How can economic stagnation be stopped?

Edmund Phelps has strong opinions and he’s not shy about expressing them. In the 1960s, he was a young economist more interested in exciting discoveries than prizes, leaving his position at RAND Corporation to become a pioneer of modern economics instead. He challenged well-established theories on the trade-off between inflation and unemployment and worked on the ‘Golden Rule’ of capital formation. Today, he discusses how economic stagnation might be stopped and why it’s important to give everyone a chance to flourish.

Edmund S. Phelps

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, 2006

At a glance

Born: 1933, Evanston, Illinois, USA

Field: Macroeconomics

Prize-winning work: Analysis of intertemporal tradeoffs in macroeconomic policy

Must-read book recommendations: Charles Dickens’ David Copperfield, Brontë’s Wuthering Heights, and Mann’s Magic Mountain

What he needs to be happy: His wife Viviana, having his next journey planned, music

What he can do without: A car, a country house

Performance skills: Sings Old Man River for dinner guests (and film crews)

A New York state of mind

If you met Phelps for the first time and didn’t know who he was, you’d probably guess he was an English teacher, musician or literary critic. He’s read everything worthwhile and quotes philosophers. Indeed, Phelps is a man of the arts. But he’s also a macroeconomist and professor at Columbia University.

With a firm handshake and inviting smile, he talks about how much he enjoys New York. The theatre, the museums and the opera. He’s a cosmopolitan man who enjoys dinner parties, lively dialogues and the diversity of the place he calls home. How does that match up with the serious world of economics?

Why economics?

Phelps might have become a philosophy teacher, if it hadn’t been for his parents. While studying humanities, his father asked if he could do him a favor and take at least one economics course. "What could I say? Of course I did," says Phelps. He didn’t regret his choice and he got nothing but straight A’s.

It’s a challenge to touch on all the things he’s worked on throughout his career, from employment theory to monetary theory, inflationary dynamics, growth theory and public finance which is precisely why he’s called a pioneer of modern economics.

How do markets really work?

The work he is best known for deepened, as the Nobel committee put it, the profession’s understanding of the relation between short-run and long-run effects of macroeconomic policy.

“In the area of employment economics there was this idea of wages being really rigid, that’s just the way it is,” he says. But that wasn’t good enough for a young man with an open mind and a desire to discover new things. So he started his research on the link between employment, wage setting and inflation.

Phelps realized that economic models hadn’t taken into account the fact that humans make decisions without having all the information or knowledge they need. It was an important insight that shed light on the way markets work and supported a new approach to employment and wages.

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The human face of economics

Phelps remembers the battles he had during the early years of his career. His research challenged the accepted views of the 1960s and earned him some criticism by those in the profession who didn’t want life-like actors in their economic models. What Phelps felt was a more realistic approach to macroeconomics, others dismissed. He admits it wasn’t a lot of fun back then but he stayed stubborn.

How can we revive people’s "innovative spirit"?

The importance of Phelps’ work is obvious, whether it’s his ideas about employment theory, or the Golden Rule savings rate he established on the basis of Robert Solow’s research in growth theory. But what gets him most excited is discussing the things that matter to him today. What makes nations prosper? Why is there a decline in innovation in most of the Western countries? And how can we revive what he calls people’s "innovative spirit"?

When Phelps talks about countries being low on innovation, it’s easy to protest that we live in a society where people are creating new things every day. "Silicon Valley is just a small part of the economy," he says. "What happened is that innovations stopped in the heartland of the country."

The importance of meaningful work

"It must be painful to earn a low income when all around you there are people swimming in money," Phelps says. He makes it clear that it’s not about material goods alone. "The government throws a lot of money around for food stamps and public housing," he explains. "But that’s no substitute for having a life." What’s missing then? Phelps can sum it up in just two words: meaningful work. He illustrates how all the money spent on welfare programs doesn’t do anything to make the careers of the working poor more meaningful, more satisfying.

For jobs to be rewarding they have to engage people’s attention and their minds to make them care enough to put in a day’s work.

What makes nations prosper?

Phelps’s book “Mass Flourishing: How Grassroots Innovation Created Jobs, Challenge, and Change” could be regarded as a kind of manifesto. He takes his readers on a journey from the early 19th century, when prosperity was exploding in many countries, to the years after World War II, when Europe and the United States lost their former dynamism.

A key element of his book is to show the connection between a decrease in innovation and a decrease in job satisfaction, a loss of "good jobs" that offered the chance to imagine and create things.

Phelps explains the need for every country to create an economy that is a "vast imaginarium." There are lots of ingredients necessary to make that possible, and he admits he hasn’t found the perfect recipe yet, but continues to discuss how economic stagnation might be stopped. His thoughts are led by what he learned from studying philosophy.

“David Hume said there wouldn’t be any progress in the world if it weren’t for human creativity,” says Phelps.

I never lost sight of that thinking. People are not just learning and stumbling on things, they’re also imagining possibilities.

How do we create a more dynamic economy?

One of his close friends is the economist and Nobel Laureate Joseph Stiglitz. They are both members of the Center on Capitalism and Society, which was founded by Phelps in 2002 to initiate new research on economic instability, inclusion and growth.

Stiglitz emphasizes how they’re on the same side when it comes to declining dynamism. "The focal point of economic attention should be on what leads to a more dynamic economy and society, not just what leads to more static efficiency,” says Stiglitz. “And that’s what Ned’s work has been focusing on.”

A more dynamic economy for Phelps means preventing what he’s called "corporatist maladies.”

If every job is protected, how can an innovator break into an industry with a new and better thing to produce?

To find a way back to this place, Phelps says we need to make inroads into established industries and avoid too much protectionism. One of his favorite examples to illustrate this is Europe. "European culture is very corporatist, there’s almost nothing that isn’t protected,” he says.

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Why is Europe in so much trouble?

"When I become pessimistic about America, I think about Europe and then I feel better about my country," Phelps admits. He worries about Europe and its future. The southern countries have been struggling for years, the United Kingdom has voted to leave the European Union, populist voices are getting louder every day and there is no productivity growth.

In Stockholm for the Nobel Prize Ceremony in 2006, Phelps told the audience at the banquet that he didn’t do his work for money or prizes but for the excitement of it.

“What I’m doing now isn’t exactly so much fun. I’m trying to figure out what it’s like to be in the working poor, what they want in life and what satisfactions they’re getting,” he says.

Are subsidies to low-wage jobs the way forward?

This focus has turned Phelps into a radical advocate of subsidies to low-wage jobs, which he thinks would encourage companies to hire more low wage-people and pull up their rates. It’s his mission to keep campaigning for those at the bottom of society. It’s hard to tell where he’s falls on the political scale but he’d probably fight against a classification anyway.

Are subsidies to low-wage jobs workable?

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