“An economist is someone who sees something that works in practice and wonders if it will work in theory.”
This is a blog post about why I don’t believe a thorough understanding of economics compels one to identify as an economic conservative. I have noticed over the past few years that there is a trend among my generation to identify as ‘socially progressive but economically conservative’. I suspect that there are a few reasons why this label has become particularly popular, such as the steady transmutation of many identifying as ‘working class’ into an ‘aspirational class’. But I believe that one of the reasons is that it is generally assumed that anyone who knows anything about economics understands that a laissez-faire market, with a very small number of exceptions in cases of clear market failure, is the way to a prosperous society. I would like to put forward a case as to why developing a fuller understanding of economic forces actually lends itself equally well to a more progressive perspective on the economy. This is largely a reflection on my own experience of completing a degree in economics.
I would, however, like to preface this blog with the following. I don’t believe that a proper understanding of how markets operate (and how people operate within markets) necessitates a progressive outlook either. A number of my fellow economists are much more intelligent than I am and have developed a strong conviction that the free operation of the market is the means to better our society. It is simply my intention to challenge the preconception that one cannot have a complete grasp of the economy and simultaneously believe in progressive economic policy. My personal view is that, once you have developed a sufficient knowledge of how the economy operates, it is more likely to be the values formed elsewhere in your life that determine your political persuasion, as opposed to economics itself.
For the sake of clarity, I see ‘progressive economic policy’ as having three key elements: a significant redistribution of income; an important role for government in intervening in markets; and legislative backing for collective bargaining to have a role in determining the relative returns to labour and capital.
I’d like to break this topic down into two blog posts. Firstly, in this post I will talk about the important distinction that needs to be drawn between empiricism and ideology within economics, and the ramifications this has for a variety of important and topical economic issues. In the next post, I will talk about the role of economics as a prescriptive discipline, rather than simply an analytical one. These mightn’t seem like the most interesting themes on the surface, but I promise that if you read on you’ll find some pretty juicy stuff. I’ve split this topic into two posts to make it more digestible, but I would encourage you to read both posts before making up your mind on the topic.
Now, after that lengthy preface…
Economics as a discipline likes to frame itself as free of value judgments and normative biases. However, I would like to suggest that this is frequently not the case. Instead, economics has come to develop a kind of unquestioning faith in the market, and this frequently comes up against its desire to be a purely empiricist discipline (where empiricism refers to the idea that knowledge is chiefly derived from an interpretation of the sensory experiences, hence prioritizing the role of observation). I’ll give three examples that show how, in my view, restoring empiricism to economics would lead the discipline to side with more progressive economic policy.
The first issue I’d like to talk about here is the way we understand who deserves what in terms of the annual output (equivalently, the annual income) of the economy. Since the days of Alfred Marshall, a famous economist in the late 19th and early 20th centuries, the dominant view within economics has been that people more or less get what they deserve. What do I mean by that? If you haven’t studied economics, this will probably seem complex, but bear with me. In the economics jargon, you receive the value of the marginal product from employing your resources at the point of market equilibrium. What I mean by this is basically that, as the orthodox view goes, if you give up your labour or your savings, you will more or less get the market value of putting those resources to use. This market value is simply how much of the product (or products) is made by employing your resources (given how much is already being used), multiplied by the market price. Hopefully you’re more familiar with how the market price is understood to be determined – the intersection of supply and demand – so for the sake of brevity I will leave that part out of this blog post.
This way of understanding who gets what in the economy is known as the Marginal Productivity Theory of Distribution. Big name, but I’ve given you the general gist of what it means above – someone who provides their labour (i.e. a worker) will get the equilibrium value of what they add to annual production, as will someone who provides their capital. I want to suggest that this theory, while mathematically elegant and tidy, is in fact a poor reflection of the reality.
Rather, I think a more accurate representation was given by David Ricardo, a classical economist who made his mark quite a few decades before Alfred Marshall. Ricardo modeled the returns to labour and capital as interdependent. Indeed, for Ricardo, profits were basically what was left over for the owners of capital after labour had been paid their wages. When you think about it carefully, this is a far better representation of what we observe in the market. Perhaps the Marginal Productivity Theory of Distribution would be useful if we lived in a world with perfectly competitive labour markets where anyone could move to any job anywhere without risk of significant loss and a very large number of firms actively competed for each others’ workers. But that is just not the world we live in. If we exclude collective bargaining, firms (and, thus, the owners of capital) have nearly all of the bargaining power when determining wages. This means that workers will simply receive as little as the firms are able to pay them.
(I won’t go into the theories about where the price of labour then comes from, but let it suffice to say that I think Adam Smith’s theory on this is actually the most convincing that I’ve come across. Smith suggests that wages are benchmarked against the minimum socially acceptable standard of living at the time, and then adjustments are made for things like the desirability or complexity of the work and conditions in the particular labour market in question).
Why is this important? Isn’t this all just very theoretical? This issue actually has some very important practical applications. In particular, it suggests that there is no reason that labour markets will naturally deliver what is fair to workers. It seems to have become increasingly popular to dislike labour unions over the last few decades. In Australia’s case they perhaps do have some things to answer for, though I think this changing attitude is probably more a result of the aforementioned shift from a ‘working class’ to an ‘aspirational class’. I would also add that I believe it is very important for unions to negotiate reasonably, recognising the various pressures businesses face in a global environment, and to avoid militancy. However, I do worry that if unions fade into insignificance workers will no longer be able to exercise the collective bargaining power that is required in order to ensure they receive a decent outcome from the wage negotiation process. Certainly, I do not buy the argument that individual enterprise bargaining will deliver an ‘efficient’ outcome – rather, it will simply allow firms to extract more value from their workers. For this reason, I think a more careful examination of how markets operate in practice should lead those with a knowledge of economics to reconsider the merits of those policies euphemistically known as ‘workplace flexibility’ policies.
