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Contents
PROLOGUEWhyBother?WHYDOYOUNEEDTOLEARNECONOMICS?
INTERLUDEIHowtoReadThisBook
PARTONE:GETTINGUSEDTOIT
CHAPTER1Life,theUniverseandEverythingWHATISECONOMICS?
CHAPTER2FromPintoPINCAPITALISM1776AND2014
CHAPTER3HowHaveWeGotHere?ABRIEFHISTORYOFCAPITALISM
CHAPTER4LetaHundredFlowersBloomHOWTO‘DO’ECONOMICS
CHAPTER5DramatisPersonaeWHOARETHEECONOMICACTORS?
INTERLUDEII:MovingOn…
PARTTWO:USINGIT
CHAPTER6HowManyDoYouWantIttoBe?OUTPUT,INCOMEANDHAPPINESS
CHAPTER7HowDoesYourGardenGrow?THEWORLDOFPRODUCTION
CHAPTER8TroubleattheFidelityFiduciaryBankFINANCE
CHAPTER9Boris’sGoatShouldDropDeadINEQUALITYANDPOVERTY
CHAPTER10I’veKnownaFewPeopleWho’veWorkedWORKANDUNEMPLOYMENT
CHAPTER11LeviathanorthePhilosopherKing?THEROLEOFTHESTATE
CHAPTER12‘AllThingsinProlificAbundance’THEINTERNATIONALDIMENSION
EPILOGUEWhatNow?HOWCANWEUSEECONOMICSTOMAKEOURECONOMYBETTER?
NOTES
ACKNOWLEDGEMENTS
FOLLOWPENGUIN
Tomyparents
WhyArePeopleNotVeryInterestedinEconomics?
Sinceyouhavepickedupthisbook,youprobablyhaveatleastapassinginterestineconomics.Evenso,youmaybereadingthiswithsometrepidation.Economicsissupposedtobedifficult–perhapsnotphysics-difficultbutdemandingenough.Someofyoumayrememberhearinganeconomistontheradiomakinganargumentthatsoundedquestionablebutacceptingitbecause,afterall,heistheexpert,andyouhaven’tevenreadaproperbookoneconomics.Butiseconomicsreallythatdifficult?Itdoesn’tneedtobe–ifitisexplainedinplainterms.Inmy
previousbook,23ThingsTheyDon’tTellYouaboutCapitalism,Ievenstuckmyneckoutandsaidthat95percentofeconomicsiscommonsense–madetolookdifficult,withtheuseofjargonsandmathematics.Economicsisnotaloneinappearingtobemoredifficulttooutsidersthanitreallyis.Inanyprofession
thatinvolvessometechnicalcompetence–beiteconomics,plumbingormedicine–jargonsthatfacilitatecommunicationwithintheprofessionmakeitscommunicationwithoutsidersmoredifficult.Alittlemorecynically,alltechnicalprofessionshaveanincentivetomakethemselveslookmorecomplicatedthantheyreallyaresothattheycanjustifythehighfeestheirmemberschargefortheirservices.Evenconsideringallthis,economicshasbeenuniquelysuccessfulinmakingthegeneralpublic
reluctanttoengagewithitsterritory.Peopleexpressstrongopinionsonallsortsofthingsdespitenothavingtheappropriateexpertise:climatechange,gaymarriage,theIraqWar,nuclearpowerstations.Butwhenitcomestoeconomicissues,manypeoplearenoteveninterested,nottospeakofnothavingastrongopinionaboutthem.WhenwasthelasttimeyouhadadebateonthefutureoftheEuro,inequalityinChinaorthefutureoftheAmericanmanufacturingindustry?Theseissuescanhaveahugeimpactonyourlife,whereveryoulive,byaffecting,positivelyornegatively,yourjobprospects,yourwageandeventuallyyourpension,butyouprobablyhaven’tthoughtaboutthemseriously.Thiscuriousstateofaffairsisonlypartlyexplainedbythefactthateconomicissueslackthevisceral
appealsthatthingslikelove,dislocation,deathandwarhave.Itexistsmainlybecause,especiallyinthelastfewdecades,peoplehavebeenledtobelievethat,likephysicsorchemistry,economicsisa‘science’,inwhichthereisonlyonecorrectanswertoeverything;thusnon-expertsshouldsimplyacceptthe‘professionalconsensus’andstopthinkingaboutit.GregoryMankiw,theHarvardeconomicsprofessorandtheauthorofoneofthemostpopulareconomicstextbooks,says:‘Economistsliketostriketheposeofascientist.Iknow,becauseIoftendoitmyself.WhenIteachundergraduates,Iveryconsciouslydescribethefieldofeconomicsasascience,sonostudentwouldstartthecoursethinkinghewasembarkingonsomesquishyacademicendeavor.’1
Asitwillbecomeclearerthroughoutthebook,however,economicscanneverbeascienceinthesensethatphysicsorchemistryis.Therearemanydifferenttypesofeconomictheory,eachemphasizingdifferentaspectsofcomplexreality,makingdifferentmoralandpoliticalvaluejudgementsanddrawingdifferentconclusions.Moreover,economictheoriesconstantlyfailtopredictreal-worlddevelopments
eveninareasonwhichtheyfocus,notleastbecausehumanbeingshavetheirownfreewill,unlikechemicalmoleculesorphysicalobjects.2
Ifthereisnoonerightanswerineconomics,thenwecannotleaveittotheexpertsalone.Thismeansthateveryresponsiblecitizenneedstolearnsomeeconomics.BythisIdon’tmeanpickingupathicktextbookandabsorbingoneparticulareconomicpointofview.Whatisneededistolearneconomicsinsuchawaythatonebecomesawareofdifferenttypesofeconomicargumentsanddevelopsthecriticalfacultytojudgewhichargumentmakesmostsenseinagiveneconomiccircumstanceandinlightofwhichmoralvaluesandpoliticalgoals(notethatIamnotsaying‘whichargumentiscorrect’).Thisrequiresabookthatdiscusseseconomicsinawaythathasnotbeentried,whichIbelievethisbookdoes.
HowIsThisBookDifferent?
Howisthisbookdifferentfromotherintroductorybookstoeconomics?OnedifferenceisthatItakemyreadersseriously.AndImeanit.Thisbookwillnotbeadigested
versionofsomecomplicatedeternaltruth.Iintroducemyreaderstomanydifferentwaysofanalysingtheeconomyinthebeliefthattheyareperfectlycapableofjudgingbetweendifferentapproaches.Idonoteschewdiscussingthemostfundamentalmethodologicalissuesineconomics,suchaswhetheritcanbeascienceorwhatrolemoralvaluesdo(andshould)playineconomics.Wheneverpossible,Itrytorevealtheassumptionsunderlyingdifferenteconomictheoriessothatreaderscanmaketheirownjudgementsabouttheirrealismandplausibility.Ialsotellmyreadershownumbersineconomicsaredefinedandputtogether,urgingthemnottotakethemassomethingasobjectiveas,say,theweightofanelephantorthetemperatureofapotofwater.*Inshort,Itrytoexplaintomyreaderhowtothink,ratherthanwhattothink.Engagingthereaderatthedeepestlevelofanalysis,however,doesnotmeanthatthebookisgoingto
bedifficult.Thereisnothinginthisbookthatthereadercannotunderstand,asfarasheorshehashadasecondaryeducation.AllIaskofmyreadersisthecuriositytofindoutwhatisreallygoingonandthepatiencetoreadthroughafewparagraphsatthesametime.Anothercriticaldifferencewithothereconomicsbooksisthatmybookcontainsalotofinformationon
therealworld.AndwhenIsay‘world’,Imeanit.Thisbookprovidesinformationonmanydifferentcountries.Thisisnottosaythatallcountriesgetequalattention.But,unlikemostotherbooksineconomics,theinformationwillnotbeconfinedtooneortwocountriesortoonetypeofcountry(say,richcountriesorpoorcountries).Muchoftheinformationprovidedwillbenumbers:howlargetheworldeconomyis,howmuchofitisproducedbytheUSorBrazil,whatproportionsoftheiroutputsChinaortheDemocraticRepublicofCongoinvest,howlongpeopleworkinGreeceorGermany.Butthiswillbecomplementedbyqualitativeinformationoninstitutionalarrangements,historicalbackgrounds,typicalpolicyandthelike.Thehopeisthatattheendofthisbookthereadercansaythatheorshehassomefeelaboutthewayinwhichtheeconomyactuallyworksintherealworld.‘Andnowforsomethingcompletelydifferent…’*
Irealizethatnotallreadersarereadytospendalotoftimeonthisbook,atleasttobeginwith.Therefore,Isuggestseveraldifferentwaysofreadingthisbook,dependingonhowmuchtimeyouthinkyoucanafford.Ifyouhavetenminutes:Readthechaptertitlesandthefirstpageofeachchapter.IfIamlucky,atthe
endofthosetenminutes,youmaysuddenlyfindthatyouhaveacoupleofhourstospare.Ifyouhaveacoupleofhours:ReadChapters1and2andthentheEpilogue.Flickthroughtherest.Ifyouhavehalfaday:Readonlytheheadlines–sectiontitlesandthesummariesinitalicsthatoccur
everyfewparagraphs.Ifyouareafastreader,youmayalsocramintheintroductorysectionandtheconcludingremarksineachchapter.Ifyouhavethetimeandthepatiencetoreadthrough:Pleasedo.Thatwillbethemosteffectiveway.
Andyouwillmakemeveryhappy.Buteventhenyoucanskipbitsthatdon’tinterestyoumuchandreadonlytheheadlinesinthosebits.
Whatiseconomics?Areaderwhoisnotfamiliarwiththesubjectmightreckonthatitisthestudyoftheeconomy.Afterall,
chemistryisthestudyofchemicals,biologyisthestudyoflivingthings,andsociologyisthestudyofsociety,soeconomicsmustbethestudyoftheeconomy.Butaccordingtosomeofthemostpopulareconomicsbooksofourtime,economicsismuchmorethan
that.Accordingtothem,economicsisabouttheUltimateQuestion–of‘Life,theUniverseandEverything’–asinTheHitchhiker’sGuidetotheGalaxy,thecultcomedysciencefictionbyDouglasAdams,whichwasmadeintoamoviein2005,withMartin‘TheHobbit’Freemanintheleadingrole.AccordingtoTimHarford,theFinancialTimesjournalistandtheauthorofthesuccessfulbookThe
UndercoverEconomist,economicsisaboutLife–hehasnamedhissecondbookTheLogicofLife.NoeconomisthasyetclaimedthateconomicscanexplaintheUniverse.TheUniverseremains,fornow,
theturfofphysicists,whommosteconomistshaveforcenturiesbeenlookinguptoastheirrolemodels,intheirdesiretomaketheirsubjectatruescience.*Butsomeeconomistshavecomeclose–theyhaveclaimedthateconomicsisabout‘theworld’.Forexample,thesubtitleofthesecondvolumeinRobertFrank’spopularEconomicNaturalistseriesisHowEconomicsHelpsYouMakeSenseofYourWorld.ThenthereistheEverythingbit.ThesubtitleofLogicofLifeisUncoveringtheNewEconomicsof
Everything.Accordingtoitssubtitle,FreakonomicsbyStevenLevittandStephenDubner–probablythebest-knowneconomicsbookofourtime–isanexplorationoftheHiddenSideofEverything.RobertFrankagrees,eventhoughheisfarmoremodestinhisclaim.InthesubtitleofhisfirstEconomicNaturalistbook,heonlysaidWhyEconomicsExplainsAlmostEverything(emphasisadded).So,therewego.Economicsis(almost)aboutLife,theUniverseandEverything.†Whenyouthinkaboutit,thisissomeclaimcomingfromasubjectthathasspectacularlyfailedinwhat
mostnon-economiststhinkisitsmainjob–thatis,explainingtheeconomy.Intherun-uptothe2008financialcrisis,themajorityoftheeconomicsprofessionwaspreachingtothe
worldthatmarketsarerarelywrongandthatmoderneconomicshasfoundwaystoironoutthosefewwrinklesthatmarketsmayhave;RobertLucas,the1995winneroftheNobelPrizeinEconomics,*haddeclaredin2003thatthe‘problemofdepressionpreventionhasbeensolved’.1Somosteconomistswerecaughtcompletelybysurprisebythe2008globalfinancialcrisis.†Notonlythat,theyhavenotbeenabletocomeupwithdecentsolutionstotheongoingaftermathsofthatcrisis.Givenallthis,economicsseemstosufferfromaseriouscaseofmegalomania–howcanasubjectthat
cannotevenmanagetoexplainitsownareaverywellclaimtoexplain(almost)everything?
EconomicsIstheStudyofRationalHumanChoice…
YoumaythinkIambeingunfair.Aren’tallthesebooksaimedatthemassmarket,wherecompetitionforreadershipisfierce,andthereforepublishersandauthorsaretemptedtohypethingsup?Surely,you
wouldthink,seriousacademicdiscourseswouldnotmakesuchagrandclaimthatthesubjectisabout‘everything’.Thesetitlesarehypedup.Butthepointisthattheyarehypedupinaparticularway.Thehypescould
havebeensomethingalongthelineof‘howeconomicsexplainseverythingabouttheeconomy’,buttheyareinsteadalongthelinesof‘howeconomicscanexplainnotjusttheeconomybuteverythingelseaswell’.Thehypesareofthisparticularvarietybecauseofthewayinwhichthecurrentlydominantschoolof
economics,thatis,theso-calledNeoclassicalschool,defineseconomics.ThestandardNeoclassicaldefinitionofeconomics,thevariantsofwhicharestillused,isgiveninthe1932bookbyLionelRobbins,AnEssayontheNatureandSignificanceofEconomicScience.Inthebook,Robbinsdefinedeconomicsas‘thesciencewhichstudieshumanbehaviourasarelationshipbetweenendsandscarcemeanswhichhavealternativeuses’.Inthisview,economicsisdefinedbyitstheoreticalapproach,ratherthanitssubjectmatter.Economics
isastudyofrationalchoice,thatis,choicemadeonthebasisofdeliberate,systematiccalculationofthemaximumextenttowhichtheendscanbemetbyusingtheinevitablyscarcemeans.Thesubjectmatterofthecalculationcanbeanything–marriage,havingchildren,crimeordrugaddiction,asGaryBecker,thefamousChicagoeconomistandthewinnerof1992NobelPrizeinEconomics,haswrittenabout–andnotjust‘economic’issues,asnon-economistswoulddefinethem,suchasjobs,moneyorinternationaltrade.WhenBeckertitledhis1976bookTheEconomicApproachtoHumanBehaviour,hewasreallydeclaringwithoutthehypethateconomicsisabouteverything.Thistrendofapplyingtheso-calledeconomicapproachtoeverything,calledbyitscritics‘economics
imperialism’,hasreacheditsapexrecentlyinbookslikeFreakonomics.LittleofFreakonomicsisactuallyabouteconomicissuesasmostpeoplewoulddefinethem.IttalksaboutJapanesesumowrestlers,Americanschoolteachers,Chicagodruggangs,participantsintheTVquizshowTheWeakestLink,realestateagentsandtheKuKluxKlan.Mostpeoplewouldthink(andtheauthorsalsoadmit)thatnoneofthesepeople,exceptrealestate
agentsanddruggangs,haveanythingtodowitheconomics.But,fromthepointofviewofmosteconomiststoday,howJapanesesumowrestlerscolludetohelpeachotheroutorhowAmericanschoolteachersfabricatetheirpupils’markstogetbetterjobassessmentsareaslegitimatesubjectsofeconomicsaswhetherGreeceshouldstayintheEurozone,howSamsungandApplefightitoutinthesmartphonemarketorhowwecanreduceyouthunemploymentinSpain(whichisover55percentatthetimeofwriting).Tothoseeconomists,those‘economic’issuesdonothaveprivilegedstatusineconomics,theyarejustsomeofmanythings(oh,Iforgot,someofeverything)thateconomicscanexplain,becausetheydefinetheirsubjectintermsofitstheoreticalapproach,ratherthanitssubjectmatter.
…orIsIttheStudyoftheEconomy?
Anobviousalternativedefinitionofeconomics,whichIhavebeenimplying,isthatitisthestudyoftheeconomy.Butwhatistheeconomy?
Theeconomyisaboutmoney–orisit?
Themostintuitiveanswertomostreadersmaybethattheeconomyisanythingtodowithmoney–nothavingit,earningit,spendingit,runningoutofit,savingit,borrowingitandrepayingit.Thisisnotquiteright,butitisagoodstartingpointforthinkingabouttheeconomy–andeconomics.Now,whenwetalkoftheeconomybeingaboutmoney,wearenotreallytalkingaboutphysicalmoney.
Physicalmoney–beitabanknote,agoldcoinorthehuge,virtuallyimmovablestonesthatwereusedasmoneyinsomePacificislands–isonlyasymbol.Moneyisasymbolofwhatothersinyoursocietyoweyou,oryourclaimonparticularamountsofthesociety’sresources.2
Howmoneyandotherfinancialclaims–suchascompanyshares,derivativesandmanycomplexfinancialproducts,whichIwillexplaininlaterchapters–arecreated,soldandboughtisonehugeareaofeconomics,calledfinancialeconomics.Thesedays,giventhedominanceofthefinancialindustryinmanycountries,alotofpeopleequateeconomicswithfinancialeconomics,butitisactuallyonlyasmallpartofeconomics.Yourmoney–ortheclaimsyouhaveoverresources–maybegeneratedinanumberofdifferentways.
Andalotofeconomicsis(orshouldbe)aboutthose.
Themostcommonwaytogetmoneyistohaveajob
Themostcommonwaytogetmoney–unlessyouhavebeenbornintoit–istohaveajob(includingbeingyourownboss)andearnmoneyfromit.So,alotofeconomicsisaboutjobs.Wecanreflectonjobsfromdifferentperspectives.Jobscanbeunderstoodfromthepointofviewoftheindividualworker.Whetheryougetajobandhow
muchyouarepaidforitdependsontheskillsyouhaveandhowmanydemandsthereareforthem.Youmaygetveryhighwagesbecauseyouhaveveryrareskills,likeCristianoRonaldo,thefootballplayer.Youmayloseyourjob(orbecomeunemployed)becausesomeoneinventsamachinethatcandowhatyoudo100timesfaster–ashappenedtoMrBucket,Charlie’sfather,atoothpastecap-screwer,inthe2005movieversionofRoaldDahl’sCharlieandtheChocolateFactory.*Oryouhavetoacceptlowerwagesorworseworkingconditionsbecauseyourcompanyislosingmoneythankstocheaperimportsfrom,say,China.Andsoon.So,inordertounderstandjobsevenattheindividuallevel,weneedtoknowaboutskills,technologicalinnovationandinternationaltrade.Wagesandworkingconditionsarealsodeeplyaffectedby‘political’decisionstochangethevery
scopeandthecharacteristicsofthelabourmarket(Ihaveput‘political’inquotationmarks,asintheendtheboundarybetweeneconomicsandpoliticsisblurry,butthatisatopicforlater–seeChapter11).TheaccessionoftheEasternEuropeancountriestotheEuropeanUnionhashadhugeimpactsonthewagesandbehavioursofWesternEuropeanworkers,bysuddenlyexpandingthesupplyofworkersintheirlabourmarkets.Therestrictiononchildlabourinthelatenineteenthcenturyandearlytwentiethcenturieshadtheoppositeeffectofshrinkingtheboundaryofthelabourmarket–suddenlyalargeproportionofthepotentialemployeeswereshutoutofthelabourmarket.Regulationsonworkinghours,workingconditionsandminimumwagesareexamplesoflessdramatic‘political’decisionsthataffectourjobs.
Therearealsoalotoftransfersofmoneygoingonintheeconomy
Inadditiontoholdingdownajob,youcangetmoneythroughtransfers–thatis,bysimplybeinggivenit.Thiscanbeeitherintheformofcashor‘inkind’,thatis,directprovisionofparticulargoods(e.g.,food)orservices(e.g.,primaryeducation).Whetherincashorinkind,thesetransferscanbemadeinanumberofdifferentways.
Therearetransfersmadeby‘peopleyouknow’.Examplesincludeparentalsupportforchildren,peopletakingcareofelderlyfamilymembers,giftsfromlocalcommunitymembers,say,foryourdaughter’swedding.Thenthereischaritablegiving,thatis,transfervoluntarilymadetostrangers.People–sometimes
individuallysometimescollectively(e.g.,throughcorporationsorvoluntaryassociations)–givetocharitiesthathelpothers.Intermsofitsquantity,charitablegivingisovershadowedinmanymultiplesbytransfersmadethrough
governments,whichtaxsomepeopletosubsidizeothers.Soalotofeconomicsisnaturallyaboutthesethings–ortheareasofeconomicsknownaspubliceconomics.Eveninverypoorcountries,therearesomegovernmentschemestogivecashorgoodsinkind(e.g.,
freegrains)tothosewhoareintheworstpositions(e.g.,theaged,thedisabled,thestarving).Buttherichersocieties,especiallythoseinEurope,havetransferschemesthataremuchmorecomprehensiveinscopeandgenerousinamounts.Thisisknownasthewelfarestateandisbasedonprogressivetaxation(thosewhoearnmorepayingproportionallylargersharesoftheirincomesintaxes)anduniversalbenefits(whereeveryone,notjustthepoorestorthedisabled,isentitledtoaminimumincomeandtobasicservices,suchashealthcareandeducation).
Resourcesearnedortransferredgetconsumedingoodsorservices
Onceyougainaccesstoresources,whetherthroughjobsortransfers,youconsumethem.Asphysicalbeings,weneedtoconsumesomeminimumamountoffood,clothes,energy,housing,andothergoodstofulfilourbasicneeds.Andthenweconsumeothergoodsfor‘higher’mentalwants–books,musicalinstruments,exerciseequipment,TV,computersandsoon.Wealsobuyandconsumeservices–abusride,ahaircut,adinneratarestaurantorevenaholidayabroad.3
Soalotofeconomicsisdevotedtothestudyofconsumption–howpeopleallocatemoneybetweendifferenttypesofgoodsandservices,howtheymakechoicesbetweencompetingvarietiesofthesameproduct,howtheyaremanipulatedand/orinformedbyadvertisements,howcompaniesspendmoneytobuildtheir‘brandimages’andsoon.
Ultimatelygoodsandserviceshavetobeproduced
Inordertobeconsumed,thesegoodsandserviceshavetobeproducedinthefirstplace–goodsinfarmsandfactoriesandservicesinofficesandshops.Thisistherealmofproduction–anareaofeconomicsthathasbeenratherneglectedsincetheNeoclassicalschool,whichputsemphasisonexchangeandconsumption,becamedominantinthe1960s.Instandardeconomicstextbooks,productionappearsasa‘blackbox’,inwhichsomehowquantitiesof
labour(workbyhumans)andcapital(machinesandtools)arecombinedtoproducethegoodsandservices.Thereislittlerecognitionthatproductionisalotmorethancombiningsomeabstractquantacalledlabourandcapitalandinvolvesgettingmany‘nitty-gritty’thingsright.Andthesearethingsthatmostreadersmaynotnormallyhaveassociatedwitheconomics,despitetheircrucialimportancefortheeconomy:howthefactoryisphysicallyorganized,howtocontroltheworkersordealwithtradeunions,howtosystematicallyimprovethetechnologiesusedthroughresearch.Mosteconomistsareveryhappytoleavethestudyofthesethingsto‘otherpeople’–engineersand
businessmanagers.But,whenyouthinkaboutit,productionistheultimatefoundationofanyeconomy.Indeed,thechangesinthesphereofproductionusuallyhavebeenthemostpowerfulsourcesofsocial
change.OurmodernworldhasbeenmadebytheseriesofchangesintechnologiesandinstitutionsrelatingtothesphereofproductionthathavebeenmadesincetheIndustrialRevolution.Theeconomicsprofession,andtherestofuswhoseviewsoftheeconomyareinformedbyit,needtopayfarmoreattentiontoproductionthancurrently.
ConcludingRemarks:EconomicsastheStudyoftheEconomy
Mybeliefisthateconomicsshouldbedefinednotintermsofitsmethodology,ortheoreticalapproach,butintermsofitssubjectmatter,asisthecasewithallotherdisciplines.Thesubjectmatterofeconomicsshouldbetheeconomy–whichinvolvesmoney,work,technology,internationaltrade,taxesandotherthingsthathavetodowiththewaysinwhichweproducegoodsandservices,distributetheincomesgeneratedintheprocessandconsumethethingsthusproduced–ratherthan‘Life,theUniverseandEverything’(or‘almosteverything’),asmanyeconomiststhink.Definingeconomicsinthiswaymakesthisbookunlikemostothereconomicsbooksinonefundamental
way.Astheydefineeconomicsintermsofitsmethodology,mosteconomicsbooksassumethatthereisonly
onerightwayof‘doingeconomics’–thatis,theNeoclassicalapproach.Theworstexampleswon’teventellyouthatthereareotherschoolsofeconomicsthantheNeoclassicalone.Bydefiningeconomicsintermsofthesubjectmatter,thisbookhighlightsthefactthattherearemany
differentwaysofdoingeconomics,eachwithitsemphases,blindspots,strengthsandweaknesses.Afterall,whatwewantfromeconomicsisthebestpossibleexplanationofvariouseconomicphenomenaratherthanaconstant‘proof’thataparticulareconomictheorycanexplainnotjusttheeconomybuteverything.
FurtherReadingR.BACKHOUSE
ThePuzzleofModernEconomics:ScienceorIdeology?(Cambridge:CambridgeUniversityPress,2012).
B.FINEANDD.MILONAKIS
FromEconomicsImperialismtoFreakonomics:TheShiftingBoundariesbetweenEconomicsandtheOtherSocialSciences(London:Routledge,2009).
FromPintoPIN
Whatisthefirsteverthingwrittenaboutineconomics?Gold?Land?Banking?Orinternationaltrade?Theansweristhepin.Nottheonethatyouuseforyourcreditcards.Butthatlittlemetalthingthatmostofyoudonotuse–
thatis,unlessyouhavelonghairandliketokeepittidyormakeyourownclothes.Themakingofthepinisthesubjectoftheveryfirstchapterofwhatiscommonly(albeitmistakenly)1
consideredtobethefirsteconomicsbook,namely,AnInquiryintotheNatureandCausesoftheWealthofNations,byAdamSmith(1723–90).Smithstartshisbookbyarguingthattheultimatesourceofincreaseinwealthliesintheincreasein
productivitythroughgreaterdivisionoflabour,whichreferstothedivisionofproductionprocessesintosmaller,specializedparts.Hearguedthatthisincreasesproductivityinthreeways.First,byrepeatingthesameoneortwotasks,workersbecomegoodatwhattheydomorequickly(‘practicemakesperfect’).Second,byspecializing,workersdonothavetospendtimemoving–physicallyandmentally–betweendifferenttasks(reductionin‘transitioncosts’).Last,butnotleast,afinerbreakdownoftheprocessmakeseachstepeasiertobeautomatedandthusbeperformedatsuperhumanspeed(mechanization).Andtoillustratethispoint,Smithdiscusseshowtenpeopledividinguptheproductionprocessof
makingapinandspecializinginoneortwoofthesub-processescanproduce48,000pins(or4,800pinsperperson)aday.Comparethistotheatmost20pinseachofthemcanproduceaday,Smithpointedout,ifeachindividualworkerperformedthewholeprocessalone.Smithcalledthepinmanufacturea‘trifling’exampleandlaterwentontonotehowmorecomplicated
thedivisionsoflabourforotherproductsare,butthereisnodenyingthathelivedinatimewhentenpeopleworkingtogethertomakeapinwasstillconsideredcool–well,atleastcoolenoughtofrontsomeone’swould-bemagnumopusinwhatthenwasacutting-edgesubject.Thenexttwoandahalfcenturieshaveseendramaticdevelopmentsintechnology,drivenby
mechanizationandtheuseofchemicalprocesses,notleastinthepinindustry.TwogenerationsafterSmith,theoutputperworkerhadnearlydoubled.FollowingSmith’sexample,CharlesBabbage,thenineteenth-centurymathematicianwhoisknownastheconceptualfatherofthecomputer,studiedpinfactoriesin1832.*Hefoundthattheywereproducingabout8,000pinsperworkeraday.150moreyearsoftechnologicalprogressincreasedproductivitybyyetanother100times,to800,000pinsperworkerperday,accordingtothe1980studybythelateCliffordPratten,aCambridgeeconomist.2
Theincreaseintheproductivityofmakingthesamething,suchasthepin,isonlyonepartofthestory.Today,weproducesomanythingsthatpeoplelivinginSmith’stimecouldonlydreamabout,suchastheflyingmachine,orcouldnotevenimagine,suchasthemicrochip,thecomputer,thefibre-opticcableandnumerousothertechnologiesthatweneedinordertouseourpin–sorry,PIN.
AllChange:HowtheActorsandtheInstitutionsofCapitalismHaveChanged
Itisnotonlyproductiontechnologies–orhowthingsaremade–thathavechangedbetweenAdamSmith’stimeandours.Economicactors–orthosewhoengageineconomicactivities–andeconomicinstitutions–ortherulesregardinghowproductionandothereconomicactivitiesareorganized–havealsogonethroughfundamentaltransformations.TheBritisheconomyinSmith’stime,whichhecalledthe‘commercialsociety’,sharedsome
fundamentalsimilaritieswiththosethatwefindinmostoftoday’seconomies.Otherwisehisworkwouldbeirrelevant.Unlikemostothereconomiesofthetime(theotherexceptionsbeingtheNetherlands,BelgiumandpartsofItaly),itwasalready‘capitalist’.Sowhatisthecapitalisteconomy,orcapitalism?Itisaneconomyinwhichproductionisorganizedin
pursuitofprofit,ratherthanforownconsumption(asinsubsistencefarming,whereyougrowyourownfood)orforpoliticalobligations(asinfeudalsocietiesorinsocialisteconomies,wherepoliticalauthorities,respectivelyaristocratsandthecentralplanningauthority,tellyouwhattoproduce).Profitisthedifferencebetweenwhatyouearnbysellingsomethinginthemarket(thisisknownasthe
salesrevenue,orsimplyrevenue)andthecostsofalltheinputsthathavegoneintotheproductionofit.Inthecaseofthepinfactory,itsprofitwouldbethedifferencebetweentherevenuefromsellingthepinsandthecoststhatithasincurredinmakingthem–thesteelwirethathasbeenturnedintopins,thewagesforitsworkers,therentforthefactorybuildingandsoon.Capitalismisorganizedbycapitalists,orthosewhoowncapitalgoods.Capitalgoodsarealsoknown
asthemeansofproductionandrefertodurableinputsintotheproductionprocess(forexample,machines,butnot,say,rawmaterials).Ineverydayusage,wealsousetheterm‘capital’forthemoneyinvestedinabusinessventure.*Capitalistsownthemeansofproductioneitherdirectlyor,morecommonlythesedays,indirectlyby
owningshares(orstocks)inacompany–thatis,proportionalclaimsonthetotalvalueofthecompany–thatownthosemeansofproduction.Capitalistshireotherpeopleonacommercialbasistooperatethesemeansofproduction.Thesepeopleareknownaswagelabourers,orsimplyworkers.Capitalistsmakeprofitsbyproducingthingsandsellingthemtootherpeoplethroughthemarket,whichiswheregoodsandservicesareboughtandsold.Smithbelievedthatcompetitionamongsellersinthemarketwillensurethatprofit-seekingproducerswillproduceatthelowestpossiblecosts,therebybenefitingeveryone.However,thesimilaritiesbetweenSmith’scapitalismandtoday’scapitalismdonotstretchmuch
beyondthosebasicaspects.Therearehugedifferencesbetweenthetwoerasintermsofhowtheseessentialcharacteristics–privateownershipofmeansofproduction,profit-seeking,wageemploymentandmarketexchange–areactuallytranslatedintorealities.
Capitalistsaredifferent
InAdamSmith’sday,mostfactories(andfarms)wereownedandrunbysingleindividualcapitalistsorbypartnershipsmadeupofasmallnumberofindividualswhoknewandunderstoodeachother.Thesecapitalistswereusuallypersonallyinvolvedinproduction–oftenphysicallyonthefactoryfloor,orderingtheirworkersabout,swearingatthemandevenbeatingthemup.Today,mostfactoriesareownedandoperatedby‘unnatural’persons,namely,corporations.These
corporationsare‘persons’onlyinthelegalsense.Theyareinturnownedbyamultitudeofindividuals,whobuysharesinthemandpart-ownthem.Butbeingashareholderdoesnotmakeyouacapitalistinthe
classicalsense.Owning300ofVolkswagen’s300millionsharesdoesnotentitleyoutoflytoitsfactoryin,say,Wolfsburg,Germanyandorder‘your’workersaboutin‘your’factoryforone-millionthoftheirworkingtime.Ownershipoftheenterpriseandcontrolofitsoperationsarelargelyseparatedinthelargestenterprises.Today’sownersinmostlargecorporationshaveonlylimitedliabilities.Inalimitedliabilitycompany
(LLC)orapubliclimitedcompany(PLC),ifsomethinggoeswrongwiththecompany,shareholdersonlylosethemoneyinvestedintheirsharesandthatisthat.InSmith’stime,mostcompanyownershadunlimitedliabilities,whichmeantthatwhenthebusinessfailed,theyhadtoselltheirownpersonalassetstopaybackthedebts,failingwhichtheyendedupinadebtors’prison.*Smithwasagainsttheprincipleoflimitedliability.Hearguedthatthosewhomanagelimitedliabilitycompanieswithoutowningthemareplayingwith‘otherpeople’smoney’(hisphrase,andthetitleofafamousplayandthen1991movie,starringDannyDeVito)andthuswon’tbeasvigilantintheirmanagementasthosewhohavetoriskeverythingtheyhave.CompaniesareorganizedverydifferentlyfrominSmith’sdaystoo,whatevertheownershipform.In
Smith’sday,mostcompaniesweresmallwithoneproductionsiteunderasimplecommandstructuremadeupofafewforemenandordinaryworkers,andperhapsa‘caretaker’(whichiswhatthehiredmanagerwascalledthen).Today,manycompaniesarehuge,oftenemployingtensofthousandsofworkersorevenmillionsofthemallovertheworld.Walmartemploys2.1millionpeople,whileMcDonald’s,includingfranchises,†employsaround1.8millionpeople.Theyhavecomplicatedinternalstructures,variouslymadeupofdivisions,profitcentres,semi-autonomousunitsandwhatnot,hiringpeoplewithcomplicatedjobspecificationsandpaygradeswithinacomplex,bureaucraticcommandstructure.
Workersaredifferenttoo
InSmith’stime,mostpeopledidnotworkforcapitalistsaswagelabourers.ThemajorityofpeoplestillworkedinagricultureeveninWesternEurope,wherecapitalismwasthenmostadvanced.3Asmallminorityofthemworkedaswagelabourersforagriculturalcapitalists,butmostofthemwereeithersmallsubsistencefarmersortenants(thosewhorentlandandpayaproportionoftheiroutputinreturn)ofaristocraticlandlords.Duringthisera,evenmanyofthosewhoworkedforcapitalistswerenotwagelabourers.Therewere
stillslavesaround.Liketractorsortractionanimals,slavesweremeansofproductionownedbycapitalists,especiallytheplantationownersintheAmericanSouth,theCaribbean,Brazilandelsewhere.ItwastwogenerationsafterthepublicationofTheWealthofNations(henceforthTWON)thatslaverywasabolishedinBritain(1833).ItwasnearlyacenturyafterTWONandafterabloodycivilwarthatslaverywasabolishedintheUS(1862).Brazilabolisheditonlyin1888.Whilealargeproportionofpeoplewhoworkedforcapitalistswerenotwagelabourers,manywage
labourerswerepeoplewhowouldn’tbeallowedtobecomewagelabourerstoday.Theywerechildren.Fewthoughtthattherewasanythingwrongwithhiringchildren.Inhis1724bookATourThroughtheWholeIslandofGreatBritain,DanielDefoe,theauthorofRobinsonCrusoe,expressedhisdelightatthefactthatinNorwich,thenacentreforcottontextiles,‘theverychildrenafter4or5yearsofagecouldeveryoneearntheirownbread’,thankstothe1700banontheimportofcalicoes,thethenprizedIndiancottontextile.4Childlaboursubsequentlybecamerestrictedandthenbanned,butthatwasgenerationsafterAdamSmith’sdeathin1790.
Today,inBritainandotherrichcountries,thepictureiscompletelydifferent.*Childrenarenotallowedtowork,exceptforlimitedhoursforalimitedrangeofthings,suchaspaperrounds.Therearenolegalslaves.Oftheadultworkers,around10percentareself-employed–thatis,theyworkforthemselves–15–25percentworkforthegovernment,andtherestarewagelabourersworkingforcapitalists.5
Marketshavechanged
InSmith’stime,marketswerelargelylocaloratmostnationalinscope,exceptinkeycommoditiesthatweretradedinternationally(e.g.,sugar,slavesorspices)oralimitedrangeofmanufacturedgoods(e.g.,silk,cottonandwoollenclothes).Thesemarketswereservedbynumeroussmall-scalefirms,resultinginthestatethateconomiststhesedayscallperfectcompetition,inwhichnosinglesellercaninfluencetheprice.ForpeoplefromSmith’stime,itwouldhavebeenimpossibleeventoimaginecompanieshiringovertwicethethensizeofLondon’spopulation(0.8millionin1800)operatinginterritoriesthatoutnumberthethenBritishcolonialterritories(aroundtwenty)byafactorofsix(McDonald’soperatesinover120countries).6
Today,mostmarketsarepopulated,andoftenmanipulated,bylargecompanies.Someofthemaretheonlysupplier(monopoly)or,moretypically,oneofthefewsuppliers(oligopoly)–notjustatthenationallevelbutincreasinglyatthegloballevel.Forexample,BoeingandAirbussupplycloseto90percentofworldcivilianaircrafts.Companiesmayalsobethesolebuyer(monopsony)oroneofthefewbuyers(oligopsony).UnlikethesmallcompaniesinAdamSmith’sworld,monopolisticoroligopolisticfirmscaninfluence
marketoutcomes–theyhavewhateconomistscallmarketpower.Amonopolisticfirmmaydeliberatelyrestrictitsoutputtoraiseitspricestothepointthatitsprofitismaximized(IexplainthetechnicalpointsinChapter11–feelfreetoignorethemnow).Oligopolisticfirmscannotmanipulatetheirmarketsasmuchasamonopolisticfirmcan,buttheymaydeliberatelycolludetomaximizetheirprofitsbynotunder-cuttingeachother’sprices–thisisknownasacartel.Asaresult,mostcountriesnowhaveacompetitionlaw(sometimescalledananti-trustlaw)inordertocountersuchanti-competitivebehaviours–breakingupmonopolies(forexample,theUSgovernmentbrokeupAT&T,thetelephonecompany,in1984)andbanningcollusionamongoligopolisticfirms.Monopsonisticandoligopsonisticfirmswereconsideredtobetheoreticalcuriositiesevenafew
decadesago.Today,someofthemareevenmoreimportantthanmonopolisticandoligopolisticfirmsinshapingoureconomy.Exercisingtheirpowersasoneofthefewbuyersofcertainproducts,sometimesonaglobalscale,companieslikeWalmart,Amazon,TescoandCarrefourexercisegreat–sometimesevendefining–influenceonwhatgetsproducedwhere,whogetshowbigasliceofprofitandwhatconsumersbuy.
Money–thefinancialsystem–hasalsochanged7
Wenowtakeitforgrantedthatcountrieshaveonlyonebankthatissuesitsnotes(andcoins)–thatis,thecentralbank,suchastheUSFederalReserveBoardortheBankofJapan.InEuropeinAdamSmith’sday,mostbanks(andevensomebigmerchants)issuedtheirownnotes.Thesenotes(orbills,ifyouareintheUS)werenotnotesinthemodernsense.Eachnotewasissuedto
aparticularperson,hadauniquevalueandwassignedbythecashierissuingit.8Itwasonlyin1759that
theBankofEnglandstartedissuingfixed-denominationnotes(the£10noteinthiscase–the£5notecameonlyin1793,threeyearsafterAdamSmithdied).Anditwasn’tuntiltwogenerationsafterSmith(in1853)thatfullyprintednotes,withnonameofthepayeeandnosignaturebyissuingcashiers,wereissued.Buteventhesefixed-denominationnoteswerenotnotesinthemodernsense,astheirvalueswereexplicitlylinkedtopreciousmetalslikegoldorsilverthattheissuingbankpossessed.ThisisknownastheGold(orSilverorother)Standard.TheGold(Silver)Standardisamonetarysysteminwhichthepapermoneyissuedbythecentralbank
isfreelyexchangeablewithaspecifiedweightofgold(orsilver).Thisdidnotmeanthatthecentralbankhadtohaveinreserveanamountofgoldequaltothevalueofthecurrencythatithadissued;however,theconvertibilityofpapermoneyintogoldmadeitnecessaryforittoholdaverylargegoldreserve–forexample,theUSFederalReserveBoardkeptgoldequivalentto40percentofthevalueofcurrencyitissued.Theresultwasthatthecentralbankhadlittlediscretionindecidinghowmuchpapermoneyitcouldissue.TheGoldStandardwasfirstadoptedbyBritainin1717–byIsaacNewton,*thethenheadoftheRoyalMint–andadoptedbytheotherEuropeancountriesinthe1870s.Thissystemplayedaveryimportantroleintheevolutionofcapitalisminthenexttwogenerations,butthatisasubjectforlater:seeChapter3.Useofbanknotesisonething,butsavingwithandborrowingfrombanks–namely,banking–is
another.Thiswasevenlessdeveloped.Onlyasmallminorityhadaccesstobanking.Three-quartersoftheFrenchpopulationdidnothaveaccesstobanksuntilthe1860s–nearlyacenturyafterTWON.EveninBritain,whosebankingindustrywasfarmoredevelopedthanthatofFrance,bankingwashighlyfragmented,withtheinterestratesbeingdifferentindifferentpartsofthecountrywellintothetwentiethcentury.Stockmarkets,wherecompanyshares(stocks)areboughtandsold,hadbeeninexistenceforacouple
ofcenturiesorsobySmith’stime.But,giventhatfewcompaniesissuedshares(asmentionedabove,therewasonlyasmallnumberoflimitedliabilitycompanies),thestockmarketremainedasideshowtotheunfoldingcapitalistdrama.Worse,manypeopleconsideredstockmarketstobelittlemorethangamblingdens(somewouldsaytheystillare).Stockmarketregulationwasminimalandhardlyenforced;stockbrokerswerenotobligedtorevealmuchinformationaboutthecompanieswhosesharestheywereselling.Otherfinancialmarketswereevenmoreprimitive.Themarketforgovernmentbonds,thatis,IOUs
thatcanbetransferredtoanyone,issuedbyagovernmentborrowingmoney(theverymarketthatisatthecentreoftheEurocrisisthathasshakentheworldsince2009),existedonlyinafewcountries,suchasBritain,FranceandtheNetherlands.Themarketforcorporatebonds(IOUsissuedbycompanies)wasnotverydevelopedeveninBritain.Today,wehaveahighlydeveloped–somewouldsayover-developed–financialindustry.Thisis
madeupofnotjustthebankingsector,thestockmarketandbondmarkets,butincreasinglythemarketsforfinancialderivatives(futures,options,swaps)andthealphabetsoupofcompositefinancialproductslikeMBS,CDOandCDS(don’tworry,IwillexplainwhatalltheseareinChapter8).Thesystemisultimatelybackedbythecentralbank,whichactsasthelenderoflastresortandlendswithoutlimitsduringfinancialcrises,whennooneelsewantstolend.Indeed,theabsenceofacentralbankmadethemanagementoffinancialpanicverydifficultbackinSmith’stime.
UnlikeinSmith’stime,todaytherearealotofrulesonwhatactorsinthefinancialmarketcando–howmanymultiplesoftheirequitycapitaltheycanlend,whatkindofinformationaboutthemselvescompaniessellingsharesneedtoreveal,whatkindsofassetsdifferentfinancialinstitutionsareallowedtohold(e.g.,pensionfundsarenotallowedtoholdriskyassets).Despitethis,themultiplicityandcomplexityoffinancialmarketshavemadetheirregulationdifficult–aswehavelearnedsincethe2008globalfinancialcrisis.
ConcludingRemarks:Real-worldChangesandEconomicTheories
Asthesecontrastsshow,capitalismhasundergoneenormouschangesinthelasttwoandahalfcenturies.WhilesomeofSmith’sbasicprinciplesremainvalid,theydosoonlyatverygenerallevels.Forexample,competitionamongprofit-seekingfirmsmaystillbethekeydrivingforceofcapitalism,
asinSmith’sscheme.Butitisnotbetweensmall,anonymousfirmswhich,acceptingconsumertastes,fightitoutbyincreasingtheefficiencyintheuseofgiventechnology.Today,competitionisamonghugemultinationalcompanies,withtheabilitynotonlytoinfluencepricesbuttoredefinetechnologiesinashortspanoftime(thinkaboutthebattlebetweenAppleandSamsung)andtomanipulateconsumertastesthroughbrand-imagebuildingandadvertising.Howevergreataneconomictheorymaybe,itisspecifictoitstimeandspace.Toapplyitfruitfully,
therefore,werequireagoodknowledgeofthetechnologicalandinstitutionalforcesthatcharacterizetheparticularmarkets,industriesandcountriesthatwearetryingtoanalysewiththehelpofthetheory.Thisiswhy,ifwearetounderstanddifferenteconomictheoriesintheirrightcontexts,weneedtoknowhowcapitalismhasevolved.Thisisthetaskweturntointhenextchapter.
FurtherReadingH.-J.CHANG
KickingAwaytheLadder:DevelopmentStrategyinHistoricalPerspective(London:Anthem,2002).
R.HEILBRONERANDW.MILBERG
TheMakingofEconomicSociety,13thedition(Boston:Pearson,2012).
G.THERBORN
TheWorld:ABeginner’sGuide(Cambridge:Polity,2011).
‘MrsLintott:Now.Howdoyoudefinehistory,MrRudge?Rudge:CanIspeakfreely,Miss?Withoutbeinghit?MrsLintott:Iwillprotectyou.Rudge:HowdoIdefinehistory?It’sjustonefuckingthingafteranother.’ALANBENNETT,THEHISTORYBOYS
OneFuckingThingafterAnother:WhatUseIsHistory?
ManyreadersprobablyfeelthesamewayabouthistoryasyoungRudgeinTheHistoryBoys–AlanBennett’shitplayand2006filmaboutabunchofbrightbutunderprivilegedSheffieldboystryingtogainadmissiontoOxfordtostudyhistory.Manypeopleconsidereconomichistory,orthehistoryofhowoureconomieshaveevolved,
especiallypointless.Dowereallyneedtoknowwhathappenedtwo,threecenturiesagoinordertoknowthatfreetradepromoteseconomicgrowth,thathightaxesdiscouragewealthcreationorthatcuttingredtapeencouragesbusinessactivities?Aren’ttheseandothereconomicwisdomsofourtimeallpropositionsderivedfromlogicallyairtighttheoriesandcheckedagainstavastamountofcontemporarystatisticalevidence?Themajorityofeconomistsagree.Economichistoryusedtobeacompulsorysubjectingraduate
economicstraininginmostAmericanuniversitiesuntilthe1980s,butmanyofthemdon’tevenoffercoursesineconomichistoryanymore.Amongthemoretheoreticallyorientedeconomists,thereisevenatendencytoconsidereconomichistoryatbestasaharmlessdistraction,liketrainspotting,andatworstasarefugefortheintellectuallychallengedwhocannothandle‘hard’stufflikemathematicsandstatistics.However,Ipresentmyreaderswithabrief(well,notsobrief)historyofcapitalismbecausehaving
someknowledgeofthathistoryisvitaltofullyunderstandingcontemporaryeconomicphenomena.
Lifeisstrangerthanfiction:whyhistorymatters
Historyaffectsthepresent–notsimplybecauseitiswhatcamebeforethepresentbutalsobecauseit(or,rather,whatpeoplethinktheyknowaboutit)informspeople’sdecisions.Alotofpolicyrecommendationsarebackedupbyhistoricalexamplesbecausenothingisaseffectiveasspectacularreal-lifecases–successfulorotherwise–inpersuadingpeople.Forexample,thosewhopromotefreetradealwayspointoutthatBritainandthentheUSbecametheworld’seconomicsuperpowersthroughfreetrade.Iftheyrealizedthattheirversionofhistoryisincorrect(asIwillshowbelow),theymightnothavesuchconvictionintheirpolicyrecommendations.Theywouldalsofindithardertopersuadeothers.Historyalsoforcesustoquestionsomeassumptionsthataretakenforgranted.Onceyouknowthatlots
ofthingsthatcannotbeboughtandsoldtoday–humanbeings(slaves),childlabour,governmentoffices–usedtobeperfectlymarketable,youwillstopthinkingthattheboundaryofthe‘freemarket’isdrawnbysometimelesslawofscienceandbegintoseethatitcanberedrawn.Whenyoulearnthattheadvancedcapitalisteconomiesgrewthefastestinhistorybetweenthe1950sandthe1970s,whentherewerealot
ofregulationsandhightaxes,youwillimmediatelybecomescepticaloftheviewthatpromotinggrowthrequirescutsintaxesandredtape.Historyisusefulinhighlightingthelimitsofeconomictheory.Lifeisoftenstrangerthanfiction,and
historyprovidesmanysuccessfuleconomicexperiences(atalllevels–nations,companies,individuals)thatcannotbetidilyexplainedbyanysingleeconomictheory.Forexample,ifyouonlyreadthingslikeTheEconomistortheWallStreetJournal,youwouldonlyhearaboutSingapore’sfreetradepolicyanditswelcomingattitudestowardsforeigninvestment.ThismaymakeyouconcludethatSingapore’seconomicsuccessprovesthatfreetradeandthefreemarketarethebestforeconomicdevelopment–untilyoualsolearnthatalmostallthelandinSingaporeisownedbythegovernment,85percentofhousingissuppliedbythegovernment-ownedhousingagency(theHousingDevelopmentBoard)and22percentofnationaloutputisproducedbystate-ownedenterprises(theinternationalaverageisaround10percent).Thereisnosingletypeofeconomictheory–Neoclassical,Marxist,Keynesian,younameit–thatcanexplainthesuccessofthiscombinationoffreemarketandsocialism.Exampleslikethisshouldmakeyoubothmorescepticalaboutthepowerofeconomictheoryandmorecautiousindrawingpolicyconclusionsfromit.Lastbutnotleast,weneedtolookathistorybecausewehavethemoraldutytoavoid‘live
experiments’withpeopleasmuchaspossible.Fromthecentralplanningintheformersocialistbloc(andtheir‘BigBang’transitionbacktocapitalism),throughtothedisastersof‘austerity’policiesinmostEuropeancountriesfollowingtheGreatDepression,downtothefailuresof‘trickle-downeconomics’intheUSandtheUKduringthe1980sandthe1990s,historyislitteredwithradicalpolicyexperimentsthathavedestroyedthelivesofmillions,oreventensofmillions,ofpeople.Studyinghistorywon’tallowustocompletelyavoidmistakesinthepresent,butweshoulddoourbesttoextractlessonsfromhistorybeforeweformulateapolicythatwillaffectlives.Ifyouhavebeenpersuadedbyanyoftheabovepoints,pleasereadthroughtherestofthechapter,in
whichalotofthehistorical‘facts’thatyouthoughtyouknewmaybechallengedandthusthewayyouunderstandcapitalismhopefullytransformedatleastalittlebit.
Tortoisevs.Snails:theWorldEconomybeforeCapitalismWesternEuropegrewreallyslowly…
CapitalismstartedinWesternEurope,especiallyinBritainandtheLowCountries(whatareBelgiumandtheNetherlandstoday)aroundthesixteenthandtheseventeenthcenturies.Whyitstartedthere–ratherthan,say,ChinaorIndia,whichhadbeencomparabletoWesternEuropeintheirlevelsofeconomicdevelopmentuntilthen–isasubjectofintenseandlong-runningdebate.EverythingfromtheChineseelite’sdisdainforpracticalpursuits(likecommerceandindustry),thediscoveryoftheAmericasandthepatternofBritain’scoaldepositshasbeenidentifiedastheexplanation.Thisdebateneednotdetainushere.ThefactisthatcapitalismdevelopedfirstinWesternEurope.Beforetheriseofcapitalism,theWesternEuropeansocieties,likealltheotherpre-capitalistsocieties,
changedveryslowly.Thesocietywasbasicallyorganizedaroundfarming,whichusedvirtuallythesametechnologiesforcenturies,withalimiteddegreeofcommerceandhandicraftindustries.Between1000and1500,themedievalera,incomepercapita,namely,incomeperperson,inWestern
Europegrewat0.12percentperyear.1Thismeansthatincomein1500wasonly82percenthigherthan
thatin1000.Toputitintoperspective,thisisagrowththatChina,growingat11percentayear,experiencedinjustsixyearsbetween2002and2008.Thismeansthat,intermsofmaterialprogress,oneyearinChinatodayisequivalenttoeighty-threeyearsinmedievalWesternEurope(whichwereequivalenttothree-and-a-halfmedievallifetimes,astheaveragelifeexpectancyatthetimewasonlytwenty-fouryears).
…butitsgrowthwasstillfasterthanelsewhereintheworld
Havingsaidallthis,growthinWesternEuropewasstillasprintcomparedtothoseinAsiaandEasternEurope(includingRussia),whichareestimatedtohavegrownatone-thirdtherate(0.04percent).Thismeansthattheirincomeswereonly22percenthigherafterhalfamillennium.WesternEuropemayhavebeenmovinglikeatortoise,butotherpartsoftheworldwerelikesnails.
TheDawnofCapitalism:1500–1820Capitalismisborn–inslowmotion
Inthesixteenthcentury,capitalismwasborn.Butitsbirthwassoslowthatwecannoteasilydetectitfromthenumbers.During1500–1820,thegrowthrateofpercapitaincomeinWesternEuropewasstillonly0.14percent–basicallythesametoallintentsandpurposesastheonefor1000–1500(0.12percent).InBritainandtheNetherlands,therewasvisiblegrowthaccelerationbythelateeighteenthcentury,
especiallyinsectorssuchascottontextilesandiron.2Asaresult,during1500–1820,BritainandtheNetherlandsachievedpercapitaeconomicgrowthratesof0.27percentand0.28percentperyear,respectively.Theseareverylowbymodernstandards,buttheywerestilldoubletheWesternEuropeanaverage.Behindthislayanumberofchanges.
Emergenceofnewsciences,technologiesandinstitutions
Firstcametheculturalshifttowardsmore‘rational’approachestounderstandingtheworld,whichpromotedtheriseofmodernmathematicsandsciences.ManyoftheseideaswereinitiallyborrowedfromtheArabworldandAsia,3butinthesixteenthandseventeenthcenturies,theWesternEuropeansstartedaddingtheirowninnovations.Thefoundingfathersofmodernscienceandmathematics–suchasCopernicus,Galileo,Fermat,NewtonandLeibniz–arefromthisera.Thisdevelopmentofsciencedidnotimmediatelyaffectthebroadereconomy,butitlaterenabledthesystemizationofknowledgethatmadetechnologicalinnovationslessdependentonindividualsandthusmoreeasilytransferable,whichencouragedthediffusionofnewtechnologiesandthuseconomicgrowth.Theeighteenthcenturysawtheemergenceofseveralnewtechnologiesthatheraldedtheadventofa
mechanizedproductionsystem,especiallyintextiles,steel-makingandchemicals.*AsinAdamSmith’spinfactory,afinerdivisionoflabourwasdeveloping,withtheuseofcontinuousassemblylinesspreadingfromtheearlynineteenthcentury.Intheemergenceofthesenewproductiontechnologies,akeydriverwasthedesiretoincreaseoutputinordertobeabletosellmoreandthusmakemoreprofit–inotherwords,thespreadofthecapitalistmodeofproduction.AsSmitharguedinhistheoryofdivisionoflabour,theincreaseinoutputmadeafinerdivisionoflabourpossible,whichthenincreasedproductivityandconsequentlyoutput,settingoffa‘virtuouscycle’betweenoutputgrowthandproductivitygrowth.
Neweconomicinstitutionsemergedtoaccommodatethenewrealitiesofcapitalistproduction.Withthespreadofmarkettransactions,banksevolvedtofacilitatethem.Emergenceofinvestmentprojectsrequiringcapitalbeyondthewealthofeventherichestindividualspromptedtheinventionofthecorporation,orlimitedliabilitycompany,andthusthestockmarket.
Colonialexpansionstarts
TheWesternEuropeancountriesstartedtoexpandrapidlyoutwardsfromtheearlyfifteenthcentury.Euphemisticallyknownasthe‘AgeofDiscovery’,thisexpansioninvolvedexpropriatingland,resourcesandpeopleforlabourfromthenativepopulationsthroughcolonialism.BeginningwithPortugalinAsiaandSpainintheAmericasfromthelatefifteenthcentury,theWestern
Europeannationsruthlesslymovedout.Bythemiddleoftheeighteenthcentury,NorthAmericawasdividedupbetweenBritain,FranceandSpain.MostLatinAmericancountrieswereruledbySpainandPortugaluntilthe1810sandthe1820s.PartsofIndiawereruledbytheBritish(mainlyBengalandBihar),theFrench(thesouth-easterncoast)andthePortuguese(variouscoastalareas,especiallyGoa).Australiawasbeginningtobesettledaroundthistime(thefirstpenalcolonywasestablishedin1788).NotmuchofAfricawasaffectedyet,withsmallcoloniesalongthecoastssettledbythePortuguese(theformerlyuninhabitedislandsofCapeVerdeandSaoTomeandPrincipe)andtheDutch(CapeTownintheseventeenthcentury).Colonialismwasrunoncapitalistprinciples.Symbolically,until1858,BritishruleinIndiawas
actuallyadministeredbyacorporation(theEastIndiaCompany),notbythegovernment.ThesecoloniesbroughtnewresourcestoEurope.Theearlyexpansionsweremotivatedbythequestforpreciousmetalstouseasmoney(goldandsilver)andspices(especiallyblackpepper).Overtime,plantationsusingslaves,mostlycaptivesfromAfrica,wereestablishedinthenewcolonies–especiallytheUS,BrazilandtheCaribbean–togrowandbringbacktoEuropenewcropssuchas(cane)sugar,rubber,cottonandtobacco.SomeoftheNewWorldcropsweregrowninEuropeandbeyondandbecamebasicfooditems.ItstretchestheimaginationtothinkofthedayswhentheBritishdidnothavetheirchips,theItalianslackedtomatoesandpolenta(madewithmaize,orsweetcorn)andtheIndians,theThaisandtheKoreansdidnoteatanychillies.
Colonialismleavesbigscars
Thereisalong-runningdebateonwhethercapitalismcouldhavedevelopedwithoutthecolonialresourcesofthesixteenth–eighteenthcenturies–preciousmetaltobeusedasmoney,extrafoodsourcessuchaspotatoandsugarandindustrialinputssuchascotton.4Whilethereisnoquestionthatthecolonizersgreatlybenefitedfromthoseresources,thosecountrieswouldprobablyhavedevelopedcapitalismevenwithoutthem.Thereisnoquestion,however,thatcolonialismdevastatedcolonizedsocieties.Nativepopulationswereexterminatedordrivenontothemargins.Theirland,andtheresourcesover
andunderit,weretakenaway.MarginalizationoftheindigenouspopulationhasbeensoextensivethatEvoMorales,thecurrentpresidentofBolivia,electedin2006,isonlythesecondheadofstatefromtheindigenouspopulationintheAmericassincetheEuropeansarrivedin1492(thefirstwasBenitoJuarez,theMexicanpresidentbetween1858and1872).MillionsofAfricans–12millionisacommonestimate–werecapturedandshippedoutasslavesby
boththeEuropeansandtheArabs.Thiswasnotonlytragedyforthosewhobecameslaves(ifthey
survivedtheatrociousjourney)butitalsodepletedmanyAfricansocietiesofworkersanddestroyedtheirsocialfabric.Countrieswerecreatedoutofthinair,witharbitraryboundaries,affectingtheinternalandtheinternationalpoliticsofthosecountriestothisday.ThefactthatsomanybordersinAfricaarestraightisatestimonytothat;naturalbordersareneverstraightbecausetheyareusuallyformedalongrivers,mountainrangesandothergeographicalfeatures.Colonialismoftenmeantthedeliberatedestructionofexistingproductiveactivitiesintheeconomically
moreadvancedregions.Mostimportantly,in1700,BritainbannedtheimportofIndiancottontextiles(‘calicoes’)–weencounteredtheeventinChapter2–inordertopromoteitsowncottontextileindustry,dealingaheavyblowtotheIndiancottontextileindustry.Theindustrywasfinishedoffinthemid-nineteenthcenturybytheinfluxofexportsfromthethenmechanizedBritishcottontextileindustry.Asacolony,IndiacouldnotusetariffsandotherpolicymeasurestoprotectitsownproducersagainstBritishimports.In1835,LordBentinck,theGovernor-GeneraloftheEastIndiaCompany,famouslyreportedthat‘thebonesofthecottonweaversarebleachingtheplainsofIndia’.5
1820–1870:TheIndustrialRevolutionTheturbo-chargeddrive:theIndustrialRevolutionstarts
Capitalismreallytookoffaround1820,withavisibleaccelerationofeconomicgrowthallaroundWesternEuropeandtheninthe‘Westernoffshoots’inNorthAmericaandOceania.Thegrowthaccelerationwassodramaticthatthehalf-centuryfollowing1820istypicallyreferredtoastheIndustrialRevolution.6
Inthosefiftyyears,percapitaincomeinWesternEuropegrewat1percent,apoorgrowthratethesedays(Japangrewatthatrateduringtheso-called‘lostdecade’ofthe1990s),butcomparedtothe0.14percentgrowthratebetween1500and1820,itwasaturbo-chargeddrive.
Expecttoliveforseventeenyearsandworkeightyhoursaweek:miseryincreasesforsome
Thisaccelerationofgrowthinpercapitaincome,however,wasinitiallyaccompaniedbyafallinlivingstandardsformany.Somewitholdskills–suchastextileartisans–losttheirjobs,havingbeenreplacedbymachinesoperatedbycheaper,unskilledworkers,includingmanychildren.Somemachineswereevendesignedwiththesmallsizesofchildreninmind.Thosewhowerehiredtoworkinfactories,orinthesmallworkshopsthatsuppliedinputsforthem,workedlonghours–seventytoeightyhoursperweekwasthenorm,andsomeworkedmorethan100hoursaweekwithusuallyonlyhalfofSundayfree.Workingconditionswereextremelyhazardous.ManyBritishcottontextileworkersdiedoflung
diseasesfromthedustgeneratedintheproductionprocess.Theurbanworkingclasslivedincrowdedconditions,sometimesfifteentotwentypeopleinaroom.Itwastypicalthathundredsofpeoplesharedonetoilet.Theydiedofflikeflies.InpoorareasofManchester,lifeexpectancywasseventeenyears7–30percentlowerthanwhatithadbeenforthewholeofBritainbeforetheNormanConquest,backin1000(thentwenty-fouryears).
Theriseofanti-capitalistmovements
Giventhemiserythatcapitalismwascreating,itisnowonderthatvariousformsofanti-capitalistmovementsarose.Someofthemmerelytriedtoturntheclockback.TheLuddites–textileartisansofEnglandwholosttheirjobstomechanizedproductioninthe1810s–turnedtodestroyingthemachines,
theimmediatecauseoftheirunemploymentandthemostobvioussymbolofcapitalistprogress.Otherssoughttobuildabetter,moreegalitariansocietythroughvoluntaryassociations.RobertOwen,theWelshbusinessman,triedtobuildasocietybasedoncommunalworkingandlivingamongthelike-minded–ratherliketheIsraelikibbutz.Themostimportantanti-capitalistvisionarywas,however,KarlMarx(1818–83),theGerman
economistandrevolutionary,whospentmostofhistimeexiledinEngland–hisgraveisinHighgateCemeteryinLondon.MarxlabelledOwenandotherslikehimas‘utopiansocialists’forbelievingthatapost-capitalistsocietycanbebasedonidylliccommunalliving.Callinghisownapproach‘scientificsocialism’,hearguedthatthenewsocietyshouldbuildon,ratherthanreject,theachievementsofcapitalism.Asocialistsocietyshouldabolishprivateownershipinthemeansofproductionbutitshouldpreservethelargeproductionunitscreatedbycapitalismsothatitcantakefulladvantageoftheirhighproductivities.Moreover,Marxproposedthatasocialistsocietyshouldberunlikeacapitalistfirminoneimportantrespect–itshouldplanitseconomicaffairscentrally,inthesamewayinwhichacapitalistfirmplansallitsoperationscentrally.Thisisknownascentralplanning.Marxandmanyofhisfollowers–includingVladimirLenin,theleaderoftheRussianRevolution–
believedthatasocialistsocietycouldonlybecreatedthrougharevolution,ledbyworkers,giventhatthecapitalistswouldnotvoluntarilygiveupwhattheyhad.However,someofhisfollowers,knownasthe‘revisionists’orsocialdemocrats,suchasEduardBernsteinandKarlKautsky,thoughtthattheproblemsofcapitalismcouldbealleviatedthroughthereform,ratherthanabolition,ofcapitalismthroughparliamentarydemocracy.Theyadvocatedmeasureslikeregulationofworkinghoursandworkingconditionsaswellasthedevelopmentofthewelfarestate.Withhindsight,itiseasytoseethatthosereformistsreadthehistoricaltrendthebest,asthesystemthey
advocatediswhatalltheadvancedcapitalisteconomieshavetoday.Atthetime,however,itwasnotobviousthatworkerscouldbemadebetteroffundercapitalism,notleastbecausetherewasfierceresistancetoreformfrommostcapitalists.Fromaround1870,therewerepalpableimprovementsintheconditionsoftheworkingclass.Wages
wentup.AtleastinBritain,theaverageadultwagewasfinallyhighenoughtoallowtheworkerstobuymorethanthebarenecessities,andsomeworkerswerenowworkinglessthansixtyhoursaweek.Lifeexpectancywasupfromthirty-sixyearsin1800toforty-oneyearsin1860.8Attheendofthisperiod,therewereeventhebeginningsofthewelfarestate,whichstartedinGermanywiththe1871industrialaccidentinsurancescheme,introducedbyOttovonBismarck,theChancellorofthenewlyunitedGermany.
Themythoffreemarketandfreetrade:Howcapitalismreallydeveloped
TheadvancementofcapitalismintheWesternEuropeancountriesandtheiroffshootsinthenineteenthcenturyisoftenattributedtothespreadoffreetradeandfreemarket.Itisonlybecausethegovernmentinthesecountries,itisargued,didnottaxorrestrictinternationaltrade(freetrade)and,moregenerally,didnotinterfereintheworkingsofthemarket(freemarket)thatthesecountriescoulddevelopcapitalism.BritainandtheUSaresaidtohaveforgedaheadofothercountriesbecausetheywerethefirstonestoadoptthefreemarketand,especially,freetrade.Thiscouldnotbefurtherfromthetruth.Thegovernmentplayedaleadingroleintheearlydevelopment
ofcapitalismbothinBritainandtheUS,aswellasinotherWesternEuropeancountries.9
Britainasthepioneerofprotectionism
StartingwithHenryVII(1485–1509),theTudormonarchspromotedthewoollentextileindustry–Europe’sthenhi-techindustry,ledbytheLowCountries,especiallyFlanders–throughgovernmentintervention.Tariffs(taxesonimports)protectedtheBritishproducersfromthesuperiorLowCountryproducers.TheBritishgovernmentevensponsoredthepoachingofskilledtextileartisans,mainlyfromFlanders,togainaccesstoadvancedtechnologies.BritishorAmericanpeoplewithnameslikeFlanders,FlemingandFlemyngaredescendantsofthoseartisans:withoutthosepolicies,therewouldn’tbe007(IanFleming)orpenicillin(AlexanderFleming);andsomehowIdon’tthinkTheSimpsonswouldhavebeenasfunasitisifNedFlanderswerecalledNedLancashire.ThesepoliciescontinuedaftertheTudors,andbytheeighteenthcenturywoollentextilegoodsaccountedforaroundhalfofBritain’sexportrevenue.Withoutthoseexportrevenues,BritainwouldnothavebeenabletoimportthefoodandtherawmaterialsthatitneededfortheIndustrialRevolution.Britishgovernmentinterventionwassteppedupin1721,whenRobertWalpole,Britain’sfirstprime
minister,10launchedanambitiousandwide-rangingindustrialdevelopmentprogramme.Itprovidedtariffprotectionandsubsidies(especiallytoencourageexport)to‘strategic’industries.PartlythankstoWalpole’sprogramme,Britainstartedtoforgeaheadinthesecondhalfoftheeighteenthcentury.Bythe1770s,BritainwassoobviouslyaheadofothercountriesthatAdamSmithsawnoneedforprotectionismandotherformsofgovernmentinterventiontohelpBritishproducers.However,itwasonlynearlyacenturyafterSmith’sTWON–in1860–thatBritainfullyswitchedtofreetrade,whenitsindustrialsupremacywasunquestioned.Atthetime,Britainaccountedfor20percentofworldmanufacturingoutput(asof1860)and46percentofworldtradeinmanufacturedgoods(asof1870),despitehavingonly2.5percentoftheworldpopulation;thesenumberscanbeputintoperspectivebynotingthatthecorrespondingfiguresforChinatodayare15percentand14percent,despiteitshaving19percentoftheworldpopulation.
TheUSasthechampionofprotectionism
TheUScaseisyetmoreinteresting.UnderBritishcolonialrule,itsdevelopmentofmanufacturingwasdeliberatelysuppressed.Itisreportedthat,uponhearingaboutthefirstattemptsbytheAmericancoloniststoengageinmanufacturing,WilliamPitttheElder,theBritishprimeminister(1766–8),saidthattheyshould‘notbepermittedtomanufacturesomuchasahorseshoenail’.Aftergainingindependence,manyAmericansarguedthattheircountryshouldindustrializeifitwasto
rubshoulderswiththelikesofBritainandFrance.LeadingthiscampwasnolessthanthefirsteverministerinchargeoftheUSeconomy,AlexanderHamilton,thetreasurysecretary(that’stheoneyouseeonthe$10bill).Inhis1791reporttotheCongress,ReportontheSubjectofManufactures,Hamiltonarguedthatthegovernmentofaneconomicallybackwardnation,suchastheUS,needstoprotectandnurture‘industriesintheirinfancy’againstsuperiorforeigncompetitorsuntiltheygrowup;thisisknownastheinfantindustryargument.Hamiltonproposedtheuseoftariffsandothermeasurestohelptheinfantindustries;subsidies,publicinvestmentsininfrastructure(especiallycanals),apatentlawtoencouragenewinventionsandmeasurestodevelopthebankingsystem.Inthebeginning,theslave-owninglandlordsfromtheSouth,whothendominatedUSpolitics,thwarted
Hamilton’splan;theydidn’tseewhytheyshouldbuyinferior‘Yankee’-manufacturedproductswhentheycouldimportbetterandcheaperthingsfromEurope.But,followingtheAnglo-AmericanWar(1812–16)–
thefirstandsofartheonlytimethattheUSmainlandwasinvaded–manyAmericanscamearoundtoHamilton’sviewthatastrongcountryneededastrongmanufacturingsector,whichwasnotgoingtohappenwithouttariffsandothergovernmentinterventions.TheonlypitywasthatHamiltonwasnotaroundtoseehisvisionrealized.Hehadbeenshotdeadinapistolduelin1804byacertainAaronBurr–theservingvicepresidentofthecountryatthetime(yes,thosewerewilddays–aservingvicepresidentshootsaformerfinanceministerdead,andnoonegoestoprison).Aftertheshiftofdirectionin1816,theUStradepolicybecameincreasinglyprotectionist.Bythe
1830s,thecountrywasboastingthehighestaverageindustrialtariffintheworld–astatusthatitwouldkeepfor(almostallof)thenexthundredyears,untiltheSecondWorldWar.Duringthatcentury,tariffsweremuchlowerinstatessuchasGermany,FranceandJapan–statesthatpeoplethesedaysnormallyassociatewithprotectionism.Inthefirsthalfofthisprotectionistcentury,togetherwithslaveryandfederalism,protectionism
remainedaconstantboneofcontentionbetweentheindustrialNorthandtheagrarianSouth.TheissuewasfinallysettledbytheCivilWar(1861–5),whichtheNorthwon.Thevictorywasnoaccident.TheNorthwonexactlybecauseithaddevelopedmanufacturingindustryintheprevioushalfacenturybehindthewallofprotectionism.InMargaretMitchell’sclassicnovelGonewiththeWind,RhettButler,theleadingmalecharacter,tellshisSoutherncompatriotsthattheYankeeswouldwinthewarbecausetheyhad‘thefactories,thefoundries,theshipyards,theironandcoalmines–allthethingswe[theSoutherners]haven’tgot’.
Freetradespreads–mostlythroughunfreemeans
Freetradewasnotresponsiblefortheriseofcapitalism,butitdidspreadthroughoutthenineteenthcentury.Someofithappenedintheheartlandofcapitalisminthe1860s–Britain’sadoptionoffreetradeandthesigningofaseriesofbilateralfree-tradeagreements(orFTAs),inwhichtwocountriesabolishimportrestrictionsandtariffsoneachother’sexports,amongtheWesternEuropeancountries.Butmuchofthespreadhappenedontheperipheryofcapitalism,inLatinAmericaandAsia.Thiswastheresultofsomethingthatyouwouldnotnormallyassociatewiththeword‘free’–thatis,
force,oratleastthethreatofusingit.Colonizationwastheobviousrouteto‘unfreefreetrade’,butevenmanycountriesthatwerenotcolonizedwerealsoforcedtoadoptfreetrade.Through‘gunboatdiplomacy’,theywereforcedtosignunequaltreatiesthatdeprivedthemof,amongotherthings,tariffautonomy(therighttosettheirowntariffs).11Theywereallowedtouseonlyalowuniformtariffrate(3–5percent)–enoughtoraisesomegovernmentrevenuebutnotenoughforinfantindustryprotection.ThemostinfamousunequaltreatyistheNankingTreaty,whichChinawasforcedtosignin1842,
followingitsdefeatintheOpiumWar.ButtheunequaltreatieshadstartedwiththeLatinAmericancountries,upontheirindependenceinthe1810sandthe1820s.Betweenthe1820sandthe1850s,astringofothercountrieswereforcedtosignthem–theOttomanEmpire(Turkey’spredecessor),Persia(Irantoday)andSiam(today’sThailand),andevenJapan.TheLatinAmericanunequaltreatiesexpiredinthe1870sandthe1880s,buttheAsianoneslastedwellintothetwentiethcentury.Theinabilitytoprotectandpromotetheirinfantindustries,whetherduetodirectcolonialruleorto
unequaltreaties,wasahugecontributingfactortotheeconomicretrogressioninAsiaandLatinAmericaduringthisperiod,whentheysawnegativepercapitaincomegrowths(attheratesof-0.1and-0.04percentperyear,respectively).
1870–1913:HighNoonCapitalismgetsintoahighergear:theriseofmassproduction
Thedevelopmentofcapitalismbegantoacceleratearound1870.Clustersofnewtechnologicalinnovationsemergedbetweenthe1860sandthe1910s,resultingintheriseoftheso-calledheavyandchemicalindustries:electricalmachinery,internalcombustionengines,syntheticdyes,artificialfertilizers,andsoon.UnlikethetechnologiesoftheIndustrialRevolution,whichhadbeeninventedbypracticalmenwithgoodintuition,thesenewtechnologiesweredevelopedthroughthesystematicapplicationofscientificandengineeringprinciples.Thismeantthat,oncesomethingwasinvented,itcouldbereplicatedandimproveduponveryquickly.Inaddition,organizationoftheproductionprocesswasrevolutionizedinmanyindustriesbythe
inventionofthemassproductionsystem.Theuseofamovingassemblyline(conveyorbelt)andinterchangeablepartsdramaticallyloweredproductioncosts.Thissystemofproductionisthebackbone(ifnottheentirety)ofourproductionsystemtoday,despitefrequenttalksofitsdemisesincethe1980s.
Neweconomicinstitutionsemergetodealwithgrowingproductionscale,risk,andinstability
Duringits‘highnoon’,capitalismacquiredthebasicinstitutionalshapethatithastoday–thelimitedliabilitycompany,bankruptcylaw,thecentralbank,thewelfarestate,labourlawsandsoon.Theseinstitutionalshiftscameaboutbasicallybecauseofthechangesinunderlyingtechnologiesandpolitics.Recognizingthegrowingneedforlarge-scaleinvestments,limitedliability,hithertoreservedonlyfor
privilegedfirms,was‘generalized’–thatis,grantedtoanyfirmthatmetsomeminimumconditions.Enablingunprecedentedscalesofinvestment,thelimitedliabilitycompanybecamethemostpowerfulvehicleforcapitalistdevelopment–KarlMarx,spottingitsenormouspotentialbeforeanyself-appointedcheerleaderofcapitalism,calledit‘capitalistproductioninitshighestdevelopment’.Beforethe1849Britishreform,thebankruptcylawfocusedonpunishingthebankruptbusinessman,
withadebtors’prisonintheworstcase.Newbankruptcylaws,introducedinthesecondhalfofthenineteenthcentury,gavefailedbusinessmenasecondchancebyallowingthemnottopayinteresttocreditorswhiletheywerereorganizingtheirbusiness(asinChapter11oftheUSFederalBankruptcyAct,introducedin1898)andbyforcingthecreditorstowriteoffpartsoftheirdebts.Beingabusinessmanbecamefarlessrisky.Withlargercompaniescamelargerbanks.Theriskwasthenheightenedthatthefailureofonebank
coulddestabiliszethewholefinancialsystem,socentralbanksweresetuptodealwithsuchproblemsbyactingasthelenderoflastresort,startingwiththeBankofEnglandin1844.Withincreasingsocialistagitationandreformistpressuresinrelationtotheconditionoftheworking
class,araftofwelfareandlabourlegislationswereimplementedfromthe1870s:industrialaccidentinsurance,healthinsurance,oldagepensionsandunemploymentinsurance.Manycountriesalsobannedtheemploymentofyoungerchildren(typically,thoseundertentotwelve)andrestrictedtheworkinghoursofolderchildren(initiallyonlytotwelvehours!).Theyalsoregulatedtheworkingconditionsandhoursofwomen.Unfortunately,thiswasdonenotoutofchivalrybutoutofcontemptforwomen.Unlikemen,itwasbelieved,womenlackedfullmentalfacultiesandthereforecouldsignalabourcontractthatwasdisadvantageoustothem–theyneededtobeprotectedfromthemselves.Thiswelfareandlabourlegislationtooktheroughestedgesoffcapitalismandmadealotofpoorpeople’slivesbetter–ifonlyslightlyatthebeginning.
Theseinstitutionalchangespromotedeconomicgrowth.Limitedliabilityanddebtor-friendlybankruptcylawsreducedriskinvolvedinbusinessactivities,therebyencouragingwealthcreation.Centralbanking,ontheonehand,andlabourandwelfarelegislations,ontheother,alsohelpedgrowthbyenhancing,respectively,economicandpoliticalstability,whichincreasedinvestmentandthusgrowth.ThegrowthrateofpercapitaincomeinWesternEuropeacceleratedduringthis‘highnoon’from1percentduring1820–70to1.3percentduring1870–1913.
Howthe‘liberal’goldenagewasnotsoliberal
The‘highnoon’ofcapitalismisoftendescribedasthefirstageofglobalization,thatis,thefirsttimeinwhichthewholeworldeconomywasintegratedintoonesystemofproductionandexchange.Manycommentatorsattributethisoutcometotheliberaleconomicpoliciesadoptedduringthisperiod,whentherewerefewpolicyrestrictionsoncross-bordermovementsofgoods,capitalandpeople.Thisliberalismontheinternationalfrontwasmatchedbythelaissez-faireapproachtodomesticeconomicpolicy(seetheboxbelowfordefinitionsoftheseterms).Allowanceofmaximumfreedomforbusiness,pursuitofabalancedbudget(thatis,thegovernmentspendingexactlyasmuchasitcollectsintaxes)andtheadoptionoftheGoldStandardwerethekeyingredients,theysay.Thingswere,however,farmorecomplicated.
‘LIBERAL’:THEMOSTCONFUSINGTERMINTHEWORLD?
Fewwordshavegeneratedmoreconfusionthantheword‘liberal’.Althoughthetermwasnotexplicitlyuseduntilthenineteenthcentury,theideasbehindliberalismcanbetracedbacktoatleasttheseventeenthcentury,startingwiththinkerslikeThomasHobbesandJohnLocke.Theclassicalmeaningofthetermdescribesapositionthatgivesprioritytofreedomoftheindividual.Ineconomicterms,thismeansprotectingtherightoftheindividualtousehispropertyashepleases,especiallytomakemoney.Inthisview,theidealgovernmentistheonethatprovidesonlytheminimumconditionsthatareconducivetotheexerciseofsucharight,suchaslawandorder.Suchagovernment(state)isknownastheminimalstate .Thefamoussloganamongtheliberalsofthetimewas‘laissezfaire’(letthingsbe),soliberalismisalsoknownasthelaissez-fairedoctrine.Today,liberalismisusuallyequatedwiththeadvocacyofdemocracy,givenitsemphasisonindividualpoliticalrights,including
thefreedomofspeech.However,untilthemid-twentiethcentury,mostliberalswerenotdemocrats.Theydidrejecttheconservativeviewthattraditionandsocialhierarchyshouldhavepriorityoverindividualrights.Buttheyalsobelievedthatnoteveryonewasworthyofsuchrights.Theythoughtwomenlackedfullmentalfacultiesandthusdidnotdeservetherighttovote.Theyalsoinsistedthatpoorpeopleshouldnotbegiventherighttovote,sincetheybelievedthepoorwouldvoteinpoliticianswhowouldconfiscateprivateproperties.AdamSmithopenlyadmittedthatthegovernment‘isinrealityinstitutedforthedefenceof
therichagainstthepoor,orofthosewhohavesomepropertyagainstthosewhohavenoneatall’.12
Whatmakesitevenmoreconfusingisthat,intheUS,theterm‘liberal’isusedtodescribeaviewthatistheleft-of-centre.American‘liberals’,suchasTedKennedyorPaulKrugman,wouldbecalledsocialdemocratsinEurope.InEurope,thetermisreservedforpeoplelikethesupportersoftheGermanFreeDemocraticParty(FDP),whowouldbecalledlibertarians intheUS.Thenthereisneo-liberalism,whichhasbeenthedominanteconomicviewsincethe1980s(seebelow).Itisverycloseto,
butnotquitethesameas,classicalliberalism.Economically,itadvocatestheclassicalminimalstatebutwithsomemodifications–mostimportantly,itacceptsthecentralbankwithnoteissuemonopoly,whiletheclassicalliberalsthoughtthatthereshouldbecompetitionintheproductionofmoneytoo.Inpoliticalterms,neo-liberalsdonotopenlyopposedemocracy,astheclassicalliberalsdid.Butmanyofthemarewillingtosacrificedemocracyforthesakeofprivatepropertyandthefreemarket.Neo-liberalismisalsoknown,especiallyindevelopingcountries,astheWashingtonConsensus view,referringtothefact
thatitisstronglyadvocatedbythethreemostpowerfuleconomicorganizationsintheworld,allbasedinWashington,DC,namely,theUSTreasury,theInternationalMonetaryFund(IMF)andtheWorldBank.
The1870–1913perioddidnotactuallyseeuniversalliberalismontheinternationalfront.Intheheartlandofcapitalism,inWesternEuropeandtheUS,tradeprotectionismactuallyincreased,notdecreased.TheUSbecameevenmoreprotectionistthanbeforefollowingtheconclusionoftheCivilWarin1865.
MostWesternEuropeancountriesthathadsignedFTAsinthe1860sandthe1870sdidnotrenewthemandsignificantlyincreasedtariffsaftertheirexpiry(theyusuallyhadatwenty-yearlifetime).Thiswaspartlytoprotectagriculture,whichwasstrugglingwithnewcheapimportsfromtheNewWorld(especiallytheUSandArgentina)andEasternEurope(RussiaandUkraine)butalsotoprotectandpromotethenewheavyandchemicalindustries.GermanyandSwedenwerethebestexamplesofthis‘newprotectionism’–famouslycalledthe‘marriageofironandrye’inGermany.Whentheunequaltreatiestheyhadsigneduponindependenceexpiredinthe1870sandthe1880s,the
LatinAmericancountriesintroducedratherhighprotectivetariffs(30–40percent).However,elsewhereinthe‘periphery’,theforcedfreetradewetalkedaboutearlierspreadmuchfurther.EuropeanpowerscompetedforpartsoftheAfricancontinentinthe‘scrambleforAfrica’,whilemanyAsiancountrieswerealsotakenascolonies(Malaysia,SingaporeandMyanmarbyBritain;Cambodia,VietnamandLaosbyFrance).TheBritishEmpireexpandedenormously,backedupbyitsindustrialmight,leadingtothefamoussaying:‘ThesunneversetsontheBritishEmpire.’CountrieslikeGermany,Belgium,theUSandJapan,whichhadnotsofarengagedinmuchcolonialism,alsojoinedin.13Notfornothingisthisperiodalsoknownasthe‘AgeofImperialism’.Thedomesticfrontalsosawamarkedincrease,notadecrease,ingovernmentinterventioninthecore
capitalistcountries.Therewas,indeed,astrongadherencetofree-marketdoctrinesinrelationtofiscalpolicy(thebalancedbudgetdoctrine)andmonetarypolicy(theGoldStandard).However,thisperiodalsosawanenormousincreaseintheroleofthegovernment:labourregulations,socialwelfareschemes,publicinvestmentsininfrastructure(especiallyrailwaysbutalsocanals)andineducation(especiallytheUSandGermany).Theliberalgoldenageof1870–1913wasthusnotasliberalaswethink.Itwasgettinglessliberalin
thecorecapitalistcountries,intermsofbothdomesticandinternationalpolicies.Liberalizationhappenedmostlyintheweakercountries,butoutofcompulsionratherthanchoice–throughcolonialismandunequaltreaties.Intheonlyperipheralregionthatexperiencedrapidgrowthduringthisperiod,namely,LatinAmerica,therewasavastincreaseinprotectionismfollowingtheexpiryoftheunequaltreaties.14
1914–45:TheTurmoilCapitalismtripsup:theFirstWorldWarandtheendoftheliberalgoldenage
TheoutbreakoftheFirstWorldWarin1914signalledtheendofaneraforcapitalism.Untilthen,despiteconstantthreatsofrevoltbythepoor(the1848revolutionsacrossEurope,the1871Pariscommune,etc.)andeconomicproblems(theLongDepressionof1873–96),theonlywayforcapitalismhadseemedtobeup–andoutwards.ThisviewwasrudelyshakenbytheFirstWorldWar(1914–18),whichtotallydiscreditedthethen
popularviewthatthethickeningwebofcommerce,whichcapitalismwasbuildingacrosstheglobe,wouldmakewarsbetweennationsthusintertwinedhighlyunlikely,ifnottotallyimpossible.
