A Century of Pseudo-Scientific Analysis, Neo-classical economics
and the 'mystery' of the business cycle
Edward J. Dodson
[Reprinted from
Geophilos, Spring 2003]
A Century of Pseudo-Scientific
Analysis Neo-classical economics and the "mystery" of
the business cycle Ed Dodson MODERN economics relies heavily on
the concept of equilibrium - the point at which the market is
cleared and resources are allocated efficiently.
In practice, economists have difficulty in defining - for the
benefit of policy-makers - the conditions that would deliver
balanced growth. The steady state appears to be unattainable.
Instead, the business cycle continues to disrupt the economy.
In his review of the neo-classical tradition, Ed Dodson traces
the swings in policy in the US as governments experimented with
one hypothesis after another in the search for equilibrium.
As governments struggled with the global downturn of the past
two years, economists were unable to provide a convincing
account of the institutional safeguards that would have
prevented the dot.com bubble - or a strategy for recovery that
would deliver balanced growth. The explanation, suggests the
author, may be in the way neo-classical economics successfully
expunged the role of land in the dynamics of the 20th century
economy.
|
BACK IN 1994 Mason Gaffney and Fred Harrison wrote the hard-hitting
book, The Corruption of Economics, in which they made a strong
case that the field of economics has a history tarnished by the
influence of special interests. They provided historical evidence that
the industrialized world's power brokers underwrote and thereby
controlled the development of economics as a scholarly discipline.
The power-brokers were driven to action by the popular reception
given to the writings and public addresses by Henry George in the last
two decades of the 19th century. The status quo was under serious
attack and had to be defended - not just for the moment but for
generations to come. Gaining control over what was to be taught in the
nation's most influential universities became an essential component
of the process.
The most significant defensive measure achieved by the first
generation of academic economics professors was to remove land
from the economic equation as a factor of production distinct from
goods produced by labor and capital goods. Every generation of
students who studied economics and then went on to teach the subject
to others accepted the new definitions without serious questioning.
Why would they? Their frame of reference was to be found in textbooks
written by professors in the vanguard of the new and modern science of
economics. Mason Gaffney explains that the new approach to economics
began with John Bates Clark, who took it upon himself to go
head-to-head with Henry George in defense of the status quo, and who
was brought to Columbia University with funding provided by J.P.
Morgan. As quickly as possible professors trained as political
economists and accustomed to making moral arguments were replaced by
men schooled in the new economic theories.
By the mid-1920s the influence of Henry George's ideas (and political
economists as a group) had essentially disappeared. Economic collapse
in the 1930s raised new challenges to economic orthodoxy but this came
from individuals who urged the strengthening of public sector
intervention. Harry Gunnison Brown was one of only a small number of
economics professors in the 1920s and 1930s challenging the new
conventional wisdoms. Yet, as Mason Gaffney concludes, "Brown …
tried to reach [neo-classical economists] in their own paradigm, and
became so habituated to it that he had no way to cope with chronic
unemployment."[1] Clearly, there were few, if any,
university-trained economists who grasped how to get the dominoes
falling in the right direction.
The theories economists had to work with in the early part of the
twentieth century fell far short of the task they were faced with. The
nature of the problem was extremely dynamic - market failures brought
about by dysfunctional socio-political arrangements and institutions.
At most, the measures political leaders were prepared to take were
incremental. The tools applied to the problem by economists were
static, imprecise and difficult to interpret:
One of the first groups of widely known economic
indicators was published in 1919 by the Harvard University Committee
on Economic Research under the direction of Warren M. Persons. The
Harvard Index Chart, later known as the Harvard ABC curves,
represented three sectors of the economy. The A curve measured stock
prices, and was interpreted to signal investor speculation. The B
curve measured the dollar volume of checks drawn on bank deposits,
which served as a rough guide of current business activity. The C
curve measured short-term interest rates, which represented the
condition of the money market. The studies of these curves indicated
that they usually moved in sequence: upturns or downturns in stock
prices usually were followed by turns in interest rates. The turns
in interest rates then usually preceded the opposite turns in stock
prices, and the sequence then occurred in the opposite direction.
