The set of economic ideas that have dominated politics for the past 40 years are rapidly losing legitimacy in the face of multiple crises, and the idea of economics as a ‘value free’ science is starting to fade. So, do we need an economic revolution? NEF Fellow and economist Laurie Macfarlane looks back at the past 40 years and explores how we can change the rules and put power at the heart of economics.
Laurie Macfarlane in a fellow at the New Economics Foundation. He is also Economics Editor at openDemocracy and Head of Finance at the UCL Institute for Innovation and Public Purpose.
Cross-posted for the New Economics Foundation
John Maynard Keynes famously said: “Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.”
For the past 40 years, we have all been the slaves of a not-yet-defunct set of economic ideas. These ideas have shaped the way that people think about the economy, and had a powerful effect on politics and government policy.
The Global Financial Crisis of 2007/08 provided a much-needed wake up call. But despite some limited progress, our lives, our classrooms and our politics remain gripped by a set of ideas and orthodoxies that are well past their sell-by date.
Ideology masquerading as science
How the production of goods and services should be organised is one of the most basic questions of economics. According to modern economic theory, goods and services are most efficiently produced by private firms operating in a competitive market. Businesses are hailed as the ‘wealth creators’ that drive innovation and technological progress. Because the state has neither the knowledge nor the expertise to allocate resources better than the market, it should avoid pursuing policies that try to ‘pick winners’ or ‘distort’ market competition. Instead, the state should only act to ‘level the playing field’ or to correct certain identifiable ‘market failures’.
The collapse of the Soviet Union and other communist regimes only served to confirm the supremacy of markets over economic planning. Wherever governments have tried to plan the allocation of resources, the result has been disastrous. In contrast, wherever governments have got out of the way, stopped intervening everywhere and let markets run their natural course, people have flourished. Or so the story goes.
There are many problems with this narrative, but one that is often overlooked is the extent to which capitalist economies are also planned. Despite their pervasiveness, markets are not spontaneous laws of nature; they are, to a large extent, creatures of the state. Throughout history, capitalist markets have been created and sustained through mass, often violent, state intervention. As Karl Polanyi put it: “The road to the free market was opened and kept open by an enormous increase in continuous, centrally organized and controlled interventionism.”
Markets are underpinned by property rights, which are defined and enforced by the state. They are further shaped by company law, intellectual property law, employment law, taxation, regulation, the decisions of central banks and so on – and are administered through the use of courts, regulators and various other public bodies. The outcomes we observe in market economies, from the prices of goods and services to the distribution of income and wealth, are a direct product of how this institutional apparatus is constructed. In other words, the invisible hand of the market is directed by an iron fist.
Given that markets themselves are government interventions, there can never be a ‘level playing field’ in any meaningful sense. The institutional apparatus underpinning markets always favours certain outcomes over others, and ensures that social arrangements stay within set parameters.
The presentation of market institutional arrangements as a natural order that shouldn’t be ‘intervened in’ unless strict criteria are met has been a remarkably powerful rhetorical tool. But in reality it is little more than ideology masquerading as science. The rules matter, and the choices around these rules are inherently political.
At a time when governments around the world are facing major social and environmental challenges, simply trying to ‘level the playing field’ will only lock us into our current trajectories. If we are to overcome the key challenges of the 21st century, we need to abandon the myth of the level playing field and instead ‘tilt’ the playing field towards an ambitious set of collective goals: transitioning to an environmentally sustainable economy, eradicating poverty, reducing inequality, improving health and education outcomes, etc. This means using every tool available – legislation, regulation, taxation, property rights, corporate governance, finance – to re-write the rules of the economy to serve different ends.
Markets may well be the best way of organising human affairs in some circumstances. Where this is the case, they should be treated not as self-regulating forces, but as outcomes that can be created, shaped and actively steered towards desired ends. Where markets do not serve any clear public purpose, they should be dismantled. The decisions to abolish the market for slaves and child labour were not made on the basis of some economic law – they were moral decisions. Today we need the same boldness from leaders on everything from fossil fuel companies to the array of socially useless financial instruments.