Atonelevel,theoutbreakoftheFirstWorldWarshouldnothavebeensurprising,giventhattheglobalizationofthe‘highnoon’hadbeeninlargepartdrivenbyimperialism,ratherthanmarketforces.Thismeantthattheinternationalrivalrybetweentheleadingcapitalistcountrieshadahighchanceofescalatingintoviolentconflicts.Somewentevenfurtherandarguedthatcapitalismhadreachedastageinwhichitcouldnotbesustainedwithoutcontinuousoutwardexpansion,whichhastocometoanendsoonerorlater,markingtheendofcapitalism.
Capitalismgetsarival:theRussianRevolutionandtheriseofsocialism
ThiswastheviewmostfamouslyexpoundedinImperialism:TheHighestStageofCapitalismbyVladimirLenin,theleaderoftheRussianRevolutionin1917.TheRussianRevolutionwasanevenbiggershocktothedefendersofcapitalismthantheFirstWorldWar,asitledtothecreationofaneconomicsystemthatclaimstoundermineallthecornerstonesofcapitalism.InthedecadefollowingtheRussianRevolution,privatepropertyinthemeansofproduction(machines,
factorybuilding,land,etc.)wasabolished.Thebigbreakcamewiththeagriculturalcollectivizationin1928,inwhichthelandsoflargefarmers,orkulaks,wereconfiscatedandturnedintostatefarms(sovkhoz)andsmallfarmerswereforcedtojoinagriculturalcooperatives(kolkhoz),whichwerestatefarmsinallbutname.Marketswereeventuallyabolishedandreplacedbyfull-blowncentralplanningby1928,whenthefirstFiveYearPlanstarted.By1928,theSovietUnionhadaneconomicsystemthatwasdefinitivelynotcapitalist.Itranwithoutprivateownershipofmeansofproduction,profitmotivesandmarkets.Asfortheothercornerstoneofcapitalism,wagelabour,thepicturewasmorecomplicated.Yes,in
theorytheSovietworkerswerenotwagelabourersbecausetheyownedallthemeansofproduction–throughstateownershiporcooperatives.Inpracticetheywereindistinguishablefromwagelabourersinacapitalisteconomy,sincetheyhadlittlecontroloverthewayinwhichtheirenterprisesandthewidereconomyoperated,andtheirdailyworkexperiencewasstillsubjecttothesamehierarchicalrelationship.Sovietsocialismwasahugeeconomic(andsocial)experiment.Untilthen,noeconomyhadbeen
centrallyplanned.KarlMarxhadleftthedetailsrathervague,andtheSovietUnionhadtomakethingsupasitwentalongthisuntroddenpath.EvenmanyMarxists,especiallyKarlKautsky,werescepticalaboutitsprospects–socialismwas,accordingtoMarxhimself,supposedtoemergefromthemostdevelopedcapitalisteconomies.Thoseeconomieswereonlyastepawayfromafullyplannedeconomy,itwasargued,becausetheireconomicactivitieswerealreadyplannedtoahighdegreebylargeenterprisesandcartelsofthoseenterprises.TheSovietUnion–evenitsmoredevelopedEuropeanpart–wasaverybackwardeconomyinwhichcapitalismhadbeenhardlydeveloped,wheresocialismreallyhadnobusinessemerging.Toeveryone’ssurprise,theearlySovietindustrializationwasabigsuccess,mostgraphicallyproven
byitsabilitytorepeltheNaziadvanceontheEasternFrontduringtheSecondWorldWar.Incomepercapitaisestimatedtohavegrownat5percentperyearbetween1928and1938–anastonishinglyrapidrateinaworldinwhichincometypicallygrewat1–2percentperyear.15
Thisgrowthcameatthecostofmillionsofdeaths–frompoliticalrepressionandthe1932famine.*However,thescaleofthefaminewasnotknownatthetime,andmanywereimpressedbySovieteconomicperformance,especiallygiventhatcapitalismwasthenonitsknees,followingtheGreatDepressionof1929.
Capitalismgetsdepressed:theGreatDepressionof1929
TheGreatDepressionwasanevenmoretraumaticeventforthebelieversincapitalismthantheriseofsocialism.ThiswasespeciallythecaseintheUS,wheretheDepressionstarted(withtheinfamous1929WallStreetcrash)andwhichwasthehardesthitbytheexperience.Between1929and1932,USoutputfellby30percentandunemploymentincreasedeightfold,from3percentto24percent.16Itwasnotuntil1937thatUSoutputregainedits1929level.GermanyandFrancealsosufferedbadly,withtheiroutputsfallingby16percentand15percentrespectively.Oneinfluentialview,propagatedbyneo-liberaleconomists,isthatthislargebuttotallymanageable
financialcrisiswasturnedintoaGreatDepressionbecauseofthecollapseinworldtradecausedbythe‘tradewar’,promptedbytheadoptionofprotectionismbytheUSthroughthe1930Smoot-HawleyTariffs.Thisstorydoesnotstanduptoscrutiny.ThetariffincreasebySmoot-Hawleywasnotdramatic–itraisedtheaverageUSindustrialtarifffrom37percentto48percent.Nordiditcauseamassivetariffwar.ExceptforafeweconomicallyweakcountriessuchasItalyandSpain,tradeprotectionismdidnotincreaseverymuchfollowingSmoot–Hawley.Mostimportantly,studiesshowthatthemainreasonforthecollapseininternationaltradeafter1929wasnottariffincreasesbutthedownwardspiralininternationaldemand,causedbytheadherencebythegovernmentsofthecorecapitalisteconomiestothedoctrineofbalancedbudget.17
Afterabigfinancialcrisislikethe1929WallStreetcrashorthe2008globalfinancialcrisis,private-sectorspendingfalls.Debtsgounpaid,whichforcesbankstoreducetheirlending.Beingunabletoborrow,firmsandindividualscuttheirspending.This,inturn,reducesdemandsforotherfirmsandindividualsthatusedtoselltothem(e.g.,firmssellingtoconsumers,firmssellingmachinerytootherfirms,workerssellinglabourservicestofirms).Thedemandlevelintheeconomyspiralsdown.Inthisenvironment,thegovernmentistheonlyeconomicactorthatcanmaintainthelevelofdemandin
theeconomybyspendingmorethanitearns,thatis,byrunningabudgetdeficit.However,inthedaysoftheGreatDepression,thestrongbeliefinthedoctrineofthebalancedbudgetpreventedsuchacourseofaction.Astaxrevenueswerefallingduetoreducedlevelsofeconomicactivity,theonlywayforthemtobalancetheirbudgetswastocuttheirspending,leavingnothingtoarrestthedownwarddemandspiral.18
Tomakethingsworse,theGoldStandardmeantthattheircentralbankscouldnotincreasethesupplyofmoneyforfearofcompromisingthevalueoftheircurrencies.Withrestrictedmoneysupply,creditbecamescarce,restrictingprivate-sectoractivitiesandthusreducingdemandevenfurther.
Reformbegins:theUSandSwedenleadtheway
TheGreatDepressionleftalastingmarkoncapitalism.Withitcamewidespreadrejectionofthelaissez-fairedoctrineandseriousattemptstoreformcapitalism.Thereformswereparticularlywidespreadandfar-reachingintheUS,wheretheDepressionwasthe
greatestandlastedthelongest.Theso-calledFirstNewDealprogramme(1933–4)underthenewpresident,FranklinDelanoRoosevelt,separatedthecommercialandinvestmentarmsofbanks(the1933Glass-SteagallAct),setupthebankdepositinsurancesystemtoprotectsmallsaversagainstbankfailures,tightenedstockmarketregulation(the1933FederalSecuritiesAct),expandedandstrengthenedthefarmcreditsystem,providedaminimumfarmpriceguaranteeanddevelopedinfrastructure(suchastheHooverDam–that’stheoneyouseeinthe1978Supermanmovie,starringthelateChristopherReeve),andsoon.Therewereevenmorereformsundertheso-calledSecondNewDeal(1935–8),
includingtheSocialSecurityAct(1935),whichintroducedoldagepensionsandunemploymentinsurance,andtheWagnerAct(1935),whichstrengthenedtradeunions.Swedenwasanothercountrywheresignificantreformswereintroduced.Ridingonthebackofthe
publicdiscontentwithliberaleconomicpolicies,whichleftunemploymentat25percent,theSocialDemocraticPartycametopowerin1932.Incometaxwasintroduced–surprisinglybelatedlyforacountrythatistodayconsideredthebastionofincometax(Britainintroducedincometaxin1842andeventhefamouslyanti-taxUSin1913).Therevenueswereusedforexpandingthewelfarestate(unemploymentinsurancewasintroducedin1934,andtheold-agepensionwasraised)andforhelpingsmallfarmers(farmcreditswereexpanded,andminimumpriceswereguaranteed).In1938,thecentralizedtradeunionandthecentralizedemployers’associationsignedtheSaltsjöbadenAgreement,establishingindustrialpeace.OthercountriesdidnotgoasfarastheUSandSwedeninreformingcapitalism,buttheirreforms
presagedtheshapeofthethingstocomeaftertheSecondWorldWar.
Capitalismfalters:growthslowsdownandsocialismoutperformscapitalism
Theturmoilofthe1914–45periodreacheditspeakwiththeoutbreakoftheSecondWorldWar,whichkilledtensofmillionsofpeople,bothsoldiersandcivilians(higherestimatesputthedeathtollat60million).Thewarresultedinthefirstreversalintheaccelerationineconomicgrowthsincetheearlynineteenthcentury.19
1945–73:TheGoldenAgeofCapitalismCapitalismperformswellonallfronts:growth,employmentandstability
Theperiodbetween1945,theendoftheSecondWorldWar,and1973,thefirstOilShock,isoftencalledthe‘GoldenAgeofcapitalism’.Theperiodreallydeservesthename,asitachievedthehighestgrowthrateever.Between1950and1973,percapitaincomeinWesternEuropegrewatanastonishingrateof4.1percentperyear.TheUSgrewmoreslowly,butatanunprecedentedrateof2.5percent.WestGermanygrewat5.0percent,earningthetitleofthe‘MiracleontheRhine’,whileJapangrewevenfasterat8.1percent,startingoffthechainof‘economicmiracles’inEastAsiainthenexthalfacentury.HighgrowthwasnottheonlyeconomicachievementoftheGoldenAge.Unemployment,thebaneofthe
workingclass,wasvirtuallyeliminatedintheadvancedcapitalistcountries(henceforthACCs)ofWesternEurope,JapanandtheUS(seeChapter10).Theseeconomieswerealsoremarkablystableonanumberofaccounts–output(andthusemployment),pricesandfinance.Outputsfluctuatedmuchlessthaninthepreviousperiods,notleastthankstoKeynesianfiscalpolicy,whichincreasedgovernmentspendingduringdownturnsandreduceditduringbooms.20Therateofinflation,thatis,therateatwhichthegeneralpricelevelrises,wasrelativelylow.21Andtherewasaveryhighdegreeoffinancialstability.DuringtheGoldenAge,virtuallynocountrywasinbankingcrisis.Incontrast,since1975,anythingbetween5and35percentofcountriesinanygivenyearhavebeeninbankingcrisis,exceptforafewyearsinthemid-2000s.22
SoineverymeasuretheGoldenAgewasaremarkableperiod.WhenHaroldMacmillan,theBritishprimeminister,said,‘You’veneverhaditsogood,’hewasn’texaggerating.Exactlywhatlaybehindthis
sterlingeconomicperformance,whichwasunprecedentedandhassincebeenunparalleled,isamatterofanongoingdispute.
FactorsbehindtheGoldenAge
Somepointoutthat,aftertheSecondWorldWar,therewasanunusuallylargepoolofnewtechnologiesthatwerewaitingtobeexploited,whichgaveanimpetustogrowthintheGoldenAge.Manynewtechnologiesthathadbeendevelopedduringthewarformilitarypurposeshadcivilianuses–computers,electronics,radar,jetengines,syntheticrubber,microwave(appliedfromradartechnology)andmuchmore.Withtheendofthewar,alotofnewinvestmentsthatusethesetechnologiesweremade,firstforpost-warreconstructionandthenforthemeetingofconsumerdemandspentupduringwartimeausterity.Therewerealsosomeimportantchangesintheinternationaleconomicsystemthatfacilitatedeconomic
developmentduringtheGoldenAge.The1944meetingoftheAlliesintheSecondWorldWarintheNewHampshireresortofBretton
Woodsestablishedtwokeyinstitutionsofthepost-warinternationalfinancialsystem,whicharethusdubbedtheBrettonWoodsInstitutions(BWIs)–theInternationalMonetaryFund(IMF)andtheInternationalBankforReconstructionandDevelopment(IBRD),morecommonlyknownastheWorldBank.23
TheIMFwasestablishedtoprovideshort-termfundingtocountriesinbalanceofpaymentscrises(balanceofpaymentsisthestatementofacountry’spositionineconomictransactionswiththerestoftheworld–seeChapter12forfulldetails).Abalanceofpaymentscrisishappenswhenacountryispayingothercountries(e.g.,whenitimportsgoodsorservices)somuchmorethanitgetsfromthemthatnooneiswillingtolendmoneytoitanymore.Thetypicalresultisafinancialpanic,followedbyadeeprecession.Byprovidingemergencyloanstocountriesinsuchasituation,theIMFallowedthemtotideoversuchcriseswithfewernegativeconsequences.TheWorldBankwasestablishedtoprovideloansfor‘projectlending’(thatis,moneythatisgivento
particularinvestmentprojects,suchasbuildingadam).Byprovidingloansoflongermaturitiesand/orlowerinterestratesthanareofferedbytheprivate-sectorbanks,theWorldBankenableditsclientcountriestoinvestmoreaggressivelythanotherwisepossible.Makingupthethirdlegofthepost-warworldeconomicsystemwastheGATT(GeneralAgreementon
TradeandTariffs),whichwassignedin1947.Between1947and1967,theGATTorganizedsixseriesofnegotiations(called‘rounds’)thatresultedincutsintariffs(mostly)amongtherichcountries.Beingbetweencountriesatsimilarlevelsofdevelopment,thesecutsbroughtaboutpositiveoutcomesbyexpandingmarketsandstimulatingproductivitygrowththroughgreatercompetition.InEurope,anewexperimentininternationalintegrationwithfar-reachingconsequenceswas
conducted.ItstartedwiththecreationoftheEuropeanCoalandSteelCommunity(ECSC)in1951bysixcountries(WestGermany,France,Italy,theNetherlands,BelgiumandLuxembourg)andculminatedinthecreationoftheEuropeanEconomicCommunity(EEC)–afree-tradeagreement–throughtheTreatyofRome(1957).24In1973,theUK,IrelandandDenmarkjoinedthegroup,whichwasbythencalledtheEC(EuropeanCommunities).Bybringingpeacetoaregionrivenwithwarsandrivalriesandbyintegratingmarkets,theEECcontributedtotheeconomicdevelopmentinthemembercountries.ThemostinfluentialexplanationoftheGoldenAgeis,however,thatitwasmainlytheresultofreforms
ineconomicpoliciesandinstitutionsthatgavebirthtothemixedeconomy–mixingpositivefeaturesof
capitalismandsocialism.FollowingtheGreatDepression,thelimitsoflaissez-fairecapitalismcametobewidelyaccepted.It
wasagreedthatthegovernmentshouldtakeanactiveroletodealwiththefailingsofunregulatedmarkets.Atthesametime,thesuccessinwartimeplanningduringtheSecondWorldWardiminishedscepticismaboutthefeasibilityofgovernmentintervention.ElectoralsuccessesbypartiesoftheleftinmanyEuropeancountries,thankstotheirkeyrolesinfightingfascism,ledtotheexpansionofthewelfarestateandgreaterlabourrights.ThesechangesinpoliciesandinstitutionsareseentohavecontributedtothemakingoftheGoldenAge
inanumberofways–creatingsocialpeace,encouraginginvestment,increasingsocialmobilityandpromotingtechnologicalinnovations.Letmeelaboratealittle,asthisisanimportantpoint.
CapitalismRemixed:pro-workerpoliciesandinstitutions
SoonaftertheSecondWorldWar,manyEuropeancountriestookprivateenterprisesintopublicownershiporsetupnewpublicenterprises,orstate-ownedenterprises(SOEs),inkeyindustries,suchassteel,railways,bankingandenergy(coal,nuclearandelectricity).ThesewerereflectiveoftheEuropeansocialistmovements’beliefinpubliccontroloverthemeansofproductionasakeyelementofsocialdemocracy,asembodiedinthefamousClauseIVoftheBritishLabourParty(abolishedin1995underTonyBlair’s‘NewLabour’make-over).IncountriessuchasFrance,Finland,NorwayandAustria,SOEsaredeemedtohaveplayedakeyroleingeneratinghighgrowthduringtheGoldenAgebyaggressivelymovingintohigh-technologyindustriesthattheprivatesectorfirmsfoundtoorisky.Welfaremeasures,firstintroducedinthelatenineteenthcentury,werevastlystrengthened,withthe
provisionofsomebasicservicesnationalizedinsomecountries(e.g.,Britain’sNationalHealthService).Thesewerefundedbyalargeincreaseintaxes(asaproportionofnationalincome).Betterwelfaremeasuresincreasedsocialmobility,increasingthelegitimacyofthecapitalistsystem.Theresultingsocialpeaceencouragedmorelong-term-orientedinvestmentsandthusgrowth.
Managedcapitalism:governmentsregulateandshapemarkets–inavarietyofways
LearningthelessonsoftheGreatDepression,governmentsinallACCsstartedtodeploydeliberatelycounter-cyclicalmacroeconomicpolicies,alsoknownasKeynesianpolicies(seeChapter4),expandinggovernmentspendingandmoneysupplyfromthecentralbankduringeconomicdownturnsandreducingthemduringupturns.Inrecognitionofthepotentialdangersofunregulatedfinancialmarkets,asmanifestedintheGreat
Depression,financialregulationswerestrengthened.FewcountrieswentasfarastheUSinseparatinginvestmentbankingfromcommercialbanking,buttheyallhadrestrictionsonwhatbanksandfinancialinvestorscando.Thiswasanerawhenbankerswereconsideredtoberespectablebutboringpeople,unliketheirswashbucklingsuccessorstoday.*Manygovernmentspractisedselectiveindustrialpolicythatdeliberatelypromotedtargeted‘strategic’
industriesthrougharangeofmeasures,suchastradeprotectionandsubsidies.TheUSgovernmentofficiallyhadnoindustrialpolicybutgreatlyinfluencedthecountry’sindustrialdevelopmentbyprovidingmassiveresearchfundingtoadvancedindustriessuchascomputers(fundedbythePentagon),semi-conductors(USNavy),aircraft(USAirForces),theinternet(theDARPA,DefenseAdvancedResearchProjectsAgency),andpharmaceuticalsandlifesciences(NationalInstitutesofHealth).25
GovernmentsincountriessuchasFrance,JapanandSouthKoreadidnotstopatpromotingparticular
industriesandexplicitlycoordinatedpoliciesacrossindustrialsectorsthroughtheirFiveYearPlans–anexerciseknownasindicativeplanning,todistinguishitfromthe‘directive’Sovietcentralplanning.
Thenewdawn:developingcountriesfinallyhaveagoateconomicdevelopment
TheGoldenAgesawwidespreaddecolonization.StartingwithKoreain1945(whichwasthendividedintoNorthandSouthin1948)andIndia(fromwhichPakistanseparated)in1947,mostcoloniesgainedindependence.Independenceinmanynationsinvolvedviolentstrugglesagainstthecolonizers.IndependencecamelatertoSub-SaharanAfrica,withGhanabecomingthefirstindependentcountryin1957.AroundhalftheSub-SaharanAfricancountriesbecameindependentinthefirsthalfofthe1960s.Somenationshadtowaitmuchlonger(AngolaandMozambiquein1975fromPortugal;Namibiain1990fromSouthAfrica),andsomearestillwaiting,butthevastmajorityofformercolonialsocieties–nowcalleddevelopingcountries–gainedindependencebytheendoftheGoldenAge.Uponindependence,mostpost-colonialnationsrejectedthefree-marketandfree-tradepoliciesthat
hadbeenimposedonthemundercolonialism.Someofthembecameoutrightsocialist(China,NorthKorea,NorthVietnamandCuba),butmostofthempursuedstate-ledindustrializationstrategieswhilebasicallyremainingcapitalist.Thestrategyisknownastheimportsubstitutionindustrialization(ISI)strategy–socalledbecauseyouaresubstitutingimportedmanufacturedgoodswithyourown.Thiswasdonebyprotectingdomesticproducersfromsuperiorforeigncompetitionbyrestrictingimports(infantindustryprotection)orheavilyregulatingtheactivitiesofforeigncompaniesoperatingwithinnationalborders.Governmentsoftensubsidizedprivate-sectorproducersandsetupSOEsinindustriesinwhichprivate-sectorinvestorswereunwillingtoinvestduetohighrisk.Withindependencedatesstretchingfrom1945to1973andbeyond,itisimpossibletotalkaboutthe
‘economicperformanceofdevelopingcountriesduringtheGoldenAge’.Theusualcompromisetimeframeforjudgingdevelopingcountryeconomicperformanceis1960–80.AccordingtotheWorldBankdata,duringthisperiod,percapitaincomeinthedevelopingcountriesgrewat3percentperyear,whichmeantthattheykeptpacewiththemoreadvancedeconomies,inwhichgrowthwas3.2percent.The‘miracle’economiesofSouthKorea,Taiwan,SingaporeandHongKonggrewat7–8percentperyearinpercapitatermsduringthisperiod,achievingsomeofthefastestgrowthratesinhumanhistory(togetherwithJapanbeforethemandChinaafterthem).Onethingtonote,however,isthateventhemoreslowlygrowingdevelopingregionssawconsiderable
progressduringthisperiod.During1960–80,withpercapitaincomegrowthof1.6percentperyear,Sub-SaharanAfricawastheslowest-growingregionintheworld–LatinAmericagrewatdoublethatrate(3.1percent),andEastAsiaatmorethantriplethatrate(5.3percent).However,thisisstillnotagrowthratetobesniffedat.RecallthatduringtheIndustrialRevolution,thegrowthrateofpercapitaincomeinWesternEuropewasonly1percent.
Themiddleway:capitalismworksthebestwithappropriategovernmentinterventions
DuringtheGoldenAgeofcapitalism,governmentinterventionincreasedenormouslyinalmostallareasinallcountries,withtheexceptionofinternationaltradeintherichcountries.Despitethis,economicperformancebothintherichandinthedevelopingcountrieswasmuchbetterthanbefore.Ithasnotbeenbetteredsincethe1980s,whenstateinterventionwasconsiderablyreduced,asIshallshowshortly.TheGoldenAgeshowsthatcapitalism’spotentialcanbemaximizedwhenitisproperlyregulatedandstimulatedbyappropriategovernmentactions.
1973–9:TheInterregnum
TheGoldenAgestartedtounravelwiththesuspensionofUSdollar–goldconvertibilityin1971.IntheBrettonWoodssystem,theoldGoldStandardwasabandonedontherecognitionthatitmademacroeconomicmanagementtoorigid,asseenduringtheGreatDepression.Butthesystemwasstillultimatelyanchoredingold,becausetheUSdollar,whichhadfixedexchangerateswithalltheothermajorcurrencies,wasfreelyconvertibletogold(at$35perounce).This,ofcourse,wasbasedontheassumptionthatthedollarwas‘asgoodasgold’–notanunreasonableassumptionwhentheUSwasproducingabouthalfoftheworld’soutputandtherewasanacutedollarshortageallaroundtheworld,aseveryonewantedtobuyAmericanthings.Withthepost-warreconstructionandthenrapiddevelopmentofothereconomies,thisassumptionwas
notvalidanymore.OncepeoplerealizedthattheUSdollarwasnotasgoodasgold,theyhadagreaterincentivetoconvertdollarsintogold,whichreducedtheUSgoldreserveevenfurtherandmadethedollarlookevenlessreliable.TheUSofficialliabilities(dollarbillsandTreasuryBills,namely,theUSgovernmentbonds),whichhadbeenonlyhalfthesizeofitsgoldreserveuntil1959,becameoneandahalftimeslargerby1967.26
In1971,theUSdroppeditscommitmenttoconvertanydollarclaimsintogold,whichledothercountriestoabandonthepracticeoftyingtheirnationalcurrenciestothedollaratfixedratesoverthenextcoupleofyears.Thiscreatedinstabilityintheworldeconomy,withcurrencyvaluesfluctuatingaccordingtomarketsentimentsandbecomingincreasinglysubjecttocurrencyspeculation(investorsbettingoncurrenciesmovingupordowninvalue).TheendoftheGoldenAgewasmarkedbytheFirstOilShockin1973,inwhichoilpricesrose
fourfoldovernight,thankstothepricecollusionofthecarteloftheoil-producingcountries,OPEC(OrganizationofPetroleumExportingCountries).Inflationhadbeenslowlyincreasinginmanycountriessincethelate1960sbut,followingtheOilShock,itshotup.Moreimportantly,thenextseveralyearswerecharacterizedbystagflation.Thisnewlycoinedterm
referredtothebreakdownoftheage-longeconomicregularitythatpricesfallduringarecession(orstagnation)andriseduringaboom.Now,theeconomywasstagnating(albeitnotexactlyinaprolongedrecession,likeduringtheGreatDepression)butpriceswererisingfast,at10,15oreven25percentperyear.27
TheSecondOilShockin1979finishedofftheGoldenAgebybringingaboutanotherboutofhighinflationandhelpingneo-liberalgovernmentscometopowerinthekeycapitalistcountries,especiallyinBritainandtheUS.Thisperiodisoftendepictedasoneofanunmitigatedeconomicdisasterbyfree-marketeconomists,
whoarecriticalofthemixedeconomymodel.Thisismisleading.GrowthintheACCsmayhavesloweddowncomparedtotheGoldenAge,but,at2percentpercapita,incomegrowthrateduring1973–80wasstillmuchhigherthananyperioduptotheSecondWorldWar(1.2–1.4percent)andslightlyhigherthanwhatfollowedinthenextthreedecadesofneo-liberalism(1.8percentfor1980–2010).28Theunemploymentrate,at4.1percentaverage,washigherthanthatoftheGoldenAge(3percent),butnotbymuch.29Still,thefactremainsthattherewasenoughdissatisfactionwitheconomicperformanceduringthisperiodfortheretoberadicalchangesinthefollowingyears.
1980–Today:TheRiseandFallofNeo-liberalismTheIronLady:MargaretThatcherandtheendofBritishpost-warcompromise
AmajorturningpointcamewiththeelectionofMargaretThatcherastheBritishprimeministerin1979.Rejectingthepost-SecondWorldWar‘wet’TorycompromisewithLabour,Thatcherbeganaradicaldismantlingofthemixedeconomy,intheprocessearningthesobriquet‘TheIronLady’forheruncompromisingattitude.TheThatchergovernmentloweredhigher-rateincometaxes,reducedgovernmentspending(especially
ineducation,housingandtransport),introducedlawsreducingunionpowerandabolishedcapitalcontrol(restrictiononthecross-bordermovementofmoney).Themostsymbolicmovewasprivatization–salesofSOEstoprivateinvestors.Gas,water,electricity,steel,airline,automobileandpartsofpublichousingwereprivatized.Interestrateswereraisedinordertoreduceinflationbydampeningeconomicactivitiesandthus
demand.Thehighinterestrateattractedforeigncapital,drivingupthevalueoftheBritishpound,thusmakingBritishexportsuncompetitive.Theresultwasahugerecession,asconsumersandcompaniesretrenched,between1979and1983.Unemploymentsoaredto3.3millionpeople–thisunderagovernmentthatcametopowerbycriticizingJamesCallaghan’sLabourgovernment’srecordonunemployment,whichwentoverthe1millionmark,withthefamousslogan‘Labourisn’tworking’,inventedbytheadvertisingagencySaatchi&Saatchi.Duringtherecession,ahugechunkofBritishmanufacturingindustry,whichhadalreadybeensuffering
fromdecliningcompetitiveness,wasdestroyed.Manytraditionalindustrialcentres(suchasManchester,LiverpoolandSheffield)andminingareas(NorthEnglandandWales)weredevastated,asdepictedinmoviessuchasBrassedOff(aboutcoalminersinGrimley,athinlydisguisedversionofYorkshirecoaltownGrimethorpe).
Theactor:RonaldReaganandthere-makingoftheUSeconomy
RonaldReagan,theformeractorandaformergovernorofCalifornia,becametheUSpresidentin1981andoutdidMargaretThatcher.TheReagangovernmentaggressivelycutthehigherincometaxrates,explainingthatthesecutswouldgivetherichgreaterincentivestoinvestandcreatewealth,astheycouldkeepmoreofthefruitsoftheirinvestments.Oncetheycreatedmorewealth,itwasargued,therichwouldspendmore,creatingmorejobsandincomesforeveryoneelse;thisisknownasthetrickle-downtheory.Atthesametime,subsidiestothepoor(especiallyinhousing)werecutandtheminimumwagefrozensothattheyhadagreaterincentivetoworkharder.Whenyouthinkaboutit,thiswasacuriouslogic–whydoweneedtomaketherichrichertomakethemworkharderbutmakethepoorpoorerforthesamepurpose?Curiousornot,thislogic,knownassupply-sideeconomics,becamethefoundationalbeliefofeconomicpolicyforthenextthreedecadesintheUS–andbeyond.AsintheUK,interestrateswerejackedupinanattempttoreduceinflation.Between1979and1981,
interestratesmorethandoubledfromaround10percenttoover20percentperyear.AsignificantportionoftheUSmanufacturingindustry,whichhadalreadybeenlosinggroundtoJapaneseandotherforeigncompetition,couldnotwithstandsuchanincreaseinfinancialcosts.ThetraditionalindustrialheartlandintheMidwestwasturnedinto‘theRustBelt’.FinancialderegulationintheUSatthistimelaidthefoundationforthefinancialsystemwehavetoday.
Therapidincreaseinhostiletakeovers,inwhichacompanyistakenoveragainstthewilloftheexisting
management,changedthewholecorporatecultureintheUS.Manyofthosetakingoverwere‘corporateraiders’onlyinterestedinassetstripping(namely,thesalesofvaluableassets,regardlessoftheimpactonthelong-termviabilityofthecompany),immortalizedbyGordon‘Greed-is-good’Gekkointhe1987movieWallStreet.Toavoidsuchafate,firmshadtodeliverprofitsfasterthanbefore.Otherwiseimpatientshareholderswouldsellup,reducingthesharepricesandthusexposingthefirmtogreaterdangerofhostiletakeover.Theeasiestwayforcompaniestodeliverquickprofitwasthroughdownsizing–reducingtheworkforceandminimizinginvestmentsbeyondwhatisnecessaryforimmediateresults,eventhoughtheseactionsdiminishtheprospectofthecompanyinthelongerrun.
TheThirdWorlddebtcrisisandtheendoftheThirdWorldIndustrialRevolution
ThemostlastinglegacyofthehighinterestratepolicyintheUSinthelate1970sandtheearly1980s–sometimescalledtheVolckerShock,namedafterthethenchairmanoftheUScentralbank(theFederalReserveBoard)–wasnotintheUSbutinthedevelopingcountries.Mostdevelopingcountrieshadborrowedheavilyinthe1970sandtheearly1980s,partlytofinance
theirindustrializationandpartlytopayforthemoreexpensiveoil,followingtheOilShocks.WhentheUSinterestratesdoubled,sodidinternationalinterestrates,andthisledtoawidespreaddefaultonforeigndebtsbydevelopingnations,startingwiththedefaultofMexicoin1982.ThisisknownastheThirdWorldDebtCrisis,thusknownbecausethedevelopingworldwasthencalledtheThirdWorld,aftertheFirstWorld(theadvancedcapitalistworld)andtheSecondWorld(thesocialistworld).Facingeconomiccrises,developingcountrieshadtoresorttotheBrettonWoodsInstitutions(theIMF
andtheWorldBank,justtoremindyou).TheBWIsmadeitaconditionthatborrowingcountriesimplementthestructuraladjustmentprogramme(SAP),whichrequiredshrinkingtheroleofthegovernmentintheeconomybycuttingitsbudget,privatizingSOEsandreducingregulations,especiallyoninternationaltrade.TheresultsoftheSAPwereextremelydisappointing,tosaytheleast.Despitemakingallthenecessary
‘structural’reforms,mostcountriesexperienceddramaticgrowthslowdowninthe1980sandthe1990s.PercapitaincomegrowthratesinLatinAmerica(includingtheCaribbean)collapsedfrom3.1percentin1960–80to0.3percentin1980–2000.InSub-SaharanAfrica(SSA),percapitaincomefellduringthisperiod;in2000,itwas13percentlowerthanin1980.TheresultwasaneffectivearrestingoftheThirdWorldIndustrialRevolution,whichisthenamethatAjitSingh,theCambridgeeconomist,usedinordertodescribetheeconomicdevelopmentexperienceofdevelopingcountriesinthefirstfewdecadesfollowingdecolonization.OnlyChiledidwelloutofneo-liberalpoliciesofthe1980sandthe1990s,butatconsiderablehuman
costunderthePinochetdictatorship(1974–90).30Alltheothersuccessstoriesofthisperiodwereeconomiesthatusedstateinterventionextensivelyandliberalizedonlygradually.ThebestexamplesofthiswereJapan,the‘tiger’(or‘dragon’,dependingonyouranimalpreference)economiesofEastAsia(SouthKorea,TaiwanandSingapore)and,increasingly,China.
Thewallcomescrashingdown:thecollapseofsocialism
Then,in1989,amomentouschangehappened.Thatyear,theSovietUnionstartedtounravel,andtheBerlinWallwastorndown.Germanywasreunited(1990),andmostEasternEuropeancountriesabandonedcommunism.By1991,theSovietUnionitselfwasdismembered.WithChinagraduallybutsurelyopeningupandliberalizingsince1978andwithVietnam(unifiedundertheCommunistrulein
1975)alsoadoptingits‘opendoor’policy(DoiMoi)in1986,thesocialistblocwasreducedtoafewdie-hardstates,notablyNorthKoreaandCuba.Theproblemswiththesocialisteconomieswerealreadywellknown:thedifficultyofplanningan
increasinglydiverseeconomy,incentiveproblemsarisingfromweaklinksbetweenperformanceandrewardandwidespreadpoliticallydeterminedinequalityinanostensiblyequalsociety(seeChapter9).Butfew,includingthemostanti-socialistcommentators,hadthoughtthattheblocwouldimplodesoquickly.TheultimateproblemwasthattheSovietbloceconomieshadtriedtobuildanalternativeeconomic
systembasedonessentiallysecond-ratetechnologies.Therewere,ofcourse,areaslikespaceandarmstechnologieswheretheywereleadingtheworld(afterall,in1957theSovietUnionputthefirstevermaninspace),thankstothedisproportionateamountofresourcespouredintothem.However,whenitbecameevidentthatitcouldonlyofferitscitizenssecond-rateconsumerproducts–assymbolizedbyTrabant,theEastGermancarwithplasticbody,whichquicklybecameamuseumpieceafterthefalloftheBerlinWall–thecitizensrevolted.Inthenextdecadeorso,thesocialistcountriesinEasternEuropemadeaheadlongdashtotransform
themselves(back)intocapitalistones.Manythoughtthatthe‘transition’couldbemadequickly.Surely,itwasjustamatterofprivatizingSOEsandreintroducingthemarketsystem,whichisafteralloneofthemost‘natural’humaninstitutions?Othersaddedthatthetransitionhadtobemadequickly,inordernottogivetimetotheoldrulingelitetoregroupitselfandresistchange.Mostcountriesadopted‘BigBang’reforms,tryingtobringcapitalismbackovernight.Theresultwasnothingshortofadisasterinmostcountries.Yugoslaviadisintegratedanddescended
intowarsandethniccleansing.ManyformerrepublicsoftheSovietUnionexperienceddeepdepressions.InRussia,theeconomiccollapseandtheresultingunemploymentandeconomicinsecuritycausedsomuchmentalstress,alcoholismandotherhealthproblemsthatitisestimatedthatmillionsmorepeoplediedthanwouldhavebeenthecaseifthepre-transitiontrendshadcontinued.31Inmanycountries,theoldelitesimply‘changedtheirsuits’andtransformedthemselvesfrompartyapparatchiksintobusinessmen,enrichingthemselveshugelybyacquiringstateassetsatknock-downpricesthroughcorruptpracticesand‘insiderdealings’intheprivatizationprocess.TheCentralEuropeancountries–Poland,Hungary,theCzechRepublicandSlovakia–faredbetter,especiallyaftertheyjoinedtheEuropeanUnionin2004,thankstobeingmoregradualistintheirreformandtotheirbetterskillbases.Buteveninthecaseofthesecountries,itisdifficulttohailthetransitionexperienceasagreatsuccess.Thefallofthesocialistblocusheredinaperiodof‘free-markettriumphalism’.Some,suchasthe
American(then)neo-conthinkerFrancisFukuyama,pronouncedthe‘endofhistory’(no,nottheendoftheworld)onthegroundsthatwehadfinallyconclusivelyidentifiedthebesteconomicsystemintheformofcapitalism.Thefactthatcapitalismcomesinmanyvarieties,eachwithparticularstrengthsandweaknesses,wasblissfullyignoredintheeuphoricmoodoftheday.
Oneworld,readyornot:globalizationandthenewworldeconomicorder
Bythemid-1990s,neo-liberalismhadspreadthroughouttheworld.Mostoftheoldsocialistworldhadbeenabsorbedintothecapitalistworldeconomy,eitherthroughthe‘BigBang’reformsor,asinthecaseofChinaandVietnam,throughgradualbutconstantopeningupandderegulation.Bythistime,marketopeningandliberalizationhadalsoprogressedconsiderablyinmostdevelopingcountries.Inmost
countries,thishappenedrapidlyduetotheSAP,butthereweresomeotherswhereithappenedmoregraduallythroughvoluntarypolicychanges,suchasinIndia.Aroundthistime,someimportantinternationalagreementsweresignedthatsignalledaneweraof
globalintegration.In1994,theNAFTA(NorthAmericanFreeTradeAgreement)wassignedbetweentheUS,CanadaandMexico.Itwasthefirstmajorfree-tradeagreementbetweendevelopedcountriesandadevelopingcountry.In1995,theUruguayRoundoftheGATTtalkswasconcluded,resultingintheexpansionoftheGATTintotheWTO(WorldTradeOrganization).TheWTOcoversmanymoreareas(e.g.,intellectualpropertyrights,suchaspatentsandtrademarks,andtradeinservices)andhasmoresanctioningpowerthantheGATTdid.EconomicintegrationprogressedfurtherintheEU,withthecompletionofthe‘SingleMarket’project(withtheso-called‘fourfreedomsofmovement’–ofgoods,services,peopleandmoney)in1993andwiththe1995accessionofSweden,FinlandandAustria.*Thecombinedresultwasthecreationofaninternationaltradingsystemthatwasmuchmoregearedtowardsfreer(althoughnotentirelyfree)trade.Alsotheideaofglobalizationemergedasthedefiningconceptofthetime.Internationaleconomic
integrationofcoursehadbeengoingonsincethesixteenthcentury,butaccordingtothenewglobalizationnarrative,thisprocesshasreachedanentirelynewstage.Thiswasthankstothetechnologicalrevolutionsincommunications(theinternet)andtransportation(airtravel,containershipping),whichwereleadingtothe‘deathofdistance’.Accordingtotheglobalizers,countriesnowhadnochoicebuttoembracethisnewrealityandfullyopenuptointernationaltradeandinvestments,whileliberalizingtheirdomesticeconomies.Thosewhoresistedthisinevitabilitywerederidedasthe‘modernLuddites’,whothinktheycanbringbackabygoneworldbyreversingtechnologicalprogress(seeabove).BooktitleslikeTheBorderlessWorld,TheWorldIsFlatandOneWorld,ReadyorNotsummeduptheessenceofthisnewdiscourse.
Thebeginningoftheend:theAsianfinancialcrisis
Theeuphoriaofthelate1980sandtheearly1990sdidn’tlast.Thefirstsignthatnoteverythingwasfinewiththe‘bravenewworld’camewiththefinancialcrisisinMexicoin1995.ToomanypeoplehadinvestedinMexicanfinancialassetswiththeunrealisticexpectationthat,havingfullyembracedfree-marketpoliciesandhavingsignedtheNAFTA,thecountrywasgoingtobethenextmiracleeconomy.MexicowasbailedoutbytheUSandtheCanadiangovernments(whodidn’twantacollapseintheirnewfree-tradepartner)aswellasbytheIMF.In1997,abiggershockcameaboutwiththeAsianfinancialcrisis.Anumberofhithertosuccessful
Asianeconomies–theso-called‘MITeconomies’(Malaysia,IndonesiaandThailand)andSouthKorea–gotintofinancialtroubles.Theculpritwastheburstingoftheassetbubbles(assetpricesrisingwellabovetheirrealisticlevels,basedonunrealisticexpectations).Whiletheyhadbeenmorecautiousthanotherdevelopingregionsinopeninguptheireconomies,these
countriesopeneduptheirfinancialmarketsquiteradicallyinthelate1980sandtheearly1990s.Nowfacingfewerrestrictions,theirbanksborrowedaggressivelyfromtherichcountries,whichhadlowerinterestrates.Intheirturn,therich-countrybankssawlittleriskinlendingtocountrieswithdecades-longexcellenteconomicrecords.Asmoreforeigncapitalflowedin,assetpriceswentup,whichenabledfirmsandhouseholdsintheAsiancountriestoborrowevenmore,usingtheirnowmorevaluableassetsascollateral.Soontheprocessbecameaself-fulfillingprophecy,astheexpectationofever-risingasset
pricesjustifiedfurtherborrowingandlending(soundsfamiliar?).Whenitlaterbecameclearthatthoseassetpriceswereunsustainable,moneywaspulledout,andfinancialcrisesensued.TheAsiancrisisleftahugescarintheafflictedeconomies.Ineconomieswhere5percentgrowth(in
percapitaterms)wasconsidereda‘recession’,outputfellin1998by16percentinIndonesiaand6–7percentintheothereconomies.Tensofmillionsofpeoplewerethrownoutofworkinsocietieswhereunemploymentmeanspenury,giventhesmallsizeofthewelfarestate.Inreturnforthebail-outmoneyfromtheIMFandtherichcountries,thecrisis-strickenAsiancountries
hadtoacceptalotofpolicychanges–allinthedirectionofliberalizingtheirmarkets,especiallytheirfinancialmarkets.WhileitpushedtheAsianeconomiesthemselvesoninamoremarket-orienteddirection,theAsiancrisis–andtheBrazilianandtheRussiancrisesthatimmediatelyfollowedit–actuallyplantedthefirstseedofscepticismaboutpost-ColdWarfree-markettriumphalism.Therewereseriousdiscussionsabouttheneedtoreformtheglobalfinancialsystem,muchofthemalongthesamelinesastheonesthatwehaveseenfollowingthe2008globalfinancialcrisis.Evenmanyleadingadvocatesofglobalization–liketheFinancialTimescolumnistMartinWolfandthefree-tradeeconomistJagdishBhagwati–startedquestioningthewisdomofallowingfreeinternationalcapitalflows.Allwasnotwellwiththenewglobaleconomy.
Thefalsedawn:fromthedot.comboomtotheGreatModeration
Whenthesecriseswerebroughtundercontrol,talkofglobalfinancialreformreceded.IntheUS,amajorpushintheotherdirectioncameintheformofthe1999repealoftheiconicNewDeallegislation,the1933Glass-SteagallAct,whichstructurallyseparatedcommercialbankingfrominvestmentbanking.Therewasanothermomentofpanicin2000,whentheso-calleddot.combubble–inwhichinternet-
basedcompanieswithnoprospectofgeneratinganyprofitintheforeseeablefuturehadtheirsharesvaluedatabsurdlyhighlevels–burstintheUS.Thepanicsoonreceded,astheUSFederalReserveintervenedandcutinterestratesaggressivelyandthecentralbanksofotherricheconomiesfollowedsuit.Fromthenon,theearlyyearsofthemillenniumseemedtobegoingswimminglywellintherich
countries,especiallyintheUS.Growthwasrobust,ifnotexactlyspectacular.Assetprices(pricesofrealestate,companysharesandsoon)seemedtobegoingupforever.Inflationremainedlow.Economists–includingBenBernanke,thechairmanoftheFederalReserveBoardbetweenFebruary2006andJanuary2014–talkedofthe‘GreatModeration’,inwhichthescienceofeconomicshadfinallyconqueredboomandbust(ortheeconomygoingupanddownbylargemargins).AlanGreenspan,thechairmanoftheFederalReserveBoardbetweenAugust1987andJanuary2006,wasreveredasthe‘Maestro’(asimmortalizedinthetitleofhisbiographybyBobWoodwardofWatergatefame)whohadanear-alchemicalskillinmanagingapermanenteconomicboomwithoutstokinginflationorcourtingfinancialtrouble.Duringthemiddleyearsofthe2000s,therestoftheworldfinallystartedtofeelthe‘miracle’growthof
Chinaoftheprecedingtwodecades.In1978,atthebeginningofitseconomicreform,theChineseeconomyaccountedforonly2.5percentoftheworldeconomy.32Ithadminimalimpactontherestoftheworld–itsshareofworldmerchandise(goods)exportwasamere0.8percent.33By2007,thecorrespondingnumbershadrisento6percentand8.7percent.34Beingrelativelypoorlyendowedwithnaturalresourcesandgrowingatbreakneckspeed,itstartedsuckinginfood,mineralsandfuelfromtherestoftheworld,andtheeffectofitsgrowingweightwasfeltmoreandmorestrongly.
Thisgaveaboosttotheraw-materialexportersofAfricaandLatinAmerica,finallyallowingtheseeconomiestomakeupsomeofthegroundtheyhadlostinthe1980sandthe1990s.ChinaalsobecameamajorlenderandinvestorinsomeAfricancountries,givingthelattersomeleverageinnegotiatingwiththeBWIsandthetraditionalaiddonors,suchastheUSandtheEuropeancountries.InthecaseoftheLatinAmericancountries,thisperiodalsosawadeparturefromtheneo-liberalpoliciesthathadservedthemsopoorlyinseveralcountries.Brazil(Lula),Bolivia(Morales),Venezuela(Chavez),Argentina(Kirchner),Ecuador(Correa)andUruguay(Vasquez)werethemostprominentexamples.
Acrackinthewall:the2008globalfinancialcrisis
Inearly2007,alarmbellswererungbythosewhowereworriedaboutthe(non-)repaymentofmortgageloansthatareeuphemisticallycalled‘subprime’(read‘havinghighchanceofdefault’),madebyUSfinancialfirmsintheprecedinghousingboom.Peoplewithnostableincomeandchequeredcredithistorieswerelentmoremoneythantheycouldaffordtopayback,ontheassumptionthathousepriceswouldkeepgoingup.Theywouldbeabletorepaytheirloans,itwasreckoned,bysellingtheirhouses,ifworsecametoworst.Ontopofthat,thousandsorevenhundredsofthousandsofthesehigh-riskmortgageloanswerecombinedinto‘composite’financialproducts,suchastheMBSandtheCDO(noneedtoknowwhattheywereatthisstage–IwillexplainthemindetailinChapter8)andsoldaslow-riskassets,ontheassumptionthatthechanceofalargenumberofborrowerssimultaneouslygettingintotroublemustbemuchlowerthanthatforindividualborrowers.Initially,theproblemmortgageloansintheUSwereestimatedtobe$50–100billion–notasmall
amountbutanamountthatcanbeeasilyabsorbedbythesystem(orsomanyclaimedatthetime).However,thecrisiseruptedproperlyinthesummerof2008,withthebankruptcyoftheinvestmentbanksBearStearnsandthenLehmannBrothers.Ahugefinancialpanicswepttheworld.Itwasrevealedthatevensomeofthemostvenerablenamesinthefinancialindustrywereinbigtrouble,havinggeneratedandboughthugenumbersofdubiouscompositefinancialproducts.
The‘Keynesianspring’andthereturnofthefree-marketorthodoxy–withavengeance
TheinitialresponsesofthemajoreconomieswereverydifferentfromthosefollowingtheGreatDepression.MacroeconomicpolicieswereKeynesianinthesensethattheylethugebudgetdeficitsdevelop–atleastnotbycuttingspendinginlinewithfallingtaxrevenuesandinsomecasesbyincreasinggovernmentspending(Chinadidthismostaggressively).Majorfinancialinstitutions(e.g.,theUK’sRoyalBankofScotland)andindustrialfirms(e.g.,GMandChryslerintheUS)werebailedoutwithpublicmoney.Centralbanksbroughtinterestratesdowntohistoricallows–forexample,theBankofEnglandcutitsinterestratetothelowestlevelsinceitsfoundationin1694.Whentheycouldnotcuttheirinterestratesanymore,theyengagedinwhatisknownasquantitativeeasing(QE)–basically,thecentralbankcreatingmoneyoutofthinairandreleasingitintotheeconomy,mainlybybuyinggovernmentbonds.Soon,however,free-marketorthodoxycamebackwithavengeance.May2010wastheturningpoint.
TheelectionoftheConservative-ledcoalitiongovernmentintheUKandtheimpositionoftheEurozonebail-outprogrammeforGreeceinthatmonthsignalledthecomebackoftheoldbalancedbudgetdoctrine.Austeritybudgets,inwhichspendingiscutradically,havebeenimposedintheUKandintheso-calledPIIGSeconomies(Portugal,Italy,Ireland,GreeceandSpain).ThesuccessoftheRepublicansinpushingtheObamagovernmentintheUStoacceptahugespendingcutprogrammein2011andthereaffirmationoftheanti-deficitbiasofthecoreEuropeancountriesintheformoftheEuropeanFiscalCompact,signed
in2012,pushedthingsevenfurtherinthatdirection.Inallthesecountries,butespeciallytheUK,thepoliticalrightareevenusingtheargumentforbalancingthebudgetasanexcusetoseverelyprunebackthewelfarestate,whichtheyhavealwayswantedtoreduce.
Theconsequences:thelostdecade?
The2008crisishashaddevastatingconsequences,anditsendisnowhereinsight.Fouryearsafterthecrisis,attheendof2012,percapitaoutputremainedlowerthanin2007intwenty-twoofthethirty-fourmembercountriesoftheOECD(OrganizationforEconomicCooperationandDevelopment),theParis-basedclubofrichcountries(withahandfulofdevelopingcountrymembers).*GDPpercapitain2012,whenfilteringouttheeffectofpriceinflation,was26percentbelowthe2007levelinGreece,12percentbelowinIreland,7percentbelowinSpainand6percentbelowintheUK.EvenintheUS,whichissaidtohaverecoveredbetterthanothercountriesfromthecrisis,percapitaincomein2012wasstill1.4percentbelowthe2007level.†Withtheausteritybudget,theprospectforeconomicrecoveryinmanyofthesecountriesisdim.The
problemisthataradicalcutingovernmentspendinginastagnating(orevenshrinking)economyholdsbackrecovery.WehavealreadyseenthisduringtheGreatDepression.Asaresult,itmaytakeagoodpartofthedecadebeforemanyofthesecountriescangetbacktowhattheyusedtobein2007.Theycouldwellbeinthemiddleofa‘lostdecade’,aswasexperiencedinJapan(the1990s)andinLatinAmerica(the1980s).Itisestimatedthat,atitsdepth,thecrisiscreated80millionextraunemployedpeopleworldwide.In
SpainandGreece,unemploymentshotupfromaround8percentbeforethecrisisto26percentand28percentrespectivelyinthesummerof2013.Youthunemploymentiswellover55percent.Evenincountriesexperiencing‘milder’unemploymentproblems,suchastheUSandtheUK,officialunemploymentratesreached8–10percentattheirheights.
Toolittletoolate?:prospectsforreform
Despitethescaleofthecrisis,policyreformshavebeenslowincoming.Despitethefactthatthecauseofthecrisislayinexcessiveliberalizationinthefinancialmarket,financialreformshavebeenrathermildandarebeingintroducedveryslowly(overseveralyears,whentheUSbankshadayeartocomplywiththemuchtougherNewDealfinancialreforms).Thereareareasoffinance,suchasthetradinginoverlycomplexfinancialproducts,inwhichevenmildandslowreformsarenotbeingintroduced.Ofcourse,thistrendcouldbereversed.Afterall,inboththepost-DepressionUSandSweden,the
reformscameonlyafterafewyearsofeconomicdownturnandhardship.Indeed,theelectorateintheNetherlands,FranceandGreecevotedoutpro-austeritypartiesinthespringof2012;Italianvotersdidlikewisein2013.TheEUhasintroducedsomefinancialregulationsthataretougherthanwhatmanypeoplehadimaginedlikely(e.g.,financialtransactiontax,caponfinancialsectorbonuses).Switzerland,frequentlyconsideredthehavenofthesuper-rich,passedalawin2013preventinghighrewardsfortopmanagerswithmediocreperformances.Whilethereremainsalotmoretobedoneinrelationtofinancialreform,theseareactuallydevelopmentsthatwouldhavebeenconsideredimpossiblebeforethecrisis.
FurtherReadingP.BAIROCH
EconomicsandWorldHistory:MythsandParadoxes(NewYorkandLondon:HarvesterWheatsheaf,1993).
H.-J.CHANG
KickingAwaytheLadder:DevelopmentStrategyinHistoricalPerspective(London:Anthem,2002).
B.EICHENGREEN
TheEuropeanEconomysince1945:CoordinatedCapitalismandBeyond(Princeton,NJ:PrincetonUniversityPress,2007).
A.GLYN
CapitalismUnleashed(Oxford:OxfordUniversityPress,2007).
D.LANDES
TheUnboundPrometheus(Cambridge:CambridgeUniversityPress,2003).
A.MADDISON
ContoursoftheWorldEconomy,1-2030AD(Oxford:OxfordUniversityPress,2007).
S.MARGLINANDJ.SCHOR(EDS.)
TheGoldenAgeofCapitalism(Oxford:Clarendon,1990).
D.NAYYAR
CatchUp:DevelopingCountriesintheWorldEconomy(Oxford:OxfordUniversityPress,2013).
‘Anycustomercanhaveacarpaintedanycolourthathewantssolongasitisblack.’HENRYFORD
‘Letahundredflowersbloom,letahundredschoolsofthoughtcontend.’MAOZEDONG
TheOneRingtoRuleThemAll?:TheDiversityofApproachestoEconomics
Contrarytowhatmosteconomistswouldhaveyoubelieve,thereisn’tjustonekindofeconomics–Neoclassicaleconomics.Inthischapter,Iintroducenolessthanninedifferentkinds,orschools,astheyareoftenknown.*Theseschoolsarenotirreconcilableenemies,however;theboundariesbetweenschoolsareactually
fuzzy.1Butitisimportanttorecognizethattherearedistinctivewaysofconceptualizingandexplainingtheeconomy,or‘doing’economics,ifyoulike.Andnoneoftheseschoolscanclaimsuperiorityoverothersandstilllessamonopolyovertruth.Onereasonisthenatureoftheoryitself.Alltheories,includingnaturalscienceslikephysics,
necessarilyinvolveabstractionandthuscannotcaptureeveryaspectofthecomplexityoftherealworld.2
Thismeansthatnotheoryisgoodatexplainingeverything.Eachtheorypossessesparticularstrengthsandweaknesses,dependingonwhatithighlightsandignores,howitconceptualizesthingsandhowitanalysesrelationshipsbetweenthem.Thereisnosuchthingasonetheorythatcanexplaineverythingbetterthanothers–or‘theoneringtorulethemall’,3ifyouareafanofTheLordoftheRings.Addedtothisisthefactthat,unlikethingsthatarestudiedbynaturalscientists,humanbeingshavetheir
ownfreewillandimagination.Theydonotsimplyrespondtoexternalconditions.Theytry–andoftensucceed–tochangethoseveryconditionsbyimaginingautopia,persuadingothersandorganizingsocietydifferently;asKarlMarxonceeloquentlyputit,‘[m]enmaketheirownhistory’.*Anysubjectstudyinghumanbeings,includingeconomics,hastobehumbleaboutitspredictivepower.Moreover,unlikethenaturalsciences,economicsinvolvesvaluejudgements,eventhoughmany
Neoclassicaleconomistswouldtellyouthatwhattheydoisvalue-freescience.AsIwillshowinthefollowingchapters,behindtechnicalconceptsanddrynumberslieallsortsofvaluejudgements:whatisthegoodlife;howminorityviewsshouldbetreated;howsocialimprovementsshouldbedefined;andwhataremorallyacceptablewaysofachievingthe‘greatergood’,howeveritisdefined.4Evenifonetheoryismore‘correct’fromsomepoliticalorethicalpointsofview,itmaynotbesofromanother.
CocktailsortheWholeDrinksCabinet?:HowtoReadThisChapter
Whilethereisagoodreasonforthereadertolearnaboutdifferentschoolsofeconomics,Iacceptthatbeingsuddenlyaskedtotasteninedifferentflavoursoficecreamwhenyouhadthoughtthatthereisonlyplainvanillacanbequiteoverwhelming.
EventhoughIsimplifythingsalot,readersmaystillfindthediscussiontoocomplicated.Inordertohelpthem,Iprefacemypresentationofeachschoolwithaone-sentencesummary.Thesesummariesare,ofcourse,fartoosimplistic,butatleasttheywillhelpyouovercometheinitialfearthatyouareabouttowalkintoanewcitywithoutamap,or,rather,asmartphone.Now,eventhosewhoarewillingtolearnaboutmorethanoneschoolmayfeelthatnineschoolsissix
orseventoomany.Iagree.Forthem,Iofferintheboxbelowanumberof‘cocktails’madeupoftwotofourdifferentschools,eachofwhichcoversparticularissueswell.Someofthesecocktails,suchasCMSIorCK,willbelikeBloodyMarywithalotofTabascosauce,giventhedisagreementspresent.Someothers,suchasMDKIorCMDS,maytastelikeaPlanter’sPunch,withdifferentflavourscomplementingeachother.Myhopeisthattastingoneortwoofthosecocktailsmayevenmakeyouwanttotastethewholedrinks
cabinet.Evenifyoudon’twanttogothewholelength,tastingoneortwoofthemwillstillhaveshownyouthatthereismorethanonewayto‘do’economics.
ECONOMICSCOCKTAILS
Ingredients:A,B,C,D,I,K,M,NandSor
Austrian,Behaviouralist,Classical,Developmentalist,Institutionalist,Keynesian,Marxist,NeoclassicalandSchumpeterian.
Ondivergingviewsofthevitalityandtheviabilityofcapitalism,takeCMSI.
Ifyouwanttoknowwhywesometimesneedgovernmentintervention,takeNDK.
Todiscoverdifferentwaysofconceptualizingtheindividual,takeNAB.
Inordertolearnthatthereisalotmoretotheeconomythanmarkets,takeMIB.
Ifyouwanttoseehowgroups,especiallyclasses,aretheorized,takeCMKI.
Tostudyhowtechnologiesdevelopandproductivitiesrise,takeCMDS.
Tounderstandeconomicsystems,ratherthanjusttheircomponents,takeMDKI.
Ifyouwanttofindoutwhycorporationsexistandhowtheywork,takeSIB.
Ifexploringhowindividualsandsocietyinteractisyourthing,takeANIB.
Fordebatessurroundingunemploymentandrecession,takeCK.
Forvariouswaysofdefendingthefreemarket,takeCAN.
Healthwarning:Onnoaccountdrinkonlyoneingredient–liabletoleadtotunnelvision,arroganceandpossiblybraindeath.
TheClassicalSchool
One-sentencesummary:Themarketkeepsallproducersalertthroughcompetition,soleaveitalone.
Today,theNeoclassicalschooldominates.Asyouwillhaveguessed,therewasClassicaleconomicsbeforeNeoclassicaleconomics,ofwhichthelatteristhesupposedheir(althoughtheMarxistschoolhasanequallygoodclaimtobeitsheir,asIshallexplain).TheClassicalschoolofeconomics–or,rathertheClassicalschoolofpoliticaleconomy,asthe
subjectwasthencalled–emergedinthelateeighteenthcenturyanddominatedthesubjectuntilthelatenineteenthcentury.ItsfounderisAdamSmith(1723–90),whowehavediscussedalready.Smith’sideaswerefurtherdevelopedintheearlynineteenthcenturybythreenear-contemporaries–DavidRicardo(1772–1823),Jean-BaptisteSay(1767–1832),andRobertMalthus(1766–1834).
Theinvisiblehand,Say’sLawandfreetrade:thekeyargumentsoftheClassicalschool
AccordingtotheClassicalschool,thepursuitofself-interestsbyindividualeconomicactorsproducesasociallybeneficialoutcome,intheformofmaximumnationalwealth.Thisparadoxicaloutcomeismadepossiblebythepowerofcompetitioninthemarket.Intheirattemptstomakeprofits,producersstrivetosupplycheaperandbetterthings,ultimatelyproducingtheirproductsattheminimumpossiblecosts,thusmaximizingnationaloutput.Thisideaisknownastheinvisiblehandandhasbecomearguablythemostinfluentialmetaphorineconomics,althoughSmithhimselfuseditonlyonceinTheWealthofNations(TWON)anddidnotaccorditaprominentroleinhistheory.*MostClassicaleconomistsbelievedintheso-calledSay’sLaw,whichstatesthatsupplycreatesits
owndemand.Thereasoningwasthateveryeconomicactivitygeneratesincomes(wages,profits,etc.)equivalenttothevalueofitsoutput.Therefore,itwasargued,therecanbenosuchthingasarecessionduetoashortfallindemand.Anyrecessionhadtobeduetoexogenousfactors,suchasawarorthefailureofamajorbank.Sincethemarketwasincapableofnaturallygeneratingarecession,anygovernmentattempttocounterit,say,throughdeliberatedeficitspending,wascondemnedasdisturbingthenaturalorder.ThismeantthatrecessionsthatcouldhavebeencutshortormademilderbecameprolongedinthedaysofClassicaleconomics.TheClassicalschoolrejectedanyattemptbythegovernmenttorestrictthefreemarket,say,through
protectionismorregulation.Ricardodevelopedanewtheoryofinternationaltrade,knownasthetheoryofcomparativeadvantage,furtherstrengtheningtheargumentforfreetrade.Histheoryshowedthat,undercertainassumptions,evenwhenacountrycannotproduceanyproductmorecheaplythananothercountrycan,freetradebetweenthemwillallowbothtomaximizetheiroutputs.Theycanachievethisbyspecializingin,andexporting,productsinwhichtheyhavecomparativeadvantage–thosewiththelargestrelativecostadvantagesinthecaseofthemoreefficientcountryandthosewiththesmallestrelativecostdisadvantagesinthecaseofthelessefficientcountry.*TheClassicalschoolviewedthecapitalisteconomyasbeingmadeupof‘threeclassesofthe
community’,inRicardo’swords–thatis,capitalists,workersandlandlords.Theschool,especiallyRicardo,emphasizedthatitisinthelong-terminterestofeveryonethatthegreatestshareofnationalincomegotothecapitalistclass(thatis,profits),becauseitistheonlyclassthatinvestsandgenerateseconomicgrowth;theworkingclasswastoopoortosaveandinvest,whilethelandlordclasswasusingitsincome(rents)on‘unproductive’luxuryconsumption,suchastheemploymentofservants.AccordingtoRicardoandhisfollowers,thegrowingpopulationinBritainwasforcingthecultivationofincreasingly
lower-qualityland,constantlyraisingtherentsforexisting(higher-quality)land.Thismeantthattheshareofprofitwasgraduallyfalling,threateninginvestmentandgrowth.Hisrecommendationwastoabolishtheprotectionforgrainproducers(calledtheCornLawsinBritainatthetime)andimportcheaperfoodfromcountrieswheregood-qualitylandwasstillavailable,sothatthesharegoingtoprofits,andthustheabilityoftheeconomytoinvestandgrow,couldberaised.
Classanalysisandcomparativeadvantage:theClassicalschool’srelevancefortoday
Despitebeinganoldschoolwithfewcurrentpractitioners,theClassicalschoolisstillrelevantforourtime.Thenotionoftheeconomyasbeingmadeupofclasses,ratherthanindividuals,allowsustoseehow
anindividual’sbehaviourisstronglyaffectedbyherplaceinthesystemofproduction.Thefactthatmarketingcompaniesstilluseclasscategoriesindevisingtheirstrategiessuggeststhatclassisstillaveryrelevantcategory,eventhoughmostacademiceconomistsmaynotusetheconceptorevenactivelydenyitsexistence.Ricardo’stheoryofcomparativeadvantage,whilehavingclearlimitationsasastatictheorythattakesa
country’stechnologiesasgiven,isstilloneofthebesttheoriesofinternationaltrade.ItismorerealisticthantheNeoclassicalversion,knownastheHeckscher-Ohlin-Samuelsontheory(henceforthHOS),whichistodaythedominantversion.*InHOS,itisassumedthatallcountriesaretechnologicallyandorganizationallycapableofproducingeverything.Theychoosetospecializeindifferentproductsonlybecausedifferentproductsusedifferentcombinationsofcapitalandlabour,whoserelativeendowmentsdifferacrosscountries.Thisassumptionleadstounrealisticconclusions:ifGuatemalaisn’tproducingthingslikeBMWs,itisnotbecauseitcannotbutbecauseitisnoteconomicaltodoso,giventhattheirproductionusesalotofcapitalandlittlelabour,whenGuatemalahasalotoflabourandlittlecapital.
Sometimeswrong,sometimesoutdated:limitationsoftheClassicalschool
SomeofthetheoriesoftheClassicalschoolweresimplywrong.Theschool’sadherencetoSay’sLawmadeitincapableofdealingwithmacroeconomicproblems(namely,problemsthataretodowiththeoverallstateoftheeconomy,suchasrecessionorunemployment).Itstheoryofthemarketatthemicroeconomiclevel(namely,thelevelofindividualeconomicactors)wasalsoseverelylimited.Itdidnothavethetheoreticaltoolstoexplainwhyunrestrainedcompetitioninthemarketmightnotproducesociallydesirableoutcomes.SomeClassicaltheories,evenifnotwronginthelogicalsense,havelimitedapplicabilitytoday
becausetheyweredesignedforaworldverydifferentfromours.Alotof‘ironlaws’ofClassicaleconomicsturnedouttobenosuchthings.Forexample,theClassicaleconomiststhoughtthatpopulationpressurewouldraiseagriculturalrentsandsqueezeindustrialprofitstosuchanextentthatinvestmentmightcease,becausetheydidnot–andcouldnot–knowhowmuchthetechnologiesforfoodproductionandbirthcontrolwoulddevelop.
TheNeoclassicalSchool
One-sentencesummary:Individualsknowwhattheyaredoing,soleavethemalone–exceptwhenmarketsmalfunction.
TheNeoclassicalschoolaroseinthe1870s,fromtheworksofWilliamJevons(1835–82)andLeonWalras(1834–1910).ItwasfirmlyestablishedwiththepublicationofAlfredMarshall’sPrinciplesofEconomicsin1890.AroundMarshall’stime,Neoclassicaleconomistsalsosucceededinchangingthenameofthe
disciplinefromthetraditional‘politicaleconomy’to‘economics’.ThechangesignalledthattheNeoclassicalschoolwanteditsanalysistobecomeapurescience,shornofpolitical(andthusethical)dimensionsthatinvolvesubjectivevaluejudgements.
Demandfactors,individualsandexchanges:differenceswiththeClassicalschool
TheNeoclassicalschoolclaimedtobetheintellectualheiroftheClassicalschoolbutfeltitselftobesufficientlydifferenttoattachtheprefix‘Neo’.Thekeydifferencesareasfollows.Itemphasizedtheroleofdemandconditions(derivedfromthesubjectivevaluationofproductsby
consumers)inthedeterminationofthevalueofagood.Classicaleconomistsbelievedthatthevalueofaproductisdeterminedbysupplyconditions,thatis,thecostsofitsproduction.Theymeasuredthecostsbythelabourtimeexpendedinproducingit–thisisknownasthelabourtheoryofvalue.Neoclassicaleconomistsemphasizedthatthevalue(whichtheycalledtheprice)ofaproductalsodependsonhowmuchtheproductisvaluedbypotentialconsumers;thefactthatsomethingisdifficulttoproducedoesnotmeanthatitismorevaluable.Marshallrefinedthisideabyarguingthatdemandconditionsmattermoreindeterminingpricesintheshortrun,whensupplycannotbechanged,whilesupplyconditionsmattermoreinthelongrun,whenmoreinvestments(disinvestments)canbemadeinfacilitiestoproducemore(less)ofwhatisdemandedmore(less).Theschoolconceptualizedtheeconomyasacollectionofrationalandselfishindividuals,ratherthan
asacollectionofdistinctclasses,astheClassicalschooldid.TheindividualasenvisagedinNeoclassicaleconomicsisaratherone-dimensionalbeing–a‘pleasuremachine’,ashewascalled,devotedtothemaximizationofpleasure(utility)andtheminimizationofpain(disutility),usuallyinnarrowlydefinedmaterialterms.AsIshalldiscussinChapter5,thisseverelylimitstheexplanatorypowerofNeoclassicaleconomics.5
TheNeoclassicalschoolshiftedthefocusofeconomicsfromproductiontoconsumptionandexchange.FortheClassicalschool,especiallyAdamSmith,productionwasattheheartoftheeconomicsystem.AswesawinChapter2,Smithwasdeeplyinterestedinhowthechangesintheorganizationofproductionweretransformingtheeconomy.Hehadaviewofhistoryinwhichsocietiesdevelopinstagesaccordingtothedominantformofproduction–hunting,pastoralism,agricultureandcommerce(thisideawasfurtherdevelopedbyKarlMarx,asIshalldiscussbelow).Incontrast,inNeoclassicaleconomics,theeconomicsystemisessentiallyenvisagedasawebofexchanges,ultimatelydrivenbychoicesmadeby‘sovereign’consumers.Thereislittlediscussionofhowactualprocessesofproductionareorganizedandchanged.
Self-interestedindividualsandself-equilibratingmarkets:similaritieswiththeClassicalschool
Despitethesedifferences,theNeoclassicalschoolinheritedanddevelopedtwocentralideasoftheClassicalschool.Thefirstistheideathateconomicactorsaredrivenbyself-interestbutthatthecompetitioninthemarketensuresthattheiractionscollectivelyproduceasociallybenignoutcome.Theotheristheideathatmarketsareself-equilibrating.Theconclusionis,asinClassicaleconomics,that
capitalism–or,rather,themarketeconomy,astheschoolpreferstocallit–isasystemthatisbestleftalone,asithasatendencytoreverttotheequilibrium.Thislaissez-faireconclusionoftheNeoclassicalschoolwasfurtherintensifiedbyacriticaltheoretical
developmentintheearlytwentiethcentury,intendedtoallowustojudgesocialimprovementsinanobjectiveway.VilfredoPareto(1848–1923)arguedthat,ifwerespecttherightsofeverysovereignindividual,weshouldconsiderasocialchangeanimprovementonlywhenitmakessomepeoplebetteroffwithoutmakinganyoneworseoff.Thereshouldbenomoreindividualsacrificesinthenameofthe‘greatergood’.ThisisknownastheParetocriterionandformsthebasisforalljudgementsonsocialimprovementsinNeoclassicaleconomicstoday.6Inreallife,unfortunately,therearefewchangesthathurtnoone;thustheParetocriterioneffectivelybecomesarecipetosticktothestatusquoandletthingsbe–laissezfaire.ItsadoptionthusimpartedahugeconservativebiastotheNeoclassicalschool.
Theanti-free-marketrevolution:themarketfailureapproach
Twotheoreticaldevelopmentsinthe1920sandthe1930sseveredtheapparentlyunbreakablelinkbetweenNeoclassicaleconomicsandtheadvocacyoffree-marketpolicies.Afterthesedevelopments,ithasbecomeimpossibletoequateNeoclassicaleconomicswithfree-marketeconomics,assomepeoplestillmistakenlydo.Themorefundamentalofthesewasthebirthofwelfareeconomics,orthemarketfailureapproach,
developedbyCambridgeprofessorArthurPigouinthe1920s.Pigouarguedthatthereareoccasionswhenmarketpricesfailtoreflectthetruesocialcostsandbenefits.Forexample,afactorymaypolluteairandwaterbecauseairandwaterhavenomarketpricesandthusitcantreatthemasfreegoods.Butasaresultofsuch‘over-production’ofpollution,theenvironmentisdestroyed,andthesocietysuffers.Theproblemisthattheeffectsofsomeeconomicactivitiesarenotpricedinthemarketandthusnot
reflectedineconomicdecisions–thisisknownasanexternality.Inthiscase,itwouldbejustifiedforthegovernmenttomakethefactory,whichissaidtocreateanegativeexternality,pollutelessthroughpollutiontaxesorregulations(e.g.,afineonexcessivereleaseofeffluents).Conversely,theremaybeactivitiesthathaveapositiveexternality.Anexamplemayberesearchanddevelopment(orR&D)activitiesbyacompany.Bygeneratingnewknowledgethatcanbeusedbyothers,R&Dcreatesmorevaluethanwhataccruestothecompanyconductingit.Onthisoccasion,thegovernmentwouldbejustifiedtopaysubsidiestoanyonewhodoesR&Dsothattherewouldbemoreofit.Subsequently,othertypesofmarketfailurewereaddedtoPigou’sexternality,asIwilldiscussinChapter11.Amoreminoryetimportantmodificationcameinthe1930s,intheformofthecompensationprinciple.
TheprincipleproposesthatachangemaybedeemedasocialimprovementevenwhenitviolatestheParetocriterion(inthesenseoftherebeingsomelosers),ifthetotalgainsforthegainersarelargeenoughtocompensateallthelosersandstillleavesomethingbehind.Byallowingthemtoendorseachangethatmayhurtsomepeople(butcanfullycompensatefortheirdamages),thecompensationprinciplehasallowedNeoclassicaleconomiststoavoidtheultra-conservativebiasoftheParetocriterion.Ofcourse,thetroubleisthatthecompensationisrarelymadeinreality.*
Thecounter-revolution:therenaissanceofthefree-marketview
Withthesemodifications,therewasnoreasonfortheNeoclassicalschooltoremaincommittedtofree-marketpoliciesanymore.Indeed,betweenthe1930sandthe1970s,manyNeoclassicaleconomistswerenotfree-marketeconomists.Thecurrentstateofaffairsinwhichthepredominantmajorityof
Neoclassicaleconomistsareoffree-marketleaningisactuallyduemoretotheshiftinpoliticalideologysincethe1980sthantotheabsenceorthepoorqualityoftheorieswithinNeoclassicaleconomicsidentifyingthelimitsofthefreemarket.Ifanything,thearsenalforNeoclassicaleconomistswhorejectfree-marketpolicieshasbeenexpandedsincethe1980sbythedevelopmentofinformationeconomics,ledbyJosephStiglitz,GeorgeAkerlofandMichaelSpence.Informationeconomicsexplainswhyasymmetricinformation–thesituationinwhichonepartytoamarketexchangeknowssomethingthattheotherdoesnot–makesmarketsmalfunctionorevenceasetoexist.7
However,sincethe1980s,manyNeoclassicaleconomistshavealsodevelopedtheoriesthatgosofarastodenythepossibilityofmarketfailures,suchasthe‘rationalexpectation’theoryinmacroeconomicsorthe‘efficientmarkethypothesis’infinancialeconomics,basicallyarguingthatpeopleknowwhattheyaredoingandthereforethegovernmentshouldleavethemalone–or,intechnicalterms,economicagentsarerationalandthereforemarketoutcomesefficient.Atthesametime,thegovernmentfailureargumentwasadvanced,toarguethatmarketfailureinitselfcannotjustifygovernmentinterventionbecausegovernmentsmayfailevenmorethanmarketsdo(moreonthisinChapter11).
Precisionandversatility:thestrengthsoftheNeoclassicalschool
TheNeoclassicalschoolhassomeuniquestrengths.Itsinsistenceonbreakingphenomenadowntotheindividuallevelgivesitahighdegreeofprecisionandlogicalclarity.Itisalsoversatile.Itmaybeverydifficultforsomeonetobea‘right-wing’Marxistora‘left-wing’Austrian,buttherearemany‘left-wing’Neoclassicaleconomists,suchasJosephStiglitzandPaulKrugman,aswellasvery‘right-wing’ones,likeJamesBuchananandGaryBecker.Toexaggerateonlyslightly,ifyouarecleverenough,youcanjustifyanygovernmentpolicy,anycorporatestrategy,oranyindividualactionwiththehelpofNeoclassicaleconomics.
Unrealisticindividuals,over-acceptanceofthestatusquoandneglectofproduction:limitationsoftheNeoclassicalschool
TheNeoclassicalschoolhasbeencriticizedforassumingtoostronglythatpeopleareselfishandrational.Fromsoldiersselflesslytakingbulletsfortheircomradestohighlyeducatedbankersandeconomistsbelievinginthefairytaleofnever-endingfinancialboom(until2008),thereissimplytoomuchevidenceagainstthisassumption(seeChapter5fordetails).Neoclassicaleconomicsistooacceptingofthestatusquo.Inanalysingindividualchoices,itacceptsas
giventheunderlyingsocialstructure–thedistributionofmoneyandpower,ifyouwill.Thismakesitlookatonlychoicesthatarepossiblewithoutfundamentalsocialchanges.Forexample,manyNeoclassicaleconomists,eventhe‘liberal’PaulKrugman,arguethatweshouldnotcriticizelow-wagefactoryjobsinpoorcountriesbecausethealternativemaybenojobatall.Thisistrue,ifwetaketheunderlyingsocio-economicstructureasgiven.However,oncewearewillingtochangethestructureitself,therearealotofalternativestothoselow-wagejobs.Withnewlabourlawsthatstrengthenworkerrights,landreformthatreducesthesupplyofcheaplabourtofactories(asmorepeoplestayinthecountryside)orindustrialpoliciesthatcreatehigh-skilledjobs,thechoiceforworkerscanbebetweenlow-wagejobsandhigher-wageones,ratherthanbetweenlow-wagejobsandnojobs.TheNeoclassicalschool’sfocusonexchangeandconsumptionmakesitneglectthesphereof
production,whichisalarge–andthemostimportant,accordingtomanyotherschoolsofeconomics–partofoureconomy.Commentingonthisdeficiency,RonaldCoase,theInstitutionalisteconomist,inhis
1992NobelEconomicsPrizelecture,disparaginglydescribedNeoclassicaleconomicsasatheoryfitonlyfortheanalysisof‘loneindividualsexchangingnutsandberriesontheedgeoftheforest’.
TheMarxistSchool
One-sentencesummary:Capitalismisapowerfulvehicleforeconomicprogress,butitwillcollapse,asprivatepropertyownershipbecomesanobstacletofurtherprogress.
TheMarxistschoolofeconomicsemergedfromtheworksofKarlMarx,producedbetweenthe1840sandthe1860s,startingwiththepublicationofTheCommunistManifestoin1848(co-authoredwithFriedrichEngels(1820–95),hisintellectualpartnerandfinancialpatron)andculminatinginthepublicationofthefirstvolumeofCapitalin1867.8ItwasfurtherdevelopedinGermanyandAustriaandthenintheSovietUnioninthelatenineteenthandtheearlytwentiethcenturies.*Morerecently,itwaselaboratedintheUSandEuropeduringthe1960sandthe1970s.
Labourtheoryofvalue,classes,andproduction:TheMarxistschoolasthetruerheiroftheClassicalschool
AsImentionedearlier,theMarxistschoolinheritedmanyelementsfromtheClassicalschool.Inmanyways,itistruertotheClassicaldoctrinethanthelatter’sself-proclaimedsuccessor,theNeoclassicalschool.Itadoptedthelabourtheoryofvalue,whichwasexplicitlyrejectedbytheNeoclassicalschool.Italsofocusedonproduction,whereasconsumptionandexchangewerethekeysfortheNeoclassicalschool.Itenvisionedaneconomycomprisedofclassesratherthanindividuals–anotherkeyideaoftheClassicalschoolrejectedbytheNeoclassicalschool.DevelopingtheClassicalschool,Marxandhisfollowerscameupwithatypeofeconomicsvery
differentfromthatofferedbyitshalf-brother,theNeoclassicalschool.
Productionatthecentreofeconomics
TakingtheClassicalschool’sproduction-basedviewoftheeconomyfurther,theMarxistschoolarguedthat‘productionis…thebasisofsocialorder’,inthewordsofEngels.Everysocietyisseenasbeingbuiltonaneconomicbase,orthemodeofproduction.Thisbaseismadeupoftheforcesofproduction(technologies,machines,humanskills)andtherelationsofproduction(propertyrights,employmentrelationship,divisionoflabour).Uponthisbaseisthesuperstructure,whichcomprisesculture,politicsandotheraspectsofhumanlife,whichinturnaffectthewaytheeconomyisrun.Inthissense,Marxwasprobablythefirsteconomisttosystematicallyexploretheroleofinstitutionsintheeconomy,presagingtheInstitutionalistschool.FurtherdevelopingAdamSmith’s‘stagesofdevelopment’theory,theMarxistschoolsawsocietiesas
evolvingthroughaseriesofhistoricalstages,definedintermsoftheirmodeofproduction:primitivecommunism(‘tribal’societies);antiquarianmodeofproduction(basedonslavery,asinGreeceandRome);feudalism(basedonlandlordscommandingsemi-slaves,orserfs,tiedtotheirlands);capitalism;communism.*Capitalismisseenasbutonestageofhumandevelopmentbeforewereachtheultimatestageofcommunism.ThisrecognitionofthehistoricalnatureofeconomicproblemsisagreatcontrasttotheNeoclassicalschool,whichconsidersthe‘economic’problemofutilitymaximizationuniversal–forRobinsonCrusoeinadesertisland,forparticipantsinaweeklymarketofmedievalEurope,for
subsistencefarmersinTanzaniaandforanaffluentGermanconsumerinthetwenty-firstcentury,younameit.
Classstruggleandthesystemiccollapseofcapitalism
TheMarxistschooltooktheclass-basedviewofsocietyoftheClassicalschooltoanotherlevel.Itviewedclassconflictsasthecentralforceofhistory–summarizedinthedeclarationinTheCommunistManifesto:‘Thehistoryofhithertoexistingsocietyisthehistoryofclassstruggles.’Moreover,theschoolrefusedtoseetheworkingclassasapassiveentity,asdidtheClassicalschool,andaccordeditanactiveroleinhistory.Classicaleconomistsviewedworkersassimplesoulsunabletoevencontroltheirbiologicalurges.As
soonastheeconomyexpandsandthedemandforlabourgrowsandhigherwagesarepaid,workershavemorechildren.Thismeansmoreworkers,bringingthewagesagaindowntosubsistencelevel.Onlyalifeofmiserylayaheadofthem,thoseeconomistsbelieved,unlesstheylearnedtoexerciserestraintandstopproducingsomanychildren–ahighlyunlikelyprospect,thoseeconomistssurmised,giventheirbasenature.Marxhadatotallydifferentview.Forhim,workerswerenotthepowerless‘huddledmass’in
Classicaleconomicsbutactiveagentsofsocialchange–the‘gravediggerofcapitalism’inhiswords–whoseorganizationalskillsanddisciplinewerebeingforgedintheharshhierarchywithinfactoriesofever-growingsizeandcomplexity.Marxdidnotbelievethatworkerscouldstartarevolutionandtopplecapitalismatwill.Thetimehad
toberipe.Thiswouldcomeonlywhencapitalismhasdevelopedsufficiently,leadingtoaheightenedcontradictionbetweenthetechnologicalrequirementsofthesystem(forcesofproduction)anditsinstitutionalset-up(relationsofproduction).Withthecontinuousdevelopmentoftechnologies,spurredbytheneedonthepartofcapitaliststoinvest
andinnovateinordertosurvivetheunrelentingcompetition,thedivisionoflabourbecomesincreasinglymore‘social’,makingcapitalistfirmsbecomemoredependentoneachotherassuppliersandbuyers.Thismakescoordinationofactivitiesamongthoserelatedfirmsincreasinglymorenecessary,butthepersistenceofprivateownershipofthemeansofproductionmakessuchcoordinationverydifficult,ifnottotallyimpossible.Theresultisincreasingcontradictioninthesystem,finallyleadingtoitscollapse.Capitalismwouldbereplacedbysocialism,inwhichthecentralplanningauthorityfullycoordinatestheactivitiesofalltherelatedenterprises,nowcollectivelyownedbyallworkers.
Fatallyflawed,butstilluseful:theoriesofthefirm,work,andtechnologicalprogress
TheMarxistschoolhasmanyfatalflaws.Aboveall,itspredictionthatcapitalismwillcollapseunderitsownweighthasnotcometrue.Capitalismhasprovedfarmorecapableofreformingitselfthantheschoolhadpredicted.Insofarassocialismemerged,itdidsoincountrieslikeRussiaandChina,wherecapitalismwashardlydeveloped,ratherthaninthemostadvancedcapitalisteconomies,asMarxhadpredicted.Becauseitwassointertwinedwithapoliticalproject,alongtheway,manyofitsfollowersdevelopedblindfaithinwhateverMarxsaidor,evenworse,whattheSovietUnionsaidwastherightinterpretationofhisideas.ThecollapseofthesocialistblochasrevealedthattheMarxisttheoryofhowthealternativetocapitalismshouldbeorganizedwashighlyinadequate.Thelistgoeson.Despitetheselimitations,theMarxistschoolstillofferssomeveryusefulinsightsintotheworkingsof
capitalism.
Marxwasthefirsteconomisttopayattentiontothedifferencesbetweenthetwokeyinstitutionsofcapitalism–thehierarchical,plannedorderofthefirmandthe(formally)free,spontaneousorderofthemarket.Hedescribedcapitalistfirmsasislandsofrationalplanninginananarchicseaofthemarket.Moreover,heforesawthatlarge-scaleenterprisesownedbymultitudesofshareholderswithlimitedliability–whichwerecalled‘jointstockcompanies’inhistime–wouldbecometheleadingactorsofcapitalism,atatimewhenmostfree-marketeconomistswerestillagainsttheveryideaoflimitedliability.Unlikemostothereconomists,Marxandsomeofhisfollowershavepaidattentiontoworkforitsown
sake,ratherthanasadisutilitythatpeoplehavetoputupwithinordertoearnmoneytopayfortheirconsumption.Hebelievedthatworkcanallowhumanbeingstoexpresstheirinherentcreativity.Hecriticizedthehierarchicalcapitalistfirmforblockingsuchpossibility.Heemphasizedthedehumanizingandmind-numbingeffectsoftherepetitiveworkthatemanatesfromincreasinglyfinedivisionsoflabour.Itisinterestingtonotethat,whilepraisingthepositiveproductivityeffectsoffinerdivisionsoflabour,AdamSmithhadalsoworriedaboutthenegativeimpactoffragmentedworkonindividualworkers.Lastbutnotleast,Marxwasalsothefirstmajoreconomistwhotrulyunderstoodtheimportanceof
technologicalinnovationintheprocessofcapitalistdevelopment,makingitthecentralelementinhistheory.
