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A Word on Economics

“Economists are not some innocent technicians who did a decent job within the narrow confines of their expertise until they were collectively wrong-footed by a once-in-a-century disaster that no one could have predicted… Economics, as it has been practised in the last three decades, has been positively harmful for most people.”

Ha-Joon Chang[1]

There seem to be two worlds in which education reform, along with everything else, proceeds. In one a purely statistical and theoretical view of economics prevails. In the other sociology, a view informed by studies of the social interaction of people. To move from the former view to the latter is to enter through a kind of ‘green door’ from a society dominated by individual utility maximisation to one more concerned with social value and which recognises the sometimes irrational behaviour of people. One is based entirely in theory and has a utility related to its alleged predictability derived from sophisticated mathematics, a predictability which in most cases is at best difficult to test. The other is supported by extensive research on what people value and what they do not and how they actually behave in relation to their stated values.

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Economics as a discipline is not to be uniformly distrusted. Nor is it based entirely on mere theory, poorly tested theory or not. Nor are sociological and anthropological research disciplines entirely unsullied by poor research: like all areas of human endeavour it can be influenced by prior beliefs. Large parts of economics are based on well analysed empirical data, even over the long run. Much of it is intellectually challenging, not to be disingenuous. But the economics which dominates society in most western countries is not like that!

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The day is not far off when the economic problem will take the back seat where it belongs, and the arena of the heart and the head will be occupied or reoccupied, by our real problems – the problems of life and of human relations, of creation and behavior and religion.

The decadent international but individualistic capitalism in the hands of which we found ourselves after the war is not a success. It is not intelligent. It is not beautiful. It is not just. It is not virtuous. And it doesn’t deliver the goods.

The difficulty lies not so much in developing new ideas as in escaping from old ones.

John Maynard Keynes

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Whilst economics is in reality a mixture of sociology and statistics, the prevailing view over the last 40 or so years has largely ignored sociology and the statistics have become sophisticated, even arcane: moreover what is readily analysed and for which there is substantial data is the focus whilst the more difficult and the rare event is put aside. That view of human beings as rational utility maximisers is the basis of neoclassical economics and has for several decades driven the agenda of public policy, usually referred to as neoliberalism, in many countries. The result has been described by many as disabling society: for the most part such views have been ignored.

Neoliberalism is sometimes, in Australia particularly, referred to as rational economics. And so the response to objections to rational economics is often to ask whether one would prefer irrational economics. That misses the point: the term rational applies because predetermined rules are assumed to underlie its application despite the fact that humans do not always behave in a rational, that is logical and consistent, manner amenable to description by strict mathematical rules. The behaviour of people caught up in boom and bust cycles such as the recent Global Financial Crisis or GFC is but one demonstration of the inadequacy of neoclassical economic theory.[2]

This neoclassical economic agenda emphasises competition as a way of achieving “efficiency” which is considered a good thing in and of itself without regard for any consequences which might be deleterious. Human behaviour in this economic world is seen to involve a search for that option amongst many – goods or services – which most likely satisfies the wants and needs at the time. And that option is chosen. The argument is that people are motivated principally by monetary reward – that they seek to maximise their utility characterised by the extent to which their preferences are satisfied.

In general, costs of transactions which cannot be directly charged, particularly those which would seem to apply generally such as public goods like water and forests, are considered to be externalities and are not counted in the pricing. Pollution produced by coal fired power stations, and which affects the whole community, is not included in calculating the cost to the energy generator, and therefore is not charged to the consumer. As a result the cost has to be met at a later time by an entity other than the generator, usually the public at large.

Where the resource is not replaceable there is no brake on its consumption. This situation is captured by the well known phrase, capitalise the gains and socialise the losses: the transfer of billions of dollars from governments to banks to stave off likely financial collapse is an example.[3] At the same time, many of these activities receive government subsidy whilst at the same time those beneficiaries declaim against subsidies for other activities. Energy is a prime example, coal fired power stations, oil and the operation of nuclear power stations receive a subsidy but solar and wind energy most often do not. The result is a distortion of choice. Heavily subsidised sport is often compared with less well subsidised arts activities, a general view being that the arts should pay for themselves.

