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.