist Economics, in 1995. Sincethen, feminists of many kinds have taken up thechallenge of rethinking economics. They haveadded or emphasized the topics of women, gen-der difference and inequality, and unpaid work.They have made evident the existence of mas-culinist bias in mainstream or “neoclassical” eco-nomic theory. They have explored nonpositivistmethodologies and alternative theories.

Toward a Feminist Philosophy of Economicsserves as a kind of showcase of efforts of feministeconomists to move beyond critiques of main-stream economics toward substantive positivecontributions both in methodology and content.It focuses on core issues that have preoccupiedfeminist economists and includes essays by manyleading feminist economists.

The book includes an excellent introduction bythe editors which surveys feminist economics’many aspects and contributions to feminist eco-nomics, and twenty essays, loosely grouped intofive sections: “Rereading History,” “ScienceStories and Feminist Economics,” “ConstructingMasculine/Western Identity in Economics,”“Beyond Social Contract: Theorizing Agency andRelatedness,” and “Rethinking Categories.”Given limits of space, I will only be able to focuson a sampling of the book’s rich offerings.

In one of the book’s historical essays, IreneVan Staveren moves beyond the boundaries ofmainstream economics by focusing on fictionwritten by the nineteenth-century feministwriter Charlotte Perkins Gilman. While Gilmanis best known in economic circles for her non-fiction book, Women and Economics, VanStaveren shows that two of her fictional works,The Yellow Wallpaper and Herland are, like the



oft-used story of Robinson Crusoe, rich ininsights about the core economic concept ofefficiency. She shows how the first reveals theinefficiencies of the traditional sexual division oflabor, through the wasting of the full-time moth-er’s productive abilities, and through her mentaldeterioration as a result of her isolation and lackof creative connection to the world— issues nottaken into account in the usual Beckerian analy-sis. From the second, about a women-onlyutopia in which women’s care-taking work ishighly valued and organized cooperativelyalongside other forms of work, and in which allwork out of intrinsic motivation, Staveren culls anew, holistic, and dynamic concept of efficiency.She notes that, because intrinsic motivation sup-plants the profit motive, “the high levels of trustand responsibility among producers and con-sumers reduce the occurrence of economiccrises while limiting the incidence of negativeexternalities such as pollution” (p. 65).

Feminist economists have been searching forways to make economic inquiry less male-biasedand more feminist, realizing that the lattereffort, by definition, takes a normative stancethat disqualifies it from being science in the eyesof many or even most mainstream economists.Seven of the essays in the volume focus com-pletely or partly on methodological issues, repre-senting a wide range of positions. In one ofthese, leading feminist philosopher of science,Sandra Harding, discusses ways to avoid the pit-falls of both positivism and relativism, whileanother key feminist economist, Julie Nelson,makes a strong case for “process ontology” whichviews the universe as alive, interconnected,based in experience, and inherently value-laden,as opposed to mainstream economics’ dualisticview of “hard” positive theory and “soft, fuzzy,and unimportant” normative analysis. Finally, ina “post-ist” (e.g., postmodernist, poststructural-ist, postcolonial) analysis of mainstream econom-ics which is unusually comprehensible, NitashaKaul notes the ways in which economic theoriesare “productive enterprises” producing a versionof reality, including a group of outsider topicsand people.

The book’s third part, entitled “ConstructingMasculine/Western Identity in Economics,”includes two fascinating articles that use psycho-analytic concepts to analyze mainstream econom-ic concepts. Edith Kuiper looks at Adam Smith’s

construction of the moral man in The Theory ofMoral Sentiments, convincingly arguing that thecommon view that Smith’s man “feels for others”is incorrect. In fact, she argues, Smith views menas incapable of experiencing emotional connec-tion or sharing feelings. This is part of Smith’sunconscious project of establishing a masculineidentity that is “radically separate from womenand all the emotionality and passion associatedwith them” (p. 146). The unconscious meaningsconnected with neoclassical economic conceptsare the subject of Susan Feiner’s thought-provok-ing, psychoanalytically grounded piece. Sheargues that the “idealized market . . . mirrors thefantasy mother of the unconscious” (p. 185).Feiner attributes the resiliency of mainstreameconomics to its appeal to the unconscious, andnotes that part of the feminist struggle has to takeplace on the symbolic level.

The book also contains a fine collection ofessays on a key topic in feminist economics: theunpaid caring labor of women. Among these,Nancy Folbre’s classic article, “Holding Hands atMidnight,” examines different theoretical expla-nations for the undervaluation of caring labor andthen underlines the problem of its declining sup-ply as women increasingly focus on gaining eco-nomic equality with men as a result of theundervaluation of caring labor. A systematicanalysis of “the caring situation,” centered in a setof useful concepts (relatedness, asymmetry,dependency, power structures, split functions,and one-way transfers), is contained in MarenJochimsen’s contribution; Jochimsen claims thatthese theories can help economic theory under-stand the many non-exchange-based economicinteractions. Susan Himmelweit presents a sim-ple and quite useful evolutionary model of theshift from full-time mothering to wage-earningmothering.

The essays in the book are uniformly well writ-ten, and both rigorous and readable (even to thenon-feminist-economist). I recommend it highlyboth to feminist economists who want to read cut-ting edge research in the field and to economistswho are not yet familiar with feminist economicsand want to learn about and from it.

JULIE MATTHAEI

Wellesley College

Modeling Rational Agents: From InterwarEconomics to Early Modern Game Theory. By

Book Reviews 145


Nicola Giocoli. Cheltenham, U.K. andNorthampton, Mass.: Elgar, 2003. Pp. x, 464.$125.00. ISBN 1–84064–868–6.

JEL 2004–0032While historians of twentieth-century econom-

ics have paid a great deal of attention to the workof Keynes and his followers, and to macroeco-nomics in general, the pendulum has begun toswing in recent years, with the appearance of anumber of books focusing on the history ofmicroeconomics, mathematical economics, andgame theory. For example, some readers of thisjournal will have already encountered Ingrao andIsrael’s The Invisible Hand (MIT Press 1990) or Roy Weintraub’s Stabilizing Dynamics(Cambridge University Press 1991), while manymore will have read Sylvia Nasar’s recent biogra-phy of John Nash, A Beautiful Mind (Simon &Schuster 1998). These books, and others likethem, offer varying perspectives on the evolutionof microeconomics in the century we have justleft behind. Some focus narrowly on the theory;others emphasize the relevance of biographicaldetails to scientific achievement; others attemptto relate the evolution of economic analysis tobroader developments in mathematics and thesciences. New to this company of historical writ-ers is Italian scholar Nicola Giocoli, winner of theHistory of Economics Society’s 2001 DorfmanPrize for his doctoral dissertation and author ofthis new book.

Modeling Rational Agents comprehensivelyexamines the evolution of microeconomic theorybetween the early neoclassicism of the turn of thetwentieth century and the game theory of vonNeumann, Morgenstern, and Nash. Giocoli’smain thesis is that microeconomics, which is takento include general equilibrium theory, has gone inthat interval from being a theory focused onSystems of Forces (SOF) to one focused onSystems of Relations (SOR). In the former, eco-nomic analysis is as much concerned with theprocess leading to equilibrium as with the finalstate itself, and there is an explicit concern for therelationship between the equilibrium constructand the “real world.” In SOR theory, on the otherhand, little attention is paid to process or, for thatmatter, to the relevance of such systems for theactual economic world, and great emphasis isplaced on the mathematical properties of equilib-rium, such as existence, stability, and uniqueness.Taking the lead from historian of mathematics

Leo Corry, Giocoli relates this shift in the contentof economic theory to a change in the latter’simage: if theory has moved in this particular direc-tion, it is because theorists’ expectations of whatthe theory is intended to accomplish havechanged too. Empirical description has been rele-gated in importance, Giocoli suggests, with math-ematical coherence tending to take precedenceover everything else.

Giocoli steers the reader through a vast rangeof theoretical contributions, using as a guidinglight the treatment of economic rationality andarranging his exploration according to severalbroad themes. An introductory chapter, “TwoImages of Economics,” sets out the plan of thebook, relating the above-mentioned change inthe image of economic theory to the mathemati-cal–historical background of Hilbert’s formalismand the later Bourbaki School. This is followed byfour thematic chapters and a conclusion.

A chapter titled “The Escape from Psychology”treats the evacuation from economics of all tracesof human psychology, with homo economicus ced-ing to a perfectly logical agent, and the explorationof the “how and why of equilibrium” giving way toa “consistency view” of economic rationality. “TheEscape from Perfect Foresight” deals with theinterwar attempts by Hayek, Morgenstern,Lindahl, and Hicks to create a theory that couldboth dispense with the assumption of the omnis-cience of agents and account for the emergence ofequilibrium in time. The chapter on vonNeumann and Morgenstern’s game theory exam-ines the former’s fundamental minimax theorempaper of 1928 and four chapters of their 1944book, The Theory of Games and EconomicBehavior. The Nash Equilibrium and its variousinterpretations are treated in the following chap-ter, while the concluding one explores the fortunesof game theory in the postwar period, arguing,inter alia, that the reason why neoclassical econo-mists initially ignored Nash’s work was because ofits inability to address their lingering Systems ofForces-style concerns for the relationship betweenrationality and equilibrium.

As Giocoli himself mentions at the beginning,his approach is to provide a rational reconstruc-tion of the evolution of theory. The result is a his-tory peopled by theorists who periodically arriveat decision nodes and make theoretical choices,which in turn constrain their subsequent choices.Thus, if the book purports to be a history, the



decision tree, nonetheless, lurks close beneaththe text. In keeping with this, Giocoli’s exclusivefocus on published theoretical contributionsensures that the economists of his history them-selves remain rather one-dimensional creatures,lacking any of that psychic or human depth withwhich the book is otherwise so concerned: wenever really get to know any of the charactersinvolved. Also, the assiduous focus on economictheory, mathematics, and the philosophy of math-ematics is achieved at the expense of acknowl-edging the tumultuous social context in whichsome of these theoretical developments tookplace. Finally, there is a suspicious tidiness to thishistory: theoretical commitments in economicsare easily explained in terms of commitmentselsewhere and theorists are convenientlygrouped under rubrics such as the “escape frompsychology” or the “escape from perfect fore-sight.” At times, given the sheer variety and inter-est of the theoretical contributions underdiscussion, one cannot help finding theSOF/SOR framework somewhat constraining.

These, however, are minor historiographicalquibbles, for one does not have to adopt Giocoli’sinterpretative framework in order to appreciatehis thoughtful, measured, and detailed discussionof the contributions of a gamut of authors, fromMax Weber to John Nash. This book is a rich andstimulating read, the product of careful labor, andit can be wholeheartedly recommended to read-ers of this journal, some of whom may wish torecommend it as background historical reading atthe advanced undergraduate and graduate level.

ROBERT LEONARD

University of Quebec, Montreal

A Companion to the History of EconomicThought. Edited by Warren J. Samuels, Jeff E.Biddle, and John B. Davis. Companions toContemporary Economics. Malden, Mass.;Oxford and Carlton, Australia: Blackwell, 2003.Pp. xvii, 712. $134.95. ISBN 0–631–22573–0.

JEL 2004–0028So what do economists retort when, after

announcing their activity to a questioner, thereply comes back “Ah! The dismal science.” Dothey mumble something about the stupidity ofsuch a view? Or do they contend that Carlyle, theoriginator of the phrase, was not an economist?Why not approach the problem from an econo-mist’s perspective and ask what was the context

for Carlyle’s condemnation of our noble profes-sion? Read this impressive compendium ofpapers, incorporating thirty-nine chapters writ-ten by forty-six historians of economic thought,and you will be ready to counter the man-in-the-street any time he mentions the “dismal science.”

The book is divided into two sections with part1 incorporating historical surveys and part 2dealing with historiography. The two sections arelinked through Jeff Biddle’s introduction wherehe poses the question as to what historians ofeconomic thought do? Are they primarilyexegetical interpreters of the great person’swork? Or perhaps they are taxonomists siftingand classifying ideas under various schools andthen drawing up the great battle lines that sepa-rate and have separated these schools? Or arethey absolutists in pursuit of the holy grail oftruth linking together the ideas of past econo-mists to provide a continuous upward movementtoward the ultimate truth of what economics ismeant to mean? Or are they holistic interpretersof human activity believing that lives and ideasare interlinked while George Stigler snorts in hisgrave that science is separate from life?

The book starts with Todd Lowry’s beautifullycondensed survey of the contributions of ancientand medieval economics. To this Hamid S.Hosseini provides a timely reminder, during aperiod when Islamophobia is gaining ground, ofthe contributions of medieval Muslim scholars tothe history of economics. Hosseini attempts todebunk Schumpeter’s Great Gap view that noth-ing of any relevance was written about economicsbetween the demise of Greek civilization and thewritings of Thomas Aquinas. As the reader worksup through Magnusson on Mercantilism, Breweron pre-Classical economics, Steiner onPhysiocracy, Skinner on Smith, O’Brien onClassical economics, he comes to Peart andLevy’s paper on “Post-Ricardian BritishEconomics 1830–1870.”

These authors, developing their own work andthat of Persky (Journal of Economic Literature1990), show that Carlyle used the term “DismalScience” when attacking economists for belong-ing to the antislave coalition. Carlyle attackedeconomists such as John Stuart Mill “because ofa view of human nature that abstracted awayfrom the possibility of racial difference” (p. 134).This difference of opinion between Mill andCarlyle on the issue of racial equality came to the

Book Reviews 147


fore during the Governor Eyre Controversy inJamaica. The Jamaica Committee, headed byMill and including John Bright, Henry Fawcett,J. E. Cairnes, Thorold Rogers, and HerbertSpencer wanted an investigation of Eyre’s run-ning of the Colony when over four hundredJamaicans had been massacred and many otherstortured and left homeless in 1865. The literati,led by Carlyle and Ruskin, and also includingDickens and Tennyson, sided with Eyre andopposed the Jamaica Committee. From Peartand Levy’s account the term “dismal” may beregarded as a badge of honor by economists as itwas equated with the idea of racial equality.Martin Luther King or Nelson Mandela wouldhave approved of being called “dismal” in thiscontext.

The “dismal economics” story is just one smallpart of a very rich body of knowledge in thisbook. Mark Blaug, a man whom Lodewijksreminds us has undergone many “changes ofmind” (p. 658), indicates the extent to which eco-nomics underwent a formalist revolution in the1950s during which end-state equilibrium theo-rizing took over the high ground and left “processanalysis relegated entirely to unorthodoxAustrian economics or equally unorthodox evolu-tionary economics” (p. 396). He accuses many oftoday’s economists as being the children of theseformalists producing a “community of mathe-maticians” where “cleverness, not wisdom or aconcern with actual economic problems, nowcame to be increasingly rewarded in departmentsof economics around the world” (p. 408). Is eco-nomics being set up for a future accusation of“dismal”? Or is it the case that the history of eco-nomic thought is becoming a refuge for a combi-nation of writers that are fleeing from (a) theabstractions and technical demands of moderneconomics and/or (b) the strong ideological biasof free market economics that dominates currentthinking? Lodewijks in “Research in the Historyof Economic Thought as a Vehicle for theDefense and Criticism of Orthodox Economics”provides a helpful paper to assist historians ofeconomic thought through these issues.

I have one regret with respect to this book. JoséLuis Cardoso dedicates his chapter “TheInternational Diffusion of Economic Thought” tothe late Ernest Lluch, a Spanish historian of eco-nomic thought, who was brutally murdered byETA terrorists in November 2000. Lluch was

both an inspiring academic and politician. Giventhe importance that the editors attach to the linkbetween economic theory and policy it wouldhave been most appropriate to dedicate thisbook, rather than a chapter, to a man who, as aminister in the Spanish government, spent part ofhis life linking economic theory and policy. Lluchwill serve as a role model not only for future gen-erations of historians of economic thought butalso for young people who believe economicideas may be harnessed for the benefit of societythereby dispelling the “dismal” association withthe subject.

ANTOIN E. MURPHY

Trinity College Dublin

D Microeconomics

Rationalizing Capitalist Democracy: The ColdWar Origins of Rational Choice Liberalism.By S. M. Amadae. Chicago and London:University of Chicago Press, 2003. Pp. xii, 401.$19.00, paper. ISBN 0–226–01653–6, cloth;0–226–01654–4, pbk. JEL 2003–1306Amadae has written a fascinating, detailed, and

challenging book that goes well beyond what thetitle intimates and provides the reader with a his-tory of rational choice theory in the context of theCold War and the ideological struggle betweenphilosophies rooted in individual freedom andthose embedded in Big Brother and thePhilosopher King. A central premise of this book,laid out in the Introduction and the Prologue, isthat rational choice theory (RCT) and its closerelation, rational choice liberalism, played apenultimate role in the defeat by free marketdemocracy of Communism and its statist, author-itarian, organic, and group ideological analogues.Central to this war was the development inAmerica of a mathematized ”neoclassical” eco-nomics as reflected in public choice theory whichprovided necessary theoretical weapons to dobattle in support of individual rights and marketeconomics. The oeuvres of Hayek, Schumpeter,and Popper, for example, could not suffice in theensuing struggle (little mention is made of IsaiahBerlin and other key European intellectual coldwarriors).

One might quarrel with particular theses putforth by the author or even with some criticalomissions. There is little discussion of Keynes


mr05_Book Review 3/30/05 1:44 PM 8

and the Keynesian Revolution as being possiblycritical to the victory of free market democracies.Nor is there consideration of multiple types ofsuccessful free market democracies or the exis-tence and stability of authoritarian organizationalforms, or how the rise of “new” ideologies (post-modernism, relativism, behavioral irrationality)might give legitimacy to such authoritarian alter-natives. And one can question the centrality ofmath as the necessary condition for the rise ofscientific economics and rational choice theory.This book is nevertheless highly recommended tothose interested in the development of contem-porary economic theory and its relationship tosocioeconomic and political change.

Amadae makes the case in chapter 1 that theRand Corporation, which developed after WorldWar II into a formidable interdisciplinary thinktank, as well as the Ford Foundation, played piv-otal roles in the development and spread ofrational choice theory and rational choice liberal-ism. It was at Rand that Arrow’s Social Choiceand Individual Values, as well as William Riker’spositive political theory and many of JamesBuchanan’s formative ideas on public choice the-ory were developed. Arrow’s contributions areviewed as foundational to the development ofRCT and to the philosophical defense of freesociety. Key Rand and Ford intellectuals andmovers and shakers (such as Robert McNamara)also played critical roles in reshaping Americanbureaucratic organization and practice (decisiontheory), and public policy in the 1960s. However,one can argue that their view was that the tech-nocracy should rule scientifically, independentlyof politics, stands in stark contradiction to thebasic premise of freedom and democracy and isquite consistent with authoritarian worldviews.

In chapter 2, Amadae presents a fascinatingdiscussion of the details and evolution of Arrow’s‘impossibility theorem,” the sovereignty andsanctity of individual preferences, rationality asconsistency, the impossibility of collective choiceabsent coercion, and the implications of this forliberal democratic free market praxis.. Amadaeargues that Arrow’s worldview undermines thetheoretical underpinning for authoritarian ideol-ogy, but also serves to weaken the ideologicalfabric for any form of collective action.

In chapter 3, James Buchanan and GordonTullock’s critique of benevolent governance byrational agents, which builds on Arrow’s work, is

well articulated. Although they constructed a the-oretical foundation for minimalist governmentand status quo politics wherein the constitutionmust be derived from the preferences of rationalself-interested individuals, Buchanan andTullock’s contributions and their creation of theinterdisciplinary Public Choice Society openedthe door to a multilayered discourse wherein thework of John Rawls was developed and discussed.Rawls’ rational individual based constitution wasopen to more government within the frameworkof free market democracy as was indeed Arrow’stheoretical frame. William Riker’s view of a polit-ical science based on rational choice, building onArrow, is discussed in chapter 4. Democracyserves here only to depose unwanted leaders.Mancur Olsen’s modeling of problems surround-ing collective action, absent coercion, derivedfrom self-interested individuals, is presented inchapter 5.

RTC (especially Buchanan’s perspective) andAdam Smith’s views on a just society are contrast-ed in chapter 6. Amadae argues that critical dif-ferences exists between the two world views,given that Smith relies on both the self-interestedindividual and the same individual imbued withthe moral sentiments of the ”impartial spectator”whereas in RCT we are left with the unrestrainedself-interested individual yielding maximumsocial welfare.

In chapter 7, marginalist economics with RCTare contrasted with regards to definitions of ration-ality and maximization. Amadae argues that the lat-ter focuses largely on consistency with no attentionto notions of scarcity, efficiency, or instrumentality.In chapter 8, RCT is discussed in the context of thecontributions of John Rawls’ rights based theory ofgovernance, wherein RCT-based arguments forgovernment intervention are raised. In this vein,the critical contributions of John Harsanyi,Amartya Sen, Russell Hardin, David Gauthier, andKen Binmore are brought to the fore. In thePrologue, Amadae critically summarizes his viewson RCT in relation to the marginalists and to theliberal democracy project.

This well-researched and thought provokingtext, in declaring the victory of liberty and free-dom in politics and the market, pays little heed tothe variety of policy inferences drawn by differ-ent proponents of RCT as well as to the existence,persistence, and rise of authoritarian ideologyand practice as we begin the new millennium. It

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remains to be seen how the various faces of RCTand the interplay between freedom and marketswill respond to this challenge.

MORRIS ALTMAN

University of Saskatchewan

Time and Decision: Economic and PsychologicalPerspectives on Intertemporal Choice. Editedby George Loewenstein, Daniel Read, and Roy Baumeister. New York: Russell SageFoundation, 2003. Pp. xiii, 569. $49.95. ISBN0–87154–549–7. JEL 2003–1315For many economists, hyperbolic discounting is

the most familiar example of time-inconsistentpreferences. This book seeks to expand our knowl-edge of the topic by examining other forms oftime-inconsistent discounting, by discussing howindividuals use self-control to overcome theseinconsistencies, and by applying these theories tohealth behavior and economics.

This book contains a collection of papers writ-ten by psychologists, behavioral economists, andother researchers in decision science. Originallyprepared for a conference on intertemporalchoice, most of these papers discuss recentdevelopments in the study of time-inconsistentpreferences.

Four sections follow the preliminary chapterof the book, which presents the standard eco-nomic model of intertemporal preferences(additive utility, exponentially discounted) anddescribes its logical shortcomings and empiricalrejections. The first section addresses the under-pinnings of intertemporal choice. One essayexamines the philosophical aspects of discount-ing (how can we justify attaching differentialweights to rewards at different times?); anotheranalyzes the evolutionary advantages of differentpatterns of behavior; a third describes the neu-robiology affecting intertemporal choice. For aneconomist, these essays primarily motivate theremainder of the book: they illustrate that thestandard economic models, based on time-con-sistent preferences, may be difficult to justifyphilosophically or biologically.

The second section presents theories underly-ing specific self-control behavior in situationswhere individuals have conflicted preferencesover a choice. One study discusses how the enjoy-ment received from delayed gratification maychange over time (as one becomes weary of adiet, for instance); another presents “self-control”

as a limited resource that individuals apply tothe most critical situations; a third examineshow individuals shy away from circumstancesthat would create conflicted preferences. Thefinal chapter in this section examines how indi-viduals force themselves to engage in activities(such as avoiding alcohol before noon) that sig-nal “desirable” preferences. Section 3 presentsmore general models of behavior. The firstpaper argues that most empirical tests of hyper-bolic discounting indicate “subadditive” prefer-ences instead: that discounting over a long spanmay be less than the sum of discounting over itssubintervals. Another paper in this section ana-lyzes how actions shape individuals’ future pref-erences, and how this in turn affects theircurrent behavior.

The final section contains applications. Most ofthese relate to health: a call for action on study-ing how time-inconsistent preferences affect pre-ventative health behavior, a study of therelationship between discounting and drugdependency, a paper displaying how “fear” can bean effective policy instrument to offset time-inconsistencies, and a discussion of behavioralanomalies of dieters.

The final two papers are the most relevant foreconomists. A chapter on inventories and self-rationing is particularly noteworthy. Its authorargues that, because of impulsive behavior andself-control problems, individuals’ current stocksaffect their current consumption (in contrast tothe predictions of the standard life-cycle model);furthermore, marketing seeks to exacerbateimpulsive behavior. This model suggests that con-sumption should track income somewhat; fur-thermore, it suggests that the availability of creditboosts spending even when liquidity constraintsare not binding (the author argues that this is whyfurniture stores advertise easy financing). Theauthor discusses how consumers respond by self-rationing (e.g., destroying extra credit cards toeliminate the temptation to spend).