The second issue I’d like to address in this post is inequality of opportunity. A paper that I studied during my degree examined the issue of intergenerational correlations in income – that is, the correlation between what parents earn and what their children earn. This correlation, which is typically used as a marker for income immobility in a country, was startlingly high. In the US, the figure is around 0.5 depending on the measure you use. (Australia has better income mobility with an intergenerational income correlation of 0.2 or, perhaps, between 0.2 and 0.3).
This figure means that, in the US, there is on average a 50% correlation between what a person earns and what their child will earn (or a 20-30% correlation in Australia’s case). This fact suggests that that, in the Western world, we do not have anything close to an equality of opportunity. Rather, the income of your parents is a significant determinant in how much you will earn.
Much conservative economic policy operates on the (probably unintentional) assumption that every person has the same opportunity to succeed in the economy so long as they apply the same effort. If this were truly the case, we would expect the earnings of parents to be an insignificant determinant in the earnings of their children. The reality, however, is that, for a variety of reasons, it is significantly more challenging for a person from a financially disadvantaged background to avoid economic hardship, irrespective of natural talent. This in turn sets up cycles of poverty for disadvantaged individuals at the same time as the wealthy enjoy cycles of prosperity. It is not my intention to try and solve this issue in this blog post, but my personal view is that continuing further along the spectrum towards means-based funding for education will probably be the most effective strategy.
The more general point, however, is that to form an opinion on economic policy based on the assumption that everybody has the same opportunities in the economy is to ignore economics’ call to empiricism and to instead embrace a blind faith in the efficiency of the market.
The third issue I’d like to explore in this first part is the idea of the ‘economic problem’. One of my favourite pieces of writing on economics is an essay by John Maynard Keynes – one of the most influential (and controversial) economists in the history of the discipline – titled ‘Economic Possibilities For Our Grandchildren’. Writing in 1930, Keynes was speculating on what the economy would look like, and what economic issues we would face, one hundred years hence.
One of the most insightful parts of the essay is when Keynes reframes the ‘economic problem’. Anyone who has studied any sort of introductory economics would have come across the conventional definition of the economic problem – how we are to allocate finite resources in order to satisfy people’s infinite wants.
This definition, however, did not simply fall from the sky. In fact, it is attributable to an economist named Lionel Robbins, who was at the London School of Economics around Keynes’ time. Keynes saw the economic problem differently. For him, there were two categories of wants. First, those things that people want as a result of their basic physiological requirements – to eat, to be sheltered, to be comfortable, and so on. Second, those things that people want precisely because they distinguish them from others. These merely cater to our selfish desire for superiority. If you pause for a moment, I’m confident you will be able to see both these categories at work in your own life. For Keynes, the second category of wants are, by definition, infinite – the greater the general level, the more people will want. However, as his essay argues, there is no natural reason why the first category of wants should be considered infinite. For Keynes, then, the real economic problem is simply humanity’s “struggle for subsistence”.
This struggle has been the defining focus of our species since its first days. However, Keynes suggests that, as a result of the explosion in technology in the latter part of the second millennium and the effect of continued, compounded economic growth over a number of centuries, the economic problem should become a relic of the past sometime in the 21st Century. In fact, in Keynes’ prediction, it was about 15 years from now – we are surprisingly close (though of course Keynes was not aiming for precision). If you pause to take stock, this is actually a huge proposition. Keynes is saying that our species will have reached an epoch clearly distinct from any in its entire history in which our physiological requirements no longer demand our constant attention.
We are continually bombarded by politicians and economists talking about the need to maintain solid economic growth. The question we should ask is ‘What for?’. Are we seeking to further grow our economy to ensure that our physiological needs are better met, or are we simply trying to speed up the treadmill of conspicuous consumption? It shouldn’t take more than a cursory thought to realise that, if we are increasing our national income in order to increase the production and consumption of goods that are used simply to try and position oneself above one’s neighbour, the effect on total wellbeing will be negligible. It is a kind of zero-sum game, in which one person’s happiness is another’s discontent.
So what’s the alternative? Just to be completely clear, I don’t believe in Socialism, as I think it has the same tendency to ignore empirical evidence as free-market fundamentalism. What I do believe, however, is that we need to change our attitude, and change our culture. In his essay, Keynes recognises the gravity of his prediction, and writes that:
“For the first time since his creation man will be faced with his real, his permanent problem – how to use his freedom from pressing economic cares, how to occupy the leisure, which science and compound interest will have won for him, to live wisely and agreeably and well.”
Instead of obsessing over increasing our consumption indefinitely, we should start to think about how we can use the opportunities this epoch will present us with to live as decent human beings that appreciate the physical comforts we have and assist those who don’t share in our abundance, to invest in relationships instead of assets, and to stop and appreciate beauty rather than to try and consume it. In this epoch, we can afford to have a generous, progressive economic policy – there will no longer be any great need to buy into the conservative economic agenda of perpetual growth.
Of course, I’m in no way wanting to suggest that further economic growth is undesirable (though, of course, there are serious environmental sustainability questions that we as a society need to consider). However, I believe it would simply be a tragic waste for us to allow the pursuit of wealth to continue to occupy the number one position in our lives. In his essay, Keynes depicts the love of money in a world beyond the economic problem in the following cutting way.
“The love of money, as a possession (as distinguished from the love of money as a means to the enjoyments and realities of life) will be recognised for what it is, a somewhat disgusting morbidity, one of those semi-criminal, semi-pathological propensities which one hands over with a shudder to the specialists in mental disease.”