This system of economic indicators proved widely popular during the
late 1920s and remained in use into the early 1930s. During the
Great Depression, however, the Harvard curves were discarded as a
tool for forecasting the near-future trend of business activity,
because the index allegedly failed to forecast that depression
correctly. It is more probable, however, that the failure was in the
interpretation of the data rather than in the Harvard curves
themselves.[2]
The above assessment is offered by researchers at the American
Institute for Economic Research, analysts outside the mainstream
academic and financial community. This is not to diminish the
importance of the observation but merely to suggest few similar views
are to be found in the economic literature. For example, at a
conference called in 1998 by researchers at the Federal Reserve Bank
of Boston to discuss the origin and nature of business cycles, bank
President, Cathy E. Minehan, made a very important admission:
Our inability to pin down the source of some of the most
important events in economic history seems to me a gaping hole in
the intellectual underpinnings of modern macroeconomics. More
important, can the economic behavior behind shocks be identified, so
that policymakers can anticipate an unsustainable boom, or an
approaching downturn, before it happens rather than after? The
ability to do that obviously relates to our biggest challenge of
late, which has been trying to foresee anything that will upset the
enviable success our economy currently enjoys.[3]
Sadly omitted from the papers presented at this conference and the
discussions surrounding these papers was any recognition that land
markets are an important variable in business cycle analysis. A
primary question conference participants attempted to resolve was
whether the actions of central banks are endogenous or exogenous to
the business cycle. Paul Samuelson opened the discussion by responding
to the question, "Are things different in 'The Age After Keynes'"?:
Eschewing the naïve attribution of this change
solely to Keynes's General Theory, I agree with the innuendo that
changed policy ideology, away from laissez faire and toward
countercyclical macro policy, helps explain the better macro
performance of real GDPs in the final half of the twentieth
century.[4]
The fact that the United States has not suffered the same type of
economic collapse experienced in the 1930s is not very strong evidence
that the application of Keynesian strategies are effective. As the
United States sank deeper and deeper into depression seventy years
ago, analysts struggled to understand what was happening. Statistics
gathered by the National Bureau of Economic Research under Wesley
Mitchell and Arthur Burns were extensively analyzed in the late 1930s
in an effort to explain how the business cycle was operating. Not
until the availability of computer technology in the 1950s, however,
did researchers begin to capture and integrate data in the analysis of
economic trends in ways that were previously impossible.
For a decade and a half, economists seemed to have found the
approximate balance between the use of Keynesian demand management,
taxation policies, trade agreements, and the supply of credit and
currency necessary to keep downturns moderate and expansions more or
less consistent. The promise of the managed economy emerged as a real
possibility. At the same time, the leaders of the United States were
faced with enormous challenges - economic, social and political. As
the economy drifted in and out of a long series of recessions,
economists expressing differing ideas of how markets work and how the
functions of monetary institutions and fiscal policies of government
agencies affect markets began to find growing - and often different --
audiences.
IF GAFFNEY provided the historic basis for the failure of economists
to create a reliable scientific set of tools, the details of the
subsequent failures are captured by the economic journalist Alfred L.
Malabre, Jr. in his own 1994 book, Lost Prophets, published
before his retirement as economics editor of The Wall Street
Journal.
Malabre details the rising influence of economists in the public
policy arena that began with the international attention given to the
anti-depression proposals put forward in Britain by John Maynard
Keynes. Even more significantly, however, was the role Keynes played
in conjunction with Harry Dexter White in the creation of the
post-Second World War international financial institutions. During the
war years, economists in the Roosevelt and Truman administrations were
among the vanguard of policy advisers convinced there was no going
back to laissez-faire practices. Their influence, combined
with the firm commitment by Truman to do all that could be done to
prevent a postwar return to economic instability, set the stage for
passage of The Employment Act of 1946, described by Malabre as "a
victory for the Keynesian view that an entire economy, like the
exchange rates of individual currencies, could be neatly managed over
a prolonged period".[5]
Other economists were less certain, recalling the ineffectiveness of
the Roosevelt New Deal measures. Yet, after a minor recession, the
U.S. economy expanded, taking advantage of the enormous pool of
savings accumulated during the war years. "As for Keynesian
influence, in truth it proved to be a relatively minor factor in the
economy's surprising performance,"[6] observes Malabre. The
United States emerged from the war poised for expansion and with its
infrastructure intact:
With wartime rationing and the outright unavailability
of many goods and services, personal savings were sky-high as the
war ended. At only $719 million in 1938, the savings total reached
$37.3 billion in 1944 before easing to $29.6 billion in 1945 and
then falling sharply to a postwar low of $7.3 billion in 1947. …Meanwhile,
private-sector spending, suppressed during the war, rose apace.
Personal consumption climbed by one-third in five years, after
adjusting for inflation, and business investment jumped nearly
fourfold. Outlays by state and local governments also rose
sharply.[7]
U.S. Presidents now also had the services of the new Council of
Economic Advisors (CEA). The CEA's first chairman, Edward Nourse,
served Truman until 1949, when he was succeeded by a non-economist,
Leon Keyserling. Dwight D. Eisenhower then brought in Arthur Burns in
1953 to lead his CEA. Malabre suggests that one of the things
distinguishing Burns from his predecessors was a good understanding of
the behaviour of business cycles. He quotes Burns from a 1949
memorial, in which Burns cautioned that during times of expansion, "costs
in many lines of activity encroach upon selling prices, money markets
become strained, and numerous investment projects are set aside until
costs of financing seem more favorable; these accumulating stresses …
lead to a recession [until] the realignment of costs and prices,
reduction of inventories, improvement of bank reserves and other
developments … pave the way for a renewed expansion."[8] As
for solutions, Burns remained throughout his career a strong skeptic
of Keynesian demand management. During the 1950s the Keynesian
proposals seemed to Burns to be unnecessary. After all, the strength
of the U.S. economy was still sufficient to absorb the cost of
fighting in Korea while bringing the budget into a surplus by 1960.
