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The desperation at the heart of economic theory

Both  classical and Marxist economic theories end up positing ideal types who give unrealistic advice on how to run an economy. The first postulates bosses who are always desperate and the second desperate workers.

Jerome Braun
19 August 2013

We are rarely reminded that economists and the profession of economics have proven better at building models of economic systems, and of speculating about lots of possible and often temporary economic equilibria, than telling us which economic model will tell us the future, and which economic equilibrium will be the real one.  Too often, economic forecasters extrapolate trends and are surprised when the future is not exactly a continuation of the past.

These economic models have lots of economic assumptions built in that may or may not be realistic.  Those who claim that cutting corporate taxes will automatically result in companies rushing out to hire more employees are assuming that they won’t just keep the money.  As to why they will risk these added profits at a time when consumer demand is still very low, that is not discussed.  Instead there is merely the assumption that businessmen have a voracious, uncontrollable desire for endlessly expanding their businesses, and also for risking their capital.

It is the same kind of model building that predicted that when the Depression of the 1930s peaked at around 25 per cent unemployment in the US, and that because prices were also falling, the 75 per cent who were employed would then splurge and create an economic boom.  That this 75 per cent were too frightened about their own economic prospects to risk whatever money they did have, and that even falling prices would not create a demand for five meals a day instead of three, conflicted with the economic assumption of people's almost insatiable propensity to rush out and consume a greater quantity of products whenever they became cheaper.

For that matter, economists with their supply and demand curves during the 1930s may well have predicted that American automobile manufacturers who had 25 per cent of the potential market would surely aim to increase that to 50 per cent, as if they were sure they knew how to do so.  And of course they would succeed because manufacturers were never satisfied with what they had, as if they were not rich already, and would always expand to get more.  Ergo, the self-correcting market would ensure that the Depression would end shortly.  But it didn’t.

For those who nowadays are sure that the U.S. would be better off if the present-day auto worker unions are busted and the auto workers’ wages cut in half, there is again that pesky assumption that the savings would be passed on to consumers, and not just be kept as greater profits.  And even if the savings are passed on to consumers there is still the question of how much better off the consumer would be and how much worse off the auto worker would be.  After all, every once in a while there is public discussion here about how farm labourers who pick our crops are grossly underpaid and have poor working conditions, and how this could be remedied by the public paying, for example, around 5 cents a head more for lettuce.  This way, the cost to the public would be minimal, and the benefit to the farm worker would be large.

In fact sometimes the public does not benefit greatly from scrounging for ever greater cost savings for themselves as consumers at the expense of their own selves in their other role as workers.  Nevertheless, in general we are told by economic theorists how the marketplace apportions the benefits and costs between the workers who make the products, and the consumers who use them, as if any loss in wages to a particular group of workers always benefits them as consumers proportionately, so no one is ever worse off.   Tell that to poorly paid workers, especially the part where you say no one can ever be poor, because poverty is then balanced equally by cheap prices.  Tell them that bosses always pass on cost savings to consumers, and never keep them, and that when prices do fall, consumers always buy ever more quantities of these products and so always create more jobs, rather than just pocket the savings.

Marxist economics on the other hand specializes in assuming that workers are always desperate and are always becoming worse off, even though its proponents are sometimes told by workers,  "Who do you believe, your theory or your own eyes?”  Proponents of classical economics assume that bosses are the ones who are always desperate, always with razor thin profit margins, and always passing on profits to the consumers instead of just keeping the profits and getting richer.

What all schools of economics need to do is to get better at finding out which of their theories and which of their built-assumptions in these theories conform to reality, both in the past, and certainly for the future.  Instead we have lots of ideologists, and lots of extrapolations from unexamined premises, and very little attempt to determine what the empirical reality will be. 

Instead, at least for some people, the 19th century ideology of Social Darwinism has now become resurrected, as if because leadership is useful for society, it should always be encouraged.  Ergo, if someone robs you, that person should be encouraged for taking initiative, by taking him home for dinner and then offering to give him all your money.  That way you can reward him for his initiative, which is so beneficial to society in general, though perhaps not in your particular case.

This situation of the state of the field of economics doesn‘t have to be dismal, and I don’t even have to give you the joke about the economists who, stranded on a desert island with cans of food but no can opener, propose to deal with this by saying, “assume we have a can opener.” This situation is only dangerous to democracy when politicians are told what they want to hear by people with some but not enough training in economics.   Then the danger will arise when the politicians confuse these tall tales and unexamined assumptions with empirical reality. 

The advice they give may be of the following sort: if people start getting lower wages, don't worry, this will always be balanced by lower prices exactly, and no one gets poorer ever.  This makes as much sense as Marxists saying, despite the advances in technology that increase productivity, and sometimes the reasonableness of their bosses, workers will only get poorer.  Sometimes to save the economy you have to start by saving us from the economists, or at least the wrong ones. 

There are any number of books out now relating to the causes of the Great Recession in the US that started in 2008: Simon Johnson’s and James Kwak’s Thirteen Bankers: The Wall Street Takeover and the Next Financial Meltdown, Michael Lewis’ The Big Short: Inside the Doomsday Machine, Joseph E. Stiglitz’s Freefall: America, Free Markets, and the Sinking of the World Economy, and one I very much recommend, John Cassidy’s How Markets Fail: The Logic of Economic Calamities. From Cassidy, we learn about markets that work, at least in theory, and those that have imperfections - externalities that the public at large must suffer through as a side-effect, like pollution that results from the production process, free riding which is so often the case for goods and certain intellectual discoveries that necessarily can be copied fairly easily, the whole issue of monopolies and oligopolies, and the motivated irrationality behind the bankers who realised that flooding the marketplace with risky securities, which they knew were risky but their buyers didn't, would eventually cause a market crash.  But as long as they could make enormous short-term profits they didn't care.  Too bad government regulators didn't care either. 

There is also the issue of winner-take-all economics, so ably discussed by Robert H. Frank and Philip J. Cook in 1996’s The Winner-Take-All Society: Why the Few at the Top Get So Much More Than the Rest of Us that discusses the kinds of competition that work well economically, such as the competition with nature to create more efficient production or just better engineered products, and the competition for status position that has an arms race quality to it.  In the latter, people compete with each other for status which drives up the costs for everyone, but with the end result of merely producing a status hierarchy that with mutual agreement (the best solution for an arms-race) could have been done much more cheaply for everyone concerned. 

Understanding markets, and when they work well and when they don't, could save a lot of grief for the average citizen, if not necessarily for politicians who believe the self-interested stories they hear from lobbyists.  You know these kinds of stories: that their clients don't need government monitoring, but merely government subsidies, just like markets are automatically self-correcting.  Sometimes those two interventions of government go hand in hand, for if markets really were self-correcting, they wouldn't need subsidies either.  And yes, government can become overbearing in monitoring how the public's money is spent.  The blame for bureaucratic inefficiency in both government and in private industry always has much room for growth, and the market is never too small.  Indeed for the public there remains the common belief that proper attribution of blame for markets that don't work as well as they should for the foreseeable future will continue to be insufficient to meet the demand.   

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