The last paper simulates the life-cycle con-sumption and savings patterns of hyperbolic andexponential discounters. The authors comparethese to observed profiles; they argue that hyper-bolic discounting can explain why householdshold relatively little liquid wealth and relativelyhigh debts. As a consequence of these obliga-tions, consumers are unable to smooth consump-tion fully. Hyperbolic discounting can also be



used to explain phenomena such as the drop inconsumption around retirement.

Overall, these essays present compelling argu-ments that individuals may have conflicted pref-erences. They present supporting evidence,mainly from experiments designed to identify thehypothesized phenomena. However, aside fromthe last two chapters, little of the book attempts torelate the behavior to economics. One ends upwondering whether these theories predict sub-stantively different behavior from standard eco-nomic models when used to examine retirementbehavior or labor supply or education, forinstance. There is little discussion of such topics;there is less evidence to show that standard mod-els are inadequate. At the same time, these poten-tial shortcomings make the book an ideal startingpoint for economists who wish to apply the theo-ries to consumer behavior, health economics, andintertemporal choice. Questions that remain to beanswered include: How does one make welfareinferences when individuals’ actions conflict withtheir preferences? Do these theories betterdescribe observed nonexperimental behavior, andhow poor an approximation are the standardmodels? How can we use these theories to boostour understanding of economic behavior?

STEPHEN LICH-TYLER

University of Copenhagen

E Macroeconomics and MonetaryEconomics

Evolution and Procedures in Central Banking.Edited by David E. Altig and Bruce D. Smith.Cambridge; New York and Melbourne:Cambridge University Press, 2003. Pp. xii, 321.$60.00. ISBN 0–521–81427–8.

JEL 2004–0091This volume collects seven papers and fourteen

comments delivered at a May 2001 conferenceon “The Origins and Evolution of CentralBanking,” the first-ever conference to be spon-sored by the Central Bank Institute of theFederal Reserve Bank of Cleveland. The workstands as a fitting memorial to its coeditor, BruceD. Smith, the prolific monetary theorist whopassed away in 2002.

Papers are grouped into three sections:“Operational Issues in Modern Central Banking”(authors Jasmina Arifovic and Thomas J. Sargent;

Charles Goodhart); “Monetary Union” (Jürgenvon Hagen and Matthias Brückner; AlbertoTrejos); and—mirabile dictu for a conferencesponsored by a central bank—“PrivateAlternatives to Central Banks” (Gary Gorton andLixin Huang; Arthur J. Rolnick, Bruce D. Smith,and Warren E Weber; Randall S. Kroszner).

In choosing discussants, the editors might havedone more to avoid cliquishness. Several discus-sants are former coauthors or long-time formercolleagues of their assigned authors. A very heavyshare of the authors and discussants are present-ly or formerly associated with a single FederalReserve Bank. With respect to monetary theory,Cleveland is apparently a suburb of Minneapolis.But, in its concern for understanding concretehistorical episodes and institutions, this volumecontrasts markedly with the Minneapolis Fed’s1980 volume Models of Monetary Economies.

The four most interesting papers question insome way the rationale for central banking.Gorton and Huang observe that, while theFederal Reserve Act was motivated by runs andpanics in the nineteenth century U.S. bankingsystem, the panic-free experience of other coun-tries like Canada shows that “these problems donot arise in banking systems with a small numberof well-diversified banks.” They survey the his-torical experience and then present a model inwhich “banks are not inherently unstable institu-tions prone to panics.” (As discussant Edward J.Green points out, their model contrasts with“bubble” or “sunspot” models that picture banksas inherently unstable. Such models cannotexplain the historical cross-country differences inpanic-proneness.) They extend the model toshow that, given a panic-prone industry of under-diversified unit banks (as created by branchingrestrictions in the nineteenth-century UnitedStates), a bank panic can create negative exter-nalities by disrupting the payments system.These externalities rationalize in principle a (sec-ond-best) role for government. InterpretingGorton–Huang as making a second-best argu-ment resolves the puzzle, noted by discussantJohn H. Boyd, that the extension’s rationale forintervention reads on its face “like a critique of the preceding sections” that supported theoptimality of laissez-faire.

Rolnick, Smith, and Weber contrast the prac-tices of the Suffolk System (1826–58), a privatenote-clearing arrangement, with those of the

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federally chartered Second Bank of the UnitedStates (1816–36) with respect to their success atachieving a uniform currency (par circulation forbanknotes from all issuers). They conclude, aspersuasively as the incomplete evidence allows,that the Suffolk System “came much closer.” Itwould be interesting to investigate whether othercountries likewise achieved par circulationthrough private clearing arrangements. A bonusof the paper is a fiscal explanation for why stategovernments took a notoriously lax attitudetoward enforcing the banks’ contractual obliga-tions to redeem notes at par on demand: manystate governments either owned banks them-selves or heavily taxed their profits. In a coupleof places, the paper says that some banknotes“circulated at a discount,” but this phrase shouldprobably not be taken too literally. Given theinconvenience, it seems implausible that notescontinually circulated (passed repeatedly fromhand to hand) below par, in areas where specieor local at-par notes were available. Rather, out-of-town notes traded at a discount whenswapped for at-par notes or specie at specialistnote-dealers (who thereby removed them fromcirculation). This interpretation is consistentwith the evidence we do have, series of quotedprices from such dealers.

Trejos argues that “given current trends towardincreased openness, small economies will find itundesirable and even unfeasible in the long runto maintain a central bank and an independentcurrency.” The paper surprisingly neglects theexisting literature on dollarization, but discussantKlaus Schmidt-Hebbel partially fills the gap.Schmidt-Hebbel offers an interesting diagramcapsulizing different views on welfare propertiesof various exchange rate systems, but unfortu-nately the labels on three of his diagram’s fivecurves do not match his text.

Kroszner provocatively proposes that centralbanks have inflated less since 1980 becauseimprovements in transaction technology havesubjected them to stronger competitive disci-pline. Discussant Jeremy C. Stein correctly cau-tions, however, that erosion of a central bank’smarket share can lead it to inflate more if it triesto make up for a smaller seigniorage tax base witha higher tax rate. More evidence is needed toconfirm Kroszner’s explanation. Kroszner consid-ers future scenarios for currency competitionsuggested by the “free banking” literature.

Three other papers take central banking forgranted and consider issues related to monetarypolicy regimes. Arifovic and Sargent report oninteresting laboratory experiments in which par-ticipants were placed in a repeated Kydland–Prescott-type monetary policy game. The time-inconsistency problem reared its head in the lab,but not as severely as in the one-shot KP model.Goodhart muses on the future of monetary poli-cy. Von Hagen and Brückner describe the firsttwo years of the European Central Bank’s makingof monetary policy.

One hopes that any future conference volumesfrom the Central Bank Institute meet the highstandard for relevance established here.

LAWRENCE H. WHITE

University of Missouri, St Louis

Who Will Pay? Coping With Aging Societies,Climate Change, and Other Long-Term FiscalChallenges. By Peter S. Heller. Foreword byJeffrey D. Sachs. Washington, D.C.:International Monetary Fund, 2003. Pp. xiv,315. $28.00, paper. ISBN 1–58906–223–X.

JEL 2004–0485The subtitle to this book is “Coping with Aging

Societies, Climate Change, and Other Long-Term Fiscal Challenges.” In fact, the book isn’tabout specific policies to cope with climatechange or demographic shifts. Rather it is, first,an analysis of why governments should look farahead in planning spending and tax policies and,second, how the framework within which fiscalpolicy is set should be adapted so as to avoidunsustainable paths.

The first half of the book is in many ways themore interesting and controversial. Heller beginsby spelling out some of the major factors that willshape the environment in which fiscal policy isset in the future. Early on a rather daunting list offactors is given:

“. . . the ageing of populations, global climatechange and other environmental pressures,globalization and the greater interconnect-ness it brings, the growing disparitiesbetween rich and poor nations, the explosivegrowth of massive urban centers, continuedrapid technological change, and potentialresource scarcities. The prospect of disrup-tive events that are even more difficult toforesee—like those of September 11,2001—adds a further layer of uncertainty.”



Heller’s position is that it is crucial for policy-makers to begin to grapple with the challenge ofinsuring long-term fiscal sustainability in the faceof these highly uncertain developments. But henotes that there are at least two other possibleresponses, quite contrary in their implications.One argument would be that living standards onehundred years from now will be so much higherthan they are today that the fiscal consequencesof the range of factors listed above can be rea-sonably handled. A quite different line of reason-ing is that the degree of uncertainty about thesefactors is so enormous that planning fiscal policytoday, in the light of where debt levels might be50, 60, or 100 years from now, simply doesn’tmake much sense. Heller takes issue with both ofthese arguments, and along the way makes somegood points. He argues, surely correctly, thatamid the very many uncertainties about thefuture, some things are known with sufficientcertainty to raise very clear doubts right nowabout the capacity of governments to pay forexplicit and implied commitments they havealready made to their citizens. And numerouscalculations on calibrated, overlapping genera-tions models show that these are not problemsthat can simply be passed on to some unknownwealthier future generation; doing so wouldalmost certainly impose dramatically larger bur-dens on generations of future tax payers and thedamage this might do is potentially large and theability of future generations to tolerate such aburden uncertain.

As regards ageing, the argument that govern-ments should pay attention to the likely long-runimplications of current commitments on pen-sions and health is compelling. The argument asapplied to the impact of climate change is, how-ever, less so because the uncertainties are somuch greater. Recent work by Nordhaus (1998,“New Estimates of the Economic Impacts ofClimate Change,” mimeo, Yale University) sug-gests that the costs of putting in place new poli-cies to reduce emissions of greenhouse gasses byenough to have any substantial effect in thefuture are very large and the value of any effect inthe future is so uncertain that a policy of “‘waitand see” (while trying to reduce uncertainty bydevising means of seeing better) is optimal.

On balance, Heller makes a pretty convincingcase in the first part of the book that in setting fis-cal policy governments should look far further

ahead than is typical, where projections three tofive years out are often thought adequate. Hellerthen moves on to consider how the way in whichfiscal policy is formulated can better reflect thoselong-term factors. There is a pretty long anddiverse list of recommendations that emerges inthe second part of the book. Some of these arehard to disagree with—more information on thelong-term implications of policy, greater trans-parency, and greater disclosure of accrual of lia-bilities all seem unambiguous goods. It is alsohard to disagree that governments should use sto-chastic simulations to assess how policy mightneed to evolve under different scenarios.

It is rather less clear what to make of the rec-ommendation that peer pressure from multina-tional regional institutions is helpful (as is impliedon page 225). Indeed it is very doubtful whether“the surveillance mechanisms within theEuropean Union provide a useful model.” First,under the stability and growth pact the govern-ments of the largest economies in Europe have,effectively, ignored its rules on deficits when itfavored their doing so. More fundamentally,because the way in which deficits are measureddoes not take into account longer term factors(for example making no distinction betweendeficits to finance current as opposed to capitalexpenditures) it really is a rather poor tool forthese purposes.

In many ways, Heller reaches somewhatgloomy conclusions about the ability of govern-ments in developed economies to handle some ofthe more predictable problems emerging fromdemographic change. He is skeptical, for exam-ple, about whether there is much scope for sig-nificant cutbacks in other areas of spending tomake room for the anticipated growth of pre-committed expenditures on pensions and health-care. His conclusion is that reform needs to bemade at the level of individual programs, ratherthan in the aggregate budget.

In his conclusions, Heller once again stressesthat certain events are highly likely and, whilethere is great uncertainty about many factors, thefact that some things are highly predictable meansthat taking account of them now is sensible. This isa reasonable argument. But when he comes to listthose things that “will occur with a high degree ofprobability” (p. 221) one is not entirely convinced.The list is: shifts in the age structure of popula-tions, changes in climatic conditions, continued

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globalization, and ongoing dramatic technologicalprogress. Added to the list we have: “The prospectof increased geopolitical tensions is also very real”(p. 221). I left this book doubtful that even amajority of this list of projections would occur withhigh probability.

DAVID MILES

Imperial College London

F International Economics

Imports, Exports, and Jobs: What Does TradeMean for Employment and Job Loss? By LoriG. Kletzer. Kalamazoo, Mich.: W. E. UpjohnInstitute for Employment Research, 2002. Pp.ix, 221. $36.00, cloth; $16.00, paper. ISBN0–88099–248–4, cloth; 0–88099–247–6, pbk.

JEL 2003–0525The costs and benefits of free trade took on

great political significance in the recent electionyear environment. Politicians who deal with tradeissues have much to learn from economists, andindeed from this book, which provides solidempirical evidence in support of two key princi-ples that should inform policy debate. Principle#1 is that trade is good absolutely. By that econo-mists mean that trading between countries inexploitation of comparative advantage increasesefficiency, defined as resulting globally in thesame goods and services being produced for lesscost, or more goods and services being producedfor the same cost. Principle #2, and the real focusof this book, is that the consequences of interna-tional trade are uneven and because of this tradeproduces “winners” and “losers” even where theeconomy as a whole may benefit. Pro-free tradegroups tend to highlight the benefits of tradeowing to Principle #1, whereas anti-free tradeadvocates focus on broad based differences in theconsequences of trade for particular sectors orgroups of workers. This book is clear that econo-mywide positive net benefits do not precludelocalized negative net benefits. Its emphasis is onthe distributional costs of free trade.

This book has three main parts—a review ofthe theory, a review of the empirical literature,and the author’s empirical analysis for manufac-turing industries. The theory review is a neces-sary synopsis of the international trade theoryliterature from “Comparative Advantage” to the“New Trade Theory.” It is a well integrated

review for the informed economist and an easy tofollow primer for the less well informed. Theempirical review offers evidence from earlierstudies on globalization and its connection withrecent U.S. manufacturing woes. It makes clearthat the literature (exclusive of this study) hasfocused primarily on the impact of trade onwages and only secondarily on the impact of tradeon employment. Job loss (as distinct fromemployment) has been virtually overlooked. Aconsensus emerges that international trade hashad minimal effects on the level of manufactur-ing employment in the United States over the1980s and early 1990s, but that it has profoundlyimpacted the distribution of employment acrosssectors. The third part of the book—and thebook’s core—is the author’s empirical evaluationof the distributional impact of international tradeon employment and job loss in manufacturingfrom 1979–94. The relative costs and benefits offree trade for particular manufacturing industriesare evaluated here.

Using descriptive data and empirical analysis,the book offers the reader several importantfacts. The descriptive data reveal that sharplydeclining exports were strongly associated withemployment decline, particularly in industriesthat accounted for the bulk of manufacturing sec-tor employment loss over this period. Althoughrising imports are also strongly associated withemployment decline, this is typically the case insmaller industries that are heavily import-com-peting. The impact of exports and imports foremployment and job loss is not exactly balanced;export-declines exert a more potent effect.Finally, “unbalanced” manufacturing industries,characterized as heavily importing or heavilyexporting with little intraindustry trade, were sig-nificantly more vulnerable to employment lossesover this period.

The empirical evidence offered adds to ourunderstanding of the distributional impact of tradeon workers by examining employment and sec-toral job loss. The book establishes that increasingexports (and domestic demand) enhancedemployment to a considerably stronger degreethan increased imports reduced employment.Within an industry on a year-to-year basis, risingexports were more strongly associated withemployment growth than were increases indomestic demand (although the parameter esti-mates on exports are overstated given the partial



equilibrium structure of the model). Within-sectorestimates reveal that job loss is more closely linkedto the loss of exports than either the loss of domes-tic demand or rising imports (which is statisticallyinsignificant in any case).

The United States lost 13.4 percent of its man-ufacturing jobs over the 1979–94 period studiedin this book. What would employment trendshave been if trade flows had remained constantover the 1979–94 period? According to the esti-mates presented in this book, manufacturingemployment would have declined by even more—16.2 percent—in the absence of changes in theterms of trade. This is because the positive effectsof growing exports after 1985 was a stronger netjob creator than the negative effects of risingimports. Among the book’s key conclusions is thattrade has had a small albeit net positive job cre-ation influence over this period in manufacturing,to the tune of an estimated 7,626 new jobs.

But of course domestic employment and jobloss outcomes have not been uniform acrossindustries. For some industries, especially thosewith high import-share content, the link betweenrising imports and employment and job loss hasbeen profound. Since these industries may berelatively high paying and heavily unionized(steel and other metal-related industries forexample), the consequences of displacement forworkers are more severe and long term. Althoughthe book advocates in favor of domestic adjust-ment assistance programs such as retraining andpartial compensation to protect displaced work-ers, it does not spell out a clear strategy or a set ofprograms that might actually work. It is also notclear on the costs of such a program. Since theoutsourcing of jobs is a critical policy issue today,this is a miss. The book makes a convincing argu-ment in favor of multilateral reductions in tradebarriers and export promotion and backs it upwith solid analysis. Few economists would arguethat this is sound policy because the benefits out-weigh the costs. But what’s left for good gover-nance is to figure out a better way to compensatethe losers and move the policy forward.

Linda A. BellHaverford College

Dollarization. Edited by Eduardo Levy Yeyatiand Federico Sturzenegger. Cambridge andLondon: MIT Press, 2003. Pp. ix, 341. $45.00.ISBN 0–262–12250–2. JEL 2003–0545

The main purpose of this book is to examinethe many issues that countries need to consideras they contemplate a move to (de jure) dollar-ization. No definite conclusions are drawn withregard to the long standing debate on fixed ver-sus flexible exchange rates. The latter, as theeditors correctly observe, can never be com-pletely resolved, owing to the inherent com-plexity of the issues involved as well as themany country-specific factors that have to beconsidered.

Although the objective of the book may be lim-ited, the papers that comprise this volume never-theless cover a broad range of issues. They werewritten as part of a study commissioned by theCentral Bank of Argentina at a time whenArgentina and several other Latin Americancountries were actively considering dollarization.While some of the momentum and early enthusi-asm for this exchange rate alternative has dissi-pated, the analyses that are presented providemany useful insights and have more generalapplicability.

The main message that emerges is that dollar-ization, like marriage, should not be regarded asa panacea nor entered into lightly. The practicalproblems that must be confronted, coupled withthe uncertain consequences of such a decision,recommend against any hasty commitments.Although some proponents of dollarization stillfavor a “just do it” approach, in which countriesdollarize in the hopes that optimum currencyarea considerations and institutional details willtake care of themselves, this seems to be aminority opinion.

The book begins with a “Primer onDollarization,” by Levy Yeyati and Sturzenegger,which provides a summary of the seven otherpapers in the volume and a review of the majortheoretical arguments for and against dollariza-tion. Traditional Mundellian approaches to thechoice of exchange rate regime are contrastedwith the more recent literature, which placesgreater emphasis on credibility concerns andfinancial vulnerability as important drivers ofdollarization. This capstone paper is followed bya similar piece, by Chang and Velasco, who usea simple stylized model to highlight some of theambiguous welfare implications of dollarization.Like many of the papers that follow, it is, on bal-ance, not very supportive of the dollarizationoption.

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Panizza, Stein, and Talvi take a more groundedapproach in their paper and attempt to measurethe net benefits of dollarization from the per-spective of Central American and Caribbeancountries. While the results suggest that many ofthe countries in their sample would be better offunder de jure dollarization, these should be inter-preted with considerable caution owing to thestrong assumptions that the authors are forced tomake.

Neumeyer and Nicolini focus on a much nar-rower question (but the one that was probably ofgreatest interest to those who sponsored thisstudy). They look at balance sheet data for vari-ous sectors of the Argentine economy over the1994–2000 period, and try to determine if itwould be preferable (from a fiscal standpoint) forArgentina to officially dollarize and then “explic-itly default” on its domestic debt or, alternatively,to float and “implicitly default” on its domesticdebt through devaluation and inflation. In theend, the authors conclude that it is impossible tosay anything definite, given the difficulty associ-ated with interpreting the balance sheets ofArgentine banks.

Devaluation and default risk are also the focusof Powell and Sturzenegger, who explain whyinterest rate spreads and default risk will not nec-essarily decline following dollarization. While dejure dollarization would eliminate the risk ofdevaluation (at least against the chosen curren-cy), it might also result in more rigid prices andwages, reduce government revenues through lostseignorage, and restrict the government’s roomfor manoeuvre in the event of a financial crisis,owing to the absence of a lender-of-last-resort(LLR) facility.

LLR considerations are highlighted in many ofthe papers included in this volume. However,Broda and Levy Yeyati give them special atten-tion and highlight some of the perverse effectsthat LLR might have on risk-taking behavior andthe vulnerability of the banking sector under par-tial dollarization. Full dollarization, they note,reduces the probability of exchange rate inducedbanking crises, but leaves the country exposed toother, more traditional, financial sector shocks.

The last two papers in the volume concentrateon a separate set of issues, concerning the transi-tion to dollarization. Gruben, Wynne, andZarazaga provide a practical step-by-step guide forwould-be dollarizers, describing how countries

should dollarize as opposed to if they should dol-larize. While many of their recommendationsmake sense, the most intriguing aspects of thispiece are the well reasoned, yet controversial,views that they offer on seignorage, LLR, andadjusting the terms of financial contracts.Although their heretical ideas are unlikely to beshared by many other authors, they neverthelessprovide interesting food for thought (and areconsistent with my own free market biases).

The final paper, by Frieden, serves as a useful,if somewhat ironic, conclusion to everything thathas preceded it. He examines the political econo-my of dollarization and observes that much of theprevious material in the volume is irrelevant.Drawing on his earlier research as a political sci-entist, he notes that the decision to move to anew currency regime is typically determined bytwo or three common factors. When he applieshis predictive model to European and LatinAmerican data, he finds general support for histheories—with Argentina as a notable exception.

Readers looking for definitive answers to thedollarization question or strong support for such amove will be disappointed with this volume. Forthose interested in thoughtful analysis and insight-ful investigation of a range of currency issues, theexperience will be more rewarding. Every paperin the volume is worth reading and provides a use-ful perspective. The main message that emerges isone of caution. Do not race into dollarization; theresults are uncertain and the transition is likely tobe painful. It is impossible to know what influ-ence this study might have had on some of thepolicy decisions which have been made over thelast few years. In the event, however, Argentina,the country which originally sponsored the study,has recently opted for a flexible exchange rate anda monetary policy framework based on inflationtargeting—a course correction for which I haveconsiderable sympathy.

John MurrayBank of Canada

G Financial Economics

The Econometrics of Corporate GovernanceStudies. By Sanjai Bhagat and Richard H.Jefferis Jr. Cambridge and London: MIT Press, 2002. Pp. x, 114. $24.00. ISBN 0–262–02517–5. JEL 2003–0130



This short book is a research allegory. Tworesearchers pursue a grand idea. Alas, it proves tobe intractable, or at least inscrutable. Properlychastened, the researchers refocus their effortson a less ambitious objective and emerge withsome interesting and provocative results.

Sanjai Bhagat and Richard Jefferis investigatewhether a firm’s takeover defenses affect its inde-pendence and managerial turnover. Conventionalwisdom holds that takeover defenses tend toentrench managers. If so, then firms with defens-es will tend to remain independent and theirmanagers will keep their jobs even in the face ofpoor performance.

The authors’ grand idea is that takeoverdefenses, takeover activity, and managerialturnover all are determined endogenously withthe firm’s governance, performance, and owner-ship. Previous research rarely acknowledges thesimultaneous nature of these phenomena. As aresult, empirical estimates of say, the effect oftakeover defenses on takeover activity, are biased.

A solution to this problem would be to estimatea structural model that treats takeover defenses,takeover activity, managerial changes, corporategovernance, firm performance, and ownership asendogenous. The authors even write down such amodel on page 35. But identifying the model isproblematic. For example, what exclusionrestrictions make sense? Are there any exoge-nous factors that affect takeover activity but notfirm performance? “. . .[W]e estimated differentspecifications of the system . . . based on exclu-sion restrictions and distributional assumptions,”the authors report. But, “We found the results ofthis exercise to be uninformative” (p. 38). I thinkthis means that the results are insignificant,counterintuitive, or highly sensitive to modelspecification.

So the authors redirect their efforts. Ratherthan tackling the endogeneity issue head-on, theyconduct a series of tests in which controls for firmperformance play a central role. The first testsexamine firm performance using analysis of vari-ance models. Two measures of firm perform-ance—market-adjusted stock returns andoperating cash flow—are higher for firms thatremain independent during a subsequent two-year period than for firms that subsequently areacquired. Performance also is relatively high forfirms with no change in management during thesubsequent two years. This implies that poorly

performing firms are strong candidates to beacquired or change their managers.

