Jeremy Grantham's Favorite Book

Jeremy Grantham has long advocated that economic growth is inexorably constrained by physical resources, especially oil and other fossil fuels. Thus, in GMO’s Third Quarter 2014 Quarterly Letter, he writes, “I think that the old growth rates in productivity will not come back, at least until we have had a transition away from fossil fuels.” But Grantham also announces that, having regularly insulted economists “for their lack of interest in resource limitations,” he gratefully notes that “a new book appears that amazes me by doing the opposite, and by an increasingly well-known economist no less … It is entirely sensible from start to finish … I agree with almost everything he writes.”

The End of Normal

In his new book, The End of Normal: The Great Crisis and the Future of Growth, James K. Galbraith actually does much more than display interest in resource limits. His argument is developed in more depth than Grantham’s – at times too much depth to fully take in – but their end results are very close.

If Galbraith is “an increasingly well-known economist,” he has had a hard row to hoe along the way. His entire position and world view fly in the face of everything that economics has become in the last 30 to 40 years. This makes him a little difficult to understand in places. He doesn’t speak the usual economics-speak. He doesn’t accept as a given most of the casual verities that the vast majority of economists accept, almost unconsciously, as their starting point.

The main thing he doesn’t accept is that if the economy is in a slump, it will recover. This puts him at odds with both Keynesians, who think it will recover relatively quickly and painlessly if the government applies stimuli, and economists of the Austrian school, who think that if the government does nothing the economy will recover after some – probably necessary – pain.

Galbraith thinks the whole idea that the economy will recover – that is, that it will recover to rejoin its former growth trajectory – was deeply embedded in economic thought by Nobel laureate Robert Solow’s growth model. One senses that it is this model, among others, Galbraith has in mind when he rightly observes, “No one with a sense of aesthetics would take the clumsy algebra of a typical professional economics article as a work of beauty.”

Solow’s model depicted economic growth as a smoothly accelerating exponential function, dependent on only two inputs, or “factors of production”: capital and labor. Solow recognized that this doesn’t come close to explaining economic growth; so even if you assume it is smoothly increasing along an exponential curve, there has to be an additional unexplained factor, which is called “technology.”

Galbraith’s biggest problem with this formularized economic growth theory is the implicit assumption of an underlying growth function with an underlying growth rate. That means that although movements in actual GDP may follow a fluctuating graph, we are prone to assume a shadowy exponential curve underlying it, showing the “real,” or “smoothed,” or “potential” values – to which we assume it will return. (The same might be said of a graph of the S&P 500 and “reversion to the mean.”)