This post is a little less objective than usual, but might be of interest to those doing OCR, pre-U, or CIE-style argumentative essays on economics, as well as of general interest. It will be available as a podcast on one of my other blogs soon.
A working knowledge of economic
theory (and practice) would be useful to policy stakeholders such as executives,
legislators, the media, and the political classes, in three ways.
Firstly, economics conveys a sense
of the contingency of economic prescriptions, and therefore would help to
illuminate policy choices, which could then be made on an informed, balanced,
and persuasive basis.
Secondly, a knowledge of
microeconomic realities could benefit policymakers in dealing with supply-side
matters and labour markets and help to stabilise and improve long-term growth.
Thirdly, a great many economic
problems are systemic and cyclical, and yet steady and long-term policies to
expand aggregate supply, maintain real interest rates, and improve productivity
are consistently associated with stable and effective governance.
Reactive policies that prioritise
one macroeconomic objective over all others for a short period of time are apt
to be counter-productive and to cause reversals and the worsening of things
like inflation, structural deficits, national debt, and market failure. In
this, the various credible theories of government failure might also help
societies to avoid bad economic policy as measured by past results and current
objectives.
Overall, an understanding that economics is
political economy, an humane science focussed on
human beings rather than, for instance, physics or chemistry, could help
economic theory as well as public policy, in that economics would escape the
grip of neoclassical mathematics. This is important because non-mathematical
explanations of political economy have provided in many cases more useful
predictive analysis of existing dilemmas, and clearer warnings of difficulty,
than the alternative, as can be seen by the contrast between the work of Hyman
Minsky and Arthur Laffer, for instance.
In terms of the benefits of an
understanding of economic contingency, I would begin by pointing to three ideas
which arguably misled policymakers who took them as being certain rather than
questionable; the application of the multiplier and deficit financing in the
nineteen sixties, the idea of crowding out in the nineteen seventies, and the
idea that tax cuts in and of themselves have a near-magical power to induce
growth which has prevailed since the mid-nineteen eighties in the west.
The period between 1956 and 1967-70
was one of post-war recovery and the beginnings of globalisation. Even
post-Stalin Stalinism managed to obtain growth. It was also the period of ‘high
Keynesianism.’ Policy makers, some of whom were informed about economics, came
to believe that Keynesian ideas were responsible for growth and not the
rebuilding. They believed—but could not prove except by faith-based references
to economists—that they could ‘fine tune’ and ‘manage’ the economy by managing
aggregate demand.
This contrasted with what were then
old-fashioned ideas which held that supply tended to create demand, that supply
gluts emerged during booms, and that quick, sharp recessions were good for the
economy by lowering prices and then costs at the expense of a temporary
slowdown. This older view emphasised the need to accumulate savings and to have
stable institutions which could facilitate the transfer of those savings to
investment, which would grow Long-Run aggregate Supply.
All but a few politicians
understood this alternative, and those who did avoided or downplayed it. They
escaped a great deal of criticism in doing so because people did not understand
the economic theories involved.
Politicians adopted the attractive elements
of Keynesian economic theory without reading it. They embraced the idea that
Aggregate Demand could be boosted in such a way that incomes led to
consumption, consumption led to investment, investment led to jobs, and jobs
led to more consumption. In this scenario, inflation was usually temporary, and
interest rates did not have much of a role except to curb speculative demand
for money. Unemployment with a welfare net, they thought, could ‘stabilise’
downturns which were engineered to stop ‘overheating.’ A whole generation
decided that their job was to limit the accumulation of individual wealth, run
budget deficits to gain growth in GDP, and to prioritise growth and low
unemployment over all other economic objectives. When asked how
government spending funded by fiat currency could be better than private
investment, such people invoked things like the ‘multiplier and accelerator’
model and the deflation that they associated with the Gold standard after 1931
as justification for their activities.
Some administrations were led by
people with a knowledge of economic theory who were ‘true believers’ in this
aspect of it, but they refused to entertain questions which arose directly from
theory that might have made for better policy. For example, once one cuts
through a curtain of mathematics, the accelerator theory is based on the idea
that aggregate supply is composed of big machines and that manufacturers buy
machines in a ratio to consumption. For instance, 100,000 more items produced
means one more machine to add to national fixed domestic capital.
No one who has been near a factory
or business thinks that this caricature of capital is how business investment works,
though it may have been presented as being accurate in the Victorian era. One
has to have a confident grasp of economic theory to know that.
Most did not know that the
questions existed. For instance, an approach that sees almost all inflation as
deriving from manageable demand-pull forces does not allow for a focus on small
business and entrepreneurs; it leaves an economy vulnerable to exogenous
shocks; and it encouraged a kind of planning and command system that also
sought to tie currencies together, leading to devaluation crises and an
inability to use monetary policy to manage the internal economy.