No surprise there, given prior research. Butthe data also indicate that prior performance isparticularly strong among firms that remain inde-pendent (or do not change managers) and havepoison pills. This is a head-scratcher, because ifstrong performance is a defense against takeover,why do firms with very strong performancerequire their poison pills? Do the pills contributeto the better performance? Did firms that wereacquired have pills? If so, what was their per-formance? Bhagat and Jefferis do not discussthese questions. Instead, they conclude simplythat the data support their initial claim, namely,that performance, defenses, takeover activity,and managerial turnover all appear to be related.An acerbic reader would note that we alreadyknew that.

The authors then estimate probit models inwhich firm acquisition and managerial turnoverare the (transformed binary) dependent vari-ables. In an unconditional test, firms withouttakeover defenses are more likely to be acquired.Again this is consistent with prior research. ButBhagat and Jefferis’s most striking result is thatacquisition likelihood is negatively related toprior performance only among firms that havetakeover defenses, particularly poison pills. Theauthors infer from this that performance swampsany effect of takeover defenses on the probabili-ty of being acquired. The correct interpretation,however, is that poorly performing firms aremore likely to be acquired if they have takeoverdefenses than if they do not.

This is a surprising result because it runs count-er to conventional wisdom. The conventionalview is that takeover defenses attenuate the linkbetween firm performance and the discipliningeffects of the market for corporate control. ButBhagat and Jefferis’ data imply that managersincrease their exposure to market discipline whenthey deploy takeover defenses!

The authors do not make this inference, per-haps because they are aware of the endogene-ity problem highlighted earlier in the book.For example, managers might adopt takeoverdefenses precisely because they anticipatepoor firm performance and future takeoverbids. This would explain the result that the per-formance–takeover linkage is particularlystrong among firms with takeover defenses.

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Still, having opened the book with a promise toinvestigate the effect of defenses on acquisitionprobability, the absence of any investigation ofthis issue is a disappointing omission.

The authors may avoid tackling some of thesemore challenging questions because of data limi-tations. The sample is creaky with age, consistingof 196 firms that had takeover defenses in 1984and 1985, plus 148 control firms without suchdefenses. Acquisitions and management changesamong these firms are tracked for only a subse-quent two-year period. Given the much largersamples and longer sample periods typical of cur-rent research in the area, few researchers willfind inferences from this sample to be definitive.

There also are problems in the definition oftakeover defenses. State takeover laws areignored, even though other researchers havefound them to substitute for firm-level defens-es. The authors argue that they can ignore stateantitakeover laws because the 1984–87 sampleperiod precedes their advent. This is simplyuntrue. From 1982 through 1987, twenty-eightdifferent states adopted approximately fortydifferent antitakeover laws.

Also important is how firm-level defenses aredefined. The authors include fair price provisionsand classified boards in their analysis. Poison pillsare treated separately. These are important pro-visions, but the analysis ignores such otherdefenses as supermajority vote requirements,restrictions on shareholders’ right to written con-sent, restrictions on shareholders’ abilities to callspecial meetings, and charter provisions thatdirect managers to consider the interest of non-shareholder stakeholders in directing corporateresources.

Despite these empirical criticisms, Bhagat andJefferis’s book provides an excellent summary of the deliberations of two accomplishedresearchers who have thought long and hardabout corporate governance issues. Not only arecorporate governance-related issues endoge-nous, but they also are difficult to unravel. Thetests reported in this book underscore just howcomplex some of these relationships are.

JONATHAN M. KARPOFF

University of Washington School of Business

Discriminating Risk: The U.S. Mortgage LendingIndustry in the Twentieth Century. By GuyStuart. Ithaca and London: Cornell University

Press, 2003. Pp. xi, 248. $39.95. ISBN0–8014–4066–1. JEL 2003–1397Guy Stuart analyzes the mortgage industry with

an eye toward developing a new institutionalstructure that “allows public and informed debat-ed about ‘who gets what’ in terms of access tocapital.” The value he most cherishes in develop-ing this structure is the “ability of people of allraces, ethnicities, and incomes to live in anyneighborhood, subdivision, or suburb theychoose” (p. 206).

To that end, he describes the lending processin the modern era with discussion of its historicalantecedents. He shows that mortgage lending isa complex process, but the central issue is thepredicted ability of the borrower to repay theloan. The industry believes that the ability torepay is a function of the borrowers’ income, theprice of the house, measures of the person’screditworthiness, and the relative quality ofhousing in the neighborhood where the house islocated. Mortgage lending in the early 1900srelied more heavily on personal knowledge bylenders who could assess the “character” of theborrower. The development of FHA and VAmortgage insurance and secondary loan marketsthrough Fannie Mae led to standardization ofloans and the development of rule-based deci-sion criteria, such as credit scores, that allowedsuch loans to become commodities that could bebought in secondary markets. The relativeimportance of these factors in determining whoobtains a loan has changed over time. Even so,decisions made by real estate agents and loanofficers still influence the process.

Since independent appraisals of house valueare central to the process, he provides a chapteron the development of the appraisal profession,including how different approaches to valuewere synthesized by the leading professionalgroup and the long-time emphasis on homo-geneity of neighborhoods. He discusses the roleof government policy in initially reinforcing seg-regation and homogeneity of neighborhoodsthrough the 1960s and the attempts to reducediscrimination in lending since. Using data fromChicago, he provides evidence on how neighbor-hoods are “constructed” by the real estate indus-try and then provides tables of evidence ondifferential denial rates for ethnic groups forvarious types of loans, institutions, and housingmarkets.



Throughout the book, he is particularly inter-ested in the feedbacks between rules, lendingnetworks, and the spatial distribution of people.In many cases, he suggests that lending networkdecisions are based on rules that are influencedby the neighborhoods where people are seekingto buy. Borrowers seeking homes in neighbor-hoods with substantial heterogeneity in valueand/or dominated by low income people andminorities tend to face greater problems inobtaining prime mortgage loans. Since absenceof lending can lead to deterioration of neighbor-hoods, the failure to lend can lead to a self-fulfill-ing prophecy of foreclosures and neighborhoodfailure. This in turn creates problems for minori-ties and low-income people to show that they aregood credit risks. The final chapter of the book isdevoted to presenting policy prescriptionsdesigned to breakdown these feedback effects.The big question is the severity of the problem.Stuart gives evidence that the problems mightstill persist, but before I put the industry throughStuart’s policy overhaul, I would like to knowmuch more about the magnitude of the problem.

Stuart’s historical discussions and institutionalcase studies are quite useful. Yet, economists willbe disappointed in the analysis of discriminationin chapter 5 and assessments of whether thelending criteria met standards of “business neces-sity” in government Fair Lending criteria (pp.193–95). The tables designed to assess discrimi-nation in denial of loans are simple cross-tabula-tions and the author does not attempt his ownmultivariate analysis. The author’s analysis is,therefore, much simpler than the complex analy-sis done by a number of institutions in the realestate industry. A central problem in Stuart’s viewis that existing parameters that determine loanquality might be focusing too much on the quali-ty of neighborhoods. He cites one study thatshows that credit scores are influenced by eco-nomic features of the zip codes in which the per-son resides. But then we find that the cited studyincludes no information on the individuals them-selves (p. 173), raising real doubts about the con-clusions we would draw had controls forindividual characteristics been included.

There is no careful attempt to analyze whetherthe loan procedures actually meet the “businessnecessity” criteria for fair lending. The authornever really defines what he means by “businessnecessity.” Too often he relies on statements from

other studies without giving us a sense of themethods used in those studies.

In the final chapter, he suggests a series of pol-icy changes. As one example, he calls for anexpansion in the roles played by Fannie Mae,Freddie Mac, and the FHA in sub-prime lendingmarkets. But there is very little discussion of howthe three institutions already play roles in parts ofthe sub-prime market and of their antidiscrimi-nation policy changes circa 2000. His prescrip-tion that Freddie and Fannie insure sub-primeloans raises a whole host of issues about subsi-dized insurance that are addressed inadequately.I share his goals that people of different ethnicgroups and minorities should not be denied loansunfairly. Although his intent “is not simply to actas a bomb-thrower” (p. 206), I was left hungry formore information that would allow me to assesswhether his policy bombs will be improvementsthat solve more problems than they create.

PRICE V. FISHBACK

University of Arizona

Moving Money: Banking and Finance in theIndustrialized World. By Daniel Verdier.Cambridge; New York and Melbourne:Cambridge University Press, 2002. Pp. xiii,311. $65.00, cloth; $24.00, paper. ISBN0–521–81413–8, cloth; 0–521–89112–4, pbk.

JEL 2003–0957A recent wave of scholarship has focused on

the nexus between financial development andeconomic growth. Advocates of the “finance-led”view of growth have suggested that institutionaldifferences in banks, securities markets, andmonetary arrangements may provide additionalinsight into why we observe variation in rates ofcapital accumulation and technological growthacross countries. The roots of empirical inquiryinto this subject lie in the observed differences inthe structure of financial systems across coun-tries, even those with comparable levels of eco-nomic development. Why do such differencesexist? In Moving Money, Daniel Verdier tacklesthis question for a set of industrialized countriesover the past one and a half centuries. Verdierfocuses on how state structure has influenced theevolution of financial systems in roughly a dozencountries—a set that consists of Western Europeand a group of British offshoots. The small sam-ple permits the author to develop a fairly detailedhistorical account of how their financial systems

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evolved and to do so in a comparative fashion.Scholars interested in understanding how nation-al banking systems have changed over time andthe forces that induced these changes will findthe rich historical detail particularly useful.

In the first part of the book, the author explainshow centralization might affect the structure ofbanking systems and the mobility of capital.Verdier’s main point is that the extent to which astate is centralized determines how financial mar-kets are organized. He argues that, due toagglomeration effects, financial capital, if leftunimpeded, has a tendency to flow toward cen-ters of economic activity. (A mathematical modelis provided in an appendix.) If governments aredecentralized in orientation, then local govern-ments, businesses, and banks will have propor-tionately more power, and will use this to block orimpede the flow of finance from the periphery tofinancial centers by encouraging regulatory inter-vention. As a result, he argues that banking struc-tures in decentralized countries will have lessmarket liberalization in their financial sectors, lessdeveloped stock markets, and less international-ized banking systems. In contrast, more central-ized countries are not as likely to impede the flowof finance to financial centers; this, in turn, willlead to financial systems with deeper financialmarkets and an international orientation as well asmore concentrated and specialized banking sys-tems. He suggests that bank regulation over thelast 150 years has been directed at altering thecompetition for market share between centrallylocated banks and those on the periphery.

The next two sections use cross-country datafrom two periods, 1850–1913 and 1960–2000, totest his thesis. For each period, Verdier devotesone chapter to four organizational characteristicsof financial systems: geographical concentration,internationalization, intermediation, and productspecialization. Each chapter provides a generaldescription of historical factors influencing thecharacteristics; this is followed by a description ofthe predictions from his model, scatter plotsbased on a subsample of present-day OECDcountries, and simple OLS regressions. Theorganization of these chapters makes for relative-ly easy comparison between the two periods;however, treating each characteristic in relativeisolation from the others leads to parsimoniouseconometric specifications, which fail to considerthe possibility of feedback effects.

Although Verdier acknowledges that other fac-tors may determine where capital locates andhow financial systems are structured, the book’ssingle-minded focus on the role of state central-ization as an explanatory variable gives otherpotential influences short shrift. This is notmeant to imply, for example, that changes infinancial products are not discussed, but ratherthat technology and economic growth are alsoimportant determinants of financial structure(and for altering regulation), and therefore couldhave been given more prominence, especially inthe empirical section. Similarly, the thesis paystoo little attention to differential rates of return asan explanation for the location of capital. Theauthor’s conclusions seem most relevant for theEuropean countries in the sample; the Britishoffshoots are often treated as outliers with uniquehistorical circumstances, and sometimes, peculiardefinitions of these countries are employed sothat statistical results including them will con-form to the thesis. (For example, all state-char-tered banks in the United States are categorizedas non-core (or periphery) banks even thoughmany state banks were located in large cities.)

The statistical analysis often suffers from lack ofidentifying variation, problems of small samplesize, and some curious omissions from the sample(Japan and Argentina). Ad hoc specifications,endogeneity, and omitted variables bias alsoundermine the empirical findings. And in somechapters, variable definitions seem peculiarly cho-sen. For example, why should market internation-alization be measured using gross foreigninvestment in 1914—a year when, because of thewar, investment flows are distorted and financialmarkets are operating abnormally? (The U.S.stock market actually shut down for nearly half theyear out of fear that Europeans would liquidatetheir holdings.) And why is it appropriate to com-pare U.S. net foreign investment with gross flowsin other countries in 1914 to measure internation-alization, especially since U.S. gross flows arelarge? (At this time, the United States was movingfrom a net debtor to a net creditor position.)

The book draws few lessons as to how anunderstanding of the factors that have shapedthese banking systems over the long run shouldbe used by policymakers. If state centralizationhas significantly altered banking structures,what is the appropriate response of policymak-ers? Does it matter for economic growth or for



financial stability? (Verdier’s view seems to bethat the current pace of disintermediation makeshis story about nineteenth century competitionover resources by core and periphery banks lessrelevant for understanding the future.) Since itexamines the present as well as the past, it wouldhave been nice if the book could have consid-ered in more detail how the movement to har-monize banking regulations across countries(Basle I and II accords) is altering the shape andstructure of national banking systems.

KRIS JAMES MITCHENER

Santa Clara University

H Public Economics

The Size of Nations. By Alberto Alesina andEnrico Spolaore. Cambridge and London: MITPress, 2003. Pp. x, 261. $35.00. ISBN 0–262–01204–9. JEL 2004–0146This book is a highly creative and lucid analysis

of the determinants of the number and size ofnations by the leading economists in the field. Itencompasses both theoretical modeling andempirical evidence; and the discussion rangesfrom the European city-states of the thirteenthcentury, through the colonial empires of thetwentieth century, to the modern-day EuropeanUnion. The book is a tour de force. It stands as anoutstanding example of how the rigors of eco-nomic analysis can be applied to new fields and ofthe insights to be gained from elegant andtractable formal models.

The nation-state is defined in terms of amonopoly of coercion and the legal use of forcewithin its boundaries. The central tenet of thebook is that the size of nations is determined by atrade-off between the benefits of economies ofscale in providing public goods (e.g., defense)and the costs of heterogeneity in preferencesover the provision of these public goods.

This raises the question why, instead of a uni-fied nation-state, we do not observe a series ofoverlapping jurisdictions that best resolve thistrade-off for individual public goods. The authorsargue convincingly that such a configurationwould face prohibitive transactions costs and failto internalize economies of scope. The nation-state monopolizes the provision of essential pub-lic goods (law and defense), and adopts a host ofother functions because of economies of scope

and transaction costs. Some functions are dele-gated to subnational levels of government, butsubnational jurisdictions do not cross nationalborders.

The book highlights a number of considera-tions that shape the way in which the trade-offbetween economies of scale and heterogeneity inpreferences is resolved. One is the politicalregime. Dictators will choose larger states thandemocracies because they can extract larger totalrents from larger populations. One of the impor-tant predictions of the analysis is, therefore, thatdemocratization will be associated with politicalseparatism and the breakup of large countries.This resonates with the experience of the formerSoviet Union and the post–World War II periodas a whole. A further finding is that democracymay not yield the socially optimal number andsize of countries because people who are ideolog-ically or geographically far from the center mayhave an individual incentive to secede. Whetherthe social optimum is attained under democracydepends on the feasibility of transfer payments.

Another consideration is the trade regime.Economies of scale imply that, under autarky,there is an economic advantage to being a largecountry. In contrast, under free trade, a country’smarket size is independent of its political size,and small countries may prosper. Thus, anothernoteworthy prediction is that economic integra-tion should go hand in hand with political disin-tegration. In their historical overview, the authorsargue that this is consistent with the experienceof the protectionist interwar period, when fewnations were created, and the trade liberalizationof the post–World War II period, when manynew countries came into being.

The international military climate also plays arole. If there are economies of scale in the provi-sion of defense, a more bellicose world tilts thetrade-off between economies of scale and het-erogeneity costs toward the former, so that coun-tries will tend to be larger and fewer in number.A further prediction of the analysis is, therefore,that a more peaceful world should lead to politi-cal separatism. Again this is consistent withevents since the end of the Cold War. For a givenprobability of conflict between any two nations,an increase in the number of countries raises theexpected number of conflicts, perhaps explainingwhy the post–Cold War “peace dividend” hasbeen smaller than anticipated.

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The authors examine issues of federalism anddecentralization, as well as the role of suprana-tional organizations such as the European Union.The trade-off between economies of scale andheterogeneity costs provides a framework forexamining which public goods should be providedat various levels of government. Decentralizationmay be a response to political separatism in orderto keep the nation-state intact.

As the authors themselves state, the book is notmeant to be the definitive word on the subject,but is intended to open up novel areas forresearch and ask more questions than it answers.More empirical evidence on the economies ofscale in the provision of various public goodswould be welcome, as would more evidence onthe role of size in determining prosperity and onhow this depends on the degree of economicintegration. As discussed in the book, variationacross subnational units within countries mayprovide an important source of identification.

There are links with a variety of other econom-ic literatures that seem open to fruitful furtherresearch. These include work on the microeco-nomics of sorting and segregation. Also relevantis the economic geography literature, whichendogenizes the distribution of income and peo-ple across space, but typically takes country sizeas given. There are a number of issues of politicaleconomy that could be explored further. How isthe quality of domestic institutions and externaltrade policy determined jointly with country size?What is the role played by vested interests? Howdoes this interact with the process of economicdevelopment?

What is clear is that this outstanding volumemakes path-breaking contributions and lights theway toward a rich seam for further research.

STEPHEN REDDING

London School of Economics and CEPR

Saving Social Security: A Balanced Approach. ByPeter A. Diamond and Peter R. Orszag.Washington, D.C.: Brookings Institution Press,2004. Pp. viii, 287. $32.95. ISBN 0–8157–1838–1. JEL 2004–0553Peter Diamond and Peter Orszag have pro-

duced an important book offering an objectiveassessment of Social Security’s financial outlookand a plan to restore its long-term solvency. Theirproposal has the important advantage of hon-esty—it is a comprehensive package of benefit

cuts and tax increases that actually would fix theproblem. There are no tricks and no free lunch-es. Anyone who reads the book carefully willcome to understand the rather complicated U.S.Social Security system, how we got into the cur-rent situation of projected shortfalls, and thedetails of a particular plan to fix it. While I don’tagree with all aspects of the authors’ prescription,their plan merits serious economic and politicalconsideration.

The authors proclaim in their title and repeat-edly in the text that theirs is a balanced approach.It is in one sense. The Diamond–Orszag planrelies roughly equally on cutting benefits andraising taxes to achieve long-run financial stabili-ty. In another way, however, the plan is not bal-anced. The big debate over the last twenty yearsregarding Social Security is whether the systemshould remain a defined benefit system (withbenefits determined by formulas) or whether weshould switch to a defined contribution system(usually termed “individual accounts”). In thisdebate, Diamond and Orszag are firmly in thedefined benefit camp. They want to keep thebasic structure of the system intact. I favor a two-tier or “some of each” approach and would char-acterize such two-part proposals as morebalanced.

Diamond and Orszag concentrate on three rea-sons why Social Security is in need of significantreform. First, there is the good news of dramati-cally increasing life expectancies. That may begood news, but it imposes financial problems ona system providing inflation-indexed life annu-ities. Second, they list increasing earningsinequality. And, third, they consider the legacycosts of the extraordinary deal that SocialSecurity offered the first couple of generations ofparticipants. Each of these factors causes theauthors to propose adjustments in legislated ben-efits (mostly cuts) and payroll tax rates (allincreases). The whole menu of adjustments ispretty sobering—but any plan that restores long-term solvency must have a comparable list oftough provisions.

The Diamond–Orszag plan can be character-ized as a “soak the rich” proposal. This isn’t par-ticularly surprising given their concern withincreasing inequality. For instance, they wouldintroduce a new 3 percent payroll tax applyingonly to earnings above the Social Security cutoff,currently $87,900. This tax would be over and



above the 2.9 percent Medicare tax that alreadyapplies above the same cutoff. This new 3 per-cent tax would be gradually increased as lifeexpectancy improved and these contributionswould not enter into the calculation of SocialSecurity benefits. This feature of completelyseparating these contributions from future bene-fits is a major departure from current practiceand would certainly be controversial. TheDiamond and Orszag proposal would also raisethe limit on earnings subject to full OASDI taxesfaster than the growth rate of wages in the econ-omy for the next several decades. Again, it is therelatively high income workers who will beaffected by this feature.

Diamond and Orszag would also concentratethe benefit reductions on people in the uppermiddle class and above. For instance, someonewhose average indexed lifetime monthly earningsgoes up by $1 and who earns between, say,$50,000 and $60,000 currently gets an extra 15cents per month in Social Security benefits.Gradually, Diamond and Orszag would lower thismarginal connection between average monthlyearnings and benefits to 10 cents. Meanwhile,their plan would increase the benefits for thosewith the lowest lifetime earnings histories. Thereis nothing wrong with the choices they make—Iam simply pointing out that they propose to sub-stantially increase the system’s progressivity—worsening the returns for the well off andimproving them for the poor.

Even though I have characterized the book’splan as a soak the rich one, the middle class hard-ly escapes pain. They can’t—in Willie Sutton’sfamous phrase—“that’s where the money is.” Thecurrent combined employee and employer pay-roll tax rate to finance OASDI is 12.4 percent.The Diamond–Orszag proposal would graduallyraise that rate to 13.43 percent in 2040, 14.43percent in 2060, and 15.36 percent in 2078.Average earners would bear these higher ratesand still see their benefits reduced from currentlegislated levels. Someone who is twenty-fiveyears old today would have their benefits reducedby about 8.6 percent, for instance.

There are aspects of the book with which I dis-agree. I think that both defined benefit plans anddefined contribution plans are risky and that ele-mentary portfolio theory would argue that SocialSecurity should have some of each. The authorsthink that the accumulation of the Social Security

trust fund over the last twenty years has added tonational saving. I think that the evidence indi-cates that the extra Social Security receipts havefinanced income tax cuts and government spend-ing and not resulted in any extra national wealth.I think that they may be overdoing it in the nameof progressivity in removing the link betweentaxes and benefits for high-income participants.

However, despite these disagreements, this isan important book that must be considered byanyone interested in reforming Social Security. Itis the most complete, thoughtful, and honest pro-posal yet of the “save the current system” type. Ifavor a more radical overhaul of Social Security,but it is great to have such worthy opponents.

JOHN B. SHOVEN

Stanford University

Wealth and Our Commonwealth: Why AmericaShould Tax Accumulated Fortunes. By WilliamH. Gates Sr. and Chuck Collins. Boston:Beacon Press, 2002. Pp. xiii, 166. $25.00. ISBN0–8070–4718–X. JEL 2003–0968A furious debate surrounds the future of the tax

levied on the estates of wealthy individuals afterthey die, a tax scheduled to be phased out by leg-islation enacted in 2001. For arcane reasons, theestate tax will only be eliminated for one year—2010—after which it will rise from the gravewhen the 2001 act expires.

This book’s authors are two of the nation’s mostprominent supporters of the estate tax. Bill GatesSr., father to the Microsoft billionaire and awealthy man in his own right, organized thefamous millionaires’ petition to preserve the tax.Chuck Collins is a liberal activist who foundedseveral organizations aimed at advocating infavor of progressive taxation and preservation ofthe estate tax. Their book is a panegyric to theestate tax.

The short book is a remarkably easy read fora tax treatise because it is well written and theauthors’ passion for the subject comes through.The book is not a balanced assessment of theestate tax, and not intended to be. The authorsare convinced that “the estate tax helps makeAmerica great” (p. 2). Although possibly in needof reform, they argue the tax is absolutelyessential to support the American way of life.

The book’s treatment of economic issuesinvolved in the estate tax debate is selective andwill not be of much interest to economists. A

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better source for an economic assessment of the estate tax is Rethinking Estate and GiftTaxation edited by William G. Gale, James R.Hines Jr., and Joel Slemrod (Washington, D.C.:Brookings Institution Press, 2001).

Instead, Wealth and Our Commonwealth isprimarily a philosophical treatise, arguing inalmost Rawlsian terms that taxing estates is aphilosophical imperative justified by first princi-ples. Indeed, the book invents a new version ofthe Rawlsian veil of ignorance: how much of one’sestate would someone precommit for the privi-lege of being born in the United States ratherthan in an impoverished third world country?

The philosophical arguments are backed byhistorical research and even biblical citations.Some of the historical tidbits are fascinating.Estate tax advocates during the Civil War andSpanish–American Wars promoted it as a “con-scription of wealth” (p. 36), a partial offset to theconscription of life and limb exacted from thoseof lesser means. The modern estate tax cameabout as a result of the efforts of progressiveRepublicans, led by Theodore Roosevelt, whosaw it as of a piece of their efforts to rein in therobber barons.

