book reviews - university of california, los angeles

Journal of Economic LiteratureVol. XLV (June 2007), pp. 429–482

Book Reviews

429

A General Economics and Teaching

Explorations in Pragmatic Economics: SelectedPapers of George A. Akerlof (and Co-authors).By George A. Akerlof. Oxford and New York:Oxford University Press, 2005. Pp. ix, 514.$110.00, cloth; $45.00, paper. ISBN 0–19–925390–0, cloth; 0–19–925391–9, pbk.

JEL 2006–0022The influential body of work produced by

George Akerlof has turned him into an economiston the verge of a retrospective for some timenow. Explorations in Pragmatic Economics pro-vides that long awaited compilation of favoritehits by Akerlof and his coauthors. The underlying

theme of the book is the interplay between microand macro behavior. Minor defections from sta-tistical sophistication, a small amount of sticki-ness in updating prices, or a slight tendency tohold self-confirming beliefs are only some of themicro phenomena that are analyzed and shown togenerate potentially significant macroeconomicconsequences.

As a compilation of papers, the book is bynature somewhat eclectic. In fact, in analogy toLeibniz’s Monadology, the book could be thoughtof as Akerlof’s Nomadology, consisting of papersjourneying from area to area in economics. Whileit is not structured as a text book, it could cer-tainly be a natural accompanying text for various

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 avoidvolumes of collected papers such as festschriften and conference volumes. Often such volumespose difficult problems for the reviewer who may find herself having to describe and evaluatemany different contributions. Among such volumes, we prefer those on a single, well-definedtheme that a typical 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.

Our policy is not to accept offers to review (and unsolicited reviews of) particular books.Coauthorship of reviews is not forbidden but it is unusual and we ask our invited reviewers to discusswith us first any changes in the authorship or assigned length of a review.

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advanced graduate classes. It is also interestingfrom a “history of thought” point of view. Indeed,the recent behavioral uprise has introduced andreintroduced many of the phenomena the articlesin the book suggest (e.g., the ideas that agentshold self-confirming beliefs or have a taste forimmediate gratification). In that respect, some ofthe ideas presented throughout the book willappear astonishingly familiar even to those whohave not been weaned on the articles themselves.

The wonderful introductory chapter is usefulin summarizing and linking the different papers.It also spells out Akerlof’s dictum that econo-mists should subject their beautiful theories tosprinkles of empirics and loitering with factsregarding the details of microeconomic behavior.Certainly, when one goes through the articles,one is left with the sense that empirical workserved as a trigger or motivation for much of the(alas, parsimonious) formal modeling. For thereader who is short on time, I highly recommendthe introduction as a stand alone piece.

The book is divided into segments broadly cat-egorized as micro- and macroeconomics, eachpresenting several conglomerates of relatedpapers. In what follows, I shall try to brieflydescribe to the aspiring reader each of the majorpieces presented in the book.

The microeconomic part of the book starts witha discussion of information asymmetries andpresents one of the most notable (and literal)exercises in turning lemons into fantastic lemon-ade, “The Market for Lemons.” This importantpaper introduced the idea that asymmetric infor-mation may cause some markets to disappear inthe absence of long-term guarantees. Indeed, if acommodity’s quality is known only to the sellerbut not to potential buyers, the seller has incen-tives to pass off a low-quality good (a “lemon”) asa higher-quality one. Sophisticated consumerstake these incentives into account. Thus, themere fact that a commodity (say, a used car) is onthe market suggests its potential undesirability(its potential for constituting a “lemon”).Consequently, in the absence of long-term guar-antees by the seller, consumers may be quitewary of purchasing such commodities, and thecorresponding markets may be restricted or van-ish altogether. This idea has been applied tonumerous realms ranging from used cars to capi-tal markets to online dating. Beyond introducinga new methodology to the bastion of economics

of complete information, the paper is also a pro-fessional exemplar for the jaded. This mightypiece has apparently fallen several times throughthe cracks of refereeing processes at a few of thetop journals until it finally got published in thedistinguished Quarterly Journal of Economics. Itis possibly the most influential paper (as of yet)appearing in the volume.

The sequence of papers that follow do notdirectly tie to the lemons paper (as Akerlofadmits, partly because of that paper’s rockyreception), though follow themes in their ownright. In particular, the second theme of thebook, presented in chapters 2–4, deals with issuespertaining to identity and their importance toeconomic phenomena. In two papers, the readerfinds the “dent” in “identity” in the form of dis-crimination. In these papers, one’s identity with agroup (a caste) may lead to economically subop-timal equilibria. Individuals may be willing toobey the caste codes because of sufficient pun-ishment norms for defection within the caste.Thus, the notion of “caste equilibrium” is coinedand two important macroeconomic implicationsare analyzed. First, caste equilibrium can entail agap between supply and demand that explainswhat would appear as discriminatory unemploy-ment. Second, the models help analyze the typeof codes that can be sustained by castes.

The third paper under this theme (“Economicsand Identity,” coauthored with Rachel Kranton)provides a more general framework for thinkingabout identity in economic contexts. It draws oninsights from sociology, and illuminates theimportant aspects of identity formation, as well asmakes the case that thinking about identity is cru-cial for understanding a plethora of economicsymptoms across fields, particularly in labor eco-nomics (e.g., why women (men) are not supposedto engage in male (female) type jobs, how racialdiscrimination occurs, and so on).

The third set of essays, chapters 5–7, studiesincome redistribution and family structure, andutilizes some of the adverse selection techniquesthat were pioneered in the lemons paper. “TheEconomics of ‘Tagging’” points to the difficultiesstemming from asymmetric information in theU.S. welfare system. Since the government doesnot know incomes a priori, it “tags” groups ofpeople who are particularly likely to be needy.This policy has many unfortunate consequencesand the paper argues for earned income credits

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as an alternative policy. Low skill, misfortune,and family structure are a troika of significantcomponents in the determination of economicneediness, and the papers that follow tackle theendogenous formation of impoverished groupsby studying the last of the three.

Empirically, the introduction of oral contra-ception and legalization of abortion in the late1960s and early 1970s was accompanied by sig-nificant declines in the rates of “shot-gun” mar-riages occurring during pregnancy. Akerlof’seconomic brethren have argued that the changesin that time empowered women, and made awoman’s pregnancy less of the “man’s fault.”Consequently, out-of-wedlock births becamemore common, their associated stigma weak-ened, and a curious feedback loop was created.Nonetheless, as Akerlof and coauthors point out,these arguments are confounded with anotherhistorical transition—the secularization of sexualrelations—that may have trumped the custom ofmarriage upon conception. The consequences forwelfare, especially in view of “tagging” policiesare dramatic. Indeed, restricting assistance to sin-gle mothers would hardly affect the scope of out-of-wedlock births, but would seriously decreasethe income and welfare of unfortunate mothersand children. The analysis crystallizes the inter-play between norms, identity, and social tagging.

The fourth group of papers, presented in chap-ters 8–10, considers the wide paradigm of eco-nomics and psychology. In two of the papers, theunderlying trade-off is between holding beliefs(e.g., regarding safety measures on the job orfinancial returns) that are accurate and holdingbeliefs that are pleasant. Even a slight taste forself-comforting beliefs may have dramatic effectsin various contexts. This is especially relevant forcollective decision settings. Each atomic individ-ual has little influence on outcomes and thereforemay as well select beliefs that are affirming ratherthan correct, but the aggregate effect may besubstantial. These two papers have a clear link tothe identity papers, the latter suggesting a poten-tial channel by which (possibly erroneous) beliefsare formed.

The idea that people exhibit a taste for immedi-ate gratification is now part of the standard dis-course of economics and psychology. It is thusbefitting for the volume to contain a paper study-ing the implications of present biases and issues ofself-control. Again, the paper builds up on a slight

taste for immediate gratification and illustrates itspotentially grand effects on procrastination,notably important for saving behavior.

The microeconomics section of the book con-cludes with a paper on financial mischief. In“Looting: The Economic Underworld ofBankruptcy for Profit,” coauthored with PaulRomer, one particular managerial malady is iden-tified. Accounting rules permitting, managersand owners may have incentives to loot a compa-ny (pay excessive dividends) in one period if theyknow the firm will declare bankruptcy later on.Indeed, the return from a marginal dollar once afirm is bankrupt is zero, and a “morbid” equilib-rium exists. Following the general theme of thebook, a small divergence between accounting andeconomic definitions may have great impacts forthe survival of firms.

The macroeconomics half of the volume com-prises four topics. The first, appearing in chapters12–14, illustrates the impacts of small frictions onthe economy. It starts with the maxim of mone-tary neutrality—expected changes in money sup-ply are classically anticipated to be accompaniedby matching changes in wages and prices thatleave real variables unchanged. However, if, forinstance, wage or price settings are staggered, theneutrality result may evaporate. This is illustratedin a few contexts. In the first paper firms simplyalternate in introducing price changes. In the fol-lowing few papers, banks use target-thresholdrules, which connect money demand and the flowof funds. Furthermore, target-threshold demandsfor money explain why both fiscal and monetarypolicy are effective in changing aggregate demandin the short run, turning (to the paper) “IrvingFisher on His Head.”

The second set of papers, chapters 15–17,deals with unemployment and the ultimate ques-tion of why involuntary unemployment exists.Indeed, a classical economist would expectwages to equilibrate demand and supply of laborso that those who want to work, will work, albeitfor a possibly very low wage. In “Jobs as DamSites,” a simple response a là Ricardo is given.Workers with sufficiently low skills, even if will-ing to work, would make employment, even atzero wage, potentially noneconomical. Just likethe construction of a low quality dam, cheap as itmay be, at a prime site may be noneconomical.In the papers that follow, an alternative style ofexplanation for voluntary unemployment is given.


Namely, the idea that firms may be reluctant toreduce wages below a certain point caring aboutworkers’ morale, as a consequence of fairness, ora reciprocal gift exchange norm (i.e., the experi-mentally grounded idea that paying workers wellwill make them exert effort in return) vis-à-vis theworkers. These “morale hazard” explanations forwages that exceed market clearing levels havestrong conceptual ties to the microeconomicpapers dealing with identity. They both stressone’s internal psychological ideals as opposed topure economic considerations.

The penultimate suite of papers, appearing inchapters 17–19, combines some of the previousideas regarding sluggish adaptation and analyzesthe nature of macroeconomic equilibria. Classicaleconomics adheres to the idea that changes inmoney supply should have no effect on economicequilibria, in particular on output or unemploy-ment. However, a sluggish response by firms (orworkers) may result in significant changes to theequilibrium at play and push money neutralityinto a very dusky horizon. Similarly, a smallamount of money illusion derived from, say, firms’response to workers’ dislike of wage cuts, can pro-duce an interesting tradeoff between inflation andunemployment even in the long-run, and causethe prevailing Phillips curve to be nonvertical,contrary to classical economics’ credo. Thesepapers illustrate, yet again, the significance ofmicro-level reactions to macro-level end results.

The closing paper of the book is Akerlof’s 2001Nobel lecture, “Behavioral Macroeconomics andMacroeconomic Behavior,” that argues for thenatural appeal of behavioral elements in macro-economic analysis. Ironically, Keynes’s GeneralTheory is filled with psychological explanations ofobserved phenomena. The economists’ weaponsof math destruction have tamed Keynes’s contri-butions and transformed it to what is knownnowadays as classical economics. The chapterillustrates how behavioral explanations can fillimportant empirical gaps using psychologicalobservations on reciprocity, fairness, loss aversion,herding, etc.

To conclude, the book compiles some of themost innovative articles written in the past fewdecades. It is a must read (or at least, a mustskim) for any economist, be it a micro, macro,behavioral, or misbehavioral one.

LEEAT YARIV

California Institute of Technology

F International Economics

A Corporate Solution to Global Poverty: HowMultinationals Can Help the Poor andInvigorate Their Own Legitimacy. By GeorgeLodge and Craig Wilson. Princeton andOxford: Princeton University Press, 2006. Pp.xii, 198. $27.95. ISBN 0–691–12229–6.

JEL 2006–0929George Lodge and Craig Wilson have tackled

an important and timely topic. The past decadehas seen much new thinking on development andpoverty alleviation issues. Much of this work—byeconomists, development organizations, civilsociety organizations, entrepreneurs, and evenlarge firms—advocates new and innovativeapproaches to development.

The time is ripe for a book that synthesizesthis research and proposes a mechanism forinstitutionalizing it. The book jacket providedhope—hyping the authors’ recommendation tocreate a “World Development Corporation” thatwill coordinate the efforts of various constituenciesfocused on development.

Unfortunately, the book falls far short of itspotential. The argument, examples, and rhetoricall seem stuck in a 1970s time warp. There is littlenew beyond a proposed shift in responsibility fromdevelopment agencies, who have failed, to MNCs,who the authors hope will stop acting like corpo-rations and sign on to the agenda set by NGOs andself appointed global elites. William Easterly1 andothers have voluminously documented that thistop-down, let-the-elites-save-you approach has ledto little development while wasting billions.Unfortunately, this work is not even mentioned.

Lodge, an emeritus Professor at HarvardBusiness School, and Wilson, an economist withthe International Finance Corporation, present athree-part argument, which proceeds as follows:

(1) The persistence of poverty amid plenty isthe overriding problem in the internationaleconomy today.

(2) Large firms are suffering from an emerging“legitimacy gap” because they are narrowly

1 Easterly has written two important books that makehis case. See The Elusive Quest for Growth: EconomistsAdventures and Misadventures in the Tropics and TheWhite Man’s Burden: Why the West’s Efforts to Aid theRest Have Done So Much Ill and So Little Good.


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focused on doing business and makingmoney, not on addressing social problems.

(3) Firms can regain their legitimacy with elitesand NGOs if they shift their focus fromgrowth and profits to addressing “communi-tarian” values—especially poverty reductionin developing countries. This is to be accom-plished through the creation of a WorldDevelopment Corporation, a “non-profitcorporation established under the auspicesof the United Nations [that] will harness theskills, capabilities, and resources of leadingglobal corporations to reduce poverty andimprove living standards in developingcountries” (p. 157).

The book is organized into three sections—whichdo not parallel the argument presented above. Thefirst section, “The Legitimacy Gap,” presents thefirst and second parts of the argument above.Chapter 1 discusses the problem of poverty in theworld. They make a reasonable, if primarilyrhetorical, case that development has beenuneven and that some groups (Africans, Muslims,groups targeted by World Bank and developmentassistance programs) have been left behind asglobalization, on average, raises living standards.The second chapter addresses the legitimacy ofbusiness and is much less convincing. The chap-ter starts by noting that firms operate in a largerenvironment that, at least in part, depends onpublic opinion. They then assert (via a quick ref-erence to Adolf A. Berle and Gardiner C. Means1967) that “the corporation has no owners . . . isnot real property and thus sits in ideologicallimbo” (p. 22). This provides the takeoff for along discourse on the shortcomings of “individu-alism” (which the authors deride) as comparedwith the benefits of “communitarianism” (whichthey laud). This philosophical discussion accountsfor the bulk of the chapter (pp. 24–37). The pos-itive references to “spaceship earth” and “a holisticconsciousness” (both p. 36) are good illustrationsof the general rhetorical approach.

The second section of the book, “Reactions,Responses, and Responsibilities,” provides a use-ful overview of key players in international opinionleadership. They devote a chapter each to NGOs,corporations, and international developmentorganizations such as the World Bank, the UnitedNations, and the U.S. Agency for InternationalDevelopment. This section provides a useful

primer for readers who are not familiar with theseorganizations.

The third and final section, “Global PovertyReduction and the Role of Big Business,” pro-poses the creation of a World DevelopmentCorporation that would coordinate and channelcorporate resources to those most in need.

Evaluation

While the book raises some interesting pointsabout poverty, it ultimately disappoints for avariety of reasons.

First, their argument is almost entirely rhetori-cal, with little or no data to support key asser-tions. The overall tone comes across as naïvepaternalism—i.e., if only large firms did (whatwe define as) the right thing, the world would bea better place. They use the passive voice exten-sively, making assertions without citations or dataand expecting the reader to accept them as fact.For example:

• “Of paramount concern to many is the fail-ure of globalization to reduce poverty andlessen wealth inequality in developingcountries” (p. 9).

• “GM and the thousands of companies like itare collectives floating in philosophic limbo,dangerously vulnerable to the charge of ille-gitimacy and to the charge that they arebeyond community control” (p. 32).

• “Sticking with the myth of the corporation asproperty as a passport to legitimacy hasbecome increasingly precarious” (p. 33).

• “The lack of a civil society imprimaturamounts to an absence of legitimacy” (p.54–55).

In the sense that someone believes these state-ments, they may be true. But, without referencesto data, surveys, or some solid foundation beyondthe authors’ perception, they provide a thin reedupon which to build an argument.

To pick one significant example, the authorsprovide almost no support to their foundationalidea of an emerging legitimacy gap that must beaddressed. The book presents dated anecdotesabout bad business behavior (slavery, p. 21; ananonymous river polluter in 1968, p. 23; AT&T’spoor treatment of women in the 1960s, p. 27;Allied Chemical polluting rivers in the 1970s, p.22). But the examples come across as both vagueand decades out of date. It’s like hearing protest-ers today reciting Vietnam-era chants against the


military industrial complex. There may be a ker-nel of truth in there somewhere, but that kernelis difficult to identify amidst the fog of rhetoricand sloganeering. The fog left this readerexhausted and skeptical.

To be fair, the book briefly mentions a WorldEconomic Forum survey (p. 24) that indicatesthat global leaders expect multinationals to domore to reduce global poverty. But no evidence ispresented that failing to focus on social issues hasharmed even a single firm’s ability to operate.Legitimacy is not defined or measured and,beyond selected quotes from professionalactivists, no evidence is provided that lack oflegitimacy is reaching crisis levels.

To gauge the validity of the legitimacy gapclaim, I examined Fortune Magazine’s “MostAdmired Corporations” listing.2 The listing failsto reveal even a casual correlation between socialfocus and “most admired” status. At most, two ofthe top twenty most admired firms (Starbucksand perhaps Johnson & Johnson) emphasize theirsocial mission. They are vastly outnumbered onthe list by firms that downplay social factors infavor of primarily business objectives—includingWalmart, Home Depot, Microsoft, and GoldmanSachs. This is by no means a definitive analysis,but it is one more data point than the authorsprovide.

Second, the authors have an unquestioned faithin the legitimacy of claims by NGOs and politicalelites. They assert that NGOs “form the basis ofworld opinion” (p. 46), that they act as “watchdogsand monitors” (p. 53), that the “lack of a civil soci-ety imprimatur amounts to an absence of legiti-macy” (p. 55), and that NGOs “reflect a risingglobal consciousness” (p. 70).

NGOs are generally presented as pristine rep-resentatives of community needs whose demandsfirms must satisfy to gain legitimacy. There is lit-tle consideration that NGO claims might beinflated or strategic. Nor do the authors considerthe fact that such claims are often in conflict witheach other. For example, how should a firm rec-oncile demands for economic development withcalls for preservation of the environment; or forrespecting local cultures versus ensuring therights on women, children and minorities? The

authors never address, or even acknowledge,such troublesome issues.

Their position seems to be that, because pri-vate property rights are not absolute—a positionthat few would dispute—these rights mean noth-ing and should be subject to the whims of vague-ly defined communities—as operationalized byNGO demands. Their approach strikes thisreviewer as a recipe for chaos and ever escalat-ing demands that corporations “do more.” I’msure that’s not what the authors intend, but theynever propose any basis for limiting thosedemands. Absent that limit, the communitarianwaters appear to be dangerous for any organiza-tion with valuable resources that could beclaimed by various communities.

Third, the book presents a straw man carica-ture of both business decision makers and theeconomics profession. Business executives andeconomists are portrayed as being mystified byintangible assets (p. 82), payback over multipleperiods (also p. 82), and the importance of insti-tutions (p. 38). This is either groundless rhetoricor a serious misunderstanding of business andeconomics research.

Similarly, their grasp of development economicsis worrisome. The authors assert that the mostsuccessful economies in the post World War II eraare those where the state led development (p. 36).This view may have been reasonable during Japanand Korea’s miracle years in the 1960s and 1970s,but it is hard to square with events over the pasttwenty-five years. To take two relatively currentcases, consider China and India. In each, the sec-tors and geographies with the most rapid growthin output and competitiveness were those wherethe state had the lightest hand (software and BPOin India, and foreign-invested manufacturing inChina). Areas where the state intervened (such asagriculture in India, and heavy industry, banking,and retail distribution in both countries) havetrailed badly. This is not to say there was no staterole in the successful sectors, but the correlationbetween state involvement and sector success isclearly and strongly negative.

The authors make the case that openness toglobalization is important to increasing livingstandards and that MNCs play an important rolein raising living standards (pp. 16–17). But theyare clearly uncomfortable with the idea of marketforces determining economic outcomes. Theycontinually return to questions such as “who is

2 Available at http://money.cnn.com/magazines/for-tune/mostadmired/top20/.

434 Journal of Economic Literature, Vol. XLV (June 2007))


Book Reviews 435

deciding its [globalization’s] purposes and priori-ties? How are the decisions made? Who will ben-efit? At what cost?” (p. 11). In every case, theiranswer is that it should be bureaucrats andNGOs, not firms or the market.

They also note that “those countries with theweakest links to the outside world are the poor-est,” and that “the problem of FDI inflows todeveloping countries and the benefits that flowfrom them are not evenly spread among or with-in developing countries . . . This is a clear form ofmarket failure” (p. 115). It’s hard to see how. Ifcountries like Zimbabwe, Venezuela, Bolivia, andUzbekistan choose to impoverish themselvesthrough bad policies and the scapegoating ofmultinationals for political purposes, it is hardly a“market failure” for MNCs to withdraw. Thisstrikes me as a non sequitur. It’s a bit like saying“Bill Belichick has done wonders for the NewEngland Patriots, but he really deserves criticismfor not doing a better job of promoting WorldCup Soccer.”

There are similar problems with the book’streatment of foreign direct investment. Chapter 2portrays FDI as key to development. It certainlyhelps, but research over the past decade hasshown that local investment, entrepreneurship,and turnover in the population of firms to bemuch more important than FDI.3

Fourth, the authors appear to be almost entire-ly unaware of a vast amount of research and newinsights on development and poverty reductionthat has been published in recent years. Thereare at least three strands of this work.

How development assistance should be struc-tured—Jeffrey D. Sachs (2005) and Easterly4

have engaged in a spirited debate over the pastfew years about how to design, implement, andevaluate development assistance programs.Easterly, a former World Bank economist andcurrently a Professor at NYU, argues that mostdevelopment programs fail to take account ofincentives on the ground and consistently misstheir targets. He argues for bottom up programs,with designed-in experimentation and the expec-tation of many failures amid a few successes thatcan be built on. Sachs, the well known economistwho heads Columbia University’s Earth Institute,

focuses on situations where business incentivesseem to not apply—for example health programs,education, and soil chemistry. While Easterly andSachs are the big names in this space, RobertCalderisi (2006) and David K. Leonard and ScottStraus (2003) have also made important contri-butions, arguing against development assistanceas currently structured.

How to do business in the informal sector (i.e.,operating at the base of the economicpyramid)—coming from a different direction,best-selling business books by C. K. Prahalad(2004) and Stuart L. Hart (2005) have made thecase that businesses should engage with thepoor, both to improve lives and because it is goodbusiness. Cornell University’s Center forSustainable Global Enterprise (www.johnson.cornell.edu/sge/resource.html), the World Re-sources Institute (www.nextbillion.net), and theUniversity of Michigan’s William DavidsonInstitute (www.wdi.umich.edu/ResearchInitia-tives/BasePyramid/Resources) all have resourcecenters with case studies, articles, books, andworking papers on these topics.

Using business tools to alleviate poverty andaddress social issues—there has been extensiveactivity in both the social and corporate sectorson this topic. For example:

• CitiBank and Duetsche Bank Group havemade major commitments to invest inmicrolending organizations looking forprofitable growth.

• Amul Dairy (www.amul.com), HindustanLever’s Project Shakti (www.hllshakti.com),and Honeycare (www.honeycareafrica.com)have all developed innovative approaches toaggregating supply and/or distribution tolower transactions costs and reach people atthe Bottom of the Pyramid. All three arefocused on commercial operations, not charity.

• The Clinton Foundation’s HIV/AIDSInitiative (http://www.clintonfoundation.org/cf-pgm-hs-ai-home.htm) has worked withpharmaceutical companies and developingcountry governments to restructure the mar-ket for and delivery of HIV, TB, and Malariadrugs to BoP populations, something thatyears of flashy NGO protests failed toaccomplish.

• Organizations such as Acumen Fund(www.acumen.org), Care Enterprise Part-ners (www.care.ca/CEP/), and Ashoka:

3 See, for example, Mark J. Roberts and James R.Tybout 1996 or Robert E. Kennedy 1997.

4 See Easterly above.


Investors for the Public (www.ashoka.org)focus on matching socially minded investorswith organizations that produce high socialreturns.

Unfortunately, the book doesn’t recognize orbuild on any of this new thinking.

Fifth, the book is quite vague regarding thespecific obstacles that keep MNCs from workingin developing countries, or how the proposedWorld Development Corporation (WDC) wouldimprove the situation.

There are many legitimate reasons that largemultinational firms don’t focus primarily on socialoutcomes in the world’s poorest communities.These include, among other issues:

• The fact that they raised money fromshareholders with the agreement that theywould pursue economic value creation onshareholders behalf;

• National regulations that keep MNCs out ormake it impossible to operate profitably;

• The risk of expropriation;• The risk that some level of involvement will

inevitably invite calls to “do more,” etc.Unfortunately, the authors provide almost no

details on how the WDC would address any ofthese issues. It comes across as a feel-good admo-nition (i.e., “let’s do something”), but one with nounderlying foundation. This would make for anice discussion over lunch at the faculty club, butis painfully naïve given existing stakeholders incorporations, the long record of failures by theUN and other development agencies, and thecomplexities of operating in developing countries.

Finally, as noted at the beginning of this review,the book offers what is essentially a deep pocketsargument. Poverty is an enduring problem andthose charged with addressing it (national gov-ernments and development organizations) havelargely failed. So the book seeks to shift the bur-den elsewhere. The book returns to this themetime and again:

• The resources of the world’s MNCs are cen-tral to solving this challenge [poverty]. “Theseare challenges that go beyond the capacity ofthe public sector. To help address these chal-lenges, the private sector has to take someresponsibility for economic and social devel-opment as well.” Quoting Peter Woicke ofthe International Finance Corp (p. 18).

