Sunday, July 22, 2007

Pop! Why Bubbles Are Great for the Economy

Every cloud has a silver lining. It’s an ill wind that blows no good. The bigger the bubble, the more useful soapsuds it leaves behind when it bursts.

That, more or less, is the thesis of Daniel Gross’s frothy book “Pop!” Contrary to conventional wisdom of a few years back, he argues, the mad rush to invest in Internet companies, whether dot-coms or telecom providers, wasn’t altogether bad. All that crazy investment led to the cheap servers and broadband connections that let us enjoy services like Google, MySpace and YouTube today.

“The tales of short-term woe experienced by bubble-burned investors, who constitute a minority of the population, frequently overlook the substantial long-term benefits that accrue to everyone, and to the economy at large, in the years after,” writes Gross, a business columnist for Newsweek and Slate and a frequent contributor to The New York Times Sunday Business section.

His book is a romp through a series of American bubbles, beginning with the telegraph boom of the 1840s. Samuel Morse wanted the federal government to take charge of building a national telegraph system. But after financing a demonstration line from Washington to Baltimore, Congress declined to go further. In 1845, Morse and his partners leased back the original line and went after local investors to patch together a national system. Holders of competing telegraph patents set out to construct their own systems.

“Within a matter of months, the nation was seized by telegraph fever,” Gross writes. “And not for the first time, an exciting new technology attracted some entrepreneurs who were, well, a little nuts. Manic, undeterred by failure, heedless of practicalities, eager to spend other people’s money, armed with unrealistic forecasts, they threw up wires on poles the way kids spray Silly String at birthday parties, fell flat on their face and built again.” (Gross’s exuberant style often leads to mixed metaphors.)

Investors lost gobs of money, but the United States soon had the world’s most extensive telegraph system: more than 23,000 miles by 1852, with an additional 10,000 under construction, compared with just 750 miles in France. Rate wars drove down prices, spurring new telegraph-dependent businesses, including brokerage houses and The Associated Press. Western Union eventually consolidated most of the independent telegraph providers, building a profitable, long-lived enterprise from other people’s losses.

If the telegraph was like the Internet, Gross suggests, the railroads were even more so. There, “the blowout came in the 1880s, a decade in which the United States enjoyed a long economic expansion and elected as president a Democratic governor around whom sexual rumors swirled,” he writes. It was “like the fiber-optic boom, except with handlebar mustaches.” Like cheap broadband, excess railroad capacity lost money for investors but spurred economic growth. “The entire population grew richer as a result of the enormously powerful new commercial and consumer platform built over the iron rails,” Gross declares.

It’s all plausible, but what’s the counterfactual? What would have happened without the railroads? Suppose Congress hadn’t made the massive land grants that subsidized rapid railroad expansion. Or suppose investors hadn’t been so taken with the new technology. Would America not have enjoyed its 19th-century growth spurt?

The economic historian Robert Fogel asked that question in his 1964 classic “Railroads and American Economic Growth.” Gross quotes Fogel in his text and cites the book in his extensive bibliography. But he completely ignores both Fogel’s empirical conclusions and his intellectual agenda.

“To establish the proposition that railroads substantially altered the course of economic growth,” Fogel wrote, “one must do more than provide information on the services of railroads. It must also be shown that substitutes for railroads could not (or would not) have performed essentially the same role.” Growth required “cheap inland transportation,” he concluded, but canals and roads could have had the same effect.

Fogel, who won the 1993 Nobel in economic science, revolutionized economic history by posing counterfactuals and assembling data to statistically test the kinds of glib narratives that make up much of “Pop!” If Gross is going to quote Fogel, he owes it to his readers to address — or at least present — Fogel’s arguments.

Amid the comic anachronisms and wise-guy smirking, Gross introduces some interesting ideas, notably that bubbles give the public a chance to develop the “mental infrastructure” needed to turn a new technology into viable new businesses and new ways of life. And he is surely right that bubbles are a small price to pay for the economic dynamism of America’s entrepreneurial culture.

But the book is deeply unsatisfying. Its good ideas are underdeveloped and its history often sloppy. As befits its title, “Pop!” is as airy as cappuccino foam. It tickles the intellectual palate but provides no real nourishment.

The Money Eating Dog

Three Million Dollars To Blog


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