The research here is deep microeconomic stuff. It’s about incentives, and imperfect information, and long-term relationships. It’s about delicate strategic interactions between people who don’t know each other’s capabilities or intentions. But it’s related to lots of real-world economic issues -- performance pay, mergers and acquisitions, bank lending and corporate structure.Mr Smith reminds readers why the history of economic thought is important.
What it’s not about is the kind of economics you read about in the news. It’s not about growth or unemployment, fiscal stimulus or interest rates, trade agreements or productivity. It might be indirectly related to those things -- Holmström’s work on financial crises and debt certainly has relevance for what happened in 2008. But it isn't what you expect to see economists arguing about when you open up Bloomberg or pick up the New York Times.
It’s not macroeconomics -- the study of how the broad economy works.
Economics debates in the news media and on the blogs tend to make a big distinction between macro and micro, painting the former as unscientific and the latter as serious science. There’s a grain of truth to that, but it’s not that simple.It might be more accurate to say that macroeconomics as we understand it emerged out of political economy, which beginning with Adam Smith and progressing at least through Karl Marx and J. S. Mill, focused on why wealth happened and who got it and who would be left out, and what might be done to Change Things. But the notion of a company was new to Adam Smith and misunderstood by Karl Marx and it took a long time to get a handle on why some transactions might be handled more effectively by markets whilst others were within the locus of control of a management. And, to use a phrase from Harold Demsetz, who really ought be considered for recognition, to think about how a world in which information is costly is different from a world in which information is free. The standard blackboard economics supply-and-demand model rests on free information. When information becomes costly, other models, such as Hart's, Holmström's, Jean Tirole's (from last year), Oliver Williamson's (from a few years ago) and the game theorists offer information.
What really happened was that macro developed first. Economists saw big, important phenomena like growth, recessions and poverty happening around them, and they wrote down simple theories to explain what they saw. The theories started out literary, and became more mathematical and formal as time went on. But they had a few big things in common. They assumed the people and the companies in the economy were each very tiny and insignificant, like particles in a chemical solution. And they typically assumed that everyone follows very simple rules -- companies maximize profits, consumers maximize the utility they get from consuming things. Pour all of these tiny simple companies and people into a test tube called “the market,” shake them up, and poof -- an economy pops out.