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Dr. Vladimir A. Masch Headshot

The Rest of the (Economic) Story

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International trade probably is the worst part of the economic theory. But the theoretical validity of the rest of economics is not much better. Wherever one throws a stone, one hits a cemetery of dead bodies. It seems that, regarding its applicability to serious real-world problems, not a single tenet of that abstract theory can withstand the joint attack of common sense and uncertainty. I will provide here only a few arguments -- I hope, cogent.

A. Let us start with the very direction of the discipline. When a worker has a job to do, his main concern is how to meet the overall goal of the operation. His tools surely should be appropriate and efficient, but what tools to use, and what "efficiency" means for this specific job, are subordinate issues, wholly determined by that goal. What matters is how well the job is executed. Perfection of tools is a derivative feature, defined by quality of the job they can provide.

Economy is a part of society. Market is a tool of economy, a part of a part of society. Efficiency of that tool is a subordinate issue, wholly determined by the primary goal of society. In general, market efficiency, or market equilibrium, should not be one of the central issues of economics. If its efficiency does not contribute to meeting that goal (for instance, if the market does not take into account proper externalities), it is not perfect.

As pointed out in my first blog ("In the Century of 'Black Swans'..."), at some stage of societal development the economy played a leading role, and market efficiency was of paramount importance. Those idyllic times ended at least one-hundred years ago, leaving some economic Rip van Winkles behind.

B. Adam Smith praised individualistic self-interest, but he was a highly moral man, and his "invisible hand" was to direct it for the benefit of society. What is that benefit? Like every living organism, a society has a goal -- long-term sustainable survival in an acceptable state.

Even if they lead to an equilibrium (which is extremely doubtful), cumulative decisions of all economic actors, both producers and consumers of goods and services, do not lead to such a goal. At best, market equilibrium might provide increased or cheaper consumption. But not by bread alone ...

C. Moreover, Smith took as a given that people are "natural bargainers and restless self-improvers, eager to be productive when productivity contributes to their well-being," that "a natural human philosophy is geared to ceaseless economic activity" (Joyce Appleby, Relentless Revolution. A History of Capitalism). A historian Appleby shows that such an attitude could come only with arrival of capitalism. A philosopher and economist Max Weber gave a better definition of human nature: "A man does not by nature wish to earn more and more money, but simply to live as he is accustomed to live and to earn as much as is necessary for that purpose."

That definition corresponds to both Maslow's hierarchy of human needs and to the conclusion of many psychologists that man is a social animal, a Homo Empathicus, whose primary drive is the search to belong (Jeremy Rifkin, The Emphatic Civilization). In this interpretation, the traditional societies that still reject the capitalistic culture are the norm, while capitalism is an unnatural perversion. Capitalism creates perverts, and professors of economics teach the youngsters to become better perverts. Capitalism is productive but destructive; it destroys families, communities, and societies even when it is productive. But, given enough followers, enough of "more, more, more" ideology, enough resources, and good technology (including computers), it can destroy anything, including its own productivity. The sky is the limit. The present crisis may give some credence to this outlook, and we still are far away from being out of woods.

The economic model of limitless growth contradicts the laws of Nature. It does not take externalities into account. Like everything else, the carrying capacity of Planet Earth is limited.

D. "Mainstream" economics has "rational expectations" about the future. In these very interesting times of the 21st century, the era of serial wars, geopolitical turmoil, the possible use by terrorists of weapons of mass destruction, crucial deterioration of ecology, and unceasing economic crises! If these expectations are "rational," what is "loony"?

E. Economics defines the well-being of a person by his consumption. But people cannot consume without an income, most often -- jobs. (Russians have even condensed the whole Marxist dogma into a one-liner: "He who does not work, does not drink.") Why at least having an income (not to speak of other items on lower rungs of the Maslow's pyramid of basic needs, such as safety) is not included in the list of components of well-being?

The danger of the present approach is that the "consumption only" view presupposes non-crisis conditions, when both income and safety are fully provided. But that is exactly how we get into crisis -- by relying on a paradigm that denies the very possibility of a crisis!

F. Individual economic actors, both producers and consumers of goods and services, do not want to take negative externalities into account; they want to use common goods for free. Therefore the "invisible hand" of a laissez-faire market, or a combined effect of individual decision models, never leads to even a short-term optimum, no matter how defined -- neither at the level of the whole economy, nor at the level of society. (It was acceptable as an approximation only long ago, when externalities were negligible.)

G. A Stanford economist Tibor de Scitovsky, a brilliant wasp mentioned in the previous blog (about comparative advantage), who spoiled quite a few economic garden parties, pointed out in 1954 that not one but two "invisible hands" are needed: one for the current production and one for developing the new production capacity to satisfy the future demand. (Let us hope, not two left hands.) Basically, an individual producer needs information about the future of not only his industry, but also all related industry sectors. But neither these individual producers, nor the market as a whole, know anything about the future, especially on a grand scale needed. A very substantial part of the presumed market's advantage disappears. Dispersed knowledge, idolized by Hayek, becomes a disadvantage. (De Scitovsky was not a communist, an advocate of planned economy: he was a scion of an elite Hungarian family and, during WWII, was a member of OSS.)