• “Recently, these agencies [developmentorganizations] together with their NGO

counterparts in civil society, have belatedlycome to the realization that the power ofMNCs can considerably augment their owndisappointing efforts to reduce global pover-ty...they have failed to harness effectively thecollective power of the MNCs” (p. 92).

• “The WDC is needed to fill the gap betweenthe poverty-reducing intentions of the inter-national development agencies and the poorcountries they are supposed to help . . . [it] isa missing link between those agencies andthe multinational corporations that have thecapacity, the resources, and increasingly thewill to do the investing” (pp. 158–59).

In the end, the authors’ argument boils down toa type of Willie Sutton wisdom. Reportedly, whenthe famous bank robber was asked why herobbed banks, he responded, “because that’swhere the money is.”

MNCs have abundant resources (capital, tal-ent, products) that Lodge and Wilson believeshould be put to better use than pursuing eco-nomic value on behalf of shareholders. Theytherefore advocate changing the rules of thegame to direct those resources to their “commu-nitarian” goals. Perhaps Willie Sutton felt thesame way about cash sitting unused in the bank.This mission change might or might not have aneffect on global poverty, but the authors nevermake the case as to why this fundamental shift infocus would be of benefit to MNC’s owners andemployees. Nor do they grapple with the possi-bility that it might change the very nature ofthese organizations, perhaps not for the better.

There is clearly something happening in thefields of development and poverty reduction.This is an exciting time for business operating indeveloping countries, for development organiza-tions considering the design of their assistanceprograms, and for academics considering theseprograms’ impact. There is still a good book to bewritten that captures this creative tumult.Unfortunately, this book is not it.

REFERENCES

Berle, Adolf A., and Gardiner C. Means. 1967. TheModern Corporation and Private Property.Harcourt, Brace & World.

Calderisi, Robert. 2006. The Trouble with Africa: WhyForeign Aid Isn’t Working. Houndmills, U.K. andNew York: Palgrave Macmillan.

Easterly, William. 2001. The Elusive Quest for Growth:Economists’ Adventures and Misadventures in the



Book Reviews 437

Tropics. Cambridge and London: MIT Press.Easterly William. 2006. The White Man’s Burden: Why

the West’s Efforts to Aid the Rest Have Done SoMuch Ill and So Little Good. New York and London:Penguin Press.

Hart, Stuart L. 2005. Capitalism at the Crossroads.Upper Saddle River, N.J.: Wharton SchoolPublishing.

Kennedy, Robert E. 1997. “A Tale of Two Economies:Economic Restructuring in Post-Socialist Poland.”World Development, 25(6): 841–65.

Leonard, David K., and Scott Straus. 2003. Africa’sStalled Development: International Causes andCures. Boulder: Lynne Rienner Publishers.

Prahalad, C. K. 2004. Fortune at the Bottom of thePyramid. Upper Saddle River, N.J.: Wharton SchoolPublishing.

Roberts, Mark J., and James R. Tybout, eds. 1996.Industrial Evolution in Developing Countries: MicroPatterns of Turnover, Productivity, and MarketStructure. Oxford and New York: Oxford UniversityPress.

Sachs, Jeffrey D. 2005. The End of Poverty: EconomicPossibilities for Our Time. New York and London:Penguin Press.

ROBERT KENNEDY

University of Michigan

A Strategy for IMF Reform. By Edwin M.Truman. Policy Analyses in InternationalEconomics, no. 77. Washington, D.C.: Institutefor International Economics, 2006. Pp. xii, 128.$23.95, paper. ISBN 0–88132–398–5.

JEL 2006–0540

Reforming the IMF for the 21st Century. Editedby Edwin M. Truman. Special Report 19.Washington, D.C.: Institute for InternationalEconomics, 2006. Pp. xiii, 559. $27.95, paper.ISBN 0–88132–387–X. JEL 2006–0946

The world economy has, to put it mildly, seendramatic changes in the past two decades. Privatecapital markets have exploded in size, complexity,and global scope. Long-moribund countries havestumbled to life economically, in Asia, centralEurope, and Africa. These transformations,which will continue, have made it imperative forthe international financial system to adapt just asdramatically. The official “architecture,” of whichthe International Monetary Fund (IMF) hasbeen both the foundation and the protective roofsince the end of World War II, can support thisongoing mansionization only if it is thoroughlymodernized.

Literature on IMF reform is not in short sup-ply, but much of it is of little practical value. The

difficulty is that the topic has a technical dimen-sion that eludes many analysts, a bureaucraticdimension that is mystifying even to many insid-ers, and a political dimension that injects emotion-al advocacy into the debate. A shelf of recentbooks that clear these hurdles reasonably wellwould include Colin I. Bradford and Johannes F.Linn (2007), Peter B. Kenen et al. (2004), GustavRanis, James Raymond Vreeland, and StephenKosack (2006), and Ngaire Woods (2006). Eachpresents points of view that illuminate certainaspects of the reform discussion, and each oneplaces the debate about the IMF within thebroader context of reform of the internationalfinancial system. The IMF itself has developed a“medium-term strategy” for reforming its opera-tions and its governance that is more firmlygrounded in the art of the possible than is most ofthe external literature (IMF 2005). The challengenow is to build on these specific contributions todevelop a comprehensive strategy that is bothbold and practical and that will give the system theflexibility it needs to respond to today’s problemsand to be prepared for tomorrow’s.

Edwin (Ted) Truman has responded to thischallenge with a linked pair of volumes. Most ofthe longer (edited) book is a collection of papersthat were presented at a conference held at theInstitute for International Economics inWashington in September 2005. It includes sev-eral papers by economists with strong academicand practical policy experience, including BarryEichengreen, Kristin Forbes, Michael Mussa,Steven Radelet, and John Taylor. Other authorsare stars of the Washington think-tank circuit,including Fred Bergsten, Nancy Birdsall, WilliamCline, Morris Goldstein, Desmond Lachman,and John Williamson. The list also includes goodrepresentation of experts from Europe (LorenzoBini Smaghi and Tommaso Padoa-Schioppa),Asia (Yu Yongding), and Latin America (ArielBuira and Martin Redrado). Roughly a third ofthe twenty-nine contributors have worked at theIMF at some point in their careers, a ratio thatlends a strong does of realism to the collectionwithout tainting it with excessive proximity.

Most of the conference papers are short expo-sitions of specific suggestions for reforming orstrengthening the IMF. Goldstein calls for theIMF to get tough with currency manipulators, ofwhich he presently counts China to be the worstoffender. Williamson repeats his long-standing


appeal for a system of reference ranges forexchange rates. Several papers propose newlending facilities within the IMF to directresources toward high-priority goals. Buira,Lachman, and Karin Lissakers offer suggestionsfor improving the financial resources of the IMF.Radelet sets out a framework for restructuringthe IMF’s assistance to low-income countries.Randall Henning wants regional entities such asthe European Union to become members of theIMF. Miles Kahler wants a more open selectionprocess for IMF management and a more inde-pendent Executive Board. Fred Bergsten urgesreplacing the “illegitimate” and “ill-equipped” G-7as a “steering committee” for the world economywith a broader group of finance officials that hedubs the “F-16” (pp. 282–90).

The last section of the book constitutes a paneldiscussion on the larger issues of IMF reform.Each of the five panelists makes substantive andthought-provoking contributions. Eichengreenargues that the IMF “is adrift on the fundamen-tal . . . issues of the day” (p. 499), and he con-cludes that the overriding issue is the need forbetter intellectual leadership from within theIMF. Mohamed El-Erian sketches a wish list ofreforms aimed at making the IMF a “trustedadvisor” for national governments and a “centerof excellence on . . . macroeconomic and financialissues,” with adequate financing and “a morelegitimate governance structure” than it now has(p. 507). Padoa-Schioppa decries what he sees asa decline in the quality of political leadership inthe world, especially in Europe, and the effectthat it has had on the IMF and other multilateralinstitutions. Yu Yongding presents a Chinese viewon exchange rate management in counterpoint toGoldstein, and he argues for more inclusive gov-ernance to overcome the damage that he believesthe IMF has done to its own reputation in recentyears, especially in East Asia. Truman concludeswith a broad overview.

In contrast to these short and pithy papers, theconference volume opens with a 126-page essayon IMF reform by the editor. Here, Trumansummarizes the many points made by othersthroughout the volume, and he sets out his owncomprehensive agenda. With just a few edits, thissection has been reproduced on its own to formthe second book under review, A Strategy forIMF Reform. Anyone who has the conferencevolume does not need the other, but the small

one will suffice for anyone who just wants theessence of the various arguments.

The core of Truman’s strategy is a governancereform in which the established but relativelystagnant advanced economies (mostly in Europe)would lose representation and voting power(“chairs and shares”) in favor of the emergingpowers (mostly in Asia) that have grown rapidlyin recent decades. The European Union, in thisscheme, would retain its influence by consolidat-ing its representation in a single seat on theExecutive Board. Without some such reform, theinstitution’s policy advice will increasingly bedenigrated as illegitimate and will ultimately beignored. Truman supplements this generally sen-sible but politically charged suggestion with adetailed and wide-ranging list of operational rec-ommendations for strengthening surveillanceand lending and for putting the Fund’s financingon a solid footing. Most of those recommenda-tions flow from the conference papers, butTruman also draws nicely on the earlier literatureand on his own long experience in dealing withthe IMF as a senior official of the FederalReserve Board and the U.S. Treasury.

Where does this strategy fall short? Obviously, itwill not convince or satisfy the legion of “academ-ics and op-ed columnists [who] have based theircareers on criticizing the IMF” (Eichengreen, p.498). These books are aimed instead at convincingthe mainstream of economists, political scientists,and policymakers that the IMF—and the interna-tional financial system—can be and must bebrought up to date in a positive way. Although anywell informed reader will—and should—findmany points with which to quibble, perhaps evenviolently so, most will find the broad canvas to bewell painted.

Two limitations stand out. First, implementa-tion of Truman’s reform strategy will require awide political consensus that will not be easy toachieve. Truman is sensitive to that problem, butnone of the contributors offers a full solution toit. Second, the world economy is continuing tochange, and the evolution of the next twentyyears may well be even more dramatic than thelast two decades have seen. For example, whathappens when sub-Saharan Africa, which haslong been the epicenter of poverty and economicstagnation, becomes the next East Asia? Even ifall of these books’ proposals were put in effecttomorrow and proved successful, how can the



Book Reviews 439

system be saved from having to play catch-upagain? This answer to this and other prospectivedynamic questions will have to wait.

REFERENCES

Bradford, Colin I., Jr., and Johannes F. Linn. 2007.Global Governance Reform: Breaking the Stalemate.Washington, D.C.: Brookings Institution Press.

International Monetary Fund. 2005. “The ManagingDirector’s Report on the Fund’s Medium-TermStrategy.” www.imf.org

Kenen, Peter B., Jeffrey R. Shafer, Nigel L. Wicks, andCharles Wyplosz. 2004. International Economic andFinancial Cooperation: New Issues, New Actors,New Responses. Geneva Reports on the WorldEconomy, vol. 6. Geneva: International Center forMonetary and Banking Studies; London: Centre forEconomic Policy Research.

Ranis, Gustav, James Raymond Vreeland, and StephenKosack. 2006. Globalization and the Nation State:The Impact of the IMF and the World Bank. Londonand New York: Routledge.

Woods, Ngaire. 2006. The Globalizers: The IMF, theWorld Bank, and Their Borrowers. Cornell Studiesin Money. Ithaca and London: Cornell UniversityPress.

JAMES M. BOUGHTON

International Monetary Fund

H Public Economics

Is War Necessary for Economic Growth? MilitaryProcurement and Technology Development. ByVernon W. Ruttan. Oxford and New York:Oxford University Press, 2006. Pp. xi, 219.$45.00. ISBN 0–19–518804–7.

JEL 2006–1344This interesting book can be read in two ways:

first as an exposition of the important place thatmilitary procurement has played in the develop-ment of some key twentieth century technolo-gies; second, as an argument that the threat ofwar may be necessary to induce the R&D need-ed to create the fundamental new technologiesthat drive long run growth.

Read in the first way, the book is a companion toVernon W. Ruttan (2001), in which he concludedthat “. . . the public sector had played an importantrole in the research and technology developmentfor almost every industry in which the UnitedStates was, in the late twentieth century, globallycompetitive” (Ruttan 2006, p. vii). In the presentbook, he concentrates specifically on military pro-curement and government-supported R&D as asource of U.S. technological advancement. Six

chapters develop this theme in relation to a seriesof new technologies, all of which he terms “gen-eral-purpose” (GPTs). In chapter 2, he argues:“The emergence of an independent machine toolindustry in the United States around the middleof the nineteenth century and of mass productionin first decades of the twentieth were the directconsequences of the investment by the U.S. WarDepartment during the first half of the nine-teenth century in the invention of armaments, inthe development of machines, and in machinemethods of manufacturing” (p. 31). Chapter 3discusses the publicly financed research adminis-tered by the NACA that developed some keyinterwar aircraft technologies, and the impor-tance of military procurement in the develop-ment of the Boeing 707 and 747. Chapter 4discusses nuclear energy, which developed fromthe government-financed Manhattan project.Chapters 5 and 6 deal with computers and theinternet, the former being heavily subsidized bythe military during the Second World War andthe later being created by the military. Chapter 7deals with the space industries, which receivedheavy government backing during and long afterWorld War II.

No one who has studied this book, and its 2001predecessor, should be willing to pronounce thecommon thought-suppressing dictum “govern-ments cannot pick winners.” Clearly, governmentshave picked and backed some spectacular win-ners. But if we are to assess the importance ofpublic support in developing these new GPTs, weneed more than the material in this book.

First, the development of some of the tech-nologies would have been long delayed, if notprecluded, if it were left solely to private-sectorR&D. Prime examples are the internet andspace-related technologies. Others would havebeen merely slowed, although it is hard to knowby how much. For example, both electronic com-puters and aircraft (propeller and jet driven)were being researched by private-sector firmsand universities. Without military and other gov-ernment support, these technologies would nodoubt have been developed more slowly but it ishard to believe that the path of their develop-mental trajectories would have been substantiallyaltered.

Second, the book deals almost exclusively withdevelopments in the United States. If one is inter-ested in U.S. competitiveness and technological


leadership, that may be an acceptable limitation.But for those interested in economic growthmore broadly, it is not. In today’s globalizedworld, the great bulk of technological advancesare made in a small subset of the advanced coun-tries and then diffuse to those others that havethe appropriate receptor capacity. There may bea persistent gap in per capita income levelsbetween leaders and advanced-country followersbut there appears to be no long term gap in theirgrowth rates. So neither world nor U.S. econom-ic growth might be seriously hampered if the pro-portion of world technological advances fell inthe United States and rose elsewhere. The book’sexclusive concentration on the United States thusdoes not help in assessing whether less U.S. pub-licly financed R&D would lead to a slowing ofworld growth rates or merely a geographicalredistribution of the sources of technologicaladvance. Consider one example. Ruttan correctlyjudges that U.S. military procurement played animportant part in the development of the Boeing707, the basis of the United States’ initial com-petitive advantage in long haul commercial jetaircraft, and in the 747 that helped the UnitedStates maintain that lead. But he does not con-sider what would have happened without thatU.S. support. The French developed the firstsuccessful medium range commercial jet aircraftin the Caravel. Although the British lost theirearly lead in jet transport when metal fatigueunexpectedly ended the commercial life of theComet 1, this did not prevent them from devel-oping a long range passenger jet. The VC-10 wasa magnificent aircraft with 4 engines mounted inthe tail rather than below the wings.Unfortunately, for the British, its operating costswere just high enough to tip the commercialscales in favor of the 707. But absent the 707, theVC-10 would have been the jet to first establishlong range flights as commonplace, and succes-sive versions would have progressively lowered itsoperating costs. The moral to this story is thatunless we know what was happening in othertechnologically advanced countries, it is hard tojudge the effect that U.S. defense-related assis-tance had on the world’s growth of technologicalknowledge, let alone the overall rate of world, orU.S., economic growth.

Ruttan does mention the rest of the worldwhen he concludes that “. . . American, and theglobal, technological landscape in which we live

today would be vastly different in the absence ofmilitary and defense-related contributions tocommercial technology development” (p. 162,emphasis added). If by “technological landscape”he means the geographical distribution of thesources of technological change, one cannot dis-agree. But if he means the overall rate of techno-logical change and economic growth, we cannotassess his claim without knowing how much ofthe competing developments elsewhere in theworld were financed for defense-related reasons.

Third, the book looks solely at government suc-cesses. As well as backing some major winners,governments throughout the advanced worldhave backed some spectacular losers. This obser-vation raises two questions. First, what is thecost–benefit balance where failures are regardedas “costs” and successes as “benefits”? Clearly,the book does not provide the raw material forsuch an assessment. Second, can we gain anyinsight into the factors that tend to make for suc-cess or failure when governments select tech-nologies for backing? By comparing a series ofcases where governments picked winners (asstudied, e.g., by Ruttan) and where they pickedlosers (as not studied by Ruttan), my coauthorsand I have been tried to identify the conditionsthat tend to favor success or failure in suchendeavors. (See in particular Richard G. Lipseyand Kenneth I. Carlaw 1996 and Lipsey, Carlaw,and Clifford T. Bekar 2005).

The second way in which the book can be read,the one the author chooses to emphasize, asks ifdefense-related support is necessary for long-term economic growth. The argument is as fol-lows: (1) GPTs are drivers of long term economicgrowth; (2) most modern GPTs have receivedsubstantial defense-related support in their earlystages; (3) the power of any one GPT to generategrowth wanes as it “matures” in the sense thatmost of its potential spillovers become exploited;(4) structural changes in the defense-related sec-tors may seriously curtail the needed public sup-port in the future; (5) such support will beunlikely without the threat of a major war?

He takes point (1) for granted, although not alleconomists would. We have argued this point indetail in Lipsey, Carlaw, and Bekar (2005) wherewe define a GPT as a technology that comes to bewidely used for multiple purposes and to havemany spillovers that enable myriad other deriva-tive and dependent technologies. Point (2) is the



Book Reviews 441

subject of his chapters 2–7, as discussed above. Heintroduces point (3) by saying: “A major deficien-cy in the induced, evolutionary, and path-depend-ency literature on technical innovation . . . isinadequate attention to the problem of technolog-ical maturity. After experiencing rapid or evenexplosive development along an initial trajectory,the older general-purpose technologies . . . haveoften experienced a period of technological matu-rity or stagnation” (p. 163). He argues that, sinceGPTs eventually reach maturity, new GPTs arethe essential driving force of sustained economicgrowth, so anything that stops or drastically slowstheir development will drastically slow the pace ofeconomic growth. As to the alleged neglect of thischaracteristic, I offer one of the many possibleconflicting quotations from our work. It comesduring the discussion of the first of a series ofmodels of GPT-induced growth: “This two-sectorversion of the model illustrates the rejuvenatingpower of GPTs. In the absence of the arrival of anew GPT. . . the growth rate . . . converge[s] tozero asymptotically . . . . However, the arrival of anew GPT encourages further applied R&D andrejuvenates growth” (Lipsey, Carlaw, and Bekar2005, p. 449).

With respect to point (4), Ruttan’s asks if“. . . changes in the structure of the U.S. econo-my and of the defense industries and the defenseindustrial base preclude military and defense-related R&D and procurement from continuingto play an important role in the generation ofnew general-purpose technologies” (p. 166).Although he does not say so explicitly, it seemsfrom his discussion of the decline of spin-offs,the demise of the dual-use model (military andcommercial) for military R&D, and the processof consolidation in which competition amongmany contractors is no longer encouraged by theDoD, that his answer is “Yes.”

He raises point (5) by asking “. . . whether amajor war, or threat of a major war, is necessary toinduce the U.S. political and economic institu-tions to commit the very large resources necessaryto generate or sustain the development of majornew general-purpose technologies” (p. 176). This,he says, generates three subquestions. First, canthe private sector generate the needed resources?He answers that it cannot because, among otherreasons, the gains are so diffuse that they are dif-ficult to capture by the firm conducting theresearch and because there is a long gestation

period before commercial gains are substantial.Second, might a more aggressive policy of target-ing public support for commercially orientedR&D provide the necessary financing? Ruttan isskeptical of this avenue because although in thepast such programs “. . . have generated substan-tial economic benefits, . . . even the most success-ful programs must be evaluated in terms of theircontributions to evolutionary rather than revolu-tionary changes in technology” (p. 182). The thirdis “. . . whether military and defense-related R&Dcan again become a source of major new general-purpose technologies” (p. 183). And he answers“no” largely for reasons given in his discussion ofpoint (4) above.

If we grant all of Ruttan’s arguments aboutnew GPTs being needed to sustain the growthprocess and the inability of the military industri-al base to generate the necessary R&D in theabsence of the threat of war, doubts still remain.First, war is not the only threat that can lead to amassive mobilization of resources. What isrequired is the public perception of a clear andpresent danger and there are threats on the hori-zon at least as serious as war. The evidence of cli-mate change is all around us. Whether or not aserious danger is perceived by the public soonenough to avert a major disaster, the demand forresources and new technologies to control thecauses and to cope with the consequences will beenormous. Even if climate change does not turnout to be as serious as most scientists believe, theday is approaching when supplies of petroleumbegin to dwindle significantly. A steadily risingprice of petroleum will then unleash a majorR&D effort to replace it, not only as a fuel butalso in its myriad byproduct uses.

Second, much of the public support for R&Din other industrialized countries, such as Franceand the United Kingdom, has come not fromdefense-related concerns but from concernsabout their national competitiveness and rates ofgrowth. Although public support may be neces-sary for the development of new fundamentaltechnologies in these countries, the threat of warprobably is not. (For an analysis of the successand failures of some such policies, see Lipsey andCarlaw 1996.)

Third, electricity provides an obvious counterexample to the proposition, implicit in Ruttan’sargument, that public support is always neededfor the development of new GPTs. Electricity’s


extended development trajectory, starting withthe publication of Gilbert’s de Magenta in 1600and ending with the invention of the dynamo in1867, was without defense-related assistance.There is insufficient space here to investigate thequestion of the types of GPTs that do and do notrequire extensive public support in their earlystages—the laser and the internal combustionengine seem to be other counter examples to thethesis of the necessity of major public support ofnew GPTs. As electricity and steam engine show,long gestation periods are not enough to makepublic support necessary, Nor are substantialnonappropriable benefits, which are a character-istic of all GPTs, since what is needed for privatedevelopment is that the small portion of the mas-sive benefits that can be captured by the privatedevelopers is sufficient to repay the risksinvolved in undertaking the necessary R&D. Inthe absence of a full analysis of this issue, it ishard to predict what happen if major public sup-port were withdrawn from the development offurther GPTs.

In conclusion, we owe Ruttan a debt of grati-tude for demonstrating yet again the importanceof public sector support in the development ofmany major technologies and for raising, if notsettling, the key issue of how important futuredefense-related support needs to be, and will be,in developing future GPTs and sustaining long-term economic growth. If he has not settled theseissues, by raising them he has pointed the way tofurther potentially fruitful research, which couldbe the subject of a valuable conference volume.

REFERENCES

Lipsey, Richard G., and Kenneth I. Carlaw. 1996. “AStructuralist View of Innovation Policy.” In TheImplications of Knowledge-Based Growth for Micro-Economic Policies, ed. P. Howitt. Industry CanadaResearch Series. Calgary: University of CalgaryPress, 255–333.

Lipsey, Richard G., Kenneth I. Carlaw, and Clifford T.Bekar. 2005. Economic Transformations: GeneralPurpose Technologies and Long-Term EconomicGrowth. Oxford and New York: Oxford UniversityPress.

Ruttan, Vernon W. 2001. Technology, Growth, andDevelopment: An Induced Innovation Perspective.New York and Oxford: Oxford University Press.

RICHARD LIPSEY

Simon Fraser University

Individual Accounts for Social Security Reform:International Perspectives on the U.S. Debate.

By John Turner. Kalamazoo, Mich.: W. E.Upjohn Institute for Employment Research,2006. Pp. ix, 195. $40.00, cloth; $18.00, paper.ISBN 0–88099–283–2, cloth; 0–88099–282–4,pbk. JEL 2006–0977While reforming Social Security might appear

to the casual observer to be on hold, the recentmidterm elections have also improved theDemocrats’ negotiating position. IndividualAccounts for Social Security Reform is a goodintroduction for readers with little or no familiar-ity with the Social Security reform debate. Manynew Democratic staffers will find much in com-mon with the author’s positions on the issue; thebook should top their reading list.

The book draws on some international evidencefor the expressed purpose of influencing theUnited States Social Security reform debate overthe adoption of individual accounts, a key elementin President Bush’s mantra to modernize SocialSecurity. John Turner begins by categorizing dif-ferent public and private pension models aroundthe world according to their main propertiesincluding whether they are voluntary or mandat-ed; whether the accounts are managed by individ-uals or by the government; and, several othercharacteristics. In doing so, a useful taxonomy ofdifferent pension programs emerges.

Turner notes in the preface that he wrote thebook on his own time and that his opinions are notnecessarily those of his employer, the AARP. Butthe book is largely consistent with AARP’s lobby-ing positions. To his credit, Turner avoids the mis-leading “privatization” label that opponents ofpersonal accounts have used with recent politicalsuccess. Yet, his analysis is a not-too-subtle attackon individual accounts.

Turner, in particular, uncovers every possiblerisk that can be associated with individualaccounts including market risk, agency risks (highadministrative fees), poor portfolio choice risk,tax policy risk, disability risk, and a litany of otherrisks. While most of the book focuses on theserisks, he does not really prioritize them or explainhow many of these risks can be mitigated with asensibly specified reform. To be sure, individualaccounts will always be susceptible to systemic(market) risk even they hold a well diversifiedportfolio; proponents of personal accounts errwhen they say otherwise. But individual accountsneed not be as scary as Turner suggests either.Indeed, the three model plans proposed by the



Book Reviews 443

President’s 2001 Commission to StrengthenSocial Security dealt sufficiently with most of therisks that Turner discusses.

