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Monday, 28 November 2011

Market Failure and Democratic Deficit

Adam Smith has been identified as the 'father' or the 'founder' of Political Economy [and of its more modern aberration, Economics] since soon after he produced his most famous book, An Inquiry into the Nature and Causes of the Wealth of Nations, which was published in 1776 - the year of some British American Colonies' Declaration of Independence. It was - and it remains - a campaigning book. He opposed the 'Political Economy' that prevailed at the time [as recently systematised by a fellow Scot, Sir James Steuart], which assumed that the government had a duty to support, control and regulate the economy. This well-established doctrine followed the political philosophy that had been set out in the previous century by Thomas Hobbes, who had argued that when there was no political system the life to which primitive men and women were condemned was 'nasty, brutish and short'. Unless there was a power that could compel all humans to behave according to common rules there could be no security for people's bodies and no guarantee that any preservable asset that anybody created would be safe in their possession: so neither civilised relationships nor the economy could develop.Hobbes assumed that at some time enough people would have recognised the gap between human creative abilities and the life that people lived while they remained in a 'state of war' with each other. So they had elected a Sovereign: to whom they gave the right to 'make war' against everybody else whenever violence may be necessary to establish and preserve the rule of law and order.

Adam Smith did not dispute the need for a government and he explicitly recognised that some non-military public works such as coastal defences could only practicably be afforded by the state; and he became a Commissioner of Customs. But his core argument about the creation of  material assets [and of the intellectual capital that supported the creative process] was that state interference and the government's protection of interest groups - such as closed trades and merchants who were granted monopolies - usually restricted economic growth and the beneficial spread of wealth among the community at large. Karl Marx was to build on that proposition, which he extended into an assertion that monopoly capitalism would so develop that it would become a system of total oppression of the proletarian majority of the population.His Communist Manifesto, published in 1848, brought global attention to the ideas that he spent the next few decades elaborating.  

After the publication of Smith's book formal Political Economy accommodated the 'Principle' that Free Trade should be supported by governments, in preference to monopoly, whenever feasible. But the professors stressed that governments, businessmen and commentators on the economy should always recognise Malthus' Principle of Population and the two Laws of their science: the Law of Diminishing Returns and The Iron Law of Wages [for definitions see blogs passim or my Personal Political Economy]. When these laws were combined with Marx's predictions  the resulting scenario was alarming: productive technologies would inescapably reach an entropic inevitability as output-per-input of additional capital declined. If the Law of Wages was maintained, so that the government insisted that the total economy must always remain in balance [and could not indulge in net borrowing], and the capitalists were demanding ever more of the national output to put into additional equipment that was achieving only diminishing returns, the increasing population would face declining living standards - reaching starvation-point - and the crisis of capitalism would explode into revolution.

This prospect scared the professors of Political Economy, so by the middle eighteen-sixties advanced thinkers in several countries started presenting a new approach that treated Marx in the same way as Adam Smith recorded he dealt with Steuart: they tried to demolish Marx's intellectual system "without once mentioning him". Their alternative involved shelving the Iron Law of Wages, pushing the operation of the Law of Diminishing Returns into the indefinite future, asserting that Malthus' Principle was unproven [and may be invalid]; instead emphasising Smith's proposition that competitive free trade optimised economic growth: this led to a theory of market Economics. Until the nineteen thirties that form of Economics became increasingly prevalent in the universities, worldwide: then in the depression protectionism - interventions by governments to protect their economies, at the expense of firms and individuals in other countries - became significant. It was ruinous for everybody because it just made the depression more intense as world trade slumped further. In these circumstances Keynes's timely publication of his propositions for macro-economic intervention by the state became popular, and was adopted by democratic governments during the second world war as one of the promised methodologies by which a better world would be built on the fruits of victory.

The crass adaptation of Keynes's principles after his death led through increased indebtedness to the nineteen seventies that were characterised by inflation, the risk of collapsing currencies and the possibility of hyperinflation. Keynes had attacked the behaviour of people in the stock and bond markets, and in banks: he referred to them making decisions on a basis of 'animal spirits' rather than of reason, which led to irrational herd behaviour triggered by 'waves of irrational psychology'. People who were supposedly developing and implementing his ideas could not ignore those assertions, so alongside macroeconomic intervention it was dogma between 1940 and 1970 that markets [and especially financial markets] must be controlled. Once Bowdlerised Keynesianism had been proven not to be the panacea for perpetual prosperity, an alternative set of ideas was adopted. At rock bottom, behind obfuscatory argument and seductive mathematical models, the new core proposition was that [though people in markets were, indeed, prone to irrationality] markets themselves were rational entities. Instead of being seen as dangerously constructed creations that were likely to be abused, to the disadvantage of outsiders and of the economy at large, rational markets were presented as intrinsically beneficial. Therefore all restraints on markets would serve as limitations on the optimisation of wealth.

This was the leitmotiv of the Reagan-Thatcher era, which briefly seemed to offer perpetual prosperity. But reckless market behaviour far worse than Keynes had condemned was unseen by the majority of Economists and commentators, who were beguiled by the figures that governments chose to collect and publicised. The Clinton-Blair-Brown-Chirac period seemed prosperous: but alongside de-industrialisation there were massive and unsustainable increases in personal and public indebtedness, uncontrolled and incomprehensible developments of money-markets in cyberspace, an appalling expansion of international trade in sex  slaves and indigenous exploitation of child prostitutes, the unrestricted growth of a vicious drugs trade; and - largely funded by those outrageous activities - the gap between the incomes of rich and poor became more significant than that between peasants and feudal aristocrats.

That was the final, abject and total failure of academic Economics: and over the four years since it became obvious I have not noticed any press reports of ritual suicides, formal statements of regret or self-conscious resignations from professorial chairs. It is a well-used adage that con-men can only succeed if they con themselves first: and by extension the professors could be those who were so deluded by their studies that they have not yet seen the scope of the disaster that they have collectively produced. After all, they are the girls and boys who faithfully learned what their professors taught them; and got their promotion by peer-reviewing each others' fantasising within an intellectual bubble that has not yet been burst by reality. If that is a fair assessment, the professors are to be pitied: but their time has come!

And the politicians just followed them. They swallowed Rational Market theory hook, line and sinker: though it is unlikely that many of them ever really understood it. By adopting an appallingly limited and profoundly defective version of Economics they ensured that whatever was delivered would not be beneficial to the people at large. Thus they engineered a simultaneous failure of Economics and Politics. The public justification for both Politics and Economics is that they should serve the common good. In the 'democratic west', they have not done so.

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