Dear Hunter,
We’ve worked together for decades, and for all the brickbats coming our way, we’ve made a difference. Those of us who’ve worked in Asia know our efforts made a small contribution to the work which lifted hundreds of millions out of crushing poverty. This remains an ethical victory of world-historic importance.
So why, after decades of extolling the benefits of free markets, am I trying to help the SDP? Am I just defecting from the free-market cause? I don’t think so. Rather, I think fundamental change in how we understand economics cannot be avoided. This letter is to explain why. I hope it may nudge you towards a similar questioning of some fundamental assumptions that I held, and you might also hold.
What you think about these things matters: you do hold abnormal power and influence and with that comes all sort of lovely things. . . but also responsibility.
I was born and brought up in a time and place where even if you weren’t interested in economics, economics was certainly interested in you. For me, that meant my economics education started at the breakfast table from about the age of five. Many Britons of my generation share that, since it was our fate to witness the collapse not only of the British economy in the mid-to-late 1970s, but also a collapse of the prevailing economic model: Keynesian demand-management.
As that decade ground on, repeated attempts to ‘demand-manage’ the economy back to health produced results that got worse and worse. A key lesson, this: the orthodoxy which was utterly dominant was just making things worse.
Into that environment came to me, revelatory and hopeful, the work of Friedrich Hayek. His determination to wrench economics back towards understanding microeconomics and the role of the market was, at the time, deeply subversive and, indeed, dismissed out of hand by my orthodox Keynesian economics teachers.
Despite that disdain, Hayek proclaimed something of profound truth and importance: that competition mattered precisely because the market could uncover information which could be discovered in no other way. True then, and true now, it remains the fundamental challenge to all economic policies which would replace the market by planning.
It was under this banner that the market has triumphed time after time, in country after country. If you believe this, you believe something true.
But around this central Hayekian truth has gathered an ever-growing cluster of ‘neo-classical’ ideas and nostrums. Almost all of these, even the most academically celebrated, have turned out to be flawed. In the beginning, those flaws seemed small, trivial - academic in both senses - considering the overwhelming evidence for the beneficent power of the free market.
The trouble is that eventually they are devastating. Consider the impact of ‘the Cambridge capital controversies’ of the 1950s and 1960s which argued that all attempts to tally a ‘capital stock’ into a useful economic aggregate were doomed to failure. The dirty little secret mouldering at the bottom of most neo-classical arguments, is that ‘the Cambridge capital controversies’ were on to something - it’s an absolutely unsolvable problem. What’s more, Paul Samuelson, considered the founder of the neo-classical school, realizing its potential for damage, set his post-grad researchers the task of disproving it. But they couldn’t, because, of course, those Cambridge economists were actually just right.
Samuelson’s neo-classical response can be summarized: ‘Don’t worry about that. If we ignore it, look what we can do with our graphs and models’. And it’s true, if you ignore the problem, you can help yourself to the full, very pretty, economics of the Solow production function and its derivatives. I have even taught those models in China, the ones showing the ‘Golden Rule’ savings rate, and what it means for the best rate of consumption and investment. It’s a great system, so persuasive. A pity it’s wrong, holed below the waterline because . . . you can’t count capital that way.
Once that simple notion of capital goes, it’s time to start thinking about labour too. In this case, the relevant question is: are wages really determined principally by supply and demand? And here the answer turns out to be ‘no.’ This was shown most clearly by Michal Kalecki, an Polish economist ignored in my (and your) economics education, probably because of his East European communist background (though he ended up in Chicago, naturally). But don’t take my word for it, you can read the Federal Reserve’s acknowledgement that in most circumstances the relative power of labour unions are what determine wages. ‘We show that a nearly 90 percent reduction in inflation volatility is possible even without any changes in monetary policy when the economy transitions from equal shares of power between workers and firms to a new balance in which firms dominate.’
After decades of chanting ‘supply and demand’, that’s quite an admission for the Feds to make. More, it’s an admission which denies free-marketeers the luxury of not thinking about wages and poverty ‘because that’s what the market dictates’.
If Kalecki and the Fed is right, you no longer have that luxury.
Wait a minute, you may say, are you telling me that capital and labour are not actually allocated by the market (interest rates and wages respectively)? OK, smartarse, how are they allocated? At this point, we join those re-discovering another long-ignored economist: the Italian economist Piero Sraffa. Wittgenstein, his friend at Cambridge, rated him the smartest-arsed thinker he’d ever met. Why? Because Sraffa managed to demonstrate from first principles the way capital, labour, pricing and profits could be determined without any crucial intervention of the interest rate. His masterpiece bears the reader-repelling title: ‘The Production of Commodities by Means of Commodities’. A slim but very tough volume, it has been called ‘perhaps the most intriguing work ever published in economic theory.’
I could go on. And of course, I do, elsewhere arguing that economics has such profound and pervasive ontological problems that all too often it is ‘Thinking in Rubbish’.
If you’ve been following my work elsewhere, you’ll know that when you analyse how profits are generated using Kalecki’s fundamental accounting identities, in economies like the UK and US, profits are no longer generated principally by successful investment, but by systemic impoverishment of households and the government. If so, it follows that the current model is, properly understood, unsustainable. And this, too, is visible in the succession of ‘crisis measures’ we’ve been treated to over the last decade.
There’s a closely allied feature which is also hard to ignore: you can hardly miss the degree to which many of our current economic worries are reflected in, and to some extent caused by, the erosion of previously healthy institutions.
This corrosion of our institutions is costly, because things like control of corruption, transparency, accountability, government effectiveness and political stability are the unacknowledged supports and buttresses which allow free markets to work their magic. Because they do this behind the scenes, their value as an input to prosperity only becomes obvious when they actually stop working. But as their health is compromised, so too is economic potential.
I think we have little choice now but to bolster those institutions, and to be willing to address those areas where ‘correct allocation’ has started to generate, not solve, problems. Hayek is right, but his insight cannot be the sole and universal answer to every problem we face today.
Economic models don’t generally take account of these ‘intangibles’, but System Dynamics models of economies do. Like this:
It’s at this point that I threw in the towel. Hayek was right, but so much of what followed was/is wrong, as we are now discovering in our daily life.
We’re right back to where my economic thinking started: the point at which the current orthodoxy is no longer solving problems, but rather directly causing them. Unless we pay attention, we will find the institutions which help a society to cohere and prosper will continue to erode before our eyes, inequalities will harden into unproductive and wasteful caste systems, the household sector - that’s us and our children - will continue to drift towards beggary, the state will rot, and the imploded financial system corrode until its function becomes primarily decorative, not functional.
That’s where we’re headed, unless we as thinkers and actors who are in positions of responsibility are prepared to help do something about it. My determination to promote the SDP was made not out of some wishy-washy sentimental political disposition. I am compelled to it by the failure both academic and practical of so much of the economics I’ve known all these years. The willingness to confront those failures is the urgent task of today, and the SDP is the only political vehicle doing it. I urge you to lend it your support.