Rethinking Economics and the Econocracy

Yesterday, after I had issued my lament for society on this blog: in which I specifically deplored the large number of students who receive degrees in Economics, I opened my TIMES to find a piece by Richard Barwell and Anthony Yates in which the 'basics' of Econocratic dogma are defended against the relative attractiveness of 'fashionable concepts'. Yates is a professor of Economics in Birmingham and Barwell is 'senior Economist' in a bank, and the article makes it pretty clear that students in Birmingham are not going to be encouraged to dabble with the growing international network which sometimes uses the descriptor Rethinking Economics. 

Yates and Barwell deny that Economics has become a narrow programme of dogma, which takes comfort in adapting simplified versions of mathematical models that have been tested and proven in Physics and Engineering, apparently to vindicate their assertions about how aspects of the economy can be understood. They refer to awards of a pseudo-Nobel Prize [called the 'Nobel Memorial Prize in Economics', and endowed by a group of bankers many decades after the real Nobel Prizes were set up] to individuals in various 'applied' areas of Economic comment and research. The Times writers imply that students can - if they so wish - divert their attention to the byways around Economics that have been explored by some of these pseudo-Nobel 'laureates' [this is my summary of their point] but such deviant study does not help them to become Econocrats.

To be gazetted as an Economist, apparently, the student must accept that the models developed by their teachers upon the work of their teachers are uniquely logical because they are mathematical. This is a re-run in these depressing times of economic failure of the argument that was first advanced in the eighteen-sixties, a period of great economic optimism, by one of the first Economists. William Stanley Jevons who held the professorship of Political Economy in Owens College, the forerunner of the University of Manchester, wrote that if Political Economy was going to be developed into a real science it must become mathematically based. He had himself come to Political Economy from a base in science. As a young man he had experienced the thrilling period of the Australian gold rush when - as in California and the Yukon - the news that gold nuggets were to be found lying on the ground and at the bed of streams brought a rush of hungry, ambitious men from all over Europe to try their luck. Jevons went to the gold field as an assayist, verifying gold discoveries and frequently disappointing those who had not found the real thing. He had plenty of time to observe the weather, the sky and the common astronomical phenomena. At that time, there was a high level of sunspot activity; which was very visible from Australia. Jevons was not the first person to form the notion that the level of sunspot activity affected the amount of solar radiation coming to the earth, and that this must surely affect the weather; but he extended the notion to become a putative explanation of the trade cycle. He wrote extensively on the applicability of statistical data to the economy, and thus earned his professorial chair. He even caused the creation of a Royal Commission - the highest level of government inquiry - by his publication of The Coal Question a book in which he declared that the entire prosperity of the United Kingdom since the first stirrings of the industrial revolution had depended on the development of steam power [both in locomotives and ships, and in stationary engines in mines and mills]. Steam power was derived from coal. Coal was still abundant in Britain in the middle decades of the nineteenth century, but demand was increasing and Jevons recognised that if the coal ran out, the economy would come to a full stop. Thus he tried to calculate the nation's coal reserves, set this against expanding demand, and concluded that well before the date when the lines expressing the depletion of reserves and the rising demand for coal converged, the national debt must be paid off and a whole new energy basis for the economy would have to be found. The Commission took evidence, cogitated, and decided that the crisis was far enough in the future not to be bothered with the issue in the short term. Jevons' two most significant attempts to cause the economy to be managed according to statistical data to which he had access were unsuccessful, but as the university system expanded teachers of Political Economy preferred to be called Economists, and tried better to develop Jevons' insight that their subject could gain credibility if it was shown to align with statistical data and mathematical models.

The first half of the twentieth century was disfigured by two world war and the removal of Russia from the normal world economy. The half-century after 1950 saw a divided human community, where the 'capitalist' states tried the flawed 'neo-Keynesian' model for economic management until it led to the chaos of the seventies, then the 'rational markets' [monetarist] model which gave the world the crash of 2007-8 [which the Econocracy did not foresee]. Economics has never given society at large any models that align with reality and with political imperatives. Thus the assumption by Barwell and Yates that the way for students to gain a broad understanding that will help them to serve humanity usefully is by learning the models that the professoriat have a vested interest in, carries no credibility. Hence contemporary students from Jevons' old stamping ground of Manchester began the challenge to the Econocracy which is simply based on the assumption that 'enough is enough'.

Rational Markets?

The degeneration of Economics in the nineteen seventies was accompanied by an unprecedented elevation of the worst aspects of the subject as a new philosophy in politics. Economic theory moved increasingly away from common sense, into a model-world where relationships could be made 'perfect' through the power of 'the market'. Every aspect of life could be imagined as a trade. A cohabiting couple of human beings engages in a mass of interactions for which no payment is offered or received, but it is arguable that the benefits and costs that are accepted by either party tended to balance-out; and if that were not the case, the relationship would end. In an even more extreme case, over a very long term, it can be postulated that the care and money that parents levy on a child over many years balances broadly with the care that the parents received from their parents plus any benefits the parents receive in later life from their children. For some people the nuclear family turns out to be a very bad deal, and as society has become less constrained by traditional and religious rules there are more cases of parents abandoning children [or accepting the children being taken from them] and young adults severing contact with their parents.

