Economics in the age of information. Why are so many conventional economists wrong?

It feels an unequal battle. On the one side are ranged distinguished Nobel laureates, such Paul Krugman and Joseph Stiglitz, formidable intellects such as the FT’s Martin Wolf, together with any number of media economics correspondents, bristling with PhDs. On the other there’s me with a trifling 2:1 BSc (Econ) awarded in 2008 by UCL. But I’m hanging on in there. Clever as these people are, I think that they are working in the wrong paradigm. The world has changed but their basic views as to how the economy works hasn’t.

In my defence I can usually quote some formidable intellects, though, pronouncing very similar views to mine, such as Adair Turner or The Economists’ Buttonwood column. In this post I sketch a narrative that explains how this divergence of views came about, and why so much intellectual firepower might be ranged on the losing side of the argument.

My narrative pictures the developed world economy moving through a series of ages,  each of which required its own style of economic management and analysis. This is a giant oversimplification, of course. But then the science of economics is a giant oversimplification, and not physics applied to the human sphere.

I start my narrative in what I will call “the age of heavy industry”. This is not the beginning of the story, of course, just a good place to start. This is the century leading up to 1945. In this period economic development is led heavy industry and the construction of public facilities. These include infrastructure such as railways, ships, roads, and houses; intermediate facilities such as coal mines and steel works; and, we should not forget, armaments.  Other things were important, of course: agricultural development released workers from the countryside; the textile industry provided an important consumer goods sector. But world leaders saw their nations’ status in terms of the big, dirty, heavy things. Railways and steel works; dreadnoughts and artillery pieces. “Guns will make us powerful; butter will make us fat,” Hermann Goering said, capturing the spirit of the age. Such concepts as GDP were hardly developed; by modern standards rates of economic growth were unexciting. The view that inflation rates should be small and positive was alien, as the world swung between bouts of positive and negative changes to prices. Classical economics dominated conventional wisdom. “Working class” was synonymous with “poverty”, something which cut through political discourse, and many simply assumed was an inevitability.

After 1945, and starting in America,  this morphed into the age of light industry. Suddenly the domestic consumer became the leading driver of the economy. Technologies developed in wartime – such as plastics, motor vehicles, antibiotics – transformed the lives of ordinary people, and their production and distribution created stable blue and white collar jobs in a virtuous circle of job creation and consumption. Growth was led by increased consumption of ordinary things like cars and fridges; alongside this grew a service economy to support the growing wealth of ordinary people. The Soviet Union, stuck in the mentality of the age of heavy industry, was caught out completely, and in the end collapsed from a complete loss of faith in itself. All those steelworks, nuclear missiles and coal mines did not lead to economic power. Economically the management of GDP started to dominate everything, and an orthodoxy of demand management, whether through fiscal or monetary policy, became taken for granted. Arguments between different schools of economics were vitriolic, and yet they agreed on much. That inflation should be low but positive, for example, or that productivity growth would generate a steady, long term increase of national income, or again that distribution of income and the workings of finance were of secondary importance in economic management. And this is the world still inhabited by the those Nobel laureates, modified only slightly by recent events.  The problem with the modern economy, they say, is a lack of demand. It needs to be stoked up with fiscal or monetary policy; once this has been achieved rising productivity will get us back onto the road of steadily increasing income and the repayment of debt.

But the world has changed. Since the 1990s the age of light industry has been supplanted by the age of information. To understand this, think about a few ideas. First is the idea of satiation. People only need a certain number of things, after which increased consumption becomes pointless. There are still plenty of poor people, of course, but they are in a minority. and it is increasingly hard to understand poverty in terms of a lack of volume of goods in circulation. Many observers define poverty in relative terms, not in terms of physical benchmarks like nutrition and shelter. Thus you might be poor because you lack a flat-screen TV. Not because you need it, but because you feel excluded without it. It is clear that this kind of poverty is not going to be solved by cranking up the volume of goods produced.

Secondly, consider that often what people buy when they spend money is actually rather intangible. They pay a lot of extra money for the right label or provenance. These goods aren’t really being bought for their direct utility, but for what owning them says about the purchaser and where they belong. Again, these things aren’t driven by quantities that are consumed and plays havoc with quantitative notions like productivity.

Thirdly consider how the nature of technology has changed. Information and communications technology, and the services delivered by the new devices,  lead the way.  These advances are not, by and large, driving us into an ever rising cycle of consumption of physical things or even services. We are consuming experiences and information. and these things do not follow the standard laws of economics developed by Marshall and Walras who laid the foundations of modern economic theory.

And fourthly look what is happening to the nature of work. Those steady blue and white collar jobs are disappearing. Once they were considered demeaning and soul-destroying. But we valued the social stability they brought. Instead we have a world of work that is increasingly polarised, and where stability, in all jobs, is becoming rarer.