While highlighting the risks in individualaccounts, Turner attempts to minimize the risksassociate with the traditional Social Security sys-tem. He devotes only a single, fairly cryptic para-graph to explaining how traditional pay-as-you-gosystems are subject to changes in the ratio ofworkers to retirees. But he fails to clarify howattempting to pre-fund the imminent significantdemographic changes inside of the U.S. SocialSecurity system requires building up a TrustFund, which is subject to enormous policy risk.Indeed, some empirical evidence suggests thatadditions to the U.S. Social Security Trust Fundduring the past several decades have contributedvery little, if at all, to an increase in national sav-ings and, therefore, have not helped the nationprepare for the retirement of the baby boomergeneration (Sita Nataraj and John B. Shoven2004; Kent Smetters 2004).

The U.S. federal government focuses on the so-called “unified budget surplus” that includesadditions to the Social Security Trust Fund.Targeting a zero or a fixed budget deficit, consis-tent with the usual rhetoric by policymakers,essentially guarantees that additions to the TrustFund are spent elsewhere in the federal budget,either in the form of non-Social Security taxreductions or spending increases.

Indeed, one of the strongest arguments forpersonal accounts is they help deny policymak-ers the opportunity to squander retirementresources on other budget priorities. Of course,personal accounts are not a guaranteed “lockbox” either since workers might demand pre-retirement access, as with 401(k) accounts. Butpolicymakers would likely be more protective ofthis perceived first-tier source of retirementincome than income from second tiers, such as401(k)’s. International evidence largely supportsthis claim.

Turner also pushes another AARP themeregarding the specific design of the personalaccounts, in particular, whether they are con-structed as a “carve out” or an “add on.” A “carveout” account is created by “carving out” some ofthe payroll tax for deposit into an individualaccount. An “add on” account imposes a newpayroll tax on workers in addition to the existingpayroll tax.

A carve-out type of reform is generally comple-mented with a reduction in the traditional SocialSecurity benefit since workers pay less into thetraditional system. An add-on account is typicallyconstructed to provide a new source of retire-ment income on top of the traditional benefit.Whereas an add-on account injects new moneyinto the retirement system, a carve out accountcould either be fiscally neutral in present valueor, as in two of President’s 2001 Commissionplans, actually reduce the government’s net rev-enue. (These two plans, however, include otherfeatures that reduce the growth rate of spending.In one of the Commission’s plans, the carve-outaccount actually increases the government’s netrevenue in present value.)

Both Turner and his employer, the AARP, arguethat carve-out accounts are not an acceptable pol-icy option. The AARP is fairly blunt: “divertingSocial Security revenues into individual accountsshifts risk to the individual and hurts the financialstatus of Social Security itself.”1 The AARP, ofcourse, does not oppose asset accumulation inaddition to Social Security, as in an add-onaccount: “Social Security was never intended tobe your only source of retirement income—justthe safe, reliable piece of a smart retirement plan.Ideally, you should build on Social Security’s basewith a pension, an IRA, a 401(k) or other invest-ments. When added to Social Security, thesekinds of private investments help provide a moreadequate retirement income.”2

The distinction by Turner and the AARPbetween carve-out and add-on accounts, howev-er, seems more based on the “principle” of notaltering Social Security benefits rather than on acareful analysis of the appropriate level of retire-ment income that should be provided by a tradi-tional Social Security system versus othersources.

Suppose, for example, that Social Security ben-efits happened to be equal to 80 percent of theircurrent levels. To increase retirement income,suppose that lawmakers then decided to institutea new add-on account so that the new combinedannuitized benefit equaled the current level. Iassume that Turner and the AARP would support

1 http://www.aarp.org/money/social_security/a2003–03–26-ssprivatization.html [last checked, December 29,2006].

2 Ibid.


this reform. But such a system would be identicalto the current system with a 20 percent carve-outaccount.

Turner provides no framework for understand-ing how much retirement income should comefrom a traditional Social Security system and howmuch should come from additional resources.His underlying principle seems to be clear andquite simple: Don’t mess with Social Security.

Turner writes that “[p]erhaps the chief ration-ale against mandating carve-out accounts is thatthey place too great a burden of financial risk onlow-income workers, especially when the plansreplace part of a traditional social security pro-gram, reducing the base level of benefits” (p. 34).To be sure, a naive carve-out plan would likelyexpose low-income workers to an unacceptablysmall retirement benefit if the accounts wereallowed to be invested in risky assets. But manycarve-out plans also substantially increased low-income worker benefits under the traditional sys-tem, including the President’s 2001 Commissionplans. A carve-out was chosen by the Commissionprecisely to help avoid requiring low-incomeAmericans from saving additional resources forretirement during a period in their lifetime whenthey are likely liquidity constrained.

REFERENCES

Nataraj, Sita, and John B. Shoven. 2004. “Has theUnified Budget Undermined the FederalGovernment Trust Funds?” NBER Working Papers,no. 10953.

Smetters, Kent. 2004. “Is the Social Security TrustFund a Store of Value?” American Economic Review,94(2): 176–81.

KENT SMETTERS

University of Pennsylvania

L Industrial Organization

Rumors of Baseball’s Demise: How the Balance ofCompetition Swung and the Critics Missed. ByRobert Cull. Jefferson, N.C. and London:McFarland, 2006. Pp. vii, 239. $29.95, paper.ISBN 0–7864–2251–3. JEL 2006–1401Competitive balance in sports leagues seems

to have become the favorite topic of debateamong sports economists. As do sports, debatesstir passion. Debates also tend to call forth strawmen, partial truths, cooked data, and occasionalmindless empiricism.

Two recent books discuss competitive balancein baseball, The Wages of Wins by David J. Berri,Martin B. Schmidt, and Stacey L. Brook, andRumors of Baseball’s Demise by Robert Cull.Although the books have different analyses, theyeach invoke the same straw man to motivatemuch of their presentation; to wit, they claim thatthe mainstream view is that baseball suffers fromserious problems of competitive imbalance.

Berri, Schmidt, and Brook, drawing from thework of Stephen Jay Gould (1986) and AndrewZimbalist (1992), argue that the principal reasonwhy baseball’s competitive balance has steadilyimproved over the decades is talent compression.That is, a smaller and smaller share of theexpanding population from which baseball drawsits talent makes it to the major leagues. As such,given the presumed normal distribution of base-ball-related skills, the difference between thebest and worst players is narrowing. This bothshrinks the talent gap among teams and makes itharder to identify (and, hence, to trade for orpurchase) the top performing players, lesseningwhat might otherwise be a significant advantageof the high-revenue teams.

Cull, in contrast, ignores talent compressionaltogether and asserts three different explana-tions: first, the introduction of baseball’s amateurdraft in 1965, as well as a series of subsequentreforms that strengthened its impact; second,what he calls “pitcher variability”; and, third,baseball’s “compensation structures.” Let meconsider each of these factors in turn.

Cull begins his discussion of the draft with aninteresting presentation of data on the number ofminor league affiliates each club had in thedecades before 1965. Although Cull doesn’t callattention to it, it turns out that the number ofaffiliates was closely correlated with a team’s citysize and also with a team’s performance. As thenumber of affiliates began to be standardizedafter 1965, it may have been the closing of thediscrepancy in the size of teams’ minor leaguesystems rather than the amateur draft itself thathad the leveling effect.

Cull traces the evolution of the amateur draft,showing how the selection of players shifted awayfrom high school and toward college graduatesafter 1981. The shift occurred, he argues, prima-rily because teams grew increasingly aware thatthe performance of college players was more pre-dictable. While Cull highlights some important



Book Reviews 445

developments, he fails to demonstrate whetherthe draft itself actually promoted balance. Hesidesteps the academic literature on the CoaseTheorem that basically concludes that the draftshould have a minimal impact. He also sidestepsthe reality that the reverse-order draft gives thebottom teams at most one pick (of dubious bene-fit) before the top teams. Finally, he does not con-sider the possible impact of the large-scaleintroduction of Latin American and other foreignplayers over the last fifteen years.

Cull’s discussion of pitcher variability is also lessthan compelling. He starts by asserting that pitch-ing is more important than hitting for winning atitle and purports to demonstrate this empiricallyby showing that most of the time championshipteams had staff ERAs that ranked among the topin their league. Cull offers no standard statisticaltests here.

Cull proceeds to argue that pitchers’ perform-ance varies sharply from year to year, making itmore difficult (a) to predict which pitchers willbe successful and (b) to hold on to a winningteam. His evidence is based on the metric ofwhether or not pitchers are in the top 25 percentof win percentages for two consecutive years. It isnot at all clear why he uses this criterion. Recentstatistical evidence suggests that pitching per-formance is most cleanly measured by ERA,strikeout–walk ratio, or hits-plus-walks perinning. Obviously, a pitcher’s win percentagedepends much more on the offensive and defen-sive support he receives than other measuresand, hence, has much more noise. In any event, itis true that pitchers’ performance has becomemore variable over the years, but so has hitters’performance. Both of these outcomes might berelated to talent compression or other factors.

Finally, Cull argues that the statistical correla-tion between team payroll and team performanceis weak. Here too he makes some worthy, thoughnot novel, observations. For instance, while thecorrelation coefficient between payroll and per-formance has been statistically significant sincethe early 1990s, the causality may be runningfrom performance to payroll rather than viceversa. Deciphering the direction of causality, henotes, is often confounded by statistical tests usingend-of-year payroll data. This is because teams inthe playoff hunt (i.e., teams already performingwell) will frequently add players (and payroll)after the All-Star break, while teams performing

poorly will often subtract players (particularlythose with high salaries). Further, teams that winsee the market value of their players rise, soplayer contracts go up in following years.

But, as elsewhere, Cull does not marshal hisevidence as well as he could. He does not doGranger causality tests. He divides MSA popula-tion by two for cities with two teams, instead ofallowing the effect of a second team to weightitself via a dummy variable. There is plenty ofeconometric evidence that having more than oneteam in the city deepens the baseball culture in atown and expands the city’s fan base. One anec-dotal piece of evidence, however, is as telling asanything. When the Giants and Dodgers left NewYork following the 1957 season, the Yankees’attendance actually dropped in 1958 relative to1957—despite the facts that (a) the team had twofewer “competitors” in New York in 1958 and (b)the team went to the World Series in 1957 andwon the World Series in 1958. He also does notconsider the effect of new stadiums and playerdevelopment expenditures on team performance.

Cull culminates by savaging baseball commis-sioner Bud Selig. While anyone who has followedbaseball since 1992 knows that the commissioneris far from being beyond reproach,3 Cull’s assaultis not justified.

Cull writes that Selig has overstated the prob-lem of competitive balance. The fact is that mostof Selig’s comments as well as those of otherauthors cited by Cull refer to a period when it wasdifficult to overstate the magnitude of the prob-lem. From 1995 to 2001, only eleven of MLB’sthirty teams made it to the League ChampionshipSeries and no team outside the top quartile inpayrolls won a single World Series game. Selighad reason to be concerned about balance, as hedid to be concerned about the financial circum-stances of many teams from smaller markets andin older facilities. In fact, Selig, to his credit, haschanged his tune. Since 2002, he consistentlyhas described MLB’s economic model and itsoutcomes as successful.

To be sure, Selig’s main analytical foray intothe competitive balance issue was more insight-ful than much of the academic writing on it. Hestated that the competitive balance goal was forfans of each team to have faith and hope at the

3 Cf. Zimbalist 2006.


beginning of each season. This perspective prop-erly focuses attention on the fans. It is the fans’reaction, after all, that makes balance important.Sports economists tend to use measures such asthe ratio of the actual to the idealized standarddeviation to measure balance which might makesense statistically, but have little meaning to thefans. If fans don’t respond to it, then it won’timpact attendance and there is little reason forthe team owners to do anything.4

Statistical measurements are fine as long asthey are grounded in institutional reality andsound theory. Cull’s treatment, while interestingand insightful at points, misses this basic con-nection and leaves his readers with less than ahome run.

REFERENCES

Berri, David J., Martin B. Schmidt, and Stacey L.Brook. 2006. The Wages of Wins: Taking Measure ofthe Many Myths in Modern Sports. Stanford:Stanford University Press.

Gould, Stephen Jay. 1986. “Entropic HomogeneityIsn’t Why No One Hits .400 Anymore.” Discover,7(8): 60–66.

Zimbalist, Andrew. 1992. Baseball and Billions: AProbing Look inside the Big Business of OurNational Pastime. New York: Harper Collins, BasicBooks.

Zimbalist, Andrew. 2002. “Competitive Balance inSports Leagues: An Introduction.” Journal of SportsEconomics, 3(2): 111–21.

Zimbalist, Andrew. 2006. In the Best Interests ofBaseball? The Revolutionary Reign of Bud Selig.Hoboken, N.J.: Wiley.

ANDREW ZIMBALIST

Smith College

N Economic History

Among Empires: American Ascendancy and ItsPredecessors. By Charles S. Maier. Cambridgeand London: Harvard University Press, 2006.Pp. 373. $27.95. ISBN 0–674–02189–4.

JEL 2006–1439Among Empires: American Ascendancy and Its

Predecessors, by Charles S. Maier, the LeverettSaltonstall Professor of History at HarvardUniversity and a distinguished scholar of interna-tional relations, is essentially two related essayson the theme of empires. One is a generalized

discussion of the rise and fall of approximatelythree dozen empires, over an extremely broadhistorical and geographic span. It is an attempt topresent a comparative perspective on the types ofproblems that past empires have had to deal with,and it does provide a rather cautionary warningthat each of these empires had come to an end,after periods varying from only a small number ofyears to about fourteen centuries. The secondessay deals with the rise of the American empire,particularly after the end of World War II, withsome attention to developments during the con-tinental expansion of the nineteenth century andwith the imperialists after 1898. It also includessome discussion of the future prospects for thepresent American empire, given the currentworld situation and “the openness of themoment” (p. 295).

According to Maier, it is generally argued thatempires represent expansion “by conquest orcoercion” and the ability to “control the politicalloyalty of the territories it subjugates,” whetherby direct power or by the installing of “compliantnative leaders” (pp. 24–25). By these standards,he claims, the United States has not, until recent-ly, met the requirements of empire since it “hasnot engaged in a sustained program of conquestoverseas” (p. 25) and since not all political deci-sion making in the territories was originated inWashington. Yet it did have considerable influ-ence throughout the world due to its militarypower, its economic strength, and its cultural andideological influences. Among the numerousinteresting aspects of empires considered byMaier are their effects on internal liberties aswell as liberties in the colonies; differencesbetween land empires and maritime empires,which have an influence on the ratio of metro-politan to colonial population; and the nature ofpolitical controls coming from settlers, from themetropolis, and from local residents. The basiccharacteristics of an empire in contrast with anation are discussed particularly in regard to thequestion of possible differences in the extent ofcivil liberties in nations and in empires, but thiscomparison is not examined in great detail.Empires often involved violence, particularly infrontier or border areas, where either they metwith rival empires or else the role of distance lim-ited ability to control some fragments of theempire. Based on the works of Edelstein, Davisand Huttenback, and O’Brien, Maier suggests4 This theoretical point is developed in Zimbalist 2002.



Book Reviews 447

that the costs of law, defense, and administrationpossibly did more to redistribute income to theelites than to provide benefits to the overalldomestic society. Although the number of mili-tary and civilian deaths in colonies and otherwisehas remained high throughout the twentieth cen-tury, for some of the nations which had liberalregimes, “colonial empires perished because theforce needed to preserve them seemed unac-ceptable to a paralyzing fraction of domesticopinion” (p. 61). Given these quite differentaspects of empire, and the shifts in ideologicalbeliefs over time, completely satisfactory general-izations are difficult, though, of course the factorsof expansion, violence, and rise and fall, are char-acteristic of most. In a brief “Afterword,” Maiertraces out the sequence of empires in theEuro–Asian continent from 2472 BCE to date,although the nature of the transitions, whethermilitary or political, is not detailed nor is it clearwhat differences could have due to whether therewere none,one, two, or three, or more competingempires. Thus, although there are many fascinat-ing insights into the history of empires, there arequestions of interest that remain for other schol-ars, as we would expect from a self-described“extended essay” (p. 3).

The discussion of “America’s Turn” focuses onthe years of the twentieth century, particularlyafter 1945, with the American ascendancy, thesuccessful conflict with the Soviet empire, andthe relative decline of the British. To Maier, a keyset of forces are economic—particularly Fordismand international currency controls, while morerecently “the advent of electronic informatics” (p.278) seems to provide hope for a continuedAmerican economic edge. He divides the successof the post–WWII American empire into twoperiods, with different internal and external fea-tures. The “Empire of Production” lasted fromthe 1940s to 1970s, influenced by standardizedmass production and the low price of energy.Then, after a period of disarray in the 1970s the“Empire of Consumption” emerged, with its lowsavings rate, federal budget deficits, and deficit inthe current account. In regard to the ideologicalaims, such as spreading democracy, Maier seessome pressure toward an American desire forempire, as would a need to combat terrorismeven if these “eroded individual liberties” (p.294). While a possible empire via the “Bushdynasty” (p. 291), is noted, one strand of the

desire for empire is not discussed, however. Thisis the current Democrat–Liberal desire to pro-vide benefits to less-developed nations via laborstandards, social concerns such as ending femalegenital circumcision, and contemporary antislav-ery measures. Thus the current debate seems lessabout the desirability of interventions elsewherethan the specifics of what is to be intervenedagainst. Clearly, however, these concerns woulddiffer from these earlier empires, typified mostextremely by the Mongols under Chinggis Khan,with their extensive destruction of people andother resources.

STANLEY ENGERMAN

University of Rochester

O Economic Development,Technological Change, and Growth

Institutional Reforms: The Case of Colombia.Edited by Alberto Alesina. Cambridge andLondon: MIT Press, 2005. Pp. x, 373. $35.00.ISBN 0–262–51182–7. JEL 2005–1381

The Political Economy of Protection: Theory andthe Chilean Experience. By Daniel Lederman.Social Science History series. Stanford:Stanford University Press, 2005. Pp. ix, 191.$55.00. ISBN 0–8047–4917–5.

JEL 2005–0952Daniel Lederman’s The Political Economy of

Protection: Theory and the Chilean Experience isa good source of historical information for any-body wanting to learn about Chilean trade policy.It provides an overview of two hundred years oftrade policy, openness, and some of the charac-ters involved in policy making from Chile’s inde-pendence in the early nineteenth century untilthe present, with a detailed focus on the liberal-ization process started in 1974 by the Pinochetadministration and carried on by the succeedingdemocratic governments.

The historical account is launched in the con-text of a “search for policy cycles” of protectionand liberalization that uses recently compileddata on imports, exports, GDP, exchange rates,and price indices ranging from 1810 to 1994. Weare presented with graphical overviews of theevolution of imports and exports over GDP, theirHodrick–Prescotted trend components, variation


in the terms of trade, and import and exportexchange rates.

We learn that openness (imports +exports / GDP) evolves more or less in the samefashion as in so many Western economies:increasing, big drop around World War I and theGreat Depression, increasing again but as of 1994not reaching yet its pre–Great Depression level.The worldwide increase in consumption of non-tradables tampers with intertemporal compar-isons of openness and it would be moreinformative to use the tradable components ofGDP. But there is of course a good chance thattotal GDP is as good as it gets when it comes todata from 1810.

Remarkably, the all time high of exports/GDPoccurs during 1918 with a catastrophic fall in thefollowing year, accompanied by the largest everfall in terms of trade. As it turns out, world peacewas the culprit: the Chilean nitrates industryflourished while demand for gunpowder washigh. More details like this follow as the accountgoes on.

What is the motivation so far? Well, there is asearch for policy cycles going on and that meansidentifying periods during which policy was pro-tectionist and periods during which policy wasliberal (in the economic British sense). As arguedby Lederman, different authors have not beenable to agree, for example, on which the period ofimport substitution was. He seeks to give his ownclassification of trade policy periods.

After looking at openness and terms of trade,the focus turns to trade policy. The appendixincludes a detailed four-page table that lists tradepolicy related events starting at colonial times,when Spanish colonies were only allowed to tradewith Spain, and ending in 1973 (the period1973–99, which starts with the Pinochet adminis-tration, is discussed in more detail later on). Herethe reader can find information such as tariffincreases and cuts, production subsidies, andexchange rate controls. Each policy measure isclassified into protectionist or liberal, and aggre-gated into graphs that plot the frequency of eachtwo types of policy over time. The graphs presentrelatively clear patterns of alternating dominanceof protectionism and liberalism.

Using these tools together with historical narra-tive about predominant ideas, presidential elec-tions, interest groups, and overall trade andindustrial policy, Lederman concludes that Chile

went through a period of open economy (until theearly twentieth century), delegitimization of liber-alism (1911–27), institutionalization of protection-ism (1927–56), delegitimization of protectionism(1956–73), and liberalization (from 1974 on). Thisnomenclature follows the work of political scien-tist Judy Goldstein. In Goldstein’s view, policydecisions are made in response to dominant eco-nomic policy “ideas.” Ideas follow cycles of “legit-imization” and “delegitimization” according totheir success and failure. Ideas get delegitimizedwhen they are associated with economic crises;this opens a window of opportunity for newideas; if new ideas are associated with success,they become legitimized and are supported bydifferent parties—until a crisis strikes again.

The categorization of Chilean trade policy his-tory into periods of protection and liberalism isfollowed by two empirical exercises. The firstexercise are several structural break tests thatseek to identify abrupt changes in the indicatorsof openness (exports, imports, and total tradeflows) and their rates of growth during the period1810–1995. Results indicate that there was astructural break during the Great Depression butnothing during Chile’s 1970s liberalization.

These results are not surprising. Structuralbreak tests are not flexible enough to identifyuneven policy cycles of protectionism and liberal-ism. The Great Depression was indeed abruptand had immediate effects. The 1970s liberaliza-tion, on the other hand, was gradual and the largeincrease in exports and imports stretched out overseveral years. Thus, the tests pick up the GreatDepression but not the 1970s liberalization.

The second exercise looks into identifying thetime-series determinants of Chilean trade policythrough two different Probit models where eachyear is one observation and liberalization (yes orno) and protection (yes or no) are the dichoto-mous dependent variables. The classification ofeach year into liberalization, protection, and no-change comes from the trade policy events tablein the appendix and includes, among others,changes in tariffs, nontariff barriers, export pro-motions and capital controls. Some of the explana-tory variables are lagged fiscal balance, tradebalance, GDP growth, employment, inflation, andimport penetration.

An alternative specification for this exercisecould have been one multinomial model withthree outcomes—liberalization, protection and



Book Reviews 449

no-change—instead of two separate binary mod-els. A multinomial specification would have takenthe correlation between liberalization and pro-tection into consideration. Another possible addi-tion is the time dependence of liberalization andprotection. As it is, the exercise looks at one-year-lagged explanatory variables and does not allowfor a “liberalization (or protection) spree.”

The last main chapter describes the past thirtyyears of Chilean trade policy and its politics ingreat detail. It starts with the military coup of1974. The Pinochet administration pushed for-ward an aggressive liberalization process. In onlyfive years, the average tariff went down from 90percent in 1974 to a uniform 10 percent in 1979.Quantitative import restrictions were eliminated.There was a step back to protectionism in themidst of an economic crisis during 1983–85 butthe liberalization efforts rapidly went back intoplace and were not interrupted by the return todemocracy in 1990. The uniform tariff level con-tinued its declining trend and reached 6 percentin 2003. The account of the period is extensiveand informative in aspects other than merelytrade policy. It includes details on stabilizationefforts, development programs, exchange rateregimes, key players within the government, andthe ideologies of advisors.

Lederman’s view of Chile’s political economy oftrade policy during the past thirty years is virtual-ly the same as that of the historical analysis in theprevious chapters: much can be explained bydominant economic ideas. This leaves out ananalysis focused on interest groups—a prolificarea of research in the political economy of tradepolicy literature. Lederman argues that the pres-sures of interest groups were minimized by theshock therapy characteristics of the reformstogether with the fact that a uniform tariff wasapplied.

Throughout the whole book, the approach ismore focused on the time series aspect of tradepolicy (periods of liberalization versus protec-tion) rather than on the across-industry details. Inlight of this, this book will be an ideal source ofinformation for the reader seeking to learn aboutthe long term evolution of protectionism in Chile.

The volume edited by Alberto Alesina looks atanother Latin American country: Colombia.Like many other countries in the region,Colombia underwent big market-orientedreforms during the 1990s. So, upon reading the

title of the book, Institutional Reforms: The Caseof Colombia, it may appear obvious what thebook is going to be about. Yet it turns out thatthe title refers not so much to past reforms butrather to the, in Alesina’s words, self-evidentneed for more institutional reforms.

After an introduction on the economic historyof Colombia during the past thirty years, thebook is organized in chapters each covering adifferent topic: separation of powers, the elec-toral and party system, crime, decentralization,the budgetary process, education, social pro-grams, and the Central Bank. Most chapters areauthored by a team including at least one expertfrom Colombia, most of them from Universidadde los Andes and from Fedesarrollo, a policy ori-ented research institution in Bogotá. Followinga common structure, all chapters start with adescription of a current situation and end withvery concrete proposals for reforms. Also fol-lowing a common view, most chapters are criti-cal of the 1991 Constitution and find it guilty ofbeing too rigid, interventionist, and inconsistentwith contemporaneous policy measures andsocioeconomic reality.

The chapter on separation of powers, byMaurice Kugler and Howard Rosenthal, dealswith the political system, which in practice meansthat they deal with a whole lot of things. Perhapsthe most notorious issue is the existence ofConstitutional Courts that often act “in an activistmanner” to overturn legislation and have a stronginfluence on economic policy. This activism, thataccording to the authors is often detrimental, aris-es in order to guarantee very literal and detailedconstitutional principles (such as indexation!) andalso as a result of the individual right to contendlegislation with the highest courts. The authorspropose the requirement of a supermajority ofseven out of nine members for the ConstitutionalCourt to overturn legislation passed by the execu-tive and Congress. Other proposals are related toestablishing court hierarchies, to the eliminationof secret voting by judges and congressmen, tomodifications of the appointment and tenure sys-tem for higher court magistrates, to giving fast-track powers to the executive, and to the size ofthe chambers. It should be noted that due to theirconstitutional nature most proposals require areform of the Constitution. There is no discussionabout the viability of a new constitutional reform(the last one was in 2001).