THE NEW PRESIDENT, John F. Kennedy, a graduate of Harvard University,
had no training in economics. One of his initial decisions was to
enlist MIT professor Paul Samuelson, a leading Keynesian in the U.S.,
to head an economic task force. Subsequently offered the chairmanship
of the CEA, Samuelson declined. His advice to the new President,
however, was that what the nation needed was increased federal
spending accompanied by targeted tax breaks to stimulate investment in
new plant and equipment.
Shortly before the election, Hubert Humphrey had introduced Kennedy
to another Keynesian, Walter Heller, who was teaching at the
University of Minnesota. Interestingly, Heller "studied under
Harold Groves, an outspoken Keynesian and an expert in the linkages
between various tax policies and overall business activity. Under
Groves, Heller was drawn to study taxation and made this the subject
of his dissertation".[9] Malabre reports that over the next three
years Walter Heller and Paul Samuelson generated hundreds of memoranda
for Kennedy on the economy. Heller concurred with Samuelson's
prescription for economic growth and pushed for greater spending and
tax cuts. Concerned with a resurgence of inflation, Kennedy pushed the
labor unions to restrict the demands for higher wages as a reward for
increased productivity. Pressure was also applied on the major steel
producers not to raise prices.
Another component of Keynesian theory - as redefined by its U.S.
practitioners - was that there was no direct correlation between
federal deficits and inflation. In a 1962 address, Kennedy echoed his
advisers: "Sizable budget surpluses after the war did not prevent
inflation, and persistent deficits for the past several years have not
upset our basic price stability."[10] Malabre reminds the reader
that the country was adjusting from war to peace, to a shift from war
materials production to meeting consumer demand. "Accordingly,"
writes Malabre, "it can be argued that the early postwar price
climb would have been still sharper had not the budget been in surplus
and that the subsequent easing of inflation would have come sooner and
would have been more pronounced had the budget not slipped back into
deficit at the decade's end."[11]
Up to this point, the postwar Presidents were more or less committed
to balancing the budget and keeping the U.S. government debt under
control. We cannot be sure whether a spending deficit or surplus
actually existed, however, because government accounting practices
were (and continue to be) both arcane and politically-influenced. In
an era before computerized accounting systems became the norm, it is
not hard to conclude the margin for error was enormous (perhaps as
enormous as the propensity to mislead the public). Based on an
expectation of stimulating business investment but without an
awareness that the government was on the verge of fighting two wars -
one against generational poverty, the other against communism in
Southeast Asia - the Kennedy tax cuts were implemented. The top
marginal rate on personal incomes was reduced from 91% to 70%, a 7%
investment tax credit was introduced, along with accelerated
depreciation on new plant and equipment. After Lyndon Johnson
succeeded the assassinated Kennedy, he followed with reductions in
excise taxes on a long list of consumer goods. To those who point to
these years as examples of successful Keynesian demand management,
Malabre suggests they need to look more closely at the data:
…such analyses fall short in a number of ways. For
one thing, the long economic expansion that we remember today as the
Soaring Sixties had been under way for almost four years before the
Kennedy tax cuts became law. The record makes it clear that much of
the healthiest growth occurred before - and not after - the cuts
were enacted.[12]
Keynesian influence continued in the Johnson White House under his
own CEA chairman, Gardner Ackley. Malabre suggests "Ackley's
party loyalty in fact may have occasionally clashed with his instincts
as an economist."[13] Keynes argued that government should build
surpluses during periods of economic expansion, then spend these
surpluses to soften downturns. Lyndon Johnson ushered in the art of
continuous debt service management. During 1968 -- Johnson's last year
in the Presidency -- Ackley departed. He was succeeded by Arthur Okun.
A surtax measure urged on Johnson by Ackley was having difficulty
finding sufficient Congressional support. Competition for credit
between the public and private sectors drove up interest rates, as
those who held purchasing power sought returns above the apparent rate
of inflation. Malabre observes that private sector spending on new
plant and equipment came to a virtual standstill. The Keynesians had
only two options - deeper tax cuts and increased government spending.
THE 1960s was also the beginning of a new theoretical interest in and
reliance on monetary policy, initiated at the University of Chicago
under the leadership of Milton Friedman. Friedman arose as a proponent
of steady monetary expansion to match the increased output in goods
and services. By the late 1960s he became an increasingly frequent
critic of the Federal Reserve's inattention to the oscillating "money
supply." At the height of his influence, in 1968, Friedman met
Walter Heller in debate at New York University:
…Heller, who as a Keynesian believed in
considerable governmental intervention in the economy, confessed
that the Chicago professor's concepts seemed wonderful. But unlike
his own prescriptions, Heller went on, Friedman's would surely work
only in heaven. By and large, Heller turned out to be right about
Friedman's concepts and wrong about his own, for in an increasingly
uncertain era, the emerging truth was that nothing seemed to work
very well, at least as far as strategies for sustaining the American
economy were concerned.[14]
Heller's skepticism aside, with the Keynesian prescriptions faltering
under the weight of so many out of control externalities, Milton
Friedman's views were finding a receptive audience at the Federal
Reserve Banks as the 1970s were ending. Malabre is not alone in his
assessment that "the economy's woes were largely due to
monetarist procedures implemented in 1979 at the Federal Reserve".[15]
Controlling the money supply proved to be far more difficult than
Friedman and his monetarist collaborators forecasted. The chain of
decisions that further destabilized the U.S. economy began with a
three-day conference chaired and sponsored by economist Sam I.