TheDevelopmentalistTradition
One-sentencesummary:Backwardeconomiescan’tdevelopiftheyleavethingsentirelytothemarket.
Aneglectedtradition
Unbeknownsttomostpeopleandrarelymentionedeveninbooksonthehistoryofeconomicthought,thereisatraditionineconomicsthatisevenolderthantheClassicalschool.ItiswhatIcalltheDevelopmentalisttradition,whichstartedinthelatesixteenthandtheearlyseventeenthcenturies–twocenturiesorsobeforetheClassicalschool.Idon’tcalltheDevelopmentalisttraditionaschool,becausethelattertermimpliesthatthereare
identifiablefoundersandfollowers,withclearcoretheories.Thistraditionisverydispersed,withmultiplesourcesofinspirationandwithacomplicatedintellectuallineage.Thisisbecausepolicy-makers,whoareinterestedinsolvingreal-worldproblems,ratherthan
intellectualpurity,startedthetradition.*Theypulledtogetherelementsfromdifferentsourcesinapragmatic,eclecticmanner,eventhoughsomeofthemhavemadeimportantoriginalcontributionsoftheirown.Butthetraditionisnolessimportantforthat.Itisarguablythemostimportantintellectualtraditionin
economicsintermsofitsimpactontherealworld.Itisthistradition,ratherthanthenarrowrationalismofNeoclassicaleconomicsortheMarxistvisionofclasslesssociety,thathasbeenbehindalmostallofthesuccessfuleconomicdevelopmentexperiencesinhumanhistory,fromeighteenth-centuryBritain,throughnineteenth-centuryAmericaandGermany,downtotoday’sChina.9
Raisingproductivecapabilitiestoovercomeeconomicbackwardness
TheDevelopmentalisttraditionisfocusedonhelpingeconomicallybackwardcountriesdeveloptheireconomiesandcatchupwiththemoreadvancedones.Foreconomistsbelongingtothetradition,
economicdevelopmentisnotsimplyamatterofincreasingincome,whichcouldhappenduetoaresourcebonanza,suchasstrikingoilordiamonds.Itisamatterofacquiringmoresophisticatedproductivecapabilities,thatis,theabilitiestoproducebyusing(anddevelopingnew)technologiesandorganizations.Thetraditionarguesthatsomeeconomicactivities,suchashi-techmanufacturingindustries,arebetter
thanothersatenablingcountriestodeveloptheirproductivecapabilities.However,itargues,theseactivitiesdonotnaturallydevelopinabackwardeconomy,astheyarealreadyconductedbyfirmsinthemoreadvancedeconomies.Insuchaneconomy,unlessthegovernmentintervenes–withtariffs,subsidiesandregulations–topromotesuchactivities,freemarketswillconstantlypullitbacktowhatitisalreadygoodat–namely,low-productivityactivities,basedonnaturalresourcesorcheaplabour.10Thetraditionemphasizesthatdesirableactivitiesandappropriatepoliciesdependontimeandcontext.Yesterday’shi-techindustry(e.g.,textilesintheeighteenthcentury)maybetoday’sdead-endindustry,whileapolicythatisgoodforanadvancedeconomy(e.g.,freetrade)maybebadforalessdevelopedcountry.
EarlystrandsintheDevelopmentalisttradition:Mercantilism,theinfantindustryargumentandtheGermanhistoricalschool
Althoughthepolicypracticestartedearlier(forexample,underHenryVII,whoreignedbetween1485and1509),theoreticalwritingsintheDevelopmentalisttraditionstartedinthelatesixteenthandtheearlyseventeenthcenturies,withRenaissanceItalianeconomistslikeGiovanniBoteroandAntonioSerra,whoemphasizedtheneedforpromotionofmanufacturingactivitiesbythegovernment.TheDevelopmentalisteconomistsoftheseventeenthandeighteenthcenturies–knownasMercantilists
–arethesedaystypicallyportrayedashavingbeensolelyfocusedongeneratingtradesurplus,thatis,thedifferencebetweenyourexportsandimportswhentheformerislarger.Butmanyofthemwereactuallymoreinterestedinpromotinghigher-productivityeconomicactivitiesthroughpolicyinterventions.Atleastthemoresophisticatedofthemvaluedtradesurplusasasymptomofeconomicsuccess(thatis,thedevelopmentofhigh-productivityactivities),ratherthanasagoalinitself.Fromthelateeighteenthcentury,sheddingtheMercantilistgarbanditsinterestintradesurplus,the
Developmentalisttraditionbecamemoreclearlyfocusedonproduction.ThecriticaldevelopmentcamefromAlexanderHamilton’sinventionoftheinfantindustryargument,whichweencounteredinthelastchapter.Hamilton’stheorywasfurtherdevelopedbytheGermaneconomistFriedrichList,whoisthesedaysoftenmistakenlyknownasthefatheroftheinfantindustryargument.11AlongsideList,inthemid-nineteenthcentury,theGermanHistoricalschoolemergedanddominatedGermaneconomicsuntilthemid-twentiethcentury.ItalsoheavilyinfluencedAmericaneconomics.*Theschoolemphasizedtheimportanceofunderstandingthehistoryofhowthematerialproductionsystemhaschanged,bothinfluencingandinfluencedbylawandothersocialinstitutions.12
TheDevelopmentalisttraditioninthemodernworld:DevelopmentEconomics
TheDevelopmentalisttraditionwasadvancedinitsmodernforminthe1950sandthe1960sbyeconomistssuchas,inalphabeticalorder,AlbertHirschman(1915–2012),SimonKuznets(1901–85),ArthurLewis(1915–91)andGunnarMyrdal(1899–87)–thistime,undertherubricofDevelopmentEconomics.WritingmostlyaboutthecountriesontheperipheryofcapitalisminAsia,AfricaandLatinAmerica,theyandtheirfollowersnotonlyrefinedtheearlierDevelopmentalisttheoriesbutalsoaddedquitealotofnewtheoreticalinnovations.
ThemostimportantinnovationcamefromHirschman,whopointedoutthatsomeindustrieshaveparticularlydenselinkages(orconnections)withotherindustries;inotherwords,theybuyfrom–andsellto–aparticularlylargenumberofindustries.Ifthegovernmentidentifiedanddeliberatelypromotedtheseindustries(theautomobileandthesteelindustriesarecommonexamples),theeconomywouldgrowmorevigorouslythanwhenlefttothemarket.Morerecently,somedevelopmenteconomistshaveemphasizedtheneedtocomplementinfantindustry
protectionwithinvestmentsinbuildinganeconomy’sproductivecapabilities.13Tradeprotectiononlycreatesthespacewithinwhichacountry’sfirmscanraiseproductivity,theyargued.Theactualraisingofproductivityrequiresdeliberateinvestmentsineducation,trainingandR&D.
Alotmorethanmeetstheeye:assessingtheDevelopmentalisttradition
AsIhavepointedoutearlier,thelackofacoherent,overarchingtheoryisacrucialweaknessoftheDevelopmentalisttradition.Giventhehumantendencytobeseducedbyatheorythatsupposedlyexplainseverything,thishasputthetraditioninseriouslyloweresteeminmostpeople’seyesthanmorecoherentandself-confidentschools,suchastheNeoclassicalschoolortheMarxistone.Thetraditionismorevulnerabletothegovernmentfailureargumentthanothereconomicschoolsthat
advocateanactiveroleforthegovernment.Itrecommendsaparticularlywide-rangingsetofpolicies,whichismorelikelytostretchtheadministrativecapabilitiesofthegovernment.Despitetheseweaknesses,theDevelopmentalisttraditiondeservesmoreattention.Itscrucial
weakness,namelyitseclecticism,canactuallybeastrength.Giventhecomplexityoftheworld,amoreeclectictheorymaybebetteratexplainingit.ThesuccessofSingapore’suniquecombinationoffree-marketpoliciesandsocialistpolicies,whichweencounteredinChapter3,isacaseinpoint.Moreover,itsimpressivetrackrecordingeneratingrealworldchangessuggeststhatthereisalotmoretoitthanmeetstheeye.
TheAustrianSchool
One-sentencesummary:Nooneknowsenough,soleaveeveryonealone.
Orangesarenottheonlyfruit:differenttypesoffree-marketeconomics
NotallNeoclassicaleconomistsarefree-marketeconomists.Norareallfree-marketeconomistsNeoclassical.TheadherentsoftheAustrianschoolareevenmoreardentsupportersofthefreemarketthanmostfollowersoftheNeoclassicalschool.TheAustrianschoolwasstartedbyCarlMenger(1840–1921)inthelatenineteenthcentury.Ludwig
vonMises(1881–1973)andFriedrichvonHayek(1899–1992)extendedtheschool’sinfluencebeyonditshomeland.Itgainedinternationalattentionduringtheso-calledCalculationDebateinthe1920sandthe1930s,inwhichitbattledtheMarxistsonthefeasibilityofcentralplanning.14In1944,Hayekpublishedanextremelyinfluentialpopularbook,TheRoadtoSerfdom,whichpassionatelywarnedagainstthedangerofgovernmentinterventionleadingtothelossoffundamentalindividualliberty.TheAustrianschoolisthesedaysinthesamelaissez-fairecampwiththefree-marketwing(todaythe
majority)oftheNeoclassicalschool,producingsimilar,ifsomewhatmoreextreme,policyconclusions.However,methodologicallyitisverydifferentfromtheNeoclassicalschool.Thealliancebetweenthetwogroupsisduemoretotheirpoliticsthaneconomics.
Complexityandlimitedrationality:theAustriandefenceofthefreemarket
Whileemphasizingtheimportanceofindividuals,theAustrianschooldoesnotbelievethatindividualsareatomisticrationalbeings,asassumedinNeoclassicaleconomics.Itseeshumanrationalityasseverelylimited.Itarguesthatrationalbehaviourisonlypossiblebecausewehumansvoluntarily,ifsubconsciously,limitourchoicesbyunquestioninglyacceptingsocialnorms–‘customandtraditionstandbetweeninstinctandreason’,Hayekintoned.Forexample,byassumingthatmostpeoplewillrespectmoralcodes,wecandevoteourmentalenergytocalculatingthecostsandthebenefitsofapotentialmarkettransaction,ratherthantocalculatingtheoddsofbeingcheated.TheAustrianschoolalsoarguesthattheworldishighlycomplexanduncertain.Asitsmembers
pointedoutintheCalculationDebate,itisimpossibleforanyone–eventheall-powerfulcentralplanningauthorityofasocialistcountrythatcandemandanyinformationitwantsfromanyone–toacquirealltheinformationneededtorunacomplexeconomy.Itisonlythroughthespontaneousorderofthecompetitivemarketthatthediverseandever-changingplansofnumerouseconomicactors,respondingtounpredictableandcomplexshiftsoftheworld,canbereconciledwitheachother.Thus,theAustrianssaythatthefreemarketisthebesteconomicsystemnotbecauseweareperfectly
rationalandknoweverything(oratleastcanknoweverythingthatweneedtoknow),asinNeoclassicaltheories,butexactlybecausewearenotveryrationalandbecausetherearesomanythingsintheworldthatareinherently‘unknowable’.ThisdefenceofthefreemarketisalotmorerealisticthantheNeoclassicalone,basedontheassumptionofabsurddegreesofhumanrationalityandontheunrealisticbeliefinthe‘knowability’oftheworld.
Spontaneousvs.constructedorder:limitstotheAustrianargument
TheAustrianschoolisabsolutelyrightinsayingthatwemaybebetteroffrelyingonthespontaneousorderofthemarketbecauseourabilitytodeliberatelycreateorderislimited.Butcapitalismisfullofdeliberately‘constructedorders’,suchasthelimitedliabilitycompany,thecentralbankorintellectualpropertylaws,whichdidnotexistuntilthelatenineteenthcentury.Thediversityofinstitutionalarrangements–andtheresultingdifferencesineconomicperformances–betweendifferentcapitalisteconomiesisalsoinlargeparttheresultofdeliberateconstruction,ratherthanspontaneousemergence,oforder.15
Moreover,themarketitselfisaconstructed(ratherthanspontaneous)order.Itisbasedondeliberatelydesignedrulesandregulationsthatprohibitcertainthings,discourageothersandencouragestillothers.Thispointcanbemoreclearlyseenwhenwerecallthattheboundariesofthemarkethavebeenrepeatedlydrawnandredrawnthroughdeliberatepoliticaldecisions–afactthattheAustrianschoolfailsto,orevenrefusesto,accept.Manyonce-legalobjectsofmarketexchange–slaves,childlabour,certainnarcotics–havebeenwithdrawnfromthemarket.Atthesametime,manyformerlyunmarketablethingshavebecomemarketableduetopoliticaldecisions.‘Commons’,thegrazinglandsthatwerecollectivelyownedbycommunitiesandthereforecouldnotbeboughtandsold,becameprivatelandthroughtheEnclosureinBritainbetweenthesixteenthandeighteenthcenturies.Themarketforcarbonemissionpermitswascreatedonlyinthe1990s.16Bycallingthemarketaspontaneousorder,theAustriansareseriouslymisrepresentingthenatureofthecapitalisteconomy.TheAustrianpositionagainstgovernmentinterventionistooextreme.Theirviewisthatany
governmentinterventionotherthantheprovisionoflawandorder,especiallyprotectionofprivate
property,willlaunchthesocietyontoaslipperyslopedowntosocialism–aviewmostexplicitlyadvancedinHayek’sTheRoadtoSerfdom.Thisisnottheoreticallyconvincing;norhasitbeenborneoutbyhistory.Thereisahugegradationinthewaysmarketandthestatecombineacrosscountriesandwithincountries.ChocolatebarsintheUSareprovidedinamuchmoremarket-orientedwaythanisprimaryschooleducation.SouthKoreamayrelymoreonmarketsolutionsthanBritaindoesintheprovisionofhealthcare,butthecaseisthereverseinwaterorrailways.Ifthe‘slipperyslope’existed,wewouldn’thavethesekindsofdiversity.
The(Neo-)SchumpeterianSchool
One-sentencesummary:Capitalismisapowerfulvehicleofeconomicprogress,butitwillatrophy,asfirmsbecomelargerandmorebureaucratic.
JosephSchumpeter(1883–1950)isnotoneofthebiggestnamesinthehistoryofeconomics.Buthisthoughtswereoriginalenoughtohaveawholeschoolnamedafterhim–theSchumpeterian,orneo-Schumpeterian,school.*(NotevenAdamSmithhasaschoolnamedafterhim.)LiketheAustrians,SchumpeterworkedundertheshadowoftheMarxistschool–somuchsothatthe
firstfourchaptersofhismagnumopus,Capitalism,Socialism,andDemocracy(henceforthCSD),publishedin1942,aredevotedtoMarx.17JoanRobinson,thefamousKeynesianeconomist,oncefamouslyquippedthatSchumpeterwasjust‘Marxwiththeadjectiveschanged’.
Galesofcreativedestruction:Schumpeter’stheoryofcapitalistdevelopment
SchumpeterdevelopedMarx’semphasisontheroleoftechnologicaldevelopmentasthedrivingforceofcapitalism.Hearguedthatcapitalismdevelopsthroughinnovationsbyentrepreneurs,namely,thecreationofnewproductiontechnologies,newproductsandnewmarkets.Innovationsgivethesuccessfulentrepreneurstemporarymonopoliesintheirrespectivemarkets,allowingthemtoearnexceptionalprofit,whichhecalledtheentrepreneurialprofit.Overtime,theircompetitorsimitatetheinnovations,forcingeveryone’sprofitdowntothe‘normal’level;justthinkaboutthewayinwhichtherearenowsomanyproductsinthetabletcomputermarket,onceanalmostexclusivedomainoftheAppleiPad.Thiscompetitiondrivenbytechnologicalinnovations,inSchumpeter’sview,ismuchmorepowerful
andimportantthanNeoclassicalpricecompetition–producerstryingtoundercuteachotherwithlowerprices,byincreasingtheefficiencywithwhichtheyusegiventechnologies.Hearguedthatcompetitionthroughinnovationis‘asmuchmoreeffectivethan[pricecompetition]asabombardmentisincomparisonwithforcingadoor’.Onthis,Schumpeterhasprovenprescient.Hearguedthatnofirm,howeverentrencheditmaylook,is
safefromthese‘galesofcreativedestruction’inthelongrun.ThedeclineofcompanieslikeIBMandGeneralMotors,orthedisappearanceofKodak,whichattheirpeaksdominatedtheworldintheirrespectiveindustries,demonstratesthepowerofcompetitionthroughinnovation.
WhydidSchumpeterpredicttheatrophyofcapitalismandwhywashewrong?
Despitebeingsuchabelieverinthedynamismofcapitalism,Schumpeterwasnotoptimisticaboutitsfuture.InCSD,heobservedthat,withthegrowingscaleofcapitalistfirmsandtheapplicationofscientificprinciplesintechnologicalinnovation(theemergenceof‘corporatelabs’),entrepreneurswere
makingwayforprofessionalmanagers,whomhedisparaginglycalledthe‘executivetypes’.Withthebureaucratizationofthemanagementofitsfirms,capitalismwouldloseitsdynamism,whichultimatelyrestsonthevisionandthedriveofcharismaticheroescalledentrepreneurs.Capitalismwouldslowlywitherawayandmorphintosocialism,ratherthanmeetingtheviolentdeathpredictedbyMarx.Schumpeter’spredictionhasnotcometrue.Capitalismhasbecomeactuallymoredynamicsincehis
gloomyforetellingofitsdeath.Hemadesuchanincorrectpredictionbecausehehadfailedtoseehowentrepreneurshipwasfastbecomingacollectiveendeavour,involvingnotjustthevisionaryentrepreneurbutalsomanyotheractorsinsideandoutsidethefirm.Muchoftechnologicalprogressincomplexmodernindustrieshappensthroughincremental
innovationsoriginatingfrompragmaticattemptstosolveproblemsarisingintheproductionprocess.Thismeansthatevenproduction-lineworkersareinvolvedininnovation.Indeed,Japaneseautomobilefirms,especiallyToyota,havebenefitedfromaproductionmethodthatmaximizesworkerinputsintotheinnovationprocess.GonearethedayswhenageniuslikeJamesWattorThomasEdisoncould(almost)single-handedlyperfectnewtechnologies.Thatisnotall.Whentheyinnovate,firmsdrawonresearchoutputandresearchfundingprovidedbyvariousnon-commercialactors–thegovernment,universitiesandcharitablefoundations.Thewholesocietyisnowinvolvedininnovation.Havingfailedtoappreciatetheroleofallthese‘otherguys’intheinnovationprocess,Schumpeter
cametothemistakenconclusionthatthediminishingroomforindividualentrepreneurswillmakecapitalismlessdynamicandatrophy.Fortunately,Schumpeter’sintellectualheirs(sometimescalledtheneo-Schumpeterianschool)have
overcomethislimitationinhistheory,especiallythroughthenationalsystemofinnovationapproach,whichlooksatinteractionsbetweendifferentactorsintheinnovationprocess–firms,universities,governments,andothers.*Havingsaidthat,the(neo-)Schumpeterianschoolmaybecriticizedforfocusingoverlyontechnologyandinnovationandrelativelyneglectingothereconomicissues,suchaslabour,financeandmacroeconomics.Tobefair,otherschoolstoofocusonparticularissues,buttheSchumpeterianschoolexhibitsanarrowerfocusthanmost.
TheKeynesianSchool
One-sentencesummary:Whatisgoodforindividualsmaynotbegoodforthewholeeconomy.BorninthesameyearasSchumpeterandsharingthehonourofhavingawholeschoolnamedafterhimisJohnMaynardKeynes(1883–1946).Intermsofintellectualinfluence,thereisnocomparisonbetweenthetwo.Keyneswasarguablythemostimportanteconomistofthetwentiethcentury.Heredefinedthesubjectbyinventingthefieldofmacroeconomics–thebranchofeconomicsthatanalysesthewholeeconomyasanentitythatisdifferentfromthesumtotalofitsparts.BeforeKeynes,mostpeopleagreedwithAdamSmithwhenhesaid,‘Whatisprudenceintheconduct
ofeveryprivatefamilycanscarcebefollyinthatofagreatkingdom.’Andsomepeoplestilldo.DavidCameron,theBritishprimeminister,saidinOctober2011thatallBritonsshouldtrytopayofftheircreditcarddebts,withoutrealizingthatdemandintheBritisheconomywouldcollapseifasufficientnumberofpeopleactuallyheededhisadviceandreducedspendingtopayofftheirdebts.Hesimplydidnotunderstandthatoneperson’sspendingisanother’sincome–untilhewasforcedbyhisadvisorstowithdrawtheembarrassingremark.
Rejectingthisview,Keynessoughttoexplainhowtherecouldbeunemployedworkers,idlefactoriesandunsoldproductsforprolongedperiodswhenmarketsaresupposedtoequatesupplyanddemand.
Whyisthereunemployment?:theKeynesianexplanation
Keynesstartedfromtheobviousobservationthataneconomydoesn’tconsumeallthatitproduces.Thedifference–thatis,savings–needstobeinvested,ifeverythingthathasbeenproducedistobesoldandifallproductiveinputs,includingthelabourserviceofworkers,aretobeemployed(thisisknownasfullemployment).Unfortunately,thereisnoguaranteethatsavingswillequalinvestment,especiallywhenthosewho
investandthosewhosavearenotoneandthesame,unlikeintheearlydaysofcapitalism,whencapitalistsmostlyinvestedoutoftheirownsavingsandworkerscouldnotsave,giventheirlowwages.Thisisbecauseinvestment,whosereturnsarenotimmediate,isdependentoninvestors’expectationsaboutthefuture.Inturn,theseexpectationsaredrivenbypsychologicalfactorsratherthanrationalcalculationbecausethefutureisfullofuncertainty.Uncertaintyisnotsimplyaboutnotknowingexactlywhatisgoingtohappeninthefuture.Forsome
things,wecanratheraccuratelycalculatetheprobabilityofeachpossiblecontingency–economistscallthisrisk.Indeed,ourabilitytocalculatetheriskinvolvedinmanyaspectsofhumanlife–death,fire,caraccidentandsoon–istheveryfoundationoftheinsuranceindustry.However,formanyotherthings,wedonotevenknowallthepossiblecontingencies,nottospeakoftheirrespectivelikelihoods.Thebestexplanationoftheconceptofuncertaintywasgivenby,perhapssurprisingly,DonaldRumsfeld,thedefencesecretaryinthefirstgovernmentofGeorgeW.Bush.InapressbriefingregardingthesituationinAfghanistanin2002,Rumsfeldopined:‘Thereareknownknowns.Therearethingsweknowthatweknow.Thereareknownunknowns.Thatistosay,therearethingsthatwenowknowwedon’tknow.Buttherearealsounknownunknowns.Therearethingswedonotknowwedon’tknow.’Theideaof‘unknownunknowns’nicelysumsupKeynes’conceptofuncertainty.
Activefiscalpolicyforfullemployment:theKeynesiansolution
Inanuncertainworld,investorsmaysuddenlybecomepessimisticaboutthefutureandreducetheirinvestments.Insuchasituation,therewillbemoresavingsthanareneeded–therewillbe,intechnicalterms,a‘savingsglut’.TheClassicaleconomiststhoughtthisglutwouldbesoonerorlatereliminated,asthelowerdemandforsavingswoulddrivetheinterestrate(thatis,thepriceofborrowing,ifyoulike)down,makinginvestmentsmoreattractive.Keynesarguedthatthisdoesnothappen.Asinvestmentfalls,overallspendingfalls,whichthen
reducesincome,asoneperson’sspendingisanother’sincome.Areductioninincomeinturnreducessavings,assavingsareessentiallywhatareleftafterconsumption(whichtendsnottochangemuchinresponsetoafallinincome,beingdeterminedbyoursurvivalnecessitiesandhabit).Intheend,savingswillcontracttomatchthenowlowerinvestmentdemand.Ifexcesssavingsarereducedinthisway,therewillbenodownwardpressureoninterestratesandthusnoextrastimulusforinvestment.Keynesthoughtthatinvestmentwillbehighenoughforfullemploymentonlywhenanimalspirits–‘a
spontaneousurgetoactionratherthaninaction’,ashedefinesit–ofthepotentialinvestorsarestimulatedbynewtechnologies,financialeuphoriaandotherunusualevents.Thenormalstateofaffairs,inhisview,wouldbethatinvestmentisequatedtosavingsatalevelofeffectivedemand(thedemandthatisactuallybackedupbypurchasingpower)thatisinsufficienttosupportfullemployment.Inordertoachievefull
employment,Keynesargued,thegovernmentthereforehastouseitsspendingactivelytopropupthelevelofdemand.18
Moneygetsarealjobineconomics:theKeynesiantheoryoffinance
TheprevalenceofuncertaintyinKeynesianeconomicsmeansthatmoneyisnotsimplyanaccountingunitormerelyaconvenientmediumofexchange,astheClassical(andtheNeoclassical)schoolthought.Itisameanstoprovideliquidity(orthemeanstoquicklychangeone’sfinancialposition)inanuncertainworld.Giventhis,thefinancialmarketisnotjustameanstoprovidemoneytoinvestbutalsoaplacetomake
moneybytakingadvantageofthedifferencesamongpeople’sviewsaboutreturnsonthesameinvestmentprojects–inotherwords,aplaceforspeculation.Inthismarket,thebuyingandsellingofanassetisdrivennotmainlybytheultimatereturnthatitwilldeliverbutbyexpectationsaboutthefuture–and,moreimportantly,theexpectationsaboutwhatotherpeopleexpect,or,asKeynesputit,the‘averageopinionabouttheaverageopinion’.This,accordingtoKeynes,providesthebasisfortheherdbehaviourthatisoftenwitnessedinfinancialmarkets,makingitinherentlypronetoboutsoffinancialspeculation,boomandultimatelybust.19
ItisuponthisanalysisthatKeynesfamouslywarnedagainstthedangerthatthespeculation-drivenfinancialsystemcanpose:‘Speculatorsmaydonoharmasbubblesonasteadystreamofenterprise.Butthepositionisseriouswhenenterprisebecomesthebubbleonawhirlpoolofspeculation.Whenthecapitaldevelopmentofacountrybecomesaby-productoftheactivitiesofacasino,thejobislikelytobeill-done.’Heshouldknow–hewasaverysuccessfulfinancialspeculatorhimself,amassingafortuneofover£10million(or$15million)intoday’smoney,evenafterverygenerousdonationstocharitablecauses.20
Aneconomictheoryfitforthetwentiethcentury–andbeyond?
TheKeynesianschoolbuiltaneconomictheorythatwasmorefitfortheadvancedcapitalisteconomyinthetwentiethcenturythanthatoftheClassicalorNeoclassicalschools.Keynesianmacroeconomictheoryisbuiltontherecognitionthatthestructuralseparationofsaversand
investorsthatemergedfromthelatenineteenthcenturyhasmadetheequalizationofsavingsandinvestment,andthustheachievementoffullemployment,moredifficult.Moreover,theKeynesianschoolrightlyhighlightsthekeyrolethatfinanceplaysinmoderncapitalism.
TheClassicalschooldidnotpaytoomuchattentiontofinance,asitwasdevelopedatatimewhenthefinancialmarketwasprimitive.TheNeoclassicaltheorywasdevelopedinaworldwhichwasalreadyquitesimilartotheoneKeyneswaslivingin,but,givenitsfailuretoacknowledgeuncertainty,moneyisnotessentialinit.Incontrast,financeplaysakeyroleinKeynesiantheories,whichiswhyithasbeensousefulinhelpingusunderstandepisodesliketheGreatDepressionof1929andthe2008globalfinancialcrisis.
‘Inthelongrunwearealldead’:shortcomingsoftheKeynesianschool
TheKeynesianschoolcanbecriticizedforpayingtoomuchattentiontoshort-termissues–assummarizedinthefamousquipbyKeynesthat‘inthelongrunwearealldead’.Keyneswasabsolutelyrightinemphasizingthatwecannotruneconomicpoliciesonthehopethatin
thelongrunthe‘fundamental’forces,suchastechnologyanddemography,willsomehowsorteverything
out,astheClassicaleconomistsusedtoargue.Nevertheless,itsfocusonshort-runmacroeconomicvariableshasmadetheKeynesianschoolratherweakonlong-termissues,suchastechnologicalprogressandinstitutionalchanges.21
TheInstitutionalistSchool–OldandNew?
One-sentencesummary:Individualsareproductsoftheirsociety,eventhoughtheymaychangeitsrules.
Fromthelatenineteenthcentury,agroupofAmericaneconomistschallengedthethendominantClassicalandNeoclassicalschoolsforunderplaying,orevenignoring,thesocialnatureofindividuals–thatis,thefactthattheyareproductsoftheirsocieties.Theyarguedthatweneedtoanalysetheinstitutions,orsocialrules,thataffect,andevenshape,individuals.ThisgroupofeconomistsareknownastheInstitutionalistschool–ortheOldInstitutionalEconomics(OIE),inrecognitionoftheemergenceoftheso-calledNewInstitutionalEconomics(NIE)sincethe1980s.
Individualsareshapedbysociety:theriseoftheInstitutionalistschool
TheemergenceoftheInstitutionalistschoolcanbetracedbacktoThorsteinVeblen(1857–1929),whomadehisnameforquestioningthenotionoftherational,self-seekingindividual.Hearguedthathumanshavelayersofmotivationsbehindtheirbehaviours–instinct,habit,beliefand,onlyfinally,reason.Veblenalsoemphasizedthathumanrationalitycannotbedefinedasatimelessthingbutisshapedbythesocialenvironment,madeupofinstitutions–formalrules(e.g.,laws,internalrulesofcompanies)andinformalrules(e.g.,socialcustoms,conventionsinbusinessdealings)–thatsurroundtheparticularindividualsthatweareobserving.Institutions,Veblenbelieved,didnotjustaffectthewayinwhichpeoplebehavedbutactuallychangedthem,andtheyinturnchangedthoseinstitutions.22
TakinginspirationfromVeblen’semphasisoninstitutions,butalsodrawing,overtlyandcovertly,fromMarxismandtheGermanHistoricalschool,anewgenerationofAmericaneconomistsemergedintheearlytwentiethcenturytoestablishadistinctiveeconomicschool.TheschoolwasofficiallyproclaimedastheInstitutionalistschoolin1918withVeblen’sblessing,undertheleadershipofWesleyMitchell(1874–1948),Veblen’sstudentandthethenleaderofthegroup.*Theschool’sshiningmomentwastheNewDeal,inwhosedesignandadministrationmanyofits
membersparticipated.ThesedaystheNewDealiscommonlythoughtofasaKeynesianpolicyprogramme.But,whenyouthinkaboutit,TheGeneralTheoryofEmployment,Interest,andMoney,Keynes’smagnumopus,didnotcomeoutuntil1936,whichisoneyearafterthesecondNewDealof1935(thefirstwasin1933).TheNewDealwasmuchmoreaboutinstitutions–financialregulation,socialsecurity,tradeunionsandutilitiesregulation–ratherthanaboutmacroeconomicpolicy,asIdiscussedinChapter3.Institutionaleconomists,suchasArthurBurns(chairmanoftheCouncilofEconomicAdvisorstotheUSPresident,1953–6;thenchairmanoftheFederalReserveBoard,1970–78),playedimportantpartsinthemakingofUSeconomicpolicyevenaftertheSecondWorldWar.
Individualsarenotfullydeterminedbysociety:thedeclineoftheInstitutionalistschool
Afterthe1960s,theInstitutionalistschoolwentintodecline.PartofthiswasduetotheriseofNeoclassicaleconomicsintheUSinthe1950s.TheNeoclassicalschool’srathernarrowviewofwhat
economicsshouldbe–withitsemphasisonindividual-basedtheory,‘universal’assumptionsandabstractmodelling–madeitregardtheInstitutionalschoolasnotjustdifferentbutintellectuallyinferior.ButthedeclinewasalsobecauseoftheweaknessesoftheInstitutionalschoolitself.Theschoolfailed
tofullytheorizethediversemechanismsthroughwhichinstitutionsthemselvesemerge,persistandchange.Theyonlysawinstitutionsasoutcomesofformalcollectivedecisions(e.g.,legislation)orasproductsofhistory(e.g.,culturalnorms).However,institutionsmaycomeintobeinginotherways:asaspontaneousorderemergingoutofinteractionsofrationalindividuals(theAustrianschoolandtheNewInstitutionalistEconomics);throughattemptsbyindividualsandorganizationstodevelopcognitivedevicesthatwillallowthemtocopewithcomplexity(theBehaviouralistschool);orasaresultofanattempttomaintainexistingpowerrelationships(theMarxistschool).Anotherbigproblemwasthatsomemembersoftheschoolwentoverboardinemphasizingthesocial
natureofindividualsandeffectivelyadoptedastructuraldeterminism.Socialinstitutionsandthestructuretheycreatewereeverything;individualswereseenasbeingtotallydeterminedbythesocietytheylivein–‘thereisnosuchthingasanindividual’,infamouslydeclaredClarenceAyres,whodominatedthe(declining)InstitutionalistschoolintheUSintheearlypost-SecondWorldWarperiod.
Transactioncostsandinstitutions:theriseoftheNewInstitutionalEconomics
Fromthe1980s,agroupofeconomistswithNeoclassicalandAustrianleanings–ledbyDouglassNorth,RonaldCoaseandOliverWilliamson–startedanewschoolofinstitutionaleconomics,knownastheNewInstitutionalEconomics(NIE).23
Bycallingthemselvesinstitutionaleconomists,theNewInstitutionalisteconomistsmadeitclearthattheywerenottypicalNeoclassicaleconomists,wholookedatonlyindividualsbutnottheinstitutionsthataffecttheirbehaviour.However,byemphasizingtheadjectivenew,thisgroupclearlydissociateditselffromtheoriginalInstitutionalistschool–nowcalledtheOldInstitutionalEconomics(OIE).ThemainpointofdeparturefromtheOIEwasthattheNIEanalysedhowinstitutionsemergeoutofdeliberatechoicesbyindividuals.24
ThekeyconceptintheNIEisthatoftransactioncost.InNeoclassicaleconomics,theonlycostisthecostofproduction(costsofmaterial,wages,etc.).However,theNIEemphasizesthattherearealsocostsoforganizingoureconomicactivities.Somedefinetransactioncostrathernarrowlyasthecostinvolvedinmarketexchangeitself–findingoutaboutalternativeproducts(‘shoppingaround’),spendingtimeandmoneyactuallydoingtheshoppingandsometimesbargainingforbetterprices.Othersdefineitmorebroadlyasthe‘costofrunningtheeconomicsystem’,whichincludesthecostofconductingmarketexchangebutalsothecostinvolvedinenforcingthecontractaftertheexchangeisover.So,inthisbroaderdefinition,transactioncostincludesthecostofpolicingagainstthefts,runningthecourtsystemandevenmonitoringworkersinfactoriessothattheyputinthemaximumpossibleamountoflabourservicespecifiedintheircontract.
Institutionsarenotjustconstraints:contributionsandlimitationsoftheNewInstitutionalEconomics
Deployingtheconceptoftransactioncost,theNIEhasdevelopedawiderangeofinterestingtheoriesandcasestudies.Oneprominentexampleisthequestionastowhy,inasupposedly‘market’economy,somanyeconomicactivitiesareconductedwithinfirms.The(simplified)answeristhatmarkettransactionsareoftenverycostlyduetothehighcostofinformationandcontractenforcement.Insuchcases,itwouldbemuchmoreefficientifthingsweredonethroughhierarchicalcommandswithinthefirm.Another
exampleistheanalysisoftheimpactsoftheexactnatureofpropertyrights(therulesonwhatownerscandowithwhichkindsofproperty)onpatternsofinvestments,choiceofproductiontechnologies,andothereconomicdecisions.Despitetheseveryimportantcontributions,theNIEhasacriticallimitasan‘institutionalist’theory.It
seesinstitutionsbasicallyasconstraints–onunfetteredself-seekingbehaviour.Butinstitutionsarenotjust‘constraining’butcanalsobe‘enabling’.Ofteninstitutionslimitourindividualfreedomexactlyinordertoenableustodomorecollectively–trafficrules,forexample.MostmembersoftheNIEwouldnotdenytheenablingroleofinstitutions,butbynottalkingaboutitexplicitlyandcontinuallyreferringtoinstitutionsasconstraints,theyconveyanegativeimpressionofinstitutions.Moreimportantly,theNIEfailstoseethe‘constitutive’roleofinstitutions.Institutionsshapethemotivesofindividualsanddonotmerelyconstraintheirbehaviour.Missingoutonthiscriticaldimensionofwhatinstitutionsdo,theNIEfallsshortofbeingafull-blowninstitutionaleconomics.
TheBehaviouralistSchool
One-sentencesummary:Wearenotsmartenough,soweneedtodeliberatelyconstrainourownfreedomofchoicethroughrules.TheBehaviouralistschoolissocalledbecauseittriestomodelhumanbehavioursastheyactuallyare,rejectingthedominantNeoclassicalassumptionthathumanbeingsalwaysbehaveinarationalandselfishway.Theschoolextendsthisapproachtothestudyofeconomicinstitutionsandorganizations–forexample,howbesttoorganizeafirmorhowtodesignfinancialregulation.Theschoolthushasafundamentalaffinity,andsomeoverlapinmembership,withtheInstitutionalistschool.TheBehaviouralistschoolistheyoungestoftheschoolsofeconomicsthatwehavesofarexamined,
butitisolderthanmostpeoplethink.Theschoolhasrecentlycometoprominencethroughthefieldsofbehaviouralfinanceandexperimentaleconomics.Butithasitsoriginsinthe1940sandthe1950s,especiallyintheworksofHerbertSimon(1916–2001),the1978Nobeleconomicslaureate.*
Limitstohumanrationalityandtheneedforindividualandsocialrules
Simon’scentralconceptisboundedrationality.HecriticizestheNeoclassicalschoolforassumingthatpeoplepossessunlimitedcapabilitiestoprocessinformation,orGod-likerationality(hecallsit‘Olympianrationality’).Simondidnotarguethathumanbeingsareirrational.Hisviewwasthatwetrytoberationalbutthat
ourabilitytobesoisverylimited,especiallygiventhecomplexityoftheworld–orgiventheprevalenceofuncertainty,ifyouwanttoformulateitintheKeynesianway.Thismeansthatoftenthemainconstraintonourdecision-makingisnotthelackofinformationbutourlimitedcapabilitytoprocesstheinformationwehave.Givenourboundedrationality,Simonargued,wedevelopmental‘shortcuts’thatallowusto
economizeonourmentalcapabilities.Theseareknownasheuristics(orintuitivethinking)andcantakedifferentforms:ruleofthumb,commonsenseorexpertjudgement.Underlyingallthesementaldevicesistheabilitytorecognizepatterns,whichallowsustoabandonalargerangeofalternativesandfocusonasmall,manageablebutmostpromisingrangeofpossibilities.Simonoftenusedthechessmastersasanexampleofsomeoneusingsuchamentalapproach–theirsecretlayintheirabilitiestorapidlyeliminate
lesspromisingsearchpathsandconvergeonasequenceofmovesthatarelikelytoyieldthebestoutcomes.Focusingonasubsetofpossibilitiesmeansthattheresultingchoicemaynotbeoptimal,butthis
approachenablesustohandlethecomplexityandtheuncertaintyoftheworldwithourboundedrationality.Therefore,Simonargues,whentheymaketheirchoices,humanbeingssatisfice,thatis,welookfor‘goodenough’solutionsratherthanthebestones,asintheNeoclassicaltheory.25
Marketeconomyvs.organizationeconomy
Eventhoughitstartswiththestudyofindividualdecision-making,theinterestoftheBehaviouralistschoolstretchesmuchfurther.Accordingtotheschool,itisn’tjustattheindividuallevelthatwebuildsimplifyingdecisionrulesthathelpusoperateinacomplexworldwithourboundedrationality.Webuildorganizationroutinesaswellassocialinstitutionssothatwecancompensateforour
boundedrationality.Likeheuristicsattheindividuallevel,theseorganizationalandsocialrulesrestrictourfreedomofchoicebuthelpusmakebetterchoicesbecausetheyalsoreducethecomplexityoftheproblem.Particularlyemphasizedisthefactthattheserulesmakeiteasierforustopredictthebehaviourofotherrelatedactors,whowouldfollowthoserulesandbehaveinparticularways.ThisisapointthattheAustrianschoolalsoemphasizesusingslightlydifferentlanguage,whentheytalkabouttheimportanceof‘tradition’asthebasisforreason.AdoptingtheBehaviouralistperspective,webegintoseeoureconomyinawaythatisverydifferent
fromthedominantNeoclassicalone.TheNeoclassicaleconomistsusuallydescribethemoderncapitalisteconomyasthe‘marketeconomy’.TheBehaviouralistsemphasizethatthemarketactuallyaccountsforonlyarathersmallpartofit.HerbertSimon,writinginthemid-1990s,reckonedthatsomethinglike80percentofeconomicactivitiesintheUShappeninsideorganizations,suchasthefirmandthegovernment,ratherthanthroughthemarket.26Hearguedthatitwouldbemoreappropriatetocallittheorganizationeconomy.
Whyemotion,loyaltyandfairnessmatter
TheBehaviouralistschoolalsoprovidespersuasivereasonsastowhyhumanqualitieslikeemotion,loyaltyandfairnessmatter–thingsthatmosteconomists,especiallytheNeoclassicalsandtheMarxists,woulddismissasatbestirrelevantandatworstasdistractingpeoplefromrationaldecisions.Thetheoryofboundedrationalityexplainswhyouremotionisnotnecessarilythestumblingblockto
rationaldecision-makingbutmaybeoftenausefulpartofour(bounded)rationaldecision-makingprocess.AccordingtoSimon,givenourboundedrationality,weneedtofocusourlimitedmentalresourcesonsolvingthemostimportantproblemathand.Emotionprovidessuchfocus.TheBehaviouralistsarguethatorganizationalloyaltyoftheirmembersisessentialfororganizationstooperatewell,asanorganizationfullofdisloyalmemberswouldbeoverwhelmedbythecostsofmonitoringandpunishingtheirselfishbehaviours.Theissueoffairnessisveryimportantinthisregard,asthemembersofanorganizationorasocietywillnotdeveloployaltytoit,iftheythinktheyarebeingtreatedunfairly.
Toofocusedonindividuals?:assessingtheBehaviouralistschool
TheBehaviouralistschool,despitebeingtheyoungestschoolofeconomics,hashelpedusradicallyrethinkourtheoriesabouthumanrationalityandmotivations.Thankstoit,wehaveamuchmoresophisticatedunderstandingofhowpeoplethinkandbehave.
TheBehaviouralistschool’sattempttounderstandhumansocietyfromindividualsup–actuallyfromaplace‘lower’thanthat,thatis,fromourthinkingprocessup–isbothitsstrengthanditsweakness.Focusingtoomuchatthis‘micro’level,theschooloftenlosessightofthebiggereconomicsystem.Thisdoesnothavetobe;afterall,Simonwrotealotabouttheeconomicsystem.Butmostmembersoftheschoolhavefocusedtoomuchonindividuals–especiallythoseeconomistswhoareengagedinexperimentaleconomics(tryingtoestablishwhetherpeoplearerationalandselfishthroughcontrolledexperiments)orneuroeconomics(tryingtoestablishlinksbetweenbrainactivitiesandparticulartypesofbehaviour).Italsoneedstobeaddedthat,givenitsfocusonhumancognitionandpsychology,theBehaviouralistschoolhasfewthingstosayaboutissuesoftechnologyandmacroeconomics.
ConcludingRemarks:HowtoMakeEconomicsBetterPreservingintellectualdiversityandencouragingcross-fertilizationofideas
Recognizingthattherearedifferentapproachestoeconomicsisnotenough.Thisdiversityneedstobepreserved,orevenpromoted.Giventhatdifferentapproachesemphasizedifferentaspectsandofferdifferentperspectives,knowingarangeofschools,andnotjustoneortwoofthem,allowsustohaveafuller,morebalancedunderstandingofthecomplexentitycalledtheeconomy.Especiallyinthelongerrun,inthesamewayinwhichabiologicalgroupwithamorediversegenepoolismoreresilienttoshocks,adisciplinethatcontainsavarietyoftheoreticalapproachescancopewithachangingworldbetterthanonecharacterizedbyintellectualmono-croppingcan.Weareactuallylivingthroughaproofofthis–theworldeconomywouldhaveexperiencedacollapsesimilartothe1929GreatDepression,hadthekeygovernmentsnotdecidedtoditchtheirfree-marketeconomicsandadoptKeynesianpoliciesintheearlydaysofthe2008globalfinancialcrisis.Iwouldgoonestepfurtherandarguethatpreservingdiversityisnotenough.Weshouldn’tjustleta
hundredflowersbloom.Weneedtohavethemcross-fertilized.Differentapproachestoeconomicscanactuallybenefitalotfromlearningfromeachother,makingourunderstandingoftheeconomicworldricher.Someschoolswithobviousintellectualaffinitieshavealreadybeencross-fertilizing.The
DevelopmentalisttraditionandtheSchumpeterianschoolhaveinteractedtothebenefitofboth,theformerprovidingtheoriestounderstandthebiggercontextinwhichtechnologicaldevelopmentoccursandthelatterprovidingmoredetailedtheoriesofhowtechnologicalinnovationhappens.TheMarxist,theInstitutionalistandtheBehaviouralistschoolshavelonginteractedwitheachother,ofteninhostilemanners,inrelationtotheunderstandingoftheinternalworkingsofthefirmandespeciallythecapitalist–workerrelationshipinit.ThecommonemphasisonpsychologicalfactorsbytheKeynesianandtheBehaviouralistschoolshasalwaysexistedbuthasrecentlyproducedparticularlynotablecross-fertilizationofideasinthenewfieldof‘behaviouralfinance’.However,cross-fertilizationcanhappenbetweenschoolsthatmostpeoplethinkareincompatiblewith
eachother.Eveniftheyarespreadacrossthepoliticalspectrum,theClassicals(right),theKeynesians(centre)andtheMarxists(left)allshareaclass-basedvisionofthesociety.TheAustriansandtheKeynesiansmayhavelockedhornssincethe1930s,buttheysharewitheachother(aswellaswiththeBehaviouralistsandtheInstitutionalists)theviewthattheworldisaverycomplexanduncertainplaceandthatourrationalitytodealwithitisseverelylimited.TheAustrians,theInstitutionalistsandthe
Behaviouralistsallshareaviewofhumanbeingsaslayeredentities,madeupof–ifweusetheInstitutionalistformulation–instinct,habit,beliefandreason,eventhoughsomeAustriansmaythinkthattheothersareobjectionableleft-wingers.
Howallofus,notjustprofessionaleconomists,canplayaroleinmakingeconomicsbetter
Eventhosereaderswhohavebeenpersuadedbymyargumentforintellectualdiversityandcross-fertilizationineconomicsmaystillask,‘Whatdoesthathavetodowithme?’Afterall,onlyaverysmallnumberofreaderswilleverhaveachancetopreserveorincreasethediversityofeconomicsasprofessionaleconomists.Thefactis,weallneedtoknowsomethingaboutdiverseapproachestoeconomicsifwearenotto
becomepassivevictimsofsomeoneelse’sdecision.Behindeveryeconomicpolicyandcorporateactionthataffectsourlives–theminimumwage,outsourcing,socialsecurity,foodsafety,pensionsandwhatnot–liessomeeconomictheorythateitherhasinspiredthoseactionsor,morefrequently,isprovidingjustificationofwhatthoseinpowerwanttodoanyway.Onlywhenweknowthattherearedifferenteconomictheorieswillwebeabletotellthoseinpower
thattheyarewrongtotellusthat‘thereisnoalternative’(TINA),asMargaretThatcheronceinfamouslyputitindefenceofhercontroversialpolicies.Whenwelearnhowmuchintellectualcommongroundthereisbetweensupposed‘enemyfactions’ineconomics,wecanmoreeffectivelyresistthosewhotrytopolarizethedebatebyportrayingeverythinginblackandwhite.Oncewelearnthatdifferenteconomictheoriessaydifferentthingspartlybecausetheyarebasedondifferentethicalandpoliticalvalues,wewillhavetheconfidencetodiscusseconomicsforwhatitreallyis–apoliticalargument–andnota‘science’inwhichthereisclearrightandwrong.Andonlywhenthegeneralpublicdisplaysawarenessoftheseissueswillprofessionaleconomistsfinditimpossibletobrowbeatthembydeclaringthemselvestobecustodiansofscientifictruths.Knowingdifferenttypesofeconomicsandknowingtheirrespectivestrengthsandweaknesses,thus
seen,isnotanesotericexercisereservedonlyforprofessionaleconomists.Itisavitalpartoflearningabouteconomicsandalsoacontributiontoourcollectiveefforttomakethesubjectbetterservehumanity.
FurtherReadingG.ARGYROUSANDF.STILLWELL
ReadingsinPoliticalEconomy(Annandale,NSW:PlutoPress,2003).
P.DEANE
TheStateandtheEconomicSystem:AnIntroductiontotheHistoryofPoliticalEconomy(Oxford:OxfordUniversityPress,1989).
J.K.GALBRAITH
AHistoryofEconomics:ThePastasthePresent(London:Penguin,1989).
R.HEILBRONER
TheWorldlyPhilosophers:TheLives,Times,andIdeasoftheGreatEconomicThinkers(Harmondsworth:Penguin,1983).
G.HODGSON
HowEconomicsForgotHistory:TheProblemofHistoricalSpecificityinSocialScience(London:Routledge,2001).
E.REINERT
HowRichCountriesBecameRich,andWhyPoorCountriesStayPoor(London:Constable,2007).
A.RONCAGLIA
TheWealthofIdeas:AHistoryofEconomicThought(Cambridge:CambridgeUniversityPress,2005).
Appendix:ComparingDifferentSchoolsofEconomics
‘Thereisnosuchthingassociety.Thereareindividualmenandwomen,andtherearefamilies.’MARGARETTHATCHER
‘Thecorporationsdon’thavetolobbythegovernmentanymore.Theyarethegovernment.’JIMHIGHTOWER
IndividualsasHeroesandHeroinesTheindividualistvisionoftheeconomy
ThedominantNeoclassicalviewisthateconomicsisthe‘scienceofchoice’,aswesawinChapter1.Accordingtothisposition,choicesaremadebyindividuals,whoareassumedtobeselfish,onlyinterestedinmaximizingtheirownwelfare–oratmostthatoftheirfamilymembers.Indoingso,allindividualsareseentomakerationalchoices,namely,theychoosethemostcost-efficientwaytoachieveagivengoal.Asaconsumer,eachindividualhasaself-generatedpreferencesystemthatspecifieswhatshelikes.
Usingthepreferencesystemandlookingatmarketpricesofdifferentthings,shechoosesacombinationofgoodsandservicesthatmaximizeherutility.Whenaggregatedthroughthemarketmechanism,thechoicesmadebyindividualconsumerstelltheproducerswhatthedemandsarefortheirproductsatdifferentprices(thedemandcurve).Thequantitythattheproducersarewillingtosupplyateachprice(thesupplycurve)isdeterminedbytheirownrationalchoices,madewithaviewtomaximizingtheirprofits.Inmakingthesechoices,producersconsidercostsofproduction,givenbytechnologiesspecifyingdifferentpossiblecombinationsofinputs,andthepricesofthoseinputs.Themarketequilibriumisattainedwherethedemandcurveandthesupplycurvemeet.Thisisastoryoftheeconomywithindividualsastheheroesandtheheroines.Sometimesthe
consumersmaybecalled‘households’andtheproducers‘firms’,buttheyareessentiallyextensionsofindividuals.Theyareseenasmakingchoicesassingle,coherentunits.SomeNeoclassicaleconomists,followingthepioneeringworkbyGaryBecker,talkof‘intra-householdbargaining’,butthisisconceptualizedasaprocessbetweenrationalindividualsultimatelyseekingtomaximizetheirpersonalutilities,ratherthanthatbetweenreal-lifefamilymembers,withtheirlove,loathing,empathy,crueltyandcommitments.
Theappealoftheindividualistvisionoftheeconomyanditslimits
Eventhoughthisindividualistvisionisnottheonlywaytotheorizeoureconomy(seeChapter4),ithasbecomethedominantonesincethe1980s.Onereasonisthatithaspowerfulpoliticalandmoralappeals.Itis,aboveall,aparableofindividualfreedom.Individualscangetwhattheywant,solongastheyare
willingtopaytherightpriceforit,whetherthoseare‘ethical’products(likeorganicfoodorfairtradecoffee)ortoysthatchildrenwillforgetbythefollowingChristmas(IrecalltheCabbagePatchKidsfeverof1983andtheFurbycrazeof1998).Individualscanproducewhateverwillmakemoneyforthem,usinganymethodofproductionthatmaximizesprofit,whetherfootballsmadebychildworkersormicrochipsmadewithhi-techmachinery.Thereisnohigherauthority–king,popeortheplanningminister–totell
individualswhattheyshouldwantandproduce.Onthisbasis,manyfree-marketeconomistshavearguedthatthereisaninseparablelinkbetweenthefreedomofindividualconsumerstochooseandtheirbroaderpoliticalfreedom.FriedrichvonHayek’sseminalcritiqueofsocialism,TheRoadtoSerfdom,andMiltonFriedman’spassionateadvocacyofthefree-marketsystem,FreetoChoose,arefamousexamples.Moreover,theindividualistviewprovidesaparadoxicalbutverypowerfulmoraljustificationofthe
marketmechanism.Weasindividualsallmakechoicesonlyforourselves,thestorygoes,buttheresultisthemaximizationofsocialwelfare.Wedon’tneedindividualstobe‘good’torunanefficienteconomythatbenefitsallitsparticipants.Or,rather,itisexactlybecauseindividualsarenot‘good’andbehaveasruthlessmaximizersofutilityandofprofitthatoureconomyisefficient,benefitingeveryone.AdamSmith’sfamouspassageistheclassicstatementofthisposition:‘Itisnotfromthebenevolenceofthebutcher,thebrewer,orthebakerthatweexpectourdinner,butfromtheirregardtotheirowninterest.’Appealingthoughtheymayappear,thesejustificationshaveseriousproblems.Asforthepoliticalone,
thereisnoclearrelationshipbetweenacountry’seconomicfreedomanditspoliticalfreedom.Alotofdictatorshipshavehadveryfree-marketpolicies,whilealotofdemocracies,suchastheScandinaviancountries,haveloweconomicfreedomduetohightaxesandplentyofregulations.Infact,manybelieversintheindividualistviewwouldrathersacrificepoliticalfreedomtodefendeconomicfreedom(thiswaswhyHayekpraisedthePinochetdictatorshipinChile).Inthecaseofthemoraljustification,Ihavealreadydiscussedmanytheories,includingthemarketfailureapproachbasedontheindividualistNeoclassicalvision,showingthatunrestrainedpursuitofself-intereststhroughmarketsoftenfailstoproducesociallydesirableeconomicoutcomes.Giventhattheselimitationswerewellknownevenbeforeitsascendancy,thecurrentdominanceofthe
individualistvisionhastobeatleastpartlyexplainedbythepoliticsofideas.Theindividualistviewgetssomuchmoresupportandapprovaloveralternativevisions(especiallytheclass-basedonesliketheMarxistortheKeynesianones)fromthosewhohavepowerandmoneyandthereforemoreinfluence.Itgetssuchsupportbecauseittakestheunderlyingsocialstructure,suchaspropertyownershiporworkerrights,asgiven,notquestioningthestatusquo.*
OrganizationsastheRealHeroes:TheRealityofEconomicDecision-making
Someeconomists,mostnotablyHerbertSimonandJohnKennethGalbraith,havelookedatthereality,ratherthantheideal,ofeconomicdecision-making.Theyfoundtheindividualisticvisiontohavebeenobsoleteatleastsincethelatenineteenthcentury.Sincethen,mostimportanteconomicactionsinoureconomieshavebeenundertakennotbyindividualsbutbylargeorganizationswithcomplexinternaldecision-makingstructures–corporations,governments,tradeunionsandincreasinglyeveninternationalorganizations.
Corporations,notindividuals,arethemostimportanteconomicdecision-makers
Themostimportantproducerstodayarelargecorporations,employinghundredsofthousands,orevenmillions,ofworkersindozensofcountries.The200largestcorporationsbetweenthemselvesproducearound10percentoftheworld’soutput.Itisestimatedthat30–50percentofinternationaltradeinmanufacturedgoodsisactuallyintra-firmtrade,ortransferofinputsandoutputswithinthesamemultinationalcorporation(MNC)ortransnationalcorporation(TNC),withoperationsinmultiple
countries.1TheToyotaenginefactoryinChonburi,Thailand,‘selling’itsoutputstoToyotaassemblyfactoriesinJapanorPakistanmaybecountedasThailand’sexporttothelattercountries,butthesearenotgenuinemarkettransactions.ThepricesoftheproductsthustradedaredictatedbytheheadquartersinJapan,notbycompetitiveforcesofthemarket.
Corporatedecisionsarenotmadelikeindividualdecisions
Legallyspeaking,wemaybeabletotracethedecisionsmadebytheselargecorporationstoparticularindividuals,suchastheCEO(chiefexecutiveofficer)orthechairmanoftheboardofdirectors.Butthoseindividuals,howeverpowerfultheymaybe,donotmakedecisionsfortheircompaniesinthewayinwhichindividualsmakedecisionsforthemselves.Howarecorporatedecisionsmade?Attherootofcorporatedecisionslieshareholders.Typicallywesaythatshareholders‘own’
corporations.Eventhoughitwoulddoasashorthanddescription,itis,strictlyspeaking,nottrue.Shareholdersownshares(orstocks),whichgivethemcertainrightsconcerningthemanagementofthecompany.TheydonotownthecompanyinthesensethatIownmycomputerormychopsticks.ThispointwouldbecomeclearerifIexplainedthatthereareactuallytwotypesofshares–‘preferred’and‘ordinary’(or‘common’).Preferredsharesgivetheirholderspriorityinthepaymentofdividends,namely,profitsdistributedto
shareholders,ratherthan‘retained’bythecorporation.Butthatpriorityisboughtatthecostoftherighttovoteforkeydecisionsconcerningthecompany–suchaswhotoappointasthetopmanagers,howmuchtopaythemandwhethertomergewith,takeoverorbetakenoverbyanothercompany.Thesharesthatcomewiththerighttovoteonthosethingsarecalledordinaryshares.The‘ordinary’shareholders(whoareanythingbutordinaryintermsofdecision-makingpower)makecollectivedecisionsthroughvotes.Thesevotesareusuallyaccordingtotheone-share-one-voterule,butinsomecountriessomeshareshavemorevotesthanothers;inSweden,somesharescouldhaveupto1,000voteseach.
Whoaretheshareholders?
Thesedays,fewverylargecompaniesaremajority-ownedbyasingleshareholder,likethecapitalistsofold.ThePorsche-Piechfamily,whichownsjustover50percentofthePorsche-Volkswagengroup,isanotableexception.Therearestillaconsiderablenumberofgiantcompaniesthathaveadominantshareholder,whoowns
sufficientsharesthathe/she/itcanusuallydeterminethecompany’sfuture.Suchashareholderisdescribedasowningacontrollingstake,usuallydefinedasanythingupwardsof20percentofthevotingshares.MarkZuckerberg,whoowns28percentofFacebook,isadominantshareholder.TheWallenberg
familyofSwedenisthedominantshareholderinSaab(40percent),Electrolux(30percent)andEricsson(20percent).Mostlargecompaniesdon’thaveonecontrollingshareholder.Their(share)ownershipissodispersed
thatnosingleshareholderhaseffectivecontrol.Forexample,asofMarch2012,JapanTrusteeServicesBank,thebiggestshareholderofToyotaMotorCorporation,ownedonlyjustover10percentofToyota’sshares.Thenexttwobiggestshareholdersownedaround6percenteach.Evenactinginunison,thesethreetogetherdonothaveone-quarterofthevotes.
Theseparationofownershipandcontrol
Dispersedownershipmeansthatprofessionalmanagershaveeffectivecontrolovermostoftheworld’slargestcompanies,despitenotowninganysignificantstakeinthem–asituationknownastheseparationofownershipandcontrol.Thiscreatesaprincipal-agentproblem,inwhichtheagents(professionalmanagers)maypursuebusinesspracticesthatpromotetheirowninterestsratherthanthoseoftheirprincipals(shareholders).Thatis,professionalmanagersmaymaximizesalesratherthanprofitormayinflatethecorporatebureaucracy,astheirprestigeispositivelyrelatedtothesizeofthecompanytheymanage(usuallymeasuredbysales)andthesizeoftheirentourage.ThiswasthekindofpracticeGordonGekko(you’vemethiminChapter3)wasattackinginWallStreet,whenhepointedoutthecompanythathewastryingtotakeoverhadnolessthanthirty-threevicepresidents,doingGodknowswhat.Manypro-marketeconomists,especiallyMichaelJensenandEugeneFama,the2013NobelEconomics
Prizewinner,havesuggestedthatthisprincipal-agentproblemcanbereduced,ifnoteliminated,byaligningtheinterestsofthemanagersmorecloselytothoseoftheshareholders.Theysuggestedtwomainapproaches.Oneismakingcorporatetakeovereasier(somoreGordonGekkos,please),sothatmanagerswhodonotsatisfytheshareholderscanbeeasilyreplaced.Thesecondispayinglargepartsofmanagerialsalariesintheformoftheirowncompanies’stocks(stockoption),sothattheyaremadetolookatthingsmorefromtheshareholder’spointofview.Theideawassummarizedinthetermshareholdervaluemaximization,coinedin1981byJackWelch,thethennewCEOandchairmanofGeneralElectric,andhassinceruledthecorporatesectorfirstintheAnglo-Americanworldandincreasinglyintherestoftheworld.
Workersandgovernmentsalsoinfluencecorporatedecisions
ThoughitisnotcommonintheUSandBritain,workersandthegovernmentalsoexercisesignificantinfluencesoncorporatedecision-making.Inadditiontotradeunionactivities(whichwe’llexplorebelow),workersinsomeEuropeancountries,
suchasGermanyandSweden,influencewhattheircompaniesdothroughformalrepresentationoncompanyboards.InparticularinGermany,largecompanieshaveatwo-tierboardstructure.Underthissystem,knownastheco-determinationsystem,the‘managerialboard’(liketheboardofdirectorsinothercountries)hastogetthemostimportantdecisions,suchasmergerandplantclosure,approvedbythe‘supervisorboard’,inwhichworkerrepresentativeshavehalfthevotes,eventhoughthemanagerialsideappointsthechairman,whohasthecastingvote.Governmentsarealsoinvolvedinmanagerialdecisionsinlargecorporationsasshareholders.
Governmentownershipofsharesinprivate-sectorcompaniesismuchmorewidespreadthanpeoplethink.StoraEnso,theworld’slargestpaperandpulpmanufacturer,is25percentownedbytheFinnishgovernment.Commerzbank,thesecond-biggestbankinGermany,isalso25percentownedbytheGermangovernment.Thelistcangoon.Workersandgovernmentshavedifferentgoalsfromthoseofshareholdersandprofessionalmanagers.
Workerswanttominimizejoblosses,increasejobsecurityandimproveworkingconditions.Thegovernmenthastoconsidertheinterestsofgroupsthatgobeyondthelegalboundaryofthecompanyinquestion–forexample,supplierfirms,localcommunitiesorevenenvironmentalcampaigngroups.Asaresult,companieswithstrongworkerandgovernmentinvolvementinmanagementbehavedifferentlyfromcompaniesdominatedbyshareholdersandprofessionalmanagers.
Volkswagenandthecomplexityofmoderncorporatedecision-making
Volkswagen,theGermancar-maker,showcasesthecomplexityofmoderncorporatedecision-making.Ithasamajorityowner,thePorsche-Piechfamily.Legallyspeaking,thatfamilycanbulldozethroughanydecisionittakes.ButthatisnothowthingsaredoneinVolkswagen.LikeotherlargeGermancompanies,ithasthetwo-tierboardsystem,whereworkershavestrongrepresentation.Also,thecompanyis20percentownedbythegovernment–ormorepreciselythestate(Land)governmentofLower-Saxony(Niedersachsen).Asaresult,decisionsinVolkswagenarereachedthroughverycomplicatedprocessesofbargaining,involvingshareholders,professionalmanagers,workersandthepopulationingeneral(throughgovernmentownership).Volkswagenisanextremeexample,butitpowerfullyillustrateshowcorporatedecisionsaremadeina
verydifferentwayfromindividualones.Wesimplycannotunderstandthemoderneconomywithouthavingatleastsomeunderstandingofthecomplexityinvolvedincorporatedecisions.
Thecooperativeasanalternativeformofenterpriseownershipandmanagement
Somelargecompaniesarecooperativesownedbytheirusers(consumersorsavers),employeesorindependentsmallerbusinessunits.Aconsumercooperative,thesupermarketchainCoop,isthesecond-largestretailerinSwitzerland.Its
UKcounterpart,Co-op,isthecountry’sfifth-biggestsupermarketchain.Consumercooperativesallowconsumerstogetbetterpricesbypoolingtheirpurchasingpowersandnegotiatingfordiscountsfromsuppliers.Ofcourse,gettingdiscountsfromsuppliersbypoolingconsumersisexactlywhatmanyretailers,fromWalmarttoGroupon,do.Butthedifferenceisthat,otherthingsbeingequal,cooperativescanpassonmorediscountstoconsumers,astheydonothaveshareholderstopay.Thecreditunionisacooperativeofsavers.Nearly200millionpeoplearoundtheworldaremembers
ofcreditunions.Someoftheworld’sbiggestbanks,suchastheNetherlands’RabobankandFrance’sCreditAgricole,areactuallycreditunions.Bothofthemstartedassavingscooperativesoffarmers.Therearetwotypesofproducercooperatives:workercooperatives,ownedbytheirownemployees,
andproducercooperatives,ownedbyindependentproducersthatagreetodocertainthingstogetherbypoolingtheirresources.MondragonCo-operativeCorporation(MCC)ofSpainhasnearly70,000employee-partnersworking
inover100cooperativesandannualsalesrevenueofaround$19billion(asof2010).2Itistheseventh-biggestcompanyinSpain,bothbysalesandemployment.Itisalsothelargestcooperativeintheworld.AnotherfamousworkercooperativeisJohnLewisPartnershipofBritain,theownerofJohnLewisdepartmentstoresandWaitrosesupermarkets(theUK’ssixth-biggestsupermarketchain).ItisofsimilarsizetothatofMondragon–over80,000partnersandaturnoverofaround$14billion(asof2011).Themostcommonexamplesofcooperativesofindependentproducersselectivelyworkingtogetherare
dairyfarmers’cooperatives,inwhichfarmersowntheircowsbuttogetherprocessandsellthemilkandmilkproducts(butter,cheese,etc.).Arla(theSwedish-DanishdairycooperativethatproducesLurpakbutterandLactofreemilk),LandO’Lake(theMinnesota-basedAmericandairyfarmercooperative)andAmul(thecooperativeofIndiandairyfarmers)arethemostfamousexamples.
One-person-one-vote:rulesofcooperativedecision-making
Beingmembershiporganizations,cooperativesmakedecisionsbasedontheone-person-one-voterule,ratherthanontheone-dollar(share)-one-voteruleofcorporations.Thisresultsindecisionsthatareimpossibletoimagineinshareholder-ownedcorporations.
TheMondragoncooperativegroupisfamousforhavingthewageruleinwhichthepartnerinchargeofthetopmanagementpositioncanbepaidonlythreetoninetimestheminimumwagepaidtoapartnerwhodoesafront-linejob,withtheexactratiobeingdecidedbyvotesamongthepartnersofeachcooperative.ComparethiswiththepaypackagesoftopAmericanmanagers,whogetatleast300–400timestheaverage(notminimum)worker’swage.*Somecooperativesevenrotatejobs,sothateveryonehasexperiencesinpositionsatdifferentlevelsinthecompany.
Manyworkersdonotmakedecisionsasindividualsanymore
Inmoderneconomies,atleastsomeworkersdonotmakeeconomicdecisionsasindividualsanymore.Manyworkersareorganizedintotradeunions,orlabourunions.Allowingworkerstobargainasagroup,ratherthanasindividualswhomaycompeteagainsteachother,tradeunionshelpworkersextracthigherwagesandbetterworkingconditionsfromtheiremployers.3
Insomecountries,tradeunionsareconsideredcounter-productive,blockingthenecessarychangesintechnologiesandworkorganization.Inothers,theyareseenasnaturalpartnersinanybusiness.WhenVolvo,theSwedishvehiclemanufacturer,boughttheheavyconstructionequipmentarmofSamsungintheaftermathofthe1997Asianfinancialcrisis,itissaidtohaveaskedtheworkerstosetupatradeunion(Samsunghad–andstillhas–aninfamous‘no-union’policy).TheSwedishmanagersdidn’tknowhowtomanageacompanywithoutatradeuniontotalkto!Likecooperatives,tradeunionsaremembershiporganizations,inwhichdecisionsaremadeaccording
totheone-member-one-voterule.Thesedecisionsbyenterprise-levelunionsareusuallyaggregatedbynational-levelunions,suchasSouthAfrica’sCOSATU(CongressofSouthAfricanTradeUnions)andtheUK’sTUC(TradesUnionCongress).Inmanycountries,thereismorethanonenational-levelunion,usuallydividedbypoliticaland/orreligiousallegiances.Forexample,SouthKoreahastwonational-levelunions,whileFrancehasasmanyasfive.Insomecountries,enterpriseunionsarealsoorganizedintoindustry-levelunions.Themostfamousof
theseareIGMetall(IndustriegewerkschaftMetall),theGermanmetalworkers’union,andtheUAW(UnitedAutoWorkers),theAmericanauto-workers’union.InthecaseofIGMetall,itsinfluencestretchesoverthemetal-relatedindustries(includingtheall-importantautomobileindustry),because,asthemostpowerfulunion,whatitdoestendstosetthetrendfortheotherunions.
Sometradeunionsevenplayapartinnationalpolicy-making
InanumberofEuropeancountries–Sweden,Finland,Norway,Iceland,Austria,Germany,IrelandandtheNetherlands–tradeunionsareexplicitlyrecognizedaskeypartnersinnational-leveldecision-making.Inthosecountries,theyareinvolvedinpolicy-makingnotjustin‘obvious’areaslikewages,workingconditionsandtraining,butalsowelfarepolicy,inflationcontrolandindustrialrestructuring.Insomecountries,sucharrangementsexistduetothefactthataveryhighproportionofworkersare
unionized.Around70percentofworkersinIceland,FinlandandSwedenbelongtotradeunions–theratioisaround11percentintheUS,toputitintoperspective.However,therateofunionization(knownas‘uniondensity’)doesnotfullyexplainthesearrangements.Forexample,moreworkersareunionizedinItaly(around35percent)orBritain(around25percent)thaninGermanyandtheNetherlands(bothlessthan20percent),buttheItalianandtheBritishunionshavemuchweakerinfluenceonnationalpolicy-makingthandotheirGermanorDutchequivalents.Thepoliticalsystem(e.g.,howstronglypoliticalpartiesarerelatedtotradeunions)andpoliticalculture(e.g.,consensualorconfrontational)mattertoo.
Thegovernmentisthesinglemostimportanteconomicactor
Inallcountriesthatarenotinavirtualstateofanarchy(theDemocraticRepublicofCongoandSomaliaatthetimeofwriting),thegovernmentisthesinglemostimportanteconomicactor.WewilldiscusswhatitdoesingreaterdetailinChapter11,soletmejustgiveyouthebigpicturefornow.Inmostcountries,thegovernmentisbyfarthesinglelargestemployer,employinganythingupto25per
centofthenationalworkforceinsomecases.*Itsexpenditureisequivalenttoanythingbetween10and55percentofnationaloutput,withtheratiogenerallyhigherintherichercountriesthaninthepoorerones.Inmanycountries,thegovernmentownsandrunsSOEs.Thesetypicallyproduce10percentofnationaloutput,eventhoughitcouldbeover15percentincountrieslikeSingaporeandTaiwan.Thegovernmentalsoaffectshowothereconomicactorsbehavebycreating,shuttingdownandregulatingmarkets.Respectiveexamplesarethecreationofthemarketfortradablepermitsforpollution,theabolitionofslaveryandvariouslawsregardingworkinghoursandconditions.
Howthegovernmentmakesitsdecisions:compromises,compromises(andlobbying)
Theprocessofgovernmentdecision-makingisfarmorecomplicatedthanthatineventhelargestcorporationswiththemostcomplexownershipstructures.Itisbecauseitdoesfarmorethingsthanacorporationdoes,whilehavingtoaccommodatefarmoreactorswithmuchmorediversegoals.Whenmakingdecisions,evenone-partystatescannotoverrideminorityinterestsinthewaythe
majoritycanincorporatedecisions.Exceptinthemostextremecases,suchasPolPot’sCambodia,politicalfactionsexist,andthecompetitionbetweenthemcanbequiteintense,asitisintoday’sChina.Indemocracies,thedecision-makingprocessisevenmorecomplex.Intheory,themajoritypartycan
imposeitswillontherestofsociety.Thisissometimesdone,butinmanycountriestheparliamentarymajorityismadeupofindependentpartiesincoalition,socompromiseshavetobemadeallthetime.AnyonewhohaswatchedtheDanishdramasTheKillingorBorgenwouldappreciatethispoint.Evenafterthepoliticianshavemadebroaddecisions,detailedpolicieshavetobedrawnupand
implementedbycivilservants,orbureaucrats.Thesepeoplehavetheirowndecisionrules,whicharehierarchical,likethosefoundincorporations,ratherthandeliberative,asfoundinparliaments.Politiciansandbureaucratsarelobbiedbyallsortsofgroupstoadoptparticularpolicies.Thereare
single-causecampaigngroups,focusingonparticularissues,suchastheenvironment.Tradeunionsalsohavedirectinfluencesonpoliticiansinsomecountries.Butcorporationsexertthegreatestinfluences.Insomecountries,suchastheUS,withweakrestrictionsoncorporatelobbying,corporateinfluencesareenormous.JimHightower,theAmericanpoliticalcommentator,wascertainlyexaggerating,butnotbymuch,whenhesaid,‘Thecorporationsdon’thavetolobbythegovernmentanymore.Theyarethegovernment.’
Internationalorganizationswithmoney:theWorldBank,theIMFandothers
Someinternationalorganizationsareimportantbecause–howshallIputit?–theyhavemoney.TheWorldBankandother‘regional’multilateralbanks,predominantlyownedbyrichcountrygovernments,makeloanstodevelopingcountries.*Whentheylend,theyoffermorefavourableterms(lowerinterestrates,longerrepaymentperiods)thandoprivate-sectorbanks.TheInternationalMonetaryFund(IMF)makeslarge-scaleloansonashort-termbasistocountriesinfinancialcrises,whichcannotborrowfromtheprivatemarket.
TheWorldBank,theIMFandothersimilarmultilateralfinancialinstitutionsdemandtheadoptionofparticulareconomicpoliciesoftheirborrowingcountries.Admittedly,alllendersattachconditionstotheirloans,buttheWorldBankandtheIMFareparticularlycriticizedforimposingconditionsthattherichcountriesthinkaregood,ratherthanthosethatwouldreallyhelptheborrowingcountries.Thishappensbecausetheyarecorporationswithone-dollar-one-voterule.Themajorityoftheirsharesareownedbytherichcountries,sotheygettodecidewhattodo.Mostimportantly,theUShasdefactovetopowerintheBankandtheFund,asthemostimportantdecisionsinthemrequirean85percentmajority,andtheUShappenstoown18percentofshares.
Internationalorganizationsthatsetrules:theWTOandtheBIS
Someinternationalorganizationshavepowerbecausetheysetrules.4OneexampleistheBankforInternationalSettlement(BIS),whichsetsinternationalrulesonfinancialregulations.Butbyfarthemostimportantoftheserule-settinginternationalorganizationsistheWorldTradeOrganization(WTO).TheWTOsetsrulesoninternationaleconomicinteractions,includinginternationaltrade,international
investmentandeventhecross-borderprotectionofintellectualpropertyrights,suchaspatentsandcopyrights.Itis,importantly,theonlyinternationalorganizationthatisbasedontheone-country-one-voterule.Thus,intheory,thedevelopingcountries,whichhavethenumericaladvantage,shoulddictatehowthingsaredonethere.Inpractice,unfortunately,votesarealmostnevertaken.Richcountriesuseallkindsofinformalinfluences(e.g.,issuingthinlydisguisedthreatstoreduceforeignaidtonon-compliantpoorcountries)toavoidvoting.
Thosethatpromoteideas:UNagenciesandtheILO
Someinternationalorganizationsinfluenceoureconomiclifebecausetheylendlegitimacytocertainideas.VariousUnitedNations(UN)organizationsbelongtothiscategory.TheUNIDO(UnitedNationsIndustrialDevelopmentOrganization),forexample,promotesindustrial
development.TheUNDP(UnitedNationsDevelopmentProgramme)promotespovertyreductiononaglobalscale,andtheILO(InternationalLabourOrganization)5workerrights.Theseorganizationspromotetheircausesmainlybyofferingaforumforpublicdiscussiononissuesin
theirrespectiveareasandbyprovidingsometechnicalassistancetocountriesthatwishtoimplementtheirideas.Sometimestheymayissuedeclarationsandconventions,butsubscriptiontothemisvoluntary,sotheyhaveverylittlepower.Forexample,virtuallynoneoftheimmigrant-receivingnationshavesigneduptotheILOconventionprotectingmigrantworkers’rights(butthenyoucannotexpectturkeystovoteforChristmas,astheysay).Notbeingbackedbymoneyandrule-settingpower,thecausesthattheseorganizationspromotearefar
lessstronglypromotedthantheagendaoftheIMF,theWorldBankandtheWTO.
EvenIndividualsAreNotWhatTheyAreSupposedtoBe
Individualisteconomictheoriesmisrepresenttherealityofeconomicdecision-makingbydownplaying,orevenignoring,theroleoforganizations.Worse,theyarenotevenverygoodatunderstandingindividuals.
Thedividedindividual:individualshave‘multipleselves’
Theindividualisteconomistsemphasizethattheindividualisthesmallestirreduciblesocialunit.Itisobviouslysointhephysicalsense.Butphilosophers,psychologistsandevensomeeconomistshavelong
debatedwhethertheindividualcanbeseenasanentitythatcannotbedividedupfurther.Individualsdon’tneedtosuffermulti-polardisordertopossessconflictingpreferenceswithin
themselves.Thismultiple-selfproblemiswidespread.Eventhoughthetermmaybeunfamiliar,itissomethingthatmostofushaveexperienced.Weoftenseethesamepersonbehavingcompletelydifferentlyunderdifferentcircumstances.Aman
maybeaveryselfishpersonwhenitcomestosharingdomesticworkwithhiswifebutinawarmaybewillingtosacrificehislifeforhiscomrades.Thishappensbecausepeoplehavemultiplerolesintheirlives–ahusbandandafootsoldierintheaboveexample.Theyareexpectedto,anddo,actdifferentlyindifferentroles.Sometimesitisduetoweaknessofwill–wedecidetodosomethinginthefuturebutfailtodoitwhen
thetimecomes.ThisbotheredtheoldGreekphilosopherssufficientlythattheyeveninventedawordforit–akrasia.Forexample,wedecidetoleadahealthierlifestylebutthenseeourwillpowercrumbleinfrontofatemptingdessert.Anticipatingthis,wemaydevisetrickstopreventour‘otherself’fromassertingitselflater,likeUlyssesaskingtobetiedtohisship’smastinordernottobeseducedbytheSirens.Youdeclareatthebeginningofdinnerthatyouareonadietandwon’tbehavingadesserttobepreventedfromorderingonelater,forfearoflosingface(andyoucanalwayshaveafewcompensatorychocolatecookieswhenyougobackhome).
Theembeddedindividual:individualsareformedbytheirsocieties
Themultiple-selfproblemshowsthatindividualsarenotatomsbecausetheycanbebrokendownfurther.Theyarenotatomsalsobecausetheyarenotclearlyseparablefromotherindividuals.Economistsworkingintheindividualisttraditiondonotaskwhereindividualpreferencescomefrom.
Theytreatthemastheultimatedata,generatedfromwithin‘sovereign’individuals.Theideaisbestsummarizedinthemaxim‘Degustibusnonestdisputandum’(‘Tasteisnotamatterofdispute’).Yetourpreferencesarestronglyformedbyoursocialenvironment–family,neighbourhood,schooling,
socialclassandsoon.Comingfromdifferentbackgrounds,youdon’tjustconsumedifferentthingsbutyougettowantdifferentthings.Thisprocessofsocializationmeansthatwecannotreallytreatindividualsasatomsseparablefromeachother.Individualsare–ifweuseafancyterm–‘embedded’intheirsocieties.Ifindividualsareproductsofsociety,MargaretThatcherwasseriouslywrongwhenshefamously(orinfamously)said,‘Thereisnosuchthingassociety.Thereareindividualmenandwomen,andtherearefamilies.’Therecannotbesuchathingasanindividualwithoutsociety.Inascenefromthe1980scultBBCsci-ficomedyRedDwarf,DaveLister,theprotagonistoftheshow,
whoisaLiverpudlianworking-classslob,guiltilyconfessesthathe’sbeentoawinebaronce,asifhehadcommittedsomekindofcrime(butthensomeofhisfriendswouldhavecalledhima‘classtraitor’forthat).SomeyoungpeoplefrompoorerclassesinBritain,evenafterdecadesofgovernmentpolicyencouraginguniversityeducationforthem,stillbelievethat‘unis’aresimplynotforthem.Inmostsocieties,womenhavebeenconditionedintobelievingthat‘hard’professionssuchasscience,engineering,lawandeconomicsarenotforthem.Itisanenduringthemeinliteratureandcinema–MyFairLady(themovieversionofGeorgeBernard
Shaw’splayPygmalion),WillyRussell’sEducatingRita(playandmovie)andMarcelPagnol’sLaGloiredemonpère(bookandmovie)–howeducation,andtheresultingexposuretodifferentlifestyles,
willtearyouawayfromyourownpeople.Youwillwantdifferentthingsfromwhattheywant–andwhatyouoncewantedyourself.Ofcourse,peoplehavefreewillandcan–anddo–makechoicesthatgoagainstwhattheyare
supposedtowantandchoose,giventheirbackgrounds,asRitadidbychoosingtodoauniversitydegreeinEducatingRita.Butourenvironmentstronglyinfluenceswhoweare,whatwewantandwhatwechoosetodo.Individualsareproductsoftheirsocieties.
Theimpressionableindividual:individualsaredeliberatelymanipulatedbyothers
Ourpreferencesarenotjustshapedbyourenvironmentbutoftendeliberatelymanipulatedbyotherswhowantustothinkandactinthewaystheywant.Allaspectsofhumanlife–politicalpropaganda,education,religiousteachings,themassmedia–involvesuchmanipulationtoonedegreeoranother.Themostwell-knowninstanceisadvertising.Someeconomists,followingtheworksofGeorgeStigler,
aleadingfree-marketeconomistofthe1960sandthe1970s,havearguedthatadvertisingisbasicallyaboutprovidinginformationabouttheexistence,pricesandattributesofvariousproducts,ratherthanmanipulationofpreferences.However,mosteconomistsagreewithJohnKennethGalbraith’sseminal1958bookTheAffluentSocietythatmuchofadvertisingisaboutmakingpotentialconsumerswanttheproductmoreeagerlythantheywouldotherwisedo–orevenwantthingsthattheyneverknewtheyneeded.Advertisementsmayassociateaproductwithacelebrity,asportteam(whichcompanylogosdoesyour
favouritefootballorbaseballteamhaveonitsuniform?)orwithafancylifestyle.Theymayusememorytriggers,whichworkonoursubconscious.Theymaybeairedattimeswhenviewersaremostsusceptible(that’swhyyougetTVadvertisementsforsnacksaround9–10p.m.).Andnottoforgetproductplacementsinmovies,savagelysatirizedinthefilmTheTrumanShow:IstillrememberMococoa,madewith‘allnaturalcocoabeansfromtheupperslopesofMountNicaragua’.Individualpreferencesarealsomanipulatedatamorefundamentallevelthroughthepropagationof
free-marketideologiesbythosewantconstraintsontheirprofit-seekingminimized(sowe’rebacktothepoliticsofideasagain).Corporationsandrichindividualsgenerouslyfinancethinktanksthatproducepro-marketideas,suchastheHeritageFoundationintheUSandtheInstituteofEconomicAffairsintheUK.Theydonatecampaignfundstopro-marketpoliticalpartiesandpoliticians.Somebigcompaniesusetheiradvertisingspendingtofavourbusiness-friendlymedia.Oncepoorpeoplearepersuadedthattheirpovertyistheirownfault,thatwhoeverhasmadealotof
moneymustdeserveitandthattheytoocouldbecomerichiftheytriedhardenough,lifebecomeseasierfortherich.Thepoor,oftenagainsttheirowninterests,begintodemandfewerredistributivetaxes,lesswelfarespending,lessregulationonbusinessandfewerworkerrights.Individualpreferences–notjustofconsumersbutalsooftax-payers,workersandvoters–canbe,and
oftenare,deliberatelymanipulated.Individualsarenotthe‘sovereign’entitiesthattheyareportrayedasinindividualisteconomictheories.
Thecomplicatedindividual:individualsarenotjustselfish
Individualisteconomictheoriesassumethatindividualsareselfish.Whencombinedwiththeassumptionofrationality,theconclusionisthatweshouldletindividualsdoastheyplease;theyknowwhatisbestforthemselvesandhowtoachievetheirgoals.