The natural sequel is a description of the elec-toral and party system. This is done by GérardRoland and Juan Gonzalo Zapata. The situation isbasically that excessive fragmentation of theSenate and House of Representatives leads toclientelistic behavior whereby representativesseek to satisfy the objectives of small electoratesand compromise the action of the Executive—thechapter mentions several historical examples ofpresidents who have tried to implement (presum-ably beneficial) nationwide reforms that wererejected by a pro-status quo Congress. Rolandand Zapata delve into the intricacies of seat quotaallocation formulas of congressional elections inColombia and other countries and come up witha suggestion to replace the current LR-Hare(largest remainders) system by a two-tier system,similar to systems currently used in severalEuropean countries, where reminders are aggre-gated over jurisdictions. The aggregation ofremainders at the national level would presum-ably yield a less fragmented Congress by forcingparties to present a sole national district list ofcandidates.

Alesina and several contributors agree thatcrime is probably the “major cause of all prob-lems in Colombia.” As such, crime is the focus ofthe following chapter, authored by Steven Levittand Mauricio Rubio. After playing with interest-ing statistics and regressions on the evolution ofdifferent crime rates over time and across differ-ent countries, on the rates of investigation, trial,sentences, and unsolved cases of different typesof crime, and on income distribution, the authorsconclude that drug dealing is the cause of thehigh crime rates and that there should be a shiftof crime-fighting resources from less violentcrimes to more violent crimes (Interestingly,Colombia is one of the countries with highesthomicides rates in the world yet property anddomestic crime rates are similar to other LatinAmerican countries).

The remaining chapters deal with issues relat-ed to economic policy. Alesina, AlbertoCarrasquilla, and Juan José Echavarría writeabout fiscal decentralization—a choice of topicmotivated by an increasing fiscal imbalance. Themajority of tax revenue is collected by the centralgovernments. Funds are allocated to regional andlocal governments for expenditure subject to verytight spending rules that leave them unable to tai-lor to specific local needs. On the other hand, the

rules dealing with regional debt are relativelylenient and have led to bailouts by the central gov-ernment. All these issues are discussed in detail,together with the general theory of fiscal decen-tralization and proposals for reform related to lim-iting local borrowing and allowing for moreflexibility in the allocation of expenditure. Theauthors claim that some of these proposals wereincorporated in the Constitutional reform of 2001.On a closely related matter, Ulpiano Ayala andRoberto Perotti describe in the following chapterthe multiplicity of formal documents, definitionalliberties, and accounting tricks that contribute tothe nontransparency of the budgetary process.They make concrete suggestions—among themost concrete throughout the book—that couldconduce to a healthier fiscal policy.

The chapter on public education is written byGeorge Borjas and Olga Acosta. Education is ahuge component of public employment andexpenditure and the sector was recentlyreformed with the background target of offeringnine grades of education to the whole population.The authors present statistics and regressions onemployment, teacher-student ratios, expenditure,salaries and pensions, and even teacher migra-tions, and discuss the sector in fairly good detailincluding the hiring process, pension system, andlabor union. One key problem seems to be thatteacher wages are set nationwide, ignoring differ-ences in purchasing power across regions andleaving the local governments with no saying inthe matter (while local governments are in chargeof hiring the majority of teachers). Overall thepicture is that incentive schemes could beimproved and that things could be done moreefficiently. Given the size and importance of thesector and apparent past conflicts, it is not clear,though, and is not discussed much in the chapter,whether it would be politically viable to introducefurther reforms on how wages are set and on thepension system.

Perotti focuses on social spending. He gives adetailed account of pension plans, programstoward family and children (mostly child careprograms) and employment programs. Overall headdresses a huge number of issues with evidentfamiliarity with Colombia’s social programs andinstitutions. Beyond commenting on the short-comings of the implementations of these pro-grams and making suggestions for improvement,Perotti’s main concern is that public expenditure



Book Reviews 451

(including education, health, and the programsmentioned above) generally fails to reach thevery poor. Individuals in rural areas have hardtime accessing education and health and are out-side of the formal pension system. Public assis-tance safety nets are often implemented throughcommunity involvement, which also excludes therural poor and urban indigents.

In the final chapter, Alesina, Carrasquilla, andRoberto Steiner write about the Central Bank, itsimprovement in terms of independence after theConstitutional reform of 1991, and the desirabili-ty for yet more independence. The authors findthat the main points of conflict are that the treas-ury minister is the president and a voting memberof the Central Bank board, and that the govern-ment is involved in exchange rate policies (andthus monetary policy) and the management of thefinancial system. Criticisms and proposals are inline with current views and trends on central bankindependence.

Summing up, the book covers a great deal oftopics from a perspective of diagnosing and pre-scribing. It is a study of those aspects ofColombian political and economic institutionsthat the editor and authors judge to be in need ofreforms. The nature of the recommendations nat-urally varies with the nature of the problems.Most proposals related to political institutionsinvolve a constitutional reform. Proposals affect-ing large influential groups, be their persuasionpower legal—such as the teachers’ union—orillegal—such as drug dealers, could be harder toimplement. The original drafts of the chaptershave been circulating for several years andAlesina argues that several proposals have beenimplemented.

IRENE BRAMBILLA

Yale University

Software Patents: Economic Impacts and PolicyImplications. By Knut Blind, Jakob Edler, andMichael Friedewald. New Horizons inIntellectual Property. Cheltenham, U.K. andNorthampton, Mass.: Elgar, 2005. Pp. xi, 204.$95.00. ISBN 1–84542–488–3.

JEL 2006–1049

The Democratization of Invention: Patents andCopyrights in American Economic Development,1790–1920. By B. Zorina Khan. NBER Series onLong-term Factors in Economic Development.

Cambridge and New York: CambridgeUniversity Press, 2005. Pp. xvi, 322. $60.00.ISBN 0–521–81135–X. JEL 2006–1098I am not sure there is any sort of “iron law,”

but there does seem to be a correlation of somesort: the literature on the economics of patentsgrows in rough proportion to the number ofpatents actually issued around the world. (Theeconomic literature on copyrights is growing too,though it is too young at this point to saywhether the iron law applies.) So the two booksunder review here, for all their differences, rep-resent two data points on a much larger trendline. But they also stand for something more:they speak to some essential themes in this larg-er literature, in particular themes concerninghistory and comparative policy that are oftenmentioned in economic treatments of the patentsystem. Because these themes are so important,and because these two books sound them out sowell, I will keep them front and center in thisreview.

Many of the differences in perspectives offeredby these two books stem from the fact thatProfessor B. Zorina Khan is American, and thevolume by Knut Blind, Jakob Edler, and MichaelFriedewald hails from Germany. Khan is farmore optimistic about the overall effect of intel-lectual property protection on economic develop-ment; Blind, Edler, and Friedewald are decidedlycooler. While part of the disagreement isundoubtedly due to the fact that Blind, Edler,and Friedewald write only about the softwareindustry—an industry in which patents have beencontroversial for decades1—while Khan consid-ers the entire American economy in the nine-teenth century, I would argue that theirdifferences run deeper. They are partly the prod-uct of history, in my view. Khan’s book retells thecanonical American success story of the nine-teenth century,2 this time through the lens of one

1 See, e.g., Aerotel v. Telco, Ltd., EWCA Civ. 1371(Court of Appeal 2006) (Jacob, L. J.) (providing an excel-lent summary of legal cases in Europe since the 1970sdealing, mostly skeptically, with software patents).

2 Of course, the characteristic American belief in thepower and social utility if technology begins in the eigh-teenth century, as described so well by Lawrence A.Peskin (2003). Peskin emphasizes the rhetoric ofAmerican self-sufficiency, and the association of industrywith rural virtue and energy (Peskin 2003, 136–37).


legal field, intellectual property. Blind, Edler, andFriedewald tell a much more cautious story aboutthe potentially harmful effects of patents on thesoftware industry. In this the German authorsecho a long continental tradition of more cau-tious optimism about the economic effects ofpatents. Thus, for this reviewer at least, the com-parative policy aspects of the two books flow inpart from the different historical experienceswith intellectual property protection in theUnited States and continental Europe.

Khan: Democracy and Creativity during the“Long Nineteenth Century”

Before Professor Kahn’s book, economic histo-rians had mostly limited their discussions of intel-lectual property policy to specific incidents andsectors. The famous article by Fritz Machlup andEdith Penrose (1950) on the “patent controversy”in Europe in the nineteenth century is a goodexample; it summarized the rising tide of (mostlyanti-patent) opinion in the newly professionaliz-ing ranks of economists in nineteenth centuryEurope. Recent work by Johann Peter Murmann(2003) on the history of the European chemicalindustry is another good example. But, with theexception of several fine studies of British patentpolicy and the “first” industrial revolution,3 occa-sional references in the work of the new institu-tional economists, and various legal-centrichistories, little systematic work had been doneanalyzing the economic effects of intellectualproperty protection in any kind of long historicalperspective. Professor Khan’s considerableachievement has now changed all that.

Khan writes from a very distinct tradition, and itis important to keep this in mind in reading andevaluating her book. She is an American econom-ic historian trained at UCLA, and her backgroundshows through on virtually every page of the book.Her mentors and heroes include NaomiLamoreaux, Ken Sokoloff, and Harold Demsetzof UCLA and Joel Mokyr of Northwestern (p. xv).These are hardheaded economists who applytheir skills to history in various ways: scholarswhose work is permeated with quantitative dataand arguments drawn straight from the logic ofmicro- and institutional economics. Khan draws

from this tradition in evaluating the effectivenessof the American intellectual property system dur-ing the “long nineteenth century” (1790–1920).She moves easily from discussion of the incentiveeffects of legal rules to macro-level assessments ofthe system as a whole. In service of the latter, shemarshals a wealth of data, much of it new, andpainstakingly gathered, in support of her overallconclusions. The tight logic of the argument andthe force of the quantitative backing they receiveadd up to a very convincing set of conclusions.Both in the methodology employed and in theclean, graceful writing style, she has set the barvery high indeed for those who would follow inthe economic history of intellectual property.

So what are her basic conclusions? Three standout. First, intellectual property law in the UnitedStates had a definite and mostly positive impacton economic growth during the extended nine-teenth century. Second, this contrasts with thesituation in Europe, where intellectual propertyprotection was less effective and thus contributedto somewhat less robust growth there. And third,the greatest divergence in national policies cen-tered on the class of people who benefited fromintellectual property protection. This, her mostoriginal contribution, is captured in the booktitle: her thesis is that the more accessible, dem-ocratic character of the U.S. intellectual propertysystem is what set it apart from its Europeancounterparts, both in style and effectiveness. ForKhan, the U.S. system did a better job of releas-ing the inventive and creative energies of its citi-zens. And in her view, this provided a notableboost to the overall economic “take-off” processat work in nineteenth century America.4

A word of caution is in order regarding Khan’sapproach. She believes that the legal system dur-ing the formative years of the American Republicwas well-nigh perfect in its balancing of varioussocial and economic interests. It is not too muchto say that Khan is a rousing cheerleader for themajor figures in the drama she describes. Twoexamples: the founding generation (particularly

3 Henry I. Dutton (1984) and Christine MacLeod(1988).

4 It should be pointed out that while there are someindications that European economies struggled to adaptto industrialization, as described for example by MalcolmI. Thomis (1976), the same was true in the United States;and also, economic growth in Europe was quite healthyoverall during the period Kahn is interested in, asdescribed for example by David S. Landes (2003).



Book Reviews 453

James Madison); and Justice Joseph Story of theU.S. Supreme Court (whose early opinions inpatent cases set the tone for a positive, pro-inno-vation view of patents that remained a distinc-tively American voice until the late nineteenthcentury). Figures such as these inspire Khan’sgreat admiration: “The economic history of intel-lectual property laws and their enforcementleads to the inevitable conclusion that the feder-al judiciary and the U.S. legal system played acentral role in facilitating social and economicprogress during the nineteenth century. . . . [T]hejudiciary objectively weighed costs and benefits,and ultimately the decisions that prevailed pro-moted social welfare rather than the interests ofany single group” (p. 11). Now I am a big fan ofthe founders, and of Justice Story in particular.And I believe that much of the writing in legalacademia is far too skeptical and critical, inclinedstill to the view that law often provides a con-venient cover for the exercise of raw politicalpower by elites. Even so, Khan may go a bit toofar in her rosy assessment of the early days ofU.S. intellectual property policy. Detailed histo-ries of specific early inventions (the steamboatand the cotton gin, to name two) are enough tocall into question just how perfect the early sys-tem was. And even if the aspirations of the“founding giants” were sound and true, onemight admit that the analytical apparatus theybrought to bear on policy questions was quiterudimentary. Thus while I agree with the overalldrift of Khan’s argument—and while I see someutility in her rhetorical excess, as a needed anti-dote to the overly critical “conventional wisdom”among many legal academics—I cannot quiteagree with her tone all the way down the line.

Although the book title includes both patentsand copyrights, most of the substantive chapters(six out of eight, by my count) are concernedwith patent law. Though relatively brief, the cov-erage of copyright issues is notable in tworespects. The first is this: it represents some ofthe most in-depth coverage of the economic his-tory of copyright yet attempted (this field longhaving been a poor cousin to the analysis ofpatent- and invention-related issues by econo-mists and economic historians). Second, it is of apiece with the general tone of the patent chap-ters. The description of U.S. copyright law is soglowing it borders on the Pollyanish. Federalpolicy regarding copyright protection in the

United States was notoriously miserly in thenineteenth century—so much so that foreignauthors such as Charles Dickens complained bit-terly about it. The primary objection was that theUnited States failed to respect foreign copyrights,and as a consequence U.S. authors received noforeign copyrights for their works. In Khan’stelling, this was a rational (indeed, optimal) poli-cy: “[D]uring the period when the U.S. was itselfa developing country, it regarded widespreadcopyright ‘piracy’ of foreign materials as interna-tional fair use” (p. 225). Khan provides solidbacking for the widespread anecdotal evidencethat the U.S. publishing industry adapted to weakprotection by specializing in “pirated” editions offoreign books. (This chapter will be especiallyuseful for policy advocates who argue that U.S.trade negotiators are ignoring their own historywhen they berate developing countries for havingweak intellectual property systems.) As a conse-quence, the descriptive aspects of these chaptersare really quite a fine contribution.

But the normative conclusions are debatableon a number of grounds. Particularly question-able is Khan’s analysis of data on the number ofU.S. citizens who chose to make a living as anauthor (particularly of fiction, a type of writingwith an inherently more international potentialmarket, compared to nonfiction works, dominat-ed by fields such as geography and law, with ahighly local dimension). She uses her carefullyconstructed tables and regressions (again, amodel of painstaking historical/empirical schol-arship) to argue that the eventual accession ofthe United States to the international copyrightregime in 1891 did not result in a large increasein the number of U.S. citizens identifying them-selves as professional authors of fiction (p. 274).But a careful look at the evidence shows that theopposite inference is at least equally plausible.Khan argues that there was significant growth inthe number of authors and “professionalauthors” in the 1840–60 birth cohort of writers offiction books and that, because fiction authorsbegin their careers on average “in the[ir] earlythirties” (p. 274), this demonstrates that the 1891change in copyright law had little effect on thissegment of the market. But three stark factsstand out. First, the median year in the birthcohort under discussion is 1850, and the averageentry age for fiction authors is 34.8 years, call it35. So the median author from this cohort


entered the fiction field around 1885, during theperiod when publishers knew quite well thatinternational copyright protection was on thehorizon.5 (Since the number of authors wasgrowing throughout the period under study, themedian year when weighted by number ofentrants would occur even later.) Second, therewas noticeable growth in the ratio of “profes-sional authors” to all authors (which includespart-timers and professionals) in the first birthcohort to enter the field after the 1891 reform(those born in 1870–89): professionals grew from17.6 to 18.2 percent during this period. And third,in the midst of this mixed empirical story, thereare the voices of numerous actual authors andpublishers based in the United States—includingthe aforementioned Putnam, and Edgar AllenPoe (p. 272)—complaining bitterly about the lackof international copyright protection and its effecton their careers and work.6 Khan ignores thisevidence, citing instead modern theories abouthow an increase in piracy can indirectly stimu-late the market for “complementary works” suchas lecture tours—shades of the argument popu-lar today that online music filesharing is actual-ly good for the music industry. Many actualmusicians, echoing the complaints of Dickensand others from long ago, might well beg to dif-fer. At any rate, if her observations were correct,we would expect (in a world of rational profitmaximizers) that some subsequent authorswould have experimented with the “Dickensmodel,” by giving away their books to stimulatethe market for lectures and the like. If anyonedid, I have never heard of it. Maybe authors inthis period were just missing out on a goodthing. On the other hand, maybe not. MaybeJames Joyce, T. S. Eliot, and all the other post-1891 authors who assiduously sought and pro-tected their U.S. copyrights knew somethingabout the market for international copyrightedworks that modern scholars—for all their knowl-edge of network externalities and bandwagoneffects (Khan, p. 274)—have overlooked. It’s athought.

American versus European Views on Intellectual Property

This talk of international copyright mattersleads to the volume by Blind, Edler, andFriedewald on software patents. Here, just aswith nineteenth century copyrights, Europe andthe United States are quite at odds over animportant question of intellectual property poli-cy. Only this time, the roles are reversed: theUnited States aggressively permits softwarepatents, while in Europe they are harder toobtain, issued on a narrower class of inventions,and generally subject to more scrutiny and criti-cism. The reasons for this disparate treatment arequite interesting in their own right, although theBlind, Edler, and Friedewald volume does notreally touch on them. These authors instead takethis difference for granted. Their interest isstrictly with European software companies. So Iwill focus on that, only returning to comparativeissues in the conclusion.

The main points of the Blind, Edler, andFriedewald volume can be stated succinctly:companies that produce software in Europe“want neither an extension of patenting [from thelevel extant in Europe in 2001] nor an exclusionof software-based inventions from patenting” (p.3). The general consensus among the Europeanfirms surveyed was general skepticism about theextension of patent protection to “software perse” in the style of the United States. But withinthe broad consensus view, there are some inter-esting contrasts and countercurrents. I willdescribe them in the following paragraphs. Butfirst, I need to explore the makeup and timing ofthe Blind, Edler, and Friedewald data sample,because this has an important bearing on some ofthe divergent trends that emerge out of this mostuseful study.

Blind and coauthors were evidently impressedby the strength of anecdotal evidence about theresistance of European software companies to thestrengthening of software patents. Impressed, butfrustrated, I should say, for right at the outset theymention that their book was motivated by a desireto get some firm empirical backing for all theanecdotal information swirling around (p. 3). Thisimpelled them into a substantial empiricalresearch project: with the backing of a Germangovernment agency (the Federal Ministry forEconomics and Labor) they solicited internet

5 See the statement by U.S. publisher G. H. Putnam ina trade press article from 1879: “An international copy-right is the first step toward that long-awaited-for GreatAmerican Novel” (Quoted by Khan, p. 265).

6 For another recent book arguing persuasively that musiccomposers responded favorably to enhanced copyrightprotection, see Frederic M. Scherer (2004).



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questionnaire responses from 1,200 Germancompanies, eventually receiving 286 usableresponses (table, p. 40). Of these, 196 were fromsoftware companies proper, 67 were from manu-facturing companies that incorporate a substantialsoftware component into their products (the so-called “secondary sector”), and 23 were compa-nies located abroad. The authors supplementedthis broad-based empirical survey with 22detailed case studies, involving extensive inter-views and follow-up questioning (p. 3). This lastfeature is a most useful aspect of the study, as itallowed more in-depth exploration of the thinkingand strategy of the respondent firms.

Overall, as I said earlier, German companiesinvolved in the software industry seem quite con-tent with the “European equilibrium” regardingpatentability as it existed in 2001 (and still large-ly exists today). In the words of the authors, they“speak out most strongly for retaining the statusquo” (p. 88). This is not really surprising. Andalthough providing ample empirical backing for awidely shared, anecdotally based belief is animportant contribution, it would not in itselfmake the Blind, Edler, and Friedewald volumereally interesting. But underneath this consensusthere are some fascinating contrasts and counter-currents. These features, which have to be teasedout of the data and case studies, are what wouldlead me to recommend the volume to a friend orcolleague interested in the European softwarepatent controversy, or the economic aspects ofpatents in general. In particular, close attentionto the survey responses and interviews revealsthree very interesting themes: (1) more maturecompanies worry about patents less than smaller,younger ones; (2) companies vary significantly intheir ability to capitalize on the novel businessstrategies made possible with the advent ofpatents; and (3) the specific concerns of softwarecompanies provide a very useful guide to policy-makers called on to make micro-adjustments inthe patent regime as it applies to software.

Taken as a whole, these themes, lurking beneaththe surface of the Blind volume’s major findings,begin to fill out a more shaded view of the eco-nomic effects of patents, and thus contrast nicelywith the vision laid out by Professor Kahn in herbook, which seems by comparison more satisfyingtheoretically but factually more monochromatic.

The first of the three countercurrents in theBlind, Edler, and Friedewald volume concerns

company maturity. Put simply, software firms thathave been around longer are more accustomed tothe ways of patents, and consequently greetpatents with less concern. This is captured in atable in Blind’s book, which shows the age of theIP departments in the firms responding to thesurvey. The preponderance of pure softwarefirms (“primary” software companies) have veryyoung IP departments (1–5 years old in 2001),while fully half of the “secondary” software firmshave IP departments older than 20 years (table,p. 68). This carries over when the data are lookedat by company size: the secondary software firms(again, manufacturing companies that incorpo-rate software into their products) are in generallarger than the “primary” or dedicated softwarecompanies, and there are far more very smallfirms (1–19 employees) among the primary soft-ware companies (36 percent), as compared tosecondary software firms (19 percent) (table 3.2,p. 74). Age and size have a good deal to do withfirms’ attitudes toward and deployment ofpatents. As the authors say, “[a] positive correla-tion [can] . . . be drawn between the age, thecompany size (according to the number ofemployees) and the export activities on the onehand, and the propensity to patent on the otherhand” (p. 71); and “[t]he use of patents increaseswith increasing company size . . . ” (p. 75). Thiscorresponds with other facts presented in thebook, and with other information about the soft-ware industry: Younger and smaller firms are tra-ditionally more afraid of patents. Indeed, theyemploy “protective measures” of all kinds far lessthan larger firms (p. 76). The authors note toothat, although some companies report a fear thatpatents will impede the innovation dynamics ofthe software industry, “[t]his fear is significantlyweaker in the firms of the secondary sector,which have worked with patents for decades intheir areas of major activity” (p. 79). This is a cru-cial fact to keep in mind, because the largeempirical part of the Blind, Edler, andFriedewald study is a survey: it is based on ques-tions asking about the experience and opinions(including predictions) of the firms that respond-ed to the authors’ questionnaire. The point is thatcautious opinions regarding patents are to someextent a function of the age and composition offirms—of industry structure, in other words.

If there is anything to this point, it counselsagainst reading too much of a comparative angle


into the findings of Blind, Edler, and Friedewald.It would be easy, for example, to relate theEuropean caution regarding patents to some ofthe themes Kahn emphasizes in her book, includ-ing differing ideologies concerning patents andintellectual property in Europe versus the UnitedStates. Someone taking this tack might draw onKahn’s discussion of the more “democratic” fea-tures of the U.S. system to argue that an industrydominated by small companies might feel lesswelcome in the European patent system, giventhe orientation of that system to larger compa-nies. I think in the end there is something to besaid for this view. But one must be careful not tomake too much of it. For even in the UnitedStates, many smaller software companies contin-ue to be less enthusiastic about patents than thelarger firms in the industry. And also, software isperhaps the quintessential global industry. Hencethe views of software firms in Germany and theUnited States are probably far more affected bythe business they are in than the country they arein while engaging in that business.

Nevertheless, differences in national attitudescan probably bear some of the weight of explana-tion for the divergence in acceptance of patentsin the German and U.S. software industries.Assuming this to be true permits me to venturean assertion: the fears of the German industrymay well be overblown. I have studied the courseof software patents in the United States, wheresimilar fears were quite common during the earlydays of software patenting. It is safe to say thatthe dire predictions about the demise of theindustry at the hands of runaway patents have notcome true, and that the U.S. software industrycontinues on its robust growth trajectory well intothe “patent era” (Robert P. Merges 2006 andforthcoming). It is also safe to say that individualcompanies—large and small—have adapted rea-sonably well to the advent of patents, and indica-tions are that patents are being incorporatedeffectively into firm-level operations and strategy.Put simply, while there is no real proof that theyhave been outright good for the industry, theyhave certainly not killed it, and many softwarefirms have found some good uses for patents(Ronald J. Mann 2005).

Divergences in firm-level strategies representthe second countercurrent in the Blind book.Here we find a very interesting contrast withKahn’s book, which by its nature describes the

effects of patents at a much more “macro” oraggregate level. When firms were asked whatpurposes they thought patents could serve, theyresponded with a number of interesting answers.Many said that patents were fairly effective atprotecting the firm from imitation by competitors(3.5 effectiveness on average, out of 5 for primarysoftware firms, higher for the secondary firms);that patents could to some degree help increase acompany’s value (over 3 effectiveness on averageout of 5); and might improve access to capital (2.5out of 5). But—and here is where the case stud-ies really shine—the aggregate numbers masksome interesting differences in firm experienceand strategies. Some of the interview reports cre-ate the impression of lightbulbs going on in theminds of software company executives. One ofthe twenty-two companies interviewed, for exam-ple, reports that although it did not in the pastseek patents, “an important customer in the hard-ware field adopted the unprotected features ofthe [interviewed] firm in its own software pro-gram and integrated it into its whole system” (p.123). My own research shows that this is notunusual: patents can help when an erstwhile part-ner attempts to carve a firm out of the “valuechain” by copying its core technical assets(Merges 2005). And indeed, many (predominant-ly medium-sized) companies reported the hopethat software patents will “positively influencethe cooperation possibilities of their firm, in thatthe trade with more strongly coded propertyrights will reduce possible difficulties in collabo-rating with other firms” (p. 96). Another compa-ny, said to be a successful firm in the competitivefield of “automation, measurement, and controlengineering” (p. 122), deploys its patents both toprotect “market share” against its much largerrivals and “as an effective instrument to under-line clearly [its] technological leadership over itscompetitors” (p. 122). These interview fragmentsare of course not determinative. But they do sug-gest that some firms have figured out how to usepatents to distinguish themselves from competi-tors. Perhaps the company interviewed after itwas “burned” by its customer will become aleader in structuring technology transfer agree-ments around a core of patent assets. Perhaps theother firm will continue to rely on patents as abulwark against larger competitors. And if notthese particular firms, then perhaps others willdeploy patents creatively. The point is this:



Book Reviews 457

enough firms may adopt strategies of this sortthat it becomes a moot point whether patents inthe abstract will help or hurt the software indus-try. When patents appear on the scene, somefirms will figure out how to use them effectively.While this would not of course prove that patentsare good for the industry, it would help to showwhy it is risky to predict doom and gloom fromthe advent of patents, or from other regulatoryand legal shocks as well. Indeed, this kind ofadaptability makes it very difficult for social sci-entists to do their jobs at all. Entrepreneurs seemto adapt to their environment faster than we canstudy how the environment is changing and whatthose changes mean.