Nakagama of First National City Bank. Every speaker took up the
monetarist banner. At the powerful New York Fed, monetarism had
acquired a strong convert in Jim Meigs. By the time the Federal
Reserve's policy committee met on October 6, 1979, consensus had been
reached. The new chairman, Paul Volcker (apparently with some
reluctance), announced the Fed would abandon its efforts to control
interest rates and concentrate on the rate of growth of the money
supply. Malabre reports on what then occurred:
During the first six months under the new operating
procedure, the rate of growth in the money supply was cut roughly in
half, which pleased many of Volcker's sternest critics abroad, as
well as most monetarists at home. The international value of the
dollar, which had been falling uninterruptedly for about two years,
reversed direction. However, interest rates went through the
roof.[16]
In response, Carter advisers urged the President to put pressure on
Volcker to tighten lending criteria used by the Fed's member banks.
The economy went into a downturn and Jimmy Carter lost his bid for
re-election to Ronald Reagan.
The Fed continued to focus on money-supply growth until the middle of
1982. Faced with double-digit and still rising unemployment and an
inability to accurately determine the size of the money supply, a
shift back to interest rate management was made. Reagan, however, had
brought his own brand of experimental economic policy with him to the
Presidency. At the heart of Reaganomics were the so-called
supply-side policies championed by economics professor Arthur
Laffer, journalist Jude Wanniski and U.S. Congressman Jack Kemp. They
argued that an across-the-board reduction in Federal tax rates would
create economic growth, increasing the tax base and generating a net
increase in tax revenue. "This idea, as it turned out, was
nonsense of the worst sort,"[17] says Malabre, who goes on to
quote a 1978 conversation he had with Martin Feldstein, who told him,
"There's absolutely no indication that Laffer's ideas will work
in the way he suggests."[18] Indeed, one result was
steadily-growing deficit spending. By the end of 1986 total federal
debt climbed to $1.2 trillion.
THE U.S. CONGRESS made matters worse by passing legislation
permitting the creation of money market funds by non-banking entities
- without granting the commercial banks and savings institutions the
opportunity to compete. The inevitable result was the removal of
hundreds of billions of dollars of savings from these depositories.
The savings banks were devastated, as most of their assets consisted
of low-yielding, fixed-rate mortgage loans. Commercial banks weathered
this financial storm more effectively, since they historically had
only a small percentage of their funds tied up in this type of asset.
Despite the closing of thousands of depository institutions, the U.S.
economy inexplicably began to generate new jobs. Malabre suggests the
reasons have to do with the natural "evolution of the business
cycle" rather than any government actions:
Deep, long recessions, economic history shows, tend to
be followed by relatively long expansions. The reason is
straightforward: recessions serve to cleanse the economy of the
excesses - from severe inflation and shortages to excessive debt -
that invariably build up during the preceding expansion phases of
the cycle. As a rule, the worse the recession, the more thorough the
cleansing process and, therefore, the more sustainable the
subsequent economic revival.[19]
Rhetoric aside, Reagan's Presidency was blessed by unprecedented
growth - in Federal spending and the Federal debt as well as corporate
profits and land prices. In the face of increasing pressures on
citizens to provide revenue to their local and state governments,
people acted based on their rational expectations of what the
future held in store for them. Those who need credit to purchase homes
or other goods, observes Malabre, "balk less and less at paying
higher rates [of interest] because they feel repayments will be made
in much cheaper dollars".[20] They also began to think of housing
less as shelter than as an investment.
A number of questions come to mind. How, for example, does one rely
on any theory of the economy or business cycles in an era when such a
large portion of economic inputs are allocated to expenditures on the
military? And what about the escalating demands by Blacks in the U.S.
for greater equality of opportunity, a more appropriate slice of the
pie? Although Malabre details the ongoing inaccuracies of economic
forecasts and failure of economic theory to explain events, he does
not raise these fundamental questions. Nor does he ask whether the
neo-classical claim that "price clears all markets for goods and
services" really applies to locations and natural-resource laden
lands.
Another problem, highlighted by Malabre, is the statistical
measurement by which the well-being of an economy was ascertained - "inflation-adjusted
GNP". He comes close to but does not directly discuss the
narrowing distribution of wealth, either to the military or to
rent-seekers in control of land, the discarded primary factor of
production. "Absolute definitions of general living standards do
not exist," he writes, "but statistics … shows what is
left of the average weekly income of non-supervisory workers after
inflation and federal tax payments have been taken into account."[21]
During the 1960s inflation-adjusted GNP kept increasing; for a
significant percentage of households in the U.S. - starting from a
point of poverty or near-poverty - their position was stabilized only
by the expanding role of government transfer payments. And, with the
lowering of the highest level of marginal federal tax rates, paying
for guns and butter required a combination of increased reliance on
borrowing (and a continuous increase in the printing of Federal
Reserve notes above what was borrowed from the existing supply in
private hands).