A further point is worth mentioning. Globalisation, and the rise world trade, especially between the West and the Far East has obscured many of these changes. Driven by the law of comparative advantage, developed economies gained from cheap manufactured imports in the 1990s and 2000s.  But this economic principle is driven by differences in the makeup of the trading economies. But each of the Far eastern economies, starting with South Korea and Taiwan and moving on to China, progressed and became more like the developed world. Comparative advantage, and gains from trade, are falling away. That party is now over. And as for the effect of global financial integration on national economic management… suffice it to say that this has profoundly changed the way nation monetary and fiscal policy works.

All these things point to a world that doesn’t follow the old macroeconomic patterns. Fiscal and monetary policies don’t seem to working as they once did. Variables such as inflation and productivity misbehave. These then join forces which old-fashioned economists understand, or should. Demographic change is reducing the number of workers as demand for labour-intensive health services is rising.

This creates a world in which economic growth cannot be assumed. Distribution of income and wealth becomes of primary importance, as does managing finance, and especially levels of debt. The world is ill equipped with economic models for this new age, and many distinguished economists are contributing nothing, especially when pontificating rather than basing their views on deep and up to date analysis of the data.

We have cause to be worried by the new trends, as it appears that much government and private debt might never be repaid. If that is gloomy, we should also reflect that this is a problem of success. The ages of heavy and light industry have achieved their wider purposes and left us with societies of unbelievable wealth and comfort. But we need to understand that improving the human lot requires a new way of looking economics.

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4 thoughts on “Economics in the age of information. Why are so many conventional economists wrong?”

  1. As an introduction to my comment on economics: If Danny was the most successful minister it was mainly because Vince Cable has been asleep at the wheel of BIS for four years. Also, he was the person who said of Merlin that is was “reasonable”, which just went to show how disinterested in microeconomics he really is.
    Your article is interesting but not helpful in relation our problems in the real economic world of work. Again, back to Cable: he tacitly accepts the policy of bonuses (as does Oakeshotte) and of cutting back on jobs in the public sector. So much for being the darling of the social libdems!
    The problem we have is of paradigms. The economists keep commenting as though there were only one kind of capitalism, i.e. that of the Anglo American nations, which has morphed into neo-liberalism with all its attendant distortions, exemplified by shareholder value primacy and bonuses. The kind of capitalism that has made Germany and Japan so successful at production and quality is never regarded.
    I think your paper would have benefited from an management ideology sweep rather than historical generalisations.

    1. Thank you John. I don’t think “asleep at the wheel” is a fair characterisation of Vince Cable’s time at BIS. “Hamstrung by coalition politics” would be much closer to the mark. Unfortunately his realm is one were big Tory donors take a close interest. Also he has not found a way through Treasury orthodoxy. His big political success has been the expansion of apprenticeships, which may not quite live up to its spin, but has been an important step.
      There may be flaws in my historical characterisation – but I’m not convinced by your one of “management ideology” either. The corporatist state approach of the early postwar consensus collapsed in failure in the 1970s. It lasted longer in Germany and Japan, thanks to much stronger solidarity amongst businenss, but in both countries deep flaws in the system are evident. It is incompatible with the free-wheeling notion of businesses dominant in the UK (and the US). The French dirigiste approach also looks deeply flawed. I am deeply suspicious of anybody who uses the word “neoliberal” to describe any kind of system of thought – as I don’t think it describes anything real or coherent. But we are in a mess now, and stumbling to find answers.
      And as for cutting back the public sector – there’s just not enough money left over from taxation and benefits. The British public sector had become bloated and much of it will not be missed. Which is not to say that a large public sector isn’t going to be needed in the future – but it needs to be managed in a wholly new way (and I’m not referring to the flawed experiments with outsourcing that this and other governments have been playing with).

  2. Matthew,
    Sorry about the delayed reply. I have been granddaughter-sitting.
    I won’t respond in order, rather thematically.
    First, Vince Cable: I worked on the Government Construction Strategy Team for two years. In that time I saw Maude, in particular, taking more and more key work from BIS, while Cable acquiesced. For example, although the lead, the Chief Construction Adviser was then based in BIS, the team was in the Cabinet Office. Eventually he ended up reporting to Francis Maude! Now given how fundamental construction is to “business” and to economic recovery, you have to ask why Cable let this happen, and why 700 school building projects were closed down early on his watch – not to mention, to this day, no industrial policy. I think he still mourns his departure from the Treasury, and has let the opportunity to run the most important department for the private sector slip away to the neocons.
    At a speech he gave at a business dinner near Harrogate a couple of years ago he said airily that it was inevitable that jobs had to be lost in BIS, as though he was a business magnate closing down unprofitable branches. I think he thought this would give him some sort of credibility, and this leads me to my next point. As an aside, you commented on the “bloated public sector”, and the need to shrink it. Just where did you get the evidence for this? I have worked on and off with the civil service since 1989 and I have never seen such hardworking and effective senior managers in any other industry, except, perhaps, construction. On our construction strategy project they were regularly working 12- 14 hour days, because they were short-staffed. Remember, in 1972 there were 732,000 civil servants. Today there are under 450,000 – a 35% decrease, while the SPADs have nearly doubled since 1979 – thanks to Thatcher, who triggered it all. They cost us over £6 million a year.
    It is not the number of civil servants that matters, it is the sheer volume and type of tasks many are given. Nothing to do with Tory donors who appear to have haunted Cable, but a hell of a lot to do with the mindless, valueless work of compliance, that idiotic complement of privatisation and “efficiency”. You and I agree here. The civil service “needs to be managed in a wholly new way.”
    Point three: This leads me to the relevance of neo-liberalism as an ideology, a term you say does not describe anything real or coherent. How on earth can you say that? What were the postwar consensus and the dirigiste if not products of ideologies around the importance of the state in macroeconomics? In the same way, what John Williamson named the Washington Consensus (without endorsing it) is underpinned by a system of thinking characterised by:

    To quote the redoubtable Susan George, “The belief in free markets (or the version being promoted) was very ideological…. From a small, unpopular sect (Chicago School) with virtually no influence, neo-liberalism has become the major world religion with its dogmatic doctrine” (George, 1999) This was promoted by the Washington Consensus and the post-Thatcherite “competition” dogma, most evident in the privatisation rules of the public sector. It is an ideology, and, as Stiglitz says in Globalization and its Discontents (2002, p 74) “Because in this model there is no need for government — that is, free, unfettered, ‘liberal’ markets work perfectly — the Washington Consensus policies are sometimes referred to as “neo-liberal,” based on “market fundamentalism,” a resuscitation of the laissez-faire policies that were popular in some circles in the nineteenth century.”
    And from that ideology comes a system of thinking about things.
    Unfortunately, this thinking can become just a habit and leads to untested assumptions about the object (business organisations) and their environment. This is what has happened to microeconomics in particular, which, in many ways is the least thought about aspect of economics. Witness the bland acceptance that economy of scale is a universally good thing, and that PRP and targets work. (When he was at the Cabinet Office Geoff Mulgan commissioned a study into the evidence for economies of scale in public-sector reform. The study found none. And all my research has shown the negative impact of external motivators)
    The big problem is that politicians and others have spent far too much time on the macro side of economics and not enough on the micro. This is like building a Formula One race track without really understanding how racing cars work best. – but it needs to be managed in a wholly new way. As you said, “we need to manage in a wholly new way”, and that begins with recognising the terrible influence of the neo-liberal paradigm and discarding it In ALL ORGANISATIONS. We can then have a further conversation about what this looks like, with supporting evidence.
    References
    Susan George, A Short History of Neoliberalism: Twenty Years of Elite Economics and Emerging Opportunities for Structural Change, Conference on Economic Sovereignty in a Globalising World, Bangkok, 24-26 March 1999
    Joseph Stiglitz (2002) Globalization and Its Discontents, London: Allen Lane

    1. Thanks for taking the trouble to respond again! I would like to respond to three things, and then try to draw out a general theme.
      Response 1: Vince Cable. My views were based on talking to two of his SPADs about how things work, or don’t, in BIS. I don’t know about the construction industry initiative though. It is worth pointing out that in 2005 Vince Cable recommended abolishing the Department of Trade, as it then was (I think).
      Response 2. Public sector bloat. My comments are based on interaction with a number of programmes in the last government – in particular Building Schools for the Future, Every Child Matters, and the NHS World Class Commissioning. In principle these were all good ideas, and no doubt many of the civil servants working on them were brilliant – but most of the money seemed to be spent on consultants of some shape or form, who generated piles of verbiage according to templates drawn up by other consultants, with as few actual decisions being taken as possible. I don’t have any particular axe to grind with the core of actual Civil Servants – but I don’t think that’s were a lot of the bloat is. The other aspect of inefficiency (which it is probably not fair to call “bloat”) is the compartmentalisation of problems into specialisms, which then fail to work together smoothly without it being anybody’s fault. That is as rampant as ever, and will take a complete rethink to address.
      Response 3. Neoliberalism. This seems to be a word generated by the political left to cover the turn away corporatist consensus of the 1970s and earlier. It in fact encompasses a huge range of approaches – neoclassical economics, neoKeynsesianism, monetarism, and whatever Alan Greenspan was thinking, to name but a few. There is very little actual coherence there – and many would violently reject the ideas of the Chicago School. The neoclassical economists accuse Alan Greenspan of causing the crash because of loose money policy. The Washington Consensus, if I understood it, referred to advice offered to developing economies, something rather different. If the idea of neoliberalism doesn’t make sense positively (i.e. it does relate to a coherent set of ideas), it doesn’t work negatively either – i.e. as being NOT something. No alternative coherent leftist approach is offered for it to oppose. Instead it is a collection of protests. And as for your idea that “neoliberalism” be “rejected”, I think the hard-edged ideological Chicago school approach (which seems to be what Ms George rails against) is already dead except in a few corners of the US. But markets are a good solution to some problems. What would have happened to China if it has not moved to marketise its economy? Of course China were totally pragmatic about it – but then isn’t everybody these days?
      Which leads to a general observation. What you call neoliberalism took hold as the end of what I call the age of light industry was coming to an end – but it was part of that age. People still thought that infinitely expanding consumer demand was the way forward. We can’t move on until we understand the particular challenges that the information age presents, some of which I have mentioned.

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