So the badge of contemporary economic expertise lies with those recognising extreme capitalism as the cause of the current economic crisis. Political figures, media commentators, and theologians concur that "extreme capitalism" must be addressed. The problem is that "extreme capitalism" is just a meaningless slogan without definition or meaning in formal economics. Such economic sloganism identifies how debased the current economic commentary has become. It is becoming increasingly clear that the slogan brigade is out if its depth. The current crisis is about fundamental economic philosophy and theory.
1980's structural reform was based upon 19th century economic philosophy modernised in the 1950's by Milton Friedman. Political scientists mistakenly attribute contemporary orthodox economics to Hayek. While Hayek is undoubtedly the darling of the far right free market brigade, it is Friedman whose modern monetarism pervades western economic policy. The Australian Reserve Bank and Australian Treasury accepted Friedman's theories in the mid 1970's. Independent central banks, inflationary expectations, natural rate of unemployment and inflation targeting policies are identifying characteristics of modern monetarism.
Led by the outgoing President Bush, the G20 and Lima Conference reaffirmed more of same. As modern monetarists assume a full employment stable real sector, monetary policy is anointed as the major policy arm. Fiscal policy is relegated to dividing the economic cake among contending sectoral interests. Consequently, free markets and free trade become critical to world growth and prosperity; and protectionism must be resisted at all costs. After all President Bush claimed protectionism caused the Great Depression.
The truth is that periodic economic depressions are recorded persistently in annals of economic literature. Six economic depressions are recorded between 1815 and 1866. Between 1876 and 1938 seven more occurred. Periodically through the history of capitalism depressions and wars have been the "cleansing mechanisms" through which excesses of the system are sorted and a more stable system restored. Historically, periodic failure of free market capitalism lies in economic philosophy based upon three 18th and 19th century theories: Adam Smith's invisible hand, Ricardo's comparative advantage; and Jean Baptiste Say's Law of Markets.
Adam Smith's Wealth of Nations published in 1776 is the accepted bible of orthodox economists, captains of industry, and media presenters. Smith's invisible hand became the standard bearer for 1980's structural reformist demanding removal of market impediments and government intervention. Welded onto the invisible hand is the 19th century Liberalism demand for small government and balanced budgets.
Say's Law of Markets (1803) claims that supply creates its own demand. Production provides income for producers who expend their income to purchase output from other producers. This 19th century theory of supply and demand still underwrites contemporary orthodox economics and general equilibrium modelling. An identifying contemporary restatement of Say's Law of markets is the assumption that all markets clear delivering a normal profit in the process. Contemporary supply side economics is postulated upon Say's 1803 Law.
Contemporary emphasis on training is also a reaffirmation of the Law. The training solution implies that a suitably trained work force will create demand for the output of appropriate training programs. This flawed theory of supply and demand goes a long way to explain the inability of contemporary economic modelling to produce accurate forecasts at a time when most needed. The reality is that in times like now markets fail while others become distorted and malfunction.
In 1933, Professor Pigou implied Say's Law in his Theory of Unemployment when he argued that purely competitive markets would adjust wage rates to meet demand and ensure full employment. In an earlier work Industrial Fluctuations, 1927, Pigou accepted that while purely competitive markets did not exist in the real world, flexible markets, a realistic alternative, would permanently abolish unemployment. While Pigou endorsed Say's Law of Markets he also inferred Smiths invisible hand.
On both sides of Australian politics, contemporary industrial relations policy embraces Professor Pigou's theory of unemployment. The real world criticism of flexible labour markets is the distribution of income. In the USA, inequality of income distribution is recognised in economic literature as a significant contributor to the Great Depression. Over time, growing inequality of income distribution becomes a serious economic policy issue. The 1980's structural reformists attempted to overcome the issue with the adoption of the social wage. Contemporary research on poverty in Australia confirms that the social wage is not the answer to income distribution emanating from flexible wage models of the labour market.
David Ricardo's foot print remains indelibly imprinted in contemporary orthodox economics. Ricardo, 1782-1823, is most famous for his theory of comparative advantage in international trade. To this day, Ricardo's theory of comparative advantage is embedded in the framework of the WTO. Adherence to the theory of comparative advantage can be read on the web site of the WTO. To uphold Ricardo's theory of comparative advantage, international trade is modelled with two commodities traded between two countries possessing different resource endowments.
John Maynard Keynes turned his back on classical economic theory in which he had been both a practitioner and university lecturer. He was particularly scathing on Say's Law of Markets. He argued that Say's theory of supply and demand confused a plausible proposition with an indubitable proposition. Say's theory assumed that supply costs of output would always equal the sale proceeds of demand. Keynes rejected this as a fallacious proposition and said that supply cost of production would not always equal the value of output demanded. Keynes pointed out the obvious that costs of production are not necessarily covered by the value of output sold.
Keynes criticised the assumption that costs of production would always be met by the sale proceeds of demand as an axiom of parallels. Once Say's law is accepted, then all the other shibboleths follow: social advantage of private and public thrift; orthodox theory of the rate of interest; classical theory of unemployment; the quantity theory of money; and unqualified advantages of free trade. The axiom of parallels identified in Keyne's 1936 work has as much relevance in explaining contemporary orthodox economic policy failure as it did back in the Great Depression. The current debate over the importance of the budget surplus is direct confirmation of the virtue of public thrift; and hence 1803 economics.
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