Impulses from outside operate upon the economy, causing it to move in a wavelike manner, just as an external shock will set a pendulum swinging. Ragnar Frisch, 1947
It was interesting to have the Agforce President identify their drought policy model as based upon business cycle behaviour (Queensland Country Life; 25th, July). In 1964, Galbraith commented “nothing in the history of social ideas is more interesting than the treatment of the so-called business cycle”. Whilst prices, wages, rents, and interest were all affected by depressions, early research into severe economic fluctuations emanating from depressions were studied on the assumption that such dislocations did not happen (Galbraith, P. 44). The drought policy comment by Agforce dates contemporary industry economics consistent with Galbraith’s description of early economic thought which assumed that severe dislocations did not exist over the business cycle
By 1934, Joseph Schumpeter and Wesley Mitchell had written that the business cycle contained a self-correcting normal rhythm which should be left to itself to do its work. Policy intervention was considered unsound as the natural work of the recession remained incomplete. Counter cyclical policy intervention would therefore produce a maladjustment of its own. Given protracted drought dislocation evident across rural and regional communities, it would be very interesting to hear peak industry bodies explain why protracted drought should be considered a rhythmical self- adjusting phenomenon.
By the 1950’s, business cycle theory had moved beyond the rhythmical explanation to embrace an assumed pathological condition within an industrialized economy which triggered the cyclical shape of the business cycle curve. Such a pathological condition could be cured only by structural reforms to the economic system. Given the structural reform of the rural sector post 1983, modern proponents of business cycle theory need to explain the Millennium Drought and the current drought unfolding.
Since the 1980’s, the New Classical School has revived interest in business cycle theory. The New Classical School assert that fluctuations in economic activity such as employment and production can be explained by applying microeconomic model assumptions to failed macroeconomic classical business cycle theory. The relevant microeconomic assumption is that all markets clear in the short run. This of course is a modern restatement of the 1803 supply and demand theory, Say’s Law of Markets, more commonly known as supply creates demand. This simple modification of traditional business cycle theory by the new classical school is known as the Theory of Real Business Cycles.
The real business cycle model is a neoclassical general equilibrium self- adjusting model. One cause of fluctuations in employment and production in New Classical Real Business Cycle theory can be technological shocks which extended can include bad weather. The bad weather extension allows the real business cycle model to be applied to drought policy. By inference, modern drought policy and more generally rural policy can be now identified with the new classical school and real business cycles theory.
John Maynard Keynes had this to say about the old classical school.
Our criticisms of the accepted classical theory of economics has consisted not so much in finding logical flaws in its analysis as in pointing out that its tacit assumptions are seldom or never satisfied, with the result that it cannot solve the economic problems of the actual world. Keynes, General Theory Money, Interest and Employment p.378
Assumptions of modern real business cycle theory
- A single commodity economy
- Flexible prices and wages
- Money supply and price level do not influence real variables such as output and employment
- Fluctuations in employment are purely voluntary
- Fixed population and labour force
- All economic agents are rational decision makers
When applied to the modern New Classical real business cycle theory, Keynes’ criticisms that the underlying assumptions of the old classical theory are unrealistic would appear as valid today as they were back in 1936.
A business cycle explanation of drought would appear more an assertion than a feature of the real world. Business cycle drought policy then meets Galbraith’s definition of the conventional wisdom. A primary requirement for understanding contemporary economic and social life depends upon a clear relationship between events and ideas which interpret them. Ideas become consolidated around what the community or particular groups find reasonable. In terms of social acceptability, familiarity becomes the critical test. Consequently, familiarity generates stability of those ideas. Galbraith consolidates this process into the term conventional wisdom. The test for the conventional wisdom becomes the unfolding of real world events. Protracted drought then becomes the real test for the conventional wisdom that drought is part of a self-adjusting business cycle.
In the real world, it is important for policy to determine whether protracted drought is endogenous or exogenous to the economic system. If drought is endogenous to the economic system, then it can be explained as an externality. In economic literature, an externality is defined as impacts upon an independent third party of a market transaction by two unrelated market participants. Drought then becomes explainable as the negative impact upon the rural production system of a market transaction somewhere in the non-rural sector. As the solution to an externality is to internalise the phenomena into a market, discretionary policy seeks to structure a market for drought. Consequently, protracted drought challenges the conventional wisdom that it is a business cycle phenomenon. Drought then becomes an unpredictable event determined outside the economic system. In other words, drought is exogenous to the economic system. Fiscal policy then becomes necessary to address drought.
In post graduate fiscal studies, an important function of fiscal policy is smoothing fluctuations over the business cycle. Counter cyclical fiscal policy therefore is directed to stabilising production, employment, investment, income distribution, and maintaining living standards as the economy moves through the business cycle. Consequently, countercyclical fiscal policy directed to drought policy would focus upon stabilising regional economies to support employment, production, and income distribution as drought manifests itself across affected regions. It is time rural industry leaders realised that flawed business cycle theory is conventional wisdom substituted for sound economics.
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