Economists,philosophers,psychologistsandothersocialscientistshaveforcenturiesquestionedtheassumptionofself-seekingindividuals.Theliteratureishuge,andmanypointsarequiteobscure,eveniftheyaretheoreticallyimportant.Let’ssticktothemainpoints.Self-seekingitselfistoosimplisticallydefined,withtheimplicitassumptionthatindividualsare
incapableofrecognizinglong-term,systemicconsequencesoftheiractions.SomeEuropeancapitalistsinthenineteenthcenturyarguedforabanonchildlabour,despitethefactthatsuchregulationwouldreducetheirprofits.Theyunderstoodthatcontinuedexploitationofchildrenwithouteducationwouldlowerthequalityoftheworkforce,harmingallcapitalists,includingthemselves,inthelongrun.Inotherwords,peoplecan,anddo,pursueenlightenedself-interest.Sometimeswearejustgenerous.Peoplecareaboutotherpeopleandactagainsttheirself-interestto
helpothers.Manypeoplegivetocharities,volunteerforcharitableactivitiesandhelpstrangersintrouble.Afiremanentersaburninghousetosaveanoldladytrappedinsideandapasser-byjumpsintoroughseatosavedrowningchildren,evenknowingthattheythemselvesmaybekilledintheprocess.Theevidenceisendless.Onlythosewhoareblindedbyabeliefinthemodeloftheself-seekingindividualwouldtrytoignoreit.6
Humanbeingsarecomplicated.Yes,mostpeopleareself-seekingmuchofthetime,buttheyarealsomovedbypatriotism,classsolidarity,altruism,senseoffairness(orjustice),honesty,commitmenttoanideology,senseofduty,vicariousness,friendship,love,pursuitofbeauty,idlecuriosityandmuchelsebesides.Theveryfactthattherearesomanydifferentwordsdescribinghumanmotivesistestimonytothefactthatwearecomplicatedcreatures.
Thebumblingindividual:individualsarenotveryrational
Individualisteconomictheoriesassumeindividualstoberational–thatis,theyknowallpossiblestatesoftheworldinthefuture,makecomplicatedcalculationsaboutthelikelihoodofeachofthesestatesandexactlyknowtheirpreferencesoverthem,therebychoosingthebestpossiblecourseofactiononeachandeverydecisionoccasion.Onceagain,theimplicationisthatweshouldletpeoplebe,because‘theyknowwhattheyaredoing’.Theindividualisteconomicmodelassumesthekindofrationalitythatnoonepossesses–Herbert
Simoncalledit‘Olympianrationality’or‘hyper-rationality’.Thestandarddefenceisthatitdoesnotmatterwhetheratheory’sunderlyingassumptionsarerealisticornot,solongasthemodelpredictseventsaccurately.Thiskindofdefenceringshollowthesedays,whenaneconomictheoryassuminghyper-rationality,knownastheEfficientMarketHypothesis(EMH),playedakeyroleinthemakingofthe2008globalfinancialcrisisbymakingpolicy-makersbelievethatfinancialmarketsneedednoregulation.Theproblemis,simplyput,thathumanbeingsarenotveryrational–orthattheypossessonlybounded
rationality.*Thelistofnon-rationalbehaviourisendless.Wearetooeasilyswayedbyinstinctsandemotioninourdecisions–wishfulthinking,panic,herdinstinctandwhatnot.Ourdecisionsareheavilyaffectedbythe‘framing’ofthequestionwhentheyshouldn’t,inthesensethatwemaymakedifferentdecisionsaboutessentiallythesameproblem,dependingonthewayitispresented.Andwetendtoover-reacttonewinformationandunder-reacttoexistinginformation;thisisfrequentlyobservedinthefinancialmarket.Wenormallyoperatewithanintuitive,heuristic(short-cut)systemofthinking,whichresultsinpoorlogicalthinking.Aboveall,weareover-confidentaboutourownrationality.
ConcludingRemarks:OnlyImperfectIndividualsCanMakeRealChoices
Aparadoxicalresultofconceptualizingindividualsashighlyimperfectbeings–withlimitedrationality,complexandconflictingmotives,gullibility,socialconditioningandeveninternalcontradictions–isthatitactuallymakesindividualscountmore,ratherthanless.Itisexactlybecauseweadmitthatindividualsareproductsofsocietythatwecanappreciatemorethe
freewillofthosewhomakechoicesthatgoagainstsocialconventions,prevailingideologiesortheirclassbackgrounds.Whenweacceptthathumanrationalityislimited,wegettoappreciatemoretheinitiativesexercisedbyentrepreneurswhentheyembarkonan‘irrational’venturethateveryoneelsethinksisgoingtofail(which,whensuccessful,iscalledaninnovation).Inotherwords,onlywhenweadmittheimperfectnatureofhumanbeingscanwetalkabout‘real’choices–nottheemptychoicesthatpeoplearedestinedtomakeintheworldofperfectindividuals,inwhichtheyalwaysknowwhichisthebestcourseofaction.Emphasizingtheimportanceof‘real’choicesisnottosuggestthatwecanmakeanychoicewelike.
Self-helpbooksmaytellyouthatyoucandoorbecomeanythingifyouchooseto.Buttheoptionsthatpeoplecanchoosefrom(ortheirchoicesets)areusuallyseverelylimited.Thiscouldbebecauseofthemeagrenessoftheresourcestheycommand;asKarlMarxdramaticallyputit,theworkersofearlycapitalismhadonlythechoicebetweenworkingeightyhoursaweekinharshconditionsandstarvingtodeath,becausetheyhadnoindependentmeanstosupportthemselves.Thelimitedchoicesetmayalsobe,asIarguedabove,becausewehavebeentaughttolimittherangeofwhatwewantandwhatwethinkmaybepossiblethroughthesocializationprocessanddeliberatemanipulationofourpreferences.Likeallgreatnovelsandmovies,therealeconomicworldispopulatedbycomplexandflawed
characters,bothindividualsandorganizations.Theorizingaboutthem(oraboutanything),ofcourse,hastoinvolvesomedegreesofgeneralizationandsimplification,butthedominanteconomictheoriesgotoofarinsimplifyingthings.Onlywhenwetakeintoaccountthemulti-facetedandlimitednatureofindividualswhilerecognizing
theimportanceoflargeorganizationswithcomplexstructureandinternaldecisionmechanismswillwebeabletobuildtheoriesthatallowustounderstandthecomplexityofchoicesinreal-worldeconomies.
FurtherReadingG.AKERLOFANDR.SHILLER
AnimalSpirits:HowHumanPsychologyDrivestheEconomyandWhyItMattersforGlobalCapitalism(Princeton:PrincetonUniversityPress,2009).
J.DAVIS
TheTheoryoftheIndividualinEconomics:IdentityandValue(London:Routledge,2003).
B.FREY
NotJustFortheMoney:AnEconomicTheoryofPersonalMotivation(Cheltenham:EdwardElgar,1997).
J.K.GALBRAITH
TheNewIndustrialState(London:Deutsch,1972).
F.VONHAYEK
IndividualismandEconomicOrder(London:RoutledgeandKeganPaul,1976).
D.KAHNEMANN
Thinking,FastandSlow(London:Penguin,2012).
H.SIMON
ReasoninHumanAffairs(Oxford:BasilBlackwell,1983).
P.UBEL
FreeMarketMadness:WhyHumanNatureIsatOddswithEconomics–andWhyItMatters(Boston,MA:HarvardBusinessSchoolPress,2009).
Thefirstpartofthisbookhasbeenabout‘gettingusedto’economics.Inthispart,wehavediscussedwhateconomicsis(astudyoftheeconomy),whattheeconomyis,howoureconomyhasbecomewhatitistoday,howtherearemanydifferentwaysofstudyingitandwhothemaineconomicactorsare.Havingbecome‘usedto’economics,letusnowdiscusshowwecan‘use’ittounderstandthereal
worldeconomy.
WHEN:Sometimeinthe1930sWHERE:TheofficeoftheGosplan,thecentralplanningauthorityoftheUSSRWHAT:Interviewforthepostofthechiefstatistician
Thefirstcandidateisaskedbytheinterviewboard,‘Whatistwoplustwo,comrade?’Heanswers:‘Five.’Thechairmanoftheinterviewboardsmilesindulgentlyandsays:‘Comrade,weverymuchappreciate
yourrevolutionaryenthusiasm,butthisjobneedssomeonewhocancount.’Thecandidateispolitelyshownthedoor.Thesecondcandidate’sansweris‘Three.’Theyoungestmemberoftheinterviewboardspringsupand
shouts:‘Arrestthatman!Wecannottoleratethiskindofcounter-revolutionarypropaganda,under-reportingourachievements!’Thesecondcandidateissummarilydraggedoutoftheroombytheguards.Whenaskedthesamequestion,thethirdcandidateanswers:‘Ofcourseitisfour.’Theprofessorial-
lookingmemberoftheboardgiveshimasternlectureonthelimitationsofbourgeoisscience,fixatedonformallogic.Thecandidatehangshisheadinshameandwalksoutoftheroom.Thefourthcandidateishired.Whatwashisanswer?‘Howmanydoyouwantittobe?’
OutputGrossDomesticProduct,orGDP
Outputfiguresarerarely‘manufactured’blatantly,eveninsocialistcountries,exceptinthemostextremepoliticalsituations–suchastheearlydaysofStalin’sruleortheGreatLeapForwardunderMaoZedonginChina.Still,itwouldbewrongtothinkthatwecanmeasureeconomicoutput,oranyothernumberineconomicsforthatmatter,inthewaywemeasurethingsinnaturalsciences,suchasphysicsorchemistry.Theeconomists’favouredmeasureforoutputisGrossDomesticProduct,orGDP.Itis,roughly
speaking,thetotalmonetaryvalueofwhathasbeenproducedwithinacountryoveraparticularperiodoftime–usuallyayear,butalsoaquarter(threemonths)orevenamonth.Isaid‘roughly’,because‘whathasbeenproduced’needsdefinition.IncalculatingGDP,wemeasure
output–orproduct–byvalueadded.Valueaddedisthevalueofaproducer’soutputminustheintermediateinputsithasused.Abakerymayearn£150,000ayearbysellingbreadandpastries,butifithaspaid£100,000inordertobuyvariousintermediateinputs–rawmaterials(e.g.,flour,butter,eggs,sugar),fuel,electricityandsoon–ithasonlyadded£50,000ofvaluetothoseinputs.Ifwedidn’ttakeawaythevalueoftheintermediateinputsandsimplyaddedupthefinaloutputsofall
theproducers,wewouldbedouble-,triple-andmultiple-countingsomecomponents,inflatingtheactualoutput.Thebakerboughtitsflourfromamillingcompany,soifwesimplyaddeduptheoutputofthebakerandthemiller,theflourthatthebakerboughtwouldbecountedtwice.Themillerboughtthewheat
fromafarmer,soifweaddedtheoutputofthewheatfarmertothoseofthebakerandthemiller,theportionofthewheatoutputthatthefarmerhadsoldtothemillerandthenwassoldontothebakerwouldbecountedthreetimes.Onlybycountingthe‘added’valuecanwemeasurethetruesizeoftheoutput.*Whataboutthe‘Gross’bitinGDP?Itmeansthatwestillhavenottakenawaysomethingthatcould
havebeenremovedfromthepicture,aswhenacanoftunaspecifiesgrossweightandnetweight(thatis,theweightofthefishwithouttheoilorbrine).Inthiscase,thatsomethingistheused-uppartsofcapitalgoods–basicallymachines,sowearetalkingthebaker’sovens,doughmixersandbreadslicers.Capitalgoods,ormachines,arenot‘consumed’andincorporatedintotheoutputinthesamewayinwhichflouristobread,buttheyexperiencereductionineconomicvaluewithuse–thisisknownasdepreciation.IfwetakeawaythewearandtearofmachinesfromGDP,wegetNetDomesticProduct,orNDP.
NetDomesticProduct,orNDP
AsNDPaccountsforeverythingthathasgoneintoproducingtheoutput–intermediateinputsandcapital-goodsinputs–itprovidesamoreaccuratepictureofwhattheeconomyhasproducedthanGDPdoes.ButwetendtouseGDPinsteadofNDPbecausethereisnooneagreedwayofestimatingdepreciation(sufficeittosayherethereareseveralcontendingways),whichmakesthedefinitionofNinNDPquitetricky.ThenhowaboutDinGDP?‘Domestic’heremeansbeingwithintheboundaryofacountry.Notall
producersinacountryareitsowncitizensorcompaniesregisteredinit.Seenfromtheotherside,notallproducersproduceintheirhomecountries;companiesrunfactoriesabroad,andpeoplegetjobsinforeigncountries.Thenumberthatmeasuresalltheoutputproducedbyyournationals(includingcompanies),ratherthantheoutputproducedwithinyourborder,iscalledGrossNationalProduct,orGNP.
GrossNationalProduct,orGNP
IntheUSorNorway,GDPandGNParemoreorlessidentical.InCanada,BrazilandIndia,withmanyforeignfirmsinsidetheirbordersandfewdomesticfirmsproducingabroad,GDPcouldbemorethan10percentbiggerthanGNP.ForSwedenandSwitzerland,whichhavemoreoftheirnationalfirmsoperatingabroadthanforeignfirmsoperatingwithintheirborders,GNPisbiggerthanGDP,around2.5and5percentrespectivelyasof2010.GDPismorefrequentlyusedthanGNP,since,intheshortrun,itisthemoreaccurateindicatorofthe
levelofproductiveactivitieswithinacountry.ButGNPisabettermeasureofaneconomy’slong-termstrength.AcountrymayhaveahigherGDP(GNP)thananother,butthatmaybebecauseithasalarger
populationthantheother.So,wereallyneedtolookatGDPorGNPfigurespercapita(perhead,orperperson,ifyoulike)ifwewanttoknowhowproductivetheeconomyis–itisactuallysomewhatmorecomplicatedthanthat,butwecanleavethisaside;ifyouareinterested,readthefootnote.*
LimitationsofGDPandGNPmeasures
AcriticallimitationofGDPandGNPmeasuresisthattheyvalueoutputsatmarketprices.Sincealotofeconomicactivitiesoccuroutsidethemarket,thevaluesoftheiroutputsneedtobesomehowcalculated–‘imputed’isthetechnicalword.Forexample,alotoffarmersindevelopingcountriesengageinsubsistencefarminginwhichtheyconsumemostofthefoodtheyproduce.Soweneedtoestimatethatquantityandimputemarketvaluestowhatthosefarmersproducedbutdidnotsellinthemarket(and
consumedthemselves).Or,whenpeopleliveinhousestheyown,weimputethevalueofthe‘dwellingservices’involved,asifthehouse-ownersarepayingtherentsatmarketratestothemselves.Unlikeoutputsexchangedthroughmarkets,theimputationofmarketvaluestonon-marketedoutputsinvolvesguesswork,impartinginaccuracytothenumbers.Worse,thereisaparticularclassofnon-marketedoutputwhosevalueisn’tevenimputed.Household
work–includingcooking,cleaning,careworkforchildrenandelderlyrelativesandsoon–issimplynotcountedaspartofGDPorGNP.Theclassic‘joke’amongeconomistsisthatyoureduceyournationaloutputifyoumarryyourhousekeeper.Thestandardexcuseisthatitisdifficulttoimputevaluestohouseholdwork,butitisaveryweakdefence.Afterall,weimputevaluestoallsortsofothernon-marketedeconomicactivities,includinglivinginone’sownhouse.Asthevastbulkofhouseholdworkisdonebywomen,women’sworkisgrosslyunder-valuedasaresultofthispractice.Manyestimatesputthevalueofhouseholdworktobeequivalenttoaround30percentofGDP.
REAL-LIFENUMBERSWhydoyouneedtoknow‘real-lifenumbers’?
Despitethecommonimpressionthatitisa‘numbers’subject,economicsasitistaughttodayisrathershortonnumbers.Itiscommonthatsomeonewithaneconomicsdegreedoesnotknowsome‘obvious’economicnumbers,suchastheGDPortheaverageworkinghoursofherowncountry.Thereisnowayanyonecanremembermorethanahandfulofthosenumbers.Indeed,inthisinternet
age,youdon’thavetorememberanyofthem,becauseyoucaneasilylookthemup.ButIbelieveitisimportantthatmyreadersfamiliarizethemselveswithsomeofthese‘real-lifenumbers’,evenjusttoknowwhatnumberstolookup.Moreimportantly,theyneedtodevelopasenseofwhatoureconomicworldlookslikeinreality:whenwetalkaboutChina’sGDP,arewetalkinghundredsofbillionsortensoftrillionsofUSdollars?Arewetalking15percentor30percentwhenwesaythatSouthAfricahasoneofthehighestunemploymentratesintheworld?WhenwesaythatahighproportionofpeopleinIndialiveinpoverty,dowemean20percentor40percent?Thus,inthisandallsubsequentchapters,Iprovideaselectionofthemostimportantreal-lifeeconomicnumbers.
Mostofworldoutputisproducedbyasmallnumberofcountries
TheworldGDPin2010,accordingtotheWorldBankdata,wasaround$63.4trillion.ThefivelargesteconomiesbyGDPweretheUS(22.7percentoftheworldeconomy),China(9.4percent),Japan(8.7percent),Germany(5.2percent)andFrance(4.0percent).*Thusthesefiveeconomiesaccountedforhalfofworldoutput.In2010,the‘high-incomecountries’intheWorldBankclassification(countrieswithabove$12,276
percapitaincome)hadcollectiveGDPof$44.9trillion.†Theyaccountedfor70.8percentoftheworldeconomy.Therestoftheworld,orthedevelopingworld,collectivelyhadaGDPof$18.5trillion,or29.2percentofworldGDP.Buttwo-thirds(66.6percent)ofthis$18.5trillionwasaccountedforbythefivelargestdevelopingeconomies,China,Brazil,India,RussiaandMexico.*Therestofthedevelopingworld,withacollectiveGDPof$6.3trillion,accountedforjustunder10percentoftheworldeconomy.
Mostdevelopingeconomiesproducetiny–Imeantiny–fractionsofwhattherichestcountriesproduce
ThetypicalGDPofverypoorsmalldevelopingcountries(5–10millionpeople),suchastheCentralAfricanRepublicorLiberia,isintheregionofoneortwobilliondollars,or$0.001trillionto$0.002
trillion.Thesearenoteven0.01percentoftheUSGDP,whichwas$14.4trillionasof2010.Thethirty-fivelow-incomecountriesaccordingtotheWorldBankclassification(countrieswithless
than$1,005percapitaGDPin2010)collectivelyhadaGDPof$0.42trillion.Thisis0.66percentoftheworldeconomyor2.9percentoftheUSeconomy.Eventhelargermiddle-incomedevelopingcountries(30–50millionpeople),suchasColombiaor
SouthAfrica,mayhaveGDPof$300–400billion.TheseareonlyaslargeastheGDPofamid-sizedUSstate,suchasWashingtonorMinnesota.IntermsofGDPpercapitafigures,wehaveahugerange.Sincethesefiguresaresimilar–actually
identicalintheory,althoughnotnecessarilysoinpractice–toincomepercapitafiguresthatwediscussshortly,sufficeittosayherethatwearetalkingaboutdifferentialsover500times.
IncomeGrossDomesticIncome,orGDI
GDPmaybeseenasasumofincomes,ratherthanoutputs,aseveryonewhoisinvolvedintheproductionactivityispaidforhis/hercontribution(whethertheamountspaidare‘fair’isanothermatter).Goingbacktothebaker’sexample,havingpaidforflour,eggsandotherintermediateinputs,thebakerywilldivideupitsvalue-addedbetweenwagesforitsworkers,profitsforitsshareholders,interestpaymentsfortheloanitmayhavecontractedandtheindirecttaxesthatareautomaticallyincludedintherevenuethatitgenerates(thatis,valueaddedtax(VAT)orsalestax).ThesumoftheseincomesisknownasGrossDomesticIncome,orGDI.Intheory,GDIshouldbe
identicaltoGDP,asitissimplyadifferentwayofaddingupthesamething.Butinpracticeitisslightlydifferent,assomeofthedatausedincompilingthetwoofthemmaybecollectedthroughdifferentchannels.
GrossNationalIncome,orGNI,andpercapitaGNI
LikeGNPistoGDP,GrossNationalIncome,orGNI,istoGDI.GNIistheresultofaddinguptheincomesofacountry’scitizens,ratherthantheincomesofthosewhoareproducingwithinitsborder,whichgivesusGDI.TheWorldBankpublishesGDPandGNI,ratherthanGNPandGDI.Thisispresumablyonthereasoningthatincome,asameasureofearnings,isbettermeasuredaccordingtothenationalityofthosewhoclaimit,whileproduct,asameasureofoutputs,isbettermeasuredaccordingtowheretheproductionactivitiesarehappening.Percapitaincome,usuallymeasuredbyGNI(oritsproductequivalent,GNP)percapita,isconsidered
bymanypeopletobethesinglebestmeasureofacountry’slivingstandard.Butsayingthatitisthebestdoesnotmeanthatitisgoodenough.OneobviousproblemisthatGNIpercapitaonlymeasurestheaverageincome.Buttheaveragemay
concealamuchgreatervariationamongdifferentindividualsandgroupsinonecountrythaninanother.Togiveasimplenumericalexample,CountriesAandBmaybothhave$5,000percapitaincomeandtenpeople(thereforeGNIof$50,000each),butAmayconsistofonepersonwith$45,500incomeandninepeoplewith$500each,whileBmayconsistofonepersonwith$9,500incomeandninepeoplewith$4,500each.Inthiscase,$5,000percapitaincomewillbearelativelyaccuratedescriptionofthestandardoflivinginCountryBbutwillbecompletelymisleadingforCountryA.Touseamoretechnical
term,youwouldsaythattheaverageincomeisamoreaccurateindicatorofthelivingstandardforacountrywithamoreequaldistributionofincome.(MoreonthisinChapter9.)
Adjustingfordifferentpricelevels:purchasingpowerparity
OneimportantadjustmentthatisoftenmadetotheGNI(orGDP)figuresisthatfordifferentpricelevelsindifferentcountries.ThemarketexchangeratebetweentheDanishkroneandtheMexicanpesomaybearoundonekroneto2.2pesos,butwith2.2pesosyoucanbuymoregoodsandservicesinMexicothanyoucanwithonekroneinDenmark(Iwillexplainshortlywhy).SotheofficialexchangeratebetweentheDanishkroneandtheMexicanpesounder-estimatestheactuallivingstandardsinMexico.Theproblemisthatmarketexchangeratesarelargelydeterminedbythesupplyanddemandfor
internationallytradedgoodsandservices,suchastheGalaxyphonesorinternationalbankingservices,whilewhatasumofmoneycanbuyinaparticularcountryisdeterminedbythepricesofallgoodsandservices,includingthosethatarenotinternationallytraded,suchaseatingoutortakingataxi.1
Todealwiththisproblem,economistshavecomeupwiththeideaofan‘internationaldollar’.Basedonthenotionofpurchasingpowerparity(PPP)–thatis,measuringthevalueofacurrencyaccordingtohowmuchofacommonsetofgoodsandservices(knownasthe‘consumptionbasket’)itcanbuyindifferentcountries–thisfictitiouscurrencyallowsustoconvertincomesofdifferentcountriesintoacommonmeasureoflivingstandards.TheresultoftheconversionisthatPPPincomesofcountrieswithexpensiveservice-sectorworkers
(therichcountries,excludingafewwithalotofcheapimmigrantlabour,suchastheUSandSingapore)aresignificantlylowerthantheirmarket-exchange-rateincomes,whilethoseofcountrieswithcheapserviceworkers(thepoorcountries)tendtobecomemuchhigherthantheirmarket-exchange-rateincomes.*StickingtotheDenmark–Mexicocomparisonabove,DanishPPPpercapitaincomein2010isaround
30percentlowerthanitsmarket-exchange-rateincome($40,140vs.$58,980),whiletheMexicanPPPpercapitaincomeisaround60percenthigherthanitsmarket-exchange-rateincome($15,010vs.$9,330).Sotheincomegapofoversixtimes($58,980vs.$9,330)isreducedtothelivingstandardgapofunderthreetimes($40,140vs.$15,010)afterthePPPadjustments.PPPadjustmentisverysensitivetothemethodologyandthedataused,notleastbecauseitreliesonthe
ratherheroicassumptionthatallcountriesconsumethesamebasketofgoodsandservices.Andwearenottalkingaboutminordifferences.BychangingitsmethodofestimatingPPPincomesin2007,theWorldBankreducedChina’sPPPincomepercapitaby44percent(from$7,740to$5,370)andincreasedSingapore’sby53percent(from$31,710to$48,520)overnight.
Incomefiguresdonotfullyrepresentlivingstandards,evenwithPPPadjustments
EvenwithPPPadjustments,incomefigures,suchasGNPpercapitaandGNIpercapita,donotfullyrepresentlivingstandards.Thereareanumberofreasonsforthis.Oneobviousbutimportantpointisthatwedon’tlivebymonetaryincomealone.Wewantpolitical
freedom,vibrantcommunitylife,self-fulfilmentandmanyotherthingsthatmoneycannotbuy.Theincreaseinmonetaryincomedoesnotguaranteeincreasesinthesethingsandmayevenunderminethem.Forexample,ifhigherincomeisgainedatthecostofworkinglongerandwithgreaterintensity,wemayhavelesstimeandenergyforcommunitylifeorself-fulfilment.
Anotheristhat,aspointedoutabove,incomefiguresdonotreflecthouseholdwork(includingcarework),whichtoasubstantialpartofthehumanity–children,theelderlyandthesick–arethemostimportantthings.Evenregardingthingsthatcanbeboughtwithmoney,weoftenmakepoordecisionsasconsumers
(recallChapter5).Influencedbyadvertisingorinourdesireto‘keepupwiththeJoneses’(ortheZhangs,thePatels,theCastros,orwhoever,dependingonwhereyoulive),mostofushaveboughtthingsthatweneverknewweneeded.Beyondprovidingthefleetingjoyofpurchaseitself,thesegoodsaddlittletoourwell-being.Evenifwearetotallyrationalasconsumers,theexistenceofpositionalgoodsmakesincomean
unreliablegaugeoftruelivingstandard(orhappiness,satisfactionorwhatyouwill).2Positionalgoodsaregoodswhosevaluesderivefromthefactthatonlyasmallproportionofpotentialconsumerscanhavethem.*Evenifourpersonalincomerises,wemaystillbeunabletoacquirethingslikehousesinprimelocations,Rembrandt’spaintingsoreliteeducationthatgivesaccesstotopjobs,ifothershavealsobecomericherandareabletostumpupevenmoremoneythanwecan.Thisproblemismoresevereinrichereconomies,asthefinerthingsinlifetendtobepositionalgoods,whileessentialgoodsareusuallynot.Theselimitationsdon’tmeanthatincomeisunimportantinmeasuringlivingstandards.Especiallyin
thepoorercountries,ahigherincomeislargelyapositivething.Inthosecountries,evenaslightlyhigherincomecanmakeallthedifferencebetweeneatingproperlyandstarvation,betweenworkinginadangerous,back-breakingjobandhavingjustahardjob,andbetweenhavingyourchilddieattheageofoneandseeingitgrowup.Intherichersocieties,thepositiveimpactsofahigherincomeonlivingstandardsarelesscertain.Buteventhere,higherincomeswillhelppeoplehavehigherstandardsofliving,iftheyareusedwell.Forexample,ahigherincomewillallowacountrytoreduceworkinghoursandthusenablepeopletohavemoretimewithfamilyandfriendsorgetmoreadulteducation,whilemaintainingpreviouslevelsofmaterialconsumption.
REAL-LIFENUMBERSWhataretheincomefigureslikeintherealworld?Herewewilllookatincomepercapitafigures,giventhatwehavealreadytalkedalotaboutoveralloutputfigures,suchasGDPandGNP,thatareidenticaltooverallincomefiguresintheoryandareverysimilartotheminpractice.
Countriesthatwetypicallyknowastherichestcountrieshaveover$40,000percapitaincome
AccordingtotheWorldBank,in2010,thecountrywiththehighestincome(GNI)percapitaintheworldwasMonaco($197,460),followedbyLiechtenstein($136,540).However,boththesearetaxhavenswithtinypopulations(33,000and36,000respectively).So,ifweexcludecountrieswithapopulationoflessthanhalfamillion,Norway,withapercapitaincomeof$85,380,istherichestcountry(thatis,ithasthehighestpercapitaGNI).AselectionoftherichestcountriesislistedinTable6.1.TheyaremostlyinWesternEuropeand
Westernoffshoots.AfewAsiancountriesbelongtothisgroup,withJapanandSingaporefirmlyintheupperleague.SouthKorea,togetherwithacoupleofEasternEuropeancountries,aretheretoo–onlyjust.
Theaveragepersoninthepoorestfourcountriesdoesn’tevenearn$1aday
Attheotherextreme,Burundi,with$160percapitaincome,wasthepoorestcountryintheworldin2010.Inseveralofthepoorestcountries,theaveragepersondidnotevenearn$1ofincomeperday($365peryear).Countrieswithlessthan$1,000percapitaincomeareofficiallyclassifiedas‘low-income’countries
intheWorldBankclassification(theWorldBankcut-offlineis$1,005),orasleast-developedcountries(LDCs)byvariousinternationaltreatiesandorganizations.Table6.2listsaselectionofLDCs.ItshowsthatmostofthemareinAfrica,withafewinAsia(Nepal,
Bangladesh,Cambodia,Tajikistan,KyrgyzRepublic)andonlyoneinLatinAmerica(Haiti).
INCOMERANGE COUNTRIES(FROMTHERICHESTTOTHEPOORESTINEACHGROUP)
$50,001andabove Norway($85,380),Switzerland($70,350),Denmark($58,980)
$45,001–$50,000 Sweden($49,930),theNetherlands($49,720),Finland($47,170),theUSA($47,140),Belgium($45,420)
$40,001–$45,000 Australia($43,740),Germany($43,330),France($42,390),Japan($42,150),Canada($41,950),Singapore($40,920)
$30,001–$40,000 TheUK($38,540),Italy($35,090),Spain($31,650)
$20,001–$30,000 NewZealand($29,050),Israel($27,340),Greece($27,240)
$15,001–$20,000 SouthKorea($19,890),CzechRepublic($17,870),Slovakia($16,220)
Table6.1Incomesoftherichestcountries(GNIpercapita,2010)Source:WorldBank,WorldDevelopmentReport,2012.
INCOMERANGE COUNTRIES(FROMTHEPOORESTTOTHERICHESTINEACHGROUP)
$300andbelow Burundi($160),DemocraticRepublicofCongo($180),Liberia($190)
£301–$400 Malawi($330),Eritrea($340),SierraLeone($340),Niger($360),Ethiopia($380),Guinea($380)
$401–$500 Mozambique($440),Togo($440),CentralAfricanRepublic($460),Zimbabwe($460),Uganda($490),Nepal($490)
$501–$600 Tanzania($530),Rwanda($540),BurkinaFaso($550),Mali($600)
$601–$800 Bangladesh($640),Haiti($650),Benin($750),Cambodia($760),Tajikistan($780)
$801–$1,000 KyrgyzRepublic($880)
Table6.2Incomesofthepoorestcountries(GNIpercapita,2010)Source:WorldBank,WorldDevelopmentReport,2012.
INCOMERANGE COUNTRIES(FROMTHERICHESTTOTHEPOORESTINEACHGROUP)
$8,001–$10,000 Chile($9,940),Russia($9,910),Turkey($9,500),Brazil($9,390),Mexico($9,330),Argentina($8,450)
$6,001–$8,000 Malaysia($7,900),CostaRica($6,580),Bulgaria($6,240),SouthAfrica($6,100)
$4,001–$6,000 Colombia($5,510),Ecuador($4,510),Algeria($4,460),China($4,260),Thailand($4,210),Tunisia($4,070)
$3,001–$4,000* Angola($3,960),ElSalvador($3,360)
$2,001–$3,000 Indonesia($2,580),Egypt($2,340),SriLanka($2,290),thePhilippines($2,050)
$1,001–$2,000 Bolivia($1,790),India($1,340),Ghana($1,240),Vietnam($1,100),Pakistan($1,050)
$1,000andbelow* LeastDevelopedCountries(LDCs)
Table6.3Incomesofselecteddevelopingcountries(GNIpercapita,2010)Source:WorldBank,WorldDevelopmentReport,2012.
Thus,thepercapitaincomeoftherichest(Norway)isastaggering534timesgreaterthanthatofthepoorest(Burundi)asof2010.EvenifwetakethelessextremecasesoftheUS(no.7fromthetopwith$47,140)versusEthiopia(no.8fromthebottom,with$380),theincomedifferentialisstill124times.
Therearepoorcountriesandtherearepoorcountries:gapsbetweendevelopingcountries
Inbetweentheseextremesliethevastmajorityofcountriesthatarecalledmiddle-incomecountriesintheWorldBankclassification.People,includingmyself,oftencallthemdevelopingcountriesorsimplypoorcountries,butthereispoorandthereispoor.Table6.3providespercapitaincomesofaselectionofdevelopingcountries,togivethereadersome
ideaofwhobelongswhereandalsothegapsthatexistbetweendevelopingcountriesthemselves.AtthetopofthedevelopingcountrygroupingarecountrieslikeBrazilandMexico,with$8,001–
$10,000percapitaincomes.ThesecountrieshavepercapitaincomesthatarefiftytosixtytimeshigherthanthoseofthepoorestcountriesthatwediscussedinTable6.2,whentheirowndifferentialswiththerichestcountriesarenomorethantentimes.Countriesthatwetypicallythinkofwhenwehearthewords‘developingcountries’–suchas
Indonesia,Egypt,SriLanka,thePhilippines,IndiaandGhana–aremostlyfoundinthe$1,001–$3,000rangeofpercapitaincome.Eventhesecountrieshavepercapitaincomesthatarefivetotentimesthoseofthepoorestcountries.
PPPadjustmentsshowthatgapsinlivingstandardsarenotassevereasgapsinproductivity
Tomorepreciselylearnaboutdifferentcountries’livingstandardsinsteadoftheirproductivity,weneedtoconverttheirincomes(outputs)intoPPPterms.Thisadjustmentresultsinsignificantchangesintherankingsofcountries.InPPPterms,Luxembourg,at$63,850,becomestherichestcountryintheworld,followedbyNorway,
Singapore,Kuwait,SwitzerlandandtheUS.*WithPPPadjustments,percapitaincomesofpoorcountriesriseinrelativeterms,asnon-tradedservices(andsomegoods)arecheaperinthesecountries.InPPP
terms,theDemocraticRepublicofCongo(DRC)($310),Liberia($330)andBurundi($390)arethethreepoorestcountriesintheworld.†WiththesePPPadjustments,theincomedifferencesbetweentherichandthepoorcountriesare
diminished,comparedwiththeonescalculatedintermsofmarketexchangerateincomes.ThedifferencebetweenthehighestandthelowestGNIpercapitaisdiminishedfrom534times(Norwayvs.Burundi)to‘only’206times(Luxembourgvs.theDRC).
HappinessNoteverythingthatcountscanbemeasured,noteverythingthatcanbemeasuredcounts:can–andshould–happinessbemeasured?
Recognizingthelimitationsofusingmonetaryincometomeasurelivingstandards,someeconomistshaveresortedtodirectlyaskingpeoplehowhappytheyare.These‘happiness’studiesallowustogetaroundalotofproblemsinvolvedinmeasuringlivingstandards:whatneedstobeincludedinthemeasurement;howweassignvaluestodifficult-to-measureelementsthataffectourlivingstandards(eventhoughthishasnotstoppedpeoplefromcomingupwiththingslike‘politicalfreedomindex’);andwhatweighttogivetoeachelement.Thebest-knownofthistypeofstudyaretheGallupHappinessSurveyandtheWorldValuesSurvey.Manypeoplequestionwhetherhappinesscanbe,andindeedshouldbe,measuredatall.Thefactthat
happinessmaybeconceptuallyabettermeasurethanincomedoesnotmeanthatweshouldtrytomeasureit.RichardLayard,theBritisheconomistwhoisaleadingscholartryingtomeasurehappiness,defendssuchattemptsbysaying,‘Ifyouthinksomethingmattersyoushouldtrytomeasureit[italicsadded].’3Butotherpeopledisagree–includingAlbertEinstein,whooncefamouslysaid,‘Noteverythingthatcountscanbemeasured.Noteverythingthatcanbemeasuredcounts.’Wecantrytoquantifyhappiness,say,byaskingpeopletoratetheirhappinessonascaleoften,and
comeupwithnumberslike6.3or7.8fortheaveragehappinessofCountriesAandB.Butsuchnumbersarenotevenhalfasobjectiveas$160or$85,380percapitaincomes–andwe’vediscussedwhyeventheincomenumbersarenottotallyobjective.
Adaptivepreferenceandfalseconsciousness:whywecannottotallyrelyonpeople’sjudgementsontheirownhappiness
Moreimportantly,itisdebatablewhetherwecantrustpeople’sjudgementontheirownhappiness.Thereareallkindsofadaptivepreferences,inwhichpeoplereinterprettheirsituationstomakethemmorebearable.‘Sourgrapes’,namely,decidingthatwhatyoucouldnotgetisactuallynotasgoodasyouhadthought,isaclassicexample.Manypeoplewhoareoppressed,exploitedordiscriminatedagainstsay–andtheywouldnotbelying
–thattheyarehappy.Manyofthemevenopposechangesthatwillimprovetheirlot:manyEuropeanwomenopposedtheintroductionoffemalesuffrageintheearlytwentiethcentury.Someofthemmayevenplayanactivepartinperpetuatinginjusticeandbrutality–likethoseslaveswhotookaleadintheoppressionofotherslaves,suchasStephen,thecharacterplayedbySamuelL.JacksoninthemovieDjangoUnchained.Thesepeoplethinktheyarehappybecausetheyhavecometoaccept–‘internalize’isthefancyword
here–thevaluesoftheoppressors/discriminators.Marxistscallthesecasesoffalseconsciousness.
TheMatrixandthelimitsofhappinessstudies
TheproblemthatfalseconsciousnessposesforhappinessstudieshasbeenmostbrilliantlyillustratedbytheWachowskisiblings’mind-blowing1999movieTheMatrix.Inthemovie,wehavethose,likeMorpheus,whothinkthatahappylifeunderfalseconsciousnessisunacceptable.Others,likeCypher,wouldratherliveinfalseconsciousnessthanleadadangerousandhardlifeofresistanceinreality.AndwhoarewetosaythatCypher’schoiceisnecessarilythewrongone?WhatrightdoesMorpheushaveto‘rescue’peopleonlytomakethemfeelmiserable?Theissueoffalseconsciousnessisagenuinelydifficultproblemthathasnodefinitesolution.We
shouldnotapproveofanunequalandbrutalsocietybecausesurveysshowthatpeoplearehappy.Butwhohastherighttotellthoseoppressedwomenorstarvinglandlesspeasantsthattheyshouldn’tbehappy,iftheythinktheyare?Doesanyonehavetherighttomakethosepeoplefeelmiserablebytellingthemthe‘truth’?Therearenoeasyanswerstothesequestions,buttheydefinitelytellusthatwecannotrelyon‘subjective’happinesssurveystodecidehowwellpeoplearedoing.
Happinessstudieswithmoreobjectivemeasures
Giventheselimitationsofsubjectivehappinessmeasures,mosthappinessstudiesnowcombinemoreobjectivemeasures(e.g.,incomelevel,lifeexpectancy)withsomeelementofsubjectiveassessment.Onegood–andquitecomprehensive–exampleinthiscategoryistheBetterLifeIndex,launchedin
2011bytheOECD.Thisindexlooksatpeople’ssubjectivejudgementsonlifesatisfaction,togetherwithtenothermore(althoughnotcompletely)objectiveindicators,rangingfromincomeandjobstocommunitylifeandwork–lifebalance(andeachoftheseindicatorshasmorethanoneconstituentelement).Evenwhileahappinessindexthatincludesmoreelementsisconceptuallymoredefensible,its
numericaloutcomeismoredifficulttodefend.Aswetrytoincorporatemoreandmoredimensionsofourlifeintothehappinessindex,wearemadetoincludemoreandmoredimensionsthatareverydifficult,ifnotimpossible,toquantify.CivicengagementandthequalityofcommunitylifeintheOECDindexaresuchexamples.Moreover,asthenumberofelementsgrowintheindex,itbecomesmoredifficulttoassignaweighttoeachelement.Itisinterestingtonotethat,inopenrecognitionofthisdifficulty,theOECDBetterLifeIndexwebsiteletsyoumakeupyourownindexbyvaryingtheweightsbetweendifferentelementsaccordingtoyourownjudgements.
REAL-LIFENUMBERSHappinessindexnumbers,whethertheyarecompletelysubjectiveorcombinedwithmoreobjectiveindicators,arenotreallymeaningfulinthemselves.Yousimplycannotcomparedifferenttypesofhappinessindexeswitheachother.Theonlythingthatyoucanreasonablydowiththemistrackchangesinhappinesslevelsforindividualcountriesaccordingtooneindexor,lessreliably,rankcountriesaccordingtooneindex.Differenthappinessindexesincludeverydifferentelements.Asaresult,thesamecountrycanrankvery
differentlydependingontheindex.Butsomecountries–theScandinaviancountries(especiallyDenmark),AustraliaandCostaRica–tendtorankhighlyinmoreindexesthanothercountriesdo.Somecountries–suchasMexicoandthePhilippines–tendtodobetterinindexeswithgreaterweightgiventosubjectivefactors,suggestinghigherdegreesof‘falseconsciousness’amongtheirpeople.
ConcludingRemarks:WhyNumbersinEconomicsCanNeverBeObjective
Definingandmeasuringconceptsineconomicscannotbeobjectiveinthewaysuchexercisesinphysicsorchemistrycanbe.Evensuchanexerciseregardingwhatareseeminglythemoststraightforwardofeconomicconcepts,suchasoutputandincome,isfraughtwithdifficulties.Alotofvaluejudgementsareinvolved–forexample,thedecisionnottoincludehouseholdworkinoutputstatistics.Therearemanytechnicalproblems–especiallyinrelationtotheimputationofvaluetonon-marketedactivitiesandtothePPPadjustments.Inthecaseofthepoorercountries,therearealsoissueswithdataquality–collectingandprocessingtherawdatarequirefinancialandhumanresourcesthatthesecountriesdonothave.Evenifwedonotdisputethenumbersthemselves,itisdifficulttosaythatoutput/incomefigures
correctlyrepresentlivingstandards,especiallyinrichercountries,inwhichmostpeoplecanmeettheirbasicneedsforfood,water,clothing,shelter,basichealthcareandbasiceducation.Itisalsonecessarytomakeallowancesfordifferencesinpurchasingpower,workinghours,non-monetaryaspectsofthestandardofliving,irrationalconsumerchoices(whetherduetomanipulationorherdbehaviour)andpositionalgoods.Happinessstudiestrytoobviatetheseneeds,buttheyhavetheirown,evenmoreserious,problems–
theinherentimmeasurabilityofhappinessandtheproblemofadaptivepreferences(especiallyofthefalseconsciousnessvariety).Allofthisdoesnotmeanthatweshouldnotusenumbersineconomics.Withouthavingsome
knowledgeofkeynumbers–likeoutputlevels,growthrates,unemploymentratesandmeasuresofinequality–aninformedunderstandingofthereal-worldeconomyisimpossible.Butweneedtousetheminfullawarenessofwhateachnumberdoesanddoesn’ttellus.
FurtherReadingJ.ALDRED
TheSkepticalEconomist:RevealingtheEthicsInsideEconomics(London:Earthscan,2009).
F.HIRSCH
SocialLimitstoGrowth(London:RoutledgeandKeganPaul,1978).
M.JERVEN
PoorNumbers:HowWeAreMisledbyAfricanDevelopmentStatisticsandWhattoDoaboutIt(Ithaca:CornellUniversityPress,2013).
R.LAYARD
Happiness:LessonsfromaNewScience(London:AllenLane,2005).
A.MADDISON
TheWorldEconomy:AMillennialPerspective(Paris:OECD,2001).
D.NAYYAR
CatchUp:DevelopingCountriesintheWorldEconomy(Oxford:OxfordUniversityPress,2013).
J.STIGLITZETAL.
Mis-measuringOurLives:WhyGDPDoesn’tAddUp(NewYork:TheNewPress,2010).
YoucouldsaythatEquatorialGuineahasbeendestinedforobscurity.ItisthesmallestcountryinmainlandAfricaintermsofpopulation,withjustover700,000people.Itisalsoaminnowintermsoflandmass–thesixthsmallest.1Whoisgoingtonoticesuchasmallcountry?Toaddinsulttoinjury,therearenolessthanfiveothercountrieswithverysimilarnames–notjustGuineaandGuineaBissauinitsneighbourhoodbutalsoPapuaNewGuineainthePacificandGuyanaandFrenchGuianainSouthAmerica.However,ifEquatorialGuinearemainsoneofthemostobscurecountriesintheworld,itisnotfor
lackoftrying.ItistherichestcountryinAfrica,withapercapitaGDPof$20,703,asof2010.Overthelastcoupleofdecades,ithasbeenoneofthefastest-growingeconomiesintheworld.Between1995and2010,itspercapitaGDPgrewattherateof18.6percentperyear–morethandoubletherateinChina,theinternationalgrowthsuperstar,whichgrewat‘only’9.1percentperyear.Honestly,whatmorecanacountrydotogetsomeattention?InvadetheUS?MakeScarlett
Johanssonthepresident?Paintthewholecountrypink?Theworldisreallyunfair.
EconomicGrowthandEconomicDevelopmentEconomicdevelopmentasthedevelopmentofproductivecapabilities
IfEquatorialGuineahasgrownsomuchfasterthanChina,whyhavewenotheardofthe‘EquatorialGuineaneconomicmiracle’,whenwehearaboutthe‘Chineseeconomicmiracle’allthetime?Thedifferenceinsizeisonereason–itispossibletoignoreverysmallcountries,eveniftheyare
doingverywell.ButmostpeopledonottakeEquatorialGuinea’sphenomenalincomegrowthseriouslymainlybecauseitisduetoaresourcebonanza.Nothingaboutthecountry’seconomychangedotherthanfindingaverylargeoilreservein1996.Withoutoil,thecountrywouldbereducedtooneofthepoorestintheworldonceagain,whichitusedtobe,asitcannotproducemuchelse.2
Iamnotsayingthatallgrowthexperiencesbasedonnaturalresources,suchasoil,mineralsandagriculturalproducts,arelikethatofEquatorialGuinea.TheeconomicgrowthoftheUSinthenineteenthcenturybenefitedhugelyfromabundantnaturalresources,suchasagriculturalproductsandminerals.Finland,exploitingitspositionasacountrywithoneoftheworld’smostabundantforestryresources,reliedheavilyonloggingforitsexportswellintothetwentiethcentury.Australia’sgrowthstilldependscriticallyonmineralexports.WhatmakesEquatorialGuineadifferentfromthoseothercasesisthatitsgrowthhasnotbeenachieved
throughanincreaseinitsabilitytoproduce.TheUSprovidesthebestcontrast.3Inthelatenineteenthcentury,theUSwasnotonlyrapidlybecomingthemostpowerfulindustrialnationintheworldbutwasalsotheworld’sleadingproducerofalmostallcommerciallyrelevantminerals.ButthisstatushadnotbeenachievedsimplybecausetheUSwasinpossessionofalotofmineraldeposits.Itwasinlargepartbecausethecountryhaddevelopedimpressivecapabilitiestolocate,extractandprocessmineralsefficiently;untilthemid-nineteenthcentury,ithadnotbeenaworld-leadingproducerofanymineral.In
contrast,EquatorialGuineanotonlycannotproducemuchelsethanoil,itdoesnotevenpossesstheabilitytoproduceoilitself–itsoilisallpumpedoutbyAmericanoilcompanies.Whileitisanextremeexample,EquatorialGuinea’sexperiencepowerfullyillustrateshoweconomic
growth,thatis,theexpansionintheoutput(orincome)oftheeconomy,isnotthesameaseconomicdevelopment.Thereisnouniversallyagreeddefinitionofeconomicdevelopment.ButIdefineitasaprocessof
economicgrowththatisbasedontheincreaseinaneconomy’sproductivecapabilities:itscapabilitiestoorganize–and,moreimportantly,transform–itsproductionactivities.
Aneconomywithlowproductivecapabilitiescannotevenbesureofthevalueofwhatitproduces
Whenaneconomyhaslowproductivecapabilitiesandreliesonnaturalresourcesoronproductsthataremadewithcheaplabour(say,cheapT-shirts),itdoesnotjustearnlowincome.Itcannotevenbesurethatinthelongrunwhatitproduceswillbeasvaluableasitisnow.Machineswipingoutentireprofessionsissucharecurringthemeineconomicdevelopmentthatitdoes
notneedfurtherdiscussion.Justthinkoftheprofessionsthathavedisappearedexceptinnametoday,suchasweavers,smiths,wheelwrightsandsoon.Moreimportantly,countrieswithsuperiorproductivecapabilitiescanevendevelopsubstitutesfor
naturalresources,vastlyreducingtheincomesofcountriesthatrelyonexportingthem.AfterGermanyandBritaindevelopedtechnologiestosynthesizenaturalchemicalsinthemid-nineteenthcentury,somecountriessawdramaticfallsintheirincomes.Guatemalausedtoearnquitealotofmoneybybeingthemainproducerofcochineal(cochinilla),thecrimsondyefavouredbythePopeandtheEuropeanroyaltiesfortheirrobes,untiltheinventionoftheartificialdyealizarincrimson.TheChileaneconomywasplungedintoyearsofcrisiswhentheHaber–Boschprocesswasdevelopedintheearlytwentiethcenturytomanufacturechemicalsubstitutesforsaltpetre(nitrate),thecountry’smainexportatthetime.
Changesintechnologiesareattherootofeconomicdevelopment
Notsolongago,ifsomeonecouldcommandathousandhorsesatthesametime,carryhundredsofbooksinhispocket,generateintenseheatwithoutanyflame,turnthousandsoflitresofseawaterintofreshwaterormakeclothesoutofstone,peoplewouldhavesaidhewasamagician.Wearenottalkingaboutthosewitch-burningfolksofmedievalEurope.Evenintheearlytwentiethcentury,whentheworldwasnottotallydissimilartotoday’s,allofthosethingswouldhavebeenconsideredimpossible.Today,theyaredoneroutinelyinmanycountries.Mostofyouwillhaveguessedhow,exceptforthelastone,whichis,unbeknowntomostpeople,doneinNorthKorea,wheretheymakeasyntheticfibrecalledvinalon,orvinylon,outoflimestone.*Allthese‘magical’developmentshavebeenpossibleonlybecausewehaveconstantlyinventedbetter
technologies,namely,bettermachinesandbetterchemicalprocesses.StartingfromAbrahamDarby’scoke-smeltingtechniqueinsteel-makingandJohnKay’sflyingshuttlefortextileweavingintheearlyeighteenthcentury,anendlessstreamoftechnologieshasemergedtochangetheworld.WediscussedsomeoftheseinChapter3.Thesteamengine,theinternalcombustionengine,electricity,organicchemistry,steelships,(wiredandwireless)telegraphy,aeroplanes,computers,nuclearfission,semiconductorsandfibreopticsareonlythemostimportantexamples.Today,geneticengineering,renewableenergy,‘advanced’materials(e.g.,graphene)andnano-technologiesareemergingtotransformtheworldyetagain.
IntheearlydaysoftheIndustrialRevolution,newtechnologieswereoftendevelopedbyindividualvisionaries.Asaresult,untilthelatenineteenthandearlytwentiethcenturies,manytechnologieswereknownbytheirinventors’names–Kay’sflyingshuttle,Watt’ssteamengine,theHaber–Boschprocessandsoon.Fromthelatenineteenthcentury,withtechnologiesbecomingincreasinglycomplex,fewerandfewerof
themhavebeeninventedbyindividuals.CompaniesstarteddevelopingthecapabilitytogeneratenewtechnologiesthroughR&Dintheircorporatelabs.Aroundthistime,governmentsalsostartedinvestingactivelyindevelopingnewtechnologiesbyeitherestablishingpublicresearchlabs(especiallyinagriculture)orsubsidizingprivate-sectorR&Dactivities.Today,technologicaldevelopmentsaretheresultoforganized,collectiveeffortsinsideandoutside
productiveenterprises,ratherthanofindividualinspiration.Thefactthatfewnewtechnologiesthesedayshavetheirinventors’namesattachedtothemisatestimonytothecollectivizationoftheinnovationprocess.
Technologiesdonottellthewholestory:theimportanceofworkorganization
Notallincreasesinourproductivecapabilitieshavecomefromtechnologicaldevelopmentinthenarrowsense:machinesandchemicals.Alotofthemareduetoimprovementsinorganizationalskills–or,ifyoulike,managementtechniques.Intheearlynineteenthcentury,factoryproductivitywasfurtherraisedbylininguptheworkersin
accordancewiththeorderoftheirtaskswithintheproductionprocess.Theassemblylinewasborn.Inthelatenineteenthcentury,theassemblylinewasputonaconveyorbelt.Themovingassemblylinemadeitpossibleforcapitaliststoincreasethepaceofworksimplybyturningupthespeedoftheconveyorbelt.Outsideindustriesliketheautomobileindustry,inwhichonecontinuousassemblylinebasically
decideswhodoeswhatatwhichspeed,improvementsinthedesignofworkflowhavebeenanimportantsourceofproductivitygrowth–howdifferentmachinesarearranged,howdifferenttasksareassignedtodifferentworkers,wherepartsandhalf-finishedproductsarestoredandsoon.Thesethingsaretakenforgrantedbyeconomists,buttheyarestillsomethingthatnoteveryproducergetsright,especiallyindevelopingcountries.
TheriseofFordism,orthemassproductionsystem
Inadditiontoorganizingtheflowofworkmoreefficiently,attemptshavebeenmadetomakeworkersthemselvesmoreefficient.ThemostimportantinthisregardwasTaylorism,namedafterFrederickWinslowTaylor(1856–1915),theAmericanengineerandlatermanagementguru.Taylorarguedthattheproductionprocessshouldbedividedupintothesimplestpossibletasksandthatworkersshouldbetaughtthemosteffectivewaystoperformthem,establishedthroughscientificanalysesoftheworkprocess.Itisalsoknownasscientificmanagementforthisreason.CombiningthemovingassemblylinewiththeTayloristprinciple,themassproductionsystemwas
bornintheearlyyearsofthetwentiethcentury.ItisoftencalledFordismbecauseitwasfirstperfected–butnot‘invented’,asthefolkloregoes–byHenryFordinhisModel-Tcarfactoryin1908.Theideaisthatproductioncostscanbecutbyproducingalargevolumeofstandardizedproducts,usingstandardizedparts,dedicatedmachineryandamovingassemblyline.Thiswouldalsomakeworkersmoreeasilyreplaceableandthuseasiertocontrol,because,performingstandardizedtasks,theyneedtohaverelativelyfewskills.
Despitemakingthemmoreeasilyreplaceable,Fordpaidhisworkerswellbecauseherealizedthathisproductionmethodwouldnotworkunlesstherewasa‘mass’marketwithalotofpeoplewithdecentincomeswhocouldbuythelarge‘mass’ofoutputproduced.WhenthemassproductionsystemwaswidelyadoptedintheUSandEuropeaftertheSecondWorldWar,risingwagesexpandedmarkets,whichthenenabledproductionatahighervolume,whichthenincreasedproductivityfurtherbyspreadingthefixedcosts(ofinstallingtheproductionfacilities)overalargervolume.ThemassproductionsystemwassoeffectivethateventheSovietUnionwasattractedtoit.Inthe
beginning,therewasahugedebatethereaboutitsadoptionbecauseofitsobvious‘anti-worker’implications.Itdestroystheintrinsicvalueofworkbymakingitsimplisticandrepetitive,whilevastlyreducingtheworker’scontroloverhis/herlabourprocess;standardizedtasksmakethemonitoringofworkerseasierwhiletheintensityofworkcanbeeasilyincreasedbyacceleratingtheassemblyline.Intheend,theefficiencyofthesystemwassooverwhelmingthattheSovietplannersdecidedtoimportit.
Modificationstothemassproductionsystem:theleanproductionsystem
Themassproductionsystem,acenturyafteritsinvention,stillformsthebackboneofourproductionsystem.Butsincethe1980sithasbeentakentoanotherlevelbytheso-calledleanproductionsystem,firstdevelopedinJapan.Thesystem,mostfamouslypractisedbyToyota,hasitspartsdelivered‘justintime’fortheproduction,
eliminatinginventorycosts.Byworkingwiththesupplierstoraisethequalityofthepartstheydeliver(theso-called‘zerodefectmovement’),itvastlyreducestheneedforreworkandfine-tuningattheendoftheassemblylinewhichhadplaguedFordistfactories.Italsousesmachinesthatallowquickchange-oversbetweendifferentmodels(e.g.,byallowingaquickexchangeofdies)andthuscanofferamuchgreatervarietyofproductsthantheFordistsystemdoes.UnliketheFordistsystem,theToyotasystemdoesnottreatworkersasinterchangeableparts.Itequips
workerswithmultipleskillsandallowsthemtoexercisealotofinitiativeindecidingworkarrangementsandsuggestingminortechnologicalimprovements.ImprovementsthusgeneratedarebelievedtohavebeencrucialinestablishingJapanesetechnologicalsuperiorityinindustriesinwhichqualityisimportant.
Productivecapabilitiesbeyondthefirmlevelarealsoveryimportant
Importantastheyare,improvedtechnologiesandbetterorganizationalskillsatthefirmlevelarenottheonlythingsthatdetermineaneconomy’sproductivecapabilities.Aneconomy’sproductivecapabilitiesalsoincludecapabilitiesthatnon-enterpriseactors–suchasthe
government,universities,researchinstitutesortraininginstitutes–haveinfacilitatingproductionandimprovingproductivity.Thesetheydobysupplyingproductiveinputs:infrastructure(e.g.,roads,fibreopticnetwork),newtechnologicalideasandskilledworkers.Economy-wideproductivecapabilitiesarealsodeterminedbytheeffectivenessofeconomic
institutions.Theinstitutionsofcorporateownershipandfinancialtransactionsdeterminetheincentivesforlong-terminvestmentsinproductivity-enhancingmachinery,workertrainingandR&D.Alsoimportantareinstitutionsthataffecteconomicactors’willingnesstobearriskandacceptchange,suchasbankruptcylawandthewelfarestate,asdiscussedinChapter3.Institutionsthatencouragesociallyproductivecooperationmattertoo;industryassociationstopromotejointexportmarketingorgovernmentresearchinstitutesprovidingR&Dforsmallfarmsorsmallfirmsareexamples.
Alsorelevantareinstitutionsthatdeterminetheeffectivenessofdialoguebetweendifferenteconomicactors–government,business,unions,CSOs(civilsocietyorganizations),suchaspovertyactiongroupsorconsumerwatchdoggroups,anduniversitiesandothereducationalinstitutions.Examplesincludeformalandinformalchannelsofgovernment-businessdialogue,government-CSOconsultation,employer-unionnegotiation,andindustry-universitycooperation.
REAL-LIFENUMBERSFailingtocheckwhethergrowthratesareoverallorpercapitacandistortyourperspective
Whenyouencountergrowthratefigures,youneedtocheckwhethertheyareoverallorpercapitarates.Thismaysoundlikeanobviousthingtodo,butfailuretodosocangiveyouaratherdistortedviewoftheworld.Ifyouaremonitoringasingleeconomy’sgrowthperformanceoverarelativelyshortperiodoftime,
sayseveralquartersorafewyears,itmaynotbecriticalthatyouareusingoverall,ratherthanpercapita,growthrate.But,ifyouarecomparingdifferenteconomiesoverarelativelylongperiodoftime,itisimportantthatyouusepercapitagrowthrates.Between2000and2010,GDPgrewattherateof1.6percentintheUSand1.0percentinGermany.Withthesefigures,youmaythinkthattheUShasdonesubstantiallybetterthanGermany.However,duringthesameperiodpopulationgrewattherateof0.9percentintheUSand-0.1percentinGermany.ThismeansthatGermanyhasactuallydonebetterinpercapitaterms–1.1percentperyeargrowthrateasopposedto0.7percentintheUS.4
Whya6percentgrowthrateisa‘miracle’
Intheory,thereisnoupperboundtotherateatwhichaneconomycangrow.Inpractice,itisnoteasyforittogrowatall.InChapter3,wehaveseenthatpercapitayearlyoutputgrowthrateusedtobeclosetozero
everywhereuntiltheendoftheeighteenthcentury.TheIndustrialRevolutionsawitgoinguptoaround1percentperyear,the‘GoldenAgeofcapitalism’sawitgoingupto3–4percentperyear.TheEastAsianeconomieshaveseengrowthratesof8–10percentperyearduringtheirgrowthpeaksduringtheir‘miracle’periodsofthreeorfourdecades.Allinall,theruleofthumbisthatpercapitaoutputgrowthrateabove3percentisgood,while
anythingabove6percentisenteringthe‘miracle’territory.Anythingsubstantiallyabove10percentforanextendedperiod(say,morethanadecade)ispossibleonlythrougheitherresourcebonanza,asinthecaseofEquatorialGuineadiscussedabove,orrecoveryfromawar,ashasbeenthecasewithBosniaandHerzegovinainthelastdecadeandahalf.
Thepowerofcompoundrates
Thegrowthratesweusearecompoundrates(orexponentialrates),meaningthattheincreasedoutputofeveryyear(orquarterorwhateverperiodistheunitofmeasurement)isaddedtotheexistingoutput.Ifaneconomyof$100billionisgrowingattheaveragerateof10percentovertenyears,itdoesnotmeanthatitsoutputincreasesby$10billioneveryyearandthesizeoftheeconomyincreasesto$200billionaftertenyears.10percentgrowthrateinthefirstyearincreasestheoutputto$110billion,butthesecondyear’s10percentgrowthisover$110billion,not$100billion,sotheresultingoutputattheendofthesecondyearis$121billion,ratherthan$120billion.Continuinglikethis,attheendoftheten-yearperiod,theeconomywillbe$259billion,not$200billion.
Theuseofcompoundratemeansthatwhatmayseemtobearelativelysmalldifferenceingrowthratescancreatealargegap,ifsustainedoverasufficientlylongperiodoftime.Ifacountrygrowsat3percentperyearandanothergrowsat6percentforoneyear,itisnobigdeal.If,however,thisdifferencepersistsforfortyyears,thefaster-growingeconomywillhavebecome10.3timesricher,whiletheslower-growingonewillhaveincreaseditsincomeonlyby3.3times.Beforetheyknowit,thecitizensofthesetwocountrieswillbelivinginworldsofentirelydifferentlevelsofcomfortandopportunity.Itisusefultohavearuleofthumbthatenablesyoutoprojectthefutureonthebasisoftoday’sgrowth
rate.Ifyouhaveagrowthrateofacountryandwanttoknowhowmuchtimeitwilltakeforthesizeofitseconomytodouble,divideseventybythegrowthrate.So,ifacountrygrowsat1percentperyear,itwilltakeitseventyyearstodoubleitsoutput,whileitwilltakesomewherebetweenelevenandtwelveyearsforthesizeofaneconomygrowingat6percenttodouble.
Unlikeeconomicgrowth,economicdevelopmentcannotbemeasuredbyasingleindicator
InChapter6,wesawhoweventheoutputfiguremaynotbetotallyobjective.But,giventheoutputstatistics,itisstraightforwardtocalculateitsgrowthrate.Incontrast,thereisnosinglenumberthatallowsustomeasureeconomicdevelopment,definedasanincreaseinproductivecapabilities.Therearemanydifferentindexesofproductivecapabilities(underdifferentnames),publishedby
internationalorganizations,includingtheUNIDO(theUnitedNationsIndustrialDevelopmentOrganization),theOECD,theWorldBankandtheWorldEconomicForum.Theseindexesaremadeupofdozensofdifferentindicatorsthatarethoughttorevealvariousaspectsofacountry’sproductivecapabilities.Mostfrequentlyincludedareindicatorsregardingthestructureofproduction(e.g.,shareofhi-technologyindustriesintotalmanufacturingoutput),infrastructure(e.g.,broadbandconnectionspercapita),skills(e.g.,theshareofworkerswithauniversitydegree)andinnovationactivities(e.g.,R&DspendingasashareofGDPornumberofpatentspercapita).However,beingmadeupofsuchdiverseelements,theseindexesaredifficulttointerpret.Therefore,
unlessyouareaprofessionaleconomist,youarebetteroffwithsimplerindicatorsthatareeasiertointerpret.Italkabouttwoofthembelow.
ShareofinvestmentinGDPisthekeyindicatorofhowacountryisdeveloping
Inordertobeused,mosttechnologieshavetobeembodiedinfixedcapital,namely,machinesandstructures(e.g.,buildings,railways).So,withouthighinvestmentinfixedcapital,technicallyknownasgrossfixedcapitalformation(GFCF),*aneconomycannotdevelopitsproductivepotentialverymuch.Thus,theinvestmentratio(GFCF/GDP)isagoodindicatorofitsdevelopmentpotential.Indeed,thepositiverelationshipbetweenacountry’sinvestmentratioanditsrateofeconomicgrowthisoneofthefewundisputedrelationshipsineconomics.Fortheworldasawhole,theinvestmentratioisaround20–22percent.Butthereisahuge
internationalvariation.InChina,thissharehasstoodatastaggering45percentinthelastfewyears.Attheotherextreme,countriesliketheCentralAfricanRepublicortheDemocraticRepublicofCongocanhaveaninvestmentratioaslowas2percentinsomeyears,althoughtypicallytheymanagearound10percent.Noeconomyhasachieved‘miracle’ratesofgrowth(thatis,over6percentperyearinpercapita
terms)overaperiodoftimewithoutinvestingatleast25percentofGDP.Attheheightsofsuchgrowth,countriesinvestatleast30percentofGDP.Theinvestmentratiowentabove35percentinJapaninthe
late1960sandtheearly1970s.Duringits‘miracle’growthperiodsincethe1980s,China’sinvestmentratehasbeen30percentandabove,goingabove40percentinthelastdecade.Thisisnottosaythatahigherinvestmentratioisnecessarilyagoodthing.Investmentbydefinition
sacrificestoday’sconsumptionandthuslivingstandards,ifonlyinthehopeofachievinghigherconsumptioninthefuture.Sotherecanbesuchathingastoomuchinvestment,eventhoughhowmuchistoomuchwoulddependonhowmuchyouvalueyourfutureincomeagainsttoday’sincome(thisisknownastimepreference).Nevertheless,theinvestmentratio–anditsevolutionovertime–isthebestsingleindicatorofhowacountryisdevelopingitsproductivecapabilitiesandthusitseconomy.
TheR&Dfigureisagoodindicatorfortherichercountries
Anothersimplebutinstructiveindicatorofacountry’seconomicdevelopment,especiallyforcountriesathigherlevelsofincome,isitsR&DspendingasaratioofGDP–anditsevolutionovertime.5
RichcountriesspendamuchhigherproportionoftheirGDPonR&Dthandopoorercountries.TheOECDaverageis2.3percent,withseveralcountriesspendingover3percentofGDPonit.*FinlandandSouthKoreatopthelist.ThesetwocountriesareparticularlyimpressiveinthattheyhaveincreasedtheirR&D/GDPratioveryrapidlyinthelastfewdecadesandachievedimpressiveprogressinhigh-technologyindustries.MostdevelopingcountriesdopracticallynoR&D.Theratiois0.1percentinIndonesia,0.2percent
inColombiaand0.5percentinKenya.China’sstoodat1.5percentin2009buthasbeenonafastrisingtrend,suggestingthatthecountryisrapidlybuildingupitscapabilitiestogeneratenewtechnologies.6
IndustrializationandDeindustrialization
Intheory,wecanachieveeconomicdevelopmentbyenhancingourproductivecapabilitiesinanyeconomicactivity,includingagricultureandservices.Inpractice,inthevastmajorityofcases,economicdevelopmenthasbeenachievedthroughindustrialization,or,moreprecisely,thedevelopmentofthemanufacturingsector.†AlbertEinsteinwasdefinitelyrightinsaying:‘Intheory,theoryandpracticearethesame.Inpractice,theyarenot.’
Mechanizationandchemicalprocessesmakeiteasiertoraiseproductivityinmanufacturing
Raisingproductivityismucheasierinmanufacturingthaninothereconomicactivities,suchasagricultureandservices.Manufacturingactivitiesaremuchlessboundbynatureandlendthemselvesmuchmoreeasilytomechanizationandchemicalprocessing.Agriculturalproductivityisverydependentonthephysicalenvironment,suchaslandmass,climate
andsoil.Itisalsoverytime-bound.Impressivewaystoovercomeallthesenaturalconstraintshavebeendeveloped,suchasirrigation,selectivebreedingandevengeneticengineering,butthereisaclearlimittothem.Noonehasdevelopedawaytogrowwheatinsixminutesinsteadofsixmonths,whichisroughlywhatshouldhavehappened,hadtheproductivityinthewheatindustrydevelopedasfastasinpin-makingoverthelasttwoandahalfcenturies.Bytheirverynature,manyserviceactivitiesareinherentlyimpervioustoincreasesinproductivity.In
somecases,theveryincreaseinproductivitywilldestroytheproductitself;astringquartetcannottrebleitsproductivitybytrottingthroughatwenty-seven-minutepieceinnineminutes.Forsomeotherservices,theapparentlyhigherproductivitymaybeduetothedebasementoftheproduct.Alotoftheincreasesin
retailserviceproductivityincountriesliketheUSandtheUKhavebeenboughtbyloweringthequalityoftheretailserviceitself–fewershopassistants,longerdrivestothesupermarket,lengthierwaitsfordeliveriesandsoon.The2008globalfinancialcrisishasrevealedthatmuchoftherecentproductivitygrowthinfinancehadbeenachievedthroughthedebasementoftheproducts–thatis,thecreationofoverlycomplex,riskierandevenfraudulentproducts.
The‘learningcentre’oftheeconomy
Themanufacturingsectorhasbeenthe‘learningcentre’ofcapitalism.Bysupplyingcapitalgoods(e.g.,machines,transportequipment),ithasspreadhigherproductivecapabilitiestoothersectorsoftheeconomy,whethertheyareothermanufacturingactivitiesproducingconsumergoods(e.g.,washingmachines,breakfastcereals),agricultureorservices.Manyoftheorganizationalinnovationsinthemanufacturingsectorhavebeentransferredtotheother
sectors,especiallytotheservicesector,andraisedtheirproductivities.Fastfoodrestaurants,suchasMcDonald’s,use‘factory’techniques,turningcookingintoanassemblyjob.Someevendeliverfoodonaconveyorbelt,asinkaiten-zushirestaurants(forpeoplelivinginBritain,that’sYo!Sushi).Largeretailchains–betheysupermarkets,clothesshopchainsoronlineretailers–applymoderninventorymanagementtechniquesdevelopedinthemanufacturingsector.Evenintheagriculturalsector,productivityhasbeenraisedinsomecountries,suchastheNetherlands
(whichisthethird-largestexporterofagricultureintheworld,aftertheUSandFrance),throughtheapplicationofmanufacturing-styleorganizationalknowledge,suchascomputer-controlledfeeding.
Theriseofthepost-industrialsociety?
Ithasrecentlybecomefashionabletoarguethatthemanufacturingsectordoesnotmatterverymuchanymore,aswehaveenteredtheeraofpost-industrialsociety.Intheearlydaysofindustrialization,manyassumedthatthemanufacturingsectorwouldkeepgrowing.
Andforalongtime,itlookedtobethecase.Theshareofmanufacturingbothinoutputandinemploymentwasalmostconstantlyrisinginmostcountries.However,fromthe1960s,somecountriesstartedexperiencingdeindustrialization–afallintheshareofmanufacturing,andacorrespondingriseintheshareofservices,inbothoutputandemployment.Thispromptedthetalkofapost-industrialsociety.Manyeconomistshavearguedthat,withrisingincome,webegintodemandservices,suchaseatingoutandforeignholidays,relativelymorethanwedemandmanufacturedgoods.Theresultingfallintherelativedemandformanufacturingleadstoashrinkingroleformanufacturing,reflectedinloweroutputandemploymentshares.Thisviewgotaboostinthe1990s,withtheinventionoftheworldwidewebandtheallegedriseofthe
‘knowledgeeconomy’.Manyarguedthattheabilitytoproduceknowledge,ratherthanthings,wasnowcritical,andhigh-valueknowledge-basedservices,suchasfinanceandmanagementconsulting,wouldbecometheleadingsectorsintherichcountriesthatwereexperiencingdeindustrialization.Themanufacturingindustry–orthe‘bricksandmortar’industry–wasviewedassecond-rateactivitythatcouldbeshiftedtocheap-labourdevelopingcountries,suchasChina.Morerecently,evensomedevelopingcountrieshaveboughtintothediscourseofthepost-industrial
economy.Theyhavestartedbelievingthat,withtheriseofthepost-industrialeconomy,theycanmoreorlessskipindustrializationandbecomerichthroughservices.TheylooktoIndia,whichissupposedtohavebecome–throughitssuccessintheexportofserviceslikesoftware,accountancyandthereadingof
medicalscanningimages–‘theofficeoftheworld’toChina’s‘workshopoftheworld’(atitlewhichhadoriginallybeenconferredonBritainafteritsIndustrialRevolution).
Deindustrializationdoesn’tmeanthatweareproducingfewermanufacturedproducts
Whilemanypeople,includingkeypolicy-makers,havebeenseducedbyit,thediscourseofpost-industrialsocietyishighlymisleading.Mostrichcountrieshaveindeedbecome‘post-industrial’or‘deindustrialized’intermsofemployment;adecreasingproportionofthelabourforceinthesecountriesisworkinginfactories,asopposedtoshopsandoffices.Inmost,althoughnotall,countriesthishasbeenaccompaniedbyafallintheshareofmanufacturinginoutput.Butthisdoesnotnecessarilymeanthatthosecountriesareproducingfewermanufacturedgoodsin
absoluteterms.Muchofthisapparentfallisduetothedeclineinthepricesofmanufacturedgoods,comparedtothepricesofservices.Thisisthankstothefasterproductivitygrowthintheirproduction.Justthinkhowcomputersandmobilephoneshavebecomecheaper(holdingthequalityconstant),comparedwiththecostsofhaircutsoreatingout.Whenthisrelativepriceeffectistakenintoaccountandthesharesofdifferentsectorsarerecalculatedinconstantprices(thatis,applyingthepricesofthestartingyeartothequantitiesproducedinsubsequentyears),asopposedtocurrentprices(today’sprices),theshareofmanufacturinghasnotfallenverymuchinmostrichcountries.Ithasevenriseninseveralcountries,asIwillshowlater.
Somedeindustrializationisdueto‘opticalillusions’
Theextentofdeindustrializationhasalsobeenexaggeratedduetothe‘opticalillusions’createdbythewayinwhichstatisticsarecompiled.Alotofservicesthatusedtobeprovidedin-houseinmanufacturingfirms(e.g.,catering,securityguards,somedesignandengineeringactivities)arenowoutsourced,thatis,suppliedbyindependentcompanies(athomeorabroad;inthelattercasethisiscalledoff-shoring).Thisgivestheillusionthatserviceshavebecomemoreimportantthantheyactuallyhave.Theseoutsourcedservicesarestillthesameactivities.Buttheyarenowcountedaspartofserviceoutput,ratherthanofmanufacturingoutput.Inaddition,seeingtheshareofmanufacturingintheiroutputfalling,somemanufacturingfirmshave
appliedtobereclassifiedasservicefirms,eventhoughtheystillconductsomemanufacturing.AUKgovernmentreportestimatesthatupto10percentofthefallinmanufacturingemploymentbetween1998and2006intheUKmaybeduetothis‘reclassificationeffect’.7
Makingthingsstillmatters
Theviewthattheworldhasnowenteredaneweraofthe‘knowledgeeconomy’,inwhichmakingthingsdoesnotconfermuchvalue,isbaseduponafundamentalmisreadingofhistory.Wehavealwayslivedinaknowledgeeconomy.Ithasalwaysbeenthequalityofknowledgeinvolved,ratherthanthephysicalnatureofthethingsproduced(thatis,whethertheyarephysicalgoodsorintangibleservices),thathasmadethemoreindustrializedcountriesricher.Thispointcanbeseenmoreclearlyifyourecallthatwoollenmanufacturing,whichusedtobeoneofthemosthi-techsectorsuntiltheeighteenthcentury,isnowoneofthelower-techsectors.Inthisregard,itisusefultorememberthat‘Therearenocondemnedsectors;thereareonlyoutmodedtechnologies,’asaFrenchministerofindustryonceeloquentlyputit.8
Recently,someserviceactivities,suchasfinanceandtransport,haveexperiencedhighproductivitygrowths,whichhavecausedmanypeopletosaythatcountriescangenerateeconomicdevelopmentonthe
basisofsuchserviceactivities.LikeBritain,theycanexporthigh-valueservicesandusetheearningsfromthemtobuynecessarymanufacturedproductsfromabroad.Thisstrategymaybeviableforaperiod.Inthedecadeorsouptothe2008financialcrisis,Britainindeedmanagedtogenerateadecentrateofgrowthdespitearapidprocessofdeindustrialization,thankstoaboomingfinancialindustry.Butthe2008crisiswasarudereminderthatalotofthisfaithinservicesasthenewengineofgrowthhasbeenillusory.Moreover,manyofthesehigh-productivityservicesare‘producerservices’,suchasengineering,
designandmanagementconsulting,forwhichthemaincustomersaremanufacturingfirms.So,aweakeningmanufacturingbasewilleventuallyleadtoadeclineinthequalityofthoseservices,whichwillmaketheirexportmoredifficult.
REAL-LIFENUMBERSAgricultureisstillsurprisinglyimportant
Untilthelatenineteenthcentury,agriculturewasthemainstayoftheeconomyinalmostallcountries.9
Eveninmanyoftoday’srichcountries,nearlythree-quartersofpeopleworkedinagricultureuntilafewgenerationsago.In1870,72percentoftheworkforcewasemployedinagricultureinSweden.Thecorrespondingfigurewas73percentinJapanin1885.Beingalowerproductivitysectorthanmanufacturingorservices,agriculturehasrarelyaccountedfor
morethanhalfofoutput,evenwhenmostofthepeoplewereworkingthere.In1870,agricultureaccountedfor50percentofoutputinDenmarkand47percentinSweden.SouthKorea’sagricultureaccountedfor47percentofoutputuntilaslateas1953.Today,agricultureplaysaverysmallrole,intermsofbothoutputandemployment,intherich
countries.Only1–2percentoftheirGDPisproducedinagriculture,whileonly2–3percentofpeopleworkthere.Thishasbeenpossiblebecauseagriculturalproductivityinthosecountrieshasrisenenormouslyinthelastcenturyorso.ThefactthattheUS,FranceandtheNetherlands–andnotsomelargedevelopingeconomies,suchasIndiaorIndonesia–arethethreelargestexportersofagricultureintheworldisatestimonytotheheightofagriculturalproductivityintherichcountries.Inmanypoorerdevelopingcountries,agricultureisstillveryimportant.Inahandfulofpoorest
countries,morethanhalftheoutputisstillproducedinagriculture.*Eveninthericherdevelopingcountries,agriculturestillaccountsfor20–40percentofoutput.Agricultureplaysanevenmoreimportantrolewhenitcomestoemployment.Itemploys80–90per
centofpeopleinsomeofthepoorestcountries,suchasBurundi(92percent),BurkinaFaso(85percent)andEthiopia(79percent).Despitethecountry’simpressiveindustrializationinthelastthreedecades,37percentofpeopleinChinastillworkinagriculture.
Manufacturingintherichcountriesislessimportantthanbefore…
Attheirpeaks(betweenthe1950sandthe1970s,dependingonthecountry),nearly40percentoftheworkforceinthethenindustrializedcountriesofWesternEuropeandtheUSworkedinthemanufacturingsector.Thenumberreachednearly50percentifyoulookedatindustryasawhole.Today,inmostrichcountries,lessthan15percentofpeopleworkinmanufacturing.Exceptionsare
countriessuchasTaiwan,SloveniaandGermany,whereupwardsof20percentarestillemployedin
manufacturing.*Insomeofthem,suchastheUK,theNetherlands,theUSandCanada,thecorrespondingnumberisonlyaround9–10percent.Thefallinemploymentshareofmanufacturinghasbeenaccompaniedbyafallinoutputshare.Insome
countries,suchasAustria,FinlandandJapan,theshareofmanufacturinginGDPusedtobearound25percentuntilthe1970s.Today,innoneoftherichestcountriesdoesitaccountformorethan20percent.10
…Butitisstillfarmoreimportantthanpeoplethinkitis
IhaveexplainedabovethatmuchoftheapparentdeclineintheshareofmanufacturinginGDPisduetothefasterproductivitygrowthinmanufacturing,whichmakesmanufacturingproductsrelativelycheapercomparedtootherthings(servicesandagriculturalproducts).Thismeansthattheshareofmanufacturingcanbeverydifferent,dependingonwhetheritiscalculatedinconstantprices(toremindyou,thepricesatthebeginningoftheperiodwearelookingat)orcurrentprices.Duringthelasttwodecades,insomerichcountries,suchasGermany,ItalyandFrance,thefallinthe
shareofmanufacturinginGDPhasbeenquitelargeincurrentprices(by20percentinGermany,30percentinItalyand40percentinFrance),butnotbeensolargeinconstantprices(bylessthan10percentinallthree).11Inseveralrichcountries,theshareofmanufacturinghasactuallyrisen,ifcalculatedinconstantprices:intheUSandSwitzerland,itssharehasrisenbyaround5percentinthelastcoupleofdecades;12inFinlandandSweden,thesharehasactuallyrisenbyasmuchas50percentoverthelastfewdecades.13
AnimportantexceptionistheUK,inwhichtheshareofmanufacturinghasfallendramaticallyinthelastcoupleofdecades,eveninconstantprices.14ThissuggeststhattheUK’sdeindustrializationhaslargelybeentheresultoftheabsolutedeclineofitsmanufacturingindustryduetolossofcompetitiveness,ratherthantherelativepriceeffectduetodifferentialproductivitygrowthrates.
‘Premature’deindustrializationindevelopingcountries
Inthelastthreedecades,manydevelopingcountrieshaveexperienced‘premature’deindustrialization.Thatis,theshareofmanufacturing(andindustryingeneral)intheiroutputsandemploymentsstartedfallingatamuchearlierstageofeconomicdevelopmentthanhadbeenthecasefortherichcountries.LatinAmerica’sshareofmanufacturinginGDProsefrom25percentinthemid-1960sto27percent
inthelate1980sbuthasfallendramaticallysincethen.Itstandsatonly17percenttoday.InBrazil,theindustrialpowerhouseofthecontinent,deindustrializationhasbeenevenmoredramatic.TheshareofmanufacturinginGDPhasfallenfrom34percentinthemid-1980sto15percenttoday.InSub-SaharanAfrica,thesharehasfallenfrom17–18percentduringthe1970sandmuchofthe1980sto12percenttoday.15
Thisprematuredeindustrializationislargelytheresultofneo-liberaleconomicpoliciesimplementedinthesecountriessincethe1980s(seeChapter3).16Suddentradeliberalizationhasdestroyedswathesofmanufacturingindustriesinthosecountries.Financialliberalizationhasallowedbankstoredirecttheirloansto(morelucrative)consumers,awayfromproducers.Policiesgearedtowardsinflationcontrol,suchashighinterestratesandover-valuedcurrencies,haveaddedtotheagonyofmanufacturingfirmsbymakingloansexpensiveandexportsmoredifficult.
Service-basedsuccessstories?:Switzerland,SingaporeandIndia
Whentalkingaboutthepost-industrialeconomy,peoplefrequentlyciteSwitzerlandandSingaporeastheexamplesofservice-basedsuccessstories.Haven’tthesetwocountriesshown,theysay,thatyoucanbecomerich–veryrich–throughservicessuchasfinance,tourismandtrading?Actuallythesetwocountriesshowtheexactopposite.AccordingtotheUNIDOdata,in2002,
Switzerlandhadthehighestpercapitamanufacturingvalueadded(MVA)intheworld–24percentmorethanthatofJapan.In2005,itrankedthesecond,afterJapan.Singaporerankedthethirdinthatyear.In2010,Singaporerankedthefirst,producing48percentmoreMVApercapitathantheUS.Switzerlandrankedthethird,afterJapan.Switzerlandproduced30percentmoreMVAthantheUSinthatyear.AsfortheclaimthatIndiahasshownhowcountriescanskipindustrializationandachieveprosperity
throughservices,itisverymuchexaggerated.Before2004,Indiahadatradedeficitinservices(namely,itimportedmoreservicesthanitexported).Between2004and2011,itdidrunatradesurplus(oppositeoftradedeficit)inservices,butthatwasequivalentonlyto0.9percentofGDP,coveringonly17percentofitstradedeficitingoods(5.1percentofGDP).Itishardlyaservice-basedsuccessstory.
RunningOutofthePlanet?:TakingEnvironmentalSustainabilitySeriouslyWeneedtotakeenvironmentalconstraintsextremelyseriously
Beforeweleavetheworldofproduction,wemustaddresstheloomingquestionoftheenvironmentallimitstoeconomicgrowth.Thereisnodoubtthatclimatechange,mainlycausedbyourmaterialproductionandconsumptionactivities,threatenshumanexistence.Moreover,manynon-renewableresources(suchasoilandminerals)arerapidlybeingdepleted.Eventheearth’scapacitytoproducerenewableresources,suchasagriculturalproductsorforestryproducts,maybeoutpacedbytheincreaseindemandforthoseresources.Givenallofthis,wearegoingtorunoutoftheplanet,sotospeak,ifwedonotfindwaystocontroltheimpactsofoureconomicactivitiesontheenvironment.Butdoesn’tthismeanthatweshouldstopeconomicdevelopment,whichIhavedefinedastheincrease
inourcapabilitiestoproduce?Ifso,doesn’tthatnegatealotofthingsIhavesaidsofarinthechapter?
Technologicaldevelopmentscanbesolutions,aswellascauses,ofenvironmentalproblems…
Itmusthavebeen1975or1976,asIthinkIwastwelveorthirteen.Icameacrossthisbook,TheLimitstoGrowth,byacuriouslynamedauthor,theClubofRome.Flickingthroughthebook,eventhoughIcouldn’tfullyunderstandit,Ibecameverydepressed.Itsaidthattheworldwillrunoutofoilin1992orthereabouts.So,evenbeforeIturnthirty,Ithought,Iamsupposedtostartridingaroundinbullockcartsandburnwoodforheating?Thatseemedmightilyunfair,especiallywhenmyfamilyhadmovedtoahousewithoil-burningcentralheatingsystemonlyfiveorsixyearsearlier.ThepredictionbytheClubturnedouttoberight.Wehaverunoutofoil–thatis,theoilthatwas
accessiblewiththetechnologiesofthe1970s.Butwearestillburningoilinhugequantitiesbecausewehavebecomemuchmoreefficientinlocatingandextractingoilfromplacesthatwerejustnotaccessiblefortyyearsago,especiallythedeepsea.Technologydoesnotonlygiveusaccesstoformerlyinaccessibleresourcesbutitexpandsthe
definitionofwhatisaresource.Seawave,formerlyonlyadestructiveforcetobeovercome,hasbecomeamajorenergyresource,thankstotechnologicaldevelopment.Coltanusedtobeararemineralofrelativelylittlevalueuntilthe1980s.Today,itisoneofthemostvaluablemineralsintheworld–tothe
extentthatmanyrebelgroupsintheDemocraticRepublicofCongoaresaidtofinancetheirwarswithslavelabourincoltanmines.Tantalum,oneofthecomponentelementsofcoltan,isakeyingredientinthemakingofpartsusedformobilephonesandotherelectronicgoods.Atalessdramaticlevel,technologicaldevelopmentallowsustoproducerenewableresourceswith
greaterefficiency.AsIpointedoutearlierinthechapter,overthelastcentury,humanity’sabilitytoproducefood–andothernaturalrawmaterials(e.g.,cotton)–hasbeenenormouslyincreasedbymechanization,useofchemicals,selectivebreedingandgeneticengineering.Wehavealsobecomemoreefficientintheuseofgivenresources.Carandaircraftenginesandpowerstationsuselessoilandcoaltogetthesameamountofenergy.Werecycleanincreasinglyhigherproportionofourmaterials.
