Changing Economics

A retrospective of this year’s postings would highlight some of the flaws in accepted economic theory. Many have been flagged up elsewhere: economic theory is not, and never has been, without its severe and knowledgeable critics. However, there are a couple of errors which are fundamental to the study of economics which are not often mentioned elsewhere.

The first of these is the basic mistake of making the market the focus of study, as opposed to the firm or enterprise. Adam Smith opened Wealth of Nations with an explanation of the economic gains to be achieved from the division of labour, using his famous pin factory to illustrate his argument. The market was acknowledged as a limiting factor on those gains. Later economists failed to accommodate the firm, focusing attention instead on the market, but it is the firm which generates economic growth. The market merely facilitates.

The second error not widely referred to is maximisation. The idea resulted from the use of differential calculus to model economic activity. Whilst totally unrealistic, the use of advanced mathematics seemed to add to the credibility of theoretical economics as a ‘science’. Smith had recognised self-interest as the driving force for his butcher, baker etc. Their self-interested aim was to make a decent living for themselves and their dependents. But they recognised, as did Smith himself, that their self-interest was served by developing long lasting relationships with customers and suppliers. It was not consistent with maximising the benefit from individual transactions, which was all calculus based models could do, thereby focusing entirely on short term / immediate outcomes. The adoption of maximisation is surely one of the greatest errors in economic theory, yet completely unacknowledged. Some seek a way round the problem by talking about long term maximisation, but it is only talk. There is no coherent quantitative model of long term maximisation.

Other errors are more widely referred to elsewhere. For example, granting capital precedence over all other factors of production, or the agency lie claiming company directors as merely the agents of shareholders, or the adoption of economic growth as the sole criterion by which economic success is to be measured, or even just the idea of short term self-interest maximising economic man. All these and many others, are widely referred to elsewhere. They are all important errors in the subject matter of economics and all either explicit or implicit in the current free market fundamentalist orthodoxy.

There is a growing discontent with that ideology. The gains in economic growth that could result from the further freeing of markets is clearly much diminished. Deregulation of post mature markets, such as Britain and the United States, encourages entry of newly developing economies and is beginning to create an industrial wasteland with most probably permanent mass unemployment at a national level. Also the primacy granted to ownership results in dysfunctional levels of inequality.

Change is almost certain to happen. Some new protections are inevitable. Some additional regulation is highly desirable. Some reduction of inequalities are likely to be demanded. And when those changes have started to take effect, the ‘madmen in authority’ (to quote Keynes) may start to loosen their grip on free market fundamentalism. Then, and only then, will alternative approaches to economic theory, such as sustainability economics, be seriously considered. As they will be on this site in 2011.

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