Rethinking Liberalism 2: economics

The discipline of economics pervades all reflection on public policy. This is only right, as it is this discipline that tries to reconcile supply and demand for resources, and present a rational framework for choices. But it can be pernicious. It can frame the policy debate in the wrong way. As we refresh liberal policy ideas so as to put sustainability and human needs at the heart of public affairs, this is becoming a major problem. Liberals must challenge many tenets of conventional thinking.

First of all, let me say what I’m not going to talk about. There has been much heated debate on the value of austerity policies in tackling the recent economic crisis. I have read some liberals who say that “Keynesianism” is a core liberal belief, something given added resonance by the fact the Maynard Keynes was a Liberal. These tended not to be professional economists, who are careful not to label their beliefs with the name a of a dead economist, however inspirational. And it is based on a misunderstanding that Keynesian policies implied free public expenditure at all times, rather than being a temporary measure in response to a short term crisis. The problem that I have with economics applies as much to conventional, liberal “Keynesian” economists, such as Paul Krugman, as it does to the neoclassical ideologues – though the liberals are the more pragmatic, and the more likely to support changes to the conventions of the discipline. Having said which, I am sure Keynes would have recognised the value of what I am trying to say.

The problem that I want to deal with lies at the boundary of what professionals call “positive” economics, which refers to the factual or “scientific” side, and “normative” economics, which deals with policy recommendations, and where personal value judgements play a role. Much normative economics is presented as if it positive. Policy makers have taken simplifying assumptions used in positive economics, and used them as the basis of concealed value judgements.

I need to get more specific. These are the sorts of things I mean:

  • Economic growth is good for a society and should be an objective of public policy.
  • High productivity, the key to economic growth, is therefore a critical policy objective.
  • Free trade promotes economic welfare and drives economic growth forward, and should therefore be maximised.
  • The more people consume the better off they are, and the healthier an economy is, provided that spending does not outreach income.

I could keep going. The issue is not that these assumptions are wrong – they have served policy makers well – it is that life is not as simple as that, and we should always question them before using them in the decision-making process. And increasingly they are taking us in the wrong direction.

To be fair, economics does not stand still. I did not put on that list that aggregated income is the critical measure of success, and how it is distributed is of secondary importance. Economists (some of them at least) are at last seeing through that idea, which had been universally accepted. Also a worship of open market mechanisms for allocating resources is coming under question. And indeed, you can have perfectly sensible conversations with professional economists in which it is clear that they understand the limitations of their discipline. But when they get back to their desks and analyse policy options, the same old things keep coming up.

The result is that policymakers are trying to push the economy in a direction that it does not want to go. Growth remains obstinately slow, distribution becomes more skewed, public services struggle for funding. We worship highly centralised, “efficient” and specialised models of business and public services that are failing to meet human needs. And we are heading in slow motion for an environmental disaster.

Economics needs to adapt to the modern world. To do so it must start to take on board ways of thinking. Consider the following, none of which are particularly wacky in terms of economic theory, but all of which undermine the conventional wisdom of public policy making.

  1. Wealth must circulate for a healthy economy. This is the main idea of George Cooper’s book Money, Blood and Revolution. If wealth is accumulated by a rich elite, it drains the life out of an economy because they don’t spend it, or don’t spend it efficiently. They save too much, and the bulk of their saving goes into unproductive assets and speculation, and not enough into productive investment. Worse, they use their accumulated wealth to skew the workings of society in their favour. This presents an economic argument for progressive taxation and the taxation of wealth – as well for trying other interventions which distort the way incomes are set.
  2. Consumption should be optimised, not maximised. Once basic human needs are met, the utility of consumption rapidly diminishes, and often gets tangled in a zero-sum game of status competition. This challenges the idea that economic growth is the be-all and end-all, as well as bringing distributional issues to the fore.
  3. Don’t confuse the acquisition of wealth with its realisation. This is a related point. The conventional wisdom, based on the gods of maximising consumption and productivity, is that we should go out in the world and work as hard as possible for the common good. But what if somebody wants to work less and consume less? Or if she prefers to consume less goods, but which are made in a less “efficient” way (organic vegetables, say rather than mass farmed ones, for example). Provided that she does not consume more than she produces, does this really matter? What is the point of piling up wealth if we can’t use it in the way that we want? Economists frown on organic vegetables as they reduce productivity, but the ability to choose such low productivity goods is a sign of a wealthy society. They are confusing the creation of wealth with its realisation. This suggests that the more developed a society becomes, the less worried it should be about productivity and income growth.
  4. Trade is a means to an end, not an end in itself. No human activity has done more to banish poverty than trade. Yes we should celebrate it, and yes protectionism usually ends badly. But there comes a point when its uses diminish. Trade between the developed world and China had economic benefits when China had a pool of very unproductive agricultural labourers who could be used to make cheap industrial goods. But these benefits diminish as China catches up, and as this happens, it is more than likely that the volume of trade (and its benefits to the developed world) will diminish. That’s economics. Don’t panic. The party was fun while it lasted. Globalisation remains key in the world of information and ideas. Trade of physical things remains is important to helping undeveloped countries to develop (though the locus of that trade is likely to be mainly with middle income countries rather than developed ones, as these bulk larger). But trade of physical things over huge distances is not so important for the sustained progress of developed economies.

Liberals should believe that an economy should develop based on free human choices, long term sustainability and a degree of human solidarity which diminishes with distance. Increasingly human preferences, technology and world development will take us away from the mass-produced, high productivity, high consumption, global trading society that policy makers favour, guided by economic conventional wisdom. It isn’t what people want (free human choices), it isn’t sustainable (carbon emissions and world resources) and it is less needed for human solidarity (developing countries are increasingly able to look after themselves, while the need for more localised solidarity grows). The discipline of economics needs to catch up.