…buttherearelimitstotechnologicalsolutions
Howeverfastourtechnologiesdevelop,therearestilldefinitelimitstotheavailabilityofnon-renewableresources,evenincludingthosenaturalsubstancesthatareyettobecomeresources.Wewon’tcompletelyrunoutofanyofthemajorresourcesinthenearfuture.Buttheirdeclining
availabilitycanmakethemunaffordabletopoorerpeople,threateningtheirwelfareorevenexistence.Therisingpriceofwaterisalreadyhurtingpoorpeoplebyincreasingwaterbornediseasesandreducingtheiragriculturalyields.Higherfoodpriceswouldincreasehungerandmalnutrition.Moreexpensivefuelwouldcauseextradeathsofpoorelderlypeopleinwinterevenintherichcountries.AsintheworldofNealStephenson’sscience-fictionnovelTheDiamondAge,poorpeoplemaybeforcedtocopewithflimsysyntheticsubstitutesmadewithnano-technology,ratherthanrealnaturalmaterials.Farmoreurgent,ofcourse,isthechallengeofclimatechange,whoseconsequencesarealreadybeing
feltandcertaintobecomeextremelyserious,ifnotnecessarilycatastrophic,withinthenextgenerationortwo.Andgiventhis,itisextremelyunlikely,ifnotlogicallyimpossible,thathumanitywillbeabletocomeupwithapurelytechnologicalsolutiontoclimatechangeintimethatdoesnotrequireanysignificantchangeinthewayinwhichwelive.
Developingcountriesstillneedmoreeconomicdevelopmentinordertoraisetheirlivingstandardsandtobetteradapttoclimatechange
Allofthisdoesnotmeanthatweneedtostopeconomicdevelopment,especiallyfordevelopingcountries.Tobeginwith,developingcountriesstillneedmoreoutput–thatis,economicgrowth–providedthatitisnottotallyappropriatedbyatinyminority.Higherincomeforthesecountriesdoesn’tjustmeananotherTVbutworkinginlessback-breakinganddangerousconditions,nothavingtoseeyourchildrendieasbabies,livinglonger,fallingilllessoftenandsoon.Suchchangeswouldbemoresustainableiftheycamefromeconomicdevelopment(thatis,increaseintheirproductivecapabilities)ratherthansimplegrowth,butevengrowthcomingfromaresourcebonanzawouldbevaluableforthesecountries.Developingcountriesalsoneedtoincreasetheirproductivecapabilitiestobeabletodealwiththe
consequencesofclimatechange(climateadaptationisthetechnicalterm).Duetotheirclimate,locationsandgeography,manydevelopingcountriesaregoingtobearthebruntoftheimpactsofglobalwarming,despitehavingverylittle,ifnotnecessarilyminimal,responsibilityforcausingit.Despitethis,theseareexactlythecountrieswiththeleastcapabilitytodealwiththoseimpacts.*Inordertobetterdealwiththeconsequencesofclimatechange,poorcountriesneedtoequipthemselveswithbettertechnologiesandorganizationalcapabilities,whichcanonlybeacquiredthrougheconomicdevelopment.
Thecaseforhavingmoreeconomicgrowthanddevelopmentintheleast-developedcountriesisoverwhelming,asgrowingtheirincometoacertainlevel(say,whereChinaistoday)wouldmakeatmostamarginaldifferencetoclimatechange,as,forexample,discussedintheGreenhouseDevelopmentRights(GDR)framework,developedbytwothinktanks,Eco-EquityandtheStockholmEnvironmentalInstitute.17
Richcountriesshouldcontinuetodeveloptheireconomiesbutradicallychangetheirproductionandconsumptionpriorities
Giventhattheyarealreadyconsumingthevastbulkoftheworld’sresourcesandtheyhavefarfewerneedstoincreaseconsumption,therichcountriesneedtoreducetheirconsumption,ifwearetodampentheextentofclimatechange.Butevenwithloweraggregateconsumption,humanwelfareneednotgodown.InhighlyunequalcountriesliketheUS,BritainandPortugal,reductionininequalitywillallowmoreconsumptionformorepeople.Eveninrelativelyequalsocieties,welfarecanbeincreasedwithoutincreaseinconsumptionbyconsumingdifferently,ratherthanconsumingmore.18Increaseintheconsumptionofcollectiveservices,especiallypublictransportandleisurefacilities,canimprovewelfarebyreducingtheresourceswastedinfragmentedindividualisticconsumption:timewastedinsittinginacarinatrafficjamorduplicationofservicesbetweensmallprivatelibrariesthatarepopularincountrieslikeKorea.Inadditiontoreducingtheamountofconsumption,itsenergyintensitycanbereduced.Stricterenergy
efficiencyrequirementsonbuildings,carsandelectricalequipmentmaybeimposed.Out-of-townshoppingcentresandsuburbandevelopmentscouldbediscouraged,whileinvestmentsinbetterpublictransportaremade,sothatpeopledriveless.Culturalshiftsmayalsobeneededifpeoplearetofindmorejoyinhavingqualitytimewithfamilyandfriendsthanbuyingthings.Continued,orevenincreased,useofnuclearpowershouldbecontemplatedoutsidemajorearthquakeareas(suchasJapan,partsoftheUSandChile)asatransitionalmeasurebeforewecompletelyshifttorenewableenergysources.19
Butallofthisdoesnotmeanthattherichcountriesshouldstopeconomicdevelopment,atleastinthesenseinwhichIhavedefineditinthischapter.Theycanstillincreasetheirproductivecapabilitiesbutusethemnottoincreasematerialconsumptionbuttoreduceworkinghourswhileproducingthesameamountas,orevenmorethan,before.Theycandevelop–andtransfertodevelopingcountriesataffordableprices–theirproductivecapabilitiesinactivitiesthatcombatclimatechangeandotherenvironmentalproblems,suchasbetterrenewableenergytechnologies,moreefficientbutenvironmentallyfriendlyagricultureandmoreaffordabledesalinationtechnology.
ConcludingRemarks:WhyWeNeedtoPayMoreAttentiontoProduction
Productionhasbeenseriouslyneglectedinthemainstreamofeconomics,whichisdominatedbytheNeoclassicalschool.Formosteconomists,economicsendsatthefactorygate(orincreasinglytheentranceofanofficeblock),sotospeak.Theproductionprocessistreatedasapredictableprocess,pre-determinedbya‘productionfunction’,clearlyspecifyingtheamountsofcapitalandlabourthatneedtobecombinedinordertoproduceaparticularproduct.Insofarasthereisinterestinproduction,itisatthemostaggregatelevel–thatofthegrowthinthesize
oftheeconomy.Themostfamousrefrainalongthisline,comingfromthedebateonUScompetitivenessinthe1980s,isthatitdoesnotmatterwhetheracountryproducespotatochipsormicro-chips.Thereis
littlerecognitionthatdifferenttypesofeconomicactivitymaybringdifferentoutcomes–notjustintermsofhowmuchtheyproducebutmoreimportantlyintermsofhowtheyaffectthedevelopmentofthecountry’sabilitytoproduce,orproductivecapabilities.Andintermsofthelattereffect,theimportanceofthemanufacturingsectorcannotbeover-emphasized,asithasbeenthemainsourceofnewtechnologicalandorganizationalcapabilitiesoverthelasttwocenturies.Unfortunately,withtheriseofthediscourseofpost-industrialsocietyintherealmofideasandthe
increasingdominanceofthefinancialsectorintherealworld,indifferencetomanufacturinghaspositivelyturnedintocontempt.Manufacturing,itisoftenargued,is,inthenew‘knowledgeeconomy’,alow-gradeactivitythatonlylow-wagedevelopingcountriesdo.Butfactoriesarewherethemodernworldhasbeenmade,sotospeak,andwillkeepbeingremade.
Moreover,eveninoursupposedpost-industrialworld,services,thesupposedneweconomicengine,cannotthrivewithoutavibrantmanufacturingsector.ThefactthatSwitzerlandandSingapore,whichmanypeopleconsidertobetheultimateexamplesofsuccessfulservice-ledprosperity,areactuallytwoofthethreemostindustrializedcountriesintheworld(togetherwithJapan)isatestimonytothis.Contrarytoconventionalwisdom,developmentofproductivecapabilities,especiallyinthe
manufacturingsector,iscrucialifwearetodealwiththegreatestchallengeofourtime–climatechange.Inadditiontochangingtheirconsumptionpatterns,therichcountriesneedtofurtherdeveloptheirproductivecapabilitiesintheareaofgreentechnologies.Evenjusttocopewiththeadverseconsequencesofclimatechange,developingcountriesneedtofurtherdeveloptechnologicalandorganizationalcapabilities,manyofwhichcanonlybeacquiredthroughindustrialization.
FurtherReadingM.ABRAMOVITZ
ThinkingaboutGrowth(Cambridge:CambridgeUniversityPress,1989).
F.ACKERMAN
CanWeAffordtheFuture?:TheEconomicsofaWarmingWorld(London:ZedBooks,2009).
H.-J.CHANG
23ThingsTheyDon’tTellYouaboutCapitalism(London:AllenLane,2010).
T.JACKSON
ProsperitywithoutGrowth:EconomicsforaFinitePlanet(London:Earthscan,2009).
S.KUZNETSModernEconomicGrowth:Rate,StructureandSpeed(NewHavenandLondon:YaleUniversityPress,1966).
N.ROSENBERG
InsidetheBlackBox:TechnologyandEconomics(Cambridge:CambridgeUniversityPress,1982).
R.ROWTHORNANDJ.WELLS
De-industrializationandForeignTrade(Cambridge:CambridgeUniversityPress,1987).
J.SCHUMPETER
Capitalism,SocialismandDemocracy(London:Routledge,2010).
Michaeldoesnotunderstand.Eventhoughhehasgivenbacktohisfathertheverythingthathascausedallthetrouble,ithasnotmadethingsrightagain.Whyaregrown-upssostrange?MichaelwantedtousehistuppencecointobuybirdfeedfromthatoldladysittingonthestepsofStPaul’sCathedral,buthisfathertrickedhimoutofit.HisfathersaidhewouldshowwhatmoreinterestingthingscouldbedonewithMichael’smoneywhenheandthechildren(Michaelwaswithhissister,Jane)gettohiswork.WhenMichaelandJanegotthere,thisveryoldmancalledMrDawes,the‘directors’(ashecalled
them)andeventheirfatherstartedsingingaboutdepositinghistuppenceinDawes,Tomes,Mousely,GrubbsFidelityFiduciaryBank(whataname).Theysaidthatthismoneywillmakehimpartofallthesethingshehasneverheardofinstrangeplaces–‘railwaysthroughAfrica;damsacrosstheNile;fleetsofoceangreyhounds;majestic,self-amortizingcanals;andplantationsofripeningtea’.Mesmerizedbythesong,Michaelmomentarilylostconcentrationandopenedhisfist,atwhichpointMrDawes,surprisinglyquicklyforsuchanoldman,snatchedthecoin.Naturally,Michaelshouted‘givemebackmymoney!’,butthissomehowmadeallthebank’s
customersrushtowithdrawtheirmoney.Thebankrefusedtopaythem,andchaosensued.HeandJaneintheendmanagedtograbthecoinbackfromtheoldmanandranaway,butuponreturninghometheyfoundoutthathisfatherhadbeenfiredfromworkforwhathadhappened.Michaelhasgiventhetuppencecoinbacktohisfather,buthisfatherhasnotgothisjobback.Whydidwhathesaidcausesuchaproblem?Whydidallthosepeoplewanttheirmoneybacktoo?
Moreconfusingly,howcouldthebankrefusetopaythecustomerstheirownmoney?
Banksandthe‘Traditional’FinancialSystemBanksmakepromisesthattheycannotquitekeep
TheaboveisaretellingofthefamousbanksceneanditsaftermathintheDisneymovieMaryPoppinsfromthepointofviewofMichaelBanks,theboytowhomMaryPoppinsisthemagicalnanny.Andthesceneisbyfarthebestsummaryofwhatbankingisabout:confidence.WhatcausedtroubleattheFidelityFiduciaryBankis,toputitbluntly,thatithadmadepromisesthatit
couldnotquitekeep.Likeallotherbanks,ithadpromisedtheholdersofdepositaccountsthattheywouldbepaidincashupondemand,whenithadonlyenoughcashtopayaproportionofthem.*Abankmakingsucha‘false’promiseisusuallynotaproblem.Atanygivenpointoftime,onlyasmall
proportionofthedepositorswouldwanttowithdrawtheirmoney,soitissafeforthebanktohavecash(or‘nearcash’,suchasgovernmentbondsthatcanbequicklysold)thatisonlyafractionoftheamountinitsdepositaccounts.Butifadepositaccountholderdevelopsanydoubtaboutthebank’sabilitytopayherback,shehasthe
incentivetowithdrawhermoneyassoonaspossible.Sheknowsthatherbankactuallydoesnothavethecashtopayallherfellowdepositors,shouldasufficientnumberofthemwanttowithdrawtheirdepositsincashatthesametime.Eventhoughthebeliefmaybetotallyunfounded–aswasthecasewiththe
FidelityFiduciaryBank–itwillbecomea‘self-fulfillingprophecy’ifenoughaccountholdersthinkandactinthisway.Thissituationisknownasabankrun.Wehaveseenexamplesofitinthewakeofthe2008global
financialcrisis.CustomersqueuedupinfrontofNorthernRockbankbranchesintheUK,whileonlinedepositorsintheUKandtheNetherlandscloggedupthewebsiteofIcesave,theinternetarmofthecollapsingIcelandicbankLandsbanki.
Bankingisaconfidencetrick(ofasort),butasociallyusefulone(ifmanagedwell)
So,isbankingaconfidencetrick?Itis–sortof.Strictlyspeaking,aconfidencetrickinvolvesmakingthevictimbelieveinsomethingthatisfalse.Inthecaseofbanking,itinvolvesmakingpeoplebelieveinsomethingthatcouldbetrueorfalse,dependingonhowmanyothersbelieveinit.Ifenoughsaversinabankbelievethattheirbankwillbeabletopaythembackanytimetheywant,itwillindeedbeabletodoso.Iftheydon’t,itwon’t.*Thefactthatbankinginvolvesaconfidencetrick(ofasort)haspromptedsomepeopletoarguefor
‘narrowbanking’,whichrequiresbankstoholdenoughcashtopayallitsdepositorsatthesametime.But,whenyouthinkaboutit,theconfidencetrickisactuallythewholepointofbanking–creatingmoremoneythantheyhaveincashbytakingadvantageofthefactthat,whileweallwanttheflexibility,ortheliquidity,providedbycash,wedon’tallneeditatthesametime.Thebanks’abilitytocreatenewmoney(thatis,credit)isboughtexactlyatthecostofinstability–that
is,theriskofhavingruns.Buttheaddeddifficultyisthat,oncethereisarunonsomebanks,therecouldbeacontagionacrossallthebanks.Thisisnotjustaboutpeoplebecominghyper-sensitiveandsuspectingallbanksbecausetheyare,well,
banks.Itisalsobecausebanksborrowfromandlendtoeachotherintheinter-bankloanmarketand,increasingly,buyandsellfinancialproductsfromeachother(moreonthisbelow).Thismeansthatconfidenceinbankshastobemanagedatthelevelofthewholebankingsystem,ratherthanatthelevelofindividualbanks.
Thecentralbankisthemostimportanttoolofmanagingconfidenceinthebankingsystem
Theclassicsolutiontothisconfidenceproblemistohaveacentralbankthatcan‘printmoney’atwill,usingthemonopolyithasinissuingnotes(andcoins),andletitlendwithoutlimittoabankthatisexperiencingaconfidenceproblem.However,this‘trick’worksonlyinsofarastheconfidenceproblemisoneofcashflows–orwhatiscalledaliquiditycrisis.Inthissituation,thebankintroubleownsassets(loansthatithasmade,bondsandotherfinancialassetsithasbought,etc.)whosevaluesaregreaterthanitsliabilities(deposits,bondsithasissued,loansfromanotherbank,etc.)butitcannotimmediatelysellthoseassetsandmeetallliabilitiesthataredue.Ifthebankhasasolvencycrisis,whichmeansthatthetotalvalueofitsliabilitiesexceedsthatofits
assets,noamountofcentralbanklendingwillfixtheproblem.Eitherthebankwillgobankruptorrequireagovernmentbail-out,whichhappenswhenthegovernmentinjectsnewcapitalintothetroubledbank(ashappenedwithNorthernRockandIcesave).Governmentbail-outofbankshasbecomehighlyvisibleafterthe2008crisis,butitisapracticethathasbeengoingonthroughoutthehistoryofcapitalism.
Shoringupconfidencefurther:depositinsuranceandprudentialregulation
Acountrycanalsoshoreupconfidenceinitsbanksthroughdepositinsurance,aswellasthroughcentralbanking.Underthisinsurancescheme,thegovernmentcommitsitselftocompensatealldepositorsuptoacertainamount(forexample,€100,000intheEurozonecountriesatthemoment),iftheirbanksareunabletopaytheirmoneyback.Withthisguarantee,saversdonothavetopanicandwithdrawtheirdepositsattheslightestfallinconfidenceintheirbanks.Thissignificantlyreducesthechanceofabankrun.Anotherwaytomanageconfidenceinthebankingsystemistorestricttheabilityofthebankstotake
risk.Thisisknownasprudentialregulation.Oneimportantmeasureofprudentialregulationisthe‘capitaladequacyratio’.Thislimitstheamountthatabankcanlend(andthustheliabilitiesitcancreateintheformofdeposits)toacertainmultipleofitsequitycapital(thatis,themoneyprovidedbythebank’sowners,orshareholders).Suchregulationisalsoknownas‘leverageregulation’,asitisaregulationonhowmuchyoucan‘leverage’youroriginalcapital.Anothertypicalmeasureofprudentialregulationis‘liquidityregulation’,thatis,todemandthateachbankholdsmorethanacertainproportionofitsassetsincashorotherhighly‘liquid’assets(assetsthatcanbequicklysoldforcash,suchasgovernmentbonds).
The‘traditional’financialsystem(asofthemid-twentiethcentury)
Bythemiddleofthetwentiethcentury,theadvancedcapitalistcountrieshadacquiredafairlywell-functioningfinancialsystem,whichfacilitatedtheGoldenAgeofcapitalism.Attheheartofthesystemwasthebankingsector,whichwehavejustdiscussed.Theotherkeyelementswerethestockmarketandthebondmarket,whichcanbedividedintothegovernmentbondmarketandthecorporatebondmarket.Stockmarketsenabledcompaniestoraisemoneyonalargescalebyallowingthemtoselltheirshares
toinvestorsthattheydon’tknow–or,ifyoulike,anonymousinvestors(thisiswhythelimitedliabilitycompanyinsomecountriesiscalledthe‘anonymoussociety’,asinSociedadAnónimainSpain).Whenacompanysellsitssharesforthefirsttimetooutsidersandturnsitselffromaprivatecompany
(acompanywhosesharesarenotsoldtothegeneralpublic)intoapubliccompany(acompanywhosesharesare),wecallittheinitialpublicoffering(ortheIPO).Youmayhaveheardoftheterminthecontextsofthe‘tech’giantsGoogleandFacebook‘goingpublic’in2004and2012respectively.Sometimescompaniesthatarealreadypublicissuenewshares,toraiseadditionalmoney.Allowingcompaniestoraisemoneybysellingnewsharesisonlyoneofthefunctionsofthestock
market.Anotherimportantfunctionofit–actuallythemoreimportantfunctioninsomecountries,suchastheUSandtheUK–istoallowcompaniestobeboughtandsold;themarketforcorporatecontrolisthefancyterm.Ifanewshareholder(oragroupofshareholdersworkingtogether)gainsthemajorityofsharesofacompany,she(orthegroup)willbecomeitsnewowner(s)anddictateitsfuture.Thisisknownasanacquisitionortakeover(asin‘hostiletakeover’,whichwediscussedinChapter3).GeneralMotors(GM)wascreatedoutofaseriesofacquisitionsintheearlytwentiethcentury.*ThepurchaseofNokiamobilephonedivisionbyMicrosoftisthemosthigh-profilecorporateacquisitionintherecentperiod.Sometimestwoormorecompaniesmayfusethemselvesintoasinglenewentitybypoolingtheirshares.Thisisknownasamerger.Themostfamous,orratherinfamous,mergerwastheonebetweenTimeWarner,thegiantoftraditionalmedia,andAOL,theinternetservicepioneer,in2001.†TheNewYorkStockExchange(NYSE)(foundedin1817),theLondonStockExchange(LSX)
(foundedin1801)andtheTokyoStockExchange(TSE)(foundedin1878)havebeenthelargeststock
marketsduringmuchofthepost-SecondWorldWarperiod.TheNASDAQ(NationalAssociationofSecuritiesDealersAutomatedQuotation),anotherUSstockexchangefoundedasa‘virtual’marketin1971(itdidnothaveaphysicalmarketplace,liketheNYSE,inthebeginning),hasgrownrapidlysincethe1980s,thankstothefactthatmanyfast-growinginformationtechnologyfirmswere‘listed’there.Itisatthemomentthesecond-biggeststockexchangeintheworld,aftertheNYSE(theTSEisthethird-largest).Thepricemovementsinastockmarketareusuallyrepresentedbyastockmarketindex,recordingaveragepricemovementsofthesharesofaselectionofimportantcompanies,weightedbytheirrelativesizes.TheNYSEpricemovementsarecapturedbytheS&P500(compiledbyStandardandPoor,thecreditratingagency),theLSXonesbyFTSE100(compiledbytheFinancialTimes)andtheTSEonesbyNikkei225(compiledbytheNihonKeizaiShimbun,orJapanEconomicTimes).*Therewerealsobondmarkets,whichallowedcompaniesorgovernmentstoborrowdirectlyfrom
investorsbyissuingIOUs(bonds)thataretransferabletoanyoneandpayfixedamountsofinterest.However,thegovernmentbondmarketwasnotverydevelopedexceptintheUS(themarketforTreasurybills,or‘T-bills’forshort),whilethecorporatebondmarketwasnotverysignificantevenintheUS.ThelistofcorporatebondissuersintheUSapparentlyfittedintothreepagesinthe1968classicbySidneyHomer,TheBondBuyer’sPrimer.1
Withinthisbroadframework,therewereimportantinternationalvariations.IntheUSandtheUK,these(stockandbond)‘markets’werebigger(inrelativeterms)andmoreinfluentialthanincountrieslikeGermany,JapanorFrance,wherebanksplayedamuchmoreimportantrole.Forthisreason,theformercountrieswereknowntohave‘market-based’financialsystemsandthelatter‘bank-based’ones.Theformersystemissaidtogenerategreaterpressureforshort-termprofitsonthepartofenterprisesthanthelatter,asshareholders(andbondholders)havelesscommitmenttothecompaniesthey‘own’thanbanksdotothecompaniestheylendto.
InvestmentBanksandtheRiseoftheNewFinancialSystemBanksthatwedonotsee:investmentbanks
SofarIhavetalkedaboutthebankswesee:theoneswithbranchesoneveryhighstreet.ThesearebankslikeHSBCorNatWestthatactivelyadvertisethemselvesonTV,onbillboardsandonwebsites.Theyremindushownicetheyaretotheirdepositors(afreerailcardforstudents!OnlyUKcallcentres!).Theytellushowwillingtheyaretogiveusaloan,shouldwewishto,say,takeanimpulsiveforeignholidayorfulfilourlife-longdreamofopeningamuffinshop.Thesebanksareknownascommercialbanksordepositbanks.*Butthentherearebankswedonotsee.Theseareknownasinvestmentbanks.Someofthemshare
brandswiththeircommercialbanksiblings.Barclayshasacommercialbank,butalsohasaninvestmentbanknamedBarclaysCapital.Oritcouldbeonecompanyengagedinboth,usingdifferentbrands:JPMorganChasehasaninvestmentbankingarm,usingthebrandofJPMorgan,andacommercialbankingarm,usingthebrandofChaseManhattan.Otherinvestmentbanks–GoldmanSachs,MorganStanley,thenow-defunctLehmanBrothers,etc.–donothavecommercialsiblings.Mostofushaveheardofthem–especiallyGoldmanSachs,whohavebeeninfamouslylikenedtoa‘vampiresquid’bythejournalistMattTaibbi–butdon’tfullyunderstandwhattheydo.
Investmentbankshaveexistedsincethenineteenthcentury–sometimesasindependententitiesbutoftenaspartsofuniversalbanksthatperformbothtypesofbanking.Germanbanks,suchasDeutscheBankorCommerzbank,arethequintessentialexamples.IntheUS,duetotheGlass-SteagallAct,thecombinationofinvestmentbankingandcommercialbankinginasingleentitywasnotallowedbetween1933and1999.Sincethe1980s,thesebankshaveplayedtheleadingroleinreshapingthefinancialsystemonaglobalscale.
Investmentbanks’keyroleis(orusedtobe)tofacilitatethecreationandthetradingofsharesandbonds
Investmentbanksaresocalledbecausetheyhelpcompaniesraisemoneyfrominvestors–atleastthatwastheiroriginalpurpose.Theyarrangetheissuanceofsharesandcorporatebondsbytheirclientcompaniesandsellthemontheirbehalf.Whentheysellsharesandbondsfortheirclientcompanies,investmentbanksdonotdealwith‘retail’
investors,namely,smallindividualinvestorswhoonlybuysmallquantities.Theyonlydealwithlargeinvestors,suchasextremelyrichindividuals(‘highnetworthindividuals’isthejargon)orinstitutionalinvestors,thatis,largefundscreatedbyindividualinvestorspoolingtheirmoney.Themostimportanttypesoffundsinclude:pensionfunds,investingmoneythatindividualssavefor
theirpensions;sovereignwealthfunds,whichmanagestate-ownedassetsofacountry(GovernmentPensionFundofNorwayandAbuDhabiInvestmentCouncilaretwoofthebiggestexamples);mutualfundsorunittrusts,whichmanagemoneypooledbysmallindividualinvestorsthatbuyintothemintheopenmarket;hedgefunds,whichinvestactivelyinhigh-risk,high-returnassets,usingapooloflargesumsgiventothembyveryrichindividualsorother,more‘conservative’,funds(e.g.,pensionfunds);privateequityfunds,whicharelikehedgefunds,butmakemoneysolelyoutofbuyingupcompanies,restructuringthemandsellingataprofit.Inadditiontosellingsharesandbondsfortheirclientcompanies,investmentbanksbuyandsellshares
andbondswiththeirownmoney,hopingtomakeaprofitintheprocess.Thisisknownasproprietarytrading.Investmentbanksalsoearnmoneyfromhelpingcompaniestoengageinmergersandacquisitions(orM&A).Buttheservicethatinvestmentbanksprovideinthisprocessismoreofaconsultingservicethana‘banking’service.Sincethe1980s,andespeciallysincethe1990s,investmentbankshaveincreasinglyfocusedonthe
creationandthetradingofnewfinancialproducts,suchassecuritizeddebtproductsandderivativefinancialproducts,orsimplyderivatives.*Thesenewfinancialproductsbecamepopularamonginvestmentbanksbecause,toputitbluntly,theyletthemmakemoremoneythandid‘traditional’businesses,suchassellingsharesandbondsoradvisingonM&A.Exactlyhowtheydosoisrathercomplicated,asIshallexplainbelow.
Securitizeddebtproductsarecreatedbypoolingindividualloansintoacompositebond
Intheolddays,whensomeoneborrowedmoneyfromabankandboughtsomething,thelendingbankownedtheresultingdebtandthatwasthat.But‘financialinnovations’inthelastfewdecadeshaveledtothecreationofanewfinancialinstrumentcalledasset-backedsecurities(ABSs)outofthesedebts.AnABSpoolsthousandsofloans–forhomes,cars,creditcards,universityfees,businessloansandwhatnot–andturnsthemintoabigger,‘composite’,bond.Ifyouaredealingwithanindividualloan,itsrepaymentwoulddryupiftheparticularborrower
defaulted.Giventhisrisk,theseloanscannotbeeasilysoldtosomeoneelse.However,ifyoucreatean
ABSbypooling,forexample,thousandsofhomemortgageloans–whichisknownasaResidentialMortgageBackedSecurity(RMBS)–youcanbesurethatonaveragetheborrowerswillmakerepayments,evenifindividuallytheyhaverelativelyhighrisksofdefault(knownintheUSas‘subprime’mortgageborrowers).Intechnicalterms,theseproductspoolriskamongalargenumberofborrowers,likeinsuranceproductsdoamongtheinsured.Inthisway,illiquidassetsthatcannoteasilybesold(suchasamortgageforoneparticularhouse,a
loanforaparticularcar)areturnedintosomething(acompositebond)thatcanbeeasilytraded.UntiltheriseofABSs,bondscouldbeissuedonlybygovernmentsandbyverylargecompanies.Now,anything–downtoahumblestudentloan–couldbebehindabond.HavingsoldofftheoriginalloansbypackagingthemintoanABS,thelendercanusethemoneythatithasgotfromthesaletoextendevenmoreloans.Untilthe1980s,ABSsweremainlyconfinedtotheUSandmostlycreatedoutofresidentialmortgages.
But,fromtheearly1990s,ABSsmadeofotherloanscameonstreamintheUSandthengraduallytookoffinotherrichcountries,astheyabolishedregulationsthatrestrictedtheabilityoflendingbankstosellofftheirloanstoathirdparty.
YoucanmakeABSsmorecomplicated–andsupposedlysafer–through‘structuring’
Morerecently,thesefinancialproductshavebecomeevenmorecomplexsinceABSshavebecome‘structured’andbeenturnedintoCollateralizedDebtObligations(orCDOs).StructuringinthiscontextinvolvescombininganumberofABSs,suchasRMBSs,intoyetanothercompositebond,suchasCDO,anddividingthenewbondintoafewtranches(slices)withdifferentialrisks.Themost‘senior’tranchewouldbemadesaferby,say,theguaranteethatitsownerswillbeaskedtobearlossesthelast(thatis,onlyaftertheownersofallother,more‘junior’,trancheshaveabsorbedtheirlosses),shouldanylossoccur.Inthisway,averysafefinancialproductcouldbecreatedoutofapoolofrelativelyunsafeassets–thatwasatleastthetheory.*Aderivativeproductcalledacreditdefaultswap(CDS)wascreatedtosupposedlyprotectyoufromdefaultontheCDOsbyactingasaninsurancepolicyagainsttheriskofdefaultofparticularCDOs(Iwilldiscusswhatthe‘swap’isabitlater).
Poolingandstructuringsimplyshiftandobscurerisk,noteliminateit
Allofthiswasdeemedtohavereducedriskforthefinancialproductsconcerned–firstthroughsafetyinnumbers(pooling),andthenthroughthedeliberatecreationofsafetyzoneswithinthatpool(structuring).The‘senior’tranchesofCDOsthuscreatedwerefrequentlygivenAAAcreditratings,traditionally
reservedforthesafestofthefinancialassets,suchasthegovernmentbondsofahandfulofrichcountriesandatinyminorityofsuper-safecompanies.HavingbeengivenAAAratings,theseassetscouldnowbesoldtopensionfunds,insurancecompanies
andcharitablefoundations,whicharemandatedtobeconservativeintheirassetchoices.Commercialbanksalsoboughttheseassetsinlargequantities.CDOs,havingAAAratingsandthuseasilysellable,helpedbanksmeettheaforementionedliquidityregulationwhilebeingpaidhigherinterestratesthantraditionalAAA-ratedfinancialassets(whichusuallybroughtlowerreturns,inreturnforthesafetytheyoffered).Themarketsforstructureddebtproductsexploded.Butthefactstillremainedthatthesebondswereultimatelybasedonshakyassets–mortgageloans
giventoworkerswithunstableemploymentorcreditcarddebtsofconsumerswithachequeredfinancial
history.WhentheUShousingbubbleburst,eventhesupposedlysuper-safeseniortranchesofCDOsprovedexactlytheopposite.
Derivativesareessentiallybetsonhow‘otherthings’aregoingtounfoldovertime2
Inadditiontothe‘pooled’and‘structured’financialproducts,investmentbankshaveplayedakeyroleingeneratingandtradingderivativefinancialproducts,orsimplyderivatives,inthelastthreedecades.Derivativesaresocalledbecausetheydonothaveanyintrinsicvalueoftheirownand‘derive’their
valuesfromthingsoreventsexternaltothemselves,inmuchthesamewayinwhichsomeoneinManchestercanderivevaluefromaboxingmatchinLasVegasbyenteringintoabetonitwithabookmakerorevenafriend.3Youcouldsaythatderivativesarebetsonhowotherthingsaregoingtounfoldovertime.
Inthebeginning,derivativeswereconfinedtocommoditymarkets
Thesedays,derivativecontractscaninvolveanything–commodities(e.g.,rice,oil),financialassets(e.g.,shares,foreignexchange),prices(e.g.,stockmarketindexes,propertyprices),orevenweather.But,inthebeginning,theywerebasicallyconfinedtocommoditymarkets.Aclassicexampleisaricefarmerandaricemerchantgoingintoacontractspecifyingthatthefarmer
willsellhisricetothemerchantatapre-agreedpricewhenheharvestshisrice.Thistypeofcontractisknownasaforwardcontract,orsimplyaforward.Aforwardisnottheonlytypeofderivative,butlet’ssticktoitforthemoment,asitisthe‘prototype’derivative.Oncethecontractisestablished,aderivativebecomeslikeabetonthereal-worldthinguponwhichit
isbased.Inthisexample,holdingaforwardcontractforricebecomeslikeholdingabetonthefuturepriceofrice.
Over-the-countervs.exchange-traded:custom-madevs.standardizedderivatives
Manyderivativesare‘custom-made’–thatis,theyarebetweentwoparticularcontractingparties,suchasthericefarmerandthericemerchantintheexampleabove.Amoremodernexamplemightbeacompanyprotectingitselffromfluctuationsinexchangeratesbygoingintoaforwardcontractwithaninvestmentbanktoconvertaparticularcurrencyatapre-agreedexchangeratein,say,twenty-threedays’time.Thesecustom-madederivativesarecalledover-the-counter(OTC)derivatives.Derivativescontractsmaybe‘standardized’andsoldinexchanges,orbecomeexchange-traded–the
ChicagoBoardofTrade(CBOT),setupinthemid-nineteenthcentury,beingthemostimportantexample.Inthecaseofaforward,itisre-christenedwhenstandardized–thesearecalledfutures.AnoilfuturescontractmightspecifythatIwillbuyfromwhoeverhappenstoholdthatcontract,say,inayear’stime1,000barrelsofaparticulartypeofoil(BrentCrude,WestTexasIntermediate,etc.)at$100abarrel.
Derivativesallowhedgingagainstriskbutalsoenablespeculation
Thestandardjustificationforderivativesisthattheyalloweconomicactorsto‘hedge’againstrisk.IfIamanoilrefinery,Icanprotectmyselfagainstthepossibilitythattheoilpricemaygoabove$100abarrelinayear’stimebybuyinganoilfuturescontractthatIhavejustdescribedabove.ThismeansthatIwillloseoutiftheoilpricefallsbelow$100abarrel(asIhavetobuytheoilat$100abarrel,evenifitisonly$90abarrel,unlessIhavealreadysoldthecontractontosomeoneelse).Naturally,IwouldbuysuchacontractonlyifIbelievedthatthechanceofthepricefallingbelow$100abarrelissmall.
Thishedging,orprotective,functionis,however,nottheonly–orthesedaysnoteventhemain–functionofderivatives.Theyalsoallowpeopletospeculate(thatis,bet)onthemovementsofoilprices.Inotherwords,someonewhohasnoinherentinterestinthepriceofoilitself,whetherasaconsumerorasanoilrefinery,canmakeabetonthemovementsofoilprices.Thus,inaprovocativebutinsightfulanalogy,BrettScott,afinancialactivist,pointsoutthat‘[saying]thatderivativesexisttoallowpeopletohedgethemselves…[is]abitlikearguingthatthehorsebettingindustryexiststohelphorseownersprotectthemselvesfromrisk[oftheirhorseslosingarace].’4
Othertypesofderivativeshaveevolved–optionsandswaps
Overtime,derivativefamiliesotherthanforward/futureshaveevolved.Therearetwomaintypes–optionsandswaps.Anoptioncontractwouldgiveacontractingpartytheright(butnottheobligation)tobuy(orsell)
somethingatapricefixednowatsomeparticulardate.Theoptiontobuyiscalleda‘call’option,andtheoptiontoselliscalleda‘put’option.Optionshavebecomemorewidelyknownthrough‘stockoptions’–thatis,therighttobuyacertainnumberofstocks(shares)atapre-agreedpriceatsomefuturedate–giventotopmanagers(andsometimesotheremployees),toencouragethemtomanagecompaniesinawaythatraisesshareprices.Whereaforwardislikeabetonasinglefutureevent,aswapislikeabetonaseriesoffutureevents;
itislikeanumberofforwardcontractslinkedtogether.Forexample,itallowsyoutoreplaceaseriesofvariablefuturepaymentsorearningswithaseriesoffixedpaymentsorearnings,likecontractsforyourmobilephoneorfixed-priceelectricitydealsoveraperiod,accordingtoScott’sinstructiveanalogy.5Thevariationinpaymentsorearningscouldbeduetovariationsinallsortsofthings,sotherearemanydifferenttypesofswaps;interestrates(interestrateswaps),exchangerates(currencyswaps),commodityprices(commodityswaps),shareprices(equityswaps),orevendefaultriskofparticularfinancialproducts(CDSs).Atthispoint,yourheadmaybespinningatthecomplexityofthings,butthatisinawaythepoint.The
complexityofthesenewfinancialproductsisexactlywhatmadethemsodangerous,asIshallexplainlater.
Derivativetradetookoffinthe1980s
Derivativemarketswerenotverysignificantuntiltheearly1980s,althoughexchangesforcurrencyfuturesandstockoptionshadbeenestablishedbytheChicagoBoardofTradeinthe1970s.6
Thenahistoricchangecamein1982.Inthatyear,twokeyUSfinancialregulatorybodies,theSecuritiesandExchangeCommission(SEC)andtheCommodityFuturesTradingCommission(CFTC)agreedthatthesettlementofaderivativecontractdoesnothavetoinvolvethedeliveryoftheunderlyinggoods(e.g.,riceoroil)butcanbesettledincash.Thisnewregulatoryruleenabledtheproliferationofderivativecontractsthatarederivedfrom
‘notional’things,suchasthestockmarketindex,whichcanneverbephysicallydelivered,andnotjustcommoditiesorparticularfinancialassets.7Fromthenon,yourimaginationwasthelimittowhatkindofderivativecontractyoucouldcreate.
REAL-LIFENUMBERSTheexplosivegrowthoffinance
Untilthe1990s,therewereveryfewsecuritizeddebtproducts(ABS,CDO,etc.)aroundinEurope.But,accordingtotheOECD,by2010,themarketforthoseproductsinEuropewasestimatedtohavegrowntoaround$2.7trillion.ThiswasstillmuchsmallerthanthemarketintheUS,estimatedtobearound$10.7trillion,wheresuchproductshadalongerhistory,especiallywhenconsideringthattheEUhadaGDPthatwasover10percentbiggerthanthatoftheUS.8
Derivativemarketshavegrownevenfaster.Theyweremarginalmarketsuntilthe1980s.By2011,theIMFestimatedtheglobalOTCderivativemarkettobe$648trillionintermsof‘outstandingvalue’(thatis,thetotalvalueofthe‘bets’,whichusuallyexceedthevalueofunderlyingassetsbymanymultiples).The‘marketvalue’ofthecontractsthemselveswasestimatedtobe$27trillion,asagainst$110trillionofglobalbankingassetsand$70trillionofworldGDP(thesenumbersarenotreallycomparablewitheachother;theyaregiventoprovideasenseofmagnitude).9
Rapidgrowthwasnotconfinedtothenewfinancialproducts.Therestofthefinancialsectorhasalsogrownfast.Between1980and2007,theratioofthestockoffinancialassetstoworldoutputrosefrom1.2to4.4,accordingtothecalculationbyGabrielPalma.10
Therelativesizeofthefinancialsectorwasevengreaterinmanyrichcountries,especially–butnotexclusively–theUSandtheUK.AccordingtoPalma,theratiooffinancialassetstoGDPintheUKreached700percentin2007.*Usingdifferentdatasources,LapavitsasestimatesthattheUKnumberrosefromaround700percentinthelate1980stoover1,200percentby2009–or1,800percent,ifweincludedassetsownedabroadbyUKcitizensandcompanies.11JamesCrotty,usingAmericangovernmentdata,calculatedthattheratiooffinancialassetstoGDPintheUSfluctuatedbetween400and500percentbetweenthe1950sand1970s,butthatitstartedtoshootupfromtheearly1980s,followingfinancialderegulation.Itbrokethroughthe900percentmarkbytheearly2000s.12
TheNewFinancialSystemandItsConsequencesThenewfinancialsystemwastobemoreefficientandsafer
Allthismeantthatanewfinancialsystemhasemergedinthelastthreedecades.Wehaveseentheproliferationofnewandcomplexfinancialinstrumentsthroughfinancialinnovation,orfinancialengineering,assomepeopleprefertocallit.Thisprocesswasenormouslyfacilitatedbyfinancialderegulation–theabolitionorthedilutionofexistingregulationsonfinancialactivities,asIshalldiscusslater.Thisnewfinancialsystemwassupposedtobemoreefficientandsaferthantheoldone,whichwas
dominatedbyslow-wittedcommercialbanksdealinginalimitedrangeoffinancialinstruments,unabletomeetincreasinglydiversedemandsforfinancialrisk.Thebeliefwasthatgreaterfreedomofcontractwouldmaximizethechancethatfinancialmarketactorscouldcomeupwithinnovativewaystoassessriskandpriceassetsmoreefficiently,therebyenhancingthestabilityofthesystem.Thepossibilitythatthesenewfinancialinstrumentsmightbetoocomplicatedtobehandledsafelywas
brushedaway.Pro-marketeconomistsarguedthat,inafreemarket,acontractwillbesignedonlywhenthecontractingpartiesknowthattheywouldbenefitfromit,especiallywhentheyare‘largelysophisticatedfinancialinstitutionsthatwouldappeartobeeminentlycapableofprotectingthemselvesfromfraudandcounterpartyinsolvencies’,accordingtoLarrySummers,thethendeputysecretaryoftheTreasury,inhistestimonytotheUSCongressin1998.*
Oneofthose‘sophisticates’–acertainJoeCassano,whowasthenthechieffinancialofficerofAIG,theAmericaninsurancecompanybailedoutbytheUSgovernmentinthefallof2008–saidonlysixmonthsbeforethecollapseofhiscompany,‘Itishardforus,withoutbeingflippant,toevenseeascenariowithinanykindofrealmofreasonthatwouldseeuslosingonedollarinanyofthe[CDS]transactions.’Thisbeliefintheinfallibilityofthemarketwassharedbytheregulators.Attheheightofthehousing
bubbleintheUS,keypolicy-makerskeptdenyingthattherewasabubble.InJune2005,whileadmittingthatthereare‘signsoffrothinsomelocalmarkets’,AlanGreenspan,thethenFedchairman,assuredthemembersoftheUSCongressthat‘a“bubble”inhomepricesforthenationasawholedoesnotappearlikely’.Afewmonthslater,inOctober2005,BenBernanke–thethenchairmanoftheCouncilofEconomicAdviserstothePresident(GeorgeW.Bush)andtheFedchairmanbetweenFebruary2006andJanuary2014–statedinhisCongressionaltestimonythatthe25percentincreaseinhomepricesthattheUShadseenintheprevioustwoyears‘largelyreflectstrongeconomicfundamentals’.
Increasingcomplexityhasmadethefinancialsystemmoreinefficientandunstable
Despitetheseassurances,theUShousingbubbleburstin2007and2008–thepricesweresimplytoohigh,giventheperformanceoftheunderlyingeconomy,andcouldnotbesustainedanymore.WithitcamethecollapseofthemarketsforCDOsandCDSsthatfedonit,resultinginthebiggestfinancialcrisissincetheGreatDepression.Followingthe2008globalfinancialcrisis,somuchinformationhascomeoutthatshowshowthoserunningSummers’s‘sophisticated’financialinstitutionsandtheconfidentregulatorsreallydidnotunderstandwhatwasgoingon.Thiswasbecauseofthevastincreaseincomplexityofthefinancialsystem.Andwearenottalking
aboutthingsgettingalittlemorecomplicated.AndyHaldane,theexecutivedirectoroffinancialstabilityattheBankofEngland,oncepointedoutthatinordertofullyunderstandaCDO2–oneofthemore,butnotthemost,complicatednewfinancialproducts–aprospectiveinvestorneedstoabsorbmorethanonebillionpagesofinformation.13Ihavealsocomeacrossbankerswhoconfessedthattheyhadfrequentlygotderivativecontractsrunningafewhundredpages,whichtheynaturallydidn’thavethetimetoread.Complicatedmathematicalmodelsweredevelopedtodealwiththisinformationoverload,butintheendeventshaveprovedthemtobe,atbest,woefullyinadequateand,atworst,sourcesofafalsesenseofcontrol.Accordingtothesemodels,thechancesofwhathappenedin2008actuallyhappeningwereequivalenttowinningthelotterytwenty-oneortwenty-twotimesinarow.14
Increasinginterconnectednesshasalsoheightenedtheinstabilityofthefinancialsystem
Themoreliberaldefinitionofwhatisalegitimatefinancialcontract(e.g.,allowanceofindex-basedderivatives)andthepooling,structuringandvastlyincreasedtradingofthoseproductshaveoccurredinthecontextofageneralderegulationofthefinancialsector.StartingfromtheUSandtheUKintheearly1980s,countryaftercountryhasrelaxed,oreven
abolished,awiderangeoffinancialregulations:prudentialregulationforcommercialbanks,especiallyliquidityregulationandleverageregulation;ceilingsoninterestratesthatlenderscancharge;restrictionsonassettypesthatdifferentfinancialfirmscanhold,suchaspre-1980srestrictionsonUSSavings&Loaninstitutionsagainstmakingconsumerloansandcommercialrealestatemortgageloans;rulesonhowaggressivethelendingcanbe(e.g.,rulesonloan-to-house-valueratioformortgageloans);andthe
relaxation,andfrequentlyabolition,ofrestrictionsoncross-bordermovementofcapital(forfurtherdiscussiononthelast,seeChapter12).Theresulthasbeentheproliferationofconnectionsbetweendifferentpartsofthefinancialsystemlike
neverbefore.Thiswasnotonlyacrossdifferentsectors–forexample,commercialbanksandinsurancecompaniesgettingdeeplyinvolvedinderivativestrading–butalsoacrossdifferentcountries–thefirstsignofproblemswithAmericanCDOsin2008werenoticedbyGermanandSwissbankswhohadboughtthem.Withthisincreaseininterconnectedness,aprobleminonepartofthesystemrapidlyspreadtootherparts,vastlyincreasingtheinstabilityofthesystem.Thepointisthat,howeverdeftlyyoumaypool,structureandderiveyourfinancialproducts,itisinthe
endthesamesubprimemortgageborrowerinFlorida,thesamesmallcompanyinNagoyaandthesameguywhoborrowedmoneytobuyhiscarinNanteswhohavetopaybacktheloansthatunderlieallthosenewfinancialproducts.Andbycreatingallsortsoffinancialproductsthatlinkdifferentbitsofthesystem,youactuallyincreasetheintensitywithwhichthefailurebythesepeopletorepaytheirloansaffectsthesystem.
Howthenewfinancialsystemhasmadenon-financialcorporationsmoreshort-term-oriented
Theriseofnewfinancehasnotjustaffectedthefinancialsector.Ithasalsosignificantlychangedthewayinwhichnon-financialcorporationsarerun.ThechangewasparticularlypronouncedintheUSandtheUK,inwhichnewfinancehasadvancedthefurthestandinwhich,unlikeinGermanyorJapan,stakeholdersotherthanshareholdershavehadlittleinfluenceonhowcompaniesaremanaged.Thefirstimportantchangehasbeenafurthershrinkingtimehorizoninmanagement.Withtheriseof
hostiletakeoversinthe1980s(recallGordonGekkofromChapter3),companieshadalreadybeenputunderincreasingpressuretodelivershort-termprofits,ifnecessaryatthecostoflong-termcompetitiveness.Butwiththeproliferationofsomanyfinancialinstrumentsthatprovidequickandhighreturns,shareholdershavebecomeevenmoreimpatientinthelastcoupleofdecades.Forexample,intheUK,theaverageperiodofshareholding,whichhadalreadyfallenfromfiveyearsinthemid-1960stotwoyearsinthe1980s,plummetedtoabout7.5monthsattheendof2007.15
Thishasresultedintheformationofan‘unholyalliance’betweentheprofessionalmanagersofcorporationsandthegrowingbandofshort-termshareholders,undertherallyingcallof‘shareholdervaluemaximization’(seeChapter5).Inthisalliance,astronomicalsalarieswerepaidtomanagersinreturnformaximizingshort-termprofits–evenatthecostofproductqualityandworkermorale–anddistributingthebiggestpossibleproportionsofthoseprofitstotheshareholders,intheformofdividendsandsharebuy-backs(companiesbuyinguptheirownsharesinordertopropuptheshareprice).Suchpracticesleftveryfewresourceswithwhichthecompanycouldinvestinthingslikemachines,
R&Dandtraining,reducingitslong-termproductivityandthuscompetitiveness.Whenthecompanygetsintotrouble,mostoftheprofessionalmanagersandshort-termshareholderswhoorchestratedthedemisearenotevenwiththecompanyanymore.
Thefinancializationofnon-financialcorporations
Thenewfinancialsystemhasnotjustmadenon-financialcorporationsoperatewithashortertimehorizon.Ithasalsomadethemmore‘financialized’–thatis,moredependentonfinancialactivitiesoftheirown.Giventhehigherreturnsthatfinancialassetsbringcomparedwithtraditionalbusinesses,manycompanieshaveincreasinglydivertedtheirresourcestothemanagementoffinancialassets.Suchashift
infocushasmadethosecompaniesbecomeevenlessinterestedinbuildinguptechnology-basedlong-termproductivecapabilitiesthanwhatwasmadenecessarybytheincreasingpressurefromshort-term-orientedshareholders.Inthelastcoupleofdecades,someofthemhaveaggressivelyexpandedtheirfinancialarms–for
example,GECapitalbyGeneralElectric,GMACbyGMandFordFinancebyFord.Someofthemhavebecomesosignificantthat,inthesummerof2013,theFinancialStabilityOversightCounciloftheUSgovernmentdesignatedthebiggestofthem,GECapital,asoneofthe‘systematicallyimportantfinancialinstitutions’(SIFIs)–astatususuallyreservedforonlythebiggestbanks.
Theover-developmentofthefinancialsectoranditsconsequences
Underthenewregime,thefinancialsectorhasbecomemuchmoreprofitablethanthenon-financialsector,whichhadnotalwaysbeenthecase.16Thishasenabledittooffersalariesandbonusesthataremuchhigherthanthoseofferedbyothersectors,attractingthebrightestpeople,regardlessofthesubjectstheystudiedinuniversities.Unfortunately,thisleadstoamisallocationoftalents,aspeoplewhowouldbealotmoreproductiveinotherprofessions–engineering,chemistryandwhatnot–arebusytradingderivativesorbuildingmathematicalmodelsfortheirpricing.Italsomeansthatalotofhigher-educationalspendinghasbeenwasted,asmanypeoplearenotusingtheskillstheywereoriginallytrainedfor.*Thedisproportionateamountofwealthconcentratedinthefinancialsectoralsoenablesittomost
effectivelylobbyagainstregulations,evenwhentheyaresociallybeneficial.Thegrowingtwo-wayflowofstaffbetweenthefinancialindustryandtheregulatoryagenciesmeansthatlobbyingisoftennotevennecessary.Alotofregulators,whoareformeremployeesofthefinancialsector,areinstinctivelysympathetictotheindustrythattheyaretryingtoregulate–thisisknownastheproblemofthe‘revolvingdoor’.Moreproblematically,therevolvingdoorhasalsoencouragedaninsidiousformofcorruption.
Regulatorsmaybendtherules–sometimestothebreakingpoint–tohelptheirpotentialfutureemployers.Sometopregulatorsareevencleverer.Whentheyleavetheirjobs,theydon’tbothertolookforanewone.Theyjustsetuptheirownprivateequityfundsorhedgefunds,intowhichthebeneficiariesoftheirpastrule-bendingwilldepositmoney,eventhoughtheformerregulatorsmayhavelittleexperienceinmanaginganinvestmentfund.Evenmoredifficulttodealwithisthedominanceofpro-financeideology,whichresultsfromthe
sectorbeingsopowerfulandrewardingtopeoplewhoworkin–orfor–it.Itisnotsimplybecauseofthesector’slobbyingpowerthatmostpoliticiansandregulatorshavebeenreluctanttoradicallyreformthefinancialregulatorysystemafterthe2008crisis,despitetheincompetence,recklessnessandcynicismintheindustrywhichithasrevealed.Itisalsobecauseoftheirideologicalconvictionthatmaximumfreedomforthefinancialindustryisinthenationalinterest.
REAL-LIFENUMBERSTherehasbeenavastincreaseinthefrequencyoffinancialcrises
Formostpeople,the2008globalfinancialcrisisisprobablyproofenoughthatthenewfinancialsystemhasfailedtodeliveronitspromisesforgreaterefficiencyandstability.Butitisimportanttonote
thatthe2008crisiswaspresagedbymanyearlier,smallercrisesinthelastthreedecades.Thelist,evencountingonlythemajorones,isimpressive.In1982,Chilegotintoamajorbankingcrisis,followingtheradicalfinancialmarketliberalizationin
themid-1970sunderthePinochetdictatorship.Inthelate1980s,theSavingsandLoan(S&L)companiesintheUS–alsoknownas‘thrifts’–gotintomassivetrouble,havingbeenallowedbythegovernmenttomoveintomorerisky,butpotentiallyhigher-yielding,activities,suchascommercialrealestateandconsumerloans.TheUSgovernmenthadtoclosedownnearlyone-quarterofS&Lsandinjectpublicmoneyequivalentto3percentofGDPtocleanupthemess.The1990sstartedwithbankingcrisesinSweden,FinlandandNorway,followingtheirfinancial
deregulationsinthelate1980s.Thentherewasthe‘tequila’crisisinMexicoin1994and1995.Thiswasfollowedbycrisesinthe‘miracle’economiesofAsia–Thailand,Indonesia,MalaysiaandSouthKorea–in1997,whichhadresultedfromtheirfinancialopening-upandderegulationinthelate1980sandtheearly1990s.OntheheelsoftheAsiancrisiscametheRussiancrisisof1998.TheBraziliancrisisfollowedin1999andtheArgentinianonein2002,bothinlargeparttheresultsoffinancialderegulation.Theseareonlytheprominentones,buttheworldhasseensomanymorefinancialcrisessincethemid-
1970s.Accordingtoawidelycitedstudy,17virtuallynocountrywasinbankingcrisisbetweentheendoftheSecondWorldWarandthemid-1970s,whenthefinancialsectorwasheavilyregulated.Betweenthemid-1970sandthelate1980s,theproportionofcountrieswithbankingcrisisroseto5–10percent,weightedbytheirshareofworldincome.Theproportionthenshotuptoaround20percentinthemid-1990s.Theratiothenbrieflyfelltozeroforafewyearsinthemid-2000s,butwentupagainto35percentfollowingthe2008globalfinancialcrisis.
The‘unholyalliance’betweenshort-term-orientedshareholdersandprofessionalmanagershasreducedtheabilityofcorporationstoinvest
Theriseofthe‘shareholdervaluemaximization’modelintheeraofnewfinancehasdramaticallyreducedtheresourcesavailableforlong-terminvestmentsinnon-financialcorporations.Theerahasseenadramaticriseindistributedprofits,thatis,profitsgiventoshareholdersinthe
formsofdividendsandsharebuy-backs.Forexample,distributedprofitsasashareoftotalUScorporateprofitsstoodat35–45percentbetweenthe1950sand70s.18Between2001and2010,thelargestUScompaniesdistributed94percentoftheirprofitsandthetopUKcompanies89percentoftheirprofits.19
Thishassignificantlyreducedtheabilityofcorporationsinthesecountriestoinvest.Contrarytothepopularperception,itisnottheissuingofnewsharesorbankloansbutretainedprofits(thatis,profitsnotdistributedtoshareholders)thatisthemainsourceofinvestmentfinancing.Giventhis,thedramaticfallinretainedprofits–from55–65percenttojust6percentinthecaseofUScorporations–hasmeantahugereductioninthecapacityofcorporationstomakelong-term-orientedinvestments.
Non-financialcompanies,atleastintheUS,havebecomeincreasinglydependentontheirfinancialactivitiesfortheirprofits
EspeciallyintheUS,non-financialcompanieshaveenormouslyincreasedtheirfinancialassets.Theratiooffinancialassetstonon-financialassetsownedbynon-financialcorporationsgraduallyrosefrom30percentin1950to40percentin1982.Thenitstartedtoshootup,reaching100percentin2001.Sincethenitfell–downto81percentin2008.Itsharplyroseagainin2009,reachinganewheightat104percent,essentiallystayingatthesamelevel.20
Forsomecompanies,theirfinancialarmshavebeenthemainsourceofprofitsintherecentperiod,dwarfingtheiroriginalmanufacturingarms.In2003,45percentofGE’sprofitcamefromGECapital.In2004,80percentoftheprofitsofGMwerefromitsfinancialarm,GMAC,whileFordmadeallitsprofitsfromFordFinancebetween2001and2003.21
ConcludingRemarks:FinanceNeedstoBeStrictlyRegulatedExactlyBecauseItIsSoPowerful
Capitalismwouldnothavedevelopedinthewayithaswithoutthedevelopmentofthefinancialsystem.Thespreadofcommercialbanking,theriseofthestockmarket,theadvanceininvestmentbankingandthegrowthofthecorporateandthegovernmentbondmarketshaveenabledustomobilizeresourcesandtopoolriskonanunprecedentedscale.Withoutsuchdevelopments,wewouldstillbelivinginaworldfullofsmallfactoriesrunandfinancedbyRicardo’s‘mastermanufacturers’,supportedbypoorlyfinancedandinadequategovernments.Unfortunately,followingtheriseof‘newfinance’inthelastthreedecades,ourfinancialsystemhas
becomeanegativeforce.Ourfinancialfirmshavebecomeverygoodatgeneratinghighprofitsforthemselvesatthecostofcreatingassetbubbleswhoseunsustainabilitytheyobscurethroughpooling,structuringandothertechniques.Whenthebubblebursts,thesefirmsdeftlyusetheireconomicweightandpoliticalinfluencetosecurerescuemoneyandsubsidiesfromthepublicpurse,whichthenhastoberefilledbythegeneralpublicthroughtaxhikesandspendingcuts.Thisscenariohasbeenplayingoutonagargantuanscalesincethe2008globalfinancialcrisis,butithadalreadybeenrepeateddozensoftimesonsmallerscalesallovertheworld–Chile,theUS,Sweden,Malaysia,Russia,Brazil,younameit–inthelastthreedecades.Unlessweregulateourfinancialsystemmuchmorestrictly,wewillseetherepeatofthesecrises.
ManyoftheregulationsthatIhavedescribedashavingbeenweakenedorabolishedsincethe1980sneedtobebroughtbackorevenstrengthened.Theseregulatorychangesinvolvetechnicaldiscussionsthatneednotdetainthereaderhere,butthereisoneclearprinciplethatneedstobeborneinmindinthinkingaboutthereform.Itisthatourfinancialsystemneedstobemadesimpler.Asdiscussedabove,ourfinancialsystemhasbecometoocomplextocontrol–notjustforsupposedly
cluelessregulatorsbutalsoforthosesupposed‘sophisticates’ofthefinancialindustry.Weneedtoreducethiscomplexitybylimitingtheproliferationofoverlycomplicatedfinancialproducts,especiallywhentheircreatorscannotprovebeyondreasonabledoubtthattheirbenefitsoutweightheircosts.Thisprinciplemaysoundveryradical,butitisnot.Wedothiskindofthingallthetimeinrelationto
medicine;giventhecomplexityofthehumanbodyandtheseriousnessofpotentialdamagenewdrugsmightdo,wedemandthatthemanufacturersprovetotherestofsocietythattheirproductshavemorebenefitsthancosts.22Indeed,theboundariesoflegitimatefinancialcontractshavebeenconstantlyredrawnthroughpoliticaldecisions,asIhaveshownabove(recallthecaseofderivatives).Arguingforastricterregulationofthefinancialsystemdoesnotimplythatitisnotanimportantpartof
theeconomy.Onthecontrary,itneedstoberegulatedexactlybecauseofitspowerandimportance.Wedidn’thavetrafficlights,ABSbreaks,seatbeltsandairbagsinthedayswhenmostpeoplewalked,usedbullockcartsandatmostsprintedonhorses.Todaywehave–andstarteddemandingthroughregulation–
thosethingsexactlybecausewehavecarsthatarepowerfulandfastbutthatcandoalotofdamageifsomething–evenasmallthing–goeswrong.Unlessthesamereasoningisappliedtofinance,wewillkeephavingtheeconomicequivalentsofcarcrashes,hit-and-runsorevenmotorwaypile-ups.
FurtherReadingY.AKYUZ
TheFinancialCrisisandtheGlobalSouth:ADevelopmentPerspective(London:PlutoPress,2013).
G.EPSTEIN(ED.)
FinancializationandtheWorldEconomy(Cheltenham:EdwardElgar,2005).
G.INGHAM
TheNatureofMoney(Cambridge:Polity,2004).
C.KINDLEBERGER
Manias,Panics,andCrashes:AHistoryofFinancialCrises(London:Macmillan,1978).
J.LANCHESTER
Whoops!:WhyEveryoneOwesEveryoneAndNoOneCanPay(London:Penguin,2010).
C.LAPAVITSAS
ProfitingwithoutProducing:HowFinanceExploitsUsAll(London:Verso,2013).
F.MARTIN
Money:TheUnauthorisedBiography(London:BodleyHead,2013).
B.SCOTT
TheHeretic’sGuidetoGlobalFinance:HackingtheFutureofMoney(London:PlutoPress,2013).
‘ThepeasantIvanisjealousofhisneighbourBoris,becauseBorishasagoat.AfairycomesalongandoffersIvanasinglewish.Whatdoeshewishfor?ThatBoris’sgoatshoulddropdead.’D.LANDES,THEWEALTHANDPOVERTYOFNATIONS
InequalityIvanisnotalone–pursuitofequalityasadriverofhumanhistory
Ivanisnotalone.InKorea,thereisasayingthatyougetabellyachewhenyourcousinbuysaplotofland.AndIamsuremanyreadersknowsimilarjokesorproverbsaboutpeoplebecomingirrationallyjealouswithotherpeopledoingbetter.Thepursuitofequalityisaverynaturalhumanemotionandhasbeenapowerfuldriverofhuman
history.EqualitywasoneoftheidealsbehindtheFrenchRevolution,oneofwhosemostfamousmottoswas‘Liberté,égalité,fraternitéoulamort’(liberty,equality,brotherhoodordeath).IntheRussianRevolution,andothersocialistrevolutionsthatfollowedit,equalitywasthedrivingmotive.Manyindustrialstrikes,demonstrations,revolutionsandcountlessotherhumanconflictswouldnothavehappenedwithoutthepursuitofequality.
‘Youknow,Ithinkit’sjustaboutenvy’
Theadvocatesoffree-marketpolicies,however,warnusagainstlettingsuchabaseinstincttakeover.Theytellusthatpoliticianswhotrytomakericherpeoplepaymoretaxesorrestrainbonusesinthebankingindustryareengagedinthe‘politicsofenvy’.Theytellusnottopulldownpeoplehigherupjustsothatwecanallbeequal.Inequalityisaninevitableoutcomeofdifferentproductivitiesofdifferentpeople.Richpeoplearerichbecausetheyarebetteratcreatingwealth.Tryingtogoagainstthisnaturaloutcome,wewillonlycreateequalityinpoverty,theywarnus.WhatMittRomney,the2012Republicanpresidentialcandidate,saidabouttheconcernaboutinequalitysumsupthispositionverywell:‘Youknow,Ithinkit’sjustaboutenvy.’Inthelastfewdecades,theadvocatesofthefreemarkethavesuccessfullypersuadedmanyothersthat
givingabiggersliceofnationalincometothetopearnerswillbenefiteveryone.Theaphorism‘arisingtideliftsallboats’,originallyattributedtoJohnF.KennedybutmadepopularrecentlybyRobertRubin,theUStreasurysecretaryunderBillClinton,hasbeentheirfavouredslogan.Whentherichhavemoremoneyattheirdisposal,theywillinvestmoreandgeneratemoreincomefor
others;theywillhiremoreworkersfortheirbusinesses,andtheirbusinesseswillbuymorefromtheirsuppliers.Withhigherpersonalincomes,therichwillspendmore,generatingmoreincomeforthosecompaniesthatsell,say,sportscarsordesignersclothestotherich.Thecompaniessupplyingthosethingswillincreasedemandfor,say,carpartsandtextiles,whiletheirworkerswillearnhigherwagesandspendmoreontheirownfoodand(non-designer)clothes.Andsoon.Thus,ifthereismoreincomeatthetop,moreofitwilleventually‘trickledown’totherestoftheeconomy,makingeveryonericherthanbefore.Eventhoughthesharesthatpoorerpeoplegetinthenationalincomemaybesmaller,theywillbebetteroffinabsoluteterms.ThisiswhatMiltonFriedman,theguruoffree-marketeconomics,meant
whenhesaid:‘Mosteconomicfallaciesderivefrom…thetendencytoassumethatthereisafixedpie,thatonepartycangainonlyattheexpenseofanother.’1
Thebeliefinthetrickle-downeffecthaspromptedmanygovernmentstoemploy–oratleasthasprovidedthemwiththepoliticalcoverfor–pro-richpoliciesinthelastthreedecades.Regulationsonproduct,labourandfinancialmarketswererelaxed,makingiteasierfortherichtomakemoney.Taxesoncorporationsandhigh-incomeearnerswerecut,makingiteasierforthemtokeepthemoneytheythusmake.
Toomuchinequalityisbadfortheeconomy:instabilityandreducedmobility
Few,ifany,peoplewouldadvocatetheextremeegalitarianismofChinaunderMaoorCambodiaunderPolPot.Nevertheless,manypeoplearguethattoomuchinequalityisabadthing,notjustethicallybutalsoineconomicterms.*Someeconomistshaveemphasizedthathighinequalityreducessocialcohesion,increasingpolitical
instability.This,inturn,discouragesinvestments.Politicalinstabilitymakesthefuture–andthusthereturnsoninvestments,whicharebydefinitioninthefuture–uncertain.Reducedinvestmentsreducegrowth.Greaterinequalityalsoincreaseseconomicinstability,whichisbadforgrowth.2Alargershareof
nationalincomegoingtothetopearnersmayincreaseinvestmentratio.Butanincreasedshareofinvestmentalsomeansthattheeconomyismoresubjecttouncertaintyandthusbecomeslessstable,asKeynespointedout(seeChapter4).Manyeconomistshavealsopointedoutthatrisinginequalityplayedanimportantroleinthemakingofthe2008globalfinancialcrisis.EspeciallyinthecaseoftheUS,topincomeshavesoaredwhilerealwageshavebeenstagnantformostpeoplesincethe1970s.Stagnantwagesmadepeopleincurhighlevelsofdebtstokeepupwiththeever-risingconsumptionstandardatthetop.Theincreaseinhouseholddebts(asaproportionofGDP)madetheeconomymorevulnerabletoshocks.Othershavearguedthathighinequalityreduceseconomicgrowthbycreatingbarrierstosocial
mobility.Expensiveeducationthatonlyatinyminoritycanaffordbutthatyouneedinordertogetawell-paidjob,personalconnectionswithinasmallprivilegedgroup(theFrenchsociologistPierreBourdieufamouslycalleditsocialcapital)*oreventhe‘subculture’amongtheelite(e.g.,accentsandattitudesyouacquireinexpensiveschools)canactasbarrierstosocialmobility.Reducedsocialmobilitymeansthatablepeoplefrompoorerbackgroundsareexcludedfromhigh-end
jobsandthushavetheirtalentswastedfrombothanindividualandasocialpointofview.Italsomeansthatsomeofthepeoplefillingthetopjobsarenotthebestthatthesocietycouldhavegot,hadithadhighersocialmobility.Ifsustainedovergenerations,suchbarriersmakeableyoungstersfromlessprivilegedbackgroundsgiveupeventryingforhigher-endjobs(recallChapter5).Thisleadstoculturalandintellectual‘inbreeding’amongtheelite.Ifyoubelievethatbigchangesrequirefreshideasandunconventionalattitudes,asocietywithan‘inbred’eliteislikelytobecomebadatgeneratinginnovation.Theresultisreducedeconomicdynamism.
Inequalityleadstoinferiorsocialoutcomes
Recently,studieshavecomeouttoshowthatinequalityleadstopooroutcomesinhealthandothersocialindicatorsofhumanwell-being.Andthisisindependentlyofthesheereffectofhigherinequalityproducingahighernumberofpoorpeople,whoareboundtoperformworseintheseregards.
ThisargumenthasbeenmadepopularrecentlybythebookTheSpiritLevel,byRichardWilkinsonandKatePickett.Thebookexaminedthedatafromtwodozenorsorichcountries(roughlycountrieswithpercapitaincomesabovethelevelofPortugal,whichisaround$20,000).Itarguesthatmoreunequalcountriesdefinitelydoworseintermsofinfantmortality,teenagebirths,educationalperformance,homicideandimprisonment,andalsopossiblyintermsoflifeexpectancy,mentalillnessandobesity.3
Moreegalitariansocietieshavegrownfasterinmanycases
Notonlyistherealotofevidenceshowingthathigherinequalityproducesmorenegativeeconomicandsocialoutcomes,therearequiteafewexamplesofmoreegalitariansocietiesgrowingmuchfasterthancomparablebutmoreunequalsocieties.4
Duringtheir‘miracle’yearsbetweenthe1950sandthe1980s,Japan,SouthKoreaandTaiwangrewmuchfasterthancomparablecountriesdespitehavinglowerinequalities.JapangrewmuchfasterthantheUS,whileKoreaandTaiwandidsotooinrelationtothemuchmoreunequalcountriesinAfricaandLatinAmerica.Despitebeingoneofthemostequalsocietiesintheworld,moreequalthaneventheformerSovietbloc
countriesinthedaysofsocialism,FinlandhasgrownmuchfasterthantheUS,oneofthemostunequalsocietiesintherichworld.Between1960and2010,Finland’saverageannualpercapitaincomegrowthratewas2.7percent,against2.0percentintheUS.Thismeansthat,duringthisperiod,theUS’sincomerose2.7timeswhileFinland’sroseby3.8times.Theseexamplesdonotprovethathigherinequalityleadstolowergrowth.Thereareotherexamples
wheremoreegalitariansocietieshavegrownmoreslowlythancomparablebutmoreunequalcountries.Buttheyareenoughtoletusrejectasimplistic‘greaterinequalityisgoodforgrowth’story.Moreover,themajorityofstatisticalstudieslookingatalargenumberofcountriesshowanegativecorrelation(whichdoesnotnecessarilymeanacausality)betweenacountry’sdegreeofinequalityanditsgrowthrate.Analysisofthesamesocietyovertimealsolendssupporttotheviewthatinequalityhasnegative
effectsongrowth.Duringthelastthreedecades,despitetheincomesharesofthoseatthetoprisinginmostcountries,investmentandeconomicgrowthhavesloweddowninmostofthem.
Someanimalsaremoreequalthanothers:toomuchequalityisbadtoo
Ofcourse,allofthisevidencedoesnotmeanthatthelowertheinequalitythebetteritis.Ifthereistoolittleincomeinequality,itcandiscouragepeoplefromworkinghardorcreatingnewthingstoearnmoney,asusedtobethecaseinthesocialistcountries–mostnotoriouslyintheagriculturalcommunesinMao’sChina.Whatmadethingsworsewasthatthelowdegreesofincomeinequalitywereoftenseenascharades.
Lowincomeinequalityinthesecountriesco-existedwithhighinequalityinotherdimensions(e.g.,accesstohigher-qualityforeigngoods,opportunitiestotravelabroad),baseduponideologicalconformityorevenpersonalnetworks.GeorgeOrwellhadseenthroughthisintheveryearlydaysofsocialism,whenhecoinedtheslogan,
‘someanimalsaremoreequalthanothers’inAnimalFarm,hissatireoftheRussianRevolution.Bythe1970s,thisrecognitionledtowidespreadcynicisminthosecountries,summarizedinthejoke‘Theypretendtopayusandwepretendtowork.’Whenthingsstartedtounravelinthelate1980s,fewwantedtodefendasystemthatcouldnowonlybedescribedashypocritical.
Themostreasonableconclusiontodrawfromthereviewofvarioustheoriesandempiricalevidenceisthatneithertoolittlenortoomuchinequalityisgood.Ifitisexcessivelyhighorexcessivelylow,inequalitymayhampereconomicgrowthandcreatesocialproblems(ofdifferentkinds).
TheKuznetshypothesis:inequalityovertime
SimonKuznets,theRussian-bornAmericaneconomist,whowononeofthefirstNobelPrizesinEconomics(in1971–thefirstonewasin1969),proposedafamoustheoryaboutinequalityovertime.Theso-calledKuznetshypothesisisthat,asacountrydevelopseconomically,inequalityfirstincreasesandthendecreases.Thishypothesishasverystronglyinfluencedthewayinwhichthestudyofinequalityhasbeenconductedoverthelasthalfcentury,soitisimportanttoknowwhatitisabout.AccordingtoKuznets,intheearlieststageofeconomicdevelopmentincomedistributionremainsquite
equal.Itisbecausemostpeoplearepoorfarmersatthatstage.Asthecountryindustrializesandgrows,moreandmorepeoplemoveoutofagricultureandintoindustry,wherewagesarehigher.Thisincreasesinequality.Astheeconomydevelopsevenfurther,Kuznetsargued,inequalitybeginstodecrease.Mostpeoplenowworkintheindustrialsectororintheurbanservicesectorthatservestheindustrialsector,whilefewremainintheagriculturalsectorwithlowwages.Theresultisthefamousinverted-U-shapedcurve,knownastheKuznetscurve,asshownbelow.
TheKuznetshypothesisdoesnotholdup…
Despiteitspopularity,theevidencefortheKuznetshypothesisisratherweak.Untilthe1970s,itseemedtohavebeenborneoutbytheexperiencesoftoday’srichcountries.Theysawrisinginequalityintheearlydaysoftheirindustrialization,peaking,forexample,inthemid-nineteenthcenturyinEnglandandintheearlytwentiethcenturyintheUS,andthenafalllater.However,sincethe1980s,mostofthesecountrieshaveexperiencedanincreaseininequality–dramaticallyinsomecases,suchastheUSandtheUK–startinganewupswinginthecurveatthetailend,sotospeak.Thehypothesishasnotreallyheldupwellintoday’sdevelopingcountrieseither.Inequalityhas
increasedwiththestartofeconomicdevelopmentinmostofthem(exceptionsincludeKoreaandTaiwan),butithashardlydecreasedwithfurthereconomicdevelopmentinthemajorityofthem.
…becauseeconomicpolicymatters
ThemainexplanationforthelackofevidencefortheKuznetshypothesisisthateconomicpolicymattershugelyindeterminingthelevelofinequality.IhavealreadymentionedthattherecentdramaticupswingsininequalityintheUSandtheUKcan
mainlybeexplainedbyderegulationandtaxcutsfortherich.
TheabsenceofinequalityupswinginKoreaorTaiwanintheirearlystagesofeconomicdevelopmentbetweenthe1950sandthe1960scanalsobeexplainedbypolicies.Duringthisperiod,thesecountriesimplementedprogrammesoflandreform,inwhichlandlordswereforcedtosellmostoftheirlandtotheirtenantsatbelow-marketprices.Theirgovernmentsthenprotectedthisnewclassofsmallfarmersthroughimportrestrictionsandtheprovisionofsubsidizedfertilizerandirrigationservices.Theyalsoheavilyprotectedsmallshopsfromcompetitionbylargestores.Indeed,Kuznetshimselfdidnotbelievethatthedecreaseininequalityinthelaterstageofeconomic
developmentwouldbeautomatic.Whilebelievingthatthenatureofmoderneconomicdevelopmentmadetheinverted-Ucurvelikely,heemphasizedthattheactualdegreeofthedecreaseininequalitywouldbestronglyaffectedbythestrengthsoftradeunionsand,inparticular,ofthewelfarestate.Theimportanceofthewelfarestateindeterminingthelevelofinequalityisprovenbythefactthat,
beforetaxesandtransfersthroughthewelfarestate,someEuropeancountrieshaveincomeinequalitythatisashighasthatoftheUS(France,AustriaandBelgium)orevenhigherthanthatoftheUS(GermanyandItaly).Asweshallseebelow,theyarefarmoreequalthantheUS,aftertaxesandtransfers.
Differenttypesofinequality
Thoughitisthemostcommonlydiscussedone,incomeinequalityisonlyonetypeofeconomicinequality.Wecanalsotalkofeconomicinequalityintermsofdistributionofwealth(e.g.,ownershipofassets,suchasrealestatesorshares)orofhumancapital(that’sthefancy–andcontroversial–wordforskillsthatindividualsacquirethrougheducationandtraining).Therearealsoinequalitiesintermsofnon-economicfactors.Inmanysocieties,peoplewitha‘wrong’
caste,ethnicity,religion,gender,sexualityorideologyhavebeendeniedaccesstothingslikepoliticaloffice,universityplacesorhigh-statusjobs.
Measuringinequality:theGinicoefficientandthePalmaratio
Ofalltheseinequalities,onlyincomeandwealthinequalitiesarereadilymeasurable.Ofthesetwo,thedataonwealtharemuchpoorer,somostoftheinformationoninequalityweseeisintermsofincome.Incomeinequalitydataaresometimesderivedfromsurveysonconsumption,ratherthanactualincomes,whicharehardertocapture.Therearenumberofdifferentwaysofmeasuringtheextenttowhichincomeisunequallydistributed.5
ThemostcommonlyusedmeasureisknownastheGinicoefficient,namedaftertheearlytwentieth-centuryItalianstatisticianCorradoGini.Ascanbeseeninthefollowinggraph,itcomparesreal-lifeincomedistribution(denotedinthegraphbytheLorenzcurve)6withthesituationoftotalequality(denotedbytheforty-five-degreelineinthegraph).TheLorenzcurveplotstheproportionoftheoverallincomeintheeconomythatiscumulativelyearnedbythebottomxpercentofthepopulation.ThecoefficientiscalculatedasaproportionoftheareabetweentheLorenzcurveandtheforty-five-degreelineoverthelowertriangleinthegraph(A/A+B).
Morerecently,myCambridgecolleagueGabrielPalmahasproposedtheuseoftheratiobetweentheincomeshareofthetop10percentandthatofthebottom40percentasamoreaccurate–andeasiertocalculate–measureofacountry’sincomeinequality.7Notingthatthesharetakenbythemiddle50percentofincomedistributionisremarkablysimilaracrosscountriesregardlessofthepoliciestheyuse,Palmaarguesthatlookingatthesharesattheextremesthatdiffermoreacrosscountriesgivesusaquickerandbetterideaofinequalitiesindifferentcountries.KnownasthePalmaratio,thisnumberovercomestheGinicoefficient’sover-sensitivitytothechangesinthemiddleoftheincomedistribution,whereitismoredifficulttomakeadifferencethroughpolicyinterventionanyway.8
Inequalityamongwhom?
Mostinequalityfigures,liketheGinicoefficient,arecalculatedforindividualcountries.However,withincreasingintegrationofnationaleconomiesthroughglobalization,peoplehavebecomemoreinterestedinthechangesintheincomedistributionfortheworldasawhole.ThisisknownastheglobalGinicoefficientandcalculatedbytreatingeachindividualintheworldasiftheyarethecitizensofthesamecountry.Somepeople,myselfincluded,thinkthattheglobalGinicoefficientisreallynotterriblyrelevant,as
theworldisnot(atleastyet)atruecommunity.Incomeinequalitymattersonlybecausewehavefeelings–positive,negative,solidaristic,murderous–inrelationtothoseotherswhoareincludedinthestatistics;thisisknownasthereferencegroup.Weactuallydon’treallycarethatmuchhowwellpeoplewhodonotbelongtoourownreferencegroupsaredoing.*Indeed,Ivaninouropeningstorydidnotwishtheczartobecomeapoormanbecausetheczarwasn’t
inhisreferencegroup;hewantedthetinyedgethathisneighbourBorishadoverhimtobewipedout.Likewise,hisKoreancounterpart–let’scallhimYoungsoo–didnotgetjealousofsomebiglandlordacquiringahugetractofland;hewasjealousofhisowncousingettingonesmalladditionalplot.
Itistruethatglobalinequalityisbecomingmorerelevant,aspeopleareincreasinglyawareofwhatishappeninginotherpartsoftheworld,thankstothedevelopmentofmassmediaandtheinternet,andthusarebeginningtodevelopasenseofglobalcommunity.However,itwillbealongtimebeforewecantellapoorChinesepeasantnottogettooupsetabouttherunawayinequalityinhiscountrybecausetheworldasawholehasbecomeaslightlymoreequalplace–especiallygiventhatitisinlargepartthankstothetopearnersinChinapullingawayfromtherestofthecountry.
REAL-LIFENUMBERSIntheory,theGinicoefficientcanbeanythingbetween0and1.Inpractice,theseextremevaluesareimpossible.Nosociety,howeveregalitarianitmaybeinspiritandpolicies,canmakeeveryoneexactlyequal,whichiswhatisneededforaGinicoefficientof0.InasocietywithaGiniof1,everyoneexceptonepersonwhohaseverythingwillsoonbedead.*Inreallife,nocountryhasaGinicoefficientbelow0.2andnonehasoneabove0.75.
Lowestandhighestinequalities:Europevs.SouthernAfricaandLatinAmerica
Ginicoefficientscandifferquitealotevenforthesamecountry,dependingontheestimateyoulookat.Forthelate2000s,theOECDgivesanincomeGiniofaround0.25forDenmark,whiletheILOgivesaslightlyhigherfigureataround0.28.InthecaseoftheUS,thegapissignificant–theOECDestimateisaround0.38buttheILOputsitaround0.45.9Inthetextbelow,IcitetheILOdata,giventhattheOECDmembershipismuchsmallerthantheILOone.10
Themostequalsocieties,mainlyfoundinEurope,haveGinicoefficientsbetween0.2and0.3.Manyoftheseareadvancedcapitalistcountrieswithastrongwelfarestate.Theyare,inalphabeticalorder,Austria,Belgium,Denmark,Finland,France,Germany,theNetherlands,Norway(themostequalcountryintheworld)andSweden.Asmentionedabove,beforetaxesandsocialspending,someofthemaremoreunequalthantheUSbuttheytaxandredistributesuchalargepartoftheirGDPsthattheyendupbeingmuchmoreequalthantheUS.Someofthemostequalcountriesareformersocialistbloceconomies,whoseegalitarianlegacieshaveheld.Croatia,CzechRepublic,Hungary,SlovakiaandSloveniabelongtothisgroup.Attheotherextreme,wehavecountrieswhoseGinicoefficientsgoupabove0.6.Theyare,in
alphabeticalorder,Botswana,Madagascar,NamibiaandSouthAfrica.TheyareallinSouthernAfrica.AnycountrywithaGinicoefficientabove0.5canbeconsideredveryunequal.ManyoftheseareLatin
Americancountries:Bolivia,Brazil,Chile,Colombia,CostaRica,Honduras,PanamaandParaguay.ButsomeofthemareinAfrica(Côted’Ivoire,MauritaniaandRwanda)andinAsia(Cambodia,thePhilippinesandThailand).Thereisevenonecountryintheformersocialistblocthatbelongstothisgroup.ItisGeorgia,whichis,veryironically,Stalin’snativecountry.Ginicoefficientsinmostothercountriesaredistributedbetween0.3and0.5.TheUSandChinaare
foundatthemoreunequalendofthatdistribution(0.45–0.5).CountrieslikeUganda,Poland,NewZealandandItalyareattheotherendofthatrange(around0.3).Roughlyspeaking,Giniof0.35isthedividinglinebetweenrelativelyequalcountriesandonesthatarenot.11
Wealthinequalityismuchhigherthanincomeinequality
Thedataonwealthinequalityaremuchlessreadilyavailableandlessreliablethanthoseonincomeinequality.Butitisclearthatwealthinequalityismuchhigherthanincomeinequalityinallcountriesfor
themainreasonthataccumulatingwealthismuchmoredifficultthanearningincome.AccordingtotheUNCTAD(UnitedNationsConferenceonTradeandDevelopment),thewealthGini
coefficientforthefifteencountriesstudied,includingpoorcountrieslikeIndiaandIndonesiaaswellasrichcountriesliketheUSandNorway,rangedbetween0.5and0.8.12Thegapbetweenacountry’sincomeinequalityandwealthinequalitywasparticularlylargeforEuropeancountrieswithlowincomeinequality,suchasNorwayandGermany.13
Incomeinequalityhasriseninthemajorityofcountriessincethe1980s
Sincethe1980s,incomeinequalityhasriseninthemajorityofcountries.14ThemostmarkedincreasewasseenintheUKandespeciallytheUS,whichledtheworldinpro-richpolicies.IntheUS,theshareofincomeforthetop1percentusedtobearound10percentbetweenthe1940sandthe1970s,butroseto23percentby2007.15Thetop0.1percentincreaseditssharefrom3–4percenttoover12percentduringthesameperiod.16
Thetrendofrisinginequalityhassloweddownsomewhatsincearound2000.Inequalityhasfallenslightlyinmanycountriesinthetraditionallyhigh-inequalityregionsofLatinAmericaandSub-SaharanAfrica,althoughtheystillremainveryunequalbyinternationalstandards.AtleastinLatinAmericacases,thiswasmainlyduetopolicyinterventions,suchasincreasedtaxesfortherich,increaseinminimumwages,andincreasedsocialwelfarespending–onceagainsupportingtheconclusionwedrewfromourdiscussionoftheKuznetshypothesis.
