Knowledge and the Wealth of Nations
David Warsh, W W Norton, 2006, xxii + 426 pages, £16.99.

David Warsh’s book provides an absorbing and very well-written account of the development of economic thought from Adam Smith’s Wealth of Nations to the present day. The story begins with the contradiction in Smith’s classic that has puzzled economists for centuries: the parables of the pin factory and the invisible hand.

The pin factory example showed how economies of scale produced increasing returns by lowering the costs of production. Increasing returns, however, can enable a few, or even a single, supplier to drive smaller firms out of existence and create oligopolies or monopolies. Uncomfortably, Smith’s other key theorem – the invisible hand – required that many suppliers compete with each other to ensure that the market operates efficiently. Economists favoured the theorem of the invisible hand over the pin factory for almost 200 years because it was not only ideologically correct, but also lent itself more readily to mathematical modelling.

Warsh entertainingly takes us through the history of economics to an analysis of an influential technical paper written by Paul Romer in 1990. In his paper, ‘Endogenous Technological Change’, Romer observed that economic growth was accelerating in rich countries causing the standard of living to diverge rapidly from that in poorer countries. This contradicted the law of diminishing returns, and pointed to increasing returns.

Warsh argues that Romer set off a revolution in economics that is still ongoing today in the now dominant ‘New Growth Theory’ by dividing economics into people, ideas and things, instead of the division into labour, capital and land associated with classical economics. Romer’s theory was that the accumulation and the deepening of knowledge in a society was the source of increasing returns. The subsequent creation of new economic models of knowledge accumulation has revolutionised the fields of industrial organisation, international trade, urbanisation, devel-opment and many other areas of economics and social science in recent years.

In covering these issues, Warsh, a former Boston Globe columnist who now writes the online newsletter Economic Principals, superbly covers the entire economics ‘culture’, bringing alive the subject’s key person-alities and institutions, and its division of schools and universities. Indeed, Warsh’s book is well worth reading solely for his description of how the academic economics profession operates.

The book has a number of shortcomings. For example, Warsh probably attaches too much importance to Romer’s paper, which others have argued is largely a mathematical version of a line of thought emphasised by Schumpeter and others, including Keynes. The book also frustrating-ly lacks detailed academic references and a bibliography. These, however, are minor quibbles and the book provides a highly-readable and useful summary of key developments in economic thought.

Martin Ellis
HBOS