The book’s central thesis is that the estate tax isan appropriate levy on the wealthy, those whobenefit most from government, a persuasiveargument in 1916 when the estate and incometaxes were created. Even tax cutter AndrewMellon apparently concluded that “unearnedincome,” that is, income from capital, should bemore heavily taxed than earned income, or laborincome.

The book also provides a nice description of themovement that led to the successful (even if onlytemporary) repeal effort, and devotes a chapterto dispatching the weakest arguments made byestate tax critics. But the book largely ignores thecritics’ strongest arguments. For one thing, eco-nomic efficiency is barely admitted as a criterionfor tax policy. Thus, the book does little toaddress the concern that the estate tax penalizesboth work and saving. The authors do not addressthe question of why those who spend their for-tunes should get more generous tax treatmentthan those who would prefer to save the wealth topass on to their children. Indeed, they quoteAndrew Carnegie: “By taxing estates heavily atdeath the State marks its condemnation of theselfish millionaire’s unworthy life” (p. 38).

Oddly, given that the purpose of the book is toargue for the estate tax’s retention, their caseseems to run out of steam when it gets to reformoptions. A very short last chapter suggests thatvoters may better connect the estate tax to gov-ernment services if the revenues were earmarkedfor particular programs. They argue “ . . . revenuefrom the estate tax should go directly to initiativesthat maintain retirement security or assist inbuilding wealth and opportunity for everyone” (p.137). For example, the revenue could be ear-marked for Social Security solvency or to providefinancial aid for higher education. They also sup-port raising the exemption to spare more smallestates, but argue that top rates of as high as 55percent should be maintained. More radicalreform ideas, such as replacing the estate tax withan inheritance tax, don’t get raised even thoughan inheritance tax would seem to be a betterinstrument to limit large concentrations ofwealth—a major concern of the authors. Andthey never discuss eliminating the many loop-holes that make estate tax planning so complexand inequitable. Indeed, closing loopholes couldraise revenues used to cut marginal tax rateswithout reducing the revenue yield of the tax.

Bottom line: the book is fascinating and wellwritten, but it is not an academic treatise. It willamuse and inform estate tax supporters and infu-riate critics. It is written at a level accessible toundergraduates, but probably should not beoffered without also presenting the opposingpoint of view.

LEONARD BURMAN

The Urban Institute, The Tax Policy Center,and Georgetown University

Motivation Agency, and Public Policy: Of Knightsand Knaves, Pawns and Queens. By Julian LeGrand. Oxford and New York: OxfordUniversity Press, 2003. Pp. xii, 191. ISBN0–19–926699–9. JEL 2004–0970Some years ago Richard Titmuss (for whom

Le Grand’s chair is named) produced a verystrong argument that the United States waswrong in purchasing blood for blood transfu-sions while England did not do so but relied onvoluntary provision. His argument was essential-ly moral but he also thought that paying forblood would actually reduce the supply. Hepointed out that England where blood was notpaid for had a surplus and United States where



it was paid for had continuous difficulties. Aboutten years later England had to buy blood fromthe United States.

As far as I know Titmuss made no comment onthe matter, but he had a sizeable impact and setoff a lot of research. Le Grand does a very goodjob of discussing this research and its resultswhich are rather surprising to most economistsincluding, originally, myself. It appears that youmay not get much return on your payment. Thepayments may actually reduce the amount ofblood or other charitable activity available unlessthey are quite large.

The explanation given by a variety of peopleand on the whole accepted by Le Grand is thatthe payment weakens the charitable motive forgifts. To take an example, the small town in Iowain which my sister lives has an organization called“meals on wheels.” The housewives participate init voluntarily, one day a week in rotation, takingmeals to housebound inhabitants. They not onlyare not paid, they contribute gasoline and time,and some cases add a little bit to the meal.

Assuming that the thesis of the book and thequite considerable amount of research by peopleother than Titmuss which is reported in it is cor-rect, offering a payment might reduce theamount of time people were willing to put intothis food delivery. The general effect, if I mayquote some work done by one of my formergraduate students, is that the amount of volun-teer work falls off as the payment increases, but,of course, if you increase it enough you get non-volunteer work. The motives for volunteer workare weakened by actual payment rather thansupplemented.

It should be pointed out that people who arenot volunteers in the strict sense, ordinaryemployees, may get some satisfaction out oftheir work. The man who, like Charlie Chaplin,tightens bolt 17 on the assembly line may feel,quite rightly, that he is contributing to society.After all, if the bolt is not tightened it may leadto accidental death.

To repeat, the research is not merely that ofTitmuss, but also that of a number of other quiterespectable experimenters. It’s surprising at firstglance. We don’t depend on volunteer labor formost of the things we make. We do however usea good deal of volunteer labor here and there.The candy stripers seen in most hospitals makelife of the injured and sick much better than they

would be without them. It would not be surpris-ing if a small payment reduced their numbers.The weakening of the charitable motive by a realpayment may make the society as a whole worseoff than it was when there was no such payment.

I originally found this surprising, and I think LeGrand was also surprised. Mostly we depend onpaying for work, but the fact that you can getsome for essentially charitable motives means thatsociety is better off. Zero or sizeable paymentsproduce more output than small payments. At thebottom, the return on payments is negative.

GORDON TULLOCK

George Mason University

Tax Policy: Theory and Practice in OECDCountries. By Ken Messere, Flip de Kam, andChristopher Heady. Oxford and New York:Oxford University Press, 2003. Pp. xii, 267.ISBN 0–19–924148–1. JEL 2003–1406This well-written nontechnical book by three

past and present staff members of the OECDdeserves to be widely read. It provides a usefulcorrective to the tendency of most people,whether tax experts, general economists, or ordi-nary citizens to consider particular features oftheir own tax systems in isolation both from eachother and from the world of taxation more gener-ally. It contains a tremendous amount of informa-tion on a wide variety of tax issues and the manydifferent ways in which they are resolved in dif-ferent countries. Its discussion of a wide varietyof controversial fiscal issues—family taxation,capital gains taxes, corporate tax rates, etc.—isalmost always reasonable, fair, and balanced.Though fiscal experts will no doubt find some-thing to argue about, most will also find somenew ideas in this book. More general readers willfind a very useful overview of the messy set ofcomplex political, economic, and practical issuesthat constitute “tax policy.”

The book should be of interest even beyond theOECD countries. While the authors exaggeratewhen they say in the preface that the tax policyproblems of developing and emerging countrieslikely differ from those in more developed coun-tries mainly in terms of “the relative efficiencyand integrity of the tax administration,” (p. v),they are nonetheless right that the issues andproblems facing those countries are not all thatdifferent from those faced in the more developedcountries of the OECD. In rich countries or poor,

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whether one is immersed in tax matters or not, itis often a good idea to stand back and look at thesystem as a whole, from above, as it were. Inshort, for those in any country or line of work whowant to know what tax policy is all about this bookis an excellent starting point. The authors do amasterful job in short compass of both describingthe major developments in tax policy in overtwenty countries over the last half-century andplacing them in appropriate political, economic,and intellectual context.

The book is divided into an introductory chap-ter and three main sections. First, twentieth cen-tury trends in revenue, in policy, in administration,and in fiscal federalism are discussed. The majorpart of the book then takes up the design of taxes,treating in turn the personal income tax, socialsecurity contributions, corporate income tax andother business taxes, consumption taxation, andtaxes on wealth, capital gains, and property.Finally, a short chapter provides a capsule com-parative overview of tax policy choices within dif-ferent subgroups of OECD countries (Europe,other industrialized OECD countries, andOECD’s developing countries—Mexico, Turkey).The book concludes with a brief discussion onwhat the future may hold for taxation.

Throughout, the discussion is enriched by thesurprisingly extensive information base on taxmatters that has, over the years, been built up inthe OECD. The book also contains an excellentset of annexes, which provide valuable commen-taries on such matters as the “irrationalities andconfusions” (p. 225) that often bedevil discus-sions about taxation and the limitations of inter-national tax comparisons. If these annexes couldsomehow be distilled into an elixir that had to beconsumed by all journalists and politicians beforewriting or speaking about tax matters, the level ofpublic discussion on tax policy would be vastlyimproved.

Another point worth noting is that this booktreats social security contributions as taxes. Toooften discussions of tax policy simply ignore theselevies, although in many OECD countries notonly has this source of revenue grown morequickly than any other over the last half-centurybut they now, in most countries, constitute themost important taxes imposed directly on mostpeople’s income. The rationale for includingsocial security taxes is set out clearly and con-vincingly (pp. 21–22)—although, as with most tax

issues, those who do not want to be convinced byreasonable argument will not be persuaded.

Finally, to illustrate both the measured reason-ableness of the book’s presentation of such(sometimes) controversial issues and to give a fla-vor of what those who dip into it will find, hereare two of its more striking conclusions: First,while there have clearly been some importantrecent trends in the rates of major taxes aroundthe world (with income tax rates coming downand VAT and social security rates generally goingup), there is neither much evidence of conver-gence of tax levels or tax structures (mixes) acrosscountries nor any clear evidence that “globaliza-tion” has restricted the freedom of even neigh-boring countries to do pretty well what they wantin terms of tax policy. There seems no pressingreason to expect this situation to change drasti-cally in the near future. Second, with the majorexception of the VAT, which has—outside of theUnited States—swept the world, most tax policyinnovations over the last fifty years (e.g., integra-tion of personal and corporate income taxes, anddual income taxes) seem—like academic ideassuch as optimal taxation that have had no visiblepolicy impact—to have been little more than“transient fashions” (p. 3).

RICHARD M. BIRD

University of Toronto

Fiscal Decentralization and the Challenge ofHard Budget Constraints. Edited by JonathanRodden, Gunnar S. Eskeland, and JennieLitvack. Cambridge and London: MIT Press,2003. Pp. x, 476. $49.95. ISBN 0–262–18229–7. JEL 2003–0974This book deals with a timely and important

topic, given the increasing trend toward decen-tralization within the government sector in devel-oping countries over the past two decades. Thisrepresents a shift parallel to globalization, whichalso reduces the authority of national governmentsover economic matters.

A general problem with such decentralizationis the propensity for subnational governments orprovinces to engage in noncooperative behaviorresulting in collectively suboptimal outcomes, aparticular example of which is the problem of thesoft budget constraint (SBC). Fiscal decentraliza-tion typically devolves greater expenditure thanrevenue responsibility to provinces, owing toproblems of tax coordination and the need to



redistribute across provinces. The vertical imbal-ance necessitates fiscal transfers from central toprovincial governments. Such transfers shouldoptimally be based on measures of relative need,but provinces are better informed than the cen-ter about their own needs, giving rise to a classicagency problem. The problem is substantiallyexacerbated by the inability of the center to com-mit to not bail out provinces that overspend, nice-ly illustrated by the editors in their introductionwith their firetruck analogy.

Anticipating such bailouts, provinces haveincentives to overspend, resulting in fiscal indis-cipline and macroeconomic instability, a storyhaving some relation to recent macroeconomicproblems of Brazil and Argentina. This bookaddresses the question of institutional mecha-nisms that rein in the SBC problem, and theexperience of diverse countries across the globewith such mechanisms. Why do they seem towork in some countries and not others? The out-come of a World Bank research project, this vol-ume pulls together an impressive range ofcountry case studies addressing the nature oftheir respective SBC problems.

The volume starts by reviewing a set of OECDcountries: the United States, Canada, Norway,and Germany, which are by and large more suc-cessful than middle income and developing coun-tries. A masterly essay by Inman covers the U.S.experience, spanning theoretical considerations,historical evolution, and a survey of recent econo-metric evidence. The relative success of theUnited States in reining in the SBC appears to bethe result of market-based disciplinary mecha-nisms, a historical combination of a weak redis-tributive mandate for the national government,and a reputation created by the latter in the nine-teenth century for refusing to bail out profligatestates. The Canadian experience has been equal-ly successful, despite a stronger interprovincialredistributive mandate for the national govern-ment. Bird and Tassonyi explain that control oflocal governments by provincial governments wasmade possible by hierarchical controls, while thesolution of the problem at the provincial level isexplained in cultural terms, so remains a bit of amystery—at least for economists. Norway is amore interesting case for developing countries,characterized by greater vertical imbalances thanCanada and the United States, and the absence ofmarket-based control mechanisms. Yet Norway

also managed to avoid SBC problems, largely dueto the application of strict hierarchical control oflocal governments by higher tiers. Germanyappears to be the only OECD country that expe-rienced the SBC disease to some extent, owingpartly to a strong redistributive mandate andgreater commitment problems for the centralgovernment.

The second section of the book deals withthree countries with a more pronounced afflic-tion: Argentina, Brazil, and India, all large coun-tries with high inequality, fragmented centralgovernments, strong regional powers, and perva-sive discretion in fiscal transfers. The worstproblems appear to be in Brazil where stateshave substantial revenue raising authority. TheArgentina chapter is a bit disappointing, espe-cially given the interest in understanding thesources of its macroeconomic instability. A sin-gle sentence of the chapter refers to the inde-pendent monetary authority of provincialgovernments: one would have hoped that thechapter would have explained the origin andconsequences of this unique phenomenon. Incontrast to many other chapters, this one tendsto be more journalistic rather than an effort toexplain the evolution and functioning of the sys-tem. The India chapter on the other hand isdetailed and perceptive, exposing clearly variousdistortions inherent in the intergovernmentalfiscal framework.

Indeed the Indian experience drives home apoint that needs more emphasis than is awardedto it by the editors—that the agency problem hasmany other dimensions apart from the SBCproblem. McCarten argues that the key problemin India has been underinvestment in publicinfrastructure, rather than fiscal indiscipline. Itunderlies a disquiet about the tendency—typicalof the IMF—to evaluate institutions in the devel-oping world in terms of the potential for fiscalindiscipline alone. This is a bit surprising in aWorld Bank research project, given that institu-tion’s own interest in decentralization as a mech-anism to promote accountability of governmentand improve delivery of public services to thepoor. Moreover, there is evidence that the resultof fiscal decentralization in much of the develop-ing world has been the precise opposite of theSBC—local governments strapped for fundsowing to a hard budget constraint, relative tospending mandates devolved on them, resulting

Book Reviews 167


in inadequate quantity and quality of publicservices delivered.

Nevertheless, with regard to the SBC prob-lem the volume is an excellent and comprehen-sive reference, devoting equal emphasis topolitics and economics. If anything, the wealthof material is a bit too rich to digest at one sit-ting: one wishes there were an executive sum-mary of the country case studies available forthe impatient reader.

DILIP MOOKHERJEE

Boston University

I Health, Education, and Welfare

Means–Tested Transfer Programs in the UnitedStates. Edited by Robert A. Moffitt. NBERConference Report series. Chicago andLondon: University of Chicago Press, 2003. Pp.ix, 644. $99.00. ISBN 0–226–53356–5.

JEL 2004–0576August 2004 represents the fortieth anniver-

sary of Lyndon Johnson’s War on Poverty.Looking today at the set of social safety net pro-grams in the United States, one sees an incredi-ble patchwork of programs serving differentgroups (elderly, disabled, single parent families)and covering different needs (health insurance,housing, food and nutrition, job training). Someprograms are federal and have little cross-statevariation (Food Stamp Program) while others aremandated federally but vary locally (TemporaryAssistance to Needy Families, Medicaid) and stillothers are purely local (state Earned Income TaxCredits). In fiscal year 2002, the total cost of U.S.means tested programs amounts to $1,809 percapita and represents about 5 percent of GDP(Vee Burke, Cash and Noncash Benefits forPersons with Limited Income: Eligibility Rules,Recipient and Expenditure Data, FY2000–FY2002, Congressional Research Service). Thiscompares to $418 per capita in 1968 (in 2002 dol-lars) and about 2 percent of GDP. Research onthese programs has grown substantially in thepast ten years, driven in part by major reformsand policy expansions.

Means Tested Transfer Programs in the UnitedStates, edited by Robert Moffitt, is an excellentvolume which promises to become the definitiveresource on means tested transfer programs. Thebook consists of an introductory chapter written

by Moffitt, followed by nine stand alone chapterswritten by leading researchers in the field andeach covering a separate program or cluster ofprograms. The chapters include: Medicaid, SSI,Earned Income Tax Credits, Food and NutritionPrograms, Temporary Assistance to NeedyFamilies, Housing Programs, Child Care SubsidyPrograms, Employment and Training Programs,and Child Support Programs. The scope andstructure of each chapter is similar and beginswith current and historical institutional details(eligibility determination, benefit assignment),program statistics (caseload, expenditures), andlaw changes. This is followed by a summary of theeconomic issues in the literature and a review ofthe evidence. The chapter typically ends with adiscussion of current policy (where applicable)and unanswered research questions.

The volume fills a significant void largelybecause of the scope of each of the chapters.People interested in institutional details, programstatistics, or rule changes usually start with theGreen Book (Background Materials and Data onPrograms Within the Jurisdiction of theCommittee on Ways and Means, U.S. House ofRepresentatives). The Green Book, however,does not provide much coverage or discussion ofthe economic issues and empirical literature.Current research papers can provide the concep-tual issues and literature review but rarely pro-vide the rich institutional details and the longhistorical view of the programs. Many excellentfull length books exist that analyze one programor sometimes a cluster of programs. This volumeprovides all of this—a comprehensive set of pro-grams, with the background, statistics, economicissues, and empirical findings.

The book will interest a wide range of readers.It is surely of interest to scholars interested inpublic programs and poverty. The economic argu-ments are nontechnical and quite accessible usingintermediate microeconomic level arguments.Some of the econometric issues require morebackground and training. Overall, it should appealto economists, noneconomists, policymakers, andadvanced undergraduate students.

In sum, Means Tested Transfer Programs in theUnited States is a useful, important volume that islikely to become the definitive reference of itstime on means tested transfer programs.

HILARY W. HOYNES

University of California, Davis



J Labor and Demographic Economics

An Economic Analysis of the Family. By John F.Ermisch. Princeton and Oxford: PrincetonUniversity Press, 2003. Pp. 271. $35.00. ISBN0–691–09667–8. 2003–1452This book builds on the strengths of neoclassi-

cal economic theory, showing how models ofindividual utility maximization can help explainfamily behavior. It departs from more traditionalapproaches by acknowledging conflicts of inter-est among family members and warning of ineffi-cient outcomes that can result from coordinationproblems. It reaches beyond traditional discipli-nary boundaries to describe social interactioneffects that challenge a strictly individualistapproach. Yet its overall approach makes it moreuseful as an exercise in the application of opti-mization theory than a guide to empiricalresearch or public policy.

Any analytical modeling effort must be willingto invoke the protective “it is assumed that . . . ”Ermisch states his assumptions clearly and oftenillustrates his points by working through thecomparative statics associated with an explicitutility function, which is pedagogically useful. Hemodels parental expenditures on children as aspecific example of the larger problem of privatecontributions to public goods, contrasting thenoncooperative equilibrium that would emerge iffamily members could not communicate with thePareto-efficient allocation that can emerge fromcooperation. He begins with the presumptionthat one parent maximizes utility subject to theother parent achieving at least a given level ofutility (as well as a resource constraint). Theresult is an extremely clear motivation for the so-called “collective” model of family decision mak-ing developed by Francois Bourguinon andPierre-Andre Chiappori that has largely displacedthe joint utility function approach.

The “collective” model generates importantpredictions regarding the impact that differentsources of income might exert on expenditures onchildren. However, it takes the preferences ofmothers and fathers as exogenously given andoffers little insight into patterns of greater invest-ment in children by mothers, a major determinantof gender inequality. Because it focuses on indi-vidual optimization, the model has little to sayabout public spending on children. Yet children

are public goods not merely to parents but also totaxpayers, who devote considerable resources tothem and expect to receive considerable fiscalbenefits from them as they grow up to shoulder alarge burden of public debt. For the last severalyears, the British government has developed amajor policy initiative aimed at eradicating childpoverty, yet Ermisch, one of Britain’s most highlyrespected family economists, apparently considersthis topic beyond the scope of his book.

The assumption that individuals try to makerational choices is a strong but credible one. Theadditional assumption made in all but one chap-ter of this book—that the preferences that indi-viduals act on are exogenously given and resistantto change—is difficult to defend in the realm offamily life. Both parents and society devote con-siderable resources to shaping the preferences ofyoung children. Most people who have experi-enced a divorce would describe it as the result ofa change in their preferences rather than merely,as Ermisch suggests, the “revelation of new infor-mation” (p. 169). They might even, using a nounthat seldom appears in this book, describe it as achange in their emotions.

As a growing body of research in behavioraleconomics demonstrates, people do not alwaysconform to postulates of strictly rational behav-ior. As Robert Pollak and others have longargued, information and transactions costs oftencomplicate family decision-making. Many of thelessons of evolutionary biology are also relevant(See, for instance, Bobbi S. Low, Why SexMatters (Princeton University Press, 2000). Thepreferences that human beings act on are notrandomly given; they have been shaped by thepressures of natural selection in a rapidlychanging environment.

Men and women, like males and females inother sexual species, may be predisposed to dif-ferent behaviors. That females invest morephysiologically in offspring than males suggeststhat they prefer a higher “quality to quantity”ratio than males do. In game-theoretic modelsof resource allocation, males can exploit theirbargaining power by making credible threats toabandon their offspring. This asymmetrystrengthens female motivation to bargain bothindividually and collectively for enforceablecontracts governing paternal behavior.

In chapter 11, Ermisch departs from stylizedmodels of optimization to consider how

Book Reviews 169


preferences may be shaped by what others insociety are perceived to be doing. Although brief,this chapter provides an elegant mathematicaland graphical exposition, as well as a useful sum-mary of a growing literature building on theinsights of Thomas Schelling. So called “socialmultiplier” and “tipping” models help explainwhy societies seem to experience sudden shifts inbehavior, such as nonmarital childrearing andcohabitation, that cannot be explained simply bychanging prices and incomes. One can hope thatthe example Ermisch sets here will have a multi-plier effect on other economists, tipping themtoward a broader perspective.

NANCY FOLBRE

University of Massachusetts

The State of Working America 2002/2003. ByLawrence Mishel, Jared Bernstein, andHeather Boushey. An Economic PolicyInstitute Book. Ithaca and London: CornellUniversity Press, ILR Press, 2003. Pp. xi, 494.$59.95, cloth; $24.95, paper. ISBN 0–8014–4064–5, cloth; 0–8014–8803–6, pbk.

JEL 2003–1010For well over a decade now, economists at the

Economic Policy Institute have been serving upa periodic assessment of the state of workingAmerica. Part Handbook of Labor Economicsreview article and part American Prospect poli-cy piece, the chapters of each volume containinformation on income, wealth, fringe benefits,and work hours, with a special focus on the lessfortunate members of the labor force. The vol-ume under review gives an analysis of these var-ious barometers of worker well-being duringthe late 1990s boom, along with their trajectoryover the last third of the twentieth century forhistorical context.

The current edition covers family income,wages, jobs, wealth, poverty, regional analysis,and international comparisons in as many chap-ters. Special care is taken with the first two sub-jects, the analysis of which composes roughly halfthe book’s length. Within the chapters, one findsanalyses of growing income and wage inequality,nonstandard work arrangements, the inadequacyof retirement wealth, the burden of studentloans, the impact of welfare reform, how the U.S.model stacks up against international competitorson the basics of worker well-being, and muchmore. The basic strategy is to slice and dice the

data in question—by education or income quin-tile, race or gender, state or country—in order tolay bare the reality of workers’ experiences.

Simple descriptive statistics are the norm(properly sliced and diced of course) and, in a fewinstances, multiple regression analysis isemployed to parse out causal determinants. Theuse of descriptive statistics makes the presenta-tion accessible to policymakers and lay people,which, judging from the book jacket blurbs, is theintended audience, but will likely prove to beonly mildly frustrating to economists and othersocial scientists. There is so much informationhere, and it is so carefully and thoughtfully pre-sented, that even top-notch empirical labor econ-omists are likely to learn things they did notknow. In fact, it is even conceivable that some willbe spurred by the presentation of simple rela-tionships to investigate matters further, sincerarely is the analysis conducted herein the lastword on the subject.

This is a “big picture” approach, one thatforces us to step back and focus on the forestinstead of the trees. I found the analysis of fami-ly income, for example, to be truly revealing afterso many years of thinking about and working onthe subject of individual worker wages. The ris-ing share of income going to capital in recentyears, the average net worth of black versuswhite households, and the changing nature of ris-ing wage inequality in the 1990s are all topicsthat were both new to me and interestinglyexplored in this edition.