There was remarkable social equity
and the provision of public housing (in countries with smaller populations
compared to today) and the crises of decolonisation and a global shift in
energy regime from coal to oil were largely overcome peacefully.
Yet the very predictable and
avoidable consequence was stagflation, corporatism, the growth of large unions
and companies, states which were trapped in ‘stop-go’ cycles with structural
budget deficits, and higher taxes every year. Few articulated a more
manageable, market-based, low tax future in which governments did less, and
where few believed in the capacity of technocratic governments to simply adjust
inflation via Phillips curves or GDP via the multiplier or negative
multiplier.
‘Crowding out’ was a barely
literate pseudo-economic idea created by Her Majesty’s Treasury in the UK in
the nineteen seventies which attempted to deal with the consequences of debts,
stagflation, and currency decline because of the policies many had followed
without applying any knowledge of monetary or supply-side theory in the
sixties.
Like the disastrous experiment in
monetarism and high exchange rates intermittently pursued soon after, it was
essentially pseudo-economic. Crowding out held that there was a ‘pool’ of
investment capital in any economy at a given time. It then suggested that
government and business had access to it. If the government was running a
deficit, it would issue bonds with an attractive coupon, and would ‘sell’ many
automatically.
This was because ‘investors’--a
class neither defined nor properly explained—would, it was assumed, always buy
government over private bonds and loans at times of uncertainty since
government could be relied on to repay. That left, in the theory, a smaller
segment of the pool for private investors who would subsequently have to pay
more for it, raising ‘private’ interest rates and leading to low growth,
unemployment, and pressure on government borrowing.
Monetarism was a reaction, which
managed to ‘out-do’ crowding out by claiming that money supply could be
identified and restricted or eliminated in ways that helped to reduce
inflation. This ran alongside very high interest rates in response to stagflation
caused by energy rises and the decline of productivity in the previous decade.
A ‘proper’ knowledge of economic
theory which integrated the demands of the real world and which understood that
economic policy should uphold multiple objectives, and which had applied an
understanding of the limits of government and government failure, would not
have wasted a good deal of the period from 1976-1986, and nor would the
benefits of North Sea Oil have been almost wholly consumed by the unemployment
that resulted. UK and US manufacturing industry might not have been ‘hollowed
out.’ Governments might not have swung between nationalisations and
privatisations and lost sight of basic fiscal and monetary truths that a clear understanding
of foundation economics would have allowed for.
In the nineteen eighties and
nineties, the idea took hold, which has been dominant until the
twenty-twenties, that ‘tax cuts’ of any sort are a good thing which will
generally result in economic growth and development. For some forty years,
ideas like or similar to the Laffer Curve have been embedded in a popular and
therefore policy-based understanding of economics. They have been attached to a
world-view.
For most people trained in economic
theory, however, this idea is almost as lacking in foundation as crowding out
or the existence of an actual measurable multiplier. For instance, some taxes
might be a social good, in the sense that redistribution of income leading to a
lack of huge inequalities has been shown to allow for savings, investment,
stable growth, and the maintenance of small businesses.
In contrast, regressive or very low
income taxes and huge inequality not only leads to economic instability and
demonstrable periodic bursts of inflation and deflation, but to other self-reinforcing
externalities which prevent productivity gains.
If large numbers of rich people do not reinvest their money in domestic
economies, but simply seek to net financial gains in tax havens which exist to
reinvest in other tax havens, stock buy-back schemes, or unstable derivative
markets, very little good bar the creation of dangerous levels of personal
credit opportunities arises for most people.
Similarly, if excise and sales
taxes are driven up and placed on most purchases of goods and services so that
income and profit taxes are low, working people and those who cannot easily
raise their wages or salaries are hurt more than those who can and who already
benefit from low income and profit taxes.
Time has shown that many consequences of such
wealth accumulation do little for allocative or productive efficiency in an
economy. Superyacht construction, which employs few, marginally benefits, as do
Martian colony plans and space tourism, for instance, but infrastructure and merit
good problems for the vast majority increase.
A knowledge of economics should
instead suggest to policy makers that progressive taxation, sound money,
restrained but effective government, national public infrastructure in energy,
transportation, and the availability of merit and public goods, and intelligent
balanced approaches to taxation based on income and wealth rather than
consumption make sense.
People who see that might also be
concerned with the limits of policy making, and would be aware of the idea of
potential government failure through public choice theory, and the Coase
theorem, and the necessity of private ownership, savings, stable real interest
rates, and the destructive capacity of personal and national debt.
Such an understanding could inform policy, tackle resource depletion and a gradual shift away from a hydrocarbon-based energy system, and allow for a higher quality of life whilst not taking an antagonistic approach to either public or private sectors. This could in turn lead to fair and effective economic management which could be scaled up or down according to constitutional and societal choices.
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