Globalinequalityhasrisenforthelasttwocenturies
AccordingtothewidelyusedestimatebyBourgignonandMorrisson,theglobalGinicoefficientwasaround0.5in1820androseto0.61in1910,0.64in1950and0.66in1992.17Accordingtotheabove-citedstudybytheUNCTAD,ithasfallenslightlyfromaround0.7inthelate1980sandtheearly1990stoaround0.66inthesecondhalfofthe2000s.18ButthesenumbersarelessreliablethannationalGinicoefficients.Thismeansthat,iftheworldwereacountry,twocenturiesagoitstartedoffasaveryunequalone,like
PanamaorRwanda,andhasbecomeanextremelyunequalone,likeSouthAfrica,althoughitmayhavebecomeslightly–onlyslightly–lessunequalsince1990,largelythankstoChinabecomingrapidlymoreprosperous.
PovertyPovertyhasbeenthedominanthumanconditionformostofhistory
Povertyhasbeenaconsistentoppressivepresencethroughouthumanhistory.Exceptwhenwetalkofkingsandqueensandheroes,muchofourfolkloreandliteraturebeforethenineteenthcenturyisaboutpovertyanditsconsequences.Andwearenotjusttalkingaboutbeingabithardup.Wearetalkingaboutthekindofpovertythatmakespeoplestealbread(asinLesMisérables),eatboiledearth(asinTheGoodEarth)andevenabandonchildrentogetridofmouthstofeed(asinHänselandGretel).Intoday’sterms,itisthekindofpovertythatyouseeinmovieslikeSlumdogMillionaire,setintheslumsofMumbai,India,inwhichevengoingtothetoiletisamajorstruggle.Economistscallthiskindofpovertyabsolutepoverty.Itisthefailuretobeincommandoverincome
tofulfilthemostbasichumanneedsforsurvival–suchasnutrition,clothingandshelter.Thishuman
conditionstartedtochangeonlyinthenineteenthcentury,withtheIndustrialRevolution.But,asIdiscussedinChapter3,inthebeginning,thingsgotworseforsome.
Differentdefinitionsofpoverty:absolutevs.relativepoverty
Today,fewpeopleintherichcountries,suchastheUSorGermany,sufferfromabsolutepoverty.Butwestilltalkaboutpovertyinthosecountries,becauseeverysocietyhascertainstandardsofconsumptionwhichareconsiderednecessarytomaintain‘decency’.ThisviewdatesbacktoAdamSmith,whoarguedthatthingsbecomenecessitieswhenitbecomes
‘indecentforcreditablepeople,evenofthelowestorder,tobewithout’.So,inafamousexample,hearguedthatalinenshirtis‘notanecessaryoflife’but‘inthepresenttimes,throughthegreaterpartofEurope,acreditableday-labourerwouldbeashamedtoappearinpublicwithoutalinenshirt,thewantofwhichwouldbesupposedtodenotethatdisgracefuldegreeofpoverty’.Thisnotionofpovertyisknownasthatofrelativepoverty.Usingthisnotionofpoverty,todaymost
countrieshavetheirownnationalpovertyline,whichisusuallysetaroundsomeproportion(usually50–60percent)ofmedian(ratherthanaverage)income.Forexample,in2012,theUSgovernmentsetthepovertylineat$23,050forafamilyoffour.Definedinthisway,relativepovertyisinherentlyrelatedtoinequality.Itispossibleforacountryto
havenoabsolutepoverty,evenifitisveryunequal,ifitissufficientlyrich.Insuchacountry,however,relativepovertywillbehigh.
Differentdimensionsofpoverty:incomepovertyvs.multidimensionalpoverty
Sofar,wehavedefinedpoverty–absoluteorrelative–onlyintermsofincome,butwecanalsotalkofwhatisknownasmultidimensionalpoverty.Thisistoreflectthefactthatsomepeoplemayhave–just–enoughincometoeatsufficientlyandclothethemselvesbutmayhavenoorlittleaccesstothingslikeeducationandhealthcare.Thereisnoagreementonwhatshouldbeincludedinthismeasure,butthismeasurenaturallyincreasesthenumberofpeoplelivinginpoverty.
Measuringtheextentofpoverty:headcountorpovertygap
Havingestablishedthepovertyline–whetherabsoluteorrelative,whetherincome-basedormultidimensional–wecantellhowmanypeoplefallbelowthatline.Thisisknownastheheadcountmeasureofpoverty.Theobviousshortcomingoftheheadcountmeasureisthatitdoesnotdistinguishbetweenpeoplewho
arejustbelowthepovertylineandthosethatfallwellbelowit.Thussomeeconomistsmeasurethepovertygap,byweighingeachpoorpersonbythedistancehe/shefallsshortofthepovertyline.Thismeasureobviouslyrequiresmoreinformationthansimpleheadcount,soitislesseasilyavailable.Whichevermeasureweuse,snapshotpicturesofpoverty,atagivenpointoftime,maynotgiveusthe
fullpicture,asmanypeoplefallinandoutofpoverty.So,inthelongrun,manymorepeopleexperiencepovertythanpovertyfiguresmeasuredatanygivenpointoftimesuggest.Thosewhoareinpovertyallormostoftheirlivesaresaidtobein‘chronicpoverty’.
Whatiswrongwithpoorpeople?:causesofpoverty
StartingfromDisneyanimationsthatwewatchasyoungchildrentellingusthatifwebelieveinourselves,wecanachieveanything,wearebombardedwiththemessagethatindividuals,andtheyalone,areresponsibleforwhattheygetintheirlives.WearepersuadedtoacceptwhatIcalltheL’Oréal
principle–ifsomepeoplearepaidtensofmillionsofpoundsperyear,itmustbebecausetheyare‘worthit’.Theimplicationisthat,ifpeoplearepoor,itmustbebecausetheyareeithernotgoodenoughornottryinghardenough.Individualsareintheendresponsibleforwhattheymakeoutoftheirlives.Eveniftheyarefrom
broadlythesamebackgrounds,differentpeopleendupindifferentpositionsbecausetheyhavedifferenttalentsindifferentthingsandmakedifferentlevelsandtypesofefforts.Itwillbesillytoblameeverythingonthe‘environment’orluck.Attemptstosuppresstheeffectsofindividualtalentsandeffortstoomuch,asintheformersocialistcountries,cancreatesocietiesthatareostensiblyequalbutfundamentallyunfair,asIdiscussedabove.Thereare,however,causesofpovertythatare‘structural’inthesensethattheyarebeyondthecontroloftheindividualconcerned.Inadequatechildhoodnutrition,lackoflearningstimulusandsub-parschools(frequentlyfoundinpoor
neighbourhoods)restrictthedevelopmentofpoorchildren,diminishingtheirfutureprospects.Parentsmayhavesomecontroloverhowmuchnutritionandlearningstimulustheirchildrenget–andsomepoorparents,totheircredit,makegreateffortsandprovidemoreofthosethingsthandootherparentsinsimilarsituations–butthereisalimittowhattheycando.Theyarebydefinitionundergreatfinancialstress.Manyofthemaretotallyexhaustedfromjugglingtwoorthreeinsecurejobs.Andmostofthemhadapoorchildhoodandpooreducationthemselves.Allofthismeansthatpoorchildrenstarttheraceoflifealreadyweigheddownbysandbagsontheir
legs.Unlesstherearesocialmeasurestoatleastpartiallycompensateforthesedisadvantages(e.g.,incomesupportforpoorparents,subsidizedchildcare,greaterinvestmentsinschoolsinpoorareas),thosechildrenwon’tbeabletofullyrealizetheirinnatepotentials.Evenwhentheyovercomechildhooddeprivationandaspiretoclimbthesocialladder,peoplefrom
poorerbackgroundsarelikelytomeetmoreobstacles.Lackofpersonalconnectionsandculturalgapwiththeeliteoftenmeanthatpeoplefromunderprivilegedbackgroundsareunfairlydiscriminatedinhiringandinpromotion.Ifthosepeoplealsohappentohaveother‘wrong’characteristics–intermsofgender,race,caste,religion,sexualorientationandwhatnot–theywillhaveanevenhardertimetogetafairchancetodemonstratetheirabilities.
Riggedmarkets
Withthesedisadvantages,thepoorfinditdifficulttowintheraceeveninthefairestofmarkets.Butmarketsareroutinelyriggedinfavouroftherich,aswehaveseenfromaseriesofrecentscandalssurroundingdeliberatemissellingoffinancialproductsandtheliestoldtotheregulators.Moneygivesthesuper-richthepowereventorewritethebasicrulesofthegameby–let’snotmince
ourwords–legallyandillegallybuyinguppoliticiansandpoliticaloffices(moreonthisinChapter11).Manyderegulationsofthefinancialandthelabourmarkets,aswellastaxcutsfortherich,havebeentheresultsofsuchmoneypolitics.
REAL-LIFENUMBERS1.4billionpeopleliveinabsolutepoverty–mostofthemcitizensofmiddle-incomecountries
Atthemoment,theinternational(absolute)povertylineissetatPPP$1.25perday.Peoplebelowthislineareseenashavingsuchlittleincomethattheyareunabletoreachthecriticalminimumevenintermsofnutrition.ThisisthedefinitionofpovertythatisusedwhenOxfamcampaignsto‘makepovertyhistory’
orwhentheworldleaderspledgeto‘eradicateextremepovertyandhunger’,astheUnitedNations’firstMillenniumDevelopmentGoalsdeclare.Translatedintoyearlyincome,thisisPPP$456,whichmeansthattheaveragePPPincomesinthe
world’sthreepoorestcountriesinPPPterms(theDRC,LiberiaandBurundi)arebelowthisline.Currently,around1.4billionpeople–oraboutoneinfivepeopleintheworld–livewithlessthan
$1.25perday.Thenumbergoesuptoaround1.7billionpeople,oroneinfourpeopleintheworld,ifweadoptthemultidimensionaldefinitionofpoverty.Onecounterintuitivefactisthatmostpoorpeopledonotliveinthepoorestcountries.Over70percent
ofpeopleinabsolutepovertyactuallyliveinmiddle-incomecountries.Asofthemid-2000s,over170millionpeopleinChina(around13percentofitspopulation)and450millionpeopleinIndia(around42percentofitspopulation)livedwithincomesbelowtheinternationalpovertyline.
Povertyaccordingtonationalpovertylinescanbeanythingbetween5and80percent
Intermsofrelativepoverty,wecantalkaboutpovertyratesincountriesaccordingtoeachcountry’sofficialpovertyline.Intherichcountries,theproportionofpeoplelivingunderthenationalpovertyline–knownasthe
povertyrate–rangesbetween5–6percent(Ireland,FranceandAustria)and20percent(PortugalandSpain).Inmanypoorcountries,themajorityofthepopulationisbelowthenationalpovertyline,whichis
invariablyhigherthanthePPP$1.25threshold.Insomecountries,thepovertyrateaccordingtothenationalpovertylinecouldreachupto80percent.ThepovertyrateinHaitiis77percentaccordingtotheWorldBankand80percentaccordingtotheCIA(asurprisinglygoodsourceofeconomicstatistics!).Thepovertyratefiguresbasedonnationalpovertyline,however,cannotbedirectlycomparedacross
countries,becausesomecountriessettheirpovertylinesmoregenerouslythanothers.Accordingtoitsnationalpovertyline,thelatestavailablepovertyrateinCanadawas9.4percent,
whilethatinDenmarkwas13.4percent.However,ifyoulookattheOECDstatistics,whichadopta‘universal’(relative)povertyline,definedastheproportionofpopulationlivingwithlessthan50percentofmedianhouseholdincomeineachcountry(aftertaxesandtransfers),DenmarkhasamuchlessseriouspovertyproblemthanCanadadoes(apovertyrateof6.0percentagainstCanada’s11.9percent).Actually,oftheOECDmembercountrieswithmorethan$20,000percapitaincomein2011,Denmark
hadthelowestpovertyrates,followedbyIceland,LuxembourgandFinland.TheoneswiththehighestpovertyrateswereIsrael(20.9percent),followedbytheUS,JapanandSpain.*
ConcludingRemarks:WhyPovertyandInequalityAreNotBeyondHumanControl
Povertyandinequalityaredisturbinglywidespread.Oneinfivepeopleintheworldstillliveinabsolutepoverty.Eveninanumberofrichcountries,suchastheUSandJapan,oneinsixpeoplelivein(relative)poverty.OutsideahandfulofcountriesinEurope,incomeinequalityrangesbetweenseriousandshocking.Fartoomanypeopleacceptpovertyandinequalityasinevitableresultsofnaturaldifferencesin
abilitiesamongindividuals.Wearetoldtolivewiththeserealitiesinthewaywelivewithearthquakesandvolcanoes.But,aswehaveseeninthischapter,thesethingsaresubjecttohumanintervention.
Giventhehighinequalityinmanypoorcountries,absolutepoverty(andrelativepoverty)canbereducedwithoutanincreaseinoutput,ifthereisappropriateredistributionofincome.Inthelongerrun,however,asignificantreductionofabsolutepovertyrequireseconomicdevelopment,ashasbeenshownbyChinaintherecentperiod.Therichcountriesmayhavevirtuallygotridofabsolutepoverty,butsomeofthemsufferfromhigh
incidencesofrelativepovertyandhighinequality.Thefactthat(relative)povertyrates(5–20percent)andGinicoefficients(0.2–0.5)varywildlyamongthesecountriessuggeststhatthemoreunequalandpoverty-riddenrichcountries,suchastheUS,cansignificantlyreduceinequalityandpovertythroughpublicintervention.Whoendsupbeingpooralsodependsalotonpublicintervention.Eventoallowpoorindividualsto
getoutofpovertythroughtheirownefforts,weneedtoprovidemoreequalchildhoodconditions(throughbetterwelfareprovisionandeducation),improveaccesstojobsbypoorpeople(byreducingdiscriminationand‘clubbiness’atthetop)andpreventtherichandthepowerfulfromriggingmarkets.Inpre-industrialKorea,theyusedtosaythat‘eventhealmightykingcannotdoanythingaboutpoverty’.
Thisisnottrueanymore,ifiteverwas.Theworldnowproducesenoughtoeliminateabsolutepoverty.Evenwithoutworldwideincomeredistribution,allcountriesexceptthepoorestproduceenoughtodoso.Inequalitywillalwaysbepresent,butwithappropriatepolicies,wecanliveinveryequalsocieties,asmanyNorwegians,Finns,SwedesandDanescantellyou.
FurtherReadingA.BANERJEEANDE.DUFLO
PoorEconomics(London:PenguinBooks,2012).
D.HULMEGlobalPoverty:HowGlobalGovernanceIsFailingthePoor(London:Routledge,2010).
B.MILANOVICTheHavesandtheHave-Nots(NewYork:BasicBooks,2011).
A.SENDevelopmentasFreedom(Oxford:OxfordUniversityPress,2001).
J.STIGLITZThePriceofInequality(London:AllenLane,2012).
D.STUCKLERANDS.BASUTheBodyEconomic:WhyAusterityKills(London:BasicBooks,2013).
R.WILKINSONANDK.PICKETTTheSpiritLevel:WhyEqualSocietiesAlmostAlwaysDoBetter(London:AllenLane,2009).
‘LadyGlossop:Doyouwork,MrWooster?Bertie:What,work,asinhonesttoil,youmean?LadyGlossop:Yes.Bertie:Hewingthewoodanddrawingtheoldwetstuffandsoforth?LadyGlossop:Quite.Bertie:Well,I’veknownafewpeoplewho’veworked.Absolutelyswearbyit,someofthem.’JEEVESANDWOOSTER,BBCSERIES,SEASON1,EPISODE1,‘JEEVES’ARRIVAL’
WorkWorkasthedefiningconditionofhumanity
ForBertieWooster–thekind-heartedbutcluelessaristocraticdandy(playedbyayoungHughLaurieofHousefame)inthe1980sBBCTVadaptationofP.G.Wodehouse’sclassicJeevesandWoosternovels–workiswhatotherpeopledo.However,exceptforatinyminorityofidlerich,ortheleisureclass,*likehim,workhasbeenthedefiningconditionofhumanitythroughoutmostofitshistory.Untilthenineteenthcentury,mostpeopleintoday’srichWesterncountriestypicallyworkedseventyto
eightyhoursaweek,withsomepeopleworkingover100hours.Sincetheyoften(notalways)hadtheSundaymorningoffforchurchattendance,thismeantthattheywereworkingatleastelevenhours,andpossiblyuptosixteenhours,perday,exceptonSundays.Today,fewworkthatlongeveninpoorcountries.Theaverageworkingweekrangesbetweenthirty-
fiveandfifty-fivehours.Evenso,themajorityoftheadultpopulationspendsaroundhalfoftheirwakinghoursatwork(more,ifweaddthetimeforcommuting),outsideweekendsandpaidholidays.
Thedogthatdidn’tbark:thecuriousabsenceofworkineconomics
Despiteitsoverwhelmingpresenceinourlives,workisarelativelyminorsubjectineconomics.Theonlymajormentionofworkis,somewhatcuriously,intermsofitsabsence–unemployment.Insofarasworkisdiscussed,itisbasicallytreatedasameanstogetincome.Weareseentovalue
incomeorleisure,butnotworkinandofitself.InthedominantNeoclassicalview,weputupwiththedisutilityfromworkonlybecausewecanderiveutilityfromthingswecanbuywiththeresultingincome.Inthisframework,weworkonlyuptothepointwherethedisutilityfromanadditionalunitofworkisequalizedwiththeutilitythatwecanderivefromtheadditionalincomefromit.Butformostpeople,workisalotmorethansimplyameanstoearnincome.Whenwespendsomuch
timeonit,whathappensintheworkplaceaffectsourphysiologicalandpsychologicalwell-being.Itmayevenshapeourveryselves.
Manyhaveworked–andarestillworking–withtheirbasichumanrightsviolated
Formanypeople,workisaboutbasichumanrights–or,rather,thelackofthem.Formuchofhumanhistory,hugenumbersofpeopleweredeprivedofthemostbasichumanrightof‘self-ownership’andwereboughtandsoldascommodities–thatis,asslaves.Aftertheabolitionofslaveryinthenineteenthcentury,around1.5millionIndians,Chinese(the
‘coolies’)andevenJapanesewentoverseasasindenturedlabourerstoreplacetheslaves.PeoplelikeV.
S.Naipaul,theIndian-Trinidadiannovelistwhowasthe2001winneroftheNobelPrizeinLiterature,Yat-senChang,theChinese-CubanballerinoattheEnglishNationalBallet,andVijaySingh,theIndian-Fijiangolfer,areremindersofthishistory.Indenturedlabourwasnotslavery,inthesensethattheworkerwasnotownedbytheemployer.Butan
indenturedlabourerhadnofreedomtochangejobsandhadonlyminimalrightsduringthecontractperiod(threetotenyears).Inmanycases,theirworkingconditionswerescarcelybetterthanthoseoftheslaveswhomtheycametoreplace;manywereputintheexactsamebarracksthattheslavesusedtolivein.Butweshouldn’tmakethemistakeofthinkingthisisallinthepast.Therearestillalotofpeople
whoseworkisfoundedupontheviolationoftheirfundamentalhumanrights.Theremaybefewlegalslaves,butstillalotofpeopleareengagedinotherformsofforcedlabour.Someofthemwouldhavebeencoercedintothosejobs(thatis,trafficked).Othersmayhavevoluntarilysignedupfortheminitially,buttheymaybepreventedfromleavingtheirjobs,duetoeitherviolence(mostcommonamongdomesticworkers)ordebtstotheemployer,artificiallyinflatedbyover-chargingontheirrecruitment,travel,foodoraccommodation.Someinternationalmigrantworkerstoilunderconditionssimilartotheindenturedlabourersofthelatenineteenthandtheearlytwentiethcenturies.
Howworkshapesus
Evenwhenitdoesnotinvolveviolationofbasichumanrights,workcansofundamentallyaffectusthatitreally‘forms’us.Nowhereisthismoreevidentthaninrelationtochildlabour.*Whenchildrenworkinadultjobs,their
mentalandphysicaldevelopmentsarearrested.Thus,byworkingfromayoungage,individualsmaynotfulfiltheirpotentialtothefull.Workformsadultstoo.AdamSmith,whilepraisingthepositiveproductivityeffectsofthefiner
divisionoflabour(seeChapter2),wasconcernedthatexcessivedivisionoflabourmightcrippletheworker’smentalcapacity.ThispointwaslaterhilariouslybutpoignantlydepictedinCharlieChaplin’sclassicmovieModernTimes,inwhichheplaysaworkerwho,havingbeenreducedtoperformingsimplerepetitivetasksathighspeed,hasamentalbreakdownandrunsamok.Workcanalsoformuspositively.Peoplewholiketheirjobsoftenhaveagreatersenseofself-
fulfilment.Itiswellunderstoodthatfactorywork,comparedtoworkinshopsorevenagriculturalwork,makesworkersmorepoliticallyawareanddisciplinedbecauseofitsverynature–alargenumberofpeopleworkinginacloselyconnectedandsynchronizedwayinaconfinedandorganizedspace.
Workaffectsourphysical,intellectualandpsychologicalwell-being
Evenwhenitdoesnotaffectussodeeplythatitactually‘forms’us,workgreatlyaffectsourwell-beinginphysical,intellectualandpsychologicalterms.Somejobsaremorephysicallydemanding,dangerousandharmfulforhealththanothers.Working
longermakespeoplemoretiredandharmstheirhealthinthelongrun.Therearejobs–crafts,arts,design,teaching,research,etc.–thatareoftenconsideredmore
intellectuallyinteresting,thankstotheirhighercreativecontents.Thepsychologicaldimensionrelatestotheemployer–employeerelationship,ratherthantothephysical
orintellectualnatureoftheworkperse.Evenifthejobisidentical,thosewhoareprovidedwithfewerbreaksduringwork,putunderexcessivepressuretoperformormadetofeelinsecurearelesshappythantheircounterpartsworkingformoredecentemployers.
‘Workingaslongasonewishes’:labourstandardsvs.freechoice
Ifpeople’swelfarecanbesodramaticallyaffectedbywhathappensattheirwork,thenitisgoingtobeaffectedhugelybythelabourstandardswesetinrelationtothingslikethelengthofworkinghours,safetyatworkorjobsecurity.Manyeconomistsareagainstsuchstandards–especiallyiftheyareimposedthroughgovernment
regulation,ratherthanthroughemployers’‘codesofconduct’orthroughvoluntaryagreementswithtradeunions.However‘excessivelylong’or‘overlydangerous’somejobsmayappear,theyargue,wehavetoacceptthemastheyare,insofarastheyhavebeentakenbyfreeworkerswithfullmentalfaculties.Ifaworkerhastakena‘bad’job,theseeconomistsargue,itisbecausehehasconcludedthatthe‘bad’conditionshehastoputupwitharemorethancompensatedbythewagehegets.Indeed,itwasexactlyonthesegroundsthatin1905theUSSupremeCourtdeclared(intheLochnervs.NewYorkcase)thataten-hourrestrictionontheworkinghoursforbakeryworkersintroducedbytheNewYorkstatewasunconstitutional,asit‘deprivedthebakersofthelibertyofworkingaslongastheywished’.1
Thisis,initself,notanunreasonableargument.Ifsomeonefreelychoosestodosomething,itmust,bydefinition,meanthatthatpersonprefersthattootheroptions.Butthequestionweneedtoaskiswhetherthatchoicewasmadeunderconditionsthatoughttobe–andcanbe–changed.Mostworkerswhowillinglytake‘bad’jobsdosobecausethealternativeisstarvation.Perhapsthereisveryhighunemployment,andtheycannotfindanyotherjob.Perhapstheyarenotattractivetoanyotheremployerbecausetheyarephysicallystuntedorilliterateduetochildhooddeprivation.Perhapstheyaremigrantsfromruralareaswhohavelosteverythinginafloodandthusaredesperateforwork–anywork.Butcanwereallycallchoicesmadeundersuchcircumstances‘free’?Aren’tthesepeopleactingundercompulsion–ofhavingtoeat?Inthiscontext,weshouldbearinmindwhattheBrazilianarchbishopofOlindaandRecife,Dom
HélderCâmara,aleadingfigureoftheleft-wingCatholic‘liberationtheology’especiallypopularinLatinAmericabetweenthe1950sandthe1970s,said:‘WhenIgivefoodtothepoor,theycallmeasaint.WhenIaskwhythepoorhavenofood,theycallmeaCommunist.’Perhapsweshouldallbeabitofa‘Communist’andquestionwhethertheunderlyingconditionsthatmakethepoorsodesperatetovoluntarilysignupfor‘bad’jobsareacceptable.*
REAL-LIFENUMBERSForcedlabour
TheILOestimatesthat,asof2012,around21millionpeopleintheworldareengagedinforcedlabour.Thisisonly0.6percentoftheestimatedglobalworkforceof3.3billion(or0.3percentoftheworldpopulation),butitisstilltoohighby0.6percentpoints.AccordingtotheILO,thefrequencyofforcedlabouristhehighestintheformersocialistcountriesin
EuropeandintheformerSovietUnion(0.42percentofthepopulation)andAfrica(0.40percent).Evenintherichcountries,0.15percentofthepopulationisestimatedtobeengagedinforcedlabour.2
Childlabour
TheILOalsoestimatesthatthereare123millionchildlabourers,agedbetweenfiveandfourteen,aroundtheworld–equivalentto3.7percentoftheglobalworkforce.However,thisisonlytheglobalpicture,andinanumberofthepoorestcountriesaroundhalfthechildrenarebelievedtobechild
labourers.GuineaBissau(57percent)topsthelist,followedbyEthiopia(53percent)andthenbytheCentralAfricanRepublic,Chad,SierraLeoneandTogo(allat47percentor48percent).Mostothercountrieswithveryhighincidencesofchildlabour(say,over30percent)areinAfrica.ButsomeofthemareinAsia(Cambodia39percent,Nepal34percent)andLatinAmerica(Peru34percent).Theratioofchildlabourisobviouslyrelatedtothecountry’spovertybutisnotdeterminedbyit.The
childlabourratioinBurundiis19percent,despitethecountryhavingthelowestpercapitaincomeintheworldin2010.ThisisonlyaroundhalfthelevelfoundinPeru,whosepercapitaincomeinthesameyear,at$4,710,wasnearlythirtytimeshigher.Foranotherexample,inthe1960s,SouthKorea,despitebeingoneofthepoorestcountriesintheworldatthetime,virtuallyeliminatedchildlabourforchildrenundertwelvebymakingprimaryeducationcompulsoryandenforcingitwithdetermination.Theseexamplesshowthatpovertyisnotanexcusefortheprevalenceofchildlabour,althoughitmaylimittheextentto,andthespeedat,whichyoucanreduceit.
Peopleinpoorcountriesworkmuchlongerthanthoseinrichcountries
Inmostrichcountries,peopleworkaroundthirty-fivehoursperweek,althoughtheworkingweekisconsiderablylongerintheEastAsiancountries(Japan,forty-twohours;Korea,forty-fourhours;Singapore,forty-sixhours).3Peopleinthosecountriesareworkinghalf,orevenlessthanhalf,thelengthofthetimethattheirgreat-grandparentsorgreat-great-grandparentsworked(seventytoeightyhoursperweek).Intoday’spoorercountries,peopledonotworkaslongaspeopleatcomparablelevelsofincomedid
intoday’srichcountriesintheeighteenthandnineteenthcenturies,buttheyworkmuchlongerthantheirmodern-daycounterpartsinrichcountries.Someofthemcanworkuptofifty-fivehoursperweekonaverage,asinEgypt(fifty-fivetofifty-sixhours)andPeru(fifty-threetofifty-fourhours).Averageweeklyworkinghoursarealsolong–forty-fivetofiftyhours–incountriessuchas,inalphabeticalorder,Bangladesh,Colombia,CostaRica,India,Malaysia,Mexico,Paraguay,SriLanka,ThailandandTurkey.Thesenumbersunderestimatethetimeweareoccupiedwithwork(asopposedtoactually‘at’work).
Incountrieswithpoorpublictransportandsprawled-outlivingspaces,thelonghoursspentbypeoplecommutingtoandbackfromworkcanseverelyreducetheirwelfare.InSouthAfrica,youcanspenduptosixhoursadaysimplycommuting,ifyouareapoorblackworkerlivinginoneofthefar-flungblacktownshipsandworkinginoneofthestillmostlywhitecities.Onanotherfront,theincreasinguseoftheinternetinbusinesshasforcedmanywhite-collarworkerstoworkoutsidethetraditionalworkinghours.
Droughtorflood?:unevendistributionofworkinghours
Whenlookingatthedataregardingworkinghours,wehavetobearinmindthatallthesenumbersareaverages.Inmanycountries,somepeopleareworkingexcessivelylonghours(theILOdefinesthisasaboveforty-eighthoursperweek),whichexposesthemtopotentialhealthrisks.Othersareintime-relatedunderemployment;thatis,theyareworkingpart-timeevenwhentheywanttoworkfull-time,asmanypeoplehavedonesincetheoutbreakofthe2008globalfinancialcrisis.Indevelopingcountries,manypeopleareindisguisedunemploymentinthesensethattheyhaveajobthataddsverylittle,ifanythingatall,tooutputandmainlyactsasawaytogetsomeincome.Examplesincluderuralpeopleworkingonanovercrowdedfamilyfarmandthosepoorpeopleintheinformalsector(thecollectionofunregisteredsmall–oftenone-person–businesses)‘inventing’jobssothattheycanbegwithout
appearingtobeg(moreontheselater).Thesepeople‘cannotaffordtobeunemployed’,asthesayinggoes.TheproportionoftheworkforceworkingexcessivelylonghoursisthehighestinIndonesia(51per
cent)andKorea(50percent),withcountriessuchasThailand,PakistanandEthiopiaallhavingproportionsover40percent.TheproportionsarethelowestinRussia(3percent),Moldova(5percent),Norway(5percent)andtheNetherlands(7percent).
Howlongpeoplereallywork:paidvacationsandannualhoursofwork
Theseweeklyworkinghours,however,donotprovideuswiththefullpicture.Insomecountries,peopleworkeveryweekoftheyear,whileinotherstheycanhaveseveralweeksofpaidvacation;inFranceandGermany,paidvacationscanbeasmanyasfiveworkingweeks(twenty-fiveworkingdays)peryear.Thusweneedtolookatannualworkinghourstogetthefullpictureofhowmuchpeopleworkindifferentcountries.SuchdataexistonlyfortheOECDmembercountries.Ofthese,theoneswiththeshortestannual
workinghoursare,asof2011,theNetherlands,Germany,NorwayandFrance.4Attheotherextreme,thelongestworkinghoursarefoundinSouthKorea,Greece,theUSandItaly.5TheOECDdatasetalsoincludesanumberofcountriesthatcannotbeconsideredrich.Inoneofthesecountries–Mexico(2,250hours)–theyearlyworkinghoursarelongerthanthoseinSouthKorea(2,090hours).6Chile,anotherdevelopingcountrymemberoftheOECD,at2,047hoursperyear,isbetweenKoreaandGreece(2,039hours).
Whoarethe‘lazy’ones?:themythsandtherealitiesofworkinghours
Thesenumbersrevealthattheculturalstereotypesofwhichpeopleworkhardandwhichdon’tareoftencompletelywrong.Mexicans,seenasthearchetypal‘lazyLatinos’intheUS,actuallyworklongerthanthe‘workerant’
Koreans.RecallthattheLatinAmericancountriesareverystronglyrepresentedintheabove-mentionedlistofcountrieswithlongestworkingweeks(fiveoutoftwelve).ItissimplynottruethattheLatinAmericansarelaid-backpeoplewhodonotworkhard,asthestereotypegoes.IntheongoingEurozonecrisis,theGreekshavebeenvilifiedaslazy‘spongers’livingoffhard-
workingNortherners.ButtheyhavelongerworkinghoursthaneverycountryintherichworldapartfromSouthKorea.TheGreeksactuallywork1.4and1.5timeslongerthanthesupposedlyworkaholicGermansandDutch.Italiansalsodefythemythof‘lazyMediterraneantypes’byworkingaslongastheAmericansand1.25timeslongerthantheirGermanneighbours.
Whyareharder-workingpeoplepoorer?
Oneexplanationforthesemisperceptionsisthattheyaresometimesbasedonhopelesslyout-datedinformation.TakethecaseoftheDutch,whosestereotypicalimageisthatofhard-working,penny-pinchingPuritans.However,thisstereotypeisbasedoninformationthatisout-datedatleastbyfiftyandpossiblyeightyyears.Betweenthe1870sandthe1920s,theNetherlandsindeeddidhaveamongthelongestworkinghoursoftoday’srichcountries,butthisstartedchanginginthe1930sandradicallychangedafterthe1960s,sincewhenithasbecomethe‘laziest’countryintheworld–thatis,thecountrywiththeshortestannualworkinghoursintheworld.
Anotherexplanationforthefaultystereotypesisthatpeopleoftenmistakenlybelievethatpovertyistheresultoflazinessandthusautomaticallyassumethatpeopleinpoorercountriesarelazier.7Butwhatmakesthosepeoplepooristheirlowproductivity,whichisrarelytheirownfault.Whatismostimportantindeterminingnationalproductivityisthecapitalequipment,technologies,infrastructureandinstitutionsthatacountryhas,whicharereallythingsthatthepoorthemselvescannotprovide.So,ifanyoneistoblame,itistherichandthepowerfulincountriessuchasGreeceandMexico,whohavecontroloverthosedeterminantsofproductivitybuthavedoneapoorjobindeliveringtheminsufficientquantityandquality.
Thehazardofwork:industrialaccidentsandjobinsecurity
Asforthequalityofwork,therearenogoodindicatorsoftheintellectualdimension,butwecanatleastgetsomeindicatorsforthephysicalandthepsychologicaldimensions.Intermsofthephysicaldimensionofqualityofwork,themostreadilyavailableindicatoristherateof
fatalinjuriesatwork(usuallymeasuredper100,000workers).Countriessuchas,inalphabeticalorder,Australia,Finland,Norway,Sweden,SwitzerlandandtheUKofferthesafestworkenvironment–onlyoneortwooftheirworkersoutof100,000dieeveryyearfromworkplaceinjuries.ThecorrespondingratioisintheregionofthirtytofortyinElSalvadorandIndiaandaroundtwentyinEthiopiaandTurkey.Theratesinmostotherdevelopingcountriesforwhichdataareavailable(theyoftenarenot)rangebetweentenandfifteen.Themostreadilyavailableindicatorsofthepsychologicalaspectsofworkare,asImentioned,those
relatedtojobsecurity.8Thereisnosingleagreedwaytomeasurejobsecurity,butthemostreliablemeasureisprobablytheshareofemployeeswithlessthansixmonths’tenure,publishedbytheOECDforitsmembercountries.Accordingtothis,asof2013,Turkishworkershavetheleastjobsecurity(at26percent),followedbythoseinKorea(24percent)andMexico(21percent).Accordingtothismeasure,workersinGreece,SlovakiaandLuxembourghavethesecurestjobs(allaround5percent).
UnemploymentGiacomoshouldremainunemployedforthegreatergood:howwehavebecomeusedtohighunemployment
In2009,ImetGiovanniDosi,theeminentItalianindustrialeconomist,ataconference.HerelatedastorythatafriendofhishadexperiencedinthecityofBolzanoinAltoAdige,theGerman-speakingpartofItaly.Knowingthatitisaveryprosperoustown,Giovanni’sfriend(notanItalian)casuallyaskedhistaxidriverhowmanyunemployedpeopleheknows.Thedrivershockedhimbysayingthattherewasonlyoneunemployedpersoninthewholetown–acertainGiacomo.Giovanni’sfriendprotested–eventhoughthetownhadonlyabout100,000people,itseemedimpossiblethattherewasonlyoneunemployedperson.Disagreeing,thecabdriverpulledupatataxirankandaskedotherdriverstobackhimup.Afterashortimpromptuconference,theothercabbiesnotonlyconfirmedtheircolleague’sassertionbutalsoaddedthattheythoughtGiacomoshouldremainunemployedforthegreatergood–ifhegotajob,theyexplained,thegovernmentjobcentrewouldhavetobeshutdownanditsfouremployeesmaderedundant.PerhapsthecabbiesofBolzanoweretakingthemickeyoutofaforeigner.Perhapstheyweretellingthe
truth.Butthepointofthisstoryisthatwehavebecomesousedtohighunemploymentinthelastthree
decadesthatwefinditshockingtohearthatasocietycanexistwithvirtuallynounemployment,eventhoughitisonlyasmallcity.However,therewasatime–duringtheGoldenAge–whenmanydevelopedcapitalistcountrieshad
verylowunemployment.Theystrivedtohavenoneandsometimesverynearlysucceeded;intheearly1970s,therewerelessthantenunemployedpeopleintheSwisscityofGeneva(populationofaround200,000atthetime).ExceptionaltheGoldenAgemayhavebeen,butitstillshowsthatfullemploymentcanbeachieved.Thereisnothing‘inevitable’aboutunemployment.
Individualcostsofunemployment:economichardship,lossofdignityanddepression
Evenifyouareunemployed,youmaybejustaboutOKfinanciallyifyouliveinoneofthoseEuropeancountrieswhereunemploymentbenefits(thatis,pay-outsfromunemploymentinsurance)are60–75percentofpreviouswagesforuptotwoyears.Buttheyareexceptionsonaglobalscale.IntheUS,theygiveonly30–40percentofyourprevioussalary(dependingonthestateyoulivein).Inmostdevelopingcountries,itisnon-existent.Unemploymentisaboutdignitytoo.KurtVonnegut,theAmericanwriter,inhis1952classicnovel
PlayerPiano,depictsaworldinwhichnoonehastodoanymanualwork.Machinesnowdoallofthat;inhisstory,thosemachinesrunoninstructionsheetsliketheonesyoufeedintotheplayerpiano,whichgivesthebookthetitle.Despitenotwantingintheirbasicmaterialneedsandhavingalltheleisuretimeintheworld,peopleofthatworld,exceptatinyminorityofengineersandmanagers,areactuallydesperatelyunhappy–theyhavebeendeprivedofthedignitytheyderivedfrombeingusefulmembersofthesociety.Unemploymentalsohassignificantnegativehealth,especiallymentalhealth,effects.Thecombination
ofeconomichardshipandlossofdignitymakesunemployedpeoplemoredepressedandmorelikelytocommitsuicide.9
Socialcostsofunemployment:wasteofresources,socialdecayandskillserosion
Unemploymentisahugewasteofresourcesfromasocialpointofview.Itcreatesasituationinwhichsomepeopleareunabletofindajobwhiletherearemachineslyingaroundidle.Long-termunemploymentconcentratedincertainregionscanleadtosocialdecayandurban
degeneration.SomeareasoftheAmerican‘rustbelt’andtheNorthern(formerly)industrialareasoftheUKstillhavenotfullyrecoveredfromtheconsequencesofhighunemploymentinthelate1970sand1980s.Ifpeopleremainunemployedforlong,theirskillsbecomeout-datedandtheirconfidenceiseroded,
makingthemlessproductiveinthefuture.Aslong-termunemployment(say,overayear)dramaticallyreducesaworker’schanceofre-employment,thoseworkersgetintoaviciouscircleofever-fallingemployabilityandever-lengtheningperiodsofunemployment.
Peopleinbetweenjobs:frictionalunemployment
Therearequiteafewdifferenttypesofunemployment–atleastfiveofthem,asIshalldiscussbelow.Firstofall,thereisunemploymentthathappens‘naturally’.Jobsappearanddisappearascompanies
areborn,grow,shrinkanddie.Workersdecidetochangetheirjobsforvariousreasons;theymayhavegrowndissatisfiedwiththeircurrentjobortheydecidetomovetoanothertown,say,totakecareof
elderlyparentswhocannottakecareofthemselvesanymoreortolivewithanewpartner.Soitisnaturalthatpeoplemoveinandoutofjobs.Thetroubleisthatthisprocessisnotinstantaneous.Ittakestimeforpeopletosearchfornewjobsand
forcompaniestofindtherightpeople.Theresultisthatsomepeopleendupspendingsometimeunemployedintheprocess.Thisisknownasfrictionalunemployment.
Someskillsarenotwantedanymore:technologicalunemployment
Thenthereisunemploymentduetothemismatchbetweenthetypesofworkersdemandedandtheavailableworkers.Thisisusuallyknownastechnologicalunemploymentorstructuralunemployment.ThisisunemploymentthatwehaveseeninmovieslikeRogerandMe,thefirstmoviemadebyMikeMoore,inwhichhedocumentstheconsequenceoftheclosureofaGMcarfactoryinhistown,Flint,Michigan,orinTheFullMonty,inwhichsixunemployedsteelworkersinSheffield,UK,afteradrainingperiodofunemployment,launchthemselvesasamalestrippergroup.Accordingtostandardeconomictheory,theseworkerscouldhaveacquiredskillsin‘sunrise’
industriesandmovedtootherareas–theelectronicsindustryinCaliforniaandinvestmentbankinginLondonwouldhavebeen,respectively,theobviousalternatives.Inreality,smoothtransitionsalmostneverhappen,ifyouleavethingstothemarketalone.Evenwithsystematicgovernmentsubsidiesandinstitutionalsupportsforretrainingandrelocation(e.g.,abridgingloantobuyahousewherethenewjobisbeforethecurrentoneissold),asusedintheScandinaviancountries,itisastruggletoeliminatetechnologicalunemployment.
Governmentsandunionscreateunemployment:politicalunemployment
BelievinginthemodernversionofSay’sLaw,manyNeoclassicaleconomistshavearguedthat,exceptintheshortrun,thelawofsupplyanddemandensuresthateveryonewhowantstoworkwillfindajobatthegoingwagerates.Ifsomepeopleareunemployed,theseeconomistsargue,itisbecausesomething–thegovernmentortradeunions–ispreventingthemfromacceptingthewageratesthatwillclearthemarket.Someworkersintherichcountriesrefusetoacceptthegoingwagerateandremainunemployed
becausetheycanliveongovernmentwelfarepayments.Tradeunionsmakeitimpossibleforthewageratetogodown.Atthesametime,governmentlabourmarketregulations(e.g.,minimumwages,brakesonfiring,requirementsforseverancepayments)andemploymenttaxes,suchasemployers’socialsecuritycontribution,allmakeworkersmoreexpensivethantheyreallyshouldbe.Thisreducestheincentiveonthepartofemployerstohirethem.Theresultishigherunemployment.Inthatitisduetotheinterferencesof‘political’entitieslikethegovernmentortradeunions,thistype
ofunemploymentmaybecalledpoliticalunemployment.Thesolutionofferedistomakethelabourmarketmore‘flexible’throughmeasureslikethereductionintradeunionpower,theabolitionofminimumwagesandtheminimizationofworkerprotectionagainstdismissal.
Theremaynotbeenoughdemand:cyclicalunemployment
AswetalkedaboutwhendiscussingKeynesinChapter4,thereareinstancesofinvoluntaryunemploymentthatarisefromdeficienciesintheaggregatedemand,asduringtheGreatDepressionorintoday’sGreatRecession,astheaftermathofthe2008globalfinancialcrisisisoftencalled.Forsuch
unemployment,knownascyclicalunemployment,theabove-mentionedsupply-sidesolutions,suchasloweringwagesorretrainingworkerswithredundantskills,arepowerless.Themainsolutiontocyclicalunemploymentistoboostdemandthroughgovernmentdeficitspending
andloosemonetarypolicy(suchastheloweringofinterestrates)untiltheprivatesectorrecoversandstartscreatingenoughnewjobs.*
Capitalismneedsunemployment:systemicunemployment
WhiletheKeynesiansseeunemploymentasacyclicalthing,manyeconomists–fromKarlMarxtoJosephStiglitz(inhis‘efficiencywage’model)–havearguedthatunemploymentissomethingthatisinherenttocapitalism.Thisviewstartsfromtheobviousbutimportantobservationthat,unlikemachines,workershaveminds
oftheirown.Thismeansthattheycancontrolhowmuchefforttheyputinwhentheywork.Naturally,capitalistshavetriedtheirbesttominimizesuchcontrolbyintroducingminuteandeasilyobservabletasksand/orintroducingtheconveyorbelt,whosespeedworkerscannotcontrol.Evenso,thereissomediscretionleftonthepartoftheworkerovertheirlabourprocess,andthecapitalistsomehowneedstomakesurethattheworkerputsinthemaximumamountofeffort–ordoesnot‘shirk’,assomewouldputit.Thebestwaytoimposesuchdisciplineonworkers,accordingtothisargument,istomakejobloss
costlytothembyraisingtheirwagesabovethemarketrate–ifworkerscangetanotherjobwithequalpayeasily,theywillnotbeafraidofthethreatofbeingfired.However,sinceallcapitalistsdothesame,theresultisthattheoverallwagerateispushedabovethe‘market-clearing’levelandunemploymentiscreated.ItisonthebasisofthisreasoningthatMarxcalledtheunemployedworkersthereservearmyof
labour,whocanbecalleduponanytimeifthehiredworkersbecometoounwieldy.ItisonthisgroundthatMichalKalecki(1899–1970),thePolisheconomistwhoinventedKeynes’stheoryofeffectivedemandbeforeKeynes,arguedthatfullemploymentisincompatiblewithcapitalism.Wemightcallthisformofunemploymentsystemicunemployment.
Differenttypesofunemploymentco-existindifferentcombinationsindifferentcontexts
Allthesedifferenttypesofunemploymentarerealandcanco-exist.Sometimesonetypewillbeprominentwhileanothermaybecomesoinothercircumstances.AlotofunemploymentintheUSandEuropeinthe1980swas‘technological’inthesensethatitwas
causedbythedeclineofawiderangeofindustriesduetocompetitionfromEastAsia.‘Systemic’unemployment,asitsnamesuggests,hasalwaysbeenanintegralpartofcapitalism,butitwasvirtuallyeliminatedinWesternEuropeandJapanduringtheGoldenAge.Today,alotofcountriesaresufferingfrom‘cyclical’unemploymentduetodemanddeficiencies,whileitwasnotsignificantintheboomyearsofthemid-2000s.‘Political’unemploymentdoesexist,eventhoughitsextentisoftenexaggeratedbythefree-marketorthodoxy.
Whocanwork,whowantstowork,andwhoworks?:definingandmeasuringunemployment
Howdowemeasureunemploymentinpractice?Themostapparentmethodmaybetocountthenumberofpeopleinacountry’spopulationwhoarenotworking.However,thisisactuallynothowwedefineandmeasureunemploymentinpractice.
Therearesomepeoplewhoaretooyoungortoooldtowork.Soweconsideronlytheworking-agepopulationwhenwecalculateunemployment.Allcountriesexcludechildrenfromtheworking-agepopulation,butthedefinitionofchildrendiffersacrosscountries;fifteenisthemostfrequentlyusedthreshold,butitcouldbeaslowasfive(IndiaandNepal).10Somecountriesalsoexcludeoldpeoplefromtheworking-agepopulation;themostfrequentlyusedthresholdagesaresixty-fourandseventy-four,butitcouldbeaslowassixty-threeorashighasseventy-nine.Evenamongthosewhobelongtotheworking-agepopulation,noteveryonewhoisnotworkingis
countedasunemployed.Someofthem,suchasstudentsorthosewhoareengagedinunpaidhouseholdworkorcareworkfortheirfamilyorfriends,maynotwantapaidjob.Inordertobeclassifiedasunemployed,thepersonshouldhavebeen‘activelyseekingwork’,whichisdefinedashavingappliedforpaidjobsintherecentpast–usuallyintheprecedingfourweeks.Whenyousubtractthosewhoarenotactivelyseekingworkfromyourworking-agepopulation,yougettheeconomicallyactivepopulation.Onlythosewhoareeconomicallyactive(thatis,activelyseekingpaidjobs)butarenotworkingarecountedasunemployed.Thisdefinitionofunemployment,knownastheILOdefinition,isusedbyallcountries(withminor
modifications),butisnotwithoutseriousproblems.Oneisthat‘working’isdefinedrathergenerouslyasdoingmorethananhour’spaidworkperweek.Anotheristhat,byrequiringthatpeopleshouldhaveactivelylookedforworktobecountedasunemployed,itexcludestheso-calleddiscouragedworkers(peoplewhohavegivenuplookingforworkduetorepeatedfailuresintheirjobapplications,eventhoughtheystillwanttowork)fromtheunemploymentstatistics.11
REAL-LIFENUMBERSUnemploymentratesintherichcountrieshaverisenalotsincetheGoldenAge
DuringtheGoldenAge,unemploymentratesinJapanandtheWesternEuropeancountrieswere1–2percent,comparedto3–10percenttypicallyfoundintheperiodsbeforethat.IncountrieslikeSwitzerland,WestGermanyandtheNetherlands,itwasoftenlessthan1percent.TheUS,with3–5percentunemploymentrate,wasthenconsideredahigh-unemploymentcountry.AftertheGoldenAge,peopleinrichcountrieshavebecomeusedtounemploymentratesof5–10per
cent,eventhoughsomecountries,notablyJapan,Switzerland,theNetherlandsandNorway,havemaintainedlowunemploymentrates,at2–4percent.Followingthe2008globalfinancialcrisis,unemploymentrateshaveriseninmostrichcountries.Inthe
US,theUKandSwedenitrosequitesubstantially:fromaround6percenttoaround9–10percent.Fiveyearsafterthecrisis,theirunemploymentratesarestillaround7–8percent.Somepeopleclaimthatthe‘real’rateofunemploymentintheUScouldeasilybe15percent,ifweincludethediscouragedworkersandthoseintime-relatedunder-employment.Inthe‘periphery’countriesoftheEurozone,whichwereparticularlyhardhitbythe2008crisis,the
unemploymentsituationrangesfromcatastrophictogrim.InGreeceandSpaintheunemploymentratehasrisenfromaround8percentbeforethecrisisto28percentand26percentrespectively,withyouth(agedfifteentotwenty-four)unemploymentratesover55percent.TheunemploymentproblemisalsoseriousinPortugal(18percent)andIreland(14percent).
Difficultyofdefiningunemploymentindevelopingcountries:under-employmentandlowproductivity
Unemploymentratesindevelopingcountriesaremuchlessstraightforwardtodefineandmeasure.Themainsourceoftheproblemisthatmanypeopleindevelopingcountriesareworkingaccordingtothestandarddefinition(onehourofpaidworkinoneweek)butmaybe‘under-employed’inthesensethattheyhavealotofidleperiodsduringtheirworkand/orareaddinglittletotheeconomy’soutput.Inthepoorestpartsoftheworld,50–60percentofpeopleworkinagriculture;theaverageforSub-
SaharanAfricais62percent,andthatforSouthAsiais51percent.Mostofthemworkonfamilyfarms,eventhoughtheymaybeaddinglittletooutput,asthatistheonlywaytheycanlayclaimtoanincome.Itisdebatablewhetherthosepeopleshouldbetreatedasemployed,whenremovingthemfromtheirfamilyfarmswouldreducetheoutputbyverylittle,ifatall.Outsidetheagriculturalsector,therearealotofpeoplewhoareworkingtoofewhours(say,under
thirtyhoursperweek)againsttheirwishes.Theyareintime-relatedunder-employment.TheILOestimatesthattheproportionoftheworkforceinsuchasituationcouldbeashighas15–20percentinsomedevelopingcountries.Inthesecountries,theunemploymentratewouldeasilyriseby5–6percentagepointsifweconvertedthosepeopletofull-timeequivalents.Evenwhentheyworklonghours,manypeopleinpoorcountriesareworkinginmarginaljobsinthe
informalsectorthataddverylittletothesocialoutput.Itisbecausetheycannotafford‘nottowork’.Someofthesejobscanonlybedescribedas‘invented’.Thesearepeoplewhocatchdoorsforothersenteringanupmarketbuilding,sellchewinggumsthatnoonereallywantsandprovideanunsolicitedcar-windscreenwashatatrafficjunction–allinthehopethatsomekindsoulsmaytossthemsomechange.Whethertocountallthesepeopleasemployedorunemployedisamootpoint.
Unemploymentindevelopingcountries
Bearinginmindthatthesefiguresneedtobeinterpretedwithutmostcaution,letuslookattheunemploymentfiguresfordevelopingcountries.Overthelastdecadeorso,thehighest-unemploymentcountryinthedevelopingworld,accordingtothe
ILO,hasbeenSouthAfrica,withunemploymentratesusuallyabove25percentandsometimesgoingover30percent.ItiscloselyfollowedbyBotswanaandNamibia(around20percent).Otherhigh-unemploymentcountriesincludeAlbania,theDominicanRepublic,EthiopiaandTunisia(15–20percent).Medium-highunemploymentisfoundincountrieslikeColombia,Jamaica,Morocco,Uruguayand
Venezuela(10–15percent).WecanclassifycountrieslikeBrazil,ElSalvador,Indonesia,Mauritius,Pakistan,ParaguayandSriLankaasmedium-low-unemploymentcountries(5–10percent).SomedevelopingcountrieshaveverylowunemploymentaccordingtotheILOdata,rangingfrom1per
centto5percent.TheseincludeBangladesh,Bolivia,China,Guatemala,Malaysia,MexicoandThailand.
ConcludingRemarks:TakingWorkSeriously
Workisthemostdominantaspectoflifeforthemajorityofpeople.Evenwhentheyareofficiallyclassifiedas‘notworking’,suchashomemakers,mostadultswork–oftenverylonghoursinhardconditions.Inthepoorerdevelopingcountriesevenalotofchildrenwork.Inthosecountries,peoplearesodesperatethattheyoften‘invent’jobsinordertosurvive.
Despiteallthis,inmosteconomicdiscussions,peoplearemainlyconceptualizedasconsumers,ratherthanworkers.EspeciallyinthedominantNeoclassicaleconomictheory,weareseenasworkingultimatelytoconsume.Insofarasworkisdiscussed,itendsatthefactorygate,orshopentrance,sotospeak.Nointrinsicvalueofworkisrecognized,whetheritiscreativepleasure,senseoffulfilmentorthefeelingofdignitythatcomesfrombeing‘useful’tosociety.Therealityisthatwhathappensatworkaffectsworkersimmeasurably,especiallyinthepoorer
countries,wheremanypeopleareengagedinjobsthatdeprivethemoftheirbasichumanrights,puttheminphysicaldangerandstunttheirfuturedevelopments(inthecaseofchildlabour).Evenintherichercountries,whathappensatworkcanmakepeoplefulfilled,bored,valuedorstressed.Atthedeepestlevelworkshapeswhoweare.Workgetsmoreattentionwhenitisabsent–thatis,whenthereisunemployment.Buteven
unemploymenthasnotbeentakenseriouslyenoughinthesensethatitisacceptedassomethinginevitable.Fullemployment–oncethemostimportant,andoftenachieved,policygoalintheadvancedcapitalistcountries–isconsideredtobesomethingunachievableandthusirrelevant.Thehumancostsofunemployment–economichardship,depression,humiliationandevensuicide–arehardlyrecognized.Allofthishasseriousconsequencesforthewayinwhichoureconomyandsocietyisrun.Workisseen
asaninconveniencethatwehavetoendureinordertogetincome,andweareseenasbeingpurelydrivenbyourdesiretoconsumewiththatincome.Especiallyintherichcountries,suchconsumeristmentalityhasledtowaste,shoppingaddictionandunsustainablehouseholddebts,whilemakingitmoredifficulttoreducecarbonemissionandfightclimatechange.Theneglectofworkmeansthatdeterioratingworkingconditionsareacceptedregardlessoftheirimpactsonworkers’physicalandmentalwell-being,asfarastheyareaccompaniedbyrisingwages.Highunemploymentisconsideredarelativelyminorproblemdespiteitsenormoushumancosts,whileaslightriseininflationistreatedasifitisanationaldisaster.Workhasbecometheembarrassingmaduncleofeconomicsthatwepretenddoesnotexist.However,
withouttakingworkmoreseriously,wecannotbuildamorebalancedeconomyandamorefulfilledsociety.
FurtherReadingH.BRAVERMAN
LabourandMonopolyCapital:TheDegradationofWorkintheTwentiethCentury(NewYork:MonthlyReviewPress,1974).
B.EHRENREICH
NickelandDimed:On(Not)GettingByinAmerica(London:Granta,2002).
J.HUMPHRIES
ChildhoodandChildLabourintheBritishIndustrialRevolution(Cambridge:CambridgeUniversityPress,2010).
S.LEE,D.MCCANNANDJ.MESSENGER
WorkingTimeAroundtheWorld:TrendsinWorkingHours,LawsandPoliciesinaGlobalComparativePerspective(London:Routledge,2007).
K.MARX
Capital(Harmondsworth:Penguin,1976),vol.1,chapter15.
U.PAGANO
WorkandWelfareinEconomicTheory(Oxford:Blackwell,1985).
G.STANDING
ThePrecariat:TheNewDangerousClass(London:BloomsburyAcademic,2011).
J.TREVITHICK
InvoluntaryUnemployment:MacroeconomicsfromaKeynesianPointofView(NewYorkandLondon:HarvesterWheatsheaf,1992).
‘Governmentexiststoprotectusfromeachother.Wheregovernmenthasgonebeyonditslimitsisindecidingtoprotectusfromourselves.’RONALDREAGAN
‘Theproofthatthestateisacreationofnatureandpriortotheindividualisthattheindividual,whenisolated,isnotself-sufficing;andthereforeheislikeapartinrelationtothewhole.’ARISTOTLE
TheStateandEconomicsPoliticaleconomy:amore‘honest’name?
Intheolddays,nocountryhadaMinistryofDefence.TheyallhadaMinistryofWarbecause,well,wariswhatitreallydoes.Patentsusedtobecalledpatentmonopolies,astheywere(andstillare)artificiallycreatedmonopolies,eventhoughtheymaybesociallyuseful.Sothereyouhaveit.Sometimes,anold,forgottennameconveystheessenceofthethingitisdescribingmuchbetterthanthemodernonedoes.Thesamegoesfortheoldnameofeconomics–politicaleconomy,orthestudyofpolitical
managementoftheeconomy.Inthisdayandage,wheneconomicshasbecomethe‘scienceofeverything’,onecaneasilygettheimpressionthatgovernmenteconomicpolicyisreallynotparticularlycentraltoeconomics.However,muchofeconomicsisstillaboutactionsbythestate,orthegovernment–orrecommendationsagainstthem.*Andindeedeventhoseeconomistswhotrytoselleconomicsasascienceofeverythingbyshowingthat‘economic’(rational)decisioniseverywhereare–atleastunwittingly–contributingtothedebateontheroleofthestateintheeconomy.Whentheyshowthatpeoplebehaverationallyeveninthemostunlikelyareasoflife–familylife,sumowrestlingandwhatnot–theyaresayingthat,inplainterms,peopleknowwhatisgoodforthemandhowtoachieveit.Theimplicationisthattheyshouldbeleftalone:nopaternalisticgovernmenttellingpeoplewhattodo,believingthatitknowswhatisgoodforthem.Ofcourse,noseriouseconomictheorysaysthatthegovernmentshouldbeabolishedaltogether.But
thereisahugespectrumofopinionontheappropriateroleofthestate.Atoneendofthespectrum,wehavethefree-marketview,whichwantsnomorethantheminimalstatethatprovidesmilitarydefence,protectionofpropertyrightsandinfrastructure(likeroadsandports).Attheotherend,wehavetheMarxistview,whichbelievesthatmarketsshouldbemarginalized–orevenabolishedaltogether–andthewholeeconomycoordinatedthroughcentralplanningbythestate.Oncewedepartfromthesetwoextremeviews,thepossiblepermutationsofexactlywhatthe
governmentshouldorshouldnotdobecomemind-bogglinglynumerous.Indeed,eventhosewhowantthe‘extreme’solutionsoftheminimalstateorcentralplanningcannotquiteagreeamongstthemselveson,respectively,whatexactlytheminimalstateshoulddoortowhatdegreeofdetailtheeconomyshouldbeplanned.
TheMoralityofStateIntervention
Thestatecannotbeaboveindividuals:thecontractarianview
Aperennialthemeinthedebateontheroleofthestateisamoralone–whetherthestatehastherighttotellindividualswhattodo.Mosteconomiststhesedaysbelieveinindividualism,namely,theviewthattherecanbenohigher
authoritythanindividuals.Initspurestform,thisphilosophicalstanceleadstotheviewthatthegovernmentisaproductofasocialcontractbetweensovereignindividualsandthuscannotbeaboveindividuals.Inthisview,knownascontractarianism,astateactioncanbejustifiedonlywheneveryindividualgiveshis/herconsent.
‘Nasty,brutish,andshort’:ThomasHobbesandtheoriginalcontractarianargument
Therearedifferenttheoriesofsocialcontract,butthecurrentlymostinfluentialversionisbasedontheideasoftheseventeenth-centuryEnglishpoliticalphilosopherThomasHobbes.Inhisfamous1651book,Leviathan,namedafterthebiblicalseamonster,Hobbesstartsbypresuminga‘stateofnature’,inwhichfreeindividualsexistedwithoutagovernment.Inthatworld,Hobbesargued,individualswereengagedinwhathecalledthe‘warofallagainstall’,andasaresulttheirliveswere‘solitary,poor,nasty,brutish,andshort’.Inordertoovercomethisstateofaffairs,individualsvoluntarilyagreedtoacceptcertainrestrictionsontheirfreedomimposedbyagovernmentsothattheycouldhavesocialpeace.
Moderncontractarian,orlibertarian,argumentontheroleofthestate
Hobbeshimselfactuallyusedthistheorytojustifyabsolutemonarchy.Headvocatedatotalsubmissionbyindividualstothemonarch’sauthority,whichisjustifiedbyitsabilitytoelevatehumanityoutofitsstateofnature.However,thephilosopherRobertNozick,theeconomistJamesBuchanan,thewinnerofthe1986NobelPrizeinEconomics,andothermodernadvocatesofcontractarianismhavedevelopedHobbes’sideasinadifferentdirectionandadvancedapoliticalphilosophytojustifytheminimalstate.Inthispro-free-marketversionofcontractarianism,morecommonlyknownaslibertarianismintheUS,Leviathancametodepictthestateasapotentialmonsterthatneedstoberestrained(whichisnotwhatHobbesintended).ThisviewisbestsummedupinRonaldReagan’scommentthat‘Governmentexiststoprotectusfromeachother.Wheregovernmenthasgonebeyonditslimitsisindecidingtoprotectusfromourselves.’Accordingtothelibertarians,anystateinterventionwithouttheunanimousconsentofallindividualsin
societyisillegitimate.Therefore,theonlyjustifiedactionsofthegovernmentarethingslikeprovisionoflawandorder(especiallytheprotectionofpropertyrights),nationaldefenceandsupplyofinfrastructure.Theseareservicesthatareabsolutelynecessaryforafunctioningmarketeconomytoexistandthuswhoseprovisionbythestatewouldbeacceptedbyallindividuals(weretheytobeasked).Anythingbeyondtheseminimalfunctions–whetheritisminimumwageslegislation,thewelfarestateortariffprotection–isseenasviolatingthesovereigntyofindividualsandthusthefirststepon‘theroadtoserfdom’,asthetitleofFriedrichvonHayek’sfamous1944bookgoes.Themoderncontractarian,orlibertarian,philosophicalpositionhastobetakenseriously.Onceyou
begintobelievethatthestateis‘above’itscitizens,itbecomesveryeasytodemandsacrificesbyaminorityforthe‘greatergood’,arbitrarilydefinedbythosewhocontrolthestate.Indeed,theworldhassufferedfromtoomanypoliticalrulersbelievingthattheyknowwhatisgoodforeveryoneelse–fromPolPotandStalinonthelefttoPinochetandHitlerontheright–andimposingtheirviews,oftenthrough
violentmeans.Assertingthatthestateisnotaboveitscitizensisaveryimportantdefenceofindividualsagainsttheabuseofpowerbythestate,or,rather,bythosewhocontrolthestatemachinery.
Thecontractarianargumentexaggeratesindividuals’independencefromsociety
Nevertheless,thecontractarianpositionalsohassomeimportantlimitations.Tobeginwith,itisbasedonafictional,ratherthanreal,history,asBuchananandNozickthemselvesreadilyadmit.Humanbeingshaveneverexistedasfree-contractingindividualsina‘stateofnature’buthavealwayslivedasmembersofsomesociety(forfurtherdiscussions,seethesectiononthe‘embeddedindividual’inChapter5).Theveryideaofthefree-standingindividualisaproductofcapitalism,whichemergedwellafterthestate.Thusseen,bybasingtheirtheoryonafictitioushistory,thecontractarianshavevastlyexaggerated
individuals’independencefromsocietyandunderestimatedthelegitimacyofcollectiveentities,especially(butnotexclusively)thestate.
MarketFailures
Marketsmayfailtoproducesociallyoptimaloutcomes–thisisknownasmarketfailure.IhavealreadydiscussedthebasicideabehindtheconceptinChapter4,usingthecaseofexternality.Buthereweinvestigateitingreaterdepth,asitgivesusveryimportantanalyticaltoolstoexploredifferentrolesthatthestatemayplay.
Somegoodshavetobecollectivelyprovided:publicgoods
Manygoods(andservices)areprivategoodsinthesensethat,onceIpayforit–say,anappleoraholiday–onlyIcanconsumeit.However,therearesomegoodswhoseusebynon-payerscannotbeprevented,oncetheyaresupplied.Suchgoods(andservices)areknownaspublicgoods.Theexistenceofpublicgoodsisarguablythemostfrequentlycitedtypeofmarketfailure,evenmorethanexternality,theoriginalmarketfailure.Classicexamplesofpublicgoodsincluderoads,bridges,lighthouses,flooddefencesystemsandother
infrastructure.Ifyoucandriveonaroadwithouthavingpaidforitsconstruction,whyshouldyou,asacarowner,volunteertopayupwhensomeoneistryingtoraisemoneytobuildone?Alighthousecannotselectivelyblockitslightfromyourshipbecauseyouhavenotcontributedtoitsconstructionandupkeep,soyou,asashipowner,canletotherspayforitandstillenjoyitsservice.Inotherwords,ifyoucanfree-rideonotherpeopletopayforapublicgood,youdon’thavethe
incentivetovoluntarilypayforit.Butifeveryonethinksthesameway,noonewillpayforit,whichmeansthatthegoodisnotgoingtobeprovidedatall.Atmost,itmaybeprovidedinsub-optimalquantitiesbylargeconsumerswhowouldratherletsomepeoplefree-rideonthemthannothavethegoodatall.Abigcompanydominatinganareamaybuildaroadandletotherpeopleuseitforfree,asthecostofnothavingagoodroadmaybetoohighforitsbusiness.Eveninthiscase,however,theroadcapacitywillbedeterminedbythecompany’sneeds,ratherthanbythoseofthesociety,andthussub-optimalfromthesocialpointofview.Itisthereforewidelyacceptedthatpublicgoodscanbesuppliedinoptimalquantitiesonlyifthe
governmenttaxesallpotentialusers(whichoftenmeansallcitizensandresidents)andusestheproceedseithertoprovidethemitselfortopaysomesuppliertoprovidethem.
Mostpublicgoodsare‘public’forpoliticalreasons:relativelyfewgoodshavetobepublicgoods
Itisimportanttonotethatthereareactuallyrelativelyfewgoodsthathavetobepublicgoods.Thereare,ofcourse,somegoodsfromwhoseuseitisimpossible(oratleastabsurdlyexpensive)toexcludethenon-payers.Nationaldefenceisaclassicexample.Itisimpossibletofightawarinawaythatonlyprotectsthosewhohavepaidfor‘defenceservice’.Flooddefencesystemisanotherexample.Youjustcannotselectivelyfloodthehousesofthosewhohavenotpaidfortheconstructionofthesystem.But,inmanycases,publicgoodsarepublicgoodsonlybecausewedecidethemtobeso.Many‘publicgoods’thatarefinancedbytaxesandprovidedbythegovernmentcaneasilybeturnedintoprivategoods.Wecanintroducetollboothstoroadsandbridges,asmanycountriesdo.Thesedays,itiseventechnicallypossibletoreplacelighthouseswithradiosignalservicesthatcanbeprovidedonlytothepayers.Despitethis,manygovernmentsprovideawiderangeofgoodsandservicesfor(goodandbad)politicalreasons.
Smallnumbersofsuppliersleadtosocialinefficiency:imperfectcompetition
Morecontroversially,manyeconomiststalkofmarketfailurewhenthereismonopolyoroligopoly–statesofaffairscollectivelyknownasimperfectcompetitioninNeoclassicaleconomics.Inamarketwithalotofcompetitors,producersdonothavethefreedomtosettheprice,asarivalcan
alwaysundercutthemuntilthepointwhereloweringthepricefurtherwillresultinaloss.Butamonopolisticoroligopolisticfirmhasthemarketpowertodecide–fullyinthecaseoftheformerandpartlyinthecaseofthelatter–thepriceitchargesbyvaryingthequantityitproduces,asIexplainedinChapter2.Inthecaseofoligopoly,thefirmscanformcartelsandbehaveasiftheyareamonopoly,whichallowsthemtochargethehigher,monopoly,price.However,accordingtoNeoclassicaleconomics,itisnotthetransferofextraprofitfromconsumersto
thefirmswithmarketpowerthatisconsideredtobeamarketfailure.Thefailureisduetothesociallossthateventhefirmswithmarketpowercannotappropriate–knownasallocativedeadweightloss.*
Breakup,nationalizeorregulate?:dealingwithimperfectcompetition
Ifamarketisdominatedbyfirmswithmarketpower,itisargued,thegovernmentmaytrytoreducethedeadweightlossbyreducingtheirmarketpower.Themostdrasticofsuchmeasuresistobreakupthefirm(s)withmarketpowerandthusincrease
competitioninthemarket.TheUSgovernmentactuallydidthisin1984withAT&T,thetelephoneservicegiant,whichwasdividedintoseven‘BabyBells’.Moreusually,thegovernmentcanbanoligopolisticfirmsfromformingcartelsandcolludinginsettingtheirprices.Itcanalsokeepthepriceinsuchamarketdowntoalevelascloseaspossibletowhatwouldhaveprevailedunderperfectcompetition.Thecaseofnaturalmonopoly–whichisfoundinindustrieslikeelectricity,water,gasandrailways–
posesauniquechallenge.Intheseindustries,havingmultiplesupplierseachwiththeirownnetworksof,say,waterpipesorrailways,increasestheproductioncostsomuchthatmonopolyisthemostcost-efficientarrangement.Insuchacase,thegovernmentmaysetupanSOEandrunitasifitisnotamonopoly.Alternatively,thegovernmentmayallowmonopolybyaprivate-sectorfirmbutregulateitspricingbehaviour,makingitsetitspriceequaltocostsperunit(oraveragecosts).*
Comparedtothecasesofpublicgoodsorexternality,thecaseofmarketfailureduetoimperfectcompetitionismorecontroversial
Feweconomistswoulddisputethatpublicgoodsandexternalitiescausemarketfailure,althoughtheymaydisputetheactualextentsofthosephenomena.Whenitcomestoimperfectcompetition,however,thecaseisfarmorecontroversial.
AsIdiscussedinChapter4,theSchumpeteriansandtheAustriansdenouncethestateofperfectcompetition,whichtheNeoclassicaleconomistsidealize,asastateofeconomicstasis,wherethereisnoinnovation.Whenthelureof(temporary)monopolyprofitisexactlywhatmotivatesfirmstoinnovate,clampingdownon–orevenbreakingup–monopolieswillreduceinnovationandbringabouttechnologicalstagnation.InwhatSchumpetercallsthe‘galesofcreativedestruction’,theyargue,nomonopolyissafeinthelongrun;GeneralMotors,IBM,Xerox,Kodak,Microsoft,Sony,BlackBerry,Nokiaandmanyothercompaniesthatoncehadnear-monopolyoftheirrespectivemarketsandhadbeenconsideredinvinciblehavelostsuchpositionsandevendisappearedintothedustbinofhistory,asinthecaseofKodak.1
Whatconstitutesamarketfailuredependsonyourtheoryofhowmarketswork
Ihavejustshownthatthesamemarketdominatedbyamonopolycanbeseenasamostsuccessfulonebyoneschoolofeconomics(theSchumpeterianschoolortheAustrianschool)andasacaseofmostabjectfailurebyanother(theNeoclassicalschool).Thecaseofmonopolymaybethemostextremeexample,butthroughoutthebookwehaveseenmanycasesinwhichsomeschoolsseeamarketsuccesswhereothersseeamarketfailure.Forexample,IhavepointedoutthataNeoclassicaleconomistmightpraisefreetradeforallowingallnationstomaximizetheirincomes,giventheirresourcesandproductivecapabilities,butadevelopmentalisteconomistmightcriticizeitforpreventingmorebackwardeconomiesfromchangingtheirproductivecapabilitiesandthusmaximizingtheirincomesinthelongrun.Thepointisthatwhatconstitutesamarketfailure–andthusajustificationforgovernmentaction–
dependsonyourtheoryofhowmarketswork.Giventhis,ifdifferenteconomictheorieshavedifferentviewsonhowmarketsworkorfailtowork,wecannotmakeabalancedjudgementontheroleofthestatewithoutknowingawholegamutofrelevanteconomictheories.ThispointstrengthensthecaseforapluralisticapproachtoeconomicsthatIhavemadeinChapter4.
GovernmentFailure
Thefactthatamarketisfailing,somefree-marketeconomistsrightlypointout,doesnotnecessarilymeanthatwewillbebetteroffwithgovernmentintervention.Theseeconomists,suchasAnneKrueger,JamesBuchananandAlanPeacockandtheirfollowers,criticizethemarketfailureargumentforuncriticallyassumingthatthestateisamodernreincarnationofPlato’s‘philosopherking’–benevolent,allknowingandallpowerful.Theypointoutthatreal-worldgovernmentsarenotliketheidealandmaynotbeableto–or,worse,maynotevenwantto–correctformarketfailures.Accordingtothisargument,knownasthegovernmentfailureargumentorsometimesthepublicchoicetheory,thecostsofgovernmentfailureareusuallyhigherthanthoseofmarketfailures.Thus,itisusuallybettertoacceptafailingmarketthantohavethegovernmentinterveneandmessthingsupevenmore.
Dictators,politicians,bureaucratsandinterestgroups:thegovernment–orratherthosewhocontrolit–maynotevenwanttopromotethegreatergood
Thegovernmentfailureargumentcitesanumberofreasonsastowhyagovernmentmaynotevenwanttoimplementthe‘right’policies,evenifitcould.Insomecases,thegovernmentiscontrolledbyadictatorwhoisinterestednotincitizens’welfarebut
intheirownpersonalenrichment.MobutuSeseSeko(Zaire,1965–97)andFerdinandMarcos(the
Philippines,1965–86)aretheclassicexamples.These‘predatorystates’or,rather,thestrongmenwhocontrolthem–aresqueezingtheeconomythroughtaxationandbribery,withdisastrouslong-termconsequences.Inademocracy,thegovernmentiscontrolledbypoliticianswhoseprimarygoalistogainandretain
power,ratherthanpromotepublicinterests.Theywillconsequentlyimplementpoliciesthatmaximizetheirchancesinelections–increasinggovernmentspendingwithoutsimultaneouslyincreasingrevenues,forexample.Inanelectoralsystembasedonconstituenciesratherthanpartylists,politicianswilltrytochannelpublicfinancestoprojectsthatdeveloptheirownconstituencies,evenwhentheycreatewastefromthenationalpointofview;thisiswhy,forexample,manycountrieshavemoreairportsandsportsstadiumsthantheyreallyneed.Evenifpoliticianssomehowchoosetherightpolicies,theymaynotbeproperlyimplementedbecause
bureaucratswhorunthemhavetheirownagendas.Theywilldesignpoliciesinsuchawaythatservesthemselvesratherthantheelectorate–inflatingtheirdepartmentalbudgets,minimizingtheirefforts,reducingcooperationwithotherdepartmentsinordertodefendtheirown‘turf’andsoon.Thistheoryisknownasthatof‘self-seekingbureaucrats’.Ifyouwanttoseeitinaction,watchtheBBCTVclassicYes,Ministeranditssequel,Yes,PrimeMinister,withthelegendarySouthAfricanactorNigelHawthorn(ofTheMadnessofKingGeorgefame)playingthesuaveanddeviousmandarinSirHumphreyAppleby.Lastbutnotleast,thereislobbyingfromvariousinterestgroups–bankerslobbyingformorelenient
financialregulation,industrialistsaskingforincreasedtradeprotection,tradeunionspushingforhigherminimumwages,whatevertheconsequences,respectively,fornationalfinancialstability,consumerpricesorunemployment.Sometimesthoseinterestgroupsdonotsimplylobbybuteffectivelytakeovertheverygovernmentagenciesthataresupposedtoregulatethem–thisisknownasthetheoryof‘regulatorycapture’.Forexample,reflectingthestrengthoftheUSfinancialindustry,duringthelastthirty-twoyears(betweenRonaldReagan’sfirstpresidency,1981–5,andBarackObama’sfirst,2009–13),sixoutofthetenholdersoftheUStreasurysecretaryposition(collectivelyinofficefor21.5years)hadworkedinthefinancialindustry.2Twoofthem–RobertRubinandHankPaulson–hadworkedforonefirm,GoldmanSachs.Thecommonpointinallthesetheoriesisthatthegovernmentiscontrolledandinfluencedby
individualswhoarelikeallotherindividuals–theyareselfish.Itisnaive,ifnotexactlydelusional,toexpectthemtoputpublicinterestsbeforetheirown.
Thegovernmentmaynotbeabletocorrectformarketfailures,evenifitwantsto,duetoasymmetricinformationandresourceconstraints
Inadditiontoquestioningthemotivesofthegovernment–or,rather,ofthosewhocontrolthegovernment–thegovernmentfailureargumentquestionswhetheritisevencapableofcorrectingformarketfailures,evenintheunlikelycaseofitgenuinelywantingtoimprovesocialwelfare.Governmentpoliciesmayfailduetoasymmetricinformation.Asymmetricinformation,toremindyou,
meansthatapartyinaninteractionmayknowmoreabouttheactivitythatitisengagedinthandoestheotherparty.Thegovernment,forexample,maycontinueinfantindustryprotectionforanindustrybecauseitslobbyistssaythattheindustryhasfailedto‘growup’duetobadluck,ratherthanalackofefforttoenhanceproductivity.Evenwhenithasovercometheinformationalproblemandsomehowdesigneda
goodpolicy,thegovernment,especiallyinpoorcountries,maysimplylackthehumanandfinancialresourcestoproperlyimplementit.
Depoliticization:ridthemarketofpolitics
Whentheintentionandtheabilityofthegovernmentaresuspect,thegovernmentfailureargumentemphasizes,lettingthegovernmentinterveneinthenameofcorrectingformarketfailuremayactuallymakethingsworse.Marketsmayfail,butgovernmentsalmostalwaysfailevenmore,istheconclusion.Thesolutionofferedistoridthemarketofpolitics–or,infancierwords,thedepoliticizationofthe
economy.Toachievethis,theargumentgoes,thegovernmentshouldbeshrunktotheminimumbycuttingitsspending(andthustaxes),deregulatingmarketsandprivatizingSOEs.Inthosefewareasinwhichwestillneedthegovernment,suchastheprovisionofmonetarystabilityortheregulationofnaturalmonopolies,thepolicyprocessshouldbeinsulatedfrompoliticsbygrantingpoliticalindependencetothegovernmentagenciesthatactuallydothesethings.Anindependentcentralbankandindependentregulatoryauthoritiesofnaturalmonopolies(e.g.,gas,telecommunications)arethemostfrequentlyrecommendedexamples.
MarketandPoliticsGovernmentfailuresneedtobetakenseriously,butwithalargepinchofsalt
Governmentfailuresarerealandneedtobetakenseriously.Thegovernmentfailureargumenthasdoneaservicetoourunderstandingoftheeconomybyremindingusthatreal-lifegovernmentsarenotasperfectasthetextbookgovernment.Exceptforthe‘predatorystate’,whichisactuallyquiterare,alltheexamplesofgovernmentfailuresraisedbytheargumentareallaroundus.However,thegovernmentfailureargumentexaggeratestheextenttowhichgovernmentsfail.Whenyouthinkaboutit,ifwhatitsaysistrue,itwouldbeamajormiracleiftherewereanydecentgovernmentatallinthisworld.Inreality,manygovernmentsfunctionquitewell,whilesomedoevenexcellently.Onereasonis,ofcourse,thatpoliticians,bureaucratsandinterestgroupsarenotasselfishasthe
governmentfailureargumentdepicts.Therearemanyexamplesinreallifeofpoliticiansstrivingtopromotenationalinterestsratherthantheirchancesofelection,bureaucratsworkinginthespiritofpublicserviceratherthantohaveacushylifeandinterestgroupsholdingbacktheirsectionalinterestsforthegreatergood.Ontopofthat,therearewaystocontrolself-seekingbehavioursofpeopleinpubliclife,rangingfromthepromotionofpublicserviceethicstotheintroductionofrulesonbriberyandothercorruptpractices(e.g.,nepotisminhiring).True,theserulescanbe–andhavebeen–circumventedorevenperverted,asthegovernmentfailureargumentpointsout.Butthefactthatthoserulesarenotperfectdoesnotmeanthattheyaretotallyineffective.Imperfecttheymaybe,butthefactisthatwehavethestandardsofpubliclifethatwehavetodayinlargepartbecauseofthoserules.3
Theproposaltodepoliticizeisanti-democratic
Giventhepossibilityofgovernmentfailure,itsoundslikeagreatideatodepoliticizetheeconomybyrollingbackthestateandgivingpoliticalindependencetoessentialagencieslikethecentralbank.Butwhatisthis‘politics’whoseinfluencewearerecommendedtocurtail?Indemocraticcountries,itistheinfluenceofthepeople.Marketsrunaccordingtothe‘one-dollar-one-vote’rule,whiledemocraticpoliticsrunontheprincipleof‘one-person-one-vote’.Thus,theproposalforgreaterdepoliticizationof
theeconomyinademocracyisintheendananti-democraticprojectthatwantstogivemorepowerintherunningofthesocietytothosewithmoremoney.
Thereisn’tasingle‘scientific’waytodrawtheboundarybetweenmarketandpolitics
Thegovernmentfailureargumentassertsthateconomics,orthelogicofthemarket,shouldtrumppolitics–andindeedotherdomainsoflife,suchasarts,academiaandsoon.Thisargumentisthesedayssowidelyacceptedthatmostpeopletakeitforgranted.Butitisaseriouslyflawedargument.Firstofall–andthisisapointthatseemsobvioustonon-economistsbutthatmanyeconomistsfind
difficulttoaccept–thereisnoreasonwhythemarketlogicshouldprevailoverotherdomainsoflife.Wedonotlivebybreadalone.Moreover,theargumentisbasedontheimplicitassumptionthatthereisonecorrect,‘scientific’wayof
decidingwhatshouldbelonginthedomainofthemarketandwhatshouldbelonginthedomainofpolitics.Forexample,theproponentsofthegovernmentfailureargumentsaythatthingslikeminimum-wagelegislationortariffprotectionforinfantindustriesareintrusionsof‘political’logicintothesacrosanctsphereofthemarketlogic.Butthereareeconomictheoriesthatjustifysuchpolicies.Giventhis,whattheseeconomistsaredoingis,ineffect,labellingothereconomictheoriesas‘political’,andthereforelesser,argumentswhileclaimingthattheirowneconomictheoryissomehowtherighteconomictheory–oreven‘the’economictheory.
TheWhiteWitchandtheDeeperMagic:theultimateimpossibilityofdepoliticization
Evenifweacceptedthattheeconomictheorythattheproponentsofthegovernmentfailureargumentadoptisthe‘correct’one,itisnotpossibletodrawaclearboundarybetweeneconomicsandpolitics.Thisisbecausetheveryboundaryofthemarketisintheenddeterminedbypoliticsandnotbyaneconomictheory–ofwhatevervariety.Beforeweevenbeginmarkettransactions,weneed(explicitandimplicit)rulesonwhatcanbetraded,
whocantradethemandhowtheycanbetradedinthemarket.Alloftheserulesarerestrictiveinsomeways,andthereforenomarketisgenuinely‘free’.*Andthesegroundrulescannotbedeterminedbyeconomiclogic.Thereisno‘scientific’listofwhatshould(orshouldn’t)beboughtandsoldinthemarket.Thedecisionisapoliticalone.Allsocietieskeepcertainthingsoffthemarket–humanbeings(slavery),humanorgans,childlabour,
firearms,publicoffices,healthcare,qualificationstopractisemedicine,humanblood,educationalcertificatesandsoon.Butthereisno‘economic’reasonwhyanyoftheseshouldnotbeboughtandsoldinmarkets.Indeed,allofthemareorwerelegalobjectsofmarkettransactionsindifferenttimesandplaces.Attheotherendofthespectrum,wehavemadecertainthingsintoobjectsofmarkettransactionthathad
notbeensobefore.Beforetheintroductionofthelawstoprotectpatents,copyrightsandtrademarksintheeighteenthandthenineteenthcenturies,‘ideas’(intellectualproperty)werenottradedinmarkets.Todaywebuyandselltherightstopollute(‘carbontrading’)orbetsonnotionaleconomicvariables(e.g.,derivativesbasedonstockmarketindexoroninflationrate),butthesethingsdidnotevenexistuntiloneortwogenerationsago.Thegovernmentalsosetsthebasicrulesregardingwhateconomicactorscanandcannotdoeven
withinthedomainofthemarket.Falseadvertising,salesbasedonmisleadinginformation,insidertrading†andotherpracticesareallprohibited.Regulationsregardingminimumwages,workplacehealth
andsafetyandworkinghourssetboundariesonhowfirmscantreatworkers.Emissionstandards,carbonquotasandnoisepollutioncontrolsregulatehowfirmsmayproducetheiroutputs.Andsoon.Sopoliticsiscreating,shapingandreshapingmarketsbeforeanytransactioncanbegin.Itislikethe
‘DeeperMagic’thathadexistedbeforethedawnoftime,whichisknowntoAslan(theLion)butnottotheWhiteWitchinTheLion,TheWitch,andTheWardrobe,thechildren’sclassicbyC.S.Lewis.