The volume is best treated as a reference bookrather than as a sustained and engaging read. Incontrast to years past, I read the current editioncover-to-cover in the course of three or four daysand wished I hadn’t. Read in this way, it becomesdry and repetitive. Buy a copy, keep it on yourbookshelf, and use it periodically as an excellentsource of information, both current and histori-cal, for research and teaching. One finds citationsto this work in economics journal articles andbooks. I have used it to great effect in under-graduate labor economics courses. It would be anexcellent tool for empirical methods courses aswell; there is a careful discussion of measurementissues, and the analysis typically leaves off just atthe point where a careful treatment of causaldeterminants would begin, leaving to the stu-dents’ imagination the hypothetical relationshipsto be tested.



Graduate students and faculty may benefitsimilarly, but they will be frustrated by the lackof citations to the literature. While the authorsperiodically refer to the work of economists andother social scientists, they typically do so withphrases such as “economists contend” or “criticsmaintain,” offering citations only in thoseinstances where the research of others is pre-sented. Moreover, some chapters are more noveland informative than others. The “jobs” and“wealth” chapters rely a great deal on previouslypublished findings of other economists. I keptwondering in the “regional analysis” chapterwhether the differences discussed were trulydifferent in a statistical sense.

Still, there is real strength in this volume; itforces us to focus on the big picture and it offerscoverage of recent events that would be hard toget, given publication lags, in published journalarticles. The late 1990s boom brought a reversalof growing wage inequality, and was especiallyrewarding for workers at the bottom of the wagedistribution, despite continued low-skill immigra-tion, welfare reform, and growing low-wageemployment. Low unemployment rates were akey ingredient; they are particularly beneficial tothe dispossessed. How has working Americafared during the bust? Those of you with theCurrent Population Survey on your hard drivealready know the answer to this question; the restare eagerly awaiting the next volume of The Stateof Working America.

DAVID FAIRRIS

University of California, Riverside

Wage Dispersion: Why Are Similar Workers PaidDifferently? By Dale T. Mortensen. ZeuthenLecture Book Series. Cambridge and London:MIT Press, 2003. Pp. xii, 143. $30.00. ISBN0–262–13433–0. 2004–0593Like researchers in many other fields of sci-

ence, some labor economists have been lookingfor a “universal theory of everything” or at leastone that encompasses labor market outcomes likeemployment and unemployment, wage distribu-tions, firm size, seniority returns, and so on. Theenthusiasm with which the literature has adoptedthe Burdett–Mortensen (1998) and Pissarides(2000) frameworks suggests that some macro-based labor economists, especially in Europe,believe they have found their holy grail. At themost recent European Economic Association–

Econometric Society European Meetings jointconference in Madrid, I counted over 40 percentof the papers with theoretical contributions inlabor economics sessions being based on one orthe other of these models.

The (short) new book by Dale Mortensen, afounding and frequent contributor to bothstrains of this literature, could easily serve as aprimer for this burgeoning field. Its early chap-ters are well written from a pedagogical perspec-tive and its later chapters introduce extensions ofthe base model that eliminate inconvenientempirical inconsistencies and accommodateever-more complicated types of behavior.Although the basic framework for the book is theBurdett–Mortensen model, its links to thePissarides model are highlighted and the impli-cations of replacing the Burdett–Mortensenwage posting hypothesis with the Pissarides bilat-eral bargaining and endogenous job vacancieshypotheses are discussed in detail. A good grad-uate labor economics class could use this book assupport for teaching the Burdett–Mortensenmodel, which should over time become a stan-dard part of any labor economist’s theoreticalbaggage.

Chapter 1 lays out the motivation for the restof the book by citing numerous empirical stud-ies, especially those based on linked employer–employee data, that demonstrate significantwage dispersion across firms for observably(and unobservably) equivalent workers. It thenproposes a static job search model with homo-geneous workers who can receive multipleoffers and Bertrand competition among homo-geneous employers. It describes several exten-sions of this model, such as introducingheterogeneity in firm productivity, multiplecontacts per firm and bilateral bargaining à laPissarides. Compensating differentials, efficien-cy wages and sorting can all be accommodatedby this framework, although Mortensen arguesthat they are unlikely to be the main source ofinter-firm wage dispersion.

Chapter 2 then presents the Burdett–Mortensen model, which is a dynamic extensionof the static model in chapter 1 and on which therest of the book is based. This model includes onthe job search by workers and undirected searchby employers, has an identical job offer arrivalrate for unemployed and employed workers andallows job-to-job mobility of employed workers

Book Reviews 171


who receive better offers. From the inflow andoutflow equations at each wage, Mortensenderives the steady-state equilibrium offeredwage distribution in closed form, the employedwage distribution and the analytical link betweenthe two. He also discusses the role of the “marketfriction parameter” (the ratio of the job destruc-tion rate to the aggregate job contact rate), a ver-sion of which also appears in the Pissaridesliterature. Although certain simplifications makethe exposition of the base model more straight-forward, they unfortunately push several inter-esting implications and complications, such asthose highlighted in Ridder and van den Berg’s(1998) work, into the background.

Chapter 3 considers the empirical implica-tions, in particular the convex, increasing offeredand employed wage densities, of the Burdett–Mortensen model and compares them with datafrom a Danish linked employer–employee dataset. The chapter first documents the densities ofcross firm average and initial wages in theDanish data (which seem consistent with a dif-ferent parametric distribution than that impliedby comparable U.S. data) and calculates somesummary statistics, broken down by occupation,for calibrating and comparing the extended ver-sions of the model that appear later in the chap-ter. Although some choices seem ad hoc andsome numerical justifications are complicatedcalculations based on shaky foundations, they donot invalidate the fundamental motivation of see-ing whether the empirical implications of themodel can be squared with data for at least onecountry. The chapter then extends the baselinemodel by allowing exogenous productive hetero-geneity and endogenous recruiting effort. Amodel that endogenizes the productivity distri-bution by allowing firms to invest in general ormatch specific capital similar to Robin and Roux(2002) is also introduced, although it does not fitthe Danish data as well as the model withendogenous recruiting effort.

Chapter 4 further extends the baseline modelby allowing workers to vary their search effort.With (exogenously) heterogeneous firms,endogenous vacancies and endogenous searcheffort, the model becomes significantly morecomplicated than the base case, although themechanisms are more interesting. Under fairlystandard assumptions, Mortensen shows that aunique steady state equilibrium exists in both

the wage posting and bilateral bargaining cases.The confrontation of theory and data in thischapter suggests that a Pissarides-type bilateralbargaining approach to wage determination ismore appropriate for the Danish data than thewage posting model in the base Burdett–Mortensen framework, and the shapes of thewage densities and the marginal cost of hiringfunction are derived explicitly. Although heagain makes some ad hoc assumptions, themodel that comes out of this chapter and theempirical implications that are drawn and testedare the high point of the book.

The final chapter, on the other hand, is a stepback. Chapter 5 addresses the wage–tenure rela-tion and is based on three other papers: Postel-Vinay and Robin (2001), Stevens (1999) andBurdett and Coles (2001). Postel-Vinay andRobin provide the most direct extension of themodel that generates a wage-seniority profile, butMortensen is unconvinced by the counter-offerapproach of their model. As a result, the presen-tation is confused, important functions are leftundefined, and the reader comes out bewildered.The Stevens contract theory-based model is pre-sented as an alternative, but Mortensen admitsthat it is not based on the Burdett-Mortensenframework and introduces another contract-based model, that of Burdett and Coles. Thismodel is also interesting (and relevant), althoughnot necessarily more realistic than Postel-Vinayand Robin, while its presentation is only slightlyless confusing. When teaching from this book,one could reasonably skip this chapter or gostraight to the papers as there is little value addedin Mortensen’s presentation.

In conclusion, this is a book that all labor econ-omists who are not already deep into this litera-ture should have. The pedagogical presentationof a model that is so intuitively appealing and canbe generalized so straightforwardly to accommo-date such a large number of labor market behav-iors makes it a good way to become familiar witha framework that is taking on impressive propor-tions. The confrontation of theory with data,although not always entirely convincing, is anoble effort, deserves to be applauded, andleaves even the microeconometrician interestedin reading more.

DAVID MARGOLIS

CNRS, University of Paris1 Panthéon-Sorbonne



K Law and Economics

Why Societies Need Dissent. By Cass R. Sunstein.Cambridge and London: Harvard UniversityPress, 2003. Pp. ix, 246. $22.95. ISBN0–674–01268–2. JEL 2004–0196This book explores the causes and conse-

quences of social and institutional conformity.Professor Sunstein claims that conformity pre-vents individuals from disclosing their privateinformation and, therefore, tends to cause indi-viduals and groups to make poorer decisionsthan they otherwise would. Though conformityis not always bad and dissent not invariablygood, Sunstein claims that the dangers of con-formity justify policies that tolerate, subsidize,and otherwise promote dissent.

Several chapters address the causes of conform-ity. Here, Sunstein nicely summarizes literaturesfrom psychology and economics, which togetheridentify two mechanisms: information and reputa-tion. Economists tend to emphasize information-based conformity. Rational individuals updatetheir beliefs in light of the beliefs of others, whichthey infer from the others’ behavior and state-ments. Economic theory describes and an experi-mental literature demonstrates the “herdbehavior” that results. At the extreme, the firstdecision controls all that follow. This processexplains sudden changes in behavior or “cas-cades.” An example is a “bandwagon disease” pro-duced when doctors, relying on their colleagues’judgment rather than their own, all diagnose thesame new disease among their different patients.

By contrast, psychologists tend to emphasizereputation-based conformity, which occursbecause individuals value the good opinion of oth-ers. Although Sunstein does not use the term, herefers here to the pursuit of “esteem,” as inGeoffrey Brennan and Philip Pettit, The Economyof Esteem (Oxford University Press 2004). Thedesire for esteem can cause individuals to con-form to behavior they expect will attract esteem.Reputational cascades cause sudden conformity.Examples may include the quick emergence of“political correctness” and large scale self-censor-ship among skeptics of an impending war. Ineither case, a community may appear to favor acertain norm or policy when most of its membersare actually concealing their dissent out of fear ofdisapproval.

Sunstein also describes the related phenome-non of “group polarization,” which is the tenden-cy of deliberation to push group members towarda “more extreme position” (p. 11). Sunstein’s ownexperimental work, for example, demonstratesthat deliberation among mock jurors causes themto reach a more extreme assessment about thepunishment the defendant deserves. If the pre-deliberation median of the mock jurors’ punish-ment assessments is low (below 4 on a scale of0–8), deliberation tends to drive down the medi-an; if the predeliberation median is high (above4), deliberation tends to drive it up. This studyconfirms the group polarization found in hun-dreds of studies around the world. Sunsteinoffers interesting analysis of how this literaturerelates to the older “groupthink” theory (pp.140–44), the more optimistic prediction of theCondorcet Jury Theorem (pp. 119–20), and newwork on “deliberative polling” (pp. 163–65).

Sunstein’s normative point is the need for poli-cies protecting dissent. Inducing individuals toreveal their actual beliefs helps to prevent patho-logical conformity, cascades, and polarization.The book derives a wide range of policy implica-tions. A striking example is his claim that grouppolarization explains terrorist recruiting, whichimplies that an antiterrorist foreign policy shouldfocus on promoting dissent abroad (pp. 115–18).Not surprisingly, Sunstein views the first amend-ment right to free speech as a key tool to promotedissent by limiting governmental censorship andprotecting access to “public fora” (streets, parks,etc.) where dissenters can reach a diverse audi-ence. Elsewhere, a chapter discusses how certaingovernmental structures—e.g., bicameralism,separation of powers, and federalism—impedethe influence of cascades on decision-making.Another claim is that law in a democratic societytends to induce obedience—conformity—by thesignals it sends: signals of what people in thecommunity disapprove produce reputation-basedconformity, while signals of private beliefs of law-makers about the harms of prohibited behaviorproduce information-based conformity. In eithercase, one enhances legal compliance by publiciz-ing the law and (any) high compliance rates itproduces.

In addition to large-scale social phenomena,Sunstein addresses conformity in groups andinstitutions: how policies protecting dissentmay improve the function of investment clubs,

Book Reviews 173


corporate boards, and presidential cabinet warplanning. Other chapters discuss the impor-tance of maintaining political diversity onthree-judge courts—given findings that federaljudges decide cases differently depending onwhether the other two judges were appointedby a president of the same or different politicalparty—and the possibility that affirmativeaction in higher education works to undermineconformity by promoting a diversity of views.Given the attention to juries and law, however,there is surprisingly little discussion of how thejury system does or could protect dissent oravoid polarization.

The book identifies but does not resolve anumber of important trade-offs. First is the ideaof the “optimal level of dissent.” Dissent fromtrue or morally correct beliefs is undesirable.Some minimal costs to dissent may be desirableso that what that remains is more likely to beuseful. Sunstein notes the particular waste ofmerely “contrarian” dissent, but rejects the pos-sibility of saying more in the abstract about opti-mality. Second, there is a trade-off in the socialconnectedness of groups. Other research sug-gests that close-knit groups have certain advan-tages in solving collective action problems. Butthe same bonds that deter free-riding alsoincrease the reputation costs of dissent, causingmore self-censorship and poorer decisions. Forsome group decisions—e.g., investments—theoptimal level of social connectedness may bezero. Third, Sunstein identifies a trade-off in theoptimal composition of deliberative groups or“enclaves” in society. Individuals seek groupswith like-minded people. On the one hand, self-selection can cause intense intra-group conform-ity and inter-group polarization. On the otherhand, there is a potential gain if individuals exitgroups in which they will not express theirbeliefs and enter groups in which they will, atleast if there is some communication betweengroups. The latter proviso is crucial; Sunsteinclaims that truly isolated deliberative enclavesare essential for producing terrorists.

In sum, Sunstein offers a rich account of con-formity, novel justifications for protecting dissent,and an array of policy recommendations. Thoughmany issues are unresolved, the book is a valuablestarting point for the subject it addresses.

RICHARD H. MCADAMS

University of Illinois

L Industrial Organization

Downsizing in America: Reality, Causes, andConsequences. By Willam J. Baumol, Alan S.Blinder, and Edward N. Wolff. New York:Russell Sage Foundation, 2003. Pp. 321.$29.95. ISBN 0–87154–094–0.

JEL 2004–0203During the late 1980s and early 1990s, reports

of firms downsizing their operations in Americarippled through the business pages of the nation’smajor newspapers. Were these reports a fad hav-ing little to do with the shifts in the industriallandscape? Or did they actually signal a trendtoward smaller sized firms? This is a carefullycrafted retrospective by three leading economistson what was reported at the time, what happenedin the various sectors, and the consequences ofthis episode. The authors assemble an impressivearray of data to investigate six hypotheses aboutdownsizing, which are laid out in their first chap-ter. First, technological change favored smallerenterprises during that era. Second, faster inno-vation led to more labor churning. Third, foreigncompetition compelled domestic firms to trimtheir fat. Fourth, labor saving devices led tosmaller firms. Fifth, the social contract betweenlabor and the owners of capital was ruptured.Sixth, blue-collar jobs replaced white-collar jobs.

The data is mainly drawn from the CensusBureau, Compustat, and the Panel Study ofIncome Dynamics. One challenge the authorsconfronted at the outset was how to define theentity being restructured, what “downsizing”means, and how the definitions of variables inthe data relate predictions from economic theo-ry. But the most original part of the data assem-bly was stimulated by their interest indocumenting how much downsizing was a phe-nomenon in the public consciousness during thattime period. The authors conducted an electron-ic search for the word “downsizing” in thearchives of the New York Times and the WallStreet Journal for the period 1993 through 1997.Their search formed the basis for a qualitativeand quantitative exegesis on what people wroteat the time. One important finding is that thereporters for these newspapers discovered“much of what was really going on” (p. 61). Inthis case, statistical data largely corroboratedwhat newspapers first reported. Perhaps a more



comprehensive analysis would include othernewspapers and weekly bulletins, grade theimportance of the articles, and compare theimportance of “downsizing” with business newson other topics of that era. Even so, theirapproach is a very ingenious use of the Internet,which may well become an empirical basis foreconomists analyzing the measurement of publicperceptions and expectations formation.

Many of the findings about what actually hap-pened are reported and discussed in chapters 4through 7. Only the manufacturing sector experi-enced significant downsizing in the 1980s and1990s, and this trend began in the 1970s. In theservices and retail trade sectors (both of whichaccount for more employment), average employ-ment, per firm and per establishment, hasincreased. Within the manufacturing sector,downsizing was not uniform; larger firms tendedto downsize, but smaller firms tended to expand.Since many industries within the manufacturingsector contracted over this period, and the oppo-site was true of many industries within the retailand service sectors, the facts seem broadly con-sistent with the theoretical model outlined inchapter 3. Having sketched the broad picture inchapter 4, the authors focus more closely on themanufacturing sector in chapters 5 and 7 and,less comprehensively, review changes in the retailand service sectors in chapter 6.

The positive correlation the authors foundbetween changes in firm size and industrygrowth implies that the six hypotheses theauthors wish to investigate could also beexpressed in terms industry growth rates, ratherthan the size distribution of firms. In their find-ings of what caused downsizing to occur withinthe manufacturing sector, reported in chapter 5,several of the hypotheses receive support. Forexample, the ratio of industry R&D spending tosales is negatively related to firm and establish-ment growth, and this is consistent with the firsttwo hypotheses. Consistent with hypothesis 5,unionized industries are more likely to downsizethan their nonunionized counterparts. Curiously,hypothesis 4 (that labor saving devices led tosmaller firms) does not receive much supportfrom the data.

In chapter 7, the authors focus on the conse-quences of downsizing in the manufacturing sec-tor. They found that profits increased in thesector, labor costs declined, productivity may

have fallen, and value of the firm declined too.This is consistent with hypothesis 5, that thesocial contract between labor and capital mayhave also frayed, and also with hypothesis 2, thatforeign competition compelled domestic firms totrim their fat. The authors assert in chapter 1 thattrimming fat “should raise the average productiv-ity of labor substantially” (p. 19), and the datacontradict this implication. But today’s over-weight population gives fat a bad wrap: it wasonce regarded as capital, literally stored energy,or interpreted in this context, reputation thatowners and managers cultivate with labor to pro-vide stable employment relationships. The factsthat the value of the firm falls when profits riseand, as the authors report in chapter 7, that jobturnover increased throughout this period, sug-gests that domestic firms anticipated lower prof-its in the future, and were writing off theirphysical capital at a faster rate, and also looseningthe ties with their own employees. Whether pro-ductivity would rise or fall in such circumstancesseems less clear to me.

Rounding off their study, the authors weave ananalysis of job turnover into an extensive existingliterature on this subject. Some of their conclu-sions in chapter 8, such as the finding that theyoung change their jobs more frequently thanolder workers, are well established facts. A con-tribution of this chapter is to integrate discus-sions of labor markets and changes in firm size.For example, the fact that men who changed jobsfared worse than non-job changers with similarsocioeconomic characteristics suggests thatadjustment costs from foreign competition areborne by the owners of the enterprises and alsoby their employees.

This is a delightful book about an importantepisode in American industry. Moreover themethods used by the authors can be applied totoday’s hot topics, such as outsourcing technologyand the continued upsizing within the retail sector.

ROBERT A. MILLER

Carnegie Mellon University

Economics of College Sports. Edited by JohnFizel and Rodney Fort. Studies in SportsEconomics. Westport, Conn. and London:Greenwood, Praeger, 2004. vi, 262. $72.00.0–275–98033–2. JEL 2005–0254The tight relationship between American uni-

versities and spectator sports is unique in the

Book Reviews 175


world. Why do American universities combineteaching and research efforts with commercialsports operations rather than, say, producingmovies? Do college sports affect the financialcondition of universities? How does the NationalCollegiate Athletic Association (NCAA) fit in? Isit an association aimed at helping universitiesachieve their chartered goals? Do intercollegiatesports enhance teaching and research at univer-sities or detract from them? These are amongthe questions addressed in this collection ofessays. A reader can learn some interestingthings by reading this volume. Here are someexamples.

In opening the volume, Joe Maxey argues thatrecent NCAA reorganization, in which those uni-versities most committed to big-time sportssecured greater autonomy, pretty much insuresthe preservation of the college football bowl sys-tem, because 90 percent of bowl revenues flow toteams in “power conferences.” A football playoffmodeled on the NCAA men’s basketball tourna-ment would likely return only 60 percent of theloot to those teams.

Evan Osborne expects that at least some ofthose colleges claiming to lose money on theirDivision I athletics programs would close theirsports operation. Because few do, he concludesthat athletic programs must serve some otheruniversity objectives. Osborne believes that stu-dents demand college athletics. They are willingto pay for sports, perhaps even enough to allowuniversities to charge a premium for undergrad-uate education in order to cross-subsidizeresearch and graduate education.

Brian Goff points out that, typically, universityathletic financial statements include scholarshipcosts based on list price tuition. The correct wayto account for opportunity costs, however, wouldbe to measure the marginal cost of an additionalstudent-athlete at open enrollment institutions orto compute lost tuition net of financial aid atinstitutions where admissions is selective. Ineither case, reported losses would be trimmed.

Robert Sandy and Peter Sloane exploit thechange in NCAA level of sports affiliation (109up; 15 down) of 124 colleges from 1991 to 1999.They find evidence that, other things equal,institutions operating at a higher level of sportsaffiliation enjoy more applications from prospec-tive students and higher SAT scores of theirenrolled class.

Promoters of the men’s NCAA “Final Four”basketball tournament commonly release “stud-ies” predicting a huge economic boost to the localeconomy. Economists, in general, scoff at suchconclusions because they know that many localsflee the area during a “mega-event” like the “FinalFour,” taking some local spending along, andmuch of the revenue generated by such eventsimmediately leaks from the area as pure econom-ic rent. Robert Baade and Victor Matheson use amodel of urban growth to compare these conflict-ing views. Remarkably, they find only one out ofthirty “Final Four” tournaments provided anyeconomic return for the host community at all.

Using a cross-section of 201 colleges, MichaelLeeds, Yelena Suris, and Jennifer Durkin showhow profitable football programs subsidizewomen’s athletics modestly ($34 of each addi-tional $1,000 of net football revenues), but foot-ball programs in general drain $112 fromwomen’s athletic programs for every $1,000spent. On balance, the average football programreduces expenditures on women’s athletics bymore than $250 thousand annually.

Robert Brown and Todd Jewell estimate themarginal revenue product of a premium collegefootball player at around $400 thousand, and abasketball player at around $1.2 million. Theseestimates leave a wide margin between the valueplayers create and the cost of their tuition,room, and board, even after accounting for theadmissions advantage accorded elite athletes.

Using data from Penn State, John Fizel andTimothy Smaby find that participants in clubsports and intercollegiate sports other than foot-ball earn grades comparable to the overall stu-dent body. In contrast, football players, who areadmitted with substantially lower average SATscores than the typical student, fail even to per-form at the modest academic expectations suchlow scores imply.

Fizel and Michael D’Itri measure the efficien-cy of NCAA Division I college basketball coach-es from 1984 to 1991. They then review whichcoaches were fired during the period and learnthat winning is more important for job retentionthan coaching efficiency. I suspect the coachesalready knew this!

Analyzing major changes in NCAA regula-tions from 1888 through 2001—for example,the formation of the NCAA in 1906, the 1949agreement not to pay players, and institution of



a minimum 1.6 GPA for eligibility in 1965,Craig Depken and Dennis Wilson find thatNCAA “reforms” generally are followed by lesscompetitive balance in college football. Theyconclude that this validates “the public choicehypothesis of special interest voting behaviorfor determining the direction of the NCAA.”

The book would be more persuasive if it con-tained fewer errors. As just a few examples, thevariable INSTRPC turns into OWNRESPC onpage 59, UGTEACH appears on page 60 with nodefinition, Georgia State morphs into GeorgiaSouthern on page 78, a quarter of page 172 isrepeated verbatim on page 173, and on page 206the sign of the estimated coefficient on the vari-able indicating the formation of the NCAA in thetable is at odds with its interpretation on page 207.On page 105, we are told that MIT lost its casedefending collusion among the overlap group onfinancial aid, when, in fact, MIT is the only insti-tution that went to trial, and it eventually settledan appeal out of court.

The book is easy to read. Economists interestedin the microeconomics of college sports will findthe time required to read this book worthwhile.The overall impression it conveys is that big-timecollege athletics is beyond academic control. Ifthat is true, we need to know if the behavior ofthose who do, in fact, control big-time college ath-letics is congruent with the missions articulated inthe charters of our institutions of higher education.This reviewer, for one, is not optimistic.