We have covered the first two countercurrents,national differences and firm-level strategy. Allthat remains is the third: suggestions about thepolicies that are appropriate in helping the soft-ware industry adapt to the advent of patents. Tobegin, it must be recalled that the firms in theBlind survey say they are content enough withlimited, moderate patent protection for software-related inventions. They do not advocate aboli-tion of patents on all aspects of software, nor dothey support more liberal claiming of software asin the United States (p. 88). I mentioned theseprimary findings of the Blind book at the outsetof this section. What interests me now is what liesbehind this desire to maintain what I have calledthe “European equilibrium” regarding softwarepatents. Or, to put it somewhat more provoca-tively, what is it that prevents European firmsfrom wholeheartedly embracing patents for allaspects of software? The Blind, Edler, andFriedewald volume, though not specificallydirected toward an answer to this question, pro-vides some very helpful guidance on this issue.And it is potentially influential guidance. Theseindustry-specific concerns could assist policy-makers to implement a patent regime that ismore responsive to the needs of the softwareindustry. The reasons why greater patent protec-tion is resisted, in other words, might be trans-muted, even in a world where software patentsbecome more common, into useful policiesdesigned to soften any negative impact patentsmight have on the industry.

Blind, Edler, and Friedewald uncover twooverriding problems with software patents thatcould be addressed through wise public policies.The first is low quality patents. The survey

response which lists “dynamic of innovationactivities” as one of the effects of patents comesup with a quite negative score in the empiricaldata (p. 98), meaning that many companies arequite worried that patents will negatively affecttheir research and development activities.Obviously, an emphasis on preventing weakpatents from issuing will help to address thisconcern. What usually worries software firms isthat too many patents will issue that cover toomany discrete features of software products.Restricting patents to truly meritorious inven-tions can go a long way toward addressing thisissue. Minor features, under a wise and effectivepatent regime, will seldom be patented.

The second problem is the feared effects ofpatents on interoperability. Many respondentsworry that patents will interfere with the abilityof different software components to interact andinterface with each other (p. 99). These are validconcerns, with far-reaching consequences. Notonly is it crucial for different software to interactat the functional level, but interoperability poli-cy can exert crucial influence on software indus-try structure. This is the great lesson of thelongstanding legal battles involving Microsoft.And of course, one motive that leads Europeanregulators to scrutinize this area quite carefullyis the belief that liberal interoperability policy isessential to the survival and health of theEuropean software industry, given that large for-eign (mostly U.S.) companies own and controlseveral essential “backbone” technologies in thesoftware industry (Windows and iPod/iTune, toname two prominent examples). What the Blindvolume makes crystal clear is that these concernsmust be addressed before European softwarefirms will be comfortable with a robust regime ofpatent protection in their industry. Fortunatelyfor them, many of the policies necessary toencourage effective interoperability are wellunderstood. What is needed is a sensitivity to theimportance of interoperability, which can beeffectuated through a number of discrete legaldoctrines and policies: rules relating to estoppeland implied licensing, injunctions, damages, andantitrust/misuse defenses. The important point isthis: these policies can be implemented regard-less of which aspects of software are patentable.They are ex post rules, which regulate not whichpatents issue but how those patents aredeployed. They are designed to guard against the


kinds of harm—such as the strategic blocking ofinteroperability—that industry members areafraid will be caused by the spread of softwarepatents.

Conclusion

There is no doubt that some of the fears ofthe software companies are realistic. And itmay be—though I myself have come to doubtit—that patents for software overall are a badidea. But for a number of reasons, patents will inall likelihood continue to creep into the softwareindustry, even in Europe where they are oftendespised. Blind, Edler, and Friedewald providehints about why this is so in their interview data;one company whose primary asset is innovativesoftware happens to operate in the automationengineering field. In the interviews, this compa-ny’s patents “belong in the area of measurementand control engineering, although the patentedprocesses are always realized in the form of soft-ware” (p. 122). This firm is not concerned aboutthe European rules, because “it can always for-mulate all [patent] claims in the language ofautomation technology,” even though for thisfirm “software of sufficient innovativeness andwith technical content is regarded equally as anengineering feat” (p. 122). In other words, undercurrent European rules, which resemble theregime in the United States in the 1980s andearly 1990s, this software firm can obtain patentsbecause all its software has a clear “hardwaredimension.” But another firm specializing in soft-ware that is in some sense further removed fromcomputer hardware has to either “characterize”its technology so as to qualify for patents, or pushever outward the boundaries of software protec-tion. In the United States, these “lines in thesand” have proven very hard to construct anddefend, at least on a consistent and principledbasis. Software is so evanescent, and can becoded, implemented, and described in so manydiverse ways that it is difficult to impose defensi-ble boundaries signifying that the software on“one side of the line” is patentable, while that on“the other side” is not.

So is there any hope that the fears expressed byrespondents to the Blind, Edler, and Friedewaldsurvey will be addressed? The answer is yes, andhere is where a return to that pragmatic and bal-anced spirit so admired by Professor Kahn in herbook could really save the day. The best we are

likely to have is a series of policies that mitigatethe deleterious effects of patents on the softwareindustry. Such policies will include (1) carefulpolicing of the quality of patents, with an eyetoward minimizing the deleterious effects of toomany patents of dubious merit; and (2) sensitivi-ty to the interoperability issues that are of suchimportance to the software industry.

Of course, in the end getting these issues rightis mostly an empirical question. But because ofthe difficulty of obtaining rock-solid empiricalevidence on the “big questions,” the best we cando is often a combination of tantalizing but notdefinitive empirical work, some case studies andhistorical/comparative research, and good old-fashioned theorizing from first principles. Fromthis point of view, we have a long way to go. Butthe volume under review makes a solid contribu-tion. It ought to encourage similar efforts, in theUnited States and elsewhere. Indeed, because ofthe relative lack of information in this area, wemight well call it a case of Blind, Edler, andFriedewald leading the blind. Or something tothat effect. . . .

While more data are being gathered, we woulddo well to remember the basic principles stressedby Kahn. Her faith in the abiding logic of proper-ty rights and markets, together with her interestin institutional detail, provides just the right per-spective on the vexing problem of softwarepatents examined by Blind, Edler, andFriedewald. A dose of that Kahnian optimismmight free the Europeans of their deep-seatedconcerns about software patents. In any event,her recounting of the success story of the U.S.economy over the “long nineteenth century”ought to reinvigorate our faith in the dynamismof economic growth. With patents or withoutthem, because of them or in spite of them, thesoftware industry is likely to face a bright future.Intellectual property policy might help, as Kahnargues it did in the United States. But it is notlikely to be decisive. For those of us interested inlegal policy, that is not only humbling; it is also ahuge relief.

REFERENCES

Dutton, Henry I. 1984. The Patent System andInventive Activity during the Industrial Revolution,1750–1852. Manchester: Manchester UniversityPress.

Landes, David S. 2003. The Unbound Prometheus:Technological Change and Industrial Development



Book Reviews 459

in Western Europe from 1750 to the Present, 2nd edi-tion. Cambridge: Cambridge University Press.

Machlup, Fritz, and Edith Penrose. 1950. “The PatentControversy in the Nineteenth Century.” Journal ofEconomic History, 10(1): 1–49.

MacLeod, Christine. 1988. Inventing the IndustrialRevolution: The English Patent System, 1660–1800.Cambridge; New York and Melbourne: CambridgeUniversity Press.

Mann, Ronald J. 2005. “Do Patents FacilitateFinancing in the Software Industry?” Texas LawReview, 83(3): 961–1004.

Merges, Robert P. 2005. “A Transactional View ofProperty Rights.” Berkeley Technology Law Journal,20(4): 1477–1510.

Merges, Robert P. 2006. “Patents, Entry and Growth inthe Software Industry.” http://ssrn.com/abstract=926204.

Merges, Robert P. Forthcoming. “Software and PatentScope: A Report from the Middle Innings.” TexasLaw Review.

Murmann, Johann Peter. 2003. Knowledge andCompetitive Advantage: The Coevolution of Firms,Technology, and National Institutions. CambridgeStudies in the Emergence of Global Enterprise.Cambridge; New York and Melbourne: CambridgeUniversity Press.

Peskin, Lawrence A. 2003. Manufacturing Revolution:The Intellectual Origins of Early American Industry.Studies in Early American Economy and Society.Baltimore and London: Johns Hopkins UniversityPress.

Scherer, Frederic M. 2004. Quarter Notes and BankNotes: The Economics of Music Composition in theEighteenth and Nineteenth Centuries. PrincetonEconomic History of the Western World series.Princeton and Oxford: Princeton University Press.

Thomis, Malcolm I. 1976. Responses to Industrialisa-tion: The British Experience 1780–1850. Hamden,Conn.: Archon Press.

ROBERT MERGES

University of California, Berkeley

Biography of a Subject: An Evolution of Develop-ment Economics. By Gerald M. Meier. Oxfordand New York: Oxford University Press, 2005.Pp. viii, 250. ISBN 0–19–517002–4, cloth;0–19–517003–2, pbk. JEL 2005–0747Gerald Meier is the James Boswell of “devel-

opment economics.” The last term is advisedlyput in quotes, for as I argued over two decadesago (Deepak Lal 1983) “development econom-ics” is different from the economics of develop-ing countries. The former is the attempt todevelop a “new” economics and denies the“mono-economics” claim of the latter that tradi-tional economics is applicable to developingcountries in the same way as it is to developedones (Albert O. Hirschman 1982). As Meier

notes “it was not until the 1950s that develop-ment economics emerged as a special subdisci-pline of economics” (p. 12). However, I haveargued that, by promoting the Dirigiste Dogma,it did great damage to the prospects of theworld’s poor. Meier’s collection of snippets of themajor writings on both “development econom-ics” and the economics of developing countriesin his various editions of Leading Issues inEconomic Development, charted and provided arunning commentary on these debates. Theywere of great value to both students and theirinstructors in the growing number of universitycourses on economic development. So onewould have hoped for a more even handedapproach if his new book were to be a roundedbiography of writings on economic development.But this turns out not to be so.

Till the end of the 1980s, Meier rightly notes,the “orthodox reaction” of mainstream economistshad won this battle with “development econom-ics.” The first half of Meier’s book charts thisfamiliar ground, which has been covered by manyothers and it is by and large uncontroversial,though I. M. D. Little (1982)—who he cites—andthe present reviewer, who he does not—arguablydid so more succinctly and analytically. This partof Meier’s book reminded me of the characteri-zation of the published record of two millenniaof Chinese history by William J. F. Jenner(1992): “that [it] rarely tells an outright lie butpasses on the views of earlier bureaucrats asmodified by later bureaucrats, and deals mainlywith matters of concern to the monarchy and toofficialdom” (p. 5). Substitute “developmenteconomist” for monarch and bureaucrat, and youhave a fair description of this part of the book.Meier’s self- appointed task of showing that hissubject—development economics—is alive, nec-essarily involves air brushing much of the cri-tique and contributions of the mainstreameconomics of developing countries from hisbiography. Perhaps that explains the strange sub-title of the book “An Evolution of DevelopmentEconomics.” Why “an” and not “the”? What arethe other evolutions of the subject?

It is in the second half of the book about whatMeier claims is “The New DevelopmentEconomics” that his judgment really goes awryand the purpose of this book becomes clear. Theheroes of this part are Joseph E. Stiglitz and DaniRodrik. Meier claims that the new development


economics is based on Stiglitz’s imperfect infor-mation paradigm, which is illustrated by analysesof share cropping and inter related factor markets.I am surprised to learn that this is “new” anddeparts from mainstream neo-classical economics.The earliest paper I know on these themes (andwhich also had empirical content) was by PranabK. Bardhan and Ashok Rudra (1978), whilstBardhan (1980) and Kaushik Basu (1983) providesurveys of this literature on rural organization.They show how many otherwise puzzling andseemingly inefficient institutions can be explainedas second best adaptations to an uncertain andimperfect environment. This was well before theso called “new development economics” emerged,according to Meier in the 1990’s, as a reactionagainst the orthodox neoclassical resurgence ofthe 1980s.

It is not any great new theoretical insights, butthe policy conclusions that Meier claims the “newdevelopment economics” draws from models ofimperfect information, “co-ordination failures,multiple equilibria, and poverty traps” (p. 119)which really excites him. He writes: “With imper-fect information and incomplete markets, theeconomy is constrained Pareto inefficient—thatis, a set of taxes and subsidies exists that can makeeveryone better off” (p. 120). This echoes a simi-lar claim made by Bruce C. Greenwald andStiglitz (1986). But they concede: “It might benoted that we ignore any discussion of the politi-cal processes by which the tax-subsidy schemesdescribed below might be effected. Critics mayclaim that as a result we have not really shownthat a Pareto improvement is actually possible”(note 7, p. 234). Whilst on their claim of the exis-tence of Pareto- improving government interven-tions, they conclude that: “we have consideredrelatively simple models, in which there is usual-ly a single distortion . . . though the basic qualita-tive proposition, that markets are constrainedPareto efficient, would obviously remain in amore general formulation, the simplicity of thepolicy prescriptions would disappear. Does thismake our analysis of little policy relevance? Thesame objection can, of course, be raised againststandard optimal tax theory. (Some critics mightsay, so much the worse for both)” (p. 258). Quite!

Meier commends Rodrik (1995) for emphasiz-ing “co-ordination failures” and in demonstrating“how the South Korean and Taiwanese govern-ments got interventions right” (p. 124). He claims

that this view and the Kevin M. Murphy, AndreiShleifer, and Robert W. Vishny (1989) modelingof the Big Push vindicates the old “developmenteconomics” of Nurkse and Rosenstein-Rodan.He supports Paul R. Krugman’s (1992) belief thatin its earlier incarnation it was not persuasivebecause its ideas were not formalized in mathe-matics. But as Stiglitz, (Krugman’s discussant),rightly noted: “That we can write down a modelof a phenomenon proves almost nothing. It doesnot make the idea right or wrong, important orunimportant.” As regards Rodrik’s views aboutsmart dirigisme in Korea and Taiwan, Little(1994) convincingly showed that social rates ofreturn to investment were inversely correlatedwith the degree of dirigisme.

This raises the question of one of the strangestomissions in Meier’s biography: a book whichexplicitly dealt with the question of whether theeconomic success of Korea and Taiwan wasbecause of, or despite, their dirigisme. Meierrightly notes the contributions of Hla Myint, par-ticularly on economic organization in the courseof development, but falls silent on the last bookMyint coauthored with the present reviewer (Laland Myint 1996). Its subject matter is relevant toMeier’s concerns. It dealt with economic historyand political economy (which Meier rightlyemphasizes have been neglected in “developmenteconomics”), provided explanations for the adop-tion of a Big Push by many countries and why itinevitably led to development disasters, as well asfor the indubitable dirigisme in Korea and Taiwan.Could the reason be that its policy conclusions didnot support the Dirigiste Dogma which both theold and new “development economics” seek topromote?

One of the abiding deficiencies of “develop-ment economics” has been its fascination withtheoretical curiosa, and the dirigiste policy con-clusions that can be drawn from them. A secondfailing is to ignore the heterogeneity of developingcountries. But, as the pioneering study by HollisChenery and Moises Syrquin (1975) showed, oneneeds to differentiate between countries in vari-ous dimensions. Thus, in the Lal–Myint (1996)study a classification based on relative factorendowments proved particularly fruitful inexplaining the different policies and outcomes inthe twenty-five developing countries studied.

Meier is right in stressing the growing recogni-tion of the importance of culture and institutions



Book Reviews 461

in economic development. But these are veryvague concepts which have become black boxesas explanations for differences in economic out-comes. The work of David Landes and VernonRuttan (cited by Meier) does not take us very farin understanding how culture effects economicperformance. Nor do the cross country regres-sions which have become so popular with theyoung. Meier rightly cites the critique made by T.N. Srinivasan and Jagdish Bhagwati (2001) of thisenterprise, which Robert M. Solow (1994) hasalso noted is not “a confidence inspiring project.It seems altogether too vulnerable to bias fromomitted variables, to reverse causation, and aboveall to the recurrent suspicion that the experiencesof very different national economies are not to beexplained as if they represented ‘points’ on somewell-defined surface” (p. 51 ).

I did make an attempt to sort out the role ofculture on economic performance in my Ohlinlectures (Lal 1998) by distinguishing betweentwo different types of beliefs constituting “cul-ture”: material, concerning ways of making a liv-ing, and cosmological concerning “how oneshould live.” I argued that, the former, which arethe main determinants of economic perform-ance, are malleable, whereas there is greater hys-terisis in the latter. This means that, even withpersisting differences in cosmological beliefs, dif-ferent “cultures” can adopt the material beliefswhich aid economic development, as Japan, andnow India and China have shown. This distinc-tion between cosmological and material beliefsalso translates into two types of transactions costswhich lie at the heart of institutions: one associat-ed with the efficiency of exchange in findingpotential trading partners and determining theirsupply–demand offers, the other with policingopportunistic behavior by economic agents. Across civilizational historical story can then betold of these changing material and cosmologicalbeliefs.

In fact the central question about the relativewealth of nations (rightly traced by Meier to theclassics) is still the grand theme of the study ofdevelopment. It centers around the GreatDivergence between the West and the Rest. Thisis where the work of economic historians (whichMeier rightly condemns development economistsfor neglecting) becomes crucial in understandinghow capitalism—the distinctive institution initiat-ing the Great Divergence—arose, and how it is

spreading or being thwarted in different countriesand regions of the world.

The mechanics of development are now wellknown—and Meier provides a fair summary inhis chapter on growth theory. There also seems tobe a fair degree of agreement amongst policymakers on the policy package known as the“Washington Consensus” (despite Meier’s cavilsechoing Stiglitz and Rodrik on this score) to pro-mote development. It is the imperfect spread ofcapitalism around the world which needs to beexplained. No coherent picture emerges of this“big story” from the work Meier cites in his lastchapters. The story of the globalization of capital-ism, and the impediments to its sway, becomesthe central unifying theme of the study of eco-nomic development. It is then a part of a study ofglobal economic history. (My own attempt is inLal 2006). This is very much what the classics,rightly regarded by Meier as the fathers of thisbroader and grander subject, would have donetoday, using some of the new theoretical toolswhich have been forged since they wrote, and thequantitative historical data that has now becomeavailable as a result of Angus Maddison’s (2001)Herculean labors.

But Meier omits many theories and constructswhich have been inspired by and are important inunderstanding the development process. Tomention just a few: the John R. Harris–Michael P.Todaro (1970) model of migration; the concept ofeffective protection (W. Max Corden 1966); EsterBoserup’s (1965) theory of agricultural evolution;Anne O. Krueger’s (1977) three factor open econ-omy growth model and its fomalization byEdward E. Leamer (1987); the analytics of theDutch Disease (Corden and J. Peter Neary1982); Evsey D. Domar’s (1976) model of a landabundant–labour scarce economy; Krueger’s(1974) model of rent-seeking (which Meier doesmention in passing); the political economy of tar-iffs (Ronald Findlay and Stanislaw Wellisz 1982;Wolfgang Mayer 1984; Lal 1989); the politicaleconomy of the predatory state (Findlay and JohnDouglas Wilson 1987; Lal 1984, 2005); and TimurKuran’s 1995 model of preference falsification.

The study of the economics of developing coun-tries has been a highly contested field. GeraldMeier has manfully tried to resurrect what manyof us on the other side believe is the dead corpseof a special “development economics.” I havebriefly set out my reasons for doubting that he has


succeeded. But in any contested field it is usefulto have the positions set out clearly. GeraldMeier does this for his first love—“developmenteconomics.” But readers of his book shouldremember that there is another side to this story.

REFERENCES

Bardhan, Pranab K. 1980. “Interlocking FactorMarkets and Agrarian Development: A Review ofIssues.” Oxford Economic Papers, 32(1): 82–98.

Bardhan, Pranab K., and Ashok Rudra. 1978.“Interlinkage of Land, Labour and Credit Relations:An Analysis of Village Survey Data in East India.”Economic and Political Weekly, 13: 367–84.

Basu, Kaushik. 1983. “The Emergence of Isolation andInterlinkage in Rural Markets.” Oxford EconomicPapers, 35(2): 262–80.

Boserup, Ester. 1965. The Conditions of AgriculturalGrowth. London: Allen and Unwin.

Chenery, Hollis, and Moises Syrquin. 1975. Patterns ofDevelopment, 1950–1970. New York and London:Oxford University Press.

Corden, W. Max. 1966. “The Structure of a TariffSystem and the Effective Protective Rate.” Journalof Political Economy, 74(3): 221–37.

Corden, W. Max, and J. Peter Neary. 1982. “BoomingSector and De-industrialisation in a Small OpenEconomy.” Economic Journal, 92(368): 825–48.

Domar, Evsey D. 1970. “The Causes of Slavery orSerfdom: A Hypothesis.” Journal of EconomicHistory, 30(1): 18–32.

Findlay, Ronald, and Stanislaw Wellisz. 1982.“Endogenous Tariffs, the Political Economy of TradeRestrictions, and Welfare.” In Import Competititionand Response, ed. J. N. Bhagwati. Chicago:University of Chicago Press.

Findlay, Ronald, and John Douglas Wilson. 1987. “ThePolitical Economy of Leviathan.” In Economic Policyin Theory and Practice, ed. A. Razin and E. Sadka.New York: St. Martin’s Press, 289–304.

Greenwald, Bruce C., and Joseph E. Stiglitz. 1986.“Externalities in Economies with ImperfectInformation and Incomplete Markets.” QuarterlyJournal of Economics, 101(2): 229–64.

Harris, John R., and Michael P. Todaro. 1970.“Migration, Unemployment & Development: A Two-Sector Analysis.” American Economic Review, 60(1):126–42.

Hirschman, Albert O. 1982. “The Rise and Decline ofDevelopment Economics.” In The Theory andExperience of Economic Development, ed. M.Gersovitz, C. F. Diaz-Alejandro, G. Ranis, and M. R.Rosenzweig. London: Allen and Unwin.

Jenner, William J. F. 1992. The Tyranny of History.London: Penguin.

Krueger, Anne O. 1974. “The Political Economy of theRent-Seeking Society.” American Economic Review,64(3): 291–303.

Krueger, Anne O. 1977. “Growth, Distortion, andPatterns of Trade among Many Countries.”Princeton Studies in International Finance, no. 40.

Krugman, Paul R. 1993. “Toward a Counter-Counterrevolution in Development Theory.” InProceedings of the World Bank Annual Conferenceon Development Economics, 1992: Supplement to theWorld Bank Economic Review and the World BankResearch Observer, ed. L. H. Summers and S. Shah.Washington, D.C.: World Bank, 15–38.

Kuran, Timur. 1995. Private Truths, Public Lies: TheSocial Consequences of Preference Falsification.Cambridge and London: Harvard University Press.

Lal, Deepak. 1984. “The Political Economy of thePredatory State.” World Bank DevelopmentResearch Department Discussion Paper, no. 105.

Lal, Deepak. 1989. “The Political Economy ofIndustrialisation in Primary Product ExportingEconomies: Some Cautionary Tales.” In The Balancebetween Industry and Agriculture in EconomicDevelopment: Proceedings of the Eighth WorldCongress of the International Economic Association,Delhi, India Volume 5 Factors Influencing Change,ed. N. Islam. New York: St. Martin’s Press in associ-ation with the International Economic Association,279–314.

Lal, Deepak. 1998. Unintended Consequences: TheImpact of Factor Endowments, Culture, and Politicson Long-Run Economic Performance. OhlinLectures, vol. 7. Cambridge and London: MIT Press.

Lal, Deepak. 2002. The Poverty of “DevelopmentEconomics.” Third Edition. London: Institute ofEconomic Affairs.

Lal, Deepak. 2005. The Hindu Equilibrium: India c.1500 B.C.–2000 A.D. Oxford, Oxford University Press.

Lal, Deepak. 2006. Reviving the Invisible Hand: TheCase for Classical Liberalism in the Twenty-FirstCentury. Princeton and Oxford: PrincetonUniversity Press.

Lal, Deepak, and Hla Myint. 1996. The PoliticalEconomy of Poverty, Equity, and Growth: AComparative Study. The Political Economy ofPoverty, Equity, and Growth series. Oxford and NewYork: Oxford University Press, Clarendon Press.

Leamer, Edward E. 1987. “Paths of Development inthe Three-Factor, N-Good General EquilibriumModel.” Journal of Political Economy, 95(5): 961–99.

Little, I. M. D. 1982. Economic Development. NewYork: Basic Books.

Little, I. M. D. 1994. “Trade and IndustrializationRevisited.” Iqbal Memorial Lecture, PakistanInstitute of Development Economics, Karachi.

Maddison, Angus. 2001. The World Economy: AMillennial Perspective. Paris: OECD.

Mayer, Wolfgang. 1984. “Endogenous TariffFormation.” American Economic Review, 74(5):970–85.

Murphy, Kevin M., Andrei Shleifer, and Robert W.Vishny. 1989. “Industrialization and the Big Push.”Journal of Political Economy, 97(5): 1003–26.

Rodrik, Dani. 1995. “Getting Interventions Right: HowSouth Korea and Taiwan Grew Rich.” EconomicPolicy: A European Forum, 20: 53–97.

Solow, Robert M. 1994. “Perspectives on GrowthTheory.” Journal of Economic Perspectives, 8(1):45–54.



