Extreme capitalism

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.

Keynes delivered some other telling weaknesses in economic theory. He raised the moral question of income distribution that had become forgotten in neoclassical mathematical economic models. In 1936 Keynes rejected Ricardo's theory of comparative advantage on the grounds that his theories ignored aggregate demand. In the real world of massive unemployment, the economic philosophies (monetarism, classical, and neoclassical) of the time were unable to explain let alone offer solution to mass unemployment.

A most interesting point in the current debate is that 78 years after the Great Depression, protectionism is blamed for that crisis. Meanwhile John Maynard Keynes working professionally through that era pointed to the inability of 18th and 19th century theories to explain and correct the Great Depression. Moreover, economic literature records events causing the Great Depression in the USA as: mal-distribution of income; industrial weakness, farm weakness; and finally financial speculation. The attempt by contemporary economic gurus, media commentators and major political parties to re-write history is objectionable to anyone who has read a little historic economic literature.

The role of protection can be understood by reading The Australian Tariff: an Economic Enquiry, 1929.This historic document is better known as the Brigden Report. Historically, protection was a carry over from the ravages of World War I. World industrial production boomed in the post war period. By the mid 1920's a slump had begun. Widespread dumping of excess production took place. Australia became a prime target of world wide dumping. As a consequence prices collapsed for traded goods. As Australia had engaged in substantial overseas borrowing, exports could no longer meet interest and redemption on debt. The only solution available was to restrict imports. To this day, advanced nations retain anti dumping legislation to protect domestic industries from predatory international dumping. This historic side of the story is never mentioned by anti protectionist movements.

So far international economic policy response has been modern monetarist. Well into 2008, the Australian RBA and ECB were telling the world that inflation was the problem and interest rates must be used to dampen inflationary expectations. In contrary moves, the US and European countries have injected large sums of money to contain financial dislocation and stabilise credit flows. Every day brings another crisis or threat of crisis despite lower and lower world interest rates.

Some token fiscal stimulus has been offered in major economies. The recent G20 has encouraged greater use of fiscal policy. The Australian fiscal package is representative of international efforts on the fiscal front. It was an ill-conceived strategy constrained by modern orthodox economic shibboleths.

Current fiscal stimulus has been supply side economics (Say's Law). Tax cuts used to bolster low income expenditure is simply subsidising consumer income that is expected to be spent to create income for producers of wanted products. The first home buyer subsidy infers that savings drive investment which again complies with Say's Law of Markets. Appropriate fiscal policy needs to break out of the orthodox straight jacket of supply side theory to address aggregate demand deficiencies stabilise employment, and contain unemployment.

Fiscal policy instruments comprise a broad spectrum of government expenditure across:

• current expenditure on goods and services;
• capital expenditure on buildings and construction by both public enterprises and public authorities;
• capital expenditure on machinery, equipment, technology by public enterprises and public authorities;
• gross operating surpluses of public owned enterprises;
• cash benefits to persons ( transfer payments);
• personal income tax rates; and
• Commonwealth Indirect tax rates

So far the only fiscal instrument used has been cash transfers to persons. This has been politically marketed as tax cuts. In fiscal stimulus terms, one-off cash transfers to persons can deliver only a one-off impulse to the economy. The strength of the impulse will depend upon the final multiplier or flow on effects which will depend upon whether or not the money is spent on domestic or foreign goods, saved, or used to extinguish debt. Current expenditure on goods and service should be reviewed to ensure Australian made products are purchased where ever possible.

If things worsen infrastructure will become the fiscal instrument focus. If the infrastructure fund is used to vet and select efficient infrastructure expenditure, there is a real danger of repeating the error of the 1980's known as 45 degree Keynesianism. This phenomenon implied that large scale infrastructure in urban or major regional areas would have multiplier or flow on effects for the wider economy. That was a fallacious assumption and hence the contemptuous name of 45 degree Keynesianism.

Rather than a one-off cash transfer to persons, sound ongoing anti recession policy should look to reduce income tax rates and GST rates. The superannuation levy should be lowered. These measures would support ongoing consumption expenditure; and, generate a positive ongoing fiscal impulse to aggregate demand. Capital expenditure programs and rearrangement of existing programs need to be planned and implemented to ensure investment expenditure will deliver orders on order books of firms. This will support employment and employment growth.

The rise of the quasi-intellectual economist post 1980's structural reform is now a liability in formulating necessary policy responses to what is in store. Unless there is some marked change in economic philosophy, pending economic dislocation will be compounded by flawed orthodox economics. Even Alan Greenspan has had the grace to publicly admit that the economic philosophy he followed for 40 years has proven flawed (modern monetarism). It is time post 1980's media, political, and industry commentators also admitted this and recognise that fluent command of slogans is inadequate to what is now required.