Another behaviour exhibited by individuals practicing rational
expectations is to make purchases at the present because of the
probability they will cost more in the future. This is particularly
the case for households who do not expect increases in nominal income
to keep pace with inflation. The opportunity to save (i.e., invest)
existed for households in the top fifth of income recipients -
homeowners, business owners, professionals and beneficiaries of
inherited wealth. Millions of additional households were able to save
as well because they had become homeowners in the 1950s, financing the
purchase of their homes with long-term (30-year), fixed-rate mortgage
loans. Inflation allowed them to repay these loans with
dollar-denominated Federal Reserve notes experiencing a constantly
declining purchasing power. Low- and moderate-income renters, on the
other hand, were forced to absorb a rising claim by landlords on their
gross incomes. Correctly, Malabre remarks that "inflation …
reflected factors that had little direct connection with labor costs -
though for many economists, as well as editorialists and politicians,
labor costs continued to be a major culprit in the price spiral".[22]
He momentarily pauses to take note of where the major inflationary
component could be found, then moves on:
Even homeownership costs, up more than 20% in a decade,
reflected rising land prices more than rising construction costs.
The average land cost for a new home soared more than 70% between
1958 and 1968, and yet the average weekly earnings of workers who
were building new homes increased roughly 50%.[23]
MALABRE apparently had not made a real attempt to study economic
literature or he might have developed an understanding of "rent-seeking"
behaviour on the part of market participants. Economists themselves
were undergoing something of a self-examination. Robert Leckachman,
for one, was a vocal critic. His Economists At Bay (1976),
challenged the cherished claim to objectivity that economists strived
to convince themselves and others they acquired by their formal
education:
Ideology is invariably buried in techniques of analysis,
however neutral they appear to be. For its partisans, community
control of government functions is far more than a mere technique of
alternative administrative style. It is the shared value that
precedes and legitimizes each practical policy choice. The ideology
of local control emphasizes the folk wisdom of local residents and
the untrustworthiness of mandarins, mercenary experts, and those
crafty beasts, professional politicians. For their part, the experts
deploy their own ideology; fostering exaggerated confidence in
techniques which equip them to generalize beyond specific
neighborhoods, they draw strength from modes of data collection and
manipulation inscrutable to the laity, and, in the end, achieve
results that are often incomprehensible to their alleged
beneficiaries. The experts can't help themselves: with the best will
in the world, their mystery converts them into wire-pullers,
practitioners of court politics, manipulators of popular opinion,
and secret rulers.[24]
Lekachman paraphrased Ricardo on how most societies were organized
and how they got that way, but he did not see that the course of
history had continued into the modern era largely intact: "Capitalists,
wage earners, and landlords quarreled over the division of a social
product inadequate to their needs and expectation. The only winners
were the landowners. Land, a fixed resource, became increasingly
scarce and valuable as population increased. Accordingly, rent was
fated to rise as a share of national income, so long as it was left in
the possession of private landlords. Wages could not fall below
subsistence. Once they reached that level, the only way rents could
continue to rise was for profits to drop. …Landlords, a
completely useless set of monopolists, were rewarded more and more
lavishly by the pure accident of inheritance."[25] Concentrations
of wealth troubled Leckachman. He advocated in a later book the
elimination of all tax shelters, on the grounds they "reward
successful speculation in real estate, commodities, and common stocks".[26]
Finally, he advised his fellow economists to keep in mind that "[f]ull
employment without inflation requires a substantial shift of net
income from the affluent and prosperous to the remainder of the
community".[27] He should have stressed that the income to be
shifted is that which is societally-created and, therefore, unearned
by any individual - the rental value of locations and natural
resource-laden lands.