Economic growth is believed to be the way to improve economic prosperity: consumption is favoured as the engine of growth. Innovative technology is believed to arise to solve any problems which might emerge. Individuals are favoured over communities and individuals are considered responsible for their future welfare other than in exceptional circumstances. That growth in consumption cannot continue indefinitely is not a realisation of those brought up on economics 101 whose opinions are quoted every day in the media as various economic statistics are reeled off to a seemingly ignorant population. It has been observed that the only people who believe in unlimited economic growth are fools and economists.

Jeremy Grantham, investor and co-founder of a major Boston-based asset management firm, is highly regarded as a highly knowledgeable investor particularly noted for his vocal criticism of government responses to the GFC. In his words “capitalism does not address long term issues easily or well … brilliant at the short end but lost, irrelevant, and even plain dangerous at the very long end”.[4] He points out that capitalism cannot deal with the tragedy of the commons issues such as overfishing and soil erosion and it ignores finiteness of natural resources, attributing no material costs to future events.

Individuals and Choice: Limits to Government

The theoretical base of neoclassical economics derives from the writings of a number of economists, especially at the University of Chicago, who had arrived there from Europe, most particularly Austria, in the years after the close of the First World War.[5] They had experienced the failure of a centralised economy and considered that a different economic model was needed. Notable among them were Friedrich Hayek and Joseph Schumpeter. Milton Friedman of the University of Chicago became the principal promoter of neoclassical economics after the Second World War and received the Nobel Prize for his efforts. These views found fertile ground in a country with an ideology grounded in individual freedom and  individual choice and a belief that commerce must be free from government interference.

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I have come to feel strongly that the greatest service I can still render to my fellow men would be that I could make the speakers and writers among them thoroughly ashamed ever again to employ the term ‘social justice’.

Frederick von Hayek, Law, Legislation and Liberty, Vol 2: The Mirage of Social Justice 1976

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Social democracy, with its advocacy for intervention by government at appropriate times, such as when benefits to the community would not otherwise be provided and its concern for the community at large, including those less fortunate, as advocated by the English economist John Maynard Keynes, was left behind in the latter day striving for individual gain. In this philosophy self-interest is believed to prevail, personal utility maximised, the market acting as a clearing house arriving always at some optimum level or equilibrium.

Private enterprise in this neoliberal philosophy is considered inherently able to perform more efficiently than government. Government is believed to be a brake on, to crowd out, the free operation of business and the market which itself is (asserted to be) self regulating. It follows that taxes should be reduced to the minimum and that governments should not incur deficits at levels beyond those which succeeding generations of taxpayers will consider they ought to afford to pay out. Further, the view is that unions are a brake on management imperative. Government employees should be subject to the same conditions of employment as those in private enterprise which means limited term contracts and wages and salaries tied to performance. Since monetary rewards are principal motivators, it is said that superior performance should be rewarded with bonuses which should be tied to the level of success; sometimes that is dangerously set as the amount of revenue generated not always with regard to the costs incurred in doing so.

The first responsibility of business enterprises is now considered to be the generation of wealth for shareholders, not the provision of goods or services to customers at an optimal quality and price, once seen as the purpose. In this context there is considered to be, generally, a tension between the motivation – and therefore the behaviour – of executives on the one hand and the shareholders, represented by the board of the enterprise on the other. Therefore performance indicators are considered necessary to allow the board, through oversight, to make sure that executives act in the best interests of the shareholders rather than themselves. This is depicted as transparency and accountability.

Neoliberalism, with its emphasis on managerialism – management in every enterprise is a management function – and the related disdain for government gained a substantial hold over the last 30 years in Australia and the UK and more widely through the policies of international agencies such as the World Bank and the International Monetary Fund and the globalisation movement. It led to fixed term contracts for senior executives and performance pay, poorly performing appointees were to be dismissed whilst those performing well were to be given bonuses. Investment in training and development was poor, all but core functions were outsourced, leading to management’s loss of control over some important aspects of the business through inability to control the contract process, let alone the quality of the subsequent performance. Public-private partnerships for infrastructure projects were favoured though they ended up costing more than they would have if they were managed within government, partly because of unfavourable interest rates on debt.  Substantial downsizing led to significant loss of corporate memory and inability to manage complex contracts.[6]

