If you rarely read to the end of a post, here’s my executive summary:
Read this book – Economists and the Powerful: Convenient Theories, Distorted Facts, Ample Rewards.
For others, read on.
Harling and Douglas intensify the attack on the accepted mainstream economic dogma with this outstanding contribution that brings back logic, evidence and honesty to the economics profession. A thorough review by Michael Hudson is here.
What impressed me most about Economists and the Powerful is the evidence-based view taken when assessing the usefulness of economic models. They don’t reject every single mainstream economic theory. They simply explain, on the basis of the evidence, when, and under what conditions, the policy prescriptions of mainstream theory appear to apply, and when they do not. Unfortunately for your mainstream economist, the answer is that a very particular set of circumstances is usually required for their predictions to hold. Once you account for other dimensions of human nature, particularly the existence of groups and social networks, and the realities of social and political institutions, you get a very different outcome.
Haring and Douglas also include a long list of evidence supporting alternative theories, which resonate with a common-sense view of the economy far more than mainstream theory.
What continues to surprise me about the economic profession is the religious attachment to a certain set of principles that make little sense in reality. In mainstream models there are never groups with common interest who may extend their power without direct coordination. When economists do try and incorporate groups in their thinking, like Becker’s classic 1983 article that defined interest group theory, they generally treat groups as individuals, ignoring their wealth and endowments, and assuming that absolute income is a goal, rather than relative income. Simply put, a desirable market outcome will ensue.
But in reality income rank, or relative income, matters more than absolute income. Which means small powerful groups will generate pressure for inefficient policy to increase their relative income, and with it their relative power.
The fundamental mainstream economic principles can essentially be boiled down to;
- there is a single equilibrium
- diminishing returns to scale exist,
- factors of production are paid at their marginal productivity, and
- individual preferences are the exogenous determinants of economic outcomes.
Together these principles, or more accurately assumptions, allow neat mathematical formulations whose solutions are generally regarded as “proofs”. These proofs simply demonstrate that a set of assumptions is internally consistent, and when further assumptions are required to generate such consistency, they generally get bundled in with little actual economic interpretation.
How a group of social scientists, ostensibly trying to understand trade and social organisation, came to accept a rather bogus model that has little empirical support as their core analytical tool has always been a mystery to me.
But what Harling and Douglas show is that this core theory is the result of relentless US dominated propaganda machine. The Cold War US propaganda machine funded the economics discipline and guided it towards this mathematical, yet unrealistic foundation. They note:
“It is hard to overestimate RAND’s impact on the modern economics mainstream let alone society. As a quick indicator, to date, some 32 recipients of the Nobel (Memorial) Prize, primarily in the fields of economics and physics, have been involved or associated with RAND at some point in their career. Among other things, it had a big role in de-emphasizing empirical real-world oriented research in favor of axiomatic, mathematical deduction across the fields it touched.”
Turning the economics profession into an instrument of propaganda is a classic Edward Bernays move (for all those fans of Adam Curtis who enjoyed Century of the Self). I would argue that present day Australia is not immune from the vested interests in academia and the economics profession at large – I have been very critical of this in the past, and will probably write more in the future about why a code of ethics for economists could help improve to corrupted public debate (why don’t economists need to declare their funding sources in their writings?).
Pervasive business interests define the acceptable scope of theoretical arguments, and they brush aside empirical evidence with evermore absurd interpretations (eg. unemployment as a coordinated holiday). The profession itself has turned into a self-perpetuating lobbying machine.
Indeed, why do hot-shot economists who sit on the President’s advisory boards, multiple bank boards, and many other prestigious positions need to continue to dominate the introductory theory by writing economics textbooks? Especially when so much of what is contained within their pages must be obviously false to someone with at least some real world business exposure. It would only make sense in a world where a single ideology needs to be drummed into the next generation.
To ground this discussion a little more, consider the neo-classical treatment of the labour market. The authors write:
“There is no power in the neoclassical labor market. Everybody has plenty of alternative and everybody is thus indifferent as to whether thay are fired or retained. Armen Alchian and Harold Demsetz (1972), two influential members of the market-emphasizing Chicago school of economics, made that explicit:
The firm has no power, no authority, no disciplinary action any different in the slightest degree from ordinary market contracting between two people. Wherein then is the relationship between a grocer and his employee any difference from that between a grocer and his customer?
This is obviously a caricature of the labor market, albeit a very influential one. Kaufman (2007) calls the perfectly competitive labour market not just unrealistic, but logically impossible. He is certainly correct. If the labor market were perfectly competitive, it would not exist. With no transaction costs, full information, and perfectly specified contracts, firms would not employ workers. In fact, there would be no firm and not labor market, and this is why:
A firm is an organization with a certain amount of capital in the form of buildings and equipment, and a number of workers who are hired for an extended period to do work together using that equipments according to the orders of the employer. If the assumptions necessary for perfect competition were met, the entrepreneur would rather buy intermediate products from other self-employed entrepreneurs, so an economy would consist entirely of single-person companies.”
This is all the more true when you realise that marginal costs curves are assumed to be upward sloping, or at best flat. Smaller firms will always produce at less cost until such time as everyone is a single-person firms and the labour market disappears. One of the puzzles for economists is why firms exist. Which should only be puzzling if you believe in the neo-classical market model. The theory of the firm somewhat sidesteps this question by inserting some economies of scale, but the puzzle essentially remains ignored.
The overarching message in the book seems to be that no market is perfect, and indeed, perfect markets are almost never a reasonable approximation. Profits are not zero (as they are in neo-classical economics), and this means that there is a surplus, or economic rent, for various groups to bargain over. This also means that particular groups, be they firms, industry associations, or political parties, may accumulate bargaining power for these social rents over time.
And what is most surprising is that all the pioneers of economics prior to the Second World War generally accepted that different classes had different bargaining power, and there is a trade-off between the share of economic rents to asset owners and wage earners.
In sum, this is the book I wish I had written. For an economic insider it provides some explanation of the collective myopia of the profession. And it provides a lot of motivation to improve the profession and advance new empirically testable theories.
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