JOHN SIEGFRIED

Vanderbilt University

Regulating Infrastructure: Monopoly, Contracts,and Discretion. By José A. Gómez-Ibáñez.Cambridge and London: Harvard UniversityPress, 2003. Pp. xi, 431. $55.00. ISBN 0–674–01177–5. JEL 2003–1485The efficacy of institutions often varies from

place to place. For example, there is evidenceshowing that secure property rights helped pro-mote growth in early Western Europe, butundermined growth in twentieth-century Africa.Similarly, there is evidence showing that publiclyowned water systems were associated with high-er waterborne disease rates than privately-ownedsystems in late-twentieth century Argentina, butthat publicly-owned water systems had relativelylow disease rates in the early twentieth centuryUnited States.

These examples suggest that economists andpolicymakers need to recognize the potentialcontingency of any policy regime. What workswell in one context might not work well in anoth-er context. These examples also highlight theimportance of perspective, whether historical orinternational, in analyzing the effects of regula-tion. Put another way, to understand the effec-tiveness of any institutional regime, one needs tounderstand not just how that regime works ingeneral, but how it has functioned in differentsettings.

It is this sort of perspective that makes José A.Gómez-Ibáñez’s new book a welcome addition tothe literature on public utility regulation. Thebook analyzes the effects of governance regimesin a wide range of settings: water in Britain, theUnited States, France, and Latin America; busesand telephones in Sri Lanka and the UnitedStates; the railroads and airlines in the Americasand Great Britain; and electricity in theAmericas. In all of these settings, the industriesemploy network technologies with high fixedcosts, which in turn leave all concerned partiesvulnerable to opportunistic behavior once therelevant investments have been made.

For Gómez-Ibáñez, the governance of publicutilities is a long-term contracting problem withno perfect solution. Awarding franchises to pri-vate companies is attractive because it encour-ages ex ante competition, but as a contractingdevice, is necessarily incomplete as all futurecontingencies can not be anticipated. Regulatorycommissions address this concern but are subjectto capture by concerned interest groups. Publicownership is a form of vertical integration—thegovernment that acquires an electricity providerbecause it cannot commit to treating thatprovider fairly is akin to the manufacturer thatacquires the supplier of a key input because itcannot commit to treating that supplier fairly.Problems with public ownership include patron-age and failures to maintain the capital stock. Indeveloping this view, the book treads territorywell worn by previous authors such as VictorGoldberg, Oliver Williamson, and Pablo Spiller.

The novel aspect of this book is to be found inits presentation of numerous case studies of reg-ulation. Taken as a whole, these studies provideimportant insights into how governance regimesevolve and how effective these regimes are acrosstime and space. Consider the description of the

Book Reviews 177


Sri Lankan bus system. Initially, the system wasone of private provision dominated by a fewmonopolies. But consumers soon grew weary ofthe high rates and poor service. Eventually, thesystem was taken over by the government but thisregime was plagued by patronage employmentand there were strong electoral incentives forofficials to keep rates too low. Because of highwages and unremunerative rate structures, theassociated infrastructure deteriorated. Later inthe twentieth century, the bus system was priva-tized and there were numerous competing buslines. The problem with competition, however,was that there was too much of it. As bus driversraced one another to stops, safety and servicequality fell. This example illustrates the difficul-ties inherent in the governance of any networkedindustry.

Also instructive are two chapters exploring thevertical unbundling of services associated withthe privatization of railways in Great Britain andthe move to market-based governance ofArgentina’s electricity system. These chaptershighlight a tradeoff that regulators must confrontwhen they break up vertically integrated systems.Such break ups promote greater competition andincreased efficiency on many margins, but theyalso increase coordination problems. For exam-ple, when Britain privatized its rail system it alsoseparated control over the tracks from controlover the trains that used the tracks. The subse-quent confusion over who was responsible fortrack safety probably resulted in three fatal trainaccidents.

In any book that covers so much territory thereare bound to be at least a few lapses. Amongother things, I found the discussion of substantivedue process wanting. The author argues that inthe United States substantive due process pre-vented the government from expropriating theinvestments of private electric companies, whilein places that had fewer constitutional con-straints, such as Canada, expropriation was muchmore common. The problem here is that theseprotections are overstated and not adequatelyqualified. When private companies in the UnitedStates appealed for the protections of substantivedue process, that protection was neither cheapnor timely (see, for example, William R. Wilcox v.Consolidated Gas Company of New York, 29S.Crt. 192 1908; and Des Moines Gas Companyv. City of Des Moines, 35 S. Crt. 811 1914). Also

problematic was the description of gas-rate regu-lation in Chicago during the early 1900s, whichignores the political opportunism associated withthat regulation.

But these are relatively minor criticisms of anotherwise thorough and thought-provoking book.Because the book is clear, well written, and cov-ers much territory, it would be a logical choice fora graduate course on regulation. Authors wantinga firm empirical grounding in what the new insti-tutional economics has to say about regulationwill also find it useful.

WERNER TROESKEN

University of Pittsburgh

N Economic History

Health and Labor Force Participation Over theLife Cycle: Evidence from the Past. Edited byDora L. Costa. NBER Conference Reportseries. Chicago and London: University ofChicago Press, 2003. Pp. xvi, 343. $75.00.ISBN 0–226–11618–2. JEL 2003–1524“You are what you eat,” or so your high school

health teacher told you, or possibly your mother,though she might have put it differently. Thepapers in this volume, edited by Dora Costa, sug-gests that you are also what “exposure to infec-tious disease, occupational hazards, malnutrition,and other types of biomedical and socioeconom-ic stress” (p. x) make you. More importantly,from a historical perspective, these biologicaland social factors change over time; thus, we—that is, homo sapiens—change over time. Thehomo economicus of today’s principles textsmight be solving the same Lagrangian problemsthat she solved in Alfred Marshall’s day, but she’snot the same woman. These biological changesmanifest themselves in numerous economic phe-nomena, including labor force participation,effort, retirement, death, and so forth. If you areintrigued by the relationship between health andeconomic activity and changes in both over time,then you will find the papers in this volumeworth reviewing.

The volume opens with a chapter in whichLarry Wimmer summarizes the history of theresearch project entitled “Early Indicators ofLater Work Levels, Disease and Death.” Thedata generated by the project, and related proj-ects, are employed in one form or another by



most of the authors of the volume. Union Armyrecords on Civil War recruits serve as the primarysource of data, which includes thousands of vari-ables and more than 35,000 individuals. (Thedetails are in an appendix authored by PeterViechnicki.) It is a big job. All who participatedare to be congratulated. In her preface, Costaexplains the importance of this data set, notingthat, unlike more recent studies, it covers the lifecycle from adolescence, or early adulthood,through old age and death. Thus it allows schol-ars to analyze long-run relationships betweenhealth and economic activity.

A theme that runs through several chapters inthe volume is the role of wealth in health andmortality. Analyzing the link between wealth andmortality is particularly important, because anoft-cited body of scholarship suggests that histor-ically a weak relationship exists between mortali-ty and standard economic indicators, such asincome and wealth. To address this issue, amongothers, Joseph Ferrie linked individuals from theantebellum population and mortality censuses,thus allowing him to test for a correlationbetween social data and death rates. His findingthat, even prior to the mastery of the germ theo-ry of disease, wealth had a substantial negativeimpact on mortality rates after controlling forother factors, contrasts with the stylized view thatthere was little or no connection.

Using the data on Union Army recruits, twoadditional chapters analyze other aspects of theapparently subtle relationship between health,wealth, and mortality. One, by Chulhee Lee, con-tains an empirical investigation of the impact onmortality from exposure to disease. Recruits fromurban areas and areas with high child mortalityrates tended to have lower mortality rates thanrecruits from rural areas, suggesting those whosurvived prior exposure fared better once theywere thrust into the high-disease, military envi-ronment. This finding differs from the so-calledinsult accumulation model, which suggests thatprior illness weakens an individual and wouldtherefore result in higher subsequent mortality.Lee also finds that, although wealth reduced thechances of contracting a disease, wealth did notlead to lower mortality rates. Daniel Scott Smithalso looks at the high mortality rates resultingfrom disease among recruits, and finds no singlesmoking gun as the source, but rather argues thatthe high rates were caused by the sheer diversity

of sources. Among the more interesting of theseis the discovery that environmental factors, suchas better food and toilet facilities, which separat-ed officers from enlisted personnel, contributedto mortality rate differentials within the ranks.Although strictly speaking, this difference is not awealth effect, and the Union Army was arguablymore egalitarian than most nineteenth-centuryarmies, the difference between officers and otherranks was still a socioeconomic one.

Much work on the biological standard of livinghas revolved around human stature. Sven Wilsonand Clayne Pope analyze the impact of local envi-ronmental factors on the height of Union Armyrecruits. Confirming the findings of earlier stud-ies, they find that urbanization had a negativeimpact on stature; while recruits from farms weretaller on average. Thus the authors support theexpectation that exposure to disease during child-hood reduces stature; while access to nutrientsincreased it. Environment also mattered when itcame to other indicators of health later in the lifecycle. Werner Troesken and Patricia Beeson findthat veterans residing in cities in which themunicipal water systems employed lead mainsexperienced health problems at greater ratesthan other veterans.

Because of the longitudinal nature of the UnionArmy data, they are well suited for the study ofeconomic behavior over the life cycle. Chen Songand Louis Nguyen focus on the impact of a com-mon and particularly troublesome ailment amongthe veterans—hernias. Though viewed as a rela-tively minor ailment today, hernias were poten-tially debilitating in the past. Song and Nguyenfind that, after controlling for other health andeconomic factors, the presence of a hernia hadvirtually no impact on a veteran’s decision toretire. This finding contrasts with studies onmore recent workers that suggest a strong posi-tive connection between poor health and retire-ment. Also, Tayatat Kanjanapipatkul confirms anearlier finding of Costa’s that the income elastici-ty of retirement was larger in the past than it istoday. Kanjanapipatkul also finds that, amongUnion Army veterans, workers who could be clas-sified as “professionals” had the largest elastici-ties, a result that is just the opposite of that oftoday’s workers.

In other papers, Mario Sanchez shows thatmigrants were more susceptible to disease thannonmigrants; thus, the relatively high rates of

Book Reviews 179


internal migration in the United States con-tributed, ceteris paribus of course, to a reductionin the biological standard of living in the nine-teenth century. This was probably an important,and underappreciated, piece of the so-called“antebellum puzzle,” the term employed todescribe the divergence of economic and biolog-ical indicators of the standard of living in theUnited States. Sven Wilson finds that, amongUnion Army veterans, respiratory diseaseincreased toward the end of the nineteenth cen-tury, and that veterans who experienced respira-tory infections during the war were more likely tohave respiratory diseases later in life, providingsome support for the insult accumulation model.

Although the papers in this volume cover alarge range of topics, in Costa’s concluding chap-ter she offers a number of suggestions for futureresearch. Space prohibits a detailed accountingof that agenda, but one can only hope that she hasanother volume in the pipeline.

LEE A. CRAIG

North Carolina State University

The Political Economy of Stalinism: Evidencefrom the Soviet Secret Archives. By Paul R.Gregory. Cambridge; New York andMelbourne: Cambridge University Press, 2004.Pp. xi, 308. $90.00, cloth; $32.00, paper. ISBN0–521–82628–4, cloth; 0–521–53367–8, pbk.

JEL 2004–0684Paul R. Gregory’s book is a welcome attempt to

relate the new data from the Soviet archives onthe Stalinist economy to the concepts and analyt-ical tools of economics, to see how far this systemcan be understood in terms of principal/agentrelations, and institutional economics. Gregoryargues that the Stalinist state corresponded inlarge measure to Mancur Olson’s “stationary ban-dit,” based on a rational calculation of how theruler could maximize the resources at his dispos-al, whilst recognizing that those subject to hiscontrol would use their area of autonomy to max-imize their advantages, through rent seekingactivity and other strategies.

Thus the adoption of the command adminis-trative economy followed a clear logic, aimed atmaximizing the ruler’s control over the econo-my, and instituting forced primitive capital accu-mulation. Following F. A. Hayek and Ludwigvon Mises, Gregory sees the centrally planned,state owned economy as crucial in establishing a

totalitarian regime. He presents the relationshipbetween economic dictatorship and politicaldictatorship in terms of an analogy: the jockeychose the horse, but the horse required a partic-ular kind of jockey. Gregory echoes Hayek’sassertion that, under this system, the politicalleaders who came to the top were those with “acomparative advantage in brutality” (p. 50).

While there were no ineluctable laws thatmeant the destruction of capitalism in Russia in1917, so there was no inevitability about theabandonment of the New Economic Policy andthe adoption of the command economy after1928. Gregory acknowledges Stalin’s central roleas architect of this system. While the investmentrate doubled from 1928–37, there was large scaledestruction of the capital stock in agriculture.Moreover, Gregory endorses the view of JamesMillar that there was no net transfer of resourcesfrom agriculture to industry. Surprisingly, nonew calculations have been done on this mattersince the opening of the archives. Whether thegrowth rates actually attained by heavy industryand the defence industries in the 1930s couldhave been attained under NEP remains a matterof contention.

Gregory takes up R. W. Davies’s finding thatthere were distinct investment cycles in theSoviet economy, with sharp cuts in investment in1932 and 1937. The regime’s objective, heargues, was always investment maximization toensure the highest rate of growth, but it had totake account of the need to motivate the laborforce, to deal with labor unrest and high laborturnover, and low labor productivity. Thisinvolved favoring consumption, and was dictat-ed by the need to accommodate some concep-tion of what constituted a fair wage at leastamong key workers. He acknowledges that theSoviet notion of a fair wage was extremely elas-tic; while high bonuses were paid to shock work-ers and Stakhanovites, others suffered sharplydepressed incomes, income inequalities becameacute and a substantial part of the economy wasplaced under forced labor. Paradoxically, asGregory notes, the impact of Stakhanovism onproductivity is very uncertain. The investmentcycles can also be explained more conventional-ly as a response to investment surges that creat-ed imbalances and overheating in the economy,threatening supplies and credit and financialstability.



Gregory endorses the view of Eugene Zaleskithat the real planners’ preferences were reflect-ed in the investment plans, not the output plans.The five-year plans were not converted intooperational plans: the plans were subject to mul-tiple revisions, were adopted after the plan peri-od had begun, and the output plans remainedhighly aggregated allowing for decision makingto be delegated to lower levels. The Politburo’smain concern, Gregory argues, were the invest-ment figures. Nevertheless, output figuresremained important, as they provided a check onperformance, particularly in failing sectors, witheven daily output figures being published in thepress. Gregory questions how far this was aplanned economy, arguing that it was basedlargely on as system of resource managementand ruble control.

Gregory insists that Stalin and the Politburocould make pitifully few decisions in relation tothe number of decisions taken within the econ-omy. Undoubtedly there was a growing trend,already evident in the early 1930s, for the detailsof economic management to be taken over bythe government (Sovnarkom), the state plan-ning commission (Gosplan), and the chief eco-nomic ministries. But there is a danger ofexaggerating Stalin’s lack of influence. Very littlehappened without his say so. Moreover, in threecrucial areas—quarterly industrial investmenttargets, procurement targets for the agriculturalregions, and targets for foreign trade—Stalin’sword was law.

While the Second Five-Year Plan saw greaterrealism in terms of industrial and agriculturaloutput figures, the figures for consumption weregreatly exaggerated. Gregory relates this to theintrinsic failures of the planning system, in termsof inadequacies of information flows, institution-al obstruction, interdepartmental and interre-gional conflicts, the tendency toward over-tautplanning, the unreliability of supply chains, andthe trend toward institutional autarchy. All thisled to an overburdening of the centre, recourseto administrative controls, interspersed withwaves of repression. Much of this will be familiarto scholars, and has been well explored by JanosKornai, and by Alec Nove, especially in the lat-ter’s The Economics of Feasible Socialism, which,curiously, receives no mention.

In considering the destruction of the adminis-trative-command economy under Gorbachev in

the late 1980s Gregory places emphasis on thedismantling of the apparatus of central planningand control. Attention might also have been givento the destruction of the state’s revenue basethrough the anti-alcohol campaign and the law onstate enterprises.

E. A. REES

European University Institute

O Economic Development, TechnologicalChange, and Growth

Taxation and Economic Development in Taiwan.By Glenn P. Jenkins, Chun-Yan Kuo, and Keh-Nan Sun. Harvard Studies in InternationalDevelopment. Cambridge: Harvard UniversityJohn F. Kennedy School of Government; dis-tributed by Harvard University Press, 2003. Pp.xviii, 284. $32.00, cloth; $16.95, paper. ISBN0–674–01102–3, cloth; 0–674–01133–3, pbk.

JEL 2003–1149Taxation and development may not seem a very

natural pairing. As this study shows, however, acountry’s tax system and its pattern of develop-ment are closely interdependent. Three groupsof readers should find this book particularlyinteresting. Development economists will findhere excellent case material for classroom use,for example, with respect to real exchange ratesand trade protection. They will also learn muchabout the important role taxes play in determin-ing economic outcomes. Public economists willfind useful insights on the design and efficacy oftax incentives and the interplay of tax administra-tion and tax policy. In addition, however, they willalso learn that if they do not consider tariff andtrade policy carefully, they may seriously misun-derstand the effects of tax policy in developingcountries. Finally, anyone interested in under-standing the “Asian miracle” will learn muchabout the roles played by macro, trade, and taxpolicy in bringing about persistent high rates ofgrowth in one of the leading “tigers,” Taiwan.

The book begins with a description of the evo-lution of Taiwan’s tax system over the last fiftyyears and a condensed history of the variousstages of economic policy and economic develop-ment—import substitution, export expansion,infrastructure development, and liberalization.The authors both set out clearly the complicatedand changing set of policies that were utilized to

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promote economic growth and describe someimportant institutional peculiarities that shapedTaiwan’s polices (such as the overlay of “national”and “provincial” administrations).

The core of the book analyzes how tax, trade,and macro policies interacted to increase percapita GDP from about US$1,400 in 1955 to overUS$13,000 in 1999. Three main conclusionsemerge from this analysis. First, the many specif-ic and focused incentives put in place over thedecades had at most a minor impact compared tomore fundamental changes in real wages and realexchange rates. Second, by far the most impor-tant incentive policies were those related toexports, particularly the combination in the earli-er period of relatively high tariffs on manufac-tured goods and the duty rebates on inputs usedin making export goods. An important reason whythis policy worked so well, however, was becauseexporting firms were allowed to sell in thedomestic market provided they paid tariffs onimported inputs used for such production so thatthe “effective protection” provided by high tariffson final goods was largely competed away. Third,although the authors make a valiant effort to ana-lyze the impact of the incredible variety of taxincentives used to promote investment and sav-ings, on the whole their conclusion is that, asusual in such analyses, the effectiveness of theincentives is largely unclear.

The last two substantive chapters discuss taxand trade administration. While of some generalinterest in showing the critical importance ofadministration in determining both the natureand the effects of policy, this material is perhapsof most interest to tax specialists. As an example,Taiwan’s VAT is unusual in several importantways. For many years (until 1999) it was a “sub-national” tax, imposed by the local rather thancentral government. This system was not verysatisfactory both because taxes accrued to wherecompanies filed taxes rather than where con-sumption (or production) took place andbecause rebates to exports often had to be paidby jurisdictions other than those that had col-lected the taxes on inputs. Nonetheless, itworked surprisingly well because from thebeginning, in part precisely because of the con-stitutional need for the VAT to be subnational,Taiwan employed a heavily computerized admin-istrative system which has enabled it to be theonly place that has successfully managed to

“match” VAT invoices, thus providing a powerful(if costly) check on evasion. The same featurehas enabled Taiwan to be one of the very fewjurisdictions that does not collect VAT at importfrom registered taxpayers: rather, tax is deferreduntil the goods are sold. Taiwan’s unusualreliance on, and experience with, land-basedtaxes is also of considerable interest.

To sum up, this is one of the best case studiesof the role of taxation in economic developmentthat I have read. It is not, of course, perfect. Forexample, the authors’ harsh condemnation ofTaiwan’s “mistake” in initially paying too muchattention to the income tax may be right in effi-ciency (avoiding “double taxation” of dividends)and especially administrative terms, given theextent to which the proliferation of income taxincentives seems to have been generated by thethen relatively high tax rates. But the absence ofany serious discussion of either distributionalissues or the political economy of Taiwan weak-ens the case. Similarly, despite the repeatedstress on the importance attached to reducingcompliance costs, these costs are never really dis-cussed with respect to inland taxes. Finally, noth-ing substantive is said about the effect, if any, oftax incentives on capital flows and in particular ondirect foreign investment.

RICHARD M. BIRD

University of Toronto

When Markets Fail: Social Policy and EconomicReform. Edited by Ethan B. Kapstein andBranko Milanovic. New York: Russell SageFoundation, 2002. Pp. x, 235. $34.95. ISBN0–87154–460–1. 2003–0703Social policy and economic reform appear to be

antagonistic: the current economic reforms espe-cially in Europe cut deeply into the omnipresentcushion of social policies. This book argues thatthe situation in emerging market countries is quitedifferent: economic reforms require the cushionof social policy. Social policies, so the authorsargue, provide the insurance which make liberat-ed markets with their increased risks economicallyand politically viable.

The book draws lessons from a workshop spon-sored by the Russell Sage Foundation. It hasambitious aims: to collect experiences fromsocial policy experiments around the entireemerging world; to do this in a strictly compara-tive fashion and with an explicit theoretical



focus; to see where “best practices” haveemerged and whether these lead to a convergingpolicy approach. Most of the authors are closelylinked to the World Bank and the Inter-American Development Bank, and the book rep-resents the ongoing search for a more balancedview on social policies away from what has beenconstrued as the neoliberal “WashingtonConsensus” among the large non-governmentinstitutions situated there.

The core of the book consists of four chapterson broad geographic regions: Nicholas Barrbegins with a sober assessment of the welfarestate reforms in Central and Eastern Europe. Hismain (and very political) point is that the crisis inthe welfare state should not be overstated: whilereforms are needed particularly in their pensionsystems, there is no reason for panic or despair.Barr stresses an aspect underemphasized in therest of the book: social insurance needs to be asclose to actuarial as possible in order to minimizelabor market distortions. Nancy Birdsall andStephan Haggard review social policies in EastAsia and point out a crucial difference in thesocial contract: while in Western countries, asophisticated social contract has emerged over thelast centuries, such a contract is simply missing—they argue— in East Asia.

I would not put it so dramatically. Rather, thedivision of obligations between state and family isa fundamentally different one in Asia, making thestate the residual safety net and the family theprimary one, not the other way around as is soprevalent in Europe. Miguel Székely and RicardoFuentes try to explain the paradox that LatinAmerica has a tradition of labor protectionexplicitly aimed at reducing poverty, yet it has thehighest income inequality in the world. Their(controversial) answer is that poverty alleviationfailed because most Latin American countriesfailed to protect the poor from the implications ofvast macroeconomic volatility. Zafiris Tzannatosand Iqbal Kaur review public social spending andprograms in the Middle East and North Africawith their huge public sectors. This well-written,sometimes gloomy article stresses the impor-tance of fixing the large public program, in par-ticular their ill-designed incentive effects andgovernance structures, because privatization canonly proceed slowly for economic and politicalreasons in the wake of the slowdown afterSeptember 11.

These four regional chapters are framed by anextensive introduction, a historical account of theemergence of social policies around the world,and a brief section on policy recommendations.The introduction by the editors attempts toestablish a common point of view, in spite of thestriking diversity of policies, histories, and cultur-al norms that make the analyses and answers inthe four regions so different. It is a very usefuland thoughtful overview of development eco-nomics. Peter Lindert searches for the commondrivers of social spending from 1780 to 2020. Hiscliometric exercise puts most weight on demog-raphy, then ethnic fractionalization, then secularincome growth. Lindert explains which politicaleconomy mechanisms transform these causesinto social policies and bravely projects them intothe future—a somewhat questionable exercisegiven the huge regression errors.

The book as a whole compels through its broadrange of issues and views, encompassing histori-cal, sociological, economic, and political sciencemechanisms. It also makes crystal clear—the titleis program—that the primary task for develop-ment is to tackle badly failing markets. The bookdoes not really fulfill its aim to provide a unifying,explicitly theoretical framework. It would help tocarefully distinguish social policies between pureredistribution, public insurance where privatemarkets fail, and regulation where private mar-kets exist but would generate socially undesirableoutcomes. The global economics of actuarialinsurance are very different from the effect onredistribution. In this respect, a more careful dis-tinction between emerging markets and develop-ing countries would have helped. Emergingmarkets, the countries addressed in this book,have in general sufficiently advanced institutionsthat can carry actuarial insurance and sufficientincome to support redistributive taxes. Moreoften than not, both fail in the truly developingcountries—misleadingly depicted on the book’scover. The book also provides little analysis whyand which markets fail, and how these failures canbe addressed directly. This lack of analysis may bethe main reason why the final chapter of this vol-ume, dedicated to policy recommendations,comes out weakest.