In the process, government functions concerned with financial matters achieved greater prominence and ministers accumulated more staff. All of this has led to an undermining of democratic government through the marginalisation of parliament and parliamentary accountability by the head of government and senior ministers and advisors.[7] Above all effectiveness came to be conflated with efficiency, microeconomic reform such as holding wages down, reducing extra allowances for overtime and so on, led to decline in commitment to the enterprise and therefore a decline in productivity.[8] Surprisingly, declines in earnings and/or profits tends to lead to reductions in staffing; in fact in some cases increased profits can also lead to reductions of staff! Despite evidence that these economic reforms lead to declines in productivity rather than increases, the strategies continue and the focus on reducing employee benefits continues.[9]

 

 


[1] Quoted by John Gray in ‘23 Things They Don’t Tell You About Capitalism‘ by Ha-Joon Chang’, The Observer, 29 August 2010; if any reader thinks this essay is too harsh or not relevant, please take the time to watch at least the trailers of the films, The Inside JobCompany Men and The Corporation. Madeleine Bunting in The Guardian (30 May 2011) observes that Inside Job “does for banking what An Inconvenient Truth did for climate change”.

[2] Nassim Nicholas Taleb’s book, The Black Swan The Impact of the Highly Improbable (Penguin Books, 2007) amply demonstrates the severe problems with the financial industry, problems which were to lead to the Global Financial Crisis of 2007-2009; until Europeans arrived in Australia, the view was that all swans were white!

[3] The tendency of firms to import trained persons from overseas rather than make the effort to train local people leads to higher unemployment which leads to further social dislocation. Companies prefer to exhort government to fix up the education system! A recent example is the UK where, only a few weeks after the riots, the Chartered Institute of Personnel and Development said demand for workers from overseas had reached record levels because companies felt young people in the UK lacked the skills to make them employable (Larry Elliott, ‘Overseas workers preferred over ‘unskilled’ school leavers in job market’, The Guardian 23 August 2011).

[4] ‘Resource Limitations 2: Separating the Dangerous from the Merely Serious’ GMO Quarterly Letter July 2011; Grantham has established the Grantham Foundation which has made substantial commitments to research institutes on climate change.

[5] Tony Judt, ‘What Is Living and What Is Dead in Social Democracy?’, New York Review of Books 56 (20) • December 17, 2009 .

[6] For one of the many discussion of the flaws in neoclassical economics see ‘Five Zombie Economic Ideas That Refuse to Die’, by John Quiggin (Foreign Affairs October 15, 2010).

[7] Christopher Foster (in British Government in Crisis or The Third English Revolution, Hart Publishing, Oxford and Portland, 2005) describes how UK Prime Minister Tony Blair replaced cabinet by “prime ministerial government”, Blair and Chancellor George Brown abrogating to themselves most of the decisions, good government becoming good news management; In, ‘Power Trip: The Political Journey of Kevin Rudd’ (Quarterly Essay 38, June 2010), David Marr describes how Kevin Rudd’s term as Prime Minister was notable for the way Rudd and three other Ministers controlled all cabinet decisions, other ministers being given almost no opportunity to discuss matters in cabinet. In ‘The Rise and Demise of the New Public Management’ (Post-autistic Economics Review no. 33, 14 September 2005) political scientist Wolfgang Drechsler writes, “In recent decades the alliance of neoclassical economics and neoliberalism has hijacked the term “economic reform”. By presenting political choices as market necessities, they have subverted public debate about what economic policy changes are possible and are or are not desirable.” (See here.) It is not irrelevant to point out that the last 20 years in the US when the Republicans in Congress led by Tom DeLay were the majority party in the House of Representatives, removal of all government regulations and related departments and agencies was a major political platform advanced not least by lobbyists associated with members of the House who made billions of dollars representing particular groups seeking to bypass existing laws; see ‘House Overturns New Ethics Rule as Republican Leadership Yields’ by Carl Hulse, The New York Times 28 April 2005.

[8] Ross Gittins, ‘Maybe economic reform is worsening productivity’, Sydney Morning Herald August 15, 2011

[9] No reference was made by the Business Council of Australia and others praising the decision of Fair Work Australia to allow employees trade off their holidays and other benefits for higher wages to the numerous arguments on these matters advanced by Sydney Morning Herald economics editor Ross Gittins.