Book Reviews 463

Srinivasan, T. N., and Jagdish Bhagwati. 2001.“Outward-Orientation and Development: AreRevisionists Right?” In Trade, Development andPolitical Economy: Essays in Honour of Anne O.Krueger, ed. D. Lal and R. H. Snape. Houndmills,U.K. and New York: Palgrave, 3–26.

DEEPAK LAL

University of California, Los Angeles

Patents: Economics, Policy and Measurement. ByFrederic M. Scherer. Cheltenham, U.K. andNorthampton, Mass.: Elgar, 2005. Pp. xvii, 310.$120.00. ISBN 1–84542–481–6.

JEL 2006–0726Professor F. M. Scherer has long been a promi-

nent figure in Industrial Organization, especiallyin the areas of patents and innovation generally.This book is a collection of eighteen of his papers,reprinted from various journals, books, andreports. The selected papers cover several areas:the role of patents in spurring innovation, sourcesof innovation, public policy regarding patents,and calculating the private and social returns toinnovative activity. Taken together, these papersmake accessible a wide range of patent-relatedeconomic and policy issues, going from ones ofbroad interest to any economist to very detailedquestions of interest mainly to specialists. To givea flavor of what the book contains, I will discussthe main themes that appear in them, rather thancover each paper separately.

The Sources and Effects of Innovation

Since his student days, Scherer has worked toisolate the importance of the patent system andgovernment policy relating to patents in spurringinnovation. While a student at Harvard BusinessSchool, Scherer and fellow MBA students workedon a class project to examine the effects on inno-vation of several recent antitrust settlements thathad required the forced cross licensing of largenumbers of patents on terms that involved mod-est or zero royalty payments. In particular, the set-tlements made by IBM and AT&T with theJustice Department involved thousands ofpatents. Scherer’s initial presumption was thatforced cross licensing would reduce the incentiveto innovate for the companies involved. Based ona number of company interviews undertaken byScherer and his fellow MBA students, the surpris-ing result was the opposite: the settlements wereprojected to have little effect on innovation. The

main reason turned out to be that the companiesinterviewed regarded innovation as a necessaryfunction required by competitive forces, and notsomething done for streams of royalty payments.The main effect of the forced cross licensingappeared to be that firms would protect theircompetitive advantages from innovation bypatenting a little less and relying more on secrecy.

This sort of result has been extended andstrengthened by a number of researchers in thelast twenty years or so. For example, Levin et al.(1987) elicited the views of corporate R&D man-agers concerning the relative effectiveness of sev-eral means of protecting the competitiveadvantages of their processes and products.Patenting was viewed as less effective that gain-ing a first-mover advantage, moving quickly downa learning curve or having a superior sales andservice force. This body of the literature has pret-ty consistently found that patents play an impor-tant role in maintaining competitive advantage,but that this role is not nearly as important asother factors.

Scherer notes that this result does not seem tobe true for the pharmaceutical industry. He citesthree reasons for this. First, for many pharma-ceutical products, the patent describes a mole-cule, which is the exact product resulting fromthe patent. Second, FDA requirements for get-ting approval involve long and costly clinical trialand analyses. Thirdly, the imitator need onlydemonstrate bio-equivalency to get FDAapproval, a much less demanding requirement.Given this fact, Scherer is concerned aboutpatent policy for gene sequences. Genesequences can make up the proteins or treat-ments that a patent may be used to produce; inthat sense, they are upstream from the pharma-ceutical product. Because they are upstream inthis particular sense, the possibility exists that aninnovation involving a gene sequence might havelittle value, but could make possible downstreaminnovations that have great commercial value.This gives rise to three issues. First, how do dif-ferent patent protection policies affect innovationat different stages of this sequential process?Second, how should rents from innovation beallocated between upstream and downstreampatent holders? Third, how should public policydeal with these problems of sequentiality?Scherer proposes several sensible schemes, butevents have overtaken his concerns. The


Intellectual Property Guidelines published bythe Justice Department address these issues,which are certainly not unique to the biotechindustry. Indeed, his suggestion that holders ofessential patents in a technology that requires allof them be encouraged by policy to form patentpools is spelled out in these guidelines.

Another important issue in this area concernsthe relationship between innovation and marketstructure. Schumpeter famously conjectured thatlarge firms facing little or no competition shouldbe especially innovative. His argument assumedthat the only effect of competition on innovationwas to dissipate the rewards to innovationthrough quick imitation. It did not take accountof what Scherer had noticed as a student: thatcompetition might force firms to innovate simplyfor survival. In a classic 1965 American EconomicReview paper, Scherer examined the empiricalrelationship between corporate patenting activityand concentration, and found little or no rela-tionship; certainly nothing to suggest that firms inhighly concentrated industries generated morepatents than other firms. The data and econo-metric techniques used by Scherer in this paperwere primitive by modern standards, but morerecent work, both by Scherer and by others, hasdone nothing to change this result in any impor-tant way. More recently, Scherer has examinedinterfirm and interindustry differences in thepropensity to patent, given R&D spending. Hefinds that there is no consistent pattern of returnsto scale in R&D spending, although the majorityof industries display constant or decreasingreturns. Holding R&D spending constant, he alsofinds that industry concentration does not seemto have a disproportionate effect on patentingactivity.

Inter-industry R&D Flows and the Return to R&D

Based partly on conversations with the lateJacob Schmookler, Scherer became interested ininterindustry flows of innovative effort. Scherercollected data on 15,112 patents issued to 443companies, issued between June 1976 and March1977. With a team of assistants, Scherer deter-mined the industry in which each patent originat-ed and the industry(ies) expected to benefit fromit. The information was then linked to R&Dspending data from the FTC’s 1974 line of busi-ness survey. This data set formed the basis for

three of the papers in the present volume. Thefirst result contained in them is that there arelarge spillover effects from one industry’s R&D toproductivity increases in other industries arelarge. In particular, it appears that nonmanufac-turing industries benefit greatly from inventionsmade in manufacturing, though the reverse is nottrue. The second result is that both the social andprivate returns to R&D appear to be high. A thirduse for this data set was to investigate the theoryof Schmookler-striking at the time—that inven-tive activity responded to economic forces and, inparticular, to demand forces. Scherer proceedsgenerally by relating patents in his data set, whichwere issued between June 1976 and March 1977,to industrial spending in 1974, taken from theFTC line of business survey. He finds a strong androbust relationship between capital spending andpatents, but not between material spending andinventions relevant to the use of materials. Finally,Scherer uses this data set to reinvestigate the rela-tionship between R&D spending. He also exam-ined whether patents per dollar of R&D variedaccording to industry concentration. Once again,he failed to find strong support for any version ofthe Schumpeterian hypothesis.

Public Policy toward Patents

Four of the articles in the book deal withpatent policy regarding pharmaceuticals in theso-called less developed countries (LDCs).Many LDCs consider pharmaceuticals to be soimportant to their national interests that intellec-tual property law does not extend to pharmaceu-ticals. Pharmaceutical companies in suchcountries often free ride on the innovativeefforts undertaken by companies located incountries where patent laws are strong. This pol-icy by LDCs has been attacked on the groundthat it removes much of the incentive to inno-vate, both for companies in advanced economiesand for local companies in LDCs.

The latter point is examined in a paper byScherer and Weisburst that describes an inter-esting natural experiment. Between 1939 and1977, Italy had no patent laws that coveredpharmaceuticals; in 1997, patent laws were heldto cover them. Itlay’s experience does not sup-port the notion that extending patent laws tocover pharmaceuticals will stimulate local inno-vation. Instead, many Italian companies wereacquired by multinationals, there has been no



Book Reviews 465

noticeable increase in either R&D spending ordrug innovations by Italian firms.

The “harmonization” of patent laws betweencountries came to a head in 1995 in the Trade-Related Aspects of Intellectual Property (TRIPS)treaty, which required that LDCs stiffen patentprotection for new drugs as a condition of joiningthe WTO. For countries such as India and Brazil,which had developed thriving generic drugindustries, this change raised the possibility thatgeneric prices of patented drugs might rise.Scherer and Watal investigate licensing and otherpolicies that are permissible under TRIPS andthat might result in relatively low pharmaceuticalprices in LDCs. In the main, they suggest thatinternational price discrimination by multination-als might result in higher prices in richeconomies and lower pricing in LDCs. They sup-port this by a rather unconvincing Ramsey pric-ing analysis. Whatever the shortcomings of thisanalysis, however, Scherer notes that, as of 2003,many AIDS-related drug prices to LDCs wereindeed cut drastically.

Patent Values and Stable Portfolios

Three of the papers in the book involve analy-ses of the distribution of patent values. Schererhas long pointed out that, by any rough meas-ure, patent values and, indeed, values of otherinnovation-related products such songs andrecord sales, have highly skewed distributions.The same is true of returns to lotteries and horseracing. In this setting, if the distribution isskewed enough, the law of large numbers mayfail to hold, in the sense that portfolios of suchitems may not have averages that converge tostable values. In the present book, Schererreports two efforts to carefully calculate the val-ues of patents in Germany and in the UnitedStates. His analysis takes account of the inter-esting feature of the German system that apatent holder must pay periodic renewal fees tokeep the patent in force. Scherer’s main goal isto estimate the distribution of such values and totry to distinguish between several distributionsthat are skewed, such as the Pareto and the log-normal. In general, he finds that the evidencefavors the lognormal, although there is a sugges-tion that for some cases a Pareto distributionwith a parameter value implying instability maybe appropriate. Because of this finding, Schererand his coauthors conclude that from 45 to 61

percent of the value of the total sample ofpatents comes from the top 5 percent; the vari-ation in results depends on excluding the high-est sample value. Due to the skewness, it iswrong to value the value of a company’s patentportfolio simply by counting patents. Also, dueto the highly skewed nature of patent values,neither businesses nor governments shouldengage in policies that involve picking a winner.Rather, they should hold contests between indi-vidual R&D projects, as venture capital firmstend to do, and not be dismayed by a high rateof project failure, unavoidable in a skewedreturn distribution.

All in all, the papers in the present book give avery good exposure to significant issues involvinginnovation. Both specialists in innovation andgeneral Industrial organization economists willfind much interesting material in this collection.

REFERENCES

Levin, Richard C., Alvin K. Klevorick, Richard R.Nelson, and Sidney G. Winter. 1987. “Appropriatingthe Returns from Industrial Research andDevelopment.” Brookings Papers on EconomicActivity, 3: 783–820.

DAVID SIBLEY

University of Texas at Austin

P Economic Systems

Reviving the Invisible Hand: The Case forClassical Liberalism in the Twenty-FirstCentury. By Deepak Lal. Princeton andOxford: Princeton University Press, 2006. Pp.xii, 320. $29.95. ISBN 978–0–691–12591–6.

JEL 2006–1498This book is a wide ranging and spirited defense

of classical liberalism as an organizing principle forthe economic affairs of the world. The first fourchapters are the heart of the book and deal withthe liberal international economic order. Chapter1 considers the liberal international economicorder of the nineteenth century—a period of rela-tively free trade in goods, along with substantiallabor and capital mobility between countries—andhow it ended in the interwar period. Chapter 2considers the transition “from laissez faire to thedirigiste dogma” in economic policy more broadly.Chapter 3 addresses the changing fortunes of freetrade in recent years. Chapter 4 examines themonetary regimes best suited to maintaining stable


money and the free flow of capital between coun-tries. Each of these chapters delve into a variety oftopics; for example, the chapter on free trade con-siders the “new” protectionism, preferential trad-ing arrangements, the WTO, the role ofadjustment assistance, and the question of global-ization backlash. In addition, each chapter containsa great deal of historical perspective and context.

Chapter 5 examines poverty and inequalityboth within and between nations and contendsthat economic growth, resulting from policiesthat embrace economic liberalism rather thandirigiste controls, have reduced both poverty andinequality. Relying on Surjit Bhalla’s work, andtaking issue with many of the statistical approach-es taken by the World Bank, Lal argues thatpoverty has been mitigated in India, China, andelsewhere and that income inequality acrosscountries has fallen as well. It is not a surprisethat the author, who also penned The Poverty ofDevelopment Economics, concludes that foreignaid is an idea whose time has passed.

Lal then shifts away from economic policyissues to consider some of the broader challengesfacing the liberal order. Chapter 6 takes up theissue of morality and capitalism, where he notesthat “previous chapters will not convince theWestern anti-globalizers” because of their“underlying belief in the immorality of capital-ism.” This chapter ranges widely, touching oncommunalism versus individualism in agrariansocieties, Hindu and Sinic civilizations, Victorianvirtues and the 1960s cultural revolution, andChristian doctrine, and winds up discussingfinancial repression in China and India.

Chapter 7 examines another form ofantiglobalizers—the “new dirigistes”—who arenot against globalization but are against capitalismitself. Among these groups is Amitai Etzioni’scommunitarian movement, which calls for a socialpaternalism to give capitalism a human face.Chapter 8 on the “Greens and Global Disorder”takes a skeptical view of nongovernmental organ-izations and civil society. The NGOs are dismissedas “the self-serving and the uninformed, withtheir own special—often ideological—agendas.”Indeed, their “left-wing agenda [seeks] to extendthe regulatory system of the U.S. New Deal tothe international arena.” Lal is critical of “eco-moralists” for their environmental scare tacticsand throws cold water on the whole notion ofsustainable development.

This book provides a nice blend of personalanecdote, literature review, economic argumenta-tion, and broad empirical evidence. One of theattractive features of the book is that the authordraws widely on past thinkers, from SaintAugustine of Hippo and Alexis de Tocqueville toJohn Maynard Keynes and John Stuart Mill, andshows their relevance to current debates. One dis-advantage of taking such a broad-minded approachis that the book sometimes seems to wander sowidely as to lose track of the specific theme in eachchapter. Still, each chapter has many striking andthought-provoking historical insights and the bookmoves along from topic to topic at a good pace andin a way that makes for pleasurable reading.

However, Lal’s book could have benefittedfrom a more systematic explanation of the mean-ing of classical liberalism, its basic principles, andits importance for today. The philosophy behindclassical liberalism is reviewed briefly on pages 48to 51, but much more could have been said. Lalalso could have improved the book by giving alonger explication of his opponent’s views andbeing more explicit about those who are express-ing such views today. Most chapters begin withjust a paragraph or two that states the antiglobal-izer view and then marches on to show why thatview is erroneous or misguided.

Most importantly, Reviving the Invisible Handdid not really give a sense for how the invisiblehand is to be revived. There is no specific agendafor the future, no specific blueprint for reform(unlike, say, Milton Friedman’s Capitalism andFreedom). The reader is left thinking that thenineteenth century order was a pretty good one,but whatever its merits that century is a differentplace than today. Lal is passionately skeptical ofthe leftist nostrums of the day, and there is oftengood reason for his skepticism. Unfortunately, hedoes not offer much of a positive vision except toreject the nonsense that he sees. One gets thesense that this book was not written to convincethose with whom he disagrees about their erro-neous beliefs (for perhaps they are unpersuad-able), but to provide reassurance and ammunitionfor those who already share his beliefs.

DOUGLAS IRWIN

Dartmouth College

The Bourgeois Virtues: Ethics for an Age ofCommerce. By Deirdre N. McCloskey. Chicagoand London: University of Chicago Press,



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2006. Pp. xviii, 616. $32.50. ISBN 0–226–55663–8. JEL 2006–1500What human motivations and social-cultural

conditions does capitalism depend upon? Formany economists the answer to this question isdeceptively simple: capitalism rests upon the self-interested activity of economic agents whorationally plan and strive to execute their planswithin a world of stable, well-enforced propertyrights and considerable individual freedom, atleast in the economic sphere.

A different tradition of thought argues that cap-italism rests upon a set of character traits andmoral virtues that motivate and guide individualsengaged in capitalist activities, without which thecapitalist system could not be sustained. Themost famous argument along these lines is MaxWeber’s. In his classic work, The Protestant Ethicand the Spirit of Capitalism, Weber argues thatmodern capitalism emerged through the “world-ly asceticism” of individuals adhering to the reli-gious principles of certain forms ofProtestantism. These individuals engaged in theirprofession or trade as a “calling” and were drivento work hard ceaselessly, never wasting money ortime, thus accumulating wealth, yet living frugal-ly, not consuming excessively, thus saving whatthey earned and reinvesting it in their business.They did this, not from economic motives, butrather to live in accordance with God’s Will,which according to their Protestant theologydemanded from men productive activity with nolapses and no squandering of resources or self-indulgence, demonstrating their worthiness to beamong the elect few who will be saved after thislife. It was these motives, Weber argues, not thedrive to make and spend money, which after allhas been a common element of human life andeconomic activity for millenia, that were crucialto the emergence of capitalism.1 Adam Smithalso recognized the importance of virtues. Hisfirst book, The Theory of Moral Sentiments, is

about the basis for moral conduct. Its sixth part isentitled “Of the CHARACTER of VIRTUE” andfocuses on the virtues of benevolence and self-command. Most modern scholars take the viewthat, while Smith championed the importance ofself-interest in the market and other social con-texts, he believed that this motive is set in abroader social context in which virtues are vitalelements in regulating behavior.

Virtues have a rich heritage in Westernthought. They are central in the classical philoso-phy of Socrates, Plato, and Aristotle; were vitalfor the Romans who were greatly concerned withcivic virtues; and were at the heart of middle agesChristianity. After a prolonger period of relativeneglect, in recent years there has been a resur-gence of interest in virtues in philosophy, sparkedespecially by Alasdair MacIntyre’s After Virtue.Meantime, virtues are also an established topic inpsychology, in positive and humanistic psycholo-gy, and among social and personality psycholo-gists. Virtues are alive and well in all these fields,recognized as normative guides to conduct thatare and should be important in guiding individualbehavior in many contexts.

To date, this rekindling of interest in virtues asessential elements in human character and con-duct has not reached economics. A few specificvirtues have been discussed in the economics lit-erature, such as benevolence or altruism. Theneoclassical model of rational choice in general isconsistent with the virtues of foresight and self-control (temperance). Virtues arise in specificeconomic contexts, such as the question of whatis proper conduct of an agent in relationship witha principal and in the view that the behavior ofindividuals who voluntarily pay their taxes is root-ed in virtues of honesty and civic-mindedness.But, speaking in broad terms, no general theoryof the virtues of capitalism or empirical literatureon virtues has developed in economics, and dis-cussion of virtues, as well as Weber’s thesis, exist

1 Weber discusses a number of distinctive features ofcapitalism. A second crucial one is the rational organizationof free, paid labor. He also is clear that capitalism no longerdepends on the Protestant religious values he describesbut rather emerged in part from them. Indeed Weberbegins his essay with quotations from Benjamin Franklinin which Franklin describes virtues that are quite similar to(and, Weber believes, rooted in) the values of worldlyasceticism Weber later describes as based in a particularbranch of Protestant theology, but which Franklin sets

forth for utilitarian purposes. More broadly, Weber studiedthe relationship between religious values and social sys-tems comparatively. In Ancient Judaism, he describes thecharacter and moral qualities of the prophet and theprophet’s role in the Jewish nation in the first millenniumb.c. In The Religions of India and The Religion of China,he describes the relationship between religious systems ofthought and attitudes and social, political, and economicsystems in these two civilizations.


relegated to the periphery of modern econom-ics.2 A focus on virtues, should it emerge, wouldconnect naturally with behavioral economics, forexample in the study of strategies for self-control.Virtues lie also in the intersection of economicsand culture, an area which, like the virtues them-selves, has remained relatively understudied andmay blossom in future.3

Deirdre N. McCloskey’s new book, TheBourgeois Virtues, is a clarion call for economiststo recognize the importance of virtues in capital-ist society and bring them into economic analysis.McCloskey brings together a wealth of materialfrom the Western tradition and modern philo-sophic currents of thought and links this, albeit inloose and not always convincing ways, with criti-cal commentary about neoclassical economics.The breadth of sources she draws upon is impres-sive, and many readers will find the way sheweaves together ideas and quotations fromdiverse sources interesting and valuable. Hernarrative is rather kaleidoscopic, however, oftenlinking one quote to the next without much inter-pretation, which makes the book frustrating inmany places, and the details don’t seem to cohereeasily into a tight structure of argument. Thus herwork has its greatest value in bringing the notionof virtues into the world of economics but stopsshort and leaves critical work ahead to integratevirtues into economic thinking.

Beyond arguing generally for the importance ofthe virtues, McCloskey has two more specificaims. One is to demonstrate that the fundamen-tal virtues in modern capitalist society are, in fact,the seven cardinal virtues that have been viewedas fundamental in Christianity and Western cul-ture for centuries. These seven cardinal virtuesare Faith, Hope, Love, Wisdom, Courage,Prudence, and Temperance. Her argument hereis thus largely opposed to Weber’s and inherentlyconservative, trying to claim for the seven cardi-nal virtues a place in the modern world equal to

what they historically had, thus that there is atight line of connection, in terms of virtues, fromearlier periods of Western civilization to our own,whereas Weber believed that there was a discon-tinuity in the rise of Protestantism and the devel-opment of modern capitalism. Her other aim is tocall to attention to the sterility of the standardeconomic description of human behavior—whatshe calls “Max U”—and start us on the road toflushing it out through incorporating virtues asdrivers of behavior. This idea interfaces in aninteresting way with behavioral economics andthe quest to develop richer models of humanconduct.

McCloskey’s desire to make both points makesher book sometimes confusing and, in the end, Ithink she is not fully successful with either, espe-cially the former. As determined as she is to forgean identity between the virtues of modern capital-ist life and the virtues of the classical andChristian tradition, and as interesting a thesis asthis is, it is problematic. Her polemics against cur-rent economic modeling of human nature oftenget lost in ire at the expense of providing clarityabout how to go about incorporating virtues intoeconomic models. Nonetheless her work isthought-provoking and in stretches fascinatingand will surely spark further debate.

It should be noted that this book is the first ofan ambitious planned four-volume set. An outlineof the succeeding three volumes is provided atthe end of this one and makes for interestingperusing. In succeeding volumes, it appearsMcCloskey will take up her two aims separately,and it is to be hoped a bit more systematically,and thus provide a more fully developed andgrounded argument for each.

In the remainder of this review, I describe someways of thinking about and defining virtues, dis-cuss and critique McCloskey’s focus on the sevencardinal virtues and present an alternative list ofvirtues, discuss the notion of a practice, and final-ly discuss psychological channels through whichvirtues act and how they might be modeled.

Defining Virtues

Aristotle defines virtues to be characteristicsthat can be voluntarily cultivated and which areenabling of man achieving his ultimate end oraims of life. For Aristotle, the ultimate end or aim(telos) involves living as a good citizen activelyengaged in the life of the polis, and attaining a

2 A search on the web of science database revealsapproximately eighty-five sources citing MacIntyre’s bookin 2005–06 and not one is an article in the field of eco-nomics. There are several cites in the fields of organiza-tional behavior and accounting in the area of ethics.

3 In contrast to the relative neglect of virtues, ethics,the study of what are good or proper rules of conduct, hashad a significant role in modern economics, for examplein the study of rules of fair division and principles forredistribution.



Book Reviews 469

state of happiness, which means both to havelived a good life in conformity with virtue and tolive in a state of well-being.4 Thus virtues areboth a means to a greater end but also essential toachieving that end—a man cannot be said to behappy in his life if he does not act virtuously,regardless of his success.

Aristotle emphasizes that virtues are the basisfor action and that a man is said to possess avirtue only when he acts in conformity with it. Itis not enough to learn about a virtue and believein it abstractly, one must act on it. He alsoemphasizes that to act virtuously is a volitionalact, that a man cannot be said to act virtuouslywhen he takes a virtuous action by accident orthrough innate predisposition, but only when heacts volitionally guided by a conception of virtue.5

We can contrast Aristotle’s position with themodern utilitarian tradition which economicthought by and large lies within. In the utilitarianview, a person’s overall happiness is evaluated ashis lifetime utility, perhaps incorporating somemeasure of the utility of others he cares about.According to utilitarian logic, a person shouldstrive to act virtuously to the extent doing soenables him to achieve greater ultimate utility.An individual should be honest, courageous, andgenerous because by acting that way he will max-imize his lifetime expected utility—and he shouldstrive to act according to these virtues only to theextent they help him achieve higher utility, forbeing honest or generous or courageous has nofurther benefit beyond its contribution to utility.A classic example is an economic agent actinghonestly because “honesty is the best policy” inthe long run.

The utilitarian view of the virtues is associatedwith Franklin and his precepts for good living.Franklin recounts in his Autobiography how hecame to form a list of thirteen virtues and statesthat his own “constant felicity” of life, includinghealth, wealth, and reputation, was due to strivingto live his life in accord with these virtues. Be vir-tuous, he believed and restated many times, andyou will have a happy, successful life.6 This utili-tarian view is probably the one shared by most ofthose among modern economists who believe thatagents behave virtuously. It also fits with the gen-eral approach of evolutionary psychology—theidea that cultures have evolved virtues as con-structs that help the members of society achievegreater ends, as well as the working hypothesis thatthere may be an evolved biologic predispositiontoward acting in accord with some virtues.

To develop this instrumental, utilitarian view ofvirtues further requires understanding whyadhering to a virtue and striving to act in a man-ner consistent with it is instrumentally beneficial,and building models to show how this processworks in economic and social systems.

One important step in addressing this issue isunderstanding how cultivating virtues and striv-ing to act according to them influences behavior,and modeling this process. There are in fact twodistinct psychological pathways through whichvirtues can influence our behavior. One is cogni-tive: virtues provide ideal models that guide us,that we strive to emulate. The other is motiva-tional: we want to act in accordance with virtues,

4 Aristotle, Nichomachean Ethics, translated withintroduction and notes by Martin Oswald (Indianapolis:Bobbs-Merrill, 1978), Books 1, 2, and 3. Aristotle para-phrases the common view, which his definition somewhatfollows, as (this is Mr. Oswald’s translation) “living well”and “doing well” (p. 6).

5 It is worth noting, though not essential to my discus-sion, that Aristotle focuses, famously, on virtues that rep-resent the mean between two extremes. For example,generosity or the correct attitude in regards money is themean between stinginess and extravagance, and courageis the mean between cowardice and excessive confidenceor recklessness. He recognizes that some actions areviewed as wrong and the corresponding virtue is not amean but an absolute prohibition, but does not focus onthese.

