This Just Might Be The Dream Team Of Economics

With the addition of Stanford University economist Joseph E. Stiglitz to the Council of Economic Advisers, the White House has a team that could revolutionize not just economic policy but also the economics profession. When Laura D'Andrea Tyson was named to chair the council, there was a great deal of carping by the profession's old boys. Tyson, they said, was not sufficiently mainstream and lacked the distinction to attract eminent economists to serve with her. On both counts, that initial reaction could not have been more wrong.

Trained at Massachusetts Institute of Technology, Tyson is a PhD economist in good standing. But she is attractively unorthodox in two key respects. First, she studies economic phenomena by seeing how industries and companies actually work, not by building algebraic models of how they ought to work. And second, she belongs to a much-maligned school of the profession that works in the tradition of "imperfect competition." Such economists dispute the standard claim that most economic phenomena can be understood by assuming that supply and demand work smoothly to steer resources to their optimal uses.

Tyson's specialty is trade policy, where the standard model of supply and demand is just not very helpful. In the days of British economist David Ricardo, who devised the theory of comparative advantage in 1817, most trade could indeed be understood as countries exploiting natural advantages. Today, most trade in advanced goods has almost nothing to do with natural advantages and everything to do with created ones. For example, if the Pentagon helps the U.S. gain a lead in aircraft production and Europe responds by subsidizing the creation of Airbus, the outcome is far removed from the model of "perfect competition." The same is true for trade in semiconductors, supercomputers, biotech, and other products where cumulative knowledge, economies of scale, military spinoffs, and who got there first tell the real story.

STRONG RECRUITS. Despite the claim by critics that she would fail to recruit colleagues of stature, Tyson enlisted Alan Blinder, a widely respected macroeconomist (and BUSINESS WEEK columnist). As readers will recall, Blinder's brand of macroeconomics stresses the need for higher rates of investment and growth, not budget balance as an end in itself. And Blinder, unlike some of his macroeconomic brethren, shares Tyson's view that the institutional variations in different forms of capitalism explain much about competitiveness.

Now, with the further addition of Stiglitz, Tyson's council acquires the profession's closest thing to a general theorist of imperfect competition. Stiglitz' own prodigious body of scholarly work deals with the crucial details of economic life that standard economics tries to assume away. Undergraduates are taught that situations where markets fail to optimize outcomes are "externalities." These are dismissed as special cases: They resist formal modeling and spoil the paradigm the professor is trying to instill in students. But in the real world, the products and services that markets price wrongly (and hence overproduce or underproduce) include research and development, education, health, pollution, and national defense. Another condition of the standard model that real economic life belies is the assumption of "perfect information." In the real world, businesses make disastrous mistakes or enjoy windfall gains that are not instantly rectified by market forces.

MARKET GUIDE. "Market failures are pervasive," Stiglitz wrote in a paper for the prestigious National Bureau of Economic Research. "They arise in all aspects of economic life." If this is true, it follows that, under the right circumstances, government regulation can sometimes improve on the outcomes of market forces.

"The assertion that the government can do no better than the market is simply false," Stiglitz said in his 1989 book, The Economic Role of the State. "Governments will intervene when markets fail to meet social needs, and the economist's role is to guide them to understanding when and how government intervention is likely to be most helpful." As the council member responsible for microeconomics and regulation, Stiglitz will have a chance to offer insights on an array of practical issues.

This council gives the Clinton Administration a coherent philosophical grounding on which to build an economic strategy that reclaims a constructive role for government. More than any CEA since John Kennedy's, which included James Tobin and Walter Heller, Tyson's council promises both to improve public grasp of the dismal science and to influence the profession's conception of its own mission.

By the time its work is done, one hopes that a whole generation of economics students will be investigating the organization of real-world industries, comparing the benefits of different strategies of intervention, evaluating the impact of strategic trade, and committing countless other heresies in good conscience. We may even see a day when knowledge of actual companies and industries is the important credential for an economist. The character who can only build models will be the dunce.