ANOTHER SET OF CRITICISMS of economic policies was raised by author
Bruce Rich in his book Mortgaging the Earth, one of the first
in-depth examinations of the World Bank and the impact of its
activities on the lives of people in the developing world. His
conclusion was that during the years under the direction of former
U.S. Secretary of Defense Robert McNamara, the World Bank funded one
mega-development project after another, declaring "the
fundamental case for development assistance is the moral one".[28]
The problem, of course, was that McNamara could not change the
socio-political arrangements and institutions of countries run by
monopolistic oligarchies, despots and military dictatorships. As Bruce
Rich concludes:
The Bank's approach to poverty also assumed that
powerful elites in developing nations, who were well ensconced in
siphoning off the benefits of development aid from government
ministries, could be induced to make institutional and structural
changes for the benefit of the poor and powerless.[29]
Understanding the global economy required a full understanding of the
individuals and interests controlling each factor of production, as
well as the ways those in power taxed and spent. Advocating policies
promising to create efficient markets meant challenging long-standing
institutional relationships and even entire system of law and
regulation. Forecasting future changes in market outcomes required the
kind of understanding that only an interdisciplinary approach to
scholarship and research could achieve. Such was the realm of the
political economist but not the individuals emerging from doctoral
programs in economics. Malabre records in some detail the failure of
economists of whatever theoretical perspective to accurately forecast
the future:
Credentials, I should add, seemed to matter little. Most
economists, then as now, were degree-laden, typically sporting a
doctorate as well as a master's degree in economics. But there was
little relationship between the accuracy of individual forecasts and
the academic backgrounds of particular forecasters. Few economists
could match the credentials of Milton Friedman, even before the
outspoken professor captured the Nobel Prize. Yet, his performance
as a forecaster was abysmal.[30]
Interestingly enough, by the end of the 1980s, some economists were
talking and writing as though theoretical economics offered little of
value to policymakers. They acknowledged that economic theory failed
to describe what occurred in the real world. They questioned
government statistics and identified enormous gaps in the quality and
depth of data available for analysis. Malabre quotes Lester Thurow on
the scale of the problem: "We've got a world economy now and it's
just not possible for forecasters to understand and take into account
all the resulting complexities and uncertainties".[31] In a 2001
interview, an elder statesman in the economic profession, Robert
Heilbroner, offered his own assessment of where economics had come to:
Today, there is no economic theory of capitalism, only a
highly refined theory of an imaginary world called the 'market.' But
the market is not the same as capitalism. It is only a part of
capitalism. There are no 'worldly philosophers' like Schumpeter or
Keynes who are thinking seriously about the long-term prospects of
the system as a whole.[32]
When Malabre interviewed David Hale, chief economist of Kemper
Financial Services, he heard a very similar message. "In the
1990s, there will be only two kinds of business economists - those who
follow the world economy and those who are unemployed".[33]
Ironically, there is an oversupply of people who have obtained the
requisite formal education in economics. The number of tenure-track
teaching positions in colleges and universities is declining. Thus,
economists must demonstrate their value in the real world, where the
tools they are relying on consistently lead them to reach incorrect
conclusions. Back in 1994, Malabre closed his book with what amounts
to a challenge to economists to do no harm:
As ineffective and misguided as the modern economists by
and large have been, useful lessons can still be drawn from the
economy's record in the difficult postwar decades, and the most
valuable of these is simply, I submit, that the business cycle
endures. It has survived fixed and then floating exchange rates,
fiscal fine-turning and then rigid monetary rules, and seen tax
slashing in the name of a balanced budget. It not doubt will
continue to endure, surviving prescriptions yet to be devised.[34]
AS THE REAGAN-BUSH era came to an end, the world situation was in the
process of dramatic change. The Soviet Union imploded, unable to keep
up the charade of acting as a global power while unable to produce
sufficient goods and basic services for its population. As the
Russians retreated from their extended territory, rival ethnic groups
emerged to engage in brutal territorial wars of their own. Meanwhile,
the Chinese leaders took the lessons of the Soviet demise to heart and
decided that one party political rule could live in harmony with
private property and investment by foreign corporations. How to deal
with these new global challenges and others became the problem for the
Clinton team. Mason Gaffney summarized the situation as it existed in
1994:
Neo-classical economics has dominated thinking and
policy now for half a century or so. The results are better than
those achieved in Eastern Europe, but NCEists cannot take credit for
our market economy, much as they boast of its. The North Atlantic
nations had a well-oiled market economy functioning long before NCE
drove out classical and Progressive economics. …
They have dismantled most of the reforms of the Progressive Era,
and discredited their rationale. They have successfully stifled the
movement to convert the general property tax into a pure land tax.
Going further, they have shifted taxes off property, especially
land, and onto payrolls and retail sales… They have achieved "uniformity"
in income taxation, and more, given preferential treatment to land
income and unearned increments. They have substantially deregulated
utility and railway rates, and seen that regulatory commissions are
drawn from the monopolies being regulated. They have privatized, or
are privatizing, much of the public domain (including fisheries, the
radio spectrum, water, and the right to clean air) without
compensation to the public. …They have turned the banks loose
to lend on speculative land values, and bailed them out when they
failed.[35]
Summing up, the recent harvest of NCE and its derived public
policies is a worsening condition of labor, lower returns to saving,
high and rising concentration of wealth and income, rising class
divisions and social problems, and a fall of national stature. It
should be enough to make us realize that NCE, forged as a stratagem
to discomfort Henry George and Georgists, is intellectually,
morally, and practically bankrupt.[36]
In a conference paper presented at a 1992 seminar at Princeton
University, Mary M. Schweitzer suggests the problem goes back to
Alfred Marshal. "[T]he concept of natural monopoly was not
particularly good news for rising big business"[37] or
neoclassical economics, writes Schweitzer. By natural monopoly,
however, she was not thinking of locations in cities and towns,
agricultural and resource-laden lands or any other portion of the
public domain that concerned Mason Gaffney. Another economist, Paul
Krugman, acknowledges that "[n]atural monopolies pose a
well-known dilemma for public policy. …[U]nconstrained
monopolists do use their power to exploit consumers. Conservatives
tend to dismiss concern about monopoly power as a liberal myth, but it
is simply the truth".[38] True to form, even Krugman fails to
recognize that the concentrated control over land - particularly
absent the societal collection of its full rental value - is a primary
cause of much of the misery in the world. He identifies "financial
wheeling and dealing"[39] as the basis for the escalating
distance between the incomes of rich and poor. His policy solution is
to impose increased taxes on the rich without regard for the source of
income or the form of assets held.