The book provides the reader with a convinc-ing line of arguments that social policy is badlyneeded to provide economic and political sup-port to economic reform in the emerging market

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countries because markets fail. It shows that a“one size fits all” approach is inappropriatebecause different markets fail in different emerg-ing countries. We still have a fascinating researchagenda ahead of us to understand how we dealwith these market failures.

AXEL BOERSCH-SUPAN

University of Mannheim

After the Washington Consensus: RestartingGrowth and Reform in Latin America. Editedby Pedro-Pablo Kuczynski and John Williamson.Washington, D.C.: Institute for InternationalEconomics, 2003. Pp. xii, 373. Paper. ISBN0–88132–347–0. JEL 2003–1123The set of reforms pursued by many Latin

American countries at the beginning of the 1990saimed at achieving macroeconomic stabilizationand a market economy, generally known as “TheWashington Consensus,” have lost its luster inrecent years. The public opinion in the region, asshown in recent polls, has turned against pro-market reforms. The rhetoric of policymakers hasincreasingly blamed free market policies formany of the economic ills in the region.International organizations, the linchpins ofstructural reform around the world, are begin-ning to question the idea that pro-market reformis a necessary condition to achieve economicdevelopment. Even some academics are havingsecond thoughts about the role of the market.The reasons are simple. Economic growth inLatin America, while positive, has been disap-pointing. Poverty remains rampant. Incomeinequality is as dreadful as ever.

Kuczynski and Williamson have brought togeth-er an impressive cast of practitioners and academ-ics who have been able to produce an appealingbook that makes an attempt at understanding thereasons for the unsatisfactory performance withthe aim at developing a new agenda for revivingeconomic momentum in Latin America. The edi-tors organize the topics in eleven chapters, oneoverview, and one appendix in four broad topics,namely, crisis proofing (chapters 4, 5, and 6),completion of first-generation reforms (chapters2, 7, and 9), second-generation reforms (chapters8 and 10), and social issues (chapter 3).Essentially, the underlying premise of the book isthat the initial reforms carried out during the1990s were not pushed far enough. Neglected orincomplete reforms, compounded with a decade

of macroeconomic crises in the region, resulted ina stumbling process that ended up bearing littletangible fruit. Thus, the book makes a case for thecompletion of first-generation reforms, such asthe privatization of public banks, the improve-ment of market access to industrial countries, andlabor market liberalization issues, as well as oncrisis proofing issues, such as budget surpluses,hard budget constraints, reserves and stabilizationfunds, exchange rates flexibility, de-dollarizationof the economy, prudential supervision of banks,and a strengthened fiscal position.

Furthermore, a perusal of the book corrobo-rates that the policy recommendations discussedare not simply just “more of the same with atwist.” The insights on many issues are, in fact,thought provoking and some of the ideas areinnovative, for instance, the proposal to estab-lish a regional peer monitoring of Maastricht-like commitments to fiscal responsibility which,as feasible as it may or may not be, has the meritof being the result of a broader, out of the boxperspective. In addition, there is some focus oninstitutional as well as on social issues. In fact,unlike in the original agenda, there is an explic-it concern on social welfare in general, andincome inequality, in particular beyond theusual “Field of Dreams” view—“if the countrygrows, redistribution will come.” In fact, thebook argues that countries should aim at makingfiscal systems more progressive, for instance, byfocusing expenditures on the universal provisionof high-quality basic education and health care.The idea is to give the poor access to assets thatwill enable them to make and sell things thatothers will pay to buy. In this context, the poorshould be empowered with education, land,credit, and titling to provide them access thatwill enable them to earn a living in a marketeconomy. In this context, a “cannot miss” is theexcellent work done by Williamson in the lastchapter drawing together the ideas expressedthroughout the volume

The book correctly points out that carefulreform of the political system, the civil service,and the judiciary are imperative and that thepolitical economy of reform will be as important,if not more important, as compared with the pre-vious round of reforms. It discusses potentialrules change in the political game, in particular,in the electoral systems. Examples are the pro-posal to set up legislatures composed of career



professionals dependent on constituents, propor-tional representation in districts of modest size,and consolidation of election dates. However, forall the emphasis placed on political economy, thebook is somewhat unbalanced in that it lacks suf-ficient policy detail on microeconomic aspectsdespite the fact that second-generation reformsare essentially microeconomic in nature. As aresult, the overall emphasis of the book tends tobe more on the what rather than on the how,whereas policymaking is about the latter.

The discussion of microeconomic interventionsis, perhaps, a good example of this. Several coun-tries in the region are currently engaged in inter-ventions to attract foreign direct investment,support small firms, promote innovation, andpromote exports that try to mirror the experienceof such countries. While the book is skepticalabout “strategic” interventions similar to thosepursued in several East Asian economies, itwould have been even more useful had it dis-cussed the theoretical and empirical foundationfor such kind of interventions which are not assolid as is commonly believed. This is under-standable in that it is not possible to discuss allthe policy-relevant issues in detail in such abroad book.

The book leaves the reader with a profoundsense of the crucial challenges in Latin Americain years to come and, in particular, the toughroad ahead in the process of transforming institu-tions from dysfunctional to functional. At thesame time, it also gives the impression that,despite the reform fatigue, the medium-run hori-zon of the proposed new reforms, and the limit-ed patience of the population, the region hasembarked, for better or worse, on an irreversiblepath of transformation.

ALBERTO CHONG

Inter-American Development Bank

P Economic Systems

The New Political Economy of Russia. By ErikBerglöf, Andrei Kunov, Julia Shvets, andKsenia Yudaeva. Cambridge and London: MITPress, 2003. Pp. x, 168. $21.95. ISBN0–262–02542–6. JEL 2003–1605In the early 1990s, Russia began to embark on

its transition from operating as a socialist econo-my to functioning as a market economy. Under

the socialist system, prices were largely setaccording to administrative criteria; the stateowned most of the enterprises, land, and housing;the state determined the overwhelming share ofdomestic investment; and the state controlledinternational and financial trade flows. The initialround of “big bang” reforms represented a radi-cal break from this socialist legacy: the Russianleadership mandated an immediate liberalizationof most prices in January of 1992; a massive pri-vatization of large, medium, and small enterpris-es was rapidly implemented during 1992–95;major efforts to set up financial markets and toestablish appropriate corporate governance pro-cedures were implemented and Russia becamemuch more integrated into international com-modity and financial markets. This book drawsupon a large body of work employing state of theart theory, survey, and econometric methods. Theresearch was conducted primarily by a younggroup of economists working at the Center forEconomic and Financial Research in Moscow inorder to analyze Russia’s economic prospectsafter more than ten years of reform.

The chapter entitled “Accounting for Growth”contains an overview and analysis of the Russiangrowth record and the determinants of growth.Before President Putin came to power, Russiahad one of the sharpest and most sustaineddeclines in aggregate output within the group ofpost-socialist transition economies in Central andEastern Europe and the former Soviet Union.However, the Russian aggregate growth recordhas been impressive since 1999. The authors per-suasively argue that the current growth recordcannot be sustained without a major improve-ment in industrial productivity and a sharp and asustained increase in investment. The analysis ofjust how the highly controversial financial groups(FIGS) that spontaneously emerged during themid-1990s have contributed to growth is superb.FIGS have enhanced industrial productivitybecause they, in general, use their substantialfinancial power to buy out inefficient owners andmangers of enterprises. This threat of buyout alsoencourages existing enterprises to operate moreefficiently. Thus, in an environment in which cor-porate governance procedures and bank lendingfor enterprises are relatively primitive, FIGShave emerged as a growth enhancing informalinstitution via their impact on productivity.However, FIGS may also impede growth via their

Book Reviews 185


impact on foreign direct investment. Carefulresearch shows that foreign direct investment isimportant for both productivity gains and overallinvestment. After the devaluation of 1998, FIGSbecame even more entrenched as owners andlenders in a larger number of sectors in Russianindustry. Foreign investors, however, are nowhesitant to work with FIGS because they employinformal and nontransparent lending andtakeover procedures. Thus, more generally, thechallenge to Russian reform is to somehowimprove property rights, small shareholder andcreditor rights and promote the development ofbanking in order to attract more foreign directinvestment. One would like to know, however,just how FIGS should be dealt with so that theywill support or, at least, not block these reforms.

The third, fourth, and fifth chapters provide afascinating overview of the ongoing drama asso-ciated with creating and sustaining market-enhancing political institutions such as anindependent judiciary, efficient and honest reg-ulators, federal and regional executives and leg-islatures that are responsive to theirconstituents, etc. One of the notable successesof the Russian reform is the widespread intro-duction and use of competitive federal, region-al, and local elections. Nevertheless, drawing onthe modern theory of political institutions, theauthors caution that the emergence of directdemocracy is necessary but not sufficient to pro-vide incentives to employees in the public sec-tor to push ahead with reform and to beaccountable to their constituents. In particular,it is also necessary to establish a system ofchecks and balances between agencies such asthe judiciary, legislature, and executive branch;and, it is also necessary that foreign institutions,such as the WTO, have the ability to monitorthe public sector. A very useful comparison ofthe accountability under the Yeltsin and Putinadministrations is presented and the authorsconclude that the Putin government has thepotential to move ahead with reform because ofits strong cooperation with federal legislature.

There are, however, several caveats about thepower that the Putin administration currentlyenjoys. First, the potential for the Putin adminis-tration to abuse its power is worrisome.Secondly, and this is an open question, it isunclear whether an independent judiciary thathas the power to enforce its rulings can emerge

under the current political conditions. There arepowerful theoretical arguments backed withstrong evidence that legislatures and executivebranches in direct democracies are more likely toempower the judiciary when they face politicalcompetition and when there are substantial poli-cy differences across parties (see William M.Landes and Richard A. Posner 1975 and F.Andrew Hanssen 2004). It is clear from readingthe book that, even though reforms to strength-en the judiciary have been implemented, muchmore needs to be done “to achieve a judiciarythat functions at a level that inspires confidencein its impartiality and specifically in its ability toenforce property rights.” (p. 96) It is important,however, to consider just how to provide incen-tives to the Putin administration to empower thejudiciary or to consider just how to create thekind of political competition that is conducive tothe emergence of an independent judiciary.

This book should be of interest to economistsworking on post-socialist transition as it providesa very sophisticated overview and analysis of theRussian reform. It should also be of interest todevelopment and comparative economistsbecause it contains an excellent analysis of thecontribution of institutions such as informallending groups and the judiciary for economicperformance.

DANIEL BERKOWITZ

University of PittsburghHanssen, F. Andrew, 2004. “Is There a PoliticallyOptimal Level of Judicial Independence?” AmericanEconomic Review, 94(3): 712–729.

Landes, William M. and Richard A. Posner, 1975. “TheIndependent Judiciary as an Interest GroupPerspective,” Journal of Law and Economics, 18:875–902.

Is the Market Moral? A Dialogue on Religion,Economics, and Justice. By Rebecca M. Blankand William McGurn. Pew Forum Dialogueson Religion and Public Life. Washington, D.C.:Brookings Institution Press, 2004. Pp. xiii, 151.$16.95, paper. ISBN 0–8157–1021–6.

JEL 2004–1133Every economist could benefit from reading

this book. It explores fundamental questionsabout the role and moral implications of themarket in society. The questions are not newbut are addressed here with honesty and a freshrelevance.



Blank is an economist with a Ph.D. from MITand is currently dean of the School of PublicPolicy at the University of Michigan. McGurn isthe chief editorial writer for the Wall StreetJournal. The book consists of separately writtensections in which each responds to the other.They were selected by the Pew Forum onReligion and Public Life and the BrookingsInstitution not just because of their professionalqualifications but also because they are deeplycommitted Christians—Blank an active memberof a Protestant denomination and McGurn adevout Catholic.

It is not that the moral criteria they apply to themarket are much different from those applied byother Americans, religious or nonreligious. Theyare concerned with matters of social equity, indi-vidual freedom, impact on family and communi-ty, and in general the effects of marketself-interest on other social values. TheirChristian commitment comes into play more interms of their willingness to examine the morali-ty of the market explicitly, dropping the standardprofessional stance of a strictly scientific inquiryand value-neutrality. The result is an unusuallyopen and candid dialogue among two wellinformed and sophisticated observers ofAmerican economic life.

Blank and McGurn both dismiss out of handthe idea that a market can be simply an imper-sonal device—a “market mechanism”— to bejudged by its ability to promote economic effi-ciency alone. As Blank writes, many of the losersin a market competition will feel real “pain” andindeed the market “can be extremely cruel.”Whatever economists may say about Pareto opti-mality, there is seldom any actual compensationfor market losers. To endorse a market system is,therefore, to make a value judgment that otherthings advanced by the market are equally ormore important than the stresses and strainsexperienced in the market process. The many los-ers in that process may be part of the necessary“price of progress,” a price that most reasonablepeople perhaps will judge that society should bewilling to pay. However, this is not a “scientific”determination.

Besides the economic advances that can liftwhole nations out of poverty, another desirablemarket feature for McGurn is the greater indi-vidual freedom it offers. In his view, humanbeings are born with a natural curiosity and a

desire to express their creativity—related to thebiblical message that men and women are creat-ed in the image of God. The market provides anopportunity for millions of people to apply theirindividual intelligence while serving the needs ofothers. Indeed, the act of production may be asworthy as the act of consumption, a truthpreached by many religions of history, if muchneglected in the current analytical framework ofeconomics.

Both Blank and McGurn are concerned that amarket ethic of self-interest should be limited tocommercial domains within society. Whatevermany University of Chicago economists may haveargued, a family that is a merely a contract amongself-interested individuals is not a real family.Indeed, even within the domain of the market,there is a danger that attitudes of greed and self-interest can extend too far. A market system, asBlank and McGurn agree, must be grounded inshared values of trust, honesty, and fair dealing.For them a world of total individual pursuit ofself-interest would function poorly in almostevery area of society, including the market itself.

It is thus an open question whether the marketmay contain the seeds of its own destruction, if itencourages an excessive individualism that mighteventually be severely harmful to its workings.Yet, both Blank and McGurn are optimistic; forthem, the Christian religion provides a strongenough moral foundation outside the market.Because higher values are so well defendedthere, an ethic of self-interest inside the market isacceptable (and for McGurn even admirable).They do not address a question that will occur tomany others—absent such a powerful religiousfaith in society, or some other firm grounding forethical behavior, how well will the market work?

Reflecting in part her Christian commitment,Blank argues that a “collection of individuals eachpursuing his or her self-interest” can not be aworld of “fully functioning human beings.”McGurn argues that “it is culture that determinesthe boundaries within which the market operatesand beyond which the market dare not go.” Anappropriate set of outside cultural rules is need-ed in society, he says, to sustain “the institutionsand values that no market can survive without.”

Does this mean that a favorable judgment onthe market system requires the presence of theChristian religion or some other satisfactoryfaith complementary to the market? Must a

Book Reviews 187


provider of economic policy advice first deter-mine the religious character of a society, andthen tailor the economic recommendations tothe actual religious circumstances—as MaxWeber early in the twentieth century might wellhave argued? If a society has a religion that isless congenial with the market (some versions ofcurrent Islam, for example), might an economistsuggest the need for new religious thinking, orwould it be necessary to suggest an alternativeset of economic institutions more compatiblewith existing religious convictions?

In a book that raises issues of such broad scope,it is not surprising that Blank and McGurn do nothave—or claim to have—the full answers. Onecould well argue that Christianity has been mar-ginalized in the modern era by more powerfulsecular religions. If they had written more, theauthors might have explored whether a secularreligious commitment to the market may even bea necessity for fending off rent seeking, oppor-tunism, and other powerful forces in society thatmight otherwise undermine the market’s effec-tiveness. Yet, if that is the case, it may be neces-sary almost to worship the market to achieve itsmaximum benefits—perhaps seeing the marketas the best possible instrument in a secular reli-gion of economic progress that will lead to a newheaven on earth. In that case, the tensionsbetween “market values” and “Christian values”in society may be considerably greater thaneither Blank or McGurn acknowledge.

It also follows from their arguments that thesubject matter of economics as presently con-ceived is incomplete. Current economists havelittle to say about the matters of the formationand defense of “social capital” that Blank andMcGurn see as critical to the functioning of theeconomic system. Most current economicinquiries thus address only a limited part of thefull terrain of major influences on economic out-comes. The economics profession at presenttherefore has a choice: it can either concede thatmany important “cultural” influences on theworkings of the economy fall outside the scope ofaccepted professional inquiry or economists cansignificantly expand the scope of legitimate areasfor their own investigations.

Until recently, any suggestion of the latterwould have seemed impossible. However, majorAmerican foundations, such as Pew, are todaycommitting significant funding to the study of the

connections between economics and religion. Itis no longer especially controversial to suggestthat a value-free economics is an impossibility.When the Brookings Institution asks two devoutChristians to explore together the moral merits ofthe market, and publishes the resulting bookunder its auspices, it is surely a sign that times arechanging.

ROBERT H. NELSON

University of Maryland

Financial Policies in Emerging Markets. Editedby Mario Blejer and Marko Skreb. Cambridgeand London: MIT Press, 2002. Pp. vi, 259.$40.00. ISBN 0–262–02525–6.

JEL 2003–0369Financial policies have assumed a crucial role

in the management of economies throughout theworld over the last thirty years or so. Financialcrises have increased, at the same time, in termsof both their frequency and severity. The “emerg-ing market economies” have not been unaffected.On the contrary, the majority of financial crisesover the period affected them, and in some casesseverely, especially in the second half of the1990s. The aim of this book is to deal with finan-cial policies in Emerging Markets (EMs), as thetitle suggests, by concentrating on two interrelat-ed issues: the degree of financial vulnerability ofEMs, and the possible connection between theexchange rate system and financial vulnerability.The book is divided into two sections, with thefirst entitled New Evidence on Financial Policiesand the Impact on Emerging Markets, compris-ing three chapters, and the second The Euro andFinancial Policies in Central and Eastern Europe,also comprising three chapters.

The editors in chapter 1, “FinancialVulnerability and Exchange Rate in EmergingMarkets: An Overview,” provide a helpful com-mentary and raise a number of issues that areaddressed more extensively in the rest of thebook. In chapter 2, entitled “Original Sin,Passthrough, and Fear of Floating,” RicardoHausemann, Ugo Panizza, and Ernesto Steinexamine the extent to which EMs float theircurrencies. The authors conclude that EMs donot have the “luxury” of exchange rate flexibilityand independent monetary policy; most EMcountries intervene heavily in the foreignexchange market. It is demonstrated, both theo-retically and empirically, that a strong negative



correlation exists between a country’s inability toborrow in own currency and degree of exchangerate flexibility.

In chapter 3, Barry Eichengreen and CarlosArteta in “Banking Crisis in Emerging Markets:Presumptions and Evidence,” identify three con-tributory factors to the instability of the bankingsystem as a major disruption in the EMs: therapid growth of domestic credit; the large size ofbank liabilities; and financial liberalization. Theauthors find no stable relationship between theexchange rate regime and banking crises (if any-thing it is banking crises that cause currencycrises), nor do they find evidence that the qualityof institutions, or deposit insurance arrange-ments, matter. Ultimately, though, the authorsconclude that, as far as the causes of bankingcrises in EMs are concerned, “it is fair to say thatthe jury remains out” (p. 55).

J. Onno de Beaufort Awijnholds and ArendKapteyn in chapter 4, entitled “InternationalFinancial Crisis: The Role of Reserves and SDRAllocations,” argue that while a stable macroeco-nomic environment and a sound financial systemmight be important prerequisites to avoid a crisis,EM countries would be strongly advised to holdan adequate level of international reserves. It is,of course, recognized that holding reservesentails costs and benefits. EM countries with rel-atively high reserves are able to manage to with-stand financial crises better than those withrelatively low reserves. A considerable cost isidentified in the case of countries that hold exces-sive reserves. It could lead to macroeconomic lax-ity since the external constraint is therebyremoved. An adequacy benchmark is, therefore,proposed.

Jacek Rostowski in chapter 5, “The EasternEnlargement of the EU and the Case forUnilateral Euroization,” examines the issue of thechoice of an appropriate exchange rate regime bythe “eastern applicant” EM countries that aspireto EU membership. For these countries, thequestion is the exchange rate regime that opti-mizes their path to the EMU. EM countriesshould adopt the euro unilaterally as the best wayto achieving convergence. Chapter 6 by D. MarioNuti in “The Costs and Benefits of Euroization inCentral and Eastern Europe Before or Instead ofEMU Membership” deals with a similar theme.The costs and benefits of euroization are exten-sively discussed to conclude that ultimately the

net balance is an empirical question. Earlyeuroization may have clear advantages but thecosts cannot be ignored.

In chapter 7, entitled “Currency Substitution,Unofficial Dollarization, and Estimates ofForeign Currency Hel Abroad: The Case ofCroatia,” Edgar L. Feige, Michael Faulend,Velimir Tonje, and Vedran Todic attempt to meas-ure the amount of foreign currency in circulationin a country, knowledge of which is important toeconomic policymakers in their choice ofexchange rate regime. Despite this there is noreliable evidence on the extent of unofficial dol-larization. This measurement is attempted in thecase of a number of countries, and Croatia in par-ticular, in the case of dollar and DM holdings. Itis argued that, when the euro replaces nationalcurrencies, the results of exercises of the typeproposed in this contribution should be veryhelpful.

Although one may very well quibble about anumber of aspects of the theoretical and empiri-cal parts of the book, especially the variables uti-lized in the estimations and techniques utilized,this is no doubt a topical book, dealing with rele-vant issues concerning EMs and their place in theworld economy. There are, however, threeaspects that are sadly downplayed in the book:the role of institutions (legal and political econo-my factors in particular); the importance of gov-ernance; and more quantitative analysis of anumber of issues raised in the book should havebeen forthcoming (e.g., cost and benefitsreferred to in a number of instances in the book).These are key aspects to the problems faced byEMs, especially so in view of the conclusionreached by the editors that EMs “must look with-in their own respective countries and find specif-ic answers to specific problems for a betterfuture. There is no alternative to a home-growndevelopment” (p. 14).

PHILIP ARESTIS

University of Cambridge

Russia’s Virtual Economy. By Clifford G. Gaddyand Barry W. Ickes. Washington, D.C.:Brookings Institution Press, 2002. Pp. xiii, 306.$49.95, cloth; $19.95, paper. ISBN0–8157–3112–4, cloth; 0–8157–3111–6, pbk.

JEL 2003–0359The book analyzes Russia’s transition from a

command economy to the market, with particular

Book Reviews 189


emphasis on the role of Russia’s industrial andbehavioral heritage in slowing down the pace oftransition. The “virtual economy” is an environ-ment in which large loss-making enterprises wereable to survive without restructuring by usinginformal and highly personalized networks thatallowed value-subtracting goods to be producedand exchanged; the oil and gas industry was theultimate source of value infusion.

Russia’s transition to a market democracy is farfrom being complete, and any analysis is boundto be interim. Reality played a cruel joke on theauthors: the book, which was begun in 1997 withthe aim of explaining the disappointing results ofeconomic reforms, was out of print by 2003, thefifth consecutive year of high growth rates. Yetwhat might be concealed by these rates fueledprimarily by high oil prices and dramatic rubledevaluation in 1998 is that the overall economicstructure remains largely intact. Recent estimatesby the World Bank show that transfer of valuefrom extractive industries to the rest of the econ-omy remains a pervasive feature of the Russianeconomy.

For a book aimed at a general economics read-ership, Russia’s Virtual Economy is a little bittoo systematic. To provide a comprehensive pic-ture, the authors invoke a lot of peculiar featuresof the Russian economy and attempt to put theminto a general perspective by contrasting themwith the Economics 101 wisdom. While theauthors’ command of Russian details is indeedimpressive, the number of issues tackled and thenumber of explanations suggested seem over-whelming. Still, despite doing a poor job ofdrawing interest to Russian transition, the bookprovides a superb analysis to those who are real-ly interested. Starting from a case study of amedium-size provincial firm, the book exploresthe basic mechanism that allows “industrialdinosaurs” to survive in the era of rapidly chang-ing market conditions. Instead of investingmoney and efforts into transition toward theefficiency frontier, firms maintain nonmarketrelations with one another and accumulate rela-tionship capital which is crucially important indealing with state authorities. The whole econo-my is then stuck in a bad equilibrium, wherethose firms that try to do business in a standardmarket mode are relatively penalized, whilethose who play by the “virtual economy” rulesare rewarded. The symptoms of the economy’s

disease include widespread barter, in-kind taxes,and other nonmonetary transactions.