WhatGovernmentsDo
Thesedays,thegovernmentproducesahugerangeofgoodsandservices–defence,lawandorder,infrastructure,education,research,health,pensions,unemploymentbenefits,childcare,carefortheelderly,incomesupportforpoorpeopleandculturalservices(e.g.,upkeepofmuseumsandnationalmonuments,subsidiestothenationalmovieindustry).Thelistisendless.MostgovernmentsalsoownSOEsthatproducegoodsandservicesthatprivatefirmsproduceinothercountries–electricity,oil,steel,semi-conductors,banking,airlineservicesandsoon.Inordertodoallthis,thegovernmenthiresalotofpeopleandspendsalotofmoneytopurchase
inputs,rangingfrompencilstonuclearreactors.Thesalariesofgovernmentemployeesandthematerialinputsarepaidforbytaxesandothersourcesofgovernmentrevenue.Taxesincludepersonalincometax,corporateincometax(taxonincomesofcompanies),propertytax,valueaddedtax(orsalestax),taxonspecifiedgoods(e.g.,alcohol,petrol)andsoon.OthersourcesofrevenueincludedividendsfromSOEs,interestpaymentsfromfinancialassetsthatitownsand,inthecaseofdevelopingcountries,transfersfromrichcountries(foreignaid).Thegovernmentalsotransfersalotofmoneyfromonepartoftheeconomytoanother;ittaxessome
peopleandusestheproceedstosubsidizeotherpeople.Socialwelfarepaymentsarethemostimportantofgovernment-mediatedtransfers.Buttheyalsoincludesubsidiesforparticulartypesofproductionactivities(e.g.,agriculture,infantindustries,decliningindustries)andinvestments(e.g.,R&Dbyprivate-sectorfirms,energy-savingrefurbishmentofhouses).Inadditiontodirectproduction,spendingandtransfers,thegovernmentsometimesusesitssheer
weighttoaffectthelevelofactivityintheeconomy.Thisisknownasfiscalpolicy.Simplybyspendingmore(orless)ortaxingless(ormore),regardlessoftheexactcontentofthatspendingandtaxation,itcanboost(ordampen)theeconomy.Usingitsmonopolyovernoteissue,itconductsmonetarypolicy,throughthecentralbank,byvaryinginterestratesorchangingtheamountofmoneyincirculation,thusaffectingthelevelofeconomicactivity.
REAL-LIFENUMBERSThesizeofthegovernment,measuredbygovernmentexpenditureasaproportionofGDP,hasgrownalotinthelastcenturyandahalf
Untilthenineteenthcentury,governmentswerequitesmalleverywhere,astheydidrelativelyfewthings.In1880,amongcountriesforwhichthedataareavailable,thebiggestgovernmentwasthatofFrance,whoseexpenditurewasequivalentto15percentofnationaloutput.IntheUKandtheUS,governmentexpenditurewasequivalentto10percentofGDP.TheSwedishonewasonly6percent.4
Overthelastcenturyandahalf,withtherequirementsofthemoderneconomy,governmentshavegrownalotinsize.Evenindevelopingcountriesthattendtohaveasmallergovernmentthandotherich
countries,governmentexpendituretypicallyisequivalentto15–25percentofGDP.*Thefigureis30–55percentfortherichcountries,withanaverageofaround45percent(theOECDaveragein2009).Atthelowerendofthedistribution(30–40percent)are,inascendingorder,Korea,Switzerland,AustraliaandJapan.Attheotherend(over55percent)are,indescendingorder,Denmark,Finland,France,SwedenandBelgium.InthemiddlearetheUSandNewZealand(over40percent),GermanyandNorway(around45percent)andtheNetherlandsandtheUK(around50percent).5
Alotofgovernmentexpenditureistransfer,ratherthanownconsumptionorinvestment
Now,notethatalotofgovernmentexpenditureisnotconsumedorinvestedbythegovernmentitself.Itinvolvestransferofmoneyfromonepartoftheeconomytoanother,especiallysocialprotectionprogrammes,suchasincomesupportforthepoorandunemploymentbenefits.Therefore,whenyoucalculateGDPyouneedtocountthetransferelementsout.Transferpaymentsareequivalenttobetween10percentand25percentofGDPintherichcountries.
So,forexample,agovernmentwhosetotalexpenditureisequivalentto55percentofGDPmayactuallyaccountforonly30percentofGDP,ifthetransferpaymentsitmakesareequivalentto25percentofGDP.Transferintheformofsocialspendingismuchlowerindevelopingcountries,sothegapbetween
governmentexpenditureasaproportionofGDPandtheshareofGDPproducedbythegovernmentismuchsmallerinthosecountries.AccordingtotheWorldBankdata,socialspendingrangesfrompracticallyzero(e.g.,Paraguay,thePhilippines)to4–5percentofGDP(e.g.,Mauritius,Ethiopia)inmostdevelopingcountries.DespitethefactthatitmakesthegovernmentlookbiggerthanitreallyisinGDPterms,mostpeople
stillusetheexpendituredata(ratherthanvalue-addeddata)astheindicatorofhowimportantthegovernmentisinacountry’seconomy.Thismaybejustifiedonthegroundsthatsomethingbeingatransferdoesnotmeanthatithasnoeffect.Itiswellknownthat,positivelyornegatively,socialspendingprogrammesaffectpeople’sattitudesandbehavioursintermsofsavings,retirementandwork.Theymayevenencouragepeopletotakegreaterriskintermsofcareerchoice,entrepreneurialactivityandwillingnesstochangejobs,byprovidingthemwitha‘safetynet’–onefamoussloganoftheSwedishSocialDemocraticPartyis‘securepeopledare’.
Theinfluenceofthegovernmentcannotbefullycapturedbynumbers
Innoareaofhumanlifecannumbersfullycapturethereality.Therearealwaysaspectsthataredifficulttoquantify,and,moreover,allnumbersareconstructedonthebasesofparticulartheories,whichbydefinitionfocusonsomeaspectsoftherealitywhileignoringothers,includingquantifiableones(recalltheexclusionofhouseholdworkintheconstructionofGDP).Butthisproblemismoreseriousinrelationtothegovernmentbecauseitisanactorthatisuniquely
endowedwiththepowertosetrulesthatconstrainandcompelothers.RegardlessofthesizeofitsbudgetorthenumberofSOEsithas,itcanexertastronginfluenceontherestoftheeconomyifitsetsalotofrulesandhasthepowertoenforcethem.Thisisnotanesoterictheoreticalquibble.Untilthe1980s,manypeoplebelievedthatthe‘miracle’
economiesofEastAsia,suchasJapan,TaiwanorKorea,wereparagonsoffree-marketpoliciesonthegroundsthattheyhadsmallgovernments(measuredbytheirbudget).However,beingsmalldidnotmeanthatthesegovernmentswerefollowingalaissez-faireapproach.Duringthe‘miracle’years,they
exercisedahugeinfluenceontheevolutionoftheireconomiesthrougheconomicplanning,regulationandotherdirectivemeasures.Bylookingatonlythebudgetarynumbers,peoplehadcometoseriouslymisunderstandthetruenatureandsignificanceofthegovernmentinthesecountries.
ConcludingRemarks:EconomicsIsaPoliticalArgument
Intherun-uptotheUSpresidentialelectionin2000,therewasanopinionpoll,reportedintheFinancialTimes,thataskedpeoplenotjustwhichcandidatetheysupportedbutalsowhytheydidn’tsupporttheothercandidate.Mostfrequentlycitedasthereasonfornotsupporting‘theotherguy’,bothbytheBushsupportersandtheGoresupporters,wasthathewas‘toopolitical’.WerethoseAmericansseriouslysuggestingthattheywantedtoelectsomeonewhowasn’tgoodat
politicsforthebiggestpoliticalofficeintheworld?Ofcoursenot.Theyweresayingthosethingsbecause‘politics’hadbecomeadirtywordandthereforecallingapolitician‘political’hasturnedintoapowerfulwaytodiscredithimorher.Americansareactuallynotaloneinthis.Therearesomeyoungdemocracieswherepoliticsarouses
suchpassionthatelectionspromptriotsanddeaths.Butinmanyothercountries,wekeephearingaboutthelowestevervoterturnoutinelections.Politicalpartiesarebleedingmembershipallaround.FromImranKhan,thecricketplayer,inPakistantoBeppoGrillo,thecomedian,inItaly,manypoliticianscometoprominenceexactlybecausetheyare–howcanIputit?–notpoliticians.Thegrowingmistrustinpoliticsispartlythepoliticians’owndoing.Allaroundtheworld,theyhave
donetheirbesttodiscreditthemselves,withSilvioBerlusconiinItalybeingthemasteroftheart.However,ithasalsobeencruciallypromotedbyfree-marketeconomics.Free-marketeconomists,morespecificallytheproponentsofthegovernmentfailureargument,havepersuadedtherestoftheworld,includingmanypoliticiansandbureaucratsthemselves,thatwecannottrustthosewhorunthegovernmenttoactinpublicinterests.Therefore,theyhavetoldus,thelessagovernmentdoes,thebetteritis.Eveninareaswherethegovernmentisa‘necessaryevil’,itshouldbeconstrainedbyrigidrulesthatpoliticianscannotmessaroundwith.Andthisdistrustinpoliticshasinturnhelpedtopopularizefree-marketeconomics,withitsproposalstominimizetheinfluenceofpoliticsontheeconomy.Butthisviewisbasedonveryproblematictheories,asIhaveexplainedinthischapter.Itisnot
supportedbyevidenceeither.AsIhaveshownthroughoutthebook,virtuallyalleconomicsuccessstorieshavebeenfacilitated,ifnotnecessarilyorchestrated,byanactivestate.Examplesofsuccessfulstateinterventiondonot,ofcourse,meanthatmoregovernmentisalways
better.Real-lifegovernmentsmaynotnecessarilybetheLeviathanofthelibertariandiscourse,buttheyarenotthemodernreincarnationofPlato’sPhilosopherKingeither.Therearemanygovernmentsthathaveharmedtheeconomy,sometimesevendisastrously.Butthefactremainsthatthestatestillremainsthemostpowerfulorganizationaltechnologythathumankindhasinventedandthusbigeconomic(andsocial)changesareverydifficulttoachievewithoutit.
FurtherReadingK.BASU
APreludetoPoliticalEconomy(Oxford:OxfordUniversityPress,2000).
J.BUCHANAN
LimitsofLiberty:BetweenAnarchyandLeviathan(Chicago:UniversityofChicagoPress,1975).
H.-J.CHANGANDR.ROWTHORN(EDS.)
TheRoleoftheStateinEconomicChange(Oxford:ClarendonPress,1995).
P.EVANS
EmbeddedAutonomy:StatesandIndustrialTransformation(Princeton,NJ:PrincetonUniversityPress,1995).
J.HARRISS
DepoliticizingDevelopment:TheWorldBankandSocialCapital(London:Anthem,2002).
C.HAY
WhyWeHatePolitics(Cambridge:Polity,2007).
F.VONHAYEK
TheRoadtoSerfdom(London:G.RoutledgeandSons,1944).
P.LINDERT
GrowingPublic:SocialSpendingandEconomicGrowthsincetheEighteenthCentury(Cambridge:CambridgeUniversityPress,2004).
M.MAZZUCATO
TheEntrepreneurialState:DebunkingPublicvs.PrivateSectorMyths(London:AnthemPress,2013).
InternationalTrade‘OurCelestialEmpirepossessesallthingsinprolificabundance’
In1792,GeorgeIIIofBritainsentEarlMacartneytoChinaashisspecialenvoy.MacartneywastoconvincetheChineseemperor,Qianlong,toallowBritaintofreelyconducttradeinallofChina,notjustthroughCanton(Guangzhou),whichwasthentheonlyportopentoforeigners.Atthetime,BritainwasrunningalargetradedeficitwithChina(so,what’snew?)inlargepartduetoitsnew-foundtastefortea.TheBritishthoughtthattheymightbeabletoreducethegapiftheycouldengageinfreertrade.Themissioncompletelyfailed.QianlongsentMacartneybackwithalettertoGeorge,tellinghimthat
theCelestialEmpiresawnoneedtohavemoretradewithBritain.HeremindedtheBritishkingthatChinahadallowedtheEuropeannationstotradeinCantononlyasa‘signalmarkoffavour’,as‘thetea,silkandporcelainwhichtheCelestialEmpireproduces,areabsolutenecessitiestoEuropeannations’.Qianlongdeclaredthat‘ourCelestialEmpirepossessesallthingsinprolificabundanceandlacksnoproductwithinitsownborders.Therewasthereforenoneedtoimportthemanufacturesofoutsidebarbariansinexchangeforourownproduce.’1
AsitwasnotevenallowedtotrytopersuadetheChinesecustomerstobuymoreofitsmanufacturedproducts,BritainresortedtosteppingupitsopiumexportsfromIndia.TheresultingspreadofopiumaddictionalarmedtheChinesegovernmentintobanningopiumtradein1799.Thatdidnotwork,soin1838theDaoguangEmperor,Qianlong’sgrandson,appointedanew‘drugczar’,LinZexu,tostartamajorcrackdownonopiumsmuggling.Inresponse,theBritishstartedtheOpiumWarin1840,inwhichChinawaspulped.VictoriousBritainforcedChinaintofreetrade,includingofopium,withtheNanjingTreatyin1842.Acenturyofexternalinvasions,civilwarandnationalhumiliationfollowed.
DavidRicardochallengestheChineseEmperor–andAdamSmith:comparativevs.absoluteadvantages
GivenChina’seventualandignominiousadoptionoffreetrade,peoplehavemadefunofQianlong’sviewoninternationaltrade;thisbackwarddespotsimplydidn’tunderstandthatinternationaltradeisgood.However,Qianlong’sviewoninternationaltradewasactuallyinlinewiththemainstreamviewamongEuropeaneconomists,includingAdamSmithhimself,atthetime.Hisviewoftradeisknownasthetheoryofabsoluteadvantage;theideathatacountrydoesnotneedtotradewithanotherifitcanproduceeverythingmorecheaplythancanitspotentialtradingpartner.Indeed–ourcommonsensetellsus–whyshouldit?Butitshould–accordingtothetheoryofcomparativeadvantage,inventedbyDavidRicardo(see
Chapter4).Accordingtothistheory,acountrycanbenefitfrominternationaltradewithanothercountry,evenwhenitcanproduceeverythingmorecheaplythantheother,likeChinacould,comparedtoBritain,inthelateeighteenthcentury–atleastaccordingtoQianlong’sview.Allthatisneededisthatitspecializesinsomethinginwhichitssuperiorityisthegreatest.Likewise,evenifacountryisrubbishatproducingeverything,itcanbenefitfromtradeifitspecializesinthingswhichitisleastrubbishat.Internationaltradebenefitseverycountryinvolved.
Thelogicbehindthetheoryofcomparativeadvantageisimpeccable–givenitsassumptions
SinceRicardoinventeditintheearlynineteenthcentury,thetheoryofcomparativeadvantagehasprovidedapowerfulargumentinfavouroffreetradeandtradeliberalization,thatis,reductioningovernmentrestrictionsontrade.Thelogicisimpeccable–thatis,insofarasweacceptitsunderlyingassumptions.Oncewequestion
thoseassumptions,itsvaliditybecomesmuchmorelimited.Letmeexplainthis,focusingontwokeyassumptionsbehindtheHeckscher-Ohlin-Samuelsonversionofthetheoryofcomparativeadvantage(henceforthHOS),whichwefirstencounteredinChapter4aslyingattheheartofthemodernargumentforfreetrade.2
HOSstructurallyrulesoutthemostimportantformofbeneficialprotectionismbyassumingthatallcountriesareequallycapable
ThemostimportantassumptionunderlyingHOSisthatallcountrieshaveequalproductivecapabilities–thatis,theycanuseanytechnologytheywant.3Accordingtothisassumption,theonlyreasonwhyacountrymightspecializeinoneproductratherthananotherisbecausethatproducthappenstobeproducedusingatechnologythatisinlinewithitsrelativefactorendowment–thatis,howmuchcapitalandlabourithas.Thereisnopossibilitythatthetechnologymightbetoodifficultforthecountry(recalltheBMWandGuatemalaexamplefromChapter4).Thistotallyunrealisticassumptionrulesoutapriorithemostimportantformofbeneficial
protectionism,namely,infantindustryprotection,whosekeyroleinthehistoricaldevelopmentoftoday’srichcountrieswediscussedindetailthroughoutthebook.
HOSisoverlypositiveabouttradeliberalizationbecauseitassumesthatcapitalandlabourcanberemouldedforuseinanysectoratnocost
InHOS,notonlyisfreetradegoodforthecountrybutmovingtowardsitincountriesthathavenotpractiseditproducesnocasualties.Whentariffson,say,steelarereduced,consumersofsteel(e.g.,car-makerswhousesteelplatesandfinalconsumersofcars)immediatelybenefitbecausetheycanimportcheapersteel.Thiswilldamagetheproducers(capitalistsandworkers)inthedomesticsteelindustryintheshortrun,ascompanieslosemoneyduetocheaperimportsandworkerslosetheirjobs.But,soon,eventheybenefit.Itisbecauseactivitiesthataremoreinlinewiththecountry’scomparativeadvantage–say,theproductionofmicro-chipsorinvestmentbanking–willnowberelativelymoreprofitableandthusexpand.Theexpandingindustrieswouldabsorbthecapitalaswellasthelabourformerlyemployedinthesteelindustryand,thankstotheirhigherproductivities,paythemhigherprofitsandwages.Everyonewinsintheend.Buttherealityisthatmostcapitalistsandworkersintheindustrythathaslostprotectionremainhurt.
Factorsofproduction–capitalandlabour–areoftenfixedintheirphysicalqualities;therearefew‘general-use’machinesorworkerswitha‘generalskill’thatcanbeemployedacrossindustries.Blastfurnacesfromabankruptsteelmillsimplycannotberemouldedintoamachinethatmakesmicro-chipsandthusmayhavetobesoldasscrapmetal.Whenitcomestotheworkers,howmanysteelworkersdoyouknowwhohaveretrainedtoworkinthesemi-conductorindustryor,evenmoreunlikely,ininvestmentbanking?(RecalltheexamplesofRogerandMeandTheFullMontyfromChapter10).HOScanpresentsuchapositiveviewoftradeliberalizationbecauseitassumesthatallcapitaland
labourarethesame(‘homogeneous’isthetechnicalterm)andthuscanbereadilyredeployedinanyactivity(technicallythisisknownastheassumptionofperfectfactormobility).4
Eventheuseofthecompensationprinciplecannotquitehidethefactthatalotofpeoplegethurtbytradeliberalization
Evenwhentheyacknowledgethattradeliberalizationmayproducelosers,free-tradeeconomistsjustifytradeliberalizationbyinvokingthe‘compensationprinciple’(seeChapter4).Theyarguethat,astradeliberalizationmakesthewholecountrybetteroff,thelosersfromtheprocesscanbefullycompensatedandthewinnersstillhaveadditionalincomeleft.AsImentionedearlier,thetroublewiththisargumentisthatthecompensationisusuallynotmade.In
therichcountries,thereispartial–butonlypartial–compensationthroughthewelfarestate,whichprovidesunemploymentinsuranceandaccesstobasicsocialservices,suchaseducationand(exceptintheUS)healthcare.Butinmostdevelopingcountriesthewelfarestateisveryweakandhaspatchycoverage,sotheresultingcompensationisminimal,ifnotnon-existent.Ifthecompensationisnotmade,invokingthecompensationprincipletojustifyapolicythathurtssome
people,suchastradeliberalization,istantamounttodemandingthatsomepeoplemakeasacrificeforthe‘greatergood’–ademandthatusedtobemadeofpeoplebythegovernmentinsocialistcountries,whichfree-tradeeconomistssoheavilycriticize.
Internationaltradeisessential,especiallyfordevelopingcountries,butthatisnottosaythatfreetradeisthebest
Whentheyhearsomeonecriticizingfreetrade,free-tradeeconomiststendtoaccusethecriticofbeing‘anti-trade’.Butcriticizingfreetradeisnottoopposetrade.Apartfromthebenefitsofspecializationthatthetheoryofcomparativeadvantageextols,international
tradecanbringmanybenefits.Byprovidingabiggermarket,itallowsproducerstoproducemorecheaply,asproducingalargerquantityusuallylowersyourcosts(thisisknownaseconomiesofscale).Thisaspectisespeciallyimportantforsmallereconomies,astheywillhavetoproduceeverythingexpensively,iftheycannottradeandhaveabiggermarket.Byincreasingcompetition,internationaltradecanforceproducerstobecomemoreefficient–insofarastheyarenotdeveloping-countryfirmsthatwouldgetwipedoutbyvastlysuperiorforeignfirms.Itmightalsoproduceinnovationbyexposingproducerstonewideas(e.g.,newtechnologies,newdesigns,newmanagerialpractices).Internationaltradeisparticularlyimportantfordevelopingcountries.Inordertoincreasetheir
productivecapabilitiesandthusdeveloptheireconomies,theyneedtoacquirebettertechnologies.Theycanintheoryinventsuchtechnologiesthemselves,buthowmanynewtechnologiescanrelativelybackwardeconomiesreallyinventontheirown?Perhapsone,suchasNorthKorea’svinalon,whichImentionedinChapter7.Perhapsnone.Forthesecountries,therefore,itwouldbemadnessnottotakeadvantageofallthosetechnologiesouttherethattheycanimport,whetherintheformofmachinesortechnologylicensing(buyingupthepermittousesomeoneelse’spatentedtechnology)ortechnicalconsultancy.Butifadevelopingcountrywantstoimporttechnologies,itneedstoexportandearn‘hardcurrencies’(universallyacceptedcurrencies,suchastheUSdollarortheEuro),asnoonewillacceptitsmoneyforpayments.Internationaltradeisthereforeessentialforeconomicdevelopment.Thecaseforinternationaltradeisindisputable.However,thisdoesnotmeanthatfreetradeisthebest
formoftrade,especially(butnotexclusively)fordevelopingcountries.Whentheyengageinfreetrade,developingcountrieshavetheirchancesofdevelopingproductivecapabilitieshampered,asIhavepointedoutinearlierchapters.Theargumentthatinternationaltradeisessentialshouldneverbeconflatedwiththeargumentthatfreetradeisthebestwaytotradeinternationally.
REAL-LIFENUMBERS
Howimportantinternationaltradeisfordifferentcountriesandhowitsimportancehasincreasedrecently
Intheearly1960s,internationaltrade,definedastheaverageofexportsandimports,ingoodsandservicesusedtobeequivalenttoaround12percentofworldGDP(averagefor1960–64).ThankstothefactthatinternationaltradehasgrownmuchfasterthanhasworldGDP,therationowstandsat29percent(averagefor2007–11).5
Eventhoughtheshareoftradeinacountry’sGDPhasriseninalmostallthecountriesduringthelasthalfcentury,thereareconsiderableinternationaldifferencesintheirlevels.ListeningtotheAmericanmediaoverthelastthreedecades,youmighthavegottheimpressionthatthe
USisacountrythatisuniquelysufferingfromthenegativeimpactsofinternationaltrade–firstwithJapanandnowwithChina.Butimportsaccountedforonly17percentofUSGDP(2007–11average),whileexportsaccountedfor13percent.Averagingtheexport/GDPandtheimport/GDPfigures,yougetatradedependenceratioof15percent.Thisiswaybelowtheworldaverageof29percent,citedabove.Indeed,theUSisoneoftheleasttrade-dependentcountriesintheworld.TheonlyothermajoreconomywithalowertradedependenceratiothanthatoftheUSisBrazil(12per
cent).Interestingly,Japan,whichinpopularimageryisthequintessentialtrade-driveneconomy,hasthesametradedependenceasthatoftheUS(15percent).Otherthings(likeeconomicpolicy)beingequal,largereconomiestendtobelessdependentontradebecausetheycanaffordtohaveamorediversifiedproductionstructurethankstotheirsize,whichallowsthemtoattaineconomiesofscaleinmoreindustries.Attheotherextreme,wehavesmalltrade-orientedeconomieslikeHongKong(206percent)and
Singapore(198percent).Sucheconomiesnotonlytradealotfortheirownneedsbecausetheyaresmall.Theyalsospecializeininternationaltradingitself,thusimportingcertainthingsonlytosellontoothers–thisisknownas‘re-exporting’.
Manycountriesarefarmoretrade-dependentthanthe‘worldaverage’,whileonlyahandfulofthemaresignificantlylessso
Giventhatinternationaltradeisequivalentto29percentofworldGDP,youcouldsaythatcountrieswithatradedependenceratioclosetoithave‘average’tradedependence.Theseincludesomeofthelargerdevelopedcountries,suchasFranceandItaly,andsomeverylargedevelopingcountries,suchasIndia,IndonesiaandChina.Manycountrieshaveatradedependenceratiothatiswellaboveaverage(say,above60percent).This
groupincludessomesmallrichcountries(e.g.,theNetherlandsandBelgium),severaloil-exportingcountries(e.g.,AngolaandSaudiArabia)anddevelopingcountriesthathavedeliberatelypromotedmanufacturedexportsthroughpolicymeasures(e.g.,MalaysiaandThailand).
Changingstructureofinternationaltrade:the(exaggerated)riseofservicestradeandtheriseofmanufacturingtrade,especiallythatfromdevelopingcountries
Overthelasthalfcentury,therehavebeenanumberofsignificantstructuralchangesininternationaltrade.Thefirstistheincreaseintheimportanceofservicestrade.Influencedbytherecentmediahypeabout
newformsoftradeinservices–airlinebackoffices,software,readingservicesforMRIresultsandwhathaveyou–mostpeoplehavecometoformtheimpressionthatservicestradehasbeenexplodingintherecentperiod.However,therealityfallsfarshortofthisimage.Servicestradeasashareofworldtrade
didgoupfrom17percentintheearly1980s(1980–82)toaround20percentintheearly1990s.However,sincethen,ithasbeenfluctuatingaroundthatlevel.6
Another,moreimportant,trendhasbeentheriseintheimportanceofmanufacturingtrade.AccordingtoanunofficialUNreport,theshareofmanufacturinginworldmerchandisetradeusedtobe40–45percentinthefirsthalfofthetwentiethcentury.7AccordingtotheofficialUNdata(ComTradedatabase),itroseto57–60percentbythe1960sandthento61–4percentinthe1970s.8ThedatasetfromtheWTO,startingfrom1980,showsthecontinuationofthetrend,eventhoughtheexactfiguresdifferfromtheUNdata.Intheearly1980s(1980–82average),manufacturingaccountedfor57percentofworldmerchandisetrade.Theratiothenroseandpeakedat78percentinthelate1990s(1998–2000average).Ithasfallensincethenandcurrentlystandsat69percent(2009–11average).9
Whatthismeansisthattheriseintheimportanceofmanufacturingtradehasbeenfarmoresignificant–orevendramatic–thanthatofservicestrade.Thisisyetanotherpieceofevidencethatwearenot(atleastyet)livinginapost-industrialknowledgeeconomy(seeChapter7).Thethirdnotablestructuralchangeininternationaltradeisthefactthatdevelopingcountrieshave
increasedtheirsharesininternationalmanufacturingtradesignificantlyfromaround9percentinthemid-1980stoaround28percenttoday.10Thisrisehasbeeninlargepartpropelledbytherapiddevelopmentofexport-orientedmanufacturingindustriesinChina.Chinausedtoaccountforonly0.8percentofworldmanufacturingexportin1980,butby2012thesharehadrisento16.8percent.
BalanceofPayments
Balanceofpaymentsisastatementthatshowshowmuchacountryisindebtorcreditinwhichareasofitseconomictransactionswiththerestoftheworld.Aswithanyfinancialstatement,itisboringstuff.Butitisimportantthatyouknowwhichitemsareinit,whattheymeanandwhatthenumberslooklikeinreality,ifyouaretounderstandaneconomy’sinternationalposition,sopleasebearwithmeforafewpages.
Tradebalance(orbalanceoftrade)
Tradeinvolvesnotonlythemovementsofgoodsandservicesbutalsotheflowsofmoneythatgowiththem.Whenacountryimportsmoregoodsandservicesthanitexports,itissaidtohaveatradedeficit,oranegativetradebalance.Whenitexportsmorethanitimports,itissaidtohaveatradesurplus,orapositivetradebalance.
Currentaccountandcapital-financialaccountbalances
Howdocountrieswithtradedeficitsmanage?Don’ttheyhavetofindthemoneytopayfortheimportbillsthatareoverandabovetheirexportearnings?Indeedtheydo.Theycandothisintwoways.Oneistoearnmoneyinwaysotherthanthroughinternationaltrade(thisiscalled‘income’inthe
technicallanguageofbalanceofpaymentsstatistics)ortobegivenmoneybysomeoneelse(thisiscalled‘currenttransfers’).Incomeincludescompensationofemployeesandinvestmentincome.‘Compensationofemployees’in
thiscontextisearningsofpeopleworkingforforeignentitieswhilebeingresidentinthehomecountry,suchasMexicanworkerscommutingtotheirworkintheUS.‘Investmentincome’isincomefrom
financialinvestmentabroad,suchasdividendsfromsharesofforeigncompaniesownedbyacountry’sresidents.Currenttransfersincludeworkers’remittances,thatis,moneysentfromworkersresidentabroad
(moreonthislater)andforeignaid,namely,grantsgivenbyforeigngovernments.Balancesintrade,incomeandcurrenttransfersmakeupthecurrentaccountbalance.Seethebox
belowtoseehowtheyaddup.
BALANCEOFPAYMENTS(SELECTEDMAINCOMPONENTS)
CURRENTACCOUNTTradeGoodsServicesIncomeCompensationofemployeesInvestmentincomeCurrenttransfersWorkers’remittancesForeignaid
CAPITALANDFINANCIALACCOUNTCapitalaccountCapitaltransfersAcquisition/disposalofnon-financialassetsFinancialaccountPortfolioinvestmentEquityDebt(includingbondsandderivatives)(Foreign)directinvestmentOtherinvestments(includingtradecreditsandbankloans)Reserveassets
Evenafteraddinguptrade,incomeandcurrenttransfers,acountrymaystillhaveacurrentaccountdeficit.Inthiscase,ithastoeitherborrowmoney(thatis,rundebts)orsellassetsithas.Theactivitiesonthisfrontarecapturedinthe‘capitalandfinancialaccount’(CFA),whichismoreoftenknownsimplyascapitalaccount.CFAis–surprise,surprise–madeupoftwomaincomponents–capitalaccountandfinancialaccount.Thecapitalaccountisdividedinto‘capitaltransfers’(mainlydebtforgivenessbyforeigncountriesor,
conversely,yourcountryforgivingdebtsofothercountries)andthe‘acquisition/disposalofnon-financialassets’,suchassellingandbuyingpatents.Thefinancialaccountismainlymadeupofportfolioinvestment,(foreign)directinvestment,other
investmentsandreserveassets.Portfolioinvestmentreferstotheacquisitionoffinancialassets,suchasequity(companyshares)anddebt(includingbondsandderivatives).Foreigndirectinvestmentinvolves
acquisitionbyaforeignentityofasignificant(10percentistheconvention)proportionofsharesinacompany,withaviewtogettinginvolvedinitsmanagement.11‘Otherinvestments’includetradecredits(companieslendingmoneytotheirbuyersbylettingthempayfortheirpurchaseslater)andloans(especiallybankloans).‘Reserveassets’includeforeigncurrenciesandgoldthatacountry’scentralbankhas.Theyareoftenreferredtoasforeignexchangereserves.Acountry’scurrentaccountbalanceanditscapitalandfinancialaccountbalance,intheory,shouldadd
uptozero,butinpracticetherearealways‘errorsandomissions’thatmakethesumdifferentfromzero.
Differentitemscandrivethebalanceofpaymentsdynamicsindifferentsituations
Changesinthetradeaccountoftendrivetherestofthebalanceofpayments.Arapidlyincreasingtradedeficitdue,say,toamajorcropfailureortoasuddenandlarge-scaletradeliberalizationcanmakeacountryaccumulateforeigndebtsandsellitsassets.Thegenerationofalargetradesurplusdueto,say,asurgeinthedemandofitsmajormineralexportmayallowacountrytobuyassetsfromabroad,thuscreatingadeficitonthecapitalaccount.Buttherearealsosituationsinwhichnon-tradecomponentsaredrivingchangesintheothercomponentsofthebalanceofpayments.Sometimestheincreaseincurrenttransferscandrivethebalanceofpaymentsdynamics.Workers’
remittancesintoacountrymaysuddenlyincreasebecause,forexample,ithasjoinedtheEUandlotsofitsworkershavegonetoGermanytowork.Orthecountrymayseeasuddenincreaseinforeignaidbecause,say,ithassuddenlybecomeimportantintheWaronTerror–thinkPakistanorDjibouti.Theincreaseintheresultingavailabilityofforeignexchangewillallowthecountrytoimportmoregoodsandservices,resultinginthedeteriorationofitstradebalance(thatis,itstradesurpluswillshrinkoritstradedeficitwillwiden),eventhoughitscurrentaccountbalancemayimprove.Onsomeoccasions,itcanbethecapitalaccountthatdrivesthedynamics.Acountrymaygetasudden
surgeintheinflowsofportfolioinvestmentbecauseithassuddenlybecomea‘hot’investmentdestinationthanksto,say,therecentelectionofapro-businesspresidentwhoispromisingalotofreforms.Oritmayexperienceabigincreaseinforeigndirectinvestmentbecause,forexample,alargeoildeposithasbeenfound.Butwhenthesehappenthedemandforthecountry’scurrencyrises,aspeopleneeditinordertobeabletobuythecountry’sassets.Thiswillleadtotheriseinthevalueofthecountry’scurrency,makingtheirexportsuncompetitiveandthusincreasingtradedeficit.Inthiscase,thechangesinthecapitalaccounthavedriventhechangeinthetradeaccount.
REAL-LIFENUMBERSTradedeficitsandsurplusesinsomecountriesareequivalenttoaroundhalfofGDP
Inmostrichcountriesandmiddle-incomecountries,tradebalancesarelikelytobeequivalenttoafewpercentagepointsofGDP,eitherpositiveornegative.Forexample,in2010,tradesurplusesasaproportionofGDPwere1.2percentinJapan,2.6percentinKorea,3.9percentinChina,5.6percentinGermanyand6.5percentinHungary.TradedeficitsasaproportionofGDPwere1percentinBrazil,2.1percentintheUK,3.5percentintheUS,4percentinEcuadorand4.4percentinIndia.ButquiteanumberofcountrieshavetradebalancesthatareverylargeasaproportionoftheirGDPs.
In2010,Bruneihadatradesurplusequivalentto49percentofitsGDP,whileKuwaithad34percentandLuxembourg32percent.Somepoorcountrieswithfewnaturalresourcestoexporthaveverylargetradedeficits–in2010,Lesothohadatradedeficitequivalentto67percentofGDP.Tradedeficitasa
proportionofGDPwasalsoverylarge(over40percentofGDP)incountrieslikeLiberia,HaitiandKosovo.12
Currentaccountdeficits(surpluses)areusuallysmaller(bigger)thantradedeficits(surpluses)
Acountry’scurrentaccountdeficit(surplus)isusuallysmaller(larger)thanitstradedeficit(surplus),asotheritemsinthecurrentaccountarelikelytoreduce(magnify)it.Fortherichcountries,investmentincomesaretypicallytheitemsthatreducethedeficits(orswellthe
surpluses)createdbythetradecomponentofthecurrentaccount.In2010,tradedeficitwas3.5percentofGDPintheUS,butitscurrentaccountdeficitwas3.1percent.InFrance,thefigureswere,respectively,2.3percentand1.6percent.TheGermantradesurplusinthesameyearwas5.6percentofGDPbutitscurrentaccountsurpluswas6.3percent.Forthedevelopingcountries,themainitemsthatclosethegapbetweentradedeficitandcurrent
accountdeficitareforeignaidand,increasinglymoreimportantly,workers’remittances,whichthesedaysarearoundthreetimesforeignaid.In2010,Haitihadatradedeficitequivalentto50percentofGDP,butitscurrentaccountdeficitwasonlyequivalentto3percentofGDP.Thiswaspossiblebecausetherewasalargeamountofcurrenttransfers,suchasforeignaid(equivalentto27percentofGDP)andremittances(equivalentto20percentofGDP).
Suddensurgesincapitalinflowsandoutflowscancreateseriousproblems
Suddensurgesincapitalinflowscanleadtoasignificantincreaseindeficitsonthecurrentaccount,especiallythetradecomponentofit,asImentionedabove.Aslongascapitalkeepsflowingin,currentaccountdeficitsequivalentto,say,severalpercentagepointsofGDP,orevenhigher,mightnotbeaproblem.Thetroubleisthatcapitalinflowcansuddenlyfalldramaticallyoreventurnnegative;foreignersmight,
forexample,sellassetstheyownandtaketheproceedsout.Thissuddenchangecanpushcountriesintoafinancialcrisis,astheireconomicactorssuddenlyfindthattheassetstheyhaveareworthalotlessthantheirliabilities.Inthecaseofdevelopingcountries,whosecurrenciesarenotacceptedintheworldmarket,sucha
situationwillalsoleadtoaforeignexchangecrisis,astheynowhaveinsufficientmeanstopayfortheirimports.Theshortageinthesupplyofforeignexchangesleadstodevaluationofthelocalcurrency,whichmakesthefinancialcrisisevenworse,astherepaymentburdenforthecountry’sforeignloanswouldskyrocketinlocalcurrencyterms.Thisiswhathappened,forexample,inThailandandMalaysiaduringthe1990s.Between1991and
1997,theannualcapitalaccountsurplusaveraged6.6percentand5.8percentofGDPinThailandandMalaysiarespectively.Thisallowedthemtomaintainhighcurrentaccountdeficits,equivalentto6.0percentand6.1percentofGDPrespectively.Whenthecapitalflowswerereversed–thecapitalaccountdeficitsuddenlysurgedto10.2percentand17.4percentoftheirrespectiveGDPin1998–theyexperiencedcombinedfinancialandforeignexchangecrises.
ForeignDirectInvestmentsandTransnationalCorporations(TNCs)Foreigndirectinvestmenthasbecomethemostdynamiccomponentinthebalanceofpayments
Inthelastthreedecades,foreigndirectinvestment(FDI)hasemergedasthemostdynamicelementinthebalanceofpayments.Ithasgrownfasterthaninternationaltrade,albeitwithamuchgreaterfluctuation.Between1970andthemid-1980s,annualglobalFDIflows(measuredintermsofinflows)were
equivalenttoaround0.5percentofworldGDP.13Sincethen,itsgrowthacceleratedrelativetoworldGDPgrowth,untilitwentuptotheequivalentof1.5percentofworldGDPin1997.ThentherewasanotheraccelerationinFDIflow,withtheratioreachingaround2.7percentofworldGDPonaveragebetween1998and2012,althoughwithbigfluctuations.14
WhatmakesFDIparticularlyimportantisthefactthatitisnotasimplefinancialflow.Itcanalsodirectlyaffectthehost(receiving)country’sproductivecapabilities.
FDIaffectstheproductivecapabilitiesoftherecipientcountry
FDIisdifferentfromotherformsofcapitalinflowsinthatitisnotapurefinancialinvestment.Itbeinganinvestmentwithaviewtoinfluencinghowacompanyisrun,FDIbydefinitionbringsinnewmanagementpractices.Itfrequently,althoughnotalways,alsobringsinnewtechnologies.Asaresult,FDIaffectstheproductivecapabilitiesofthecompanythatisreceivingit,whetheritisgreenfieldFDI,thatis,aforeigncompanysettingupanewsubsidiary(liketheIntelsubsidiaryestablishedinCostaRicain1997)oritisbrownfieldFDI,thatis,aforeigncompanytakingoveranexistingcompany(likeDaewoo,theKoreancarmakerboughtbyGMin2002).TheimpactofFDIisnotconfinedtotheenterprisereceivingit.Especiallywhenthegapinproductive
capabilitiesbetweentheinvestingcountryandtherecipientcountryislarge,FDImighthaveparticularlystrongindirectinfluencesontheproductivecapabilitiesoftherestoftheeconomy.Thismighthappeninanumberofways.Tobeginwith,therewouldbe‘demonstrationeffects’,inwhichlocalproducerswatchTNC
subsidiariesandlearnnewpracticesandideas.Thenthereistheinfluencethroughthesupplychain.Whentheybuyfromlocalsuppliers,TNCsubsidiarieswilldemandhigherstandardsinproductqualityanddeliverymanagementthandotheirlocalcounterparts.LocalsupplierswillhavetoupgradethemselvesiftheywanttokeepthecustomofTNCsubsidiaries.ThenthereareeffectsfromtheemployeesofTNCsubsidiariesleavingthemtojoinotherfirmsoreventosetuptheirownenterprises.Theseworkerscanteachothershowtousenewtechnologiesandhowtomanagetheproductionprocessinamoreefficientway.Collectively,theseindirectpositiveeffectsofFDIareknownasspill-overeffects.
TheevidenceforpositiveeffectsofFDIisratherweak
Despiteallthesepotentiallypositive(directandindirect)effectsofFDI,theevidenceonwhetherFDIbenefitstherecipienteconomyisatbestmixed.15
OnereasonforthisisthatthebenefitsIhavediscussedabovearetheoretical.ManyTNCsubsidiariesmightactuallybuyverylittlefromlocalproducersandimportmostoftheirinputs–theyaresaidtoexistasenclaves.Inthesecasesthebenefitsthroughsupplychainswillbenon-existent.WorkerscancarrytheirknowledgefromTNCsubsidiariestotherestoftheeconomyonlywhentherearealreadysomelocalfirmsoperatinginrelevantindustries,whetherasaspiringcompetitorsorassuppliers.Frequently,thisisnotthecase,especiallywhentheTNCsubsidiaryinquestionhasjustcometoexploitnaturalresourcesorcheaplabourinyourcountryratherthantoestablishalong-termproductionbase.
ButthemoreimportantreasonwhyFDIhasnotunambiguouslybenefitedtherecipienteconomyisbecauseithasnegative,aswellaspositive,effects.
Someofthebiggestcompaniesdon’tmakeanymoney–intheplacestheychoosenotto
In2012,apublicoutragebrokeoutwhenitwasrevealedthatStarbucks,GoogleandotherbiginternationalcompanieshavepaidverylittleincorporationtaxinBritain,Germany,FranceandotherEuropeancountriesovertheyears.Thiswasnotbecausetheyhavenotpaidthetaxesthattheyowe.Itwasbecausetheynevermademuchmoneyandthusowedverylittleintax.Butifthesecompaniesaresoincompetent,howisitpossiblethattheyhavebecomesomeoftheworld’sbiggestandbest-known–ifnotnecessarilythemostliked–companies?*ThesecompaniesminimizedtheirtaxobligationsincountrieslikeBritainbyinflatingthecostsfortheir
Britishsubsidiariesbyhavingtheirsubsidiariesinthirdcountries‘over-charge’(thatis,chargemorethanwhattheywouldhaveinopenmarkets)theBritishsubsidiariesfortheirservices.ThesethirdcountrieswerecountrieswithacorporatetaxratethatislowerthantheUKrate(e.g.,Ireland,SwitzerlandortheNetherlands)oreventaxhavens,namely,countriesthatattractforeigncompaniestosetup‘papercompanies’bychargingverylow,orevenno,corporatetaxes(e.g.,Bermuda,theBahamas).16
Theage-oldtrickoftransferpricing
Takingadvantageofthefactthattheyoperateincountrieswithdifferenttaxrates,TNCshavetheirsubsidiariesover-chargeorunder-chargeeachother–sometimesgrossly–sothatprofitsarehighestinthosesubsidiariesoperatingincountrieswiththelowestcorporatetaxrates.Inthisway,theirglobalpost-taxprofitismaximized.A2005reportbyChristianAid,thedevelopmentcharity,documentscasesofunder-pricedexportslike
TVantennasfromChinaat$0.40apiece,rocketlaunchersfromBoliviaat$40andUSbulldozersat$528andover-pricedimportssuchasGermanhacksawbladesat$5,485each,Japanesetweezersat$4,896andFrenchwrenchesat$1,089.17TheStarbucksandGooglecasesweredifferentfromthoseexamplesonlyinthattheymainlyinvolved‘intangibleassets’,suchasbrandlicensingfees,patentroyalties,interestchargesonloansandin-houseconsultancy(e.g.,coffeequalitytesting,storedesign),buttheprincipleinvolvedwasthesame.WhenTNCsevadetaxesthroughtransferpricing,theyusebutdonotpayforthecollectiveproductive
inputsfinancedbytaxrevenue,suchasinfrastructure,educationandR&D.ThismeansthatthehosteconomyiseffectivelysubsidizingTNCs.
TherearealsootherpotentiallynegativeeffectsofFDIforthehosteconomy
TransferpricingisonlyoneofthepossiblenegativeeffectsofFDI,especiallywhenitcomestoFDIintodevelopingcountries.AnotheroneisthatTNCsubsidiariesmay‘crowdout’localfirms(intheirownindustryandinotherindustries)inthecreditmarket.Thismightnotnecessarilybeabadthingiftheyaremoreattractivetolendersthankstohigherefficiency.Buttheymightgeteasieraccesstocredit,evenwhentheyarelessefficient,becausetheyare,well,TNCsubsidiaries.Theyareseen,rightly,asbeingimplicitlybackedbytheirmotherfirms,whicharefarmorecreditworthythananylocalfirminadevelopingcountrycanaspiretobe.Ifthisisthecase,TNCsubsidiarieshoggingthelocalcreditmarketmaymeanloansgoingintolessefficientuses.
AnotherreasonisthatTNCsubsidiarieswillbebigfirmsinamonopolisticoroligopolisticpositioninthedevelopingcountrymarket,eventhoughtheyaresmallpartsoftheTNCthatownsthem.Thesesubsidiariescan–anddo–exploitsuchpositions,whichcreatessocialcosts,asdiscussedinChapter11.Moreover,TNCs,havingalotofmoneyandthepoliticalbackingoftheirhomecountries,canchange
thepoliciesofthehostcountryinawaythatisbeneficialforthem,ratherthanforthehosteconomy.Wearenotsimplytalkingaboutlobbyingandbribing,asinthe2013scandalinvolvingGlaxoSmithKlineandotherglobalpharmaceuticalTNCsinChina.Wearealsotalkingaboutthebananarepublic.ThetermisthesedaysbetterknownasabrandownedbyGap,theglobalclothingretailchain.Butit
hasadarkorigin.Thetermwascoinedduringthetimeofthetotaleconomicandpoliticaldominationofcertainbanana-growingcountriesinLatinAmerica,suchasHonduras,GuatemalaandColombia,bytheUnitedFruitCompany(UFC)intheearlydecadesofthetwentiethcentury.Themosttragicepisodeinthathistorywasthe1928massacreofstrikingworkersinaUFCbananaplantationinColombia;whenitwasthreatenedwithaninvasionbytheUSMarinestoprotecttheinterestsoftheUFC,theColombiangovernmentsentinitsarmyandkilledpossiblythousandsofworkers(thenumberhasneverbeenconfirmed).TheeventwasfictionalizedinthemasterpieceOneHundredYearsofSolitudebythegreatColombianwriterGabrielGarciaMárquez.AmericanTNCsaresaidtohaveactivelycooperatedwithright-wingmilitaryandtheCIAtotoppleleftistregimesinLatinAmericainthe1960sandthe1970s.Inthelongrun,themostimportantnegativeeffectofFDIisthatitmaymakeitmoredifficultforthe
hostcountrytoincreaseitsownproductivecapabilities.OnceyouallowTNCstoestablishthemselveswithinyourborder,yourlocalfirmswillstruggletosurvive.Thisiswhymanyoftoday’srichcountries–especiallycountrieslikeJapan,Korea,TaiwanandFinland–strictlyrestrictedFDIuntiltheircompaniesacquiredtheabilitytocompeteintheworldmarket.Forexample,hadtheJapanesegovernmentopeneditsautomobileindustrytoFDIinthelate1950s,aswaswidelysuggestedfollowingthedebacleofToyota’sfirstcarexportstotheUS,18Japanesecar-makerswouldhavebeeneitherwipedoutortakenoverbyAmericanorEuropeanTNCs,giventhestateoftheindustryatthetime;backin1955GeneralMotorsaloneproduced3.5millioncarswhereasthewholeoftheJapaneseautomobileindustryproducedamere70,000.
BenefitsofFDIcanbeonlyfullyrealizedunderappropriateregulations
FDIhascomplexeffectsthatdifferacrossindustriesanddependingoncountrycharacteristics,makingitdifficulttogeneralizewhetheritisgoodorbad.Judgementonitsdesirabilitywouldalsodependontheperformancecriteria(e.g.,employment,export,productivity,long-termgrowth)andthetimehorizonyouuse,astheirbenefitstendtobemoreimmediatewhiletheircostsmaybeofmorelong-termnature.Nevertheless,whatseemscertainisthatcountries,especiallydevelopingcountries,canmaximizethebenefitsfromFDIonlywhentheyuseappropriateregulations.Andthelistofregulationsusedforsuchapurposeisimpressive.ManycountrieshaveestablishedrulesoninwhichindustriesFDImaybemade.Theyhavedemanded
thatTNCshavealocalinvestmentpartner(knownasjointventurerequirement).Theyhavehadrulesonhowmuchofthejointventureaforeigninvestorcanown;majorityforeignownershiphastypicallybeenbannedinimportantindustries.ManygovernmentshaverequiredthattheTNCmakingtheinvestmenttransferstheirtechnologiestoitslocaljointventurepartner(technologytransferrequirement)orthat
theytrainlocalworkers.CountrieshavealsodemandedthatTNCsubsidiariesbuycertainproportionsofinputslocally(knownasthelocalcontentsrequirement).19
Japan,Korea,TaiwanandChinahavebeenparticularlysuccessfulwiththeseregulatorymeasures–theyallowed,orevenwelcomedinsomesectors,FDIbutputinallthosemeasurestoensurethatthebenefitsweremaximizedwhilethecostswereminimized.However,usingtheWTOagreement(knownastheTRIMSagreement,ortheTrade-relatedInvestmentMeasuresagreement),bilateralfree-tradeagreements(FTAs)andbilateralinvestmenttreaties(BITs),therichcountries(includingJapan,whichusedtoregulateFDImostseverelyintheworld)havemadeanumberoftheseregulations,suchasthelocalcontentsrequirement,‘illegal’.20
ThesuccesswithallthoseregulationsincountriessuchasJapanandChinadoesnotmeanthat‘stick’istheonlywaytomanageFDI.Someothercountries,suchasSingaporeandIreland,haveused‘carrot’inordertoattractFDIintoareasthattheythinkareimportantfortheirnationaleconomicdevelopment.21
Their‘carrots’includedsubsidiesforTNCsmakinginvestmentin‘priority’sectors,provisionofcustom-madeinfrastructureandproductionofengineersandskilledworkersneededinparticularindustries.
REAL-LIFENUMBERSGrowthinFDIflows
Inthemid-1980s,whenFDIstartedgrowingrapidly,totalworldFDIflowwasaround$75billionperyear(1983–7average).22Today,at$1,519billion(2008–12average),itisovertwentytimesthemid-1980sfigure,implyingthatithasgrownataround12.8percentperyear.Thesefigureslooklikehugesumsandaveryrapidgrowthrate,buttheyshouldbeputintoperspective.Inthemid-1980s,theworld’stotalFDIwasequivalentto0.57percentofworldGDP(1983–7
averageof$13.5trillion).Thefigureforthe2008–12period,howeverlargeitmayseeminabsoluteterms,isstillequivalentonlyto2.44percentofworldGDP.
MostFDIhappensbetweenrichcountries,butdevelopingcountrieshaverecentlybecome‘over-represented’inglobalFDI,largelythankstoChina
MostFDIhappensbetweentherichcountries.Inthemid-1980s(1983–7),87percentofFDIwenttotherichcountries.Giventhatthesecountriesaccountedfor83percentofworldGDPatthetime,thismeantthatrichcountriesgotslightlymorethantheir‘fair’shareofFDI.Thisratiohasfallen,althoughwithupsanddowns,to66percentintherecentperiod(2008–12).Giventhattherichcountriesstillaccountfor70.8percentofworldGDPin2010,itisnowthedevelopingcountries,ratherthantherichcountries,thatare–onceagain,slightly–over-representedinglobalFDI.TheUShasbeenbyfarthesinglelargestrecipientofFDIoverthelastthreedecades.Between1980
and2010,itreceived18.7percentofworldFDIinflows.ItwasfollowedbytheUK,China,FranceandGermany.*DespitebeingbyfarthelargestrecipientofFDIinabsoluteterms,theUSreceivedmuchlessthanwouldhavebeenexpectedfromitsweightintheworldeconomy(itproduced26.9percentofworldGDPduringthisperiod).Incontrast,ChinaandtheUKreceivedalotmorethanwouldhavebeenexpectedfromtheirweightintheworldeconomy.†NotablebyitsabsenceinthislistisJapan.Despiteproducing12percentofworldGDPduringthisperiod,itreceivedonly0.7percentofworldFDI,thankstoitsdraconianregulationofFDIuntilrecently.
Focusingonthemorerecentperiod,thetoptenrecipientsofFDI(2007–11)aretheUS,China,theUK,Belgium,HongKong,Canada,France,Russia,SpainandBrazil.Ofthese,theUS,FranceandBrazilgotlessthantheir‘fair’share,whilealltheothersgotmorethantheir‘fair’share.23
ThefactthatdevelopingcountriesasagrouphavebecomemoreimportantintheglobalFDIflowsdoesnotmeanthatalldevelopingcountrieshavebeenequallyactiveparticipantsinthisgame.Between1980and2010,thetoptenrecipientsofFDIflowsintothedevelopingworldaccountedfor75.7percentoftotalflows,despiteaccountingforonly71.4percentofdevelopingworldGDP.24Inparticular,Chinareceived32.2percentoftotalFDIintothedevelopingworldduringthisperiod,despiteaccountingforonly22.8percentofdevelopingworldGDP.
TherecentperiodhasseenanincreaseintheshareofbrownfieldinvestmentintotalFDI,changingtheglobalindustriallandscape
Inthefirstsevenyearsofthe1990s,brownfieldFDI,thatis,FDIintheformofcross-borderM&A,wasequivalentto31.5percentoftheworld’sFDI.25Thenumbershotupto57.7percentbetween1998and2001intheglobalcross-borderM&Aboom.Afterdippingbackto33.7percentforafewyearsbetween2002and2004,itroseagainto44.7percentbetween2005and2008.Eventhoughtheratiohasfallentothelowestlevelintwodecades(25.3percentbetween2009and2012),followingthe2008globalfinancialcrisis,thegeneraltrendhasbeenthatbrownfieldFDIhasrisenrelativetogreenfieldFDI.ThisriseinbrownfieldinvestmentiscloselylinkedwithwhattheCambridgeeconomistPeterNolan
callstheglobalbusinessrevolution.26Inthelastcoupleofdecades,throughanintenseprocessofcross-borderM&As,virtuallyallindustrieshavebecomedominatedbyasmallnumberofglobalplayers.Theglobalaircraftindustryisdominatedbytwofirms,BoeingandAirbus,whileindustryobserversaredebatingwhethermorethanthetopsixmass-marketautomobilefirms(Toyota,GM,Volkswagen,Renault-Nissan,Hyundai-KiaandFord)cansurviveinthelongrun,whichmeansthattheyarenotevensureaboutsuchmajorcompaniesasPeugeot-Citroën,Fiat-ChryslerandHonda.Moreover,throughwhatNolancallsthe‘cascadeeffect’,evenmanyofthesupplierindustrieshave
becomeconcentrated.Forexample,theglobalaircraftengineindustryisnowdominatedbythreefirms(Rolls-Royce,Pratt&WhitneyandFairfield,aGE(GeneralElectric)subsidiary).
ImmigrationandRemittancesOpenborders–exceptforpeople?
Free-marketeconomistswaxlyricalaboutthebenefitsofopenborders.Theyarguethatopenbordershaveallowedcompaniestosourcethecheapestthingsfromacrosstheglobeandofferthebestdealstoconsumers.Openborders,theypointout,haveincreasedcompetitionamongproducers(ofmaterialgoodsandservices),forcingthemtocuttheircostsand/orimprovetheirtechnologies.Anyrestrictiononthecross-bordermovementofanypotentialobjectofeconomictransaction–goods,services,capital,younameit–wouldbeharmful,theysay.Butthereisaneconomictransactionthattheydon’ttalkaboutinthesameway–immigration,orcross-
bordermovementofpeople.Thereareveryfewfree-marketeconomistswhoadvocatefreeimmigrationinthewaytheyadvocatefreetrade.27Manyfree-marketeconomistsdonotevenseemtorealizethattheyarebeinginconsistentwhentheyadvocatefreemovementofeverythingexceptforpeople.Othersseemto
instinctivelykeepawayfromthetopic,deepdownknowingthatfreeimmigrationwouldbeeconomicallyunfeasibleandpoliticallyunacceptable.
Immigrationrevealsthepoliticalandtheethicalnatureofmarkets
Whatmakesimmigration–namely,thecross-bordermovementofpeopleasprovidersoflabourservices–differentfromcross-bordermovementsofotherthings(goods,financialservicesorcapital)isthatlabourservicescannotbeimportedwithoutbringingtheirprovidersphysicallyintothecountryaswell.WhenyoubuyaniPadfromChinaorinvestmentbankingservicefromBritain,youdon’tneedtohave
theChineseassemblyworkerortheBritishbankercomeandliveinyourcountry.Therearesomecasesinwhichworkerscommuteacrossborders(say,betweentheUSandMexico),thusearning‘compensationofemployees’intheincomeelementofthecurrentaccount(seeabove).Ingeneral,however,whenpeoplecometoworkinyourcountry,theyhavetostay,atleastforawhile.Andwhenpeoplestayandworkwithinyourborders,theyhavetobegivencertainminimumrights,at
leastindemocraticcountries.28Youcannotsaythataworkerwhohasmovedfrom,say,IndiatoSwedenshouldstillbepaidanIndianwageandhaveonlyanIndianlevelofworkplacerightsbecause–well–heisanIndian.Butwhatrightsshouldbegiventotheimmigrants?Shouldtheygetthesamefreedomofchoosing
occupations,onceadmitted,orshouldtheybetiedtoaparticularindustryorevenaparticularemployer,asisthepracticeinmanyimmigrant-receivingcountries?Shouldimmigrantsbemadetopayforcertainsocialservicesthatarefreeatpointofaccesstocitizens,suchasbasiceducationandhealthcare?*Shouldweevenmakethemconformtotheculturalnormsofthereceivingcountry(say,abanonthehijab)?Theseareallquestionsthathavenoeasyanswers–especiallyonesthatstandardNeoclassicaleconomicscangive.Answerstothesequestionsrequireexplicitpoliticalandethicaljudgements,onceagainshowingthateconomicscannotbea‘value-freescience’.
Immigrationusuallybenefitstherecipientcountries
Thereisageneralagreementthatimmigrantsthemselvesbenefitfromimmigration–oftengreatly,especiallyiftheyaremovingfromapoortoarichcountry.Theopinionismoredividedonwhethertherecipientcountriesbenefit,buttheevidencesuggeststhattheydo,albeittoalimitedextent.29
Immigrantsusuallycometofilllabourshortages(thoughdefininglabourshortageisactuallynotastraightforwardmatter).30Itcouldbegeneralshortagesthattheyarefilling,liketheTurkishworkersdidinWestGermanyinthe1960sandthe1970s,whentheWirtschaftswunder(economicmiracle)createdall-roundlabourshortages.Butmoreoftentheycometofillshortagesinparticularsegmentsofthelabourmarket–whetherfor‘3D’jobs(notjobsin3Dcinemas,butdirty,dangerousanddemeaningjobs)orforhighlyskilledjobsinSiliconValley.Inshort,immigrantscomebecausetheyareneeded.Insomerichcountries,especiallyintheUK(whichactuallydoesn’thaveaparticularlygenerous
welfarestatebyEuropeanstandards)thereisafearof‘welfaretourism’–immigrantsfrompoorcountriescomingtoliveoffthewelfarestateoftherecipientcountry.Butinmostofthesecountriesimmigrantspayonaveragemoretaxesthantheyclaimfromthewelfarestate.Thisisbecausetheytendtobeyounger(andthusdon’tusehealthcareandothersocialservicesverymuch)and,thankstoimmigrationpolicyfavouringskilledworkers,tendtobemoreskilled(andthusearningmore)thantheaveragelocalperson.31
Immigrantsaddtoculturaldiversity,whichmaystimulateboththenativesandtheimmigrantsintobeingmorecreativebybringingnewideas,newsensitivitiesandnewwaysofdoingthings.Thisistrueornotjustimmigration-basedcountries,suchastheUS,butalsothelessimmigration-drivencountriesofEurope.
Somenativeworkersloseoutbutnotbymuchandtheirwoesaremostlycreatedby‘wrong’corporatestrategiesandeconomicpolicies,notmigrants
Thefactthatimmigrationbenefitstherecipientcountrydoesnotmeanthatallcitizensinthatcountrybenefitequally.Thoseatthelowerendofthelabourmarketwithfewprizedskills,whohavetofightforjobswithimmigrants,canloseoutbybeingmadetoacceptlowerwages,poorerworkingconditionsandhigherchancesofunemployment.Butstudiesshowthattheextentoftheirlossesissmall.32
Especiallyindifficulteconomictimes,suchasthe1930sortoday,disaffectednativeworkers,manipulatedbyright-wingpopulistpoliticians,cometobelievethattheirwoeshavelargelybeencausedbyimmigrants.Butmuchbiggercausesofstagnantwagesanddecliningworkingconditionsareintherealmofcorporatestrategyandgovernmenteconomicpolicy:shareholdervaluemaximizationbycorporations,whichrequiressqueezingworkers,poormacroeconomicpoliciesthatcreateunnecessaryamountsofunemployment,inadequatesystemsforskillstrainingthatmakelocalworkersuncompetitiveandsoon.Unfortunately,theinabilityandtheunwillingnessofmainstreampoliticianstotacklethoseunderlyingstructuralissueshavecreatedthespaceforanti-immigrantpartiesinmanyrichcountries.
‘Braindrain’and‘braingain’:impactsonthesendingcountries
Theimmigrant-sendingcountriesloseworkers.Thismaybeagoodthing,ifthecountryhashighunemploymentanditisunemployedunskilledworkerswhoemigrate.However,thoseworkersusuallyfinditdifficulttoemigratebecauseimmigrant-receivingcountrieswantpeoplewithskillsandbecauseemigrationcostsmoney,whichtheseworkersdon’thave(e.g.,searchcosts,applicationfees,airtickets).Soveryoftenitisthe‘wrong’peoplewhoemigrate–skilledworkers.Thisisknownasbraindrain.Someofthoseskilledworkersmaylearnevenmoreskillsintheirdestinationcountriesandeventually
comebackhome,teachingothersnewskills.Thisisknownasbraingain,buttheevidenceforitislimited.
Remittancesarethemainchannelthroughwhichtheimmigrant-sendingcountryisaffected
Themainchannelthroughwhichtheimmigrant-sendingcountryisaffectedisremittances.Remittanceshavecompleximpactsonthereceivingcountry.33
Ahighproportion(60–85percent)ofremittancesisusedfordailyhouseholdexpenses.Thiscertainlyimprovesthemateriallivingstandardsoftherecipients.Whatisnotconsumedmaybeploughedintosmallbusinessesrunbyfamiliesreceivingremittances,generatingfurtherincome.IncountrieslikeMexico,remittanceshavealsobeenchannelledintopublicinvestmentsatthelocallevelthroughtheso-called‘hometownassociations’(e.g.,clinics,schools,irrigation).34
Havinghigherincomes,themembersofrecipientfamiliesdonothavetoworkasmuchasbefore.Thisoftenmeansreductioninchildlabour.Italsoreducesinfantmortality,asmotherswithyoungchildrenaregivenprioritybytherestofthefamilytoreduceoutsidework.Lastbutnotleast,therearenegativehumancoststopaytogettheremittances.Emigrationoftenbreaks
upfamiliesandputschildreninthecareofothers,oftenforthemotherstoworkasbabysittersand
housemaidselsewhere.Theincalculablecostsfromsuchsufferingmaynotbefullymadeupbyremittances.
REAL-LIFENUMBERSImmigrationintotherichcountrieshasincreasedinthelasttwodecadesbutnotasmuchaspeoplethink
Readingthepopularpressintherichcountriesandobservingtherecentsuccessofanti-immigrantpartiesinsomeEuropeancountries(especiallyFrance,theNetherlands,SwedenandFinland),youmightgettheimpressionthatthosecountrieshaveseenhugeinfluxesofimmigrantsintherecentperiods.Butimmigrationintotherichcountrieshasnotincreasedsodramatically.Between1990and2010,the
numberofimmigrantslivinginthesecountriesincreasedfrom88millionto145million.Inproportionalterms,thismeantthatthestockofimmigrantsintherichcountriesrosefrom7.8percentofthepopulationin1990to11.4percentin2010.35Thisisasubstantialrise,buthardlytheseismicshiftthatitissometimesmadeouttobe.
One-thirdofimmigrantsliveindevelopingcountries
Immigrationisnotexclusivelyfromdevelopingcountriesintorichcountries.Thereisabigflowofimmigrationbetweendevelopingcountries–usuallyfrompoorertoricherones,butalsobetweenneighbouringcountriesduetonaturaldisastersorarmedconflicts.Asof2010,therewere214millionimmigrantsworldwide;145millionofthemlivedintherich
countriesandtherest(69millionpeople)indevelopingcountries,whichmeansaroundathirdoftheworld’simmigrantsliveindevelopingcountries.
Globalimmigrantstockasashareofworldpopulationhasrisenverylittleinthelasttwodecades
Theshareofimmigrantsinthepopulationofthedevelopingworldhasactuallyexperiencedafallinthelasttwodecades.Itfellfrom1.6percentofitspopulationin1990to1.2percentin2010.Sincethepopulationofthedevelopingworldisnearly4.5timesthatoftherichworld(5.60billionvs.
1.29billion),thishasnearlyoffsettheriseintheimmigrantstockoftherichworldthatIhavediscussedabove.Ontheworldwidescale,immigrantstockhasbeenbasicallystagnant–risingfrom3.0percentin1990to3.1percentin2010.
Remittanceshaverisenratherdramaticallyinthelastdecade
Remittanceshavedramaticallyincreasedsincetheearly2000s.AsImentionedearlier,itis,atover$300billion,nowaroundthreetimeslargerthanforeignaidgiventodevelopingcountriesbyrichcountries(around$100billion).Inabsoluteterms,thebiggestrecipientofremittancesin2010wasIndia($54.0billion).36Itwas
closelyfollowedbyChina($52.3billion).Mexico($22.1billion)andthePhilippines($21.4billion)weredistantthirdandfourth.OtherdevelopingcountrieswithlargeremittancesincludedNigeria,EgyptandBangladesh.Somedevelopedcountries–France,Germany,SpainandBelgium–alsohadhighremittances.Theimportanceofremittancesisseenmoreclearlywhenweseetheminproportiontothecountry’s
GDP,ratherthanasabsoluteamounts.Eventhoughtheyarethelargestintheworldinabsoluteterms,India’sremittancesareonlyabout3.2percentofitsGDP.Insomecountries,remittancesasashareofGDPcouldbegiganticasaproportionofGDP.In2010,Tajikistantoppedtheworldleaguetableonthis
account,byhavingremittancesequivalentto41percentofGDP.Lesotho,with28percent,cameinadistantsecond.KyrgyzRepublic,Moldova,Lebanonandafewothershadremittancesequaltoorbiggerthan20percentofGDP.
Highremittancescanaffecttherecipientcountryseriously,bothpositivelyandnegatively
Whenremittancesarethishigh,theycanaffecttherecipientcountriesseriously,bothpositivelyandnegatively.Onthepositiveside,anadditionoffinancialresourcesequivalentto20percentofGDPwouldraisea
country’sconsumptionandinvestmenthugely.Large-scaleremittanceshavealsofunctionedasashockabsorberinmanycountries.Afternaturaldisasters(e.g.,earthquakeinHaiti),financialcrises(e.g.,South-eastAsiancountriesin1997)orcivilwars(e.g.,SierraLeone,Lebanon),remittancesareknowntoincrease,partlybecausemorepeopleemigratebutalsobecauseexistingworkerssendmoremoneytohelptheirfamiliesandfriendsintimesofgreaterneed.Onthenegativeside,however,highremittanceshavefedfinancialbubbles,asinthenotoriouscaseof
the1995–6pyramidschemeofAlbania,whichcollapsedin1997.Asuddenlargeinflowofforeigncurrenciesintheformofremittancescanalsoweakentherecipientcountry’sexportcompetitivenessbyabruptlyraisingthevalueofitscurrency,thusmakingitsexportsrelativelymoreexpensiveintermsofforeigncurrencies.
ConcludingRemarks:BestofAllPossibleWorlds?
Therapidlychanginginternationalenvironmentinthelastthreedecadeshassignificantlyaffectednationaleconomiesinmanyways.Greatlyincreasedcross-borderflowsofgoods,services,capitalandtechnologieshavechangedthewayinwhichcountriesorganizetheirproduction,earnforeigncurrenciestoimportwhattheyneedandmakeandreceivefinancialandphysicalinvestments.Theincreaseinthecross-bordermovementofpeoplehasbeenfarlessthanincreasesinotherareas,butithasalsosignificantlyaffectedalargenumberofcountries–bycausingtensionsbetweentheimmigrantsandthe‘natives’(inrecipientcountries)orbybringinginhugeremittanceflowsthathavesignificantlychangedpatternsofconsumption,investmentandproduction(insendingcountries).Thesechanges,oftensummedupastheprocessofglobalization,havebeenthedefiningfeatureofour
time.Inthelastcoupleofdecades,triumphantbusinesselites,fashionablemanagementgurus,politiciansrunningpowerfulrichcountriesandclevereconomistswhosupportthemhavedeclaredtheprocesstobeaninevitableandunstoppableone.Claimingtheprocesstobedrivenbytechnologicalprogress,theyhavecriticizedanyonewhoistryingtoreverseormodifyanyaspectofitasbackward-looking.The2008globalfinancialcrisishassomewhatdentedtheconfidencewithwhichthesepeoplemaketheircase,butthethinkingbehinditstilldominatesourworld:protectionismisalwaysbad;freecapitalflowswillensurethatthebestmanagedcompaniesandcountriesgetmoney;youhavetowelcomeTNCswithopenarms;andsoon.However,globalizationisnotaninevitableconsequenceoftechnologicalprogress.DuringtheGolden
Ageofcapitalism(1945–73),theworldeconomywasmuchlessglobalizedthanitscounterpartintheLiberalGoldenAge(1870–1913).Andthiswasdespitehavingmuchmoreadvancedtechnologiesoftransportationandcommunicationsthanthesteamshipsandwired(notevenwireless)telegraphyofthe
earlierperiod.Theworldhasbecomeglobalizedinthewayithasinthelastthreedecadesonlybecausethepowerfulgovernmentsandthebusinesseliteintherichworlddecidedthattheywanteditthatway.Norhasglobalizationcreated‘thebestofallpossibleworlds’,toborrowafamousexpressionfromthe
FrenchwriterandphilosopherVoltaire’snovellaCandide,asitsproponentshaveclaimed.Inthelastthreedecadesofhyper-globalization,economicgrowthhassloweddown,inequalityhasincreased,andfinancialcriseshavebecomefarmorefrequentinmostcountries.Allofthisisnottosaythatinternationaleconomicintegrationisharmfulinanyformnorthatcountries
shouldminimizetheirinteractionwiththeoutsideworld.Onthecontrary,theyneedtoactivelyparticipateintheworldeconomy,iftheyaretomaintainadecentstandardofliving.Whenitcomestodevelopingcountries,interactionwiththeinternationaleconomyisessentialfortheirlong-termdevelopment.Ourprosperityabsolutelydependsonaseriousdegreeofinternationaleconomicintegration.However,thisdoesnotmeanthatallformsanddegreesofinternationaleconomicintegrationare
desirable.Whereandhowmuchacountryshouldbeopen,andthushowmuchoverallinternationalintegrationweshouldhaveinwhichareasandtowhatdegrees,dependsonitslong-termgoalsandcapabilities:protectionismmaybegoodifitisdoneintherightwayfortherightindustry;thesameregulationofFDImaybegoodforsomecountriesbutharmfulforothers;somecross-borderfinancialflowsareessentialwhiletoomanyofthemmaybeharmful;immigrationmayormaynotbenefitboththesendingandthereceivingcountries,dependingonhowitisorganized.Unlesswerecognizethiscriticalpoint,wewillnotbeabletoreapthefullbenefitsthatinternationaleconomicintegrationcanbringus.
FurtherReadingH.-J.CHANG
BadSamaritans:RichNations,PoorPoliciesandtheThreattotheDevelopingWorld(London:RandomHouse,2007).
P.HIRST,G.THOMPSONANDS.BROMLEY
GlobalizationinQuestion,3rdedition(Cambridge:Polity,2009).
R.KOZUL-WRIGHTANDP.RAYMENT
TheResistibleRiseofMarketFundamentalism:RethinkingDevelopmentPolicyinanUnbalancedWorld(London:ZedBooksandThirdWorldNetwork,2007).
W.MILBERGANDD.WINKLER
OutsourcingEconomics:GlobalValueChainsinCapitalistDevelopment(CambridgeandNewYork:CambridgeUniversityPress,2013).
D.RODRIK
TheGlobalizationParadox(Oxford:OxfordUniversityPress,2011).
J.STIGLITZ
MakingGlobalizationWork(LondonandNewYork:W.W.NortonandCo.,2006).
M.WOLF
WhyGlobalizationWorks(NewHavenandLondon:YaleUniversityPress,2004).
Thefirstpartofthisbookhasbeenabout‘gettingusedto’economics.Inthispart,wehavediscussedwhateconomicsis(astudyoftheeconomy),whattheeconomyis,howoureconomyhasbecomewhatitistoday,howtherearemanydifferentwaysofstudyingitandwhothemaineconomicactorsare.Havingbecome‘usedto’economics,letusnowdiscusshowwecan‘use’ittounderstandthereal
worldeconomy.
‘Italwaysseemsimpossibleuntilitisdone.’NELSONMANDELA
Howto‘Use’Economics?
Myaiminthisbookhasbeentoshowthereaderhowtothink,notwhattothink,abouttheeconomy.Wehavecoveredmanytopics,andIdon’texpectmyreaderstorememberall–orevenmost–ofthem.Butthereareafewimportantthingstokeepinmindwhenyouare‘using’economics(thisis,afterall,aUser’sGuide).
Cuibono?:economicsisapoliticalargument
Economicsisapoliticalargument.Itisnot–andcanneverbe–ascience;therearenoobjectivetruthsineconomicsthatcanbeestablishedindependentlyofpolitical,andfrequentlymoral,judgements.Therefore,whenfacedwithaneconomicargument,youmustasktheage-oldquestion‘Cuibono?’(Whobenefits?),firstmadefamousbytheRomanstatesmanandoratorMarcusTulliusCicero.Sometimesitiseasytoseethepoliticalnatureofaneconomicargumentbecauseitisbasedon
questionableassumptionsthatblatantlyfavourcertaingroups.Thetrickle-downargument,forexample,cruciallydependsontheassumptionthat,whengivenabiggersliceofnationaloutput,therichwilluseittoincreaseinvestments–anassumptionthathasnotbeenborneoutbyreality.Inothersituations,anargumentmayfavourcertainpeopleunintentionally.Forexample,anargument
usingtheParetocriterionmayseemnottofavouranyone,asitsaysachangeisasocialimprovementonlywhenitmakessomepeoplebetteroffwithoutmakinganyoneworseoffandthusdoesnotallowevenasinglepersontobetrampledonbytherestofsociety.Yetitimplicitlyfavoursthosewhobenefitmorefromthestatusquo,asthecriterionallowsthemtopreventanychangetothestatusquothathurtsthem.Politicalandethicaljudgementsarepresenteveninostensiblyvalue-freeexercises,suchasdefining
theboundariesofthemarket.Decidingwhatbelongsinthedomainofthemarketisanintenselypoliticalexercise.Onceyoucandragsomething(say,water)intothedomainofthemarket,youcanapplythe‘one-dollar-one-vote’ruletodecisionssurroundingit,makingiteasierfortherichtoinfluencetheoutcome.Conversely,ifyoucantakesomething(say,childlabour)outofthedomainofthemarket,itbecomesimpossibletoinfluenceitsusewiththepowerofmoney.Sayingthateconomicsisapoliticalargumentdoesnotmeanthat‘anythinggoes’.Sometheoriesare
betterthanothers,dependingonthesituationathand.Butitdoesmeanthatyoushouldneverbelieveanyeconomistwhoclaimstooffer‘scientific’,value-freeanalysis.
Don’tbecomea‘manwithahammer’:thereismorethanonewayto‘do’economics,eachwithitsstrengthsandweaknesses
Aswehaveseen,thereisn’tjustonerightwayof‘doing’economics,despitewhatmosteconomiststellyou.ThoughtheNeoclassicalapproachhasbeenthedominantoneinrecentdecades,thereareatleastninedifferentschoolsofeconomics,eachwithitsstrengthsandweaknesses.
Theeconomicrealityiscomplexandcannotbefullyanalysedwithjustonetheory.Thevariouseconomictheoriesconceptualizebasiceconomicunitsdifferently(e.g.,individualsvs.classes),focusondifferentthings(e.g.,macro-economyvs.micro-economy),askdifferentquestions(e.g.,howtomaximizetheefficiencywithwhichweusegivenresourcesvs.howtoincreaseourabilitiestoproducethoseresourcesinthelongrun)andtrytoanswerthemusingdifferentanalyticaltools(e.g.,hyper-rationalityvs.boundedrationality).Asthesayinggoes,‘hewhohasahammerseeseverythingasanail’.Ifyouapproachaproblemfroma
particulartheoreticalpointofview,youwillendupaskingonlycertainquestionsandansweringtheminparticularways.Youmightbelucky,andtheproblemyouarefacingmightbea‘nail’forwhichyour‘hammer’isthemostappropriatetool.But,moreoftenthannot,youwillneedtohaveanarrayoftoolsavailabletoyou.Youareboundtohaveyourfavouritetheory.Thereisnothingwrongwithusingoneortwomorethan
others–wealldo.Butpleasedon’tbeaman(orawoman)withahammer–stilllesssomeoneunawarethatthereareothertoolsavailable.Toextendtheanalogy,useaSwissarmyknifeinstead,withdifferenttoolsfordifferenttasks.
‘Everythingfactualisalreadyatheory’:facts,evennumbers,areintheendnotobjective
JohannWolfgangvonGoethe,theGermanwriter(Faust)andscientist(TheoryofColours),oncesaidthat‘everythingfactualisalreadyatheory’.1Thisissomethingtobearinmindwhenlookingateconomic‘facts’.Manypeoplewouldassumethatnumbersarestraightforwardandobjective,buteachofthemis
constructedonthebasisofatheory.ImightnotgoasfarasBenjaminDisraeli,theformerBritishprimeminister,whoquippedthat‘therearelies,damnedlies,andstatistics’,butnumbersineconomicsareinvariablytheresultsofattemptstomeasureconceptswhosedefinitionsareoftenextremelycontentiousoratleastdebatable.2
Thisisnotjustanacademicquibble.Thewayweconstructeconomicindicatorshashugeconsequencesforhowweorganizeoureconomy,whatkindofpoliciesweimplementandultimatelyhowweliveourlives.Thisappliestoeventhemostbasicfiguresthatwetakeforgranted,likeGDPortherateof
unemployment.TheexclusionofhouseholdworkandunpaidcareworkfromGDPhasinevitablyledtotheunder-valuationofthosetypesofwork.GDP’sinabilitytotakeintoaccountpositionalgoodshasdirectedconsumptioninthewrongdirectionandmadeitanunreliablemeasureoflivingstandardsforrichcountries,wherethosegoodsaremoreimportant(seeChapter6).Thestandarddefinitionofunemploymentunderestimatesthetrueextentofitbyexcludingdiscouragedworkersintherichcountriesandtheunder-employedinthedevelopingcountries(seeChapter10).Naturally,thesetypesofjoblessnesshavebeenratherneglectedbypolicy-makers.Allofthisisnottosaythatnumbersineconomicsarealluselessorevennecessarilymisleading.We
neednumberstobeabletogetthesenseofmagnitudeofoureconomicworldandmonitorhowitchanges;wejustshouldn’tacceptthemunthinkingly.
Theeconomyismuchbiggerthanthemarket:theneedtothinkaboutproductionandwork
Muchofeconomicsthesedaysisaboutthemarket.MosteconomiststodaysubscribetotheNeoclassicalschool,whichconceptualizestheeconomyasawebofexchangerelationships–individuals
buyvariousthingsfrommanycompaniesandselltheirlabourservicestooneofthem,whilecompaniesbuyandsellfrommanyindividualsandothercompanies.Buttheeconomyshouldnotbeequatedwiththemarket.Themarketisonlyoneofmanydifferentwaysoforganizingtheeconomy–indeed,itaccountsforonlyasmallpartofthemoderneconomy.Manyeconomicactivitiesareorganizedthroughinternaldirectiveswithinfirms,whilethegovernmenthasinfluenceover–andevencommands–largesectionsoftheeconomy.Governments–andincreasinglyinternationaleconomicorganizationsliketheWTO–alsodrawtheboundariesofmarketswhilesettingrulesofconductinthem.HerbertSimon,thefounderoftheBehaviouralistschool,onceestimatedthatonlyabout20percentofeconomicactivitiesintheUSareorganizedthroughthemarket.Thefocusonthemarkethasmademosteconomistsneglectvastareasofoureconomiclife,with
significantnegativeconsequencesforourwell-being.Theneglectofproductionattheexpenseofexchangehasmadepolicy-makersinsomecountriesoverlycomplacentaboutthedeclineoftheirmanufacturingindustries.Theviewofindividualsasconsumers,ratherthanproducers,hasledtotheneglectofissuessuchasthequalityofwork(e.g.,howinterestingitis,howsafeitis,howstressfulitisandevenhowoppressiveitis)andwork–lifebalance.Thedisregardoftheseaspectsofeconomiclifepartlyexplainswhymostpeopleintherichcountriesdon’tfeelmorefulfilleddespiteconsumingthegreatesteverquantitiesofmaterialgoodsandservices.Theeconomyismuchbiggerthanthemarket.Wewillnotbeabletobuildagoodeconomy–oragood
society–unlesswelookatthevastexpansebeyondthemarket.
SoWhat?:TheEconomyIsTooImportanttobeLefttoProfessionalEconomists
Allofthissoundsfine,youmaysay,butsowhat?Itwouldbeentirelyreasonableforyoutosay:Iamonlyaconsumerofinformationproducedbyprofessionaleconomists,sowhatamIsupposedtodowiththisnewknowledge?Thereisactuallyagreatdealyoucan–andshould–dowithit.Iwillmentiononlythethreemost
importantthings.
‘Anexpertissomeonewhodoesn’twanttolearnanythingnew’:hownottobe‘used’byeconomists
HarryS.Truman,inhistypicalno-nonsensestyle,oncesaidthat‘Anexpertissomeonewhodoesn’twanttolearnanythingnew,becausethenhewouldnotbeanexpert.’Expertknowledgeisabsolutelynecessary,butanexpertbydefinitionknowswellonlyanarrowfield
andwecannotexpecthimorhertomakeasoundjudgementonissuesthatinvolvemorethanoneareaoflife(thatis,mostissues),balancingoffdifferenthumanneeds,materialconstraintsandethicalvalues.Thepossessionofexpertknowledgecansometimesgiveyouablinkeredview.Thisdoseofscepticismaboutexpertknowledgeshouldbeappliedtoallareasoflife,notjusteconomics.Butitisespeciallyimportantineconomics–apoliticalargumentoftenpresentedasascience.Youshouldbewillingtochallengeprofessionaleconomists(and,yes,thatincludesme).Theydonot
haveamonopolyonthetruth,evenwhenitcomestoeconomicmatters(nottospeakof‘everything’).Tobeginwith,mostofthetimetheycannotagreeamongthemselves.Veryoften,theirviewscanbenarrowanddistortedinparticularways–likeallotherprofessions,theeconomicsprofessionissubjecttowhattheFrenchcalldéformationprofessionelle.Itisentirelypossibleforpeoplewhoarenotprofessional
economiststohavesoundjudgementsoneconomicissues,basedonsomeknowledgeofkeyeconomictheoriesandappreciationofunderlyingpoliticalandethical,aswellaseconomic,assumptions.Sometimes,theirjudgementsmayevenbebetterthanthoseofprofessionaleconomists,sincetheymaybemorerootedinrealityandlessnarrowlyfocused.Theeconomyistooimportanttobelefttotheprofessionaleconomistsalone.Iwouldgoonestepfurtherandsaythatthewillingnesstochallengeprofessionaleconomists–and
otherexperts–shouldbeafoundationofdemocracy.Whenyouthinkaboutit,ifallwehavetodoistolistentotheexperts,whatisthepointofhavingademocracyatall?Unlesswewantoursocietiestoberunbyabodyofself-electedexperts,weallhavetolearneconomicsandchallengeprofessionaleconomists.
‘Auditeetalterampartem’(listeneventotheotherside):theneedforhumilityandanopenmind
OnthewallsofthecityhallofGoudaintheNetherlandsiswrittentheLatinmotto:‘Auditeetalterampartem’(Listeneventotheotherside).3Thisistheattitudeyoushouldhaveindebatingeconomicissues.Giventhecomplexityoftheworldandgiventhenecessarilypartialnatureofalleconomictheories,youshouldbehumbleaboutthevalidityofyourfavouritetheoryandshouldkeepanopenmindaboutit.Thisisnottosaythatyoushouldhavenoopinion–youneedtohaveyourown–hopefullystrong–view,butthatisnotthesameasbelievingthatitisrightinsomeabsolutesense.Ihavearguedthatthereissomethingtolearnfromallthosedifferentschoolsofeconomics–fromthe
MarxistschoolonthelefttotheAustrianschoolontheright.Indeed,throughouthistory,toomanyliveshavebeenruinedbypeoplewithexcessiveconvictionintheirownviews–fromtheKhmerRougeonthelefttotheneo-liberalmarketfundamentalistontheright.