THE ONE REAL HOPE for economics now seems to be with economists who
have decided to pursue scientific investigation in the interest of
sustainable development and environmental preservation. Those who have
come to these similar concerns have Herman Daly, for one, to draw
energy from. Daly's 1973 book, Toward A Steady-State Economy,
wondered at how economists could have defended for so long the
policies of unthinking output growth:
"We take the real costs of increasing GNP as
measured by the defensive expenditures incurred to protect ourselves
from the unwanted side effects of production, and addM these
expenditures to GNP rather than subtract them. We count the real
costs as benefits - this is hyper-growthmania. Since the net benefit
of growth can never be negative with this Alice-in-Wonderland
accounting system, the rule becomes "grow forever" or at
least until it kills you - and then count your funeral expenses as
further growth. This is terminal hyper-growthmania. …As we
press against the carrying capacity of our physical environment,
these 'extra-effort' and 'defensive' expenditures (which are really
costs masquerading as benefits) will loom larger and larger. As more
and more of the finite physical world is converted into wealth, less
and less is left over as non-wealth - i.e., the non-wealth physical
world becomes scarce, and in becoming scarce it gets a price and
thereby becomes wealth. This creates the illusion of becoming better
off, when in actuality we are becoming worse off. We may already
have passed the point where the marginal cost of growth exceeds the
marginal benefit. This suspicion is increased by looking at who
absorb the costs and who receive the benefits. We all get some of
each, but not equal shares. …The benefits of growth go mainly
to the rich, the costs go mainly to the poor."[40]
One measurement of the cost of how we now share the earth is what is
spent responding to natural disasters such as floods, earthquakes,
tornadoes, windstorms and volcanoes. A growing proportion of the
earth's population lives in harms way - in areas of the globe highly
susceptible to the worst nature has to offer. "By destroying
forests, damming rivers, filling in wetlands, and destabilizing the
climate, we are unraveling the strands of a complex ecological safety
net",[41] concludes Janet Abramovitz of Worldwatch Institute.
What at least a few of us understand is that greater well-being for
all could have - should have - occurred while effectively protecting
our natural environment. All that was needed way to introduce systems
of law that prevented monopolistic privilege.
Even a cursory examination of conditions in many countries strongly
suggests a strong correlation between widespread poverty and
environmental degradation. Every year there are nearly 80 million more
people added to the world's population. Most of this growth - 95
percent - occurs in countries already stressed by severe poverty and
the spread of AIDS. Solving these problems will require a massive
investment in health care, family planning, education and greater
economic security for the billions of poor people whose lives are most
at risk under existing conditions. None of these things will happen in
a world organized to protect rent-seeking privilege. Far too much of
the wealth produced is siphoned off by the landed either as rental
charges to tenants or imputed rents enjoyed from deeded land left
minimally taxed by government.
Had more economists consistently pressed for policies based on a full
understanding of the role of land markets in societies, many of these
problems might have been avoided. Every parcel of land has an annual
rental value (from nearly zero for locations that cannot be profitably
exploited for natural resources, to enormous sums for sites at the
center of commerce in the world's great cities). This value is
affected by what uses are permitted by law and the costs of meeting
environmental and other regulations. A party bidding to gain access to
a location will tend to bid more when restrictions are few and
regulation is minimal. The rental value of a location, then, is
determined by what potential users calculate they can pay while still
earning an acceptable return on their investment - or would be so
determined under competitive market conditions. Unfortunately, owning
land has remained for centuries a central rent-seeking activity, and
land markets do not operate under the same competitive pressures as
the markets for goods and services.
RENT THEORY is less well-understood today than it was when David
Ricardo took up the pen to elaborate on the insights of Adam Smith
while responding to challenges raised by Jean-Baptiste Say. "A
landlord by his assiduity, economy, and skill to increase his annual
revenue", declared Say, "but a landlord has no means of
employing his assiduity, economy, and skill on his land unless he
farms it himself; and then it is in quality of capitalist and farmer
that he makes the improvement, and not in quality of landlord".[42]
Ricardo's political economy recognized only cash (or product) flows
from tenants to landlords. He held that a landowner who also
functioned as a producing farmer earned all that his labor created,
subject to reasonable taxation. He warned, however, that if taxation
was too high "and the price of produce did not rise, how could
those farmers obtain the usual profits of stock who paid very moderate
rents, having that quality of land which required a much larger
proportion of labour to obtain a given result than land of a more
fertile quality?".[43] He answers by first raising a different
question:
But from what fund would those pay the tax who produce
corn without paying any rent? It is quite clear that the tax must
fall on the consumer.[44]
Thus does Ricardo set the stage for a sustained defense of the status
quo against the taxation of rent for societal purposes. By exempting
the landed from any taxation of imputed rent, the argument goes,
tenant farmers (and anyone who must negotiate ground leases from those
who hold deeds to locations) are able to pass on the costs of paying
rents and taxes to consumers - or at least to those consumers with
incomes high enough to absorb increasing prices and without available
substitutes at lower prices.