H. Each company has three main stakeholders: its providers of capital, its employees, and its sector of industry (from its suppliers to its final consumers). How then dare economists to throw out the last two stakeholders, leaving only profit on capital as a sole purpose of company's activities? In a complex society any single-factor theory of value, such as the labor theory of value (Marx), is to be a failure, and replacing labor by capital (Milton Friedman) does not improve its validity.

I. And how dare economists equate liquid shareholders (really, short-term speculators) with illiquid long-term investors?

Even "Neutron Jack" Welch, one of the founders and champions of that idea, recently denied any complicity and called the shareholder value "the dumbest idea in the world." He added, "Your main constituencies are your employees, your customers and your products."

No doubt that Jeffrey Immelt fully concurs. But two questions arise. First, why hasn't GE stopped its practice of firing each year 10 percent of its non-union worst-performing employees -- worst-performing by the standard of short-term profit, too? Second, what might be the collective opinion of those "your employees," fired by GE during all these years?

J. The maximization approach of economics is valid only if we know the future, at least probabilistically. But we do not. Under radical uncertainty, to be omnipresent in this century, maximization turns into extremization, which is very risky: it always gets us out on a limb, most likely in a wrong direction, and as a rule too far.

K. Economics is wrong in describing human (or organizational) behavior as "maximizing." Even if self-interest is indeed the prime mover of behavior, maximization is not tantamount to self-interest: it is possible only with a single one-dimensional goal. In human society, pursuing such a goal is considered an abnormal behavior of a psychopath, an obsession, monomania, paranoia. In accordance with both evolution theory and psychology (the Maslow's hierarchy of needs), rational behavior of both people and animals can usually be characterized as self-preservation ("catastrophe avoidance"), rather than maximal satisfaction of their needs and wants.

* * *

In my first blog I provided a short summation, which contained some unsupported declarations. (It really was just a condensed Preview of the subsequent argumentation.) The present blog, together with the previous one, begins providing that argumentation.

Let me repeat that summation; it is very important. The overall direction of "mainstream" economics brings us back up to 200 years in social progress. Its yearning for autonomous economy, for which its primitive abstractions may be acceptable, is late by at least one hundred years. Its philosophy is asocial, individualistic self-interested per se, rather as a means of serving the society. It in effect denies the very existence of radical uncertainty, and its current skills of dealing with it are, at best, at a kindergarten level. The discipline is able to address only wrong issues (short-term, "rearranging the chairs on the deck of the Titanic," instead of the crucially important long-term problems of survival, presently facing mankind) and therefore gets wrong answers. It does not take into account externalities and ecological limits. Its major assumptions are mostly non-realistic, too often absurd. Moreover, it cannot predict or decide correctly, too, thus not being able to justify by good results its using wrong assumptions. Its tools (maximization models) are wrong, primitive, and absolutely inadequate.

Not a single component of the discipline is good, and their aggregating brings no benefits. To the contrary, maximization tends to aggravate the errors.

This is a dangerous combination. We can only wait -- what blows up next, what "black swan" (an unexpected disastrous scenario) comes into existence. The present economic condition of the global, American, and European economy results from one of them.

* * *

Four comments. First, in the last blog there seems to be an error in defining baseball specialties of Babe Ruth. The error, if any, is all mine, not Krugman's.

Second, several times I disapprovingly quoted there the work of Paul Samuelson. But the remarks really referred not to him as a father of an abstract theory, but to the "mainstream" attempts to justify, by this Never-Never theory, the policies that -- in this sinful real world -- are infinitely dangerous.

Samuelson has been chosen only because he is a classic. I deeply respect his work. His textbooks "Qualifications" may indeed had been lately curtailed, but many other textbooks never had even the curtailed ones. He certainly did not want to rock the boat of the (abstract) discipline he largely founded, but -- within these limitations -- he tried to be as scrupulous as possible. For those who cannot read between lines, he explicitly warned that "When the economy is in depression or the price system malfunctions, we cannot be sure that countries will gain from trade or that the theory of comparative advantage will hold in every case."

Larry Summers probably is one of the main architects of our disastrous trade policy with China, but even he has recently quoted Samuelson that if your trading partner misbehaves, do not turn the other cheek: respond in kind. (That's the advantage of having a classic -- one can find in his work both "pro" and "con" quotations on any relevant issue.)

Third, David Ricardo contradicts Adam Smith only under conditions of the 20th and 21st centuries. At his time, workers specialization and social costs were negligible. When conditions changed, economists forgot to change the assumptions.

Besides, Ricardo never claimed universal applicability, or honorific name of "law," for his specific example of trade "wine vs. wool." Both occurred much later. He is not responsible for behavior of his quasi-followers.

Fourth, I am not an enemy of capitalism. To the contrary, like Keynes, I want to save it, as far as it is possible. Of course, not at his exalted level. Talk about that later, alligator.