Rethinking Liberalism 1: capitalism

In my last post I suggest that liberalism, and its British variant Liberalism, had lost its way. To many people it does not address the key issues of today, and looks to be a political irrelevance. I want to address this by thinking about how liberals, and British Liberal Democrats, should deal with these critical issues. In my first essay I will take on the burning issue for the political left: what to do about capitalism?

To get a flavour of how some on the left are thinking, read thus piece by David Graeber in last weekend’s Guardian: Savage capitalism is back – and it will not tame itself. Mr Graeber is a self-described anarchist, who wrote Debt: the first 5,000 years, which I reviewed last year. His view is that the capitalists are taking over the political system, and pushing everybody else into effective slavery (though he doesn’t put it quite like that). Stopping them will take more than a bit of polite political debate and a few tweaks to the tax system. He has jumped on the Thomas Piketty bandwagon, appropriating the French economist’s recent book to his cause. He says that it shows how the capitalism is reverting to it natural state whereby the wealthy accumulate the lion’s share of the riches. Mr Graeber is somebody I find extremely annoying. But he says a lot of perceptive things, and he should always be taken seriously – up the point where he runs dry and turns silly.

What do I mean by capitalism? It is best seen as the marriage of two ideas: maximising the reach of open market trade, and a system of private ownership for accumulating gains from trade. Both ideas are initially appealing to liberals.

Let’s start with markets. To many, the use of free competitive markets is the ultimate form of democracy. Consumers choose freely, and the producers must adapt themselves to consumer demand. This idea has currency on the political right, who think markets should replace many functions of government, and reached into Britain’s New Labour project under Tony Blair. There is some truth to this view, but there are limits. There are two groups of arguments against the extension of open markets: those concerning economic efficiency, and those concerning human preferences.

The arguments concerning economic efficiency are rehearsed often. Efficient markets require information and trust; these can be expensive to maintain. This gives rise to the shape of the developed economy, which is dominated by large organisations that are run using command and control methods, not market exchanges, and by strong governments that are required to maintain the institutions that allow markets to flourish, and supervise the delivery of services that markets cannot provide efficiently.

We talk less about human preferences. Market exchanges are of their nature transactional; they require very little of human relationships. Once the deal is done, the parties walk away from each other. The word “arm’s length” is often used to describe the arrangement, with the suggestion that markets will not be efficient unless transactions are conducted at arms length. Such arrangements do little to satisfy many human and social needs. People choose to limit market relationships to only part of their lives. If we lend a friend a hedge-trimmer, we don’t ask for anything in return, still less establish a fair price – because that would be inimical to friendship.

So markets are constrained by the requirements of efficiency on the one hand, and our preference for cooperative, trusting relationships on the other. But, if we allow for these important constraints, free markets are a vital part a modern, liberal society.

But that is only one side of capitalism. But, as its very name suggests, capitalism is about much more than this. It is about wealth and capital. The profits from trade are retained by owners of businesses, capitalists. The capitalists then invest this wealth. To optimists this is a thoroughly benign process: new businesses are created, which help economies to expand and innovate, benefiting all society. To pessimists the wealth is simply used to maximise status and power. In Mr Graeber’s view an important dimension of this is the loaning of the wealth as a means of establishing power over the debtors – a dynamic that has a long history. Both optimists and pessimists have a point.

On the optimistic side, investment and laons in modern society do not lead to enslavement as they used to. Expanding economies provide many opportunities to pay debt back. Furthermore modern legal systems place severe constraints on the power of creditors. They used to be able to cart your children off as slaves, even after your death. They aren’t allowed to nowadays, and there are many ways, through death and bankruptcy, by which debts are extinguished to the loss of creditors. Furthermore, the instruments of ownership, shares and bonds, are mechanisms by which wealth, and power, can be distributed more widely through society. It is the basis on which the middle classes, who form the bulk of a developed society, maintain a degree of independence.

On the pessimistic side, there is a tendency for wealth to accumulate amongst an elite. And for the last generation, it seems that this elite is growing while the fortunes of the middle and lower classes stagnate – one of the central political challenges of our time. There four interrelated sets of problems that should worry liberals:

  1. The capitalist system is creating an elite who are gaining undue political influence, which is tending to perpetuate their own dominance.
  2. The amassing of wealth, only a small proportion of which is invested in new production, is slowly suffocating the economy as a whole.
  3. The poor, and even not so poor, are finding their market power is diminishing, reducing their overall power and control that they have over their lives.
  4. The relationship between the capitalists and their employees, and, all too often, their customers is often abusive and exploitative.

There are alternative ownership models to the capitalistic one: state ownership; cooperatives including customers and/or workers; non-profit enterprises with non-commercial aims. But each of these carries its own disadvantages; it is difficult to see how a healthy economy can work without a large component under capitalist ownership.

So what are my conclusions?

  • The capitalist system remains essential to a modern, liberal society. Without it life would spiral into even greater depths of poverty and exploitation.
  • The capitalist system is only a part of that that modern, liberal society and should be confined to those areas where it is efficient, and where people want it to be. It should be part of a diverse, pluralistic system.
  • There should be specific measures to counteract excessive power accumulated by capitalists, and protection for those vulnerable to exploitation.

So that set’s a general tone. It is different from the hard left, like Mr Graeber, that wants the capitalist system dismantled entirely. It also differs from the far right, that wants the capitalist system extended into further areas of society, and for the capitalists to be given more power over their employees and customers. But it covers a broad spectrum of views, from mainstream left to centre-right. Any distinctively liberal ideas are going to come from precisely how the problems of modern capitalism are addressed. That is where my future essays will go.