FOR OVER A CENTURY, the fallacies of Ricardo's analysis have been
available for analysis in the works of Henry George. As Mason Gaffney
and Fred Harrison detailed in The Corruption of Economics, the
systematic deconstruction of George's political economy by
practitioners of economics determined to preserve the status quo
opened the door for a new generation of credentialed economic
professors to advance their own theories of how to outmaneuvre the
business cycle. Few seem to have given any thought at all to the
possibility that the business cycle is primarily an effect of unjust
systems of law and methods of raising revenue for public purposes
adopted by societies. The lesson to be learned is that politics does
indeed dictate economic outcomes. Social democracy in the West evolved
as a set of policy measures designed to mitigate extremes in wealth
ownership and income without materially attacking entrenched
privileges. Economists, by and large, have - often unwittingly -
served privilege as a terrible master. The story has been well told by
Gaffney and Harrison, Malabre and Lekachman. In this new century, let
us hope a growing number of economists will emerge from their long
entrapment in the practice of pseudo-science.
FOOTNOTES AND REFERENCES
1. Mason Gaffney and Fred
Harrison. The Corruption of Economics (London:
Shepheard-Walwyn), p.58.
2. Forecasting Business Trends, edited by Morgan T. Davis
(Great Barrington, MA: American Institute for Economic Research,
1987), p.14.
3. From the "Forward" to Beyond Shocks: What Causes
Business Cycles, conference proceedings edited by Jeffrey C.
Fuhrer and Scott Schuh (Boston: Federal Reserve Bank, June 1998).
4. Paul Samuelson, "Summing Up on Business Cycles," Ibid.,
pp.34-35.
5. Alfred L. Malabre, Jr., Lost Prophets, A n Insider's History
of the Modern Economists (Boston: Harvard Business School Press),
p.41.
6. Ibid., p.44.
7. Ibid., p.46.
8. Ibid., p.57.
9. Ibid., p.78.
10. Ibid., p.82.
11. Ibid., p.83.
12. Ibid., p.89.
13. Ibid., p.97.
14. Ibid., p.72.
15. Ibid., p.142.
16. Ibid., p.168.
17. Ibid., p.175.
18. Ibid., p.183.
19. Ibid., p.191.
20. Ibid., p.107.
21. Ibid., p.94.
22. Ibid., p.133.
23. Ibid., p.134.
24. Robert Leckachman. Economists At Bay (New York:
McGraw-Hill Book Company, 1976), pp.132-133.
25. Ibid., p.219.
26. Robert Leckachman. Greed Is Not Enough (New York:
Pantheon Books, 1982), p.75.
27. Robert Leckachman. Economists At Bay, p.287.
28. Quoted in: Bruce Rich. Mortgaging The Earth (Boston:
Beacon Press, 1994), p.82.
29. Bruce Rich. Mortgaging The Earth (Boston: Beacon Press,
1994), p.300.
30. Alfred L. Malabre, Jr. Fallen Profits, An Insider's History
of the Modern Economists, p.119.
31. Ibid., p.210.
32. From an interview of Robert Heilbroner in New Perspectives
Quarterly, Vol.6, No.3, Fall 1989 (on-line version).
33. Alfred L. Malabre, Jr., Fallen Profits, pp.220-221.
34. Ibid., p.232.
35. Mason Gaffney and Fred Harrison. The Corruption of Economics,
p.128.
36. Ibid., p.137.
37. Mary McKinney Schweitzer, "Economic Theory and Historical
Interpretation: Bridging a Century of Disdain Between Economists and
Historians," paper delivered at the Davis Center Seminar,
Department of History, Princeton University, February 1992 (on-line
version), p.2.
38. Paul Krugman, Peddling Prosperity (New York: W.W. Norton &
Company, 1994), p.179.
39. Paul Krugman, The Age of Diminished Expectations (Cambridge, MA:
The MIT Press edition, 1994. Originally published in 1990 by The
Washington Post Company), p.27.
40. Herman E. Daly, "The Steady-State Economy: Toward a
Political Economy of Biophysical Equilibrium and Moral Growth."
The Steady-State Economy, edited by Herman E. Daly (San
Francisco: W.H. Freeman and Company, 1973) pp.150-151.
41. Janet N. Abramovitz. "Toll of Natural Disasters Grows,"
in Vital Signs 2001 (New York: W.W. Norton & Company),
p.117.
42. David Ricardo.The Principles of Political Economy &
Taxation (New York: E.P. Dutton & Co. edition, 1933.
Originally published 1817), p.119.
43. Ibid., p.169.
44. Ibid.
|