In part, the Russian virtual economy was a reac-tion to a particular strategy of exchange-ratebased macroeconomic stabilization pursued bythe Russian government in 1995–96 rather thanthe legacy of the Soviet past. The same “virtualeconomy” symptoms were observed lately inArgentina between the Brazilian devaluation andthe Argentine default. Still, one of the truly valu-able points raised by the book is the extent towhich enterprises inherited from the Soviet erahave been unable rather than unwilling torestructure. Early students of Russian reformsput a lot of emphasis on incentives. Though thereis no doubt that proper incentive design is of cru-cial importance, Gaddy and Ickes are right topoint out that the constraints due to initial condi-tions have been binding for large industrial enter-prises. This is in contrast with the empiricalevidence on newly created firms, which areshown to respond to changes in the rules of thegame, e.g., an improvement of property rightsprotection, in a market way. The authors are rightto argue that Russia’s unique features by nomeans imply that a market system cannot everwork properly in Russia. All the available evi-dence demonstrates that transition economies areinhabited by agents who are genuinely interestedin enjoying fruits of their own efforts.

One aspect, mysteriously missed in the book,is politics. Russia is a federal country, and gover-nors who are elected in contested elections haveplayed a crucially important role in regionaleconomies. Without taking governors’ incentivesinto account, it is hard to understand why it is soimportant for the directors of large enterprisesto maintain employment far above the efficien-cy level, and why close relations with largeregional business lead to governor’s unfriendli-ness toward small and new business develop-ment. In the book, the “missing politics”phenomenon is more of a linguistic nature. Withan apparent aim to widen the readership, theauthors sometimes choose to introduce newconcepts rather than to stick to more traditionalacademic language. For example, once invest-ment in relational capital—be it a bribe to apolice officer or putting a senator’s wife on thepayroll—is understood as a private protection ofproperty rights, the picture starts to look morefamiliar to students of capitalist economy.



The whole phenomenon of the “virtual econo-my” was probably no less characteristic of the latedecades of the Soviet Union than of post-SovietRussia. In the 1990s, while official Russian GDPmay have been overestimated as a result of “vir-tual economy” accounting, as the authors claim,the same estimates might also have failed toaccount for the informal economy, and thus thenet effect may be that GDP was understated. Inthe Soviet Union, where prices had been set by acentral planning body, value was transferred fromextracting to manufacturing industries throughartificially low energy prices.

To those readers who reach chapter 9, there isan analysis that is a model of clarity and precision,which are sometimes lacking in earlier chapters.The authors outline the “impossible trinity” ofthe Russian state: to simultaneously achieve eco-nomic growth, democracy, and security. The cur-rent trend of cutting down still-young democraticinstitutions in the name of sustaining high growthrates and maintaining security fits very well intothis paradigm. In the final analysis, it might be abit of overstatement to say that the book is amust-read for anyone who is interested in theeconomics of transition. But the “virtual econo-my,” the main mechanism that Gaddy and Ickeswere first to identify, describe, and analyze, issurely something that must be understood.

KONSTANTIN SONIN

Institute for Advanced Study and NewEconomic School/CEFIR

Regressive Taxation and the Welfare State: PathDependence and Policy Diffusion. By JunkoKato. Cambridge; New York and Melbourne:Cambridge University Press, 2003. Pp. xi, 260.$55.00. ISBN 0–521–82452–4.

JEL 2004–0339Junko Kato, a political scientist, tells a historical

political story of the relationship between theadoption of regressive taxation—value-addedtaxes (VAT)—and the growth of the welfarestate—social security expenditures—across vari-ous industrialized and newly developed or devel-oping nations during the twentieth century.Kato’s interest is in examining the funding base ofthe welfare state. She begins with a look at evi-dence on the cross-national patterns in welfareexpenditures for 1960–1996 in eight industrial-ized nations, concluding that there was little con-vergence among high-spending and low-spending

welfare states. The explanation: there was in factlittle retrenchment among the high-spendingstates during the 1980s welfare retrenchment era.Kato argues that a greater funding capacity with-in a nation in the 1980s blunted any movementtoward welfare retrenchment, while in nationswith financial problems retrenchment wasinevitable. She further contends that “The diver-gent funding capacity of the welfare state is path-dependent upon the institutionalization ofregressive taxes” (p. 1). If the regressive (VAT)taxes were institutionalized during periods ofhigh economic growth, they created greater fund-ing capacity and welfare spending; if during peri-ods of low growth, they caused less fundingcapacity and spending.

The book does not have an introductory chap-ter; instead, chapter 1 is organized similarly to ajournal article. It serves as an introduction to thetopic, places it in the context of the (principally)political science literature, discusses varioushypotheses and propositions, analyzes data, dis-cusses findings, and draws conclusions. Thechapter examines the cross-national patterns intax revenues, tax composition, and welfare expen-ditures for 1965–2000 for eighteen OECD coun-tries, which are labeled according to variouspolitical classifications that may seem odd toeconomists. Thus, the high-spending, high-taxDenmark, Finland, Norway, Sweden, Austria,and Belgium are labeled “nonright hegemony”welfare states while the low-tax, low-spendingCanada, France, Ireland, Japan, Switzerland, andthe United States are labeled “liberal” welfarestates. The high-tax, low-spending Australia, NewZealand, and the United Kingdom are labeled“radical” while the low-tax, high-spendingGermany (West), Italy, and Netherlands arelabeled “conservative” (p. 7). Detailed data on taxcomposition and tax revenues for the eighteencountries is presented next, indicating a largecross-national variation that increased between1965 and 1980. But while total taxes generallyincreased, the relative positions of countriesremained the same in 1995 and 2000. The lateryears still indicate a large, but unexpected, cross-national variation in both the composition andlevel of tax revenues. The continuing variation inthe postwar period is unexpected, according toKato, because of the widespread diffusion of theprogressive income tax during the 1940s and1950s and the “worldwide tax reform in the

Book Reviews 191


1980s” (p. 13), both of which should havedecreased cross-national variation in tax composi-tion. Yet despite the worldwide movement awayfrom reliance on progressive income taxes towardreliance on regressive VAT taxes, there was rela-tively heavier reliance among the high-tax coun-tries, which was not diffused to the low-taxcountries. Finally, the chapter finishes with esti-mation of a two-stage regression model of welfarespending in the eighteen OECD countries for1965–1992. The econometric findings (pp.42–51) generally support the hypothesis thathigher welfare expenditures are consistent withheavier reliance upon VAT. While globalizationand other political and economic factors alsoinfluence welfare spending, they do not blunt theeffect of reliance on VAT.

The next three chapters present detaileddescriptive case studies of the history of selectedcountries’ tax and welfare policies during the lasthalf of the twentieth century. The case studies arebased on existing political science literature inter-spersed with references to statements of variouspolitical actors involved in formulating differentcountries’ tax and welfare polices, made in inter-views with the author. None of the chapters con-tains formal quantitative analysis; they rely onqualitative descriptions of detailed minutiae ofthe policy-making process, with emphasis on thehistory of tax legislation. Chapter 2 presents casestudies of Sweden, the United Kingdom, andFrance. Chapter 3 presents case studies ofAustralia, New Zealand, Canada, and the UnitedStates. Chapter 4 presents a detailed case studyof Japan with a brief overview of South Koreanpolicy (and mention of Taiwan) for comparativepurposes. But prior to the case study, the chapterlooks at data on the cross-national patterns in taxrevenues and welfare expenditures for ninenewly developed or developing nations (CzechRepublic, Greece, Hungary, Mexico, Poland,Portugal, South Korea, Spain, and Turkey) duringthe last third of the twentieth century, indicatingthat the relative positions of most remained thesame between 1965 and 2000. Chapter 4 alsolooks at when VAT taxes were introduced and itsrate in nearly three dozen Latin American,African, and former Eastern Block countries. Thedetailed case study of Japan and overview ofSouth Korea are then presented.

The case studies overall are well done for whatthey are: detailed political histories of the minutiae

of tax and welfare policies relying on secondary lit-erature supported with a few interviews of politicalactors involved. The cases contain little or no eco-nomic analysis, though. And readers will have todetermine how much credence they wish to give tothe recall and rationale given by policy makers forparticular tax or welfare legislation.

The concluding chapter 5 presents (1) anoverview of financing the welfare state, includingwhy some countries were outliers, (2) incomeinequality data indicating heavy reliance onregressive VAT revenues does not work againstequality (because the revenues are used for redis-tribution), and (3) public opinion data on tax andpublic spending polices in the eight case-study-countries that in the author’s opinion offer somesupport for her hypotheses.

Overall, depending upon their interest, readersmay find this book worth a look.

ROBERT A. MCGUIRE

University of Akron

Q Agricultural and Natural ResourceEconomics – Environmental and

Ecological Economics

Priceless: On Knowing the Price of Everythingand the Value of Nothing. By Frank Ackermanand Lisa Heinzerling. New York: The NewPress; 2004. Pp. 277. $25.95. ISBN1–56584–850–0.Is it progress if a cannibal uses knife and fork?—Stanislaw Lec, Unkempt ThoughtsThe preceding quote captures the essence of

Priceless, a remarkably well-written book by aneconomist (Ackerman) and an environmental lawprofessor (Heinzerling), hereafter AH. Throughmany anecdotes, AH argue that benefit–costanalysis is fatally flawed for public sector deci-sions, frequently resulting in outcomes that sen-sible people find both bizarre and inappropriate.The typical activist will find the book very appeal-ing and persuasive, while the typical economistwill likely be uncomfortable with both the argu-ments and the emotional tone. There are goodreasons for both reactions. However, a carefulreading of AH should reduce smugness on thepart of economists who see nothing wrong withapplied benefit–cost analysis.

In part, environmental and health activists willlike Priceless because it places great emphasis on



the very real problems of valuing outcomes in thepublic sector. What, for example, is it “worth”when a policy changes the probability of death?AH conclude, from a nice discussion of the issuesinvolved, that many such outcomes are funda-mentally impossible to price in the way that isrequired for benefit–cost analysis. Activists willalso likely enjoy AH’s barbs aimed at thoseattempting such valuation (e.g., Kip Viscusi’s VSLmeasures). AH argue (p. 234) instead for “an atti-tude rather than an algorithm,” claiming margin-al willingness-to-pay to be impossibly difficult toquantify in practice.

Activists will also share AH’s equity viewswhich further undermine the policy relevance ofaggregated marginal willingness-to-pay in publicsector decision making. The impoverished of theworld have a smaller marginal willingness-to-payfor anything, including policies protecting theirhealth and environments, than do the rich (LarrySummers being on AH’s hot seat here). Toattempt to provide public good levels and loca-tions (for location-specific public goods) as theywould be provided by a perfectly functioningprivate market, were it able to exist, is taken byAH to be unfair.

I approached the reading of Priceless with hopesince I also have very strong misgivings aboutbenefit–cost analysis as it is currently practiced.For example, benefits might be dramaticallyunderstated because there is no incentive to gen-erate income if you cannot get more of what youwant by doing so (see Graves 2002 athttp://spot.colorado.edu/~gravesp/GravesRevtext.htm for details). That is, if what you care aboutare ordinary private goods, you will know that youcan acquire them if you generate the income todo so. However, to the extent that you care aboutgoods such as clean air, species preservation, CO2reduction, expanded wilderness areas and thelike, generating income does not enable you toget what you want; since leisure is valuable, youwill therefore undergenerate income. You willlook, to economists, like you have little marginalwillingness-to-pay, despite very large public goodvaluations. Hence, the income levels at whichbenefit–cost analysis is being conducted are toolow—and all of the ungenerated income wouldhave been spent on public goods, apart from gen-eral equilibrium effects.

It was arguments akin to the preceding I washoping to find more of in Priceless. Illustrating

further, what is the appropriate jurisdiction overwhich the benefits and costs should be calculat-ed? Americans care about whether the giantpanda is preserved, but China is unlikely to con-sider our preferences (CO2 abatement provides aparticularly thorny example of jurisdictionalproblems). The distinction, in the case of airquality, between primary and secondary stan-dards is similarly irrational (one should add up allthe benefits a given policy generates to comparethem to the costs, not just a portion of them).Damages to other species that humans do careabout are seldom included in the benefit calcula-tions of an environmental policy. That benefitsfor normal public goods will grow over time dueto both rising income and rising population is typ-ically ignored in practice, yet the combinedeffects could easily offset discounting impacts(AH discuss discounting in a chapter called“Honey, I Shrunk the Future”). And, of course,the magnitude of the physical effects are in manycases as uncertain as the values to be attached tothem, the latter being the specific concern of AH.Yes, there are certainly a great many problems inthe conduct of benefit–cost analysis.

Ken Boulding used to speak of the “tragedy ofthe radical,” arguing that even valid criticism ofthe established way of doing things is of littlevalue in the absence of a preferred alternative.This is the problem that many mainstream econ-omists will have with AH’s Priceless. We have tomake decisions. That some of these decisions aredifficult does not alter the fact that they are nec-essary, as a matter of scarcity. The essence ofrationality is to compare the advantages with thedisadvantages of alternative courses of action,pursuing those with highest net advantage. Theuse of dollars, per se, is of no consequence—real,physical effects either are or are not going tooccur as a result of a public policy decision. Someof the benefits and most of the costs automatical-ly come in dollar terms, making dollars the mostconvenient unit of account to gauge the(inevitably occurring) advantages and disadvan-tages. Attempting this calculation, particularlywith sensitivity analysis to alternative valueswhen they are highly uncertain, allows at leastrough comparison/ranking of projects. This isnecessary to prioritize the virtually limitless list ofcompeting health and environmental projects,something that having the right “attitude” doesnot allow.

Book Reviews 193


AH would retort, with some empirical justifica-tion, that tax cuts and military spending decisionsare not made on benefit–cost grounds, so deci-sions about health and the environment shouldnot be made that way either. This is particularlyso if political tampering renders objective bene-fit–cost analysis unlikely. Moreover, AH wouldassert that many very good decisions were madewithout reliance on benefit–cost analysis in the1970s and 1980s.

Many traditional economists will still feel thatAH “throw the baby out with the bath water” inarguing that benefit–cost analysis should bescrapped, rather than greatly improved. ButPriceless makes some important arguments thatdeserve greater discussion within the economicsprofession.

PHILIP E. GRAVES

University of Colorado

The Wealth of Nature: How MainstreamEconomics Has Failed the Environment. ByRobert L. Nadeau. New York: ColumbiaUniversity Press, 2003. Pp. xii, 253. $29.50,cloth. ISBN 0–231–12798–7, cloth; 0–231–12799–5, pbk. JEL 2003–1632Economists with research interests in the envi-

ronment are used to evaluating and defendingthe relevance of economic theory as it applies toenvironmental problem-solving. In The Wealth ofNature: How Mainstream Economics Has Failedthe Environment, Robert Nadeau assembles apointed attack on the ability of neoclassical eco-nomics to ever contribute to the resolution ofenvironmental problems. The crux of Nadeau’sargument is that there is a fundamental discon-nect between the assumptions embedded in neo-classical theory (mostly relating to thepresumption that individual decisions lead tosocially optimal outcomes) and the functioning ofnatural systems.

While the carefully researched historicalaccount of the foundations of neoclassical theo-ry is effectively and convincingly articulated inthis book, I found the author’s primary thesis tobe deficient in two ways. First, and most impor-tantly, the book pays scant attention to impor-tant innovations by environmental economistsover the past several decades that address theeconomic and environmental problems associ-ated with public goods provision and externali-ties. For example, scholars spend careers

developing economic approaches for balancingthe costs and benefits of environmental protec-tion, a need that arises precisely because manyenvironmental goods are not traded in tradi-tional markets. Contrary to claims in the text,while imputing a monetary value to those goodsposes a challenge, most economists do not dis-pute the existence of their value. Second, thebook provides a paucity of evidence that eco-nomics has, in fact, “failed the environment.”For these reasons, the book reads more like acriticism of the ability of the free market tosolve environmental problems than either (1) adetailed account of how economic reasoninghas lead to deleterious environmental outcomesor (2) a careful analysis of why economic theoryis inherently inapplicable to the environment.

Nadeau does strike an appropriate and per-suasive balance between the details of the ori-gins of neoclassical economic theory and therelevance of that theory to environmental prob-lem-solving. The author’s primary focus on theinconsistency between parts (individuals actingin a market system) and wholes (market out-comes) of free-market operations vs. nature iswell articulated in the introduction and wellsupported throughout the text.

The book begins with an overview of the ori-gins of neoclassical economic theory that high-lights several thought-provoking but rhetoricalassumptions about mainstream economics, suchas “the external environment is a bottomlesssink for waste materials and pollutants” (p. 9).Underscoring the physical science foundationsof economics, the book turns to a discussion offree-market operations and makes some tenu-ous references to the “environmental crisis”(e.g., p. 100) and the fundamental inability ofneoclassical theory to contribute to its solution.To his credit, Nadeau acknowledges the (main-stream) field of environmental economics,although I found his description to be somewhatthin given its relevance to his main thesis. Forexample, Nadeau writes: “The power of a per-fectly functioning market rests in its decentral-ized process of decision-making and exchange;no omnipotent planner is needed to allocateresources” (p. 116). While certainly true, thissentence reflects Nadeau’s tone throughout thatunder no circumstances would economists viewmarket intervention as sound policy. This is sim-ply not the case, as nearly all economists would



agree that intervention may be justified whenmarkets are incomplete.

Indeed, most university courses on environ-mental economics begin with a derivation of theFirst Fundamental Welfare Theorem. The sec-ond day of the same course typically illustratesthat public goods and externalities (with associ-ated environmental problems such as biodiver-sity loss, fishery collapse, or pollution) areinconsistent with the assumptions of this theo-rem. The remainder of this canonical course isthen devoted to deriving efficient economicinstruments to internalize these external costs.Focusing largely on the inability of free marketsto efficiently allocate environmental resources,Nadeau provides insufficient discussion of theopportunities for market-based solutions toenvironmental problems, though the text isclear that “neoclassical economic theory cannotin principle realistically account for the costs ofdoing business in the global environment” (p.17). The fact is that a large fraction of theresearch in environmental economics is nowdevoted to deriving market-based solutions toenvironmental problems. And while work is yetto be done, the past successes of economistsshould not be trivialized.

Nadeau concludes the book by proposing a“new theory of economics” (p. 185) that pre-sumably could account for the environmentalcosts of economic activity. In addition to otherfeatures, his theory contains (1) a role for gov-ernment in environmental decision-making, (2)scientifically valid measures of the relationshipbetween economic activity and ecosystemfunction, (3) an ability to inform decision-mak-ing under uncertainty about environmentaloutcomes, and (4) fees that would reflect theenvironmental damage associated with produc-tion or consumption. Nadeau never acknowl-edges that these are already central features ofcontemporary environmental economics.

Despite my critique, Nadeau’s account of neo-classical economic history and theory, in particu-lar as it applies to part/whole relationships andtheir links to environmental problem-solving,make reading this book worthwhile for econo-mists who have an interest in the environment. Isuspect that the book will be welcomed by abroader environmental community alreadyskeptical of the ability of economics to improveefficiency, much less environmental outcomes.

I enjoyed the rhetorical criticism delivered byThe Wealth of Nature, whose subtitle might bemore accurately rewritten as How the Free-Market Might Fail the Environment. But, to theextent that environmental problems merelyreflect public goods and/or externalities, this the-sis would be wholly consistent with contemporarythought in mainstream economics.

CHRISTOPHER COSTELLO

University of California, Santa Barbara

Economic Theory and Global Warming. ByHirofumi Uzawa. Cambridge; New York andMelbourne: Cambridge University Press, 2003.Pp. xii, 279. $75.00. ISBN 0–521–82386–2.

JEL 2004–0400In the often fractious debate surrounding cli-

mate policy, it is easy to lose sight of the broadagreement among economists of all methodolog-ical persuasions that governmental action to mit-igate global warming is warranted. Mosteconomists recognize the need for action toreduce greenhouse gas emissions, becauseresponsible earth scientists are concerned thatglobal climate change is a very serious problemindeed. Hirofumi Uzawa’s Economic Theory andGlobal Warming is a significant contribution tothe economic consensus.

Uzawa’s approach is thoroughly neoclassical.His analysis falls strictly in the tradition of opti-mizing agents operating with full information inperfectly competitive markets. Greenhouse gasemissions are a global public bad that have anincreasingly negative impact (as atmosphericconcentrations approach the point of “irrevocabledamage on the global environment” (p. 25)) onthe utilities of the representative consumers whomake up each of the nations of the world. Uzawashows how a system of emissions taxes or tradablepermits would increase world welfare, given min-imal assumptions about the size and shape of theglobal warming impact factor.

The book’s introduction lays out the main scien-tific facts about climate change, and reviews someof the political and institutional responses to date.Here and elsewhere, Uzawa is keenly aware of theequity issues that are central to the climate prob-lem. He notes the discrepancy between those ofthe current generation who benefit from costlessemissions of greenhouse gases and the future gen-erations who will suffer the worst consequences ofthose emissions, as well as the disparity between

Book Reviews 195


the wealthy countries whose economic growth hasbeen built to some degree on fossil energy and thepoor countries that have not made as great a con-tribution to the buildup of greenhouse gases inthe atmosphere.

Most of the book is devoted to extensions of thebasic model that is set forth in chapter 1. In thefirst part of this chapter, Uzawa shows that theNash equilibrium with differential carbon taxes ischaracterized by taxes proportional to nationalincomes. The remainder of chapter 1, along withchapters 2 and 3, is devoted to exploring the con-sequences of a globally uniform carbon tax (oremissions permit system), and the circumstancesunder which such a framework produces aLindahl equilibrium.

Uzawa finds the Lindahl equilibrium appealingon welfare grounds because it “corresponds tothe situation in which the present level . . . oftotal CO2 emissions is exactly equal to the levelthat would be chosen by each country . . . whenit would be free to choose the most desirablelevel on the assumption that the price to be paidwould be equal to that country’s marginal disutil-ity” (pp. 45–46). He shows that a Lindahl equi-librium exists, and that such an equilibrium canbe reached by a suitable allocation of tradableemissions permits. The rub is that the allocationthat achieves the Lindahl equilibrium is one inwhich the permits are given out in proportion tothe countries’ national incomes, an outcome that“has a tendency to reinforce, rather than miti-gate, the inequality that exists for the initial dis-tribution of welfare among individual membersof the society” (p. 62). Of course, the Lindahl cri-terion is not the only possible equity standard,and Uzawa later (in the summary and concludingnotes) advocates creation of an InternationalFund for Atmospheric Stabilization under whicha fraction of the emissions tax or permit revenueswould be transferred from the richer to the poor-er countries to promote development and assistin environmental protection.

In chapters 4 and 5, Uzawa addresses the ques-tion of sustainability under dynamic conditions.

He notes that it is unsatisfactory to regard thewelfare of future generations purely from theperspective of the present, then solves this prob-lem by “defin[ing] the concept of sustainability interms of imputed price. That is, dynamic process-es involving social overhead capital such asforests, the oceans, and the atmosphere are sus-tainable when each member of the society tries toensure that the imputed prices of the variouskinds of social overhead capital remain constantover time” (p. 155). This neatly enables Uzawa toadd the condition of sustainability to dynamicgrowth models.

The other equity problem, between countriesof different income levels, is touched on in chap-ter 6 (Global Warming and Forests), the only partof the book containing numerical calculations.Using a parameterized version of the climateimpact function, Uzawa estimates the imputedcarbon price and corresponding per capita car-bon tax assessment for a number of countries.For example, the imputed carbon price for theUnited States is $319/ton with a per capita carbontax assessment of $1,700 per annum; for a low-income country like Indonesia the imputed car-bon price is $6/ton with a per capita assessmentof $2 per annum. The calculations are based onthe theoretical model, so the imputed carbonprices are proportional to per capita nationalincomes.

It would be interesting to see how the resultsmight change under assumptions less strong thanthose made by Uzawa—that the utility functionsare strongly separable in consumption and green-house gas emissions or atmospheric concentra-tions; that the climate change impact index is thesame across countries; and that capital accumula-tion exhibits the Penrose effect. Questions likethese should not obscure Uzawa’s contribution,however; this book demonstrates that, even in apurely neoclassical world, careful economicanalysis affirms the need for action to protect ourplanet’s climate.

STEPHEN J. DECANIO

University of California, Santa Barbara



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