6 In fact, this is probably an oversimplification and mis-statement of Franklin’s own views, at least as a matureadult. Franklin believed in God, and believed that to bevirtuous was to follow God’s way. In describing how hecame to write his list of thirteen virtues and develop ascheme for living in accord with them, he writes that heconceived the project as a way to arrive at “moral perfec-tion.” “I wished to live without committing any fault at anytime,” he writes. This type of reasoning is not marginalist,involving being virtuous only to the degree that and situa-tions in which it is beneficial. Rather it involves a commit-ment to be virtuous for its own sake. In addition he statesthat in the notebook in which he traced his progress inacting in accord with the virtues he had this quote fromAddison’s Cato: “‘Here will I hold. If there’s a power aboveus // (And that there is all nature cries aloud // Thro’ all herworks), He must delight in virtue; // And that which hedelights in must be happy.’” Franklin (1963), p. 89–98,quote p. 94. This is utilitarian in some sense, but througha religious path of interpretation.


to feel that we are virtuous and act virtuously.The stories of virtuous behavior that are soimportant to cultivating virtues and transmittingthem culturally—courage transmitted throughstories of great heroism, exemplified say by JohnF. Kennedy’s Profiles in Courage, wisdom in thestory of Solomon—provide both ideal images ofvirtue in action and are highly motivating in pro-viding exemplars that one can associate oneselfwith by emulating the virtuous conduct depicted.To incorporate the logic through which virtuesinfluence behavior into economic models in aconvincing, well-grounded way requires incorpo-rating these psychological pathways into modelsdescribing human conduct, a more psychological-ly based approach than is manifest either in TheBourgeois Virtues or in traditional economicmodeling. I discuss this further in the last section.

The next step is to build models describing howvirtues are transmitted culturally, an issue I touchon below, and the last step is the construction ofmodels of the influence of virtuous conduct oneconomic and social outcomes. This last step isthe one that economics in its current form is mostwell-suited to, and indeed there are many specif-ic examples of analyses studying the impact of vir-tuous behavior, such as honesty—for example inmodels of reputation and models of compliance.7A more general framework, in which there areseveral virtues, each having its own sphere ofinfluence, in a larger general equilibrium envi-ronment, has not yet been developed, but, fol-lowing the logic of McCloskey’s work, can beenvisioned.

I note to conclude this section that there may beroom for Aristotle’s view that being virtuous itselfcontributes to happiness in the utilitarian view,through incorporating virtues into a utility func-tion. His stronger argument that being virtuous isnecessary for happiness could perhaps be cap-tured through a Leontief-style min utility functiondefined over a set of virtues and a bundle of allother goods: for example (this is just a sketch of an

idea), U = Min(v1;v2; :::vq;G(x1;x2; :::xn)).8 Herevirtuous conduct gives its own reward, which maybe (but does not have to be fully) separate fromother components of utility.

Virtues of Modern Capitalism

There are two main issues to address in consid-ering virtues in relation to modern capitalism:

(1) Do virtues have a significant role in capital-ism? This has two parts:(A) Are virtues crucial in underpinning

capitalism, in regulating the behavior ofindividuals in economic transactionsand capitalist enterprises?

(B) Is modern capitalist life conducive to theflourishing of virtues—does it encour-age or lead individuals to be virtuous?

(2) Given an affirmative answer to (1), whatspecific virtues are most important for mod-ern capitalist society?

McCloskey clearly believes that the answer to(1), both parts, is a resounding yes. The BourgeoisVirtues is peppered with examples in which eco-nomic agents act virtuously, or at least strive to,thus are guided by a conception of virtue. We readof Joe, who takes pride in being able to fix everypiece of equipment in his factory and relishes thechallenge of fixing a machine that isn’t working, isnot guided by any kind of marginalist maximumutility principle but by the virtue of doing his jobas well as possible (p. 470). We are treated to adescription of the Royal Palace on the DamSquare in Amsterdam, built in the Dutch GoldenAge of mercantilist capitalism, with its four statuesrepresenting the four pagan virtues of justice,prudence, temperance, and, substituting forcourage, vigilance (p. 290–92). We are told that,for the most part, “honesty is the best policy” rulesin the business world. For example, DonaldMacaulay’s findings presented in a 1963 paperabout firms doing business in Wisconsin are pre-sented as evidence that generally businessdepends on mutual trust, not narrowmindedlegalism (p. 129). We learn about the values of theDutch middle class—that the same word is usedin Dutch to connote both clean and beauty and7 In the classic reputation model of David M. Kreps

and Robert Wilson, there are two kinds of agent—honestand not inherently honest. Thus some agents act virtuous-ly. See Kreps and Wilson (1982), “Reputation and imper-fect information.” This model has had wide application.An example exploring the impact of honesty and socialoutcomes is my work with Brian Erard (1994), “Honestyand evasion in the tax compliance game.”

8 If a person derives utility from acting in accord witha bundle of virtues, the model can be expanded to defineutility over sets of virtues.



Book Reviews 471

that the Dutch take enormous pride in the clean-liness of their homes. To be sure, some coun-terexamples are provided, such as the ruthlessmentality of traders in the pit of the ChicagoMercantile Exchange (p. 29) and the excess greedof CEO’s.9 But these are treated as exceptionsthat prove the rule, and McCloskey’s view seemsto be that there will be unvirtuous behavior in allsystems and these cases hardly make capitalismless virtuous than other economic systems.

The idea that many economic agents behave ina trustful and trusting manner, take pride in theirwork, and exhibit a variety of other virtuousbehaviors is not news. Many economists areundoubtedly open to the possibility that this istrue, that virtues matter, even if they remain notfully convinced. McCloskey’s scattershot exam-ples on this point, while often interesting and edi-fying, don’t advance the discussion much, and shefalls well short of the kind of systematic empiricalinquiry that would be convincing to those whoare not already convinced. A more thoroughinvestigation should consider a broad range ofdifferent contexts of modern capitalism. Indeeddeveloping a taxonomy of contexts vis-à-visvirtues would be useful. For each context, the rel-evant virtues need to be identified, then anempirical investigation (and perhaps experimentsas well) conducted to investigate whether indi-viduals who participate in this business contextarticulate virtues for their roles and strive to actaccording to them.

Believing in the truth of (1) is consistent bothwith the Aristotelian view that it is intrinsicallyvaluable as well as important for achieving happi-ness in life to act in accord with the virtues andalso with the instrumental, utilitarian view thatacting virtuously is the surest, most direct way toachieve high lifetime utility. Many economistswho believe economic agents act virtuously prob-ably take the second view, believe that agents actvirtuously because it is in their own long-termself-interest to do so. McCloskey believes thateconomic agents strive to act virtuously not onlyfrom the viewpoint of their long-term success in

the capitalist world, but also so they can feel theyhave lived a virtuous life, thus follows Aristotleand a long tradition. She not only puts forth thisview directly, but it is also present in the religiousundertones in her book—she calls herself onewho has recently discovered (or rediscovered)Christianity. However her examples are not suf-ficiently carefully presented to clearly distin-guish between the Aristotelian and utilitarianpositions. Surprisingly, many of her examplesare fictional—drawn from the books of JaneAustin, Shakespeare, movies, contemporarynovels—thus we must believe are at least in partdidactic and meant to illustrate the importance ofliving virtuously. The examples of actual peopletend to be relatively brief vignettes without muchcontext, for which we cannot be sure a clever util-itarian can’t come up with a rationale for theapparently exemplary virtuous behavior that isdescribed. To make the point, McCloskey reallywants to make—that most people live virtuouslyfor its own sake—requires building a much morecareful and extensive empirical case, focusingespecially on cases in which the virtuous actionand narrowly self-interested action do not, as faras can be determined, coincide. Citing more ofthe scientific evidence on this, for example onaltruism, would strengthen her argument, but forthe more specific argument that economic agentsstrive to be virtuous in their roles in the economyI think far more needs to be done.

The more interesting aspect of (1) is (B), thepossibility that market activity is conducive to thedevelopment of virtues. McCloskey’s view here,which resonates with earlier ideas of Albert O.Hirschman and others writing at the intersectionof economics and sociology (and often history), isthat market activity supports civility and “smallacts of virtue every day” (p. 31), in contrast per-haps to grand heroic acts, which virtue theory issometimes too focused on. People who trade witheach other are less likely to go to war against eachother, more likely to respect each other. Engagingin economic activity engenders charity, trust,recognition of the other’s point-of-view, builds thesense of hope that goes with investing for thefuture, and helps develop many other positive,virtuous qualities.109 Indeed Chicago (not to mention the Chicago School

of economics) is given some tough treatment. McCloskeylauds the trusting environment of life in Iowa as comparedwith the more mercenary, less trusting economic world ofthe big city (pp. 130–32). This seems to run counter to hermain argument.

10 Hirschman (1982), “Rival Interpretations of MarketSociety: Civilizing, Destructive, or Feeble?”


McCloskey gives three main reasons why capi-talism is conducive to the flourishing of at leastmany virtues, if not all. One is a wealth effect:greater prosperity offers more opportunities formore people to have a more meaningful life.Poverty is definitely not a source of virtuousnessin McCloskey’s world, but rather makes peoplemean, money-grubbing, more pressured, thus lessable to develop fully and virtuously. Part of thewealth effect is the greater longevity that eco-nomic development brings, which offers a personmore time to develop himself or herself in multi-farious ways, which McCloskey believes generallyleads to the gaining of virtue. A second reasonwhy capitalism is virtuous is that it is linked to thebreaking of traditional social and cultural con-straints. The opening of markets is associated withthe weakening of strong, traditional ties that pinpeople to very specific roles that straitjacket them,for example working in the family trade and livingin a particular place. These forced requirementsstunt human development, therefore reduce vir-tuousness for McCloskey. In capitalist society,people are freer to construct their own ties, espe-cially the many weak ties that are constitutive ofso much of modern life, and construct their iden-tities for themselves. While in philosophy thereare different views about whether this is or is notconducive to human flourishing and virtuousbehavior, McCloskey is firmly of the view thatconstructing one’s own life makes one more ableand willing to pursue the development of virtue.The third reason why capitalism is virtuous thatMcCloskey offers is that day-to-day life in capital-ism is conducive to learning to treat others withrespect and fairly and, in general, to cultivation ofat least some virtues, such as prudence (good for-ward-looking decision making) and temperance(learning self-control in the face of all thosetempting choices) and at least some kinds ofbenevolence and a sense of fairness (in regardsbusiness transactions, wages, and prices). Thisargument hearkens back to 1(A)—one learnsthese virtues because it is through them that onecan succeed in the capitalist world.

These arguments are all interesting and in ageneral way they are all familiar. McCloskey’sspecial contribution is to link the general discus-sion with virtue. Her basic line of argument isthat greater opportunity, more freedom tochoose one’s life, more need to deal with a widerange of others, and the living of longer life of

lesser deprivation all lead people to becomemore virtuous. This is an interesting thesis butone that needs empirical evidence to support it,while McCloskey offers no more than scatteredanecdotes. Further, virtue needs to be opera-tionalized in some way in order to pursue thisline of inquiry. How can we tell how virtuous aperson is? Should we ask others who know him?Should we assess his virtuousness based on hisknown actions?

Also, there are surely downsides to capitalismfrom the viewpoint of the development of virtues,which need to be considered. What happens tothose who fail in the open, competitive, less role-encumbered world of capitalism, either becausethey do not have abilities that are rewarded in thecapitalist system, or fail in certain key virtues, forexample fail to be prudent or temperate or areunable to forge good working relationships? Itseems there is a need in capitalism, if the goal isto enhance virtue, for some mechanism in thesystem to provide for second chances and mercy,itself a virtue which may or may not be cultivatedby capitalism. And how virtues are cultivatedneeds to be spelled out.

The Seven Virtues and Other Virtue Lists

As interesting as this general discussion ofvirtues in capitalism is, much of the real meat ofThe Bourgeois Virtues concerns issue (2), thequestion of which specific virtues are fundamen-tal for modern capitalism. McCloskey has astrong opinion about which virtues are important.She believes that the seven cardinal virtues, atthe heart of Christianity and the classical Westerntradition, are the key virtues for capitalism, as forall human life, and should be the focus of analy-sis.11 This is an interesting thesis, and may wellbe original, and is worthy of consideration andfurther examination.12 As I noted at the outset, tothe extent virtues have been discussed at all ineconomics, it is generally piecemeal, with no realsystem in mind or larger framework to guide thediscussion in terms of nomenclature and what are

11 She writes that she seeks “to enfold” discussionabout virtues in modern life “into the seven virtues of theclassical and Christian world” (p. 65), and describes herproject as “finding how the classical virtues lie down oncapitalism” (p. 317).

12 One author McCloskey cites who has plowed somerelated fields is Michael Novak.



Book Reviews 473

the fundamental virtues to focus on. McCloskeyhas taken things to a new level, where systems ofvirtues can be set forth, explored empirically, andargued about.

McCloskey’s theoretical position in terms ofvirtues is rooted in Western culture and perhapsmost closely the thought of Thomas Aquinas.She quotes from Aquinas in defense of the sevenvirtues as foundational: “The cardinal virtues,”Aquinas notes, “are called more principal, notbecause they are more perfect than all the othervirtues, but because human life more principallyturns on them and the other virtues are based onthem.”13 “The seven virtues of the Western tra-dition . . . are ethical primary colors,” she claims,all other virtues are subsumed under them orcombinations of them. Her argument is not justthat these virtues are foundational, but also, fol-lowing a long tradition, that one is truly virtuouswhen one acts in accord with the full set or alarge subset of them, not any single one. Indeedacting in accord with one virtue and not the oth-ers is often akin to vice—for example beingcourageous but not prudent is foolish, and tem-perance and prudence without love can bemiserly. And her argument is not just about mak-ing manifest that the virtues are the bedrock ofmodern life but also about critiquing moderneconomic thought, which in her view rests on asingle virtue, prudence (“Max U”), and thus failsto capture the inherently multi-faceted nature ofhuman conduct.

McCloskey describes the seven virtues in 22consecutive chapters over 200 pages, providing arich tour of historical sources, contemporary dis-cussions, and diverse contexts in which the virtuesmatter. The seven are divided into the four classi-cal virtues: justice, courage, temperance, pru-dence; and the three Christian virtues: love, faith,and hope. McCloskey takes up each set in turn,beginning with the Christian virtues. Her sourcesrange from philosophy, feminist thought, andsociology to classical works, artists (Vincent vanGogh gets a chapter), novels, and movies (JerryMaguire and Shane get notice, among many oth-ers). No one can doubt her expertise in the fieldof economic history, and she evinces considerable

knowledge of feminist ethics. The Netherlandscomes in for special treatment, and there is dis-cussion of Japanese culture and society, thoughMcCloskey acknowledges she is not an expert inthis field.

Love is the virtue McCloskey discusses firstand in greatest detail, and the nature of herapproach and its limitations are well-exhibited byher discussion of this virtue. She begins her dis-cussion with this statement: “Love can bethought of as a commitment of the will to the truegood of another.” By love she means not the loveof desire but the love of genuine caring, concern,and appreciation for another. She means the loveof domesticity and good society, referring as anexample to the concept of love in Jane Austin—akind of ethical goodness that is central for beinga good person.14

A major peeve McCloskey has, here andthroughout the book, is the reduction of virtue toutility. In her view, love cannot be reduced to analtruistic term included in utility, the way forexample Gary Becker and many economistswould like to proceed. Doing this, she says, isinvalid because this definition makes love inher-ently self-interested, since one is obtaining utili-ty through loving another and thus through theother’s good fortune one obtains utility for one-self. In addition to not being, so she argues, whatwe mean by love, this violates a basic principle ofethics in making another person a means ratherthan an end in herself—think back to ImmanuelKant’s categorical imperative and Critique ofPractical Reason. Rather, as McCloskey developsit through citing the work of a string of philoso-phers, love is disinterested and is inherentlymanifested as a constraint on one’s will in such away that one respects the will and being ofanother; and love is an appreciation for anothershown as an attentiveness to the other simply forthe sheer love of that person, with no furthergood to be gained. These distinctions have merit.Yet, without disagreeing with the conceptualdefinitions McCloskey offers, I was not con-vinced that love thus defined cannot be repre-sented with a mathematical function that guides

13 Page 361 in The Bourgeois Virtues. Original fromThomas Aquinas, Disputed Questions, 1269–72, “TheCardinal Virtues,” Art. 1., p. 112, as cited in The BourgeoisVirtues.

14 In her religious worldview, this love is rooted in loveof God and comes from God (chapter 5 of The BourgeoisVirtues). She also notes that acting on love alone is notvirtuous—love must be combined with other virtues, likejustice and prudence, for true virtue.


a person in his decisions and actions, regardlessof whether or not we call it utility. Perhaps thefunction guiding decision making and actionneeds to have two parts, one utility and the othervirtue-based. These two parts may be separate ormore likely linked through the notion that rightconduct requires attending both to one’s ownneeds and those of others. If constraint is centralto love, then love should be incorporated as con-straints on will or actions. If appreciation andattention are central, these should be incorporat-ed, perhaps in models of limited attention. Thusthe discussion offers useful perspectives butleaves the door open for modeling love in a waythat can incorporate it into economic thought.

McCloskey’s second point is that the kind oflove she means—ethical caring, respect, andappreciation of the other—is central to the work-ings of economic systems of capitalism. Look atthe way individuals paired in business transac-tions trust each other, without any formal legalprotection, and sometimes with no long-termrelationship—think of the example of leaving atip in a restaurant in an exotic foreign countryone will never visit again. Consider the way thatcoworkers show genuine concern for one anoth-er, so important in sustaining the camaraderieand teamwork needed for an organization tofunction properly. Consider the not-for-profitworld and the commitment individuals make tohelping others as part of socially responsible busi-ness. These are all, in her view, actions rooted inlove, and the failure to recognize the importanceof love as integral in the fabric of modern eco-nomic life is a glaring deficiency in modern eco-nomic thought, one she traces in part to the malebias of the profession.

The point McCloskey is making is surely sensi-ble; and it is useful to push economists to broad-en and enrich their conceptual frameworks toexplore the relevance of love in economic life.Her work is helpful in sketching how to thinkabout the virtue of love and its potential roles ineconomic contexts.

Her approach has significant failings, however.Starting from the fixed list of seven traditionalvirtues creates a very rigid structure into whichall the variety of moral states and feelings rele-vant to modern economic life must be crammed.The result is a good deal of word-stretching and aloss of subtlety of description. The variety of feel-ings and behaviors grouped as all falling under

the single virtue love illustrates this. McCloskeybegins with love as in the ethical caring andmutual respect in a good marriage à la JaneAustin. She moves on to love of God, then to loveof parents for children. Only after all of this doesshe finally come round to the economic sphere,at which point she argues that this same principleof love that is the basis for a good marriage, loveof God and love of children is the basis for manybehaviors we see in the economy, such as thecomradeship of coworkers and treating cus-tomers as people and not just potential sales. Thisidentification of domestic and transcendent lovewith relationships in the business world seemsforced. None of these business relationships hasthe same intensity of commitment—which,McCloskey argues, recall, is basic to the defini-tion of love—as is typical between parent andchild or in the spiritual commitment to God. Thelevel of self-sacrifice, especially thought of asongoing and long-term, is just a lot lower in help-ing out a customer than in meeting the dailyneeds of children. Further, the feelings that areassociated with these different forms of relation-ship are different—love for my child is qualita-tively different than that associated withfriendship with a coworker—which for that mat-ter is different than the feeling associated with aclose personal friendship. One cannot help feelingthat, in equating these different forms of relation-ship, McCloskey has ended up in a position closerto what many traditional economists with their“Max U” models do than what many philosopherswhose ideas McCloskey has otherwise embracedfeel comfortable with.

Further, grouping all of these different kinds ofrelationships and caring for others under the sin-gle term love just to emphasize a rather rigid cul-tural continuity strikes me as counterproductive.McCloskey’s position seems to be the very con-servative one that, when it comes to virtues, theyhave already been mapped out, long ago, and weneed only follow the ancients. One of the pointsof Habits of the Heart, a book which comes in forsome criticism in McCloskey’s book, is that ourvocabulary for describing our personal values isdepleted, so that we are not very good at articu-lating the meaning we seek in life or our reasonsfor why we live the way we do, including thevirtues that are most important and we seek tocultivate. While such articulation may not be nec-essary—one of McCloskey’s points—it hardly



Book Reviews 475

seems useful to develop a theoretical frameworkthat is so limited in the number of distinctvirtues, but rather better to open up the vocabu-lary and give more choices—choice is good hereas in other realms of life. Why not recognize thatthere are certain virtues specific to economic life,indeed to modern capitalism, as Weber believed,such as (Weber did not pursue this line) the spe-cial sense of friendship and willingness to helpthat coworkers in an organization feel who sharecommon goals and office space, while also realiz-ing that their friendship is grounded in this set-ting and does not, in most cases, transcend it.And rather than calling this love, give it it’s ownterm, such as “working friendship and solidarity.”This particular quality is undoubtedly cultivatedthrough particular channels, like work experi-ences, that are distinct from those through whichdomestic love is cultivated, and it is surely possi-ble for an individual to be highly virtuous in histreatment of coworkers but not loving at home,or vice-versa. The advance of analysis hererequires making more distinctions, not fewer.

This same grouping and word-stretchingoccurs with much of McCloskey’s discussion ofthe other virtues. Is faith rooted in God and thebelief in ultimate salvation the same as the faithan entrepreneur has that he will launch a suc-cessful business? Here I think culturally we domore commonly use the same word for both, butperhaps that points more to an impoverishedvocabulary than to the idea that these are thesame personal qualities.15 As a considerable lit-erature in modern philosophy has discussed, jus-tice is a word used to describe a wide range ofdifferent decision rules and circumstances. Thusagain we should think carefully about whetherwe want to equate the commitment to fair deal-ing and quid pro quo in business with our viewabout what is just punishment for murder. Othervirtues work better. For example, I foundMcCloskey’s discussion of humility (Chapter 14;considered by her as part of temperance) and itsrelation to activities like listening to the cus-tomer quite persuasive—here a single moralquality seems common across a span of activities(but of course this may simply reflect my ownbias and a lack of careful empirical studies).

Likewise honesty may well be a fundamentalvirtue common across many activities. But a par-tial match is not sufficient: McCloskey states thather program is “finding how the classical virtueslie down on capitalism” (p. 317), that is the fullset of seven, and they don’t seem to lie down allthat neatly.

A different, more empirical approach would beto observe individuals closely at work (and play)in the capitalist system, see what virtues theyexhibit in their business behavior, and ask themwhat virtues they view as important for their worklife, that their business practices rest on and inturn cultivate. From this empirical base onecould develop a list of virtues, which could in turnbe subject to further scrutiny and testing.

Leaving this empirical approach for subse-quent research, what do other researchers andobservers have to say about the virtues impor-tant for capitalism? In the Introduction I havelisted some of the virtues Weber thought werecentral. His list is more focused thanMcCloskey’s, and clearly not encompassing.Modern psychology offers a quite rich menu ofalternatives that is definitely worthy of consid-eration, and which I hope McCloskey herselfwill consider more seriously as she continuesher research. The book Character Strengthsand Virtues: A Handbook and Classification,viewing virtues from the perspective of positivepsychology, is organized around this template ofvirtues:

Wisdom and Knowledge: creativity, curiosity,open-mindedness, love of learning, perspective.Courage: bravery, persistence, integrity, vitality.Humanity: love, kindness, social intelligence.Justice: citizenship, fairness, leadership.Temperance: forgiveness and mercy, humilityand modesty, prudence, self-regulation.Transcendence: appreciation of beauty andexcellence, gratitude, hope, humor, spirituality.16

One evident difference from the traditionalseven cardinal virtues is in the first category, the

15 Faith also has a psychological basis. Erik H. Eriksonroots it in the basic trust that develops in infancy—see hisChildhood and Society.

16 Christopher Peterson and Martin Seligman (2004),Character Strengths and Virtues: A Handbook andClassification. McCloskey discusses this book in chapter27, but the chapter is only six pages and seems an after-thought. In general, a stronger engagement with psychol-ogy would be helpful.

jun07_BookReviews 5/11/07 3:46 PM 5

cluster of creativity, curiosity, and open-minded-ness. These qualities seem especially importantin the context of discussing the virtues associatedwith capitalism, which is distinguished by itsextraordinarily dynamic nature—waves of newinnovations and enterprises that arise and over-whelm existing businesses and established prac-tices and technologies, with the continualopening of new markets and ceaseless expansion,penetrating into more and more realms of humanlife. The virtues that accompany this dynamisminclude openness to change, creativity, tolerancefor diversity, and flexibility, which is connected tothe notion of being able to take the perspective ofothers (also important for the negotiating that isso pervasive a part of business), the last term inthis category.

The last category, transcendence, is also onethat does not show up in the traditional sevenvirtues, though it can be argued it is part of loveand faith. In regards capitalism I think tran-scendence is most relevant in the notion of per-sonal development in a free society—theintrinsic value we place on an individual beingable freely to fashion his or her own life, tobecome a unique person—in other words, thevalue of individualism. Transcendent individu-alism is partly a heritage of Romanticism.McCloskey argues that Romanticism was large-ly anticapitalist and anti many of the values andvirtues she holds dear, but I believe that iswrong. Romanticism is in fact historicallylinked with the Enlightenment and the rise ofmodern society, and was crucial to the rise ofindividualism, which is a cornerstone of the freeenterprise system, especially in its Americanform.17

It is worth noting that not only have the moretraditional virtues that McCloskey focuses onbeen neglected in economic thought, which is thepoint of her book, but there is also a striking lackof tradition in terms of theorizing about creativi-ty and individualism in economics. I am engaged

in such an enterprise, which I believe involvesconstructing different, richer models of humannature and our conceptual worlds.18

Surely many other virtue lists could be pro-duced, each somewhat different and having someinteresting insight about modern life. But to gofurther and construct a list specifically focused oncapitalist enterprise would be a novel and worth-while endeavor.