‘Pessimismoftheintellect,optimismofthewill’:changesaredifficulttomake,butevenbigonesarepossible,ifyoutryhardenoughandlongenough
Throughoutthebook,wehaveseenhowdifficultitistochangeeconomicreality–whetheritislowwagesinpoorcountries,taxhavensthatservethesuper-rich,excessivecorporatepoweroranoverlycomplexfinancialsystem.Indeed,thedifficultyofchangingthestatusquo,evenwhenmostpeopleagreethatitisonlyservingatinyminority,ismanifestednowhereasclearlyasinthelimitedreformthathasbeenmadetoourcurrentneo-liberaleconomicpolicies(andtheeconomictheoriesthatarebehindthem)evenafterthe2008financialcrisishasclearlyshowntheirlimitations.Sometimesthedifficultyisduetotheactiveattemptsbythosewhobenefitfromthecurrent
arrangementstodefendtheirpositionsthroughlobbying,mediapropaganda,bribingorevenviolence.However,thestatusquooftengetsdefendedevenwithoutsomepeopleactively‘beingevil’.The‘one-dollar-one-vote’ruleofthemarketdrasticallyconstrainstheabilityofthosewithlessmoneytorefuseundesirableoptionsgiventothembytheunderlyingdistributionofincomeandwealth(recallmycriticismofPaulKrugmanonlowwagesinChapter4).Moreover,wecanbesusceptibletobeliefsthatgoagainstourowninterests(‘falseconsciousness’fromChapter5).Thistendencymakesmanylosersfromthecurrentsystemdefendit:someofyoumayhaveseenAmericanpensionersprotestingagainst‘Obamacare’withplacardssaying‘Governmenthandsoffmymedicare’whenmedicareis–well,letmeputitdelicately–agovernment-fundedand-runprogramme.Acknowledgingthedifficultiesinvolvedinchangingtheeconomicstatusquoshouldnotcauseusto
giveupthefighttocreateaneconomythatismoredynamic,morestable,moreequitableandmore
environmentallysustainablethanwhatwehavehadforthelastthreedecades.Yes,changesaredifficult,but,inthelongrun,whenenoughpeoplefightforthem,many‘impossible’thingshappen.Justremember:200yearsago,manyAmericansthoughtitwastotallyunrealistictoarguefortheabolitionofslavery;100yearsago,theBritishgovernmentputwomeninprisonforaskingforvotes;fiftyyearsago,mostofthefoundingfathersoftoday’sdevelopingnationswerebeinghunteddownbytheBritishandtheFrenchas‘terrorists’.AstheItalianMarxistAntonioGramscisaid,weneedtohavepessimismoftheintellectandoptimism
ofthewill.
FinalThoughts:EasierThanYouThink
The2008globalfinancialcrisishasbeenabrutalreminderthatwecannotleaveoureconomytoprofessionaleconomistsandother‘technocrats’.Weshouldallgetinvolvedinitsmanagement–asactiveeconomiccitizens.Ofcourse,thereis‘should’andthereis‘can’.Manyofusarephysicallytooexhaustedbyourdaily
struggleforexistenceandmentallyoccupiedwithourownpersonalandfinancialaffairs.Theprospectofmakingtheinvestmentsnecessarytobecomeanactiveeconomiccitizen–learningeconomicsandpayingattentiontowhatisgoingonintheeconomy–mayseemdaunting.However,theseinvestmentsaremucheasiertomakethanyoumightthink.Economicsisfarmore
accessiblethanmanyeconomistswouldhaveyoubelieve.Onceyouhavesomebasicunderstandingofhowtheeconomyworks,monitoringwhatisgoingonbecomesalotlessdemandingintermsofyourtimeandattention.Likemanyotherthingsinlife–learningtorideabicycle,learninganewlanguageorlearningtouseyournewtabletcomputer–beinganactiveeconomiccitizengetseasierovertime,onceyouovercometheinitialdifficultiesandkeeppractisingit.Pleasegiveitatry.
Notes
PROLOGUE:WHYBOTHER?:WHYDOYOUNEEDTOLEARNECONOMICS?
1.Thesearethefirstsentencesofhisarticle‘Themacroeconomistasscientistandengineer’,JournalofEconomicPerspectives,vol.20,no.4(2006).
2.Forasimilarview,seethearticle,‘Iseconomicsascience?’byRobertShiller,oneofthe2013NobelEconomicslaureates.Thearticlecanbedownloadedat:http://www.theguardian.com/business/economics-blog/2013/nov/06/is-economics-a-science-robert-shiller.
CHAPTER1:LIFE,THEUNIVERSEANDEVERYTHING:WHATISECONOMICS?
1.R.Lucas,‘Macroeconomicpriorities’,AmericanEconomicReview,vol.93,no.1(2003).ThiswashispresidentialaddresstotheAmericanEconomicAssociation.
2.ThisisbrilliantlyexplainedbyFelixMartininhisbookMoney:TheUnauthorisedBiography(London:TheBodleyHead,2013).3.Manyoftheseservicesalsoinvolveconsumptionofmaterialthingsaswell–forexample,thefoodinarestaurant–butwearealso
purchasingthecookingandtheservingservices.
CHAPTER2:FROMPINTOPIN:CAPITALISM1776AND2014
1.BeforeSmith,therewereothereconomists,liketheeconomicthinkersofRenaissanceItaly,thePhysiocratsofFrance,andthe‘mercantilists’,someofwhomIdiscussinChapter4.
2.CliffordPratten,‘Themanufactureofpins’,JournalofEconomicLiterature,vol.18(March1980),p.94.Prattensaysthatthefigurewasforthemoreefficientofthetwomanufacturerstheninexistence.Thelessefficientoneproducedaround480,000pinsperworkerperday.
3.Eveninthemostindustrializedcountries,likeBritainandtheNetherlands,over40percentofpeopleworkedinagriculture.IntheotherWesternEuropeancountries,theratiowasover50percentandinsomecountriesupto80percent.
4.D.Defoe,ATourThroughtheWholeIslandofGreatBritain(Harmondsworth:Penguin,1978),p.86.5.Dependingonthecountry,60–80percentofthosewhoworkforcapitalistsworkforsmallandmedium-sizedenterprises (SMEs),
employinglessthanafewhundredpeople.SMEsaredefinedasenterprisesemployinglessthan250peopleintheEuropeanUnionandlessthan500intheUS.
6.AtthetimeLondonwasthebiggestcityinEuropeandthesecondbiggestintheworldafterBeijing,whichhadover1.1millionpeople.HavingjustlosttheAmericancolonies,theBritishcolonialterritoriesatthetimewhenTWONcameoutconsistedof(partsof)India,Canada,IrelandandaroundadozenandahalfCaribbeanislands.
7.TheinformationintherestofthesectionisfromH.-J.Chang,KickingAwaytheLadder:DevelopmentStrategyinHistoricalPerspective(London:AnthemPress,2002),pp.93–9,unlessotherwisespecified.
8.AlltheinformationontheBankofEnglandbanknotesisfromthewebsiteoftheBankofEngland.See:http://www.bankofengland.co.uk/banknotes/Pages/about/history.aspx.
CHAPTER3:HOWHAVEWEGOTHERE?:ABRIEFHISTORYOFCAPITALISM
1.A.Maddison,ContoursoftheWorldEconomy,1–2030AD(Oxford:OxfordUniversityPress,2007),p.71,table2.2.Thelong-termhistoricalgrowthfiguresinthenextfewparagraphsarealsofromthesamesource.
2.Britain’scottontextileoutputgrewat1.4percentperyearduring1700–1760,butgrewat7.7percentperyearduring1770–1801.Especiallybetween1780and1790,thegrowthratewas12.8percentperyear–highevenbytoday’sstandardsbutastonishingatthe
time.Theironindustryincreaseditsoutputby5percentperyearbetween1770and1801.ThesefiguresarecalculatedfromN.Crafts,BritishEconomicGrowthduringtheIndustrialRevolution(Oxford:ClarendonPress,1995),p.23,table2.4.
3.SeeJ.Hobson,TheEasternOriginsofWesternCivilization(Cambridge:CambridgeUniversityPress,2004)forevidenceonhowtheearlyscientificandtechnologicaldevelopmentsintheWestdrewextensivelyfromtheArab,IndianandChineseworlds.
4.AnauthoritativeandbalanceddiscussiononthisisprovidedbyP.Bairoch,EconomicsandWorldHistory:MythsandParadoxes(NewYorkandLondon:HarvesterWheatsheaf,1993),Chapters5–8.
5.B.HartmannandJ.Boyce,NeedlessHunger(SanFrancisco:InstituteforFoodandDevelopmentPolicy,1982),p.12.6.Unlikepoliticalrevolutions,suchastheFrenchRevolutionortheRussianRevolution,economicrevolutionsdonothaveclearstartandend
dates.TheIndustrialRevolutionhasbeendefinedasaslongas1750–1850andasshortas1820–70.7.R.HeilbronerandW.Milberg,TheMakingofEconomicSociety,13thedition(Boston:Pearson,2012),p.62.8.N.Crafts,‘Somedimensionsofthe“qualityoflife”duringtheBritishindustrialrevolution’,EconomicHistoryReview,vol.50,no.4
(November1997):table1,p.623,forthe1800figure,andtable3,p.628,forthe1860figure.9.SeeChang,KickingAwaytheLadder,andH.-J.Chang,BadSamaritans:RichNations,PoorPoliciesandtheThreattothe
DevelopingWorld(RandomHouse,London,2007),forfurtherdetails.10.Walpole’sofficialjobtitlewasactuallythechiefminister,butwemaybeexcusedcallinghimthefirstprimeminister.Hewasthefirsthead
ofBritishgovernmentwhocontrolledallministries–beforehim,therehadbeentwooreventhreejointheadsofgovernment.Walpolewasalsothefirstonewhotookupresidence(in1735)at10DowningStreet,thefamousofficialresidenceoftheBritishprimeminister.
11.Throughtheprovisionknownas‘extra-territoriality’,thesetreatiesalsodeprivedtheweakercountriesoftheabilitytotryforeigncitizensforcrimescommittedintheirterritories.Someotherunequaltreatiesdemandedthattheweakercountriescedeor‘lease’partsoftheirterritories;ChinacededtoBritainHongKongIslandin1842andKowloonin1860,whileBritain‘leased’theso-calledNewTerritoriesofHongKongforninety-nineyearsin1898.Unequaltreatiesoftenforcedtheweakercountrytosellforeignerstherightstoexploitnaturalresources(e.g.,minerals,forestry)forminimalfees.
12.A.Smith,AnInquiryintotheNatureandCausesoftheWealthofNations(Oxford:ClarendonPress,1976),p.181.13.GermanytookTanzania,Namibia,Rwanda,Burundi,Togoandsoon,althoughmanyoftheseweregiventothewinnersintheFirstWorld
War.TheUSgotCubaandthePhilippines,whileBelgiumtookCongo.JapancolonizedKorea,TaiwanandManchuria(thenorth-easternpartofChina).
14.Between1870and1913,percapitaincomegrowthinLatinAmericasawamassiveacceleration,from-0.04percentduring1820–70to1.86percentattheendofthisperiod,makingthecontinentthefastest-growingregionintheworld(higherthanthatoftheUS,1.82percent,insecondplace).
15.CalculatedfromA.Maddison,TheWorldEconomy:HistoricalStatistics(Paris:OECD,2003),p.100,table3c.16.ThesenumbersandinformationintherestofthisparagrapharefromC.Dow,MajorRecessions:BritainandtheWorld,1920–1995
(Oxford:OxfordUniversityPress,1998),p.137,table6.1(for1929–32)andp.182(for1932–7).17.ThispointisexplainedinanaccessiblewaybyStephanieFlanders,theBBCeconomicsjournalist,atthefollowingblogpost:
http://www.bbc.co.uk/blogs/thereporters/stephanieflanders/2009/02/04/index.html.18.Forexample,itisestimatedthattheUSgovernmentfiscalpolicyaddedamere0.3percenttotheGDPbetween1929and1933,against
the31.8percentfallduringthesameperiod(Dow,MajorRecessions,p.164,table6.11),whileUKfiscalpolicyaddedamere0.4percent,againstthe5.1percentfallinGDPbetween1929and1932(ibid.,p.192,table6.23).
19.Percapitaincomegrowthratefortheworldfellfrom1.31percentduring1870–1913to0.88percentduring1913–50.Maddison,TheWorldEconomy,p.383,tableA.8.
20.A.Glyn,A.Hughes,A.LipietzandA.Singh,‘TheriseandfalloftheGoldenAge’,inS.MarglinandJ.Schor(eds.),TheGoldenAgeofCapitalism(Oxford:OxfordUniversityPress,1990),p.45,table2.4.
21.TheaverageinflationfortheACCsduringthisperiodwasaround4percent.Ibid.,p.45,table2.4.22.C.ReinhartandK.Rogoff,ThisTimeIsDifferent:EightCenturiesofFinancialFolly(Princeton:PrincetonUniversityPress,2009),p.
252,figure16.1.23.Today,peoplethinkoftheWorldBankasthebankforpoorcountries,butitsfirstclientswerethewar-torneconomiesofEurope.Thisis
reflectedinitsofficialname,whichistheInternationalBankforReconstructionandDevelopment(IBRD).(Emphasisadded.)24.TheECSCcoordinatedeffortstoupgradetheproductionfacilitiesinthecoalandsteelindustries.The1957TreatyofRomecreatedthe
EuropeanAtomicEnergyCommunity(Euroatom)aswellastheEEC.In1967,thesethreecommunitieswereintegratedtoformtheEuropeanCommunities(EC).
25.FurtherdetailscanbefoundinF.Block,‘Swimmingagainstthecurrent:theriseofahiddendevelopmentalstateintheUnitedStates’,PoliticsandSociety,vol.36,no.2(2008),andinM.Mazzucato,TheEntrepreneurialState:DebunkingPrivatevs.PublicSectorMyths(London:AnthemPress,2013).
26.Glynetal.,‘TheriseandfalloftheGoldenAge’,p.98.27.TheaverageinflationrateofEuropereachedupto15percentwhiletheUSratealsosurgedabove10percent.TheUKsuffered
particularly,withtheinflationratereachingalmost25percentin1975.FromDow,MajorRecessions,p.293,figure8.5.28.GrowthratesinpercapitaincomeintheACCswere1.4percentduring1870–1913,1.2percentduring1913–50,and3.8percentduring
1960–70.ThesefiguresarefromGlynetal.,‘TheriseandfalloftheGoldenAge’,p.42,table2.1.
29.Ibid.,p.45,table2.4.30.Itshould,however,benotedthattheChileangovernmenthashadanimportantroleintheeconomyeveninthecountry’sneo-liberalphase.
CODELCO,thelargestcopperminingcompanyintheworld,whichhadbeennationalizedin1971bytheleft-wingAllendegovernment,waskeptunderstateownership.Anumberofpublicandsemi-publicagencies(suchasFundaciónChile)haveprovideditsagriculturalproducerswithsubsidizedtechnicalconsultancyandexportmarketinghelp.
31.S.BasuandD.Stuckler,TheBodyEconomic:WhyAusterityKills(London:BasicBooks,2013),Chapter2,forfurtherdetailsandanalyses.
32.China’soutputin1978wasaround$219billion.Worldoutputinthatyearwasabout$8,549billion.CalculatedfromWorldBank,WorldDevelopmentReport1980(Washington,DC:WorldBank,1980),pp.110–11,table1.
33.Ibid.,pp.124–5,table8.34.China’sGDPin2007was$3,280billion.WorldGDPwas$54,347billion.WorldBank,WorldDevelopmentReport2009(NewYork:
OxfordUniversityPress,2009),pp.356–7,table3.China’smerchandiseexportwas$1,218billion,whilethatfortheworldwas$13,899billion(ibid.,pp.358–9,table4).
CHAPTER4:LETAHUNDREDFLOWERSBLOOM:HOWTO‘DO’ECONOMICS
1.CarlMengerisconsideredtobethefoundingfatheroftheAustrianschool,butsomewouldrightlysaythathewas,togetherwithLeonWalrasandWilliamJevons,oneofthefoundingfathersoftheNeoclassicalschool.AnevenmorecomplicatedexampleisFrankKnight,theearlytwentieth-centuryeconomist,whotaughtattheUniversityofChicago.HeisoftenthoughtofasanAustrianeconomist(no,notbyhisnationality–hewasanAmerican),buthehadalotofInstitutionalistinfluences,andsomeofhisideasoverlapwiththeKeynesianandtheBehaviouralistones.
2.Physicistshavetried,andfailed,toconstructwhattheycallthe‘theoryofeverything’.3.‘…andintheirdarknessbindthemall’,goestherestofthesentence.4.JosephSchumpeteremphasizedthatallanalysisineconomicsisprecededbyapre-analyticalcognitiveact,calledvision,inwhichthe
analyst‘visualise[s]adistinctsetofcoherentphenomenaasaworth-whileobjectof[his]analyticefforts’.Hepointedoutthat‘thisvisionisideologicalalmostbydefinition’,as‘thewayinwhichweseethingscanhardlybedistinguishedfromthewayinwhichwewishtoseethem’.ThequoteisfromJ.Schumpeter,HistoryofEconomicAnalysis(NewYork:OxfordUniversityPress,1954),pp.41–2.IthankWilliamMilbergforpointingmetothisquote.
5.TheelevationoftheindividualbytheNeoclassicalschoolgoesbeyondthelabellingofeconomicactorsasindividuals,ratherthanclasses.Mostmembersoftheschoolbelieveinmethodologicalindividualismaswell–namely,theviewthatascientificexplanationofanycollectiveentity,suchastheeconomy,shouldbebasedonitsdecompositiontothesmallestpossibleunit–thatis,theindividual.
6.AnotherwaytoputitistosaythatasocietyisinastateofParetooptimalityifnoonecanbemadebetteroffwithoutmakingsomeoneworseoff.
7.InAkerlof’sclassicexampleof‘themarketforlemons’,giventhedifficultyofascertainingthequalityofusedcarsbeforepurchase,prospectivebuyerswillnotbewillingtostumpupgoodmoneyevenforwhatisatrulygoodsecond-handcar.Giventhis,ownersofgoodusedcarswillshunthemarket,loweringtheaveragequalityofcarsfurther,leading,intheextremecase,tothedisappearanceofthemarketitself.SeeG.Akerlof,‘Themarketfor“lemons”:qualityuncertaintyandthemarketmechanism’,QuarterlyJournalofEconomics,vol.84,no.4(1970).
8.TheremainingtwovolumeswereeditedbyEngelsandpublishedafterMarx’sdeath.9.Forthishistory,seemybooksKickingAwaytheLadder(moreacademicanddetailed)andBadSamaritans(lessdetailedandmore
user-friendly).10.Typicallyrecommendedwere:promotionofnewindustriesthroughtariffs,subsidiesandpreferentialtreatmentingovernmentprocurement
(thatis,governmentbuyingthingsfromtheprivatesector);encouragementofdomesticprocessingofrawmaterialsthroughexporttaxesonrawmaterialsorthroughabanontheirexports;discouragementoftheimportsofluxurygoodsthroughtariffsorprohibitionssothatmoreresourcescanbechannelledintoinvestments;exportpromotionthroughmarketingsupportandqualitycontrol;supportfortechnologicalimprovementsthroughgovernment-grantedmonopoly,patentsandgovernment-subsidizedrecruitmentofskilledworkersfromeconomicallymoreadvancedcountries;and,lastbutnotleast,publicinvestmentininfrastructure.
11.Liststartedoutasafree-trader,promotingtheideaofafree-tradeagreementbetweenvariousGermanstates,whichwasrealizedin1834asZollverein(literallythecustomsunion).However,duringhispoliticalexileintheUSduringthe1820s,hecameacrossHamilton’sideas,throughtheworksofDanielRaymondandHenryCarey,andcametoacceptthatfreetrademaybegoodbetweencountriesatsimilarlevelsofdevelopment(e.g.,theGermanstatesthen)butnotsobetweeneconomicallymoreadvancedcountries,suchasBritain,andbackwardcountries,suchasGermanyandtheUSthen.Itmaybeaddedthat,likemostEuropeansatthetime,Listwasaracistandexplicitlyarguedthathistheoryappliedonlyto‘temperate’countries.
12.Thiscontrastswiththepredominantly(althoughnotexclusively)one-waycausalitysupposedbytheMarxistschool,frommaterialproductionsystem–orthebase–toinstitutions–orthesuperstructure.
13.Importantnamesinclude,inalphabeticalorder,AliceAmsden,MartinFransman,JorgeKatz,SanjayaLallandLarryWestphal.14.Onthisdebate,seeD.Lavoie,RivalryandCentralPlanning:TheSocialistCalculationDebateReconsidered(Cambridge:Cambridge
UniversityPress,1985).15.HerbertSimon,thefounderoftheBehaviouralistschool,haspointedoutthatmoderncapitalismisbetterdescribedasan‘organization’
economythanasamarketeconomy.Thesedays,mosteconomicactionshappenwithinorganizations–predominantlyfirmsbutalsogovernmentsandotherorganizations–ratherthanthroughmarkets.SeeChapter5forfurtherdiscussion.
16.Theideathat‘permitstopollute’canbeboughtandsoldmaystillsoundalientomanynon-economists.Butthemarketforthesepermitsisalreadyathrivingone,withanestimatedvalueoftradein2007at$64billion.
17.Theyarenamed,‘MarxtheProphet’,‘MarxtheEconomist’,‘MarxtheSociologist’and‘MarxtheTeacher’.18.Overtime–inhisgrandchildren’sgeneration,asKeynesputinafamousarticletitled‘EconomicPossibilitiesforOurGrandchildren’
(thoughhehimselfhadnochildren)–livingstandardsincountrieslikeBritainwillhaverisensufficientlythatnotmuchnewinvestmentwouldbeneeded.Atsuchapoint,heenvisaged,thefocusofpolicyshouldbeswitchedtoreducingworkinghoursandincreasingconsumption,mainlybyredistributingincometopoorergroups,whichspendlargerproportionsoftheirincomesthanthericherones.
19.ThehistoryoffinancialspeculationisbeautifullydocumentedinC.Kindleberger,Manias,Panics,andCrashes:AHistoryofFinancialCrisis(London:Macmillan,1978).
20.HealsoearnedlargesumsforKing’sCollege,Cambridge,whoseinvestmentportfoliohewasinchargeofasthebursar(financialmanager)between1924and1944.
21.MichalKalecki(1899–1970),withhisMarxistinfluenceandinterestindevelopingeconomies,andNicholasKaldor(1908–86),whohadonefootintheDevelopmentalisttraditionandwhowas,havingbeenbroughtupintheAustro-HungarianEmpire,nostrangertotheideasoftheAustriansandSchumpeter,wereexceptionsinthisregard.
22.Veblenalsotriedtounderstandthechangesinsocietyinevolutionaryterms,drawinginspirationfromthethennewtheoryofCharlesDarwin.
23.MostmembersoftheNIEacceptthe‘self-seeking’partofthe‘rationalself-seekingindividual’assumptionoftheNeoclassicalschool,butmostofthem(notnecessarilyanoverlappingsetwiththeformer‘most’)rejectthe‘rational’part.Someofthem,especiallyWilliamson,evenexplicitlyemploytheBehaviouralistconceptofboundedrationality,whichseeshumanrationalityasseverelylimited.
24.ThereisalsoanunacknowledgedinfluencefromtheMarxistschool(NorthwasaMarxistinhisyoungdays),atleastintermsofthesubjectmatter,suchaspropertyrelations(NorthandCoase)andtheinternalworkingsofthefirm(CoaseandWilliamson).
25.SomeNeoclassicaleconomistshavetriedtoreinterpretboundedrationalitysothatitfitsintooptimizationmodels.Somearguethatboundedrationalitysimplymeansthatweneedtoseeeconomicdecisionasthe‘joint-optimization’ofresourcecosts(atraditionalNeoclassicalconcern)andthecostsofdecision-making.Inanothercommonreinterpretation,peopleareseentooptimizebychoosingthebestdecisionrules,ratherthantryingtomaketherightchoiceineverydecisioninstance.BoththesereinterpretationsintheenddonotworkbecausetheyassumeevenmoreunrealisticlevelsofrationalitythanthestandardNeoclassicalmodeldoes.Howcanagentsthatarenotevenrationalenoughtooptimizeononefront(resourcecosts)optimizetwo(resourcecostsanddecisioncosts)?Howcanagentsthatarenotsmartenoughtomakerationaldecisionsonindividualoccasionsdesigndecisionrulesthatwillallowthemtomakeoptimaldecisionsonaverage?
26.H.Simon,TheSciencesoftheArtificial,3rdedition(Cambridge,MA,TheMITPress1996),p.31.
CHAPTER5:DRAMATISPERSONAE:WHOARETHEECONOMICACTORS?
1.Thedataonintra-firmtradearehardtocomeby.Intra-firmtradeis,at20–25percent,estimatedtobelessimportantinservicesthaninmanufacturing.Butincertain‘producerservices’,suchasconsultingandR&D,itisevenmoreimportantthaninmanufacturing;inthecaseofUSandCanadianfirms,forwhichdetaileddataareavailable,itwasintheregionof60–80percent.ThedataarefromR.LanzandS.Miroudot,‘Intra-firmtradepatterns,determinantsandpolicyimplications’,OECDTradePolicyPapersno.114(Paris:OECD,2011).
2.MCCalsohasnearly150subsidiariesthatarenotcooperativesandover10,000workerswhoarenotemployee-partners.Thesalesrevenueincludesthoseofthesesubsidiaries.
3.Preciselyforthisreason,thefirstanti-trustlawoftheUS(theShermanActof1890)actuallytreatedtradeunionsasanti-competitive‘trusts’–untiltheprovisionwasdroppedintherevisedanti-trustlawof1914,calledtheClaytonAct.
4.TheEuropeanUnion(EU)derivesitspowerfromamixtureofmoneyandrule-settingpower.Asseenintherecent‘rescue’packagesforthe‘periphery’countries,likeGreeceandSpain,someofitsinfluenceisthroughitsfinancialpower.Butmoreimportantisitsabilitytosetsrulesonallaspectsofeconomic(andother)lifeinitsmembercountries,includingbudget,competitionamongfirmsandworkingconditions.EUdecisionsaremadeonthebasisof‘qualifiedmajorityvoting’(QMV),inwhichvotesheldbyeachcountryreflecttheirpopulationsizebutonlyuptoapoint,inamanneranalogoustothedistributionofelectoralcollegevotesforUSpresidentialelectionamongthefiftystatesoftheUS.IntheCounciloftheEuropeanUnion,GermanyhastentimesmorevotesthanMalta(twenty-nineagainstthreevotes),butithasapopulationmorethan200timesbigger(82millionv.0.4million).
5.TheILOisquitedifferentfromotherUNorganizations.WhileotherUNbodiesareinter-governmentalorganizations,theILOisatripartitebody,madeupofgovernments,tradeunionsandemployers’associations,with2:1:1distributionofvotesbetweenthethreegroups.
6.Thereareanumberofexperimentsthatshowthateconomicsstudentsaremoreselfishthanothers.Partofitmaybetheresultof‘self-selection’–hearingthateconomicseducationtodayemphasizesthepredominanceofself-seeking,selfishpeoplearemorelikelytofeelthatitistheirkindofsubject.Butitmayalsobetheresultofeducationitself–beingtaughtallthetimethateveryoneisouttopromotehimself/herself,economicsstudentsmaygettoseetheworldmoreinthatway.
CHAPTER6:HOWMANYDOYOUWANTITTOBE?:OUTPUT,INCOMEANDHAPPINESS
1.Thisisexceptfortheverylimitedamountconsumedbytourists.2.ThispointisveryclearlyandcarefullyexplainedinJ.Aldred,TheSkepticalEconomist(London:Earthscan,2009),especiallypp.59–61.3.RichardLayard,talkingtoJulianBagginiin‘Theconversation:canhappinessbemeasured?’,Guardian,20July2012.
CHAPTER7:HOWDOESYOURGARDENGROW?:THEWORLDOFPRODUCTION
1.AftertheGambia,Swaziland,Djibouti,RwandaandBurundi.2.Backin1995,EquatorialGuinea’spercapitaGDPwasamere$371ayear,makingitoneofthethirtypoorestcountriesintheworld.3.TheinformationontheUSminingindustryprovidedbelowisfromG.WrightandJ.Czelusta,‘Exorcisingtheresourcecurse:miningasa
knowledgeindustry,pastandpresent’,workingpaper,StanfordUniversity,2002.4.ThesegrowthratesmeanthatGermany’s2010percapitaincomewas11.5percenthigherthanits2000income,whereastheUS’s2010
percapitaincomewasonly7.2percenthigherthanits2000income.5.ThefollowingR&DfiguresarefromOECD,PerspectivesonGlobalDevelopment2013–ShiftingUpaGear:IndustrialPoliciesin
aChangingWorld(Paris:OECD,2013),Chapter3,figure3–1.6.Inthepoorercountries,withfewcorporationsthatarebigenoughtoconducttheirownR&D,thevastmajorityofR&Disfinancedbythe
government.Theratiocouldbenearly100percentinsomecountries,butaretypically50–75percent.Intherichercountries,theshareofthegovernmentinR&Dislower,typicallybetween30percentand40percent.ItisconsiderablylowerinJapan(23percent)andKorea(28percent),whileSpainandNorway(both50percent)makeuptheotherend.IntheUS,theratioisaround35percentthesedays,butusedtobemuchhigher(50–70percent)duringtheColdWar,whenitsfederalgovernmentspentahugeamountindefenceresearch(seeChapter3).
7.DepartmentforBERR(Business,EnterpriseandRegulatoryReform),GlobalisationandtheChangingUKEconomy(London:HerMajesty’sGovernment,2008).
8.PierreDreyfus,aformerFrenchministerofindustry,ascitedinP.Hall,GoverningtheEconomy(Cambridge:PolityPress,1987),p.210.9.ThedatainthisparagraphandthenextarefromH.-J.Chang,‘Rethinkingpublicpolicyinagriculture:lessonsfromhistory,distantand
recent’,JournalofPeasantStudies,vol.36,no.3(2009),unlessotherwisestated.10.Ifweexpandittotheindustrialsector,theshareinGDPwas30–40percent.Today,innoneofthemdoesitaccountformorethan25per
cent.ThedataarefromO.Debande,‘De-industrialisation’,EIBPapers,vol.11,no.1(2006);downloadableat:http://www.eib.org/attachments/efs/eibpapers/eibpapers_2006_v11_n01_en.pdf.
11.InGermany,theshareofmanufacturinginGDPfellfrom27percentto22percentincurrentpricesbetween1991and2012.Inconstantprices,thefallwasfrom24percentto22percent.CorrespondingnumbersinItalywere22percentto16percentincurrentpricesand19percentto17percentinconstantprices.InFrance(1991–2011),theywerefrom17percentto10percentincurrentpricesandfrom13percentto12percentinconstantprices.ThedataarefromEurostats,issuedbytheEuropeanUnion.
12.IntheUS,theshareofmanufacturinginGDPfellfrom17percentto12percentincurrentpricesbetween1987and2012.But,inconstantprices,itactuallyrosealittle,from11.8percentto12.4percentduringthisperiod.Between1990and2012,theshareofmanufacturinginSwitzerland’sGDPfellfrom20percentto18percentincurrentprices.Butwhencalculatedinconstantprices,itactuallyrosefrom18percentto19percent.TheSwissdataarefromEurostats.TheUSdataarefromtheUSgovernment’sBureauofEconomicAnalysis(BEA).
13.InFinland(1975–2012),theshareincurrentpricesfellfrom25percentto17percentbuttheshareinconstantpricesrosefrom14percentto21percent.InSweden(1993–2012),thecorrespondingfigureswereafallfrom18percentto16percentandarisefrom12percentto18percent.ThedataarefromEurostats.
14.Between1990and2012,theshareofmanufacturingintheUK’sGDPfellfrom19percentto11percentincurrentprices,representinga42percentdecline.Itfellfrom17percentto11percentinconstantprices,representinga35percentdecline.ThedataarefromEurostats,issuedbytheEuropeanUnion.
15.AllthedataarefromtheWorldBank.
16.Foramorein-depthdiscussion,seeG.Palma,‘Foursourcesof“de-industrialisation”andanewconceptofthe“DutchDisease”’,paperpresentedattheEGDI(EconomicGrowthandDevelopmentInitiative)RoundtableoftheHSRC(HumanSciencesResearchCouncil)ofSouthAfrica,21May2007,downloadableat:http://intranet.hsrc.ac.za/Document-2458.phtml.
17.TheGDRframeworkidentifiestheshareofburdenforeachcountryinreducinggreenhousegasestopreventthepotentiallycatastrophic‘two-degreewarming’,consideringbothhistoricalresponsibilityforglobalwarmingandcapacitytobeartheburdenofadjustments.
18.SeeAldred,TheSkepticalEconomist,Chapter5,forfurtherdetails.19.Ourperceptionoftheriskofnuclearpowerstationsisdistortedbythefactthatnuclearaccidentshaveveryhighprofilesinthenews
media,notleastbecausetheyusuallyhappeninrichcountries.But,unbeknownsttotheoutsideworld,atleastafewthousandcoalminersdieinaccidentseveryyearinChinaalone.Wedon’tevenknowhowmanypeoplehavediedfrompollutionfromcoalburningoverthelastcoupleofcenturiesallovertheworld.The1952GreatSmogofLondonissaidtohavecausedanythingbetween4,000and12,000extradeaths,butthatisjustone–admittedlybyfartheworst–ofdozensofyearswhenBritainsufferedfromcoalpollution.Today,manypeopleincitiesinChina,Indiaandelsewheredieprematurelyfromrespiratorydiseasescausedbycoalpollution.Ifweaddallofthese‘silentdeaths’up,wecaneasilysaythatcoalhas‘killed’farmorepeoplethannuclearenergy,evenifweacceptthemostextreme–andhighlydisputed–estimatesofonemillionextradeathscausedbytheChernobyldisaster(mostlythroughcancerduetoincreasedradiation).
CHAPTER8:TROUBLEATTHEFIDELITYFIDUCIARYBANK:FINANCE
1.Martin,Money,p.242.2.AlotofwhatIsayaboutderivativesisderivedfromB.Scott,TheHeretic’sGuidetoGlobalFinance:HackingtheFutureofMoney
(London:PlutoPress,2013),pp.63–74andmypersonaldiscussionswithitsauthor.J.Lanchester,Whoops!WhyEveryoneOwesEveryoneandNoOneCanPay(London:AllenLane,2010),Chapter2,providesalesstechnicalbutaninsightfulexplanation.
3.IthankBrettScottforsuggestingthisexample.Inthissense,wecansaythatsecuritizeddebtproductsarederivativesinthatthey‘derive’theirvaluefromunderlyingassets.However,inthesamevein,wecansaythatsharesarealsoderivatives,ascompaniesalsohave‘underlying’assets,suchasphysicalequipmentandotherassets(likepatentsandotherintellectualproperties).Thus,alldistinctionsbetweendifferenttypesoffinancialassetsareintheendfuzzy.
4.Scott,TheHeretic’sGuidetoGlobalFinance,p.65.5.Ibid.,pp.69–70.6.OnthehistoryofthedevelopmentofderivativemarketsandtheroleoftheCBOTintheprocess,seeY.Millo,‘Safetyinnumbers:how
exchangesandregulatorsshapedindex-basedderivatives’,apaperpresentedattheConferenceontheSocialStudiesofFinance,CenteronOrganizationalInnovation(COI),ColumbiaUniversity,3–4May2002;downloadableat:http://www.coi.columbia.edu/ssf/papers/millo.rtf,and‘ABriefHistoryofOptions’,downloadableat:http://www.optionsplaybook.com/options-introduction/stock-option-history/.
7.SeeMillo,‘Safetyinnumbers’,andC.Lapavitsas,ProfitingwithoutProducing:HowFinanceExploitsAll(London:Verso,2013),p.6.8.H.Blommesteinetal.,‘Outlookforthesecuritisationmarket’,OECDJournal:MarketTrends,vol.2011,issue1(2011),p.6,figure6,
downloadedfrom:http://www.oecd.org/finance/financial-markets/48620405.pdf.AccordingtotheEurostat,theEU’sstatisticalagency,in2010,GDPwas€12.3trillionintheEuropeanUnionand€10.9trillionintheUS.
9.L.LinandJ.Sutri,‘Capitalrequirementsforover-the-counterderivativescentralcounterparties’,IMFWorkingPaper,WP/13/3,2013,p.7,figure1,downloadablefrom:http://www.imf.org/external/pubs/ft/wp/2013/wp1303.pdf.
10.G.Palma,‘Therevengeofthemarketontherentiers:whyneo-liberalreportsoftheendofhistoryturnedouttobepremature’,CambridgeJournalofEconomics,vol.33,no.4(2009).
11.Lapavitsas,ProfitingwithoutProducing,p.206,figure2.12.J.Crotty,‘Iffinancialmarketcompetitionissointense,whyarefinancialfirmprofitssohigh?:Reflectionsonthecurrent“goldenage”of
finance’,WorkingPaperno.134(Amherst,MA:PERI(PoliticalEconomyResearchInstitute),UniversityofMassachusetts,April2007).13.A.Haldane,‘Rethinkingthefinancialnetwork’,SpeechdeliveredattheFinancialStudentAssociation,Amsterdam,April2009,pp.16–17.
Thespeechcanbedownloadedfrom:http://www.bankofengland.co.uk/publications/Documents/speeches/2009/speech386.pdf.14.M.Blyth,Austerity:TheHistoryofaDangerousIdea(Oxford:OxfordUniversityPress,2013),pp.26–7.15.Theaverageshareholdingperiodsforbanksfellfromaboutthreeyearsin1998toaboutthreemonthsin2008.P.Sikka,‘NickClegg’splan
forshareholderstotacklefat-catpaywon’twork’,Guardian,6December2011,downloadablefrom:http://www.guardian.co.uk/commentisfree/2011/dec/06/nick-clegg-shareholders-fat-cat-pay?.
16.Thefinancialsectorhasnotalwaysbeenmoreprofitablethanthenon-financialsector.Accordingtoastudypublishedin2005,intheUS,betweenthemid-1960sandthelate1970s,therateofprofitforfinancialfirmswaslowerthanthatofthenon-financialfirms.But,followingfinancialderegulationintheearly1980s,theprofitrateoffinancialfirms(onarisingtrend,rangingbetween4percentand12percent)wassignificantlyhigherthanthatofnon-financialfirms(2–5percent)untiltheearly2000s(thedatainthestudyendedthere).InFrance,theprofitrateoffinancialcorporationswasnegativebetweentheearly1970sandthemid-1980s(nodataareavailableforthe
1960s).Withthefinancialderegulationofthelate1980s,itstartedrisingandovertookthatofnon-financialfirmsintheearly1990s,whenbothwereabout5percent,androsetoover10percentby2001.Incontrast,theprofitrateofFrenchnon-financialfirmsdeclinedfromtheearly1990s,toreacharound3percentin2001.SeeG.DuménilandD.Lévy,‘Costsandbenefitsofneoliberalism:aclassanalysis’,inG.Epstein(ed.),FinancialisationandtheWorldEconomy(Cheltenham:EdwardElgar,2005).
17.ReinhartandRogoff,ThisTimeIsDifferent,p.252,figure16.1.18.Palma,‘Therevengeofthemarketontherentiers’,p.851,figure12.19.W.Lazonick,‘Bigpayoutstoshareholdersareholdingbackprosperity’,Guardian,27August2012;downloadablefrom:
http://www.theguardian.com/commentisfree/2012/aug/27/shareholder-payouts-holding-back-prosperity.20.Itremainedat99percentin2011and2012.ThedatainthisparagrapharefromtheFederalReserveBoardflowoffundsdata;
downloadablefrom:http://www.federalreserve.gov/apps/fof/.Similarestimatesuptotheearly2000scanbefoundinCrotty,‘Iffinancialmarketcompetitionissointense’.Anotherestimatecomesupwithlowernumbers,butthetrendisthesame:justover20percentin1955,risingtoaround30percentbythemid-1980s,risingto50percentintheearly2000s,fallingtoaround45percentintherun-uptothe2008crisisandrisingbackover50percentby2010.SeeW.MilbergandN.Shapiro,‘Implicationsoftherecentfinancialcrisisforinnovation’,NewSchoolforSocialResearch,mimeo,February2013.
21.TheinformationforGEisfromR.Blackburn,‘Financeandthefourthdimension’,NewLeftReview,May/June2006,p.44.J.Froudetal.,FinancialisationandStrategy:NarrativeandNumbers(London:Routledge,2006)estimatesthattheratiocouldbeashighas50percent.TheFordnumbercomesfromtheFroudetal.studyandtheGMnumberfromtheBlackburnstudy.
22.ThispointisveryclearlyandinsightfullymadebyAndyHaldaneoftheBankofEngland(seeabove)in‘Thedogandthefrisbee’,speechdeliveredattheFederalReserveBankofKansasCity’s36thEconomicPolicySymposiumon‘TheChangingPolicyLandscape’,JacksonHole,Wyoming,31August2012;downloadablefrom:http://www.bankofengland.co.uk/publications/Documents/speeches/2012/speech596.pdf.
CHAPTER9:BORIS’SGOATSHOULDDROPDEAD:INEQUALITYANDPOVERTY
1.M.FriedmanandR.Friedman,FreetoChoose(Harmondsworth:PenguinBooks,1980),pp.31–2.2.Foramoredetailedargumentalongthisline,seeJ.Stiglitz,ThePriceofInequality(London:AllenLane,2012),Chapter4.3.Wilkinson’sandPickett’sexplanationisthatlower-incomeindividualsinmoreunequalsocietiesaresubjecttogreaterstressthanaretheir
counterpartsinmoreequalsocieties.Thisstresscomesfromwhattheycall‘statusanxiety’,namely,theanxietyaboutone’slowstatusandinabilitytoovercomeit,especiallyinearlylife.Thisstress,WilkinsonandPickettargue,negativelyaffectsthehealthoftheindividualsconcernedandmakesthemmorepronetoantisocialbehaviour,likecrime.
4.ComprehensiveandbalancedreviewsoftheevidencecanbefoundinF.Stewart,‘Incomedistributionanddevelopment’,QueenElizabethHouseWorkingPaper,no.37,UniversityofOxford,March2000;downloadablefrom:http://www3.qeh.ox.ac.uk/pdf/qehwp/qehwps37.pdf,andinB.Milanovic,TheHavesandtheHave-Nots(NewYork:BasicBooks,2011).
5.OtherindexesincludetheTheilIndex,theHooverIndexandtheAtkinsonIndex.6.Itisnamedaftertheearlytwentieth-centuryAmericaneconomistMaxLorenz.7.SeeG.Palma,‘Homogeneousmiddlesvs.heterogeneoustails,andtheendofthe“Inverted-U”:Theshareoftherichiswhatit’sall
about’,CambridgeWorkingPapersinEconomics(CWPE)1111,FacultyofEconomics,UniversityofCambridge,January2011;downloadablefrom:http://www.dspace.cam.ac.uk/bitstream/1810/241870/1/cwpe1111.pdf).
8.Foradetaileddiscussionofthesepoints,seeA.CobhamandA.Sumner,‘PuttingtheGinibackinthebottle?:“ThePalma”asapolicy-relevantmeasureofinequality’,mimeo,King’sInternationalDevelopmentInstitute,King’sCollegeLondon,March2013;downloadablefrom:http://www.kcl.ac.uk/aboutkings/worldwide/initiatives/global/intdev/people/Sumner/Cobham-Sumner-15March2013.pdf.Auser-friendlyvisualexplanationcanbefoundat:http://www.washingtonpost.com/blogs/worldviews/wp/2013/09/27/map-how-the-worlds-countries-compare-on-income-inequality-the-u-s-ranks-below-nigeria/.
9.SeeOECD,DividedWeStand:WhyInequalityKeepsRising(Paris:OrganizationforEconomicCooperationandDevelopment,2011),andILO,WorldofWork2012(Geneva:InternationalLabourOrganization,2012).
10.ThefollowingGinicoefficientsarefor2010fromILO,WorldofWork2012,p.15,figure1.9.FiguresforBotswanaandNamibiaarefromoldersources.
11.Interestingly,thedividinglinehereissimilartowhatsomeofthefriendlycriticsofTheSpiritLevelusewhentheysaythatinequalityproducesnegativesocialoutcomesincountriesaboveacertainlevelofinequality.
12.UNCTAD,TradeandDevelopmentReport2012(Geneva:UnitedNationsConferenceonTradeandDevelopment,2012),Chapter3,p.66,chart3.6.ThefifteencountriesstudiedwereAustralia,Canada,Chile,China,Germany,India,Indonesia,Italy,Japan,(South)Korea,NewZealand,Norway,Thailand,theUKandtheUS.Thedatausedrangedfrom1988forKoreato2008fortheUK,showingthedifficultyofgettinginformationonwealthdistribution.
13.TheirincomeGiniswerebelow0.3,buttheirwealthGiniswereover0.7.TheirwealthGiniswerehigherthanthoseofsomecountrieswithmuchhigherincomeinequality,suchasThailand(justover0.6wealthGini;incomeGiniover0.5)orChina(wealthGiniaround0.55;
incomeGinicloseto0.5).14.Detailedinformationisprovidedbyibid.,especiallyChapter3.15.A.Atkinson,T.PikettyandE.Saez,‘Topincomesinthelongrunofhistory’,JournalofEconomicLiterature,vol.49,no.1(2011),p.7,
figure2.16.Ibid.,p.8,figure3.17.F.BourguignonandC.Morrisson,‘Thesizedistributionofincomeamongworldcitizens,1820–1990’,AmericanEconomicReview,vol.
92,no.4(2002).18.UNCTAD,TradeandDevelopmentReport2012.ButseeMilanovic,TheHavesandtheHave-Nots,Chapter3,foramorecautious
interpretationofthedata.
CHAPTER10:I’VEKNOWNAFEWPEOPLEWHO’VEWORKED:WORKANDUNEMPLOYMENT
1.J.GarratyandM.Carnes,TheAmericanNation:AHistoryoftheUnitedStates,10thedition(NewYork:AddisonWesleyLongman,2000),p.607.
2.TheILOdoesnotprovidenationalbreakdownsforforcedlabourduetothedataqualityproblem.3.Therearedifferentsourcesforworkinghours,butIusetheILOdatabecausetheyarethemostcomprehensive.Fortherichcountries,I
sometimesusetheOECDdata,whentheILOdataarenotavailable.4.Thehoursare1,382hoursfortheNetherlands,1,406hoursforGermany,1,421hoursforNorwayand1,482hoursforFrance.5.Thehoursare2,090hoursforKorea,2,039hoursforGreece,1,787hoursfortheUSand1,772hoursforItaly.6.KoreaactuallyhadthelongestworkinghoursintheOECD(includingMexico)until2007.7.Forfurtherdiscussions,seeChang,BadSamaritans,Chapter9(‘LazyJapaneseandthievingGermans’),andH.-J.Chang,23Things
TheyDon’tTellYouaboutCapitalism(London:AllenLane,2010),‘Thing3’(Chapter3).8.AccordingtotheInternationalSocialSurveyProgramme,runbyaconsortiumofresearchinstitutesintheUS,theUK,Germanyand
Australia,workersfromrichcountriesvaluesecuritymorehighlythananyotherattributeofajob(e.g.,wage,interestingness,usefulnessforsociety).
9.Theso-calledactivelabourmarketprogrammes(ALMPs)inSwedenandFinlandhavevastlyreducedsuchproblemsbyretrainingunemployedworkersandhelpingthemestablishandfollowthroughare-employmentstrategy.SeeBasuandStuckler,TheBodyEconomic,Chapter7.
10.Inmanypoorcountries,alotofchildrenbelowthethresholdagework.Theiremploymentisoftennotrecognizedintheofficialemployment/unemploymentstatistics.
11.Inordertodealwiththedifficultiescreatedbydiscouragedworkers,economistssometimeslookatthelabourforceparticipationrate ,whichistheshareoftheeconomicallyactivepopulation(theemployedandtheofficiallyunemployed)intheworking-agepopulation.Asuddenfallinthatrateislikelytoindicatethattherehasbeenanincreaseinthenumberofdiscouragedworkers,whoarenotcountedasunemployedanymore.
CHAPTER11:LEVIATHANORTHEPHILOSOPHERKING?:THEROLEOFTHESTATE
1.Someeconomists,includingmyself,goevenfurtherandarguethat,inindustriesthatrequirelargecapitalinvestmentsforproductivitygrowth(e.g.,steel,automobile),‘anti-competitive’arrangementsamongoligopolisticfirms–suchascartels–canbesociallyuseful.Insuchindustries,unfetteredpricecompetitionreducesprofitmarginsofthefirmstotheextentthatitreducestheirabilitytoinvest,harmingtheirlong-termgrowth.Whensuchcompetitionleadstobankruptcyofcertainfirms,themachinesandtheworkersdeployedinthemmaybelosttothesociety,astheycannotbeeasilydeployedinotherindustries.Forexample,seeH.-J.Chang,ThePoliticalEconomyofIndustrialPolicy(Basingstoke:MacmillanPress,1994),Chapter3,andA.AmsdenandA.Singh,‘TheoptimaldegreeofcompetitionanddynamicefficiencyinJapanandKorea’,EuropeanEconomicReview,vol.38,nos.3/4(1994).
2.TheholderswithafinancebackgroundwereDonaldRegan(January1981–February1985),NicholasBrady(September1988–January1993),LloydBentsen(January1993–December1994),RobertRubin(January1995–July1999),HenryPaulson(July2006–January2009),TimGeithner(January2009–January2013).
3.Forinformationoncorruptionandotherillsofpubliclifeintoday’srichcountriesinthepast,seeChang,KickingAwaytheLadder,Chapter3,especiallypp.71–81,andChang,BadSamaritans,Chapter8.
4.WorldBank,WorldDevelopmentReport1991(Washington,DC:TheWorldBank,1991),p.139,table7.4.5.ThedataarefromOECD,GovernmentataGlance,2011(Paris:OECD,2011).
CHAPTER12:‘ALLTHINGSINPROLIFICABUNDANCE’:THEINTERNATIONALDIMENSION
1.ThefulltextofEmperorQianlong’slettertoGeorgeIIIcanbefoundat:http://www.history.ucsb.edu/faculty/marcuse/classes/2c/texts/1792QianlongLetterGeorgeIII.htm.
2.ThereareotherassumptionsunderlyingHOSwhoserelaxationalsounderminesthe‘freetradeisthebest’conclusion,eventhoughIdon’tdiscusstheminthischapter.Oneoftheseisthatofperfectcompetition(thatis,theabsenceofmarketpower),whoserelaxationhasgeneratedtheso-called‘NewTradeTheory’,representedbyPaulKrugman.Anotherimportantassumptionisthattherearenoexternalities(seeChapter4foradefinitionofexternalities).
3.TheRicardianversionassumesthatdifferentcountrieshavedifferentproductivecapabilitiesbutalsoassumesthatthesedifferencescannotbedeliberatelychanged.
4.Foramoredetaileddiscussion,seeH.-J.ChangandJ.Lin,‘Shouldindustrialpolicyindevelopingcountriesconformtocomparativeadvantageordefyit?:AdebatebetweenJustinLinandHa-JoonChang’,DevelopmentPolicyReview,vol.27,no.5(2009).
5.TradedatainthenextfewparagraphsarefromtheWorldBankdataset,WorldDevelopmentIndicators2013.6.ThedataarefromtheWTO.7.UnitedNations,InternationalTradeStatistics,1900–1960(NewYork:UnitedNations,1962).8.Thenumberisbasedonexportfigures.Fortheperiodbeforethe1980s,therearequitesignificantgapsinexportandimportdata,sothe
shareswere50–58percentinthe1960sand54–61percentforthe1970s,ifweuseimportfigures.9.Asaproportionofoveralltrade(primarycommodities,manufacturing,andservices),manufacturing’ssharerosefrom47percentin1980–
82to63percentin1998–2000andstoodat55percentin2009–11.10.Theaveragefor1984–6was8.8percent.Theaveragefor2009–11was27.8percent.11.AmoredetaileddefinitionisprovidedbytheUNCTAD(UnitedNationsConferenceonTradeandDevelopment)at:
http://unctad.org/en/Pages/DIAE/Foreign-Direct-Investment-(FDI).aspx.12.Thefigureswere63percentforLiberia,50percentforHaitiand42percentforKosovo.13.AlltheFDIflowfigurescitedbelowareinflowfigures.Intheory,inflowsandoutflowsofFDIontheworldscaleshouldbethesame,but
theactualdataalwaysshowdiscrepancies.14.CalculationbasedonWorldBankdata.15.SeeR.Kozul-WrightandP.Rayment,TheResistibleRiseofMarketFundamentalism:RethinkingDevelopmentPolicyinan
UnbalancedWorld(London:ZedBooksandThirdWorldNetwork,2007),Chapter4,foranexcellentreviewoftheevidence.16.Ontaxhavens,seeN.Shaxson,TreasureIslands:TaxHavensandtheMenWhoStoletheWorld(London:Vintage,2012),andthe
websiteofTaxJusticeNetwork,www.taxjustice.net.Atthetimeofwriting(autumn2013),therehasbeenalotoftalkofaclamp-downontaxhavens,especiallythroughtheG20,butnoconcreteactionhasbeentaken.
17.ChristianAid,‘Theshirtsofftheirbacks:howtaxpoliciesfleecethepoor’,September2005,downloadablefrom:http://www.christianaid.org.uk/images/the_shirts_off_their_backs.pdf.
18.ThestoryofthisdebacleistoldinfullinChang,BadSamaritans,Chapter1(‘TheLexusandtheOliveTreerevisited’).19.FurtherdiscussionsofthesemeasurescanbefoundinN.Kumar,‘Performancerequirementastoolsofdevelopmentpolicy:lessonsfrom
developedanddevelopingcountries’,inK.Gallagher(ed.),PuttingDevelopmentFirst(London:ZedBooks,2005).Amoreuser-friendlydiscussioncanbefoundinChang,BadSamaritans,Chapter4(‘TheFinnandtheelephant’).
20.Fordiscussionsonhowtheserulesmaybeharmfulforeconomicdevelopment,seeH.-J.ChangandD.Green,TheNorthernWTOAgendaonInvestment:DoasWeSay,NotasWeDid(Geneva:SouthCentre,andLondon:CAFOD(CatholicAgencyforOverseasDevelopment),2003),andR.ThrasherandK.Gallagher,‘21stcenturytradeagreements:implicationsfordevelopmentsovereignty’,ThePardeePapersno.2,TheFrederickS.PardeeCenterfortheStudyoftheLonger-RangeFuture,BostonUniversity,September2008;downloadablefrom:http://www.ase.tufts.edu/gdae/Pubs/rp/KGPardeePolSpaceSep08.pdf.
21.SeeChangandGreen,TheNorthernWTOAgenda,fordetailsontheIrishcase.22.Theaverageoveraperiod,ratherthanfiguresforparticularyears,hasbeenusedbecauseFDIflowsfluctuatealotyearbyyear.23.TheUSgotonly15.0percentofworldFDIdespiteaccountingfor23.1percentofworldGDPduringthisperiod.InthecaseofFrance
thecorrespondingnumberswere3.0percentagainst4.3percent,whilethoseforBrazilwere2.8percentand3.0percent.Intermsofover-representedcountries,BelgiumandHongKongstandout;theygotrespectively6percentand4.1percentofworldFDIdespiteaccountingforonly0.8percentand0.4percentofworldGDP.TheUK(6.8percentvs.4.0percent)wasalsostronglyover-represented,followedbyChina(11.0percentvs.8.5percent).
24.TheywereChina,Brazil,Mexico,Russia,India,Hungary,Argentina,Chile,ThailandandTurkey.25.ThestatisticsavailableforbrownfieldFDI(thatis,cross-borderM&A)andforoverallFDIflowsarenotdirectlycomparabletoeach
other.Thisisforanumberofreasons.Onereasonisthatpartofcross-borderM&Amaybefinancedlocally.Anotherreasonisthatpaymentsforcross-borderM&Amaybemadeoveraperiod,ratherthaninasingleyear.
26.SeeP.Nolan,J.ZhangandC.Liu,‘Theglobalbusinessrevolution,thecascadeeffect,andthechallengeforfirmsfromdevelopingcountries’,CambridgeJournalofEconomics,vol.32,no.1(2008).
27.PhilippeLegrain,theauthorofImmigrants:YourCountryNeedsThem,isoneofthefewfree-marketeconomistswhoseriouslyadvocatehighlyliberalized(althoughnotcompletelyfree)immigration.
28.Ontheissueofworkerrightsinimmigration,seeM.Ruhs,ThePriceofRights:RegulatingInternationalLabourMigration(Princeton:PrincetonUniversityPress,2013).
29.Ofcourse,thisisexcludingdistress-drivenimmigration,namely,refugeesfromcivilwarornaturaldisasterinaneighbouringcountry.30.Onthedebatessurroundingthedefinitionoflabourshortage,seeM.RuhsandB.Anderson(eds.),WhoNeedsMigrantWorkers?:
LabourShortages,Immigration,andPublicPolicy(Oxford:OxfordUniversityPress,2012),Chapter1.31.Forexample,seeC.DustmannandT.Frattini,‘ThefiscaleffectsofimmigrationtotheUK’,DiscussionPaperno.22/13(London:
CReAM(CentreforResearchandAnalysisofMigration),UniversityCollegeLondon,2013).32.Forexample,seeG.OttavianoandG.Peri,‘Rethinkingthegainsofimmigrationonwages’,NBERWorkingPaperno.12497(Cambridge,
MA:NBER(NationalBureauofEconomicResearch),2006);downloadablefrom:http://www.nber.org/papers/w12497.33.Foracomprehensivediscussionoftheimpactsofremittances,seeI.Grabel,‘Thepoliticaleconomyofremittances:Whatdoweknow?
Whatdoweneedtoknow?’,PERIWorkingPaperSeries,no.184(Amherst,MA:PERI(PoliticalEconomyResearchInstitute),UniversityofMassachusetts,2008);downloadablefrom:http://www.peri.umass.edu/fileadmin/pdf/working_papers/working_papers_151–200/WP184.pdf).
34.InMexico,thegovernmentusedtomatchthesumofremittancesusedforthoseinvestmentswithpublicgrants,buttheschemehasbeendiscontinued.
35.ThedataonimmigrantstockinthisandfollowingparagraphsarefromWorldBank’sWorldDevelopmentIndicatorsdatabase.36.TheremittancesdatainthisandfollowingparagraphsarebasedontheWorldBank’sMigrationandRemittancesStatistics.
EPILOGUE:WHATNOW?:HOWCANWEUSEECONOMICSTOMAKEOURECONOMYBETTER?
1.J.W.vonGoethe,SämtlicheWerke,Part1:MaximenundReflexionen,SchriftenzurNaturwissenschaft,Jubiläumsausgabexxxix,72,ascitedinA.Gerschnkron,ContinuityinHistoryandOtherEssays(CambridgeMA:HarvardUniversityPress,1968),Chapter2,p.43.
2.TheodorePorter,theeminenthistorianofscience,arguesthatevenmanyscientificnumbersareconstructedinresponsetopoliticalandsocialpressures.SeehisbookTrustinNumbers:ThePursuitofObjectivityinScienceandPublicLife(Princeton:PrincetonUniversityPress,1995).
3.IthankDeirdreMcCloskeyforpointingmetothisquote.
Acknowledgements
TheideaofwritinganintroductiontoeconomicsthatisaccessibletothebroadestpossibleaudiencewasfirstraisedbyPenguinthroughmytheneditor,WillGoodlad,intheautumnof2011.Willhassincethenmovedontootherthings,butheprovidedhelpfulinputsintotheshapingandthewritingofthebook,evenwhilehewasgoingthroughanintensephaseofestablishinganewventure.ThebookcouldnothavebeenwrittenwithoutLauraStickney,myeditor.Itmusthavebeendifficultfor
her,asshehadtoputupwithperiodsofsilenceandnumerousrewritesoftheearlierchapters.However,sheputherfaithinmeandsawmethroughtheprocess,withonlythegentlestproddingandwithanenormousamountofexcellentadvice,bothsubstantiveandeditorial.Icannotthankhermore.IvanMulcahy,myliteraryagent,asusual,providedveryimportantinput.Inparticular,hissuggestions
onsomeofanearlierincompletedraftbreathedlifebackintothebook,whenthewritingprocesswasindangeroflosingitsmomentum,andIwasindangeroflosingmyfaithinthebookmyself.PeterGinna,myUSeditor,alsogavemealotofimportantinput,especiallyinthefinalphaseofthe
book.Numerousfriendsprovidedmewithhelpandencouragement,butthreeindividualsdeserveaspecial
mention.DuncanGreen,WilliamMilbergandDeepakNayyarreadallthechapters(someoftheminmorethanoneversion)andgavemeextremelyhelpfulcomments.Theyalsogavememoralsupportthroughdifficultphasesoftheproject,ofwhichthereweremany.FelixMartinprovidedveryimportantinputsintotheshapingofthebookfromthestagewhenitwasa
mereplan.Healsoreadseveralchaptersofthebookandgivenmeveryhelpfulcomments.MilfordBatemanreadalmostallthechaptersofthebookandofferedveryusefulcomments.FinlayGreenalsoreadmostofthechaptersandsuggestedmanywaysinwhichIcouldimprovetheaccessibilityofmywriting.Iwouldalsoliketothankmanypeoplewhoreadvariousversionsofthebookplanorchaptersofthe
bookandgavemeusefulcomments.Theyare,inalphabeticalorder,JonathanAldred,AntonioAndreoni,JohnAshton,RogerBackhouse,StephanieBlankenberg,AdityaChakrabortty,HasokChang,VictoriaChick,MicheleClara,GaryDymski,IleneGrabel,GeoffreyHodgson,AdrianaKocornik-Mina,DavidKucera,CostasLapavitsas,SangheonLee,CarlosLopez-Gomez,TiagoMata,GayMeeks,SeumasMilne,DimitrisMilonakis,BrettScott,JeffSommers,DanielTudor,BhaskarViraandYuanYang.MyPhDstudentandresearchassistant,MingLeongKuan,providedmewithextremelyefficientand
creativehelpinsecuringandprocessingthenecessarydataforthebook.GiventheimportancethatIamattachingto‘real-lifenumbers’inthisbook,MingLeong’sassistancewasessentialinmakingthebookwhatitis.
DuringthetwoyearsinwhichIwaswritingthebook,Hee-Jeong,mywife,Yuna,mydaughter,andJin-Gyu,myson,sufferedalotbutgavemeahugeamountofloveandsupport.Hee-JeongandYunaalsoreadmanyofthechaptersandgavemealotofveryhelpfulcomments.Jin-Gyukeptremindingmethattherearemoreimportantthingsinlifethaneconomics,suchasDrWho,HerculePoirotandHarryPotter.MylittlefamilyinEnglandwouldnothavehadthesolidityithaswithouttheloveofourextended
familybackinKorea.Myparents-in-lawhaveshowereduswithalotoflovingsupport.Myownparentshavebeenacontinuoussourceofloveandencouragementforus.Aboveall,IwouldnotbewhatIamtodaywithouttheirsacrificeandnurturing.Idedicatethebooktothem.
RobinDunbar
HUMANEVOLUTIONWhatmakesushuman?
Howdidwedeveloplanguage,thoughtandculture?Whydidwesurvive,andotherhumanspeciesfail?
RobinDunbarisanevolutionaryanthropologistandDirectoroftheInstituteofCognitiveandEvolutionaryAnthropologyatOxfordUniversity.HisacclaimedbooksincludeHowManyFriendsDoesOnePersonNeed?andGrooming,GossipandtheEvolutionofLanguage,
describedbyMalcolmGladwellas‘amarvellousworkofpopularscience’.
OrlandoFiges
REVOLUTIONARYRUSSIA,1891–1991WhatcausedtheRussianRevolution?
Diditsucceedorfail?Dowestilllivewithitsconsequences?
OrlandoFigesteacheshistoryatBirkbeck,UniversityofLondonandistheauthorofmanyacclaimedbooksonRussianhistory,includingAPeople’sTragedy,whichTheTimesLiterarySupplementnamedasoneofthe‘100mostinfuentialbookssincethewar’,Natasha’sDance,TheWhisperers,CrimeaandJustSendMeWord.TheFinancialTimescalledhim‘thegreateststorytellerofmodernRussian
historians’.
BruceHood
THEDOMESTICATEDBRAINWhydowecarewhatothersthink?
Whatkeepsusboundtogether?Howdoesthebrainshapeourbehaviour?
BruceHoodisanaward-winningpsychologistwhohastaughtandresearchedatCambridgeandHarvarduniversitiesandiscurrentlyDirectoroftheCognitiveDevelopmentCentreattheUniversityofBristol.HedeliveredtheRoyalInstitution’sChristmasLecturesin2011andisthe
authorofTheSelfIllusionandSupersense,describedbyNewScientistas‘important,crystalclearandutterlyengaging’.
MelissaLane
GREEKANDROMANPOLITICALIDEASWheredoourideasaboutpoliticscomefrom?
WhatcanwelearnfromtheGreeksandRomans?Howshouldweexercisepower?
MelissaLaneteachespoliticsatPrincetonUniversity,andpreviouslytaughtforffteenyearsatCambridgeUniversity,whereshealsostudiedasaMarshallandTrumanscholar.ThehistorianRichardTuckcalledherbookEco-Republic‘avirtuosoperformancebyoneofourbest
scholarsofancientphilosophy’.
THEBEGINNING
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*Butthenscientistswilltellyouthateventhosenumbersarenottotallyobjective,ifyouaskedthem
*AstheyusedtosayonMontyPython’sFlyingCircus.
*Thisisknownasacaseofphysicsenvy.†Incidentally,thisshouldmakeeconomists’jobsreallyeasy,becausewealreadyknowtheanswertothatUltimateQuestion:itis42.Butlet’sleavethatsubjectasideforthemoment.
*TheNobelPrizeinEconomicsisnotarealNobelprize.UnliketheoriginalNobelPrizes(Physics,Chemistry,Physiology,Medicine,LiteratureandPeace),establishedbytheSwedishindustrialistAlfredNobelattheendofthenineteenthcentury,theeconomicsprizewasestablishedbytheSwedishcentralbank(SverigesRiksbank)in1968andisthusofficiallycalledtheSverigesRiksbankPrizeinEconomicSciencesinMemoryofAlfredNobel.
†ButthenthiswouldnothavesurprisedthelateJohnKennethGalbraith(1908–2006),whooncedeadpannedthat‘theonlyfunctionofeconomicforecastingistomakeastrologyrespectable’.
*Intheoriginalnovel,MrBucketlosthisjobbecausehisfactorywentbustratherthanbecauseitboughtamachinetoreplacehim.
*Babbage’sfirstcomputerwascalledthedifferenceengine,whichprovidedthetitleforoneoftheclassic‘steampunk’sci-finovelsbyWilliamGibsonandBruceSterling.
*Ineconomicstheory,thisisknownasfinancecapitalormoneycapital.
*Asmallnumberofcompaniesengagedinriskyventuresofnationalsignificance,suchascolonialexpansion(theEastIndiaCompaniesofBritainandoftheNetherlands)orlarge-scalebanking,wereallowedtobebasedonlimitedliabilities.
†Franchisesareindependentcompaniesusingabiggercompany’sbrandandsupplies,ratherthanbranchesoperateddirectlybythebiggercompany.
*Inmostdevelopingcountries,inwhichcapitalismisstillunderdeveloped,thesituationisstillnottoodissimilarfromthatfoundinWesternEuropeinSmith’stime.Inthepoorestones,childlabourisstillprevalent,whilealotofpeoplearestilltenantsofsemi-feudallandlords.Anythingbetween30percentand90percentoftheworkforceinthesecountriesmaybeself-employed,manyofwhomareengagedinsubsistencefarming.
*Yes,that’sthescientist,whoalsodoubledasanalchemistandastockmarketspeculator.
*Theseincludedtheflyingshuttle(1733)andspinningjenny(1764)inthetextileindustry,coke-smelting(1709)insteel-makingandvariousprocessesforlarge-scalesulphuric-acidmanufacture(the1730sandthe1740s)inthechemicalindustry.
*Tosimplifythestory,the1932faminehappenedbecausetoomuchfoodwasshippedoutoftheruralareas,followingthe1928agriculturalcollectivization.Therapidlyrisingurbanpopulationhadtobefed,andgrainshadtobeexportedtoearnforeignexchangeswithwhichtoimportadvancedmachinerythattheSovietUnionneededforindustrialization.
*PaulKrugmanwrotein2009:‘Thirty-plusyearsago,whenIwasagraduatestudentineconomics,onlytheleastambitiousofmyclassmatessoughtcareersinthefinancialworld.Eventhen,investmentbankspaidmorethanteachingorpublicservice–butnotthatmuchmore,andanyway,everyoneknewthatbankingwas,well,boring’(‘Makingbankingboring’,TheNewYorkTimes,9April2009).
*Being‘neutral’countriesintheColdWar,thesecountrieshadkepttheirdistancefromtheEU,despitebeinginWesternEurope.
*TheOECDwasfoundedin1961,andcomprisesmostWesternEuropeancountries,Turkey,theUSandCanada.Bythemid-1970s,Japan,Finland,AustraliaandNewZealandwereadded.Sincethemid-1990s,severalformersocialistcountries(e.g.,HungaryandEstonia)andsomericherdevelopingcountries(MexicoandChile)havejoinedit.
†Atthetimeofwriting(earlyJanuary2014),thefiguresfor2013werenotout,but,onaprovisionalestimatemadeonthebasisoftheOECDdata,inthethirdquarterof2013percapitaoutputremainedlowerthanin2007innineteenoutofthethirty-fourOECDmembercountries.
*Thereareevenmore,ifweincludesmallerschools(e.g.,theNeo-Ricardianschool,theLatinAmericanStructuralistschool,feministeconomics,ecologicaleconomics).Thenumberwouldbeincreasedifwemadesub-schoolsofsomeoftheschoolsindependent(e.g.,differentstrandslistedundertheDevelopmentalisttradition).
*Hethenimmediatelyaddedthat‘theydonotmakeitundercircumstanceschosenbythemselves’,emphasizingthatwechangeourenvironmentbutarealsoitsproducts.
*Smith,unlikemostotherClassicaleconomists,wasawarethatpeoplehavemotivesbesidesself-seeking,suchassympathy,passionandadherencetosocialnorms.ThesemotiveswerethemainsubjectsofTheTheoryofMoralSentiments,thecompanionvolumetoTWON.
*So,comparativeincomparativeadvantagereferstocomparisonbetweentheproductsthatacountrycanpotentiallyproduce.Thepossibilitythatonecountryismoreefficientthananotherinproducingthesameproductisalreadyreflectedinthetermadvantage.Foramoredetailedexpositionofthetheory,seeChapter3,‘MySixYearOldSonShouldGetaJob’,inmybookBadSamaritans.
*ThetheoryisnamedafterEliHeckscherandBertilOhlin,thetwoSwedisheconomistswhodevelopedtheidea,andPaulSamuelson,theAmericaneconomist(andtheauthorofthemostfamouseconomicstextbookinthetwentiethcentury),whoperfectedit.
*DespitethefactthatitwasgoingtohurtUSworkersinindustrieslikeautomobileandtextiles,manyNeoclassicaleconomistsadvocatedtheNAFTA,thefree-tradeagreementwithMexicoandCanada,onthegroundthatthenationalgainsfromincreasedtradearemorethanenoughtocompensatethose(andother)losers.Unfortunately,thelosershavenotbeenfullycompensated,sotheoutcomecouldnotbecalledaParetoimprovement.
*BeforetheRussianRevolution,theleadingMarxisteconomistswereKarlKautsky(1854–1938),RosaLuxemburg(1871–1919)andRudolfHilferding(1877–1941).ThekeySovietMarxisttheoristswereVladimirLenin(1870–1924),YevgeniPreobrazhensky(1886–1937)andNikolaiBukharin(1888–1938).
*Insomeformulations,communismisdividedintotwophases.Thefirstphaseisalsocalledsocialismandisrunthroughcentralplanning.Thesecond,or‘higher’,phaseiscalled‘purecommunism’,inwhichthestatewillhavewitheredaway.Inthisbook,Iusethetermscommunismandsocialisminterchangeably.
*Afew,likeJean-BaptisteColbert(LouisXIV’sfinanceministerbetween1665and1683),arestillrememberedfortheirpolicies.Mostareforgottenaltogether.Some,suchasHenryVIIandRobertWalpole,arestillrememberedbutnotfortheireconomicpolicies.
*TheearlyleadersoftheAmericanEconomicAssociation,JohnBatesClark(1847–1938)andRichardEly(1854–1943)studiedundereconomistsoftheGermanHistoricalschool,suchasWilhelmRoscher(1817–94)andKarlKnies(1821–98).
*Theprefix‘neo’isdebatable.Thedifferencesbetweenthetwoaremuchlessthanthosebetween,forexample,theClassicalschoolandtheNeoclassicalschool.
*Leadingmembersoftheschool,whichissometimescalledevolutionaryeconomics,are,inalphabeticalorder,MarioCimoli,GiovanniDosi,thelateChristopherFreeman,Bengt-ÅkeLundvall,RichardNelsonandSidneyWinter.
*TheheavyweightJohnCommons(1862–1945),whoseworkhadaffinitywiththeschool,explicitlydeclaredhismembershipoftheschoolinthemid-1920s.JohnMauriceClark(1884–1963),thesonofJohnBatesClark,wasanotherimportant,younger,figure.
*SimonwasthelastRenaissanceMan,asIcallhiminThing16ofmybook,23ThingsTheyDon’tTellYouaboutCapitalism.Hemadepath-breakingcontributionsnotjustineconomicsbutacrossmanyfields.Hewasoneofthefoundingfathersofartificialintelligence(AI)andofOperationsResearch(OR,abranchofbusinessadministration).Healsowroteoneoftheclassicsinthefieldofpublicadministration(AdministrativeBehaviour,publishedin1947)andwasaleadingscholarincognitivepsychology.Soheknewathingortwoabouthowpeoplethinkandact.
*Insayingthis,Iamsimplifyingtherelationshipbetweenpeople’seconomicpositionandtheideastheysupport;WarrenBuffet,GeorgeSorosandplentyofotherrichpeoplehavesupportedpoliciesthatwouldharmthempersonally.AndIamcertainlyexaggeratingthedegreetowhichmoneyandpowercaninfluenceideas.Nevertheless,itisimportanttorecognizethattheindividualistvisionoftheeconomyhasnotbecomedominantpurelyonitsintellectualmerit.
*Someestimatesthatincludestockoptions–whosevaluesarenoteasytocalculate–saythatitcouldbeover1,000times.
*ThefactthatWalmart,thebiggestprivatesectoremployerintheUS,employsonlyabout1percentoftheUSlabourforce(1.4millionpeople)putsthenumberinperspective.
*ThemostimportantregionalmultilateralbanksaretheAsianDevelopmentBank(ADB),theAfricanDevelopmentBank(AfDB)andtheInter-AmericanDevelopmentBank(IDB).
*Thereisahugeamountofevidence,wellpresentedinaccessibleforminbookslikePeterUbel’sFreeMarketMadness,GeorgeAkerlof’sandRobertShiller’sAnimalSpiritsandthepsychologistand2002NobelEconomicslaureateDanielKahnemann’sThinking,FastandSlow.
*Averyroughbutusefulruleofthumbisthatthevalue-addedfigureisusuallyaroundone-thirdofsales(turnover)figureofacompany.
*Whatreallyrepresentsanation’sproductivityishowmuchpeoplehavetoworkinordertoproduceagivenamountofoutput,ratherthanwhattheoutputisforeachpersonalive.Therefore,inordertojudgeaneconomy’sproductivity,ideallywehavetolookatGDPperhourworked,ratherthanpercapita,butthosenumbersarenotreadilyavailable,soweuseGDPpercapitafiguresasproxiesforacountry’sproductivity.
*TheGDPfigureswere$14.4trillionfortheUS,$5.9trillionforChina,$5.5trillionforJapan,$3.3trillionforGermanyand$2.5trillionforFrance.
†Thisdefinitionmeansthatseveralcountriesthatpeoplewouldn’tnormallyconsiderrichareincludedinthe‘high-income’world–afewformersocialistcountries(Poland,Hungary,CroatiaandSlovakia)andtwoofthepooreroilstates(SaudiArabiaandLibya).Buttheyarenotlargeenoughtoaltertheoverallpicture.
*GDPswere$5.9trillionforChina,$2.1trillionforBrazil,$1.7trillionforIndia,$1.5trillionforRussiaand$1.0trillionforMexico.Theseaddupto$12.2trillion.
*Notethatwecannot,strictlyspeaking,directlycomparethesetwodifferentincomefigures.
*Sheldon,theman-childphysicistprotagonistofTheBigBangTheory,thecultTVdramaseries,explainedthesegoodsbeautifully,whenheexplainedtohisfriendRajwhyHoward,theirfriend,doeswhatRajcalls‘lovey-doveystuff’withhisnewgirlfriendonthemobilephoneinfrontofhisfriends:‘There’saneconomicconceptknownasapositionalgoodinwhichanobjectisonlyvaluedbythepossessorbecauseit’snotpossessedbyothers.Thetermwascoinedin1976byeconomistFredHirschtoreplacethemorecolloquial,butlessprecise,“neener-neener”’(‘TheLargeHadronCollision’,season3,episode15).Hirsch’sseminalworkisthebookSocialLimitstoGrowth.
*IntheWorldBankclassification,acountryisconsidered‘uppermiddleincome’ifithadGNIpercapitahigherthan$3,975and‘low’incomeifithadonelowerthan$1,005in2010.
*ThePPP-adjustedpercapitaincomesare$57,130inNorway,$54,700inSingapore,$53,630inKuwait,$49,180inSwitzerlandand($47,020intheUS.TheyarefollowedbytheNetherlands($42,590),Denmark($40,140)andSweden($39,600).
†TheyarefollowedbyEritrea($540),Niger($700),theCentralAfricanRepublic($760),Togo($790)andSierraLeone($830).
*Justincase,theanswersfortheothersare:themostpowerfulsportscars,whichhaveengineswithover1,000horsepower;aUSBmemorystickorane-reader,ifhisjacketpocketislarge;thenuclearpowerstation;andthedesalinationplant.
*Theterm‘gross’heremeansthatwearenotcountingdepreciationofcapital,asexplainedinChapter6.
*Asof2010,Finlandspent3.9percentofitsGDPonR&D,withSouthKoreafollowingcloselyat3.7percent.Sweden(3.4percent),Japan(3.3percent),Denmark(3.1percent),Switzerland(3percent),theUS(2.9percent)andGermany(2.8percent)areothereconomieswithhighR&DspendingasaproportionofGDP.
†Industryincludesthingslikemining,electricitygenerationandgasdelivery,aswellasmanufacturing.Sometimesstatisticsareavailableonlyfor‘industry’asawhole,ratherthan‘manufacturing’only.
*AccordingtotheWorldBank,theyare,asof2009,SierraLeone(59percent),Liberia(58percent),theCentralAfricanRepublic(57percent)andEthiopia(51percent).
*Thesharesin2011were28percentinTaiwan,23percentinSloveniaand20percentinGermany.
*Thephysicalintensityofanaturaldisasterismuchlessimportantthantheadaptabilityofthehumancommunitythatitaffectsindeterminingitsimpacts.Forexample,the2010earthquakeinHaiti,whichkilledover200,000peopleandhasscarredthecountryforageneration,wasonly7ontheRichterscale,whichwouldhavekillednomorethanahandfulofexceptionallyunluckypeopleinJapan.
*Itisimportanttonotethatdepositorsofabankincludeitsborrowers.Whenyouborrowmoneyfromabank,itopensadepositaccountforyou,creditedwiththeagreedsum,ratherthanpayingyouthatamountincash.So,byborrowingmoneyfromabank,youalsobecomeoneofitsdepositors.
*Thisspecialkindofconfidencetrickisactuallyusedquiteoftenineconomicmanagement.Anotherprominentexampleistheuseofgovernmentdeficitspendinginarecession.Thegovernmentinitiallyspends‘moneyitdoesnothave’andrunsabudgetdeficit.Butthespendingincreasesdemandintheeconomy,whichstimulatesbusinessandmakesconsumersmoreoptimistic.Ifenoughbusinessmenandconsumersbegintoformpositiveexpectationsforthefutureasaresult,theywillinvestandspendmore.Increasedinvestmentandconsumptionthengeneratehigherincomesandthushighertaxrevenues.Iftaxrevenuesincreasesufficiently,governmentdeficitmaybeeliminated,whichmeansthatthegovernmenthadthemoneythatitspentafterall.
*TheoriginalGM,establishedin1908,producedBuick.Between1908and1909,itacquiredaseriesofcompaniesproducingOldsmobile,Cadillacandotherbrands,aswellaswhatsubsequentlybecameitstruckdivision.ItacquiredChevroletin1918.
†Thismergerdidnotwork–totheextentthatitwasdescribedas‘thebiggestmistakeincorporatehistory’bythecurrentTime-WarnerCEO,JeffBewkes–andwasundone(thisisknownas‘de-merger’)in2009.AOL’sbusinessfailedtogrowaspredictedatthetimeofthemerger(itwasattheheightofthedot.combubble)andtherewereirreconcilabledifferencesbetweenthecorporateculturesofthetwocompanies.
*Thenumbersintheirnamesdenotethenumberofcompanieswhosesharepricesmakeuptheindex.
*Whencommercialbanksdealwithindividuals,takingdepositsfromthemorlendingthemmoneytobuyhousesorcars,theyaresaidtoengagein‘retailbanking’.Whentheydealwithbusinesses–lendingthemmoney,takingdepositsfromthem–theyaresaidtoengagein‘corporatebanking’.
*Eventhoughpeople,includingmyselfelsewhere,havecalledboththeseproducts‘financialderivatives’,itismoreaccuratetoseparatethetwotypesofproductsforreasonsIexplainbelow.
*Thingsgotmorecomplicatedovertime.CDOs-squaredwerecreatedbypoolingtranchesfromCDOsandstructuringtheminthewaydescribedabove.AndthenCDOs-cubedwerecreatedbycreatingastructureddebtproductoutoftranchesofCDOs-squared.Evenmorehigh-poweredCDOswerecreated.
*France,whichoftenstylesitselfasacounterpointtoAnglo-Americanfinancecapitalism,hasnotlaggedfarbehindtheUKinthisrespect–theratioofitsfinancialassetstoGDPisonlymarginallylowerthanthatoftheUK.
*Summers,aprofessorofeconomicsonleavefromHarvardandaformerchiefeconomistoftheWorldBank(1991–3),subsequentlybecametheTreasurysecretary(July1999–January2001)duringBillClinton’ssecondpresidencyandthenwasthedirectoroftheNationalEconomicCouncil(January2009–December2010)duringBarackObama’sfirstterm.
*Afewyearsago,ProfessorDavidKing,theeminentCambridgechemistandthechiefscientificadvisortotheBritishgovernmentbetween2000and2007,toldmethatprobably60percentofhisformerPhDstudentsareworkinginthefinancialindustry.
*Ethicalargumentsagainstinequalityincludethefollowing:ahighdegreeofinequalityismorallyunacceptablebecausealargepartofwhatyouearnisdowntoluck(e.g.,towhichparentsyouwereborn)ratherthana‘justdesert’(e.g.,effortsyouhavemade);agroupwithtoomanydiscrepanciesbetweenitsmemberscannotfunctionasatruecommunity;toomuchinequalityunderminesdemocracybyallowingtherichtoexercisedisproportionatepoliticalinfluence.
*Anotherdefinitionoftheterm,popularizedbytheAmericanpoliticalscientistRobertPutnam,referstothecollectionofsocialbondsamongthemembersofasociety.
*Toseethispointmoreclearly,doalittlethoughtexperiment.Supposethatyouaretoldthatscientistshaveidentifiedfifty-fiveplanetswithsentientbeingswithinourgalaxythatareallvastlyricherthantheearthandalsohavehugeincomegapsbetweenthemselves,givingaveryhighgalacticGinicoefficient.Wouldyoubeterriblyupsetaboutit?Probablynot–becauseyoudon’treallyknowthosebeingsandcannotevenimaginehowtheylive.
*TherebyreducingitsGinicoefficienttoo,asitwillbeaperfectlyequalsociety–ofoneperson.
*Povertyrateswere6.4percentinIceland,7.2percentinLuxembourgand7.3percentinFinland.Theywere17.4percentintheUS,16.0percentinJapanand15.4percentinSpain.
*ThetermhasbecomefamousineconomicsthankstoTheTheoryoftheLeisureClassbyThorsteinVeblen(whomwemetinChapter4),asavagecritiqueofwhathecalledconspicuousconsumption(consumptiontoshowoffone’swealth,ratherthanforthepleasureofit).
*TheILOdefineschildlabouraschildrenundertheageoffifteen(ortwelve,forsomejobs)doingjobsthathampertheirphysicaldevelopmentandeducation,therebyexcludingcasessuchaschildrenhelpingwithdomesticchoresordoingpaperrounds.
*Thispointisdiscussedinthe‘Unrealisticindividuals,over-acceptanceofthestatusquoandneglectofproduction:limitationsoftheNeoclassicalschool’sectioninChapter4.
*TheKeynesiantheorysaysthatatthatpointthegovernmentshouldtightenitsfiscalandmonetarypolicies,lesttheeconomyoverheatsandgeneratestoomuchinflation.
*Manypeopleusetheterm‘thestate’assomethingbroaderthan‘thegovernment’andsomethingakinto‘thecountry’.Thisdistinctionhasgoodphilosophicalandpoliticaljustifications.But,forthepurposeofthisbook,thetwotermscanbeusedinterchangeably.
*Whenafirmhasmarketpower,theprofit-maximizinglevelofoutputislowerthanthesociallyoptimalone,whichiswherethemaximumpricethataconsumeriswillingtopayisthesameastheminimumpricethattheproducerrequiresinordernottolosemoney.Whentheamountproducedislessthanthesociallyoptimalquantity,itmeansnotservingsomeconsumerswhoareperfectlywillingtopaymorethantheminimumpricethattheproducerrequiresbutwhoareunwillingtobearthepriceatwhichthefirmcanmaximizeitsprofit.Theunfulfilleddesireofthoseneglectedconsumersistheallocativedeadweightloss,whichisthesocialcostofmonopolyandoligopoly.
*Costshereinclude‘normalreturn’,namely,thereturnthatthefirm’sownerswouldhavegotfrominvestinginothernon-monopolyindustries.
*ThisiswhatImeantwhenIdeclaredthat‘thereisnosuchthingasafreemarket’inthefirstchapter(Thing1)ofmybook,23ThingsTheyDon’tTellYouaboutCapitalism.
†Thisreferstothetradingofsharesofpubliclylistedcorporationsbyindividualswhohaveexclusiveaccesstointernalinformationaboutthosecorporations.
*ExceptionsincludeMyanmar(10percent)atthelowerendandMongoliaandBurundiatthehigherend(over40percent).
*SomeofyoumayrememberthatDrEvilinAustinPowersmoviesplanshisworldtakeoverintheStarbucksTowerinSeattle.
*Thefgureswere9.4percentfortheUK,7.8percentforChina,4.7percentforFrance,3.5percentforGermany†Theybothproduced4.4percentofworldGDPduringthisperiod.
*Butnotethatultimatelymostcitizenspayforpartsofthecostsofsuchservicesthroughtaxes.
