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When Economics Fails

I have been working on this, now what feels like a year overdue.  Look for more this week.

Economics is nothing more nor less than the study of the primary way in which people connect with society and get on with their lives.

In everyday life, you may interact with a few people – family, colleagues, and friends. But through the process of eating and paying the mortgage you interact, at some distance, with hundreds more. Because this interaction is entirely through something called “money,” a way of keeping score, it’s very tempting to look at it entirely through numbers. The dizzying details of tens of millions of exchanges every day makes a top-view in bulk the most desired method of analyzing how things are going.

Yet this process has proven wrong over and over again. The failure of economics, particularly macro-economics, is the primary reason why the only true study of an economy has to be a People’s Economics.

Vive ex Machina

The very idea that it is possible to get some kind of read on this massive thing called an economy in bulk is a product of the industrial age. The more the world came to be a series of whirring gears in need of motivating force and occasional maintenance the more it seemed desirable to even try to create something called “macro-economics.” This is nothing more than an analysis of where the money is at any one moment. Balance sheets, surveys, and contracts hold every number we need to understand and eventually control our world, the theory goes, awaiting only the right math to render it all into wisdom.

After the mechanical horrors of World War II it was a widely accepted belief that this mechanical approach would deliver us into some kind of mechanical paradise.

There is work to be done.

The problem with all of this is that it has not only failed, it has failed repeatedly pretty much from the moment it was implemented. It’s an approach which works very well in static conditions when everything is going along fine, but it has proven lousy at predicting the crises and shortcomings of our system. If analysis is going to have any use at all it would be when things change or go wrong – and indeed an economy based on technology is an economy based on constant change.

What we have now fails whether you look at it from the left, right, or center. This is not a political problem.

A good article on the problem with modern economics from a leftist perspective can be found in this undated article. They are summarized at the top very well, and boil down to this:

  • Economics has no respect for nature and resources,
  • The models are all built on unsustainable consumption, and
  • There is no place for resilience in the systems we have developed.

In short, the primary argument is that economics as we have come to understand it today is unsustainable. This is important to the left because the advancement of any social goal you can name – civil rights, equity, or environmental protection – is going to perform better in a sustainable world where individuals are not compelled to compete for every small scrap they can grab ahold of.

It always takes a little more.

That’s not to say that modern economics has many defenders on the right. As the “General Theory” of John Maynard Keynes was still hardening into the basis of modern economics it met its detractors form the outside. Henry Hazlitt was a journalist for the Wall Street Journal when he summarized the in his 1959 book, “The Failure of the New Economics,” now considered a foundation of Libertarian thinking. To Hazlitt, the problem with the era of macro-economics of Keynes was that had no concern at all for constant improvement and favored ever bigger intervention:

Because Keynes, with his lump, aggregate thinking, is opposed to restoring employment or equilibrium by small, gradual, piecemeal adjustments . . . we must achieve the same result by inflating the money supply and raising the price level, so everybody’s real wages are slashed by the same percentage. . . . The Keynesian remedy, in short, is like changing the lock to avoid changing to the right key, or like adjusting the piano to the stool instead of the stool to the piano.

These two are contrasted with each other here for several reasons . They are both criticisms from far outside the field by observers dismayed with the “product” that modern economics is in effect selling. They also have a unique symmetry to them in that they both decry an aversion to details – a key feature of macro-economics as we have come to understand it. Both of these observations come from the same perspective, after all. Macro-economics does not produce a product for them. It is designed for those who run things at various levels of government, not for the people who supposedly elect these leaders in a democratic republic.

The product was never designed for free citizens making choices in any social or political system.

Awaiting real leadership.

So, then, let’s take a look from the perspective of the managers of our world. If they are in place to make the best decisions possible for the people of this great republic, what is it that they really need? The ability to predict the future has to be the top definition of utility for any policy maker. After all, the wheels of government naturally turn slowly in the consensus-based system defined by our constitution.

So how is the predictive nature of today’s economics?

Bloomberg columnist and finance professor Noah Smith has studied the last official recession, in 2008. His conclusion comes from an in-depth study on that phenomenon, well predicted by the markets but not by economists. To him, it comes down to this:

Recessions just aren’t very predictable from economic data. The reason economists couldn’t foresee the Great Recession isn’t that they’re blinkered or closed-minded or arrogant or stupid – it’s because no one could predict it, at least not with the kind of macroeconomic data that now exist.

