Edmund Phelps won the Nobel prize in economics in 2006 for “for his analysis of intertemporal tradeoffs in macroeconomic policy.”

However, he has spent a considerable chunk of this time in the last few decades musing over strengths and weaknesses of capitalism and, more generally, a dynamic economy. Jon Hartley interviews Phelps on both topics, and more, at his Capitalism and Freedom in the 21st Century website (July 10, 2024, “Edmund Phelps (Nobel Prize Winner and Columbia Economics Professor) on His Career and Contributions To Macroeconomics”). Here are a few points that caught my eye:

On how Phelps came to think about what he called “the equilibrium rate of unemployment,” which is often referred to today as the “natural rate of unemployment:

While thinking of Frank Knights Risk, Uncertainty and Profit and Keynes’s “sticky wages,” I noticed two things: Knight while offering a departure from neoclassical models in acknowledging the presence of uncertainty, particularly among investors, did not assert that uncertainty could sometimes be a force driving wide swings of employment. And Keynes in his General Theory had offered a theory of employment without offering a theory of wage-setting  by firms.

What I did was introduce a formulation of wage behavior that included the expectations of the rate at which wages are changing in the economy as a whole – if these expectations were to adjust slowly, the wage rate would adjust slowly too. While the Phillips Curve is essentially a statistical estimate of a mechanistic hypothesis, my theory is microeconomic in that it derives from the conception of decision-making of individual firms – it came to be termed “micro-macro.”

Exploring expectations further led me to developing a model of a theoretical economy built around price expectations and behavior of that nature which postulated that the rate of inflation depends on the rate of unemployment and the expected rate of inflation. This model featured the “natural rate of unemployment.”

Regarding the natural rate, I should clarify that Milton Friedman and I were not working on the idea of the natural rate together. Rather it was a coincidence that came about in our independent research. What I dubbed the “equilibrium rate of unemployment,” Friedman had dubbed “the natural rate of unemployment.” It just so happened that it was Friedman’s term that stuck.

On what people need from the economy, and what is not included in current economic theory:

People need an economy that provides them not only with pecuniary rewards but also non-pecuniary rewards. They need work that is interesting and engaging with occasional opportunities to use their creativity, to hit upon and share new ideas with managers. For a good life, they need to feel a sense that they are at times succeeding at something.

This comment from Phelps reminded me of a comment he made in an interview with Howard R. Vane and Chris Mulhearn published in 2009 in the Journal of Economic Perspectives (where I work as Managing Editor). Phelps said: 

I’ve been trying to develop a new justification for capitalism, at least I think it’s new, in which I say that if we’re going to have any possibility of intellectual development we’re going to have to have jobs offering stimulating and challenging opportunities for problem solving, discovery, exploration, and so on. And capitalism, like it or not, has so far been an extraordinary engine for generating creative workplaces in which that sort of personal growth and personal development is possible; perhaps not for everybody but for an appreciable number of people, so if you think that it’s a human right to have that kind of a life, then you have on the face of it a justification for capitalism. There has to be something pretty powerful to overturn or override that.

On the idea that a dynamic and innovative economy can’t just rely on some prominent scientists and inventors, but needs a broad-based commitment across the population to seeking innovation:

My focus is on grassroots innovation – ordinary people, as I call them, participating in the economy, using their imagination to create new products and new methods of production. My indigenous theory differs sharply from Schumpeter’s theory in which innovation is exogenous coming mostly from scientists and navigators outside of the economy. Western societies are rife with dissatisfaction and despair. For some time I have been pointing to the loss of modern values – mainly individualism (not to be confused with selfishness), vitalism, and the desire for self-expression –  as a major cause of the loss of dynamism, thus the slowdown of innovation and economic growth. This is not to say there is no innovation happening. We’ve still got a few geniuses out there, some of whom have new ideas of immense commercial value. But we’re not going to get anywhere close to the mass of innovation that we had from the 1880s until about 1970 until a more fundamental shift in societal values occurs.

For more on Phelps and his ideas about the value of broad-based economic dynamism vs. narrow and short-term corporatism, see this earlier post about an essay that Phelps wrote a few years ago: “Phelps on Dynamism and Corporatism” (May 9, 2017).