Pop!: Why Bubbles are Great for the Economy

Bubbles leave behind an economic infrastructure that spurs later growth.  The telegraph and railroad bubbles of the 19th century gave birth to modern communications and transportation.  The fiber-optic bubble of the 90s paved the way for YouTube and MySpace.  Might we need a "green bubble" to solve current energy problems?  So argues Daniel Gross, Slate.com and NYT columnist, and also blogger.

I can think of two mechanisms:

1. The bubbly asset price spurs overoptimistic innovators, thus counteracting the tendency to underinvest in new ideas (which are public goods to some extent)

2. The bubbly asset price spurs clusters of production, which help overcome the fixed costs of innovating with a new technology.  I am reminded of Andrei Shleifer’s seminal work on implementation cycles.

Of course Gross is smart enough not to defend all bubbles.  Perhaps bubbles are best when an economy has the potential for breaking through to a new high-growth mode; that would cover today and the mid- to late 19th century.  I am less convinced by his treatment of the 1920s bubble, which he cites as beneficial in paving the way for the New Deal.  I see a smoother economic path as having brought the better parts of the New Deal without so many of the overreactions.

Gross argues that government should support many bubbles instead of choking them off.  At the very least, bubbles are underrated.  This is a stimulating book, worth your time and money. 

I am of course interested in the cross-sectional cultural contrasts.  Paintings are resold for profit, and they are possibly bubbly assets, but CDs are not.  Does that make the artistic market more supportive of innovation than the music market?  Are bubbles beneficial in the auctions for book contracts?  Was this book the result of a bubble?

Here is an FT review.


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