Where does this leave us? The conclusion is inescapable. Economics, as we know it now, is not suited for any kind of democratic politics – whether it is progressive or conservative. Nor is it particularly effective for anyone charge with the careful management of things from afar.

The future is theirs. Let’s make it bright!

What use is the mechanical, mathematical macro-economics which we have come to rely on? The long and short of it is that a large part of today’s politics, left and right, is based on the observation that something is deeply wrong. Voters, with great intuition if not always perfect logic, have it mostly right.

The truth is that no one actually knows what they are doing because the basic science which supposedly drives policy is deeply flawed. We really don’t know what we are doing and It’s long past time we admit that and simply start over.

That is the need for a new economics. That is the need for People’s Economics.

2 thoughts on “When Economics Fails

  1. Economics is the study of how ‘scarce’ resources (everything is assumed to be scarce in the short-run, but not scarce in the long-run) are allocated. Economics has always existed in its various guises. The economics in medieval western Europe was determined by social organisation. The dominant economic ideology in Early-Modern Europe was Mercantilism. Economics today is based on capital, that is slightly different to money. Carrots were produced as they are produced today. Goods and services were created and traded before the time of Abraham. The first services included hunting, the making of meals or washing the dishes. The first goods to be produced were the making of clothes, eating implements and hunting implements. ‘The economy’ didn’t just invent itself overnight with the first factory, on July 4th 1775 or when Adam Smith published ‘The Wealth of Nations’ in 1776. Economics informs debates on Capitol Hill. Most economic decisions are made by private individuals – the US economy has a bigger private sector than the UK. The public and private ‘the economy’ is the collectivised economic activity which happens in a defined geographical space. The economy became more complex when society became more complex.

    Money is the most efficient tool for doing that because bartering relies on the double coincidence of wants – for me to sell a cow someone else has to have something I also want, in the same way when I wanted that cow someone else had to want something I have. Money is a way of offsetting that missed connection. In the UK money is the substitute for gold – on each note there is “A promise to pay the bearer of this note x gold [sovereigns]”. In effect a currency coin or currency note, is a credit note. Money is reliable because $5 is worth $5, like £5 is worth £5.

    The price, in terms of supply, is the marginal cost of producing the next one. Its not the cost of producing one, but the cost of 101 when 100 are produced. A business has limited resources at any given transaction moment and so to produce the 101st the business requires an invest in what it needs (land, labour, capital and enterprise) to produce the 101st. Depending on how easy that is, different firms will. The price, in terms of demand, is the cost of forgoing the next best alternative and how much utility an individual puts on the item or service being produced and consumed. All that matters for the economist is that markets have an equilibrium – the right number of goods/services are being produced for those who demand the goods/services.

    Obviously there is interaction in economics, but that’s a social thing. Humans are deemed to be social creatures, so its society generating social interactions rather than economics generating social interactions for the sake of interaction. Social groups also exist outside of economics: cultural groups, family and friendship groups being the most obvious. Economics does create social groups, regarded as class, so interaction and social gathering is inclusive of economics, but by no means limited to economics. These days, I can make a purchase without having to interact with another human being. The goods in a warehouse might also be sorted by robots and only overseen by a human mechanic. That can be paid for on a debit card, so there’s the person working at the bank branch missed out of the transaction. Some markets in corporate finance are run by algorithms with, again, only a human mechanic to make sure the printer’s ink cartridge is full when the time comes to print the accounts off for auditing or security personnel to make sure nothing is physically stolen (or apprehend a person if something is stolen). Even then data can be mined by a computer virus, so its not a perfect system.

    Economics, the market, fails when the goods/services too much or too little is produced. The market can’t and won’t deliver everything. The cause of any market failure is when not enough accurate, full and trustworthy information is out there. How can people make the right decision (a policy maker in government or a business decision be made by a person – ‘the government’ or ‘business’ is short-hand for the collective people in those institutions and organisations). Of course, there’s a profit motive for doing nothing in the short-run, but those decisions can be corrected by the Government in the form of taxes, quotas or the banning of production. Look at environmental protections, the UK’s sugar tax. The market can’t produce less demerits, if it doesn’t know what is produced is bad, likewise with producing not enough merits. Think of ‘the state’ in terms of Hobbes’ Leviathan – the State is the embodiment of the people it serves, a function of society, rather than the end goal of society. Some believe the need of a state (be that a Court, Dictator, Theocracy, Technocracy, Oligarch, Monarch, President or Parliament etc) because there should be a neutral arbitrator in disputes. Other forms of market failure happen when a firm over-charges for a product. That means too much is cost is created in a situation when more benefit to the consumer can be obtained. Its an inefficient use of resources.

