The Hindu Business Line : The Golden Rules of Edmund S. Phelps

The Royal Swedish Academy of Sciences has posted on www.nobelprize.org a four-page document, as `information for public' about `the Prize in Economic Sciences 2006'. The winner, as you know, is Edmund S. Phelps.

"In one of his first published articles from 1961, Phelps derived the so-called golden rule of capital formation," informs the document. Now, what is a golden rule? "A basic principle which should always be followed," says Concise Oxford English Dictionary.

In arithmetic, golden rule refers to `the Rule of Three', says Dictionary of Phrase and Fable. But Wikipedia explains the rule as "the method of finding the fourth term of a mathematical proportion when three terms are known," and provides an example: "If a car driving at a constant speed can in 3 hours drive 240 miles, how far can the car drive in 7 hours?" Golden rule or ratio is defined in the Free Encyclopedia as one that expresses `the relationship that the sum of two quantities is to the larger quantity as the larger is to the smaller'.

Striking `gold'

The `disambiguation' page on http://en.wikipedia.org is where you can strike `gold' in varied contexts. Such as, in law, that the `golden rule' requires words of a statute to be understood in their ordinary sense.

In the realm of fiscal policy, "the golden rule states that over the economic cycle, the Government will borrow only to invest and not to fund current spending." And in quantum physics, there is Fermi's golden rule.

Golden rule is "the rule of conduct that advises people to treat others in the same manner as they wish to be treated themselves," defines Encarta. The phrase has a place `in morals', to mean `Do unto others as you would be done by,' as www.bartleby.com explains.

"A rule of ethical conduct referring to Matthew 7:12 and Luke 6:31," informs Merriam-Webster Online Dictionary. "What you do not wish upon yourself, extend not to others," is a quote of Confucius cited by Wiki. "Hurt no one so that no one may hurt you," reads a similar thought, of Muhammad, from The Farewell Sermon.

That the term `golden rule' of Phelps makes reference to the ethic of reciprocity, `Do unto others as you would have them do unto you,' notes the brief `public information' on the Nobel Foundation's site.

"Taking an inter-generational perspective he posited that the goal is to attain the maximum consumption per capita that is sustainable in the long run."

Economics and morals

To know the connection between economics and morals, read up `the history of economic thought' on http://cepa.newschool.edu, where one of the essays is on `Golden Rule Growth'. It starts with a snatch from Phelps' 1961 essay `Golden Rule of Accumulation', in American Economic Review: "Then a policy-maker was heard to say, `Forget grand optimality. Solovians are a simple people. We need a simple policy... If we make investment a constant proportion of output, our search for the ideal investment policy reduces to finding the best value of s, the fixed investment ratio.' `It's fair,' Solovians all said. The King agreed. So he established a prize for discovery of the optimum investment ratio."

The story

Reads like a fable? Yes, it is, `for Growthmen', as you can see on JSTOR (www.jstor.org), `the Scholarly Journal Archive' that offers researchers `the ability to retrieve high-resolution, scanned images of journal issues and pages as they were originally designed, printed, and illustrated'.

Phelps begins the story thus: "Once upon a time the Kingdom of Solovia was gripped by a great debate." The argument was about growth, faster and sustainable. "The King appointed a task force to learn the facts of Solovian economic life."

Solovia is a fictitious place, perhaps more to pun with the Solow-Swan growth model. Named after Robert M. Solow and Trevor Swan, this model (1956), also called neoclassical, "shows how capital accumulation and technological change in combination lead to growth in output and consumption," as explains a 34-page `advanced information on Sveriges Riksbank Prize in Economic Sciences' about `Edmund Phelps's Contributions to Macroeconomics', on www.nobelprize.org.

The ethical tilt in Phelps' work was his argument that the consumption level should be the same for all generations. According to his golden rule, the desirable savings ratio should equal the ratio of capital income-to-national income. "Savings rate should be high enough to maintain a capital stock that yields a return (a real rate of interest) that is equal to the rate of growth in the economy." It is assumed that each generation will save for future generations a proportion of the income, which was in turn saved for it by its previous generation, explains www.economyprofessor.com in a page on `golden rule of capital accumulation', queerly credited to `English economist Ernest Phelps (1906-1994)'.

To the economics-hungry, apt references should be: The End of the Golden Age in Solovia: A Further Fable for Growthmen Hoping to Be One Up on Oiko by I. F. Pearce, and Phelps' comment in response, on www.bi.go.id, the site of Bank Indonesia; Solovia Revisited by Tomas Restad of Stockholm University, on www.ne.su.se; and The Empirical Foundation of the Golden Rule by Víctor J. Elías. Decades-old papers of Phelps, like Second Essay on the Golden Rule of Accumulation, are on http://cowles.econ.yale.edu.

Golden Rule of investment

His 1964 paper titled Models of Technical Progress and the Golden Rule of Research, spoke of the general GR or `Golden Rule' of investment. To maximise golden-age consumption, `equate the rate of return from each kind of investment to the rate of growth', he declared. Golden Rules of Economic Growth: Studies of Efficient and Optimal Investment is a 1968 book in which Phelps put together a dozen essays on GR or golden rule.

Resuming the Solovia fable, who won the prize? Oiko Nomos. He guessed rightly the best savings rate for the kingdom, and called his solution the `Golden Rule' of growth. The hero gets his name from oikonomos, Greek for manager or steward, which lies at the root of `economy'.

ZeroBase@TheHindu.co.in

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