The Notion of a Practice: A Context for Virtues

In After Virtue, MacIntyre emphasizes thatvirtues are defined in the context of practices. Apractice is a socially constituted activity that hasinternally defined standards of excellence thatindividuals engaged in the practice strive toachieve, and that is an ongoing, open-endedactivity that is continually being modified,improved, and extended. The key feature of apractice as MacIntyre defines it is that there aregoods internal to the practice, e.g., standards ofexcellence in performance, and at the same timeexternal goods like resources and fame areattached to the practice, accruing to individualsengaged in it, and thus impinge upon it. A niceexample is baseball: there are standards for whatis excellence in baseball, for example the way apitcher controls his pitches and sets up a specificpitch to strikeout a batter, and to be recognized asan excellent baseball player is to be recognized ashaving achieved excellence in regards these stan-dards. At the same time, external goods—fame

17 Some argue that Romanticism was one root of fas-cism and thus implicated in the atrocities committed bythe Nazis. The fact is that early capitalism had barbaric ele-ments within it, notably the plight of the urban poor—thefocus of so much of Charles Dickens’s writing, roots fromwhich sprang socialism and communism. Thus both ide-ologies are linked to social movements that had diresocial consequences; but both also are the root of ourmodern life.

18 Jonathan S. Feinstein (2006), The Nature of CreativeDevelopment, especially the Epilogue. Individualismseems to have been lost from the tradition, split off fromthe mathematical approach that became the hallmark ofeconomics from the late nineteenth century to neoclassicaleconomics. An example of this splitting is John Stuart Mill’swork—his essay On Liberty is one of the great statementsof personal freedom of individualism, yet in his Principlesof Political Economy he never mentions these principles;thus his thought seems split. One can detect the split in thework of Alfred Marshall as well. He is famous for hisPrinciples of Economics, which develops the abstract mar-ket model in which all individuality is suppressed; but theplanned second volume of this work, which was eventuallypublished as Industry and Trade has a long section on thechains of innovations made by specific individuals in keyindustries, showing his recognition of the importance ofindividual enterprise. In the Twentieth Century the splitshows in the divide between Friedrich A. Hayek’sapproach, exemplified in The Constitution of Liberty, andthe highly mathematical neoclassical school, which hasbeen dominant.



Book Reviews 477

and money—are clearly part of professional base-ball and impinge upon it. A virtue, in MacIntyre’sdefinition, is “an acquired human quality the pos-session and exercise of which tends to enable us toachieve those goods which are internal to prac-tices and the lack of which effectively prevents usfrom achieving any such goods.”19 One must actin accord with the virtues to achieve the goodsinternal to practices. Thus, it is not simply a ques-tion of success, for example winning the game,but rather how one plays also matters. If a pitch-er strikes out a batter to win a game by scuffingup the ball he has acted against the rules of base-ball and regardless of what external goods hethereby gains cannot be viewed as havingattained excellence in the playing of baseball.

It would be interesting to consider how thisconcept of virtues embedded in practices worksfor capitalist activities. A small literature hasdeveloped recently exploring this idea for organi-zational practices.20 Of course for capitalism the“external” goods are in a sense internal: makingmoney is in the spirit of capitalism. But for a hostof specific practices, including management &business leadership, manufacturing, and transac-tions (“the art of the deal”) there may well beinternal goods or standards for which specificvirtues are crucial.

Modeling Virtues

There are two basic behavioral processes thatneed to be modeled in order to incorporatevirtues into economic modeling. One is howvirtues are learned and internalized. AsMcCloskey discusses in her book, we learn virtuesmainly through stories in which individuals exhib-it specific virtues, like courage or love, to the high-est degree, thus are exemplars of thesevirtues—think of Jesus, Solomon, Martin LutherKing or, in the world of capitalism, Warren Buffet.Virtues are cultural constructs, and passed on inculture, like memes or broader concepts.21 Interms of modeling, in an overlapping generationsframework, individuals learn virtues through the

stories they hear describing virtuous behavior ofmembers of earlier generations. To the extent welearn virtues not just from a few famous exem-plars, but also from our parents and other adultmodels, the virtues and virtuousness of the previ-ous one or two generations may be an importantfactor in the development of virtue in the currentgeneration.

The other process, at the heart of any social sci-ence model of the virtues, is the process throughwhich individuals draw upon their sense of virtueand act virtuously: the behavior virtues lead to. Ifan individual has internalized a virtue and valuesacting virtuously, then a sensible model is that heevaluates each possible action or decision in agiven situation in terms of how close it comes tothe ideal behavior the virtue calls for. He thenweighs this distance as one factor in his decision,presumably together with other, more traditionalutility factors. When multiple virtues areinvolved, as is typically the case, he would evalu-ate the distance of each possibility from thesevirtues using a metric of some kind.

As simple and natural as this process seems,deeper issues are at stake. The procedure I haveoutlined is based on a cognitive model in whichindividuals evaluate the virtuousness of acts byreference to ideal points—for virtues are inher-ently ideals. Thus we must ask why this approachis preferred to simply evaluating each act in termsof its virtuousness without any ideal point servingas a benchmark. Indeed in economics, rooted, asMcCloskey points out often, in the single virtue ofprudence, which itself in its modern form at leastis viewed as tied to calculation of the benefits andcosts of various courses of action, ideals are reallynot the basis for decisions and actions. The opti-mal decision or action generally trades off differ-ent benefits and costs and is generally not anextreme or ideal point.22

Why then are virtues, inherently ideals, soimportant? It may be that we learn virtues best asideals, so that the use of the ideal is really rootedin the process of internalization. Alternatively, itmay be that cognitively having an ideal available is

19 MacIntyre (1984), pp. 181–91; the quote is on p. 191and is in italics in the original.

20 See, for example, Rosa Chun (2005) and the specialissue of Organization Studies (2006), Special Issue onOrganizational Virtue and Moral Agency in Organizations.

21 Susan Blackmore 1999; Jonathan Feinstein 2006,chapter 17.

22 A virtue is an absolute standard such that an individ-ual acting truly in accord with a virtue is not adjusting hisaction to equate some marginal benefit of action withmarginal cost. Rather, he is striving for purity of action, forthat is what it means to be virtuous. The philosopher whocomes to mind is Kierkegaard.


the best way to calibrate virtuousness. Followingthis logic, it is plausible that an important valuevirtues have in guiding behavior is rooted inbounded rationality. The virtuous course of actionin a given situation may be relatively simpler todetermine, assuming one possesses a well-inter-nalized, well-formed understanding of the rele-vant virtues, whereas trying to balance competinginterests may be too difficult. Thus it may be rel-atively easy to understand what is the honest orcourageous action, whereas figuring out the costsand benefits to all interested parties, includingoneself, so as to determine the action that maxi-mizes some sense of social welfare may be verydifficult. Similarly following a concretely definedprinciple of fairness in a particular circumstance,such as equal division, is likely to be simpler thantrying to weigh all potential costs and benefits,including those far in the future. Virtues areapplicable across a wide range of situations—forexample, in the world of business, standards ofgood conduct in business dealings apply across awide spectrum of business transactions and con-texts, thus cultivating virtues is an efficient wayfor an individual to prepare himself to act appro-priately in a diverse range of situations he mayconfront. Finally, another reason virtues as idealsmay be so important is that virtuous ideals areimportant not only in guiding individuals cogni-tively, but also in motivating them: inspired bythe ideal of virtue and the exemplars we know, weare motivated to behave virtuously. If this thirdpossibility is correct virtues influence behaviorthrough both cognitive and motivational path-ways, as I have discussed above in “DefiningVirtues,” and for this dual role virtues as idealsare an efficient, powerful construct.23 This last,motivational factor is clearly related to the issueof commitment. In a situation where it is hard tocommit to the right attitude or action having astrong sense of relevant virtues may help onecommit. Developing formal models based inthese ideas of how virtues influence individuals intheir behavior is a challenging and potentiallyquite important task to be undertaken.

These arguments have analogs at the sociallevel. Thus, just as virtues may be an efficient

model for an individual to try to follow, virtuesand stories of virtuous behavior seem to be a veryefficient way to transmit information about social-ly appropriate behaviors in a wide range of situa-tions. In particular, it is impossible in transmittingculture to imagine or teach individuals about allpossible situations they may find themselves in.Virtues are a powerful social-psychological con-struct that can guide and motivate individualsacross a wide range of situations to act in a social-ly beneficial manner, thus may be culturally veryadaptive.

Conclusion

The Bourgeois Virtues is a significant contribu-tion to the study of the moral basis of economiclife and thought. McCloskey has woven manysources and a number of traditions together toprovide the beginnings of an argument and dis-cussion of the role of virtues in economic life.Her approach intersects with, but also chal-lenges, ongoing streams of research in the areasof behavioral economics and social, cultural, andinstitutional economics, and her vision is origi-nal. Both empirical and theoretical work will beneeded to develop her thesis, evaluate its impor-tance, and shape it to fit the contours of moderncapitalist life.

I have argued that focusing on the classicalseven virtues is possibly not the best way to pro-ceed in bringing virtues into economics, ratherthat a more tailored set of virtues should bedeveloped, rooted in careful empirical research. Ihave sketched a few approaches for modelingvirtues in ways that may fit with economicmethodology, but I am confident that if theoreti-cally oriented researchers take up the challenge anumber of approaches may be explored anddeveloped.

Virtues have truly been neglected, and the fur-ther development of this topic can only enrichand improve economics. Virtues should be recog-nized as important constructs for individualbehavior and brought into economic models ofindividual behavior. They are also important ascultural constructs, and exploring their role inmodern economic life and economic modelingcan contribute towards the development of aninterface between economics and cultural stud-ies, important for many fields of economics,including economic development and culturalchange.

23 These different possibilities are of course not mutu-ally exclusive—all three may factor into the way virtuesinfluence behavior.



Book Reviews 479

REFERENCES

Aristotle. 1962. Nichomachean Ethics. Indianapolis:Bobbs–Merrill Educational Publishing, The LiberalArts Press.

Bellah, Robert N., Richard Madsen, William N.Sullivan, Ann Swidler, and Steven M. Tipton. 1985.Habits of the Heart: Individualism and Commitmentin American Life. Berkeley: University of CaliforniaPress.

Blackmore, Susan. 1999. The Meme Machine. Oxford:Oxford University Press.

Chun, Rosa. 2005. “Ethical Character and Virtue ofOrganizations: An Empirical Assessment andStrategic Implications.” Journal of Business Ethics,57(3): 269–84.

Erard, Brian, and Jonathan S. Feinstein. 1994.“Honesty and Evasion in the Tax ComplianceGame.” RAND Journal of Economics, 25(1): 1–19.

Erikson, Erik H. 1950. Childhood and Society. NewYork: W. W. Norton.

Feinstein, Jonathan S. 2006. The Nature of CreativeDevelopment. Stanford: Stanford University Press,Stanford Business Books.

Franklin, Benjamin. 1963. The Autobiography andOther Writings. New York: Dodd, Mead andCompany.

Hayek, Friedrich A. 1960. The Constitution of Liberty.Chicago: University of Chicago Press.

Hirschman, Albert O. 1982. “Rival Interpretations ofMarket Society: Civilizing, Destructive, or Feeble?”Journal of Economic Literature, 20(4): 1463–84.

Kant, Immanuel. 1989. Critique of Practical Reason.New York: MacMillan Publishing.

Kennedy, John F. 1956. Profiles in Courage. New York:Harper.

Kreps, David M., and Robert Wilson. 1982.“Reputation and Imperfect Information.” Journal ofEconomic Theory, 27(2): 253–79.

MacIntyre, Alasdair. 1984. After Virtue: A Study inMoral Theory. Second edition. Notre Dame:University of Notre Dame Press.

Marshall, Alfred. 1919. Industry and Trade; A Study ofIndustrial Technique and Business Organization;and of Their Influences on the Condition of VariousClasses and Nations. London: MacMillan.

Marshall, Alfred. 1961. Principles of Economics.London and New York: MacMillan

McCloskey, Deirdre N. 2006. The Bourgeois Virtues:Ethics for an Age of Commerce. Chicago andLondon: University of Chicago Press.

Mill, John Stuart. 1978. On Liberty. Indianapolis:Hackett Publishing.

Mill, John Stuart. 1987. Principles of PoliticalEconomy, with Some of Their Applications to SocialPhilosophy. Reprint of 1909 London edition Editedwith an introduction by Sir William Ashley. Reprintsof Economics Classics series. Fairfield, N.J.: Kelley.

Nielsen, Richard P., ed. 2006. “Special Issue on ‘InSearch of Organizational Virtue: Moral Agency inOrganizations.’” Organization Studies, 27(3).

Peterson, Christopher, and Martin Seligman. 2004.Character Strengths and Virtures: A Handbook andClassification. New York: Oxford University Press.

Smith, Adam. 1982. The Theory of Moral Sentiments.Indianapolis: Liberty Press.

Weber, Max. 1958. The Protestant Ethic and the Spiritof Capitalism. New York: Charles Scribner’s Sons.

Weber, Max. 1967. Ancient Judaism. New York: FreePress.

Weber, Max. 1968. The Religion of China. New York:Free Press.

Weber, Max. 1992. The Religion of India. New Delhi:Munshiram Manoharlal Publishers.

JONATHAN S. FEINSTEIN

Yale University

R Urban, Rural, and RegionalEconomics

Entrepreneurship, Geography, and AmericanEconomic Growth. By Zoltan J. Acs andCatherine Armington. Cambridge and NewYork: Cambridge University Press, 2006. Pp.xii, 250. $70.00. ISBN 978–0–521–84322–5.

JEL 2006–1534This stimulating book analyzes the interplay

between entrepreneurship, innovation, and eco-nomic growth in the United States of America.The starting premise is that innovation is thedriving force of growth in the “knowledge econo-my.” The book draws on insights from theories ofendogenous growth and economic geography topropose a unified conceptual framework thatplaces entrepreneurship center stage in theprocess of innovation and growth. Empirical evi-dence on entrepreneurship and employmentgrowth is presented using an impressive dataseton more than 14 million establishments thatexisted at some time between 1989 through 2001across 394 Labor Market Areas (LMAs) of theUnited States.

While there are now large theoretical literatureson economic geography, innovation, and growth,there are few formal models of entrepreneurshipand little is known about its underlying determi-nants. Indeed, in most economic models entrepre-neurship is firmly encased within the familiar blackbox. The authors are therefore to be applauded fortheir theoretical and empirical contributions in thisarea, but a thorough understanding of the micro-economics of entrepreneurship remains some wayoff. A central challenge in understanding entre-preneurship is identifying the right institutionaland regulatory framework toward entry andemployment. Progress in this direction is startingto be made by innovative recent empirical work on


entry barriers and labor regulation using detailedinformation on actual policy measures (see, in par-ticular, Timothy Besley and Robin Burgess 2004;Juan C. Botero et al. 2004; Simeon Djankov et al.2002; and Thomas J. Holmes 1998).

In their empirical work, the authors consider arestrictive definition of entrepreneurship as newfirm formation. While this is undoubtedly animportant facet of entrepreneurship, concentrat-ing exclusively on new firm formation sits awk-wardly with recent empirical evidence on theimportance of reallocation within firms. Forexample, Andrew B. Bernard, Stephen J.Redding, and Peter K. Schott (2006) find that onethird of the net increase in real U.S. manufactur-ing output between 1972 and 1997 is due to thenet adding and dropping of products by survivingfirms, a contribution that dwarfs that of net firmentry and exit. Clearly new firm formation is onlyone dimension of innovation and existing firmsaccount for a large share of total research anddevelopment (R&D) in many industries such asPharmaceuticals. As the authors themselves dis-cuss, the spin-off of existing operations and theacquisition of independent start-ups are nowimportant dimensions of new process and productdevelopment.

The delineation of the causal connectionsbetween entrepreneurship, innovation andgrowth raises formidable identification challengesthat face any study in this area. For example,employment growth across LMAs is strongly pos-itively correlated with firm formation, but thisdoes not necessarily imply that entrepreneurshipcauses growth. There may be third factors thatcause employment growth and firm formation tocovary, and it is hard to find instruments thataffect firm formation but have no independenteffect on employment growth. The interpretationof the correlation between employment growthand firm formation relates to old debates in eco-nomic geography about whether workers followfirms, firms follow workers, or there are mutuallyreinforcing feedbacks between firms’ and work-ers’ locations decisions. It is noticeable that manyof the high rates of firm formation in the map onthe book’s cover are observed in the West andSoutheast of the United States, consistent with ageneral reorientation of economic activity towardthese regions. Since many areas within theseregions enjoy favorable climates, as emphasized inJordan Rappaport (forthcoming), it is at least pos-

sible that the differences in firm formation arepartly endogenous to a relocation of populationthat is occurring for other reasons.

In the final chapter of the book, the authors dis-cuss the foundations of entrepreneurial policy anddistinguish four broad actors: (a) individual agentswho identify business opportunities and choose toexploit them, (b) newly formed businesses whichinnovate using new knowledge and otherresources, (c) the economy including all institu-tions that influence economic growth, and (d)society as the collection of all agents who are theultimate beneficiaries of wealth creation. Withinthis organizing framework, several policy instru-ments are proposed to promote entrepreneurship.While several interesting suggestions are made,the market failures that rationalize interventionare not always clear, nor is the way in which thesemarket failures could be quantified. In contrast tosome of the specific policy instruments consid-ered, the most important dimension of public pol-icy may well be the regulatory framework thatshapes the overall business climate.

One of the most interesting theses in the bookis the claim that the success of American capital-ism can be understood in terms of a nexusbetween the creation of wealth (entrepreneur-ship) and the reconstitution of wealth (philan-thropy). Philanthropy is viewed as beingimportant because it creates new opportunitiesfor future generations of entrepreneurs, which iscrucial because new firm formation is so closelyidentified with entrepreneurship. But philan-thropy is surely only one of several factors thatare important in enabling new profit opportuni-ties to be exploited and wealth to be created. Theinstitutional environment including the protec-tion of property rights, the legal system, entrybarriers and labor regulation all surely have rolesto play. The quantification of these factors, bothwithin and across countries, is one of the mostexciting contributions of the growing literatureon the new institutional economics.

Taken together, this book is the source for awealth of ideas and empirical facts that will beof great interest to researchers concerned witheconomic growth and spatial inequality in eco-nomic development. In emphasizing entrepre-neurship, the authors are drawing attention to awoefully neglected area of theoretical andempirical economics and pointing the way toseveral interesting areas for further research.



Book Reviews 481

REFERENCES

Bernard, Andrew B., Stephen J. Redding, and Peter K.Schott. 2006. “Multi-product Firms and ProductSwitching.” NBER Working Papers, no. 12293.

Besley, Timothy, and Robin Burgess. 2004. “Can LaborRegulation Hinder Economic Performance?Evidence from India.” Quarterly Journal ofEconomics, 119(1): 91–134.

Botero, Juan C., Simeon Djankov, Rafael La Porta,Florencio Lopez-de-Silanes, and Andrei Shleifer.2004. “The Regulation of Labor.” Quarterly Journalof Economics, 119(4): 1339–82.

Djankov, Simeon, Rafael La Porta, Florencio Lopez-de-Silanes, and Andrei Shleifer. 2002. “TheRegulation of Entry.” Quarterly Journal ofEconomics, 117(1): 1–37.

Holmes, Thomas J. 1998. “The Effect of State Policieson the Location of Manufacturing: Evidence fromState Borders.” Journal of Political Economy, 106(4):667–705.

Rappaport, Jordan. Forthcoming. “Moving to NiceWeather.” Regional Science and Urban Economics.

STEPHEN REDDING

London School of Economics

Z Other Special Topics

The Economy of Prestige: Prizes, Awards, and theCirculation of Cultural Value. By James F.English. Cambridge and London: HarvardUniversity Press, 2005. Pp. xii, 409. $29.95.ISBN 0–674–01884–2. JEL 2006–0403In 1993, the British sculptor Rachel Whiteread

won the $20,000 Turner Prize, often referred to asthe “Booker Prize for artists.” This accomplishmentmight have only been noticed in very select circleshad it not been for the fact that on the same day sheaccepted, albeit reluctantly, the K FoundationPrize for Worst British Artist, which took the formof L= 40,000 nailed to a gilt-framed board that wouldbe publicly burned if rejected. Given that so muchof the Turner Prize’s legitimacy was derived fromthe monetary value of the prize, the sarcastic KFoundation Prize could not be ignored, and themedia attention associated with simultaneouslybeing named the most and least worthy artist inBritain caused her work to be much more widelynoticed than it would otherwise have been.

In this fascinating book, James F. English,Professor of English at the University ofPennsylvania, deftly paints a portrait of the currentstate of play in the “economy of cultural value.”While describing the history of cultural prizes,he offers a compelling explanation for the eco-nomic forces that have led to their extraordinary

proliferation over the last several decades—thecircumstances that could result in a controversialartist receiving more recognition for winning aprestigious high-purse prize because she wassimultaneously humiliated by another.

English notes that, while royal families haveawarded cultural prizes for centuries, the modernglobal cultural prize emerged at the end of thenineteenth century, most notably with the found-ing of the festival now known as the VeniceBiennale in 1895. It is no accident that this coin-cided with Alfred Nobel’s will establishing theNobel Prizes and the first modern internationalOlympics in 1896. Instead, it marked the formal-ization of a notion of the arts as internationalsport, in which the cultural accomplishments ofsome societies could be pitted directly againstthose of others. And the competition, of course,was not just on the “playing field.” Just as citiescompeted to host the Olympic Games as a way ofcementing their relative global prestige, so toodid cities (and benefactors) clamor to establishcultural awards and competitions.

But while sporting competitions (the emer-gence of international football also occurred at vir-tually the same time) have well-defined rules andrelatively observable outcomes, cultural competi-tions are by their very nature subjective, and thework of determining the most meritorious artistsand writers falls into the hands of judges, each ofwhom may have their own agendas and none ofwhom are particularly well-compensated for thetask. (Of course, as any overworked reviewer canattest, these circumstances are not limited to thearts and literature.) And like all other subjectivedecisions, the awarding of these prizes invites con-troversy. The very first award in 1901 of the NobelPrize in Literature, to Sully Prudhomme over, forinstance, Leo Tolstoy, sparked immediate contro-versy, and was exacerbated by the SwedishAcademy’s subsequent omission of Tolstoy in eachof the nine other years in which he was alive—amove potentially intended to thumb its nose at itscritics. Tolstoy is not alone: The list of otherauthors of works of eminent, enduring value(e.g., Hardy, Ibsen, Joyce, Kafka, Proust, andRilke) who were later snubbed the Nobel Prize isstaggering, and Tolstoy’s omission shows that thecontroversy over the prize’s legitimacy wasalready firmly ensconced at the prize’s inception.

English argues that these glaring omissions areactually a necessary component of the cultural


prize—that contempt for the awards system itselfis founded on a belief that culture cannot be com-modified. “This threat of scandal,” according toEnglish, “is constitutive of the cultural prize.”Historically, indeed, some of the most distin-guished would-be recipients of cultural prizesrefused to accept them. Jean-Paul Sartre, whoassiduously refused all awards offered to him, evenfamously rejected the Nobel Prize for Literaturein 1964. Sartre recognized that the value to him, interms of the perceived importance of his work, ofrefusing the Nobel Prize far outstripped the ben-efits that would accompany accepting the prize.The Swedish Academy also recognized this,English intimates, and knew that to proffer a prizeto an awardee who had previously publicly refusedall other prizes would be “in effect a Trojan horse.”

English suggests that the rules of the gameappear to be changing, and points to ThomasPynchon’s near-simultaneous acceptance of aNational Book Award while snubbing theAmerican Academy of Arts and Letters as a piv-otal moment. By 1989, Pynchon was more thanhappy to accept a MacArthur “Genius” Grant.And around the same time, after she had beenpassed over for several prestigious prizes, ToniMorrison’s supporters openly and actively lobbiedfor her to win the Pulitzer Prize, which she did,for “Beloved.” Shortly thereafter she won theNobel Prize as well. English suggests that bybreaking with the customary public disdain forprizes, Morrison’s supporters may actually havehelped to usher in the demise of their importance.

The rapid expansion in the number of prizesand awards has placed considerable burden onorganizations and individuals. The number ofsubmissions for any given prize award is suchthat it is nearly impossible for judges to devoteenough time to give all submissions sufficientattention to make a decision—if they even seemany of the submissions at all. One conse-quence of the massive proliferation of prizes is,ironically, the concentration of awards. Englishprovides numerous examples of how the majorcultural awards frequently arrive at the same win-ner. Hence, Steven Spielberg has won 90 awards,as compared with 21 by Alfred Hitchcock, and“Lord of the Rings: Return of the King” won (atleast) 79 awards, compared with 3 for“Casablanca.” Frank Gehry’s total at the time of

writing was over 130, while Michael Jackson’sexceeded 240. The awardees of MacArthur“Genius” grants, intended to provide start-upcapital for talented rising stars, tend to be someof the most established (and best-funded) artists,writers, and scholars in the business.

Meanwhile, as the monetary value of the actualprize award is trivial compared with the costsassociated with administering, awarding and mar-keting the prize (even for the very large pursesthat command instant respect), the “endowment”of prizes by individuals imposes significant exter-nalities on the organizations “gifted” with prizeadministration—and, of course, the individualsresponsible for making this work. Even the NobelPrize’s endowment imposed these externalities:The Swedish Academy’s raison d’etre was “todefend the purity, vigor, and majesty of theSwedish language.” But the Nobel did more thanjust increase the Academy’s workload. In accept-ing responsibility for the Nobel Prize, theAcademy “transform[ed] its cultural place andpurpose, overriding the intentions of its illustriousfounder, King Gustav III, with those of the mid-dle-class engineer and munitions manufacturerAlfred Nobel.”

The Economy of Prestige deftly describes therationale for the cultural prize and the importantrole of controversy in providing currency for themarket of cultural production. Missing, however,from the analysis is some sense of a counterfactu-al: What would have happened in markets of ideasthat possessed different circumstances? Are theresituations that English would suggest to lead to agreater proliferation of prizes, or a greater or less-er degree either of controversy or of concentrationof awards? Awards in the arts and literature areparticularly susceptible to being co-opted for polit-ical agendas; does this facilitate or counteract thephenomena that English describes? And whatabout disciplines whose work output is more easilyquantifiable—or commodifiable? Such an enter-prise would geometrically increase English’s task,but it would provide greater insight into the condi-tions under which award expansions, seeminglycounterintuitive behaviors, and “winner-take-all”markets would emerge and flourish.

DAVID FIGLIO

University of Florida and National Bureau of Economic Research



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