    How does the market provide security? One cause of the English Civil War was when people inland were forced to pay Ship Duty to help pay for a navy. However, those inland would have benefited from an invasion being stopped. There’s no way of excluding someone from the stopping of an invasion. Defence and security are public goods – non-rivaled and non-excludable. The same can be said for police catching a criminal, fire crews putting out a house fire and street lighting which make the streets safer. Courts are slightly different. You can exclude someone from the courts by saying you have to pay to get your case heard. How does the market produce less de-merit goods/services? Pollution that leads to poor health is a demerit can be overproduced. How does the market produce more merit goods, like healthcare? Its not only a good thing for the individual, but a good thing for society*. Individuals benefit, those around the individual benefit, business benefits (from not having to constantly hire and train people) and government also benefits from good heath care. Education is also a merit good. ‘Fairness’ is also something that the market on its own cannot deliver. Socially bad things happen when a society is fixed in an unfair way. This can be expressed in many different ways too.

    The use of mathematical economics, is that predictions can be made, based on past behaviour. Political economy is the State/Government fine-tuning things with mathematical models. However, predictions can’t be made with any certainty because of the assumption that goes in to all economic analysis: “Assuming all other factors to be equal”. However, populations change on a macro level, people and their situations change on a micro level. Policy changes. People become aware of non-economic factors involved in a transaction. This all causes economic behaviour to change at the micro and macro level. Marco statistics like economic growth, unemployment and the fluctuation of prices use Mathematics. Its often expressed as percentage, so the equation is: (change divided by base point) times 100. The figure will be 0 or -/+x%. Maths is used all the time in economics – “If a product costs x, then how many single dollar-bills will I need and how much change will I have?” Its even used when coming to define cost and marginal cost, as well as the marginal benefits.

    Anyway, what do you really mean by “people’s economics”? Economics doesn’t change for poor people, rich people, businesses or governments. Economic power might be different, but the principles don’t change. £5 is still £5. There’s no ‘rich person’s’ magic to make a £5 in to £5000. Bias exists because of societal, or structural, biases rather than economic bias. Interest paid on deposits is a bank’s reward for saving and investing with a particular bank, rather than a conspiracy of rich people for rich people. Economies of scale exist for big firms because they are big enough to utilize economies by being big. Some economies of scale are at a market level. Cluster developments are the best example. Clusters like the City of London for banking, Silicon Valley for computer technology mean there is already a cluster of people with knowledge working close by. That’s a economy for a firm recruiting because the chosen candidate working close by doesn’t have to relocate. As well, knowledge and experience comes with that candidate. In the past, an example might have been a power station built close to a coal field. These economies of scale have developed over time or at a decisive moment, like a merger or takeover. Some firms suffer from dis-economies of scale. A firm basically becomes too big and lumbering. The UK railways, when nationalised was just British Rail. All the stock, locomotives, everything belong to British Rail. Then bits of the network were turned in to cost centres (Intercity, Regional Railways, Network SouthEast and the various freight services) and were allocated there own provision. Maybe the question was “How can we achieve economies of scale?” because the subsidy was proving to be an unreasonable opportunity cost for the government (be that higher taxes or less spending on the NHS or education, prisons, defence etc). A perfectly competitive market is a competitive market, which is different to a competitive market in which brands exist, which different to a market where there are only a few firms or, rarer, where there is only one firm in the whole market. The economy is a factual, functional, entity. People’s experience will be different. However, economics unlike in politics, the experience doesn’t then change the facts or the function.