But markets cannot resolve all the dilemmas faced by modern economies. Throughout history, many of humanity’s greatest achievements have arisen not from profit-oriented competition, but from collective action – whether it is landing on the moon or achieving universal healthcare. And when it comes to the major technological breakthroughs of the past century, most of the heavy lifting has in fact been done by the state. Many of humanity’s boldest advances – from the internet and microchips to biotechnology and nanotechnology – were only made possible by early stage public sector investment. In each of these areas the private sector only enter much later, piggybacking on the technological advances made possible by long-term, high-risk public investment.
But after four decades of neoliberalism, the public sector’s capacity has been drastically hollowed out. Key public functions have been delegated to management consultants and parasitic outsourcing companies, while the application of private sector management techniques to the public sphere has placed civil servants in an administrative straightjacket. If we are to transform our economy on the scale that is required we must urgently rebuild public sector institutions, and increase their capacity to think and act big.
Who gets what and why
How should the wealth created in an economy be distributed among the population? This question has been the subject of considerable debate among economists throughout history. In 1817, the economist David Ricardo described this as “the principal problem in political economy”.
In recent decades, however, this debate has attracted much less attention. That’s because modern economic theory developed an answer to this problem, called ‘marginal productivity theory’. This theory, developed at the end of the 19th century by the American economist John Bates Clark, states that each factor of production is rewarded in line with its contribution to production. Marginal productivity theory describe a world where, so long as there is sufficient competition and free markets, all will receive their just rewards in relation to their true contribution to society. There is, in Milton Friedman’s famous terms, “no such thing as a free lunch”.
The aim was to develop a theory of distribution that was based on scientific ‘natural laws’, free from political or ethical considerations. As Bates Clark wrote in his seminal book, The Distribution of Wealth: “[i]t is the purpose of this work to show that the distribution of income to society is controlled by a natural law, and that this law, if it worked without friction, would give to every agent of production the amount of wealth which that agent creates”.
Marginal productivity theory states that each factor of production will be rewarded in line with its true contribution to production. But although presented as an objective theory of distribution, marginal productivity theory has a strong normative element. It says nothing about the rules and laws that govern the ownership and use of the factors of production, which are essentially political variables
For example, rules that favour capitalists and landlords over workers and tenants, such as repressive trade union legislation and weak tenants’ rights, increase returns on capital and land at the expense of labour. In contrast, rules that favour workers and tenants, such as minimum wage laws and rent controls, reduce returns on capital and land to the benefit of labour.
In reality, the distribution of wealth has little to do with contribution or productivity, and everything to do with politics and power. This is particularly true when viewed in a global context.
Today the main factor determining someone’s standard of living in the world is not what they do, but where they were born. A worker in Malawi will get paid a fraction of a worker in London, even if they perform roughly the same type of labour. Why? Because the worker in London is lucky enough to be born in a powerful country with a legacy of imperialism that has rigged rules of the global economy its favour. In the age of the ‘self-made’ millionaire, the truth is that the lottery of birth is more important than ever.
For economists who see their discipline as a ‘value free’ science governed by laws which are separate from politics, this is uncomfortable territory. But if the aim is to understand the global economy as it really exists, and to change it for the better, we need to put power at the heart of economics. Among other things, this means grappling with the power dynamics that underpin ownership, trade and property relations, as well as those that that drive inequalities between different countries, social groups and identities.
Political economic paradigms do not last forever. In the past century, Western political economy has experienced two major shifts from one paradigm to another: firstly from laissez-faire to the post-war consensus after the Great Depression of the 1930s, and secondly from the post-war consensus to neoliberalism in the 1980s.
Today the set of economic ideas that have dominated politics for the past 40 years are rapidly losing legitimacy in the face of multiple crises: stagnant or falling living standards, sharply rising inequality of income and wealth, financial fragility and environmental breakdown. The need for a new economics has never been more urgent.
Margaret Thatcher famously said that “economics are the method: the object is to change the soul”. That was in 1981. Today we need a similar revolution. But this time, new economics are the method: the object is to change the world.