In countries where monetarism and the dogma of rational markets dictated policy, family life responded to the withdrawal of state spending from social and peripheral educational services [such as libraries and Darby and Joan Clubs] by taking on more of the aspects of a market. The perceived lack of an acceptable trade-off between the parties in a cohabitation could easily lead to a rupture: and nobody seemed to care. Religion had less and less influence on personal behaviour as the church leaders treacherously followed secular intellectual fashion: the Bishops acquiesced as the law was changed to facilitate the new fashion. Social norms by which people had for centuries recognised that some relationships - especially the most intimate - were not conducted on a market basis were abandoned. Margaret Thatcher declared that "there is no such thing as society". The next generation of politicians who have accepted Thatcherism as positive reform movement affect to be surprised at signs of absolute societal failure, reflected in child abuse and child neglect and the riots of summer 2011; whilst such societal failure is obviously the outcome of policies that were wantonly adopted by the patrons and exemplars of the pathetic crew of politicians who sit on the front benches of both sides of the House of Commons.

Thatcher's nominally 'conservative' cohorts, who discounted traditional morality and loyalty, also supported deindustrialisation as a manifestation of modernity and applauded the emergence of the cyberspace excrescences of so-called 'financial services' which they patently could not understand. 'New Labour' went along with the fashion and repudiated its roots in trade unionism; with the exception that it was still prepared to take the unions' donations while ignoring their members' interests. Now the breakdown of social cohesion [exemplified in the disappearance of the symbols of trade union autonomy such as bands, clubs, benevolent funds and rest homes] is causing acute concern all across the political spectrum. Applied Thatcherism has undeniably ended in something much worse and more far-reaching than the 'market failure' that collapsed the financial services boom.

Since the financial services collapsed in 2008 firms in the sector have survived only under huge governmental subsidies and an outpouring of money from central banks: but the firms continue to exploit practices that politicians and bureaucrats still have not understood. The profundity of that incomprehension is evident in the political nonsense that has been spoken about 'bankers' bonuses' in recent weeks, to which reference has several times been made in this blog.

Meanwhile it remains painfully obvious that markets do not behave according to any version of equilibrating supply and demand modelling that has featured in Economics since the eighteen-seventies. Trade in even the most simple material commodities that cross the boundaries of states [or of economic communities] is hamstrung by taxes and tax reliefs or rebates, quotas, tariffs, currency manipulation, prejudicially applied safety regulations and a host of other influences which ensure that asking prices are by no means the outcome of open competition. Demand is similarly affected by tax and regulatory interventions and while people grumble about the price of petrol they buy it to enable them to go shopping for quons which they know are priced at several times more than the cost of the materials of which they are constructed.

In share and bond markets the disparity of reality from Economists' models is even more stark. Very few commentators even pretend that share markets, bond markets or any form of 'casino banking' establish prices according to 1870s supply-and-demand models. Speculative Economists still make good livings from advising the economic regulators of  privatised utilities [and the firms they regulate] on the fantasy of 'rational' pricing, but otherwise the notion lives on only in academe. Government bonds are priced according to what interventionist central banks will pay for them, and shares even in successful companies are sold according to the decisions of corporate strategists in investment institutions for whom the revenue-generating potential of the shares is a minor issue - if it is considered at all. The current hoo-ha about the 'premium' above market price that should be offered by Glencore for the mining corporation Xstrata is a case in point. There was a price for Xstrata shares that had been set more-or-less by supply-and-demand on the date when the bid was announced, and the potential buyer offered approximately 8% above that price. The stage army of analysts and representatives of shareholding organisations declared that the premium should be more: the consensus settled around 30%. This was based on the sort of premium that had been offered for very different companies - in disparate sectors of the economy - during the previous few weeks. The only way a really worthwhile valuation can be established for any share is by looking back to today from the future. What a share is really worth today depends entirely on what will be paid out in dividend to the shareholders in future years, and whether the sale price of the share will increase or diminish - relative to overall price inflation - in future.

Nobody investing an insurance company's reserves, or future pensioners' savings, or child trust funds, should follow short-term movements in the prices of even [relatively] secure investments: the investments for which they are Trustees must be made for the long term. Thinking about such investment must transcend short-term conditions. The 'rational' behaviour of a hedge-fund manager who dives in and out of asset ownership with a view to profiting instantaneously from momentary juxtapositions of market positions and the availability of purchasing-power is wholly inappropriate for long-term investing institutions. Those pension funds and similar organisations that have tried to square the circle by investing a segment of their portfolio in shares in hedge funds have taken a massive gamble that could work adversely for the funds that they manage.

There is no 'right answer' to the question of how any buyer of bonds or of shares can optimise the security and the profitability of their investments in the future. But it is glaringly apparent that any suggestion that 'markets' are innately 'rational' on a day-by-day basis is nonsense. Economic theory implicitly requires participants in the market to anticipate the next move before it happens, and to back their hunch with significant trading activity. That moribund Economic theory has taken its final refuge in the universities where its aficionados still delude students whose challenges to the dogma will soon force it into its ultimate dissolution.

Pragmatism and cool thinking are of supreme value to long-term savers at this time: Economists' versions of 'rationality' bring nothing useful to the matter.

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.