    The point you make Hazlitt is valid, but not accurate. I regard that as a more neo-Keynesian perspective because its still advocating demand management, but in a more refined and precise way. Keynes was arguing against non-intervention and interested in saving capitalism at a time when the Soviet Union was going from an economic backwater to an industrial superpower in less than a generation, but at huge human costs caused by the illiberal policies of people with authority and power shooting people who disagreed with Stalin’s ideas. Even Stalin’s policies of collectivisation and economic planning were economic policies. They, interestingly borrowed from the American economic ideas of Fordism (mass production) and Taylorism (rationalisation). Keynes advocated paying one person to dig a hole and pay someone else to fill the created hole. That’s fine for stopping unemployment in the short-run. However, what does it do for the long-run? Applied Keynesian policies included building the Hoover Dam in the US or the building of the Autobahns in Germany. The UK’s answer to the Wall Street Crash of 1929 was to go back to the gold standard (fixed exchange rates based on the value of gold). Others policy options include cutting taxes, increasing government spending, devaluing currencies to promote exports. Keynesian policies failed when they were used to control cost-push inflation. The analysis, not the logic, was wrong. The policy choice is dependent on what is causing the problem. Some economists will swear blind that resources are never used to their maximum potential, others will swear blind that firms have let costs get out of control and that business is pricing itself out of opportunities. Some economists believe that an economy can have too many people, or other resources, employed. The point is called the Non-Accelerating Inflation Rate of Unemployment and beyond that point inflation happens exponentially, that inflation causes inflation, cost-push inflation occurs to catch up with inflation. However, NAIRU is only valid if you believe that inflation is the primary problem for an economy and that slack in the economy can absorb some of the shock of sudden inflationary pressures. The rapid inflation the UK was blighted by during the 1970s was caused by the tripling of oil prices by OPEC as a result of the Yom Kippur War of 1973. This was exacerbated, in the UK, by the 1972-74 miners strike resulting in a three-day week and people doing work by candlelight, strong trade unions and other markets which weren’t as free as they could have been and inefficient state-run industries. That said,these problems were accepted because there were other goals deemed to be more important than controlling inflation. One argument for the shift to concentrating on inflation was that uncontrolled, run-away, inflation leads to unemployment (a little bit of inflation is good as it increases the incentive to spend). In the long-run, non-intervention will cause the economy to get back on its feet, but at what cost? The UK’s welfare state isn’t about rewarding the feckless or lazy or to interfere and manipulate private markets in a communistic takeover of capitalism. The welfare state was advocated Beveridge, so people could escape the five giants: disease, idleness, ignorance, squalor, and want. Perhaps it was also advocated in response to WWII, the rise of Communism and Fascism or Nazism. Perhaps the welfare state was an alternative to all four possible reasons. The welfare state, is also an applied Keynesian idea, is also used as an automatic stabiliser for the macro-economy, a safety net to stop the whole economy crashing through the floor.

    Marx’s analysis falls down when he says that its people’s material, economic, condition that is the determinant of outcomes. He forgets disability, gender, geographic/environmental conditions, nation, political identity, race etc. However, to be fair, Marx was writing at a particular time, in a society transitioning from that to this society. In contemporary society are less rigid. In the past, it was easier to make causal links between ‘class’ or ‘position’ and outcome. The other problem with Marx’s analysis is that it proves what its already assumed – that capitalism is immoral. Its not. Capitalism is a-moral (neither moral nor immoral, but a function of supply and demand – there are causes of and consequences to transactions, but no ‘right’ or ‘wrong’ other than the morality/immorality we ourselves impose on to the transaction). One can also accept consequences, but argue “Its a price worth paying…” or “So what?” It was Locke who is credited as being the first to philosphise about property in an abstract sense. The Barons who made King John sign Magna Carta first felt property existed, but reacted to events. They thought property was passed down from generation to generation and there was no need to ‘prove’ property because property had always existed like that. King John also came up with a concept of property, but that property belonged to the Crown and anything else was there for the taking. Magna Carta is a document that formed arbitration between the two different views. The King probably signed Magna Carta on the basis of numerical sword advantage to the Barons. The Europeans who went to The Americas had a similar idea. Capitalism doesn’t work, doesn’t work at all rather than just badly, without property rights.

    *I’ve assumed society to exist because of AJ Ayer’s argument that language proves the existence of other people, a wider society than just the individual. Ayer argues that language is an ‘other corrected’ communication. We use communication to interact with others. In other words, his argument is: If society was a creation of an individual’s mind, then there is no point to a shared language because, if every other is in the mind, then the other is just an extension of me and I know my own thoughts. Also, if there was no need for a shared communication method, then there is no point of correcting communication. Of course, the point of society falls down if you take the Thatcherite point of view that “There’s no such thing as society. Only individuals and families.”

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