The Region

Book Reviews

Edward Lotterman | Agricultural Economist

Published June 1, 1994  | June 1994 issue

The Misunderstood Economy:
What Counts and How to Count It

By Peter G. Peterson
Simon & Schuster
412 pages

Facing Up: How to Rescue the Economy from
Crushing Debt and Restore the American Dream

By Robert Eisner
Harvard Business School Press
222 pages

A quick multiple-choice test for Region readers:

The U.S. national debt is:

  1. crushing the nation's economy and impoverishing our children
  2. in great part a figment of our inadequate national accounting procedures and nothing to lose sleep over
  3. both of the above
  4. none of the above

The best way to invigorate the U.S. economy is to:

  1. cut entitlements, wasteful subsidies and other spending
  2. increase spending on infrastructure and on help to the needy, financed by monetary expansion
  3. both of the above
  4. none of the above

If you chose answers "a" above you share Peter Peterson's views—and you would do well to read Robert Eisner's The Misunderstood Economy to discover some possible flaws in your thinking. If you chose "b" your thinking follows the lines of Eisner—and you should probably read Peterson's Facing Up. If you chose "c" or "d" you might want to read both.

It is rare to find two books, published within a few months of each other, that so starkly juxtapose alternative views on the economy as do these volumes. Both have flaws, but both contribute significantly to the level of public discussion about economic policy in the country today.

Peter G. Peterson argues that the United States is in big trouble and that major changes are needed or disaster will occur. For him, national economic problems of sagging productivity growth and chronic budget deficits are symptoms of a larger malaise in US society. We have become soft and self-indulgent. Consumption and the desire for immediate gratification have replaced saving and prudence. Unwilling to make hard choices, we and our elected representatives end up not making any choices at all. Policy is largely determined by gridlock. Political and social inertia propels the economy down the slippery slope of declining investment and slow growth into a swamp of stagnant living standards and declining power relative to other nations.

CEO of Bell and Howell, Secretary of Commerce in the Nixon administration and CEO of Lehman Brothers prior to founding The Blackstone Group, a New York investment bank, Peterson is by his own definition a "Republican fat cat." But regardless of his party affiliation, he is harshly critical of the way the economy was mismanaged during the Reagan and Bush administrations.

And there is plenty of blame to go around. Peterson also expresses disappointment at President Clinton's failure to seize the anti-deficit initiative more boldly following his inauguration. And he is sometimes scathing in his denunciation of Democrats who, in his view, gave away the store in the 1960s and 1970s.

According to Peterson, we need to cut back on entitlements, reduce our expectations of health care, tax gasoline more heavily, reform tort litigation, redefine national security, cut discretionary spending and restructure our tax system to discourage consumption and foster savings. The alternative is economic disaster for our children or grandchildren.

Robert Eisner, in contrast, believes that most of the public debate about budget deficits and the national debt is simply dithering, resulting from muddled thinking. Deficits and national debt are poorly measured, ill-defined and widely misunderstood. Politicians, journalists and other economists who warn of dire results to come simply do not understand many of the issues they are exercised about, and even if they do, they apparently slept through Logic 101 when they were college freshmen.

Eisner, past president of the American Economics Association and holder of an endowed chair in Economics at Northwestern University (William R. Kenan Professor of Economics), discusses how we measure economic welfare and what we mean by savings and investment. Nearly everywhere he finds his intellectual opponents committing fallacies of composition, that is, they confuse what is true for an individual or household with what is true for a national economy. Individuals borrow from without, from some entity outside the household structure. Nations largely borrow from within, that is, "We owe the debt to ourselves." Debts of individuals must be repaid, if only at death. A nation can roll debts forward as long as someone is willing to buy its bonds, and no one suggests that US Treasury securities are losing their cachet as a safe investment. If one family increases its savings, it will have more in the future. But if everyone attempts to save more, consumption may drop, some people's incomes will decline due to slack business conditions, and total national savings and investment may not change one iota.

This last scenario, of course, is classic Keynesianism, and Eisner would probably not be insulted to be called the last of the red-hot Keynesians. In his closing chapters, he proposes policy measures-new and expanded spending on infrastructure, job training, subsidies for hiring the unemployed, higher taxes on income and capital gains, much looser monetary policies by the Fed-that will give academic critics of Keynesians and popular critics of "tax and spend liberals" plenty of reason to holler "I told you so." Through all this is an almost explicit cry of "the deficit be damned."

What is the reader to make of all this? Are deficits bad or good? Is the national debt a threat or a negligible accounting entry? As a young agricultural economist in Peru, I soon learned that to find out what was going on, I had to read at least two daily newspapers. El Comercio covered events from the viewpoint of the conservative oligarchic establishment. El Diario de Marka viewed the same scene from the radical left. Reality, one soon learned, lay somewhere in between.

The same is true of these two books. Eisner is right; there is a lot of muddled thinking about deficits, debts and inter-generational transfers. People do confuse the real economy with the monetary one. Fallacies of composition are the stock in trade of journalists and politicians. There are several areas in which Eisner, in concise and readable prose, quickly sheds needed logic and light. I am sure that many macro principles instructors will crib illustrations from The Misunderstood Economy to spice up their own lectures.

But on a broader level, few mainstream economists or policymakers will endorse Eisner's policy agenda. Many of his arguments about the national debt were commonly made in principles of economics texts 20 years ago. But the effective quadrupling of the debt since that time has made them less rather than more relevant. And few people would dare to bet their own investment portfolios on his claim that Fed policies toward looser short-term interest rates would reassure financial markets that long-term rates would stay low.

Peterson errs by playing the Cassandra role a bit too strongly. The budget deficit may pose serious problems, but the rhetoric of "rescuing the economy from crushing debt" is overdone to the point of counter productivity. And he hauls out every cliche except the distance he had to trudge through snow to school when he contrasts the profligacy of the current generation with the frugality of that of his parents. Peterson does fall into some of the fallacy of composition traps that Eisner details, and at times flip flops between the real and monetary economies without realizing what he is doing.

But in terms of policy prescriptions, most well-informed readers will probably be more convinced by Peterson than by Eisner. After the somewhat overblown rhetoric about the dangers of the deficit, Facing Up ends with 24 specific policy suggestions from "keep cutting defense" to "index capital gains." The majority of these suggestions would be endorsed by most economists, regardless of political party or school of thought to which they adhere.

Somewhat surprisingly, Bob Eisner would probably do so too. In spite of the stark differences between the two books in terms of analysis of budget deficits and national debt, the two authors are not far apart on at least some practical policies.

I could not recommend either of these books as the final word on current economic issues. But anyone who reads both of them—carefully and with a large grain of salt—will certainly gain deeper insights into the economic and political choices faced by our society today.